Text

Middle South Utils,Inc,Annual Rept 1988
	ML20245E119
Person / Time
Site:	Grand Gulf, Arkansas Nuclear, Waterford, 05000000
Issue date:	12/31/1988
From:	Lupberger E; MIDDLE SOUTH UTILITIES, INC.
To:	;
Shared Package
ML20245E111	List: ML20245E117; ML20245E119; ML20245E126; W3P89-1102, Forwards 1988 Annual Repts for Louisiana Power & Light Co, Middle South Utils,Inc & New Orleans Public Svc,Inc;
References
	NUDOCS 8905020037
	Download: ML20245E119 (60)
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, PERFORMANCE HIGHLIGHTS T

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? OE L ,gjy + t 7-... u t 1 7 M[ li.. 4 9 'Is ~ '^ r ':l ' I l ~i' [ e 3 I 1988!

1987- : (decrease);

i fpf e.

U

~ $3,565 L e ' ($3,455 :l $2,

Total operating revenues (millions) 1 l

23.2., $2,496 J. 4 .' Total operating expenses (millions) ",, $ ' 983 F.. L $ i 9821 >, 0.1 T j! 7 l Fuel, purchased power & purchased gas costs (millions). . Rate deferrds - net of write-of'(million's) : 3l 1$ 292: 'i$ 333, ; (12.3) w - ; Operatingincome(millions)~ $1.,070) $1,010lC fl5.9j J' y'

p ;$ c411;

< $1357-. 15.3; "r

Netincome(millions)

o i ' 8.72% v,,l 8.20% ' 16.3:

Rate of return on average common equity ;
$ 2.01l

$l1.74 ; 15.5: jl. !-g Earnings per common share r... 1

$' 11.2 -

i.(1.1) c Net utility plant at year-end (billions) . $ 11.1; Constr6ction expenditures (millions) $.( 3507 ", K $; 362 : . (3.3); ' 1,693,592 ; '1,678,284'- i0.9a ' Retailelectriccustomersatyear-endE ' , Retail electric energy sales (million kWh) - 52,575 > 51,411

2.3 L l v

' 11,270 - 1.5l 11,442' Systempeakload(megawatts) 1 Average number of common shaies outstanding (thousands) ' ?204,581: .204,5811 ' --D m q. } . 3 q. 4 e 5 y f,' 5 .I ,.i I), yi. - .y y n y a., a { ( .] ..]- . t '9, n) l l 1 1 y 7 A e$at Utdsam,lnc The "Entergy" shown emerging on the cover of this report is emblematic of the new direction being forged for this Company - a bold new direction embodied in a name. Entergy combines the words " enterprise," " energy," and " synergy," three qualities that describe the Company's new approach to navigating the rapidly evolving energy marketplace. At the 1989 Annual Meeting, stockholders will be asked to approve "Entergy Corporation" as the Company's new name. If approved,"Entergy Corporation" will be presented with the red symbol below to form a new Company logo, one spearheading a new graphic look for the entire Middle South Electric System. l ,Jumum %,, f -. ;:1- }. -):),1 q..,:g~ p)..y.} ,.%. [g / y. g);l_3g. i.. J.:/:,y,;.., .e - ; %..,,3- -? l .a f:, -,;.-*.... ' ......,;g.') x*. ...... *- : ) ; s el, : -

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prospects forless adversarial measured against the ] relations with our regulators performance of neighboring j L Nineteen are alsoimproved. We can utilities and competing eighty-eight was an exciting now set our sights on success suppliers. I year. It began with oral - not just survival-in the We can count arguments before the U.S. rapidly changingelectric on fewer and fewer " captive" Supreme Coun,and ended utility marketplace. While a customers. We can no longer with resumption of stock-number ofimpediments to assume cost-based rates. We holderdividends and our progress remain,in are working hard to keep planning for a new corporate 1988 we were freed to vigor-customers "on tlie grid"- image. In all respects,it was ously pursue the vision I and that means stabilizing or a year of successful responses announced last year. reducing costs, improving tothe challenges of change. That vision, service, assuring quality and In many "to become a customer-reliability,and advertising ways, the year began onJune , oriented, socially respon-our services just like compet-24,1988, when the U.S. sible, financially strong, itors in any other business. Supreme Court handed successful competitorin the The changes down a favorable decision in evolving electric energy we faceimpact many areas: our MississippiPower & tvisiness," calls for a different regulatory, financial, organ-Light appeal. That victory type of organization-dif-izational,and social. But broke through the uncer-ferent focusin leadership, rather than continuing to be tainty and conflict that had different attitudes,and buffeted by the forces now fettered us since our fire different ways of doing shaping the utilityindustry, attempt to collect rate <.or business-than those the Company has begun Grand Gulf 1,our System considered traditionalin the capitalizing on these forces, Energy Resources, Inc. sub-utility industry. Like the adjusting to meet the sidiary's nuclear unit. The banking, telecommunica-challenges of change. Supreme Court decision not tions,and airlineindustries Our new only affirmed our right to before us,the electric utility strategic planningprocess, collect Grand Gulf rates,it industryis in the midst of introduced last year, sets also established the Federal regulatory upheaval that Systemwide goals, programs, Energy Regulatory Com-offers both opportunity and and objectives,so that the mission's exclusive authority risk. efforts of each operating to regulate wholesale electric In the era we company directly contribute rates-and established that have entered,':tilities are not to the System's progress states may not keep utilities guaranteed a fair return or toward our vision. from passing through to even financial survival. Like The System retailcustomers FERC-any other business in the has restructured its top man-mandated wholesale costs. country, we can fail-as agement, assigning System With the issue some have already demon-Executive positions toJerry of Grand Gulf rate collec-strated. Maulden, Arkansas Power & tions resolved,the monies While we Light and MississippiPower heldin escrow pending the have always had to account & Light chairman and CEO; Court's decision were for our actions, now the James Cain, Louisiana Power released, enabling the System demands on utility perfor- & Light /New Orleans to pay down its debts. The mance are much greater;and Public Service Inc. chairman ensuingfinancialstability that performance is being and CEO;and Donald has resultedinimproved Meiners,MSU System ratings for System securities Services,Inc. president and l and has allowedthe price of CEO,who are responsible, q MSU stock to climb. Our respectively, for Arkansas, Mississippi,and Missouri operations; Louisiana operations; and for System services. 4

faltered in taking the More than symbol we present to the necessary steps -in as just a conciliatory attitude, world, as wc!1. Its use by humane and constructive Project Olive Branch is a all of the Company's subsidi-je a way as possible. series of programs aimed at aries, as well as the parent A We are also reducing costs, stabilizing company, reinforces that we S af taking aggressive action to rates, and thereby improving are all part of one System, develop our markets-relationships with our supplying electric energy to within our service area and customers and local regula-the Middle South and beyond. Our System tors, while at the same time beyond. Strategic P!an has established building stockholder value. Also symbolic ambitious marketing goals in 1988, we announced two of the Company's new direc-for recruiting new and major components of Project tion is our proposal to adopt expandingindustries, Olive Branch: the planned a new name for the Com-s retaining commercialand consolidation of our nuclear pany: Entergy Corporation. 1 industrial customers at risk operations management Comprising the words 0,* to alternative suppliers,in-under System Energy, and " enterprise,"" energy," and cluding cogenerators, and the sr.le/ leaseback of a " synergy," Entergy aptly gaining market share in our portion of Grand Gulf 1. As describes our revitalized residential and commercial we describe in the

Financial Company -its new atti-markets.

Change"and "Organiza-tude, assertiveness, and We are also tional Change" sections of adaptability. taking advantage of our this report, both of these ini-The operating The new strategic location and well-tiatives are bold, forward-company subsidiaries,which, responsibilities of the three developed transmission looking programs to lower along with the parent new System Executives system to sell power to costs, boost efficiency, save company, will continue to be strengthen our Systemwide utilities beyond our fran-money, and give both identified collectively as teamwork by bringing their chise area. And,along with customers and stockholders "The Middle South Electric subsidiary company. con-others in the industry, we more for their money. System," will not change cerns and their personal are taking an active rolein On every their names. The System's expertise to the System's top FERC's proposed rule front - political, regulatory, service company, MSU decision-making team. changes-to ensure that the financial, organizational, and System Services,Inc., would, As part of resulting transmission social-we are changing to however, become Entergy our new strategic planning policies, and pricing,are fair meet the challenges of a Services,Inc. process,each subsidiary and reasonable, rapidly evolving electric Last,but company has examined its Another utility industry. Emblematic certainly foremost in the eyes operations in exhaustive major initiative introduced of the changes we have made of our stockholders and the detail. We have established in 1988is Project Olive is the Company's new logo. investment community,1988 goals for reducing costs and Branch-so named because The red Systemark, which in was the year we resumed improvingefficiencyin its purposeis to rebuild the past year has been used as dividend payments,after manyareas. Eachof the relationships with our an emblem of Systemwide three long, difficult years. operating companies has customers and regulators. teamwork,is now the Our goalin 1989 and be-reorganized for greater pro-We recognize that the yond,indeed,oneof the ductivity-with fewer conflictandlitigationof the primary reasons we are in I personnel. Ahhoughthese last few years have been business,is to build the level workforce reductions have detrimental to all concerned. of thosedividend payments been painful, we have not Even though our position and reward yourlong-was upheld by the Supreme standing faith in us. Court, we know that our continued success depends Sincerciv on the goodwill and confi-dence of those who regulate a us and those we serve. v Edwin Lupberger Chairman and President Mar ch 15,1989 l 5 L

REGULATORY CHANGE MJJic South Utam, lou. lo 1 E [ deregulation. Competition. The electric utility industry at a crisis point brought about by the changes of the last 10 years: the oil embargo, high inflation, increased costs, and reduced demand. Unraveling y I[ of the regulatory compact. Obligation to serve without a corresponding obligation g yI to pay. Prudence reviews. Disallowances. l A trend to let " market conditions" determine l rates. A more active wholesale market. Vertical disintegration of the industry into separate gener-t ating, transmission, and distribution companies. Litigation over the proper boundaries between state and federal regulatory jurisdiction. Competition S among electric utilities. Competition between ~ / utilities and independent power producers. Pressure for increased access to transmission lines. A new era characterized by risk and reward, rather than by the stability and control of years past. Compar y n Ivt. ent in 2;llr 's"?;"'ls'l,TL,n $Z'!:'%dfsAT 6

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l REGULAVORY CHANGE ( x,ssia s,-es vutana.1.< Middle South collection of Grand Gulf The Federal Energy Regula-Utilities is moving decisively rates,it also resolved -in an tory Commission has toward the kind of utility emphatic way-the issue of proposed several rule industry leadership de-who is responsible for regu-changes that would boost scribed by Chairman and lating wholesale electricity competition in the electric President Edwin Lupberger rates. utility industry. The first I in his Company vision, The resolution proposal offers states and I annaunced last year. That of this issue has cleared the utility companies the option vision issued a directive: way for resolution of many of competitive biddingfor "During the next decade, the other obstacles in the new generatingcapacity. Company will become and System's path: Newplants could be built by be widely recognized as a

System Energy Resources, the lowest qualified bidder.

customer-oriented, socially Inc., our subsidiary that The second responsible, financially owns and operates Grand proposal streamlines strong, successful competi-Gulf 1,was able to recover regulations pertaining to tor in the evolving electric the monies held in escrow independent power produc-energy business." and has been able to pay ers,and establishes a bidding That leader-down its bank loans. or negotiation process for ship responsibilityincludes a

The uncertainty over Grand IPP rates, rather than more active, effective role in Gulf rate collections has been traditionalcost-of-service the regulatory and political cased, lowering financing regulation. The third arena that so profoundly costs across the System and proposal halts the practice of affects the nation's investor-allowing our common stock forcing utilities to make owned electric utilities. Un-price to climb.

capacity payments to certainties currently facing

System attorneys, arguing cogenerators for capacity the industry can become our New Orleans Public they don't need.

opportunities if we present Service Inc. subsidiary's case Middle South our viewpoint to regulators before the U.S. Supreme Utilities has testified on and policy-makers more Court and Louisiana state behalf of the commission's persuasively thanin the past. courts,can rely on stronger proposed changes, which,if The most legal precedent. structured properly, would important demonstration of

Future dealings with local expand utilities' options for our renewed effectiveness regulators will not be providing for future electric-came onJune 24,1988, when clouded by questions of ity needs flexibly and the U.S. Supreme Court jurisdictionalauthority.

efficiently. FERC's propos-i decided MP&Us appealin lluildingon als are the most recent " Delivering the volts" our favor. Our high court the momentum of this indication of atrend toward l con ent$ongav the victory not only enabled the victory,the Company is " vertical disintegration"of '# '^ Companya chance to positioningitself tocapitalize the industry: separation of shine in the national on increased access to the the electricity generation and spotlight-wholesale electric market. transmission business from The U.S. Supreme i Court estabitshed the l'3---=? y A_ ' 9 Company's right to ~ W~g,1 co11ect FERC-allocated ) / Grand nuit rates. r

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the localelectricity distribu-become an independent costs, replace litigation with stockholder grassroots tion business. power producer. With a negotiation,and build program, now being devel-This separa-consortium of partners, we goodwill as well as stock-oped, will help keep stock-tion would makeit possible offered to invest our coal-holder value. holders informed about for a company like ours to plant equipment and Two Project issues affecting the Com-engagein both types of expertisein a plant to be built Olive Branch initiatives have pany and the electric utility activities, but with different in the Bahamas. The already been announced: the industry. This information rules in effect for each. electricity generated would sale / leaseback of Grand Gulf will not only help make For example, be sold to the Florida utility. (see " Financial Change")and stockholders more knowl-the Company would Although this the consolidation of nuclear edgeable investors, but, we continue to generate, project did not materialize,it operations under System hope,will make them more transmit,and distribute - or others like it - may Energy (see" Organizational informed and active partici-electricity through its state-eventually find a buyer. Change"). In the coming pants in the politicalprocess regulated operating compa-When it does,the Company year, Project Olive Branch -especially as it affects nies - AP&L, MP&L,and will find another market for initiatives will embrace all electric utilities,and particu-LP&L. The Company could its product-one free from facets of our operations: larly,the Middle South also bid to build and operate some of the regulatory regulatory, financial, Electric System. a generating plant for a restrictions on our operating organizational,and social. These are but utilityin need of power-company subsidiaries. Weare also a fewof the ways that the doing so as an independent The Com-buildingourpoliticalmuscle Company is raising its power producer. The capital pany is also working in another, more personal profilein the changing put at risk to build the plant diligently to rebuild its way. Employees at each regulatory and political would be jeopardized onlyif relationships with local company are organizing arena in which we operate. we failed to honor our regulators,and to more grassroots political groups. By taking an active role, we contractual agreements, effectively articulate its These groups educate believe we can make a subject to review by FERC. position at alllevels of the employees on issues, hold difference in whether the It would not be directly politicaland regulatory candidate forums,and changes shaking the industry exposed to local opposition process. Project Olive communicate with elected work for us-our stock-to rateincreases at the retail Branch is the name we have officials. Although the holders and customers-or level. Further, the competi-given to this rebuilding groups are young-the against us. We are already tive bidding process would effort. In addition to our oldest is little more than a feeling the positive results of help ensure that only cost-willingness to put the year in operation-they are our efforts, and we will keep effective projects are built, conflicts of the past behind already having a noticeable you informed of our resuhs. and would reassure custom-us, Project Olive Branch effeet on local politics. ers that costs incurred are includes substantive pro-Stockholders prudent. grams intended to lower are beingincludedin the This was Company's grassroots essentially what we pro-efforts, as well. Like the posed to dolast y car for employee programs,a Florida Power & Light-Regulatory relationships in Arkansas. Louisiana, Mississippi, and gyggyggg The. lune 24 VS Missouriare betr>g Supreme Court rebuilt through decision made head- " Project Olwe Branch ~ lines and signaled the Company's n" y turnaround. 'W ,~ c n[)Wg s #%& Ti W&. 'D 1 v. 4 ; g V,(' a

l l f ir 5 urh Utdrews im. l tility bankruptcies. Plant closings. High interest rates, reflecting regulatory and financialuncertainties. Competitive pressures to reduce costs. Reluctance to invest in high-cost, long lead-time projects. Conflict between ratepayers and j stockholders. Loss of dividends. Loss of stockholderloyalty. A higher percentage of ~ institutional investors and " computerized" stockholders. Mergers and acquisitions. Municipal buyouts. The threat of takeover. Jpf' Utility diversification. Efforts to minimize debt 2 U and buy back stock. A search for new financing U, options. Sale and leaseback of generating facilities.. High-stake business strategies. Risk and reward versus cost-based rates. The fundamental question for utility companies: whether to bet 1 their financial future on more regulation or more competition or some mix of both. l As part of the Treasu S uart al meets mth leading New York 10

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i FINANCIAL CHANGE l us.v. smai, vauw l' Thechacee< have been released, enabling MiddleSouth of the last 10 years have System Energy to pay down Chairman and President pushed a number of utilitics debts and refinance certain Edwin Lupberger,accompa-to the brink of bankruptcy of tl.ose that remain. For nied by key System exec - -where at least one has example, prior to the tives, personally metlast fall tumbled over. Middle South Supreme Court decision, with the nation's top ratinr 1 UtiEties was pushed very System Energy had approxi-agencies to campaign for { nearly to that brink,from mately $285 million of better credit ratings. 1985 untilJune 24,1988;but "floatingrate" poll stion The top three with our 1988 victory at the control revenue bonds. Not agencies raised the ratings on U.S. Supreme Court, a only did the rate on these the System's senior debt and stream oflife-giving reve-bonds fluctuate with market preferred stock following the nues has been assured. The conditions,the bonds could U.S.Sopreme Court Company'sinvestment be returned to System decision. Moody's Investors ratings haveimproved. Energy annually for refund Service,Inc.again raised ) Stock prices have climbed by the bondholders. The ratings for AP&L, MP&L, j out of the cellar. D:vidend U.S. Supreme Court and System Energy securities 1 payments have resumed. decision,however, enabled following approvalby the These are sig-System Energy to obtain Arkansas and M:ssissippi nificant rewards for our last fixed rates on approximately Public Service Commissions three years' work on $256 million ofits PCRBs, of revised Grand Gulf rate maintaining Grand Gulf eliminating both the risk of phase-in plans. The revised rates. Nevertheless,they are rising rates and of bondhold-plans conform to new omy the beginning. In ers causing a large cash drain accounting rules issued by fulfilling our commitment to by returningthe bonds for the Financial Accounting becoming a financially refund. Standards Board. strong,successfulcompeti-tor, we are pursuing innova-tive and aggressive strategies . k.c _f * ~ to lower costs and increase g 4}Q l 1 Ab the value of our operatmns

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i On December f,19BB. for both customers and Vi 1 i!?g%. ,an %w the Company paid stockholders. g., 4, its first quarterly _3 % The Grand dividend in more than Gulf payments heldin ... M g.;' k j common stock n . ^. N b TOW three years. escrow, pend!ng our appeal ' ' 3 N-lh kf to the U.S. Supreme Court, WefE. jh - hQ N j y q' %{. %g;, ( n g 4 y N (eg., r m g6 g biliXGTidis pc ~,;lQQ The sale and leaseback of a portion X a;; @ l; f 5 % T C %=L.}..y'w'lf ,f of Grand Guli1is T . me. net =m2 expected to save l , wgg*Ruw,.n g. }C 1 n.. .i -%a - w.% millions over the hie l g, Q_l ,l 'QQ of theplant. n MN' :i

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1 l I System program to repair relation-controversy between stockholders, the most Energy'simproveddebt rat-ships with the System's NOPSI and the City of New concreteevidenceof the ings also madeit possible to regulators and customers. Orleans in a manner benefi-financial changes we have renegotiate the company's The costs saved by the sale / cial to our customers as well made-and of our im-nuclear fuel financings. Enr-leaseback are expected to as our stockholders. Nego-proved prospects. We said ly in 1989, System Energy lower costs for ratepayers-tiations are proceeding that 1987 was a pivotal year: obtained new financing that making our regulators' jobs cautiously-as is to be we positioned ourselves for will reduce by $4.5 million a casier-and improve expected in an asset transfer the positive U.S. Supreme year its fuel financing charges earnings for stockholders. of this size-but representa-Court decision we hoped alone. Our partici-tives on both sides of the 19P ould bring. In 1988, In addition to pation in negotiations for a bargaining table remain that decision came, bringing paying down and refinancing pt. sible sale of NOPSI hopeful that an agreement us the opportunity to dem-debt,in 1988 the Company facilities to the City of New can be reached. onstrate our abilities in the also began pursuing more Orleans is another demon-The resump-changing electric utility aggressive, innovative means stration of Project Olive tion of dividend payments industry. We are confident to lower costs to customers Branch r work. Such a sale by the Company is, for our that the future will bring and increase returns to stock-offers the potential to resolve additional changes. We are holders. The December 1988 the litigation and regulatory ready for them. sale and leaseback of a portion of System Energy's Grand Gulf I generating Middle South Utliities Common Stock '"'8""""""""8"""'"^'""d'/"#" facilityisanexampleof these 37 efforts. Underthe o 16 ~ sale / leaseback plan, System g Energy sold a 12.8 percent portion ofits 90 percent 34 share of Grand Gulf 1 to 13 7 private investors for approxi-p 8 12 j mately $500 million cash, which was used primarily to pay off some of the high-g. g i; interest first mortgage bonds .f z t that financed the unit's con-10 struction. System Energy continues to operate the ~. _ 9 8 plant, leasing back for the next 26 years the shares of J F M A M J J A S O N D the plant sold to the private E 8'DC# aO O investors. gW g posted the greatest gO,Og The plan n. 9 s paceincrease otany O expected to produce savings investor-owned Og gOg of about $40 million its first electnc utdity. g O year, and as much as $150 g O g g g milhon m current dollars gg g O O g g over the life of the plant. O O l Other rale / leaseback g Og O O O O g O O gO arrangements are being ggOg $g l O 9 Og,9 gg considered. The sale / O g g O g,e g g OO 8C e leaseback of Grand Gulfl is g among the Company's first It stockholders g hg e #,! l tangible demonstrations of approve the $aWga $g e e i Project Olive Branch,our company's new name, the new e g eC OO g stock symbol wdl

