ITEM 1. Business - -------
General -------
Illinois Power Company (IP) was incorporated under the laws of the State of Illinois on May 25, 1923.
Illinova Corporation (Illinova) was incorporated under the laws of the State of Illinois on May 27, 1994 and currently serves as the parent holding company of four principal operating subsidiaries: IP, Illinova Generating Company (IGC), Illinova Energy Partners, Inc. (IEPI), and Illinova Insurance Company (IIC). In May, 1996, the services group of Illinova Power Marketing (IPMI) consolidated with Illinova Energy Services (IES) and the non-regulated marketing activities of Illinova to form a new venture known as IEPI. On February 12, 1997, the Illinova Board of Directors approved a merger of IEPI and IPMI. In the merger, IPMI will be the surviving corporation and will change its name to IEPI.
IP, the primary business of Illinova, is engaged in the generation, transmission, distribution and sale of electric energy and the distribution, transportation and sale of natural gas in the State of Illinois. IP is affected by changes in the electric utility industry driven by regulatory and legislative initiatives to introduce competition and end monopoly franchises in at least the generation side of the business. One aspect of this change is "direct access," meaning giving customers the freedom to purchase electricity from suppliers they choose. In 1995, IP was a participant in the development of Energy Choice 2000, a basis for formal review of utility regulation in Illinois. From this framework, IP continued its efforts to ensure a managed transition to direct access with the introduction of a legislative proposal in November 1996. For a more detailed discussion of these developments, refer to the "Competition" section of this item.
IP provides funds to Illinova for operations and investments. Illinova accrues interest due to IP on any borrowed funds at a rate equal to the higher of the rate that Illinova would have to pay if it used a currently outstanding line of credit, or IP's actual cost of the funds provided. At the end of each quarter, if needed, IP effects a common stock repurchase from Illinova by accepting shares equal in market value to the amount of the funds provided to Illinova during the quarter plus the accrued interest for the quarter. During 1996, IP provided approximately $81 million in funds to Illinova. IP also provides funds to Illinova in the form of cash dividends payable on the Common Stock of IP. In 1996, approximately $85 million in such dividends was declared and paid. Since Illinova's inception in 1994, IP has provided approximately $135 million to Illinova. For further information on IP common stock repurchases, see Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operation" of this report.
IP's financial position and results of operations are currently the principal factors affecting Illinova's consolidated financial position and results of operations.
IGC is Illinova's wholly-owned independent power subsidiary that invests in energy-related projects throughout the world. IGC is an equity partner with Tenaska, Inc. in four natural gas- fired generation plants, of which three plants totaling approximately 700 megawatts (MW) are in operation and one 240 MW plant has had construction suspended. Tenaska, Inc. is an Omaha, Nebraska-based developer of independent power projects throughout the United States. IGC also owns 50 percent of the North American Energy Services Company (NAES). NAES supplies a broad range of operations, maintenance and support services to the world-wide independent power generation industry and operates the Tenaska generation plants in which IGC has an equity interest. IGC is an equity partner in the Indeck North American Power Fund (Fund). The Fund has generation projects in Long Beach, California, and Pepperell, Massachusetts. In addition to these ventures, IGC is involved in generation projects in Teesside, England; Puerto Cortez, Honduras; Zhejiang Province, People's Republic of China; Aguaytia, Peru; Old Harbour, Jamaica; Barranquilla, Columbia; and Balochistan, Pakistan. In August, 1996, Illinova's interest in the 1000 MW coal-fired plant in Joppa, Illinois was transferred to IGC.
IEPI is Illinova's wholly-owned subsidiary that engages in the brokering and marketing of electric power and gas and the development and sales of energy related services. In May 1995, IPMI obtained approval from the Federal Energy Regulatory Commission (FERC) to conduct business as a marketer of electric power and gas to various customers outside of IP's present service territory. In September 1995, IPMI began buying and selling wholesale electricity in the western United States. IPMI owns 50 percent of Tenaska Marketing Ventures (TMV). IPMI and TMV have formed Tenaska Marketing Canada to market natural gas in Canada. In May 1996, IPMI expanded operations to include the midwestern United States. In July 1996, IP received FERC approval to sell electricity to IPMI without prior transaction approval from FERC.
IIC was licensed in August 1996 by the State of Vermont as a captive insurance company. The primary business of IIC is to insure the risks of the subsidiaries of Illinova and risks related to or associated with their business enterprises.
Competition - -----------
Competition has become a dominant issue for the electric utility industry. It has been promoted by federal legislation, starting with the Public Utility Regulatory Policies Act of 1978, which facilitated the development of co-generators and independent power producers. Federal promotion of competition continued with enactment of the Energy Policy Act of 1992, which authorized the FERC to mandate wholesale wheeling of electricity by utilities at the request of certain authorized generating entities and electric service providers. Wheeling is the transport of electricity generated by one entity over transmission and distribution lines belonging to another entity.
Competition arises not only from co-generation or independent power production, but also from municipalities seeking to extend their service boundaries to include customers being served by utilities. The right of municipalities to have power wheeled to them by utilities was established in 1973. IP has been obligated to wheel power for municipalities and cooperatives in its territory since 1976. The Illinois Commerce Commission (ICC) has been supportive of IP's attempts to maintain its customer base through approval of special contracts and flexible pricing that help IP to compete with existing municipal providers.
Further competition may be introduced by state action or by federal regulatory action. While the Energy Policy Act precludes the FERC from mandating retail wheeling, state regulators and legislators could open utility franchise territories to full competition at the retail level. Legislative action at the state level would be required for retail wheeling to occur in Illinois. Retail wheeling involves the transport of electricity to end-use residential, commercial or industrial customers. Such a change would be a significant departure from existing regulation in which public utilities have an universal obligation to serve the public in return for relatively protected service territories and regulated pricing which is designed to allow a reasonable return on prudent investment and recovery of operating costs.
