ML18106A458

PECO Energy 1997,Annual Rept.

ML18106A458
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Site:	Salem, Hope Creek
Issue date:	12/31/1997
From:	Corbin McNeil PECO ENERGY CO., (FORMERLY PHILADELPHIA ELECTRIC
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ML18106A456	List: ML18106A455 ML18106A457 ML18106A458
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FINANCIAL HIGHLIGHTS (Thousands of Dollars) Ope r at i ng Revenues Operat i ng Expe n ses, excluding taxes Taxes Charged to Operations Operating Income E xtraordinary Item (Net of taxes) Earnings Applicable to Common Stock (After extraordinary item) Earnings Applicable to Common Stock (Before ex t raord i nary item) E arnings per Average Common Share (Dollars) (After extraordinary item) Cash Dividends Paid per Common Share (Dollars)

Average Shares of Common Stock Outstan di ng (Thousands)

Construction Expenditures Common Shareholders

' Equity Book Value Per Average Common Share (Dollars) 1997 $4,617 , 901 $3,302 , 179 $602 , 860 $1 , 005,6 3 1 ($1 , 833,664) ($1 , 513 , 910) $319, 754 ($6.80) $1.80 222 , 543 $490 , 200 $2 , 726 , 731 $1 2.25 1996 °lo Change $4, 2 83,650 7 .8% $2 , 735,603 20. 7% $639,647 (5.8%) $1 , 248 , 501 (19.5%) $499, 169 (403.3%) $499, 169 (35.9%) $2.24 (403.6%) $1.755 2.6% 222,490 $548,854 (10.7%) $4,645 , 981 (41.3%) $20.88 (41.3%) This Annual Report contains farward-looking statements which should be read in conjunction with the cautionary statement o n looking statements located on page 2 0.

• Nineteen-ninety-seven was a tumultuous year for PECO Energy. I t was a year that opened with the uncertainty of e l ectric competit i on and restructuring in Penn sy l van ia, grew to o n e of great expec tati ons of a fa i r tran sit ion t o competition, but ended w ith the great disappointment of a n o ne rous res tru c turing rate or der. During the year. th e r e was much promise of an early resolution of th e issues related to Pennsylvania's Electricity Generation Customer Cho i ce and Competition Act. Over the summer , we worked in cooperation with other parties, some of whom had previously opposed our positions, to structure a settlement which we felt was fa i r to both our customers and our share h o ld ers. But at the end of the year. the P e n nsylvania Public Utility Co mmi ssion voted, by a ba r e m a j or it y, t o adop t a much more one rous plan. Thi s ac ti o n le d t o the dramatic financial wri te-o ff and d i vidend '.educt i on announced in J an u ary of this year. I n fac i ng these difficu lt deci s ions, I believe both management and the Board of Directors took the appropriate steps for the long-term interests of you, the investor.

We have appealed the Commission' s actions in both Commonwealth and federal courts, but continue to move qu i ck l y to posit i on PEC O En ergy to be successful in the new compet i tive e nvironment bei ng created by a myriad of state and federal r egulato r y ac ti ons a n d pending legislation.

PE CO En ergy's 1997 financi a l results we r e dominated by th e Comm i ssion actions that transpired during the year. The Company ed a net loss of $1.5 billion or $6.80 per share. This loss was primarily due to an extraordinary charge before taxes of $3.1 billion, or $8.24 per share after taxes, to reflect the effects of the Commiss i on's order in the Company's restructuring proceeding, along with several o n e-time charges totaling $214 m illion before taxes , or $0.5 6 per share after ta xes. E arnings per share for 1997, excluding the above items, we re $2.00 versus $2.24 in 1996. The decision t o reduce the dividend was a d if ficu lt one, but I firmly believe it was the prudent thing to do. The one dol l ar per share dividend level will give us the flexibility we need to deal with the demand s of competition while carrying out our non-regulated growth strategy. We feel the new d iv idend level is sustainable.

• There is li tt l e doubt that the most s i g n ificant event of last year was the Company's r estruc turin g proceeding before the Commission.

W e felt stro n g l y that the interests of both customers and share h o ld ers would best be served by reac hing a se ttl ement in stead of endur i ng protracted l i tigation In A ugust, we announced a settlement agreement with a group of intervenors.

Th e settlement i ncluded, among other things , the recovery of $5.461 billion in s t ra nd ed assets and costs; an agreement by the Compan y to w ri te off $2 bil li o n of add iti o n al stranded assets and costs; the tr a n sfe r of generating assets and operations to a sepa rat e entity; and the voluntary reduction by th e C ompa ny of the phase-in period to full customer choice of generation supp l ie r from three years to two. In tion, the sett le ment wou l d have provided all of our customers an average ten percent rate reduction beginning September 1998. I n December 199 7 , however. the Commission, in a 3-2 vote, rejected the settlement ag r eeme nt and adopted its own radical p l an. The Commission reduc ed our s t ra nd ed cost re cov e ry to u n de r $5 billion, r ed uced the return al l owed on stranded costs, provided no guaranteed rate r e ductions for customers and ordered that th e transition to tion be acce le rated. Because of the adve r se effect the Commission's dec i sion would have on the Company, we filed appeals in both the Commonwealth Court of Pennsylvania and in U.S. District Court. Avoiding litigation was a primary factor l eading to the settlement agreement; however , the Commission's act i o n left us wit h no alternative.

The Company t oo k numerous actio n s l as t year t o put us in a stro n g compe titive posit i o n for the future. In September, we announced the formation o f AmerGen Ene rgy Company, LLC, a joint ventu r e with B riti sh Energy of Edinbu rgh, Sco tlan d. AmerGen's mission is to pursue nities to acquire and operate nuclear generating stations in the U.S. AmerGen is backed with the recognized expertise of both PECO Energy and British En ergy in operating nuclear power plants. This strategy is desig ned t o position PEC O En ergy as o ne of the nation's major electric generating companies.

Our expertise in operating and m a in taining nuclear plant s i s a ls o being recog ni zed , as ev idenced by our agreement w ith Northeast Utilitie s to manage th e return to service o f two units a t the Mill sto n e. Connecticut.

nuclear power plant and our three-year contract with Ill inois P ower to manage the restart and operation of its Clinton nuclear power station. Last summer, we launched EnergyOne with Utilicorp United of Kansas City, Missouri, with the a i m of developing a national energy b rand. PECO Energy is an equity partner wi th Uti licorp and the first En ergyO n e franchi see.

Company Profile Incorporated in Pennsylvania in 1929 , PECO Energy Company provides retail elect r ic and natural gas ser v ice i n sou t heastern Pennsy l van i a and , through pi l ot programs , natural gas service to areas in Maryland and New Jersey. The Company also engages i n the wholesale marketing of electricity on a national basis and participates in joint ventures which provide telecommunication vices in the Philadelphia area. PECO Energy's traditional retail service territory covers 2,107 square miles. Electr i c service i s furnished to an area of 1 , 972 square miles with a populat i on of about 3.6 million, including 1.6 million i n the City of Philadelphia.

Approximately 94% of the retail electric service area and 64% of retail watthour sales are in the suburbs around Philadelphia , and 6% of the retail service area and 36% of such sales are in the City of Philadelphia.

Natural gas serv i ce is supplied in a 1,475-square-mile area of southeastern Pennsylvania adjacent to Philadelphia with a population of 1.9 million. Through Horizon Energy , a wholly owned subsidiary of the Company , and PECO Energy/EnergyOne , a franchised energy products brand, PECO Energy pates in Pennsylvania

's electric competition pilot program. Strategic Architecture The year 1997 brought with it a tremendous change in Pennsylvania's electric utility industry.

For the first time, although initially through limited pilot grams, Pennsylvania's retail electric customers have the opportunity to choose their generation suppliers. After a phase-in period beginning in 1999, all Pennsylvania electricity customers will have this opportunity. Knowing that the industry would soon be in turmoil with marketers from every corner of the nation wanting a p i ece of the deregulated energy pie , the Company began to look for other means to secure revenues and i ncrease shareholder value. To this end, the Company reviewed its strategy and developed a new strategic architecture. Keeping in mind what it does best -operating generating fac ities , constructing reliable power-delivery systems and marketing electric power -PECO Energy has ventured beyond the traditional bounds of the i ndustry, yet has not strayed from i ts co r e competenc i es. T his annual report describes this strategic architecture and some of the innovative measures the Company is taking to enhance shareholder value. *

• 3

• In November, we signed an agreement with the Massachusetts Health and Education Facilities Authority to provide more than one b illi on watthours annually to it s 462-member organizat i on and 130,000 employees.

We believe that this type of agreement could serve as a print in the new, compet itive power marketplace.

This year also marks the retirement of three dedicated members of your Board -Joseph J Mclaughlin, Richard G. Gilmore and James A. Ha gen. We thank them for their long years of serv i ce to our Company. Another change in the Board occurred last summer when Joe Paquette retired as chairman.

F or more than four decades he committed himse lf to the success of PECO Energy. Th roughout the year we took these and other actions to implem ent our strategic arch it ecture, which focuses on our core competencies of infrastructure excellence, energy logistics and custom i zed solu ti ons. This strategy i s aimed at adding shareholder value through future growth opportunities.

Bu il ding upon our core compe-*infrastructure excellence, grow our generation business. Our ability to fully manage energy l og i stics, demonstrated by the rapid expansion of the Company's Power Team into 47 states, gives us many value-added opportuni-ties. From th ese two core competencies we built the third -customized solutions

-to enable us to provide our customers w ith the so l ut i ons that best suit their energy needs. You'll read more about our st r ategic architecture, what it means today and in the future, in this annual report. The Company benefits from the guidance and sel of a qualified and involved Board of Directors.

In June 1997, Daniel L Cooper, a retired vice admiral in the U.S. Navy and retired v i ce president and general manager of the Nuclear Services Division of Gilbert/Commonwealth, Inc., joined the Board.

• The three rays of the Company's Strategic Architecture represent the paths that PECO Energy will take in order to compete in the competitive marketplace. Infrastructure Excellence , the world class operation and maintenance of facilities , and Energy Logistics , the informational and physical aspects of buying, selling and delivering energy products and vices , are two of PECO Energy's core competencies

-that is, the things it does best Custom i zed Solutions

-delivering t o customers the specific services that meet customers' needs -grew from these core competencies. Co r bin A McNeill , Jr., His vision, guidance and leadership set our course, and we are pleased that he continues to serve as a valuable member of you r Board. There were a l so several sicant senio r management changes l ast year. Michael J Egan was named Senior V i ce President of F inance and Chief Financial Off i cer, Kenneth G. Lawrence became Senior Vice Pres id ent of the L ocal Distribution Company, Gregory A Cucchi was named Senior Vice President of Ventures and William H. Smith, Ill became Senior V ic e President of Business Services.

These are, indeed, challeng i ng times. Wh i le we are confront in g changes in our indu stry unlike any we h ave seen before, we are tak in g the actions that are d iffi cult but necessary to successfully compete in the future. I strongly believe that PECO Energy will emerge from this period of transition as a stro n g competitor -a national company with global opportunities.

With your ued support, I am confident we can overcome the chal l enges, seize the opportunit i es before us and continue to add value t o your inve s tment. PECO Ene r gy C h ai r man, President and Chief Execut i ve Officer February 2, 1 998 4 P ECO Energy has clearly demonstrated it s world-c l ass capabi l ities in ture e x cellence , which grew out of the processes developed over several years at the Company's Peach Bottom and Li merick nuclear generating stations. " Infr astruc tur e excel l ence is really what PECO Nuclear is a ll about ," said Dickinson Smith, PECO En ergy's Chief Nuclear Officer. " W e're world class managers of nuclear power plants, evidenced by our abili t y t o pu t systems in place that can operate nuclear p l ants safely and efficiently." AmerGen, a j oin t v entu r e with B riti sh Energ y, combines the core com p etencies of PECO Energ y and Britis h Energ y. AmerGen is ing nuclear plants for acquisition and w ill bring its collective best pr act ices an d proven work proc esse s to improve the saf et y and effi ciency of acquired plants. "Ame rGen wi ll combine th e sha red values and cultures of PECO En e rgy and British Energy and tran sp lant them into the ac quir ed plants as a comp l e t e package," said Smith. Another example of infrastructure e xce llence is the Company's joint ven ture wi th AT&T Wireless Services.

The ability of P E CO Energy's Po w er Delivery and Telecommunicat io ns groups t o instal l Person a l Communicati ons Syst em (PCS) equipment atop the Company's existing t owers and buildings was a major con t ribut io n to this ven ture. "P E CO E nergy w as the first utility AT&T wor ked w ith in bui ld ing a PCS network and w e were very impressed by its skills and project management

," said Da nie l R. H esse, CEO and Presid ent o f A T&T Wireless.

Another ven tu re, based on the Company's ext en sive f ibe r op tic net wo r k, became the bone o f a ne w tel ecomm unicati o ns sy s t em p r ov i ding services to medium and la rge businesses. PECO H yp er ion Tele communications, a jo int ve nture betwe en PECO En ergy and H yp eri on Tel ecommunications of Penn sy l vania, a subsidiary of Adelphia Cable Company, will vide a lower-cost local l ink to a subscriber's l ong dis tan ce carrier. E xelon Corporation, a subsidiary of PECO Energy, operates the cogeneration facility on the s ite of the former USX Fairless Plant in Bucks C o unt y, P e nnsyl va nia , an d pro v ides operating and mai nt enance services t o the gas and electric d i stribution systems for that site. These opportunities arose, in part, from the Company's V ision Quest program, wh i ch reduced costs w h ile improving ti me d el ivery and re l iabi lit y at its fossil and hydro-electric pla nts. Th e Company's new D istribu te d Network Management program will take the work management philosophy dev elo ped at PECO Nuclear and apply it to pow er de li v e ry services offered to smaller entities.

" Under this venture, we ta ke the infras tru c tu re lence skills from n uclea r, combine them wi th those of power delivery and p ro v i de them to network managers th ro ugh a performance tra ct to operate and maintain the i r s y stems ," said Greg Cucchi, Senior Vice President of Ventures.

" Th is wil l become more and more attractive as th e in dust ry deregulates an d managers come un der increased p r essu re t o operate their tems effi c ient ly." Most recently, on January 5, 1998, I ll i nois P owe r C ompany of Dec a tur , I llin o i s , chose PECO Nuclear to manage its Clinton nucl ear plant, shut dow n by the Nu c lear Regulat ory Commission in September 199 7. Un der the three-year contract, w hich may be rene wed for an add iti onal five yea rs, a cor e group of PECO N uclear emp l oyees will provide managemen t expertise t o Illinoi s Po wer. I n the future, as PECO Ene rgy fu rthe r deveops and enhances its expertise in infrastru c ture e xcel len ce, the Company w il l expand ca l ly and bring i t s capabili t ies t o an increasing number of cus tom ers.

• Beginning in late 1995, the three units at Millstone Nuclear Station in Connecticut, operated by Northeast Utilities (NU), were shut down due to numerous problems associated with the units. *ecutives realized that, in eturn the units to cial operation, NU must demonstrate to the NRC that NU is able to effectively operate the facility.

NU contracted with PECO Nuclear to provide core management support for the restart of Millstone Unit No. 1. PECO Nuclear was chosen due to its experience in returning its Peach Bottom station to service after an NRC-ordered shutdown.

Peach Bottom is now recognized as an industry leader in safe, reliable operations.

A group of PECO Nuclear ees, led by John McElwain, PECO Energy's Vice President of Nuclear Projects, was assigned to Millstone to implement PECO Nuclear's work management processes.

According to McElwain, "One of the major concerns with the Millstone restart activities was the lack of acceptance of responsibility for the work to be done. It was our job to reverse this attitude." Recognizing PECO Nuclear's strength in infrastructure excellence, NU approached the Company about not only returning Millstone to commercial operation, but also how NU could adopt PECO Nuclear's philosophies. "What PECO Nuclear is selling is operational excellence;*

said PECO Nuclear's Dickinson Smith. "We feel capable of entering almost any situation and delivering a safe, effective and workable solution." PECO Energy's role at Millstone has recently been expanded.

It is now assisting with the restart operations at Unit No. 3.

Nancy Bessey knows how energy logistics, a core competency of PECO Energy, has helped make Power Team, which she leads, so successful.

Power Team's strong position is enhanced by PECO Energy's generating capacity, located in the middle of the Northeast Corridor.

By using this generating capacity and its access to transmission, Power Team is exceptionally reliable and is not just a go-between in transactions. "We have developed a culture that clearly distinguishes us from the other players," she says. "That culture really builds on the foundation of PECO Energy, which is 'we deliver a highly reliable product.'

We built on this foundation of responsibility, reliability and service orientation that started with PECO Energy.

Power Team is viewed as a unique entity in the national power-marketing business, building a large supply business while maintaining integrity of product delivery. "This is a supply and demand business," Bessey said. "So, the more supply we can obtain and market, the stronger the cash flow for the Company.

In order to succeed in this business, it is necessary to have all the systems in place to complete thousands of transactions each day smoothly and quickly. "We have the advantage of having been building our system for quite some time," Bessey said. "Before body even thought about an open market for electricity, we were ready allocating resources to systems development.

We were marketers before marketing was cool. Power Team's goal is to be at the top of the list of power marketers in the country. Currently, it is considered the largest national real-time deliverer of electricity.

Another major strength of Power Team is its employees. "The

• thing we can really be proud that we don't have the trader turnover that a lot of our competitors have, Bessey noted. "That's because our people know we are here for the long haul; they see success here and they realize that this success is going to continue.

• *

• xpertise in energy l ogistics enables the Company to efficient l y manage the comp le x informational and physical aspects of buying, selling and delivering energy products and services so that these services can be used by customers anytime, anywhere.

With ample reliable generation and a location in the center o f the Northeast Corridor, P E CO Energy began with a strong position in energy logistics and was able to easily begin moving supp l y to other areas. "We started with a competitive supply," sa i d Nancy Bessey, th e Company's Vice President of Power Transactions and President of Power Team. " From there we simply started expanding . Our competitors were in a more difficult position.

If they didn't have direct access to compet i tive power, they had to go out and buy it." Since beginning operations in 1994, the growth of the Company's wholesale power-marketing business has made the Company's Power T eam one of the t op power marketers in the U.S. Fo r now, Power Te am sells electricity to wholesale purchasers

-primarily utilities

-and helps to serve the load in PECO Energ y's ttional service territory.

As the Company expands its sources of electric generation through tions, partnerships and marketing agreements, its power-marketing business will explore the option of adding natural gas to its marketing portfo li o. As deregula t ion of electric generation accelerates, PECO Energy is poised to pursue r etail sales directly to large power users, such as l arge industria l customers and national commercial accounts. This type of business-to-business energy service will be the gateway to new customers . This is a key mission of the Ventures Group, the Company's business unit formed to seek out energy-re lat ed opportunities in emerging markets. Th e focus will be on large commercial and industrial customers and large load aggregators such as electric co-operatives, municipalit i es 7 and other utilities. Also targeted are national accounts like fast-food chains and national retailers; regional accounts, such as ket chains; and state and federal governments.

