UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q/A
(Mark One) AMENDMENT NO. 1 TO
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2005
Or
[_] TRANSITION REPORT PURSUANT 1TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission Registrant, State of Incorporation IRS Employer
File Number Address, and Telephone Number Identification No.
1-2893 Louisville Gas and Electric Company 61-0264150
(A Kentucky Corporation)
220 West Main Street
P.O. Box 32010
Louisville, KY 40232
(502) 627-2000
1-3464 Kentucky Utilities Company 61-0247570
(A Kentucky and Virginia Corporation)
One Quality Street
Lexington, KY 40507-1428
(859) 255-2100
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes X No _
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes No X
Indicate by check mark whether the registrant is a shell company (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 31,2005, all held by LG&E Energy LLC
Kentucky Utilities Company - 37,817,878 shares, without par value, as of
October 31, 2005, all held by LG&E Energy LLC
This combined Form 10-Q/A 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.
EXPLANATORY NOTE
Kentucky Utilities Company is filing this Amendment No. 1 on Form 10-Q/A for
the quarterly period ended September 30, 2005, to reflect a correction to
information contained in a single paragraph as described below in Part 1,
Item 2, "Management's Discussion and Analysis of Financial Condition and
Results of Operations" ("MD&A") of the original Form 10-Q. For reasons not
understood by the Company, the final version of Kentucky Utility Company's
original Form 10-Q did not agree with the Edgarized version. This
filing modifies the originally filed document to agree with the final
version. Except as described in this Explanatory Note, no other MD&A
information and no other information included in the original Form 10-Q
("Original Filing") is amended hereby.
As reflected in this Form 10-Q/A, the below-excerpted paragraph in KU's
"Results of Operations" for the "Three Months Ended September 30, 2005,
Compared to the Three Months Ended September 30, 2004" contains corrections
to each of the two sub-paragraphs (bullet-points). The paragraph, as
corrected, reads as follows:
Fuel for electric generation increased $40.3 million (52%) in 2005
primarily due to:
- Increased cost per Btu (36% higher), resulting in $31.2 million
higher fuel costs. Fuel costs are significantly higher due to
the MISO's dispatch of gas-fired units committed by the MISO's
Reliability Assessment and Commitment process in the real-time
market.
- Increased generation (12%) higher, resulting in $9.0 million
higher fuel costs, primarily due to higher dispatch of gas-fired
units
While this combined Form 10-Q/A contains information relating to Louisville
Gas and Electric Company due to the combined nature of its reporting
documents and process with its sister company, KU, no change or amendment
is hereby made to any LG&E information or items contained in that company's
original Form 10-Q.
Pursuant to Rule 12b-15 under the Securities Exchange Act of 1934, as a
result of this Amendment No. 1, the certifications of our Chief Executive
Officer and Chief Financial Officer required by Sections 302 and 906 of the
Sarbanes-Oxley Act of 2002, which were filed and furnished, respectively,
as exhibits to the Original Filing, have been re-executed and re-filed and
re-furnished, respectively, as of the date of this Form 10Q/A and are
attached to Amendment No. 1 as Exhibits 31.1, 31.2, 31.3, 31.4 and 32,
respectively.
For the convenience of the reader, Amendment No. 1 sets forth the Original
Filing in its entirety. However, except as described above, no other
information in the Original Filing is amended hereby. This Amendment No. 1
does not reflect events occurring after the filing of the Original Filing
or modify or update those disclosures in any way other than as required to
reflect the amendments as described above and set forth below.
INDEX OF ABBREVIATIONS
AG Attorney General of Kentucky
ARO Asset Retirement Obligation
CCN Certificate of Public Convenience and Necessity
DSM Demand Side Management
ECR Environmental Cost Recovery
EEI Electric Energy, Inc.
EITF Emerging Issues Task Force
E.ON E.ON AG
EPA Environmental Protection Agency
EPAct 2005 Energy Policy Act of 2005
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
FTR Financial Transmission Right
IMEA Illinois Municipal Electric Agency
IMPA Indiana Municipal Power Agency
ITP Independent Transmission Provider
IRS Internal Revenue Service
Kentucky Commission Kentucky Public Service Commission
KIUC Kentucky Industrial Utility Consumers, Inc.
KU Kentucky Utilities Company
LIBOR London Interbank Offer Rate
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
NOX Nitrogen Oxide
OMU Owensboro Municipal Utilities
PJM PJM Interconnection, LLC
Powergen Powergen Limited (formerly Powergen plc)
PUHCA Public Utility Holding Company Act of 1935
RSGMWP Revenue Sufficiency Guarantee Make Whole Payment
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
TABLE OF CONTENTS
PART I
ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)
LOUISVILLE GAS AND ELECTRIC COMPANY
STATEMENTS OF INCOME 1
STATEMENTS OF RETAINED EARNINGS 1
BALANCE SHEETS 2
STATEMENTS OF CASH FLOWS 4
STATEMENTS OF OTHER COMPREHENSIVE INCOME 5
KENTUCKY UTILITIES COMPANY
STATEMENTS OF INCOME 6
STATEMENTS OF RETAINED EARNINGS 6
BALANCE SHEETS 7
STATEMENTS OF CASH FLOWS 9
STATEMENTS OF OTHER COMPREHENSIVE INCOME 10
NOTES TO FINANCIAL STATEMENTS 11
ITEM 2.MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS. 25
ITEM 3.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. 39
ITEM 4.CONTROLS AND PROCEDURES. 41
PART II
ITEM 1.LEGAL PROCEEDINGS. 42
ITEM 6.EXHIBITS 43
SIGNATURES 44
EXHIBITS 45
Part I. Financial Information - Item 1. Financial Statements (Unaudited)
Louisville Gas and Electric Company
Statements of Income
(Unaudited)
(Millions of $)
Three Months Nine Months
Ended Ended
September 30, September 30,
2005 2004 2005 2004
OPERATING REVENUES:
Electric $284.0 $227.0 $741.2 $617.8
Gas 34.6 34.8 259.8 242.2
Total operating revenues 318.6 261.8 1,001.0 860.0
OPERATING EXPENSES:
Fuel for electric generation 79.4 53.8 207.8 154.5
Power purchased 34.1 19.3 101.3 65.6
Gas supply expenses 20.2 20.2 191.5 181.9
Other operation and maintenance
expenses 87.9 75.4 227.3 227.0
Depreciation and amortization 31.1 30.3 93.0 86.0
Total operating expenses 252.7 199.0 820.9 715.0
NET OPERATING INCOME 65.9 62.8 180.1 145.0
Other expense (income) - net - 1.9 (0.1) 2.8
Interest expense (Note 3) 5.6 5.1 17.4 15.1
Interest expense to affiliated
companies (Note 9) 3.0 3.0 9.0 9.1
INCOME BEFORE INCOME TAXES 57.3 52.8 153.8 118.0
Federal and state income
taxes (Note 6) 15.3 20.3 50.0 44.1
NET INCOME $ 42.0 $ 32.5 $103.8 $ 73.9
The accompanying notes are an integral part of these financial statements.
Statements of Retained Earnings
(Unaudited)
(Millions of $)
Three Months Nine Months
Ended Ended
September 30, September 30,
2005 2004 2005 2004
Balance at beginning of period $555.4 $516.9 $534.0 $497.4
Net income 42.0 32.5 103.8 73.9
Subtotal 597.4 549.4 637.8 571.3
Cash dividends declared on stock:
5% cumulative preferred 0.3 0.3 0.8 0.8
Auction rate cumulative preferred 0.4 0.2 1.3 0.6
Common - 21.0 39.0 42.0
Subtotal 0.7 21.5 41.1 43.4
Balance at end of period $596.7 $527.9 $596.7 $527.9
The accompanying notes are an integral part of these financial statements.
Louisville Gas and Electric Company
Balance Sheets
(Unaudited)
(Millions of $)
ASSETS
September 30, December 31,
2005 2004
CURRENT ASSETS:
Cash and cash equivalents $ 5.8 $ 6.8
Accounts receivable -
less reserve of $1.2 million and $0.8 million
as of September 30, 2005 and December 31, 2004,
respectively 131.3 167.0
Materials and supplies - at average cost:
Fuel (predominantly coal) 29.0 21.8
Gas stored underground 106.8 77.5
Other 27.5 26.1
Prepayments and other 15.6 3.9
Total current assets 316.0 303.1
OTHER PROPERTY AND INVESTMENTS -
less reserve of less than $0.1 million as of
September 30, 2005 and December 31, 2004 0.6 0.5
UTILITY PLANT:
At original cost 4,010.8 3,915.8
Less: reserve for depreciation 1,485.8 1,396.3
Net utility plant 2,525.0 2,519.5
DEFERRED DEBITS AND OTHER ASSETS:
Restricted cash 12.2 10.9
Unamortized debt expense 8.5 8.4
Regulatory assets (Note 5) 73.3 91.9
Other 31.8 32.2
Total deferred debits and other assets 125.8 143.4
Total assets $2,967.4 $2,966.5
The accompanying notes are an integral part of these financial statements.
Louisville Gas and Electric Company
Balance Sheets (cont.)
(Unaudited)
(Millions of $)
CAPITALIZATION AND LIABILITIES
September 30, December 31,
2005 2004
CURRENT LIABILITIES:
Current portion of long-term debt (Note 8) $247.5 $247.5
Current portion of long-term debt to
affiliated company (Note 8) - 50.0
Notes payable to affiliated companies (Note 8) 56.6 58.2
Accounts payable 107.5 106.1
Accounts payable to affiliated companies (Note 9) 57.8 31.7
Accrued income taxes - 6.2
Customer deposits 16.7 14.0
Other - 18.5
Total current liabilities 486.1 532.2
DEFERRED CREDITS AND OTHER LIABILITIES:
Accumulated deferred income taxes - net 324.4 347.2
Investment tax credit, in process of amortization 43.1 46.2
Accumulated provision for pensions
and related benefits 123.2 120.6
Customer advances for construction 9.6 10.6
Asset retirement obligation 10.7 10.3
Regulatory liabilities (Note 5):
Accumulated cost of removal of utility plant 218.8 220.2
Deferred income taxes - net (Note 6) 52.7 37.2
Other 9.5 15.0
Other 32.2 29.4
Total deferred credits and other liabilities 824.2 836.7
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 (47.5) (45.6)
Retained earnings 596.7 534.0
Total common equity 1,013.6 952.8
Cumulative preferred stock 70.4 70.4
Mandatorily redeemable preferred stock 20.0 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 1,657.1 1,597.6
Total capital and liabilities $2,967.4 $2,966.5
The accompanying notes are an integral part of these financial statements.
Louisville Gas and Electric Company
Statements of Cash Flows
(Unaudited)
(Millions of $)
Nine Months Ended
September 30,
2005 2004
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 103.8 $ 73.9
Items not requiring cash currently:
Depreciation and amortization 93.0 86.0
Value delivery team amortization 22.6 22.6
Deferred income taxes - net (7.3) 6.8
Investment tax credit - net (3.1) (3.1)
Other (1.0) 2.8
Changes in current assets and liabilities-net (8.4) (10.6)
Change in accounts receivable securitization - net - (58.0)
Pension funding (Note 11) - (34.5)
Provision for post-retirement benefits 2.6 (8.1)
Gas supply clause receivable, net (2.8) 12.0
Earnings sharing mechanism receivable 2.1 6.9
Litigation settlement - 7.0
Other (12.1) 15.5
Net cash provided by operating activities 189.4 119.2
CASH FLOWS USED IN INVESTING ACTIVITIES:
Change in restricted cash (1.3) (11.5)
Construction expenditures (95.0) (94.2)
Other (0.1) 0.1
Net cash used for investing activities (96.4) (105.6)
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of long-term debt (Note 8) 38.5 -
Retirement of long-term debt (Note 8) (40.0) -
Long-term borrowings from affiliated
company (Note 8) - 125.0
Repayment of long-term borrowings
from affiliated company (Note 8) (50.0) (50.0)
Short-term borrowings from affiliated
company (Note 8) 480.5 399.5
Repayment of short-term borrowings
from affiliated company (482.1) (439.2)
Payment of dividends (41.1) (43.4)
Other 0.2 (1.3)
Net cash used for financing activities (94.0) (9.4)
CHANGE IN CASH AND CASH EQUIVALENTS (1.0) 4.2
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 6.8 1.7
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 5.8 $ 5.9
SUPPLEMENTAL DISCLOSURES:
Cash paid during the period for:
Income taxes $74.6 $42.4
Interest on borrowed money 15.8 12.7
Interest to affiliated companies on borrowed money 9.7 8.9
The accompanying notes are an integral part of these financial statements.
