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 June 30, 2002
or
[ ] TRANSITION REPORT PURSUANT TO 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.
2-26720 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, Kentucky 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 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 July 31, 2002,
all held by LG&E Energy Corp.
<page>
Kentucky Utilities Company
37,817,878 shares, without par value, as of July 31, 2002,
all held by LG&E Energy Corp.
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 relating
to the other registrants.
<page>
TABLE OF CONTENTS
PART I
Item 1 Consolidated Financial Statements
Louisville Gas and Electric Company and Subsidiary
Statements of Income 1
Balance Sheets 2
Statements of Cash Flows 4
Statements of Retained Earnings 5
Statements of Other Comprehensive Income 6
Kentucky Utilities Company and Subsidiary
Statements of Income 7
Balance Sheets 8
Statements of Cash Flows 10
Statements of Retained Earnings 11
Statements of Other Comprehensive Income 12
Notes to Consolidated Financial Statements 13
Item 2 Management's Discussion and Analysis of Financial Condition
and Results of Operations 20
Item 3 Quantitative and Qualitative Disclosures About
Market Risk 28
PART II
Item 1 Legal Proceedings 30
Item 6 Exhibits and Reports on Form 8-K 30
Signatures 31
<page>
Part I. Financial Information - Item 1. Financial Statements
Louisville Gas and Electric Company and Subsidiary
Consolidated Statements of Income
(Unaudited)
(Thousands of $)
Three Months Six Months
Ended Ended
June 30, June 30,
2002 2001 2002
2001
OPERATING REVENUES:
Electric (Note 7) $191,813 $196,290 $358,059 $351,664
Gas (Note 7) 30,938 32,551 148,056 190,448
Total operating revenues 222,751 228,841 506,115 542,112
OPERATING EXPENSES:
Fuel for electric generation 50,550 41,749 94,657 80,233
Power purchased 22,064 32,744 45,645 44,085
Gas supply expenses 18,346 18,822 101,813 144,058
Non-recurring charges (Note 4) - - - 144,385
Other operation expenses 54,807 36,398 103,216 71,681
Maintenance 15,572 13,683 27,573 24,238
Depreciation and amortization 25,889 25,572 51,167 50,840
Federal and state
income taxes 8,335 17,828 21,572 (20,183)
Property and other taxes 4,778 4,421 9,314 8,883
Total operating expenses 200,341 191,217 454,957 548,220
NET OPERATING INCOME (LOSS) 22,410 37,624 51,158 (6,108)
Other income (deduction) - net (67) 363 (66) 1,358
Interest charges (Note 5) 7,087 9,520 14,893 20,898
NET INCOME (LOSS) 15,256 28,467 36,199 (25,648)
Preferred stock dividends 1,049 1,220 2,114 2,518
NET INCOME (LOSS) AVAILABLE
FOR COMMON STOCK $ 14,207 $ 27,247 $ 34,085 $ (28,166)
The accompanying notes are an integral part of these consolidated financial
statements.
<page> -1-
Louisville Gas and Electric Company and Subsidiary
Consolidated Balance Sheets
(Unaudited)
(Thousands of $)
ASSETS
June 30, Dec. 31,
2002 2001
UTILITY PLANT:
At original cost $3,486,441 $3,423,037
Less: reserve for depreciation 1,426,609 1,381,874
Net utility plant 2,059,832 2,041,163
OTHER PROPERTY AND INVESTMENTS -
less reserve of $63 as of June 30, 2002
and Dec. 31, 2001 1,277 1,176
CURRENT ASSETS:
Cash 20,454 2,112
Accounts receivable - less reserve of $1,575
as of June 30, 2002 and Dec. 31, 2001 (Note 6) 61,856 85,667
Materials and supplies - at average cost:
Fuel (predominantly coal) 34,974 22,024
Gas stored underground 16,226 46,395
Other 28,896 29,050
Prepayments and other 4,119 4,688
Total current assets 166,525 189,936
DEFERRED DEBITS AND OTHER ASSETS:
Unamortized debt expense 6,042 5,921
Regulatory assets (Note 8) 161,949 197,142
Other 13,996 13,016
Total deferred debits and other assets 181,987 216,079
Total assets $2,409,621 $2,448,354
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 of $)
CAPITALIZATION AND LIABILITIES
June 30, Dec. 31,
2002 2001
CAPITALIZATION:
Common stock, without par value -
Outstanding 21,294,223 shares $ 425,170 $ 425,170
Additional paid-in capital 40,000 40,000
Retained earnings 404,721 393,636
Accumulated other comprehensive income (21,357) (19,900)
Other (836) (836)
Total common equity 847,698 838,070
Cumulative preferred stock 95,140 95,140
Long-term debt (Notes 10 and 11) 370,704 370,704
Total capitalization 1,313,542 1,303,914
CURRENT LIABILITIES:
Current portion of long-term debt 246,200 246,200
Notes payable to parent 91,553 94,197
Accounts payable 100,446 149,070
Accrued taxes 21,105 20,257
Accrued interest 5,421 5,818
Other 13,380 12,840
Total current liabilities 478,105 528,382
DEFERRED CREDITS AND OTHER LIABILITIES:
Accumulated deferred income
taxes 308,769 298,143
Investment tax credit, in
process of amortization 56,581 58,689
Accumulated provision for pensions
and related benefits 165,364 167,526
Customer advances for construction 10,072 9,745
Regulatory liabilities (Note 8) 54,720 65,349
Other 22,468 16,606
Total deferred credits and other liabilities 617,974 616,058
Total capital and liabilities $2,409,621 $2,448,354
The accompanying notes are an integral part of these consolidated financial
statements.
<page> -3-
Louisville Gas and Electric Company and Subsidiary
Consolidated Statements of Cash Flows
(Unaudited)
(Thousands of $)
Six Months
Ended
June 30,
2002 2001
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 36,199 $ (25,648)
Items not requiring cash currently:
Depreciation and amortization 51,167 50,840
Deferred income taxes - net 9,507 (41,833)
Investment tax credit - net (2,108) (2,133)
Non-recurring charges (Note 4) - 113,645
Other 20,917 7,466
Changes in current assets and liabilities (21,917) 16,670
Changes in accounts receivable
securitization-net(Note 6) 16,100 52,900
Other 6,855 (18,568)
Net cash flows from operating activities 116,720 153,339
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of securities (101) -
Proceeds from sales of securities - 4,350
Construction expenditures (69,524) (96,050)
Net cash flows from investing activities (69,625) (91,700)
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of pollution control bonds 119,067 -
Retirement of pollution control bonds (120,000) -
Short-term borrowings 278,100 35,763
Repayment of short-term borrowings (280,744) (89,600)
Payment of dividends (25,176) (2,665)
Net cash flows from financing activities (28,753) (56,502)
CHANGE IN CASH 18,342 5,137
CASH AT BEGINNING OF PERIOD 2,112 2,495
CASH AT END OF PERIOD $ 20,454 $ 7,632
SUPPLEMENTAL DISCLOSURES:
Cash paid during the period for:
Income taxes $ 16,681 $ 15,882
Interest on borrowed money $ 13,019 $ 16,090
For the purposes of these statements, all temporary cash investments
purchased with a maturity of three months or less are considered cash
equivalents.
The accompanying notes are an integral part of these consolidated financial
statements.
<page> -4-
Louisville Gas and Electric Company and Subsidiary
Consolidated Statements of Retained Earnings
(Unaudited)
(Thousands of $)
Three Months Six Months
Ended June 30, Ended June 30,
2002 2001 2002 2001
Balance at beginning
of period $413,514 $259,181 $393,636 $314,594
Net income (loss) 15,256 28,467 36,199 (25,648)
Subtotal 428,770 287,648 429,835 288,946
Cash dividends declared on stock:
5% cumulative preferred 269 269 538 538
Auction rate cumulative
preferred 413 584 842 1,246
$5.875 cumulative preferred 367 367 734 734
Common 23,000 - 23,000 -
Subtotal 24,049 1,220 25,114 2,518
Balance at end of period $404,721 $286,428 $404,721 $286,428
The accompanying notes are an integral part of these consolidated financial
statements.
