SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For quarterly period ended June 30, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
----------------- -----------------
Commission file number 1-15467
VECTREN CORPORATION
(Exact name of registrant as specified in its charter)
INDIANA 35-1654378
(State or other jurisdiction of (I.R.S Employer
incorporation or organization) Identification No.)
20 N.W. Fourth Street, Evansville, Indiana 47741
------------------------------------------------
(Address of principal executive offices and Zip Code)
(812) 491-4000
(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 such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
Common Stock -Without par value 67,701,131 August 10, 2001
- ---------------------------------- ---------- ---------------
Class Number of shares Date
2
TABLE OF CONTENTS
Item Page
Number Number
PART I. FINANCIAL INFORMATION
1 Financial Statements (Unaudited)
Vectren Corporation and Subsidiary Companies
Condensed Consolidated Balance Sheets 3 - 4
Condensed Consolidated Statements of Operations 5
Condensed Consolidated Statements of Cash Flows 6
Notes to Unaudited Condensed Consolidated Financial Statements 7 - 22
2 Management's Discussion and Analysis of Results of Operations
and Financial Condition 23 - 42
3 Quantitative and Qualitative Disclosure About Market Risk 43 - 44
PART II. OTHER INFORMATION
1 Legal Proceedings 45
4 Submission of Matters to a Vote of Security Holders 45
6 Exhibits and Reports on Form 8-K 46
Signatures 47
3
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)
VECTREN CORPORATION AND SUBSIDIARY COMPANIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited - Thousands)
June 30, December 31,
---------- -----------
ASSETS 2001 2000
------ ---------- ----------
Current Assets:
Cash and cash equivalents $ 18,849 $ 15,170
Accounts receivable, less reserves of $5,403
and $5,716, respectively 255,483 295,351
Accrued unbilled revenues 21,790 143,365
Inventories 63,460 95,245
Prepaid gas delivery service 31,099 34,849
Recoverable fuel and natural gas costs 96,705 96,084
Prepayments and other current assets 13,847 20,998
---------- ----------
Total current assets 501,233 701,062
---------- ----------
Utility Plant:
Original cost 2,835,978 2,786,694
Less: accumulated depreciation and amortization 1,272,409 1,233,033
---------- ----------
Net utility plant 1,563,569 1,553,661
---------- ----------
Other Investments:
Investments in leveraged leases 36,684 93,145
Investments in partnerships and other corporations 113,331 109,766
Notes receivable 66,264 64,276
Other 1,071 1,057
---------- ----------
Total other investments 217,350 268,244
---------- ----------
Nonutility property, net of accumulated depreciation 125,335 104,456
Other Assets:
Deferred charges, net 49,417 31,541
Goodwill, net 195,563 197,977
Regulatory assets 53,456 52,246
---------- ----------
Total other assets 298,436 281,764
---------- ----------
TOTAL ASSETS $2,705,923 $2,909,187
========== ==========
The accompanying notes are an integral part of these
condensed consolidated financial statements.
4
VECTREN CORPORATION AND SUBSIDIARY COMPANIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited - Thousands)
June 30, December 31,
----------- ------------
LIABILITIES AND SHAREHOLDERS' EQUITY 2001 2000
- ------------------------------------ ----------- -----------
Current Liabilities:
Current maturities of adjustable rate bonds
subject to tender $ - $ 53,700
Current maturities of long-term debt and
other obligations 31 249
Short-term borrowings 612,462 759,908
Accounts payable 118,953 201,481
Accounts payable to affiliated companies 24,240 102,540
Refunds to customers and customer deposits 17,283 22,922
Accrued taxes 12,782 9,571
Accrued interest 15,141 10,272
Deferred income taxes 16,005 16,531
Other current liabilities 51,876 70,750
----------- -----------
Total current liabilities 868,773 1,247,924
----------- -----------
Deferred Credits and Other Liabilities:
Deferred income taxes 208,185 204,365
Accrued postretirement benefits other
than pensions 48,897 45,883
Unamortized investment tax credits 22,026 23,165
Other 21,345 5,826
----------- -----------
Total deferred credits and other liabilities 300,453 279,239
----------- -----------
Commitments and Contingencies (Notes 11 through 14)
Minority Interest in Subsidiary 922 1,421
Capitalization:
Long-term debt and other obligations, net
of current maturities 678,812 631,954
Preferred stock of subsidiary:
Redeemable 7,500 7,500
Nonredeemable 9,312 9,465
----------- -----------
Total preferred stock of subsidiary 16,812 16,965
----------- -----------
Common stock (no par value) - issued and
outstanding 67,701 and 61,419, respectively 346,821 217,720
Retained earnings 497,874 506,462
Accumulated other comprehensive income (4,544) 7,502
----------- -----------
Total common shareholders' equity 840,151 731,684
----------- -----------
Total capitalization 1,535,775 1,380,603
----------- -----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 2,705,923 $ 2,909,187
=========== ===========
The accompanying notes are an integral part of these
condensed consolidated financial statements.
5
VECTREN CORPORATION AND SUBSIDIARY COMPANIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited - Thousands, except per share data)
Three Months Six Months
Ended June 30, Ended June 30,
-------------------------- --------------------------
OPERATING REVENUES: 2001 2000 2001 2000
----------- ----------- ----------- -----------
Gas utility $ 153,798 $ 100,485 $ 676,687 $ 301,330
Electric utility 95,020 78,289 183,229 151,279
Energy services and other 183,456 84,584 455,446 170,312
----------- ----------- ----------- -----------
Total operating revenues 432,274 263,358 1,315,362 622,921
----------- ----------- ----------- -----------
OPERATING EXPENSES:
Cost of gas sold 94,800 55,898 498,872 174,425
Fuel for electric generation 17,857 18,772 35,842 35,465
Purchased electric energy 33,662 9,159 46,815 12,636
Cost of energy services and other 177,015 76,959 438,795 158,681
Other operating 58,974 49,565 120,606 95,987
Merger and integration costs - 3,261 762 30,442
Restructuring costs 11,802 - 11,802 -
Depreciation and amortization 31,794 26,031 63,265 48,693
Taxes other than income taxes 11,053 7,456 30,596 16,056
----------- ----------- ----------- -----------
Total operating expenses 436,957 247,101 1,247,355 572,385
----------- ----------- ----------- -----------
OPERATING INCOME (LOSS) (4,683) 16,257 68,007 50,536
OTHER INCOME:
Equity in earnings of unconsolidated
investments 6,051 2,313 13,901 14,007
Other, net 4,052 7,020 5,735 10,219
----------- ----------- ----------- -----------
Total other income 10,103 9,333 19,636 24,226
INTEREST EXPENSE 20,937 12,319 43,756 24,592
----------- ----------- ----------- -----------
INCOME (LOSS) BEFORE INCOME TAXES (15,517) 13,271 43,887 50,170
INCOME TAXES (5,659) 4,293 13,116 18,656
MINORITY INTEREST IN SUBSIDIARY (149) 439 (171) 581
PREFERRED DIVIDEND REQUIREMENT OF SUBSIDIARY 242 266 480 535
----------- ----------- ----------- -----------
INCOME (LOSS) BEFORE EXTRAORDINARY LOSS AND
CUMULATIVE EFFECT OF CHANGE IN
ACCOUNTING PRINCIPLE (9,951) 8,273 30,462 30,398
Extraordinary loss - net of tax (7,706) - (7,706) -
Cumulative effect of change in accounting
principle - net of tax - - 3,938 -
----------- ----------- ----------- -----------
NET INCOME (LOSS) $ (17,657) $ 8,273 $ 26,694 $ 30,398
=========== =========== =========== ===========
AVERAGE COMMON SHARES OUTSTANDING 67,710 61,227 66,165 61,266
DILUTED COMMON SHARES OUTSTANDING 67,710 61,317 66,295 61,338
EARNINGS PER SHARE OF COMMON STOCK:
BASIC:
INCOME (LOSS) BEFORE EXTRAORDINARY LOSS
AND CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING
PRINCIPLE $ (0.15) $ 0.14 $ 0.46 $ 0.50
Extraordinary loss (0.11) - (0.12) -
Cumulative effect of change in accounting
principle - - 0.06 -
----------- ----------- ----------- -----------
EARNINGS (LOSS) PER SHARE OF COMMON STOCK $ (0.26) $ 0.14 $ 0.40 $ 0.50
=========== =========== =========== ===========
DILUTED:
INCOME (LOSS) BEFORE EXTRAORDINARY LOSS
AND CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING
PRINCIPLE $ (0.15) $ 0.13 $ 0.46 $ 0.50
Extraordinary loss (0.11) - (0.12) -
Cumulative effect of change in accounting
principle - - 0.06 -
----------- ----------- ----------- -----------
EARNINGS (LOSS) PER SHARE OF COMMON STOCK $ (0.26) $ 0.13 $ 0.40 $ 0.50
=========== =========== =========== ===========
DIVIDENDS DECLARED PER SHARE OF COMMON STOCK $ 0.26 $ 0.24 $ 0.51 $ 0.49
=========== =========== =========== ===========
The accompanying notes are an integral part of these
condensed consolidated financial statements.
6
VECTREN CORPORATION AND SUBSIDIARY COMPANIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited - Thousands)
Six Months
Ended June 30,
----------------------
CASH FLOWS FROM OPERATING ACTIVITIES 2001 2000
--------- ---------
Net income $ 26,694 $ 30,398
--------- ---------
Adjustments to reconcile net income to cash provided
from operating activities -
Depreciation and amortization 63,265 48,693
Preferred dividend requirement of subsidiary 480 535
Deferred income taxes and investment tax credits (1,492) (5,971)
Allowance for funds used during construction (1,168) (270)
(Gain) loss on sale or retirement of assets 7,706 (8,961)
Unrealized loss on derivatives 2,369 -
Undistributed earnings of unconsolidated investments (13,901) (7,551)
Restructuring costs 11,802 -
Cumulative effect of change in accounting principle (3,938) -
Changes in assets and liabilities -
Receivables and accrued unbilled revenues 208,169 50,398
Inventories 31,785 24,745
Prepaid gas delivery service 3,750 (32)
Recoverable fuel and natural gas costs (621) (14,986)
Prepayments and other current assets 7,151 17,904
Regulatory assets (1,210) 2,020
Accounts payable, refunds to customers, customer
deposits, other current liabilities (197,143) (7,764)
Accrued taxes and interest 11,727 (17,699)
Accrued post-retirement benefits other than pensions 3,014 2,446
Other assets and liabilities (2,759) 6,192
--------- ---------
Total adjustments 128,986 89,699
--------- ---------
Net cash flows from operating activities 155,680 120,097
--------- ---------
CASH FLOWS (REQUIRED FOR) FINANCING ACTIVITIES
Issuance of common stock 129,671 -
Retirement of common and preferred stock (153) (116)
Proceeds from long-term debt - -
Retirement of long-term debt and other obligations (7,060) (2,637)
Net change in short-term borrowings (147,446) 10,374
Dividends on common stock (34,439) (29,533)
Other - -
--------- ---------
Net cash flows (required for) financing activities (59,427) (21,912)
--------- ---------
CASH FLOWS (REQUIRED FOR) INVESTING ACTIVITIES
Capital expenditures (87,321) (72,687)
Investments in partnerships and other corporations (5,603) (483)
Change in notes receivable (1,988) (29,465)
Cash distributions from unconsolidated investments 5,922 3,261
Other (3,584) 2,565
--------- ---------
Net cash flows (required for) investing activities (92,574) (96,809)
--------- ---------
Net increase in cash 3,679 1,376
Cash and cash equivalents at beginning of period 15,170 17,351
--------- ---------
Cash and cash equivalents at end of period $ 18,849 $ 18,727
========= =========
The accompanying notes are an integral part of these
condensed consolidated financial statements.
7
VECTREN CORPORATION AND SUBSIDIARY COMPANIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. Organization and Nature of Operations
Vectren Corporation (Vectren) is an Indiana corporation that was organized on
June 10, 1999, solely for the purpose of effecting the merger of Indiana Energy,
Inc. (Indiana Energy) and SIGCORP, Inc. (SIGCORP). On March 31, 2000, the merger
of Indiana Energy with SIGCORP and into Vectren was consummated with a tax-free
exchange of shares and has been accounted for as a pooling-of-interests.
Vectren is a public utility holding company, whose wholly owned subsidiary,
Vectren Utility Holdings, Inc. (VUHI), is the intermediate holding company for
Vectren's three operating public utilities, Indiana Gas Company, Inc. (Indiana
Gas), formerly a wholly owned subsidiary of Indiana Energy, Southern Indiana Gas
and Electric Company (SIGECO), formerly a wholly owned subsidiary of SIGCORP,
and the Ohio operations (defined hereafter).
On October 31, 2000, Vectren acquired the natural gas distribution assets of The
Dayton Power and Light Company for approximately $465 million. The acquisition
has been accounted for as a purchase transaction in accordance with Accounting
Principles Board (APB) Opinion No. 16 and accordingly, the results of operations
of the acquired businesses are included in the accompanying financial statements
since the date of acquisition.
Vectren acquired the natural gas distribution assets as a tenancy in common
through two separate wholly owned subsidiaries. Vectren Energy Delivery of Ohio,
Inc. (VEDO) holds a 53% undivided ownership interest in the assets and Indiana
Gas holds a 47% undivided ownership interest. VEDO is the operator of the
assets, operations of which are referred to as "the Ohio operations."