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1 n industryin flux quickly moving away from regulated monopolies and restricted markets. Competition. One in four large utilities forced to cut costs. Few willing to risk new plant construction. Greater emphasis on ,f efficient plant operations. Organizational reshuffling. Diversification. Greater emphasis on marketing and off-System sales. Proposals to break up the industry into separate generation, transmission, and distribution companies. Growing options for customers: conservation; cogeneration; photovoltaic; competing utilities; independent ~ power producers; municipalization. Threat of large customers leaving the grid. Pressure to f. achievelow-costproducerstatus. Company downsizing and restructuring. Working to do l more with less. i .4 l An example of the a et g and cu to e service: EdBailey, AP&L wt J e Ka r p s de of SMI Steel. Magnolia, Arkansas. 14 1

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i ORGANIZATIONAL CHANGE Muldle Saath Utdaws Im. We believe In 1987, Jerry that the forces sweeping the AP&L completed an 11 Maulden, AP&L and MP&L clectric utility industry make percent workforce reduction chairman and CEO,is now clear that "businr. 2s usual" that resulted in 553 fewer the System Executive re-is no longer an chective positions and an annual sponsible for Arkansas, Mis-strategy for success. In payroll savings of $19 sissippi,and Missouri opera-fulfilling our commitment to million. LP&L and NOPSI tions; James Cain, LP&L/ become "a customer-have been consolidating their NOPSI chairman and CEO, oriented, financially strong operations for thelast several is responsible for Louisiana competitor," the Company years. Upon completion of operations;and Don is systematically changing nuclear consolidation under Meiners,SSI president and the way it does business-System Energy,their efforts CEO, oversees System to lower operating costs, will have culminated in a services. These subsidiary improve service to custom-15 percent reduction in the company CEOs join other ers,and provide a better companies' workforce. System Executives respon-return for our investors. MSU System sible for the finance, legal To do this Services,Inc., our service and external affairs, opera-means more than adopting a compan),in 1988 began a tions, and nuclear areas, and new corporate attitude. restructuring that resulted in strengthen the intercompany Becoming a successful a 22.5 percent reduction in teamwork essential to the competitor has meant taking approved positions, and an smooth functioning of the a good, hard look at our annual savings of $9 million System. organization-from the to $11 million. MP&L also Our restruc-number of employees and announced plans to reorgan-turings are more than just their compensation, to the ize to meet future operating cost-cutting measures. cost-effectiveness of our environments and competi-Functionalconsolidations operations -our entire way tive challenges. This is in have also resulted in a mote of doing business. addition to a two-year hiring agile, responsive organiza-In the last freeze that keeps MP&L's tion-one that can quickly Map fa the future: two years,each subsidiary employee-to-customer ratio adapt to changing circum-50o transmission company has examined its the lowest in the System. stances. 9y,g p,o increasingly valuable orgamzational structure to At the highest access to marAets identify opportunities for level, restructuring has meant beyond our service improvement.That exami-adding new responsibilities nation has led to "down-to three System Executives 8*8' sizing," or workforce and organizing System op-reductions. erations into new divisions , ~y% $ encompassing Arkansas, Q~ , ; yQj, Mississippi,and Missouri: ; Mk Og{ m. Louisiana; and System Y Cr services. 'y - > '.,4@$g ' Y. h { _&;p' & A4A.'. M g : f 0 Fr..

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The most departmentalperformance, for example,can be imple-Ambitious recent example is the including cost performance, mented at each of their stores industrv recruitment goals proposed consolidation of We are making clear to or offices throughout the hrce also been implemented. nuclear operations under employees, customers, and region. Economic development System Energy, currently regulators our awareness that While efforts under way in Arkan-I awaiting regulatory ap-the old cost-recovery form of commercial sales are being sas, Louisiana, Mississippi, proval. By consolidating the rate-making can be a recipe developed,the System has and Missouri are expected to System's nuclear operations for failure if our costs set aggressive marketing attract new industries to the under one company, the outpace those of our com-goals in the industrial sector, Middle South and to develop System plans to increase petitors. We are rapidly as well. A portion of these localindustries with pros-management focus on adopting a cost-conscious, goals will be met through the pects for success. These nuclear safety, streamline performance-oriented retention ofload at risk to efforts could add substan-nuclear operations and attitude designed to make cogeneration and ahernative tially to the System's load in support activities, eliminate sure our prices remain suppliers. LP&L,for the next five years. duplicatejob functions, competitive. example,has successfully We were on utilize personnel more Another competed against several the brink of bankruptcy; efficiently, share information aspect of successful competi-proposed cogeneration we're back now. We were and expertise more readily, tion is effective marketing. pmjects,and has begun perceived as insensitive to reduce reliance on outside We are actively selling negotiating agreements with our customers' needs; we're j vendors,and create a greater electricity's benefits as an major customers to retain seeking to better demon-

esprit de corps" among the energy source. Futhermore, more than 1,400 megawatts strate the concern we have System *. nuclear personnel.

we are marketing our electric ofdemand. always felt for our custom-Savings of $23 million capacity beyond the Middle ers. Like the utility industry I g in general, we were thought I anneally in operating and South region to utilities in ,[7 , ; =g= maintenance expense have need of power. to be staid, bureaucratic, been projected once consoli-We are also incapable of surviving in "the dation is complete. An marketing the capabilities of f] real world" of competition. 4 additional $6 millionin the Middle South Electric ^ Today we're flexing our capital savings are antici-System, as a whole. Through .q competitive muscles and pated. ourcommercialchain ac-WE j finding them capable of The Com-count pt ogram, for example, 2W taking us the distance-h ' Vgh dd even ofleading the evolving pany has set additional cost-System marketing personnel electric utility industry. cutting goals for nuclear fuel are calling on the corporate and non-fuel operation and offices of companies doing WN4

'i maintenance expenditures-business in the Middle l

including administrative and South, so that we can streamlining generalover, eads. In fact, coordinate our solunons to operations and n l employee and manager pay alltheirenergy needs. A reducing costs. the raises are now tied closely to decision to go all-electric, system pmposes a I Consolidation of l nuclear operahons. N l 1 a gh7pr ' l l The color of excellence; members l of the year's bect operating shift at each An LP&L Isneman of the System's sports his company's nuclear plants were new logo, awarded red jackets.

l """"*"!L..,v.a.c l l 1 unemployment. Illiteracy. A shrinking tax base. Little funding for public schools. Government deficits. Crumbling i infrastructure. Foreign competition. ! Overdependence on a few large industries nowin a slump. Lack of confidence. iack of training. Lack ofinvestment capital. overburdened state and local governments. Into this environment add three young governors with a commitment to education. A commitment to integrity and fiscal responsibility. A beliefin the ability of the region to pull itself up. Formation of the Delta Development Commission to study economic and social needs. Unique opportunities for public and private partnerships. Regional cooperation. Transforming the Middle South into an area of opportunity. l l l .a,1%"l"nll %"?" set"lC': ' TrCe?l%,"'le',Tl pcog,ams. 4 18

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~ . + < +f, T SOCIAL CHANGE MsJJte Samh Iinhun, Inc The Middle asignificantportionof the The governors South Electric System is a region, and the private sector met with Prime Minister proud sponsor of the region demonstrating a willingness Noboru Takeshita, U.S. we serve. As the Company's to back the region with Ambassador Mansfield,and vision states, we are as dollars and expertise,I don't with key business and committed to being" socially believe there's anywhere we financialleaders, including responsible" as we are to can go but up." executives of Sony, Toyota, being a" financially strong" Prospects for and Nomura Securitic;,one competitor. Happily, we the Middle South were of theworld'slargest don't ne the two goals as encouraged by theTri-State securities firms. A press i counteractive. As ourregion Governors' Agreement, conferenceinTokyo grows,so does its demand signed last May by three of attracted five television l for electricity. As its eco-the region's governors stations and 35 reporters. romic indicators rise, so do (Clinton of Arkansas,Mabus The trip was ours. Astheeducationof the of Mississippi,and Roemer not the Company's first workforceimproves,so does of Louisiana). The pact trade mission to the orient, that of ourlaborpool. As commits the three states to however. System economic community opinion of our cooperate in attracting development specialists have Company becomes more investors, finding markets met with business leaders in positive, so do our relation-for the region's products, Japan, Taiwan,and South ships with our regulators. and developing the eduer.- Korea,and with prospective "Right now, tional, transportation, and investors from Italy, Ger-the Middle South has ar. other systems that support many, Austria, Belgium, and unprecedented opportunity economic development. Yugoslavia to discuss the for growth and develop-Last summer's region's development ment," says MSU Chairman successful Mid-SouthTrade capabilities. More than 2,000 and President Edwin . Mission toJapan was the foreign firms that have ex-Lupberger. "With Gover-first joint activity resulting pressed an interest in doing nors Clinton, Mabus, and from the pact. Lupberger business in the U.S.have Roemer cooperating on the accompanied the governors been contacted as a result of MSU Chairman Edwin region's behalf, the Delta on their trip, which greatly the Company's business Lupberger reads with Deve]opment Commission impressed thejapanese,who development programs. C ' f cusingfederalattentionon had never before seen three The region's E e ta Sch ol-one of the Company's states work together as a potential consists ofits partners in education. team to promote their fisheries and seafood region. industries, timber and agricultural resources,its transportation infrastructure and New Orleans' port,its , sem ~ 's s y s I / \\' M 'n \\ y N.' } / @ ( g I p' t .~ k N. \\ )

Chnstmas in the

\\ '),' Daks"has become + a New Orleans - ;~* tradition, sponsored by New Orleans Public Semce Inc. s 20 I

centrallocation as a distribu-The Middle an interactive computer On the tion hub,and its resource South Electric System is also system that enab!cs one tutor economic development base for the petrochemical, undertaking the nuts and to simultaneously teach 16 front, the Company regu-plastic and resins industries, bolts ofindustrial recruit-individuals to read. Specifi-larly sponsors entrepre-the pulp and paper, food, ment. In fact, operating cally designed for function-neurial skills workshops aircraft and aerospace,and company efforts are ex-ally-illiterate adults, PALS where small-business medical and surgical supply pected to contribute to at increases the average owners can gain practical industries. least 25 percent of all the new student's reading level by advice on how to set up and it also jobs created in the Middle three grades in 20 weeks. manage a successful, grow-includes the Company's South. The Com-ing business. More than 600 capabilitiesasoneof the Recognizing pany has sponsored the people have attended the nation's largest electric education as a prerequ: site to installation of four PALS workshops to date. utilities, with operating economic growth, the learning centers in New Last year, the companies and competitive Company sponsors a Orleans and Monroe, Company also sponsored a rates in each state of the number of "New Opportu-Louisiana; Jackson, Missis-business incubation institute Middle South, and a willing-nities" programs that have sippi;and Helena, Arkansas. in New Orleans. Business ness to work with any made impressive gains The centers will handle 640 incubators are low-cost company interested in the toward improving the area people a year, once they are start-up facilities where new region. economy and reducing fully operational. First Lady businesses can share support In addition to illiteracy in the region. Barbara Bush visited Nr w services and office space trade visits and personal Perhaps the most notable is Orleans' PALS laboratory while they are young and follow-up with investors,in PALS (Principleof the last year, and commended financially vulnerable. 1988 the Company began an Alphabet Literacy System), the program for its contribu-In short, we at advertising campaign to tion to adult literacy. Middle South Utilities promote the region as a understand that our future is fertile ground for growing inextricably linked with the businesses. The ads, which Economic region we serve. We are were the Company's first development in the doing everythingin our since 1985, appeared on Middle South region power to help the region, our television,in local and g,ms y ad ertiIn"g customers, employees, and '8 #' ^' stockholders reach their full selected national business ,/ campaign. publications, and m a /

potennal, number ofJapanese business a

/ publications. The Company's ' ~ entrepreneurial i s workshops ennch pT; d 3 s small-business . V 'y U- ~,. owners hke Clarence s Moret, of New Orleans Diesel. ~ ,4 '[',.4 +,

r..,)

-p / %l D,p y .s. 4 n demonstrated by SQ,l ; Community support is l Company sponsorship advertising ,. [L y of United Way u l V 21 g fa 2

MANAGEMENTS FINANCIAL DISCUSSION AND ANALYSIS Middle South Utdam. Inc and54udwm Financial Condition 1985. Dividends on common Arkansas Power & Light i In 1988, the stock had been omitted Company's (AP&L) Grand ( Middle South Electric during the interim period Gulf 1-related rate issues System (System) made con-due to the major uncertain-(settlement agreement)and siderable progress in ties facing the System. in the orderissued with resolving certain ofits legal In December respect to MP&L's Grand and regulatory difficulties, 1988, System Energy con-Gulf 1-related rate issues when, onJune 24,1988, the summated certain arrange-(final order on rehearing), U. S. Supreme Court ments relating to the re-these companies requested rendered a decision (June 24 marketing of two series of and ieceived approvals from Decision)which affirmed outstanding pollution their state regulatory bodies MississippiPower& Light control revenue bonds, to revise their rate phase-in Company's(MP&L) right to previously secured by letters plans relating to the recovery recover fromits retail of credit, on a long-term of Grand Gulf 1-related customers as reasonable unsecured basis, prepaid in costs such that their plans operating expenses the costs full amounts remaining are now in compliance with of Unit 1 of the Grand Gulf outstanding underits bank the requirements of State-Station (Grand Gulf 1) loan agreements,and paid a ment of Financial Account-capacity and caergy allo-cash dividend onits common ing Standards (SFAS)No.92. cated to MP&L by the stock of $300 million to (See Note 2 " Rate and Federal Energy Regulatory MSU.This dividend was the Regulatory Matters.") Commission (FERC). The first ever paid by System While the June 24 Decision thereby Energy. Forfurtherinfor-June 24 Decision and the upheld the principle of mation regarding the other developments stated federalpreemption,which is consummation of various above represent and reflect necessary to secureimple-steps taken by System very favorable develop-mentation of System Energy Energy,which allowed it to ments, the System still faces Resources,Inc.'s (System pay cash dividends on other uncertainties, de-Energy) federally mandated common stock, see Note 4 scribed herein,which may wholesale rates through the - Lines of Credit and adverselyimpactits future retail rate structures of the Related Borrowings " financial condition. System operating companies. Also,in On February (See Note 2 " Rate and December 1988, System 4,1988,after a lengthy Regulatory Matters.")The Energy completed a sale and prudenceinvestigation,the removal of this uncertainty leaseback transaction with New Orleans City Council strengthened the System's respect to a portion ofits (council) adopted a resolu-financial position,made 90% ownership interest in tion (February 4 Resolution) possible the resumption of Grand Gulf 1,for an aggre-requiring New Orleans Middle South Utilities,Inc. gate of $500 million. Lower Public Service Inc.(NOPSI) (the Company or MSU) cost of capital and acceler-to absorb $135 million ofits common stock dividends, ated use of tax benefits as a previously deferred Grand and has resultedin a more result of the sale and lease-Gulf 1-related costs,which favorable financialmarket back transaction willenable was recorded as a write-off forSystem financing System Energy to charge the in 1987,in addition to the activities. System operating companies $51.2 million of such costs On eachof lower than previously previously absorbedin September 30,1988, and projected rates for Grand connection with the March January 27,1989, the MSU Gulf 1 capacity and energy. 1986 rate settlement between Board of Directors declared For furtherinformation NOPSIand the council (rate acommon stock dividend of regarding System Energy's settlement).The conse-20 cents per share, payable sale and leaseback, see quences of the February 4 on December 1,1988, and Note 9 " Leases." Resolution, so long as it March 1,1989, respectively. In another remains in effect, are that Prior to December 1,1988, favorable development, NOPSl's ability to effect MSU had last paid a com-under provisions contained long-or short-term external mon stock dividendinJuly in the agreement settling borrowings or to satisfy 22

l l 1 potential obligations to should be reclassified to decided that suspension of Electricity Generation by FuelType l purchase allor a portion of accounts receivable from construction should be its outstanding generaland associated companies. continued and that a further refunding (G&R) bonds will System Energy has strongly decision be made by 1990 on cantinue to be significantly disagreed with the staff's the future status of Grand and adversely affected,and position, asserting that the Gulf 2 in light of alternatives NOPSIcould ultimately be staff's position is in violation available at that time. System f rendered insolvent. In this of the Securities and Ex-Energy does not intend, k p connection, NOPSI has change Commission's (SEC) prior to a further decision Q continued to retain inde-tax allocation regulations concerning the status of a a o pendent special counsel applicable to holding Grand Gulf 2, to make an l 3 experienced in bankruptcy company systems and application to FERC with g d l matters to help evaluate the contrary to FERC's own respect te the recovery options available to NOPSI. accounting rules. If certain of through rates of System i (See Note 8 " Commit-the staff's findings are Energy's investment in ments and Contingencies-ultimately sustained, the Grand Gulf 2. During 1989, NOPSI Prudence Disallow-resulting charges against net System Energy willanalyze m ance and Other Controver-income and refund require-the future status of Grand sies Concerning Grand Gulf ments would have a materi-Gulf 2. (See Note 8 "Com-1," for more information.) ally adverse impact on mitments and Contingencies

2 sa s< as s6 s7 ss In addition, System Energy, and its

-Uncertainties Relating to theJune 13 Decision, prospective earnings, cash Grand Gulf 2," for further Bau D oa 13 u a,,, E co.i whereby FERCallocated flow, and financial condition information concerning " W lgy g/g g Q the capacity and energy from would be adversely affected. Grand Gulf 2, including <=jlyE System Energy's share of The effect on the System if issues regarding recovery by Grand Gulf I and the costs the staff's findings are ulti-System Energy ofits invest-associated therewith among mately sustained and refunds mentin Grand Gulf 2,the the System operating to the System operating adoption by FERC ofits companies, was reaffirmed companies are required "50/50 sharing" policy by FERC in a November 30, would depend upon the regarding recovery of 1987, order (November 30 associated r etail rate treat-canceled or abandoned plant System Retail Customer EletricMsa Order), which has been ment.(See Note 8 "Com-costs, and the effect on MSU appealed by various parties mitments and Contingencies of certain accounting stan-to the D.C. Circuit. Further, -FERC Audit of System dards should Grand Gulf 2 l various state and local Energy."' be abandoned.) n regulatory bodies have been In September The council -l>jlg consideringinitiating a 1985,when construction was has been considering the proceeding before FERC suspended, Unit 2 of the acquisition by the City of 50 g E u regarding various Grand Grand Gulf Station (Grand New Orleans of the electric Gulf 1 prudence issues. (See Gulf 2) was approximately and gas utility properties of E Note 2 " Rate and Regula-34% complete based on the NOPSI. NOPSI believes ,s f tory Matters.") man-hours then estimated to that any attempt by the city OnJune 18, be needed to complete the to municipalize NOPSI's l~ll'l 1987, FERC issued an audit unit. As of December 31, electric utility facilitiesin gg g g repon pertaining to System 1988, System Energy had order to attempt to enable am m m d5 P PPP PP Energy and the Grand Gulf recorded approximately electric customers in the city dd ' d d d Station. In its report, the $905 million onits balance to avoid paying their l ll l FERC staff (staff) states, sheet as an investment in fedaily allocated share of l ll l l among other things,that the Grand Gulf 2.In December Grand Gulf 1-related costs i l Grand Gulf Station's 1986, based on the recom-could result in extensive and

