Text

1997 Annual Rept for PECO Energy Co
	ML20217A600
Person / Time
Site:	Peach Bottom, Limerick
Issue date:	12/31/1997
From:	; PECO ENERGY CO., (FORMERLY PHILADELPHIA ELECTRIC
To:	;
Shared Package
ML20217A587	List: ML20217A583; ML20217A600;
References
	NUDOCS 9803250138
	Download: ML20217A600 (50)
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s 9 i () r: t 4 4 + 4 W k$ 14 y-. o 4 .- f /.- e FINANCIAL HIGHLIGHTS I (Thousands of Dollars) 1997 1996 % Change Operating Revenues $ 4,617,901 $4.283,650 7.8% l Operating Expenses, excluding taxes $ 3,302,17 9 $2,735,603 20.7 % Taxes Charged to Operations $602,860 1639,647 (5.8%) Operating Income $ 1,005,631 $1,248,501 (19.5%) e f xtraordinary item ~[$1833 664) ~ (Net of taxes) Earnings Applicable to Common Stock ($ 1,513,910) $499,169 (403.3%) (After extraordinary item) f aEings Applicable to Common Stock $ 319,7 54 $499,169 (35.9%) (Before extraordinary item) Iarnings per Average Common Share (Dollars) (56.80) $2.24 (403.6%) (After extraordinary item) Cash Dividends Paid per Common Share (Dollars) $1.80 $1.755 2.6% Average Shares of Common Stock Outstanding (Thousands) 222,543 222,490 Construction Expenditures $ 490,200 $548,854 (10.7%) Common Shareholders' Equity $ 2,726,731 $4,645.981 (41.k Book Value Per Average Common Share (Dollars) $12.2 5 $20.88 (41.3%) This Annual Report contains forward-looking statements which should be read in conjunction with the cautionary statement on forward-looking statements located on page 20.

Company Profile incorporated in Pennsylvania in 1929, PECO Energy Company provides retail electric and natural gas service in southeastern Pennsylvania and, through pilot programs, natural gas service to areas in Maryland and New Jersey. The g Company also engages in the wholesale marketing of electricity on a national basis and participates in joint ventures which provide telecommunication ser-vices in the Philadelphia area. PECO Energy's traditional retail service territory covers 2,107 square miles. Electric service is furnished to an area of 1,972 square miles with a population of about 3.6 million, including 1.6 million in the City of Philadelphia. Approximately 94% of the retail electric service area and 64% of retail kilo-watthour sales are in the suburbs around Philadelphia, and 6% of the retail service area and 36% of such sales are in the City of Philadelphia. Natural gas service is supplied in a 1,475 square-mile area of southeastern Pennsylvania adjacent to Philadelphia with a population of 1.9 million. Through Horizon Energy, a wholly owned subsidiary of the Company, and PECO Energy / Energy 0ne, a franchised energy products brand, PECO Energy partici-pates in Pennsylvania's electric competition pilot program. i Strategic Architecture ~ The year 1997 brought with it a tremendous change in Pennsylvania's electric utility industry. For the first time, although initially through limited pilot pro-grams, Pennsylvania's retail electric customers have the opportunity to choose their generation suppliers. After a phase-in period beginning in 1999, all Pennsylvania electricity customers will have this opportunity. y Knov.ing that the industry would soon be in turmoil with marketers from every corner of the nation wanting a piece of the deregulated energy pie,the ( Company began to look for other means to secure revenues and increase 3 - shareholder value. To this end, the Company reviewod its strategy and developed a new strategic l;a architecture. Keeping in mind what it does best-operating generating facili-ties, constructing reliable power-delivery systems and marketing electric power-PECO Energy has ventured beyond the traditional bounds of the industry, yet has not strayed from its core competencies. This annual report describes this strategic architecture and some of the innova-tive measures the Company is taking to enhance shareholder value.

g Si.. ~ e f. ~ . g 4, q Fellow Shareholders: J 4 Nineteen-ninety-seven was a tumultuous year for PECO Energy. It in August, we announced a settlement agreement with a group of was a year that opened with the uncertainty of electric competition and intervenors. The settlement included, among other things, the recovery of restructuring in Pennsylvania, grew to one of great expectations of a fair $5.461 billion in stranded assets and costs; an agreement by the transition to competition, but ended with the great disappointment of an Company to write off $2 billion of additional stranded assets and costs; onerous restructuring rate order. the transfer of generating assets and operations to a separate entity; During the year, there was much promise of an early resolution of the and the voluntary reduction by the Company of the phase-in period to full issues related to Pennsylvania's Electricity Generation Customer Choice customer choice of generation supplier from three years to two. In addi-and Competition Act. Over the summer, we worked in cooperation with tion, the settlement would have provided all of our customers an average other parties, some of whom had previously opposed our positions, to ten percent rate reduction beginning September 1998. structure a settlement which we felt was fair to both our customers and In December 1997, however, the Commission, in a 3-2 vote, rejected our shareholders. But at the end of the year, the Pennsylvania Public the settlement agreement and adopted its own radical plan. The Utility Commission voted, by a bare majority, to adopt a much more oner. Commission reduced our stranded cost recovery to under $5 billion, ous plan. This action led to the dramatic financial write-off and dividend reduced the return allowed on stranded costs, provided no guaranteed reduction announced in January of this year. rate reductions for customers and ordered that the transition to competi-In facing these difficult decisions, I believe both management and tion be accelerated. the Board of Directors took the appropriate steps for the long-term Because of the adverse effect the Commission's decision would have interests of you, the investor. We have appealed the Commission's on the Company, we filed appeals in both the Commonwealth Court of actions in both Commonwealth and federal courts, but continue to move Pennsylvania and in U.S. District Court. Avoiding litigation was a primary quickly to position PECO Energy to be successful in the new competitive factor leading to the settlement agreement; however, the Commission's environment being created by a myriad of state and federal regulatory action left us with r.o altemative. actions and pending legislation. The Company took numerous actions last year to put us in a strong PECO Energy's 1997 hnancial results were dor..inated by the competitive position for the future. In September, we announced the for-Commission actions that transpired during the year. The Company report-mation of AmerGen Energy Company, LLC, a joint venture with British ed a net loss of $1.5 billion or $6.80 per share. This loss was primarily Energy of Edinburgh, Scotland. AmerGen's mission is to pursue opportu-due to an extraordinary charge before taxes of $3.1 bilkon, or $8.24 per nities to acquire and operate nuclear generating stations in the U S. share after taxes, to reflect the effects of the Commission's order in the AmerGen is backed with the recognized expertise of both PECO Energy" Company's restructuring proceeding, along with several one-time charges and British Energy in operating nuclear power plants. This strategy is totakng $214 million before taxes, or $0.56 per share after taxes. designed to position PECO Energy as one of the nation's major electric, Eamings per share for 1997, excluding the above items. were $2.00 generating companies. versus $2.24 in 1996. Our expertise in operating and maintaining nuclear plants is also being The decision to reduce the dividend was a difficult one, but I firmly recognized, as evidenced by our agreement with Northeast Utilities to believe it was the prudent thing to do. The one dollar per share dividend manage the retum to service of two units at the Millstone, Connecticut, level will give us the flexibihty we need to deal with the demands of nuclear power plant and our three-year contract with Illinois Power to competition while carrying out our non-regulated growth strategy. We manage the restart and operation of its Clinton nuclear power station. feel the new dividend level is sustainable. Last summer, we launched Energy 0ne with Utilicorp United of There is little doubt that the most cignificant event of last year was Kansas City, Missouri, with the aim of developing a national energy the Company's restructuring ptoceeding before the Commission We felt brand. PECO Energy is an equity partner with Utilicorp and the first strongly that the interests of both customers and shareholders would Energy 0ne franchisee. best be serv 9d by reaching a settlement instead of enduring protracted litigation.

3 In November, we signed an agreement with the Massachusetts Health This year also marks the retirement of three dedicated members of and Education facilities Authority to provide more than one billion kilo-your Board - Joseph J. McLaughlin, Richard G. Gilmore and James A. w'atthours annually to its 462-member organization and 130,000 Hagen. We thank them for their long years of service to our Company. employees. We believe that this type of agreernent could serve as a blue-Another change in the Board occurred last summer when Joe print in the new, competitive power marketplace. Paquette retired as chairman. For more than four decades he Throughout the year we took these and other actions to committed himself to the success of PECO Energy. implement our strategic architecture, which focuses His vision, guidance and leadership set our on our core competencies of infrastructure course, and we are pleased that he continues to serve as a valuable excellence, energy logistics and customized 16 _ .f solutions. This strategy is aimed at d member of your Board. adding shareholder value through ~ There were also several signif-future growth opportunities. scant senior management Building upon our core compe-changes last year. Michael J. tency of infrastructure excellence, Egan was named Senior Vice we will grow our generation President of Finance and business. Our ability to success-Chief FinancialOfficer, fully manage energy logistics, Kenneth G. Lawrence became Senior Vice demonstrated by the rapid Vk President of the local expansion of the Company's /g (M, Distribution Company, Gregory Power Team into 47 states, gives A. Cucchiwas named Senior us many value-added opportuni-Vice President of Ventures and ties. From these two core competencies we built the third - William H. Smith,Ill became Senior customized solutions - to enable us to Vice President of Business Services. provide our customers with the solutions These are,indeed, challenging ttIat best suit their energy needs. The three revs of the company's strategic times. While we are confronting changes in You'll read more about our strategic architecture, Architecture represent the paths that our industry unlike any We have seen before, we what it means today and in the f uture, in this annual report. [C tnergy ia ejnorderioconiplte are taking the actions that are difficult but necessary ,h p,, ,,,p,, The Company benefits from the guidance and coun-infruiructure tacenence,the world class to successfully compete in the future. I strongly sel of a qualified and involved Board of Directors. In

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believe that PECO Energy will emerge from this peri-and Energy Logistics, the informational June 1997, Daniel L Cooper, a retired vice admiral in end physico ipects of buying. setiing od of transition as a strong competitor - a national the U.S. Navy and retired vice president and general sad delivering energy products and **r-company with global opportunities. With your contin-manager of the Nuclear Services Division of li**[,,lj_*,,$,$f,,',",7,',j,,',,l ued support, I am confident we can overcome the Gilbert / Commonwealth, Inc., joined the Board. best. customired solutions - delivering challenges, seize the opportunities before us and to customers the specific services that Continue to add value to your investment. sneet customers' needs - grew from these core competencies. CofDrn A fANedl.sr. PECo Enegy CWman. Pmsnient and cNef Ewcutive othr Febuy 2. 28

4 ECO Energy has clearly demonstrated and maintenance services Pture excellence, which grew out of the its world-class capabilities in infrastruc-to the gas and electric dis-tribution systems for that processes developed over several years site. These opportunities at the Company's Peach Bottom and Limerick arose, in part, from the nuclear generating stations. Company's Vision Quest " Infrastructure excellence is really what program, which reduced PECO Nuclear is all about," said Dickinson costs while improving on-(/j ' y' ' ' g[%, f[2j[~ ' Smith, PECO Energy's Chief NucWar Officer. time delivery and reliability 4 ,s "We're world class managers of nuclear at its fossil and hydro-elec- } pr $i power plants, evidenced by our ability to put tric plants. systems in place that can operate nuclear The Company's new t plants safely and efficiently." Distributed Network AmerGen, a joint venture with British Energy, Management program will combines the core competencies of PECO take the work management Energy and British Energy. AmerGen is evaluat-philosophy developed at g g ing nuclear plants for acquisition and will bring PECO Nuclear and apply it its collective best practices and proven work to power delivery services processes to improve the safety and efficiency offered to smaller entities. of acquired plants. "Under this venture, we "AmerGen will combine the shared values take the infrastructure excel-and cultures of PECO Energy and British Energy lence skills from nuclear, and transplant them into the acquired plants as a combine them with those of complete package," said Smith. power delivery and provide Another example of infrastructure excellence them to network managers is the Company's joint venture with AT&T through a performance con-Wireless Services. The ability of PECO Energy's tract to operate and Power Delivery and Telecommurncations groups maintain their systems," to install Personal Communications System said Greg Cucchi, Senior (PCSI equipment atop the Company's existing Vice President of Ventures. towers and buildings was a major contribution to "This will become more and morr attractive as this venture. the industry deregulates and managers come "PECO Energy was the first utility AT&T under increased pressure to operate their sys-worked with in building a PCS network and we tems efficiently." were very impressed by its skills and project Most recently, on January 5,1998, Illinois management," said Daniel R. Hesse, CEO and Power Company of Decatur, Illinois, chose President of AT&T Wireless. PECO Nuclear to manage its Clinton nuclear Another venture, based on the Company's plant, shut down by the Nuclear Regulatory extensive fiber optic network, became the back-Commission in September 1997. Under the bone of a now telecommunications systern three-year contract, which may be renewed for providing services to medium and large busi-an additional five years, a core group of PECO nesses. PECO Hyperion Telecommunications, a Nuclear employees will provide management joint venture between PECO Energy and expertise to Illinois Power. Hyperion Telecommunications of Pennsylvania, a in the future, as PECO Energy further devel-subsidiary of Adelphia Cable Company, will pro-ops and enhances its expertise in infrastructure vide a lower-cost local link to a subscriber's long excellence, the Company will expand geographi-distance carrier. cally and bring its capabilities to an increasing Exelon Corporation, a subsidiary of PECO number of customers. Energy, operates the cogeneration facility on the site of the former USX Fairless Plant in Bucks County, Pennsylvania, and provides operating

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{. ..-i YS ' W .g ;% p .e< u rali Beginning in late 1995, the three PECO Nuciear was chosen due According to McElwein, "One of "What PECO Nuclear is selling is units at Millstone Nuclear Station in to its experience in returning its the major concerns with the operational excellence," said PECO Connecticut, operated by Northeast Peach Bottom station to service Millstone restart activities was the Nuclear's Dickinson Smith. "We feel Utilities (NU), were shut down due to after an NRC-ordered shutdown. lack of acceptance of responsibility capalA of entering almost any numerous problems associated with Peach Bottom is now recognized for the work to be done. it was our situation and delivering a safe, cost-the units. as an industry leader in safe, job to reverse this attitude." effective and workable solution." NU executives realized that,in reliable operations. Recogniting PECO Nuclear's PECO Energy's role at Millstone order to return the units to A group of PECO Nuclear employ-strength in infrastructure excellence, has recently been expanded. it is commercial operation, NU must ces, led by John McElwain PECO NU approached the Company about now assisting with the restart demonstrate to the NRC that NU ls Energy's Vice President of Nuclear not only returning Millstone to operations at Unit No. 3. able to effectively operate the facihty. Projects, was assigned to Millstone commercial operation, but also NU contracted with PECO Nuclear to to implement PECO Nuclear's work how NU could adopt PECO Nuclear's provide core management support for management processes. philosophies. the restart of Millstone Unit No.1,

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.cp.h ?Vi '/?*. Nancy Bessey knows how energy really builds on the foundation of market,the stronger the cash flow Power Team's goalis to be at the j, logistics, a core competency of PECO PECO Energy. which is 'we deliver a for the Company." top of the list of power marketers in '. ':h Energy, has helped make Power Team, highly reliable product! We built on in order to succeed in this the country. Currently, it is considered f.:,7. which she leads, so successful. this foundation of responsibility, business,it is necessary to have all the largest national real-time ~.. f Power Team's strong position is reliability and service orientation that the systems in place to complete deliverer of electricity. l':.'j enhanced by PECO Energy's started with PICO Energy." thousands of transactions each day Another major strength of Power y generating capacity, located in the Power Team is viewed as a unique smoothly and quickly. Team is its employees. "The one 9 middle of the Northeast Corridor. By entity in the national power-marketing "We have the advantage of having thing we can really be proud of is .Q using this generating capacity and its business, building a large supply been building our system for quite that we don't have the trader i access to transmission. Power Team business while maintaining integrity some time," Bessey said. "Before any-turnover that a lot of our competitors .;.f[' is exceptionally reliable and is not of product delivery, body even thought about an open have," Bessey noted. "That's because just a go-between in transactions. "This is a supply and demand market for electricity, we were al-our people know we are here for the f(.,yy "We have developed a culture that business," Dessey said. "So,the ready allocating resources to systems long haul; they see success here and clearly distinguishes us from the other more supply we can obtain and development.We were marketers they realize that this success is going players.* she says. "That culture before marketing was coot." to continue." '.1... i \\ ...s.';.,

7 SWE xpertise in energy logistics enables the and other utilities. Also targeted are national Company to efficiently manage the accounts like fast-food chains and national Q complex informational and physical retailers; regional accounts, such as supermar-b?T2 aspects of buying, selling and delivering ket chains; and state and federal governments. energy products and services so that these ser-in addition, the Company expects to gain vices can be used by customers anytime, access to retail customers outside of its tradi-anywhere. tional service territory through agreements with With ample reliable generation and a location power resellers. in the center of the Northeast Corridor, PECO A key element of energy logistics is energy Energy began with a strong position in energy supply, which concentrates on the marketing of logistics and was able to easily begin moving electricity, gas and other fuels for customers. supply to other areas. Power Team recently entered into an agree- "We started with a competitive supply," said ment with Tenaska, Inc., of Omaha, Nebraska, to Nancy Bessey, the Company's Vice President of market the output of an 800-megawatt, natural Power Transactions and President of Power gas-fired merchant power plant to be developed, Team. "From there we simply started expanding. financed, constructed, owned and operated by Our competitors were in a more difficult position. Tenaska. Uoon completion, scheduled for the If they didn't have direct access to competitive year 2000, the plant will be the largest merchant power, they had to go out and buy it." power plant in the U.S. Since beginning operations in 1994, the "The strategy is to build upon the portfolio of N growth of the Company's wholesale power-mar-assets we have," said Bessey. "Everybody else keting business has made the Company's Power in this business seems to be talking about con-k Team one of the top power marketers in the U.S. solidation or merger. Based upon our firsthand For now, Power Team sells electricity to knowledge of the market, we will acquire access wholesale purchasers - primarily utilities - and to energy to serve the demand where it exists." helps to serve the load in PECO Energy's tradi-tional service temtory. As the Company expands its sources of electric generation through acquisi-tions, partnerships and marketing agreements, its power-marketing business will explore the option of adding natural gas to its marketing portfolio. As deregulation of electric generation acceler-ates, PECO Energy is poised to pursue retail sales directly to larpje power users, such as large industrial customers and national cornmercial accounts. This type of business-to-business energy service will be the gateway to new customers. This is a key mission of the Ventures Group, the Company's business unit formed to seek out energy-related opportunities in emerging markets. The focus will be on large commercial and industrial customers and large load aggregators such as electric co-operatives, municipalities

a ECO Energy is building on its core com-The Company converted Yeatman's 80-horse-Pand energy logistics to provide cu petencies of infrastructure excellence power portable steam boiler into a dual-fuel boiler that can use either oil or gas. The boiler tomers with specific targeted services generates steam needed to kill bacteria and that meet their needs. mold and to facilitate compost pasteurization.

