45
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 JuneSeptember 30, 2004
Or
[_] TRANSITION REPORT PURSUANT 1TOTO 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 JulyOctober 31, 2004,
all held by LG&E Energy LLC
Kentucky Utilities Company
37,817,878 shares, without par value, as of JulyOctober 31, 2004,
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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TABLE OF CONTENTS
PART I
Item 1 Consolidated Financial Statements
Louisville Gas and Electric Company and Subsidiary
Statements of Income 1
Statements of Retained Earnings 1
Balance Sheets 2
Statements of Cash Flow 4
Statements of Other Comprehensive Income 5
Kentucky Utilities Company and Subsidiary
Statements of Income 6
Statements of Retained Earnings 6
Balance Sheets 7
Statements of Cash Flow 9
Statements of Other Comprehensive Income 10
Notes to Consolidated Financial Statements 11
Item 2 Management's Discussion and Analysis of F
Financial Condition and Results of Operations 2223
Item 3 Quantitative and Qualitative Disclosures
About Market Risk 3638
Item 4 Controls and Procedures 3739
PART II
Item 1 Legal Proceedings 3840
Item 2 Unregistered Sales of Equity Securities
and Use of Proceeds 41
Item 4 Submission of Matters to a Vote of Security Holders 41
Item 6 Exhibits and Reports on Form 8-K 3942
Signatures 4043
Exhibits 41
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Part I. Financial Information - Item 1. Financial Statements
Louisville Gas and Electric Company and Subsidiary
Consolidated Statements of Income
(Unaudited)
(Thousands of $)
Three Months SixNine Months
Ended Ended
JuneSeptember 30, JuneSeptember 30,
2004 2003 2004 2003
OPERATING REVENUES (Note 5):
Electric $192,566 $173,917 $390,815 $360,936(Note 10) $227,024 $230,174 $617,839 $591,110
Gas 43,646 41,456 207,360 181,28034,818 32,659 242,178 213,939
Total operating revenues 236,212 215,373 598,175 542,216261,842 262,833 860,017 805,049
OPERATING EXPENSES:
Fuel for electric generation 47,615 46,277 100,139 95,75453,653 55,628 153,792 151,382
Power purchased 17,345 17,313 46,233 41,440(Note 10) 19,344 18,805 65,578 60,245
Gas supply expenses 30,991 25,963 161,747 132,07020,172 19,509 181,919 151,579
Other operation expenses 57,110 53,379 115,171 106,90748,129 51,890 163,300 158,797
Maintenance 15,266 17,690 26,807 29,58323,072 12,526 49,879 42,109
Depreciation and amortization 28,223 30,293 55,722 57,43730,299 28,429 86,021 85,866
Federal and state income taxes 9,374 4,714 24,399 21,35521,089 23,707 45,487 45,062
Property and other taxes 5,069 3,454 10,140 8,1894,343 4,659 14,483 12,848
Total operating expenses 210,993 199,083 540,358 492,735220,101 215,153 760,459 707,888
NET OPERATING INCOME 25,219 16,290 57,817 49,48141,741 47,680 99,558 97,161
Other income (expense) - net 133 (1,395) (328) (335)(1,091) 285 (1,419) (49)
Other income from affiliated
company (Note 10) - 12 - 56
Interest expense (Note 3) 5,236 5,849 10,013 12,1045,072 5,985 15,086 18,090
Interest expense to affiliated
companies (Note 10) 2,976 1,292 6,117 2,0273,040 2,111 9,157 4,137
NET INCOME $ 17,14032,538 $ 7,75539,871 $ 41,35973,896 $ 35,02074,891
Consolidated Statements of Retained Earnings
(Unaudited)
(Thousands of $)
Three Months SixNine Months
Ended Ended
JuneSeptember 30, JuneSeptember 30,
2004 2003 2004 2003
Balance at beginning of period $521,204 $435,647$516,856 $442,498 $497,441 $409,319
Net income 17,140 7,755 41,359 35,02032,538 39,871 73,896 74,891
Subtotal 538,344 443,402 538,800 444,339549,394 482,369 571,337 484,210
Cash dividends declared on stock:
5% cumulative preferred 269 269 538 538807 807
Auction rate cumulative preferred 219 268 406 569244 174 649 743
$5.875 cumulative preferred (Note 8)9) - 367- - 734
Common 21,000 - 21,00042,000 -
Subtotal 21,488 904 21,944 1,84121,513 443 43,456 2,284
Balance at end of period $516,856 $442,498 $516,856 $442,498$527,881 $481,926 $527,881 $481,926
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
(Unaudited)
(Thousands of $)
ASSETS
JuneSeptember 30, December 31,
2004 2003
UTILITY PLANT:
At original cost $3,857,231$3,880,901 $3,804,183
Less: reserve for depreciation 1,366,281 1,326,4421,390,301 1,326,899
Net utility plant (Note 7) 2,490,950 2,477,7412,490,600 2,477,284
OTHER PROPERTY AND INVESTMENTS -
less reserve of $63 as of JuneSeptember 30, 2004
and December 31, 2003 507508 611
CURRENT ASSETS:
Cash and cash equivalents 13,9845,902 1,706
Restricted cash 11,524 -
Accounts receivable - less reserve of $1,415 and
$3,515 as of JuneSeptember 30, 2004 and December 31,
2003, respectively (Note 4) 114,072108,761 84,585
Materials and supplies - at average cost:
Fuel (predominantly coal) 32,84322,268 25,260
Gas stored underground 21,79576,416 69,884
Other 26,08526,214 24,971
Prepayments and other 2,9811,634 5,281
Total current assets 211,760252,719 211,687
DEFERRED DEBITS AND OTHER ASSETS:
Unamortized debt expense 8,6538,555 8,753
Regulatory assets (Note 6) 113,553100,183 143,626
Long-term derivative asset (Note 3) 2,368 -
Other 33,03832,789 40,121
Total deferred debits and other assets 157,612141,527 192,500
Total assets $2,860,829 $2,882,539$2,885,354 $2,882,082
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
(Unaudited)
(Thousands of $)
CAPITALIZATION AND LIABILITIES
JuneSeptember 30, December 31,
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 (34,444)(39,902) (38,111)
Retained earnings 516,856527,881 497,441
Total common equity 946,746952,313 923,664
Cumulative preferred stock 70,425 70,425
Mandatorily redeemable preferred stock (Note 8) 22,5009) 21,250 22,500
Long-term debt (Note 9) 328,104 328,104
Long-term debt to affiliated company (Note 9) 225,000 200,000
575,604Total long-term debt 574,354 550,604
Total capitalization 1,592,7751,597,092 1,544,693
CURRENT LIABILITIES:
Current portion of mandatorily
redeemable preferred stock (Note 8)9) 1,250 1,250
Current portion of long-term debt (Note 9) 246,200 246,200
Current portion of long-term debt to
affiliated company (Note 9) 50,000 -
Notes payable to affiliated companies (Note 9) 25,95040,700 80,332
Accounts payable 76,26162,959 93,118
Accounts payable to affiliated companies (Note 10) 27,60622,455 38,343
Accrued income taxes 2,6058,330 11,472
Customer deposits 11,01512,255 10,493
Accrued interest 2,1462,593 1,999
Accrued interest to affiliated company (Note 10) 3,6482,996 2,750
Other 14,89318,493 11,784
Total current liabilities 461,574468,231 497,741
DEFERRED CREDITS AND OTHER LIABILITIES:
Accumulated deferred income taxes - net 344,337347,092 337,704
Investment tax credit, in process of amortization 47,53547,202 50,329
Accumulated provision for pensions
and related benefits 106,695109,436 140,598
Customer advances for construction 10,34410,637 9,890
Asset retirement obligation 10,06410,155 9,747
Regulatory liabilities (Note 6):
Accumulated cost of removal of utility plant 218,022 216,948214,950 216,491
Other 49,51153,535 51,822
Long-term derivative liability (Note 3) 12,19818,883 15,966
Other 7,7748,141 7,101
Total deferred credits and other liabilities 806,480 840,105820,031 839,648
Total capital and liabilities $2,860,829 $2,882,539$2,885,354 $2,882,082
The accompanying notes are an integral part of these consolidated financial
statements.
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Louisville Gas and Electric Company and Subsidiary
Consolidated Statement of Cash Flows
(Unaudited)
(Thousands of $)
SixNine Months
Ended
JuneSeptember 30,
2004 2003
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 41,35973,896 $ 35,02074,891
Items not requiring cash currently:
Depreciation and amortization 55,722 57,43786,021 85,866
Deferred income taxes - net 4,909 12,8766,803 24,589
Investment tax credit - net (2,794) (2,105)(3,127) (3,156)
Value Delivery Team (VDT) amortization (Note 6) 15,067 15,33222,601 22,866
Mark-to-market financial instruments (6,136) 1,551(Note 3) 2,916 (651)
Provision for post-retirement benefits (Note 8) (8,047) (4,801)
Other 4,957 9,557(147) 7,997
Changes in current assets and liabilities (19,580) 14,956(10,576) (28,028)
Changes in accounts receivable
securitization-net (Note 4) - (14,000)(58,000) 11,600
Pension funding (Note(Notes 9 and 12) (34,492) (83,125)
Provision for post-retirement benefits (8,047) (4,201)(89,125)
Gas supply clause 8,340 (19,834)(Note 6) 12,008 (14,970)
Earnings sharing mechanism 2,357 1,772(Note 6) 6,913 6,189
Combustion turbine litigation settlement 7,1077,003 -
Other 9,769 3,40115,460 10,698
Net cash flows from operating activities 78,538 28,637119,232 103,965
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sales of securities 103 163153
Construction expenditures (64,958) (119,412)(94,220) (153,064)
Net cash flows from investing activities (64,855) (119,249)(94,117) (152,911)
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase in restricted cash (11,524) -
Long-term borrowings from affiliated
company (Note 9) 125,000 100,000200,000
Short-term borrowings from affiliated
company (Note 9) 260,550 349,400399,550 478,800
Repayment of long-term borrowings from d
affiliated company (Note 9) (50,000) -
Repayment of short-term borrowings from
affiliated company (314,932) (370,737)(Note 9) (439,182) (596,721)
Retirement of mandatorily redeemable preferred
stock (Note 9) (1,250) (1,250)
Retirement of first mortgage bonds - (42,600)
Issuance costs of pollution control bonds (133)(135) -
Payment of common dividends (21,000)(42,000) -
Payment of preferred dividends (890) (1,993)(1,378) (2,898)
Net cash flows from financing activities (1,405) 76,670(20,919) 35,331
CHANGE IN CASH AND CASH EQUIVALENTS 12,278 (13,942)4,196 (13,615)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 1,706 17,015
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 13,9845,902 $ 3,0733,400
SUPPLEMENTAL DISCLOSURES:
Cash paid during the period for:
Income taxes $ 33,06242,375 $ 15,94712,968
Interest on borrowed money 8,539 10,70512,674 17,204
Interest to affiliated companies on
borrowed money 5,282 1,3158,937 1,707
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 of $)
Three Months SixNine Months
Ended Ended
JuneSeptember 30, JuneSeptember 30,
2004 2003 2004 2003
Net income $17,140 $7,775 $41,359 $35,020$32,538 $39,871 $73,896 $74,891
Gains/(losses) on derivative instruments
and hedging activities - net of tax
benefit/(expense) of $(4,866)$3,639, $(1,416),
$1,021,
$(2,449)$1,189 and $1,034,$(382), respectively
(Note 3) 7,299 (1,531) 3,667 (1,551)
Other comprehensive income (loss),
net of tax 7,299 (1,531) 3,667 (1,551)(5,457) 2,123 (1,790) 573
Comprehensive income $24,439 $6,224 $45,026 $33,469$27,081 $41,994 $72,106 $75,464
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 of $)
Three Months SixNine Months
Ended Ended
JuneSeptember 30, JuneSeptember 30,
2004 2003 2004 2003
OPERATING REVENUES $232,369 $197,174 $479,755 $422,157(Note 10) $252,669 $235,426 $732,424 $657,583
OPERATING EXPENSES:
Fuel for electric generation 67,631 59,641 137,515 125,96478,151 75,300 215,666 201,264
Power purchased 30,662 33,648 71,969 74,848(Note 10) 33,182 31,702 105,152 106,550
Other operation expenses 36,536 38,130 74,990 77,01937,844 35,603 112,834 112,622
Maintenance 17,024 7,403 28,908 36,36912,070 13,031 40,978 49,400
Depreciation and amortization 25,950 27,762 51,199 51,91229,065 24,751 80,265 76,663
Federal and state income taxes 17,461 7,467 38,562 14,06719,565 18,196 58,127 32,263
Property and other taxes 4,284 3,968 8,537 8,1634,406 4,067 12,942 12,230
Total operating expenses 199,548 178,019 411,680 388,342214,283 202,650 625,964 590,992
NET OPERATING INCOME 32,821 19,155 68,075 33,81538,386 32,776 106,460 66,591
Other income - net 1,958 2,697 3,420 4,8033,094 2,140 6,514 6,944
Other income (expense) from
affiliated company (Note 10) 11 5 26 4 (3) 14 -
Interest expense (Note 3) 3,682 6,582 4,417 11,1133,116 2,695 7,532 13,808
Interest expense to affiliated
companies
(Note 10) 3,536 1,108 7,083 1,4853,557 1,916 10,641 3,401
NET INCOME $ 27,56534,818 $ 14,15930,310 $ 60,00994,827 $ 26,02056,330
Consolidated Statements of Retained Earnings
(Unaudited)
(Thousands of $)
Three Months SixNine Months
Ended Ended
JuneSeptember 30, JuneSeptember 30,
2004 2003 2004 2003
Balance at beginning of period $623,050 $513,321$629,051 $526,916 $591,170 $502,024
Net income 27,565 14,159 60,009 26,02034,818 30,310 94,827 56,330
Subtotal 650,615 527,480 651,179 528,044663,869 557,226 685,997 558,354
Cash dividends declared on stock:
4.75% cumulative preferred 237 237 475 475712 711
6.53% cumulative preferred 327 327 653 653980 981
Common 21,000 - 21,00042,000 -
Subtotal 21,564 564 22,128 1,12843,692 1,692
Balance at end of period $629,051 $526,916 $629,051 $526,916$642,305 $556,662 $642,305 $556,662
The accompanying notes are an integral part of these consolidated financial
statements.