<page> -5-
Louisville Gas and Electric Company and Subsidiary
Consolidated Statements of Other Comprehensive Income
(Unaudited)
(Thousands of $)
Three Months Six Months
Ended Ended
June 30, June 30,
2002 2001 2002 2001
Net income (loss) $15,256 $28,467 $36,199 $(25,648)
Cumulative effect of change in
Accounting principle - Accounting
For Derivative Instruments and
Hedging Activities (Note 5) - - - (5,998)
Gains (losses) on derivative
instruments and hedging
activities (Note 5) (3,939) 977 (2,430) (1,058)
Other comprehensive income (loss)
before tax 11,317 29,444 33,769 (32,704)
Income tax benefit (expense)
related to items of other
comprehensive income (loss) 1,576 (391) 973 2,822
Other comprehensive income (loss) $12,893 $29,053 $ 34,742$ (29,882)
The accompanying notes are an integral part of these consolidated financial
statements.
<page> -6-
Kentucky Utilities Company and Subsidiary
Consolidated Statements of Income
(Unaudited)
(Thousands of $)
Three Months Six Months
Ended Ended
June 30, June 30,
2002 2001 2002 2001
OPERATING REVENUES (Note 7) $203,555 $219,360 $418,723 $431,153
OPERATING EXPENSES:
Fuel for electric generation 57,368 55,523 115,639 111,451
Power purchased 39,911 52,023 80,971 84,908
Non-recurring charges (Note 4) - - - 63,788
Other operation expenses 36,201 27,343 70,723 53,961
Maintenance 15,386 15,549 26,945 27,519
Depreciation and amortization 23,515 23,818 46,574 47,646
Federal and state
income taxes 7,365 11,821 21,748 5,371
Property and other taxes 3,762 4,277 7,876 8,432
Total operating expenses 183,508 190,354 370,476 403,076
NET OPERATING INCOME 20,047 29,006 48,247 28,077
Other income - net 1,685 2,621 3,324 4,414
Interest charges (Note 5) 8,980 10,425 14,462 18,542
NET INCOME before Cumulative Effect
of Accounting Change 12,752 21,202 37,109 13,949
Cumulative Effect of Change in
Accounting for Derivative Instruments
and Hedging Activities, net of tax - - - 136
NET INCOME 12,752 21,202 37,109 14,085
Preferred stock dividends 564 564 1,128 1,128
NET INCOME AVAILABLE
FOR COMMON STOCK $ 12,188 $ 20,638 $ 35,981 $ 12,957
The accompanying notes are an integral part of these consolidated financial
statements.
<page> -7-
Kentucky Utilities Company and Subsidiary
Consolidated Balance Sheets
(Unaudited)
(Thousands of $)
ASSETS
June 30, Dec. 31,
2002 2001
UTILITY PLANT:
At original cost $3,108,339 $3,064,220
Less: reserve for depreciation 1,501,947 1,457,754
Net utility plant 1,606,392 1,606,466
OTHER PROPERTY AND INVESTMENTS -
less reserve of $129 as of June 30, 2002
and Dec. 31, 2001 10,089 9,629
CURRENT ASSETS:
Cash and temporary cash investments 3,513 3,295
Accounts receivable - less reserve of $520
as of June 30, 2002, and Dec. 31, 2001 (Note 6) 54,047 45,291
Materials and supplies - at average cost:
Fuel (predominantly coal) 42,238 43,382
Other 27,060 26,188
Prepayments and other 6,522 4,942
Total current assets 133,380 123,098
DEFERRED DEBITS AND OTHER ASSETS:
Unamortized debt expense 3,843 4,316
Regulatory assets (Note 8) 57,768 66,467
Other 17,162 16,926
Total deferred debits and other assets 78,773 87,709
Total assets $1,828,634 $1,826,902
The accompanying notes are an integral part of these consolidated financial
statements.
<page> -8-
Kentucky Utilities Company and Subsidiary
Consolidated Balance Sheets (cont.)
(Unaudited)
(Thousands of $)
CAPITALIZATION AND LIABILITIES
June 30, Dec. 31,
2002 2001
CAPITALIZATION:
Common stock, without par value -
Outstanding 37,817,878 shares $ 308,140 $ 308,140
Additional paid-in capital 15,000 15,000
Retained earnings 446,877 410,896
Accumulated other comprehensive income 2,685 1,588
Other (595) (595)
Total common equity 772,107 735,029
Cumulative preferred stock 40,000 40,000
Long-term debt (Notes 10 and 11) 336,323 434,506
Total capitalization 1,148,430 1,209,535
CURRENT LIABILITIES:
Current portion of long-term debt 153,930 54,000
Notes payable to parent 19,590 47,790
Accounts payable 77,502 85,149
Accrued taxes 16,868 20,520
Accrued interest 4,452 5,668
Other 16,810 16,482
Total current liabilities 289,152 229,609
DEFERRED CREDITS AND OTHER LIABILITIES:
Accumulated deferred income
taxes 238,680 239,204
Investment tax credit, in
process of amortization 9,977 11,455
Accumulated provision for pensions
and related benefits 91,827 91,235
Customer advances for construction 1,511 1,526
Regulatory liabilities (Note 8) 33,475 33,889
Other 15,582 10,449
Total deferred credits and other liabilities 391,052 387,758
Total capital and liabilities $1,828,634 $1,826,902
The accompanying notes are an integral part of these consolidated financial
statements.
<page> -9-
Kentucky Utilities Company and Subsidiary
Consolidated Statements of Cash Flows
(Unaudited)
(Thousands of $)
Six Months
Ended
June 30,
2002 2001
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 37,109 $ 14,085
Items not requiring cash currently:
Depreciation and amortization 46,574 47,646
Deferred income taxes - net (3,106) (28,061)
Investment tax credit - net (1,478) (1,723)
Non-recurring charges (Note 4) - 50,078
Other 13,237 5,169
Changes in current assets and liabilities (24,551) (23,032)
Changes in accounts receivable
securitization-net (Note 6) 2,300 40,000
Other 8,208 (1,545)
Net cash flows from operating activities 78,293 102,617
CASH FLOWS FROM INVESTING ACTIVITIES:
Construction expenditures (47,844) (80,170)
Net cash flows from investing activities (47,844) (80,170)
CASH FLOWS FROM FINANCING ACTIVITIES:
Short-term borrowings 505,938 229,094
Repayment of short-term borrowings (534,138) (250,543)
Issuance of pollution control bonds 37,027 -
Retirement of pollution control bonds (37,930) -
Payment of dividends (1,128) (1,128)
Net cash flows from financing activities (30,231) (22,577)
CHANGE IN CASH AND TEMPORARY
CASH INVESTMENTS 218 (130)
CASH AND TEMPORARY CASH INVESTMENTS AT
BEGINNING OF PERIOD 3,295 314
CASH AND TEMPORARY CASH INVESTMENTS AT
END OF PERIOD $ 3,513 $ 184
SUPPLEMENTAL DISCLOSURES:
Cash paid during the period for:
Income taxes $ 27,905 $ 34,994
Interest on borrowed money $ 16,120 $ 16,735
For the purposes of these statements, all temporary cash investments
purchased with a maturity of three months or less are considered cash
equivalents.
The accompanying notes are an integral part of these consolidated financial
statements.
<page> -10-
Kentucky Utilities Company and Subsidiary
Consolidated Statements of Retained Earnings
(Unaudited)
(Thousands of $)
Three Months Six Months
Ended June 30, Ended June 30,
2002 2001 2002 2001
Balance at beginning
of period $434,689 $339,557 $410,896 $347,238
Net income 12,752 21,202 37,109 14,085
Subtotal 447,441 360,759 448,005 361,323
Cash dividends declared on stock:
4.75% preferred 237 237 475 475
6.53% preferred 327 327 653 653
Subtotal 564 564 1,128 1,128
Balance at end of period $446,877 $360,195 $446,877 $360,195
The accompanying notes are an integral part of these consolidated financial
statements.
