PLA-5773, Annual Financial Report

Annual Financial Report

ML041900139
Person / Time
Site:	Susquehanna
Issue date:	06/30/2004
From:	Shriver B Susquehanna
To:	Document Control Desk, Office of Nuclear Reactor Regulation
References
PLA-5773
Download: ML041900139 (175)

Text

-.------ -- I-hi ~II Bryco L Shriver PPL Susquehanna, LLC . l, Senior Vice President and 769 Salem Boulevard ' Ij*

• Chief Nuclear Officer Berwick, PA 18603 pp *_

Tel. 570.542.3120 Fax 570.542.1504 bishriver pplweb.com JUN 3 0 2004 U. S. Nuclear Regulatory Commission Attn: Document Control Desk Mail Station OP1-17 Washington, DC 20555 SUSQUEHANNA STEAM ELECTRIC STATION ANNUAL FINANCIAL REPORT Docket Nos. 50-387 PLA-5773 and 50-388 In accordance with 10 CFR 50.71(b), enclosed is the 2003 Annual Report for PPL Corporation, the parent company of PPL Susquehanna, LLC, and the 2003 Annual Report for Allegheny Electric Cooperative, Inc.

Please contact Rocco R. Sgarro, Manager, Nuclear Regulatory Affairs at (610) 774-7552, if you have any questions concerning the reports.

Sincerely, 1d B. L.Shri Enclosures (2) cc: NRC Region I Mr. A. Blarney, NRC Sr. Resident Inspector Mr. R. V. Guzman, NRC Project Manager Mr. R. Janati, DEP/BRP

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Wherever you are, whatever you're doing, whatever the time of day or night, PPL is working. We strive, 24 hours2.777778e-4 days <br />0.00667 hours <br />3.968254e-5 weeks <br />9.132e-6 months <br /> a day, seven days avweek, to generate and deliver reliable, affordable power to our customers.

We continuously strengthen the company, building shareowner value, both for the short term and long term. We are always on, 24/7, because we have to be. That's what it takes to succeed in this always changing, always challenging business.

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mr; ompanies in the United lor'and Latin America

--treat every. n  :. I., .:; I :, -

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'the U.K. over Zheprestigious MrkA 3

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0 t , of Thomas'Edison. Today, PPOLpeople are carrying 0 0

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--  : iHghest ' customer satisfacti

'with residentialand t nmidsize business electrc sen 4 - the Eastern United State j-*-In 4S

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I PPL's network of power'plants is known for

~~-Jts reliability. At 37 sites in Pennsylvania, Montana,

~ Maine Connecticut, Arizona, Illinois and New York, high-ly, trained mechanics and operators make sure PPLs'sl 1,500 megawatts of electricity-

• capacity are available ivhen needed.

,Keeping a modern poweir-~lant ready for service isa comn~lex undertaking, inivolving exten.

sive preventive maintenance and a staff that is v trained to spdt the warning* signs of trouble.

generalin

• electriit f One of the keys to the compn ys operating success has been the- sharing of best practices-among our power plants. Many of the lessons we Ihave learned 'at 'our'nuclear plant,for inistance in operations imp~rovements at our 0 ote aiii'have'resulted otenancilitige particulairly in the area o mainte - ~

nane utgeplanning.

'World-class power plant performance takes 4  :-superb planning and attention to detail in all ~

aspects of operation and maintenance. PPL people j~!~

~ iave prven they have what it takes.

Jj1 Total US~ Gen'e'ration at PPL Plants (Billions of kWh)~~

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When aPPLnmarketing representative makes 1% a deal "tosiell'electricity, he or she is bac'ked by

' ia proven-process for assessing the deal's potential benefits and risks.

In PPL's approach to energy marketing, there is no such thing as a seat-of-the-pants'decision. Each decisionh is backed by experience, study and a'-

',-special analysis of the opportunity presenting itself.

-sophisticate d ain aly -

.odays eerchanging energy market demands discipline and an understanding of the complex-ities associated with each decision. PPL's risk l managemnent office. which reports directly to the,,

CEO, is responsible for providinrg an independent-

`f~-ianalysis of all major transactions involving the com-:.

- -pany.-This helps us to ensure that we are doing everything possible to improve potential benefits.;....

-while guarding against the downside risk.

Such analysis is an essential element in the (C I!.company'sbhedging approach to the competitive: 7 electricity market. This approach involves signing contractslof varying lengths with creditworthy'.-.-

parties, to buy and sell electricity and to buy and i.

sell the fuel to6run our power plants Our hedging 1 '--'strategy has allowed us to take advantage of-IA D_ I_. marke,* t . .., Hg. e ....

market oppotunities without e xposingthe om, 7pany,andq its shareowners,-todtheblargeriskso-ften; As rsul, e avee&xperiencedisteady, ii - .0 i -

'sustained growth in the company's energy supply -rn

.2_business. -j. .-..

_-:.-oReparted Net Income From Supply Business

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600.

/ 500 .. . 502-T'7?t.e i;

400 368 356

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Using a disciplined and very selective.

approach,-PPL has expanded its operations-into

'tw'o international markets: the United Kingdom ' .

and-Latin America.  : .

.Our businesses in England, Wales, Chile,EBolivia I and jEl Salvadorare focusing on a strength that PPL has developed over more than eight decades:

the'delivery ofielectricity. -

This international expansion has allowed us` (

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to produce greater, earnings growth from our v electricity delivery business than wou have been the case had we restricted operationsto our

.traditional Pennsylvania region.

growihg>

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.-We are continuing to streamline operations in our international delivery companies, and these

'4 improved efficiencies, along with significant sales growth in Latin Arnerica, hold the promise of

.4'continued earnings contributions from overseas.

8 The recent passage of the U.S.-Chile free trade agreement is expected to result in even more

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growth, fueled by increased Chileari exports.

0 While the company has no plans to 0 1. r...... N ,

significantly expand its international investments. II 11,;  % :

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The: company's selective eNson of its operations into new markets is pying off for shareowners.

Over the past five years, PPLs stock price has risen 57 percent, faring bettrtthanal Nbut of the 32 electric companies that are part of the lshareowners ant; compared

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• PPL Corporation

• S&P 500' Index

• Edison Electric Institute Index of Investor-owned Electric Utilities

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PPL'has taken a'very strategic approach to: -

energy marketing act-ivities, pursuing a variety of opportunities in both.the wholesale and retail markets.

As a result,-the company has in place a wide variety of contracts to supply electricity to numer-ous'rdi\ ' ' ; '

"I -cut;Imers

- ous crerditworthy parties,.from retail'customers like Advanced'Silicon Materials'in Morntana to'

.wholesale customers like.large electricityV\

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We have contracts with ai large' rimber of busi-~~- ~--

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tot9supply electricity..to PPL~IiEIlectrb Utiliti

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§2'gv opportunities to'maximize our energy margns.;

z j $,'.;t*This diversity of long- and intermediate-term:

contracts is allowing the company to make~the most of its outstanding fleet of power plants as -UM 0

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..:Ttai U.S. Electric Energy Sales Retail and Wholesale -

(Billions of kwh) 80so ' 78.7.,175~

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The delivery of electricity is all~bout customer

.IN service - and efficiency. When nery\ I million customers depend on your prodctvfaround the:

clock, there is little margin for err time to waste. , ';

To ensure that delivery company employees are spending time on things that are truly important to customers, the PPL companies in the United States, the United Kingdom and Latin America are ad continually improving service and response times..

In the United States, for instance, PPL Electric Utilities now has installed more than 1 million high-tech meters that ensure more accurate billing, reduce costs and can even help in restoring service after storms.

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I I le ivering electricity InWales line crews use global positioning

'satellite technology to, pinpoint the 'source of an>

.Outage to within a few feet This system and 14 9.other improvements have helped Western Power--

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Dear Shareowners William F. Hecht Chairman, President and Chief Executive Officer Successful companies take advantage of This strategy takes advantage of our experience tomorrow's opportunities without losing sight of today's and the strength of PPL people. For instance, we imperatives. have expanded our electricity generation capability In this year's annual report, we tell the story of in the United States based on the knowledge that 17 PPL people, on three continents, providing superb we could leverage PPL's long-standing record of 11

-U service to our customers - today's imperative. excellent power plant performance. 0 To 0

Electricity demand never sleeps. So, the people Another company strength is PPL's dedication -u 0

of PPL- from the coast of Wales to the foothills of to reliability and customer service in electricity the Rockies - are on the job, 24 hours2.777778e-4 days <br />0.00667 hours <br />3.968254e-5 weeks <br />9.132e-6 months <br /> a day, 7 days delivery. This strength led us to expand our delivery z I:1 a week, expertly anticipating and meeting our business overseas. We now have 3.6 million delivery customers' needs. customers in the United Kingdom and Latin America, ni D

z zD Our confidence in the extraordinary ability of in addition to our 1.3 million Pennsylvania delivery c m

0 PPL employees to remain focused on doing the job customers.

Mu right has enabled your company to take advantage As we were expanding, however, we also To 0

of new opportunities in the energy business - realized that there were some skills that we needed opportunities that have fueled solid earnings for to grow, notably wholesale energy marketing and today and tomorrow. quantitative, statistical risk management. Growing PPL continues to concentrate on steady, sustain- these new activities meant training people inside the able growth in three business areas: U.S. generation company and seeking new expertise from outside and marketing; electricity delivery in Pennsylvania; PPL - and outside the electricity business.

and electricity delivery in the United Kingdom Because our electricity generation and market-and Latin America. ing operation is responsible for about 75 percent

Our confidence in the extraordinary ability of PFPL employees to remain focused on doing the job right has enabled your company to take advantage of new opportunities in the energy business - opportunities that have fueled solid earnings for today and tomorrow.

of PPL's earnings, it is in this business that the which substantially limit risk to the company if the company's prudence and thoughtful risk manage- power plant is unavailable.

ment activity is ever present. This risk-managed approach has allowed The company's cautious and conservative risk your company to maximize margins in the energy management activity balances exposures in four areas business, to create growth and to produce stable,

-0 of our generation and marketing business: fluctua- predictable earnings.

0 M0 tions in energy prices; power plant performance; Our record speaks for itself. In spite of very fuel prices and supply; and counterparty credit risk. challenging energy market conditions in 2003 and Z0 Any one of these exposures, if unmanaged, could reduced earnings in our Pennsylvania electricity seriously hamper earnings from our generation and delivery business, we reported record earnings marketing business. Our management processes - of $4.24 per share. Our earnings from ongoing C both qualitative and quantitative - ensure that all of the operations, which excluded the effect of unusual i i

risks are properly balanced not only across a items, also were a record, at $3.71 per share, an m

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particular contract but also throughout the company's increase of nearly 5 percent over 2002.

iI business portfolio.

It is our thoughtful management approach to PPL also did very well in comparison to others in 2003. Our common stock price outperformed III the commodity market that has resulted in a wide variety of energy sales instruments. We have the Standard & Poor's" Electric Utilities Index by 35 percent. III intermediate- and long-term contracts. We have Our total return to shareowners was 31 percent 4I contracts in the eastern and western United States. in 2003 and has been 88 percent over the past five VII II We have contracts in the wholesale and retail years, putting PPL among the leaders in the U.S.

markets. We have contracts that are unit-contingent, electricity business. And, the company's common

Our total return to shareowners was 31 percent in 2003 and has been 88 percent over the past five years, putting PPL among the leaders in the U.S. electricity business.

And, the company's common stock price has risen by 57 percent over the past five years.

stock price has risen by 57 percent over the past We are forecasting earnings per share of $3.45 five years, an increase better than all but two of the to $3.75 in 2004.

FORTUNE 500" electric companies. As we look beyond 2004, we are forecasting We also continue to grow our dividend. With continued growth of 3 to 5 percent in earnings per 19 the announcement of an increase in late February, share over the long term. ID M

the company's annualized dividend is now $1.64 per The people of PPL are optimistic about the 0 C) 0 share, a level that is more than 50 percent higher future because they know what it takes to thrive -

0 than just three years ago. both strategically and operationally.

Even as we are growing the dividend, we're In continuing to grow PPL, we will be disciplined 0 z

also improving your company's financial position. and opportunistic, retaining our focus on the Z

Since September of 2002, we have issued about things we do well and ensuring that we have the z z

$1 billion of common stock, which has strengthened operational capability to carry through on our C the company's balance sheet. This new common commitments to you.

-U stock, combined with other financial transactions The people of PPL are dedicated to growing 0 IM and cash from operations, allowed us to virtually value for you - 24/7.

eliminate our short-term debt and finish 2003 with

$476 million of cash on hand. And, we made these improvements while increasing earnings for shareowners.

We also have reduced our capital expenditures William F. Hecht and improved our cash flow so that we now project Chairman, President and Chief Executive Officer

$50 million in free cash flow in 2004. March 15, 2004

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Environmental values,: Walking the talk Restoring Atlantic salmon migration in Maine 21 0

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M When it comes to the environment, PPL has a track PPL, meanwhile, also gets additional rights to 0 record of innovation and partnership. This was never increase energy output at its remaining dams if future more in evidence than when the company negotiated market conditions are favorable.

a preliminary agreement that could reopen the It's a groundbreaking agreement that meets PPL's D zm c

Penobscot River to salmon migration. obligation to its shareowners and energy customers 0 PPL is giving the Penobscot Indian Nation and a while dramatically improving the environment for an

-u coalition of government agencies and private groups a endangered species and the Penobscot Indian Nation. 0 five-year option to purchase its Veazie, Great Works and The Maine agreement is just one of the many ways Howland dams. PPL will be compensated for the value PPL practices good corporate citizenship in its commu-of the dams and the value of the energy they would nities around the world. For example, we're a member of have generated in the future. CERES, a coalition of environmental, investor and advo-If they exercise the options, the groups may cacy groups working together for a sustainable future.

demolish two of the dams and bypass or remove the And, recently we agreed to transfer to Pennsylvania third, reopening 500 miles of Maine rivers to the annual mineral rights on 13,600 acres of state forest land, helping migration of Atlantic salmon and several other species. protect one of the state's largest wilderness areas.

The plan also would allow the Penobscot Indians, who From Maine to Montana to the United Kingdom to live on an island near one of PPL's dams, to reclaim Latin America, PPL people are finding innovative ways to their native fishing traditions. contribute to the communities where we do business.

Selected financial and operating data PPL Corporation (a) 2003 2002 2001 2000 1999 Income Items - millions Operating revenues (b) $ 5,587 $ 5,481 $ 5,115 $ 4,545 $ 3,697 Operating income "') 1,340 1,246 850 1,194 821 Income from continuing operations 719 360 169 487 478 Net income 734 208 179 498 432 Balance Sheet Items - millions (c)

Property, plant and equipment-net 10,446 9,566 5,947 5,948 5,624 Recoverable transition costs 1,687 1,946 2,172 2,425 2,647 Total assets 17,123 15,552 12,562 12,360 11,174 Long-term debt 7,859 6,267 5,579 4,784 4,157 Long-term debt with affiliate trusts (d) 681 Company-obligated mandatorily redeemable preferred securities of subsidiary trusts holding solely company debentures (d) 661 825 250 250 Preferred stock With sinking fund requirements 31 31 46 46 Without sinking fund requirements 51 51 51 51 51 Common equity 3,259 2,224 1,857 2,012 1,613 Short-term debt 56 943 118 1,037 857 Total capital provided by investors 11,906 10,177 8,461 8,180 6,974 Capital lease obligations 12 125 Financial Ratios Return on average common equity- % 26.56 10.27 8.41 27.49 24.70 Embedded cost rates "c)

Long-term debt - % 6.56 7.04 6.84 6.98 6.95 Preferred stock - % 5.14 5.81 5.81 5.87 5.87 Preferred securities - % (d) 8.02 813 8.44 8.44 Times interest earned before income taxes 2.92 1.97 2.19 3.05 3.37 Ratio of earnings to fixed charges - total enterprise basis (e) 2.5 1.9 1.7 2.5 2.7 22 Common Stock Data Number of shares outstanding - thousands Year-end 177,362 165,736 146,580 145,041 143,697 Average 172,795 152,492 145,974 144,350 152,287 o Number of record shareowners "c) 83,783 85,002 87,796 91,777 91,553 Icm from continuing operations- Basic EPS - 4.15 $ 2.36 $ 1.16 $ 3.38 $ 3.14 o Income from continuing operations - Diluted EPS $ 4.15 $ 2.36 $ 1.15 $ 3.37 $ 3.14

> Net income - Basic EPS $ 4.25 $ 1.37 $ 1.23 $ 3.45 $ 2.84 o Net income - Diluted EPS $ 4.24 $ 1.36 $ 1.22 $ 3.44 $ 2.84 Z Dividends declared per share $ 1.54 $ 1.44 $ 1.06 $ 1.06 $ 1.00 o Book value per share (c) $ 18.37 $ 13.42 $ 12.67 $13.87 $ 11.23 Market price per share (c) $ 43.75 $ 34.68 $ 34.85 $45.188 $22.875

> Dividend payout rate- %( 36 106 87 31 35 z Dividend yield - %(go 3.52 4.15 3.04 2.35 4.37

> Price earnings ratio ON(Da 10.32 25.50 28.57 13.14 8.05

0 Sales Data - millions of kWh o Domestic - Electric energy supplied - retail 36,774 36,746 37,395 37,758 33,695 Domestic-Electric energy supplied-wholesale 41,709 36,849 27,683 40,925 32,045 Domestic - Electric energy delivered 36,083 35,712 35,534 34,731 33,874 International - Electric energy delivered Qh 31,952 33,313 5,919 3,735 2,942 (a) The earnings each year were affected by unusual items, which affected net income. SeeEarnings' in Managements Discussion and Analysis for adescription of unusual items in 2003, 2002 and 2001.

(b) Operating revenues and operating income of certain years are restated to conform to the current presentation.

'c) At year-end.

(d) On July 1, 2003, PPL adopted the provisions of SFAS 150, "Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity.' The company-obligated mandatorily redeemable preferred securities are mandatorily redeemable financial instruments, as they require the issuer to redeem the securities for cash on a specified date. Thus, -

they should beclassified as liabilities, as a component of long-term debt, instead of 'mezzanine" equity on the Balance Sheet. However. as of December 31,2003, no amounts were included in Long-term Debt' for these securities because PPL Capital Funding Trust I and SIUK Capital Trust I were deconsolidated effective December 31,2003 in connection with the adoption of FIN 46, "Consolidation of Variable Interest Entities, an Interpretation of ARBNo. 51,- for certain entities. Instead, the subordinated debt securities that support the company-obligated mandatorily redeemable preferred securities of the trust are reflected in 'Long-term Debt with Affiliate Trusts as of December 31,2003. See Note 22 for additional information on SFAS 150 and FIN46.

(e) Computed using earnings and fixed charges of PPL and its subsidiaries. Fixed charges consist of interest on short- and long-term debt, other interest charges, interest on capital lease obligations, the estimated interest component of other rentals and preferred dividends.

I Based on diluted EPS.

In) Based on year-end market prices.

(') Deliveries for 2002 include the electricity deliveries of WPD for the full year and of CEMAR prior to deconsolidation.

Management's Discussion and Analysis Terms and abbreviations appearing here are explained in the glossary on pages99-101. Dollars in millions, except per share data,unless otherwise noted.

FORWARD-LOOKING INFORMATION New factors that could cause actual results to differ materially from those Certain statements contained in this report concerning expectations, beliefs, described inforward-looking statements emerge from time to time, and it is plans, objectives, goals, strategies, future events or performance and under- not possible for PPL to predict all of such factors, or the extent to which any lying assumptions and other statements which are other than statements of such factor or combination of factors may cause actual results to differ from historical facts are 'torward-looking statements" within the meaning of the those contained inany forward-looking statement. Any forward-looking state-federal securities laws. Although PPL believes that the expectations and ment speaks only as of the date on which such statement is made, and PPL assumptions reflected inthese statements are reasonable, there can be no undertakes no obligations to update the information contained in such assurance that these expectations will prove to be correct. These forward- statement to reflect subsequent developments or information.

looking statements involve anumber of risks and uncertainties, and actual results may differ materially from the results discussed inthe forward-looking OVERVIEW statements. Inaddition to the specific factors discussed inthe Management's PPL isan energy and utility holding company with headquarters inAllentown, Pa.

Discussion and Analysis section herein, the following are among the important Through its subsidiaries, PPL is primarily engaged in the generation and market-factors that could cause actual results to differ materially from the forward- ing of electricity intwo key markets -the northeastern and western U.S. -and looking statements: inthe delivery of electricity in Pennsylvania, the U.K. and Latin America. PPL's

• market demand and prices for energy, capacity and fuel; strategy for its electricity generation and marketing business is to match

• weather variations affecting customer energy usage; energy supply with load, or customer demand, under long-term and intermedi-

• competition inretail and wholesale power markets; ate-term contracts with creditworthy counterparties. PPL's strategy for its

• the effect of any business or industry restructuring; electricity delivery businesses is to own and operate these businesses at the

• the profitability and liquidity of PPL and its subsidiaries; highest level of quality and reliability and at the most efficient cost.

• new accounting requirements or new interpretations or applications PPL faces several risks inits generation business. The principal risks of existing requirements; are electricity wholesale price risk, fuel supply and price risk, power plant

• operation of existing facilities and operating costs; performance and counterparty credit risk. PPL attempts to manage these risks

• environmental conditions and requirements; through various means. For instance, PPL operates aportfolio of generation

• transmission and distribution system conditions and operating costs; assets that is diversified as to geography, fuel source, cost structure and 23

• development of new projects, markets and technologies; operating characteristics. PPL is focused on the operating efficiency and

• performance of new ventures; maintaining availability of these power plants. Inaddition, PPL has inplace -0

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• asset acquisitions and dispositions; and continues to pursue long-term and intermediate-term contracts for energy

• political, regulatory or economic conditions instates, regions or countries sales and fuel supply, and other means, to mitigate the risks associated with 0 where PPL or its subsidiaries conduct business; adverse changes inthe difference, or margin, between the cost to produce 0 z

• receipt of necessary governmental permits, approvals and rate relief; electricity and the price at which PPL sells it. PPLs contractual commitments

• impact of state or federal investigations applicable to PPL and its for energy sales are primarily satisfied through its own generation assets -

subsidiaries and the energy industry; i.e., PPL primarily markets and trades around its physical portfolio of generat- z0

• the outcome of litigation against PPL and its subsidiaries; ing assets through integrated generation, marketing and trading functions.

• capital market conditions and decisions regarding capital structure; Finally, PPL attempts to reduce its exposure to the various risks it faces z C

• stock price performance;

• through its risk management program, which, among other things, includes r-

• the market prices of equity securities and resultant cash funding an evaluation of market risks and the creditworthiness of all counterparties. m U

requirements for defined benefit pension plans; PPUs electricity delivery businesses are rate-regulated. Accordingly, these 0

• securities and credit ratings; businesses are subject to regulatory risk in terms of the costs that they may

• state and federal regulatory developments; recover and the investment returns that they may collect incustomer rates.

• foreign exchange rates; The principal challenge that PPL faces in its electricity delivery businesses is

• new state or federal legislation, including new tax legislation; to maintain high standards of customer service and reliability ina cost-effec-

• national or regional economic conditions, including any potential effects tive manner. PPL seeks to apply its experience in operating and managing its arising from the September 11, 2001 terrorist attacks inthe U.S., the Pennsylvania delivery business to its international businesses. Inturn, PPL situation in Iraq and any consequential hostilities or other hostilities; and has also gained valuable experience by operating and managing these interna-

• the commitments and liabilities of PPL and its subsidiaries. tional businesses. PPL faces certain financial risks by conducting international operations, such as fluctuations in currency exchange rates. PPL attempts to Any such forward-looking statements should be considered in light of manage these financial risks through its risk management program.

such important factors and inconjunction with PPL's Form 10-K and other reports on file with the SEC.

- -r Management's Discussion and Analysis Akey challenge for PPIs business as awhole is to maintain astrong RESULTS OF OPERATIONS credit profile. Inthe past few years, investors, analysts and rating agencies that Earnings in2003 and 2002 were impacted by the acquisition of acontrolling follow companies inthe energy industry have been particularly focused on the interest inWPD on September 6,2002, and the resulting consolidation, as credit quality and liquidity position of energy companies. PPL is focused on described inNote 9 to the Financial Statements. Therefore, the comparison of strengthening its balance sheet and improving its liquidity position, thereby reported income statement line items between 2002 and 2001 is not meaning-improving its credit profile. ful without eliminating the impact of the WPD consolidation. The following The purpose of 'Managements Discussion and Analysis' is to provide table shows the 2002 Statement of Income as reported, the adjustments to information concerning PP1s past and expected future performance in eliminate the impact of the WPD consolidation (by reflecting WPD on the equity implementing the strategies and managing the risks and challenges outlined method), and as adjusted to exclude the WPD consolidation. The following above. Specifically: discussion, that explains significant annual changes in principal items on the

'Results of Operations' provides an overview of PPUs operating results Statement of Income, compares 2003 to 2002, unadjusted, and compares in2003, 2002 and 2001, starting with a review of earnings. The earnings 2002, as adjusted, to 2001.

review includes a listing of certain unusual items that had significant PPL Corporation and Subsidiaries impacts inthese years, and it also includes a description of key factors that Consolidated Statement of Income management expects may impact future earnings. 'Results of Operations" Adjusted to Eliminate WPD Consolidation 2002 also includes an explanation of changes during this three-year period in As Reported Adjustment As Adjusted significant income statement components, such as energy margins, utility Operating Revenues

- revenues, operation and maintenance expenses, financing costs, income Utility $3,676 $579 $3,097 taxes and cumulative effects of accounting changes. Unregulated retail electric and gas 182 182

• Financial Condition - Liquidity" provides an analysis of PPUs liquidity Wholesale energy marketing 1,036 1,036 position and credit profile, including its sources of cash (including bank Net energy trading margins 19 19 credit facilities and sources of operating cash flow) and uses of cash Energy related businesses 568 (60) 628 (including contractual commitments and capital expenditure requirements) Total 5,481 519 4,962 and the key risks and uncertainties that impact PPL's past and future liquid- Operating Expenses 24 Operation ity position and financial condition. This subsection also includes an Fuel 584 584 explanation of recent rating agency decisions affecting PPL, as well as a r Energy purchases 916 916 0

listing of PPUs current credit ratings. Other operation and maintenance 1,136 42 1,094

• 0 * 'Financial Condition - Risk Management - Energy Marketing & Trading Amortization of recoverable transition costs 226 226 0

and Other" includes an explanation of PP1s risk management program Depreciation 367 112 255 ro relating to market risk (i.e., commodity price, interest rate and foreign Taxes, other than income 231 42 189 0

(A currency exchange risk) and credit risk (i.e., counterparty credit risk). Energy related businesses 543 29 514 Other charges z * 'New Accounting Standards" provides adescription of accounting standards Write-down of international energy projects 113 113 that impact PPUs Financial Statements and that were implemented in2003 Workforce reduction 75 75 I z

z or are pending adoption. Write-down of generation assets 44 44 C:

' Application of Critical Accounting Policies" provides an overview of the Total 4,235 225 4,010

-4 accounting policies that are particularly important to the results of operations Operating Income 1,246 294 952 0 and financial condition of PPL and that require PPIs management to make Other Income - net 30 20 10 q I3 significant estimates, assumptions and other judgments. Although PPUs Interest Expense 561 127 434 i management believes that these estimates, assumptions and other judg- Income Taxes 210 105 105 Minority Interest 78 73 5 I ments are appropriate, they relate to matters that are inherently uncertain.

Distributions on Preferred Securities 67 9 58 i I

Accordingly, changes inthe estimates, assumptions and other judgments Loss from Discontinued Operations 2 2 I applied to these accounting policies could have asignificant impact on Cumulative Effect of aChange in PPIs results of operations and financial condition, as reflected in PPUs Accounting Principle (150) (150) i I

Financial Statements. Net Income $ 208 $ $ 208 I

The information provided in "Management's Discussion and Analysis" should be read in conjunction with PPUs Financial Statements and the I

Notes thereto. 4 Terms and abbreviations appearing herein are explained in the glossary.

i Dollars are inmillions, except per share data, unless otherwise noted.

I

-J i

I

The comparability of certain items on the Statement of Income has also The changes in net income from year to year were, inpart, attributable to been impacted by PPL Global's investment inCEMAR. The consolidated several unusual items with significant earnings impacts, including accounting results of CEMAR are included for periods during which PPL had a controlling changes, discontinued operations and infrequently occurring items. The after-interest, from January 1,2001 to August 2002. See Note 9 to the Financial tax impacts of these unusual items are shown below.

Statements for more information. Impact on Net Income WPD's results, as consolidated in PPL% Statement of Income, are impacted 2003 2002 2001 by changes inforeign currency exchange rates. For the twelve months ended Accounting changes:

December 31, 2003, as compared to the same period in 2002, changes infor- Asset retirement obligation (Note 21) $ 63 eign exchange rates increased WPD's portion of revenue and expense line Consolidation of variable interest entities (Note 22) (27) items by about 9%.

Goodwill impairment (Note 18) $(150)

Earnings Pensions (Note 12) $ 10 Net income, and the related EPS, were as follows: Discontinued operations (Note 9) (20) 2003 2002 2001 CEMAR-related net tax benefit (Note 5) 81 Worktorce reduction (Note 20) (5) (44)

Net income $ 734 $ 208 $179 Write-down of generation assets (Note 9) (26)

EPS - basic $4.25 $1.37 $1.23 CEMAR operating losses (Note 9) (23)

EPS - diluted $4.24 $1.36 $1.22 CEMAR impairment (Note 9) (98) (217)

Cancellation of generation projects The after-tax changes innet income were primarily due to: (Note 9) (88) 2003 vs. 2002 2002 vs. 2001 WPD impairment (Note 9) (117)

Tax benefit - Teesside (Note 9) 8 Domestic:

---Enron impact on trading (Note 17) (8)

Wholesale energy margins $ 68 $ (81)

Enron impact - write-down investment Net energy trading margins (4) (11) inTeesside (Note 9) (21)

Unregulated retail energy margins (6) (33)

Regulated retail energy margins (43) 59 Total $ 92 $(333) $(441)

Delivery revenues (net of CTC/ITC amortization 25 and interest expense on transition bonds) 11 (10) The year to year changes in earnings components, including margins by Operation and maintenance expenses (41) (34) activity and income statement line items, are discussed in the balance of the -V Realized earnings on decommissioning trust fund 12 discussion in'Results of Operations.' 0 Depreciation 4 0 PPUs future earnings could be, or will be, impacted by a number of key CD Contribution of property 12 Taxes other than income (excluding factors, including the following: 21 211 0

gross receipts tax) (14) 5

• Based upon current electricity and natural gas price levels, there is a risk ->

Syntuel tax credits 2 10 0 that PPL may be unable to recover its investment innew gas-fired genera- z Mechanical contractors earnings (4) tion facilities. Under GAAP, PPL does not believe that there is an impairment Interest expense and preferred dividends 51 (29) M charge to be recorded for these facilities at this time. PPL is unable to pre-Other (12) (5) dict the ultimate earnings impact of this issue, based upon future energy z Total Domestic 36 (129) z C

International: price levels, applicable accounting rules and other factors, but such impact U.K. operations: may be material. (See "Application of Critical Accounting Policies - Asset Benefit of complete ownership Impairment' for additional information.) 0 of WPD (see Note 9) 29 11

• PPL is unable to predict whether future impairments of goodwill may be 21 Impact of changes inforeign currency exchange rates 14 1 required for its domestic and international investments. While no goodwill Other 1 1 impairments were required based on the annual review performed inthe Latin America 18 (24) fourth quarter of 2003, future impairments may occur due to determinations Other 3 61 of fair value exceeding the carrying value of these investments. (See Total International 65 50 "Application of Critical Accounting Policies - Asset Impairment" for addi-Unusual items 425 108 tional information.)

$526 $ 29

Management's Discussion and Analysis

• Earnings in2004 and beyond will be impacted by the consolidation of vari- Changes in Domestic Gross Energy Margins by Activity able interest entities (as discussed inNote 22 to the Financial Statements). Gross margin calculations are dependent on the allocation of fuel and

• PPL Electric expects to file a request for adistribution rate increase with purchased power costs to the activities listed below. That allocation is based the PUG in March 2004. Ifapproved, the new rates will go into effect in on monthly MWh consumption levels compared to monthly MWh supply January 2005, when PPL Electric's distribution rate cap expires. In addition, costs. Any costs specific to an activity are charged to that activity.

beginning January 1,2005, PPL Electric expects to fully recover from its 2003 vs. 2002 2002 vs. 2001 retail customers the charges that it pays to PJM for transmission-related Wholesale- Eastern U.S. $ 67 $(64) services. PPL Electric cannot predict the amount of the rate increase that Wholesale-Western U.S. 49 (71) will ultimately be approved by the PUG. Net enbrgy trading (7) (18)

. Earnings in2005 and beyond may be impacted by a rate review of the Unregulated retail (10) (55)

Regulated retail (74) 111 delivery business of WPD (South West) and WPD (South Wales). PPL cannot predict the ultimate outcome of the rate review. Domestic gross energy margins $ 25 $(97)

• PPL operates a synfuel facility and receives tax credits pursuant to Section 29 of the Internal Revenue Code based on its sale of synfuel to unaffiliated Wholesale -Eastern U.S.

third-party purchasers. See Note 14 to the Financial Statements for adis- Eastern U.S. wholesale margins were higher in2003 compared to 2002 primar-cussion of the IRS review of synfuel production procedures, and the ily due to higher volumes, which increased by 47%. The higher volumes were projected annual earnings attributable to PPUs synfuel operations. primarily driven by market opportunities to optimize the value of generating

. Future earnings may also be impacted by the ultimate exiting of the CEMAR assets and by higher spot prices that allowed PPL to increase the utilization of investment (see Note 9to the Financial Statements for additional informa- its higher cost generating units, including 699 MW of new generation that tion) or other investments. began commercial operation in mid-2002. In PJM, where the majority of PPr's Eastern wholesale activity occurs, average on-peak spot market real time prices Domestic Gross Energy Margins rose 34% in2003 compared to 2002. Partially offsetting the increase inwhole-The following table provides changes inincome statement line items that sale energy margins in2003 compared to 2002, was the buyout of a NUG comprise domestic gross energy margins:

contract inFebruary 2002, which reduced power purchases by $25 million.

2003 vs. 2002 2002 vs. 2001 Eastern wholesale margins were lower in 2002 compared to 2001, despite Utility revenues $ 34 $ 63 abuyout of aNUG contract inFebruary 2002 that reduced purchased power Unregulated retail electric and gas revenues (30) (174) costs by $25 million. The decline inmargins was primarily attributable to Wholesale energy marketing revenues 178 9 the decline inwholesale prices for energy and capacity. PJM on-peak prices Net energy trading margins (7) (18) averaged $6/MWh less, adecline of 14%, for 2002 compared to 2001.

Other revenue adjustments (a) 6 41 Additionally, because new generating capability came on-line within PJM in Total revenues 181 (79) 2002, the prices for the PJM monthly auctions for unforced capacity credits Fuel 33 (18) fell from an average of $100/MW-month in2001 to an average of $38/MW-Energy purchases 114 5 month in2002. However, higher volumes of energy sales partially offset the Other cost adjustments (a) 9 31 decline in prices, as wholesale transactions in2002 increased by about 33%

Total cost of sales 156 18 over 2001 due to better generating unit availability.

Domestic gross energy margins $ 25 $ (97)

Wholesale - Western U.S.

(a) Adjusted to exclude the impact of any revenues and costs not associated with domestic energy margins, in particular, revenues and energy costs related to the Western U.S. wholesale margins consist of margins inthe Northwest and international operations of PPL Global and the domestic delivery operations of PPL inthe Southwest.

Electric and PPL Gas Utilities. Also adjusted to include gains on sales of emission allowances, which are reflected in 'Other operation and maintenance expenses on In the Northwest, margins were $31 million higher in2003 compared the Statement of Income, and the reduction of the reserve for Enron receivables, as to 2002, primarily due to higher wholesale prices. Average wholesale prices described in Note 17 to the Financial Statements.

for 2003 were $6/MWh higher than prices in2002. A favorable settlement of $3million with Energy West Resources Inc. inJune 2003 also positively impacted margins in2003. Margins were $74 million lower in2002 compared to 2001, primarily due to adecrease inaverage realized wholesale prices by

$15/MWh, partially offset by a7%increase involumes.

Inthe Southwest, margins were $9million higher in2003 compared to Utility Revenues 2002, primarily due to the inception of new tolling agreements inArizona and The increase (decrease) in utility revenues was attributable to the following:

due to an increase of average wholesale prices in 2003 by $16/MWh compared 2003 vs. 2002 2002 vs. 2001 to 2002. Margins were $9million lower in 2002 compared to 2001, primarily Domestic:

due to adecrease in average wholesale prices by $40/MWh. These lower Retail electric revenue (PPL Electric) prices were offset by increased sales, which were three times higher than the Electric delivery $ 48 $ (1) prior period, as a result of the Griffith Energy and Sundance facilities coming PLR electric supply 22 102 on-line in2002. Other (11)

Wholesale electric revenue (PPL Electric) (5)

The above explanation is exclusive of $9million related to the 2003 partial Gas revenue (PPL Gas Utilities) 10 (15) reversal of areserve against Enron receivables, and a2001 charge of $12 mil- Intemational:

lion for the Enron bankruptcy, both of which affected gross margins. These Retail electric delivery (PPL Global) items are discussed in further detail inNote 17 to the Financial Statements. U.K 35 ElSalvador 13 4 Net Energy Trading Bolivia 1 2 PPL enters into certain contractual arrangements that meet the criteria of Chile 18 4 energy trading derivatives as defined by EITF 02-3, Issues Involved in Brazil (113) (17)

Accounting for Derivative Contracts Held for Trading Purposes and Contracts $ 34 $ 63 Involved in Energy Trading and Risk Management Activities.' These physical and financial contracts cover trading activity associated with electricity, gas The increase inutility revenues for 2003 compared with 2002 was and oil. The $7million decrease in 2003 compared to 2002 was primarily due attributable to:

to realized electric swap losses in2003. The $18 million decrease in 2002 . higher PPL Electric delivery revenues resulting from a1.1% increase in compared to 2001 was primarily due to unrealized, mark-to-market gains in delivery sales, inpart due to colder winter weather inthe first quarter of 2003; 2001 and lower energy margins in2002. The physical volumes associated

• higher PPL Electric PLR supply revenues due to higher energy and capacity with energy trading were 9,100 GWh and 12.6 Bcf in 2003; 10,700 GWh and rates in2003 compared with 2002; 12.4 Bcf in2002; and 7,700 GWh and 22.4 Bcf in 2001. The amount of energy

• higher PPL Gas Utilities revenues primarily due to higher sales volumes of 27 trading margins from unrealized mark-to-market transactions was not signifi- propane and natural gas; cant in 2003, 2002 and 2001.

• higher WPD revenues in the U.K. primarily due to the change in foreign -U currency exchange rates from period to period; 0 0

UnregulatedRetail

• higher revenues in El Salvador primarily due to higher volumes and higher -U Unregulated retail margins declined in 2003 compared to 2002 primarily due 0 pass-through energy costs, partially offset by a6%tariff reduction effective to significantly lower electric retail prices inthe Western U.S. Western U.S. January 1,2003; and retail contract prices decreased about 19% in2003 compared to 2002. The

• higher revenues inChile primarily due to higher volumes and the consolida- z decline in2002 compared to 2001 was primarily due to lower revenues result- tion of TransEmel (see Note 9 to the Financial Statements); partially offset by ing from the expiration of contracts which were not renewed inthe Eastern

• tower revenues in Brazil attributable to the deconsolidation of CEMAR in D a

U.S. and due to significantly lower retail prices inthe Western U.S., somewhat August 2002 (see Note 9). z 0m offset by an increase inthe number of customers inthe Western U.S.

so The increase inutility revenues in2002 compared with 2001 was Regulated Retail primarily due to:

Regulated retail margins inthe Eastern U.S. for 2003 decreased by 9%com-

• higher PPL Electric PLR supply revenues, see 'Regulated Retail for addi-pared to 2002, due to higher supply costs resulting from higher purchased tional information; partially offset by power prices. Purchased power prices were higher because of increased gas . lower PPL Gas Utilities revenues primarily due to lower sales volumes and oil prices and an abnormally cold winter. Regulated retail margins for (due inpart to milder winter weather experienced inthe first quarter of 2002.were 17% higher than in 2001. Higher sales volumes and higher average 2002) and adecrease inthe fuel cost component of customer rates; and prices, caused by changes inusage among customer classes, provided the

• lower revenues in Brazil, as noted above.

improved margins. Inaddition, lower supply costs in2002, due to lower fuel costs and increased generating unit availability, further improved margins.

Management's Discussion and Analysis Energy Related Businesses Other Operation and Maintenance Energy related businesses contributed $17 million less to operating income The increase (decrease) inother operation and maintenance expenses was in2003 compared with 2002. The decrease resulted primarily from: primarily due to:

. $7million of credits recorded on development projects in2002, due largely 2003 vs. 2002 2002 vs. 2001 to afavorable settlement on the cancellation of ageneration project in Decrease in domestic and international Washington state; pension income $ 53 $17

• a$5million operating loss on some Hyder properties inthe first quarter Increased operating expenses in domestic business lines and other 44 2 of 2003, which were subsequently sold inApril 2003; Additional expenses of new generating facilities 28 27

• an $8million decrease in Latin America revenues from lower material and Increase inWPD expenses due to regulatory construction project sales. (In2002, aBolivian subsidiary participated in accounting adjustments, and resolution of purchase accounting contingencies inthe the construction of a 1,500 kilometer transmission line inrural areas); and second quarter of 2002 related to the

• a $3million decrease inmargins from telecommunications, due to the Hyder acquisition 18 acquisition of afiber optic network and start-up activities for new products; Increase inforeign currency exchange rates 10 Accretion expense as a result of applying partially offset by SFAS 143 (see Note 21) 18

• a$3million improvement incontributions from mechanical contracting Increase in other postretirement benefit expense 15 6 subsidiaries due to enhanced project controls that were implemented to Outage costs associated with the turbine minimize project overruns, offset by acontinuing decline inconstruction replacement at the Susquehanna station 7 Change to account for CEMAR on the cost method (38) (9) markets in2003.

Estimated reduction in salaries and benefits as a result of the workforce reduction initiated in2002 (28) (11)

Energy related businesses (when adjusted to include WPD on an equity Insurance settlements - property damage basis) contributed $12 million less to operating income in2002 compared and environmental (27) with 2001. This was primarily due to: Decrease in PPL Globals administrative

• a $14 million benefit recorded in2001 from an equity interest inGriffith and general expenses (10)

Gains on sales of emission allowances (17) (2)

Energy related to margins on forward electricity contracts executed prior Vacation liability adjustment in 2002 in 28 to commercial operation; conjunction with the workforce reduction (15) 15

• a$9million decline from the mechanical contracting and engineering sub- $68 $35

-U C, sidiaries, primarily due to cost overruns experienced at two major projects; 0

M0

• a$6million operating loss on start-up telecommunications operations; and The $53 million decrease in net pension income was attributable to

. $4million of pre-tax operating losses from synfuel projects; partially offset by decreased asset values at the end of 2002 and reductions inthe discount

-4

• a $23 million decrease inPPL Global's expenses due to lower spending on rate assumptions for PPLs domestic and international pension plans, which 0 development projects in 2002, including afavorable settlement on the can- were the result of weakness in the financial markets during 2002. The 2002 z

cellation of a generation project inWashington state. year-end asset values and discount rates were used to measure net pension a

income for 2003. Through December 31, 2003, PPL recorded $42 million z Although operating income from synfuel operations declined in2002 com-of net pension income.

pared lo 2001, the synfuel projects contributed $7million more to net income C;

> Although financial markets have improved and PPUs domestic and after recording tax credits.

M-international pension plans have experienced significant asset gains in2003, interest rates on fixed-income obligations have continued to fall, requiring a 0

M further reduction inthe discount rate assumption as of December 31, 2003.

The reduction inthe discount rate assumption has asignificant impact on the measurement of plan obligations and net pension cost, which will result in PPUs recognition of lower levels of net pension income in 2004. See Note 12 to the Financial Statements for details of the funded status of PPLs pension plans.

a

Depreciation Other Income - net Impacts on depreciation were as follows: See Note 16 to the Financial Statements for details of other income and 2003 vs. 2002 2002 vs. 2001 deductions.

Additions to PP&E $ 32 $ 20 Financing Costs Foreign currency exchange rates 10 Interest expense decreased by $86 million in 2003 compared with 2002 Lower depreciation due to deconsolidation of CEMAR in2002 (7) (7) primarily due to the net effect of:

Discontinuation of recording goodwill

• a $55 million decrease in long-term debt interest due to debt retirements amortization in2002 due to adoption of in 2003; SFAS 142 (see Note 18) (10)

• a $34 million decrease in long-term debt interest from the deconsolidation Extension of Susquehanna station's depreciable life (14) of CEMAR in August 2002; No decommissioning expense in2003 due

• a $24 million charge that occurred in 2002 to cancel a remarketing agreement; to application of SFAS 143 (a) (22)

• a $20 million decrease in short-term debt interest expense;

$ 13 $(11)

• a $15 million decrease due to a 2002 charge to expense related to the inef-(a)There was acorresponding recording of accretion expense for PPL Susquehanna in fectiveness and subsequent dedesignation of hedges on anticipated debt 2003, which is part of 'Other operation and maintenance' expense.

issuances that did not occur; and Depreciation expense increased in2003 by $13 million. An additional

• a $7million decrease due to changes in interest rates caused by economic

$32 million of depreciation was recorded related to several projects, the largest hedges that did not qualify for hedge accounting treatment under SFAS 133, of which were the Susquehanna Unit 2turbine replacement and the Automated Accounting for Derivative Instruments and Hedging Activities;' offset by Meter Reading and Power Management System projects. The additional depre- * $27 million of interest on Preferred Securities and preferred stock with sink-ciation was partially offset by the removal of decommissioning expense from ing fund requirements due to reclassifications from applying SFAS 150, depreciation expense as required by SFAS 143, 'Accounting for Asset Retirement 'Accounting for Certain Financial Instruments with Characteristics of Both Obligations.' See Note 21 to the Financial Statements for additional information. Liabilities and Equity.' See Note 22 to the Financial Statements for additional information; Taxes, Other Than Income

• a $14 million increase in long-term debt interest expense due to issuances 29 Taxes, other than income, increased by $25 million in2003 compared with of $100 million Senior Secured Bonds and $400 million Convertible Senior 2002 due to the settlement of prior years' capital stock tax refund claims of -0 Notes; -u

$8million in2002, higher taxes related to an increase inthe basis on which 0

• a $14 million decrease in capitalized interest; and capital stock tax is calculated in 2003 and higher real estate taxes. -u 0

• an $11 million write-off of unamortized swap costs on WPD debt restructur-Taxes, other than income, increased by $34 million in 2002 compared ing in 2003.

with 2001, primarily due to a$42 million increase ingross receipts tax, Z0 partially offset by a$12 million decrease in capital stock tax. Interest expense increased by $48 million in 2002 compared with 2001 z The gross receipts tax increase in2002 was due to an increase inthe rev- primarily due to: N enue-neutral reconciliation (RNR) tax component of the effective Pennsylvania

• a $24 million charge to cancel the remarketing agreement of the 7.7% 0 23 gross receipts tax rate inJanuary 2002. The RNR, which adjusts the base gross Reset Put Securities; -

C 0

receipts tax rate of 4.4%, was enacted as part of the Customer Choice Act as

• a $19 million net increase in long-term debt interest related to a full year of c atax revenue replacement component to recoup losses to the Commonwealth interest in 2002 from the issuances in 2001 of $800 million of senior D m0 of Pennsylvania or return benefits to customers that may result from the secured bonds by PPL Electric, $500 million of senior unsecured notes by 0o M

restructuring of the electric industry. This increase was partially offset by the PPL Energy Supply and debt by PPL Global's consolidated subsidiaries, settlement of prior years' capital stock tax refund claims and alower capital partially offset by bond retirements; stock tax rate in2002.

• a $15 million charge due to ineffectiveness and subsequent dedesignation of hedges on anticipated debt issuances that did not occur in 2002; Other Charges

• a $3million charge due to market fluctuations for economic hedges that Other charges of $9million in 2003 consisted of acharge for aworkforce did not qualify for hedge accounting treatment under SFAS 133; and reduction program (see Note 20 to the Financial Statements).

• a $7million decrease in capitalized interest; offset by Other charges of $232 million in2002 consisted of the write-down of PPL

• a $24 million decrease in short-term debt interest as a portion of the Global's investment in CEMAR and several smaller impairment charges on proceeds from the issuance of long-term debt was used to pay down other international investments (see Note 9), the write-down of generation assets commercial paper.

(see Note 9)and acharge for aworkforce reduction program (see Note 20).

Other charges of $486 million in2001 consisted of the write-down of inter-national energy projects and the cancellation of generation projects (see Note 9).

Management's Discussion and Analysis Distributions an preferred securities decreased by $38 million in 2003 PPL adopted SFAS 143, "Accounting for Asset Retirement Obligations,"

compared with 2002. This decrease was due to: effective January 1,2003. SFAS 143 addresses the accounting for obligations

• $27 million of distributions on Preferred Securities and preferred stock associated with the retirement of tangible long-lived assets. It requires legal with sinking fund requirements are categorized as interest expense due obligations associated with the retirement of long-lived assets to be recognized to the implementation of SFAS 150 on July 1,2003 (see Note 22); and as a liability inthe financial statements. Application of the new rules resulted

• the retirement of preferred securities in2002. inacumulative effect of adoption that increased net income by $63 million in2003. See Note 21 to the Financial Statements for additional information.

Distributions on preferred securities increased by $6million in 2002 PPL adopted SFAS 142, "Goodwill and Other Intangible Assets," on compared with 2001. This increase was due to:

January 1, 2002. SFAS 142 requires an annual impairment test of goodwill

• a $15 million increase in distributions on the PEPS Units, issued inthe and other intangible assets that are not subject to amortization. PPL conducted second quarter of 2001; offset by atransition impairment analysis in the first quarter of 2002 and recorded a

• a$10 million decrease individends and distributions due to the retirements transition goodwill impairment charge of $150 million. See Note 18 to the and redemptions in 2002 of preferred securities.

Financial Statements for additional information.

Income Taxes In2001, PPL changed its method of amortizing unrecognized gains or Income tax expense decreased by $40 million in 2003 compared with 2002. losses in the annual pension expense or income determined under SFAS 87, This decrease was due to: "Employers Accounting for Pensions." This change resulted inacumulative-

• a $31 million reduction related to deferred income tax valuation allowances effect credit of $10 million. See Note 12 to the Financial Statements for recorded on impairment charges on PPIs investment in Brazil recorded additional information.

during 2002;

• an $84 million reduction in income taxes related to the tax benefit FINANCIAL CONDITION recognized in 2003 on foreign investment losses included inthe 2002 Liquidity federal income tax return; PPL is focused on maintaining a strong liquidity position and strengthening

• a$9million decrease related to acontribution of property; and its balance sheet, thereby improving its credit profile. PPL believes that its

• a$2million decrease related to additional federal synfuel tax credits cash on hand, operating cash flows, access to debt and equity capital markets recognized; offset by and borrowing capacity, taken as awhole, provide sufficient resources to fund

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• higher pre-tax domestic book income, resulting in an $84 million increase its ongoing operating requirements, future security maturities and estimated in income taxes. future capital expenditures. PPL currently expects cash on hand at the end of 0M

-V 2004 to be approximately $400 million, with about $1.5 billion insyndicated M0 Income tax expense decreased by $156 million in2002 compared with credit facilities. PPL also expects that cash from operations less payments for 2001. This decrease was due to:

capital expenditures, dividends and transition bonds will be positive in2004.

0

• lower pre-tax domestic book income, resulting ina$75 million reduction However, PPUs cash flows from operations and its access to cost effective in income taxes; 0 bank and capital markets are subject to risks and uncertainties, including but

• lower impairment charges on PPUs investment inBrazil resulting ina not limited to, the following:

$30 million decrease inthe amount of deferred income tax valuation 0

• changes in market prices for electricity; allowances recorded:

• changes in commodity prices that may increase the cost of producing power

• a$27 million reduction inincome taxes due to losses recognized on r- or decrease the amount PPL receives from selling power; foreign investments; and 0 . price and credit risks associated with selling and marketing products inthe H

• a$10 million decrease related to additional federal synfuel tax credits wholesale power markets; recognized.

. ineffectiveness of trading, marketing and risk management policies and pro-Discontinued Operations grams used to mitigate PPUs risk exposure to adverse energy and fuel prices, PPL reported a loss of $20 million inconnection with the approval of aplan interest rates, foreign currency exchange rates and counterparty credit; of sale of PPL Global's investment in aLatin American telecommunications *unusual or extreme weather that may damage PPUs transmission and distri-company. See 'Discontinued Operations" in Note 9 to the Financial Statements bution facilities or effect energy sales to customers; for additional information.

• reliance on transmission and distribution facilities that PPL does not own or control to deliver its electricity and natural gas; Cumulative Effects of Changes inAccounting Principles

• unavailability of generating units (due to unscheduled or longer-than-antici-In2003, PPL recorded achafge of $27 million, atter-tax, as a cumulative effect paled generation outages) and the resulting loss of revenues and additional of achange inaccounting principle in connection with the adoption of FIN 46, costs of replacement electricity; "Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51,"

for certain entities. See "New Accounting Standards" for further discussion.

C0

• ability to recover, and timeliness and adequacy of recovery of costs associ- through cash settlement inthe event of adowngrade of PPL or the respective ated with regulated utility businesses; and subsidiary's credit ratings or adverse changes inmarket prices. For example,

• a downgrade inPPUs or PPLs subsidiaries' credit ratings that could nega- in addition to limiting its trading ability, if PPL or its respective subsidiary's tively affect their ability to access capital and increase the cost of ratings were lowered to below 'investment grade' and energy prices increased maintaining credit facilities and any new debt. by 10%, PPL estimates that, based on its December 31, 2003 position, it would have to post collateral of approximately $190 million as compared At December 31, 2003, PPL had $476 million incash and cash equivalents to $121 million at December 31, 2002. PPL has in place risk management and $56 million of short-term debt as compared to $245 million in cash and programs that, among other things, are designed to monitor and manage cash equivalents and $943 million of short-term debt at December 31, 2002, its exposure to volatility of cash flows related to changes in energy prices, and $933 million incash and cash equivalents and $118 million of short-term interest rates, foreign currency exchange rates, counterparty credit quality debt at December 31, 2001. The changes incash and cash equivalents and the operational performance of its generating units.

resulted from the following:

Net cash provided by operating activities decreased by $107 million in 2003 2002 2001 2002 versus 2001. This decrease was primarily due to $152 million of turbine Net Cash Provided by Operating Activities $1,340 $ 802 $909 cancellation payments made in 2002, a $50 million payment to terminate a Net Cash Used inInvesting Activities (729) (1,129) (702) NUG contract also made in2002 and an $89 million decrease individends Net Cash Provided by (Used in)

Financing Activities (387) (363) 249 received from unconsolidated affiliates, partially offset by increases innet Effect of Exchange Rates on income adjusted for non-cash items.

Cash &Cash Equivalents 7 2 (3)

Net Cash Used in Investing Activities Increase (Decrease) in Cash &Cash Equivalents $ 231 $ (688) $453 Net cash used ininvesting activities decreased by 35%, or $400 million, in 2003 versus 2002, primarily as aresult of reduced investment ingeneration Net Cash Provided by Operating Activities assets and electric energy projects and the acquisition of the controlling inter-Net cash provided by operating activities increased by 67%, or $538 million est inWPD in September 2002. The primary use of cash for investing activities in 2003 versus 2002, reflecting higher net income adjusted for non-cash is capital and investment expenditures, which are summarized by category in items, working capital improvements and lower cash income taxes. Inaddition, the table in Capital Expenditure Requirements.' In2004, PPL expects to be 31 2002 included cash outlays of $152 million for the cancellation of generation able to fund all of its capital expenditures with cash from operations.

-U projects and $50 million for the termination of a NUG contract. The higher net Net cash used in investing activities in2002 was $1.1 billion, compared income in2003 was principally driven by complete ownership of WPD, higher to $702 million in 2001. The primary reasons for the $427 million increase in ~0 0

wholesale energy margins, lower interest expense and savings from a cash used in investing activities were the acquisition of the controlling interest workforce reduction program in the U.S. that commenced in 2002. The work- in WPD for $211 million, net of cash acquired, and a repayment of the loan 211 20 ing capital improvements resulted from adecrease inaccounts receivable and from a non-consolidated affiliate in 2001. C prepayments. These positive changes were partially offset by rising transmis- z Net Cash Provided by (Used in) Financing Activities sion and distribution operating costs at PPL Electric and other factors.