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Kentucky Utilities Company and Subsidiary
Consolidated Balance Sheets
(Unaudited)
(Thousands of $)
ASSETS
JuneSeptember 30, December 31,
2004 2003
UTILITY PLANT:
At original cost $3,645,814$3,670,707 $3,596,657
Less: reserve for depreciation 1,377,302 1,355,0551,403,583 1,360,253
Net utility plant (Note 7) 2,268,512 2,241,6022,267,124 2,236,404
OTHER PROPERTY AND INVESTMENTS -
less reserve of $131 as of JuneSeptember 30, 2004 and
December 31, 2003 19,19619,721 17,862
CURRENT ASSETS:
Cash and cash equivalents 9,7924,677 4,869
Accounts receivable - less reserve of $673$482 and $672
as of JuneSeptember 30, 2004 and December 31, 2003,
respectively (Note 4) 94,80497,437 49,289
Materials and supplies - at average cost:
Fuel (predominantly coal) 35,55230,260 45,538
Other 27,36727,653 27,094
Prepayments and other 9,8666,802 13,100
Total current assets 177,381166,829 139,890
DEFERRED DEBITS AND OTHER ASSETS:
Unamortized debt expense 4,3494,295 4,481
Regulatory assets (Note 6) 64,97462,668 72,318
Long-term derivative asset (Note 3) 7,5847,530 12,223
Other 11,10212,164 21,916
Total deferred debits and other assets 88,00986,657 110,938
Total assets $2,553,098 $2,510,292$2,540,331 $2,505,094
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 of $)
CAPITALIZATION AND LIABILITIES
JuneSeptember 30, December 31,
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 (6,045)(6,071) (6,031)
Retained earnings 629,051642,305 591,170
Total common equity 945,824959,052 907,957
Cumulative preferred stock 39,727 39,727
Long-term debt (Note 9) 307,940307,564 312,646
Long-term debt to affiliated company (Note 9) 333,000 283,000
640,940Total long-term debt 640,564 595,646
Total capitalization 1,626,4911,639,343 1,543,330
CURRENT LIABILITIES:
Current portion of long-term debt (Note 9) 87,130 91,930
Notes payable to affiliated company (Note 9) 53,18129,830 43,231
Accounts payable 48,35641,317 69,947
Accounts payable to affiliated companies (Note 10) 15,72718,979 26,426
Accrued income taxes 10,45412,337 7,104
Customer deposits 13,86714,163 13,453
Accrued interest 1,9723,019 2,024
Accrued interest to affiliated company (Note 10) 3,4933,866 2,454
Other 17,01920,566 9,767
Total current liabilities 251,199231,207 266,336
DEFERRED CREDITS AND OTHER LIABILITIES:
Accumulated deferred income taxes - net 275,860274,207 261,258
Investment tax credit, in process of amortization 4,8324,318 5,859
Accumulated provision for pensions and
related benefits 63,14065,260 103,101
Customer advances for construction 1,6241,608 1,564
Asset retirement obligation 20,33920,661 19,698
Regulatory liabilities (Note 6):
Accumulated cost of removal of utility plant 266,218 261,942262,971 256,744
Other 30,90828,301 38,027
Other 12,48712,455 9,177
Total deferred credits and other liabilities 675,408 700,626669,781 695,428
Total capital and liabilities $2,553,098 $2,510,292$2,540,331 $2,505,094
The accompanying notes are an integral part of these consolidated financial
statements.
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Kentucky Utilities Company and Subsidiary
Consolidated Statement of Cash Flows
(Unaudited)
(Thousands of $)
SixNine Months
Ended
JuneSeptember 30,
2004 2003
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 60,00994,827 $ 26,02056,330
Items not requiring cash currently:
Depreciation and amortization 51,199 51,91280,265 76,663
Deferred income taxes - net 13,346 1,48511,064 10,277
Investment tax credit - net (1,027) (1,321)(1,540) (1,981)
Value Delivery Team (VDT) amortization (Note 6) 5,877 6,1538,816 9,091
Mark-to-market financial instruments (67) 2,016(Note 3) (389) 1,231
Provision for post-retirement benefits (Note 8) (3,373) (4,417)
Deferred storm costs (3,760) -
Other 1,632 14,5482,401 15,212
Changes in current assets and liabilities (52,855) 4,6283,164 (4,888)
Changes in accounts receivable securitization
- net (Note 4) (50,000) -
Pension funding (Note(Notes 9 and 12) (43,409) (3,515)
Provision for post-retirement benefits (3,372) (3,036)(9,515)
Earnings sharing mechanism 344 4,464(Note 6) 4,920 7,708
Environmental cost recovery mechanism (Note 6) (7,089) 1,157
Combustion turbine litigation settlement 11,59511,426 -
Other 6,296 11,43410,231 23,242
Net cash flows from operating activities 49,568 114,788117,554 180,110
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of securities (1,334) (1,786)(1,858) (2,818)
Construction expenditures (76,338) (175,507)(103,992) (263,899)
Net cash flows from investing activities (77,672) (177,293)(105,850) (266,717)
CASH FLOWS FROM FINANCING ACTIVITIES:
Long-term borrowings from affiliated
company (Note 9) 50,000 100,000175,000
Short-term borrowings from affiliated
company (Note 9) 255,000 360,640380,500 520,840
Repayment of short-term borrowings from affiliated
company (245,050) (333,700)(Note 9) (393,900) (541,600)
Retirement of first mortgage bonds - (62,000)
Retirement of pollution control bonds (4,800) (62,000)-
Refund of issuance costs of pollution
control bonds 5(4) -
Payment of common dividends (21,000)(42,000) -
Payment of preferred dividends (1,128) (1,128)(1,692) (1,692)
Net cash flows from financing activities 33,027 63,812(11,896) 90,548
CHANGE IN CASH AND CASH EQUIVALENTS 4,923 1,307(192) 3,941
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 4,869 5,391
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 9,7924,677 $ 6,6989,332
SUPPLEMENTAL DISCLOSURES:
Cash paid during the period for:
Income taxes $ 21,26440,792 $ 13,76319,012
Interest on borrowed money 7,562 11,0459,195 12,681
Interest to affiliated companies on borrowed money 6,070 7249,269 1,060
The accompanying notes are an integral part of these consolidated financial
statements.
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Kentucky Utilities Company and Subsidiary
Consolidated Statements of Other Comprehensive Income
(Unaudited)
(Thousands of $)
Three Months SixNine Months
Ended Ended
JuneSeptember 30, JuneSeptember 30,
2004 2003 2004 2003
Net income $27,565 $14,159 $60,009 $26,020$34,818 $30,310 $94,827 $56,330
Losses on derivative instruments
and hedging activities - net of tax
benefit/(expense) of $18$17, ($121), $23
and $5($121), respectively (Note 3) (27) - (14) -
Other comprehensive loss, net of tax (27) - (14) -(26) 182 (40) 182
Comprehensive income $27,538 $14,159 $59,995 $26,020$34,792 $30,492 $94,787 $56,512
The accompanying notes are an integral part of these consolidated financial
statements.
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Louisville Gas and Electric Company and Subsidiary
Kentucky Utilities Company and Subsidiary
Notes to Consolidated Financial Statements
(Unaudited)
1. General
The unaudited consolidatedcondensed financial statements include the accounts of
Louisville Gas and Electric Company and Subsidiary and Kentucky
Utilities Company and Subsidiary (each "LG&E" and "KU", or the
"Companies"). The common stock of each of LG&E and KU is wholly-owned
by LG&E Energy LLC ("LG&E 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") 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, 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 and sixnine
months ended JuneSeptember 30, 2003, have been revised to conform to
certain reclassifications in the current three months and sixnine months
ended JuneSeptember 30, 2004. These reclassifications had no impact on the
balance sheet net assets or net income, as previously reported.
2. Mergers and Acquisitions
LG&E and KU are each subsidiaries of LG&E Energy. In July 2002, E.ON
AG ("E.ON"), a German company, completed its acquisition of Powergen
Limited ("Powergen"), the former parent company of 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 of 5.1 billion pounds sterling
($7.3 billion) for Powergen in April 2001.
Following the purchase of Powergen by E.ON, 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, including LG&E
and KU, and certain of its non-utility subsidiaries are subject to
extensive regulation by the SEC 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. 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, 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 began direct
reporting arrangements to E.ON.
- - New Page -
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.
Page 11
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 and the underlying hedged items are periodically
marked to market with the resulting net gains and losses recorded
directly into net income. Upon termination of any fair value hedges,hedge,
the resulting gain or loss is recorded into net income.
As of JuneSeptember 30, 2004, LG&E was party to various interest rate swap
agreements with aggregate notional amounts of $228.3 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 1.01%1.37% at JuneSeptember 30, 2004. The swap
agreements in effect at JuneSeptember 30, 2004 have been designated as cash
flow hedges and mature on dates ranging from 2005 to 2033. The hedges
have been deemed to be fully effective resulting in a pretax gainloss of
$12.2$9.1 million and $6.1a pretax loss of $2.9 million for the three months and
sixnine months ended JuneSeptember 30, 2004, respectively, 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 are
immaterial.
As of JuneSeptember 30, 2004, KU was party to various interest rate swap
agreements with aggregate notional amounts of $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 2.23%2.70%, and
received fixed rates averaging 7.74% at JuneSeptember 30, 2004. The swap
agreements in effect at JuneSeptember 30, 2004 have been designated as fair
value hedges and mature on dates ranging from 2007 to 2025. During the
three months and sixnine months ended JuneSeptember 30, 2004, the effect of
marking these financial instruments and the underlying debt to market
resulted in a net pretax gain/(loss)gain of $(0.5)$0.3 million and $0.7$1.0 million
(representing the hedges' ineffectiveness), respectively, recorded as a
decrease/(increase)decrease in interest expense.
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 JuneSeptember 30, 2004, KU's debt reflects an increase by a
$10.0of
$9.7 million related to such mark-to-market adjustment.
- - New Page -
In February 2004, KU terminated the swap it had in place related to
its 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, resulting in a gain of $0.8
million.
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, originally implemented in February 2001, and
replaced them with intercompany loans from an E.ON affiliate. In May
2004, LG&E and KU dissolved their inactive accounts receivable
securitization-related subsidiaries, LG&E Receivables LLC and KU
Receivables LLC. The accounts receivable securitization-related
subsidiaries were the only subsidiaries of LG&E and KU.
5. SegmentSegments of Business
LG&E's revenues and net income by business segment for the three and
sixnine months ended JuneSeptember 30, 2004 and 2003, follow:
Three Months Ended SixNine Months Ended
JuneSeptember 30, JuneSeptember 30,
(in thousands) 2004 2003 2004 2003
LG&E Electric
Revenues 192,566 173,917 390,815 360,936$227,024 $230,174 $617,839 $591,110
Net income 20,441 9,457 36,384 27,48934,648 41,924 71,031 69,413
LG&E Gas
Revenues 43,646 41,456 207,360 181,28034,818 32,659 242,178 213,939
Net income (3,301) (1,682) 4,975 7,531(2,110) (2,053) 2,865 5,478
Total
Revenues 236,212 215,373 598,175 542,216261,842 262,833 860,017 805,049
Net income 17,140 7,775 41,359 35,02032,538 39,871 73,896 74,891
KU is an electric utility company. It does not provide gas service and
therefore, is presented as a single business segment.
6. Regulatory Assets and Liabilities
The following regulatory assets and liabilities were included in
LG&E's balance sheets as of JuneSeptember 30, 2004 and December 31, 2003:
Louisville Gas and Electric Company
(Unaudited)
JuneSeptember 30,December 31,
(in thousands) 2004 2003
VDT costs $ 52,74345,209 $ 67,810
Gas supply adjustments due from customers 11,93011,068 22,077
Unamortized loss on bonds 20,80220,537 21,333
Earnings sharing mechanism (ESM) provision 10,0025,446 12,359
Merger surcredit 5,5295,183 6,220
Asset retirement obligation (ARO) 6,4806,674 6,015
Gas performance-based ratemaking (PBR) 3,3783,467 5,480
Other (including fuel adjustment clause
(FAC), demand side management (DSM),
etc.) 2,6892,599 2,332
Total regulatory assets $ 113,553 $ 143,626$100,183 $143,626
Accumulated cost of removal of
utility plant $(218,022) $(216,948)$214,950 $216,491
Deferred income taxes - net (39,457) (41,180)38,595 41,180
Gas supply adjustments due to customers (4,999) (6,805)7,804 6,805
DSM (2,904) (1,706)2,602 1,706
Other (including environmental cost
recovery (ECR), ARO, FAC and ESM) (2,151) (2,131)4,534 2,131
Total regulatory liabilities $(267,533) $(268,770)
- New$268,485 $268,313
Page -13
LG&E currently earns a return on all regulatory assets except for gas
supply adjustments, ESM, gas performance-based ratemaking, FAC, and
FAC,DSM, 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.
The following regulatory assets and liabilities were included in KU's
balance sheets as of JuneSeptember 30, 2004 and December 31, 2003:
Kentucky Utilities Company
(Unaudited)
JuneSeptember 30, December 31,
(in thousands) 2004 2003
VDT costs $ 20,57417,635 $ 26,451
Unamortized loss on bonds 10,1279,946 10,511
ESM provision 12,0387,462 12,382
Merger surcredit 4,2804,012 4,815
ARO 12,09512,464 11,322
FAC 2,8651,713 4,298
Deferred storm costs 3,760 -
Other 2,9955,676 2,539
Total regulatory assets $ 64,97462,668 $ 72,318
Accumulated cost of removal of
utility plant $(266,218) $(261,942)$262,971 $256,744
Deferred income taxes - net (22,802) (24,058)22,174 24,058
ARO (1,288) (1,162)1,351 1,162
Spare parts (1,071) (1,055)1,062 1,055
ECR (3,671) (9,189)2,100 9,189
Other (including FAC and DSM) (2,076) (2,563)1,614 2,563
Total regulatory liabilities $(297,126) $(299,969)$291,272 $294,771
KU currently earns a return on all regulatory assets except for ESM,
FAC, and FAC, bothDSM, all 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.
