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 September 30, 2004March 31, 2005
Or
[_] TRANSITION REPORT PURSUANT TO1TO 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 October 31, 2004,April 30, 2005,
all held by LG&E Energy LLC
Kentucky Utilities Company
37,817,878 shares, without par value, as of October 31, 2004,April 30, 2005,
all held by LG&E Energy LLC
This combined Form 10-Q is separately filed by Louisville Gas and Electric
Company and Kentucky Utilities Company. Information contained herein
related to any individual registrant is filed by such registrant on its own
behalf. Each registrant makes no representation as to information related
to the other registrants.
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INDEX OF ABBREVIATIONS
AEP American Electric Power Company, Inc.
AG Attorney General of Kentucky
ARB Accounting Research Bulletin
ARO Asset Retirement Obligation
CCN Certificate of Public Convenience and Necessity
DSM Demand Side Management
ECR Environmental Cost Recovery
EEI Electric Energy, Inc.
E.ON E.ON AG
ESM Earnings Sharing Mechanism
FAC Fuel Adjustment Clause
FASB Financial Accounting Standards Board
FERC Federal Energy Regulatory Commission
Fidelia Fidelia Corporation (an E.ON affiliate)
FIN FASB Interpretation No.
FGD Flue Gas Desulfurization
FSP FASB Staff Position
IMEA Illinois Municipal Electric Agency
IMPA Indiana Municipal Power Agency
IRS Internal Revenue Service
Kentucky Commission Kentucky Public Service Commission
KU Kentucky Utilities Company
LIBOR London Interbank Offer Rate
LEM LG&E Energy Marketing Inc.
LG&E Louisville Gas and Electric Company
LG&E Energy LG&E Energy LLC (as successor to LG&E Energy Corp.)
LG&E Services LG&E Energy Services Inc.
LMP Locational Marginal Pricing
MGP Manufactured Gas Plant
MISO Midwest Independent Transmission System Operator Inc.
Moody's Moody's Investor Services, Inc.
Mw Megawatts
Mwh Megawatt hours
NOPR Notice of Proposed Rulemaking
OMU Owensboro Municipal Utilities
OVEC Ohio Valley Electric Corporation
PJM PJM Interconnection, LLC
Powergen Powergen Limited (formerly Powergen plc)
PUHCA Public Utility Holding Company Act of 1935
RTO Regional Transmission Operator
S&P Standard & Poor's Rating Services
SEC Securities and Exchange Commission
SFAS Statement of Financial Accounting Standards
SMD Standard Market Design
SO2 Sulfur Dioxide
VDT Value Delivery Team Process
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TABLE OF CONTENTS
PART I
ItemITEM 1 Consolidated Financial Statements
Louisville Gas and Electric Company and Subsidiary
Statements of IncomeFINANCIAL STATEMENTS (UNAUDITED)
LOUISVILLE GAS AND ELECTRIC COMPANY
STATEMENTS OF INCOME 1
Statements of Retained EarningsSTATEMENTS OF RETAINED EARNINGS 1
Balance SheetsBALANCE SHEETS 2
Statements of Cash FlowSTATEMENTS OF CASH FLOWS 4
Statements of Other Comprehensive IncomeSTATEMENTS OF OTHER COMPREHENSIVE INCOME 5
Kentucky Utilities Company and Subsidiary
Statements of IncomeKENTUCKY UTILITIES COMPANY
STATEMENTS OF INCOME 6
Statements of Retained EarningsSTATEMENTS OF RETAINED EARNINGS 6
Balance SheetsBALANCE SHEETS 7
Statements of Cash FlowSTATEMENTS OF CASH FLOWS 9
Statements of Other Comprehensive IncomeSTATEMENTS OF OTHER COMPREHENSIVE INCOME 10
Notes to Consolidated Financial StatementsNOTES TO FINANCIAL STATEMENTS 11
ItemITEM 2 Management's Discussion and Analysis of F
Financial Condition and Results of Operations 23
ItemMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS. 25
ITEM 3 Quantitative and Qualitative Disclosures
About Market Risk 38
ItemQUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. 32
ITEM 4 Controls and Procedures 39CONTROLS AND PROCEDURES. 34
PART II
ItemITEM 1 Legal Proceedings 40
Item 2 Unregistered Sales of Equity Securities
and Use of Proceeds 41
Item 4 Submission of Matters to a Vote of Security Holders 41
ItemLEGAL PROCEEDINGS 35
ITEM 6 Exhibits 42
Signatures 43
Exhibits 44EXHIBITS 35
SIGNATURES 36
EXHIBITS 37
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Part I. Financial Information - Item 1. Financial Statements (Unaudited)
Louisville Gas and Electric Company
and Subsidiary
Consolidated Statements of Income
(Unaudited)
(Thousands(Millions of $)
Three Months Nine Months
Ended
Ended
September 30, September 30,March 31,
2005 2004 2003 2004 2003
OPERATING REVENUES (Note 5)4):
Electric (Note 10) $227,024 $230,174 $617,839 $591,110$229.8 $198.3
Gas 34,818 32,659 242,178 213,939172.6 163.7
Total operating revenues 261,842 262,833 860,017 805,049402.4 362.0
OPERATING EXPENSES:
Fuel for electric generation 53,653 55,628 153,792 151,38260.3 52.9
Power purchased (Note 10) 19,344 18,805 65,578 60,24539.0 28.9
Gas supply expenses 20,172 19,509 181,919 151,579135.6 130.8
Other operation and maintenance expenses 48,129 51,890 163,300 158,797
Maintenance 23,072 12,526 49,879 42,10975.2 74.3
Depreciation and amortization 30,299 28,429 86,021 85,866
Federal and state income taxes 21,089 23,707 45,487 45,062
Property and other taxes 4,343 4,659 14,483 12,84830.7 27.5
Total operating expenses 220,101 215,153 760,459 707,888340.8 314.4
NET OPERATING INCOME 41,741 47,680 99,558 97,16161.6 47.6
Other income (expense) - net (1,091) 285 (1,419) (49)
Other income from affiliated
company (Note 10) - 2 - 60.2 (0.8)
Interest expense (Note 3) 5,072 5,985 15,086 18,0905.8 4.8
Interest expense to affiliated companies (Note 10) 3,040 2,111 9,157 4,1379) 3.1 3.1
INCOME BEFORE INCOME TAXES 52.9 38.9
Federal and state income taxes (Note 6) 19.0 14.7
NET INCOME $ 32,53833.9 $ 39,871 $ 73,896 $ 74,891
Consolidated Statements of Retained Earnings
(Unaudited)
(Thousands of $)
Three Months Nine Months
Ended Ended
September 30, September 30,
2004 2003 2004 2003
Balance at beginning of period $516,856 $442,498 $497,441 $409,319
Net income 32,538 39,871 73,896 74,891
Subtotal 549,394 482,369 571,337 484,210
Cash dividends declared on stock:
5% cumulative preferred 269 269 807 807
Auction rate cumulative preferred 244 174 649 743
$5.875 cumulative preferred (Note 9) - - - 734
Common 21,000 - 42,000 -
Subtotal 21,513 443 43,456 2,284
Balance at end of period $527,881 $481,926 $527,881 $481,92624.2
The accompanying notes are an integral part of these consolidated financial statements.
Page 1Statements of Retained Earnings
(Unaudited)
(Millions of $)
Three Months Ended
March 31,
2005 2004
Balance at beginning of period $534.0 $497.5
Net income 33.9 24.2
Subtotal 567.9 521.7
Cash dividends declared on stock:
5% cumulative preferred 0.3 0.3
Auction rate cumulative preferred 0.4 0.2
Common 29.0 -
Subtotal 29.7 0.5
Balance at end of period $538.2 $521.2
The accompanying notes are an integral part of these financial statements.
- 2 -
Louisville Gas and Electric Company
and Subsidiary
Consolidated Balance Sheets
(Unaudited)
(Thousands(Millions of $)
ASSETS
September 30,March 31, December 31,
2005 2004 2003
UTILITY PLANT:
At original cost $3,880,901 $3,804,183
Less: reserve for depreciation 1,390,301 1,326,899
Net utility plant (Note 7) 2,490,600 2,477,284
OTHER PROPERTY AND INVESTMENTS -
less reserve of $63 as of September 30, 2004
and December 31, 2003 508 611
CURRENT ASSETS:
Cash and cash equivalents 5,902 1,706
Restricted cash 11,524 -$ 6.7 $ 6.8
Accounts receivable -
less reserve of $1,415$1.2 million and $3,515$0.8 million as of
September 30, 2004March 31, 2005 and December 31, 2003,2004,
respectively (Note 4) 108,761 84,585161.4 167.0
Materials and supplies - at average cost:
Fuel (predominantly coal) 22,268 25,26021.9 21.8
Gas stored underground 76,416 69,88424.8 77.5
Other 26,214 24,97126.2 26.1
Prepayments and other 1,634 5,2814.9 3.9
Total current assets 252,719 211,687245.9 303.1
OTHER PROPERTY AND INVESTMENTS -
less reserve of less than $0.1 million as of
March 31, 2005 and December 31, 2004 0.6 0.5
UTILITY PLANT:
At original cost 3,934.3 3,915.8
Less: reserve for depreciation 1,432.4 1,396.3
Net utility plant 2,501.9 2,519.5
DEFERRED DEBITS AND OTHER ASSETS:
Restricted cash 10.8 10.9
Unamortized debt expense 8,555 8,7538.4 8.4
Regulatory assets (Note 6) 100,183 143,6265) 76.4 91.9
Other 32,789 40,12132.8 32.2
Total deferred debits and other assets 141,527 192,500128.4 143.4
Total assets $2,885,354 $2,882,082$2,876.8 $2,966.5
The accompanying notes are an integral part of these consolidated financial statements.
Page- 2 -
Louisville Gas and Electric Company
and Subsidiary
Consolidated Balance Sheets (cont.)
(Unaudited)
(Thousands(Millions of $)
CAPITALIZATION AND LIABILITIES
September 30,March 31, December 31,
2005 2004 2003
CAPITALIZATION:
Common stock, without par value -
Outstanding 21,294,223 shares $ 425,170 $ 425,170
Common stock expense (836) (836)
Additional paid-in capital 40,000 40,000
Accumulated other comprehensive loss (39,902) (38,111)
Retained earnings 527,881 497,441
Total common equity 952,313 923,664
Cumulative preferred stock 70,425 70,425
Mandatorily redeemable preferred stock (Note 9) 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
Total long-term debt 574,354 550,604
Total capitalization 1,597,092 1,544,693
CURRENT LIABILITIES:
Current portion of mandatorily
redeemable preferred stock (Note 9) 1,250 1,250$ 1.3 $ 1.3
Current portion of long-term debt (Note 9) 246,200 246,200246.2 246.2
Current portion of long-term debt to
affiliated company (Note 9) 50,0008) - 50.0
Notes payable to affiliated companies (Note 9) 40,700 80,3328) 35.0 58.2
Accounts payable 62,959 93,11888.2 106.1
Accounts payable to affiliated companies (Note 10) 22,455 38,3439) 26.3 31.7
Accrued income taxes 8,330 11,47231.4 6.2
Customer deposits 12,255 10,493
Accrued interest 2,593 1,999
Accrued interest to affiliated company (Note 10) 2,996 2,75015.0 14.0
Other 18,493 11,7844.8 18.5
Total current liabilities 468,231 497,741448.2 532.2
DEFERRED CREDITS AND OTHER LIABILITIES:
Accumulated deferred income taxes - net 347,092 337,704326.3 347.2
Investment tax credit, in process of amortization 47,202 50,32945.2 46.2
Accumulated provision for pensions
and related benefits 109,436 140,598122.1 120.6
Customer advances for construction 10,637 9,8909.6 10.6
Asset retirement obligation 10,155 9,74710.4 10.3
Regulatory liabilities (Note 6)5):
Accumulated cost of removal of utility plant 214,950 216,491214.1 220.2
Other 53,535 51,822
Long-term derivative liability (Note 3) 18,883 15,96672.5 52.2
Other 8,141 7,10126.1 29.4
Total deferred credits and other liabilities 820,031 839,648826.3 836.7
CAPITALIZATION:
Common stock, without par value -
Outstanding 21,294,223 shares 425.2 425.2
Common stock expense (0.8) (0.8)
Additional paid-in capital 40.0 40.0
Accumulated other comprehensive loss (45.1) (45.6)
Retained earnings 538.2 534.0
Total common equity 957.5 952.8
Cumulative preferred stock 70.4 70.4
Mandatorily redeemable preferred stock 21.3 21.3
Long-term debt (Note 8) 328.1 328.1
Long-term debt to affiliated company (Note 8) 225.0 225.0
Total capitalization 1,602.3 1,597.6
Total capital and liabilities $2,885,354 $2,882,082$2,876.8 $2,966.5
The accompanying notes are an integral part of these consolidated financial statements.
