UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended SeptemberJune 30, 20042005
Or
[_] TRANSITION REPORT PURSUANT TO1TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission Registrant, State of Incorporation IRS Employer
File Number Address, and Telephone Number Identification No.
1-2893 Louisville Gas and Electric Company 61-0264150
(A Kentucky Corporation)
220 West Main Street
P.O. Box 32010
Louisville, KY 40232
(502) 627-2000
1-3464 Kentucky Utilities Company 61-0247570
(A Kentucky and Virginia Corporation)
One Quality Street
Lexington, KY 40507-1428
(859) 255-2100
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes X.X No _._
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes No X
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date:
Louisville Gas and Electric Company
21,294,223 shares, without par value, as of OctoberJuly 31, 2004,2005,
all held by LG&E Energy LLC
Kentucky Utilities Company
37,817,878 shares, without par value, as of OctoberJuly 31, 2004,2005,
all held by LG&E Energy LLC
This combined Form 10-Q is separately filed by Louisville Gas and Electric
Company and Kentucky Utilities Company. Information contained herein
related to any individual registrant is filed by such registrant on its own
behalf. Each registrant makes no representation as to information related
to the other registrants.
New PageINDEX OF ABBREVIATIONS
AEP American Electric Power Company, Inc.
AG Attorney General of Kentucky
ARB Accounting Research Bulletin
ARO Asset Retirement Obligation
CCN Certificate of Public Convenience and Necessity
DSM Demand Side Management
ECR Environmental Cost Recovery
EEI Electric Energy, Inc.
E.ON E.ON AG
EPA Environmental Protection Agency
ESM Earnings Sharing Mechanism
FAC Fuel Adjustment Clause
FASB Financial Accounting Standards Board
FERC Federal Energy Regulatory Commission
Fidelia Fidelia Corporation (an E.ON affiliate)
FIN FASB Interpretation No.
FGD Flue Gas Desulfurization
FSP FASB Staff Position
IMEA Illinois Municipal Electric Agency
IMPA Indiana Municipal Power Agency
ITP Independent Transmission Provider
IRS Internal Revenue Service
Kentucky Commission Kentucky Public Service Commission
KU Kentucky Utilities Company
LIBOR London Interbank Offer Rate
LEM LG&E Energy Marketing Inc.
LG&E Louisville Gas and Electric Company
LG&E Energy LG&E Energy LLC (as successor to LG&E Energy Corp.)
LG&E Services LG&E Energy Services Inc.
LMP Locational Marginal Pricing
MGP Manufactured Gas Plant
MISO Midwest Independent Transmission System Operator,
Inc.
Moody's Moody's Investor Services, Inc.
Mw Megawatts
Mwh Megawatt hours
NOPR Notice of Proposed Rulemaking
OMU Owensboro Municipal Utilities
OVEC Ohio Valley Electric Corporation
PJM PJM Interconnection, LLC
Powergen Powergen Limited (formerly Powergen plc)
PUHCA Public Utility Holding Company Act of 1935
RTO Regional Transmission Operator
S&P Standard & Poor's Rating Services
SEC Securities and Exchange Commission
SFAS Statement of Financial Accounting Standards
SMD Standard Market Design
SO2 Sulfur Dioxide
SOA The Sarbanes-Oxley Act of 2002
VDT Value Delivery Team Process
TABLE OF CONTENTS
PART I
ItemITEM 1. FINANCIAL STATEMENTS (UNAUDITED)
LOUISVILLE GAS AND ELECTRIC COMPANY
STATEMENTS OF INCOME 1
Consolidated Financial Statements
Louisville Gas and Electric Company and Subsidiary
Statements of IncomeSTATEMENTS OF RETAINED EARNINGS 1
Statements of Retained Earnings 1
Balance SheetsBALANCE SHEETS 2
Statements of Cash FlowSTATEMENTS OF CASH FLOWS 4
Statements of Other Comprehensive IncomeSTATEMENTS OF OTHER COMPREHENSIVE INCOME 5
Kentucky Utilities Company and Subsidiary
Statements of IncomeKENTUCKY UTILITIES COMPANY
STATEMENTS OF INCOME 6
Statements of Retained EarningsSTATEMENTS OF RETAINED EARNINGS 6
Balance SheetsBALANCE SHEETS 7
Statements of Cash FlowSTATEMENTS OF CASH FLOWS 9
Statements of Other Comprehensive IncomeSTATEMENTS OF OTHER COMPREHENSIVE INCOME 10
Notes to Consolidated Financial StatementsNOTES TO FINANCIAL STATEMENTS 11
Item 2 Management's Discussion and Analysis of F
Financial Condition and Results of Operations 23
Item 3 Quantitative and Qualitative Disclosures
About Market Risk 38
Item 4 Controls and ProceduresITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS. 24
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. 36
ITEM 4. CONTROLS AND PROCEDURES. 39
PART II
Item 1 Legal ProceedingsITEM 1. LEGAL PROCEEDINGS. 40
Item 2 Unregistered Sales of Equity Securities
and Use of ProceedsITEM 6. EXHIBITS 41
Item 4 Submission of Matters to a Vote of Security Holders 41
Item 6 Exhibits 42
SignaturesSIGNATURES 43
ExhibitsEXHIBITS 44
New Page
Part I. Financial Information - Item 1. Financial Statements (Unaudited)
Louisville Gas and Electric Company
and Subsidiary
Consolidated Statements of Income
(Unaudited)
(Thousands(Millions of $)
Three Months NineSix Months
Ended Ended
SeptemberJune 30, SeptemberJune 30,
2005 2004 20032005 2004
2003
OPERATING REVENUES (Note 5):REVENUES:
Electric (Note 10) $227,024 $230,174 $617,839 $591,110$228.2 $192.5 $457.2 $390.8
Gas 34,818 32,659 242,178 213,93952.5 43.7 225.1 207.4
Total operating revenues 261,842 262,833 860,017 805,049280.7 236.2 682.3 598.2
OPERATING EXPENSES:
Fuel for electric generation 53,653 55,628 153,792 151,38268.2 47.8 128.5 100.6
Power purchased (Note 10) 19,344 18,805 65,578 60,24528.2 17.3 67.2 46.2
Gas supply expenses 20,172 19,509 181,919 151,57935.6 31.0 171.2 161.8
Other operation and maintenance expenses 48,129 51,890 163,300 158,797
Maintenance 23,072 12,526 49,879 42,10965.0 77.3 139.3
151.7
Depreciation and amortization 30,299 28,429 86,021 85,866
Federal and state income taxes 21,089 23,707 45,487 45,062
Property and other taxes 4,343 4,659 14,483 12,84831.2 28.2 62.0 55.7
Total operating expenses 220,101 215,153 760,459 707,888228.2 201.6 568.2 516.0
NET OPERATING INCOME 41,741 47,680 99,558 97,16152.5 34.6 114.1 82.2
Other income (expense)expense (income) - net (1,091) 285 (1,419) (49)
Other income from affiliated
company (Note 10) - 2 - 60.1 0.1 (0.1) 0.8
Interest expense (Note 3) 5,072 5,985 15,086 18,0905.9 5.2 11.8 10.1
Interest expense to affiliated companies
(Note 10) 3,040 2,111 9,157 4,1379) 2.8 3.0 5.9 6.1
INCOME BEFORE INCOME TAXES 43.7 26.3 96.5 65.2
Federal and state income taxes (Note 6) 15.7 9.2 34.7
23.9
NET INCOME $ 32,53828.0 $ 39,87117.1 $ 73,89661.8 $ 74,891
Consolidated Statements of Retained Earnings
(Unaudited)
(Thousands of $)
Three Months Nine Months
Ended Ended
September 30, September 30,
2004 2003 2004 2003
Balance at beginning of period $516,856 $442,498 $497,441 $409,319
Net income 32,538 39,871 73,896 74,891
Subtotal 549,394 482,369 571,337 484,210
Cash dividends declared on stock:
5% cumulative preferred 269 269 807 807
Auction rate cumulative preferred 244 174 649 743
$5.875 cumulative preferred (Note 9) - - - 734
Common 21,000 - 42,000 -
Subtotal 21,513 443 43,456 2,284
Balance at end of period $527,881 $481,926 $527,881 $481,92641.3
The accompanying notes are an integral part of these consolidated financial statements.
Page 1Statements of Retained Earnings
(Unaudited)
(Millions of $)
Three Months Six Months
Ended Ended
June 30, June 30,
2005 2004 2005 2004
Balance at beginning of period $538.2 $521.3 $534.0 $497.5
Net income 28.0 17.1 61.8 41.3
Subtotal 566.2 538.4 595.8 538.8
Cash dividends declared on stock:
5% cumulative preferred 0.3 0.3 0.5 0.5
Auction rate cumulative preferred 0.5 0.2 0.9 0.4
Common 10.0 21.0 39.0 21.0
Subtotal 10.8 21.5 40.4 21.9
Balance at end of period $555.4 $516.9 $555.4 $516.9
The accompanying notes are an integral part of these financial statements.
Louisville Gas and Electric Company
and Subsidiary
Consolidated Balance Sheets
(Unaudited)
(Thousands(Millions of $)
ASSETS
SeptemberJune 30, December 31,
2005 2004 2003
UTILITY PLANT:
At original cost $3,880,901 $3,804,183
Less: reserve for depreciation 1,390,301 1,326,899
Net utility plant (Note 7) 2,490,600 2,477,284
OTHER PROPERTY AND INVESTMENTS -
less reserve of $63 as of September 30, 2004
and December 31, 2003 508 611
CURRENT ASSETS:
Cash and cash equivalents 5,902 1,706
Restricted cash 11,524 -$ 4.8 $ 6.8
Accounts receivable -
less reserve of $1,415$1.2 million and $3,515$0.8 million as of
SeptemberJune 30, 20042005 and December 31, 2003,2004,
respectively (Note 4) 108,761 84,585140.9 167.0
Materials and supplies - at average cost:
Fuel (predominantly coal) 22,268 25,26027.6 21.8
Gas stored underground 76,416 69,88419.3 77.5
Other 26,214 24,97127.0 26.1
Prepayments and other 1,634 5,2813.3 3.9
Total current assets 252,719 211,687222.9 303.1
OTHER PROPERTY AND INVESTMENTS -
less reserve of less than $0.1 million as of
June 30, 2005 and December 31, 2004 0.6 0.5
UTILITY PLANT:
At original cost 3,966.8 3,915.8
Less: reserve for depreciation 1,459.4 1,396.3
Net utility plant 2,507.4 2,519.5
DEFERRED DEBITS AND OTHER ASSETS:
Restricted cash 13.1 10.9
Unamortized debt expense 8,555 8,7538.4 8.4
Regulatory assets (Note 6) 100,183 143,6265) 73.9 91.9
Other 32,789 40,12131.8 32.2
Total deferred debits and other assets 141,527 192,500127.2 143.4
Total assets $2,885,354 $2,882,082$2,858.1 $2,966.5
The accompanying notes are an integral part of these consolidated financial statements.
Page 2
Louisville Gas and Electric Company
and Subsidiary
Consolidated Balance Sheets (cont.)
(Unaudited)
(Thousands(Millions of $)
CAPITALIZATION AND LIABILITIES
SeptemberJune 30, December 31,
2005 2004 2003
CAPITALIZATION:
Common stock, without par value -
Outstanding 21,294,223 shares $ 425,170 $ 425,170
Common stock expense (836) (836)
Additional paid-in capital 40,000 40,000
Accumulated other comprehensive loss (39,902) (38,111)
Retained earnings 527,881 497,441
Total common equity 952,313 923,664
Cumulative preferred stock 70,425 70,425
Mandatorily redeemable preferred stock (Note 9) 21,250 22,500
Long-term debt (Note 9) 328,104 328,104
Long-term debt to affiliated company (Note 9) 225,000 200,000
Total long-term debt 574,354 550,604
Total capitalization 1,597,092 1,544,693
CURRENT LIABILITIES:
Current portion of mandatorily
redeemable preferred stock (Note 9) 1,250 1,250$ 1.3 $ 1.3
Current portion of long-term debt (Note 9) 246,200 246,2008) 246.2 246.2
Current portion of long-term debt to
affiliated company (Note 9) 50,0008) - 50.0
Notes payable to affiliated companies (Note 9) 40,700 80,3328) 20.8 58.2
Accounts payable 62,959 93,11866.9 106.1
Accounts payable to affiliated companies (Note 10) 22,455 38,3439) 60.8
31.7
Accrued income taxes 8,330 11,472- 6.2
Customer deposits 12,255 10,493
Accrued interest 2,593 1,999
Accrued interest to affiliated company (Note 10) 2,996 2,75016.2 14.0
Other 18,493 11,7849.9 18.5
Total current liabilities 468,231 497,741422.1 532.2
DEFERRED CREDITS AND OTHER LIABILITIES:
Accumulated deferred income taxes - net 347,092 337,704318.7 347.2
Investment tax credit, in process of amortization 47,202 50,32944.1
46.2
Accumulated provision for pensions
and related benefits 109,436 140,598122.1 120.6
Customer advances for construction 10,637 9,8909.7 10.6
Asset retirement obligation 10,155 9,74710.6 10.3
Regulatory liabilities (Note 6)5):
Accumulated cost of removal of utility plant 214,950 216,491216.2 220.2
Deferred income taxes - net (Note 6) 54.2 37.2
Other 53,535 51,822
Long-term derivative liability (Note 3) 18,883 15,9669.7 15.0
Other 8,141 7,10138.9 29.4
Total deferred credits and other liabilities 820,031 839,648824.2 836.7
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 (52.8) (45.6)
Retained earnings 555.4 534.0
Total common equity 967.0 952.8
Cumulative preferred stock 70.4 70.4
Mandatorily redeemable preferred stock 21.3 21.3
Long-term debt (Note 8) 328.1 328.1
Long-term debt to affiliated company (Note 8) 225.0 225.0
Total capitalization 1,611.8 1,597.6
Total capital and liabilities $2,885,354 $2,882,082$2,858.1 $2,966.5
The accompanying notes are an integral part of these consolidated financial statements.
Page 3
Louisville Gas and Electric Company
and Subsidiary
Consolidated StatementStatements of Cash Flows
(Unaudited)
(Thousands(Millions of $)
NineSix Months Ended
SeptemberJune 30,
2005 2004 2003
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 73,89661.8 $ 74,89141.3
Items not requiring cash currently:
Depreciation and amortization 86,021 85,86662.0 55.7
Value delivery team amortization 15.1 15.1
Change in fair value of derivative instruments 4.0 (6.1)
Deferred income taxes - net 6,803 24,589(11.5) 4.9
Investment tax credit - net (3,127) (3,156)
Value Delivery Team (VDT) amortization (Note 6) 22,601 22,866
Mark-to-market financial instruments (Note 3) 2,916 (651)
Provision for post-retirement benefits (Note 8) (8,047) (4,801)(2.1) (2.8)
Other (147) 7,997(4.7) 5.5
Changes in current assets and liabilities (10,576) (28,028)
Changes in accounts receivable
securitization-net (Note 4) (58,000) 11,600liabilities-net 55.5 (19.6)
Pension funding (Notes 9 and 12) (34,492) (89,125)(Note 11) - (34.5)
Provision for post-retirement benefits (2.6) (8.0)
Gas supply clause (Note 6) 12,008 (14,970)receivable, net 2.0 8.3
Earnings sharing mechanism (Note 6) 6,913 6,189
Combustion turbine litigationreceivable 2.1 2.4
Litigation settlement 7,003 - 7.1
Other 15,460 10,698(2.5) 9.3
Net cash flows fromprovided by operating activities 119,232 103,965179.1 78.6
CASH FLOWS FROMUSED IN INVESTING ACTIVITIES:
Proceeds from sales(Purchase) sale of securities 103 153long-term investments (0.1) -
Change in restricted cash (2.2) (6.5)
Construction expenditures (94,220) (153,064)(51.0) (64.9)
Net cash flows fromused for investing activities (94,117) (152,911)(53.3) (71.4)
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase in restricted cash (11,524) -
Long-term borrowings from affiliated company (Note 9) 125,000 200,0008) - 125.0
Repayment of long-term borrowings
from affiliated company (Note 8) (50.0) (50.0)
Short-term borrowings from affiliated company (Note 9) 399,550 478,800
Repayment of long-term borrowings from d
affiliated company (Note 9) (50,000)8) - 260.5
Repayment of short-term borrowings
from affiliated company (Note 9) (439,182) (596,721)
Retirement of mandatorily redeemable preferred
stock (Note 9) (1,250) (1,250)
Retirement of first mortgage bonds - (42,600)
Issuance costs of pollution control bonds (135) -(37.4) (314.9)
Payment of common dividends (42,000)(40.4) (21.9)
Other - Payment of preferred dividends (1,378) (2,898)(0.1)
Net cash flows fromused for financing activities (20,919) 35,331(127.8) (1.4)
CHANGE IN CASH AND CASH EQUIVALENTS 4,196 (13,615)(2.0) 5.8
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 1,706 17,0156.8 1.7
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 5,9024.8 $ 3,4007.5
SUPPLEMENTAL DISCLOSURES:
Cash paid during the period for:
Income taxes $ 42,375 $ 12,968$51.6 $33.1
Interest on borrowed money 12,674 17,20410.9 8.5
Interest to affiliated companies on borrowed money 8,937 1,7076.4 5.3
The accompanying notes are an integral part of these consolidated financial statements.
Page 4
Louisville Gas and Electric Company and Subsidiary
Consolidated
Statements of Other Comprehensive Income
(Unaudited)
(Thousands(Millions of $)
Three Months NineSix Months
Ended Ended
SeptemberJune 30, SeptemberJune 30,
2005 2004 20032005 2004 2003
Net income $32,538 $39,871 $73,896 $74,891
Gains/(losses)$28.0 $17.1 $61.8 $41.3
Income Taxes - Minimum Pension
Liability (Note 6) - - (1.1) -
Gain (loss) on derivative instruments and
hedging activities - net of tax benefit/(expense)benefit
/(expense) of $3,639, $(1,416)$5.0, $(4.8), $1,189$3.9 and
$(382)$(2.4),respectively (Note 3) (5,457) 2,123 (1,790) 573(7.7) 7.3 (6.1) 3.7
Other comprehensive income (loss),
net of tax (7.7) 7.3 (7.2) 3.7
Comprehensive income $27,081 $41,994 $72,106 $75,464$20.3 $24.4 $54.6 $45.0
The accompanying notes are an integral part of these consolidated financial statements.
Page 5
Kentucky Utilities Company and Subsidiary
Consolidated
Statements of Income
(Unaudited)
(Thousands(Millions of $)
Three Months NineSix Months
Ended Ended
SeptemberJune 30, SeptemberJune 30,
2005 2004 20032005 2004 2003
OPERATING REVENUES (Note 10) $252,669 $235,426 $732,424 $657,583$265.2 $232.4 $551.5 $479.7
OPERATING EXPENSES:
Fuel for electric generation 78,151 75,300 215,666 201,26484.0 67.7 171.5 137.7
Power purchased (Note 10) 33,182 31,702 105,152 106,55050.0 30.7 96.3 72.0
Other operation and maintenance
expenses 37,844 35,603 112,834 112,622
Maintenance 12,070 13,031 40,978 49,40067.8 57.8 126.2 112.2
Depreciation and amortization 29,065 24,751 80,265 76,663
Federal and state income taxes 19,565 18,196 58,127 32,263
Property and other taxes 4,406 4,067 12,942 12,23029.2 25.9 57.7 51.2
Total operating expenses 214,283 202,650 625,964 590,992231.0 182.1 451.7 373.1
NET OPERATING INCOME 38,386 32,776 106,460 66,59134.2 50.3 99.8 106.6
Other income(income) - net 3,094 2,140 6,514 6,944
Other income (expense) from
affiliated company (Note 10) 11 5 26 4(1.8) (1.9) (3.1) (2.9)
Interest expense (Note 3) 3,116 2,695 7,532 13,8084.2 3.7 7.0 4.4
Interest expense to affiliated companies
(Note 10) 3,557 1,916 10,641 3,4019) 3.7 3.5 7.2 7.1
NET INCOME BEFORE INCOME TAXES 28.1 45.0 88.7 98.0
Federal and state income taxes (Note 6)10.4 17.4 33.4 38.0
NET INCOME $ 34,81817.7 $ 30,31027.6 $ 94,82755.3 $ 56,330
Consolidated Statements of Retained Earnings
(Unaudited)
(Thousands of $)
Three Months Nine Months
Ended Ended
September 30, September 30,
2004 2003 2004 2003
Balance at beginning of period $629,051 $526,916 $591,170 $502,024
Net income 34,818 30,310 94,827 56,330
Subtotal 663,869 557,226 685,997 558,354
Cash dividends declared on stock:
4.75% cumulative preferred 237 237 712 711
6.53% cumulative preferred 327 327 980 981
Common 21,000 - 42,000 -
Subtotal 21,564 564 43,692 1,692
Balance at end of period $642,305 $556,662 $642,305 $556,66260.0
The accompanying notes are an integral part of these consolidated financial statements.