In September 2004, KU reclassified from maintenance expense to a
regulatory asset, $4.0 million related to unreimbursed costs from the
2003 ice storm based on an order from the Kentucky Commission. These
costs will be amortized through June 2009. KU earns a return of these
amortized costs, which are included in KU's jurisdictional operating
expenses.
During May and July, LG&E and KU incurred $17.0 million and $3.5
million, respectively, of storm restoration costs associated with
severe storms in their service territories. Of these amounts LG&E
incurred $12.6 million of Operations and Maintenance ("O&M") expense
and $4.4 million of expenditures that were capitalized and KU incurred
$2.7 million of O&M expense and $0.8 million of expenditures that were
capitalized. The Companies are considering requesting the Kentucky
Commission to allow deferral of these O&M expenses for recovery in a
future rate proceeding during the fourth quarter of 2004.
Page 14
7. Utility Plant
KU retired two steam generating units, Green River Units 1 and 2, in
the amount of $17.2 million, from its books as of March 31, 2004.
Approximately $4 million in common assets, which are shared by Green
River Units 3 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 gross book value of Green River Units 1 and 2 was charged
to the accumulated reserve for depreciation in accordance with FERC
regulations and no gain or loss was recorded. The impact of the
retirement of Green River Units 1 and 2 on the ARO is immaterial. A
partial redemption of pollution control Series 14 bonds totaling $4.8
million was required in the second quarter as a result of the
retirement (see Note 9).
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The following data represent shares of jointly-owned additions to the
Trimble County plant for four combustion turbines ("CT's"CTs") as of
JuneSeptember 30, 2004. Trimble County CT Units 7 and 8 began commercial
operation on June 1, 2004. The addition to LG&E plant in service was
$37.0 million and for KU the addition was $63.2 million. Trimble County
CT Units 9 and 10 began commercial operation on July 1, 2004.2004, resulting
in an increase to plant in service of $37.3 and $63.8 million for LG&E
and KU, respectively.
($ in millions) LG&E KU Total
Trimble CT 7
Ownership % 37% 63% 100%
Mw capacity 59 101 160
Cost $18.5 $31.7 $50.2
Depreciation 0.2 0.3 0.5
Net book value $18.7 $32.1 $50.8$18.3 $31.4 $49.7
Trimble CT 8
Ownership % 37% 63% 100%
Mw capacity 59 101 160
Cost $18.5 $31.5 $50.0
Depreciation 0.2 0.3 0.5
Net book value $18.6 $31.9 $50.5$18.3 $31.2 $49.5
Trimble CT 9
Ownership % 37% 63% 100%
Mw capacity 59 101 160
Cost $18.7 $31.9 $50.6
Depreciation 0.1 0.2 0.3
Net book value (in construction work in progress) $18.7 $32.0 $50.7$18.6 $31.7 $50.3
Trimble CT 10
Ownership % 37% 63% 100%
Mw capacity 59 101 160
Cost $18.6 $31.9 $50.5
Depreciation 0.1 0.2 0.3
Net book value (in construction work in progress) $18.6 $32.0 $50.6$18.5 $31.7 $50.2
8. New Accounting Pronouncements
FIN 46
In January 2003, 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 required 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.
Page 15
In December 2003, FIN 46 was revised, delaying the effective dates for
certain entities created before February 1, 2003, 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.
Both LG&E and KU hold investment interests in Ohio Valley Electric
Corporation ("OVEC"), and KU holds an investment interest in Electric
Energy, Inc. ("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.
- New Page -
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%, representing approximately 55 Mw of generation capacity.
LG&E's and KU's original investments in OVEC were 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 investments in OVEC are accounted for under the cost
method of accounting. As of JuneSeptember 30, 2004, LG&E's and KU's
investments 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
investments. 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
generally recover associated incremental costs through regulatory rate
mechanisms. See Note 11 and Part II, Item 1, for further discussion of
developments 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.
KU's original investment in EEI was made in 1953. KU's investment in
EEI is accounted for under the equity method of accounting and, as of
JuneSeptember 30, 2004, totaled $11.9$12.7 million. KU's maximumdirect exposure to
loss as a result of its involvement with EEI is generally 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
generally recover associated incremental costs through regulatory rate
mechanisms.
SFAS No. 150
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.
As of June 30, 2004, LG&E had 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. On July 15, 2004, LG&E redeemed 12,500 shares as required at
a price of $100 per share.
KU has no financial instruments that fall within the scope of SFAS No.
150.
FSP 106-2
In May 2004, the FASB finalized FASB Staff Position ("FSP") 106-2,
Accounting and Disclosure Requirements Related to the Medicare
- - New Page -
Prescription Drug, Improvement and Modernization Act of 2003 ("Medicare
Act") with guidance on accounting for subsidies provided under the
Medicare Act which became law in December 2003. FSP 106-2 is effective
for the first interim or annual period beginning after June 15, 2004.
KU will adopt FSP 106-2 in the third quarter of 2004. LG&E's medical
plan does not providehave a benefit that is actuarially equivalent to
Medicare Part D; therefore, FSP 106-2 is not expected to have anmaterial impact on LG&E.
On the basis of actuarial estimates, the Medicare Act will result in an
overall reduction of the accumulated postretirement benefit obligation
("APBO") for postretirement health and life insurance benefits for KU
amounting to approximately $5.0 million as of January 1, 2004.
Accordingly, KU's net periodic postretirement benefit cost for 2004
will be reduced by approximately $0.7 million. The APBO and the net
periodic postretirement benefit cost as of and for the periods ending
June 30, 2004 and 2003 do not reflect amounts associated with the
subsidies provided by the Medicare Act.Companies.
Page 16
9. Short-Term and Long-Term Debt
Under the provisions for LG&E's variable-rate pollution control bonds,Pollution Control Bonds,
Series S, T, U, BB, CC, DD and EE, and KU's variable-rate pollution
control bondsPollution
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 and nine months ending JuneSeptember
30, 2004 was 1.11%1.20% and 1.14%, respectively, for the LG&E bonds and
1.30% and 1.18%, respectively, for the KU bonds.
In January 2004, LG&E entered into two long-term notesloans from Fidelia
Corporation ("Fidelia"), an E.ON financing subsidiary, one totaling $25
million with an interest rate of 4.33% that matures in January 2012,
and a one-year noteone totaling $100 million with an interest rate of 1.53%. that
matures in January 2005. 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.
In May 2004, KU redeemed $4.8 million of its Series 14 pollution
control bondsPollution
Control Bonds which were initially issued in the amount of $7.2
million.
On October 20, 2004, KU completed a refinancing transaction regarding
$50 million in existing pollution control indebtedness. The original
indebtedness, 5.75% Pollution Control Bonds, Series 9, due December 1,
2023, will be discharged on November 22, 2004, with the proceeds from
the replacement indebtedness, KU Pollution Control Bonds, Series 17,
due October 1, 2034, which will carry a variable, auction rate of
interest.
LG&E maintains five bilateral lines of credit totaling $185 million
that mature in 2005. There was no outstanding balance under these
facilities at JuneSeptember 30, 2004. Management expects to renew these
facilities as they expire.
LG&E and KU 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 as 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.
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LG&E had $26.0$40.7 million in money pool loans from LG&E Energy (included
in "Notes payable to affiliated companies") at an average rate of 1.04%1.60%
at JuneSeptember 30, 2004, and $171.7$75.1 million at an average rate of 1.21%1.06% at
JuneSeptember 30, 2003. The balance of the money pool loans from LG&E
Energy to KU (included in "Notes payable to affiliated companies") was
$53.2$29.8 million at an average rate of 1.04%1.60% and $146.4$98.7 million at an
average rate of 1.21%1.06% at JuneSeptember 30, 2004 and 2003, respectively.
The amount available to LG&E under the money pool agreement at
JuneSeptember 30, 2004, was $374.0$359.3 million. The amount available to KU
under the money pool agreement at JuneSeptember 30, 2004, was $346.8$370.2
million. LG&E Energy maintains a revolving credit facility totaling
$150 million with an E.ON affiliate to ensure funding availability for
the money pool. LG&E Energy had an outstanding balance of $69.7$79.1
million at an average rate of 1.79%2.13% under this facility as of JuneSeptember
30, 2004, and availability of $80.3$70.9 million remained.
10.RelatedPage 17
As of September 30, 2004, LG&E had 225,000 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 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 are charged as interest
expense, pursuant to SFAS No. 150. On July 15, 2004, LG&E redeemed
12,500 shares as required at a price of $100 per share.
10. Related Party Transactions
LG&E, KU, certain subsidiaries of LG&E Energy and other subsidiaries of
E.ON engage in related-party transactions. Transactions among LG&E, KU
and LG&E Energy subsidiaries are eliminated upon consolidation of LG&E
Energy subsidiaries. Transactions between LG&E or KU and E.ON
subsidiaries are eliminated upon consolidation of E.ON subsidiaries.
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")) for the three months and
sixnine months ended JuneSeptember 30, 2004 and 2003, were as follows:
Three months ended SixendedNine months ended
JuneSeptember 30, JuneSeptember 30,
(in thousands) 2004 2003 2004 2003
LG&E
Electric operating revenues
from KU $8,426 $10,850 $30,504 $27,820$10,095 $11,980 $40,598 $39,799
Electric operating revenues
from LEM 622 1,077 1,350 8,2261,092 537 2,443 8,691
Purchased power from KU 9,114 9,211 30,699 23,67512,206 11,000 42,905 34,675
KU
Electric operating revenues
from LG&E $9,114 $9,211 $30,699 $23,675$12,206 $11,000 $42,905 $34,675
Electric operating revenues
from LEM 390 318 550 2,100346 174 895 2,196
Purchased power from LG&E 8,426 10,850 30,504 27,82010,095 11,980 40,598 39,799
Interest ChargesIncome and Expense
LG&E intercompany interest income and expense for the three months and
sixnine months ended JuneSeptember 30, 2004 and 2003, were as follows:
Three months ended SixNine months ended
JuneSeptember 30, JuneSeptember 30,
(in thousands) 2004 2003 2004 2003
Interest to affiliate
(money pool) $ (13)102 $ 536305 $ 35 $1,269137 $1,573
Interest to affilitateaffiliate
(Fidelia loans) 2,986 758 6,069 7582,927 1,801 8,995 2,560
Interest to affiliate (KU) 11 5 25 4
(3) 14 -
Interest expense to
affiliated companies $3,040 $2,111 $9,157 $4,137
Interest income from affiliate (KU) - 1$ 2 - 5
- New$ 6
Page -18
KU intercompany interest income and expense for the three months and
sixnine months ended JuneSeptember 30, 2004 and 2003, were as follows:
Three months ended SixNine months ended
JuneSeptember 30, JuneSeptember 30,
(in thousands) 2004 2003 2004 2003
Interest to affiliate
(money pool) $ 75 $34996 $ 219 $722279 $ 315 $1,001
Interest to affiliate
(Fidelia loans) 3,461 758 6,864 7581,635 10,326 2,394
Interest to affiliate (LG&E) - 12 - 56
Interest expense to affiliated
companies $3,557 $1,916 $10,641 $3,401
Interest income from
affiliate (LG&E) $ 11 $ 5 $ 26 $ 4 (3) 14 -
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 and sixnine months
ended JuneSeptember 30, 2004 and 2003, were as follows:
Three months ended SixNine months ended
JuneSeptember 30, JuneSeptember 30,
(in thousands) 2004 2003 2004 2003
LG&E Services billings to LG&E $60,390 $61,404 $98,552 $88,034$40,221 $44,607 $138,796 $132,894
LG&E Services billings to KU 44,613 64,915 75,188 86,40942,342 48,508 117,530 134,916
LG&E billings to LG&E Services 1,490 1,281 4,525 6,1435,951 12,801 10,475 18,944
LG&E billings to KU 33,796 39,111 94,509 91,760
KU billings to LG&E 31,683 22,203 83,516 55,79514,962 25,127 48,464 61,248
KU billings to LG&E Services 1,097 770 3,915 7,864516 4,774 4,430 12,638
KU billings to LG&E 2,097 3,104 26,928 11,549
11.Commitments and Contingencies
Except as discussed in this Quarterly Report on Form 10-Q, 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 31, 2003, (including in
Notes 3 and 11 to the financial statements of LG&E and KU contained
therein and incorporated herein by reference) or Quarterly ReportReports on
Form 10-Q for the quarterquarters ended March 31, 2004 and June 30, 2004.
Electric and Gas Rates 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 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.
On June 30, 2004, the Kentucky Commission issued an order approving
increases in the base electric and gas rates of LG&E and the base
electric rates of KU. The Kentucky Commission's order largely accepted
proposed settlement agreements filed in May 2004 by LG&E, KU and a
majority of the parties to the rate case proceedings. The rate
increases took effect on July 1, 2004.
Page 19
In the Kentucky Commission's order, (a) LG&E was granted increases in
annual base electric rates of approximately $43.4 million (7.7%) and in
annual base gas rates of approximately $11.9 million (3.4%) and (b) KU
was granted an increase in annual base electric rates of approximately
$46.1 million (6.8%). Other provisions of the order include decisions
on certain depreciation, gas supply clause, ECR and VDT amounts or
mechanisms and a termination of the ESM with respect to all periods
after 2003. The order also provided for a recovery before March 31,
2005, by the Companies of previously requested amounts relating to the
ESM during 2003.
- New Page -
During July 2004, the Attorney General of Kentucky ("AG") served
subpoenas on KU and LG&E, and KU, as well as on the Kentucky Commission and its
staff, requesting information regarding allegedly improper
communications between the CompaniesKU and LG&E and the Kentucky Commission,
particularly during the period covered by the rate cases. The Kentucky
Commission has procedurally reopened the rate cases for the limited
purpose of taking evidence, if any, as to the communication issues.