Page- 3 -
Louisville Gas and Electric Company
and Subsidiary
Consolidated StatementStatements of Cash Flows
(Unaudited)
(Thousands(Millions of $)
NineThree Months Ended
September 30,March 31,
2005 2004 2003
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 73,89633.9 $ 74,89124.2
Items not requiring cash currently:
Depreciation and amortization 86,021 85,866
Deferred income taxes - net 6,803 24,589
Investment tax credit - net (3,127) (3,156)
Value Delivery Team (VDT)30.7 27.5
VDT amortization (Note 6) 22,601 22,866
Mark-to-market financial7.6 7.5
Change in fair value of derivative instruments (Note 3) 2,916 (651)
Provision for post-retirement benefits (Note 8) (8,047) (4,801)(1.3) 6.1
Other (147) 7,997(0.1) (3.8)
Changes in current assets and liabilities (10,576) (28,028)
Changes in accounts receivable
securitization-net (Note 4) (58,000) 11,600liabilities-net 46.3 (29.2)
Pension funding (Notes 9 and 12) (34,492) (89,125)(Note 11) - (34.5)
Gas supply clause (Note 6) 12,008 (14,970)receivable, net 1.9 7.8
Earnings sharing mechanism (Note 6) 6,913 6,189
Combustion turbine litigation settlement 7,003 -receivable 3.5 3.0
Other 15,460 10,698(1.2) 7.7
Net cash flows fromprovided by operating activities 119,232 103,965121.3 16.3
CASH FLOWS FROMUSED IN INVESTING ACTIVITIES:
Proceeds from sales(Purchase) sale of securities 103 153long-term investments (0.1) 0.1
Construction expenditures (94,220) (153,064)(18.5) (27.0)
Net cash flows fromused for investing activities (94,117) (152,911)(18.6) (26.9)
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase in restricted cash (11,524) -
Long-term borrowings from affiliated company (Note 9) 125,000 200,0008) - 125.0
Repayment of long-term borrowings
from affiliated company (Note 8) (50.0) -
Short-term borrowings from affiliated company (Note 9) 399,550 478,800
Repayment of long-term borrowings from d
affiliated company (Note 9) (50,000)8) - 131.2
Repayment of short-term borrowings
from affiliated company (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 (135) -(23.2) (218.2)
Payment of common dividends (42,000) -
Payment of preferred dividends (1,378) (2,898)(29.7) (0.4)
Other 0.1 (0.1)
Net cash flows from(used for) provided by financing
activities (20,919) 35,331(102.8) 37.5
CHANGE IN CASH AND CASH EQUIVALENTS 4,196 (13,615)(0.1) 26.9
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 1,706 17,0156.8 1.7
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 5,9026.7 $ 3,40028.6
SUPPLEMENTAL DISCLOSURES:
Cash paid during the period for:
Income taxes $ 42,375(0.7) $ 12,968(5.2)
Interest on borrowed money 12,674 17,204$ 3.9 $ 3.9
Interest to affiliated companies on borrowed money 8,937 1,707$ 4.0 $ 2.8
The accompanying notes are an integral part of these consolidated financial statements.
Page- 4 -
Louisville Gas and Electric Company and Subsidiary
Consolidated
Statements of Other Comprehensive Income
(Unaudited)
(Thousands(Millions of $)
Three Months Nine Months
Ended
Ended
September 30, September 30,March 31,
2005 2004 2003 2004 2003
Net income $32,538 $39,871 $73,896 $74,891
Gains/(losses)$33.9 $24.2
Income Taxes - Minimum Pension Liability (Note 6) (1.1) -
Gain (loss) on derivative instruments and hedging
activities - net of tax benefit/(expense) of
$3,639, $(1,416),
$1,189$(1.0) and $(382),$2.4 for 2005 and 2004,
respectively (Note 3) (5,457) 2,123 (1,790) 5731.6 (3.6)
Other comprehensive income (loss), net of tax 0.5 (3.6)
Comprehensive income $27,081 $41,994 $72,106 $75,464$34.4 $20.6
The accompanying notes are an integral part of these consolidated financial statements.
Page- 5 -
Kentucky Utilities Company and Subsidiary
Consolidated
Statements of Income
(Unaudited)
(Thousands(Millions of $)
Three Months Nine Months
Ended
Ended
September 30, September 30,March 31,
2005 2004 2003 2004 2003
OPERATING REVENUES (Note 10) $252,669 $235,426 $732,424 $657,583$287.5 $247.4
OPERATING EXPENSES:
Fuel for electric generation 78,151 75,300 215,666 201,26487.4 70.0
Power purchased (Note 10) 33,182 31,702 105,152 106,55046.3 41.3
Other operation and maintenance expenses 37,844 35,603 112,834 112,622
Maintenance 12,070 13,031 40,978 49,40059.6 54.5
Depreciation and amortization 29,065 24,751 80,265 76,663
Federal and state income taxes 19,565 18,196 58,127 32,263
Property and other taxes 4,406 4,067 12,942 12,23028.6 25.2
Total operating expenses 214,283 202,650 625,964 590,992221.9 191.0
NET OPERATING INCOME 38,386 32,776 106,460 66,59165.6 56.4
Other income - net 3,094 2,140 6,514 6,944
Other income (expense) from
affiliated company (Note 10) 11 5 26 41.0 0.4
Interest expense (Note 3) 3,116 2,695 7,532 13,8082.9 0.7
Interest expense to affiliated companies (Note 10) 3,557 1,916 10,641 3,4019) 3.6 3.6
NET INCOME BEFORE INCOME TAXES 60.1 52.5
Federal and state income taxes (Note 6) 22.6 20.1
NET INCOME $ 34,81837.5 $ 30,310 $ 94,827 $ 56,330
Consolidated Statements of Retained Earnings
(Unaudited)
(Thousands of $)
Three Months Nine Months
Ended Ended
September 30, September 30,
2004 2003 2004 2003
Balance at beginning of period $629,051 $526,916 $591,170 $502,024
Net income 34,818 30,310 94,827 56,330
Subtotal 663,869 557,226 685,997 558,354
Cash dividends declared on stock:
4.75% cumulative preferred 237 237 712 711
6.53% cumulative preferred 327 327 980 981
Common 21,000 - 42,000 -
Subtotal 21,564 564 43,692 1,692
Balance at end of period $642,305 $556,662 $642,305 $556,66232.4
The accompanying notes are an integral part of these consolidated financial statements.
PageStatements of Retained Earnings
(Unaudited)
(Millions of $)
Three Months Ended
March 31,
2005 2004
Balance at beginning of period $659.4 $591.2
Net income 37.5 32.4
Subtotal 696.9 623.6
Cash dividends declared on stock:
4.75% cumulative preferred 0.2 0.2
6.53% cumulative preferred 0.3 0.3
Common 30.0 -
Subtotal 30.5 0.5
Balance at end of period $666.4 $623.1
The accompanying notes are an integral part of these financial statements.
- 6 -
Kentucky Utilities Company
and Subsidiary
Consolidated Balance Sheets
(Unaudited)
(Thousands(Millions of $)
ASSETS
September 30,March 31, December 31,
2005 2004 2003
UTILITY PLANT:
At original cost $3,670,707 $3,596,657
Less: reserve for depreciation 1,403,583 1,360,253
Net utility plant (Note 7) 2,267,124 2,236,404
OTHER PROPERTY AND INVESTMENTS -
less reserve of $131 as of September 30, 2004 and
December 31, 2003 19,721 17,862
CURRENT ASSETS:
Cash and cash equivalents 4,677 4,869$ 3.9 $ 4.6
Accounts receivable - less reserve of $482$0.7 million
and $672$0.6 million as of September 30, 2004March 31, 2005 and
December 31, 2003,
2004,respectively (Note 4) 97,437 49,289103.6 112.6
Materials and supplies - at average cost:
Fuel (predominantly coal) 30,260 45,53849.9 52.2
Other 27,653 27,09428.4 28.0
Prepayments and other 6,802 13,1009.4 9.9
Total current assets 166,829 139,890195.2 207.3
OTHER PROPERTY AND INVESTMENTS -
less reserve of $0.1 million as of March 31,
2005 and December 31, 2004, respectively 21.1 20.5
UTILITY PLANT:
At original cost 3,730.6 3,712.1
Less: reserve for depreciation 1,438.1 1,415.0
Net utility plant 2,292.5 2,297.1
DEFERRED DEBITS AND OTHER ASSETS:
Unamortized debt expense 4,295 4,4814.7 4.7
Regulatory assets (Note 6) 62,668 72,3185) 58.9 61.4
Long-term derivative asset (Note 3) 7,530 12,2235.5 6.1
Other 12,164 21,91614.6 13.3
Total deferred debits and other assets 86,657 110,93883.7 85.5
Total assets $2,540,331 $2,505,094$2,592.5 $2,610.4
The accompanying notes are an integral part of these consolidated financial statements.
Page- 7 -
Kentucky Utilities Company
and Subsidiary
Consolidated Balance Sheets (cont.)
(Unaudited)
(Thousands(Millions of $)
CAPITALIZATION AND LIABILITIES
September 30,March 31, December
31,
2005 2004 2003
CAPITALIZATION:
Common stock, without par value -
Outstanding 37,817,878 shares $ 308,140 $ 308,140
Common stock expense (322) (322)
Additional paid-in capital 15,000 15,000
Accumulated other comprehensive loss (6,071) (6,031)
Retained earnings 642,305 591,170
Total common equity 959,052 907,957
Cumulative preferred stock 39,727 39,727
Long-term debt (Note 9) 307,564 312,646
Long-term debt to affiliated company (Note 9) 333,000 283,000
Total long-term debt 640,564 595,646
Total capitalization 1,639,343 1,543,330
CURRENT LIABILITIES:
Current portion of long-term debt (Note 9) 87,130 91,930$ 123.1 $ 87.1
Current portion of long-term notes to
affiliated company 75.0 75.0
Notes payable to affiliated company (Note 9) 29,830 43,2318) 26.0 34.8
Accounts payable 41,317 69,94750.3 77.9
Accounts payable to affiliated companies (Note 10) 18,979 26,4269) 21.0 32.8
Accrued income taxes 12,337 7,10433.4 5.9
Customer deposits 14,163 13,453
Accrued interest 3,019 2,024
Accrued interest to affiliated company (Note 10) 3,866 2,45415.7 15.0
Other 20,566 9,7674.6 15.4
Total current liabilities 231,207 266,336349.1 343.9
DEFERRED CREDITS AND OTHER LIABILITIES:
Accumulated deferred income taxes - net 274,207 261,258267.7 282.6
Investment tax credit, in process of amortization 4,318 5,8593.4 3.8
Accumulated provision for pensions and
related benefits 65,260 103,101
Customer advances for construction 1,608 1,56480.0 77.9
Asset retirement obligation 20,661 19,69821.2 21.0
Regulatory liabilities (Note 6)5):
Accumulated cost of removal of utility plant 262,971 256,744271.6 266.8
Other 28,301 38,02741.4 24.7
Other 12,455 9,17715.9 17.0
Total deferred credits and other liabilities 669,781 695,428701.2 693.8
CAPITALIZATION:
Common stock, without par value -
Outstanding 37,817,878 shares 308.1 308.1
Common stock expense (0.3) (0.3)
Additional paid-in capital 15.0 15.0
Accumulated other comprehensive loss (13.6) (13.3)
Retained earnings 653.8 647.3
Undistributed subsidiary earnings 12.6 12.1
Total common equity 975.6 968.9
Cumulative preferred stock 39.7 39.7
Long-term debt (Note 8) 268.9 306.1
Long-term debt to affiliated company (Note 8) 258.0 258.0
Total capitalization 1,542.2 1,572.7
Total capital and liabilities $2,540,331 $2,505,094$2,592.5 $2,610.4
The accompanying notes are an integral part of these consolidated financial statements.
Page- 8 -
Kentucky Utilities Company
and Subsidiary
Consolidated StatementStatements of Cash Flows
(Unaudited)
(Thousands(Millions of $)
NineThree Months Ended
September 30,March 31,
2005 2004 2003
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 94,82737.5 $ 56,33032.4
Items not requiring cash currently:
Depreciation and amortization 80,265 76,663
Deferred income taxes - net 11,064 10,277
Investment tax credit - net (1,540) (1,981)
Value Delivery Team (VDT)28.6 25.2
VDT amortization (Note 6) 8,816 9,091
Mark-to-market financial2.9 2.9
Change in fair value of derivative instruments (Note 3) (389) 1,231
Provision for post-retirement benefits (Note 8) (3,373) (4,417)
Deferred storm costs (3,760) -(1.2) (0.5)
Other 2,401 15,212(1.1) 6.4
Changes in current assets and liabilities 3,164 (4,888)
Changes in accounts receivable securitization
- net (Note 4) (50,000) -
Pension funding (Notes 9 and 12) (43,409) (9,515)(10.6) (41.7)
Earnings sharing mechanism receivable 5.1 3.3
Pension funding (Note 6) 4,920 7,708
Environmental cost recovery mechanism (Note 6) (7,089) 1,157
Combustion turbine litigation settlement 11,42611) - (43.4)
Other 10,231 23,242(3.8) 10.9
Net cash flows fromprovided by operating activities 117,554 180,11057.4 (4.5)
CASH FLOWS FROMUSED IN INVESTING ACTIVITIES:
Purchase of securities (1,858) (2,818)long-term investments (0.1) (0.7)
Construction expenditures (103,992) (263,899)(18.5) (38.6)
Net cash flows fromused in investing activities (105,850) (266,717)(18.6) (39.3)
CASH FLOWS FROM FINANCING ACTIVITIES:
Long-term borrowings from affiliated company (Note 9) 50,000 175,0008) - 50.0
Short-term borrowings from affiliated company (Note 9) 380,500 520,8408) - 128.0
Repayment of short-term borrowings
from affiliated company (Note 9) (393,900) (541,600)
Retirement of first mortgage bonds - (62,000)
Retirement of pollution control bonds (4,800) -
Refund of issuance costs of pollution
control bonds (4) -(8.9) (130.5)
Payment of common dividends (42,000) -
Payment of preferred dividends (1,692) (1,692)(30.6) (0.5)
Net cash flows from financing activities (11,896) 90,548(39.5) 47.0
CHANGE IN CASH AND CASH EQUIVALENTS (192) 3,941(0.7) 3.2
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 4,869 5,3914.6 4.9
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 4,6773.9 $ 9,3328.1
SUPPLEMENTAL DISCLOSURES:
Cash paid during the period for:
Income taxes $ 40,792(2.3) $ 19,0121.0
Interest on borrowed money 9,195 12,681$ 2.2 $ 1.6
Interest to affiliated companies on borrowed money 9,269 1,060$ 3.2 $ 2.2
The accompanying notes are an integral part of these consolidated financial statements.
