UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 20042005
Or
[_] TRANSITION REPORT PURSUANT 1TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission Registrant, State of Incorporation IRS Employer
File Number Address, and Telephone Number Identification No.
1-2893 Louisville Gas and Electric Company 61-0264150
(A Kentucky Corporation)
220 West Main Street
P.O. Box 32010
Louisville, KY 40232
(502) 627-2000
1-3464 Kentucky Utilities Company 61-0247570
(A Kentucky and Virginia Corporation)
One Quality Street
Lexington, KY 40507-1428
(859) 255-2100
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes X. No _.
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes No X
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date:
Louisville Gas and Electric Company
21,294,223 shares, without par value, as of April 30, 2004,2005,
all held by LG&E Energy LLC
Kentucky Utilities Company
37,817,878 shares, without par value, as of April 30, 2004,2005,
all held by LG&E Energy LLC
This combined Form 10-Q is separately filed by Louisville Gas and Electric
Company and Kentucky Utilities Company. Information contained herein
related to any individual registrant is filed by such registrant on its own
behalf. Each registrant makes no representation as to information related
to the other registrants.
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INDEX OF ABBREVIATIONS
AEP American Electric Power Company, Inc.
AG Attorney General of Kentucky
ARB Accounting Research Bulletin
ARO Asset Retirement Obligation
CCN Certificate of Public Convenience and Necessity
DSM Demand Side Management
ECR Environmental Cost Recovery
EEI Electric Energy, Inc.
E.ON E.ON AG
ESM Earnings Sharing Mechanism
FAC Fuel Adjustment Clause
FASB Financial Accounting Standards Board
FERC Federal Energy Regulatory Commission
Fidelia Fidelia Corporation (an E.ON affiliate)
FIN FASB Interpretation No.
FGD Flue Gas Desulfurization
FSP FASB Staff Position
IMEA Illinois Municipal Electric Agency
IMPA Indiana Municipal Power Agency
IRS Internal Revenue Service
Kentucky Commission Kentucky Public Service Commission
KU Kentucky Utilities Company
LIBOR London Interbank Offer Rate
LEM LG&E Energy Marketing Inc.
LG&E Louisville Gas and Electric Company
LG&E Energy LG&E Energy LLC (as successor to LG&E Energy Corp.)
LG&E Services LG&E Energy Services Inc.
LMP Locational Marginal Pricing
MGP Manufactured Gas Plant
MISO Midwest Independent Transmission System Operator Inc.
Moody's Moody's Investor Services, Inc.
Mw Megawatts
Mwh Megawatt hours
NOPR Notice of Proposed Rulemaking
OMU Owensboro Municipal Utilities
OVEC Ohio Valley Electric Corporation
PJM PJM Interconnection, LLC
Powergen Powergen Limited (formerly Powergen plc)
PUHCA Public Utility Holding Company Act of 1935
RTO Regional Transmission Operator
S&P Standard & Poor's Rating Services
SEC Securities and Exchange Commission
SFAS Statement of Financial Accounting Standards
SMD Standard Market Design
SO2 Sulfur Dioxide
VDT Value Delivery Team Process
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TABLE OF CONTENTS
PART I
ITEM 1. CONSOLIDATED1 FINANCIAL STATEMENTS (UNAUDITED)
LOUISVILLE GAS AND ELECTRIC COMPANY
AND SUBSIDIARY
STATEMENTS OF INCOME 1
STATEMENTSTATEMENTS OF RETAINED EARNINGS 1
BALANCE SHEETS 2
STATEMENTSTATEMENTS OF CASH FLOWS 4
STATEMENTS OF OTHER COMPREHENSIVE INCOME 5
KENTUCKY UTILITIES COMPANY
AND SUBSIDIARY
STATEMENTS OF INCOME 6
STATEMENTSTATEMENTS OF RETAINED EARNINGS 6
BALANCE SHEETS 7
STATEMENTSTATEMENTS OF CASH FLOWS 9
STATEMENTS OF OTHER COMPREHENSIVE INCOME 10
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 11
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS. 1925
ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. 2832
ITEM 4 CONTROLS AND PROCEDURES. 3034
PART II
ITEM 1 LEGAL PROCEEDINGS. 31PROCEEDINGS 35
ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K 3135
SIGNATURES 3336
EXHIBITS 37
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Part I. Financial Information - Item 1. Consolidated Financial Statements (Unaudited)
Louisville Gas and Electric Company
and Subsidiary
Consolidated Statements of Income
(Unaudited)
(Thousands(Millions of $)
Three Months Ended
March 31,
2005 2004 2003
OPERATING REVENUES (Note 5)4):
Electric $198,249 $187,020$229.8 $198.3
Gas 163,714 139,824172.6 163.7
Total operating revenues 361,963 326,844402.4 362.0
OPERATING EXPENSES:
Fuel for electric generation 52,524 49,47760.3 52.9
Power purchased 28,888 24,12839.0 28.9
Gas supply expenses 130,756 106,107135.6 130.8
Other operation and maintenance expenses 58,061 53,528
Maintenance 11,541 11,89375.2 74.3
Depreciation and amortization 27,499 27,145
Federal and state income taxes 15,025 16,641
Property and other taxes 5,071 4,73530.7 27.5
Total operating expenses 329,365 293,654340.8 314.4
NET OPERATING INCOME 32,598 33,19061.6 47.6
Other income (expense) - net (461) 1,060
Other income from affiliated company (Note 10) - 40.2 (0.8)
Interest expense (Note 3) 4,777 6,2555.8 4.8
Interest expense to affiliated companies (Note 10) 3,141
7359) 3.1 3.1
INCOME BEFORE INCOME TAXES 52.9 38.9
Federal and state income taxes (Note 6) 19.0 14.7
NET INCOME $ 24,21933.9 $ 27,264
Consolidated Statement of Retained Earnings
(Unaudited)
(Thousands of $)
Three Months Ended
March 31,
2004 2003
Balance at beginning of period $497,441 $409,319
Net income 24,219 27,264
Subtotal 521,660 436,583
Cash dividends declared on stock:
5% cumulative preferred 269 269
Auction rate cumulative preferred 187 300
$5.875 cumulative preferred - 367
Subtotal 456 936
Balance at end of period $521,204 $435,64724.2
The accompanying notes are an integral part of these consolidatedfinancial statements.
Statements of Retained Earnings
(Unaudited)
(Millions of $)
Three Months Ended
March 31,
2005 2004
Balance at beginning of period $534.0 $497.5
Net income 33.9 24.2
Subtotal 567.9 521.7
Cash dividends declared on stock:
5% cumulative preferred 0.3 0.3
Auction rate cumulative preferred 0.4 0.2
Common 29.0 -
Subtotal 29.7 0.5
Balance at end of period $538.2 $521.2
The accompanying notes are an integral part of these financial statements.
- - Page 12 -
Louisville Gas and Electric Company
and Subsidiary
Consolidated Balance Sheets
(Unaudited)
(Thousands(Millions of $)
ASSETS
March 31, December 31,
2005 2004 2003
UTILITY PLANT:
At original cost $3,826,311 $3,804,183
Less: reserve for depreciation 1,339,855 1,319,768
Net utility plant (Note 7) 2,486,456 2,484,415
OTHER PROPERTY AND INVESTMENTS -
less reserve of $63 as of March 31, 2004
and December 31, 2003 507 611
CURRENT ASSETS:
Cash and cash equivalents 28,629 1,706$ 6.7 $ 6.8
Accounts receivable -
less reserve of $3,515$1.2 million and $0.8 million as of
March 31, 20042005 and December 31, 2003 (Note 4) 128,986 84,585
Notes receivable from affiliated companies 6,600 -2004,
respectively 161.4 167.0
Materials and supplies - at average cost:
Fuel (predominantly coal) 22,081 25,26021.9 21.8
Gas stored underground 24,756 69,88424.8 77.5
Other 25,583 24,97126.2 26.1
Prepayments and other 4,661 5,2814.9 3.9
Total current assets 241,296 211,687245.9 303.1
OTHER PROPERTY AND INVESTMENTS -
less reserve of less than $0.1 million as of
March 31, 2005 and December 31, 2004 0.6 0.5
UTILITY PLANT:
At original cost 3,934.3 3,915.8
Less: reserve for depreciation 1,432.4 1,396.3
Net utility plant 2,501.9 2,519.5
DEFERRED DEBITS AND OTHER ASSETS:
Restricted cash 10.8 10.9
Unamortized debt expense 8,718 8,4688.4 8.4
Regulatory assets (Note 6) 122,534 142,7725) 76.4 91.9
Other 37,506 40,97532.8 32.2
Total deferred debits and other assets 168,758 192,215128.4 143.4
Total assets $2,897,017 $2,888,928$2,876.8 $2,966.5
The accompanying notes are an integral part of these consolidated financial statements.
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Louisville Gas and Electric Company
and Subsidiary
Consolidated Balance Sheets (cont.)
(Unaudited)
(Thousands(Millions of $)
CAPITALIZATION AND LIABILITIES
March 31, December 31,
2005 2004 2003
CAPITALIZATION:
Common stock, without par value -
Outstanding 21,294,223 shares $ 425,170 $ 425,170
Common stock expense (836) (836)
Additional paid-in capital 40,000 40,000
Accumulated other comprehensive loss (41,743) (38,111)
Retained earnings 521,204 497,441
Total common equity 943,795 923,664
Cumulative preferred stock 70,425 70,140
Mandatorily redeemable preferred stock (Note 8) 22,500 22,500
Long-term debt (Note 9) 328,104 328,104
Long-term debt to affiliated company (Note 9) 225,000 200,000
Total capitalization 1,589,824 1,544,408
CURRENT LIABILITIES:
Current portion of mandatorily
redeemable preferred stock (Note 8) 1,250 1,250$ 1.3 $ 1.3
Current portion of long-term debt 246,200 246,200246.2 246.2
Current portion of long-term debt to
affiliated company (Note 9) 100,0008) - 50.0
Notes payable to affiliated companies (Note 9) - 80,3328) 35.0 58.2
Accounts payable 72,171 93,11888.2 106.1
Accounts payable to affiliated companies (Note 10) 19,875 38,3439) 26.3 31.7
Accrued income taxes 23,617 18,61531.4 6.2
Customer deposits 10,578 10,49315.0 14.0
Other 10,519 9,3084.8 18.5
Total current liabilities 484,210 497,659448.2 532.2
DEFERRED CREDITS AND OTHER LIABILITIES:
Accumulated deferred income taxes - net 338,843 337,704326.3 347.2
Investment tax credit, in process of amortization 49,278 50,32945.2 46.2
Accumulated provision for pensions
and related benefits 100,937 140,598122.1 120.6
Customer advances for construction 10,020 9,8909.6 10.6
Asset retirement obligation 9,911 9,74710.4 10.3
Regulatory liabilities (Note 6)5):
Accumulated cost of removal of utility plant 227,187 223,622214.1 220.2
Other 50,584 51,822
Long-term derivative liability 22,041 15,96672.5 52.2
Other 14,182 7,18326.1 29.4
Total deferred credits and other liabilities 822,983 846,861826.3 836.7
CAPITALIZATION:
Common stock, without par value -
Outstanding 21,294,223 shares 425.2 425.2
Common stock expense (0.8) (0.8)
Additional paid-in capital 40.0 40.0
Accumulated other comprehensive loss (45.1) (45.6)
Retained earnings 538.2 534.0
Total common equity 957.5 952.8
Cumulative preferred stock 70.4 70.4
Mandatorily redeemable preferred stock 21.3 21.3
Long-term debt (Note 8) 328.1 328.1
Long-term debt to affiliated company (Note 8) 225.0 225.0
Total capitalization 1,602.3 1,597.6
Total capital and liabilities $2,897,017 $2,888,928$2,876.8 $2,966.5
The accompanying notes are an integral part of these consolidated financial statements.
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Louisville Gas and Electric Company
and Subsidiary
Consolidated StatementStatements of Cash Flows
(Unaudited)
(Thousands(Millions of $)
Three Months Ended
March 31,
2005 2004 2003
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 24,21933.9 $ 27,26424.2
Items not requiring cash currently:
Depreciation and amortization 27,499 27,145
Deferred income taxes - net 276 5,510
Investment tax credit - net (1,051) (1,052)30.7 27.5
VDT amortization 7,534 7,696
Marked-to-market financial7.6 7.5
Change in fair value of derivative instruments 6,075 33(1.3) 6.1
Other (2,992) 5,573(0.1) (3.8)
Changes in current assets and liabilities (29,225) 22,413
Changes in accounts receivable securitization
-net (Note 4) - 11,800liabilities-net 46.3 (29.2)
Pension funding (Note 9) (34,492) (83,125)
Provision for post-retirement benefits (5,169) (1,425)11) - (34.5)
Gas supply clause 7,773 (19,353)receivable, net 1.9 7.8
Earnings sharing mechanism (ESM) 3,032 (1,147)receivable 3.5 3.0
Other 12,864 4,122(1.2) 7.7
Net cash flows fromprovided by operating activities 16,343 5,454121.3 16.3
CASH FLOWS USED IN INVESTING ACTIVITIES:
Proceeds from sales(Purchase) sale of securities 103 162long-term investments (0.1) 0.1
Construction expenditures (27,061) (71,255)(18.5) (27.0)
Net cash flows used infor investing activities (26,958) (71,093)(18.6) (26.9)
CASH FLOWS FROM FINANCING ACTIVITIES:
Long-term borrowings from affiliated company (Note 9) 125,0008) - 125.0
Repayment of long-term borrowings
from affiliated company (Note 8) (50.0) -
Short-term borrowings from affiliated company (Note 9) 131,200 229,2008) - 131.2
Repayment of short-term borrowings
from affiliated company (218,132) (173,741)
Issuance expense of pollution control bonds (96) -(23.2) (218.2)
Payment of dividends (434) (1,057)(29.7) (0.4)
Other 0.1 (0.1)
Net cash flows from(used for) provided by financing
activities 37,538 54,402(102.8) 37.5
CHANGE IN CASH AND CASH EQUIVALENTS 26,923 (11,237)(0.1) 26.9
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 1,706 17,0156.8 1.7
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 28,6296.7 $ 5,77828.6
SUPPLEMENTAL DISCLOSURES:
Cash paid during the period for:
Income taxes $ 5,241(0.7) $ (1,739)(5.2)
Interest on borrowed money $ 3,9173.9 $ 6,7003.9
Interest to affiliated companies on borrowed money $ 2,7774.0 $ 6982.8
The accompanying notes are an integral part of these consolidated financial statements.
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Louisville Gas and Electric Company
and Subsidiary
Consolidated Statements of Other Comprehensive Income
(Unaudited)
(Thousands(Millions of $)
Three Months Ended
March 31,
2005 2004 2003
Net income $24,219 $27,264
Losses$33.9 $24.2
Income Taxes - Minimum Pension Liability (Note 6) (1.1) -
Gain (loss) on derivative instruments and hedging
activities - net of tax benefit/(expense) of
$2,417$(1.0) and $13$2.4 for 20042005 and 2003,2004,
respectively (Note 3) (3,632) (20)1.6 (3.6)
Other comprehensive loss,income (loss), net of tax (3,632) (20)0.5 (3.6)
Comprehensive income $20,587 $27,244$34.4 $20.6
The accompanying notes are an integral part of these consolidated financial statements.