In addition, the Company expects to gain access to retail customers outside of its tional service territory through agreements wi th power resellers.

A key e l ement of energy logistics is energy supp l y, which concentrates on the marketing of electricity, gas and other fuels for custome r s. Power Team recently entered into an ment with Tenaska, In c, of Omaha, Nebraska, to market the output of an 800-megawatt, natural gas-fired merchant power plant to be developed, financed, constructed, owned and op erated by T enaska. Upon completion, scheduled for t he year 2000, the plant wi l l be the la r gest merchant power plant in the U.S. "The strategy is to build upon the portfolio of assets we have," said Bessey. "Everybody else in this business seems to be talking about solidation or merger. Ba sed upon our firsthand knowledge of the market, we will acquire access to energy to serve the demand where it exists."

8 P ECO Energy is building on its core petencies of infrastructure excellence and energy logistics to provide tomers with specific targeted services that meet their needs. In June 1997, the Company announced it would offer a variety of services, previously able only on an individual basis, to industrial and commercial customers under its customized energy solutions program. The aim of the program is to provide larger customers wi th a single point of contact for energy products and vices. The diverse offerings range from traditional utility services to those not associated w ith the generation of electricity.

Traditional utility areas such as plant tions and gas delivery have led to the design and development of on-site programs for customers' generation needs, management of their fuel plies and general oversight of their power-related operations and maintenance.

Based on its broad experience in providing energy, the Company a l so provides customers w ith information on economic development and relocation services, as well as information as diverse as specialized financing, information tems and management se rvices. For examp l e, the owners of C.P. Yeatman & Sons, a 240-acre mushroom farm, wan ted to spend less of their time on fuel handling in the pasteurization and growing processes and more time on its basic business -raising mushrooms.

They came to PECO Energy looking for a solution. "PECO Energy understands our business," said Tim Hahn, Yeatman's controller, corpora te secretary and treasurer.

• The Company converted Yeatman's power portable steam boiler into a dual-fuel boiler that can use either oil or gas. The boiler generates steam needed to kill bacteria and mold and to fa cil itate compost pasteurization.

Yeatman also converted three oil-fired, hot-water boilers used for temperature control. "PECO Energy came up with the idea for applying this technology to our boilers and made sure the project went smoothly," Hahn said. PECO Energy is focused on helping its tomers be competitive in their marketplaces by building strong relationships. With customized ene rgy solutions, PECO Energy can focus on what it does best and customers can focus on what they do best.

• For instance, b ased on the Company's buying and handling capabilities, E xelon Corporation obtained a contract with the City of Vineland, New Jersey , to supply i t s coal. E xelon provides Vi neland with a fully integrated fuel management system, including the purchase of 20,000 tons of coal annually, as well as storage, handling and transpo r tation. Vinela nd uses the coal to provide electricity to homes and businesses in the city.

• In November 1997, PECO Energy signed an agreement with the Massachusetts Health and Education Facilities Authority (HEFA) which could serve as a blueprint in the emerging market for competitive e of the Company's

p. p ilities to manage plants and efficiently move power, it was possible to develop a customized energy solution which met HEFA's needs. The Company will provide more than one billion kilowatthours annually to HEFA's 462-member organization and its 130,000 employees.

HEFA's power-buying consortium is the largest in New England and one of the largest in the country. PECO Energy won the contract in a competition with 27 other companies who responded to HEFA's request for proposal. "Our contract with HEFA heralds our entry into retail markets outside of Pennsylvania," said Greg Cucchi, PECO Energy's Senior Vice President of Ventures. Anticipating expected savings of between 10 and 20 percent, HEFA's members expressed satisfaction with the PECO Energy contract.

Warren Young, director of engineering services for the Boston Museum of Fine Arts, told The Wall Street Journal, "We spend a little over one million dollars a year on electricity.

It's a significant part of our operating budget. You can do a lot of programs with that extra $100,000 minimum and $200,000 on the upside." The Wall Street Journal also noted that many critics of deregulation claim that "individuals would be the last in line to benefit from competition because they'd be too small for power marketers to bother with. But the authority's agreement with PECO (which includes 130,000 employees of member organizations) enables the small customers to benefit by being part of the large buying group."

I *

• PECO Energy is committed to providing high-quality, value-added services to customers in its traditional service territory.

To enhance its ability to provide such services, the Company entered into a partnership with UtiliCorp United of Kansas City, Missouri, and formed EnergyOne.

The goal of EnergyOne is to create the industry's first nationwide, branded energy marketing company that will enable its franchisees to provide customers with one-stop shopping for a variety of products and services.

Local electric utilities, the EnergyOne franchised distributors, will provide to customers a single invoice and point-of-payment for a full range of services.

er to build a strong national me, EnergyOne sought out s whose products were y known and respected.

EnergyOne contracted with companies such as AT&T for telecommunications services; ADT for home and business security and environmental monitoring services; AT&T Solutions to establish and manage EnergyOne's integrated call center services; and Itron for advanced metering and communications technology.

Adding to its strong stable of suppliers, EnergyOne recently entered into a strategic alliance with Saville Systems, a leading provider of convergent billing solutions for the cations industry.

This alliance will provide the first integrated billing system for utility services in the U.S. market. PECO Energy/EnergyOne, the distributor of EnergyOne products in the Company's

' traditional service territory, will be the first EnergyOne franchisee to use the system, as part of Pennsylvania's electric competition pilot program .

• EnergyOne, we're able to front of the marketplace," 0 Energy Chairman Corbin McNeill. "And, we can do this without the risks and costs of going it alone, while being among the leaders in a new business category -integrated utility services. "We can give utilities the ability to be immediately competitive," said Andy Guarriello, CEO of EnergyOne.

It is anticipated that EnergyOne will serve more than 30 million customers nationwide over the next three to five years, while providing three major benefits for PECO Energy. First, it will provide a branding strategy to compete with national brand entities in PECO Energy's traditional service territory.

Second, it will establish a national distribution channel for products that PECO Energy develops.

And third, it will provide an opportunity to earn revenues from other utilities who join EnergyOne as franchisees.

11 W hile PECO Energy's strategic architecture wi l l help the Company grow into a national ny with global opportunities, it remains crit i cally important for the Company's future success that it operate a safe, efficient and cost-effec t ive Local Distribution Company (LDC) in Southeastern Pennsyl v ania. Kenneth G. La w rence, PECO Energy's Senior Vice Pres i dent of the LDC , said the mission of the LDC is to vide high-quality energy services to customers.

Doing this wil l help to enhan c e shareholder value as the LDC assumes responsibility for more than $3 billion in revenue for P E CO Energy. "When most people in the Grea t er Phi l ade l phia area think of P E CO E nergy w hat they will be thinking of is the L DC," L awrence said. "Our highest priori t y is to focus on t he customer. We want to make sure our high levels of service and reliability are continued as we enter a customer choice ro nme n t , and that cu stomers ar e pleased w ith the qual i ty of service they receive from P E CO E nergy. Additional l y, the L DC w ill work to assure that custome r s will be ab l e to move more smoothly into the new competitive marketplace

." The Company formed the LDC in 1997 as a separate business unit and will continue to shape it through 1 998. "The year 1998 will really be one of integration, reinvention and repositioning of the LDC. Beginning in 1998 and ing int o the year 2000 , PECO Energy and the LDC wi l l focus on the continued transition of the business to competition," Lawrence said. Bey o nd that, th e LDC plans to ass i st customers with new and improved applications for electric and gas use, while keeping i ts sights on enhancing shareholder value. The LDC's key roles in the transition to customer choice have already been d e fined by the Pennsyl v ania Pu b l i c Utility Commission.

It is charged with the responsibility of providing re l iable service to cust o mers , and is designat e d as the default supplier for those customers who do not select an al t erna t ive electrici t y supplier.

Its respons i bility w ill be to secure compet i tively priced electric supplies for those customers who do not elec t to change. "Just because we have been designated as the del i verer of electric and gas energy to customers , we cannot rest on our laurels ," said Lawrence. "We must continue to maintain our ex istin g infrastructure and impro v e o ur lev e l of service in order t o cont i nue t o p ro v i d e reliable e nergy services to our tomers. I believe w e are up to that challenge."

Management's Discussion and Analysis of F inancia l Cond i t i on and Results of Operations 13

• Management's Discussion and Analysis of Financial Condition and Results of Operations General In December 1996, Pennsylvania Governor Ridge signed into l aw the Electricity Generation Customer Choice and Competition Act (Competition Act) which provides for the restructuring of the electric utility industry in Pennsylvania , including retail competition for generation beginning in 1999. Pursuant to the Competition Act , in April 1997 , the Company filed with the Pennsylvania Public Utility Commission (PUC) a comprehensive restructuring plan ing its proposal to implement full customer choice of electric generation supplier.

The Company's restructuring plan fied $7.5 billion of stranded costs (the loss in value of the Company's electric generation-related assets which will result from competition).

In August 1997 , the Company and various intervenors in the Company's restructuring proceeding filed with the PUC a Joint Petition for Partial Settlement (Pennsylvania Plan). In December 1997, the PUC rejected the Pennsylvania Plan and entered an Opinion and Order, revised in January 1998 (PUC R estructuring Order). that deregulates the Company's elec t ric generation operations. The PUC Restructuring Order authorizes the Company to recover

• stranded costs of $4.9 billion on a discounted basis, or.$5.3 billion on a book value basis , over 8 1/2 years beg1nn1ng 1n 1999. In January 1998 , the Company f i led appeals of the PUC Restructuring Order with the U.S. District Court for the Eastern District of Pennsylvania (Eastern District Court) and the Commonwealth Court of Pennsylvania (Commonwealth Court). The Company believes that the PUC Restructuring Order provides sufficient details regarding the deregulation of the Company's electric generation operations t o require the Company to discontinue the use of regulatory accounting in its financial statements for those operations.

T he Company determined that at December 31, 1997 , $5.8 billion of its $7.1 billion of electric generation assets were impaired and it had $2.6 billion of other electric generation-related regulatory assets. Effective December 31 , 1997 , the Company recorded an e x traord i nary charge against income of $3.1 billion ($1.8 billion net of income taxes) to reflect the amount of such electric generation-related assets which will not be recovered from customers either prior to the commencement of petition or under the PUC Restructuring Order. F or additional information regarding the extraordinary charge, see note 4 of Notes to Consolidated Financial Statements. On January 26, 1998, the Company's Board of Directors reduced the quarterly common stock dividend from $0.45 per share to $0.25 per share , effective w ith the dividend payable on March 31 , 1998. The Board of Directors concluded that. , given the impact of the PUC Rest r u c tur i ng Order , the divi-* dend reduction was necessary to provide the Company with the financia l fl exibility needed to meet the demands of com-. petition.

Although the Company cannot predict the ultimate effect of the P UC Restructuring Order and competition for electric generation services , the Company bel i eves that its future financial condition and results of operations w ill be adversely affected. See "Outlook-PUC Restructuring Order." Discussion of Operating Results Earnings The Company recorded a loss per common share of $6.80 in 1997 as compared with earnings per share of $2.24 and $2.64 in 1996 and 1995, respectively. The loss in 1997 was primarily due to an e x traordinary charge of $8.24 per share reflecting the effects of the PUC Restructuring Order and deregulation of the Company's e l ectric generation operations.

1997 earnings were also reduced by several one-time charges totaling $0.56 per share for changes in emp l oyee benefits, write-offs of information systems development charges reflecting clarification of accounting guidelines and additional reserves, including for environmental site tion; by $0.30 per share for higher depreciation expense resulting from a full year's increase in depreciation and tization of assets associated with Limerick Generating Station (Limerick) and other assets; by $0.12 per share for income ta x adjustments; by $0.09 per share for losses from new non-utility ventures; and by $0.05 per share for increased depreciation expense due to normal plant additions.

These decreases were partia l ly offset by a one-time $0.18 per share recognition of income resulting from the settlemen t of litigation arising from the current outage of Salem Generating Stat i on (Salem); by $0.08 per share for operational eff icies; and by higher revenues net of fuel of $0.06 per share primarily due to increased sales to other utilities. The $0.40 per share decrease in 1996 earnings was marily due to higher Salem outage-related replacement power and maintenance costs which reduced earnings by $0.27 per share. E arnings also decreased by $0.18 per share in 1996 due to lower electric revenues resulting from milder weather conditions compared to 1995; by $0.12 p e r share due to the gain recognized in 1995 on the sa l e of Conowingo Power Company (COPCO); by $0.11 per share due to higher customer e x penses; and by $0.10 per share due to the increased depreciat i on of assets associated with Limerick. These decreases were partially offset by $0.18 per share due to the Company's continuing cost control initiatives; by $0.09 per share due to savings resulting from the Company's ing debt and preferred stock refunding and refinancing program; and by $0.08 per share due to higher revenues resulting from increased sales to other utilities.

14 PECO Ene r g y C o m pa n y and S u b si di ary Companies Significant Operating Items Revenue and E x pense Items as a Percentage of Total Operating Revenues Percentage Dollar Changes 1 99 5 19 9 6 199 7 199 7-1996 1996-1995 90% 90% 90% Electric 8% 2% 10% 10% 10% Gas 5% 4% 100% 100% 100% Total Operating Revenues 8% 2% 18% 23% 28% Fuel and Energy Interchange 33% 27% 30% 30% 31% Operation and Maintenance 12% 2% 11 % 11% 12% Depreciation 19% 7% 8% 7% 7% Taxes Other Than Income 4% (5%) 67% 71% 78% Total Operating Expenses 19% 9% 33% 29% 22% Operating Income (19%) (11%) (11 %) (10%) (9%) Interest E xpense (2%) (8%) (9%) (9%) (8%) Total Other Income and D eductions 4% (9%) 24% 20% 14% Income B efore Taxes and E xtraordinary Item (27%) (18%) 10% 8% 6% Income T axes (1 4%) (21 %) 14% 12% 8% Income Before Extraordinary Item (35%) (15%) Operating Revenues Tota l operating revenues increased in 1997 by $334 mil l ion to $4,618 million. This represented a $312 million increase in e l ectric revenues and a $22 million increase in gas revenues over 1996. The increase in electric revenues was primarily due to increased sales to other utilities.

The increase in gas revenues was primarily due to higher revenues from sales to commercial, house heating and residential customers ring from higher purchased gas-clause revenues charged in 1997 compared to 1996, parti a lly offset by lower sales ume resulting from milder weather conditions in 1997. This increase was partially offset by reduced sales to interruptible customers switching to trans p ortation service. Total ope r ating revenues increased in 1996 by $98 mi llion to $4,284 m i llion. T his re p resented an $80 mi l l i on increase in electric revenues and an $18 mi l lion increase in gas revenues over 1995. The increase in electric revenues was primarily due to increased sales to other utilities, partially offset by decreased retail sales due to milder weather t i ons. The increase in gas revenues was primarily due to increased sales to retail customers from co l der weather ditions in the first half of 1996 and higher levels of firm sales resulting from customers switching from transportation vice to firm service. These increases were partially offset by decreased sales and transportation revenues resulting from unusually mild weather in December 1996. lncreases/(decreases) in e l ectric sa l es and operat i ng enues by class of customer for 1997 compared to 1996 and 1996 compared to 1995 are set forth as follows: 1997 -1996 1996 -1995 Electric Electric Electric Electric Sales Revenues Sales Revenues (Millions of kWh) (Millions of$) (Millions of kWh) (Millions of$) Res i dential (48) $ (1) (86) $ (14) House Heating (217) (12) 121 5 Small Commercial and Industrial 194 30 291 19 Large Commercial and Industrial (174) (21) (555) (37) Other (61) 8 42 3 Unbilled 397 45 (862) (69) Service Territory 91 49 (1,049) (93) Interchange Sales 992 33 439 9 Sales to Other Utilities 8,650 230 6,202 164 Total 9,733 $ 312 5 , 592 $ 80 Fuel and Energy Interchange Expense F uel and energy interchange expense increased in 1997 by $318 million to $1,290 million. T he increase was primarily due to purchases needed for increased sales to other utilities and a one-time billing credit in 1996 fr om a non-utility generator.

Fuel and energy i nterchange expense as a percentage of operating reve n ues increased from 23% to 28% principal l y due to purchases needed for increased sales to other utilities.

Fuel and energy interchange expense increased in 1996 by $210 million to $9 7 3 million. T he increase was primarily due to *

• purchases needed for increased sales to other utilities,

• increased replacement power costs resulting from the shut-down of Salem and a net credit to expense in 199 5 from certain energy sales to other utilities. Fuel and energy interchange expense as a percentage of operating revenues increased from 18% to 23% princ i pa l ly due to i ncreased replacement power costs resulting from the shutdown of Salem.

Management's Discussion and Analysis of Financial Condition and Results of Operations 1 5

• Operating and Maintenance Expense Operating and maintenance expense increased in 1997 by $157 million to $1.431 million primarily due to several time charges totaling $187 million. including charges for changes in employee benefits , write-offs of information tems development charges reflecting clarification of accounting guidelines and additional reserves, including for environmental site remediation.

These increases were ly offset by lower operating costs at Company-operated nuclear generating stations and lower administrative and eral e x penses resulting from Company's ongoing cost-control efforts. Operating and maintenance expense increased in 1996 by $23 million to $1,274 million due to higher customer expenses, higher contractor costs and higher nuclear ing station charges resulting from the shutdown of Salem. These increases were partially offset by lower operating costs at Company-operated nuclear generating stations and lower administrative and general expenses resulting from the Company's ongoing cost-control efforts. Depreciation Expense Effective October 1 , 1996, the Company increased tion and amortization on assets associated with Limerick by $100 million per year and decreased depreciation and zation on other Company assets by $10 million per year. Depreciation expense increased in 1997 by $92 million to * $581 million. The increase was primarily due to increased depreciation of assets associated with Limer i ck. Depreciation e x pense also increased due to addit i ons to plant in service. Depreciation e x pense increased in 1996 by $32 million to * $489 million. The increase was primarily due to increased depreciation of assets associated with Limerick. Depreciation expense also increased due to addit i ons to plant in serv i ce. Interest Charges Interest charges decreased in 1997 by $7 million to $402 million. The decrease was primarily due to the Company's ongoing program to reduce and/or refinance higher-cost. term debt. This decrease was partially offset by the replacement of $62 million of preferred stock with Monthly Income Preferred Securities (MIPS) in the third quarter of 1997. MI PS are recorded in the financial statements as Company Obligated Mandatorily Redeemable Preferred Securities of a Partnership.