Page- 9 -
Kentucky Utilities Company and Subsidiary
Consolidated
Statements of Other Comprehensive Income
(Unaudited)
(Thousands(Millions of $)
Three Months Nine Months
Ended
Ended
September 30, September 30,March 31,
2005 2004 2003 2004 2003
Net income $34,818 $30,310 $94,827 $56,330
Losses on derivative instruments
and hedging activities$37.5 $32.4
Income Taxes - Minimum Pension Liability (Note 6) (0.3) -
Other comprehensive loss, net of tax benefit/(expense) of $17, ($121), $23
and ($121), respectively (Note 3) (26) 182 (40) 182(0.3) -
Comprehensive income $34,792 $30,492 $94,787 $56,512$37.2 $32.4
The accompanying notes are an integral part of these consolidated financial statements.
Page- 10 -
Louisville Gas and Electric Company
and Subsidiary
Kentucky Utilities Company
and Subsidiary
Notes to Consolidated Financial Statements
(Unaudited)
1. General
The unaudited condensed financial statements include the accounts of Louisville GasLG&E and Electric Company and Subsidiary and Kentucky
Utilities Company and Subsidiary (each "LG&E" and "KU", or the
"Companies").KU.
The common stock of each of LG&E and KU is wholly-owned by LG&E Energy LLC ("LG&E Energy").Energy.
In the opinion of management, the unaudited interim financial
statements include all adjustments, consisting only of normal recurring
adjustments, necessary for a fair statement of consolidated financial position,
results of operations, comprehensive income and cash flows for the
periods indicated. Certain information and footnote disclosures
normally included in financial statements prepared in accordance with
generally accepted accounting principles have been condensed or omitted
pursuant to Securities and
Exchange Commission ("SEC")SEC rules and regulations, although the Companies believe
that the disclosures are adequate to make the information presented not
misleading.
See LG&E's and KU's Annual Reports on Form 10-K for the year ended
December 31, 2003,2004, for information relevant to the accompanying
financial statements, including information as to the significant
accounting policies of the Companies.
The accompanying financial statements for the three months and nine
months ended September 30, 2003,March
31, 2004, have been revised to conform to certain reclassifications in
the current three months and nine months
ended September 30, 2004.March 31, 2005. These reclassifications
had no impact on the
balance sheet net assets or net income, as previously reported. LG&E
and KU net operating income previously reported for the three months
ended March 31, 2004 increased by $15.0 million and $21.1 million,
respectively, because the income statement presentation was changed in
2005 to report income tax expense in the category Federal and State
income taxes, which appears just before net income. LG&E and KU other
income (expense) - net previously reported for the three months ended
March 31, 2004 decreased $0.3 million and $1.0 million, respectively,
also due to the income tax reclassification.
2. Mergers and Acquisitions
LG&E and KU are each subsidiaries of LG&E Energy. InOn July 1, 2002, E.ON
AG ("E.ON"), a German company, completed its acquisition of Powergen, Limited ("Powergen"),including
LG&E Energy, for approximately 5.1 billion pounds sterling ($7.3 billion).
As a result of the former parent companyacquisition, LG&E Energy became a wholly-owned
subsidiary of LG&E Energy. AsE.ON and, as a result, LG&E and KU also became indirect
subsidiaries of E.ON. LG&E and KU have continued their separate
identities and serve customers under their existing names. The preferred
stock and debt securities of LG&E and KU were not affected by this
transaction and the utilities continue to file SEC reports. Following the
purchase of Powergen by E.ON,acquisition, E.ON became a registered holding company under the Public Utility Holding Company Act of 1935
("PUHCA"). As a result, E.ON, its utility subsidiaries, includingPUHCA. LG&E
and KU, and certainas subsidiaries of its non-utility subsidiariesa registered holding company, are subject to
extensive regulation by the SECadditional regulations under PUHCA with respect to issuances
and sales of securities, acquisitions and sales of certain utility
properties, and intra-system sales of certain goods and services.PUHCA. In addition, PUHCA generally limits the ability of registered holding
companies to acquire additional public utility systems and to acquire
and retain businesses unrelated to the utility operations of the
holding company. LG&E and KU believe that they have adequate authority
(including financing authority) under existing SEC orders and
regulations to conduct their business. LG&E and KU will seek
additional authorization when necessary.
As contemplated in their regulatory filings in connection with the E.ON
acquisition,March 2003, E.ON, Powergen and
LG&E Energy completed an administrative reorganization to move the LG&E
Energy group from an indirect Powergen subsidiary to an indirect E.ON
subsidiary. This reorganization was
effective in March 2003. In early 2004, LG&E Energy begancommenced direct reporting
arrangements to E.ON.
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 terminationincome to
correspond with income or expense recognized from changes in market
value of any fair value hedge,
the resulting gain or loss is recorded into net income.items being hedged.
As of September 30, 2004,March 31, 2005, LG&E was party to various interest rate swap
agreements with aggregate notional amounts of $228.3$211.3 million. Under
these swap agreements, LG&E paid fixed rates averaging 4.38% and
received variable rates based on LIBOR or the Bond Market Association's
municipal swap index averaging 1.37%1.86% at September 30, 2004.March 31, 2005. The swap
agreements in effect at September 30, 2004March 31, 2005 have been designated as cash
flow hedges and mature on dates ranging from 20052020 to 2033. The hedges
have been deemed to be fully effective resulting in a pretax lossgain of
$9.1 million and a pretax loss of $2.9$2.6 million for the three months and
nine months ended September 30, 2004, respectively,March 31, 2005, recorded in
other comprehensive income. Upon expiration of these hedges, the
amount recorded in other comprehensive income will be reclassified into
earnings. The amounts expected to be reclassified from other
comprehensive income to earnings in the next twelve months areis
immaterial. A deposit in the amount of $10.8 million, used as
collateral for the $83.3 million interest rate swap, is classified as
restricted cash on LG&E's balance sheet. The amount of the deposit
required is tied to the market value of the swap.
In February 2005, an LG&E interest rate swap with a notional amount of
$17 million matured. The swap was fully effective upon expiration,
therefore, the impact on earnings and other comprehensive income from
the swap maturity was less than $0.1 million.
As of September 30, 2004,March 31, 2005, 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 2.70%3.80%, and
received fixed rates averaging 7.74% at September 30, 2004.March 31, 2005. The swap
agreements in effect at September 30, 2004March 31, 2005 have been designated as fair
value hedges and mature on dates ranging from 2007 to 2025. During the
three months and nine months ended September 30, 2004,For 2005,
the effect of marking these financial instruments and the underlying
debt to market resulted in a net pretax gain of $0.3 million and $1.0 million
(representing the hedges' ineffectiveness), respectively,gains recorded as a
decrease in interest expense.expense of
$0.7 million.
- 12 -
Interest rate swaps hedge interest rate risk on the underlying debt.
Under SFAS No. 133, Accounting for Derivative Instruments and Hedging
Activities, in addition to swaps being marked to market, the item being
hedged using a fair value hedge must also be marked to market.
Consequently at September 30, 2004,March 31, 2005, KU's debt reflects an increase of
$9.7a $7.0 million related to such mark-to-marketmark-
to-market adjustment.
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 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. Segments of Business
LG&E's revenues and net income by business segment for the three and
nine months
ended September 30,March 31, 2005 and 2004, and 2003, follow:
Three Months Ended
Nine Months Ended
September 30, September 30,March 31,
(in thousands)millions) 2005 2004 2003 2004 2003
LG&E Electric
Revenues $227,024 $230,174 $617,839 $591,110$ 229.8 $ 198.3
Net income 34,648 41,924 71,031 69,41323.9 15.9
Total assets 2,394.1 2,427.4
LG&E Gas
Revenues 34,818 32,659 242,178 213,939172.6 163.7
Net income (2,110) (2,053) 2,865 5,47810.0 8.3
Total assets 482.7 469.6
Total
Revenues 261,842 262,833 860,017 805,049402.4 362.0
Net income 32,538 39,871 73,896 74,89133.9 24.2
Total assets 2,876.8 2,897.0
KU is an electric utility company. It does not provide gas service and
therefore, is presented as a single business segment.
6.5. Rates and Regulatory AssetsMatters
For a description of each line item of regulatory assets and
Liabilitiesliabilities for LG&E and KU, reference is made to Part I, Item 8,
Financial Statements and Supplementary Data, Note 3 of LG&E's and KU's
Annual Reports on Form 10-K for the year ended December 31, 2004.
The following regulatory assets and liabilities were included in LG&E's
balance sheets as of September 30, 2004March 31, 2005 and December 31, 2003:2004:
- 13 -
Louisville Gas and Electric Company
(Unaudited)
September 30,March 31, December 31,
(in thousands)millions) 2005 2004
2003
VDT costsCosts $ 45,20930.1 $ 67,81037.7
Unamortized loss on bonds 20.0 20.3
ARO 7.1 6.9
Merger surcredit 4.5 4.8
ESM - 2.1
Rate case expenses 1.0 1.1
FAC - 0.8
Gas supply adjustments due from customers 11,068 22,077
Unamortized loss on bonds 20,537 21,333
Earnings sharing mechanism (ESM) provision 5,446 12,359
Merger surcredit 5,183 6,220
Asset retirement obligation (ARO) 6,674 6,01510.2 13.3
Gas performance-basedperformance base ratemaking (PBR) 3,467 5,480
Other (including fuel adjustment clause
(FAC), demand side management (DSM),
etc.) 2,599 2,3322.4 3.7
Manufactured gas sites 1.1 1.2
Total regulatory assets $100,183 $143,626$ 76.4 $ 91.9
Accumulated cost of removal of utility plant $214,950 $216,491$214.1 $220.2
Deferred income taxes - net 38,595 41,180(Note 6) 55.8 37.2
ARO 0.1 0.1
ECR 4.0 4.0
FAC 0.8 -
ESM 1.4 -
DSM 3.3 2.5
Gas supply adjustments due to customers 7,804 6,805
DSM 2,602 1,706
Other (including environmental cost
recovery (ECR), ARO, FAC and ESM) 4,534 2,1317.1 8.4
Total regulatory liabilities $268,485 $268,313
Page 13$286.6 $272.4
LG&E currently earns a return on all regulatory assets except for gas
supply adjustments, ESM, gas performance-based ratemaking, FAC, and DSM,gas performance based ratemaking, all
of which are separate rate mechanisms with recovery within twelve
months. Additionally, no current return is earned on the ARO
regulatory asset. This regulatory asset will be offset against the
associated regulatory liability, ARO asset and ARO liability at the
time the underlying asset is retired.removed.
The following regulatory assets and liabilities were included in KU's
balance sheets as of September 30, 2004March 31, 2005 and December 31, 2003:2004:
- Page 14 -
Kentucky Utilities Company
(Unaudited)
September 30,March 31, December 31,
(in thousands)millions) 2005 2004 2003
VDT costs $ 17,63511.8 $ 26,45114.7
Unamortized loss on bonds 9,946 10,511
ESM provision 7,462 12,38211.2 11.4
ARO 13.3 12.8
Merger surcredit 4,012 4,815
ARO 12,464 11,3223.5 3.7
ESM - 3.1
Rate case expenses 1.0 1.1
FAC 1,713 4,29813.1 9.4
Deferred storm costs 3,760 -
Other 5,676 2,5393.4 3.6
Post retirement and pension 1.2 1.2
Management audit expenses 0.4 0.4
Total regulatory assets $ 62,66858.9 $ 72,31861.4
Accumulated cost of removal of utility plant $262,971 $256,744$271.6 $266.8
Deferred income taxes - net 22,174 24,058(Note 6) 32.4 19.3
ARO 1,351 1,1621.5 1.4
ECR 2.5 1.2
FAC - 0.1
ESM 2.0 -
DSM 1.9 1.6
Spare parts 1,062 1,055
ECR 2,100 9,189
Other (including FAC and DSM) 1,614 2,5631.1 1.1
Total regulatory liabilities $291,272 $294,771$313.0 $291.5
KU currently earns a return on all regulatory assets except for ESM and
FAC, and DSM, allboth of which are separate recovery mechanisms with recovery
within twelve months. Additionally, no current return is earned on the
ARO regulatory asset. This regulatory asset will be offset against the
associated regulatory liability, ARO asset and ARO liability at the
time the underlying asset is retired.
Inremoved.
Based on an order from the Kentucky Commission in September 2004, KU
reclassified from maintenance expense to a regulatory asset, $4.0
million related to unreimbursed costs not reimbursed from the 2003 ice storm based on an order from the Kentucky Commission.storm. These
costs will be amortized through June 2009. KU earns a return of theseThese amortized costs,
which are included in KU's jurisdictional operating expenses.
During May and July,expenses, are
recovered in base rates.
Due to a number of changes in Kentucky's tax system, including the
reduction of the Corporate income tax, timing differences included in
the reserve for deferred state income taxes at December 31, 2004 will
reverse at lower rates than previously provided. See Note 6.
- 15 -
ELECTRIC AND GAS RATE CASES
On June 30, 2004, the Kentucky Commission issued an order approving an
increase in the base electric rates of LG&E and KU incurred $17.0 million and $3.5
million, respectively,the gas rates of
storm restoration costs associated with
severe storms in their service territories. Of these amountsLG&E. The rate increases took effect on July 1, 2004.
During July 2004, the AG served subpoenas on 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 requestingas well as on
the Kentucky Commission and its staff, requesting information regarding
alleged improper communications between LG&E and KU and the Kentucky
Commission. The Kentucky Commission procedurally reopened the rate case
for the limited purpose of taking evidence, if any, as to the
communication issues. In September and October 2004, various
proceedings were held in circuit courts in Franklin and Jefferson
Counties, Kentucky regarding the scope and timing of document
production or other information required or agreed to be produced under
the AG's subpoenas and matters were consolidated into the Franklin
County court.
In January 2005, the AG conducted interviews of certain employees of
LG&E and KU and submitted its report to the Franklin County, Kentucky
Circuit Court in confidence. Concurrently, the AG filed a motion
summarizing the report as containing evidence of improper
communications and record-keeping errors by LG&E and KU in their
conduct of activities before the Kentucky Commission or other state
governmental entities and requesting release of the report to such
agencies. During February 2005, the court ruled that the report be
forwarded to the Kentucky Commission under continued confidential
treatment to allow deferral of these O&M expenses for recovery in a
future rate proceeding duringit to consider the fourth quarter of 2004.