Subsequently, the AG filed pleadings with the Kentucky Commission
requesting rehearing of the rate cases on certain computational
components of the increased rates, including income tax, cost of
removal and depreciation amounts. In August 2004, the Kentucky
Commission denied the AG's rehearing request on the cost of removal and
depreciation issues, with the effect that the rate increase order is
final as to these matters, subject to the parties' rights to judicial
appeals. The Kentucky Commission further agreed to hold in abeyance
until mid-October 2004 its further proceedings regardingin the rate cases, including the AG's concerns
about alleged improper communications, until the AG could file with the
Kentucky Commission an investigative report regarding the latter issue.
In addition, the Kentucky Commission granted a rehearing on the income
tax component once the abeyance discussed above is lifted.
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. On October 12, 2004,
the AG filed a status report with the Kentucky Commission in which the
AG indicated that it had not completed its investigation and requested
that the Kentucky Commission continue to hold these matters in
abeyance. On October 21, 2004, the AG filed a motion with the Kentucky
Commission requesting that the previously granted rate increases be set
aside, that the Companies resubmit any applications for rate increases
and that relevant Kentucky Commission personnel be recused from
participation in rate case proceedings. On November 8, 2004, the
Franklin County, Kentucky court denied an AG request for sanctions on
KU and LG&E relating to production matters and narrowed the AG's
permitted scope of discovery. As so required, LG&E's and KU's
production of materials requested by the AG is expected to continue.
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 estimate the general status or
progress of the AG investigation, including when the AG will submit its
report to the Kentucky Commission, and the content, findings and
recommendations contained in any such report. The Companies are
currently unable to determine the ultimate impact, if any, of, or any
possible future actions of the AG or the Kentucky Commission arising
out of, the AG's report and investigation, onincluding whether there will
be further actions to appeal, review or otherwise challenge the recently concluded rate case
or their operations generally.granted
increases in base rates.
Page 20
Earnings Sharing Mechanism
The Companies filed their final 2003 ESM calculations with the Kentucky
Commission on March 1, 2004, and applied for recovery of $13.0 million
related to LG&E and $16.2 million related to KU. Based upon estimates,
the Companies previously accrued $8.9 million at LG&E and $9.3 million
at KU for the 2003 ESM as of December 31, 2003.
On June 30, 2004, the Kentucky Commission issued an order largely
accepting proposed settlement agreements by the Companies and all
intervenors regarding the ESM mechanisms of LG&E and KU. Under the ESM
settlements, LG&E and KU will 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.
As a result of the settlement, the Company accrued an additional $4.1
million at LG&E and $6.9 million at KU in June 2004, related to 2003
ESM revenue.
OVEC Power Agreement and Share Purchase
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.
- New Page -
LG&E's estimated future minimum annual demand payments under the
Amended and Restated Inter-Company Power Agreement are as follows:
(in thousands)
2006 $ 10,098
2007 9,726
2008 9,932
2009 10,144
2010 10,361
Thereafter 170,646
Total $220,907
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 the fourth quarter of 2004,2005, subject to receipt of certain
regulatory approvals. The change to the power agreement and the share
purchase are expected to have no impact on the accounting for OVEC
under FIN 46R as discussed in Footnote 8.
Owensboro Contract Litigation
In May 2004, the City of Owensboro, Kentucky and Owensboro Municipal
Utilities (collectively "OMU"), filed suit in Davies County, Kentucky
District Court against KU concerning a long-term power supply contract
(the "OMU Agreement") with KU. The dispute involves interpretational
differences regarding certain issues under the OMU Agreement, including
various payments or charges between KU and OMU and rights concerning
excess power, termination and emissions allowances, respectively. The
complaint seeks approximately $6 million in damages for historical
periods, as well as injunctive and other relief, including a
declaration that KU is in material breach. KU has removed this
litigation to the U.S. District Court for the Western District of
Kentucky, and filed an answer in that court denying the OMU claims and
presenting certain counterclaims. KU has also initiatedcounterclaims and commenced a FERC proceeding at theto
request FERC to obtain the FERC's rulingjurisdiction on certain ofissues. In October 2004, FERC
declined to exercise exclusive jurisdiction regarding the issues in
dispute.dispute, which ruling KU has appealed.
Environmental Matters
In September 1998, the EPA announced its final "NOx SIP Call" rule
requiring states to impose significant additional reductions in NOx
emissions by May 2003, in order to mitigate alleged ozone transport
impacts on the Northeast region. The Commonwealth of Kentucky SIP,
Page 21
which was approved by EPA June 24, 2003, required reductions in NOx
emissions from coal-fired generating units to the 0.15 lb./Mmbtu level
on a system-wide basis. In related proceedings in response to
petitions filed by various Northeast states, in December 1999, the EPA
issued a final rule pursuant to Section 126 of the Clean Air Act
directing similar NOx reductions from a number of specifically targeted
generating units including all LG&E and KU units. As a result of
appeals to both rules, the compliance date was extended to May 2004.
LG&E and KU have complied with these NOx emissions reduction rules by
adding significantinstalling additional NOx controls to their generating units.
InstallationInstallations of additional NOx controls have beenwere performed on a phased
basis, commencingwhich commenced in late 2000 and continuingcontinued through the final
compliance date. As of JuneSeptember 30, 2004, LG&E has incurred total
capital costs of approximately $182$185 million to reduce its NOx emissions
to the 0.15 lb./Mmbtu level on a company-wide basis. As of JuneSeptember
30, 2004, KU has incurred total capital costs of approximately $193$203
million to reduce its NOx emissions to the 0.15 lb./Mmbtu level on a
company-wide basis. In addition, LG&E and KU have begun incurring
additional operation and maintenance costs in operating new NOx
controls. LG&E and KU believe their costs in this regard to be
comparable to those of similarly situated utilities with like
generation assets. In April 2001, the Kentucky Commission granted
recovery of these costs under the environmental surcharge mechanism for
LG&E and KU.
During August 2004, KU, the EPA and the Department of Justice agreed in
principle to settle outstanding matters concerning a 1999 oil discharge
at KU's E.W. Brown plant for approximately $0.6 million, a portion of
which may be satisfied by KU's construction of a separate environmental
capital project. The settlement is subject to completion of final
definitive documents. In December 2003, KU recorded an accrual and
expense to operations of $0.6 million.
LG&E and KU are also monitoring several other air quality issues which
may potentially impact coal-fired power plants, including the EPA's
revised air quality standards for ozone and particulate matter,
measures to - - New Page -
implement the EPA's regional haze rule, and the EPA's
December 2003 proposals to regulate mercury emissions from steam
electric generating units and to further reduce emissions of sulfur
dioxide and nitrogen oxides under the Clean Air Interstate Rule. In
addition, LG&E is currently reviewing and making comments on proposed
regulations concerning toxic air emissions within Metro Louisville,
where the company operates two coal-fired generating stations. LG&E is
also working with local regulatory authorities to review the
effectiveness of remedial measures aimed at controlling particulate
matter emissions from its Mill Creek Station. LG&E previously settled
a number of property damage claims from adjacent residents and
completed significant remedial measures as part of its ongoing capital
construction program. LG&E has converted the Mill Creek Station to a
wet stack operation in an effort to resolve all outstanding issues
related to particulate matter emissions.
12. PensionFERC Developments
A number of regional or industry-wide FERC proceedings regarding
transmission market structure changes are in varying stages of
development. In August 2004, MISO filed its FERC-required proposed
Transmission and Energy Markets Tariff ("TEMT"). In September and
October 2004, many MISO-related parties filed proposals with the FERC
regarding pending MISO-filed changes to transmission pricing
principles, including the TEMT and elimination of through-and-out
transmission ("T&O") charges. Additional filings of the Companies
before FERC in September 2004 sought to address issues relating to the
Page 22
treatment of certain "grandfathered" transmission agreements ("GFA's")
should TEMT become effective. The utility proposals generally seek to
appropriately delay the T&O and TEMT tariff effective dates based upon
errors in administrative or procedural processes used by FERC or to
appropriately limit potential reductions in transmission revenues
received by LG&E and KU should the T&O, TEMT or GFA tariffs structures
be implemented. At present, existing FERC orders conditionally approve
elimination of T&O rates and implementation of general TEMT rates in
MISO of December 1, 2004 and March 1, 2005, respectively. At this
time, LG&E and KU cannot predict the outcome or effects of the various
FERC proceedings described above, including whether such will have a
material impact on the financial conditions or results of operations of
the Companies.
12.Pension and Other Post-retirement Benefit Plans
The following table provides the components of net periodic benefit
cost for pension and other benefit plans:
Three Months Ended Year to Date
JuneSeptember 30, 2004 JuneSeptember 30, 2004
(in thousands) LG&E KU LG&E KU
Components of net periodic benefit cost:
Service cost $ 934977 $ 1,1031,152 $ 3,0223,997 $ 3,4904,754
Interest cost 4,709 3,538 15,233 11,1874,910 3,692 20,092 15,240
Expected return on plan assets (4,289) (3,195) (13,874) (10,104)(4,469) (3,334) (18,287) (13,764)
Amortization of prior
service cost (2) 148 (7) 467154 (9) 636
Amortization of transition
obligation 897 269 2,900 853939 281 3,843 1,161
Recognized actuarial loss 494 388 1,599 1,227515 331 2,107 1,369
$ 2,7432,870 $ 2,2512,276 $11,743 $ 8,873 $ 7,1209,396
In January 2004, LG&E and KU made discretionary contributions to their
pension plans in the amounts of $34.5 million and $43.4 million,
respectively. No contributions are required for 2004 for either LG&E
or KU and no further discretionary contributions are planned.
13.Subsequentplanned for 2004.
13. Subsequent Events
July Storms
In JulyOn October 20, 2004, violent thunderstorms swept through Kentucky, causing
significant damage and widespread power outages. At the height of the
storms, 115,000 LG&E customers and 22,700 KU customers were without
power. The cost to repair the damage incurred in the LG&E service
territory ascompleted a result of these storms is estimated to be $8.4refinancing transaction regarding
$50 million in operations and maintenance expense and $2.1 million in capital
expenditures.existing pollution control indebtedness. The cost to repairoriginal
indebtedness, 5.75% Pollution Control Bonds, Series 9, due December 1,
2023, will be discharged on November 22, 2004, with the damage incurred inproceeds from
the replacement indebtedness, KU service
territory asPollution Control Bonds, Series 17,
due October 1, 2034, which will carry a resultvariable, auction rate of
these storms is estimated to be $0.5 million
in operations and maintenance expense and $0.1 million in capital
expenditures.
Rate Cases Update
During July 2004, the AG requested a rehearing of the LG&E and KU rate
cases. For a description 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.
Trimble County Combustion Turbines Units 9 & 10
Trimble County Combustion Turbines Units 9 and 10 began commercial
operation on July 1, 2004. See Note 7 of the Notes to Consolidated
Financial Statements on Part 1, Item 1 of this Quarterly Report on Form
10-Q.
- - New Page -interest.
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 and sixnine month periods
ended JuneSeptember 30, 2004, and should be read in connection with the
financial statements and notes thereto.
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.
Executive Summary
LG&E's net income for the three months ended JuneSeptember 30, 2004 was $17.1$32.5
million ($9.47.3 million higherlower than the three months ended JuneSeptember 30,
2003). The increasedecrease was primarily related to highermaintenance costs resulting
from severe storms which swept through the service territory in July and
lower electric revenues. Retail
sales volumes increased due to warmer weather, while gas volumes decreased.milder weather. KU's net income for the three
months ended JuneSeptember 30, 2004, was $27.6$34.8 million ($13.44.5 million higher
than the three months ended JuneSeptember 30, 2003). The increase was
primarily due to higher retail electric revenues due to higher retail
sales volumes resulting from warmer weather,the general
rate increase, partially offset by higher maintenancedepreciation expense.
Page 23
LG&E's net income for the sixnine months ended JuneSeptember 30, 2004 was $41.4$73.9
million ($6.41.0 million higherlower than the sixnine months ended JuneSeptember 30, 2003).
The increasedecrease was primarily related to higher operations and maintenance
expense, offset by higher electric revenues due to warmer
weather.resulting from the general rate
increase and a higher environmental cost recovery surcharge. KU's net
income for the sixnine months ended JuneSeptember 30, 2004 was $60.0$94.8 million
($34.038.5 million higher than the sixnine months ended JuneSeptember 30, 2003). The
increase was primarily due to higher electric revenues and lower
maintenance expense.expense (KU service territory experienced a severe ice storm in
2003).
As regulated utilities, LG&E and KU's financial performance is greatly
impacted by regulatory proceedings. On June 30, 2004, the Kentucky
Commission issued an order approving increases in the base rates of LG&E
and KU. The rate increase took effect on July 1, 2004. In July 2004,Subsequently, the
AG commenced an investigation examining communications between the Kentucky
Commission and the Companies and, separately, filed for a rehearing of the
rate cases on such issue and certain calculation components of the
increased rates.rates and filed for the existing rate increases to be set aside.
The Kentucky Commission ordered a reopening ofis considering the rate
casesmatters relating to take evidence in the communications issue.AG's
actions. For a description 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.10-Q.
Results of Operations
The results of operations for LG&E and KU are affected by fluctuations in
temperature and other weather-related factors. Because of these and other
factors, the results of one period are not necessarily indicative of
results or trends to be expected for another period.
- - New Page -
Three Months Ended JuneSeptember 30, 2004, Compared to
Three Months Ended JuneSeptember 30, 2003
LG&E Results:
LG&E's net income increased $9.4decreased $7.3 million (121%(18%) for the three months ended
JuneSeptember 30, 2004, as compared to the three months ended JuneSeptember 30,
2003, primarily due to higher retailmaintenance expenses related to July storms
and lower electric revenues, partially offset by
higher other operation expenses.sales.