Page 6Statements of Retained Earnings
(Unaudited)
(Millions of $)
Three Months Six Months
Ended Ended
June 30, June 30,
2005 2004 2005 2004
Balance at beginning of period $666.4 $623.1 $659.4 $591.2
Net income 17.7 27.6 55.3 60.0
Subtotal 684.1 650.7 714.7 651.2
Cash dividends declared on stock:
4.75% cumulative preferred 0.2 0.2 0.5 0.4
6.53% cumulative preferred 0.3 0.3 0.6 0.6
Common 10.0 21.0 40.0 21.0
Subtotal 10.5 21.5 41.1 22.0
Balance at end of period $673.6 $629.2 $673.6 $629.2
The accompanying notes are an integral part of these financial statements.
Kentucky Utilities Company
and Subsidiary
Consolidated Balance Sheets
(Unaudited)
(Thousands(Millions of $)
ASSETS
SeptemberJune 30, December 31,
2005 2004 2003
UTILITY PLANT:
At original cost $3,670,707 $3,596,657
Less: reserve for depreciation 1,403,583 1,360,253
Net utility plant (Note 7) 2,267,124 2,236,404
OTHER PROPERTY AND INVESTMENTS -
less reserve of $131 as of September 30, 2004 and
December 31, 2003 19,721 17,862
CURRENT ASSETS:
Cash and cash equivalents 4,677 4,869$ 4.0 $ 4.6
Accounts receivable - less reserve of $482 and $672$0.6 million
as of SeptemberJune 30, 20042005 and December 31, 2003,
respectively (Note 4) 97,437 49,2892004 107.7 112.6
Materials and supplies - at average cost:
Fuel (predominantly coal) 30,260 45,53857.3 52.2
Other 27,653 27,09429.3 28.0
Prepayments and other 6,802 13,1005.9 9.9
Total current assets 166,829 139,890204.2 207.3
OTHER PROPERTY AND INVESTMENTS -
less reserve of $0.1 million as of June 30,
2005 and December 31, 2004 21.7 20.5
UTILITY PLANT:
At original cost 3,756.1 3,712.1
Less: reserve for depreciation 1,462.7 1,415.0
Net utility plant 2,293.4 2,297.1
DEFERRED DEBITS AND OTHER ASSETS:
Unamortized debt expense 4,295 4,4814.3 4.7
Regulatory assets (Note 6) 62,668 72,3185) 68.9 61.4
Long-term derivative asset (Note 3) 7,530 12,2231.9 6.1
Other 12,164 21,91641.1 13.3
Total deferred debits and other assets 86,657 110,938116.2 85.5
Total assets $2,540,331 $2,505,094$2,635.5 $2,610.4
The accompanying notes are an integral part of these consolidated financial statements.
Page 7
Kentucky Utilities Company
and Subsidiary
Consolidated Balance Sheets (cont.)
(Unaudited)
(Thousands(Millions of $)
CAPITALIZATION AND LIABILITIES
SeptemberJune 30, December 31,
2005 2004 2003
CAPITALIZATION:
Common stock, without par value -
Outstanding 37,817,878 shares $ 308,140 $ 308,140
Common stock expense (322) (322)
Additional paid-in capital 15,000 15,000
Accumulated other comprehensive loss (6,071) (6,031)
Retained earnings 642,305 591,170
Total common equity 959,052 907,957
Cumulative preferred stock 39,727 39,727
Long-term debt (Note 9) 307,564 312,646
Long-term debt to affiliated company (Note 9) 333,000 283,000
Total long-term debt 640,564 595,646
Total capitalization 1,639,343 1,543,330
CURRENT LIABILITIES:
Current portion of long-term debt (Note 9) 87,130 91,9308) $ 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 9) 29,830 43,2318) 93.1 34.8
Accounts payable 41,317 69,94757.7 77.9
Accounts payable to affiliated companies (Note 10) 18,979 26,4269) 68.0 32.8
Accrued income taxes 12,337 7,1043.7 5.9
Customer deposits 14,163 13,453
Accrued interest 3,019 2,024
Accrued interest to affiliated company (Note 10) 3,866 2,45416.2 15.0
Other 20,566 9,7672.6 15.4
Total current liabilities 231,207 266,336439.4 343.9
DEFERRED CREDITS AND OTHER LIABILITIES:
Accumulated deferred income taxes - net 274,207 261,258267.1 282.6
Investment tax credit, in process of amortization 4,318 5,8593.0 3.8
Accumulated provision for pensions and
related benefits 65,260 103,101
Customer advances for construction 1,608 1,56478.7 77.9
Asset retirement obligation 20,661 19,69821.5 21.0
Regulatory liabilities (Note 6)5):
Accumulated cost of removal of utility plant 262,971 256,744273.7 266.8
Deferred income taxes - net (Note 6) 30.9 19.3
Other 28,301 38,0279.9 5.4
Other 12,455 9,17715.4 17.0
Total deferred credits and other liabilities 669,781 695,428700.2 693.8
CAPITALIZATION:
Common stock, without par value -
Outstanding 37,817,878 shares 308.1 308.1
Common stock expense (0.3) (0.3)
Additional paid-in capital 15.0 15.0
Accumulated other comprehensive loss (13.6) (13.3)
Retained earnings 660.4 647.3
Undistributed subsidiary earnings 13.2 12.1
Total retained earnings 673.6 659.4
Total common equity 982.8 968.9
Cumulative preferred stock 39.7 39.7
Long-term debt (Note 8) 215.4 306.1
Long-term debt to affiliated company (Note 8) 258.0 258.0
Total capitalization 1,495.9 1,572.7
Total capital and liabilities $2,540,331 $2,505,094$2,635.5 $2,610.4
The accompanying notes are an integral part of these consolidated financial statements.
Page 8
Kentucky Utilities Company
and Subsidiary
Consolidated StatementStatements of Cash Flows
(Unaudited)
(Thousands(Millions of $)
NineSix Months Ended
SeptemberJune 30,
2005 2004 2003
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 94,82755.3 $ 56,33060.0
Items not requiring cash currently:
Depreciation and amortization 80,265 76,663
Deferred income taxes - net 11,064 10,277
Investment tax credit - net (1,540) (1,981)57.7 51.2
Value Delivery Team (VDT)delivery team amortization (Note 6) 8,816 9,091
Mark-to-market financial5.9 5.9
Change in fair value of derivative instruments (Note 3) (389) 1,231
Provision for post-retirement benefits (Note 8) (3,373) (4,417)
Deferred storm costs (3,760) -(4.7) 0.1
Other 2,401 15,212(3.6) 13.9
Changes in current assets and liabilities 3,164 (4,888)
Changes in accounts receivable securitization
- net (Note 4) (50,000) -
Pension funding (Notes 9 and 12) (43,409) (9,515)3.7 (52.9)
Earnings sharing mechanism receivable 3.1 0.3
Pension funding (Note 6) 4,920 7,708
Environmental cost recovery mechanism (Note 6) (7,089) 1,157
Combustion turbine litigation11) - (43.4)
Provision for post-retirement benefits 0.8 (3.4)
Litigation settlement 11,426 - 11.6
Fuel adjustment clause receivable (13.3) 2.9
Other 10,231 23,242(2.0) 3.4
Net cash flows fromprovided by operating activities 117,554 180,110102.9 49.6
CASH FLOWS FROMUSED IN INVESTING ACTIVITIES:
Purchase of securities (1,858) (2,818)long-term investments - (1.3)
Construction expenditures (103,992) (263,899)(44.0) (76.4)
Net cash flows fromused for investing activities (105,850) (266,717)(44.0) (77.7)
CASH FLOWS FROM FINANCING ACTIVITIES:
Long-term borrowings from affiliated company (Note 9) 50,000 175,0008) - 50.0
Short-term borrowings from affiliated company (Note 9) 380,500 520,8408) 58.3 255.0
Repayment of long-term debt (50.0) -
Repayment of short-term borrowings
from affiliated company (Note 9) (393,900) (541,600)
Retirement of first mortgage bonds8) - (62,000)(245.1)
Retirement of pollution control bonds (4,800) - Refund(4.9)
Repayment of issuance costs of pollution
control bonds (4)other borrowings (Note 8) (26.7) -
Payment of common dividends (42,000) -
Payment of preferred dividends (1,692) (1,692)(41.1) (22.0)
Net cash flows fromused for financing activities (11,896) 90,548(59.5) 33.0
CHANGE IN CASH AND CASH EQUIVALENTS (192) 3,941(0.6) 4.9
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 4,869 5,3914.6 4.9
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 4,6774.0 $ 9,3329.8
SUPPLEMENTAL DISCLOSURES:
Cash paid during the period for:
Income taxes $ 40,792 $ 19,012$39.8 $21.3
Interest on borrowed money 9,195 12,6817.8 7.6
Interest to affiliated companies on borrowed money 9,269 1,0607.1 6.1
The accompanying notes are an integral part of these consolidated financial statements.
Page 9
Kentucky Utilities Company and Subsidiary
Consolidated
Statements of Other Comprehensive Income
(Unaudited)
(Thousands(Millions of $)
Three Months NineSix Months
Ended Ended
SeptemberJune 30, SeptemberJune 30,
2005 2004 20032005 2004 2003
Net income $34,818 $30,310 $94,827 $56,330
Losses on derivative instruments
and hedging activities$17.7 $27.6 $55.3 $60.0
Income Taxes - Minimum Pension Liability
(Note 6) - - (0.3) -
Other comprehensive loss, net of tax benefit/(expense) of $17, ($121), $23
and ($121), respectively (Note 3) (26) 182 (40) 182- - (0.3) -
Comprehensive income $34,792 $30,492 $94,787 $56,512$17.7 $27.6 $55.0 $60.0
The accompanying notes are an integral part of these consolidated financial statements.
Page 10
Louisville Gas and Electric Company
and Subsidiary
Kentucky Utilities Company
and Subsidiary
Notes to Consolidated Financial Statements
(Unaudited)
1. General
The unaudited condensed financial statements include the accounts of Louisville GasLG&E and Electric Company and Subsidiary and Kentucky
Utilities Company and Subsidiary (each "LG&E" and "KU", or the
"Companies").KU.
The common stock of each of LG&E and KU is wholly-owned by LG&E Energy LLC ("LG&E Energy").Energy.
In the opinion of management, the unaudited condensed interim financial
statements include all adjustments, consisting only of normal recurring
adjustments, necessary for a fair statement of consolidated financial position,
results of operations, comprehensive income and cash flows for the
periods indicated. Certain information and footnote disclosures
normally included in financial statements prepared in accordance with
generally accepted accounting principles have been condensed or omitted
pursuant to Securities and
Exchange Commission ("SEC")SEC rules and regulations, although the Companies believe
that the disclosures are adequate to make the information presented not
misleading.
See LG&E's and KU's Annual Reports on Form 10-K for the year ended
December 31, 2003,2004, for information relevant to the accompanying
financial statements, including information as to the significant
accounting policies of the Companies.
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 adjustment was 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, LG&E revenues
were increased $4.8 million and KU revenues were decreased $2.4 million
in the current period results of operations. Net income in the current
period was increased $2.9 million for LG&E and was reduced $1.5 million
for KU.
The accompanying financial statements for the three months and ninesix
months ended SeptemberJune 30, 2003,2004, have been revised to conform to certain
reclassifications in the current three months and ninesix months ended SeptemberJune
30, 2004.2005. These reclassifications had no impact on the
balance sheet net assets or net
income, as previously reported.
LG&E and KU net operating income previously reported for the three
months ended June 30, 2004, increased by $9.4 million and $17.5
million, and for the six months ended June 30, 2004, increased by $24.4
million and $38.5 million, respectively, because the income statement
presentation was changed in 2005 to report income tax expense in the
category Federal and State income taxes, which appears just before net
income. LG&E and KU other income (expense) - net previously reported
for the three months ended June 30, 2004, decreased $0.2 million and
$0.1 million, and for the six months ended June 30, 2004, decreased
$0.5 million and $0.5 million, respectively, also due to the income tax
reclassification.
2. Mergers and Acquisitions
LG&E and KU are each subsidiaries of LG&E Energy. InOn July 1, 2002, E.ON
AG ("E.ON"), a German company, completed its acquisition of Powergen, Limited ("Powergen"),including
LG&E Energy, for approximately 5.1 billion pounds sterling
($7.3 billion). As a result of the former parent companyacquisition, LG&E Energy became a
wholly-owned subsidiary of LG&E Energy. AsE.ON and, as a result, LG&E and KU also became
indirect subsidiaries of E.ON. LG&E and KU have continued their separate
identities and serve customers under their existing names. The preferred
stock and debt securities of LG&E and KU were not affected by this
transaction and the utilities continue to file SEC reports. Following
the purchase of Powergen by E.ON,acquisition, E.ON became a registered holding company under the Public Utility Holding Company Act of 1935
("PUHCA"). As a result, E.ON, its utility subsidiaries, includingPUHCA.
LG&E and KU, and certainas subsidiaries of its non-utility subsidiariesa registered holding company, are subject
to extensive regulation by the SECadditional regulations under PUHCA with respect to issuances
and sales of securities, acquisitions and sales of certain utility
properties, and intra-system sales of certain goods and services.PUHCA. In addition, PUHCA generally limits the ability of registered holding
companies to acquire additional public utility systems and to acquire
and retain businesses unrelated to the utility operations of the
holding company. LG&E and KU believe that they have adequate authority
(including financing authority) under existing SEC orders and
regulations to conduct their business. LG&E and KU will seek
additional authorization when necessary.
As contemplated in their regulatory filings in connection with the E.ON
acquisition,March 2003, E.ON, Powergen and
LG&E Energy completed an administrative reorganization to move the LG&E
Energy group from an indirect Powergen subsidiary to an indirect E.ON
subsidiary. This reorganization was
effective in March 2003. In early 2004, LG&E Energy begancommenced direct reporting
arrangements to E.ON.
The utility operations (LG&E and KU) of LG&E Energy have continued
their separate identities and continue to serve customers in Kentucky,
Virginia and Tennessee under their existing names. The preferred stock
and debt securities of LG&E and KU were not affected by these
transactions and LG&E and KU continue to file SEC reports.
Page 11
Effective December 30, 2003, LG&E Energy LLC became the successor, by
assignment and subsequent merger, to all the assets and liabilities of
LG&E Energy Corp. Following the conversion, LG&E Energy became a
registered holding company under PUHCA.
3. Financial Instruments
The Companies use interest rate swaps to hedge exposure to market
fluctuations in certain of their debt instruments. Pursuant to the
Companies' policies, use of these financial instruments is intended to
mitigate risk, earnings and cash flow volatility and is not speculative
in nature. Management has designated all of the Companies' interest
rate swaps as hedge instruments. Financial instruments designated as
cash flow hedges have resulting gains and losses recorded within other
comprehensive income and stockholders' equity. To the extent a
financial instrument designated as a cash flow hedge or the underlying
item being hedged is prematurely terminated or the hedge becomes
ineffective, the resulting gains or losses are reclassified from other
comprehensive income to net income. Financial instruments designated
as fair value hedges and the underlying hedged items are periodically marked to market with the
resulting net gains and losses recorded directly into net income. Upon terminationincome to
correspond with income or expense recognized from changes in market
value of any fair value hedge,
the resulting gain or loss is recorded into net income.items being hedged.
As of SeptemberJune 30, 2004,2005, LG&E was party to various interest rate swap
agreements with aggregate notional amounts of $228.3$211.3 million. Under
these swap agreements, LG&E paid fixed rates averaging 4.38% and
received variable rates based on LIBOR or the Bond Market Association's
municipal swap index averaging 1.37%2.18% at SeptemberJune 30, 2004.2005. The swap
agreements in effect at SeptemberJune 30, 20042005 have been designated as cash flow
hedges and mature on dates ranging from 20052020 to 2033. The hedges have
been deemed to be fully effective resulting in a pretax loss of $9.1$12.7
million and a pretax loss of $2.9$10.0 million for the three months and ninesix months ended
SeptemberJune 30, 2004,2005, respectively, recorded in other comprehensive income.
Upon expiration of these hedges, the amount recorded in other
comprehensive income will be reclassified into earnings. The amountsamount
expected to be reclassified from other comprehensive income to earnings
in the next twelve months areis immaterial. A deposit in the amount of
$13.1 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 SeptemberJune 30, 2004,2005, KU was party to variousone interest rate swap agreementsagreement
with aggregatea notional amountsamount of $103.0$53.0 million. Under thesethis swap agreements,agreement, KU
paid a variable ratesrate based on eitherthe LIBOR or
the Bond Market Association's municipal swap index averaging 2.70%of 5.34%, and received a
fixed rates averaging 7.74%rate of 7.92% at SeptemberJune 30, 2004.2005. The swap agreementsagreement in effect at
SeptemberJune 30, 2004 have2005 has been designated as a fair value hedgeshedge and maturematures in
2007. In June 2005, an 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
dates ranging from 2007 to 2025.earnings occurred as a result of the bond call and related swap
termination.
During the three months and ninesix months ended SeptemberJune 30, 2004,2005, the effect
of marking these financial instruments and the underlying debt to
market resulted in a netpretax loss of $0.2 million and a pretax gain of
$0.3$0.5 million, and $1.0 million
(representing the hedges' ineffectiveness), respectively, recorded as a
decrease in interest expense.
Interest rate swaps hedge interest rate risk on the underlying debt.
Under SFAS No. 133, Accounting for Derivative Instruments and Hedging
Activities, in addition to swaps being marked to market, the item being
hedged using a fair value hedge must also be marked to market.
Consequently at SeptemberJune 30, 2004,2005, KU's debt reflects an increase of
$9.7a $3.5 million related to such mark-to-marketmark-
to-market adjustment.
In February 2004, KU terminated the swap it had in place related to
its Series 9 pollution control bonds. The notional amount of the
terminated swap was $50 million and KU received a payment of $2.0
million as part of the termination, resulting in a gain of $0.8
million.
Page 12
4. Accounts Receivable Securitization Programs
In January 2004, LG&E and KU terminated their accounts receivable
securitization programs, originally implemented in February 2001, and
replaced them with intercompany loans from an E.ON affiliate. In May
2004, LG&E and KU dissolved their inactive accounts receivable
securitization-related subsidiaries, LG&E Receivables LLC and KU
Receivables LLC. The accounts receivable securitization-related
subsidiaries were the only subsidiaries of LG&E and KU.
5. Segments of Business
LG&E's revenues, and net income and total assets by business segment for
the three months and ninesix months ended SeptemberJune 30, 20042005 and 2003,2004, follow:
Three Months Ended NineSix Months Ended
SeptemberJune 30, SeptemberJune 30,
(in thousands)millions) 2005 2004 20032005 2004 2003
LG&E Electric
Revenues $227,024 $230,174 $617,839 $591,110$228.2 $192.5 $457.2 $390.8
Net income 34,648 41,924 71,031 69,41330.0 20.4 53.8 36.4
Total assets 2,404.3 2,417.2 2,404.3 2,417.2
LG&E Gas
Revenues 34,818 32,659 242,178 213,93952.5 43.7 225.1 207.4
Net income (2,110) (2,053) 2,865 5,478(2.0) (3.3) 8.0 4.9
Total assets 453.8 443.6 453.8 443.6
Total
Revenues 261,842 262,833 860,017 805,049280.7 236.2 682.3 598.2
Net income 32,538 39,871 73,896 74,89128.0 17.1 61.8 41.3
Total assets 2,858.1 2,860.8 2,858.1 2,860.8
KU is an electric utility company. It does not provide gas service and
therefore, is presented as a single business segment.
6.5. Rates and Regulatory AssetsMatters
For a description of each line item of regulatory assets and
Liabilitiesliabilities for LG&E and KU, reference is made to Part I, Item 8,
Financial Statements and Supplementary Data, Note 3 of LG&E's and KU's
Annual Reports on Form 10-K for the year ended December 31, 2004.
The following regulatory assets and liabilities were included in LG&E's
balance sheets as of SeptemberJune 30, 20042005 and December 31, 2003:2004:
Louisville Gas and Electric Company
(Unaudited)
SeptemberJune 30,December 31,
(in thousands)millions) 2005 2004
2003
VDT costsCosts $ 45,20922.6 $ 67,81037.7
Unamortized loss on bonds 21.2 20.3
ARO 7.3 6.9
Merger surcredit 4.1 4.8
ESM - 2.1
Rate case expenses 0.9 1.1
FAC 3.5 0.8
ECR 2.1 -
Gas supply adjustments due from customers 11,068 22,077
Unamortized loss on bonds 20,537 21,333
Earnings sharing mechanism (ESM) provision 5,446 12,359
Merger surcredit 5,183 6,220
Asset retirement obligation (ARO) 6,674 6,0159.2 13.3
Gas performance-based ratemaking (PBR) 3,467 5,480
Other (including fuel adjustment clause
(FAC), demand side management (DSM),
etc.) 2,599 2,3322.0 3.7
Manufactured gas sites 1.0 1.2
Total regulatory assets $100,183 $143,626$ 73.9 $ 91.9
Accumulated cost of removal of utility
plant $214,950 $216,491$216.2 $220.2
Deferred income taxes - net 38,595 41,180(Note 6) 54.2 37.2
ARO 0.1 0.1
ECR - 4.0
DSM 3.3 2.5
Gas supply adjustments due to customers 7,804 6,805
DSM 2,602 1,706
Other (including environmental cost
recovery (ECR), ARO, FAC and ESM) 4,534 2,1316.3 8.4
Total regulatory liabilities $268,485 $268,313
Page 13$280.1 $272.4
LG&E currently earns a return on all regulatory assets except for gas
supply adjustments, ESM, FAC, ECR and gas performance-basedperformance based ratemaking, FAC, and
DSM,
all of which are separate rate mechanisms with recovery within twelve
months. Additionally, no current return is earned on the ARO
regulatory asset. This regulatory asset will be offset against the
associated regulatory liability, ARO asset and ARO liability at the
time the underlying asset is retired.removed.
