PPL

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended June 30, 1998, for PP&L Resources, Inc. (the parent holding company) and its primary subsidiary, PP&L, Inc. PP&L Resources operates as a full-service provider of retail and wholesale energy, with PP&L constituting substantially all of its assets, revenues, and earnings. The reporting period is defined by a major regulatory transition: effective June 30, 1998, PP&L discontinued the application of SFAS 71 (regulatory accounting) for its generation business following a Pennsylvania Public Utility Commission (PUC) order, marking a shift from a regulated utility to a competitive market participant.

Key Financial Metrics (Six Months Ended June 30, 1998)

Note: Net income figures are heavily impacted by a $948 million extraordinary charge (net of tax) related to regulatory restructuring.

Material Changes vs. Prior Period

• Revenue Growth: Total operating revenues increased by 15.5% to $1,719 million (from $1,488 million in 1997). This was driven primarily by a 88.8% increase in wholesale energy and trading activities ($504 million vs. $267 million), offsetting a 2.4% decline in traditional electric operations due to milder weather.
• Profitability: Operating income decreased 10.5% to $385 million. While wholesale trading revenues surged, operating expenses rose significantly, particularly energy purchases ($432 million vs. $220 million) and other operating costs ($260 million vs. $238 million) due to increased trading volume and labor costs.
• Extraordinary Loss: The company recorded a pre-tax extraordinary charge of $1,614 million ($948 million net of tax). This consisted of a $1,558 million charge for the under-recovery of stranded costs following the PUC restructuring order and a $56 million charge related to a FERC settlement with municipalities.
• Asset Write-downs: Generation plant assets were written down by $2.388 billion due to the discontinuation of regulatory accounting (SFAS 71) and impairment testing under SFAS 121.
• Capital Structure: Short-term debt increased significantly to $397 million (from $135 million) to fund operations and a pending tender offer. Long-term debt increased to $2.73 billion.

Guidance, Outlook, and Risks

Management Commentary and Strategy: Management is executing a financial strategy to position the company for a competitive environment. Key actions include:

• Dividend Reduction: The quarterly common stock dividend was reduced from $0.4175 to $0.25 per share (effective October 1, 1998) to target a payout ratio of 45%-55% and increase financing flexibility.
• Share Repurchase: A "Dutch Auction" tender offer was announced to purchase up to 17 million shares (approx. 10% of outstanding) at prices between $24.50 and $27.00.
• Asset Optimization: PP&L announced the closure of the Holtwood coal-fired station (May 1999) and plans to sell the Sunbury station, expecting a workforce reduction of approximately 250 employees.

Regulatory Outlook: A tentative settlement regarding the PUC restructuring proceeding was approved in August 1998. This allows PP&L to recover approximately $2.97 billion in transition costs over 11 years via a Competitive Transition Charge (CTC). The settlement includes a 4% rate reduction for retail customers in 1999 and a phased opening of the retail market to competition.

Risks and Contingencies:

• Market Volatility: Wholesale energy markets experienced extreme price volatility in Q2 1998. While PP&L profited as a net seller, future price spikes or transmission constraints could lead to material damages if firm obligations cannot be met.
• Environmental Compliance: Future capital expenditures for Clean Air Act compliance (acid rain, NOx, particulates) and groundwater remediation are estimated to be material but not currently determinable.
• Year 2000 Compliance: Estimated remediation costs are approximately $15 million. The company aims for full compliance of mission-critical systems by March 31, 1999.
• Legal Proceedings: Ongoing disputes with Schuylkill Energy Resources (SER) regarding power purchase rates involve approximately $97 million in disputed past payments.

Investor Verification Checklist

• Extraordinary Charge Impact: Verify the finality of the $948 million net extraordinary charge and the specific terms of the PUC settlement regarding the recovery of stranded costs.
• Wholesale Trading Exposure: Assess the company's risk management policies regarding wholesale energy trading, given the volatility in the ECAR and PJM regions and the potential for damages on undelivered capacity.
• Dividend Sustainability: Confirm the new dividend policy ($0.25/share) and its alignment with the company's target payout ratio in a competitive, non-regulated environment.
• Asset Disposition: Monitor the progress of the planned sale of the Sunbury generating station and the closure of the Holtwood station.
• Debt Maturity Profile: Review the maturity schedule of the $200 million "Reset Put Securities" issued in May 1998, which may require repurchase or remarketing in 2001.