<page> -11-
Kentucky Utilities Company and Subsidiary
Consolidated Statements of Other Comprehensive Income
(Unaudited)
(Thousands of $)
Three Months Six Months
Ended Ended
June 30, June 30,
2002 2001 2002 2001
Net income $12,752 $21,202 $37,109 $14,085
Cumulative effect of change in
accounting principle-Accounting
for Derivative Instruments and
Hedging activities (Note 5) - - - 2,647
Gains on derivative instruments and
hedging activities 1,828 - 1,828 -
Other comprehensive income, before tax 14,580 21,202 38,937 16,732
Income tax (expense) related to items
of other comprehensive income (731) - (731) (1,059)
Other comprehensive income $13,849 $21,202 $38,206 $15,673
The accompanying notes are an integral part of these consolidated financial
statements.
<page> -12-
Louisville Gas and Electric Company and Subsidiary
Kentucky Utilities Company and Subsidiary
Notes to Consolidated Financial Statements
(Unaudited)
1. The unaudited consolidated financial statements include the accounts of
Louisville Gas and Electric Company and Subsidiary and Kentucky
Utilities Company and Subsidiary ("LG&E" and "KU" or the "Companies").
The common stock of each of LG&E and KU is wholly-owned by LG&E Energy
Corp. ("LG&E Energy"). In the opinion of management, the unaudited
interim data includes all adjustments, consisting only of normal
recurring adjustments, necessary for a fair statement of consolidated
financial position, results of operations, comprehensive income and
cash flows for the periods indicated. Certain information and footnote
disclosures normally included in financial statements prepared in
accordance with generally accepted accounting principles have been
condensed or omitted pursuant to Securities and Exchange Commission
("SEC") rules and regulations, although the Companies believe that the
disclosures are adequate to make the information presented not
misleading.
See LG&E's and KU's Annual Reports on Form 10-K for the year ended
December 31, 2001 for information relevant to the accompanying
financial statements, including information as to the significant
accounting policies of the Companies.
2. On December 11, 2000, LG&E Energy was acquired by Powergen plc
("Powergen") for cash of approximately $3.2 billion or $24.85 per share and
the assumption of all of LG&E Energy's debt. As a result of the
acquisition, among other things, LG&E Energy became a wholly-owned indirect
subsidiary of Powergen and, as a result, LG&E and KU became indirect
subsidiaries of Powergen. The utility operations (LG&E and KU) of LG&E
Energy have continued their separate identities and continue to serve
customers in Kentucky and Virginia under their existing names. The
preferred stock and debt securities of the utility operations were not
affected by this transaction resulting in the utility operations'
obligations to continue to file SEC reports. Following the acquisition,
Powergen became a registered holding company under the Public Utility
Holding Company Act of 1935 ("PUHCA"), and LG&E and KU, as subsidiaries of
a registered holding company, became subject to additional regulation under
PUHCA.
As a result of the Powergen acquisition and in order to comply with
PUHCA, LG&E Energy Services Inc. ("LG&E Services") was formed and
became operational on January 1, 2001. LG&E Services provides certain
services to affiliated entities, including LG&E and KU, at cost, as
required under PUHCA. On January 1, 2001, approximately 1,000
employees, primarily from LG&E Energy, LG&E and KU, were moved to LG&E
Services.
3. On April 9, 2001, a German company, E.ON AG ("E.ON"), announced a pre-
conditional cash offer of 5.1 billion pounds sterling ($7.3 billion) to
acquire Powergen. The final regulatory approval needed was received on
June 14, 2002 from the SEC. Effective July 1, 2002, the acquisition of
Powergen was completed by E.ON. Following this acquisition, E.ON became
a registered holding company under PUHCA and subject to regulation
thereunder.
4. During the first quarter 2001, LG&E recorded a $144 million charge and
KU recorded a $64 million charge for a workforce reduction program.
Primary components of the charge were separation benefits, enhanced
early retirement benefits, and health care benefits. The result of
this workforce reduction was the net elimination of approximately 950
positions, accomplished primarily through a voluntary enhanced
severance program.
On June 1, 2001, LG&E and KU filed an application ("VDT case") with the
Kentucky Public Service Commission (the "Kentucky Commission") to
create a regulatory asset relating to these first quarter 2001 charges.
The application requested permission to amortize these costs over a
four-year period. The Kentucky Commission also opened a case to review
a depreciation study and resulting depreciation rates implemented in
2001.
<page> -13-
LG&E and KU reached a settlement in the VDT case as well as the other
cases involving depreciation rates and the Earnings Sharing Mechanism
with all intervening parties. The settlement agreement was approved by
the Kentucky Commission on December 3, 2001.
The Kentucky Commission's December 3, 2001 order allowed LG&E to set up
a regulatory asset of $141 million for the workforce reduction costs
and begin amortizing these costs over a five year period starting in
April 2001. The first quarter charge of $144 million represented all
employees who had accepted the voluntary enhanced severance program.
Between the time of the original filing and the December 3, 2001 order,
some employees rescinded their participation in the voluntary enhanced
severance program, thereby decreasing the original charge from $144
million to $141 million. The settlement will also reduce revenues by
approximately $26 million through a surcredit on bills to customers
over the same five year period. The surcredit represents stipulated
net savings LG&E anticipates realizing from implementation of best
practices through the value delivery process. The agreement also
established LG&E's new depreciation rates in effect retroactive to
January 1, 2001. The new depreciation rates decreased depreciation
expense by $5.6 million in 2001.
The Kentucky Commission's December 3, 2001 order allowed KU to set
up a regulatory asset of $54 million for the workforce reduction costs
and begin amortizing these costs over a five year period starting in
April 2001. The first quarter charge of $64 million represented all
employees who had accepted the voluntary enhanced severance program.
Some employees rescinded their participation in the voluntary enhanced
severance program and, along with the non-recurring charge of $6.9
million for FERC and Virginia jurisdictions, decreased the original
charge from $64 million to $54 million. The settlement will also reduce
revenues by approximately $11 million through a surcredit on bills to
customers over the same five year period. The surcredit represents
stipulated net savings KU anticipates realizing from implementation of
best practices through the value delivery process. The agreement also
established KU's new depreciation rates in effect retroactive to
January 1, 2001. The new depreciation rates decreased depreciation
expense by $6.0 million in 2001.
5. Statement of Financial Accounting Standards ("SFAS") No. 133,
Accounting for Derivative Instruments and Hedging Activities, establishes
accounting and reporting standards requiring that every derivative
instrument (including certain derivative instruments embedded in other
contracts) be recorded on the balance sheet as either an asset or a
liability measured at its fair value. SFAS No. 133 requires that changes
in the derivative's fair value be recognized currently in earnings unless
specific hedge accounting criteria are met. Special accounting for
qualifying hedges allows a derivative's gains and losses to offset related
results on the hedged item in the income statement, and requires that LG&E
and KU must formally document, designate, and assess the effectiveness of
transactions that receive hedge accounting. SFAS No. 133 could increase the
volatility in earnings and other comprehensive income. LG&E and KU adopted
SFAS No. 133 on January 1, 2001. The effect of adopting this statement in
2001 resulted in a $3.6 million (net of tax of $2.4 million) decrease in
other comprehensive income from a cumulative effect of change in accounting
principle for LG&E and a $1.6 million (net of tax of $1.1 million) increase
in other comprehensive income from a cumulative effect of change in
accounting principle for KU.
The Companies use interest rate swaps to hedge exposure to market
fluctuations in certain of their debt instruments. Pursuant to Company
policy, 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.
As of June 30, 2002, LG&E had fixed rate swaps covering $117,335,000 in
notional amounts of variable rate debt and with fixed rates ranging
from 4.184% to 5.495%. The average variable rate on the debt during
<page> -14-
the quarter and six months ended June 30, 2002 was 1.53% and 1.47%. The
swaps have been designated as cash flow hedges and expire on various
dates from September 2003 through November 2020. The hedges were deemed
to be fully effective resulting in a pretax loss for the quarter and
six months ended June 30, 2002 of $3.9 million and $2.4 million,
respectively, recorded in Other Comprehensive Income. Upon expiration
of these hedges, the amount recorded in Other Comprehensive Income will
be reclassified into earnings. The amount expected to be reclassified
from Other Comprehensive Income to earnings in the next twelve months
is immaterial.