Interest charges decreased in 1996 by $36 million to $409 million. The decrease was primarily due to the Company's ongoing program to reduce and/or refinance er-cost, long-term debt. This decrease was partially offset by the replacement of $78 million of preferred stock with MIPS in the fourth quarter of 1995. Other Income and Deductions Other income and deductions excluding interest charges increased in 1997 by $6 million to $4 million. The increase was primarily due to the settlement of litigation arising from the shutdown of Salem. The increase was partially offset by losses from the Company's new non-utility ventures. Also offsetting the increase was the write-off of one of the Company's telecommunications investments as a result of the circumstances involved in the Federal Communication Commission

's auct i oning of the personal communications systems " C-block" licenses. Other income and deductions excluding interest charges decreased in 1996 by $60 million to a net deduction of $2 million. The decrease was primarily due to the gain nized in 1995 on the sale of COPCO. Income Taxes Income taxes on operating and non-operating income decreased in 1997 by $47 million to $293 million. T he decrease was primarily due to lower operating income. The decrease was partially offset by reduced tax depreciation benefits from plant and regulatory assets which are not fully normalized for ratemaking purposes. Income taxes decreased in 1996 by $92 million to $340 million. The decrease was primarily due to lower operating income and the gain recognized in 1995 on the sale of COPCO. Preferred Stock Dividends Preferred stock dividends decreased in 1997 by $1 million to $17 million. The decrease was primarily due to the ment of $62 million of preferred stock with MIPS in the third quarter of 1997. Preferred stock dividends decreased in 1996 by $5 lion to $18 million. The decrease was primarily due to the replacement of $78 million of preferred stock with MIPS in the fourth quarter of 1995. Discussion of Liquidity and Capital Resources The Company's capital resources are primarily provided by internally generated cash flows from utility operations and, to the extent necessary, external financing. Such capital resources are generally used to fund the Company's capital requirements, including investments in new and existing tures , to repay maturing debt and to make preferred and common stock dividend payments.

In 1997, 1996 and 1995, internally generated cash exceeded the Company's capital requirements and dividend payments.

The Company anticipates that it will be able to meet its capital requirements with internally generated cash from utility operations in 1998. Beginning in 1999, the Company e x pects that internally generated cash will be reduced due to price pressures resulting from competition for electric generation services and the effects of the PUC Restructuring Order. In anticipation of this expected reduction of internally generated cash , in January 1998. the Board of Directors voted to reduce the Company's common stock dend, effective with the first quarter 1998 dividend.

Based upon the 222.5 million shares of common stock currently out-16 standing , the common stock dividend reduction will reduce the Company's cash requirements by $178 million per year. Absent increases in the market price of electric generation services, the Company e x pects that internally generated cash w ill be further red uc ed in 2007, when the Company completes the recovery of i ts allowed stranded costs fr om customers. The magnitude of the reduction of internally erated cash will be affected by a number of factors, including how quickly electric generation competition develops, the Company's ability to compete, the impact of additional cutting initiatives, future market prices of electric generation and the outcome of the Company's appeals of the PUC Restructuring Order. The Competition Act authorizes the securitization of the recovery of allowed stranded costs. Under the Competition Act, securitization proceeds must be used principally to reduce qualified stranded costs and related capitalization.

Unless extended by the PUC, the Company has authorization until May 22, 1998 to securitize

$1.1 billion of stranded costs. It is unlikely that the Company will securitize the recovery of its stranded costs until the appeals of the PUC Restructuring Order are resolved. If the Company does securitize, it cannot predict the level of stranded cost recovery that it would be permitted to securitize or the impact of such securitization on the Company's capitalization. At December 31 , 1997, the Company's capital structure consisted of 36.8% common equity; 7.9% preferred stock and Company obligated mandatorily redeemable preferred securities (which comprised 4.8% of the Company's total capitalization structure)

and 55.3% long-term debt. The Company e x pects its level of net capital investment to decrease in future years. Total capital expenditures, ly for utility plant, were $573 million in 1997 and are estimated to be $600 million in 1998. Due to the expected adverse impact of the PUC Restructuring Order and competition for electric generating services on its future capital resources , the Company is currently evaluating its capital commitments for 1999 and beyond. Certain facilities under construction and to be constructed may require permits and licenses which the Company has no assurance will be granted. The Company's operations have in the past and may in the future require substantial capital e x penditures in order to comply with environmental laws. The Company has undertaken a number of new tures, principally through its Telecommunications Group, some of which require significant cash commitments.

For 1998 , the Company's e x pected capital e x penditures include appro x imately $150 million in such ventures. Cash flows from operations were $1 , 038 million in 1997 as compared to $1, 172 million in 1996 and $1,240 million in 1995. Cash flows consist of earnings, non-cash charges of depreciation and deferred income taxes. Cash flows used in investing activities were $573 million in 1997 as compared to $663 million in 1996 and $465 million in 1995. Expenditures under the Company's construction gram decreased in 1997. The Company has also made significant investments in diversified activities and other obligations.

Net funds used in these activities in 1997 were $83 million, consisting of $26 million for telecommunications ventures , $54 million fo r nuclear plant decommissioning trust f und s a n d $3 mill i on fo r ot h er depo s it s and ventures. In 1996 and 1995 , fund s u s ed in s i milar a ct i vit i es w ere $114 mi l l i on PECO Energy Company and Subsidiary Companies and $82 million, respectively. 1995 cash flows benefited from

• the sale of COPCO. Cash flows used in financing activities were $461 million in 1997 as compared to $501 million in 1996 and $802 million in 1995. The decreases in 1997 and 1996 were primarily due to l ess available cash permitting fewer retirements of highercost debt. The Company meets its short-term liquidity requirements primarily through the issuance of commercial paper and rowings under an unsecured credit facility with a group of banks. The Company had $402 million of short-term debt, i ncluding $314 million of commercial paper , outstanding at December31, 1997. At December 31, 1997, the Company's embedded cost of debt was 6.9% with 12.0% of the Company's long-term debt having floating rates. As a result of the extraordinary charge in December 1997, the Company does not expect to meet the earnings test under the Company's mortgage required for the issuance of additional bonds against property additions for the twelve months ended December 31, 1998. As of December 31, 1997, the Company was entitled to issue approximately

$3.6 billion of mortgage bonds without regard to the earnings test against previously retired mortgage bonds. As a result of the e x traordinary charge, the Company also does not expect to meet the coverage test under Company's Articles of Incorporation required for the issuance of additional preferred stock for the twelve months ended December 31, 1998. The Company cannot predict whether the Competition Act or the PUC Restructuring Order will ultimately affect the Company's credit ratings. Outlook The Company is entering a period of financial uncertainty with the deregulation of its electric generation operations in which revenues from regulated rates will be replaced by enues from the competitive sale of electric generation at market prices. The Company believes that the deregulation of its electric generation operations and other regulatory tives designed to encourage competition will increase the Company's risk profile by changing and increasing the ber of factors upon which the Company's financial results are dependent.

This may result in more volatility in the Company's future results of operations. The Company believes that it has significant advantages that will assist it in the increasingly competitive electric generation environment.

These advantages include the ability to produce electricity at a low marginal-cost, a high reserve margin and the strated ability to efficiently operate its electric generation facilities. The Company's future financial condition and results of operations are substantially dependent upon the effects of the Competition Act and the PUC Restructuring Order. Additional factors that affect the Company's financial condition and results of operations include operation of nuclear generating facilities, sales to other utilities, accounting issues, inflation, weather and compliance with environmental regulations. Another factor affecting the Company's future financial condition i s i ts ability to develop its investments in new tures i nto profitable enterpr i ses. *

• Management's Discussion and Analysis of Financial Condition and Results of Operations 17

• PUC Restructuring Order The Compet i tion Act was enacted in December 1996 , pro v iding for the restructuring of the electric utility industry i n Pennsylvania , including retail competition for generat i on beginning in 1999. The Competition Act requires the unbundling of electric services into separate generation, transmission and distribution services with open retail petition for generation.

Electric distribution and transmission services will remain regulated by the PUC. The Competition Act requires utilities to submit to the PUC restructuring plan s, including their quantification of stranded costs which w ill result from competition. The Competition Act author i zes the recovery of stranded costs through charges to distribution customers for up to nine years (or for an alternative period determined by the PUC for good cause shown). During that period, the utility is subject to a rate cap which provides that total charges to customers cannot exceed rates in place as of December 31, 1996, subject to certain exceptions.

The Competition Act also caps transmission and distribution rates from December 31 , 1996 through June 30 , 2001 , subject to certain e x ceptions.

Pursuant to the Compet i tion Act, in April 1997, the Company filed with the PUC a comprehensive restructuring plan. In December 1997, the PUC adopted its own ing plan which deregulates the Company's electric generation operations and allows the Company to recover stranded costs of $4.9 billion on a discounted basis, or $5.3 billion on a

• book value basis, over 8 1/2 years beginning in 1999. Recovery of allowed stranded costs w i ll be through a separate charge to be levelized over the recovery period using a 7.47% cost of capital. Other major provisions of the PUC Restructuring Order include capping customer bills at the year-end 1996 system-w ide average of 9.95 cents per kWh; beginning January 1 , 1999, unbundling rates into a transmission and tribution component, the charge for recovery of stranded costs and a "shopping credit" for generation; and phasing-in customer choice of electric generation supplier for all tomers in three steps, one-third of the peak load of each customer class on January 1 , 1999, one-third on January 2 , 1999 (one day later) and the remainder on January 2 , 2000. To encourage competition , the PUC established the "ping credit" for generation in e x cess of current market prices. On January 21, 1998, the Company filed a complaint in the Eastern District Court seeking injunctive and monetary relief on the grounds that the Competition Act and the PUC Restructuring Order: (1) are preempted by Section 201 (b) of the Federal Power Act; (2) effect a taking of private property without just compensation in violation of the Fifth and Fourteenth Amendments to the U.S. Constitution; (3) v i olate the Due Process Clause, the Contract Clause and the First Amendment of the U.S. Constitution

and (4) deprive the Company of certain other federally protected rights. On January 22, 1998, the Company filed two Petitions for Review in the Commonwealth Court, appealing the PUC Restructuring Order. The petitions state that the PUC

• Restructuring Order must be set aside because it is based upon errors of law , is not supported by substantial evidence , constitutes an arbitrary and capricious abuse of administrative discretion and deprives the Company of the due process of law , to which i t is entitled under Article I of the Pennsylvania Constitution.

Uncertainties of Electric Generation Restructuring Competition in wholesale and retail electric generation i s e xpected to create new uncertainties in the utility industry.

These uncertainties include future prices of electricity in both the retail and wholesale markets, potential changes in the Company's sales portfolio and supply and demand volatility.

The Company expects that deregulation of the Company's electric generating operations will result in price pressures that will reduce the Company's future revenues.

While the Company cannot predict the ultimate impact of the PUC Restructur i ng Order on customer b i lls , the PUC mates that customers will save up to 15% of their total electric bill beginning in 1999 through June 30, 2007 and w i ll save 30% of their total electric bill thereafter.

Competition is also expected to affect the ultimate position of the Company's electricity sales. The "shopping credit" established by the PUC encourages electric retail tomers to choose a supplier.

The Company cannot predict how successful its affiliated generation marketers will be in competing for these customers and customers elsewhere in Pennsylvania. To the e x tent that the Company loses retail customers , it will be compelled to sell generation previously used to serve retail customers in the wholesale market. Since margins in the wholesale market are currently lower than in the retail market, this could adversely affect the Company's profit margins. The Company is a low marginal-cost electricity producer, which puts it in a favorable position to take advantage of opportunities in the electric retail and w holesale generation markets. The Company's competitive position and its future financial condition and results of operations are dependent on the Company's ability to successfully operate its low marginal-cost power plants. The Company enters into commitments to buy and sell power. Currently, these commitments make the Company a net power purchaser.

Since the price and supply volatility of electricity generation cannot be predicted at this time, the Company's position as a net purchaser e x poses it to risk to the extent that it has entered into contracts that may require the Company to pay prices for purchased power in e x cess of market prices. The Company, as the local distribution provider , is gated under the PUC Restructuring Order to ser v e as the electric generation supplier of last resort in its service ry. This obligation will include all customers who do not elect to choose an electricity supplier as well as all customers who seek a new energy supplier but are unable to reach a service agreement with another supplier.

The Company's rates are capped at 1996 levels. If energy prices rise above that level , the Company would still be obligated to serve these tomers at the capped rate. Other Competitive Initiatives During 1996 , the Federal Energy Regulatory Commission (FERC) issued Order No. 888 which requires public utilities to file open-access transmission tariffs for w holesale sion services in accordance with non-discriminatory terms and conditions established by the FERC. In response to Order No. 888, in December 1996, the Company and the other members of PJM Interconnection, L.L.C. (PJM) filed a joint compliance filing with the FERC 18 proposing to restructure PJM. In November 1997, the FERC issued an order which allows for the establishment of an Indep endent System Operator to operate the day-to-day ations of PJM. Transmission service is on a pool-wide, open-access basis using the transmission facilities of the eight historical PJM companies with a flat rate based on the costs of the transmission system where the point of delivery is located (thus there are eight rates). By January 1, 2003, PJM is required to have in place a uniform system-wide transmission rate. The Company received approval from the FERC to remove the e xi sting cost-based cap on prices charged for power purchased by the Company in anticipation of later resale in the wholesale market and certain changes regarding the terms of the buy-for-resale agreements.

The new tariff provisions allow the Company to purchase and re-sell energy at market-based rates both within PJM and outside PJM. The gas industry is continuing to undergo structural changes in response to FERC policies designed to increase competition.

FERC policies have required interstate gas pipelines to unbundle their gas sales service from other lated tariff services, such as transportation and storage. In anticipation of these changes, the Company has modified its gas purchasing arrangements to enable the purchase of gas and transportation at lower cost. The Company, through Horizon Energy Company, a wholly owned subsidiary, has successfully participated in pilot programs outside the Company's gas service territory to market natural gas and other services.

There is an initiative in the Pennsylvania legislature to deregulate the gas industry, which has the support of Governor Ridge. The Company cannot predict whether the Pennsylvania legislature will enact legislation that deregulates the gas industry or whether Governor Ridge will ultimately sign into law any such legislation.

The Company cannot dict the ultimate effect of gas industry deregulation on its future financial condition or results of operations. As a result of competitive pressures , the Company has continued to negotiate long-term contracts with many of its larger-volume industrial customers. Although these ments have generally resulted in reduced margins, they have permitted the Company to retain these customers.

Regulation and Operation of Nuclear Generating Facilities The Company's financial condition and results of operations are in part dependent on the continued successful operation of its nuclear generating facilities.

The Company's nuclear generating facilities represent approximately 44% of its installed generating capacity.

Because of the Company's reliance on its nuclear generating units, any changes in lations by the Nuclear Regulatory Commission (NRC) requiring additional investments or resulting in increased operating costs of nuclear generating units could adversely affect the Company. During 1997, Company-operated nuclear plants operated at a 90% weighted-average capacity factor and owned nuclear plants operated at a 73% weighted-average capacity factor. Company-owned nuclear plants produced 39% of the Company's electricity, despite the shutdown of the Salem units. Nuclear generation is the most tive way for the Company to meet customer needs and commitments for sales to other utilities.

PECO Energy Company and Subsidiary Companies Public Service Electric and Gas Company (PSE&G). the

• operator of Salem Units No. 1 and No. 2, which are 42.59% owned by the Company, removed the units from service in the second quarter of 1995. PSE&G informed the NRC at that time that it had determined to keep the Salem units shut down pending review and resolution of certain equipment and management issues and NRC agreement that each unit is sufficiently prepared to restart. Unit No. 2 returned to ser-vice on August 30, 1997 and Unit No. 1 is expected to return to service late in the first quarter of 1998. The Company expects to incur and expense at least $20 million in 1998 for increased costs related to the shutdown.

As of Decembe r 31, 1997, 1996 and 1995, the Company had incurred and expensed $152, $149 and $50 million, respectively, for replacement power and maintenance costs related to the shutdown of Salem. See note 5 of Notes to Consolidated Financial Statements.

Sales to Other Utilities The Company's electric utility operations include the sale marketing of electricity.

At December 31, 1997, the Company had long-term commitments relating to the chase from unaffiliated utilities and others, energy associated with 1,330 megawatts (MW) of capacity in 1998, with 2, 540 MW of capacity during the period 1999 through 2002 and with 2,430 MW of capacity thereafter.

These purchases will be utilized through a combination of sales to jurisdictional customers, long-term sales to other utilities and open-market sales. Under some of these contracts, the Company may chase, at its option, additional power as needed. The Company's future results of operations are dependent in part on its ability to successfully market the rest of this tion. See note 5 of Notes to Consolidated Financial Statements.

In the wholesale market, the Company has increased its sales to other utilities, but increased competition has reduced the Company's profit margins on these sales. At December 31, 1997, the Company had entered into long-term ments with unaffiliated utilities to sell energy associated with 4 ,28 0 MW of capacity, of which 540 MW of these ments are for 1998, 1, 700 MW are for 1999 through 2002 and the remaining 2,040 MW extend through 2022. Accounting Issues Effective December 31, 1997, the Company discontinued accounting for its electric generation operations in dance with Statement of Financial Accounting Standards (SFAS) No. 71, "Accounting for the Effe cts of Certain Types of Regulation

." For further information, see note 4 of Notes to Consolidated Financial Statements.

The Company believes that its electric transmission and distribution system and gas operations continue to meet the provisions of SFAS No. 71. The Company believes that it is probable that regulatory assets associated with these operations wi ll be recovered.

In 1997, the Financial Accounting Standards Board * (FASB) issued SFAS No. 130, "Reporting Comprehensive Income," to establish standards for reporting and display of comprehensiv e income and its components in financial state-ments. The new standard requires an entity to classify items of other comprehensive income by their nature in a financial statement and to display the accumulated balance of other comprehensive income separately from retained earnings and Management's Discussion and Analysis of Financial Condition and Results of Operations 19

• additional paid-in capital in the equity section of a statement of financial position. The new standard is effective for fiscal years beginning after December 15, 1997. The Company will adopt SFAS No. 130 in 1998. Adoption of SFAS No. 130 will not affect the Company's financial condition or results of operations.

The Company is evaluating the impact on its closures, but does not expect SFAS No. 130 to materially change its disclosures. In 1997 , the FASB issued SFAS No. 131, "Disclosures About Segments of an Enterpr i se and Related Informat i on," to establ i sh standards for reporting information about ing segments in annual financial statements and to require reporting of selected information about operating segments in interim financial reports issued to shareholders.

It also establishes standards for related disclosures about products and services, geographical areas and major customers.

The new standard is effective for fiscal years beginning after December 31, 1997. Adoption of SFAS No. 131 will not affect the Company's financial condition or results of operations. The Company is evaluating the impact on its operating ment d i sclosures.

During 1996, the FASB i ssued the E x posure Draft " Accounting for Certain Liabilities Related to Closure or Removal of Long-Lived Assets." The FASB has e x panded the scope of the project to include closure or removal liabilities that are incurred at any time in the operating life of the ed long-lived asset. The FASB has decided that it should proceed toward either a final Statement or a revised

• Exposure Draft. The timing of this project is still to be mined. Until such time that the final Statement is issued, the Company will be unable to determine what, if any, effect this issue might have on its financial cond i tion or results of opera-tions. See note 5 of Notes to Consolidated F i nanc i al Statements.

Other Factors Annual and quarterly operating results can be significantly affected by weather. Since the Company's peak demand is in the summer months, temperature variations in summer months are generally more significant than variations during winter months. Inflat i on affects the Company through increased operati ng costs and increased cap i tal costs for utility plant. As a result of the rate cap i mposed by the Competition Act, the elimination of the Energy Cost Adjustment and e x pected price pressures due to competition , the Company may have limited opportunity to pass the costs of inflation through to customers.