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Kentucky Utilities Company
and Subsidiary
Consolidated Statements of Income
(Unaudited)
(Thousands(Millions of $)
Three Months Ended
March 31,
2005 2004 2003
OPERATING REVENUES (Note 5) $247,386 $224,983$287.5 $247.4
OPERATING EXPENSES:
Fuel for electric generation 69,884 66,32387.4 70.0
Power purchased 41,307 41,19946.3 41.3
Other operation and maintenance expenses 38,454 38,889
Maintenance 11,884
28,96659.6 54.5
Depreciation and amortization 25,249 24,150
Federal and state income taxes 21,101 6,601
Property and other taxes 4,253 4,19528.6 25.2
Total operating expenses 212,132 210,323221.9 191.0
NET OPERATING INCOME 35,254 14,66065.6 56.4
Other income - net 1,462 2,106
Other income from affiliated company (Note 10) 10 31.0 0.4
Interest expense (Note 3) 735 4,5312.9 0.7
Interest expense to affiliated companies (Note 10) 3,547 3779) 3.6 3.6
NET INCOME BEFORE INCOME TAXES 60.1 52.5
Federal and state income taxes (Note 6) 22.6 20.1
NET INCOME $ 32,44437.5 $ 11,861
Consolidated Statement of Retained Earnings
(Unaudited)
(Thousands of $)
Three Months Ended
March 31,
2004 2003
Balance at beginning of period $591,170 $502,024
Net income 32,444 11,861
Subtotal 623,614 513,885
Cash dividends declared on stock:
4.75% cumulative preferred 237 237
6.53% cumulative preferred 327 327
Subtotal 564 564
Balance at end of period $623,050 $513,32132.4
The accompanying notes are an integral part of these consolidatedfinancial statements.
Statements of Retained Earnings
(Unaudited)
(Millions of $)
Three Months Ended
March 31,
2005 2004
Balance at beginning of period $659.4 $591.2
Net income 37.5 32.4
Subtotal 696.9 623.6
Cash dividends declared on stock:
4.75% cumulative preferred 0.2 0.2
6.53% cumulative preferred 0.3 0.3
Common 30.0 -
Subtotal 30.5 0.5
Balance at end of period $666.4 $623.1
The accompanying notes are an integral part of these financial statements.
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Kentucky Utilities Company
and Subsidiary
Consolidated Balance Sheets
(Unaudited)
(Thousands(Millions of $)
ASSETS
March 31, December 31,
2005 2004 2003
UTILITY PLANT:
At original cost $3,612,033 $3,596,657
Less: reserve for depreciation 1,351,851 1,350,165
Net utility plant (Note 7) 2,260,182 2,246,492
OTHER PROPERTY AND INVESTMENTS -
less reserve of $131 and $130 as of March 31,
2004 and December 31, 2003, respectively 18,564 17,862
CURRENT ASSETS:
Cash and cash equivalents 8,072 4,869$ 3.9 $ 4.6
Accounts receivable - less reserve of $673$0.7 million
and $672$0.6 million as of March 31, 20042005 and
December 31, 2003, 2004,respectively (Note 4) 83,596 49,289103.6 112.6
Materials and supplies - at average cost:
Fuel (predominantly coal) 38,125 45,53849.9 52.2
Other 27,235 27,09428.4 28.0
Prepayments and other 13,045 13,1009.4 9.9
Total current assets 170,073 139,890195.2 207.3
OTHER PROPERTY AND INVESTMENTS -
less reserve of $0.1 million as of March 31,
2005 and December 31, 2004, respectively 21.1 20.5
UTILITY PLANT:
At original cost 3,730.6 3,712.1
Less: reserve for depreciation 1,438.1 1,415.0
Net utility plant 2,292.5 2,297.1
DEFERRED DEBITS AND OTHER ASSETS:
Unamortized debt expense 4,410 4,4814.7 4.7
Regulatory assets (Note 6) 63,556 70,7855) 58.9 61.4
Long-term derivative asset 12,163 12,2235.5 6.1
Other 18,499 23,44914.6 13.3
Total deferred debits and other assets 98,628 110,93883.7 85.5
Total assets $2,547,447 $2,515,182$2,592.5 $2,610.4
The accompanying notes are an integral part of these consolidated financial statements.
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Kentucky Utilities Company
and Subsidiary
Consolidated Balance Sheets (cont.)
(Unaudited)
(Thousands(Millions of $)
CAPITALIZATION AND LIABILITIES
March 31, December
31,
2005 2004 2003
CAPITALIZATION:
Common stock, without par value -
Outstanding 37,817,878 shares $ 308,140 $ 308,140
Common stock expense (322) (322)
Additional paid-in capital 15,000 15,000
Accumulated other comprehensive loss (6,018) (6,031)
Retained earnings 623,050 591,170
Total common equity 939,850 907,957
Cumulative preferred stock 39,727 39,727
Long-term debt (Note 9) 312,027 312,646
Long-term debt to affiliated company (Note 9) 333,000 283,000
Total capitalization 1,624,604 1,543,330
CURRENT LIABILITIES:
Current portion of long-term debt 91,930 91,930$ 123.1 $ 87.1
Current portion of long-term notes to
affiliated company 75.0 75.0
Notes payable to affiliated company (Note 9) 40,731 43,2318) 26.0 34.8
Accounts payable 53,545 69,94750.3 77.9
Accounts payable to affiliated companies (Note 10) 9,601 26,4269) 21.0 32.8
Accrued income taxes 24,198 8,80933.4 5.9
Customer deposits 13,672 13,45315.7 15.0
Other 14,521 11,6544.6 15.4
Total current liabilities 248,198 265,450349.1 343.9
DEFERRED CREDITS AND OTHER LIABILITIES:
Accumulated deferred income taxes - net 267,908 261,258267.7 282.6
Investment tax credit, in process of amortization 5,345 5,8593.4 3.8
Accumulated provision for pensions and
related benefits 57,629 103,101
Customer advances for construction 1,576 1,56480.0 77.9
Asset retirement obligation 20,023 19,69821.2 21.0
Regulatory liabilities (Note 6)5):
Accumulated cost of removal of utility plant 269,127 266,832271.6 266.8
Other 34,157 38,02741.4 24.7
Other 18,880 10,06315.9 17.0
Total deferred credits and other liabilities 674,645 706,402701.2 693.8
CAPITALIZATION:
Common stock, without par value -
Outstanding 37,817,878 shares 308.1 308.1
Common stock expense (0.3) (0.3)
Additional paid-in capital 15.0 15.0
Accumulated other comprehensive loss (13.6) (13.3)
Retained earnings 653.8 647.3
Undistributed subsidiary earnings 12.6 12.1
Total common equity 975.6 968.9
Cumulative preferred stock 39.7 39.7
Long-term debt (Note 8) 268.9 306.1
Long-term debt to affiliated company (Note 8) 258.0 258.0
Total capitalization 1,542.2 1,572.7
Total capital and liabilities $2,547,447 $2,515,182$2,592.5 $2,610.4
The accompanying notes are an integral part of these consolidated financial statements.
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Kentucky Utilities Company
and Subsidiary
Consolidated StatementStatements of Cash Flows
(Unaudited)
(Thousands(Millions of $)
Three Months Ended
March 31,
2005 2004 2003
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 32,44437.5 $ 11,86132.4
Items not requiring cash currently:
Depreciation and amortization 25,249 24,150
Deferred income taxes - net 6,022 913
Investment tax credit - net (513) (660)28.6 25.2
VDT amortization 2,938 3,106
Marked-to-market financial2.9 2.9
Change in fair value of derivative instruments (560) 726(1.2) (0.5)
Other 842 14,324(1.1) 6.4
Changes in current assets and liabilities (41,734) (6,371)(10.6) (41.7)
Earnings sharing mechanism receivable 5.1 3.3
Pension funding (Note 9) (43,409) (3,503)
Provision for post-retirement benefits (2,062) (1,311)
ESM 3,318 3,01011) - (43.4)
Other 13,008 4,866(3.8) 10.9
Net cash flows fromprovided by operating activities (4,457) 51,11157.4 (4.5)
CASH FLOWS USED IN INVESTING ACTIVITIES:
Long-termPurchase of long-term investments (702) (485)(0.1) (0.7)
Construction expenditures (38,582) (103,317)(18.5) (38.6)
Net cash flows used in investing activities (39,284) (103,802)(18.6) (39.3)
CASH FLOWS FROM FINANCING ACTIVITIES:
Long-term borrowings from affiliated company (Note 9) 50,0008) - 50.0
Short-term borrowings from affiliated company (Note 9) 128,000 444,0118) - 128.0
Repayment of short-term borrowings
from affiliated company (130,500) (388,970)
Refund on issuance expense of
pollution control bonds 8 -(8.9) (130.5)
Payment of dividends (564) (564)(30.6) (0.5)
Net cash flows from financing activities 46,944 54,477(39.5) 47.0
CHANGE IN CASH AND CASH EQUIVALENTS 3,203 1,786(0.7) 3.2
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 4,869 5,3914.6 4.9
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 8,0723.9 $ 7,1778.1
SUPPLEMENTAL DISCLOSURES:
Cash paid during the period for:
Income taxes $ 966(2.3) $ (5,110)1.0
Interest on borrowed money $ 1,5772.2 $ 1,7641.6
Interest to affiliated companies on borrowed money $ 2,1603.2 $ 3662.2
The accompanying notes are an integral part of these consolidated financial statements.
- - Page 9 -
Kentucky Utilities Company and Subsidiary
Consolidated
Statements of Other Comprehensive Income
(Unaudited)
(Thousands(Millions of $)
Three Months Ended
March 31,
2005 2004 2003
Net income $32,444 $11,861
Gains on derivative instruments and hedging
activities$37.5 $32.4
Income Taxes - Minimum Pension Liability (Note 6) (0.3) -
Other comprehensive loss, net of tax benefit/(expense) of
$(13) for 2004 13 -
Other comprehensive income, net of tax 13(0.3) -
Comprehensive income $32,457 $11,861$37.2 $32.4
The accompanying notes are an integral part of these consolidated financial statements.
- - Page 10 -
Louisville Gas and Electric Company
and Subsidiary
Kentucky Utilities Company
and Subsidiary
Notes to Consolidated Financial Statements
(Unaudited)
1. General
The unaudited consolidated financial statements include the accounts of Louisville GasLG&E and Electric Company and Subsidiary and Kentucky
Utilities Company and Subsidiary (each "LG&E" and "KU", or the
"Companies").KU.
The common stock of each of LG&E and KU is wholly-owned by LG&E Energy LLC ("LG&E Energy").Energy.
In the opinion of management, the unaudited interim financial
statements include all adjustments, consisting only of normal recurring
adjustments, necessary for a fair statement of consolidated financial position,
results of operations, comprehensive income and cash flows for the
periods indicated. Certain information and footnote disclosures
normally included in financial statements prepared in accordance with
generally accepted accounting principles have been condensed or omitted
pursuant to Securities and
Exchange Commission ("SEC")SEC rules and regulations, although the Companies believe
that the disclosures are adequate to make the information presented not
misleading.
See LG&E's and KU's Annual Reports on Form 10-K for the year ended
December 31, 2003,2004, for information relevant to the accompanying
financial statements, including information as to the significant
accounting policies of the Companies.
The accompanying financial statements for the three months ended March
31, 2003,2004, have been revised to conform to certain reclassifications in
the current three months ended March 31, 2004.2005. These reclassifications
had no impact on the balance sheet net assets or net income, as previously reported. LG&E
and KU net operating income previously reported for the three months
ended March 31, 2004 increased by $15.0 million and $21.1 million,
respectively, because the income statement presentation was changed in
2005 to report income tax expense in the category Federal and State
income taxes, which appears just before net income. LG&E and KU other
income (expense) - net previously reported for the three months ended
March 31, 2004 decreased $0.3 million and $1.0 million, respectively,
also due to the income tax reclassification.
2. Mergers and Acquisitions
LG&E and KU are each subsidiaries of LG&E Energy. InOn July 1, 2002, E.ON
AG ("E.ON"), a German company, completed its acquisition of Powergen, Limited ("Powergen"), the former parent company ofincluding
LG&E Energy. As a
result, LG&E and KU became indirect subsidiaries of E.ON. E.ON had
announced its pre-conditional cash offer ofEnergy, for approximately 5.1 billion pounds sterling ($7.3 billion) for Powergen in April 2001..
As a result of the acquisition, LG&E Energy became a wholly-owned
subsidiary of E.ON and, as a result, LG&E and KU also became indirect
subsidiaries of E.ON. LG&E and KU have continued their separate
identities and serve customers under their existing names. The preferred
stock and debt securities of LG&E and KU were not affected by this
transaction and the utilities continue to file SEC reports. Following the
purchase of Powergen by E.ON,acquisition, E.ON became a registered holding company under the Public Utility Holding Company Act of 1935
("PUHCA"). As a result, E.ON, its utility subsidiaries, includingPUHCA. LG&E
and KU, and certainas subsidiaries of its non-utility subsidiariesa registered holding company, are subject to
extensive regulation by the SECadditional regulations under PUHCA with respect to issuances
and sales of securities, acquisitions and sales of certain utility
properties, and intra-system sales of certain goods and services.PUHCA. In addition, PUHCA generally limits the ability of registered holding
companies to acquire additional public utility systems and to acquire
and retain businesses unrelated to the utility operations of the holding
company. LG&E and KU believe that they have adequate authority
(including financing authority) under existing SEC orders and
regulations to conduct their business. LG&E and KU will seek additional
authorization when necessary.
As contemplated in their regulatory filings in connection with the E.ON
acquisition,March 2003, E.ON, Powergen and
LG&E Energy completed an administrative reorganization to move the LG&E
Energy group from an indirect Powergen subsidiary to an indirect E.ON
subsidiary. This reorganization was
effective in March 2003. In early 2004, LG&E Energy begancommenced direct reporting
arrangements to E.ON.
- - Page 11 -
The utility operations (LG&E and KU) of LG&E Energy have continued
their separate identities and continue to serve customers in Kentucky,
Virginia and Tennessee under their existing names. The preferred stock
and debt securities of LG&E and KU were not affected by these
transactions and LG&E and KU continue to file SEC reports.
Effective December 30, 2003, LG&E Energy LLC became the successor, by
assignment and subsequent merger, to all the assets and liabilities of
LG&E Energy Corp. Following the conversion, LG&E Energy became a
registered holding company under PUHCA.