Page 14
7. Utility Plant
KU retired two steam generating units, Green River Units 1report, including its impact, if
any, on completing its investigation and 2,any remaining steps in the
amountrate case, including ending the current abeyance. To date, LG&E and KU
have neither seen nor requested copies of $17.2 million, fromthe report or its books ascontents.
LG&E and KU believe no improprieties have occurred in their
communications with the Kentucky Commission and are cooperating with
the proceedings before the AG and the Kentucky Commission.
LG&E and KU are currently unable to determine any possible future
actions of the AG or the Kentucky Commission or the ultimate impact, if
any, of the AG's report and investigation, including whether there will
be further actions to appeal, review or otherwise challenge the granted
increases in base rates.
- 16 -
VDT
The current five-year VDT amortization period is scheduled to expire in
March 31, 2004.
Approximately $4 million2006. As part of the settlement agreements in common assets, which are shared by Green
River Units 3the electric and
4,gas rate cases, LG&E and KU shall file with the Kentucky Commission a
plan for the future ratemaking treatment of the VDT surcredits and
costs six months prior to the March 2006 expiration. The surcredit
shall remain on KU's books. The common assets will
remain on KU's booksin effect following the expiration of the fifth year until
the final retirementCommission enters an order on the future disposition of Green River Units 3VDT-related
issues.
ECR
In December 2004, KU and 4.LG&E filed applications with the Kentucky
Commission for approval of a CCN to construct new SO2 control
technology (FGDs) at KU's Ghent and Brown stations, and to amend LG&E's
compliance plan to allow recovery of new and additional environmental
compliance facilities. The 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 impactestimated capital cost of the retirement of Green River Units 1 and 2 on the AROadditional
facilities is immaterial. A
partial redemption of pollution control Series 14 bonds totaling $4.8$742.7 million was required in the second quarter as a result of the
retirement (see Note 9).
The following data represent shares of jointly-owned additions to the
Trimble County plant for four combustion turbines ("CTs") as of
September 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, resulting
in an increase to plant in service of $37.3 and $63.8($40.2 million for LG&E and KU, respectively.
($$702.5 million
for KU), of which $658.9 million is for the FGDs. Hearings in millions)these
cases occurred during May 2005 and final orders are expected in June
2005.
MISO
The MISO implemented a day-ahead and real-time market, including a
congestion management system in April 2005. This system is similar to
the LMP system currently used by the PJM RTO and contemplated in FERC's
SMD NOPR, currently being discussed. The MISO filed with FERC a
mechanism for recovery of costs for the congestion management system.
The MISO proposed the addition of two new Schedules, 16 and 17.
Schedule 16 is the MISO's cost recovery mechanism for the Financial
Transmission Rights Administrative Service it provides. Schedule 17 is
the MISO's mechanism for recovering costs it incurs for providing
Energy Marketing Support Administrative Service. The MISO transmission
owners, including LG&E and KU, 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 $18.3 $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 $18.3 $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 $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 $18.5 $31.7 $50.2
8. New Accounting Pronouncements
FIN 46
In January 2003,objected to the Financial Accounting Standards Board ("FASB")
issued Financial Accounting Standards Board Interpretation No. 46,
Consolidationallocation of Variable Interest Entities,costs
among market participants and retail native load. FERC ruled in 2004 in
favor of the MISO.
The Kentucky Commission opened an Interpretationinvestigation into LG&E and KU's
memberships in the MISO in July 2003. The Kentucky Commission directed
LG&E and KU to file testimony addressing the costs and benefits of ARB
No. 51 ("FIN 46"). FIN 46 requiredthe
MISO membership both currently and over the next five years and other
legal issues surrounding continued membership. LG&E and KU engaged an
independent third-party to conduct a cost-benefit analysis on this
issue. The information was filed with the Kentucky Commission in
September 2003. The analysis and testimony supported the exit from the
MISO, under certain variable interest entitiesconditions. The MISO filed its own testimony and
cost benefit analysis in December 2003. A final Kentucky Commission
order was expected in the second quarter of 2004. The ruling has since
been delayed due to the Kentucky Commission's request for additional
testimony on the MISO's Market Tariff filing at FERC; a ruling is
expected by summer 2005.
- 17 -
Should LG&E and KU be ordered to exit the MISO, current MISO rules may
also impose an exit fee. While LG&E and KU believe legal and
regulatory precedent should permit most or many of the MISO-related
costs to be consolidated byrecovered in their rates charged to customers, they can
give no assurance that state or federal regulators will ultimately
agree with such position with respect to all costs, components or
timing of recovery. In April 2005, the primary beneficiaryKentucky Commission issued an
order declining an LG&E and KU request for an automatic monthly tracker
of certain MISO-related costs, to be recovered through a new rate
mechanism.
At this time, LG&E and KU cannot predict the outcome or effects of the
entity ifvarious FERC and Kentucky Commission proceedings described above,
including whether such proceedings will have a material impact on the
equity investorsfinancial condition or results of operations of the Companies.
Financial consequences (changes in transmission revenues and costs)
associated with the entity dotransmission market tariff charges are subject to
varying assumptions and calculations and are therefore difficult to
estimate. Changes in revenues and costs related to broader shifts in
energy market practices and economics are not havecurrently estimable.
KENTUCKY COMMISSION STRATEGIC BLUEPRINT
In February 2005, Kentucky's Governor signed an executive order
directing the characteristics ofKentucky Commission, in conjunction with the Commerce
Cabinet and the Environmental and Public Protection Cabinet, to
develop a controlling financial interest or do not have sufficient equity at riskStrategic Blueprint for the entitycontinued use and development of
electric energy'. This Strategic Blueprint will be designed to finance its activities without additional
subordinated financial support from other parties. FIN 46 was
effective immediatelypromote
future investment in electric infrastructure for the Commonwealth of
Kentucky, to protect Kentucky's low-cost electric advantage, to
maintain affordable rates for all new variable interest entities created or
acquired after January 31, 2003.
Page 15Kentuckians, and to preserve
Kentucky's commitment to environmental protection. In December 2003, FIN 46 was revised, delayingMarch 2005, the
effective dates for
certain entities created before February 1, 2003,Kentucky Commission established Administrative Case No. 2005-00090 to
collect information from all jurisdictional utilities in Kentucky,
including LG&E and making other
amendmentsKU, pertaining to clarify applicationKentucky electric generation,
transmission and distribution systems. The Kentucky Commission must
provide its Strategic Blueprint to the Governor in early August 2005.
LG&E and KU responded to the Kentucky Commission's first set of 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 applieddata
requests at the end of March 2005.
6. Income Taxes
Kentucky House Bill 272, also known as Kentucky's Tax Modernization
Plan, was signed into law on March 18, 2005. This bill contains a
number of changes in Kentucky's tax system, including the first interim or annual reporting period ending after December
15, 2003. FIN 46R may be applied prospectively with a cumulative-
effect adjustment asreduction of
the date it is first applied, or by restating
previously issued financial statements withCorporate income tax rate from 8.25% to 7% effective January 1,
2005, and a cumulative-effect
adjustment asfurther reduction to 6% effective January 1, 2007. Because
of the beginningtax rate reduction, timing differences included in the reserve
for deferred state income taxes at December 31, 2004, will reverse at
lower rates than previously provided. Without some form of adjustment,
- 18 -
the first year restated. FIN 46R
also requires certain disclosuresdeferred tax reserve amount will exceed the actual deferred tax
liability attributable to existing timing differences. This excess
amount is referred to as excess deferred income taxes. The Company has
filed an application with the Kentucky Commission requesting approval
of an entity's relationship with
variable interest entities.its accounting treatment to establish and amortize a regulatory
liability for its net excess deferred tax balance. 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.
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 foramortizing their depreciation-related excess deferred tax balances
under the costaverage rate assumption method. The average rate assumption
method of accounting. As of September 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 tomatches the value of their
investments. In the eventamortization of the inabilityexcess deferred taxes with the
life of OVECthe timing differences to fulfill its
powerwhich it relates.
Significant judgment is required in determining the provision requirements,for
income taxes, and there are many transactions for which the ultimate
tax outcome is uncertain. To provide for these uncertainties
or exposures, LG&E and KU would substitute such power
supply with either owned generation or market purchasesmaintain an allowance for tax contingencies,
the balance of which management believes is adequate. Tax
contingencies are analyzed periodically 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 EEIadjustments are made when
events occur to warrant a change. LG&E and KU are currently in the
examination phase of IRS audits for the years 1999 to 2003 and
expect some or all of these audits to be completed within the
next twelve months. LG&E is also under a contractual formula which has resulted in costs which wereKentucky sales and use tax
audit for the periods October 1, 1997 through December 31, 2001, and an
initial assessment is expected within the next three months. The
results of audit assessments by taxing authorities could have a
material effect on quarterly or annual cash flows as well as results of
operations over the next three to twelve months as these audits are
expected to be comparable to the costcompleted. However, LG&E and KU do not believe that any of other power purchased or
generated by KU. Such power equated to approximately 9%these
matters will have a material adverse effect on results 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
September 30, 2004, totaled $12.7 million. KU's direct 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.operations.
7. New Accounting Pronouncements
FSP 106-2
In May 2004, the FASB finalized FASB Staff Position ("FSP")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 iswas effective for the first interim or annual
period beginning after June 15, 2004. FSP 106-2 does not have a
material impact on LG&E or KU.
FSP 109-1
In December 2004, the Companies.
Page 16
9.FASB finalized FSP 109-1, Accounting for Income
Taxes, Application of FAS 109 to the Tax Deduction on Qualified
Production Activities Provided by the American Jobs Creation Act of
2004, which requires the tax deduction on qualified production
activities to be treated as a special deduction in accordance with FAS
109. FSP 109-1 became effective December 21, 2004. For the three
months ended March 31, 2005, LG&E and KU recognized $0.4 million and
$0.2 million, respectively, in tax benefits related to this deduction.
- 19 -
FIN 47
In March 2005, the FASB issued Financial Accounting Standards Board
Interpretation No. 47, Accounting for Conditional Asset Retirement
Obligations, an interpretation of FASB Statement No. 143 ("FIN 47").
FIN 47 clarifies that the term "conditional asset retirement
obligation" as used in SFAS No. 143, Accounting for Asset Retirement
Obligations, refers to a legal obligation to perform an asset
retirement activity in which the timing and (or) method of settlement
are conditional on a future event that may or may not be within the
control of the entity. The obligation to perform the asset retirement
activity is unconditional even though uncertainty exists about the
timing and (or) method of settlement. An entity is required to
recognize a liability for the fair value of a conditional asset
retirement obligation if the fair value of the liability can be
reasonably estimated. The fair value of a liability for the
conditional asset retirement obligation should be recognized when
incurred; generally, upon acquisition, construction, or development and
through the normal operation of the asset. FIN 47 is effective no
later than the end of fiscal years ending after December 15, 2005. LG&E
and KU are currently evaluating the impact of this pronouncement.
8. 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 Bonds,pollution
control bonds Series 10, 12, 13, 14, and 15, the bonds are subject to
tender for purchase at the option of the holder and to mandatory tender
for purchase upon the occurrence of certain events, causing the bonds
to be classified as current portion of long-term debt in the Consolidated Balance
Sheets. The average annualized interest rate for these bonds during
the three months ending March 31, 2005 was 1.96% for both LG&E and nine months ending September
30,KU.
During June 2004, LG&E renewed five revolving lines of credit with
banks totaling $185 million. There was 1.20%no outstanding balance under
any of these facilities at March 31, 2005. The Company expects to
renew these facilities prior to their expiration in June 2005.
LG&E, KU and 1.14%, respectively,LG&E Energy participate in an intercompany money pool
agreement. Details of the balances at March 31, 2005 and March 31, 2004
were as follows:
Total Money Amount Balance Average
(millions of $) Pool Available Outstanding Available Interest Rate
March 31, 2005:
LG&E $400.0 $35.0 $365.0 2.65%
KU 400.0 26.0 374.0 2.65
March 31, 2004:
LG&E $400.0 $ - $400.0 -%
KU 400.0 40.7 359.3 0.98
- 20 -
LG&E Energy maintains a revolving credit facility totaling $200 million
with E.ON North America, Inc. to ensure funding availability for the
LG&E bonds and
1.30% and 1.18%, respectively, for the KU bonds.money pool. There was no balance outstanding on this facility at March
31, 2005.
In January 2004,2005, LG&E entered into two long-term loans 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 one totaling $100 million with an interest rate of 1.53% that
matures in January 2005. The loans are secured bypaid at maturity 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. Theusing proceeds were used to fund a pension
contribution and to repay other debt obligations.from short-term loans from the money pool.
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
$50April 2005, LG&E refinanced $40 million in existing pollution
control indebtedness. The original indebtedness, 5.75%5.90% Pollution
Control Bonds, Series 9,X, due December 1,April 15, 2023, will bewas discharged on November 22, 2004, withMay 13,
2005, using the proceeds from the replacement indebtedness, KULG&E
Pollution Control Bonds, Series 17,HH, due OctoberFebruary 1, 2034,2035, 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 September 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 $40.7 million in money pool loans from LG&E Energy (included
in "Notes payable to affiliated companies") at an average rate of 1.60%
at September 30, 2004, and $75.1 million at an average rate of 1.06% at
September 30, 2003. The balance of the money pool loans from LG&E
Energy to KU (included in "Notes payable to affiliated companies") was
$29.8 million at an average rate of 1.60% and $98.7 million at an
average rate of 1.06% at September 30, 2004 and 2003, respectively.
The amount available to LG&E under the money pool agreement at
September 30, 2004, was $359.3 million. The amount available to KU
under the money pool agreement at September 30, 2004, was $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 $79.1
million at an average rate of 2.13% under this facility as of September
30, 2004, and availability of $70.9 million remained.
Page 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.