The Year 2000 Issue is the result of computer programs being written using two digits rather than four to define the applicable year and other programming techniques which constrain date calculations or assign special meanings to tain dates. Any of the Company's computer systems that have date-sensit i ve soft w are or mi c roprocessors may ni ze a date us i ng "00" as the y e ar 1900 rathe r than the year

• 2000. This could result in a system failure or miscalculations causing d i sruptions of operations, including, among other things, a temporary inability to process transactions, send bills or operate electric generation stations. The Company has determined that it will be required to modify or replace significant port i ons of its software so that its computer systems will properly utilize dates beyond December 31, 1999. The Company presently believes that, with modifications to existing software and conversions to new software, the Year 2000 Issue can be mitigated.

However, if such modifications and conversions are not made , or are not completed timely, the Year 2000 Issue could have a material adverse impact on the operations and financial tion of the Company. The costs associated with this potential impact are speculative and not presently quantifiable. The Company initiated formal communications with all of its significant suppliers in March 1997 to determine the extent to which the Company is vulnerable to the suppliers' failure to remediate their own Year 2000 issue. The Company's estimated total Year 2000 project costs include the estimated costs and time associated with the impact of Year 2000 issues of third parties and are based on presently available information.

There can be no guarantee that the tems of other companies on which the Company's systems rely will be timely converted, or that a failure to convert by another company, or a convers i on that is incompatible w i th the Company's systems, would not have a mater i al adverse impact on the Company. The Company will utilize both internal and external resources to reprogram, or replace, and test software and computer systems for Year 2000 modifications.

Management believes that adequate resources are being devoted to the Year 2000 Issue. The Company plans to complete the Year 2000 project not later than June 1, 1999. To date, the Company has funded the Year 2000 project from current operating cash flows as a base level of activ i ty for the preliminary efforts i n connection with its Year 2000 ment and remediat i on plan. The Company e x pects the remaining costs of the Year 2000 project to be appro x imately $25 million. The costs of the project and the date on which the Company plans to complete the Year 2000 modifications are based on Management's best estimates , which were derived utilizing numerous assumptions of future events including the continued availability of certain resources, third-party cation plans and other factors. However , there can be no guarantee that these estimates will be achieved; actual resu l ts could differ materially from those plans. Specific tors that might cause such material differences include, but are not limited to, the availability and cost of personnel trained in this area, the ability to locate and correct all vant computer programs and microprocessors, and similar uncertainties. The Company's operations have in the past and may in the future require substantial capital expenditures in order to comply with environmental laws. Additionally , under federal and state environmental la w s , the Company is generally liable for the costs of remed i ating environmental contamination of property now or formerly owned by the Company and of property contaminated by hazardous substances gene r ated by the Company. The Company owns or leases a number of real estate parcels, including parcels on which its operations or the operations of others may have resulted in tion by substances which are considered hazardous under environmental laws. The Company is currently involved in a number of proceedings relating to sites where hazardous 20 substances have been deposited and may be subject to tional proceedings in the future. The Company has identified 27 sites where former ufactured gas plant (MGP) activities have or may have resulted in site contamination. The Company is presently engaged in performing various levels of activities at these sites, including initial evaluation to determine the existence and nature of the contamination, detailed evaluation to mine the extent of the contamination and the necessity and possible methods of remediation, and implementation of remediation.

The Pennsylvania Department of Environment al Protection has approved the Company's clean-up of two sites. Six other sites are currently under some degree of active study and/or remediation.

As of December 31, 1997 and 1996, the Company had accrued $63 and $28 million, respectively, for environmental investigation and remediation costs, including

$35 and $16 million, respectively, for MGP investigation and remediation that currently can be reasonably estimated.

The Company expects to expend $5 million for environmental remediation activities in 1998. The Company cannot currently predict whether it will incur other significant liabilities for any tional investigation and remediation costs at these or additional sites identified by the Company, environmental agencies or others, or whether such costs will be recoverable from third parties. For a discussion of other contingencies, see notes 3, 4 and 5 of Notes to Consolidated Financial Statements.

Forward-Looking Statements E xcept for the historical information contained herein, certain of the matters discussed in this Report are forward-looking statements which are subject to risks and uncertainties.

The factors that could cause actual results to differ materially include those discussed herein as well as those listed in notes 3, 4 and 5 of Notes to Consolidated Financial Statements and other factors discussed in the Company's ings with the Securities and Exchange Commission.

Readers are cautioned not to place undue reliance on these looking statements, which speak only as of the date of this Report. The Company undertakes no obligation to publicly release any revision to these forward-looking statements to reflect events or circumstances after the date of this Report. PECO Energy Company and Subsidiary Companies

• * *

• *

• Report of Independent Accountants To the Shareholders and Board of Directors PECO Energy Company: 21 We have audited the accompanying consolidated balance sheets of PECO Energy Company and Subsidiary Companies as of December 31, 1997 and 1996, and the related consolidated statements of income, cash flows, and changes in common shareholders' equity and preferred stock for each of the three years in the period ended December 31, 1997. These financial statements are the responsibility of the Companies' management.

Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance w i th generally accepted auditing dards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of mate r ial misstatement.

An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes ing the accounting principles used and significant estimates made by management , as well as evaluating the overall financial statement p r esentat i on. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of PECO Energy Company and Subsidiary Companies as of December 31 , 1997 and 1996, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, i n conformity with generally accepted accounting principles.

2400 El even Penn Center Philadelphia , Pennsylvania F e b r ua ry 2 , 1998 22 PECO Energy Company and Subsidiary Companies Consolidated Statements of Income

• For the Years Ended December 31 , 1997 1996 1995 Thousands of Dollars Operating Revenues Electric $ 4 , 166,669 $ 3 , 854,836 $ 3,775 , 326 Gas 451 , 232 428,814 410,830 Total Operating Revenues 4,617,901 4,283,650 4,186,156 Operating Expenses Fuel and Energy Interch a nge 1,290,164 972,380 762,762 Operating and Maintenance 1,431,420 1,274,222 1,251,273 Depreciation 580,595 489,001 457,254 Taxes O ther T han Income 310,091 299, 5 46 314,071 Total Operating E xpenses 3 , 612,270 3,035 , 149 2,785,360 Operating Income 1,005,631 1,248,501 1,400,796 Other Income and Deductions Interest Expense (372,857)

(382,443)

(423,711 I Company Obligated Mandator il y Redeemable Preferred Securities of a Partnership, which holds Solely Subordinated Debentures of the Company (28 , 990) (26,723) (20,987) Allowance for Funds Used During Construction 21 , 771 19,947 27,050 Settlement of Salem Litigation 69,800 Gain on Sale of Subsidiary 58,745 Other, net (66,028) (1,976) (444) Total Other Income and Deductions (376,304)

(391,195)

(359,347)

Income Before Income Taxes and Extraordinary Item 629,327 857,306 1,041,449 Income Taxes 292,769 340, 101 431,717 Income Before Extraordinary Item 336,558 517,205 609,732 E xtraordinary Item (net of $1,290,961 income taxes) (1,833,664)

Net (Loss) Income (1,497,106) 517,205 609,732 Preferred Stock Dividends 16,804 18,036 23,217 Earnings Applicable to Common Stock $ (1,513,910)

$ 499, 169 $ 586,515 Average Shares of Common Stock Outstanding (Thousands) 222,543 222,490 221,859 Basic and Dilutive Earnings per Average Common Share Before Extraordinary Item (Dollars)

$ 1.44 $ 2.24 $ 2.64 Extraordinary Item (Dollars)

$ (8.24) $ $ Basic and Dilutive Earnings per Average Common Share (Dollars)

$ (6.80) $ 2.24 $ 2.64 Dividends per Common Share (Dollars)

$ 1.80 $ 1.755 $ 1.65

• See Notes to Consolidated Finondal Statements.

PECO Energy Company and Subsidiary Companies 23

• Consolidated Statements of Cash Flows For the Years Ended December 31, 1997 1996 1995 Thousands of Dollars Cash Flows from Operating Activities Net Income $ (1,497 ,1 06) $ 517,205 $ 609,732 E xtraordinary Item (net of $1,290,961 income taxes) (1,833,664)

Income Before E xtraordinary Item 336 , 558 517,205 609,732 Adjustments to reconcile Net Income to Net Cash provided by Operating Activities:

Depreciation and Amortization 664 , 294 566,412 531,299 Deferred Income Taxes (17,228) 166,771 183,514 Salem L itigation Settlement 69,800 Gain on Sale of Subsidiary (58,745) Deferred Energy Costs (5,652) (66, 151) (71, 104) Amortization of Leased Property 39,100 31,400 42,900 Changes in Working Capital: Accounts Receivable (289,610) 53,681 (8,198) Inventories 28,628 (2,729) (10,872) Accounts Payable 93,881 (86,765) (4,686) Other Current Assets and Liabilities 58,539 (25,040) 9,641

• Deferred Credits -Other 78,846 (4,609) 5,172 Other Items affecting Operations (19,005) 22,070 11,683 Net Cash Flo ws from Operating Activities 1,038,151 1 , 172,245 1,240,336 Cash Flows from Investing Activities Investment in Plant (490,200)

(548,854)

(532,614)

Proceeds from Sale of Subsidiary 150,000 Increase in Other Investments (83,261) (114,126)

(82 , 041) Net Cash Flows from Investing Activities (573,461)

(662,980)

(464,655)

Cash Flows from Financing Activities Change in Short-Term Debt 114,000 287,500 (11,499) Issuance of Common Stock 117 11,301 15,585 Retirement of Preferred Stock (61,895) (78,105) Issuance of Company Obligated Mandatorily Redeemable Preferred Securities of a Partnership 50,000 81,032 Issuance of Long-Term Debt 161,813 43,700 182,540 Retirement of Long-Term Debt (283,303) (427,463) (575,713)

Loss on Reacquired Debt 22,752 24,724 12,302 Dividends on Preferred and Common Stock (417,383)

(411,569)

(390,340)

Change in Dividends Payable (5,438) 1,685 5,626 Expenses of Issuing L ong-Term Debt and Capital Stock (2,084) 890 (577) Capital Lease Payments (39,100) (31,400) (42,900) Net Cash Flows from Financing Activities (460,521)

(500,632)

(802,049)

Increase (Decrease) in Cash and Cash Equivalents 4 , 169 8,633 (26 , 368)

• Cash and Cash Equivalents at beginning of period 29,235 20,602 46,970 Cash and Cash Equivalents at end of period $ 33 , 404 $ 29,235 $ 20,602 See Notes to Consolidated Financial Statements.

24 Consolidated Balance Sheets At December 31, Assets Utility Plant Electric-Transmission

& Distribution Ele ctric-Generation Gas Common Less Accumulated Provision for Depreciation Nuclear Fuel, net Construction Work in Progress Lea sed Property, net Net Utility Plant Current Assets Cash and Temporary Cash Investments Accounts Receivable, net Customers Other Inventories, at average cost Fossi l F uel Materials and Supplies Deferred Generation Costs R ecoverable in Current Rates Deferred Energy Costs-Gas Other Total Current Assets Deferred Debits and Other Assets Competitive Transition Charge Recoverable Deferred Income Ta xes Deferred Limeric k Costs Deferred Non-Pension Postretirement Benefits Costs Deferred Energy Costs-Electric Investments Los s on Reacquired Debt Other Total Deferred Debits and Other Assets Total Assets See Notes to Consolidoted Financial Statements.

PECO Energy Company and Subsidiary Companies

$ 1997 3,617,666 1,434,895 1,071,819 302,672 6,427,052 2,690,824 3,736,228 147,359 611,204 175 , 933 4,670 , 724 33,404 173,350 139,996 84,858 90,890 424,497 35,665 20,115 1 , 002,775 5,274,624 590,267 97,409 515,835 83,918 121,016 6,683,069 1996 Thousands of Dollars $ 3,494,778 10, 127,602 1,005,507 317,065 14,944,952 5,046,950 9,898,002 199,579 661,871 182,088 10,941,540 29,235 19,159 74,377 84,633 119,743 30,013 63,234 420,394 2,325,721 361.762 233,492 92,021 432,574 283,853 169 ,262 3,898,685

• $ 12,356,568

$ 15,260,619

• PECO Energy Company and Subsidiary Companies 25

• Consolidated Balance Sheets (Continued)

At December 31, 1997 1996 Thousands of Dollars Capitalization and Liabilities Capitalization Common Shareholders' Equity Common Stock s 3,517,731

$ 3 ,51 7,614 Other Paid-In Capital 1,239 1 ,326 Retained (Deficit)

E arnings (792,239) 1 , 127,041 2,726,731 4 , 645 ,981 Preferred and Preference Stock Without Mandatory Redemption 137,472 199 ,367 With Mandatory Redempt ion 92,700 92 ,700 Company Obligated Mandatorily Redeemable Preferred Securities of a Partne rship, which holds Solely Subordinated Debentures of the Company 352,085 302, 182 Long-Term Debt 3,853,141 3,935,514 Total Capitalization 7, 162, 129 9, 175,744

• Current Liabilities Notes Payable, Ban k 401,500 287,500 Long-Term Debt Due Within One Year 247,087 283,303 Capital Lease Ob ligations Due Within One Year 55,808 49,347 Accounts Payable 306,847 212,966 Taxes Accrued 66,397 71,482 Interest Accrued 77,911 82,006 Dividends Payable 16,969 22,407 Deferred Income Ta xes 185,696 2,745 Other 260,457 91,608 Total Current Liabilities 1,618,672 1 , 103,364 Deferred Credits and Other Liabilities Capital Lease Obligations 120, 125 132,741 Deferred Income Ta xes 2,297,042 3,745,242 Unamortized Investment Ta x Credits 318,065 336, 132 Pension Obligation 211,596 224,454 Non-Pension Postretirement Benefits Obligat ion 324 , 850 315,058 Other 304,089 227,884 Total Deferred Credits and Other Liabilities 3,575,767 4,981,511 Commitments and Contingencies (Notes 3 , 4 and 5}

• Total Capitalization and Liabilities s 12,356,568

$ 15,260,619 See Notes to Consolidated Financial Statements.

26 PECO Energy Company and Subsidiary Companies Consolidated Statements of Changes in Common Shareholders' Equity and Preferred Stock

• Other Retained Common Stock Paid-In Earnings Preferred Stock All Amounts in Thousands Shares Amount Capital (Defi cit) Shares Amount Balance at January 1 , 1995 221,609 $ 3.490,728

$ 1 , 271 $ 810 , 507 3,702 $ 370, 172 Net Income 609,732 Cash Dividends Declared Preferred Stoc k (at specified annual rates) (24,253) Common Stock ($1.65 per share) (366,087)

E xpenses of Capital Stock Activity (4,035) Capital Stock Activity Longl"erm Incentive Plan Issuances 563 15,585 (2,156) Preferred Stock Issuances 55 Preferred Stock Redemptions (781) (78 , 105) Balance at December 31 , 1995 222, 172 3,506,313 1 , 326 1 , 023,708 2,921 292,067 Net Income 517,205 Cash Dividends Declared Preferred Stock (at specified annual rates) (21,042) Common Stoc k ($1.755 per share) (390,527)

• Expenses of Capital Stock Activity (275) Capital Stock Activity Longl"erm Incent ive Plan Issuances 370 11,301 (2,028) Balance at December 31, 1996 222,542 3,517,614 1,326 1, 127,041 2,921 292,067 Net Loss (1,497,106)

Cash Dividends Declared Preferred St ock (at specified annual rates) (16,805) Common Stock ($1.80 per share) (400,578)

E xpenses of Capital Stock Activity 98 Interest on Stock Repurchase Forward Contract (4,889) Capital Stock Activity Longl"erm Incentive Plan Issuances 5 117 Preferred Stock Redemptions (87) (619) (61,895) Balance at December 31, 1997 222,547 $ 3 , 517,731 $ 1,239 $ (792,239) 2,302 $ 230,172

• See Notes to Consolidated Financial Statements.

Notes to Consolidated Financial S tatements

• Notes to Consolidated Financial Statements

1. Significant Accounting Policies General The consolidated financial statements of PECO E nergy Company include the accounts of its utility subsidiary companies, all of which are wholly owned. Accounting policies are in accordance with those prescribed by the regulatory ities having jurisdiction , principally the Pennsylvania Public Utility Commission (PUC) and the Federal Energy Regulatory Commission (FER C). The Company has unconsolidated utility subsidiaries which are not material.

The unconsolidated subsidiaries are accounted for under the equity method. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires ment to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could fer from those estimates.

E stimates are used in the Company's accounting for unbilled revenue, the allowance for uncollectible accounts fuel adjustment clause, depreciation and amortization, reserves for contingencies, employee benefits, certain fair value and recoverability determinations, and nuclear outage costs , among others. Accounting for the Effects of Regulation The Company accounts for all of its regulated operations in accordance with Statement of F inancial Accounting Standards (SFAS) No. 71, " Accounting for the Effects of Certain Types of Regulation," requiring the Company to record the financial statement effects of the rate regulation to which the Company is currently subject. If a separable tion of the Company's business no longer meets the provisions of SFAS No. 71 , the Company is required to nate the financial statement effects of regulation for that portion. Effective December 31, 1997, the Company mined that the electric generation portion of its business no longer met the criteria of SFAS No. 71 and, accordingly , implemented SFAS No. 101, "Regulated Enterprises

-Accounting for the Discontinuation of FASB Statement No. 71," for that portion of its business (see note 4). Revenues Electric and gas revenues are recorded as service is rendered or energy is delivered to customers. At the end of each month, the Company accrues an estimate for the unbilled

• amount of energy delivered or services provided to tomers (see note 8). 27 Energy and Purchased Gas Cost Adjustment Clause T he Company's gas rates are subject to a fuel adjustment clause designed to recover or refund the difference between the actual cost of purchased gas and the amount included in base rates. Differences between the amounts billed to tomers and the actual costs recoverable are deferred and recovered or refunded in future periods by means of tive adjustments to rates. Such rates are adjusted quarterly.

Prior to December 31, 1996, the Company's retail tric rates were subject to an Energy Cost Adjustment (ECA) clause designed to recover or refund the difference b e tween the actual cost of fuel, energy interchange or purchased power and the amount of such cos t s included in base rates. Effective December 31, 1996, the P UC approved the roll-in of electric energy costs into the base rates charged to the Company's retail electric customers and such rates are no longer subject to the ECA. Utility Plant Effective December 31, 1997, electric generation plant is ued at the lower of original cost or market pursuant to SFAS No. 121, "Accounting for the Impairment of L ong-L ived Assets and for Long-Lived Assets to be Disposed Of." All other utility plant continues to be valued at original cost (see note 4). Nuclear Fuel The cost of nuclear fuel is capitalized and charged to fuel expense on the unit of production method. Estimated costs of nuclear fuel disposal are charged to fuel expense as the related fuel is consumed.

