UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended September 30, 2005
IPALCO ENTERPRISES, INC.
(Exact name of Registrant as specified in its Charter)
Commission file number 1-8644
| Indiana | 35-1575582 |
| (State or Other Jurisdiction of Incorporation or Organization) | (I.R.S. Employer Identification Number) |
One Monument Circle
Indianapolis, IN 46204
(Address of Principal Executive Offices including Zip Code)
(317) 261-8261
(Registrant's Telephone Number, Including Area Code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file reports), and (2) has been subject to such filing requirements for the past 90 days. YES [X] NO [ ]
Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2) YES [ ] NO [X]
At December 13, 2005, 89,685,177 shares of IPALCO Enterprises, Inc. common stock were outstanding. All of such shares were owned by The AES Corporation.
THE REGISTRANT MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTIONS H(1)(a) AND (b) OF FORM 10-Q AND IS THEREFORE FILING THIS FORM WITH THE REDUCED DISCLOSURE FORMAT.
IPALCO ENTERPRISES, INC.
FORM 10-Q
INDEX
| PART I - Financial Information | Page No. |
| | |
| Item 1: Financial Statements: | |
| | |
Unaudited Consolidated Statements of Income for the Three-month and Nine-month
Periods Ended September 30, 2005 and 2004
| 3 |
| | |
Unaudited Consolidated Balance Sheets as of September 30, 2005
and December 31, 2004 | 4 |
| | |
Unaudited Consolidated Statements of Cash Flows for the
Nine-month Periods Ended September 30, 2005 and 2004 | 5 |
| | |
| Notes to Unaudited Consolidated Financial Statements | 6 |
| | |
Item 2: Management's Discussion and Analysis of Financial Condition
and Results of Operations | 10 |
| | |
| Item 3: Quantitative and Qualitative Disclosure About Market Risk | 14 |
| | |
| Item 4: Controls and Procedures | 14 |
| | |
| PART II - Other Information | |
| | |
| Item 1: Legal Proceedings | 15 |
| | |
| Item 6: Exhibits | 15 |
| | |
| Signature | 16 |
PART I -- FINANCIAL INFORMATION
Item 1. Financial Statements
IPALCO ENTERPRISES, INC. and SUBSIDIARIES
Unaudited Consolidated Statements of Income
(In Thousands)
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------- ---------------------
2005 2004 2005 2004
---------- ---------- ---------- ----------
UTILITY OPERATING REVENUES $ 254,207 $ 230,229 $ 709,895 $ 660,123
UTILITY OPERATING EXPENSES:
Operation:
Fuel 42,874 49,536 135,407 144,805
Other operating expenses 42,274 35,338 111,711 93,371
Power purchased 23,213 7,489 33,866 13,353
Maintenance 15,541 16,477 54,801 56,552
Depreciation and amortization 33,929 32,160 101,374 91,006
Taxes other than income taxes 8,847 8,988 27,061 26,092
Income taxes-net 30,505 26,284 83,294 78,563
---------- ---------- ---------- ----------
Total utility operating expenses 197,183 176,272 547,514 503,742
---------- ---------- ---------- ----------
UTILITY OPERATING INCOME 57,024 53,957 162,381 156,381
---------- ---------- ---------- ----------
OTHER INCOME AND (DEDUCTIONS):
Allowance for equity funds used
during construction 504 321 1,825 1,659
Gain on sales of assets-net - - - 852
Other - net (780) (964) (379) (1,254)
Income tax benefit-net 6,894 6,991 19,747 20,279
---------- ---------- ---------- ----------
Total other income and
(deductions)-net 6,618 6,348 21,193 21,536
---------- ---------- ---------- ----------
INTEREST AND OTHER CHARGES:
Interest on long-term debt 27,763 28,239 83,941 84,818
Other interest 166 157 474 426
Allowance for borrowed funds
used during construction (373) (568) (1,070) (1,822)
Amortization of redemption premiums
and expense on debt-net 724 679 2,088 1,961
Preferred dividends of subsidiary 803 803 2,410 2,410
---------- ---------- ---------- ----------
Total interest and
other charges-net 29,083 29,310 87,843 87,793
---------- ---------- ---------- ----------
NET INCOME 34,559 30,995 95,731 90,124
---------- ---------- ---------- ----------
Other comperehensive income (loss) 849 (980) 7 3,200
---------- ---------- ---------- ----------
TOTAL COMPREHENSIVE INCOME $ 35,408 $ 30,015 $ 95,738 $ 93,324
========== ========== ========== ==========
See notes to unaudited consolidated financial statements.
IPALCO ENTERPRISES, INC. and SUBSIDIARIES
Unaudited Consolidated Balance Sheets
(In Thousands)
September 30, December 31,
2005 2004
-------------- ------------
ASSETS
UTILITY PLANT:
Utility plant in service $ 3,492,590 $ 3,421,828
Less accumulated depreciation 1,418,964 1,356,364
-------------- ------------
Utility plant in service - net 2,073,626 2,065,464
Construction work in progress 71,703 76,303
Property held for future use 1,085 1,085
-------------- ------------
Utility plant - net 2,146,414 2,142,852
-------------- ------------
OTHER ASSETS:
Nonutility property - at cost, less
accumulated depreciation 1,405 1,499
Other investments 9,701 7,270
-------------- ------------
Other assets - net 11,106 8,769
-------------- ------------
CURRENT ASSETS:
Cash and cash equivalents 4,049 3,779
Short term investments 3,300 12,250
Accounts receivable and unbilled revenue
(less allowance for doubtful accounts
of $2,084 and $2,137, respectively) 55,302 56,125
Fuel - at average cost 16,583 22,392
Materials and supplies - at average cost 53,025 48,929
Net income tax refunds receivable - 2,998
Regulatory Assets 27,614 1,966
Prepayments and other current assets 6,498 4,526
-------------- ------------
Total current assets 166,371 152,965
-------------- ------------
DEFERRED DEBITS:
Regulatory assets 156,150 144,730
Miscellaneous 32,187 32,669
-------------- ------------
Total deferred debits 188,337 177,399
-------------- ------------
TOTAL $ 2,512,228 $ 2,481,985
============== ============
CAPITALIZATION AND LIABILITIES
CAPITALIZATION:
Common shareholder's deficit:
Premium on 4% cumulative preferred stock $ 649 $ 649
Paid in capital 1,795 791
Accumulated deficit (46,385) (58,194)
Accumulated other comprehensive loss (51,321) (51,328)
-------------- ------------
Total common shareholder's deficit (95,262) (108,082)
Cumulative preferred stock of subsidiary 59,135 59,135
Long-term debt 1,502,098 1,502,064
-------------- ------------
Total capitalization 1,465,971 1,453,117
-------------- -----------
CURRENT LIABILITIES:
Accounts payable and accrued expenses 60,225 55,611
Accrued real estate and personal property taxes 12,355 15,840
Accrued income taxes 8,975 9,700
Accrued interest 37,393 27,869
Customer deposits 12,668 11,706
Other current liabilities 9,153 4,848
-------------- ------------
Total current liabilities 140,769 125,574
-------------- ------------
DEFERRED CREDITS AND OTHER LONG-TERM LIABILITIES:
Accumulated deferred income taxes - net 367,280 369,921
Asset retirement obligations 399,631 382,559
Unamortized investment tax credit 23,481 25,464
Accrued postretirement benefits 7,981 6,799
Accrued pension benefits 95,239 107,080
Miscellaneous 11,876 11,471
-------------- ------------
Total deferred credits and other
long-term liabilities 905,488 903,294
-------------- ------------
COMMITMENTS AND CONTINGENCIES (Note 8)
TOTAL $ 2,512,228 $ 2,481,985
============== ============
See notes to unaudited consolidated financial statements.
