DPL Inc. and The Dayton Power and Light Company
Index
2 DPL Inc. and The Dayton Power and Light Company file current, annual and quarterly reports, proxy statements (as to DPL Inc.) and other information required by the Securities Exchange Act of 1934, as amended, with the Securities and Exchange Commission (SEC). You may read and copy any document we file at the SEC’s public reference room located at 100 F Street N.E., Washington, D.C. 20549, USA. Please call the SEC at (800) SEC-0330 for further information on the public reference rooms. Our SEC filings are also available to the public from the SEC’s web site at http:// Our public internet site is http:// In addition, our public internet site includes other items related to corporate governance matters, including, among other things, our governance guidelines, charters of various committees of the Board of Directors and our code of business conduct and ethics applicable to all employees, officers and directors. You may obtain copies of these documents, free of charge, by sending a request, in writing, to DPL Investor Relations, 1065 Woodman Drive, Dayton, Ohio 45432. Part 1 This report includes the combined filing of DPL Inc. (DPL) and The Dayton Power and Light Company (DP&L). DP&L is the principal subsidiary of DPL providing approximately 99% of DPL’s total consolidated revenue and approximately
Item 1
DPL INC. CONDENSED CONSOLIDATED
See Notes to Condensed Consolidated Financial Statements.
See Notes to Condensed Consolidated Financial Statements. These interim statements are unaudited.
DPL INC. CONDENSED CONSOLIDATED BALANCE SHEET
See Notes to Condensed Consolidated Financial Statements. These interim statements are unaudited. DPL INC. CONDENSED CONSOLIDATED BALANCE SHEET
See Notes to Condensed Consolidated Financial Statements. These interim statements are unaudited. THE DAYTON POWER AND LIGHT COMPANY CONDENSED CONSOLIDATED STATEMENT OF RESULTS OF OPERATIONS
See Notes to Condensed Consolidated Financial Statements. These interim statements are unaudited. THE DAYTON POWER AND LIGHT COMPANY CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
See Notes to Condensed Consolidated Financial Statements. These interim statements are unaudited 9 THE DAYTON POWER AND LIGHT COMPANY CONDENSED CONSOLIDATED BALANCE SHEET
See Notes to Condensed Consolidated Financial Statements. These interim statements are unaudited. THE DAYTON POWER AND LIGHT COMPANY CONDENSED CONSOLIDATED BALANCE SHEET
See Notes to Condensed Consolidated Financial Statements. These interim statements are unaudited. Notes to Condensed Consolidated Financial Statements 1. Basis of Presentation Description of Business DPL is a diversified regional energy company organized in 1985 under the laws of Ohio. DPL’s principal subsidiary is The Dayton Power and Light Company (DP&L). DP&L is a public utility incorporated in 1911 under the laws of Ohio. DP&L sells electricity to residential, commercial, industrial and governmental customers in a 6,000 square mile area of West Central Ohio. Electricity for DP&L’s 24 county service area is primarily generated at eight coal-fired power plants and is distributed to more than 500,000 retail customers. DP&L also purchases retail peak load requirements from DPL Energy LLC (DPLE, one of our wholly-owned subsidiaries). Principal industries served include automotive, food processing, paper, plastic manufacturing, and defense. DP&L’s sales reflect the general economic conditions and seasonal weather patterns of the area. DP&L sells any excess energy and capacity into the wholesale market. DPL’s other significant subsidiaries (all of which are wholly-owned) include DPLE, which engages in the operation of peaking generating facilities; DPL Energy Resources, Inc. (DPLER), which sells retail electric energy under contract to major industrial and commercial customers in West Central Ohio; MVE, Inc., which was primarily responsible for the management of our financial asset portfolio; and Miami Valley Insurance Company (MVIC), our captive insurance company that provides insurance sources to us and our subsidiaries. DP&L has one significant subsidiary, DPL Finance Company, Inc., which is wholly-owned and provides financing to DPL, DP&L and other affiliated companies. DPL and DP&L conduct their principal business in one business segment - Electric. Financial Statement Presentation We prepare consolidated financial statements in accordance with Generally Accepted Accounting Principles (GAAP) in the United States of America. The Pursuant to the Securities and Exchange Commission (SEC) rules, certain information and footnote disclosures normally included in the annual financial statements prepared in accordance with GAAP have been omitted from interim reports. Therefore, these financial statements should be read along with the annual financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2006. In the opinion of our management, the condensed consolidated financial statements contain all adjustments (which are all of a normal recurring nature) necessary to fairly state our financial condition as of Estimates, Judgments and Reclassifications The preparation of financial statements in conformity with GAAP requires us to make estimates and judgments that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the revenue and expenses of the period reported. Different estimates could have a material effect on our financial results. Judgments and uncertainties affecting the application of these estimates may result in materially different amounts being reported under different conditions or circumstances. Significant items subject to such estimates and judgments include the carrying value of property, plant and equipment; unbilled revenues; the valuation of derivative instruments; the valuation of insurance and claims costs; valuation allowances for receivables and deferred income taxes; regulatory assets and liabilities; reserves recorded for income tax exposures; litigation; and assets and liabilities related to employee benefits. Actual results may differ from those estimates. Certain amounts from prior periods have been reclassified to conform to the current reporting presentation. Depreciation Expense Depreciation expense is calculated using the straight-line method, which depreciates the cost of property over its estimated useful life. For DPL’s and DP&L’s generation, transmission, and distribution assets, straight-line depreciation is applied on an average annual composite basis using group rates. With the addition of scrubbers at certain of its generation facilities, DP&L has undertaken an evaluation of its depreciation rates which it expects to be completed during the third quarter of 2007. Management expects depreciation rates to decrease due to the extension of depreciation lives for certain of its assets. The Public Utility Commission of Ohio would need to approve a change in depreciation rates for our regulated assets. Recently Adopted Accounting Standards Accounting for Uncertainty in Income Taxes On January 1, 2007, we adopted Financial Accounting Standards Board (FASB) Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (FIN 48). There was no significant impact to our overall results of operations, cash flows or financial position. The total amount of unrecognized tax benefits as of the date of adoption was $36.8 million and we have recorded $3.5 million (net of tax) of accrued interest. We recognize interest and penalties related to unrecognized tax benefits in income taxes. Taxes for calendar years 2004 Accounting for Taxes Collected from Customers and Remitted to Governmental Authorities
Recently Issued Accounting Standards Accounting for Fair Value Measurements In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, “Fair Value Measurements,” (SFAS 157) effective for fiscal years beginning after November 15, 2007. SFAS 157 applies whenever other standards require (or permit) assets or liabilities to be measured at fair value. SFAS 157 clarifies the 2. Earnings per Share Basic earnings per share (EPS) is based on the weighted-average number of DPL common shares outstanding during the year. Diluted earnings per share is based on the weighted-average number of DPL common and common equivalent shares outstanding during the year, except in periods where the inclusion of such common equivalent shares is anti-dilutive. Excluded from outstanding shares for this weighted-average computation are the unallocated shares held by DP&L’s Master Trust Plan for deferred compensation and unallocated shares held by DP&L’s Employee Stock Ownership Plan (ESOP). As a result of the May 21, 2007 settlement of the litigation with three former executives (see Note 10 of Notes to Condensed Consolidated Financial Statements), the three former executives relinquished all of their rights to certain deferred compensation, restricted stock units (RSUs), MVE incentives, stock options and reimbursement of legal fees. There were approximately 1.3 million RSUs and 3.6 million stock options relinquished and cancelled that were included in the dilutive share calculation through May 20, 2007. These RSUs and stock options will no longer be included in the dilutive share calculation. For the The following illustrates the reconciliation of the numerators and denominators of the basic and diluted earnings per share computations for income after discontinued operations:
14 3. Discontinued Operations
On February 13, 2005, DPL’s subsidiaries, MVE and MVIC, entered into an agreement to sell their respective interests in forty-six private equity funds to AlpInvest/Lexington 2005, LLC, a joint venture of AlpInvest Partners and Lexington Partners, Inc. Sales proceeds and any related gains or losses were recognized during 2005 as the sale of each During 2005, MVE entered into alternative closing arrangements with AlpInvest/Lexington 2005, LLC for the remaining funds where legal title to said funds could not be transferred until a later time. Pursuant to these arrangements, MVE transferred the economic aspects of the remaining private equity funds, consisting of two funds and a portion of one fund, to AlpInvest/Lexington 2005, LLC without a change in ownership of the interests. The alternative arrangements resulted in a 2005 deferred gain of $27.1 million in 2005 and
4. Supplemental Financial Information DPL Inc.
(a) The sale of $283.5 million of assets held for sale at December 31, 2006 was completed on April 25, 2007.
4. Supplemental Financial Information (Continued) DPL Inc.
DP&L
18
Sale of Peaking Units On April 25, 2007, DPLE completed the sale of its Darby and Greenville electric peaking generation facilities providing DPL with approximately $151 million in cash. Darby Station was sold to Columbus Southern Power Company, a utility subsidiary of American Electric Power Company (AEP), for approximately $102 million in cash. Greenville Station was sold to Buckeye Power, Inc.
for approximately $49 million in cash.
Sale of Corporate Aircraft On June 7, 2007, Miami Valley CTC, Inc. (indirect wholly-owned subsidiary of DPL), sold its corporate aircraft and associated inventory and parts for $7.4 million. The net book value of the assets In relation to this sale, Miami Valley CTC, Inc., placed in escrow approximately $2.2 million. These funds are listed as the caption “Restricted funds held in trust” in the Condensed Consolidated Balance Sheet for DPL. These funds were released from escrow on July 12, 2007. 6. Pension and Postretirement Benefits We sponsor a defined benefit plan for substantially all full-time employees. For collective bargaining employees, the defined benefits are based on a specific dollar amount per year of service. For all other employees, the defined benefit plan is based primarily on compensation and years of service. We fund pension plan benefits as accrued in accordance with the minimum funding requirements of the Employee Retirement Income Security Act of 1974, as amended (ERISA). In addition, we have a Supplemental Executive Retirement Plan (SERP) for certain active and retired key executives. Benefits under this SERP have been frozen and no additional benefits can be earned. Wealso have unfunded liabilities related to retirement benefits for certain active, terminated and retired key executives (not related to the litigation settlement with three former executives) that include The DPL Inc. Supplemental Executive Defined Contribution Retirement Plan (SEDCRP). These liabilities totaled approximately $0.8 million at June 30, 2007. Qualified employees who retired prior to 1987 and their dependents are eligible for health care and life insurance benefits. We have funded the union-eligible health benefit using a Voluntary Employee Beneficiary Association Trust. The net periodic benefit costs of the pension and postretirement benefit plans for the quarter ended June 30, 2007 and 2006 were: Net periodic benefit cost
(a)The market-related value of assets is equal to the fair value of assets at implementation with subsequent asset gains and losses recognized in the market-value systematically over a three-year period. The net periodic benefit costs of the pension and postretirement benefit plans for the six months ended June 30, 2007 and 2006 were: Net periodic benefit cost
(a)The market-related value of assets is equal to the fair value of assets at implementation with subsequentasset gains and losses recognized in the market-value systematically over a three-year period. (b)In 2006, a special termination benefit cost was recognized as a result of 16 employees who participated in a voluntary early retirement program and retired at various dates during 2006; this program was completed as of April 1, 2006. The following estimated benefit payments, which reflect future service, are expected to be paid as follows: Estimated Future Benefit Payments
7. Share-Based Compensation As a result of the May 21, 2007 settlement of the litigation with three former executives (see Note 10 of the Notes to the Condensed Consolidated Financial Statements), the three former executives relinquished all of their rights to certain deferred compensation, restricted stock units (RSUs), MVE incentives, stock options and reimbursement of legal fees. A portion of this settlement included the forfeitures and cancellations of RSUs and stock options of 1.3 million and 3.6 million, respectively. The following table summarizes share-based compensation expense:
Share-based awards issued in DPL’s common stock will be distributed from treasury stock. DPL believes it has sufficient treasury stock to satisfy all outstanding share-based awards. Determining Fair Value Valuation and Amortization Method. We estimate the fair value of stock options and RSUs using a Black-Scholes-Merton model; performance shares are Expected Volatility. The Company’s expected volatility assumptions are based on the historical volatility of DPL’s stock. The volatility range captures the high and low volatility values for Expected Life. The expected life assumption represents the estimated period of time from grant until exercise and reflects historical employee exercise patterns. Risk-Free Interest Rate. The risk-free interest rate for the expected term of the award is based on the corresponding yield curve in effect at the time of the valuation for U.S. Treasury bonds having the same term as the expected life of the award, i.e., a five year bond rate is used for valuing an award with a five year expected life. Expected Dividend Yield. The expected dividend yield is based on DPL’s current dividend rate, adjusted as necessary to capture anticipated dividend changes and the 12 month average DPL Inc. stock price. Expected Forfeitures. The forfeiture rate used to calculate compensation expense is based on the Company’s historical experience, adjusted as necessary to reflect special circumstances. Stock Options In 2000, DPL’s Board of Directors adopted, and DPL’s shareholders approved, The DPL Inc. Stock Option Plan. On April 26, 2006, DPL’s shareholders approved The DPL Inc. 2006 Equity and Performance Incentive Plan (EPIP). With the approval of the EPIP, no new awards will be granted under The DPL Inc. Stock Option Plan, but shares relating to awards that are forfeited or terminated under The DPL Inc. Stock Option Plan may be granted under the EPIP. There are currently 10,000 unvested stock options outstanding under The DPL Inc. Stock Option Plan that will vest as of December 21, 2007. The schedule of option activity for the six months ended June 30, 2007 was as follows:
Summarized stock option activity was as follows:
(a) As a result of the settlement of the former executive litigation on May 21, 2007, 3.6 million outstanding options shown above were forfeited in the second quarter of 2007 and another approximately one million disputed options not shown above were also forfeited.
The following table reflects information about stock option activity during the period:
The following table shows the assumptions used in the Black-Scholes-Merton model to calculate the fair value of the non-vested stock options at the time of grant:
No options were granted during 2006 and 2007. Restricted Stock Units (RSUs) RSUs were granted to certain key employees prior to 2001. As a result of the settlement of the former executive litigation, all disputed RSUs were forfeited by the three former executives. There were 49,998 RSUs outstanding as of June 30, 2007, of which all have not vested. The non-vested RSUs will be paid in cash upon vesting and will vest as follows: 20,097 in the second half of 2007; 14,688 in 2008; 10,205 in 2009; and 5,008 in 2010. Non-vested RSUs are valued quarterly at fair value using the Black-Scholes-Merton model to determine the amount of compensation expense to be recognized. Non-vested RSUs do not earn dividends.