A comparison of LG&E's revenues for the three months ended JuneSeptember 30,
2004, with the three months ended JuneSeptember 30, 2003, reflects increases
and (decreases) which have been segregated by the following principal
causes:
Cause(in thousands) Electric Gas
(in thousands)Cause Revenues Revenues
Retail sales:
Fuel and gas supply adjustments $ 1,159 $ 7,751(425) $1,243
Environmental cost recovery surcharge 5,5133,707 -
Earnings sharing mechanism 518139 -
LG&E/KU merger surcredit (947)123 -
Value delivery surcredit (256) 28
Demand side management 3 (42)
General rate increase 10,105 1,443
Variation in sales volume and other 17,303 (5,777)(11,353) (647)
Total retail sales 23,546 1,9742,043 2,025
Wholesale sales (4,026) 279(2,448) -
Provision for rate collections 1,017refunds (2,689) -
Other (1,888) (63)(56) 134
Total $ 18,649 $ 2,190$(3,150) $2,159
Page 24
Electric revenues increased $18.6decreased $3.2 million primarily as thea result of an
increase inlower
sales volumes to ultimate consumers of 9.2%. The retail sales
volume increase was due to warmerfrom cooler weather than the prior year as cooling degree days increased 89%. However, overall volumes decreased duedeclined 3.2% from
last year. Also contributing to the decrease were lower wholesale sales.revenues
and higher provisions for rate refunds. The provision for rate refunds
decreased revenues $2.7 million, largely as a result of a higher provision
for the environmental cost recovery surcharge. The revenue decreases were
partially offset by the general rate increase, effective with service
rendered July 1, 2004, and an increase in environmental cost recovery. Gas
revenues increased $2.2 million primarily as a result of the general rate
increase, effective with service rendered July 1, 2004, and an increase in
recovery of higher natural gas prices billed to customers through the gas
supply clause partially offset by lower sales volumes to ultimate consumers due to
warmer weather.
The provision for rate collections increased $1.0 million, including a $3.4
million higher provision for the earnings sharing mechanism, offset by a
$2.4 million lower provision for the environmental cost recovery surcharge.clause.
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. Fuel for electric generation increased $1.3decreased $2.0 million
(3%(4%) for the three months ended due to an increasea decrease in generation ($1.8 million) and a decrease in the
cost of coal burned ($2.0 million), partially offset by a decrease in generation ($0.70.2 million). Gas supply expenses increased $5.0$0.7
million (19%(3%) due to an increase in net gas supply cost ($6.71.2 million),
offset by a decrease in the volume of retail gas sold ($1.70.5 million).
Other operation expenses increased $3.7decreased $3.8 million (7%), as compared to 2003.
An estimated $7.4Pension expense decreased $1.2 million. Electric distribution operations
expense decreased $2.9 million was recorded in the second quarterdue to transfer of 2004 for
costs incurred$4.0 million to
maintenance (related to storms) offset by higher non-storm related
to May 2004 storms. Results for 2003 includeddistribution operations of $1.1 million in cost to achieve amortization related to the KU/LG&E merger and
the One Utility initiative, which ended June 30, 2003, and September 30,
2003, respectively. In addition, pension expense was $1.3 million lower
and bad debt expense was $0.5 million lower in 2004.million.
Maintenance expenses decreased $2.4increased $10.5 million (14%(84%) primarily due to storms
($8.8 million, including $4.0 million transferred from Operations to
Maintenance in third quarter 2004). A write-off of obsolete
inventory of $1.1 million was included in 2003 and steam power generation
was $0.7 million lower in 2004.Non-storm related distribution
maintenance increased $2.1 million.
Depreciation and amortization decreased $2.1increased $1.9 million (7%) due to a
corresponding increase in plant in service of $199.4 million (5.8%). The
increase in plant included $37.2 million related to the completion of
Trimble County CT's 9 and 10, as well as increases to steam production
plant of $59.3 million, to electric distribution plant of $31.0 million and
to gas distribution plant of $29.9 million. The increase in depreciation
adjustmentand amortization was partially offset by a reduction in amortization
expense related to certain software, which became fully amortized in the
secondfinal quarter of 20032003.
Other income decreased $1.4 million, resulting from a $1.3 million write-
off in July 2004 related to assets
capitalized in that period.
- - New Page -
Property and other taxes increased $1.6 million (47%). In June 2003,
property taxes reflected a $1.2 million coal incentive tax credit.the cancellation of the "Pay As You Go"
metering project.
Variations in income tax expense are largely attributable to changes in pre-
tax income.
Three Months Three Months
Ended Ended
JuneSept. 30, 2004 JuneSept. 30, 2003
Effective Rate
Statutory federal income tax rate 35.0% 35.0%
State income taxes net of federal benefit 5.8 6.54.6 4.9
Amortization of investment tax credit & R&D (6.6) (9.5)(0.6) (1.7)
Other differences 0.6 (2.2)(0.7) (2.4)
Effective income tax rate 34.8% 29.8%38.3% 35.8%
Page 25
The variation in the tax rate is largely attributable to excess deferred
tax benefits recorded in 2003, reflecting the benefits of deferred taxes
reversing at lower tax rates than what were provided, and lower
amortization of the investment tax credit and other differences were
approximately the same in both periods, but lower pretax income for the
three months ended June 30, 2003, caused the percentage changes to be
greater in the 2003 period.credit.
Interest chargesexpense decreased $0.6$0.9 million (10%(15%) primarily due to the $ 1.0
million savings on
interest expense realized from the refinancing of fixed-
ratefixed-rate Series V and
Series W pollution control bondsPollution Control Bonds to the variable-rate Series GG pollution control bondsPollution
Control Bonds in November 2003.
Interest expense to affiliated companies increased $1.7$0.9 million (130%(44%)
primarily due to a $2.2$1.1 million increase in interest expense to Fidelia
related to new notes issued in August 2003 and January 2004. Offsetting
this increase is a $0.5$0.2 million decrease in interest expense on borrowings
from the money pool due to lower borrowing levels.
The weighted average interest rate on variable-rate bonds for the three
months ended JuneSeptember 30, 2004, was 1.07%1.30% and the corresponding rate for
the three months ended JuneSeptember 30, 2003, was 1.15%0.99%.
KU Results:
KU's net income increased $13.4$4.5 million (95%(15%) for the three months ended
JuneSeptember 30, 2004, as compared to the three months ended JuneSeptember 30,
2003. The increase was primarily due to higher revenues relateddue to higher sales
volumes,July 2004
rate increases, partially offset by higher maintenancedepreciation expense.
A comparison of KU's revenues for the three months ended JuneSeptember 30,
2004, with the three months ended JuneSeptember 30, 2003, reflects increases
and (decreases) which have been segregated by the following principal
causes:
Cause
(in thousands) Electric
Cause Revenues
Retail sales:
Fuel supply adjustments $(2,503)$ 2,297
Environmental cost recovery surcharge 1,6151,151
Earnings sharing mechanism 1,3951,332
LG&E/KU merger surcredit (1,071)(615)
Value delivery surcredit (111)
Demand side management 404
General rate increase 9,596
Variation in sales volume and other 16,967(446)
Total retail sales 16,40313,608
Wholesale sales 5,3621,465
Provision for rate collections 11,6941,794
Other 1,736376
Total $35,195
- - New Page -$17,243
Electric revenues increased $35.2$17.2 million primarily as the result of the
general rate increase, effective with service rendered July 1, 2004, and
increases in fuel adjustment clause recoveries, recovery of environmental
costs, earnings sharing mechanism revenues, wholesale revenues and an
increase in sales volumes to ultimate consumers of 11.3%. The sales volume
increase was due to warmer weather than last year as cooling degree days
increased 73%. Also contributing to higher revenues for the quarter were
increases in the provision for rate collections and wholesale sales.collections. The provision for rate
collections includedincreased $1.8 million largely as the result of a $3.8 million higher
provision for the environmental cost recovery surcharge ($4.2 million),
partially offset by lower provisions for the earnings sharing mechanism
a $5.4 million higher provision related to
the environmental cost($1.3 million) and fuel clause recovery surcharge, and a $2.4 million higher
provision related to the fuel adjustment clause.($1.1 million).
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.
Fuel for electric generation increased $8.0$2.9 million (13%(4%) for the quarter
because of an increase in generation ($8.13.2 million), partially offset by a
slight decrease in the cost of coal burned ($0.10.3 million).
Page 26
Power purchased decreased $3.0increased $1.5 million (8%(5%) due to a decreasean increase in the price
of power purchased ($1.73.1 million) and, offset by a decrease in the volume
purchased ($1.31.6 million).
Other operation expenses decreased $1.6increased $2.2 million (4%(6%) as compared to 2003.
CostSteam power operations increased $1.9 million, primarily due to achieve amortization for the KU/LG&E merger, which ended in June
2003, wasincreased
emission allowance expense ($1.2 million) and higher expense related to
SCR/NOX reduction ($0.4 million).
Maintenance expense decreased $1.0 million, primarily due to a decrease of
$1.4 million in 2003.
Maintenance expenses increased $9.6distribution maintenance. In September 2004, $4.0 million
(130%). Maintenance expenses
in 2003 were reduced by an $8.9 million insurance reimbursement received incosts related to the second quarter of 2003 for costs incurred in a February 2003 ice storm.storm were reclassified from maintenance
expense to a regulatory asset, based on an order from the Kentucky
Commission, to be amortized through June 2009. KU earns a return of these
amortized costs, which are included in KU's jurisdictional operating
expenses. Offsetting this decrease was $1.3 million in expense related to
2004 storms, $0.6 million higher vegetation management expense, and $0.2
million amortization of the ice storm deferral.
Depreciation and amortization decreased $1.8increased $4.3 million (7%(17%) becausedue to a
corresponding increase in plant in service of a
depreciation adjustment$155.4 million (5%). The
increase in the second quarter of 2003plant included $63.8 million related to assets
capitalized that quarter.the completion of
Trimble County CT's 9 and 10, as well as increases to transmission plant of
$11.1 million and to electric distribution plant of $30.6 million.
Variations in income tax expense are largely attributable to changes in
pretax income.
Three Months Three Months
Ended Ended
JuneSept. 30, 2004 JuneSept. 30, 2003
Effective Rate
Statutory federal income tax rate 35.0% 35.0%
State income taxes net of federal benefit 6.0 6.54.1 5.0
Amortization of investment tax credit & R&D (1.2) (3.1)(1.0) (1.4)
Other differences (1.8) (4.6)(3.2) (2.9)
Effective income tax rate 38.0% 33.8%
The amortization of the investment tax credit and other differences were
approximately the same in both periods, but lower pretax income for the
three months ended June 30, 2003, caused the percentage change to be
greater34.9% 35.7%
Interest expense increased $0.4 million (16%). A reduction in the 2003 period.
Interestsavings
associated with interest rate swaps, caused primarily by the termination of
a swap, increased interest expense decreased $2.9 million (44%) primarily due to $1.6by $1.2 million. This increase was
offset by $0.7 million in interest expense savings from the redemption of
pollution control bonds
Series Q at 6.32% and8.55% Series P at 8.55%Pollution Control Bonds redeemed in June and November of 2003, respectively. Additionally, interest rate swaps yielded a $1.2
million decrease in related interest expenses resulting primarily from the
termination of a swap in February 2004 and better performance of the
remaining swaps.2003.
Interest expense to affiliated companies increased $2.4$1.6 million (219%(86%)
primarily due to a $2.7$1.8 million increase in interest expense to Fidelia
related to new notes issued infrom August 2003 through January 2004.
Offsetting this increase is a $0.3$0.2 million decrease in interest expense on
borrowings from the money pool due to lower borrowing levels.
The weighted average interest rate on variable-rate bonds for the three
months ended JuneSeptember 30, 2004, was 1.11%1.32% and the corresponding rate for
the three months ended JuneSeptember 30, 2003, was 1.14%0.91%.
- - New Page -
SixNine Months Ended JuneSeptember 30, 2004, Compared to
SixNine Months Ended JuneSeptember 30, 2003
LG&E Results:
LG&E's net income increased $6.4decreased $1.0 million (18%(1%) for the sixnine months ended
JuneSeptember 30, 2004, as compared to the sixnine months ended JuneSeptember 30,
2003, primarily due to higher electricoperations and gas revenues, partiallymaintenance expense, offset by
higher other
operations expenses and higher interest expense.electric revenues.
Page 27
A comparison of LG&E's revenues for the sixnine months ended JuneSeptember 30,
2004, with the sixnine months ended JuneSeptember 30, 2003, reflects increases and
(decreases) which have been segregated by the following principal causes:
Cause(in thousands) Electric Gas
(in thousands)Cause Revenues Revenues
Retail sales:
Fuel and gas supply adjustments $(1,646) 45,381$(1,493) $ 46,625
Environmental cost recovery surcharge 7,91111,618 -
Earnings sharing mechanism 3,7743,913 -
LG&E/KU merger surcredit (1,418)(1,296) -
Value delivery surcredit (786) 5
Demand side management 357 (420)
Weather normalization - 2,419
General rate increase 10,105 1,443
Variation in sales volume and other 15,998 (22,275)4,244 (22,523)
Total retail sales 24,619 25,52526,662 27,549
Wholesale sales 8,0915,642 1,034
Provision for rate refunds (2,982)(5,670) -
Other 151 (479)95 (344)
Total $29,879$26,729 $ 26,08028,239
Electric revenues increased $29.9$26.7 million primarily becauseas a result of
increased
sales volumes to ultimate consumers of 4.4% due to warmer weather than
prior year as cooling degrees days increased 94%. Increased wholesale
revenues and environmental cost recovery, also contributedthe general rate increase, effective
with service rendered July 1, 2004, wholesale revenues (4% higher pricing
offset by 3% lower volumes), and higher retail sales volumes. The
provision for rate refunds decreased revenues $5.7 million due to the increasea
decrease in revenues.environmental cost recovery surcharge ($6.7 million) and
earnings sharing mechanism recoveries ($0.9 million), partially offset by
higher fuel adjustment clause recoveries ($1.9 million).