10.9. 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.Energy. Transactions between LG&E or KU and E.ON subsidiaries are
eliminated upon consolidation of E.ON subsidiaries.E.ON. These transactions are generally
performed at cost and are in accordance with the SEC regulations under
the PUHCA and the applicable Kentucky Public Service Commission ("Kentucky Commission") regulations. Accounts
payable to and receivable from related parties are netted and presented
as accounts payable to affiliated companies on the balance sheets of
LG&E and KU, as allowed due to the right of offset. Obligations related
to intercompany debt arrangements with LG&E Energy and Fidelia are
presented as separate line items on the balance sheet, as appropriate.
The significant related-party transactions are disclosed below.
Electric Purchases
LG&E and KU intercompany electric revenues and purchased power expense
(including LG&E Energy Marketing Inc. ("LEM"))from affiliated companies for the three months ended March 31, 2005 and
nine months ended September 30, 2004 and 2003, were as follows:
Three months endedNine months ended
September 30, September 30,____LG&E____ ______KU______
(in thousands)millions) 2005 2004 20032005 2004 2003
LG&E
Electric operating revenues from KU $10,095 $11,980 $40,598 $39,799$25.8 $22.1 - -
Electric operating revenues from LG&E - - $30.1 $21.6
Electric operating revenues from LEM 1,092 537 2,443 8,6910.3 0.7 - -
Purchased power from KU 12,206 11,000 42,905 34,675
KU
Electric operating revenues
from LG&E $12,206 $11,000 $42,905 $34,675
Electric operating revenues
from LEM 346 174 895 2,19630.1 21.6 - -
Purchased power from LG&E 10,095 11,980 40,598 39,799- - 25.8 22.1
- 21 -
Interest Income and ExpenseCharges
LG&E intercompany interest income and expense for the three months and
nine months ended September 30, 2004 and 2003, were as follows:
Three months ended Nine months ended
September 30, September 30,
(in thousands) 2004 2003 2004 2003
Interest to affiliate
(money pool) $ 102 $ 305 $ 137 $1,573
Interest to affiliate
(Fidelia loans) 2,927 1,801 8,995 2,560
Interest to affiliate (KU) 11 5 25 4
Interest expense to
affiliated companies $3,040 $2,111 $9,157 $4,137
Interest income from affiliate (KU) - $ 2 - $ 6
Page 18 KU intercompany interest income and expense for the three
months ended March 31, 2005 and nine months ended September 30, 2004 and 2003, were as follows:
Three months ended Nine months ended
September 30, September 30,____LG&E____ ______KU______
(in thousands)millions) 2005 2004 20032005 2004
2003
Interest to affiliate
(money pool)on money pool loans $0.4 $ 96 $ 279 $ 315 $1,001- $0.1 $0.2
Interest to affiliate
(Fidelia loans) 3,461 1,635 10,326 2,394
Interest to affiliate (LG&E) - 2 - 6
Interest expense to affiliated
companies $3,557 $1,916 $10,641 $3,401
Interest income from
affiliate (LG&E) $ 11 $ 5 $ 26 $ 4on Fidelia loans 2.7 3.1 3.5 3.4
Other Intercompany Billings
Other intercompany billings (including LG&E Energy Services Inc. ("LG&E
Services")) related to LG&E and KU for the three months
ended March 31, 2005 and nine months
ended September 30, 2004 and 2003, were as follows:
Three months ended Nine months ended
September 30, September 30,
(in thousands)millions) 2005 2004 2003 2004 2003
LG&E Services billings to LG&E $40,221 $44,607 $138,796 $132,894$32.3 $38.2
LG&E Services billingsbilling to KU 42,342 48,508 117,530 134,91625.8 30.6
LG&E billings to LG&E Services 5,951 12,801 10,475 18,944
LG&E billings to KU 14,962 25,127 48,464 61,2484.7 3.0
KU billings to LG&E Services 516 4,774 4,430 12,6383.2 2.8
LG&E billings to KU 14.1 16.6
KU billings to LG&E 2,097 3,104 26,928 11,549
11.Commitments4.0 1.5
10. Commitments and Contingencies
Except as may be discussed in this Quarterly Report on Form 10-Q
(including Note 5), material changes have not occurred in the current
status of various commitments or contingent liabilities from that
discussed in the Companies' Annual Report on Form 10-K for the year
ended December 31, 2003,2004 (including in Notes 3 and 11 to the financial
statements of LG&E and KU contained thereintherein.) See Notes 3 and incorporated herein by reference) or Quarterly Reports11 to
the Companies' Annual Report on Form 10-Q10-K for the quarters 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.information regarding
such commitments or contingencies.
LITIGATION
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 litigation commenced 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.
During July 2004, the Attorney General of Kentucky ("AG") served
subpoenas on KU and LG&E, as well as on the Kentucky Commission and its
staff, requesting information regarding allegedly improper
communications between KU 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
further proceedings in 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, including whether there will
be further actions to appeal, review or otherwise challenge the 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.
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 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 CourtOMU against KU concerning a long-termlong-
term power supply contract (the "OMU Agreement") with KU. The dispute involves interpretational
differences regarding certain issues under thecontinues. To date, OMU Agreement, including
various payments or charges between KU and OMU and rights concerning
excess power, termination and emissions allowances, respectively. The
complaint seekshas claimed
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 currently has removedjurisdictional or summary judgment
motions, respectively, pending before the FERC and district court
regarding aspects of this litigationmatter.
ENVIRONMENTAL MATTERS
LG&E and KU are subject to the U.S. District Court for the Western District of
Kentucky, filed an answer in that court denying the OMU claimsSO2 and presenting certain counterclaims and commenced a FERC proceeding to
request FERC jurisdictionNOx emission limits on certain issues. In October 2004, FERC
declined to exercise exclusive jurisdiction regarding the issues in
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-firedtheir
electric 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 allAct. 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
installing additionalplaced into operation significant NOx controls to their generating
units.
Installations of additional NOx controls were performed on a phased
basis, which commenced in late 2000 and continued throughunits prior to the final
compliance date.2004 Summer Ozone Season. As of September 30,December 31, 2004,
LG&E hasand KU incurred total capital costs of approximately $185$186 million
and $219 million, respectively, to reduce itstheir NOx emissions to the 0.15 lb./Mmbtu level on a company-wide basis. As of September
30, 2004, KU has incurred total capital costs of approximately $203
million to reduce its NOx emissions to the 0.15 lb./Mmbtu level on a
company-wide basis.below
required levels. In addition, LG&E and KU have begun incurringincur additional operationoperating
and maintenance costs in operating new NOx controls.
LG&E- 22 -
KU has implemented a plan for adding significant additional SO2
controls to its generating units. Installation of additional SO2
controls will proceed on a phased basis, with construction of controls
(i.e. FGDs) commencing in mid-2005 and continuing through the final
installation and operation in 2009. KU believe theirestimates that it will incur
$658.9 million in capital costs related to the construction of the FGDs
to achieve compliance with current emission limits on a company-wide
basis. In addition, KU will incur additional operating and maintenance
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.operating new SO2 controls.
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 regulateClean Air Mercury Rule which
regulates mercury emissions from steam electric generating units and
to further reducereductions in emissions of sulfur
dioxideSO2 and nitrogen oxidesNOx required 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 StationFrom time to a
wet stack operation in an effort to resolve all outstanding issues
related to particulate matter emissions.
FERC 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 predictconduct negotiations with the outcomeapplicable
regulatory authorities to finalize cleanup plans or effectsdetermine financial
responsibility concerning other environmental matters, including
remediation steps regarding former LG&E and KU MGP sites, a settlement
agreement relating to a fuel oil discharge at KU's E.W. Brown plant and
matters relating to a KU transformer scrap yard.
In January 2005, approximately 1,000 gallons of fuel oil leaked
from a cracked weld in a storage tank at KU's Green River
Generating Station. KU commenced immediate spill containment,
recovery and remediation actions and has received satisfactory
inspections from state regulators to date. The cost related to
the cleanup of the oil spill was less than $0.2 million.
In the normal course of business, lawsuits, claims, environmental
actions, and various FERCnon-ratemaking governmental proceedings describedarise
against LG&E and KU. To the extent that damages are assessed in any of
these lawsuits, LG&E and KU believe that their insurance coverage or
other appropriate reserves are adequate. Management, after
consultation with legal counsel, and based upon the present status of
these items, does not anticipate that liabilities arising out of other
currently pending or threatened lawsuits and claims of the type
referenced above including whether such will have a material impactadverse effect on theLG&E's or KU's
financial conditionsposition or results of operationsoperations.
EEI CONTRACT
KU owns 20% of the Companies.
12.Pensioncommon 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
- 23 -
are expected to be comparable to the cost of other power generated by
KU. This contract governing the purchases from EEI will terminate on
December 31, 2005. Such power equated to approximately 10% of KU's net
generation system output in 2004 and for the first quarter of 2005.
Discussions are on-going related to the extension of the contract.
11. Pension and Other Post-retirement Benefit Plans
The following table provides the components of net periodic benefit
cost for pension and other benefit plans:
Three Months Ended Year to Date
September 30, 2004 September 30, 2004plans for the three months ended
March 31, 2005:
(in thousands)millions) LG&E KU
LG&E KUPension and Other Benefit Plans:
Components of net periodicperiod benefit cost:cost
Service cost $ 9771.7 $ 1,152 $ 3,997 $ 4,7541.8
Interest cost 4,910 3,692 20,092 15,2406.5 4.3
Expected return on plan assets (4,469) (3,334) (18,287) (13,764)(6.0) (4.0)
Amortization of prior service cost (2) 154 (9) 6361.3 0.3
Amortization of transition obligation 939 281 3,843 1,161- 0.2
Recognized actuarial loss 515 331 2,107 1,3690.7 0.6
$ 2,8704.2 $ 2,276 $11,743 $ 9,3963.2
In January 2004, LG&E and KU made discretionary contributions to theirthe
pension plans in the amountsplan of $34.5 million and $43.4 million, respectively. No
discretionary contributions to the pension plans are required for 2004planned for either
LG&E or KU and no furtherfor 2005, but one or both Companies may make a discretionary
contributions are planned for 2004.
13.contribution to the other post-retirement benefit plans.
12. Subsequent Events
On October 20, 2004, KU completed a refinancing transaction regarding
$50April 13, 2005, LG&E refinanced $40 million in existing pollution
control indebtedness. The original indebtedness, 5.75%5.90% Pollution
Control Bonds, Series 9,X, due December 1,April 15, 2023, will bewas discharged on November 22, 2004, withMay 13,
2005, using the proceeds from the replacement indebtedness, KULG&E
Pollution Control Bonds, Series 17,HH, due OctoberFebruary 1, 2034,2035, which will carry a
variable, auction rate of interest.
On May 12, 2005, KU issued a redemption notice to bondholders for its
7.55% First Mortgage Bonds, Series R, totaling $50 million. It is
currently anticipated the bond will be redeemed on June 13, 2005, and
the Company will pay a call premium of 3.775%. KU has also received
notice from the counterparty to the interest rate swap related to this
bond that it will terminate the swap and pay to KU the same 3.775% call
premium pursuant to the terms of the swap.
- 24 -
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations.
General
The following discussion and analysis by management focuses on those
factors that had a material effect on LG&E's and KU's financial results of
operations and financial condition during the three and nine month periodsperiod ended
September 30, 2004,March 31, 2005, 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,
2003.2004.
Executive Summary
LG&E's net income&E and KU, subsidiaries of LG&E Energy LLC (an indirect subsidiary of
E.ON), are regulated public utilities. LG&E supplies electricity to
approximately 391,000 customers and natural gas to approximately 320,000
customers in Louisville and adjacent areas in Kentucky. KU provides
electric service to approximately 490,000 customers in over 77 counties in
central, southeastern and western Kentucky, to approximately 30,000
customers in southwestern Virginia and to less than 10 customers in
Tennessee. KU also sells wholesale electric energy to 12 municipalities.
The mission of LG&E and KU is to build on our tradition and achieve world-
class status providing reliable, low-cost energy services and superior
customer satisfaction; and to promote safety, financial success and quality
of life for the three months ended September 30, 2004 was $32.5
million ($7.3 million lower than the three months ended September 30,
2003). The decrease was primarily related to maintenance costs resulting
from severe storms which swept through the service territory in Julyour employees, communities and lower electric sales due to milder weather. KU's net income for the three
months ended September 30, 2004, was $34.8 million ($4.5 million higher
than the three months ended September 30, 2003). The increase was
primarily due to higher retail electric revenues resulting from the general
rate increase, partially offset by higher depreciation expense.
Page 23
LG&E's net income for the nine months ended September 30, 2004 was $73.9
million ($1.0 million lower than the nine months ended September 30, 2003).
The decrease was primarily related to higher operations and maintenance
expense, offset by higher electric revenues resulting from the general rate
increase and a higher environmental cost recovery surcharge. KU's net
income for the nine months ended September 30, 2004 was $94.8 million
($38.5 million higher than the nine months ended September 30, 2003). The
increase was primarily due to higher electric revenues and lower
maintenance expense (KU service territory experienced a severe ice storm in
2003).
As regulated utilities,other stakeholders.
LG&E and KU's financial performance is greatly
impacted by regulatory proceedings. Onstrategy focuses on the following:
- Execute all our business processes to secure a world-class
competitive advantage
- Develop and transfer best practices in generation, customer service,
distribution and supply
- Operate our commercial hub to enhance margins and manage risks across
the company
- Pursue flexible asset portfolio management
- Attract, retain and develop the best people.
- 25 -
In a June 30, 2004 order, the Kentucky Commission issued an order approving increasesaccepted the settlement
agreements reached by the majority of the parties in the base rates ofrate cases filed
by LG&E and KU.KU in December 2003. Under the ruling, the LG&E utility base
electric rates have increased $43.4 million (7.7%) and base gas rates have
increased $11.9 million (3.4%), on an annual basis. The rate increaseincreases
took effect on July 1, 2004. Subsequently,Base electric rates at KU have increased
$46.1 million (6.8%) annually. The 2004 increases were the AG commenced an investigation examining communications betweenfirst increases
in electric base rates for LG&E and KU in 13 and 20 years, respectively;
the last gas rate increase for the LG&E gas utility took effect in
September 2000.