Summarized RSU activity was as follows:
Compensation expense is recognized each quarter based on the change in the market price of DPL common shares. As of June 30, 2007 and 2006, liabilities recorded for outstanding RSUs were $1.4 million and $35.7 million, respectively, which are included in “Other deferred credits” on the Condensed Consolidated Balance Sheets. The decrease in the liability is due to the executive litigation settlement and the forfeiture of 1.3 million RSUs (see Note 10 to Condensed Consolidated Financial Statements). The following table shows the assumptions used in the Black-Scholes-Merton model to calculate the fair value of the non-vested RSUs during the respective periods:
Performance Shares Under the EPIP, the Board adopted a Long-Term Incentive Plan (LTIP) under which DPL will award a targeted number of performance shares of common stock to executives. Awards under the LTIP will be awarded based on a Total Shareholder Return Relative to Peers performance. No performance shares will be earned in a performance period if the three-year Total Shareholder Return Relative to Peers is below the threshold of the 40th percentile. Further, the LTIP awards will be capped at 200% of the target number of performance shares, if the Total Shareholder Return Relative to Peers is at or above the threshold of the 90th percentile. The Total Shareholder Return Relative to Peers is considered a market condition under FAS 123R. There is a three year requisite service period for each tranche of the Performance Shares. The schedule of non-vested performance share activity for the six months ended June 30, 2007 follows:
24 The following table reflects information about performance share activity during the period:
The following table shows the assumptions used in the Monte Carlo Simulation to calculate the fair value of the performance shares granted during the period:
Under the EPIP, the Board granted shares of DPL Restricted Shares to various executives. The Restricted Shares are to be registered in the executive’s name, receive dividends as declared and paid on all DPL common stock and will vest after a specified service period. During the second quarter of 2007, 11,400 restricted shares were awarded.
The following table reflects information about restricted share activity during the period:
Under the EPIP, as part of their annual compensation for service to DPL and DP&L, each non-employee Director received a $54,000 retainer in restricted stock units (RSUs) on the date of the annual meeting. The RSUs will become non-forfeitable on April 15 of the following year but, if the Director resigns, dies or retires prior to the April 15 vesting date, the vested shares will be distributed on a pro rata basis. The RSUs accrue quarterly dividends in the form of additional RSUs. Upon vesting, the RSUs will become exercisable and will be distributed in DPL common shares, unless the Director chooses to defer receipt of the shares until a later date. The RSUs are valued at the closing stock price on the day prior to the grant and the compensation expense is recognized evenly over the vesting period.
The following table reflects information about non-employee Director RSU activity during the period:
8. Long-Term Debt and Notes Payable DPL Inc.
(a)DP&L’s unamortized debt discount was $(1.2) million and $(1.2) million for June 30, 2007 and December 31, 2006, respectively. DP&L
At June 30, 2007, DP&L’s scheduled maturities of long-term debt, including capital lease obligations, over the next five years are $0.4 million for the remainder of 2007, $0.7 million in 2008, $0.8 million in 2009, $0.6 million in 2010 and none in 2011. Substantially all property of DP&L is subject to the mortgage lien securing the first mortgage bonds. During the first quarter of 2006, the Ohio Department of Development (ODOD) awarded DP&L the ability to issue over the next three years up to $200 million of qualified tax-exempt financing from the ODOD’s 2005 volume cap carryforward. The financing is to be used to partially fund the ongoing flue gas desulfurization (FGD) capital projects. On September 13, 2006, the Ohio Air Quality Development Authority (OAQDA) issued $100 million of 4.80% fixed interest rate OAQDA Revenue Bonds 2006 Series A due September 1, 2036. In turn, DP&L borrowed these funds from the OAQDA. These funds were placed in escrow with a trustee and, as of April 3, 2007, DP&L has drawn out the entirety of the funds. DP&L is considering issuing in conjunction with the OAQDA another series of tax-exempt bonds to finance the remaining qualifying solid waste disposal facility costs at Miami Fort, Killen and Stuart Generating Stations. On November 21, 2006, DP&L entered into a new $220 million unsecured revolving credit agreement replacing its $100 million facility. This new agreement has a five-year term that expires November 21, 2011 and provides DP&L with the ability to increase the size of the facility by an additional $50 million at any time. The facility contains one financial covenant: DP&L’s total debt to total capitalization ratio is not to exceed 0.65 to 1.00. This covenant is currently met. As of June 30, 2007, DP&L had no borrowings outstanding under this facility. Fees associated with this credit facility are approximately $0.2 million per year. Changes in credit ratings, however, may affect fees and the applicable interest rate. This revolving credit agreement also contains a $50 million letter of credit sublimit. DP&L has certain contractual agreements for the sale and purchase of power, fuel and related energy services that contain credit rating related clauses allowing the counter parties to seek additional surety under certain conditions. As of June 30, 2007, DP&L had no outstanding letters of credit against the facility. During the second quarter of 2007, DPL entered into a short-term loan to DP&L for $105 million. There are no other inter-company debt collateralizations or debt guarantees between DPL, DP&L and their subsidiaries. None of the debt obligations of DPL or DP&L are guaranteed or secured by affiliates and no cross-collateralization exists between any subsidiaries. 9. Commitments and Contingencies
We enter into various contractual obligations and other commercial commitments that may affect the liquidity of our operations. At June 30, 2007, these include: Contractual Obligations
(a) DP&L-operated units Long-term debt: DPL’s long-term debt as of June 30, 2007 consists of DP&L’s first mortgage bonds and tax-exempt pollution control bonds, DPL unsecured notes and includes current maturities and unamortized debt discounts. DP&L’s long-term debt as of June 30, 2007 consists of first mortgage bonds, tax-exempt pollution control bonds and includes an unamortized debt discount. See Note 8 of Notes to Condensed Consolidated Financial Statements. Interest payments: Interest payments associated with the long-term debt described above. Pension and postretirement payments: As of June 30, 2007, DP&L had estimated future benefit payments as outlined in Note 6 of Notes to Condensed Consolidated Financial Statements. These estimated future benefit payments are projected through 2016. Capital leases: As of June 30, 2007, DP&L had two capital leases that expire in November 2007 and September 2010. Operating leases: As of June 30, 2007, DPL and DP&L had several operating leases with various terms and expiration dates. Not included in this total is approximately $88,000 per year related to right-of-way agreements that are assumed to have no definite expiration dates. Coal contracts: DP&L has entered into various long-term coal contracts to supply portions of its coal requirements for its generating plants. Contract prices are subject to periodic adjustment and have features that limit price escalation in any given year. Limestone contracts: DP&L has entered into a limestone contract to supply limestone for its generating facilities. Reserve for uncertain tax positions: On January 1, 2007, we adopted Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (FIN 48). There was no significant impact to our overall results of operations, cash flows or financial position. The total amount of unrecognized tax benefits as of the date of adoption was $36.8 million and we have recorded $3.5 million (net of tax) of accrued interest. During the second quarter ending June 30, 2007, we recorded an additional $0.9 million in accrued interest resulting in a total reserve for uncertain tax positions of $41.2 million as of June 30, 2007. None of the amount of unrecognized tax benefits is due to uncertainty in the timing of deductibility. Other contractual obligations: As of June 30, 2007, DPL and DP&L had various other contractual obligations including non-cancelable contracts to purchase goods and services with various terms and expiration dates. We enter into various commercial commitments, which may affect the liquidity of our operations. At June 30, 2007, these include: Credit facilities: In November 2006, DP&L replaced its previous $100 million revolving credit agreement with a $220 million five-year facility that expires on November 21, 2011. DP&L has the ability to increase the size of the facility by an additional $50 million at any time. At June 30, 2007, there were no outstanding borrowings under this facility. Guarantees: DP&L owns a 4.9% equity ownership interest in an electric generation company. As of June 30, 2007, DP&L could be responsible for the repayment of 4.9%, or $21.8 million, of a $445 million debt obligation that matures in 2026. In two separate transactions in November and December 2006, DPL agreed to be a guarantor of the obligations of its wholly-owned subsidiary, DPL Energy, LLC (DPLE) regarding the sale of the Darby Electric Peaking Station to American Electric Power and the sale of the Greenville Electric Peaking Station to Buckeye Electric Power, Inc. In both cases, DPL has agreed to guarantee the obligations of DPLE over a multiple year period as follows:
Contingencies In the normal course of business, we are subject to various lawsuits, actions, proceedings, claims and other matters asserted under laws and regulations. We believe the amounts provided in our Condensed Consolidated Financial Statements, as prescribed by GAAP, are adequate in light of the probable and estimable contingencies. However, there can be no assurances that the actual amounts required to satisfy alleged liabilities from various legal proceedings, claims, tax examinations and other matters discussed below, and to comply with applicable laws and regulations, will not exceed the amounts reflected in our Condensed Consolidated Financial Statements. As such, costs, if any, that may be incurred in excess of those amounts provided as of June 30, 2007, cannot be reasonably determined. Employees Approximately 53% of our employees are under a collective bargaining agreement. Environmental Matters DPL, DP&L and our subsidiaries’ facilities and operations are subject to a wide range of environmental regulations and law. In the normal course of business, we have investigatory and remedial activities underway at these facilities to comply, or to determine compliance, with such regulations. We have been identified, either by a government agency or by a private party seeking contribution to site clean-up costs, as a potentially responsible party (PRP) at two sites pursuant to state and federal laws. We record liabilities for probable estimated loss in accordance with Statement of Financial Accounting Standards No. 5 (SFAS 5), “Accounting for Contingencies.” To the extent a probable loss can only be estimated by reference to a range of equally probable outcomes, and no amount within the range appears to be a better estimate than any other amount, we accrue for the low end of the range. Because of uncertainties related to these matters, accruals are based on the best information available at the time. We evaluate the potential liability related to probable losses quarterly and may revise our estimates. Such revisions in the estimates of the potential liabilities could have a material effect on our results of operations and financial position. In September 2004, the Sierra Club filed a lawsuit against DP&L and the other owners of the Stuart Generating Station in the United States District Court for the Southern District of Ohio for alleged violations of the Clean Air Act (CAA) and the Station’s operating permit. DP&L, on behalf of all co-owners, is leading the defense of this matter. A sizable amount of discovery has taken place, the first set of expert reports have been filed with additional reports scheduled to be filed in September 2007. Dispositive motions are to be filed in January 2008. No trial date has been set yet. In February 2007, Ohio’s Regional Air Pollution Control Agency (RAPCA), issued a Notice of Violation (NOV) to DP&L with respect to an allegedly failed performance test of one boiler in November 2006 for particulate matter at DP&L’s Hutchings Generating Station. On June 29, 2007, the federal Environmental Protection Agency Region V, issued an NOV to DP&L with respect to the same performance test and with respect to earlier tests for particulates conducted in 1996 and 1998 for a different boiler at the same station. Representatives from DP&L met with officials from EPA Region V and RAPCA on July 24, 2007 to discuss the referenced performance tests, subsequent performance tests, and past and planned operations at the station. DP&L is unable to predict at this time what further actions, if any, will be taken by the US EPA or RAPCA with respect to these NOVs. 10. Executive Litigation On May 21, 2007, we settled the litigation with the three former executives. As part of this settlement, the three former executives relinquished and dismissed all their claims including those related to certain deferred compensation, RSUs, MVE incentives, stock options and legal fees. The RSUs and stock options relinquished and forfeited were 1.3 million and 3.6 million, respectively. Prior to the settlement date, DPL had accrued obligations of approximately $64.2 million of which DP&L had accrued obligations of approximately $60.3 million. Included in these amounts is approximately $3.1 million associated with the forfeiture of stock options. In exchange for our payment of $25 million, all of these claims were settled. As a result of this settlement, DPL realized a net pre-tax gain in continuing and discontinued operations of approximately $31.0 million and $8.2 million, respectively. The net gain is comprised of the reversal of the $64.2 million of accrued obligations less the $25 million settlement. The obligations related to the discontinued operations were associated with the management of DPL’s financial asset portfolio, which was conducted in our MVE subsidiary. The MVE operations were discontinued in 2005 with the sale of the financial asset portfolio. The $25 million settlement expense was allocated between continuing and discontinued operations based on the proportionate share of continuing and discontinued obligations. The following table outlines the components of DPL’s net pre-tax gain for continuing and discontinued operations:
As a result of this settlement, DP&L realized a net pre-tax gain in continuing operations of approximately $35.3 million. Accrued obligations associated with the former executives’ litigation were recorded by DP&L since the obligations were associated with our non-qualified benefit plans. DP&L had no ownership of DPL’s discontinued financial asset portfolio business, therefore these liabilities were reversed and DP&L’s net pre-tax gain was recorded within continuing operations. The following table outlines the components of DP&L’s net gain:
The $25 million settlement was funded from the sale of financial assets held in DP&L’s Master Trust Plan for deferred compensation. As part of this transaction, DPL and DP&L recorded a $3.2 million realized gain which is reflected in investment income. 11. Insurance Recovery Claim On April 30, 2007, DP&L executed a settlement agreement with one of our insurers, Associated Electric & Gas Insurance Services (AEGIS), under a fiduciary liability policy to recoup a portion of legal fees associated with our litigation against the three former executives for $14.5 million. This was recorded as a reduction to operation and maintenance expense during the quarter ended June 30, 2007. On May 16, 2007, DPL and DP&L notified one of our insurers, Energy Insurance Mutual Limited, under an umbrella fiduciary liability policy, of our intent to pursue a claim for legal fees that DPL and DP&L incurred in defending claims made by the three former executives. 12. Regulatory Matters We apply the provisions of SFAS 71 to our regulated operations. This accounting standard defines regulatory assets as the deferral of costs expected to be recovered in future customer rates and regulatory liabilities as current cost recovery of expected future expenditures. Regulatory liabilities are reflected on the Condensed Consolidated Balance Sheet under the caption entitled “Other Deferred Credits”. Regulatory assets and liabilities on the Condensed Consolidated Balance Sheet include:
Regulatory Assets We evaluate our regulatory assets each period and believe recovery of these assets is probable. We have received or requested a return on certain regulatory assets for which we are currently recovering or seeking recovery through rates. Deferred recoverable income taxes represent deferred income tax assets recognized from the normalization of flow-through items as the result of amounts previously provided to customers. Since currently existing temporary differences between the financial statements and the related tax basis of assets will reverse in subsequent periods, deferred recoverable income taxes are amortized. Pension and postretirement benefits represent the unfunded benefit obligation related to the transmission and distribution areas of our electric business. We have historically recorded these costs on the accrual basis and this is how these costs have been historically recovered through rates. This factor, combined with the historical precedents from the PUCO and the FERC, makes future rate recovery of these costs probable. Electric Choice systems costs represent costs incurred to modify the customer billing system for unbundled rates and electric choice bills relative to other generation suppliers and information reports provided to the state administrator of the low-income electric program. In February 2005, the PUCO approved a stipulation allowing us to recover certain costs incurred for modifications to its billing system from all customers in its service territory. We filed a subsequent case to implement the PUCO’s order to begin charging customers for billing costs. On March 1, 2006, the PUCO issued an order that approved our tariff as filed. We began collecting this rider immediately, and expect to recover all costs over five years. Regional transmission organization costs represent costs incurred to join a Regional Transmission Organization (RTO) that controls the receipts and delivery of bulk power within the service area. These costs are being amortized over a 10-year period that commenced in October 2004. Deferred storm costs include costs incurred by us to repair damage from December 2004 and January 2005 ice storms. On July 12, 2006, the PUCO approved our tariff as proposed and we began recovering these deferred costs over a two-year period beginning August 1, 2006. 34 PJM administrative costs contain the administrative fees billed to us by PJM Interconnection, L.L.C. (PJM) as a member of Power plant emission fees represent costs paid to the State of Ohio for environmental monitoring that are or will be recovered over various periods under a PUCO rate rider from customers. Retail settlement system costs represent costs to implement a retail settlement system that reconciles the amount of energy a competitive retail electric service (CRES) supplier delivers to its customers and what its customers actually use. Based on case precedent in other utilities’ cases, the cost of this system is recoverable through PJM integration costs include infrastructure costs and other related expenses incurred by PJM and reimbursed by DP&L to integrate us into the RTO. Pursuant to a FERC order, the costs are being recovered over a 10-year period beginning May 2005 from wholesale customers within PJM. Rate case expenses represent costs incurred in connection with the Rate Stabilization Surcharge that was approved by the PUCO and implemented in January 2006. These costs are being amortized over a five-year period. Other costs include consumer education advertising regarding electric deregulation and costs pertaining to a recent rate case and are or will be recovered over various periods.