As of June 30, 2002, KU had variable rate swaps covering
$153,000,000 in notional amounts of fixed rate debt. The average
variable rate on these swaps during both the quarter and six months
ended June 30, 2002 was 2.43%. The underlying debt has fixed rates
ranging from 5.75% to 7.92%. The swaps have been designated as fair
value hedges and expire on various dates from May 2007 through June
2025. During the quarter and six months ended June 30, 2002, the
effect of marking these financial instruments and the underlying debt
to market resulted in pretax losses of $2.2 million and $0.4 million,
respectively, recorded as an increase in interest expense.
The Financial Accounting Standards Board created the Derivatives
Implementation Group ("DIG") to provide guidance for implementation of
SFAS No. 133. DIG Issue C15, Normal Purchases and Normal Sales
Exception for Option Type Contracts and Forward Contracts in
Electricity was adopted in 2001 and had no impact on results of
operations and financial position of the Companies. DIG Issue C16,
Applying the Normal Purchase and Normal Sales Exception to Contracts
that Combine a Forward Contract and a Purchased Option Contract, was
cleared in the third quarter 2001 and stated that option contracts do
not meet the normal purchases and normal sales exception and should
follow SFAS No. 133. DIG Issue C16 was effective in the second quarter
of 2002. The adoption of DIG Issue C16 did not have a material impact
on the financial position or results of operations of the Companies
pursuant to regulatory treatment prescribed by SFAS No. 71, Accounting
for the Effects of Certain Types of Regulation. KU recorded a mark to
market asset and corresponding regulatory liability of $1.4 million in
the second quarter of 2002.
6. SFAS No. 140, Accounting for Transfers and Servicing of Financial
Assets and Extinguishments of Liabilities, revises the standards for
accounting for securitizations and other transfers of financial assets
and collateral and requires certain disclosures, and provides
accounting and reporting standards for transfers and servicing of
financial assets and extinguishments of liabilities. The Companies
adopted SFAS No. 140 in the first quarter of 2001, when LG&E and KU
entered into accounts receivable securitization programs.
On February 6, 2001, LG&E and KU implemented an accounts receivable
securitization program. The purpose of this program is to enable the
utilities to accelerate the receipt of cash from the collection of
retail accounts receivable, thereby reducing dependence upon more
costly sources of working capital. The securitization program allows
for a percentage of eligible receivables to be sold. Eligible
receivables are generally all receivables associated with retail sales
that have standard terms and are not past due. LG&E and KU are able to
terminate these programs at any time without penalty. If there is a
significant deterioration in the payment record of the receivables by
retail customers or if the Companies fail to meet certain covenants of
the program, the program may terminate at the election of the financial
institutions. In this case, payments from retail customers would first
be used to repay the financial institutions participating in the
program, and would then be available for use by the Companies.
As part of the program, LG&E and KU sold retail accounts receivables to
wholly owned subsidiaries, LG&E Receivables LLC ("LG&E R") and KU
Receivables LLC ("KU R"). Simultaneously, LG&E R and KU R entered into
two separate three-year accounts receivable securitization facilities
with two financial institutions and their affiliates whereby LG&E R and
KU R can sell, on a revolving basis, an undivided interest in certain
of their receivables and receive up to $75 million and $50 million,
respectively, from an unrelated third party purchaser. The effective
cost of the receivables programs is comparable to the Companies' lowest
<page> -15-
cost source of capital, and is based on prime rated commercial paper.
LG&E and KU retain servicing rights of the sold receivables through
separate servicing agreements with the third party purchasers. LG&E
and KU have obtained opinions from independent legal counsel indicating
these transactions qualify as true sales of receivables. As of June
30, 2002 and December 31, 2001, LG&E's outstanding program balances
were $58.1 million and $42.0 million, respectively, and KU's balances
were $47.4 million and $45.1 million, respectively.
Management expects to renew these facilities when they expire.
The allowance for doubtful accounts associated with the eligible
securitized receivables was $1.6 million for LG&E and $0.5 million for
KU for both June 30, 2002 and December 31, 2001, respectively. Charge
offs were immaterial for LG&E and KU. The risk of uncollectibility
associated with the sold receivables is minimal.
7. External and intersegment revenues (related party transactions between
LG&E and KU) and income by business segment for the three and six
months ended June 30, 2002, follow (in thousands of $):
Three Months Ended June 30, 2002
Net
Income/
(Loss)
Inter- Avail.
External segment For-
Revenues Revenues Common Stock
LG&E electric $ 181,963 $ 9,850 $ 16,893
LG&E gas 30,938 - (2,686)
Total $ 212,901 $ 9,850 $ 14,207
KU electric $ 195,460 $ 8,095 $ 12,188
Six Months Ended June 30, 2002
Net
Income/
(Loss)
Inter- Avail.
External segment For
Revenues Revenues Common Stock
LG&E electric $ 335,156 $ 22,903 $ 27,071
LG&E gas 148,056 - 7,014
Total $ 483,212 $ 22,903 $ 34,085
KU electric $ 395,847 $ 22,876 $ 35,981
External and intersegment revenues (related party transactions between
LG&E and KU) and income by business segment for the three and six
months ended June 30, 2001, follow (in thousands of $):
Three Months Ended June 30, 2001
Net
Income/
(Loss)
Inter- Avail.
External segment For
Revenues Revenues Common Stock
LG&E electric $ 187,472 $ 8,818 $ 27,867
LG&E gas 32,551 - (620)
Total $ 220,023 $ 8,818 $ 27,247
KU electric $ 209,507 $ 9,853 $ 20,638
<page> -16-
Six Months Ended June 30, 2001
Net
Income/
(Loss)
Inter- Avail.
External segment For-
Revenues Revenues Common Stock
LG&E electric $ 335,833 $ 15,831 $ (16,575)
LG&E gas 190,448 - (11,591)
Total $ 526,281 $ 15,831 $ (28,166)
KU electric $ 415,618 $ 15,535 $ 12,957
8.The following regulatory assets and liabilities were included in the
balance sheet of LG&E and KU as of June 30, 2002 and December 31, 2001 (in
thousands of $):
Louisville Gas and Electric
(Unaudited)
Jun. 30, Dec. 31,
2002 2001
REGULATORY ASSETS:
VDT costs $ 112,529 $ 127,529
Unamortized loss on bonds 17,972 17,902
Gas supply adjustments due from customers 16,342 30,135
LG&E/KU merger costs 3,629 5,444
One utility costs 2,299 3,643
Manufactured gas sites 1,911 2,062
Other 7,267 10,427
Total 161,949 197,142
REGULATORY LIABILITIES:
Deferred income taxes - net 47,584 48,703
Gas supply adjustments due to customers 6,207 15,702
Other 929 944
Total $ 54,720 $ 65,349
Kentucky Utilities
(Unaudited)
Jun. 30, Dec. 31,
2002 2001
REGULATORY ASSETS:
VDT costs $ 43,061 $ 48,811
Unamortized loss on bonds 6,916 6,142
LG&E/KU merger costs 4,093 6,139
One utility costs 2,619 4,365
Other 1,079 1,010
Total 57,768 66,467
REGULATORY LIABILITIES:
Deferred income taxes - net 31,021 32,872
Mark to market coal supply option contracts 1,419 -
Other 1,035 1,017
Total $ 33,475 $ 33,889
<page> -17-
9. SFAS No. 141, Business Combinations and No. 142, Goodwill and Other
Intangible Assets were issued in the second quarter of 2001. Therefore,
the provisions of these new pronouncements were effective July 1, 2001,
for LG&E and KU. SFAS No. 141 requires all business combinations
initiated after June 30, 2001, to be accounted for using the purchase
method. SFAS No. 142 requires goodwill to be recorded, but not
amortized. Furthermore, goodwill will now be subject to a periodic
assessment for impairment. LG&E and KU have no recorded goodwill and
have no merger or acquisitions in progress. Accordingly, the Companies
experienced no impact on the financial position or results of operation
as a result of adopting these standards.
SFAS No. 143, Accounting for Asset Retirement Obligations and SFAS No.
144, Accounting for the Impairment or Disposal of Long-Lived Assets,
were also issued during 2001. SFAS No. 143 establishes accounting and
reporting standards for obligations associated with the retirement of
tangible long-lived assets and the associated asset retirement costs.