VUHI's regulated subsidiaries serve approximately one million customers. Indiana
Gas provides natural gas and transportation services to a diversified base of
customers in 311 communities in 49 of Indiana's 92 counties. SIGECO provides
generation, transmission, distribution and the sale of electric power to
Evansville, Indiana, and 74 other communities, and the distribution and sale of
natural gas to Evansville, Indiana, and 64 communities in ten counties in
southwestern Indiana. The Ohio operations provide natural gas distribution and
transportation services to Dayton, Ohio and 16 counties in west central Ohio.
Vectren is involved in non-regulated activities through three primary business
groups: Energy Services, Utility Services, and Communications. Energy Services
trades and markets natural gas and provides energy performance contracting
services. Utility Services provides utility products and services, such as
underground construction and facilities locating, meter reading and materials
management, and the mining and sale of coal. Communications provides integrated
broadband communications services, including local and long distance telephone,
Internet access and cable television. In addition, other businesses invest in
other energy-related opportunities and corporate technology.
8
2. Basis of Presentation
The interim condensed financial statements included in this report have been
prepared by Vectren, without audit, as provided in the rules and regulations of
the Securities and Exchange Commission. Certain information and footnote
disclosures normally included in financial statements prepared in accordance
with accounting principles generally accepted in the United States have been
omitted as provided in such rules and regulations. Vectren believes that the
information in this report reflects all adjustments necessary to fairly state
the results of the interim periods reported. These condensed financial
statements and related notes should be read in conjunction with Vectren's
audited annual consolidated financial statements for the year ended December 31,
2000 filed on Form 10-K. Because of the seasonal nature of Vectren's utility
operations, the results shown on a quarterly basis are not necessarily
indicative of annual results.
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the statements
and the reported amounts of revenues and expenses during the reporting periods.
Actual results could differ from those estimates.
Certain reclassifications have been made to prior period financial statements to
conform with the current year classification. These reclassifications have no
impact on previously reported net income.
3. Merger and Integration Costs
Merger and integration costs incurred for the three and six months ended June
30, 2001 were zero and $0.8 million, respectively, and for the three and six
months ended June 30, 2000 totaled $3.3 million and $30.4 million, respectively.
The continued merger and integration activities will be completed in 2001.
Since March 31, 2000, $41.9 million has been expensed associated with merger and
integration activities. Accruals were established at March 31, 2000 totaling
$20.7 million. Of this amount, $5.5 million related to employee and executive
severance costs, $13.1 million related to transaction costs and regulatory
filing fees incurred prior to the closing of the merger, and the remaining $2.1
million related to employee relocations that occurred prior to or coincident
with the merger closing. At June 30, 2001, the accrual remaining for such costs
totaled $1.5 million, all related to severance costs. Of the $41.9 million
expensed, the remaining $21.2 million was expensed through June 30, 2001 ($20.4
million in 2000 and $0.8 million in 2001) for accounting fees resulting from
merger related filing requirements, consulting fees related to integration
activities such as organization structure, employee travel between company
locations as part of integration activities, internal labor of employees
assigned to integration teams, investor relations communications activities, and
certain benefit costs.
The integration activities experienced by the company included such things as
information system consolidation, process review and definition, organization
design and consolidation, and knowledge sharing.
As a result of merger integration activities, management has identified certain
information systems that are expected to be retired in 2001. Accordingly, the
useful lives of these assets have been shortened to reflect this decision,
resulting in additional depreciation expense of approximately $2.7 million ($1.7
million after tax) and $5.5 million ($3.4 million after tax) for the three and
six months ended June 30, 2001, respectively, and $3.3 million ($2.1 million
after tax) for both the three and six months ended June 30, 2000.
9
4. Restructuring Costs
In June 2001, Vectren's management and board of directors approved a plan to
restructure, primarily, its regulated operations. The restructuring plan will
involve the elimination of administrative and supervisory positions in its
utility operations and corporate office. Restructuring and related charges of
$11.8 million were expensed during the second quarter. These charges were
comprised of $8.0 million for severance, related benefits and other employee
related costs, $2.0 million for lease termination fees related to duplicate
facilities, and $1.8 million for consulting fees incurred as of June 30, 2001.
Components of restructuring expenses incurred through June 30, 2001 and
components of the restructuring accrual, which is included in other current
liabilities, as of June 30, 2001 were as follows:
In millions Accrual for
Expected Cash Incurred Expenses
-----------------
Payments Paid in Cash Non-Cash Total Expense
--------- ------------ -------- -------------
Severance and related costs $ 6.8 $ 0.4 $ 0.8 $ 8.0
Lease termination fees 2.0 - - 2.0
Consulting fees - 1.8 - 1.8
------ ------ ------ -------
Total $ 8.8 $ 2.2 $ 0.8 $ 11.8
====== ====== ====== =======
The $6.8 million accrued for restructuring costs for employee separation is
associated with approximately 90 employees. Employee separation benefits include
severance, healthcare and outplacement services. Employees are expected to begin
exiting the business beginning August 2001.
The restructuring program will be substantially completed by December 31, 2001.
5. Extraordinary Loss
In June 2001, the Southern Indiana Properties, Inc., a non-regulated wholly
owned subsidiary, agreed to sell certain leverage lease investments with a net
book value of $59.1 million at a loss of $12.4 million ($7.7 million after tax).
Because of the transaction's significance and because the transaction occurred
within two years of the effective date of the merger of Indiana Energy and
SIGCORP, which was accounted for as a pooling-of-interests, Accounting
Principles Board (APB) Opinion No. 16, "Business Combinations" calls for the
loss on disposition of these investments to be treated as extraordinary.
Proceeds from the sale of $46.7 million will be used to retire short-term
borrowings.
Proceeds from the transaction were received after June 30, 2001 and therefore
have been omitted from the Condensed Consolidated Statements of Cash Flows.
6. Short - Term Borrowings
At March 31, 2001, Indiana Gas was not in compliance with the total indebtedness
to capitalization ratio contained in its back up credit facility for its
commercial paper program. The non-compliance resulted from the indebtedness
incurred to purchase its ownership interest in the Ohio operations and working
capital requirements associated with higher gas costs. A waiver on the Indiana
Gas facility was obtained to waive the non-compliance through and including
March 31, 2001 which effectively waived the noncompliance up to June 30, 2001,
the date of the next quarterly test of the financial covenants. During the
quarter ended June 30, 2001, Vectren made a $100 million equity investment in
Indiana Gas. In addition, Indiana Gas was granted a modification to the credit
agreement by the syndicate banks raising the total indebtedness to
capitalization ratio. As a result of these events, Indiana Gas is in compliance
with its debt covenants at June 30, 2001. No amount is outstanding under the
back up facility.
10
VUHI's credit facility was renewed on June 27, 2001 and extended though June 27,
2002. As part of the renewal, the capacity of the facility was decreased from
$435 million to $350 million.
7. Long - Term Debt
SIGECO has $53.7 million of adjustable rate pollution control series first
mortgage bonds which could, at the election of the bondholder, be tendered to
SIGECO when the interest rates are reset. Prior to the latest reset on March 1,
2001, the interest rates were reset annually, and the bonds subject to tender
were presented in the Condensed Consolidated Balance Sheets as current
liabilities. Effective March 1, 2001, the bonds were reset for a five-year
period and have been classified as long-term debt. Resulting from the reset, the
interest rate on the $31.5 million Series A bonds increased from 4.30% to 4.75%,
and the interest rate on the $22.2 million Series C bonds increased from 4.45%
to 5.00%.
8. Shareholders' Equity
Vectren At-Risk Compensation Plan
At the annual shareholders meeting on April 25, 2001, Vectren shareholders
approved the company's At-Risk Compensation Plan. On May 1, 2001, per the terms
of the plan, 4,000,000 shares were reserved for issuance in the form of stock
options, restricted stock, and other awards. Also on May 1, 2001, approximately
740,000 stock options were granted to employees of the company.
Common Stock Offering
On January 19, 2001, Vectren filed a registration statement with the Securities
and Exchange Commission with respect to a public offering of 5.5 million shares
of new common stock. On February 8, 2001, the registration became effective and
agreement was reached to sell 5.5 million shares to a group of underwriters. On
February 14, 2001, the shares were sold, at which time the underwriters
exercised their over-allotment option to sell an additional 825,000 shares for a
total of approximately 6.3 million shares. The net proceeds of $129.4 million
were used to repay outstanding commercial paper utilized for recent acquisitions
and investments.
9. Comprehensive Income
Vectren's components of comprehensive income (loss) include its portion of
ProLiance Energy, LLC's (ProLiance) other comprehensive income and market value
fluctuation of an interest rate swap designated as a cash flow hedge.
ProLiance's other comprehensive income is the result of its adoption of
Statement of Financial Accounting Standard No. 133 "Accounting for Derivative
Instruments and Hedging Activities" (SFAS 133). See Note 14 for more information
on ProLiance and Note 16 for more information on SFAS 133.
11
Comprehensive income (loss) consists of the following:
Three Months Six Months
Ended June 30, Ended June 30,
-------------------- ---------------------
In thousands 2001 2000 2001 2000
--------- --------- --------- --------
Net income (loss) $(17,657) $ 8,273 $ 26,694 $ 30,398
Comprehensive (loss) of
unconsolidated investments, net of tax (4,436) - (11,064) -
Interest rate swap and other, net of tax (76) 55 (982) 149
-------- -------- -------- --------
Total comprehensive income (loss) $(22,169) $ 8,328 $ 14,648 $ 30,547
======== ======== ======== ========
10. Earnings Per Share
Basic earnings per share is computed by dividing net income available to common
shareholders by the weighted-average number of common shares outstanding for the
period. Diluted earnings per share assumes the conversion of stock options into
common shares using the treasury stock method to the extent the effect of the
conversion would be dilutive.
The following table details the number of shares of common stock added to the
average common shares outstanding to show the effects of the assumed exercise of
stock options for the purpose of calculating diluted earnings per share.
Three Months Ended June 30,
-----------------------------------------------------------------
2001 2000
------------------------------- -------------------------------
In thousands, except Per Per
per share amounts Share Share
Loss Shares Amount Income Shares Amount
--------- -------- -------- -------- -------- --------
Basic EPS $(17,657) 67,710 $ (0.26) $ 8,273 61,227 $ 0.14
Effect of dilutive stock
options - - - 90
-------- -------- -------- -------- -------- --------
Diluted EPS $(17,657) 67,710 $ (0.26) $ 8,273 61,317 $ 0.13
======== ======== ======== ======== ======== ========
Six Months Ended June 30,
------------------------------------------------------------
2001 2000
---------------------------- -----------------------------
Per Per
Share Share
Income Shares Amount Income Shares Amount
------- ------- -------- ------- -------- --------
Basic EPS $26,694 66,165 $ 0.40 $30,398 61,266 $ 0.50
Effect of dilutive stock options - 130 - 72
------- ------- -------- ------- ------- --------
Diluted EPS $26,694 66,295 $ 0.40 $30,398 61,338 $ 0.50
======= ======= ======== ======= ======= ========
For the three months ended June 30, 2001 and 2000, options to purchase an
additional 1,514,060 and 545,778 common shares of the company's common stock
were outstanding, but were not included in the computation of diluted earnings
per share because their effect would be antidilutive. Exercise prices for
options excluded from the computation ranged from$13.82 to $24.05 in 2001 and
ranged from $19.83 to $24.05 in 2000.
12
For the six months ended June 30, 2001 and 2000, options to purchase an
additional 834,304 and 545,778 common shares of the company's common stock were
outstanding, but were not included in the computation of diluted earnings per
share because their effect would be antidilutive. Exercise prices for options
excluded from the computation ranged from $22.54 to $24.05 in 2001 and ranged
from $19.83 to $24.05 in 2000.
11. Commitments and Contingencies
Legal Proceedings
Vectren is party to various legal proceedings arising in the normal course of
business. In the opinion of management, with the exception of litigation matters
related to the Culley Generating Station Investigation Matter (See Note 12) and
ProLiance (See Note 14), there are no legal proceedings pending against Vectren
that are likely to have a material adverse effect on its financial position or
results of operations.
Vectren Advanced Communications
Vectren Advanced Communications (VAC), a wholly owned non-regulated subsidiary,
was formed to hold Vectren's investments in Utilicom Networks, LLC (Utilicom)
and related entities. Utilicom is a provider of bundled communications services
through high capacity broadband networks, including high speed Internet service,
cable television and telephone service. SIGECOM, LLC (SIGECOM), which is a
venture between VAC and Utilicom, provides services to the greater Evansville,
Indiana area. VAC and Utilicom plan to provide services to the greater
Indianapolis, Indiana and Dayton, Ohio markets.
As part of Utilicom's plans to establish operating ventures in the Indianapolis
and Dayton markets and to recapitalize SIGECOM, Utilicom plans to raise $600
million in capital. Vectren is committed to invest up to $100 million, subject
to Utilicom obtaining all required funding. Prior to the end of 2001, VAC
expects to fund an additional investment in Utilicom and SIGECOM of $10 million,
which is a portion of the $100 million discussed above. This investment, along
with an additional investment by an existing investor, is expected to fully fund
SIGECOM as a stand alone entity.
In July 2001, Utilicom announced a delay in the funding of projects in
Indianapolis and Dayton. This delay, with which Vectren management agrees, is
due to the current environment in the capital debt markets particularly related
to telecommunication related investments which has prevented Utilicom from
obtaining debt financing on terms which they consider acceptable. While the
existing investors are still committed to the Indianapolis and Dayton markets,
Vectren does not intend to proceed unless the Indianapolis and Dayton projects
are fully funded.
At June 30, 2001, VAC's investments in all Utilicom related entities approximate
$34 million, of which approximately $2 million has been invested directly in the
Indianapolis and Dayton ventures.