7. Share-Based Compensation As a result of the May 21, 2007 settlement of the litigation with three former executives (see Note 10 of the Notes to the Condensed Consolidated Financial Statements), the three former executives relinquished all of their rights to certain deferred compensation, restricted stock units (RSUs), MVE incentives, stock options and reimbursement of legal fees. A portion of this settlement included the forfeitures and cancellations of RSUs and stock options of 1.3 million and 3.6 million, respectively. The following table summarizes share-based compensation expense:
Share-based awards issued in DPL’s common stock will be distributed from treasury stock. DPL believes it has sufficient treasury stock to satisfy all outstanding share-based awards. Determining Fair Value Valuation and Amortization Method. We estimate the fair value of stock options and RSUs using a Black-Scholes-Merton model; performance shares are valued using a Monte Carlo simulation; restricted shares are valued at the market price on the day of grant and the Directors’ RSUs are valued at the market price on the day prior to the grant date. We amortize the fair value of all awards on a straight-line basis over the requisite service periods, which are generally the vesting periods. Expected Volatility. The Company’s expected volatility assumptions are based on the historical volatility of DPL’s stock. The volatility range captures the high and low volatility values for each award granted based on its specific terms. Expected Life. The expected life assumption represents the estimated period of time from grant until exercise and reflects historical employee exercise patterns. Risk-Free Interest Rate. The risk-free interest rate for the expected term of the award is based on the corresponding yield curve in effect at the time of the valuation for U.S. Treasury bonds having the same term as the expected life of the award, i.e., a five year bond rate is used for valuing an award with a five year expected life. Expected Dividend Yield. The expected dividend yield is based on DPL’s current dividend rate, adjusted as necessary to capture anticipated dividend changes and the 12 month average DPL Inc. stock price. Expected Forfeitures. The forfeiture rate used to calculate compensation expense is based on the Company’s historical experience, adjusted as necessary to reflect special circumstances. Stock Options In 2000, DPL’s Board of Directors adopted, and DPL’s shareholders approved, The DPL Inc. Stock Option Plan. On April 26, 2006, DPL’s shareholders approved The DPL Inc. 2006 Equity and Performance Incentive Plan (EPIP). With the approval of the EPIP, no new awards will be granted under The DPL Inc. Stock Option Plan, but shares relating to awards that are forfeited or terminated under The DPL Inc. Stock Option Plan may be granted under the EPIP. There are currently 10,000 unvested stock options outstanding under The DPL Inc. Stock Option Plan that will vest as of December 21, 2007. The schedule of option activity for the six months ended June 30, 2007 was as follows:
Summarized stock option activity was as follows:
(a) As a result of the settlement of the former executive litigation on May 21, 2007, 3.6 million outstanding options shown above were forfeited in the second quarter of 2007 and another approximately one million disputed options not shown above were also forfeited. The following table reflects information about stock options outstanding at June 30, 2007:
The following table reflects information about stock option activity during the period:
The following table shows the assumptions used in the Black-Scholes-Merton model to calculate the fair value of the non-vested stock options at the time of grant:
No options were granted during 2006 and 2007. Restricted Stock Units (RSUs)
RSUs were granted to certain key employees prior to 2001. As a result of the settlement of the former executive litigation, all disputed RSUs were forfeited by the three former executives. There were 49,998 RSUs outstanding as of June 30, 2007, of which all have not vested. The non-vested RSUs will be paid in cash upon vesting and will vest as follows: 20,097 in the second half of 2007; 14,688 in 2008; 10,205 in 2009; and 5,008 in 2010. Non-vested RSUs are valued quarterly at fair value using the Black-Scholes-Merton model to determine the amount of compensation expense to be recognized. Non-vested RSUs do not earn dividends.
Summarized RSU activity was as follows:
Compensation expense is recognized each quarter based on the change in the market price of DPL common shares. As of June 30, 2007 and 2006, liabilities recorded for outstanding RSUs were $1.4 million and $35.7 million, respectively, which are included in “Other deferred credits” on the Condensed Consolidated Balance Sheets. The decrease in the liability is due to the executive litigation settlement and the forfeiture of 1.3 million RSUs (see Note 10 to Condensed Consolidated Financial Statements). The following table shows the assumptions used in the Black-Scholes-Merton model to calculate the fair value of the non-vested RSUs during the respective periods:
Performance Shares Under the EPIP, the Board adopted a Long-Term Incentive Plan (LTIP) under which DPL will award a targeted number of performance shares of common stock to executives. Awards under the LTIP will be awarded based on a Total Shareholder Return Relative to Peers performance. No performance shares will be earned in a performance period if the three-year Total Shareholder Return Relative to Peers is below the threshold of the 40th percentile. Further, the LTIP awards will be capped at 200% of the target number of performance shares, if the Total Shareholder Return Relative to Peers is at or above the threshold of the 90th percentile. The Total Shareholder Return Relative to Peers is considered a market condition under FAS 123R. There is a three year requisite service period for each tranche of the Performance Shares. The schedule of non-vested performance share activity for the six months ended June 30, 2007 follows:
24 The following table reflects information about performance share activity during the period:
The following table shows the assumptions used in the Monte Carlo Simulation to calculate the fair value of the performance shares granted during the period:
Restricted Shares Under the EPIP, the Board granted shares of DPL Restricted Shares to various executives. The Restricted Shares are to be registered in the executive’s name, receive dividends as declared and paid on all DPL common stock and will vest after a specified service period. During the second quarter of 2007, 11,400 restricted shares were awarded.
The following table reflects information about restricted share activity during the period:
Non-Employee Director Restricted Stock Units Under the EPIP, as part of their annual compensation for service to DPL and DP&L, each non-employee Director received a $54,000 retainer in restricted stock units (RSUs) on the date of the annual meeting. The RSUs will become non-forfeitable on April 15 of the following year but, if the Director resigns, dies or retires prior to the April 15 vesting date, the vested shares will be distributed on a pro rata basis. The RSUs accrue quarterly dividends in the form of additional RSUs. Upon vesting, the RSUs will become exercisable and will be distributed in DPL common shares, unless the Director chooses to defer receipt of the shares until a later date. The RSUs are valued at the closing stock price on the day prior to the grant and the compensation expense is recognized evenly over the vesting period.
The following table reflects information about non-employee Director RSU activity during the period:
8. Long-Term Debt and Notes Payable DPL Inc.
(a)DP&L’s unamortized debt discount was $(1.2) million and $(1.2) million for June 30, 2007 and December 31, 2006, respectively. DP&L
At June 30, 2007, DPL’s scheduled maturities of long-term debt, including capital lease obligations, over the next five years are $0.4 million for the remainder of 2007, $100.7 million in 2008, $175.8 million in 2009, $0.6 million in 2010 and $297.4 million in 2011. At June 30, 2007, DP&L’s scheduled maturities of long-term debt, including capital lease obligations, over the next five years are $0.4 million for the remainder of 2007, $0.7 million in 2008, $0.8 million in 2009, $0.6 million in 2010 and none in 2011. Substantially all property of DP&L is subject to the mortgage lien securing the first mortgage bonds. During the first quarter of 2006, the Ohio Department of Development (ODOD) awarded DP&L the ability to issue over the next three years up to $200 million of qualified tax-exempt financing from the ODOD’s 2005 volume cap carryforward. The financing is to be used to partially fund the ongoing flue gas desulfurization (FGD) capital projects. On September 13, 2006, the Ohio Air Quality Development Authority (OAQDA) issued $100 million of 4.80% fixed interest rate OAQDA Revenue Bonds 2006 Series A due September 1, 2036. In turn, DP&L borrowed these funds from the OAQDA. These funds were placed in escrow with a trustee and, as of April 3, 2007, DP&L has drawn out the entirety of the funds. DP&L is considering issuing in conjunction with the OAQDA another series of tax-exempt bonds to finance the remaining qualifying solid waste disposal facility costs at Miami Fort, Killen and Stuart Generating Stations. On November 21, 2006, DP&L entered into a new $220 million unsecured revolving credit agreement replacing its $100 million facility. This new agreement has a five-year term that expires November 21, 2011 and provides DP&L with the ability to increase the size of the facility by an additional $50 million at any time. The facility contains one financial covenant: DP&L’s total debt to total capitalization ratio is not to exceed 0.65 to 1.00. This covenant is currently met. As of June 30, 2007, DP&L had no borrowings outstanding under this facility. Fees associated with this credit facility are approximately $0.2 million per year. Changes in credit ratings, however, may affect fees and the applicable interest rate. This revolving credit agreement also contains a $50 million letter of credit sublimit. DP&L has certain contractual agreements for the sale and purchase of power, fuel and related energy services that contain credit rating related clauses allowing the counter parties to seek additional surety under certain conditions. As of June 30, 2007, DP&L had no outstanding letters of credit against the facility. During the second quarter of 2007, DPL entered into a short-term loan to DP&L for $105 million. There are no other inter-company debt collateralizations or debt guarantees between DPL, DP&L and their subsidiaries. None of the debt obligations of DPL or DP&L are guaranteed or secured by affiliates and no cross-collateralization exists between any subsidiaries. 9. Commitments and Contingencies Contractual Obligations and Commercial Commitments We enter into various contractual obligations and other commercial commitments that may affect the liquidity of our operations. At June 30, 2007, these include: Contractual Obligations
(a) DP&L-operated units
DPL’s long-term debt as of June 30, 2007 consists of DP&L’s first mortgage bonds and tax-exempt pollution control bonds, DPL unsecured notes and includes current maturities and unamortized debt discounts. DP&L’s long-term debt as of June 30, 2007 consists of first mortgage bonds, tax-exempt pollution control bonds and includes an See Note 8 of Interest payments: Interest payments associated with the long-term debt described above. Pension and postretirement payments: As of June 30, 2007, DP&L had estimated future benefit payments as outlined in Capital leases: As of June 30, 2007, DP&L had two capital leases that expire in November 2007 and September 2010. Operating leases: As of June 30, 2007, DPL and DP&L had several operating leases with various terms and expiration dates. Not included in this total is approximately $88,000 per year related to right-of-way agreements that are assumed to have no definite expiration dates. Coal contracts: DP&L has entered into various long-term coal contracts to supply portions of its coal requirements for its generating plants. Contract prices are subject to periodic adjustment and have features that limit price escalation in any given year. Limestone contracts: DP&L has entered into a limestone contract to supply limestone for its generating facilities. Reserve for uncertain tax positions: On January 1, 2007, we adopted Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (FIN 48). There was no significant impact to our overall results of operations, cash flows or financial position. The total amount of unrecognized tax benefits as of the date of adoption was $36.8 million and we have recorded $3.5 million (net of tax) of accrued interest. During the second quarter ending June 30, 2007, we recorded an additional $0.9 million in accrued interest resulting in a total reserve for uncertain tax positions of $41.2 million as of June 30, 2007. None of the amount of unrecognized tax benefits is due to uncertainty in the timing of deductibility. Other contractual obligations: As of June 30, 2007, DPL and DP&L had various other contractual obligations including non-cancelable contracts to purchase goods and services with various terms and expiration dates. We enter into various commercial commitments, which may affect the liquidity of our operations. At June 30, 2007, these include: Credit facilities: In November 2006, DP&L replaced its previous $100 million revolving credit agreement with a $220 million five-year facility that expires on November 21, 2011. DP&L has the ability to increase the size of the facility by an additional $50 million at any time. At June 30, 2007, there were no outstanding borrowings under this facility. Guarantees: DP&L owns a 4.9% equity ownership interest in an electric generation company. As of June 30, 2007, DP&L could be responsible for the repayment of 4.9%, or $21.8 million, of a $445 million debt obligation that matures in 2026. In two separate transactions in November and December 2006, DPL agreed to be a guarantor of the obligations of its wholly-owned subsidiary, DPL Energy, LLC (DPLE) regarding the sale of the Darby Electric Peaking Station to American Electric Power and the sale of the Greenville Electric Peaking Station to Buckeye Electric Power, Inc. In both cases, DPL has agreed to guarantee the obligations of DPLE over a multiple year period as follows:
Contingencies In the normal course of business, we are subject to various lawsuits, actions, proceedings, claims and other matters asserted under laws and regulations. We believe the amounts provided in our Condensed Consolidated Financial Statements, as prescribed by GAAP, are adequate in light of the probable and estimable contingencies. However, there can be no assurances that the actual amounts required to satisfy alleged liabilities from various legal proceedings, claims, tax examinations and other matters discussed below, and to comply with applicable laws and regulations, will not exceed the amounts reflected in our Condensed Consolidated Financial Statements. As such, costs, if any, that may be incurred in excess of those amounts provided as of June 30, 2007, cannot be reasonably determined. Employees Approximately 53% of our employees are under a collective bargaining agreement. Environmental Matters DPL, DP&L and our subsidiaries’ facilities and operations are subject to a wide range of environmental regulations and law. In the normal course of business, we have investigatory and remedial activities underway at these facilities to comply, or to determine compliance, with such regulations. We have been identified, either by a government agency or by a private party seeking contribution to site clean-up costs, as a potentially responsible party (PRP) at two sites pursuant to state and federal laws. We record liabilities for probable estimated loss in accordance with Statement of Financial Accounting Standards No. 5 (SFAS 5), “Accounting for Contingencies.” To the extent a probable loss can only be estimated by reference to a range of equally probable outcomes, and no amount within the range appears to be a better estimate than any other amount, we accrue for the low end of the range. Because of uncertainties related to these matters, accruals are based on the best information available at the time. We evaluate the potential liability related to probable losses quarterly and may revise our estimates. Such revisions in the estimates of the potential liabilities could have a material effect on our results of operations and financial position. In September 2004, the Sierra Club filed a lawsuit against DP&L and the other owners of the Stuart Generating Station in the United States District Court for the Southern District of Ohio for alleged violations of the Clean Air Act (CAA) and the Station’s operating permit. DP&L, on behalf of all co-owners, is leading the defense of this matter. A sizable amount of discovery has taken place, the first set of expert reports have been filed with additional reports scheduled to be filed in September 2007. Dispositive motions are to be filed in January 2008. No trial date has been set yet. In February 2007, Ohio’s Regional Air Pollution Control Agency (RAPCA), issued a Notice of Violation (NOV) to DP&L with respect to an allegedly failed performance test of one boiler in November 2006 for particulate matter at DP&L’s Hutchings Generating Station. On June 29, 2007, the federal Environmental Protection Agency Region V, issued an NOV to DP&L with respect to the same performance test and with respect to earlier tests for particulates conducted in 1996 and 1998 for a different boiler at the same station. Representatives from DP&L met with officials from EPA Region V and RAPCA on July 24, 2007 to discuss the referenced performance tests, subsequent performance tests, and past and planned operations at the station. DP&L is unable to predict at this time what further actions, if any, will be taken by the US EPA or RAPCA with respect to these NOVs. 10. Executive Litigation On May 21, 2007, we settled the litigation with the three former executives. As part of this settlement, the three former executives relinquished and dismissed all their claims including those related to certain deferred compensation, RSUs, MVE incentives, stock options and legal fees. The RSUs and stock options relinquished and forfeited were 1.3 million and 3.6 million, respectively. Prior to the settlement date, DPL had accrued obligations of approximately $64.2 million of which DP&L had accrued obligations of approximately $60.3 million. Included in these amounts is approximately $3.1 million associated with the forfeiture of stock options. In exchange for our payment of $25 million, all of these claims were settled. As a result of this settlement, DPL realized a net pre-tax gain in continuing and discontinued operations of approximately $31.0 million and $8.2 million, respectively. The net gain is comprised of the reversal of the $64.2 million of accrued obligations less the $25 million settlement. The obligations related to the discontinued operations were associated with the management of DPL’s financial asset portfolio, which was conducted in our MVE subsidiary. The MVE operations were discontinued in 2005 with the sale of the financial asset portfolio. The $25 million settlement expense was allocated between continuing and discontinued operations based on the proportionate share of continuing and discontinued obligations. The following table outlines the components of DPL’s net pre-tax gain for continuing and discontinued operations:
As a result of this settlement, DP&L realized a net pre-tax gain in continuing operations of approximately $35.3 million. Accrued obligations associated with the former executives’ litigation were recorded by DP&L since the obligations were associated with our non-qualified benefit plans. DP&L had no ownership of DPL’s discontinued financial asset portfolio business, therefore these liabilities were reversed and DP&L’s net pre-tax gain was recorded within continuing operations. The following table outlines the components of DP&L’s net gain:
The $25 million settlement was funded from the sale of financial assets held in DP&L’s Master Trust Plan for deferred compensation. As part of this transaction, DPL and DP&L recorded a $3.2 million realized gain which is reflected in investment income. 11. Insurance Recovery Claim On April 30, 2007, DP&L executed a settlement agreement with one of our insurers, Associated Electric & Gas Insurance Services (AEGIS), under a fiduciary liability policy to recoup a portion of legal fees associated with our litigation against the three former executives for $14.5 million. This was recorded as a reduction to operation and maintenance expense during the quarter ended June 30, 2007. On May 16, 2007, DPL and DP&L notified one of our insurers, Energy Insurance Mutual Limited, under an umbrella fiduciary liability policy, of our intent to pursue a claim for legal fees that DPL and DP&L incurred in defending claims made by the three former executives. 12. Regulatory Matters We apply the provisions of SFAS 71 to our regulated operations. This accounting standard defines regulatory assets as the deferral of costs expected to be Regulatory liabilities are reflected on the Condensed Consolidated Balance Sheet under the caption entitled “Other Deferred Credits”. Regulatory assets and liabilities on the Condensed Consolidated Balance Sheet include:
Regulatory Assets We evaluate our regulatory assets each period and believe recovery of these assets is probable. We have received or requested a return on certain regulatory assets for which we are currently recovering or seeking recovery through rates.
