ML20235W574

Sys Energy Resources,1986 Annual Rept. Rept

ML20235W574
Person / Time
Site:	Grand Gulf
Issue date:	12/31/1986
From:	SYSTEM ENERGY RESOURCES, INC.
To:
Shared Package
ML20235W492	List: AECM-87-0134, Forwards Sys Energy Resources,Inc,South Mississippi Electric Power Assoc & Mississippi Power & Light Co 1986 Annual Financial Repts ML20235W574 ML20235W593 ML20235W635
References
NUDOCS 8707230606
Download: ML20235W574 (29)

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SELECTED FINANCIAL DATA-FIVE-YEAR COMPARISON Years Ended December 31, 1986 1985 1984 1983 1982 (In 11wusands) l Operating Revenues . . . . $ 959,737 $ 524,012 - - -

, Allowance for Funds Used During Construction (AFDC) . 5 (4,591) $ 224,360 $ 376,477 5 293,179 $ 260,832 Net income. .. . .. . .. . . $ 189,135 $ 218,067 $ 188,425 $ 151,581 $ 121,857

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Construction Expenditures (includes AFDC) . . . . . $ 40,782 $ 335,656 $ 581,184 $ 572,448 $ 551,786 Total Assets. .. . .... . . 54,950,118 $4,947,418 $4,780,456 $3,747,945 $3,045,266 s-h l )

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• .. a Grand Gulf Nuclear Station 1

PRESIDENT'S LETTER

, As we at System Energy Resources, Inc. (SERI) learned in 1986, the initial

h. . , development phase of any newly reorgamzed company is a time of innovation and challenge. At the same time, we're proud to report

) '

that this period also created a pro-e -

gressive atmosphere conducive to significant accomplishment.

t^ SERI, which owns 90% of the

- k. Grand Gulf Nuclear Station, changed

/ its name in July 1986 from Middle South Energy, Inc. to SERI.

Also in 1986, SERI became the newest operating company of Middle South Utilities, Inc. when it assumed

., . the primary responsibilities previously

!g assigned to Mississippi Power & Light Company (MP&L) to manage and I operate the Grand Gulf Nuclear Station, located 50 miles southwest of Jackson, Mississippi, near Port Gibson. On December 20,1986, the Nuclear Regulatory Commission (NRC) amended the Unit 1 operating license and the Unit 2 construction

,j

~

permit to make official the transfer i ' of duties from MP&L to SERI.

/ Several solid reasons for establishing SERI as an operating company were outlined by Edwin Lupberger, chair-man and president of Middle South Utilities, Inc. when our formation was announced last July:

-Establishing SER! allows manage-ment and staff to focus full attention on the ude and efficient operation of Grand Gulf;

-Support functions of the new company are more specialized and more effective;

-Creation of a nuclear operating company establishes a work environ-ment that attracts and retains nuclear professionals; and,

-Increased safety and efficiency results from dedicated management attention to nuclear operations.

The benefits of creating SERI as an operating company mesh with its 2

mission to attain operating and safety Grand Gulf and SERI as part ofits Allowance for Funds Used During standards which are among the best Systematic Assessment of Licensee Construction on Unit 2 during its in the nuclear industry, operate Performance (SALP). That evaluation continued suspension.

Grand Gulf in a cost effective and covered an 18-month period ending in September,weissued $750 million efficient manner, and provide a fair October 31 and was designed to of first mortgage bonds in three return to Middle South Utilities,Inc. identify areas of performance that series. It was the largest single first Those benefits have already become may require more attention from mortgage bond sale ever by an elec-realities since Grand Gulf reached management as well as the NRC. tric utility.

several milestones over the past year. We were justifiably encouraged to SERI's future financial performance For instance, Unit 1 operated at find that the NRC awarded Grand is key to Middle South Utilities and record levels prior to shutting down Gulf the highest rating in three areas. with this in mind, we have set goals i for its first refueling outage. The unit The eight remaining areas were targeted at maximizing plant output j 1

had its longest continuous run of graded in the next highest of the and efficiency and related objectives 105 days, an achievement we plan to three categories, with three of those oriented toward minimizing cost.

surpass in 1987. Unit 1 also had a listed as " improving." There were SERI's future financial performance 1986 availability factor of 89 percent no performance areas in the lowest will be influenced significantly by before refueling. category. The success of our initia- the resolution of certain pending SERI's training programs continued tives is evidenced in the NRC evalua- financial, rate and regulatory issues.

to improve and produce desired tion that stated,in part: These issues are fully discussed in )

results. In 1986, the passing rate at "The leect of performance of your this Annual Report.

Grard Gulf for NRC licensing exam- Grand Gulf facility has continued to We view 1987 and beyond as an inations was 95 percent (a 22 percent improve...The reorgani:ation of your staff era of unprecedented opportunity.

increase over the previous year), and the attitude of your staff has shoten The challenges ahead dictate that we Additionally, three of our ten training a marked increased posture towards continue to strive for achievement, programs were accredited by the nucicar safety. This is reflected in the both corporately and personally.

National Nuclear Accrediting Board, fact that no Category 3 ratings were issued." The underlying objective that drives meaning Grand Gulf achieved branch Continued improvement in SALP all that we do at SERI is to become status in the National Academy for ratings is another of our goals this year, the absolute best in an industry that Nuclear Training. The Institute of with the ultimate objective of being daily demands the highest levels of Nuclear Power Operations (INPO) in the top category across the board. excellence. The accomplishments of has evaluated our remaining seven Construction of Unit 2 was sus- our first year give cause for genuine programs and we fully anticipate pended in September 1985 following optimism that-today and tomorrow-accreditation for them, as well as full an order of the Mississippi Public System Energy Resources, Inc. will membership in the National Acad- Service Commission. After a year- attain that standard.

emy, by mid-year 1987. long evaluation, the SERI Board of it is SERI's goal to achieve stand- Directors (with the Middle South ,

ards of excellence in safety and Utilities Board concurring) moved to operation and, consequently, to be continue suspension of construction of William Cavanaugh, Ill recognized byINPO and the NRC as a the unit and by 1990 to determine President and Chief Executive Officer nuclear station with the highest ranking. the future status of the unit considering In 1986, INPO highly rated our the alternatives available at that time.

overall performance in maintaining In another major area, SERI's finan-the professional standards required cial condition improved in 1986 as we in the nuclear industry; however, were able to refinance a substantial areas for improvement were noted. amount of our debt, which had been We are vigorously addressing those limiting our financial flexibility. Our areas and are aiming to achieve a 1986 earnings and cash flow reflect the significantly superior performance first full year of Unit l's commercial rating on the 1987 evaluation. operation. Earnings, however, also At year-end, the NRC evaluated reflect the impact of not accruing 3

System Enzrgy Resourers, Inc.

REPORT OF MANAGEMENT The management of System Energy Resources,Inc. policies and procedures and testing by a comprehensive has prepared and is responsible for the financial state- internal audit program.

ments and related financial information included in The independent certified public accountants provide this annual report. The financial statements are based an objective assessment of the degree to which man-on generally accepted accounting principles, consistent- agement meets its responsibility for fairness of financial

. ly applied. Financial information included elsewhere in reporting. They regularly evaluate the system ofinternal this report is consistent wkh the financial statements. accounting controls and perform such tests and other To meet its responsibilities with respect to financial procedures as they deem necessary to reach and express information, management maintains and enforces a an opinion on the fairness of the financial statements.

system of internal accounting controls which is designed Management believes that these policies and proced-to provide reasonable assurance, on a cost effective - ures provide reasonable assurance that its operations basis, as to the integrity, objectivity and reliability of are carried out with a high standard of business cc.n--

the financial records and as to the protection of assets. duct.

This system includes communication through written Management's Financial Discussion And Analysis Financial Condition The financial condition of System Energy Resources, Upon the suspension of construction of Grand Gulf 2 Inc. (Company) improved during 1986 primarily because in September 1985 (discussed below), the Company the Company was able to refinance a substantial ceased accruing AFDC on that unit. The Company amount of indebtedness which had been limiting its continues to accrue a small amount of AFDC in con-financial flexibility. Specifically, t he Company in 1986 nection with retrofits and design modifications for redeemed its 9.25% Series and 12.50% Series First Grand Gulf 1.

Mortgage Bonds and also prepaid $628 million (exclud- Since September 1985, the Company has continued ing 1986 mandatory repaymentsi of debt due under suspension of construction on Grand Gulf 2 and has the Company's loan agreement with a group of U.S. limited expenditures to only those activities which are Banks (U.S. Bank Loan Agreement). The redemption absolutely necessary for demobilization and suspension of the first mortgage bonds removed the restrictive of the unit. A special group (Study Team) of Middle covenants under the indenture with respect to the South System officials and outside consultants completed payment of dividends on common stock and the in November 1986 its evaluation and review of Grand requirement to complete Grand Gulf 2 by December Gulf 2. On December 5,1986, the Company's Board of 31,1988. In addition, the prepayment of bank debt in Directors (with the Middle South Utilities, Inc. (MSU)

January 1987, eliminated the restrictive provisions Board of Directors concurring) adopted the recommenda-under the U.S. Bank Loan Agreement with respect to tion of the Study Team that suspension of construction capital expenditures, additional mandatory prepay- activities be continued and that a further decision be ments and the payment of dividends on common stock. made by 1990 on the future status of Grand Gulf 2,in The Company's 1986 earnings continued to reflect light of alternatives available at that time. During the the impact of the July 1,1985 commercial operation of period of continued suspension, the energy needs of Grand Gulf 1 and the resultant receipt of revenues the region served by the Middle South System as well from the System operating companies for their share as some of the uncertainty about the costs of building of capacity and energy from Grand Gulf 1. Allowance nuclear power plants should be further clarified. In for Funds Used During Construction (AFDC) attribut- addition, during the continued suspension, AFDC will able to construction on Grand Gulf 1, which accounted not be accrued and capitalized on the Company's invest-for a significant portion of the Company's 1985 earnings, ment in the unit. Consequently, during this period, the i ceased accruing concurrent with commercial operation. increase in the Company's investment in Grand Gulf 2 will be limited, and the Company will forego any return on this investment.

4

While the Company believes that all of its investment Supreme Court found reversible error in the MPSC's to date in Grand Gulf 2 has been prudent, the Company prior rate order based, in part, on the assertion that the will, at an appropnate time, make a determination as to MPSC failed to consider prudence issues. Moreover, the appropriate recovery of its investment. Any action separate prudence investigations are also being con- )

to seek recovery of Grand Gulf 2 costs would likely ducted by the MPSC and the Council of the City of involve a filmg by the Company with the Federal New Orleans, Louisiana (Council) relative to MP&L's Energy Regulatory Commission (FERC) request- and New Orleans Public Service Inc.'s respective ing such recovery, over a period of years, through Grand Gulf 1 cost recoveries. See Nete 7," Commit-charges to the System operating companies, and related ments and Contingencies-Potential Debt Acceleration filings by the System operating companies before state and Related Matters" and Note 8," Rate and Regulatory or local regulatory authorities to recognize the FERC- Matters-Rate Activity-System Operating Companies" allowed charges in retail rates. There can be no assur- for further information regarding these issues.

ance that the Company would be permitted by the FERC in addition to the impact of the resolution of the to recover the full amount of its investment in Grand issues stated above, the Company's future finmcial Gulf 2 and proceedings before the FERC, among others, condition is dependent on the ultimate resolut en of could be protracted and strongly contested on various proceedings challenging the FERC's June 13 D , cision grounds, including imprudence. Any nonrecovery of allocating the capacity and energy from Grand Gulf 1.

the Company's investment in Grand Gulf 2 would On January 6,1987, the U.S. Court of Appeals for the result in a charge against earnings or restatement of District of Columbia Circuit affirrred the FERC's June prior years' financial statements for any unrecoverable 13 Decision. Petitions for rehearing and for a writ of investment when that event becomes probable. In the certiorari to the U.S. Supreme Court have been filed.

event such a charge were substantial, the financial . .