3 ##

l allowance for funds used mendation of a special group complex proceedings before during construction of System officials and various regulatory authori-(AFUDC)is overstated, and outside consultants, System ties and the courts, all of that a significant portion of Energy's Board of Directors which could take many years System Enes gy's unrealized (with the MSU Board of to resolve. On March 29, recorded income tax benefits Directors concurring) 1988, the council proposed 23

f MANAGEMENTS FINANCIAL DISCUSSION AND ANALYSIS AJJ!r south Uidam. Im w,J$nhndwm l to MSU to discuss a the February 4 Resolution in of regulatory and judicial System Energy anticipnes " friendly buyout" of 1989, reinst.nment on proceedings, financing plans, that its projected internally l NOPSI by the city.MSU NOPSI's books of an asset and access to capital markets. generated funds for the ) responded by indicating a of $135 million previously Depending upon the period 1989-91 will enable it willingness to consider any written off,and resumption resolutionof theabove to largely satisfy its cash l alternatives that the council of rate collection at thelevel matters, material changes in requirements. AP&L, might propose if they are in provided in the rate settle-capital and financing Louisiana Power & Light the bestinterests ofits ment;(3) the resolution in requirements could result. Company (LP&L),and stockholders, customers, and System Energy's favor of The System's MP&L will requirelimited employees. Representatives FERC audit issues;(4) the capital and refinancing re-amounts of external financ-of NOPSIand MSU are continued suspension of quirements in the period ing during the period. continuing to meet with construction activities at 1989-91 are expected to be NOPSI willalso require membersof thecounciland Grand Gulf 2,except for met primarily with internally external financing during the their consultants to discuss those activities necessary for generated funds. However,a period 1989-91, which it these matters.The ultimate demobilization and suspen-number of uncertainties hopes to be able to obtain outcome of these discussions sion of the unit;(5) no continue to confront the through a combination of cannot be predicted. transfer of ownership of a System, and, depending means, including sales of in December substantial portion of upon the ultimate resolution G&R bonds, the making of I 1988,the Financial Account-NOPSI's electric and/or gas of such uncertainties and the short-term borrowings, and i ingStandards Board (FASB) utility properties; and (6) effects thereof upon the the sales of such other issued SFAS No.100, certain other assumptions System operating companies securities and the effecting of Accounting for Income and judgments with respect and System Energy, addi-such other financings as may Taxes-Deferralof the to, among other things, earn-tional funds from external be determined appropriate Effective Date of FASB ings, dividends, the outcome sources may b required. under the circumstances. Statement No. 96, which extended the effective date of SFAS No.96, Accounting Capital and external financing requirements for the System for the period for IncomeTaxes, to fiscal 1989-91 are estimated to be as follows: years beginning after 19s9 1990 1991 Toul December 15,1989. Based gg on a prehmmary study,it is Cap,tal Requ,rements: i i expected that the adoption of Construction expenditures $393.0 $416.0 $41L5 $1,220.5 SFAS No.96 will result in a Phase-in requirements (1) 180.6 97.0 (30.0) 247.6 net increase in accumulated Nuclear fuel not financed deferred income taxes with a under lease _ 26.3 %) corresponding increase in Total capital requirements $599.7 $513.0 assets. MSU, the System Financing Requirements: ~ ~ ~~53_81_.5 $1,494.2 ~ operating companies, and Total capital requirements $599.7 $513.0 $381.5 $ 1,494.2 System Energy's resuhs of Less internally generated funds operations are not expected and changes in cash and i to be significantly impacted short-term debt .682.9 493 _458.5 1,609 3 l by the adoption of SEAS Net financing requirements (83.2) 45.1 (77.0) (115.1) ) No.96. (See Note 3 - Plus refinancing requirements: l " Income Taxes.") Long-term debt maturities j Liquidity and CapitalResources and sinking funds (2) 45.4 29.5 368.1 443.0 The capital Preferred stock sinking funds _204 _ 42.3 _ 31.9 _ 94,2 and external fm, anc.mg Total external financing I requirements of the System, requirements $(17.8) $116.9 $323.0 $ 422.1 discussed herein, are based on a number of assumptions, (1) See Note 2 " Rate and Regulatory Matters - Resised Rate Phase-In Plans" for information with respect to includmg (1) the continued phat,e-in plans of the System operating companies. allocation of Grand Gulf 1 (2) System Ener y and LP&L expect to remarket $27.1 million and $220 million, respectively, of pollution capacity and energy in c ntr I avenue mds in 1989. T the extent such remarketing is not successful System Energy and LP&L may he required to reacquire such bonds, resulting in aJditional fmancing requirements. NOPSI may be required to i accordance with theJune 13 purchase up to $115 million principal amount of its outstanding G&R bonds on February 9,1990. (See Note 2 - Decision and the November " Rate and Regulatory Matters - NOPSI Prudence Disallowance.") System Fuels, Inc. plans to replace a nuclear f el fi"2"'i"8 ""2"S*"*"' i" 19893" 'h' '*"' this arrangement is not extended or replaced, additional 30 Order;(2) the reversal of P fmanang requirements of up to 50 million could result. Such amounts are not mcluded in the above table, i l 24

' However,asdiscussed future are contingent upon The System Capital Requirements Related to Expenditures and herein,NOPSPs ability to earnings, the amounts of un-operatingcompanies and f",8'f"j,",",i, obtain funds from extgrnal funded bondable property System Energyareauthor- - sources is severely hmited at and,m the case of MP&L ized through 1990 by the i l. L this time. and NOPSI, the amounts of SEC to effect short-term l In addition, cumulative Grand Gulf 1-borrowings in an aggregate i i certainof theSystem related ra:e deferrals re-amount outstanding at any ,,y operating companies are corded as assets available to one time of up to a specified preceeding, subject to the support the issuance of dollar amount for each t i receipt ofnecessary regula-additional G&R bonds. company [(in millions) mo tory approval, with arrange-Based on earnings coverage AP&L-$125; LP&L-$125; j ments for the possible tests,available bondable MP&L-$100;NOPSI-$30; a j redemption, purchase,or property and,in the case of and System Energy-$125], m ~ other acquisitionof all or a MP&L and NOPSI, subject toincrease to a maxi-j portion of certain outstand-cumulative Crand Gulf 1-mum of 10% of each com-ing series of high-cost debt related rate deferrals re-pany's respective capitaliza-m t and preferred stock. Further, corded as of December 31, tions with further SEC 1 System Energy and certain 1988, the System operating approval. However,the 2w Systemoperatingcompanies companies andSystem ability of the System operat. may enterinto arrangements Energy could haveissued ing companics and System for the sale and leaseback of mortgage bonds or preferred Energy to borrow is subject " ## 8' #2 #3 ## ## property in which the stock in the following ap-to the availability of funds proceeds from such transac-proximate amounts, at an through bank lines and other . conur ama crre duare, tions could be used to retire assumed annualinterest or credit sources. System D"fjr,,ds u>cd Darms certain debt issues at par. dividend rate of11% In Energy is limited by one ofits co,ntruaum In general, the addition, AP&L, LP&L, credit arrangements to short-System operating companies MP&L,and System Energy term borrowings in an External FinancinD Activity and System Energy's ability had the ability at that date, aggregate amount not udium ofooit n to access the capital markets subject to meetingcertain exceeding 5% of capitaliza-2m and to raise funds from conditions, to issue bonds tion (approximately $234.8 external sources will be against the retirement of million at December 31, subject to receipt of SEC, bonds without meeting an 1988).MP&L and NOPSI mo and, in certain cases, state carnings coverage test. arelimited by the terms of and local regulatory,ap-their G&R mortgages to provaland maybe affected by a number or factors, includinglegal and reg-aggyy,,,g fy,,,, p,g,,,,j ulatorydevelopments (see Atadable as ofDec. J1,1988 Bonds Stod Note 2 "Rateand Regula- ~],, %,,jg ~ me tory Matters"and Note 8 - AP&L $308,000 $213,000 " Commitments and Contm-LP&L 97,000 E "g gencies"), the credit ratmgs MP&L i18,600 3,600 m of theirsecunties, market NOPSI _m 7,000 condit ons,and contractual System Energy 256,000m m and regulatory restrictions limiting the amounts of (i> oue to the counciPs February 4 Resolution, NOPSI was compelled to bonds and other securities write off $135 million of accumulated deferred Grand Gulf 1-related costs P'c'i"l c 'ded *5 8" *5'c' ""i b "k5 ^$ a result. at necember 31, that the System operating Y 1988, NOPSI's cumulative deferred Grand Gulf I-related costs aggregated sx compames and System $m8J million.Since the amount of NOPSPs GER bonds outstanding at

3 #4 35 86 #7 83 Energy mayissue.

occcmber 31,1988,($1is minion) exceeded 66 20% of NOPSPs cumulative E *"" I""E "#"U#""d'"") The amounts deferred Grand Gulf 1-related costs as recorded on its books, NOPSI was precluded, under the terms f its indenture, from issuing any additional G& R E Net runs Nwded of additionalmort e bonds as of that date. IIN'un hn Renremenn/ bonds and preferred stock (2) The amount of bonds issuable on the basis of System Energy's unfunded R'd'*r"") ^UN'N"jd"T "[#"("j I that can be issued by the bondable property is calculated based only upon Grand Gulf i unfunded g g= iay bondable propeny YP'""id"f"' /EMM sy System operating companies and System Energy in the Q"#*jd;,'l"'[f I"'"'P"'""" d ""' '""#"'l I, 25

I MANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS Muldte sourir litdum. Ju. end 5sbudwm short-term borrowings in an previously deferred,(2) a aggregate amount not nonrecurringaccounting exceedmg, m general,the a y,jf,3f, adjustment reported by l l greater of 10% of capitaliza-Authorized sank. L,ne, sank, yoney g t NOPSIin 1986,and (3) the tion or 50% of Grand Gulf 1-Un Thousands) discontinuance of Waterford related rate deferrals available AP&L $125,000 $43,288 3 deferrals by LP&L to support the issuance of LP&L 73,000 67,300 throughout most of 1987. G&R bonds. In addition, MP&L 100,000 30,000 22,000

For1988, LP&L,MP&L, and NOPSI NOPSI earnings per share on MSU are subject to an SEC order System Energy 125,000 common stock increased to that prohibits incurrence of

$2.01, up from $1.74 re-short-term indebtedness if ne authorized amounts (based on the most restrictive applicable hmitation) corded in 1987, but down of short. term borrowings, available bank lines, and the amounts outstanding from the 1986 amount of common stock equity is,or at February 28,1989, for the System operating companies and System would thereby become,less Energy are set forth in the above table. $2.22.The 1988 increase and than 30% of the sum of total the 1987 decrease reflect the capitalization plus short-factors mentioned herein. term indebtedness. As a Fuel and fuel-j result of the $135 million the funds available in the nesults of operations related expenses for electric write-off of previously money pool for borrowing Discussed generation for 1987 declined deferred Grand Gulf 1-aggregated approximately herein are those factors $57.8 million, or 6.7%, from related costs, and the reduc- $619.0 million. affecting results of opera-1986.This decrease was due tion of NOPSI's common The Com-tions for which significant primarily to increased stock equity caused thereby pany does not have any changes have occurred for nuclear gcneration, which is (19.3% of total capitalization present plans to issue the year 1988 compared at alower average unit price as of December 31,1988), additional shares ofits with 1987 and for the year than other types of genera-NOPSIis currently pre-common stock or otherwise 1987 compared with 1986. tion, and to a general decline cluded from effecting any to obtain funds from The Sys-in unit prices for other fuel short-term borrowings, external sources through tem's net income for 1988 types. whether through bank loans future issuances of securities was $411.0 million,an Purchased or money pool borrowings, or other financings. increase of approximately power expenses in 1988 without further SEC ap-In connection $54.4 million,or 15.3%, increased $45.4 million,or proval, which is not likely to with the Grand Gulf Station, from 1987.This increase was 47.0%, compared with 1987, be obtained under the present the Company has under-primarily attributable to the whereas purchased power circumstances. taken to provide or cause to write-off by NOPSIin 1987 expenses in 1987 decreased Short-term be provided to System of $135 million ($72.9 $31.8 million, or 24.8%, borrowings of System Energy sufficient capital to million net of tax) of disal-compared with 1986.The Energy and each System (1) maintain System En-lowed Grand Gulf I costs 1988 increase was due operating company up to the ergy's equity capital at an that were previously primarily to increased authorized amounts can be amount at least equal to 35% deferred. Partially offsetting amounts of power being effected through the money of totalcapitalization(ex-this factor was a redaction in purchased from outside pool, subject to the availabil-cluding short-term debt), System Energy's rate of utilities underlong-term ity of funds that at any (2) construct, own, and place return on common equity purchase contracts.The 1987 particular time may be in commercial operation from 16% to 14%, effective decrease was due primarily I limited.The money pool the Grand Gulf Station, July 1,1987, applied to a to the use of nuc! car generat-provides the means whereby (3) provide for pre-operating lower net unit investment. ing capacity provided by System companies participat-expenses and interest charges The System's net income for Grand Gulf 1 and Waterford ing therein and having of System Energy,(4) permit 1987 was $356.6 million,a 3 (which began commercial available funds can lend those the continuation of commer-decrease of approximately operationinJuly 1985 and funds to other participating cial operation after com- $97.9 million, or 21.5%, September 1985, respec-companies in the System mencement thereof, and from 1986.This decrease was tively) rather than the (other than MSU)having (5)payin fullallindebted-primarily attributable to purchase of power from short-term borrowing needs, ness for borrowed money of (1) the write-off by NOPSI companies outside the thereby reducing the Sys-System Energy whether at in 1987 of $135 million System. l tem's dependence upon maturity, on prepayment, on ($72.9 million net of tax)of In connection j external short-term borrow-acceleration, or otherwise. disallowed Grand Gulf 1-with their respective rate ings. At December 31,1988, related costs that were moderation plans, the l 26

System operating companies with 1986.The 1988 and 1987 summary operating Revenues deferred for future recovery decreases are primarily A maior and Expenses through rates certain attributable to a decline in uncertainty facing the l operadng expenser totaling pre-tax book income and the System was favorably l $292.1 million, $333.5 enactment of the Tax Reform resolved with theJune 24 million, and $785.9 million, Act of 1986,which effectively Decision of the U.S.Su-33 respectively,in 1988,1987, reduced the maximum preme Court. Prospects for aE and 1986.The decrease in corporateincome tax rate significant improvement in ic E 1988 from 1987 was due to from46% to 34%, effective the System's financial l certain of the System operat-July 1,1987. position occasioned by, 2T l ing companies recovering a Miscellaneous among other things,theJune 3 largerportionof their income and deductions-net 24 Decision have permitted 2T ) current Grand Gulf 1-related increased $28.0 million, or the Company's Board of costs through increased 32.6%,in 1988 compared Directors to resume the ,7 rates,and thereby deferring a with 1987,and increased $9.4 declaration of common stock ' lesser amount.The decrease million, or 12.4 %,in 1987 dividends. Additionally, in 1987 from 1986 was compared with 1986.The another major uncertainty primarily dueto(1) 1988 increaseis due primarily facing the System has been g, NOPSI's w rite-off of $135 to increased interest income favorably resolved with the millionin 1987 of previously earned on temporary cash modifications of the rate

3 ##

8'

6 8'

8" deferred Grand Gulf 1-investments and also due to phase-in plans of AP&L and related costs,(2) LP&L's an $8.2 million gain recorded MP&L. While the outlook g n,s op,,,,,, a,,,,,,, discontinuance for most of on the sale of Associated for the System's future g ^Ltd o m'mx f#""""' r n r=" 1987, pursuant to orders of Natural Gas Company financialcondition has the Louisiana Public Service (ANG) inJune 1988.The greatly improved,a number Commission,of additional 1987 increase is also due to of significant uncertaintic; Waterford 3 deferrals,and increased interest income. remain.These uncertainties (3)NOPSI's one-time Interest on include (1)the outcome of deferralin 1986 of $29.5 fong-term debt showed a continuing controversies million ofits Grand Gulf 1-decrease of $55.8 million, or concerning Grand Gulf 1, wholesale Electricity Sales to related costs that had been 8.1%,in 1987 compared with including a $135 million pru-Adjoining utility systems expensed in 1985. 1986.The 1987 decreaseis dence disallowance with u,us. s m.u, Aun Depreciation primarily attributable to the respect to NOP51, (2) the 3m g expense increased $44.9 carly retirement or refi-potential adverseimpact on E million, or 13.2%,in 1987 nancing of previously System Energy if certain 45x from 1986. EffectiveJanuary outstanding high-interest rate findings stemming from a 1,1987, System Energy's bonds. FERC audit of System depreciation rate was Other Energy and the Grand Gulf g{ ,3x changed from the units-of-interest-net decreased $8.3 Station are ultinely E production method to a million, or 18.8%,in 1988 sustained,and Q) the xx straight-line basis.The use of compared with 1987, ar.d ultimate resolution of the 2m the straight-line method in decreased $9.5 million,or status of Grand Gulf 2, 1987 resulted in increased 27.4%,in 1987 compared construction of which has M 2m depreciation expense over with 1986.The decreasein been suspended, including ~ ~ B theprior yeardue primarily 1988 is due primarily to the related accounting and rate um to the recording of additional retirement inJanuary 1988 of issues. In add: tion,NOPSI's clepreciation expense in $158.0 million of sho-* term financial position could be l connection with the com-notes that had been outstand-affected by the outcome of E m mercial operation of Grand ing since April 1987.The the council's consideration 3 Gulf 1 and Waterford 3. 1987 decrease reflects a oimunicipalization of ,, y ,3 ,7 Totalincome reduction in the amount of NOPSI's electric and gas tax expense decreased $33.7 short-term borrowings and utility properties. million, or 12.3%,in 1988 in interest rates on such compared with 1987,and borrowings. decreased $251.9 million, or 47.8%,in 1987 compared 27

I i Report of Management Company's financial reporting. The meetings were designed The management of Middle South Utilities,Inc. to facilitate and encourage any private communication has prepared and is responsible for the financial statements and between the committee and the internal auditor or indepen-related financial information included in this annual report. dent public accountant. 1 I The financial statements are based on generally accepted /M e M**kg% accounting principles. Financialinformation included else-l where in this report is consistent with the financial statements. Kancaster HodgesJr., Chairman l To meet its responsibilities with respect to Audit Committee financial information, management mt.intains and enforces a system of internal accounting controls that is designed to independent Auditors' Report q provide reasonable assurance, on a cost-effective basis, as to the The Stockholders and the BoarJ of Directors of Middle South integrity, objectivity, and reliability of the financial records and Utilities,Inc.: as to the protection of assets. This system includes communica-We have audited the consolidated balance sheets tion through written policies and procedures, a recently issued of Middle South Utilities,Inc. as of December 31,1988 and employee Code of Conduct, and an organizational structure 1987, and the related statements of consolidated income, of that provides for appropriate division of responsibility and the retained earnings and paid-in capital, and of cash flows for each training of personnel. This system is also tested by a compre-of the three years in the period ended December 31,1988. hensive internal audit program. These financial statements are the responsibility of the Com-The independent public avountant provides an pany's management. Our responsibility is to express an objective assessment of the degree to which management meets opinion on these financial statements based on our audits. its responsibility for fairness of financial reporting. They We conducted our audits in accordance with regularly evaluate the system of internal accounting controb generally accepted auditing standards. Those standards and perform such tests and other procedures as they deem require that we plan and perform the audit to obtain reasonable necessary to reach and express an opinion on the fairness of the a,surance about whether the financial statements are free of financial statements. material misstatement. An audit includes examining, on a test Management believes that these policies and basis, evidence supporting the amounts and disclosures in the procedures provide reasonable assurance that its operations are financial statements. An audit also includes assessing the carried cut with a high standard of business conduct. accounting principles used and significant estimates made by "/ _ - A249 m:nagement, as well as evaluating the overall financial state-Q T-ment presentation. We beheve that our audits provide a Edwin Lupberger John L Cowan reasonable basis for our opinion. Chairman and President System Executive-Finance In our opinion, the above-mentioned consoli-dated financial statemenis present fairly, in all material respects, Audit Commmee Chairmars Lettst the financial position of the Company and its subsidiaries at The MSU Board of Directors' Audit Committee December 31,1988 and 1987, and the results of their opera-comprises five directors, who are not officers of the Company: tions and their cash flows for each of the three years in the Kaneaster Hodges Jr. (Chairman), W. Frank Blount, James B. period ended December 31,1988,in conformity with generally Campbell, James R. Nichols, and Dr. Walter Washington. The accepted accounting principles. committee held four meetings during 1988. As discussed in Notes 2 and 8 of the Notes to The Audit Committee oversees the Company's Consolidated Financial Statements, there are several uncertain-financial reporting process on behalf on the MSU Board of ties facing the Company and its subsidiaries. Thee uncertain-Directors. In fulfilling its responsibility, the committee ties involve the recoverability of a suspended construction recommended to the board, subject to stockholder approval, project, the potential adverse impact stemming from a regula-the selection of the Company's independent public accountant tory audit if certain findings are ultimately sustained, and the (Deloitte Haskins & Sells). Also, the com.mittee oversees and potential obligation of c,ne of the System operating companies coordinates the activities and policies of the subsidiary compa-to purchase a portion of its outstanding bonds which,if nies' audit committees. required, could render that company insolvent as there is no The Audit Committee discussed with the assurance that it would have sufficient available cash resocrces internal auditor and the independent public accountant the or financing capabilities to meet this obligation. The ultimate overall scope and specific plans for their respective audits, as outcome of these uncertainties cannot presently be deter-well as the Company's consolidated financial statements and mined. Accordingly, no provision for any loss that may result the adequacy of the Company's internal controls. The commit-upon resolution of these matters has been made in the accom-tee met separately with the Company's internal auditor and in-panying consolidated financial statements. dependent public accountant, without management present, to (3 discuss the results ofits examinations,its evaluations of the )(/,. M # /d.4/ 7 2 /4 Company's internal centrols, and the overall quality of the New Orleans, Louisiana March 3,1989 28

STATEMENTS OF CONSOLIDATED INCOME Maddir $n& Utdaus,1w andsabudwws l For theYea".s Ended December 31, 1988 1987 1986 l Operating Revenues: (InThousands). . Electric $ 3,473,552 $3,327,117 $3,339,132 Naturalgas. 91,853 127,703 146,780 Total 3,565,405 3,454,820 3,485,912 Operating Expenses: y Operation: Fuel for electric generation and fuel-related expenses 778,138 801,594 859,350 3 ~ Purchased power 141,992 96,595 128,405 Gas purchased for resale 62,661 83,800 104,036 Other 751,274 686,460 722,664 Maintenance 235,733 256,202 242,261 Depreciation 390,554 384,374 339,438 Taxes other thanincome taxes 172,135 169,696 161,042 Income taxes (Note 3) 152,638 161,817 166,036 Rate deferrals: Rate deferrals (Notes 1 and 2) (292,078) (468,495) (785,897) Write-off of previously deferred Grand Gulf 1 expenses (Notes 2 and 8) 135,000 Income taxes (Note 3) 102,789 137,721 383,180 Total 2,495,836 2,444,764 2,320,515 Operating Income 1,069,569 1,010,056 1,165,397 OtherIncome: Allowance for equity funds used during construction 7,818 7,901 8,830 . Miscellaneous income and deductions - net 113,845 85,849 76,403 Income taxes-credit (Note 3) 14,549 24,918 22,656 Total ~ ~ 136,212 118,668 107,889 Interest and Other Charges: Interest on long-term debt 663,477 637,139 692,980 Other interest-net 35,826 44,095 34,608 Allowance for borrowed funds used during construction 8,680 (1,092) 590 Preferred dividend requirements of subsidiaries 86,770 91,978 90,643 Total 794,753 772,120 818,821 Net Income... _ _ _ _ _ .._$ _ 411,028 5 356,6_04 $ 454,465 Earningsper Common Share $2.01 $1.74 $2.22 Dividends Declaredper Common Share (Note 7) $0.20 NumberofCommon Shares Outstanding 204,581,092 204,581,092 204,581,092 See Notes to Consolidated financial Statements. 29