IPALCO ENTERPRISES, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
Nine Months Ended
September 30,
---------- ---------
2005 2004
--------- ---------
Cash Flows from Operations:
Net income $ 95,731 $ 90,124
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 99,862 91,183
Amortization of regulatory assets 3,644 2,016
Deferred income taxes and investment tax credit
adjustments - net (7,113) 443
Gain on sale of land held for sale - (5,924)
Gain on sales of assets - (852)
(Gain) loss on investments (417) 154
Pension funding (17,500) (6,000)
Allowance for funds used during construction (1,825) (1,659)
Change in certain assets and liabilities:
Accounts receivable 823 (6,222)
Fuel, materials and supplies 1,713 5,523
Income taxes receivable or payable 2,273 9,443
Accounts payable and accrued expenses (208) 2,855
Accrued real estate and personal property taxes (3,485) (6,798)
Pension benefits 5,659 6,520
Accrued interest 9,524 12,883
Short-term and long-term regulatory assets (37,363) (1,604)
Other - net 5,318 1,611
--------- ---------
Net cash provided by operating activities 156,636 193,696
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures - utility (77,692) (133,266)
Proceeds from sales of assets - 14,309
Purchase of short-term investments (749,112) (720,925)
Proceeds from sales and maturities of
short-term investments 758,062 713,525
Other (2,714) (4,855)
--------- ---------
Net cash used in investing activities (71,456) (131,212)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Long-term borrowings 71,850 100,000
Retirement of long-term debt (71,850) (80,000)
Dividends on common stock (83,922) (80,977)
Other (988) (1,083)
--------- ---------
Net cash used in financing activities (84,910) (62,060)
--------- ---------
Net change in cash and cash equivalents 270 424
Cash and cash equivalents at beginning of period 3,779 4,274
--------- ---------
Cash and cash equivalents at end of period $ 4,049 $ 4,698
========= =========
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest (net of amount capitalized) $ 74,232 $ 70,544
========= =========
Income taxes $ 68,393 $ 51,123
========= =========
See notes to unaudited consolidated financial statements.
IPALCO ENTERPRISES, INC. and SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
1. ORGANIZATION
IPALCO Enterprises, Inc. ("IPALCO") is a wholly-owned subsidiary of The AES Corporation ("AES"). IPALCO owns all of the outstanding common stock of its subsidiaries. These include its regulated electric utility subsidiary, Indianapolis Power & Light Company ("IPL"), and its unregulated subsidiary, Mid-America Capital Resources, Inc. ("Mid- America"). Substantially all of IPALCO's business consists of the generation, transmission, distribution and sale of electric energy conducted through IPL. IPL has more than 460,000 retail customers in the city of Indianapolis and neighboring cities, towns and communities, and adjacent rural areas all within the state of Indiana, the most distant point being approximately forty miles from Indianapolis. IPL has an exclusive right to provide electric service to those customers. IPL owns and operates two primarily coal-fired generating plants, one combination coal and gas-fired plant and a separately-sited combustion turbine that are all used for generating electricity. IPL's net electric generation capability for winter is 3,370 megawatts and net summer capability is 3,252 megawatts. Mid-America conducts IPALCO's unregulated activities.
2. BASIS OF PRESENTATION
The accompanying consolidated financial statements include the accounts of IPALCO, IPL and Mid-America. All significant intercompany amounts have been eliminated. The accompanying financial statements are unaudited; however, they have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP") for interim financial information and in conjunction with the rules and regulations of the Securities and Exchange Commission. Accordingly, they do not include all of the disclosures required by GAAP for annual fiscal reporting periods. In the opinion of management, all adjustments of a normal recurring nature necessary for fair presentation, have been included. The electric utility business is affected by seasonal weather patterns throughout the year and, therefore, the operating revenues and associated operating expenses are not generated evenly by month during the year. These unaudited financial statements have been prepared in accordance with the accounting policies described in IPALCO's audited financial statements for the year ended December 31, 2004, included in its annual report on Form 10-K and should be read in conjunction therewith.
The preparation of financial statements in conformity with GAAP requires that management make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements. The reported amounts of revenues and expenses during the reporting period may also be affected by the estimates and assumptions management is required to make. Actual results may differ from those estimates.
Certain prior period amounts have been reclassified to conform to current year presentation. The accompanying unaudited consolidated balance sheet as of December 31, 2004 reflects a reclassification of instruments used in IPALCO's cash management program from cash and cash equivalents to short-term investments of $12.3 million. This reclassification is to present certain auction rate securities and other highly-liquid instruments as short-term investments rather than as cash equivalents. The reclassification was made based on recent accounting interpretations considering the stated tenor of the maturities of these investments. Corresponding changes were also made to the accompanying unaudited consolidated statements of cash flows. The change resulted in reductions of $17.1 million and $9.7 million, in amounts presented as cash and cash equivalents as of September 30, 2004 and December 31, 2003, respectively.
During 2005, IPALCO determined that the amounts recorded for both deferred income taxes and regulatory assets were understated as of December 31, 2004 by $14.6 million. The December 31, 2004 balances have been adjusted in the accompanying financial statements to reflect the correction.
Certain other prior period amounts have been reclassified to conform to current year presentation, all of which management deems to be immaterial individually and in the aggregate with the reclassifications described above.
3. NEW ACCOUNTING PRONOUNCEMENTS
In March 2005, the Financial Accounting Standards Board ("FASB") issued FASB Interpretation No. 47, "Accounting for Conditional Asset Retirement Obligations, an interpretation of FASB Statement No. 143" ("FIN 47"). FASB Statement No. 143, "Accounting for Asset Retirement Obligations" ("SFAS 143"), addressed financial accounting and reporting for obligations associated with retirement of tangible long-lived assets and the associated asset retirement costs. FIN 47 clarifies that the termconditional asset retirementobligation as used in SFAS 143 refers to a legal obligation to perform an asset retirement activity in which the timing and (or) method of settlement are conditional on a future event that may or may not be within the control of the entity. FIN 47 also clarifies when an entity would have sufficient information to reasonably estimate the fair value of an asset retirement obligation. The provisions of FIN 47 are effective for IPALCO no later than the fiscal year ending December 31, 2005. Retrospective application for interim financial information is permitted but is not required. Management is evaluating what impact, if any, the provisions of FIN 47 will have on our financial statements.
In May 2005, the FASB issued FASB Statement No. 154, "Accounting Changes and Error Corrections" ("SFAS 154"). SFAS 154 replaces APB Opinion No. 20, "Accounting Changes," and FASB Statement No. 3, "Reporting Accounting Changes in Interim Financial Statements," and changes the requirements for the accounting for and reporting of a change in accounting principle. SFAS 154 requires retrospective application of changes in accounting principle, unless it is impracticable to determine either the period- specific effects or the cumulative effect of the change. SFAS 154 defines retrospective application as the application of a different accounting principle to prior accounting periods as if that principle had always been used or as the adjustment of previously issued financial statements to reflect a change in the reporting entity. SFAS 154 also redefines restatement as the revising of previously issued financial statements to reflect the correction of an error. SFAS 154 is effective for accounting changes and correction of errors made in fiscal years beginning after December 15, 2005.
4. SEGMENT INFORMATION
IPALCO's operations are made up almost entirely of its ownership of IPL, its consolidated electric utility, which is a reportable business segment. In addition, IPALCO has outstanding $750 million of Senior Secured Notes as of September 30, 2005 and December 31, 2004; approximately $0.5 million and $0.8 million of nonutility cash and cash equivalents, as of September 30, 2005 and December 31, 2004, respectively; short-term and long-term nonutility investments of $10.2 million and $8.3 million at September 30, 2005 and December 31, 2004, respectively; and income taxes and interest related to those items. There was no utility operating income other than the activities of IPL during the periods covered by this report. Nonutility assets represented less than 1% of IPALCO's total assets as of September 30, 2005 and December 31, 2004 and there were no nonutility capital expenditures during the nine month periods ended September 30, 2005 and 2004.