SFAS No. 144 supersedes SFAS No. 121, Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of and the
accounting and reporting provisions of APB Opinion No. 30, Reporting
the Results of Operations - Reporting the Effects of Disposal of a
Segment of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions. SFAS No. 144, among other
provisions, eliminates the requirement of SFAS No. 121 to allocate
goodwill to long-lived assets to be tested for impairment. The
effective implementation date for SFAS No. 144 is January 1, 2002 and
SFAS No. 143 is January 1, 2003. SFAS No. 144 had no impact on the
financial position or results of operations of LG&E or KU. Management
is currently conducting an analysis and has not determined what impact
SFAS No. 143 will have on the financial position or results of
operations of the Companies.
SFAS No. 145, Rescission of SFAS Nos. 4, 44 and 64, amendment of SFAS
No. 13, and technical corrections was issued in the second quarter
2002. The provisions related to SFAS No. 13 were effective for fiscal
years beginning after May 15, 2002. All other provisions of SFAS No.
145 shall be effective for financial statements issued on or after May
15, 2002. The adoption of this standard will not have a material
impact on financial position or results of operations of the Companies.
SFAS No. 146, Accounting for Costs Associated with Exit or Disposal
Activities, was issued in July 2002. SFAS No. 146 requires companies
to recognize costs associated with exit or disposal activities when
they are incurred rather than at the date of a commitment to an exit or
disposal plan. The provisions of this Statement are effective for exit
or disposal activities that are initiated after December 31, 2002. The
Companies do not expect the adoption of this standard to have a
material impact on financial position or results of operations of the
Companies.
10.On May 23, 2002 KU refinanced its pollution control series 1B, 2B, 3B,
and 4B bonds, totaling $37.9 million. The new bonds, series 12, 13, 14
and 15 are due in February 2032 and bear interest at a variable rate.
The new bonds are secured by first mortgage bonds and have the same
principal amount as the prior bonds. The variable rate will be
established by the remarketing agent based on conditions in the tax-
exempt debt market.
On March 22, 2002, LG&E refinanced two $35 million unsecured pollution
control bonds due November 1, 2027. The replacement variable rate
bonds are secured by first mortgage bonds and will mature November 1,
2027. The variable rate will be established by the remarketing agent
taking into account market conditions in the commercial paper market.
On March 6, 2002, LG&E refinanced $22.5 million and $27.5 million in
unsecured pollution control bonds, both due September 1, 2026. The
replacement bonds, due September 1, 2026, are variable rate bonds and
are secured by first mortgage bonds. The variable rate will be
established by the remarketing agent taking into account market
conditions in the commercial paper market.
<page> -18-
11.As of June 30, 2002, LG&E Energy owned $104.6 million in varying
portions of LG&E's outstanding variable rate pollution control bonds.
The bonds were acquired during May 2002 by LG&E Energy as an investment
and were sold in their entirety during the first half of July 2002 to
unaffiliated third parties.
12.In the normal course of business, lawsuits, claims, environmental
actions, and various non-ratemaking governmental proceedings arise
against LG&E and KU. To the extent that damages are assessed in any of
these lawsuits, LG&E and KU believe that their insurance coverage is
adequate. Management, after consultation with legal counsel, and based
upon the present status of these items, does not anticipate that
liabilities arising out of other currently pending or threatened
lawsuits and claims of the type referenced above will have a material
adverse effect on LG&E's or KU's consolidated financial position or
results of operations, respectively.
<page> -19-
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 six month periods
ended June 30, 2002 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 and fuel industry or markets; 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 Securities and Exchange Commission, including Exhibit No.
99.01 to their Annual Report on Form 10-K for year ended December 31, 2001.
Results of Operations
The results of operations for LG&E and KU are affected by seasonal
fluctuations in temperature and other weather-related factors. Because of
these and other factors, the results of one interim period are not
necessarily indicative of results or trends to be expected for the full
year.
Three Months Ended June 30, 2002, Compared to
Three Months Ended June 30, 2001
LG&E Results:
LG&E's net income decreased $13.2 million for the quarter ended June 30,
2002, as compared to the quarter ended June 30, 2001, primarily due to
amortization expenses associated with LG&E's workforce reduction program
(See Note 4) and higher employee benefit-related costs caused by lower
investment returns.
A comparison of LG&E's revenues for the quarter ended June 30, 2002, with
the quarter ended June 30, 2001, reflects increases and decreases which
have been segregated by the following principal causes (in thousands of $):
Electric Gas
Cause Revenues Revenues
Retail sales:
Fuel and gas supply adjustments $ 5,972$ (17,227)
Environmental cost recovery surcharge 2,039 -
Demand side management cost recovery 151 253
LG&E/KU merger surcredit (830) -
Value delivery surcredit (274) (48)
Variation in sales volume, etc. 10,547 15,643
Total retail sales 17,605 (1,379)
Wholesale sales (23,925) (44)
Gas transportation - net - (114)
Other 1,843 (76)
Total $ (4,477)$ (1,613)
Electric revenues decreased primarily because of a decrease in wholesale
sales, partially offset by increased retail sales. The decrease in
wholesale sales is attributable to lower sales volumes ($12.5 million) and
a decrease in wholesale sales prices ($11.4 million). The retail sales
<page> -20-
increase was due in part to warmer weather experienced this period.
Cooling degree days increased 8% for the three months ended June 2002 as
compared to three months ended June 2001. Gas revenues decreased primarily
as a result of lower gas supply costs billed to customers through the gas
supply clause, partially offset by an increase in gas sales volume.
Fuel for electric generation and gas supply expenses comprise a large
portion 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 may be
reflected in retail rates, subject to the approval of the Kentucky
Commission. Fuel for electric generation increased $8.8 million (21%) for
the quarter because of an increase in the cost of coal burned ($10.4
million), partially offset by a decrease in quantity of coal burned ($1.6
million). Gas supply expenses decreased $0.5 million (3%) due to a
decrease in net gas supply cost ($4.4 million), partially offset by an
increase in the volume of retail gas delivered to the distribution system
($3.9 million).
Power purchased decreased $10.7 million (33%) primarily because of a
decrease in volume of purchases to support wholesale sales ($4.0 million)
and a decrease in cost of power purchased ($6.7 million).
Other operation expenses increased $18.4 million (51%) in 2002, as compared
to 2001, primarily due to amortization expenses associated with LG&E's
workforce reduction program ($7.5 million), increased costs for pension
expenses ($2.2 million), electric transmission expenses ($3.8 million),
post-retirement medical expenses ($1.3 million), and steam operation
expenses ($1.8 million).
Maintenance expenses increased $1.9 million (14%) in 2002 primarily due to
increased repairs to steam production ($0.7 million) and maintenance to the
electric distribution plant ($0.8 million).
A reconciliation of differences between the U.S. statutory federal income
tax rate and effective income tax rate for the three months ended June
follows:
June June
Effective Rate 2002 2001
Statutory federal income tax rate 35.0% 35.0%
State income taxes net of federal benefit 4.3% 5.5%
Amortization of investment tax credit & R&D -4.5% -2.3%
Other differences -0.4% -0.5%
Effective Income Tax Rate 34.4% 37.7%
Interest charges decreased $2.4 million (26%) due to lower interest rates
on variable rate long-term debt ($1.7 million) and a decrease in interest
associated with the accounts receivable securitization program ($0.5
million). The weighted average interest rate on variable-rate tax-exempt
debt for the three months ended June 30, 2002 was 1.63%, compared to 3.96%
for the comparable period in 2001.
KU Results:
KU's net income decreased $8.4 million for the quarter ended June 30, 2002,
as compared to the quarter ended June 30, 2001. The decrease was primarily
due to increased other operation expense and decreased electric revenues
partially offset by decreased interest expense.
A comparison of KU's revenues for the quarter ended June 30, 2002, with the
quarter ended June 30, 2001, reflects increases and decreases which have
been segregated by the following principal causes (in thousands of $):
<page> -21-
Retail sales:
Fuel supply adjustments $ 4,226
Environmental cost recovery surcharge 1,033
Demand side management cost recovery 512
LG&E/KU merger surcredit (1,136)
Value delivery surcredit (149)
Variation in sales volume, etc. 8,595
Total retail sales 13,081
Wholesale sales (30,745)
Other 1,859
Total $ (15,805)
Electric revenues decreased primarily due to a decrease in volume ($25.3
million) and price ($5.4 million) of wholesale sales, partially offset by
increased retail sales.