Net cash used in financing activities was $387 million in 2003, compared to Important elements supporting the stability of PPLs cash provided by

$363 million in 2002, and primarily reflected the repayment of short-term debt, operating activities are the long-term and intermediate-term commitments from C retirement of long-term debt and increased dividends to shareholders. In 2003, wholesale and retail customers and long-term fuel supply contracts PPL has the $387 million primarily consisted of net debt retirements of $460 million, inplace. In2003, PPL EnergyPlus entered into several new wholesale agree- -U common stock sale proceeds of approximately $426 million, preferred 0 ments to provide capacity and/or electricity to utilities in New Jersey, Arizona 11 stock retirements of $31 million and common and preferred dividends paid and Connecticut. These agreements supplement previously existing long-term of $287 million. In 2002, the $363 million primarily consisted of net debt contracts with PPL Electric, NorthWestern and the Long Island Power Authority retirements of $412 million, company-obligated mandatorily redeemable pre-(see Note 14 to the Financial Statements for additional information). PPL esti-ferred securities retirements of $250 million, common stock sale proceeds of mates that, on average, approximately 80% of its expected annual generation

$587 million and common and preferred stock dividends paid of $261 million.

output for the period 2004 through 2008 is committed under long-term and PPL currently has no plans to issue any additional common stock other than intermediate-term energy supply contracts. PPL EnergyPlus also enters into the shares associated with the May 2004 common stock conversion related contracts under which it agrees to sell and purchase electricity, natural gas, to the $575 million aggregate stated amount of PEPS Units and PEPS Units, oil and coal. These contracts often require cash collateral or other 6redit Series B. See Note 8 to the Financial Statements for additional information enhancement, or reductions or terminations of aportion or the entire contract on common stock sales in 2003.

Management's Discussion and Analysis PPUs debt financing activity in2003 wa! as follows: Debt issued during 2003 had stated interest rates ranging from 2.62% to Additions Payments Net 5.87% and maturities from 2008 through 2027. See Note 8 to the Financial PPL Electric First Mortgage Bonds (FMB) $100 $ (85) $ 15 Statements for more detailed information regarding PPLs borrowings.

PPL Electric FMB Pollution Control Bonds 90 (90) InJuly 2003, PPL Energy Supply and PPL Electric each determined that, PPL Electric Commercial Paper (net change) (15) (15) based on their current cash positions and anticipated cash flows, they would not PPL Transition Bond Company (255) (255) need to access the commercial paper markets through at least the end of 2003.

North Penn Gas, Inc. Notes (1) (1) As aresult, PPL Energy Supply and PPL Electric each requested Standard &

PPL Capital Funding Medium-Term Notes (85) (85) Poor's Ratings Services (S&P), Moody's Investors Service, Inc. (Moody's) and PPL Energy Supply Convertible Notes PPL Energy Supply Commercial Paper Fitch Ratings (Fitch) to withdraw their ratings for these currently inactive com-(net change) (374) (374) mercial paper programs, which the rating agencies did effective as of July 9, WPD (South West) (USD equivalent) 402 (409) (7) 2003. This decision has not limited the ability of either PPL Energy Supply or -

WPDH Limited (USD equivalent)

(53) (53) PPL Electric to fund its short-term liquidity needs. Neither company currently Latin America Companies (USD equivalent)

Payment on amounts advanced from trustee in has any commercial paper outstanding. PPL Electric expects to renew its com-synthetic lease agreement and other (81) (81) mercial paper program inearly 2004. PPL Energy Supply currently does not Total $992 $(1,452) $(460) anticipate a need to access the commercial paper market in2004.

At December 31, 2003, PPUs total committed borrowing capacity and the use of this borrowing capacity were as follows:

Committed Letters of Available Capacity Borrowed Credit Issued (d) Capacity)' it PPL Electric Credit Facilities (a) $ 300 $ 42 $ 258 PPL Energy Supply Credit Facilities (b) 1,100 87 1,013 WPD (South West) Bank Facilities (0) 435 $48 387 Total $1,835 $48 $129 $1,658 (a) PPL Electric's credit facilities allow for borrowings at LIBOR-based rates plus a spread, depending upon the company's public debt rating. PPL Electric also has the capability to issue up to $250 million of letters of credit under these facilities, which issuance reduces available borrowing capacity.

These credit facilities contain afinancial covenant requiring debt to total capitalization not greater than 70%. At December 31, 2003 and 2002, PPL Electric's consolidated debt to total capitalization percentages, as calculated in accordance with its credit facilities, were 57% and 58%. PPL Electric's 364-day credit facility also allows it to borrow up to the full amount of the credit facility on the day of expiration for up to a one-year period. The credit agreements also contain certain representations and warranties that must be met for PPL Electric to borrow under them, including, but not limited to, a material adverse change clause that relates to PPL Electric's ability to perform its obligations under the credit agreement and related loan documents.

(b) PPL Energy Supply's credit facilities allow for borrowings at LIBOR-based rates plus a spread, depending upon the company's public debt rating. PPL Energy Supply also has

. the capability to issue up to $800 million of letters of credit under these facilities, which issuance reduces available borrowing capacity.

These credit facilities contain financial covenants requiring debt to total capitalization not greater than 65% and an interest coverage ratio of not less than 2.0 times consolidated earnings before income taxes, depreciation and amortization. At December 31, 2003 and 2002, PPL Energy Supplys consolidated debt to total capitalization percentages, as calculated in accordance with its credit facilities, were 36% and 35%. At December 31, 2003 and 2002, PPL Energy Supply's interest coverage ratios, as calculated inaccordance

. with its credit facilities, were 6.3 and 7.4. The credit agreements also contain certain representations and warranties that must be made for PPL Energy Supply to borrow under them, including, but not limited to a material adverse change clause that relates solely to PPL Energy Supplys ability to perform its obligations under the credit agreements and related loan documents.

(c)WPD (South West)s credit facilities allow for borrowings at LIBOR-based rates plus a spread, depending upon the company's public debt rating.

These credit facilities contain financial covenants that require it to maintain an interest coverage ratio of not less than 3.0 times consolidated earnings before income taxes, depre-ciation and amortization, and the regulatory asset base must be £150 million greater than total gross debt, in each case as calculated in accordance with the credit facilities. At December 31, 2003 and 2002, WPD (South West)s interest coverage ratio, as calculated inaccordance with its credit lines, was 6.7 and 10.3. At December 31, 2003 and 2002, WPD (South West)'s regulatory asset base exceeded its total gross debt by £457 million and £491 million.

(d) The Borrower under each of these facilities has a reimbursement obligation to the extent any letters of credit are drawn upon. The letters of credit issued as of December 31, 2003 expire in 2004.

a

These credit agreements contain various other covenants. Failure to meet Operating Leases those covenants beyond applicable grace periods could result in acceleration PPL and its subsidiaries also have available funding sources that are provided of due dates of borrowings and/or termination of the agreements. PPL monitors through operating leases. PPLs subsidiaries lease vehicles, office space, land, the covenants on aregular basis. At December 31, 2003, PPL was in compli- buildings, personal computers and other equipment under master operating ance with those covenants. At this time PPL believes that these covenants and lease arrangements. These leasing structures provide PPL with additional other borrowing conditions will not limit access to these funding sources. PPL operating and financing flexibility. The operating leases contain covenants that Electric intends to reduce its total syndicated credit facilities to $200 million in are typical for these arrangements, such as maintaining insurance, maintaining the first quarter of 2004. In early 2004, PPL Electric also intends to participate corporate existence and timely payment of rental and other fees. Failure to inan Asset-Backed Commercial Paper (ABCP) Program for up to $150 mil- meet these covenants could limit or restrict access to these funds or require lion that would be secured by aportion of its accounts receivable. The ABCP early payment of obligations. At this time, PPL believes that these covenants Program would provide amore reliable and stable source of liquidity than an will not limit access to these funding sources or cause acceleration or termina-unsecured commercial paper program. PPL Energy Supply intends to reduce tion of the leases.

its syndicated credit facilities to $800 million inthe first quarter of 2004 PPL, through its subsidiary PPL Montana, leases a50% interest in Colstrip because of lower development and acquisition requirements related to its Units 1and 2and a30% interest inUnit 3,under four 36-year non-cancelable supply business. WPD (South West) intends to renew and extend all of its operating leases. These operating leases are not recorded on PPLs Balance syndicated credit facilities in 2004. Sheet, which is inaccordance with applicable accounting guidance. The leases Net cash used infinancing activities was $363 million in2002, compared place certain restrictions on PPL Montanas ability to incur additional debt, sell to net cash provided by financing activities of $249 million in2001. In2001, assets and declare dividends. At this time, PPL believes that these restrictions PPL had net issuances of $544 million of debt, preferred securities and equity, will not limit access to these funding sources or cause acceleration or termina-compared to net retirements of $75 million in 2002. tion of the leases. See Note 8to the Financial Statements for a discussion of other dividend restrictions related to PPL subsidiaries.

See Note 10 to the Financial Statements for further discussion of the operating leases.

33 Contractual Obligations

-u At December 31, 2003, the estimated contractual cash obligations of PPL were as follows:

C C

Less Than 1-3 3-5 After 5

-u Contractual Cash Obligations Total 1 Year Years Years Years M0 Long-term Debt (a) $ 8,525 $ 395 $2,365 $2,350 $3,415 Capital Lease Obligations 20 1 2 2 15 Operating Leases (b) 827 79 131 112 505 0 Purchase Obligations (c) 3,251 628 1,189 588 846 z Other Long-term Liabilities Reflected on the Balance Sheet under GAAP Total Contractual Cash Obligations $12,623 $1,103 $3,687 $3,052 $4,781 z C

(a) Reflects principal maturities only, including maturities of consolidated lease debt.

M oNExcludes amounts for the leases of the Sundance, University Park and Lower Mt. Bethel generation facilities as the lessors were consolidated effective December 31, 2003 as a result of the adoption of FIN 46 for certain entities. See 'New Accounting Standards" for further discussion. 0 I1 (c)The payments reflected herein are subject to change as certain purchase obligations included are estimates based on projected obligated quantities and/or projected pricing under the contracts.

Management's Discussion and Analysis Credit Ratings Rating Agency Actions in 2003 The following table summarizes the credit ratings of PPL and its key finani Iing In2003, S&P, Moody's and Fitch reviewed the credit ratings on the debt and subsidiaries at December 31, 2003: preferred securities of PPL and its subsidiaries. Based on their respective Standard Fitch reviews, the rating agencies made certain ratings revisions that are described Moody's & Poor's

- below. Management does not expect these ratings decisions to impact PPL PPL Issuer Rating BBB and its subsidiaries' ability to raise new debt or equity capital or to have a BBB Subordinated Debt Baa3 BBB- significant impact on the cost of any new capital or the cost of maintaining Senior Unsecured Debt BBB BBB their credit facilities.

Short-term Debt The ratings of S&P, Moody's and Fitch are not arecommendation to buy, Outlook STABLE NEGATIVE NEG ATIVE sell or hold any securities of PPL or its subsidiaries. Such ratings may be PPL Energy Supply subject to revisions or withdrawal by the agencies at any time and should Issuer Rating BBB Senior Unsecured Notes Baa2 BBB BBB+ be evaluated independently of each other and any other rating that may be Outlook STABLE NEGATIVE NEG ATIVE assigned to their securities.

PPL Capital Funding Senior Unsecured Debt Baa3 BBB- BBB PPL AND DOMESTIC SUBSIDIARIES Subordinated Debt Bal BBB- S&P Medium-Term Notes Baa3 BBB- BBB In April 2003, S&P notified PPL, PPL Energy Supply and PPL Electric that it:

Outlook ST) ABLE NEGATIVE NEGATIVE

• affirmed both the 'A-' ratings on PPL Electric's first mortgage bonds and PPL Capital Funding Trust I senior secured bonds and the 'BBB' corporate credit ratings for PPL and PEPS Units* Bal BB+ EBB-PPL Energy Supply; PPL Electric Senior Unsecured/Issuer Rating Baal A-

• lowered the rating on PPL Capital Funding's senior unsecured debt to First Mortgage Bonds Baal A- A- 'BBB-' from 'BBB';

Pollution Control Bonds*- Aaa AAA

• placed PPL Electric on negative outlook. S&P indicated that PPL and Senior Secured Bonds Baal A- A- PPL Energy Supply remain on negative outlook; and Preferred Stock Bal BBB BBB+

• affirmed the 'A-2' commercial paper ratings of PPL Energy Supply and 34 Outlook ST) \ELE NEGATIVE STABLE

-v PPL Transition Bond Company PPL Electric.

Transition Bonds Aaa AAA AAA S&P indicated that the rating revision on PPL Capital Funding's senior 0

PPL Montana

_0 Pass-Through Certificates Baa3 BBB- BBB unsecured debt is based on the addition of debt at PPL Energy Supply, which Outlook Poss. Downgrade NEGATIVE it noted is expected to increase further inthe future. PPL Energy Supply pro-0 z WPDH Limited vides significant cash flows to PPL Capital Funding to support PPL Capital Issuer Rating Baa2 BBB- Funding's cash requirements. S&P also indicated that the negative outlook for Ca Senior Unsecured Debt Baa2 BBB- BBB PPL and its subsidiaries reflects its view of weak credit metrics due to low W

Outlook STABLE NEGATIVE STABLE wholesale energy prices.

WPD LLP Issuer Rating BBB-In December 2003, S&P downgraded PPL Montana's 8.903% Pass C

Senior Unsecured Debt Baa2 BBB- BBB Through Certificates due 2020 to BBB- from BBB. S&P indicated that its out-Capital Trust Securities* Baa3 BB look for these securities remains negative.

-U M0 Outlook STABLE NEGATIVE STABLE S&P indicated that its downgrade reflects certain risks that it believes PPL WPD (South Wales)

Montana faces, including counterparty credit risk resulting from the Chapter 11 Issuer Rating BBB+

Senior Unsecured Debt A- bankruptcy filing of NorthWestern, which is PPL Montana's largest customer.

Baal BBB+

Commercial Paper A-2 F2 S&P noted, however, that the bankruptcy court has approved NorthWestern's Outlook STABLE NEGATIVE STABLE request to affirm the power sales agreements with PPL Montana and that WPD (South West) NorthWestern has strong incentives to maintain this status. See Note 14 for Issuer Rating Baal BBB+ more detailed information regarding NorthWestern's bankruptcy filing.

Senior Unsecured Debt BBB+ A-Commercial Paper P-2 A-2 F2 Moody!

Outlook STABLE NEGATIVE STABLE In May 2003, Moody's downgraded the credit ratings on the debt and preferred

• These trust preterred securities were deconsolidated effective December 31, 2003 securities of PPL, PPL Electric and PPL Energy Supply. The ratings from the Balance Sheet. See Note 22 to the Financial Statements.

downgraded include:

• • Insured as to payment of principal and interest.

. PPL Electric's first mortgage bonds and senior secured bonds,

.to 'Baal' from 'A3';

• PPL Energy Supply's senior unsecured notes, to 'Baa2' from 'Baal';

• affirmed both the 'BBB+' rating of PPL Energy Supply's senior unsecured

• PPL Capital Funding's senior unsecured debt, to 'Baa3' from 'Baa2'; and debt, and the 'F2' rating of its commercial paper; and

• PPUs senior unsecured debt that is not currently outstanding but that may

• placed each of PPL, PPL Capital Funding and PPL Energy Supply on be issued under PPUs shelf registration statement on file with the SEC, to negative outlook.

'Baa3' from 'Baa2'.

Fitch indicated that the revised ratings for PPL and PPL Capital Funding The Moody's ratings outlook is stable for each of PPL, PPL Electric, reflect the structural subordination of the obligations of PPL to those of its PPL Energy Supply and PPL Capital Funding. Neither PPL Electric's nor subsidiaries and Fitch's expectations of lower cash flow from PPL Electric until PPL Energy Supply's short-term debt ratings was impacted by Moody's long- early 2005. Fitch indicated that the change inoutlook for these companies term debt review. results from the increase during 2002 inPPUs generation asset portfolio that Moody's stated that the downgrades reflect its concerns about PPIs high is dependent on merchant generation, continued weakness inU.S. merchant debt levels, PPL Energy Supply's modest exposure to merchant generation risk, energy markets and exposure to international distribution assets primarily in the continued weakness inthe wholesale power market and the associated Latin America and the U.K. However, Fitch noted that PPL Energy Supply derives financial impact on PPL Energy Supply, and concerns regarding the amount significant earnings and cash flow from long-term supply contracts, including of cash flow to be generated from PPL Energy Supply's non-regulated domes- the full requirements contract between PPL Electric and PPL EnergyPlus, that tic operations and the free cash flow available from its regulated international on average account for about 70% of PPL Energy Supply's gross margin over assets. However, Moody's also indicated that the full requirements contract the next five years.

between PPL Electric and PPL EnergyPlus, which previously was approved by WPD AND SUBSIDIARIES the PUC and which extends through December 2009, mitigates PPL Electric's InFebruary 2003, Moody's confirmed the ratings of WPDH Limited at 'Baa2' supply and price risk and provides apredictable stream of cash flows to and WPD (South West) and WPD (South Wales) at 'Baal', and downgraded PPL Energy Supply during such time period. Moody's also noted that PPUs WPD LLP from 'Baal' to 'Baa2' and SIUK Capital Trust I from 'Baa2' to 'Baa3'.

management had implemented anumber of initiatives to strengthen its current The outlook on all ratings was stable. InMarch 2003, S&P assigned its credit quality and reduce its debt levels, such as the issuance of over $1billion

'BBB+' senior unsecured debt rating to the £200 million bonds issued by WPD of common stock and mandatorily convertible securities over the last few (South West). At the same time, the 'BBB+' and 'A-2' corporate credit ratings years, a sizeable reduction inplanned capital expenditures, the cancellation 35 on SIUK Limited were withdrawn as aresult of the acquisition of its debt by of projects under development, workforce reductions and write-downs of WPD LLP. S&P assigned its 'BBB' long-term and 'A-2' short-term corporate certain investments. -0 credit ratings to WPD LLP, in line with the ratings on the rest of the WPD group. C)

InSeptember 2003, Moody's announced that it was placing PPL Montana's To 0

Following a review of holding companies of U.K. regulated utilities, in 8.903% Pass-Through Certificates due 2020 under review for possible down- 'O July 2003 S&P downgraded the long-term ratings from 'BBB' to 'BBB-' and grade. These securities currently are rated 'Baa3' by Moody's. Moody's stated 0 short-term ratings from 'A-2' to 'A-3' for both WPDH Limited and WPD LLP, that its review is prompted by its concerns about the credit profile of PPL and retained anegative outlook. At the same time, S&P reaffirmed the credit z Montana's largest customer, NorthWestern, and lower cash flow generation 0 ratings for WPD (South West) and WPD (South Wales) at 'BBB+'. S&P stated than was forecasted at the time the securities were issued in 2000. See Note that this is inline with S&P U.K.'s recently announced implementation of a 14 to the Financial Statements for additional information on NorthWestern's new methodology related to U.K. electric distribution holding companies, z current situation. Management does not expect any action by Moody's based C whereby electric distribution operating companies rated in the 'BBB' category on this review to limit PPL Montana's ability to fund its short-term liquidity will have the parent holding company (WPDH Limited) notched down by two 'D needs. PPL Montana has no plans to raise new long-term debt. Any ratings categories from the operating company rating level. WPD's management 0 I2 downgrade by Moody's would have an insignificant impact on PPL Montana's Ho does not expect the placement of WPD on negative outlook to limit its ability cost of maintaining the credit facility that it has inplace with its affiliate. In to fund its short-term liquidity needs or access to new long-term debt or to addition, management does not expect any ratings downgrade by Moody's materially impact the cost of any new long-term debt.

based on this review to have any adverse impact on the credit ratings of PPL or PPL Energy Supply. Subsequent Events InFebruary 2004, PPL successfully remarketed an aggregate liquidation amount Fitch of $257 million of the PPL Capital Funding Trust I trust preferred securities In May 2003, Fitch notified PPL, PPL Energy Supply and PPL Capital Funding that were a component of the PEPS Units. The trust preferred securities were that it:

remarketed at a price of 107.284% of their aggregate stated liquidation

• downgraded PPL Capital Funding's senior unsecured debt to 'BBB' amount, resulting in ayield to maturity of 3.912% based on the reset distribu-from 'BBB+';

tion rate of 7.29% per annum. Under the terms of the PEPS Units, holders

• downgraded PPL's senior unsecured debt that is not currently outstanding were entitled to surrender their trust preferred securities for remarketing in but that may be issued under PPUs shelf registration statement on file with the SEC, to 'BBB' from 'BBB+';

Management's Discussion and Analysis order to settle the purchase contract component of the PEPS Units. Holders of Risk Management - Energy Marketing & Trading and Other an aggregate liquidation amount of $218 million of the trust preferred securi- Market Risk ties elected not to participate inthe remarketing. Those holders will retain Background their trust preferred securities at adistribution rate of 7.29% per annum. Market risk is the potential loss PPL may incur as aresult of price changes Both the trust preferred securities that were remarketed and those that were associated with aparticular financial or commodity instrument. PPL is not remarketed will mature in May 2006. exposed to market risk from:

Additionally, inFebruary 2004, PPL Capital Funding issued $201 million . commodity price risk for energy and energy-related products associated of senior unsecured notes guaranteed by PPL. The senior notes bear interest with the sale of electricity, the purchase of fuel for the generating assets, at a rate of 4.33% per year that is payable semiannually on March 1and and energy trading activities; September 1 of each year, from September 1,2004 through the maturity date . interest rate risk associated with variable-rate debt and the fair value of of March 1,2009. The senior notes are not redeemable by PPL or PPL Capital fixed-rate debt used to finance operations, as well as the fair value of Funding, and the holders will not be entitled to require PPL or PPL Capital debt securities invested in by PPL's nuclear decommissioning fund; Funding to repurchase the senior notes before maturity. The senior notes were . foreign currency exchange rate risk associated with investments inaffiliates sold in an SEC Rule 144A private offering to qualified institutional buyers in inLatin America and Europe, as well as purchases of equipment incurren-exchange for $185 million aggregate liquidation amount of the trust preferred cies other than U.S. dollars; and securities ot PPL Capital Funding Trust 1,which were surrendered for cancella- . equity securities price risk associated with the fair value of equity securities tion, and for apayment of $400,000 incash. Except for the receipt of $400,000 invested inby PPLs nuclear decommissioning fund.

in cash, neither PPL nor PPL Capital Funding received any cash proceeds PPL has arisk management policy approved by the Board of Directors from the sale of the senior notes. Pursuant to aregistration rights agreement to manage market risk and counterparty credit risk. (Credit risk isdiscussed with the initial purchasers, PPL and PPL Capital Funding intend to consum-below.) The RMC, comprised of senior management and chaired by the Vice mate an exchange offer for the notes to register them with the SEC for resale.

President-Risk Management, oversees the risk management function. Key risk Also inFebruary 2004, notice was provided to the holders of the trust pre-control activities designed to monitor compliance with risk policies and detailed ferred securities that PPL has elected to liquidate PPL Capital Funding Trust I programs include, but are not limited to, credit review and approval, validation and cause the distribution of the underlying PPL Capital Funding 7.29% sub-of transactions and market prices, verification of risk and transaction limits, ordinated notes due 2006 to the holders of the trust preferred securities. The sensitivity analyses, and daily portfolio reporting, including open positions, liquidation date isexpected to occur on or about March 23, 2004. From and mark-to-market valuations and other risk measurement metrics. In addition, after the liquidation date, the trust preferred securities will no longer be deemed efforts are ongoing to develop systems to improve the timeliness, quality and to be outstanding and the underlying PPL Capital Funding 7.29% subordinated breadth of market and credit risk information.

notes will be held by the former holders of the trust preferred securities.

The forward-looking information presented below provides estimates of Finally, in February 2004, PPL announced an increase to its quarterly what may occur inthe future, assuming certain adverse market conditions, due common stock dividend, payable April 1,2004, to 41 cents per share (equivalent to reliance on model assumptions. Actual future results may differ materially to $1.64 per annum). Future dividends, declared at the discretion of the Board from those presented. These disclosures are not precise indicators of expected of Directors, will be dependent upon future earnings, cash flows, financial future losses, but only indicators of reasonably possible losses.

requirements and other factors.

Contract Valuation Off-Balance Sheet Arrangements PPL utilizes forward contracts, futures contracts, options, swaps and tolling PPL, PPL Energy Supply and PPL Electric provide guarantees for certain agreements as part of its risk management strategy to minimize unanticipated affiliate financing arrangements that enable certain transactions. Some of the fluctuations inearnings caused by commodity price, interest rate and foreign guarantees contain financial and other covenants that, if not met, would limit currency volatility. When available, quoted market prices are used to determine or restrict the affiliates' access to funds under these financing arrangements, the fair value of acommodity or financial instrument. This may include exchange require early maturity of such arrangements or limit PPrs ability to enter into prices, the average mid-point bid/ask spreads obtained from brokers, or an certain transactions. At this time, PPL believes that these covenants will not independent valuation by an external source, such as abank. However, market limit access to the relevant funding sources.

prices for energy or energy-related contracts may not be readily determinable PPL has entered into certain guarantee agreements that are within the scope because of market illiquidity. If no active trading market exists, contracts are of FIN 45, 'Guarantor's Accounting and Disclosure Requirements for Guarantees, valued using internally developed models, which are then reviewed by an inde-Including Indirect Guarantees of Indebtedness of Others, an Interpretation of pendent, internal group. Although PPL believes that its valuation methods are FASB Statements No. 5,57, and 107 and Rescission of FASB Interpretation reasonable, changes inthe underlying assumptions could result insignificantly No. 34. See Note 14 to the Financial Statements for adiscussion on guarantees.

different values and realization infuture periods.

To record derivatives at their fair value, PPL discounts the forward values contracts that met the definition of energy trading activities as defined by EITF using LIBOR. Additionally, PPL reduces derivative assets' carrying values to 98-10, "Accounting for Energy Trading and Risk Management Activities" are recognize differences incounterparty credit quality and potential illiquidity in reflected inthe financial statements using the accrual method of accounting.

the market: Under the accrual method of accounting, unrealized gains and losses are not

• The credit adjustment takes into account the probability of default, as calcu- reflected inthe financial statements. Prior periods were reclassified. No cumu-lated by an independent service, for each counterparty that has an out-of- lative effect adjustment was required upon adoption.

the money position with PPL. PPL has adopted the final provisions of EITF 03-11 prospectively as of

. The liquidity adjustment takes into account the tact that it may not be appro- October 1, 2003. As aresult of this adoption, non-trading bilateral sales of priate to value contracts at the midpoint of the bid/ask spread. PPL might electricity at major market delivery points are netted with purchases that offset have to accept the 'bid" price if PPL wanted to close an open sales position the sales at those same delivery points. Amajor market delivery point is or PPL might have to accept the "ask" price if PPL wanted to close an open any delivery point with liquid pricing available. See Note 17 to the Financial purchase position. Statements for the impact of the adoption of EITF 03-11.

PPLs short-term derivative contracts are recorded as "Price risk management Accounting and Reporting assets" and "Price risk management liabilities" on the Balance Sheet. Long-term PPL follows the provisions of SFAS 133, 'Accounting for Derivative Instruments derivative contracts are included in "Regulatory and Other Noncurrent Assets -

and Hedging Activities," as amended by SFAS 138, 'Accounting for Certain Other" and "Deferred Credits and Other Noncurrent Liabilities - Other."

Derivative Instruments and Certain Hedging Activities," and SFAS 149,

'Amendment of Statement 133 on Derivative Instruments and Hedging Accounting Designation Activities," and interpreted by DIG issues (together, "SFAS 133"), EITF 02-3, Energy contracts that do not qualify as derivatives receive accrual accounting.

'Issues Involved inAccounting for Derivative Contracts Held for Trading For energy contracts that meet the definition of a derivative, the circumstances Purposes and Contracts Involved inEnergy Trading and Risk Management and intent existing at the time that energy transactions are entered into deter-Activities," and EITF 03-11, "Reporting Realized Gains and Losses on Derivative mine their accounting designation. These designations are verified by PPLs Instruments That Are Subject to FASB Statement No. 133 and Not 'Held for risk control group on a daily basis. The following is a summary of the guide-Trading Purposes' as Defined inIssue No. 02-3," to account for and report lines that have been provided to the traders who are responsible for contract on contracts entered into to manage market risk. SFAS 133 requires that all designation for derivative energy contracts due to the adoption of SFAS 149: 37 derivative instruments be recorded at fair value on the balance sheet as an

• Any wholesale and retail contracts to sell or buy electricity and the related asset or liability (unless they meet SFAS 133s criteria for exclusion) and capacity that are expected to be delivered from PPLs generation or that are 00 that changes inthe derivative's fair value be recognized currently in earnings approved by the RMC to fulfill a strategic element of PPLs overall marketing ~0 0

unless specific hedge accounting criteria are met. strategy are considered "normal." These transactions are not recorded in -v In April 2003, the FASB issued SFAS 149, which amends and clarifies the financial statements and have no earnings impact until delivery.

SFAS 133 to improve financial accounting and reporting for derivative

• Physical electricity-only transactions can receive cash flow hedge treatment Z0 instruments and hedging activities. To ensure that contracts with comparable if all of the qualifications under SFAS 133 are met. Any unrealized gains z

characteristics are accounted for similarly, SFAS 149 clarifies the circumstances or losses on transactions receiving cash flow hedge treatment are recorded under which acontract with an initial net investment meets the characteristics in other comprehensive income. These unrealized gains and losses become z zD of aderivative, clarifies when aderivative contains afinancing component, realized when the contracts settle and are recognized in income when the C

£3 amends the definition of an "underlying" and amends certain other existing hedged transactions occur.

0 pronouncements. Additionally, SFAS 149 placed additional limitations on the

• Physical electricity purchases that increase PP~s long position and any 0

use of the normal purchase or normal sale exception. SFAS 149 was effective energy sale or purchase judged a "market call" are considered speculative, for contracts entered into or modified and for hedging relationships designated with unrealized gains or losses recorded immediately through earnings.

after June 30, 2003, except certain provisions relating to forward purchases

• Financial transactions, which can be settled incash, cannot be considered or sales of when-issued securities or other securities that did not yet exist. "normal" because they do not require physical delivery. These transactions PPL adopted SFAS 149 as of July 1, 2003. The adoption of SFAS 149 did receive cash flow hedge treatment it they lock-in the price PPL will receive not have asignificant impact on PPL. or pay for energy expected to be generated or purchased inthe spot market.

PPL adopted the final provisions of EITF 02-3 during the fourth quarter Any unrealized gains or losses on transactions that receive cash flow hedge of 2002. As such, PPL now reflects its net realized and unrealized gains and treatment are recorded in other comprehensive income. These unrealized losses associated with all derivatives that are held for trading purposes in the gains and losses become realized when the contracts settle and are recog-

"Net energy trading margins' line on the Statement of Income. Non-derivative nized inincome when the hedged transactions occur.

Management's Discussion and Analysis

• Physical and financial transactions for gas and oil to meet fuel and retail state regulations. To hedge the impact of market price fluctuations on PPus requirements can receive cash flow hedge treatment if they lock-in the energy-related assets, liabilities and other contractual arrangements, PPL price PPL will pay in the spot market. Any unrealized gains or losses on EnergyPlus sells and purchases physical energy at the wholesale level under transactions receiving cash flow hedge treatment are recorded inother FERC market-based tariffs throughout the U.S. and enters into financial comprehensive income. These unrealized gains and losses become realized exchange-traded and over-the-counter contracts. Because of the generating when the contracts settle and are recognized inincome when the hedged assets PPL owns or controls, the majority of PPUs energy transactions qualify transactions occur. for accrual or hedge accounting.

• Option contracts that do not meet the requirements of DIG Issue C15, Within PPL's hedge portfolio, the decision to enter into energy contracts Scope Exceptions: Interpreting the Normal Purchases and Normal Sales hinges on the expected value of PPMs generation. To address this risk, PPL Exception as an Election," do not receive hedge accounting treatment takes a conservative approach in determining the number of MWhs that are and are marked to market through earnings. available to be sold forward. Inthis regard, PPL reduces the maximum poten-tial output that a plant may produce by three factors - planned maintenance, In addition to energy-related transactions, PPL enters into financial unplanned outages and economic conditions. The potential output of a plant interest rate and foreign currency swap contracts to hedge interest expense is first reduced by the amount of unavailable generation due to planned main-associated with both existing and anticipated debt issuances. PPL also tenance on aparticular unit. Another reduction, representing the unplanned enters into foreign currency swap contracts to hedge the fair value of firm outage rate, isthe amount of MWhs that historically is not produced by a commitments denominated in foreign currency and net investments inforeign plant due to such factors as equipment breakage. Finally, the potential output operations. As with energy transactions, the circumstances and intent existing of certain plants (like peaking units) are reduced because their higher cost at the time of the transaction determine acontract's accounting designation, of production will not allow them to economically run during all hours.

which is subsequently verified by PPUs risk control group on adaily basis.

PPLs non-trading portfolio also includes full requirements energy contracts.

The following isa summary of certain guidelines that have been provided to The net obligation to serve these contracts changes minute by minute. PPL the Treasury Department, which is responsible for contract designation:

analyzes historical on-peak and off-peak usage patterns, as well as spot prices

• Transactions to lock-in an interest rate prior to adebt issuance are consid-and weather patterns, to determine amonthly level of a block of electricity that ered cash flow hedges. Any unrealized gains or losses on transactions best fits the usage patterns in order to minimize earnings volatility. On aforward 38 receiving cash flow hedge treatment are recorded in other comprehensive basis, PPL reserves a block amount of generation for full requirements energy

'0 income and are amortized as a component of interest expense over the contracts that isexpected to be the best match with their anticipated usage

'0 life of the debt.

0 patterns and energy peaks. Anticipated usage patterns and peaks are affected 0 . Transactions entered into to hedge fluctuations inthe value of existing IM0 by expected load growth, regional economic drivers and seasonality.

debt are considered fair value hedges with no earnings impact until the PPUs commodity derivative contracts that qualify for hedge accounting D

aZ0 debt is terminated because the hedged debt is also marked to market.

treatment mature at various times through 2010. The following chart sets forth 0m . Transactions entered into to hedge the value of a net investment of foreign z PPUs net fair market value of these contracts as of December 31, 2003.

z operations are considered net investment hedges. To the extent that the derivatives are highly effective at hedging the value of the net investment, Gains/(Losses)

M Z gains and losses are recorded inother comprehensive income/loss and Fair value of contracts outstanding at the beginning of the year $63 Contracts realized or otherwise settled during the year (67)

C will not be recorded inearnings until the investment is disposed of.

I-Fair value of new contracts at inception IIX . Transactions which do not qualify for hedge accounting treatment are Other changes infair values 90 ii marked to market through earnings.

0 Fair value of contracts outstanding at the end of the year $86 Commodity Price Risk Commodity price risk is one of PPUs most significant risks due to the level of During 2003, PPL realized or otherwise settled net gains of approximately investment that PPL maintains in its generation assets, coupled with the volatil- $67 million related to contracts entered into prior to January 1,2003. This ity of prices for energy and energy-related products. Several factors influence amount does not reflect intra-quarter contracts that were entered into and price levels and volatilities. These factors include, but are not limited to, seasonal settled during the period.

changes in demand, weather conditions, available generating assets within "Other changes infair values,' again of approximately $90 million, repre-regions, transportation availability and reliability within and between regions, sents changes inthe market value that occurred during 2003 for contracts that market liquidity, and the nature and extent of current and potential federal and were outstanding at the end of 2003.

The following chart segregates estimated fair values of PPUs commodity derivative contracts that qualify for hedge accounting treatment at December 31, 2003 based on whether the fair values are determined by quoted market prices or other more subjective means.

Maturity Maturity Less Than Maturity Maturity inExcess Total Fair Fair Value of Contracts at Period-End Gains/(Losses) 1Year 1-3 Years 3-5 Years of 5 Years Value Source of Fair Value Prices actively quoted $7 $1 $8 Prices provided by other external sources 47 32 $(1) 78 Prices based on models and other valuation methods Fair value of contracts outstanding at the end of the period $54 $33 $(1) - $86 The 'Prices actively quoted" category includes the fair value of exchange- As of December 31, 2003, PPL estimated that a 10% adverse movement traded natural gas futures contracts quoted on the New York Mercantile in market prices across all geographic areas and time periods would have Exchange (NYMEX). The NYMEX has currently quoted prices through 2010. decreased the value of the commodity contracts in its non-trading portfolio The 'Prices provided by other external sources' category includes PPL's by approximately $146 million, which is equal to the estimated decrease at forward positions and options innatural gas and power and natural gas basis December 31, 2002. However, the change inthe value of the non-trading port-swaps at points for which over-the-counter (OTC) broker quotes are available. folio would have been substantially offset by an increase inthe value of the The fair value of electricity positions recorded above use the midpoint of the underlying commodity, the electricity generated, because these contracts serve bidlask spreads obtained through OTC brokers. On average, OTC quotes for to reduce the market risk inherent in the generation of electricity. Additionally, forwards and swaps of natural gas and power extend one and two years into the value of PPLs unsold generation would be improved. Because PPts elec-the future. tricity portfolio is generally in anet sales position, the adverse movement in The 'Prices based on models and other valuation methods' category prices is usually an increase inprices. Conversely, because PPLs commodity includes the value of transactions for which an internally developed price fuels portfolio is generally ina net purchase position, the adverse movement curve was constructed as aresult of the long-dated nature of the transaction inprices is usually adecrease inprices. If both of these scenarios happened, 39 or the illiquidity of the market point, or the value of options not quoted by an the implied margins for the unsold generation would increase.

exchange or OTC broker. Additionally, this category includes "strip" transac- PPL also executes energy contracts to take advantage of market opportuni-tions whose prices are obtained from external sources and then modeled to ties. As a result, PPL may at times create a net open position inits portfolio C) monthly prices as appropriate. that could result insignificant losses if prices do not move inthe manner or

~0

-0 I

M0 Because of PPLM efforts to hedge the value of the energy from its genera- direction anticipated. The margins from these trading activities are shown tion assets, PPL has open contractual positions. If PPL were unable to deliver inthe Statement of Income as "Net energy trading margins.'

0 firm capacity and energy under its agreements, under certain circumstances PP1s trading contracts mature at various times through 2005. The z it would be required to pay damages. These damages would be based on the following chart sets forth PPUs net fair market value of trading contracts z

difference between the market price to acquire replacement capacity or energy as of December 31, 2003:

and the contract price of the undelivered capacity or energy. Depending on price Gains/(Losses) C volatility inthe wholesale energy markets, such damages could be significant. Fair value of contracts outstanding at the beginning of the year $ (6) I Extreme weather conditions, unplanned power plant outages, transmission dis- Contracts realized or otherwise settled during the year 21 23 H

ruptions, non-performance by counterparties (or their counterparties) with which Fair value of new contracts at inception 1 M0 it has power contracts and other factors could affect PPLs ability to meet its firm Other changes infair values (13) capacity or energy obligations, or cause significant increases inthe market Fair value of contracts outstanding at the end of the year $ 3 price of replacement capacity and energy. Although PPL attempts to mitigate these risks, there can be no assurance that it will be able to fully meet its firm During 2003, PPL realized or otherwise settled net losses of approximately obligations, that it will not be required to pay damages for failure to perform, $21 million related to contracts entered into prior to January 1,2003. This or that it will not experience counterparty non-pertormance inthe future. amount does not reflect intra-year contracts that were entered into and settled during the period.

Management's Discussion and Analysis The fair value of new contracts at inception is usually zero, because they As of December 31, 2003, the net loss on PPUs trading activities expected are entered into at current market prices. However, when PPL enters into an to be recognized inearnings during the next three months is approximately option contract, apremium is paid or received. PPL paid $1million, net, $2million.

during 2003 for these option contracts. The following chart segregates estimated fair values of PPUs trading port-

'Other changes infair values,' aloss of approximately $13 million, repre- folio at December 31, 2003 based on whether the fair values are determined sent changes inthe market value of contracts outstanding at the end of 2003. by quoted market prices or other more subjective means.

Maturity Maturity Less Than Maturity Maturity inExcess Total Fair Fair Value of Contracts at Period-End Gains/(Losses) 1 Year 1-3 Years 3-5 Years of 5 Years Value Source of Fair Value Prices actively quoted Prices provided by other external sources Prices based on models and other valuation methods $3 $3 Fair value of contracts outstanding at the end of the period $3 $3 The 'Prices actively quoted" category includes the fair value of exchange- Interest Rate Risk traded natural gas futures contracts quoted on the NYMEX. The NYMEX has PPL and its subsidiaries have issued debt to finance their operations. PPL currently quoted prices through 2010. utilizes various financial derivative products to adjust the mix of fixed and The "Prices provided by other external sources' category includes PPUs floating interest rates in its debt portfolio, adjust the duration of its debt port-forward positions and options in natural gas and power and natural gas basis folio and lock in U.S. Treasury rates (and interest rate spreads over treasuries) swaps at points for which OTC broker quotes are available. The fair value of inanticipation of future financing, when appropriate. Risk limits under the electricity positions recorded above use the midpoint of the bid/ask spreads risk management program are designed to balance risk exposure to volatility obtained through OTC brokers. On average, OTC quotes for forwards and ininterest expense and changes inthe fair value of PPUs debt portfolio due swaps of natural gas and power extend one and two years into the future. to changes inthe absolute level of interest rates.

40 The "Prices based on models and other valuation methods" category At December 31, 2003, PP1s potential annual exposure to increased

-D includes the value of transactions for which an internally developed price interest expense, based on a 10% increase in interest rates, was estimated

_0 0

curve was constructed as aresult of the long-dated nature of the transaction at $2million, compared to a$3million increase at December 31, 2002.

or the illiquidity of the market point, or the value of options not quoted by an PPL is also exposed to changes inthe fair value of its U.S. and international M0

-U exchange or OTC broker. Additionally, this category includes "strip" transac- debt portfolios. At December 31, 2003, PPL estimated that its potential expo-tions whose prices are obtained from external sources and then modeled to sure to a change inthe fair value of its debt portfolio, through a10% adverse monthly prices as appropriate. movement ininterest rates, was $168 million, compared to $219 million at 0

As of December 31, 2003, PPL estimated that a10% adverse movement December 31, 2002.

0 in market prices across all geographic areas and time periods would have PPL utilizes various risk management instruments to reduce its exposure

-U decreased the value of the commodity contracts inits trading portfolio by to adverse interest rate movements for future anticipated financing. While C:

r-

$3million compared to adecrease of $7million at December 31, 2002. PPL isexposed to changes inthe fair value of these instruments, they are Inaccordance with its marketing strategy, PPL does not completely hedge designed such that an economic loss invalue should generally be offset by

-U 0 its generation output or fuel requirements. PPL estimates that for its entire interest rate savings at the time the future anticipated financing is completed.

M portfolio, including all generation and physical and financial energy positions, At December 31, 2003, PPL estimated that its potential exposure to achange a 10% adverse change inpower prices across all geographic zones and time inthe fair value of these instruments, through a 10% adverse movement in periods will decrease expected 2004 gross margins by about $3million. interest rates, was approximately $6million, compared to an $18 million Similarly, a 10% adverse movement inall fossil fuel prices will decrease 2004 exposure at December 31, 2002.

gross margins by $15 million.

a

Foreign Currency Risk hypothetical 10% increase in interest rates and a 10% decrease inequity prices PPL is exposed to foreign currency risk, primarily through investments in would have resulted inan estimated $24 million reduction inthe fair value of affiliates inLatin America and Europe. Inaddition, PPL may make purchases the trust assets, as compared to a$16 million reduction at December 31, 2002.

of equipment in currencies other than U.S. dollars. PPL Electric's 1998 restructuring settlement agreement provides for the PPL has adopted a foreign currency risk management program designed collection of authorized nuclear decommissioning costs through the CTC.

to hedge certain foreign currency exposures, including firm commitments, Additionally, PPL Electric is permitted to seek recovery from customers of up to recognized assets or liabilities and net investments. Inaddition, PPL enters 96% of certain increases inthese costs. Under the power supply agreements into financial instruments to protect against foreign currency translation risk. between PPL Electric and PPL EnergyPlus, these revenues are passed on to PPL holds contracts for the forward purchase of 26 million euros to pay PPL EnergyPlus. Similarly, these revenues are passed on to PPL Susquehanna for certain equipment of PPL Susquehanna in2004. The estimated value of under a power supply agreement between PPL EnergyPlus and PPL Susquehanna.

these forward purchases as of December 31, 2003, being the amount PPL would These revenues are used to fund the trusts.

receive to terminate them, was $1million.

Credit Risk PPL executed forward sale transactions for £25 million to hedge aportion of Credit risk relates to the risk of loss that PPL would incur as a result of its net investment inWPDH Limited. The estimated value of these agreements non-performance by counterparties of their contractual obligations. PPL main-as of December 31, 2003 was $4million, being the amount PPL would pay to tains credit policies and procedures with respect to counterparties (including terminate the transactions.

requirements that counterparties maintain certain credit ratings criteria) and PPL executed forward sale transactions for 3.1 billion Chilean pesos to requires other assurances inthe form of credit support or collateral incertain hedge aportion of its net investment in its subsidiary that owns CGE. The circumstances inorder to limit counterparty credit risk. However, PPL has estimated value of these agreements as of December 31, 2003 was $1million, concentrations of suppliers and customers among electric utilities, natural gas being the amount PPL would pay to terminate the transactions.

distribution companies and other energy marketing and trading companies.

To protect expected income in Chilean pesos, PPL entered into average These concentrations of counterparties may impact PPUs overall exposure to rate options for 2.4 billion Chilean pesos. At December 31, 2003, the market credit risk, either positively or negatively, inthat counterparties may be similarly value of these positions, representing the amount PPL would pay to terminate affected by changes in economic, regulatory or other conditions. As discussed them, was insignificant.

above under "Contract Valuation," PPL records certain non-performance reserves 41 WPDH Limited executed cross-currency swaps totaling $1.5 billion to to reflect the probability that acounterparty with contracts that are out of the hedge the interest payments and value of its U.S. dollar-denominated bonds. -D money (from the counterpartys standpoint) will default inits performance, in r The estimated value of this position on December 31, 2003, being the amount which case PPL would have to sell into alower-priced market or purchase 0 PPL would pay to terminate them, including accrued interest, was $84 million. -UM from a higher-priced market. These reserves are reflected inthe fair value of M0 On the Statement of Income, gains and loses associated with hedges of I assets recorded in'Price risk management assets" on the Balance Sheet.

interest payments denominated inforeign currencies are reflected in 'Interest PPL also records reserves to reflect the probability that acounterparty will not Z0 Expense." Gains and losses associated with the purchase of equipment are make payments for deliveries PPL has made but not yet billed. These reserves reflected in'Depreciation." Gains and losses associated with net investment are reflected in 'Unbilled Revenues" on the Balance Sheet. PPL has also estab-hedges remain in "Accumulated other comprehensive loss" on the Balance lished areserve with respect to certain sales to the California ISO for which C Sheet until the investment isdisposed.

PPL has not yet been paid, as well as areserve related to PPLs exposure as M 1

Nuclear Decommissioning Fund - Securities Price Risk aresult of the Enron bankruptcy, which are reflected in "Accounts receivable" Inconnection with certain NRC requirements, PPL Susquehanna maintains on the Balance Sheet. See Notes 14 and 17 to the Financial Statements.

0 trust funds to fund certain costs of decommissioning the Susquehanna station. I Related Party Transactions As of December 31, 2003, these funds were invested primarily indomestic PPL is not aware of any material ownership interests or operating responsibil-equity securities and fixed-rate, fixed-income securities and are reflected at ity by senior management of PPL inoutside partnerships, including leasing fair value on PPLs Balance Sheet. The mix of securities is designed to provide transactions with variable interest entities, or other entities doing business returns to be used to fund Susquehanna's decommissioning and to compen-with PPL.

sate for inflationary increases indecommissioning costs. However, the equity

. For additional information on related party accounting transactions, see securities included inthe trusts are exposed to price fluctuation in equity Note 15 to the Financial Statements.

markets, and the values of fixed-rate, fixed-income securities are exposed to changes in interest rates. PPL Susquehanna actively monitors the investment Capital Expenditure Requirements performance and periodically reviews asset allocation inaccordance with its The schedule below shows PPLs current capital expenditure projections for nuclear decommissioning trust policy statement. At December 31, 2003, a the years 2004-2008 and actual spending for the year 2003:

Management's Discussion and Analysis Actual Projected 2003 2004 2005 2006 2007 2008 Construction expenditures (a) (b)

Generating facilities (c) $300 $167 $193 $161 $194 $180 Transmission and distribution facilities 467 427 416 436 473 476 Environmental 21 5 12 32 74 102 Other 47 39 28 23 16 16 Total Construction Expenditures 835 638 649 652 757 774 Nuclear fuel 53 56 59 62 63 64 Total Capital Expenditures $888 $694 $708 $714 $820 $838 (a) Construction expenditures include AFUDC and capitalized interest, which are expected to be less than $12 million in each of the years 2004-2008.

(b) This information excludes any investments by PPL Global for new projects.

to Expenditures for generating facilities in2003 include $116 million for facilities under synthetic lease agreements that had been reflected oft-balance sheel prior to December 31, 2003. Projected capital expenditures on these facilities are also included for the years 2004 through 2008.

PPL's capital expenditure projections tor the years 2004-2008 total about NEW ACCOUNTING STANDARDS

$3.8 billion. Capital expenditure plans are revised periodically to reflect changes FIN 46 and FIN 46(R) inmarket and asset regulatory conditions. PPL also leases vehicles, personal In January 2003, the FASB issued Interpretation No. 46, 'Consolidation of computers and other equipment, as described in Note 10 to the Financial Variable Interest Entities, an Interpretation of ARB No. 51. FIN 46 clarifies that Statements. See Note 14 for additional information regarding potential capital variable interest entities, as defined therein, that do not disperse risks among expenditures for environmental projects. the parties involved should be consolidated by the entity that is determined to be the primary beneficiary. FIN 46 also requires certain disclosures to be made Acquisitions, Development and Divestitures by the primary beneficiary and by an enterprise that holds a significant variable From time-to-time, PPL and its subsidiaries are involved innegotiations with interest in a variable interest entity but is not the primary beneficiary. FIN 46 third parties regarding acquisitions, joint ventures and other arrangements 42 applies immediately to variable interest entities created after January 31, 2003 which may or may not result in definitive agreements. See Note 9 to the and to variable interest entities in which an enterprise obtains an interest after

-U

-U Financial Statements for information regarding recent acquisitions and devel-January 31, 2003. For variable interest entities in which an enterprise holds a 0

opment activities.

0 variable interest that was acquired before February 1, 2003, FIN 46 was origi-At December 31, 2003, PPL Global had investments in foreign facilities,

-U nally required to be adopted no later than the first fiscal year or interim period 0 including consolidated investments in WPD, Emel, EC and others. See Note 3 beginning after June 15, 2003. However, in October 2003, the FASB issued to the Financial Statements for information on unconsolidated investments 0 FSP FIN 46-6, "Effective Date of FASB Interpretation No. 46, Consolidation z

accounted for under the equity method.

of Variable Interest Entities, which delayed the effective date for applying the PPL Global isexploring potential sale opportunities for its interest in z provisions of FIN 46 to interests held by public entities in variable interest zH CGE, within the context of an on-going review of its international minority entities or potential variable interest entities created before February 1, 2003 ownership investments.

C until the end of the first interim period ending after December 15, 2003.

At December 31, 2003, PPL had domestic generation projects under In December 2003, the FASB revised FIN 46 by issuing Interpretation No. 46 development which will provide 663 MW of additional generation.

(revised December 2003), which is known as FIN 46(R) and replaces FIN 46.

-a 0

PPL is continuously reexamining development projects based on market I, FIN 46(R) does not change the general consolidation concepts of FIN 46. Among conditions and other factors to determine whether to proceed with these projects, other things, FIN 46(R) again changes the effective date for applying the provi-sell them, cancel them, expand them, execute tolling agreements or pursue sions of FIN 46 to certain entities, clarifies certain provisions of FIN 46 and other opportunities.

provides additional scope exceptions for certain types of businesses. For enti-Environmental Matters ties to which the provisions of FIN 46 have not been applied as of December 24, See Note 14 to the Financial Statements for adiscussion of environmental 2003, FIN 46(R) provides that a public entity that is not a small business issuer matters.

should apply the provisions of FIN 46 or FIN 46(R) as follows: (i) FIN 46(R) The trusts hold subordinated debt securities of PPL Capital Funding, in shall be applied to all entities no later than the end of the first reporting period the case of PPL Capital Funding Trust I, and WPD LLP, inthe case of SIUK that ends after March 15, 2004 and (ii) FIN 46 or FIN 46(R) should be applied Capital Trust 1.As aresult of deconsolidating the trusts, the subordinated debt to entities that are considered to be SPEs no later than the end of the first securities are no longer eliminated in the consolidated financial statements. As reporting period that ends after December 15, 2003. of December 31, 2003, $681 million is reflected as 'Long-term Debt with As permitted by FIN 46(R), PPL adopted FIN 46 effective December 31, 2003 Affiliate Trusts' in PPLs Balance Sheet.

for entities created before February 1,2003 that are considered to be SPEs. The effect on the Balance Sheet as a result of deconsolidating the trusts This adoption resulted inthe consolidation of the lessors under the operating was an increase inboth total assets and total liabilities of $21 million. The leases for the Sundance, University Park and Lower Mt. Bethel generation increase inassets relates to the investments inthe common securities of the facilities, as well as the deconsolidation of two wholly-owned trusts. See below trusts, which are no longer eliminated in the consolidated financial statements.

for further discussion. Also, as permitted by FIN 46(R), PPL deferred the appli- The increase in liabilities consists primarily of the difference between the car-cation of FIN 46 for other entities and plans to adopt FIN 46(R) for all entities rying value of the preferred securities issued by the trusts compared to the on March 31, 2004. carrying value of the subordinated debt securities of PPL Capital Funding and PPL is inthe process of evaluating entities in which it holds a variable WPD LLR The deconsolidation of the trusts did not impact the eamings of PPL.

interest in accordance with FIN 46(R). PPL is currently not aware of any vari- See the Statement of Company-obligated Mandatorily Redeemable able interest entities that are not consolidated as of December 31, 2003 but Securities contained inthe Financial Statements for a discussion of the trusts which it will be required to consolidate inaccordance with FIN 46(R) effective and their preferred securities, as well as the subordinated debt securities March 31, 2004. As it continues to evaluate the impact of applying FIN 46(R), issued to the trusts.

PPL may identify additional entities that it would need to consolidate.

Other Additional Entities Consolidated See Note 22 to the Financial Statements for information on other new account-The lessors under the operating leases for the Sundance, University Park ing standards adopted in2003 or pending adoption.

and Lower Mt. Bethel generation facilities are variable interest entities that are considered to be SPEs. PPL is the primary beneficiary of these entities. APPLICATION OF CRITICAL ACCOUNTING POLICIES Consequently, PPL was required to consolidate the financial statements of the PPUs financial condition and results of operations are impacted by the methods, 43 lessors effective December 31, 2003. Upon initial consolidation, PPL recog- assumptions and estimates used inthe application of critical accounting nized $1.1 billion of additional assets and liabilities on its balance sheet and a policies. The following accounting policies are particularly important to the -0

-u financial condition or results of operations of PPL, and require estimates or 0 charge of $27 million, after-tax, as acumulative effect of achange inaccount-ing principle. The additional assets consist principally of the generation other judgments of matters inherently uncertain. Changes in the estimates 0 I

facilities, and the additional liabilities consist principally of the lease financ- or other judgments included within these accounting policies could result in

-4 ing. See Note 22 to the Financial Statements for adiscussion of the leases. a significant change to the information presented in the financial statements. 0 z

(These accounting policies are also discussed in Note 1 to the Financial Entities Deconsolidated Statements.) PPUs senior management has reviewed these critical accounting Effective December 31, 2003, PPL deconsolidated PPL Capital Funding policies, and the estimates and assumptions regarding them, with its Audit Trust I and SIUK Capital Trust I. These trusts are considered to be SPEs and z Committee. Inaddition, PPUs senior management has reviewed the following C were deconsolidated because PPL is not the primary beneficiary of the trusts disclosures regarding the application of these critical accounting policies M under current interpretations of FIN 46. Therefore, the "Company-obligated with the Audit Committee. I Mandatorily Redeemable Preferred Securities of Subsidiary Trusts Holding W0

-m Solely Company Debentures" amounting to $661 million, which would have 1) Price Risk Management been recorded as a component of long-term debt in 2003 in accordance with See "Risk Management - Energy Marketing & Trading and Other' inFinancial SFAS 150, "Accounting for Certain Financial Instruments with Characteristics Condition.

of Both Liabilities and Equity,' if the trusts were consolidated, are not reflected

2) Pension and Other Postretirement Benefits in PPLs Balance Sheet at December 31, 2003. Instead, the subordinated PPL follows the guidance of SFAS 87, "Employers' Accounting for Pensions,"

debt securities that support the trust preferred securities are reflected in and SFAS 106, 'Employers' Accounting for Postretirement Benefits Other

'Long-term Debt with Affiliate Trusts" as of December 31, 2003. See below Than Pensions,' when accounting for these benefits. Under these accounting for further discussion.