5. REGULATORY ASSETS (Current and Long Term)
IPL's regulated operations are subject to FASB Statement No. 71,"Accounting for the Effects of Certain Types of Regulation." Accordingly, IPL records assets and liabilities that result from the regulated ratemaking processes that would not be recorded under GAAP for non- regulated entities if it is probable that there will be a corresponding increase or decrease in future rates through the rate-making process. Consequently, IPL has deferred certain costs, which will be amortized over various future periods. These costs are deferred based on our assessment of the probability of recovery. In making such assessment, we consider many factors including, but not limited to, rate orders issued by the Indiana Utility Regulatory Commission (the "IURC"), advice from legal counsel, and IPL's experience with prior rate cases.
Midwest Independent Transmission System Operator, Inc. ("Midwest ISO").IPL is one of many transmission owners of the Midwest ISO network. IPL pays the Midwest ISO a transmission fee on its retail load and a fee for each wholesale transaction. A portion of the transmission fee paid to the Midwest ISO is deferred as a regulatory asset and the remaining transmission fee, along with all transaction fees, are expensed in other operating expenses.
On April 1, 2005, IPL began participation in the restructured wholesale energy market operated by the Midwest ISO. The implementation of this restructured market marks a significant change in the way IPL buys and sells electricity and schedules generation. Prior to the restructured market, IPL dispatched its generation and purchased power resources directly to meet its demands. In the restructured market, IPL offers its generation and bids its demand into the market on an hourly basis. The Midwest ISO settles these hourly offers and bids based on locational marginal prices ("LMP"),i.e., pricing for energy at a given location based on a market clearing price that takes into account physical limitations, generation and demand throughout the Midwest ISO region. The Midwest ISO evaluates the market participants' energy injections into, and withdrawals from, the system to economically and reliably dispatch the entire Midwest ISO system on a five-minute basis. Market participants are able to hedge their exposure to congestion charges, which result from constraints on the transmission system, by acquiring certain Financial Transmission Rights ("FTRs"). Participants are allocated FTRs each year and are permitted to purchase additional FTRs.
On July 9, 2004, IPL and other Indiana utilities filed a joint petition with the IURC requesting approval of certain changes in operations and determination of cost recovery resulting from the Midwest ISO implementation of day-ahead and real-time energy markets. On June 1, 2005, the IURC issued an order which approved the changes in operations and allowed IPL to recover the Midwest ISO components of the cost of fuel through fuel adjustment charge proceedings as well as to defer certain administrative and socialized Midwest ISO costs.
The amounts of regulatory assets are as follows:
September 30, December 31, Recovery
2005 2004 Period
------------- ------------ ----------------------
In Thousands
Current:
Deferred Fuel costs $25,807 $8 Through 2006 (1)
NOx project expenses 1,247 1,726 Through 2006 (1)
Air Conditioning Load Management
(Demand Management) 232 143 Through 2006 (1)
Other Demand Side Mgmt. Program Costs 328 89 Through 2006 (1)(2)
------------- ------------
Total Current Regulatory Assets 27,614 1,966
------------- ------------
Long Term:
Related to Deferred Income Taxes $98,630 $96,140 Various
Unamortized reacquisition premium
on debt 15,457 15,463 Over remaining life of
Unamortized Petersburg
unit 4 carrying charges
and certain other costs 22,056 22,847 Through 2026 (1)(2)
Deferred Midwest ISO costs 17,661 7,791 To be determined
Nox project expenses - Pete Unit 2
Precipitator 2,346 2,489 Through 2021 (1)
------------- ------------
Total Long Term Regulatory Assets 156,150 144,730
------------- ------------
Total Regulatory Assets $183,764 $146,696
============= ============
(1)Recovered per specific rate orders
(2) Recovered with a current return
Deferred Fuel.Deferred fuel costs are a component of current regulatory assets and are expected to be recovered through future fuel adjustment charge proceedings. IPL records deferred fuel in accordance with standards prescribed by the Federal Energy Regulatory Commission (the "FERC"). The deferred fuel adjustment is the result of variances between estimated fuel and purchased power costs in IPL's fuel adjustment charge and actual fuel and purchased power costs. IPL is permitted to recover underestimated fuel and purchased power costs in future rates through the fuel adjustment charge proceedings and therefore the costs are deferred and amortized into fuel expense in the same period that IPL's rates are adjusted. Deferred fuel costs have increased $25.8 million during the nine months ended September 30, 2005 because actual fuel and purchased power costs during the period were higher than the estimate of such costs in the fuel adjustment charge proceedings.
Deferred Income Taxes: This amount represents the portion of deferred income taxes that we believe will be recovered through future rates, based upon established regulatory practices, which permit the recovery of current taxes. Accordingly, this regulatory asset is offset by a deferred tax liability and is expected to be recovered, without interest, over the period underlying book-tax timing differences reverse and become current taxes.
Deferred Midwest ISO costs: These consist of administrative and socialized costs from IPL's participation in the Midwest ISO market. IPL received orders from the IURC that granted authority for the deferral of Midwest ISO administrative and socialized costs for recovery in a future base rate case.
6. INDEBTEDNESS
During April 2005, IPL issued, in two separate series, $71.9 million of variable-rate first mortgage bonds. The interest rate for each series is established through a weekly auction. The initial interest rate on both series was 2.25% and the rate in effect as of September 30, 2005 was 2.55% on both series. The 2005A Series bonds, in the principal amount of $41.9 million, mature January 1, 2016. The 2005B Series bonds, in the principal amount of $30.0 million, mature October 1, 2023. In May 2005, the net proceeds of the new debt were used to retire two series of existing fixed-rate first mortgage bonds: (i) $41.9 million at 6.1% maturing January 2016 and (ii) $30.0 million at 5.5% maturing October 2023.
In May 2005, IPLamended three financing arrangements to extend the maturity dates. IPL's $45 million committed line of credit was extended to May 18, 2006.IPL's credit agreement, which includes a $30 million committed line of credit and a $40.6 million liquidity facility (related to $40 million of IPL variable rate bonds, which are remarketed weekly), was extended to May 30, 2006. IPL's receivable sale agreement was extended to May 30, 2006.
7. PENSION BENEFITS
Employees' Retirement Plan: Most of IPL's employees are covered by the Employees' Retirement Plan of Indianapolis Power & Light Company (the "Defined Benefit Pension Plan"). The Defined Benefit Pension Plan is noncontributory and is funded through a trust. Benefits are based on each individual employee's pension band and years of service as opposed to their compensation. Pension bands are based primarily on job duties and responsibilities.
Supplemental Retirement Plan:Additionally, a select group of former management employees of IPALCO and IPL who have terminated vested benefits are covered under a funded supplemental retirement plan.
Pension Funding:IPL's funding policy for the Defined Benefit Pension Plan and the supplemental retirement plan is to contribute annually no less than the minimum required by applicable law, nor more than the maximum amount that can be deducted for federal income tax purposes. IPL made a $17.5 million contribution to the Defined Benefit Pension Plan on September 14, 2005. This was the only contribution to date during 2005 and IPL does not anticipate any further contributions in 2005.