Fuel for electric generation comprises a large portion 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 Public Service Commission,
the Virginia State Corporation Commission, and the Federal Energy
Regulatory Commission. Fuel for electric generation increased $1.8 million
(3%) for the quarter due to an increase in the cost of coal burned ($7.1
million) partially offset by a decrease in volume burned ($5.3 million).
Power purchased decreased $12.1 million (23%) in 2002 primarily because of
a decrease in volumes purchased ($7.6 million) and a decrease in unit cost
of purchases ($4.5 million).
Other operation expenses increased $8.9 million (32%) compared to 2001,
primarily due to amortization expenses associated with KU's workforce
reduction program ($2.9 million), higher pension expenses ($0.9 million),
outside services ($0.8 million), property insurance ($0.5 million), post-
retirement medical expenses ($0.5 million), and increased operation of the
electric transmission system ($2.0 million) and distribution system ($0.7
million).
A reconciliation of differences between the U.S. statutory federal income
tax rate and effective income tax rate for the three months ended June
follows:
June June
Effective Rate 2002 2001
Statutory federal income tax rate 35.0% 35.0%
State income taxes net of federal benefit 6.8% 5.9%
Amortization of investement tax credit & R&D -3.9% -2.5%
Other differences -4.5% -3.3%
Effective Income Tax Rate 33.4% 35.1%
Interest charges decreased $1.4 million (14%) for the second quarter 2002
compared to the second quarter 2001 due to lower rates on variable rate
debt ($0.8 million) and a decrease in interest associated with the accounts
receivable securitization program ($0.6 million). The weighted average
interest rate on variable-rate tax-exempt debt for the three months ended
June 30, 2002 was 1.64%, compared to 3.55% for the comparable period in
2001.
<page> -22-
Six Months Ended June 30, 2002, Compared to
Six Months Ended June 30, 2001
LG&E Results:
LG&E's net income increased $61.8 million for the six months ended June 30,
2002, as compared to the six months ended June 30, 2001, primarily because
of a non-recurring charge of $86.1 million, net of tax, for LG&E's
workforce reduction program incurred in 2001. Excluding this one-time
charge, LG&E's net income would have decreased $24.3 million primarily due
to amortization expenses associated with LG&E's workforce reduction program
(See Note 4), lower wholesale margins expenses and higher pension expenses
caused by lower investment returns partially offset by lower interest
expense.
A comparison of LG&E's revenues for the six months ended June 30, 2002,
with the six months ended June 30, 2001, reflects increases and decreases
which have been segregated by the following principal causes (in thousands
of $):
Electric Gas
Cause Revenues Revenues
Retail sales:
Fuel and gas supply adjustments $ 3,704 $ (58,158)
Environmental cost recovery surcharge 3,685 -
Demand side management cost recovery 203 675
LG&E/KU merger surcredit (1,035) -
Value delivery surcredit (510) (169)
Variation in sales volume, etc. 9,776 5,345
Total retail sales 15,823 (52,307)
Wholesale sales (10,825) 9,979
Gas transportation - net - 75
Other 1,397 (139)
Total $ 6,395 $ (42,392)
Electric revenues increased primarily because of an increase in sales to
retail customers, partially offset by decreased wholesale sales. The
increase in retail sales was due in part to warmer weather experienced in
the period. Cooling degree days increased 8% for the six months ended June
2002 as compared to the six months ended June 2001. Wholesale sales
decreased due to lower unit prices ($29.1 million) partially offset by
increased volume sold ($18.3 million). Gas revenues decreased primarily as
a result of lower gas supply costs billed to customers through the gas
supply clause.
Fuel for electric generation increased $14.4 million (18%) for the six
months because of an increase in the cost of coal burned ($12.9 million)
and an increase in quantity of coal burned ($1.5 million). Gas supply
expenses decreased $42.2 million (29%) due to a decrease in net gas supply
cost ($44.0 million), and a decrease in the volume of retail gas delivered
to the distribution system ($6.4 million), partially offset by increased
wholesale gas expenses ($8.2 million).
The decrease in non-recurring charges of $144.4 million ($86.1 million
after tax) is due to the costs associated with LG&E's workforce reduction
initiative which were recorded in the first quarter of 2001 (See Note 4).
Other operation expenses increased $31.5 million (44%) in 2002, compared to
2001, primarily due to amortization expenses associated with LG&E's
workforce reduction program ($15.0 million), increased costs for electric
transmission ($5.9 million), pension expenses ($4.9 million), post-
retirement medical expenses ($1.8 million), and property insurance ($1.3
million).
Maintenance expenses increased $3.3 million (14%) in 2002 primarily due to
increased repairs to steam production ($1.6 million) and maintenance to the
electric distribution system ($1.1 million).
Other income(deduction)-net decreased $1.4 million in 2002 primarily due to
an increase in repairs to non-utility property ($0.6 million), a decrease
in gains recorded on the sale of non-utility property ($.3 million) and an
increase in the tax provision related to other income ($0.6 million).
<page> -23-
A reconciliation of differences between the U.S. statutory federal income
tax rate and effective income tax rate for the six months ended June 30
follows:
June June
Effective Rate 2002 2001
Statutory federal income tax rate 35.0% -35.0%
State income taxes net of federal benefit 5.0% -5.5%
Amortization of investment tax credit & R&D -3.7% -4.5%
Other differences -0.2% -1.2%
Effective Income Tax Rate 36.1% -46.2%
The six months ended June 2001 included a net pretax loss because of the
workforce reduction charge.
Interest charges decreased $6.0 million (29%) due to lower interest rates
on variable rate long term debt ($3.7 million), a decrease in interest on
debt to parent company ($0.9 million), and a decrease in interest
associated with the accounts receivable securitization program ($1.5
million). The weighted average interest rate on variable-rate tax-exempt
debt for the six months ended June 30, 2002 was 1.66%, compared to 4.23%
for the comparable period in 2001.
KU Results:
KU's net income increased $23.0 million for the six months ended June 30,
2002, as compared to the six months ended June 30, 2001. The increase was
primarily due a non-recurring charge of $38.0 million, net of tax, made in
the first quarter of 2001 for costs associated with KU's workforce
reduction program. Excluding this one-time charge, net income decreased
$15.0 million, due largely to increased operation expenses and lower
electric revenues, partially offset by lower interest expense.
A comparison of KU's revenues for the six months ended June 30, 2002, with
the six months ended June 30, 2001, reflects increases and decreases which
have been segregated by the following principal causes (in thousands of $):
Retail sales:
Fuel supply adjustments $ 9,359
Environmental cost recovery surcharge 2,543
Demand side management cost recovery 1,296
LG&E/KU merger surcredit (2,161)
Value delivery surcredit (338)
Variation in sales volume, etc. 4,782
Total retail sales 15,481
Wholesale sales (31,050)
Other 3,139
Total $ (12,430)
Electric revenues decreased primarily due to a decrease in wholesale sales,
partially offset by increased sales to retail customers. The decrease in
wholesale sales is primarily due to a decrease in the price of wholesale
sales ($21.4 million) and a decrease in volume sold ($9.7 million).
Fuel for electric generation increased $4.2 million (4%) for the six months
due to a $12.6 million increase in the cost of coal burned partially offset
by a decrease of $8.4 million in volume burned.
<page> -24-
Power purchased decreased $3.9 million (5%) in 2002 primarily because of a
decrease in unit cost ($10.2 million), partially offset by an increase in
KWH purchased ($6.3 million).
Non-recurring charges decreased $63.8 million ($38.0 million after tax).
These costs were due to KU's workforce reduction program which were
recorded in the first quarter of 2001 (See Note 4).
Other operation expenses increased $16.8 million (31%) compared to 2001,
primarily due to amortization expenses associated with KU's workforce
reduction program ($5.8 million), higher pension expenses ($2.1 million),
property insurance ($1.3 million) and outside services ($1.9), higher costs
for electric transmission ($3.4 million) and increases in uncollectible
accounts and customer assistance programs ($1.3 million).