12. Environmental Matters
Clean Air Act
NOx SIP Call Matter. On October 27, 1998, the United States Environmental
Protection Agency (USEPA) issued a final rule "Finding of Significant
Contribution and Rulemaking for Certain States in the Ozone Transport Assessment
Group Region for Purposes of Reducing Regional Transport of Ozone," (63 Fed.
Reg. 57355) that required uniform nitrogen oxide (NOx) emissions reductions of
85% by utilities and other large sources in certain Midwestern states and the
District of Columbia. These emission levels are below those already imposed by
Phase I and Phase II of the Clean Air Act Amendments of 1990 (the Act).
13
In their state implementation plans (SIPs), the USEPA encouraged states to
target utility coal-fired boilers for the majority of the reductions required,
especially NOx emissions. Northeastern states have claimed that ozone transport
from Midwestern states (including Indiana) is the primary reason for their ozone
concentration problems. Although this premise is challenged by others based on
various air quality modeling studies, including studies commissioned by the
USEPA, the USEPA intends to incorporate a regional control strategy to reduce
ozone transport.
The NOx emissions budget for Indiana stipulated in the USEPA's final ruling
requires a 31% reduction in total NOx emissions from Indiana. Indiana's
implementation plan requires SIGECO to lower its system-wide NOx emissions to
.14/mmbtu. Based on the level of system-wide emissions reductions required and
the control technology utilized to achieve the reductions, the estimated
construction cost of the control equipment could reach $160 million and is
expected to be expended during the 2001-2004 period. Related additional annual
operation and maintenance expenses could be an estimated $8 million to $10
million. The deadline for the company's compliance is May 31, 2004 (the
compliance date).
In April 2001, Vectren initiated steps toward compliance with the revised
regulations. These steps include upgrading Culley Generating Station Unit 3,
Warrick Generating Station Unit 4, and A.B. Brown Generating Station Unit 2 with
a selective catalytic reduction (SCR) systems. SCR systems reduce flue gas NOx
emissions to atmospheric nitrogen and water using ammonia in chemical reaction.
This technology is known to be the most effective method of reducing NOx
emissions where high removal efficiencies are required. The company expects the
Culley, Warrick and A.B. Brown SCR systems to be operational by the compliance
date. Modifications to these stations are expected to reduce the company's
overall NOx emissions to levels compliant with Indiana's NOx emissions budget
allotted by the USEPA. No accrual has been recorded by the company related to
the NOx SIP Call matter. The rules governing NOx emissions are to be applied
prospectively.
Culley Generating Station Investigation Matter. The USEPA initiated an
investigation under Section 114 of the Act of SIGECO's coal-fired electric
generating units in commercial operation by 1977 to determine compliance with
environmental permitting requirements related to repairs, maintenance,
modifications and operations changes. The focus of the investigation was to
determine whether new source performance standards should be applied to the
modifications and whether the best available control technology was, or should
have been, used. Numerous other electric utilities were, and are currently,
being investigated by the USEPA under an industry-wide review for similar
compliance. SIGECO responded to all of the USEPA's data requests during the
investigation. In July 1999, SIGECO received a letter from the Office of
Enforcement and Compliance Assurance of the USEPA discussing the industry-wide
investigation, vaguely referring to the investigation of SIGECO and inviting
SIGECO to participate in a discussion of the issues. No specifics were noted;
furthermore, the letter stated that the communication was not intended to serve
as a notice of violation. Subsequent meetings were conducted in September and
October with the USEPA and targeted utilities, including SIGECO, regarding
potential remedies to the USEPA's general allegations.
On November 3, 1999, the USEPA filed a lawsuit against seven utilities,
including SIGECO. The USEPA alleges that, beginning in 1992, SIGECO violated the
Act by: (i) making modifications to its Culley Generating Station in Yankeetown,
Indiana without obtaining required permits; (ii) making major modifications to
the Culley Generating Station without installing the best available emission
control technology; and (iii) failing to notify the USEPA of the modifications.
In addition, the lawsuit alleges that the modifications to the Culley Generating
Station required SIGECO to begin complying with federal new source performance
standards.
SIGECO believes it performed only maintenance, repair and replacement activities
at the Culley Generating Station, as allowed under the Act. Because proper
14
maintenance does not require permits, application of the best available emission
control technology, notice to the USEPA, or compliance with new source
performance standards, SIGECO believes that the lawsuit is without merit, and
intends to vigorously defend the lawsuit.
The lawsuit seeks fines against SIGECO in the amount of $27,500 per day per
violation. The lawsuit does not specify the number of days or violations the
USEPA believes occurred. The lawsuit also seeks a court order requiring SIGECO
to install the best available emissions technology at the Culley Generating
Station. If the USEPA is successful in obtaining an order, SIGECO estimates that
it would incur capital costs of approximately $40 million to $50 million to
comply with the order. As a result of the NOx SIP call issue, the majority of
the $40 million to $50 million for best available emissions technology at Culley
Generating Station is included in the $160 million expenditure previously
discussed.
The USEPA has also issued an administrative notice of violation to SIGECO making
the same allegations, but alleging that violations began in 1977.
While it is possible that SIGECO could be subjected to criminal penalties if the
Culley Generating Station continues to operate without complying with the new
source performance standards and the allegations are determined by a court to be
valid, SIGECO believes such penalties are unlikely as the USEPA and the electric
utility industry have a bonafide dispute over the proper interpretation of the
Act. Accordingly, no accrual has been recorded by the company, and SIGECO
anticipates at this time that the plant will continue to operate while the
matter is being decided.
Information Request. On January 23, 2001, SIGECO received an information request
from the USEPA under Section 114(a) of the Act for historical operational
information on the Warrick and A.B. Brown generating stations. SIGECO has
provided all information requested, and management believes that no significant
issues will arise from this request.
Manufactured Gas Plants
In the past, Indiana Gas and others operated facilities for the manufacture of
gas. Given the availability of natural gas transported by pipelines, these
facilities have not been operated for many years. Under currently applicable
environmental laws and regulations, Indiana Gas, and the others, may now be
required to take remedial action if certain byproducts are found above the
regulatory thresholds at these sites.
Indiana Gas has identified the existence, location and certain general
characteristics of 26 gas manufacturing and storage sites for which it may have
some remedial responsibility. Indiana Gas has completed a remedial
investigation/feasibility study (RI/FS) at one of the sites under an agreed
order between Indiana Gas and the Indiana Department of Environmental Management
(IDEM), and a Record of Decision was issued by the IDEM in January 2000.
Although Indiana Gas has not begun an RI/FS at additional sites, Indiana Gas has
submitted several of the sites to the IDEM's Voluntary Remediation Program and
is currently conducting some level of remedial activities including groundwater
monitoring at certain sites where deemed appropriate and will continue remedial
activities at the sites as appropriate and necessary.
In conjunction with data compiled by expert consultants, Indiana Gas has accrued
the estimated costs for further investigation, remediation, groundwater
monitoring and related costs for the sites. While the total costs that may be
incurred in connection with addressing these sites cannot be determined at this
time, Indiana Gas has accrued costs that it reasonably expects to incur totaling
approximately $20.3 million.
15
The estimated accrued costs are limited to Indiana Gas' proportionate share of
the remediation efforts. Indiana Gas has arrangements in place for 19 of the 26
sites with other potentially responsible parties (PRP), which serve to limit
Indiana Gas' share of response costs at these 19 sites to between 20 and 50
percent.
With respect to insurance coverage, as of June 30, 2001, Indiana Gas has
received and recorded settlements from all known insurance carriers in an
aggregate amount approximating its $20.3 million accrual.
Environmental matters related to manufactured gas plants have had no material
impact on earnings since costs recorded to date approximate PRP and insurance
settlement recoveries. While Indiana Gas has recorded all costs which it
presently expects to incur in connection with activities at these sites, it is
possible that future events may require some level of additional remedial
activities which are not presently foreseen.
13. Rate and Regulatory Matters
Gas Costs Proceedings
Commodity prices for natural gas purchases have increased significantly,
primarily due to a colder winter, increased demand and tighter supplies. Subject
to compliance with applicable state laws, Vectren's utility subsidiaries are
allowed full recovery of such changes in purchased gas costs for their retail
customers through commission-approved gas cost adjustment (GCA) mechanisms.
On October 11, 2000, Indiana Gas filed for approval of its regular GCA. In early
December, the Indiana Utility Regulatory Commission (IURC) issued an interim
order approving the request by Indiana Gas for a GCA factor for December 2000.
On January 4, 2001, the IURC approved the January and February 2001 GCA as
filed. The order also addressed the claim by the Indiana Office of Utility
Consumer Counselor (OUCC) that a portion of the requested GCA be disallowed
because Indiana Gas should have entered into additional commitments for the
winter's gas supply in late 1999 and early 2000. In procuring gas supply for
winter, Indiana Gas followed the gas procurement practices that it had employed
over the last several years. In response to the claim by the OUCC, the IURC
found that there should be a $3.8 million disallowance related to gas
procurement for the winter season. As a result, Indiana Gas recognized a pre-tax
charge of $3.8 million in December 2000. Both Indiana Gas and the OUCC appealed
the ruling. The Citizens Action Coalition of Indiana, Inc. (CAC), a not for
profit consumer advocate, also filed with the IURC a petition to intervene and a
notice of appeal of the order.
In March 2001, Indiana Gas and SIGECO reached agreement with the OUCC and CAC
regarding the matters raised by the IURC Order. As part of the agreement, among
other things, the companies agreed to contribute an additional $1.9 million to
the State of Indiana's Low Income Heating Assistance Program in 2001 and to
credit $3.3 million of the $3.8 million disallowed amount to Indiana Gas
customers' April 2001 utility bills in exchange for both the OUCC and the CAC
dropping their appeals of the IURC Order. In April 2001, the IURC issued an
order approving the settlement. The contributions to Indiana's Low Income
Heating Assistance Program totaling $1.9 million were made in 2001 and were
charged to other operating expense. There was no impact to 2000 operations as a
result of this contribution.
Purchased Power Costs
As a result of the ongoing appeal of a generic order issued by the IURC in
August 1999 regarding guidelines for the recovery of purchased power costs,
SIGECO entered into a settlement agreement with the OUCC that provides certain
terms with respect to the recoverability of such costs. The settlement,
originally approved by the IURC on August 9, 2000, has been extended by
agreement through March 2002. Under the settlement, SIGECO can recover the
16
entire cost of purchased power up to an established benchmark, and during forced
outages, SIGECO will bear a limited share of its purchased power costs
regardless of the market costs at that time. Based on this agreement, SIGECO
believes it has limited its exposure to unrecoverable purchased power costs.
14. ProLiance Energy, LLC
ProLiance, a 50 % owned, non-regulated, energy marketing affiliate of Vectren,
began providing natural gas and related services to Indiana Gas, Citizens Gas
and Coke Utility (Citizens Gas) and others effective April 1, 1996. The sale of
gas and provision of other services to Indiana Gas by ProLiance is subject to
regulatory review through the quarterly GCA process administered by the IURC.
On September 12, 1997, the IURC issued a decision finding the gas supply and
portfolio administration agreements between ProLiance and Indiana Gas and
ProLiance and Citizens Gas to be consistent with the public interest and that
ProLiance is not subject to regulation by the IURC as a public utility. The
IURC's decision reflected the significant gas cost savings to customers obtained
through ProLiance's services and suggested that all material provisions of the
agreements between ProLiance and the utilities are reasonable. Nevertheless,
with respect to the pricing of gas commodity purchased from ProLiance, the
pricing of fees paid by ProLiance to the utilities for the prospect of using
pipeline entitlements if and when they are not required to serve the utilities'
firm customers, and the pricing of fees paid by the utilities to ProLiance for
portfolio administration services, the IURC concluded that additional review in
the GCA process would be appropriate and directed that these matters be
considered further in the pending, consolidated GCA proceeding involving Indiana
Gas and Citizens Gas.
As a result of an appeal of the IURC's order, on September 22, 2000, the Indiana
Supreme Court issued a decision affirming the IURC's decision with respect to
Indiana Gas' and Citizens Gas' agreements with ProLiance in all respects.
The IURC has recently commenced the processing of the further GCA proceeding
regarding the three pricing issues by conducting a prehearing conference.
Discovery is ongoing in this proceeding at the current time. Until the three
pricing issues reserved by the IURC are resolved, Vectren will continue to
reserve a portion of its share of ProLiance earnings.
In August 1998, Indiana Gas, Citizens Gas and ProLiance each received a Civil
Investigative Demand (CID) from the United States Department of Justice
requesting information relating to Indiana Gas' and Citizens Gas' relationship
with and the activities of ProLiance. The Department of Justice issued the CID
to gather information regarding ProLiance's formation and operations, and to
determine if trade or commerce has been restrained. Indiana Gas has provided all
information requested and management believes there are no significant issues in
this matter.
Indiana Gas continues to record gas costs in accordance with the terms of the
ProLiance contract, and Vectren continues to record its proportional share of
ProLiance's earnings. Pre-tax income of $4.0 million and $1.5 million was
recognized as ProLiance's contribution to earnings for the three months ended
June 30, 2001 and 2000, respectively. Pre-tax income of $9.6 million and $4.8
million was recognized as ProLiance's contribution to earnings for the six
months ended June 30, 2001 and 2000, respectively. Earnings recognized from
ProLiance are included in equity in earnings of unconsolidated investments on
the Condensed Consolidated Statements of Operations. At June 30, 2001 and
December 31, 2000, Vectren has reserved approximately $3.1 million and $2.4
million, respectively, of ProLiance's earnings after tax pending resolution of
the remaining issues. The reserve represents 10% of ProLiance's pretax earnings
and serves as management's best estimate of potential exposure arising from the
three pricing issues.