Pension and postretirement benefits Electric Choice systems costs represent costs incurred to modify the customer billing system for unbundled rates and electric choice bills relative to other generation suppliers and information reports provided to the state administrator of the low-income electric program. In February 2005, the PUCO approved a stipulation allowing us to recover certain costs incurred for modifications to its billing system from all customers in its service territory. We filed a subsequent case to implement the PUCO’s order to begin charging customers for billing costs. On March 1, 2006, the PUCO issued an order that approved our tariff as filed. We began collecting this rider immediately, and expect to recover all costs over five years. Regional transmission organization costs represent costs incurred to join a Regional Transmission Organization (RTO) that controls the receipts and delivery of bulk power within the service area. These costs are being amortized over a 10-year period that commenced in October 2004. Deferred storm costs include costs incurred by us to repair damage from December 2004 and January 2005 ice storms. On July 12, 2006, the PUCO approved our tariff as proposed and we began recovering these 34 PJM administrative costs contain the administrative fees billed to us by PJM Interconnection, L.L.C. (PJM) as a member of PJM. Pursuant to a PUCO order issued on January 25, 2006, these deferred costs will be
Retail settlement system costs PJM integration costs include infrastructure costs and
These
Other costs include consumer education advertising regarding electric deregulation and costs pertaining to a recent rate case and are or will be recovered over various periods.
Estimated Future Benefit Payments
The following table summarizes share-based compensation
Share-based awards issued in DPL’s common stock will be
Valuation and Amortization Method. We estimate the fair value of stock options and RSUs Expected Volatility. The Company’s expected volatility assumptions are based on the historical volatility of DPL’s stock. The volatility range captures the high and low volatility values for each award granted based on its specific terms. Expected Life. The expected life assumption represents the estimated period of time from grant until exercise and reflects historical employee exercise patterns. Risk-Free Interest Rate. The risk-free interest rate for the expected term of the award is based on the corresponding yield curve in effect at the time of the valuation for U.S. Treasury bonds having the same term as the expected life of the award, i.e., a five year bond rate is used for valuing an award with a five year expected life. Expected Dividend Yield. The expected dividend yield is based on DPL’s current dividend rate, adjusted as necessary to capture anticipated dividend changes and the 12 month average DPL Inc. stock price. Expected Forfeitures. The forfeiture rate used to calculate compensation expense is based on the Company’s historical experience, adjusted as necessary to reflect special circumstances. Stock Options In 2000, DPL’s Board of Directors adopted, and DPL’s shareholders approved, The DPL Inc. Stock Option Plan. On April 26, 2006, DPL’s shareholders approved The DPL Inc. 2006 Equity and Performance Incentive Plan (EPIP). With the approval of the EPIP, no new awards will be granted under The DPL Inc. Stock Option Plan, but shares relating to awards that are forfeited or terminated under The DPL Inc. Stock Option Plan may be granted under the EPIP. There are currently 10,000 unvested stock options outstanding under The DPL Inc. Stock Option Plan that will vest as of December The schedule of option activity for the
Summarized stock option activity was as follows:
(a) As a result of the settlement of the former executive litigation on May 21, 2007, 3.6 million outstanding options shown above were forfeited in the second quarter of 2007 and another approximately one million disputed options not shown above were also forfeited. The following table reflects information about stock options outstanding at June 30, 2007:
The following table reflects information about stock option activity during the period:
The following table shows the assumptions used in the Black-Scholes-Merton model to calculate the fair value of the non-vested stock options at the time of grant:
Restricted Stock Units (RSUs)
Summarized RSU activity was as follows:
Compensation expense is recognized each quarter based on the change in the market price of DPL common shares. As of June 30, 2007 and 2006, liabilities recorded for outstanding RSUs were $1.4 million and $35.7 million, respectively, which are included in “Other deferred credits” on the Condensed Consolidated Balance Sheets. The decrease in the liability is due to the executive litigation settlement and the forfeiture of 1.3 million RSUs (see Note 10 to Condensed Consolidated Financial Statements). The following table shows the assumptions used in the Black-Scholes-Merton model to calculate the fair value of the non-vested RSUs during the respective periods:
Performance Shares
Under the EPIP, the Board adopted a Long-Term Incentive Plan (LTIP) under which DPL will award a targeted number of performance shares of common stock to executives. Awards under the LTIP will be awarded based on a Total Shareholder Return Relative to Peers performance. No performance shares will be earned in a performance period if the three-year Total Shareholder Return Relative to Peers is below the threshold of the 40th percentile. Further, the LTIP awards will be capped at 200% of the target number of performance shares, if the Total Shareholder Return Relative to Peers is at or above the threshold of the 90th percentile. The Total Shareholder Return Relative to Peers is considered a market condition under FAS 123R. There is a three year requisite service period for each tranche of the Performance Shares.
The schedule of non-vested performance share activity for the
24 The following table reflects information about performance share activity during the period:
The
Restricted Shares
Under the EPIP, the Board granted shares of DPL During the
Under the EPIP, as part of their annual compensation for service to DPL and DP&L, each non-employee Director received a $54,000 retainer in restricted stock units (RSUs) on the date of the annual meeting. The RSUs will become non-forfeitable on April 15 of the following year but, if the Director resigns, dies or retires prior to the April 15 vesting date, the vested shares will be distributed on a pro rata basis. The RSUs accrue quarterly dividends in the form of additional RSUs. Upon vesting, the RSUs will become exercisable and will be distributed in DPL common shares, unless the Director chooses to defer receipt of the shares until a later date. The RSUs are valued at the closing stock price on the day prior to the grant and the compensation expense is recognized evenly over the vesting period.
The following table reflects information about non-employee Director RSU activity during the period:
8. Long-Term Debt and Notes Payable DPL Inc.
DP&L
At At
During the first quarter of 2006, the Ohio Department of Development (ODOD) awarded DP&L the ability to issue over the next three years up to $200 million of qualified tax-exempt financing from the ODOD’s 2005 volume cap carryforward. The financing is to be used to partially fund the ongoing flue gas desulfurization (FGD) capital projects. On September 13, 2006, the Ohio Air Quality Development Authority (OAQDA) issued $100 million of 4.80% fixed interest rate OAQDA Revenue Bonds 2006 Series A due September 1, 2036.
On November 21, 2006, DP&L entered into a new $220 million unsecured revolving credit agreement replacing its $100 million facility. This new agreement has a five-year term that expires November 21, 2011 and provides DP&L with the ability to increase the size of the facility by an additional $50 million at any time. The facility contains one financial covenant: DP&L’s total debt to total capitalization ratio is not to exceed 0.65 to 1.00. This covenant is currently met. As of
$105 million. There are no other inter-company debt collateralizations or debt guarantees between DPL, DP&L and their subsidiaries. None of the debt obligations of DPL or DP&L are guaranteed or secured by affiliates and no cross-collateralization exists between any subsidiaries.
Contractual Obligations and Commercial Commitments We enter into various contractual obligations and other commercial commitments that may affect the liquidity of our operations. At Contractual Obligations
(a)DP&L-operated units Long-term debt: DPL’s long-term debt as of DP&L’s long-term debt as of See Note Interest payments: Interest payments associated with the long-term debt described above. Pension and postretirement payments: As of Capital leases: As of Operating leases: As of Coal contracts: DP&L has entered into various long-term coal contracts to supply portions of its coal requirements for its generating plants. Contract prices are subject to periodic adjustment and have features that limit price escalation in any given year. Limestone contracts: DP&L has entered into Reserve for uncertain tax positions: On January 1, 2007, we adopted Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (FIN 48). There was no significant impact to our overall results of operations, cash flows or financial position. The total amount of unrecognized tax benefits as of the date of adoption was $36.8 million and we have recorded $3.5 million (net of tax) of accrued interest. During the second quarter ending June 30, 2007, we recorded an additional $0.9 million in accrued interest resulting in a total reserve for uncertain tax positions of $41.2 million as of June 30, 2007. None of the amount of unrecognized tax benefits is due to uncertainty in the timing of deductibility.
Other contractual obligations: As of We enter into various commercial commitments, which may affect the liquidity of our operations. At Credit facilities: In November 2006, DP&L replaced its previous $100 million revolving credit agreement with a $220 million five-year facility that expires on November 21, 2011. DP&L has the ability to increase the size of the facility by an additional $50 million at any time. At Guarantees: DP&L owns a 4.9% equity ownership interest in an electric generation company. As of In two separate transactions in November and December 2006, DPL agreed to be a guarantor of the obligations of its wholly-owned subsidiary, DPL Energy, LLC (DPLE) regarding the
Contingencies
In the normal course of business, we are subject to various lawsuits, actions, proceedings, claims and other matters asserted under laws and regulations. We believe the amounts provided in our Condensed Consolidated Financial Statements, as prescribed by GAAP, are adequate in light of the probable and estimable contingencies. However, there can be no assurances that the actual amounts required to satisfy alleged liabilities from various legal proceedings, claims, tax examinations and other matters discussed below, and to comply with applicable laws and regulations, will not exceed the amounts reflected in our Condensed Consolidated Financial Statements. As such, costs, if any, that may be incurred in excess of those amounts provided as of Employees Approximately 53% of our employees are under a collective bargaining agreement. Environmental Matters
DPL, DP&L and our subsidiaries’ facilities and operations are subject to a wide range of environmental regulations and law. In the normal course of business, we have investigatory and remedial activities underway at these facilities to comply, or to determine compliance, with such regulations. We have been identified, either by a government agency or by a private party seeking contribution to site clean-up costs, as a potentially responsible party (PRP) at two sites pursuant to state and federal laws. We record liabilities for probable estimated loss in accordance with Statement of Financial Accounting Standards No. 5 (SFAS 5), “Accounting for Contingencies.” To the extent a probable loss can only be estimated by reference to a range of equally probable outcomes, and no amount within the range appears to be a better estimate than any other amount, we accrue for the low end of the range. Because of uncertainties related to these matters, accruals are based on the best information available at the time. We evaluate the potential liability related to probable losses quarterly and may revise our estimates. Such revisions in the estimates of the potential liabilities could have a material effect on our results of operations and financial position.