Other income-net decreased $1.1 million (25%) in 2002 primarily due to a
gain on disposition of property in 2001 of $1.3 million.
A reconciliation of differences between the U.S. statutory federal income
tax rate and effective income tax rate for the six months ended June
follows:
June June
Effective Rate 2002 2001
Statutory federal income tax rate 35.0% 35.0%
State income taxes net of federal benefit 6.3% 7.7%
Amortization of investment tax credit & R&D -3.5% -9.7%
Other differences -3.0% -11.4%
Effective Income Tax Rate 34.8% 21.6%
The amortization of investment tax credit and other differences were
approximately the same in both periods, but lower pretax income for the six
months ended June 30, 2001 (resulting from the workforce reduction charge)
caused the percentage changes to be greater in the 2001 period.
Interest charges decreased $4.1 million (22%) for the first six months of
2002 as compared to the six months of 2001 primarily due to lower rates on
variable rate debt ($2.7 million) and a decrease in interest associated
with the accounts receivable securitization program ($1.0 million). The
weighted average interest rate on variable-rate tax-exempt debt for the six
months ended June 30, 2002 was 1.66%, compared to 3.76% for the comparable
period in 2001.
Liquidity and Capital Resources
LG&E's and KU's need 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, the
accounts receivable securitization programs, and commercial paper programs
are maintained to fund short-term capital requirements.
Construction expenditures for the six months ended June 30, 2002 for LG&E
and KU amounted to $69.5 million and $47.8 million, respectively. Such
expenditures related primarily to construction to meet nitrogen oxide (NOx)
emission standards, and were financed with internally generated funds and
accounts receivable securitization program funds. Also, a common stock
dividend of $23 million was paid by LG&E. See Note 6 of Notes to Financial
Statements concerning accounts receivable securitization.
LG&E's and KU's cash and temporary cash investment balance increased $18.3
million and $0.2 million, respectively during the six months ended June 30,
2002. The increases reflect cash flows from operations, partially offset
by construction expenditures and LG&E's common dividend payment. KU also
reduced notes payable by $28.2 million.
Variations in accounts receivable, accounts payable and materials and
supplies are generally not significant indicators of LG&E's and KU's
liquidity. Such variations are primarily attributable to fluctuations in
weather, which have a direct effect on sales of electricity and natural
<page> -25-
gas. The increases in accounts receivable for KU resulted primarily from
seasonal fluctuations. The decrease in accounts receivable at LG&E
resulted primarily from the increased sale of accounts receivable through
the accounts receivable securitization program. (See Note 6 of Notes to
Financial Statements). The increase in fuel inventory at LG&E and the
decrease in LG&E's gas stored underground resulted from seasonal
fluctuations.
LG&E and KU participate in a money pool whereby LG&E Energy can make funds
available to LG&E and KU at market-based rates up to $200 million each.
LG&E Energy maintains a facility of $200 million with a Powergen subsidiary
to ensure funding availability for the money pool. There is no balance
outstanding under the Powergen line of credit as of June 30, 2002 and no
outstanding commercial paper program balance. LG&E Energy has provided
loans to LG&E and KU through the money pool that total $91.6 million and
$19.6 million, respectively, as of June 30, 2002. These borrowings carried
a commercial paper grade interest rate of 1.82% at June 30, 2002.
On March 6, 2002, LG&E refinanced its $22.5 million and $27.5 million
unsecured pollution control bonds, both due September 1, 2026. The
replacement bonds, due September 1, 2026, are variable rate bonds and are
secured by first mortgage bonds.
On March 22, 2002, LG&E refinanced its two $35 million unsecured pollution
control bonds due November 1, 2027. The replacement variable rate bonds
are secured by first mortgage bonds and will mature November 1, 2027.
On May 23, 2002 KU refinanced its pollution control series 1B, 2B, 3B, and
4B bonds, totaling $37.9 million. The new bonds, series 12, 13, 14 and 15
are due in February 2032 and bear interest at a variable rate. The new
bonds are secured by first mortgage bonds and have the same principal
amount as the prior bonds. The variable rate will be established by the
remarketing agent based on conditions in the tax-exempt debt market.
As of June 30, 2002, LG&E Energy owned $104.6 million in varying portions
of LG&E's outstanding variable rate pollution control bonds. The bonds
were acquired during May 2002 by LG&E Energy as an investment and were sold
in their entirety during the first half of July 2002 to unaffiliated third
parties.
LG&E's security ratings as of June 30, 2002, were:
Moody's S&P Fitch
First mortgage bonds A1 A- A+
Preferred stock a2 BBB- A-
Commercial paper P-1 A-2 F-1
KU's security ratings as of June 30, 2002, were:
Moody's S&P Fitch
First mortgage bonds A1 A- A+
Preferred stock a2 BBB- A-
Commercial paper P-1 A-2 F-1
The S&P ratings of LG&E's and KU's debt securities are on Credit Watch for
upgrade as the result of the E.ON acquisition. Fitch has placed LG&E and
KU on credit watch evolving as a result of the acquisition by E.ON. These
ratings reflect the views of Moody's, S&P and Fitch. 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> -26-
LG&E's capitalization ratios at June 30, 2002, and December 31, 2001,
follow:
Jun. 30, Dec. 31,
2002 2001
Long-term debt (including current portion) 37.4% 37.5%
Notes payable 5.5 5.7
Preferred stock 5.8 5.8
Common equity 51.3 51.0
Total 100.0% 100.0%
KU's capitalization ratios at June 30, 2002, and December 31, 2001, follow:
Jun. 30, Dec. 31,
2002 2001
Long-term debt (including current portion) 37.1% 37.2%
Notes payable 1.5 3.6
Preferred stock 3.0 3.1
Common equity 58.4 56.1
Total 100.0% 100.0%
New Accounting Pronouncements
SFAS No. 141, Business Combinations and No. 142, Goodwill and Other
Intangible Assets were issued in the second quarter of 2001. Therefore, the
provisions of these new pronouncements were effective July 1, 2001, for
LG&E and KU. SFAS No. 141 requires all business combinations initiated
after June 30, 2001, to be accounted for using the purchase method. SFAS
No. 142 requires goodwill to be recorded, but not amortized. Furthermore,
goodwill will now be subject to a periodic assessment for impairment. LG&E
and KU have no recorded goodwill and have no merger or acquisitions in
progress. Accordingly, the Companies experienced no impact on the
financial position or results of operation as a result of adopting these
standards.
SFAS No. 143, Accounting for Asset Retirement Obligations and SFAS No. 144,
Accounting for the Impairment or Disposal of Long-Lived Assets, were issued
during 2001. SFAS No. 143 establishes accounting and reporting standards
for obligations associated with the retirement of tangible long-lived
assets and the associated asset retirement costs. SFAS No. 144 supersedes
SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of and the accounting and reporting
provisions of APB Opinion No. 30, Reporting the Results of Operations -
Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions.
SFAS No. 144, among other provisions, eliminates the requirement of SFAS
No. 121 to allocate goodwill to long-lived assets to be tested for
impairment. The effective implementation date for SFAS No. 144 is January
1, 2002 and SFAS No. 143 is January 1, 2003. SFAS No. 144 had no impact on
the financial position or results of operations of LG&E or KU. Management
is currently conducting an analysis and has not determined what impact SFAS
No. 143 will have on the financial position or results of operations of the
Companies.
The Financial Accounting Standards Board created the Derivatives
Implementation Group ("DIG") to provide guidance for implementation of SFAS
No. 133. DIG Issue C15, Normal Purchases and Normal Sales Exception for
Option Type Contracts and Forward Contracts in Electricity was adopted in
2001 and had no impact on results of operations and financial position of
the Companies. DIG Issue C16, Applying the Normal Purchase and Normal
Sales Exception to Contracts that Combine a Forward Contract and a
Purchased Option Contract, was cleared in the third quarter 2001 and stated
that option contracts do not meet the normal purchases and normal sales
exception and should follow SFAS No. 133. DIG Issue C16 was effective in
the second quarter of 2002. The adoption of DIG Issue C16 did not have a
material impact on the financial position or results of operations of the
Companies pursuant to regulatory treatment prescribed by SFAS No. 71,
Accounting for the Effects of Certain Types of Regulation. KU recorded a
mark to market asset and corresponding regulatory liability of $1.4 million
in the second quarter of 2002.