In June 1997, the Company announced it Yeatman also converted three oil-fired, hot-water would offer a variety of services, previously avail-boilers used for temperature control.

able only on an individual basis, to industrial and "PECO Energy came up with the idea for commercial customers under its customized applying this technology to our boilers and made energy solutions program. The aim of the pro-sure the project went smoothly," Hahn said. gram is to provide larger customers with a single PECO Energy is focused on helping its cus-point of contact for energy products and ser-tomers be competitive in their marketplaces by vices. The diverse offerings range from building strong relationships. With customized traditional utility services to those not associated energy solutions, PECO Energy can focus on with the generation of electricity. what it does best and customers can focus on Traditional utility areas such as plant opera-what they do best. tions and gas delivery have led to the design and For instance, based on the Coinpany's coal development of on-site programs for customers' buying and handling capabilities, Exelon generation needs, management of their fuel sup-Corporation obtained a contract with the City of plies and general oversight of their power-related Vineland, New Jersey, to supply its coal. Exelon operations and maintenance. provides Vineland with a fully integrated fuel Based on its broad experience in providing management system, including the purchase of energy, the Company also provides customers 20,000 tons of coal annually, as well as storage, with information on economic development and handling and transportation. Vineland uses the relocation services, as well as information as coal to provide electricity to homes and busi-diverse as specialized financing, information sys-nesses in the city, tems and management services. For example, the owners of C.P. Yeatman & Sons, a 240-acro mushroom farm, wanted to spend less of their time on fuel handling in the pasteurization and growing processes and more time on its basic business - raising mushrooms. They came to PECO Energy looking for a solution. "PECO Energy understands our business," said Tim Hahn, Yeatman's controller, corporate secretary and treasurer. I l

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,,,1 in November 1997, PECO Energy The Company will provide more of Pennsylvania," said Greg Cucct.i, programs with that extra $100,000 N signed on agreement with the than one billion kilowatthours PECO Energy's Senior Vice President minimum and $200,000 on the upside." f7 Massachusetts Health and Education annually to HEFA's 462-member of Ventures. The WallStreetJournalalso noted j Facilities Authority (HEFA)which organization and its 130,000 Anticipating expected savings of that many critics of deregulation jj could serve as a blueprint in the employees. between 10 and 20 percent. HEFAs claim that " individuals would be the EN emerging market for competitive HEFA's power-buying consortium is members expressed satisfaction with last in line to benefit from 'j! power. the largest in New England and one the PECC Energy contract. competition because they'd be too Decouse of tlio Company's of thelargestinthe countrv PECO Warren Young, director of small for power marketers to bother en ll; proven abilities to manage plants Energy won the contract m a engineering services for the Boston with. But the authority s agreement i4 and efficiently move power, it was competition with 27 other companies Museum of Fine Arts, told The Wall with PECO (which includes 130,000 . lC ? possible to develop a customized who responded to HEFNs request for StreetJournal,"We spend a Intle employees of member organizations) 4 energy soluton which met proposal. over one million dollars a year on enables the small customers to HEFKs needs. "Our contract with HEFA heralds electricity, it's a significant part of ocr benefit by being part of the large our entry into retail markets outside operating budget. You can do a lot of buying group." m.,4-(.'e ,~y.,

r 11 hile PECO Energy's strategic architecture will W critically important fo help the Company grow into a national compa-ny with global opportunities, it remains success that it operate a safe, efficient and cost-effective Local Distribution Company (LDC) in Southeastem Pennsylvania. PECO Energy is committed to "We can give utilities the ability Kenneth G. Lawrence, PECO Energy's Senior Vice provi2ng high-quality, value-added to be immediately competitive," said President of the LDC, said the mission of the LDC is to pro-services to customers in its Andy Guarriello, CEO of Energy 0ne. vide highquality ene gy services to customers. Doing th.is will traditional service territory. To it is anticipated that Energy 0ne enhance its abihty to provide such will serve more than 30 million help to enhance shareholder value as the LDC assumes services, the Company entered into customers nationwide over the next responsibility for more than $3 billion in revenue for PECO a partnership with UtiliCorp United three to five years, while providing of Kansas City, Missouri, and formed three major benefits for PECO Energy. Energy 0ne. The goal of Energy 0ne Energy. "When most people in the Greater Philadelphia area think I'd? create the industry's first First,it will provide a branding of PECO Energy what they will be thinking of is the LDC," Eationwide, branded energy strategy to compete with national marketing company that will enable brand entities in PECO Energy's Lawrence said. "Our highest priority is to focus on the cus-its franchisees to provide customers traditional service territory. Second, tomer. We want to make sure our high levels of service and with one-stop shopping for a variety it will establish a national reliability are continued as we enter a customer choice envi-of products and serv,ces. Local distribution channel for products i clectric utilities, the Energy 0ne that PECO Energy develops. And ronment, and that customers are pleased with the quality of franchised distributors, will provide third, it will provide an opportunity service they receive from PECO Energy. Additionally, the LDC to customers a single invoice and to earn revenues from other utilities wiI work to assure that customers will be able to move more point-of. payment for a full range of who som Energy 0ne as franchisees. services. smoothly into the new competitive marketplace.,, b order to build a strong national The Company formed the LDC in 1997 as a separate busi-

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ness unit and will continue to shape it through 1998. ,,d es nationally known and respected. "The year 1998 will really be one of integration, reinvention Energy 0ne contracted with and repositioning of the LDC. Beginning in 1998 and continu-co n ufica io s services; ADT ing into the year 2000, PECO Energy and the LDC will focus f:t home and business security and on the continued transition of the business to competition," environmental monitoring services; Lawrence seid. Beyond that, the LDC plans to assist customers with new man go gy ne's in g a ed call center services; and ltron for and improved applications for electric and gas use, while advanced metering and keeping its sights on enhancing shareholder value. The LDC's commu~.ications technology. key roles in the transition to customer choice have already Adding tz its strong stable of suppli:rs, Energy 0ne recently been defined by the Pennsylvania Pubke Utility Commission. It ent: red into a atrategic alliance is charged with the responsibility of providing reliable service with Seville Systems, a leading provider of convergent billing to customers, and is designated as the defau!t supplier for solutions for the telecommuni-those custorners who do not select an alternative electricity s d ry

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priced electric supplies for those customers who do not elect mark 2 PECO Energy / Energy 0ne, to change. 'h',[8 "',,',chEnorg "Just because we have been designated as the deliverer of ne p, traditional service territory, will electric and gas energy to customers, we cannot rest on our be the first Energy 0ne franchisee laurels," said Lawrence. "We must continue to maintain our existing infrastructure and improve our level of service in order Pennsy va as e oc r c co petition pil.: program. to continue to provide rehable energy services to our cus- "With Energy 0ne, we're able to tomers. I believe we are up to that challenge." get out b front of the marketplace," said PECO Energy Chairman Corbin McNeill. "And, we can do this without the risks and costs of going it alone, while being among the leaders in a new business category -integrated utility services."

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Management's Discussion and Analysis of Finandal Condition and Results of Operations 13 Management's Discursion and Analysis of Financial Condition and Results of Operations General Discussion of Operating Results la December 1996, Pennsylvania Governor Ridge signed into Earnings 1:w the Electricity Generation Customer Choice and The Company recorded a loss per common share of $6.80 in Competition Act (Competition Act) which provides for the 1997 as compared with earnings per share of $2.24 and restructuring of the electric utility industry in Pennsylvania, $2.64 in 1996 and 1995, respectively. The loss in 1997 was including retail competition for generation beginning in 1999-primarily due to an extraordinary charge of $8.24 per share . Pursuant to the Competition Act, in April 1997, the reflecting the effects of the PUC Restructuring Order and Company filed with the Pennsylvania Public Utility deregulation of the Company's electric generation operations. Commission (PUC) a comprehensive restructuring plan detail-1997 earnings were also reduced by several one-time ing its proposal to imolement full customer choice of electric charges totaling $0.56 per share for changes in employee generation supplier. The Company's restructuring plan identi-benefits, write-offs of information systerns development fied $7,5 billion of stranded costs (the loss in value of the charges reflecting clarification of accou% guidelines and Company's electric generation-related assets which will result additional reserves, including for environmental site remedia-from competition). In August 1997, the Company and various tion; by $0.30 per share for higher depreciation expense intervonors ia the Company's restructuring proceeding filed resulting from a full year's increase in depreciation and amor-with the PUC a Joint Petition for Partial Settlement tization of assets associated with Limerick Generating Station (Pennsylvania Plan). (Limerick) and other assets; by $0.12 per share for income in December 1997, the PUC rejected the Pennsylvania tax adjustments; by $0.09 per share for losses from new Plan and entered an Opinion and Order, revised in January non-utility ventures; and by $0.05 per share for increased 1998 (PUC Restructuring Order), that deregulates the depreciation expense due to normal plant additions. These Company's electric generation operations. The PUC decreases were partially offset by a one-time $0.18 per share Restructuring Order authorites the Company to recover recognition of income resulting from the settlement of litiga-stranded costs of $4.9 bi!Iion on a discounted basis, or $5.3 tion arising from the current outage of Salem Generating billion on a book value basis, over 8% years beginning in Station (Salem); by $0.08 per share for operational efficien-1999. In January 1998, the Compaay filed appeals of the PUC cies; and by higher revenues net of fuel of $0.06 per share Restructuring Order with the U.S. District Court for the primarily due to increased sales to other utilities. Eastern District of Pennsylvania (Eastern District Court) and The $0.40 per share decrease in 1996 eamings was pri-the Commonwealth Court of Pennsylvania (Commonweatth marily due to higher Salem outage-related replacement Court). power and maintenance costs which reduced earnings by The Company believes that the PUC Restructuring $0.27 per share. Eamings also decreased by $0.18 per share Order provides sufficient details regarding the deregulation of in 1996 due to lower electric revenues resulting from milder the Company's electric generation operations to require the weather conditions compared to 1995, by $0.12 per share Company to discontinue the use of regulatory accounting in due to the gain recognized in 1995 on the sale of Conowingo its financial statements for those operations. The Company Power Company (COPCO); by $0.11 per share due to higher determined that at December 31,1997, $5.8 billion of its customei *xpenses; and by $0.10 per share due to the $7.1 billion of electric generation assets were impaired and it increased depreciation of assets associated with Limerick. had $2.6 billion of other electric generation-related regulatory These decreases were partially offset by $0.18 per share due assets. Effective December 31,1997, the Company recorded to the Company's continuing cost control initiatives; by $0.09 an extraordinary charge against income of $3.1 billion ($1.8 per share due to savings resulting from the Company's ongo-billion net of income taxes) to reflect the amount of such ing debt and preferred stock refunding and refinancing electric generatbn-related assets which will not be recovered program; and by $0.08 per share due to higher revenues from customers either prior to the commencement of com-resulting from increased sales to other utilities. petition or under the PUC Restructuring Order. For additional information regarding the extraordinary charge, see note 4 of Notes to Consolidated Financial Statements. On January 26,1998, the Company's Board of Directors reduced the quarterly common stock dividend from $0.45 per share te $0.25 per share, effective with the dividend payable on March 31,1998. The Board of Directors concluded that, given the impact of the PUC Restructuring Order, the divi-dend reduction was necessary to provide the Company with the financial flexibility needed to meet the demands of com-petition. Although the Company cannot predict the ultimate Effect of the PUC Restructuring Order and competition for Clectric generation services, the Company believes that its future financial condition and results of operations will be adversely affected. See " Outlook-PUC Restructuring Order." c

.14 - PECO Energy Company and Subsidiary Companies Slgnificant Operating Items Revenue and Expense iterns as a Percentage of Total Operating Revenues Percentage Donar Changes ~ 1995 1996 1997 1997-1996 1996 1995 90 % 90 % 90 % Electric 8% 2% 10 % 10% 10 % Gas 5% 4% 100 % 100 % 100 % Total Operating Revenues 8% 2% 18 % 23 % 28 % Fuel and Energy Interchange 33 % 27 % 30 % 30 % 31 % Operation and Maintenance 12 % 2% 11 % 11 % 12 % Depreciction 19 % 7% 8% 7% 7% Taxes Other Than income 4% (5%) 67 % 71 % 78 % Total Operating Expenses 19% 9% 33% ' 29% 22 % Operating income (19%) (11%) (11 %) (10%) (9%) Interest Expense (2%) (8%) (9%) (9%) (8%) Total Other income and Deductions 4% (9%) 24 % 20 % 14 % income Before Taxes and Extraordinary item (27%) (18%) 10 % 8% 6% ' income Taxes (14%) (21 %) 14 % 12 % 8% income Before Extraordinary item (35%) (15%) Operating Revenues ~~~ ~ m1; tees teseriens Total operating revenues increased in 1997 by $334 million to 1~ 7d~ Einwk E M ' ~0mww $4,618 million. This represented a $312 million increase in seia n.=un sein n el ctric revenues and a $22 million increase in gas revenues [n F d r iessinssdi# 9 67#i-over 1996. The increase in electric revenues was pnmarily due to increased sales to other utilities. The increase in gas Residential (48) $ (1) (86) $ (14) revenues was primarily due to higher revenues from sales to House Heating (217) (12) 121 5 Srn rnetc al commercial, house heatirg and residential customers result-194 30 291 19 ing from higher purchased gas-clause revenues charged in 1997 compared to 1996, partially offset by lower sales vol- $*ndn ri]l (176 (21! (555) (37) ume resulting from milder weather conditions in 1997. This Other 'dl) 8 42 3 increase was partially offset by reduced sales to interruptible Unbilled 397 45 (862) (69) customers switching to transportation service. Service Territorv 91 49 (1,049) (93) l Total operating revenues increased in 1996 by $98 mil-Interchange Saler 992 33 439 9 lion to $4,284 million. This represented an $80 million Sale = +a o?.or Utilities 8.650 230 6.202 164 increase in electric revenues and an $18 million increase in Total 9,733 S 312 5,592 8 80 gas revenues over 1995. The increase in electric revenues was primarily due to increased sales to other utilities, partially offset by decreased retail sales due to milder weather condi-tions. The increase in gas revenues was primarily due to increased sales to retail customers from colder weather con-Fuel and Energy Interchange Expense ditions in the first half of 1996 and higher levels of firm sales p rssulting from customers svetching from transportation ser-Fuel and energy interchange expense increased in 1997 by vice to firm service. These increases were partially offset by $318 million to $1,290 million. The increase was primarily due decreased sales and transportation revenues resulting from to purchases needed for increased sales to other utilities and unusually mild weather in December 1996, a one-time billing credit in 1996 from a non-utility generator. Increases /(decreases) in electric sales and operating rev-Fuel and energy interchange expense as a percentage of . enues by class of customer for 1997 compared to 1996 and operating revenues increased from 23% to 28% principally 1996 compared to 1995 are set forth as follows: due to purchases needed for increased sales to other utilities. Fuel and energy interchange expense increased in 1996 by $210 million to $973 million. The increase was primarily due to purchases needed for increased sales to other utilities, incrvased replacement power costs resulting from the shut-down of Salem and a net credit to expense in 1995 from certain energy sales to other utilities. Fuel and energy interchange expense as a percentage of operating revenues increased from 18% to 23% principally due to increased replacement power costs resulting from the shutdown of Salem.

Managment's Discussion and Analysis of financial Condition and RIsults of Operations 15 Operating and Maintenance Expense Other Income and Deductions Operating and maintenance expense increased in 1997 by Other income and deductions excluding interest charges $157 million to $1,431 million primarily due to several one-increased in 1997 by $6 million to $4 million. The increase time charges totaling $187 million, including charges for was primarily due to the settlement of litigation arising from changes in employee benefits, write-offs of information sys-the shutdown of Salem. The increase was partially offset by tems development charges reflecting clarification of losses from the Company's new non-utility ventures. Also accounting guidelines and additional reserves, including for offsetting the increase was the write-off of one of the environmental site remediation. These increases were partial-Company's telecommunications investments as a result of ly offset by lower operating costs at Company-operated the circumstances involved in the Federal Communication Commission's auctioning cf he personal communications nuclear generating stations and lower administrative and gen-t eral expenses resulting from Company's ongoing cost-control systems "C-block" license c

efforts, Other income and deovtions excluding interest charges Operating and maintenance expense increased in 1996 decreased in 1996 by $60 raillion to a net deduction of $2 by $23 million to $1,274 million due to higher customer.

million. The decrease was pr Tiarily due to the gain recog-expenses, higher contractor costs and higher nuclear generat-nized in 1995 on the sale of COPCO. ing station charges resulting from the shutdown of Salem. These increases were partially offset by lower operating Income Taxes costs at Company-operated nuclear generating stations end income taxes on operating and non-operating income lower administrative and general expenses resulting from the decreased in 1997 by $47 million to $293 million. The Company's ongoing cost-control efforts. decrease was primarily due to lower operating income. The decrease was partially offset by reduced tax depreciation Depreciation Expense benefits from plant and regulatory assets which are not fully Effective October 1,1996, the Company increased deprecia-normalized for ratemaking purposes. tion and amortization on assets associated with Limerick by income taxes decreased in 1996 by $92 million to $340 $100 million per year and decreased depreciation and amorti-million. The decrease was primarily due to lower operating zation on other Company assets by $10 million per year. income and the gain recognized in 1995 on the sale of Depreciation expense increased in 1997 by $92 million to COPCO. $581 million. The increase was primanly due to increased depreciation of assets associated with Limerick. Depreciation Preferred Stock Dividends expense also increased due to additions to plant in service. Preferred stock dividends decreased in 1997 by $1 million to Deprec,ation expense increased in 1996 by $32 million t $17 million. The decrease was primarily due to the replace-i $489 million. The increase was primarily due to increased ment of $62 million of preferred stock with MIPS in the third depreciation of assets associated with Limerick. Depreciation quarter of 1997. expense also increased due to additions to plant in service. Preferred stock dividends cecreased in 1996 by $5 mil-tion to $18 million. The decrease was primarily due to the Interest Che jes replacement of $78 million of preferred stock with MIPS in Interest charges decreased in 1997 by $7 million to $402 the fourth quarter of 1995. million. The decrease was primarily due to the Company's ongoing program to reduce and/or refinance higher-cost, long-term debt. This decrease was partially offset by the DiscLission of Liquidity and Capital Resources replacement of $62 million of preferred stock with Monthly income Preferred Secunties (MIPS) in the third quarter of The Company's capital resources are primarily provided by intemally generated cash flows from utility operations and, to 1997. MIPS are recorded in the firiancial statements as the extent necessary, external financing. Such capital Company Obligated Mandatorily Redeemable Preferred resources are generally used to fund the Company's capital Securities of a Partnership. requirements, including investments in new and existing ven-Interest charges decreased in 1996 by $36 million to tures, to repay maturing debt and to make preferred and $409 million. The decrease was primarily due to the common stock dividend payments. Company's ongoing program to reduce and/or refinance high. in 1997,1996 and 1995, intemally generated cash er-cost, long-term debt. This decrease was partially offset by the replacement of $78 million of preferred stock with MIPS exceeded the Company's capital requirements and dividend payments. The Company anticipates that it will be able to in the fourth quarter of 1995. meet its capital requirements with intemally generated cash from utility operations in 1998. Beginning in 1999, the Company expects that intemally generated cash will be reduced due to price pressures resulting from competition for electric generation services and the effects of the PUC Restructuring Order. In anticipation of this expected reduction of internally generated cash, in January 1998, the Board of Directors voted to reduce the Company's common stock divi-dend, effective with the first quarter 1998 dividend. Based upon the 222.5 million shares of common stock currently out-