3. Financial Instruments
The Companies use interest rate swaps to hedge exposure to market
fluctuations in certain of their debt instruments. Pursuant to the
Companies' policies, use of these financial instruments is intended to
mitigate risk, earnings and cash flow volatility and is not speculative
in nature. Management has designated all of the Companies' interest
rate swaps as hedge instruments. Financial instruments designated as
cash flow hedges have resulting gains and losses recorded within other
comprehensive income and stockholders' equity. To the extent a
financial instrument designated as a cash flow hedge or the underlying
item being hedged is prematurely terminated or the hedge becomes
ineffective, the resulting gains or losses are reclassified from other
comprehensive income to net income. Financial instruments designated
as fair value hedges are periodically marked to market with the
resulting gains and losses recorded directly into net income to
correspond with income or expense recognized from changes in market
value of the items being hedged.
As of March 31, 2004,2005, LG&E was party to various interest rate swap
agreements with aggregate notional amounts of $228.3$211.3 million. Under
these swap agreements, LG&E paid fixed rates averaging 4.38% and
received variable rates based on LIBOR or the Bond Market Association's
municipal swap index averaging 0.94%1.86% at March 31, 2004.2005. The swap
agreements in effect at March 31, 20042005 have been designated as cash
flow hedges and mature on dates ranging from 20052020 to 2033. The hedges
have been deemed to be fully effective resulting in a pretax lossgain of
$6.1$2.6 million for the three months ended March 31, 2004,2005, recorded in
other comprehensive income. Upon expiration of these hedges, the
amount recorded in other comprehensive income will be reclassified into
earnings. The amounts expected to be reclassified from other
comprehensive income to earnings in the next twelve months is
immaterial. A deposit in the amount of $10.8 million, used as
collateral for the $83.3 million interest rate swap, is classified as
restricted cash on LG&E's balance sheet. The amount of the deposit
required is tied to the market value of the swap.
In February 2005, an LG&E interest rate swap with a notional amount of
$17 million matured. The swap was fully effective upon expiration,
therefore, the impact on earnings and other comprehensive income from
the swap maturity was less than $0.1 million.
As of March 31, 2004,2005, KU was party to various interest rate swap
agreements with aggregate notional amounts of $103$103.0 million. Under
these swap agreements, KU paid variable rates based on either LIBOR or
the Bond Market Association's municipal swap index averaging 2.09%3.80%, and
received fixed rates averaging 7.74% at March 31, 2004.2005. The swap
agreements in effect at March 31, 20042005 have been designated as fair
value hedges and mature on dates ranging from 2007 to 2025. For 2004,2005,
the effect of marking these financial instruments and the underlying
debt to market resulted in immaterial pretax gains recorded in interest expense.expense of
$0.7 million.
- 12 -
Interest rate swaps hedge interest rate risk on the underlying debt.
Under SFAS No. 133, Accounting for Derivative Instruments and Hedging
Activities, in addition to swaps being marked to market, the item being
hedged using a fair value hedge must also be marked to market.
Consequently at March 31, 2004,2005, KU's debt reflects a $14.1$7.0 million mark-
to-market adjustment.
In February 2004, KU terminated the swap it had in place related to
the Series 9 pollution control bonds. The notional amount of the
terminated swap was $50 million and KU received a payment of $2.0
million as part of the termination.
- - Page 12 -
4. Accounts Receivable Securitization Programs
In February 2001, LG&E and KU implemented accounts receivable
securitization programs. The purpose of these programs was to enable
LG&E and KU to accelerate the receipt of cash from the collection of
retail accounts receivable, thereby reducing dependence upon more
costly sources of working capital.
In January 2004, LG&E and KU terminated their accounts receivable
securitization programs and replaced them with intercompany loans from
an E.ON affiliate. LG&E and KU anticipate dissolving their inactive
accounts receivable securitization-related subsidiaries during 2004.
5. SegmentSegments of Business
LG&E's revenues and net income by business segment for the three months
ended March 31, 20042005 and 2003,2004, follow:
Three Months Ended
March 31,
2004
(in thousands) Revenues Net Incomemillions) 2005 2004
LG&E electric $198,249 $15,943Electric
Revenues $ 229.8 $ 198.3
Net income 23.9 15.9
Total assets 2,394.1 2,427.4
LG&E Gas
Revenues 172.6 163.7
Net income 10.0 8.3
Total assets 482.7 469.6
Total
Revenues 402.4 362.0
Net income 33.9 24.2
Total assets 2,876.8 2,897.0
KU is an electric utility company. It does not provide gas 163,714 8,276
Total $361,963 $24,219
Three Months Ended March 31, 2003
(in thousands) Revenues Net Incomeservice and
therefore, is presented as a single business segment.
5. Rates and Regulatory Matters
For a description of each line item of regulatory assets and
liabilities for LG&E electric $187,020 $18,051and KU, reference is made to Part I, Item 8,
Financial Statements and Supplementary Data, Note 3 of LG&E gas 139,824 9,213
Total $326,844 $27,264
6. Regulatory Assets&E's and LiabilitiesKU's
Annual Reports on Form 10-K for the year ended December 31, 2004.
The following regulatory assets and liabilities were included in LG&E's
balance sheets as of March 31, 20042005 and December 31, 2003:2004:
- 13 -
Louisville Gas and Electric Company
(Unaudited)
March 31, December 31,
(in thousands)millions) 2005 2004
2003
Value delivery team (VDT) costsVDT Costs $ 60,27630.1 $ 67,81037.7
Unamortized loss on bonds 20.0 20.3
ARO 7.1 6.9
Merger surcredit 4.5 4.8
ESM - 2.1
Rate case expenses 1.0 1.1
FAC - 0.8
Gas supply adjustments due from customers 13,896 22,077
Unamortized loss on bonds 21,068 21,333
Earnings sharing mechanism
(ESM) provision 9,327 12,359
Merger surcredit 5,874 6,22010.2 13.3
Gas performance base ratemaking 2.4 3.7
Manufactured gas sites 1,377 1,454
Asset retirement obligation (ARO) 6,209 6,015
Gas performance-based ratemaking (PBR) 4,502 5,480
Other 5 241.1 1.2
Total regulatory assets $ 122,53476.4 $ 142,77291.9
Accumulated cost of removal of utility plant $(227,187) $(223,622)$214.1 $220.2
Deferred income taxes - net (40,319) (41,180)(Note 6) 55.8 37.2
ARO 0.1 0.1
ECR 4.0 4.0
FAC 0.8 -
ESM 1.4 -
DSM 3.3 2.5
Gas supply adjustments due to customers (6,397) (6,805)
ARO (107) (85)
ESM provision (16) (79)
Environmental cost recovery (ECR) (1,076) (17)
Fuel adjustment clause (FAC) (210) (1,950)
Demand side management (DSM) (2,459) (1,706)7.1 8.4
Total regulatory liabilities $(277,771) $(275,444)$286.6 $272.4
LG&E currently earns a return on all regulatory assets except for gas
supply adjustments, ESM, FAC, and gas performance-basedperformance based ratemaking, and other,
- Page 13 - all
of which are separate rate mechanisms with recovery within twelve
months. Additionally, no current return is earned on the ARO
regulatory asset. This regulatory asset will be offset against the
associated regulatory liability, ARO asset and ARO liability at the
time the underlying asset is retired.removed.
The following regulatory assets and liabilities were included in KU's
balance sheets as of March 31, 20042005 and December 31, 2003:2004:
- Page 14 -
Kentucky Utilities Company
(Unaudited)
March 31, December 31,
(in thousands)millions) 2005 2004 2003
VDT costs $ 23,51211.8 $ 26,45114.7
Unamortized loss on bonds 10,309 10,511
ESM provision 9,064 12,382
FAC 3,305 4,29811.2 11.4
ARO 13.3 12.8
Merger surcredit 4,547 4,815
ARO 11,692 11,322
Post-retirement3.5 3.7
ESM - 3.1
Rate case expenses 1.0 1.1
FAC 13.1 9.4
Deferred storm costs 3.4 3.6
Post retirement and pension 1,127 1,0061.2 1.2
Management audit expenses 0.4 0.4
Total regulatory assets $ 63,55658.9 $ 70,78561.4
Accumulated cost of removal of utility plant $(269,127) $(266,832)$271.6 $266.8
Deferred income taxes - net (23,430) (24,058)(Note 6) 32.4 19.3
ARO (1,225) (1,162)1.5 1.4
ECR 2.5 1.2
FAC - 0.1
ESM 2.0 -
DSM 1.9 1.6
Spare parts (1,064) (1,055)
ECR (6,604) (9,189)
FAC (134) (1,000)
DSM (1,700) (1,563)1.1 1.1
Total regulatory liabilities $(303,284) $(304,859)$313.0 $291.5
KU currently earns a return on all regulatory assets except for ESM and
FAC, allboth of which are separate recovery mechanisms with recovery
within twelve months. Additionally, no current return is earned on the
ARO regulatory asset. This regulatory asset will be offset against the
associated regulatory liability, ARO asset and ARO liability at the
time the underlying asset is retired.
7. Utility Plantremoved.
Based on an order from the Kentucky Commission in September 2004, KU
retired two steam generating units, Green River Units 1 and 2,reclassified from maintenance expense to a regulatory asset, $4.0
million related to costs not reimbursed from the 2003 ice storm. These
costs will be amortized through June 2009. These amortized costs,
which are included in KU's jurisdictional operating expenses, are
recovered in base rates.
Due to a number of changes in Kentucky's tax system, including the
reduction of the Corporate income tax, timing differences included in
the amountreserve for deferred state income taxes at December 31, 2004 will
reverse at lower rates than previously provided. See Note 6.
- 15 -
ELECTRIC AND GAS RATE CASES
On June 30, 2004, the Kentucky Commission issued an order approving an
increase in the base electric rates of $17.2LG&E and KU and the gas rates of
LG&E. The rate increases took effect on July 1, 2004.
During July 2004, the AG served subpoenas on LG&E and KU, as well as on
the Kentucky Commission and its staff, requesting information regarding
alleged improper communications between LG&E and KU and the Kentucky
Commission. The Kentucky Commission procedurally reopened the rate case
for the limited purpose of taking evidence, if any, as to the
communication issues. In September and October 2004, various
proceedings were held in circuit courts in Franklin and Jefferson
Counties, Kentucky regarding the scope and timing of document
production or other information required or agreed to be produced under
the AG's subpoenas and matters were consolidated into the Franklin
County court.
In January 2005, the AG conducted interviews of certain employees of
LG&E and KU and submitted its report to the Franklin County, Kentucky
Circuit Court in confidence. Concurrently, the AG filed a motion
summarizing the report as containing evidence of improper
communications and record-keeping errors by LG&E and KU in their
conduct of activities before the Kentucky Commission or other state
governmental entities and requesting release of the report to such
agencies. During February 2005, the court ruled that the report be
forwarded to the Kentucky Commission under continued confidential
treatment to allow it to consider the report, including its impact, if
any, on completing its investigation and any remaining steps in the
rate case, including ending the current abeyance. To date, LG&E and KU
have neither seen nor requested copies of the report or its contents.
LG&E and KU believe no improprieties have occurred in their
communications with the Kentucky Commission and are cooperating with
the proceedings before the AG and the Kentucky Commission.
LG&E and KU are currently unable to determine any possible future
actions of the AG or the Kentucky Commission or the ultimate impact, if
any, of the AG's report and investigation, including whether there will
be further actions to appeal, review or otherwise challenge the granted
increases in base rates.
- 16 -
VDT
The current five-year VDT amortization period is scheduled to expire in
March 2006. As part of the settlement agreements in the electric and
gas rate cases, LG&E and KU shall file with the Kentucky Commission a
plan for the future ratemaking treatment of the VDT surcredits and
costs six months prior to the March 2006 expiration. The surcredit
shall remain in effect following the expiration of the fifth year until
the Commission enters an order on the future disposition of VDT-related
issues.
ECR
In December 2004, KU and LG&E filed applications with the Kentucky
Commission for approval of a CCN to construct new SO2 control
technology (FGDs) at KU's Ghent and Brown stations, and to amend LG&E's
compliance plan to allow recovery of new and additional environmental
compliance facilities. The estimated capital cost of the additional
facilities is $742.7 million ($40.2 million for LG&E and $702.5 million
for KU), of which $658.9 million is for the FGDs. Hearings in these
cases occurred during May 2005 and final orders are expected in June
2005.
MISO
The MISO implemented a day-ahead and real-time market, including a
congestion management system in April 2005. This system is similar to
the LMP system currently used by the PJM RTO and contemplated in FERC's
SMD NOPR, currently being discussed. The MISO filed with FERC a
mechanism for recovery of costs for the congestion management system.
The MISO proposed the addition of two new Schedules, 16 and 17.
Schedule 16 is the MISO's cost recovery mechanism for the Financial
Transmission Rights Administrative Service it provides. Schedule 17 is
the MISO's mechanism for recovering costs it incurs for providing
Energy Marketing Support Administrative Service. The MISO transmission
owners, including LG&E and KU, objected to the allocation of costs
among market participants and retail native load. FERC ruled in 2004 in
favor of the MISO.
The Kentucky Commission opened an investigation into LG&E and KU's
memberships in the MISO in July 2003. The Kentucky Commission directed
LG&E and KU to file testimony addressing the costs and benefits of the
MISO membership both currently and over the next five years and other
legal issues surrounding continued membership. LG&E and KU engaged an
independent third-party to conduct a cost-benefit analysis on this
issue. The information was filed with the Kentucky Commission in
September 2003. The analysis and testimony supported the exit from the
MISO, under certain conditions. The MISO filed its books asown testimony and
cost benefit analysis in December 2003. A final Kentucky Commission
order was expected in the second quarter of 2004. The ruling has since
been delayed due to the Kentucky Commission's request for additional
testimony on the MISO's Market Tariff filing at FERC; a ruling is
expected by summer 2005.
- 17 -
Should LG&E and KU be ordered to exit the MISO, current MISO rules may
also impose an exit fee. While LG&E and KU believe legal and
regulatory precedent should permit most or many of the MISO-related
costs to be recovered in their rates charged to customers, they can
give no assurance that state or federal regulators will ultimately
agree with such position with respect to all costs, components or
timing of recovery. In April 2005, the Kentucky Commission issued an
order declining an LG&E and KU request for an automatic monthly tracker
of certain MISO-related costs, to be recovered through a new rate
mechanism.
At this time, LG&E and KU cannot predict the outcome or effects of the
various FERC and Kentucky Commission proceedings described above,
including whether such proceedings will have a material impact on the
financial condition or results of operations of the Companies.
Financial consequences (changes in transmission revenues and costs)
associated with the transmission market tariff charges are subject to
varying assumptions and calculations and are therefore difficult to
estimate. Changes in revenues and costs related to broader shifts in
energy market practices and economics are not currently estimable.
KENTUCKY COMMISSION STRATEGIC BLUEPRINT
In February 2005, Kentucky's Governor signed an executive order
directing the Kentucky Commission, in conjunction with the Commerce
Cabinet and the Environmental and Public Protection Cabinet, to
develop a Strategic Blueprint for the continued use and development of
electric energy'. This Strategic Blueprint will be designed to promote
future investment in electric infrastructure for the Commonwealth of
Kentucky, to protect Kentucky's low-cost electric advantage, to
maintain affordable rates for all Kentuckians, and to preserve
Kentucky's commitment to environmental protection. In March 2005, the
Kentucky Commission established Administrative Case No. 2005-00090 to
collect information from all jurisdictional utilities in Kentucky,
including LG&E and KU, pertaining to Kentucky electric generation,
transmission and distribution systems. The Kentucky Commission must
provide its Strategic Blueprint to the Governor in early August 2005.