Management's Discussion and Analysis standards, assumptions are made regarding the valuation of benefit obligations Inselecting an expected return on plan assets, PPL considers tax implica-and the performance of plan assets. Delayed recognition of differences between tions, past performance and economic forecasts for the types of investments actual results and expected or estimated results is aguiding principle of these held by the plan. At December 31, 2003, PPLs expected return on plan assets standards. This delayed recognition of actual results allows for asmoothed remained at 9.0% for its domestic pension plans and 7.8% for its other post-recognition of changes in benefit obligations and plan performance over the retirement plans. For its international plans, PPL maintained aweighted aver-working lives of the employees who benefit under the plans. The primary age of 8.30% as the expected return on plan assets at December 31, 2003.

assumptions are as follows: Inselecting a rate of compensation increase, PPL considers past experience

• Discount Rate - The discount rate is used in calculating the present value in light of movements in inflation rates. At December 31, 2003, PPUs rate of of benefits, which is based on projections of benefit payments to be made compensation increase remained at 4.0% for its domestic plans. For its inter-inthe future. national plans, PPIs rate of compensation increase remained at 3.75% at

• Expected Return on Plan Assets - Management projects the future return December 31, 2003.

on plan assets considering prior performance, but primarily based upon Inselecting health care cost trend rates, PPL considers past performance the plans' mix of assets and expectations for the long-term returns on those and forecasts of health care costs. At December 31, 2003, PPLs health care asset classes. These projected returns reduce the net benefit costs the cost trend rates were 11% for 2004, gradually declining to 5.0% for 2010.

company will record currently. Avariance in the assumptions listed above could have asignificant impact

• Rate of Compensation Increase - Management projects employees' annual on projected benefit obligations, accrued pension and other postretirement ben-pay increases, which are used to project employees' pension benefits at efit liabilities, reported annual net periodic pension and other postretirement retirement. benefit cost and other comprehensive income (OCI). The following chart reflects

• Health Care Cost Trend Rate - Management projects the expected increases the sensitivities associated with achange in certain assumptions. While the inthe cost of health care. chart below reflects either an increase or decrease ineach assumption, the inverse of this change would impact the projected benefit obligation, accrued In selecting discount rates, PPL considers fixed-income security yield rates.

pension and other postretirement benefit liabilities, reported annual net periodic At December 31, 2003, PPL decreased the discount rate for its domestic plans pension and other postretirement benefit cost and OCI by a similar amount from 6.75% to 6.25% as a result of decreased fixed-income security returns.

inthe opposite direction. Each sensitivity below reflects an evaluation of the 44 For its international plans, PPL decreased the discount rate for its international change based solely on achange inthat assumption.

-v plans from 5.75% to 5.50% at December 31, 2003.

• 0 Increase/(Decrease)

_0 Change in Impact on Impact on Impact Impact M0 Actuarial Assumption Assumption Obligation Liabilities a) on Cost on OCI Z0 Discount Rate (0.25)% $160 $6 $6 $ 89 Expected Return on Plan Assets (0.25)% N/A 10 10 0

Rate of Compensation Increase 0.25% 20 4 4 Health Care Cost Trend Rate (b) 1.0% 33 5 5 N/A (a)Excludes the impact of additional minimum liability.

C: (b) Only impacts other postretirement benefits.

r o

_0 At December 31, 2003, PPL had recognized accrued pension and other In2003, PPL recognized net periodic pension and other postretirement 2

- postretirement benefit liabilities totaling $463 million, included in'Deferred costs charged to operating expenses of $1million. This amount represents a Credits and Other Noncurrent Liabilities - Other" on the Balance Sheet. At $62 million decrease from the credit recognized during 2002. This decrease December 31, 2003, PPL had recognized $4million of prepaid postretirement was primarily due to the decrease inthe discount rate at December 31, 2002.

benefit costs included in Prepayments' on the Balance Sheet. PPLs total pro- As a result of the decrease in the assumed discount rate at December 31, jected obligation for these benefits was approximately $4.8 billion, which was 2003, PPL was required to increase its recognized additional minimum pension offset by $4.0 billion of assets held in various trusts. However, these amounts liability. Recording the change in the additional minimum liability resulted in a are not fully reflected in the current financial statements due to the delayed $10 million increase to the pension related charge to OCI, net of taxes, transla-recognition criteria of the accounting standards for these obligations. tion adjustment and unrecognized prior service costs, with no effect on net

income. This charge increased the pension-related balance inOCI, which PPL performs impairment analyses of goodwill in accordance with is areduction to shareowners equity, to $316 million at December 31, 2003. SFAS 142, "Goodwill and Other Intangible Assets.' SFAS 142 requires an The charges to OCI will reverse infuture periods if the fair value of trust annual impairment test of goodwill and other intangible assets that are not assets exceeds the accumulated benefit obligation. subject to amortization.

Refer to Note 12 to the Financial Statements for additional information PPL completed its annual goodwill impairment test inthe fourth quarter regarding pension and other postretirement benefits. of 2003. This test did not result inan impairment. PPLs most significant assumptions surrounding the goodwill impairment test relate to the determi-

3) Asset Impairment nation of fair value. PPL determined fair value based upon discounted cash PPL and its subsidiaries review long-lived assets for impairment when events flows. A decrease inthe forecasted cash flows of 10% or an increase of the or circumstances indicate carrying amounts may not be recoverable. Assets discount rates by 25 basis points would have resulted inimpairment.

subject to this review, for which impairments have been recorded in2003 or prior years, include international equity investments, new generation assets, 4) Leasing consolidated international energy projects and goodwill. PPL applies the provisions of SFAS 13, "Accounting for Leases,' to all PPL performs impairment analyses for tangible long-lived assets in leasing transactions. In addition, PPL applies the provisions of numerous accordance with SFAS 144, "Accounting for the Impairment or Disposal of other accounting pronouncements issued by the FASB and the EITF that Long-Lived Assets." For long-lived assets to be held and used, SFAS 144 provide specific guidance and additional requirements related to accounting requires companies to (a)recognize an impairment loss only if the carrying for various leasing arrangements. Ingeneral, there are two types of leases amount is not recoverable from undiscounted cash flows and (b)measure from a lessee's perspective: operating leases - leases accounted for off-an impairment loss as the difference between the carrying amount and fair balance sheet; and capital leases - leases capitalized on the balance sheet.

value of the asset. Inaccounting for leases, management makes various assumptions, In determining asset impairments, management must make significant including the discount rate, the fair market value of the leased assets and judgments and estimates to calculate the fair value of an investment. Fair value the estimated useful life, indetermining whether a lease should be classified is developed through consideration of several valuation methods including com- as operating or capital. Changes inthese assumptions could result inthe parison to market multiples, comparison to similar recent sales transactions, difference between whether alease is determined to be an operating lease comparison to replacement cost and discounted cash flow. Discounted cash or acapital lease, thus significantly impacting the amounts to be recognized 45 flow is calculated by estimating future cash flow streams, applying appropriate inthe financial statements.

discount rates to determine the present value of the cash flow streams, and then Inaddition to uncertainty inherent inmanagement's assumptions, leasing -0 0

assessing the probability of the various cash flow scenarios. The impairment is transactions and the related accounting rules become increasingly complex z

-U then recorded based on the excess of the carrying value of the investment over when they involve: sale/leaseback accounting (leasing transactions where fair value. Changes inassumptions and estimates included within the impair- the lessee previously owned the leased assets); synthetic leases (leases that ment reviews could result in significantly different results than those identified qualify for operating lease treatment for book accounting purposes and financ- 0 z

0 and recorded inthe financial statements. ing treatment for tax accounting purposes); and lessee involvement inthe During 2003, PPL and its subsidiaries evaluated certain gas-fired gen- construction of leased assets. W eration assets for impairment, as events and circumstances indicated that the At December 31, 2003, PPL subsidiaries participated in one significant z z

carrying value of these investments may not be recoverable. PPL did not record sale/leaseback transaction which has been accounted for as an operating C an impairment of its new gas-tired generation assets in2003. For these impair- lease. As discussed in Note 22 to the Financial Statements, the lessors under certain synthetic operating leases previously accounted for off-balance sheet :D ment analyses, the most significant assumption was the estimate of future cash *0 0

flows. PPL estimates future cash flow using information from its corporate busi- were consolidated effective December 31, 2003 as aresult of the adoption ness plan adjusted for any recent sales or purchase commitments. Key factors of FIN 46, "Consolidation of Variable Interest Entities, an Interpretation of that impact cash flows include projected prices for electricity and gas as well ARB No. 51, for certain entities.

as firm sales and purchase commitments. A10% decrease inestimated future cash flows for certain in-service gas-fired generation assets would have resulted inan impairment charge.

Management's Discussion and Analysis Sale/I easeback than remote but less than likely.' See Note 14 to the Financial Statements for InJuly 2000, PPL Montana sold its interest inthe Colstrip generating plant disclosure of potential loss contingencies, most of which have not met the to owner lessors who are leasing the assets back to PPL Montana under four criteria for accrual under SFAS 5.

36-year operating leases. This transaction is accounted for as an operating Reducing Recorded Loss Contingencies lease inaccordance with current rules related to sale/leaseback arrangements.

When a loss contingency is recorded, PPL identifies, where applicable, the Itfor any reason this transaction did not meet the requirements for off-balance triggering events for subsequently reducing the loss contingency. The trigger-sheet operating lease treatment as a sale/leaseback, PPL would have approxi-ing events generally occur when the contingency has been resolved and the mately $315 million of additional assets and liabilities recorded on its balance actual loss is incurred, or when the risk of loss has diminished or been elimi-sheet at December 31, 2003 and would have recorded additional expenses nated. The following are some of the triggering events which provide for the currently estimated at $9million, alter-tax, in2003.

reduction of certain recorded loss contingencies:

See Note 10 to the Financial Statements for additional information related

• Certain loss contingencies are systematically reduced based on the to operating leases.

expiration of contract terms. An example of this is the recorded liability

5) Loss Contingencies for above-market NUG purchase commitments, which is described below.

PPL periodically records the estimated impacts of various conditions, situa- This loss contingency is being reduced over the lives of the NUG purchase tions or circumstances involving uncertain outcomes. These events are called contracts.

"contingencies," and PPLs accounting for such events is prescribed by SFAS 5, . Allowances for excess or obsolete inventory are reduced as the inventory "Accounting for Contingencies.' SFAS 5 defines acontingency as "an existing items are pulled from the warehouse shelves and sold as scrap or otherwise condition, situation, or set of circumstances involving uncertainty as to possible disposed.

gain or loss to an enterprise that will ultimately be resolved when one or more . Allowances for uncollectible accounts are reduced when accounts are future events occur or fail to occur. written off alter prescribed collection procedures have been exhausted.

For loss contingencies, the loss must be accrued if (1)information is . Environmental loss contingencies are reduced when PPL makes payments available that indicates it is 'probable' that the loss has been incurred, given for environmental remediation.

the likelihood of the uncertain future events and (2)the amount of the loss On-going Assessment of Recorded Loss Contingencies 46 can be reasonably estimated. FASB defines 'probabte" as cases inwhich 'the PPL reviews its loss contingencies on a regular basis to assure that the

-U future event or events are likely to occur." SFAS 5 does not permit the accrual

-U recorded potential loss exposures are reasonable. This involves on-going of contingencies that might result ingains.

0 communication and analyses with internal and external legal counsel, engineers, 0

22 The accrual of a loss contingency involves considerable judgment on the tax specialists, managers invarious operational areas and other parties.

0 part of management. The accounting aspects of loss contingencies include:

All three aspects of accounting for loss contingencies - the initial iden-

-4 (1)the initial identification and recording of the loss contingency; (2)the tification and recording of a probable loss, the identification of triggering 0 determination of a triggering event for reducing a recorded loss contingency; z events to reduce the loss contingency, and the ongoing assessment of the and (3)the on-going assessment as to whether arecorded loss contingency reasonableness of arecorded loss contingency - require significant judgment C.' is reasonable.

by PPLs management.

z z Initial Identification and Recording of the Loss Contingency The largest loss contingency on PPLs balance sheet, and the loss contin-C PPL uses its internal expertise and outside experts (such as lawyers, tax gency that changed most significantly in2003, was for above-market NUG

-UM specialists and engineers), as necessary, to help estimate the probability that a purchase commitments. This loss contingency reflects the estimated difference M0 loss has been incurred and the amount (or range) of the loss. PPL continuously between the above-market contract terms under the purchase commitments,

-4 assesses potential loss contingencies for environmental remediation, litigation and the fair value of electricity. This loss contingency was originally recorded claims, regulatory penalties and other events. at $854 million in 1998, when PPL Electric's generation business was deregu-PPL has identified certain events which could give rise to a loss, but lated. Under regulatory accounting, PPL Electric recorded the above-market which do not meet the conditions for accrual under SFAS 5.SFAS 5requires cost of the purchases from NUGs as part of its purchased power costs on an disclosure, but not arecording, of potential losses when it is "reasonably pos- as-incurred basis, since these costs were recovered in regulated rates. When sible" that a loss has been incurred. FASB defines "reasonably possible" as the generation business was deregulated, the loss contingency associated with cases inwhich "the chance of the future event or events occurring is more the commitment to make above-market NUG purchases was recorded. This

loss contingency for the above-market portion of NUG purchase commitments liability in the financial statements. The initial obligation should be measured was recorded because it was probable that the loss had been incurred and at the estimated fair value. An equivalent amount should be recorded as an the estimate of future energy prices could be reasonably determined, using increase inthe value of the capitalized asset and allocated to expense over the the then forward prices of electricity and capacity. This loss contingency was useful life of the asset. Until the obligation is settled, the liability should be transferred to PPL EnergyPlus inthe July 1,2000 corporate realignment. The increased, through the recognition of accretion expense inthe income state-above-market loss contingency was $352 million at December 31, 2003. ment, for changes inthe obligation due to the passage of time. SFAS 143 is When the loss contingency related to NUG purchases was recorded in effective for fiscal years beginning after June 15, 2002.

1998, PPL Electric established the triggering events for when the loss contin- Indetermining asset retirement obligations, management must make gency would be reduced. Aschedule was established to reduce the liability significant judgments and estimates to calculate fair value. Fair value is devel-based on projected purchases over the lives of the NUG contracts. All but one oped through consideration of estimated retirement costs intodays dollars, of the NUG contracts expire by 2009, with the last one ending in2014. PPL inflated to the anticipated retirement date and then discounted back to the date EnergyPlus reduces the above-market NUG liability based on the aforementioned the asset retirement obligation was incurred. Changes inassumptions and schedule. As PPL EnergyPlus reduces the liability for the above-market NUG estimates included within the calculations of asset retirement obligations could purchases, it offsets the actual cost of NUG purchases, thereby bringing the result insignificantly different results than those identified and recorded in net power purchase expense more inline with market prices. the financial statements.

PPL EnergyPlus assessed the remaining $352 million above-market PPL adopted SFAS 143 effective January 1, 2003. Initial adoption of liability at December 31, 2003, comparing the projected electricity purchases the new rules resulted inan increase in net PP&E of $32 million, reversal of under the terms of the NUG contracts, with the purchases assuming projected previously recorded liabilities of $304 million, recognition of asset retirement market prices for the energy. This assessment was based on projected PJM obligations of $229 million, recognition of adeferred tax liability of $44 million market prices, including capacity, through 2014. The assessment also used and acumulative effect of adoption that increased net income by $63 million.

sensitivities around the market prices, adjusting such prices upwards and At December 31, 2003, PPL had asset retirement obligations totaling $242 mil-downwards by 10%. lion recorded on the Balance Sheet. PPL's most significant assumptions The assessment is dependent on the market prices of energy and the surrounding asset retirement obligations are the forecasted retirement cost, estimated output levels of the NUGs. Market prices of energy are dependent discount rate and inflation rate. Avariance inthe forecasted retirement cost, 47 on many variables, including growth inelectricity demand in PJM, available discount rate or inflation rate could have a significant impact on the ARO

-u generation, and changes in regulatory and economic conditions. Accordingly, liability and the cumulative effect gain. -C market price sensitivities were used in the assessment. It estimated market The following chart reflects the sensitivities associated with a change in 0 0

prices were adjusted upwards by 10% ineach of the years from 2004 through these assumptions upon initial adoption. Each sensitivity below reflects an

-0 2014, the contingency for the above-market NUG purchase commitments evaluation of the change based solely on achange in that assumption only.

0 would be approximately $296 million. Conversely, if estimated market prices Impact on - Impact M 0

were adjusted downwards by 10% during the remaining term of the NUG Change in Cumulative on ARO contracts, the contingency for the above-market NUG purchase commitments Assumption Effect Liability Z C

would be approximately $386 million. The recorded above-market liability Retirement Cost 10%I(10)% $(10)/$10 $22/$(22) C.

a a

Discount Rate 0.25%/(0.25)% $10l$(11) $(23)/$26 of $352 million at December 31, 2003 falls within the range calculated inthe 2 Inflation Rate 0.25%1(0.25)% $(12)/$11 $271$(24) -

year-end assessment. As noted above, it is very difficult to estimate future 2 electricity prices, which are dependent on many variables and subject to significant volatility. However, PPUs management believes that the current OTHER INFORMATION 0

recorded NUG above-market liability was fairly stated at December 31, 2003. PPL's Audit Committee has approved the independent auditor to provide audit and audit-related services and other services permitted by the Sarbanes-

6) Asset Retirement Obligations Oxley Act of 2002 and SEC rules. The audit and audit-related services include In 2001, the FASB issued SFAS 143, 'Accounting for Asset Retirement services inconnection with statutory and regulatory filings, reviews of offering Obligations,' which addresses the accounting for obligations associated with documents and registration statements, employee benefit plan audits, and the retirement of tangible long-lived assets. SFAS 143 requires legal obligations internal control reviews.

associated with the retirement of long-lived assets to be recognized as a

Report of Independent Auditors To the Board of Directors and Shareowners of PPL Corporation: its method of accounting for the amortization of unrecognized gains or losses inthe annual pension expense/income determined under SFAS No. 87, In our opinion, the accompanying consolidated balance sheet and the related Employers'Accounting for Pensions, in 2001. As discussed in Note 18 to consolidated statements of preferred stock, of company-obligated mandatorily the consolidated financial statements, PPL adopted SFAS No. 142, Goodwill redeemable securities and of long-term debt and the related consolidated and Other Intangible Assets, in2002. As discussed inNote 21 to the consoli-statements of income, of cash flows and of shareowners' common equity and dated financial statements, PPL adopted SFAS No. 143, Accounting forAsset comprehensive income present fairly, inall material respects, the financial Retirement Obligations, in2003. As discussed in Note 22 to the consolidated position of PPL Corporation and its subsidiaries (APPLY) at December 31, financial statements, PPL adopted SFAS No. 150, Accounting for Certain 2003 and 2002, and the results of their operations and their cash flows for Financial Instruments with Characteristics of both Liabilities and Equity, each of the three years inthe period ended December 31, 2003 inconformity Emerging Issues Task Force No. 03-11, Reporting Realized Gains and Losses with accounting principles generally accepted in the United States of America. on Derivative Instruments That Are Subject to FAS 133 and Not Held for These financial statements are the responsibility of PPL's management; our Trading Purposes as Defined inIssue No. 02-3, FASB Interpretation ('FIN')

responsibility is to express an opinion on these financial statements based on No. 45, Guarantors Accounting and Disclosure Requirements for Guarantees, our audits. We conducted our audits of these statements in accordance with Including Indirect Guarantees of Indebtedness of Others, and FIN No. 46, auditing standards generally accepted inthe United States of America, which Consolidation of Variable Interest Entities - an interpretation ofARB 51, require that we plan and perform the audit to obtain reasonable assurance as amended by FIN 46(R), in2003. Inaddition, as discussed in Note 1to the about whether the financial statements are free of material misstatement. An consolidated financial statements, PPL elected the fair value method of account-audit includes examining, on atest basis, evidence supporting the amounts ing for stock-based compensation as prescribed by SFAS No. 123, Accounting and disclosures in the financial statements, assessing the accounting princi- for Stock-Based Compensation, as amended by SFAS No. 148, Accounting ples used and significant estimates made by management, and evaluating the for Stock-Based Compensation Transition and Disclosure, an Amendment of overall financial statement presentation. We believe that our audits provide FASB Statement No. 123, in 2003.

a reasonable basis for our opinion.

As discussed in Note 17 to the consolidated financial statements, PPL changed its method of accounting for derivative and hedging activities 48 pursuant to Statement of Financial Accounting Standards (SFAS") No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended

-0 by SFAS No. 138, Accounting for Certain Derivative Instruments and Certain PricewaterhouseCoopers LLP 0

0 Hedging Activities (an amendment of FASB Statement 133), in2001. As dis- Philadelphia, PA cussed in Note 12 to the consolidated financial statements, PPL also changed February 2, 2004 M0 z

'D z

z C

'1' 0

Management's Report on Responsibility for Financial Statements PPL management is responsible for the preparation, integrity and objectivity The Audit Committee of the Board of Directors consists entirely of indepen-of the consolidated financial statements and all other information inthis - - dent directors who are not employees of PPL. The Audit Committee reviews annual report. The financial statements were prepared inaccordance with audit plans related to PPUs internal controls, financial reports and related mat-accounting principles generally accepted inthe United States of America ters and meets regularly with management as well as the independent auditors and include amounts based on management's best estimates and judgments and internal auditors. The independent auditors and the internal auditors have where necessary. Management believes that the financial statements are free free access to the Audit Committee, without management present, to discuss of material misstatements and present fairly the financial position, results internal accounting control, auditing and financial reporting matters.

of operations and cash flows of PPL. PricewaterhouseCoopers LLP, the independent certified public accountants, PPL management is responsible for establishing and maintaining an audited PPLs consolidated financial statements and issued their opinion above.

effective internal control structure and effective disclosure controls and proce- PPL management also recognizes its responsibility for fostering astrong dures for financial reporting. PPL maintains asystem of internal control that ethical climate so that it conducts its business affairs according to the highest is designed to provide reasonable assurance that PPL assets are safeguarded standards of personal and corporate conduct.

from loss or unauthorized use or disposition and that transactions are executed inaccordance with management's authorization and are properly recorded to permit the preparation of financial statements inaccordance with generally accepted accounting principles. This system is augmented by a careful William F Hecht selection and training of qualified personnel, specific delegations of authority, Chairman, President and Chief Executive Officer a proper division of responsibilities, and utilization of written policies and procedures. An internal audit program monitors the effectiveness of this control system. Management believes that its internal control structure and its disclosure controls and procedures for financial reporting are adequate John R.Biggar and effective.. Executive Vice President and Chief Financial Officer 49 0

0 0

0 In

-4 0

Consolidated Statement of Income (Millions of dollars, except per share data) For the years ended December31, 2003 2002 2001 Operating Revenues Utility $3,710 $3,676 $3,034 Unregulated retail electric and gas 152 182 356 Wholesale energy marketing 1,214 1,036 1,027 Net energy trading margins 12 19 37 Energy related businesses 499 568 661 Total 5,587 5,481 5,115 Operating Expenses Operation Fuel 617 584 602 Energy purchases 1,030 916 911 Other operation and maintenance 1,204 1,136 1,059 Amortization of recoverable transition costs 260 226 251 Depreciation (Note 1) 380 367 266 Taxes, other than income (Note 5) 256 231 155 Energy related businesses 491 543 535 Other charges Write-down ot international energy projects (Note 9) 113 336 Cancellation of generation projects (Note 9) 150 Worktorce reduction (Note 20) 9 75 Write-down of generation assets (Note 9) 44 Total 4,247 4,235 4,265 Operating Income 1,340 1,246 850 Other income - net (Note 16) 60 30 16 Interest expense 475 561 386 Income From Continuing Operations Before Income Taxes, Minority Interest 50 and Distributions on Preferred Securities 925 715 480

-u Income taxes (Note 5) 170 210 261 Minority interest (Note 1) 7 78 (2)

Distributions on preferred securities (Note 22) 29 67 52 0

Income From Continuing Operations 719 360 169 Loss from discontinued operations (net of income taxes) (Note 9) 20 2 0

Income Before Cumulative Etfects of Changes in Accounting Principles 699 358 169 0 Cumulative effects of changes in accounting principles (net of income taxes) (Notes 12,18, 21 and 22) 35 (150) 10 Net Income $ 734 $ 208 $ 179 Earnings per Share of Common Stock (Note 4)

C Income From Continuing Operations Basic $ 4.16 $ 2.36 $1.16 Diluted $ 4.15 $ 2.36 $ 1.15 Net Income 0

2, Basic $ 4.25 $1.37 $1.23 Diluted $ 4.24 $1.36 $1.22 Dividends Declared per Share of Common Stock $ 1.54 $ 1.44 $ 1.06 The accompanying Notes to Consolidated Financial Statements are an integral part of the financial statements.

Consolidated Statement of Cash Flows (Millions of dollars) For the years ended December31, 2003 2002 2001 Cash Flows From Operating Activities Net income $ 734 $ 208 $ 179 Adjustments to reconcile net income to net cash provided by operating activities Loss from discontinued operations 20 Cumulative effects of changes in accounting principles (35) 150 (10)

Depreciation 380 289 266 Amortizations - recoverable transition costs and other 244 198 224 Charge for cancellation of generation projects 150 Payments to cancel generation projects (152)

Dividends received from unconsolidated affiliates 7 14 103 Pension income - net (41) (42) (47)

Pension funding (18)

Write-down of assets 13 157 336 Gain on asset sales and insurance settlements (21)

Distribution requirements - preferred securities 29 60 52 Equity inearnings of unconsolidated affiliates 11 9 (13)

Equity inearnings of WPD prior to acquiring controlling interest in2002 (75) (112)

Deferred income taxes and investment tax credits 96 85 (47)

Deferral of storm-related costs (15)

Workforce reduction - net of cash paid 9 67 Unrealized (gain) loss on derivative hedging activities (38) 24 (16)

Gain on NUG contract termination (25)

NUG contract termination payment (50)

Realized gain on nuclear trust fund (19)

Interest accretion on asset retirement obligation and other 22 4 6 Other - net 9 7 (2)

Change incurrent assets and current liabilities Accounts receivable 11 (48) 35 Accounts payable 7 (73) (101)

Other - net (40) (6) (36) 51 Other operating activities - net Other assets 37 1 (69) -n

-u Other liabilities (62) 11 Net cash provided by operating activities 1,340 802 909 0 Cash Flows From Investing Activities 0 Expenditures for property, plant and equipment (771) (649) (569)

Investment in generating assets and electric energy projects (261) (312) 0 Acquisition of controlling interest inWPD, net of cash acquired (211) 2, Proceeds from sale of assets and insurance settlements and other 49 20 Net increase innotes receivable from affiliates 210 Other investing activities - net (7) (28) (31) 2, Net cash used in investing activities (729) (1,129) (702) 2, a

Cash Flows From Financing Activities Issuance of long-term debt 992 1,529 Retirement of long-term debt (575) (823) (616) _0 2,

Issuance (retirement) of company-obligated mandatorily redeemable preferred securities (250) 575 -4 Issuance of common stock 426 587 52 Retirement of preferred stock (31) (15)

Payment of common dividends and preferred distributions (287) (261) (201)

Net increase (decrease) inshort-term debt (877) 411 (981)

Other financing activities - net (35) (27) (94)

Net cash provided by (used in)financing activities (387) (363) 249 Effect of Exchange Rates on Cash and Cash Equivalents 7 2 (3)

Net Increase (Decrease) in Cash and Cash Equivalents 231 (688) 453 Cash and Cash Equivalents at Beginning of Period 245 933 480 Cash and Cash Equivalents at End of Period $ 476 $ 245 $ 933 Supplemental Disclosures of Cash Flow Information Cash paid during the period for:

Interest (net of amount capitalized) $ 456 $ 412 $ 373 Income taxes $ 19 $ 100 $ 328 The accompanying Notes to Consolidated Financial Statements areanintegral part of the financial statements.

Consolidated Balance Sheet (Millions of dollars) AtDecember31, 2003 2002 ASSETS Current Assets Cash and cash equivalents (Note 1) $ 476 $ 245 Accounts receivable (less reserve: 2003, $93; 2002, $111) 555 588 Unbilled revenues 341 303 Fuel, materials and supplies - at average cost 256 242 Prepayments 54 122 Deferred income taxes (Note 5) 105 104 Price risk management assets (Notes 1 and 17) 90 103 Other 162 112 2,039 1,819 Investments Investment in unconsolidated affiliates - at equity (Notes 1and 3) 230 234 Investment in unconsolidated affiliates - at cost (Note 1) 126 107 Nuclear plant decommissioning trust fund (Note 6) 357 287 Other 29 28 742 656 Property, Plant and Equipment - net (Note 1)

Electric plant inservice Transmission and distribution 5,456 5,603 Generation 3,362 2,679 General 431 479 9,249 8,761 52 Construction work in progress 627 223

-u Nuclear fuel 144 129 Electric plant 10,020 9,113 M0 Gas and oil plant 205 201 Other property 221 252

-0 10,446 9,566

-4 0

z a

Regulatory and Other Noncurrent Assets (Note 1) a Recoverable transition costs 1,687 1,946 Goodwill (Note 18) 1,068 474 z

z Other intangibles (Note 18) 230 212 Other 911 879 3CD 3,896 3,511

$17,123 $15,552 0

-4 The accompanying Notes to Consolidated Financial Statements are an integral part of the financial statements.

Consolidated Balance Sheet (Millions of dollars) DtDecember31, 2003 2002 LIABILITIES AND EQUITY Current Liabilities Short-term debt (Note 8) $ 56 $ 943 Long-term debt 395 366 Accounts payable 456 452 Above market NUG contracts (Note 14) 74 75 Taxes 182 193 Interest 121 101 Dividends 70 66 Price risk management liabilities (Notes 1and 17) 82 110 Other 337 307 1,773 2,613 Long-term Debt 7,464 5,901 Long-term Debt With Affiliate Trusts (Notes 15 and 22) 681 Deferred Credits and Other Noncurrent Liabilities Deferred income taxes and investment tax credits (Note 5) 2,201 2,287 Above market NUG contracts (Note 14) 278 352 Other (Notes 1,6, 9,12 and 21) 1,362 1,396 3,841 4,035 Commitments and Contingent Liabilities (Note 14)

Minority Interest (Note 1) 54 36 Company-obligated Mandatorily Redeemable Preferred Securities of Subsidiary Trusts Holding Solely Company Debentures (Note 22) 661 53

-V Preferred Stock With sinking fund requirements 31 0 Without sinking fund requirements 51 51 0 51 82 M0 Shareowners' Common Equity 0

Common stock 2 2 'D z

Capital inexcess of par value 2,973 2,539 Treasury stock (Note 1) (837) (836)

Earnings reinvested 1,478 1,013 Accumulated other comprehensive loss (Notes 1and 17) (297) (446) z m

z Capital stock expense and other (60) (48) C 3,259 2,224

$17,123 $15,552 -v M0 The accompanying Notes to Consolidated Financial Statements areanintegral part ot the tinancial statements. I

- I Consolidated Statement of Shareowners' Common Equity and Comprehensive Income (Millions of dollars, except per share amounts) For the years ended December31, 2003 2002 2001 Common stock at beginning of year $. 2 $ 2 $ 2 Common stock at end of year 2 2 2 Capital in excess of par value at beginning of year 2,539 1,956 1,895 Common stock issued 426 587 54 Other 8 (4) 7 Capital in excess of par value at end of year 2,973 2,539 1,956 Treasury stock at beginning of year (836) (836) (836)

Treasury stock purchased (1)

Treasury stock at end of year (837) (836) (836)

Earnings reinvested at beginning of year 1,013 1,023 999 Net income (b) 734 208 179 Cash dividends declared on common stock (269) (218) (155)

Earnings reinvested at end of year 1,478 1,013 1,023 Accumulated other comprehensive loss at beginning of year (c) (446) (251) (36)

Foreign currency translation adjustments (b) 106 125 (234)

Unrealized gain (loss) on available-for-sale securities (b) 24 (3) (4)

Minimum pension liability adjustments lb) (d) (10) (301)

Unrealized gain (loss) on qualifying derivatives (b) 29 (16) 23 Accumulated other comprehensive loss at end of year (297) (446) (251)

Capital stock expense and other at beginning of year (48) (37) (12)

Issuance costs and other charges to issue common stock (9) (18)

Issuance costs and other charges to issue PEPS Units (3) (25)

Other 7 Capital stock expense and other at end of year (60) (48) (37)

Total shareowners' common equity $3,259 $2,224 $1,857 Common stock shares at beginning of year (a) 165,736 146,580 145,041 54 Common stock issued through the ESOP, DRIP, ICP, ICPKE, structured equity program and public offering 11,652 19,156 1,539 Treasury stock purchased (26)

Common stock shares at end of year 177,362 165,736 146,580 0

M0 tat Shares in thousands; $.01 par value. 390 million shares authorized. Each share entitles the holder to one vote on any question presented to any shareowners' meeting.

-0 (b) Statement of Comprehensive Income (Loss) (Note 1):

Net income $734 $ 208 $179

-4 Other comprehensive income (loss):

i Foreign currency translation adjustments, netof tax (benefit) of $0,$(5), $15 106 125 (234)

Z0 z Unrealized gain (loss) on available-for-sale securities, net of tax (benefit) of $14, $(2), $(3) 24 (3) (4)

Minimum pension liability adjustments, net of tax (benefit) of $(4), $(131) (10) (301) 0 Unrealized gain (loss) onqualifying derivatives, net of tax (benefit) of $15. $(10), $12 29 (16) 23 Total other comprehensive income (loss) 149 (195) (215) z Comprehensive income (loss) $883 $ 13 $ (36) z

'c SeeNote 1 for disclosure of balances for each component of Accumulated Other Comprehensive Loss.

c (d)SeeNote 12 for additional information on the adjustments to the additional minimum pension liability.

-0 m1 The accompanying Notes to Consolidated Financial Statements arean integral part of the financial statements.

Consolidated Statement of Preferred Stock Shares Outstanding Outstanding Shares (Millions of dollars) AlDecember31, 2003 2002 2003 Authorized PPL ELECTRIC (a)

Preferred Stock -$100 par, cumulative 4-1/2% $25 $25 247,524 629,936 Series Preferred 26 57 257,665 10,000,000

$51 $82 DETAILS OF PREFERRED STOCK (b)

Outstanding Shares Optional OttnigOutstanding Redemption (Millions of dollars) 2003 2002 2003 Price per Share With Sinking Fund Requirements (c)

Series Preferred 6.125% $17 6.15% 10 6.33% 4

$31 Without Sinking Fund Requirements 4-1/2% Preferred $25 $25 247,524 $110.00 Series Preferred 3.35% 2 2 20,605 103.50 4.40% 12 12 117,676 102.00 4.60% 3 3 28,614 103.00 6.75% 9 9 90,770 103.38

$51 $51 55 DECREASES IN PREFERRED STOCK 2003 2002 2001 Shares Amount Shares Amount Shares Amount 4-1/2% Preferred (134) 0

-4 Series Preferred 0 5.95% (10,000) $ (1) z 6.125% (167,500) $(17) (148,000) (14) 0 D

6.15% (97,500) (10) 6.33% (46,000) (4) z0 So z

cM Decreases in Preferred Stock normally represent: (i)the redemption of stock pursuant to mandatory sinking fund requirements; or (ii) shares redeemed pursuant to optional 1' redemption provisions.

JJ (a)Each share of PPL Electric's preferred stock entitles the holder to one vote on any question presented to PPL Electric' shareowners' meetings. There were also 10 million shares of PPLls preferred stock and 5 million shares of PPL Electric's preference stock authorized; none were outstanding at December 31,2003 and 2002.

(b)The involuntary liquidation price of the preferred stock is$100 per share. The optional voluntary liquidation price isthe optional redemption price per share in effect, except for the 4-1/2% Preferred Stock for which such price is$100 per share (plus ineach case any unpaid dividends).

(c)See Note 22 for additional information.

The accompanying Notes to Consolidated Financial Statements are an integral part of the financial statements.

Consolidated Statement of Company-obligated Mandatorily Redeemable Securities Outstanding (Millions of dollars) Al December 31, 20031(c) 2002 Company-obligated Mandatorily Redeemable Preferred Securities of Subsidiary Trusts Holding Solely Company Debentures

$25 per security 7.75% (a) $575

$1,000 per security 8.23%°W 86

$661 (a) In May 2001, PPL and PPL Capital Funding Trust 1,a wholly-owned financing subsidiary ot PPL, issued $575 million of 7.75% PEPS Units. Each PEPS Unit consists of (i)a contract to purchase shares o1PPL common stock on or prior to May 18, 2004 and (ii)atrust preferred security of PPL Capital Funding Trust I with a maturity date of May 2006 and astated liquidation amount of $25. Each purchase contract requires PPL to make contract adjustment payments of .46% per year, paid quarterly, on the $25 stated amount of the PEPS Unit and requires the holders of the contracts to purchase a number of shares of PPL common stock on or prior to May 18, 2004. The number of shares required to bepurchased will depend on the average market price of PPL's common stock prior to the purchase date, subject to certain limitations. The holders obligations to purchase shares under the purchase contracts may be settled with the proceeds of a remarketing of the trust preferred securities, which have been pledged to secure these obligations. The distribution rate on each preferred security is 7.29% per year,paid quarterly, until May 18, 2004. The trusts sole source of funds for distributions are from payments of interest on the 7.29% subordinated notes of PPL Capital Funding, due May 18, 2006, issued to the trust. PPL has guaranteed the payment of principal and interest on the subordinated notes issued to the trust by PPL Capital Funding. PPL has also fully and unconditionally guaranteed all of the trusts obligations under the trust preferred securities. SeeNote 8 for a discussion of dividend restrictions related to PPLs subsidiaries.

(b) SIUK Capital Trust I issued $82 million of 8.23% preferred securities maturing in February 2027 and invested the proceeds in 8.23% subordinated debentures maturing in February 2027 issued by SIUK Limited. Thus, the preferred securities are supported by acorresponding amount of subordinated debentures. SIUK Limited owned all of the common securities of SIUK Capital Trust I and guaranteed all of SIUK Capital Trust I's obligations under the preferred securities. InJanuary 2003, SIUK Limited transferred its assets and liabilities, including the common securities of SIUK Capital Trust I and the obligations under the subordinated debentures, to WPD LLP. Therefore, WPD LLP currently guarantees all ofSIUK Capital Trust l's obli-gations under the preferred securities. SIUK Capital Trust I may, atthe discretion of WPD LLP, redeem the preferred securities, in whole or in part, at 104.115% of par beginning February 2007 and thereafter atan annually declining premium over par through January 2017, after which time they are redeemable atpar. With PPLs acquisition of the controlling interest in WPD in September 2002, these preferred securities were consolidated on the books of PPL at their then fair value of $86 million. SeeNote 9 for information on the acquisition of a con-trolling interest in WPD.

(ci OnJuly 1,2003, PPL adopted the provisions of SFAS150, 'Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity.' These preferred securities are mandatorily redeemable financial instruments, as they require the issuer to redeem the securities for cash on a specified date. Thus, they should beclassified as liabilities, as a com-ponent of long-term debt, instead of mezzanine' equity on the Balance Sheet. However, as of December 31, 2003, no amounts were included in 'Long-term Debt' for these securities because PPL Capital Funding Trust I and SIUK Capital Trust I were deconsolidated effective December 31, 2003 in connection with the adoption of FIN46, 'Consolidation of Variable 56 Interest Entities, an Interpretation of ARBNo. 51,' for certain entities. Instead, the subordinated debt securities that support the trust preferred securities are reflected in 'Long-term Debt With Affiliate Trusts' as of December 31, 2003. SeeNote 22 for additional information on SFAS 150 and FIN46.

0 The accompanying Notes to Consolidated Financial Statements arean integral part of the financial statements.

0

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0

Consolidated Statement of Long-term Debt Outstanding (Millions of dollars) AtDecember31, 2003 2002 Maturityla)

Bonds:

6-1/2% 7/8% First Mortgage Bonds Nb) $ 297(d) $ 382 2003-2024 3.125% - 6.40% First Mortgage Pollution Control Bonds )b) 314(e) 314 2008-2029 4.30% 1/4% Senior Secured Bonds I) 900'o .800 2007-2013 6.08% to 7.15% Series 1999-1 Transition Bonds 1,423'a) 1,678 2003-2008 5.875% - 9.25% Unsecured Bonds 1,982(h) 1,583 2004-2028 6.20% - 6.40% Inflation-linked Bonds 1500)' 131 2006-2022 1.54% Pollution Control Revenue Bonds 9 9 2027 Notes:

5.75% - 8.375% Medium-term Notes c) 7370) 822 2004-2007 6.40% Senior Unsecured Notes 500 500 2011 8.05% - 8.30% Senior Secured Notes 4370, 2013 2.625% Convertible Senior Notes 400 0) 2023 8.70% - 9.64% Unsecured Promissory Notes 12im) . 12 2010-2022 Term loan - variable rate (2.56% at December 31, 2003) 625 In) 2008 Trust securities - variable rate (3.435% at December 31, 2003) 31 (n) 2008 Other long-term debt 27 21 2003-2013 7,844 6,252 Fair value swaps 28 28 Unamortized discount (13) (13) 7,859 6,267 Less amount due within one year (395) (366)

Total long-term debt $7,464 $5,901 Long-term Debt With Affiliate Trusts:

7.29% Subordinated Notes $ 592(o) 2006 8.23% Subordinated Debentures .89() 2027 Total long-term debt with affiliate trusts $ 681 57 (a)Aggregate maturities of long-term debt through 2008 are (millions of dollars): 2004, $395; 2005, $911; 2006, $1,454; 2007, $1,070; and 2008, $1,280.

N' The First Mortgage Bonds and the First Mortgage Pollution Control Bonds were issued under, and are secured by, the lien of the 1945 First Mortgage Bond Indenture. The lien of the 1945 First Mortgage Bond Indenture covers substantially all electric transmission and distribution plant owned by PPL Electric. The Senior Secured Bonds were issued under the 2001 -0 0 :D Senior Secured Bond Indenture. The Senior Secured Bonds are secured by (i) an equal principal amount of First Mortgage Bonds issued under the 1945 First Mortgage Bond Indenture and (ii) the lien of the 2001 Senior Secured Bond Indenture, which covers substantially all electric transmission and distribution plant owned by PPL Electric and which isjunior to -0 the lien of the 1945 First Mortgage Bond Indenture.

(c)PPL fully and unconditionally guarantees the medium-term notes of PPL Capital Funding, awholly-owned financing subsidiary of PPL. See Note 8for a discussion of dividend restrictions related to PPLs subsidiaries. 0 0

(d) InApril 2003, PPL Electric redeemed and retired all of its outstanding First Mortgage Bonds 7-7/8% Series due 2023, at anaggregate par value of $46 million, and inDecember 2003, z retired $19 million of its First Mortgage Bonds 6-3/4% Series due 2023.

"e'InFebruary 2003, PPL Electric issued $90 million of 3.125% Pollution Control Bonds and also retired $90 million of its 6.40% Series HPollution Control Bonds. 0 (n In May 2003, PPL Electric issued $100 million of 4.30% Senior Secured Bonds.

i0) InAugust 1999, PPL Transition Bond Company issued $2.4 billion of transition bonds to securitize aportion of PPL Electrics stranded costs. The bonds were issued ineight different z

classes, with expected average lives of 1 to 8.7 years. Bond principal payments of $255 million were made in2003.

(h) In March 2003, WPD issued £200 million of 5.875% bonds due 2027 and inMay 2003 WPD issued an additional £50 million of 5.875% bonds due 2027. During the fourth quarter, z WPD retired $53 million of 7.375% bonds due 2028. :2

'i Increase due to an increase inforeign currency exchange rates.

I' During 2003, PPL Capital Funding retired the following series of medium-term notes: $60 million of 6.375% Series due 2003, $20 million of 6.23% Series due 2003 and $5million of 6.40% Series due 2003. 0 01 Represents lease financing consolidated through a variable interest entity. See Note 22 for additional information. Secured by, among other things, the generation facility, which had a m Ho carrying value of $442 million as of December 31,2003 and was included in'Property, Plant and Equipment - net - Construction work inprogress" on the Balance Sheet.

01 Issued by PPL Energy Supply in May 2003.

(m)InSeptember 2003, PPL Gas Utilities made a $750,000 principal payment on its 9.64% Notes due 2010.

(n) Represents lease financing consolidated through a variable interest entity. See Note 22 for additional information. Borrowings bear interest ata floating rate, based, at PPLs option, upon (i) LIBOR plus an applicable percentage that issubject to change based on the credit ratings of PPL Energy Supply or (ii) the greater of (a)the Wachovia Bank N.A. corporate base rate or (b)the federal funds rate plus 0.50%, plus anapplicable percentage that is subject to change based on the credit ratings of PPL Energy Supply. Secured by, among other things, the generation facilities and the land on which the facilities are located. As of December 31, 2003, the aggregate carrying value of the facilities and the land was $617 million, net of accumulated depreciation of $26 million, and was included in "Property, Plant and Equipment - net - Electric plant inservice" and "Regulatory and Other Noncurrent Assets - Other intangibles' on the Balance Sheet.

t0) Represents debt with awholly-owned trust that was deconsolidated effective December 31, 2003 as aresult of the adoption of FIN 46, "Consolidation of Variable Interest Entities, an Interpretation of ARBNo. 51," for certain entities. SeeNote 22 for further discussion.

The accompanying Notes to Consolidated Financial Statements are anintegral part of the financial statements.

Notes to Consolidated Financial Statements Temns and abbreviations appearing in Notes to Consolidated Financial Statements are explained in the glossary Dollars are in millions, except per share data,unless otherwise noted i

SUMMARY

OF SIGNIFICANT ACCOUNTING POLICIES Effective August 21, 2002, PPL Global deconsolidated CEMAR and began accounting for it using the cost method. See Note 9 for further discussion.

Business and Consolidation Effective December 31, 2003, PPIs consolidated financial statements PPL is an energy and utility holding company that, through its subsidiaries, is include the accounts of the lessors under the operating leases for the primarily engaged inthe generation and marketing of electricity inthe north-Sundance, University Park and Lower Mt. Bethel generation facilities. These eastern and western U.S. and inthe delivery of electricity in Pennsylvania, the entities are not included in the consolidated financial statements for periods U.K. and Latin America. Based inAllentown, Pennsylvania, PPLs principal ending prior to December 31, 2003. See "FIN 46 and FIN 46(R)f inNote 22 subsidiaries are PPL Energy Funding, PPL Electric, PPL Gas Utilities, PPL for further discussion.

Services and PPL Capital Funding.

Effective December 31, 2003, PPL deconsolidated PPL Capital Funding PPL Energy Funding is the parent of PPL Energy Supply, which serves as Trust I and SIUK Capital Trust 1,both of which are wholly-owned trusts. Both the holding company for PPUs principal unregulated subsidiaries. PPL Energy entities are included inPPLs consolidated financial statements for periods Supply is the parent of PPL Generation, PPL EnergyPlus and PPL Global.

ending prior to December 31, 2003. See 'FIN 46 and FIN 46(R)" inNote 22 PPL Generation owns and operates aportfolio of domestic power generat-for further discussion.

ing assets. These power plants are located inPennsylvania, Montana, Arizona, The consolidated financial statements of PPL include its share of undivided Illinois, Connecticut, New York and Maine and use well-diversified fuel sources interest injointly-owned facilities, as well as its share of the related operating including coal, nuclear, natural gas, oil and hydro. PPL EnergyPlus markets or costs of those facilities. See Note 13 for additional information.

brokers electricity produced by PPL Generation, along with purchased power, natural gas and oil in competitive wholesale and deregulated retail markets, Use of Estimates primarily inthe northeastern and western portions of the U.S. PPL Global The preparation of financial statements inconformity with U.S. GAAP requires acquires and develops domestic generation projects that are, inturn, operated management to make estimates and assumptions that affect the reported amounts by PPL Generation as part of its portfolio of generation assets. PPL Global of assets and liabilities, the disclosure of contingent liabilities at the date of also acquires and holds international energy projects that are primarily the financial statements and the reported amounts of revenues and expenses focused on the distribution of electricity. during the reporting period. Actual results could differ from those estimates.

PPL Electric isthe principal regulated subsidiary of PPL. PPL Electric's PPL records loss accruals inaccordance with SFAS No. 5,"Accounting principal businesses are the transmission and distribution of electricity to serve for Contingencies."

retail customers inits franchised territory ineastern and central Pennsylvania, Accounting Records

~0 and the supply of electricity to retail customers inthat territory as a PLR.

The system of accounts for PPL Electric and PPL Gas Utilities are maintained M0 PPL Montana commenced operations in 1999, after the purchase of sub-inaccordance with the Uniform System of Accounts prescribed by the FERC

_0 stantially all of the generation assets and certain contracts of the utility division and adopted by the PUC.

of Montana Power. PPL Montana operates steam generation and hydroelectric Z0 facilities throughout Montana. PPL Montana has been designated as an EWG Cash Equivalents under the Federal Power Act and sells wholesale power throughout the western All highly liquid debt instruments purchased with original maturities of three U.S. PPL Montana Holdings, LLC isthe sole Member of PPL Montana and months or less are considered to be cash equivalents.

a is an indirect, wholly-owned subsidiary of PPL.

Property, Plant and Equipment m The consolidated financial statements of PPL, PPL Energy Supply, PPL PP&E is recorded at original cost, unless impaired. If impaired, the asset is Electric and PPL Montana include each company's own accounts as well as written down to fair value at that time, which becomes the asset's new cost the accounts of all entities inwhich the company has a controlling financial

-0 basis. Original cost includes material, labor, contractor costs, construction interest. Investments inentities in which the company has the ability to exer-

-4 overheads and financing costs, where applicable. The cost of repairs and cise significant influence but does not have acontrolling financial interest minor replacements are charged to expense as incurred. PPL records costs are accounted for under the equity method. All other investments are carried associated with planned major maintenance projects inthe period in which at cost. All significant intercompany transactions have been eliminated. Any the costs are incurred. No costs are accrued inadvance of the period in minority interests inoperating results, and equity ownership, are reflected in which the work is performed.

the consolidated financial statements.

When acomponent of PP&E is retired that was depreciated under the Itis the policy of PPL Global to consolidate foreign subsidiaries and composite or group method, the original cost is charged to accumulated record equity inearnings of other foreign entities on alag, based on the avail-depreciation. When all or asignificant portion of an operating unit is retired ability of financial data on aU.S. GAAP basis:

or sold that was depreciated under the composite or group method, the prop-

. Earnings from foreign equity method investments are recorded on athree-erty and the related accumulated depreciation account is reduced and any month lag.

gain or loss is included in income, unless otherwise required by regulators.

• PPL and its subsidiaries consolidate the results of foreign entities inwhich Depreciation is computed over the estimated useful lives of property using they have acontrolling financial interest (WPD, Emel, EC, the Bolivian subsidiaries and other investments) on aone-month lag.

various methods including the straight-line, composite and group methods. Debt Securities PPL and its subsidiaries periodically review and adjust the depreciable lives Debt securities that have been classified as held-to-maturity have been so clas-of their fixed assets. sified due to the intent to hold such securities to maturity and the ability to do AFUDC iscapitalized as part of the construction costs for regulated projects. so. All other debt securities have been classified as available-for-sale or trading.

Interest is capitalized as part of construction costs for non-regulated projects.

Regulation Following are the classes of PP&E, with the associated accumulated PPL Electric, PPL Gas Utilities, and a Latin American affiliate account for regu-depreciation, at December 31:

lated operations inaccordance with the provisions of SFAS 71, 'Accounting for 2003 2002 the Effects of Certain Types of Regulation,' which requires rate-regulated entities Electric plant to reflect the effects of regulatory decisions intheir financial statements.

Generation $ 8,191 $ 7,407 The following regulatory assets were included inthe 'Regulatory and Other Transmission and distribution 7,324 7,279 Noncurrent Assets section of the Balance Sheet at December 31:

General 728 749 Construction work inprogress 627 223 PPL 2003 2002 Nuclear fuel 308 312 Recoverable transition costs $1,687 $1,946 Gas and oil 321 321 Taxes recoverable through future rates 250 260 Other property 276 301 Other 24 13 17,775 16,592 $1,961 $2,219 Less: Accumulated depreciation and amortization 7,329 7,026

$10,446 $9,566 Based on the PUC Final Order, PPL Electric began amortizing its competi-Following are the weighted-average rates of tive transition (or stranded) costs, $2.97 billion, over an 11-year transition depreciation at December 31: period effective January 1, 1999. InAugust 1999, competitive transition costs Generation 2.01% 1.88%

of $2.4 billion were converted to intangible transition costs when they were Transmission and distribution 3.16% 2.99%

General 3.75% 2.72% securitized by the issuance of transition bonds. The intangible transition costs are being amortized over the life of the transition bonds, through December The annual provisions for depreciation have been computed principally inaccordance 2008, inaccordance with an amortization schedule filed with the PUC. The 59 with the following ranges, inyears, assets of PPL Transition Bond Company, including the intangible transition of asset lives: -U property, are not available to creditors of PPL or PPL Electric. The transition Generation 5-65 n Transmission and distribution 15-80 bonds are obligations of PPL Transition Bond Company and are non-recourse 0 JD General 3-80 to PPL and PPL Electric. The remaining competitive transition costs are also -u C

being amortized based on an amortization schedule previously filed with the As of July 1,2003, PPL Generation changed the depreciable lives of its PUC, adjusted for those competitive transition costs that were converted to 0 z

gas-fired peaking plants from 30 to 40 years based upon engineering estimates. intangible transition costs. As aresult of the conversion of asignificant portion This change decreased depreciation by $1million in 2003 and isexpected to of the competitive transition costs into intangible transition costs, amortization decrease depreciation by $8million in2004 and thereafter, which includes the of substantially all of the remaining competitive transition costs will occur in2009. I impact for certain gas-fired peaking plants consolidated inaccordance with Included in Other' above, are approximately $15 million of storm restora- 0 a,

FIN 46. See Note 22 for further discussion of FIN 46. tion costs associated with the September 2003 Hurricane Isabel. These costs m

-4 have been deferred inaccordance with the PUC declaratory order of January Z0 Property, Plant and Equipment and Intangible Asset-impairments -U 16, 2004. The ratemaking treatment of these losses will be addressed in the Long-lived assets and identifiable intangibles held and used by PPL and its 2004 rate proceeding. PPL believes there is areasonable basis for recovery subsidiaries are reviewed for impairment when events or circumstances of all regulatory assets.

indicate carrying amounts may not be recoverable. An impairment loss is recognized if the carrying amount of PP&E and identifiable intangibles is not Accounting for Derivatives and Other Contracts Held recoverable from undiscounted future cash flow. The impairment charge is for Trading Purposes measured by the difference between the carrying amount of the asset and its PPL enters into energy and energy-related contracts. PPL enters into interest fair value. Goodwill isreviewed for impairment annually or more frequently rate derivative contracts to hedge their exposure to changes in the fair value when events or circumstances indicate that the carrying value may be greater of their debt instruments and to hedge their exposure to variability inexpected than the implied fair value. Ifthe carrying value of the reporting unit exceeds cash flows associated with existing debt instruments or forecasted transactions.

its fair value, the implied fair value of goodwill must be calculated. Ifthe implied PPL also enters into foreign currency derivative contracts to hedge foreign cur-fair value goodwill is less than its carrying value, the difference represents rency exposures, including firm commitments, recognized assets or liabilities, the amount of the impairment. See Notes 9and 18 for a discussion of asset forecasted transactions or net investments.

impairment charges recorded.

Notes to Consolidated Financial Statements Contracts that meet the definition of aderivative are accounted for under with SFAS 52, "Foreign Currency Translation," and are included in "Foreign SFAS 133, "Accounting for Derivative Instruments and Hedging Activities,' currency translation adjustments,' acomponent of accumulated other compre-as amended and interpreted. Certain energy contracts have been excluded from hensive income (loss).

the requirements of SFAS 133 because they meet the definition of a "normal Inthe fourth quarter of 2002, PPL adopted the accounting requirements purchase or normal sale under DIG Issue C15, "Scope Exceptions: Normal under EITF 02-3, "Issues Involved inAccounting for Derivative Contracts Purchases and Normal Sales Exception for Certain Option-Type Contracts and Held for Trading Purposes and Contracts Involved in Energy Trading and Risk Forward Contracts in Electricity.' These contracts are reflected inthe financial Management Activities." As such, PPL reflects its net realized and unrealized statements using the accrual method of accounting. gains and losses associated with all derivatives that are held for trading Additionally, PPL adopted SFAS No. 149, 'Amendment of Statement 133 purposes in the 'Net energy trading margins' line on the Statement of Income.

on Derivative Instruments and Hedging Activities," as of July 1,2003. The Non-derivative contracts that met the definition of energy trading activities as requirements of SFAS 149, which required prospective application, placed defined by EITF 98-10, "Accounting for Energy Trading and Risk Management additional limitations on the use of the normal purchase or normal sale Activities" are reflected inthe financial statements using the accrual method exception. Therefore, the accounting for certain types of transactions has of accounting. Prior periods were restated.

been changed on a prospective basis to conform with SFAS 149. PPL has adopted the final provisions of EITF 03-11, "Reporting Realized Under SFAS 133, all derivatives are recognized on the balance sheet at Gains and Losses on Derivative Instruments That Are Subject to FASO their fair value. On the date the derivative contract is executed, PPL designates Statement No. 133 and Not 'Held for Trading Purposes' as Defined in Issue the derivative as a hedge of the fair value of arecognized asset or liability or No. 02-3," prospectively as of October 1,2003. As a result of the adoption, of an unrecognized firm commitment ("fair value" hedge), ahedge of aforecasted non-trading bilateral sales of electricity at major market delivery points transaction or of the variability of cash flows to be received or paid related to a are netted with purchases that offset the sales at those same delivery points.

recognized asset or liability ("cash flow' hedge), a foreign currency fair value or A major market delivery point isany delivery point with liquid pricing available.

cash flow hedge ("foreign currency' hedge), ahedge of anet investment ina The impact of adopting EITF 03-11 was a reduction in both 'Wholesale foreign operation or atrading derivative. Changes inthe fair value of aderivative energy marketing' revenues and "Energy purchases' of $105 million in that is highly effective as, and is designated and qualifies as, afair value hedge, PPL's Statement of Income.

along with the loss or gain on the hedged asset or liability that is attributable to See Note 17 for additional information on SFAS 133, its amendments 60 the hedged risk, are recorded in current-period earnings. Changes inthe fair and related accounting guidance.