Louisville Gas and Electric Company
Statements of Other Comprehensive Income
(Unaudited)
(Millions of $)
Three Months Nine Months
Ended Ended
September 30, September 30,
2005 2004 2005 2004
Net income $42.0 $32.5 $103.8 $73.9
Income Taxes - Minimum Pension
Liability - - (1.1) -
Gain (loss) on derivative instruments
and hedging activities - net of
tax benefit / (expense) of
$(3.1), $3.6, $0.9 and
$1.2,respectively (Note 3) 5.3 (5.4) (0.8) (1.8)
Other comprehensive income (loss),
net of tax 5.3 (5.4) (1.9) (1.8)
Comprehensive income $47.3 $27.1 $101.9 $72.1
The accompanying notes are an integral part of these financial statements.
Kentucky Utilities Company
Statements of Income
(Unaudited)
(Millions of $)
Three Months Nine Months
Ended Ended
September 30, September 30,
2005 2004 2005 2004
OPERATING REVENUES $347.2 $252.6 $898.7 $732.4
OPERATING EXPENSES:
Fuel for electric generation 118.5 78.2 290.0 215.9
Power purchased 64.8 33.2 161.1 105.1
Other operation and maintenance
expenses 80.1 54.2 206.3 166.5
Depreciation and amortization 28.4 29.1 86.1 80.3
Total operating expenses 291.8 194.7 743.5 567.8
NET OPERATING INCOME 55.4 57.9 155.2 164.6
Other income - net (1.1) (2.2) (3.3) (4.0)
Interest expense (Note 3) 3.1 3.2 10.1 7.6
Interest expense to affiliated
companies (Note 9) 4.2 3.5 11.4 10.6
NET INCOME BEFORE INCOME TAXES 49.2 53.4 137.0 150.4
Federal and state income
taxes (Note 6) 17.5 18.6 50.0 55.6
NET INCOME $ 31.7 $ 34.8 $ 87.0 $ 94.8
The accompanying notes are an integral part of these financial statements.
Statements of Retained Earnings
(Unaudited)
(Millions of $)
Three Months Nine Months
Ended Ended
September 30, September 30,
2005 2004 2005 2004
Balance at beginning of period $673.6 $629.1 $659.4 $591.2
Net income 31.7 34.8 87.0 94.8
Subtotal 705.3 663.9 746.4 686.0
Cash dividends declared on stock:
4.75% cumulative preferred 0.3 0.3 0.7 0.7
6.53% cumulative preferred 0.4 0.3 1.1 1.0
Common 10.0 21.0 50.0 42.0
Subtotal 10.7 21.6 51.8 43.7
Balance at end of period $694.6 $642.3 $694.6 $642.3
The accompanying notes are an integral part of these financial statements.
Kentucky Utilities Company
Balance Sheets
(Unaudited)
(Millions of $)
ASSETS
September 30, December 31,
2005 2004
CURRENT ASSETS:
Cash and cash equivalents $ 4.2 $ 4.6
Restricted cash 13.3 -
Accounts receivable - less reserve of
$0.6 million as of September 30, 2005
and December 31, 2004 119.6 112.6
Materials and supplies - at average cost:
Fuel (predominantly coal) 50.3 52.2
Other 29.4 28.0
Prepayments and other 12.2 9.9
Total current assets 229.0 207.3
OTHER PROPERTY AND INVESTMENTS -
less reserve of $0.1 million as of September 30,
2005 and December 31, 2004 22.1 20.5
UTILITY PLANT:
At original cost 3,788.4 3,712.1
Less: reserve for depreciation 1,486.7 1,415.0
Net utility plant 2,301.7 2,297.1
DEFERRED DEBITS AND OTHER ASSETS:
Unamortized debt expense 4.6 4.7
Regulatory assets (Note 5) 70.6 61.4
Long-term derivative asset 1.5 6.1
Cash surrender value of key man
life insurance 32.0 3.6
Other 10.0 9.7
Total deferred debits and other assets 118.7 85.5
Total assets $2,671.5 $2,610.4
The accompanying notes are an integral part of these financial statements.
Kentucky Utilities Company
Balance Sheets (cont.)
(Unaudited)
(Millions of $)
CAPITALIZATION AND LIABILITIES
September 30, December 31,
2005 2004
CURRENT LIABILITIES:
Current portion of long-term debt (Note 8) $ 123.1 $ 87.1
Current portion of long-term notes to
affiliated company (Note 8) 75.0 75.0
Notes payable to affiliated company (Note 8) 31.8 34.8
Accounts payable 67.5 77.9
Accounts payable to affiliated companies (Note 9) 58.1 32.8
Accrued income taxes - 5.9
Customer deposits 16.7 15.0
Other 0.4 15.4
Total current liabilities 372.6 343.9
DEFERRED CREDITS AND OTHER LIABILITIES:
Accumulated deferred income taxes - net 278.0 282.6
Investment tax credit, in process of amortization 2.5 3.8
Accumulated provision for pensions and
related benefits 81.0 77.9
Asset retirement obligation 21.9 21.0
Regulatory liabilities (Note 5):
Accumulated cost of removal of utility plant 277.6 266.8
Deferred income taxes - net (Note 6) 29.9 19.3
Other 10.4 5.4
Other 18.3 17.0
Total deferred credits and other liabilities 719.6 693.8
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 680.9 647.3
Undistributed subsidiary earnings 13.7 12.1
Total retained earnings 694.6 659.4
Total common equity 1,003.8 968.9
Cumulative preferred stock (Note 12) 39.7 39.7
Long-term debt (Note 8) 227.8 306.1
Long-term debt to affiliated company (Note 8) 308.0 258.0
Total capitalization 1,579.3 1,572.7
Total capital and liabilities $2,671.5 $2,610.4
The accompanying notes are an integral part of these financial statements.
Kentucky Utilities Company
Statements of Cash Flows
(Unaudited)
(Millions of $)
Nine Months Ended
September 30,
2005 2004
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 87.0 $ 94.8
Items not requiring cash currently:
Depreciation and amortization 86.1 80.3
Value delivery team amortization 8.8 8.8
Change in fair value of derivative instruments (5.5) (0.4)
Other 8.4 8.2
Changes in current assets and liabilities (13.1) 3.2
Changes in accounts receivable securitization-net - (50.0)
Earnings sharing mechanism receivable 3.1 4.9
Pension funding (Note 11) - (43.4)
Provision for post-retirement benefits 3.1 (3.4)
Litigation settlement - 11.4
Fuel adjustment clause receivable (18.4) (1.1)
Other (2.0) 4.3
Net cash provided by operating activities 157.5 117.6
CASH FLOWS USED IN INVESTING ACTIVITIES:
Change in restricted cash (13.3) -
Construction expenditures (76.3) (104.0)
Other - (1.9)
Net cash flows used for investing activities (89.6) (105.9)
CASH FLOWS FROM FINANCING ACTIVITIES:
Long-term borrowings from affiliated
company (Note 8) 50.0 50.0
Short-term borrowings from affiliated
company (Note 8) 462.3 380.5
Repayment of long-term debt - -
Repayment of short-term borrowings
from affiliated company (Note 8) (465.4) (393.9)
Proceeds from issuance of pollution control bonds 13.3 -
Retirement of pollution control bonds (50.0) (4.8)
Repayment of other borrowings (Note 8) (26.7) -
Payment of dividends (51.8) (43.7)
Net cash flows used for financing activities (68.3) (11.9)
CHANGE IN CASH AND CASH EQUIVALENTS (0.4) (0.2)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 4.6 4.9
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 4.2 $ 4.7
SUPPLEMENTAL DISCLOSURES:
Cash paid during the period for:
Income taxes $58.3 $40.8
Interest on borrowed money 5.1 9.2
Interest to affiliated companies on borrowed money 6.7 9.3
The accompanying notes are an integral part of these financial statements.
Kentucky Utilities Company
Statements of Other Comprehensive Income
(Unaudited)
(Millions of $)
Three Months Nine Months
Ended Ended
September 30, September 30,
2005 2004 2005 2004
Net income $31.7 $34.8 $87.0 $94.8
Income Taxes - Minimum Pension
Liability - - (0.3) -
Other comprehensive loss, net of tax - - (0.3) -
Comprehensive income $31.7 $34.8 $86.7 $94.8
The accompanying notes are an integral part of these financial statements.
Louisville Gas and Electric Company
Kentucky Utilities Company
Notes to Financial Statements
(Unaudited)
1. General
The unaudited financial statements include the accounts of LG&E and KU.
The common stock of each of LG&E and KU is wholly-owned by LG&E Energy.
In the opinion of management, the unaudited condensed interim financial
statements include all adjustments, consisting only of normal recurring
adjustments, necessary for a fair statement of 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 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, 2004, for information relevant to the accompanying
financial statements, including information as to the significant
accounting policies of the Companies.
During the second quarter of 2005, LG&E and KU made out-of-period
adjustments for estimated over/under collection of ECR revenues to be
billed in subsequent periods. The adjustments were immaterial during
all reporting periods involved (March 2003 through October 2004 for
LG&E and May 2003 through January 2005 for KU). As a result, year-to-
date LG&E revenues were increased $4.8 million and KU revenues were
decreased $2.4 million. Year-to-date net income was increased $2.9
million for LG&E and was reduced $1.5 million for KU.
During the third quarter of 2005, LG&E and KU reclassified RSGMWP from
other operation and maintenance expenses to other revenue to better
reflect this revenue as part of the sales price paid by MISO. As a
result, LG&E's revenues and expenses increased $12.6 million and KU's
revenues and expenses increased $3.1 million. Also, during the third
quarter, the estimated allocation of RSGMWP between LG&E and KU was
revised based on better information about the percent of generation
contributed for the hour(s) the make whole payment was received. As a
result, LG&E revenues were decreased $6.7 million and KU revenues were
increased $6.7 million in the current period results of operations. Net
income in the current period was decreased $4.0 million for LG&E and
was increased $4.0 million for KU.
The accompanying financial statements for the three months and nine
months ended September 30, 2004, have been revised to conform to
certain reclassifications in the current three months and nine months
ended September 30, 2005. These reclassifications had no impact on net
assets or net income, as previously reported.
LG&E and KU net operating income previously reported for the three
months ended September 30, 2004, increased by $21.1 million and $19.5
million, and for the nine months ended September 30, 2004, increased by
$45.5 million and $58.1 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 other(income)expense - net previously reported
for the three months and nine months ended September 30, 2004,
increased $0.8 million and $1.4 million, respectively, as a result of
the reclassification. KU other income - net decreased $0.9 million and
$2.5 million, respectively, as a result of the reclassification.
2. Mergers and Acquisitions
On July 1, 2002, E.ON completed its acquisition of Powergen, including
LG&E Energy, for approximately 5.1 billion pounds sterling ($7.3
billion). As a result of the acquisition, LG&E Energy became a
wholly-owned subsidiary of E.ON and, as a result, LG&E and KU also
became indirect subsidiaries of E.ON. LG&E and KU have continued
their separate identities and serve customers under their existing
names. The preferred stock and debt securities of LG&E and KU were
not affected by this transaction and the utilities continue to file
SEC reports. Following the acquisition, E.ON became a registered
holding company under PUHCA (for discussion of recent changes to PUHCA,
see EPAct 2005 under Note 5). LG&E and KU, as subsidiaries of a
registered holding company, are subject to additional regulations under
PUHCA. In 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. In early
2004, LG&E Energy commenced direct reporting arrangements to E.ON.