16 PECO Energy Cornpany and Subsidiary Cornpanies standing, the common stock dividend reduction will reduce and $82 million, respectively.1995 cash flows benefited from the Cor,pany's cash requirements by $178 million per year. the sale of COPCO. Absent increases in the market price of electric generation Cash flows used in financing activities were $461 million services, the Company expects that intemally generated cash in 1997 as compared to $501 million in 1996 and $802 million will be further reduced in 2007, when the Company com-in 1995. The decreases in 1997 and 1996 were primarily due pletes the recovery of ris allowed stranded costs from to less available cash permitting fewer retirements of higher-customers. The magnitude of the reduction of intemally gen-cost debt. erated cash will be affected by a number of factors, including The Company meets its short-term liquidity requirements how quickly electric generation competition develop 3, the primarily through the issuance of commercial paper and bor-Company's ability to compete, the impact of additional cost-rowings under an unsecured credit facility with a group of cutting initiatives, future market pricos of electric generation banks. The Company had $402 million of short-term debt, and the outcome of the Compary's appeals of the PUC including $314 million of commercial paper, outstanding at Restructuring Order. December 31,1997. The Competition Act authorizes the securitization of the At December 31,1997, the Company's embedded cost recovery of allowed stranded costs. Under the Competition of debt was 6.9% with 12.0% of the Company's long-term Act, securitization proceeds must be used principally to debt having floating rates. As a result of the extraordinary reduce qualified stranded costs and related capitalization. charge in December 1997, the Company does not expect to Unless extended by the PUC, the Company has authorization meet the eamings test under the Company's mortgage a until May 22,1998 to securitize $1.1 billion of stranded costs. required fcr the issuance of additional bonds against property it is unlikely that the Company will securitize the recovery of additions for the twelve months ended December 31,1998. its stranded costs until the appeals of the PUC Restructuring As of December 31,1997, the Company was entitled to issue Order are resolved. If the Company does securitize, it cannot approximately $3.6 billion of mortgage bonds without regard predict the level of stranded cost recovery that it would be to the earnings test against previously retired mortgage permitted to secuntize or the impact of such securitization on bonds. As a result of the extraordinary charge, the Company the Company's capitalization. also does not expect to meet the coverage test under At December 31,1997, the Company's capital structure Company's Articles of Incorporation required for the issuance consisted of 36 8% common equity; 7.9% preferred stock of additional preferred stock for the twelve months ended and Company obligated mandatorily redeemable preferred December 31,1998. secunties (which comprised 4.8% of the Company's total The Company cannot predict whether ;he Competition capitalization structure); and 55.3% long-term debt. Act or the PUC Restructuring Order will ultimately affect the The Company expects its level of net capital investment Company's credit ratings. to decrease in future years. Total capital expenditures, primari-ly for utility plant, were $573 million in 1997 and are estimated to be $600 million in 1998. Due to the expected adverse Outl00k impact of the PUC Restructuring Order and competition for The Company is entering a period of financial uncertainty electric generating services on its future capital resources, the with the deregulation of its electric generation operations in Company is currently evaluating its capital commitments for which revenues from regulated rates will be replaced by rev-1999 and beyond. Certain facilities under construction and to enues from the competitive sale of electric generation at be constructed may require permits and licenses which the market prices. The Company believes that the deregulation of Company has no assurance will be granted. its electric generation operations and other regulatory initia-The Company's operations have in the past end may in the futute require substantial capital expenditures in order to tives designed to encourage competition will increase the Company's risk profile by changing and increasing the num-comply with environmental laws. ber of factors upon which the Company's financial results are The Company has undertaken a number of new ven, tures, principally through its Telecommunications Group, dependent. This may result in more volatility in the some of which require significant cash commitments. For Company's future results of operations. The Company 1998, the Company's expected capital expenditures include believes that it has significant advantages that will assist it in approximately $150 million in such ventures. the increasingly competitive efectric generation environment. Cash flows from operations were $1,038 million in 1997 These advantages include the ability to produce electricity at ts compared to $1,172 million in 1996 and $1,240 million in a low marginal-cost, a high reserve margin and the demon-1995. Cash flows consist of earnings, non-cash charges of strated ability to efficiently operate its electric generation facilities. depreciation and deferred income taxes. ' Cash flows used in investing activities were $573 million The Company's future financial condition and results of in 1997 as compared to $663 million in 1996 and $465 million perations are substantially dependent upon the effects of the in 1995. Expenditures under the Company's construction pro-Competition Act and the PUC Restructuring Order. Additional gram decreased in 1997. The Company has also made factors that affect the Company's financial condition and significant investments in diversified activities and other msults of operations include operation of nuclear generating obligations. Net funds used in these activities in 1997 were facHities, sales to other utilities, accounting issues, inflation, $83 million, consisting of $26 million for telecommunications weather and compliance with environmental regulations. v:ntures, $54 million for nuclear plant decommissioning trust An ther factor affecting the Company's future financial funds and $3 million for other deposits and ventures. In 1996 condition is its ability to develop its investments in new ven-cnd 1995, funds used in sirnitar activities were $114 million tures into profitable enterpnses.

Management's Discussion and Analysis of Financial Condition and Results of Operations t7 PUC Restructuring Order Uncertainties of Electric Generation Restructuring The Competition Act was enacted in December 1996, provid-Competition in wholesale and retail electric generation is ing for the restructuring of the electric utility industry in expected to create new uncertainties in the utility industry. Pennsylvania, including retail competition for generation These uncertainties include future prices of electricity in both beginning in 1999. The Competition Act requires the the retail and wholesale rnarkets, potential changes in the unbundling of electric services into separate generation, Company's sales portfolio and supply and demand volatility. transmission and distribution services with open retail com-The Company expects that deregulation of the petition for generation. Electric distribution and transmission Company's electric generating operations will result in price services will remain regulated by the PUC. The Competition pressures that will reduce the Company's future revenues. Act requires utilities to submit to the PUC restructuring plans, While the Company cannot predict the ultimate impact of the including their quantification of stranded costs which will PUC Restructuring Order on customer bills, the PUC esti-result from competition. The Competition Act authorizes the mates that customers will save up to 15% of their total recovery of stranded costs through charges to distobution electric bill beginning in 1999 through June 30,2007 and will customers for up to nine years (or for an ahemative period save 30% of their total electric bill thereafter. determined by the PUC for good cause shown). During that Competition is also expected to affect the ultimate com-period, the utility is subject to a rate cap which provides that position of the Company's electricity sales. The " shopping total charges to customers cannot exceed rates in place as of credit" established by the PUC encourages electnc retail cus-December 31,1996, subject to certain exceptions. The tomers to choose a supplier. The Company cannot predict Competition Act also caps transmission and distribution rates how successful its affiliated generation marketers will be in from December 31,1996 through June 30,2001, subject to competing for these customers and customers elsewhere in certain exceptions. Pennsylvania. To the extent that the Company loses retail Pursuant to the Competition Act, in April 1997, the customers, it will be compelled to sell generation previously Company filed with the PUC a comprehensive restructuring used to serve retail customers in the wholesale market. plan. In December 1997, the PUC adopted its own restructur-Since margins in the wholesale market are currently lower ing plan which deregulates the Company's electric generation than in the retail market, this could adversely affect the operations and allows the Company to recover stranded Company's profit margins. costs of $4.9 billion on a discounted basis, or $5.3 billion on a The Company is a low marginal-cost electricity producer, book value basis, over 8% years beginning in 1999. Recovery which puts it in a favorable position to take advantage of of allowed stranded costs will be through a separate charge opportunities in the electric retail and wholesale generation to be levelized over the recovery period using a 7.47% cost markets. The Company's competitive position and its future of capital. Other major provisions of the PUC Restructunng financial condition and results of operations are dependent Order include capping customer bills at the year-end 1996 on the Company's ability to successfully operate its low system-wide average of 9.95 cents per kWh; beginning marginal-cost power plants. January 1,1999, unbundling rates into a transmission and dis-The Company enters into commitments to buy and sell tribution component, the charge for recovery of stranded power. Currently, these commitments make the Company a costs and a " shopping credit" for generation; and phasing-in net power purchaser. Since the price and supply volatility of customer choice of electric generation supplier for all cus-electncity generation cannot be predicted at this time, the tomers in three steps, one-third of the peak load of each Company's position as a net purchaser exposes it to nsk to customer class on January 1,1999, one third on January 2, the extent that it has entered into contracts that may require 1999 (one day later) and the remaindar on January 2, 2000, the Compary to pay prices for purchased power in excess of To encourage competition, the PUC established the " shop-market prices, ping credit" for ge,,eration in excess of current market prices. The Company, as the local distnbution provider, is obli-On January 21,1998, the Company filed a complaint in gated under the PUC Restructuring Order to serve as the the Eastern District Court seeking injunctive and monetary electric generation supplier of last resort in its service territo-relief on the grounds that the Competition Act and the PUC ry. This obligation will include all customers who do not elect Restructuring Order: (1) are preempted by Section 201(b) of to choose an electricity supplier as well as all customers who the Federal Power Act; (2) effect a taking of private property seek a new energy supplier but are unable to reach a service without just compensation in violation of the Fif th and agreement with another supplier. The Company's rates are Fourteenth knendments to the U.S. Constitution; (3) violate capped at 1996 levels. If energy prices rise above that level, the Due Process Clause, the Contract Clause and the First the Company would still be obligated to serve these cus-Amendment of the U,S. Constitution; and (4) deprive the tomers at the capped rate. Company of certain other federally protected rights. On January 22,1998, the Company filed two Petitions Other Competitive Initiatives for Review in the Commonwealth Court, appeakng the PUC During 1996, the Federal Energy Regulatory Commission Restructuring Order. The petitions state that the PUC (FERC) issued Order No. 888 which requires public utilities to Restructuring Order must be set aside because it is based file open-access transmission tariffs for wholesale transmis-upon errors of law, is not supported by substantial evidence, sion services in accordance with non-discriminatory terms constitutes an arbitrary and capricious abuse of administrative and conditions established by the FERC. discretion and deprives the Company of the due process of In response to Order No. 888, in December 1996, the law, to which it is entitled under Article 1 of the Pennsylvan.ia Company and the other members of PJM Interconnection, Constitution' L.L.C. (PJM) filed a joint compliance filing with the FERC

I 18 PECO Energy Company and Subsidiary Companies proposing to restructure PJM. In November 1997, the FERC Public Service Dectnc and Gas Company (PSE&G), the issued an order which allows for the establishment of an operator of Salem Units No.1 and No. 2, which are 42.59% Independent System Operator to operate the day-to-day oper-owned by the Company, removed the units from service in ations of PJM. Transmission service is on a pool-wide, the second quarter of 1995. PSE&G informed the NRC at that open-access basis using the transmission facilities of the time that it had determined to keep the Salem units shut eight historical PJM companies with a flat rate based on the down pending review and resolution of certain equipment costs of the transmission system where the point of delivery and management issues and NRC agreement that each unit is located (thus there are eight rates). By January 1,2003, is sufficiently prepared to restart. Unit No. 2 returned to ser. PJM is required to have in place a uniform system-wide vice on August 30,1997 and Unit No.1 is expected to retum transmission rate. to service late in the first quarter of 1998. The Company The Company received approval from the FERC to expects to incur and expense at least $20 million in 1998 for remove the existing cost-based cap on piices charged for increased costs related to the shutdown. As of December 31, power purchased by the Company in anticipation of later 1997,1996 and 1995, the Company had incurred and resale in the wholesale market and certain changes regarding expensed $152, $149 and $50 million, respectively, for the terms of the buy-for-resale agreements. The new tariff replacement power and maintenance costs related to the provisions allow the Company to purchase and re-sell energy shutdown of Salem. See note 5 of Notes to Consolidated at market-based rates both within PJM and outside PJM. Financial Statements. The gas industry is continuing to undergo structural changes in response to FERC policies designed to increase Sales to Other Utilities competition. FERC policies have required interstate gas The Company's electric utility operations include the whole-pipelines to unbundle their gas sales service from other regu-sale marketing of electricity. At December 31,1997, the lated tariff services, such as transportation and storage. In Company had long-term commitments relating to the pur-anticipation of these changes, the Company has modified its chase from unaffiliated utilities and others, energy associated gas purchasing arrangements to enable the purchase of gas w th 1,330 megawatts (MW) of capacity in 1998, with 2,540 and transportation at lower cost. The Company, through MW of capacity during the period 1999 through 2002 and Horizon Energy Company, a wholly owned subsidiary, has with 2,430 MW of capacity thercafter. These purchases will successfully participated in pilot programs outside the be utilized through a combination of sales to jurisdictional Company's gas service territory to market natural gas and customers, long-term sales to other utilities and open-market other se. vices. sales. Under some of these contracts, the Company may pur. There is an initiative in the Pennsylvania legislature t chase, at its option, additional power as needed. The deregulate the gas industry, which has the support of Company's future results of operations are dependent in part Gcvemor Rioge. The Company cannot predict whether the on its ability to successfully market trrt rest of this genera-Pennsylvania legislature will enact legislation that deregulates tion. See note 5 of Notes to Consolidated Financial the gas industry or whether Govemor Ridge will ultimately Statements. sign into law any such legislation. The Company cannot pre-In the wholesale market, the Company has increased its dict the ultimate effect of gas industry deregulation on its sales to other utilities, but increased competition has reduced future financial condition or results of operations. the Company's profit margins on these sales. At December As a result of competitive pressures, the Company has 31,1997, the Company had entered into long-term agree-continued to negotiate long-term contracts with many of its ments with unaffiliated utilities to sell energy associated with larger-volume industrial customers. Although these agree-4,280 MW of capacity, of which 540 MW of these agree-ments have generally resulted,n reduced margins, they have ments are for 1998,1,700 MW are for 1999 through 2002 i permitted the Company to retain these customers. and the remaining 2,040 MW extend through 2022. Regulation and Operation of Acc:unting Issues Nuclear Generating Facilities Effective December 31,1997, the Company discontinued The Company's financial condition and results of operations accounting for its electnc generation opeiations in accor-are in part dependent on the continued successful operation dance with Statement of Financial Accounting Standards of its nuclear generating facilities. The Company's nuclear (SFAS) No. 71, " Accounting for the Effects of Certain Types generating facilities represent approximately 44% of its of Regulation." For further information, see note 4 of Notes installed generating capacity. S-cause of the Company's to Consolidated Financial Statements. The Company believes reliance on its nuclear generating units, any changes in regu-that its electric transmission and distribution system and gas I:tions by the Nuclear Regulatory Commission (NRC) operations continue to meet the provisions of SFAS No. 71. requiring additional investments or resulting in increased The Company believes that it is probable that regulatory operating costs of nuclear generating units could adversely assets associated with these operations will be recovered. affect the Company. In 1997, the Financial Accounting StanLds Board During 1997, Company-operated nuclear plants operated (FASB) issued SFAS No.130, " Reporting Comprehensive at a 90% weighted-average capacity factor and Company' income " to establish standards for reporting and display of owned nuclear plants operated at a 73% weighted-average comprehensive income and its components in financial state-c:pacity factor. Company-owned nuclear plants produced ments. The new standard requires an entity to classify items 39% of the Company's electncity, despite the shutdown of of other comprehensive income by their nature in a financial the Salem units. Nuclear generation is the most cost-effec-statement and to display the accumulated balance of other tive way for the Company to meet customer needs and comprehensive income separately from retained earnings and commitments for sales to other utilities.