On November 21, 1996, IP and its partners in the Illinois Coalition for Responsible Electricity Choice announced a legislative proposal which would begin transformation of the Illinois electric industry from a highly regulated monopoly to a competitive, customer-choice environment. The proposal, which was introduced in the Illinois House of Representatives on January 29, 1997, would allow for a managed transition to direct access for all consumers by the year 2005. The plan balances the need to ensure the financial stability of current utility providers with the timing of customer choice. Other parties have introduced plans that allow for full competition by as early as 1998. On February 18, 1997, the Citizen's Utility Board (CUB) outlined its regulatory reform proposal which would require utilities to separate their generation assets, shop for the cheapest available power in the wholesale market, and sell that power to consumers, by January 1999. In addition, CUB's plan calls for direct access for all customers by April 2000. On March 11, 1997, a new restructuring bill was introduced in the Illinois House. This bill, supported by a broad-based alliance representing residential, commercial and industrial consumers, would allow all customers served by investor-owned utilities to have equal access to a competitive electric market by May 1, 1998. The plan also calls for a 10 percent rate reduction in the first year, with further reductions possible in the second and third years. Utilities needing additional revenues to ensure financial viability and reliability would be able to participate in a trust fund by charging a surcharge to all consumers on their system.
A Joint Committee on Electric Utility Regulatory Reform of the Illinois General Assembly deliberated the issue of regulatory reform for 18 months. Their report, issued December 4, 1996, stated that the Committee was unable to reach consensus on a legislative proposal. It is reasonable to assume that significant change will be made to the state laws governing IP's electric operations, but impossible at this time to predict what these changes will be.
If there is significant change in the laws governing electric utility operations, IP may be required to discontinue reporting under Statement of Financial Accounting Standards No. 71, "Accounting for the Effects of Certain Types of Regulation" (FAS 71). According to disclosures made by utilities in states that have enacted such legislation, the Securities and Exchange Commission (SEC) is raising the issue of continued qualification to report under FAS 71, even where the legislation provides for a transition to full competition and for stranded cost recovery. Reporting under FAS 71 allows companies whose service obligations and prices are regulated, to maintain assets on their balance sheets representing costs they reasonably expect to recover from customers in the future, through inclusion of such costs in their rates. If IP ceased to qualify for reporting under FAS 71, it could be required to write off its regulatory assets, and this could have a material, adverse impact on IP and its operations.
IP received approval from the ICC on March 13, 1996, and from FERC on April 24, 1996, to conduct an open access experiment beginning in 1996 and ending on December 31, 1999. The experiment allows certain industrial customers to purchase electricity and related services from other sources. On April 25, 1996, the first of the 21 eligible customers began buying a portion of their electricity from a supplier other than IP. Currently, 16 customers are participating in the experiment. The experiment has demonstrated immediate advantages competition brings to customers, such as lower prices and innovative service offerings. It has also provided evidence of challenges the industry faces as it moves toward customer choice. Challenges include dispatching small amounts of electricity such as one or two megawatt hours (MWHs), and the absence of requisite technology to dispatch fractional MWHs. In 1996, the experiment cost IP approximately $3.2 million in lost revenue net of avoided fuel cost and variable operating expenses. This loss was partially offset by selling the surplus energy and capacity on the open market and by $.9 million in transmission service charges.
The issue of competition is one that raises both risks and opportunities. At this time, the ultimate effect of competition on Illinova's consolidated financial position and results of operations is uncertain.
Customer and Revenue Data - -------------------------
Approximately 79 percent and 21 percent of Illinova's and its subsidiaries' operating revenues are derived from the sale of electricity and the sale and transportation of natural gas, respectively. The territory served by IP comprises substantial areas in northern, central and southern Illinois, including ten cities with populations greater than 30,000 (1990 Federal Census data). IP supplies electric service at retail to an estimated aggregate population of 1,265,000 in 310 incorporated municipalities, adjacent suburban and rural areas, and numerous unincorporated communities and retail natural gas service to an estimated population of 920,000 in 257 incorporated municipalities and adjacent areas. IP holds franchises in all of the 310 incorporated municipalities in which it furnishes retail electric service and in all of the 257 incorporated municipalities in which it furnishes retail gas service. At February 28, 1997, IP served 577,862 active electric customers and 404,838 active gas customers. These numbers do not include non-metered customers such as street lights. Sales of electricity and gas sales and transportation are affected by seasonal weather patterns, and, therefore, operating revenues and associated operating expenses are not distributed evenly during the year.
For more information, see "Note 13 - Segments of Business" on page A-30 of the 1996 Annual Report to Shareholders in the appendix to the Illinova Proxy Statement which is incorporated herein by reference. To the extent that information incorporated by reference herein appears identically in both the 1996 Annual Report to Shareholders of Illinova Corporation and the 1996 Annual Report to Shareholders of Illinois Power Company, reference will be made herein only to the 1996 Annual Report to Shareholders of Illinova Corporation, and such reference will be deemed to include a reference to the 1996 Annual Report of Illinois Power Company.
Electric Business -----------------
Overview - --------
IP supplies electric service at retail to residential, commercial and industrial consumers in substantial portions of northern, central and southern Illinois. Electric service at wholesale is supplied for resale to one electric utility and to the Illinois Municipal Electric Agency (IMEA) as agent for 11 municipalities. IP also has a power coordination agreement with Soyland Power Cooperative, Inc. (Soyland). See the sub-caption "Soyland" hereunder for additional information. In 1996, IP provided interchange power to 44 entities, including 27 power marketers.
IP's highest system peak hourly demand (native load) in 1996 was 3,444,651 kilowatts on July 18, 1996. IP's record for peak load is 3,666,738 kilowatts, set on July 13, 1995.
IP owns and operates generating facilities with a total net summer capability of 4,571,250 kilowatts. The generating capability comes from six major steam generating plants and three peaking service combustion turbine plants. See Item 2