3. Financial Instruments
The Companies use interest rate swaps to hedge exposure to market
fluctuations in certain of their debt instruments. Pursuant to the
Companies' policies, use of these financial instruments is intended to
mitigate risk, earnings and cash flow volatility and is not speculative
in nature. Management has designated all of the Companies' interest
rate swaps as hedge instruments. Financial instruments designated as
cash flow hedges have resulting gains and losses recorded within other
comprehensive income and stockholders' equity. To the extent a
financial instrument designated as a cash flow hedge or the underlying
item being hedged is prematurely terminated or the hedge becomes
ineffective, the resulting gains or losses are reclassified from other
comprehensive income to net income. Financial instruments designated as
fair value hedges are periodically marked to market with the resulting
gains and losses recorded directly into net income to correspond with
income or expense recognized from changes in market value of the items
being hedged.
As of September 30, 2005, LG&E was party to various interest rate swap
agreements with aggregate notional amounts of $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 2.61% at September 30, 2005. The swap
agreements in effect at September 30, 2005, have been designated as
cash flow hedges and mature on dates ranging from 2020 to 2033. The
hedges have been deemed to be fully effective resulting in a pretax
gain of $8.4 million and a pretax loss of $1.7 million for the three
months and nine months ended September 30, 2005, 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. A deposit in the amount of $12.2 million, used as
collateral for an $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. As a
result, the impact on earnings and other comprehensive income from the
swap maturity was less than $0.1 million.
As of September 30, 2005, KU was party to one interest rate swap
agreement with a notional amount of $53.0 million. Under this swap
agreement, KU paid a variable rate based on the LIBOR index of 5.86%,
and received a fixed rate of 7.92% at September 30, 2005. The swap
agreement in effect at September 30, 2005 has been designated as a fair
value hedge and matures in 2007. During the three months and nine
months ended September 30, 2005, the effect of marking this financial
instrument and the underlying debt to market resulted in pretax gains
of $0.4 million and $0.9 million, respectively, recorded in interest
expense, as required under SFAS No. 133 to recognize fair value hedge
effectiveness.
In June 2005, a KU interest rate swap with a notional amount of $50
million was terminated by the counterparty pursuant to the terms of the
swap agreement. KU received a payment of $1.9 million in consideration
for the termination of the agreement. KU also called the underlying
debt (First Mortgage Bond Series R) and paid a call premium of $1.9
million. The swap was fully effective upon termination. No impact on
earnings occurred as a result of the bond call and related swap
termination.
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, 2005, KU's debt reflects a $2.7 million
mark-to-market adjustment.
4. Segments of Business
LG&E's revenues, net income and total assets by business segment for
the three months and nine months ended September 30, 2005 and 2004,
follow:
Three Months Ended Nine Months Ended
September 30, September 30,
(in millions) 2005 2004 2005 2004
LG&E Electric
Revenues $284.0 $227.0 $741.2 $617.8
Net income 45.3 34.6 99.1 71.0
Total assets 2,416.1 2,376.7 2,416.1 2,376.7
LG&E Gas
Revenues 34.6 34.8 259.8 242.2
Net (loss) income (3.3) (2.1) 4.7 2.9
Total assets 551.3 508.7 551.3 508.7
Total
Revenues 318.6 261.8 1,001.0 860.0
Net income 42.0 32.5 103.8 73.9
Total assets 2,967.4 2,885.4 2,967.4 2,885.4
KU is an electric utility company. It does not provide gas service and
therefore, is presented as a single business segment.
5. Rates and Regulatory Matters
For a description of each line item of regulatory assets and
liabilities for LG&E 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, 2005 and December 31, 2004:
Louisville Gas and Electric Company
(Unaudited)
September 30,December 31,
(in millions) 2005 2004
VDT Costs $ 15.1 $ 37.7
Unamortized loss on bonds 20.9 20.3
ARO 7.5 6.9
Merger surcredit 3.8 4.8
FAC 7.1 0.8
Gas supply adjustments due from customers 13.6 13.3
Other 5.3 8.1
Total regulatory assets $ 73.3 $ 91.9
Accumulated cost of removal of utility
plant $218.8 $220.2
Deferred income taxes - net 52.7 37.2
ECR 0.7 4.0
Gas supply adjustments due to customers 5.9 8.4
Other 2.9 2.6
Total regulatory liabilities $281.0 $272.4
LG&E currently earns a return on all regulatory assets except for gas
supply adjustments, ESM, FAC, ECR and 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 removed.
Due to a 2005 reduction in Kentucky's corporate income tax rate, LG&E
and KU established additional regulatory liabilities in accordance with
SFAS No. 71 for their excess state deferred income tax balances related
to depreciation. In June 2005, LG&E and KU each received orders from
the Kentucky Commission authorizing this treatment.
The following regulatory assets and liabilities were included in KU's
balance sheets as of September 30, 2005 and December 31, 2004:
Kentucky Utilities Company
(Unaudited)
September 30, December 31,
(in millions) 2005 2004
VDT costs $ 5.9 $ 14.7
Unamortized loss on bonds 11.2 11.4
ARO 14.1 12.8
Merger surcredit 2.9 3.7
FAC 27.7 9.4
Deferred storm costs 3.0 3.6
Other 5.8 5.8
Total regulatory assets $ 70.6 $ 61.4
Accumulated cost of removal of utility
plant $277.6 $266.8
Deferred income taxes - net 29.9 19.3
ECR 5.8 1.2
Other 4.6 4.2
Total regulatory liabilities $317.9 $291.5
KU currently earns a return on all regulatory assets except for ESM,
FAC, and ECR, all of which are separate recovery mechanisms with
recovery within twelve months. Additionally, no current return is
earned on the ARO regulatory asset. This regulatory asset will be
offset against the associated regulatory liability, ARO asset and ARO
liability at the time the underlying asset is removed.
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 costs not reimbursed from the 2003 ice storm. These
costs will be amortized through June 2009. These amortized costs, which
are included in KU's jurisdictional operating expenses, are recovered
in base rates.
Due to a 2005 reduction in Kentucky's corporate income tax rate, LG&E
and KU established additional regulatory liabilities in accordance with
SFAS No. 71 for their excess state deferred income tax balances related
to depreciation. In June 2005, LG&E and KU each received orders from
the Kentucky Commission authorizing this treatment.
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 and the gas rates of
LG&E. The rate increases took effect on July 1, 2004.
During July 2004, the Attorney General of Kentucky (AG) served
subpoenas on LG&E and KU, as well as on the Kentucky Commission and its
staff, requesting information regarding alleged improper communications
between LG&E and KU and the Kentucky Commission. The Kentucky
Commission procedurally reopened the rate case for the limited purpose
of taking evidence, if any, as to the communication issues. In
September and October 2004, various proceedings were held in circuit
courts in Franklin and Jefferson Counties, Kentucky, regarding the
scope and timing of document production or other information required
or agreed to be produced under the AG's subpoenas and matters were
consolidated into the Franklin County court.
In January 2005, the AG conducted interviews of certain employees of
LG&E and KU and submitted its report to the Franklin County, Kentucky
Circuit Court in confidence. Concurrently, the AG filed a motion
summarizing the report as containing evidence of improper
communications and record-keeping errors by LG&E and KU in their
conduct of activities before the Kentucky Commission or other state
governmental entities, and requesting release of the report to such
agencies. During February 2005, the court ruled that the report would
be forwarded to the Kentucky Commission under continued confidential
treatment to allow it to consider the report, including its impact, if
any, on completing its investigation and any remaining steps in the
rate case, including ending the current abeyance. To date, LG&E and KU
have neither seen nor requested copies of the report or its contents.
During Spring 2005, LG&E and KU responded to additional information
requests from the AG. LG&E and KU have also responded to investigative
requests for information from the Kentucky Commission.
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 the ultimate impact of,
if any, 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.
VDT
The current five-year VDT amortization period is scheduled to expire in
March 2006. As part of the settlement agreements in the electric and
gas rate cases, LG&E and KU are required to file with the Kentucky
Commission a plan for the future ratemaking treatment of the VDT
surcredits and costs six months prior to the March 2006 expiration. The
surcredit shall remain in effect following the expiration of the fifth
year unless and until the Commission enters an order on the future
disposition of VDT-related issues. On September 30, 2005, LG&E and KU
filed a plan with the Kentucky Commission in accordance with the
requirements of the settlement agreement calling for termination of the
VDT surcredit effective upon the expiration of the fifth year. The AG
and KIUC were granted intervention in the VDT proceedings. A procedural
schedule has been established for discovery and rebuttal testimony but
no public hearing has been scheduled yet.
ECR
In December 2004, KU and LG&E filed applications with the Kentucky
Commission for approval of a CCN to construct new SO2 control
technology (FGDs) at KU's Ghent and Brown stations, and to amend LG&E's
and KU's compliance plans to allow recovery of new and additional
environmental compliance facilities. The estimated capital cost of the
additional facilities is $742.7 million ($40.2 million for LG&E and
$702.5 million for KU), of which $658.9 million is for the FGDs.
Hearings in these cases occurred during May 2005 and final orders were
issued in June 2005, granting approval of the CCN and amendments to
LG&E's and KU's compliance plans.
During the second quarter of 2005, LG&E and KU made out-of-period
adjustments for estimated over/under collection of ECR revenues to be
billed in subsequent periods. The adjustments were immaterial during
all reporting periods involved (March 2003 through October 2004 for
LG&E and May 2003 through January 2005 for KU). As a result, year-to-
date LG&E revenues were increased $4.8 million and KU revenues were
decreased $2.4 million. Year-to-date net income was increased $2.9
million for LG&E and was reduced $1.5 million for KU.
IRP
In April 2005, LG&E and KU filed their 2005 Joint Integrated Resource
Plan (IRP) with the Kentucky Commission. The IRP is filed triennially
and provides historical and projected demand, resource, and financial
data, and other operating performance and system information. The AG
and the KIUC were granted intervention in the IRP proceeding. Discovery
is complete and an informal conference has not yet been scheduled.
MISO
The MISO implemented a day-ahead and real-time market (MISO Day 2),
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. The MISO filed with FERC a mechanism
for recovery of costs for the congestion management system proposing
the addition of two new Schedules, 16 and 17. Schedule 16 is the MISO's
cost recovery mechanism for the Financial Transmission Rights
Administrative Service it provides. Schedule 17 is the MISO's mechanism
for recovering costs it incurs for providing Energy Marketing Support
Administrative Service. The MISO transmission owners, including LG&E
and KU, objected to the allocation of these regional market-related
costs among market participants and retail native load. FERC ruled in
2004 in favor of the MISO.
The Kentucky Commission opened an investigation into LG&E and KU's
memberships in the MISO in July 2003. The Kentucky Commission directed
LG&E and KU to file testimony addressing the costs and benefits of the
MISO membership both currently and over the next five years and other
legal issues surrounding continued membership. LG&E and KU engaged an
independent third-party to conduct a cost-benefit analysis on this
issue. The information was filed with the Kentucky Commission in
September 2003. The analysis and testimony supported the Companies'
exit from the MISO, under certain conditions. The MISO filed its own
testimony and cost benefit analysis in December 2003. The Kentucky
Commission requested additional testimony on the MISO's Market Tariff
filing. This additional testimony was received and a hearing before the
Kentucky Commission was held in July 2005. Additional post-hearing data
requests were submitted in September with an order expected in the
first half of 2006.
Should LG&E and KU be ordered to exit the MISO, an aggregate exit fee
up to $41 million could be imposed, depending on the timing and
circumstances of actual withdrawal. While LG&E and KU believe legal and
regulatory precedent should permit most or many of the MISO-related
costs to be recovered in their rates charged to customers, they can
give no assurance that state or federal regulators will ultimately
agree with such position with respect to all costs, components or
timing of recovery. In April 2005, the Kentucky Commission issued an
order declining an LG&E and KU request for an automatic monthly
recovery mechanism for certain MISO-related costs and benefits.
On October 7, 2005, LG&E and KU filed an application with the FERC
seeking the requisite authority to exit the MISO. This proceeding is
expected to continue into 2006.
At this time, LG&E and KU cannot predict the outcome or effects of the
various Kentucky Commission and FERC proceedings described above,
including whether such proceedings will have a material impact on the
financial condition or results of operations of the Companies. Further,
ultimate financial consequences (changes in transmission revenues and
costs) associated with the April 2005 implementation of transmission
day-ahead and real-time market tariff charges are subject to varying
assumptions and calculations and are therefore difficult to estimate.
Changes in revenues and costs related to broader shifts in energy
market practices and economics are not currently estimable.