Liquidity and Capital Resources condition of the Company could be materially and adversely af'ected (although its cash position would During the period 1984-1986, the Company incurred not be adversely affected), and the Company's ability construction expenditures totaling $957.6 million, in-to pay dividends on its capital stock could be impaired. cluding AFDC of $590.5 million. Funding for this con-See Note 7," Commitments and Contingencies-Grand struction activity was obtained primarily from the sales Gulf 2" for further information regarding this issue. of first mortgage bonds and pollution control revenue Under traditional utility regulatory principles, whole_ bonds, bank borrowings, payments received from cer-sale rates approved by the FERC should be charged to tain of the System operating companies for advance retail ratepayers. As a result of the FERC decision on power purchases and income tax benefits. The Com-June 13,1985 (June 13 Decision), all of the costs, capacity Pany's 1986 construction expenditures were substantially and energy associated with the Company's 90 percent reduced due to the commercial operation of Grand

! share of Grand Gulf I were allocated to the System Gulf 1 and the suspension of construction on Grand l

operating companies upon commercial operation of Gulf 2, both occurring in the third quarter of 1985. The the unit. As of December 31,1986, all of the System Company's total construction expenditures for 1987, operating companies had received rate relief for their 1988 and 1989 are expected to be approximately allocated share of costs associated with Grand Gulf 1 $57.5 million, $57.0 million and $61.0 million, respec-which they believed would be sufficient to meet their tively, for its 90 percent ownership in the Grand Gulf respective Grand Gulf 1 obligations. The System oper- Station. These estimated expenditures assume virtually ating companies' future financial condition remains no construction on Grand Gulf 2 except for those dependent on the continued effectiveness of their activities which are absolutely necessary for demobiliza-respective rate orders. Certain of the System operating tion and suspension.

companies' Grand Gulf 1 rate orders are being chal. The Company estimates that it will require approxi-lenged and the existing rate structures could change, mately $942.7 million from internal and external sources depending upon further actions of regulatory bodies for the period 1987 through 1989 to refinance maturing or the courts. In this connection, on February 25,1987, indebtedness, to meet sinking fund obligations and to the Mississippi Supreme Court reversed and remanded finance its other capital requirements (primarily the the September 1985 order of the Mississippi Public construction expenditures listed above). The Company Service Commission (MPSC) granting permanent rate expects to obtain a significant portion of such funds relief to Mississippi Power & Light Company (MP&L) with respect to its recovery of Grand Gulf 1 costs. The 5

System Encrgy Resources, Inc.

MANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS (contim<ed) through its receipt of payments from the allocation of either extend the credit line or arrange alternative costs associated with Grand Gulf 1 to the System credit lines. To the extent, however, that this does not operating companies. The balance of amounts needed occur, additional capital requirements of up to by the Company will be obtained from external sources, $175 million could result.

including, but not limited to, issuances of first mort- In connection with the Grand Gulf Station, MSU has gage bonds, preferred and/or preference stock and undertaken in the Capital Funds Agreement to provide such other sources as may be appropriate. The Com- or cause to be provided to the Company sufficient pany has received SEC approval to sell up to capital (i) to maintain the Company's equity capital at an

$200 million of preferred stock, with the proceeds to amount at least equal to 35 percent of total capitaliza-be used for the repayment and refinancing of outstand- tion, (ii) to construct, own and place in commercial ing indebtedness and for other corporate purposes. operation the Grand Gulf Station, (iii) to provide for During the second quarter of 1986, the Company pre-operating expenses and interest charges of the sold $90 million of pollution control revenue bonds Company, (iv) to permit the continuation of commer-under an agreement entered into with Claiborne cia' c ration after commencement thereof, and (v) to Coenty, Mississippi, and $300 million principal amount pay in full all indebtedness for borrowed money of the of first mortgage bonds. A portion of the proceeds was Company whether at maturity, on prepayment, on used to repay certain deferred payments, due June 16, acceleration or otherwise.

1986, un ter the U.S. and Foreign Bank Loan Agree- The Company has amended the U.S. and Foreign ments. m September 1986, the Company sold Bank Loan Agreements to convert borrowings there-

$750 million principal amount of first mortgage bonds. under to term loans. In September 1986, the Company 1 The proceeds of the sale were used for the prepayment reduced its U.S. Bank Lean balance by $628.2 million l of outstanding indebtedness under the U.S. Bank Loan and concurrently collateralized a portion of the Com-Agreement due in 1989 and for the redemption of pany's letter of credit obligation in connection with its certain previously issued securities. Series C Pollution Control Revenue Bonds by paying At December 31,1986, the earnings coverage for the $19.2 million into an escrow account for the benefit of Company's first mortgage bonds, which must be a the banks providing the letter of credit (Series C Letter minimum of 1.5 times the annual mortgage interest of Credit Banks). At December 31,1986, the Company requirements for issuance of additional first mortgage had outstanding $473.2 million and $236.2 million, bonds, was 4.01. Assuming an annualinterest rate of respectively under the U.S. and Foreign Bank Loan 10 percent and subject to the availability of bondable Agreements and had an obligation to collateralize the property, the Company could have issued $2,936 million remaining $215.4 million of the letter of credit under of additional first mortgage bonds (plus any bonds the Series C Pollution Control Revenue Bonds. In issued for refunding purposes). However, at December addition, in January 1987, the Company prepaid )

31,1986, unfunded bondable property of Grand Gulf 1 approximately $53 million and $15 million, respectively, would only support the issuance of approximately of bank notes outstanding under the U.S. and Foreign

$463.3 million of additional first mortgage bonds. Bank Loan Agreements and paid approximately 1 The Company's Articles of Incorporation will be $12 million into the escrow account for the benefit of amended in connection with the issuance of preferred the Series C Letter of Credit Banks. In February 1987, stock to require a minimum earninga coverage of 1.5 the Company paid the scheduled $47.25 million semi-times the pro forma annual interest charges and annual annual installment due under the Foreign Bank Loan preferred stock dividends (subject to reduction to 1.25 Agreement. On March 2,1987, the Company paid the with SEC approval) for the issuance of preferred stock. scheduled semi-annualinstallment of $125 million due At December 31,1986, the Company's earnings coverage under the U.S. Bank Loan Agreement, $35.1 million of .

for preferred stock was 1.67. Assuming an annual which was paid into the escrow account for the Series l dividend rate of 10% the Company could have sold C Letter of Credit Banks.

$351.4 million of preferred stock at December 31,1986. The Company is subject to limitations on the maxi-The Company's $175 million nuclear fuel lease may mum amount of short-term borrowings outstanding terminate in June 1987 if the credit line supporting the under both the Holding Company Act and the terms nuclear fuel lease terminates. The Company intends to of its bank loan agreements. At December 31,1986, the maximum permitted was the lesser of $200 million or five percent of capitalization, which was $226.3 million. ,

l 6

At December 3L 1986, and December 31,1985, the aggregated $188.2 million and $97.6 million, respec-Company did not have any available bank lines of tively, for 1986 and 1985.

credit or any other sources of short-term borrowings. Total AFDC for 1986 decreased $229 million from However, the Company has received SEC authorization, the year ended December 31,1985. Total AFDC for effective January 1,1987, to effect short-term borrow- 1985 was $224.4 million (including $207.6 million of ings through a System money pool, whereby those AFDC during the first half of 1985), a decrease of 40.4 companies in the Middle South System with available percent from 1984. The higher AFDC amounts through funds can invest in the pool while other companies in June 30,1985, reflected the increasing amount of con-the System (except MSU) having short-term cash needs struction work in progress. all attributable to the Grand can borrow frora the pool, thereby reducing the Gulf Station, the increasing amount of long-term debt System's dependence on external short-term borrow- outstanding and higher prevailing interest rates. Sub-ings. The Company's participation is subject to the sequent to June 30,1985, the decreasing amounts of availability of funds which, at any particular time, may AFDC reflect the cessation of AFDC on Grand Gulf 1 be limited. concurrent with its July 1,1985 commercial operation On October 22,1986, the President signed into law and, to a lesser extent, the cessation of AFDC on the Tax Reform Act of 1986 (Act), portions of which Grand Gulf 2 following the suspension of construction could have a significant impact on the utility industry, of that unit in September 1985. Total AFDC for the Provisions contained in this law will, among other twelve months ended December 31,1986 also reflected things, diminish the value of investment tax credit the impact of normalizing the income tax effect of l carryforwards, lengthen the period over which utility utilizing state income tax loss carryforwards.

, property can be depreciated for tax purposes, impose a Operating revenues and operating expenses increased new alternative minimum tax, and reduce the marginal $435.7 million and $220.7 million, respectively, in 1986 corporate income tax rate. over 1985 due to 1986 reflecting a full year of opera-For the Company, the above provisions of the Act tions of Grand Gulf 1.

will have varying consequences. As a result of signifi- Income taxes and credits in lieu ofincome taxes on cant amounts of net operating loss and investment tax the Company's income statement prior to commercial credit carryforwards, these provisions are not expected operation of Grand Gulf 1 reflected the tax benefit that to have a substantial effect on the Company's results of has been or will be realized during the carryforward operations or financial condition through 1989. How- periods resulting from the Company's Federal tax Icsses ever, the future cash flow of the Company will be included in the MSU consolidated income tax return.

impacted as the lower corporate income tax rates will The Company charged to operations approximately result in reduced charges to customers. While these $234 million of income tax expense in 1986 and reduced collections will lower internal cash generation, approximately $119 million in 1985 due to recognizing cash flow is not expected to be so severely impacted as taxable earnings related to the commercial operation of to substantially increase the need for external financings. Grand Gulf 1.

Totalinterest expense for the year 1986 declined Results of Operations $57.2 million, or 15.2 percent, from the year 1985. The The Conapany began to report results of operations lower interest expense is due primarily to a decrease in with the July 1,1985 commercial operation date of amounts outstanding under the Company's U.S. and I Grand Gulf 1. Prior to that time, the Company's Fon ign Bank Loan Agreements, lower rates on such income statement reflected only non-operating items. borrowings in effect in 1986 as compared to 1985, and Prior to the commercial operation of Grand Gulf 1, a lower balance in 1986 of power purchase advance all of the Company's net income had been the equity payments on which interest accrued. This decrease was component of AFDC, which consisted solely of non- partially offset by an increase in interest expense associ-cash credits to the income statement that represented a ated with the issuance of additional pollution control reasonable return on equity funds used for construc- revenue bonds and first mortgage bonds in late 1985 tion. With the commercial operation of Grand Gulf 1, and in 1986.