In September 2004, the Sierra Club filed a lawsuit against DP&L and the other owners of the Stuart Generating Station in the United States District Court for the Southern District of Ohio for alleged violations of the Clean Air Act (CAA) and the Station’s operating permit. DP&L, on behalf of all co-owners, is leading the defense of this matter. A sizable amount of discovery has taken place,
10. Executive Litigation On May 21, 2007, we settled the litigation with the three former executives. As part of this settlement, the three former executives relinquished and dismissed all their claims including those related to certain deferred compensation, RSUs, MVE incentives, stock options and legal fees. The RSUs and stock options relinquished and forfeited were 1.3 million and 3.6 million, respectively. Prior to the settlement date, DPL had accrued obligations of approximately $64.2 million of which DP&L had accrued obligations of approximately $60.3 million. Included in these amounts is approximately $3.1 million associated with the forfeiture of stock options. In exchange for our payment of $25 million, all of these claims were settled. As a result of this settlement, DPL realized a net pre-tax gain in continuing and discontinued operations of approximately $31.0 million and $8.2 million, respectively. The net gain is comprised of the reversal of the $64.2 million of accrued obligations less the $25 million settlement. The obligations related to the discontinued operations were associated with the management of DPL’s financial asset portfolio, which was conducted in our MVE subsidiary. The MVE operations were discontinued in 2005 with the sale of the financial asset portfolio. The $25 million settlement expense was allocated between continuing and discontinued operations based on the proportionate share of continuing and discontinued obligations. The following table outlines the components of DPL’s net pre-tax gain for continuing and discontinued operations:
As a result of this settlement, DP&L realized a net pre-tax gain in continuing operations of approximately $35.3 million. Accrued obligations associated with the former executives’ litigation were recorded by DP&L since the obligations were associated with our non-qualified benefit plans. DP&L had no ownership of DPL’s discontinued financial asset portfolio business, therefore these liabilities were reversed and DP&L’s net pre-tax gain was recorded within continuing operations. The following table outlines the components of DP&L’s
The $25 million settlement was funded from the sale of financial assets held in
On April
On May 16, 2007, DPL and DP&L notified one of our insurers, Energy Insurance Mutual Limited, under an umbrella fiduciary liability policy, of our intent to pursue a claim for legal fees that DPL and DP&L incurred in defending claims made by the three former executives. 12. Regulatory Matters We apply the provisions of SFAS 71 to our regulated operations. This accounting standard defines regulatory assets as the deferral of costs expected to be recovered in future customer rates and regulatory liabilities as current cost recovery of expected future expenditures. Regulatory liabilities are reflected on the Condensed Consolidated Balance Sheet under the caption entitled “Other Deferred Credits”. Regulatory assets and liabilities on the Condensed Consolidated Balance Sheet include:
Regulatory Assets We evaluate our regulatory assets each period and believe recovery of these assets is probable. We have received or requested a return on certain regulatory assets for which we are currently recovering or seeking recovery through rates. Deferred recoverable income taxes represent deferred income tax assets recognized from the normalization of flow-through items as the result of amounts previously provided to customers. Since currently existing temporary differences between the financial statements and the related tax basis of assets will reverse in subsequent periods, deferred recoverable income taxes are amortized. Pension and postretirement benefits represent the unfunded benefit obligation related to the transmission and distribution areas of our electric business. We have historically recorded these costs on the accrual basis and this is how these costs have been historically recovered through rates. This factor, combined with the historical precedents from the PUCO and the FERC, makes future rate recovery of these costs probable. Electric Choice systems costs represent costs incurred to modify the customer billing system for unbundled rates and electric choice bills relative to other generation suppliers and information reports provided to the state administrator of the low-income electric program. In February 2005, the PUCO approved a stipulation allowing us to recover certain costs incurred for modifications to its billing system from all customers in its service territory. We filed a subsequent case to implement the PUCO’s order to begin charging customers for billing costs. On Regional transmission organization costs represent costs incurred to join a Regional Transmission Organization (RTO) that controls the receipts and delivery of bulk power within the service area. These costs are being amortized over a 10-year period that commenced in October 2004. Deferred storm costs include costs incurred by us to repair damage from December 2004 and January 2005 ice storms. On July 12, 2006, the PUCO approved our tariff as proposed and we began recovering these deferred costs over a two-year period beginning August 1, 2006. 34 PJM administrative costs contain the administrative fees billed to us by PJM Interconnection, L.L.C. (PJM) as a member of PJM. Pursuant to a PUCO order issued on January 25, 2006, these deferred costs will be recovered over a 3-year period from retail ratepayers beginning February 2006. Power plant emission fees represent costs paid to the State of Ohio for environmental monitoring that are or will be recovered over various periods under a PUCO rate rider from customers. Retail settlement system costs represent costs to implement a retail settlement system that reconciles the amount of energy a competitive retail electric service (CRES) supplier delivers to its customers and what its customers actually use. Based on case precedent in other utilities’ cases, the cost of this system is recoverable through our next transmission rate case that will be filed at the FERC. The timing of this case is uncertain at this time. PJM integration costs include infrastructure costs and other related expenses incurred by PJM and reimbursed by DP&L to integrate us into the RTO. Pursuant to a FERC order, the costs are being recovered over a 10-year period beginning May 2005 from wholesale customers within PJM. Rate case expenses represent costs incurred in connection with the Rate Stabilization Surcharge that was approved by the PUCO and implemented in January 2006. These costs are being amortized over a five-year period. Other costs include consumer education advertising regarding electric deregulation and costs pertaining to a recent rate case and are or will be recovered over various periods. Regulatory Liabilities Asset retirement obligations - regulated property reflect an estimate of amounts recovered in rates that are expected to be expended to remove existing transmission and distribution property from service upon retirement. Postretirement benefits reflect a regulatory liability that was recorded for the portion of the unrealized gain on our postretirement trust assets related to the transmission and distribution areas of our electric business. We have historically recorded these transactions on the accrual basis and this is how these costs have historically been recovered through rates. This factor, combined with the historical precedents from the PUCO and the FERC, make it probable that these amounts will be reflected in future rates. SECA (Seams Elimination Charge Adjustment) net revenue subject to refund represents the deferral of net SECA revenue accrued in 2005 and 2006. SECA revenue and expenses represent FERC-ordered transitional payments to replace the through-and-out transmission rates that were eliminated within the PJM/MISO region. A hearing was held in early 2006 to determine the amount of these transitional payments. As of June 30, 2007, no ruling has been issued. We received and paid these transitional payments from May 2005 through March 2006. 13. Ownership of Facilities DP&L and other Ohio utilities have undivided ownership interests in seven electric generating facilities and numerous transmission facilities. Certain expenses, primarily fuel costs for the generating units, are allocated to the owners based on their energy usage. The remaining expenses, as well as investments in fuel inventory, plant materials and operating supplies, and capital additions, are allocated to the owners in accordance with their respective ownership interests. As of June 30, 2007, DP&L DP&L’s undivided ownership interest in such jointly owned facilities at June 30, 2007 is as follows:
DPL’s and DP&L
share of the investment in facilities is included in the Condensed Consolidated Balance Sheets. Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations Certain statements contained in this Forward-looking statements speak only as of the date of the document in which they are made.
BUSINESS OVERVIEW This report includes the combined filing of DPL Inc. (DPL) and The Dayton Power and Light Company (DP&L). DP&L is the principal subsidiary of DPL providing approximately 99% of DPL’s total consolidated revenue and approximately DPL is a regional electric energy and utility company and through its principal subsidiary, DP&L, is primarily engaged in the generation, transmission and distribution of electricity in West Central Ohio. DPL and DP&L strive to achieve disciplined growth in energy margins while limiting volatility in both cash flows and earnings, and to achieve stable, long-term growth through efficient operations and strong customer and regulatory relations. More specifically, DPL and DP&L’s strategy is to match energy supply with load or customer We operate and manage generation assets and are exposed to a number of risks through this Like other electric utilities and energy marketers, DP&L and DPL Energy, LLC (DPLE, one of our wholly-owned subsidiaries) may sell or purchase electric products on the wholesale market. DP&L and DPLE compete with other generators, power marketers, privately and municipally-owned electric utilities and rural electric cooperatives when selling electricity. The ability of DP&L and DPLE to sell this electricity will depend on how DP&L’s and DPLE’s price, terms and conditions compare to those of other suppliers. We operate and manage transmission and distribution assets in a rate-regulated environment. Accordingly, this subjects us to regulatory risk in terms of the costs that we may recover and the investment returns that we may collect in customer rates. We are focused on delivering electricity and maintaining high standards of customer service and reliability in a cost-effective manner. We operate in a regulated and deregulated environment. The electric utility industry has historically operated in a regulated environment. However, in recent years, there have been a number of federal and state regulatory and legislative decisions aimed at promoting competition and providing customer choice. Market participants have therefore created new business models to exploit opportunities. The marketplace is now comprised of independent power producers, energy marketers and traders, energy merchants, transmission and distribution providers and retail energy suppliers. There have also been new market entrants and activity among the traditional participants, such as mergers, acquisitions, asset sales and spin-offs of lines of business. In addition, transmission systems are being operated by Regional Transmission Organizations (RTOs). As part of Ohio’s electric deregulation law, all of the state’s investor-owned utilities are required to join a RTO. The role of the RTO is to administer an electric marketplace and ensure reliability of the transmission grid. In October 2004, DP&L successfully integrated its 1,000 miles of high-voltage transmission into the PJM Interconnection, L.L.C. (PJM) RTO. As a member of PJM, DP&L is subject to charges and costs associated with PJM operations as approved by the associated with the transmission system to UPDATES / OTHER MATTERS Executive Litigation On May 21, 2007, we settled the litigation with the three former executives. As part of this settlement, the three former executives relinquished and dismissed all their claims including those related to certain deferred compensation, RSUs, MVE incentives, stock options and legal fees. The RSUs and stock options relinquished and forfeited were 1.3 million and 3.6 million, respectively. Prior to the settlement date, DPL had accrued obligations of approximately $64.2 million of which DP&L had accrued obligations of approximately $60.3 million. Included in these amounts is approximately $3.1 million associated with the forfeiture of stock options. In exchange for our payment of $25 million, all of these claims were settled. As a result of this settlement, DPL realized a net pre-tax gain in continuing and discontinued operations of approximately $31.0 million and $8.2 million, respectively. The net gain is comprised of the reversal of the $64.2 million of accrued obligations less the $25 million settlement. The obligations related to the discontinued operations were associated with the management of DPL’s financial asset portfolio, which was conducted in our MVE subsidiary. The MVE operations were discontinued in 2005 with the sale of the financial asset portfolio. The $25 million settlement expense was allocated between continuing and discontinued operations based on the proportionate share of continuing and discontinued obligations. The following table outlines the components of DPL’s net pre-tax gain for continuing and discontinued operations:
As a result of this settlement, DP&L realized a net pre-tax gain in continuing operations of approximately $35.3 million. Accrued obligations associated with the former executives’ litigation were recorded by DP&L since the obligations were associated with our non-qualified benefit plans. DP&L had no ownership of DPL’s discontinued financial asset portfolio business, therefore these liabilities were reversed and DP&L’s net pre-tax gain was recorded within continuing operations. The following table outlines the components of DP&L’s net gain:
The $25 million settlement was funded from the sale of financial assets held in DP&L’s Master Trust Plan for deferred compensation. As part of this transaction, DPL and DP&L recorded a $3.2 million realized gain which is reflected in investment income. Sale of Corporate Aircraft On June 7, 2007, Miami Valley CTC, Inc. (indirect wholly-owned subsidiary of DPL), sold its corporate aircraft and associated inventory and parts for $7.4 million. The net book value of the assets being written down and subsequently sold were approximately $1.0 million and severance and other costs of approximately $0.4 million were accrued. Miami Valley CTC, Inc. recorded a net gain on the sale of approximately $6.0 million for the quarter and the six-month period ended June 30, 2007, which is included in DPL’s operation and maintenance expense. In relation to this sale, Miami Valley CTC, Inc., placed in escrow approximately $2.2 million. These funds are listed as the caption “Restricted funds held in trust” in the Condensed Consolidated Balance Sheet for DPL. These funds were released from escrow on July 12, 2007. Sale of Peaking Units On April 25, 2007, DPL Energy, LLC, completed the sale of its Darby and Greenville electric peaking generation facilities providing DPL with approximately
Insurance Recovery Claim On On Depreciation Study Depreciation expense is calculated using the straight-line method, which depreciates the cost of property over its estimated useful life. For DPL’s and DP&L’s generation, transmission, and distribution assets, straight-line depreciation is applied on an average annual composite basis using group rates. With the addition of scrubbers at certain of its generation facilities, DP&L Updates on Competition and Regulation Ohio Matters Since January 2001, DP&L’s electric customers have been permitted to choose their retail electric generation supplier. DP&L continues to have the exclusive right to provide delivery service in its state certified territory. The Public Utilities Commission of Ohio (PUCO) maintains jurisdiction over DP&L’s delivery of electricity, the standard offer supply service that customers receive if they do not choose an alternative retail electricity supplier, and other rates and charges associated with the provision of retail electric service.
As of DP&L agreed to implement a Voluntary Enrollment Program (VEP) that would provide customers with an option to choose a competitive supplier to provide their retail generation service should switching not reach 20% in each customer class. The 20% threshold has never been reached. Customers who elected to participate in the program have been grouped together and collectively bid out to CRES providers. The
Federal Matters On April 19, 2007, the FERC issued an Order with regard to the allocation of costs associated with new planned transmission facilities. FERC ordered that the cost of new, high-voltage facilities be socialized across the PJM region and the costs of new facilities at lower voltages be assigned to the load centers that benefit from the new facilities. The methodology for identifying beneficiaries has been set for hearing. constructing such projects and will be reflected in PJM charges to DP&L. Over time, this order is likely to increase PJM charges to DP&L. Although the impact of cost allocation could be material, management believes these costs should be recoverable through retail rates. As a member of PJM, the value of
ENVIRONMENTAL CONSIDERATIONS DPL, DP&L and our subsidiaries’ facilities and operations are subject to a wide range of environmental regulations and laws. In the normal course of business, we have investigatory and remedial activities underway at these facilities to comply, or to determine compliance, with such regulations. We record liabilities for probable estimated loss in accordance with Statement of Financial Accounting Standards No. 5 (SFAS 5), “Accounting for Contingencies.” To the extent a probable loss can only be estimated by reference to a range of equally probable outcomes, and no amount within the range appears to be a better estimate than any other amount, we accrue for the low end of the range. Because of uncertainties related to these matters, accruals are based on the best information available at the time. DPL,
FINANCIAL OVERVIEW As more fully discussed in later sections of this Form 10-Q, the following were the significant themes and events for the · DPL’s revenues for the · DPL’s cash flows from operations for the ·DPL realized a net (pre-tax) gain in both continuing and discontinued operations of approximately $31.0 million and $8.2 million, respectively, resulting from the $25.0 million settlement of the litigation with the three former executives. See note 10 of the Notes to Condensed Consolidated Financial Statements. · DP&L’s revenues for the · DP&L’s cash flows from operations for the · ·DP&L had borrowings against the $220 million
RESULTS OF OPERATIONS – DPL Inc. DPL’s results of operations include the results of its subsidiaries, including the consolidated results of DP&L and all of DP&L’s consolidated subsidiaries. DP&L provides approximately 99% of the total revenues of DPL. All material intercompany accounts and transactions have been eliminated in consolidation. A separate specific discussion of the results of operations for DP&L is presented elsewhere in this report. Financial Highlights
DPL Inc. – Revenues Retail customers, especially residential and commercial customers, consume more electricity on warmer and colder days. Therefore, DPL’s retail sales volume is impacted by the number of heating and cooling degree days occurring during a year. Since DPL plans to utilize its internal generating capacity to supply its retail customers’ needs first, increases in retail demand will decrease the volume of internal generation available to be sold in the wholesale market and vice versa. The wholesale market covers a multi-state area and settles on an hourly basis throughout the year. Factors impacting DPL’s wholesale sales volume each hour of the year include wholesale market prices, DPL’s retail demand, retail demand elsewhere throughout the entire wholesale market area, DPL and non-DPL plants’ availability to sell into the wholesale market and weather conditions across the multi-state region. DPL’s plan is to make wholesale sales when market prices allow for the economic operation of its generation facilities not being utilized to meet its retail demand.
For the quarter ended For the six months ended June 30, 2007, revenues increased $72.7 million, or 11% to $722.8 million from $650.1 million for the same period in the prior year. This increase was primarily the result of higher average rates and sales volume for both retail and wholesale. Retail revenues increased DPL Inc. – Margins, Fuel and Purchased PowerFor the the second quarter of 2007 compared to For the six months ended June 30, 2007, gross margin of $433.6 million increased $8.6 million, or 2%, from $425.0 million compared to the same period in 2006. As a percentage of total revenues, gross margin decreased to 60.0% in 2007 compared to 65.4% in 2006. This result reflects the favorable impact of both retail and wholesale revenues discussed above and lower fuel costs offset by increased purchased power costs. Fuel costs, which include coal, gas, oil and emission allowance costs, decreased by $9.0 million, or 6%, for the six months ended June 30, 2007 compared to the same period in 2006 primarily due to a 7% decrease in generation output (580 GWh), partially offset by an increase in average fuel prices. Purchased power increased $73.1 million for the six months ended June 30, 2007 compared to the same period in 2006 primarily resulting from increased charges of $56.9 million relating to higher purchased power volume (1,148 GWh) and $11.1 million increase due to higher average market rates. The increase in purchased power volume was primarily the result of increased sales volume and partner operated generating facilities being less available compared to the prior year due to planned and unplanned outages. In addition, we purchase power when market prices are below the marginal costs associated with our higher cost generating facilities. DPL Inc.