EPAct 2005
EPAct 2005 was enacted on August 8, 2005. Among other matters, this
comprehensive legislation contains provisions mandating improved
electric reliability standards and performance; providing economic and
other incentives relating to transmission, pollution control and
renewable generation assets; increasing funding for clean coal
generation incentives; and repealing the Public Utility Holding Company
Act of 1935.
The FERC was directed by the EPAct 2005 to adopt rules to address many
areas previously regulated by the other agencies under other statutes,
including PUHCA. The FERC is in various stages of rulemaking on these
issues and the Companies are monitoring these rulemaking activities and
actively participating in these and other rulemaking proceedings. The
Companies are still evaluating the potential impacts of the EPAct 2005
and the associated rulemakings and cannot predict what impact the EPAct
2005, and any such rulemakings, will have on their operations or
financial position.
FERC SMD NOPR
In July 2002, the FERC issued a NOPR which would substantially alter
the regulations governing the nation's wholesale electricity markets by
establishing a common set of rules, known as SMD. The SMD NOPR would
require each public utility that owns, operates, or controls interstate
transmission facilities to become an ITP, belong to an RTO that is an
ITP, or contract with an ITP for operation of its transmission assets.
It would also establish a standardized congestion management system,
real-time and day-ahead energy markets, and a single transmission
service for network and point-to-point transmission customers. On July
19, 2005, the FERC issued an order terminating the SMD proceeding. FERC
noted that the industry has made significant progress in the voluntary
development of the RTO/ITP functions and asserted its intent to
consider revisions to the Order 888 pro-forma Open Access Transmission
Tariffs to reflect the current experience with open transmission over
the last decade.
KENTUCKY COMMISSION STRATEGIC BLUEPRINT
In February 2005, Kentucky's Governor signed an executive order
directing the Kentucky Commission, in conjunction with the Commerce
Cabinet and the Environmental and Public Protection Cabinet, to develop
a Strategic Blueprint for the continued use and development of electric
energy. This Strategic Blueprint will be designed to promote future
investment in electric infrastructure for the Commonwealth of Kentucky,
to protect Kentucky's low-cost electric advantage, to maintain
affordable rates for all Kentuckians, and to preserve Kentucky's
commitment to environmental protection. In March 2005, the Kentucky
Commission established Administrative Case No. 2005-00090 to collect
information from all jurisdictional utilities in Kentucky, including
LG&E and KU, pertaining to Kentucky electric generation, transmission
and distribution systems. LG&E and KU responded to the Kentucky
Commission's first set of data requests at the end of March 2005 and to
a second set of data requests in May 2005. The Commission held a
Technical Conference on June 14, 2005, in which all parties
participated in a panel discussion. A final report was provided on
August 22, 2005 from the Kentucky Commission to the Governor. Some of
the key findings are that (1)Kentucky's electric utilities currently
have adequate infrastructure as well as adequate planning to serve the
needs of customers through 2025, (2) Kentucky will need 7,000 megawatts
of additional generating capacity by 2025, (3) Kentucky's electric
transmission is reliable but intrastate power transfers are limited,
(4) additional incentives to use renewable energy and educate the
public on the benefits of renewables are needed, (5) financial
incentives should be available for coal gasification and other clean
air technologies, (6) cautious approach should be taken towards
deregulation, and (7) Kentucky must be involved in federal decisions
that impact its status as a low cost energy provider.
LOCK 7
On September 27, 2005, KU filed an application with FERC seeking
authority to transfer the operating license for the Lock 7
Hydroelectric Station, a 2.04 Mw facility, from KU to the Lock 7 Hydro
Partners, LLC, an unaffiliated third party, for less than $0.1 million.
On September 28, 2005, KU filed an application with the Kentucky
Commission seeking: 1) a determination that Kentucky Commission
approval is not required for the transfer of the Lock 7 Hydroelectric
Station or 2) Kentucky Commission approval, pursuant to a Kentucky
Commission order in Case No. 2005-00405, to sell any real property
associated with the Lock 7 Hydroelectric Station to Lock 7 Hydro
Partners, LLC. These proceedings are expected to conclude in 2005.
6. Income and Other Taxes
On September 19, 2005, E.ON U.S. Investments Corp., the parent of LG&E
Energy, LG&E and KU, received notice from the Congressional Joint
Committee on Taxation approving the Internal Revenue Service's audit of
the Companies' income tax returns for the periods December 1999 through
December 2003. As a result of this audit, LG&E and KU released income
tax reserves of $5.1 million and $4.4 million, respectively.
During the quarter, KU recognized additional deferred tax expense ($3.1
million) related to the undistributed earnings of its EEI
unconsolidated investment. Recent EEI management decisions regarding
changes in the distribution of EEI's earnings led to the decision to
provide deferred taxes for all book and tax basis differences in this
investment.
Significant judgment is required in determining the provision for
income taxes, and there are many transactions for which the ultimate
tax outcome is uncertain. To provide for these uncertainties
or exposures, LG&E and KU maintain an allowance for tax contingencies,
the balance of which management believes is adequate. Tax contingencies
are analyzed periodically and adjustments are made when events occur to
warrant a change.
LG&E's Kentucky sales and use tax audit for the periods October 1, 1997
through December 31, 2001 resulted in an initial assessment of $1.1
million. LG&E filed a protest on July 22, 2005, stating that no
additional tax was due and that LG&E was owed a refund. At Kentucky's
request, the Company has provided additional information to supplement
the initial protest. This audit assessment is not expected to have a
material adverse impact on the Company.
KU is also being audited by the Kentucky Department of Revenue. This
audit began on September 19, 2005 and covers the period August 1, 2000
through July 31, 2005. At this time there are no proposed adjustments.
The results of the audit assessments described above and any future
audits by taxing authorities could have a material effect on quarterly
or annual cash flows as well as results of operations. However, LG&E
and KU do not believe any existing matters will have a material adverse
effect on their results of operations.
7. New Accounting Pronouncements
FSP 109-1
In December 2004, the FASB finalized FSP 109-1, Accounting for Income
Taxes, Application of SFAS No. 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 SFAS
No. 109. FSP 109-1 became effective December 21, 2004. For the nine
months ended September 30, 2005, LG&E and KU recognized $1.2 million
and $0.6 million, respectively, in tax benefits related to this
deduction.
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,
Series S, T, U, BB, CC, DD and EE, and KU's variable-rate pollution
control bonds Series 10, 12, 13, 14, and 15, the bonds are subject to
tender for purchase at the option of the holder and to mandatory tender
for purchase upon the occurrence of certain events, causing the bonds
to be classified as current portion of long-term debt in the Balance
Sheets. The average annualized interest rate for these bonds during the
three and nine months ending September 30, 2005 was 2.63% and 2.36%,
respectively, for LG&E and 2.59% and 2.40%, respectively, for KU.
During June 2005, LG&E renewed five revolving lines of credit with
banks totaling $185 million. There was no outstanding balance under any
of these facilities at September 30, 2005. The Company expects to renew
these facilities prior to their expiration in June 2006.
LG&E, KU and LG&E Energy participate in an intercompany money pool
agreement. Details of the balances at September 30, 2005, and September
30, 2004, were as follows:
Total Money Amount Balance Average
($ in millions) Pool Available Outstanding Available Interest Rate
September 30, 2005:
LG&E $400.0 $56.6 $343.4 3.64%
KU $400.0 $31.8 $368.2 3.64%
September 30, 2004:
LG&E $400.0 $40.7 $359.3 1.60%
KU $400.0 $29.8 $370.2 1.60%
LG&E Energy maintains a revolving credit facility totaling $200 million
with an affiliated company, E.ON North America, Inc., to ensure funding
availability for the money pool. The balance outstanding on this
facility at September 30, 2005, was $65.4 million.
Redemptions and maturities of long-term debt year-to-date through
September 30, 2005, are summarized below:
($ in millions)
Principal Secured/
Year Company Description Amount Rate Unsecured Maturity
2005 LG&E Pollution control bonds $40.0 5.90% Secured Apr 2023
2005 LG&E Due to Fidelia $50.0 1.53% Secured Jan 2005
2005 LG&E Mand. Red. Pref. Stock $1.3 5.875% Unsecured Jul 2005
2005 KU First mortgage bonds 50.0 7.55% Secured Jun 2025
Issuances of long-term debt year-to-date through September 30, 2005,
are summarized below:
($ in millions)
Principal Secured/
Year Company Description Amount Rate Unsecured Maturity
2005 LG&E Pollution control bonds $40.0 Variable Secured Feb 2035
2005 KU Pollution control bonds $13.3 Variable Secured Jun 2035
2005 KU Due to Fidelia $50.0 4.735% Unsecured Jul 2015
In May 2005, KU repaid a $26.7 million loan against the cash surrender
value of life insurance policies.
9. Related-Party Transactions
LG&E, KU, 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. Transactions between LG&E or KU and E.ON subsidiaries are
eliminated upon consolidation of E.ON. These transactions are generally
performed at cost and are in accordance with the SEC regulations under
the PUHCA and the applicable Kentucky Commission regulations (for
discussion of recent changes to PUHCA, see EPAct 2005 under Note 5).
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, an E.ON affiliate, 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
from affiliated companies for the three months and nine months ended
September 30, 2005, and 2004, were as follows:
Three months ended Nine months ended
September 30, September 30,
(in millions) 2005 2004 2005 2004
LG&E
Electric operating revenues
from KU $14.8 $ 10.1 $61.5 $40.6
Purchased power from KU 15.9 12.2 64.6 42.9
KU
Electric operating revenues
from LG&E $15.9 $ 12.2 $64.6 $42.9
Purchased power from LG&E 14.8 10.1 61.5 40.6
Interest Charges
LG&E and KU intercompany interest expense for the three months and nine
months ended September 30, 2005 and 2004, were as follows:
Three months ended Nine months ended
September 30, September 30,
(in millions) 2005 2004 2005 2004
LG&E intercompany interest
expense $3.0 $3.0 $9.0 $9.1
KU intercompany interest expense $4.2 $3.5 $11.4 $10.6
Other Intercompany Billings
Other intercompany billings related to LG&E and KU for the three months
and nine months ended September 30, 2005 and 2004, were as follows:
Three months ended Nine months ended
September 30, September 30,
(in millions) 2005 2004 2005 2004
LG&E Services billings to LG&E $52.8 $40.2 $160.9 $138.8
LG&E Services billings to KU 44.3 42.3 145.5 117.5
LG&E billings to LG&E Services 0.8 6.0 6.1 10.5
KU billings to LG&E Services 0.4 0.5 3.9 4.4
LG&E billings to KU 54.9 14.9 83.4 48.5
KU billings to LG&E 7.6 2.1 20.7 5.5
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, 2004 and Quarterly Reports on Form 10-Q for the
three months ended March 31, 2005 and June 30, 2005. See Notes 3 and 11
to the Companies' Annual Report on Form 10-K and Note 10 to the
Companies' Quarterly Reports on Form 10-Q for the three months ended
March 31, 2005, and June 30, 2005, for information regarding such
commitments or contingencies.
LITIGATION
In May 2004, OMU commenced litigation against KU concerning a long-term
power supply contract. KU filed counterclaims against OMU. To date, OMU
has claimed approximately $6 million in damages for periods through
early 2004, and is expected to claim further amounts for later-
occurring periods. OMU has additionally requested injunctive and other
relief, including a declaration that KU is in material breach of the
contract. In March 2005, the FERC denied a rehearing request by KU
regarding the FERC's December 2004 decision to decline to exercise
exclusive jurisdiction regarding certain issues in dispute. In July
2005, the district court resolved a summary judgment motion of KU in
OMU's favor, ruling that a contractual provision grants OMU the ability
to terminate the contract without cause upon 4 years' prior notice. OMU
filed a motion seeking to make that ruling "final and appealable." In
October 2005, however, the Court denied OMU's motion. This case is
otherwise currently in the discovery stage and a trial schedule has not
yet been established.
ENVIRONMENTAL MATTERS
LG&E and KU are subject to SO2 and NOX emission limits on their
electric generating units pursuant to the Clean Air Act. LG&E and KU
placed into operation significant NOX controls for their generating
units prior to the 2004 Summer Ozone Season. As of December 31, 2004,
LG&E and KU incurred total capital costs of approximately $186 million
and $219 million, respectively, to reduce their NOX emissions below
required levels. In addition, LG&E and KU incur additional operating
and maintenance costs in operating the new NOX controls.