Due to a number of changes in Kentucky's tax system, including the
reduction of the corporate income tax, timing differences included in
the reserve for deferred state income taxes at December 31, 2004 will
reverse at higher rates than the current statutory rate. See Note 6.
The following regulatory assets and liabilities were included in KU's
balance sheets as of SeptemberJune 30, 20042005 and December 31, 2003:2004:
Kentucky Utilities Company
(Unaudited)
SeptemberJune 30, December 31,
(in thousands)millions) 2005 2004 2003
VDT costs $ 17,6358.8 $ 26,45114.7
Unamortized loss on bonds 9,946 10,511
ESM provision 7,462 12,38211.4 11.4
ARO 13.7 12.8
Merger surcredit 4,012 4,815
ARO 12,464 11,3223.2 3.7
ESM - 3.1
Rate case expenses 0.9 1.1
FAC 1,713 4,29822.8 9.4
ECR 3.3 -
Deferred storm costs 3,760 -
Other 5,676 2,5393.2 3.6
Post retirement and pension 1.3 1.2
Management audit expenses 0.3 0.4
Total regulatory assets $ 62,66868.9 $ 72,31861.4
Accumulated cost of removal of utility
plant $262,971 $256,744$273.7 $266.8
Deferred income taxes - net 22,174 24,058(Note 6) 30.9 19.3
ARO 1,351 1,1621.6 1.4
ECR 5.3 1.2
FAC - 0.1
DSM 1.9 1.6
Spare parts 1,062 1,055
ECR 2,100 9,189
Other (including FAC and DSM) 1,614 2,5631.1 1.1
Total regulatory liabilities $291,272 $294,771$314.5 $291.5
KU currently earns a return on all regulatory assets except for ESM,
FAC, and DSM,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 retired.
Inremoved.
Based on an order from the Kentucky Commission in September 2004, KU
reclassified from maintenance expense to a regulatory asset, $4.0
million related to unreimbursed costs not reimbursed from the 2003 ice storm based on an order from the Kentucky Commission.storm. These
costs will be amortized through June 2009. KU earns a return of theseThese amortized costs,
which are included in KU's jurisdictional operating expenses.
During May and July,expenses, are
recovered in base rates.
Due to a number of changes in Kentucky's tax system, including the
reduction of the corporate income tax, timing differences included in
the reserve for deferred state income taxes at December 31, 2004 will
reverse at higher rates than the current statutory rate. See Note 6.
ELECTRIC AND GAS RATE CASES
On June 30, 2004, the Kentucky Commission issued an order approving an
increase in the base electric rates of LG&E and KU incurred $17.0 million and $3.5
million, respectively,the gas rates of
storm restoration costs associated with
severe storms in their service territories. Of these amountsLG&E. The rate increases took effect on July 1, 2004.
During July 2004, the Attorney General of Kentucky ("AG") served
subpoenas on LG&E incurred $12.6 million of Operations and Maintenance ("O&M") expense
and $4.4 million of expenditures that were capitalized and KU, incurred
$2.7 million of O&M expense and $0.8 million of expenditures that were
capitalized. The Companies are considering requestingas well as on the Kentucky Commission and its
staff, requesting information regarding alleged improper communications
between LG&E and KU and the Kentucky Commission. The Kentucky
Commission procedurally reopened the rate case for the limited purpose
of taking evidence, if any, as to the communication issues. In
September and October 2004, various proceedings were held in circuit
courts in Franklin and Jefferson Counties, Kentucky, regarding the
scope and timing of document production or other information required
or agreed to be produced under the AG's subpoenas and matters were
consolidated into the Franklin County court.
In January 2005, the AG conducted interviews of certain employees of
LG&E and KU and submitted its report to the Franklin County, Kentucky
Circuit Court in confidence. Concurrently, the AG filed a motion
summarizing the report as containing evidence of improper
communications and record-keeping errors by LG&E and KU in their
conduct of activities before the Kentucky Commission or other state
governmental entities, and requesting release of the report to such
agencies. During February 2005, the court ruled that the report be
forwarded to the Kentucky Commission under continued confidential
treatment to allow deferral of these O&M expenses for recovery in a
future rate proceeding duringit to consider the fourth quarter of 2004.
Page 14
7. Utility Plant
KU retired two steam generating units, Green River Units 1report, including its impact, if
any, on completing its investigation and 2,any remaining steps in the
amountrate case, including ending the current abeyance. To date, LG&E and KU
have neither seen nor requested copies of $17.2 million,the report or its contents.
During Spring 2005, LG&E and KU responded to additional information
requests from its books asthe 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 31, 2004.
Approximately $4 million2006. As part of the settlement agreements in common assets, whichthe electric and
gas rate cases, LG&E and KU are shared by Green
River Units 3required to file with the Kentucky
Commission a plan for the future ratemaking treatment of the VDT
surcredits and 4,costs six months prior to the March 2006 expiration.
The surcredit shall remain on KU's books. The common assets will
remain on KU's booksin effect following the expiration of the
fifth year until the final retirementCommission enters an order on the future
disposition of Green River Units 3VDT-related issues. Prior to September 30, 2005, LG&E
and 4. The gross book value of Green River Units 1 and 2 was charged
toKU will file a plan with the accumulated reserve for depreciationKentucky Commission in accordance with
FERC
regulations and no gain or loss was recorded. The impactthe requirements of the retirementsettlement agreement.
ECR
In December 2004, KU and LG&E filed applications with the Kentucky
Commission for approval of Green River Units 1a CCN to construct new SO2 control
technology (FGDs) at KU's Ghent and 2 on the ARO is immaterial. A
partial redemptionBrown stations, and to amend LG&E's
and KU's compliance plans to allow recovery of pollution control Series 14 bonds totaling $4.8
million was required in the second quarter as a resultnew and additional
environmental compliance facilities. The estimated capital cost of the
retirement (see Note 9).
The following data represent shares of jointly-owned additions to the
Trimble County plant for four combustion turbines ("CTs") as of
September 30, 2004. Trimble County CT Units 7 and 8 began commercial
operation on June 1, 2004. The addition to LG&E plant in service was
$37.0additional facilities is $742.7 million and for KU the addition was $63.2 million. Trimble County
CT Units 9 and 10 began commercial operation on July 1, 2004, resulting
in an increase to plant in service of $37.3 and $63.8($40.2 million for LG&E and
KU, respectively.
($$702.5 million for KU), of which $658.9 million is for the FGDs.
Hearings in millions)these cases occurred during May 2005 and final orders 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 Total
Trimble CT 7
Ownership % 37% 63% 100%
Mw capacity 59 101 160
Cost $18.5 $31.7 $50.2
Depreciation 0.2 0.3 0.5made out-of-period
adjustments for estimated over/under collection of ECR revenues to be
billed in subsequent periods. The adjustment was 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, LG&E revenues
were increased $4.8 million and KU revenues were decreased $2.4 million
in the current period results of operations. Net book value $18.3 $31.4 $49.7
Trimble CT 8
Ownership % 37% 63% 100%
Mw capacity 59 101 160
Cost $18.5 $31.5 $50.0
Depreciation 0.2 0.3 0.5
Net book value $18.3 $31.2 $49.5
Trimble CT 9
Ownership % 37% 63% 100%
Mw capacity 59 101 160
Cost $18.7 $31.9 $50.6
Depreciation 0.1 0.2 0.3
Net book value $18.6 $31.7 $50.3
Trimble CT 10
Ownership % 37% 63% 100%
Mw capacity 59 101 160
Cost $18.6 $31.9 $50.5
Depreciation 0.1 0.2 0.3
Net book value $18.5 $31.7 $50.2
8.income in the current
period 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 under Case No. 2005-00162, the 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. Data discovery is expected to continue through
September 2005.
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 are expected to be submitted in August with an order
expected in the fourth quarter 2005.
Should LG&E and KU be ordered to exit the MISO, the MISO may seek to
impose an aggregate exit fee up to $40 million, or seek recovery of
other amounts, 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 tracker of certain MISO-related costs
and benefits.
At this time, LG&E and KU cannot predict the outcome or effects of the
various Kentucky Commission proceedings described above, including
whether such proceedings will have a material impact on the financial
condition or results of operations of the Companies. 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.
FERC SMD NOPR
In July 2002, the FERC issued a NOPR in Docket No. RM01-12-000 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 is due in August
2005 from the Kentucky Commission to the Governor.
6. Income Taxes
Kentucky House Bill 272, also known as Kentucky's Tax Modernization
Plan, was signed into law on March 18, 2005. This bill contains a
number of changes in Kentucky's tax system, including the reduction of
the Corporate income tax rate from 8.25% to 7% effective January 1,
2005, and a further reduction to 6% effective January 1, 2007. Because
of the tax rate reduction, timing differences included in the reserve
for deferred state income taxes at December 31, 2004, will reverse at
higher rates than the current statutory rate. Without some form of
adjustment, the deferred tax reserve amount will exceed the actual
deferred tax liability attributable to existing timing differences.
This excess amount is referred to as excess deferred income taxes.
LG&E and KU filed applications with the Kentucky Commission requesting
approval of accounting treatment to establish and amortize a regulatory
liability for net excess deferred income tax balances. Both LG&E and KU
are amortizing their depreciation-related excess deferred income tax
balances under the average rate assumption method. The average rate
assumption method matches the amortization of the excess deferred
income taxes with the life of the timing differences to which it
relates. Excess deferred income tax balances related to non-
depreciation timing differences will be expensed in the current year
due to their immaterial amount. In June 2005, LG&E and KU each received
orders from the Kentucky Commission authorizing its prescribed methods
to establish and amortize a regulatory liability for its excess
deferred income tax balance.
Significant judgment is required in determining the provision for
income taxes, and there are many transactions for which the ultimate
tax outcome is uncertain. To provide for these uncertainties
or exposures, LG&E and KU maintain an allowance for tax contingencies,
the balance of which management believes is adequate. Tax
contingencies are analyzed periodically and adjustments are made when
events occur to warrant a change. LG&E and KU are currently in the
examination phase of IRS audits for the years 1999 to 2003 and have
received the Income Tax Examination Changes for the years 1999 to 2001.
As a result, LG&E and KU expect to receive immaterial refunds for these
years, subject to review by the Congressional Joint Committee on
Taxation.
LG&E is also under a Kentucky sales and use tax audit for the periods
October 1, 1997 through December 31, 2001. An initial assessment of
$1.1 million has been received and will be protested as the Company
believes it has meritorious defenses for the issues raised during the
examination.
The Company is presently unable to assess the ultimate impact of the
results of audit assessments by taxing authorities on quarterly or
annual cash flows as well as results of operations over the next three
to twelve months as these audits are completed. However, LG&E and KU
do not currently believe that any of these matters will have a material
adverse effect on financial position or 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 FAS 109 to the Tax Deduction on Qualified
Production Activities Provided by the American Jobs Creation Act of
2004, which requires the tax deduction on qualified production
activities to be treated as a special deduction in accordance with FAS
109. FSP 109-1 became effective December 21, 2004. For the six months
ended June 30, 2005, LG&E and KU recognized $0.8 million and $0.4
million, respectively, in tax benefits related to this deduction.
FIN 4647
In January 2003,March 2005, the Financial Accounting Standards Board ("FASB")FASB issued Financial Accounting Standards Board
Interpretation No. 46,
Consolidation47, Accounting for Conditional Asset Retirement
Obligations, an interpretation of Variable Interest Entities, an Interpretation of ARBFASB Statement No. 51143 ("FIN 46"47").
FIN 46 required certain variable interest entities47 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 consolidated bywithin the primary beneficiarycontrol
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
equity investors infair value of the entity do not have the characteristicsliability can be reasonably estimated. The fair
value of a controlling financial interest or do not have sufficient equity at riskliability for the entity to finance its activities without additional
subordinated financial support from other parties. FIN 46 was
effective immediately for all new variable interest entities createdconditional asset retirement obligation
should be recognized when incurred; generally, upon acquisition,
construction, or acquired after January 31, 2003.
Page 15
In December 2003, FIN 46 was revised, delayingdevelopment and through the effective dates for
certain entities created before February 1, 2003, and making other
amendments to clarify applicationnormal operation of the
guidance. For potential
variable interest entities other than special purpose entities, the
revisedasset. FIN 46 ("FIN 46R")47 is now required to be appliedeffective no later than the end of the first fiscal year or interim reporting period ending
after March 15, 2004. For all special purpose entities created prior
to February 1, 2003, FIN 46R is now required to be applied at the end
of the first interim or annual reporting periodyears
ending after December 15, 2003. FIN 46R may be applied prospectively with a cumulative-
effect adjustment as of the date it is first applied, or by restating
previously issued financial statements with a cumulative-effect
adjustment as of the beginning of the first year restated. FIN 46R
also requires certain disclosures of an entity's relationship with
variable interest entities.
Both2005. LG&E and KU hold investment interests in Ohio Valley Electric
Corporation ("OVEC"),are currently evaluating
the impact of this pronouncement.
8. Short-Term and KU holds an investment interest in Electric
Energy, Inc. ("EEI"). Neither LG&E nor KU are the primary beneficiary
of OVEC or EEI, and thus neither are consolidated into the financial
statements of LG&E or KU.
LG&E, KU and ten other electric utilities are participating owners of
OVEC, located in Piketon, Ohio. OVEC owns and operates two power
plants that burn coal to generate electricity, Kyger Creek Station in
Ohio and Clifty Creek Station in Indiana. LG&E's share is 7%,
representing approximately 155 Mw of generation capacity and KU's share
is 2.5%, representing approximately 55 Mw of generation capacity.
LG&E's and KU's original investments in OVEC were made in 1952. LG&E's
investment in OVEC is the equivalent of 4.9% of OVEC's common stock and
KU's investment is the equivalent of 2.5% of OVEC's common stock.
LG&E's and KU's investments in OVEC are accounted for under the cost
method of accounting. As of September 30, 2004, LG&E's and KU's
investments in OVEC totaled $0.5 million and $0.3 million,
respectively. LG&E's and KU's maximum exposure to loss as a result of
their involvement with OVEC is limited to the value of their
investments. In the event of the inability of OVEC to fulfill its
power provision requirements, LG&E and KU would substitute such power
supply with either owned generation or market purchases and would
generally recover associated incremental costs through regulatory rate
mechanisms. See Note 11 and Part II, Item 1, for further discussion of
developments regarding LG&E's and KU's ownership interests and power
purchase rights.
KU owns 20% of the common stock of EEI, which owns and operates a 1,000-
Mw generating station in southern Illinois. KU is entitled to take 20%
of the available capacity of the station. Purchases from EEI are made
under a contractual formula which has resulted in costs which were and
are expected to be comparable to the cost of other power purchased or
generated by KU. Such power equated to approximately 9% of KU's net
generation system output in 2003.
KU's original investment in EEI was made in 1953. KU's investment in
EEI is accounted for under the equity method of accounting and, as of
September 30, 2004, totaled $12.7 million. KU's direct exposure to
loss as a result of its involvement with EEI is generally limited to
the value of its investment. In the event of the inability of EEI to
fulfill its power provision requirements, KU would substitute such
power supply with either owned generation or market purchases and would
generally recover associated incremental costs through regulatory rate
mechanisms.
FSP 106-2
In May 2004, the FASB finalized FASB Staff Position ("FSP") 106-2,
Accounting and Disclosure Requirements Related to the Medicare
Prescription Drug, Improvement and Modernization Act of 2003 ("Medicare
Act") with guidance on accounting for subsidies provided under the
Medicare Act which became law in December 2003. FSP 106-2 is effective
for the first interim or annual period beginning after June 15, 2004.
FSP 106-2 does not have a material impact on the Companies.
Page 16
9.Long-Term Debt
Under the provisions for LG&E's variable-rate Pollution Control Bonds,pollution control bonds,
Series S, T, U, BB, CC, DD and EE, and KU's variable-rate Pollution
Control Bonds,pollution
control bonds Series 10, 12, 13, 14, and 15, the bonds are subject to
tender for purchase at the option of the holder and to mandatory tender
for purchase upon the occurrence of certain events, causing the bonds
to be classified as current portion of long-term debt in the Consolidated Balance
Sheets. The average annualized interest rate for these bonds during
the three months and nine months ending SeptemberJune 30, 20042005 was 1.20% and 1.14%, respectively,2.50% for the LG&E bonds and 1.30% and 1.18%, respectively,2.64% for
the KU bonds.
In January 2004,KU.
During June 2005, LG&E entered into two long-term loans from Fidelia
Corporation ("Fidelia"), an E.ON financing subsidiary, one totaling $25
million with an interest rate of 4.33% that matures in January 2012,
and one totaling $100 million with an interest rate of 1.53% that
matures in January 2005. The loans are secured by a lien subordinated
to the first mortgage bond lien. The proceeds were used to fund a
pension contribution and to repay other debt obligations. In April
2004, LG&E prepaid $50 million of the $100 million 1.53% note payable
to Fidelia. The prepayment was paid out of cash balances and there was
no prepayment fee.
In January 2004, KU entered into an unsecured long-term loan from
Fidelia totaling $50 million with an interest rate of 4.39% that
matures in January 2012. The proceeds were used to fund a pension
contribution and to repay other debt obligations.
In May 2004, KU redeemed $4.8 million of its Series 14 Pollution
Control Bonds which were initially issued in the amount of $7.2
million.
On October 20, 2004, KU completed a refinancing transaction regarding
$50 million in existing pollution control indebtedness. The original
indebtedness, 5.75% Pollution Control Bonds, Series 9, due December 1,
2023, will be discharged on November 22, 2004, with the proceeds from
the replacement indebtedness, KU Pollution Control Bonds, Series 17,
due October 1, 2034, which will carry a variable, auction rate of
interest.
LG&E maintainsrenewed five bilateralrevolving lines of credit with
banks totaling $185 million
that mature in 2005.million. There was no outstanding balance under
any of these facilities at SeptemberJune 30, 2004. Management2005. The Company expects to renew
these facilities as they expire.prior to their expiration in June 2006.
LG&E, KU and KULG&E Energy participate in an intercompany money pool
agreement whereinagreement. Details of the balances at June 30, 2005, and June 30, 2004,
were as follows:
Total Money Amount Balance Average
($ in millions) Pool Available Outstanding Available Interest Rate
June 30, 2005:
LG&E Energy and$400.0 $20.8 $379.2 3.06%
KU make funds available to$400.0 $93.1 $306.9 3.06%
June 30, 2004:
LG&E at market-based rates
(based on an index of highly rated commercial paper issues as of the
prior month end) up to $400 million. Likewise, LG&E Energy and LG&E
make funds available to$400.0 $26.0 $374.0 1.04%
KU at market-based rates up to $400 million.
LG&E had $40.7 million in money pool loans from LG&E Energy (included
in "Notes payable to affiliated companies") at an average rate of 1.60%
at September 30, 2004, and $75.1 million at an average rate of 1.06% at
September 30, 2003. The balance of the money pool loans from LG&E
Energy to KU (included in "Notes payable to affiliated companies") was
$29.8 million at an average rate of 1.60% and $98.7 million at an
average rate of 1.06% at September 30, 2004 and 2003, respectively.
The amount available to LG&E under the money pool agreement at
September 30, 2004, was $359.3 million. The amount available to KU
under the money pool agreement at September 30, 2004, was $370.2
million.$400.0 $53.2 $346.8 1.04%
LG&E Energy maintains a revolving credit facility totaling $150$200 million
with an affiliated company, E.ON affiliateNorth America, Inc., to ensure funding
availability for the money pool. LG&E Energy had anThe balance outstanding balance of $79.1
million at an average rate of 2.13% underon this
facility asat June 30, 2005 was $159.7 million.
Redemptions and maturities of Septemberlong-term debt year-to-date through June
30, 2004, and availability2005, are summarized below:
($ 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 KU First mortgage bonds $50.0 7.55% Secured Jun 2025
Issuances of $70.9long-term debt year-to-date through June 30, 2005, are
summarized below:
($ in millions)
Principal Secured/
Year Company Description Amount Rate Unsecured Maturity
2005 LG&E Pollution control bonds $40.0 Variable Secured Feb 2035
The proceeds of the 2005 loan at LG&E were used to refinance existing
pollution control bonds.
In May 2005, KU repaid a $26.7 million remained.