. the Company's net income began reflecting cash earn- Interest on long-term debt decreased $36.6 rnillion, 4 ings resulting from the allocation to the System operat- or 10 4 percent, in 1986 compared to 1985. This ing companies of the unit's capacity and energy. Net income, exclusive of the equity component of AFDC, I

7

)

System Energy Resources, Inc.

MANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS (continuni) decrease was due to a smaller amount of long-term years as a note to the financial statenients, has been debt outstanding and lower prevailing interest rates in deleted from this year's report.

1986 on both floating rate bank debt and refinanced The Company was not significantly affected by infla- i debt. By contrast, interest on long-term debt increased tion during the period 1984-1986.

by $17.4 million in 1985 compared to 1984 due to an increase in long-term debt outstanding in 1985. b""*"7 Interest on the power purchase advance payments During 1986, the Company (1) accomplished the made by certain of the System operating companies to refinancing of a substantial amount of first mortgage the Company (between January 1984 and June 1985) bond and bank debt which had been limiting its finan-decreased in 1986 by $23.5 million, or 96.7 percent, cial flexibility, (2) decided, after a comprehensive study, from the 1985 amount. All of the advance payments that suspension of construction of Grand Gulf 2 be had been utilized as credits against the operating continued and that a further decision be made by 1990 on companies' purchased power billings by March 31, the unit's future, and (3) completed a full year of 1986. The 1986 decrease in interest reflected the commercial operation of Grand Gulf 1 and received a decrease in the balance of the advance payments. resultant full year's operating revenues from the System Conversely,1985 interest on the power purchase operating companies. In addition, in early 1987 the advance payments increased by $12.5 million over 1984 Company successfully eliminated certain restrictions due to an increasing balance (in 1985) of advance under the U.S. Bank Loan Agreement with respect to payments upon which interest was accrued. Other capital expenditures and the payment of dividends on interest-net remained at a minimal level in 1986 while common stock. However, the Company continues to decreasing 76.5 percent in 1985 (from 1984) due to a be confronted with several uncertainties which, if substantial reduction in short-term borrowings. adversely resolved, could affect its ability to maintain a financial condition strong enough to meet its financial Effect of Inflation commitments and provide a reasonable return to MSU.

In December 1986, the Financial Accounting Standards The Company's financial condition could be materially Board issued SFAS No. 89 which rescinded the require- and adversely affected in the event all or a substantial ment to provide certain supplementary information amount of its investment in Grand Gulf 2 is ultimately concerning the effect of changing prices on the Com- not recovered. In addition, certain of the System oper-pany. This infonnation, which was presented in previous ating companies' respective Grand Gulf 1 rate orders have either been challenged, reversed by judicial decisions or are subject to prudence investigations. See Notes 7 and 8 for a further discussion of these contin-gencies.

8

Y l'

Financial Statements l

a

' System Energy Resources, Inc. ]

. FINANCIAL STATEMENTS BALANCE SHEETS .

r 1 Decernkr 31, '

1986 1985 ASSETS (In Thousands) l

Utility Plant (Notes 5,7 and 9)

El ect ric . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $3,328,964 $3,281,242 Construction work in progress. . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . ...... 28,664 944,176 Nuclear fuel. . . . . . .... ............ .. .... ..... ... .. ..... . - 34,142 Total.......................................................... 3,357,628 4,259,560 less-Accumulated depreciation . . . ..... ... . ................ ... ... . .. 95,988 37,856 Utility plant-net . . . . . . . . . ............................ .. . ... ....... 3,261,640 4,221,704 Other Investments-Funds held in escrow (Notes 3 and 5) . .. ................... 19,162 -

Current Assets:

Ca s h (Not e 3) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ... . .... ....... 176 307 Temporary investments-at cost, which approximates market. . . . . . . . . . . . . . . . . . . 42,584 31,121 Accounts receivable:

Other........ .. ........... .. .. .. . . . ............ .... . .. ... 6,275 3,771 Associated companies . . . . . . . . . . . . . . . . . . . . . . . . . . ............... ... ...... 72,492 76,480 Materials and supplies-at average cost . . ..... ............. .... .......... 19,947 15,834 Other prepayments . . . . . . ........... .. .... .......... ..... ... . ..... 2,386 2,091 Recoverable income taxes (Notes 1 and 2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . - 55,071 Unamortized fuel expense . . . ..... ..... . .... .. .... . ... ...... .... 2,860 1,691 Other.... ........ ... ...... ......... .... ... ... .. ....... ... .. .. 1,944 1,467 Total . . . . . .... . ....... ..... . ... . .... . . .. .. . 148,664 187,833 Deferred Debits:

Suspended construction project (Note 1) . . . . . . . . . . ..... . . ..... .. . .. 908,572 -

Future benefits related to AFDC (Notes 1 and 2) . . . . . . . . . . . . . . . .. .... . 589,883 532,360 Unamortized premium on aacquired debt . . . . . ... . ........... . ... 16,250 -

Other. ....... .. .. . ..... ... ... .. . ... ... ..... ... . .. 5,947 5,521 Total . . . . . . . . . . . . . . ........ ,. . .. . ...... . .. .. . 1,520,652 537,881 TOTAL..... .. . .. ... . ... . .. .. .. . $4,950,118 $4,947,418 See Notes to Financial Staternents, i

1 i

10

i 1

1 December 31, 1986 1985 CAPITALIZATION AND LIABILITIES (In Timusands)

Capitalization:

Common stock, no par v 'ue, authorized 1,000,000 shares; issued and outstanding 789,350 shares (Note 4). . ., . . . . $ 789,3 50 $ 789,350 j Retained earnings (Note 6). . ... . ..... 1,161,104 971,969

]'

Total coramon shareholder's equity . . .. . .. .. 1,950,454 1,761,319 Long-term debt (Notes 3,5 and 7) .. . . .. .. . 2,266,824 2,317,225 Total . . . .. . . .. . . . .. . 4,217,278 4,078,544 Current Liabilities:

Currently maturing long-term debt (Notes 3,5 and 7) .. . . . 277,025 523,735 Accounts payable:

Associated companies . . ... . . . . . . 2,676 2,344 Other . .. . . .. . . . . .. .. . 45,771 35,776 Taxes accrued . . . . . . . .. . . . .. . 78,667 15,201 Interest accrued . . . ... .. . .. . . . .. . .. . 56,073 55,524 Power purchase advance payments. . . . .

- 51,152 Other. ... .. . ... . .. . .. . . 14,137 -

Total . . ... .. .. .. . .. .. . 474,349 683,732 Deferred Credits:

Accumulated deferred income taxes (Notes 1 and 2). .. . . 246,386 158,657 I Accumulated deferred investment tax credits (Notes 1 and 1). 12,105 12,348 Other . .. . .

- 14,137 Total . , .. .. .

258,491 185,142 I Commitments and Contingencies (Notes 7 and 8)

TOTAL. . 54,950,118 54,947,418 i

4 i

i 1

11  !

Sy:tzm Energy Resources, Inc.

FINANCIAL STATEMENTS (continued)

STATEMENTS OF INCOME For the Years Ended December 3L 1986 1985 1984 (In Tlwusands)

Operating Revenu es. . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . $959,737 $524,012 -

Operating Expenses:

Operation:

Fuel............................... ....... ,, .. ... .45,199 29,450 -

Other...... ... ..... ... ... . .. . . ..... .. .. . ...... . 98,172 57,403 -

Maintenance . . . . . . . . . ........ .. .... ... . . ... ... 31,801 19,597' -

Depreciation and decommissioning . .... . . ..... . . . ... .. 59,245 38,412 -

Taxes other than income taxes . . . ... . .. .... . ... . .. 23,688 7,568 -

Income taxes (Note 2) , . .. .. ... ....... .. ... . .. . . .. 233,881 118,815 -

To tal . . . . . . . . . . . . . . . . . ... . .. . . . ........ . . 491,986 271,245 -

Operating income. ...... . ........ ..... . .. .... . . . .. . 467,751 252,767 -

Other Income:

Allowance for equity funds used during construction . . . . . .. . . 972 120,508- $188,425 Miscellaneous income and deductions-net . . ... ... ... .... . . . 5,962 8,707 91

. Income taxes and credits in lieu of income taxes (Notes 1 and 2) . .. 39,406 108,838 163,067 Totai . . , . .. ... ......, .. .... . .. .. . .. .... . . . 46,340 238,053 351,583 Interest Charges:

Long-term debt . . . . . . ... ....... ......... . .. .. ... ... . 314,297 350,446 333,531 Power purchase advances. . . . . . .... . ... . .. .. . . ... 802 24,256- 11,724 Other-net. . .. . .. ............. .. . .. .... . .. . 4,294 1,403 5,955-Allowance for borrowed funds used during construction. . . . . .. .. 5,563 (103,852) (188,052)

Total . . . . . . . . . . . . . . . . . . . . . . . .. .... . . ... 324,956 272,753 163,158 Net income '. .... . . ..... ........ .... .. . . .. . . . $189,135 $218,067 $188,425 STATEMENTS OF RETAINED EARNINGS Tor the Years Ended December 31, 1986 1985 1984 (In TIwusands)

' Retained Earnings, January 1. .. . ... .. . .. $ 971,969 $753,902 $565,477

-. Add-Net Income. . .. ... . .. ... . . . .. 189,135 218,067 188,425 Retained Earnings, December 31 (Note 6) . . .. . . . . $1,161,104 $971,969 $753,902 See Notes to Financial Statements.

4 12

STATEMENTS OF CHANGES IN FINANCIAL POSITION For the Years Ended Decernber 31, l 4

1986 1985 1984 j Funds Provided By: (in rimusands)

Operations: l Net income . . ... . . ... ... . $ 189,135 $ 218,067 -

Depreciation and decommissioning . .,. . . 59,245 38,412 -

Deferred income taxes and investment tax credit adjustments-net . . . . .. 87,486 71,498 5 55,202 Amortization of premium on reacquired debt . . 942 - -

Allowance for equity funds used during construction. (972) (120,508) -

Total funds provided by operations . .. . 335,836 207,469 55,202 Other:

Allowance for equity funds used during construction. . 972 120,508 188,425 Power purchase advance payments . .. - 99,256 161,723 Decrease in working capital * . . 139,111 - 4,764 Total funds provided excluding financing transactions. . 475,919 427,233 410,114 Financing transactions:

Common stock. - - 99,450 First mortgage bonds . . .. . . 1,050,000 100,000 300,000 Pollution control revenue bonds. . . 90,000 250,000 27,100 Bank notes .. . . . . .

- 15,000 404,000 Sale and leaseback of nuclear fuel. . . 34,419 14,975 -

Short-term securities-net . .. , .

- 251,927 -

Total funds provided by financing transactions .. 1,174,419 631,902 830,550 Total funds provided. $1,650,338 $1,059,135 $1,240,664 Funds Applied To:

Utility plant additions:

Construction expenditures for utility plant . $ 40,782 $ 335,656 5 581,184 Nuclear fuel .. . . 277 625 26,508 Total gross additions (includes allowance for funds used during construction) 41,059 336,281 607,692 Other:

Future benefits related to AFDC. . . 57,523 23,587 95,310 Power purchase advance payments . . 51,152 209,827 -

Increase in working capital * .