On March 10, 2005, EPA issued the final Clean Air Interstate Rule
(CAIR) which requires substantial additional reductions in SO2 and NOX
emissions from electric generating units. The CAIR rule provides for a
two-phased reduction program with Phase I reductions in NOX and SO2
emissions in 2009 and 2010, respectively, and Phase II reductions in
2015. On March 15, 2005, EPA issued a related regulation, the final
Clean Air Mercury Rule (CAMR), which requires substantial mercury
reductions from electric generating units. CAMR also provides for a two-
phased reduction, with the Phase I target in 2010 achieved as a "co-
benefit" of the controls installed to meet CAIR. Additional control
measures will be required to meet the Phase II target in 2018. Both
CAIR and CAMR establish a cap and trade framework, in which a limit is
set on the total amount of emissions and allowances that can be bought
or sold on the open market, that can be used for compliance unless the
state chooses another approach.
In order to meet these new regulatory requirements, 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) having commenced in
September 2005 and continuing through the final installation and
operation in 2009. KU estimates 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
operating the new SO2 controls. LG&E currently has FGDs on all its
units but will continue to evaluate improvements to further reduce SO2
emissions.
LG&E and KU are also monitoring several other air quality matters which
may potentially impact coal-fired power plants, including EPA's revised
air quality standards for ozone and particulate matter, and measures to
implement EPA's regional haze rule.
After extensive negotiations between KU and the EPA and Department of
Justice, the government filed a consent decree in U. S. District Court
on October 13, 2005, that would resolve alleged violations relating to
oil spills at the E.W. Brown plant occurring in October 1999 and
January 2001. Under the terms of the settlement, KU would pay a civil
penalty of $0.2 million (which has been accrued), construct a
supplemental environmental project at a cost of $0.8 million, and
maintain that project for ten years at a cost of $0.4 million. After
reviewing any public comments, the Court will consider entry of the
consent decree.
From time to time, LG&E and KU have conducted negotiations with the
relevant regulatory authorities to address various environmental-
related matters, including: remedial measures aimed at controlling
particulate matter emissions from LG&E's Mill Creek plant; liability
for cleanup of off-site facilities that allegedly handled materials
associated with company operations; and investigation and cleanup of
company properties including former LG&E and KU MGP sites. Based on
negotiations to date, management does not anticipate that any of the
liabilities arising out of any of these matters will have a material
adverse affect on LG&E's or KU's financial position or results of
operations.
In the normal course of business, lawsuits, claims, environmental
actions, and various non-ratemaking governmental proceedings arise
against LG&E and KU. To the extent that damages are assessed in any of
these lawsuits, LG&E and KU believe that their insurance coverage or
other appropriate reserves are adequate. Management, after
consultation with legal counsel, and based upon the present status of
these items, does not anticipate that liabilities arising out of other
currently pending or threatened lawsuits and claims of the type
referenced above will have a material adverse effect on LG&E's or KU's
financial position or results of operations.
EEI CONTRACT
KU owns 20% of the common stock of EEI, which owns and operates a 1,000-
Mw generating station in southern Illinois. KU presently purchases 20%
of the available capacity and energy 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
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 nine months of
2005. Discussions are on-going related to the extension or replacement
of the contract, including whether any such future contract will be at
cost or market-based rates, and whether the purchasing party will
continue to be the shareholding utility, such as KU. The outcome of
such discussions cannot be predicted at this time. However, EEI has
filed for authority from FERC for EEI to sell its output at market-
based rates, and management of EEI has indicated to KU that future
power offers by EEI will be made only at market based prices.
E W BROWN FIRE
On September 12, 2005, a fire occurred at KU's E.W. Brown unit 3
resulting in damage to the switchgear and computer room. The total of
the repair and replacement costs of damaged equipment is approximately
$3.3 million, approximately $0.3 million of which will be covered by
insurance. Net operating income at KU is expected to be reduced by
approximately $7.4 million due to increased purchased power costs not
covered by the FAC, and potential losses of off-system sales revenue
due to the outage.
11.Pension and Other Post-retirement Benefit Plans
The following table provides the components of net periodic benefit
cost for pension and other benefit plans for the three months and nine
months ended September 30, 2005 and 2004:
LG&E
Three months ended Nine months ended
September 30, September 30,
(in millions) 2005 2004 2005 2004
Pension and Other Benefit Plans:
Components of net period benefit
cost
Service cost $ 1.3 $ 1.0 $ 4.4 $ 4.0
Interest cost 5.1 4.9 17.3 20.0
Expected return on plan assets (4.8) (4.5) (16.1) (18.2)
Amortization of prior service
cost 1.1 - 3.6 -
Amortization of transition
obligation - 1.0 - 3.8
Recognized actuarial loss 0.6 0.5 2.0 2.1
$ 3.3 $ 2.9 $11.2 $11.7
KU
Three months ended Nine months ended
September 30, September 30,
(in millions) 2005 2004 2005 2004
Pension and Other Benefit Plans:
Components of net period benefit
cost
Service cost $ 2.3 $ 1.1 $ 5.8 $ 4.8
Interest cost 5.6 3.7 14.1 15.2
Expected return on plan assets (5.2) (3.3) (13.2) (13.8)
Amortization of prior service
cost 0.4 0.2 1.1 0.6
Amortization of transition
obligation 0.2 0.3 0.6 1.2
Recognized actuarial loss 0.8 0.3 2.0 1.4
$ 4.1 $ 2.3 $ 10.4 $ 9.4
In January 2004, LG&E and KU made discretionary contributions to the
pension plans of $34.5 million and $43.4 million, respectively. No
discretionary contributions to the pension plans are currently
anticipated for either LG&E or KU for 2005. LG&E and KU contributed
$0.7 million and $3.0 million, respectively, to their other post-
retirement benefit plans during the second quarter of 2005.
12.Subsequent Events
On October 24, 2005, KU redeemed all outstanding shares of preferred
stock. The Company paid $101 per share for the 4.75% Series and
$102.939 per share for the 6.53% Series.
On October 27, 2005, LG&E received an order issuing a new license to
upgrade, operate and maintain the Ohio Falls Hydroelectric Project from
the FERC. The license is issued to LG&E for a period of 40 years,
effective November 11, 2005. LG&E intends to spend approximately $75
million to refurbish the facility and add approximately 20 Mw of
generating capacity.
On November 1, 2005, the Kentucky Commission approved the application
of LG&E and KU to expand the Trimble County electric generating
plant. The Companies plan to construct a 750-megawatt coal-fired
generating unit at the plant. The unit is expected to cost about $1.1
billion and be completed by 2010. LG&E's and KU's share of LG&E
Energy's total capital cost of $885 million for Trimble County Unit 2
is estimated to be $168 million and $717 million, respectively, through
2010. The Companies have not yet entered into final construction
contracts. The Companies also need to obtain approval from the
Kentucky State Board on Electric Generation and Transmission Siting, as
well as obtain the air permit from the Kentucky Department of Air
Quality, both of which are expected by the end of November 2005. In
September 2005, the Kentucky Commission approved one of three
transmission facilities for the additional Trimble County unit. The
Companies expect to refile the applications for the remaining two
transmission facilities in the fourth quarter.
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 periods
ended September 30, 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,
2004.
Executive Summary
LG&E and KU, subsidiaries of LG&E Energy (an indirect subsidiary of E.ON),
are regulated public utilities. LG&E supplies electricity to approximately
395,000 customers and natural gas to approximately 320,000 customers in
Louisville and adjacent areas in Kentucky. KU provides electric service to
approximately 492,000 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 our employees, communities and other stakeholders.
LG&E and KU's strategy focuses on the following:
- - Achieve scale as an integrated U.S. electric and gas business through
organic growth
- - Maintain excellent customer satisfaction
- - Maintain best-in-class cost position versus U.S. utility companies
- - Develop and transfer best practices throughout the company
- - Invest in infrastructure to meet expanding load and comply with
increasing environmental requirements
- - Achieve appropriate regulated returns on all investment
- - Attract, retain and develop the best people
- - Act with a commitment to corporate social responsibility that enhances
the well being of our employees, demonstrate environmental stewardship,
promote quality of life in our communities and reflect the diversity of
the society we serve
In a June 2004 order, the Kentucky Commission accepted the settlement
agreements reached by the majority of the parties in the rate cases filed
by LG&E and KU in December 2003. Under the ruling, the LG&E utility base
electric rates have increased $43.4 million (7.7%) and base gas rates have
increased $11.9 million (3.4%), on an annual basis. The rate increases took
effect on July 1, 2004. Base electric rates at KU have increased $46.1
million (6.8%) annually. The 2004 increases were the first increases in
electric base rates for LG&E and KU in 13 and 20 years, respectively; the
previous gas rate increase for the LG&E gas utility took effect in
September 2000.
With the installation of four combustion turbines at Trimble County in
2004, 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 Kentucky Department of Air Quality in December 2004. A
public hearing on the draft air permit application occurred in August 2005.
The Kentucky Commission ruled favorably on the CCN application on November
1, 2005. The air permit is expected to be issued by the Kentucky Department
of Air Quality in November 2005. LG&E's and KU's share of LG&E Energy's
total capital cost of $885 million for Trimble County Unit 2 is estimated
to be $168 million and $717 million, respectively, through 2010.
Three applications for transmission CCN's were filed with the Kentucky
Commission in May 2005 for the construction of three transmission
facilities to support Trimble County Unit 2. In September 2005, the
Kentucky Commission approved one of the transmission facilities and denied
the other two on the basis that the Companies did not sufficiently
investigate alternative routes. The Kentucky Commission recognized the need
for transmission upgrades contingent upon the approval of the generation
CCN. The Companies expect to refile the applications in the fourth quarter
with the additional supporting documentation requested by the Kentucky
Commission.
In addition to the Trimble 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 CCN to
construct four FGDs at an estimated cost of $658.9 million, which was
approved in June 2005.
The Kentucky Commission opened an investigation into LG&E's and KU's
membership in the MISO in July 2003. Should LG&E and KU be ordered to exit
the MISO, an aggregate fee of up to $41 million could be imposed, depending
on the timing and circumstances of actual withdrawal. On October 7, 2005,
LG&E and KU filed an application with the FERC seeking the requisite
authority to exit the MISO. This proceeding is expected to continue into
2006. At this time, LG&E and KU cannot predict the outcome or effects of
the various Kentucky Commission and FERC proceedings, including whether
they will have a material impact on the financial condition or the results
of operations of the Companies.
The MISO implemented a day-ahead and real-time market (MISO Day 2),
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. Ultimate financial consequences (changes in transmission
revenues and costs) associated with the implementation of MISO Day 2 are
subject to varying assumptions and calculations and are therefore difficult
to estimate.
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 September 30, 2005, Compared to
Three Months Ended September 30, 2004
LG&E Results:
LG&E's net income increased $9.5 million (29%) for the three months ended
September 30, 2005, as compared to the three months ended September 30,
2004, primarily due to higher retail electric revenues resulting from
warmer summer weather (cooling degree days were 29% higher than in 2004),
higher wholesale revenues and lower income tax expense.
A comparison of LG&E's revenues for the three months ended September 30,
2005, with the three months ended September 30, 2004, reflects increases
and (decreases) which have been segregated by the following principal
causes:
Cause Electric Gas
(in millions) Revenues Revenues
Retail sales:
Fuel and gas supply adjustments $ 13.3 $(0.1)
Environmental cost recovery surcharge 0.7 -
Earnings sharing mechanism (5.1) -
Variation in sales volume and other 22.4 0.1
Total retail sales 31.3 -
Wholesale sales 19.7 -
Other 6.0 (0.2)
Total $57.0 $(0.2)
Electric revenues increased $57.0 million (25%) in 2005 primarily due to:
- - Higher sales volume ($27.3 million) related to weather
- - Wholesale sales increased $19.7 million
- Higher MISO related revenue ($13.1 million), due to MISO Day 2 RSGMWP,
earned due to the MISO's dispatch of higher cost gas-fired units ($7.2
million) and a $12.6 million reclass to revenue from expense offset by a
$6.7 million reclass to KU revenue for activity dating back to the
inception of MISO Day 2
- Higher wholesale revenues ($6.6 million), primarily due to 6% higher
prices ($12.7 million) partially offset by 3% lower volumes ($6.1 million)
- - Higher fuel supply adjustments ($13.3 million) due to significantly
higher fuel costs
- - Lower MISO Day 1 transmission revenue ($1.3 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.