Page 17
Asloan against the cash surrender
value of September 30, 2004, LG&E had 225,000 shares of $5.875 series
mandatorily redeemable preferred stock outstanding having a current
redemption price of $100 per share. The preferred stock has a sinking
fund requirement sufficient to retire a minimum of 12,500 shares on
July 15 of each year commencing with July 15, 2003, and the remaining
187,500 shares on July 15, 2008 at $100 per share. Beginning September
30, 2003, LG&E reclassified its $5.875 series preferred stock as long-
term debt with the minimum shares mandatorily redeemable within one
year classified as current. Dividends accrued are charged as interest
expense, pursuant to SFAS No. 150. On July 15, 2004, LG&E redeemed
12,500 shares as required at a price of $100 per share.
10. Related Partylife insurance policies.
9. Related-Party Transactions
LG&E, KU, certain subsidiaries of LG&E Energy and other subsidiaries of E.ON
engage in related-party transactions. Transactions among LG&E, KU and
LG&E Energy subsidiaries are eliminated upon consolidation of LG&E
Energy subsidiaries.Energy. Transactions between LG&E or KU and E.ON subsidiaries are
eliminated upon consolidation of E.ON subsidiaries.E.ON. These transactions are generally
performed at cost and are in accordance with the SEC regulations under
the PUHCA and the applicable Kentucky Public Service Commission ("Kentucky Commission") regulations. Accounts
payable to and receivable from related parties are netted and presented
as accounts payable to affiliated companies on the balance sheets of
LG&E and KU, as allowed due to the right of offset. Obligations related
to intercompany debt arrangements with LG&E Energy and Fidelia are
presented as separate line items on the balance sheet, as appropriate.
The significant related-party transactions are disclosed below.
Electric Purchases
LG&E and KU intercompany electric revenues and purchased power expense
(including LG&E Energy Marketing Inc. ("LEM"))from affiliated companies for the three months and ninesix months ended
SeptemberJune 30, 20042005 and 2003,2004, were as follows:
Three months endedNineSix
months ended Septembermonths ended
June 30, SeptemberJune 30,
(in thousands)millions) 2005 2004 20032005 2004 2003
LG&E
Electric operating revenues
from KU $10,095 $11,980 $40,598 $39,799
Electric operating revenues
from LEM 1,092 537 2,443 8,691$21.0 $ 8.4 $46.8 $30.5
Purchased power from KU 12,206 11,000 42,905 34,67518.6 9.1 48.7 30.7
KU
Electric operating revenues
from LG&E $12,206 $11,000 $42,905 $34,675
Electric operating revenues
from LEM 346 174 895 2,196$18.6 $ 9.1 $48.7 $30.7
Purchased power from LG&E 10,095 11,980 40,598 39,79921.0 8.4 46.8 30.5
Interest IncomeCharges
LG&E and Expense
LG&EKU intercompany interest income and expense for the three months and ninesix
months ended SeptemberJune 30, 20042005 and 2003,2004, were as follows:
Three Six
months ended Nine months ended
SeptemberJune 30, SeptemberJune 30,
(in thousands)millions) 2005 2004 20032005 2004
2003
Interest to affiliate
(money pool) $ 102 $ 305 $ 137 $1,573
Interest to affiliate
(Fidelia loans) 2,927 1,801 8,995 2,560
Interest to affiliate (KU) 11 5 25 4
InterestLG&E intercompany interest expense to
affiliated companies $3,040 $2,111 $9,157 $4,137
Interest income from affiliate (KU) - $ 2 - $ 6
Page 18$2.8 $3.0 $5.9 $6.1
KU intercompany interest income and expense for the three months and
nine months ended September 30, 2004 and 2003, were as follows:
Three months ended Nine months ended
September 30, September 30,
(in thousands) 2004 2003 2004 2003
Interest to affiliate
(money pool) $ 96 $ 279 $ 315 $1,001
Interest to affiliate
(Fidelia loans) 3,461 1,635 10,326 2,394
Interest to affiliate (LG&E) - 2 - 6
Interest expense to affiliated
companies $3,557 $1,916 $10,641 $3,401
Interest income from
affiliate (LG&E) $ 11 $ 5 $ 26 $ 4$3.7 $3.5 $7.2 $7.1
Other Intercompany Billings
Other intercompany billings (including LG&E Energy Services Inc. ("LG&E
Services")) related to LG&E and KU for the three months
and ninesix months ended SeptemberJune 30, 20042005 and 2003,2004, were as follows:
Three Six
months ended Nine months ended
SeptemberJune 30, SeptemberJune 30,
(in thousands)millions) 2005 2004 20032005 2004 2003
LG&E Services billings to LG&E $40,221 $44,607 $138,796 $132,894$75.8 $60.4 $108.5 $98.6
LG&E Services billings to KU 42,342 48,508 117,530 134,91675.6 44.7 101.5 75.4
LG&E billings to LG&E Services 5,951 12,801 10,475 18,944
LG&E billings to KU 14,962 25,127 48,464 61,2480.6 1.5 5.3 4.5
KU billings to LG&E Services 516 4,774 4,430 12,6380.3 1.1 3.6 3.9
LG&E billings to KU 14.4 16.9 28.5 33.5
KU billings to LG&E 2,097 3,104 26,928 11,549
11.Commitments9.0 1.9 13.0 3.4
10.Commitments and Contingencies
Except as may be discussed in this Quarterly Report on Form 10-Q
(including Note 5), material changes have not occurred in the current
status of various commitments or contingent liabilities from that
discussed in the Companies' Annual Report on Form 10-K for the year
ended December 31, 2003, (including in2004 and Quarterly Report on Form 10-Q for the three
months ended March 31, 2005. See Notes 3 and 11 to the financial statements of LG&ECompanies'
Annual Report on Form 10-K and KU contained
therein and incorporated herein by reference) orNote 10 to the Companies' Quarterly
ReportsReport on Form 10-Q for the quartersthree months ended March 31, 2004 and June 30, 2004.
Electric and Gas Rates Cases
In December 2003, LG&E and KU filed applications with the Kentucky
Commission requesting increases in LG&E's and KU's electric rates and
LG&E's gas rates. The Companies requested general adjustments in
electric rates and LG&E requested general adjustments in gas rates
based on the twelve-month test year ended September 30, 2003. The
revenue increases requested by LG&E were $63.8 million2005 for electric and
$19.1 million for gas. The revenue increase requested by KU was $58.3
million.
On June 30, 2004, the Kentucky Commission issued an order approving
increases in the base electric and gas rates of LG&E and the base
electric rates of KU. The Kentucky Commission's order largely accepted
proposed settlement agreements filed in May 2004 by LG&E, KU and a
majority of the parties to the rate case proceedings. The rate
increases took effect on July 1, 2004.
Page 19
In the Kentucky Commission's order, (a) LG&E was granted increases in
annual base electric rates of approximately $43.4 million (7.7%) and in
annual base gas rates of approximately $11.9 million (3.4%) and (b) KU
was granted an increase in annual base electric rates of approximately
$46.1 million (6.8%). Other provisions of the order include decisions
on certain depreciation, gas supply clause, ECR and VDT amounts or
mechanisms and a termination of the ESM with respect to all periods
after 2003. The order also provided for a recovery before March 31,
2005, by the Companies of previously requested amounts relating to the
ESM during 2003.
During July 2004, the Attorney General of Kentucky ("AG") served
subpoenas on KU and LG&E, as well as on the Kentucky Commission and its
staff, requesting
information regarding allegedly improper
communications between KU and LG&E and the Kentucky Commission,
particularly during the period covered by the rate cases. The Kentucky
Commission has procedurally reopened the rate cases for the limited
purpose of taking evidence, if any, as to the communication issues.
Subsequently, the AG filed pleadings with the Kentucky Commission
requesting rehearing of the rate cases on certain computational
components of the increased rates, including income tax, cost of
removal and depreciation amounts. In August 2004, the Kentucky
Commission denied the AG's rehearing request on the cost of removal and
depreciation issues, with the effect that the rate increase order is
final as to these matters, subject to the parties' rights to judicial
appeals. The Kentucky Commission further agreed to hold in abeyance
further proceedings in the rate cases, including the AG's concerns
about alleged improper communications, until the AG could file with the
Kentucky Commission an investigative report regarding the latter issue.
In addition, the Kentucky Commission granted a rehearing on the income
tax component once the abeyance discussed above is lifted.
In September and October 2004, various proceedings were held in circuit
courts in Franklin and Jefferson Counties, Kentucky regarding the scope
and timing of document productionsuch commitments or other information required or
agreed to be produced under the AG's subpoenas. On October 12, 2004,
the AG filed a status report with the Kentucky Commission in which the
AG indicated that it had not completed its investigation and requested
that the Kentucky Commission continue to hold these matters in
abeyance. On October 21, 2004, the AG filed a motion with the Kentucky
Commission requesting that the previously granted rate increases be set
aside, that the Companies resubmit any applications for rate increases
and that relevant Kentucky Commission personnel be recused from
participation in rate case proceedings. On November 8, 2004, the
Franklin County, Kentucky court denied an AG request for sanctions on
KU and LG&E relating to production matters and narrowed the AG's
permitted scope of discovery. As so required, LG&E's and KU's
production of materials requested by the AG is expected to continue.
LG&E and KU believe no improprieties have occurred in their
communications with the Kentucky Commission and are cooperating with
the proceedings before the AG and the Kentucky Commission.
LG&E and KU are currently unable to estimate the general status or
progress of the AG investigation, including when the AG will submit its
report to the Kentucky Commission, and the content, findings and
recommendations contained in any such report. The Companies are
currently unable to determine the ultimate impact, if any, of, or any
possible future actions of the AG or the Kentucky Commission arising
out of, the AG's report and investigation, including whether there will
be further actions to appeal, review or otherwise challenge the granted
increases in base rates.
Page 20
Earnings Sharing Mechanism
The Companies filed their final 2003 ESM calculations with the Kentucky
Commission on March 1, 2004, and applied for recovery of $13.0 million
related to LG&E and $16.2 million related to KU. Based upon estimates,
the Companies previously accrued $8.9 million at LG&E and $9.3 million
at KU for the 2003 ESM as of December 31, 2003.
On June 30, 2004, the Kentucky Commission issued an order largely
accepting proposed settlement agreements by the Companies and all
intervenors regarding the ESM mechanisms of LG&E and KU. Under the ESM
settlements, LG&E and KU will continue to collect approximately $13.0
million and $16.2 million, respectively, of previously requested 2003
ESM revenue amounts through March 2005. As part of the settlement, the
parties agreed to a termination of the ESM mechanism relating to all
periods after 2003.
As a result of the settlement, the Company accrued an additional $4.1
million at LG&E and $6.9 million at KU in June 2004, related to 2003
ESM revenue.
OVEC Power Agreement and Share Purchase
On April 30, 2004, OVEC and its shareholders, including LG&E and KU,
entered into an Amended and Restated Inter-Company Power Agreement, to
be effective beginning March 2006, upon the expiration of the current
power contract among the parties. Under the new contract, which has a
20-year term from its effective date, LG&E and KU have purchase rights
for 5.63% and 2.5%, respectively, of OVEC power at marginal cost-based
rates. LG&E and KU are entitled to 7% and 2.5% of OVEC power,
respectively, under the current contract.
LG&E's estimated future minimum annual demand payments under the
Amended and Restated Inter-Company Power Agreement are as follows:
(in thousands)
2006 $ 10,098
2007 9,726
2008 9,932
2009 10,144
2010 10,361
Thereafter 170,646
Total $220,907
In addition, LG&E will purchase from American Electric Power Company
Inc. ("AEP") an additional 0.73% interest in OVEC for a purchase price
of approximately $104,000, resulting in an increase in LG&E ownership
in OVEC from 4.9% to 5.63%. The share purchase transaction is
anticipated to be completed during 2005, subject to receipt of certain
regulatory approvals. The change to the power agreement and the share
purchase are expected to have no impact on the accounting for OVEC
under FIN 46R as discussed in Footnote 8.
Owensboro Contract Litigationcontingencies.
LITIGATION
In May 2004, the City of Owensboro, Kentucky and Owensboro Municipal
Utilities (collectively "OMU"), filed suit in Davies County, Kentucky
District CourtOMU commenced litigation against KU concerning a long-term
power supply contract
(the "OMU Agreement") with KU. The dispute involves interpretational
differences regarding certain issues under thecontract. To date, OMU Agreement, including
various payments or charges between KU and OMU and rights concerning
excess power, termination and emissions allowances, respectively. The
complaint seekshas claimed approximately $6
million in damages for historical
periods as well asthrough early 2004, and may claim
further amounts for later-occurring periods. OMU has additionally
requested injunctive and other relief, including a declaration that KU
is in material breach.breach of the contract. In March 2005, the FERC denied a
rehearing request by KU has removed this
litigationregarding the FERC's December 2004 decision to
the U.S. District Court for the Western District of
Kentucky, filed an answer in that court denying the OMU claims and
presenting certain counterclaims and commenced a FERC proceeding to
request FERC jurisdiction on certain issues. In October 2004, FERC
declineddecline to exercise exclusive jurisdiction regarding thecertain issues in
dispute, whichdispute. 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 sufficient
prior notice. This case is currently in the discovery stage and a
trial schedule has not yet been established.
ENVIRONMENTAL MATTERS
LG&E and KU has appealed.
Environmental Matters
In September 1998, the EPA announced its final "NOx SIP Call" rule
requiring statesare subject to impose significant additional reductions in NOx
emissions by May 2003, in order to mitigate alleged ozone transport
impactsSO2 and NOX emission limits on the Northeast region. The Commonwealth of Kentucky SIP,
Page 21
which was approved by EPA June 24, 2003, required reductions in NOx
emissions from coal-firedtheir
electric generating units to the 0.15 lb./Mmbtu level
on a system-wide basis. In related proceedings in response to
petitions filed by various Northeast states, in December 1999, the EPA
issued a final rule pursuant to Section 126 of the Clean Air Act
directing similar NOx reductions from a number of specifically targeted
generating units including allAct. LG&E and KU
units.placed into operation significant NOX controls for their generating
units prior to the 2004 Summer Ozone Season. As a result of appeals to both rules, the compliance date was extended to May 2004.December 31, 2004,
LG&E and KU have complied with these NOx emissions reduction rules by
installing additional NOx controls to their generating units.
Installations of additional NOx controls were performed on a phased
basis, which commenced in late 2000 and continued through the final
compliance date. As of September 30, 2004, LG&E has incurred total capital costs of approximately $185$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 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 NOx emissionsgenerating
units. Installation of additional SO2 controls will proceed on a
phased basis, with construction of controls (i.e. FGDs) commencing 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 0.15 lb./Mmbtu level on a company-wide basis. Asconstruction of September
30, 2004, KU has incurred total capital costs of approximately $203
millionthe FGDs to reduce its NOx emissions to the 0.15 lb./Mmbtu levelachieve
compliance with current emission limits on a company-wide basis. In
addition, LG&E and KU have begun incurringwill incur additional operationoperating and maintenance costs in
operating the new NOxSO2 controls. LG&E and KU believe their costs in this regard to be
comparable to those of similarly situated utilities with like
generation assets. In April 2001, the Kentucky Commission granted
recovery of these costs under the environmental surcharge mechanism for
LG&E and KU.
During August 2004, KU, the EPA and the Department of Justice agreed in
principle to settle outstanding matters concerning a 1999 oil discharge
at KU's E.W. Brown plant for approximately $0.6 million, a portion of
which may be satisfied by KU's construction of a separate environmental
capital project. The settlement is subject to completion of final
definitive documents. In December 2003, KU recorded an accrual and
expense to operations of $0.6 million.
LG&E and KU are also monitoring several other air quality issuesmatters which
may potentially impact coal-fired power plants, including the EPA's revised
air quality standards for ozone and particulate matter, and measures to
implement the EPA's regional haze rule,rule.
From time to time, LG&E and KU have conducted negotiations with the
EPA's
December 2003 proposals to regulate mercury emissions from steam
electric generating units and to further reduce emissions of sulfur
dioxide and nitrogen oxides under the Clean Air Interstate Rule. In
addition, LG&E is currently reviewing and making comments on proposed
regulations concerning toxic air emissions within Metro Louisville,
where the company operates two coal-fired generating stations. LG&E is
also working with localrelevant regulatory authorities to review the
effectiveness ofaddress various environmental-
related matters, including: remedial measures aimed at controlling
particulate matter emissions from itsLG&E's Mill Creek Station. LG&E previously settled
a numberplant; settlement
of property damage claims from adjacent residents and
completed significant remedial measures as part of its ongoing capital
construction program. LG&E has converted the Mill Creek Stationrelating to a wet stack operation in an effort to resolve all outstanding issues
related to particulate matter emissions.
FERC Developments
A numberfuel oil spill at KU's E.W. Brown plant;
liability for cleanup of regional or industry-wide FERC proceedings regarding
transmission market structure changes are in varying stagesoff-site facilities that allegedly handled
materials associated with company operations; and investigation and
cleanup of development. In August 2004, MISO filed its FERC-required proposed
Transmission and Energy Markets Tariff ("TEMT"). In September and
October 2004, many MISO-related parties filed proposals with the FERC
regarding pending MISO-filed changes to transmission pricing
principles,company properties including the TEMT and elimination of through-and-out
transmission ("T&O") charges. Additional filings of the Companies
before FERC in September 2004 sought to address issues relating to the
Page 22
treatment of certain "grandfathered" transmission agreements ("GFA's")
should TEMT become effective. The utility proposals generally seek to
appropriately delay the T&O and TEMT tariff effective dates based upon
errors in administrative or procedural processes used by FERC or to
appropriately limit potential reductions in transmission revenues
received byformer LG&E and KU shouldMGP sites.
Based on negotiations to date, management does not anticipate that any
of the T&O, TEMTliabilities arising out of any of these matters will have a
material adverse affect on LG&E's or GFA tariffs structures
be implemented. At present, existing FERC orders conditionally approve
eliminationKU's financial position or results
of T&O ratesoperations.
In the normal course of business, lawsuits, claims, environmental
actions, and implementationvarious non-ratemaking governmental proceedings arise
against LG&E and KU. To the extent that damages are assessed in any of
general TEMT rates in
MISO of December 1, 2004 and March 1, 2005, respectively. At this
time,these lawsuits, LG&E and KU cannot predictbelieve that their insurance coverage or
other appropriate reserves are adequate. Management, after
consultation with legal counsel, and based upon the outcomepresent status of
these items, does not anticipate that liabilities arising out of other
currently pending or effectsthreatened lawsuits and claims of the various
FERC proceedings describedtype
referenced above including whether such will have a material impactadverse effect on theLG&E's or KU's
financial conditionsposition or results of operationsoperations.
EEI CONTRACT
KU owns 20% of the Companies.
12.Pensioncommon stock of EEI, which owns and operates a 1,000-
Mw generating station in southern Illinois. KU is presently entitled
to take 20% of the available capacity of the station. Purchases from
EEI are made under a contractual formula which has resulted in costs
which were and are expected to be comparable to the cost of other power
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 six 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.
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:plans for the three months and six
months ended June 30, 2005 and 2004:
LG&E
Three Months Ended Year to Date
SeptemberSix
months ended months ended
June 30, June 30,
(in millions) 2005 2004 September 30,2005 2004
(in thousands) LG&E KU LG&E KUPension and Other Benefit Plans:
Components of net periodicperiod benefit cost:cost
Service cost $ 9771.4 $ 1,1520.9 $ 3,9973.1 $ 4,7543.0
Interest cost 4,910 3,692 20,092 15,2405.6 4.7 12.1 15.3
Expected return on plan assets (4,469) (3,334) (18,287) (13,764)(5.2) (4.3) (11.2) (13.9)
Amortization of prior service
cost (2) 154 (9) 6361.2 - 2.5 -
Amortization of transition
obligation 939 281 3,843 1,161- 0.9 - 2.9
Recognized actuarial loss 515 331 2,107 1,3690.6 0.5 1.4 1.6
$ 2,8703.6 $ 2,276 $11,7432.7 $ 9,3967.9 $ 8.9
KU
Three Six
months ended months ended
June 30, June 30,
(in millions) 2005 2004 2005 2004
Pension and Other Benefit Plans:
Components of net period benefit cost
Service cost $ 1.7 $ 1.1 $ 3.4 $ 3.5
Interest cost 4.1 3.5 8.5 11.2
Expected return on plan assets (3.8) (3.2) (7.8) (10.1)
Amortization of prior service
cost 0.3 0.2 0.7 0.5
Amortization of transition
obligation 0.2 0.3 0.3 0.8
Recognized actuarial loss 0.6 0.4 1.2 1.2
$ 3.1 $ 2.3 $ 6.3 $ 7.1
In January 2004, LG&E and KU made discretionary contributions to theirthe
pension plans in the amounts of $34.5 million and $43.4 million, respectively. No
discretionary contributions to the pension plans are required for 2004currently
anticipated for either LG&E or KU for 2005. LG&E and no further discretionary contributions are planned for 2004.