With the recent installation of four combustion turbines at Trimble County,
near-term regulated load growth in Kentucky is expected to be satisfied.
However, the Integrated Resource Plan submitted by LG&E and KU to the
Kentucky Commission in April 2005 indicated the requirement for additional
base-load capacity in the longer-term. Consequently, LG&E and KU have
begun development efforts for a new base-load coal-fired unit. Trimble
County Unit 2, with a 732 Mw capacity rating, is expected to be jointly
owned by LG&E and KU (75% aggregate ownership) and IMEA and IMPA (25%
aggregate ownership). Of their 75% (549 Mw) ownership, LG&E will own 19%
(104 Mw) and KU will own 81% (445 Mw). An application for a construction
CCN was filed with the Kentucky Commission and an air permit application
was filed with the CompaniesKentucky Department of Air Quality in December 2004.
LG&E's and separately, filedKU's share of the total capital cost of $885 million for Trimble
County Unit 2 is estimated to be $168 million and $717 million,
respectively, through 2010. An application for a rehearing of the
rate cases on such issue and certain calculation components of the
increased rates and filed for the existing rate increasestransmission CCN is
anticipated to be set aside.
Thefiled with the Kentucky Commission is considering the matters relatingduring 2005.
In addition to the AG's
actions. ForTrimble County Unit 2 project, another focus of major
utility investment is environmental expenditures. In order to mitigate the
declining SO2 allowance bank at KU over the next several years, KU filed
with the Kentucky Commission in December 2004 an application for a descriptionCCN to
construct four FGDs at an estimated cost 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.$658.9 million; a decision is
expected by late June 2005.
Results of Operations
The results of operations for LG&E and KU are affected by seasonal
fluctuations in temperature and other weather-related factors. Because of
these and other factors, the results of one interim period are not
necessarily indicative of results or trends to be expected for another period.the full
year.
- 26 -
Three Months Ended September 30, 2004,March 31, 2005, Compared to
Three Months Ended September 30, 2003March 31, 2004
LG&E Results:
LG&E's net income decreased $7.3increased $9.7 million (18%(40%) for the three months ended
September 30, 2004,March 31, 2005, as compared to the three months ended September 30,
2003,March 31, 2004,
primarily due to the increase in electric and gas base rates effective July
1, 2004 and higher maintenance expenses related to July stormselectric and lower electricgas wholesale sales.
A comparison of LG&E's revenues for the three months ended September 30,
2004,March 31, 2005,
with the three months ended September 30, 2003,March 31, 2004, reflects increases and
(decreases) which have been segregated by the following principal causes:
(in thousands)Cause Electric Gas
Cause(in millions) Revenues Revenues
Retail sales:
Fuel and gas supply adjustments $ (425) $1,2433.6 $ 1.3
Environmental cost recovery surcharge 3,707(0.8) -
Earnings sharing mechanism 139(3.6) -
Demand side management cost recovery 0.1 -
LG&E/KU merger surcredit 123(1.1) -
Value delivery surcredit (256) 28
Demand side management 3 (42)
General(0.3) (0.2)
Weather normalization - (0.7)
Rates and rate increase 10,105 1,443structure 15.3 4.3
Variation in sales volume and other (11,353) (647)2.0 (1.9)
Total retail sales 2,043 2,02515.2 2.8
Wholesale sales (2,448)14.4 5.9
Gas transportation - net - (0.3)
Provision for rate refunds (2,689)collections 2.3 -
Other (56) 134(0.4) 0.5
Total $(3,150) $2,159
Page 24$31.5 $ 8.9
Electric revenues decreased $3.2increased $31.5 million (16%) in 2005 primarily asdue to:
- - An increase in rates and a result of lower
sales volumes from cooler weather as cooling degree days declined 3.2% from
last year. Also contributing to the decrease were lowerchange in rate structure ($15.3 million).
- - Higher wholesale revenues and($14.4 million), primarily due to 21% 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.prices.
Gas revenues increased $2.2$8.9 million (5%) in 2005 primarily as a result of the general rate
increase, effective with service rendered July 1, 2004,due to:
- - Higher wholesale revenues ($5.9 million) due to 42% higher sales
volumes and an11% higher prices.
- - An increase in recovery of higher natural gas prices billed to customers through the gas
supply clause.rates and a change in rate structure ($4.3 million).
Fuel for electric generation and gas supply expenses comprise a large
component of LG&E's total operating expenses. LG&E's electric and gas
rates contain a fuel adjustment clause and a gas supply clause,
respectively, whereby increases or decreases in the cost of fuel and gas
supply are reflected in retail rates, subject to the approval of the
Kentucky Commission.
- 27 -
Fuel for electric generation decreased $2.0increased $7.4 million (4%(14%) in 2005
primarily due to a decreaseto:
- Increased cost per BTU (15% higher), resulting in $7.8 million higher
fuel costs.
- Decreased generation ($1.8 million) and a decrease(1% lower), resulting in the
cost of coal burned ($0.2 million).$0.4 million lower fuel
costs.
Gas supply expenses increased $0.7$4.8 million (3%(4%) in 2005 primarily due to:
- Increased cost of purchases for wholesale sales ($5.5 million).
- Increased recovery of performance-based rates ($0.2 million).
- Decreased volume of gas delivered to the distribution system ($1.1
million).
Power purchased increased $10.1 million (35%) in 2005 primarily due to:
- Increased cost per Mwh (35% higher), primarily related to increased
intercompany purchase costs due to an increaseSO2 allowance costs.
Other operations and maintenance expenses increased $0.9 million (1%) in
net gas supply cost ($1.2 million),
offset by a decrease in the volume of retail gas sold ($0.5 million).2005.
Other operation expenses decreased $3.8$2.7 million (7%(5%), as compared to 2003.
Pension in 2005 primarily
due to:
- Decreased MISO-related transmission expense decreased $1.2 million. Electric distribution($3.0 million).
- Decreased information technology systems operations expense
decreased $2.9 million due to transfer of $4.0 million($1.3 million) (charged to maintenance (related to storms) offset by higher non-storm related
distributionexpenses in 2005).
- Decreased property insurance expense ($0.2 million).
- Increased steam generation operations of $1.1 million.expense ($0.6 million).
- Increased customer billing expense ($0.5 million).
- Increased gas underground storage costs ($0.5 million).
Maintenance expenses increased $10.5$3.5 million (84%(30%) in 2005 primarily
due to:
- Increased Cane Run maintenance due to stormsoutage repairs ($8.8 million, including $4.0 million transferred from Operations1.4 million).
- Increased distribution system maintenance (including tree trimming and
underground conductor repairs) ($0.7 million).
- Increased information technology systems maintenance ($1.3 million)
(charged to Maintenanceoperation expenses in third quarter 2004).
Non-storm related distribution
maintenanceProperty and other taxes increased $2.1 million.
Depreciation and amortization$0.1 million (2%) in 2005 primarily
due to:
- Increased property tax ($0.1 million).
In total, other income (expense) - net increased $1.9$1.0 million (7%(125%) in
2005 primarily due to a
corresponding increase in plant in service of $199.4 million (5.8%). The
increase in plant included $37.2 millionto:
- - Increased mark-to-market income ($0.2 million) related to energy
trading contracts.
- - Decreased miscellaneous deductions ($0.7 million).
In total, interest expense increased $1.0 million (13%) in 2005 primarily
due to:
- - Increased interest on variable-rate debt ($1.1 million).
- - Increased interest on customer deposits ($0.5 million).
- - Decreased interest costs on interest rate swaps ($0.6 million).
- 28 -
The weighted average interest rate on variable-rate bonds for the completion of
Trimble County CT's 9 and 10, as well as increasesthree
months ended March 31, 2005, was 1.91%, compared 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 increase1.03% for the
comparable period in depreciation
and amortization was partially offset by a reduction in amortization
expense related to certain software, which became fully amortized in the
final quarter of 2003.
Other income decreased $1.4 million, resulting from a $1.3 million write-
off in July 2004 related to the cancellation of the "Pay As You Go"
metering project.
Variations2004.
Variances in income tax expense are largely attributable to changes in pre-
tax income.income and a reduction in the statutory Kentucky rate.
Three Months Three Months
Ended Ended
Sept. 30,March 31, 2005 March 31, 2004
Sept. 30, 2003Effective Rate
Statutory federal income tax rate 35.0% 35.0%
State income taxes net of federal benefit 4.6 4.94.3 5.6
Amortization of investment and other tax credit & R&D (0.6) (1.7)credits (1.9) (2.7)
Other differences (0.7) (2.4)(1.5) (0.1)
Effective income tax rate 38.3% 35.8%
Page 2535.9% 37.8%
The variationincreased tax benefit in the tax rateother differences is largely attributable to
the new Internal Revenue Code Section 199 Qualified Production Activities
deduction and the amortization of excess deferred tax benefits recorded in 2003, reflectingincome taxes, which
reflect the benefits of deferred taxestax reversing at lower tax rates than what
were provided, and lower
amortizationprovided.
Kentucky House Bill 272, also known as Kentucky's Tax Modernization Plan,
was signed into law on March 18, 2005. See Note 6 for additional
discussion of the investment tax credit.
Interest expense decreased $0.9 million (15%) primarily due to savings on
interest expense realized from the refinancing of fixed-rate Series V and
Series W Pollution Control Bonds to the variable-rate Series GG Pollution
Control Bonds in November 2003.
Interest expense to affiliated companies increased $0.9 million (44%)
primarily due to a $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 $0.2 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 September 30, 2004, was 1.30% and the corresponding rate for
the three months ended September 30, 2003, was 0.99%.income taxes.
KU Results:
KU's net income increased $4.5$5.1 million (15%(16%) for the three months ended
September 30, 2004,March 31, 2005, as compared to the three months ended September 30,
2003.March 31, 2004. The
increase was primarily due to increase in base rates effective July 1, 2004
and higher revenues due to July 2004
rate increases, partially offset by higher depreciation expense.wholesale sales.
A comparison of KU's revenues for the three months ended September 30,
2004,March 31, 2005,
with the three months ended September 30, 2003,March 31, 2004, reflects increases and
(decreases) which have been segregated by the following principal causes:
Cause Electric
(in thousands) Electric
Causemillions) Revenues
Retail sales:
Fuel supply adjustments $ 2,297$13.1
Environmental cost recovery surcharge 1,1514.6
Earnings sharing mechanism 1,332(4.5)
Demand side management cost recovery 0.2
LG&E/KU merger surcredit (615)(0.8)
Value delivery surcredit (111)
Demand side management 404
General(0.2)
Rates and rate increase 9,596structure 13.9
Variation in sales volume and other (446)(1.8)
Total retail sales 13,60824.5
Wholesale sales 1,46515.6
Provision for rate collections 1,7940.8
Other 376(0.8)
Total $17,243$40.1
- 29 -
Electric revenues increased $17.2$40.1 million (16%) in 2005 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,due to:
- - Higher wholesale revenues ($15.6 million), primarily due to 44% higher
prices and an8% higher sales volumes.
- - An increase in provisionrates and a change in rate structure ($13.9 million).
- - Higher fuel supply adjustments ($13.1 million) due to higher cost of
fuel used for rate collections. The provision for rate
collections increased $1.8 million largely as the result of a higher
provision for the environmental cost recovery surcharge ($4.2 million),
partially offset by lower provisions for the earnings sharing mechanism
($1.3 million)generation and fuel clause recovery ($1.1 million).purchased power.
Fuel for electric generation comprises a large component of KU's total
operating expenses. KU's electric rates contain a fuel adjustment clause,
whereby increases or decreases in the cost of fuel are reflected in retail
rates, subject to the approval of the Kentucky Commission, the Virginia
State Corporation Commission, and the Federal Energy Regulatory Commission.FERC.
Fuel for electric generation increased $2.9$17.4 million (4%(25%) for the quarter
because of an increase in 2005
primarily due to:
- Increased cost per BTU (23% higher), resulting in $16.3 million higher
fuel costs.
- Increased generation ($3.2 million)(2% higher), partially offset by a
slight decreaseresulting in the cost of coal burned ($0.3 million).
Page 26$1.1 million higher fuel
costs.
Power purchased increased $1.5$5.0 million (5%(12%) in 2005 primarily due to an increaseto:
- Increased cost per MWh (10% higher), resulting in the price$4.1 million higher
costs.
- Increased volumes of powerMWh purchased ($3.1 million)(2% higher), offset by a decreaseresulting in the volume
purchased ($1.6 million).$0.9
million higher costs.
Other operations and maintenance expenses increased $5.1 million (9%) in
2005.
Other operation expenses decreased $0.1 million (less than 1%) in 2005
primarily due to:
- Decreased information technology systems operation expenses ($1.1
million) (charged to maintenance expenses in 2005).
- Decreased property insurance expense ($0.2 million).
- Increased customer billing expense ($0.6 million).
- Increased MISO-related transmission expense ($0.5 million).
Maintenance expenses increased $5.2 million (44%) in 2005 primarily due
to:
- Increased E.W. Brown plant maintenance expense ($0.7 million).
- Increased Ghent plant maintenance expense ($1.7 million).
- Increased distribution system maintenance ($1.5 million) due to storm
restoration expenses.
- Increased information technology systems maintenance ($1.1 million)
(charged to operation expenses in 2004).
- 30 -
In total, other income (expense) - net increased $0.6 million (150%) in
2005 primarily due to:
- - Decreased allowance for funds used during construction ($0.5 million).
In total, interest expense increased $2.2 million (6%(51%) asin 2005 primarily
due to:
- - Increased interest costs associated with the mark-to-market of the
interest rate swaps ($1.9 million). In the first quarter of 2004, a swap
was terminated, resulting in a $0.8 million gain.
The weighted average interest rate on variable-rate bonds for the three
months ended March 31, 2005, was 1.90%, compared to 2003.
Steam power operations increased $1.9 million, primarily due to increased
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 million1.03% for the
comparable period in distribution maintenance. In September 2004, $4.0 million
in 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 $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 increased $4.3 million (17%) due to a
corresponding increase in plant in service of $155.4 million (5%). The
increase in plant included $63.8 million related to 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.2004.