- 140,040 -

Miscellaneous-net . 30,805 13,333 8,941 Total other funds applied . . 139,480 386,787 104,251 Financing transactions:

Retirement of bank notes (Notes 3 and 5). 1,097,717 281,832 161,000 Retirement of first mortgage bonds (Note 5) 324,265 54,235 48,000 Funds held in escrow 19,162 - -

l Premium on reacquired debt. 17,192 - - .

Short-term securities-net . . 11,463 - 319,721 Total funds applied to financing transactions . . 1,469,799 336,067 528,721 >

Total funds applied . .. $1,650,338 $1,059,135 _ $1,240,664

• Increase (Decrease) in Working Capital:

Cash. . . $ (131) $ (149) $ (1,259)

Accounts receivable. . (1,484) 78,799 1,014 Other current assets (49,017) 37,934 36,500 Accounts payable and other current liabilities . (24,464) (19,941) (11,187)

Taxes and interest accrued . (64,015) 43,397 (29,832)

Total . 5 (139,111) $ 140,040 $ (4,764)

• Working capital excludes tentporary itn'estntents, current tnaturities oflong-tertu debt, and power purchase advance payrnents.

See Notes to FinancialStatements.

13 e____-___-_ _ _ _ _ - - - _ _ _ - _ _ _ _ _ _ ._

Syst:m En:rgy Resources,Inc.

NOTES TO FINANCIAL STATEMENTS life insurance benefits was $945,000 in 1986. The Company did not directly employ any personnel prior l NOTE L

SUMMARY

OF SIGNIFICANT ACCOUNTING to December 1986.

POLICIES D. Income Taxes A. Organization The Company joins its parent and affiliates in the filing of a consolidated Federalincome tax return.

System Energy Resources, Inc. (Company), formerly Middle South Energy,Inc.,is a wholly-owned subsid- Income taxes are allocated to the Company in propor-iary of Middle South Utilities, Inc. (MSU). The Com- tion to its contribution to consolidated taxable income.

pany was created in 1974 to finance, construct, and In addition, the Company files a consolidated Missis-l Si PPi state income tax return with certain other System

) operate a two-unit nuclear generating plant, known as

! the Grand Gulf Nuclear Station, to be located near Port companies.

l Gibson, Mississippi. On July 28,1986, the name of E. Allowance for Funds Used During Construction Middle South Energy, Inc. was changed to System in accordance with the regulatory system of accounts, Energy Resources, Inc. and, c'fective December 20, the Company capitalizes, as an appropriate cost of 1986, the Company assumed the primary responsibil- utility plant, an allowance for funds used during con-ities, previously assigned to Mississippi Power & Light struction (AFDC). Under this utility industry practice, Company (MP&L), for the management, operation and construction work in progress on the balance sheet is maintenance of the Grand Gulf Station. On October 28, charged and the income statement is credited for the 1986, the Company amended its bylaws to change the approximate net composite interest cost of borrowed location ofits principal business offices from New funds and for a reasonable return on the equity funds Orleans, Louisiana to Jackson, Mississippi. used for construction. This procedure is intended to The Company and South Mississippi Electric Power remove from the income statement the effect of the i Association (SMEPA) own undivided ownership inter- cost of financing the construction program and results ests of 90% and 10%, respectively,in the Grand Gulf in treating the AFDC charges in the same manner as Station. The Company records its investment associated construction labor and material costs. As non-cash with the Grand Gulf Station to the extent to which it items, these credits to the income statement have no owns and participates in the station. effect on current cash earnings. After the property is The Company's only significant activity to date has placed in service the AFDC charged to construction been the construction and operation of, and financing costs is recoverable from customers through deprecia-of its 90% ownership interest in, the Grand Gulf Station. tion provisions included in rates charged for utility The Grand Gulf Station consists of two 1250 megawatt service. Through June 1985, the Company used an (MW) nuclear generating units. The Company sells accrual rate for AFDC based on a return on average capacity and energy from Grand Gulf 1 to Arkansas common equity of 14% plus actual interest cost net of Power & Light Company (AP&L), Louisiana Power & related income taxes. As a result of the FERC's decision Light Company (LP&L), MP&L and New Orleans Public on June 13,1985, the 14% return on common equity Service Inc. (NOPSI), collectively referred to as the rate was increased to 16% effective July 1,1985.

" System operating companies." AFDC attributable to Grand Gulf I construction There were no operating revenues or expenses prior {

ceased accruing as of July 1,1985, the commercial a to July 1,1985. The Nuclear Regulatory Commission operation date of the unit.

(NRC) issued a full power operating license for Grand On September 18,1985, the Mississippi Public Gulf 1 on August 31,1984. This unit began commercial Service Commission (MPSC) issued an Order Directing operation on July 1,1985. Construction work on Grand Suspension of Construction of Grand Gulf 2, which j Gulf 2 was suspended in September 1985. d;rected the Company and MP&L to suspend construc-D. System of Accounts tion of Grand Gulf 2 as of the date of the Order. Fol-lowing the suspension of construction of Grand Gulf 2, The accounts of the Company are maintained in i the Company ceased accruing AFDC on the unit effec- '

accordance with the system of accounts prescribed by tive September 18,1985. (See Note 7," Commitments the Federal Energy Regulatory Commission (FERC).

• and Contingencies-Grand Gulf 2.")

C. Postretirement Benefits F. Utility Plant, Depreciation and Decommissioning At December 31,1986, substantially all of the C -

Utility plant is stated at original cost. The cost of pany's employees were covered under postretirement additions to utility plant includes contracted work, benefit plans administered by MP&L In return, the direct labor and materials, allocable overheads and Company reimbursed MP&L for the cost of these AFDC. The costs of units of property retired are re-plans applicable to its employees. Total 1986 pension moved from utility plant and such costs plus removal expense of the Company was $1,744,000 while the costs, less salvage, are charged to accumulated depreci-Company's cost of providing certain health care and 14 .

l 1

i 1

ation. Maintenance and repairs of property and the per year for nuclear plant decommissioning costs for repheement of items determined to be less than units Grand Gulf 1 and will deposit these monies in an of property are charged to operating expenses. Substan. external fund held by a trustee. The Company was tially all of the utility plant is subject to the lien of the permitted by the FERC to recover these amounts based Company's first mortgage bond indenture. on studies of the estimated costs of decommissioning -

I Depreciation on Grand Gulf 1 was computed on the Grand Gulf 1.

units-of-pioduction method for the initial twelve G. Reclassifications months of commercial operation (which began July 1, 1985) and, with FERC approval, for an additional six Certain reclassifications of previously reported months thereafter. Subsequent to December 31,1986, amounts have been made to conform with current depreciation will be computed on a straight-line basis. classifications. Due to the continued suspension of Depreciation provisions on average depreciable prop. c nstruction on Grand Gulf 2, the total costs to date of  ;

crty approximated 1.8% in 1986 and 2.3% in 1985. No construction on the unit were reclassified in December depreciation was recorded in 1984. The Company has 1986 from Utility Plant-Construction Work in Progress filed an application with the FERC and the FERC has to Deferred Debits-Suspended Construction Project.

initiated a proceeding to determine the appropriate (See Note 7," Commitments and Contingencies-straight-line depreciation rate for Grand Gulf 1. Grand Gulf 2.") These reclassifications have no effect The Company is recovering approximately $1.1 million on net income.

NOTE 2. INCOME TAXES AND CREDITS IN LIEU OF INCOME TAXES Income tax expense (credit) consists of the following: Year Ended December 31, l

1986 1985 1984 (hn Tlumsands)

Federal. . . .

5106,989 $ (55,513) $(215,394)

State. . . . .. . . .

- (6,007) (2,875)

Total . . .. . .. . . . . .

106,989 (61,520) (218,269)

Deferred-net:

Taxes capitalized in the financial statements . . .. 1,546 5,731 8,994 1.iberalized depreciation . . 76,446 69,1t 0 45,490 Test energy , . . . .. 27 (3,272) 718 Other . . . .

9,710 - -

Total . . . .

87,729 71,619 55,202 Investment tax credit adjustments-net. . .

(243) (122) -

Recorded income taxes and credits in lieu of income taxes . $194,475 5 9,977 $(163,067)

Charged to operations. . $233,881 $ 118,815 -

Credited to other income . (39,406) (108,838) $(163,067)

Recorded income taxes and credits in lieu of income taxes . . 194,475 9,977 (163,067)

Income taxes applied against the debt component of AFDC . , (5,281) 98,589 160,192 Total income taxes and credits in lieu of income taxes . $189,194 5 108,566 5 (2,875) 15

System Energy Resources, Inc.

NOTES TO FINANCIAL STATEMENTS (continued) i Total income taxes and credits in lieu of income taxes statutory Federal income tax rate to income before differ from the amounts computed by applying the taxes. The reasons for the differences are as follows:

Year Ended Decc'nber 31, 1986 1985 1984

% of  % of  % of Pre-Tax Pre-Tax Pre-Tax Amount income Amount Income Amount income (In Tiwusands)

Compmed at statutory rate. $176,461 46.0 $104,900 46.0 $ 11,665 46.0 Increases (reductions) in tax resulting from:

AFDC. . . 2,111 .5 (103,206) (45.2) (173,179) (682.9)

Difference between book depreciation and tax straight-line depreciation 11,337 3.0 7,845 3.4 - -

State income taxes net of Federal income tax expense . 5,184 1.4 961 .4 (1,553) (6.1)

Other. . ,

(618) (.2) (523) (.2) - -

Recorded income taxes and credits in lieu of income taxes. 194,475 50.7 9,977 4.4 (163,067) (643.0)

Income taxes applied against the debt component of AFDC. . (5,281) (1.4) 98,589 28.8 160,192 641.5 l Total income taxes and credits in lieu of income taxes. $189,194 49.3 $108,566 33.2 _ $ (2,875) (1.5)

Grand Gulf 1 was placed in service for tax purposes Federal taxable income, future benefits related to in 1984. Deferred income taxes are provided for differ- AFDC will expire in 1993 through 2000, ences between book and taxable income to the extent Investment tax credits allocated to the Company permitted by the FERC for ratemaking purposes. have been deferred and those relating to Grand Gulf 1 AFDC is excluded for purposes of determing taxable are being amortized based upon the average usefullife income, of the related property. Unused investment tax credits Future benefits related to AFDC represent the tax at December 31,1986 amounted to $221.3 million benefit of the Company's portion of the consolidated before any reductions resulting from the Tax Reform Federal tax losses that is expected to be realized Act of 1986. These credits may be applied against during the loss carryforward period. Such benefits are Federal income tax liabilities in future years. If not paid to the Company when realized in the consolidated used, they will expire in 1992 through 2001.

return of MSU. The income tax benefits for the See Management's Financial Discussion and Analysis years 1986,1985 and 1984 that were realized amounted for a discussion of the Tax Reform Act of 1986 and its to 50.0 million, $10.0 million and $123.8 million, impact on the Company.