17
Purchases from ProLiance for resale and for injections into storage for the
three months ended June 30, 2001 and 2000 totaled $146.0 million and $70.3
million, respectively; and for the six months ended June 30, 2001 and 2000
totaled $414.4 million and $136.3 million, respectively. Amounts owed to
ProLiance at June 30, 2001 and December 31, 2000 for those purchases were $23.1
million and $97.7 million, respectively and are included in accounts payable to
affiliated companies on the Condensed Consolidated Balance Sheets. Amounts
charged by ProLiance are market based.
ProLiance has a standby letter of credit facility with a bank for letters up to
$45 million at June 30, 2001 and December 31, 2000. This facility is
collaterialized in part by a support agreement from Vectren. Letters of credit
outstanding at June 30, 2001 and December 31, 2000 totaled $13.2 million, and
$22.0 million, respectively. Subsequent to June 30, 2001, this facility was
renegotiated with another bank and the support agreement is no longer in effect.
15. Other Affiliate Transactions
CIGMA, LLC (CIGMA), owned jointly and equally by a wholly owned subsidiary of
Vectren and a third party, provides materials acquisition and related services
that are used by certain wholly owned subsidiaries of Vectren. Purchases of
these services during the three months ended June 30, 2001 and 2000 totaled $5.2
million and $4.1 million, respectively; and for the six months ended June 30,
2001 and 2000 totaled $8.6 million and $8.1 million, respectively. Amounts
charged by CIGMA are market based.
Vectren is a two-thirds guarantor of certain surety bonds and other obligations
of Energy Systems Group, LLC, a two-thirds owned consolidated subsidiary.
Vectren's share of the guarantee of such obligations totaled $79.8 million and
$50.6 million at June 30, 2001 and December 31, 2000, respectively.
Amounts owed to other unconsolidated affiliates, excluding ProLiance, totaled
$1.1 million, and $4.8 million at June 30, 2001 and December 31, 2000,
respectively, and are included in accounts payable to affiliated companies on
the Condensed Consolidated Balance Sheets. Amounts due from other unconsolidated
affiliates totaled $25.1 million and $17.6 million at June 30, 2001 and December
31, 2000 respectively, and are included in accounts receivable on the Condensed
Consolidated Balance Sheets.
16. Risk Management, Derivatives and New Accounting Principle
Risk Management
Vectren is exposed to market risks associated with commodity prices, interest
rates, and counterparty credit. These financial exposures are monitored and
managed by the company as an integral part of its overall risk management
program.
Commodity Price Risk. Vectren's regulated operations have limited exposure to
commodity price risk for purchases and sales of natural gas and electric energy
for its retail customers due to current Indiana and Ohio regulations, which
subject to compliance with applicable state regulations, allow for recovery of
such purchases through natural gas and fuel cost adjustment mechanisms.
(See Note 13 Rate and Regulatory Matters.)
Vectren does engage in limited, wholesale power marketing and natural gas
marketing activities that may expose the company to commodity price risk
associated with fluctuating electric power and natural gas commodity prices.
18
Vectren's non-regulated wholesale power marketing activities manage the
utilization of its available electric generating capacity. Vectren's wholesale
natural gas marketing activities purchase and sell natural gas to meet customer
demands. Both operations enter into forward contracts that commit the company to
purchase and sell commodities in the future.
Commodity price risk results from forward sales contracts that commit Vectren to
deliver either electric power or natural gas on specified future dates. Power
marketing uses planned unutilized generation capability and forward purchase
contracts to protect certain sales transactions from unanticipated fluctuations
in the price of electric power, and periodically, will use derivative financial
instruments to protect its interests from unplanned outages and shifts in
demand. Additionally, gas marketing uses natural gas stored inventory and
forward purchase contracts to protect certain sales transactions from
unanticipated fluctuations in the price of natural gas.
Open positions in terms of price, volume and specified delivery points may occur
to a limited extent and are managed using methods described above and frequent
management reporting.
Interest Rate Risk. The company is exposed to interest rate risk associated with
its short-term borrowings and adjustable rate long term debt. Its risk
management program seeks to reduce the potentially adverse effects that market
volatility may have on operations.
Under normal circumstances, the company tries to limit the amount of short-term
debt and adjustable rate long-term debt outstanding to a maximum of 25% of total
debt. However, there are times when this targeted level of interest rate
exposure may be exceeded. To manage this exposure, the company may periodically
use derivative financial instruments to reduce earnings fluctuations caused by
interest rate volatility.
Other Risks. By using forward purchase contracts and derivative financial
instruments to manage risk, the company exposes itself to counterparty credit
risk and market risk. The company manages this exposure to counterparty credit
risk by entering into contracts with financially sound companies that can be
expected to fully perform under the terms of the contract. The company attempts
to manage exposure to market risk associated with commodity contracts and
interest rates by establishing and monitoring parameters that limit the types
and degree of market risk that may be undertaken.
Accounting for Forward Contracts and Other Financial Instruments
Commodity Contracts. At origination all contracts to buy and sell electric power
and natural gas are designated as "physical", "other-than-trading" or "trading."
Power marketing contracts are designated as "physical" when there is intent and
ability to physically deliver power from SIGECO's unutilized generating
capacity. Power marketing contracts are designated as "other-than-trading" when
there is intent to receive power to manage base and peak load capacity. Both
contract designations generally require settlement by physical delivery of
electricity. However, certain of these contracts may be net settled in
accordance with industry standards when unplanned outages, favorable pricing
movements, and shifts in demand occur.
Prior to the adoption of SFAS 133, contracts in the "physical" and
"other-than-trading" portfolios receive accounting recognition on settlement
with revenues recorded in electric utility revenues and costs recorded in fuel
for electric generation for those contracts fulfilled through generation and in
purchased electric energy for contracts purchased in the wholesale energy
market. Subsequent to the adoption of SFAS 133, certain contracts that are
periodically settled net are recorded at market value.
19
Gas marketing contracts are designated as "physical" when the company has the
intent to physically deliver or receive natural gas. Certain contracts in this
portfolio may be settled net in accordance with industry standards. Prior to the
adoption of SFAS 133, "physical" contracts received accounting recognition upon
settlement with revenues recorded in energy services and other revenues and
costs recorded in cost of energy services and other. After the adoption of SFAS
133, certain contracts that are periodically settled net are recorded at market
value.
Vectren may occasionally enter into forward purchase and sale contracts
designated as "trading" that attempt to take advantage of short-term movement in
commodity prices. Commodity contracts designated as "trading" are generally
settled net in accordance with industry trading standards. These contracts are
accounted for at market value. As of June 30, 2001, the company has no contracts
designated as "trading."
Contracts recorded at market value are recorded as assets or liabilities in the
Condensed Consolidated Balance Sheet as deferred charges, net, other current
assets, other current liabilities and other liabilities, as appropriate, and
changes in market value are recorded in the Condensed Consolidated Statements of
Operations as purchased electric energy or cost of energy services and other, as
appropriate. Market value is determined using quoted market prices from
independent sources.
Financial Contracts. On December 28, 2000, the company entered into an interest
rate swap used to hedge interest rate risk associated with VUHI's $150 million
floating rate notes. The swap was entered into concurrently with the issuance of
the floating rate debt on December 28, 2000 and swaps the debt's variable
interest rate of three month LIBOR plus 0.75 percent for a fixed rate of 6.64%.
The swap expires on December 27, 2001, the date that the debt agreement expires.
Prior to the adoption of SFAS 133, instruments hedging interest rate risk were
accounted for upon settlement in interest expense. After adoption of SFAS 133,
hedging instruments are carried at market value in deferred charges, net or
other current liabilities, as appropriate, and changes in market value are
recorded in accumulated other comprehensive income and recorded to interest
expense as settled.
Impact of New Accounting Principle
In June 1998, the Financial Accounting Standards Board (FASB) issued SFAS 133,
which requires that every derivative instrument be recorded on the balance sheet
as an asset or liability measured at its market value and that changes in the
derivative's market value be recognized currently in earnings unless specific
hedge accounting criteria are met.
SFAS 133, as amended, requires that as of the date of initial adoption, the
difference between the market value of derivative instruments recorded on the
balance sheet and the previous carrying amount of those derivatives be reported
in net income or other comprehensive income, as appropriate, as the cumulative
effect of a change in accounting principle in accordance with APB Opinion No.
20, "Accounting Changes."
Resulting from the adoption of SFAS 133, certain contracts in the power
marketing operations and gas marketing operations that are periodically settled
net were required to be recorded at market value. Previously, the company
accounted for these contracts on settlement. The cumulative impact of the
adoption of SFAS 133 resulting from marking these contracts to market on January
1, 2001 was an earnings gain of approximately $6.3 million ($3.9 million net of
tax) recorded as a cumulative effect of accounting change in the Condensed
Consolidated Statements of Operations. The majority of this gain results from
the company's power marketing operations. SFAS 133 did not impact other
commodity contracts because they were normal purchases and sales that are
specifically excluded.
20
As of June 30, 2001, the company has derivative assets resulting from its power
marketing operations of $6.0 million classified in deferred charges, net as well
as derivative liabilities of $2.0 million classified in other current
liabilities. Unrealized losses totaling $2.4 million arising from the difference
between the current market value and the market value on the date of adoption is
included in purchased electric energy in the Condensed Consolidated Statements
of Operations for the six months ended June 30, 2001. Unrealized losses for the
three months ended June 30, 2001 were $7.9 million. Derivatives used in gas
marketing operations are not significant.
Vectren has documented the hedging relationship between an interest rate swap
and floating rate debt as well as its risk management objectives and strategies
for undertaking the hedging transaction. The company expects the swap to be
highly effective at hedging the cash flow related to the interest payments.
Accordingly, the swap has been designated as a cash flow hedge. The adoption of
SFAS 133 had no impact as the market value of the swap was zero.
As of June 30, 2001, the market value of the interest rate swap is $1.6 million
and is included in other current liabilities on the Condensed Consolidated
Balance Sheets. The difference between the current market value and the market
value on the date of adoption of $1.6 million ($1.0 million after tax) is
included in accumulated other comprehensive income in the Condensed Consolidated
Balance Sheets and will be reclassified to interest expense by December 31,
2001.
In addition to Vectren's wholly owned subsidiaries, ProLiance, a 50 % owned
equity method investment, adopted SFAS 133 on June 1, 2000. The impact of
adoption on ProLiance is reflected in accumulated other comprehensive income due
to the nature of the derivatives used.
17. Segment Reporting
Operating segments are defined as components of an enterprise for which separate
financial information is available and evaluated regularly by the chief
operating decision makers in deciding how to allocate resources and in the
assessment of performance.
There were three operating segments of Vectren during the reported periods: (1)
Gas Utility Services, (2) Electric Utility Services, and (3) Non-regulated
Operations. The Gas Utility Services segment distributes, transports and sells
natural gas in southwest and central Indiana and west central Ohio and is
comprised of the operations of Indiana Gas, the Ohio operations and SIGECO's
natural gas business. The Electric Utility Services segment generates,
transmits, distributes and sells electricity primarily within southwestern
Indiana and in periods of under utilized capacity, sells excess electricity to
other wholesale customers. This segment is comprised of SIGECO's electric
business. The Non-regulated Operations segment is made up of various businesses
providing energy-related products and services; telecommunication products and
services; materials management, debt collection and meter reading services;
underground utility asset location and construction services; structured finance
and investment transactions including leveraged leases of real estate and
equipment; venture capital projects; coal mining and sales; and other
energy-related services. Revenues for each segment are principally attributable
to customers in the United States.
Effective January 1, 2001, the utility operations announced the realignment of
those operations into two primary business units: Energy Delivery and Power
Supply. During 2001, organizational alignment will occur along with the
development of management reporting processes. As a result, Vectren will report
utility segment information as Gas Utility Services and Electric Utility
Services.
21
The following tables provide information about business segments. Vectren makes
decisions on finance and dividends at the corporate level; these topics are
addressed on a consolidated basis. In addition, adjustments have been made to
the segment information to arrive at information included in the consolidated
results of operations and financial position. These adjustments include
unallocated corporate assets, revenues and expenses and the elimination of
intercompany transactions.
Three Months Six Months
Ended June 30, Ended June 30,
-------------------------- --------------------------
In thousands 2001 2000 2001 2000
----------- ----------- ----------- -----------
Operating Revenues:
Gas Utility Services $ 153,798 $ 100,485 $ 676,687 $ 301,330
Electric Utility Services 95,020 78,289 183,229 151,279
Non-regulated Operations 202,402 98,154 494,867 199,609
Intersegment Eliminations (18,946) (13,570) (39,421) (29,297)
----------- ----------- ----------- -----------
Total operating revenues $ 432,274 $ 263,358 $ 1,315,362 $ 622,921
=========== =========== =========== ===========
Net Income (Loss):
Gas Utility Services $ (15,987) $ (2,917) $ 2,818 $ 7,304
Electric Utility Services 3,272 5,875 20,141 8,483
Non-regulated Operations (4,942) 5,315 3,735 14,611
----------- ----------- ----------- -----------
Net income (loss) $ (17,657) $ 8,273 $ 26,694 $ 30,398
=========== =========== =========== ===========
June 30, December 31,
2001 2000
----------- -----------
Identifiable Assets:
Gas Utility Services $ 1,475,455 $ 1,658,778
Electric Utility Services 761,935 799,104
Non-regulated Operations 757,236 749,237
Intersegment Eliminations (288,703) (297,932)
----------- -----------
Total identifiable assets $ 2,705,923 $ 2,909,187
=========== ===========
18. Impact of Recently Issued Accounting Guidance
The FASB issued two new statements of financial accounting standards in July
2001: SFAS No. 141, "Business Combinations" (SFAS 141), and SFAS No. 142,
"Goodwill and Other Intangible Assets" (SFAS 142). These interrelated standards
change the accounting for business combinations and goodwill in two significant
ways:
SFAS 141 requires that the purchase method of accounting be used for
all business combinations initiated after June 30, 2001. Use of the
pooling-of-interests method is prohibited. This change does not affect
the pooling-of-interest transaction forming Vectren.