LG&E and KU responded to the Kentucky Commission's first set of data
requests at the end of March 2005.
6. Income Taxes
Kentucky House Bill 272, also known as Kentucky's Tax Modernization
Plan, was signed into law on March 18, 2005. This bill contains a
number of changes in Kentucky's tax system, including the reduction of
the Corporate income tax rate from 8.25% to 7% effective January 1,
2005, and a further reduction to 6% effective January 1, 2007. Because
of the tax rate reduction, timing differences included in the reserve
for deferred state income taxes at December 31, 2004.
Approximately $4 million in common assets, which are shared by Green
River Units 32004, will reverse at
lower rates than previously provided. Without some form of adjustment,
- 18 -
the deferred tax reserve amount will exceed the actual deferred tax
liability attributable to existing timing differences. This excess
amount is referred to as excess deferred income taxes. The Company has
filed an application with the Kentucky Commission requesting approval
of its accounting treatment to establish and 4, remain on KU's books. The common assets will
remain on KU's books until the final retirement of Green River Units 3
and 4.
The following data represents shares of jointly-owned additions to the
Trimble County plantamortize a regulatory
liability for four combustion turbines as of March 31, 2004:its net excess deferred tax balance. Both LG&E and KU
Total
Ownership % 37% 63% 100%
Mw capacity 237 403 640
Plantare amortizing their depreciation-related excess deferred tax balances
under construction ($mill) $73 $124 $197
Depreciation - - -
Net book value $73 $124 $197
- - Page 14 -
8.the average rate assumption method. The average rate assumption
method matches the amortization of the excess deferred taxes with the
life of the timing differences to which it relates.
Significant judgment is required in determining the provision for
income taxes, and there are many transactions for which the ultimate
tax outcome is uncertain. To provide for these uncertainties
or exposures, LG&E and KU maintain an allowance for tax contingencies,
the balance of which management believes is adequate. Tax
contingencies are analyzed periodically and adjustments are made when
events occur to warrant a change. LG&E and KU are currently in the
examination phase of IRS audits for the years 1999 to 2003 and
expect some or all of these audits to be completed within the
next twelve months. LG&E is also under a Kentucky sales and use tax
audit for the periods October 1, 1997 through December 31, 2001, and an
initial assessment is expected within the next three months. The
results of audit assessments by taxing authorities could have a
material effect on quarterly or annual cash flows as well as results of
operations over the next three to twelve months as these audits are
completed. However, LG&E and KU do not believe that any of these
matters will have a material adverse effect on results of operations.
7. New Accounting Pronouncements
FSP 106-2
In JanuaryMay 2004, the FASB finalized FSP 106-2, Accounting and Disclosure
Requirements Related to the Medicare Prescription Drug, Improvement and
Modernization Act of 2003 ("Medicare Act") with guidance on accounting
for subsidies provided under the Financial Accounting Standards Board ("FASB")
issued Financial Accounting Standards Board Interpretation No. 46,
Consolidation of Variable Interest Entities, an Interpretation of ARB
No. 51 (FIN 46). FIN 46 requires certain variable interest entities to
be consolidated by the primary beneficiary of the entity if the equity
investorsMedicare Act which became law in
the entity do not have the characteristics of a
controlling financial interest or do not have sufficient equity at risk
for the entity to finance its activities without additional
subordinated financial support from other parties. FIN 46December 2003. FSP 106-2 was effective immediately for all new variable interest entities created or
acquired after January 31, 2003. For variable interest entities
created or acquired prior to February 1, 2003, the provisions of FIN 46
must have been applied for the first interim or annual
period beginning after June 15, 2003.2004. FSP 106-2 does not have a
material impact on LG&E or KU.
FSP 109-1
In December 2003,2004, the FASB finalized FSP 109-1, Accounting for Income
Taxes, Application of FAS 109 to the Tax Deduction on Qualified
Production Activities Provided by the American Jobs Creation Act of
2004, which requires the tax deduction on qualified production
activities to be treated as a special deduction in accordance with FAS
109. FSP 109-1 became effective December 21, 2004. For the three
months ended March 31, 2005, LG&E and KU recognized $0.4 million and
$0.2 million, respectively, in tax benefits related to this deduction.
- 19 -
FIN 46 was revised, delaying47
In March 2005, the effective datesFASB issued Financial Accounting Standards Board
Interpretation No. 47, Accounting for certain entities created before February 1, 2003,Conditional Asset Retirement
Obligations, an interpretation of FASB Statement No. 143 ("FIN 47").
FIN 47 clarifies that the term "conditional asset retirement
obligation" as used in SFAS No. 143, Accounting for Asset Retirement
Obligations, refers to a legal obligation to perform an asset
retirement activity in which the timing and making other
amendments to clarify application(or) method of settlement
are conditional on a future event that may or may not be within the
control of the guidance. For potential
variable interest entities other than special purpose entities,entity. The obligation to perform the revised FIN 46 (FIN 46R)asset retirement
activity is nowunconditional even though uncertainty exists about the
timing and (or) method of settlement. An entity is required to
recognize a liability for the fair value of a conditional asset
retirement obligation if the fair value of the liability can be
appliedreasonably estimated. The fair value of a liability for the
conditional asset retirement obligation should be recognized when
incurred; generally, upon acquisition, construction, or development and
through the normal operation of the asset. FIN 47 is effective no
later than the end of the first fiscal year or interim reporting period ending
after March 15, 2004. For all special purpose entities created prior
to February 1, 2003, FIN 46R is now required to be applied at the end
of the first interim or annual reporting periodyears ending after December 15, 2003. FIN 46R may be applied prospectively with a cumulative-
effect adjustment as of the date it is first applied, or by restating
previously issued financial statements with a cumulative-effect
adjustment as of the beginning of the first year restated. FIN 46R
also requires certain disclosures of an entity's relationship with
variable interest entities.
Both2005. LG&E
and KU hold investment interests inare currently evaluating the Ohio Valley Electric
Corporation ("OVEC"), and KU holds an investment interest in Electric
Energy, Inc. ("EEI"). Neither LG&E nor KU are the primary beneficiaryimpact of OVEC or EEI, and thus neither are consolidated into the financial
statements of LG&E or KU.
LG&E, KU and ten other electric utilities are participating owners of
OVEC, located in Piketon, Ohio. OVEC owns and operates two power plants
that burn coal to generate electricity, Kyger Creek Station in Ohio and
Clifty Creek Station in Indiana. LG&E's share is 7%, representing
approximately 155 Mw of generation capacity and KU's share is 2.5%,
approximately 55 Mw of generation capacity.
LG&E's and KU's original investment in OVEC was made in 1952. LG&E's
investment in OVEC is the equivalent of 4.9% of OVEC's common stock and
KU's investment is the equivalent of 2.5% of OVEC's common stock.
LG&E's and KU's investment in OVEC is accounted for on the cost method
of accounting. As of March 31, 2004, LG&E's and KU's investment in OVEC
totaled $0.5 million and $0.3 million, respectively. LG&E's and KU's
maximum exposure to loss as a result of their involvement with OVEC is
limited to the value of their investment. In the event of the inability
of OVEC to fulfill its power provision requirements, LG&E and KU would
substitute such power supply with either owned generation or market
purchases and would recover any associated incremental costs through
regulatory rate mechanisms. See Part II, Item 1, for further
discussion of current legal proceedings regarding LG&E's and KU's
ownership interests and power purchase rights.
KU owns 20% of the common stock of EEI, which owns and operates a 1,000-
Mw generating station in southern Illinois. KU is entitled to take 20%
of the available capacity of the station. Purchases from EEI are made
under a contractual formula which has resulted in costs which were and
are expected to be comparable to the cost of other power purchased or
generated by KU. Such power equated to approximately 9% of KU's net
generation system output in 2003.
- - Page 15 -
KU's original investment in EEI was made in 1953. KU's investment in
EEI is accounted for on the equity method of accounting. As of March
31, 2004, KU's investment in EEI totaled $11.4 million. KU's maximum
exposure to loss as a result of its involvement with EEI is limited to
the value of its investment. In the event of the inability of EEI to
fulfill its power provision requirements, KU would substitute such
power supply with either owned generation or market purchases and would
recover any associated incremental costs through regulatory rate
mechanisms.
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and
Equity. SFAS No. 150 was effective immediately for financial
instruments entered into or modified after May 31, 2003, and otherwise
was effective for interim reporting periods beginning after June 15,
2003.
LG&E has 237,500 shares of $5.875 series mandatorily redeemable
preferred stock outstanding having a current redemption price of $100
per share. The preferred stock has a sinking fund requirement
sufficient to retire a minimum of 12,500 shares on July 15 of each year
commencing with July 15, 2003, and the remaining 187,500 shares on July
15, 2008 at $100 per share. Beginning with the three months ended
September 30, 2003, LG&E reclassified its $5.875 series preferred stock
as long-term debt with the minimum shares mandatorily redeemable within
one year classified as current. Dividends accrued beginning July 1,
2003 are charged as interest expense.
KU has no financial instruments that fall within the scope of SFAS No.
150.
9.this pronouncement.
8. Short-Term and Long-Term Debt
Under the provisions for LG&E's variable-rate pollution control bonds,
Series S, T, U, BB, CC, DD and EE, and KU's variable-rate pollution
control bonds Series 10, 12, 13, 14, and 15, the bonds are subject to
tender for purchase at the option of the holder and to mandatory tender
for purchase upon the occurrence of certain events, causing the bonds
to be classified as current portion of long-term debt in the Consolidated Balance
Sheets. The average annualized interest rate for these bonds during
the three months ending March 31, 20042005 was 1.10%1.96% for theboth LG&E bonds and 1.07% for the KU bonds.
In JanuaryKU.
During June 2004, LG&E entered into a long-term loan from Fidelia
Corporation ("Fidelia"), an E.ON financing subsidiary, totaling $25
million with an interest rate of 4.33% that matures in January 2012,
and a one-year loan totaling $100 million with an interest rate of
1.53%. The loans are secured by a lien subordinated to the first
mortgage bond lien. The proceeds were used to fund a pension
contribution and to repay other debt obligations. In April 2004, LG&E
prepaid $50 million of the $100 million 1.53% note payable to Fidelia.
The prepayment was paid out of cash balances and there was no
prepayment fee.
In January 2004, KU entered into an unsecured long-term loan from
Fidelia totaling $50 million with an interest rate of 4.39% that
matures in January 2012. The proceeds were used to fund a pension
contribution and to repay other debt obligations.
LG&E maintainsrenewed five bilateralrevolving lines of credit with
banks totaling $185 million
that mature in 2004.million. There was no outstanding balance under
any of these facilities at March 31, 2004. Management2005. The Company expects to
renew these facilities as they expire.prior to their expiration in June 2005.
LG&E, KU and KULG&E Energy participate in an intercompany money pool
agreement wherein
LG&E Energy and KU make funds available to LG&E at market-based rates
(based on an index of highly rated commercial paper issues asagreement. Details of the prior month end) up to $400 million. Likewise, LG&E Energy and LG&E
- - Page 16 -
make funds available to KU at market-based rates up to $400 million.
LG&E had no money pool loan from LG&E Energy (shown as "Notes payable
to affiliate")balances at March 31, 2004,2005 and had a balance of $248.5 million
at an average rate of 1.25% at March 31, 2003. The balance of the money
pool loans from LG&E Energy and LG&E to KU (shown as "Notes payable to
affiliate") was $40.7 million at an average rate of 0.98% and $174.5
million at an average rate of 1.25% at March 31, 2004
and 2003,
respectively. The amount available towere as follows:
Total Money Amount Balance Average
(millions of $) Pool Available Outstanding Available Interest Rate
March 31, 2005:
LG&E under the money pool
agreement at$400.0 $35.0 $365.0 2.65%
KU 400.0 26.0 374.0 2.65
March 31, 2004 was $400 million. The amount available to2004:
LG&E $400.0 $ - $400.0 -%
KU under the money pool agreement at March 31, 2004 was $359.3 million.400.0 40.7 359.3 0.98
- 20 -
LG&E Energy maintains a revolving credit facility totaling $150$200 million
with an affiliateE.ON North America, Inc. to ensure funding availability for the
money pool. LG&E Energy hadThere was no balance outstanding balance underon this facility as ofat March
31, 2004 and availability2005.
In January 2005, LG&E paid at maturity a $50 million loan from Fidelia
using proceeds from short-term loans from the money pool.
In April 2005, LG&E refinanced $40 million in existing pollution
control indebtedness. The original indebtedness, 5.90% Pollution
Control Bonds, Series X, due April 15, 2023, was discharged on May 13,
2005, using the proceeds from the replacement indebtedness, LG&E
Pollution Control Bonds, Series HH, due February 1, 2035, which carry
a variable, auction rate of $150 million remained.
10.Relatedinterest.
9. Related Party Transactions
LG&E, KU, subsidiaries of LG&E Energy and other subsidiaries of E.ON
engage in related-party transactions. Prior to the termination of the
accounts receivable securitization programs at LG&E and KU in January
2004, transactions between LG&E and its accounts receivable subsidiary,
LG&E Receivables LLC ("LG&E R"), were eliminated upon consolidation
with LG&E. Transactions between KU and its accounts receivable
subsidiary, KU Receivables LLC ("KU R"), were eliminated upon
consolidation with KU. Transactions among LG&E, KU and
LG&E Energy subsidiaries are eliminated upon consolidation of LG&E
Energy. Transactions between LG&E or KU and E.ON subsidiaries are
eliminated upon consolidation of E.ON. These transactions are generally
performed at cost and are in accordance with the SEC regulations under
the PUHCA and the applicable Kentucky Public Service Commission ("Kentucky
Commission") regulations. Accounts
payable to and receivable from related parties are netted and presented
as accounts payable to affiliated companies on the balance sheets of
LG&E and KU, as allowed due to the right of offset. Obligations related
to intercompany debt arrangements with LG&E Energy and Fidelia are
presented as separate line items on the balance sheet, as appropriate.
The significant related-party transactions are disclosed below.