The Company's share of nuclear fuel at Peach B ottom Atomic Power Station (Peach Bottom) and Salem Generating Station (Salem) is accounted for as a capital lease. Nuclear fuel at L imerick Generating Station (Limerick) is owned. Depreciation and Decommissioning Depreciation is provided over the estimated service lives of plant on the straight-line method. The Company is currently reviewing the useful lives of its electric generation assets. Annual depreciation provisions for financial reporting es, expressed as a percentage of average depreciable utility plant in service, were approximately 3.3% in 1997, 2.9% in 1996 and 2.8% in 1995. See note 3 for information ing the change in 1996 to depreciation and amortization.

T he Company's current estimate of the costs for decommissioning its ownership share of its nuclear generating stations is currently included in electric base rates and is charged to operations over the expected service life of the related plant. The amounts recovered from customers are deposited in trust accounts and invested for funding of future costs. These amounts, and realized investment earnings thereon, are credited to accumulated depreciation.

The Company believes that the amounts being recovered from customers through electric rates will be sufficient to fully fund the unrecorded portion of its decommissioning tion (see note 5).

28 Income Taxes The Company uses an asset and liab i lity approach for financial a c counting and report i ng of income ta x es. Investment ta x credits are deferred and amortized to income over the mated useful life of the related property (see note 14). Allowance for Funds Used During Construction (AFUDC) AFUDC is the cost, during the period of construction, of debt and equity funds used to finance construction projects.

AFUDC is recorded as a charge to Construction Work in Progress and as a credit to Other Income and Deductions.

The rates used for capitalizing AFUDC, which averaged 8.88% in 1997, 9.38% in 1996 and 9.88% in 1995, are puted under a method prescribed by regulatory authorities. AFUDC is not included in regular taxable income and the depreciation of capitalized AFUDC is not tax deductible.

Effective January 1, 1998, the Company ceased accruing AFUDC for electric generation

-related construction projects and will use SFAS No. 34, "Capitalizing Interest Costs," to calculate the costs during the period of construction of debt funds used to finance its electric generation-related tion projects. Nuclear Outage Costs Incremental nuclear maintenance and refueling outage costs are accrued over the unit operating cycle. For each unit. an accrual for incremental nuclear maintenance and refueling outage e x pense is estimated based upon the latest planned outage schedule and estimated costs for the outage. 2. Nature of Operations and Segment Information T he Company provides retail electric and natural gas service to the public in southeastern Pennsylvania and, in pilot programs, natural gas service to areas in Maryland and New Jersey. T he Company also engages in the wholesale ing of electricity on a national basis. The Company participates in joint ventures which provide telecommunications services in the Philadelphia area. The Company's traditional retail service territory covers 2, 107 square miles. E lectric service is furnished to an area of 1,972 square miles F o r the Years Ended December 31 , Electric Operations Operating revenues:

Residential Small commercial and industrial Large commercial and industrial Other Unbilled Service territory Interchange sales Sales to other utilities Total operating revenues Operating expenses , e x cluding depreciation Depreciation Operating income U ti l i t y p l a nt a dditi o n s PECO Energy Company and Subsidiary Companies Differences between the accrued and actual expense for the outage are recorded when such differences are known. Capitalized Software Costs Software projects which e x ceed $5 million are capitalized.

At December 31, 1997 and 1996 , capitalized software costs totaled $86 and $78 million (net of $29 million accumulated amortization in each year), respectively. Such capitalized amounts are amortized ratably over the expected lives of the projects when they become operational, not to exceed ten years. Gains and Losses on Reacquired Debt Prior to December 31, 1997, gains and losses on reacquired debt were deferred and amortized to interest expense over the period approved for ratemaking purposes.

Effective January 1, 1998, gains and losses on reacquired debt as sated with the electric generation portion of the Comp a ny's operations will be expensed as incurred.

Gains and losses on reacquired debt associated with the Company's regulated operations will continue to be deferred and amortized to interest expense over the period approved for ratemaking purposes.

Reclassifications Certain prior-year amounts have been reclassified for ative purposes. These reclassifications had no effect on net income or common shareholders

' equity. with a popula t ion of 3.6 million, including 1 .6 million in the City of Philadelphia.

Approximately 94% of the retail electric service area and 64% of retail kilowatthour (kWh) sales a re in the suburbs around Philadelphia, and 6% of the re t ail service area and 36% of such sales are in the City of P hiladelphia.

Natural gas service is supplied in a 1 ,475-square-mile ar e a of southeastern Pennsylvania adjacent to Philadelphia with a population of 1.9 million. 1997 1 99 6 1 9 95 Thousands of D ollars $ 1 , 357.449 $ 1,370, 158 $ 1,379,046 778,743 748,561 730,220 1 , 077,374 1 , 098,307 1, 13 5 ,550 147 , 523 140,133 136,988 19, 130 (25,950) 42,580 3 , 380,219 3 , 331,209 3,424,384 58 , 614 25,991 1 7,488 727,836 49 7 ,636 333,4 5 4 4 , 166 , 669 3,854,836 3,77 5 ,326 2 , 697,877 2 , 243,094 2,026, 112 552 , 667 462,315 430,993 $ 916 ,1 25 $ 1,149,427

$ 1,318,221

$ 382,157 $ 447,105 $ 435,400 * *

• Notes t o Co n solidated F ina n cial S tate m ents

• F or the Ye a rs Ended D ecember 31, Gas Operations Opera t ing revenues:

Residential House heating C omm e rcial and industrial O ther Unb i lled Subtotal O ther revenues (including transported for customers)

Total operating revenues Operating expenses, excluding depreciation Dep r eci a tion O p e rating income U t ility plant additions Identifiable Assets* at December 31 , E lectric G as Nonallocable assets Total assets $ 1997 16,852 265 , 299 144,801 3,228 (969) 429 , 211 22 , 021 451 , 232 333 , 798 27,928 $ 89 , 506 $ 85 , 212 $ 9 , 610 , 984 966 , 685 1,778 , 899 $ 12,356 , 568 29 1996 1995 $ 15, 716 249 , 507 132,822 11.462 (4,250) 405,257 23,557 428,814 303,0 5 4 26,686 $ 99,074 $ 68,394 $ 10,287.444 858.471 4, 114,704 $ 15,260,619 Thousands of Dollars $ 15.482 235.456 125,631 5,382 6,540 388.491 22,339 410,830 301,994 26 , 261 $ 82,5 75 $ 63,19 2 $ 10.408, 105 785,881 4,114,519

$ 15,308,505

• Incl u des utility plant less accumulated depreciation, inventories, segment-specific regulatory assets and allocated common utility property . *

• 3. Rate Matters Competition Act The E lectricity Generation Customer Choice and Competition Act (Competition Act) was enacted in December 1996, viding for the restructuring of the electric utility industry in P ennsylvania, including retail competition for generation beginning in 19 9 9. The Competition Act requires the unbundling of electric services into separate generation , transmission and distribution services with open retail competition for gen e ration. E lectric d i str i bution and transmission services wi l l remain regulat e d by the P UC. The Competition Act requires utilities to submit to the PUC restructuring plans, including their quantification of stranded costs (the loss in value of the Company's electric generation-related assets, which will result from competition).

The Competition Act authorizes the recovery of stranded costs through charges to dist r ibution cu s tom e rs for up to nine years (or for an tive period determined by the PUC for good cause shown). D uring t h at period, the utility is subject to a rate cap which prov i des t hat total char g es to customers cannot exceed rates in p lace as of D ecember 31, 1996, s u bject to cer t ain exceptions. T he C ompe t ition Act a l so caps transmission and distr i bution rates from D ecember 31, 1996 through June 30, 2001 , subject to certain e xc eptions. Pursuant to the Competition Act, in April 1997 , the Company filed with the PUC a comprehensive restructuring plan detai l ing its proposal to implement full customer choice of electric generation supplier.

The Company's restructuring p l an identified

$7.5 billion of s tranded costs. I n August 1997, the Comp a ny and va r ious in t ervenors in the Company's rest r ucturing proceeding filed with the P UC a Joint P etition for Part ia l Settlement (P ennsy l vania P l an). In December 1997 , the PUC rejected the Pennsylvania Plan and entered an Opinion and Order, revised in January 1998 (PUC Restructuring Order), that deregulates the Company's electric generation operations. The PUC Restructuring Order allows the Company to recover $4.9 lion on a discounted basis, or $5.3 billion on a book value basis , over 8 1/2 years beginning in 1999. Recovery of allowed stranded costs will be through a separate charge to be elized over the recovery period using a 7.47% cost of capital. Other major provisions of the P UC R estructuring Order include capping customer bills at the year-end 1996 wide average of 9.95 cents per kWh; beginning January 1, 1999, unbundling rates into a transmission and distribution component, the charge for recovery of stranded costs and a "s hopping credit" for generation

and phasing-in customer choice of electric generation supplier for all customers in three steps

one-third of the peak load of each customer class on January 1, 1999, one-third on January 2, 1999 (one day later) and the remainder on January 2, 2000. To age competition, the P UC established the "shopping credit" for generation in excess of current market prices. On January 21, 1998, the Company filed a complaint in the U.S. District Court for the Eastern District of Pennsylvania seeking injunctive and monetary relief on the grounds that the Competition Act and the PUC Restructuring Order: (1) are pre-empted by Section 201 (b) of the Federal Power Act; (2) effect a taking of private property without just compensation in violation of the Fifth and Fourteenth Amendments to the U.S. Constitution; (3) violate the Due P rocess Clause. the Contract Clause and the First Amendment of the U.S. Constitution; and (4) deprive the Company of certain other federally protected rights.

30 On January 22, 1998, the Company filed two Petitions for Review in the Commonwealth Court of Pennsylvania, appealing the PUC Restructuring Order. The petitions state that the PUC Restructuring Order must be set aside because it is based upon errors of law, is not supported by substantial evidence, constitutes an arbitrary and capricious abuse of administrative discretion and deprives the Company of the due process of law, to which it is entitled under Article I of the Pennsylvania Constitution.

Limerick Under its electric tariffs through December 31, 1997, the Company was recovering

$285 million of deferred Limerick costs representing carrying charges and depreciation ated with 50% of L imerick common facilities.

T he Company also deferred certain operating and maintenance expenses, depreciation and accrued carrying charges on its capital investment in Limerick Unit No. 2 and 50% of Limerick mon facilities.

These costs were included in base rates and were being recovered over a nine-year period beginning October 1, 1996. The Company was also recovering

$137 million of Limerick Unit No. 1 costs over a ten-year period without a return on investment.

At December 31, 1997, the unamortized portion of these regulatory assets were included as part of electric generation-related regulatory assets (see note 4). Under its electric tariffs and ECA. the Company was allowed to retain for shareholders any proceeds above the average energy cost for sales of 399 megawatts (MW) of near-term excess capacity and/or associated energy and to share in the benefits of energy savings which resulted from the operation of both Limerick Units No. 1 and No. 2. The Company's ECA was discontinued at December 31, 1996. During 1996 and 199 5 , the Company recorded as revenue net of fuel costs $82 and $79 million, respectively, as a result of the sale of the 399 MW of capacity and/or associated energy and the Company's share of Limerick energy savings. Declaratory Accounting Order P ursuant to a PUC Declaratory Order, effective October 1, 1996, the Company increased depreciation and amortization on assets associated with Limerick by $100 million per year and decreased depreciation and amortization on other Company assets by $10 million per year, for a net increase in depreciation and amortization of $90 million per year. Effective December 31, 1997, the Company ceased this increased depreciation since this Declaratory Order has been superseded by the PUC Restructuring Order. At December 31, 1997, the* $90 million of depreciation and amortization that would have been recognized in 1998 was deferred as a regulatory asset, since the Company's rates will continue to be cost-based until January 1, 1999, and will be amortized and recovered in 1998. Recovery of Non-Pension Postretirement Benefits Costs Effective January 1995, the Company increased electric base rates by $25 million per year to recover the increased costs, including the annual amortization of the transition obligation (over 18 years) deferred in 1994 and 1993, associated with the implementation of SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions" (see note 7). During 1997 and 1996, the Company PECO Energy Company and Subsidiary Companies deposited

$26 and $47 million, respectively, in trust accounts to fund its retail electric non-pension postretirement benefits costs. These costs include amounts charged to operating expense or capitalized during 1997 and 1996. At December 31, 1997, $121 million of the previously recorded transition obligation was included as part of electric generation-related regulatory assets (see note 4). The Company recognizes

$2.8 million in non-pension postretirement benefits costs annually associated with gas utility operations. During 1997 and 1996, the Company deposited

$2.8 and $2.9 million, respectively, in trust accounts to fund its gas non-pension postretirement benefits costs. Energy Cost Adjustment Through December 31, 1996, the Company was subject to a P UC-established electric ECA which, in addition to reconciling fuel costs and revenues, incorporated a nuclear performance standard which allowed for financial bonuses or penalties depending on whether the Company's system nuclear ty factor exceeded or fell below a specified range. For the years ended December 31, 1996 and 1995, the Company recorded bonuses of $22 and $13 million, respectively.

4. Accounting Changes The Company accounts for all of its regulated operations in accordance with SFAS No. 71 which allows the Company to record the financial statement effects of the rate regulation to which the Company is subject. Use of SFAS No. 71 is able to the utility operations of the Company which meet the following criteria:

(1) third-party regulation of rates; (2) based rates; and (3) a reasonable assumption that all costs will be recoverable from customers through rates. In 1997, the Financial Accounting Standards Board (F ASB) through its E merging Issues Task F orce (EI T F) issued EI T F No. 97-4, "Deregulation of the P ricing of E lectricity

-Issues Related to the Application of F ASB Statements No. 71, Accounting for the E ffects of Certain Types of Regulation, and No. 101, Regulated Enterprises

-Accounting for the Discontinuation of Application of F ASB Statement No. 71." T he EIT F agreed that: a) an entity should cease to apply SFAS No. 71 no later than the date the specific deregulation plan is enacted and the details of that plan are known, and b) both stranded costs and regulated assets and liabilities should tinue to be recognized to the extent that the transition plan provides for their recovery through the regulated sion and distribution portion of the business.

The Company believes that the PUC Restructuring Order provides sufficient details regarding the deregulation of the Company's electric generation operations to require the Company to discontinue the application of SFAS No. 71 for those operations. E ffective December 31, 1997, the Company adopted the provisions of SFAS No. 101 for its electric generation operations.

S F AS No. 101 requires a determination of impairment of plant assets under S F AS No. 121, and the elimination of all effects of rate regulation that have been recognized as assets and liabilities pursuant to SFAS No. 71. * *

• Notes to Consolidated F inancial Statements

• At December 31, 1997, the Company performed an impairment test of its electric generation assets pursuant to SFAS No. 121 on a plant spe c ific bas i s and determined that $6.1 billion of its $7.1 bill i on of electr i c generation assets would be impaired as of December 31 , 1998. The Company estimated the fair value for each of its electric generating units by determining its estimated future operating cash inflows and outflows.

The net future cash flows for each electric generating plant were then compared to its net book value. For any electric generation plant with future counted cash flows less than its book value, net cash flows were discounted using a discount rate commensurate with the risk of each electric generating plant. Since the Company's retail electric rates will continue to be cost-based until January 1, 1999, $0.3 billion representing depreciation e x pense on electric generation-related assets in 1998 has been reclassified to a regulatory asset and w ill be amortized and recovered in 1998. At December 31, 1997, the Company had $2.7 billion of electric generation-related regulatory assets , of which $0.1 billion will be amortized and recovered through cost-based rates in 1998. At December 31 , 1997, the Company had total electric generation-related stranded costs of $8.4 billion, representing

$5.8 billion of net stranded electric generation plant and $2.6 billion of electric generation-related regulatory assets. The PUC Restructuring Order allows the Company to recover * $4.9 billion on a discounted basis, or $5.3 billion on a value basis, of its generation-related stranded cos t s from customers. This results in a net unrecoverable amount of $3.1 billion.

• Although the Company is appealing the PUC Restructuring Order, Management believes that EITF No. 97-4 required it to write off all electric generation-related stranded costs for which recovery through rates has not been provided. Accordingly, the Company recorded an nary charge at December 31, 1997 of $3.1 billion ($1.8 billion net of taxes) of electric generation-related stranded costs that will not be recovered from customers.

A summary as of D ecember 31, 1997 of the electric generation-related stranded costs and the amount of such stranded costs wr i tten-off by the Company is shown in the following table: 31 (Thousands of Dollars) Electric generation-related asset impairment determined pursuant to SFAS No. 121 Net book value of electric generation-related assets before write-down December 31, 1998 market value of electric generation-related assets pursuant to SFAS No. 121 E x pected 1998 change in net plant recognized for recovery until cost-based rates cease at December 31, 1998 Electric generation-related asset impairment

$ Electric generation-related regulatory assets R ecoverable D eferred Income Taxes Deferred Limerick Costs Deferred Non-Pension Postretirement Benefits Other Than Pensions Deferred Energy Costs -Electric Loss on Reacquired Debt Additional assets written-off pursuant to discontinuance of S F AS No. 71 Other Regulatory asset recognized for recovery until cost-based rates cease at December 31, 1998 Total electric generation-related regulatory assets Total electric generation-related stranded costs Amounts approved for collection from customers (regulatory asset pursuant to EITF No. 97-4) 7 , 115 , 155 (990,376)

(303,800) 5,820,979 1,762 , 946 321,420 120 , 899 92 , 021 177,183 104 , 818 90,480 (91,497) 2,578 , 270 8 , 399,249 (5,274,624)

Total Extraordinary Item $ 3,124,625 Due to the market-based pricing of electric generation provisions of the PJM Interconnection, L.L.C. restructuring order approved by the FERC in November 1997, the Company believes that its wholesale energy sales operations are no longer subject to the provisions of SFAS No. 71. Based on projections of the Company's retail load growth , the Company believes all of its owned generation capacity is necessary to meet its electric retail load. As a result. the discontinuance of SFAS No. 71 for its wholesale energy sales operations has not resulted in an additional charge against income. The Company bel i eves that its electric transmission and distribution system and gas operations continue to meet the provisions of SFAS No. 71. The Company believes that it is probable that regulatory assets associated with these tions will be recovered.

32 The Company has adopted SFAS No. 128, "Earnings Per Share," which is designed to simplify the existing tional guidelines for the earnings per share (EPS) information provided in financial statements, to revise the disclosure requirements and to increase the comparability of EPS data on an international basis. Pursuant to SFAS No. 128, the Company reflected on its Consolidated Statements of Income basic EPS and dilutive EPS for the years ended December 31, 1997, 1996 and 1995. Adoption of SFAS No. 128 did not impact the amount of EPS reported and there is no ence in the amounts calculated as basic EPS and dilutive EPS. 5. Commitments and Contingencies Capital Commitments Total capital expenditures , primarily for utility plant. are mated to be $600 million in 1998. Due to the expected adverse impact of the PUC Restructuring Order and tion for electric generating services on its future capital resources, the Company is currently evaluating its capital commitments for 1999 and beyond. Certain facilities under construction and to be constructed may require permits and licenses which the Company has no assurance will be ed. The Company has undertaken a number of new ventures, principally through its Telecommunications Group, some of which require significant cash commitments.