Fuel for electric generation increased $25.6 million (48%) in 2005
primarily due to:
- Increased cost per Btu (42% higher), resulting in $23.6 million higher
fuel costs. Fuel costs are significantly higher due to the MISO's
dispatch of gas-fired units committed by the MISO's Reliability
Assessment and Commitment process in the real-time market.
- Increased generation (4% higher), resulting in $1.9 million higher fuel
costs
Power purchased increased $14.8 million (77%) in 2005 primarily due to:
- Increased cost per Mwh (53% higher), resulting in $11.8 million higher
costs
- Increased Mwh purchases (15% higher), resulting in $2.9 million higher
costs
- Higher purchased power costs from the MISO due to unit outages totaled
$9.2 million
Other operations and maintenance expenses increased $12.5 million (17%) in
2005.
Other operation expenses increased $19.9 million (41%) in 2005 primarily
due to:
- Increased other power supply expenses ($18.7 million) due largely to
MISO Day 2 costs ($19.0 million), including a $12.6 million reclass from
expense to revenue for activity dating back to the inception of MISO Day 2
and $6.4 million administration charges and allocated charges from the
MISO for Day 2 operations
- Increased distribution costs ($3.1 million) largely due to the transfer
of storm expenses in the third quarter of 2004 from operations expenses to
maintenance expenses
- Increased administrative and general expenses ($1.2 million) largely
for increased employee benefit costs
- Increased cost of gas losses due to the increase in the unit cost of
natural gas ($0.6 million)
- Decreased transmission expenses ($3.5 million), primarily MISO related.
Prior to the MISO Day 2 market, most bilateral transactions required the
purchase of transmission; however with the Day 2 market, most transactions
are handled directly with MISO and no additional transmission is
necessary.
Maintenance expenses decreased $7.3 million (32%) in 2005 primarily due
to:
- Decreased distribution costs ($8.9 million) due to the transfer of
storm expenses to from operations expenses to maintenance expenses in 2004
and lower storm costs in 2005
- Increased administrative and general maintenance ($1.3 million)
- Increased maintenance on combustion turbines ($0.4 million)
Depreciation and amortization expense increased $0.8 million (3%) in 2005
primarily due to additional plant in service.
Other expense - net decreased $1.9 million in 2005 primarily due to:
- Decreased miscellaneous deductions ($1.4 million)
- Increased mark-to-market gains related to energy trading contracts
($0.6 million)
In total, interest expense increased $0.5 million (6%) in 2005 primarily
due to:
- Increased interest on variable-rate debt ($1.7 million)
- Decreased interest costs on interest rate swaps ($0.8 million)
- Decreased interest due to refinancing fixed rate debt with variable
rate debt ($0.4 million)
The weighted average interest rate on variable-rate bonds for the three
months ended September 30, 2005, was 2.54%, compared to 1.30% for the
comparable period in 2004.
Variances in income tax expense are largely attributable to changes in pre-
tax income, a reduction of previous accruals per final IRS audit, and a
reduction in the statutory Kentucky income tax rate.
Three Months Three Months
Ended Ended
Sept. 30, 2005 Sept. 30, 2004
Effective Rate
Statutory federal income tax rate 35.0% 35.0%
State income taxes net of federal benefit 3.7 4.6
Reduction of previous accruals per final
IRS audit (9.0) -
Amortization of investment and other
tax credits (1.8) (0.6)
Other differences (1.2) (0.7)
Effective income tax rate 26.7% 38.3%
The increased tax benefit in other differences is largely attributable to
the new Internal Revenue Code Section 199 Qualified Production Activities
deduction and the amortization of excess deferred income taxes, which
reflect the benefits of deferred tax reversing at higher tax rates than the
current statutory rate.
See Part 1 - Item 1, Notes to Financial Statements, Note 6 for additional
discussion of income taxes.
KU Results:
KU's net income decreased $3.1 million (9%) for the three months ended
September 30, 2005, as compared to the three months ended September 30,
2004. The decrease was primarily due to higher operation and maintenance
expenses, partially offset by increased retail revenues as a result of
warmer summer weather (cooling degree days were 77% higher than in 2004)
and higher wholesale revenues.
A comparison of KU's revenues for the three months ended September 30,
2005, with the three months ended September 30, 2004, reflects increases
and (decreases) which have been segregated by the following principal
causes:
Cause Electric
(in millions) Revenues
Retail sales:
Fuel supply adjustments $41.7
Environmental cost recovery surcharge 2.1
Earnings sharing mechanism (5.1)
Rates and rate structure 0.8
Variation in sales volume and other 19.4
Total retail sales 58.9
Wholesale sales 36.7
Other (1.0)
Total $94.6
Electric revenues increased $94.6 million (37%) in 2005 primarily due to:
- Higher fuel supply adjustments ($41.7 million) due to higher cost of
fuel used for generation and purchased power
- Higher sales volumes ($23.6 million) due to weather
- Wholesale sales increased $36.7 million
- Higher wholesale revenues ($18.6 million), primarily due to 6% higher
prices ($14.8 million) and 2% higher sales volume ($3.8 million)
- Higher MISO related revenue ($18.1 million), due to MISO Day 2 RSGWMP,
earned due to the MISO's dispatch of higher cost gas-fired units
($8.3 million), a $3.1 million reclass to revenue from expense and
a $6.7 million reclass from LG&E revenue for activity dating back
to the inception of MISO Day 2
- Lower MISO Day 1 transmission revenue ($2.6 million)
Fuel for electric generation comprises a large component of KU's total
operating expenses. KU's electric rates contain a fuel adjustment clause,
whereby increases or decreases in the cost of fuel are reflected in retail
rates, subject to the approval of the Kentucky Commission, the Virginia
State Corporation Commission, and the FERC.
Fuel for electric generation increased $40.3 million (52%) in 2005
primarily due to:
- Increased cost per Btu (36% higher), resulting in $31.2 million higher
fuel costs. Fuel costs are significantly higher due to the MISO's
dispatch of gas-fired units committed by the MISO's Reliability
Assessment and Commitment process in the real-time market.
- Increased generation (12% higher), resulting in $9.0 million higher
fuel costs, primarily due to higher dispatch of gas-fired units
Power purchased increased $31.6 million (95%) in 2005 primarily due to:
- Increased cost per Mwh (89% higher), resulting in $30.5 million higher
costs
- Increased volumes of Mwh purchased (3% higher), resulting in $1.1
million higher costs
- Higher purchased power costs from the MISO due to unit outages totaled
$12.7 million
Other operations and maintenance expenses increased $25.9 million (48%) in
2005.
Other operation expenses increased $20.3 million (54%) in 2005 primarily
due to:
- Increased other power supply expenses due largely to MISO Day 2 costs
($19.0 million), including a $3.1 million reclass from expense to revenue
for activity dating back to the inception of MISO Day 2 and $15.9 million
of administration charges and allocated charges from the MISO for Day 2
operations
- Increased administrative and general expenses ($2.4 million) largely
the result of increased employee benefit costs
- Decreased transmission expenses ($0.9 million), primarily MISO related.
Prior to the MISO Day 2 market, most bilateral transactions required the
purchase of transmission; however with the Day 2 market, most transactions
are handled directly with MISO and no additional transmission is necessary.
Maintenance expenses increased $6.4 million (53%) in 2005 primarily due
to:
- Increased distribution system costs ($2.4 million), the result of
reclassifying $4.0 million in storm expenses in 2004 from maintenance to a
regulatory asset
- Increased steam generation maintenance ($2.1 million) due to outages at
E.W. Brown and Green River
- Increased administrative and general maintenance ($1.2 million)
- Increased combustion turbine expenses ($0.7 million)
Property and other taxes decreased $0.8 million (18%).
Other (income) - net decreased $1.1 million (50%) in 2005 primarily due to:
- Increased miscellaneous deductions $1.7 million.
- Increased mark-to-market gains related to energy trading contracts
($0.6 million)
In total, interest expense increased $0.6 million (9%) in 2005 primarily
due to:
- Increased interest costs associated with the interest rate swaps ($1.1
million)
- Increased interest costs associated with variable rate debt ($0.6
million)
- Decreased interest costs due to refinancing fixed rate debt with
variable rate debt ($0.4 million)
- Decreased interest costs due to refinancing first mortgage bonds with
long-term debt from affiliates ($0.4 million)
- Decreased interest costs for mark-to-market of the interest rate swaps
($0.1 million)
The weighted average interest rate on variable-rate bonds for the three
months ended September 30, 2005, was 2.54%, compared to 1.32% for the
comparable period in 2004.
Variations in income tax expense are largely attributable to changes in
pretax income and a reduction of previous accruals per final IRS audit.
Three Months Three Months
Ended Ended
Sept. 30, 2005 Sept. 30, 2004
Effective Rate
Statutory federal income tax rate 35.0% 35.0%
State income taxes net of federal benefit 4.6 4.1
Reduction of previous accruals per final
IRS audit (8.9) -
EEI adjustment 6.3 -
Amortization of investment and other
tax credits (0.9) (1.0)
Other differences (0.5) (3.3)
Effective income tax rate 35.6% 34.8%
The reduced tax benefit in other differences for 2005 is attributable to
the recognition of a deferred tax liability on the undistributed earnings
from the Company's investment in EEI. In prior periods, the effective rate
was reduced for the anticipated EEI dividends received deduction.
See Part 1 - Item 1, Notes to Financial Statements, Note 6 for additional
discussion of income taxes.
Nine Months Ended September 30, 2005, Compared to
Nine Months Ended September 30, 2004
LG&E Results:
LG&E's net income increased $29.9 million (40%) for the nine months ended
September 30, 2005, as compared to the nine months ended September 30,
2004, primarily due to the full period effect of the increase in electric
and gas base rates effective July 1, 2004 increased electric sales volumes
due to warmer summer weather and higher wholesale sales.
A comparison of LG&E's revenues for the nine months ended September 30,
2005, with the nine months ended September 30, 2004, reflects increases and
(decreases) which have been segregated by the following principal causes:
Cause Electric Gas
(in millions) Revenues Revenues
Retail sales:
Fuel and gas supply adjustments $ 22.7 $ 12.4
Environmental cost recovery surcharge 4.3 -
Earnings sharing mechanism (12.3) -
LG&E/KU merger surcredit (1.3) -
Rates and rate structure 25.1 4.9
Variation in sales volume and other 22.4 (8.9)
Total retail sales 60.9 8.4
Wholesale sales 56.1 9.2
Other 6.4 -
Total $123.4 $17.6
Electric revenues increased $123.4 million (20%) in 2005 primarily due to:
- - Higher revenues due to an increase in rates and a change in rate
structure ($25.1 million), related to the rate case order which took
effect on July 1, 2004
- - Higher sales volumes ($32.7 million) due to weather
- - Higher fuel supply adjustments ($22.7 million) due to higher cost of
fuel used for generation and purchased power
- - Wholesale sales increased $56.1 million
- Higher wholesale revenues ($43.0 million), primarily due to 5% higher
prices ($30.5 million) and 2% higher sales volumes ($12.5 million)
- Higher MISO related revenue ($13.1 million), due to MISO Day 2 RSGMWP,
earned due to the MISO's dispatch of higher cost gas-fired units
- - Lower ESM revenues ($12.3 million)
- - Lower MISO Day 1 transmission revenue ($3.4 million)
During the second quarter of 2005, LG&E made out-of-period adjustments for
estimated under collection of ECR revenues to be billed in subsequent
periods. The adjustments were immaterial during all reporting periods
involved (March 2003 through October 2004). As a result, year-to-date LG&E
revenues were increased $4.8 million. Year-to-date net income was increased
$2.9 million for LG&E.