Electric Purchases
LG&E and KU intercompany electric revenues and purchased power expense
(including LG&E Energy Marketing Inc. ("LEM"))from affiliated companies for the three months ended March 31, 20042005 and
20032004 were as follows:
____LG&E____ ______KU______
(in thousands)millions) 2005 2004 2003
LG&E2005 2004
Electric operating revenues from KU $22,077 $16,969$25.8 $22.1 - -
Electric operating revenues from LG&E - - $30.1 $21.6
Electric operating revenues from LEM 728 7,1490.3 0.7 - -
Purchased power from KU 21,585 14,464
KU
Electric operating revenues from LG&E $21,585 $14,464
Electric operating revenues from LEM 160 1,78230.1 21.6 - -
Purchased power from LG&E 22,077 16,969- - 25.8 22.1
- 21 -
Interest Charges
LG&E intercompany interest income and expense for the three months
ended March 31, 2004 and 2003 were as follows:
(in thousands) 2004 2003
Interest on money pool loans $ 48 $732
Interest on Fidelia loans 3,082 -
Interest expense paid to KU 10 3
Interest income received from KU - 4 KU intercompany interest income and expense for the three
months ended March 31, 20042005 and 20032004 were as follows:
____LG&E____ ______KU______
(in thousands)millions) 2005 2004 20032005 2004
Interest on money pool loans $0.4 $ 144 $373- $0.1 $0.2
Interest on Fidelia loans 3,403 -
Interest expense paid to LG&E - 4
Interest income received from LG&E 10 3
- - Page 17 -2.7 3.1 3.5 3.4
Other Intercompany Billings
Other intercompany billings (including LG&E Energy Services Inc. ("LG&E
Services")) related to LG&E and KU for the three months
ended March 31, 20042005 and 20032004 were as follows:
(in thousands)millions) 2005 2004 2003
LG&E Services billings to LG&E $38,161 $26,630$32.3 $38.2
LG&E Services billing to KU 30,575 21,49425.8 30.6
LG&E billings to LG&E Services 3,035 4,8624.7 3.0
KU billings to LG&E Services 2,818 7,0943.2 2.8
LG&E billings to KU 16,559 18,71014.1 16.6
KU billings to LG&E 8,663 4,664
11.Commitments4.0 1.5
10. Commitments and Contingencies
InExcept as may be discussed in this Quarterly Report on Form 10-Q
(including Note 5), material changes have not occurred in the current
status of various commitments or contingent liabilities from that
discussed in the Companies' Annual Report on Form 10-K for the year
ended December 2003,31, 2004 (including in Notes 3 and 11 to the financial
statements of LG&E and KU filed applications withcontained therein.) See Notes 3 and 11 to
the Kentucky
Commission requesting increasesCompanies' Annual Report on Form 10-K for information regarding
such commitments or contingencies.
LITIGATION
The May 2004 litigation commenced by OMU against KU concerning a long-
term power supply contract continues. To date, OMU has claimed
approximately $6 million in LG&E'sdamages for historical periods, as well as
injunctive and KU's electric ratesother relief, including a declaration that KU is in
material breach. KU currently has jurisdictional or summary judgment
motions, respectively, pending before the FERC and district court
regarding aspects of this matter.
ENVIRONMENTAL MATTERS
LG&E's gas rates. The Companies requested general adjustments in
electric rates&E and LG&E requested general adjustments in gas rates
based on the twelve-month test year ended September 30, 2003. The
revenue increases requested by LG&E were $63.8 million for electric and
$19.1 million for gas. The revenue increase requested by KU was $58.3
million. The Kentucky Commission has suspended the effective date of
the proposed new tariffs for five months, so that the rates may go into
effectare subject to refund by July 1, 2004. The Kentucky Commission
established a procedural schedule forSO2 and NOx emission limits on their
electric generating units pursuant to the cases pertainingClean Air Act. LG&E and KU
placed into operation significant NOx controls to discovery
and hearings.
The Companies filed their final 2003 ESM calculations withgenerating
units prior to the Kentucky
Commission on March 1, 2004 and applied for recovery of $16.2 million
related to KU and $13.0 million related to LG&E. Based upon estimates,
the Companies previously accrued $9.3 million at KU and $8.9 million at
LG&E for the 2003 ESM asSummer Ozone Season. As of December 31, 2003. The Companies have not
booked or accrued to date the respective increases of $6.9 million and
$4.1 million, pending resolution of ongoing Kentucky Commission
proceedings regarding aspects of the ESM mechanism, including allowable
recoverable amounts. On March 31, 2004, the Kentucky Commission issued
orders consolidating the prior ESM cases into the general
LG&E and KU proceedings regarding increases in base rates.
During May 2004, the Kentucky Commission held hearings on the
applications for rate increases. On May 12, the Companiesincurred total capital costs of approximately $186 million
and all
intervenors filed a partial settlement agreement, stipulation and
recommendation with the Kentucky Commission providing for settlement of
all outstanding issues, except electric revenue requirements. All
intervenors except the Kentucky Attorney General entered a stipulation
on the electric revenue requirements. Testimony for the utilities and
the Attorney General was presented on electric revenues. All testimony
of all other intervenors and testimony of the Attorney General on other
issues was withdrawn. The agreement and stipulation provides for
increases in annual base electric rates of $43.4$219 million, for LG&E and
$46.1 million for KU, and in annual gas rates of $11.9 million for LG&E
and provides for settlement of other issues such as various tariff
provisions, implementation of a pilot real-time pricing program,
implementation of a home energy assistance program and others. The
agreement provides that the rate increases would be effective
commencing July 1, 2004.
The Companies and the intervenors, including the Attorney General, also
filed proposed settlements regarding the ESM mechanisms of LG&E and KU.
Under the ESM settlements,respectively, to reduce their NOx emissions below
required levels. In addition, LG&E and KU would continueincur additional operating
and maintenance costs in operating new NOx controls.
- 22 -
KU has implemented a plan for adding significant additional SO2
controls to collect
approximately $13.0its generating units. Installation of additional SO2
controls will proceed on a phased basis, with construction of controls
(i.e. FGDs) commencing in mid-2005 and continuing through the final
installation and operation in 2009. KU estimates that it will incur
$658.9 million and $16.2 million, respectively, of
previously requested 2003 ESM revenue amounts through March 2005. As
partin capital costs related to the construction of the settlement, the parties agreedFGDs
to achieve compliance with current emission limits on a termination of the ESM
mechanism relating to all periods after 2003.
- - Page 18 -
The potential settlements are subject to Kentucky Commission approval.
Final Kentucky Commission orderscompany-wide
basis. In addition, KU will incur additional operating and maintenance
costs in the rate case and related
proceedings, including the tendered settlements, are anticipated before
July 1, 2004. The Companies can provide no assurance regarding the
Commission's final decision regarding the partial agreement,
stipulation and recommendation of the parties or the ESM settlement.
Regulatory proceedings are also continuing concerning the Midwest
Independent Transmission System Operator ("MISO").operating new SO2 controls.
LG&E and KU obtained membershipare also monitoring several other air quality issues which
may potentially impact coal-fired power plants, including EPA's revised
air quality standards for ozone and particulate matter, measures to
implement EPA's regional haze rule, EPA's Clean Air Mercury Rule which
regulates mercury emissions from steam electric generating units and
reductions in emissions of SO2 and NOx required under the MISO in 1998 in responseClean Air
Interstate Rule.
In addition, LG&E is currently working with local regulatory
authorities to federal policy
initiatives. During March and April 2004,review the Kentucky Commission held
hearings in the proceedings examining the cost and benefitseffectiveness of MISO
membership, including rate treatment of MISO costs and continuedremedial measures aimed at
controlling particulate matter emissions from its Mill Creek Station.
From time to time, LG&E and KU participation. A final orderconduct negotiations with the applicable
regulatory authorities to finalize cleanup plans or determine financial
responsibility concerning other environmental matters, including
remediation steps regarding former LG&E and KU MGP sites, a settlement
agreement relating to a fuel oil discharge at KU's E.W. Brown plant and
matters relating to a KU transformer scrap yard.
In January 2005, approximately 1,000 gallons of fuel oil leaked
from a cracked weld in a storage tank at KU's Green River
Generating Station. KU commenced immediate spill containment,
recovery and remediation actions and has received satisfactory
inspections from state regulators to date. The cost related to
the proceedings is anticipated
in mid-2004.cleanup of the oil spill was less than $0.2 million.
In the normal course of business, lawsuits, claims, environmental
actions, and various non-ratemaking governmental proceedings arise
against LG&E and KU. To the extent that damages are assessed in any of
these lawsuits, LG&E and KU believe that their insurance coverage or
other appropriate reserves are adequate. Management, after
consultation with legal counsel, and based upon the present status of
these items, does not anticipate that liabilities arising out of other
currently pending or threatened lawsuits and claims of the type
referenced above will have a material adverse effect on LG&E's or KU's
consolidated financial position or results of operations.
Except as discussedEEI CONTRACT
KU owns 20% of the common stock of EEI, which owns and operates a 1,000-
Mw generating station in this Quarterly Reportsouthern Illinois. KU is entitled to take 20%
of the available capacity of the station. Purchases from EEI are made
under a contractual formula which has resulted in costs which were and
- 23 -
are expected to be comparable to the cost of other power generated by
KU. This contract governing the purchases from EEI will terminate on
Form 10-Q, material
changes have not occurredDecember 31, 2005. Such power equated to approximately 10% of KU's net
generation system output in the current status of various commitments
or contingent liabilities from that discussed in the Companies' Annual
Report on Form 10-K2004 and for the year ended December 31, 2003 (including in
Notes 3 and 11first quarter of 2005.
Discussions are on-going related to the financial statementsextension of LG&E and KU contained
therein and incorporated herein by reference).
12.Pensionthe contract.
11. Pension and Other Post-retirement Benefit Plans
The following table provides the components of net periodic benefit
cost for pension and other benefit plans for the three months ended
March 31, 2004:2005:
(in thousands)millions) LG&E KU
Pension and Other Benefit Plans:
Components of net period benefit cost
Service cost $ 2,0881.7 $ 2,3861.8
Interest cost 10,524 7,6506.5 4.3
Expected return on plan assets (9,585) (6,909)(6.0) (4.0)
Amortization of prior service cost 2,003 5831.3 0.3
Amortization of transition (asset)
or obligation (5) 319- 0.2
Recognized actuarial (gain) or loss 1,105 8390.7 0.6
$ 6,1304.2 $ 4,8683.2
In January 2004, LG&E and KU made discretionary contributions to theirthe
pension plans in the amountsplan of $34.5 million and $43.4 million, respectively. No
discretionary contributions to the pension plans are required for 2004planned for either
LG&E or KU for 2005, but one or both Companies may make a discretionary
contribution to the other post-retirement benefit plans.
12. Subsequent Events
On April 13, 2005, LG&E refinanced $40 million in existing pollution
control indebtedness. The original indebtedness, 5.90% Pollution
Control Bonds, Series X, due April 15, 2023, was discharged on May 13,
2005, using the proceeds from the replacement indebtedness, LG&E
Pollution Control Bonds, Series HH, due February 1, 2035, which carry a
variable, auction rate of interest.
On May 12, 2005, KU issued a redemption notice to bondholders for its
7.55% First Mortgage Bonds, Series R, totaling $50 million. It is
currently anticipated the bond will be redeemed on June 13, 2005, and
no further discretionary contributions are planned.the Company will pay a call premium of 3.775%. KU has also received
notice from the counterparty to the interest rate swap related to this
bond that it will terminate the swap and pay to KU the same 3.775% call
premium pursuant to the terms of the swap.
- 24 -
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations.
General
The following discussion and analysis by management focuses on those
factors that had a material effect on LG&E's and KU's financial results of
operations and financial condition during the three month period ended
March 31, 2004,2005, and should be read in connection with the financial
statements and notes thereto.
- - Page 19 -
Some of the following discussion may contain forward-looking statements
that are subject to certain risks, uncertainties and assumptions. Such
forward-looking statements are intended to be identified in this document
by the words "anticipate," "expect," "estimate," "objective," "possible,"
"potential" and similar expressions. Actual results may vary materially.
Factors that could cause actual results to differ materially include:
general economic conditions; business and competitive conditions in the
energy industry; changes in federal or state legislation; unusual weather;
actions by state or federal regulatory agencies; and other factors
described from time to time in LG&E's and KU's reports to the SEC,
including the Annual Reports on Form 10-K for the year ended December 31,
2003.2004.
Executive Summary
LG&E's net income for the three months ended March 31, 2004 was $24.2
million ($3.0 million lower&E and KU, subsidiaries of LG&E Energy LLC (an indirect subsidiary of
E.ON), are regulated public utilities. LG&E supplies electricity to
approximately 391,000 customers and natural gas to approximately 320,000
customers in Louisville and adjacent areas in Kentucky. KU provides
electric service to approximately 490,000 customers in over 77 counties in
central, southeastern and western Kentucky, to approximately 30,000
customers in southwestern Virginia and to less than the three months ended March 31, 2003).
The decrease was primarily related to higher operation expenses (MISO-
related costs and data conversion costs), somewhat offset by higher10 customers in
Tennessee. KU also sells wholesale electric revenues. Electric sales volumes increased dueenergy to higher
wholesale sales while gas volumes decreased due12 municipalities.
The mission of LG&E and KU is to milder weather. KU's
net incomebuild on our tradition and achieve world-
class status providing reliable, low-cost energy services and superior
customer satisfaction; and to promote safety, financial success and quality
of life for the three months ended March 31, 2004 was $32.4 million
($20.6 million higher than the three months ended March 31, 2003). The
increase was primarily due to higher electric revenues in both the retailour employees, communities and wholesale sectors and lower maintenance expense (KU experienced
unusually high maintenance costs in the first quarter of 2003 due to a
major ice storm).
As regulated utilities,other stakeholders.
LG&E and KU's financial performance is greatly
impactedstrategy focuses on the following:
- Execute all our business processes to secure a world-class
competitive advantage
- Develop and transfer best practices in generation, customer service,
distribution and supply
- Operate our commercial hub to enhance margins and manage risks across
the company
- Pursue flexible asset portfolio management
- Attract, retain and develop the best people.
- 25 -
In a June 2004 order, the Kentucky Commission accepted the settlement
agreements reached by regulatory proceedings. In December 2003,the majority of the parties in the rate cases filed
by LG&E and KU in December 2003. Under the ruling, the LG&E utility base
electric rates have increased $43.4 million (7.7%) and base gas rates have
increased $11.9 million (3.4%), on an annual basis. The rate increases
took effect on July 1, 2004. Base electric rates at KU have increased
$46.1 million (6.8%) annually. The 2004 increases were the first increases
in electric base rates for LG&E and KU in 13 and 20 years, respectively;
the last gas rate increase for the LG&E gas utility took effect in
September 2000.
With the recent installation of four combustion turbines at Trimble County,
near-term regulated load growth in Kentucky is expected to be satisfied.
However, the Integrated Resource Plan submitted by LG&E and KU to the
Kentucky Commission in April 2005 indicated the requirement for additional
base-load capacity in the longer-term. Consequently, LG&E and KU have
begun development efforts for a new base-load coal-fired unit. Trimble
County Unit 2, with a 732 Mw capacity rating, is expected to be jointly
owned by LG&E and KU (75% aggregate ownership) and IMEA and IMPA (25%
aggregate ownership). Of their 75% (549 Mw) ownership, LG&E will own 19%
(104 Mw) and KU will own 81% (445 Mw). An application for a construction
CCN was filed
applications with the Kentucky Commission requestingand an adjustmentair permit application
was filed with the Kentucky Department of Air Quality in December 2004.