Gas revenues increased $26.1$28.2 million primarily as a result of higher
natural gas prices billedpassed on to customers through the gas supply clause,
partially offset by lower sales volumes to ultimate consumers due to warmer weather.
The provision for rate refunds decreased $3.0 million, primarily due to a
$3.9 million lower provision related toresulting from milder weather
during the environmental cost recovery
surcharge.heating months than in the prior period.
Fuel for electric generation increased $4.4$2.4 million (5%(2%) for the sixnine
months due to an increase in the cost of coal burned ($4.41.4 million) whileand
higher generation volume was flat.($1.0 million). Gas supply expenses increased $29.7$30.3
million (22%(20%) due to an increase in net gas supply cost ($40.842.0 million),
offset by a decrease in the volume of retail gas delivered to the
distribution system ($11.111.5 million).
Power purchased increased $4.8$5.3 million (12%(9%) due to an increase in the price
of power purchased ($1.04.3 million) and ana 2% increase in the volume of the
purchases ($3.81.0 million). primarily to meet slightly higher load
requirements.
Other operations expenses increased $8.3$4.5 million (8%(3%) in 2004, as compared
to 2003, due to higher transmission expense of $3.5$2.7 million, primarily due
to higher MISO-related expense, and $7.5$4.6 million higher electric
distribution expense, due in part to the May and July 2004 storms. These
higher expenses were partially offset by $2.9$2.8 million lower costamortization of
costs to achieve amortization
related to the KU/LG&E merger and One Utility initiative,initiative. These
costs were fully amortized by June 2003 (KU/LG&E merger) and $1.5 million
lower benefits expense.September 2003
(One Utility).
Maintenance expenses decreased $2.8increased $7.8 million (9%(18%). Distribution
maintenance increased $9.6 million, primarily due to the May and July storm
restoration. In 2003, $2.1 million inof obsolete inventory was written off.
- - New Page -28
Depreciation and amortization decreased $1.7increased $0.2 million (3%(0.2%). The net
increase in depreciation and amortization expense for the nine months ended
was due to an increase in depreciation related to an increase in plant in
service of $199.4 million (5.8%) because ofwhich was largely offset by a depreciation adjustmentdecrease in
amortization expense related to certain software, which became fully
amortized in the secondfinal quarter of 2003, related to assets
capitalized in that period.2003.
Variations in income tax expense are largely attributable to changes in pre-
tax income.
SixNine Months Ended SixNine Months Ended
JuneEnde
d
Sept. 30, 2004 JuneSept. 30, 2003
Effective Rate
Statutory federal income tax rate 35.0% 35.0%
State income taxes net of federal benefit 5.7 5.85.2 5.3
Amortization of investment tax credit & R&D (4.3) (3.8)(2.7) (2.7)
Other differences 0.2 (0.8)(0.1) (1.6)
Effective income tax rate 36.6% 36.2%37.4% 36.0%
The variation in the other differences is largely attributable to excess
deferred tax benefits recorded in 2003, reflecting the benefits of deferred
taxes reversing at lower tax rates than what were provided.
Property and other taxes increased $2.0$1.6 million (24%(13%). Property taxes in
2003tax
expense reflected a $1.2 million coal incentive tax credit.credit in 2003, and a
$0.7 million credit in 2004. The remaining increase related primarily to
increased property tax accruals, as a result of capital expansion, and
higher employment taxes.
Interest chargesexpense decreased $2.1$3.0 million (17%) primarily. Interest related to long-
term debt decreased $5.8 million due to the $2.9
million savings of interest expense realized from the refinancing of fixed-
ratefixed-rate
Series V and Series W pollution control bondsPollution Control Bonds into the variable-rate Series
GG. Also,GG Pollution Control Bonds and the redemption of the first mortgage bond in
August 2003
contributed to the decrease2003. These savings were partially offset by an increase in interest
expense by $1.3 million.
Offsetting these decreases is an increase of $1.9 million fromrelated to interest rate swaps.swaps associated with the Series GG bonds
totaling $2.6 million.
Interest expense to affiliated companies increased $4.1$5.0 million (202%(121%)
primarily due to a $5.3$6.4 million increase in interest expense to Fidelia
related to new notes issued in August 2003 and January 2004. Offsetting
this increase is a $1.2$1.4 million decrease in interest expense on borrowings
from the money pool due to lower borrowing levels.
The weighted average interest rate on variable-rate bonds for the sixnine
months ended JuneSeptember 30, 2004 was 1.06%1.14%, compared to 1.19%1.12% for the
comparable period in 2003.
KU Results:
KU's net income increased $34.0$38.5 million (131%(68%) for the sixnine months ended
JuneSeptember 30, 2004, as compared to the sixnine months ended JuneSeptember 30,
2003. The increase was primarily due to higher electric revenues and lower
maintenance expense.
Page 29
A comparison of KU's revenues for the sixnine months ended JuneSeptember 30, 2004,
with the sixnine months ended JuneSeptember 30, 2003, reflects increases and
(decreases) which have been segregated by the following principal causes:
Cause
(in thousands) Electric
Cause Revenues
Retail sales:
Fuel supply adjustments $ 2,683
Environmental cost recovery surcharge $ 2,0673,218
Earnings sharing mechanism 5,3046,636
LG&E/KU merger surcredit (1,829)(2,443)
Value delivery surcredit (296)
Demand side management 424
General rate increase 9,596
Variation in sales volume and other 19,54118,874
Total retail sales 25,08338,692
Wholesale sales 11,91813,382
Provision for rate collections 15,86317,657
Other 4,7345,110
Total $57,598
- - New Page -$74,841
Electric revenues increased $57.6$74.8 million primarily due to increased sales
volumes to ultimate consumers of 6.1%3.9% due to warmer weather than last year
as cooling degree days increased 75%3%. The general rate increase, effective
with service rendered July 1, 2004, increased revenues approximately $9.6
million. Also contributing to the overall revenue increase were increases
in the provision for rate collections, wholesale revenues and(26% higher
pricing offset by 3% lower volumes), earnings sharing mechanism recoveries.recoveries
and the recovery of fuel and environmental costs. The provision for rate
collections included higher provisions for the environmental cost recovery
($10.414.6 million), the earnginsearnings sharing mechanism ($3.52.2 million) and the fuel
adjustment clause ($2.00.9 million).
Fuel for electric generation increased $11.6$14.4 million (9%(7%) for the sixnine
months due to an increase in the cost of coal burned ($3.56.4 million) and an
increase in generation ($8.18.0 million).
Power purchased decreased $2.9$1.4 million (4%(1%) due to a decrease in the price
of power purchased ($5.42.1 million), partially offset by an increase in
volumes purchased ($2.50.7 million). due to higher retail and wholesale loads.
Other operation expenses decreased $2.0increased $0.2 million. Steam generation expense
increased $4.3 million, (3%). Costprimarily due to achieve
amortizationhigher emission allowance expense,
and transmission expense increased $0.5 million. Amortization of $3.2$2.9
million related to costs to achieve the KU/LG&E merger and One Utility
initiative was recorded in 2003 and was fully amortized as of June 2003.
In 2004, benefitsPension expense decreased $1.5$0.8 million, and distributionbad debt expense decreased $0.7 million due to the February 2003 ice storm. These decreases
were offset by higher emission allowance expense of $2.3 million and higher
transmission expense of $1.1
million.
Maintenance expenses decreased $7.5$8.4 million (21%(17%). Steam power maintenance
expense decreased $5.5$3.2 million; Ghent Unit 3, Green River Unit 4 and Tyrone
Unit 3 all had major overhauls in 2003. Distribution maintenance decreased
$1.3$2.8 million. In September 2004, $4.0 million and transmissionin costs related to the 2003
ice storm were reclassified from maintenance expense to a regulatory asset,
based on an order from the Kentucky Commission, to be amortized through
June 2009. KU earns a return of these amortized costs, which are included
in KU's jurisdictional operating expenses. Offsetting this decrease was
$2.2 million in expense related to the 2004 storms. Transmission overhead
line maintenance decreased $0.6$0.4 million.
Page 30
Depreciation and amortization increased $3.6 million in 2004(5%) due to an
increase in plant in service of $155.4 million (4.8%). The increase in
plant included $63.8 million related to the February 2003 ice storm.completion of Trimble County
CTs 9 and 10, as well as increases to transmission plant of $11.1 million
and to electric distribution plant of $30.6 million.
Variations in income tax expense are largely attributable to changes in
pretax income.
SixNine Months Ended SixNine Months Ended
JuneSept. 30, 2004 JuneSept. 30, 2003
Effective Rate
Statutory federal income tax rate 35.0% 35.0%
State income taxes net of federal benefit 5.9 6.75.3 5.8
Amortization of investment tax credit & R&D (1.1) (3.4)(1.0) (2.3)
Other differences (1.7) (4.4)(2.4) (3.6)
Effective income tax rate 38.1% 33.9%36.9% 34.9%
The amortization of the investment tax credit and other differences were
approximately the same in both periods, but lower pretax income for the
sixnine months ended JuneSeptember 30, 2003, caused the percentage changes to be
greater in the 2003 period.
Interest expense decreased $6.7$6.3 million (60%(45%) due primarily to the
redemption of pollution control bonds8.55% Series P at 8.55%Pollution Control Bonds and 6.32% Series Q
at
6.32%Pollution Control Bonds redeemed in November and June of 2003,
respectively. Additionally, interest rate swaps yielded a $2.8$1.6 million
decrease in related interest expenses resulting primarily from the February
termination of a swap related to the Series 9 pollution control bondsPollution Control Bonds and
better performance of remaining swaps.
- - New Page -
Interest expense to affiliated companies increased $5.6$7.2 million (377%(213%)
primarily due to a $6.1$7.9 million increase in interest expense to Fidelia
related to new notes issued in August 2003 through January 2004.
Offsetting this increase is a $0.5$0.7 million decrease in interest expense on
borrowings from the money pool due to lower borrowing levels.
The weighted average interest rate on variable-rate bonds for the sixnine
months ended JuneSeptember 30, 2004, was 1.08%1.16% and the corresponding rate for
the sixnine months ended JuneSeptember 30, 2003, was 1.16%1.08%.
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
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.
As of JuneSeptember 30, 2004, LG&E and KU are in a negative working capital
position.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. The Companies
expect to cover any working capital deficiencies with cash flow from
operations, money pool borrowings, and borrowings from Fidelia, an E.ON
financing subsidiary.
Construction expenditures for the sixnine months ended JuneSeptember 30, 2004 for
LG&E and KU amounted to $64.9$94.2 million and $76.3$104.0 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 sixnine months ended JuneSeptember 30, 2004,
by LG&E and KU for NOx construction were $5.6$4.1 million and $21.9$29.2 million,
respectively. Expenditures for the sixnine months ended JuneSeptember 30, 2004,
for Trimble County combustion turbines, Units 7 through 10, by LG&E and KU
were $5.5$7.0 million and $9.5$12.0 million, respectively. In addition, LG&E
construction expenditures include $8.4$10.0 million for distribution overhead
line construction, $5.8$4.1 million for Mill Creek Unit 3 ductwork installation
related to the flue gas desulfurization ("FGD") project, and $5.3$8.3 million
for gas main replacements. At KU, construction expenditures include $6.4
million for E.W. Brown Unit 3 cooling tower and precipitator rebuild and
$6.0$9.0 million for distribution construction in the Lexington area. The
expenditures were financed with internally generated funds and intercompany
loans from affiliates.
Page 31
LG&E's cash balance increased $12.3$4.2 million during the six months ended
June 30, 2004, primarily due to higher net income and increased net borrowings
from affiliated companies, partially offset by pension funding construction expenditures, and payment
of common dividends to its parent company. LG&E's restricted cash balance
increased $11.5 million during the nine months ended September 30, 2004,
primarily due to an increase in collateral held by third parties related to
interest rate swaps. KU's cash balance increased $4.9remained level, decreasing $0.2
million during the sixnine months ended JuneSeptember 30, 2004. The increase reflects2004, as higher net
income and increased net borrowings from affiliated companies partially offset by
pension funding, construction expenditures and the payment of common
dividends to its parent company.
Variations in accounts receivable, accounts payable and materials and
supplies are generally not significant indicators of LG&E's and KU's
liquidity. In general, such variations are usually attributable to
seasonal fluctuations in weather, which have a direct effect on sales of
electricity and natural gas. However, the increase in accounts receivable
at LG&E and KU, as of JuneSeptember 30, 2004, was primarily due to the
termination of the accounts receivable securitization programs in January
2004. Discontinuing the accounts receivable securitizationssecuritization programs
resulted in an increase in accounts receivable of $58.0 million at LG&E and
by $50.0 million at KU. (LG&E and KU maintained a fully funded reserve for uncollectible
accounts related to receivables sold during the securitization program.)program).
The increase in accounts receivable at LG&E as of JuneSeptember 30, 2004 was
somewhat offset by the impact of decreased gas sales in JuneSeptember 2004
compared to December 2003. The decrease in LG&E's gas stored
underground relatesfuel inventory at KU as of
September 30, 2004, was due to seasonal usesan increase in tons burned and a slow down
of gas.coal deliveries.
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 JuneSeptember 30, 2004, LG&E had swaps with a combined
notional value of $228.3 million and KU had swaps with a combined notional
value of $103.0 million. LG&E's swaps exchange floating-rate interest
payments for fixed-rate interest payments to reduce the impact of interest
rate changes on LG&E's pollution control bonds. KU's swaps effectively
convert fixed-
ratefixed-rate obligations on KU's first mortgage bondsFirst Mortgage Bonds Series P and R
to variable-
ratevariable-rate obligations.
In February 2004, KU terminated the swap it had in place at December 31,
2003 related to its Series 9 pollution control bonds.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, resulting in a gain of $0.8 million.
- - New Page -
At JuneSeptember 30, 2004, variable rate debt, including the impact of interest
rate swaps, was 36.9%38.0% of LG&E's total debt at $331.9$346.7 million and 45.7%44.0% of
KU's total debt at $352.2$328.9 million. At December 31, 2003, variable rate
debt, including the impact of interest rate swaps, was 44.0% of LG&E's
total debt at $386.3 million and 55.5% of KU's total debt at $397.1
million.