SFAS 142 changes the accounting for goodwill from an amortization
approach to an impairment-only approach. Thus, amortization of
goodwill, including goodwill recorded in past business combinations,
such as the company's acquisition of the Ohio operations, will cease
upon adoption of the statement. Goodwill is to be tested for impairment
at a reporting unit level at least annually.
22
SFAS 142 also requires the initial impairment review of all goodwill and other
intangible assets within six months of the adoption date, which is January 1,
2002 for Vectren. The impairment review consists of a comparison of the fair
value of a reporting unit to its carrying amount. If the fair value of a
reporting unit is less than its carrying amount, an impairment loss would be
recognized. Results of the initial impairment review are to be treated as a
change in accounting principle in accordance with APB Opinion No. 20 "Accounting
Changes." An impairment loss recognized as a result of an impairment test
occurring after the initial impairment review is to be reported as a part of
operations.
SFAS 142 also changes certain aspects of accounting for intangible assets;
however, the company does not have any significant intangible assets.
The adoption of SFAS 141 will not materially impact operations. As required by
SFAS 142, amortization of goodwill relating to the acquisition of the Ohio
operations, which approximates $5.0 million per year, will cease on January 1,
2002. The company has not determined the potential impact of initial impairment
reviews to be performed within six months of adoption of SFAS 142.
Also in July 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations" (SFAS 143). SFAS 143 requires entities to record the
fair value of a liability for an asset retirement obligation in the period in
which it is incurred. When the liability is initially recorded, the entity
capitalizes a cost by increasing the carrying amount of the related long-lived
asset. Over time, the liability is accreted to its present value, and the
capitalized cost is depreciated over the useful life of the related asset. Upon
settlement of the liability, an entity either settles the obligation for its
recorded amount or incurs a gain or loss upon settlement. SFAS 143 is effective
for fiscal years beginning after June 15, 2002, with earlier application
encouraged. Vectren is currently evaluating the impact that SFAS 143 will have
on its operations.
23
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
VECTREN CORPORATION AND SUBSIDIARY COMPANIES
Description of the Business
Vectren Corporation (Vectren) is an Indiana corporation that was organized on
June 10, 1999, solely for the purpose of effecting the merger of Indiana Energy,
Inc. (Indiana Energy) and SIGCORP, Inc. (SIGCORP). On March 31, 2000, the merger
of Indiana Energy with SIGCORP and into Vectren was consummated with a tax-free
exchange of shares and has been accounted for as a pooling-of-interests.
Vectren is a public utility holding company, whose wholly owned subsidiary,
Vectren Utility Holdings, Inc. (VUHI), is the intermediate holding company for
Vectren's three operating public utilities, Indiana Gas Company, Inc. (Indiana
Gas), formerly a wholly owned subsidiary of Indiana Energy, Southern Indiana Gas
and Electric Company (SIGECO), formerly a wholly owned subsidiary of SIGCORP,
and the Ohio operations (defined hereafter).
On October 31, 2000, Vectren acquired the natural gas distribution assets of The
Dayton Power and Light Company for approximately $465 million. The acquisition
has been accounted for as a purchase transaction in accordance with Accounting
Principles Board (APB) Opinion No. 16 and accordingly, the results of operations
of the acquired businesses are included in the accompanying financial statements
since the date of acquisition.
Vectren acquired the natural gas distribution assets as a tenancy in common
through two separate wholly owned subsidiaries. Vectren Energy Delivery of Ohio,
Inc. (VEDO) holds a 53% undivided ownership interest in the assets and Indiana
Gas holds a 47% undivided ownership interest. VEDO is the operator of the
assets, operations of which are referred to as "the Ohio operations."
VUHI's regulated subsidiaries serve approximately one million customers. Indiana
Gas provides natural gas and transportation services to a diversified base of
customers in 311 communities in 49 of Indiana's 92 counties. SIGECO provides
generation, transmission, distribution and the sale of electric power to
Evansville, Indiana, and 74 other communities, and the distribution and sale of
natural gas to Evansville, Indiana, and 64 communities in ten counties in
southwestern Indiana. The Ohio operations provide natural gas distribution and
transportation services to Dayton, Ohio and 16 counties in west central Ohio.
Vectren is involved in non-regulated activities through three primary business
groups: Energy Services, Utility Services, and Communications. Energy Services
trades and markets natural gas and provides energy performance contracting
services. Utility Services provides utility products and services, such as
underground construction and facilities locating, meter reading and materials
management, and the mining and sale of coal. Communications provides integrated
broadband communications services, including local and long distance telephone,
Internet access and cable television. In addition, other businesses invest in
other energy-related opportunities and corporate technology.
24
Overview
Vectren's consolidated earnings result from the operations of its utility
subsidiaries, Indiana Gas, SIGECO and the Ohio operations, and from the
non-utility operations and investments of Vectren's non-regulated businesses.
Three Months Six Months
In millions, except per share amounts Ended June 30, Ended June 30,
------------------- ---------------
2001 2000 2001 2000
--------- ------- ------ ------
Net income (loss), as reported $ (17.7) $ 8.3 $ 26.7 $ 30.4
Restructuring charge, net of tax 7.3 - 7.3 -
Merger and integration costs, net of tax 1.7 5.9 3.9 25.1
Extraordinary loss, net of tax 7.7 - 7.7 -
Gain on restructuring of a non-regulated
investment, net of tax - - - (4.9)
Net income (loss) before nonrecurring items $ (1.0) $ 14.2 $ 45.6 $ 50.6
Attributed to:
Regulated $ (4.3) $ 8.9 $ 33.6 $ 40.1
Non-regulated $ 3.3 $ 5.3 $ 12.0 $ 10.5
Basic earnings (loss) per share, as reported $ (0.26) $ 0.14 $ 0.40 $ 0.50
Restructuring charge, net of tax 0.11 - 0.11 -
Merger and integration costs, net of tax 0.02 0.09 0.06 0.41
Extraordinary loss, net of tax 0.11 - 0.12 -
Gain on restructuring of a non-regulated
investment, not of tax - - - (0.08)
Basic earnings (loss) per share before
nonrecurring items $ (0.02) $ 0.23 $ 0.69 $ 0.83
Attributed to:
Regulated $ (0.07) $ 0.14 $ 0.51 $ 0.66
Non-regulated $ 0.05 $ 0.09 $ 0.18 $ 0.17
Three Months Ended June 30, 2001
Consolidated net income decreased $26.0 million, or $0.40 per share, compared to
the same period of 2000. The decrease reflects nonrecurring charges including:
|X| An extraordinary loss of $7.7 million after tax, or $0.11 per share,
associated with the sale of investments in leveraged leases (See
extraordinary loss discussion below.), and
|X| A restructuring charge of $7.3 million after tax, or $0.11 per share. (See
restructuring charge discussion below.) These nonrecurring expenses were
partially offset by a decrease in merger and integration costs incurred
during the quarter, compared to the prior year. Merger and integration
costs, including additional depreciation, decreased $4.2 million after tax,
or $0.07 per share. (See merger and integration costs discussion below.)
Earnings before the impact of nonrecurring items decreased $15.2 million, or
$0.25 per share, because of unrealized after tax losses resulting from marking
certain derivatives to market as required by Statement of Financial Accounting
Standard No. 133 "Accounting for Derivative Instruments and Hedging Activities"
25
(SFAS 133) (See new accounting principle discussion below.), the impact of
increased gas costs, and weather.
Six Months Ended June 30, 2001
Consolidated net income decreased $3.7 million, or $0.10 per share, compared to
the same period of 2000. The decrease primarily results from the one-time gain
recorded in 2000 from the restructuring of a non-regulated investment of $4.9
million after tax, or $0.08 per share, in addition to the nonrecurring charges
recorded in the current quarter discussed above. These decreases were offset by
a decrease in merger and integration costs incurred during the quarter, compared
to the prior year. Merger and integration costs, including additional
depreciation, decreased $21.2 million after tax, or $0.35 per share. (See merger
and integration costs discussion below.)
Consolidated net income before the impact of nonrecurring items decreased $5.0
million, or $0.14 per share. The decrease results from the impacts of increased
gas costs, offset by the inclusion of the Ohio operations and cooler weather
than the prior year.
Dividends
Dividends declared for the three and six months ended June 30, 2001 were $0.255
per share and $0.510 per share, respectively, compared to $0.243 per share and
$0.485 per share for the same periods in 2000. The dividend for the twelve
months ended June 30, 2001 was $1.02 per share compared to $0.96 per share for
the twelve months ended June 30, 2000.
Extraordinary Loss
In June 2001, the Southern Indiana Properties, Inc., a non-regulated wholly
owned subsidiary, agreed to sell certain leverage lease investments with a net
book value of $59.1 million at a loss of $12.4 million ($7.7 million after tax).
Because of the transaction's significance and because the transaction occurred
within two years of the effective date of the merger of Indiana Energy and
SIGCORP, which was accounted for as a pooling-of-interests, Accounting
Principles Board (APB) Opinion No. 16, "Business Combinations" calls for the
loss on disposition of these investments to be treated as extraordinary.
Proceeds from the sale of $46.7 million will be used to retire short-term
borrowings.
Restructuring Costs
In June 2001, Vectren's management and board of directors approved a plan to
restructure, primarily, its regulated operations. The restructuring plan will
involve the elimination of administrative and supervisory positions in its
utility operations and corporate office. Restructuring and related charges of
$11.8 million ($7.3 million after tax), or $0.11 on a basic earnings per share
basis, were expensed during the second quarter. These charges were comprised of
$8.0 million for severance, related benefits and other employee related costs,
$2.0 million for lease termination fees related to duplicate facilities, and
$1.8 million for consulting fees incurred as of June 30, 2001.
Components of restructuring expenses incurred through June 30, 2001 and
components of the restructuring accrual, which is included in other current
liabilities, as of June 30, 2001 were as follows:
In millions Accrual for
Expected Incurred Expenses
Cash ---------------------
Payments Paid in Cash Non-Cash Total Expense
-------- ------------ -------- -------------
Severance and related costs $ 6.8 $0.4 $0.8 $8.0
Lease termination fees 2.0 - - 2.0
Consulting fees - 1.8 - 1.8
-------- ------------ -------- -------------
Total $ 8.8 $2.2 $0.8 $11.8
======== ============ ======== =============
26
The $6.8 million accrued for restructuring costs for employee separation is
associated with approximately 90 employees. Employee separation benefits include
severance, healthcare and outplacement services. Employees are expected to begin
exiting the business beginning August 2001.
The restructuring program will be substantially completed by December 31, 2001.
Merger and Integration Costs
Merger and integration costs incurred for the three and six months ended June
30, 2001 were zero and $0.8 million, respectively, and for the three and six
months ended June 30, 2000 totaled $3.3 million and $30.4 million, respectively.
Vectren expects to realize net merger savings of nearly $200 million over the
next ten years from the elimination of duplicate corporate and administrative
programs and greater efficiencies in operations, business processes and
purchasing encompassed in operations. The continued merger integration
activities, which will contribute to the merger savings, will be completed in
2001.
Since March 31, 2000, $41.9 million has been expensed associated with merger and
integration activities. Accruals were established at March 31, 2000 totaling
$20.7 million. Of this amount, $5.5 million related to employee and executive
severance costs, $13.1 million related to transaction costs and regulatory
filing fees incurred prior to the closing of the merger, and the remaining $2.1
million related to employee relocations that occurred prior to or coincident
with the merger closing. At June 30, 2001, the accrual remaining for such costs
totaled $1.5 million, all related to severance costs. Of the $41.9 million
expensed, the remaining $21.2 million expensed through June 30, 2001 ($20.4
million in 2000 and $0.8 million in 2001) was for accounting fees resulting from
merger related filing requirements, consulting fees related to integration
activities such as organization structure, employee travel between company
locations as part of integration activities, internal labor of employees
assigned to integration teams, investor relations communications activities, and
certain benefit costs.
The integration activities experienced by the company included such things as
information system consolidation, process review and definition, organization
design and consolidation, and knowledge sharing.
As a result of merger integration activities, management has identified certain
information systems that are expected to be retired in 2001. Accordingly, the
useful lives of these assets have been shortened to reflect this decision,
resulting in additional depreciation expense of approximately $2.7 million ($1.7
million after tax) and $5.5 million ($3.4 million after tax), for the three and
six months ended June 30, 2001, respectively, and $3.3 million ($2.1 million
after tax) for both the three and six months ended June 30, 2000.
In total, for the three months ended June 30, 2001, merger and integration costs
totaled $2.7 million ($1.7 million after tax), or $0.02 on a basic earnings per
share basis compared to $6.6 million ($5.9 million after tax), or $0.09 on a
basic earnings per share basis for the same period in 2000.
In total, for the six months ended June 30, 2001, merger and integration costs
totaled $6.3 million ($3.9 million after tax), or $0.06 on a basic earnings per
share basis compared to $33.7 million ($25.1 million after tax), or $0.41 on a
basic earnings per share basis for the same period in 2000.
New Accounting Principle
In June 1998, the Financial Accounting Standards Board (FASB) issued SFAS 133,
which requires that every derivative instrument be recorded on the balance sheet
as an asset or liability measured at its market value and that changes in the
27
derivative's market value be recognized currently in earnings unless specific
hedge accounting criteria are met.