-a value of a derivative that is highly effective as, and isdesignated as and qualifies

-0 Revenue Recognition 0

as, a cash flow hedge are recorded in other comprehensive income, until earn-

-o Operating revenues, except for energy related businesses, are recorded based 0 ings are affected by the variability of cash flows being hedged. Changes inthe on energy deliveries through the end of the calendar month. Unbilled retail fair value of derivatives that are designated as and qualify as foreign currency 0 revenues result because customers' meters are read and bills are rendered

-a hedges are recorded ineither current-period earnings or other comprehensive throughout the month, rather than all being read at the end of the month.

z income, depending on whether the hedge transaction isa fair value hedge or 0

r3 Unbilled revenues for amonth are calculated by multiplying an estimate of a cash flow hedge. Ifaderivative is used as ahedge of a net investment ina U,

C unbilled kWh by the estimated average cents per kWh. Unbilled wholesale foreign operation, its changes infair value, to the extent effective as ahedge, energy revenues are recorded at month end to reflect estimated amounts until z> are recorded within other comprehensive income. Changes in the fair value 0

co actual dollars and MWhs are confirmed and invoiced. At that time unbilled r

of derivatives that are not designated as hedging instruments are reported in D

revenue is reversed and actual revenue is recorded.

m current-period earnings.

11 "Energy related businesses' revenue includes revenues from the mechani-

-0 Unrealized gains and losses from changes inmarket prices of energy con-cal contracting and engineering subsidiaries and PPL Global's proportionate tracts accounted for as fair value hedges are reflected in"Energy purchases' share of affiliate earnings under the equity or cost method of accounting, as on the Statement of Income, as are changes inthe underlying positions. Gains described inthe "Business and Consolidation" section of Note 1.The mechan-and losses from changes inmarket prices of energy contracts accounted for as ical contracting and engineering subsidiaries record profits from construction cash flow hedges, when recognized on the Statement of Income, are reflected contracts on the percentage-of-completion method of accounting. Income from in'Wholesale energy marketing' revenues or "Energy purchases,' consistent time and material contracts is recognized currently as the work is performed.

with the hedged item. Gains and losses from changes inthe market price of interest rate and foreign currency derivative contracts, when recognized on the Utility Revenue Statement of Income, are accounted for in "Interest Expense." The Statement of Income "Utility" line item contains revenues from domestic Gains or losses on interest rate derivative contracts that settled prior to and international rate-regulated delivery operations, including WPD.

the adoption of SFAS 133 were deferred and are being recognized over the life WPD revenues are stated net of value-added tax.

of the debL Market gains and losses on foreign currency derivative contracts Since most of PPL Electric's operations are regulated, it is not meaningful that settled prior to the adoption of SFAS 133 were recognized in accordance to use a 'Utility" caption. Therefore, the revenues of PPL Electric are presented according to specific types of revenue.

Income Taxes method under SFAS 123 for all stock-based compensation awards granted, The income tax provision for PPL and its subsidiaries is calculated in accor- modified or settled on or after January 1,2003. Thus, all awards granted prior dance with SFAS 109, "Accounting for Income Taxes." PPL and its domestic to January 1,2003 continue to be accounted for under the intrinsic value subsidiaries file aconsolidated U.S. federal income tax return. method of APB Opinion No. 25, to the extent such awards are not modified or The provision for PPL Electric's deferred income taxes for regulated assets settled. Stock-based compensation is included in 'Other operation and main-is based upon the ratemaking principles reflected in rates established by the tenance" expense on PPLs Statement of Income.

PUC and the FERC. The difference inthe provision for deferred income taxes Use of the fair value method prescribed by SFAS 123 requires PPL and for regulated assets and the amount that otherwise would be recorded under its subsidiaries to recognize compensation expense for stock options issued.

U.S. GAAP is deferred and included intaxes recoverable through future rates Fair value for the stock options is determined using the Black-Scholes options in 'Regulatory and Other Noncurrent Assets - Other" on the Balance Sheet. pricing model.

See Note 5 for additional information. PPL and its subsidiaries were not required to recognize compensation PPL Electric deferred investment tax credits when they were utilized and expense for stock'options issued under the intrinsic value method of APB isamortizing the deferrals over the average lives of the related assets. Opinion No. 25, since PPL grants stock options with an exercise price that is not less than the fair market value of PPL's common stock on the date of Leases grant. For stock options granted under the fair value method of SFAS 123, PPL and its subsidiaries apply the provisions of SFAS 13, 'Accounting for stock option expense for PPL was approximately $3million for 2003. As cur-Leases" as amended and interpreted, to all leasing transactions. See Note 10 rently structured, awards of restricted stock, restricted stock units and stock for adiscussion of accounting for leases under which PPL is lessee.

units result inthe same amount of compensation expense under the fair value In2002, PPL began commercial operation of its 79.9 MW oil-powered method of SFAS 123 as they would under the intrinsic value method of APB station in Shoreham, New York. The Long Island Power Authority has Opinion No. 25.

contracted to purchase all of the plant's capacity and ancillary services as part The following table illustrates the pro forma effect on net income and EPS of a 15-year power purchase agreement with PPL EnergyPlus. The capacity as if the fair value method had been used to account for all outstanding stock-payments in the power purchase agreement result inthe plant being classified based compensation awards in the years shown: -

as adirect financing lease, under which PPL EnergyPlus is the lessor. As of December 31, 2003 and 2002, PPL had a receivable balance of $277 million 2003 2002 2001 61 (included in "Current Assets - Other" and "Regulatory and Other Noncurrent Income

-u Net Income -as reported $ 734 $ 208 $179 -u Assets - Other") and an unearned revenue balance of $167 million (included Add: Stock-based employee in "Deferred Credits and Other Noncurrent Liabilities - Other"). Rental income compensation expense included in 0 received through this direct financing lease during 2003 and 2002 was $15 mil- reported net income, net of tax 5 3 3 -u lion and $5million. Total future minimum lease payments expected to be received Deduct: Total stock-based compensation expense determined under the fair value  ;-40 are estimated at $16 million for each of the years from 2004 through 2008. based method for all awards, net of tax 9 8 6 Z0 z

Stock-Based Compensation Pro forma net income $ 730 $ 203 $176 C a

PPL grants stock options, restricted stock, restricted stock units and stock EPS units to employees and directors under several stock-based compensation Basic-asreported $4.25 $1.37 $1.23 Basic-proforma $4.23 $1.34 $1.21 C plans. SFAS 123, "Accounting for Stock-Based Compensation," encourages r-Diluted-as reported $4.24 $1.36 $1.22 entities to record compensation expense for stock-based compensation plans Diluted -pro forma $4.22 $1.33 $1.20 23 at fair value but provides the option of measuring compensation expense using 0 23 the intrinsic value method prescribed by APB Opinion No. 25, "Accounting Pension and Other Postretirement Benefits for Stock Issued to Employees.' The fair value method under SFAS 123 isthe See Note 12 for adiscussion of accounting for pension and other postretire-preferable method of accounting for stock-based compensation, as it provides ment benefits.

aconsistent basis of accounting for all stock-based awards, thereby facilitating Comprehensive Income abetter measure of compensation cost and improved financial reporting.

Comprehensive income consists of net income and other comprehensive Prior to 2003, PPL accounted for stock-based compensation inaccordance income, defined as changes incommon equity from transactions not related with APB Opinion No. 25, as permitted by SFAS 123. Effective January 1,2003, to shareowners. Other comprehensive income consists of foreign currency PPL and its subsidiaries adopted the fair value method of accounting for translation adjustments recorded by PPL Global, unrealized gains or losses stock-based compensation, as prescribed by SFAS 123, using the prospective on available-for-sale securities and qualifying derivatives, and the excess of method of transition permitted by SFAS 148, "Accounting for Stock-Based additional pension liability over unamortized prior service costs, net of taxes.

Compensation - Transition and Disclosure, an Amendment of FASB Statement Comprehensive income isreflected on the Statement of Shareowners' Common No. 123. See Note 22 for further discussion of SFAS 148. The prospective Equity and Comprehensive Income, and "Accumulated other comprehensive method of transition requires PPL and its subsidiaries to use the fair value loss" is presented on the Balance Sheet.

Notes to Consolidated Financial Statements The accumulated other comprehensive loss of PPL consisted of the follow- Other ing at December 31: See Note 18 for a discussion of the accounting for goodwill and other intangi-

.2003 2002 ble assets, Note 21 for a discussion of the accounting for asset retirement Foreign currency translation adjustments $ (37) $(143) obligations, and Note 22 for a discussion of other new accounting standards.

Unrealized gains (losses) on available-for-sale securities 20 (4)

Minimum pension liability (316) (306)

Unrealized gains on qualifying derivatives 36 7 2. SEGMENT AND RELATED INFORMATION

$(297) $(446)

PPL's reportable segments are Supply, Delivery and International. The Supply Treasury Stock segment primarily consists of the domestic energy marketing, domestic gener-Treasury shares are reflected on the balance sheet as an offset to common ation and domestic development operations of PPL Energy Supply. The equity under the cost method of accounting. Management has no definitive Delivery segment includes the regulated electric and gas delivery operations plans for the future use of these shares. Treasury shares are not considered of PPL Electric and PPL Gas Utilities. The International segment includes PPL outstanding in calculating EPS. Global's responsibility for the acquisition and holding ot international energy projects. The majority of PPL Globals international investments are located Foreign Currency Translation and Transactions in the U.K., Chile, El Salvador and Bolivia.

Assets and liabilities of international operations, where the local currency is Segments include direct charges, as well as an allocation of indirect corpo-the functional currency, are translated at year-end exchange rates, and related rate costs, for services provided by PPL Services. These service costs include revenues and expenses are translated at average exchange rates prevailing functions such as financial, legal, human resources and information services.

during the year. Adjustments resulting from translation are recorded inaccu- Financial data for the segments are as follows:

mulated other comprehensive loss.

2003 2002 2001 Gains or losses relating to foreign currency transactions are recognized Income Statement Data currently inincome. The aggregate transaction gain (loss) was $(1) million, Revenues from external customers

$(9) million and $8million in2003, 2002 and 2001. Supply $1,795 $1,697 $1,668 62 Delivery 2,778 2,706 2,867 Independent System Operator International (a) 1,014 1,078 580

-T Certain PPL subsidiaries participate inPJM in several roles. Certain PPL 5,587 5,481 5,115 subsidiaries also participate in the New England Power Pool (NEPOOL) and Intersegment revenues 0 the New York ISO (NYISO) ina less significant way than in PJM. In PJM, PPL Supply 1,451 1,434 1,331

-U 0 EnergyPlus is amarketer, aload-serving entity to its customers who selected it Delivery 160 183 196 21 as a supplier under the Customer Choice Act and aseller for PPLs Pennsylvania Equity inearnings of unconsolidated affiliates 0

Z0 Supply (14) (12) 12 generation subsidiaries. PPL Electric isa transmission owner and provider of zM International (a) 3 3 113 last resort in PJM. InNEPOOL, PPL EnergyPlus is amarketer and aseller for (11) (9) 125 z PPUs New England generating assets. In the NYISO, PPL EnergyPlus acts as Depreciation z

a marketer. PPL Electric does not participate inNEPOOL or NYISO. Supply 120 129 126 C Afunction of interchange accounting isto match participants' MWh enti- Delivery 110 100 96 Mr International (a) 150 138 44 tlements (generation plus scheduled bilateral purchases) against their MWh obligations (load plus scheduled bilateral sales) during every hour of every 380 367 266 0

Amortizations - recoverable 11 day. If the net result during any given hour is an entitlement, the participant transition costs and other is credited with aspot market sale to the ISO at the respective market price Supply (27) (38) (35) for that hour; if the net result is an obligation, the participant is charged with Delivery 271 236 259 aspot market purchase from the ISO at the respective market price for that 244 198 224 hour0.00259 days <br />0.0622 hours <br />3.703704e-4 weeks <br />8.5232e-5 months <br />. ISO purchases and sales are not allocated to individual customers. Interest income PPL records the hourly net sales and purchases in its financial statements Supply (2) (5) 3 Delivery 7 20 10 as sales to and purchases from the respective ISOs, inaccordance with the International (a) 7 13 2 FERC and industry accounting.

12 28 15 Reclassifications Interest expense Supply 43 108 58 Certain amounts inthe 2002 and 2001 financial statements have been reclas-Delivery 214 214 233 sified to conform to the current presentation. International (a) 218 239 95 475 561 386

2003 2002 2001 3. INVESTMENT IN UNCONSOLIDATED Income taxes AFFILIATES - AT EQUITY Supply 177 119 153 Delivery 23 24 71 Inthe third quarter of 2002, PPL Global acquired acontrolling interest in International (a) (30) 67 37 WPD. As a result, PPL Global fully consolidated the financial results of 170 210 261 WPD at September 30, 2002. See Note 9 for additional information.

Net Income Investment in unconsolidated affiliates accounted for under the equity Supply (b) 502 356 368 method were as follows as of December 31 (equity ownership percentages Delivery 36 48 126 International () 196 (196) (315) as of December 31, 2003):

$734 $208 $179 2003 2002 Cash Flow Data Aguaytia Energy, LLC - 11.4% $ 11 $ 14 Expenditures for property, plant and equipment Bangor Pacific Hydro Associates - 50.0% 15 14 Supply $274 $299 $ 290 Hidro Iberica, B.V.-50.0% 9 8 Delivery 251 237 153 Latin American Energy & Electricity Fund I, LP - 16.6% 3 3 International 246 113 126 PPL Capital Funding Trust I - 100% 18 771 649 569 Safe Harbor Water Power Corporation - 33.3% 15 17 Investment ingenerating assets and SIUK Capital Trust I - 100% 3 electric energy projects Southwest Power Partners, LLC - 50.0% 156 167 Supply 261 176 Teesside Power Limited - 15.4%

International (d) 211 136 Other PPL Global investments (a) 11

$ $472 $312 Total PPL $230 $234 (a) In 2003, PPL Global sold its investment in Wind Resources Limited, and fully As of December31, 2003 2002 consolidated its investment inTransEmel, upon acquisition of the remaining Balance Sheet Data interest. See Note 9 for additional information on TransEmel.

Net investment inunconsolidated affiliates - at equity Summarized below is information from the financial statements of Supply $ 207 $ 198 unconsolidated affiliates accounted for under the equity method, underlying 63i International 23 36 the amounts included inthe consolidated financial statements: -U 230 234 Total assets 2003 2002 2001(a) 0 0

Supply 6,491 4,910 Income Statement Data -V Delivery 5,690 5,867 Revenues $126 $118 $111 0 International 4,942 4,775 Operating Income 17 13 42

$17,123 $15,552 Net Income (Loss) (5) (9) 52 Z0 z

2003 2002 2001 As ofDecember31, 2003 2002 0 z

Geographic Data Balance Sheet Data Revenues from external customers z Current Assets $ 131 $139 D C

Domestic $ 4,573 $4,403 $4,535 Noncurrent Assets 1,414 807 Foreign (a) 1,014 1,078 580 Current Liabilities 47 31

$ 5,587 $5,481 $5,115 Noncurrent Liabilities 924 298 MU 0Mo (a)For purpose of comparability, the summarized information of WPD isexcluded As of December31, 2003 2002 from 2001.

Property, plant and equipment - net Domestic $ 7,072 $5,795 Foreign 3,374 3,771

$10,446 $9,566 (a) 2002 contains the consolidated results of WPD. See Note 9 for additional informa-tion on the acquisition of a controlling interest in WPD.

(b) 2003 includes Iwocumulative-effect changes in accounting principle adjustments recorded inJanuary and December 2003. See Note 21 and 22 for additional infor-mation.

(c 2002 includes the cumulative-effect change in accounting principle recorded in March 2002. See Note 18 for additional information. The International segment also includes the write-downs of the CEMAR investment recorded in March and June 2002 described in Note 9.

(d) The 2002 amount represents the acquisition of the controlling interest inWPD.

Notes to Consolidated Financial Statements

4. EARNINGS PER SHARE InMay 2001, PPL and PPL Capital Funding Trust I issued 23 million PEPS Units that contain apurchase contract component for PPLs common Basic EPS is calculated by dividing 'Net Income' on the Statement of Income stock. The purchase contracts will only be dilutive if the average price of PPUs by the weighted-average number of common shares outstanding during the common stock exceeds athreshold appreciation price, which isadjusted for period. Diluted EPS is calculated similarly for PPL, except that weighted cash distributions on PPL common stock. The appreciation price was initially average shares outstanding are increased for additional shares that would be set at $65.03 and has subsequently been adjusted to $63.94 as of December outstanding it potentially dilutive securities were converted to common stock.

31, 2003 based on dividends paid on PPLs common stock since issuance.

Potentially dilutive securities consist of:

Since the average price has not exceeded the threshold appreciation price, the

• stock options, restricted stock and restricted stock units granted under purchase contracts were excluded from the diluted EPS calculations.

the incentive compensation plans, InJanuary 2004, PPL completed an exchange offer resulting inthe exchange

• stock units representing common stock granted under the directors of approximately 4 million PEPS Units for PEPS Units, Series B.The primary compensation programs, difference inthe units relates to the debt component. The purchase contract

• common stock purchase contracts that are acomponent of the PEPS units, and components of both units, which are potentially dilutive, are identical. The

• convertible senior notes.

threshold appreciation price for the purchase contract component of the PEPS The basic and diluted EPS calculations, and the reconciliation of the Units, Series Bwas set at the last adjusted threshold appreciation price of $63.94 shares (inthousands) used inthe calculations, are shown below: for the PEPS Units and will be adjusted inthe same manner as that of the 2003 2002 2001 PEPS Units. See Note 8 for amore detailed discussion of the exchange offer.

In May 2003, PPL Energy Supply issued $400 million of 2.625%

Income (Numerator)

Income from continuing operations $ 719 $360 $169 Convertible Senior Notes due 2023. The notes are guaranteed by PPL and can Loss from discontinued operations (20) (2) be converted into shares of PPL common stock, at an initial conversion rate of Cumulative effect of achange in 20.1106 shares per $1,000 principal amount of notes, subject to adjustment if:

accounting principle (net of tax) 35 (150) 10

• during any fiscal quarter starting after June 30, 2003, the market price of Net Income $ 734 $208 $179 PPL's common stock trades at or above $59.67 per share over a certain Shares (Denominator) period during the preceding fiscal quarter; Shares for Basic EPS 172,795 152,492 145,974

• PPL calls the debt for redemption; Add: Incremental shares Stock options and other share-based awards 597 317 640

• the holder exercises its right to put the debt on any five-year anniversary of the offering; Shares for Diluted EPS 173,392 152,809 146,614

• the long-term credit rating assigned to the notes by Moody's and Standard Basic EPS Income from continuing operations $ 4.16 $2.36 $1.16 & Poor's falls below Ba2 and BB or the notes are not rated; or Loss from discontinued operations (0.11) (0.01)

• certain specified corporate transactions occur, e.g., change incontrol and Cumulative effect of achange in certain distributions to the holders of PPL common stock.

accounting principle (net of tax) 0.20 (0.98) 0.07 Net Income $ 4.25 $1.37 $1.23 As none of these events has occurred, the Convertible Senior Notes were Diluted EPS excluded from the diluted EPS calculations.

Income from continuing operations $ 4.15 $ 2.36 $1.15 The following number of stock options to purchase PPL common shares Loss from discontinued operations (0.11) (0.01) were excluded in the periods' computations of diluted EPS, because the Cumulative effect of achange in exercise price of the options was greater than the average market price of accounting principle (net of tax) 0.20 (0.99) 0.07 the common shares. Therefore, the effect would have been antidilutive.

Net Income - $4.24 $1.36 $1.22 (Thousands of Shares) 2003 2002 2001 Antidilutive stock options 1,683 1,294 896 a

15. INCOME AND OTHER TAXES - .I 2003 2002 2001 Reconciliation of Income Tax Expense For 2003, 2002 and 2001, the statutory U.S. corporate federal income tax rate Indicated federal income tax on was 35%. The statutory corporate net income tax.rates for Pennsylvania and pre-tax income before cumulative Montana were 9.99% and 6.75%. effect of a change in accounting principle at statutory tax rate - 35% $ 324 $250 $168 The tax effects of significant temporary differences comprising PPLts net Increase/(decrease) due to:

deferred income tax liability were as follows: State income taxes 25 11 25 2003 2002 Amortization of investment tax credit (10) (11) (1 1)

International energy projects -

Deferred Tax Assets charges (benefits) (83) 14 144 Deferred investment tax credits $ 48 $ 54 Difference related to income NUG contracts & buybacks 168 203 recognition of foreign affiliates Accrued pension costs 81 89 (net of foreign income taxes) (7) 18 (9)

Foreign loss carryforwards 278 232 Federal income tax credits (52) (50) (40)

Foreign - pensions 144 125 Contribution of property (9)

Foreign - other 18 3 Other (18) (22) (16)

Write-down of generation assets 18 (154) (40) 93 Impairment write-down 91 Total Income tax expense $ 170 $210 $261 Contribution inaid of construction 63 56 Other 222 223 Effective Income tax rate 18.4% 29.4% 54.4%

Valuation allowance (288) (327) Taxes, Other than Income 734 767 State gross receipts $155 $154 $112 State utility realty 3 3 4 Deferred Tax Liabilities State capital stock 27 7 20 Plant - net 1,061 976 Property - foreign 44 42 Restructuring - CTC 613 700 Domestic property and other 27 25 19 Taxes recoverable through future rates 106 104 Reacquired debt costs 11 11 $ 256 $231 $155 Foreign - plant 617 792 Foreign - pensions 227 167 PPL Global had foreign net operating loss carryforwards of approximately Foreign - other 6 38 $13 million and $28 million at December 31, 2003 and 2002. PPL Global also Other domestic 73 31 had foreign capital loss carryforwards of $920 million at December 31, 2003 2,714 2,819 and $760 million at December 31, 2002. All of these losses have an unlimited Net deferred tax liability $1,980 $2,052 carryforward period. However, it is more likely than not that these losses will not be utilized and as such, afull valuation allowance has been provided.

Details of the components of income tax expense, a reconciliation of PPL Global does not pay or record U.S. income taxes on the undistributed federal income taxes derived from statutory tax rates applied to income from earnings of its foreign subsidiaries where management has determined that continuing operations for accounting purposes, and details of taxes other the earnings are permanently reinvested. The cumulative undistributed earn-than income are as follows: ings are included in 'Earnings reinvested" on the Balance Sheet. The amounts 2003 2002 2001 considered permanently reinvested at December 31, 2003 and 2002 were Income Tax Expense $530 million and $295 million. Ifthe earnings were remitted as dividends, Current- Federal $ 26 $ 41 $270 PPL Global may be subject to additional U.S. taxes, net of allowable foreign Current - State 13 (9) 36 tax credits. It is not practical to estimate the amount of additional taxes that Current - Foreign 35 52 8 might be payable on these foreign earnings.

. 74 84 314 Deferred - Federal 39 70 (86)

Deferred - State 24 27 4 Deferred - Foreign 48 44 44 6. NUCLEAR DECOMMISSIONING COSTS 111 141 (38) The cost to decommission the Susquehanna station is based on a 2002 site-Investment tax credit, net - federal (15) (15) (15) specific study to dismantle and decommission each unit immediately following Total $170 $210 $261 final shutdown. PPL Susquehanna's 90% share of the total estimated cost of Total income tax expense - Federal $ 50 $ 96 $169 decommissioning the Susquehanna station was approximately $936 million Total income tax expense - State 37 18 40 measured in 2002 dollars. This estimate includes decommissioning the radio-Total income tax expense - Foreign 83 96 52 logical portions of the station and the cost of removal of non-radiological Total $170 $210 $261 structures and materials.

Notes to Consolidated Financial Statements Beginning in January 1999, in accordance with the PUC Finai Order, 8. CREDIT ARRANGEMENTS AND FINANCING ACTIVITIES approximately $130 million of decommissioning costs are being recovered Credit Arrangements from customers through the CTC over the 11-year life of the CTC rather than In order to enhance liquidity, and as a credit support to its commercial paper the remaining life of Susquehanna. The recovery will include areturn on program, PPL Electric maintained a $400 million 364-day credit facility which unamortized decommissioning costs. Effective January 1,2003, PPL adopted matured inJune 2003. PPL Electric replaced its facility with a$200 million, SFAS 143 'Accounting for Asset Retirement Obligations.' Inconnection with 364-day facility maturing inJune 2004 and a $100 million three-year credit the adoption, the previously recorded liability for nuclear decommissioning facility maturing inJune 2006. PPL Energy Supply maintains three credit facil-of $296 million was reversed and a liability of $202 million was recorded.

ities: a $300 million three-year credit facility maturing inJune 2006, (this Accretion expense, as determined under the provisions of SFAS 143, was credit facility replaced a$300 million 364-day credit facility which matured

$16 million in2003 and is included in 'Other operation and maintenance.'

in June 2003), a $500 million three-year credit facility maturing inJune 2004 In2002 and 2001, decommissioning expenses were $22 million and $24 mil-and a$300 million three-year credit facility maturing inJune 2005. Both PPL lion, and were recorded as acomponent of depreciation expense. Accrued Electric and PPL Energy Supply have the ability to cause the lenders to issue nuclear decommissioning expenses, as determined under the provisions of letters of credit under their respective facilities. At December 31, 2003, no SFAS 143, were $218 million at December 31, 2003, and are included in cash borrowings were outstanding under any credit facilities of PPL Electric "Deferred Credits and Other Noncurrent Liabilities - Other.' See Note 21 for or PPL Energy Supply. At December 31, 2003, PPL Electric had $42 million additional information on SFAS 143.

of letters of credit outstanding under its $100 million three-year facility, and Amounts collected from PPL Electric's customers for decommissioning, PPL Energy Supply had $87 million of letters of credit outstanding under less applicable taxes, are deposited inexternal trust funds for investment and its $500 million three-year facility.

can be used only for future decommissioning costs.

InOctober 2003, WPD (South West) replaced its expiring credit facility In November 2001, PPL Susquehanna notified the NRC that it intends to I with a new £100 million 364-day credit facility maturing inOctober 2004 i file for 20-year license renewals for each of the Susquehanna units. It approved, and extended its £150 million five-year credit facility to October 2008. At the operating licenses would be extended from 2022 to 2042 for Unit 1and December 31, 2003, WPD (South West) had £27 million ($48 million based from 2024 to 2044 for Unit 2.

on current exchange rates) of outstanding borrowings under its 364-day credit i

66 facility and no outstanding borrowings under its five-year credit facility. At I

7. FINANCIAL INSTRUMENTS December 31, 2003, WPD (South West) had uncommitted credit line borrow-ings of £25 million ($44 million based on current exchange rates) inseparate I

I CD 0 At December 31, 2003 and 2002, the carrying value of cash and cash equivalents, agreements with lender banks.

M0

-U 0

nuclear plant decommissioning trust fund, other investments and short-term WPD (South West) maintained a £250 million bridge facility, which expired debt approximated fair value due to the short-term nature of the instruments, in April 2003, for short-term liquidity. This bridge facility was paid down with 0 variable interest rates associated with the financial instruments or the carrying the proceeds from the issuance of long-term bonds and borrowings under z

value of the instruments being based on established market prices. Price risk another credit facility. The long-term bond issuance is discussed inmore 0

0 management asset and liabilities are valued using either exchange traded mar- detail under "Financing Activities."

z ket quotes or prices obtained through third party brokers and are recorded at The subsidiaries of PPL are separate legal entities. PPLs subsidiaries are zz a fair value. Financial instruments where the carrying amount on the Balance not liable for the debts of PPL. Accordingly, creditors of PPL may not satisfy X1 Sheet and the estimated fair value (based on quoted market prices for the their debts from the assets of the subsidiaries absent aspecific contractual m securities where available and estimates based on current rates offered to PPL

-u undertaking by asubsidiary to pay PPrs creditors or as required by applicable 0

where quoted market prices are not available) are different, are set forth below: law or regulation. Similarly, absent aspecific contractual undertaking or as

-I1 December31, 2003 December 31, 2002 required by applicable law or regulation, PPL is not liable for the debts of its Carrying Fair Carrying Fair subsidiaries. Accordingly, creditors of PPLs subsidiaries may not satisfy their Amount Value Amount Value debts from the assets of PPL absent a specific contractual undertaking by Liabilities PPL to pay the creditors of its subsidiaries or as required by applicable law Long-term debt $7,859 $8,589 $6,267 $6,657 or regulation.

Long-term debt with affiliate trusts 681 612 Financing Activities Company-obligated mandatorily PPL Capital Funding retired the following medium-term notes, at par, redeemable preferred securities of subsidiary trusts holding during 2003:

solely company debentures 661 507

• all of its $60 million 6.375% Series due March 2003; Preferred stock with sinking

. all of its $20 million 6.23% Series due October 2003; and fund requirements 31 30

• all of its $5million 6.40% Series due October 2003.

M

In November 2003, PPL launched an offer to exchange up to $573 million repay the LCIDA, PPL Electric issued $90 million aggregate principal amount aggregate stated amount of its outstanding PEPS Units for up to $573 million of its Senior Secured Bonds under its 2001 Senior Secured Bond Indenture, aggregate stated amount of its PEPS Units, Series Band acash payment by having terms corresponding to the terms of the LCIDA bonds:

PPL of $0.375 for each validly tendered and accepted outstanding PEPS Unit. In February 2003, PPL Electric retired $19 million of its outstanding First The exchange offer, which closed inJanuary 2004, resulted in3,975,160 PEPS Mortgage Bonds, 6-7/8% Series due February 2003, at par value.

Units, or 17.28% of the 23 million outstanding PEPS Units, being exchanged. InApril 2003 and December 2003, as permitted by the 1945 First Mortgage PPL conducted the exchange offer to reduce its future interest expense. Bond Indenture, PPL Electric retired approximately $46 million aggregate During the twelve months ended December 31, 2003, PPL issued $426 mil- principal amount of its First Mortgage Bonds, 7-7/8% Series due 2023, and lion of common stock, including $109 million through its Structured Equity $19 million aggregate principal amount of its First Mortgage Bonds, 6.75%

Shelf Program and $270 million through apublic offering in May 2003. Inthis Series due 2023. Both issues were retired at par value, plus accrued interest, public offering, PPL issued 7.1 million shares of common stock for $38.25 per through the application of cash deposited with the trustee to release certain share. PPL received net proceeds of approximately $261 million, which were transmission lines and other equipment from the lien of the 1945 First used to repurchase commercial paper of PPL Energy Supply and for general Mortgage Bond Indenture.

corporate purposes. In May 2003, PPL Electric issued $100 million of 4.30% Senior Secured In March 2003, WPD (South West) issued £200 million of 5.875% bonds Bonds due 2013. The proceeds were used for general corporate purposes due 2027. The proceeds from this issuance were used to repay £200 million including the refunding of higher-cost securities.

of borrowings under its bridge facility. Additionally, in May 2003, WPD PPL Electric redeemed all outstanding shares of the following preferred (South West) issued an additional £50 million of 5.875% bonds due 2027. stock, at par value of $100 per share plus accumulated and unpaid dividends, WPD (South West) used the proceeds from this issuance to pay down short-term inaccordance with the mandatory sinking fund requirements or through the borrowings. The issuance of this long-term debt resulted inan $11 million optional redemption provisions of each series:

write-off of unamortized swap restructuring costs in the second quarter of 2003.

• inApril 2003, $10 million of 6.15% Series Preferred Stock; In May 2003, PPL Energy Supply issued $400 million of 2.625%

• inJuly 2003, $4million of 6.33% Series Preferred Stock; and Convertible Senior Notes due 2023, which are guaranteed by PPL and convert-

• inOctober 2003, $17 million of 6.125% Series Preferred Stock.

ible into PPL common stock. The convertible notes were sold ina Rule 144A InJanuary 2004, PPL Electric notified holders of its intent to redeem 67 private offering to qualified institutional buyers, and PPL Energy Supply and on March 1,2004 approximately $6million aggregate principal amount of its -D PPL subsequently registered the resale of the notes with the SEC for the bene- 'U 7.30% First Mortgage Bonds. This issue will be retired at par value, plus any fit of the holders. See Note 4for additional information on the convertibility accrued and unpaid interest, through the application of cash deposited with features of the notes. PPL Energy Supply used the proceeds from the private 0 the trustee to release certain transmission lines and other equipment from the -

0 offering of the convertible notes to repurchase commercial paper and for gen-lien of the 1945 First Mortgage Bond Indenture. 0 eral corporate purposes.

During the twelve months ended December 31, 2003, PPL Transition Bond During the twelve months ended December 31, 2003, WPD retired z Company made principal payments on transition bonds totaling $255 million.

$53 million of 7.375% Unsecured Bonds due 2028.

During the twelve months ended December 31, 2003, PPL Electric received (0 At December 31, 2003, PPL Energy Supply had no commercial paper a capital contribution of $75 million from PPL.

outstanding. z At December 31, 2003, PPL Electric had no commercial paper outstanding. C During the twelve months ended December 31, 2003, PPL Energy Supply distributed approximately $1.2 billion to its parent company, PPL Energy Dividends and Dividend Restrictions Funding, and received capital contributions of $261 million. InFebruary 2003, PPL announced an increase of its quarterly common _0 0

In February 2003, the Lehigh County Industrial Development Authority stock dividend, effective April 1, 2003, from 36 cents per share to 38.5 cents -4 (LCIDA) issued $90 million of 3.125% Pollution Control Revenue Refunding per share (equivalent to $1.54 per annum). Future dividends, declared at the Bonds due November 2008 on behalf of PPL Electric. The proceeds of the discretion of the Board of Directors, will be dependent upon future earnings, bonds were used to refund the LCIDAs $90 million, 6.40% Pollution Control cash flows, financial requirements and other factors.

Revenue Refunding Bonds due 2021. Inorder to secure its obligations to

Notes to Consolidated Financial Statements The PPL Montana Colstrip lease places certain restrictions on PPL Montana's InApril 2003, PPL Susquehanna completed the replacement of the Unit 2 ability to declare dividends. At this time, PPL believes that these covenants steam turbine at the Susquehanna station. This project provides anominal will not limit PPL Montana's ability to operate as desired and will not affect power increase of 50 MW of generation capacity, of which PPL Susquehanna PPL's ability to meet any of its cash obligations. Certain of PPL Global's inter- has a 90% undivided interest. An additional turbine upgrade is in progress for national subsidiaries also have financing arrangements which limit their ability Unit 1 and isexpected to be completed in 2004. Through December 31, 2003, to pay dividends. However, PPL does not, at this time, expect that any of such atotal of approximately $125 million had been incurred on these projects.

limitations would significantly impact its ability to meet its cash obligations. InOctober 2003, PPL Maine entered into an agreement inprinciple with a PPL Electric's 2001 Senior Secured Bond Indenture restricts dividend pay- coalition of government agencies and private groups to sell three of its nine ments inthe event that PPL Electric fails to meet interest coverage ratios or hydroelectric dams in Maine. Ifthe agreement is finalized, anon-profit organi-fails to comply with certain separateness formalities undertaken in connection zation designated by the coalition would have afive-year option to purchase with its strategic initiative (see Note 19 for additional information). PPL Electric the dams for approximately $25 million, and PPL Maine would receive rights does not, at this time, expect that any of such limitations would significantly to increase energy output at its other hydroelectric dams in Maine. The coali-impact its ability to declare dividends. tion has indicated that it plans to remove or bypass the dams subject to the agreement in order to restore runs of Atlantic salmon and other migratory fish to the Penobscot River. Any final agreement will require several approvals

9. ACQUISITIONS, DEVELOPMENT AND DIVESTITURES by the FERC.

InNovember 2003, PPL Generation sold four of the six spare gas combus-Domestic Generation Projects tion turbine generators and related equipment for approximately $33 million.

In2001, PPL Global made a decision to cancel approximately 2,100 MW of PPL Generation received substantially all of the proceeds in January 2004.

previously planned generation development in Pennsylvania and Washington The pre-tax loss on the sale of about $3million isincluded in"Other Income -

state. These projects were inthe early stage of development and would have net" on the Statement of Income.

had an estimated capital cost of approximately $1.3 billion. The charge for See Note 22 for adiscussion of the Lower Mt. Bethel facility.

cancellation of these generation projects, which was primarily due to cancel-lation fees under turbine purchase contracts, was approximately $150 million, International Energy Projects 68 or $88 million after-tax, and was reported on the Statement of Income as Acquisitions "Cancellation of generation projects,' acomponent of "Other charges." At WPD C)

-0 June 30, 2002, PPL Global had completed payment of the cancellation fees. On September 6, 2002, PPL Global acquired the remaining 49% equity interest 2, In November 2002, PPL Global evaluated its options with respect to six inWPDH Limited and WPDL from Mirant for approximately $236 million,

~0

-0 unassigned turbines and SCRs that were complete or substantially complete. including acquisition costs. The acquisition of Mirant's 49% interest provides 0 These units were intended to be used at the Kings Park site on Long Island, PPL Global with complete ownership of WPD.

I,,1 New York. At that time, given low energy prices and the unavailability of a Prior to the acquisition, PPL Global held 51% of the equity interest in C

C power contract, PPL Global was reevaluating its options with respect to the WPD but shared control with Mirant pursuant to ashareholders' agreement.

N' 2,

Kings Park project. The shareholders' agreement was terminated inconnection with the closing of Due to the uncertainty of the project and the absence of other viable the acquisition. No regulatory approvals were required for this transaction.

C projects, avaluation based upon replacement costs of the turbines and The purchase of Mirant's interest inWPD was accounted for as astep-the SCRs was completed. This resulted inthe recognition of a$44 million acquisition and resulted inthe consolidation of WPD's accounts by PPL.

impairment charge, which is reported on the Statement of Income as "Write- The assets acquired and liabilities assumed were recorded at estimated

_0 M0 down of generation assets," acomponent of "Other charges." Adeferred fair value as determined by management based on information available at the income tax benefit of $18 million was recognized on the write-down. time of acquisition. As of October 1, 2003, management completed its review InJanuary 2003, PPL announced that it had decided not to proceed with and determination of the fair values assigned to assets acquired and liabilities development of the 300 MW Kings Park project. InMarch, PPL Global sold assumed. The fair value of PP&E, based on an independent appraisal, was its interest in Kings Park Energy, LLC. At that time, the six unassigned gas approximately $800 million lower than the preliminary valuation. Accordingly, combustion turbine generators and SCRs to be used at the Kings Park site PP&E was reduced, with offsetting increases ingoodwill and reductions in were retained as spare parts. deferred income taxes.

The following table summarizes the final allocation of purchase price made adecision to exit the investment. At that time, PPL Global's remaining based on fair values of the assets acquired and liabilities assumed at the date portion of its CEMAR investment, which related to foreign currency translation of acquisition, plus the book value of assets and liabilities underlying PPL adjustments (CTA), was written-off. The $94 million charge was recorded in Global's previous 51% equity ownership: 'Write-down of international energy projects." Accounting guidance prohibited the inclusion of CTA inimpairment calculations prior to designating such Current assets $ 236 assets as held for disposal.

Investments (a) (450)

PP&E 2,629 On August 21, 2002, ANEEL authorized an administrative intervention in Goodwill 740 CEMAR and fully assumed operational and financial control of the company.

Other intangibles 4 Inits public announcement relating to the intervention, ANEEL said that its Other 244 intervention and control of CEMAR would last for an initial term of 180 days Total assets acquired 3,403 and that it could be extended.

Current liabilities 767 The intervener appointed by ANEEL issued a public statement and schedule Long-term debt 1,668 for the transfer of the ownership interest inCEMAR to a new owner. Although Other 732 the schedule announced by the intervener reflected a closing for the transfer of Total liabilities assumed 3,167 control of CEMAR to athird party on December 20, 2002, the closing did not Net assets acquired - $ 236 occur. The deadline for the sale process was extended to February 17, 2003, (a) Includes the reversal of PPL Global's equity investment. the same day the initial term of the intervention was scheduled to end. No con-forming bids were submitted to ANEEL by the February 17 deadline due to three The goodwill reflected above includes the remaining value of PPL Global's outstanding injunctions preventing the sale process from continuing. ANEEL 51% share of the goodwill recognized by WPD on its acquisition of Hyder, in publicly announced a 180-day extension of the initial intervention on February addition to the $568 million of non-deductible goodwill arising upon acquisi-14, citing the continuing unresolved financial crisis of CEMAR as the primary tion of Mirant's 49% interest.

reason for the extension. As of February 11, 2003, due to the inability to dis-The PPL income statements for 2003 and 2002 include consolidated WPD charge their obligations under the continuing intervention, PPL-related officers results for the twelve-month periods ended November 30, 2003 and 2002. This and directors of CEMAR resigned from their respective positions.

reflects PPL Global's policy of recording the results of foreign controlled sub- 69 InApril 2003, PPL learned that the Brazilian Federal Appellate Court hear-sidiaries on a one-month lag. The portion of earnings attributable to Mirant, ing the appeal of one of the above-mentioned injunctions accepted ANEEL's -u

$73 million for the year ended December 31, 2002, isreported on the Statement arguments and cancelled the injunction. InJune, ANEEL's officials indicated to 0 To of Income in 'Minority Interest.!

PPL that the other two injunctions outstanding against the sale process had 0 TransEmel been lifted as well. The intervenor appointed by ANEEL issued apublic state-Emel acquired the remaining 40% interest ina provider of transmission ser- ment and revised schedule for the transfer of the ownership interest inCEMAR -4 Z0 vice to northern Chile inJuly 2003 at anet cost of $3million, bringing its to a new owner. InJuly, ANEEL pre-qualified a Brazilian private equity fund, z total ownership interest inTransEmel to 100%. As aresult of this acquisition, GP Investimentos (GP), as the sole qualified bidder. However, on August 12, 0 Co 0

the operating results of TransEmel have been consolidated from the beginning ANEEL announced that it could not proceed with GP's offer because, among z

of the year. The portion of earnings attributable to the minority shareholder is other reasons, it was unacceptable to CEMAR's creditors. On August 16, ANEEL 3C reported on the Statement of Income in'Minority Interest." extended the intervention for up to an additional 180 days. On September 4, ANEEL published a revised schedule for the sale of CEMAR to athird party by Write-down of International Energy Projects the end of 2003. On December 16, 2003, a federal judge enjoined the sale pro- 0 m4 CEMAR I cess to allow another party (MT Baker) 30 days to submit a bid for CEMAR.

In2001, PPL Global estimated that the long-term viability of its CEMAR However, GP was the only party that submitted abid by the revised deadline.

investment was jeopardized and that there was minimal probability of positive On February 3,2004, ANEEL announced that it had accepted the bid of GP.

future cash flows. At that time, PPL Global recorded an impairment loss of Before assuming control of CEMAR, GP must complete negotiations with

$217 million inthe carrying value of its net assets inCEMAR, including a CEMAR's creditors and other third parties. ANEEL has extended the closing

$179 million charge to "Write-down of international energy projects," a com-date for the sale of CEMAR to GP to March 30, 2004. At this time, PPL Global ponent of "Other charges" on the Statement of Income. In March 2002, PPL cannot predict when or it GP will complete these negotiations and assume Global recorded afurther impairment loss of $6million, which was also control of CEMAR.

charged to 'Write-down of international energy projects." InJune 2002, PPL

Notes to Consolidated Financial Statements PPL Global no longer controls or manages CEMAR, and PPL Global has of the Latin American telecommunications company, which was aloss of deconsolidated the financial assets and liabilities of CEMAR from its financial approximately $2million for 2003, are reflected as 'Loss from Discontinued statements. Consistent with the cost method of accounting, PPL Global is no Operations" on the Statement of Income. The results of operations have been longer recording CEMAR's operating results. classified as discontinued operations for all periods presented. The assets and At December 31, 2003, the negative investment inCEMAR of $18 million liabilities of the discontinued operations totaled $5million and $4million at was included in 'Deferred Credits and Other Noncurrent Liabilities - Other.' December 31, 2003, and are included in 'Current Assets - Other' and "Current Any negative carrying value will be reversed upon the final sale or other dispo- Liabilities - Other' on the Balance Sheet. Balance Sheet amounts have not sition of the company. been reclassified at December 31, 2002.

WPD/Teesside Sales of Property WPD has an equity interest inTeesside Power Limited (Teesside), the owner of Inthe second quarter of 2003, asubsidiary of WPD sold certain Hyder proper-the 1,875 MW Teesside Power Station, located innortheast England. Through ties. PPL Global received approximately $17 million from the sales, and its European affiliates, Enron was an owner, operator and power purchaser of recorded apre-tax gain of about $2million. This gain is included in"Other the station's output. As a result of Enron being placed into receivership inthe Income - net' on the Statement of Income.

U.K. and its default on obligations under the power purchase agreements, in Other 2001, WPD wrote off its entire equity investment in Teesside. PPL Global's InApril 2003, a subsidiary of PPL Telcom acquired the fiber optic network of a share of the impairment loss was $21 million and is included in"Write-down Fairfax, Virginia-based company for approximately $21 million, consisting of of international energy projects' on the Statement of Income.

$9million in cash and a $12 million capital lease obligation for the right to In connection with the Enron bankruptcy and the probable resulting loss of use portions of afiber optic network. The 1,330-route-mile metropolitan area Teesside cash flows, PPL and its subsidiaries evaluated the carrying value ot fiber network connects New York, northern New Jersey, Philadelphia, Baltimore WPD. Fair value, measured using discounted cash flows, was compared to the and Washington, D.C. The acquisition required certain regulatory approvals carrying value to determine whether impairment existed at December 31, 2001.

and authorizations inthe area served by the network.

Fair value was determined considering the loss of the value of the future cash flows from the Teesside Power Station and aforecasted reduction infuture 70 operating cash flows at WPD. The probability-weighted impairment loss was 1 0. LEASES

$117 million, after-tax. The pre-tax charge was $134 million, and was recorded

-u as acharge to 'Write-down of international energy projects." Colstrip Generating Plant 0

0 In2002, PPL Global recognized an $8million tax benefit on the worthless- PPL Montana leases a 50% interest inColstrip Units 1and 2and a30%

-U 0

ness of WPD's investment in Teesside. interest in Unit 3, under four 36-year non-cancelable operating leases. These

-I leases provide two renewal options based on the economic useful life of the r Other 0

Z generation assets. PPL Montana isrequired to pay all expenses associated with z In2002, PPL Global evaluated certain investments for impairment and a the operations of the generation units. The leases place certain restrictions on C

recorded a$5million impairment charge inconnection with its investment in PPL Montana's ability to incur additional debt, sell assets and declare dividends 2 CGE, a$4million impairment of acorporate joint venture's investment in 2 and require PPL Montana to maintain certain financial ratios related to cash 21 Brazil, and a$4million write-down of certain non-electrical assets inBolivia.

C flow and net worth. The amount outstanding under these leases at December 31,

-4 I-Discontinued Operations 2003 was $295 million. There are no residual value guarantees inthese leases.

InDecember 2003, PPL Global's Board of Managers authorized PPL Global However, upon an event of default or an event of loss, the lessee could be

• 0 0

to sell its investment inaLatin American telecommunications company, required to pay atermination value of amounts sufficient to allow the lessor to and approved a plan of sale. It was determined that the viability of this non- repay amounts owing on the lessor notes and make the lessor whole for its strategic business was uneconomical. PPL Global believes a sale isprobable equity investment and anticipated return on investment. The events of default within one year. include payment defaults, breaches of representations or covenants, acceleration As aresult, PPL Global recorded awrite-down inthe carrying value of the of other indebtedness of PPL Montana, change in control of PPL Montana and company's net assets to their estimated fair value of approximately $1million. certain bankruptcy events. The termination value isestimated to be $583 mil-This write-down totaling approximately $18 million, as well as operating results lion at December 31, 2003.

Other Leases of common stock underlying such an award are again available for grant.

Inaddition to the leasing arrangements discussed above, PPL and its Shares delivered under the Plans may be inthe form of authorized and unis-subsidiaries also have leases for vehicles, office space, land, buildings, sued common stock, common stock held intreasury by PPL or common stock personal computers and other equipment. Rental expense for all operating purchased on the open market (including private purchases) inaccordance leases was as follows: with applicable securities laws.

2003 $85 Restricted Stock 2002 62 Restricted shares of PPL common stock are outstanding shares with full voting 2001 52 and dividend rights. Restricted stock awards are subject to a restriction or vesting period as determined by the CCGC inthe case of the ICP, and the CLC Total future minimum rental payments for all operating leases are inthe case of the ICPKE. Inaddition, the shares are subject to forfeiture or estimated as follows:

accelerated payout under Plan provisions for termination, retirement, disability 2004 $ 79 and death of employees. Restricted shares vest fully if control of PPL changes, 2005 68 as defined by the plans.

2006 63 2007 56 Restricted Stock Units 2008 56 In2003, the Plans were amended to allow for the grant of restricted stock Thereafter 505 units. Restricted stock units are awards based on the fair market value of PPL

$827 common stock. Actual PPL common shares will be issued upon completion of arestriction or vesting period as determined by the CCGC inthe case of the Inconnection with the acquisition of the fiber optic network discussed in ICP, and the CLC inthe case of the ICPKE. Recipients of restricted stock units Note 9,asubsidiary of PPL Telcom assumed a$12 million capital lease obliga-may also be granted the right to receive dividend equivalents through the end tion through 2020 for the right to use portions of the fiber optic network. Total of the restriction period or until the award is forfeited. Restricted stock units future minimum rental payments for this capital lease are estimated at $1million are subject to forfeiture or accelerated payout under the Plan provisions for for each of the years from 2004 through 2008, and $15 million thereafter.

termination, retirement, disability and death of employees. Restricted stock See Note 22 for discussion of synthetic leases. 71 units vest fully if control of PPL changes, as defined by the Plans.

0 Asummary of restricted stock/unit grants follows:

00 Weighted Weighted 1 . STOCK-BASED COMPENSATION Restricted Average Restricted Average M

M D

Restricted Stock/ Shares Fair Units Fair Under the PPL Incentive Compensation Plan (ICP) and the Incentive Units Granted Granted Value Granted Value

0 I

Compensation Plan for Key Employees (ICPKE) (together, the 'Plans"),

2003 42,090 $36.23 139,732 $35.09 0 restricted shares of PPL common stock, restricted stock units and stock 2002 147,735 $34.12 z Z

options may be granted to officers and other key employees of PPL, PPL 2001 202,590 $43.09 Z Electric and other affiliated companies. Awards under the Plans are made by the Compensation and Corporate Governance Committee (CCGC) of the Compensation expense related to restricted stock and restricted stock M o

C PPL Board of Directors, inthe case of the ICP, and by the PPL Corporate unit awards was $5million, $5million and $6million for PPL for 2003, 2002 2D Leadership Council (CLC), inthe case of the ICPKE. The ICP limits the and 2001. At December 31, 2003, there were 491,014 restricted shares and 0

total number of awards that may be granted under it after April 23, 1999 to 135,078 restricted units outstanding. These awards currently vest from three X 21 7,884,715 awards, or 5%of the total shares of common stock that were out- to 25 years from the date of grant.

standing at April 23, 1999. The ICPKE limits the total number of awards that Stock Options may be granted under it after April 25, 2003, to 8,286,804 awards, or 5%of Under the Plans, stock options may also be granted with an option exercise the total shares of common stock that were outstanding at January 1, 2003, price per share not less than the fair market value of PPUs common stock on reduced by outstanding awards for which common stock was not yet issued as the date of grant. The options are exercisable beginning one year after the date of April 25, 2003. In addition, each Plan limits the number of shares available of grant, assuming the individual is still employed by PPL or asubsidiary, in for awards inany calendar year to 2%of the outstanding common stock of installments as determined by the CCGC inthe case of the ICP, and the CLC in PPL on the first day of such calendar year. The maximum number of options the case of the ICPKE. Options outstanding at December 31, 2003 vest over a that can be awarded under each Plan to any single eligible employee inany three-year period from the date of grant inequal installments. The CCGC and calendar year is1.5 million shares. Any portion of these options that has not CLC have discretion to accelerate the exercisability of the options. All options been granted may be carried over and used inany subsequent year. If any expire no later than ten years from the grant date. The options become exercis-award lapses, is forfeited or the rights of the participant terminate, the shares able immediately if control of PPL changes, as defined by the Plans.

Notes to Consolidated Financial Statements

- Asummary of stock option activity follows:

2003 2002 2001 Weighted Weighted Weighted Number of Average Number of Average Number of Average

- Options Exercise Price Options Exercise Price Options Exercise Price Outstanding at beginning of year 3,008,685 $32.09 2,255,051 $31.36 1,969,301 $23.64 Granted 816,110 35.23 840,430 33.49 922,860 43.16 Exercised (860,915) 24.09 (62,710) 22.82 (548,424) 23.49 Forfeited (51,622) 35.32 (24,086) 36.18 (88,686) 31.31 Outstanding at end of year 2,912,258 35.56 3,008,685 32.09 2,255,051 31.36 Options exercisable at end of year 1,354,075 1,400,701 306,544 Weighted-average fair value of options granted $11.92 $11.68 $10.42 The estimated fair value of each option granted was calculated using a Black-Scholes option-pricing model. The weighted average assumptions used in the model were as follows:

2003 2002 2001 Risk-free interest rate 3.81% 5.35% 5.46%

Expected option life 7.75 yrs. 10 yrs. 10 yrs.

Expected stock volatility 39.94% 39.11% 30.24%

Dividend yield 3.48% 3.34% 4.28%

The following table summarizes information about stock options at December 31, 2003:

Options Outstanding Options Exercisable Weighted Number Average Weighted Number Weighted Outstanding Remaining Average Exercisable Average 72 Range of Exercise Prices at12/31/03 Contractual Life Exercise Prices at 12/31/03 Exercise Price

-V

$19.00-$24.00 206,415 6.1 $22.26 206.415 $22.26

-U $25.00-$29.00 327,712 5.3 26.84 327,712 26.84 0 $30.00-$35.00 705,403 8.1 33.49 193,547 33.49 M0

$36.00-$39.00 816,110 9.1 36.23 0

$40.00-$45.00 856,618 7.1 43.16 626,401 43.16

-4 I

0 Total options outstanding had a weighted-average remaining life of 7.6 years at December 31, 2003.

2 Ca Director Stock Units period and have a10-year term, during which time employees are entitled 2

Under the Directors Deterred Compensation Plan, stock units are used to to receive a cash payment of any appreciation inthe price of PPl's common compensate members of PPUs Board of Directors who are not employees stock over the grant date value. At December 31, 2003, there were 70,815 r, of PPL. Such stock units represent shares of PPLs common stock to which stock appreciation rights outstanding. Compensation expense for all periods board members are entitled after they cease serving as a member of the Board reported was insignificant.

-o M0

'D of Directors. Board members are also entitled to deter any or all of their cash 24 Method ol Accounting compensation into stock units. The stock unit accounts of each board member Effective January 1, 2003, PPL and its subsidiaries adopted the fair value are increased based on dividends paid or other distributions on PPL's common method of accounting for stock-based compensation, as prescribed by SFAS stock. There were 77,428 stock units outstanding at December 31, 2003.

123, 'Accounting for Stock-Based Compensation," using the prospective Compensation expense for all periods reported was insignificant.

method of transition permitted by SFAS 148, 'Accounting for Stock-Based Stock Appreciation Rights Compensation - Transition and Disclosure, an amendment of FASB Statement WPD uses stock appreciation rights to compensate senior management No. 123." Prior to 2003, PPL applied the intrinsic value method, permitted employees. Stock appreciation rights are granted with areference price to under SFAS 123 and defined inAPB Opinion No. 25, "Accounting for Stock PPLs common stock at the date of grant. These awards vest over athree-year Issued to Employees" and related interpretations. See Note 1for additional information related to the adoption of the fair value method.

12. RETIREMENT AND POSTEMPLOYMENT BENEFITS tional liability for the cost of health care of retired miners of former subsidiaries that had been engaged incoal mining. At December 31, 2003, the liability was Pension and Other Postretirement Benefits

$28 million. The liability is the net of $57 million of estimated future benefit PPL and certain of its subsidiaries sponsor various pension and other post-payments offset by $29 million of available assets in aPPL Electric-funded retirement and postemployment benefit plans. PPL follows the guidance of VEBA trust.