Under the provisions of LG&E's variable-rate pollution control bonds,Pollution Control Bonds,
Series S, T, U, BB, CC, DD and EE, and KU's variable-rate pollution control
bondsPollution 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 sixthree
months and nine months ending JuneSeptember 30, 2004, was 1.10%1.20% and 1.14%,
respectively, for the LG&E bonds and 1.13%1.30% and 1.18%, respectively, for the
KU bonds.
In January 2004, LG&E entered into two long-term notesloans with Fidelia, one
totaling $25 million with an interest rate of 4.33% that matures in January
2012, and a one-year noteone totaling $100 million with an interest rate of 1.53%. that
matures in January 2005. 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.
Page 32
In May 2004, KU redeemed $4.8 million of its Series 14, Pollution Control
Bonds which were initially issued in the amount of $7.2 million.
On October 20, 2004, KU completed a refinancing transaction regarding $50
million in existing pollution control indebtedness. The original
indebtedness, 5.75% Pollution Control Bonds, Series 9, due December 1,
2023, will be discharged on November 22, 2004, by the proceeds from the
replacement indebtedness, KU Pollution Control Bonds, Series 17, due
October 1, 2034, which will carry a variable, auction rate of interest.
LG&E maintains five bilateral lines of credit with banks totaling $185
million that mature in 2005. There was no outstanding balance under these
facilities at JuneSeptember 30, 2004. Management expects to renew these
facilities as they expire.
LG&E and KU 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 as 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 $26.0$40.7
million in money pool loans from LG&E Energy (included in "Notes payable to
affiliated companies") at an average rate of 1.04%1.60% at JuneSeptember 30, 2004,
and $171.7$75.1 million at an average rate of 1.21%1.06% at JuneSeptember 30, 2003. The
balance of the money pool loans from LG&E Energy to KU (included in "Notes
payable to affiliated companies") was $53.2$29.8 million at an average rate of
1.04%1.60% and $146.4$98.7 million at an average rate of 1.21%1.06% at JuneSeptember 30, 2004
and 2003, respectively. The amount available to LG&E under the money pool
agreement at JuneSeptember 30, 2004, was $374.0$359.3 million. The amount available
to KU under the money pool agreement at JuneSeptember 30, 2004, was $346.8$370.2
million. LG&E Energy maintains a revolving credit facility totaling $150
million with an affiliate to ensure funding availability for the money
pool. LG&E Energy had an outstanding balance of $69.7$79.1 million at an
average rate of 1.79%2.13% under this facility as of JuneSeptember 30, 2004 and
availability of $80.3$70.9 million remained.
As of September 30, 2004, LG&E had 225,000 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 are charged as interest
expense, pursuant to SFAS No. 150. On July 15, 2004, LG&E redeemed 12,500
shares as required at a price of $100 per share.
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 are planned.planned in 2004.
LG&E's security ratings as of JuneSeptember 30, 2004, were:
Moody's S&P
First mortgage bonds A1 A-
Preferred stock Baa1 BBB-
Commercial paper P-1 A-2
- - New Page -
KU's security ratings as of JuneSeptember 30, 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.
Page 33
LG&E's capitalization ratios at JuneSeptember 30, 2004, and December 31, 2003,
follow:
JuneSeptember 30,December 31,
2004 2003
Long-term debt (including current portion) 31.2%30.8% 31.9%
Long-term debt to affiliated company
(including current portion) 14.314.2 10.7
Notes payable to affiliated companies 1.42.1 4.3
Preferred stock 3.73.6 3.8
Common equity 49.449.3 49.3
Total 100.0% 100.0%
KU's capitalization ratios at JuneSeptember 30, 2004, and December 31, 2003,
follow:
JuneSeptember 30,December 31,
2004 2003
Long-term debt (including current portion) 22.4% 24.1%
Long-term debt to affiliated company
(including current portion) 18.819.0 16.8
Notes payable to affiliated companies 3.01.7 2.6
Preferred stock 2.3 2.4
Common equity 53.554.6 54.1
Total 100.0% 100.0%
New Accounting Pronouncements
FIN 46
In January 2003, 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 required 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.
In December 2003, FIN 46 was revised, delaying the effective dates for
certain entities created before February 1, 2003, 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.
- - New Page -
Both LG&E and KU hold investment interests in OVEC and KU holds an
investment interest in EEI. Neither LG&E nor KU areis the primary beneficiary
of OVEC or EEI, and thus neither areis consolidated into the financial
statements of LG&E or KU.
Page 34
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%, representing
approximately 55 Mw of generation capacity.
LG&E's and KU's original investments in OVEC were 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 investments in OVEC are accounted for on the cost method of
accounting. As of JuneSeptember 30, 2004, LG&E's and KU's investments 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 generally recover associated incremental costs through
regulatory rate mechanisms. See Part II, Item 1, for further discussion of
developments regarding LG&E's and KU's OVEC 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.
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 JuneSeptember 30,
2004, KU's investment in EEI totaled $11.9$12.7 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 generally recover associated
incremental costs through regulatory rate mechanisms.
SFAS No. 150
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.
As of June 30, 2004, LG&E had 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.
- - New Page -
FSP 106-2
In May 2004, the FASB finalized FASB Staff Position ("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 Medicare Act which
became law in December 2003. FSP 106-2 is effective for the first interim
or annual period beginning after June 15, 2004. KU will adopt FSP 106-2 in
the third quarter of 2004. LG&E's medical plan does not providehave a
benefit
that is actuarially equivalent to Medicare Part D; therefore, FSP 106-2 is
not expected to have anmaterial impact on LG&E.
On the basis of actuarial estimates, the Medicare Act will result in an
overall reduction of the accumulated postretirement benefit obligation
("APBO") for postretirement health and life insurance benefits for KU
amounting to approximately $5.0 million as of January 1, 2004.
Accordingly, KU's net periodic postretirement benefit cost for 2004 will be
reduced by approximately $0.7 million. The APBO and the net periodic
postretirement benefit cost as of and for the periods ending June 30, 2004
and 2003 do not reflect amounts associated with the subsidies provided by
the Medicare Act.Companies.
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; to Part
II, Item 1, Legal Proceedings in LG&E's and KU's Quarterly ReportReports on Form
10-Q for the quarterquarters ended March 31, 2004 and June 30, 2004; and to Part
II, -
Item 1, Legal Proceedings herein.
Page 35
Electric and Gas Rates Cases
On June 30, 2004, the Kentucky Commission issued an order approving
increases in the base electric and gas rates of LG&E and the base electric
rates of KU. In July 2004,Subsequently, the AG commenced an investigation examining
communications between the Kentucky Commission and the Companies and
separately filed for a rehearing of the rate cases on such issue and
certain calculation components of the increased rates.rates and filed for the
existing rate increases to be set aside. The Kentucky Commission ordered a procedural reopening ofis
considering the rate cases for the limited
purpose of taking evidence, if any, asmatters relating to the communication issue.AG's actions. For a description 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.10-
Q.
Earnings Sharing Mechanism
The Companies filed their final 2003 ESM calculations with the Kentucky
Commission on March 1, 2004, and applied for recovery of $13.0 million
related to LG&E and $16.2 million related to KU. Based upon estimates, the
Companies previously accrued $8.9 million at LG&E and $9.3 million at KU
for the 2003 ESM as of December 31, 2003.
On June 30, 2004, the Kentucky Commission issued an order largely accepting
proposed settlement agreements by the Companies and all intervenors
regarding the ESM mechanisms of LG&E and KU. Under the ESM settlements,
LG&E and KU will 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.
As a result of the settlement, the CompanyCompanies accrued an additional $4.1
million at LG&E and $6.9 million at KU in June 2004, related to 2003 ESM
revenue.
- - New Page -
OVEC Power Agreement and Share Purchase
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.
LG&E's estimated future minimum annual demand payments under the Amended
and Restated Inter-Company Agreement are as follows:
(in thousands)
2006 $ 10,098
2007 9,726
2008 9,932
2009 10,144
2010 10,361
Thereafter 170,646
Total $220,907
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 the fourth quarter of 2004,2005, subject to receipt of certain regulatory approvals.
The changes to the power agreement and the share purchases are expected to
have no impact on the accounting for OVEC under FIN 46R as described in
Footnote 8.
Owensboro Contract Litigation
In May 2004, the City of Owensboro, Kentucky and Owensboro Municipal
Utilities (collectively "OMU"), filed suit in Davies County, Kentucky
District Court against KU concerning a long-term power supply contract (the
"OMU Agreement") with KU. The dispute involves interpretational
differences regarding certain issues under the OMU Agreement, including
various payments or charges between KU and OMU and rights concerning excess
power, termination and emissions allowances, respectively. The complaint
seeks approximately $6 million in damages for historical periods, as well
as injunctive and other relief, including a declaration that KU is in
material breach. KU has removed this litigation to the U.S. District Court
for the Western District of Kentucky, and filed an answer in that court denying
the OMU claims and presenting certain counterclaims. KU has also
initiatedcounterclaims and commenced a FERC
proceeding at theto request FERC to obtain the FERC's rulingjurisdiction on certain ofissues. In October
2004, FERC declined to exercise exclusive jurisdiction regarding the issues
in dispute.dispute, which ruling KU has appealed.
Page 36
Environmental Matters
In September 1998, the EPA announced its final "NOx SIP Call" rule
requiring states to impose significant additional reductions in NOx
emissions by May 2003, in order to mitigate alleged ozone transport impacts
on the Northeast region. The Commonwealth of Kentucky SIP, which was
approved by EPA June 24, 2003, required reductions in NOx emissions from
coal-fired generating units to the 0.15 lb./Mmbtu level on a system-wide
basis. In related proceedings in response to petitions filed by various
Northeast states, in December 1999, the EPA issued a final rule pursuant to
Section 126 of the Clean Air Act directing similar NOx reductions from a
number of specifically targeted generating units including all LG&E and KU
units. As a result of appeals to both rules, the compliance date was
extended to May 2004.
LG&E and KU have complied with these NOx emissions reduction rules.
LG&E and KU have added significantrules by
installing additional NOx controls to their generating units. InstallationInstallations
of additional NOx controls have beenwere performed on a phased basis, with installation of controls which
commenced in late 2000 and continued through the final compliance date. As
of JuneSeptember 30, 2004, LG&E has incurred total capital costs of
approximately $191$185 million to reduce its NOx emissions to the 0.15
lb./Mmbtu level on a company-wide basis. As of JuneSeptember 30, 2004, KU has
incurred total capital costs of approximately $252$203 million to reduce its
NOx emissions to the 0.15 lb./Mmbtu level on a company-wide basis. In
addition, LG&E and KU have begun incurring additional operation and
maintenance costs in operating new NOx controls. LG&E and KU believe their
costs in this regard to be comparable to those of similarly situated
utilities with like generation assets. In April 2001, the Kentucky
Commission granted recovery of these costs under the environmental
surcharge mechanism for LG&E and KU.
- - New Page -During August 2004, KU, the EPA, and the Department of Justice agreed in
principle to settle outstanding matters concerning a 1999 oil discharge at
KU's E.W. Brown plant for approximately $0.6 million, a portion of which
may be satisfied by KU's construction of a separate environmental capital
project. The settlement is subject to completion of final definitive
documents. In December 2003, KU recorded an accrual and expense to
operations of $0.6 million.
LG&E and KU are also monitoring several other air quality issues which may
potentially impact coal-fired power plants, including the EPA's revised air
quality standards for ozone and particulate matter, measures to implement
the EPA's regional haze rule, and the EPA's December 2003 proposals to
regulate mercury emissions from steam electric generating units and to
further reduce emissions of sulfur dioxide and nitrogen oxides under the
Clean Air Interstate Rule. In addition, LG&E is currently reviewing and
making comments on proposed regulations concerning toxic air emissions
within Metro Louisville, where the company operates two coal-fired
generating stations. LG&E is also working with local regulatory
authorities to review the effectiveness of remedial measures aimed at
controlling particulate matter emissions from its Mill Creek Station. LG&E
previously settled a number of property damage claims from adjacent
residents and completed significant remedial measures as part of its
ongoing capital construction program. LG&E has converted the Mill Creek
Station to a wet stack operation in an effort to resolve all outstanding
issues related to particulate matter emissions.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
LG&E and KU, and their respective ratepayers, are exposed to market risks.
Market risk exposures include 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.
Page 37
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.
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.
The potential change in interest expense associated with a 1% change in
base interest rates of LG&E's and KU's unswapped debt is estimated at $3.3$3.5
million and $3.5$3.3 million, respectively, at JuneSeptember 30, 2004. LG&E's
exposure to floating interest rates decreased $1.1$1.0 million and KU's
exposure to floating interest rates decreased $1.0$1.2 million during the first
sixnine months of 2004.
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 $23.6$25.8 million as of JuneSeptember 30, 2004. 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 $4.3$2.4 million as
of JuneSeptember 30, 2004. These estimates are derived from third-party
valuations. Changes in the market values of these swaps, if held to
maturity, will have no effect 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 JuneSeptember
30, 2004, LG&E and KU have a minimum pension liability as prescribed by
SFAS No. 87, Employers' Accounting for Pensions, in the pre-tax amounts of
$47.6
- - New Page - and $9.9 million, respectively. The liabilities are recorded as a
reduction to other comprehensive income, and do not affect net income. The
amount of the liabilities depends upon the asset returns experienced in
2003 and contributions made by LG&E and KU to the plan during 2003. If the
fair value of the plan assets exceeds the accumulated benefit obligation,
the recorded liability will be reduced and other comprehensive income will
be restored in the Consolidated Balance Sheets.
A 1% increase or decrease in the assumed discount rate could have an
approximate $41 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 million positive or negative
impact to the accumulated benefit obligation of KU.
In January 2004, LG&E and KU made contributions to their pension plans of
$34.5 million and $43.4 million, respectively.