Variations in income tax expense are largely attributable to changes in
pretax income.
Three Months Three Months
Ended Ended
Sept. 30,March 31, 2005 March 31, 2004
Sept. 30, 2003Effective Rate
Statutory federal income tax rate 35.0% 35.0%
State income taxes net of federal benefit 4.1 5.04.6 5.8
Amortization of investment and other tax credit & R&Dcredits (0.7) (1.0) (1.4)
Other differences (3.2) (2.9)(1.3) (1.5)
Effective income tax rate 34.9% 35.7%
Interest expense increased $0.4 million (16%). A reduction in the savings
associated with interest rate swaps, caused primarily by the termination37.6% 38.3%
Kentucky House Bill 272, also known as Kentucky's Tax Modernization Plan,
was signed into law on March 18, 2005. See Note 6 for additional
discussion of a swap, increased interest expense by $1.2 million. This increase was
offset by $0.7 million in interest expense savings from the redemption of
8.55% Series P Pollution Control Bonds redeemed in November of 2003.
Interest expense to affiliated companies increased $1.6 million (86%)
primarily due to a $1.8 million increase in interest expense to Fidelia
related to new notes issued from August 2003 through January 2004.
Offsetting this increase is a $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 September 30, 2004, was 1.32% and the corresponding rate for
the three months ended September 30, 2003, was 0.91%.
Nine Months Ended September 30, 2004, Compared to
Nine Months Ended September 30, 2003
LG&E Results:
LG&E's net income decreased $1.0 million (1%) for the nine months ended
September 30, 2004, as compared to the nine months ended September 30,
2003, primarily due to higher operations and maintenance expense, offset by
higher electric revenues.
Page 27
A comparison of LG&E's revenues for the nine months ended September 30,
2004, with the nine months ended September 30, 2003, reflects increases and
(decreases) which have been segregated by the following principal causes:
(in thousands) Electric Gas
Cause Revenues Revenues
Retail sales:
Fuel and gas supply adjustments $(1,493) $ 46,625
Environmental cost recovery surcharge 11,618 -
Earnings sharing mechanism 3,913 -
LG&E/KU merger surcredit (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 4,244 (22,523)
Total retail sales 26,662 27,549
Wholesale sales 5,642 1,034
Provision for rate refunds (5,670) -
Other 95 (344)
Total $26,729 $ 28,239
Electric revenues increased $26.7 million primarily as a result of
increased environmental cost recovery, the 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 a
decrease in 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 $28.2 million primarily as a result of higher
natural gas prices passed on to customers through the gas supply clause,
partially offset by lower sales volumes resulting from milder weather
during the heating months than in the prior period.
Fuel for electric generation increased $2.4 million (2%) for the nine
months due to an increase in the cost of coal burned ($1.4 million) and
higher generation ($1.0 million). Gas supply expenses increased $30.3
million (20%) due to an increase in net gas supply cost ($42.0 million),
offset by a decrease in the volume of retail gas delivered to the
distribution system ($11.5 million).
Power purchased increased $5.3 million (9%) due to an increase in the price
of power purchased ($4.3 million) and a 2% increase in the volume of the
purchases ($1.0 million) primarily to meet slightly higher load
requirements.
Other operations expenses increased $4.5 million (3%) in 2004, as compared
to 2003, due to higher transmission expense of $2.7 million, primarily due
to higher MISO-related expense, and $4.6 million higher electric
distribution expense, due in part to the May and July 2004 storms. These
higher expenses were partially offset by $2.8 million lower amortization of
costs to achieve the KU/LG&E merger and One Utility initiative. These
costs were fully amortized by June 2003 (KU/LG&E merger) and September 2003
(One Utility).
Maintenance expenses increased $7.8 million (18%). Distribution
maintenance increased $9.6 million, primarily due to the May and July storm
restoration. In 2003, $2.1 million of obsolete inventory was written off.
Page 28
Depreciation and amortization increased $0.2 million (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%) which was largely offset by a decrease in
amortization expense related to certain software, which became fully
amortized in the final quarter of 2003.
Variations in income tax expense are largely attributable to changes in pre-
tax income.
Nine Months Ended Nine Months Ende
d
Sept. 30, 2004 Sept. 30, 2003
Statutory federal income tax rate 35.0% 35.0%
State income taxes net of federal benefit 5.2 5.3
Amortization of investment tax credit & R&D (2.7) (2.7)
Other differences (0.1) (1.6)
Effective income tax rate 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 $1.6 million (13%). Property tax
expense reflected a $1.2 million coal incentive tax 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 expense decreased $3.0 million (17%). Interest related to long-
term debt decreased $5.8 million due to the refinancing of fixed-rate
Series V and Series W Pollution Control Bonds into the variable-rate Series
GG Pollution Control Bonds and the redemption of the first mortgage bond in
August 2003. These savings were partially offset by an increase in interest
expense related to interest rate swaps associated with the Series GG bonds
totaling $2.6 million.
Interest expense to affiliated companies increased $5.0 million (121%)
primarily due to a $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 $1.4 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 nine
months ended September 30, 2004 was 1.14%, compared to 1.12% for the
comparable period in 2003.
KU Results:
KU's net income increased $38.5 million (68%) for the nine months ended
September 30, 2004, as compared to the nine months ended September 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 nine months ended September 30, 2004,
with the nine months ended September 30, 2003, reflects increases and
(decreases) which have been segregated by the following principal causes:
(in thousands) Electric
Cause Revenues
Retail sales:
Fuel supply adjustments $ 2,683
Environmental cost recovery surcharge 3,218
Earnings sharing mechanism 6,636
LG&E/KU merger surcredit (2,443)
Value delivery surcredit (296)
Demand side management 424
General rate increase 9,596
Variation in sales volume and other 18,874
Total retail sales 38,692
Wholesale sales 13,382
Provision for rate collections 17,657
Other 5,110
Total $74,841
Electric revenues increased $74.8 million primarily due to increased sales
volumes to ultimate consumers of 3.9% due to warmer weather than last year
as cooling degree days increased 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 (26% higher
pricing offset by 3% lower volumes), earnings sharing mechanism recoveries
and the recovery of fuel and environmental costs. The provision for rate
collections included higher provisions for the environmental cost recovery
($14.6 million), the earnings sharing mechanism ($2.2 million) and the fuel
adjustment clause ($0.9 million).
Fuel for electric generation increased $14.4 million (7%) for the nine
months due to an increase in the cost of coal burned ($6.4 million) and an
increase in generation ($8.0 million).
Power purchased decreased $1.4 million (1%) due to a decrease in the price
of power purchased ($2.1 million), partially offset by an increase in
volumes purchased ($0.7 million) due to higher retail and wholesale loads.
Other operation expenses increased $0.2 million. Steam generation expense
increased $4.3 million, primarily due to higher emission allowance expense,
and transmission expense increased $0.5 million. Amortization of $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.
Pension expense decreased $0.8 million, and bad debt expense decreased $0.7
million.
Maintenance expenses decreased $8.4 million (17%). Steam power maintenance
expense decreased $3.2 million; Ghent Unit 3, Green River Unit 4 and Tyrone
Unit 3 all had major overhauls in 2003. Distribution maintenance decreased
$2.8 million. In September 2004, $4.0 million in 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 $0.4 million.
Page 30
Depreciation and amortization increased $3.6 million (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 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.
Nine Months Ended Nine Months Ended
Sept. 30, 2004 Sept. 30, 2003
Statutory federal income tax rate 35.0% 35.0%
State income taxes net of federal benefit 5.3 5.8
Amortization of investment tax credit & R&D (1.0) (2.3)
Other differences (2.4) (3.6)
Effective income tax rate 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
nine months ended September 30, 2003, caused the percentage changes to be
greater in the 2003 period.
Interest expense decreased $6.3 million (45%) due primarily to the
redemption of 8.55% Series P Pollution Control Bonds and 6.32% Series Q
Pollution Control Bonds redeemed in November and June of 2003,
respectively. Additionally, interest rate swaps yielded a $1.6 million
decrease in related interest expenses resulting primarily from the February
termination of a swap related to the Series 9 Pollution Control Bonds and
better performance of remaining swaps.
Interest expense to affiliated companies increased $7.2 million (213%)
primarily due to a $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 $0.7 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 nine
months ended September 30, 2004, was 1.16% and the corresponding rate for
the nine months ended September 30, 2003, was 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 September 30, 2004,At March 31, 2005, LG&E and KU are in a negative working capital position
in part because of the classification of certain variable-rate pollution
control bonds that are subject to tender for purchase at the option of the
holder as current portion of long-term debt. The CompaniesLG&E and KU expect to cover
any working capital deficiencies with cash flow from operations, money pool
borrowings and borrowings from Fidelia, an E.ON
financing subsidiary.Fidelia.
Construction expenditures for the ninethree months ended September 30, 2004 for
LG&E and KUMarch 31, 2005
amounted to $94.2 million and $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 nine months ended September 30, 2004,
by LG&E and KU for NOx construction were $4.1 million and $29.2 million,
respectively. Expenditures for the nine months ended September 30, 2004,
for Trimble County combustion turbines, Units 7 through 10, by LG&E and KU
were $7.0 million and $12.0 million, respectively. In addition, LG&E
construction expenditures include $10.0$18.5 million for distribution overheadeach Company. At LG&E, expenditures included
gas main replacements ($1.9 million), the construction of a 138Kv
transmission line construction, $4.1 million for($1.1 million), and Mill Creek Unit 3 ductwork installation
related to the flue4 boiler tubing ($1.1
million), along with expenditures for electric and gas desulfurization ("FGD") project, and $8.3 million
for gas main replacements.distribution system
construction. At KU, construction expenditures include $6.4
million for E.W.included Brown Unit 3 cooling tower and precipitator rebuild and
$9.0 million forcontrols upgrade
($1.2 million), distribution construction in the Lexington area.line transformers ($1.0 million), along with
electric distribution system construction. The expenditures were financed
with internally generated fundsfunds.
- 31 -
LG&E's and intercompany
loans from affiliates.
PageKU's cash balances decreased $0.1 million and $0.7 million,
respectively, during the three months ended March 31, LG&E's cash balance increased $4.2 million2005, primarily due
to increased net borrowingsthe payment of dividends, lower levels of borrowing from affiliated
companies partiallyand construction expenditures, offset by pension funding and payment
of common dividends to its parent company. LG&E's restrictedhigher cash balance
increased $11.5 million during the nine months ended September 30, 2004,
primarily due to an increase in collateral heldprovided by
third parties related to
interest rate swaps. KU's cash balance remained level, decreasing $0.2
million during the nine months ended September 30, 2004, as higher net
income and increased net borrowings from affiliated companies offset
pension funding, construction expenditures and the payment of common
dividends to its parent company.operating activities.
Variations in accounts receivable, accounts payable and materials and
suppliesinventories are
generally not significant indicators of LG&E's and KU's liquidity. In general, suchSuch
variations are usuallyprimarily attributable to seasonal fluctuations in weather,
which have a direct effect on sales of electricity and natural gas. However, the increaseThe
decrease in accounts receivable at LG&E and KU as of September 30, 2004, was primarily due to lower
revenues at the terminationend of the accounts receivable securitization programs in January
2004. Discontinuing the accounts receivable securitization programs
resulted in an increase in accounts receivable of $58.0 million at LG&E and
$50.0 million at KU. (LG&E and KU maintained a reserve for uncollectible
accounts related to receivables sold during the securitization program).
The increase in accounts receivable at LG&E as of September 30, 2004 was
somewhat offset by the impact of decreased gas sales in September 2004
compared to December 2003.heating season. The decrease in fuel inventory at KU asLG&E's gas
stored underground relates to seasonal uses of September 30, 2004, was due to an increase in tons burned and a slow down
of coal deliveries.gas.
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 September 30, 2004,March 31, 2005, LG&E had swaps with a combined notional
value of $228.3$211.3 million and KU had swaps with a combined notional value of
$103.0 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 the2005, an LG&E interest rate swap it had in place at December 31,
2003 related to its Series 9 Pollution Control Bonds. Thewith a notional amount of the terminated$17
million matured. The swap was $50 millionfully effective upon expiration, therefore,
the impact on earnings and KU received a payment of $2.0
million as part ofother comprehensive income from the termination, resulting in a gain of $0.8swap
maturity was less than $0.1 million.
At September 30, 2004,March 31, 2005, LG&E's and KU's percentage of debt having a variable
rate, debt, including the impact of interest rate swaps, was 38.0% of LG&E's total debt at $346.7 million41.8% ($358.0
million) and 44.0% of
KU's total debt at $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.50.4% ($375.0 million), respectively.
Under the provisions offor 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
Bonds,pollution control
bonds Series 10, 12, 13, 14, and 15, the bonds are subject to tender for
purchase at the option of the holder and to mandatory tender for purchase
upon the occurrence of certain events, causing the bonds to be classified
as current portion of long-term debt in the Consolidated Balance Sheets. The average
annualized interest rate for these bonds during the three months ending
March 31, 2005 was 1.96% for both the LG&E and nine months ending September 30,KU bonds.
During June 2004, LG&E renewed five revolving lines of credit with banks
totaling $185 million. There was 1.20%no outstanding balance under any of these
facilities at March 31, 2005. The Company expects to renew these facilities
prior to their expiration in June 2005.