SFAS 87, 'Employers' Accounting for Pensions,' and SFAS 106, 'Employers' PPL Energy Supply subsidiaries engaged inthe mechanical contracting Accounting for Postretirement Benefits Other Than Pensions,' when account-business make contributions to various multi-employer pension and health and ing for these benefits.

welfare plans, depending on an employee's status. Contributions of $23 million, PPL and certain of its subsidiaries also provide supplemental retirement

$30 million and $21 million were made in2003, 2002 and 2001. The change benefits to directors, executives and other key management employees through incontributions from year to year is primarily the result of the changes in the unfunded nonqualified retirement plans.

workforce at the mechanical contracting companies. The contribution rates The majority of employees of PPL's domestic subsidiaries will become have also increased from year to year.

eligible for certain health care and life insurance benefits upon retirement Inthe third quarter of 2002, PPL Global acquired complete ownership of through contributory plans. Postretirement benefits under the PPL Retiree WPD. Included inthe fully consolidated financial results of PPL for 2003 and Health Plans (covering retirees of PPL Electric and various other affiliated 2002 is the impact of the various pension plans WPD sponsors in the U.K.

PPL companies) and the North Penn Gas Plans are paid from funded VERA The following disclosures distinguish between PPUs domestic and interna-trusts sponsored by the respective companies.

tional pension plans.

At December 31, 2003, PPL Electric had a regulatory asset of $5million PPL uses aDecember 31 measurement date for its domestic pension and relating to postretirement benefits that is being amortized and recovered in other postretirement benefit plans and its international pension plans.

rates, with a remaining life of nine years. PPL Electric also maintains an addi-Net pension and other postretirement benefit costs (credits) were as follows:

Pension Benefits - Other Postretirement Benefits 2003 2002 2001 2003 2002 2001 73 Domestic International Domestic International Domestic* International Service cost $ 42 $ 14 $ 40 $ 13 $ 38 $1 $ 7 $ 5 $ 5 0 Interest cost 105 124 99 98 91 3 31 26 22 D0 Expected return on plan assets (143) (188) (147) (179) (140) (3) (13) (12) (11) 0

=3 Net amortization and deferral (6) 4 (31) 3 (50) 25 15 12 0 Net periodic pension and 0 zNa postretirement costs/(credits) prior to special termination benefits (2) (46) (39) (65) (61) 1 50 34 28 z Special termination benefits 9 62 3 4 Net periodic pension and postretirement benefit cost(credit) $ 7 $ (46) $ 23 $ (65) $ (58) $1 $ 50 $38 $28 z C

Net periodic pension cost charged (credited) to operating expense, excluding 0 amounts charged to construction and other non-expense accounts, were: -u 0

2003 2002 2001 Domestic International Domestic International Domestic International Operating Expense (a) $(2) $(40) $(31) $(58) $(48) $1 (a)The domestic amounts for 2003 and 2002 exclude the $9million and $62 million cost of special termination benefits, which are included separately on the Statement of Income, within the 'Workforce reductiona charge for those years.

In2001, PPL changed its method of amortizing unrecognized gains or value of plan assets were amortized on astraight-line basis over the losses inthe annual pension expense or income determined under SFAS 87, estimated average future service period of plan participants. Market-related

'Employers' Accounting for Pensions" for its primary domestic pension plan. value of assets is calculated by rolling forward the prior year market-related Under the ofd method, the net unrecognized gains or losses in excess of 10% value with contributions, disbursements and expected return on investments.

of the greater of the plan's projected benefit obligation or the market-related This expected value is then compared to the actual fair value of assets.

Notes to Consolidated Financial Statements One fifth of the difference between the actual value of assets and the expected The pro forma effect of retroactive application of this change in accounting value isadded (or subtracted if negative) to the expected value to arrive at the principle would have been:

new market-related value. 2001 Under the new method, asecond corridor is utilized for the net unrecog- Net Income EPS nized gains or losses inexcess of 30% of the plan's projected benefit $(10) $(.07) obligation. The net unrecognized gains or losses outside the second corridor are now amortized on astraight-line basis over aperiod equal to one-half of The international plans adopted the double corridor approach when the average future service period of the plan participants. The new method is PPL gained control of WPD. This had no effect on prior figures.

preferable under SFAS 87 because it provides more current recognition of Other post retirement benefits costs charged to operating expense, gains and losses, thereby lessening the accumulation of unrecognized gains excluding amounts charged to construction and other non-expense accounts, and losses. were $43 million in2003, $27 million in2002 and $21 million in2001.

The following assumptions were used in the valuation of the benefit obligations at December 31 and determination of net periodic benefit cost for the years ended December 31:

Pension Benefits 2003 2002 2001 Domestic International Domestic International Domestic International Discount rate

- obligations 6.25% 5.50% 6.75% 5.75% 7.25% 10.24%

- cost 6.75% 5.75% 7.25% 5.75% 7.50% 10.24%

Expected return on plan assets

- obligations 9.0% 8.30% 9.0% 8.31% 9.2% 10.24%

- cost 9.0% 8.31% 9.2% 8.31% 9.2% 10.24%

Rate of compensation increase

- obligations 4.0% 3.75% 4.0% 3.75% 4.25% 7.12%

74 - cost 4.0% 3.75% 4.25% 3.75% 4.75% 7.12%

0 Other Postrelirement Benefits 2003 2002 2001 A one-percentage point change in the assumed health care costs trend 0

Discount rate assumption would have the following effects in2003:

0P

- obligations 6.25% 6.75% 7.25%

One Percentage Point

- cost 6.75% 7.25% 7.50%

Increase Decrease Z0 Expected return on plan assets a - obligations 7.80% 7.80% 7.60% Effect on service cost and interest cost components $3 $ (2)

- cost 7.80% 7.60% 7.60% Effect on postretirement benefit obligation 34 (29) z a Rate of compensation increase 2.

- obligations 4.0% 4.0% 4.25% The expected long-term rate of return for PPI's domestic pension plans 2,

C - cost 4.0% 4.25% 4.75% . considers the plans' historical experience, but is primarily based on the plans'

-F mix of assets and expectations for long-term returns of those asset classes.

M Assumed Health Care Cost 0

2, Trend Rates at December31, 22003 2002 2001 The expected long-term rate of return for PPUs other postretirement benefit plans is based on the VEBA trusts' mix of assets and expectations for long-Health care cost trend rate assumed for next year term returns of those asset classes considering that a portion of those assets

- obligations 11% 12% 7% are taxable.

- cost 12% 7% 7.25% The expected rate of return for PPUs international pension plans considers Rate to which the cost trend rate isassumed that a portfolio largely invested in equities would be expected to achieve an to decline (the ultimate trend rate) 5% 5% 6% average rate of return in excess of a portfolio largely invested in long-term

- obligations

- cost 5% 6% 6% bonds. The historical experience has been an excess return of 2% to 4% per Year that the rate reaches the ultimate annum on average over the return on long-term bonds.

trend rate

- obligations 2010 2010 2006

- cost 2010 2006 2006

The funded status of the PPL plans was as follows:

Pension Benefits Other Postretirement Benefits 2003 2002 2003 2002 Domestic International Domestic International Change in Benefit Obligation Benefit Obligation, January 1 $1,558 $2,126 $1,279 $ 37 $ 423 $ 330 Service cost 42 14 40 13 7 5 Interest cost 105 124 99 98 31 26 Participant contributions 5 4 1 1 Plan amendments 3 80 39 48 21 Actuarial (gain)/loss 127 101 76 (53) 30 59 Special termination benefits 9 62 4 Acquisition/divestitures 1,970 Setlements/curtailments (30)

Actual expense paid (1) (1)

Net benefits paid (71) (131) 77) (128) (28) (23)

Currency conversion 235 176 Benefit Obligation, December31 1,772 2,474 1,558 2,126 512 423 Change In Plan Assets Plan assets at air value, January 1 1,376 1,757 1,633 21 163 155 Actual return on plan assets 329 332 (182) (335) 27 (11)

Employer contributions 20 3 1 56 41 Participant contributions 5 4 1 1 Acquisition/divestitures 2.050 Settlements/curtailments (21)

Actual expense paid (1) (1)

Net benefits paid (71) (131) (77) (128) (28) (23) 75 Currency conversion 201 165 10 Plan assets atfair value, December31 1,653 2,164 1,376 1,757 219 163 0

Funded Status -u 0

Funded Status of Plan (119) (310) (182) (369) (293) (260) 1o Unrecognized actuarial (gain)/loss (187) 477 .(144) 497 134 123 zZ0 M0 Unrecognized prior service cost 167 33 178 34 76 39 Unrecognized transition assets (27) (31) 78 87 W Currency conversion 57 26 D M

Net amount recognized atend of year $ (166) $ 257 $ (179) $ 188 $ (5) $ (11) zC z

=1 Amounts recognized inthe -

_V Balance Sheet consist of: M0 Prepaid benefit cost $ 4 $ 257 $ 1 $ 219 $ 4 Accrued benefit liability (170) (180) (31) (9) $(11)

Additional minimum liability (28) (516) (29) (453)

Intangible asset 9 37 5 37 Accumulated other comprehensive income (pre-tax) 19 434 24 416 Cumulative translation adjustment 45 Netamountrecognizedatendof year $ (166) $ 257 $ (179) $ 188 $ (5) $ (11)

Total accumulated benefit obligation for defined benefit pension plans $1,553 $2,423 $1,376 $2,022

Notes to Consolidated Financial Statements Information for pension plans with projected and accumulated benefit obli- PPLs investment strategy with respect to its other postretirement benefit gations inexcess of plan assets follows: obligations is to fund the VEBA trusts with voluntary contributions and to 2003 2002 invest inatax efficient manner utilizing aprudent mix of assets. Based on Domestic Int'l Domestic Int l the current VEBA and pdstretirement plan structure, atargeted asset allocation Projected benefit range of 50% to 60% equity and 40% to 50% debt is maintained.

obligation pensions $1,765 $2,474 $1,551 $2,126 Accumulated benefit obligation $1,546 $2,423 $1,369 $2,022 Plan Assets - International Pension Plans Fairvalueof assets $1,646 $2,164 $1,369 $1,757 WPD operates three defined benefit plans, the WPD Group segment of the Electricity Supply Pension Scheme (ESPS), the Western Power Utilities Information for pension plans with accumulated benefit obligations in Pension Scheme (WPUPS), and the Infralec 1992 Scheme (Infralec). The excess of plan assets follows: assets of all three schemes are held separately from those of WPD in trustee-2003 2002 administered funds.

Domestic Int'l Domestic Intnl PPLs international pension plan asset allocation and target allocation are Projected benefit detailed below.

obligation pensions $142 $2,474 $122 $2,126 Percentage of plan Target asset Accumulated benefit obligation $130 $2,423 $110 $2,022 assets at December 31, allocation Fairvalueof assets $ 76 $2,164 $ 46 $1,757 Asset Category 2003 2002 Information for other postretirement benefit plans with accumulated Equity securities 75% 75% 75%

Debt securities 21% 21% 23%

postretirement benefit obligations in excess of plan assets follows:

Real estate and other 4% 4% 2%

2003 2002 Total 100% 100% 100%

Accumulated postretirement benefit obligation $512 $423 Fair value of assets $219 $163 Inconsultation with its investment advisor and with WPD, the group trustees of the WPD Group of the ESPS have drawn up aStatement of Investment Plan Assets - Domestic Pension Plans Principles (the Statement) to comply with the requirements of U.K. legislation.

The asset allocation for the PPL Retirement Plan Master Trust and the target The group trustees' primary investment objective isto maximize allocation, by asset category, are detailed below.

-U investment returns within the constraint of avoiding excessive volatility Percentage of plan Target asset inthe funding position.

0

-U0 assets at December 31, allocation

-0 Asset Category 2003 2002 Expected Cash Flows - Domestic Pension Plans Equity securities 73% 66% 70% There are no contributions required for PPrs primary domestic pension plan Z0 Debt securities 22% 29% 25% or any of PPLs other domestic subsidiary pension plans. However, PPL sub-z Real estate and other 5% 5% 5% sidiaries expect to contribute approximately $9million to their pension plans 0

Total 100% 100% 100 0% in 2004 to ensure future compliance with minimum funding requirements.

PPL sponsors various non-qualified supplemental pension plans for C

The domestic pension plan assets are managed by outside investment which no assets are segregated from corporate assets. PPL expects to make managers and are rebalanced as necessary to maintain the target asset alloca-approximately $2million of benefit payments under these plans in2004.

m tion ranges. PPUs investment strategy with respect to the domestic pension 0 assets is to achieve asatisfactory risk adjusted return on assets that, incombi- Expected Cash Flows - Domestic Other Postretirement nation with PPLs funding policy and tolerance for return volatility, will ensure Benefit Plans that sufficient dollars are available to provide benefit payments. PPL is not required to make contributions to its other postretirement benefit plans, but has historically funded these plans in amounts equal to the postre-Plan Assets - Domestic Other Postretirement Benefit Plans tirement benefit costs recognized. Continuation of this past practice would The asset allocation for the PPL other postretirement benefit plans by asset provide for PPL to contribute $35 million to its other postretirement benefit category, are detailed below. plans in2004.

Percentage of plan assets at December 31, Asset Category 2003 2002 Expected Cash Flows - International Pension Plans Equity securities 56% 52% The pension plans of WPD are subject to formal actuarial valuations every Debt securities 44% 46% three years, which are used to determine funding requirements. WPD expects Total 100% 100% to make contributions of approximately $3million in2004. Future contribu-tions will be evaluated inaccordance with these formal actuarial valuations,

the next of which will be performed as of March 31, 2004 inrespect of WPD's ESOP shares outstanding at December 31, 2003 totaled 4,841,488, or 3%

principal pension scheme, the ESPS, to determine contribution requirements of total common shares outstanding, and are included inall EPS calculations.

for 2005 and forward.

Postemployment Benefits Medicare Prescription Drug, Improvement and Certain PPL subsidiaries provide health and life insurance benefits to disabled Modernization Act of 2003 employees and income benefits to eligible spouses of deceased employees.

On December 8, 2003, the Medicare Prescription Drug, Improvement and Posteemployment benefits charged to operating expenses were not significant Modernization Act of 2003 (the Act) was signed into law. The Act introduces a in2003, 2002 or 2001.

prescription drug benefit under Medicare and also provides for afederal sub- Certain of PPL Global subsidiaries, including Emel, EC, Elfec and Integra, sidy to sponsors of retiree health care benefit plans that provide an actuarially provide limited non-pension benefits to all current employees. All active equivalent level of prescription drug benefits. The subsidy would be 28% of employees are entitled to benefits inthe event of termination or retirement in eligible drug costs for retirees that are over age 65 and covered under PPLs accordance with government-sponsored programs. These plans generally obli-other postretirement benefit plans. gate a company to pay one month's salary per year of service to employees in The impact of the Act on the provisions of SFAS 106 has yet to be deter- the event of involuntary termination. Under certain plans, employees with five mined by the FASB. PPL has elected to defer recognition of the potential impact or more years of service are entitled to this payment inthe event of voluntary of the Act, as allowed under FSP FAS 106-1, "Accounting and Disclosure or involuntary termination. There is no limit on the number of years of service Requirements Related to the Medicare Prescription Drug, Improvement and inthe calculation of the benefit obligation.

Modernization Act of 2003," which was issued by the FASB inJanuary 2004. The liabilities for these plans are accounted for under the guidance of Thus, the measures of PPLs accumulated postretirement benefit obligations and EITF 88-1, "Determination of Vested Benefit Obligation for a Defined Benefit net postretirement benefit costs inthe financial statements and accompanying Pension Plan," using, what is commonly referred to as, the "shut down" notes do not reflect the effects of the Act. PPL could be required to change method, where acompany records the undiscounted obligation as if it were previously reported information upon issuance of final accounting guidance payable at each balance sheet date. The combined liabilities for these plans related to the Act, as PP~s other postretirement benefit plans provide prescrip- at December 31, 2003 and 2002 were $8million and $6million, and are tion drug coverage to retirees that may be eligible for the federal subsidy. recorded in "Deferred Credits and Noncurrent Liabilities - Other" on the Balance Sheet. 77 Savings Plans Substantially all employees of PPLs domestic subsidiaries are eligible to par-

• 0 ticipate in deferred savings plans (401(k)s). Contributions to the plans charged to operating expense approximated $11 million in both 2003 and 2002 and

13. JOINTLY-OWNED FACILITIES CM 0

0

$10 million in2001. At December 31, 2003, subsidiaries of PPL owned undivided interests inthe following facilities listed below. The Balance Sheet of PPL includes the Employee Stock Ownership Plan amounts noted inthe table below: 0 PPL sponsors anon-leveraged ESOP, inwhich substantially all employees, Accumu- a excluding those of PPL Global, PPL Montana, PPL Gas Utilities and the Electric lated Construc-mechanical contractors, are enrolled after one year of credited service. Dividends Ownership Plant in Other Depre- tion Work z0 Interest Service Property ciation inProgress z2J paid on ESOP shares are treated as ordinary dividends by PPL. Under existing C PPL Generation income tax laws, PPL is permitted to deduct the amount of those dividends for Generating Stations I income tax purposes and to contribute the resulting tax savings (dividend- Susquehanna 90.00% $4,320 $3,541 $63 based contribution) to the ESOP. Conemaugh 16.25% 191 70 1 The dividend-based contribution is used to buy shares of PPUs common Keystone 12.34% 97 49 1 stock and isexpressly conditioned upon the deductibility of the contribution Wyman Unit 4 8.33% 15 4 Merrill Creek Reservoir 8.37% $22 13 for federal income tax purposes. Contributions to the ESOP are allocated to eligible participants' accounts as of the end of each year, based 75% Each PPL Generation subsidiary provided its own funding for its share on shares held inexisting participants' accounts and 25% on the eligible of the facility. Each receives a portion of the total output of the generating participants' compensation. stations equal to its percentage ownership. The share of fuel and other operat-Amounts charged as compensation expense for ESOP contributions ing costs associated with the stations is reflected on the Statement of Income.

approximated $5million ineach of 2003 and 2002 and $4million in2001. PPL Montana isthe operator of the jointly-owned, coal-fired generating These amounts were offset by the dividend-based contribution tax savings units comprising the Colstrip steam generation facility. At December 31, 2003 and had no impact on PPL's earnings. and 2002, PPL Montana had a50% undivided leasehold interest in Colstrip Units 1 and 2and a30% undivided leasehold interest in Colstrip Unit 3 under operating leases. See Note 10 for additional information.

Notes to Consolidated Financial Statements PPL Montana's share of direct expenses associated with the operation credit downgrades to below investment grade in late-2002, PPL Montana and and maintenance of these facilities is included inthe corresponding operating NorthWestern agreed to modify the payment provisions of the energy contracts expenses on the Statement of Income. Each joint-owner inthese facilities such that NorthWestern would pay PPL Montana on aweekly basis, in arrears.

provides its own financing. As operator of all Colstrip Units, PPL Montana In September 2003, NorthWestern filed avoluntary petition for relief seek-invoices each joint-owner for their respective portion of the direct expenses. ing to reorganize under Chapter 11 of the U.S. Bankruptcy Code. NorthWestern The amount due from joint-owners was approximately $9million and $8mil- made its filing infederal bankruptcy court inDelaware. Between the time of lion at December 31, 2003 and 2002. NorthWestern's last weekly payment and the bankruptcy filing date, PPL At December 31, 2003, Montana Power continued to own a30% leasehold Montana made approximately $1.6 million of energy sales to NorthWestern.

interest inColstrip Unit 4. As part of the purchase of generation assets from Following the date that NorthWestern filed for bankruptcy, PPL Montana Montana Power, PPL Montana and Montana Power entered into a reciprocal and NorthWestern agreed to amend the power supply agreements to, among sharing agreement to govern each party's responsibilities regarding the opera- other things, eliminate the weekly payment arrangements and resume more tion of Colstrip Units 3 and 4,and each party is responsible for 15% of the typical monthly invoicing and payment arrangements. The amendments were respective operating and construction costs, regardless of whether aparticular contingent on NorthWestern's assumption of the power supply agreements in cost isspecified to Colstrip Unit 3 or 4.However, each party is responsible its bankruptcy proceeding.

for its own fuel-related costs. InSeptember 2003, NorthWestern filed a motion with the bankruptcy court seeking, among other things, to assume the two five-year power supply agree-ments (as amended) and to pay PPL Montana for the approximately $1.6 million

14. COMMITMENTS AND CONTINGENT LIABILITIES of energy sales made immediately prior to the time of the bankruptcy filing. In October 2003, the bankruptcy court entered an order granting NorthWestern's Energy Purchases and Sales Commitments motion. NorthWestern has, in accordance with the terms of the judge's order, Liability for Above Market NLG Contracts paid PPL Montana for the pre-filing energy sales, and the parties have resumed In1998, PPL Electric recorded a loss accrual for above market contracts with monthly invoicing and payment arrangements.

NUGs of $854 million, due to its generation business being deregulated.

As a result of New Jersey's Electric Discount and Energy Competition Act, Effective January 1999, PPL Electric began reducing this liability as an offset its Board of Public Utilities authorized and made available to power suppliers, 78 to "Energy purchases' on the Statement of Income. This reduction is based on a competitive basis, the opportunity to provide Basic Generation Service

-u on the estimated timing of the purchases from the NUGs and projected market (BGS) to all non-shopping New Jersey customers. In February 2003, PPL C, prices for this generation. The final existing NUG contract expires in2014. In 0 EnergyPlus was awarded 34-month fixed-price BGS and 10-month hourly connection with the corporate realignment in2000, the remaining balance of this M0 energy price BGS for afixed percentage of customer load (approximately liability was transferred to PPL EnergyPlus. At December 31, 2003, the remain-ro 1,000 MW) for Atlantic City Electric Company, Jersey Central Power & Light M0 ing liability associated with the above market NUG contracts was $352 million.

Company and Public Service Electric & Gas Company. These contracts z

M Wholesale Energy Commitments commenced inAugust 2003.

0 As part of the purchase of generation assets from Montana Power, PPL Montana InApril 2003, PPL EnergyPlus entered into an agreement with Arizona j >

CD assumed apower purchase agreement and a power sales agreement (for the Public Service Company to provide 112 MW of capacity and associated m

!z

-uO Flathead Irrigation Project), which were still ineffect at December 31, 2003. electricity from July through September of 2003 and 150 MW from June z

0 Inaccordance with purchase accounting guidelines, PPL Montana recorded through September of 2004 and 2005.

-4z liabilities of $66 million as the estimated fair value of these agreements at the In May 2003, PPL EnergyPlus entered into agreements with Tucson Electric acquisition date. These liabilities are being reduced over the terms of the agree- Power Company to provide 37 MW of capacity and associated electricity from ments, through 2010, as adjustments to 'Wholesale energy marketing' revenues June through December of 2003 and 75 MW from January 2004 through and 'Energy purchases' on the Statement of Income. The unamortized balance December 2006.

of the liability related to the power purchase agreement at December 31, 2003 In May 2003, PPL EnergyPlus entered into a20-year agreement with was $57 million and is included in 'Wholesale energy commitments' on the Community Energy, Inc. to purchase energy from its Bear Creek wind power Balance Sheet. project innortheastern Pennsylvania. The project is expected to produce up On July 1,2002, PPL EnergyPlus began to sell to NorthWestern an aggre- to 20 MW and be completed in2004.

gate of 450 MW of energy to be supplied by PPL Montana. Under two five-year InSeptember 2003, Connecticut Light and Power Company (CL&P) issued agreements, PPL EnergyPlus is supplying 300 MW of around-the-clock elec- arequest for proposals seeking energy supply for CL&P's Transitional Standard tricity and 150 MW of unit-contingent on-peak electricity. PPL Montana also Offer retail customer load. In October 2003, PPL EnergyPlus was awarded a makes short-term energy sales to NorthWestern. Following NorthWestern's three-year, fixed-price contract beginning inJanuary 2004 to supply 12.5% of CL&P's Transitional Standard Offer load. During peak hours, PPL EnergyPlus' obligation to supply CL&P's Transitional Standard Offer load may reach 625 MW.

Legal Matters $9million for 2002 and $6million for 2003. PPL Montana's dispute with PPL and its subsidiaries are involved in numerous legal proceedings, claims respect to most of the 2002 and 2003 tax liability is based on the assessed and litigation inthe ordinary course of business. PPL and its subsidiaries value used by the MOOR for PPL Montana's hydroelectric facilities versus cannot predict the ultimate outcome of such matters, or whether such matters the assessed value used for the facilities of another hydroelectric generator in may result inmaterial liabilities. the state. The state tax appeals board is scheduled to hear the 2000 and 2001 disputes in April 2004, while the hearing for the 2002 dispute is scheduled Tax Assessment Appeals for May 2004. Ahearing for the 2003 dispute has not yet been scheduled.

Pursuant to changes in PURTA enacted in1999, PPL subsidiaries have filed a number of tax assessment appeals invarious Pennsylvania counties where Montana Power Shareholders' Litigation PPL facilities are located. These appeals challenge existing local tax assess- InAugust 2001, a purported class-action lawsuit was filed by a group of share-ments, which now comprise the basis for payment of the PURTA tax on PPL's holders of Montana Power against Montana Power, the directors of Montana properties. Also, as of January 1, 2000, generation facilities are no longer Power, certain advisors and consultants of Montana Power and PPL Montana.

taxed under PURTA, and these local assessments will be used directly to The plaintiffs allege, among other things, that Montana Power was required determine local real estate tax liability for PPIs power plants. InJuly 1999, to, and did not, obtain shareholder approval of the sale of Montana Powers PPL filed retroactive appeals for tax years 1998 and 1999, as permitted by generation assets to PPL Montana in 1999. Although most of the claims in the the new law. Inaddition, PPL has filed appeals for 2000 and beyond, as per- complaint are against Montana Power, its board of directors, and its consultants mitted under normal assessment procedures. It is anticipated that assessment and advisors, two claims are asserted against PPL Montana. In the first claim, appeals may now be an annual occurrence. plaintiffs seek a declaration that because Montana Power shareholders did not Hearings on the pending appeals were held by the boards of assessment vote on the 1999 sale of generating assets to PPL Montana, that sale "was null appeals ineach county, and decisions have now been rendered by all counties. and void ab initio." The second claim alleges that PPL Montana was privy to To the extent the appeals were denied or PPL was not otherwise satisfied with and participated in a strategy whereby Montana Power would sell its generation the results, PPL filed further appeals from the board decisions with the appro- assets to PPL Montana without first obtaining Montana Power shareholder priate county Courts of Common Pleas. approval, and that PPL Montana has made net profits in excess of $100 million Of the two pending proceedings in Pennsylvania, only the appeal concern- as the result of this alleged illegal sale. In the second claim, plaintiffs request ing the assessed value of the Susquehanna nuclear station will result inannual that the court impose a "resulting and/or constructive trust" on both the gener- 79 local taxes exceeding $1million. PPL's appeal of the Susquehanna station ation assets themselves and all profits, plus interest on the amounts subject

-v assessment was decided in its favor by the Luzerne County Court of Common to the trust. This lawsuit is currently pending in the U.S. District Court of Pleas, and PPL subsequently settled with the local taxing authorities, resulting Montana, Butte Division. PPL cannot predict the outcome of this matter. M0 inannual local tax liability of approximately $3million for tax years 2000 and 0 NorthWestern Corporation Litigation beyond and no additional PURTA tax liability for tax years 1998 and 1999. 211 In connection with the acquisition of the Montana generation assets, the However, the settlement of the tax liability for tax years 1998 and 1999 was 0 Montana Power APA, which was previously assigned to PPL Montana by z subject to the outcome of claims asserted by certain intervenors which are PPL Global, includes a provision concerning the proposed purchase by PPL 0 described below.

Montana of a portion of NorthWestern's interest in the 500-kilovolt Colstrip InAugust 2000, over PPL's objections, the Luzerne County Court of z Transmission System (CTS) for $97 million. During 2002, PPL Montana had z Common Pleas permitted Philadelphia City and County, the Philadelphia C been in discussions with NorthWestern regarding the proposed purchase of School District and the Southeastern Pennsylvania Transportation Authority the CTS and the claims that PPL Montana believes it has against NorthWestern (SEPTA) (collectively, the 'Philadelphia parties') to intervene inthe case -U arising from the Montana Power APA and related agreements. Notwithstanding 0 because a change in the assessment of the plant affected the amount they col- 21 such discussions, in September 2002, NorthWestern filed a lawsuit against PPL lected under PURTA for the tax years 1998 and 1999. Based on the appraisal Montana in Montana state court seeking specific performance of PPL Montana's obtained by the Philadelphia parties, PPL would have been required to pay up purchase of the CTS or, alternatively, damages for breach of contract. Pursuant to an extra $213 million in PURTA taxes for 1998 and 1999. The court ruled in to PPL Montana's application, the mailer was removed to the U.S. District PPLs favor concerning the assessed value of the plant, and this determination Court of Montana, Butte Division. Following removal, NorthWestern asserted was affirmed by the Commonwealth Court in October 2003. The Philadelphia additional claims for damages against PPL Montana, and PPL Montana filed parties subsequently petitioned the Commonwealth Court for reargument, defenses denying liability for NorthWestern's claims as well as counterclaims and this request was denied. The Philadelphia parties did not seek further against NorthWestern seeking damages PPL Montana believes it has suffered appellate review of this matter.

under the Montana Power APA and related agreements. This matter currently PPL Montana is currently protesting certain property tax assessments is scheduled for trial in the Montana federal district court in mid-2005.

by the Montana Department of Revenue (MOOR) on its generation facilities.

The tax liabilities in dispute are approximately $2million for 2000 and 2001,

Notes to Consolidated Financial Statements InSeptember 2003, NorthWestern filed apetition in Delaware for reorgani- an evidentiary hearing concerning refund amounts. In April 2003, the FERC zation under the U.S. Bankruptcy Code, which has resulted inan automatic changed the manner inwhich this refund liability is to be computed and stay of PPL Montana's counterclaims against NorthWestern. PPL Montana ordered further proceedings to determine the exact amounts that the sellers, has applied to the bankruptcy court for relief from the automatic stay. In including PPL Montana, would be required to refund.

December 2003, NorthWestern filed amotion to transfer this litigation from the InJune 2003, the FERC took several actions as aresult of anumber of Montana federal district court to the federal district court inDelaware where related investigations. The FERC terminated proceedings pursuant to which it NorthWestern's bankruptcy proceeding is pending. PPL Montana has opposed had been considering whether to order refunds for spot market bilateral sales the motion for transfer, which will be decided by the Montana federal district made in the Pacific Northwest, including sales made by PPL Montana, during court. NorthWestern and PPL Montana also have stipulated in NorthWestern's the period December 2000 through June 2001. The FERC explained that the bankruptcy proceeding that the automatic stay of PPL Montana's counterclaims totality of the circumstances made refunds unfeasible and inequitable, and that will be lifted ten days after the Montana federal district court rules on the it had provided adequate relief by adopting a price cap throughout the western transfer motion. PPL cannot predict the outcome of this litigation. U.S. The FERC also denied pending complaints against long-term contracts in the western U.S. Inthese complaints, various power buyers challenged selected Montana Hydroelectric Litigation long-term contracts that they entered into during 2000 and 2001, complaining In October 2003, alawsuit was filed against PPL Montana, PPL Services, Avista that the power prices were too high and reflected manipulation of those energy Corporation, PacifiCorp and nine John Doe defendants inthe U.S. District markets. The FERC found that the complainants had not met their burden of Court of Montana, Missoula Division, by two residents allegedly acting ina showing that changing or canceling the contracts was "inthe public interest" representative capacity on behalf of the State of Montana. InJanuary 2004, the and that the dysfunction inthe California markets did not justify changing these complaint was amended to, among other things, include the Great Falls school long-term contracts. Intwo separate orders, the FERC also ordered 65 different districts as additional plaintiffs. The action seeks adeclaratory judgment, companies, agencies or municipalities to show cause why they should not be compensatory damages for unjust enrichment, trespass and negligence, and ordered to disgorge profits for gaming" or anomalous market behavior during attorneys fees on a "private attorney general' theory for use of state and/or 2000 and 2001. These orders to show cause address both unilateral and joint

.school trust" lands without the compensation required by law and to require conduct identified as the "Enron trading strategies." Neither PPL EnergyPlus defendants to adequately compensate the state and/or the State School Trust nor PPL Montana was included inthese orders to show cause, and they previ-80 fund for full market value of lands occupied. Generally, the suit is founded on ously have explained in responses to data requests from the FERC that they

-U allegations that the bed of navigable rivers is state-owned property following

-U have not engaged insuch trading strategies. Finally, the FERC issued anew admission to statehood, and that the use thereof for placement of dam struc-0 investigation order directing its stati to investigate any bids made into the tures, affiliated structures and reservoirs should trigger lease payments for C) 0 California markets in excess of $250/MWh during the period from May 2000 use of land underneath. The plaintiffs allege that the State Land Board and

-4 to October 2000, a period of time prior to the period examined in connection Department of Natural Resources and Conservation tailed to exercise their duty

-0 with most of the proceedings described above. To their knowledge, neither to administer riverbeds for the maximum benefit of public education and/or the z PPL EnergyPlus nor PPL Montana is being investigated by the FERC under N) state. No specific amount of damages has been claimed. PPL Montana and a

C this new order.

PPL Services cannot predict the outcome of this litigation.

Litigation arising out of the California electricity supply situation has z

z Regulatory Issues been filed in California courts against sellers of energy to the California ISO.

C CaliforniaISO and Western Markets The plaintiffs and intervenors in these legal proceedings allege, among other 11 Through its subsidiaries, PPL has made approximately $18 million of sales to things, abuse of market power, manipulation of market prices, unfair trade

-U 0 the California ISO, of which $17 million has not been paid to PPL subsidiaries. practices and violations of state antitrust laws, and seek other relief, including

-4 Given the myriad of electricity supply problems presently faced by the California treble damages and attorneys' fees. While PPLs subsidiaries have not been electric utilities and the California ISO, PPL cannot predict whether or when named by the plaintiffs inthese legal proceedings alleging abuses of market it will receive payment. As of December 31, 2003, PPL has fully reserved for power, manipulation of market prices, unfair trade practices and violations possible underrecoveries of payments for these sales. of state antitrust laws, PPL Montana was named by adefendant inits cross-Regulatory proceedings arising out of the California electricity supply complaint inaconsolidated court proceeding, which combined into one master situation have been filed at the FERC. The FERC has determined that all proceeding several of the lawsuits alleging antitrust violations and unfair trade sellers of energy into markets operated by the California ISO and the California practices. This generator denies that any unlawful, unfair or fraudulent conduct Power Exchange, including PPL Montana, should be subject to refund liability occurred but asserts that, if it is found liable, the other generators and power for the period beginning October 2,2000 through June 20, 2001 and initiated marketers, including PPL Montana, caused, contributed to and/or participated inthe plaintiffs' alleged losses.

In May 2003, the Port of Seattle filed alawsuit inthe U.S. District Court The PUC stated that it was not authorized to, and was not attempting to, adju-for the Western District of Washington against eighteen defendants, including dicate the merits of PPL's defenses to its allegations, but referred the matter to PPL Montana. The lawsuit asserts claims against all defendants under the the U.S. Department of Justice - Antitrust Division (DOJ), the FERC and the federal and state antitrust laws, the federal Racketeer Influenced and Corrupt Pennsylvania Attorney General.

Organizations Act and for common law fraud. The complaint centers on many InJune 2003, the DOJ notified PPL that it had closed its investigation in of the same alleged activities that are the basis for the litigation arising out of this matter. Also in June, the Pennsylvania Attorney General's office completed the California electricity supply situation described above. The Port of Seattle its investigation and notified the PUC that PPL did not violate antitrust or is seeking actual, trebled and punitive damages, as well as attorneys' fees. PPL other laws in its capacity market activities. The FERC already has completed Montana and several other defendants have filed amotion to dismiss this com- two investigations related to these capacity market questions and has found plaint that has not been ruled on by the court. In December 2003, this matter no reason to take action against PPL. PPL continues to believe that the PUC's was transferred to the U.S. District Court for the Southern District of California report is inaccurate, that its conclusions are groundless, and that PPL acted for inclusion with proceedings already centralized and pending in that court. ethically and legally, incompliance with all applicable laws and regulations.

In February 2004, the Montana Public Service Commission initiated a InSeptember 2002, PPL was served with acomplaint filed by limited investigation of the Montana retail electricity market for the years 2000 Utilimax.com, Inc., which was amember of PJM, inthe U.S. District Court and 2001, focusing on how that market was affected by transactions involving for the Eastern District of Pennsylvania against PPL and PPL EnergyPlus the possible manipulation of the electricity grid inthe western U.S. The investi- alleging, among other things, violations of the federal antitrust laws incon-gation includes all public utilities and licensed electricity suppliers inMontana, nection with the capacity transactions described inthe Market Monitor's as well as other entities that may possess relevant information. Through its report. The court dismissed the complaint with prejudice inJuly 2003, and subsidiaries, PPL is a licensed electricity supplier in Montana and awholesale Utilimax has appealed the court's dismissal to the U.S. Court of Appeals for supplier inthe western U.S. As with the other investigations taking place as a the Third Circuit.

result of the issues arising out of the electricity supply situation in California In December 2002, PPL was served with acomplaint against PPL, PPL and other western states, PPL and its subsidiaries believe that they have not EnergyPlus and PPL Electric filed inthe U.S. District Court for the Eastern engaged inany improper trading or marketing practices affecting the Montana District of Pennsylvania by a group of 14 Pennsylvania boroughs that appar-retail electricity market. ently alleges, inbroad terms, similar violations of the federal antitrust laws.

81 While PPL and its subsidiaries believe that they have not engaged inany These boroughs were wholesale customers of PPL Electric. Inaddition, in

'U improper trading practices, they cannot predict whether, or the extent to which, November 2003, PPL and PPL EnergyPlus were served with a complaint which -U any PPL subsidiaries will be the target of any additional governmental investi- was filed in the same court by Joseph Martorano, IlIl(d/b/a ENERCO), that also 0 0

gations or named in other lawsuits or refund proceedings, the outcome of any alleges violations of the federal antitrust laws. The complaint indicates that such lawsuits or proceedings or whether the ultimate impact on them of the ENERCO provides consulting and energy procurement services to clients in IIl 0

electricity supply situation in California and other western states will be material. Pennsylvania and New Jersey. Although PPL believes the claims inthese com- I plaints are without merit, they cannot predict the outcome of these matters.

PJM Capacity Transactions 0 z

InNovember 2001, the PJM Market Monitor publicly released areport prepared New England Investigation for the PUC entitled Capacity Market Questions relating to the pricing of InJanuary 2004, PPL became aware of an investigation by the Connecticut installed capacity inthe PJM daily market during the first quarter of 2001. The Attorney General and the FERC's Office of Market Oversight and Investigation C report concluded that PPL EnergyPlus (identified inthe report as 'Entity 1') (OMOI) regarding allegations that natural gas-fired generators located inNew 21 was able to exercise market power to raise the market-clearing price above the England illegally sold natural gas instead of generating electricity during the m

-V 0

competitive level during that period. PPL EnergyPlus does not agree with the week of January 12, 2004. Subsequently, PPL and other generators were served 21 Market Monitor's conclusions that it exercised market power, and the Market with adata request by OMOI. The data request indicated that PPL was not Monitor acknowledged inhis report that PJM's standards and rules did not under suspicion of a regulatory violation but that OMOI was conducting an prohibit PPL EnergyPlus' conduct. In November 2001, the PUC issued an initial investigation. PPL has responded to this data request. While PPL does Investigation Order directing its Law Bureau to conduct an investigation into not believe that it committed any regulatory or other violations concerning the PJM capacity market and the allegations inthe Market Monitor's report. the subject matter of the investigation, PPL cannot predict the outcome of InJune 2002, the PUC issued an investigation report alleging, among other the investigation.

things, that PPL had unfairly manipulated electricity markets inearly 2001.

Notes to Consolidated Financial Statements FERC Market-based Rate Authority Wallingford Deactivation In December 1998, the FERC issued an order authorizing PPL EnergyPlus to In January 2003, PPL negotiated an agreement with the ISO - New England make wholesale sales of electric power and related products at market-based that would declare that four of the five units at PPL's Wallingford, Connecticut rates. Inthat order, the FERC directed PPL EnergyPlus to file an updated market facility are 'reliability must run' units and put those units under cost-based rates.

analysis within three years of the date of the order, and every three years there- This agreement and the cost-based rates are subject to the FEROs approval, and after. PPL EnergyPlus filed its initial updated market analysis in December 2001. PPL filed a request with the FERC for such approval. PPL requested authority Several parties thereafter filed interventions and protests requesting that, in for cost-based rates because the current and anticipated wholesale prices in light of the PJM Market Monitor's report described above, PPL EnergyPlus be New England are insufficient to cover the costs of keeping these units available required to provide additional information demonstrating that it has met the for operation. In March 2003, PPL filed an application with the New England FERO's market power tests necessary for PPL EnergyPlus to continue its market- Power Pool to temporarily deactivate these tour units. In May 2003, FERC based rate authority. PPL EnergyPlus has responded that the FERC does not denied PPLs request for cost-based rates in light of FERCs changes to the require the economic test suggested by the intervenors and that, inany event, market and bid mitigation rules of the ISO - New England made in asimilar it would meet such economic test if required by the FERC. PPL EnergyPlus case involving generating units owned by NRG Energy, Inc. PPL subsequently cannot predict the outcome of this matter. has explained to the FERO that its changes to the market and bid mitigation rules of ISO - New England will not provide sufficient revenues to PPL, and PPL FERC Proposed Rules continues to seek approval of its cost-based rates. However, PPL has informed InJuly 2002, the FERC issued a Notice of Proposed Rulemaking entitled the New England Power Pool that it will not pursue its request to temporarily

'Remedying Undue Discrimination through Open Access Transmission Service deactivate certain Wallingford units. InFebruary 2004, PPL appealed the and Standard Electricity Market Design." The proposed rule is currently available FERC's denial of its request for cost-based rates to the U.S. Court of Appeals for public comment and contains aproposed implementation date of July 31, for the D.C. Circuit. PPL cannot predict the outcome of this matter.

2003. However, since the issuance of the proposed rule, the FERC has delayed the implementation date. This far-reaching proposed rule, in its current form, IRS Synthetic Fuels Tax Credits purports to establish uniform transmission rules and astandard market design Through one of its subsidiaries, PPL operates a synfuel facility inSomerset, by, among other things: Pennsylvania and receives tax credits pursuant to Section 29 of the Internal 82 . enacting standard transmission tariffs and uniform market mechanisms, Revenue Code based on its sale of synfuel to unaffiliated third-party purchasers.

• monitoring and mitigating "market power," Section 29 of the Internal Revenue Code provides tax credits for the production

-0 . managing transmission congestion through pricing and tradable and sale of solid synthetic fuels produced from coal. To qualify for the Section 0

financial rights, 29 tax credits, the synthetic fuel must meet three primary conditions: (i) there M0 0

. requiring independent operational control over transmission facilities, must be a significant chemical change inthe coal feedstock, (ii) the product

• forming state advisory committees on regional transmission organizations must be sold to an unaffiliated entity, and (iii) the production facility must have Z0 and resource adequacy, and been placed inservice before July 1,1998. Section 29 tax credits are currently z

• exercising FERC jurisdiction over all transmission service. scheduled to expire at the end of 2007.

PPL received aprivate letter ruling from the IRS in November 2001 pur-InApril 2003, the FERC issued awhite paper describing certain modifica-z CO M suant to which, among other things, the IRS concluded that the synthetic fuel Z tions to the proposed rule. The FERC has requested comments and is holding produced at the Somerset facility qualifies for Section 29 tax credits. PPL uses numerous public comment sessions concerning the white paper.

the Covol technology to produce synfuel at the Somerset facility, and the IRS Ifadopted, this proposed rule may have asignificant impact on PPL and I-C -I issued the private letter ruling after its review and approval of that technology.

0 its subsidiaries, which cannot be predicted at this time.

II In reliance on this private letter ruling, PPL has sold synfuel produced at the InNovember 2003, the FERC adopted aproposed rule to condition all Somerset facility resulting inan aggregate of approximately $147 million of tax new and existing electric market-based tariffs and authorizations to include credits as of December 31, 2003. PPL has estimated that the Somerset facility provisions prohibiting the seller from engaging inanticompetitive behavior or will contribute approximately $0.13 to its EPS in each year from 2004 through the exercise of market power. The FERC order adopts a list of market behavior 2007. PPL also purchases synfuel from unaffiliated third parties, at prices rules that apply to all electric market-based rate tariffs and authorizations, below the market price of coal, for use at its coal-fired power plants.

including those of PPL EnergyPlus and any other PPL subsidiaries that hold InJune 2003, the IRS announced that it had reason to question the scien-market-based rate authority. PPL does not expect this rule to have a significant tific validity of certain test procedures and results that have been presented to it impact on its subsidiaries.

by taxpayers with interests insynfuel operations as evidence that the required

significant chemical change has occurred, and that it was reviewing informa- and financing costs. Under the Electricity Act, WPD is under a statutory duty to tion regarding these test procedures and practices. Inconjunction with such offer terms to connect any customer requiring electricity within their area and review, the IRS suspended the issuance of private letter rulings concerning to maintain that connection. The allowed revenue that is.recovered from elec-whether asignificant chemical change has occurred for requests relying on tricity supply businesses through charges by the Distribution Network Operator the procedures and results being reviewed. Inaddition, the IRS indicated that (DNO) made for the use of the distribution network is regulated on the basis of it might revoke existing private letter rulings that relied on the procedures and the Retail Price Index (RPI) minus Xformula. The allowed revenue is increased results under review if it determined that those test procedures and results do by RPI minus Xduring the tenure of each price control period. (RPI is a mea-not demonstrate that asignificant chemical change has occurred. sure of inflation and equals the percentage change inthe U.K. RPI between InOctober 2003, the IRS announced that it had completed its review of the six-month period of July to December inthe previous year. The Xfactor the scientific validity of test procedures and results presented by taxpayers as is established by the Regulator following review and represents an annual evidence of significant chemical change and determined that the test procedures efficiency factor.) The Regulator currently sets the Distribution Price Control and results used by taxpayers are scientifically valid, if the procedures are Formula for five-year periods.

applied ina consistent and unbiased manner. Further, the IRS announced that it The current Distribution Price Control Formula permits DNOs, within will continue to issue rulings on significant chemical change under applicable a review period, to partially retain additional revenues due to increased IRS guidelines, despite some question by the IRS as to whether those processes distribution of units and to retain all increases inoperating profit due to effi-result inthe level of significant chemical change required by Section 29 of the cient operations and the reduction of expenses (including financing costs).

Internal Revenue Code and IRS revenue rulings. Finally, the IRS indicated that it The Regulator may reduce this increase in operating profit through aone-oft would require taxpayers to comply with certain sampling and data/record reten- price reduction in the first year of the new pricing regime, if the Regulator tion practices to obtain or maintain aruling on significant chemical change. determines that it is not afunction of efficiency savings, or if genuine efficiency PPL believes that the October IRS announcement confirms that PPL is savings have been made and the Regulator determines that customers should justified in its reliance on the private letter ruling for the Somerset facility, benefit through lower prices.

that the test results that PPL presented to the IRS inconnection with its private InDecember 1999, the Regulator published final price proposals for distri-letter ruling are scientifically valid and that PPL has operated the Somerset bution price control for the 12 DNOs in England and Wales. These proposals facility incompliance with the private letter ruling and Section 29 of the represented a reduction to distribution prices of 20% for WPD (South West) 83 Internal Revenue Code. and 26% for WPD (South Wales) effective April 2000, followed by areduction InOctober 2003, following the IRS announcement, it was reported that the in real terms (i.e., before inflation is taken into account) of 3%each year from

'U U.S. Senate Permanent Subcommittee on Investigations, of the Committee on April 2001. This price control is scheduled to operate until March 2005. 0

• 0 M

Governmental Affairs, had begun an investigation of the synthetic fuel industry Improvements inquality of supply form an important part of the final pro-0 and its producers. PPL cannot predict when the investigation will be completed posals. Revised targets for system performance, interms of the security and or the potential results of the investigation. availability of supply, were proposed with new targets for reductions inminutes 0

lost and interruptions. z U.K Electricity Regulation The Regulator has introduced aquality of service incentive plan for the The principal legislation governing the structure of the electricity industry in Co period from April 2002 to March 2005. Companies will be penalized annually Great Britain is the Electricity Act 1989 (the 'Electricity Act"), as amended by z up to 2%of revenue for failing to meet their quality of supply targets for the 2, z

the Utilities Act 2000 (the 'Utilities Act"). C incentive plan. The plan includes a mechanism for rewarding companies which The provisions inthe Utilities Act include the replacement of individual exceed their targets based on their rate of improvement of performance during gas and electricity regulators with the Gas and Electricity Markets Authority -u the period and a process for rewarding exceptional performance by specifying 0 (the 'Regulator"). The principal objective of the Regulator is to protect the 2o how the targets will be reset.

interests of consumers, wherever appropriate, by promoting effective competi-Distribution businesses must also meet the Guaranteed and Overall tion in electricity generation and supply. There currently is no competition Standards of Performance, which are set by the Regulator to ensure an appro-inelectricity distribution, but recently asmall operator has applied to the priate level of quality of supply. If acompany fails to provide the level of Regulator for a license to operate inGreat Britain.

service specified, it must make afixed payment to the retail customer affected.

Each distribution business constitutes anatural regional monopoly and is InJune 2003, the Regulator published areport on the quality of supply subject to control on the prices it can charge and the quality of supply it must from April 2001 through March 2002. The report confirms that WPD (South provide. The operations of WPD are regulated under its distribution licenses, West) and WPD (South Wales) met or exceeded such standards and that no pursuant to which income generated is subject to an allowed revenue regulatory payments were required to be made by either company.

framework that provides economic incentives to minimize operating, capital

Notes to Consolidated Financial Statements Any significant lowering ot rates implemented by the Regulator after the Therefore, at this time, PPL is unable to predict whether such EPA enforcement current price control ends inMarch 2005 could lower the amount of revenue actions will be brought with respect to any of its affiliates' plants. However, WPD generates inrelation to its operational cost and could materially lower the EPA regional offices that regulate plants in Pennsylvania (Region l1l)and the income of WPD. Montana (Region VIII) have indicated an intention to issue information requests to all utilities intheir jurisdiction. The Region VIII office issued such a request Environmental Matters - Domestic to PPL Montanas Corette plant in2000 and the Colstrip plant in2003. The Due to the environmental issues discussed below or other environmental Region IlIloffice issued such arequest to PPL Generation's Martins Creek plant matters, PPL subsidiaries may be required to modify, replace or cease in2002. PPL and its subsidiaries have responded to the Corette and Martins operating certain facilities to comply with statutes, regulations and actions Creek information requests and are inthe process of responding to the Colstrip by regulatory bodies or courts. In this regard, PPL subsidiaries also may information request. The EPA has taken no further action following the Martins incur capital expenditures or operating expenses inamounts which are not Creek and Corette submittals. PPL cannot presently predict what, if any, action now determinable, but which could be significant.

the EPA might take inthis regard. Should the EPA or any state initiate one or Air more enforcement actions against PPL or its subsidiaries, compliance with The Clean Air Act deals, inpart, with acid rain, attainment of federal ambient any such enforcement actions could result inadditional capital and operating ozone standards and toxic air emissions inthe U.S. PPrs subsidiaries are in expenses inamounts which are not now determinable, but which could substantial compliance with the Clean Air Act. The Bush administration and be significant.

certain members of Congress have made proposals regarding possible amend- In2003, the EPA issued changes to its "New Source' regulations that ments to the Clean Air Act. These amendments could require significant further clarify what projects are exempt from 'New Source" requirements as routine reductions in nitrogen oxide, sulfur dioxide and mercury and could possibly maintenance and repair. Under these clarifications, any project to replace require measures to limit carbon dioxide. Inaddition, several states have taken existing equipment with functionally equivalent equipment would be consid-their own actions requiring mandatory carbon dioxide emission reductions. ered routine maintenance and excluded from "New Source" review if the cost Pennsylvania and Montana have not, at this time, established any formal of the replaced equipment does not exceed 20% of the replacement cost ot programs to address carbon dioxide and other greenhouse gases. the entire process unit, the basic design is not changed and no permit limit The Pennsylvania DEP has finalized regulations requiring further seasonal is exceeded. These clarifications would substantially reduce the uncertainties 84 (May-June) nitrogen oxide reductions to 80% from 1990 levels starting in under the prior 'New Source" regulations; however, they have been stayed by

_0 2003. These regulations are pursuant to EPA's 1998 State Implementation Plan the U.S. Court of Appeals for the District of Columbia Circuit. PPL is therefore C) 0 (SIP) call to 22 eastern states, including Pennsylvania, to revise their state continuing to operate under the "New Source" regulations as they existed s0 implementation plans. PPL achieved the 2003 nitrogen oxide reductions with prior to the EPAs clarifications.

0 D3" the installation of SCR technology on the Montour units, and may install SCR The New Jersey DEP and some New Jersey residents raised environmental or other additional nitrogen oxide reduction technology on one or more concerns with respect to the Martins Creek plant, particularly with respect to 0

z Brunner Island units at a later date. sulfur dioxide emissions and the opacity of the plants plume. These issues were The EPA has also developed new standards for ambient levels of ozone raised inthe context of an appeal by the New Jersey DEP of the Air Duality Plan z

3" and fine particulates inthe U.S. These standards have been upheld following Approval issued by the Pennsylvania DEP to the adjacent Lower Mt. Bethel z court challenges. The new particulates standard may require further reductions facility, which iscurrently under construction. InOctober 2003, PPL finalized 0

in sulfur dioxide and year-round nitrogen oxide reductions commencing in an agreement with the New Jersey DEP and the Pennsylvania DEP pursuant 2010-2012 at SIP-call levels in Pennsylvania for certain PPL subsidiaries, to which it will reduce sulfur dioxide emissions from its Martins Creek power

-o 0 and at slightly less stringent levels inMontana. The revised ozone standard plant. Under the agreement, PPL Martins Creek will shut down the plant's two is not expected to have amaterial effect on facilities of PPL subsidiaries. coal-fired generating units by September 2007 and may repower them any time The EPA has proposed mercury and nickel regulations and is expected to after shutting them down so long as it follows all applicable state and federal finalize these regulations in2004. The cost of complying with these regulations requirements, including installing the best available pollution control tech-is not now determinable, but could be significant. nology. PPL Martins Creek also will reduce the fuel sulfur content for those In 1999, the EPA initiated enforcement actions against several utilities, units as well as the plant's two oil-fired units beginning in2004. Inaddition, asserting that older, coal-tired power plants operated by those utilities have, PPL will donate to a non-profit organization 70% of the excess emission over the years, been modified inways that subject them to more stringent allowances and emission reduction credits that result from shutting down or "New Source' requirements under the Clean Air Act. The EPA has since issued repowering the coal units. As aresult of the agreement, the New Jersey DEP notices of violation and commenced enforcement activities against other utilities. has withdrawn its challenge to the Air Quality Plan Approval for the Lower The future direction of the EP~s enforcement initiative is presently unclear. Mt. Bethel facility. The agreement will not result inmaterial costs to PPL.

The agreement does not address the issues raised by the New Jersey DEP The EPA has significantly tightened the water quality standard for arsenic.

regarding the visible opacity of emissions from the Martins Creek plant. The revised standard may require several PPL subsidiaries to either further If it is determined that actions must be taken to address the visible opacity treat wastewater or take abatement action at their power plants, or both. The of these emissions, such actions could result incosts that are not now deter- cost of complying with the revised standard is not now determinable, but could minable, but which could be significant. be significant.

Inaddition to the opacity concerns raised by the New Jersey DEP, the The EPA recently finalized requirements for new or modified water intake Pennsylvania DEP also has raised concerns about the opacity of emissions structures. These requirements will affect where generating facilities are built, from the Martins Creek and Montour plants. PPL is discussing these concerns will establish intake design standards, and could lead to requirements for with the Pennsylvania DEP. If it isdetermined that actions must be taken to cooling towers at new and modified power plants. If the source of water for address the Pennsylvania DEPs concerns, such actions could result in costs the plants is surface water, these rules could impose significant capital and that are not now determinable, but which could be significant. operating costs on PPL subsidiaries. Another new rule, expected to be finalized InDecember 2003, PPL Montana, as operator of the Colstrip facility, in2004, will address existing structures. PPL has begun preliminary studies received an Administrative Compliance Order (ACO) from the EPA pursuant to evaluate options to comply with the expected rule. Each of these rules could to the Clean Air Act. The ACO alleges that Units 3and 4 of the facility have impose additional costs on PPL subsidiaries, which are not now determinable, been in violation of the Clean Air Act permit at Colstrip since 1980. The permit but which could be significant.

required Colstrip to submit for review and approval by the EPA an analysis Superfund and Other Remediation and proposal for reducing emissions of nitrogen oxides (NOX) to address Under the Pennsylvania Clean Streams Law, subsidiaries of PPL Generation visibility concerns if and when EPA promulgates Best Available Retrofit are obligated to remediate acid mine drainage at former mine sites and may be Technology requirements for NOX. The EPA is asserting that regulations it required to take additional measures to prevent potential acid mine drainage at promulgated in 1980 triggered this requirement. PPL believes that the ACO previously capped refuse piles. One PPL subsidiary is pumping and treating is unfounded and is discussing the matter with the EPA. The ACO does not mine water at two mine sites. Another PPL subsidiary plans to install passive expressly seek penalties, and it is unclear at this time what, if any, additional wetlands treatment at athird site, and the Pennsylvania DEP has suggested control technology the EPA may consider to be required. Accordingly, the that it may require that PPL subsidiary to pump and treat the mine water at that costs to install any additional controls for NOx, if required, are not now third site. At December 31, 2003, PPL had accrued $29 million to cover the 85 determinable, but could be significant.

costs of pumping and treating groundwater at two mine sites for 50 years and Water/Waste for installing passive wetlands treatment at the third site. C)

'O A final permit for water discharges (NPDES permit) has been issued to the In 1995, PPL Electric and PPL Generation entered into aconsent order 0 Brunner Island generating plant. The permit contains a provision requiring with the Pennsylvania DEP to address a number of sites that were not being -1 0

further studies on the thermal impact of the cooling water discharge from the addressed under another regulatory program such as Superfund, but for which :a plant. These studies are underway and are expected to be completed in2006. PPL Electric or PPL Generation may be liable for remediation. This may include 0 The Pennsylvania DEP has stated that it believes the studies to date show that potential PCB contamination at certain PPL Electric substations and pole sites; the temperature of the discharge must be lowered. The Pennsylvania DEP has potential contamination at anumber of coal gas manufacturing facilities for-also stated that it believes the plant is in violation of a permit condition pro- merly owned or operated by PPL Electric; oil or other contamination which 0 CO hibiting the discharge from changing the river temperature by more than two may exist at some of PPL Electric's former generating facilities; and potential D W

degrees per hour. PPL is discussing these matters with the agency. Depending contamination at abandoned power plant sites owned by PPL Generation. As 11 D

on the outcome of these discussions, the plant could be subject to additional of December 31, 2003, work has been completed for 94% of the sites included M capital and operating costs that are not now determinable, but which could inthe consent order. Additional sites formerly owned or operated by PPL be significant. Electric are added to the consent order on acase-by-case basis.