Management's Discussion and Arialysis of Financial Condition and Results of Optrations 19 additional paid-in capital in the equity section of a statement The Company has oetermined that it will be required to of financial position. The new standard is effective for fiscal modify or replace significant portions of its software so that years beginning after December 15,1997. The Company will its computer systems will properly utikze dates beyond adopt SFAS No.130 in 1998. Adoption of SFAS No.130 will December 31,1999. The Company presently believes that, not affect the Company's financial condition or results of with modifications to existing software and conversions to operations. The Company is evaluating the impact on its dis-new software, the Year 2000 issue can be mitigated. closures, but does not expect SFAS No.130 to materially However, if such modifications and conversions are not made, change its disclosures. or are not completed timely, the Year 2000 issue could have a in 1997, the FASB issued SFAS No.131, " Disclosures material adverse impact on the operations and financial condi-About Segments of an Enterprise and Related Information," tion of the Company. The costs associated with this potential to establish standards for reporting information about operat-impact are speculative and not presently quantifiable. ing segments in annual financial statements and to require The Company initiated formal communications with all of reporting of selected information about operating segments its significant suppliers in March 1997 to determine the in interim financial reports issued to shareholders, It also extent to which the Company is vulnerable to the suppliers' establishes standards for related disclosures about products failure to remediate their own Year 2000 issue. The and services, geographical areas and major customers. The Company's estimated total Year 2000 project costs include new standard is effective for fiscal years beginning after the estimated costs and time associated with the impact of December 31,1997, Adoption of SFAS No.131 will not affect Year 2000 issues of third parties and are based on presently the Company's financial condition or results of operations, available information. There can be no guarantee that the sys-The Company is evaluating the impact on its operating seg-terns of other companies on which the Company's systems meat disclosures. rely will be timely converted, or that a failure to convert by During 1996, the FASB issued the Exposure Draft another company, or a conversion that is incompatible with " Accounting for Certain Liabilities Related to Closure or the Company's systems, would not have a material adverse Removal of Long-Lived Assets." The FASB has expanded the impact on the Company. scope of the project to include closure or removal liabilities The Company will utilize both internal and extemal ..that are incurred at any time in the operating life of the relat-resources to reprogram, or replace, and test software and ed long-lived asset. The FASB has decided that it should computer systems for Year 2000 modifications. Management proceed toward either a final Statement or a revised believes that adequate resources are being devoted to the Exposure Draft. The timing of this project is still to be deter. Year 2000 Issue. The Company plans to complete the Year mined. Until such time that the final Statement is issued, the 2000 project not later than June 1,1999. To date, the Company will be unable to determine what, if any, effect this Company has funded the Year 2000 project from current issue might have on its financial condition or results of opera-operating cash flows as a base level of activity for the tions. See note 5 of Notes to Consolidated Financial preliminary efforts in connection with its Year 2000 assess-Statements. ment and remediation plan. The Company expects the remaining costs of the Year 2000 project to be approximately Other Factors $25 million. The costs of the project and the date on which the Annual and quarterly operating results can be significantly Company plans to complete the Year 2000 modifications are affected by weather. Since the Company's peak demand is in based on Management s best estimates, which were derived the summer months, temperature variations in summer utilizing numerous assumptions of future events including the months are generally more significant than variations during continued availability of certain resources, third-party modife,- winter months. cation plans and other factors. However, there can be no Inf!ation affects the Company through increased operat-guarantee that these estimates will be achieved; actual ing costs and increased capital costs for utility plant. As a results could differ materially from those plans. Specific fac-result of the rate cap imposed by the Competition Act, the tors that might cause such material differences include, but elimination of the Energy Cost Adjustment and expected are not limited to, the availability and cost of personnel price pressures due to competition, the Company may have trained in this area, the ability to locate and correct all rele-limited opportunity to pass the costs of inflation through to vant computer programs and microprocessors, and similar customers, m an The Year 2000 issue is the result of computer programs be,ng wntten using two digits rather than four to define the the future require substantial capital expenditures in order to i applicable year and other programming techniques which comply with environmentallaws. Additionally, under federal constrain date calculations or assign special meanings to cer+ and state environmental laws, the Company is generally liable tain dates. Any of the Company's computer systems that for the costs of remediating environmental contamination of have date-sensitive software or microprocessors may recog-property now or formerly owned by the Company and of nize a date using "00" as the year 1900 rather than the year property contaminated by hazardous substances generated 2000. This could result in a system failure or miscalculations by the Company. The Company owns or leases a number of causing disruptions of operations, including, among other real estate parcels, including parcels on which its operations thingsc a temporary inability to process transactions, send r the operations of others may have resulted in contamina-bills or operate electric generation stations. tion by substances which are considered hazardous under environmental laws. The Company is currently involved in a number of proceedings relating to sites where hazardous w..

20 PECO Energy Company and Subsidiary Ccmpanies substances have been deposited and may be subject to addi-tional proceedings in the future, The Company has identified 27 sites whero former man-uf:ctured gas plant (MGP) activities have or may have resulted in site contamination. The Company is presently engaged in performing various levels of activities at these sit:s, including initial evaluation to determine the existence and nature of the contamination, detailed evaluation to deter-mine the extent of the contamination and the necessity and possible methods of remediation, and implementation of remediation. The Pennsylvania Department of Environmental Protection has approved the Company's clean-up of two sitts. Six other sites ard currently under some degree of active study and/or remediation. As of December 31,1997 and 1996, the Company had eccrued $63 and $29 million, respectively, for environmental investigation and te,ediation costs, including $35 and $16 milhon, respectively, for MGP investigation and remediation that currently can be reasonably estimated. The Company expects to expend $5 million for environmental remediation activities in 1998. The Company cannot currently predict whether it will incur other significant liabilities for any addi-tional investigation and remediation costs at these or additional sites identified by the Company, environmental agencies or others, or whether such costs will be recoverable from third parties. For a discussion of other contingencies, see notes 3,4 and 5 of Notes to Consolidated Financial Statements. Forward-Looking Statements Except for the historical information contained hers n, certain of the matters discussed in this Report are forward-looking statements which are subject to risks and uncertainties. The factors that could cause actual results to differ materially include those discussed herein as well as those hsted in notes 3,4 and 5 of Notes to Conschdated Financial Statements and other factors discussed in the Company's fil-ings with the Securities and Exchange Commission. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this Report. The Company undertakes no obligation to publicly release any revision to these forward-looking statements to reflect events or circumstances af ter the date of this Report.

21 Report of Independent Accountants lo the Shareholders and Board of Directors PECO Energy Company: We have audited the accompanying consolidated balance sheets of PECO Energy Company and Subsidiary Companies as of December 31,1997 and 1996, and the related consolidated statements of income, cash flows, and changes in common shareholders' equity and preferred stock for each of the three years in the period ended December 31,1997. These financial statements are the responsibility of the Companies' management. Our responsibility is to express an opinion on these finan-cial statements based on our audits. We conducted our audits in accordance with generally accepted auditing stan-dards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assess-ing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of PECO Energy Company and Subsidiary Companies as of December 31,1997 and 1996, and the consolidated results of their operations and their cash flows t,r each of the three years in the period ended December 31,1997, in conformity with generally accepted accounting principles. t -Af I 2400 Eleven Penn center Philadelphia, Pennsylvania February 2,1998

PECO Energy Company and Subsidiary Companies 22 Censolidated Statements of Income 1997 1996 1995 For the Years Ended December 31, Thousands of Dollars . Operating Revenues - Electric 4,166,669 $ 3,854,836 $ 3,775,326 Gas 451,232 _ 428,814 410,830 Total Operating Revenues 4,617,901 4,283,650 4,186.156 Operating Expenses Fuel and Energy Interchange 1,290,164 972,380 762,762 Operating and Maintenance 1,431,420 1,274,222 1,251,273 Depreciation 580,595 489,001 457,254 Taxes Other Than income 310,091_ 299,546 _ 314,071 Total Operating Expenses 3,612,270 3.035,149 2,785,360 Operating Income 1,005,631 1,248,501 1,400,796 Other income and Deductions interest Expense (372,857) (382,443) (423,711) Company Obligatad Mandatorily Redeemable Preferred Securities of a Partnership, which holds Solely Subordinated Debentures of the Company (28,990) (26,723) (20,987) Allowance for Funds Used During Construction 21,771 19,947 27,050 Settlement of Salem Litigation 69,800 Gain on Sale of Subsidiary 58,745 Other, net (66,028)_ (1,976) (444) Total Other Income and Deductions (376,304) (391,195) (359,347) Income 8efore income Taxes and Extraordinary item 629,327 857,306 1,041,449 income Taxes 292,769 340,101 431,717 incorne Before Extraordinary item 336,558 517,205 609,732 Extraordinary item (net of 31,290,961 income taxes) (1,833,664) Net (Loss) Income (1,497,106) 517,205 609,732 Preferred Stock Dividends 16,804 18.036 23,217 Earnings Applicable to Common Stock $ (1,513,910) $ 499.169 $ 586.515 Average Shares of Common Stock Outstanding (r8ousands) 222,543 222.490 221,859 BIsic and Dilutive Earnings per Average Common Share Before Extraordinary Item rovum) 1,44 2.24 $ 2IA Extraordinary Item ruors) S (8.24) $ Basic and Dilutive Earnings per Average Common Share (odon) (6.80) $ 2.24 2.64 Dividends per Common Share (ponon) 1.80 $ 1.755 $ 1.65 ' See Notes to Consolidated FinancialStatements,

PECO Energy Company and Subsidiary Companies 23 C0nsolidated Statements of Cash Flows for_the Years Ended December 31, 1997 1996 1995 t Thousands of Douars Cash Flows from Operating Activities Net locome 8 (1,497,106) $ 517,205 $ 609,732 Extraordinary item (net of $1,290,961 income taxes) (1,833,664)_ Income Before Extraordinary item 336,558 517,205 609,732 Adjustments to reconcile Net income to Net Cash provided by Operating Activities: Depreciation and Amortization 664,294 566,412 531,299 Deferred Income Taxas (17,228) 166,771 183,514 Salem Litigation Settlement 69,800 (58,745) Gain on Sale of Subsidiary ~ Deferred Energy Costs (5,652) (66,151) (71,104) Amortization of Leased Property 39,100 31,400 42,900 Changes in Working Capital: Accounts Receivable (289,610) 53,681 (8,198) inventories 28,628 (2,729) (10,872) Accounts Payable 93,881 (86,765) (4,686) Other Current Assets and Liabilities 58,539 (25,040) 5,641 Deferred Credits - Other 78,846 (4,609) 5,172 Other Items affecting Operations (19,005) 22,070 11J83_ Net Cash Flows from Operating Activities 1,038,151 1,172,245 1,240,336 Cash Flows from Investing Activities investment in Plant (490,200) (548,854) (532,614) 150,000 Proceeds from Sale of Subsidiary Increase in Other investments (83,261) (114,126) (82,041) Net Cash Flows from Investing Activities (573,461) (662,980) (464,655) Cash Flows from Financing Activities Change in Short Term Debt 114,000 287,500 (11,499) Issuance of Common Stock 117 11,301 15,585 Retirement of Preferred Stock (61,895) (78,105) .lssuance of Company Obligated Mandatorily Redeemable Preferred Securities of a Partnership 50,000 81,032 issuance of Long-Term Debt 161,813 43,700 182,540 Retirement of Long-Term Debt (283,303) (427,463) (575,713) 22,75: 24,724 12,302 ' Loss on Reacquired Debt Dividends on Preferred and Common Stock (417,383) (411,569) (390,340) Change in Dividends Payable (5,438) 1,685 5,626 ' Expenses of issuing Long-Term Debt and Capital Stock (2,084) 890 (577) Capital Lease Payments (39,100) (31,400) (42,900) Net Cash Flows from Financing Activities (460,521) (500,632) (802,049) Increase (Decrease) in Cash and Cash Equivalents 4,169 8,633 (26,368) Cash and Cash Equivalents at beginning of period 29/ 35 20,602 46,970 Cash and Cash Equivalents at end of period 8 33,404 $ 29,235 $ 20.602 See hotes to Consolidated financial Statements,

PECO Energy Company and Subsidiary Companies 26 Consolidated Balance Sheets 1997 1996 At December 31, Thousands of Dollars Assets Utility Plant Electric-Transmission & Distribution S 3,617,666 $ 3,494,778 Elactric Generation 1,434,895 10,127,602 Gas 1,071,819 1,005,507 Common 302,672 317,065 6,427,052 14,944,952 Less Accumulated Provision for Depreciation 2,690,824 5,046,950 3,736,228 9,898,002 Nuclear Fuel, nel 147,359 199,579 Construction Work in Progress 611,204 661,871 Leased Property, net 175,933 182,088 Net Utikty Plant 4,670,724 _ 10,941,540 Current Assets Cash and Temporary Cash investments 33,404 29,235 Accounts Receivable, net Customers 173,350 19,159 Other 139,996 74,377 Inventories, at average cost Fossil Fuel 84,858 84,633 Materials and Supplies 90,890 119,743 Deferred Generation Costs Recoverable in Current Rates 424,497 Deferred Energy Costs-Gas 35,665 30,013 Other 20,115 63,234 Total Current Assets 1,002,775 420,394 DGferred Debits and Other Assets Competitive Transition Charge 5,274,624 Recoverable Deferred income Taxes 590,267 2,325,721 361,762 Deferred Limerick Costs Deferred Non-Pension Postretirement Benefits Costs 97,409 233,492 Deferred Energy Costs-Electric 92,021 investments - 515,835 432,574 Loss on Reacquired Debt 83,918 283,853 Other 121,016 169,262_ Total Deferred Debits and Other Assets 6,683,069 3,898,685 Tetal Assets 8 12,356,568 $ 15.260.619 See Notes to Consolidated Financial Statements.

PECO Energy Company and Subsidiary Companies 25 Consolidated Balance Sheets (continued) At December 31, 1997 1996 Thousands of Dollars Capitallration and Liabilities Capitallration Common Shareholdars' Equity Common Stock 8 3,517,731 $ 3,517.614 Other Paid-in Cepital 1,239 1,326 Retained (Deficit) Earnings (792,239) 1,127,041 2,726,731 4.645,981 Preferred and Preference Stock Without Mandatory Rede.nption 137,472 199,367 With Mandatory Redemption 92,700 92,700 Company Obligated Mandatorily Redeemable Preferred Securities of a Partnership, which holds Solely Subordinated Debentures of the Company 352,085 302,182 Long-Term Debt 3,853,141 3,935,514 Total Capitalization 7,162,129 9,175,744 Current Llabilities Notes Payable, Bank 401,500 287,500 Long-Term Debt Due Within One Year 247,087 283,303 Capital Lease Obligations Due Within One Year 55,808 49,347 Accounts Payable 306,847 212,966 . Taxes Accrued 66,397 71,482 Interest Accrued 77,911 82,006 Dividends Payable 16,969 22,407 Deferred Income Taxes 185,696 2,745 Other 260,457_ 91,608 Total Current Liabilities 1,618,672 1,103,364 Deferred Credits and Other Liabilities Capital Lease Obligations 120,125 132,741 Deferred Income Taxes 2,297,042 3,745,242 Unamortized investment Tax Credits 318,065 336,132 Pension Obhgation 211,596 224,454 ~~ - Non-Pension Postretirement Benefits Obhgation 324,850 315,058 Other 304,089 227,884 Total Deferred Credits and Other Liabilities 3,575 767_ 4,981,511 C:mmitments and Contingencies (Notes 3,4 and 5) T:tal Capitaltration and Liabilities S 12,356,568 $ 15.260.619 See Notes to Consolidated finandal Statements.

PECO Energy Company and subsidiary Compants 26-Consolidated Statements of Changes in Common Shareholders' Equity and Preferred Stock Other Retained _ Common Stock __ Paid-in Earnings Preferred Stock AII Amounts in thousands Shares A. mount, Capttal (Deficit) $ hares Amount _ Balance at.lanuary 1,1995 221,609 $ 3,490,728 $ 1,271 $ 810,507 3,702 $ 370,172 Net income 609,732 Cash Dividends Declared Preferred Stock (at specified annual rates) (24,253) Common Stock ($1.65 per share) (366,087) Expenses of Capital Stock Activity (4.035) Capital Stock Activity Longterm incentive Plan Issuances 563 15,585 (2,156) Preferred Stock issuances 55 Preferred Stock Redemptions (781) (78,105) Balance at December 31,1995 222,172 3,506,313 1,326 1.023,708 2,921 292,067 Net income 517,205 Cash Dividends Declared Preferred Stock (at specified annual rates) (21,042) Common Stock ($1.755 per share) (390.527) Expenses of Capital Stock Activity (275) Capital Stock Activity Longterm Incentive Plan Issuances 370 11,301 (2,028) Balance at December 31,1996 222,542 3,517,614 1,326 1,127,041 2,921 292,067 Net Loss (1,497,106) Cash Dividends Declared Preferred Stock (at specified annual rates) (16,805) Common Stock ($1.80 per share) (400,578) Expenses of Capital Stock Activity 98 Interest on Stock Repurchase Forward Contract (4,889) Capital Stock Activity Longterm incentive Plan issuances 5 117 Preferred Stock Redemptions (87) (619) (61,895)_ Balance at December 31,1997 222,547 8 3,517,731 S 1,239 $ (792,239) 2,302 S 230,172 See Notes to Consolidated Financial Statements.

Notes to Consolidat:d Financti St:tements ~ 27 ' Notes to Consolidated Financial Statements

1. Significant Accounting Policies Energy and Purchased Gas Cost Adjustment Clause The Company's gas rates are subject to a fuel adjustment clause designed to recover or refund the difference between General The consolidated financial statements of PECO Energy the actual cost of purchased gas and the amount included in base rates. Differences between the amounts billed to cus-Company include the accounts of its utility subsidiary compa.

tomers and the actual costs recoverable are deferred and nies, all of which are wholly owned. Accounting policies are recovered or refunded in future periods by means of prospec-in accordance with those presenbed by the regulatory author-tive adjustments to rates. Such rates are adjusted quarterly. stics having jurisdiction, principally the Pennsylvania Public Frior to December 31,1996, the Company's retail elec-Utility Commission (PUC) and the Federal Energy Regulatory tric rates were subject to an Energy Cost Adjustment (ECA) Commission (FERC). The Company has unconsolidated non-clause designed to recover or refund the difference between utikty subsidiaries which are not material. The unconsolidated the actual cost of fuel, energy interchange or purchased subsidiaries are accounted for under the equity method, power and the amount of such costs included in base rates. Effective December 31,1996, the PUC approved the roll-in of Use of Istimates electric energy costs into the base rates charged to the The preparation of financiaf statements in conformity with Company's retail electric customers and such rates are no generally accepted accounting principles requires manage-longer subject to the ECA. ment to make estimates and assumptions that affect the r: ported amounts of assets and habihties and disclosure of Utility Plant contingent assets and habilities at the date of the financial Effective December 31,1997, efectric generation plant is val-statements and the reported amounts of revenues and ued at the lower of onginal cost or market pursuant to SFAS expentes during the reporting period. Actual results could dif, No.121, " Accounting for the Impairment of Long-Lived for from those estimates. Assets and for Long-Lived Assets to be Disposed Of." All Estimates are used in the Company's accounting for other utihty plant continues to be valued at original cost (see unbilled revenue, the allowance for uncollectible accounts, note 4). fuel adjustment clause, depreciation and amortization, taxes, reserves for contingencies, employee benefits, certain fair Nuclear Fuel value and recoverability determinations, and nuclear outage The cost of nuclear fuelis capitalized and charged to fuel costs, among others. expense on the unit of production method. Estimated costs of nuclear fuel disposal are charged to fuel expense as the Accounting for the Effects of Regulation related fuel is consumed. The Company's share of nuclear The Company accounts for all of its regulated operations in fuel at Peach Bottom Atomic Power Station (Peach Bottom) accordance with Statement of Financial Accounting and Salem Generating Station (Salem) is accounted for as a Standards (SFAS) No. 71, " Accounting f or the Effects of capital fease. Nuclear fuel at Limerick Generating Station Certain Types of Regulation," requiring the Company to (Limerick) is owned. ricord the financial statement effects of the rate regulation to which the Company is currently subject. If a separable por-tion of the Company's business no longer meets the Depreciation and Decommissioning provisions of SFAS No. 71, the Company is required to elimi. Depreciation is provided over the estimated service lives of .nate the financial statement effects of regulation for that plant on the straight-line method. The Company is currently portion. Effective December 31,1997, the Company deter. reviewing the useful lives of its electric generation assets, mined that the electric generation portion of its business no Annual depreciation provisions for financial reporting purpos-longer met the criteria of SFAS No. 71 and, accordingly, es, expressed as a percentage of average depreciable utility implemented SFAS No.101, " Regulated Enterprises - plant in service, were approximately 3.3% in 1997,2.9% in Accounting for the Discontinuation of FASB Statement No. 1996 and 2.8% in 1995. See note 3 for information concern-71," for that portion of its business (see note 4). ing the change in 1996 to depreciation and amortization. ~ The Company's current estimate of the costs for decom-missioning its ownership share of its nuclear generating Revenues Electric and gas revenues are recorded as service is rendered stations is currently included in electric base rates and is or energy is delivered to customers. At the end of each charged to operations over the expected service life of the related plant. The amounts recovered from customers are 1 month, the Company accrues an estimate for the unbilled deposited in trust accounts and invested for funding of future I amount of energy delivered or services provided to cus, costs. These amounts, and realized investment eamings tomers (see note 8). thereon, are credited to accumulated depreciation. The Company believes that the amounts being recovered from customers through electric rates will be sufficient to fully fund the unrecorded portion of its decommissioning obliga-tion (see note 5).