For 1998, the Company's expected capital expenditures include mately $150 million in such ventures.

The Company's operations have in the past and may in the future require substantial capital expenditures in order to comply with environmental laws. Nuclear Insurance The Price-Anderson Act currently limits the liability of nuclear reactor owners to $8.9 billion for claims that could arise from a single incident.

The limit is subject to change to account for the effects of inflation and changes in the number of licensed reactors.

The Company carries the maximum available mercial insurance of $200 million and the remaining

$8.7 billion is provided through mandatory participation in a cial protection pool. Under the Price-Anderson Act. all nuclear reactor licensees can be assessed up to $79 million per tor per incident, payable at no more than $10 million per reactor per incident per year. This assessment is subject to inflation and state premium taxes. In addition, Congress could impose revenue raising measures on the nuclear try to pay claims. The Company carries property damage, decontamination and premature decommissioning insurance in the amount of its $2.75 billion proportionate share for each station loss resulting from damage to its nuclear plants. In the event of an accident, insurance proceeds must first be used for tor stabilization and site decontamination.

If the decision is made to decommission the facility, a portion of the insurance proceeds will be allocated to a fund, which the Company is required by the Nuclear Regulatory Commission (NRC) to maintain, to provide for decommissioning the facility.

The Company is unable to predict the timing of the availability of insurance proceeds to the Company for the Company's holders. and the amount of such proceeds which would be PECO Energy Company and Subsidiary Companies available.

Under the terms of the various insurance agree-* ments, the Company could be assessed up to $26 million for losses incurred at any plant insured by the insurance compa-nies. The Company is self-insured to the extent that any losses may exceed the amount of insurance maintained.

Such losses could have a material adverse effect on the Company's financial condition and results of operations. The Company is a member of an industry mutual ance company which provides replacement power cost insurance in the event of a major accidental outage at a nuclear station. The premium for this coverage is subject to assessment for adverse loss experience.

The Company's maximum share of any assessment is $13 million per year. Nuclear Decommissioning and Spent Fuel Storage The Company's current estimate of its nuclear fac ilities' decommissioning cost of $1 .5 billion in 1997 dollars is being collected through electric rates over the life of each ing unit. Beginning in 1999, these amounts will be recoverable through transmission and distribution rates. Under current rates, the Company collects and expenses approximately

$20 million annually from customers.

The expense is accounted for as a component of depreciation expense and accumulated depreciation.

At December 31, 1997 and 1996, $294 and $256 million, respectively, was included in accumulated depreciation.

In order to fund future decommissioning costs, at December 31, 1997 and 1996, the Company held $320 and $266 million, respectively, in trust

• accounts which are included as an Investment in the Company's Consolidated Balance Sheet and include both net unrealized and realized gains. Net unrealized gains of $43 and $26 million were recognized as a Deferred Credit in the Company's Consolidated Balance Sheet at December 31, 1997 and 1996, respectively.

The Company recognized net realized gains of $11, $10 and $9 million as Other Income in the Company's Consol idated Statement of Income for the years ended December 31, 1997, 1996 and 1995, respective-ly. The Company believes that the amounts being recovered from customers through electric rates will be sufficient to fully fund the unrecorded portion of its decommissioning obligation.

In an E xposu re Draft issued in 1996, the FASB proposed changes in the accounting for closure and removal costs of production facilities, including the recognition, measurement and classification of decommissioning costs for nuclear erating stations.

The FASB has expanded the scope of the Exposure Draft to include closure or removal liabilities that are incurred at any time during the operating life of the ed long-lived asset. The FASB has decided that it should proceed toward either a final Statement or a revised E xposure Draft. The timing of this project is still to be mined. If current electric utility industry accounting practices for decommissioning are changed, annual provisions for decommissioning could increase and the estimated cost for decommissioning could be recorded as a liability rather than as accumulated depreciation with recognition of an increase

• in the cost of a related regulatory asset. Under the Nuclear Waste Policy Act of 1982 (NWPA), the U.S. Department of Energy (DOE) is required to begin taking possession of all spent nuclear fuel generated by the Company's nuclear units for long-term storage by no later than 1998. Based on recent public pronouncements, it is not Notes to Consolidated Financial Statements likely that a permanent disposal site will be available for the i ndustry before 2015, at the earliest.

In reaction to ments from the DOE that it was not legally obligated to begin to accept spent fuel in 1998, a group of utilities and state government agencies filed a lawsuit against the DOE which resulted in a decision by the U.S. Court of Appeals for the District of Columbia (D.C. Court of Appeals) in July 1996 that the DOE had an unequivocal obligation to begin to accept spent fuel in 1998. In accordance with the NWPA, the Company pays the DOE one mill ($.001) per kilowatthour of net nuclear generation for the cost of nuclear fuel disposal.

This fee may be adjusted prospect i vely in order to ensure full cost recovery. Because of inaction by the DOE following the D.C. Court of Appeals finding of the DOE's obligation to begin receiving spent fuel in 1998, a group of forty-two utility companies, including the Company, and forty-si x state agencies, filed suit against the DOE seeking authorization to suspend further payments to the U.S. government under the NWPA and to deposit such payments into an escrow account until such time as the DOE takes effective action to meet its 1998 obligations. In November 1997, the D.C. Court of Appeals issued a decision in which it held that the DOE had not ed by i ts prior determ i nation that the DOE has an unconditional obl i gation to begin disposal of spent nuclear fuel by January 31, 1998. The D.C. Court of Appeals also cluded the DOE from asserting that it was not required to begin receiving spent nuclear fuel because it had not yet pared a permanent repository or an interim storage facility. The DOE and one of the utility companies have filed a Petition for Reconsideration of the decision.

The U.S. House of Representatives and the U.S. Senate passed separate bills in 1997 authorizing construction of a temporary storage fac ity which could accept spent nuclear fuel from ut i lities in 2003. In addit i on , the DOE is e x ploring other options to address delays in the waste acceptance schedule.

Peach Bottom has on-site facilities with capacity to store spent nuclear fuel discharged from the units through 2000 for Unit No. 2 and 2001 for Unit No. 3. Life-of-plant storage capacity will be provided by on-site dry cask storage facilities, the construction of which will begin in 1998. Limerick has site facilities with capacity to store spent nuclear fuel to 2007. Salem has on-site facilities with spent fuel storage capacity through 2008 for Unit No. 1 and 2012 for Un i t No. 2. Public Service Electric and Gas Company (PSE&G) is the operator of Salem, which is 42.59% owned by the Company. Energy Commitments The Company's electric utility operations include the sale marketing of electricity.

At December 31, 1997, the Company had long-term commitments relating to the chase from unaffiliated utilities and others energy associated with 1,330 MW of capacity in 1998 , with 2,540 MW of ty during the period 1999 through 2002 and with 2,430 MW of capacity thereafter.

During 1997, purchases under long-term commitments resulted in e x penditures of $311 million. As of

• December 31, 1997 , these purchases result i n c ommitments of appro x imately $240 million for 1998 , $620 million for 1999 through 2002 and $830 million thereafter.

These purchases will be utilized through a combination of sales to jurisdictional customers, long-term sales to other utilities and open market sales. Under some of these contracts, the Company may chase, at its option, additional power as needed. 33 In the wholesale market, the Company has increased its sales to other utilities, but increased competition has reduced the Company's profit margins on these sales. At December 31, 1997, the Company had entered into long-term ments with unaffiliated utilities to sell energy associated with 4,280 MW of capacity, of which 540 MW of these ments are for 1998, 1,700 MW are for 1999 through 2002 and the remaining 2,040 MW extend through 2022. Environmental Issues The Company's operations have in the past and may in the future require substantial capital expenditures in order to comply with environmental laws. Additionally , under federal and state environmental laws, the Company is generally liable for the costs of remediating environmental contamination of property now or formerly owned by the Company and of property contaminated by hazardous substances generated by the Company. The Company owns or leases a number of real estate parcels, including parcels on which its operations or the operations of others may have resulted in contamination by substances which are considered hazardous under environmental laws. The Company is currently involved in a number of proceedings relating to sites where hazardous substances have been deposited and may be subject to tional proceedings in the future. The Company has identified 27 sites where former manufactured gas plant (MGP) activities have or may have resulted in actual site contamination.

The Company is presently engaged in performing various levels of activities at these sites, including initial evaluation to determine the e x istence and nature of the contaminat i on, detailed tion to determine the e x tent of the contamination and the necessity and possible methods of remediation, and implementation of remediation. The Pennsylvania Department of Environmental Protection has approved the Company's clean-up of two sites. Six other sites are currently under some degree of active study and/or remediation.

As of December 31, 1997 and 1996, the Company had accrued $63 and $28 million , respectively, for environmental investigation and remediation costs, including

$35 and $16 million, respectively, for MGP investigation and remediation , that currently can be reasonably estimated.

The Company cannot predict whether it will i ncur other significant liabilities for additional investigation and remed i ation costs at these or addit i onal sites identified by the Company , environmental agencies or others, or whether such costs will be recoverable from third parties. Shutdown of Salem Generating Station PSE&G removed Salem Units No. 1 and No. 2 from service in the second quarter of 1995 and informed the NRC at that time that it had determined to keep the Salem units shut down pending review and resolut i on of certain equipment and management issues and NRC agreement that each unit is sufficiently prepared to restart. Unit No. 2 returned to vice on August 30 , 1997 , and PSE&G estimates the restart of Un i t No. 1 to occur late in the first quarter of 1998. For the years ended December 31, 1997, 1996 and 1995 , the Company incurred and expensed approximately

$152, $149 and $50 million of shutdown-related replacement power and maintenance costs , respectively (see note 21 ).

34 PECO Energy Company and Subsidiary Companies Telecommunications The Company periodically reviews its investments to determine that they are properly valued in its financial ments. Due to circumstances involved in the Federal Communication Commission's auctioning of the personal communications systems "C-block" licenses, the Company has determined that $20 million of its telecommunications investments were impaired at December 31, 1997. Accordingly, at December 31, 1997. the Company incurred a $20 million charge against Other Income and Deductions to write off this telecommunications investment.

Litigation

• The Company is involved in various other litigation matters. The ultimate outcome of such matters, while uncertain.

is not expected to have a material adverse effect on the Company's financial condition or results of operations.

6. Retirement Benefits The Company and its subsidiaries have a non-contributory trusteed retirement plan applicable to all regular employees.

The efits are based primarily upon employees' years of service and average earnings prior to retirement.

The Company's funding policy is to contribute, at a minimum, amounts sufficient to meet the Employee Retirement Income Security Act requirements. Approximately 89%, 80% and 74% of pension costs were charged to operations in 1997, 1996 and 1995, respectively, and the remainder, associated with construction labor, to the cost of new utility plant. Pension costs for 1997, 1996 and 1995 included the following components:

Service cost benefits earned during the period Interest cost on projected benefit obligation Actual return on plan assets Amortization of transition asset Amortization and deferral Net pension cost $ $ 1997 25,368 150,057 (377,803)

(4,538) 197,480 (9,436) $ $ 1996 27,627 145,570 (320,247)

(4,538) 154.402 2,814 1995 Thousands of Dollars $ $ 19.710 147,261 (456,057)

(4,538) 300,214 6,590 The changes in net periodic pension costs in 1997, 1996 and 1995 were as follows: Change in number, characteristics and salary levels of participants and net actuarial gain Change in plan provisions Change in actuarial assumptions Net change Plan assets consist principally of common stock, U.S. ment obligations and other fixed income instruments.

In determining pension costs, the assumed long-term rate of return on assets was 9.5% for 1997, 1996 and 1995. The weighted-average discount rate used in determining the actuarial present value of the projected benefit obligation was 7.25% at De cember 31, 1997, 7.75% at December 31, $ $ 1997 (7,839) 3,118 (7,529) (12,250) $ $ 1996 (12,893) 9, 117 (3,776) 1995 Thousands of D ollars $ $ 1.486 (8,305) (3,136) (9,955) 1996 and 7.25% at December 31, 1995. The average rate of increase in future compensation levels ranged from 4% to 6% at December 31, 1997, 1996 and 1995. Prior service cost is amortized on a straight-line basis over the average remaining service period of employees expected to receive benefits under the plan.

• Notes to Consolidated Financial Statements 3 5

• The funded status of the plan at December 31, 1997 and 1996 is summarized as follows: 1997 1996

• Actuarial present value of accumulated plan benefit obligations:

Vested benefit obligation Accumulated benefit obligation Projected benefit obligation for services rendered to date Plan assets at fair value Funded status Unrecognized transition asset Unrecognized prior service costs Unrecognized net gain Pension obligation recognized on the balance sheet 7. Non-Pension Postretirement Benefits The Company provides certain health care and life insurance benefits for retired employees.

Company employees become eligible for these benefits if they retire from the Company with ten years of service. These benefits and lar benefits for active employees are provided by an insurance company whose premiums are based upon the benefits paid during the year. The transition obligation, which represents the previously unrecognized accumulated non-pension postretirement fit obligation, is being amortized on a straight-line basis over an allowed 20-year period. At December 31, 1997 , the Company accelerated recognition of $121 million of its pension postretirement benefits obligation related to its electric generation operations and included this regulatory asset as part of electric generation-related regulatory assets (see note 4). $ 1,794,222 1,890,848

$ 2,141,040 (2,538,039)

(396,999) 35,713 (83,188) 649,903 $ 205,429 Th ousands of Dollars $ 1,657,098 1,742,116

$ 1,982,915 (2,302,935)

(320,020) 40,251 (92,682) 588,013 $ 215,562 The transition obligation was determined by application of the terms of medical, dental and life insurance plans, including the effects of established maximums on covered costs, together with relevant actuarial assumptions and health care cost trend rates, which are projected to range from 7% in 1998 to 5% in 2002. The effect of a 1 % annual increase in these assumed cost trend rates would increase the accumulated postretirement benefit obligation by $85 lion and the annual service and interest costs by $10 million. Total costs for all plans were $73 million in 1997 and $71 million in 1996 and 1995. The net periodic benefits costs for 1997, 1996 and 1995 included the following components:

Service cost benefits earned during the period Interest cost on projected benefit obligation Amortization of transition asset Actual return on plan assets Deferred asset gain Net postretirement benefits costs Plan assets consist principally of common stock, U.S. government obligations and other fixed income instruments.

In determining non-pension postretirement benefits costs, the assumed long-term rate of return on assets was 8% for 1997, 1996 and 1995. The weighted-average discount rate used in determining the actuarial present value of the projected benefit obligation

$ $ 1997 14,401 54,149 14,882 (22,6911 12,707 73,448 $ $ 1996 11,855 48,524 14,882 (13,257) 9,320 71,324 1995 Thousands of Dollars $ $ 8,681 48,641 14,882 (2,075) 1,359 71,488 was 7.75% at January 1, 1997, 7.50% at January 1 , 1996 and 8.50% at January 1, 1995. The average rate of increase in future compensation levels ranged from 4% to 6% at December 31, 1997, 1996 and 1995. Prior service cost is amortized on a straight-line basis over the average remaining service period of employees expected to receive benefits under the plan.

36 P ECO E nergy Company and Subsidiary Companies The funded status of the plan at December 31. 1997 and 1996 is summariz e d as follo w s: A c cumulated postretir e ment ben e fit obligat i on: Retirees Fully eligible active plan part i cipant s Other active plan participants Total Plan assets at fair value $ 1 997 697 , 084 8 , 875 73 , 272 779,231 (178 , 045) Thousands of Dollars $ 609 , 206 4 , 509 48 , 986 662 , 701 (126,661)

Accumulated postretirement benefit obligation in e x cess of plan assets Unrecognized transition obligation 601 , 186 (223,226)

(53 , 110) 536 , 040 (238 , 108) 17.126 Unrecogni z ed net ga i n Accrued postretirement benefits obligation recognized on the balance sheet $ 324,850 $ 315,058 Measurement of the accumulated postretirement benefits obligation w as based on a 7.25% and 7.75% assumed discount rate as of December 31 , 1997 and 1996 , respectively.

8. Accounts Receivable Accounts receivable at December 31, 1997 and 1996 ed unbilled operating revenues of $135 and $117 million, respective l y. Accounts receivable at December 31, 1997 and 1996 were net of an allowance for uncollectible accounts of $32 and $24 million , respectively. The Company has adopted SFAS No. 125 , " Accounting for T ransfers and Servicing of F inancial Assets and Extinguishments of L iabilities

," which provides a standard for dis t inguishing be t ween transfers of financial assets that are accounted for as sales from those that are accounted for as secured borrowings.

9. Common Stock At D ecember 31, 199 7 and 1996, common stock without par value consisted of 500,0 0 0 , 000 shares authorized and 222,546 , 562 and 222,542 , 087 shares ou t standing, ly. At D ecember 31 , 1997, there were 5 , 800,841 shares reserved for issuance under the Company's D ividend R einvestment and Stock Purchase P lan. Stock Repurchase During 1997, the Company's Board of Directors authorized the repurchase of up to 25 million shares of its common stock from time to time through open-market.

private l y tiated and/or other types of transactions in conformity with the rules of the Securities and E x change Commission. Pursuant to these author i zations, the Company has entered into forward purchase agreements to be settled from time to time, at the Company's election , on either a physical, net share or net cash basis. T he amount at which these The Company is party to an agreement with a financial institution under which it can sell or finance with limited recourse an undivided interest.

adjusted daily, in up to $425 m ilion of designated accounts receivable until November 2000. At December 31, 1997. the Company had sold a $425 million est in accounts receivable , consisting of a $296 million inte r est in ac c ounts receivable which the Company accounts for as a sale under SFAS No. 125 and a $129 mil l ion interest in special agreement accounts receivable which were accounted for as a long-term note payable (see no t e 12). T he Company retains the servicing responsibi l ity for these receivables. agreements can be settled is dependent principally upon the market price of t he Company's common stock as compared to the forward purchase price per share and the numb e r of shares to be settled. If these agreements had been settled on a net share bas i s at D ecember 31, 1997, based on the closing price of the Company's Common Stock on that date, the Company would have received approximately 1 , 16 0 ,000 shares of Company common s t ock. Long-Term Incentive Plan (LTIP) The Company maintains an L T IP for certain full-time salaried em pl oyees of the Company. The types of long-term incentive awards which have been granted under the L TIP are non-qualified options to purchase shares of the Company's common stock, dividend equivalents and shares of restricted common stock. The Company uses the disclosure

-only provisions of SFAS No. 123, "Accounting for Stock-Based Compensation

." *

• Notes to Consolidated Financial Statements 37 If the Company elected to account for the LTIP based on SFAS No. 123, earnings applicable to common stock and earnings per average common share would have been changed to the pro forma amounts as follows: 1997 1996 Thousands of Dollars E arnings applicable to common stock As reported $ (1,513,910)

$ 499, 169 Proforma $ (1,515,895)

$ 497,887 Earn ings per average common share (Dollars)

As reported $ (6.80) $ 2.24 Proforma $ (6.81) $ 2.24 Options granted under the LTI P become exercisable one year after the date of grant and all options expire 10 years from the date of the grant. Information with respect to the LTIP at December 31, 1997 and changes for the three years then ended, is as follows: Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise Price Price Price Shares (per share) Shares (per share) Shares (per share) 1997 1997 1996 1996 1995 1995 Balance at January 1 2 , 961 ,1 94 $ 26.68 2,591,765

$ 26.16 2,651,397

$ 26.73 Options granted 1, 139,000 22.49 786,500 28.12 850,700 26.46 Options exercised (369,871) 25.07 (561,232) 23.91 Options cancelled (283.400) 24.96 (47,200) 29.36 (349, 100) 35.57 Balance at December 31 3,816,794 26.14 2,961, 194 26.68 2,591,765 26.16 E xercisab le at December 31 2,800,794 26.65 2, 192,694 26.17 1,813,565 25.91

• Weighted average fair value of options granted during year $ 2.97 $ 2.78 $ 2.91

• The fair value of each option is estimated on the date of the grant using the Black-Scholes option-pricing model, with the ing weighted average assumptions used for grants in 1997, 1996 and 1995, respectively:

1997 1996 1995 Dividend yield 6.2% 6.2% 6.2% Expected volatility 19.5% 16.6% 15.3% Risk-free interest rate 6.4% 5.5% 6.9% E xpec ted life (years) 5 5 5 At December 31, 1997, the option groups outstanding based on ranges of exercise prices is as follows: Range of Exercise Prices $15.75 -$20.00 $20.01 -$25.00 $25.01 -$30.00 $30.01 -$50.00 Total Number Outstanding 156 ,094 863,500 2,607,000 190,200 3,816,794 Opt i ons Outstanding Weighted-Average Remaining Contractual Life (Years) 4.47 $ 8.23 6.72 9.58 Options Exercisable Weighted Weighted-Average Average Exercise Number Exercise Price Exercisable Price 18.65 117,594 $ 18.43 22.35 153,000 22.66 27.32 2,518,000 27.22 33.27 12,200 37.18 2,800,794 38 PECO Energy Company and Subsidiary Companies

10. Preferred and Preference Stock At December 31, 1997 and 1996, Series Preference Stock consisted of 100,000,000 shares authorized, of which no shares were outstanding.