I CONSOLIDATED BALANCE SHEETS (, MadJte ksah utdam, lu, and 5abudwm DecemberJi, 1988 1987 (in Thousands) 1 Assets Utility Plant (Notes land 9): Electric $13,222,773 $12,855,563 Property under capital lease - electric 120,766 120,018 ~I Natural gas 94,942 135,174 d Property under capitallease-gas 1,001 815 Construction work in progress 170,265 263,465 Nuclear fuel 95,456 182,557 ( Nuclear fuct undei apitallease 396,052 397,867 Total 14,101,255 13,955,459 Less-Accumulated depreciation and amortizatiort _ 2,989,863 2,715,314 Utility plant-net 11,111,392 11,240,145 Other Property andInvestments: Letter of credit escrow (Note 4) 108,562 Other 86,207 103,635 Total 86,207 212,197 Current Assets: Cash 15,389 19,996 Temporary investments - at cost, which approximates market (Notes 2 and 9) 1,366,555 579,899 Total cash and cash equivalents (Note 1) 1,381,944 599,895 Funds held by first mortgage bond trustee 60,000 Bonding trust arrangement (Note 2) 101,202 Special deposits 13,510 15,477 Notes receivable 2,916 1,170 Accounts receivable: Customer [less allowance for doubtful accounts of(in thousands) $7,596 in 1988 and $7,574 in 1987] 147,509 136,807 Other 34,483 20,407 Accrued unbilled revenues (Note 1) 54,726 50,9 ' '. State income taxes receivable 2,859 8,'< 78 Accumulated deferred income taxes (Note 3) 38,598 Fuelinventory (Notes 1 and 4) 64,739 95,312 Materials and supplies - at average cost 179,534 110,323 Rate deferrals (Notes 1 and 2) 91,229 11,765 Prepayments and other 64,538 55,910 Total _ 2,076,585 1,267,982 DefenedDebits: Rate deferrals (Notes 1 and 2) 1,559,724 1,346,090 Suspended construction project (Note 8) 904,984 889,780 Other 202,924 200,638 Total 2,667,632 2,436,508 Total . $15,941,816 -.$15,156,832___ See Notes to Consohdated financi.d Statemnts. 30

, CONSOUDATED BALANCE SHEETS Maddie South Utdawn, lu andSubsJwws DecemberJI, 1988 1987 I (InThousands) Capitalization andLiabilities l J Capitalization: 1 Common stock, $5 par value, authorized 500,000,000 shares; issued and outstanding 204,581,092 shares $ 1,022,905 $ 1,022,905 Paid-in capital 1,567,781 1,565,466 Eepined ca.rnings (Note 7) 2,310,2_42 1 939,757 1 Totalcommon stockholders' equity 4,900,928 4,528,128 F Subsidiaries' preferred stock (Note 5): Without sinking fund 330,967 330,967 With sinking fund 462,965 496,405 Long-term debt (Notes 6,8, and 9) 6,187,442 5,945,054 Total 11,882,302 11,300,554 Noncurrent Liabilities: Obligations under capital leases (Note 9) 260,858 245,477 Other 56,876 50,581 Total 317,734 296,058 Current Liabilities: Notes payable (Note 4): Commercialpaper 26,000 65,000 Other 21,657 190,667 Currently maturing long-term debt (Note 6) 306,346 336,382 Accounts payable 286,989 271,293 Gas contract settlements -liability to customers (Notes 2 and 11) 257,054 60,765 Deferred fuelcost 9,535 32,458 Customer deposits 73,880 67,904 Taxes accrued 162,485 76,142 Accumulated deferred income taxes (Note 3) 9,773 Interest accrued 165,723 168,896 Preferred dividends declared 23,454 22,192 Obligations under capital leases (Note 9) 300,118 318,460 _Other 52,209 84,279 Total 1,685,450 1,704,211 Deferred Credits: Accumulated deferred income taxes (Note 3) 1,597,921 1,327,932 Accumulated deferred investment tax credits (Note 3) 66,621 55,332 Gas contract settlements -liability to custamers (Note 11) 225,329 281,612 _O her 166,459 191,13_3_ 3 Total 2,056,330 1,856,009 Commitments and Contingencies (Note 8) Total $15,941,816 $15,156,832 See Notes to Consohdated Finanaal Statements. 31

STATEMENTS OF CONSOLIDATED CASH FLOWS Mddle kmtb utdam, lm. nnJ subudwnes For the Years EndedDecember31, 1988 1987 1986 OperatingActivities: (In Thousands) Net income $ 411,028 $ 356,604 $ 454,465 Non-cash items included in net income: Rate defertals (Notes 1 and 2) (292,078) (468,495) (785,897) i Write-off of previously deferred Grand Gulf 1 expenses (Notes 2 and 8) 135,000 I Depreciation 390,554 384,374 339,438 i Deferred income taxes and investment tax credits 209,219 264,187 559,983 Allowance for equity funds used during construction (7,818) (7,901) (8,830) j Write-off of deferred costs relating to standard coal plant design l and equipment 31,657 ( Write-off of deferred costs relating to SFPs fuel acquisition program 19,151 Provisions for estimated losses (693) 5,025 19,842 Net gain on the sale of ANG (5,350) Changes in workingcapitah Receivables (37,657) 59,887 13,824 Fuelinventory 30,573 (1,946) 26,177 Accounts payable 15,696 (8,898) (82,307) Other working capital accounts (43,687) (11,898) (54,373) Proceeds from gas contract settlements (Notes 2 and i I) 196,835 20,091 12,219 Refunds to customers - gas contract settlements (Note 11) (57,152) (252,785) (56,374) Change in bonding trust arrangement (Note 2) 101,202 (101,202) Increase in decommissioning trust (26,705) (2,744) Other_. _ 20,195 25,49I (43,784) Net cash flow provided by operating activ~ities 904,162 394,790 445,191 l 1 InvestingActivities: Construction expenditures (338,091) (351,227) (335,289) Allowance for equity funds used during construction 7,818 7,901 8,830 Nuclear fuel sales to lessors 58,607 109,579 Nuclear fuel expenditures (40,123) (65,800) (74,718) ) Expenditures on suspended construction project (Note 8) (12,194) (10,403) Proceeds received from the sale of ANG 27,095 Other property-net 1,724 Net cash flow used by investing _ activities (353,771) (360,922) (291,598) Financing Activities: Proceeds from issuance of: Preferred stock 35,000 85,000 First mortgage bonds 75,000 375,000 1,750,000 General and refunding mortgage bonds 115,000 75,000 ) Bank notes and other long-term debt (Note 9) 504,628 51,377 427,846 Retirement of first mortgage bonds (106,603) (107,365) 2 60,548) Retirement of bank notes and other long-term debt (381,250) (406,758) f1,352,912) Redemption of preferred stock (30,420) (48,030) (40,961) Sale and leaseback of nuclear fuel 129,827 66,446 34,419 Common stock dividends paid (40,916) l Proceeds from letter of credit escrow (Note 4) 192,885 ( Letter of credit escrow payments (Note 4) (84,323) (89,400) (19,162) Funds released by first mortgage bond trustec 60,000 (60,000) Changes in short-term borrowings (208,010) 119,667 (162,295) i Proceeds from sale of spareparts inventory 5,741 Other 99 NetIncrease in cash arid (cishiq}uihlMs~g activities NetcasEflowprovided used)b financin 231,658 10,937 (138,613) { 782,049 44,805 14,980 j Cash and cash equivalents at beginning,of p~eriod 599,895 555,090 540,110 i dash ~andiaske~quiialents at end oT[~enod ~ ~~ ~ ~'$1,381,944 "$ 599,895 $ $55,090 SupplementalDisci5s ls2fb 5lol$$$rbt%T' ~ Cash paid (received) during the period for: Interest 5 767,311 $ 745,608 $ 767,491 i income taxes (net of refunds) 4,418 (4,815) 2,479 l SupplementalSchedule ofNon-Cash Investing and Tinanang Actit ities: Capitallease obhgations incurred $ 129,629 71,088 67,607 I First mortgage bonds assumed by third party in the sale of ANG (3,780) Preferred stock dividend requirements of subsidiaries 86,770 91,978 $ 90,643 See Notes to ConsolidatedFinancidStatements. 32 L-_ -_

STATEMENTS OF CONSOLIDATED RETAINED EARNINGS AND PAID 4N CAPITAL MnJdir Sunth thdum. Inc adSubudwin fortheYears EndedDecember31, 1988 1987 1986 (In Thousands) Retainedfarnings,fanuary l $1,939,757 $1,583,402 $1,130,995 Add-Net income 411,028 356,604 454,465 Total 2,350,785 1,940,006 1,585,460 Deduct: Dividends declared on common stock -(Note 7) 40,916 Capital stock and other expenses (373) 249 2,058 Total 40,543 249 2,058 . Retained Eamings, DecemberJ1 (Notc 7) $2,310,242 ' $1,939,757 $1,583,402 Paid-in Capita 6nuary1 $1,565,466 $1,565,889 $1,567,866 Add: Gain (loss) on the reacquisition of preferred stock and other '2,315 (423). (1,97,7_) Paid-in Capital, December 31 $1,567,781 $1,565,466 $1,565,889 See Notes to Consolidated financialStatements. NOTE 1. SUlHIARY OF SIGNIFICANT ACCOUNTING POLICIES by the Federal Energy Regulatory Commission (FERC). The accompanying consoli. The accounts of the generating subsidiary, System Energy, dated financial statements include the accounts of Middle are maintained in accordance with the system of accounts South Utilities, Inc. (the Company or MSU) and its direct prescribed by FERC. The accounts of the non-utility and indirect subsidiaries: Arkansas Power & Light Com-subsidiary, Electec, Inc., are maintained in accordance with. pany (AP&L), Louisiana Power & Light Company the system of accounts prescribed by the SEC. (LP&L), Mississippi Power & Light Company (MP&L), Revenues and Fuel Costs New Orleans Public Service Inc. (NOPSI), MSU System Three of the operating subsidi-Services, Inc. (SSI), System Energy Resources,-Inc. (System aries record electric and gas revenues as billed to their cus-Energy), System Fuels, Inc. (SFI), and Electec, Inc. The tomers on a cycle-billing basis. Revenues are not accrued above companies, excluding Electec, Inc., are collectively for energy delivered but not yet billed by the end of the fis-referred to as the Middle South Electric System or System. cal period. LP&L accrues revenue for the non-fuel portion All significant intercompany transactions have been elimi-of estimated unbilled revenues. Unbilled revenues result nated except as allowed by Statement of Financial Account-from energy delivered since the period covered by the latest ing Standards (SFAS) No. 71. billings to customers. Substantially all of the operating sub-On June 1,1988, AP&L, as sidiaries' rate schedules include adjustment clauses under required by the Securities and Exchange Commission which the cost of fuel used for generation and gas purchased (SEC), disposed of its interest in Associated Natural Gas for resale above or below specified base levels is permitted to Company (ANG) by means of a cash merger of ANG with be billed or required to be credited to customers. and into Arkansas Western Gas Company, a subsidiary of MP&L has a fuel adjustment Southwestern Energy Company. Financial data shown for clause which allows current recovery of fuel costs. The 1987 and 1986 has not been restated for the disposition of three other operating subsidiaries utilize a deferral method ANG since the effect of consolidation is immaterial. of accounting for those fuel costs recoverable under fuel Systems of Accounts adjustment clauses. Under this method, such costs are The accounts of the Company deferred until related revenues are billed. ) and its service subsidiary, SSI, are maintained in accordance The fuel adjustment factor for l with the Public Utility Holding Company Act of 1935, as AP&L contains an amount for a nuclear reserve estimated to 1 administered by the SEC. cover the cost of replacement energy when the nuclear plant i The accounts of the System is down for scheduled maintenance and refueling. The . operating companies (AP&L, LP&L, MP&L, and NOPSI) reserve bears interest and is used to reduce fuel expense for are maintained in accordance with the systems of accounts fuel adjustment purposes during the maintenance and a prescribed by the applicable regulatory bodies, which sys-refueling period. ) tems of accounts substantially conform to those prescribed j 33 . ____ - _ _____-_ O

NOTES TO FINANCIAL STATEMENTS %dJk %th Utdaws loc and %budsarm Ut;Hty Plant and Depreciation Postretirement Benefits Utility plant is stated at original The Company and its subsidi-cost. Partial disallowances of plant costs,as ordered by the aries have various defined postretirement benefit plans Louisiana Public Service Commission (LPSC), have been covering substantially all of their employees. The policy of removed from utility plant. The cost of additions to utility the Company and its subsidiaries is to fund pension costs in plant includes contracted work, direct labor and materials, accordance with contribution guidelines established by the i allocable overheads, and an allowance for the composite Employee Retirement income Security Act of 1974, as / cost of funds used during construction. The costs of units amended, and to fund and record other postretirement plan of property retired are removed from utility plant and such costs on a cash basis. costs, plus removal costs, less salvage, are charged to incorne Taxes accumulated depreciation. Maintenance and repairs of The Company and its subsidi-property and replacement of items determined to be less aries file a consolidated federalincome tax return. Pursuant than units of property are charged to operating expenses, to an intra-System income tax allocation agreement, income Depreciation is computed on taxes are allocated to the System companies in proportion to the straight-line basis at rates based on the estimated service their contribution to the consolidated taxable income. In i lives of the various classes of property. However, deprecia-accordance with SEC regulations, no System company is j tion on Unit 1 of the Grand Gulf Station (Grand Gulf 1) required to pay more income taxes than would have been was computed on the units-of-production method for the paid had a separate income tax return been filed. Deferred initial 12 months of commercial operation (which began income taxes are provided for differences between book and July 1,1985) and, with FERC's approval, for an additional taxable income to the extent permitted by the regulatory six months thereafter. Subsequent to December 31,1986, bodies for ratemaking purposes. Investment tax credits depreciation on Grand Gulf 1 is being computed on a utilized are deferred and amortized based upon the average straight-line basis at an annual rate of 2.85%. Depreciation useful life of the related property. provisions on average depreciable property approximated Allowance for Funds Used During Construction 3.0%,3.0%, and 2.7% in 1988,1987, and 1986, respectively. To the extent that the Com-Substantially all of the System's utility plant is subject to the pany's operating subsidiaries are not permitted by their l liens of the subsidiaries' mortgage bond indentures. regulatory bodies to recover in current rates the carrying Rate Deferrals costs of funds used for construction, they capitalize, as an The System operating compa-appropriate cost of utility plant, an allowance for funds nies have in effect various rate moderation or rate phase-in used during construction (AFUDC) that is calculated and plans in order to reduce the immediate effect on ratepayers recorded as provided by the regulatory systems of accounts. of the inclusion of Grand Gulf 1 and Unit 3 of the Water-Under this utility industry practice, construction work in ford Steam Electric Generating Station (Waterford 3) costs progress on the balance sheet is charged and the income in rates. Under these plans, certain costs are either perma-statement is credited for the approximate net composite nently retained (and not recovered from ratepayers), interest cost of borrowed funds and for a reasonable return deferred in the early years of commercial operation and on the equity funds used for construction. This procedure collected in the later years, or recovered currently from is intended to remove from the income statement the effect customers. These plans vary both in the proportions of of the cost of financing the construction program. It i costs that each company retains, defers, or recovers and in effectively results in treating the AFUDC charges in the j the length of the deferral / recovery periods. By deferring same manner as construction labor and material costs in that i costs associated with the rate moderation plans to the future each is capitalized rather than expensed. As non-cash items, i when they will be collected through increased rates billed to these income statement credits have no effect on current customers, the impact of the deferral aspect of these plans cash earnings. After the property is placed in service, the on the income statement has been removed. Only those AFUDC charged to construction costs is recoverable from costs permanently retained and not recovered through rates customers through depreciation provisions included in or through sales to third parties result in a reduction of net utility service rates. Effective composite rates of the System income. Because the actual collection of revenues to operating companies for AFUDC were 9.6%,9.0%, and recover the deferred amounts will not occur until the future, 9.2% for 1988,1987, and 1986, respectively. each company records a deferred asset representing the On September 18,1985,the amount of the deferrals and, at the same time, incurs Mississippi Public Service Commission (MPSC) ordered additional capital requirements associated with these System Energy and MP&L to suspend construction of deferrals. In most cases, the carrying chuges associated Unit 2 of the Grand Gulf Station (Grand Gulf 2) as of that with the unamortized deferrals are recovered currently from date. Concurrent with the suspension of construction, customers. (See Note 2 " Rate and Regulatory Matters.") System Energy ceased accruing AFUDC on the unit effec-tive September 18,1985. (See Note 8 " Commitments and Contingencies - Uncertainties Relating to Grand Gulf 2.") 34 i

f-t l.p I ,. Other Noncurrent Liabilities within FERC's jurisdiction." Afterissuance of the Court's [ It is the policy of AP&L, mandate in August 1988, funds, which had been placed in J .LP&L, and NOPSI to record provisions for uninsured trust by System Energy pursuant to a bonding arrangement property risks, certain employee benefits, and claims for. to secure any potential refund obligations of MP&L in injuries and damages through charges to operating expenses connection with this case, were released and returned to on an accrual basis. Accruals for these provisions, classified System Energy. i as other noncurrent liabilities, have been allowed for Following receipt by the ratemaking purposes. Mississippi Supreme Court of the U.S. Supreme Court's Feet Inventories mandate, on October 20,1988, the Mississippi Attorney Effective June 1,1988, SFI General filed its brief with the Mississippi Supreme Court changed its method of accounting for fuel oil inventory to requesting that court to remand the matter to the MPSC to an average cost method from the last-in-first-out method. determine whether savings could be realized in other areas This change had no significant effect on net income. All to offset MP&L's Grand Gulf 1-related costs. MP&L System companies' fuel inventories are valued at average opposed the remand in its reply to the attorney general's cost. brief, which was filed November 3,1988. In the event that Statement of Cash Flows the Mississippi Supreme Court remands the matter to the For purposes of this statement, MPSC, MP&L believes that any subsequent review by the the Company considers all unrestricted highly liquid debt MPSC would not justify a decrease in MP&L's retail rates. instruments purchased with a maturity of three months or Pursuant to the phase-in less to be cash equivalents. provisions of the retail rate agreements and orders under Reclassitiestions which AP&L, MP&L, and NOPSI recover costs related to Certain reclassifications of Grand Gulf 1, periodic rate schedule filings must be made previously reported amounts have been made to conform with regulatory authorities to implement rate increases with current classifications. These reclassifications had no associated with the step-up provisions of the phase-in plans. effect on net income. TheJune 24 Decision, as discussed herein, affirmed the principle that state and local regulatory authorities must NOTE 2. RATE AND REGULATORY MATTERS recognize Grand Gulf I-related costs as reasonable operat-U.S. Supreme Court Decision ing expenses in setting the retail rates of the System operat-On June 24,1988, the principle ing companies. Because AP&L, MP&L, and NOPSI are of federal preemption, which is necessary to secure imple-entitled to collect such costs under their respective phase-in mentation of System Energy's federally mandated wholesale plans, regulatory bodies or other parties could attempt to rates through the retail rate structures of the System operat-change existing non-Grand Gulf 1-related rate structures in ing companies, was upheld by the U.S. Supreme Court the future in an effort to moderate overall higher retail rates Gune 24 Decision). In theJune 24 Decision, the Court as the step-up provisions of these retail rates become . reversed the February 25,1987, decision of the Mississippi effective. Supreme Court which had held, among other things, that NOPSI Prudence Disallowance the MPSC had improperly granted MP&L retail rate relief On February 4,1988, after a to pay for its Grand Gulf 1-related costs without first lengthy prudence investigation, the New Orleans City determining that such costs were prudently incurred. The Council (council) adopted a resolution (February 4 Resolu-Court held that states may not alter FERC-ordered alloca-tion) that required NOPSI to write off, and not recover tions of wholesale power by substituting their own determi-from its retail electric customers, $135 million of its previ-l nation of what would be just and fair, and that the MPSC ously deferred Grand Gulf 1-related costs in addition to the must therefore recognize MP&L's Grand Gulf 1-related $51.2 million of such costs that NOPSI absorbed as part of costs as reasonable operating expenses. The Court stated its March 1986 rate settlement between NOPSI and the that "FERC-mandated allocations of power are binding on council (rate settlement). ' the states, and states must treat those allocations as fair and NOPSIis seeking reliefin reasonable when determining retail rates." The Court also federal and state courts from this action by the council. In 1 held that the MPSC lacks jurisdiction to reevaluate the this connection, the U.S. Supreme Court has agreed to l reasonableness of the various agreements among MP&L, review the question of whether the federal courts have i System Energy, and MSU relating to Grand Gulf 1. Fur-discretion to abstain from taking jurisdiction over NOPSI's thermore, the Court stated that "the MPSC cannot evaluate petition seeking reversal of this disallowance based upon either the prudence of MSU's decision to invest in Grand principles of federal preemption. NOPSI believes that the Gulf and bring it on-line or the prudence of MP&L's February 4 Resolution is in violation of the Federal Power decision to be a party to agreements to construct and Act, FERC ord.:rs with respect to the allocation of Grand ' operate Grand Gulf without traversing matters squarely Gulf 1, and federal law as interpreted by the Court (includ-ing, most recently,in the June 24 Decision), and will 35 __a