The Pennsylvania DEP has issued awater quality certification and a draft In 1996, PPL Gas Utilities entered into asimilar consent order with the NPDES permit to PPL Holtwood, LLC in the FERC license renewal proceeding Pennsylvania DEP to address anumber of sites where subsidiaries of PPL for its Lake Wallenpaupack hydroelectric facility. PPL has appealed the certifi- Gas Utilities may be liable for remediation. The sites primarily include former cation and is discussing both the certification and the NPDES permit with the coal gas manufacturing facilities. Subsidiaries of PPL Gas Utilities are also Pennsylvania DER If these discussions are unsuccessful, PPL expects to investigating the potential for any mercury contamination from gas meters and appeal the permit as well. Depending on the outcome of these appeals, each regulators. Accordingly, PPL Gas Utilities and the Pennsylvania DEP have agreed of the certification and the NPOES permit could impose additional costs on to add 72 meter/regulation sites to the consent order. As of December 31, 2003, PPL, which are not now determinable, but which could be significant. PPL Gas Utilities had addressed 24% of the sites under its consent order.

Notes to Consolidated Financial Statements At December 31, 2003, PPL Electric and PPL Gas Utilities had accrued Electric and Magnetic fields approximately $3million and $9million, representing the estimated amounts Concerns have been expressed by some members of the public regarding they will have to spend for site remediation, including those sites covered by the potential health effects of EMFs. These fields are emitted by all devices each company's consent orders mentioned above. Depending on the outcome carrying electricity, including electric transmission and distribution lines and of investigations at sites where investigations have not begun or have not been substation equipment. Government officials in the U.S. and the U.K. have completed, the costs of remediation and other liabilities could be substantial. focused attention on this issue. PPL and its subsidiaries support the current PPL also could face other non-remediation liabilities at sites included in the efforts to determine whether EMFs cause any human health problems and are consent order or other contaminated sites, the costs of which are not now taking steps to reduce EMFs, where practical, inthe design of new transmis-determinable, but which could be significant. sion and distribution facilities. PPL is unable to predict what effect, if any, Inconjunction with its 1999 sale of generating assets to PPL Montana, the EMF issue might have on its operations and facilities either in the U.S.

Montana Power prepared a Phase I and Phase IIEnvironmental Site Assessment. or abroad, and the associated cost, or what, if any, liabilities it might incur The assessment identified various groundwater remediation issues. Based related to the EMF issue.

upon subsequent assessments and actions taken by PPL Montana, the costs tower Mt. Bethel to PPL Montana of the groundwater remediation measures identified in those InAugust 2002, the Northampton County Court of Common Pleas issued a assessments are expected to be approximately $3million. However, additional decision concerning the permissible noise levels from the Lower Mt. Bethel expenditures could be required inamounts which are not now determinable, facility when it becomes operational. Specifically, the court's decision sets but which could be significant.

certain permissible noise levels required for plant operation. PPL appealed InMay 2003, approximately 40 plaintiffs brought an action inthe Montana the courts decision to the Commonwealth Court, and an intervenor inthe Second Judicial District Court, Butte-Silver Bow County, against PPL Montana lawsuit cross-appealed the court's decision. In May 2003, the Commonwealth and the other owners of the Colstrip plant alleging property damage from fresh-Court remanded the case to the Court of Common Pleas for further findings water pond seepage and contamination from wastewater ponds at the plant.

of fact concerning the zoning application relating to the construction of the This action has been moved to the Montana Sixteenth Judicial District Court, facility. InSeptember 2003, the Court of Common Pleas ruled inPPL's favor Rosebud County. This action could result in PPL Montana and the other while also reaffirming its decision on the noise levels, and the intervenor Colstrip owners being liable for damages and being required to take additional has appealed this ruling to the Commonwealth Court. The Lower Mt. Bethel remedial measures, the costs of which are not now determinable, but which facility is expected to be operational in2004. However, PPL and PPL Energy could be significant.

Supply cannot predict the outcome of the ongoing litigation concerning the In 1999, the Montana Supreme Court held infavor of several citizens' facility or its ultimate impact on the Lower Mt. Bethel facility, but such impact groups that the right to aclean and healthful environment isafundamental may be material.

right guaranteed by the Montana Constitution. The courts ruling could result insignificantly more stringent environmental laws and regulations, as well as Environmental Matters - International an increase incitizens' suits under Montana's environmental laws. The effect on UK PPL Montana of any such changes inlaws or regulations or any such increase WPD's distribution businesses are subject to numerous regulatory and statu-inlegal actions is not currently determinable, but it could be significant. tory requirements with respect to environmental matters. PPL believes that Future cleanup or remediation work at sites currently under review, or at WPD has taken and continues to take measures to comply with the applicable sites not currently identified, may result in material additional operating costs laws and governmental regulations for the protection of the environment.

for PPL subsidiaries that cannot be estimated at this time. There are no material legal or administrative proceedings pending against WPD with respect to environmental matters. See "Environmental Matters -

Asbestos Domestic - Electric and Magnetic Fields" for a discussion of EMFs.

There have been increasing litigation claims throughout the U.S. based on exposure to asbestos against companies that manufacture or distribute Latin America asbestos products or that have these products on their premises. Certain of Certain of PPUs affiliates have electric distribution operations in Latin America.

PPLs generation subsidiaries and certain of its energy services subsidiaries, PPL believes that these affiliates have taken and continue to take measures such as those that have supplied, may have supplied or installed asbestos to comply with the applicable laws and governmental regulations for the material inconnection with the repair or installation of process piping and protection of the environment. There are no material legal or administrative heating, ventilating and air conditioning systems, have been named as defen- proceedings pending against PPUs affiliates inLatin America with respect dants inasbestos-related lawsuits. PPL cannot predict the outcome of these to environmental matters.

lawsuits or whether additional claims may be asserted against its subsidiaries in the future. PPL does not expect that the ultimate resolution of the current lawsuits will have amaterial adverse effect on its financial condition.

Other gate face value of the trust's outstanding preferred securities was $575 million Nuclear Insurance at December 31, 2003. See the Statement of Company-Obligated Mandatorily PPL Susquehanna is a member of certain insurance programs which provide Redeemable Securities for adiscussion of the terms of the trust preferred coverage for property damage to members' nuclear generating stations. Facilities securities of PPL Capital Funding Trust I and Note 8 for adescription of the at the Susquehanna station are insured against property damage losses up to exchange oiler involving the PEPS Units and PEPS Units, Series Band the

$2.75 billion under these programs. PPL Susquehanna isalso a member of an remarketing of the trust preferred securities of PPL Capital Funding Trust I.

insurance program which provides insurance coverage for the cost of replace- .WPD LLP guarantees all of the obligations of SIUK Capital Trust I, an ment power during prolonged outages of nuclear units caused by certain unconsolidated wholly-owned financing subsidiary of WPD LLP, under its specified conditions. Under the property and replacement power insurance trust preferred securities. The aggregate face value of the trust's outstanding programs, PPL Susquehanna could be assessed retroactive premiums inthe preferred securities was $82 million at December 31, 2003. See the Statement event of the insurers' adverse loss experience. At December 31, 2003, this of Company-Obligated Mandatorily Redeemable Securities for adiscussion maximum assessment was about $40 million. of the terms of the trust preferred securities of SIUK Capital Trust I.

PPL Susquehanna's public liability for claims resulting from a nuclear PPL Generation has entered into certain partnership arrangements for the incident at the Susquehanna station is limited to about $10.9 billion under sale of coal to third parties. PPL Generation has also executed support agree-provisions of The Price Anderson Amendments Act of 1988. PPL Susquehanna ments, which expire in2007, for the benefit of these third-party purchasers is protected against this liability by acombination of commercial insurance pursuant to which it guarantees the partnerships' obligations in an amount up and an industry assessment program. Inthe event of a nuclear incident at any to its pro rata ownership interest inthe partnerships. PPL Generation's maximum of the reactors covered by The Price Anderson Amendments Act of 1988, PPL aggregate exposure under these support arrangements was approximately Susquehanna could be assessed up to $201 million per incident, payable at $9million as of December 31, 2003.

$20 million per year. PPL Susquehanna is contingently obligated to pay $40 million related to potential retroactive premiums that could be assessed under its nuclear Guaranteesand Other Assurances insurance programs. Additionally, under the Price Anderson Amendments In the normal course of business, PPL enters into agreements that provide Act of 1988, PPL Susquehanna could be assessed up to $201 million for financial performance assurance to third parties on behalf of certain subsidiaries.

each incident at any of the nuclear reactors covered by this Act. See 'Nuclear Such agreements include, for example, guarantees, stand-by letters of credit 87 Insurance" for additional information.

issued by financial institutions and surety bonds issued by insurance compa- -U PPL EnergyPlus enters into written put option contracts under which, in -V nies. These agreements are entered into primarily to support or enhance the 0 exchange for apremium received, it agrees to purchase aspecified quantity C) creditworthiness attributed to a subsidiary on a stand-alone basis, thereby 0 21 of acommodity for a specified price if the counterparty exercises the option. M facilitating the extension of credit to accomplish the subsidiaries' intended 0 The aggregate carrying value of such contracts that were outstanding as of -U commercial purposes.

December 31, 2003 was insignificant. These option contracts expire from June :0 PPL provides certain guarantees that are required to be disclosed in 2004 through August 2004. The aggregate maximum amount of payments that z accordance with FIN 45, Guarantor's Accounting and Disclosure Requirements PPL EnergyPlus could be required to make if the options are exercised by the for Guarantees, Including Indirect Guarantees of Indebtedness of Others, an counterparties under these contracts is $3million.

Interpretation of FASB Statements No. 5, 57, and 107 and Rescission of FASB z Certain acquisition agreements relating to the acquisition of mechanical z Interpretation No. 34." See Note 22 for a discussion of FIN 45. The guarantees C contractors contain provisions that require a PPL subsidiary to make contingent :Z) provided as of December 31, 2003 are discussed below. Inaccordance with payments to the former owners based upon the profitability of the business the provisions of FIN 45, the fair values of guarantees related to arrangements unit. The maximum amount of potential payments is not explicitly stated in 0 entered into prior to January 1,2003, as well as guarantees excluded from the I1 the acquisition agreements. These arrangements expire at the end of 2004.

initial recognition and measurement provisions of FIN 45, are not recorded in Based on current expectations, PPL estimates that any amounts to be paid the financial statements.

under these arrangements for future performance of the business units will PPL fully and unconditionally guarantees the debt securities of PPL Capital be insignificant.

Funding, awholly-owned financing subsidiary of PPL, including PPL Capital Certain agreements relating to the purchase of ownership interests in Funding's medium-term notes and the notes issued by PPL Capital Funding in synfuel projects contain provisions that require certain PPL subsidiaries to connection with the PEPS Units and PEPS Units, Series B. PPL also fully and make contingent purchase price payments to the former owners. These unconditionally guarantees all of the obligations of PPL Capital Funding Trust payments are non-recourse to PPL and its subsidiaries and are based primarily I, an unconsolidated wholly-owned financing subsidiary of PPL, under the upon production levels of the synfuel projects. The maximum amounts of trust preferred securities that are a component of the PEPS Units. The aggre-

Notes to Consolidated Financial Statements potential payments are not explicitly stated inthe agreements. These arrange- related offering documents. Inaddition, in connection with these securities ments expire in2007. Based on current expectations, PPL estimates that the offerings and other financing transactions, the companies also engage subsidiaries could pay up to an aggregate of approximately $60 million under trustees or custodial, escrow or other agents to act for the benefit of the these arrangements. As of December 31, 2003, PPLs Balance Sheet reflects investors or to provide other agency services. The companies and their a liability of approximately $4million related to the contingent purchase price subsidiaries typically provide indemnification to these agents for any obligations of a subsidiary of PPL. liability or expenses incurred by them inperforming their obligations.

PPL Electric provides aguarantee inthe amount of approximately $7million,

• PPL EnergyPlus is party to numerous energy trading or purchase and as of December 31, 2003, related to debt of an unconsolidated entity. The sale agreements pursuant to which the parties indemnity each other for any guarantee expires inJune 2008. damages arising from events that occur while the indemnifying party has PPL Electric and PPL Montana lease certain equipment under master oper- title to the electricity or natural gas. For example, inthe case of the party ating lease agreements. The term for each piece of equipment leased ranges that is delivering the product, such party would be responsible for damages from one to three years, after which time the lease term may be extended for arising from events occurring prior to delivery.

certain equipment either (i)from month-to-month until terminated or (ii) for up

• Inconnection with their sales of various businesses, WPD and its affiliates to two additional years. Under these lease arrangements, PPL Electric and PPL have provided the purchasers with indemnifications that are standard for such Montana provide residual value guarantees to the lessors. PPL Electric and transactions, including indemnifications for certain pre-existing liabilities PPL Montana generally could be required to pay a residual value guarantee if and environmental and tax matters. Inaddition, inconnection with certain the proceeds received from the sale of apiece of equipment, upon termination of these sales, WPD and its affiliates have agreed to continue their obliga-of the lease, are less than the expected residual value of the equipment. As of tions under existing third-party guarantees, either for aset period of time December 31, 2003, the maximum aggregate amount of future payments that following the transactions or upon the condition that the purchasers make could be required to be made as aresult of these residual value guarantees reasonable efforts to terminate the guarantees. They also have guaranteed was approximately $92 million. As of December 31, 2003, the aggregate carry- the payment of up to £19 million, or $34 million at current exchange rates, ing value of residual value guarantees issued subsequent to December 31, under acontract that expires in2005 assigned as part of one of these sales.

2002 was $16 million and is included in Current Liabilities - Other' on the Finally, WPD and its affiliates remain secondarily responsible for lease Balance Sheet. These guarantees generally expire within one year, unless the payments under certain leases that they have assigned to third parties.

88 lease terms are extended.

PPL, on behalf of itself and its subsidiaries, maintains insurance that 0 PPL and its subsidiaries provide other miscellaneous guarantees through m covers liability assumed under contract for bodily injury and property damage.

contracts entered into inthe normal course of business. These guarantees

-o The coverage requires a$4million deductible per occurrence and provides 0 are primarily in the form of various indemnifications or warranties related to maximum aggregate coverage of approximately $175 million. This insurance services or equipment, and vary induration. Except as otherwise noted below, z may be applicable to certain obligations under the contractual arrangements H the obligated amounts of these guarantees often are not explicitly stated; there-0 discussed above.

fore, the overall maximum amount of the obligation under such guarantees zz cannot be reasonably estimated. Historically, PPL and its subsidiaries have not

~0 0

made any significant payments with respect to these types of guarantees. As of r > December 31, 2003, the aggregate fair value of these indemnifications related

15. RELATED PARTY TRANSACTIONS to arrangements entered into subsequent to December 31, 2002 was insignifi- See Note 22 for a discussion of the implementation of FIN 46, 'Consolidation cant. These guarantees include the following: of Variable Interest Entities, an Interpretation of ARB No. 51." Adoption of this

'D 22

• The companies' or their subsidiaries' leasing arrangements, including those statement on December 31, 2003 for certain entities required the deconsolida-H_ discussed above, contain certain indemnifications infavor of the lessors tion of wholly-owned trusts that had issued preferred securities. As a result, the (e.g., tax and environmental matters). subordinated debt securities of PPL Capital Funding, inthe case of PPL Capital

• In connection with their issuances of securities, the companies and their Funding Trust I, and WPD LLP, inthe case of SIUK Capital Trust I, which sup-subsidiaries engage underwriters, purchasers and purchasing agents to port the trust preferred securities, are no longer eliminated inconsolidation.

whom they provide indemnification for damages incurred by such parties As of December 31, 2003, $681 million is reflected as 'Long-term Debt with arising from the companies' material misstatements or omissions inthe Affiliate Trusts" on PPUs Balance Sheet.

16. OTHER INCOME- NET or sales of when-issued securities or other securities that did not yet exist.

PPL adopted SFAS 149 as of July 1,2003. The adoption of SFAS 149 did not The breakdown of PPLs Other Income- net" was as follows:

have asignificant impact on PPL.

2003 2002 2001 Management of Market Risk Exposures Other Income Interest income v $12 $28 $15 Market risk isthe potential loss PPL may incur as a result of price changes Equity earnings (loss) 2 (2) associated with aparticular financial or commodity instrument. PPL is Realized earnings on nuclear decommissioning trust 20 exposed to market risk from:

Gain by WPD on the disposition of property 3 6

• Commodity price risk for energy and energy-related products associated Hyder-related activity .; 8 with the sale of electricity from its generating assets and other electricity Rental income 4 Reduction of reserves for receivables from Enron 10 marketing activities, the purchase of fuel for the generating assets and Legal claim settlements 3 energy trading activities; Miscellaneous - domestic 11 7 11

• interest rate risk associated with variable-rate debt and the fair value of Miscellaneous- international 10 5 12 fixed-rate debt used to finance operations, as well as the fair value of debt Total 81 48 36 securities invested inby PPLs nuclear decommissioning fund; Other Deductions

• foreign currency exchange rate risk associated with investments inaffiliates Asset valuation write-down 3 1 inLatin America and Europe, as well as purchases of equipment incurren-Non-operating taxes other than income 1 3 5 cies other than U.S. dollars; and Miscellaneous - domestic 7 10 15 Miscellaneous - international 10 4

• equity securities price risk associated with the fair value of equity securities invested inby PPls nuclear decommissioning fund.

Other Income-net $60 $30 $16 PPL has a risk management policy approved by the Board of Directors to manage market risk and counterparty credit risk. The RMC, comprised of

17. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES senior management and chaired by the Vice President-Risk Management, oversees the risk management function. Key risk control activities designed PPL adopted SFAS 133, "Accounting for Derivative Instruments and Hedging 89 to ensure compliance with risk policies and detailed programs include, but Activities," on January 1,2001. Upon adoption and inaccordance with the are not limited to, credit review and approval, validation of transactions and M 0

transition provisions of SFAS 133, PPL Energy Supply recorded acumulative- market prices, verification of risk and transaction limits, sensitivity analyses, 0 effect credit of $11 million in earnings, included as an increase to "Wholesale and daily portfolio reporting, including open positions, mark-to-market valua- M

-1 energy marketing" revenues and adecrease to "Energy purchases" on the tions, and other risk measurement metrics. Inaddition, efforts are ongoing to 0 Statement of Income. develop systems to improve the timeliness, quality and breadth of market and D X

0 InApril 2003, the FASB issued SFAS 149, "Amendment of Statement 133 credit risk information. O z

on Derivative Instruments and Hedging Activities," which amends and clari- PPL utilizes forward contracts, futures contracts, options and swaps as fies SFAS 133 to improve financial accounting and reporting for derivative Z part of its risk management strategy to minimize unanticipated fluctuations instruments and hedging activities. To ensure that contracts with comparable inearnings caused by commodity price, interest rate and foreign currency C

characteristics are accounted for similarly, SFAS 149 clarifies the circumstances volatility. All derivatives are recognized on the balance sheet at their fair value, under which a contract with an initial net investment meets the characteristics Z>

m unless they meet SFAS 133 criteria for exclusion (see discussion in'Related of aderivative, clarifies when aderivative contains a financing component, Implementation Issues" below). 0 amends the definition of an *underlying. and amends certain other existing pronouncements. Additionally, SFAS 149 placed additional limitations on the Fair Value Hedges use of the normal purchase or normal sale exception. SFAS 149 was effective PPL subsidiaries enter into financial or physical contracts to hedge aportion for contracts entered into or modified and for hedging relationships designated of the fair value of firm commitments of forward electricity sales. These con-after June 30, 2003, except certain provisions relating to forward purchases tracts range inmaturity through 2006. Additionally, PPL and its subsidiaries enter into financial contracts to hedge fluctuations inmarket value of existing debt issuances. These contracts range inmaturity through 2029.

Notes to Consolidated Financial Statements PPL recognized the following net gainsl(losses), after-tax, resulting from Related Implementation Issues hedges of firm commitments that no longer qualified as fair value hedges For energy contracts that meet the definition of aderivative, the circumstances (reported in 'Wholesale energy marketing" revenues and Energy purchases' on and intent existing at the time that energy transactions are entered into deter-the Statement of Income): $1million in2003, $0million in 2002 and $7mil- mine their accounting designation. The following summarizes the electricity lion in2001. guidelines that have been provided to the traders who are responsible for con-PPL did not recognize any gainsl(losses) resulting from the ineffective tract designation for derivative energy contracts inaccordance with SFAS 149:

portion of fair value hedges for the twelve months ended December 31, 2003,

• Any wholesale and retail contracts to sell electricity and the related capacity 2002 or 2001. that are expected to be delivered from PPUs generation or that are approved by the RMC as being astrategic element of PPUs overall marketing strategy Cash Flow Hedges are considered "normal." These transactions are not recorded inthe financial PPL subsidiaries enter into financial and physical contracts, including forwards, statements and have no earnings impact until delivery.

futures and swaps, to hedge the price risk associated with electric, gas and oil

• Physical electricity-only transactions can receive cash flow hedge treatment commodities. These contracts range inmaturity through 2010. Additionally, PPL if all of the qualifications under SFAS 133 are met. Any unrealized gains or and its subsidiaries enter into financial interest rate swap contracts to hedge losses on transactions receiving cash flow hedge treatment are recorded in interest expense associated with both existing and anticipated debt issuances.

other comprehensive income.

These swaps range in maturity through 2014. PPL and its subsidiaries also

• Physical electricity purchases that increase PPUs long position and any enter into foreign currency forward contracts to hedge exchange rates associated energy sale or purchase judged a "market call" are considered speculative, with firm commitments denominated inforeign currencies and to hedge the with unrealized gains or losses recorded immediately through earnings.

net investment of foreign operations. These forward contracts range inmaturity

• Financial transactions, which can be settled in cash, cannot be considered through 2028.

.normal" because they do not require physical delivery. These transactions Cash flow hedges may be discontinued because it is probable that the receive cash flow hedge treatment if they lock in the price PPL will receive original forecasted transaction will not occur by the end of the originally speci-or pay for energy expected to be generated or purchased inthe spot market.

fied time period. PPL and its subsidiaries discontinued certain cash flow hedges Any unrealized gains or losses on transactions that receive cash flow hedge which resulted inthe following net gain/(loss), after tax, reclassifications from treatment are recorded inother comprehensive income.

other comprehensive income (reported in"Wholesale energy marketing" rev-enues, "Energy purchases" and "Interest Expense" on the Statement of Income): Transactions that do not qualify for hedge accounting treatment are marked

$(7) million in2003, $(9) million in 2002 and $(14) million in2001. to market through earnings.

Due to hedge ineffectiveness, PPL and its subsidiaries reclassified the fol- In June 2001, the FASB issued definitive guidance on DIG Issue C15, lowing net gains/(losses), after tax, from other comprehensive income "Scope Exceptions: Normal Purchases and Normal Sales Exception for Certain (reported in "Wholesale energy marketing" revenues and "Energy purchases" Option-Type Contracts and Forward Contracts inElectricity." DIG Issue C15 on the Statement of Income): $0million in both 2003 and 2001 and $(2) mil- provides additional guidance on the classification and application of derivative lion in2002. accounting rules relating to purchases and sales of electricity utilizing forward As of December 31, 2003, the deferred net gain/(loss), after tax, on deriva- and option contracts. This guidance became effective as of July 1, 2001. In tive instruments in "Accumulated other comprehensive income" expected to be December 2001, the FASB revised the guidance inDIG Issue C15, principally reclassified into earnings during the next twelve months was $(1) million. related to the eligibility of options for the normal purchases and normal sales The following table shows the change inaccumulated unrealized gains or exception. The revised guidance was effective April 1,2002. InNovember 2003, losses on derivatives inother comprehensive income for the following periods: the FASB again revised the guidance inDIG Issue C15 to clarify the application 2003 2002 of derivative accounting rules for contracts that may involve capacity. The guid-Beginning accumulated derivative gain $ 7 $23 ance iseffective January 1,2004 for PPL. PPL does not expect this guidance Net change associated with current period to have asignificant impact on its financial statements.

hedging activities and other 129 12 Net change associated with net investment hedges (2) (3)

Net change from reclassification into earnings (98) (25)

Ending accumulated derivative gain $ 36 $ 7

InJune 2003, the FASB issued DIG Issue C20, 'Scope Exceptions: PPL's subsidiaries have adopted the final provisions of EITF 03-11, Interpretation of the Meaning of Not Clearly and Closely Related inParagraph: 'Reporting Realized Gains and Losses on Derivative Instruments That Are 10(b) Regarding Contracts with aPrice Adjustment Feature,' which became Subject to FASB Statement No. 133 and Not 'Held for Trading Purposes' as effective October 1, 2003. DIG Issue C20 addresses arequirement inSFAS 133 Defined inIssue No. 02-3," prospectively, as of October 1 2003. As aresult of that contracts that qualify for normal treatment must feature pricing that is clearly this adoption, non-trading bilateral sales of electricity at major market delivery and closely related to the asset being sold. Diversity in practice had developed points are netted with purchases that offset the sales at those same delivery among companies. DIG Issue C20 permits normal treatment if a price adjust- points. Amajor market delivery point is any delivery point with liquid pricing ment factor, such as abroad market index (e.g., Consumer Price Index), isnot available. The impact of adopting EITF 03-11, beginning October 1,2003, extraneous to both the cost and the fair value of the asset being sold and is not was areduction inboth "Wholesale energy marketing' revenues and "Energy significantly disproportionate interms of the magnitude and direction when purchases" by $105 million on the Statement of Income.

compared with the asset being sold. However, DIG Issue C20 also stated that Credit Concentration prior guidance did not permit the use of abroad market index to serve as a PPL and its subsidiaries enter into contracts with many entities for the pur-proxy for an ingredient or direct factor. Thus, DIG Issue C20 required that con-chase and sale of energy. Most of these contracts are considered anormal tracts that had been accounted for as normal but were not eligible for normal part of doing business and, as such, the mark-to-market value of these treatment under prior guidance be reflected on the balance sheet at their fair contracts is not reflected inthe financial statements. However, the mark-value, with an offsetting amount reflected in income as of the date of adoption.

to-market value of these contracts is considered when committing to new These contracts could then be evaluated under the provisions of DIG Issue C20 business from acredit perspective.

to determine whether they could qualify for normal treatment prospectively.

PPL and its subsidiaries have credit exposures to energy trading partners.

PPL recorded apre-tax charge to income of $2million inthe fourth quarter The majority of these exposures were the mark-to-market value of multi-year of 2003 to comply with the provisions of DIG Issue C20.

contracts for energy sales. Therefore, it these counterparties fail to perform In December 2001, the FASB revised guidance on DIG Issue C16, "Scope their obligations under such contracts, the companies would not experience Exceptions: Applying the Normal Purchases and Normal Sales Exception to an immediate financial loss, but would experience lower revenues infuture Contracts that Combine a Forward Contract and a Purchased Option Contract."

years to the extent that replacement sales could not be made at the same DIG Issue C16 provides additional guidance on the classification and applica-prices as sales under the defaulted contracts. 91 tion of SFAS 133, "Accounting tor Derivative Instruments and Hedging At December 31, 2003, PPL had a credit exposure of $234 million to Activities," relating to purchases and sales ot electricity utilizing forward con-energy trading partners. Eight counterparties accounted for 51% of this C) tracts and options, as well as the eligibility of fuel contracts for the normal 0 exposure. No other individual counterparty accounted for more than 4%of purchases and normal sales exception. The revised guidance was effective 0 the exposure. With one exception, each of the eight primary counterparties April 1,2002. PPL had no financial statement impact from the revised guidance had an investment grade credit rating from Standard & Poors Ratings Services 0 on fuel contracts classified as normal. :x z

(S&P). The non-investment grade counterparty. NorthWestern, has filed for zC PPL adopted the final provisions of EITF 02-3, "Issues Involved in Chapter 11 bankruptcy protection. NorthWestern has assumed the power Accounting for Derivative Contracts Held for Trading Purposes and Contracts N supply agreements in its bankruptcy proceeding. NorthWestern has remained z Involved inEnergy Trading and Risk Management Activities," during the fourth current on all post-bankruptcy obligations with PPL Montana. Payment on all quarter of 2002. As such, PPL reflects its net realized and unrealized gains and pre-bankruptcy obligations was received inOctober 2003. See Note 14 under C losses associated with all derivatives that are held for trading purposes inthe

'Wholesale Energy Commitments" for additional information regarding the H "Net energy trading margins" line on the Statement of Income. Non-derivative I, NorthWestern bankruptcy proceeding. -U contracts that met the definition of energy trading activities as defined by EITF M0 PPL and its subsidiaries have the right to request collateral from each 98-10, 'Accounting for Energy Trading and Risk Management Activities" are of these counterparties, except for one government agency, inthe event their reflected inthe financial statements using the accrual method of accounting.

credit ratings fall below investment grade or, in one case, below current levels.

Under the accrual method of accounting, unrealized gains and losses are not PPL Montana and NorthWestern have mutually agreed not to request collateral reflected inthe financial statements. Prior periods were reclassified. No cumu-from each other while NorthWestern's Chapter 11 bankruptcy proceeding is lative effect adjustment was required upon adoption.

pending. It isalso the policy of PPL and its subsidiaries to enter into netting agreements with all of their counterparties to minimize credit exposure.

Notes to Consolidated Financial Statements Enron Bankruptcy undergo an annual impairment test. PPL changed the classification of certain In connection with the December 2001 bankruptcy filings by Enron Corporation intangible assets on the balance sheet upon adopting SFAS 142. Previously and its affiliates (collectively "Enron'), PPL EnergyPlus and PPL Montana reported information has been restated to conform to the current presentation.

terminated certain electricity, gas and other trading agreements with Enron. The following information is disclosed inaccordance with SFAS 142.

PPL EnergyPlus' 2001 after-tax earnings exposure associated with termination Acquired Intangible Assets of these contracts was approximately $8million, which was recorded in The carrying amount and the accumulated amortization of acquired intangible "Wholesale energy marketing" and 'Energy purchases" in the Statement of assets were as follows:

Income. Additionally, at the time that these trading agreements were terminated, they were at prices more favorable to PPL EnergyPlus and PPL Montana than December 31, 2003 December 31, 2002 current market prices, and PPL established a reserve for uncollectible accounts Accumu- Accumu-in the aggregate amount of $50 million. InOctober 2002, PPL EnergyPlus and Carrying lated Carrying lated PPL Montana filed proofs of claim inEnron's bankruptcy proceedings for approx- Amount Amortization Amount Amortization imately $21 million and $29 million, respectively. These claims were against Land and transmission rights $256 $94 $245 $90 Enron North America and Enron Power Marketing (the "Enron Subsidiaries"), Emission allowances 49 41 and against Enron Corporation, which had guaranteed the Enron Subsidiaries' Licenses and other 51 4 37 3 performance (the 'Enron Corporation Guarantees"). $356 $98 $323 $93 During 2003, PPL EnergyPlus, PPL Montana and Enron engaged indis-cussions regarding the amount of claims that would be allowed against the Current intangible assets are included in "Current Assets - Other,"

Enron Subsidiaries. Although no formal agreement on such amounts has been and long-term intangible assets are included in"Other intangibles" on the reached, based on informal discussions with Enron's counsel, PPL EnergyPlus Balance Sheet.

and PPL Montana believe that their claims against the Enron Subsidiaries Amortization expense was approximately $6million for 2003 and 2002.

will eventually be allowed in the bankruptcy at approximately $21 million and Amortization expense is estimated at $6million per year for 2004 through 2008.

$25 million, respectively. Accordingly, PPL reduced its receivables from Enron, Goodwill and the associated reserve for uncollectible accounts, by $4million. PPL The changes inthe carrying amounts of goodwill by segment were as follows:

also determined that it is probable that PPL EnergyPlus and PPL Montana

-U will recover approximately $4million and $6million, respectively, of these Supply Intemational Delivery Total

-D 0 receivables from the Enron Subsidiaries, and may collect additional amounts Balance as of January 1,2002 $72 $ 257 $55 $ 384 0

under the Enron Corporation Guarantees. Therefore, PPL determined that it Goodwill acquired 13 6 19

-U a

D Interest inWPD goodwill (a) 225 225 was appropriate to reduce its reserve by an additional $10 million.

> Effect of foreign currency

-4 InNovember 2003, Enron Corporation filed suits against each of PPL exchange rates (4) (4) 0 z EnergyPlus and PPL Montana, asserting that the Enron Corporation Guarantees Impairment losses (150) (150) 0 should be avoided as fraudulent transfers. IfEnron Corporation were success- Balance as of December 31, 2002 $85 $334 $55 $ 474 ful inthese suits, PPL EnergyPlus' and PPL Montana's claims against Enron Effect of foreign currency 0 exchange rates 92 92 Z Corporation under the Enron Corporation Guarantees would not be allowed Purchase accounting adjustments (a) 8 500 508 I

I C z>

r, in the bankruptcy proceeding. Discontinued operations (6) (6)

I mO Balance as of December 31,2003 $93 $ 920 $55 $1,068 I 0 l Ml 1 8. GOODWILL AND OTHER INTANGIBLE ASSETS (a)See Note 9for additional information.

Goodwill is included in 'Goodwill" on the Balance Sheet.

On January 1,2002, PPL and its subsidiaries adopted SFAS 142, "Goodwill The reporting units of the Supply, Delivery and International segments and Other Intangible Assets," which eliminates the amortization of goodwill completed the transition impairment test inthe first quarter of 2002. Atransi-and other acquired intangible assets with indefinite economic useful lives.

tion goodwill impairment loss of $150 million was recognized inthe Latin SFAS 142 requires an annual impairment test of goodwill at the reporting unit American reporting unit within the International segment, and is reported as a level, which compares the carrying value of the reporting unit to its fair value.

"Cumulative Effects of Changes inAccounting Principles" on the Statement of Areporting unit is asegment or one level below asegment. Intangible assets Income. The fair value of the reporting unit was estimated using the expected other than goodwill that are not subject to amortization are also required to present value of future cash flows.

In December 2003, the PPL Global Board of Manageis authorized the sale at current favorable prices, and enabled PPL to raise capital at attractive rates of its investment ina Latin American telecommunications company. As aresult for its unregulated businesses, while allowing PPL to retain valuable advan-of this decision, PPL Global wrote off $6million of goodwill. tages related to operating both energy supply and energy delivery businesses.

In connection with this initiative, PPL Electric:

Reconciliation of Prior Periods to Exclude Amortization

• obtained along-term electric supply contract to meet its PLR obligations, The following table reconciles reported earnings for 2001 to earnings adjusted at prices generally equal to the pre-determined 'capped" rates it is autho-to exclude amortization expense related to goodwill and equity method good-rized to charge its PLR customers from 2002 through 2009 under the 1998 will. Those expenses were no longer recorded in2002 or 2003 inaccordance PUC settlement order; with SFAS 142. PPL was not affected by changes inamortization periods for

• agreed to limit its businesses to electric transmission and distribution and other intangible assets.

activities relating to or arising out of those businesses; 2003 2002 2001

• adopted amendments to its Articles of Incorporation and Bylaws containing Income from continuing operations $719 $ 360 $169 'corporate governance and operating provisions designed to reinforce its Goodwill amortization 13 corporate separateness from affiliated companies; Equity method goodwill amortization 3

• appointed an independent director to its Board of Directors and required Pro forma income from continuing operations $ 719 $ 360 $185 the unanimous consent of the Board of Directors, including the consent of Reported net income $734 $ 208 $179 the independent director, to amendments to these corporate governance Goodwill amortization 13 and operating provisions or to the commencement of any insolvency pro-Equity method goodwill amortization 3 ceeding, including any filing of avoluntary petition in bankruptcy or other Adjusted net income $ 734 $208 $195 similar actions; Basic EPS:

• appointed an independent compliance administrator to review, on a semi-Income from continuing operations $4.16 $2.36 $1.16 annual basis, its compliance with the new corporate governance and Goodwill amortization 0.09 operating requirements contained in its amended Articles of Incorporation Equity method goodwill amortization 0.02 and Bylaws; and Pro forna income from continuing operations $4.16 $2.36 $1.27

• adopted aplan of division pursuant to the Pennsylvania Business Reported net income $4.25 $1.37 $1.23 93 Corporation Law. The plan of division resulted in two separate corporations.

Goodwill amortization 0.09 PPL Electric was the surviving corporation and anew Pennsylvania corpora-

'a Equity method goodwill amortization 0.02 -0 tion was created. Under the plan of division, $5million of cash and certain 0 Adjusted net income $4.25 $1.37 $1.34 of PPL Electric's potential liabilities were allocated to the new corporation. C)

-0 PPL has guaranteed the obligations of the new corporation with respect to Diluted EPS: Z 00 Income from continuing operations $4.15 $2.36 $1.15 such liabilities.

Goodwill amortization 0.09 0 The enhancements to PPL Electric's legal separation from its affiliates zo Equity method goodwill amortization 0.02 are intended to minimize the risk that acourt would order PPL Electric's assets Pro forma income from continuing operations $4.15 $2.36 $1.26 and liabilities to be substantively consolidated with those of PPL or another a CD Reported net income $4.24 $1.36 $1.22 affiliate of PPL inthe event that PPL or another PPL affiliate were to become Goodwill amortization . 0.09 M Equity method goodwill amortization 0.02 a debtor in abankruptcy case.

At aspecial meeting of PPL Electric's shareowners held on July 17, Adjusted net income $4.24 $1.36 $1.33 0 2001, the plan of division and the amendments to PPL Electric's Articles of 23 Incorporation and Bylaws were approved, and became effective upon filing the articles of division and the plan of division with the Secretary of State of

19. STRATEGIC INITIATIVE the Commonwealth of Pennsylvania. This filing was made inAugust 2001.

In August 2001, PPL completed astrategic initiative to confirm the structural As part of the strategic initiative, PPL Electric solicited bids to contract separation of PPL Electric from PPL and PPL's other affiliated companies. This with energy suppliers to meet its obligation to deliver energy to its customers initiative enabled PPL Electric to reduce business risk by securing asupply from 2002 through 2009. InJune 2001, PPL Electric announced that PPL contract adequate to meet its PLR obligations, enabled PPL Electric to lower its EnergyPlus was the low bidder, among six bids examined, and was selected to capital costs, enabled PPL EnergyPlus to lock inan electric supply agreement provide the energy supply requirements of PPL Electric from 2002 through

Notes to Consolidated Financial Statements 2009. Under this contract, PPL EnergyPlus will provide electricity at pre- pension and postretirement benefit liabilities by $65 million. The remaining determined capped prices that PPL Electric is authorized to charge its PLR $10 million of costs related primarily to non-pension benefits, such as sever-customers, and received a$90 million payment to offset differences between ance payments and outplacement costs, which will be paid by PPL.

the revenues expected under the capped prices and projected market prices Inthe third quarter of 2003, PPL Electric recorded an additional $9million, through the life of the supply agreement (as projected by PPL EnergyPlus at or $5million after-tax, charge for the completion of the workforce reduction the time of its bid). The contract resulted inPPL EnergyPlus having an eight- program that commenced in2002. This additional charge covers the final 94 year contract at current market prices. PPL has guaranteed the obligations of employees anticipated to be separated as part of the Automated Meter Reader PPL EnergyPlus under the new contract. implementation project. The charge was related to pension enhancements, InJuly 2001, the energy supply contract was approved by the PUC and which will be paid from the PPL Retirement Plan pension trust.

accepted for filing by the FERC. PPL Montana expected to ultimately eliminate up to ten employees and Also inJuly 2001, PPL Electric filed ashelf registration statement with recorded an insignificant charge for the year ended December 31, 2002.

the SEC to issue up to $900 million indebt. InAugust 2001, PPL Electric sold As of December 31, 2003, 490 employees of PPL subsidiaries were termi-

$800 million of senior secured bonds under this registration statement. The nated. Approximately 129 positions, which are primarily bargaining unit, will offering consisted of two series of bonds: $300 million of 5-7/8% Series due be evaluated for termination over the next six months, due to the timing of the 2007 and $500 million of 6-1/4% Series due 2009. PPL Electric used aportion Automated Meter Reader implementation and the displacement process under of the proceeds from these debt issuances to make the $90 million up-front the bargaining unit contract. Substantially all of the accrued non-pension payment to PPL EnergyPlus, and $280 million was used to repurchase aportion benefits have been paid.

of its common stock from PPL. The remainder of the proceeds was used for general corporate purposes.

Taken collectively, the steps in the strategic initiative were intended to 21. ASSET RETIREMENT OBLIGATIONS protect the customers of PPL Electric from volatile energy prices and lower In2001, the FASB issued SFAS 143, Accounting for Asset Retirement its cost of capital. PP~s shareowners also benefited from this initiative Obligations,' which addresses the accounting for obligations associated with because it provided low-cost capital to the higher-growth, unregulated side the retirement of tangible long-lived assets. SFAS 143 requires legal obliga-of PPLs business.

94 tions associated with the retirement of long-lived assets to be recognized as a

-t liability inthe financial statements. The initial obligation should be measured

-u at the estimated fair value. An equivalent amount should be recorded as an

20. WORKFORCE REDUCTION increase inthe value of the capitalized asset and allocated to expense over the

-U In an effort to improve operational efficiency and reduce costs, PPL and its useful life of the asset. Until the obligation is settled, the liability should be subsidiaries commenced aworkforce reduction assessment inJune 2002 that increased, through the recognition of accretion expense in the income state-

-I 0 was expected to eliminate up to 598 employees, or about 7%of PPUs U.S. work- ment, for changes inthe obligation due to the passage of time.

z z force, at an estimated cost of $74 million. The program was broad-based and PPL adopted SFAS 143 effective January 1,2003. Application of the new z impacted all employee groups except certain positions that are key to providing rules resulted in an increase innet PP&E of $32 million, reversal of previously high-quality service to PPrs electricity delivery customers. Linemen, electricians recorded liabilities of $304 million, recognition of asset retirement obligations 22 a

and line foremen, for example, were not affected by the reductions. An addi- of $229 million, recognition of adeferred tax liability of $44 million and a m

22 tional $1million workforce reduction charge was recorded inSeptember 2002, cumulative effect of adoption that increased net income by $63 million or $0.36

-4

-u when plans specific to PPL Global and PPL Montana subsidiaries were final- per share. In2003, as aresult of applying SFAS 143, PPL recognized $18 mil-M0 ized which were expected to impact 26 employees. These additional reductions lion of accretion expense and an insignificant amount of depreciation expense.

increased PPLs total charge for workforce reductions to $75 million for the PPL identified various legal obligations to retire long-lived assets, the elimination of up to 624 positions. largest of which relates to the decommissioning of the Susquehanna station.

PPL recorded the charges inthe Statement of Income as 'Workforce PPL identified and recorded other asset retirement obligations related to signifi-reduction' for the year ended December 31, 2002. These charges reduced net cant interim retirements at the Susquehanna station, and various environmental income by $44 million after taxes. The program provides primarily for enhanced requirements for coal piles, ash basins and other waste basin retirements.

early retirement benefits and/or one-time special pension separation allowances PPL also identified legal retirement obligations that were not measurable based on an employee's age and years of service. These features of the program at this time. These items included the retirement of certain transmission assets will be paid from the PPL Retirement Plan pension trust and increased PPL's and a reservoir. These retirement obligations were not measurable due to indeterminable dates of retirement.

Amounts collected from PPL Electrics customers for decommissioning, less EITF Issue No. 94-3, 'Liability Recognition for Certain Employee Termination applicable taxes, are deposited in external trust funds for investment and can Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred only be used for future decommissioning costs. The fair value of the nuclear in aRestructuring)." SFAS 146 requires the recognition of aliability for costs decommissioning trust was $357 million and $287 million as of December 31, associated with exit or disposal activities when the liability is incurred rather 2003 and 2002. than at the date of a commitment to an exit or disposal plan. SFAS 146 also PPL's asset retirement obligations are included in Deferred Credits and - establishe fat the initial liability should be measured at its estimated fair value.

Other Noncurrent Liabilities - Other" on the Balance Sheet. The changes inthe The provisions of SFAS 146 are effective for exit or disposal activities initiated carrying amounts of asset retirement obligations were as follows: after December 31, 2002, with earlier application encouraged. PPL and its subsidiaries adopted SFAS 146 effective January 1,2003. SFAS 146 did not Asset retirement obligation at January 1,2003 $229 siau: mGUIrLIUIupenste ArlXAronfin evene 1Q Io have an impact on EEL or its subsidiaries during 2003.

Less: Settlement 5 SFAS 148 Asset retirement obligation at December 31, 2003 - $242 In2002, the FASB issued SFAS 148, "Accounting for Stock-Based Compensation - Transition and Disclosure, an Amendment of FASB Statement Reconciliation of Prior Annual Periods No. 123." SFAS 148 provides three transition methods for adopting the fair The pro forma asset retirement obligation liability balances, calculated as if value method of accounting for stock-based compensation prescribed under SFAS 143 had been adopted on January 1, 2001 (rather than January 1,2003), SFAS 123 and enhances the required disclosures regarding stock-based com-were $229 million, $211 million and $196 million as of December 31, 2002, pensation effective for fiscal years ending after December 15, 2002. SFAS 148 December 31, 2001 and January 1, 2001. also requires certain disclosures infinancial reports issued for interim periods The pro forma income statement effects of the application of SFAS 143, beginning after December 15, 2002.

calculated as it it had been adopted prior to January 1,2001 (rather than PPL and its subsidiaries elected to adopt the fair value method of account-January 1,2003) are presented below:

ing for stock-based compensation as of January 1, 2003 using the prospective For the years ended December31, 2003 2002 2001 method of transition, as permitted by SFAS 148. The prospective method pro-Income from continuing operations $ 719 $ 360 $ 169 vides that PPL and its subsidiaries will recognize expense for all stock-based Pro torma income from continuing operations $ 719 $ 351 $167 compensation awards granted, modified or settled on or after January 1,2003. 95 Reported net income $ 734 $ 208 $179 See Note 1for adiscussion of the change inaccounting for stock-based com-Pro forma net income $ 671 $ 199 $177 M I-pensation and the disclosures required by SFAS 148.

0 Basic EPS: AC)

SFAS 149 Income from continuing operations $4.16 $2.36 $1.16 T0 0

Pro forma income from continuing operations $4.16 $2.30 $1.15 See Note 17 for adiscussion of SFAS 149, "Amendment of Statement 133 on 0

Reported net income $4.25 $1.37 $1.23 Derivative Instruments and Hedging Activities," and the impact of its adoption. -4 Pro forma net income $3.89 $1.31 $1.21 z Z0 SFAS 150 I"o Diluted EPS: InMay 2003, the FASB issued SFAS 150, "Accounting for Certain Financial Income from continuing operations $4.15 $2.36 $1.15 Instruments with Characteristics of Both Liabilities and Equity." SFAS 150 z Pro fornma income from continuing operations $4.15 $2.30 $1.14 establishes standards for classifying and measuring certain financial instruments z

C Reported net income $4.24 $1.36 $1.22 that have characteristics of both liabilities and equity. The standards established Pro forma net income $3.88 $1.31 $1.21 by it require certain financial instruments that, under previous guidance, could -D 0

be classified as equity or 'mezzanine" equity to now be classified as liabilities D

on the balance sheet. SFAS 150 requires the following freestanding financial 2 2. NEW ACCOUNTING STANDARDS instruments to be classified as liabilities (or assets insome circumstances):

SFAS 143

• mandatorily redeemable financial instruments, See Note 21 for a discussion of SFAS 143, 'Accounting for Asset Retirement . financial instruments that embody obligations to repurchase equity shares Obligations," and the impact of its adoption. in exchange for cash or other assets, including written put options and forward purchase contracts, and SFAS 146

• certain financial instruments that embody obligations to issue avariable In2002, the FASB issued SFAS 146, "Accounting for Costs Associated with number of shares.

Exit or Disposal Activities." SFAS 146 addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies

Notes to Consolidated Financial Statements SFAS 150 also requires disclosure regarding the nature and terms of under which the guarantee is issued, and the initial liability should typically those instruments and settlement alternatives. Except as discussed below, be reduced as the guarantor isreleased from risk under the guarantee. FIN 45 SFAS 150 is effective for all financial instruments entered into or modified after also requires aguarantor to make significant new disclosures for guarantees May 31, 2003 and is otherwise effective at the beginning of the first interim even if the likelihood of the guarantor's having to make payments isremote.

period beginning alter June 15, 2003. In November 2003, the FASB issued The provisions relating to the initial recognition and measurement of guarantee FSP FAS 150-3, "Effective Date, Disclosures, and Transition for Mandatorily obligations must be applied on a prospective basis for guarantees issued or Redeemable Financial Instruments of Certain Nonpublic Entities and Certain modified after December 31, 2002. PPL and its subsidiaries adopted FIN 45 Mandatorily Redeemable Noncontrolling Interests under FASB Statement effective January 1,2003. FIN 45 did not have asignificant impact on earnings No. 150, 'Accounting tor Certain Financial Instruments with Characteristics in 2003. See Note 14 for disclosure of guarantees and other assurances exist-of Both Liabilities and Equity,' " which, as it relates to public entities, deferred ing as of December 31, 2003.

indefinitely certain provisions of SFAS 150 related to certain mandatorily FIN 46 and FIN 46(R) redeemable noncontrolling interests. SFAS 150 prohibits the restatement of InJanuary 2003, the FASE issued Interpretation No. 46, "Consolidation of financial statements for periods prior to its adoption.

Variable Interest Entities, an Interpretation of ARB No. 51." FIN 46 clarifies that Inaccordance with SFAS 150, effective July 1, 2003, PPL changed its variable interest entities, as defined therein, that do not disperse risks among classification of the trust preferred securities of PPL Capital Funding Trust I, the parties involved should be consolidated by the entity that is determined to which were issued as acomponent of the PEPS Units, changed its classification be the primary beneficiary. FIN 46 also requires certain disclosures to be made of the trust preferred securities issued by SIUK Capital Trust Iand changed its by the primary beneficiary and by an enterprise that holds a significant variable classification of PPL Electric's preferred stock with sinking fund requirements.

interest inavariable interest entity but is not the primary beneficiary. FIN 46 These securities are mandatorily redeemable financial instruments, as they applies immediately to variable interest entities created after January 31, 2003 require the issuer to redeem the securities for cash on aspecified date. Thus, and to variable interest entities inwhich an enterprise obtains an interest after they should be classified as liabilities, as acomponent of long-term debt, January 31, 2003. For variable interest entities inwhich an enterprise holds a instead of "mezzanine" equity, on the balance sheet. As of December 31, 2003, variable interest that was acquired before February 1,2003, FIN 46 was origi-PPL deconsolidated PPL Capital Funding Trust I and SIUK Capital Trust I in nally required to be adopted no later than the first fiscal year or interim period accordance with FASB Interpretation No. 46, 'Consolidation of Variable Interest 96 beginning after June 15, 2003. However, inOctober 2003, the FASB issued Entities, an Interpretation of ARB No. 51,' and there was no preferred stock

-D FSP FIN 46-6, "Effective Date of FASB Interpretation No. 46, Consolidation

-U with sinking fund requirements of PPL Electric outstanding (due to preferred of Variable Interest Entities," which delayed the effective date for applying the stock redemptions discussed in Note 8). As aresult of the deconsolidation of 0 provisions of FIN 46 to interests held by public entities invariable interest the trusts, the subordinated debt securities that support the trust preferred 0

entities or potential variable interest entities created before February 1,2003 securities, rather than the trust preferred securities themselves, are reflected in

_0 until the end of the first interim period ending after December 15, 2003.

long-term debt as of December 31, 2003. See "FIN 46 and FIN 46(R)" for a 0~

2' InDecember 2003, the FASB revised FIN 46 by issuing Interpretation

-4 discussion of the deconsolidation of the trusts.

No. 46 (revised December 2003), which is known as FIN 46(R) and replaces SFAS 150 also requires the distributions on these mandatorily redeemable FIN 46. FIN 46(R) does not change the general consolidation concepts of

-n securities to be included as acomponent of Interest Expense instead of z FIN 46. Among other things, FIN 46(R) again changes the effective date for zha "Distributions on Preferred Securities" inthe Statement of Income effective applying the provisions of FIN 46 to certain entities, clarifies certain provisions CD July 1,2003. "Interest Expense' for 2003 includes distributions on these of FIN 46 and provides additional scope exceptions for certain types of busi-securities totaling $27 million for PPL. Periods ending prior to July 1, 2003 0 nesses. For entities to which the provisions of FIN 46 have not been applied have not been restated to conform to these presentations since SFAS 150

-4 as of December 24, 2003, FIN 46(R) provides that apublic entity that is not a specifically prohibits the restatement of financial statements for periods prior small business issuer should apply the provisions of FIN 46 or FIN 46(R) as to its adoption.

follows: (i) FIN 46(R) shall be applied to all entities no later than the end of FIN 45 the first reporting period that ends after March 15, 2004, and (ii) FIN 46 or In2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting FIN 46(R) should be applied to entities that are considered to be SPEs no later and Disclosure Requirements for Guarantees, Including Indirect Guarantees than the end of the first reporting period that ends after December 15, 2003.

of Indebtedness of Others, an Interpretation of FASB Statements No. 5,57, As permitted by FIN 46(R), PPL and its subsidiaries adopted FIN 46 and 107 and Rescission of FASB Interpretation No. 34.' FIN 45 clarifies that effective December 31, 2003 for entities created before February 1,2003 that upon issuance of certain types of guarantees, the guarantor must recognize are considered to be SPEs. This adoption resulted inthe consolidation ot the an initial liability for the fair value of the obligation it assumes under the lessors under the operating leases for the Sundance, University Park and Lower guarantee. The offsetting entry will be dependent upon the circumstances S.

Mt. Bethel generation facilities, as well as the deconsolidation of two wholly- Mandatorily Redeemable Preferred Securities of Subsidiary Trusts Holding owned trusts. See below for further discussion. Also, is permitted by FIN 46(R), Solely Company Debentures,' amounting to $661 million, which would have PPL and its subsidiaries deferred the application of FIN 46 for other entities been recorded as acomponent of long-term debt in2003 inaccordance with and plans to adopt FIN 46(R), for all entities on March 31, 2004. SFAS 150 if the trusts were consolidated, are not reflected in PPUs Balance PPL and its subsidiaries are inthe process of evaluating entities in Sheet at December 31, 2003. Instead, the subordinated debt securities that which they hold avariable interest inaccordance with FIN 46(R). PPL and its support the trust preferred securities are reflected in 'Long-term Debt with subsidiaries are currently not aware of any variable interest entities that are Affiliate Trusts' as of December 31, 2003. See below for further discussion.

not consolidated as of December 31, 2003 but which they will be required to The trusts hold subordinated debt securities of PPL Capital Funding, in consolidate inaccordance with FIN 46(R) effective March 31, 2004. As they the case of PPL Capital Funding Trust I, and WPD LLP, inthe case of SIUK continue to evaluate the impact of applying FIN 46(R), PPL and its subsidiaries Capital Trust 1.As a result of deconsolidating the trusts, the subordinated debt may identify additional entities that they would need to consolidate. securities are no longer eliminated inthe consolidated financial statements.

As of December 31, 2003, $681 million is reflected as "Long-term Debt with Additional Entities Consolidated Affiliate Trusts" in PPIs Balance Sheet.

The lessors under the operating leases for the Sundance, University Park and The effect on the Balance Sheet as a result of deconsolidating the trusts Lower Mt. Bethel generation facilities are variable interest entities that are was an increase in both total assets and total liabilities of $21 million for PPL.

considered to be SPEs. PPL is the primary beneficiary of these entities.