At December 31, 1997 and 1996, cumulative Preferred Stock, no par value, consisted of 15,000,000 shares authorized.

Current Shares Amount Redemption Outstanding Thousands of Do ll ars Price(a) 1997 1996 1997 Series (without mandatory redemption)

$4.68 104.00 150,000 150,000 $ 15,000 $4.40 112.50 274 , 720 274,720 27,472 $4.30 102.00 150,000 150,000 15,000 $3.80 106.00 300,000 300,000 30,000 $7.96 618,954 $7.48 (b) 500,000 500,000 50,000 1,374,720 1,993 ,674 137,472 Series (with mandatory redemption)

$6.12 (cl 927,000 927,000 92,700 Total preferred stock 2,301,720 2,920,674

$ 230,172 (a) Redeemable, at the option of the Company, at the indicated dollar amounts per share, plus accrued dividends. (b) None of the shares of this series are subject to redemption prior to April 1, 2003. 1996 $ 15,000 27,472 15,000 30,000 61,895 50,000 199,367 92,700 $ 292,067 (c) There are no annual sinking fund requirements in 1998. Annual sinking fund requirements in 1999 -2003 are $18,540,000.

None of the shares of this series are subject to redemption prior to August 1, 1999. 11. Company Obligated Mandatorily Redeemable Preferred Securities of a Partnership (COMRPS)

• At December 31, 1997 and 1996, PECO Energy Capital, L.P. (Partnership), a Delaware limited partnership of which a ly owned subsidiary of the Company is the sole general partner, had outstanding three and two series, respectively, Partnership, which bear interest at rates equal to the distribu-* tion rates on the secur ities. The interest paid by the Company on the debentures is included in Other Income and Deductions in the Consolidated Statements of Income and is deductible for income tax purposes. of cumulative COMRPS, each with a liquidation value of $25 per security.

Each series is supported by the Company's deferrable interest subordinated debentures, held by the Mandatory Amount Redemption Distribution Trust Rece i pts Outstanding Thousands of Dollars At December 31 Date Rate 1997 1996 1997 1996 Series A 2043 9.00% 8,850 , 000 8,850,000

$ 221,250 $ 221,250 B (a) 2025 8.72% 3, 124, 183 3, 124, 183 80,835 80,932 c (b) 2037 8.00% 2,000,000 50,000 Total (a) Ownership of this series is evidenced by Trust Receipts, each representing an 8.72% COMRPS, Series B, senting limit ed partnership interests.

The Trust Receipt s were issued by PECO Energy Capital Trust I, the sole assets of which are 8.72% COMRPS, Series B. Each holder of Trust Receipts is entitled to withdraw the sponding number of 8.72% COMRPS, Series B from the Trust in exchange for the Trust Receipts so held. 13,974,183 11 ,974, 183 $ 352,085 $ 302, 182 (b) Ownership of this series is evidenced by Tru s t Receipts, each representing an 8.00% COMRPS, Series C, senting limited partnership interests.

The Trust Receipts were issued by PECO Energy Capital Trust 11 , the sole assets of which are 8.00% COMRPS, Series C. Each holder of Trust Receipts is entitled to withdraw the sponding number of 8.00% COMRPS, Series C from the Trust in exchange for the Trust Re ceipts so held.

• Notes to Consolidated Fi nancial S tatements

12. Long-Term Debt At De cembe r 31 , First and refunding mortgage bonds (a) Total first and refunding mortgage bonds Notes payable Term loan agreements Pollution control notes Medium-term notes Note payable -accounts receivable agreement Unamortized debt discount and premium, net Total long-term debt Due within one year Long-term debt included in capitalization (a) Utility plant is subject to the lien of the Company's

• (b) (c) mortgage.

Floating rates, which were an average annual interest rate of 3.725% at December 31, 1997. The Company has a $900 million unsecured revolving credit facility with a group of banks. The credit facility is composed of a $450 million 364-day credit agreement and a $450 million three-year credit agreement.

The Company uses the credit facility principally to support the Company's commercial paper program, which was expanded from $300 million to $600 million in 1997. There was no debt outstanding under this credit facility at December 31, 1997. (d) Floating rates, which were an average annual interest rate of 3.75% at December 31, 1997. 13. Short-Term Debt Average borrowings Average interest rates, computed on daily basis Maximum borrowings outstanding Average interes t rates, at December 31 39 Series Due 1997 1996 Th ousa nds of D ollars 6 1/8 % 1997 $ $ 75,000 5 3/8 % 1998 225,000 225,000 7 1/2%-9 1/4 % 1999 325,000 325,000 5 5/8%-7 3/8 % 2001 330 , 000 330,000 7 1/8%-8 % 2002 500,000 500,000 6 3/8%-10 1/4 % 2003-2007 565,625 569,688 (b) 2008-2012 154,200 154,200 6 5/8%-8 3/4% 2018-2022 832 , 130 832, 130 7 1/8%-7 3/4% 2023-2024 775,000 775,000 3,706,955 3, 786,018 15,574 (c) 1997 175,000 (d) 2016-2034 212,705 212,705 (e) 1998-2005 62,400 74,400 (f) 2000 128,999 (26,405) (29,306) 4,100,228 4,218,817 (g) 247,087 283,303 (h) $ 3 , 853,141 $ 3,935,514 (e) Medium-term notes collateralized by mortgage bonds. The average annual interest rate was 8.7 5% at December 31, 1997. (f) See note 8. (g) Long-term debt maturities, including mandatory sinking fund requirements, in the period 1998-2002 are as lows: 1998-$247,087,409; 1999-$361,945,982; 2000 -$137, 129, 159; 2001 -$338,433,453; 2002 -$508,759,067. (h) The annualized interest on long-term debt at December 31, 1997, was $286 million, of which $269 million was associated with mortgage bonds and $17 million was associated with other long-term debt. 1997 1996 1995 Thousands of Dollars $ 248, 111 $ 198,090 $ 17,560 5.83% 5.64% 6.25% $ 464,500 $ 369,500 $ 182,000 6.74% 6.90% The Company has a $600 million commercial paper program which is supported by the $900 million revolving credit facility (see note 12). At December 31, 1997, $314 million of commercial paper was outstanding. At December 31 , 1997 , the Company had formal and informal lines of credit with banks aggregating

$75 million. At December 31, 1997, no short-term debt was outstand-* ing under these lines.

40 PECO E nergy Company and Subsidiary Companies

14. Income Taxes

• Income tax expense (benefit) is comprised of the following components:

For the Years Ended December 31, 1 99 7 1996 1995 Thousands of D ollars Included in operations:

Federal Current $ 251 , 509 $ 126.471 $ 190,796 Deferred (11,378) 154,564 167,526 Investment tax credit. net (18,201) (15,979) (21,679) State Current 76,689 62,839 79,086 Deferred (5,850) 12,206 15,988 292,769 340, 101 431.71 7 Included in extraordinary item: Federal Current (123) Deferred (987,234)

State Current (29) Deferred (303,575)

(1,290,961)

Total $ (998,192)

$ 340, 101 $ 431,717 The total income tax provisions.

excluding the extraordinary item, differed from amounts computed by app l ying the federal

• statutory tax rate to income as follows: 1997 1996 1995 Thous a nd s of D o llar s Net Income $ 336,558 $ 517,205 $ 609,732 Total income tax provisions 292,769 340, 101 431, 71 7 Income before income taxes $ 629,327 $ 8 57 ,306 $ 1,041.449 Income taxes on above at federal statutory rate at 35% $ 220,264 $ 300 ,0 57 $ 36 4 , 50 7 Increase (decrease) due to: Property basis differences 40,828 9,903 11, 1 96 State income taxes, net of federal income ta x benefit 46,046 48,779 6 1 , 799 Amortization of investment tax credit (18,201) (15,979) (13,604) Prior period income taxes (2,985) (1,707) 1 ,79 1 Other, net 6,817 (952) 6, 0 28 Total income tax provisions

$ 292,769 $ 340, 101 $ 431.717 Effective income tax rate 46.5% 39.7% 41.5% *

• Notes to Consolid a t ed Fi nancial S tatements 41 Provisions for deferred i n c ome ta x es consist of the ta x effects of the following temporary differences:

1997 19 9 6 1995 Th ousands of D olla r s D epreciation and amortization

$ 57 , 530 $ 42 , 385 $ 32 , 28 7 D eferred energy costs 2,256 27,374 30 , 073 Retirement and separation programs (12,734) 19,746 15,733 Incremental nuclear outage cos t s (981) 2,440 8 , 079 Uncollectib l e accounts (1 , 710) (2,805) (1,99 1) R eacquired debt (8,607) (9,578) (3,266) Unbilled revenue (5,110) 3,910 (5) Env i ronmental clean-up costs (15,121) (714) 2,433 Obsolete i nventory (7 , 074) 5,829 6,362 Li merick plant disallowances and phase-in plan (747) (74 7) 2,5 0 7 AM T credits 83,01 0 9 1 , 399 O ther nuclear operating costs (9,892) O ther (15,038) (4 , 08 0) (97) Subtotal $ (17,228) $ 166 , 770 $ 183,514 E x traordinary item (1,290,809)

Total $ (1 , 308,037) $ 166,770 $ 183,514 T he ta x effect of temporary differences giving rise to the Company's net deferred ta x liability as of December 31, 1997 and 1996 is as follows: Nature of temporary difference

P lant basis difference D eferred investment ta x credit Deferred debt refinancing costs Other , net Deferred income ta x es (net) on the balance sheet T he net deferred ta x liab i lity shown above as of D ecember 31, 1 997 and 1 9 96 is compr i sed of $3, 153 and $4,34 7 million o f de f erred tax l iab i lities, and $352 and $263 mil l ion of defe r red tax assets, respective l y. I n accordance with S F AS No. 71, t he Company recorded a recoverab l e deferred income tax asset of $586 and $2,322 million at D ecember 31 , 1997 and 1996, respectively. The D ecember 31, 1997 balance w as applicable only to non-e ltric generation assets, due to the discontinuance of SFAS No. 7 1 for the Company's electric generation operations.

These recoverable deferred income taxes include the deferred tax effects associated princip a lly with libera l ized dep r eciation accounted for in accordance with t he r at e mak i ng po l icies of t h e P UC , as well as the revenue impacts thereon, and assume recovery of t hese costs i n future rates. At Li a bil i t y o r (A sset) 1997 1 9 96 Th ou s a nds of D o ll ar s $ 2,620,254 $ 3 , 795 , 786 318,065 336, 132 111,651 120 , 031 (249 , 167) (1 67,830) $ 2,800,803

$ 4 , 084 , 119 3 1 , 1997, $1,763 million of electric genera t ion-re l a t ed recoverable def e rred i ncome taxes were included as part of elec t ric genera t ion-related regulatory assets (see note 4). The Internal Revenue Service (I RS) has completed and settled its examinations of the Company's federal income tax returns th r ough 1986. The 1987 through 1990 federal income tax returns have been e x amined and the Company and the IRS have reached a tentative settlement which wou l d not result in an adverse impact on the Company. T he years 1 991 through 1993 a r e currently being examined by t he IR S. The AM T credit was fully uti l ized for tax pu r poses at D ecemb er 31 , 1 99 7 , and reduced federal income taxes current l y payab l e by $6 million in 1 997.

42 15. Taxes, Other Than Income -Operating For the Years Ended December 31, Gross receipts Capital stock Real estate Payroll Other Total 16. Leases Leased property included in utility plant was as follows: At December 31, Nuclear fuel Electric plant Gross leased property Accumulated amortization Net leased property 1997 $ 163,552 48 , 085 69,597 25,976 2,881 $ 310,091 PECO Energy Company and Subsidiary Companies 1996 1995 Thousands of Dollars $ 160 , 246 $ 165, 172 41,972 42,444 69 , 185 71 , 600 27 , 585 30,109 558 4 , 746 $ 299,546 $ 314,071 1997 1996 Thousands of D ollars $ 521,921 $ 527 , 116 2,321 2,069 524,242 529, 185 (348,309)

(347 , 097) $ 175,933 $ 182,088 Nuclear fuel is amortized as the fuel is consumed.

Amortization of leased property totaled $39 , $31 and $43 million for the years ended December 31, 1997, 1996 and 1995, respectively.

Other operating expenses included interest on capital lease obligations of $9 million in 1997 and 1996, and $10 million in 1995. Minimum future lease payments as of December 31, 1997 were: For the Years Ending December 31, 1998 1999 2000 2001 2002 Remaining years Total minimum future lease payments Imputed interest (rates ranging from 6.5% to 17.0%) Present value of net minimum future lease payments $ $ $ Capital L eases 69,820 68,530 43,827 10,892 92 806 193,967 (18,034) 175,933 Operating Leases $ $ 50,584 49,370 45,923 43,219 42,327 537 , 645 769,068 Rental expense under operating leases totaled $74 million in 1997 and 1996, and $115 million in 1995. Total Thousands of Dollars $ $ 120,404 117,900 89,750 54, 111 42,419 538,451 963,035 * *

• Notes to Consolidated Financi a l S tatements 43

• 17. Jointly Owned Electric Utility Plant The Company's ownership interests in jointly owned electric utility plant at December 31, 1997 were as follows: Transmission Production Plants and Other Plant Peach Bottom Salem Keystone Conemaugh Public Service GPU GPU PECO Energy Electr ic and Generating Generating Various Operator Company Gas Company Corp. Corp. Companies Participating interest 42.49% 42.59% 20.99% 20.72% 21%to43% Company's share (Thousands of Dollars) Utility plant $ 307,029 $ 18,331 $ 110,661 $ 184,037 $ 81,072 Accumulated depreciation 175,304 11, 134 66.487 78 ,605 31,273 Construction work in progress 50,208 713 10,067 9,100 1,943 The Company's participating interests are financed with Company funds and, when placed in service, all operations are ed for as if such participating interests were wholly owned facilities.

18. Cash and Cash Equivalents For purposes of fhe Statements of Cash Flows, the Company considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents.

The following disclosures supplement the accompanying Statements of Cash Flows: Cash paid during the year: Interest (net of amount capitalized)

• Income taxes (net of refunds) Noncash investing and financing:

Capital lease obligations incurred 19. Investments At De cem ber 31, Trust accounts for decommissioning nuclear plants Telecommunications ventures Energy services and other ventures Nonutility property Other Total 20. Financial Instruments

$ 1997 405,838 345,232 32,909 $ $ $ 1996 415,063 251,554 33,063 1997 320,442 85,601 65,578 24,697 19,517 515,835 1995 Th ousands of Dollars $ 449,664 257,677 48,760 1996 Th ousands of Dollars $ $ 266,270 79,833 44,023 26,349 16,099 432,574 Fair values of financial instruments, including liabilities, are estimated based on quoted market prices for the same or similar issues. The carrying amounts and fair values of the Company's financial instruments as of December 31, 1997 and 1996 were as follows: Thousands of Do llars Cash and temporary cash investments Long-term debt (including amounts due within one year)

• Trust accounts for decommissioning nuclear plants Financ ial instruments which potentially subject the Company to concent rat ions of credit risk consist principally of temporary cash investments and customer accounts receivable.

The Company places its temporary cash investments with credit quality financial institutions.

At times, such investments 1997 1996 Carrying Fair Carrying Fair Amount Value Amount Va lue $ 33,404 $ 33,404 $ 29,235 $ 29,235 4,100,228 4 , 210,885 4,218,817 4,239,357 320 , 442 320,442 266,270 266,270 may be in excess of the Federal Deposit Insurance Corporation limit. Concentrations of credit risk with respect to customer accounts receivable are limited due to the Company's large number of customers and their dispersion across many industries.

44 21. Other Income Settlement of Salem Litigation On December 31, 1997, the Company received $70 million pursuant to the May 1997 settlement agreement with PSE&G resolving a suit filed by the Company concerning the shutdown of Salem. The agreement also provides that if the outage exceeds 64 reactor unit months, PSE&G will pay the Company $1 million per reactor unit month. As of December 31, 1997, the shutdown of Salem totaled 58 reactor unit months. During the second quarter of 1997, the Company recorded $70 million ($41 million net of income taxes) as Other Income. 22. Regulatory Assets and Liabilities P ECO Energy Company and S ubsidiary Companies Sale of Subsidiary In June 1995, the Company completed the sale of Conowingo Power Company to Delmarva Power & Light Company (Delmarva) for $150 million. The transaction also included a ten-year contract for the Company to sell power to Delmarva.