Item 2. Properties - -------
IP owns and operates six steam generating stations with composite net summer capacity of 4,424,250 kilowatts. In addition, IP owns nine quick start combustion turbine peaking units at three locations with a combined net summer capacity of 147,000 kilowatts. All of IP's generating stations are in the State of Illinois, including IP's only nuclear generating station, Clinton. IP owns 50% of three combustion turbine units, located in Bloomington, Illinois, with combined net capacity of 5,250 kilowatts. State Farm Insurance Company owns the other 50% of these units. The total IP available net summer capability is 4,571,250 kilowatts.
The major coal fired units at Baldwin, Havana, Hennepin and Wood River make up 2,936,000 kilowatts of summer capacity. Units comprising 377,000 kilowatts of summer capacity at the Wood River and Havana stations currently are not staffed but are available to meet reserve requirements with a maximum of four months notice.
On December 18, 1996, the control and computer rooms for Wood River units 4 and 5 were damaged by an in-plant fire. The extent of the damage is currently being evaluated and repairs have been started to return these two units to service as soon as possible. Preliminary expectations are to return Unit 4 to service in the second quarter of 1997, and Unit 5 later in the year.
During 1995, natural gas firing capability was added to the Vermilion station. Vermilion now has the capability for either coal or natural gas firing to achieve its summer capacity of 176,000 kilowatts. Vermilion is operated as a peaking plant, mainly during the summer season.
IP owns an interconnected electric transmission system of approximately 2,800 circuit miles, operating from 69,000 to 345,000 volts and a distribution system which includes about 37,400 circuit miles of overhead and underground lines.
All outstanding first mortgage bonds issued under the Mortgage and Deed of Trust dated November 1, 1943 are secured by a first mortgage lien on substantially all of the fixed property, franchises and rights of IP with certain exceptions expressly provided in the mortgage securing the bonds. All outstanding New Mortgage Bonds issued under the General Mortgage and Deed of Trust dated November 1, 1992, are secured by a lien on IP's properties used in the generation, purchase, transmission, distribution and sale of electricity and gas, which lien is junior to the lien of the Mortgage and Deed of Trust dated November 1, 1943. IP anticipates that during 1997 the 1943 mortgage will be amended to be consistent with the 1992 mortgage.
Item 3.