<page> -27-
SFAS No. 145, Rescission of SFAS Nos. 4, 44 and 64, amendment of SFAS No.
13, and technical corrections was issued in the second quarter 2002. The
provisions related to SFAS No. 13 were effective for fiscal years beginning
after May 15, 2002. All other provisions of SFAS No. 145 shall be
effective for financial statements issued on or after May 15, 2002. The
adoption of this standard will not have a material impact on financial
position or results of operations of the Companies.
SFAS No. 146, Accounting for Costs Associated with Exit or Disposal
Activities, was issued in July 2002. SFAS No. 146 requires companies to
recognize costs associated with exit or disposal activities when they are
incurred rather than at the date of a commitment to an exit or disposal
plan. The provisions of this Statement are effective for exit or disposal
activities that are initiated after December 31, 2002. The Companies do
not expect the adoption of this standard to have a material impact on
financial position or results of operations of the Companies.
Contingencies
For a description of significant contingencies that may affect LG&E and KU,
reference is made to Part I, Item 3, Legal Proceedings, and Notes 12 (LG&E)
and 11 (KU) to the financial statements contained in LG&E's and KU's Annual
Reports on Form 10-K for the year ended December 31, 2001 and to Part II -
Item 1, Legal Proceedings herein.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
LG&E and KU are exposed to market risks. Both operations are exposed to
market risks from changes in interest rates and commodity prices. To
mitigate changes in cash flows attributable to these exposures, the
Companies have entered into various derivative instruments. Derivative
positions are monitored using techniques that include market value and
sensitivity analysis.
The Companies use interest rate swaps to hedge exposure to market
fluctuations in certain of their debt instruments. Pursuant to Company
policy, use of these financial instruments is intended to mitigate risk and
earnings volatility and is not speculative in nature. Management has
designated all of the Companies' interest rate swaps as hedge instruments.
Financial instruments designated as cash flow hedges have resulting gains
and losses recorded within other comprehensive income and stockholders'
equity. To the extent a financial instrument or the underlying item being
hedged is prematurely terminated or the hedge becomes ineffective, the
resulting gains or losses are reclassified from other comprehensive income
to net income. Financial instruments designated as fair value hedges are
periodically marked to market with the resulting gains and losses recorded
directly into net income to correspond with income or expense recognized
from changes in market value of the items being hedged.
The potential change in interest expense resulting from changes in base
interest rates of the Companies' unswapped debt did not change materially
during the first six months of 2002. The potential changes in the fair
values of the Company's interest-rate swaps resulting from changes in
interest rates and the yield curve also did not change materially during
the first six months of 2002. The Companies' exposure to market risks from
changes in commodity prices remained immaterial during the first six months
of 2002.
The Companies have entered into fuel purchase contracts that contain
options which allow the Companies to purchase additional tons of coal, as
needed, or purchase less coal that contractually required, as needed. The
potential change resulting from variations in coal commodity prices of the
Companies' coal supply contracts containing option features are not
material during the first six months of 2002. The Companies' exposure to
market risks from changes in commodity prices are immaterial during the
first six months of 2002.
<page> -28-
Energy Trading & Risk Management Activities
LG&E and KU conduct energy trading and risk management activities to
maximize the value of power sales from physical assets it owns, in addition
to the wholesale sale of excess asset capacity. Certain energy trading
activities are accounted for on a mark-to-market basis in accordance with
EITF 98-10 Accounting for Contracts Involved in Energy Trading and Risk
Management Activities, SFAS No. 133 Accounting for Derivative Instruments
and Hedging Activities, and SFAS No. 138 Accounting for Certain Derivative
Instruments and Certain Hedging Activities. Wholesale sales of excess
asset capacity and wholesale purchases are treated as normal sales and
purchases under SFAS No. 133 and SFAS No. 138 and are not marked to market.
The table below summarizes both LG&E and KU's energy trading and risk
management activities during January through June of 2002 (in thousands of
$), as trading volumes are evenly divided between the two regulated
utilities.
Fair value of contracts at 12/31/01, net liability $ (186)
Fair value of contracts when entered into
during Jan- Jun 2002 (57)
Contracts realized or otherwise settled during Jan-
Jun 2002 335
Changes in fair values due to changes in assumptions (66)
Fair value of contracts at 6/30/02, net asset $ 26
No changes to valuation techniques for energy trading and risk management
activities occurred during January through June of 2002. All contracts
outstanding at June 30, 2002 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 revalues
credit exposures daily to monitor compliance with those policies. As June
30, 2002, 100% of the trading and risk management commitments were with
counterparties rated BBB- equivalent or better.
<page> -29-
Part II. Other Information
Item 1. Legal Proceedings.
For a description of the significant legal proceedings involving LG&E and
KU, reference is made to the information under the following items and
captions of LG&E's and KU's (A) respective combined Annual Report on Form
10-K for the year ended December 31, 2001: Item 1, Business; Item 3, Legal
Proceedings; Item 7, Management's Discussion and Analysis of Financial
Condition and Results of Operations; Notes 3, 12 and 16 of LG&E's Notes to
Financial Statements under Item 8 and Notes 3, 11 and 14 of KU's Notes to
Financial Statements under Item 8 and (B) respective combined Quarterly
Report on Form 10-Q for the quarter ended March 31, 2002: Item I of Part
II, Legal Proceedings. Except as described herein, to date, the
proceedings reported in LG&E's and KU's respective combined Annual Report
on Form 10-K have not changed materially.
E.ON-Powergen Transaction
Effective July 1, 2002, E.ON, a Germany company, completed its acquisition
of Powergen, following receipt of the final necessary regulatory approval
on June 14, 2002 from the Securities and Exchange Commission. E.ON had
announced its pre-conditional cash offer of 5.1 billion pounds sterling
($7.3 billion) for Powergen on April 9, 2001.
LG&E Employment Discrimination Claim
In June 2002, alternative amended complaints were filed against LG&E and
certain related and unrelated parties whereby approximately 30 employees or
former employees claimed past and current instances of employment
discrimination. The complaints demand various forms of declarative,
injunctive and class action relief, as well as a claim of $150 million in
monetary damages. LG&E has removed the case to the U.S. District Court for
the Western District of Kentucky and filed an answer denying all
plaintiffs' claims. Certain plaintiffs' claims have completed a process of
preliminary administrative review before the U.S. Equal Employment
Opportunity Commission, which has, to date, declined to proceed on any of
the claims reviewed. LG&E intends to vigorously defend itself in the
action and management does not anticipate that the outcome will have a
material impact on LG&E's operations or financial condition.
Fuel Adjustment Clause Proceedings
In May 2002 the Kentucky Commission granted final approval to the December
21, 2001 comprehensive settlement regarding pending fuel adjustment clause
proceedings involving LG&E and KU and in July 2002 the Kentucky Court of
Appeals dismissed the associated appeal. Pursuant to such settlement, LG&E
and KU credited customers approximately $720,000 and $954,000,
respectively, during June and July 2002. See Legal Proceedings under Item
3 of LG&E's and KU's Annual Report on Form 10-K for the year ended December
31, 2001.
Other
On April 16, 2002, the LG&E 5% Cumulative Preferred class of stock was
delisted from the NASDAQ Small Capitalization Market. On June 3, 2002, the
KU 4.75% Cumulative Preferred class of stock was delisted from the
Philadelphia Stock Exchange. Delisting will enable the Companies to
realize certain administrative and corporate governance efficiencies.
Item 6(a). Exhibits.
None.
Item 6(b). Reports on Form 8-K.
None.
<page> -30-
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Louisville Gas and Electric Company
Registrant
Date: August 14, 2002 /s/ S. Bradford Rives
S. Bradford Rives
Senior Vice President - Finance and
Controller
(On behalf of the registrant in his
capacity as Principal Accounting Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Kentucky Utilities Company
Registrant
Date: August 14, 2002 /s/ S. Bradford Rives
S. Bradford Rives
Senior Vice President - Finance and
Controller
(On behalf of the registrant in his
capacity as Principal Accounting Officer)
<page> -31-