SFAS 133, as amended, requires that as of the date of initial adoption, the
difference between the market value of derivative instruments recorded on the
balance sheet and the previous carrying amount of those derivatives be reported
in net income or other comprehensive income, as appropriate, as the cumulative
effect of a change in accounting principle in accordance with APB Opinion No.
20, "Accounting Changes."
Resulting from the adoption of SFAS 133, certain contracts in the power
marketing operations and gas marketing operations that are periodically settled
net were required to be recorded at market value. Previously, the company
accounted for these contracts on settlement. The cumulative impact of the
adoption of SFAS 133 resulting from marking these contracts to market on January
1, 2001 was an earnings gain of approximately $6.3 million ($3.9 million net of
tax) recorded as a cumulative effect of accounting change in the Condensed
Consolidated Statements of Operations. The majority of this gain results from
the company's power marketing operations. SFAS 133 did not impact other
commodity contracts because they were normal purchases and sales that are
specifically excluded.
As of June 30, 2001, the company has derivative assets resulting from its power
marketing operations of $6.0 million classified in deferred charges, net as well
as derivative liabilities of $2.0 million classified in other current
liabilities. Unrealized losses totaling $2.4 million arising from the difference
between the current market value and the market value on the date of adoption is
included in purchased electric energy in the Condensed Consolidated Statements
of Operations for the six months ended June 30, 2001. Unrealized losses for the
three months ended June 30, 2001 were $7.9 million. Derivatives used in gas
marketing operations are not significant.
Vectren has documented the hedging relationship between an interest rate swap
and floating rate debt as well as its risk management objectives and strategies
for undertaking the hedging transaction. The company expects the swap to be
highly effective at hedging the cash flow related to the interest payments.
Accordingly, the swap has been designated as a cash flow hedge. The adoption of
SFAS 133 had no impact as the market value of the swap was zero.
As of June 30, 2001, the market value of the interest rate swap is $1.6 million
and is included in other current liabilities on the Condensed Consolidated
Balance Sheets. The difference between the current market value and the market
value on the date of adoption of $1.6 million ($1.0 million after tax) is
included in accumulated other comprehensive income in the Condensed Consolidated
Balance Sheets and will be reclassified to interest expense by December 31,
2001.
In addition to Vectren's wholly owned subsidiaries, ProLiance Energy, LLC
(ProLiance), a 50 % owned equity method investment, adopted SFAS 133 on August
31, 2000. The impact of adoption on ProLiance is primarily reflected in
accumulated other comprehensive income due to the nature of the derivatives
used.
Organizational Realignment
Effective January 1, 2001, the utility operations announced the realignment of
those operations into two primary business units: Energy Delivery and Power
Supply. During 2001, organizational alignment will occur along with the
development of management reporting processes. As a result, Vectren will report
utility segment information as Gas Utility Services and Electric Utility
Services.
28
Results of Regulated Operations
The results of regulated operations for the three and six months ended June 30,
2001 compared to the prior year are as follows:
Three Months Six Months
In millions, except per share amounts Ended June 30, Ended June 30,
--------------- -----------------
2001 2000 2001 2000
------- ------ ------- -------
Gas operating margin $ 59.0 $ 44.6 $ 177.8 $ 126.9
Electric operating margin 43.5 50.4 100.6 103.2
Total operating margin $ 102.5 $ 95.0 $ 278.4 $ 230.1
Other operating $ 54.5 $ 45.6 $ 110.0 $ 90.1
Depreciation and amortization $ 31.3 $ 25.6 $ 62.3 $ 48.1
Taxes other than income taxes $ 10.6 $ 6.8 $ 29.8 $ 15.0
Other income, net $ 2.0 $ 1.2 $ 1.8 $ 2.3
Interest $ 17.3 $ 9.9 $ 36.7 $ 19.7
Income tax $ (7.5) $ 3.4 $ 10.3 $ 14.3
Net income (loss), as reported $ (12.7) $ 3.0 $ 23.0 $ 15.8
Restructuring costs, net of tax 6.7 - 6.7 -
Merger and integration costs,
net of tax 1.7 5.9 3.9 24.3
Net income (loss) before nonrecurring
items $ (4.3) $ 8.9 $ 33.6 $ 40.1
Basic earnings (loss) per share,
as reported $ (0.19) $ 0.05 $ 0.35 $ 0.26
Restructuring costs 0.10 - 0.10 -
Merger and integrations costs 0.02 0.09 0.06 0.40
Basic earnings (loss) per share
before nonrecurring items $ (0.07) $ 0.14 $ 0.51 $ 0.66
Before nonrecurring items, regulated utility operations incurred a net loss of
$4.3 million, or $0.07 per share, for the three months ended June 30, 2001,
compared to net income before nonrecurring items of $8.9 million, or $0.14 per
share for the same period in 2000.
Before nonrecurring items, regulated utility operations contributed net income
of $33.6 million, or $0.51 per share, for the six months ended June 30, 2001,
compared to net income before nonrecurring items of $40.1 million, or $0.66 per
share for the same period in 2000.
For the three months ended June 30, 2001 compared to the prior year, earnings
before the impact of nonrecurring items decreased $13.2 million because of
unrealized after tax losses resulting from marking certain derivatives to market
as required by SFAS 133, the impact of increased gas costs, and weather.
For the six months ended June 30, 2001 compared to the prior year, earnings
before the impact of nonrecurring items decreased $6.5 million because of the
impacts of increased gas costs, offset by the inclusion of the Ohio operations
and cooler weather than the prior year.
Utility Margin (Operating Revenues Less Cost of Gas Sold, Fuel for Electric
Generation, Purchased Electric Energy)
29
Gas Utility Margin
Gas Utility margin for the three months ended June 30, 2001 of $59.0 million
increased $14.4 million, or 32%, compared to 2000. The Ohio operations represent
$12.5 million of the increase. The remaining increase of $1.9 million related to
Indiana Gas and SIGECO results from customer growth offset by weather 24% warmer
than the prior year and reduced consumption resulting from increased gas costs.
Total cost of gas sold was $94.8 million for the three months ended June 30,
2001 and $55.9 million in 2000. Excluding $38.9 million related to the Ohio
operations, total cost of gas sold was comparable to 2000 even though volumes
sold were lower. The total average cost per dekatherm of gas purchased by
Indiana Gas and SIGECO for the three months ended June 30, 2001 was $6.28
compared to $4.49 for the same period in 2000.
Gas Utility margin for the six months ended June 30, 2001 of $177.8 million
increased $50.9 million, or 40%, compared to 2000. The Ohio operations represent
$48.0 million of the increase. The remaining increase of $2.9 million related to
Indiana Gas and SIGECO is due to a 5% increase in sales to residential and
commercial customers resulting primarily from weather 8% colder than the
previous year and a 1% increase in their combined residential customer base.
These favorable impacts on gas margin were partially offset by reduced
consumption, the cost of unaccounted for gas, and a 8% decrease in transported
volumes for the benefit of contract customers, all due to the effects of
increased gas costs.
Total cost of gas sold was $498.9 million for the six months ended June 30, 2001
and $174.4 million in 2000. Excluding $186.3 million related to the Ohio
operations, total cost of gas sold increased $138.1 million, or 79%, during 2001
compared to 2000, and is primarily due to significantly higher per unit
purchased gas costs. The total average cost per dekatherm of gas purchased by
Indiana Gas and SIGECO for the six months ended June 30, 2001 was $7.04 compared
to $4.12 for the same period in 2000.
The price changes in the cost of gas purchased are due primarily to changing
commodity costs in the marketplace. Subject to compliance with applicable state
laws, Vectren's utility subsidiaries are allowed full recovery of such changes
in purchased gas costs from their retail customers through commission-approved
gas cost adjustment mechanisms. (See rate and regulatory matters discussion
below.)
Electric Utility Margin
Electric Utility margin for the three months ended June 30, 2001 of $43.5
million, decreased $6.9 million, or 14 %, compared to 2000 primarily due to a
$7.9 million reduction in margin recorded to reflect certain wholesale power
marketing purchase and sale contracts at current market values as required by
SFAS 133. This overall decrease was partially offset by 5% and 3% increases in
volumes sold to residential and commercial customers, respectively, for the
quarter. Increases in retail sales result from weather 22% warmer than the
previous year and combined residential and commercial customer growth of 4%.
Electric Utility margin for the six months ended June 30, 2001 of $100.6
million, decreased $2.6 million, or 3%, compared to 2000 primarily due to a $2.4
million reduction in margin recorded to reflect certain wholesale power
marketing purchase and sale contracts at current market values as required by
SFAS 133. The remaining decrease results from decreased margins from sales to
wholesale energy markets despite volumes increasing 86% over 2000, offset by an
increase in sales to retail customers for the period due to the impact of warmer
weather and increasing residential and commercial customer bases.
Purchased electric energy was $33.7 million and $46.8 million for the three and
six months ended June 30, 2001, respectively, and $9.2 million and $12.6 million
for the three and six months ended June 30, 2000, respectively. The increases of
$24.5 million, or 268%, for the three months period and $34.2 million, or 270%
for the six month period are due primarily to increased purchased power related
to the greater sales to other utilities and power marketers as well as the
reductions in margin recorded as a result of SFAS 133.
30
Utility Operating Expenses (excluding Cost of Gas Sold, Fuel for Electric
Generation and Purchased Electric Energy)
Utility Other Operating
Excluding $8.8 million in expenses related to the Ohio operations, utility other
operating expenses for the three months ended June 30, 2001 were comparable to
the prior year, and excluding $20.8 million in expenses related to the Ohio
operations, utility other operating expenses decreased $0.9 million for the six
months ended June 30, 2001. The results reflect less current year maintenance
expenditures, offset by increased bad debt provisions and Low Income Heating
Assistance Program contributions (See rate and regulatory matters discussion
below.), both due to the increased gas costs.
Utility Depreciation and Amortization
Utility depreciation and amortization increased $5.7 million and $14.2 million,
respectively, for the three and six months ended June 30, 2001 compared to the
prior year due primarily to the inclusion of the Ohio operations and, for the
six month period, additional depreciation related to merger and integration
activities. (See merger and integration costs above.) Utility depreciation and
amortization related to the Ohio operations was $3.9 million and $7.8 million
for the three and six months ended June 30, 2001, respectively. The remaining
increases are attributable to depreciation of additions to utility plant.
Utility Taxes Other Than Income Taxes
Utility taxes other than income taxes increased $3.8 million and $14.8 million,
respectively, for the three and six month periods ended June 30, 2001. The three
and six month periods include $3.5 million and $13.2 million, respectively, of
primarily Ohio state excise tax related to the Ohio operations. The remaining
increases result from increases in gross receipts taxes.
Utility Interest Expense
Utility interest expense increased $7.4 million and $17.0 million, respectively,
for the three and six months ended June 30, 2001, when compared to the prior
year. The increases were due primarily to interest related to the financing of
the acquisition of the Ohio operations and increased working capital
requirements resulting from higher natural gas prices.
Utility Income Tax
Federal and state income taxes related to utility operations decreased $10.9
million and $4.0 million for the three and six months ended June 30, 2001,
respectively, compared to the prior year due to lower pre-tax earnings and
normal effective tax rates in 2001. The effective tax rate in 2000 was higher as
a result of the non-deductibility of certain merger and integration costs.
31
Results of Non-regulated Operations
Non-regulated operations have three primary business groups: Energy Services,
Utility Services, and Communications. Energy Services trades and markets natural
gas and provides energy performance contracting services. Utility Services
provides utility products and services, such as underground construction and
facilities locating, meter reading and materials management, and the mining and
sale of coal. Communications provides integrated broadband communications
services, including local and long distance telephone, Internet access and cable
television. In addition, other businesses invest in other energy-related
opportunities and corporate technology. The results of non-regulated operations
for the three and six months ended June 30, 2001 compared to the prior year are
as follows:
Three Months Six Months
In thousands, except per share amounts Ended June 30, Ended June 30,
---------------- -----------------
2001 2000 2001 2000
------- ------ ------- -------
Energy services and other revenues $ 183.5 $ 84.6 $ 455.5 $ 70.3
Cost of energy services and other revenues 177.1 77.0 438.8 158.7
Total operating margin $ 6.4 $ 7.6 $ 16.7 $ 11.6
Other operating $ 4.5 $ 4.0 $ 10.6 $ 5.9
Depreciation and amortization 0.5 0.4 1.0 0.6
Taxes other than income taxes 0.5 0.7 0.8 1.1
Total other operating expenses $ 5.5 $ 5.1 $ 12.4 $ 7.6
Other income, net $ 2.1 $ 5.8 $ 3.9 $ 7.9
Equity in earnings of unconsolidated invesments $ 6.0 $ 2.3 $ 13.9 $ 14.0
Interest $ 3.6 $ 2.4 $ 7.1 $ 4.9
Income tax $ 1.8 $ 0.9 $ 2.8 $ 4.4
Net income (loss), as reported $ (5.0) $ 5.3 $ 3.7 $ 14.6
Restructuring costs, net of tax 0.6 - 0.6 -
Merger and integrations costs, net of tax - - - 0.8
Gain on restructuring of a non-regulated
investment, net of tax - - - (4.9)
Extraordinary loss, net of tax 7.7 - 7.7 -
Net income before nonrecurring items $ 3.3 $ 5.3 $ 12.0 $ 10.5
Basic earnings (loss) per share, as reported $ (0.07) $ 0.09 $ 0.05 $ 0.24
Restructuring costs 0.01 - 0.01 -
Merger and integrations costs - - - 0.01
Gain on restructuring of a non-regulated
investment - - - (0.08)
Extraordinary loss 0.11 - 0.12 -
Basic earnings per share before
nonrecurring items $ 0.05 $ 0.09 $ 0.18 $ 0.17
Before nonrecurring items, non-regulated operations contributed net income of
$3.3 million, or $0.05 per share, for the three months ended June 30, 2001,
compared to $5.8 million, or $0.09 per share, for the same period in 2000.