Item 3. Legal Proceedings - -------
See discussion of legal proceedings under Item 1 "Competition" of this report and in "Manufactured-Gas Plant (MGP)" in "Note 4 - Commitments and Contingencies" on page A-21 of the 1996 Annual Report to Shareholders in the appendix to the Illinova Proxy Statement which is incorporated herein by reference.
See "Environmental Matters" reported under Item 1 of this report for information regarding legal proceedings concerning environmental matters.
Item 4.

Item 4. Submission of Matters to a Vote of Security Holders - -------
Neither Illinova nor IP submitted any matter to a vote of security holders during the fourth quarter of the fiscal year ended December 31, 1996.
PART II - -------------------------------------------------------------------------------
Item 5.

Item 5. Market for Registrants' Common Equity and Related - ------- Stockholder Matters
For Illinova the information under the caption "Quarterly Consolidated Financial Information and Common Stock Data (Unaudit ed)" on page A-31 of the 1996 Annual Report to Shareholders in the appendix to the Illinova Proxy Statement is incorporated herein by reference.
For IP the information under the caption "Quarterly Consolidated Financial Information and Common Stock Data (Unaudited)" on page A-31 of the 1996 Annual Report to Shareholders in the appendix to the IP Information Statement is incorporated herein by reference.
Item 6.

Item 6. Selected Financial Data - -------
For Illinova the information under the caption "Selected Consolidated Financial Data" on page A-32 of the 1996 Annual Report to Shareholders in the appendix to the Illinova Proxy Statement is incorporated herein by reference.
For IP the information under the caption "Selected Consolidated Financial Data" on page A-32 of the 1996 Annual Report to Shareholders in the appendix to the IP Information Statement is incorporated herein by reference.
Item 7.

Item 7. Management's Discussion and Analysis of Financial - ------- Condition and Results of Operations
For Illinova the information under the caption "Management's Discussion and Analysis" on pages A-2 through A-9 of the 1996 Annual Report to Shareholders in the appendix to the Illinova Proxy Statement is incorporated herein by reference.
For IP the information under the caption "Management's Discussion and Analysis" on pages A-2 through A-9 of the 1996 Annual Report to Shareholders in the appendix to the IP Information Statement is incorporated herein by reference.
In March 1995, the ICC approved a program whereby IP will reacquire shares of its common stock from Illinova, from time to time, at prices determined to be equivalent to current market value. The reacquired stock will be retained as treasury stock or canceled. The ICC did not set a limit on the number of shares of common stock that can be repurchased, subject to meeting certain financial tests. During 1996, IP repurchased 714,811 shares for a total of $18.9 million, averaging about $26 per share.
For information regarding the redemption of IP preferred stock, see "Note 10 - Preferred Stock of Subsidiary" in the "Notes to Consolidated Financial Statements" in the 1996 Annual Report to Shareholders in the appendix to the Illinova Proxy Statement or "Note 9 - Preferred Stock" in the "Notes to Consolidated Financial Statements" in the 1996 Annual Report to Shareholders in the appendix to the IP Information Statement.
Item 8.

Item 8. Financial Statements and Supplementary Data - -------
For Illinova the consolidated financial statements and related notes on pages A-11 through A-31 and Report of Inde pendent Accountants on page A-10 of the 1996 Annual Report to Shareholders in the appendix to the Illinova Proxy Statement are incorporated herein by reference. With the exception of the aforementioned information and the information incorporated in Items 1, 3, 5, 6 and 7, the 1996 Annual Report to Shareholders in the appendix to the Illinova Proxy Statement is not to be deemed filed as part of this Form 10-K Annual Report.
For IP the consolidated financial statements and related notes on pages A-11 through A-31 and Report of Independent Accountants on page A-10 of the 1996 Annual Report to Shareholders in the appendix to the IP Information Statement are incorporated herein by reference. With the exception of the aforementioned information and the information incorporated in Items 1, 3, 5, 6 and 7, the 1996 Annual Report to Shareholders in the appendix to the IP Information Statement is not to be deemed filed as part of this form 10-K Annual Report.
Item 9.