13.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 20, 2004,July 7, 2005, KU completed a refinancing transaction regarding
$50 million in existing pollution control indebtedness.new tax-exempt financing totaling $13.3
million. The original
indebtedness, 5.75% Pollution Control Bonds, Series 9,new bonds, due DecemberJune 1, 2023, will be discharged on November 22, 2004, with the proceeds from
the replacement indebtedness, KU Pollution Control Bonds, Series 17,
due October 1, 2034, which will2035, carry a variable, auction
rate of interest. The proceeds will be used to finance a portion of the
costs of new pollution control equipment at KU's Ghent Station.
On July 8, 2005, KU entered into a $50 million long-term unsecured loan
from Fidelia. The new loan matures in July 2015 and has an interest
rate of 4.735%. This loan replaces the $50 million, 7.55% First
Mortgage Bonds, Series R that were called in June 2005.
On July, 15, 2005, LG&E redeemed 12,500 shares of its 5.875%
mandatorily redeemable preferred stock pursuant to sinking fund
requirements at $100 per share.
The Energy Policy Act of 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 Companies are currently examining the
potential impacts of the Energy Policy Act of 2005.
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 ninesix month periodsperiod ended SeptemberJune
30, 2004,2005, and should be read in connection with the financial statements
and notes thereto.
Some of the following discussion may contain forward-looking statements
that are subject to certain risks, uncertainties and assumptions. Such
forward-looking statements are intended to be identified in this document
by the words "anticipate," "expect," "estimate," "objective," "possible,"
"potential" and similar expressions. Actual results may vary materially.
Factors that could cause actual results to differ materially include:
general economic conditions; business and competitive conditions in the
energy industry; changes in federal or state legislation; unusual weather;
actions by state or federal regulatory agencies; and other factors
described from time to time in LG&E's and KU's reports to the SEC,
including the Annual Reports on Form 10-K for the year ended December 31,
2003.2004.
Executive Summary
LG&E's net income&E and KU, subsidiaries of LG&E Energy LLC (an indirect subsidiary of
E.ON), are regulated public utilities. LG&E supplies electricity to
approximately 394,000 customers and natural gas to approximately 321,000
customers in Louisville and adjacent areas in Kentucky. KU provides
electric service to approximately 490,000 customers in over 77 counties in
central, southeastern and western Kentucky, to approximately 30,000
customers in southwestern Virginia and to less than 10 customers in
Tennessee. KU also sells wholesale electric energy to 12 municipalities.
The mission of LG&E and KU is to build on our tradition and achieve world-
class status providing reliable, low-cost energy services and superior
customer satisfaction; and to promote safety, financial success and quality
of life for the three months ended September 30, 2004 was $32.5
million ($7.3 million lower than the three months ended September 30,
2003). The decrease was primarily related to maintenance costs resulting
from severe storms which swept through the service territory in Julyour employees, communities and lower electric sales due to milder weather. KU's net income for the three
months ended September 30, 2004, was $34.8 million ($4.5 million higher
than the three months ended September 30, 2003). The increase was
primarily due to higher retail electric revenues resulting from the general
rate increase, partially offset by higher depreciation expense.
Page 23
LG&E's net income for the nine months ended September 30, 2004 was $73.9
million ($1.0 million lower than the nine months ended September 30, 2003).
The decrease was primarily related to higher operations and maintenance
expense, offset by higher electric revenues resulting from the general rate
increase and a higher environmental cost recovery surcharge. KU's net
income for the nine months ended September 30, 2004 was $94.8 million
($38.5 million higher than the nine months ended September 30, 2003). The
increase was primarily due to higher electric revenues and lower
maintenance expense (KU service territory experienced a severe ice storm in
2003).
As regulated utilities,other stakeholders.
LG&E and KU's financial performance is greatly
impacted by regulatory proceedings. Onstrategy focuses on the following:
- Execute all our business processes to secure a world-class competitive
advantage
- Develop and transfer best practices in generation, customer service,
distribution and supply
- Operate our commercial hub to enhance margins and manage risks across
the company
- Pursue flexible asset portfolio management
- Attract, retain and develop the best people.
In a June 30, 2004 order, the Kentucky Commission issued an order approving increasesaccepted the settlement
agreements reached by the majority of the parties in the base rates ofrate cases filed
by LG&E and KU.KU in December 2003. Under the ruling, the LG&E utility base
electric rates have increased $43.4 million (7.7%) and base gas rates have
increased $11.9 million (3.4%), on an annual basis. The rate increaseincreases
took effect on July 1, 2004. Subsequently,Base electric rates at KU have increased
$46.1 million (6.8%) annually. The 2004 increases were the AG commenced an investigation examining communications betweenfirst increases
in electric base rates for LG&E and KU in 13 and 20 years, respectively;
the last gas rate increase for the LG&E gas utility took effect in
September 2000.
With the 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 CompaniesKentucky Department of Air Quality in
December 2004. LG&E's and separately,KU's share of the total capital cost of $885
million for Trimble County Unit 2 is estimated to be $168 million and $717
million, respectively, through 2010. 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. Hearings on the air permit application are scheduled to commence
in August 2005.
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 rehearingCCN to
construct four FGDs at an estimated cost of the
rate cases on such issue and certain calculation components of the
increased rates and filed for the existing rate increases to be set aside.
The Kentucky Commission is considering the matters relating to the AG's
actions. For a description of developments$658.9 million, which was
approved in these cases, see Note 11 of
the Notes to Consolidated Financial Statements in Part 1, Item 1 of this
Quarterly Report on Form 10-Q.June 2005.
Results of Operations
The results of operations for LG&E and KU are affected by seasonal
fluctuations in temperature and other weather-related factors. Because of
these and other factors, the results of one interim period are not
necessarily indicative of results or trends to be expected for another period.the full
year.
Three Months Ended SeptemberJune 30, 2004,2005, Compared to
Three Months Ended SeptemberJune 30, 20032004
LG&E Results:
LG&E's net income decreased $7.3increased $10.9 million (18%(64%) for the three months ended
SeptemberJune 30, 2004,2005, as compared to the three months ended SeptemberJune 30, 2003,2004,
primarily due to the increase in electric and gas base rates effective July
1, 2004, higher maintenance expenses related to July stormselectric wholesale revenues, and lower electric sales.operation expenses.
A comparison of LG&E's revenues for the three months ended SeptemberJune 30, 2004,2005,
with the three months ended SeptemberJune 30, 2003,2004, reflects increases and
(decreases) which have been segregated by the following principal causes:
(in thousands)Cause Electric Gas
Cause(in millions) Revenues Revenues
Retail sales:
Fuel and gas supply adjustments $ (425) $1,2435.7 $ 3.5
Environmental cost recovery surcharge 3,7074.4 -
Earnings sharing mechanism 139(3.5) -
LG&E/KU merger surcredit 123Weather normalization - Value delivery surcredit (256) 28
Demand side management 3 (42)
General0.7
Rates and rate increase 10,105 1,443structure 10.0 2.1
Variation in sales volume and other (11,353) (647)(2.1) (0.8)
Total retail sales 2,043 2,02514.5 5.5
Wholesale sales (2,448)22.0 3.3
Other (0.8) -
Provision for rate refunds (2,689) -
Other (56) 134
Total $(3,150) $2,159
Page 24$35.7 $ 8.8
Electric revenues decreased $3.2increased $35.7 million (19%) in 2005 primarily asdue to:
- Higher wholesale revenues ($22.0 million), primarily due to 6% higher
prices and 67% higher sales volume.
- An increase in rates and a result of lower
sales volumes from cooler weather as cooling degree days declined 3.2% from
last year. Also contributingchange in rate structure ($10.0 million),
related to the decrease were lower wholesale revenues
andrate case order which took effect on July 1, 2004.
- Higher fuel supply adjustments ($5.7 million) due to significantly
higher provisions for rate refunds. The provision for rate refunds
decreased revenues $2.7 million, largely as a result of a higher provision
for thefuel costs.
- Higher environmental cost recovery surcharge.surcharge ($4.4 million).
- Lower earnings sharing mechanism, resulting from termination of the
mechanism in March 2005 ($3.5 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 revenue decreasesadjustment was immaterial during all reporting periods
involved (March 2003 through October 2004). As a result, LG&E revenues were
partially offset byincreased $4.8 million in the general rate increase, effective with service
rendered July 1, 2004, and an increasecurrent period results of operations. Net
income in environmental cost recovery.the current period was increased $2.9 million for LG&E.
Gas revenues increased $2.2$8.8 million (20%) in 2005 primarily asdue to:
- - Higher gas supply adjustment ($3.5 million) due to higher gas costs.
- - Higher wholesale revenues ($3.3 million) due to higher sales volumes
(476,000 MCF in 2005 versus 49,000 MCF in 2004) and 32% higher prices.
- - An increase in rates and a result ofchange in rate structure ($2.1 million),
related to the general rate increase, effective with service renderedcase order which took effect on July 1, 2004, and an increase in
recovery of higher natural gas prices billed to customers through the gas
supply clause.2004.
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 decreased $2.0increased $20.4 million (4%(43%) in 2005
primarily due to a decreaseto:
- Increased cost per Btu (24% higher), resulting in $13.3 million higher
fuel costs.
- Increased generation ($1.8 million) and a decrease(15% higher), resulting in the$7.1 million higher
fuel costs.
Power purchased increased $10.9 million (63%) in 2005 primarily due to:
- Increased cost of coal burned ($0.2 million).per Mwh (38% higher), resulting in $7.8 million higher
costs.
- Increased Mwh purchases (18% higher), resulting in $3.1 million higher
costs.
Gas supply expenses increased $0.7$4.6 million (3%(15%) in 2005 primarily due
to:
- Increased cost of purchases for wholesale sales ($2.7 million).
- Increased volume of gas delivered to an increase in netthe distribution system ($2.5
million).
- Decreased recovery of performance-based rates ($0.3 million).
- Decreased gas price (net of gas supply cost ($1.2clause adjustments)($0.3
million),
offset by a decrease.
Other operations and maintenance expenses decreased $12.3 million (16%) in
the volume of retail gas sold ($0.5 million).2005.
Other operation expenses decreased $3.8$15.7 million (7%(28%), as compared in 2005 primarily
due to:
- Decreased other power supply expense ($7.6 million). This is primarily
related to 2003.
Pensioncredits received from MISO for Day 2 revenue sufficiency
guarantee payments (RSGs) totaling $12.6 million (received by LG&E when
units are required to run at a higher generating cost than the market will
pay). Excluding the RSGs, other power supply expense decreased $1.2 million. Electricincreased $5.0
million due to MISO Day 2 costs related to meeting native load
requirements.
- Decreased distribution operations expense decreased $2.9($6.9 million); storm expense
of approximately $7.4 million due to transferwas recorded in the second quarter of $4.0 million2004.
- Decreased transmission expense, primarily MISO-related ($2.5 million).
- Decreased information technology systems operations expense ($1.3
million) (charged to maintenance (relatedexpenses in 2005).
- Increased steam generation operations expense ($1.9 million), primarily
related to storms) offset by higher non-storm related
distribution operations of $1.1 million.scrubber reactant expense.
- Increased customer records and collections expense ($0.6 million).
Maintenance expenses increased $10.5$3.2 million (84%(21%) in 2005 primarily due
to:
- Increased information technology systems maintenance ($1.3 million)
(charged to operation expenses in 2004).
- Increased steam generation maintenance, primarily due to stormsoutage repairs
at Cane Run ($8.81.1 million).
- Increased gas distribution system maintenance ($0.3 million) and
underground storage maintenance ($0.1 million).
- Increased combustion turbine maintenance ($0.2 million).
Property and other taxes increased $0.2 million including $4.0 million transferred from Operations to
Maintenance(5%) in third quarter 2004). Non-storm related distribution
maintenance increased $2.1 million.2005.
Depreciation and amortization expense increased $1.9$3.0 million (7%(11%) in 2005
primarily due to a
corresponding increase inadditional plant in service of $199.4service.
In total, interest expense increased $0.5 million (5.8%(6%) in 2005 primarily
due to:
- - Increased interest on variable-rate debt ($2.0 million).
- - Decreased interest costs on interest rate swaps ($0.9 million).
- - Decreased interest due to interest paid on tax payments in April 2004
($0.3 million).
- - Decreased interest on Fidelia debt ($0.3 million).
The increaseweighted average interest rate on variable-rate bonds for the three
months ended June 30, 2005, was 2.61%, compared to 1.08% for the comparable
period in plant included $37.2 million related to the completion of
Trimble County CT's 9 and 10, as well as increases to steam production
plant of $59.3 million, to electric distribution plant of $31.0 million and
to gas distribution plant of $29.9 million. The increase in depreciation
and amortization was partially offset by a reduction in amortization
expense related to certain software, which became fully amortized in the
final quarter of 2003.
Other income decreased $1.4 million, resulting from a $1.3 million write-
off in July 2004 related to the cancellation of the "Pay As You Go"
metering project.
Variations2004.
Variances in income tax expense are largely attributable to changes in pre-
tax income.income and a reduction in the statutory Kentucky rate.
Three Months Three Months
Ended Ended
Sept.June 30, 2005 June 30, 2004
Sept. 30, 2003Effective Rate
Statutory federal income tax rate 35.0% 35.0%
State income taxes net of federal benefit 4.6 4.95.3 5.8
Amortization of investment and other tax credit & R&D (0.6) (1.7)credits (2.3) (6.6)
Other differences (0.7) (2.4)(2.0) 0.6
Effective income tax rate 38.3% 35.8%
Page 2536.0% 34.8%
The variationincreased tax benefit in the tax rateother differences is largely attributable to
the new Internal Revenue Code Section 199 Qualified Production Activities
deduction and the amortization of excess deferred tax benefits recorded in 2003, reflectingincome taxes, which
reflect the benefits of deferred taxestax reversing at lowerhigher tax rates than what were provided, and lower
amortizationthe
current statutory rate.
See Part 1 - Item 1, Notes to Financial Statements, Note 6 for additional
discussion of the investment tax credit.
Interest expense decreased $0.9 million (15%) primarily due to savings on
interest expense realized from the refinancing of fixed-rate Series V and
Series W Pollution Control Bonds to the variable-rate Series GG Pollution
Control Bonds in November 2003.
Interest expense to affiliated companies increased $0.9 million (44%)
primarily due to a $1.1 million increase in interest expense to Fidelia
related to new notes issued in August 2003 and January 2004. Offsetting
this increase is a $0.2 million decrease in interest expense on borrowings
from the money pool due to lower borrowing levels.
The weighted average interest rate on variable-rate bonds for the three
months ended September 30, 2004, was 1.30% and the corresponding rate for
the three months ended September 30, 2003, was 0.99%.income taxes.
KU Results:
KU's net income increased $4.5decreased $9.9 million (15%(36%) for the three months ended
SeptemberJune 30, 2004,2005, as compared to the three months ended SeptemberJune 30, 2003.2004. The
increasedecrease was primarily due to higher revenues due to July 2004
rate increases, partially offset byincreased operation and maintenance expenses
and higher depreciation expense.expenses.
A comparison of KU's revenues for the three months ended SeptemberJune 30, 2004,2005,
with the three months ended SeptemberJune 30, 2003,2004, reflects increases and
(decreases) which have been segregated by the following principal causes:
Cause Electric
(in thousands) Electric
Causemillions) Revenues
Retail sales:
Fuel supply adjustments $ 2,297$22.6
Environmental cost recovery surcharge 1,1512.1
Earnings sharing mechanism 1,332
LG&E/KU merger surcredit (615)
Value delivery surcredit (111)
Demand side management 404
General(3.9)
Rates and rate increase 9,596structure 14.6
Variation in sales volume and other (446)(0.1)
Total retail sales 13,60835.3
Wholesale sales 1,4655.2
Provision for rate collections 1,794(5.4)
Other 376(2.3)
Total $17,243$32.8
Electric revenues increased $17.2$32.8 million (14%) in 2005 primarily asdue to:
- - Higher fuel supply adjustments ($22.6 million) due to higher cost of
fuel used for generation and purchased power.
- - An increase in rates and a change in rate structure ($14.6 million),
related to the result of the
general rate increase, effective with service renderedcase order which took effect on July 1, 2004, and
increases in fuel adjustment clause recoveries,2004.
- - Higher wholesale revenues ($5.2 million), primarily due to 19% higher
prices.
- - Higher environmental cost recovery of environmental
costs,surcharge ($2.1 million).
- - Lower provision for rate collections ($5.4 million).
- - Lower earnings sharing mechanism revenues, wholesaleresulting from termination
of the mechanism in March 2005 ($3.9 million).
During the second quarter of 2005, KU made out-of-period adjustments for
estimated over collection of ECR revenues and an
increaseto be billed in provisionsubsequent
periods. The adjustment was immaterial during all reporting periods
involved (May 2003 through January 2005). As a result, KU revenues were
decreased $2.4 million in the current period results of operations. Net
income in the current period was reduced $1.5 million for rate collections. The provision for rate
collections increased $1.8 million largely as the result of a higher
provision for the environmental cost recovery surcharge ($4.2 million),
partially offset by lower provisions for the earnings sharing mechanism
($1.3 million) and fuel clause recovery ($1.1 million).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 Federal Energy Regulatory Commission.FERC.
Fuel for electric generation increased $2.9$16.3 million (4%(24%) for the quarter
because of an increase in 2005
primarily due to:
- Increased cost per Btu (37% higher), resulting in $22.5 million higher
fuel costs.
- Decreased generation ($3.2 million)(9% lower), partially offset byresulting in $6.2 million lower fuel
costs, primarily due to a slight decrease in the cost of coal burned ($0.3 million).
Page 26major turbine overhaul at E.W. Brown Unit 3 and
outage at Green River Unit 4.
Power purchased increased $1.5$19.3 million (5%(63%) in 2005 primarily due to an increaseto:
- Increased cost per Mwh (30% higher), resulting in the price$11.4 million higher
costs.
- Increased volumes of powerMwh purchased ($3.1 million)(26% higher), offset by a decreaseresulting in the volume
purchased ($1.6 million).$7.9
million higher costs.
Other operations and maintenance expenses increased $10.0 million (17%) in
2005.
Other operation expenses increased $2.2$3.8 million (6%(11%) as comparedin 2005 primarily
due to:
- Increased other power supply expense ($3.5 million). KU received from
MISO RSGs totaling $3.1 million (received when KU units are required to
2003.
Steamrun at a higher generating cost than the market will pay). Excluding the
RSGs, other power operationssupply expense increased $1.9$6.6 million due to MISO Day 2
costs related to meeting native load requirements.
- Increased pension expense ($1.2 million).
- Increased customer accounts and collection expense ($1.0 million).
- Decreased transmission expense, primarily MISO-related ($1.1 million).
- Decreased information technology systems operation expenses ($1.1
million) (charged to maintenance expenses in 2005).
Maintenance expenses increased $6.0 million (35%) in 2005 primarily due
to:
- Increased steam generation maintenance expense ($4.6 million),
primarily due to increased
emission allowance expensemajor turbine overhauls at E.W. Brown and Ghent.
- Increased information technology systems maintenance ($1.21.1 million)
and higher expense related(charged to SCR/NOX reductionoperation expenses in 2004).
- Increased transmission system maintenance ($0.40.3 million).
Maintenance expense decreased $1.0 million, primarily due to a decrease of
$1.4 million in distribution maintenance. In September 2004, $4.0 million
in costs related to the 2003 ice storm were reclassified from maintenance
expense to a regulatory asset, based on an order from the Kentucky
Commission, to be amortized through June 2009. KU earns a return of these
amortized costs, which are included in KU's jurisdictional operating
expenses. Offsetting this decrease was $1.3 million in expense related to
2004 storms, $0.6 million higher vegetation management expense,Property and other taxes increased $0.2 million amortization of the ice storm deferral.(4%).
Depreciation and amortization increased $4.3$3.3 million (17%(13%) primarily due to
a
corresponding increase inadditional plant in serviceservice.
In total, interest expense increased $0.7 million (10%) in 2005 primarily
due to:
- - Increased interest costs associated with variable rate debt ($0.8
million).
- - Increased interest costs associated with the interest rate swaps ($0.7
million).
- - Decreased interest costs due to refinancing fixed rate debt with
variable rate debt ($0.4 million).
- - Decreased interest costs for mark-to-market of $155.4 million (5%)the interest rate swaps
($0.3 million).
The increaseweighted average interest rate on variable-rate bonds for the three
months ended June 30, 2005, was 2.72%, compared to 1.11% for the comparable
period in plant included $63.8 million related to the completion of
Trimble County CT's 9 and 10, as well as increases to transmission plant of
$11.1 million and to electric distribution plant of $30.6 million.2004.
Variations in income tax expense are largely attributable to changes in
pretax income.
Three Months Three Months
Ended Ended
Sept.June 30, 2005 June 30, 2004
Sept. 30, 2003
Statutory federal income tax rate 35.0% 35.0%
State income taxes net of federal benefit 4.1 5.0
Amortization of investment tax credit & R&D (1.0) (1.4)
Other differences (3.2) (2.9)
Effective income tax rate 34.9% 35.7%
Interest expense increased $0.4 million (16%). A reduction in the savings
associated with interest rate swaps, caused primarily by the termination of
a swap, increased interest expense by $1.2 million. This increase was
offset by $0.7 million in interest expense savings from the redemption of
8.55% Series P Pollution Control Bonds redeemed in November of 2003.