LG&E's electric and gas rates and KU's electric rates. LG&E applied for
revenue increasesshare of $63.8the total capital cost of $885 million for electricTrimble
County Unit 2 is estimated to be $168 million and $19.1$717 million,
respectively, through 2010. An application for gas.
KU applied for revenue increases of $58.3 million.
During May 2004, the Kentucky Commission held hearings on the applications
on rate increases. On May 12, the Companies and all intervenorsa transmission CCN is
anticipated to be filed a
partial settlement agreement, stipulation and recommendation with the Kentucky Commission providing for settlementduring 2005.
In addition to the Trimble County Unit 2 project, another focus of all outstanding issues,
except electric revenue requirements. All intervenors exceptmajor
utility investment is environmental expenditures. In order to mitigate the
Kentucky
Attorney General entered a stipulation ondeclining SO2 allowance bank at KU over the electric revenue
requirements. Testimony for the utilities and the Attorney General was
presented on electric revenues. All testimony of all other intervenors and
testimony of the Attorney General on other issues was withdrawn. The
agreement and stipulation provides for increases in annual base electric
rates of $43.4 million for LG&E and $46.1 million fornext several years, KU and in annual gas
rates of $11.9 million for LG&E and provides for settlement of other issues
such as various tariff provisions, implementation of a pilot real-time
pricing program, implementation of a home energy assistance program and
others. The agreement provides that the rate increases would be effective
commencing July 1, 2004.
The Companies and the intervenors, including the Attorney General, also
filed
proposed settlements regarding the ESM mechanisms of LG&E and KU.
Under the ESM settlements, LG&E and KU would continue to collect
approximately $13.0 million and $16.2 million, respectively, of previously
requested 2003 ESM revenue amounts through March 2005. As part of the
settlement, the parties agreed to a termination of the ESM mechanism
relating to all periods after 2003. Previously, on March 31, 2004,with the Kentucky Commission had issued orders consolidating the prior ESM cases
into the general LG&E and KU proceedings regarding increases in base rates.
The potential settlements are subjectDecember 2004 an application for a CCN to
Kentucky Commission approval.
Final Kentucky Commission orders in the rate case and related proceedings,
including the tendered settlements, are anticipated before July 1, 2004.
The Companies can provide no assurance regarding the Commission's finalconstruct four FGDs at an estimated cost of $658.9 million; a decision regarding the partial agreement, stipulation and recommendation of
the parties or the ESM settlement.
- - Page 20 -is
expected by late June 2005.
Results of Operations
The results of operations for LG&E and KU are affected by seasonal
fluctuations in temperature and other weather-related factors. Because of
these and other factors, the results of one interim period are not
necessarily indicative of results or trends to be expected for the full
year.
- 26 -
Three Months Ended March 31, 2004,2005, Compared to
Three Months Ended March 31, 20032004
LG&E Results:
LG&E's net income decreased $3.0increased $9.7 million (11%(40%) for the three months ended
March 31, 2004,2005, as compared to the three months ended March 31, 2003,2004,
primarily due to higher other operation expensesthe increase in electric and gas base rates effective July
1, 2004 and higher interest
expenses, partially offset by higher electric revenues.and gas wholesale sales.
A comparison of LG&E's revenues for the three months ended March 31, 2004,2005,
with the three months ended March 31, 2003,2004, reflects increases and
(decreases) which have been segregated by the following principal causes:
Cause Electric Gas
(in thousands)millions) Revenues Revenues
Retail sales:
Fuel and gas supply adjustments $ (2,805)3.6 $ 37,6311.3
Environmental cost recovery surcharge 2,398(0.8) -
Earnings sharing mechanism 3,256(3.6) -
Demand side management cost recovery 184 (299)0.1 -
LG&E/KU merger surcredit (472)(1.1) -
Value delivery surcredit (181) -(0.3) (0.2)
Weather normalization - 2,686(0.7)
Rates and rate structure 15.3 4.3
Variation in sales volume and other (1,307) (16,468)2.0 (1.9)
Total retail sales 1,073 23,55015.2 2.8
Wholesale sales 12,116 75514.4 5.9
Gas transportation - net - (69)(0.3)
Provision for rate collections (refunds) (3,999)2.3 -
Other 2,039 (346)(0.4) 0.5
Total $31.5 $ 11,229 $ 23,8908.9
Electric revenues increased $11.2$31.5 million (16%) in 2005 primarily due to:
- - An increase in rates and a change in rate structure ($15.3 million).
- - Higher wholesale revenues ($14.4 million), primarily due to an increase in
wholesale sales volumes of 22%.21% higher
prices.
Gas revenues increased $23.9$8.9 million (5%) in 2005 primarily as a result of increased gas prices billeddue to:
- - Higher wholesale revenues ($5.9 million) due to customers through
the gas supply clause, partially offset by 11% lower gas42% higher sales
volumes resulting from warmer weather as heating degree days declined 12.3% from
the previous year.and 11% higher prices.
- - An increase in rates and a change in rate structure ($4.3 million).
Fuel for electric generation and gas supply expenses comprise a large
component of LG&E's total operating expenses. LG&E's electric and gas
rates contain a fuel adjustment clause and a gas supply clause,
respectively, whereby increases or decreases in the cost of fuel and gas
supply are reflected in retail rates, subject to the approval of the
Kentucky Commission.
- 27 -
Fuel for electric generation increased $3.0$7.4 million (6%(14%) in 2005
primarily due to:
- Increased cost per BTU (15% higher), resulting in $7.8 million higher
fuel costs.
- Decreased generation (1% lower), resulting in $0.4 million lower fuel
costs.
Gas supply expenses increased $4.8 million (4%) in 2005 primarily due to:
- Increased cost of purchases for wholesale sales ($5.5 million).
- Increased recovery of performance-based rates ($0.2 million).
- Decreased volume of gas delivered to the distribution system ($1.1
million).
Power purchased increased $10.1 million (35%) in 2005 primarily due to:
- Increased cost per Mwh (35% higher), primarily related to increased
intercompany purchase costs due to SO2 allowance costs.
Other operations and maintenance expenses increased $0.9 million (1%) in
2005.
Other operation expenses decreased $2.7 million (5%) in 2005 primarily
due to:
- Decreased MISO-related transmission expense ($3.0 million).
- Decreased information technology systems operations expense
($1.3 million) (charged to maintenance expenses in 2005).
- Decreased property insurance expense ($0.2 million).
- Increased steam generation operations expense ($0.6 million).
- Increased customer billing expense ($0.5 million).
- Increased gas underground storage costs ($0.5 million).
Maintenance expenses increased $3.5 million (30%) in 2005 primarily
due to:
- Increased Cane Run maintenance due to outage repairs ($1.4 million).
- Increased distribution system maintenance (including tree trimming and
underground conductor repairs) ($0.7 million).
- Increased information technology systems maintenance ($1.3 million)
(charged to operation expenses in 2004).
Property and other taxes increased $0.1 million (2%) in 2005 primarily
due to:
- Increased property tax ($0.1 million).
In total, other income (expense) - net increased $1.0 million (125%) in
2005 primarily due to:
- - Increased mark-to-market income ($0.2 million) related to energy
trading contracts.
- - Decreased miscellaneous deductions ($0.7 million).
In total, interest expense increased $1.0 million (13%) in 2005 primarily
due to:
- - Increased interest on variable-rate debt ($1.1 million).
- - Increased interest on customer deposits ($0.5 million).
- - Decreased interest costs on interest rate swaps ($0.6 million).
- 28 -
The weighted average interest rate on variable-rate bonds for the three
months ended March 31, 2004, due2005, was 1.91%, compared to 7% higher megawatt
hour ("MWH") generation resulting1.03% for the
comparable period in a $3.4 million volume variance, offset
by 1% lower fuel costs per MWH, resulting in a ($0.4) million price
variance. Gas supply expenses increased $24.6 million (23%) due to 9%
higher gas prices per million cubic feet ("MCF"), resulting in a $37.0
million price variance, and $0.2 million in higher costs due to the impact
of the gas PBR mechanism, partially offset by 11% lower volumes, resulting
in a ($12.7) million volume variance.
- - Page 21 -
Power purchased increased $4.8 million (20%) due to 20% higher MWH
purchases, resulting in a $5.2 million volume variance. The cost per MWH
of purchased power decreased 1% resulting in a ($0.4) million price
variance.
Other operation expenses increased $4.5 million (9%) due primarily to
higher transmission expense of $3.1 million due to increased MISO expense
resulting from higher off-system sales and higher MISO administrative fees.
Electric distribution expense increased $1.4 million primarily due to data
conversion costs related to a distribution systems project.2004.
Variances in income tax expense are largely attributable to changes in pre-
tax income.income and a reduction in the statutory Kentucky rate.
Three Months Three Months
Ended Ended
March 31, 20042005 March 31, 20032004
Effective Rate
Statutory federal income tax rate 35.0% 35.0%
State income taxes net of federal benefit 5.64.3 5.6
Amortization of investment and other tax credits (1.9) (2.7) (2.4)
Other differences (1.5) (0.1) (0.4)
Effective income tax rate 35.9% 37.8%
37.8%
In total, interest expenseThe increased $0.9 million (13%)tax benefit in 2004. Interest
expense decreased $1.5 million due to a $2.3 million decrease in interest
expense on long-term debt related to lower variable rates (including the
$102 million Series V and $26 million Series W pollution control bonds
which were refinanced from higher fixed rates to lower variable rates in
November 2003). This decrease was partially offset by an increase of $0.9
million primarily due to new interest rate swaps relatedother differences is largely attributable to
the refinancingnew Internal Revenue Code Section 199 Qualified Production Activities
deduction and the amortization of Series V and W. Interest expense to affiliated companies increased $2.4
million due to $3.1 million related to new loans from Fideliaexcess deferred income taxes, which
reflect the benefits of deferred tax reversing at lower tax rates than what
were only in effectprovided.
Kentucky House Bill 272, also known as Kentucky's Tax Modernization Plan,
was signed into law on March 18, 2005. See Note 6 for 2004, partially offset by a decreaseadditional
discussion of $0.7 million due
to lower borrowing levels from the money pool. The weighted average
interest rate on variable-rate bonds for the three months ended March 31,
2004, was 1.03%, compared to 1.22% for the comparable period in 2003.
In total, other income (expense) - net decreased $1.5 million (143%). Mark-
to-market income from energy trading contracts was $0.6 million lower in
2004 and other non-operating expense was $1.1 million higher, offset by
taxes $0.2 million lower.taxes.
KU Results:
KU's net income increased $20.6$5.1 million (174%(16%) for the three months ended
March 31, 2004,2005, as compared to the three months ended March 31, 2003.2004. The
increase was primarily due to increase in base rates effective July 1, 2004
and higher electric revenues and lower
maintenance expense.wholesale sales.
A comparison of KU's revenues for the three months ended March 31, 2004,2005,
with the three months ended March 31, 2003,2004, reflects increases and
(decreases) which have been segregated by the following principal causes:
Cause Electric
(in thousands)millions) Revenues
Retail sales:
Fuel supply adjustments $ 2,889$13.1
Environmental cost recovery surcharge 4514.6
Earnings sharing mechanism 3,909(4.5)
Demand side management cost recovery (243)0.2
LG&E/KU merger surcredit (757)(0.8)
Value delivery surcredit (79)(0.2)
Rates and rate structure 13.9
Variation in sales volume and other 2,510(1.8)
Total retail sales 8,68024.5
Wholesale sales 6,55515.6
Provision for rate collections (refunds) 4,1690.8
Other 2,999(0.8)
Total $22,403$40.1
- - Page 2229 -
Electric revenues increased $22.4$40.1 million (16%) in 2005 primarily due to:
- - Higher wholesale revenues ($15.6 million), primarily due to increased
wholesale44% higher
prices and 12%8% higher volumes, increased billings for the
earnings sharing mechanism and fuel cost recovery, increased retail sales volumes of 2% and anvolumes.
- - An increase in the provisionrates and a change in rate structure ($13.9 million).
- - Higher fuel supply adjustments ($13.1 million) due to higher cost of
fuel used for rate collections.generation and purchased power.
Fuel for electric generation comprises a large component of KU's total
operating expenses. KU's electric rates contain a fuel adjustment clause,
whereby increases or decreases in the cost of fuel are reflected in retail
rates, subject to the approval of the Kentucky Commission, the Virginia
State Corporation Commission, and the Federal Energy Regulatory Commission
("FERC").FERC.
Fuel for electric generation increased $3.6$17.4 million (5%(25%) in 2005
primarily due to:
- Increased cost per BTU (23% higher), resulting in $16.3 million higher
fuel costs.
- Increased generation (2% higher), resulting in $1.1 million higher fuel
costs.
Power purchased increased $5.0 million (12%) in 2005 primarily due to:
- Increased cost per MWh (10% higher), resulting in $4.1 million higher
costs.
- Increased volumes of MWh purchased (2% higher), resulting in $0.9
million higher costs.
Other operations and maintenance expenses increased $5.1 million (9%) in
2005.
Other operation expenses decreased $0.1 million (less than 1%) in 2005
primarily due to:
- Decreased information technology systems operation expenses ($1.1
million) (charged to maintenance expenses in 2005).
- Decreased property insurance expense ($0.2 million).
- Increased customer billing expense ($0.6 million).
- Increased MISO-related transmission expense ($0.5 million).
Maintenance expenses increased $5.2 million (44%) in 2005 primarily due
to:
- Increased E.W. Brown plant maintenance expense ($0.7 million).
- Increased Ghent plant maintenance expense ($1.7 million).
- Increased distribution system maintenance ($1.5 million) due to storm
restoration expenses.
- Increased information technology systems maintenance ($1.1 million)
(charged to operation expenses in 2004).
- 30 -
In total, other income (expense) - net increased $0.6 million (150%) in
2005 primarily due to:
- - Decreased allowance for funds used during construction ($0.5 million).
In total, interest expense increased $2.2 million (51%) in 2005 primarily
due to:
- - Increased interest costs associated with the mark-to-market of the
interest rate swaps ($1.9 million). In the first quarter of 2004, a swap
was terminated, resulting in a $0.8 million gain.
The weighted average interest rate on variable-rate bonds for the three
months ended March 31, 2004, due2005, was 1.90%, compared to 5% higher fuel costs per MWH,
resulting in a $0.3 million price variance, and 0.4% higher MWH generation,
resulting in a $3.3 million volume variance.
Power purchased increased $0.1 million (0.3%) due to 8% higher MWH
purchases, resulting in a $3.4 million volume variance, partially offset by
7% lower cost per MWH purchased, resulting in a ($3.3) million price
variance.
Maintenance expense decreased $17.1 million (59%). An ice storm in the KU
service territory in 2003 resulted in increased expenses of $15.9 million1.03% for the
three months ended March 31, 2003, for repairs to electric
distribution equipment. Steam maintenance expense was $2.6 million lowercomparable period in 2004 due to the timing of outages and other maintenance projects.2004.