For the For the six months ended June 30, 2007, operation and maintenance expense decreased $2.2 million, or 2%, compared to the same period in 2006 primarily resulting from a $14.5 million insurance settlement reimbursing us for legal fees relating to the litigation with the three former executives, the gain on sale of the corporate aircraft of $6.0 million and an actuarial adjustment of $2.0 million, partially offset by increased power production costs largely related to boiler maintenance of $7.1 million and other power production maintenance costs of $7.1 million and increased legal costs of $4.3 million related to the litigation with the three former DPL Inc. – Depreciation and Amortization For the DPL Inc. – Amortization of Regulatory Assets For the DPL Inc. – Investment IncomeFor the quarter ended June 30, 2007, investment income increased $0.8 million to $5.3 million from $4.5 million for the same period in 2006. This increase was primarily the result of $3.2 million realized gains from the sale of financial assets held in DP&L’s Master Trust Plan for deferred compensation used for the settlement payment to the three former executives, partially offset by lower interest income relating to lower cash and short-term investment balances in 2007 compared to 2006. For the six months ended DPL Inc. – On May 21, 2007, we settled the litigation with the three former executives. In exchange for a payment of $25 million, the three former executives relinquished and dismissed all of their claims including those related to deferred compensation, RSUs, MVE incentives, stock options and legal fees. As a result of this settlement, DPL realized a net pre-tax gain in continuing and discontinued operations of approximately $39.2 million. See Note 10 of Notes to Condensed Consolidated Financial Statements. DPL Inc. –Interest Expense For the quarter ended June 30, 2007, interest expense For the six months ended June 30, 2007, interest expense decreased $9.7 million or 19% compared to 2006 primarily from $5.7 million of greater capitalized interest than the prior year mostly relating to increased pollution control capital expenditures; and lower interest of $6.2 million from redemption of DPL debt ($225 million 8.25% Senior Note). These decreases were partially offset by $2.4 million of interest expense associated with DP&L’snew $100 million 4.8% Series pollution control bonds issued September 13, 2006 and DPL Inc. – Other Income For the For the six months ended DPL Inc. – Income Tax ExpenseFor the DPL Inc. – Discontinued Operations For the quarter ended June 30, 2007, discontinued operations increased $5.1 million compared to the same period in 2006, primarily resulting from the net (pre-tax) gain of $8.2 million realized from the settlement of the litigation with the three former executives less associated income For the six months ended June 30, 2007, discontinued operations increased $2.4 million compared to the same period in 2006 primarily resulting from the net (pre-tax) gain of $8.2 million realized from the settlement of the litigation with the three former executives less associated income taxes. This increase See Note 3 and Note 10 of the Notes to Condensed Consolidated Financial Statements. RESULTS OF OPERATIONS – The Dayton Power and Light Company (DP&L) Income Statement Highlights – DP&L
DP&L – Revenues
Retail customers, especially residential and commercial customers, consume more electricity on warmer and colder days. Therefore, DP&L’s retail sales volume is impacted by the number of heating and cooling degree days occurring during a year. Since DP&L plans to utilize its internal generating capacity to supply its retail customers’ needs first, increases in retail demand will decrease the volume of internal generation available to be sold in the wholesale market and vice versa. The wholesale market covers a multi-state area and settles on an hourly basis throughout the year. Factors impacting DP&L’s wholesale sales volume each hour of the year include wholesale market prices, DP&L’s retail demand, retail demand elsewhere throughout the entire wholesale market area, DP&L and non-DP&L plants’ availability to sell into the wholesale market and weather conditions across the multi-state region. DP&L’s plan is to make wholesale sales when market prices allow for the economic operation of its generation facilities not being utilized to meet its retail demand.
For the For the six months ended June 30, 2007, revenues increased $72.9 million, or 11%, to $718.7 million from $645.8 million for the same period in the prior year. This increase was primarily the result of higher average rates and greater sales volumes for both retail and wholesale customers. Retail revenues increased $41.4 million resulting from a 6% increase in weather driven sales volume as total degree days increased 16% and a 3% increase in average retail rates related to the Rate Stabilization Plan surcharge and other regulated asset recovery riders. These increases resulted in a $26.8 million sales volume variance and a $15.7 million price variance. For the six months ended June 30, 2007, wholesale revenue increased $24.9 million over the same period of the prior year primarily as a result of a 12% increase in sales volume (178 GWh) and an 6% increase in wholesale average rates. These increases resulted in a $15.9 million sales volume variance and a $9.0 million price volume variance for wholesale revenues. For the six months ended June 30, 2007, the RTO ancillary revenues increased $6.6 million compared to the same period in 2006 primarily resulting from $4.3 million realized from the PJM capacity auction, $1.8 million of PJM transmission congestion credits and $2.4 million from the sale of financial transmission rights (FTRs), partially offset by an adjustment of $2.8 million for Seams Elimination Cost Adjustment (SECA). RTO ancillary revenues primarily consist of compensation for use of DP&L’s transmission assets, regulation services, reactive supply and operating reserves. These revenues are substantially offset by RTO ancillary charges included in purchased power costs. DP&L | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Three Months
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| Three Months Ended |
| |||
|
| March 31, |
| |||
$ in millions |
|
|
| 2007 vs. 2006 |
| |
Mark-to-market adjustments of restricted stock units (RSUs) |
| $ | 2.6 |
| ||
Power production costs |
| 2.4 |
| |||
Service operations |
| 1.9 |
| |||
Legal fees |
| 0.9 |
| |||
Low-Income Assistance Program costs |
| 0.7 |
| |||
Long-term and other incentive compensation |
| (2.3 | ) | |||
Expenses for injures and damages |
| (1.3 | ) | |||
Pension and benefits |
| (0.8 | ) | |||
RTO administrative fees |
| (0.8 | ) | |||
Other, net |
| 1.9 |
| |||
Total operation and maintenance expense |
| $ | 5.2 |
| ||
For the threesix months ended March 31,June 30, 2007, operation and maintenance expensegross margin of $430.4 million increased $5.2$8.7 million, or 10%2%, from $421.7 million compared to the same period in 2006. As a percentage of total revenues, gross margin decreased to 59.9% in 2007 compared to 65.3% in 2006. This result reflects the favorable impact of both retail and wholesale revenues discussed above and lower fuel costs offset by increased purchased power costs. Fuel costs, which include coal, gas, oil and emission allowance costs, decreased by $8.3 million, or 5%, for the six months ended June 30, 2007 compared to the same period in 2006 primarily due to a 7% decrease in generation output (580 GWh), partially offset by an increase in average fuel prices. Purchased power increased $72.5 million for the six months ended June 30, 2007 compared to the same period in 2006 primarily resulting from a $2.6increased charges of $62.2 million relating to higher purchased power volume (1,148 GWh) and $10.3 million increase in mark-to-market adjustments of restricted stock units; a $2.4 milliondue to higher average market rates. The increase in purchased power productionvolume was primarily the result of increased sales volume and partner operated generating facilities being less available compared to the prior year due to planned and unplanned outages. In addition, we purchase power when market prices are below the marginal costs primarily reflectingassociated with our higher boiler maintenance and plant operating expenses; a $1.9 million increase in service operation costs resulting primarily from two major ice storms in February 2007; a $0.9 million increase in legal fees and Low-Income Assistance Program costs of $0.7 million. These increases were partially offset by a $2.3 million decrease in long-term and other incentive compensation; a $1.3 million decrease in expenses for injuries and damages a $0.8 million decrease in pension and benefits expenses; and a $0.8 million decrease in RTO administrative fees.cost generating facilities.
DP&L – Depreciation Operation and AmortizationMaintenance
| Three Months Ended |
| Six Months Ended |
| |||
$ in millions |
| 2007 vs. 2006 |
| 2007 vs. 2006 |
| ||
Mark-to-market adjustments of restricted stock units (RSUs) |
| $ | (0.5 | ) | $ | 2.1 |
|
Power production costs |
| 12.0 |
| 14.2 |
| ||
Low income payment program |
| 0.8 |
| 1.5 |
| ||
Service operations |
| 1.3 |
| 1.9 |
| ||
Long-term and other incentive compensation |
| — |
| (2.4 | ) | ||
Legal fees |
| (2.3 | ) | (1.4 | ) | ||
Other, net |
| 1.5 |
| 2.1 |
| ||
Total operation and maintenance expense |
| $ | 12.8 |
| $ | 18.0 |
|
Depreciation
For the quarter ended June 30, 2007, operation and amortization decreased $0.6maintenance expense increased $12.8 million, in the first quarter of 2007,or 21%, compared to the same period in 2006 primarily reflectingresulting from increased power production costs largely related to boiler maintenance of $6.6 million and other power production maintenance expense of $5.4 million.
For the impactsix months ended June 30, 2007, operation and maintenance expense increased $18.0 million, or 16%, compared to the same period in 2006 primarily resulting from increased power production costs largely related to boiler maintenance of asset retirements.$7.1 million and other power production maintenance of $7.1 million. In addition, we had increased mark-to-market adjustments relating to RSUs and increased expense in service operation’s costs relating to overhead line maintenance.
DP&L – Amortization of Regulatory Assets
For the threequarter and six months ended March 31,June 30, 2007, amortization of regulatory assets increased $1.8$0.8 million to $2.9and $2.6 million, respectively, compared to the same period in 2006. The increase reflectsThese increases reflect the amortization of costs incurred to accommodate unbundled rates and electric choice bills in the customer billing system; the amortization of PJM administrative fees deferred for the period October 2004 through January 2006; and the amortization of incremental 2004/2005 severe storm costs.
DP&L – Investment Income
For the quarter ended June 30, 2007, investment income increased $3.4 million to $4.7 million from $1.3 million for the same period in 2006. This increase was primarily the result of $3.2 million realized gains from the sale of financial assets held in DP&L’s Master Trust Plan for deferred compensation used for the settlement payment to the three former executives.
For the six months ended June 30, 2007, investment income increased $3.0 million to $6.2 million from $3.2 million for the same period in 2006. This increase was primarily the result of $3.2 million realized gains from the sale of financial assets held in DP&L’s Master Trust Plan for deferred compensation used for the settlement payment to the three former executives, partially offset by lower interest income relating to lower cash and short-term investment balances in 2007 compared to 2006.
DP&L – Interest ExpenseNet Gain on Settlement of Executive Litigation
On May 21, 2007, we settled the litigation with the three former executives. In exchange for a payment of $25 million, the three former executives relinquished and dismissed all of their claims including those related to deferred compensation, RSUs, MVE incentives, stock options and legal fees. As a result of this settlement, DP&L realized a net pre-tax gain in continuing operations of approximately $35.3 million. See Note 10 of Notes to Condensed Consolidated Financial Statements.
DP&L –Interest Expense
For the quarter ended June 30, 2007, interest expense decreased $1.3$0.5 million or 19% in the three months ended March 31, 2007, compared to the same period of 2006, primarily relating to $2.8$2.9 million of increased capitalized interest resulting from pollution control capital expenditures at the generating plants, partially offset by increased interest of $1.2 million related to the $100 million 4.8% Series pollution control bonds issued in September 2006 and $0.3$0.7 million of interest related to the $65$95 million draw on our revolving credit facilityfacility.
For the six months ended June 30, 2007, interest expense decreased $1.8 million compared to the same periods of 2006, primarily relating to $5.7 million of increased capitalized interest resulting from pollution control capital expenditures at the generating plants, partially offset by increased interest of $2.4 million related to the $100 million 4.8% Series pollution control bonds issued in February 2007.September 2006 and $1.1 million of interest related to the $95 million draw on our revolving credit facility.
DP&L – Other Income (deductions)(Deductions)
For the threequarter ended June 30, 2007, other deductions of $0.2 million changed from $0.8 million of other income in 2006 primarily resulting from a refund of tax penalties in 2006.
For the six months ended March 31,June 30, 2007, other income (deductions) was $1.3of $0.6 million higher than the same periodincreased from $0.3 million of other income in 2006 primarily due to gains of $0.7 million realized in the first quarter of 2007resulting from the sale of NOxemission allowances and $0.3 million of greater gains realized in 2007 compared to 2006 related to derivative activity. There were no saleson the expiration of pollution control emission allowances duringforward contracts partially offset by a refund of tax penalties in 2006.
DP&L – Income Tax Expense
For the firstsecond quarter ofand six months ended June 30, 2007, income taxes decreased $1.5increased $10.1 million or 3%,and $8.6 million compared to the same periodperiods in 2006, primarily reflecting a decrease in the effective tax rate resulting from the phase-out of the Ohio Franchise Tax that was partially offset by an increase in pre-tax book income and an increase in the accrual for open tax years.income.
40
0FINANCIALFINANCIAL CONDITION, LIQUIDITY AND CAPITAL REQUIREMENTS
DPL’s financial condition, liquidity and capital requirements, includes the consolidated results of DP&L and all of DP&L’s consolidated subsidiaries. All material intercompany accounts and transactions have been eliminated in consolidation.
DPL’s Cash Position
DPL’s cash and cash equivalents totaled $106.4$103.9 million at March 31,June 30, 2007, compared to $262.2 million at December 31, 2006, a decrease of $155.8$158.3 million. In addition, DPL had no restricted funds held in trust at March 31,June 30, 2007 of $2.2 million in comparison to $10.1 million at December 31, 2006 related to the issuance of the $100 million pollution control bonds.2006. The decrease in cash and cash equivalents was primarily attributed to the retirement of the $225.0 million DPL 8.25% Senior Notes, $80.5$171.2 million in capital expenditures and $27.8$55.8 million in dividends paid on common stock. The decrease caused by such payments was partially offset by $97.1$158.4 million in proceeds realized from the sale of property ($151.0 million for two peaking units and $7.4 million for an aircraft); $112.4 million in cash generated from operating activities, $65.0activities; $15.0 million from the exercise of short-term debt issued against the $220.0 million unsecured revolving credit agreement,stock options, including tax effects; and $10.1 million of restricted funds drawn to fund pollution control capital expenditures.
DP&L’s Cash Position
DP&L’s cash and cash equivalents totaled $53.4$4.4 million at March 31,June 30, 2007, compared to $46.1 million at December 31, 2006, an increasea decrease of $7.3$41.7 million. The increasedecrease in cash and cash equivalents was primarily attributed to $137.0$169.3 million in capital expenditures and $125.0 million in dividends paid on common stock to our parent DPL. These cash outflows were largely offset by $137.9 million in cash generated from operating activities, $65.0$105.0 million in a draw onshort-term debt owed to our revolving credit facilityparent DPL, and $10.1 million in restricted fund draws to finance pollution control capital expenditures at our generating plants, partially offset by $125.0 million in dividends paid on common stock to our parent DPL and $79.6 million in capital expenditures.plants.
49
Operating Activities
For the quarterssix months ended March 31,June 30, 2007 and 2006, cash flows from operations were as follows:
Net Cash provided by Operating Activities
Net Cash provided by Operating Activities |
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| Quarters Ended |
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| 2007 |
| 2006 |
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$ in millions |
| 2007 |
| 2006 |
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| ||||
DPL |
| $ | 97.1 |
| $ | 91.6 |
|
| $ | 112.4 |
| $ | 133.4 |
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DP&L |
| $ | 137.0 |
| $ | 143.5 |
|
| $ | 137.9 |
| $ | 175.2 |
|
The tariff-based revenue from our energy business continues to be the principal source of cash from operating activities. Management believes that the diversified retail customer mix of residential, commercial, and industrial classes coupled with the rate relief approved by the PUCO for 2006 and beyond provides us with a reasonably predictable gross cash flow from operations.