NOTES TO FINANCIAL STATEMENTS MuJdir hauth Utelaws. lw ad subudunn ultimately be so declared by the courts. For further infor-recovery share, as described herein, and the inventorying of mation regarding these issues and the potential financial an additional portion of Arkansas costs. Under the revised implications to NOPSI, see Note 8 " Commitments and settlement agreement, an additional 12.47% and 6.95% of Contingencies - NOPSI Prudence Disallowance and Other such costs (stated as a percentage of System Energy's share Controversies Concerning Grand Gulf 1." of Grand Gulf 1) will be deferred in 1989 and 1990, respec-I Revised Rate Phase-in Plans tively, for future collection (deferral share). The deferral j In August 1987, the Financial share, plus the $578 million of previously deferred costs j' Accounting Standards Board (FASB) issued Statement of (collectively, deferred balance) will be recovered by AP&L Financial Accounting Standards (SFAS) No. 92, Regulated in increasing percentages from 1991 through 1998, at which Enterprises - Accounting for Phase-in Plans, an amendment time the deferred balance will have been fully collected. I of SFAS No. 71, which requires, subject to certain transition AP&L is permitted to recover on a current basis th provisions, that amounts deferred under phase-in plans that incremental cost of financing the unrecovered portion of 1 do not meet the requirements of SFAS No. 92 be written the deferred balance. l off. The retail rate phase-in plans of AP&L and MP&L, MP&L's revised plan provides, embodied in the agreement settling AP&L's Grand Gulf 1-among other things, for the recovery by MP&L, in equal related rate issues (settlement agreement) and in the order annual installments over the 10-year period beginning ) issued with respect to MP&L's Grand Gulf 1-related rate October 1,1988, of all Grand Gulf 1-related costs deferred issues (final order on rehearing) and providing for the through September 30,1988, pursuant to the final order on deferred recovery by these companies of their Grand Gulf rehearing. These deferred amounts totaled approximately 1-related ce>ts, although in compliance with generally $648 million. Additionally, the revised plan provides that accepted accounting principles at the time of adoption, did MP&L will defer decreasing amounts of its Grand Gulf 1-not meet the criteria of SFAS No. 92. However,in Septem-related costs over the four annual periods commencing ber and October 1988, MP&L and AP&L, respectively, October 1,1988, with the total deferrals estimated to received approvals from their state regulatory bodies to approximate $152 million, $114 million, $70 million, and revise their rate phase-in plans, in the manner described $33 million for each annual period. These deferrals will herein, such that they are now in compliance with SFAS then be recovered by MP&L over the succeeding six-year No. 92. Accordingly, no write-off of costs previously period ending September 30,1998,in accordance with the deferred by MP&L and AP&L has been required as a result annual recovery schedule specified in the revised plan. The of SFAS No. 92. revised plan further allows for the recovery by MP&L of AP&L's revised settlement carrying charges on all deferred amounts on a current basis, agreement provides, as did the original settlement agree-FERC's June 13 Decision ment, that AP&L permanently retain and not recover, FERC's June 13 Decision except through other sales, a portion of its Arkansas retail allocating the capacity and energy from System Energy's Grand Gulf 1-related costs (retained share). The retained share of Grand Gulf 1 among the System operating compa-share (stated as a percentage of System Energy's share of nies (June 13 L)ccision) was appealed by various parties to Grand Gulf 1) ranges from 5.67% in 1989 to 7.92% in 1994 the U.S. Court of Appeals for the District of Columbia and all succeeding years of the unit's commercial operation. Circuit (court of appeals). On January 6,1987, the court of Under the terms W evised appeals affirmed theJune 13 Decision, holding, among settlement agreement, AP&L is permitted to.act on a other things, that FERC had authority to review and I current basis a portion of its Arkansas retail Grand Gulf 1-modify the allocation of power from Grand Gulf I and to I related costs (current recovery share). Prior toJanuary 1, establish an allocation of such power that FERC found to l 1989, the settlement agreement had provided that a portion be just and reasonable under the Federal Power Act. ) of the current recovery share would be phased in, with Various parties filed petitions for certiorari with the U.S. AP&L deferring for future recovery certain costs in the first Supreme Court (which were denied on December 14,1987, thre years. Under the revised settlement agreement, these thereby leaving in place that part of the court of appeals' j previously deferred amounts are now included in the decision upholding FERC's jurisdiction to allocate Grand deferred balance described herein, and there is no further Gulf I costs) and requests for rehearing with the court of deferral of any part of the current recovery share. The appeals. After granting rehearing of two issues raised in the current recovery share (stated as a percentage of System January 6,1987, decision, the court of appeals on June 24, Energy's share of Grand Gulf 1) ranges from 17.86% in 1987, reversed,in part, the June 13 Decision and remanded 1989 to 28.08% in 1994 and thereafter. the June 13 Decision to FERC (the June 24 Remand) for Under the provisions of the reconsideration of its decision to equalize the capacity and settlement agreement, through December 31,1988, AP&L costs of all System nuclear plants and for an explanation of had deferred approximately $578 million of its Arkansas the criteria used to determine what constitute s " undue retail Grand Gulf 1-related costs ( Arkansas costs) for future discrimination" under the Federal Power Act and why the recovery, through both the phasing-in of part of the current June 13 Decision is not unduly discriminatory. In reversing, 36

1 in part, the June 13 Decision, the court of appeals did not ultimately disallowed for ratemaking purposes, System change that part of its January 6,1987, decision upholding Energy's carnings, cash flow, and financial condition would FERC's authority to review and modify the allocation of be adversely affected. power from Grand Gulf 1. NOPSI Municipaltration On November 30,1987, FERC The council, in connection with issued an order in response to the June 24 Remand whereby controversies surrounding the allocation of capacity and FERC reaffirmed and reinstated theJune 13 Decision, thus energy costs of the Grand Gulf Station, has been consider-l maintaining the previous allocation of Grand Gulf I capac-ing the municipalization by the City of New Orleans of the ity and energy among the System operating companies electric and gas utility properties of NOPSI and the electric (November 30 Order). In issuing the November 30 Order, utility properties of LP&L in the 15th Ward of the city. FERC found that the allocation in the June 13 Decision was (See Note 8 " Commitments and Contingencies-NOPSI not unduly discriminatory. Various parties filed requests Municipalization.") for rehearing of FERC's November 30 Ordct and, by order NDPSI Management Audit dated January 29,1988, FERC denied these requests. In the interest of increased Petitions for review of FERC's November 30,1987, and economic efficiency, LP&L and NOPSI have functionally January 29,1988, orders have been filed with the court of consolidated their company management and personnelin a appeals by various parties. In this connection, the Arkansas number of areas. On May 19,1988, the council adopted a Public Service Commission (APSC) and other Arkansas and resolution calling for a " management audit and evaluation Missouri parties are attempting to again raise the issue of of NOPSI," expressing the council's concern "with the FERC jurisdiction to allocate capacity and energy and degree and status of the so-called functional consolidation related costs to AP&L. A motion for summary affirmance of NOPSI with LP&L that has reportedly occurred to date, as to its jurisdiction was filed by FERC. The court of notwithstanding the lack of appropriate regulatory approv-appeals ordered that the jurisdictional issue be referred to als for formal consolidation, including that required by the the panel of judges that will decide this appeal on the merits, council," and initiating "an investigation into the manage-and that the parties are not to further brief the jurisdictional ment and operations of NOPSL" On June 14,1988, issue. Oral argument is scheduled for May 8,1989. NOPSI received a letter from a national accounting firm, It is not possible at this time to which set out the auditing procedures that the accounting predict the ultimate outcome of these matters, including firm, a local accounting firm, and a national engineering possible reallocation,if any, or the effect thereof upon firm plan to follow, along with an initial request for docu-System Energy and the System operating companies, ments. The audit has continued with additional data including possible refunds,if any. Any material modifica-requests and employee interviews and is nearly completed. tion of the allocation established by the June 13 Decision The matter i; pending. could give rise to additional litigation, disputes, and chal-LPSC Rate Order lenges in the affected jurisdictions. LP&L filed a retail rate applica-Grand Gulf 1 Prudence tion with the LPSC on February 19, is, and updated the As noted, the U.S. Supreme filing in July 1988, requesting an increase in annual base Court's June 24 Decision affirmed the principle that various rates with respect to LPSC jurisdictional customers of matters regarding the prudence of Grand Gulf 1 are within $107.4 million over and above rates then in effect. Subse-FERC's exclusive jurisdiction. In this connection, represen-quently, consultants for the LPSC recommended adjust-tatives of certain governmental bodies, including the ments that,if adopted, would produce a $45.9 million Arkansas Attorney General, the LPSC, the MPSC, the annual rate increase. Mississippi Attorney General, and the council, have pub-In a related development, a licly stated that they are considering whether to retain a judgment was obtained in a suit between LP&L and a gas consulting firm to develop information regarding the supplier in longstanding litigation stemming from, among construction and operation of Grand Gulf 1 that may be other things, the gas supplier's failure to deliver contracted-used to approach FERC with a request to open a prudence for quantities of natural gas for power plant use during the proceeding. The System cannot predict whether any period 1971-81, and on October 24,1988, LP&L received consulting firm will be retained for this purpose, whether from the gas supplier $193.7 million as judgment proceeds. any proceeding before FERC regarding Grand Gulf 1 The LPSC has asserted jurisdiction over approximately prudence issues will be initiated, or in what context any 97.4% of these proceeds in terms of the treatment thereof prudence issues might arise. However, the System would for the benefit of LPSC jurisdictional ratepayers. vigorously defend against any possible allegations of On March 1,1989, the LPSC imprudence with respect to Grand Gulf 1 that might be issued an order that addressed both LP&L's February 1988 l made before FERC and believes that its investment in retail rate application and the distribution of the gas sup-l Grand Gulf I was prudently incurred. In the event that a plier judgment proceeds. The 1.PSC found in its order that portion of System Energy's investment in Grand Gulf I was 37

NOTES TO FINANCIAL STATEMENTS Msddle South Utdam,Inc and subudwm I LP&L was entitled to an annual increase in retail rates of NOTE 3. lNCOME TAXES l approximately $45.9 million, based upon a return on equity The tax effect of the consoli-of 12.76% and an overall rate of return of 11.075 dated 1986 net operating loss has been recorded as a reduc-The March 1989 order ruled, tion of deferred income taxes. The remaining net operating however, that in lieu of a rate increase, LP&L retain the loss carryforward at December 31,1988, amounted to $24.7 LPSC jurisdictional portion of the $193.7 million judgment million and is available to offset federal regular taxable proceeds (stated to approximate $188.6 million) and flow income in future years. If not used, it will expire in the year back to ratepayers, beginning immediately, through a rate 2001. Unused investment tax credits at December 31,1988, amortization schedule that currently extends over a 5.3-year amounted to $421.2 million after the 35% reduction period, such jurisdictional proceeds plus accrued interest required by the Tax Reform Act of 1986. These credits may thereon through February 28,1989. This amortization be applied against federalincome tax liabilities in future schedule provides for a reduction in LP&Us rate base by the years. If not used, they will expire in 1992 through 2003. amount of the unamortized balance of such proceeds The alternative minimum tax through completion of the amortization. LP&L believes (AMT) credit at December 31,1988, was $54.5 million. that the March 1989 order should have the effect of provid-This AMT credit can be carried forward indefinitely and ing approximately the same amount d additional net will reduce federal regular income tax in the future. income available for common stock as would an increase in Cumulative income tax timing LP&Us revenues of $45.7 million annually (approximatmg differences for which deferred income tax expenses have not the amount of LP&Us revenue deficiency as determined by been provided are $443.4 million, $430.6 million, and $431.6 the LPSC) over the next 5.3 years, without requiring any million in 1988,1987, and 1986, respectively. increase in LP&Us retail rates collected from LPSC jurisdic-In December 1987, FASB tional customers. In this connection, LP&L agreed to a issued SFAS No. 96, Accounting for income Taxes, which five-year base rate freeze at the current level, subject to was effective for years beginning after December 15,1988. certain conditions. The conditions include, among others, a In December 1988, FASB issued SFA3 No.100, Accounting provision that would allow LP&L to apply for rate relief for Income Taxes - Deferral of the Effective Date of FASB during the five-year period to reflect a change in the federal Statement No. 96, which extended the effective date of tax law or any net increase in its costs associated with SFAS No. 96 to fiscal years beginning after December 15, Grand Gulf 1 resulting from proceedings commenced at 1989. SFAS No. 96 expands the requirement to record FERC by the LPSC. In addition, LP&L could request a deferred income taxes for all temporary differences that are waiver of the five-year freeze if a catastrophic event caused reported in one year for financial reporting purposes and a dramatic changes in costs. Further, the five-year freeze different year for tax purposes. This will require the would not servo as a bar to flowing through to retail recognition of deferred tax balances for certain items not ratepayers any net decrease in LP&L's costs resulting from previously reflected in the financial statements, such as a proceedings at FERC relating to the Grand Gulf Station or deferred tax liability relating to AFUDC. Under the any decrease related to changes in the federal tax law. liability method adopted by 5FAS No. 96, deferred tax While the LPSC's March 1, balances will be based on enacted tax laws at tax rates that 1989, order purported to address virtually all the issues are expected to be in effect when the temporary differences presented in LP&Us rate application, the LPSC determined reverse. that several issues warranted further investigation. Specifi-It is expected that reductions in cally, the LPSC established subdockets in the preceeding to deferred taxes resulting from the lower corporate federal tax consider, among other issues, the propriety of the use by rates will be reflected as liabilities to customers since the LP&L of an automatic adjustment clause for recovery ofits System companies' regulators may require any such savings Grand Gulf 1-related costs and the level and appropriate-to be passed on to the ratepayers. However, based on a ness of the Grand Gulf 1-related costs being charged by preliminary study, MSU, the System operating companies, System Energy to LP&L. and System Energy expect that the adoption of SFAS No. The LPSC's March 1,1989, 96 will result in a net increase in accumulated deferred order is subject to requests for rehearing and to appeal. income taxes with a corresponding increase in assets. One of the interveners in these proceedings has indicated Results of operations for MSU, the System operating that it intends to appeal the order, and has filed a motion companies, and System Energy are not expected to be with the LPSC asking, among other things, that the LPSC significantly impacted by the adoption of SFAS No. 96. j prohibit LP&L from using and expending the LPSC jurisdictional portion of the judgment proceeds pending further order of the LPSC or a court. At this time, LP&L l has not determined whether it will appeal the order, but intends to vigorously defend against such intervenor's motion and any appeal adverse to LP&L. 38

Income tax expense (credit) consists of the following: 1988 1987 1986 Current: Federal $ 17,144 $ 10,138 State 14,509 295 (33,423). Total 31,653 10,433 (33,423) Deferred-Net: Reclassification due to net operating loss 227,278 32,078 (209,799) Tax gain on sale / leaseback of Grand Gulf 1 (126,286) Rate deferrals 102,789 137,721 383,180 Other deferred purchased power cos's (3,397) 17,396 11,091 Gas contract settlements (69,201) 1,037 81,096 Liberalized depreciation 71,785 166,272 274,790 Amortization of excess deferred income taxes (22,644),,, (23,468) (3,954) Unbilled revenue (20,455) (12,530) 730 Customer deposits 13,976 (1,022) Accrued research expenses 2,493 (2,493) Bond reacquisition costs 9,080 Nuclear refueling and maintenance 11,827 (9,328) 2,178 Deferred fuel 11,498 (2,222) 8,082 Deferred revenue and related interest (1,817) (8,660) 12,585 Alternative minimum tax 75 (32,302) Other (1,086) (3,148) 6,045 Total 196,835 269,433 565,002 Investment tax credit : Amortization (17,799) (5,246) (5,019) Provision _30,189 Recorded income tax expen_se__ _ _ _______ $240,878_ $274,620_ $526,560 Charged to operations $255,427 $299,538 $549,216 Credited to other income (14,549) (24,918) (22,656) RecordeJmcome tax expense 240,878 274,620 526,560 Income taxes applied against the debt component of AFUDC (8,520) (2,545) (3,157) Totalincome taxes $232,358 $272,075 $523,403 Total income taxes differ from the amounts computed by applying the statutory federal income tax rate to income before taxes. The reasons for the differences are as follows (dollars in thousands): 1988 1987 1986 %of %of %of Pre-Tax Pre-Tax Pre-Tax Amount income Amount income Amount income j Computed at statutory rate $251,149 34.0 $289,281 40.0 $492,967 46.0 l Increases (reductions)in tax resulting from: Amortization of excess deferred income taxes (22,644) (3.1) (23,468) (3.2) (3,954) (0.3) i Write-off of LP&l's state-deferred taxes related ) l to depreciation timing differences (23,828) (3.3) State income taxes net of federal income tax effect 4,833 0.7 16,251 2.2 28,185 2.7 Inyestment tax credit amortization (17,758) (2.4) (5,157) (0.7) (5,044) (0.4) Depreciation 17,198 2.3 25,659 3.5 21,536 2.1 Other-net 8,100 1.1 (4,118) (0.5) (7,130) (1.0) Recorded income tax expense 240,878 32.6 274,620 38.0 526 560 49.1 1 Income taxes applied against the debt component of AFUDC (8,520) (1.1) (2,545) (0.4) (3,157) (0.3) _ __ Total _ income. tax;es __ _ _ __ _ _ 5232,3 8 31 5 $272,075 37.6 $523,403 48 8 39

l l l NOTES TO FINANCIAL STATEMENTS %ddle South Unhaes. lu ad $nbudunes l NOTE 4. LINES OF CREDIT AND RELATED BORROWINGS G&R bonds to short-term borrowings in an aggregate On December 1,1988, System amount not exceeding,in general, the greater of 10% of j Energy consummated certain remarketing arrangements capitalization or 50% of Grand Gulf 1 rate deferrals 1 i relating to its Series A and Series C Pollution Control available to support the issuance of G&R bonds. In Revenue Bonds. In connection with this remarketing addition, LP&L, MP&L, and NOPSI are subject to an SEC pre,pm, the separate bank letters of credit that had been order which prohibits incurrence of shor t-term indebted-i sed ir. support of each series were terminated, and ap-ness if common stock equity is, or would thereby become, proximuch $193.6 million of funds that had been held on less than 30% of the sum of total capitalization plus short-lepos;t in cr. escrow account for the benefit of the banks term indebtedness. As a result of the $135 million write-off

.roviding ds letter of credit for the Series C Pollution of previously deferred Grand Gulf 1-related costs and the Lurd nevenn Donds were released. System Energy reduction of NOPSI's common stock equity caused thereby applied a portion of the escrow funds, together with other (19.3% of total capitalization as of December 31,1988),

available funds, to prepay in full the $81.92 million and NOPSI is currently precluded from effecting any short- $32.25 million of borrowings remaining outstanding under term borrowings, whether through bank loans or money its U.S. and foreign bank loan agreements, respectively, pool borrowings, without further SEC approval, which is thereby terminating these agreements. The termination of not likely to be obtained under the present circumstances. these agreements resulted in the expiration of a number of The System operating compa-financial covenants and restrictions binding upon System nies, excluding NOPSI, have lines of credit, not requiring Energy, including an agreement by System Energy not to commitment fees, providing for short-term borrowings of pay any dividends on its common stock to MSU until all $140.6 million through loans from banks within their loans outstanding thereunder were fully paid, service territory. Additionally, the four System operating The System operating compa-companies, together with MSU, System Energy, SSI, and nies and System Energy are authorized through 1990 by the SFI, are authorized to participate in a System money pool, SEC to effect short-term borrowings in an aggregate whereby those companics in the System with available amount outstanding at any one time of up to a specified funds can invest in the pool while other companies in the dollar amount for each company (AP&L- $125 million; System (except MSU) having short-term needs can borrow LP&L - $125 million; MP& L - $100 million; NOPSI - $30 from the pool, thereby reducing the System's dependence million; and System Energy - $125 million), subject to on external short-term borrowings. The maximum borrow-increase to a maximum of 10% of each company's respec-ing and average borrowing by participants from the System tive capitalization with further SEC approval. However, the money pool during 1988 were $26.4 million and $21.9 ability of each of the System operating companies and million, respectively. At December 31,1988, the funds System Energy to borrow is subject to the availability of available in the money pool for borrowing aggregated funds through bank lines and other credit sources. System $619.0 million. In cddition, SSI has a line of credit with Energy is limited by one of its credit arrangements to short-MSU for $30 million through December 31,1989, term borrowings in an aggregate amount not exceeding 5% At December 31,1988, SFI had of capitalization (approximately $234.8 million at Decembr a fuel oil financing arrangement allowing for borrowings of 31,1988). MP&L and NOPSI are limited by the terms of up to $40 million, subject to a limit equivalent to the lower their respective indentures providing for the issuance of of the cost or the fair market value of SFI's fuel oilinven-Credit facilities (excluding the money pool) at December 31,1988,1987, and 1986 and borrowings thereunder of the System companies were as follows. Years Ended Dewmber31, I988 !987 I986 Credit Credit Credit Faalities Borrowings Faahties Borrowings Facilities Borrowings (In Thousands) Short-term; System Energy $158,000 $158,000 ) SFI $105,000 $43,500 $105,000 $ 97,000 $170,000 $131,000 l Operating subsidiaries $140,588 $ 4,157 $220,800 $270,485 $ 5,000 j Long-term: Company $ 60,000 $ 60,000 t System Energy $374,349 $374,349 $709,450 $709,450 SFI $ 50,000 $ 50,000 $ 18,000 40 e L

tory and certain related receivables. SFI's borrowings under Years Ended this fuel oil financing arrangement were $17.5 million at December 31, 1988 1987 1986 year-end. Effective January 31,1989, this arrangement was 7pyff,7, jy 7.housands) terminated and replaced by a bank line of credit allowing AverageBorrow, g: m for borrowings of up to $30 million. This new arrangement Bank loans $ 52,933 $ 12,665 $ 90,270 is scheduled to terminate in January 1992. In addition, at Commercialpaper $ 53,216 $ 72,738 $121,603 December 31,1988, SFI had an arrangement to borrow up Other $ 19,127 $173,558 $ 32,542 to $65 million in the aggregate through the sale of commer-Maximum Borrowing: cial paper for use in financing its nuclear fuelinventory. SFI Bankloans $100,805 $ 26,000 $125,160 had $26.0 milhon outstanding under this arrangement at Commercial paper $ 65,000 $ 85,000 $125,000 December 31,1988. Borrowings under these arrangements Other $ 32,667 $210,667 $ 49,135 are restricted as to use and are secured by a portion of SFI's fuel oil inventory and a portion of its nuclear fuel inventory, Year-end Borrowing: respectively, and certain accounts receivable arising from the Commercialpaper $ 26,000 $ 65,000 $105,000 sale of these inventories. Other $ 21,657 $190,667 $ 31,000 System short-term borrowings Average Interest Rate: (excluding money pool borrowings) and the interest rates During period.- (determined by dividing applicable interest expense by the Bank loans 9.3% 8.1 % 8.9% average amount borrowed) are given at right: Commercialpaper 9.1% 7.8 % 8.1% Other 10.4 % 9.4% 9.2% tt end of period - Commercialpaper 9.3% 7.8 % 7.4 % Other 11.0 % 9.7% 8.6% NOTE 5. PRUERRED STOCK The number of shares of preferred stock of the System operating companies as of the end of the last two years was as follows: Shares CallPrice At December 31, Cumulative, $100 par value 1988 1988 1987 Without sinking fund: 4.16 % -5.56 % 1,070,774 1,070,106 1,070,106 $102.50 to $107.00 6.08 % -8.56 % 1,180,000 1,180,000 1,180,000 $1C2.80 to $105.28 9.16 % -11.48 % 795,000 795,000 795,000 $104.06 to $111.11 Total 3,045,774 3,045,106. _._ 3,045,106 With sinkingfund: -~~ - ~ ~ 8.52 % - 9.76 % 1,200,000 1,200,000 1,200,000 $108.52 to $109.00 10.60 % -12.00 % 373,000 373,000 431,337 $106.74 to $109.00 14.75 % -17.00 % 266,995 266,995 266,995 $111.58 to $116.16 _Unissued_ TgtaC~ _ 1,839,995 1,839 195 IJ98,332 5,358,500 Total _ _ _ _.__ ____10,244,269 . = =. =. _... _ Cumulative, $25 par value Without sinking fund: 8.84 % 400,000 400,000 400,000 $27.11 10.40 % 600,00_0 _ 600,000 _600,000 ',,2 7.3 0 Total 1,000,000 1,000,000 1,000,000 With sinking fund: ?.92 % - 12.64 % 5,276,063 5,276,063 5,671,871 $27.01 to $27.56 13.12 % -15.20 % 4,645,823 4,645,823 5,258,168 $27.46 to $29.05 19.20 % 2,000,000 2,000,000 2,000,000 527.67 Total 11,921,886 11,92_1,886 _12,930,039 Unissued 15,373,396 . _ _ _ _ _.._ Total _ _ _. _.. ~~ " Cumulative, $0.0f par valuc ~ ' ~ ~ ~ ~ ~ ~ _~ 28,295,282 _Unissued_ _._.._ _ _ _ _ 15,000,0_00 Total _ _.15,0_00,000