Gas revenues increased $17.6 million (7%) in 2005 primarily due to:
- - Higher revenues due to an increase ($12.4 million) in recovery of
higher natural gas prices billed to customers through the gas supply clause
- - Higher wholesale revenues ($9.2 million) due to 3% higher sales prices
and 1% higher volumes
- - Higher revenues due to an increase in rates and a change in rate
structure ($4.9 million), related to the rate case order which took effect
on July 1, 2004
- - Lower retail revenues ($8.9 million) due to lower retail volumes
Fuel for electric generation and gas supply expenses comprise a large
component of LG&E's total operating expenses. LG&E's electric and gas rates
contain a fuel adjustment clause and a gas supply clause, respectively,
whereby increases or decreases in the cost of fuel and gas supply are
reflected in retail rates, subject to the approval of the Kentucky
Commission.
Fuel for electric generation increased $53.3 million (34%) in 2005
primarily due to:
- Increased cost per Btu (28% higher), resulting in $45.1 million higher
fuel costs. Fuel costs are significantly higher due to the MISO's dispatch
of gas-fired units committed by the MISO's Reliability Assessment and
Commitment process in the real-time market.
- Increased generation (5% higher), resulting in $8.2 million higher fuel
costs
Power purchased increased $35.7 million (54%) in 2005 primarily due to:
- Increased cost per Mwh (43%), resulting in $30.2 million higher costs
- Increased volume of power purchased (8%), resulting in $5.5 million
higher costs
- Higher purchased power costs from the MISO due to unit outages totaled
$9.8 million
Gas supply expenses increased $9.6 million (5%) in 2005 primarily due to:
- Increased cost of purchases for wholesale sales ($8.3 million)
- Increased cost per MCF ($1.6 million)
- Decreased volume of gas delivered to the distribution system ($0.4
million)
Other operations and maintenance expenses increased $0.3 million (less than
1%) in 2005.
Other operation expenses increased $0.7 million (less than 1%) in 2005
primarily due to:
- Increased power supply expenses ($10.8 million) due largely to MISO Day
2 costs ($11.6 million) of administration charges and allocated charges
from the MISO for Day 2 operations
- Increased steam power costs ($2.5 million) due primarily to increased
scrubber reactant expenses
- Increased gas storage losses ($1.4 million) due to the increased unit
cost of natural gas
- Decreased transmission expenses ($9.0 million), primarily MISO related.
Prior to the MISO Day 2 market, most bilateral transactions required the
purchase of transmission; however with the Day 2 market, most transactions
are handled directly with MISO and no additional transmission is necessary.
- Decreased distribution costs ($4.5 million) due to significantly lower
storm expenses in 2005
- Decreased administrative and general expenses ($0.7 million)
Maintenance expenses decreased $0.6 million (1%) in 2005 primarily due
to:
- Decreased distribution expenses ($8.1 million) due to significantly
lower storm costs in 2005
- Increased administrative and general expenses ($3.9 million) primarily
for information technology expenses charged to operations in 2004
- Increased steam generation costs ($2.5 million) due to boiler and
pollution control equipment repairs
- Increased repairs to combustion turbines ($0.8 million)
- Increased repairs to gas distribution facilities $(0.4 million)
Depreciation and amortization increased $7.0 million (8%) primarily due to
additional plant in service.
Other expense - net decreased $2.9 million in 2005 primarily due to:
- Increased mark-to-market gains related to energy trading contracts
($1.7 million)
- Decreased miscellaneous deductions ($1.3 million)
In total, interest expense increased $2.2 million (9%) in 2005 primarily
due to:
- Increased interest on variable-rate debt ($4.9 million)
- Increased interest on money pool debt ($0.6 million)
- Increased interest on customer deposits ($0.6 million)
- Decreased interest costs on interest rate swaps ($2.3 million)
- Decreased interest on affiliated loans with Fidelia ($0.8 million)
- Decreased interest due to refinancing fixed rate debt with variable
rate debt ($0.5 million)
- Decreased interest on income taxes ($0.3 million)
The weighted average interest rate on variable-rate bonds for the nine
months ended September 30, 2005, was 2.36%, compared to 1.14% for the
comparable period in 2004.
Variances in income tax expense are largely attributable to changes in pre-
tax income, reduction of previous accruals per final IRS audit and a
reduction in the statutory Kentucky rate.
Nine Months Nine Months
Ended Ended
Sept. 30, 2005 Sept. 30, 2004
Effective Rate
Statutory federal income tax rate 35.0% 35.0%
State income taxes net of federal benefit 4.3 5.2
Reduction of previous accruals per
final IRS audit (3.4) 0.0
Amortization of investment and other
tax credits (2.0) (2.7)
Other differences (1.4) (0.2)
Effective income tax rate 32.5% 37.3%
The increased tax benefit in other differences is largely attributable to
the new Internal Revenue Code Section 199 Qualified Production Activities
deduction and the amortization of excess deferred income taxes, which
reflect the benefits of deferred tax reversing at higher tax rates than the
current statutory rate.
See Part 1 - Item 1, Notes to Financial Statements, Note 6 for additional
discussion of income taxes.
KU Results:
KU's net income decreased $7.8 million (8%) for the nine months ended
September 30, 2005, as compared to the nine months ended September 30,
2004. The decrease was primarily due higher operations and maintenance
expenses partially offset by the increase in base rates effective July 1,
2004, and higher retail and wholesale sales.
A comparison of KU's revenues for the nine months ended September 30, 2005,
with the nine months ended September 30, 2004, reflects increases and
(decreases) which have been segregated by the following principal causes:
Cause Electric
(in millions) Revenues
Retail sales:
Fuel supply adjustments $77.4
Environmental cost recovery surcharge 8.9
Earnings sharing mechanism (13.5)
LG&E/KU merger surcredit (1.8)
Rates and rate structure 27.6
Variation in sales volume and other 20.1
Total retail sales 118.7
Wholesale sales 57.5
Other (9.9)
Total $166.3
Electric revenues increased $166.3 million (23%) in 2005 primarily due to:
- - Higher fuel supply adjustments ($77.4 million) due to higher cost of
fuel used for generation and purchased power
- - Wholesale sales increased $57.5 million
- Higher wholesale revenues ($39.4 million), primarily due to 5% higher
prices ($36.6 million) and less than 1% higher sales volumes
($2.8 million)
- Higher MISO related revenue ($18.1 million), due to MISO Day 2 RSGMWP,
earned due to the MISO's dispatch of higher cost gas-fired units
- - An increase in rates and a change in rate structure ($27.6 million),
related to the rate case order which took effect on July 1, 2004
- - Higher sales volumes ($24.3 million) due to weather
- - Lower revenues due to the discontinuation of the earnings sharing
mechanism (ESM) in the first quarter of 2005 ($13.5 million)
- - Lower MISO Day 1 transmission revenue ($6.7 million)
During the second quarter of 2005, KU made out-of-period adjustments for
estimated over collection of ECR revenues to be billed in subsequent
periods. The adjustments were immaterial during all reporting periods
involved (May 2003 through January 2005). As a result, year-to-date KU
revenues were decreased $2.4 million. Year-to-date net income in the
current period was reduced $1.5 million for KU.
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 FERC.
Fuel for electric generation increased $74.1 million (34%) in 2005
primarily due to:
- Increased cost per Btu (32% higher), resulting in $70.5 million higher
fuel costs. Fuel costs are significantly higher due to the MISO's dispatch
of gas-fired units committed by the MISO's Reliability Assessment and
Commitment process in the real-time market.
- Increased generation (2% higher), resulting in $3.5 million higher fuel
costs.
Power purchased increased $56.0 million (53%) in 2005 primarily due to:
- Increased cost per Mwh (41% higher), resulting in $46.5 million higher
costs.
- Increased volumes of Mwh purchased (9% higher), resulting in $9.4
million higher costs.
- Higher purchased power costs from the MISO due to unit outages totaled
$15.5 million
Other operations and maintenance expenses increased $39.8 million (24%) in
2005.
Other operation expenses increased $23.3 million (21%) in 2005 primarily
due to:
- Increased power supply costs ($22.5 million) due largely to MISO Day 2
costs ($22.4 million) administration charges and allocated charges from the
MISO for Day 2 operations
- Increased administrative and general costs ($2.4 million) due to
increases in customer accounts and collection expenses
- Decreased transmission expense ($1.6 million), primarily MISO related.
Prior to the MISO Day 2 market, most bilateral transactions required the
purchase of transmission; however with the Day 2 market, most transactions
are handled directly with MISO and no additional transmission is necessary.
Maintenance expenses increased $17.6 million (43%) in 2005 primarily due
to:
- Increased steam generation maintenance ($9.1 million) due to outages at
E.W. Brown, Ghent and Green River.
- Increased distribution system costs ($4.0 million), the result of
reclassifying $4.0 million in storm expenses in 2004 from maintenance to a
regulatory asset.
- Increased administrative and general expenses ($3.3 million) primarily
for information technology expenses charged to operations in 2004.
- Increased combustion turbine expenses ($0.8 million).
- Increased transmission line maintenance ($0.3 million).
Property and other taxes decreased $1.1 million.
Other (income) - net decreased $0.7 million (18%) in 2005 primarily due to:
- Decreased miscellaneous deductions ($2.4 million)
- Increased mark-to-market gains related to energy trading contracts
($1.7 million)
Depreciation and amortization increased $5.8 million (7%) primarily due to
additional plant in service.
In total, interest expense increased $3.3 million (18%) in 2005 primarily
due to:
- Increased interest costs on interest rate swaps ($1.9 million).
- Increased interest on variable rate debt ($1.8 million).
- Increased interest costs associated with the mark-to-market of the
interest rate swaps ($1.5 million).
- Decreased interest costs due to refinancing fixed rate debt with
variable rate debt ($1.3 million).
- Decreased interest costs from refinancing first mortgage bonds with
long-term debt from affiliates ($0.6 million).
The weighted average interest rate on variable-rate bonds for the nine
months ended September 30, 2005, was 2.39%, compared to 1.16% for the
comparable period in 2004.
Variations in income tax expense are largely attributable to changes in
pretax income and a reduction of previous accruals per final IRS audit.
Nine Months Nine Months
Ended Ended
Sept. 30, 2005 Sept. 30, 2004
Effective Rate
Statutory federal income tax rate 35.0% 35.0%
State income taxes net of federal benefit 4.7 5.3
Reduction of previous accruals per
final IRS audit (3.2) 0.0
EEI adjustment 2.3 0.0
Amortization of investment and other
tax credits (0.9) (1.0)
Other differences (1.4) (2.3)
Effective income tax rate 36.5% 37.0%
The reduced tax benefit in other differences for 2005 is attributable to
the recognition of a deferred tax liability on the undistributed earnings
from the Company's investment in EEI. In prior periods, the effective rate
was reduced for the anticipated EEI dividends received deduction.
See Part 1 - Item 1, Notes to Financial Statements, Note 6 for additional
discussion of income taxes.
Liquidity and Capital Resources
LG&E and KU's needs for capital funds are largely related to the
construction of plant and equipment necessary to meet the needs of electric
and gas utility customers, in addition to debt service requirements and
dividend payments. 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.
At September 30, 2005, LG&E and KU were in a negative working capital
position in part because of the classification of certain variable-rate
pollution control bonds that are subject to tender for purchase at the
option of the holder as current portion of long-term debt. LG&E and KU
expect to cover any working capital deficiencies with cash flow from
operations, money pool borrowings and borrowings from Fidelia.
Construction expenditures for the nine months ended September 30, 2005,
amounted to $95.0 million for LG&E and $76.3 million for KU. At LG&E,
expenditures include connection of new customers ($9.8 million),
expenditures to improve boiler and other generation equipment ($9.6
million), enhancements/upgrades to distribution equipment ($9.6 million),
pollution control facilities ($5.7 million), a new transmission line ($2.4
million) and gas main replacements ($2.2 million). At KU, expenditures
included improvements to boiler and other generation equipment ($14.8
million), connection of new customers ($8.4 million), enhancements/upgrades
to distribution equipment ($6.6 million) and pollution control facilities
($3.4 million). The expenditures were financed with internally generated
funds.
LG&E's and KU's cash balances decreased $1.0 million and $0.4 million,
respectively, during the nine months ended September 30, 2005, primarily
due to the payment of dividends and repayments of debt and construction
expenditures, partially offset by higher cash provided by operating
activities.
Variations in accounts receivable, accounts payable and inventories are
generally not significant indicators of LG&E's and KU's liquidity. Such
variations are primarily attributable to seasonal fluctuations in weather,
which have a direct effect on sales of electricity and natural gas. The
decrease in accounts receivable at LG&E was primarily due to the seasonal
impact of decreased gas sales. The increase in LG&E's gas stored
underground relates to an increase in the average unit cost of gas in
inventory.