respectively. If not utilized to offset consolidated NOTE 3. LINES OF CREDIT AND RELATED BORROWINGS Prior to June 28,1985, the Company had two Bank Loan Agreements. The loans with U.S. Banks revolving credit agreements with various banks provid- have a maturity date of February 5,1989, subject to ing for borrowings totaling $2,089 million. One agree- mandatory semi-annual payments of $125 million due ment, for $1,711 million, was with a group of U.S. Banks on the first day of each March and September, with the (U.S. Bank Loan Agreement); the other agreement, unpaid balance due on the maturity date. A portion of with a group of Foreign Banks (Foreign Bank Loan these se'mi-annual payments will be applied to an Agreement), was for $378 million. On August 2,1985, escrow account for the benefit of certain banks partici-and August 9,1985, respectively, the Foreign and U.S. pating in the U.S. Bank Loan Agreement that provided f

l Bank Loan Agreements were amended, effective as of a letter of credit in connection with the Series C Pol-June 28,1985, to convert the borrowings thereunder to lution Control Revenue Bonds (Series C Letter of term leans. At December 31,1986, the Company had Credit Banks). The maturity date for the loans with i outstanding borrowings of $473.2 million and Foreign Banks is February 5,1989, subject to mandatory ,

I

$236.2 million, respectively, under the U.S. and Foreign semi-annual payments of $47.25 million to be made on 16  !

l

_ _ _ _ _ _ _ _________-__-________-_______________A

i February 5 and August 5 of each year, agreements, each with a bank, through February 1989 In March 1986, the Foreign Bank Loan Agreement for $105.0 million and $131.3 million, respectively (as

. was amended to (1) increase the interest rate on bor- of December 31,1986), of the amounts outstanding rowings thereunder by 1% effective from February 5, under the Foreign Bank lean Agreement. The Com-1986, and (2) to change certain provisions of the pany has agreed to make semi-annualinterest pay- q Foreign Bank Loan Agreement relating to Grand Gulf 2 ments based upon an 11.5% and 11.16% fixed rate, such that prepayment of outstanding borrowings under respectively, in exchange for semi-annual interest i this agreement would not be required for condemna- payments by the banks based upon the London Inter-tion, abandonment or non-completion of Grand Gulf 2. bank Offered Rate (LIBOR). These agreements serve to These amendments relating to Grand Gulf 2 became offset fNetuations in variable rates to be paid under the effective in June 1986 when the Company paid to the Company's Foreign Bank Loan Agreement. They do Foreign Banks the deferred payments discussed below not change the Company's obligations to the Foreign as well as the $47.25 million payment due to the Banks for interest payments of LIBOR plus 2%.

Foreign Banks on August 5,1986. The Company is subject to limitations on the maxi-In March 1986, the U.S. and Foreign Banks allowed mum amount of short-term borrowings outstanding the Company to defer to June 1986, $268.1 million of under both the Public Utility Holding Company Act of scheduled payments due in February and March 1986. 1935 and the terms of its bank loan agreements. At On Jurie 5,1986, the Company repaid the $215.8 million December 31,1986, the maximum permitted was the remaining principal balance due on these deferred lesser of $200 million or five percent of capitalization, amounts. In addition, on June 30,1986, the Company which was $226.3 million. However, at December 31, prepaid the $47.25 million semi-annual payment due 1986, the Company had no sources of short-term bor-August 5,1986 under the Foreign Bank Loan Agree- rowings. Prior to 1987, the Company participated only ment and the $125 million semi-annual payment due as a lender / investor with certain other companies of September 1,1986 under the U.S. Bank Loan Agree- the Middle South System in a money pool arrangement ment. In September 1986, the Company prepaid whereby those companies with available funds made

$628.2 million of bank notes outstanding under the short-term loans to other companies in the System U.S. Bank Loan Agreement. (excluding the Company) having short-term borrowing in January 1987, the Company prepaid $52.82 million requirements. Effective January 1,1987, the money l

of bank notes under the U.S. Bank Loan Agreement pool arrangement was amended to allow the Company I

and $15 million under the Foreign Bank loan Agree- to borrow funds, subject to its maximum authorized ment and paid approximately $12 million into the level of short-term borrowings and limitations in its escrow account for the benefit of the Series C Letter of bank loan agreements, as well as lend / invest an aggre-Credit Banks. In addition, the Company paid in Febru- gate amount of up to $10.0 million through the pool,in ary 1987 the $47.25 million semi-annual installment accordance with limitations in its bank loan agreements.

due under the Foreign Bank Loan Agreement. On The short-term borrowings and the interest rates March 2,1987, the Company paid the scheduled semi- (determined by dividing applicable interest expense by annualinstallment of $125 million due under the U.S. the average amount borrowed ) for the Company were Bank Loan Agreement, $35.1 million of which was paid as follows:

Year Ended December 31, into the escrow account.

The Company has separate " interest rate swap" 1986 1985 1984 (ht Tlwusands)

Lines of credit. . ...

- - $14,680 Average borrowing:

Lines of credit. . . . .

- $ 1,342 $32,076 Unsecured short-term notes. - $ 4,275 $18,228 Maximum borrowing:

Lines of credit. - $ 5,149 $70,361 Unsecured short-term notes. - $10,000 $29,000 Year-end borrowing:

'.ines of credit . .

Unsecured short-term notes. . .

- - $10,000 Average interest rate:

During period-Lines of credit. .

- 10.4 % 11.8 %

Unsecured short-term notes. - 9.4% 10.9 %

v 2nd of period-Lines of credit. .

Unsecured short-term notes. . - - 9.6 %

17

_ _ _ _ _ _ -~

Syst:m En:rgy Resources, Inc.

NOTES TO FINANCIAL STATEMENTS (continued)

NOTE 4. COh1 MON STOCK There were no changes in the number of shares of Articles of Incorporation will be amended in cor,nection the Company's common stock during the years 1986 with the issuance of preferred stock to split its com-and 1985. In 1984, the Company sold a total of 99,450 mon stock 100 to 1.

shares to MSU at $1,000 per share. The Company's NO7E 5. LONG-7ERAf DEBT l

The long-term debt of the Company at December 31,1986 and 1985 was as follows:

2 December 31, l 1986 1985 ~

1 (in Thousands)

First Mortgage Bonds:

Due 1989,9.25% Series. . . .. . . . .

- S 232,000 Due 2000,12.50% Series . ....,. .. .. . .

- 92,265 l Due 2000,16% Series . .. . .. .. . 5 300,000 300,000 Due 2000,15%% Series . . . . .. . . 100,000 100,000 Due 2000,11% Series. . .. ... . . 300,000 -

Due 1991,9%% Series . . . .. . . .. ... . 300,000 -

Due 1996,10%% Series . . . , . .. .. .. 250,000 -

Due 2016,11%% Series . .. . ... .. . 200,000 -

Total . . . . . . .. .. .. . .. . 1,450,000 ,

724,265 Bank Notes (Note 3):

Domestic bank line-Due 1987-1989, at 110% of the sum of prime and 1.3%. . . . . . . . . . .. .. . 473,200 1,476,417 Foreign bank line-Due 1987-1989, at 11.16% plus 2%. .. . 131,250 183,750 Due 1987-1989, at 11.5% plus 2%. . . 105,000 147,000 Total . . . . . . .. .. 709,450 1,807,167 Pollution Control Revenue Bonds:

Claiborne County, Mississippi-Due 2013, at 4.7% adjustable / fixed rate. . . 49,500 49,500 Due 2014, at 8.75% adjustable / fixed rate. . 27,100 27,100 Due 2014, at 8.5% adjustable / fixed rate. 206,000 206,000 Due 2015, at 12.5% , . . 44,000 44,000 Due 2016, at 9.5% .. 90,000 -

Total . . . .

416,600 326,600 Unamortized discount on debt . . (32,201) (17,072)

Total Long-Term Debt. 2,543,849 2,840,960 Less-Amount due within one year. . 277,025 523,735 Long-Term Debt Excluding Amount Due Within One Year . 52,266,824 $2,317,225 18

The Pollution Control Revenue Bonds due 2015 at credit requiring the Company to make semi-annual 12.50% and those due 2016 at 9.50% are collateralized payments into an escrow account. The uncollateralized by $47.2 million and $95.6 million, respectively, of amount needed to fund the escrow account was non-interest bearing first mortgage bonds. approximately $215.4 million at December 31,1986.

In connection with the Series C Pollution Control Sinking fund requirements and maturities for the Revenue Bonds due 2014, certain banks that participated ensuing five years for the Company's long-term debt at in the U.S. Bank Loan Agreement provided a letter of December 31,1986 were as follows:

Cash Sinking Fund Maturities *

(In Tlwusands) 1987. . .. . . . .... ... .. . .. .. .... .

- $277,025 1988. . . . .. ... . . . . . . .

- $260,177 1989. . .. . .. .. .. .. . . . . .. ... $53,500 $172,248 1990... . . . . . . . . .. $53,500 -

l 1991. .. .. . . . . ,. . .. ... . $68,500 $300,000 l

• Excludes requirements for escrow payments of $215.4 million through 1989 for the benefit of the Series C Letter of Credit Banks.

Substantially all of the Company's utility plant is subject to the lien of its first mortgage bond indenture.

NOTE 6. RETAINED EARNINGS The provisions of certain of the Company's financing A and B Pollution Control Revenue Bonds, as described agreemats and its first mortgage bond indentures have below. The declaration and payment of dividends by restricted the amount of retained earnings available for the Company is dependent upon appropriate action by cash dividends on common stock. In addition, banks the Company's Board of Directors.

which are parties to the Company's U.S. and Foreign The Company continues to be limited in the pay-l Bank Loan Agreements voted in 1986, pursuant to ment of cash dividends on common stock by provisions such Agreements, to deny the Company the right to of the Foreign Bank Loan Agreement and the Reim-pay any cash dividends on common stock. Accordingly, bursement Agreements for its Series A and B Pollution prior to January 1987, all of the Company's retained Control Revenue Bonds. Under these agreements, the earnings were restricted as to the payment of cash Company is presently limited in the amount of dividends dividends on common stock. it may pay on its capital stock (other than dividends The provisions of the U.S. and Foreign Bank Loan payable solely in shares of common stock and dividends Agreements allow the Company the right to pay cash payable in cash where, concurrently, the Company divideads on common stock upon making sufficient receives a capital contribution or sells shares of its prepayments to the U.S. Banks to reduce the amount common stock) in an amount equal to its accumulated owing undec the U.S. Bank Loan Agreement at matur- net income for the period July 1,1985 to the date of ity to $125 million or less. On January 5,1987, the the payment. Such amount was approximately Company made a payment under the U.S. Bank Loan $299.6 million at December 31,1986. The Company Agreement in the amount of $65 million, which was has paid no dividends on its capital stock to date. In sufficient to reduce the obligations thereunder to an the event the Company experienced a loss that amount which, among other things, cancelled the exceeded such accumulated net income,less the sum suspension pursuant to the Bank Loan Agreements of of certain dividends paid since July 1,1985, dividends the Company's right to pay common stock dividends. could not be paid until such a deficit was restored by Consequently, the Company would be permitted to subsequently earned net income, except where concur-pay common dividends to its parent, MSU, within rently the Company receives a capital contribution or the limits prescribed in the Foreign Bank Loan Agree- sells shares of its common stock.

ment and the Reimbursement Agreements for its Series 19

_ ________ _________ a

Sy: tem Energy Resources, Inc.