-==-m

41 1

NOTES TO FINANCIAL. STATEMENTS Muldie kmsh Utdmes, im. and Sad udwies Changes in the numberof shares Cash sinking fund regnirements of preferred stock of the System operating companies, all of for the ensuing five years for preferred stock outstanding at which were with sinking fund, during the last three years were December 31,19F8, are as follows (in thousands): as follows: 1989 - $22,250; 1990 - $32,250; 1991 - $41,750; 1992 - $41,750; and 1993 - $48,750. ^"* ' Y?

P*U"E Numberof%res companies were current with respect to their quarterly 1988 1937 1986 preferred stock diviuend payments throughJanuary 1,1989.

Sales: As a consequence of the February 4 Resolution, the elimina-AP&L tion of NOPSI's retained earnings due to the write-off of $135 8.52%, $100 par 500,000 million of Grand Gulf 1-related costs in 1987, and the record-MP&L ing of an accumulated deficit, NOPSI's Board of Directors did 9.00 $100 par 350,000 not declare the regular April 1, July 1, and October 1,1988, 9.76%, $100 par 350,000 quarterly dividends on preferred stock, aggregating approxi-Retirements: mately $2.1 million. In November 1988, NOPSI's Board of AP&L Directors (1)with the consent of MSU as NOPSI's comrmon 9.92%, $25 par (137,043) (111,000) (l8,000) stockholder, effected a recapitalization program pursuant to 10.60%, $100 par (18,012) (13,880) which NOPSI restructured its common stock accounts and 11.04 %, $100 par (35,325) (24,675) (37,572) eliminated the prior deficit as of November 30,1988, and (2) 13.28%, $25 par (200,175) (280,325) declared for payment on January 1,1989, the dividends in LP&L arrears and the regular quarterly preferrni dividend payable on 10.72%, $25 par '93,635) (480,000) (119,750) January 1,1989. Such dividends, aggregating approximately 12.64%,$25 par (165,130) (134,500) $2.8 million, were paid as ofJanuary 1,1989. 13.12%, $25 par (291J90) (202,489) (85,000) 14.72%, $25 par (900) (366,684) 15.20%, $25 par (119,880) (119,960) (65,000) MP&L 12.00%, $100 par (5,000) l 14.75%, $100 par - (100,000) 17.00%, $100 par - (200,000) NOPSI 15.44%, $100 par (18,000) (100) Totai (1,066,490) g401,513) 22y78._ The amounts (.f preferred stock of the System operating companies as of the ei d of the last two years were as follows: December 31, 1 983 _ _ 1937_ Without sinkingfund: Stated at $100 a share $304,511 $304,511 Stated at $25 a share 25,000 25,000 Premium __1d56 _ Id56 Totalwithout sinking fund $330,967 With sinkingfund: ~ ~ ~ ~ ~ ~ ~~5330,96_7 Stated at $100 a share $184,000 $189,834 l Stated at $25 a share 298,047 323,250 l Premium 567 645 issuance and discount expense (19,649) (17,324) Totalwith sinking fund $462,965 $496,405 42

NDTE 6. LONG-TERM DEBT l The long-term debt of the Company and its subsidiaries as of the end of the last two years was: December 31, 1988 1987 j (In ThousarcJs) First mortgage _ bond.s __ __ $4273,910_ $4,809,293 General and refu_nding bonds - due 1993-97,10.95 % - 14.95 % 190,000 75,000 l Benk notes: Due: 1989, at 110% of the sum of prime and 1.3% 247,599 1989, at LIBOR_plus_2% 126,750 Total bank notes 374,349_ Other: Long-term obligation - Department of Energy (Note 8) 75,733 71,106 Municipal revenue bonds - due serially thre ugh 2004,1-1/4% - 8% 23,397 26,344 Pollution control revenue bonds and installment purchase contracts: Due serially through 2014,6.4% - 9.5% 59,770 60,870 Due 1995-2016,5-1/4% 1/2% 896,225 896,225 Purchase obligations under inventory supply agreement 27,997 25,110 Grand Gulf 1 lease obligation,9.8%_(Note 9). _ _ 1,583,122 1,079,655 500,000 Total other Unamortized premium and discount - net _ _._.__ __ _ _ __ (53,2 4 4)_ ___{56 861) 1 Total long-term debt 6,493,788 6,281,436 Less__ amount.due_within oneyear. __ 306,346 336,3.82 Long-term debt excluding amount _ _ _=b." *i' }l " - "' Y##' $6,187,4{ $5,945,054. i

========_

=

Maturities and sinking fund On December 28,1988, System requirements for the ensuing five years on long-term debt Energy entered into arrangements for the sale and leaseback outstanding at December 31,1988, are as follows: of an approximate 11.5% ownership interest in Grand Gulf Naturitics Sinking fund Requirernents I f r an aggregate cash consideration of $500 million. (See Note 9 " Leases" for further mformation on these arrange- _ cash _ Other* * *_ ments.) The net proceeds received by System Energy were (In Thousands) placed on deposit with System Energy's mortpge trustee untilJanuary 22,1989, at which time System Energy used 1989 $251,946* $54,400 $21,798 the proceeds to redeem $300 million of its First Mortgage 1990 $ 54,777** $54,400 $21,798 Bonds,16% Series due 2000, $100 million of its First 1991 $342 222 $69,300 $21,328 Mortgage Bonds,15-3/8% Series duc 2000, and $87,697 1992 $276,558 $69,300 $21,248 million of its First Mortgage Bonds,11-3/8% Series due 1993 $403,005 $58,050 $36,828 2016,in each case at the redemption price of 100% of the principal amount plus accrued interest to the date of

Includes $27.1 millwn and $220 mdlion of System 1:ncrgy and LP&L.

redemption. The fallowing amounts of future sinking fund respectively, pollution control revenue bonds expeard to be rema4cted requirements, which were included in the table at left, were

- Yx I d s otentialoblugation of NOPSI to purchase up to 5115 mdlioneliminated upon the redemption of the above series of of G6R onds (see Note # "Commuments and Contingencies -

outstanding first mortgage bonds: 1989 - $53.5 million; NOPSI Prudence Disallowance and Other Controvernes Concernmg 1990 - $53.5 million; 1991 - $38.5 million; I 992 - $38.5 Grand Gulf !").

- - Smhingfund requirements may be met by certification ofproperty million; and 1993 - $27.25 m. h.d on, addnions at the rate of 167% of the requsred amount l

43 .__________J

I NOTES TO FINANCIAL STATEMENTS Muldte Soudr Uqdam. inc ondSahndwrin l The outstanding first mortgage bonds of the Company's subsidiaries as of December 31,1988 l and 1987, were: W i Maturity 4-1/8%d-7/8% 6%8-7/8% 9W11-7/8% 12 % 14-7/8 % 13 % 16 % Total (In Thousands) l 1988 ] 1989 1990 $ 20,600 $ 30,000 $ 50,600 ) 1991 $ 27,000 $300,000 327,000 1992 $ 8,000 $265,000 273,000 1993 $ 15,000 $200,000 $100,000 315,000 l 1994-2003 $236,250 $461,560 $785,500 $215,000 $500,000 2,198,310 2004-2013 $ 85,000 $450,000 $250,000 785,000 2014-2016 $600,000 $190,000 $ 35,000 825,000 Total first mortgage bonds $4,773,910 1987 1988 $ 15,283 $ 45.000 $ 60,283 1989 $ 45,000 45,000 1990 $ 20,700 $ 30,000 50,700 1991 $ 27,000 $300,000 327,000 1992 $ 8,000 $265,000 273,000 1993-2002 $251,250 $287,160 $914,900 $315,000 $500,000 2,268,310 2003-2012 $260,000 $450,000 $ 75,000 785,000 2013-2016 $600,000 $365,000 $ 35,000 1,000,000 Total first mortgage bonds $4,809,293 i l NOTE 7. RETAINED EARNINGS On each of September 30, j The Public Utility Holding 1988, and January 27,1989, the MSU Board of Directors Company Act of 1935 prohibits the Company's subsidiaries declared a common stock dividend of 20 cents per share, from making loans or advances to MSU. The indenture aul payable on December 1,1988cand March 1,1989, respec-charter provisions relating to the operating companies' tively. Prior to December 1,1988, MSU had last paid a long-term debt and preferred stock, respectively, and the dividend in July 1985. Dividends on common stock had provisions of certain of System Energy's financing agree-been omitted during the intecim period due to de major ments and indenture restrict the amount of consolidated uncertainties facing tne System. The decision of 31SU's l retained earnings available for cash dividends on common Board of Directors to resume the declaration of common stock of the subsidiaries. In addition, transfers by the stock dividends reflects, among other things, the significant operating companies from retained earnings to the stated improvement in the financial position and prospects of the value of common stock impose similar restrictions on the System occasioned by the June 24 Decision. amount of consolidated retained earnings available for cash In December 1988, System dividends on common stock of the subsidiaries. As of Energy consummated various steps which resulted in the December 31,1988, $1,185.2 million of consolidated expiration of a number of financial covenants and restric-retained earnings were free from such restrictions, including tions binding upon System Energy, including,in particular, $785.0 million of unrestricted, undistributed retained an agreement by Sptem Energy not to pay any dividends earnings of the Company's subsidiaries. The unrestricted, on its common stock to MSU until allloans outstanding undistributed retained earnings of any MSU subsidiary are under its bank loan agreements were fully paid. In Decem-not available for distribution to the common stockholders ber 1988, System Energy paid a cash dividend on common of MSU until such earnings are made available to the stock of $300 million to its common stockholder, MSU. Company through the declaration of dividends by such This dividend was the first ever paid by System Energy. On subsidiary. February 21,1989, System Energy paid an additional cash dividend on its common stock to MSU of $47.3 million. 44

i NOTE 8. COMMITMENTS AND CONTINGENCIES the future,its monthly payments to System Energy for At December 31,1988, a similar periods in order to conserve cash. [The failure of . number of significant uncertainties continued to face the - NOPSI to make any monthly payment to System Energy -System. A discussion of these matters follows under under the Unit Power Sales Agreement within 30 days after

NOPSI Prudence Disallowance and Other Controversies such payment is due couki result in acceleration of System 8

Concerning Grand Gulf 1,""FERC Audit of System Energy's obligations in respect of its Series B Pollution Energy," and " Uncertainties Relating to Grand Gulf 2." In Control Revenue Bonds (PCRBs) (currently outstanding in addition, the System's financial position could be affected the. amount of $27.1 million), unless waivers were obtained by the outcome of the council's consideration of municipali-or other arrangements were negotiated.] In addition, zation of NOPSI's electric and gas utility properties (see - NOPSI terminated its pension plan, effective October 1, ' "NOPSI Municipalization" herein). 1988, resulting in the reversion to NOPSI in January 1989 NOPSI Prudence Disallowance and Other Controversies of approximately $16.7 million. (See Note 10 "Postretire-Concerning Grand Gulf 1 ment Benefits ") On February 4,1988, after a In view of the fact that NOPSI l lengthy prudence investigate i, the council adopted the was not able to obtain a timely court injunction staying February 4 Resolution that required NOPSI to write off, enforcement of the February 4 Resolution, NOPSI was and not recover from its retail electric customers, $135 required, by the terms of its 1987 mortgage indenture, to million ofits previously deferred Grand Gulf 1-related cause an independent arbiter to deliver to the trustee for the costs,in addition to the $51.2 million of such costs that holders of NOPSI's $115 million of outstanding G&R NOPSI absorbed as part of its rate settlement. NOPSI is bonds a certificate as to whether, in the independent seeking relief in federal and state courts from the action of arbiter's opinion, the February 4 Resolution has materially the council (see Nate 2 " Rate and Regulatory Matters"). impaired or will materially impair NOPSI's ability to In the meantime, the February perform its obligations in respect of the outstanding G&R 4 Resolution will continue to have a substantial and adverse bonds. In a certificate dated June 24,1988 (arbiter's report), effect upon NOPSPs financial condition and to constrain the independent arbiter concluded, based upon the hypo-NOPSPs cash flow. Specifically, the $135 million disallow-thetical assumption that the February 4 Resolution would ance was written off, net of income taxes, and reflected as a not be reversed by the courts and upon certain related loss in 1987. Should the February 4 Resolution remain in assumptions of NOPSI's management regarding future effect, NOPSI would have its future revenues over the events, that NOPSPs projected cash flows during certain period of the rate settlement reduced not only by the $135 future periods " appear to be insufficient to cover projected million disallowance, but also by the loss of the accumu-regularly scheduled debt service requirements when re-lated carrying charges that would have been recoverable on quired." Because the arbiter's report indicated that the the deferred amounts written off, which could amount to an February 4 Resolution would materially impair NOPSPs additional $165 million over that period, ability to perform its obligations in respect of the outs tand-The consequences of the ing G&R bonds, any holder thereof had the option, through February 4 Resolution, so long as it remains in effect, are August 11,1988, to require NOPSI to redcem its G&R that NOPSPs ability to effect long-or short-term external bonds on August 26,1988, at a price of 100% of the princi-borrowings or to satisfy potential obligations to purchase pal amount plus accreed interest to the date of redemption. all or a portion of its outstanding G&R bonds (as discussed However, NOPSI successfully herein) will continue to be significantly and adversely negotiated with its G&R bondholders two extensions of the affected, and NOPSI could ultimately be rendered insol-right to tender their bonds to NOPSI such that the G&R vent. In this connection, NOPSI has continued to retain bondholders now have the right to tender their G&R bonds independent special counsel experienced in bankruptcy between November 24 and December 13,1989, for pur-matters to help evaluate the options availalle to NOPSI. chase on February 9,1990. The G&R bondholders would in order to mitigate the nega-not have the right to give notice between November 24 and tive effects upon NOPSPs financial condition and cash flow December 13,1989, and NOPSI would not be required to caused by the February 4 Resolution and thereby reduce the purchase any G&R bonds on February 9,1990,if an risk of insolvency, NOPSI has implemented a series of cash independent arbiter has delivered on or prior to November conservation and othen measures. In this connection, 23,1989, a certificate stating that the impairment of commencing in April 1988, NOPSI has deferred, from time NOPSPs ability to perform its obligations in respect of the to time for limited periods (in each case less than 30 days), G&R bonds, described in the arbiter's report, has ceased its monthly payment to System Energy under the Unit because of judicial or regulatory action. Power Sales Agreement covering NOPSPs monthly pay-While NOPSI believes that the ment obligations for capacity and energy from Grand June 24 Decision represents a very favorable development in Gulf 1. NOPSI may defer, as needed, from time to time in terras of NOPSPs ability to obtain ultimate reversal of the February 4 Resolution, there is no assu-ance that the matter 45

NOTES TO FINANCIAL STATEMENTS Muddle suurh Utdum. im. and 5abudwm will be favorably resolveWoy November 1989 and that one to reflect adjusted plant and equity balances, and refund, or more G&R bondholders will not demand purchase of with interest, the difference between the recomputed their GNR bonds. If this were to occur and ary significant billings and amounts previously charged customers. Fur-amount of G&R bonds were tendered for parchase, there is ther, the staff recommends that $327.2 million of " Recover-no assurance dat NOPSI would ha e sufficient available able Taxes," representing a significant portion of System cash resources or financing capabilities at that time to meet Energy's unrealized recorded income tax benefits, should be its purchase obligations. As a result, NOPSI could ulti-reclassified to " Accounts Receivable from Associated mately be rendered insolvent unless such obligations were Companies," the net effect of which would be a $258.1 1 teferred, restructured, or other arrangements negotiated, million reduction of Grand Gulf l's rate base on which Insolvency of NOPSI, should System Energy earns a return. The staff recommends that it occur, could result in acceleration of System Energy's System Energy refund, with interest, the change in billings obligations relating to its Series B PCRBs, unless waivers since July 1,1985, due to this rate base reduction. were obtained or other arrangements were negotiated. System Energy has strongly l Also, certain of SFI's financing agreements and leases may disagreed with the staff's position, asserting that the staff's require payments by the System operating companies or position is in violation of the SEC's tax allocation regula-l MSU in the event that SFI's obligations under such agree-tions applicable to holding company systems and contrary l ments are accelerated as a result of the insolvency of to FERC's own accounting rules. This matter is being NOPSI, and in the event that SFI is unable to meet these litigated in an administrative proceeding at FERC. Various obligations or to otherwise satisfy these obligations through parties, including the APSC, the LPSC, the MPSC, and the i the sale of the collateral securing such obligations. In council, have intervened in this proceeding. Hearings on addition, insolvency of NOPSI could affect the terms of this matter have concluded. Briefs have been scheduled for financing, including an increase in the cost of financing, or filing between February 7,1989, and April 18,1989. System could preclude financing for other System companies. Energy filed its brief on February 7,1989. Oral arguments in addition to the NOPSI are scheduled to begin on April 25,1989. j proceedings (discussed herein), litigation is continuing If certain of the staff's findings regarding FERC's Grand Gulf 1 allocation. TheJune 13 are ultimately sustained, the resulting charges against net L)ecision, whereby FERC allocated the capacity and energy income and refund requirements would have a material from System Energy's share of Grand Gulf 1 and the costs adverse impact on System Energy. System Energy estimates associated therewith among the System operating compa-that, as of December 31,1988, the impact on net income nies., was reaffirmed by FERC in its November 30,1987, could be as high as approximately $300 million (net of tax order. Hewever, the November 30 Order has been effect), and System Energy could be obligated to refund apocaltd by various parties to the D.C. Circuit, where the approximately $290 million (inclusive of interest) to its matter is still pending. Further, various state and local customers, the System operating companies. In addition, regulatory bodies have been considering initiating a pro-the staff's proposed adjustments would adversely impact ceeding before FERC regarding various Grand Gulf 1 System Energy's prospective earnings, cash flow, and pmdence issues. (See Note 2 " Rate 2nd Regulatory financial condition. System Energy cannot predict the Matters - U.S. Suprene Court Decision.") ultimate outcome of the examination. The effect on the FERC Aedit of System Energy System if the staff's findings are ultimately sustained and FERC has performed an audit refunds to the System operating companies are required of System Energy and the Grand Gulf Station as part of its would depend upon the associated retail rate treatment. regulatory furction in auditing utilities subject to its juris-Uncertainties Relating to Srand Gutt 2 diction. The audit report, whkh pertains to the period from As recorded on its balance sheet System Energy's inception through December 31,1985, was as of December 31,1988, System Energy's totalinvestment issued on June 18,1987. In the report, as updated by FERC in Grand Gulf 2 was approximately $905 million (including staff (staff) testin ony, the staff states, among other things, approximately $401 million of AFUDC). From late 1979 that the Grand Gulf Station's AFUDC is overstated by until September 1985, only a limited amount of construc- $126.5 million ($99.8 million relating to Grand Gulf I and tion was performed on Grand Gulf 2. Effective September $26.7 million relating to Grand Gulf 2) because the 18,1985, System Energy suspended construction activities