1 28 PECO Energy Company and Subsidiary Companies Incorne Taxes Differences between ths accrued and actual expense for the - The Company uses an asset and liability apprc,ach for finan-outage are recorded when such differences are known, cial accounting and reporting of income taxes. Investment tax credits are deferred and amortized to income over the esti-Capitalized Software Costs mated useful life of the related property (see note 14). Software projects which exceed $5 million are capitalized. At December 31,1997 and 1996, capitalized software costs Allowance for Funds Used During Construction (AFUDC) totaled $86 and $78 million (net of $29 million accumulated AFUDC is the cost, during the period of construction, of debt amortization in each year), respectively. L.,h capitalized and equity funds used to finance construction projects.. amounts are amortized ratably over the expected lives of the AFUDC is recorded as a charge to Construction Work in projects when they become operational, not to exceed ten Progress and as a credit to Other locome and Deductions. years. The rates used for capitalizing AFUDC, vuhich averaged 8,88% in 1997, 9.38% in 1996 and 9.88% in 1995, are com-Gains and Losses on Reacquired Debt puted under a method prescribed by regulatory authorities. Prior to December 31,1997, gains and losses on reacquired AFUDC is not included in regular taxable income and the debt were deferred and amortized to interest expense over depreciation of capitalized AFUDC is not tax deductible. the period approved for ratemaking purposes. Effective Effective January 1,1998, the Company ceased accruing January 1,1998, gains and losses on reacquired debt associ-AFUDC for electric generation-related construction projects ated with the electric generation portion of the Company's + and will use SFAS No. 34, " Capitalizing Interest Costs," to operations will be expensed as incurred. Gains and losses on calculate the costs during the period of construction of debt reacquired debt associated with the Company's regulated funds used to finance its electric generation-related construc-operations will continue to be deferred and amortized to tion projects, interest expense over the period approved for ratemaking purposes. Nuclear Outage Costs incremental nuclear maintenance and refueling outage costs Reclassifications are accrued over the unit operating cycle. For each unit, an Certain prior-year amounts have been reclassified for compar-accrual for incremental nuclear maintenance and refueling ative purposes. These reclassifications had no effect on net outage expense is estimated based upon the latest planned income or common shareholders' equity. outage schedule and estimated costs for the outage.

2. Nature of Operations and Segment Information The Company provides retail electric and natural gas service with a population of 3.6 million, including 1.6 million in the to the public in southeastern Pennsylvania and, in pilot pro.

City of Philadelphia. Approximately 94% of the retail electric grams, natural gas service to areas in Maryland and New service area and 64% of retail kilowatthour (kWh) sales are in Jersey, The Company also engages in the wholesale market. the suburbs around Philadelphia, and 6% of the retail service ing of electricity on a national basis. The Company area and 36% of such sales are in the City of Philadelphia. ' participates in joint ventures which provide telecommunica. Natural gas service is supplied in a 1,475-square-mile area of tions services in the Philadelphia area. The Company's southeastern Pennsylvania adjacent to Philadelphia with a traditional retail service territory covers 2,107' square miles. population of 1.9 million. Electric service is fumished to an area of 1,972 square miles For the Years Ended Decernber 31, 1997 1996 1995 Thousands of Dollars Electric Operations Operating revenues: Residential 8 1,357,449 1,370,158 1,379,046 Small commercial and industrial 778,743 748,561 730,220 Large commercial and industrial 1,077,374 1,098,307 1,135,550 Other 147,523 140,133 136,988 Unbilled 19,130 (25,950) 42,580 Service terntory 3,380,219 3,331,209 3,424,384 Interchange sales 58,614 25,991 17.488 Sales to other utilities - 727,836 497,636 333.454 Total operating revenues 4,166,689 3.854,836 3,775,326 Operating expenses, excluding depreciatbn 2,697,877 2,243,094 2,026,112 Depreciation 552,667 462,315 430,993 Operating income S 916,125 1,149.427 1.318.221 Utility plant additions s 382,157 447,105 435.400

hiotes to Consolidated Financti Statements 29 1997 1996 1995 For the Years Ended Decemt>er 31,_ Thousands of Dollars Gas Operations Operating revenues: Residential 8 16,852 15,716 15,482 House heating. 265,299 249,507 235,456 Commercial and industrial 144,801 132,822 125.631 Other 3,228 11,462 5,382 Unbilled (969) (4,250) 6,540 Subtotal 429,211 405,257 388,491 Other revenues (including transported for customers) 22,021 23,557 22,339 Total operating revenues 451,232_ 428,814 410,830 Operating expenses, excluding depreciation 333,798 303,054 301,994 Depreciation 27,928 26,686 26,261 Operating income S 89,506 99.074 82,575 Utility plant additions S 85,212 68,394 63,192 Identifiable Assets

at December 31, Electric 5

9,610,984 $ 10,287,444 $ 10,408,105 Gas 966,685 858,471 785,881 Nonallocable assets 1,778,899 4,114,704 4,114,519 Total assets 8 12,356,568 $ 15.260.619 $ 15.308.505

Includes utility plant less accumulated depreciation, inventories, segment-specific regulatory assets and allocated common utility property.

3. Rate Matters.

In December 1997, the PUC rejected the Pennsylvania Competition Act Plan and entered an Opinion and Order, revised in January The Electricity Generation Customer Choice and Competition 1998 (PUC Restructuring Order), that deregulates the Act (Competition Act) was enacted in December 1996, pro. Company's electric generation operations. The PUC viding for the restructuring of the electric utility industry in Restructuring Order allows the Company to recover $4.9 bil-Pennsylvania, including retail competition for generation lion on a discounted basis, or $5.3 billion on a book value beginning in 1999. The Competition Act requires the basis, over 8% years beginning in 1999. Recovery of allowed unbundling of electric services into separate generation, stranded costs will be through a separate charge to be lev-transmission and distnbution services with open retail com-elized over the recovery period using a 7.47% cost of capital. petition for generation. Electric distribution and transmission Other major provisions of the PUC Restructuring Order services will remain regulated by the PUC. The Competition include capping customer bills at the year end 1996 system-Act requires utilities to submit to the PUC restructuring plans, wide average of 9.95 cents per kWh; beginning January 1, including their quantification of stranded costs (the loss in 1999, unbundling rates into a transmission and distribution value of the Company's electric generation-related assets, component, the charge for recovery of stranded costs and a which will result from competition). The Competition Act " shopping credit" for generation; and phasing-in customer authorizes the recovery of stranded costs through charges to choice of electric generation supplier for all customers in distribution customers for up to nine years (or for an attema-three steps: one-third of the peak load of each customer tive period determined by the PUC _for good cause shown), class on January 1,1999, one-third on January 2,1999 (one During that period, the utility is subject to a rate cap which day later) and the remainder on January 2, 2000. To encour-provides that total charges to customers cannot exceed rates age competition, the PUC established the " shopping credit" in place as of December 31,1996, subject to certain excep-for generation in excess of current market prices. tions. The Competition Act also caps transmission and On January 21,1998, the Company filed a complaint in distributior, rates from December 31,1996 through June 30, the U.S. District Court for the Eastern District of Pennsylvania

2001, subject to certain exceptions.

seeking injunctive and monetary relief on the grounds that Pursuant to the Competition Act, in April 1997, the the Competition Act and the PUC Restructuring Order: (1) are Company filed with the PUC a comprehensive restructuring pre-empted by Section 201(b) of the Federal Power Act; (2) plan detailing its proposal to implement full customer choice effect a taking of private property without just compensation of electric generation supplier. The Company's restructuring in violation of the Fifth and Fourteenth Amendments to the plan identified $7,5 billion of stranded costs. In August 1997, U.S. Constitution; (3) violate the Due Process Clause, the the Company and various intervenors in the Company's Contract Clause and the First Amendment of the U.S. restructuring proceeding filed with the PUC a Joint Petition for Constitution; and (4) deprive the Company of certain other Partial Settlement (Pennsylvania Plan). . federally protected rights. 1

PECO Energy Company and Subsidiary Companies 30 On January 22,1998, the Company filed two Petitions deposited $26 and $47 million, respectively, in trust accounts for Review in the Commonwealth Court of Pennsylvania, to fund its retail electric non-pension postretirement benefits appeahng the PUC Restructuring Order. The petitions state costs. These costs include amounts charged to operating that the PUC Restructuring Order must be set aside because expense or capitafized during 1997 and 1996. At December ' it is based upon errors of law, is not supported by substantial 31,1997,$121 million of the previously recorded transition evidence, constitutes an arbitrary and capricious abuse of obligation was included as part of electric generation-related administrative discretion and deprives the Company of the regulatory assets (see note 4). due process of law, to which it is entitled under Article I of The Company recognizes $2.8 million in non-pension the Pennsylvania Constitution, postretirement benefits costs annually associated with gas utility operations. During 1997 and 1996, the Company Liinerfck deposited $2.8 and $2.9 million, respectively, in trust Under its electric tariffs through December 31,1997, the accounts to fund its gas non-pension postretirement benefits Company was recovering $285 million of deferred Limerick costs. costs representing carrying charges and depreciation associ-ated with 50% of Limerick common facilities. The Company Energy Cost Adjustment also deferred certain operating and maintenance expenses, Through December 31,1996, the Company was subject to a depreciation and accrued carrying charges on its capital PUC-estabhshed efectric ECA which, in addition to reconciling investment in Limerick Unit No. 2 and 50% of Limerick com-fuel costs and revenues, incorporated a nuclear performance mon facihties. These costs were included in base rates and standard which allowed fur financial bonuses or penalties were being recovered over a nine-year period beginning depending on whether the Company's system nuclear capaci-October 1,1996. The Company was also recovering $137 ty factor exceeded or fell below a specified range. For the mifl ion of Limerick Unit No.1 costs over a ten-year period years ended December 31,1996 and 1995, the Company without a retum on investment. At December 31,1997, the recorded bonuses of $22 and $13 milhon, respectively. unamortized portion of these regulatory assets were included as part of electric generation-related regulatory assets (see note 4)-

4. Accounting Changes Under its electric tanffs and ECA, the Company was The Company accounts for all of its regulated operations in allowed to retain for shareholders any proceeds above the accordance with SFAS No. 71 which allows the Company to average energy cost for sales of 399 megawatts (MW) of record the financial statement effects of the rate regulation to near-term excess capacity and/or associated energy and t which the Company is subject. Use of SFAS No. 71 is applic-share in the benefits of energy savings which resulted from the operation of both Limerick Units No.1 and No. 2. The foll wing criteria: (1) th:rd-party regulation of rates; (2) cost-Company's ECA was discontinued at December 31,1996.

based rates; and (3) a reasonable assumption that all costs During 1996 and 1995, the Company recorded as revenue M be awaW hm astomes h@ rams. net of fuel costs $82 and $79 million, respectively, as a result in 1997, the Financial Accounting Standards Board of the sale of the 399 MW of capacity and/or associated (FASB) through its Emerging Issues Task Force (EITF) issued energy and the Company's share of Limerick energy savings. EITF No. 97-4, " Deregulation of the Pncing of Electricity - issues Related to the Application of FASB Statements No. Declaratory Accounting Order 71, Accounting for the Effects of Certain Types of Regulation, Pursuant to a PUC Declaratory Order, effective October 1, and No.101, Regulated Enterprises - Accounting for the 1996, the Company increased depreciation and amortization Discontinuation of Application of FASB Statement No. 71." on assets associated with Limerick by $100 million per year The EITF agreed that: a) an entity should cease to apply SFAS and decreased depreciation and amortization on other No. 71 no later than the date the specific deregulation plan is Company assets by $10 milhon per year, for a net increase in enacted and the details of that plan are known, and b) both depreciation and amortization of $90 milhon per year. stranded costs and regulated assets and liabikties should con-Effective December 31,1997, the Company ceased this tinue to be recognized to the extent that the transition plan increased depreciation since this Declaratory Order has been P.rovides for their recovery through the regulated transmis-superseded by the PUC Restructuring Order. At December sion and distribution portion of the business, 31,1997, the $90 milhon of depreciation and amortization The Company believes that the PUC Restructuring Order that would have been recognized in 1998 was deferred as a provides sufficient details regarding the deregulation of the regulatory asset, since the Company's rates will continue to Company's electric generation operations to require the be cost-based until January 1,1999, and will be amortized Compa7y to discontinue the application of SFAS No. 71 for and recovered in 1998. those operations. Effective December 31,1997, the Company adopted the provisions of SFAS No.101 for its Rscovery of Non-Pension Postretirement Benefits Costs I ctric generation operations. SFAS No.101 requires a Effective January 1995, the Company increased electric base d termination of impairment of plant assets under SFAS No. rates by $25 million per year to recover the increased costs e ram Wah dat including the annual amortization of the transition obhgation ecognized as assets and liabilities pursuant to (over 18 years) deferred in 1994 and 1993, associated with gp[g 7' the implementation of SFAS No.106, " Employers' Accounting for Postretirement Benefits Other Than Pensions" (see note 7). During 1997 and 1996, the Company

Notes to Consolidated financti Statements - 31 At December 31,1997, the Company performed an (rhousands or ooliarsi impairment test of its electric generation assets pursuant to ~ SFAS No.121 on a plant specific basis and determined that Electric generation-related asset impairment $6.1 billion of its $7.1 billion of electric generation assets determined pursuant to SFAS No.121 would be impaired as of December 31,1998. The Company Net book value of electric estimated the fair value for each of its electric generating generation-related assets units by determining its estimated future operating cash before write-down 7,115.155 inflows and outflows. The net future cash flows for each December 31,1998 market value of electric generating plant were then compared to its net book electric generation-related assets value. For any electric generation plant with future undis-pursuant to SFAS No.121 (990,376) counted cash flows less than its book value, net cash flows Expected 1998 change in net plant were discounted using a discount rate commt nsurate with recognized for recovery until the risk of each electric generating plant. Since the cost-based rates cease at Company's retail electric rates will continue to be cost-based December 31,1998 (303,800) until January 1,1999, $0.3 billion representing depreciation Electric generation-related asset expenso on electric generation-related assets in 1998 has impairment 5,820,979 been reclassified to a regulatory asset and will be amortized e and recovered in 1998. Electric generation-related regulatory assets At December 31,1997, the Company had $2.7 billion of Recoverable Deferred Income Taxes 1,762,946 slectric generation-related regulatory assets, of which $0.1 Deferred Limerick Costs 321,420 billion will be amortized and recovered through cost-based Deferred Non-Pension Postretirement rates in 1998. Benefits Other Than Pensions 120,899 At December 31,1997, the Company had total electric Deferred Energy Costs - Electric 92,021 generation-related stranded costs of $8.4 billion, representing Loss on Reacquired Debt 177,183 $5.8 billion of net stranded electric generation plant and $2.6 Additional assets written-off pursuant to billion of electric generation-related regulatory assets. The discontinuance of SFAS No. 71 104.818 PUC Restructuring Order allows the Company to recover Other 90,480 $4.9 billion on a discounted basis, or $5.3 billion on a book-Regulatory asset recognized for value basis, of its generation-related stranded costs from recovery until cost-based customers. This results in a net unrecoverable amount of rates cease at December 31,1998 (91,497) $3.1 billion. Total electric generation-related Although the Company is appealing the PUC regulatory assets 2,578,270 Restructuring Order, Management believes that EITF No. 97-4 required it to write off all electric generation-related Total electric generation-related stranded costs for which recovery through rates has not been stranded costs 8,399,249 provided. Accordingly, the Company recorded an extraordi-nary charge at December 31,1997 of $3.1 billion ($1.8 billion Amounts approved for collection net of taxes) of electric generation-related stranded costs that from customers (regulatory asset will not be recovered from customers. pursuant to EITF No. 97-4) (5,274,624) A summary as of December 31,1997 of the electric gen-eration-related stranded costs and the amount of such Total Extraordinary item S 3,124,625 stranded costs written-off by the Company is shown in the f 11 w ng table: e provisions of the PJM Interconnection, LL.C. restructuring order approved by the FERC in November 1997, the Company believes that its wholesale energy sales operations are no longer subject to the provisions of SFAS No. 71. Based on projections of the Company's retail load growth, the Company believes all of its owned generation capacity is necessary to meet its electric retail load. As a result, the dis-continuance of SFAS No. 71 for its wholesale energy sales operations has not resulted in an additional charge against income. The Company believes that its electric transmission and distribution system and gas operations continue to meet the provisions of SFAS No. 71. The Company believes that it is probable that regulatory assets associated with these opera-tions will be recovered.