- 32 -
LG&E, KU and 1.14%,
respectively,LG&E Energy participate in an intercompany money pool
agreement. Details of the balances at March 31, 2005 and March 31, 2004
were as follows:
Total Money Amount Balance Average
(millions of $) Pool Available Outstanding Available Interest Rate
March 31, 2005:
LG&E $400.0 $35.0 $365.0 2.65%
KU 400.0 26.0 374.0 2.65
March 31, 2004:
LG&E $400.0 $ - $400.0 -%
KU 400.0 40.7 359.3 0.98
LG&E Energy maintains a revolving credit facility totaling $200 million
with E.ON North America, Inc. to ensure funding availability 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 loans with Fidelia, one
totaling $25 million with an interest rate of 4.33% that matures in January
2012, and one totaling $100 million with an interest rate of 1.53% that
matures in Januarymoney
pool. There was no balance outstanding on this facility at March 31, 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 2004,2005, 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 $50refinanced $40 million in existing pollution control
indebtedness. The original indebtedness, 5.75%5.90% Pollution Control Bonds,
Series 9,X, due December 1,April 15, 2023, will bewas discharged on November 22, 2004, byMay 13, 2005, using the
proceeds from the replacement indebtedness, KULG&E Pollution Control Bonds,
Series 17,HH, due OctoberFebruary 1, 2034,2035, which will carry a variable, auction rate of
interest.
In January 2005, LG&E maintains five bilateral lines of credit with banks totaling $185paid at maturity the $50 million that mature in 2005. There was no outstanding balance under these
facilities at September 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 $40.7
million in money poolloan from Fidelia
using proceeds from short-term loans from LG&E Energy (included in "Notes payable to
affiliated companies") at an average rate of 1.60% at September 30, 2004,
and $75.1 million at an average rate of 1.06% at September 30, 2003. The
balance of the money pool loans from LG&E Energy to KU (included in "Notes
payable to affiliated companies") was $29.8 million at an average rate of
1.60% and $98.7 million at an average rate of 1.06% at September 30, 2004
and 2003, respectively. The amount available to LG&E under the money pool
agreement at September 30, 2004, was $359.3 million. The amount available
to KU under the money pool agreement at September 30, 2004, was $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 $79.1 million at an
average rate of 2.13% under this facility as of September 30, 2004 and
availability of $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 to the pension plans are planned in 2004.for either
LG&E's security&E or KU for 2005, but one or both Companies may make a discretionary
contribution to the other post-retirement benefit plans.
Security ratings as of September 30, 2004,March 31, 2005, were:
LG&E KU
Moody's S&P Moody's S&P
First mortgage bonds A1 A- A1 A
Preferred stock Baa1 BBB- Baa1 BBB-
Commercial paper P-1 A-2
KU's security ratings as of September 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-
Capitalization ratios at September 30, 2004,March 31, 2005, and December 31, 2003,2004, follow:
September 30,LG&E KU
March 31, December 31, March 31,December 31,
2005 2004 20032005 2004
Long-term debt
(including current portion) 30.8% 31.9%31.7% 30.5% 22.2% 22.2%
Long-term debt to affiliated
company (including current
portion) 14.2 10.711.9 14.1 18.9 18.8
Notes payable to affiliated
companies 2.1 4.31.9 3.0 1.5 2.0
Preferred stock 3.7 3.6 3.82.2 2.2
Common equity 49.3 49.350.8 48.8 55.2 54.8
Total 100.0% 100.0%
KU's capitalization ratios at September 30, 2004, and December 31, 2003,
follow:
September 30,December 31,
2004 2003
Long-term debt (including current portion) 22.4% 24.1%
Long-term debt to affiliated company
(including current portion) 19.0 16.8
Notes payable to affiliated companies 1.7 2.6
Preferred stock 2.3 2.4
Common equity 54.6 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, ConsolidationFor a discussion 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,accounting pronouncements and making other
amendments to clarify application of the guidance. For potential variable
interest entities other than special purpose entities, the revised FIN 46
("FIN 46R") is now required to be applied no later than the end of the
first fiscal year or interim reporting period ending after March 15, 2004.
For all special purpose entities created prior to February 1, 2003, FIN 46R
is now required to be applied at the end of the first interim or annual
reporting period ending after December 15, 2003. FIN 46R may be applied
prospectively with a cumulative-effect adjustment as of the date it is
first applied, or by restating previously issued financial statements with
a cumulative-effect adjustment as of the beginning of the first year
restated. FIN 46R also requires certain disclosures of an entity's
relationship with variable interest entities.
Boththeir impacts on LG&E
and KU, hold investment interests in OVEC and KU holds an
investment interest in EEI. Neither LG&E nor KU is the primary beneficiary
of OVEC or EEI, and thus neither is 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 September 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. Seesee Part II,I - 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 entitledNotes to take 20% of the
available capacity of the station. Purchases from EEI are made under a
contractual formula which has resulted in costs which were and are expected
to be comparable to the cost of other power purchased or generated by KU.
Such power equated to approximately 9% of KU's net generation system output
in 2003.
KU's original investment in EEI was made in 1953. KU's investment in EEI
is accounted for on the equity method of accounting. As of September 30,
2004, KU's investment in EEI totaled $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.
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. FSP 106-2 does not have a
material impact on the Companies.Financial Statements, Note 7.
Contingencies
For a description of significant contingencies that may affect LG&E and KU,
reference is made to Part I, Item 3, Legal Proceedings in LG&E's and KU's
Annual Reports on Form 10-K for the year ended December 31, 2003;2004; and to
Part I - Item 1, Notes to Financial Statments, Notes 5 and 10, and Part II
- - Item 1, Legal Proceedings in LG&E's and KU's Quarterly Reports on Form
10-Q for the quarters 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. 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 and filed for the
existing rate increases to be set aside. The Kentucky Commission is
considering the matters relating to the 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.
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 Companies 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.
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 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, filed an answer in that court denying
the OMU claims and presenting certain counterclaims and commenced a FERC
proceeding to request FERC jurisdiction on certain issues. In October
2004, FERC declined to exercise exclusive jurisdiction regarding the issues
in 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 by
installing additional NOx controls to their generating units. Installations
of additional NOx controls were performed on a phased basis, which
commenced in late 2000 and continued through the final compliance date. As
of September 30, 2004, LG&E has incurred total capital costs of
approximately $185 million to reduce its NOx emissions to the 0.15
lb./Mmbtu level on a company-wide basis. As of September 30, 2004, KU has
incurred total capital costs of approximately $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 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&E's and KU, and their respective ratepayers,KU's operations are exposed to market risks.
Market risk exposures includerisks from changes in
interest rates and commodity prices. To mitigate changes in cash flows
attributable to these exposures, the Companies have entered into various
derivative instruments. Derivative positions are monitored using
techniques that include market value and sensitivity analysis.
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.
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The potential change in interest expense associated with a 1% change in
base interest rates of LG&E's and KU's unswapped variable debt is estimated
at $3.5$3.58 million and $3.3$3.75 million, respectively, at September 30, 2004.March 31, 2005. LG&E's
exposure to floating interest rates decreased $1.0 million
and KU's exposure to floating interest rates decreased $1.2 milliondid not materially change
during the first ninethree months of 2004.2005.
The potential loss in fair value of LG&E's interest rate swaps resulting
from a hypothetical 1% change in base interest rates is estimated at
approximately $25.8$22.0 million as of September 30, 2004.March 31, 2005. The potential loss in
fair value of KU's interest rate swaps resulting from a hypothetical 1%
change in base interest rates is estimated at approximately $2.4$1.0 million as
of September 30, 2004.March 31, 2005. 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 September
30, 2004, LG&E and KU
have arecognized an additional minimum pension liability as prescribed by SFAS No.
87, Employers' Accounting for Pensions inbecause the pre-tax amountsaccumulated benefit
obligation exceeds the fair value of $47.6 and $9.9 million, respectively.their plans' assets. The liabilities
arewere recorded as a reduction to other comprehensive income, and dodid not
affect net income. The amount of the liabilitiesliability depends upon the discount
rate, the asset returns experienced in
2003 and contributions made by LG&E and KUthe Companies to the
plan during 2003.plans. If the fair value of the planplans' assets exceeds the accumulated
benefit obligation, the recorded liabilityliabilities will be reduced and other
comprehensive income will be restored in the Consolidated Balance Sheets.balance sheet.
A 1% increase or decrease in the assumed discount rate could have an
approximate $41$39.9 million positive or negative impact to the accumulated
benefit obligation of LG&E. A 1% increase or decrease in the assumed
discount rate could have an approximate $27$26.8 million positive or negative
impact to the accumulated benefit obligation of KU.
In January 2004, LG&E and KU made discretionary contributions to their
pension plans of $34.5 million and $43.4 million, respectively. Page 38No
discretionary contributions to the pension plans are planned for either
LG&E or KU for 2005, but one or both Companies may make a discretionary
contribution to the other post-retirement benefit plans.
Energy Trading & Risk Management Activities
The table below summarizes LG&E's and KU's energy trading and risk
management activities for the three months ended March 31, 2005, and nine months ended September
30, 2004, and 2003 (in thousands of $).2004.
Trading volumes are allocated evenly divided between LG&E and KU.
Three Months Nine Months
Ended
Ended
September 30, September 30,March 31,
2005 2004
2003 2004 2003(in millions)
Fair value of contracts at beginning of
period, net asset/(liability) $ 541(0.2) $ 318 $572 $(156)0.6
Fair value of contracts when entered
into during the period (70) (30) (75) 2,590- -
Contracts realized or otherwise
settled during the period (431) (356) (663) (639)0.2 (0.2)
Changes in fair value due to changes in assumptions 107 148 313 (1,715)- 0.2
Fair value of contracts at end of period,
net asset $ 147- $ 80 $ 147 $ 800.6
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No changes to valuation techniques for energy trading and risk management
activities occurred during 2005 or 2004. Changes in market pricing,
interest rate and volatility assumptions were made during bothall periods. The
outstanding mark-to-market value is sensitive to changes in prices, price
volatilities, and interest rates. The Companies estimate that a movement
in prices of $1 and a change in interest and volatilities of 1% would not
result in a change of a material amount. All contracts outstanding at
September 30, 2004,March 31, 2005, have a maturity of less than one year and are valued using
prices actively quoted for proposed or executed transactions or quoted by
brokers.
LG&E and KU maintain policies intended to minimize credit risk and revalue
credit exposures daily to monitor compliance with those policies. As of
September 30, 2004,March 31, 2005, 100% of the trading and risk management commitments were
with counterparties rated BBB-/Baa3 equivalent or better.
Item 4. Controls and Procedures.
LG&E and KU maintain a system of disclosure controls and procedures
designed to ensure that information required to be disclosed by the
Companies in reports they file or submit under the Securities Exchange Act
of 1934 is recorded, processed, summarized and reported, within the time
periods specified in the Securities and Exchange Commission rules and
forms. LG&E and KU conducted an evaluation of such controls and procedures
under the supervision and with the participation of the Companies'
management, including the Chairman, President and Chief Executive Officer
("CEO") and the Chief Financial Officer ("CFO"). Based upon that
evaluation, the CEO and CFO have concluded that the Companies' disclosure
controls and procedures are effective as of the end of the period covered
by this report.
LG&E and KU are not accelerated filers under the Sarbanes-Oxley Act of 2002
and associated rules (the "Act") and consequently anticipate issuing
Management's Report on Internal Control over Financial Reporting pursuant
to Section 404 of the Act in their first periodic report covering the
fiscal year ended December 31, 2006 as permitted by SEC rulemaking.
In preparation for required reporting under Section 404 of the Sarbanes-
Oxley Act of 2002, the Companies are conducting a thorough review of their
internal controls over financial reporting, including disclosure controls
and procedures. Based on this review, the Companies have made internal
controls enhancements and will continue to make future enhancements to
their internal controlscontrol over financial reporting. There has been no change
in the Companies' internal controlscontrol over financial reporting that occurred
during the fiscal quarter ended September 30, 2004,March 31, 2005, that has materially
affected, or is reasonably likely to materially affect, the Companies'
internal controlscontrol over financial reporting.
Page 39- 36 -
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, 2003:2004: Item 1, Business; Item 3, Legal
Proceedings; Item 7, Management's Discussion and Analysis of Financial
Condition and Results of Operations, and Item 8, Financial Statements and
Supplementary Data in Note 11. Reference is also made to the matters
described in Notes 5 and (b) LG&E's and KU's Quarterly Reports on Form 10-Q
for the periods ended March 31, 2004 and June 30, 2004:10 of Part I, Item I, Legal
Proceedings.1 of this 10-Q. 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.
ElectricOther
In the normal course of business, other lawsuits, claims, environmental
actions, and Gas Rates Cases
On June 30, 2004, the Kentucky Commission issued an order approving
increases in the base electric and gas rates ofother governmental proceedings arise against LG&E and KU. To
the base electric
ratesextent that damages are assessed in any of KU. 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 and filed for the
existing rate increases to be set aside. The Kentucky Commission is
considering the matters relating to the 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.
MISO
During 2004 to-date, the Kentucky Commission has continued its proceedings
examining the costs and benefits of MISO membership, 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, includinglawsuits, LG&E and KU
entered into an Amendedbelieve that their insurance coverage is adequate. Management, after
consultation with legal counsel, does not anticipate that liabilities
arising out of other currently pending or threatened lawsuits and 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 hasclaims
will have 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 2005, subject to receipt of certain regulatory approvals.
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, filed an answer in that court denying
the OMU claims and presenting certain counterclaims and commenced a FERC
proceeding to request FERC jurisdictionadverse effect on certain issues. In October
2004, FERC declined to exercise exclusive jurisdiction regarding the issues
in 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 andor KU's Annual Meetings of Shareholders were held on July 8,
2004.
b)Not applicable.
Page 41
c)The matters voted upon and thefinancial position or
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,operations, 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.
Applicable to Form
10-Q of
Exhibit
No. LG&E KU Description
31 X X CertificationsCertification - Section 302 of Sarbanes-Oxley Act of 2002
31.1X Certification of Chairman of the Board, President and Chief
Executive Officer, pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
31.2X Certification of Chief Financial Officer, pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
31.3 X Certification of Chairman of the Board, President and Chief
Executive Officer, pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
31.4 X Certification of Chief Financial Officer, pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
32 X X Certification pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
Certain instruments defining the rights of holders of certain long-term
debt of LG&E andor KU have not been filed with the SEC but will be furnished
to the SEC upon request.
Page 42- 37 -
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: November 12, 2004May 13, 2005 /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: November 12, 2004May 13, 2005 /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)
- 38 -