Interest expense to affiliated companies increased $1.6 million (86%)
primarily due to a $1.8 million increase in interest expense to Fidelia
related to new notes issued from August 2003 through January 2004.
Offsetting this increase is a $0.2 million decrease in interest expense on
borrowings from the money pool due to lower borrowing levels.
The weighted average interest rate on variable-rate bonds for the three
months ended September 30, 2004, was 1.32% and the corresponding rate for
the three months ended September 30, 2003, was 0.91%.
Nine Months Ended September 30, 2004, Compared to
Nine Months Ended September 30, 2003
LG&E Results:
LG&E's net income decreased $1.0 million (1%) for the nine months ended
September 30, 2004, as compared to the nine months ended September 30,
2003, primarily due to higher operations and maintenance expense, offset by
higher electric revenues.
Page 27
A comparison of LG&E's revenues for the nine months ended September 30,
2004, with the nine months ended September 30, 2003, reflects increases and
(decreases) which have been segregated by the following principal causes:
(in thousands) Electric Gas
Cause Revenues Revenues
Retail sales:
Fuel and gas supply adjustments $(1,493) $ 46,625
Environmental cost recovery surcharge 11,618 -
Earnings sharing mechanism 3,913 -
LG&E/KU merger surcredit (1,296) -
Value delivery surcredit (786) 5
Demand side management 357 (420)
Weather normalization - 2,419
General rate increase 10,105 1,443
Variation in sales volume and other 4,244 (22,523)
Total retail sales 26,662 27,549
Wholesale sales 5,642 1,034
Provision for rate refunds (5,670) -
Other 95 (344)
Total $26,729 $ 28,239
Electric revenues increased $26.7 million primarily as a result of
increased environmental cost recovery, the general rate increase, effective
with service rendered July 1, 2004, wholesale revenues (4% higher pricing
offset by 3% lower volumes), and higher retail sales volumes. The
provision for rate refunds decreased revenues $5.7 million due to a
decrease in environmental cost recovery surcharge ($6.7 million) and
earnings sharing mechanism recoveries ($0.9 million), partially offset by
higher fuel adjustment clause recoveries ($1.9 million).
Gas revenues increased $28.2 million primarily as a result of higher
natural gas prices passed on to customers through the gas supply clause,
partially offset by lower sales volumes resulting from milder weather
during the heating months than in the prior period.
Fuel for electric generation increased $2.4 million (2%) for the nine
months due to an increase in the cost of coal burned ($1.4 million) and
higher generation ($1.0 million). Gas supply expenses increased $30.3
million (20%) due to an increase in net gas supply cost ($42.0 million),
offset by a decrease in the volume of retail gas delivered to the
distribution system ($11.5 million).
Power purchased increased $5.3 million (9%) due to an increase in the price
of power purchased ($4.3 million) and a 2% increase in the volume of the
purchases ($1.0 million) primarily to meet slightly higher load
requirements.
Other operations expenses increased $4.5 million (3%) in 2004, as compared
to 2003, due to higher transmission expense of $2.7 million, primarily due
to higher MISO-related expense, and $4.6 million higher electric
distribution expense, due in part to the May and July 2004 storms. These
higher expenses were partially offset by $2.8 million lower amortization of
costs to achieve the KU/LG&E merger and One Utility initiative. These
costs were fully amortized by June 2003 (KU/LG&E merger) and September 2003
(One Utility).
Maintenance expenses increased $7.8 million (18%). Distribution
maintenance increased $9.6 million, primarily due to the May and July storm
restoration. In 2003, $2.1 million of obsolete inventory was written off.
Page 28
Depreciation and amortization increased $0.2 million (0.2%). The net
increase in depreciation and amortization expense for the nine months ended
was due to an increase in depreciation related to an increase in plant in
service of $199.4 million (5.8%) which was largely offset by a decrease in
amortization expense related to certain software, which became fully
amortized in the final quarter of 2003.
Variations in income tax expense are largely attributable to changes in pre-
tax income.
Nine Months Ended Nine Months Ende
d
Sept. 30, 2004 Sept. 30, 2003Rate
Statutory federal income tax rate 35.0% 35.0%
State income taxes net of federal benefit 5.2 5.36.0
Amortization of investment and other tax
credit & R&D (2.7) (2.7)credits (1.5) (1.2)
Other differences (0.1) (1.6)(2.7) (1.8)
Effective income tax rate 37.4% 36.0% 38.0%
The variationincreased tax benefit in the other differences for 2005 is largely
attributable to excess deferred tax benefits recorded in 2003, reflectingincome taxes (1.9%), which reflect the
benefits of deferred taxestax reversing at lowerhigher tax rates than what were provided.
Property and other taxes increased $1.6 million (13%). Property tax
expense reflected a $1.2 million coal incentive tax credit in 2003, and a
$0.7 million credit in 2004. The remaining increase related primarilythe current
statutory rate.
See Part 1 - Item 1, Notes to increased property tax accruals, as a resultFinancial Statements, Note 6 for additional
discussion of capital expansion, and
higher employmentincome taxes.
Interest expense decreased $3.0 million (17%). Interest relatedSix Months Ended June 30, 2005, Compared to
long-
term debt decreased $5.8 million due to the refinancing of fixed-rate
Series V and Series W Pollution Control Bonds into the variable-rate Series
GG Pollution Control Bonds and the redemption of the first mortgage bond in
August 2003. These savings were partially offset by an increase in interest
expense related to interest rate swaps associated with the Series GG bonds
totaling $2.6 million.
Interest expense to affiliated companies increased $5.0 million (121%)
primarily due to a $6.4 million increase in interest expense to Fidelia
related to new notes issued in August 2003 and January 2004. Offsetting
this increase is a $1.4 million decrease in interest expense on borrowings
from the money pool due to lower borrowing levels.
The weighted average interest rate on variable-rate bonds for the nine
months ended SeptemberSix Months Ended June 30, 2004
was 1.14%, compared to 1.12% for the
comparable period in 2003.
KULG&E Results:
KU'sLG&E's net income increased $38.5$20.5 million (68%(50%) for the ninesix months ended
SeptemberJune 30, 2004,2005, as compared to the ninesix months ended SeptemberJune 30, 2003. The increase was2004, primarily
due to the increase in electric and gas base rates effective July 1, 2004
and higher electric revenues and lower
maintenance expense.
Page 29gas wholesale sales.
A comparison of KU'sLG&E's revenues for the ninesix months ended SeptemberJune 30, 2004,2005,
with the ninesix months ended SeptemberJune 30, 2003,2004, reflects increases and (decreases)
which have been segregated by the following principal causes:
Cause Electric Gas
(in thousands) Electric
Causemillions) Revenues Revenues
Retail sales:
Fuel and gas supply adjustments $ 2,6839.3 $ 4.8
Environmental cost recovery surcharge 3,2183.6 -
Earnings sharing mechanism 6,636(7.1) -
LG&E/KU merger surcredit (2,443)(1.7) -
Value delivery surcredit (296)
Demand side management 424
General(0.5) (0.3)
Rates and rate increase 9,596structure 25.3 12.4
Variation in sales volume and other 18,8740.7 (8.6)
Total retail sales 38,69229.6 8.3
Wholesale sales 13,38236.3 9.2
Provision for rate collections 17,6572.3 -
Other 5,110(1.8) 0.2
Total $74,841$66.4 $17.7
Electric revenues increased $74.8$66.4 million (17%) in 2005 primarily due to:
- - Higher wholesale revenues ($36.3 million), primarily due to increased16% higher
prices and 20% higher sales volumesvolumes.
- - An increase in rates and a change in rate structure ($25.3 million),
related to ultimate consumers of 3.9%the rate case order which took effect on July 1, 2004.
- - Higher fuel supply adjustments ($9.3 million) due to warmer weather than last year
as cooling degree days increased 3%higher cost of
fuel used for generation and purchased power.
- - Higher environmental cost recovery surcharge ($3.6 million).
The general rate increase, effective
with service rendered July 1, 2004, increased revenues approximately $9.6
million. Also contributing to the overall revenue increase were increases
in the provision for rate collections, wholesale revenues (26% higher
pricing offset by 3% lower volumes),- - Lower earnings sharing mechanism recoveriesrevenues, resulting from termination
of the mechanism in March 2005 ($7.1 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 adjustment was immaterial during all reporting periods
involved (March 2003 through October 2004). As a result, LG&E revenues were
increased $4.8 million in the current period results of operations. Net
income in the current period was increased $2.9 million for LG&E.
Gas revenues increased $17.7 million (9%) in 2005 primarily due to:
- - An increase in rates and a change in rate structure ($12.4 million),
related to the recoveryrate case order which took effect on July 1, 2004.
- - Higher wholesale revenues ($9.2 million) due to 106% higher sales
volumes and 15% higher prices.
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 environmental costs. The provision for rate
collections included higher provisions forgas
supply are reflected in retail rates, subject to the environmental cost recovery
($14.6 million),approval of the
earnings sharing mechanism ($2.2 million) and the fuel
adjustment clause ($0.9 million).Kentucky Commission.
Fuel for electric generation increased $14.4$27.9 million (7%(28%) for the nine
monthsin 2005
primarily due to an increaseto:
- Increased cost per Btu (20% higher), resulting in the cost of coal burned ($6.4 million) and an
increase$21.5 million higher
fuel costs.
- Increased generation (6% higher), resulting in generation ($8.0 million).$6.4 million higher fuel
costs.
Power purchased decreased $1.4increased $21.0 million (1%(45%) in 2005 primarily due to a decreaseto:
- Increased cost per Mwh (37%), resulting in the price$18.2 million higher costs.
- Increased volume of power purchased ($2.1 million)(6%), partially offset by an increaseresulting in volumes purchased$2.8 million
higher costs.
Gas supply expenses increased $9.4 million (6%) in 2005 primarily due to:
- Increased cost of purchases for wholesale sales ($0.78.3 million) due.
- Increased volume of gas delivered to higher retailthe distribution system ($1.1
million).
Other operations and wholesale loads.maintenance expenses decreased $12.4 million (8%) in
2005.
Other operation expenses increased $0.2decreased $19.8 million (17%) in 2005 primarily
due to:
- Decreased distribution operations expense ($7.5 million); storm expense
of approximately $7.4 million was recorded in the second quarter of 2004.
- Decreased other power supply expense ($7.4 million). This is primarily
related to credits received from RSGs totaling $12.6 million. Steam generationExcluding
the RSGs, other power supply expense increased $4.3$5.2 million due to MISO
Day 2 costs related to meeting native load requirements.
- Decreased transmission expense, primarily MISO-related ($5.6 million).
- Decreased information technology systems operations expense ($2.6
million) (charged to maintenance expenses in 2005).
- Decreased property insurance expense ($0.4 million).
- Increased steam generation operations expense ($2.4 million).
- Increased customer records and collection expenses ($1.0 million).
Maintenance expenses increased $6.7 million (25%) in 2005 primarily due
to:
- Increased information technology systems maintenance ($2.6 million)
(charged to operation expenses in 2004).
- Increased steam generation maintenance, primarily due to higher emission allowanceoutage repairs
at Cane Run ($2.2 million).
- Increased distribution system maintenance (including tree trimming and
underground conductor repairs) ($0.7 million).
- Increased gas distribution system expense ($0.8 million).
- Increased electric transmission system maintenance ($0.4 million).
Property and transmission expenseother taxes increased $0.5 million. Amortization of $2.9$0.7 million related to costs to achieve the KU/LG&E merger and One Utility
initiative was recorded(8%) in 2003 and was fully amortized as of June 2003.
Pension expense decreased $0.8 million, and bad debt expense decreased $0.7
million.
Maintenance expenses decreased $8.4 million (17%). Steam power maintenance
expense decreased $3.2 million; Ghent Unit 3, Green River Unit 4 and Tyrone
Unit 3 all had major overhauls in 2003. Distribution maintenance decreased
$2.8 million. In September 2004, $4.0 million in costs related to the 2003
ice storm were reclassified from maintenance expense to a regulatory asset,
based on an order from the Kentucky Commission, to be amortized through
June 2009. KU earns a return of these amortized costs, which are included
in KU's jurisdictional operating expenses. Offsetting this decrease was
$2.2 million in expense related to the 2004 storms. Transmission overhead
line maintenance decreased $0.4 million.
Page 302005.
Depreciation and amortization increased $3.6$6.3 million (5%(11%) primarily due to
an
increase inadditional plant in service of $155.4service.
Other income - net increased $0.9 million (4.8%in 2005 primarily due to:
- - Increased mark-to-market income (net) ($0.3 million) related to energy
trading contracts.
- - Decreased miscellaneous deductions ($0.7 million).
In total, interest expense increased $1.5 million (9%) in 2005 primarily
due to:
- - Increased interest on variable-rate debt ($3.1 million).
- - Increased interest on customer deposits ($0.6 million).
- - Increased interest on money pool borrowings ($0.4 million).
- - Decreased interest costs on interest rate swaps ($1.5 million).
- - Decreased interest on affiliated loans with Fidelia ($0.6 million).
- - Decreased interest due to interest paid on tax payments in April 2004
($0.3 million).
The increaseweighted average interest rate on variable-rate bonds for the six
months ended June 30, 2005, was 2.27%, compared to 1.06% for the comparable
period in plant included $63.8 million related to the completion of Trimble County
CTs 9 and 10, as well as increases to transmission plant of $11.1 million
and to electric distribution plant of $30.6 million.
Variations2004.
Variances in income tax expense are largely attributable to changes in pretax income.
Ninepre-
tax income and a reduction in the statutory Kentucky rate.
Six Months Six Months
Ended Nine Months Ended
Sept.June 30, 2005 June 30, 2004
Sept. 30, 2003Effective Rate
Statutory federal income tax rate 35.0% 35.0%
State income taxes net of federal benefit 5.3 5.84.7 5.7
Amortization of investment and other tax credit & R&D (1.0) (2.3)credits (2.1) (4.3)
Other differences (2.4) (3.6)(1.7) 0.2
Effective income tax rate 36.9% 34.9%35.9% 36.6%
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 investmentbenefits of deferred tax creditreversing at higher tax rates than the
current statutory rate.
Kentucky House Bill 272, also known as Kentucky's Tax Modernization Plan,
was signed into law on March 18, 2005. See Note 6 for additional
discussion of income taxes.
KU Results:
KU's net income decreased $4.7 million (8%) for the six months ended June
30, 2005, as compared to the six months ended June 30, 2004. The decrease
was primarily due to higher operations and maintenance expenses and higher
depreciation expense, partially offset by the increase in base rates
effective July 1, 2004 and higher wholesale sales.
A comparison of KU's revenues for the six months ended June 30, 2005, with
the six months ended June 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 $35.7
Environmental cost recovery surcharge 6.8
Earnings sharing mechanism (8.3)
LG&E/KU merger surcredit (1.6)
Rates and rate structure 26.9
Variation in sales volume and other differences were
approximately the same0.4
Total retail sales 59.9
Wholesale sales 20.8
Provision for rate collections (4.6)
Other (4.3)
Total $71.8
Electric revenues increased $71.8 million (15%) in both periods, but lower pretax income2005 primarily due to:
- - Higher fuel supply adjustments ($35.7 million) due to higher cost of
fuel used for the
nine months ended September 30, 2003, caused the percentage changes to be
greatergeneration and purchased power.
- - An increase in the 2003 period.
Interest expense decreased $6.3 million (45%) due primarily to the
redemption of 8.55% Series P Pollution Control Bondsrates and 6.32% Series Q
Pollution Control Bonds redeemeda change in November and June of 2003,
respectively. Additionally, interest rate swaps yielded a $1.6 million
decrease in related interest expenses resulting primarily from the February
termination of a swapstructure ($26.9 million),
related to the Series 9 Pollution Control Bondsrate case order which took effect on July 1, 2004.
- - Higher wholesale revenues ($20.8 million), primarily due to 25% higher
prices.
- - Higher environmental cost recovery surcharge ($6.8 million).
- - Lower earnings sharing mechanism, resulting from termination of the
mechanism in March 2005($8.3 million).
- - Lower provision for rate collections ($4.6 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 adjustment was immaterial during all reporting periods
involved (May 2003 through January 2005). As a result, KU revenues were
decreased $2.4 million in the current period results of operations. 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 better performancethe FERC.
Fuel for electric generation increased $33.8 million (25%) in 2005
primarily due to:
- Increased cost per Btu (10% higher), resulting in $38.9 million higher
fuel costs.
- Decreased generation (4% lower), resulting in $5.1 million lower fuel
costs.
Power purchased increased $24.3 million (34%) in 2005 primarily due to:
- Increased cost per Mwh (20% higher), resulting in $16.2 million higher
costs.
- Increased volumes of remaining swaps.
InterestMwh purchased (11% higher), resulting in $8.1
million higher costs.
Other operations and maintenance expenses increased $14.0 million (12%) in
2005.
Other operation expenses increased $2.4 million (3%) in 2005 primarily
due to:
- Increased other power supply expenses ($3.6 million). KU received from
MISO RSGs totaling $3.1 million. Excluding the RSGs, other supply expense
increased $6.7 million due to affiliated companiesMISO Day 2 costs related to meeting native
load requirements.
- Increased customer records and collections expenses ($1.6 million).
- Decreased information technology systems operation expenses ($2.2
million) (charged to maintenance expenses in 2005).
Maintenance expenses increased $7.2$11.2 million (213%(39%) in 2005 primarily due
to:
- Increased steam generation maintenance ($7.0 million) due to outages at
Ghent, E.W. Brown, and Green River plants.
- Increased distribution system maintenance ($1.6 million) due to storm
restoration expenses.
- Increased information technology systems maintenance ($2.2 million)
(charged to operation expenses in 2004).
- Increased transmission system maintenance ($0.4 million).
Property and other taxes increased $0.4 million.
Depreciation and amortization increased $6.5 million (13%) primarily due to
a $7.9 million increaseadditional plant in service.
In total, interest expense to Fidelia
related to new notes issuedincreased $2.7 million (23%) in August 2003 through January 2004.
Offsetting this increase is a $0.7 million decrease in2005 primarily
due to:
- Increased interest expensecosts associated with the mark-to-market of the
interest rate swaps ($1.6 million).
- Increased interest on borrowings from the money poolvariable rate debt ($1.2 million).
- Increased interest costs on interest rate swaps ($0.8 million).
- Decreased interest costs due to lower borrowing levels.refinancing fixed rate debt with
variable rate debt ($0.9 million).
The weighted average interest rate on variable-rate bonds for the ninesix
months ended SeptemberJune 30, 2005, was 2.31%, compared to 1.08% for the comparable
period in 2004.
Variations in income tax expense are largely attributable to changes in
pretax income.
Six Months Six Months
Ended Ended
June 30, 2005 June 30, 2004
Effective Rate
Statutory federal income tax rate 35.0% 35.0%
State income taxes net of federal benefit 4.8 5.9
Amortization of investment and other tax
credits (1.0) (1.1)
Other differences (1.8) (1.7)
Effective income tax rate 37.0% 38.1%
Kentucky House Bill 272, also known as Kentucky's Tax Modernization Plan,
was 1.16% and the corresponding ratesigned into law on March 18, 2005. See Note 6 for the nine months ended September 30, 2003, was 1.08%.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.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.
As of SeptemberAt June 30, 2004,2005, LG&E and KU arewere in a negative working capital position
in part because of the classification of certain variable-rate pollution
control bonds that are subject to tender for purchase at the option of the
holder as current portion of long-term debt. The CompaniesLG&E and KU expect to cover
any working capital deficiencies with cash flow from operations, money pool
borrowings and borrowings from Fidelia, an E.ON
financing subsidiary.Fidelia.
Construction expenditures for the ninesix months ended SeptemberJune 30, 20042005 amounted
to $51.0 million for LG&E and KU amounted to $94.2$44.0 million and $104.0 million, respectively.
Suchfor KU. At LG&E, expenditures
include constructionconnection of new customers ($14.3 million), gas main replacements
($5.9 million), enhancements to distribution system to meet nitrogen oxide (NOx)
emission standardsdemand ($3.0
million), replacement of defective distribution equipment ($3.1 million),
and the acquisition of combustion turbines to meet peak
power demands. Expenditures for the nine months ended September 30, 2004,
by LG&E and KU for NOx construction were $4.1 million and $29.2 million,
respectively. Expenditures for the nine months ended September 30, 2004,
for Trimble County combustion turbines, Units 7 through 10, by LG&E and KU
were $7.0 million and $12.0 million, respectively. In addition, LG&E
construction expenditures include $10.0 million for distribution overheada new transmission line construction, $4.1 million for Mill Creek Unit 3 ductwork installation
related to the flue gas desulfurization ("FGD") project, and $8.3 million
for gas main replacements.($1.7 million). At KU, construction expenditures include $6.4
million for E.W. Brown Unit 3 cooling towerincluded
connection of new customers ($18.0 million), expenditures to improve boiler
and precipitator rebuildother generation equipment reliability ($5.9 million), and $9.0 million forreplacement
of defective distribution construction in the Lexington area.equipment ($2.3 million). The expenditures were
financed with internally generated fundsfunds.