32
Before nonrecurring items, non-regulated operations contributed net income of
$12.0 million, or $0.18 per share, for the six months ended June 30, 2001,
compared to $10.5 million, or $0.17 per share, for the same period in 2000.
Energy Services and Other Revenues
Revenues from Vectren's non-utility operations (primarily the operating
companies of its Energy Services, Utility Services and Communications groups)
for the three and six months ended June 30, 2001 were $183.5 million and $455.4
million, respectively, compared to $84.6 million and $170.3 million in 2000. The
significant increases over prior year amounts are primarily from Energy
Services' natural gas marketing operations resulting from higher prices for
natural gas reflected in sales to its customers during the periods and increased
volume.
Costs of Energy Services and Other Revenues
Cost of energy services and other, which is primarily the cost of natural gas
purchased for resale by Energy Services and project contract costs at Energy
Services and Communications, increased $100.1 million and $280.1 million for the
three and six months ended June 30, 2001, respectively, over 2000. The increase
is primarily due to higher per unit purchased gas costs and growth in gas sales
at Energy Services.
Non-regulated Margin
Margin for the three months ended June 30, 2001 from non-regulated operations
decreased $1.2 million, or 16 %, to $6.4 million. The decrease, which is
primarily attributable to Energy Services performance contracting business, is
due to unanticipated costs incurred on one of its large projects.
For the six month period, margin increased $5.0 million, or 43%, to $16.7
million. Growth in margin principally results from continued growth of the
company's natural gas marketing operations, performance contracting and energy
efficiency project operations (both Energy Services), and expanded coal mining
operations (Utility Services).
Non-regulated Operating Expenses (excluding Costs of Energy Services and Other
Revenues)
Non-regulated operating expenses consist of other operating expenses,
depreciation and amortization, and taxes other than income taxes. For the three
and six months ended June 30, 2001, non-regulated operating expenses increased
$0.4 million and $4.8 million respectively. Growth in non-regulated operating
expenses is primarily attributable to continued growth at Energy Services and
Utility Services. In addition, Energy Services' gas marketing operations have
experienced increased bad debts as a result of increased gas costs.
Non-regulated Other Income
Equity in Earnings of Unconsolidated Investments
For the three months ended June 30, 2001, earnings from unconsolidated
investments increased $3.7 million compared to the prior year. The increase
results from increased earnings from Energy Services investment in ProLiance
Energy, LLC (See ProLiance discussion below.).
For the six months ended June 30, 2001, earnings from unconsolidated investments
was comparable to the prior year; however, excluding the gain recognized in 2000
related to restructuring Communication's investment in SIGECOM, LLC of $8.0
million, earnings from unconsolidated investments increased $7.9 million. The
33
increase is due to increased earnings from Energy Services' investment ProLiance
and a gain on the sale of one of Haddington Energy Partners, LP's (Haddington)
investments.
In March 2001, Haddington, an investment accounted for on the equity method and
included in non-regulated other businesses, sold its investment in Bear Paw
Investments, LLC (Bear Paw) in exchange for a combination of cash and
securities. The cost of Haddington's Bear Paw investment approximated $5.1
million, and the net proceeds received approximated $18.1 million, resulting in
a pre tax gain of $13.0 million. Vectren recognized its portion of the pre-tax
gain, allocated per the terms of the partnership agreement, through equity
earnings in unconsolidated investments. The amount of the pre-tax gain
recognized by Vectren approximates $3.9 million.
Non-regulated Other Income, Net
Non-regulated other income, net decreased $3.7 million and $4.0 million,
respectively, for the three and six months ended June 30, 2001. The decreases
are due to a $2.3 million gain on the sale of a partial interest in an Energy
Services investment and $1.1 million premium earned by non-regulated other
businesses for a loan guarantee, both occurring in the second quarter of 2000.
The remaining decreases are due to increased charitable contributions and
fluctuations in interest income.
Non-regulated Interest Expense
Non-regulated interest expense increased by $1.2 million and $2.2 million,
respectively, for the three and six months ended June 30, 2001, respectively,
when compared to the prior year. The increases were due primarily to increased
debt to fund additional investments in non-regulated businesses.
Non-regulated Income Tax
Federal and state income taxes related to non-regulated operations have
increased $0.9 million for the three months ended June 30, 2001 compared to the
prior year. The increase results from the interim recording of income taxes at
the company's estimated effective tax rate. For the six months ended June 30,
2001, income taxes have decreased $1.6 million primarily as a result of lower
pretax earnings.
34
Financial Condition
Liquidity and Capital Resources
Vectren's equity capitalization objective is 40-50 % of total capitalization.
This objective may have varied, and will vary, from time to time, depending on
particular business opportunities and seasonal factors that affect the company's
operation. Vectren's equity component was 55% and 51% of total capitalization,
including current maturities of long-term debt, at June 30, 2001 and December
31, 2000, respectively. The common equity component of 55% at June 31, 2001 is
expected to be reduced in 2001 upon the refinancing of approximately $300
million of short term debt issued for the acquisition of the Ohio operations
with long-term debt. Subsequent to December 31, 2000, Vectren repaid $129.4
million of commercial paper with proceeds from a public offering of its common
stock.
Short-term cash working capital is required primarily to finance customer
accounts receivable, unbilled utility revenues resulting from cycle billing, gas
in underground storage, prepaid gas delivery services, capital expenditures and
investments until permanently financed. Short-term borrowings tend to be
greatest during the summer when accounts receivable and unbilled utility
revenues related to electricity are highest and gas storage facilities are being
refilled. However, working capital requirements have been significantly higher
throughout 2001 due to the higher natural gas costs and the acquisition of the
Ohio operations.
Cash Flow from Operations
Vectren's primary source of liquidity to fund working capital requirements has
been cash generated from operations, which totaled approximately $155.7 million
and $120.1 million for the six months ended June 30, 2001 and 2000,
respectively.
Cash flow from operations increased during the six months ended June 30, 2001
compared to 2000 by $35.6 million due primarily to higher earnings after
considering non-cash income and expenses.
Vectren expects the majority of its capital expenditures and debt security
redemptions to be provided by internally generated funds.
Financing Activities
Cash flow required for financing activities of $59.4 million for the six months
ended June 30, 2001 includes $154.5 million of reductions in net borrowings and
$34.4 million common stock dividends, offset by the issuance of $129.7 million
of common stock. This is a increase in cash required for financing activities
when compared to the six months ended June 30, 2000 of $37.5 million. The
increase in cash requirements is primarily due to increased debt and dividend
payments funds in 2001.
SIGECO has $53.7 million of adjustable rate pollution control series first
mortgage bonds which could, at the election of the bondholder, be tendered to
SIGECO when the interest rates are reset. Prior to the latest reset on March 1,
2001, the interest rates were reset annually, and the bonds subject to tender
were presented in the Condensed Consolidated Balance Sheets as current
liabilities. Effective March 1, 2001, the bonds were reset for a five-year
period and have been classified as long-term debt. Resulting from the reset, the
interest rate on the $31.5 million Series A bonds increased from 4.30 % to 4.75
%, and the interest rate on the $22.2 million Series C bonds increased from 4.45
% to 5.00 %.
On January 19, 2001, Vectren filed a registration statement with the Securities
and Exchange Commission with respect to a public offering of 5.5 million shares
of new common stock. On February 8, 2001, the registration became effective and
agreement was reached to sell 5.5 million shares to a group of underwriters. On
35
February 14, 2001, the shares were sold, at which time, the underwriters
exercised their over-allotment option to sell an additional 825,000 shares for a
total of approximately 6.3 million shares. The net proceeds of $129.4 million
were used to repay outstanding commercial paper utilized for recent
acquisitions.
At June 30, 2001, Vectren has approximately $859 million of short-term borrowing
capacity, including $679 million for its regulated operations and $180 million
for its non-regulated operations, of which approximately $177 million is
available for regulated operations and $70 million is available for
non-regulated operations. On October 31, 2000, the acquisition of the Ohio
operations was completed for a purchase price of approximately $465 million.
Commercial paper was issued to fund the purchase and is being replaced over time
with permanent financing.
At March 31, 2001, Indiana Gas was not in compliance with the total indebtedness
to capitalization ratio contained in its back up credit facility for its
commercial paper program. The non-compliance resulted from the indebtedness
incurred to purchase its ownership interest in the Ohio operations and working
capital requirements associated with higher gas costs. A waiver on the Indiana
Gas facility was obtained to waive the non-compliance through and including
March 31, 2001 which effectively waived the noncompliance up to June 30, 2001,
the date of the next quarterly test of the financial covenants. During the
quarter ended June 30, 2001, Vectren made a $100 million equity investment in
Indiana Gas. In addition, Indiana Gas was granted a modification to the credit
agreement by the syndicate banks raising the total indebtedness to
capitalization ratio. As a result of these events, Indiana Gas is in compliance
with its debt covenants at June 30, 2001. No amount is outstanding under the
back up facility.
VUHI's credit facility was renewed on June 27, 2001 and extended though June 27,
2002. As part of the renewal the capacity of the facility was decreased from
$435 million to $350 million.
Indiana Gas' and SIGECO's credit ratings on outstanding debt at June 30, 2001
were A/A2 and A/A1, respectively. VUHI's commercial paper related to the October
2000 Ohio operations acquisition has a credit rating of A-1/P-2. Indiana Gas'
commercial paper retains an A-1/P-1 rating.
Capital Expenditures and Other Investment Activities
Cash required for investing activities of $92.6 million for the six months ended
June 30, 2001 includes $87.3 million of capital expenditures. Investing
activities for the six months ended June 30, 2000 were $96.8 million. The
decrease from the prior period results from additional investments in notes
receivable made in 2000, offset by increased capital expenditures in 2001,
principally for additional generating assets.
New construction, normal system maintenance and improvements, and information
technology investments needed to provide service to a growing customer base will
continue to require substantial expenditures. Capital expenditures and
non-regulated investments for the remainder of 2001 are estimated at $168
million.
Vectren Advanced Communications
Vectren Advanced Communications (VAC), a wholly owned non-regulated subsidiary,
was formed to hold Vectren's investments in Utilicom Networks, LLC (Utilicom)
and related entities. Utilicom is a provider of bundled communications services
through high capacity broadband networks, including high speed Internet service,
cable television and telephone service. SIGECOM, LLC (SIGECOM), which is a
venture between VAC and Utilicom, provides services to the greater Evansville,
Indiana area. VAC and Utilicom plan to provide services to the greater
Indianapolis, Indiana and Dayton, Ohio markets.
36
As part of Utilicom's plans to establish operating ventures in the Indianapolis
and Dayton markets and to recapitalize SIGECOM, Utilicom plans to raise $600
million in capital. Vectren is committed to invest up to $100 million, subject
to Utilicom obtaining all required funding. Prior to the end of 2001, VAC
expects to fund an additional investment in Utilicom and SIGECOM of $10 million,
which is a portion of the $100 million discussed above. This investment, along
with an additional investment by an existing investor, is expected to fully fund
SIGECOM as a stand alone entity.
In July 2001, Utilicom announced a delay in the funding of projects in
Indianapolis and Dayton. This delay, with which Vectren management agrees, is
due to the current environment in the capital debt markets particularly related
to telecommunication related investments which has prevented Utilicom from
obtaining debt financing on terms which they consider acceptable. While the
existing investors are still committed to the Indianapolis and Dayton markets,
Vectren does not intend to proceed unless the Indianapolis and Dayton projects
are fully funded.
At June 30, 2001, VAC's investments in all Utilicom related entities approximate
$34 million, of which approximately $2 million has been invested directly in the
Indianapolis and Dayton ventures.
Environmental Matters
Clean Air Act
NOx SIP Call Matter. On October 27, 1998, the United States Environmental
Protection Agency (USEPA) issued a final rule "Finding of Significant
Contribution and Rulemaking for Certain States in the Ozone Transport Assessment
Group Region for Purposes of Reducing Regional Transport of Ozone," (63 Fed.
Reg. 57355) that required uniform nitrogen oxide (NOx) emissions reductions of
85% by utilities and other large sources in certain Midwestern states and the
District of Columbia. These emission levels are below those already imposed by
Phase I and Phase II of the Clean Air Act Amendments of 1990 (the Act).
In their state implementation plans (SIPs), the USEPA encouraged states to
target utility coal-fired boilers for the majority of the reductions required,
especially NOx emissions. Northeastern states have claimed that ozone transport
from Midwestern states (including Indiana) is the primary reason for their ozone
concentration problems. Although this premise is challenged by others based on
various air quality modeling studies, including studies commissioned by the
USEPA, the USEPA intends to incorporate a regional control strategy to reduce
ozone transport.
The NOx emissions budget for Indiana stipulated in the USEPA's final ruling
requires a 31% reduction in total NOx emissions from Indiana. Indiana's
implementation plan requires SIGECO to lower its system-wide NOx emissions to
.14/mmbtu. Based on the level of system-wide emissions reductions required and
the control technology utilized to achieve the reductions, the estimated
construction cost of the control equipment could reach $160 million and is
expected to be expended during the 2001-2004 period. Related additional annual
operation and maintenance expenses could be an estimated $8 million to $10
million. The deadline for the company's compliance is May 31, 2004 (the
compliance date).
In April 2001, Vectren initiated steps toward compliance with the revised
regulations. These steps include upgrading Culley Generating Station Unit 3,
Warrick Generating Station Unit 4, and A.B. Brown Generating Station Unit 2 with
a selective catalytic reduction (SCR) systems. SCR systems reduce flue gas NOx
emissions to atmospheric nitrogen and water using ammonia in chemical reaction.