AFUDC calculation failed to take into account all cost-on Grand Gulf 2 following an MPSC order. As of that date, free capital generated by System Energy expenditures and Grand Gulf 2 was approximately 34% complete based on claimed on consolidated income tax returns." The staff the man-hours estimated at that time to be needed to com-recommends that System Energy change its income tax plete the unit.

accounting procedures and record an accounting entry to Since September 1985, System charge the alleged AFUDC overstatement arising from Energy has limited expenditures to only those activities System Energy's alleged incorrect acwunting against net which are necessary for demobilization and suspension of income, recompute billings to customers sinceJuly 1,1985, the unit. A special group of System officials and outside 46

consultants completed,in late November 1986, its evalu-charges to the System operating companies. The System ation and review of Grand Gulf 2. Among the possibilities operating companies would in turn be required to file evaluated were (1)immediate resumption of construction of applications with state or local regulatory authorities to the unit,(2) cancellation of the unit,(3) continued suspen-recognize the FERC-allocated Grand Gulf 2 charges in sion of construction of the unit through 1989 or beyond, retail rates. In view of the controversies over the Grand and (4) conversion of the unit to an alternative fuel source. Gulf Station, including the adverse reaction of various rate In December 1986, System Energy's Board of Directors regulatory bodies to allocar:on of costs, regulatory uncer-(with the MSU Board of Directors concurring) adopted the tainties, including ratemaking, attendant to a delay in the group's recommendation that suspension of construction be decision as to the future of Grand Gulf 2 and imprudence continued and that a further decision be made by 1990 on issues, there can be no assurance that the cost of Grand Gulf the future status of Grand Gulf 2 in light of alternatives 2 will be recovered or as to the timing of any recovery. As available at that time. was the case with Grand Gulf 1, proceedings before FERC During the period of suspen-and, with respect to recognition in retail rates of FERC-sion, System Energy's expenditures on Grand Gulf 2 have approved rates, before state or local regulatory authorities continued to be limited, and System Energy, during this could be protracted and strongly contested on various time, has not accrued AFUDC on its investment in the unit. grounds, including imprudence. If costs associated with' Consequently, during the suspension period, System Grand Gulf 2 were allocated to the System operating Energy has foregone any return on this investment. Fur-companies and they were unable to recover these costs from ther, System Energy has previously indicated that it has no their customers, the System operating companies' financial intention, prior to a further decision on the status of Grand condition could be materially and adversely affected. Any Gulf 2, of seeking FERC approval for the recovery through nonrecovery of System Energy's investment in Grand charges to the System operating companies of its investment Gulf 2 would result in a charge against current income for in the unit. any unrecoverable investment when that event becomes System Energy is continuing to probable. In the event such a charge were substantial, the evaluate various alternatives for the future of Grand Gulf 2 financial condition of System Energy could be materially and to assess whether the equipment and facilities con-and adversely affected and System Energy's ability to pay structed and acquired to date should continue to be carried dividends on its common stock could be impaired. at their full cost. In this connection,in 1989 System Energy Failure to obtain rate relief for will analyze the future status of Grand Gulf 2, including an all or a substantial portion of the cost of Grand Gulf 2 evaluation of various possibilities similar to those studied in could have a material and adverse effect upon the financial 1986. Any determination that the value of System Energy's condition of System Energy, MSU, and, possibly, the investment should be reduced and the amount of any such System operating companies, depending upon, among other redaction written off could adversely affect various compa-things, the timing of the realization of any such loss. nies in the System. Certain issues re!atirg to the value of in January 1988, FERC issued System Energy's investment in Grand Gulf 2 also exist in an order which modified its policy regarding recovery of connection wJth an audit by FERC of System Energy and canceled or abandoned plant costs by utilities subject to its the Grand Gulf Station discussed herein in "FERC Audit of jurisdiction. The revised policy provides for a "50/50 System Energy." sharing" of prudently incurred costs of a canwled plant While System Energy believes between the owner arsd the ratepayers, whereby 50% of the that all of its investment to date in Grand Gulf 2 has been prudently incurred costs of the canceled plant would be prudent, in connection with any further decision as to the amortized and recovered from ratepayers over the expected value of Grand Gulf 2 or the ultimate decision with respect life of the plant, as if it had been completed. The currently to the future of Grand Gulf 2, System Energy wiU, at an unamortized portion of such amount would also be in-l appropriate time, make a determination as to the appropri-cluded in rate base, thereby allowing for a return thereon. ate recovery of all or a portion of its investment, including, The remaining 50% of prudently incurred costs would be in the event of cancellation of the unit, the possibilities of written off. In May 1988, FERC denied requests for seeking recovery. In making such determination, System rehearing pertaining to that portion of its January 1988 Energy will consider, among other things, the regulatory order that adopted the "50/50 sharing" methodology, and j environment generally, legal standards then applicable, and FERC's order is now final. the anticipated financial, regulatory, and political effects in December 1986, FASil j upon System Energy and the other System companies of issued SEAS No. 90, Regulated Enterprises - Accountmg l various alternatives. for Abandonments and Disallowances of Plant Costs, an l In the event that System Energy amendment of SFAS No. 71. SFAS No. 90 requires, among j ultimately were to seek recovery of Grand Gulf 2 costs,it other things, that, when abandonment of a plant becomes I would likely be required to make a filir.g with FERC probable, the cost of such plant in excess of the present requesting such recovery over a period of years through value of estimated recoveries through rates with respect 47

l l HOTES TO FINANCIAL STAYEMENTS Meddle South Unluws. Inc and Subudwrm thereto, net of related tax benefits, shall be reported by (excluding nuclear fuel) during the years 1989,1990, and recording a charge against current income. The provisions 1991 are estimated to aggregate approximately $393.0 of SFAS No. 90 would apply should System Energy decide million, $416.0 million, and $411.5 million, respectively. to cancel Grand Gulf 2 or should cancellation of Grand Capital requirements associated with rate phase-in plans are Gulf 2 become probable. estimated at $180.6 million, $97.0 million, and $(30.0) I NDPSI Municipalization million for 1989,1990, and 1991, respectively. It is also The council,in connection with estimated that approximately $26.1 million will be required controversies surrounding the allocation of capacity and in 1989 to acquire nuclear fuelin addition to amounts energy costs of the Grand Gulf Station, has been consider-financed under lease. The foregoing estimates are based ing the municipalization by the City of New Orleans of the on a number of assumptions, including certain assumptions electric and gas utility properties of NOPSI and the electric and judgments with respect to, among other things, utility properties of LP&L in the 15th Ward of the city. The earnings, dividends, the outcome of regulatory and judicial ordinances under which NOPSI operates state, among proceedings, financing plans, and access to capital markets. other things, that the city has a continuing option to Accordingly, depending upon the occurrence of future purchase NOPSI's properties. On March 7,1985, the events, material changes in capital requirements could council established a public power authority for the pur-result. pose, among others, of acquiring and operating electric In addition to the capital power utilities in the City of New Orleans. The council has requirements described herein, the System operating com-also received various reports from legal, engineering, and panies and System Energy will require funds of approxi-financial advisors with respect to the potential municipaliza-mately $537.2 million during the period 1989-91 to refi-tion of NOPSI's electric utility facilities. These reports have nance maturing long-term debt and to meet inkig fund asserted, among other things, that such municipalization requhements. AMhionally, NOPSI could be required to could be accomplished without the city being required to purchase up to $115 million of its outstanding GRR bonds assume TPSI's obligations with respect to its FERC-on February 9,1990. (See "NOPSI Prudence Disallowance allocated share of Grand Gulf I capacity and energy. and Other Controversies Concerning Grand Gulf 1" here-NOPSI believes that any attempt by the city to municipal-in.) Further, System Energy and LP&L expect to remarket ize NOPSI's electric utility facilities in order to attempt to $27.1 million and $220 million, respectively, of pollution enable electric customers in the city to avoid paying their conn,1 revenue bonds in 1989. To the extent such re. federally allocated share of Grand Gulf 1-related costs marketing is not successful, System Energy and LP&L may could result in extensive and complex proceedings before be required to reacquire such bonds, resulting in additional various regulatory authorities and the courts, all of which financing requirements. Finally, SFI plans to replace a could take many years to resolve.The February 4 Resolu-nuclear fuel financing arrangement in 1989. To the extem tion,if not reve sed, could have the effect of reducing the this arrangement is not extended or replaced, additional fi-purchase price under municipalization by $135 million. nancing requirements of up to $65 million could result. Condemnation or other The System's capital and involuntary taking of substantially all of the property of.my refinancing requirements in the period 1989-91 are expected System operating company might cause acceleration of a to be met primarily with internally generated funds. substantial portion of System Energy's indebtedness (but However, a number of uncertainties continue to confront only upon further action by or on behalf of System En-the Sptem, and, dependir g upon the ultimste resolution of ergy's creditors), unless waivers were obtained, the debt snch uncertainties and the effects thereof upon the System were restructured, or other arrangements were made. operating companies and System Energy, additional funds On March 29,1988, the council from externr1 sources may be required. System Energy an-proposed to MSU to discuss a " friendly buyout" of NOPSI ticipates that its projected internally generated funds for the by the city. MSU responded by indicating a willingness to period 1989-91 will enable it to largely satisfy its cash re-consider any alternatives that the council might propose if quirements. AP&L, LP&L, and MP&L will require limited they are in the best interests of its stockholders, customers, amounts of external financing during the period. NOPSI and employees. Representatives of NOPSI and MSU are also will require external financing during the period continuing to meet with members of the council and their 1989-91, which it hopes to be able to obtain through a com-consultants to discuss these matters. The ultimate outcome bination of means, including sales of G&R bonds, the of these discussions cannot be predicted. making of short-term borrowings, and the sales of such Capital Requirements ant! Financing other securities and the effecting of such other financings as Capital requirements of the may be determined to be appropriate under the circum-System during the period 1989-91 include (1) construction stances. However, as noted under "NOPSI Prudence expenditures,(2) costs associated with rate phase-in plans, Disallowance and Other Controversies Concerning Grand and (3) costs of nuclear fuel in addition to amounts leased Gulf 1," NOPSI's ability to obtain funds from external under nuclear fuelleases. Construction expenditures sources is severely limited at this time. 48 1 l l

capital Funds. Unit Power Sales. Availability, Grand Gulf Station. Each of the System operating compa-land Realleestion Aereements nies, including AP&L, would, however, have remained Under the Capital Funds primarily 1:able to System Energy and its assignees for Agreement, as supplemented, the Company has agreed to payments or advances under the Availability Agreement and supply or cause to be supplied to System Energy (1) such the assignments thereof. AP&L was obligated to make its emounts of capital as may be required in order to maintain share of the payments or advances only if the other System System Energy's equity capital at an amount equal to at least operating companies were unable to meet their contractual

35% of its total capitalization (excluding short-term debt) obligat ons. However, FERC's June 13 Decision allocating i

and (2) such amounts of capital as shall be required in order a portion of Grand Gulf I capacity and energy to AP&L (a) for System Energy to construct, own, and place in and FERC's November 30,1987, order supersedes the coramercial operation the Grand Gulf Station, (b) to Reallocation Agreement insofar as it relates to Grand provide for pre-operating expenses and interest charges of Gulf 1. (See Note 2' " Rate and Regulatory Matters" for System Energy,(c) to permit the continuation of such further information.) commercial operation after commencement thereof, and stockholder Litigation (d) to pay in full allindebtedness for borrowed money of MSU and certain other System System Energy whether at maturity, on prepayment, on companies and individuals are defendants in a purported acceleration, or otherwise. In addition, the Company has consolidated class action suit. The initial complaint was agreed to make cash capital contributions to enable System. filed on August 19,1985, by an MSU stockholder (purport. Energy to make payments when due on its long-term debt, ing to represent a class that purchased MSU common System Energy has, with the consent of the Company, stock). Four similar complaints were filed on August 20, assigned its rights under the Capital Funds Agreement to 1985; August 23,1985; September 6,1985; and September certain creditors. 19,1985, respectively, by MSU stockholders (purporting to Pursuant to the allocation represent classes that purchased MSU common stock). The - specified in the Unit Power Sales Agreement among System five actions were consolidated in the U.S. District Court for Energy and the Sys em operating companies as ordered by the Eastern District of Louisiana (district court). The con-FERC in theJune 13 Decision, System Energy has agreed to solidated, amended, and supplemental complaint alleges sell to the System operating companies all of its 90% share violations of the disclosure requirements of the Securities of the capacity and energy from Grand Gulf 1 in accordance Exchange Act of 1934 and the Securities Act of 1933, with specified percentages (AP&L - 36%, LP&L - 14%, common law fraud, and common law negligent misrepre-MP&L-33%, and NOPSI-17%). Charges under the sentation in connection with the financial condition of MSU Unit Power Sales Agreement, which are computed monthly, and prays for compensatory and punitive damages, legal are based on System Energy's total cost of service, including costs and fees, and other proper relief against MSU, System System Energy's operating expenses, depreciation, and Encrgy, LP&L, MP&L, AP&L, and NOPSI; certain current . capital costs, and former memben of MSU's Board of Directors, and The System operating compa-certain current and former officers of MSU, System Energy, nies are severally obligated under the Availability Agree-LP&L,MP&L, AP&L,and NOPSI;theindependent ment in accordance with stated percentages (AP&L - auditor of MSU; and certain underwriters of MSU common 17.1 L LP&L - 26.9%, MP&L - 31.3%, NOPSI - 24.7%) stock. On March 14,1986, the plaintiffs in the consolidated to make payments'or subordinated advances in amounts action filed a motion for class action determination. On which, when added to any amounts received by System April 18,1986, MSU and certain other System companies Energy under the Unit Power Sales Agreement or other-and individual defendants filed a motion to dismiss or,in wise, are adequate to cover all of the operating expenses, in-the alternative, a motion for summary judgment. On cluding depreciation and interest charges, of System Energy. January 12,1987, the district court entered a judgment System Energy has, with the consent of the System operat-granting defendants' motions for summary judgment and ing companies, assigned its rights to payment and advances dismissed the suit. On February 6,1987, the plaintiffs in l from the System operating companies under the Availability the consolidated action filed a notice of appealin the U.S. l ' Agreement to certain creditors. Court of Appeals for the Fifth Circuit. OnJune 7,1988, In November 1981, the System the Fifth Circuit rendered a decision vacating the judgment operating companies entered into the Reallocation Agree-of the district court, based,in part, on the conclusion that ment which would have allocated the capacity and energy the district court had not adequately explained the bases for available to System Energy from the Grand Gulf Station its decision. In remanding the case to the district court for and the related costs to LP&L, MP&L, and NOPSI. These further proceedings, the Fifth Circuit suggested that the companies thus agreed to assume all the responsibilities and district court could again consider the merits of the defen-obligations of AP&L with respect to the Grand Gulf dants' motion for summary judgment and determine, with Station under the Availability Agreement, with AP&L the benefit of certain guidelines as to the interpretation of relinquishing its rights to capacity and energy from the governing law articulated by the Fifth Circuit, whether the 49 A

NOTES TO FINANCIAL STATEMENTS Msddle South Utdmes. Inc.mdSabudwm defendants are entitled to summary judgment as a matter of respectively. In addition, AP&L, LP&L, MP&L, and law. The district court was directed, if it makes such a NOPSI are members of an insurance program that provides determination, to provide a detailed analysis supporting its insurance coverage for certain costs of replacement power conclusions that would facilitate judicial review. Alterna-incurred due to certain prolonged outages of nuclear units. tively, the Fifth Circuit noted, the district court could These coverages are subject to assessment provisions. At decline to rule on the defendants' motion for summary December 31,1988, the maximum amounts of such assess-judgment until further development of the case has taken ments were: AP&L - $14.07 million, LP&L - $9.79 million, place and the issues have been narrowed through the MP&L - $.36 million, NOPSI - $.22 million, and System available pretrial techniques. On September 6,1988, Energy - $34.87 million. defendants filed a petition for a writ of certiorari with the The property insurance carried U.S. Supreme Court. On October 31,1988, the Court by AP&L, LP&L, and System Energy exceeds that required i denied this petition. Based upon the Fifth Circuit's deci-by the amended regulations dated October 5,1987, by $465 sion, the district court allowed the parties to rebrief the million, $665 million, and $665 million, respectively. The motion for summary judgment, and on January 17,1989, Nuclear Regulatory Commission (NRC) regulations i the defendants filed a renewed motion for summary judg-further provide that any proceeds of this insurance must be ment and a verified answer to the consolidated, amended, segregated in a trust and be used, first, to place and maintain and supplemental complaint. The district court has sched-the reactor in a safe and stable condition and, second, to uled the trial to commence March 12,1990. The outcome of complete required decontamination operations. this pending matter and its impact on the System's financial The NRC has issued, on behalf condition cannot be predicted. of all nuclear licensees, including AP&L, LP&L, and fuel Contracts System Energy, temporary exemptions from the stabiliza-The System has long-term tion and decontamination priority and trusteeship provi-I contracts for the supply of coal for the White Bluff Station sions until completion of the pending rulemaking extending j and the Independence Station. Coal for the White Bluff the implementation date of the regulations, but not later l Station is supplied under a contract providing for the than April 1,1989. It is anticipated that the temporary l deliveries of coal from a mine being operated in the state of exemptions will be extended beyond that date. ] Wyoming in amounts sufficient for the operation of the Spent Nuclear Fuel and Decommissioning Costs l White Bluff Station through approximately 2002. Coal for Under the Nuclear Waste the Independence Station is being provided under a contract Policy Act of 1982 (NWPA), the Department of Energy with a joint venture operating another mine in the state of (DOE)is required to construct storage facilities for and Wyoming. Coal supplied under this contract is expected to dispose of all spent nuclear fuel and other high-level radio-J provide for the projected requirements of the Independence active waste generated by domestic nuclear power reactors, l Station through approximately 2015. The System believes, for a specified fee. The NRC, pursuant to the NWPA, also therefore, that it will have adequate supplies of coal for its requires operators of nuclear power reactors to enter into generating needs for the foreseeable future. spent fuel disposal contracts with the DOE. The affected Nuclear Insurance System companies have entered into such contracts with :he The Price Anderson Act was DOE whereby it will furnish disposal service at a cost of i amended in 1988 to exterd it, coverage to August L 2002, one mill per kilowatt-hour of net g,eneration after April 7, i and to hmit the public hability for a single nuclear incident 1983, plus a ora time fee for gmtmion prior to tlat date. l to approximately $7 billion. AP&L, LP&L, and System AP&L, the ordy System company which generated nuckar Energy are protected against this liability by a combination power prior to that date, has elected to pay the one-time fee, of private insurance (presently $160 million; expected to p3us accrued interest, no earlier than 1998, and had recorded incrme to $200 ndlion by the end of 1989) and an industry at December 31,1988, approximately $75 7 million (includ- ) assessment program. Urder the assessment program, for ing accrued interest) for this payment. The fees payable to each nuclear incident at a licensed nuclear facility, each the DOE may be adjusted in the future to assure full cost licensee will be responsible for up to $66 million per reactor recovery. AP&', LP&L, and System Energy consider all (such amount to be indexed every five years for inflation), costs incurred ca to be incurred in connection with disposal payable at a rate of $10 million per year, including a 5% of spent nuclear fuel to be proper cor ponents of nuclear surcharge in the event the total public liability approaches fuel expense and provisions to recover such costs have been $7 billion. The System has a total of four licensed reactors. or will be made in applications to regulatory authorities. AP&L, LP&L, and System Under the NWPA, the DOE Energy are members of certain insurance programs that was to begin accepting spent fuel in 1998 and continue until provide coverage for property damage, including decon-the disposal of all fuel from reactor sites is accomplished. taminatun expense, to members' nuclear generating However, the DOE's repository program has been delayed, plants. These companies are insured against such losses up with estimated initial operation of a permanent repository to $1.525 billion, $1.725 billion, and $1.725 billion, scheduled for 2003. In the meantime, AP&L, LP&L, and 50 1 [