PfC0 Energy Company and Subsidiary Compznies 32 The Company has adopted SFAS No.128, "Eamings Per available. Under the terms of the various insurance agree. Share," which is designed to simplify the existing computa-ments, the Company could be assessed up to $26 million for tional guidehnes for the earnings per share (EPS) information losses incurred at any plant insured by the insurance compa-provided in financial statements, to revise the disclosure nies. The Company is self-insured to the extent that any requirements and to increase the comparabikty of EPS data losses may exceed the amount of insurance maintained. on an international basis. Pursuant to SFAS No.128, the Such losses could have a material adverse effect on the Company reflected on its Consolidated Statements of income Company's financial condition and results of operations. basic EPS and dilutrve EPS for the years ended December The Company is a member of an industry mutual insur-31,1997,1996 and 1995. Adoption of SFAS No.128 did not ance company which provides replacement power cost impact the amount of EPS reported and there is no differ-insurance in the event of a major accidental outage at a ence in the amounts calculated as basic EPS and dilutive nuclear station. The premium for this coverage is subject to assessment for adverse loss experience. The Company's EPS. maximum share of any assessment is $13 million per year. Nuclear Decommissioning and Spent Fuel Storage

5. Commitments and Contingencies The Company's current estimate of its nuclear facilities' Czpital Commitments decommissioning cost of $1.5 billion in 1997 dollars is being Total capital expenditures, pnmarily for utility plant, are esti-collected through electric rates over the life of each generat-mated to be $600 million in 1998 Due to the expected ing unit. Beginning in 1999, these amounts will be adverse impact of the PUC Restructuring Order and competi-recoverable through transmission and distobution rates, tion for electric generating services on its future capital Under current rates, the Company collects and expenses resources, the Company is currently evaluating its capital approximately $20 million annually from customers. The commitments for 1999 and beyond. Certain facilities under expense is accounted for as a component of depreciation construction and to be constructed may require permits and expense and accumulated depreciation. At December 31, licenses which the Company has no assurance will be grant-1997 and 1996, $294 and $256 million, respectively, was ed. The Company has undertalcen a number of new ventures, included in accumulated depreciation. In order to fund future principally through its Telecommunications Group, some of decommissioning costs, at December 31,1997 and 1996, the which require significant cash commitments. For 1998, the Company held $320 and $266 million, respectively, in trust Company's expected capital expenditures include approxi-accounts which are included as an investment in the mately $150 million in such ventures.

Company's Consolidated Balance Sheet and include both net The Company's operations have in the past and may in unrealized and realized gains. Net unrealized gains of $43 and the future require substantial capital expenditures in order to $26 million were recognized as a Deferred Credit in the comply with environmental laws. Company's Consolidated Balance Sheet at December 31, 1997 and 1996, respectively. The Company recognized net Nuclear Insurance realized gains of $11, $10 and $9 million as Other Income in The Price-Anderson Act currently limits the liability of nuclear the Company's Consolidated Statement of Income for the reactor owners to $8.9 billion for claims that could arise frc m years ended December 31,1997,1996 and 1995, respective-a single incident. The hmit is subject to change to account for ly. The Company believes that the amounts being recovered the effects of inflation and changes in the number of licensed from customers through electric rates will be sufficient to reactors. The Company cames the maximum available com-fully fund the unrecorded portion of its decommissioning mercial insurance of $200 milhon and the remaining $8.7 obhgation bilhon is provided through mandatory participation in a finan-In an Exposure Draft issued in 1996, the FASB proposed cial protection pool. Under the Price-Anderson Act, all nuclear changes in the accounting for closure and removal costs of reactor licensees can be assessed up to $79 million per reac-production facilities, including the recognition, measurement tor per incident, payable at no more than $10 million per and classification of decommissioning costs for nuclear gen-reactor per incident per year. This assessment is subject to erating stations. The FASB has expanded the scope of the inflation and state premium taxes. In addition, Congress Exposure Draft to include closure or removal liabilities that could impose revenue raising measures on the nuclear indus-are incurred at any time during the operating life of the relat-try to pay claims. ed long-lived asset. The FASB has decided that it should The Company carries property damage, decontamination proceed toward either a final Statement or a revised and premature decommissioning insurance in the amount of Exposure Draft. The timing of this project is still to be deter-its $2.75 billion proportionate share for each station loss mined. If current electric utihty industry accounting practices resulting from damage to its nuclear plants. In the event of for decommissioning are changed, annual provisions for an accident, insurance proceeds must first be used for reac-decommissioning could increase and the estimated cost for tor stabihzation and site decontamination. If the decision is decommissioning could be recorded as a liabihty rather than m:de to decommission the f acility, a portion of the insurance as accumulated depreciation with recognition of an increase proceeds will be allocated to a fund, which the Company is in the cost of a related regulatory asset. required by the Nuclear Regulatory Commission (NRC) to Under the Nuclear Waste Policy Act of 1982 (NWPA), the m:intain, to provide for decommissioning the facility. The U.S. Department of Energy (DDE) is required to begin taking Company is unable to predict the timing of the availability of possession of all spent nuclear fuel generated by the insurance proceeds to the Company for the Company's bond-Company's nuclear units for long-term storage by no later holders, and the amount of such proceeds which would be than 1998. Based on recent public pronouncements, it is not

Notes to Consolidated Financial Statzments 33 likely that a permanent disposal site will be available for the in the wholesale market, the Company has increased its industry before 2015, at the earliest. In reaction to state-sales to other utilities, but increased competition has reduced ments from the DOE that it was not legally obligated to begin the Company's profit margins on these sales. At December to accept spent fuel in 1998, a group of utilities and state 31,1997, the Company had entered into long-term agree-government agencies filed a lawsuit against the DOE which ments with unaffiliated utilities to sell energy associated with resulted in a decision by the U.S. Court of Appeals for the 4,280 MW of capacity, of which 540 MW of these agree-Cistrict of Columbia (D.C. Court of Appeals) in July 1996 that ments are for 1998,1,700 MW are for 1999 through 2002 the DOE had an unequivocal obligation to begin to accept and the remaining 2,040 MW extend through 2022. spent f uel in 1998. In accordance with the NWPA, the Company pays the DOE one mill ($.001) per kilowatthour of EnvironmentalIssues net nuclear generation for the cost of nuclear fuel disposal. The Company's operations have in the past and may in the This fee may be adjusted prospectively in order to ensure full future require substantia; capital expenditures in order to cost recovery. Because of inaction by the DOE following the comply with environmental laws. Additionally, under federal D.C. Court of Appeals finding of the DOE's obligation to begin and state environmental laws, the Company is generally liable receiving spent fuel in 1998, a group of forty-two util:ty com-for the costs of remediating environmental contamination of panies, including the Company, and forty-six state agencies, property now or formerly owned by the Company and of filed suit against the DOE seeking authorization to suspend property contaminated by hazardous substances generated further payments to the U.S. govemment under the NWPA hy the Company. The Company owns or leases a number of and to deposit such payments into an escrow account until real estate parcels, including parcels on which its operations such time as the DOE takes effective action to meet its 1998 or the operations of others may have resulted in contamina-obligations. In November 1997, the D.C. Court of Appeals tion by substances which are considered hazardous under issued a decision in which it held that the DOE had not abid-environmental laws. The Company is currently involved in a ed by its prior determination that the DOE has an number of proceedings relating to sites where hazardous unconditional obligation to begin disposal of spent nuclear substances have been deposited and may be subject to addi-fuel by January 31,1998. The D.C. Court of Appeals also pre-tional proceedings in the future. ciuded the DOE from asserting that it was not required to The Company has identified 27 sites where former begin receiving spent nuclear fuel because it f.ad not yet pre-manufactured gas plant (MGP) activities have or may have pared a permanent repository or an interim storage facility. resulted in actual site contamination. The Company is The DOE and one of the utility companies have filed a presently engaged in performing various levels of activities Petition for Reconsideration of the decision. The U.S. House at these sites, including initial evaluation to determine the of Representatives and the U.S. Senate passed separate bills existence and nature of the contamination, detailed evalua-in 1997 authorizing construction of a temporary storage facili-tion to determine the extent of the contamination and the ty which could accept spent nuclear fuel from utilities in necessity and porsible methods of remediation, and imple-2003. In addition, the DOE is ex, loring other options to mentation of remediation. The Pennsylvania Department of address delays in the waste acceptance schedule. Environmental Protection has approved the Company's Peach Bottom has on-site facilities with capacity to store clean-up of two sites. Six other sites are currently under spent nuclear fuel discharged from the units through 2000 for some degree of active study and/or remediation. Unit No. 2 and 2001 for Unit No. 3. Life-of-plant storage As of December 31,1997 and 1996, the Company had capacity will be provided by on-site dry cask storage facilities, eccrued $63 and $28 million, respectively, for environmental the construction of which will begin in 1998. Limerick has on-investigation and remsdiation costs, including $35 and $16 site facilities with capacity to store spent nuclear fuel to million, respectively, for MGP investigation and remediation, 2007. Salem has on-site facilities with spent fuel storage that currently can be reasonably estimated. The Company capacity through 2008 for Unit No.1 and 2012 for Unit No. 2. cannot predict whether it will incur other significant liabilities Public Service Electric and Gas Company (PSE&G) is the for additional investigation and remediation costs at these or operator of Salem, which is 42.59% owned by the Company. additional sites identified by the Company, environmental agencies or others, or whether such costs will be recoverable Energy Commitments from third parties. a The Company's electric utility operations include the whole-sale marketing of electricity. At December 31,1997, the Shutdown of Salem Generating Station Cornpany had long-term commitments relating to the pur-PSE&G removed Salem Units No.1 and No. 2 from service in chase from unaffiliated utilities and others energy associated the second quarter of 1995 and informed the NRC at that with 1,330 MW of capacity in 1998, with 2,540 MW of cap:,ci-time that it had determined to keep the Salem units shut ty during the period 1999 through 2002 and with 2,430 MW of down pending review and resolution of certain equipment c pacity thereafter. During 1997, purchases under long-term and management issues and NRC agreement that each unit commitments resulted in expenditures of $311 million. As of is sufficiently prepared to restart. Unit No. 2 retumed to ser-December 31,1997, these purchases result in commitments vice on August 30,1997, and PSE&G estimates the restart of of approximately $240 million for 1998, $620 million for 1999 Unit No.1 to occur late in the first quarter of 1998. For the through 2002 and $830 million thereafter. These purchases years ended December 31,1997,1996 and 1995, the will be utilized through a combination of sales to jurisdictional Company incurred and expensed approximately $152, $149 customers, long-term sales to other utilities and open market and $50 million of shutdown-related replacement power and sales. Under some of these contracts, the Company may pur-maintenance costs, respectively (see note 21). chase, at its option, additional power as needed.

. PECO Energy Company and Subsidiary Companies l St I Tdecommunications Litigation The Company periodically reviews its irvestments to The Company is involved in various other litigation matters. d;termine that they are properly valued in its financial state-The ultimate outcome of such matters, while uncertain, is not ments. Due to circumstances involved in the Federal expected to have a material adverse effect on the Company's Communication Commission's auctioning of the personal financial condition or results of operations. communications systems "C-block" licenses, the Company . has determined that $20 million of its telecommunications investments were impaired at December 31,1997. Accordingly, at December 31,1997, the Company incurred a $20 million charge against Other income and Deductions to write off this telecommunications investment.-

6. Retirement Benefits.

The Company and its subsidiaries have a non contributory trusteed retirement plan applicable to all regular employees. The ben-' efits are based primarily upon employees' years of service and average earnings prior to retirement. The Company's funding policy is to contribute, at a minimum, amounts sufficient to meet the Employee Retirement income Security Act requirements. Approximately 89%,80% and 74% of pension costs were charged to operations in 1997,1996 and 1995, respectively, and the remainder, associated with construction labor, to the cost of new utility plant. Pension costs for 1997,1996 and 1995 included the following components: 1997 1996 1995 Thousands of Dollars Service cost benefits eamed during the period S 25,368 27,627 19,710 Interest cost on projected benefit obligation 150,057 145,570 147,261 Actual return on plan assets (377,803) (320,247) (456,057) Amortization of transition asset (4,538) (4,538) (4,538) Amortization and deferral 1?7,480 154,402 300.214 Net pension cost - S (9,436) 2.814 6.590 The changes in net periodic pension costs in 1997,1996 and 1995 were as follows:. 1997 1996 1995 ~ Thousands of Dollars Change in number, characteristics and salary levels of participants and net actuarial gain 5 (7,839) (12,893) 1,486 Change in plan provisions 3,118 (8,305) Change in actuarial assumptions (7,529) 9.117 (3,136) Net change (12,250) (3,776) (9.955) Plan assets consist principally of common stock, U.S. govern- - 1996 and 7.25% at December 31,1995. The average rate of ment obligations and other fixed income instruments. In increase in future compensation levels ranged from 4% to determining pension costs, the assumed long term rate of 6% et December 31,1997,1996 and 1995. . return on assets was 9.5% for 1997,1996 and 1995. Prior service cost is amortized on a straight-line basis The weighted-average discount rate used in determining over the average remaining service period of employees the actuarial present value of the projected benefit obligation expected to receive benefits under the plan, was 7.25% at December 31,1997,7.75% at December 31,

Notes to Consolidated financti Stat:ments 33 The funded status of the plan at December 31,1997 and 1996 is summarized as follows: 1997 1996 Thousands of Dollars Actuarial present value of accumulated plan benefit obligations: Vested benefrt obligation 8 1,794,222 1,657,098 Accumulated benefit obligation 1,890,848 1,742,116 Projected benefit obligation for services rendered to date 2,141,040 1,982,915 Plan assets at fair value (2,538,039) (2,302,935) Funded status (396,999) (320.020) Unrecognized transition asset 35,713 40,251 Unrecognized prior service costs (83,188) (92,682) Unrecognized net gain 649,903 588,013 Pension obligation recognized on the balance sheet 8 205,429 215.562 e 7 ' Non-Pension Postretirement Benefits The Company provides certain health care and life insurance The transition obligation was determined by application benefits for retired employees. Company employees of the terms of medical, dental and life insurance plans, become eligible for these benefits if they retire from the including the effects of established maximums on covered Company with ten years of service. These benefits and simi-costs, together with relevant actuarial assumptions and lar benefits for active employees are provided by an health care cost trend rates, which are projected to range insurance company whose premiums are based upon the from 7% in 1998 to 5% in 2002. The effect of a 1% annual benefits paid during the year. increase in these assumed cost trend rates would increase The transition obligation, which represents the previously the accumulated postretirement benefit obligation by $85 mil-unrecognized accumulated non-pension postretirement bene-lion and the annual service and interest costs by $10 million. fit obligation, is being amortized on a straight-line basis over Total costs for all plans were $73 million in 1997 and $71 an allowed 20-year period. At December 31,1997, the million in 1996 and 1995. Company accelerated recognition of $121 million of its non-pension postretirement benefits obligation related to its electric generation operations and included this regulatory asset as part of electric generation < elated regulatory assets (see note 4). l I The net periodic benefits costs for 1997,1996 and 1995 included the following components: 1995_ 1997 1996 Thousands of Dollars l l Service cost benefits eamed dunng the period 14,401 11,855 8,681 Interest cost on projected benefit obligation 54,149 48,524 48,641 Amortization of transition asset 14,882 14,882 14,882 Actual return on plan assets (22,691) (13,257) (2,075) Deferred asset gain 12,707 9,320 1,359 Net postretirement benefits costs 8 73,448 71,324 71,488 Plan assets consist principally of common stock, U.S. govern-was 7.75% at January 1, 1997, 7.50 % at January 1,1996 ment obligations and other fixed income instruments. In and 8.50% at January 1,1995. The average rate of increase determining non-pension postretirement benefits costs, the - in future compensation levels ranged from 4% to 6% at assumed long-term rate of retum on assets was 8% for December 31,1997,1996 and 1995. 1997,1996 and 1995. Prior service cost is amortized on a straight-line basis The weighted-average discount rate used in determining over the average remaining service period of employees the actuarial present value of the projected benefit obligation expected to receive benefits under the plan. I i

r ?36 PECO Energy Company and Subsidiary Companies The funded status of the plan at December 31,1997 and 1996 is summarized as follows: 1907 1996 Thousands of Dollars Accumulated postretirement benefit obligation: Retirees S 697,084 5 609,206 Fully eligible active plan participants 8,875 4,509 Other active plan participants 73,272 48,986 ' Total 779,231 '662,701 Plan assets at fair value ' (178,045) (126,661)- Accumulated postretirement benefit obligation in excess of plan assets 601,186 536,040 ~ Unrecognized transition obligation (223,226) (238,108) Unrecognized net gain (53,110) 17,126 Accrued postretirement benefits obligation recognized on the balance sheet 324,860 315.058 Measurement of the accumu!ated postretirement benefits obligation was based on a 7.25% and 7.75% assumed discount rate as of December 31,1997 and 1996, respectively. 8.' Accounts Receivable Accounts receivable at December 31,1997 and 1996 includ-The Ccimpany is party to an agreement with a financial ed unbilled operating revenues of $135 and $117 million, institution under which it can sell or finance with limited respectively. Accounts receivable at December 31,1997 and ' recourse an undivided interest, adjusted daily, in up to $425 mih 1996 were net of an allowance for uncollectible accourts of lion of designated accounts receivable until November 2000. At $32 and $24 million, respectively. December 31,1997, the Company had sold a $425 million inter-The Company has adopted SFAS No.125, " Accounting est in accounts receivable, consisting of a $296 million interest . for Transfers and Servicing of Financial Assets and in accounts receivable which the Company accounts for as a Extinguishments of Liabilities," which provides a standard for sale under SFAS No.125 and a $129 million interest in special distinguishing between transfers of financial assets that are agreement accounts receivable which were accounted for as a accounted for as sales from those that are accounted for as long-term note payable (see note 12). The Company retains the secured borrowings. servicing responsibility for these receivables.