NOTES TO FINANCIAL STATEMENTS (continunf)

NOTT 7. COA 1MITMENTS AND CONTINGENCIES _ See Note 8," Rate and Regulatory Matters-Rate Activity--System Operating Companies."

Potential Debt Acceleration and Related Matters

. . . . Capital Requirements and Financing The Mississippi Supreme Court has reversed and remanded the prior MPSC rate order granting MP&L The Company will require approximately $942.7 million permanent rate relief with respect to its recovery of fr m internal and external sources for the period 1987 Grand Gulf I costs, and MP&L's rate structure estab- through 1989, to refinance maturing indebtedness, to lished by that rate order is under further review by the meet sinking fund requirements and to finance its other MPSC. Further, the Council of the City of New Orleans capital requirements. Of this amount, the Company (Council) is continuing to conduct a prudence inquiry has paid $205 million during the period January 1,1987 into NOPSI's involvement in G. rand Gulf 1, and the through March 15,1987. In addit on, the Company's Council's consultants have recommended, notwith, nuclear fuel lease may termmate m June 1987 if the standing the March 1986 rate settlement between credit line supporting the nuclear fuel lease termmates.

l NOPSI and the Council, that NOPSI could economically It is currently assumed that either the credit 1me will I sustain substantial additional disallowances with be extended or that alternative credit imes will be respect to its allocable share of Grand Gulf I costs. The arranged. To the extent, however, that this does not Company cannot predict the outcome of these matters occur, dditional capital requirements of up to or whether the current rate structures of these two $175 million could result. While the Company would operating companies will remain in effect. Without expect to obtain a significant portmn of the required adequate rates to recover Grand Gulf I charges, MP&L funds through its receipt of payments from the alloca-and NOPSI could suffer such liquidity constraints that tion of costs associated with Grand Gulf 1 to the they would, in a short period of time, be unable to System operating companies under the Unit Power meet their contractual obligations to the Company in Sales Agreement (see" Unit Power Sales Agreement" respect of the Grand Gulf Station. below), the balance of amounts needed by the Com-Unless (1) waivers were obtained, (2) the debt were pany would be obtained from external sources, includ-restructured or (3) other arrangements could be nego- ing, but not limited to, issuances of additional first tiated, the failure of either MP&L or NOPSI to make mortgage bonds, preferred stock and such other sources the required payments to the Company or to maintain as m y be appropriate.

their current rate structures might, under certain in connection with the Grand Gulf Station, MSU has agreements related to the Company's indebtedness undertaken, to the extent not obtained by the Com-(but only upon further action by the requisite per- p ny fr m ther sources, to furnish or to cause to be centage of the Company's creditors), lead to acceleration f"f"IShed to the Company sufficient capital for con-of such indebtedness. In the absence of such waivers' struction and operation and related purposes. Through December 31,1986, MSU had invested $789.4 million debt restructuring or other negotiated arrangements, acceleration of such indebtedness could also occur if in the common stock of the Company.

either operating company were rendered insolvent as At December 31,1986, the Company estimated con-a result of a substantial reduction in retail rates. struction expenditures (excluding nuclear fuel) of Acceleration of the Company's indebtedness could Approximately $57.5 million in 1987, $57.0 million in also occur if the MPSC took action in the proceeding 1988 and $61.0 million in 1989 in connection with the relating to the Certificate of Public Convenience and Grand Gulf Station. Grand Gulf I expenditures, includ-Necessity for the Grand Gulf Station which made the ing retrofits, are estimated to be (including minimal continued operation of Grand Gulf 1 impractical. amounts of AFDC) $37.7 million in 1987, $37.1 million Given the substantial amount of the Company's debt, in 1988 and $41.0 million in 1989. Grand Gulf 2 con-

) it would not be able to fully meet its obligations, if struction expenditures are for demobilization and accelerated. Under the Company's financing agree _ suspension and assume virtually no construction on

) the unit. Through December 31,1986, the Company l ments, MSU, and not the System operating companies, l

would be responsible to pay the Company's accelerated had invested $4,266 million (excluding nuclear fuel) in obligations if the Company could not. MSU, with its the Grand Gulf Station. The Company estimates, pend-financial resources currently limited, would not at this ing a final review of the cost allocation between the time be in a position to fully satisfy the Company's two units, that of this total, $3,358 million was invested obligations if accelerated. In addition, the ability'of by the Company in Grand Gulf 1 and $908 million in various Middle South System companies to ob'tain Grand Gulf 2.

financing in the capital markets could be impaired and, Grand Gulf 2 in the event of insolvency of a System operating As of December 31,1986, the Company had in-company, certain of the financing arrangements and vested approximately $908 million in Grand Gulf 2 leases of the Middle South System's fuel subsidiary, (including approximately $390 million of AFDC), which System Fuels Inc., could require payments by the was approximately 34% complete based on the esti-System operating companies, MSU or the Company. mated man-hours needed to complete the unit. From late 1979 through September 1985, only a limited amount of construction was being performed on

Grand Gulf 2. The Company had been accruing and connection with any subsequent decision as to the capitalizing AFDC on its investment in Grand Gulf 2 at value of Grand Gulf 2 or the ultimate decision with the rate of approximately $8 million per month. On respect to the future of Grand Gulf 2, the Company September 18,1985, the Company suspended construc- will, at an appropriate time, make a determination as to tion activities and ceased accruing AFDC on Grand the appropriate recovery of its investment. In making I Gulf 2 following an order of the MPSC. such a determination, the Company would consider, Since September 1985, the Company has continued among other things, the regulatory environment, suspension of construction on Grand Gulf 2 and has generally, and legal standards then applicable. Any limited expenditures to only those activities which are action to seek recovery of Grand Gulf 2 costs would absolutely necessary for the demobilization and sus- likely involve a filing by the Company with the FERC pension of the unit. In November 1986, a special group requesting such recovery, over a period of years, (Study Team) formed by management, which included through charges to the System operating companies, Middle South System officials and outside consultants, and related filings by the System operating companies completed a comprehensive year-long study that before state or local regulatory authorities to recognize analyzed in depth the various alternatives regarding the FERC-allowed charges in retail rates. There can be Grand Gulf 2 and the complex issues concerning its no assurance that the Company would be permitted by future status. In December 1986, the Company's Board the FERC to recover the full amount of its investment of Directors adopted the recommendation of the Study in Grand Gulf 2. Proceedings before the FERC and, Team that suspension of construction be continued with respect to recognition in retail rates of FERC and that a further decision be made by 1990 on the approved rates, before state or local regulatory future status of Grand Gulf 2,in light of alternatives authorities, could be protracted and strongly contested available at that time. on various grounds, including imprudence. If costs During the period of continued suspension, the associated with Grand Gulf 2 were allocated to the Company's expenditures on Grand Gulf 2 will be System operating companies and they were unable to limited, and it will continue not to accrue and capitalize recover these costs from their customers, the System AFDC on its investment in the unit. Consequently, operating companies' financial condition could be during the suspension period, the increase in the materially and adversely affected. Any nonrecovery of Company's investment in Grand Gulf 2 will be limited the Company's investment in Grand Gulf 2 would and the Company will forego any return on this invest- result in a charge against earnings or restatement of ment. Further, the Company does not intend to make prior years' financial statements for any unrecoverable an application to the FERC during the period of sus- investment when that event becomes probable. In the pension with respect to recovery through rates of its event such a charge were substantial, the financial investment in Grand Gulf 2. condition of the Company could be materially and The Company will continue during the suspension adversely affected (although its cash position would period to evaluate various alternatives for the future of not be adversely affected), and the Company's ability Grand Gulf 2 and will also continue to assess whether to pay dividends on its capital stock could be impaired.

certain equipment or facilities should continue to be See Note 6," Retained Earnings" for further informa-  ;

carried at their full cost. Any determination that the tion regarding these restrictions. Also, reference is value of the Company's investment should be reduced made to "New Accounting Standard" below for infor-and the amount of any such reduction written off could mation concerning an accounting standard which adversely affect various companies in the Middle South addresses the accounting treatment of issues similar to System. The Company currently believes, however, those discussed herein.

that it is justified in carrying Grand Gulf 2 at its full in the third quarter of 1985, SMEPA, which has a value because the property currently comprising Grand 10% ownership interest in Grand Gulf 2, ceased mak-Gulf 2 is of the same design as that of Grand Gulf 1 ing payments for its proportionate share of Grand Gulf and is being properly maintained and is therefore suit- 2 costs incurred subsequent to July 31,1985. Effective able for its intended purpose. Certain issues relating to February 7,1986, SMEPA and the Company adopted a the value of the Company's investment in Grand Gulf settlement agreement. Under the terms of the settle-2 also exist in connection with an audit by the FERC ment agreement, SMEPA will pay its proportionate discussed below, share of the Grand Gulf 2 costs incurred subsequent to Under the Foreign Bank Loan Agreement, the Com- July 31,1985 and future costs for suspension and pany has covenanted to limit capital expenditures demobilization of the unit up to a maximum of $4.951 (other than those required by regulation) to not in million but will no longer be obligated to pay cc,sts of excess of $80 million per annum in the aggregate. construction on Grand Gulf.2 should construction of l 3

Unless waived, this covenant would preclude resump- the unit resume. Any Grand Gulf 2 costs applicable to  !

tion of full construction on Grand Gulf 2 prior to 1989. SMEPA's interest in excess of this amount would be While the Company believes that all of its invest- paid by the Company. Should the Company decide to ment to date in Grand Gulf 2 has been prudent,in 21

Syst:m Energy Resources, Inc.