DPL’s Cash provided by Operating Activities
DPL generated net cash from operating activities of $97.1$112.4 million and $91.6$133.4 million infor the first quarter ofsix months ended June 30, 2007 and 2006, respectively. The net cash provided by operating activities infor the first quarter ofsix months ended June 30, 2007 was primarily the result of operating profitability, partially offset by an increase in cash used for working capital, specifically payments for interest.receivables, taxes and inventories. The net cash provided by operating activities for the six months ended June 30, 2006 was primarily the result of operating profitability, partially offset by cash used for working capital, specifically taxes and inventories.taxes.
DP&L’s Cash provided by Operating Activities
DP&L generated net cash from operating activities of $137.0$137.9 million and $143.5$175.2 million in the first quarter ofsix months ended June 30, 2007 and 2006, respectively. The net cash provided by operating activities for both yearsthe six months ended June 30, 2007 was primarily the result of operating profitability, as well aspartially offset by an increase in cash generated fromused for working capital, specifically from accounts payablereceivables, taxes and accrued taxes.inventories. The net cash provided by operating activities for the six months ended June 30, 2006 was primarily the result of operating profitability.
Investing Activities
For the quarterssix months ended March 31,June 30, 2007 and 2006, cash flows from investing activities were as follows:
Net Cash used for Investing Activities
Net Cash used for Investing Activities |
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| Quarters Ended |
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|
| 2007 |
| 2006 |
| |||||||||
$ in millions |
| 2007 |
| 2006 |
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DPL |
| $ | (80.5 | ) | $ | (110.9 | ) |
| $ | (15.0 | ) | $ | (72.3 | ) |
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DP&L |
| $ | (79.6 | ) | $ | (110.5 | ) |
| $ | (169.3 | ) | $ | (199.3 | ) |
DPL’s Cash used for Investing Activities
DPL’s net cash used for investing activities was $80.5$15.0 million and $110.9$72.3 million infor the first quarter ofsix months ended June 30, 2007 and 2006, respectively. Net cash flows used for investing activities infor the first quarter ofsix months ended June 30, 2007 were related to capital expenditures.expenditures that were largely offset by proceeds from the sale of two peaking units and an aircraft. Net cash flows used for investing activities for the quartersix months ended March 31,June 30, 2006 were related to capital expenditures;expenditures, partially offset by the net sale of short-term investments and purchases of investments had no effect on investing activities for the quarter.securities.
DP&L’s Cash used for Investing Activities
DP&L’s net cash flows used for investing activities were $79.6$169.3 million and $110.5$199.3 million infor the first quarter ofsix months ended June 30, 2007 and 2006, respectively. Net cash flows used for investing activities for both years were related to capital expenditures.
Financing Activities
For the quarterssix months ended March 31,June 30, 2007 and 2006, cash flows from financing activities were as follows:
Net Cash used for Financing Activities
Net Cash used for Financing Activities |
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| Quarters Ended |
| |||||||||||
|
| 2007 |
| 2006 |
| |||||||||
$ in millions |
| 2007 |
| 2006 |
| |||||||||
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|
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|
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|
|
|
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| ||||
DPL |
| $ | (172.4 | ) | $ | (185.4 | ) |
| $ | (255.7 | ) | $ | (407.0 | ) |
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| ||||
DP&L |
| $ | (50.1 | ) | $ | (0.2 | ) |
| $ | (10.3 | ) | $ | (0.4 | ) |
DPL’s Cash used for Financing Activities
DPL’s net cash flows used for financing activities for the first quarter ofsix months ended June 30, 2007 were $172.4$255.7 million compared to the first quartersame period of 2006 of $185.4$407.0 million. Net cash flows used for financing activities infor the first quarter ofsix months ended June 30, 2007 were the result of cash used to redeem the $225 million 8.25% Senior Notes on March 1, 2007 and to pay dividends to stockholders of $27.8$55.8 million, partially offset by cash received from borrowing $65.0the exercise of stock options, including tax effects, of $15.0 million against the $220 million unsecured revolving credit facility and the $10.1 million of restricted funds held in trust. Net cash flows used for financing activities infor the first quarter ofsix months ended June 30, 2006 were the result of cash used to repurchase $155.3$348.2 million of common stock and pay dividends to common stockholdersshareholders of $30.2$59.0 million.
DP&L’s Cash used for Financing Activities
DP&L’s net cash flows used for financing activities were $50.1$10.3 million and $0.2$0.4 million infor the first quarters ofsix months ended June 30, 2007 and 2006, respectively. Net cash flows used for financing activities for 2007 were the result of cash used to pay common stock dividends to our parent DPL of $125.0 million and preferred dividends to third parties of $0.2$0.4 million, partially offset by $65.0$105.0 million from a draw onshort-term borrowings from our revolving credit facilityparent DPL and $10.1 million of withdrawals from the trust set up as a result of issuing the $100 million 4.8% Series pollution control bonds in September 2006. Net cash flows used for financing activities in 2006 were for the payment of preferred dividends.dividends to third parties.
DPL and DP&L have obligations to make future payments for capital expenditures, debt agreements, lease agreements and other long-term purchase obligations, and have certain contingent commitments such as guarantees. We believe our cash flows from operations, the credit facilities (existing or future arrangements), the senior notes and other short- and long-term debt financing, will be sufficient to satisfy our future working capital, capital expenditures and other financing requirements for the foreseeable future. Our ability to generate positive cash flows from operations is dependent on general economic conditions, competitive pressures and
other business and risk factors described in Item 1a of our fiscal 2006 Form 10-K and Part II, Item 1a of this Form 10-Q. If we are unable to generate sufficient cash flows from operations, or otherwise comply with the terms of our credit facilities, the senior notes and other long-term debt, we may be required to refinance all or a portion of our existing debt or seek additional financing alternatives. A discussion of each of our critical liquidity commitments is outlined below.
Capital Requirements
DPL’s construction additions were $78.9$193.5 million and $94.8$184.2 million infor the first quartersix months of 2007 and 2006, respectively.
DP&L’s construction additions were $192.0 million and $183.1 million for the first six months of 2007 and 2006, respectively, and are expected to approximate $345$308 million in 2007.
DP&L’s construction additions were $78.0 million and $94.4 million in the first quarter of 2007 and 2006, respectively, and are expected to approximate $345 million in 2007. Planned construction additions for 2007 relate to DP&L’s environmental compliance program, power plant equipment and its transmission and distribution system.
Capital projects are subject to continuing review and are revised in light of changes in financial and economic conditions, load forecasts, legislative and regulatory developments and changing environmental standards, among other factors. Over the next three years, DPL, through its subsidiary DP&L, is projecting to spend an estimated $645$675 million in capital projects, approximately 40% of which is to meet changing environmental standards. In our Form 10-K10-Q as of DecemberMarch 31, 2006,2007, we reported our estimated capital spending to be approximately $605$645 million. This increase is due primarily to increases in the flue gas desulfurizationcapital projects at both DPL-operated and partner-operated generating plants. Our ability to complete capital projects and the reliability of future service will be affected by
our financial condition, the availability of internal funds and the reasonable cost of external funds. We expect to finance our construction additions in 2007 with a combination of cash on hand, short-term financing, tax-exempt debt and cash flows from operations.
Debt and Debt Covenants
On August 29, 2005, DPL redeemed $200 million of its 8.25% Senior Notes due 2007. The remaining $225 million of these notes were retired March 1, 2007, the maturity date.
During the first quarter of 2006, the Ohio Department of Development (ODOD) awarded DP&L the ability to issue over the next three years up to $200 million of qualified tax-exempt financing from the ODOD’s 2005 volume cap carryforward. On September 13, 2006, the Ohio Air Quality Development Authority (OAQDA) issued $100 million of 4.80% fixed interest rate OAQDA Revenue bonds 2006 Series A due September 1, 2036. In turn, DP&L borrowed these funds from the OAQDA. These funds were placed in escrow with a trustee and, as of April 3, 2007, DP&L has drawn out the entirety of the funds.
DP&L expects to use the remaining $100 million of volume cap carryforward prior to the end of 2008. DP&Lis planning to issueconsidering issuing in conjunction with the OAQDA this $100 millionanother series of tax-exempt bonds to finance the remaining solid waste disposal facilitiesfacility costs at Miami Fort, Killen Stuart and ConesvilleStuart Generating Stations.
On November 21, 2006, DP&L entered into a new $220 million unsecured revolving credit agreement replacing its $100 million facility. This new agreement has a five year term that expires on November 21, 2011 and that provides DP&L with the ability to increase the size of the facility by an additional $50 million at any time. The facility contains one financial covenant: DP&L’s total debt to total capitalization ratio is not to exceed 0.65 to 1.00. This covenant is currently met. As of March 31,June 30, 2007, DP&L has borrowed $65 million fromhad no borrowings outstanding under this facility for ninety-two days at 5.63%.facility. Fees associated with this credit facility are approximately $0.2 million per year. Changes in credit ratings, however, may affect fees and the applicable interest.interest rate. This revolving credit agreement also contains a $50 million letter of credit sublimit. DP&L has certain contractual agreements for the sale and purchase of power, fuel and related energy services that contain credit rating related clauses allowing the counter parties to seek additional surety under certain conditions. As of March 31,June 30, 2007, DP&L had no outstanding letters of credit against the facility.
On February 24, 2005, DP&L entered into an amendment to extend the term of its Master Letter of Credit Agreement with a financial lending institution for one year and to reduce the maximum dollar volume of letters of credit to $10 million. On February 17, 2006, DP&L renewed its $10 million agreement for one year. This agreement supports performance assurance needs in the ordinary course of business. In February 2007, DP&L opted not to renew this agreement.
Issuance of additional amounts of first mortgage bonds by DP&L is limited by the provisions of its mortgage; however, management believes that DP&L continues to have sufficient capacity to issue first mortgage bonds to
satisfy its requirements in connection with its current refinancing and construction programs. The amounts and timing of future financings will depend upon market and other conditions, rate increases, levels of sales and construction plans.
During the second quarter of 2007, DPL entered into a short-term loan to DP&L for $105 million. This short-term loan does not affect our debt covenants. There are no other inter-company debt collateralizations or debt guarantees between DPL, DP&L and itstheir subsidiaries. None of the debt obligations of DPL or DP&L are guaranteed or secured by affiliates and no cross-collateralization exists between any subsidiaries.
There was no change to our debt covenants as described in our Form 10-K as of December 31, 2006.
Credit Ratings
Currently, DPL’s senior unsecured and DP&L’s senior secured debt credit ratings are as follows:
| DPL Inc. |
| DP&L |
| Outlook |
| Effective | ||
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|
|
|
|
|
|
| |
Fitch Ratings |
| BBB+ |
| A+ |
| Stable |
| March 2007 | |
Moody’s Investors Service |
| Baa3 |
| A3 |
| Positive |
| June 2006 | |
Standard & Poor’s Corp. |
| BBB- |
| BBB+ |
| Stable |
| February 2007 |
Off-Balance Sheet Arrangements
DPL and DP&L do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors.
Contractual Obligations and Commercial Commitments
We enter into various contractual obligations and other commercial commitments that may affect the liquidity of our operations. At March 31,June 30, 2007, these include:
Contractual Obligations
|
|
|
| Payment Year |
|
| ||||||||||||||||||||||||
|
|
|
| Less Than |
| 2 - 3 |
| 4 - 5 |
| More Than |
|
| ||||||||||||||||||
$ in millions |
|
|
| Total |
| 1 Year |
| Years |
| Years |
| 5 Years |
| |||||||||||||||||
DPL Inc. |
|
|
|
|
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| ||||||||||||||||||
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| ||||||||||||||||||
Long-term debt |
| $ | 1,549.9 |
| $ | — |
| $ | 275.0 |
| $ | 297.4 |
| $ | 977.5 |
|
| |||||||||||||
Interest payments |
| 1,074.3 |
| 71.8 |
| 170.7 |
| 144.0 |
| 687.8 |
|
| ||||||||||||||||||
Pension and postretirement payments |
| 230.1 |
| 16.5 |
| 45.2 |
| 46.5 |
| 121.9 |
|
| ||||||||||||||||||
Capital leases |
| 2.8 |
| 0.7 |
| 1.5 |
| 0.6 |
| — |
|
| ||||||||||||||||||
Operating leases |
| 0.7 |
| 0.3 |
| 0.3 |
| 0.1 |
| — |
|
| ||||||||||||||||||
Coal contracts (a) |
| 467.8 |
| 246.5 |
| 110.5 |
| 110.8 |
| — |
|
| ||||||||||||||||||
Limestone contracts |
| 58.4 |
| 1.5 |
| 9.4 |
| 10.8 |
| 36.7 |
|
| ||||||||||||||||||
Other contractual obligations |
| 436.7 |
| 370.0 |
| 57.1 |
| 9.6 |
| — |
|
| ||||||||||||||||||
Total contractual obligations |
| $ | 3,820.7 |
| $ | 707.3 |
| $ | 669.7 |
| $ | 619.8 |
| $ | 1,823.9 |
|
| |||||||||||||
|
|
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| ||||||||||||||||||
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|
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| ||||||||||||||||||
DP&L |
|
|
|
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|
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| ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||||
Long-term debt |
| $ | 783.2 |
| $ | — |
| $ | — |
| $ | — |
| $ | 783.2 |
|
| |||||||||||||
Interest payments |
| 562.2 |
| 29.4 |
| 78.3 |
| 78.3 |
| 376.2 |
|
| ||||||||||||||||||
Pension and postretirement payments |
| 230.1 |
| 16.5 |
| 45.2 |
| 46.5 |
| 121.9 |
|
| ||||||||||||||||||
Capital leases |
| 2.8 |
| 0.7 |
| 1.5 |
| 0.6 |
| — |
|
| ||||||||||||||||||
Operating leases |
| 0.7 |
| 0.3 |
| 0.3 |
| 0.1 |
| — |
|
| ||||||||||||||||||
Coal contracts (a) |
| 467.8 |
| 246.5 |
| 110.5 |
| 110.8 |
| — |
|
| ||||||||||||||||||
Limestone contracts |
| 58.4 |
| 1.5 |
| 9.4 |
| 10.8 |
| 36.7 |
|
| ||||||||||||||||||
Other contractual obligations |
| 436.7 |
| 370.0 |
| 57.1 |
| 9.6 |
| — |
|
| ||||||||||||||||||
Total contractual obligations |
| $ | 2,541.9 |
| $ | 664.9 |
| $ | 302.3 |
| $ | 256.7 |
| $ | 1,318.0 |
|
| |||||||||||||
|
| Payment Year |
| |||||||||||||
|
|
|
|
|
| 2008- |
| 2010- |
| 2012 & |
| |||||
$ in millions |
| Total |
| 2007 |
| 2009 |
| 2011 |
| Thereafter |
| |||||
DPL Inc. |
|
|
|
|
|
|
|
|
|
|
| |||||
|
|
|
|
|
|
|
|
|
|
|
| |||||
Long-term debt |
| $ | 1,550.0 |
| $ | — |
| $ | 275.0 |
| $ | 297.4 |
| $ | 977.6 |
|
Interest payments |
| 1,050.3 |
| 47.8 |
| 170.7 |
| 144.0 |
| 687.8 |
| |||||
Pension and postretirement payments |
| 224.6 |
| 11.0 |
| 45.2 |
| 46.5 |
| 121.9 |
| |||||
Capital leases |
| 2.5 |
| 0.4 |
| 1.5 |
| 0.6 |
| — |
| |||||
Operating leases |
| 0.7 |
| 0.3 |
| 0.3 |
| 0.1 |
| — |
| |||||
Coal contracts (a) |
| 716.4 |
| 195.9 |
| 362.8 |
| 157.7 |
| — |
| |||||
Limestone contracts (a) |
| 58.1 |
| 1.0 |
| 9.5 |
| 10.9 |
| 36.7 |
| |||||
Reserve for uncertain tax provisions |
| 41.2 |
| 41.2 |
| — |
| — |
| — |
| |||||
Other contractual obligations |
| 465.6 |
| 397.0 |
| 55.4 |
| 11.0 |
| 2.2 |
| |||||
Total contractual obligations |
| $ | 4,109.4 |
| $ | 694.6 |
| $ | 920.4 |
| $ | 668.2 |
| $ | 1,826.2 |
|
(a)DP&L-operated
DP&L |
|
|
|
|
|
|
|
|
|
|
| |||||
|
|
|
|
|
|
|
|
|
|
|
| |||||
Long-term debt |
| $ | 783.2 |
| $ | — |
| $ | — |
| $ | — |
| $ | 783.2 |
|
Interest payments |
| 552.4 |
| 19.6 |
| 78.3 |
| 78.3 |
| 376.2 |
| |||||
Pension and postretirement payments |
| 224.6 |
| 11.0 |
| 45.2 |
| 46.5 |
| 121.9 |
| |||||
Capital leases |
| 2.5 |
| 0.4 |
| 1.5 |
| 0.6 |
| — |
| |||||
Operating leases |
| 0.7 |
| 0.3 |
| 0.3 |
| 0.1 |
| — |
| |||||
Coal contracts (a) |
| 716.4 |
| 195.9 |
| 362.8 |
| 157.7 |
| — |
| |||||
Limestone contracts (a) |
| 58.1 |
| 1.0 |
| 9.5 |
| 10.9 |
| 36.7 |
| |||||
Reserve for uncertain tax provisions |
| 41.2 |
| 41.2 |
| — |
| — |
| — |
| |||||
Other contractual obligations |
| 465.6 |
| 397.0 |
| 55.4 |
| 11.0 |
| 2.2 |
| |||||
Total contractual obligations |
| $ | 2,844.7 |
| $ | 666.4 |
| $ | 553.0 |
| $ | 305.1 |
| $ | 1,320.2 |
|
(a) DP&L operated units |
Long-term debt:
DPL’s long-term debt as of March 31,June 30, 2007, consists of DP&L’s first mortgage bonds and tax-exempt pollution control bonds, DPL unsecured notes and includes current maturities and unamortized debt discounts.