The increase inassets relates to the investments inthe common securities of the Consequently, PPL was required to consolidate the financial statements of the trusts, which are no longer eliminated inthe consolidated financial statements.

lessors effective December 31, 2003. Upon initial consolidation, PPL recog-The increase inliabilities consists primarily of the difference between the car-nized $1.1 billion of additional assets and liabilities on its balance sheet and a rying value of the preferred securities issued by the trusts compared to the charge of $27 million, after-tax, as a cumulative effect of achange in account-carrying value of the subordinated debt securities of PPL Capital Funding and ing principle. The additional assets consist principally of the generation WPD LLR The deconsolidation of the trusts did not impact the earnings of PPL.

facilities, and the additional liabilities consist principally of the lease financing.

See the Statement of Company-Obligated Mandatorily Redeemable Securities See below for a discussion of the leases.

for adiscussion of the trusts and their preferred securities, as well as the sub-In May 2001, a subsidiary of PPL entered into a lease arrangement, as ordinated debt securities issued to the trusts.

lessee, for the development, construction and operation of commercial power 97 generation facilities. The lessor was created for the sole purpose of owning the EITF 03-11 'a

-U facilities and incurring the related financing costs. The $660 million operating InAugust 2003, the FASB ratified EITF 03-11, "Reporting Realized Gains and 0

lease arrangement covers the 450 MW gas-powered Sundance project near Losses on Derivative Instruments That Are Subject to FASB Statement No. 133, Coolidge, Arizona and the 540 MW gas-powered University Park project near Accounting for Derivative Instruments and Hedging Activities, and Not 'Held -D 0

University Park, Illinois. These facilities were substantially complete inJuly for Trading Purposes' as Defined in EITF Issue No. 02-3, "Issues Involved in 2002, at which time the initial lease term commenced. See the Statement of Accounting for Derivative Contracts Held for Trading Purposes and Contracts ,0 Long-term Debt for a discussion of the related financing. Involved inEnergy Trading and Risk Management Activities'." EITF 03-11 z In December 2001, another subsidiary of PPL entered into a $455 million addresses whether realized gains and losses on physically settled derivative z operating lease arrangement, as lessee, for the development, construction and contracts not "held for trading purposes' should be reported inthe income C operation of a600 MW gas-fired combined-cycle generation facility located statement on a gross or net basis. It requires that each entity make this deter-in Lower Mt. Bethel Township, Northampton County, Pennsylvania. The lessor mination for itself based on the relevant facts and circumstances in the context C was created for the sole purpose of owning the facilities and incurring the related of the various activities of the entity rather than based solely on the terms of -U 0

financing costs. The initial lease term commences on the date of commercial the individual contracts. EITF 03-11 is effective for transactions entered into -4 operation, which is expected to occur in 2004, and ends in December 2013. on or after October 1,2003. See Note 17 for adiscussion of the impacts of See the Statement of Long-term Debt for adiscussion of the related financing. the adoption of EITF 03-11.

Entities Deconsolidated FSP FAS 106-1 Effective December 31, 2003, PPL deconsolidated PPL Capital Funding Trust I See Note 12 for adiscussion of FSP FAS 106-1, "Accounting and Disclosure and SIUK Capital Trust 1.These trusts are considered to be SPEs and were Requirements Related to the Medicare Prescription Drug, Improvement and deconsolidated because PPL is not the primary beneficiary of the trusts under Modernization Act of 2003.'

current interpretations of FIN 46. Therefore, the 'Company-obligated

Reconciliation of Financial Measures (Unaudited)

Millions of dollars, except persharedata "Net Income" and 'Cash Provided by Operating Activities" are financial mea- also uses earnings from ongoing operations inmeasuring certain corporate sures determined in accordance with generally accepted accounting principles performance goals. Other companies may use different measures to present (GAAP). 'Earnings from Ongoing Operations" and 'Free Cash Flow," as refer- financial performance.

enced inthis Annual Report, are non-GAAP financial measures. However, Free Cash Flow PPLs management believes that they provide useful information to investors,

'Free cash flow' is derived by deducting the following from cash provided as asupplement to the comparable GAAP financial measures. Following is by operating activities: capital expenditures (net of disposals, but adjusted additional information on these non-GAAP financial measures, including to include lease financing), dividend payments and repayment of transition reconciliations to Net Income and Cash Provided by Operating Activities, bonds. Free cash tlow should not be considered as an alternative to cash pro-respectively.

vided by operating activities, which isdetermined inaccordance with GAAR Earnings From Ongoing Operalions PPL believes tree cash flow isan important measure to both management and

'Earnings from ongoing operations' excludes the impact of unusual items. investors since itisan indicator of the company's ability to sustain operations Earnings from ongoing operations should not be considered as an alternative and growth without additional outside financing beyond the requirement to net income, which is an indicator of operating performance determined in to fund maturing debt obligations. Other companies may calculate free cash accordance with GAAR PPL believes that earnings from ongoing operations, flow ina different manner. PPLs forecast for 2004 projects approximately although anon-GAAP measure, is also useful and meaningful to investors $1.30 billion incash provided by operating activities. Net of capital expendi-because it provides them with PPIs underlying earnings performance as tures of $690 million, common and preferred dividends of $300 million and another criterion inmaking their investment decisions. PPLs management repayment of $260 million intransition bonds, PPL expects to have positive free cash flow of approximately $50 million for 2004.

Reconciliation of Earnings from Ongoing Operations and Net Income Millions of Dollars Per Share - Diluted 2003 2002 1998 2003 2002 1998 Earnings from Ongoing Operations $642 $ 541 $ 310 $ 3.71 $ 3.54 $1.87 Unusual items (net of tax):

Asset retirement obligation 63 0.36 Consolidation of off-balance sheet projects (27) (0.16) 0 Discontinued operations (20) (0.11) 0~

CEMAR-related net tax benefit 81 0.47

-o 0 Workforce reduction (5) (44) (0.03) (0.29)

Goodwill impairment (150) (0.99) 0 CEMAR operating losses (23) (0.15) rz CEMAR impairment (98) (0.64) 0 Tax benefit - Teesside writedown 8 0.06 Writedown of generation equipment (26) (0.17) z PUC restructuring charge (915) (5.56) z C FERC municipalities settlement (32) (0.19)

Schuylkill Energy Resources settlement 18 0.11 U.K. tax rate reduction 9 0.06 0

2, PPL Gas Utilities acquisition costs 3 0.03 Other impacts of restructuring 38 0.22 Total unusual items 92 (333) (879) 0.53 (2.18) (5.33)

Net Income (Loss) $734 $208 $(569) $4.24 $1.36 $(3.46)

See page 25 inManagement's Discussion and Analysis for financial statement note references for each of these unusual items for 2003 and 2002.

Glossary of Terms and Abbreviations

£ - British pounds sterling. DIG - Derivatives Implementation Group.

1945 First Mortgage Bond Indenture -PPL Electrics Mortgage and Deed DOE - Department of Energy, a U.S. government agency.

of Trust, dated as of October 1,1945, to Deutsche Bank Trust Company Americas, DRIP - Dividend Reinvestment Plan.

as trustee, as supplemented.

EC - Electricidad de Centroamerica, S.A. de CX.,an El Salvadoran holding 2001 Senior Secured Bond Indenture - PPL Electrics Indenture, dated as company and the majority owner of DelSuF and El Salvador Telecom, S.A. de CV.

of August 1,2001, to JPMorgan Chase Bank, as trustee, as supplemented.

PPL Global has 100% ownership of EC.

AFUDC (Allowance for Funds Used During Construction) - the cost of EGS - electric generation supplier.

equity and debt funds used to finance construction projects of regulated businesses that is capitalized as part of construction cost. EITF - Emerging Issues Task Force, an organization that assists the FASB in improving financial reporting through the identification, discussion and resolution ANEEL - National Electric Energy Agency, Brazil's agency that regulates the of financial issues within the framework of existing authoritative literature.

transmission and distribution of electricity.

Elfec - Empresa de Luz y Fuerza Electrica Cochabamba, S.A., a Bolivian electric APA - Asset Purchase Agreement.

distribution company inwhich PPL Global has amajority ownership interest.

APB - Accounting Principles Board.

Emel - Empresas Emel SA., aChilean electric distribution holding company ARB - Accounting Research Bulletin. inwhich PPL Global has majority ownership.

ARO - asset retirement obligation. EMF - electric and magnetic fields.

Bangor Hydro - Bangor Hydro-Electric Company. Enrichment - the concentration of fissionable isotopes to produce afuel suitable for use inanuclear reactor.

Bcf - billion cubic feet.

EPA - Environmental Protection Agency, a U.S. government agency.

CEMAR - Companhia Energetica do Maranhao, aBrazilian electric distribution company inwhich PPL Global has amajority ownership interest. EPS - earnings per share.

CGE - Compania General de Electricidad, S.A., adistributor of electricity and ESOP - Employee Stock Ownership Plan.

99 natural gas with other industrial segments in Chile and Argentina inwhich EWG - exempt wholesale generator.

PPL Global has an 8.7% direct and indirect minority ownership interest. -D Fabrication - the process which manufactures nuclear fuel assemblies for Clean Air Act - federal legislation enacted to address certain environmental 0 0

insertion into the reactor.

issues related to air emissions including acid rain, ozone and toxic air emissions.

0 FASB - financial Accounting Standards Board, arulemaking organization that CTC - competitive transition charge on customer bills to recover allowable establishes financial accounting and reporting standards.

transition costs under the Customer Choice Act. 0 z

FERC - Federal Energy Regulatory Commission, the federal agency that regulates Customer Choice Act - the Pennsylvania Electricity Generation Customer interstate transmission and wholesale sales of electricity and related matters. z Choice and Competition Act, legislation enacted to restructure the state's electric z utility industry to create retail access to acompetitive market for generation of FIN - FASB Interpretation.

electricity. C GAAP - generally accepted accounting principles. 1' DelSur - Distribuidora de Electricidad Del Sur, S.A de CV., an electric distribution Griffith Energy - Griffith Energy LLC, which owns and operates a600 MW company inElSalvador, a majority of which is owned by EC. 0 gas-fired station in Kingman, Arizona, and which isjointly owned by subsidiaries DEP - Department of Environmental Protection, astate government agency. of PPL Generation and Duke Energy Corporation.

Derivative - afinancial instrument or other contract with all three of the following GWh - gigawatt-hour, one million kilowatt-hours.

characteristics:

Hyder - Hyder Limited, asubsidiary of WPDL that was the previous owner of

a. Ithas (1)one or more underlyings and (2)one or more notional amounts or South Wales Electricity plc. InMarch 2001, South Wales Electricity pIc was payment provisions or both. Those terms determine the amount of the settlement acquired by WPDH Limited and renamed WPD (South Wales).

or settlements, and, insome cases, whether or not asettlement isrequired.

b. It requires no initial net investment or an initial net investment that is smaller Integra - Empresa de Ingenieria y Servicios Integrales Cochabamba S.A., a than would be required for other types of contracts that would be expected to have Bolivian company providing construction and engineering services inwhich asimilar response to changes inmarket factors. PPL Global has a majority ownership interest.

c. Its terms require or permit net settlement, it can readily be settled net by a IBEW - International Brotherhood of Electrical Workers.

means outside the contract, or it provides for delivery of an asset that puts the recipient inaposition not substantially different from net settlement. ICP - Incentive Compensation Plan.

Glossary of Terms and Abbreviations (continued)

ICPKE - Incentive Compensation Plan for Key Employees. PP&E - property, plant and equipment.

IRS - Internal Revenue Service, a U.S. government agency. PPL - PPL Corporation, the parent holding company of PPL Electric, PPL Energy Funding and other subsidiaries.

ISO - Independent System Operator.

PPL Capital Funding - PPL Capital Funding, Inc., a PPL financing subsidiary.

ITC - intangible transition charge on customer bills to recover intangible transition costs associated with securilizing stranded costs under the Customer Choice Act. PPL Capital Funding Trust I - aDelaware statutory business trust created to issue PEPS Units, whose common securities are held by PPL.

kWh - kilowatt-hour, basic unit of electrical energy.

PPL Coal Supply - PPL Coal Supply, LLC, alimited liability company owned kVA - kilovolt-ampere.

by PPL Coal Holdings Corporation (asubsidiary of PPL Generation) and Iris Energy LIBOR - London Interbank Offered Rate. LLC. PPL Coal Supply procures coal, which it sells to PPL Generation for power plants and to Iris Energy for syntuel production.

Mirant - Mirant Corporation, adiversified energy company based inAtlanta.

PPL Global and Mirant jointly owned WPD from 1996 until September 6,2002. PPL Electric - PPL Electric Utilities Corporation, aregulated utility subsidiary of PPL that transmits and distributes electricity inits service territory and provides Montana Power - The Montana Power Company, aMontana-based company electric supply to retail customers inthis territory as aPLR.

that sold its generating assets to PPL Montana inDecember 1999. Through a series of transactions consummated during the first quarter of 2002, Montana PPL Energy Funding - PPL Energy Funding Corporation, asubsidiary of Power sold its electricity delivery business to NorthWestern. PPL and the parent company of PPL Energy Supply.

MW - megawatt, one thousand kilowatts. PPL EnergyPlus - PPL EnergyPlus, LLC, asubsidiary of PPL Energy Supply, which markets wholesale and retail electricity, and supplies energy and energy MWh - megawatt-hour, one thousand kilowatt-hours.

services inderegulated markets.

NorthWestern - NorthWestern Energy Division, aDelaware corporation and PPL Energy Supply - PPL Energy Supply, LLC, the parent company of adivision of NorthWestern Corporation and successor ininterest to Montana PPL Generation, PPL EnergyPlus, PPL Global and other subsidiaries. Formed in Power's electricity delivery business, including Montana Power's rights and November 2000, PPL Energy Supply is asubsidiary of PPL Energy Funding.

obligations under contracts with PPL Montana.

PPL Gas Utilities - PPL Gas Utilities Corporation, aregulated utility subsidiary 100 NPDES - National Pollutant Discharge Elimination System.

of PPL specializing innatural gas distribution, transmission and storage services,

• 0 NRC - Nuclear Regulatory Commission, the federal agency that regulates and the competitive sale of propane.

0 0X operation of nuclear power facilities.

PPL Generation - PPL Generation, LLC, asubsidiary of PPL Energy Supply,

• 0 NUGs (Non-Utility Generators) - generating plants not owned by public which owns and operates U.S. generating facilities through various subsidiaries.

0 utilities, whose electrical output must be purchased by utilities under the PURPA PPL Global - PPL Global, LLC, asubsidiary of PPL Energy Supply, which acquires

0 it the plant meets certain criteria.

and develops domestic generation projects and acquires and holds international 0

z OSM - Office of Surface Mining, aU.S. government agency. energy projects that are primarily focused on the distribution of electricity.

PCB - polychlorinated biphenyl, an additive to oil used incertain electrical PPL Holtwood - PPL Holtwood, LLC, asubsidiary of PPL Generation, which C

equipment up to the late-1 970s. Now classified as ahazardous chemical. owns PPLs hydroelectric generating operations inPennsylvania.

PEPS Units (Premium Equity Participating Security Units, or PEPSsM PPL Maine - PPL Maine, LLC, asubsidiary of PPL Generation, which owns M

Units) - securities issued by PPL and PPL Capital Funding Trust I, consisting of generating operations inMaine.

0 aPreferred Security and aforward contract to purchase PPL common stock.

-4 PPL Martins Creek- PPL Martins Creek, LLC, a generating subsidiary of PEPS Units, Series B(Premium Equity Participating Security Units, PPL Generation.

or PEPSsM Units, Series B)- securities issued by PPL and PPL Capital PPL Montana - PPL Montana, LLC, an indirect subsidiary of PPL Generation, Funding, consisting of an undivided interest inadebt security issued by which generates electricity for wholesale sales inMontana and the Pacific PPL Capital Funding and guaranteed by PPL, and aforward contract to purchase Northwest PPL common stock.

PPL Services - PPL Services Corporation, asubsidiary of PPL, which provides PJM (PJM Interconnection, L.L.C.) - operates the electric transmission shared services for PPL and its subsidiaries.

network and electric energy market inthe mid-Atlantic region of the U.S.

PPL Susquehanna - PPL Susquehanna, LLC, the nuclear generating subsidiary PLR (Provider of Last Resort) - PPL Electric providing electricity to retail of PPL Generation.

customers within its delivery territory who have chosen not to shop for electricity under the Customer Choice Act.

PPL Telcom-PPLTelcom, LLC, an indirect subsidiary of PPL Energy Funding, VEBA - Voluntary Employee Benefit Association Trust, trust accounts for health which delivers high bandwidth telecommunication services inthe Northeast and welfare plans for future benefit payments for employees, retirees or their corridor from Washington, D.C., to New York City and to six metropolitan areas beneficiaries.

incentral and eastern Pennsylvania.

WPD - refers collectively to WPDH Limited and WPDL. PPL Global purchased PPL Transition Bond Company - PPL Transition Bond Company, LLC, a Mirant's 49% ownership interest inthese entities on September 6,2002, thereby wholly-owned subsidiary of PPL Electric that was formed to issue transition bonds achieving 100% ownership and operational control.

under the Customer Choice Act.

WPD LLP.- Western Power Distribution LLP, awholly-owned subsidiary of Preferred Securities - company-obligated mandatorily redeemable preferred WPDH Limited, which owns WPD (South West) and WPD (South Wales).

securities issued by PPL Capital Funding Trust 1,holding solely debentures of WPD (South Wales) -Western Power Distribution (South Wales) plc, aBritish PPL Capital Funding, and by SIUK Capital Trust 1,holding solely debentures regional electric utility company.

of WPD LLR WPD (South West) - Western Power Distribution (South West) pIc, aBritish PUC - Pennsylvania Public Utility Commission, the state agency that regulates regional electric utility company.

certain ratemaking, services, accounting and operations of Pennsylvania utilities.

WPDH Limited -Western Power Distribution Holdings Limited, an indirect, PUC Final Order - final order issued by the PUC on August 27, 1998, approving wholly-owned subsidiary of PPL Global. WPDH Limited owns WPD LLR the settlement of PPL Electric Utilities' restructuring proceeding.

WPDL - WPD Investment Holdings Limited, an indirect wholly-owned subsidiary PUHCA - Public Utility Holding Company Act of 1935, legislation passed by of PPL Global. WPDL owns 100% of the common shares of Hyder.

the U.S. Congress.

PURPA - Public Utility Regulatory Policies Act of 1978, legislation passed by the U.S. Congress to encourage energy conservation, efficient use of resources and equitable rates.

PURTA - the Pennsylvania Public Utility Realty Tax Act.

RMC - Risk Management Committee.

101 SCR -selective catalytic reduction, apollution control process. -u SEC - Securities and Exchange Commission, aU.S. government agency. 0 M0 SFAS - Statement of Financial Accounting Standards, the accounting and financial reporting rules issued by the FASB.

0 I

SIUK Capital Trust I - abusiness trust created to issue preferred securities, 0

whose common securities are held by WPD LLR I-M 0

M SIUK Limited - was an intermediate holding company within the WPDH Limited group. InJanuary 2003, SIUK Limited transferred its assets and liabilities to z0r I2 WPD LLR C SPE - special purpose entity. 2J 0

-D Superfund -federal environmental legislation that addresses remediation of contaminated sites; states also have similar statutes.

Synfuel projects - production facilities that manufacture synthetic fuel from coal or coal byproducts. Favorable federal tax credits are available on qualified synfuel products.

Tolling agreement -agreementwherebythe owner of an electric generating facility agrees to use that facility to convert fuel provided by athird party into electric energy for delivery back to the third party.

UF - inflation-indexed peso-denominated unit.

Board of Directors William F Hecht, Frederick M.Bernthal, E.Allen Deaver Stuart Heydt, W Keith Smith, Louise K. Goeser William F.Hecht Stuart Heydt Allentown, Pa. Hershey Pa.

Chairman, Presidentand Chief Executive Officer Former Chief Executive Officer PPL Corporation Geisinger Health System Age 61, Director since 1990 Anonprofit health care provider Age 64, Director since 1991 Mr. Hecht has served as PPLs top executive since 1993. Prior to that, he served as president and chief operating officer for two years. He also serves as a Dr. Heydt retired in2000 as chief executive officer of the Geisinger Health director of PPL Electric Utilities Corporation, DENTSPLY International Inc., the System, an institution that he directed for eight years. He is past president Federal Reserve Bank of Philadelphia and RenaissanceRe Holdings Ltd. Mr. Hecht, and a Distinguished Fellow of the American College of Physician Executives.

who earned bachelor's and master's degrees inelectrical engineering from Dr. Heydt attended Dartmouth College and received an M.D. from the Lehigh University, joined PPL in 1964. University of Nebraska.

102

-u Frederick M. Bernthal W. Keith Smith

-V Washington, D.C. Pittsburgh, Pa.

0 President Former Vice Chairman 0

'a Universities Research Association Mellon Financial Corporation 0 A consortium of 90 universities engaged inthe Major financial services company construction and operation of major research facilities Age 69, Director since 2000 Age 61, Director since 1997 0 Mr. Smith served as vice chairman of Mellon Financial Corporation and senior Dr. Bernthal has served as president of URA since 1994. Prior to joining that vice chairman of Mellon Bank, N.A., before his retirement in1998. He also is a 0

organization, he was deputy director of the National Science Foundation. He director of DENTSPLY International Inc., Allegheny General Hospital, Invesmart, zD z

also has served as a member of the U.S. Nuclear Regulatory Commission and Inc., Baytree Bancorp, Inc., Baytree National Bank and Trust Co. and several C as assistant secretary of state for Oceans, Environment and Science. Dr. Bernthal nonprofit boards. Mr. Smith earned a Bachelor of Commerce degree from the earned a Bachelor of Science degree inchemistry from Valparaiso University University of Saskatchewan and a Master of Business Administration degree

-uM and a Ph.D. innuclear chemistry from the University of California at Berkeley. from the University of Western Ontario and is a Chartered Accountant.

0

-4M E. Allen Deaver Louise K. Goeser Lancaster, Pa.

Dearborn,

Mich.

Former Executive Vice President and Director Vice President of Duality Armstrong World Industries, Inc. Ford Motor Company Manufacturer of interior furnishings and specialty products Manufacturer of cars, trucks and related parts and accessories Age 68, Director since 1991 Age 50, Director since 2003 Mr. Deaver retired from Armstrong in 1998, after a career of 37 years, spanning Ms. Goeser has been vice president of quality for Ford for four years after a number of key management positions. He earned a Bachelor of Science degree serving ina similar position at Whirlpool Corporation, where she also headed inmechanical engineering from the University of Tennessee. Whirlpool's refrigeration unit. Ms. Goeser started her career with Westinghouse Electric Corporation, where - over a 20-year period - she held a variety of key positions inthe Energy Systems and Environmental businesses. She earned a bachelor's degree inmathematics from Pennsylvania State University and a master's degree in business administration from the University of Pittsburgh.

I -IBoard Committees John R.Biggar, Susan M. Stalnecker, John W Conway John R. Biggar Executive Committee Allentown, Pa. William F Hecht, Chair Executive Vice President and Chief Financial Officer Frederick M.Bemlhal PPL Corporation E Allen Deaver Age 59, Director since 2001 Stuart Heydt Mr. Biggar has served as executive vice president and chief financial officer of Audit Committee PPL Corporation since 2001. He also serves as adirector of PPL Electric Utilities Stuart Heydt, Chair Corporation and as atrustee of Lycoming College. He began his career with Frederick M.Bernthal PPL in1969. Prior to being named to his current position, Mr. Biggar served as WKeith Smith senior vice president and chief financial officer as well as vice president - Finance.

Susan M.Stalnecker Mr. Biggar earned abachelors degree inpolitical science from Lycoming College and aJuris Doctor degree from Syracuse University.

Compensation and Corporate Governance -VU Susan M. Stalnecker Committee Wilmington, Del. E.Allen Deaver Chair C) 0 Vice President - Government and Consumer Markets John W Conway DuPont Safety& Protection 0 Stuart Heydt El. du Pont de Nemours and Company :0 Manufacturer ofpharmaceuticals, specialty chemicals, z Finance Committee biotechnology and high-performance materials W Keith Smith, Chair 0 Age 51, Director since 2001 John W Conway W

Ms. Stalnecker served as vice president - Finance and treasurer for five years E Allen Deaver zz before being named to her present position in 2003. She also serves on the Susan M. Stalnecker C board of Duke University and is president of the Board of Trustees of the Delaware Art Museum. Ms. Stalnecker earned a bachelors degree from Duke Nuclear Oversight Committee University and her M.B.A. from the Wharton School of Graduate Business Frederick M. Bernthal, Chair 0 at the University of Pennsylvania. E.Allen Deaver Louise K Goeser John W. Conway Stuart Heydt Philadelphia, Pa.

Chairman of the Board, President and Chief Executive Officer Crown Holdings, Inc.

A leading international manufacturer of packaging products for consumer goods Age 58, Director since 2000 Mr. Conway has served as Crown's top executive since 2001. Prior to that, he had been president and chief operating officer of the company. Mr. Conway joined Crown, Cork &Seal in1991 as aresult of its acquisition of Continental Can Intemational Corporation, where he served as president and invarious management positions. He earned aBachelor of Arts degree ineconomics from the University of Virginia and alaw degree from Columbia Law School.

Management and Officers CORPORATE LEADERSHIP MAJOR BUSINESS LINE OFFICERS COUNCIL EXECUTIVE PRESIDENTS COMMITTEE William F.Hecht Paul T.Champagne James E.Abel Rick L.Klingensmith Chairman, President and CEO PPL EnergyPlus VP- Finance and Treasurer VP - Finance PPL Corporation PPL Corporation PPL Global James H.Miller John R. Biggar PPL Generation Richard L. Anderson Michael E. Kroboth VP - Nuclear Operations VP- Energy Services Executive VP and CFO Roger L. Petersen PPL Susquehanna PPL Corporation PPL EnergyPlus PPL Global Robert W.Burke Jr. Dennis J. Murphy Lawrence E. De Simone John F.Sipics VP and Chief Counsel VP and COO - Eastern Fossil and Hydro Executive VP PPL Electric Utilities PPL Global PPL Generation PPL Corporation John F.Cotter Joanne H. Raphael James H.Miller VP-Energy Marketing VP -External Affairs Executive VP PPL EnergyPlus PPL Services PPL Corporation Paul A. Farr Ronald Schwarz Senior VP VP - Human Resources Robert J. Grey PPL Global PPL Services Senior VP, General Counsel and Secretary Robert M. Geneczko James M. Seif PPL Corporation VP - Customer Services VP- Corporate Relations PPL Electric Utilities PPL Services 104 President Bryce L.Shriver PPL Gas Utilities Senior VP and Chief Nuclear Officer

-o_0 Robert S. Gombos PPL Susquehanna 0'O VP -Field Services Vijay Singh 0

> PPL Electric Utilities VP-Risk Management 0*0 M

Michael D. Hill PPL Services "I

VP-Corporate Information Offti icer Bradley E.Spencer ao PPL Services VP and COO-Western Fossil and Hydro W

C George T.Jones PPL Generation Z

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CONTENTS.

4 &5 About Continental Cooperative Services 6 &7 A Message From the Executive Committee and President &CEO 8-13 Year in Review 14 Continental Cooperative Services Fact Sheet 15 Continental Cooperative Services Board of Directors 16 &17 Soyland Power Cooperative, Inc. Board of Directors 18 Allegheny Electric Cooperative, Inc.

Board of Directors 19 Financial Section Table of Contents

• 20-47 2003 Allegheny Electric Cooperative, Inc.

• Financial Review 48-66 2003 Soyland Power Cooperative, Inc.

Financial Review I

About Continental Cooperative Services At t Continental Cooperative Services (CCS), the deliv-ery of reliable, affordable and competitive power is mission one. A dedicated and experienced team of board members, manage-ment and employees make certain that wholesale electricity is pro-vided round-the-clock to 25 affili-ated electric distribution coopera-tives in Illinois, New Jersey and Pennsylvania. CCS-affiliated cooperatives, in turn, provide electric generation to nearly one million ultimate consumers.

CCS, based in Harrisburg, Pa., was created in March 2000, the result of a strategic alliance between Allegheny Electric Cooperative, Inc. (CCS/

Allegheny), the wholesale power supplier to electric cooperatives in Pennsylvania and New Jersey, and Illinois' Soyland Power Cooperative, Inc. (CCS/Soyland).

CCS marks the first time two geo-graphically non-contiguous genera-tion and transmission cooperatives have joined forces in this fashion.

Cooperative electric systems comprising the CCS network are a Soyland Power critical part of local rural infrastruc-ture, powering more than 300,000 Cooperative, nc.

homes, farms, businesses and industries. In Illinois, the 11 elec-

1. Adams Electric Cooperative 7. Menard Electric Cooperative ' I tric distribution cooperatives affili-

2. Coles-Moultrie Electric Cooperative 8. Rural Electric Convenience II ated with CCS serve nearly one-

3. Eastern Illini Electric Cooperative Cooperative Company third of the state's land area across

4. Farmers Mutual Electric Cooperative 9. Shelby Electric Cooperative 44 counties. The 13 CCS-affiliated cooperatives in Pennsylvania own 5. Illinois Rural Electric Cooperative 10. Spoon River Electric Cooperative, Inc.

approximately 12 percent of the 6. McDonough Power Cooperative 11. Western Illinois Electrical Cooperative (continues on next page)

1. cO  %.

Coopratve,~'o~peat~e, nc.IL lectic oopratveInc.

ative Inc Coope ln~,14. arren Elec ric Coo Inc.

perative (continuedfrom previous page) state's electric distribution lines, spanning one-third of the Commonwealth in 41 counties. New Jersey's lone elec-tric cooperative maintains roughly 1 percent of the Garden State's total miles of line.

A Message; I From the -:

Executive Committee R-and President

& CEO Fnor the past few years, much light has been shed on the scandalous' behavior of some top companies.' Starting with ener-gy giant Enron, a domino effect of unethical business practices, dubi-ous financial reporting and just plain bad judgment has toppled Arthur Andersen, WorldCom and other big names in American corporate life.

As a result, the public has been left wondering about the market's ability to police itself, a loss of con-fidence that will haunt our nation for many years.

In all of this, electric utilities perhaps have suffered the most.

Headlines focused on the collapse:

of Enron soon wvere replaced with difficulties experienced by other merchant energy companies, crimi-nal indictments of utility officials,.

charges of fraud and evidence of complex schemes to manipulate markets and increase profits at the expense of consumers.

The bad apples that produced the first business scandals of this new century also generated a strong congressional response. The federal Sarbanes-Oxley Act, signed into law in 2002, provides that all publicly traded companies must abide by detailed financial and cor-porate governance requirements or risk stiff penalties.

The Sarbanes-Oxley Act

basically says "Beware of the CEO, comes to understanding the elec- disgraced industry, electric make sure he or she appoints good tric utility industry andlacual cooperatives are uniquely people to boards of directors,'not workings of their cooperative. In positioned. The very concepts just cronies." But the not-for-profit addition, cooperative boards of upon which cooperatives were cooperative business model is dif- directi5ors, and particularly board founded -,quality service, ferent - electric cooperative direc- audit committees, must focus consumer representation and tors' are elected by fellow members, increased attention onimonitoring community involvement - con-not appointed by a CEO. As a the financial health .and business tinue to shine as a beacon to all.

result, the board-management rela- practices of their organizations. In today's troubled utility tionship - so often criticized in' While electric cooperatives can environment, CCS - embodying investor-owvned companies -tends take pride that our image remains the basic electric cooperative oper-to work effectively in cooperative unsullied even though many other ating principle of cooperation environments. utilities and companies undergo a among cooperatives -- stands ready While electric cooperatives gut-wrenching shakedown, CCS to light the wvay to a successful' were not part of the problem that is using this opportunity to study future while furthering our cooper-led to passage of the Sarbanes- whether our governance practices ative values. We look forward to Oxley Act, it is safe to 'say that the are all that they can be. We are the challenge of wvorking for the law has raised the bar for all busi- running through' a checklist to benefit of our affiliated member nesses operating in the U.S. today- ensure that all of our policies and electric distribution cooperatives For electric cooperatives, it means procedures are consistent with the and their consumers.

that boards of directors are held Sarbanes-Oxley Act.

to a higher standard when it Virtually alone within a The CCS Executive Committee, from left to right, seated:James Coleman, secretary; Alston Teeter, vice chairman;and David White, chairman. Standing, left to right: Bradley Ludwvig, at-large member; Lowell Friedline, at-large member; Kathryn Cooper-Winters, treasurer;and Frank Betley, president &' CEO.:

I 1

i i

2 41

CCS's diversified generation periods of peak electric use. Since Year' portfolio played a key 'role in help-ing the organization negotiate air permits for the facility limit emissions to no more than 250 in attractive wholesale power supply contracts with AmerenEnergy tons of nitrogen oxide annually, operation is capped at 937 hours0.0108 days <br />0.26 hours <br />0.00155 weeks <br />3.565285e-4 months <br /> Review Marketing and Williams Power Company. Here is a look at CCS's per year.

Pearl Station: A 22-megawatt, power plant portfolio: : coal-fired baseload power plant C Power Supply CS continued to enjoy the benefits of advantageous Alsey Generating Station:

Owned by CCS/Soyland and oper-ated by CCS staff, the Alsey located in Pike County, Ill., along the Illinois River near the town of Pearl, Pearl Station - owned by power supply contracts that Generating Station is a five-unit, CCS/Soyland and operated by were inked in 2002 with natural gas-fired peaking complex CCS staff- first event on-line in AmerenEnergy Marketing for the located in Scott County, Ill., near 1968. In fiscal 2003, Pearl pro-Illinois area and Williams Powver the village of Alsey. The facility- *ducednearly 167 million kilowatt-:

Company for the Pennsylvania/ entered service in July 1999 and hours of electricity.'

New Jersey region. Both arrange- has a nameplate rating of 125 Other Illinois Peaking Plants:

ments continue until the end of megawatts.'(The units can also During times of peak electricity 2008, a move that brings all of the operate on fuel oil, if necessary.) -demand and system emergencies, organization's supplemental power Alsey Station operates in con- (continues on next page) contracts into synch and secures a junction with 0-~="-

reasonable rate for'power over a rel- a private atively long period. power com-pany when it Generation is more cost-A diverse mix of self-owned effective to E generation coupled with demand- run the com-side management capabilities pro- bustion tur-vide the cornerstone for CCS to bines than fulfill its core mission - achieving purchase stable and affordable'wholesale power from powver rates for affiliated electric dis- other tribution cooperatives in Illinois, providers. It New Jersey and Pennsylvania. is designed to "Fuel diversity" affords CCS run during ng_

better balance and increased leverage in a competitive energy.

market easily shaped by national and global events. Crude oil prices, natural gas supplies, drought, even mar ket jitters over regional power crises all affect how electricity markets -

operafe and signifi-candy impact power prices.

I- -,-i,

. .V t -

- . . _ 6 . . .

(continuedfrom previouspage) III. Typically, both facilities run less Lawrence rivers in upstate New than 200 hours0.00231 days <br />0.0556 hours <br />3.306878e-4 weeks <br />7.61e-5 months <br /> per year. York. Both are operated by the r

9 CCS/Soyland can call on a 20- New York Power Authority: New York Power Authority megawatt oil-fired combustion tur- Since 1966, CCS/Allegheny has (NYPA).

bine based at Pearl Station and purchased power generated by In 2003, Pennsylvania nine megawatts of diesel units federal hydroelectric projects received an allocation of 47.9 located at Pittsfield in Pike County, located along the Niagara and St. megawatts (MW) from the 1,880-ill'-'

I:

Hisr dir naQs I'AfF

Fl Raystown Corps controls water releases from Raystown Lake, the largest man-H-ydroelectric made body of water in Project, Pennsylvania.,

2 § B William F. Susquehanna Steam Electric Station: CCS/Allegheny owns 10 S W ~Matson -

percent of the Susquehanna Steam Generating Electric Station (SSES), a 2,250-Station. megawatt, two-unit nuclear power plant located in Luzerne County, Pa. PPL Susquehanna, a division of

~asown Allentown, Pa.-based PPL Hydroelectric Corporation, owns the remaining Project, William F. 90 percent and operates the boiling Matson water reactor facility. -

Generating In 2003, this 10 percent share EEStation of SSES provided 1.8 billion kilo-(Raystown) is a watt-hours of electricity at delivery two-unit, 21- to Pennsylvania and New Jersey megawatt, run-of- electric cooperatives. The capacity river hydropower factor of SSES Unit 1 was 95.2 MW Niagara Power Project and facility located at Raystown Lake percent; Unit 2 was 84.4 percent.

20.3 MW from the 912-MW St. and Dam in Huntingdon County, This works out to an average annu- -

Lawvrence Powver Project. Out of Pa. Buoyed by abundant rainfall al composite capacity factor for the this, CCS/Allegheny and its across the Mid-Atlantic region, facility of 89.8 percent.

member electric cooperatives in the Raystown in 2003 provided-110 Both Unit I and Unit 2 run on Commonwealth received nearly 42 million kilowatt-hours at delivery a 24-month refueling cycle.

MW (41 MW from Niagara and 1' - its second highest production Load Management: In 1986, MW from St; Lawrence). An addi- level ever - exceeding projections CCS/Allegheny, along with CCS tional 2 MW from the projects is by more than 29 percent. affiliated distribution cooperatives allocated to Sussex REC, a CCS CCS staff operates the hydro in Pennsylvania and New Jersey, affiliated electric distribution coop- project in close cooperation with launched the Coordinated Load erative in New Jersey. the Baltimore District of the U.S. Management System (CLMS) to CCS/Allegheny handles all Army Corps of Engineers. The (continues on next page) contracts, billing and transmission arrangements for Pennsylvania utili-ties that receive NYPA power in itsr role as state NYPA Bargaining Agent. During 2003, CCS/Allegheny and representatives from'six other states reached agree-ments with NYPA to extend their existing contracts for electricity pro-duced at the Niagara Power Project through August 2007. Reallocation of NYPA power among the states will reduce the amounts received by CCS/Allegheny and its member cooperatives during 2004.

Raystown Hydroelectric I Project: CCS/Allegheny's Susquehanna Steam Electric Station.

-I

Niagara As part of an in-depth evaluation,

-CSdirectors reviewed the history Power of each organization, focusing on Project oper- equity positions, recent account-Do1 t atcd!by the ing rule changes affecting the:

decommissioning of generating Newv York stations, retirement of capital.'

X l FZ~,:Powver credits, CCS's competitive posi-Authority. tion compared to other utilities in Illinois, New Jersey and Pennsylvania, working capital facilities and needs and future financing generating plant sources.

performance. Following this study, the board Through directed that various financial plan-SCADA, real-. ning options be developed that (continuedfron previous page) time decisions about generation or would allow the member organiza-purchased power requirements and tions to continue to improve equity reduce demand peaks at coopera- consumer load reductions can be but still maintain competitive rates.

tive substations. made based on forecasts, schedules Underlying the forecasts were some By shifting electricity use of and actual system performance. basic assumptions, namely that residential water heaters, electric'- This 'decision-making capability is CCS/Allegheny and CCS/Soyland thermal storage units, dual fuel key in today's market-based electric will enter into new power supply home heating systems and other utility industry. contracts with wholesale suppliers special appliances from peak use As part of energy supply agree- after existing agreements expire at periods to times of lesser demand, ments with local private poweer the end of 2008, own additional CLMS improves system efficiency, companies, remote terminal units generation, or both.

cuts costly demand charges cooper- installed on the cooperative's inter- Based upon a CCS board rec-atives must pay for purchased connection points are connected ommendation, CCS/Allegheny power and reduces the need for through the SCADA system, allow- and CCS/Soyland approved indi-new generating capacity. CLMS is ing CCS/Soyland to furnish real- vidual long-range financial plans also used during summer peaks to time load signals from one control and their various components in reduce CCS capacity obligations area to another. This helps CCS May.

under procedures established by the minimize PJM Interconnection. energy imbal-In 2003, CLMS reduced coop- ance costs erative purchased power costs by': incurred undei

$2.4 million, bringing total net transmission power cost savings achieved since tariffs.

December 1986 to more than $68 million. Currently, 183 substations Financing -

are being utilized for load control CCS and more than 45,000 load control entered 2003 receivers have been installed on taking a hard appliances, mostly water heaters, in look at the the homes of volunteer cooperative ,financial post-consumers. tion of its CCS/Soyland employs a members System Control and Data CCS/,

Acquisition (SCADA) system to Allegheny and' monitor load levels, transmission CCS/Soyland. CoordinatedLoad Management System.

if Continental Cooperative McDonough Power Cooperative, Macomb, Ill.

Services Fact Sheet :-: Menard Electric Cooperative, Petersburg, Ill.

Incorporated: March 2000

• 154 MW of oil- and gas-fired 'Rural Electric Convenience peaking units Cooperative Company, Members: Allegheny Electric - 125-MW Alsey Generating Auburn, Ill.

Cooperative,' Inc. and Soyland -Station, a; gas-fired peaking Shelby Electric Cooperative, Pover Cooperative, Inc. facility in Scott County, -Shelbyville, Ill.

Alsey, Ill. Spoon River Electric States Served: Illinois, New MW oil-fired peaker at Cooperative, Inc., Canton, Ill.

Jersey and Pennsylvania Pearl, Ill. Western Illinois Electrical MW diesel peaker at Cooperative, Carthage, Ill.

Total Meters Served By Affiliated Pittsfield, Ill.

Electric Distribution Cooperatives: New Jersey:

Nearly 300,000, representing 670 miles of transmission lines approximately one million elec-

• 588 miles of transmission Sussex Rural Electric tric cooperative consumers lnes in Illinois Cooperative, Inc., Sussex, N.J.

• 42 miles of high-voltage Governance: 25-member board transmission lines in Pennsylvania:

of directors (one director rep- Pennsylvania resenting each affiliated electric

• 40 miles of other transmis- Adams Electric Cooperative, distribution cooperative) sion lines in Pennsylvania Inc., Gettysburg, Pa.

operated at various voltages Bedford Rural Electric NERC Operating Regions: in conjunction with member Cooperative, Inc., Bedford, Pa.

• Mid-Atlantic Area Council cooperatives Central Electric Cooperative, (MAAC) Inc., Parker, Pa.

• Mid-America Interconnected Other facilities Claverack Rural Electric Network (MAIN)

• 134 powver delivery points in Cooperative, Inc., Wysox, Pa.

a East Central Area Reliability Illinois'- New Enterprise Rural Electric Coordination Agreement

• 200 powver delivery points in Cooperative, Inc., Newv (ECAR) Pennsylvania, one in New Enterprise, Pa.

Jersey Northwestern Rural Electric Total 2003 System Peak Load:

• Load management system Cooperative Association, Inc.,

960 megaNvatts with maximum peak Cambridge Springs, Pa.

reduction capabilities of REA Energy Cooperative, Inc.,

Generation and 90 MW Indiana, Pa.

Transmission Facilities Somerset Rural Electric Affiliated Electric -Cooperative, Inc.,

423 megawatts (MW) of generation Distribution Cooperatives Somerset, Pa.

• 269 MW of nuclear, coal and :P Sullivan County Rural Electric hydro baseload generation Illinois: Cooperative, Inc.,

- 226 MW nuclear baseload Forksville, Pa.

(Susquehanna Steam Adams Electric Cooperative, Tri-County Rural Electric Electric Station, Luzerne Camp Point, Ill. Cooperative, Inc.,

County, Berwick, Pa.) , Coles-Moultrie Electric Mansfield, Pa.

- 22 MW coal-fired baseload Cooperative, Mattoon, Ill. United Electric Coopera tive, (Pearl Station, Pike County, Eastern Illini Electric Inc., DuBois, Pa.

Pearl, Ill.) Cooperative, Paxton, Ill. Valley Rural Electric

- 21 MW hydro baseload Farmers Mutual Electric Cooperative, Inc.,

(Raystowvn Hydroelectric Company, Geneseo, Ill. Huntingdon, Pa.

Project at Raystoxvn Lake, Illinois Rural Electric Warren Electric Cooperative, Huntingdon County, Pa.) Cooperative, Winchester, Ill. Inc., Youngsville, Pa.

r

Michael Carls Menard Electric Cooperative Petersburg, Ill.'

Robert Guyer New Enterprise Rural Electric Cooperative, Inc.

-CCS Board of Directors New Enterprise, Pa.

David White David Cowan Wayne Stiles Chairman Adams Electric Cooperative, Inc. REA Energy Cooperative, Inc.

Rural Electric Convenience Gettysburg, Pa. Indiana, Pa.

Cooperative Company Auburn, Ill. C.Robert Koontz Jack Clark Bedford Rural Electric Spoon River Electric Alston Teeter Cooperative, Inc. Cooperative, Inc.

Vice Chairman Bedford, Pa. Canton, Ill.'

Tri-County Rural Electric Cooperative, Inc. Richard Weaver Curtin Rakestraw 11 Mansfield, Pa. Central Electric Sullivan County Rural Electric Cooperative, Inc. Cooperative, Inc.

James Coleman Parker, Pa. Forksville, Pa.

Secretary Shelby Electric Cooperative John McNamara Thomas Webb Shelbyville, Ill. Claverack Rural Electric Sussex Rural Electric.

Cooperative, Inc. Cooperative, Inc.

Kathryn Cooper-Winters Wysox, Pa. Sussex, N.J.

Treasurer Northwestern Rural Electric Scott Uphoff Stephen Marshall Cooperative Association, Inc. Coles-Moultrie Electric United Electric Cambridge Springs, Pa. Cooperative Cooperative, Inc.

Mattoon, Ill. DuBois, Pa.

Bradley Ludwig At-Large Murray Madsen Robert Holmes Eastern Illini Electric Cooperative Farmers Mutual Electric Valley Rural Electric Paxton, Ill. Company Cooperative, Inc.

Geneseo, Ill. Huntingdon, Pa.

Lowell Friedline At-Large Merton Pond Dave Turner Somerset Rural Electric Illinois Rural Electric Warren Electric Cooperative, Inc. Cooperative Cooperative, Inc.

Somerset, Pa. Winchester, Ill. Youngsville, Pa.

Robert Willis William Pollock Haven Vaughn Adams Electric Cooperative McDonough Power Western Illinois Electrical Camp Point, Ill. Cooperative Cooperative Macomb, Ill. Carthage, Ill.

Each affiliated electric distribution cooperative has one seat on the CCS Board of Directors.

I

Soyland Board

• of Directors7 Lynn Frasco, PE. Robert Willis* Douglas Aeilts, PE. David White*

Chairman Vice Chairman Secretary-Treasurer Assistant Manager Director Manager Secretary-Treasurer Director Bradley Ludwig* Murray Madsen* Jack Clark* M. L. (Chris) Christman At-Large At-Large At-Large Manager Director Director Director Scott Uphoff Wm. David Champion Ir. Robert Delp Bruce Giffin Director Manager Manager Manager

Soyland Board of Directors-Merton Pond*  ;  :

-on Miles William Pollock* :: : Michael Carls*

Director Manager Director Director David Stuva James Coleman* Richard Boggs W.Edward Cox-Manager Manager Director Manager Paul Dion Haven Vaughn*

Manager Director

• Denotes CCS director.

I-Allegheny Board of Directors Alston Teeter  : Lowell Friedline i Kathryn Cooper- Robert Holmes Chairman . Vice Chairman Winters Treasurer Director Director Secretary Director Director

David Cowan C.- Robert Koontz Richard Weaver John McNamara Robert Guyer

- Director Director Director Director Director Wayne Stiles Curtin Rakestraw 11 Thomas Webb Stephen Marshall Dave Turner Director Director Director Director Director All Allegheny Electric Cooperative, Inc. directors also serve as CCS directors.

I

( Financial Contents 20.47 2003 Allegheny Electric Cooperative, Inc.

Financial Review 48-66 2003 Soyland Power Cooperative, Inc.

Financial Review

Allegheny Electric Cooperative, Inc.

Accountants' Report and Financial Statements December 31, 2003 and 2002

-TABLE OF CONTENTS 21 INDEPENDENT ACCOUNTANTS' REPORT FINANCIAL STATEMENTS 22 &23 Balance Sheets 24 'Statements of Income 26 Statements of Member Equities (Deficits) 28 Statements of Cash FloWs 29-47 Notes to Financial Statements I

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-ad 225 North Water Street, Suite 400 P.O. Box 1580 Decatur, IL62525-1580 217429-2411 Fax217429-109 IIP bkd.com Independent Accountants' Report Board of Directors Allegheny Electric Cooperative, Inc.

Harrisburg, Pennsylvania We have audited the accompanying balance sheets of Allegheny Electric Cooperative, Inc.

(Cooperative) as of December 31, 2003 and 2002, and the related statements of 'income, members' equities (deficits), and cash flows for the years then ended. These financial statements are the responsibility of the Cooperative's management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable' assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Allegheny Electric Cooperative, Inc. as of December 31, 2003 and 2002, and the results of its operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.

As discussed in Note 8 to the financial statements, the Cooperative changed its method of accounting for its asset retirement obligation to comply with Financial Accounting Standard 143 (FAS 143)..

February 27, 2004 Solutions far Success I

'Anmefberof Mindin Rows

' kiterrab.a -

Allegheny Electric Cooperative, Inc.

Balance Sheets December 31, 2003 and 2002 (In Thousands)

Assets 2003 2002 Electric Utility Plant, at cost In service (see Note 2) $ 778,438 $ 737,288 Less accumulated depreciation (677.589) (663,938) 100,849 73,350 Construction work in progress t 7,692 II 9,958 Nuclear fuel in process (see Note 1 and 3) 14.918 14,175 Net electric utility plant (see Note 1, 2 and 3) 123.459 - 97,483 Investments and Other Assets Investments in associated organizations (see Note 4) 841 972 Other investments (see Note 1 and 6) 44,065 39,385 Notes receivable, members, less current portion (see Note 5) 88  ; 106 Non-utility property, at cost (net of accumulated depreciation of

$4,422 in 2003 and $4,149 in 2002) 4,332 4,267 Other non-current assets 158 - 191 49.484 44,921 Current Assets Cash and cash equivalents - 17,889 16,991 Accounts receivable, members (see Note 1) 13,439 14,336 Other receivables 358 1,035 Inventories (see Note 1) 5,865 4,861 Other current assets 2,594 3,282 If11 Total current assets 40.145 40,505 I Restricted Investments (see Note 1) 15.777 15,315 Deferred Charges (see Note 1 and 7)

Capital retirement asset 135,422 167,289 Other 1.290 1,746 136,712 169.035

!I I;

See Notes to FinancialStatements.

Members' Equities (Deficits) and Liabilities 2003 .2002 Members' Equities (see Note 1)

Membership fees $' 3. $ 3 Patronage capital 34,122 34,122 Donated capital 38 38 Retained earnings (deficit) (67.788) (26,967)

Members' equities (deficits) (33,625) 7,196 Accumulated other comprehensive income 2.405 1,549 -

Total equities (deficits) (31.220) 8.745  :

Asset Retirement Obligation (see Note 8) 108.178 Long-Term Debt (see Note 9) 232,083 261.377 Current Liabilities Current installments of long-term debt 30,214 33,246 Accounts payable and accrued expenses 21,097 22,220 Accounts payable to affiliated organizations 310 60 Total current liabilities 51,621 55.526 Other Liabilities and Deferred Revenue Accrued nuclear decommissioning (See Note 8) 36,001 Accrued decontamination and decommissioning of nuclear fuel 617 925 Deferred income tax obligation from safe harbor lease (see Note

13) 2,748 3,073 Other deferred revenue (see Note 14) 1,550 1,612 4,915 41.611

$ 365,577 $I 367,25

'I I

Allegheny Electric Cooperative, Inc.

Statements of Income Years Ended December 31, 2003 and 2002 (In Thousands) 2 2003  :~200 A Operating Revenues , $ 154.786 S 155.286 Operating Expenses Operations Purchased capacity and energy costs 47,300 52,388 Transmission Operation 20,785.  : 18,524 Maintenance 196 136 Production Operation 16,693 22,615 Maintenance 8,576 7,959.

Fuel 7,021 7.762 100,571 109,384

Depreciation . - 4,695 3,644 Accretion 4,161 Amortization of capital retirement asset 31,867  : 33,979 Administrative and general 5,033 4,853 Property and other taxes - . 442 :706 146.769 152.566 Operating Margin Before Interest and Other Expenses 8,017 2,720 Other Expenses Interest expense 924 , 951 Other deductions, net 1.202 - 1.056 2.126 2.007 Operating Margin 5,891 713 Non-Operating Margins Net non-operating rental income 1,220 1,199 Interest income 2,436 797 Other income 768 365 Net income before cumulative effect of adoption of FAS 143 10,315 3,074 Cumulative Effect of Adoption of FAS 143 (see Note 8) (51.136)

Net Income (Loss). (40,821) 3,074 Other Comprehensive Income Unrealized appreciation (depreciation) in investments 856 (560)

Comprehensive Income (Loss) $ (39,965) $ 2 k -

See Notes to FinancialStatements.

I __ __

Allegheny Electric Cooperative, Inc.

Statements of Members'. Equities (Deficits)-

Years Ended December 31, 2003'and 2002 (In Thousands)

Membership,; m Donat ted I Patronage XFees  ; - Capit al  : Capital Balance, January 1, 2002: - II$ 3 $ - 38 S 34,122 Comprehensive income Net income Change in unrealized appreciation on investments Balance, December 31, 2002' 3 38 34,122 Comprehensive income Net loss Change in unrealized appreciation on investments ll! ; : 0 Balance, December 31, 2003 $----------------- 1 $ 38. $ -34122 F - -- =  :

' 0 0E

'.  :: ' 0

' . .  : S ' -

4 F

i 7. . f

7f X  :

.  : f  :

L? .,

a R

- 0: 0 X

S I X

. i-  :

f Q

F ::

L F See Notes to FinancialStatements.

[':  :

Total I Accumulated Members' I :Other Other Equities Equities ' Comprehensive Total Equities (Deficits) (Deficits)  ::L:Income (Deficits)

$  : (30,041) $ 4,122 $ 2,109 $ 6,231 3,074 3,074 3,074

-- -. (560) (560)

(26,967) 7,196 ' 1,549 8,745 (40,821) (40,821) . (40,821)

- _ . : 856 856

$ (33,62 $ - 2,405 $ (31,220)

I I

Allegheny Electric Cooperative,-Inc.

Statements of Cash Flows Years Ended December 31, 2003 and 2002 (In Thousands) 2003 2002_

Operating Activities Net margin (loss) (40,821) $ 3,074 Items not requiring (providing) cash Depreciation and fuel amortization 9,604 9,587 Amortization of deferred charges and deferred revenue 31,867 33,979 Accretion of asset retirement obligation 4,161 Cumulative effect of adoption of FAS 143 51,136 Change in Accounts receivable, members 897 (1,197)

Other receivables, 677

• 453 Inventories (1,004) (655)

Other current and non-current assets 848 *(873)

Accounts payable and accrued expenses (1,123) 8,735 Accounts payable to affiliated organizations 250 (381)

Other liabilities and deferred credits (36,240) 3,226 Asset retirement obligation 36.001  : _

Net cash provided by operating activities 56,253 55.948 Investing Activities Additions to electric utility plant and non-utility property, net (18,765) (16,582)

Payments received on notes receivable, members 22 12 Purchase of restricted investments (462)

Purchase of other investments (3,824) (2,860)

Proceeds from sale of restricted investments 2.946 Net cash used in investing activities (23.029) (16,484)

Financing Activity - Principal payments on long-term debt (32.326) (33,895)

Net Increase in Cash and Cash Equivalents 898 5,569 Cash and Cash Equivalents, Beginning of Year 16.991 11.422 Cash and Cash Equivalents, End of Year Supplemental Cash Flows Information Interest paid $ 940 $ 834 Income tax paid 250 See Notes to FinancialStatements.

r

Allegheny Electric Cooperative, Inc.

Notes to Financial Statements December 31,2003 and 2002 Note 1: Nature of Operations and Summary of Significant Accounting Policies Nature of Operations Allegheny Electric Cooperative, Inc. (Cooperative) is a rural electric cooperative corporation established under the laws of the Commonwealth of Pennsylvania. Financing assistance has been provided by the U.S. Department of Agriculture, Rural Utilities Service (RUS) formerly known as the Rural Electrification Administration (REA) and, therefore, the Cooperative is subject to certain rules and regulations promulgated for rural electric borrowers by RUS. The Cooperative is a.

generation and transmission cooperative, providing power supply to 14 members who are rural electric distribution cooperatives providing electric power to members in certain areas of Pennsylvania and New Jersey. The Cooperative extends unsecured credit to its members. The Cooperative's primary operating asset is its 10% undivided interest in the Susquehanna Steam Electric Station (SSES), a 2,250 megawatt, two-unit nuclear power plant, co-owned by a subsidiary of PPL Corporation (PPL).

The Board of Directors of the Cooperative, appointed by its members, has full authority to establish electric rates subject to approval by RUS. Rates are established on a cost of service basis.

Basis of Accounting The Cooperative maintains its accounting records in accordance with the Federal Energy Regulatory Commission's (FERC) uniform system of accounts as modified and adopted by RUS.

In accordance with FERC guidelines, the Cooperative also maintains its accounts in accordance with Statement of Financial Accounting Standards No. 71, Accountingfor the Effects ofCertain Types of Regulations.