The following table presents information relating to the Defined Benefit Pension Plan and supplemental retirement plan:
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
-------------------- --------------------
2005 2004 2005 2004
-------------------- --------------------
Pension Benefits (IN THOUSANDS)
Components of net periodic
benefit cost
Service cost $1,033 $914 $3,100 $2,741
Interest cost 6,473 6,426 19,419 19,278
Expected return on plan assets (6,547) (6,782) (19,526) (20,287)
Amortization of transition asset (318) (353) (954) (1,060)
Amortization of prior service cost 434 386 1,303 1,160
Recognized actuarial gain 781 953 2,342 2,859
-------------------- --------------------
Net periodic benefit cost $1,856 $1,544 $5,684 $4,691
==================== ====================
8. COMMITMENTS AND CONTINGENCIES
Legal
IPALCO and certain former officers and directors of IPALCO are defendants in a class action lawsuit under the Employment Retirement Income Security Act, filed in the U.S. District Court for the Southern District of Indiana, regarding matters arising from the acquisition of IPALCO by AES. The lawsuit was filed in March 2002 and alleges breach of fiduciary duties with respect to shares held in IPL's 401(k) thrift plan. IPALCO filed a motion for summary judgment in October 2003, as did the plaintiffs. On August 11, 2005, the court denied both motions for summary judgment. The matter is set for bench trial on February 21, 2006 to determine whether there were any breaches of fiduciary duties. While we cannot predict the outcome, we do not believe that the suit will have a material adverse effect on IPALCO's consolidated financial statements.
In September 2002, IPALCO and certain of its former officers and directors were sued in the U.S. District Court for the Southern District of Indiana in connection with IPALCO's acquisition by AES. The lawsuit was filed on behalf of all persons who exchanged their shares of IPALCO common stock for shares of AES common stock. On July 7, 2005, the court dismissed all claims against all remaining defendants in this matter. The plaintiffs' right to file an appeal expired on August 8, 2005.
Since May 2003, IPALCO, IPL, AES and certain former directors and officers of IPALCO and/or IPL have received subpoenas from the Securities Division of the Indiana Secretary of State seeking information related to the acquisition of IPALCO by AES. On October 5, 2005, the Indiana Secretary of State's office announced the conclusion of its investigation, having found no evidence of Indiana Securities Laws violations.
In November 2002, IPL was sued in a Fair Labor Standards Act ("FLSA") collective action lawsuit filed in the U.S. District Court for the Southern District of Indiana. The complaint alleges that certain of IPL's current and former employees were not paid overtime pay at the rate required by the FLSA. We believe that IPL did not violate the FLSA. While we cannot predict the outcome, we do not believe the suit will have a material adverse effect on IPALCO's consolidated financial statements.
Many years ago, IPL obtained, through purchases from several owners, a substantial tract of land as a potential site for a future power plant. IPL later determined it no longer intended to build a power plant on that land and sold it in 2004. In September 2004, a former owner of a parcel included within IPL's land sued IPL in Morgan County Superior Court in a purported class action to force IPL to pay any profit on the sale to the various former owners, as well as profits received from ground leases and timber sales. The plaintiff contended, in essence, that IPL obtained the various parcels through eminent domain or the threat of eminent domain and alleged violations of Indiana's eminent domain statute, conversion and unjust enrichment. IPL believes the suit is without merit. At this time discovery has not yet begun and the court has not certified a class. While we cannot predict the outcome, we do not expect the matter will have a material adverse effect on IPALCO's consolidated financial statements.
As of September 30, 2005 and December 31, 2004, IPL is a defendant in approximately 110 and 113 pending lawsuits, respectively, alleging personal injury or wrongful death stemming from exposure to asbestos and asbestos containing products formerly located in IPL power plants. IPL has been named as a "premises defendant" in that IPL did not mine, manufacture, distribute or install asbestos or asbestos containing products. These suits have been brought on behalf of persons who worked for contractors or subcontractors hired by IPL. IPL has insurance which may cover some portions of these claims; currently, these cases are being defended by counsel retained by various insurers who wrote policies applicable to the period of time during which much of the exposure has been alleged.
It is possible that material additional loss with regard to the asbestos lawsuits could be incurred. At this time, an estimate of additional loss cannot be made. IPL has settled a number of asbestos related lawsuits for amounts which, individually and in the aggregate, are not material to IPL or IPALCO's financial position, results of operations, or cash flows. Historically, settlements paid on IPL's behalf have been comprised of proceeds from one or more insurers along with comparatively smaller contributions by IPL. We are unable to estimate the number of, the effect of, or losses or range of loss which are reasonably possible from the pending lawsuits or any additional asbestos suits. Furthermore, we are unable to estimate the portion of a settlement amount, if any, that may be paid from any insurance coverage for any known or unknown claims. Accordingly, there is no assurance that the pending or any additional suits will not have a material adverse effect on IPALCO's consolidated financial statements.
In addition, IPALCO and IPL are involved in litigation arising in the normal course of business. While the results of such litigation cannot be predicted with certainty, management, based upon advice of counsel, believes that the final outcome will not have a material adverse effect on IPALCO's consolidated financial statements.
Environmental
IPALCO and IPL are subject to various federal, state and local environmental protection and health and safety laws and regulations governing, among other things, the generation, storage, handling, use, disposal and transportation of hazardous materials; the emission and discharge of hazardous and other materials into the environment; and the health and safety of our employees. These laws and regulations often require a lengthy and complex process of obtaining and renewing permits and other governmental authorizations from federal, state and local agencies. Violation of these laws, regulations or permits can result in substantial fines, other sanctions, permit revocation and/or facility shutdowns. We believe that we operate in material compliance with environmental laws, regulations and permits and health and safety laws. We cannot assure, however, that we have been or will be at all times in full compliance with such laws, regulations and permits. Please see Note 12 "Commitments and Contingencies - Environmental" of IPALCO's audited financial statements for the year ended December 31, 2004, included in its annual report on Form 10-K, for a more comprehensive discussion of environmental matters impacting IPALCO and IPL.
9. RELATED PARTY TRANSACTION
In July 2005, IPL purchased, in an arm's length transaction, 3,500 SO2 air emissions allowances at the then current market price of $840 per ton, for a total of $2.9 million from another wholly owned subsidiary of The AES Corporation.
10. SUBSEQUENT EVENT
On October 28, 2005 IPL and the Indiana Office of Utility Consumer Counselor (the "OUCC") reached an agreement to resolve certain Fuel Adjustment Charge allocation issues previously raised by the OUCC, including the treatment of IPL's alternative regulation program (Elect Plan) through the balance of its expiration at the end of 2006. The parties have also agreed to enter into good faith discussions regarding a new alternative regulation program to replace the Elect Plan upon its expiration and the potential filing of new depreciation rates. IPL is phasing out new offers and renewals under the Elect Plan, and beginning August 2005, will voluntarily treat Elect Plan revenues in excess of fuel and purchased power costs as jurisdictional revenue for purposes of the authorized annual jurisdictional net operating income computation. IPL also filed for regulatory approval to provide a one-time energy assistance credit to residential customers, payable in January 2006, of $25 per customer (for approximately $10.4 million in the aggregate). IPL accrued the liability for the credit in the fourth quarter, 2005.
Item 2. Management's Discussion And Analysis Of Financial Condition And Results Of Operations
Cautionary Note Regarding Forward-Looking Statements
This Report on Form 10-Q includes ``forward-looking statements'' including, in particular, the statements about our plans, strategies and prospects under the heading ``Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.'' Forward-looking statements express an expectation or belief and contain a projection, plan or assumption with regard to, among other things, our future revenues, income or capital structure. Such statements of future events or performance are not guarantees of future performance and involve estimates, assumptions and uncertainties. The words "could," "may," "predict," "anticipate," "would," "believe," "estimate," "expect," "forecast," "project," "objective," and similar expressions are intended to identify forward-looking statements.