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, 2005, LG&E had swaps with a combined
notional value of $211.3 million and KU had one swap with a notional value
of $53.0 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 swap effectively converts fixed-
rate obligations on KU's first mortgage bonds Series P to variable-rate
obligations.
In June 2005, a KU interest rate swap with a notional amount of $50 million
was terminated by the counterparty pursuant to the terms of the swap
agreement. KU received a payment of $1.9 million in consideration for the
termination of the agreement. KU also called the underlying debt (First
Mortgage Bond Series R) and paid a call premium of $1.9 million. The swap
was fully effective upon termination, therefore, no impact on earnings
occurred as a result of the bond call and related swap termination.
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.
At September 30, 2005, LG&E's and KU's percentage of debt having a variable
rate, including the impact of interest rate swaps, was 47.8% ($419.6
million) and 45.1% ($344.1 million), respectively.
Under the provisions for LG&E's variable-rate pollution control bonds,
Series S, T, U, BB, CC, DD and EE, and KU's variable-rate pollution control
bonds Series 10, 12, 13, 14, and 15, the bonds are subject to tender for
purchase at the option of the holder and to mandatory tender for purchase
upon the occurrence of certain events, causing the bonds to be classified
as current portion of long-term debt in the Balance Sheets. The average
annualized interest rate for these bonds during the three and nine months
ending September 30, 2005 was 2.63% and 2.36%, respectively, for LG&E and
2.59% and 2.40%, respectively, for KU.
During June 2005, LG&E renewed five revolving lines of credit with banks
totaling $185 million. There was no outstanding balance under any of these
facilities at September 30, 2005. The Company expects to renew these
facilities prior to their expiration in June 2006.
LG&E, KU and LG&E Energy participate in an intercompany money pool
agreement. Details of the balances at September 30, 2005 and September 30,
2004 were as follows:
Total Money Amount Balance Average
($ in millions) Pool Available Outstanding Available Interest Rate
September 30, 2005:
LG&E $400.0 $56.6 $343.4 3.64%
KU $400.0 $31.8 $368.2 3.64%
September 30, 2004:
LG&E $400.0 $40.7 $359.3 1.60%
KU $400.0 $29.8 $370.2 1.60%
LG&E Energy maintains a revolving credit facility totaling $200 million
with an affiliated company, E.ON North America, Inc., to ensure funding
availability for the money pool. The balance outstanding on this facility
at September 30, 2005 was $65.4 million.
Redemptions and maturities of long-term debt year-to-date through September
30, 2005, are summarized below:
($ in millions)
Principal Secured/
Year Company Description Amount Rate Unsecured Maturity
2005 LG&E Pollution control bonds 40.0 5.90% Secured Apr 2023
2005 LG&E Due to Fidelia $50.0 1.53% Secured Jan 2005
2005 LG&E Mand. Red. Pref. Stock $1.3 5.875% Unsecured Jul 2005
2005 KU First mortgage bonds $50.0 7.55% Secured Jun 2025
Issuances of long-term debt year-to-date through September 30, 2005, are
summarized below:
($ in millions)
Principal Secured/
Year Company Description Amount Rate Unsecured Maturity
2005 LG&E Pollution control bonds $40.0 Variable Secured Feb 2035
2005 KU Pollution control bonds $13.3 Variable Secured Jun 2035
2005 KU Due to Fidelia $50.0 4.735% Unsecured Jul 2015
In May 2005, KU repaid a $26.7 million loan against the cash surrender
value of life insurance policies.
In January 2004, LG&E and KU made discretionary contributions to their
pension plans of $34.5 million and $43.4 million, respectively. No
discretionary contributions to the pension plans are currently anticipated
for either LG&E or KU for 2005. LG&E and KU contributed $0.7 million and
$3.0 million, respectively, to their other post-retirement benefit plans
during the second quarter of 2005.
Security ratings as of September 30, 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 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.
Capitalization ratios at September 30, 2005, and December 31, 2004, follow:
LG&E KU
Sept. 30, Dec. 31, Sept. 30, Dec. 31,
2005 2004 2005 2004
Long-term debt
(including current portion) 30.3% 30.5% 19.4% 22.2%
Long-term debt to
affiliated company (including
current portion) 11.5 14.1 21.2 18.8
Notes payable to affiliated
companies 2.9 3.0 1.7 2.0
Preferred stock 3.6 3.6 2.2 2.2
Common equity 51.7 48.8 55.5 54.8
Total 100.0% 100.0% 100.0% 100.0%
New Accounting Pronouncements
For a discussion of new accounting pronouncements and their impacts on LG&E
and KU, see Part I - Item 1, Notes to 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, 2004; and to
Part I - Item 1, Notes to Financial Statements, Notes 5 and 10, and Part II
- - Item 1, Legal Proceedings herein.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
LG&E's and KU's operations are exposed to market risks from changes in
interest rates and commodity prices. To mitigate changes in cash flows
attributable to these exposures, the Companies have entered into various
derivative instruments. Derivative positions are monitored using techniques
that include market value and sensitivity analysis.
Interest Rate Risk
The Companies use interest rate swaps to hedge exposure to market
fluctuations in certain of their debt instruments. Pursuant to the
Companies' policies, use of these financial instruments is intended to
mitigate risk and earnings volatility and is not speculative in nature.
Management has designated all of the Companies' interest rate swaps as
hedge instruments. Financial instruments designated as cash flow hedges
have resulting gains and losses recorded within other comprehensive income
and stockholders' equity. To the extent a financial instrument or the
underlying item being hedged is prematurely terminated or the hedge becomes
ineffective, the resulting gains or losses are reclassified from other
comprehensive income to net income. Financial instruments designated as
fair value hedges are periodically marked to market with the resulting
gains and losses recorded directly into net income to correspond with
income or expense recognized from changes in market value of the items
being hedged.
The potential change in interest expense associated with a 1% change in
base interest rates of LG&E's and KU's unswapped variable debt is estimated
at $4.2 million and $3.4 million, respectively, at September 30, 2005.
LG&E's and KU's exposure to floating interest rates did not materially
change during the first nine months of 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 $18.0 million as of September 30, 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 $0.8 million as
of September 30, 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. LG&E and KU have
recognized an additional minimum liability as prescribed by SFAS No. 87,
Employers' Accounting for Pensions because the accumulated benefit
obligation exceeds the fair value of their plans' assets. The liabilities
were recorded as a reduction to other comprehensive income, and did not
affect net income. The amount of the liability depends upon the discount
rate, the asset returns and contributions made by the Companies to the
plans. If the fair value of the plans' assets exceeds the accumulated
benefit obligation, the recorded liabilities will be reduced and other
comprehensive income will be restored in the balance sheet.
A 1% increase or decrease in the assumed discount rate could have an
approximate $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 $26.8 million positive or negative
impact to the accumulated benefit obligation of KU.
In January 2004, LG&E and KU made discretionary contributions to their
pension plans of $34.5 million and $43.4 million, respectively. No
discretionary contributions to the pension plans are currently anticipated
for either LG&E or KU for 2005. LG&E and KU contributed $0.7 million and
$3.0 million, respectively, to their other post-retirement benefit plans
during the second quarter of 2005.
Energy Risk Management Activities
LG&E conducts 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 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 are treated as normal
sales under SFAS No. 133 and SFAS No. 138 and are not marked to market.
The rescission of EITF No. 98-10 for fiscal periods ending after December
15, 2002, had no impact on LG&E's energy trading and risk management
reporting as all contracts marked to market under EITF No. 98-10 are also
within the scope of SFAS No. 133.
Since the inception of the MISO Day 2 market in April 2005, LG&E and KU
have been eligible to receive Financial Transmission Rights (FTRs) from
MISO. FTRs are assigned by MISO to market participants for a 12 month
period of time beginning June 1, 2006 for off-peak and peak periods based
on each market participant's share of generation. FTRs entitle the holder
to manage price risk associated with hourly market price fluctuations
caused by transmission congestion. The value of FTRs is determined by the
transmission congestion charges that arise when the transmission grid is
congested in the day-ahead market. Holders of FTRs use them to cover
charges assessed for congestion in the hourly market, while market
participants without FTRs must pay congestion costs in order to obtain less
expensive power through the transmission system. FTRs are obtained through
an allocation from MISO, however, they can also be bought and sold.
Although FTRs are financial instruments they are not marked to market under
SFAS No. 133 due to the lack of liquidity in the forward market.
The table below summarizes LG&E's and KU's energy risk management
activities for the three months and nine months ended September 30, 2005,
and 2004. Volumes are allocated evenly between LG&E and KU.
Three Months Nine Months
Ended Ended
September 30, September 30,
2005 2004 2005 2004
(in millions)
Fair value of contracts at beginning of
period, net asset/(liability) $ - $ 0.5 $(0.2) $ 0.6
Fair value of contracts when entered
into during the period 0.2 (0.1) 0.2 (0.1)
Contracts realized or otherwise
settled during the period - (0.4) 0.2 (0.7)
Changes in fair value due to
changes in assumptions - 0.1 - 0.3
Fair value of contracts at end
of period,net asset $ 0.2 $ 0.1 $ 0.2 $ 0.1
No changes to valuation techniques for energy risk management activities
occurred during 2005 or 2004. Changes in market pricing, interest rate and
volatility assumptions were made during all periods. The outstanding mark-
to-market value is sensitive to changes in prices, price volatilities, and
interest rates. The Companies estimate that a movement in prices of $1 and
a change in interest and volatilities of 1% would result in a change in the
mark-to-market value of less than $0.1 million. All contracts outstanding
at September 30, 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, 2005, 100% of the transactions marked-to-market according to
SFAS No. 133 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, 2007, 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 controls over financial reporting. On April 1, 2005, the
MISO Day 2, a day-ahead and real-time energy market, became effective which
impacted the Companies' regulated electric generation operations and
purchased power. In connection with the implementation of MISO Day 2, LG&E
and KU have implemented a new software system and modified existing
processes to facilitate participation in, and validate resultant
settlements from the MISO market. Apart from this change, there have been
no other changes in the Companies' internal control over financial
reporting that occurred during the fiscal quarter ended September 30, 2005,
that have materially affected, or are reasonably likely to materially
affect, the Companies' internal control over financial reporting.
Part II. Other Information
Item 1. Legal Proceedings.
For a description of the significant legal proceedings involving LG&E and
KU, reference is made to the information under the following items and
captions of LG&E's and KU's respective combined Annual Report on Form 10-K
for the year ended December 31, 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 10 of Part I, Item 1 of LG&E's and KU's Quarterly
Report on Form 10-Q for the three months ended March 31, 2005, June 30,
2005, and this 10-Q, respectively. 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 materially changed.
Other
In the normal course of business, other lawsuits, claims, environmental
actions, and other 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, does not anticipate that liabilities
arising out of other currently pending or threatened lawsuits and claims
will have a material adverse effect on LG&E's or KU's financial position or
results of operations, respectively.
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,
2005, leaving 212,500 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 2005 August 2005 September 2005
Total number of 12,500 n/a n/a
shares (or units) ($5.875 Pref.)
purchased
Average price $100 n/a n/a
paid per share
(or unit)
Total number of 12,500 n/a n/a
shares (or units) ($5.875 Pref.)
purchased as part
of publicly
announced plans
or programs
Maximum number 212,500 n/a n/a
(or approximate ($5.875 Pref.)
dollar value) of
shares (or units)
that may yet be
purchased under
the plans or
programs
Item 6. Exhibits.
Applicable to Form
10-Q of
Exhibit
No. LG&E KU Description
31 X X Certification - Section 302 of Sarbanes-Oxley Act of 2002
31.1 X Certification of Chairman of the Board, President and Chief
Executive Officer, pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
31.2 X Certification of Chief Financial Officer, pursuant to
Section 302 of
the Sarbanes-Oxley Act of 2002
31.3 X Certification of Chairman of the Board, President and Chief
Executive Officer, pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
31.4 X Certification of Chief Financial Officer, 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 or KU have not been filed with the SEC but will be furnished
to the SEC upon request.
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 14, 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 14, 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)
_______________________________