Deregulation On December 3, 1996, House Bill No. 1509, Pennsylvania's "Electricity Generation Customer Choice and Competition Act" was signed by the Governor of Pennsylvania, with an effective date of January 1, 1998, as Act No. 138 of 1996. This Act enabled retail electric customers, including consumer members of Pennsylvania's 13 rural electric cooperatives, to choose the power supplier, or generator, from which they buy electricity. The Cooperative's management believes the Act will not significantly affect its operations or ability to recover its costs through future rates charged to members.

I

Allegheny Electric Cooperative, Inc.-

Notes to Financial Statements December 31, 2003 and 2002:

The Financial Accounting Standards Board (FASB) Emerging Issues Task Force (EITF) has issued EITF Issue No. 97-4, Deregulation of the Pricing of Electricity- Issues Related to the Application of FASB Statement No. 71, Accounting for the Effects of Certain Types of Regulation, and No.

101, Regulated Enterprises - Accounting for the Discontinuation of Application of FASB Statement No. 71. EITF No. 97-4 provides guidance for determining when an entity should cease

• applying SFAS No. 71 and to what extent stranded costs and regulatory assets and liabilities should continue to be recognized; The Cooperative reviewed the provisions set forth in EITF No. 97-4 and determined that regulatory assets and liabilities should continue to be accounted for under the

• provisions of SFAS No._71 because management believes that it is reasonable to assume that the Cooperative will continue to be able to charge and collect its cost of service-based rates.

Use of Estimates, The preparation of financial statements in conformity with accounting principles generally

= accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and lliabilities at the date of financial report and the reported amounts of revenues and expenses during the years then ended. Actual results could differ from those estimates.

Electric UtilityPlant Electric utility plant is carried at cost. Depreciation of electric utility plant is provided over the estimated useful lives of the respective assets on the straight-line basis, except for nuclear fuel, as follows:

Nuclear Utility Plant Production 39 years Transmission 2.75% i General plant 3%- 12.5%

Nuclear fuel Heat production Non-Nuclear Utility Plant 3% - 33%

Maintenance and repairs of property and replacements and renewals of items determined to be less than units of property are charged to expense. Replacements and renewals of items considered to be units of property are charged to the property accounts. At the time properties are disposed of, the original cost, plus cost of removal less salvage of such property, is charged to accumulated depreciation.

I

Allegheny Electric Cooperative, Inc.

Notes to Financial Statements December 31, 2003 and 2002 Nuclear Fuel Nuclear fuel is charged to fuel expense based on the quantity of heat produced for electric generation. Under the Nuclear Waste Policy Act of 1982, the U.S. Department of Energy (DOE) is responsible for the permanent storage and disposal of spent nuclear fuel removed from nuclear reactors. The Cooperative currently pays to PPL its portion of DOE fees for such future disposal services.

Other Investments Debt and equity securities for which the Cooperative has no immediate plan to sell but that may be sold in the future are classified as available for sale and carried at fair value.

Realized gains and losses, based on the specifically identified cost of the security, are included in net income.

Cash Equivalents Cash and cash equivalents consist of bank deposits in federally insured accounts and temporary investments. For purposes of the statements of cash flows, the Cooperative considers all highly liquid investments with an original maturity of three months or less when purchased to be cash equivalents. Cash equivalents are carried at cost.

The Cooperative's cash and investments are in a variety of financial instruments. The related values as presented in the financial statements are subject to various market fluctuations, which include changes in the equity markets, interest rate environment and the general economic conditions. The Cooperative's credit losses have historically been minimal and within management's expectations.

Accounts Receivable and Notes Receivable Accounts receivable are stated at the amount billed to members. Accounts receivable are due in accordance with approved policies. An allowance for doubtful accounts has not been recorded as all accounts receivable are considered fully collectible.

Notes receivable are stated at their outstanding principal amount. An allowance for uncollectible notes has not been recorded, because all notes receivable are considered fully collectible.

I II

Allegheny Electric Cooperative,: Inc.

Notes to Financial Statements December 31, 2003 and 2002 Inventories -

The Cooperative accounts for certain power plant spare parts using a deferred inventory mnethod.

Under this method, purchases of spare parts under inventory control are included inman inventory' account and then'charged to the appropriate capital or expense accounts when the parts are used or consumed. Inventories are carried at cost, cost being determined on the average cost method.

Restricted Investments The Cooperative was required by RUS to establish a trust account for the proceeds from the settlement of litigation with a former power supply provider. RUS is a named beneficiary'of the trust fund and RUS requires that the Cooperative seek prior approval to utilize any of the amounts from this account. Such uses to date have consisted of providing collateral for financial obligations and for capital expenditures. Restricted investments consist of interest bearing sweep accounts and are stated at market.

Patronage Capital and Other Margins and Equities (Deficiencies)

The Cooperative has' established an unallocated equity account, Other Equities (Deficits), as a result of charges against income. These charges against income were recorded as deficits in an unallocated equity' account because the amount is not allocable to the Cooperative's members.

RUS requires that subsequent net income recognized by the Cooperative must be used to reduce the deficit.

Income Taxes Deferred tax assets and liabilities are recognized for the tax effects of differences between the financial statement and tax bases of assets and liabilities.. A valuation allowance is established to reduce deferred tax assets if it is more likely than not that a deferred tax asset will not be realized.

Revenue Recognition. -

Revenue from the sale of electricity to members is recorded based on contracted power usage.

Impairment of Long-LivedAssets The Cooperative reviews the carrying amount of an asset for possible impairment whenever events or changes in circumstances indicate that such amount may not be recoverable. For the years ended 2003 and 2002, no such circumstances were noted.

Ii

Allegheny Electric Cooperative, Inc.

Notes to Financial Statements December 31, 2003 and 2002 Reclassifications Certain reclassifications have been made to the 2002 financial statements to conform to the 2003 financial statement presentation. These reclassifications had no effect on net income.

Note 2: Electric Utility Plant in Service 2003 2002 (in thousands)

Nuclear Utility Plant Production $ .580,031: $ 547,481 Transmission 41,555 41,570 General plant -1,298 1,314 Nuclear fuel 142,700 :136.986 0765,584; .727,351 Non-Nuclear Utility Plant  : 12.854. 9.937 Total $ 778,438 $ 73, Note 3: Susquehanna Steam Electric Station The Cooperative owns a 10% undivided interest in SSES. PPL owns the remaining 90%.. Both participants provide their own financing. The Cooperative's portion of SSES's gross assets, which includes electric utility plant in service, construction and nuclear fuel in progress, totaled $778 million and $737 million as of December 31, 2003 and 2002, respectively. The Cooperative's share of anticipated costs for ongoing construction and nuclear fuel for SSES is estimated to be approximately $67.5 million over the next five years. The Cooperative receives a portion of the total SSES output equal to its percentage ownership. SSES accounted for approximately 66% and 65% of the total kilowatt hours sold by the Cooperative during the years ended December 31, 2003 and 2002, respectively. The balance sheets and statements of income reflect the Cooperative's respective share of assets, liabilities and operations associated with SSES.

I

Allegheny Electric Cooperative, Inc.

Notes to Financial Statements December 31, 2003 and 2002 Note 4: Investments in Associated Organizations 2003 2002 (In thousands)

National Rural Utilities Cooperative Finance Corporation (CFC) Subordinated Term Certificates, bearing interest from 0% to 5%, maturing January 1, K

2014 through October 1, 2080 $ 471 $ . 600 Other 370  : 372

$ 841 $ 972 The Cooperative is required to maintain these investments pursuant to certain loan and guarantee agreements. Such investments are carried at cost.

Note 5: Notes Receivable from Members Notes receivable from members arise from the lease of load management equipment to the member cooperatives. Such notes bear interest at a variable rate (2.60% and 3.35% as of December 31, 2003 and 2002, respectively) and mature on March 31, 2009. Notes receivable from members were $105,000 and $127,000 as of December 31, 2003 and 2002, respectively.

I-

Allegheny Electric Cooperative, Inc.

Notes to Financial Statements December 31, 2003 and 2002 Note 6: Other Investments Other investments consist of the following as of December 31, 2003 and 2002:

-~December 31, 2003

. Gross Gross

Unrealized Unrealized Fair Cost  : Gains Losses Value

. (In thousands) ~.

Decommissioning Trust -

Fund A:

Cash .$, 94 $ -- $ 94 U.S. Government securities 10,455 -  ; 10,455 Corporate bonds 4,670 196 4,866 Other obligations 288 :288 Corporate stocks 3 ,085 383 _ 3,468 579 19,171 NRC mandated Decommissioning Trust Fund B:

Cash . 208 208 U.S. Government securities 10,133 (49) 10,084 Corporate bonds 4,428 178 4,606 Other obligations 1,544 - .-11 - 1,555 Common stocks -4,919 -1.'686 6,605 (49)

Debt Service Reserve Fund -

U.S. Government securities

$ 41.660 I

'I

Allegheny, Electric Cooperative, Inc.

Notes to Financial Statements December 31, 2003 and 2002-.

December 31, 2002 Gross Gro Gro; Unrealized Unrealized Fair Cost Gains Losses: Value I I I

(In thousands) v Decommissioning Trust a Fund A:

Cash $ : . 139 $ 139 .

U.S. Government securities 11,788 7351 12,523  !

Corporate bonds 3,355 342 !3,697 Corporate stocks 2,096 (548)  : -1.548 ,.

IQ,.

il:

17,378 1.077 17,907 NRC mandated Decommissioning Trust Fund B:  !

Cash 493 493

- U.S. Government securities 7,066 312 7,378 Corporate bonds 5,282 411 5,693 Other obligations 1,499 65 1,564

); Common stocks 4,283 232 4,515 1 020 19.643 Debt Service Reserve Fund-U.S. Government securities 1,835: 1.835 3 3 $ 2097 $4 $ 39,385 Certain investments in debt securities are reported in the financial statements at an amount less than their historical cost. Total fair value of these investments at December 31, 2003, was $10.1 million. These declines primarily resulted from increases in market interest rates prior to the balance sheet date, which management believes is temporary. The gross unrealized losses at December 31, 2003 and for a period of less than 12 months was $49,000.

Allegheny Electric Cooperative, Inc.

Notes to Financial Statements December 31, 2003 and 2002 Note 7: :Deferred Charges Deferred charges consist of the following regulatory assets as of December 31, 2003 and 2002.

2003 2002 (Inthousands)

Capital retirement asset $ 135,422 $ :167,289 Accrued decontamination and decommissioning of nuclear fuel 1,181- 1,628 Safe harbor lease closing costs 109 118

$ 136,712 $ 169,035 Based on membership agreements signed by the 14 member distribution cooperatives on March 29, 1999, with an effective date of January 1, 1999, a portion of the SSES impairment writedown, which took place in 1998, has been recognized as a regulatory asset, referred to as the capital.

retirement asset. Under this agreement, the Cooperative will recover from members certain:

financing costs related primarily to the Cooperative's investment in SSES in the amount of

$311 million over a nine-year period.

Note 8: Asset Retirement Obligation Financial Accounting Standards (FAS) 143, AccountingforAsset Retirement Obligations, addresses the accounting for obligations associated with the retirement of tangible long-lived assets. FAS 143 requires legal obligations associated with the retirement of long-lived assets to be recognized as a liability in the financial statements. The initial obligation should be measured at the estimated fair value. An equivalent amount should be recorded as an increase in the value of the capitalized asset and allocated to expense over the useful life of the asset. Until the obligation is settled, the liability should be increased, through the recognition of accretion expense in the income statement, for changes in the obligation due to the passage of time. -

The Cooperative adopted FAS 143 effective January 1, 2003. Initial adoption of the new rules resulted in an increase in net electric utility plant of $16.9 million, reversal of previously recorded liabilities of $36.0 million, recognition of asset retirement obligations of $104.0 million, and a cumulative effect of adoption that decreased net income by $51.1 million. The obligation is associated with the expected decommissioning costs of SSES.

Amounts collected from the Cooperative's members for decommissioning, less applicable taxes, are deposited in external trust funds for investment and can only be used for future decommissioning costs. The fair value of the nuclear decommissioning trust was $42.2 million and

$37.5 million for the years ended December 31, 2003 and 2002, respectively.

Allegheny Electric Cooperative, Inc.

. I Notes to Financial Statements December 31, 2003 and 2002 The changes in the carrying amounts of asset retirement obligations were as follows (in thousands):

Asset retirement obligation at January 1, 2003 w$ 104,017 Accretion expense - 0; 4,161 Asset retirement obligation at December 31, 2003

. . .g 1$ 108,178 I- The amount of actual obligation could differ materially from the estimates reflected in these financial statements.

The pro forma asset retirement obligation, calculated as if FAS 143 had been adopted on January 1, 2002 (rather than January 1, 2003), would be $98.1 million.

The pro forma income statement effects of the application of FAS 143, calculated as if ithad been adopted on January 1, 2002 (rather than January 1, 2003), are presented below:

2003 2002 (In thousands)-

Reported net income - before cumulative effect of adoption i $ 10,315 S 3,074 Pro forma net income - before cumulative effect of adoption 10,315 (679)

Reported net income (40,821) 3,074 Pro forma net income 10,315 (48,534)

. t I

Allegheny Electric Cooperative, Inc.

Notes to Financial Statements December 31, 2003 and 2002 Note 9: Long-Term Debt 2003 . 2002

-(In thousands)

Debt settlement note payable to RUS at an interest rate X varying from 0.0% to 7.18%, due in varying amounts through 2007 $ 236,354 $ 266,527 6.00% replacement notes payable to RUS due in varying amounts through 2007 1,864 2,265 Pollution Control Revenue Bonds, payable semiannually, including interest through 2014.

Variable rates ranged from 1.15% to 1.0% in 2003 and 1.9% to 1.10% 2002 19,100 20,200 5.00% mortgage notes payable to RUS due in varying amounts through 2019 4,979 5.631 262,297 294,623 Less current installments 30.214 33,246

$ 232,083 $ 261.3 Long-term debt consisted principally of advances under mortgage notes payable for electric utility plant to RUS and to the United States of America acting through the Federal Financing Bank (FFB) and guaranteed by RUS. Substantially all of the assets of the Cooperative are pledged as collateral.

The Cooperative made application for a FFB loan, guaranteed by RUS, in May. 2003 in the amount of approximately $50 million to finance system improvements and new construction of existing generating facilities.

Pursuant to the provisions set forth in 7 CFR Part 1717, Settlement of Debt Owed by Electric Borrowers, the Cooperative entered into a restructuring agreement with RUS on March 29, 1999, with an effective date of January 1, 1999. Under the restructuring, the original advances under the mortgage notes to FFB were replaced with a new RUS note in the amount of $406 million. The new note has a final maturity date on January 1, 2008, with an option for early termination on January 1, 2006 and January 1, 2007. Interest on the new note is 7.18%. The Cooperative, however, can receive an interest credit up to the amount of total interest expense based on the number of participating members. All of the Cooperative's members are currently participating.

I1 I

Allegheny Electric Cooperative, Inc.

Notes to Financial Statements December 31, 2003 and 2002 0 eve:p- .:=.En-t..

Long-term Pollution Control Revenue Bonds (Bonds) were issued by an industrial development authority on the Cooperative's behalf. .The Bonds are subject to"purchase on demand of the holder and remarketing on a "best efforts" basis until the Bonds are converted to a fixed interest rate at the Cooperative's option. If a fixed interest rate is established for the Bonds, the Bonds will cease to be subject to purchase by the remarketing agent or the trustee.' The indenture agreement contains various redemption provisions with redemption prices ranging from 100% to 103%. Included in '

other investment, at December 31, 2003 and 2002, respectively; are $1,836,000 and $1,835,000 of investments which relate to a debt service reserve fund required under the Bond Indenture. '

In the event that the Bonds are called and cannot be remarketed; the Bonds are collateralized by irrevocable letters of credit from Rabobank Nederland (Rabobank). The trustee may draw on the

-letters of credit to' make required payments to the bondholders. If Rabobank draws on such letters of credit and the Cooperative does not reimburse Rabobank for such draws under thle terms of the agreements, the letters of credit are converted into a one-year term loan, with payments of principal and interest due quarterly.

The letters of credit and respective reimbursement agreements were amended as of July 21,2003 and the stated termination date of each of the agreements is on October 31, 2006 or such later date as may be determined by Rabobank.

Future maturities of all long-term debt are as follows (in thousands):

2004 . $ 30,214 2005 38,833 2006 37,023 2007 36,804 2008 102,797 Thereafter 16,626 The Cooperative is required by mortgage covenants to maintain certain levels of interest coverage and annual debt service coverage. The Cooperative was in compliance with the applicable mortgage covenants as of December 31, 2003 and 2002.

Certain of the Cooperative's long-term debt is at variable interest rates and is therefore subject to

'various market and interest rate fluctuations.

During 2003 and 2002, the Cooperative incurred interest costs of $924,000 and $951,000, respectively.

F-

Allegheny Electric Cooperative, Inc.

Notes to Financial Statements December 31, 2003 and 2002 Note 10: Income Taxes There was no provision for federal income taxes at December 31, 2003 and 2002. The Cooperative is not subject to state income taxes.

At December 31, 2003, the Cooperative had available non-member net operating loss carryforwards of approximately $76 million for tax reporting purposes expiring in 2003 through 2021, and AMT credit carryforwards of approximately $330,000 which carry forward indefinitely.

The effect of the Cooperative's restructuring has been considered in determining the deferred tax balances at December 31,-2003 and 2002. Specifically, the Cooperative's non-member net operating loss carryforwards have been reduced by approximately $111 million as a result of its, March 29, 1999 restructuring agreement with RUS.

Temporary differences that give rise to deferred tax balances are principally attributable to fixed asset basis, safe harbor lease treatment, gain on installment sale, and financial statement accruals.;

Deferred tax assets also include the effect of net operating loss carryforwards. The temporary.

differences and the carryforward items produce a net deferred tax asset at year-end. Realization of the net deferred tax asset is contingent upon the Cooperative's future earnings. A valuation allowance had been established against the asset since it has been determined, at present, that it is more likely than not that the net deferred tax asset will not be realized.

Note 11: Pennsylvania Public Utility Realty Taxes:

In December of 1998, the Pennsylvania Department of Revenue issued, pursuant to the Pennsylvania Public Utility Realty Tax Act (PURTA), additional assessments to PURTA taxpayers in order to cover the shortfall between PURTA tax revenues and the distributions. The Cooperative's additional assessment was $1,868,000,' which was recorded as of October 1998. The Cooperative satisfied the 1997 reassessment by applying 1998 prepaid taxes against the assessment. -

In 1999, approximately 20 utilities and the Cooperative filed suits against the Commonwealth of Pennsylvania challenging provisions of PURTA. The state later amended the PURTA statute and the way in which the tax is calculated retroactive to 1998. The Cooperative subsequently'received and paid a 1998 PURTA tax bill of approximately $380,000.

In 2000, the Commonwealth removed electric generation assets from the PURTA tax base and effectively returned those assets to local real estate tax jurisdiction with liability calculations based on assessed values. During 2001, PPL settled the 2000 liability for county, municipality, and school district real estate taxes on the full value of the jointly owned SSES property. Also during 2001, the Cooperative's portion of these real estate taxes was billed by and paid to PPL.

Although the final resolution of 1998 and 1999 PURTA issues remains unknown, the Cooperative believes that it has recorded appropriate liabilities for any remaining PURTA taxes.

I

Allegheny Electric Cooperative, Inc.

Notes to Financial Statements December 31, 2003 and 2002 Note 12: Related Party Transactions The Cooperative has arrangements with two affiliated organizations, the'Pennsylvania Rural Electric Association (PREA) and Continental Cooperative Services (CCS). Both organizations have provided the Cooperative with certain management, general, and administrative services on a cost reimbursement basis. The costs for the services provided by PREA were $252,928 and

$292,782 for the years ended December 31, 2003 and 2002, respectively. The costs for services provided by CCS were $5,628,271 and $5,089,108 for the same two comparative periods, respectively.

CCS was incorporated in March 2000, the result of a strategic alliance between the Cooperative, based in Harrisburg, Pennsylvania, and Soyland Power Cooperative, Inc. (Soyland), formerly based in Decatur, Illinois. CCS is'organized as a Non-Profit Electric Cooperative Corporation in'the Commonwealth of Pennsylvania. -

CCS is governed by a board of directors, composed of one representative from each affiliated distribution cooperative in Pennsylvania, New Jersey, and Illinois. Included in the Cooperative's investment in associated organizations is $100,000 for its membership in CCS.

Note 13: Commitments and Contingencies, Power Supply and Transmission Agreements

_o'ert Th :y . .rnm i with The Cooperative has entered into power supply and transmission agreements with approximately 45 service providers. A significant amount of these agreements are umbrella type agreements and do not bind the Cooperative to enter into any type of transaction. As of December 31, 2003, there were no ongoing transactions under these agreements.

The Cooperative has a number of power supply agreements under which it currently purchases capacity and power. These agreements contain no minimum purchase or take-or-pay provisions.

Power supply agreements are as follows:

New York Power Authority This contract meets a portion of the Cooperative's base load requirements and its delivered cost to the Cooperative's members is below market. The current contract terminates in August 2007 for the Niagara Project. A new contract for the St. Lawrence Project expires in 2017.

Williams Energy Marketing & Trading, Inc.

Effective on April 1, 2001, the Cooperative entered into an arrangement with Williams Energy Marketing & Trading, Inc. (Williams). The arrangement provides that Williams receives the output of all power from the Cooperatives' owned and controlled resources and in turn supplies all of the Cooperatives' load requirements in certain geographic areas. The agreement with Williams is scheduled to terminate on December 31, 2008.

I.

Allegheny Electric :Cooperative, Inc.

Notes to Financial Statements December 31, 2003 and 2002 The Williams agreement contains certain hourly and monthly energy caps. Energy provided above these thresholds is purchased at market prices. The Williams agreement also contains thresholds related to output from the Cooperative's resources. ;If the Cooperative fails to. provide energy sufficient to meet the thresholds, the balance is purchased from Williams at market prices.

Transmission service for this load is provided under the appropriate PJM Open Access Transmission Tariff (OATT) or the GPU WASP agreement as explained below.

The Williams Agreement requires the Cooperative to provide credit support in the amount of $9 million. The National Rural Utilities Cooperative Finance Corporation (CFC) issued an irrevocable standby letter of credit on behalf of the Cooperative in the amount of $9 million in favor of Williams. The letter of credit is valid until June 1,2006. In a related agreement to facilitate the transmission of power received from Williams, the Cooperative executed a Load Serving Entity Agreement with PJM LLC (PJM). =The terms of the agreement required the Cooperative to provide $2 million of credit support for activities with PJM. To provide for the credit support, the Cooperative has an irrevocable standby letter of credit from CFC for $2 million in favor of PJM. This standby letter of credit is also valid until June 1, 2006.

SSES Replacement Power Insurance Policy The Cooperative has mitigated a portion of the economic risk of an outage by purchasing a Replacement Power Insurance Policy from ACE American Insurance Company. Under the terms of the policy, if SSES has a forced outage event, the Cooperative will be reimbursed the cost of replacement power for the insured quantity (110 MW/unit or 220 MW maximum). Replacement power cost is the total of the loss, in dollars, as calculated by subtracting the insured price of

$50/MWh from the market price index (PJM Western Hub LMP) and multiplying that difference by the insured quantity. The policy stipulates that the outage limit for each such forced outage is 30 days, the effective policy period is calendar year 2003 and the aggregate coverage limit is $25 million. For this coverage, the Cooperative paid ACE a total premium of $975,000. Effective on January 1, 2004, the Cooperative entered into a similar insurance arrangement with XL Specialty Insurance Company. The insured quantity, however, was modified to a maximum of 230 MW and the maximum covered outage duration is limited to 90 consecutive days. Under the new policy, the maximum policy limit is $25 million and the Cooperative will pay a total premium of $861,000 for the policy period ending on December 31, 2004.

GPU Energy The Cooperative terminated its supplemental generation portion of its Wheeling and Supplemental Power (WASP) agreement with GPU Energy (GPU) on March 31, 2001. However, the Cooperative continues to purchase transmission service in the GPU zone from GPU under the WASP agreement and the PJM OATT. Beginning April 1, 2001, the Cooperative's loads and resources in the GPU zones were no longer included within GPU's zone. Consequently, the Cooperative executed a Load Serving Entity (LSE) agreement with PJM, which outlines the responsibilities of each party with respect to the revised transmission and power supply arrangement. As part of its new LSE status, it was also necessary to take Network Integration Transmission Services (NITS) under the PJM OATT. GPU will pay for most of the PJM NITS charges to prevent double billing for transmission service.

Allegheny Electric Cooperative Infc.

Notes to Financial Statements December 31, 2003 and 2002 Insurance PPL, as the 90% owner and sole operator of SSES, and the Coop'erative, as owner of a 10%

undivided interest in SSES, are members of certain insurance programs which provide coverage for property damage to SSES nuclear generation plant.' Under thes&programs, the plant, as a whole,.

has property damage coverage for up to $2.75 billion. Additionally, there is coverage for thfe cost-F: of replacement power during prolonged outages of nuclear units caused by certain specifiede conditions. Under the property and replacement power insurance programs, PPL and the Cooperative could be assessed retrospective premiums in the event the insurers' losses exceed their reserves. At December 31, 2003, the maximum amount PPL and the Cooperative could jointly be assessed under these programs ranged from $20 million to $40 million annually.

PPL and the Coop'erative's public liability for claims resulting from a nuclear incident is currently limited to $9.5 billion under provisions of the Price-Anderson Amendment Acts of 1988 (Act),

which extended the Price-Anderson Act to August 1, 2002. In 2002, the act was extended through the end of 2003 for NRC licenses. Congress has not yet passed an energy Bill with a renewal of Price-Anderson.: Failure to renew Price-Anderson means the NRC will'not be able to indemnify new licenses. PPL and the Cooperative are protected against this potential liability by a combination of commercial insurance and an industry retrospective assessment program.

In the event of a nuclear incident at any of the reactors covered by the Act, PPL and the

• Cooperative could be assessed up to $100.6 million per reactor per incident, payable at $20 million

• per year.

Safe Harbor Lease The Cooperative previously sold certain investment and energy tax credits and depreciation deductions pursuant to a safe harbor lease. The proceeds from the sale, including interest earned thereon, have been deferred and are being recognized on the statements of operations over the 30-

• year term lease. The deferred gain was $2.7 million and $3.1 million as of December 31, 2003 and 2002, respectively. The net proceeds and related interest were required by RUS to be used to retire outstanding FFB debt.

Under the term of the safe harbor lease, the Cooperative is contingently liable in varying amounts

.* in the event the lessor's tax benefits are disallowed and in the event of certain other occurrences.

The maximum amount for which the Cooperative was contingently liable as of December 31, 2003 was approximately $8.5 million. Payment of this contingent liability has been guaranteed by CFC..

Litigation

\ In the normal course of business, there are various claims and suits pending against the Cooperative. In the opinion of the Cooperative's management, the amount of such losses that might result from these claims and suits, if any, would not materially affect the financial position or results of operations of the Cooperative.

I~

Allegheny Electric Cooperative, Inc.

Notes io Financial Statements' December 31, 2003 and 2002 Note 14: Sale/Leaseback Arrangement The Cooperative previously completed a sale and leaseback of its hydroelectric generation facility at the Raystown Dam (the Facility). The Facility was sold to a trustee bank representing Ford Motor Credit Company (Ford) for $32.0 million in cash.- During 1996, Ford transferred its interest in the Facility to a third party. Under terms of the arrangement, the Cooperative is leasing the Facility for an initial term of 30 years. Payments under the lease are due in semi-annual installments which commenced January 10, 1989. At the end of the 30-year term, the Cooperative, will have the option to purchase the Facility for an amount equal to the Facility's fair market value or for a certain amount fixed by the transaction documents.

The Cooperative also has the option to renew the lease for a five-year fixed rate renewal and three fair market renewal periods, each of which may not be for a term of less than two years. Payments during the fixed rate renewal period are 30% of the average semi-annual installments during the initial lease term. The Cooperative will retain co-licensee status for the Facility throughout the term of the lease. The gaini of $1.9 million related to the sale is being recognized over the lease term. The unrecognized gain is recorded in other deferred revenue and was $1.15 million and

$1.19 million as of December 31, 2003 and 2002, respectively.'

The payments by the Cooperative under this lease were determined in part on the assumption that Ford, or its successor, will be entitled to certain income tax benefits as a result of the sale and leaseback of the Facility. In the event that Ford, or its successor, were to lose all or any portion of such tax benefits, the Cooperative would be required to indemnify Ford, or its successor, for the amount of the additional federal income tax payable to Ford, or its successor, as a result of any such loss.

The leaseback of the Facility is accounted for as an operating lease by the Cooperative. As of December 31, 2003, future minimum lease payments under this lease; which can vary based on the interest paid on the debt used to finance the transaction, are estimated as follows (in thousands):

2004 $ 2,281-2005 1,932 2006 i,932 '-

2007 1,932

Thereafter 23,609' Total minimum lease payments $ 31,686 The future minimum lease payments shown above are for the initial lease term and the five-year renewal period. These payments are based on an assumed interest rate of 8.8% and may fluctuate based on differences between the future interest rate and the assumed interest rate. Rental expense for this lease totaled $2.2 million and $2.0 million in years ended December 31, 2003 and 2002.

I

Allegheny Electric Cooperative, Inc.

Notes to Financial Statements December 31, 2003 and 2002 Note 15: Concentrations of Credit Risk L  : :0 rat..: whs .prt -ns............

The Cooperative is composed of member rural electric cooperatives, whose operations are located in Pennsylvania and New Jersey. The member cooperatives' primary service areas are rural areas located throughout much of rural Pennsylvania and a portion of New Jersey.

Note 16: Government Regulations The Energy Policy Act of 1992 established, among other things, a fund to pay for the decontamination and decommissioning of three nuclear enrichment facilities operated by DOE. A portion of the fund is to be' collected from electric utilities that have purchased enrichment services from DOE and will be in the form of annual special assessments for a period not to exceed more than 15 years. The special assessments are based on a formula that takes into account the amount of enrichment services purchased by the utilities in past periods.t '

The Cooperative has previously recorded its share of the liability in connection with PPL's recognition of the liability in the accounts of SSES: The Cooperative's share of the liability is $4.4 million. The Cooperative recorded its share of the liability as a deferred charge which is being amortized to expense and paid over 15 years, consistent with the ratemaking treatment. The remaining liability to be amortized was $1.2 million and $1.6 million as of December 31, 2003 and 2002, respectively.

Note 17: Fair Value of Financial Instruments The estimated fair value amounts have been determined by the Cooperative using available market information and appropriate valuation methodologies. However, considerable judgment is required in interpreting market data to develop the estimates of fair value.

Accordingly, the estimates presented herein are not necessarily indicative of the amounts that the Cooperative could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.

The following methods and assumptions were used to estimate the fair value of each class of financial instruments:

Assets

• Cash andRestrictedInvestments - The carrying amounts of these items are a reasonable estimate of their fair value due to the short-term nature of the instruments.

Allegheny Electric Cooperative, Inc.

Notes to Financial Statements December 31, 2003 and 2002

• Other Investments and Investments in Associated Organizations- The fair value of other investments are estimated based on quoted market prices. Fair values of investments in associated organizations approximate their carrying amount.

• Notes Receivablefrom Members - The carrying amount of the Cooperative's notes receivable from members, which primarily relate to sales-type leases, approximates fair value because the notes bear a variable rate of interest which is reset on a frequent basis.

Liabilities

• Long-term debt - The fair value of the Cooperative's fixed rate long-term debt is estimated using discounted cash flows based on current rates offered to the Cooperative for similar debt of the same remaining maturities.

The estimated fair values of the Cooperative's financial instruments at December 31, 2003 and 2002, are as follows (in thousands):

- . 2003 . -2002 - -

Carrying Estimated Carrying Estimated Amount - FairValue Amount Fair.Value Cash and cash equivalents $ 17,889 $pA 17,887 $ 16,991 $: 16,991 Restricted investments 15,777 15,777 15,315 ;15,315 Other investments 44,065 44,065 39,385 39,385 Investment in associated organizations 841 841 972 972 Notes receivable from members 88 88 106 -- 106 Long-term debt 262,297 212,457 294,623 226,422 IIII

Soyland ;Power P Cooperafive, Inc.'

Accountants' Report and Financial Statements T December 31, 2003 and 2002 i -I I-w TABLE OF-CONTENTS, 49 INDEPENDENT ACCOUNTANTS' REPORT FINANCIAL STATEMENTS 50 &51 Balance Sheets 52 Statements of Income 53 Statements of Members' Equities (Deficits) 54 Statements of Cash Flows

.55-66 Notes to Financial Statements I

L

6.c k ISR 225 North Water Street, Suite 400 P.O. Box 1580 Decatur, IL 62525-1580 217 429-2411 Fax217429-6109 bkd.comi Independent Accountants' Report Board of Directors Soyland Power Cooperative, Inc.

Harrisburg, Pennsylvania I 4 1 1 . 7 i

We have audited the accompanying balance sheets of Soyland Power Cooperative, Inc. (Cooperative) as of December 31, 2003 and 2002, and the related statements of income, members' equities, and cash flows for the years then ended. These financial statements are the responsibility of the.

Cooperative's management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Soyland Power Cooperative, Inc. as of December 31, 2003 and 2002, and the results of its operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.

As discussed in Note 6 to the financial statements, the Cooperative changed its method of accounting for its asset retirement obligation to comply with Financial Accounting Standard 143 (FAS 143).-

February 13, 2004 Solutions for Success Aawrngerot Mres RoWarad in ntemabcwnaf _

Soyland Power Cooperative, Inc.

Balance Sheets December 31, 2003 and 2002 Assets 2003 2002 Electric Utility Plant, at cost In service (See Note 2) $ 79,746,905 $ 74,555,198 Less accumulated depreciation (40.396.666) (36.456.623) 39,350,239 38,098,575 Construction work in progress 4,069,097 6,356,996 Plant site held for future use 3.921.195 3,921.195 Net electric utility plant 47,340,531 - 48.376,766 Investments (See Notes 3 and 9) 12,312,894 11,085.851 Current Assets Cash 103,996 108,963 Temporary investments 2,802,330 - 2,042,874 Accounts receivable, members 7,902,362 8,931,963 Other receivables 710,270 223,334 Inventories 2,401,370 2,462,015 Prepayments and other assets  : 322,813  : 264,332 Advance energy payments 249,050

• 249,050 Total current assets 14.492.191 14.282.531 Deferred Charges (See Note 4)

- Deferred loss on asset write-down 16,018,977 - 24,923,299 Deferred opt-out fee 23,047,005 27,579,683 Deferred recoverable energy 9.196,620 10.116.620 48.262,602 62.619,602

$ 122,408,218 $ 136,36_4,5 It See Notes to FinancialStatements.

I'

Soyland Power Cooperative, Inc.

Members' Equities and Liabilities 2003 2002 Members' Equities Membership fees $ 1,675 $ 1,675 Patronage capital 1,638,736 1,638,736 Retained earnings 9.879,926 8.030,628 Total members' equities 11.520,337 9,671,039 Long-Term Debt (See Notes 5 and 9) 71,674.548 75,806,484 Asset Retirement Obligation (See Note 6) 5,679.957 Current Liabilities Current installments of long-term debt 12,522,838 13,289,456 Line of credit 1,000,000 9,846,615 Accounts payable 5,093,220 5,839,292 Member prepayments 1,780,315 2,236,387 Accrued interest 353,342 . 314,185 Accrued expenses -533.068 - 4,157.925 Total current liabilities 21,282,783 35,683.860 Deferred Revenue (See Note 1) 12,250,593 15.203.367

$ 122,408,218 $ 136,364,750 I

Soyland-Power Cooperative, Inc.

Statements of Income-Years Ended December 31, 2003 and 2002 2003 2002 0' i:

Operating Revenues ,' . .

Electric energy sales  :$ 80,098,503 $ 89,465,967 Distribution revenue = 922,002 1,008,256 Rent of electric property 65,740  : 62,222 81.086.245 i 90,536,445 Operating Expenses Operations Purchased capacity and energy costs 46,625,105 54,070,342 Production-other - 4,599,587 3,822,602 Transmission a - 712,441 - 653,734 Distribution -V ' r 217,522 328,983 52,154,655 58,875,661 Maintenance Ii ~. ; 891,479 - 1,168,109 Administrative and general  : 2,551,100 2,441,617 Depreciation and amortization. 17,506,768 16,655,790 Accretion I 420,737 Property and other taxes . .480.858 65,600 74.005,597 79,206,777 Net Operating Margin 7,080,648 11,329,668.

Other Revenue (Expense) L

• Interest and other patronage capital income 653,906 787,229 Gain on member buyout (see Note 7) 1,115,206 Other expense (see Note 7) (1,334,000)

Net lMargin Before Interest Charges 7,734,554 11.898.103 Interest Charges Interest on long-term debt 4,479,230 5,094,108 Other - 339,985 770,123 4,819,215 5,864,231 Net income before cumulative effect of adoption of FAS 143 2,915,339 6,033,872 Cumulative Effect of Adoption of FAS 143 (see Note 6) (1,066 041)

Net Income $ 1,849,298 See Notes to FinancialStatements.

IL

Soyland Power: -Cooperative, Inc.

Statements of Members' Equities:

Years Ended December 31, 2003 and 2002 Total Membership - Patronage. Retained Members' Fees :Capital Earnings Equities Balance, January 1, 2002 $ 1,675; $ 1,638,736 $ 1,996,756 $ 3,637,167 Net income 6,033,872 6,033.872

- Balance, December 31,2002 1,675-, 1,638,736 8,030,628 9,671,039 Net income -1,849,298 1.849.298

$----- J.

Balance, December 31, 2003 $9,879,926  ;$ 11,520,337 See Notes to FinancialStatements.

-I

Soyland&Power Cooperative, Inc.

Statements of Cash Flows Years Ended December 31, 2003 and 2002 2003 2002 Operating Activities Net income .$ 1,849,298 $ 6,033,872 Items not requiring (pr6viding) cash Gain on member buyout (1,115,206)

Depreciation of electric utility plant 3,149,768 3,027,786 Amortization of deferred charges 14,357,000 13,628,004 Accretion of asset retirement obligation 420,737 Loss on equity investment 40,871 Gain on sale of investments (819,654)

Cumulative effect of adoption of FAS 143 1,066,041 Change in Accounts and other receivables . 5542,665 t (53,088)

Inventories 60,645 24,524 Prepayments and other assets; (58,481) 167,012 Accounts payable and accrued expenses * (4,331,772) (317,431)

Deferred revenue 1 - (2,952,774) (1,299,694)

Asset retirement obligation 3.656.017 Net cash provided by operating activities 17.800.015 19.276.125 Investing Activities Additions to electric utility plant, net (1,576,371) i (3,963,401)

Additions to investments (2,103,881) (719,583)

Proceeds from investments 835.967 . 2.586.101

Net cash used in investing activities (2.844.285) (2.096.883)

Financing Activities Net payments on line of credit (8,846,615) (1,503,385)

Principal payments on long-term debt (13,428,017) (25,602,587)

- Proceeds from member buyout 9,943,119 Proceeds from long-term debt 8,529,463 Change in member prepayments (456.072) 271.711 Net cash used in financing activities (14.201.241) (16.891.142)

Net Increase in Cash and Cash Equivalents 754,489 288,100 Cash and Cash Equivalents, Beginning of Year 2.151.837 1.863.737 Cash and Cash Equivalents, End of Year $ - 2,906,326 $ 2,151 837 Supplemental Cash Flows Information Cash paid for interest $ 4,780,058 $ 5,924,864 Proceeds from member buyout applied to:

Deferred charges 3,891,153 Accounts payable and accrued expenses 512,110 Deferred revenue 3,587,371 Investments 12,000 I

See Notes to FinancialStatements.

Soyland Power Cooperative, Inc.

Notes to Financial Statements December,31, 2003 and 2002 -

Note 1: Nature of Operations and Significant Accounting Policies Nature of Operations Soyland Power Cooperative, Inc. (Cooperative) is a not-for-profit organization engaged in the generation and transmission of wholesale electric service to its eleven members located throughout Illinois. The Cooperative extends unsecured credit to its members. The Cooperative has entered into wholesale power agreements with each of its members which require the members to buy and receive from the Cooperative all of their power and energy requirements and require the Cooperative to sell and deliver power and energy in satisfaction of such requirements. The wholesale power agreements with members extend to various dates from years 2015 to 2017.

The Cooperative has a formal buyout policy under which a member who seeks to buy out of the wholesale power agreement is required to reimburse the Cooperative for all liabilities, including' any related to Soyland's power supply and transmission agreements, incurred in connection with such buyout, in accordance with a predetermined formula.

The Cooperative's wholesale power rate charged to members is established by the Board of Directors. Such wholesale power rate charged to members is determined based on annual cash requirements, including debt service requirements. The formula on which the rate is determined is subject to the approval of the Federal Energy Regulatory Commission (FERC). Such approval for the formulary rate was received. The Cooperative is not subject to the regulatory authority of the Illinois Commerce Commission.

Deregulation In 1997, the State of Illinois passed Public Act 90-561, Electric Service Customer Choice and Rate Relief Law of 1997 (Act). The Act is intended to bring competition to the electric industry in the State of Illinois and ultimately lead to market based pricing of electric generation services. The Act provides the framework for future deregulation and open market competition among electric power suppliers. The Act phased in competition by customer class over time. All customer classes now can choose their electric supplier. Transitional rules included in the Act provide for the recovery of certain "stranded" costs by electric power suppliers whose customers choose another supplier. Cooperatives, while specifically exempted from the provisions of the Act, may voluntarily choose to participate in open market competition and comply with the Act.

Cooperative management believes the Act will not significantly affect the Cooperative's operations or its ability to recover its costs through future rates charged to members.

,IJ 0 -:-

Soyland Power Cooperative, Inc.

Notes to Financial Statements December 31, 2003 and 2002 Use of Estimates :.:

The preparation of financial statements in conformity with accounting principles generally ,

accepted in the United States of America requires management to make estimates aand assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial report, as well as the reported amounts 'of revenues fand expenses during the years then ended. Actual results could differ from those estimates.,

§ t Basis of Accounting The accounting records of the Cooperative are maintained in accordance with the Uniform System of Accounts prescribed by FERC. In accordance with FERC guidelines, the Cooperative also maintains its accounts in accordance with Statement of Financial Accounting Standards No. 71, Accountingfor the Effects of Certain Types of Regulation.

Electric Utility Plant:.:

Electric utility plant is carried at cost. Depreciation of electric utility plant in service is provided over the estimated useful lives of the respective assets on the straight-line basis at rates as follows:

Production Plant Steam 3.1%-4.0%

Gas turbine' and diesel 6.7%

Transmission Plant 2.8%

Distribution Plant I 3.0%

General Plant 2.5% - 20.0 %

Maintenance and repairs of property and replacements and renewals of items determined to be less than units of property are charged to expense.' Replacement and renewals of items considered to be units of property are charged to the property accounts. At the time properties are disposed of, the original cost, plus cost of removal less salvage of such property, is charged to accumulated depreciation.

Cash and Cash Equivalents Cash and cash equivalents consist of bank deposits in federally insured accounts and temp6rary investmnents. The Cooperative has one banking arrangement which requires the maintenance of a compensating balance. At December 31, 2003, the Cooperative's cash accounts exceeded federally insured limits by approximately $2,923,000.

For purposes of the statement of cash flows, the Cooperative considers all highly liquid debt instruments, if any, purchased with an original maturity of three months or less to be cash equivalents.

i

Soyland Power Cooperative, Inc.

Notes to Financial Statements

December 31, 2003 and 2002 Temporary Investments Temporary investments consist of an interest bearing sweep account and are stated at market.

Accounts Receivable Accounts receivable are stated at the amount billed to members. Accounts receivable are due in accordance with approved policies. An allowance for doubtful accounts has not been recorded because all accounts receivable are considered fully collectible.

Inventories Inventories consist of fuel, materials and supplies and are stated at moving average cost.

Deferred Charges Deferred charges consist of amounts that are expected to be recovered through future rates.

Member Prepayments Member prepayments represent cash advances from members. The Cooperative uses these advances to reduce borrowings. The Cooperative pays interest on member advances at a rate lower than that on outstanding debt. Such interest payments on member advances totaled $71,604 and

$78,926 for the years ended December 31, 2003 and 2002, respectively.

Power Supply Payments Payments made under power supply agreements are classified as purchased capacity and energy costs in the statement of income.

Income Taxes The Cooperative is exempt from income taxes under Section 501 of the Internal Revenue Code and a similar provision of state law. However, the Cooperative is subject to federal income tax on any unrelated business taxable income. No income taxes were due or paid in 2003 and 2002.

Soyland Power Cooperative, Inc.

Notes to Financial Statements December 31, 2003 and 2002 Deferred Revenue Deferred revenue consists of payments received from members that have bought out of the wholesale power agreement and regulatory asset prepayments. Deferred revenue is being amortized over the period during which it would have been earned (through 2007).

2003 2002 Member buyout payments .$ 10,515,691 $ 12,853,491

-Regulatory asset prepayments 1,734,902 2.349.876 Total $ 12,250,593- $ 15,203,367 Revenue Recognition Revenue from the sale of electricity to members is recorded based on contracted power use.

Reclassifications Certain reclassifications have been made to the 2002 financial statements to conform to the 2003 financial statement presentation. These classifications had no effect on net earnings.

Note 2: Electric Utility Plant in Service 2003 2002 Steam and other production plant $ 40,075,298 $ 37,673,882 Transmission plant 27,503,218 24,604,319 Distribution plant 8,741,571 8,503,929 General plant 3,426,818 3,773,068 Total $ 79,746,9 $ 74,555,1

Soyland Power Cooperative, Inc.

Notes to Financial Statements December 31, 2003 and 2002 Note 3: Investments 2003 2002 National Rural Utilities Cooperative Finance Corporation (CFC) - -

Membership fees $ 1,000 $ 1,000 Patronage capital 3,982,639 4,098,455 Subscription capital term certificates 2,252,049 2,252,049 Loan capital term certificates 5,799,881 4.408,651 Total 12,035,569 10,760,155 Other associated organizations 180,595 228,966 Investments in economic development organizations 96.730 96.730 Total $ 12,312,894 $ 11,085,851 The Cooperative considers CFC capital term certificates to be a condition of borrowing and patronage capital to be directly related to borrowing.

Loan capital term certificates mature at various intervals in the years 2006 through 2022 and bear interest at rates ranging from 0% to 4.92%.

Subscription capital term certificates at December 31, 2003 bear interest at 5% and mature at various dates from years 2070 to 2080.

Note 4: Deferred Charges The amount of the deferred loss on asset write-down relates to an interest in the Clinton nuclear generating facility. The regulatory asset will be amortized to operations as the amounts are collected in the rate charged to members.

The remaining amount of the Opt-Out Fee paid to Illinois Power is-expected to be recovered in future rates charged to members beginning in 2002 and has, therefore, been recorded as a regulatory asset at December 31, 2003 and 2002.

The recoverable energy amount is also expected to be recovered in future rates charged to members beginning in 2002 and has, therefore, been recorded as a regulatory asset at December 31, 2003 and 2002.

Amortization of regulatory assets totaled $14,357,000 and $13,628,004 in 2003 and 2002, respectively.

I I

.,I

Soyland Power Cooperative, Inc.

Notes to Financial Statements December 31, 2003 and 2002 Note 5: Long-Term Debt 2003 2002 CFC - fixed rates (ranging between 3.75% and 6.95%)

promissory notes payable, due in quarterly installments through'2022 $ 26,157,711 $ 26,932,173 CFC - fixed rate (3.75%) mortgage note payable, due in various quarterly installments through 2006 12,781,183 18,583,961 CFC - fixed rate (5.95%) capital addition loan note payable, due in quarterly installments through 2014: 19,300,000 20,600,000 CFC - fixed rate (7.05%) promissory notes payable, due in quarterly installments through 2007 ( 9,558,058 14,090,736 CFC -fixed rate (5.25%) promissory note payable, due in quarterly installments through 2011- 7,870,971 8,889,070 CFC - fixed rate (3.10%) capital addition loan note, payable, due in quarterly installments through 2015 7,463,000 CFC - fixed rate (6.15%) promissory note payable, due in quarterly installments through 2015 1.066.463 Total long-term debt 84,197,386 ' 89,095,940 Less current installments 12.522,838 13,289,456 Long-term debt, excluding current installments $ 71,674,548 $ 75,806,484 Certain Promissory Notes (Notes) to CFC are partially guaranteed by the members of the Cooperative. All Notes are secured by a mortgage on the assets of the Cooperative.

Annual maturities of long-term debt at December 31, 2003 are as follows: 2004, $12,522,838; 2005, $13,226,066; 2006, $6,937,750; 2007, $5,864,165, 2008, $4,624,037 and thereafter,

$41,022,530.

The Cooperative had $12,537,000 available at December 31, 2003 from long-term loans approved by CFC for capital additions and an $18,000,000 operating line of credit that expires December 31, 2004 approved by' CFC, of which $ 1,000,000 and $9,846,615 had been borrowed at December 31, 2003 and 2002. The interest rate on the CFC line of credit fluctuates monthly based on CFC's cost of funds (2.80% at December 31, 2003).

I

Soyland Power- Cooperative, Inc.

Notes to Financial Statements Deceflnber 31, 2003 and 2002 During 2003, the Cooperative borrowed $7,463,000 of $20,000,000 available for capital additions, of which $3,963,000 was used to fund 2002 capital additions and an additional $3,500,000 was used to fund estimated 2003 capital additions. Capital additions for 2003 totaled only $1,576,371; therefore, the Cooperative is required by agreement with CFC to return $1,923,629 by May 31, 2004.

All assets of the Cooperative are pledged to secure the CFC debt.

Note 6: Asset Retirement Obligation Financial Accounting Standard 143 (FAS 143), .Accounting for Asset Retirement Obligations,".

addresses the accounting for obligations associated with the retirement of tangible long-lived assets. FAS 143 requires legal obligations associated with the retirement of long-lived assets to be recognized as a liability in the financial statements. The initial obligation should be measured at the estimated fair value. An equivalent amount should be recorded as an increase in the value of the capitalized asset and allocated to expense over the useful life of the asset. Until the obligation is settled, the liability should be increased, through the recognition of accretion expense in the income statement, for changes in the obligation due to the passage of time.

The Cooperative adopted FAS 143 effective January 1,2003. Initial adoption of the new rules resulted in an increase in net electric utility plant of $537,162, reversal of previously recorded liabilities of $3,656,017, recognition of asset retirement obligations of $5,259,220, and a cumulative effect of adoption that decreased net income by $1,066,041. The obligation is associated with the expected decommissioning costs of the Pearl Station.

The changes in the carrying amounts of asset retirement obligations were as follows:

Asset retirement obligation at January 1, 2003 I $ 5,259,220 Accretion expense - 420,737-Asset retirement obligation at December 31, 2003 $ 5,679,957 The amount of the actual obligation could differ materially from the estimates reflected in these financial statements.

The pro forma asset retirement obligation liability balance, calculated as if FAS 143 had been adopted on January 1, 2002 (rather than January 1, 2003), would be $4,869,648.

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Soyland Power Cooperative, Inc.

Notes to Financial Statements December 31, 2003 and 2002 The pro forma income statement effects of the application of FAS 143, calculated as if it had been adopted on January 1, 2002 (rather than January 1, 2003), are presented below:

- 2003 2002 Reported net income - before cumulative effect of adoption $ 2,915,339 $ 6,033,872 Pro forma net income - before cumulative effect of adoption 2,915,339 6,263,986 Reported net income 1,849,298 6,033,872 Pro forma net income 2,915,339 4,967,835 Note 7: Member Buyout' In December 2002, one member bought out of the wholesale power agreement and made a required buyout payment to the Cooperative of $9,943,119. Such payment represents the member's share of the Cooperative's outstanding debt and certain unavoidable future fixed'costs, less the member's share of certain Cooperative assets and future capacity assignment credits. As a result of the member buyout, the Cooperative has made all contractually required payments to CFC under its loan agreements.

Payment amounts related to future unavoidable fixed costs of $3,587,371 in 2002 were deferred and are being amortized to income over the future periods in which the actual costs will be incurred and paid. Such periods range from one'to ten years.

The Cooperative has recognized a gain in the 2002 statements of income related to the member buyout of $1,115,206 determined as follows:

2002 Member payment received .$ 9,943,119 Gain on sale of fixed assets (473,928)

Deferred revenues (3,587,371)

Deferred recoverable energy (1,083,376)

Deferred opt-out-fee (2,807,777)

Other, net (875,461)

$ 1,115,206 During 2002, the Cooperative entered into certain negotiations with five former members related to their previous buyout payments. As a result, the Cooperative paid $1,334,000 to these previous members.

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Soyland Power Cooperative, Inc.

Notes to Financial Statements December 31, 2003 and 2002 Note 8: Related Parties The Cooperative has an arrangement with an affiliated organization, Continental Cooperative Services (CCS). The organization provides the Cooperative with certain management, general, and administrative services on a cost reimbursement basis.; The costs for services provided by CCS were $4,204,011 and $3,506,747 for the years ended December 31, 2003 and 2002. The Cooperative had accounts receivable from CCS of $328,060 as of December 31, 2003 and accounts payable to CCS of $365,031 as of December 31, 2002.

CCS was incorporated in March 2000, the result of a strategic alliance between Allegheny Electric Cooperative, Inc. (Allegheny), based in Harrisburg, Pennsylvania, and the Cooperative which is now based in Harrisburg, Pennsylvania. CCS is organized as a Non-Profit Electric Cooperative Corporation in the Commonwealth of Pennsylvania.

CCS is governed by a board of directors, composed of one representative from each affiliated distribution cooperative in Pennsylvania, New Jersey, and Illinois. Included in the Cooperative's investments is $100,000 for its membership in CCS.

Note 9: Disclosures About Fair Value of Financial Instruments The estimated fair value amounts have been determined by the Cooperative using available market information and appropriate valuation methodologies. However, considerable judgment is necessarily required in interpreting market data to develop the estimates of fair value.

Accordingly, the estimates presented herein are not necessarily indicative of the amounts that the Cooperative could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.

Soyland Power Cooperative, Inc.

Notes to Financial Statements December 31, 2003 and 2002 The following methods and assumptions were used to estimate the fair value of each class of financial instruments:

Assets Investments -The investment balances comprise the following:

2003 2002 W CFC capital term certificates (1)

Subscription certificates $ 2,252,049 $ 0 2,252,049 Loan certificates 5,799,881 4.408.651 8,051,930 6,660,700 Patronage capital certificates Other patronage (1) 3,982,639 X 4,098,455 Memberships and miscellaneous patronage (2) 181,595 . 229,966 Other associated organizations (3) 96.730 96,730 Total $ 12,312,894 Fair value for investments is estimated as follows:

1) The Cooperative considers CFC capital term certificates to be a condition of borrowing and patronage capital to be directly related to borrowing. As such, Cooperative!

management believes the fair value of these items is not determinable and they are reflected at their carrying amount.

2) Management was not able to estimate the fair value of instruments that represent the Cooperative's investment in memberships and miscellaneous patronage and they remain at their carrying value.

3) Management was not able to estimate the fair value of instruments that represent the Cooperative's investment in economic development instruments and they remain at their carrying amount.

- Cash and Temporary Investments - The carrying amounts of these items are a reasonable estimate of their fair value due to the short-term nature of the instruments.

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Soylanid Power Cooperative, Inco

- Notes to Financial Statements December 31, 2003 and 2002 Liabilities Long-Term Debt -Due to the current market interest rates and/or short-term maturities of the Cooperative's debt, carrying amount approximates fair value.

- 2003 :2002 '

Carrying - Estimated Carrying - - Estimated II4 Amount Fair Value Amount Fair Value Assets Investments $ 12,312,894 * (see above) $ 11,085,851 (see above)

Cash and temporary investments 2,906,326 2,906,326 2,151,837 2,151,837 Liabilities Long-term debt (including current 89-maturities) 84,197,386 - 84,197,386  : 89,095,940 89,095,940 Note 10: -Commitments Power Supply The Cooperative owns generating capacity of 178 MW. Currently all additional energy requirements are being furnished through a power supply agreement.

Effective January 2003, the Cooperative has contracted with AmerenEnergy Marketing Company to purchase energy at varying monthly minimum and maximum quantities of energy through December 2008. The contract commits the Cooperative to purchase an annual minimum of

$39,716,270. The members guarantee performance under this contract.

Patronage Capital Allocation In accordance with the Cooperatives' bylaws, a patronage capital allocation will be made during 2004. The patronage capital allocation shall be all amounts in excess of operating costs and expenses offset for losses incurred during the current or prior fiscal years. All non-operating revenues in excess of expenses are considered contributions to capital and are not allocated.

Patronage capital retirements are restricted by the terms of the CFC mortgage and the Cooperative's bylaws.

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Soyland Power Cooperative, Inc.

Notes to Financial Statements December 31, 2003 and 2002 Note 11: Contingencies The Cooperative is a defendant in various claims and lawsuits arising in the ordinary course of business. The Cooperative is a defendant in a contractual disagreement with a former member.

Based upon FERC's final order Soyland was awarded approximately $1.8 million plus accrued interest. Soyland has not recorded this award on the accompanying financial statements because of various compliance issues still awaiting FERC decision.

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