Some important factors that could cause our actual results or outcomes to differ materially from those discussed in the forward-looking statements include, but are not limited to:
- changes in our credit ratings
- performance of pension plan assets
- fluctuations in customer growth and demand
- weather and weather-related damage
- fuel costs
- generating unit availability and capacity
- transmission and distribution system reliability and capacity
- purchased power costs and availability
- regulatory action, including, but not limited to, the review of our basic rates and charges by the IURC
- our ownership by The AES Corporation
- federal and state legislation
- changes in financial or regulatory accounting policies
- environmental matters
- interest rates and the availability and other cost of capital
- labor strikes or other workforce factors
- unanticipated maintenance and capital expenditures
- local economic conditions
- acts of terrorism
- unanticipated generation outages, facility maintenance or repairs
- costs and effects of legal and administrative proceedings, settlements, investigations and claims and the ultimate disposition of litigation
- industry restructuring, deregulation and competition
- issues related to our participation in the Midwest ISO, including recovery of costs incurred
- product development and technology changes
Most of these factors affect us through our consolidated subsidiary Indianapolis Power & Light Company. All such factors are difficult to predict, contain uncertainties that may materially affect actual results and many are beyond our control. We undertake no obligation to publicly update or review any forward-looking information, future events or otherwise.
Overview
IPALCO Enterprises, Inc. is a holding company incorporated under the laws of the state of Indiana. Our principal subsidiary is Indianapolis Power & Light Company, a regulated electric utility operating in the state of Indiana. Substantially all of our business consists of the generation, transmission, distribution and sale of electric energy conducted through IPL. Our other direct subsidiary, Mid-America Capital Resources, Inc., is the holding company for our unregulated activities. Mid-America's only significant investment is a small minority ownership interest in EnerTech Capital Partners II L.P., a venture capital fund. The investment was recorded at $5.8 million, as of September 30, 2005. Our business segments are electric and "all other."
IPL is engaged primarily in generating, transmitting, distributing and selling electric energy to more than 460,000 retail customers in the city of Indianapolis and neighboring areas within the state of Indiana. IPL has an exclusive right to provide electric service to those customers. IPL owns and operates four generating stations, all within the state of Indiana. Historically, approximately 99% of the total electricity produced by IPL was generated from coal. Natural gas and fuel oil combined to provide the remaining kWh generation (primarily for peaking capacity). IPL's net electric generation capability for winter and summer is 3,370 and 3,252 megawatts, respectively. Our corporate mission is to serve our customer's needs for electric power in ways that provide exceptional value to our customers, shareholders, people and communities.
Midwest Independent Transmission System Operators "Midwest Energy Markets" Operations.On April 1, 2005, IPL began participation in the restructured wholesale energy market operated by the Midwest ISO. The implementation of this restructured market marks a significant change in the way IPL buys and sells electricity and schedules generation. Prior to the restructured market, IPL dispatched its generation and purchased power resources directly to meet its demands. In the restructured market, IPL offers its generation and bids its demand into the market on an hourly basis. Midwest ISO settles these hourly offers and bids based on LMPsi.e., pricing for energy at a given location based on a market clearing price that takes into account physical limitations, generation and demand throughout the Midwest ISO region. The Midwest ISO evaluates the market participants' energy injections into, and withdrawals from, the system to economically dispatch the entire Midwest ISO system on a five- minute basis. Market participants are able to hedge their exposure to congestion charges, which result from constraints on the transmission system, with certain Financial Transmission Rights. Participants are allocated FTRs each year and are permitted to purchase additional FTRs. The net of expenses related to congestion charges and/or FTRs have not been material to our financial statements thus far and we do not expect them to be material in the near term.
As anticipated and in keeping with similar market start-ups around the world, LMPs are volatile and there are process, data, and model issues requiring editing and enhancement. IPL and other market participants have raised concerns with certain Midwest ISO transactions and the resolution of these items could impact our results of operations.
On July 9, 2004, IPL and other Indiana utilities filed a joint petition with the IURC requesting approval of certain changes in operations and determination of cost recovery resulting from the Midwest ISO implementation of Midwest Energy MarketsOperations. On June 1, 2005, the IURC issued an order approving the changes in operations and allowing for recovery of the Midwest ISO components of the cost of fuel through fuel adjustment charge proceedings as well as the deferral of certain administrative and socialized Midwest ISO costs. Total Midwest ISO costs deferred as long-term regulatory assets were $17.7 million and $7.8 million as of September 30, 2005 and December 31, 2004, respectively (See also Note 5).
Material changes in our consolidated financial condition and results of operations, except where noted, are attributed to the operations of IPL. Consequently, the following discussion is centered on IPL.
Results of Operations
The electric utility business is affected by seasonal weather patterns throughout the year and, therefore, the operating revenues and associated operating expenses are not generated evenly by month during the year.
Comparison of Quarters Ended September 30, 2005 and September 30, 2004
Our third quarter 2005 net income of $34.6 million increased $3.6 million from net income of $31.0 million in the third quarter of 2004. The following discussion highlights the significant factors contributing to this change.
Utility Operating Revenues
Utility operating revenues increased by $24.0 million during the three months ended September 30, 2005 compared to the prior year as a result of the following (dollars in thousands):
September 30, September 30, Increase Percentage
2005 2004 (Decrease) Change
--------------------------------------------------
Retail Revenues $237,106 $218,518 $18,588 8.5%
Wholesale Revenues 13,142 7,979 5,163 64.7%
Miscellaneous Revenues 3,959 3,732 227 6.1%
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Total Operating Revenues $254,207 $230,229 $23,978 10.4%
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Heating Degree Days 18 42 (24) -57.1%
Cooling Degree Days 917 584 333 57.0%
The 8.5% increase in retail revenues was primarily due to an 8.4% increase in the quantity of kWhs sold ($18.4 million) and an increase in costs IPL recovered from its retail customers associated with its NOx compliance construction program ($6.1 million), offset by a decrease in the weighted average price, excluding NOx recovery, of retail kWhs sold (approximately $5.8 million). The increase in the quantity of retail kWhs sold is primarily due to a 57.0% increase in cooling degree days during the comparative periods and because we increased our retail customer base by approximately 3,100 customers or 0.7% from September 30, 2004 to September 30, 2005. The $5.8 million decrease in the weighted average price, excluding NOx recovery, of retail kWhs sold was primarily due to a lower weighted average per kWh rate, excluding NOx recovery, charged to our residential customers (approximately $4.6 million). IPL's declining block rate structure generally provides for residential customers to be charged a lower per kWh rate at higher consumption levels.
The increase in wholesale revenues was primarily due to a 66.4% increase in the average price of wholesale kWhs sold (approximately $5.6 million), partially offset by a 1.0% decrease in the quantity of wholesale kWhs sold (approximately $0.4 million). The price of wholesale electricity is impacted by changes in delivered fuel prices (primarily natural gas) and the price of environmental emission allowances, as well as the supply of electricity and demand for electricity. Wholesale prices in the Midwest Energy Markets, which began April 1, 2005, are now based upon cleared generation offers and demand bids in the day-ahead and real-time markets. The quantity of wholesale kWh sales is impacted primarily by our replacement cost of coal, the market price of electricity, our retail load requirements and our generation capacity and unit availability.
Utility Operating Expenses
Operating Expenses for the Quarter Ended September 30, 2004 $176.3
Change in deferred fuel costs (20.1)
Increase in purchased power expense 15.7
Increase in fuel costs 14.1
Increase in wages and benefits 5.3
Increase in income tax expense 4.2
Increase in emissions allowance expense 1.5
Other miscellaneous variances 0.2
-----------
Operating Expenses for the Quarter Ended September 30, 2005 $197.2
===========
The deferred fuel adjustment is the result of variances between estimated fuel and purchased power costs in IPL's fuel adjustment charge and actual fuel and purchased power costs. IPL is permitted to recover underestimated fuel and purchased power costs in future rates through the fuel adjustment charge proceedings and therefore the costs are deferred and amortized into expense in the same period that IPL's rates are adjusted. The increase in the deferred fuel credit is primarily because the fuel and purchased power costs were much higher than estimated in the fuel adjustment charge proceedings. The increase in purchased power and fuel costs are partially offset by the deferred fuel adjustment, which is included in "Fuel" on the accompanying statements of income. Purchased power expense increased primarily due to an increase in the market price of purchased power, which is influenced by changes in delivered fuel prices (primarily natural gas) and the price of environmental emission allowances, as well as the supply of electricity and demand for electricity. Fuel costs increased primarily due to the increase in the average price of fuel consumed and because we produced a greater portion of our electricity during 2005 using peaking unit resources as a result of higher electricity demand, primarily caused by average temperatures in the third quarter of 2005 being significantly higher than the same period in 2004.