The Company's gain of $59 million ($27 million net of taxes) on the sale was recorded in the second quarter of 1995. At December 31, 1997 and 1996, the Company had deferred the following regulatory assets on the Consolidated Balance Sheet Competitive transition charge (see note 4) Recoverable deferred income taxes (see note 14) Deferred generation costs recoverable in current rates (see note 4) Deferred Limerick costs (see note 3) Loss on reacquired debt Compensated absences Deferred energy costs (see note 3) Non-pension postretirement benefits (see note 3) Total 23. Quarterly Data (Unaudited)

$ $ 1997 1996 T ho us a n ds of D ollars 5,274,624

$ 585,661 2,321,692 424,497 361,762 83,918 283,853 3 , 881 37,727 35 , 665 122,034 97,409 233,492 6 , 505,655 $ 3,360,560 T he data shown below include all adjustments which the Company considers necessary for a fair presentation of such amounts: 012erating Revenues 012erating Income Net Income (Loss) Millions of Dollars Quarter ended Ma r ch 31 June 30 September 30 December 31 $ 1997 1,163 $ 1 , 032 1,278 1,144 1996 1997 1, 171 $ 302 989 250 1, 110 388 1,014 66 1996 1997 1996 $ 357 $ 113 $ 150 267 123 99 347 158 150 278 (1,891) 118 Earnings Applicable Average Shares Earnings to Common Stock Outstanding Per Average Share Millions of Dollars Quarter ended March 31 June 30 September 30 December 31 $ 1997 109 $ 118 154 (1,895) The decrease in 1997 first quarter results was primarily due to increased fuel and energy interchange expense resulting primarily from additional purchases needed for increased sales to other utilities and higher replacement power costs due to the Salem outage, milder weather and increased depreciation of assets associated with Limerick.

The increase in 1997 second quarter results was ly due to the recognition of the settlement of litigation arising from the Salem outage. Offsetting this increase was higher depreciation of assets associated with Limerick.

1996 1997 1996 1997 1996 146 222.5 222.4 $ 0.49 0.65 94 222.5 222.5 0.53 0.43 145 222.5 222.5 0.69 0.65 114 222.5 222.5 (8.51) 0.51 The decrease in 1997 fourth quarter results was primarily due to the extraordinary charge of $8.24 per share resulting from the ef f ects of the PUC Restructuring Order and deregu-lation of the Company's electric generation operations;

• several one-time adjustments for changes in employee benefits, write-offs of information systems deve l opment charges reflecting clarification of accounting guidelines and additional reserves to revise estimates for accruals; higher income tax adjustments; and higher losses from the Company's non-utility ventures.

Notes to Consoli d ated F inancial S tate me n t s 4 5 Financial Statistics Summary of Earnings and Financial Condition F o r th e Y e ars E nd ed De c e mbe r 3 1 , 1997 1 996 1 9 9 5 19 9 4 1993 1992 Mill i ons of D ollars Income Data Operating Revenues $ 4,618 $ 4 , 284 $ 4 , 186 $ 4 , 041 $ 3 , 988 $ 3 , 963 Operating Income 1,006 1 , 249 1,401 1,064 1,390 1,298 Income before E x traordinary Item 337 517 610 427 591 479 E xtraordinary Item (net of income ta x es) (1,834) Net I ncome (1,497) 5 17 610 427 591 479 E arning s Applicable to Common Stock B efore Extraordinary It em (1,514) 499 587 389 542 418 E arnings per Average Common Share B efore E x traordinary I tem (D oll a rs) 1.44 2.24 2.64 1.76 2.45 1.90 Ext r ao r dinary Item (P er S hare) (8.24) Earnings per Average Common Share (6.80) 2.24 2.64 1.76 2.45 1.90 Dividends per Common Share !D oll a rs! 1.80 1.755 1.65 1.545 1.43 1.325 Common Stock Equity (Pe r S har e) 12.25 20.88 20.40 19.41 19.25 18.24 Average Shares of Common S t ock Outstanding

!M illions) 222.5 22 2.5 2 2 1.9 2 21.6 221.1 220.2 At D e c em b er 31 , Balance Sheet Data Net Utility P l ant $ 4,495 $ 10,760 $ 10 , 758 $ 10,829 $ 10 , 763 $ 10 , 691 L eased Property, net 176 182 181 174 194 210 Total Current Assets 1,003 4 2 0 426 427 515 550 T ota l Deferred D ebits and Other Assets 6,683 3 , 899 3 , 944 3,992 3,90 5 1, 127 T o t a l Assets $ 12 , 357 $ 1 5 ,2 6 1 $ 1 5 , 309 $ 15,422 $ 15 , 377 $ 12 , 578 Common Shareholders' Equity $ 2,727 $ 4 , 646 $ 4 , 531 $ 4,303 $ 4,263 $ 4,022 Preferred and Preference Stock Without Mandatory Redemption 137 199 199 277 423 423 With Mand a tory Redemption 93 93 93 93 187 231 Company Obligated Mandatori l y R edeemab l e P refer r ed Securi t ies of a Partnership 352 302 302 221 L ong-term Deb t 3,853 3, 9 36 4,199 4,786 4 , 884 5 , 204 T o ta l Capi t aliza t ion 7 , 162 9 , 1 76 9,324 9,680 9 , 7 5 7 9 , 880 T o t a l Current L iabili t ies 1 , 619 1, 1 03 1 , 052 850 954 830 T o t al D eferred Credits and Other L iabili t ies 3,576 4,982 4,933 4,892 4,666 1,868 T otal Capitalization and Liabilities

$ 12 , 357 $ 15 , 261 $ 15 , 309 $ 15,422 $ 15 , 377 $ 12,578 46 PECO Energy Company and Subsidiary Companies Operating Statistics For the Years Ended December 31, 1997 1996 1995 1994 1993 1992 Electric Operations Output (Millions of Kilowatthours)

Fossil 9,659 10,856 10 , 792 11,239 10,352 8,082 Nuclear 25, 8 53 24,373 25,499 28, 195 27,026 24,428 Hydro 1,55 8 2,404 1,425 1,970 1 , 699 1,803 Pumped storage output 1,4 0 3 1,540 1,741 1 , 596 1,478 1,597 Pumped storage input (1, 924) (2,230) (2,507) (2,256) (2,192)

(2,217) Purchase and interchange 2 9 , 615 19 , 539 13,945 6,164 6,447 8,675 Internal combustion 1 44 179 175 106 56 29 Total electric output 66 , 308 56 , 661 51 , 070 47,014 44,866 42,397 Sales (Million s of K il ow a tt h ours) Residential 10,40 7 10 , 671 10,636 10,859 10,609 9,965 Small commercial and industrial 6 , 68 5 6,491 6,200 6,150 5,769 5,396 Large commercial and industrial 1 5 , 034 15,208 15,763 15 , 968 15 , 956 15 , 829 Other 841 902 860 791 771 962 Unbilled 70 (327) 535 (205) 31 (159) Service territory 33 , 037 32,945 33,994 33,563 33 , 136 31,993 Interchange sales 1 , 927 935 496 768 457 1,231 Sales to other utilities 28 , 893 20 , 243 14,041 10,039 8 , 670 6 , 699 Total electric sales 63 , 857 54 , 123 48,531 44,370 42,263 39,923 Number of Customers, D ecem b er 31, Residential 1 , 333 , 861 1 , 324,448 1 ,3 21 , 379 1,350,210 1,341,873 1,333,926 Small commercial and industrial 144 , 142 142,431 141,653 143,605 142,363 141 , 253 Large commercial and industrial 3,308 3,299 3 , 394 3,603 3,742 3,972 Other 1,094 1,051 959 944 888 857 Total electric customers 1,482,405 1,471,229 1,467,385 1,498 , 362 1,488 , 866 1,480,008 Operating Revenues (Millions of D oll a rs) Residential

$ 1 , 357 $ 1,370 $ 1,379 $ 1 , 371 $ 1 , 351 $ 1 , 308 Small commercial and industrial 779 749 730 710 679 672 Large commercial and industrial 1, 077 1,098 1, 135 1,149 1,168 1 , 225 Other 148 140 137 136 161 168 Unbilled 19 (26) 43 (11) (1) (7) Service territory 3 , 380 3,331 3,424 3,355 3,358 3,366 Interchange sales 59 26 17 23 14 32 Sales to other utilities 728 498 334 247 233 199 Total electric revenues 4,167 3,855 3,775 3,625 3 , 605 3,597 Operating Expenses Operating expenses, excluding depreciation 2,698 2,244 2,026 2,209 1,894 1,990 Depreciation 553 462 431 416 401 391 Total operating e x penses 3,251 2,706 2,457 2,625 2 , 295 2,381 Electric Operating Income $ 916 $ 1,149 $ 1,318 $ 1,000 $ 1 ,3 10 $ 1,216 Average Use per Residential Customer (Kilowatthours)

Without electric heating 6,695 6,771 6,908 6,736 6,727 6,259 With electric heating 16,400 17 , 946 17 , 189 17,527 17,096 16,298 Total 7,830 8 , 074 8,130 8,041 7,970 7,443 Electric Peak Load, Demand * {Thousands of Kilowatts) 7,390 6,509 7 , 244 7,227 7,100 6,617 Net Electric Generating Capacity-Year-end Summer Rating {Thousands of K i lowatts) 9 , 204 9,201 9 , 078 8,956 8,877 8 , 836 Cost of Fuel per Million BTU $ 0.84 $ 0.93 $ 0.8 7 $ 0.8 9 $ 0.90 $ 0.82 BTU per Net Kilowatthour Generated 10,737 10,682 10,705 11,617 10,675 10,657 Notes to Consolidat e d Financial S tatements 4 7 Opera ing Statistics (continued)

• Fo"ho "" Eodod 1997 1996 1995 1994 1993 1992 Gas Operations Sales (Millions of Cubic Feet) Residential 1,614 1,681 1,516 1,636 1,637 1,819 House heating 32 , 666 35,471 30,698 32,246 30,242 30,218 Commercial and industrial 19,830 20,999 18,464 19,762 18 , 635 19,026 Other 673 2,571 1 , 582 7,039 9,733 4,885 Unbilled 212 (1,306) 1,710 (474) 676 (736) Total gas sales 54,995 59,416 53,970 60,209 60,923 55,212 Gas transported for customers 30,412 27 ,8 91 48 , 531 29,801 22,946 22,060 Total gas sales and gas transported 85,407 87,307 102,501 90,010 83,869 77,272 Number of Customers Residential 55,592 56 , 003 56 , 533 5 7, 122 59,573 59,859 House heating 314 , 335 303,996 295,481 287,481 277,500 269,5 77 Commercial and industrial 35 , 215 34 , 182 33,308 32,292 31 , 573 3 0 ,956 Total gas customers 405 , 142 394,181 385 , 322 376,895 368,646 360,392 Operating Revenues (Millions of Dollars) Residential

$ 17 $ 16 $ 15 $ 16 $ 15 $ 16 House heating 265 249 236 238 202 203 Commercial and industrial 145 133 126 128 110 113 Other 3 11 5 20 28 12 Unbilled (1) (4) 7 (3) 5 (1) Subtotal 429 405 389 399 360 343

• Other revenues (including transported for customers) 22 24 22 17 23 23 Total gas revenues 451 429 411 416 383 366 Operating Expenses Operating e xp enses, excluding depreciation 333 302 302 326 279 261 Depreciat ion 28 27 26 26 24 23 Total operating expenses 361 329 328 352 303 284 Gas Operating Income $ 90 $ 100 $ 83 $ 64 $ 80 $ 82 Securities Statistics Ratings on PECO Energy Company's securities Mortgage B o nds Preferred Sto c k Date Date Agency Rating E stablished Rating E stabl i shed Duff and Phelps, Inc. BBB+ 4/92 BBB-8/91 Fitch Investors Service, Inc. A-9/92 BBB+ 9/92 Moody's Investors Service Baal 4/92 baa2 4/92 Standard & Poor's Corporation BBB+ 4/92 BBB 4/92 NYSE-Composite Common Stock Prices , Earnings and Dividends by Quarter (Per Share) 1 997 1996 Fourth Third Second First Fourth Third Second First Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter High price $ 25-1/8 $24-5/16 $ 21-1/8 $ 26-3/8 $ 27-3/8 $ 2 6-1/4 $ 2 6-7/8 $ 32-1/2 L o w pri c e $21-7/16 $ 20-3/4 $ 18-3/4 $ 20 $ 23-7/8 $ 23 $ 22-1/2 $ 26-1/4 C l ose $ 24-1/4 $23-7/16 $ 21 $ 20-3/8 $ 25-1/4 $ 2 3-3/4 $ 26 $ 26-5/8 Earn i ngs ($8.51) 69¢ 53¢ 49¢ 5 1¢ 65¢ 43¢ 65¢ Div i den d s 45¢ 45¢ 45¢ 45¢ 45¢ 43.5¢ 43.5¢ 43.5¢ 48 Board of Directors Susan W. Catherwood (54) Chairman, Trustee Board, The University of Pennsylvania Medical Center and Health System Daniel L. Cooper (62)(2) Former Vice President and General Manager, Nuclear Services Division , Gilbert/Commonwealth, Inc. M. Walter D'Alessio (64) President and Chief Executive Officer, Legg Mason Real Estate Services (Commercial mortgage banking and pension fund advisors)

G. Fred DiBona, Jr. (46) President and Chief E xecutive Officer, Independence Blue Cross R. Keith Elliott (55) Chairman, President and Chief Executive Officer, Hercules, Inc. Richard G. Gilmore (70)(ll Former Senior Vice President, Finance and Chief Financial Officer of the Company Richard H. Glanton, Esquire (51)(1) Partner of the law firm Reed Smith Shaw and McClay James A. Hagen (65)

Inc. Admiral Kinnaird R. McKee (68) Director Emeritus , U.S. Navy Nuclear Propulsion Joseph J. Mclaughlin (69)(1) Former President and Chief Executive Officer, Beneficial Mutual Sa vings Ban k Corbin A. McNeill, Jr. (58)(1) Chairman of the Board , President and Chief E xecutive Officer of the Company John M. Palms, PhD. (62) Pre sident, University of South Carolina Joseph F. Paquette, Jr. (63)(1) Former Chairman of the Board of the Company Ronald Rubin (66)(1) Chief E xecutive Officer, The Rubin Organization, Inc. (Real estate development and management)

Robert Subin (59) Senior Vice President , Campbell Soup Company Officers Corbin A. McNeill, Jr. (58) Chairman of the Board, President and Chief Executive Officer Dickinson M. Smith (64) President, PECO Nuclear and Chief Nuclear Officer Gregory A. Cucchi (48)(3l Senior Vice President, Ventures James W. Durham (60) Senior Vice President, Legal and General Counsel Michael J. Egan (44)(4) Senior Vice President , Finance and Chief Financ ial Officer William J. Kaschub (55) Senior Vice President , Human Resources Kenneth G. Lawrence (50)(4) Senior Vice President, Local Distribution Company John M. Madara, Jr. (54) Senior Vice President, Power Generation Group William H. Smith, III (49)(5) Senior Vice President, Business Services Group Alvin J. Weigand (59) Senior Vice President Gerald R. Rainey (48) Senior Vice President, Nuclear Operations Nancy J. Bessey (44) Vice President , Power Transactions John B. Cotton (53)(6) Vice President, Station Support PECO Energy Company and Subsidiary Companies John Doering, Jr. (54) Vice President, Operations, Power Generation Group Gregory N. Dudkin (40)(3) Vice President, Power Delivery Drew B. Fetters (46) Vice President, Nuclear Planning and Development Thomas P. Hill, Jr. (49) Vice President and Controller Cassandra A. Matthews (47)(7) Vice President, Information Systems John P. McElwain ( 47)(6) Vice President, Nuclear Projects, PECO Nuclear J. Barry Mitchell (50) Vice President, Finance and Treasurer Thomas N. Mitchell (42) Vice President, Peach Bottom Atomic Power Station William E. Powell, Jr. (61) Vice President, Support Services James D. von Suskil (51)(8) Vice President, Limerick Generating Station Katherine K. Combs (47) Corporate Secretary Edward J. Cullen, Jr. (50) Assistant Corporate Secretary Todd D. Cutler (37) Assistant Corporate Secretary Diana Moy Kelly (43) Assistant Treasurer George R. Shicora (51) Assistant Treasurer (1) Member of the Executive Committee of the Board of Directors (2) Elected June 23 , 1997 (3) Effective June 1, 1997 (4) Effective October 13, 1997 (5) Effective November 7 , 1997 (6) Effective April 9, 1997 (7) Effective July 28, 1997 (8) Effecti ve January 26, 1998 * *

• 5 HAR.EH 0 L DER INFORMATION

• Stock Exchange Listings Most Company securities are listed on the New York Stock E xchange and the Philadelphia Stock E xchange. Dividends T he Company has pa id d i vidends on its common stock cont ily since 1902. The Board of Directors normally considers common stock dividends for payment in March, June, September and December.

The Company expects that the $1.80 per share dend paid to common shareholders in 1 997 is fully taxable as dividend income for federal income tax purposes.

Shareholders may use their dividends to purchase additional shares of common stock through the Company's Dividend Reinvestment and Stock Purchase Plan (Plan). The Company pays a l l b r okerage and service fees for P l an purchases.

All share-*l d s have the opportunity to invest additional funds in on stock of the Company, whether or not they have their nds reinvested, with all purchasing fees paid by the Company. In 1997, over 55 percent of the Company's common ers were participants in the Plan. Information concerning the Plan may be obtained from: First Chicago Trust Company of New York, PECO Energy Company Plan, PO. Box 2598, Jersey City, NJ 07303-2598.

Comments Welcomed The Company is always pleased to an swer questions and provide information.

Please address your comments to Katherine K. Combs, Corporate Secretary, PECO Energy Company, 2301 Market Street, P.O. Box 8699, Philadelphia, PA 19101-8699.

Inquiries relating to shareholder accounting records, stock fer and change of address shou l d be directed to: First Chicago T rust Company of New York, P.O. Box 2500, Jersey City, NJ 07303-2500. Toll-Free Telephone Tol l-free telephone lines are available to the Company's holders for inquiries concerning their stock ownership.

Calls .d be rn'de to Hl00-626-8729.

Annual Meeting The Annual Meeting of the Shareholders of the Company will be held at the Valley Forge Convention Center in King of Prussia, Pennsylvania on April 8, 1998 at 9:30 AM. T he record date for voting at the shareholders' meeting is F ebruary 20, 1998. Prompt return of proxies wi l l be appreciated.

Form 10-K Form 10-K, the annual report filed with the Securities and Exchange Commission, is available without charge to ers upon written request to PECO Energy Company, 2301 Market Street, P.O. Box 8699, Philadelphia, PA 19101-8699, Attention:

Investor and Shareholder Relations Division, S21-1 Shareholders The Company had 163,049 shareholders of record of common stock as of December 31, 1997. Transfer Agents and Registrars Preferred and Common Stock Regi stra r and T ransfer Agent: First Chicago Trust Company of New York, P.O. Box 2500, Jersey City, NJ 07303-2500.

First and Refunding Mortgage Bond Trustee: First Union National Bank, Corporate Trust Ope r ations, Customer Information Center 1525 West WT Harris Blvd. Charlotte, NC 28288-1153 New York Agent for bonds: First Trust of New York, National Association Corporate Trust Department, 100 Wall Street, Suite 1600, New York, NY 10005. Internet Site Visit our internet site at http://www.peco.com General Office: 2301 Market Street Philadelphia, Pennsylvania 19103 (215) 841-4000