9. Common Stock At December 31,1997 and 1996, common stock without par agreements can be settled is dependent principally upon the value consisted of 500,000,000 shares authorized and market price of the Company's common stock as compared

~ 222,546,562 and 222,542,087 shares outstanding, respective-to the forward purchase price per share and the number of ly. At December 31,1997, there were 5.800,841 shares shares to be settled. If these agreements had been settled reserved for issuance under the Company's Dividend on a net share basis at December 31,1997, based on the - Reinvestment and Stock Purchase Plan. closing price of the Company's Common Stock on that date, the Company would have received approximately 1,160,000 ~ Stock Repurchase. shares of Company common stock. During 1997, the Company's Board of Directors authorized the repurchase of up to 25 million shares of its common Long-Term Incentive Plan (LTIP) . stock from time to time through open-market, privately nego-The Company maintains an LTIP for certain full-time salaried a tiated and/or other types of transactions in conformity with employees of the Company. The types of long-term incentive. the rules of the Securities and Exchange Commission. awards which have been granted under the LTIP are non-quali- . Pursuant to these authorizations, the Company has fied options to purchase shares of the Company's common entered into forward purchase agreements to be settled from stock,. dividend equivalents and shares of restricted common time to. time, at the Company's election, on either a physical, stock. The Company uses the disclosure-only provisions of . net share or net cash basis. The amount at which these SFAS No.123, " Accounting for Stock-Based Compensaticn. .x

Notes to Consolidated Financial St:t:rnents 37 L l if the Company elected to account for the LTIP based on SFAS No 123, earnings applicable to common stock and earnings per average common share wou'd have been changed to pro forma amounts as follows: 1997 1996 Thousands of Dollars Earnings applicable to common stock As reported S (1,513,910) 499,169 Pro forma $ (1,615,895) 497,887 i Earnings per average common share (Dollars) As reported (6.80) 2.24 l Pro forma (6.81) 2.24 l l Options granted under the LTIP become exercisable one year after the date of grant and all options expire 10 years from the date of the grant. Information with respect to the LTIP at December 31,1997 and changes for the three years then ended, is as follows Weighted Weighted Weighted l e Average Average Average Exercise Exercise Exercise Price Pnce Prico Shores (per ehere) Shares (per share) Shares (per share) l ._ 1887 _ _ _ 1997 1996 _, _ _ 1996_ 1995 1995_ Balance at January 1 2,961,194 8 26.68 2,591,765 $ 26.16 2.651,397 $ 26.73 Options granted 1,139,000 22,49 786,500 28.12 850,700 29.46 l (369,871) 25.07 (561,232) 73.91 Options exercised _ 283,4001 24.96 (47,200) 29 36 (349,100) 05.57 Options cancelled ( Balance at December 31 3,816,794 26.14 2.961,194 26.68 2,591,765 26.16 ~7192,694 26.17 1,813.565 25.91 Exercisable at December 31 2,800,794 26.66 2 Weighted average fair value of options granted during year 8 2.97 2.78 2.91 The fair value of each option is estimated on the date of the grant using the Black-Scholes option-pricing model, with the follow-ing weighted everage assumptions used for grants in 1997,1996 and 1995, respectively: ~. _ _, _. -.. _ _ _ _ _ _ _ _._ _. 1997 _ _1996 _ _ 1995_ Dividend yield 6.2% 6.2 % 6.2% Expected volatility 19.5 % 16.6 % 15.3 % Risk-free interest re'e 6.4 % 5.5% 6.9% Expected life (years) 5 5 5 At December 31,1997, the option groups outstanding based on ranges of exercise prices is as follows: _ _ _ _._. _ Options Outstanding _ _ _ _ _ _ _, Opt,ons Exercisable Weighted-Average Weighted Weighted-Remaining Average Average Number Contractual 1.ife Exercise Number Exercise Range of Exercise Prices Outstanding (Years) Pnce Exercisable Pnce $15.75 $20.00 156,094 4.47 $ 18.65 117,594 $ 18.43 $20.01 - $25.00 863,500 8.23 22.35 153,000 22.66 $25.01 - $30.00 2,607,000 6.72 27.32 2,518.000 27.22 $30.01 $50 00 190.200 9.58 33.27 12,200 37.18 Total 3.816.794 2.800.794

38 PECO Energy Company and Subsidiary Companies.

10. Preferred and Preference Stock At Decembar 31,1997 and 1996, Series Preference Stock consisted of 100,000,000 shares ' authorized, of which no shares were outstanding. At December 31,1997 and 1996, cumulative Preferred Stock no par value, consisted of 15,000,000 shares authorized.

Current Shares Arnount Redempton Outstanding Thousands of Dollars Price!al 1M7 1996 1M7 1996_ . Ssries (without mandatory redemption) $4.68 104.00 150,000 150,000 8 15,000 $ 15,000 $4.40 112.50 274,720 274,720 27,472 27,472 $4.30 102.00 150,000 150,000 15,000 15,000 $3.80 106.00 300,000 300,000 30,000 30,000 61,895 618,954 $7.96 $7.48 (b) 500,000_ 500,000 50,000_ 50,000 1,374,720 1,993,674 137,472 199,367 Series (with mandatory redemption) $6.12 (c) 927 00 _0 927,000_ 92,700 92,700 2 Total preferred stock 2,301,720 2.920,674 8 230,172 $ 292.067 (a) Redeemable, at the option of the Company, at the indicated dollar amounts per share, plus accrued dividends. -(b) None of the shares of this series are subject to redemption prior to April 1,2003. (c) - There are no annual sinking fund requirements in 1998. Annual sinking fund requirements in 1999 - 2003 are $18,540,000. ' %ne of the shares of this series are subject to redemption prior to August 1,1999.

11. Company Obligated Mandatority Redeemable Preferred Securities of a Partnership (COMRPS)

' At December 31,1997 and 1996. PECO Energy Capital, LP. Partnership, which bear interest at rates equel to the distribu-(Partnership), a Delaware limited partnership of which a whol-tion rates on the secunties. The interest paid by the ly owned subsidiary of the Company is the sole general Company on the debentures is included in Other income and partner, had outstanding three and two series, respectively, Deductions in the Consolidated Statements of income and is of cumulative COMRPS, each with a liquidation value of $25 deductible for income tax purposes. per security, Each series is supported by the Company's deferrable interest subevdinated debentures, held by the Amount Mandatory Redempton Distnbuten Trust Receipts Outstanding Thousands of Dollars At pecember }1 pate Rate 1ML19961M71996_ Smes A 2043 9.00 % E,850,000 8.850,000 $ 221,250 $ 221,250 B(a) 2025 8.72 % 3,124,183 3,124,183 80,835 80,932 C(b) 2037 8.00 %,, 2.,000,00 _0 50,000 Total 13,974,183 11.974.183 $ 352,085 $ 302.182 (a) Ownership of this series is evidenced by Trust Receipts, (b) Ownership of this series is evidenced by Trust Receipts, each representing an 8.72% CO*ARPS, Series B, repre-each representing an 8.00% COMRPS, Series C. repre-senting limited partnership interests. The Trust Receipts senting limited partnership interests. The Trust Receipts were issued by PECO Energy Capital Trust I, the sole were issued by PECO Energy Capital Trust II, the sole assets of which are 8.72% COMRPS, Series B. Each assets of which are 8.00% COMRPS, Series C. Each holder of Trust Receipts is entitled to withdraw the corre-holder of Trust Receipts is entitled to wit oraw the corre-sponding number of 8.72% COMRPS, Series B from the sponding number of 8.00% COMRPS, Sei

C from the Trust in exchange for We Trust Receipts so held.

Trust in exchange for the Trust Receipts so i. eld.

Notes to Consolidated Finandal Stat:ments 39 12, Long-Term Debt At Decernber 31, Senes Due 1997 1996 Thouends of Dollarn S 75,000 First and refunding mortgage bonds (a) 61/8 % 1997 8 53/8 % 1998 225,000 225,000 71/2%91/4 % 1999 325,000 325,000 55/8 73/8 % 2001 330,000 330,000 71/8W8 % 2002 500,000 500,000 63/8%-101/4 % 2003-2007 565,625 569,688 (b) 2008-2012 154,200 154,200 6 5/8W8 3/4% 2018-2022 832,130 832,130 71/8&73/4% 2023-2024 775,000 775,000 Total first and refunding mortgage bonds 3,706,955 3,786,018 Notes payable 15,574 175,000 Tzrm loan agreements (c) 1997 Pollution control notes (d) 2016-2034 212,705 212,705 - Medium-term notes (e) 1998-2005 62,400 74,400 Note payable - accounts receivable agreement (f) 2000 128,999 Unamortized debt discount and premium, net (26,405) (29,306) Totallong-term debt 4,100,228 4,218,817 Due within one year (g) 247,087 283,303 Long-term debt included in capitalization (h) $ 3,853,141 $ 3.935.514 (a) Utility plant is subject to the lien of the Company's (e) Medium-term notes collateralized by mortgage bonds. mortgage. The average annual interest rate was 8.75% at (b) Floating rates, which were en average annual interest December 31,1997. rate of 3.725% at December 31,1997. (f) See note 8. (c) The Company has a $900 million unsecured revolving (g) Long-term debt maturities, including mandatory sinking credit facility with a group of banks. The credit facility is fund requirements, in the period 1998-2002 are as fol-composed of a $450 million 364-day credit agreement lows: 1998 - $247,087,409; 1999 $361,945,982; and a $450 million three-year credit agreement. The 2000 - $137,129,159; 2001 - $338,433.453; Company uses the credit facility principally to support the 2002 - $508,759,067. Company's commercial paper program, which was (h) The annualized interest on long-term debt at December expanded from $300 million to $600 million in 1997. 31,1997, was $286 million, of which $269 million was There was no debt outstanding under this credit facility associated with mortgage bonds and $17 million was at Deceniber 31,1997, associated with other long-term debt. (d) Floating rates, which were an average annual interest rate of 3.75% at December 31,1997,

23. Short Term Debt Thousands of Dollars Average borrowings 248,111 198,090 17,560 Average interest rates, computed on daily basis 5.83 %

5.64 % 6.25 % Maximum borrowings outstanding 8 464,500 369,500 182,000 Average interest rates, at December 31 6.74% 6.90 % The Company has a $600 million commercial paper program which is supported by the $900 million revolving credit facility (see ' note 12). At December 31,1997, $314 million of commercial paper was outstanding. At December 31,1997, the Company had formal and informal lines of credit with banks aggregeting $75 million. At December 31,1997, no short-term debt was outstand-ing under these lines, t. 1

i 40 PECO Energy Company and Subsidiary Companies 14, Income Taxes income tax expense (benefit) is comprised of the following components: For the Years Ended Decernber 31, 1997 1996 1995 Thousands of Dollars included in operations: Federal Current 251,509 126,471 190,796 Deferred ' (11,378) 154,564 167,526 Investment tax credit, net (18,201) (15,979) (21,679) State Current 76,689 62,839 79,086

Deferred (5,850) 12,206 15,988

+ 292,789 340,101 431,717 included in extraordinary item: Federal Cur' rent (124s Deferred (987,234) State-. Current (29) Deferred (303,575) (1,290,961) Total 8 (998,192) 340,101 431,717 The total income tax provisions, excluding the extraordinary item, differed from amounts computed by applying the federal statutory tax rate to income as follows: 1997 1906 1995 Thousands of Dollars Net income s 336,558 517,205 609,732 Total income tax provisions 292,769 340,101 431,717 income before income taxes S 629,327 857,306 1,041,449 Income taxes on above at federal statutory rate at 35% 220,264 300,057 364.507 increase (decrease) due to: Property basis differences 40,828 9,903 11,196 State income taxes, net of federal income tax benefit 46,046 48,779 61,799 Amortization of investment tax credit (18,201) (15,979) (13,604) Prior period income taxes (2,985) (1,707) 1,791 Other, net ' 6,817 (952) 6,028 . Totalincome tax provisions S 292,769 340,101 431,717 Effective income tax rate 46.5 % 39.7 % 41.5 % 1 i l

Notes to Consolidated firendal Statements : 41 Provisions f' or deferred income taxes consist of the tax effects of the following temporary differences: 1997 1996 1995 Thousands of Dollars Depreciation and amortization 8 57,530 42,385 32.287 Deferred energy costs - 2,256 27,374 30,073 Retirement and separation programs (12,734) 19,746 15,733 incremental nuclear outage costs (981) 2,440 8,079 Uncollectible accounts (1,710) (2,805) (1,991) Reacquired debt (8,607) (9,578) (3,266) Unbilled revenue (5,110) 3,910 (5) Environmental clean-up costs (15,121) (714) 2,433 Obsolete inventory (7,074) 5,829 6,362 Limerick plant disallowances and phase-in plar. (747) (747) 2,507 83,010 91,399 AMT credits Other nuclear operating costs (9,892) Other (15,038) (4,080) (97) Subtotal 8 (17,228) 166,770 183,514 Extre, Cry item (1,290,809) W $ (1,308,037) 166.770 183.514 The tax effect of temporary differences giving rise to the Company's net deferred tax liability as of December 31,1997 and 1996 is as follows: Liability or (Asset) 1997 1996 Thousands of Dollars Nature of temporary difference: Plant basis difference 8 2,620,254 3,795,786 Deferred investment tax credit 318,065 336,132 Deferred debt refinancing costs 111,651 120,031 Other, net (249,167) (167,830) Deferred income taxes (net) on the balance sheet S 2,800,803 4.024.119 The not deferred tax liability shown above as of December 31,1997, $1,763 million of electric generation-related recover-31,1997 and 1996 is comprised of $3,153 and $4,347 million able deferred income ta.<es were included as part of electric of deferred tax liabilities, and $352 and $263 million of generation related regulatory assets (see note 4). deferred tax assets, respectively. The Internal Revenue Service (IRS) has completed and -In accordance with SFAS No. 71, the Company recorded settled its examinations of the Company's federal income tax a recoverable deferred income tax asset of $586 and $2,322 returns through 1986. The 1987 through 1990 federal income million at December 31,1997 and 1996, respectively. The tax returns have been examined and the Company and the December 31,1997 balance was applicable only to non-elec-IRS have reached a tentative settlement which would not tric generation assets, due to the discontinuance of SFAS No. result in an adverse impact on the Company. The years 1991 71 for the Company's electric generation operations. These through 1993 are currently being examined by the IRS. recoverable deferred income taxes include the deferred tax The AMT credit was fully utilized for tax purposes at effects associated principally with liberalized depreciation December 31,1997, and reduced federal income taxes cur-accounted for in accordance with the ratemaking policies of rently payable by $6 million in 1997. the PUC, as well as the revenue impacts thereon, and assume recovery of these costs in future rates. At December

i 42' PECO Entrgy Company and Subsidiary Companies i 25, Taxes, Other Than Income - Operating Ftr the Years Ended December 31, 1997 1996 1995 Thousands of Dollars Gross receipts -S 163,552 160,246 165,172 Capital stock. 48,005 41,972 42,444 Rral estate 89,597 69,185 71,600 ' Payroll 25,976 27,585 30,109 Other 2,881 558 4,746 ' Total 8 310,091 299.546 314,071

16. Leases Leased property included in utility plant was as follows:

At December 31, 1997 1996 Thousands of Dollars Nuclear fuel 8 521,921 5 527,116 Electric plant 2,321 2,069 Gross leased property 524,242 529,185 Accumulated amortization (348,309) (347,097) Net leased property 8 175,933 182,088 Nuclear fuel is amortized as the fuel is consumed. Arnortization of leased property totaled $39, $31 and $43 million for the years ended December 31,1997,1996 and 1995, respectively. Other operating expenses included interest on capital lesse obligations of $9 million in 1997 and 1996, and $10 million in 1995. Minimum future lease payments as of December 31,1997 were: i [3L(he Ygars Egng December 31, Capital Leases Operating Leases Total Thousands of Dollars 1998 69,820 50,584 14 404 1999 68,530 49,370 117,900 2000 43,827 45,923 89,750 2001 10,892 43,219 54,111 2002 92 42,327 42,419 Remaining years 806 537,645 538,451 Total minimum future lease payments 193,967 769.068 963.035 imputed interest (rates ranging from 6.5% to 17.0%) (18,034) Present value of net minimum future lease payments 175.933 e Rental expense under operating leases totaled $74 million in 1997 and 1996, and $115 million in 1995. f . a

Notes to Consolidated Fir ncial Statements 43

17. Jointly Owned Electric Utility Plant The Company's ownership interests in jointly owned electric utility plant at December 31,1997 were as follows:

Transmission Production Plants and Other Plant Peach Bottom Salem Keystone Conemaugh_ Pubhc Service GPU GPU PECO Energy Electnc and Generatog Generating Vanous Companies Oper,ator Company Gas Company Corp. Corp. _ Participating interest 42.49 % 42.59 % 20.99 % 20.72 % 21% to 43% .- Company's share trhousands orDolierst Utility plant $ 307,029 18,331 $ 110,661 $ 184,037 $ 81,072 ' Accumulated depreciation 175,304 11,134 66,487 78,605 31,273 Construction work in progress 50,208 713 10,067 9,100 1,943 e The Company's participating interests are financed with Company funds and, when placed in service, all operations are account-ed for as if such participating interests were wholly owned facilities. e

18. Cash and Cash Equivalents '

For purposes of the Statements of Cash Flows, the Company considers all highly liquid debt instruments purchased with a mGturity of three months or less to be cash equivalents. The following disclosures supplement the accompanying Statements of Cash Flows: 1997 1996 1995 Thousands of Dollars Cash paid during the year: Interest (net of amount capitalized) S 405,838 415.063 449,664 Income taxes (net of refunds) 345,232 251,554 257,677 Noncash investing and financing: Capital lease obligations incurred 32,909 33,063 48,760

19. Investments At December 31, 1997 1996 Thousands of Dollars Trust accounts for decommissioning nuclear plants S

320,442 266,270 Telecommunications ventures 85,601 79,833 Energy services and other ventures 65,578 44,023 Nonutility property 24,697 26.349 Other 19,517 16,099 Total s 515,835 432,574

20. Financial Instruments Fair values of financial instruments, including liabilities, are estimated based on quoted market prices for the same or similar e

issues. The carrying amounts and fair values of the Company's financial instruments as of December 31,1997 and 1996 were as follows: -.h. o. u. s.a.n.d. s o. f D.ol.lars' 1997 199.6 T Amount. Value Amount VaJue_ ' Cash and temporary cash investments S 33,404 8 33,404 $ 29,235 $ 29,235 Long-term debt (including amounts due within one year) 4,100,228 4,210,885 4,218,817 4,239,357 ' Trust accounts for decommissioning nuclear plants 320,442 320,442 2f'.S 270 266,270 Financial instruments which potentially subject the Company may be in excess of the Federal Deposit Insurance . to Concentrations of credit risk consist principally of temporary . Corporation limit, Concentrations of credit risk with respect to cash investments and customer accounts receivable'. The customer accounts receivable are limited due to the Company places its temporary cash investments with high-Company's large number of customers and their dispersion credit quality financial institutions. At times, such investments across many industries.

- 44 PECO Energy Company and Subsidiary Cornpanies

21. Other Income Settlement of Salem Litigation Sale of Subsidiary -

On December 31,1997, the Company received $70 million in June 1995, the Company completed the sale of pursuant to the May 1997 settlement agreement with Conowingo Power Company to Delmarva Power & Light i PSE&G resolving a suit filed by the Company conceming the Company (Delmarva) for $150 million. The transaction also shutdown of Salem. The agreement also provides that if the included a ten-year contract for the Company to sell power to I outage exceeds 64 reactor unit months, PSE&G will pay the Delmarva. The Company's gain of $59 million ($27 million net Company $1 million per reactor unit month. As of December of taxes) on the sale was recorded in the second quarter of j 31,1997, the shutdown of Salem totaled 58 reactor unit 1995. months During the second quarter of 1997, the Company recorded $70 million ($41 million net of income taxes) as Other income.