NOTES TO FINANCIAL STATEMENTS (continued) resume full construction of Grand Gulf 2, SMEPA will to continue suspension of Grand Gulf 2 (see above).

have the option of having refunded to it all payments The provisions of SFAS No. 90 would apply should made under the settlement agreement for costs incurred the Company decide to abandon Grand Gulf 2.

subsequent to July 31,1985 which could result, if Shareholder Litigation necessary, in the periodic adjustment of SMEPA,s and the Company's ownership interests in proportion to in 1985, MSU, certain other Middle South System their respective investments in Grand Gulf 2. companies, including the Company, and individuals I

became defendants in a purported class action suit. The FERC Audit initial complaint was filed in August 1985 by an MSU i The FERC has performed an audit of the Company shareholder (purporting to represent a class that pur- )

i and the Grand Gulf Station as part of its regulatory chased MSU common stock) followed by four similar j l function in auditing utilities subject to its jurisdiction, complaints filed by MSU shareholders in August and l and, on May 8,1986, the FERC Staff sent to the Com- September 1985. The five actions were consolidated in pany for review and comment a draft audit report out- the U.S. District Court for the Eastern District of lining the Staffs tentative findings and recommendations. Louisiana. The consolidated, amended and supple-The draft report included preliminary findings which mental complaint alleged violations of the disclosure (i) questioned the Company's accrual of AFDC on requirements of the Securities Exchange Act of 1934 Grand Gulf 2 as a construction cost during the period and the Securities Act of 1933, common law fraud and of 1979-1985 during which time construction work on common law negligent misrepresentation in connection the unit was limited, and (ii) questioned the Company's with the financial condition of MSU and prayed for accounting for its unrealized tax benefits in relation to compensatory and punitive damages, legal costs and the computation of AFDC on the Grand Gulf Station. fees and other proper relief against MSU, various other On June 13,1986, the Company submitted a response Middle South System companies, including the Com-to the FERC Staffs draft report disagreeing with most pany, and certain officers (and former officers) and of the Staffs preliminary findings. The FERC Staff held directors of MSU, the Company's outside auditors and a meeting with the Company on September 10,1986 to certain underwriters of MSU Common Stock. In April discuss the issues raised in the draft report and has 1986, MSU and the other defendants, including the indicated that it would require additional information Company, filed a motion to dismiss or, in the alterna-and time to consider certain issues. If the FERC Staff's tive, a motion for summary judgment. On January 12, preliminary findings are adopted and sustained, the 1987, the District Court entered a judgment granting resolution of certain of these issues could have a sig- defendants' motions for summary judgment and dis-nificant adverse impact on the Company. The Company missed the suit. On February 6,1987, the plaintiffs in cannot predict the ultimate outcome of this examination. the consolidated action filed a Notice of Appealin the urt of Appeals for the Fifth Circuit. The New Accounting Standard defendants miend to vigorously oppose the appeal of The accounting standards relating specifically to the District Court's decision.

public utilities and certain other regulated enterprises are set forth in Statement of Financial Accounting Unit Power Sales Agreement Standards (SFAS) Nos. 71 and 90. SFAS No. 90, On June 10,1982, the Company and the System Regulated Enterprises-Accounting for Abandonments operating companies entered into a Unit Power Sales and Disallowances of Plant Costs, was issued by the Agreement pursuant to which the Company agreed to Financial Accounting Standards Board in December sell all of the capacity and energy available to it from 1986 as an amendment of SFAS No. 71. It provides Grand Gulf 1 and Grand Gulf 2 to LP&l, MP&L and that, when an abandonment of a plant or a disallowance NOPSI in accordance with percentages specified therein, of costs with respect to a newly completed plant be- which conform with the percentages set forth in the come probable, the following amounts, net of related Reallocation Agreement described below. As discussed tax benefits, would be reported either by restating the under Note 8," Rate and Regulatory Matters," the Unit appropriate prior years' financial statements or by Power Sales Agreement was, with certain modifications charging such amounts against current income: (1) the (including an allocation of capacity and energy from cost of an abandoned plant in excess of the present Grand Gulf 1 to AP&L) approved by the FERC in its value of estimated recoveries or (2) the amount of a June 13 Decision and ordered to become effective partial disallowance by regulators of a recently com- upon the initiation of service of Grand Gulf 1, which pleted plant for ratemaking purposes. The new state- occurred on July 1,1985. The FERC did not rule on ment is effective for fiscal years beginning after Grand Gulf 2's allocation and ordered the Company to December 15,1987 with retroactive application for remove the proposed Grand Gulf 2 percentage alloca-prior transactions. 3FAS No. 90 will not have any cur- tion from the Unit Power Sales Agreement.

rent effect upon the Company in light of the decision The Unit Power Sales Agreement, as currently in 22

effect, specifies the rates to be charged to the System ating companies, including AP&l, however, would have operating companies for their respective entitlement remained primarily liable to the Company and its to receive capacity and energy from Grand Gulf 1. assignees for payments or advances under these agree-Such rates are computed monthly on the basis of the ments. AP&L was obligated to make its share of the Company's total cost of service, which is based on the payments or advances only if the other System oper-Company's operating expenses, depreciation and ating companies were unable to meet their contractual i capital costs attributable to the unit for the month. obligations. However, the FERC's June 13 Decision l- These rates are paid in consideration for the respective allocating a portion of Grand Gulf I capacity and entitlement of these companies to receive such capacity energy to AP&L supersedes the Reallocation Agree-and energy, and are payable irrespective of the quantity ment insofar as it relates to Grand Gulf 1.

of energy delivered so long as the unit remains in Amounts to be received by the Company under the commercial operation. Generally, operating expenses Unit Power Sales Agreement are expected to exceed are computed by reference to amounts chargeable to the amounts payable under the Availability Agreement the Company's operating expense accounts. Capital for the foreseeable future and, consequently, no pay-costs are computed by allowing a 16% return on the ments under the Availability Agreement are expected Company's common equity funds and adding to such to be required. Should there be a shortfall in any amount the effective interest and dividend cost to the month, amounts received by the Company from any Company during the billing period for its respective other sources (including financings, sales of property long-term debt and preferred stock. and the like) and available at that time would be credited toward the obligations owing under the Avail.

Capital Funds, Availability and Reallocatiort ability Agreement.

Agreements Under the Capital Funds Agreement, as supple- Nuclear Liability Insurance mented, MSU has agreed to supply or cause to be At December 31,1986, the Price-Anderson Act (Act) supplied to the Company (1) such amount 3 of capital limited the public liability of a licensee of a nuclear power I as may be required in order to maintain equity capital plant to 5695 million for a single nuclear incident. This at an amount equal to at least 35% of the Compa,y's limit will increase by $5 million f er each additional total capitalization (excluding short-term debt) and (2) operating license issued by the N3C. Insurance for this such amounts of capital as shall be required in order exposure is provided by private insurance and an (a) for the Company to construct, own and place in indemnity agreement with the NRC. Every licensee of commercial operation the Grand Gulf Station, (b) to a nuclear power plant is obligated,in the event of a nuclear provide for pre-operating expenses and interest charges incident involving any commercial nuclear facility in the of the Company,(c) to permit the continuation of such United States that results in damages in excess of the commercial operation after commencement thereof private insurance, to pay retrospective assessments of and (d) to pay in full all indebtedness for borrowed up to 55 million per incident for each licensed reactor money whether at maturity, on prepayment, on acceler- it operates or up to a maximum per reactor owned of ation or otherwise. In addition, MSU has agreed to $10 million in any calendar year. At December 31,1986, make cash capital contributions to enable the Company the Company had one licensed reactor. The Act is to make payments when due on its borrowings. scheduled to expire in August 1987, and Congress is The System operating companies are severally obli- considering several proposals to amend it. The Com-gated under the Availability Agreement in accordance pany is unable to predict what action Congress might with stated percentages (AP&L 17.1%, LP&L 26.9%, ultimately take regarding the Act and what effect such MP&L 3L3%, NOPSI 24.7%) to make payments or action might have on the Company's potential liability.

subordinated advances adequate to cover all of the The Company is a member-insured of Nuclear Elec-operating expenses, including depreciation,of the tric Insurance Limited, a mutual insurer that, as of Company. In November 1981, the System operating January 15,1987, provided its members with insurance companies entered into a Reallocation Agreement coverage of $610 million for property damage e astained which would have allocated the capacity, energy and by the insured in excess of $500 million cauad by the related costs available to the Company from the radioactive contamination or other specified damage.

Grand Gulf Station to LP&L, MP&L and NOPSI. These The Company is also a member-insured under a pri-companies thus agreed to assume all the responsibilities mary property damage insurance program provided by and obligations of AP&L with respect to the Grand Nuclear Mutual Limited, ancher mutualinsurer. As a Gulf Station under the Availability Agreement and member-insured with these muwals, the Company is Power Purchase Advance Payment Agreement, with subject to assessments if losses exced the accumulated AP&L relinquishing its rights to capacity and energy funds available to the insurec. The Cunpany's present from the Grand Gulf Station. Each of the System oper-23

Systrm Energy Resources,Inc.

NOTES TO FINANCIAL STATEMENTS (continued) ,.

proposed maximum assessment for incidents occurring nuclear fuel. The Company has executed a contract during a policy year is approximately $40 million at with the U.S. Department of Energy (DOE) whereby December 31,1986, the DOE will furnish disposal service for the Company's spent nuclear fuel at a cost of one mill per kilowatt-Spent Nuclear Fuel hour of net generation. The Company includes this Under the terms of its nucicar fuellease, the one mill per kilowatt-hour cost as a component ofits Company is responsible for the disposal of spent nuclear fuel expense.

i' NOH 8. RATE AND REGULATORY MATTERS Unit Power Sales Agreement sioning expense be set at $1,113,188 rather than On June 18,1982, the Company tendered for filing $1,236,876 as proposed by the ALJ and be accumulated with the FERC, as an initial rate schedule, the Unit in an external fund.

Power Sales Agreement under which the Company Various parties to these proceedings requested would sell from its 90% share of Grand Gulf 1 and rehearings of the June 13 Decision. On September 26, Grand Gulf 2 the following percentage allocations of 1985, the FERC issued an order denying all requests capacity and energy: LP&L 38.57% and 26.23%; for rehearing of the June 13 Decision. Various parties, MP&L 31.63% and 43.97%; and NOPSI,29.80% and including AP&L and MP&L, filed appeals of these 29.80%, respectively. The rates and charges after orders in the United States Court of Appeals for the commercial operation commenced were to be based District of Columbia Circuit. On January 6,1987, the on the cost of service of each unit. Various parties, Court of Appeals affirmed the FERC's June 13 Decision.

including the Arkansas Public Service Commission, in its Opinion, the Court of Appeals held, among other the Louisiana Public Service Commission (LPSC), the things, that the allocation of Grand Gulf 1 capacity and MPSC, the Missouri Public Service Commission, and costs was within the FERC's jurisdiction; that state the Council, intervened in the proceedings, and some commissions may not interfere with the FERC's plenary of these interveners proposed, among other things, power to allocate Grand Gulf I capacity and costs; and revised allocations of capacity and energy to the System that the FERC's June 13 Decision "was both rational operating companies, including an allocation of capacity and within the Commission's range of discretion to and energy to AP&L. remedy unduly discriminatory rates." Petitions for On February 3,1984, the administrative law judge rehearing and for a writ of certiorari to the U.S.