Variations in income tax expense are largely attributable to changes in
pretax income.
Three Months Three Months
Ended Ended
March 31, 20042005 March 31, 20032004
Effective Rate
Statutory federal income tax rate 35.0% 35.0%
State income taxes net of federal benefit 4.6 5.8 6.9
Amortization of investment and other tax credits (0.7) (1.0) (3.7)
Other differences (1.6) (4.1)(1.3) (1.5)
Effective income tax rate 38.2% 34.1%
In total, other37.6% 38.3%
Kentucky House Bill 272, also known as Kentucky's Tax Modernization Plan,
was signed into law on March 18, 2005. See Note 6 for additional
discussion of income - net decreased $0.6 million (30%) in 2004 primarily
due to lower mark-to-market income from energy trading contracts of $0.6
million and $1.0 million higher other non-operating expenses, partially
offset by a decrease in taxes ($0.6 million) and higher allowances for
funds used during construction ($0.3 million).
In total, interest expense decreased $0.6 million (13%) for the three
months ended March 31, 2004 as compared to the three months ended March 31,
2003. Interest expense to affiliated companies increased $3.4 million due
to loans from Fidelia, which were only in effect for 2004, partially offset
by a decrease of $0.2 million due to lower borrowing levels from the money
pool. Interest expense on other long-term debt decreased $1.8 million due
to a decrease in variable rates, and interest on interest rate swaps
decreased $1.6 million, primarily resulting from the February 2004
termination of a swap related to the Series 9 pollution control bonds. In
addition, interest decreased $0.2 million due to the termination of the
accounts receivable securitization program in January 2004. The weighted
average interest rate on variable-rate bonds for the three months ended
March 31, 2004, was 1.04% and the corresponding rate for the three months
ended March 31, 2003, was 1.17%.taxes.
Liquidity and Capital Resources
LG&E and KU's needs for capital funds are largely related to the
construction of plant and equipment necessary to meet the needs of electric
and gas utility customers. Internal and external lines of credit are
- - Page 23 -
maintained to fund short-term capital requirements. LG&E and KU believe
that such sources of funds will be sufficient to meet the needs of the
business in the foreseeable future.
At March 31, 2005, LG&E and KU are in a negative working capital position
in part because of the classification of certain variable-rate pollution
control bonds that are subject to tender for purchase at the option of the
holder as current portion of long-term debt. LG&E and KU expect to cover
any working capital deficiencies with cash flow from operations, money pool
borrowings and borrowings from Fidelia.
Construction expenditures for the three months ended March 31, 2004 for
LG&E and KU2005
amounted to $27.1$18.5 million and $38.6 million, respectively.
Such expenditures include construction to meet nitrogen oxide (NOx)
emission standards and the acquisition of combustion turbines to meet peak
power demands. Expenditures for the three months ended March 31, 2004, byeach Company. At LG&E, expenditures included
gas main replacements ($1.9 million), the construction of a 138Kv
transmission line ($1.1 million), and Mill Creek Unit 4 boiler tubing ($1.1
million), along with expenditures for electric and gas distribution system
construction. At KU, for NOx construction were $1.8 million and $12.5 million,
respectively. Expenditures for the three months ended March 31, 2004, for
Trimble County combustion turbines, Units 7 through 10, by LG&E and KU were
$3.3 million and $5.6 million, respectively.expenditures included Brown Unit 3 controls upgrade
($1.2 million), distribution line transformers ($1.0 million), along with
electric distribution system construction. The expenditures were financed
with internally generated fundsfunds.
- 31 -
LG&E's and intercompany loans from
affiliates.
LG&E'sKU's cash balance increased $26.9balances decreased $0.1 million and $0.7 million,
respectively, during the three months ended March 31, 2004,2005, primarily due
to increased borrowingsthe payment of dividends, lower levels of borrowing from affiliated
companies partiallyand construction expenditures, offset by pension funding and construction
expenditures. KU'shigher cash balance increased $3.2 million during the three
months ended March 31, 2004. The increase reflects increased borrowings
from affiliated companies, partially offsetprovided by
pension funding and
construction expenditures.operating activities.
Variations in accounts receivable, accounts payable and materials and
suppliesinventories are
generally not significant indicators of LG&E's and KU's liquidity. Such
variations are primarily attributable to seasonal fluctuations in weather,
which have a direct effect on sales of electricity and natural gas. The
increasedecrease in accounts receivable at LG&E and KU was primarily due to lower
revenues at the terminationend of the accounts receivable securitization
programs in January 2004, offset by the impact of decreased electric and
gas sales in March 2004 compared with December 2003.heating season. The decrease in LG&E's gas
stored underground relates to seasonal uses of gas. The
decrease in the fuel inventory at KU was due to lower purchases due to unit
outages. The decrease at LG&E was due to seasonal fluctuations.
Interest rate swaps are used to hedge LG&E's and KU's underlying variable-
rate debt obligations. These swaps hedge specific debt issuances and,
consistent with management's designation, are accorded hedge accounting
treatment. As of March 31, 2004,2005, LG&E had swaps with a combined notional
value of $228.3$211.3 million and KU had swaps with a combined notional value of
$103$103.0 million. LG&E's swaps exchange floating-rate interest payments for
fixed ratefixed-rate interest payments to reduce the impact of interest rate changes
on LG&E's pollution control bonds. KU's swaps effectively convert fixedfixed-
rate obligations on KU's first mortgage bonds Series P and R to variable-
rate obligations.
In February 2004, KU terminated the2005, an LG&E interest rate swap it had in place at December 31,
2003 related to the Series 9 pollution control bonds. Thewith a notional amount of the terminated$17
million matured. The swap was $50 millionfully effective upon expiration, therefore,
the impact on earnings and KU received a payment of $2.0
million as part ofother comprehensive income from the termination.swap
maturity was less than $0.1 million.
At March 31, 2004,2005, LG&E's and KU's percentage of long-term debt having a variable
rate, including the impact of interest rate swaps, was 33.2% at
$306.0 million41.8% ($358.0
million) and 43.1% at $318.0 million,50.4% ($375.0 million), respectively.
Under the provisions for LG&E's variable-rate pollution control bonds,
Series S, T, U, BB, CC, DD and EE, and KU's variable-rate pollution control
bonds Series 10, 12, 13, 14, and 15, the bonds are subject to tender for
purchase at the option of the holder and to mandatory tender for purchase
upon the occurrence of certain events, causing the bonds to be classified
as current portion of long-term debt in the Consolidated Balance Sheets. The average
annualized interest rate for these bonds during the three months ending
March 31, 20042005 was 1.10%1.96% for both the LG&E bonds and 1.07% for the KU bonds.
- - Page 24 -
In JanuaryDuring June 2004, LG&E entered into a long-term loan with Fidelia totaling
$25 million with an interest rate of 4.33% that matures in January 2012,
and a one-year loan totaling $100 million with Fidelia. The interest rate
on the loan is 1.53%. The loans are secured by a lien subordinated to the
first mortgage bond lien. The proceeds were used to fund a pension
contribution and to repay other debt obligations. In April 2004, LG&E
prepaid $50 million of the $100 million 1.53% note payable to Fidelia. The
prepayment was paid out of cash balances and there was no prepayment fee.
In January 2004, KU entered into an unsecured long-term loan from Fidelia
totaling $50 million with an interest rate of 4.39% that matures in January
2012. The proceeds were used to fund a pension contribution and to repay
other debt obligations.
LG&E maintainsrenewed five bilateralrevolving lines of credit with banks
totaling $185 million that
mature in 2004.million. There was no outstanding balance under any of these
facilities at March 31, 2004. Management2005. The Company expects to renew these facilities
as they
expire.prior to their expiration in June 2005.
- 32 -
LG&E, KU and KULG&E Energy participate in an intercompany money pool
agreement wherein
LG&E Energy and KU make funds available to LG&E at market-based rates
(based on an index of highly rated commercial paper issues asagreement. Details of the prior
month end) up to $400 million. Likewise, LG&E Energy and LG&E make funds
available to KU at market-based rates up to $400 million. LG&E had no
money pool loan from LG&E Energy (shown as "Notes payable to affiliate")balances at March 31, 2004,2005 and $248.5 million at an average rate of 1.25% at March 31,
2003. The balance of the money pool loans from LG&E Energy and LG&E to KU
(shown as "Notes payable to affiliate") was $40.7 million at an average
rate of .98% and $174.5 million at an average rate of 1.25% at March 31, 2004
and 2003, respectively. The amount available towere as follows:
Total Money Amount Balance Average
(millions of $) Pool Available Outstanding Available Interest Rate
March 31, 2005:
LG&E under the money
pool agreement at$400.0 $35.0 $365.0 2.65%
KU 400.0 26.0 374.0 2.65
March 31, 2004 was $400 million. The amount available to2004:
LG&E $400.0 $ - $400.0 -%
KU under the money pool agreement at March 31, 2004 was $359.3 million.400.0 40.7 359.3 0.98
LG&E Energy maintains a revolving credit facility totaling $150$200 million
with an affiliateE.ON North America, Inc. to ensure funding availability for the money
pool. LG&E
Energy hadThere was no balance outstanding balance under LG&E Energy'son this facility as ofat March 31, 2004 and availability2005.
In April 2005, LG&E refinanced $40 million in existing pollution control
indebtedness. The original indebtedness, 5.90% Pollution Control Bonds,
Series X, due April 15, 2023, was discharged on May 13, 2005, using the
proceeds from the replacement indebtedness, LG&E Pollution Control Bonds,
Series HH, due February 1, 2035, which carry a variable, auction rate of
$150interest.
In January 2005, LG&E paid at maturity the $50 million remained.loan from Fidelia
using proceeds from short-term loans from the money pool.
In January 2004, LG&E and KU made discretionary contributions to their
pension plans of $34.5 million and $43.4 million, respectively. No
contributions are required for 2004 and no further discretionary contributions to the pension plans are planned.planned for either
LG&E's security&E or KU for 2005, but one or both Companies may make a discretionary
contribution to the other post-retirement benefit plans.
Security ratings as of March 31, 2004,2005, were:
LG&E KU
Moody's S&P Moody's S&P
First mortgage bonds A1 A- A1 A
Preferred stock Baa1 BBB- Baa1 BBB-
Commercial paper P-1 A-2
KU's security ratings as of March 31, 2004, were:
Moody's S&P
First mortgage bonds A1 A
Preferred stock Baa1 BBB-
Commercial paper P-1 A-2
These ratings reflect the views of Moody's and S&P. A security rating is
not a recommendation to buy, sell or hold securities and is subject to
revision or withdrawal at any time by the rating agency.
- 33 -
Page 25 -
LG&E's capitalizationCapitalization ratios at March 31, 2004,2005, and December 31, 2003,2004, follow:
LG&E KU
March 31, December 31, March 31,December 31,
2005 2004 20032005 2004
Long-term debt
(including current portion) 30.9% 31.9%31.7% 30.5% 22.2% 22.2%
Long-term debt to affiliated
company (including current
portion) 16.8 10.711.9 14.1 18.9 18.8
Notes payable to affiliated
companies - 4.31.9 3.0 1.5 2.0
Preferred stock 3.7 3.6 3.82.2 2.2
Common equity 48.7 49.350.8 48.8 55.2 54.8
Total 100.0% 100.0%
KU's capitalization ratios at March 31, 2004, and December 31, 2003,
follow:
March 31, December 31,
2004 2003
Long-term debt (including current portion) 23.0% 24.1%
Long-term debt to affiliated company
(including current portion) 18.9 16.8
Notes payable to affiliated companies 2.3 2.6
Preferred stock 2.3 2.4
Common equity 53.5 54.1
Total 100.0% 100.0%
New Accounting Pronouncements
In January 2003, the Financial Accounting Standards Board ("FASB") issued
Financial Accounting Standards Board Interpretation No. 46, ConsolidationFor a discussion of Variable Interest Entities, an Interpretation of ARB No. 51 (FIN 46).
FIN 46 requires certain variable interest entities to be consolidated by
the primary beneficiary of the entity if the equity investors in the entity
do not have the characteristics of a controlling financial interest or do
not have sufficient equity at risk for the entity to finance its activities
without additional subordinated financial support from other parties. FIN
46 was effective immediately for all new variable interest entities created
or acquired after January 31, 2003. For variable interest entities created
or acquired prior to February 1, 2003, the provisions of FIN 46 must have
been applied for the first interim or annual period beginning after June
15, 2003.
In December 2003, FIN 46 was revised, delaying the effective dates for
certain entities created before February 1, 2003,accounting pronouncements and making other
amendments to clarify application of the guidance. For potential variable
interest entities other than special purpose entities, the revised FIN 46
(FIN 46R) is now required to be applied no later than the end of the first
fiscal year or interim reporting period ending after March 15, 2004. For
all special purpose entities created prior to February 1, 2003, FIN 46R is
now required to be applied at the end of the first interim or annual
reporting period ending after December 15, 2003. FIN 46R may be applied
prospectively with a cumulative-effect adjustment as of the date it is
first applied, or by restating previously issued financial statements with
a cumulative-effect adjustment as of the beginning of the first year
restated. FIN 46R also requires certain disclosures of an entity's
relationship with variable interest entities.
Boththeir impacts on LG&E
and KU, hold investment interests in OVEC and KU holds an
investment interest in EEI. Neither LG&E nor KU are the primary
beneficiary of OVEC or EEI, and thus neither are consolidated into the
financial statements of LG&E or KU.
LG&E, KU and ten other electric utilities are participating owners of OVEC,
located in Piketon, Ohio. OVEC owns and operates two power plants that burn
coal to generate electricity, Kyger Creek Station in Ohio and Clifty Creek
Station in Indiana. LG&E's share is 7%, representing approximately 155 Mw
of generation capacity and KU's share is 2.5%, approximately 55 Mw of
generation capacity.see Part I - - Page 26 -
LG&E's and KU's original investment in OVEC was made in 1952. LG&E's
investment in OVEC is the equivalent of 4.9% of OVEC's common stock and
KU's investment is the equivalent of 2.5% of OVEC's common stock. LG&E's
and KU's investment in OVEC is accounted for on the cost method of
accounting. As of March 31, 2004, LG&E's and KU's investment in OVEC
totaled $0.5 million and $0.3 million, respectively. LG&E's and KU's
maximum exposure to loss as a result of their involvement with OVEC is
limited to the value of their investment. In the event of the inability of
OVEC to fulfill its power provision requirements, LG&E and KU would
substitute such power supply with either owned generation or market
purchases and would recover any associated incremental costs through
regulatory rate mechanisms. See Part II, Item 1, for further discussion of
current legal proceedings regarding LG&E's and KU's ownership interests and
power purchase rights.
KU owns 20% of the common stock of EEI, which owns and operates a 1,000-Mw
generating station in southern Illinois. KU is entitledNotes to take 20% of the
available capacity of the station. Purchases from EEI are made under a
contractual formula which has resulted in costs which were and are expected
to be comparable to the cost of other power purchased or generated by KU.
Such power equated to approximately 9% of KU's net generation system output
in 2003.