The increase in wages and employee benefits includes a $2.8 million increase in employee group insurance benefit expenses, a $1.7 million increase in payroll costs and a $0.5 million increase in pension and other postretirement benefits. The increase in employee group insurance benefit expenses results primarily from escalating health insurance claims and additional employees. The increase in payroll costs reflects annual wage increases and additional employees.
Emissions allowance expenses have increased $1.5 million in the third quarter of 2005, as compared to the third quarter of 2004, primarily because in 2004 we were able to rely on allowances allocated to us by the EPA at no cost, as opposed to the third quarter of 2005 when we purchased 3,500 allowances for a total cost of $2.9 million. The price of such allowances has been volatile, therefore, it is difficult to predict what our cost may be in the future, but we do expect our SO2 air emissions allowance costs to increase in the last quarter of 2005 and in 2006, relative to prior years. Pre-tax net operating income increased $7.3 million for the third quarter of 2005 as compared to the same period in the prior year, which contributed $3.0 million to the increase in income tax expense.
Additionally, we expect maintenance expenses to be higher in 2006 as a result of the timing of major generating unit overhauls.
Interest and Other Charges
Interest and other charges decreased by $0.2 million in the third quarter of 2005 as compared to the same period in 2004. The decrease was primarily driven by a $0.5 million decrease in interest paid on long-term debt due to $71.8 million of bonds refinanced in the 2nd quarter of 2005 (see Liquidity and Capital Resources). This decrease was partially offset by a $0.2 million decrease in the allowance for borrowed funds used during construction, which resulted primarily from $53.5 million of equipment being placed in service in May 2005 designed to reduce NOx emissions ($0.2 million).
Comparison of Nine Month Periods Ended September 30, 2005 and September 30, 2004
Our net income during the nine month period ended September 30, 2005 increased by $5.6 million to $95.7 million from the $90.1 million in the same period in 2004. The following discussion highlights the significant factors contributing to this change.
Utility Operating Revenues
Utility operating revenues increased by $49.8 million during the nine months ended September 30, 2005 compared to the prior year as a result of the following (dollars in thousands):
September 30, September 30, Increase Percentage
2005 2004 (Decrease) Change
--------------------------------------------------
Retail Revenues $656,866 $616,069 $40,797 6.6%
Wholesale Revenues 40,386 32,565 7,821 24.0%
Miscellaneous Revenues 12,643 11,489 1,154 10.0%
--------------------------------------
Total Operating Revenues $709,895 $660,123 $49,772 7.5%
======================================
Heating Degree Days 3,181 3,223 (42) -1.3%
Cooling Degree Days 1,270 947 323 34.1%
The 6.6% increase in retail revenues was primarily due to a 3.3% increase in the quantity of retail kWhs sold ($21.1 million) and a 3.2% increase in the weighted average price per kWhs sold (approximately $19.7 million). The quantity increase is primarily due to a 34.1% increase in cooling degree days during the comparative periods, and because we increased our retail customer base by approximately 3,100 customers or 0.7% from September 30, 2004 to September 30, 2005. The price variance is primarily the result of costs associated with our NOx compliance construction program ($17.7 million). The increase in wholesale revenues was primarily due to a 37.1% increase in the price of wholesale kWhs sold (approximately $12.1 million), partially offset by a 9.6% decrease in the quantity of wholesale kWhs sold (approximately $4.3 million). Wholesale prices in the Midwest Energy Markets, which began April 1, 2005, are now based upon cleared generation offers and demand bids in the day-ahead and real-time markets.
Utility Operating Expenses
Operating Expenses for the Nine Months Ended September 30, 2004 $503.7
Change in deferred fuel costs (29.3)
Increase in fuel costs 21.1
Increase in purchased power expense 20.5
Increase in depreciation and amortization 10.4
Increase in wages and benefits 11.1
Land sale gain in 2004 6.0
Increase in income tax expense 4.7
Other miscellaneous variances (0.7)
-----------
Operating Expenses for the Nine Months Ended September 30, 2005 $547.5
===========
The deferred fuel adjustment is the result of variances between estimated fuel and purchased power costs in IPL's fuel adjustment charge and actual fuel and purchased power costs. IPL is permitted to recover underestimated fuel and purchased power costs in future rates through the fuel adjustment charge proceedings and therefore the costs are deferred and amortized into expense in the same period that IPL's rates are adjusted. The increase in the deferred fuel credit is primarily because the fuel and purchased power costs were much higher than estimated in the fuel adjustment charge proceedings. The increase in purchased power and fuel costs are partially offset by the deferred fuel adjustment, which is included in "Fuel" on the accompanying statements of income. Our fuel costs have risen 15.5% in the comparative periods, primarily as a result of a 8.0% increase in the average price of coal consumed and because we produced a greater portion of our electricity during 2005 using peaking unit resources as a result of higher electricity demand, primarily caused by average summer temperatures in 2005 being significantly higher than in 2004. Purchased power expense increased primarily due to an increase in the market price of purchased power, which is influenced by changes in delivered fuel prices (primarily natural gas) and the price of environmental emission allowances, as well as the supply of electricity and demand for electricity.
The increase in wages and employee benefits includes a $4.6 million increase in payroll costs, a $3.8 million increase in employee group insurance benefit expenses and a $1.6 million increase in pension and other postretirement benefits. The increase in payroll costs reflects annual wage increases and additional employees. The increase in employee group insurance benefit expenses results primarily from escalating health insurance claims and additional employees.
The increase in depreciation and amortization is primarily due to a $5.0 million increase in depreciation on $156.9 million of equipment placed in service in May of 2004 and $53.5 million placed in service in May 2005 designed to reduce NOx emissions and a $4.5 million increase in amortization of regulatory assets related to such equipment. The gain from the sale of land held for sale, recorded as a reduction of other operating expenses, was recognized during 2004 for the sale of approximately 4,000 acres of undeveloped property near Martinsville, Indiana. Pre- tax net operating income increased $10.7 million for the nine months ended September 30, 2005 as compared to the same period in 2004, which contributed $4.3 million to the increase in income tax expense.
Interest and Other Charges
Interest and other charges increased less than 1% during the nine month period ended September 30, 2005 as compared to the same period in 2004, but included a 41.3% decrease in the allowance for borrowed funds used during construction ($0.8). This decrease is primarily related to $156.9 million of equipment being placed in service in May of 2004 and $53.5 million being placed in service in May 2005 designed to reduce NOx emissions ($0.6 million).