LG&E's and intercompany
loans from affiliates.
Page 31
LG&E'sKU's cash balance increased $4.2balances decreased $2.0 million and $0.6 million,
respectively, during the six months ended June 30, 2005, primarily due to
increased net borrowings
from affiliated companies,the payment of dividends and repayments of debt and construction
expenditures, partially offset by pension funding and payment
of common dividends to its parent company. LG&E's restrictedhigher cash balance
increased $11.5 million during the nine months ended September 30, 2004,
primarily due to an increase in collateral heldprovided by third parties related to
interest rate swaps. KU's cash balance remained level, decreasing $0.2
million during the nine months ended September 30, 2004, as higher net
income and increased net borrowings from affiliated companies offset
pension funding, construction expenditures and the payment of common
dividends to its parent company.operating
activities.
Variations in accounts receivable, accounts payable and materials and
suppliesinventories are
generally not significant indicators of LG&E's and KU's liquidity. In general, suchSuch
variations are usuallyprimarily attributable to seasonal fluctuations in weather,
which have a direct effect on sales of electricity and natural gas. However, the increaseThe
decrease in accounts receivable at LG&E and KU, as of September 30, 2004, was primarily due to the termination of the accounts receivable securitization programs in January
2004. Discontinuing the accounts receivable securitization programs
resulted in an increase in accounts receivable of $58.0 million at LG&E and
$50.0 million at KU. (LG&E and KU maintained a reserve for uncollectible
accounts related to receivables sold during the securitization program).
The increase in accounts receivable at LG&E as of September 30, 2004 was
somewhat offset by theseasonal
impact of decreased gas sales in September 2004
compared to December 2003.sales. The decrease in fuel inventory at KU asLG&E's gas stored
underground relates to seasonal uses of September 30, 2004, was due to an increase in tons burned and a slow down
of coal deliveries.gas.
Interest rate swaps are used to hedge LG&E's and KU's underlying variable-
rate debt obligations. These swaps hedge specific debt issuances and,
consistent with management's designation, are accorded hedge accounting
treatment. As of SeptemberJune 30, 2004,2005, LG&E had swaps with a combined notional
value of $228.3$211.3 million and KU had swapsone swap with a combined notional value of $103.0$53.0
million. LG&E's swaps exchange floating-rate interest payments for fixed-ratefixed-
rate interest payments to reduce the impact of interest rate changes on
LG&E's pollution control bonds. KU's swapsswap effectively convertconverts fixed-rate
obligations on KU's First Mortgage Bondsfirst mortgage bonds Series P and R to variable-rate
obligations.
In February 2004, KU terminated theJune 2005, an interest rate swap it had in place at December 31,
2003 related to its Series 9 Pollution Control Bonds. Thewith a notional amount of the terminated swap was $50 million
andwas terminated by the counterparty pursuant to the terms of the swap
agreement. KU received a payment of $2.0$1.9 million as partin 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, resulting intherefore, no impact on
earnings occurred as a gainresult of $0.8the 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 SeptemberJune 30, 2004,2005, LG&E's and KU's percentage of debt having a variable
rate, debt, including the impact of interest rate swaps, was 38.0% of LG&E's total debt at $346.7 million45.5% ($383.7
million) and 44.0% of
KU's total debt at $328.9 million. At December 31, 2003, variable rate
debt, including the impact of interest rate swaps, was 44.0% of LG&E's
total debt at $386.3 million and 55.5% of KU's total debt at $397.1
million.51.5% ($392.2 million), respectively.
Under the provisions offor LG&E's variable-rate Pollution Control Bonds,pollution control bonds,
Series S, T, U, BB, CC, DD and EE, and KU's variable-rate Pollution Control
Bonds,pollution control
bonds Series 10, 12, 13, 14, and 15, the bonds are subject to tender for
purchase at the option of the holder and to mandatory tender for purchase
upon the occurrence of certain events, causing the bonds to be classified
as current portion of long-term debt in the Consolidated Balance Sheets. The average
annualized interest rate for these bonds during the three
months and ninesix months ending SeptemberJune
30, 2004,2005 was 1.20% and 1.14%,
respectively,2.23% for the LG&E bonds and 1.30% and 1.18%, respectively,2.30% for the KU bonds.
In January 2004,During June 2005, LG&E entered into two long-term loans with Fidelia, one
totaling $25 million with an interest rate of 4.33% that matures in January
2012, and one totaling $100 million with an interest rate of 1.53% that
matures in January 2005. The loans are secured by a lien subordinated to
the first mortgage bond lien. The proceeds were used to fund a pension
contribution and to repay other debt obligations. In April 2004, LG&E
prepaid $50 million of the $100 million 1.53% note payable to Fidelia. The
prepayment was paid out of cash balances and there was no prepayment fee.
In January 2004, KU entered into an unsecured long-term loan from Fidelia
totaling $50 million with an interest rate of 4.39% that matures in January
2012. The proceeds were used to fund a pension contribution and to repay
other debt obligations.
Page 32
In May 2004, KU redeemed $4.8 million of its Series 14, Pollution Control
Bonds which were initially issued in the amount of $7.2 million.
On October 20, 2004, KU completed a refinancing transaction regarding $50
million in existing pollution control indebtedness. The original
indebtedness, 5.75% Pollution Control Bonds, Series 9, due December 1,
2023, will be discharged on November 22, 2004, by the proceeds from the
replacement indebtedness, KU Pollution Control Bonds, Series 17, due
October 1, 2034, which will carry a variable, auction rate of interest.
LG&E maintainsrenewed five bilateralrevolving lines of credit with banks
totaling $185 million that mature in 2005.million. There was no outstanding balance under any of these
facilities at SeptemberJune 30, 2004. Management2005. The Company expects to renew these facilities
as they expire.prior to their expiration in June 2006.
LG&E, KU and KULG&E Energy participate in an intercompany money pool
agreement whereinagreement. Details of the balances at June 30, 2005 and June 30, 2004 were
as follows:
Total Money Amount Balance Average
($ in millions) Pool Available Outstanding Available Interest Rate
June 30, 2005:
LG&E Energy and$400.0 $20.8 $379.2 3.06%
KU make funds available to$400.0 $93.1 $306.9 3.06%
June 30, 2004:
LG&E at market-based rates
(based on an index of highly rated commercial paper issues as of the prior
month end) up to $400 million. Likewise, LG&E Energy and LG&E make funds
available to$400.0 $26.0 $374.0 1.04%
KU at market-based rates up to $400 million. LG&E had $40.7
million in money pool loans from LG&E Energy (included in "Notes payable to
affiliated companies") at an average rate of 1.60% at September 30, 2004,
and $75.1 million at an average rate of 1.06% at September 30, 2003. The
balance of the money pool loans from LG&E Energy to KU (included in "Notes
payable to affiliated companies") was $29.8 million at an average rate of
1.60% and $98.7 million at an average rate of 1.06% at September 30, 2004
and 2003, respectively. The amount available to LG&E under the money pool
agreement at September 30, 2004, was $359.3 million. The amount available
to KU under the money pool agreement at September 30, 2004, was $370.2
million.$400.0 $53.2 $346.8 1.04%
LG&E Energy maintains a revolving credit facility totaling $150$200 million
with an affiliateaffiliated company, E.ON North America, Inc., to ensure funding
availability for the money pool. LG&E Energy had anThe balance outstanding balance of $79.1 million at an
average rate of 2.13% underon this facility
asat June 30, 2005 was $159.7 million.
Redemptions and maturities of September 30, 2004 and
availability of $70.9 million remained.
As of September 30, 2004, LG&E had 225,000 shares of $5.875 series
mandatorily redeemable preferred stock outstanding having a current
redemption price of $100 per share. The preferred stock has a sinking fund
requirement sufficient to retire a minimum of 12,500 shares on July 15 of
each year commencing with July 15, 2003, and the remaining 187,500 shares
on July 15, 2008 at $100 per share. Beginning with the three months ended
September 30, 2003, LG&E reclassified its $5.875 series preferred stock as long-term debt withyear-to-date through June 30,
2005, are summarized below:
($ 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 KU First mortgage bonds $50.0 7.55% Secured Jun 2025
Issuances of long-term debt year-to-date through June 30, 2005, are
summarized below:
($ in millions)
Principal Secured/
Year Company Description Amount Rate Unsecured Maturity
2005 LG&E Pollution control bonds $40.0 Variable Secured Feb 2035
The proceeds of the minimum shares mandatorily redeemable within one
year classified as current. Dividends accrued are charged as interest
expense, pursuant2005 loan at LG&E were used to SFAS No. 150. On July 15, 2004, LG&E redeemed 12,500
shares as required atrefinance existing
pollution control bonds.
In May 2005, KU repaid a price$26.7 million loan against the cash surrender
value of $100 per share.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
contributions are required for 2004 and no further discretionary contributions to the pension plans are planned in 2004.currently anticipated
for either LG&E's security&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 SeptemberJune 30, 2004,2005, were:
LG&E KU
Moody's S&P Moody's S&P
First mortgage bonds A1 A- A1 A
Preferred stock Baa1 BBB- Baa1 BBB-
Commercial paper P-1 A-2
KU's security ratings as of September 30, 2004, were:
Moody's S&P
First mortgage bonds A1 A
Preferred stock Baa1 BBB-
Commercial paper P-1 A-2
These ratings reflect the views of Moody's and S&P. A security rating is
not a recommendation to buy, sell or hold securities and is subject to
revision or withdrawal at any time by the rating agency.
Page 33
LG&E's capitalizationCapitalization ratios at SeptemberJune 30, 2004,2005, and December 31, 2003,2004, follow:
SeptemberLG&E KU
June 30,December 31, June 30, December 31,
2005 2004 20032005 2004
Long-term debt
(including current portion) 30.8% 31.9%31.7% 30.5% 19.0% 22.2%
Long-term debt to affiliated
company
(includingcompany(including current
portion) 14.2 10.712.0 14.1 18.6 18.8
Notes payable to affiliated
companies 2.1 4.31.1 3.0 5.2 2.0
Preferred stock 3.7 3.6 3.82.2 2.2
Common equity 49.3 49.351.5 48.8 55.0 54.8
Total 100.0% 100.0%
KU's capitalization ratios at September 30, 2004, and December 31, 2003,
follow:
September 30,December 31,
2004 2003
Long-term debt (including current portion) 22.4% 24.1%
Long-term debt to affiliated company
(including current portion) 19.0 16.8
Notes payable to affiliated companies 1.7 2.6
Preferred stock 2.3 2.4
Common equity 54.6 54.1
Total 100.0% 100.0%
New Accounting Pronouncements
FIN 46
In January 2003, the Financial Accounting Standards Board ("FASB") issued
Financial Accounting Standards Board Interpretation No. 46, ConsolidationFor a discussion of Variable Interest Entities, an Interpretation of ARB No. 51 ("FIN 46").
FIN 46 required certain variable interest entities to be consolidated by
the primary beneficiary of the entity if the equity investors in the entity
do not have the characteristics of a controlling financial interest or do
not have sufficient equity at risk for the entity to finance its activities
without additional subordinated financial support from other parties. FIN
46 was effective immediately for all new variable interest entities created
or acquired after January 31, 2003.
In December 2003, FIN 46 was revised, delaying the effective dates for
certain entities created before February 1, 2003,accounting pronouncements and making other
amendments to clarify application of the guidance. For potential variable
interest entities other than special purpose entities, the revised FIN 46
("FIN 46R") is now required to be applied no later than the end of the
first fiscal year or interim reporting period ending after March 15, 2004.
For all special purpose entities created prior to February 1, 2003, FIN 46R
is now required to be applied at the end of the first interim or annual
reporting period ending after December 15, 2003. FIN 46R may be applied
prospectively with a cumulative-effect adjustment as of the date it is
first applied, or by restating previously issued financial statements with
a cumulative-effect adjustment as of the beginning of the first year
restated. FIN 46R also requires certain disclosures of an entity's
relationship with variable interest entities.
Boththeir impacts on LG&E
and KU, hold investment interests in OVEC and KU holds an
investment interest in EEI. Neither LG&E nor KU is the primary beneficiary
of OVEC or EEI, and thus neither is consolidated into the financial
statements of LG&E or KU.
Page 34
LG&E, KU and ten other electric utilities are participating owners of OVEC,
located in Piketon, Ohio. OVEC owns and operates two power plants that
burn coal to generate electricity, Kyger Creek Station in Ohio and Clifty
Creek Station in Indiana. LG&E's share is 7%, representing approximately
155 Mw of generation capacity and KU's share is 2.5%, representing
approximately 55 Mw of generation capacity.
LG&E's and KU's original investments in OVEC were made in 1952. LG&E's
investment in OVEC is the equivalent of 4.9% of OVEC's common stock and
KU's investment is the equivalent of 2.5% of OVEC's common stock. LG&E's
and KU's investments in OVEC are accounted for on the cost method of
accounting. As of September 30, 2004, LG&E's and KU's investments in OVEC
totaled $0.5 million and $0.3 million, respectively. LG&E's and KU's
maximum exposure to loss as a result of their involvement with OVEC is
limited to the value of their investment. In the event of the inability of
OVEC to fulfill its power provision requirements, LG&E and KU would
substitute such power supply with either owned generation or market
purchases and would generally recover associated incremental costs through
regulatory rate mechanisms. Seesee Part II,I - Item 1, for further discussion of
developments regarding LG&E's and KU's OVEC ownership interests and power
purchase rights.
KU owns 20% of the common stock of EEI, which owns and operates a 1,000-Mw
generating station in southern Illinois. KU is entitledNotes to take 20% of the
available capacity of the station. Purchases from EEI are made under a
contractual formula which has resulted in costs which were and are expected
to be comparable to the cost of other power purchased or generated by KU.
Such power equated to approximately 9% of KU's net generation system output
in 2003.
KU's original investment in EEI was made in 1953. KU's investment in EEI
is accounted for on the equity method of accounting. As of September 30,
2004, KU's investment in EEI totaled $12.7 million. KU's maximum exposure
to loss as a result of its involvement with EEI is limited to the value of
its investment. In the event of the inability of EEI to fulfill its power
provision requirements, KU would substitute such power supply with either
owned generation or market purchases and would generally recover associated
incremental costs through regulatory rate mechanisms.
FSP 106-2
In May 2004, the FASB finalized FASB Staff Position ("FSP") 106-2,
Accounting and Disclosure Requirements Related to the Medicare Prescription
Drug, Improvement and Modernization Act of 2003 ("Medicare Act") with
guidance on accounting for subsidies provided under the Medicare Act which
became law in December 2003. FSP 106-2 is effective for the first interim
or annual period beginning after June 15, 2004. FSP 106-2 does not have a
material impact on the Companies.Financial Statements, Note 7.
Contingencies
For a description of significant contingencies that may affect LG&E and KU,
reference is made to Part I, Item 3, Legal Proceedings in LG&E's and KU's
Annual Reports on Form 10-K for the year ended December 31, 2003;2004; and to
Part I - Item 1, Notes to Financial Statements, Notes 5 and 10, and Part II
- - Item 1, Legal Proceedings in LG&E's and KU's Quarterly Reports on Form
10-Q for the quarters ended March 31, 2004 and June 30, 2004; and to Part
II, Item 1, Legal Proceedings herein.
Page 35
Electric and Gas Rates Cases
On June 30, 2004, the Kentucky Commission issued an order approving
increases in the base electric and gas rates of LG&E and the base electric
rates of KU. Subsequently, the AG commenced an investigation examining
communications between the Kentucky Commission and the Companies and
separately filed for a rehearing of the rate cases on such issue and
certain calculation components of the increased rates and filed for the
existing rate increases to be set aside. The Kentucky Commission is
considering the matters relating to the AG's actions. For a description of
developments in these cases, see Note 11 of the Notes to Consolidated
Financial Statements in Part 1, Item 1 of this Quarterly Report on Form 10-
Q.
Earnings Sharing Mechanism
The Companies filed their final 2003 ESM calculations with the Kentucky
Commission on March 1, 2004, and applied for recovery of $13.0 million
related to LG&E and $16.2 million related to KU. Based upon estimates, the
Companies previously accrued $8.9 million at LG&E and $9.3 million at KU
for the 2003 ESM as of December 31, 2003.
On June 30, 2004, the Kentucky Commission issued an order largely accepting
proposed settlement agreements by the Companies and all intervenors
regarding the ESM mechanisms of LG&E and KU. Under the ESM settlements,
LG&E and KU will continue to collect approximately $13.0 million and $16.2
million, respectively, of previously requested 2003 ESM revenue amounts
through March 2005. As part of the settlement, the parties agreed to a
termination of the ESM mechanism relating to all periods after 2003.
As a result of the settlement, the Companies accrued an additional $4.1
million at LG&E and $6.9 million at KU in June 2004, related to 2003 ESM
revenue.
OVEC Power Agreement and Share Purchase
On April 30, 2004, OVEC and its shareholders, including LG&E and KU,
entered into an Amended and Restated Inter-Company Power Agreement, to be
effective beginning March 2006, upon the expiration of the current power
contract among the parties. Under the new contract, which has a 20-year
term from its effective date, LG&E and KU have purchase rights for 5.63%
and 2.5%, respectively, of OVEC power at marginal cost-based rates. LG&E
and KU are entitled to 7% and 2.5% of OVEC power, respectively, under the
current contract.
LG&E's estimated future minimum annual demand payments under the Amended
and Restated Inter-Company Agreement are as follows:
(in thousands)
2006 $ 10,098
2007 9,726
2008 9,932
2009 10,144
2010 10,361
Thereafter 170,646
Total $220,907
In addition, LG&E will purchase from American Electric Power Company Inc.
("AEP") an additional 0.73% interest in OVEC for a purchase price of
approximately $104,000, resulting in an increase in LG&E ownership in OVEC
from 4.9% to 5.63%. The share purchase transaction is anticipated to be
completed during 2005, subject to receipt of certain regulatory approvals.
The changes to the power agreement and the share purchases are expected to
have no impact on the accounting for OVEC under FIN 46R as described in
Footnote 8.
Owensboro Contract Litigation
In May 2004, the City of Owensboro, Kentucky and Owensboro Municipal
Utilities (collectively "OMU"), filed suit in Davies County, Kentucky
District Court against KU concerning a long-term power supply contract (the
"OMU Agreement") with KU. The dispute involves interpretational
differences regarding certain issues under the OMU Agreement, including
various payments or charges between KU and OMU and rights concerning excess
power, termination and emissions allowances, respectively. The complaint
seeks approximately $6 million in damages for historical periods, as well
as injunctive and other relief, including a declaration that KU is in
material breach. KU has removed this litigation to the U.S. District Court
for the Western District of Kentucky, filed an answer in that court denying
the OMU claims and presenting certain counterclaims and commenced a FERC
proceeding to request FERC jurisdiction on certain issues. In October
2004, FERC declined to exercise exclusive jurisdiction regarding the issues
in dispute, which ruling KU has appealed.
Page 36
Environmental Matters
In September 1998, the EPA announced its final "NOx SIP Call" rule
requiring states to impose significant additional reductions in NOx
emissions by May 2003, in order to mitigate alleged ozone transport impacts
on the Northeast region. The Commonwealth of Kentucky SIP, which was
approved by EPA June 24, 2003, required reductions in NOx emissions from
coal-fired generating units to the 0.15 lb./Mmbtu level on a system-wide
basis. In related proceedings in response to petitions filed by various
Northeast states, in December 1999, the EPA issued a final rule pursuant to
Section 126 of the Clean Air Act directing similar NOx reductions from a
number of specifically targeted generating units including all LG&E and KU
units. As a result of appeals to both rules, the compliance date was
extended to May 2004.
LG&E and KU have complied with these NOx emissions reduction rules by
installing additional NOx controls to their generating units. Installations
of additional NOx controls were performed on a phased basis, which
commenced in late 2000 and continued through the final compliance date. As
of September 30, 2004, LG&E has incurred total capital costs of
approximately $185 million to reduce its NOx emissions to the 0.15
lb./Mmbtu level on a company-wide basis. As of September 30, 2004, KU has
incurred total capital costs of approximately $203 million to reduce its
NOx emissions to the 0.15 lb./Mmbtu level on a company-wide basis. In
addition, LG&E and KU have begun incurring additional operation and
maintenance costs in operating new NOx controls. LG&E and KU believe their
costs in this regard to be comparable to those of similarly situated
utilities with like generation assets. In April 2001, the Kentucky
Commission granted recovery of these costs under the environmental
surcharge mechanism for LG&E and KU.
During August 2004, KU, the EPA, and the Department of Justice agreed in
principle to settle outstanding matters concerning a 1999 oil discharge at
KU's E.W. Brown plant for approximately $0.6 million, a portion of which
may be satisfied by KU's construction of a separate environmental capital
project. The settlement is subject to completion of final definitive
documents. In December 2003, KU recorded an accrual and expense to
operations of $0.6 million.