System Energy will be responsible for storage of spent fuel. Rental expense for capital and These companies estimate that on-site spent fuel storage op.erating leases (excluding nuclear fuel leases and the sale capacity at Arkansas Nuclear One (Units 1 and 2), Water-and leaseback transaction) amounted to approximately ford 3, and Grand Gulf 1 will be sufficient to store fuel $85.3 million, $77.6 million, and $76.6 million in 1988,1987, from normal operations until 1994,1996,2000, and 2003, and 1986, respectively. respectively, it is expected that any additional storage Nuclear Fuel Leases capacity required due to, among other things, delay of the Three subsidiaries have nuclear DOE repository program will be provided by the affected fuelleasing arrangements. As of December 31,1988, companies. nuclear fuelleases aggregated $495.5 million. On December AP&L, LP&L, and System 22,1988, AP&L entered into a new nuclear fuellease which Energy are recovering decommissioning costs for the will permit the lease of up to $195 million of nuclear fuel. Arkansas Nuclear One (ANO) Station, Waterford 3, and On February 3,1989, and February 24,1989, LP&L and Grand Gulf 1, respectively. With respect to total estimated System Energy also entered into new nuclear fuel leasing decommissioning costs, the APSC has approved a total arrangements permitting the lease of up to $125 million and recovery of approximately $686 million for the ANO $185 m.illion of nuclear fuel, respectively. Each lessor Station. Decommissioning costs for Waterford 3 are finances its acquisition and ownership of nuclear fuel under currently estimated to be approximately $203 million. In a credit agreement and through the issuance of intermediate addition, System Energy has entered into an agreement with term notes. The credit agreements all have terms of five an outside engineering firm to conduct a new decommis-years and the intermediate term notes have varying matuti-smning cost study, which is anticipated to be completed in ties of 1-1/2 to 10 years. It is contemplated that these credit the second quarter of 1989, arrangements will be extended or alternative financing will be secured by each lessor upon the maturity of the current NOTE 9. LEASES arrangements, based on the particular lessee's nuclear fuel General requirements. if a lessor cannot arrange for ahernative Prior to 1987, the Company's financing upon the regularly scheduled maturity ofits operating subsidiaries accounted for leases entered into borrowings, the particular lessee must purchase nuclear fuel before 1983 as operating leases, consistent with the basis in an amount equal to the amount required by the lessor to used in the ratemaking process. The Company's operating retire such borrowings. All prior nuclear fuel leasing subsidiaries account for capital leases entered into subse-arrangements were effectively canceled with the start of the quent to 1982 in accordance with SFAS No.13 and SFAS new nuclear fuel lease arrangements. No. 71. Beginning in 1987, compliance with SFAS No. 71 Lease payments are based on for pre-1983 capitalleases required the recording of assets nuclear fuel use. Nuclear fuel lease expenses of $219.7 and liabilities on the balance sheet with respect to such million, $190.8 million, and $161.4 million were charged to leases. The recording of these capitalleases did not affect operations in 1988,1987, and 1986, respectively. The the amounts reported as either expenses or net income. unrecovered cost base of the leases was $396.1 million, At December.;1,1988, the $397.9 millio n, and $410.8 nillion at December 31,1988, i System companies had capital leases and noncancellable 1987, and 1936, respectively, opeming leases (excludir,g nuclear fuel leases and the sale Sale and Leaseback Transaction and le. Mack transaction d:scussed berein) s ith minimum Ot December 25 1988, System rental commitmems as follows: Energ entered iran arrangements for the sale and leasebacu of an approximate 11.5% ownership interest in Grand Capital Orcrating Gulf I for an aggregate cash consideration of $500 million. ,Re sale was made to an owner trus tee under two senarate Leaset leases trust agreements with two owner participants. System (In 7hsands) Energy is leasing back the sold interest from the owner 1989 $ 32,895 $ 53,965 participants on a net lease basis over a 26-1/2-year basic lease term. 1990 32.451 51,294 1991 31,679 40,969 The owner trustee acquired the 1992 27,997 35,574 interest with funds provided by the owner participants and 1993 21,009 34,505 with funds borrowed on an interim basis by the owner Years thereafter 153,643 179,516 trustee through the issuance of notes to interim lenders. It is anticipated that the interim debt will be refunded in the Minimum rental commitments 299,674 $395,823 second quarter of 1989 with the proceeds from the issuance Less: Amount representinginterest 134,746 and sale of long-term bonds. The lease payments to be i Present value of net made bv System Energy will be sufficient to service the debt l minimum lease payments $164,928 51 1 1 __________.________________.________________j

NOTES 10 FINANCIAL STATEMENTS MnJJte Somb % laws. Im e,d Sabudwws incurred by the owner trustee and to provide a return of Pension plans are administered and on investment to the owner participants. by a trustee who is responsible for pension payments to With regard to the funds retirees. Various investment managers have responsibility provided by the owner participants, letters of credit in the for management of the plans' assets. In addition, an I aggregate amount of $D0 million have been provided by independent actuary performs the necessary actuarial banks for the benefit of the owner participants to secure the valuation for the individual company plans. payment of certain amounts payable by System Energy Effective October 1,1988, under the lease. Upon the occurrence of certain adverse NOPSI terminated its defined benefit pension plan and as events, the owner participants wculd be entitled to draw on of that same date adopted, as a participating employer, a the letters of credit in amounts sufficient to enable the defined benefit pension plan sponsored by LP&L. This owner participants to withdraw from the lease, but not in successor plan provides employees with substantially the amounts sufficient to cover the debt of the owner trustee. same benefit program with no loss of accrued benefits as Under these circumstances, System 1:nergy would be obli-provided under the terminated plan. In January 1989, the gated, pursuant to a reimbursement agreement between accumulated benefit obligation of the terminated plan was System Energy and the letter of credit banks, to repay settled by purchasing annuity contracts. As a result, amounts drawn under the letters of credit within a short NOPSI recorded a settlement gain, net of applicable taxes, period of time, and System Energy may be required to of approximately $9.1 million in January 1989 in accordance assume the debt of the owner trustee. with the provisions of SFAS No. 88, Employers' Account-In May 1988, FASB issued ing for Settlements and Curtailments of Defined Benefit SFAS No. 98, Accounting for Leases. Under SFAS No. 98, Pension Plans and for Termination Benefits. On January the letter of credit backing, described herein, meets the 31,1989, NOP51 was refunded approximately $16.7 million criteria of a " continuing involvement" by System Energy. (net of a 10% excise tax) from the terminated plan in excess As a result, the sale and leaseback transaction is accounted of amounts required to purchase the annuity contracts, pay for as a financing transaction in System Energy's financial certain plan participants a pro rata portion (approximately statements,in accordance with the provisions of SEAS No. $1.3 million) of excess plan assets as required by law, and

98. However, the transaction is accounted for as a sale and satisfy other related costs and expenses connected with the leaseback for regulatory and income tax purposes.

settlement. At December 31,1988, System Total 1988 and 1987 pension Energy had future minimum lease payments (reflecting an cost of the Company and its subsidiaries, including amounts overall implicit rate of 9.8%)in connection with the sale capitalized, included the following components: and leaseback transaction as follows (approximate amounts in thousands): 19ss 1987 i (in kusands) I Service cost - benef.its carned ~ 1989 $ 27,254 M 6,391 318,501 l 1990 48,762 during the period Interest cost on projected benefit a 1991 48,761 1992 48,761 obligation 40,504 38,260 J 1993 48,761 Actua! return on plan assets (67,794) (19,554) l Net amortization end deferral 5,167 (38,713) l krs thereafter 1,257,566 1988 LP&L and NOPSI carly $1,479,865 retirement 3 rograms __12,150 -- -= N,t pension cost (income) $ 6,418 $JI,4_86) NOTE 10. POSTRETIREMENT BENEFITS The System companies have various postretirement benefit plans covering substantially The assets of the plans consist all of their employees. The pension plans are noncontribu-primarily of common and preferred stocks, fixed income tory and provide pension benefits that are based on the securities, interest in a money market fund, and insurance employees' credited service and average compensation, contracts. generally during the last five years before retirement. The policy of the Company and its subsidiaries is to fund pension costs in accordance with contribution guidelines established by the Employee Retirement income Security Act of 1974, as amended. 52

The funded status of the Com-NOTE 11. SETTLEMENT AGREEMENTS WITH GAS SUPPLIERS pany's various pension plans at December 31,1988 and A dispute between a gas 1987,is as follows: supplier and LP&L arising from the gas supplicr's claimed 198# 19#7 inability to deliver full quantities of fuel gas duc LP&L g%g under several natural gas contracts was settled by the Actuarial present value of accumulated execution of a sett'ement agreement on June 4,1982. pension plan benefits: The settlement agreement provides for the payment of Vested $390,477 $349,437 $1.087 billion in cash plus a guaranty of savings of at least Nonvested 29,135 26,680 $585 million in certain ga; acquisition costs between 1982 Accumulated benefit obligation $4_19,612 _$376,,117 and 1996. In March 1983, the LPSC ordered LP&L to m Projected benefit obligation $518,360 $469,141 1983-93. Through December 31,1988, LP&L had refunded Plan assets at fair value 623,179 589,959 a total of approximately $882 million to its customers. . In January 8 and Febmary Plzn assets in excess of projected 88, a gas supph.er submitted invoices to MP&L for benefit obligation 104,819 120,818 Unrecognized prior service cost 4,634 2,206 appmxunatdy m mWm, n ad $@ mWmn, respecody, Unrecognized transition asset (122,960) (126,440) for amounts allegedly owed the supplier for MP&L's failure Unrecognized net gain (25,038) (30,546) take certain vohnnes of gas durmg 1986 and 1987 under a t Accrued pension liability $j38,5T5) i(33,9Q) take-or-pay provismn in a gas sales contract, which expired December 31,1987. MP&L is of the opmmn that it does not owe these amounts because the supplier was overcharg-Total pension cost of the ing MP&L for gas deliveries during 1986 and 1987. Ac-Company and its subsidiaries for 1988,1987, and 1986 was cordingly,in 1987, MP&L brought suit against the supplier $7.3 million, $1 million (1988 and 1987 amounts include seeking an adjudication and declaration of rights that it is miscellaneous immaterial adjustments not reflected in the not required to pay the supplier for any gas not actually above table), and $13.4 million, respectively. The Company received during 1986 and 1987 by MP&L, and that MP&L and its subsidiaries adopted SFAS No. 87, Employers' is excused from any obligation to take gas from the supplier Accounting for Pensions, effective January 1,1987. Adop-so long as the supplier continues to overcharge MP&L for tion of SFAS No. 87 reduced 1987 pension cost by approxi. gas. This suit was amended by an order of the court on mately $9.3 million. March 25,1988, to include issues raised by the supplier's l The weighted average discount second invoice. On April 18,1988, the supplier filed its rate and rate of increase in future compensation used in amended answer and counterclaim for the amount of the determining the 1988 and 1987 actuarial present value of the 1987 and 1988 bills plus interest, costs and attorney's fees, projected benefit obligation were 9.0% and 5.6%, respec-The time for discovery ;n this case ended on June 30,1988. tively. The exp eted long-term rate of return on plan assets The MPSC has intervened in opposition t, the supplier in for 1988 and 1987 was 8.5% Transition assets are being this matter. amortized over the greaar of the rcmaining service period In the event that the court of active participants or 15 years. holds that the supplier did not overebarge MP&L during The System companies also 1986 and 1987 and that a deficiency occurred in the amount provide certain health care and life insurance benefits for of gas raken by MP&L during those years after all credits s etired employees Substantially all employees may become have been applied,it would be MP&L's intention to pay the eligible for these boefits if thej reach retiremeot age while supplier for the deficiency and ash the court to allow it to still workirg for the System companies. The :ost of take the gas paid fm during the year following any such providing postretirement health care and life insurance final judicial ruling. In addition to the questions of whether benefits is recorded on a cash basis. The cost of providing MP&L was excused from its obligation to the supplier these benefits for retirees is not separable from the cost of under the gas sales agreement in 1986 and 1987, and providing benefits for active employees. The total cost of whether or not the supplier overcharged MP&L under the providing these benefits and the number.of active employ-agreement, the court will address issues such as (1) the ces and retirees for the last three years were as follows: amount of any credits available to MP&L under the agree-ment,(2) the method of calculation, the timing, and the 19ss 1937 /9#6 manner of any payment due to the supplier, and (3) the l Total cost of health care and method of accounting for takes of gas after payment under l life insurance (in thousands) $35,730 $32,133 $25,718 the agreement. The matter is pending. Number of active employecs 13,049 13,560 13,307 Number of retirees 3,322 3,098 2,983 53

NOTES TO FINANCIAL STATEMENTS Muldle south Utdaus, Inc and Sabudwus NOTE 12. QUARTERLY RESULTS (UNAUDITED) Consolidated operating results for the four quarters of 1988 and 1987 were as follows: Quarter Operating Operating Net Earnings Ended Revenues Income Income Per Share (in Thousands, except per share amounts) 1988: March $ 786,907* $258,394* $ 92,167 $0.45 June $ 819,681 $249,790 $ 88,845 $0.43 September $1,095,335 $345,260 $171,755 $0.84 December $ 863,482 $216,125 $ 58,261 $0.29 1987+*: March i 769,650 $268,414 $100,707 $0.49 June $ 831,753 $258,753 $ 94,454 $0.46 September $1,075,049 $350,086 $186,391 $0.91 q December $ 778,504 $ 132,803 * * * $ (24,948)* ** $(0.12)* *

i

(

Restated to exclude gas operations of ANG, whach was duposed ofin June 1988.
- Quarterly data for 1987 has not been restatedfor the dispoution of ANG, as noted above. (See Note 1 ' Summary of Sigmficant Accounting Policies.")
  - Includes the net effect of(1) the write-off of NOPSI's prudence duallowance of approximately $72.9 million, and (2) the discontinuance of LP& L's Waterford 3 rate deferrals of approximately $24.4 million.

l The business of the System is subject to seasonal fluctuations with the peak period occurring during the summer months. Accordingly, earnings information for any three-month period should not be considered as a basis for estimating results of operations for a full year. SELECTED FINANCIAL DATA-FIVE YEAR COMPARISDN 1988 1987 108f> 1985 1984 j (In Thousands, except per share amounts) ) Net operating sevenues S 3,565,405 $ 3,454,820 $ 3,485,912 $ 3,238d9 $ 3,146,035 Net income $ 411,028 5 356,604 $ 454,465 $ 215,518 $ 508,d37 j Ear nings er share 2.01 1.74 5 2.22 1.08 2.86 Dividend declated per share 0.20 0.89 1.75 Book value per share, year-end 23.96 22 13 20.39 10.19 78.36 Total assets $15,941,816 $15,156,832 $14,090,431 $13,390,015 $12,565,546 Long-term debt (excluding current maturities) $ 6,187,442 $ 5,945,054 $ 5,983,029 $ 5,680,590 $ 5,865,304 l Preferred stock with } smking fund $ 462,965 $ 496,405 $ 508,165 $ 467,293 $ 476,928 j l l l l 54

_ _ ~ _ _ DIRECTORS AND OFFICERS ' Moddle Smah Unlaws Im. John A. Cooper Jr. James R. Nichols H. Duke Shackelford j President of Cooper Panner of Nichols & Pratt President of Shackelford ] Communities, Inc., Ben-(Family Trustees) and Co_, Inc., Shackelford Gin, tonville, Arkansas. Finance Attorney, Boston, Massa - Incand Louisiana Cotton i and Nuclear Committees. chesetts. Audit, Executive, Warchouse Co. Inc.; j . MSU DIRECTDRS and Finance (Chairman) Chairman of Union Oil 1 Brooke H. Duncan Committees. Mill, Inc. (all agricuhural William C. Battle President of Foster Com-and agribusinesses), Bonita, Retired President and Chief pany, Inc., New Orleans, LeRoy P. Percy" Louisiana. Personnel and Executive Officer of Louisiana. Executive, Cotton farmer; President of Public Affairs Committees. Fielderest mis, Inc., Ivy, Personnel, and Public Greenville Compress Co., Virginia; Chairman of the Affairs (Chairman) Greenville, Missinippi; Wm. Clifford Smith Board of W. AltonJones Committees. Retired Chairman of the President of T. Baker Smith Cell Science Center. Boards of Mississippi & Son, Inc., Houma, Finance and Nuclear Kansaster Hodges Jr. Chemical Company Louisiana. Executive, Committees. Attorney, Newport, and First Mississippi Finance, and. Nuclear Arkansas. Audit (Chair-Corporation. (Chairman) Committees. W. Frank Blount man), Nuclear, and Public President, Network Affairs Committees. Robert D. Pugh Dr. Walter WasNngton Operations Group, AT&T Chairman of the Board of President of Alcorn State Company, Basking Ridge, Edwin Lupberger Portland Gin Company University, Lorman, NewJersey. Audit and Chairman and President of (agricultural and agribusi-Mississippi. Audit and Personnel Committees. Middle South Utilities, Inc., ness)and Portland Agri-Public Affairs Committees. i New Orleans, Louisiana. Credit Corporation, James B. Campbell

Executive (Chairman),

Portland, Arkansas. Chairman of the Board and Nuclear, and Personnel Executive, Finance, and President of MISSCO Committees. Personnel (Chairman) Corporation, Jackson, Cammittces.

Elected to the Board of Directors Mississippi. Audit and at the May2a 1988. Annual Meeting of Stockholders.

Public Affa. irs Committees. ' Rctired from the Mard of Directon on May 20. I28. at the AnnualMeeting of Stockholders William Cavanaugh til Jack L. King H. Stuart Balt Senior Vice President, Senior Vice President, Treasurer. Age 45. Joined System Executive - System Executive - the System in 1985. Nuclear. Age 50. Joined Operations. Age 49. the System in 1969 Joined the System in 1966. Dan E. Stapp M30 0FFICERS Secretary. Age 54. Joined John L. Cowan Jerry L. Madden the System in 1958. Edwin Lupberger Senior Vice President, Senior Vice President, Chairman and Preacient. System Executive - Syst/m Executive-Dorothy M. Antoine i Age 52. Joined the Middle linance. Age 61. Joined Arkansas, Mississippi, and Assistant Secretary. Age South Electric System in the System in 1987. Missouri Division. Age 52.

56. Joined the System in 1979. Sixteen years prior joined the System in 1965.

1952. utility industry service. Jerry D. Jackson Senior Vice President, Donald E. Meiners James M. Cain System Executive-Legal Senior Vice President, Senior Vice President, and External Affairs. Age System Executive - System Executive -

44. First joined the System Services Division. Age 53.

Louisiana Division. Age in 1979. Joined the System in 1960.

55. Joined the System in 1960.

SS - - - ______-________-__-___ ___ _ 2

i INVESTOR INFORMATION %ddle Somb Utdmes. Im Stockholders of Record Form 10-K Investor Relations At the close The Middle The Middle i of 1988, there were 88,346 South Electric System 1988 South Electric System stockholders of record of Annual Report to the conducts an active investor Middle South Utilities, Inc. Securities and Exchange relations program to A total of 204,581,092 Commission on Form communicate the System's ) Annual Meeting shares were outstanding. 10-K (including financial performance to institu-I The 1989 statement schedules) is tional investors, security Annual Meeting of Stock-Stockholder Records available to stockholders analysts, registered repre-holders will be held at 10 All corre-upon request. To receive a sentatives, and individual a.m. (CDT) on May 19, spondence concerning copy without cbvge, call investors. System Investor 1989, at the Natchez Eola stockholder records should or write to: Relations may be contacted Hotel, Natchez, Missis-be directed to: by writing or calling: sippi. A notice of the Dan E. Stapp, Secretary meetmg and proxy material Middle South Utilities, Inc. Middle South Utilities, Inc. Middle South Utilities,Inc. will be mailed on or about Stockholder Services P.O. Box 61005 System Investor Relations April 10,1989, to stock-P.O. Box 61236 New Orleans, LA 70161 P.O. Box 61005 holders of record as of the New Orleans,.LA 70161 (504) 529-5262 New Orleans, LA 70161 close of business on April (504) 569-4365 3,1989. A badge for Transfer Agent and Petrar Financial and Statistical Review admission may be obtained Morg,ai. Historical Exch&n00 Listings at the registration desk at Shareholder Services Trust statistics and financial The common l the meeting. Stockholders Company is the transfer information supplemental stock of Middle South whose shares are held in agent and registrar for to the 1988 Annual Report Utilities, Inc. is listed and " street name," i.e., in the MSU. All correspondence and Form 10-K are traded on the New York, name of their broker, must concerning the issuance or available in the Company's Midwest, and Pacific stock l present a letter from their transfer of common stock 1988 Financial and exchanges. The ticker 1 broker indicating owner-certificates should be Statistical Review, which symbol for the Company is ship of the Company's directed to: will be available for MSU. Newspaper stock common stock as of April distribution in July. table listing is MidSUt. 3,1989. Morgan Shareholder Copies of the Review may Should stockholders Services Trust Company be obtained by contacting approve the name change to Olvidends Stock Transfer System Investor Relations Ertergy Corporation, the 30 West Broadway at the address given in the ticker symbol and newspa-At its September 30,1988, New York, NY 10007-2192 next section, per stock table listing meeting, the Board of would be ETR. Directors of Middle South Utilities,Inc. declared the first quarterly dividend in Compostte Common Stock Pricer by Quarters over three years. 'Ihe dividend declared was 20 1988 Price Range Fi st Second Third Fourth cents per share, payaole on December 1,1988, to High-Low S10W8% $14%-8% $15%-12% $16%-14% stockholders of record as 1987 l' rice Range of November 9,1988. On High-Low $16%-13 $14%-10 $11%-9% $11W7% january 27,1989, the Board of Directors declared a second quarterly dividend of 20 cents per share payable on March 1,1989, to stockholders of record as of February 10,1989. 1 56

COMPAH7 DESCRIPTION & MedJk Sourb ilarm $yarm Mississippi, and Missouri are operating companies: AP&L and LP&L oversight, provided electric services Arkansas Power & Light of the System's other three through the System's vast (AP&L), Louisiana Power & nuclear units. network of interconnected Light (LP&L), Mississippi Three transmission and distribu-Power & Light (MP&L), additional subsidiary tion lines, and a balanced and New Orleans Public companies complete the For the past grid of fossilfueland nuclear Service Inc.(NOPSI); and a System: MSU System 40 years, the Middle South generating plants that are nuclear generating company, Services,Inc. (SSI),which Electric System has been the controlled and operated as a System Energy Resources, provides various technical, leading electric energy unit. Inc. (System Energy), which administrative, and corpo-supplier to the Middle In addition, is responsible for the man-rate services to all of the South, a 91,000-square-mile electricity is sold wholesale agement and operation of System companies; System regional area along the lower to other utilities, including the Grand Gulf Nuclear Fuels,Inc. (SFI), a fuels reaches of the Mississippi municipalities and coopera-Station. System Energy is subsidiary;and Electec,Inc. River. tives, and gas service is currently seeking regulatory (EI), a subsidiary that More than provided in New Orleans, approval to assume operat-markets the commercial 1.6 million retail customers Louisiana. ing responsibility, subject to capabilities, expertise,and in Arkansas, Louisiana, Headquar-resources of the System tered in New Orleans, the companies. Middle South Electric System includes four retail e l WDOLE SOUTH ELECTRIC SYSTEM U RetailService Area l I The MiddleSouth Elearic j System, throughits subsidi-ary companies,provides electricservice witbin the portions ofArkansas, Louisiana, Mississippi, and Missourishown in red }

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ML20245E119

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