(ALJ) in the Unit Power Sales Agreement proceeding Supreme Court have been filed.

issued his initial decision. Principally, the decision On September 17,1986, the LPSC sent to the FERC recommended that the Company's request for the use for filing a complaint against the Company alleging of an automatic cost of service adjustment clause for that the 16.00% rate of return on common equity Grand Gulf I be upheld, with certain modifications. under the Unit Power Sales Agreement authorized by The ALJ also recommended a proposal made by the toe June 13 Decision has become an unjust and LPSC, an intervenor in the proceeding, to allocate unreasonable rate, and seeking the reduction thereof capacity and energy from Grand Gulf 1 and the cost "to a just and reasonable level based on current con-thereof as follows: AP&L 36%; LP&L 14%; MP&L ditions." Various parties have intervened in this pro-33%; and NOPSI,17%. On June 13,1985, the FERC ceeding. On January 27,1987, finding that the 16%

issued a decision (June 13 Decision) affirming the return on common equity may be excessive," the allocation of capacity and energy as proposed by the LPSC. FERC denied the Company's motion to dismiss the in the June 13 Decision, the FERC affirmed the ALJ's complaint and ordered that hearings be held on the decision on allissues except for rate of return, depre- justness and reasonableness of such amount. Any ciation, annual amount of decommissioning expense, change ordered by the FERC would be prospective amortization of limited-term electric plant and use of only. The matter is pending.

an income tax formula. The FERC held that the Com- Rate Activity-System Operating Companies pany be granted a 16.00% return on common equity instead of 16.04% as proposed by the AL), that the As of December 31,1986, all of the System operating units-of-production depreciation method be allowed companies had received retail rate increase authoriza-for up to twelve months (later extended to eighteen tions approved by their respective regulatory author-months) with straight-line depreciation being required ities which they believed would be sufficient to enable thereafter, and that the annual amount of decommis. them to meet their respective Grand Gulf 1 obligations to the Company. However, certain of these rate struc-tures are being contested or are subject to possible 24

adjustment as a result of prudence investigations as establishing a docket for the stated purposes, among discussed below and in Note 7," Commitments and other things, of examining the prudence of the actions Contingencies-Potential Debt Acceleration and Related of MP&L and/or the Company relating to the construc-Matters." tion and operation of the Grand Gulf Station and the AP&L LP&L and NOPSI are required to retain per- appropriate regulatory treatment of the associated nunently and not recover certain costs, and AP&L costs; obtaining FERC review of the Company's rate of MP&L and NOPSI are required to phase-in certain return on common equity; obtaining FERC review costs associated with Grand Gulf 1. In connection with and/or modification of various aspects of MP&L's NOPSI's request for permanent retail electric rate relief, Grand Gulf 1 expenses established by the FERC, the Council, on October 17,1985, initiated an investi- including the allocation of Grand Gulf 1 costs; and gation into all aspects of NOPSI's prudence regarding its performing a detailed audit of the books and records involvement with Grand Gulf 1. This matter is pending. of the Company. On November 4,1986, the Company See Note 7," Commitments and Contingencies- filed a Motion to Dismiss this proceeding based in part Potential Debt Acceleration and Related Matters." on the grounds that the MPSC is without jurisdiction The MPSC's September 16,1985 Order, establishing over the Company and is without subject matter juris-a phase-in plan allowing recovery by MP&L of its pay- diction over costs associated with the Grand Gulf Sta-ments to the Company with respect to costs associated tion. At the same time, MP&L also filed with the MPSC with Grand Gulf 1, was appealed to the Mississippi a separate, but similar, Motion to Dismiss the proceed-Supreme Court by the Mississippi Attorney General ing. The MPSC, on January 28,1987, overruled the I and the Mississippi Legal Services Coahtion. On Motions to Dismiss of the Company and of MP&L.

February 25,1987, the Mississippi Supreme Court Furthermore, on February 3,1987, the MPSC issued rendered a decision reversing and remanding the rate an order in this docket directing the Company and case to the MPSC for further proceedings not inconsis- MP&L to show cause why their Certificate of Public tent with the Court's opinion. The Supreme Court Convenience and Necessity relating to the Grand Gulf found reversible error in the MPSC's September 16, Station should not be cancelled for the failure of the 1985 order on the grounds that the MPSC (1) adopted Company and MP&L to allow the MPSC to audit the retail rates to pay Grand Gulf 1 expenses without first books and records of the Company. The Company had determining that the expenses were prudently incurred, objected to the MPSC auditing its books and records (2) failed to join MSU and the Company as parties to on jurisdictional and other grounds. On February 23, the rate proceeding, and (3) should not have allowed 1987, the Company and MP&L in response to the intervention in the proceeding by security holders of Show Cause Order, filed with the MPSC separate MSU. On March 10,1987, MP&L filed a petition for Motions to Dismiss, Response and Reservation of rehearing with the Mississippi Supreme Court, and Rights. These filings asked the MPSC to dismiss the MSU and the Company filed with the Court a Motion show cause proceeding on jurisdictional, constitutional  ;

to Intervene in the case. The matter is pending. See and other grounds. On March 3,1987, the MPSC Note 7," Commitments and Contingencies-Potential allowed SMEFA to intervene in the show cause pro-Debt Acceleration and Related Matters." ceeding. In addition, the MPSC announced it would j In a separate proceeding, the MPSC initiated, r.mong rule on the responses to the Show Cause Order on other things, an investigation of the prudence of April 7,1987. The matter is pending. See Note 7,  ;

MP&L's involvement in the Grand Gulf Station. On " Commitments and Contingencies-Potential Debt September 16,1986, the MPSC issued an Initial Order Acceleration and Related Matters."

NOTT 9. NUCLEAR FUEL LEASE At December 31,1986, the Company had a nuclear extent, however, that this does not occur, additional fuel lease permitting a maximum of $175 million in capital requirements of up to $175 million could result.

nuclear fuel under lease. Lease payments, based upon The unrecovered cost base of the lease at December nuclear fuel use, are treated as a cost of fuel. Lease 31,1986,1985 and 1984 was $147 million, $146 million expense charged to operations for the year ended and $168 million, respectively.

December 31,1986 was $41.0 million. This lease, which Beginning in 1987, compliance with SFAS No. 71 for was to continue through 2029, is instead expected to capital leases entered into prior to 1983 will require the be terminated on June 1,1987 upon termination of the Company to record its nuclear fuel lease on the balance credit line. The Company intends to either extend the sheet. q credit line or e.rrange alternative credit lines. To the 25

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SystIm Energy Resources,Inc.

NOTES TO FINANCIAL STATEMENTS (contirnved)

NOTE 10. TRANSACTIONS WITH AFFILIATE 5 The Company sells all of the capacity and energy cant Accounting Policies.") In return, the Company from its 90% share of Grand Gulf 1 to the System paid MP&L the actual cost of rendering these services operating companies of MSU under rate schedules and granted to MP&L the power and authority to act approved by the FERC in its June 13 Decision regarding on the Company's behalf as agent. In addition, pursu-the Unit Power Sales Agreement. Accordingly, all of ant to another service agreement, the Company receives the Company's operating revenues consist of billings technical and advisory services from MSU System to the System operating companies. Services, Inc. Operating expenses included charges from Pursuant to a service agreement, MP&L provided MP&L and MSU System Services, Inc. for technical technical and advisory services to the Company for the and advisory services totaling $45.8 million in 1986, design, construction, maintenance and operation of the $40.7 million in 1985 and $35.0 million in 1984.

Grand Gulf Station. (See Note 1," Summary of Signifi-NOTE 11. QUARTERLY RESULTS (UNAUDITED)

Results for the four quarters of 1986 and 1985 were as follows:

I Quarter Operating Operating Net Ended Revenues Income Income (In Tiwusands) 1986:

March . .. . . . . . . ... . .. .. .. .. $248,997 $121,719 $46,104 >

June. . . . . . . . .. . . . .. $251,523 $117,897 $46,490 September . . . .. . . . , .. .. . .. . $239,563 $113,776 $47,958 j December. . . .. ... .. . . ... . ... . . ., . . . .. $219,654 $114,359 $48,583 1985:

March . . ... . .. . . .. .

- - $53,635 June. . .. .. . . ..

- - $53,938 ,

September . .... . .

$274,342 5142,017 $65,970 l December. . . . . . . . $249,670 $110,750 $44,524* 1

• Net income decreased for this and subsequent quarters primarily due to the absence of an AFDC accrual on Grand Gulf 2.

Through June 30,1985, the Company's net income expenses on July 1,1985 when Grand Gulf 1 was placed consisted of the equity component of AFDC. The in commercial operation.

Company began recording operating revenues and 26

AUDITOR'S OPINION System Energy Resources,Inc.:

We have examined the balance sheets of System on the 1984 and 1985 financial statements was qualified Energy Resources, Inc. (formerly Middle South Energy, as being subject to the effects of such adjustments, if Inc.) as of December 31,1986 and 1985 and the related any, as might have been required had the outcome of statements of income, retained earnings and changes uncertainties concerning, among other things, the in financial position for each of the three years in the receipt of adequate rate relief by Louisiana Power &

period ended December 31,1986. Our examinations Light Company ("LP&L") been known. In January 1987, were made in accordance with generally accepted LP&L received a rate increase which management of auditing standards and, accordingly, included such LP&L believes is sufficient to enable it to meet its Grand tests of the accounting records and such other auditing Gulf 1 obligation. Accordingly, our opinion on the 1984 procedures as we considered necessary in the circum- and 1985 financial statements, as expressed herein, is stances. different from that expressed in our previous report

! As discussed in Notes 7 and 8 of Notes to Financial with respect to the uncertainty associated with the Statements, there are uncertainties associated with the receipt of adequate rate relief by LP&L Grand Gulf Nuclear Station. These uncertainties involve: In our opinion, subject to the effects on the financial the recovery of the investment in Grand Gulf 2, a statements of such adjustments, if any, as might have suspended construction project; the resolution of rate been required had the outcome of the uncertainties and regulatory matters involving the possible adjust- referred to in the second paragraph been known, the ment of certain existing rate structures (which are being above-mentioned financial statements present fairly contested or are subject to prudence investigations) the financial position of the Company at December 31, l implemented by the Middle South System operating 1986 and 1985 and the results of its operations and l companies to recover their Grand Gulf I related costs; changes in its financial position for each of the three and the potential acceleration of certain indebtedness years in the period ended December 31,1%6,in of the Company as a result of the possible failure of conformity with generally accepted accounting principles certain of the Middle South System operating com- applied on a consistent basis.

panies to maintain adequate rates to recover their Grand Gulf 1 related costs. The Company is unable to predict the ultimate outcome of these matters, and no -

provision for any losses that may result from their /' <

I resolution has been made in the financial statements.

in our report dated March 14,1986, except for Note New Orleans, Louisiana 12 as to which the date was March 25,1986, our opinion February 27,1987 27

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m ni 7 System Energy Resources, Inc. ,

DIRECTORS AND EXECUTIVE OFFICERS Directors Executive Officers t

. EDWIN LIJPEERGER EDWIN LUPBERGER : /

Chairman of the Board of the Company Chairman of the Board

. j i9Chairmar. of the Beard and . .

' ' V President olMiddie South Utilities,Inc. WILLIAM CAVANAUGH,III President and Chief WILLIAM CAVANAUGH,III hecutive Officer President and Chief hecutive

- Officer of the Company. R. DRAKE KEITH Senior Vice Pressdent, System Senior Vice President-hecutive-Nuclear of Middle Chief FinancialOfficer

. South Utilities, Inc. and MSU System Services,Inc. GLENN E. HARDER Vice President-Aircur< ting JAMES M. CAIN and Treasurer :

President and Chief Decutive Officer of Louisiana Power & RICHARD J. LANDY Light Company, President of Vice President-Human Resources and Admmistratw, n

' New Orleans Public Service Inc.

OLIVER D. KINGSLEY, JR.

DONALD C. LUTKEN Vice President-Nuclear Chairman of the Board and Operations President of Mississippi Power &

Light Company TED H. CLGNINGER Vice PresUent-Nuclear 1%RRY L. MAULDEN Engineenng and Support President and Chief Decutive Officer of Arkansas Power & DAN E. STAPP light Company Secretary The Company's 1986 Annual Report to the Securities and Exchange Commissian on Form 10-K (including .

financial statement schedules) is avanable to any interested parties without charge. Interested parties can obtain a copy by writing to:

Glenn E. Harder Vice President-Accounting and 1reasurer System Energy Resources, Inc.

P.O. Box 23070 Jackson, Mississippi 39225-3070 Telephone: (601) 960-9600 28

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