DP&L’s long-term debt as of March 31,June 30, 2007, consists of first mortgage bonds, tax-exempt pollution control bonds and includes an unamortized debt discount.
See Note 98 of Notes to Condensed Consolidated Financial Statements.
Interest payments:
Interest payments associated with the long-term debt is described above.
Pension and postretirement payments:
As of March 31,June 30, 2007, DP&L had estimated future benefit payments as outlined in Note 76 of Notes to Condensed Consolidated Financial Statements. These estimated future benefit payments are projected through 2016.
Capital leases:
As of March 31,June 30, 2007, DP&L had two capital leases that expire in November 2007 and September 2010.
Operating leases:
As of March 31,June 30, 2007, DPL and DP&L had several operating leases with various terms and expiration dates. Not included in this total is approximately $88,000 per year related to right of wayright-of-way agreements that are assumed to have no definite expiration dates.
Coal contracts:
DP&L has entered into various long-term coal contracts to supply portions of its coal requirements for its generating plants. Contract prices are subject to periodic adjustment and have features that limit price escalation in any given year.
Limestone contracts:
DP&L has entered into variousa limestone contractscontract to supply limestone for its generating facilities.
Reserve for uncertain tax positions:
On January 1, 2007, we adopted Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (FIN 48). There was no significant impact to our overall results of operations, cash flows or financial position. The total amount of unrecognized tax benefits as of the date of adoption was $36.8 million and we have recorded $3.5 million (net of tax) of accrued interest. During the second quarter ending June 30, 2007, we recorded an additional $0.9 million in accrued interest resulting in a total reserve for uncertain tax positions of $41.2 million as of June 30, 2007. None of the amount of unrecognized tax benefits is due to uncertainty in the timing of deductibility.
Other Contractual Obligation:contractual obligations:
As of March 31,June 30, 2007, DPL and DP&L had various other contractual obligations including non-cancelable contracts to purchase goods and services with various terms and expiration dates.
We enter into various commercial commitments, which may affect the liquidity of our operations. At March 31,June 30, 2007, these include:
Credit facilities:
In November 2006, DP&L replaced its previous $100 million revolving credit agreement with a $220 million five yearfive-year facility that expires on November 21, 2011. DP&L has the ability to increase the size of the facility by an additional $50 million at any time. At March 31,June 30, 2007, there was $65 millionwere no outstanding borrowings under this credit agreement due May 29, 2007 at 5.63% interest.facility.
Guarantees:
DP&L owns a 4.9% equity ownership interest in an electric generation company. As of March 31,June 30, 2007, DP&L could be responsible for the repayment of 4.9%, or $21.8 million, of a $445 million debt obligation that matures in 2026.
In two separate transactions in November and December 2006, DPL agreed to be a guarantor of the obligations of its wholly-owned subsidiary, DPL Energy, LLC (DPLE) regarding the pending sale of the Darby Electric Peaking Station to American Electric Power and the sale of the Greenville Electric Peaking Station to Buckeye Electric Power, Inc. In both cases, DPL has agreed to guarantee the obligations of DPLE over a multiple year period as follows:
| 2007 |
| 2008 |
| 2009 |
| 2010 |
| ||||||||||||||||||
$ in millions |
| 2007 |
| 2008 |
| 2009 |
| 2010 |
| |||||||||||||||||
Darby |
| $ | 30.6 |
| $ | 23.0 |
| $ | 15.3 |
| $ | 7.7 |
|
| $ | 30.6 |
| $ | 23.0 |
| $ | 15.3 |
| $ | 7.7 |
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Greenville |
| $ | 14.8 |
| $ | 11.1 |
| $ | 7.4 |
| $ | 3.7 |
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| $ | 14.8 |
| $ | 11.1 |
| $ | 7.4 |
| $ | 3.7 |
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MARKET RISK
As a result of itsour operating, investing and financing activities, we are subject to certain market risks including changes in commodity prices for electricity, coal, environmental emissions and gas andas well as fluctuations in interest rates. Commodity pricing exposure includes the impacts of weather, market demand, increased competition and other economic conditions. For purposes of potential risk analysis, we use sensitivity analysis to quantify potential impacts of market rate changes on the results of operations. The sensitivity analysis represents hypothetical changes in market values that may or may not occur in the future.
Commodity Pricing Risk
Approximately 15%12% of DPL’s and 24%22% of DP&L’s first quarter of 2007 electric revenues for the six months ended June 30, 2007 were from sales of excess energy and capacity in the wholesale market. Energy and capacity in excess of the needs of existing retail customers are sold on the wholesale market when we can identify opportunities with positive margins. As of March 31,June 30, 2007, a hypothetical increase or decrease of 10% in DPL’s annual wholesale revenues could result in approximately a $14.0an $11 million increase or decrease to annual net income, assuming no increases or decreases in fuel and purchased power costs. As of March 31,June 30, 2007, a hypothetical increase or decrease of 10% in DP&L’s annual wholesale revenues could result in approximately a $23.0$20 million increase or decrease to annual net income, assuming no increases or decreases in fuel and purchased power costs.
DPL’s fuel (including coal, gas, oil and emission allowances) and purchased power costs as a percent of total operating costs in the first quarter ofsix months ended June 30, 2007 and 2006, respectively, were 52% and 46%, respectively. DP&L’s fuel (including coal, gas, oil and emission allowances) and purchased power costs as a percent of total operating costs was 54%were 53% and 49% in the first quarter ofsix months ended June 30, 2007 and 2006, respectively. We have substantially all of the total expected coal volume needed to meet our retail and firm wholesale sales requirements for 2007 under contract. The majority of our contracted coal is purchased at fixed prices. Some contracts provide for periodic adjustment and some are priced based on market indices. Substantially all contracts have features that limit price escalations in any given year. Our consumption of SO2 allowances should decline in 2007 due to planned emission control upgrades. We do not expect to purchase SO2 allowances for 2007. The exact consumption of SO2 allowances will depend on market prices for power, availability of our generation units, the timing of emission control equipment upgrade completion and the actual sulfur content of the coal burned. DP&L does not plan to purchase NOx allowances for 2007. Fuel costs are impacted by changes in volume and price and are driven by a number of variables including weather, reliability of coal deliveries, scheduled outages and generation plant mix. Based on weather normalized sales and our co-owners’ projections, fuelFuel costs are forecasted to be flat in 2007 compared to 2006.
Purchased power costs depend, in part, upon the timing and extent of planned and unplanned outages of our generating capacity. We will purchase power on a discretionary basis when wholesale market conditions provide opportunities to obtain power at a cost below our internal production costs. As of March 31,June 30, 2007, a hypothetical increase or decrease of 10% in DPL’s annual fuel and purchased power costs could result in approximately a $33.0$32 million increasedecrease or decreaseincrease to annual net income, assuming no increasedecreases or decreasesincreases in salesales revenues. As of March 31,June 30, 2007, a hypothetical increase or decrease of 10% in DP&L’s annual fuel and purchased power costs could result in approximately a $34.0$32 million increase or decrease to annual net income, assuming no increasedecreases or decreasesincreases in salesales revenues.
Interest Rate Risk
As a result of our normal borrowing and leasing activities, our results are exposed to fluctuations in interest rates, which we manage through our regular financing activities. We maintain both cash on deposit and investments in cash equivalents that may be affected by adverse interest rate fluctuations. Our long-term debt represents publicly and privately held secured and unsecured notes and debentures with fixed interest rates. At March 31,June 30, 2007, we had $65 million in short-termno outstanding borrowings at 5.63% against the $220 million unsecuredunder our revolving credit agreement.facility.
The carrying value of DPL’s debt was $1,552.7$1,552.5 million at March 31,June 30, 2007, consisting of DP&L’s first mortgage bonds, DP&L’s tax-exempt pollution control bonds, our unsecured notes and DP&L’s capital leases. The fair value of this debt was $1,592.1$1,566.8 million, based on current market prices or discounted cash flows using current rates for similar issues with similar terms and remaining maturities. The principal cash repayments and related weighted average interest rates by maturity date for long-term, fixed-rate debt at March 31,June 30, 2007, are as follows:
Expected Maturity |
| DPL’s Long-term Debt |
| |||
Date |
| Amount |
| Average Rate |
| |
|
| ($ in millions) |
|
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| |
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| |
2007 |
| $ | 0.4 |
| 6.3 | % |
2008 |
| 100.7 |
| 6.3 | % | |
2009 |
| 175.8 |
| 8.0 | % | |
2010 |
| 0.6 |
| 6.9 | % | |
2011 |
| 297.4 |
| 6.9 | % | |
2012 |
| — |
| — |
| |
Thereafter |
| 977.6 |
| 5.6 | % | |
Total |
| $ | 1,552.5 |
| 6.2 | % |
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| |
Fair Value |
| $ | 1,566.8 |
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| DPL’s Long-term Debt |
| ||||||||
Expected Maturity |
|
|
| Amount |
|
|
| |||
Date |
|
|
| ($ in millions) |
| Average Rate |
| |||
2007 |
| $ | 0.7 |
| 6.2 | % | ||||
2008 |
| 100.7 |
| 6.3 | % | |||||
2009 |
| 175.7 |
| 8.0 | % | |||||
2010 |
| 0.6 |
| 6.9 | % | |||||
2011 |
| 297.4 |
| 6.9 | % | |||||
2012 |
| — |
| — |
| |||||
Thereafter |
| 977.6 |
| 5.6 | % | |||||
Total |
| $ | 1,552.7 |
| 6.2 | % | ||||
|
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|
|
|
| |||||
Fair Value |
| $ | 1,592.1 |
|
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| ||||
The carrying value of DP&L’s debt was $786.0$785.7 million at March 31,June 30, 2007, consisting of our first mortgage bonds, our tax-exempt pollution control bonds and our capital leases. The fair value of this debt was $786.2$767.3 million, based on current market prices or discounted cash flows using current rates for similar issues with similar terms and remaining maturities. The principal cash repayments and related weighted average interest rates by maturity date for long-term, fixed-rate debt at March 31,June 30, 2007, are as follows:
| DP&L’s Long-term Debt |
| ||||||||||||
Expected Maturity | Expected Maturity |
| Amount |
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|
| DP&L’s Long-term Debt |
| |||||
Date |
|
|
| ($ in millions) |
| Average Rate |
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| Amount |
| Average Rate |
| ||
|
| ($ in millions) |
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2007 | 2007 |
| $ | 0.7 |
| 6.2 | % |
| $ | 0.4 |
| 6.3 | % | |
2008 | 2008 |
| 0.7 |
| 6.9 | % |
| 0.7 |
| 6.9 | % | |||
2009 | 2009 |
| 0.7 |
| 6.9 | % |
| 0.8 |
| 6.9 | % | |||
2010 | 2010 |
| 0.6 |
| 6.9 | % |
| 0.6 |
| 6.9 | % | |||
2011 | 2011 |
| — |
| — |
|
| — |
| — |
| |||
2012 | 2012 |
| — |
| — |
|
| — |
| — |
| |||
Thereafter | Thereafter |
| 783.3 |
| 5.0 | % |
| 783.2 |
| 5.0 | % | |||
Total | Total |
| $ | 786.0 |
| 5.0 | % |
| $ | 785.7 |
| 5.0 | % | |
|
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| |||
Fair Value | Fair Value |
| $ | 786.2 |
|
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|
| $ | 767.3 |
|
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| |
Debt maturities for DPL and DP&L in 2007 are expected to be financed with a combination of short-term borrowings, tax-exempt pollution control bonds and internal funds.
CRITICAL ACCOUNTING ESTIMATES
DPL’s and DP&L’s condensed consolidated financial statements are prepared in accordance with GAAP. In connection with the preparation of these financial statements, our management is required to make assumptions, estimates and judgments that affect the reported amounts of assets, liabilities, revenues, expenses and the related disclosure of contingent liabilities. These assumptions, estimates and judgments are based on our historical experience and assumptions that we believed to be reasonable at the time. However, because future events and their effects cannot be determined with certainty, the determination of estimates requires the exercise of judgment. Our critical accounting estimates are those which require assumptions to be made about matters that are highly uncertain.
Different estimates could have a material effect on our financial results. Judgments and uncertainties affecting the application of these policies and estimates may result in materially different amounts being reported under different conditions or circumstances. Significant items subject to such judgments include: the carrying value of property, plant and equipment; unbilled revenues; the valuation of insurance and claims costs; valuation allowances for receivables and deferred income taxes; the valuation of reserves related to current litigation; and assets and liabilities related to employee benefits. Actual results may differ from those estimates. Refer to our 2006 Annual Report filed on Form 10-K for a complete listing of our critical accounting policies and estimates.
47