Liquidity and Capital Resources
As of September 30, 2005, IPALCO had cash and cash equivalents of $4.0 million and highly liquid short-term investments of $3.3 million. In addition, as of September 30, 2005, IPL has available borrowing capacity of $74.3 million under its $75.0 million committed credit facilities after outstanding existing letters of credit. All long-term borrowings by IPL must first be approved by the IURC and the aggregate amount of IPL's short-term borrowings must be approved by FERC. IPL has approval from FERC to borrow up to $500 million of short-term indebtedness outstanding at any time through July 29, 2006. IPL and IPALCO also have restrictions on the amount of new debt that may be issued due to contractual obligations of AES and by financial covenant restrictions under their existing debt obligations. Under such restrictions, IPL is generally allowed to fully draw the amounts available on its committed credit facilities, refinance existing debt, issue an additional $30 million of long-term debt approved by the IURC and incur certain other indebtedness. We believe that existing cash balances, cash generated from operating activities and borrowing capacity on IPL's committed credit facilities will be adequate on a short-term and long-term basis to meet anticipated operating expenses, interest expense on outstanding indebtedness, recurring capital expenditures and pay dividends to AES. Sources for principal payments on outstanding indebtedness and nonrecurring capital expenditures are expected to be obtained from: (i) existing cash balances; (ii) cash generated from operating activities; (iii) borrowing capacity on IPL's committed credit facilities and (iv) additional debt financing.
We actively invest a portion of our available cash balances in various financial instruments, such as tax-exempt debt securities that frequently have stated maturities of 20 years or more and taxable and tax-exempt auction rate securities. These instruments provide for a high degree of liquidity through features such as daily and seven day notice put options and 7, 28, and 35 day auctions which allow for the redemption of the investments at their face amounts plus earned income. As we intend to sell these instruments within one year or less, they are classified as current assets.
During April 2005, IPL issued, in two separate series, $71.9 million of variable-rate first mortgage bonds. The interest rate for each series is established through a weekly auction. The initial interest rate on both series was 2.25% and the rate in effect as of September 30, 2005 was 2.55% on both series. The 2005A Series bonds, in the principal amount of $41.9 million, mature January 1, 2016. The 2005B Series bonds, in the principal amount of $30.0 million, mature October 1, 2023. In May 2005, the net proceeds of the new debt were used to retire two series of existing fixed-rate first mortgage bonds: (i) $41.9 million at 6.1% maturing January 2016 and (ii) $30.0 million at 5.5% maturing October 2023.
In May 2005, IPL amended three financing arrangements to extend the maturity dates. IPL's $45 million committed line of credit was extended to May 18, 2006. IPL's credit agreement, which includes a $30 million committed line of credit and a $40.6 million liquidity facility (related to $40 million of IPL variable rate bonds, which are remarketed weekly), was extended to May 30, 2006. IPL's receivable sale agreement was extended to May 30, 2006.
In October 2005, Fitch Ratings upgraded the credit ratings of IPL and IPALCO as follows:
New Previous
Rating Rating
IPL Senior Secured Debt BBB+ BBB
IPL Senior Unsecured Debt BBB BBB-
IPL Preferred Stock BBB- BB+
IPALCO Senior Unsecured Debt BBB- BB
In addition, the ratings outlook for both companies was changed from "positive" to "stable". These changes did not impact the interest rates on any of the outstanding indebtedness at either IPL or IPALCO.
Capital Requirements. Our capital requirements are primarily related to IPL's construction expenditures needed to meet customers' needs for electricity and for environmental compliance. IPL's capital expenditures totaled $77.7 million during the nine months ended September 30, 2005. This represented a decrease of $55.6 million from the comparable period in 2004, primarily because expenditures associated with NOx emission reductions have decreased as the NOx compliance construction program nears completion. Construction expenditures during the first nine months of 2005 were financed with internally generated cash provided by operations. IPL's construction program is composed of capital expenditures necessary for prudent utility operations and compliance with environmental laws and regulations, along with discretionary investments designed to improve overall performance. Our capital expenditure program for the three- year period 2005-2007 is currently estimated to be approximately $476 million. The estimated cost of the overall program by year is $134 million in 2005, $215 million in 2006 and $127 million in 2007. It includes approximately $131 million for additions, improvements and extensions to transmission and distribution lines, substations, power factor and voltage regulating equipment, distribution transformers and street lighting facilities. The capital expenditure program also includes approximately $28 million for construction projects designed to reduce NOx emissions; $204 million for construction projects designed to reduce SO2 and mercury emissions; $102 million for power plant related projects; and $11 million primarily for miscellaneous office equipment and furniture.
Pension Funding. In September 2005, we contributed $17.5 million to the Defined Benefit Pension Plan. This was the only contribution to date during 2005 and IPL does not anticipate making any further pension funding contributions during 2005. We do, however, anticipate our pension funding commitments in 2006 to be greater than 2005. This estimate is based on actuarial assumptions using a discount rate of 6.0% and an assumed long-term rate of return on plan assets of 8.0%.
Dividends. All of our outstanding common stock is owned by AES. During the first nine months of 2005, we paid $83.9 million in dividends to AES. Future distributions will be determined at the discretion of our board of directors and will depend primarily on dividends received from IPL. Dividends from IPL are affected by IPL's results of operations, cash flows, the timing of financings, financial condition, capital requirements, regulatory considerations, and such other factors as IPL's board of directors deems relevant.
Other Regulatory Matters
Purchased Power. IPL is generally allowed to recover, through its fuel adjustment charge, the fuel portion of purchased power costs incurred to meet jurisdictional retail load. Purchased power costs below an established benchmark are presumed to be recoverable energy costs. Prior to March 2005, the benchmark for IPL was fixed at $77.50 per MWh. Under a new settlement agreement approved by the IURC in March 2005, which expires March 31, 2007, the benchmark for IPL is established prospectively each month based on the higher of the prompt month price (futures settlement price on the last trading day of the current month for next month) for natural gas or no. 2 fuel oil. The settlement also generally provides for recovery of 85% of power purchased up to $700/MWh to replace capacity losses for certain full forced outages and environmental derates (unit impairment for environmental conditions) for power purchases up to the first 11% of IPL's total rated summer capacity in any hour and full recovery for power purchases exceeding 11% of IPL's total rated summer capacity in any hour.
Fuel Adjustment Charge Proceedings.On June 1, 2005, the IURC issued an order (the "Midwest ISO Order") approving the changes in operations and allowing for recovery of the Midwest ISO components of the cost of fuel through fuel adjustment charge proceedings as well as the deferral of certain administrative and socialized Midwest ISO costs. In our two most recent quarterly fuel adjustment charge proceedings, the IURC issued orders (the "FAC Orders") which stated that our request for recovery of the Midwest ISO components of the cost of fuel was in conformance with the Midwest ISO Order. The OUCC is responsible for reviewing the costs included in our fuel filings and they are working with each of the Indiana utilities, including IPL, to better understand the Midwest Energy Markets costs. Due to the continued discussions with the OUCC about the implementation of the Midwest ISO Order as well as questions regarding our jurisdictional allocators, the FAC Orders in the fuel adjustment charge proceedings stated that the rates approved should be interim rates, subject to refund. The allocators referenced in the FAC Orders are used to determine our jurisdictional net operating income.
IPL and the OUCC have reached an agreement to resolve certain Fuel Adjustment Charge allocation issues previously raised by the OUCC, including the treatment of IPL's alternative regulation program (Elect Plan) through the balance of its expiration at the end of 2006. The parties have also agreed to enter into good faith discussions regarding a new alternative regulation program to replace the Elect Plan upon its expiration and the potential filing of new depreciation rates. IPL is phasing out new offers and renewals under the Elect Plan, and beginning August 2005, will voluntarily treat Elect Plan revenues in excess of fuel and purchased power costs as jurisdictional revenue for purposes of the authorized annual jurisdictional net operating income computation. IPL also filed for regulatory approval to provide a one-time energy assistance credit to residential customers, payable in January 2006, of $25 per customer (for approximately $10.4 million in the aggregate). IPL accrued the liability for the credit in the fourth quarter, 2005.