Page 38
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 and sixnine months ended JuneSeptember
30, 2004, and 2003(in2003 (in thousands of $). Trading volumes are evenly divided
between LG&E and KU.
Three Months SixNine Months
Ended Ended
JuneSeptember 30, JuneSeptember 30,
2004 2003 2004 2003
Fair value of contracts at beginning of
period, net asset/(liability) $ 603541 $ 403 $ 572318 $572 $(156)
Fair value of contracts when entered
into during the period (5) - (5) 2,620(70) (30) (75) 2,590
Contracts realized or otherwise
settled during the period (82) (226) (232) (283)(431) (356) (663) (639)
Changes in fair value due to changes
in assumptions 25 141 206 (1,863)107 148 313 (1,715)
Fair value of contracts at end of period,
net asset $ 541147 $ 31880 $ 541147 $ 31880
No changes to valuation techniques for energy trading and risk management
activities occurred during 2004 or 2003.2004. Changes in market pricing, interest rate
and volatility assumptions were made during allboth periods. All contracts
outstanding at JuneSeptember 30, 2004, have a maturity of less than one year
and are valued using prices actively quoted for proposed or executed
transactions or quoted by brokers.
LG&E and KU maintain policies intended to minimize credit risk and revalue
credit exposures daily to monitor compliance with those policies. As of
JuneSeptember 30, 2004, 98.9%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'
- - New Page -
management, including the Chairman, President and Chief Executive Officer
("CEO") and the Chief Financial Officer ("CFO"). Based upon that
evaluation, the CEO and CFO have concluded that the Companies' disclosure
controls and procedures are effective as of the end of the period covered
by this report.
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 controls over financial reporting. There has been no change
in the Companies' internal controlcontrols over financial reporting that occurred
during the fiscal quarter ended JuneSeptember 30, 2004, that has materially
affected, or is reasonably likely to materially affect, the Companies'
internal controlcontrols over financial reporting.
Page 39
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 (a) LG&E's and KU's respective combined Annual Report on Form
10-K for the year ended December 31, 2003: 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 and (b) LG&E's and KU's Quarterly ReportReports on Form 10-Q
for the periodperiods ended March 31, 2004 and June 30, 2004: Item I, Legal
Proceedings. Except as described herein, to date,to-date, the proceedings reported
in LG&E's and KU's respective combined Annual Report on Form 10-K or
Quarterly Reports on Form 10-Q have not changed materially.
Electric and Gas Rates Cases
On June 30, 2004, the Kentucky Commission issued an order approving
increases in the base electric and gas rates of LG&E and the base electric
rates of KU. In July 2004,Subsequently, the AG commenced an investigation examining
communications between the Kentucky Commission and the Companies and
separately filed for a rehearing of the rate cases on such issue and
certain calculation components of the increased rates.rates and filed for the
existing rate increases to be set aside. The Kentucky Commission ordered a procedural reopening ofis
considering the rate cases for the limited
purpose of taking evidence, if any, asmatters relating to the communication issue.AG's actions. For a description 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.10-
Q.
MISO
During March and April 2004 to-date, the Kentucky Commission held hearings in thehas continued its proceedings
examining the costcosts and benefits of MISO membership. In July
2004, the Kentucky Commission reopenedmembership, including reopening
the matter for further testimony and hearings on recently-filed MISO energy
market tariffs and analysis of potential membership in other Regional
Transmission Organizations. Proceedings in this matter are anticipated to
continue into 2005. In September 2004, in response to requests of the
Kentucky Commission, the Companies filed pleadings indicating that MISO
membership will not provide benefits commensurate with its costs to the
Companies and to Kentucky ratepayers. The Companies requested an order of
the Kentucky Commission directing their ultimate exit from MISO, if
approved by the FERC and under other appropriate conditions.
OVEC Power Agreement and Share Purchase
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 the fourth quarter of 2004,2005, subject to receipt of certain regulatory approvals.
- - New Page -40
Owensboro Contract Litigation
In May 2004, the City of Owensboro, Kentucky and Owensboro Municipal
Utilities (collectively "OMU"), filed suit in Davies County, Kentucky
District Court against KU concerning a long-term power supply contract (the
"OMU Agreement") with KU. The dispute involves interpretational
differences regarding certain issues under the OMU Agreement, including
various payments or charges between KU and OMU and rights concerning excess
power, termination and emissions allowances, respectively. The complaint
seeks approximately $6 million in damages for historical periods, as well
as injunctive and other relief, including a declaration that KU is in
material breach. KU has removed this litigation to the U.S. District Court
for the Western District of Kentucky, and filed an answer in that court denying
the OMU claims and presenting certain counterclaims. KU has also
initiatedcounterclaims and commenced a FERC
proceeding at theto request FERC to obtain the FERC's rulingjurisdiction on certain ofissues. In October
2004, FERC declined to exercise exclusive jurisdiction regarding the issues
in dispute.dispute, which ruling KU has appealed.
Environmental Matter
During August 2004, KU and the EPA and Department of Justice agreed in
principle to settle outstanding matters concerning a 1999 oil discharge at
KU's E.W. Brown plant for approximately $628,750, a portion of which may be
satisfied by KU's construction of a separate environmental capital project.
The settlement is subject to completion of final definitive documents.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
2(c)
LG&E has an existing $5.875 series of 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 a minimum of 187,500 shares on July 15, 2008 at $100 per share.
LG&E redeemed 12,500 shares in accordance with these provisions on July 15,
2004, leaving 225,500 shares currently outstanding. Beginning with the
three months ended September 30, 2003, LG&E reclassified, at fair value,
its $5.875 series preferred stock as long-term debt with the minimum shares
mandatorily redeemable within one year classified as current portion of
long-term debt. Dividends accrued beginning July 1, 2003 are charged as
interest expense, pursuant to SFAS No. 150.
July August September
Period 2004 2004 2004
Total number of shares (or units) 12,500 n/a n/a
purchased ($5.875 Pref.)
Average price paid per share (or unit)$100 n/a n/a
Total number of shares (or units)
purchased as part of publicly 12,500
announced plans or programs ($5.875 Pref.) n/a n/a
Maximum number (or approximate
dollar value) of shares (or
units) that may yet be purchased 225,000
under the plans or programs ($5.875 Pref.) n/a n/a
Item 4. Submission of Matters to a Vote of Security Holders.
a)LG&E's and KU's Annual Meetings of Shareholders were held on July 8,
2004.
b)Not applicable.
Page 41
c)The matters voted upon and the results of the voting at the Annual
Meetings are set forth below:
1. LG&E
i)The shareholders voted to elect LG&E's nominees for election to the
Board of Directors, as follows:
Victor A. Staffieri - 21,294,223 common shares and 88,855
preferred shares cast in favor of election and 5,725 preferred
shares withheld.
S. Bradford Rives - 21,294,223 common shares and 89,005 preferred
shares cast in favor of election and 5,575 preferred shares
withheld.
John R. McCall - 21,294,223 common shares and 89,191 preferred
shares cast in favor of election and 5,389 preferred shares
withheld.
No holders of common or preferred shares abstained from voting on
this matter.
ii)The shareholders voted 21,294,223 common shares and 91,600
preferred shares in favor of and 991 preferred shares against the
approval of PricewaterhouseCoopers LLP as independent accountants
for 2004. Holders of 1,989 preferred shares abstained from voting
on this matter.
2. KU
i)The sole shareholder voted to elect KU's nominees for election to
the Board of Directors, as follows:
37,817,878 common shares cast in favor of election and no shares
withheld for each of Victor A. Staffieri, S. Bradford Rives and
John R. McCall, respectively.
ii)The sole shareholder voted 37,817,878 common shares in favor of and
no shares withheld for approval of PricewaterhouseCoopers LLP as
independent accountants for 2004.
No holders of common shares abstained from voting on these matters.
d) Not applicable.
Item 6. Exhibits and Reports on Form 8-K.
6(a)Exhibits.
Applicable to Form
10-Q of
Exhibit
No. LG&E KU Description
10.01 X X Copy of Amended and restated inter-company power
agreement dated as of March 13, 2006, among Ohio Valley
Electric Corporation and sponsoring companies, including
LG&E and KU.
10.02 X X Copy of Fourth Amendment dated as of February 1,
2004 to Employment and Severance Agreement dated as of
February 25, 2000 by and among E.ON AG, LG&E Energy,
Powergen and Victor A. Staffieri.
10.03 X X Copy of Modification No. 15, dated as of April 30,
2004, to Inter-Company Power Agreement dated July 10, 1953
among Ohio Valley Electric Corporation and Sponsoring
Companies.
31 X X Certification - Section 302 of Sarbanes-Oxley Act of 2002
31.1 X Certification of Chairman of the Board, President and Chief
Executive Officer, pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
31.2 X 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 302 of the
Sarbanes-Oxley Act of 2002
31.4 X Certification of Chief Financial Officer,Certifications 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
Certain instruments defining the rights of holders of certain long-term
debt of LG&E and KU have not been filed with the SEC but will be furnished
to the SEC upon request.
6(b). Reports on Form 8-K.
On July 1, 2004, LG&E and KU filed a Current Report on Form 8-K describing
the June 30, 2004, order of the Kentucky Commission regarding increases in
their base rates.
- - New Page -42
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: August 13,November 12, 2004 /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: August 13,November 12, 2004 /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)
- - New Page -
Exhibit 31 - CERTIFICATIONS
Exhibit 31.1
Louisville Gas and Electric Company
I, Victor A. Staffieri, Chairman of the Board, President and Chief
Executive Officer, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Louisville
Gas and Electric Company;
2. Based on my knowledge, this report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this report;
3. Based on my knowledge, the financial statements, and other
financial information included in this report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
report;
4. The registrant's other certifying officer(s) and I are responsible
for establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant
and have:
(a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures and presented in this report our conclusions
about the effectiveness of the disclosure controls and procedures, as
of the end of the period covered by this report based on such
evaluation; and
(c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
most recent fiscal quarter (the registrant's fourth fiscal quarter in
the case of an annual report) that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting; and
5. The registrant's other certifying officer(s) and I have disclosed,
based on our most recent evaluation of internal control over financial
reporting, to the registrant's auditors and the audit committee of the
registrant's board of directors (or persons performing the equivalent
functions):
(a) All significant deficiencies and material weaknesses in the design
or operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
Date: August 13, 2004
/s/ Victor A. Staffieri
Victor A. Staffieri
Chairman of the Board, President and Chief Executive Officer
- - New Page -
Exhibit 31.2
Louisville Gas and Electric Company
I, S. Bradford Rives, Chief Financial Officer, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Louisville
Gas and Electric Company;
2. Based on my knowledge, this report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this report;
3. Based on my knowledge, the financial statements, and other
financial information included in this report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
report;
4. The registrant's other certifying officer(s) and I are responsible
for establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant
and have:
(a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
(c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
most recent fiscal quarter (the registrant's fourth fiscal quarter in
the case of an annual report) that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting; and
5. The registrant's other certifying officer(s) and I have disclosed,
based on our most recent evaluation of internal control over financial
reporting, to the registrant's auditors and the audit committee of the
registrant's board of directors (or persons performing the equivalent
functions):
(a) All significant deficiencies and material weaknesses in the design
or operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
Date: August 13, 2004
/s/ S. Bradford Rives
S. Bradford Rives
Chief Financial Officer
- - New Page -
Exhibit 31.3
Kentucky Utilities Company
I, Victor A. Staffieri, Chairman of the Board, President and Chief
Executive Officer, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Kentucky
Utilities Company;
2. Based on my knowledge, this report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this report;
3. Based on my knowledge, the financial statements, and other
financial information included in this report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
report;
4. The registrant's other certifying officer(s) and I are responsible
for establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant
and have:
(a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
(c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
most recent fiscal quarter (the registrant's fourth fiscal quarter in
the case of an annual report) that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting; and
5. The registrant's other certifying officer(s) and I have disclosed,
based on our most recent evaluation of internal control over financial
reporting, to the registrant's auditors and the audit committee of the
registrant's board of directors (or persons performing the equivalent
functions):
(a) All significant deficiencies and material weaknesses in the design
or operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
Date: August 13, 2004
/s/ Victor A. Staffieri
Victor A. Staffieri
Chairman of the Board, President and Chief Executive Officer
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Exhibit 31.4
Kentucky Utilities Company
I, S. Bradford Rives, Chief Financial Officer, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Kentucky
Utilities Company;
2. Based on my knowledge, this report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this report;
3. Based on my knowledge, the financial statements, and other
financial information included in this report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
report;
4. The registrant's other certifying officer(s) and I are responsible
for establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant
and have:
(a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
(c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
most recent fiscal quarter (the registrant's fourth fiscal quarter in
the case of an annual report) that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting; and
5. The registrant's other certifying officer(s) and I have disclosed,
based on our most recent evaluation of internal control over financial
reporting, to the registrant's auditors and the audit committee of the
registrant's board of directors (or persons performing the equivalent
functions):
(a) All significant deficiencies and material weaknesses in the design
or operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
Date: August 13, 2004
/s/ S. Bradford Rives
S. Bradford Rives,
Chief Financial Officer
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Exhibit 32
Certification Pursuant to 18 U.S.C. Section 1350
As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
In connection with the Quarterly Report of Louisville Gas and
Electric Company and Kentucky Utilities Company (the "Companies") on Form
10-Q for the period ended June 30, 2004, as filed with the Securities and
Exchange Commission (the "Report"), each of the undersigned does hereby
certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002, that, to such officer's knowledge,
1) The Report fully complies with the requirements of Section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
2) The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations of the
Companies as of the dates and for the period expressed in the Report.
August 13, 2004
/s/ Victor A. Staffieri
Chairman of the Board, President
and Chief Executive Officer
Louisville Gas and Electric Company
Kentucky Utilities Company
/s/ S. Bradford Rives
Chief Financial Officer
Louisville Gas and Electric Company
Kentucky Utilities Company
The foregoing certification is being furnished solely pursuant to 18 U.S.C.
Section 1350 and is not being filed as part of the Report or as a separate
disclosure document.