KU's original investment in EEI was made in 1953. KU's investment in EEI
is accounted for on the equity method of accounting. As of March 31, 2004,
KU's investment in EEI totaled $11.4 million. KU's maximum exposure to
loss as a result of its involvement with EEI is limited to the value of its
investment. In the event of the inability of EEI to fulfill its power
provision requirements, KU would substitute such power supply with either
owned generation or market purchases and would recover any associated
incremental costs through regulatory rate mechanisms.
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. SFAS No.
150 was effective immediately for financial instruments entered into or
modified after May 31, 2003, and otherwise was effective for interim
reporting periods beginning after June 15, 2003.
LG&E has 237,500 shares of $5.875 series mandatorily redeemable preferred
stock outstanding having a current redemption price of $100 per share. The
preferred stock has a sinking fund requirement sufficient to retire a
minimum of 12,500 shares on July 15 of each year commencing with July 15,
2003, and the remaining 187,500 shares on July 15, 2008 at $100 per share.
Beginning with the three months ended September 30, 2003, LG&E reclassified
its $5.875 series preferred stock as long-term debt with the minimum shares
mandatorily redeemable within one year classified as current. Dividends
accrued beginning July 1, 2003 are charged as interest expense.
KU has no financial instruments that fall within the scope of SFAS No. 150.Statements, Note 7.
Contingencies
For a description of significant contingencies that may affect LG&E and KU,
reference is made to Part I, Item 3, Legal Proceedings in LG&E's and KU's
Annual Reports on Form 10-K for the year ended December 31, 2003;2004; and to
Part I - Item 1, Notes to Financial Statments, Notes 5 and 10, and Part II
- - Item 1, Legal Proceedings herein.
Electric and Gas Rate Cases
In December 2003, LG&E and KU filed applications with the Kentucky
Commission requesting increases in LG&E's and KU's electric rates and
LG&E's gas rates. The Companies requested general adjustments in electric
rates and LG&E requested general adjustments in gas rates based on the
- - Page 27 -
twelve-month test year ended September 30, 2003. The revenue increases
requested by LG&E were $63.8 million for electric and $19.1 million for
gas. The revenue increase requested by KU was $58.3 million. The Kentucky
Commission has suspended the effective date of the proposed new tariffs for
five months, so that the rates may go into effect subject to refund by July
1, 2004. The Kentucky Commission established a procedural schedule for the
cases pertaining to discovery and hearings.
The Companies filed their final 2003 ESM calculations with the Kentucky
Commission on March 1, 2004, and applied for recovery of $16.2 million
related to KU and $13.0 million related to LG&E. Based upon estimates, the
Companies previously accrued $9.3 million at KU and $8.9 million at LG&E,
for the 2003 ESM as of December 31, 2003. The Companies have not booked
or accrued to date the respective increases of $6.9 million and $4.1
million, pending resolution of ongoing Kentucky Commission proceedings
regarding aspects of the ESM mechanism, including allowable recoverable
amounts. On March 31, 2004, the Kentucky Commission issued orders
consolidating the prior ESM cases into the general LG&E and KU proceedings
regarding increases in base rates.
During May 2004, the Kentucky Commission held hearings on the applications
for rate increases. On May 12, the Companies and all intervenors filed a
partial settlement agreement, stipulation and recommendation with the
Kentucky Commission providing for settlement of all outstanding issues,
except electric revenue requirements. All intervenors except the Kentucky
Attorney General entered a stipulation on the electric revenue
requirements. Testimony for the utilities and the Attorney General was
presented on electric revenues. All testimony of all other intervenors and
testimony of the Attorney General on other issues was withdrawn. The
agreement and stipulation provides for increases in annual base electric
rates of $43.4 million for LG&E and $46.1 million for KU, and in annual gas
rates of $11.9 million for LG&E and provides for settlement of other issues
such as various tariff provisions, implementation of a pilot real-time
pricing program, implementation of a home energy assistance program and
others. The agreement provides that the rate increases would be effective
commencing July 1, 2004.
The Companies and the intervenors, including the Attorney General, also
filed proposed settlements regarding the ESM mechanisms of LG&E and KU.
Under the ESM settlements, LG&E and KU would continue to collect
approximately $13.0 million and $16.2 million, respectively, of previously
requested 2003 ESM revenue amounts through March 2005. As part of the
settlement, the parties agreed to a termination of the ESM mechanism
relating to all periods after 2003.
The potential settlements are subject to Kentucky Commission approval.
Final Kentucky Commission orders in the rate case and related proceedings,
including the tendered settlements, are anticipated before July 1, 2004.
The Companies can provide no assurance regarding the Commission's final
decision regarding the partial agreement, stipulation and recommendation of
the parties or the ESM settlement.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
LG&E&E's and KU are exposed to market risks. BothKU's operations are exposed to market risks from changes in
interest rates and commodity prices. To mitigate changes in cash flows
attributable to these exposures, the Companies have entered into various
derivative instruments. Derivative positions are monitored using
techniques that include market value and sensitivity analysis.
The Companies use interest rate swaps to hedge exposure to market
fluctuations in certain of their debt instruments. Pursuant to the
Companies' policies, use of these financial instruments is intended to
mitigate risk and earnings volatility and is not speculative in nature.
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Management has designated all of the Companies' interest rate swaps as
hedge instruments. Financial instruments designated as cash flow hedges
have resulting gains and losses recorded within other comprehensive income
and stockholders' equity. To the extent a financial instrument or the
underlying item being hedged is prematurely terminated or the hedge becomes
ineffective, the resulting gains or losses are reclassified from other
comprehensive income to net income. Financial instruments designated as
fair value hedges are periodically marked to market with the resulting
gains and losses recorded directly into net income to correspond with
income or expense recognized from changes in market value of the items
being hedged.
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The potential change in interest expense associated with a 1% change in
base interest rates of LG&E's and KU's unswapped variable debt is estimated
at $3.0$3.58 million and $3.4$3.75 million, respectively, at March 31, 2004.2005. LG&E's exposure
to floating interest rates decreased $1.45 million
and KU's exposure to floating interest rates decreased $1.02 milliondid not materially change
during the first three months of 2004.2005.
The potential loss in fair value of LG&E's interest rate swaps resulting
from a hypothetical 1% change in base interest rates is estimated at
approximately $28.7$22.0 million as of March 31, 2004.2005. The potential loss in
fair value of KU's interest rate swaps resulting from a hypothetical 1%
change in base interest rates is estimated at approximately $3.3$1.0 million as
of March 31, 2004.2005. These estimates are derived from third-party
valuations. Changes in the market values of these swaps, if held to
maturity, will have no affecteffect on LG&E's or KU's net income or cash flow.
Pension Risk
LG&E's and KU's costs of providing defined-benefit pension retirement plans
is dependent upon a number of factors, such as the rates of return on plan
assets, discount rate, and contributions made to the plan. At December 31,
2002, LG&E was required to recognizeand KU
have recognized an additional minimum liability as prescribed by SFAS No.
87, Employers' Accounting for Pensions.Pensions because the accumulated benefit
obligation exceeds the fair value of their plans' assets. The liability wasliabilities
were recorded as a reduction to other comprehensive income, and did not
affect net income. The amount of the liability dependeddepends upon the discount
rate, the asset returns experienced in 2002 and contributions made by LG&Ethe Companies to the
plan during 2002.plans. If the fair value of the planplans' assets exceeds the accumulated
benefit obligation, the recorded liabilityliabilities will be reduced and other
comprehensive income will be restored in the consolidated balance sheet.
A 1% increase or decrease in the assumed discount rate could have an
approximate $41$39.9 million positive or negative impact to the accumulated
benefit obligation of LG&E. A 1% increase or decrease in the assumed
discount rate could have an approximate $27$26.8 million positive or negative
impact to the accumulated benefit obligation of KU.
In January 2004, LG&E and KU made discretionary contributions to their
pension plans of $34.5 million and $43.4 million, respectively. No
discretionary contributions to the pension plans are planned for either
LG&E or KU for 2005, but one or both Companies may make a discretionary
contribution to the other post-retirement benefit plans.
Energy Trading & Risk Management Activities
The table below summarizes LG&E's and KU's energy trading and risk
management activities for the three months ended March 31, 2004,2005, and 2003.2004.
Trading volumes are allocated evenly between LG&E and KU.
Three Months Ended
March 31,
2005 2004
2003
(in thousands)millions)
Fair value of contracts at beginning of
period, net asset/(liability) $ 572(0.2) $ (156)0.6
Fair value of contracts when entered
into during the period - 2,620-
Contracts realized or otherwise
settled during the period (150) (57)0.2 (0.2)
Changes in fair value due to changes in assumptions 181 (2,004)- 0.2
Fair value of contracts at end of period,
net asset/(liability)asset $ 603- $ 4030.6
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No changes to valuation techniques for energy trading and risk management
activities occurred during 20042005 or 2003.2004. Changes in market pricing,
interest rate and volatility assumptions were made during all periods. The
outstanding mark-to-market value is sensitive to changes in prices, price
volatilities, and interest rates. The Companies estimate that a movement
in prices of $1 and a change in interest and volatilities of 1% would not
result in a change of a material amount. All contracts outstanding at
March 31, 2004,2005, have a maturity of less than one year and are valued using
prices actively quoted for proposed or executed transactions or quoted by
brokers.
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LG&E and KU maintain policies intended to minimize credit risk and revalue
credit exposures daily to monitor compliance with those policies. As of
March 31, 2004,2005, 100% of the trading and risk management commitments were
with counterparties rated BBB-/Baa3 equivalent or better.
Item 4. Controls and Procedures.
LG&E and KU maintain a system of disclosure controls and procedures
designed to ensure that information required to be disclosed by the
Companies in reports they file or submit under the Securities Exchange Act
of 1934 is recorded, processed, summarized and reported, within the time
periods specified in the Securities and Exchange Commission rules and
forms. LG&E and KU conducted an evaluation of such controls and procedures
under the supervision and with the participation of the Companies'
management, including the Chairman, President and Chief Executive Officer
("CEO") and the Chief Financial Officer ("CFO"). Based upon that
evaluation, the CEO and CFO are of the conclusionhave concluded that the Companies' disclosure
controls and procedures are effective as of the end of the period covered
by this report.
LG&E and KU are not accelerated filers under the Sarbanes-Oxley Act of 2002
and associated rules (the "Act") and consequently anticipate issuing
Management's Report on Internal Control over Financial Reporting pursuant
to Section 404 of the Act in their first periodic report covering the
fiscal year ended December 31, 2006 as permitted by SEC rulemaking.
In preparation for required reporting under Section 404 of the Sarbanes-
Oxley Act of 2002, the Companies are conducting a thorough review of their
internal controls over financial reporting, including disclosure controls
and procedures. Based on this review, the Companies have made internal
controls enhancements and will continue to make future enhancements to
their internal control over financial reporting. There has been no change
in the Companies' internal control over financial reporting that occurred
during the fiscal quarter ended March 31, 2004,2005, that has materially
affected, or is reasonably likely to materially affect, the Companies'
internal control over financial reporting.
- - Page 3036 -
Part II. Other Information
Item 1. Legal Proceedings.
For a description of the significant legal proceedings involving LG&E and
KU, reference is made to the information under the following items and
captions of LG&E's and KU's respective combined Annual Report on Form 10-K
for the year ended December 31, 2003:2004: Item 1, Business; Item 3, Legal
Proceedings; Item 7, Management's Discussion and Analysis of Financial
Condition and Results of Operations, and Item 8, Financial Statements and
Supplementary Data.Data in Note 11. Reference is also made to the matters
described in Notes 5 and 10 of Part I, Item 1 of this 10-Q. Except as
described herein, to date, the proceedings reported in LG&E's and KU's
respective combined Annual Report on Form 10-K have not changed materially.
ElectricOther
In the normal course of business, other lawsuits, claims, environmental
actions, and Gas Rate Cases
During May 2004,other governmental proceedings arise against LG&E and KU. To
the Kentucky Commission held hearings on the applications
filed byextent that damages are assessed in any of these lawsuits, LG&E and KU
for increases in base rates. Forbelieve that their insurance coverage is adequate. Management, after
consultation with legal counsel, does not anticipate that liabilities
arising out of other currently pending or threatened lawsuits and claims
will have a descriptionmaterial adverse effect on LG&E's or KU's financial position or
results of developments in these cases, see Note 11 of the Notes to Consolidated
Financial Statements in Part 1, Item 1 of this Quarterly Report on Form 10-
Q. Final orders in the proceedings are expected before July 2004.
MISO
During March and April 2004, the Kentucky Commission held hearings in the
proceedings examining the cost and benefits of MISO membership, including
rate treatment of MISO costs and continued LG&E and KU participation. A
final order in the proceedings is anticipated in mid-2004.
OVEC Power Agreement and Related Matter
On April 30, 2004, OVEC and its shareholders, including LG&E and KU,
entered into an Amended and Restated Inter-Company Power Agreement, to be
effective beginning March 2006, upon the expiration of the current power
contract among the parties. Under the new contract, which has a 20-year
term from its effective date, LG&E and KU have purchase rights for 5.63%
and 2.5%, respectively, of OVEC power at marginal cost-based rates. LG&E
and KU are entitled to 7% and 2.5% of OVEC power, respectively, under the
current contract.
In addition, LG&E will purchase from American Electric Power Company Inc.
("AEP") an additional 0.73% interest in OVEC for a purchase price of
approximately $104,000, resulting in an increase in LG&E ownership in OVEC
from 4.9% to 5.63%. The share purchase transaction is anticipated to be
completed during 2004, subject to receipt of certain regulatory approvals.operations, respectively.
Item 6. Exhibits and Reports on Form 8-K.
6(a)Exhibits.
Applicable to Form
10-Q of
Exhibit
No. LG&E KU Description
31 X X Certification - Section 302 of Sarbanes-Oxley Act of 2002
31.1X Certification of Chairman of the Board, President and Chief
Executive Officer, pursuant to Section 302 of the
Sarbanes-
OxleySarbanes-Oxley Act of 2002
31.2X Certification of Chief Financial Officer, pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
31.3 X Certification of Chairman of the Board, President and Chief
Executive Officer, pursuant to Section 203302 of the
Sarbanes-Oxley Act of 2002
31.4 X Certification of Chief Financial Officer, pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
32 X X Certification pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
- - Page 31 -
Certain instruments defining the rights of holders of certain long-term
debt of LG&E andor KU have not been filed with the SEC but will be furnished
to the SEC upon request.
6(b). Reports on Form 8-K.
None.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Louisville Gas and Electric Company
Registrant
Date: May 13, 20042005 /s/ S. Bradford Rives
S. Bradford Rives
Chief Financial Officer
(On behalf of the registrant in his
capacities as Principal Financial Officer
and Principal Accounting Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Kentucky Utilities Company
Registrant
Date: May 13, 20042005 /s/ S. Bradford Rives
S. Bradford Rives
Chief Financial Officer
(On behalf of the registrant in his
capacities as Principal Financial Officer
and Principal Accounting Officer)
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