IPL's authorized annual jurisdictional net operating income, for purposes of the quarterly operating income tests, is $163 million, as established in IPL's last base rate case, plus additional returns authorized in the Environmental Compliance Cost Recovery Adjustment filings of $12.7 million, as of IPL's most recent quarterly measurement date on July 31, 2005. With Elect Plan revenues in excess of fuel and program costs being phased into the authorized annual jurisdictional net operating income determination, we are likely to exceed the authorized annual jurisdictional net operating income in future measurement periods. As of July 31, 2005, IPL had a cumulative net operating income deficiency (calculated by summing the quarterly measurement period annual results from the date of the last rate order) of approximately $774 million which can be used as an offset when net operating income in a measurement period exceeds authorized annual jurisdictional net operating income. Because of the deficiency, IPL can, for a period of time, earn above the authorized annual electric jurisdictional retail net operating income without being required to make customer refunds.
Energy Policy Act of 2005.On August 8, 2005, the Energy Policy Act of 2005 (the "EPACT") was signed into law. Much of the legislation directs the FERC, the Department of Energy, and other agencies to develop rules for the implementation of the EPACT. We continue to review the details of the EPACT and are actively engaged in the rulemaking processes of the FERC. The EPACT contains provisions specifically related to the electric utility industry including, but not limited to, the following: climate change issues, mandatory reliability standards, amendments to the Public Utility Regulatory Policies Act, repeal of the Public Utility Holding Company Act, clean power initiatives and energy efficiency proposals.
FERC will certify an electric reliability organization (the "ERO") which will be charged with developing and enforcing mandatory electric reliability standards. FERC issued a notice of proposed rulemaking (the "NOPR") on September 1, 2005, and the comment period has expired. The NOPR outlines criteria for establishing the ERO, the procedures for governing the enforcement action by the ERO and FERC, the criteria for the ERO to delegate authority to regional entities, and the funding for the ERO.
Based on our preliminary analysis, IPL currently believes that there may be some costs and challenges associated with implementation of the EPACT, but we currently do not anticipate a significant effect on our results of operations.
Midwest ISO Transmission and Energy Markets Tariff. On October 7, 2005, the Midwest ISO submitted to FERC a document describing the process to be used by the Midwest ISO to consider and develop expansion projects for the Midwest ISO Transmission Expansion Plan and to designate cost responsibility for such projects. If approved, the plan would require IPL to pay for a portion of the projects. We would likely seek recovery for such costs.
Other
Related Party Transaction. In July 2005, we purchased, in an arm's length transaction, 3,500 SO2 air emissions allowances at the then current market price of $840 per ton, for a total of $2.9 million from another wholly owned subsidiary of The AES Corporation.
Union Negotiations. The collective bargaining agreement with the physical unit of the International Brotherhood of Electrical Workers ("IBEW") will expire on December 19, 2005. This unit of the IBEW represents approximately 760 IPL employees. On December 13, 2005, IPL and the IBEW came to a tentative agreement on a three-year labor contract for the physical bargaining unit. This agreement is conditional upon ratification by union membership. A vote is planned on or before Thursday, December 15, 2005.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Not applicable pursuant to General Instruction H of the Form 10-Q.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures. We carried out an evaluation, under the supervision and with the participation of our management, including the chief executive officer ("CEO") and chief financial officer ("CFO"), of the effectiveness of our "disclosure controls and procedures" (as defined in the Securities Exchange Act of 1934 Rules 13a-15(e) and 15-d-15 (e) as required by paragraph (b) of the Exchange Act Rules 13a-15 or 15d-15) as of September 30, 2005. IPL's management, including the CEO and CFO, is engaged in a comprehensive effort to review, evaluate and improve our controls; however, management does not expect that our disclosure controls or our internal controls over financial reporting will prevent all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system's objectives will be met. In addition, we have interests in certain unconsolidated entities. As we do not control or manage these entities, our disclosure controls and procedures with respect to such entities is generally more limited than those we maintain with respect to our consolidated subsidiaries.
Due to the material weakness described below, our CEO and CFO concluded that our disclosure controls and procedures as of September 30, 2005 were not effective to ensure that information required to be disclosed by us in reports we file or submit under the Exchange Act, is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission. In light of this material weakness, we performed additional analysis and other procedures to ensure that our consolidated financial statements are prepared in accordance with generally accepted accounting principles.
A material weakness is a significant deficiency (within the meaning of PCAOB Auditing Standard No.2), or combination of significant deficiencies, that results in there being more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected.
In conjunction with the analysis and review of tax account balances by The AES Corporation, IPL's parent company, management completed an analysis of its deferred income tax related regulatory asset balances on December 6, 2005. Although the Company has completed its preliminary analysis of the accounts and did not identify any adjustments to the third quarter financial statements, it is in the process of completing a more detailed analysis that we expect to complete by year end. The Company does not believe that this analysis will result in material adjustments to the financial statements. However, it determined that a material weakness in internal control over financial reporting existed as of September 30, 2005. Specifically, the Company lacked effective controls to monitor and assess individual components of the deferred income tax related regulatory asset balances to ensure a more than remote likelihood that a material misstatement of annual or interim financial statements would not be prevented or detected.
The Company's remediation efforts with respect to our deferred income tax regulatory asset balances include identification of all significant components and enhanced controls over the analyses and reconciliation of the activity related to these components. Moreover, these components will be incorporated into and tracked in our tax accounting system in order to facilitate an on- going review. The total deferred income taxes per the Company's financial accounting system will be reconciled to the deferred taxes reported in the tax accounting system on a quarterly basis.
Changes in Internal Controls: In the course of our evaluation of disclosure controls and procedures, management considered certain internal control areas in which we have made and are continuing to make changes to improve and enhance controls. Based upon that evaluation, the CEO and CFO concluded that there were no changes in our internal controls over financial reporting identified in connection with the evaluation required by paragraph (d) of Exchange Act Rules 13a-15 or 15d-15 that occurred during the third quarter ended September 30, 2005 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.
Compliance with Section 404 of the Sarbanes Oxley Act of 2002. Beginning with the year ending December 31, 2007, Section 404 of the Sarbanes-Oxley Act of 2002 will require us to include an internal control report of management with our annual report on Form 10-K. The internal control report must contain (1) a statement of management's responsibility for establishing and maintaining adequate internal controls over financial reporting for our Company, (2) a statement identifying the framework used by management to conduct the required evaluation of the effectiveness of our internal controls over financial reporting, (3) management's assessment of the effectiveness of our internal controls over financial reporting as of the end of our most recent fiscal year, including a statement as to whether or not our internal controls over financial reporting are effective, and (4) a statement that our independent auditors have issued an attestation report on management's assessment of our internal controls over financial reporting.
Management has developed a comprehensive plan in order to achieve compliance with Section 404 within the prescribed period and to review, evaluate and improve the design and effectiveness of our controls and procedures on an on-going basis. The comprehensive compliance plan includes (1) documentation and assessment of the adequacy of our internal controls over financial reporting, (2) remediation of control weaknesses, (3) validation through testing that controls are functioning as documented and (4) implementation of a continuous reporting and improvement process for internal controls over financial reporting. As a result of this initiative, we have made and will continue to make changes from time to time in our internal controls over financial reporting.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
Please refer to Note 8 of the accompanying consolidated financial statements for a summary of significant legal proceedings involving IPALCO and/or IPL. We are also subject to routine litigation, claims and administrative proceedings arising in the ordinary course of business, none of which is expected to have a material adverse effect on our financial position or results of operations.
Item 6. Exhibits
3.2 Amended and Restated Bylaws of IPALCO
31.1 Certification by Chief Executive Officer required by Rule 13a-14(a)
or 15d-14(a).
31.2 Certification by Chief Financial Officer required by Rule 13a-14(a)
or 15d-14(a).
32 Certification required by Rule 13a-14(b) or 15d-14(b).
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
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| Date: December 13, 2005 | By: | /s/ Frank Marino |
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| | Frank Marino |
| | Vice President and Chief Financial Officer |
| | (Principal Financial Officer
and Duly Authorized Officer) |