Item 10. Directors and Executive Officers of the Registrants - --------
For Illinova the information under the caption "Board of Directors" on pages 3 through 7 of Illinova's Proxy Statement for its 1997 Annual Meeting of Stockholders is incorporated herein by reference. The information relating to Illinova's executive officers is set forth in Part I of this Annual Report on Form 10-K.
For IP the information under the caption "Board of Directors" on pages 4 through 7 of IP's Information Statement for its 1997 Annual Meeting of Stockholders is incorporated herein by reference. The information relating to Illinois Power Company's executive officers is set forth in Part I of this Annual Report on Form 10-K.
Item 11.

Item 11. Executive Compensation - --------
For Illinova the information under the caption "Executive Compensation" on pages 8 through 12 of Illinova's Proxy Statement for its 1997 Annual Meeting of Stockholders is incorporated herein by reference.
For IP the information under the caption "Executive Compensation" on pages 8 through 13 of IP's Information Statement for its 1997 Annual Meeting of Stockholders is incorporated herein by reference.
Item 12.

Item 12. Security Ownership of Certain Beneficial Owners and Management - --------
For Illinova the information under the caption "Security Ownership of Management and Certain Beneficial Owners" on page 7 and the information regarding securities owned by certain officers and directors under the caption "Board of Directors" on pages 3 through 7 of Illinova's Proxy Statement for its 1997 Annual Meeting of Stockholders is incorporated herein by reference.
For IP the information under the caption "Security Ownership of Management and Certain Beneficial Owners" on page 7 and the information regarding securities owned by certain officers and directors under the caption "Board of Directors" on pages 4 through 7 of IP's Information Statement for its 1997 Annual Meeting of Stockholders is incorporated herein by reference.
Item 13.

Item 14. Exhibits, Financial Statement Schedules, and Reports on - -------- Form 8-K
(a) Documents filed as part of this report. (1a) Financial Statements: Page in 1996 Annual Report to Shareholders in the appendix to the Illinova Proxy Statement* ----------------
Report of Independent Accountants A-10 Consolidated Statements of Income for the three years ended December 31, 1996 A-11 Consolidated Balance Sheets at December 31, 1996 and 1995 A-12 Consolidated Statements of Cash Flows for the three years ended December 31, 1996 A-13 Consolidated Statements of Retained Earnings for the three years ended December 31, 1996 A-13 Notes to Consolidated Financial Statements A-14 - A-31
* Incorporated by reference from the indicated pages of the 1996 Annual Report to Shareholders in the appendix to the Illinova Proxy Statement.
(1b) Financial Statements: Page in 1996 Annual Report to Shareholders in the appendix to the IP Information Statement** ---------------
Report of Independent Accountants A-10 Consolidated Statements of Income for the three years ended December 31, 1996 A-11 Consolidated Balance Sheets at December 31, 1996 and 1995 A-12 Consolidated Statements of Cash Flows for the three years ended December 31, 1996 A-13 Consolidated Statements of Retained Earnings for the three years ended December 31, 1996 A-13 Notes to Consolidated Financial Statements A-14 - A-31
** Incorporated by reference from the indicated pages of the 1996 Annual Report to Shareholders in the appendix to the IP Information Statement (See page 22 of this Form 10-K).
Item 14. Exhibits, Financial Statement Schedules, and Reports on - -------- Form 8-K (Continued)
(2) Financial Statement Schedules:
All Financial Statement Schedules are omitted because they are not applicable or the required information is shown in the financial statements or notes thereto.
(3) Exhibits
The exhibits filed with this Form 10-K are listed in the Exhibit Index located elsewhere herein. All management contracts and compensatory plans or arrangements set forth in such list are marked with a ~.
(b) Reports on Form 8-K since September 30, 1996:
Report filed on Form 8-K on January 29, 1997 Other Events: NRC informed IP via letter that it viewed Clinton as having a declining safety performance trend, but did not place Clinton on its semiannual "watch list". Report filed on Form 8-K on March 6, 1997 Other Events: Communication to the Financial Community regarding the status of Clinton outage.