22. Regulatory Assets and Liabilities At December 31,1997 and 1996, the Company had deferred the following regulatory assets on the Consolidated Balance Sheet:

1997 1996 Thousands of Dollars Competitive transition charge (see note 4) 5,274,624 Recoverable deferred income taxes (see note 14) 585,661 2,321,692 Deferred generation costs recoverable in current rates (see note 4) 424,497 361,762 Deferred Limerick costs (see note 3) Loss on reacquired debt 83,918 283,853 Compensated absences 3,881 37,727 Dsferred energy costs (see note 3) 35,665 122.034 Non-pension postretirement benefits (see note 3) 97,409 233,492_ Total 8 6,505,655 3.360.560

23. Quarterly Data (Unaudited)

The data shown below include all adjustments which the Company considers necessary for a fair presentation of such amounts: Operating Revenues Operating income Net income (Lossi Md/ sons of Do/lars 1997 1996 1997 1996 1997 1996 Quarter ended March 31 S 1,163 $ 1,171 8 302 $ 357 $ 113 $ 150 June 30 1,032 989 250 267 123 99 September 30 1,278 1,110 388 347 158 150 December 31 1,144 1,014 66 278 (1,891) 118 Earnings Apphcable Average Shares Earnings to Q,omrnon Stock Outstanding Per Aerage Share _Mdhons of Dollars _ 1997 1996 1997 1996 1997 1996_ Quarter ended March 31 S 109 $ 146 222.5 222.4 $ 0.49 0.65 June 30 118 94 222.5 222.5 0.53 0.43 September 30 154 145 222.5 222.5 0.69 0.65 December 31 (1,895) 114 222.5 222.5 (8.51) 0.51 Th3 d'ecrease in 1997 first quarter results was primarily due The decrease in 1997 fourth quarter results was primarily to increased fuel and energy ' interchange expersse resulting. due to the extraordinary charge of $8.24 per share resulting primarily from additional purchases needed for increased from the effects of the PUC Restructuring Order and deregu-sales to other utilities and higher replacement power costs lation of the Company's electric generation operations; - due to the Salem outage, milder weather and increased . several one-time adjustments for changes in employee depreciation of assets associated with Limerick. benefits, write 4ffs of information systems development . The increase in 1997 second quarter results was primari-charges reflecting clarification of accounting guidelines and ly due to the recognition of the settlement of litigation arising additional reserves to revise estimates for accruals; higher from the Salem outage. Offsetting this increase was higher income tax adjustments; and higher losses from the = depreciation of assets associated with Limerick. - Company's non-utility ventures.

. Notes to Consolidated finandal Statements 65 Financial Statistics Summary of Earnings and Finandal Condition [ '?*l**l.81"L*d2*f*9 31- "L _ __ls96_,_, '1995 N 1993 1992 Millions of Dollars Income Data - Operating Revenues 8-4,618 $ 4,284 $ 4,186 $ 4,041 $ 3,988 $ 3,963 Operating income 1,006 1,249 1,401 1,064 1,390 1,298 income before Extraordinary item 337 517 610 427 591-479 e Extraordinary item (net of income taxes) (1,834) Net income (1,497) 517 610 427 591 479 Eamings Applicable to Common Stock Before Extraordinary item - (1,514) 499 587 389 542 418 Eamings per Average Common Share Before Extraordinary item roollars/ 1.44 2.24 2.64 1,76 2.45 1.90 Extraordinary item Iver shares (8.24) Earnings per Average Cornmon Share (6.80) 2.24 2.64 1.76 2.45 1.90 ' Dividends per Common Share (Dollars) 1.80 1.755 1.65 1.545 1.43 1.325 Common Stock Equity (Per share) 12.25 20.88 20.40 19.41 19.25 18.24 Average Shares of Common Stock Outstanding (M,thons) 222.5 222.5-221.9 221.6 221.1 220.2 ' $D*St".**'.3h _ Balance Sheet Data Net Utility Plant S 4,495 $ 10,760 $ 10,758 $ 10,829 $ 10,763 $ 10,691 Leased Property, net - 176 182 181 174 194 210 TotalCurrent Assets 1,003 420 426 427 515 550 Total Deferred Debits and Other Assets 6,683_ 3,899 3,944 3,992 3,905 1,127 Total Assets 8 12,357 $ 15.261 $ 15,309 $ 15.422 $ 15.377 $ 12.578 Common Shareholders' Equity 8 2,727 $ 4,646 $ 4,531 $ 4,303 $ 4,263 $ 4,022 Preferred and Preference Stock Without Mandatory Redemption 137 199 199 277 423 423 With Mandatory Redemption 93 93 93 93 187 231 Company Obligated Mandatority Redeemable Preferred Secunties of a Partnership 352 302 302 221 Long-term Debt. 3,853_ 3,936-4,199 4,786_ 4,884_ 5,204 Total Capitalization 7,162 9,176 9,324 9,680 9,757 9,880 Total Current Liabilities 1,619 1,103 1,052 850 954 830 Total Deferred Credits and Other Liabilities 3,576 _ 4,982 4,933 - 4,892 4,666 1,868 Total Capitalization and Liabilities 8 12,357 $ 15.261 $ 15.309 $ 15.422 $ 15,377 $ 12.578

46 PECO Energy Company and Subsidiary Companies Operating Statistics L*'?f**'*1"*

- "?" - -..-..-.2*L

?.** l**- 2 Et:ctriC Operations Output (Mahum of Howatthoun) Fossil 9,859 10,856 10,792 11,239 10,352 8,082 Nuclear 25,853 24,373 25,499 28,195 27,026 24,428 Hydro 1,558 2,404 1,425 1,970 1,099 1,803 Pumped storage output 1,403 1,540 1,741 1,596 1,478 1,597 Pumped storage input (1,924) (2,230) (2,507) (2,256) (2,192) (2,217) Purchase and interchange 29,615 19,539 13,945 6,164 6,447 8,675 Internal combustion 144_ 179_

___175, 106_

56, 29 Total electric output 66,308 56,661 51,070 47,014 44,866 42,397 Sat:s cuatwm of nowerikoun) Residential 10,407 10,671 10,636 10,859 10,609 9,965 Small commercial and industnal 6,685 6,491 6,200 6,150 5,769 5.396 . Large commercial and industrial 15,034 15,208 15,763 15,968 15,956 15,829 Other 841 902 860 791 771 962 Unbilled 70_ (327L

535, 20R 3.L

[159L Service territory 33,037 32,945 33,994 33,563 33,136 31,993 Interchange sales 1,927 935 496 768 457 1,231 Sales to other utilities 28,893, _20J4L 14,041 10.039 8f70_ 6,699 Total electric sales 63,857 54,123 48,531 44,370 42,263 39,923 Number of Customers, (memoer n. Residential 1,333,861 1,324,448 1,321,379 1,350,210 1,341,873 1,333,926 Small commercial and industrial 144,142 142,431 141,653 143,605 142,363 141,253 Large commercial and industrial 3,308 3,299 3,394 3,603 3,742 3,972 Other 1,094_ _ 1,051_ 959_ 944_

888, 857 Total electric customers 1,482,405 1,471,220 1,467,385 1,498,362 1,488,866 1,480,008 Opsrating Revenues (Manos cf Mm)

Residential 8 1,357 $ 1,370 $ 1,379 $ 1,371 $ 1,351 1,308 Small commercial and industrial 779 749 730 710 679 672 Large commercial and industrial 1,077 1,098 1,135 1,149 1,168 1,225 Other 148 140 137 130 161 168 Unbilled 19 (26) 43 (11) (1) (7) Service territory 3,380 3,331 3,424 3,355 3,358 3,366 Intaa,hange sales 59 26 17 23 14 32 Sales to other utilities 728 498 334 247 233 199 Total electnc revenues 4,167 3,855 3,775 3,625 3,605 3,597 Opsrating Expenses e Operating expenses, excluding depreciation 2,698 2,244 2,026 2,209 1,894 1,990 Depreciation

_553, 462_

431_ 416_ 401_ 391 Total operating expenses 3,251 2,706 2A57 2,625 2,295 2,381 _ Etsctric Operating Income 8 916 $ 1,149 $ 1,318 $ 1,000 $ 1,310 $ 1,216 Av2 rage Use per Residential Customer (tr!owarrhours) Without electric heating 6,695 6,771 6,908 6,736 6,727 6,259 With electric heating 16,400 17,946 17,189 17,527 17.096 16,298 ( Total 7,830 8,074 8,130 8,041 7,970 7,443 Etutric Peak Load, Demand rrw wnao w aru 7,390 6,509 7,244 7,227 7,100 6,617 r Nit Electric Generating Capacity-Year-end Summer Rating fr w w xs or w u ro 9,204 9,201 9,078 8.956 8.877 8.836 Ctst of fuel per Million BTU 8 0.84 $ 0.93 $ 0.87 $ 0 89 $ 0.90 $ 0.82 BTU per Net Kilowatthour Generated 10,737 10.682 10,705 11,617 10,675 10,657 L

Notes to Consolidated Financial Stat:rrents 47 Op; rating Statistics (continued) For the Years Ended Decerr.ber 31, 1997 1996 1995 1994 1993 1992 Gas Operations Sties (Mwm of c&c feet) Residential 1,614 1,681 1,516 1,636 1,637 1,819 House heating - 32,666 35,471 30,698 32,246 30,242 30,218 Commercial and industrial 19,830 20,999 18,464 19,762 18,635 19,026 Other 673 2,571 1,582 7,039 9,733 4,885 Unbilled 212 (1,306) 1,710 (474) 676 (736) Total gas sales 54,995 59,416 53,970 60,20') 60,923 55,212 Gas transported for customers 30,412 27,891 48,531 29,801 22,946 22,060 Total gas sales and gas transported 85,407 87,307 102,501 90,010 83,869 77,272 a Number of Customers Residential 55,592 56,003 56,533 57,122 59,573 59,859 House heating 314,335 303,996 295,481 287,481 277,500 269,577 Commercial and industrial 35,215 34,182 33,308 32,292 31,573 30,956 Tntal gas customers 405,142 394,181 385,322 376,895 368,646 360,392 Operating Revenues (Mem,s of poltes) Residential 8 17 $ 16 $ 15 $ 16 $ 15 $ 16 House heating 265 249 236 238 202 203 Commercial and industrial 145 133 126 128 110 113 Other 3 11 5 20 28 12 Unbilled (1) (4) 7 (3) 5 (1) Subtotal 429 405 389 399 360 343 Other revenues (including transported for customers) 22_._ 24 22_ 17 23_ 23 Total gas revenues 451 429 411 416 383 366 Operating Expenses Operating expenses, excluding depreciation 333 302 302 326 279 261 Depreciation 28_ 27 26 26 __ 24 23 Total operating expenses 361_ 329 328_ 352 303 284 Gas Operating Income S 90 $ 100 $ 83 $ 64 $ 80 $ 82__ Sicurities Statistics Ratings on PECO Energy Company's securities Mortgage Bonds Preferred Stock Date Date AgeR,,_,,,.,_ Rat (ng _ _ __ _ Estabhsbed Rating Estabhshed e Duff and Phelps, Inc. BBB+ 4/92 BBB-8/91 Fitch Investors Service, Inc. A-9/92 BBB+ 9/92 Moody's investors Service Baal 4/92 baa2 4/92 Standard & Poor's Corporation BBB+ 4/92 BBB 4/92 NYSE-Composite Common Stock Prices, Earnings and Dividends by Quarter (rer share) 1997 1996 Fourth - Third Second First Fourth Third Second First .._.Ouaner Queney Ouaner quaney Quaner Quarter Quaner Quarter _ High prics S 25 1/8 S24-5/16 8 21-1/8 8 26-3/8 $ 27-3/8 $ 26-1/4 $ 26-7/8 $ 32-1/2 L.:w price $217/16 8 20-3/4 8 18-3/4 8 20 $ 23-7/8 $ 23 $ 22-1/2 $ 26-1/4 Close $ 24-1/4 823-7/16 8 21 8 20-3/8 $ 25-1/4 $ 23-3/4 $ 26 $ 26-5/8 Eirnings (88.51) 69c 53c 49C 51c 65c 43c 65c Dividends 45c 45c 45c 45c 45c 43.5c 43.5c 43.5c

PECO Energy Company and Subsidiary Cornpanies 48 8:ard of Directors Officers Susan W. Catherwood (54) Corbin A. McNellt, Jr. (5s) John Doering, Jr. (54) j Chairman, Trustee Board, Chairman of the Board,' Vice President, Operations, The University of Pennsylvania President and Chief Executive Power Generation Group i Medical Center and Health System Officer ' Gregory N. Dudkin (40)m Daniel I., Cooper (62)m Dickinson M. Smith (64) Vice President, Former Vice President and General President, PECO Nuclear Power Delivery Manager, Nuclear Services Division, and Chief Nuclear Officer Drew B. Fetters (46) Gilbert / Commonwealth, Inc. Gregory A.Cucchi(48)m Vice President. M. Walter D'Alessio (64) Senior Vice President, Nuclear Planning and Development Pr:sident and Chief Executive Ventures Thomas P. Hill, Jr. (49) ames W. am (64 ce es and knm ason Real Estate Services Senior Vice President, Legal and Cassandra A. Matthews (47)m (Commercial mortgage banking m alCounsd and pension fund advisors) Vice President, Michae J. Egan (44)w Information Systems G. Fred DlBona, Jr. (46) President and Chief Executive John P. McElwain (47)* and Chief FinancialOfficer

Offker, Vice President, Independence Blue Cross William J. Kaschub (55)

Nuclear Projects, PECO Nuclear R. Keith Elliott (55) J. Barry Mitchell(50) Chairman, President and Chief Vice President, Encutive Officer, Kenneth G. Lawrence (50)W Finance and Treasurer Hircules, Inc. Senior Vice President, ThKNdM '"E*"Y Richard G. Gilmore (70)m Vice President, Former Senior Vice President, John M. Madara, Jr. (54) Peach Bottom Atomic Power Finance and Chief Financial Officer Senior Vice President, Station of the Company Power Generation Group William E. Powell, Jr. (61) Richard H. Gianton, Esquire (51)W William H. Smith, Ill (49)m Vice President, Partner of the law firm Reed Smith Senior Vice President, Support Services Shaw and McClay Business Services Group James D. von Suskit (51)m James A. Hagen (65) Alvin J. Weigand (59) Vice President, Former Chairman, Conrail, Inc. Senior Vice President Limerick Generatmg Station Admiral Kinnstrd R. McKee (68) Gerald R. Rainey (48) Katherine K. Combs (47) Dirictor Emeritus, Senior Vice President, Corporate Secretary U.S. Navy Nuclear Propulsion Nuclear Operations 7 Joseph J. McLaughlin (69)m Nancy J.14essey (44) Assistant Corporate Secretary Former President and Chief Vice President, gg Exxutive Officer, Power Transactions g g BIneficial Mutual Savings Bank John B. Cotton (53)* N I'3) Corbin A. McNellt, Jr. (58)m Vice President, As stant kasum Chairman of the Board, Station Support President and Chief Executive George R. Shicora (51) Officer of the Company Assistant Treasurer John M. Palms, PhD. (62) President, 9 University of South Carolina of the Board of onectors Joseph F. Paquette, Jr. (63)m former Chairman of the m Elected June 23,1997 Board of the Company m Effective Je'ie 1,1997 m Effective October 13,1997 Ronald Rubin (66)N m Effective November 7,1997 Chief Executive Officer, m Effective April 9,1997 The Rubin Organization. Inc. (R;al estate development and n Iffective July 28,1997 management) m Effective January 26,1996 Robert Subin (59) Senior Vice President. 1 I Campbell Soup Company

5;H A R'E H O'L D E;R-I N F O'R M A T I O N Sttck Exchange Listings Annual Meeting Most Company securities are listed on the New York Stock The Annual Meeting of the Shareholders of the Company will be Exch nge and the Phi!adelphia Stock Exchange-held at the Valley Forge Convention Center in King of Prussia, Pennsylvania on April 8,1998 at 9:30 AM. The record date for. DividInds voting at the shareholders' meeting is February 20,1998. Prompt The Company has paid dividends on its common stock continual-return of proxies will be appreciated. ly since 1902, The Board of Directors normally considers common stock dividends for payment in March, June, September and. Form 10-K Decsmber. The Company expects that the $1.80 per share divi-Form 10-K, the annual report filed with the Securities and dind paid to common shareholders in 1997 is fully taxable as Exchange Commission, is available without charge to sharehold-dividend income for federal income tax purposes. . ers upon written request to PECO Energy Company,2301 Market Street, RO. Box 8699, Phdadelphia, PA 19101-8699, Attention: Shareholders may use their dividends to purchase additional Investor and Shareholder Relations Division, S21-1 - shares of common stock through the Company's Dividend Reinvestment and Stock Purchase Plan (Plan). The Company Shareholders pays all brokerage and service fees for Plan purchases. All share-The Company had 163,049 shareholders of record of common holders have the opportunity to invest additional funds in stock as of December 31,1997. common stock of the Company, whether or not they have the.ir dividends reinvested, with all purchasing fees paid by th Transfer Agents and Registrars Compsny. Preferred and Common Stock Registrar and Transfer Agent, in 1997, over 55 percent of the Company's common sharehold-First Chicago Trust Company of New York, P.O. Box 2500, Jersey City, NJ 07303-2500. ers were participants in the Plan. Information concerning the Plan may be obtained from: First Chicago Trust Company of New York, PECO Energy Company Plan, RO Box 2598, Jersey City, NJ First and Refunding Mortgage Bond Trustee: First Union National Bank, Corporate Trust Operations, 07303-2598. Customer information Center 1525 West W.T. Harris Blvd. ' Ccmm%nts Welcomed Charlotte, NC 28288-1153 The Company is always pleased to answer questions and provide information. Please address your comments to Katherine K. New York Agent for bonds: , Combs, Corporate Secretary, PECO Energy Company,2301 First Trust of New York, National Association Corporate Trust Market Street, RO. Box 8699, Philadelphia, PA 19101-8699. Department,100 Wall Street, Suite 1600, New York, NY 10005. jnquiries relating to shareholder accounting records, stock trans-Internet Site - fer and change of address should be directed to: First Chicago Visit our internet site at http://www.peco.com Trust Company o New York, RO. Box 2500, Jersey City, NJ 07303-2500. General Office: T;tt Free Telephone-2301 Market Street Philadelphia, Pennsylvania 19103

Toll-free telephone lines are available to the Company's share-(215) 841-4000 holders for inquiries concerning their stock ownership. Calls should be made to 1-800426-8729,

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