LG&E and KU are also monitoring several other air quality issues which may
potentially impact coal-fired power plants, including the EPA's revised air
quality standards for ozone and particulate matter, measures to implement
the EPA's regional haze rule, and the EPA's December 2003 proposals to
regulate mercury emissions from steam electric generating units and to
further reduce emissions of sulfur dioxide and nitrogen oxides under the
Clean Air Interstate Rule. In addition, LG&E is currently reviewing and
making comments on proposed regulations concerning toxic air emissions
within Metro Louisville, where the company operates two coal-fired
generating stations. LG&E is also working with local regulatory
authorities to review the effectiveness of remedial measures aimed at
controlling particulate matter emissions from its Mill Creek Station. LG&E
previously settled a number of property damage claims from adjacent
residents and completed significant remedial measures as part of its
ongoing capital construction program. LG&E has converted the Mill Creek
Station to a wet stack operation in an effort to resolve all outstanding
issues related to particulate matter emissions.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
LG&E&E's and KU, and their respective ratepayers,KU's operations are exposed to market risks.
Market risk exposures includerisks from changes in
interest rates and commodity prices. To mitigate changes in cash flows
attributable to these exposures, the Companies have entered into various
derivative instruments. Derivative positions are monitored using
techniques that include market value and sensitivity analysis.
Page 37Interest 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 $3.5$3.8 million and $3.3$3.9 million, respectively, at SeptemberJune 30, 2004.2005. LG&E's
exposure to floating interest rates decreased $1.0 million
and KU's exposure to floating interest rates decreased $1.2 milliondid not materially change
during the first ninesix months of 2004.2005.
The potential loss in fair value of LG&E's interest rate swaps resulting
from a hypothetical 1% change in base interest rates is estimated at
approximately $25.8$20.5 million as of SeptemberJune 30, 2004.2005. The potential loss in
fair value of KU's interest rate swaps resulting from a hypothetical 1%
change in base interest rates is estimated at approximately $2.4$0.8 million as
of SeptemberJune 30, 2004.2005. These estimates are derived from third-party valuations.
Changes in the market values of these swaps, if held to maturity, will have
no effect on LG&E's or KU's net income or cash flow.
Pension Risk
LG&E's and KU's costs of providing defined-benefit pension retirement plans
is dependent upon a number of factors, such as the rates of return on plan
assets, discount rate, and contributions made to the plan. At September
30, 2004, LG&E and KU
have arecognized an additional minimum pension liability as prescribed by SFAS No.
87, Employers' Accounting for Pensions inbecause the pre-tax amountsaccumulated benefit
obligation exceeds the fair value of $47.6 and $9.9 million, respectively.their plans' assets. The liabilities
arewere recorded as a reduction to other comprehensive income, and dodid not
affect net income. The amount of the liabilitiesliability depends upon the discount
rate, the asset returns experienced in
2003 and contributions made by LG&E and KUthe Companies to the
plan during 2003.plans. If the fair value of the planplans' assets exceeds the accumulated
benefit obligation, the recorded liabilityliabilities will be reduced and other
comprehensive income will be restored in the Consolidated Balance Sheets.balance sheet.
A 1% increase or decrease in the assumed discount rate could have an
approximate $41$39.9 million positive or negative impact to the accumulated
benefit obligation of LG&E. A 1% increase or decrease in the assumed
discount rate could have an approximate $27$26.8 million positive or negative
impact to the accumulated benefit obligation of KU.
In January 2004, LG&E and KU made discretionary contributions to their
pension plans of $34.5 million and $43.4 million, respectively. Page 38No
discretionary contributions to the pension plans are 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 Trading & Risk Management Activities
The table below summarizes LG&E's and KU's energy trading and risk management
activities for the three months and ninesix months ended SeptemberJune 30, 2004,2005, and
2003 (in thousands of $). Trading volumes2004. Volumes are allocated evenly divided between LG&E and KU.
Three Months NineSix Months
Ended Ended
SeptemberJune 30, SeptemberJune 30,
2005 2004 20032005 2004
2003(in millions)
Fair value of contracts at beginning of
period, net asset/(liability) $ 541- $ 318 $572 $(156)0.6 $(0.2) $ 0.6
Fair value of contracts when entered
into during the period (70) (30) (75) 2,590- - - -
Contracts realized or otherwise
settled during the period (431) (356) (663) (639)- (0.1) 0.2 (0.3)
Changes in fair value due to
changes in assumptions 107 148 313 (1,715)- - - 0.2
Fair value of contracts at end of
period, net asset $ 147- $ 800.5 $ 147- $ 800.5
No changes to valuation techniques for energy trading and risk management activities
occurred during 2005 or 2004. Changes in market pricing, interest rate and
volatility assumptions were made during bothall periods. The outstanding mark-
to-market value is sensitive to changes in prices, price volatilities, and
interest rates. The Companies estimate that a movement in prices of $1 and
a change in interest and volatilities of 1% would not result in a change of
a material amount. All contracts outstanding at SeptemberJune 30, 2004,2005, have a
maturity of less than one year and are valued using prices actively quoted
for proposed or executed transactions or quoted by brokers.
LG&E and KU maintain policies intended to minimize credit risk and revalue
credit exposures daily to monitor compliance with those policies. As of
SeptemberJune 30, 2004,2005, 100% of the trading and risk management commitments were
with counterparties rated BBB-/Baa3 equivalent or better.
Item 4. Controls and Procedures.
LG&E and KU maintain a system of disclosure controls and procedures
designed to ensure that information required to be disclosed by the
Companies in reports they file or submit under the Securities Exchange Act
of 1934 is recorded, processed, summarized and reported, within the time
periods specified in the Securities and Exchange Commission rules and
forms. LG&E and KU conducted an evaluation of such controls and procedures
under the supervision and with the participation of the Companies'
management, including the Chairman, President and Chief Executive Officer
("CEO") and the Chief Financial Officer ("CFO"). Based upon that
evaluation, the CEO and CFO have concluded that the Companies' disclosure
controls and procedures are effective as of the end of the period covered
by this report.
LG&E and KU are not accelerated filers under the Sarbanes-Oxley Act of 2002
and associated rules (the "Act") and consequently anticipate issuing
Management's Report on Internal Control over Financial Reporting pursuant
to Section 404 of the Act in their first periodic report covering the
fiscal year ended December 31, 2006, as permitted by SEC rulemaking.
In preparation for required reporting under Section 404 of the Sarbanes-
Oxley Act of 2002, the Companies are conducting a thorough review of their
internal controls over financial reporting, including disclosure controls
and procedures. Based on this review, the Companies have made internal
controls enhancements and will continue to make future enhancements to
their internal controlscontrol over financial reporting. There hasOn April 1, 2005, the MISO
Day 2, a day-ahead and real-time energy market, became effective which
impacted our 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 changeother changes in
the Companies' internal controlscontrol over financial reporting that occurred
during the fiscal quarter ended SeptemberJune 30, 2004,2005, that has materially
affected, or is reasonably likely to materially affect, the Companies'
internal controlscontrol over financial reporting.
Page 39
Part II. Other Information
Item 1. Legal Proceedings.
For a description of the significant legal proceedings involving LG&E and
KU, reference is made to the information under the following items and
captions of (a) LG&E's and KU's respective combined Annual Report on Form 10-K
for the year ended December 31, 2003:2004: Item 1, Business; Item 3, Legal
Proceedings; Item 7, Management's Discussion and Analysis of Financial
Condition and Results of Operations, and Item 8, Financial Statements and
Supplementary Data in Note 11. Reference is also made to the matters
described in Notes 5 and (b)10 of Part I, Item 1 of LG&E's and KU's Quarterly
ReportsReport on Form 10-Q for the periodsthree months ended March 31, 20042005 and June 30, 2004: Item I, Legal
Proceedings.this 10-
Q, respectively. Except as described herein, to-date,to date, the proceedings
reported in LG&E's and KU's respective combined Annual Report on Form 10-K
or
Quarterly Reports on Form 10-Q have not changed materially.
ElectricOther
In the normal course of business, other lawsuits, claims, environmental
actions, and Gas Rates Cases
On June 30, 2004, the Kentucky Commission issued an order approving
increases in the base electric and gas rates ofother governmental proceedings arise against LG&E and KU. To
the base electric
ratesextent that damages are assessed in any of KU. Subsequently, the AG commenced an investigation examining
communications between the Kentucky Commission and the Companies and
separately filed for a rehearing of the rate cases on such issue and
certain calculation components of the increased rates and filed for the
existing rate increases to be set aside. The Kentucky Commission is
considering the matters relating to the AG's actions. For a description of
developments in these cases, see Note 11 of the Notes to Consolidated
Financial Statements in Part 1, Item 1 of this Quarterly Report on Form 10-
Q.
MISO
During 2004 to-date, the Kentucky Commission has continued its proceedings
examining the costs and benefits of MISO membership, including reopening
the matter for further testimony and hearings on recently-filed MISO energy
market tariffs and analysis of potential membership in other Regional
Transmission Organizations. Proceedings in this matter are anticipated to
continue into 2005. In September 2004, in response to requests of the
Kentucky Commission, the Companies filed pleadings indicating that MISO
membership will not provide benefits commensurate with its costs to the
Companies and to Kentucky ratepayers. The Companies requested an order of
the Kentucky Commission directing their ultimate exit from MISO, if
approved by the FERC and under other appropriate conditions.
OVEC Power Agreement and Share Purchase
On April 30, 2004, OVEC and its shareholders, includinglawsuits, LG&E and KU
entered into an Amendedbelieve that their insurance coverage is adequate. Management, after
consultation with legal counsel, does not anticipate that liabilities
arising out of other currently pending or threatened lawsuits and Restated Inter-Company Power Agreement, to be
effective beginning March 2006, upon the expirationclaims
will have a material adverse effect on LG&E's or KU's financial position or
results of the current power
contract among the parties. Under the new contract, which has a 20-year
term from its effective date, LG&E and KU have purchase rights for 5.63%
and 2.5%, respectively, of OVEC power at marginal cost-based rates. LG&E
and KU are entitled to 7% and 2.5% of OVEC power, respectively, under the
current contract.
In addition, LG&E will purchase from American Electric Power Company Inc.
("AEP") an additional 0.73% interest in OVEC for a purchase price of
approximately $104,000, resulting in an increase in LG&E ownership in OVEC
from 4.9% to 5.63%. The share purchase transaction is anticipated to be
completed during 2005, subject to receipt of certain regulatory approvals.
Page 40
Owensboro Contract Litigation
In May 2004, the City of Owensboro, Kentucky and Owensboro Municipal
Utilities (collectively "OMU"), filed suit in Davies County, Kentucky
District Court against KU concerning a long-term power supply contract (the
"OMU Agreement") with KU. The dispute involves interpretational
differences regarding certain issues under the OMU Agreement, including
various payments or charges between KU and OMU and rights concerning excess
power, termination and emissions allowances,operations, respectively. The complaint
seeks approximately $6 million in damages for historical periods, as well
as injunctive and other relief, including a declaration that KU is in
material breach. KU has removed this litigation to the U.S. District Court
for the Western District of Kentucky, filed an answer in that court denying
the OMU claims and presenting certain counterclaims and commenced a FERC
proceeding to request FERC jurisdiction on certain issues. In October
2004, FERC declined to exercise exclusive jurisdiction regarding the issues
in dispute, which ruling KU has appealed.
Environmental Matter
During August 2004, KU and the EPA and Department of Justice agreed in
principle to settle outstanding matters concerning a 1999 oil discharge at
KU's E.W. Brown plant for approximately $628,750, a portion of which may be
satisfied by KU's construction of a separate environmental capital project.
The settlement is subject to completion of final definitive documents.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
2(c)
LG&E has an existing $5.875 series of mandatorily redeemable preferred
stock outstanding having a current redemption price of $100 per share. The
preferred stock has a sinking fund requirement sufficient to retire a
minimum of 12,500 shares on July 15 of each year commencing with July 15,
2003, and a minimum of 187,500 shares on July 15, 2008 at $100 per share.
LG&E redeemed 12,500 shares in accordance with these provisions on July 15,
2004, leaving 225,500 shares currently outstanding. Beginning with the
three months ended September 30, 2003, LG&E reclassified, at fair value,
its $5.875 series preferred stock as long-term debt with the minimum shares
mandatorily redeemable within one year classified as current portion of
long-term debt. Dividends accrued beginning July 1, 2003 are charged as
interest expense, pursuant to SFAS No. 150.
July August September
Period 2004 2004 2004
Total number of shares (or units) 12,500 n/a n/a
purchased ($5.875 Pref.)
Average price paid per share (or unit)$100 n/a n/a
Total number of shares (or units)
purchased as part of publicly 12,500
announced plans or programs ($5.875 Pref.) n/a n/a
Maximum number (or approximate
dollar value) of shares (or
units) that may yet be purchased 225,000
under the plans or programs ($5.875 Pref.) n/a n/a
Item 4. Submission of Matters to a Vote of Security Holders.
a)LG&E's and KU's Annual Meetings of Shareholders were held on July 8,
2004.June 17,
2005.
b)Not applicable.
Page 41
c)The matters voted upon and the results of the voting at the Annual
Meetings are set forth below:
1. LG&E
i)The shareholders voted to elect LG&E's nominees for election to the
Board of Directors, as follows:
Victor A. Staffieri - 21,294,223 common shares and 88,85594,209
preferred shares cast in favor of election and 5,7255,713 preferred
shares withheld.
S. Bradford Rives - 21,294,223 common shares and 89,00594,209 preferred
shares cast in favor of election and 5,5755,713 preferred shares
withheld.
John R. McCall - 21,294,223 common shares and 89,19193,950 preferred
shares cast in favor of election and 5,3895,972 preferred shares
withheld.
Paul W. Thompson - 21,294,223 common shares and 94,261 preferred
shares cast in favor of election and 5,661 preferred shares
withheld.
Chris Hermann - 21,294,223 common shares and 94,237 preferred
shares cast in favor of election and 5,685 preferred shares
withheld.
No holders of common or preferred shares abstained from voting on
this matter.
ii)The shareholders voted 21,294,223 common shares and 91,60098,044
preferred shares in favor of and 991310 preferred shares against the
approval of PricewaterhouseCoopers LLP as independent accountants
for 2004.2005. Holders of 1,989 preferred shares abstained from voting
on this matter.
2. KU
i)The sole shareholder voted to elect KU's nominees for election to
the Board of Directors, as follows:
37,817,878 common shares cast in favor of election and no shares
withheld for each of Victor A. Staffieri, S. Bradford Rives,
and
John R. McCall, Paul W. Thompson, and Chris Hermann, respectively.
ii)The sole shareholder voted 37,817,878 common shares in favor of and
no shares withheld for approval of PricewaterhouseCoopers LLP as
independent accountants for 2004.2005.
No holders of common shares abstained from voting on these matters.
d) Not applicable.
Item 6. Exhibits.
Applicable to Form
10-Q of
Exhibit
No. LG&E KU Description
4.1 X Supplemental Indenture dated as of April 1, 2005
from Louisville Gas and Electric Company to BNY Midwest
Trust Company, Chicago, Illinois, as trustee [Filed as
Exhibit 4.1 to LG&E's Form 8-K Current Report dated April
13, 2005]
4.2 X Loan Agreement dated February 1, 2005 between
Louisville Gas and Electric Company and the
Louisville/Jefferson County Metro Government, Kentucky
[Filed as Exhibit 10.1 to LG&E's Form 8-K Current Report
dated April 13, 2005]
4.3 XSupplemental Indenture dated as of June 15, 2005 from
Kentucky Utilities Company to U.S. Bank National
Association, Chicago, Illinois, as trustee [Filed as Exhibit
4.1 to KU's Form 8-K Current Report dated July 7, 2005]
4.4 XLoan Agreement dated May 1, 2005 between Kentucky Utilities
Company and the County of Carroll, Kentucky [Filed as
Exhibit 4.2 to KU's Form 8-K Current Report dated July 7,
2005]
4.5 XLoan Agreement dated July 8, 2005 between Kentucky
Utilities Company and Fidelia Corporation [Filed as Exhibit
4.3 to KU's Form 8-K Current Report dated July 7, 2005]
4.6 XCopy of Promissory Note from KU to Fidelia Corporation,
dated as of July 8, 2005 [Filed as Exhibit 4.4 to KU's Form
8-K Current Report dated July 7, 2005]
31 X X CertificationsCertification - Section 302 of Sarbanes-Oxley Act of 2002
31.1X Certification of Chairman of the Board, President and Chief
Executive
Officer, pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002
31.2X Certification of Chief Financial Officer, pursuant to
Section 302 of
the Sarbanes-Oxley Act of 2002
31.3 X Certification of Chairman of the Board, President and Chief
Executive
Officer, pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002
31.4 X Certification of Chief Financial Officer, pursuant to
Section 302 of
the Sarbanes-Oxley Act of 2002
32 X X Certification pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
Certain instruments defining the rights of holders of certain long-term
debt of LG&E andor KU have not been filed with the SEC but will be furnished
to the SEC upon request.
Page 42
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: NovemberAugust 12, 20042005 /s/ S. Bradford Rives
S. Bradford Rives
Chief Financial Officer
(On behalf of the registrant in his
capacities as Principal Financial Officer
and Principal
Accounting Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Kentucky Utilities Company
Registrant
Date: NovemberAugust 12, 20042005 /s/ S. Bradford Rives
S. Bradford Rives
Chief Financial Officer
(On behalf of the registrant in his
capacities as Principal Financial Officer
and Principal
Accounting Officer)
Exhibit 31.1
CERTIFICATIONS
Louisville Gas and Electric Company
I, Victor A. Staffieri, Chairman of the Board, President and Chief
Executive Officer, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Louisville Gas and
Electric Company;
2. Based on my knowledge, this report does not contain any untrue statement
of a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its subsidiaries, is made known to us by others
within those entities, particularly during the period in which this
report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
most recent fiscal quarter (the registrant's fourth fiscal quarter in
the case of an annual report) that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting; and
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to
the registrant's auditors and the audit committee of the registrant's board
of directors (or persons performing the equivalent functions):
a) All significant deficiencies and material weaknesses in the design
or operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
Date: August 12, 2005
/s/ Victor A. Staffieri
Victor A. Staffieri
Chairman of the Board, President and Chief Executive Officer
Exhibit 31.2
Louisville Gas and Electric Company
I, S. Bradford Rives, Chief Financial Officer, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Louisville Gas and
Electric Company;
2. Based on my knowledge, this report does not contain any untrue statement
of a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its subsidiaries, is made known to us by others
within those entities, particularly during the period in which this
report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
most recent fiscal quarter (the registrant's fourth fiscal quarter in
the case of an annual report) that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting; and
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to
the registrant's auditors and the audit committee of the registrant's board
of directors (or persons performing the equivalent functions):
a) All significant deficiencies and material weaknesses in the design
or operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
Date: August 12, 2005
/s/ S. Bradford Rives
S. Bradford Rives
Chief Financial Officer
Exhibit 31.3
Kentucky Utilities Company
I, Victor A. Staffieri, Chairman of the Board, President and Chief
Executive Officer, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Kentucky Utilities
Company;
2. Based on my knowledge, this report does not contain any untrue statement
of a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its subsidiaries, is made known to us by others
within those entities, particularly during the period in which this
report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
most recent fiscal quarter (the registrant's fourth fiscal quarter in
the case of an annual report) that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting; and
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to
the registrant's auditors and the audit committee of the registrant's board
of directors (or persons performing the equivalent functions):
a) All significant deficiencies and material weaknesses in the design
or operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
Date: August 12, 2005
/s/ Victor A. Staffieri
Victor A. Staffieri
Chairman of the Board, President and Chief Executive Officer
Exhibit 31.4
Kentucky Utilities Company
I, S. Bradford Rives, Chief Financial Officer, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Kentucky Utilities
Company;
2. Based on my knowledge, this report does not contain any untrue statement
of a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its subsidiaries, is made known to us by others
within those entities, particularly during the period in which this
report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
most recent fiscal quarter (the registrant's fourth fiscal quarter in
the case of an annual report) that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting; and
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to
the registrant's auditors and the audit committee of the registrant's board
of directors (or persons performing the equivalent functions):
a) All significant deficiencies and material weaknesses in the design
or operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
Date: August 12, 2005
/s/ S. Bradford Rives
S. Bradford Rives
Chief Financial Officer
Exhibit 32
Certification Pursuant to 18 U.S.C. Section 1350
As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
In connection with the Quarterly Report of Louisville Gas and Electric
Company and Kentucky Utilities Company (the "Companies") on Form 10-Q for
the period ended June 30, 2005, as filed with the Securities and Exchange
Commission on the date hereof (the "Report"), each of the undersigned does
hereby certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002, that, to such officer's
knowledge,
1) The Report fully complies with the requirements of Section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
2) The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations of the
Companies as of the dates and for the periods expressed in the Report.
August 12, 2005
/s/ Victor A. Staffieri
Chairman of the Board, President
and Chief Executive Officer
Louisville Gas and Electric Company
Kentucky Utilities Company
/s/ S. Bradford Rives
Chief Financial Officer
Louisville Gas and Electric Company
Kentucky Utilities Company
The foregoing certification is being furnished solely pursuant to 18 U.S.C.
Section 1350 and is not being filed as part of the Report or as a separate
disclosure document.
_______________________________
1