This technology is known to be the most effective method of reducing NOx
emissions where high removal efficiencies are required. The company expects the
Culley, Warrick and A.B. Brown SCR systems to be operational by the compliance
date. Modifications to these stations are expected to reduce the company's
overall NOx emissions to levels compliant with Indiana's NOx emissions budget
allotted by the USEPA. No accrual has been recorded by the company related to
the NOx SIP Call matter. The rules governing NOx emissions are to be applied
prospectively.
37
Culley Generating Station Investigation Matter. The USEPA initiated an
investigation under Section 114 of the Act of SIGECO's coal-fired electric
generating units in commercial operation by 1977 to determine compliance with
environmental permitting requirements related to repairs, maintenance,
modifications and operations changes. The focus of the investigation was to
determine whether new source performance standards should be applied to the
modifications and whether the best available control technology was, or should
have been, used. Numerous other electric utilities were, and are currently,
being investigated by the USEPA under an industry-wide review for similar
compliance. SIGECO responded to all of the USEPA's data requests during the
investigation. In July 1999, SIGECO received a letter from the Office of
Enforcement and Compliance Assurance of the USEPA discussing the industry-wide
investigation, vaguely referring to the investigation of SIGECO and inviting
SIGECO to participate in a discussion of the issues. No specifics were noted;
furthermore, the letter stated that the communication was not intended to serve
as a notice of violation. Subsequent meetings were conducted in September and
October with the USEPA and targeted utilities, including SIGECO, regarding
potential remedies to the USEPA's general allegations.
On November 3, 1999, the USEPA filed a lawsuit against seven utilities,
including SIGECO. The USEPA alleges that, beginning in 1992, SIGECO violated the
Act by: (i) making modifications to its Culley Generating Station in Yankeetown,
Indiana without obtaining required permits; (ii) making major modifications to
the Culley Generating Station without installing the best available emission
control technology; and (iii) failing to notify the USEPA of the modifications.
In addition, the lawsuit alleges that the modifications to the Culley Generating
Station required SIGECO to begin complying with federal new source performance
standards.
SIGECO believes it performed only maintenance, repair and replacement activities
at the Culley Generating Station, as allowed under the Act. Because proper
maintenance does not require permits, application of the best available emission
control technology, notice to the USEPA, or compliance with new source
performance standards, SIGECO believes that the lawsuit is without merit, and
intends to vigorously defend the lawsuit.
The lawsuit seeks fines against SIGECO in the amount of $27,500 per day per
violation. The lawsuit does not specify the number of days or violations the
USEPA believes occurred. The lawsuit also seeks a court order requiring SIGECO
to install the best available emissions technology at the Culley Generating
Station. If the USEPA is successful in obtaining an order, SIGECO estimates that
it would incur capital costs of approximately $40 million to $50 million to
comply with the order. As a result of the NOx SIP call issue, the majority of
the $40 million to $50 million for best available emissions technology at Culley
Generating Station is included in the $160 million expenditure previously
discussed.
The USEPA has also issued an administrative notice of violation to SIGECO making
the same allegations, but alleging that violations began in 1977.
While it is possible that SIGECO could be subjected to criminal penalties if the
Culley Generating Station continues to operate without complying with the new
source performance standards and the allegations are determined by a court to be
valid, SIGECO believes such penalties are unlikely as the USEPA and the electric
utility industry have a bonafide dispute over the proper interpretation of the
Act. Accordingly, no accrual has been recorded by the company, and SIGECO
anticipates at this time that the plant will continue to operate while the
matter is being decided.
38
Information Request. On January 23, 2001, SIGECO received an information request
from the USEPA under Section 114(a) of the Act for historical operational
information on the Warrick and A.B. Brown generating stations. SIGECO has
provided all information requested, and management believes that no significant
issues will arise from this request.
Manufactured Gas Plants
In the past, Indiana Gas and others operated facilities for the manufacture of
gas. Given the availability of natural gas transported by pipelines, these
facilities have not been operated for many years. Under currently applicable
environmental laws and regulations, Indiana Gas, and the others, may now be
required to take remedial action if certain byproducts are found above the
regulatory thresholds at these sites.
Indiana Gas has identified the existence, location and certain general
characteristics of 26 gas manufacturing and storage sites for which it may have
some remedial responsibility. Indiana Gas has completed a remedial
investigation/feasibility study (RI/FS) at one of the sites under an agreed
order between Indiana Gas and the Indiana Department of Environmental Management
(IDEM), and a Record of Decision was issued by the IDEM in January 2000.
Although Indiana Gas has not begun an RI/FS at additional sites, Indiana Gas has
submitted several of the sites to the IDEM's Voluntary Remediation Program and
is currently conducting some level of remedial activities including groundwater
monitoring at certain sites where deemed appropriate and will continue remedial
activities at the sites as appropriate and necessary.
In conjunction with data compiled by expert consultants, Indiana Gas has accrued
the estimated costs for further investigation, remediation, groundwater
monitoring and related costs for the sites. While the total costs that may be
incurred in connection with addressing these sites cannot be determined at this
time, Indiana Gas has accrued costs that it reasonably expects to incur totaling
approximately $20.3 million.
The estimated accrued costs are limited to Indiana Gas' proportionate share of
the remediation efforts. Indiana Gas has arrangements in place for 19 of the 26
sites with other potentially responsible parties (PRP), which serve to limit
Indiana Gas' share of response costs at these 19 sites to between 20 and 50
percent.
With respect to insurance coverage, as of June 30, 2001, Indiana Gas has
received and recorded settlements from all known insurance carriers in an
aggregate amount approximating its $20.3 million accrual.
Environmental matters related to manufactured gas plants have had no material
impact on earnings since costs recorded to date approximate PRP and insurance
settlement recoveries. While Indiana Gas has recorded all costs which it
presently expects to incur in connection with activities at these sites, it is
possible that future events may require some level of additional remedial
activities which are not presently foreseen.
Rate and Regulatory Matters
Gas Cost Proceedings
Commodity prices for natural gas purchases have increased significantly,
primarily due to a colder winter, increased demand and tighter supplies. Subject
to compliance with applicable state laws, Vectren's utility subsidiaries are
allowed full recovery of such changes in purchased gas costs from their retail
customers through commission-approved gas cost adjustment (GCA) mechanisms, and
margin on gas sales should not be impacted. However, in 2001, Vectren 's utility
39
subsidiaries have experienced and may continue to experience higher working
capital requirements, increased expenses including unrecoverable interest costs,
uncollectibles and unaccounted for gas, and some level of price sensitive
reduction in volumes sold.
On October 11, 2000, Indiana Gas filed for approval of its regular quarterly
GCA. In early December, the Indiana Utility Regulatory Commission (IURC) issued
an interim order approving the request by Indiana Gas for a GCA factor for
December 2000. On January 4, 2001, the IURC approved the January and February
2001 GCA as filed. The order also addressed the claim by the Indiana Office of
Utility Consumer Counselor (OUCC) that a portion of the requested GCA be
disallowed because Indiana Gas should have entered into additional commitments
for this winter's gas supply in late 1999 and early 2000. In procuring gas
supply for winter, Indiana Gas followed the gas procurement practices that it
had employed over the last several years. In response to the claim by the OUCC
the IURC found that there should be a $3.8 million disallowance related to gas
procurement for the winter season. As a result, Indiana Gas recognized a pre-tax
charge of $3.8 million in December 2000. Both Indiana Gas and the OUCC appealed
the ruling. The Citizens Action Coalition of Indiana, Inc. (CAC), a not for
profit consumer advocate, also filed with the IURC a petition to intervene and a
notice of appeal of the order.
In March 2001, Indiana Gas and SIGECO reached agreement with the OUCC and CAC
regarding the matters raised by the IURC Order. As part of the agreement, among
other things, the companies agreed to contribute an additional $1.9 million to
the state of Indiana's Low Income Heating Assistance Program in 2001 and to
credit $3.3 million of the $3.8 million disallowed amount to Indiana Gas
customers' April 2001 utility bills in exchange for both the OUCC and the CAC
dropping their appeals of the IURC Order. In April 2001, the IURC issued an
order approving the settlement. The contributions to Indiana's Low Income
Heating Assistance Program totaling $1.9 million were made in 2001 and were
charged to other operating expense. There was no impact to 2000 operations as a
result of this contribution.
Purchased Power Costs
As a result of the ongoing appeal of a generic order issued by the IURC in
August 1999 regarding guidelines for the recovery of purchased power costs,
SIGECO entered into a settlement agreement with the OUCC that provides certain
terms with respect to the recoverability of such costs. The settlement,
originally approved by the IURC on August 9, 2000, has been extended by
agreement through March 2002. Under the settlement, SIGECO can recover the
entire cost of purchased power up to an established benchmark, and during forced
outages, SIGECO will bear a limited share of its purchased power costs
regardless of the market costs at that time. Based on this agreement, SIGECO
believes it has limited its exposure to unrecoverable purchased power costs.
ProLiance Energy, LLC
ProLiance, a 50 % owned, non-regulated, energy marketing affiliate of Vectren,
began providing natural gas and related services to Indiana Gas, Citizens Gas
and Coke Utility (Citizens Gas) and others effective April 1, 1996. The sale of
gas and provision of other services to Indiana Gas by ProLiance is subject to
regulatory review through the quarterly GCA process administered by the IURC.
On September 12, 1997, the IURC issued a decision finding the gas supply and
portfolio administration agreements between ProLiance and Indiana Gas and
ProLiance and Citizens Gas to be consistent with the public interest and that
ProLiance is not subject to regulation by the IURC as a public utility. The
IURC's decision reflected the significant gas cost savings to customers obtained
through ProLiance's services and suggested that all material provisions of the
agreements between ProLiance and the utilities are reasonable. Nevertheless,
with respect to the pricing of gas commodity purchased from ProLiance, the
pricing of fees paid by ProLiance to the utilities for the prospect of using
40
pipeline entitlements if and when they are not required to serve the utilities'
firm customers, and the pricing of fees paid by the utilities to ProLiance for
portfolio administration services, the IURC concluded that additional review in
the GCA process would be appropriate and directed that these matters be
considered further in the pending, consolidated GCA proceeding involving Indiana
Gas and Citizens Gas.
As a result of an appeal of the IURC's order,on September 22, 2000, the Indiana
Supreme Court issued a decision affirming the IURC's decision with respect to
Indiana Gas' and Citizens Gas' agreements with ProLiance in all respects.
The IURC has recently commenced the processing of the further GCA proceeding
regarding the three pricing issues by conducting a prehearing conference.
Discovery is ongoing in this proceeding at the current time. Until the three
pricing issues reserved by the IURC are resolved, Vectren will continue to
reserve a portion of its share of ProLiance earnings.
In August 1998, Indiana Gas, Citizens Gas and ProLiance each received a Civil
Investigative Demand (CID) from the United States Department of Justice
requesting information relating to Indiana Gas' and Citizens Gas' relationship
with and the activities of ProLiance. The Department of Justice issued the CID
to gather information regarding ProLiance's formation and operations, and to
determine if trade or commerce has been restrained. Indiana Gas has provided all
information requested and management believes there are no significant issues in
this matter.
Indiana Gas continues to record gas costs in accordance with the terms of the
ProLiance contract, and Vectren continues to record its proportional share of
ProLiance's earnings. Pre-tax income of $4.0 million and $1.5 million was
recognized as ProLiance's contribution to earnings for the three months ended
June 30, 2001 and 2000, respectively. Pre-tax income of $9.6 million and $4.8
million was recognized as ProLiance's contribution to earnings for the six
months ended June 30, 2001 and 2000, respectively. Earnings recognized from
ProLiance are included in equity in earnings of unconsolidated investments on
the Condensed Consolidated Statements of Operations. At June 30, 2001 and
December 31, 2000, Vectren has reserved approximately $3.1 million and $2.4
million, respectively, of ProLiance's earnings after tax pending resolution of
the remaining issues. The reserve represents 10% of ProLiance's pretax earnings
and serves as management's best estimate of potential exposure arising from the
three pricing issues.
Impact of Recently Issued Accounting Guidance
The FASB issued two new statements of financial accounting standards in July
2001: SFAS No. 141, "Business Combinations" (SFAS 141), and SFAS No. 142,
"Goodwill and Other Intangible Assets" (SFAS 142). These interrelated standards
change the accounting for business combinations and goodwill in two significant
ways:
SFAS 141 requires that the purchase method of accounting be used for
all business combinations initiated after June 30, 2001. Use of the
pooling-of-interests method is prohibited. This change does not affect
the pooling-of-interest transaction forming Vectren.
SFAS 142 changes the accounting for goodwill from an amortization
approach to an impairment-only approach. Thus, amortization of
goodwill, including goodwill recorded in past business combinations,
such as the company's acquisition of the Ohio operations, will cease
upon adoption of the statement. Goodwill is to be tested for impairment
at a reporting unit level at least annually.
41
SFAS 142 also requires the initial impairment review of all goodwill and other
intangible assets within six months of the adoption date, which is January 1,
2002 for Vectren. The impairment review consists of a comparison of the fair
value of a reporting unit to its carrying amount. If the fair value of a
reporting unit is less than its carrying amount, an impairment loss would be
recognized. Results of the initial impairment review are to be treated as a
change in accounting principle in accordance with APB Opinion No. 20 "Accounting
Changes." An impairment loss recognized as a result of an impairment test
occurring after the initial impairment review is to be reported as a part of
operations.
SFAS 142 also changes certain aspects of accounting for intangible assets;
however, the company does not have any significant intangible assets.
The adoption of SFAS 141 will not materially impact operations. As required by
SFAS 142, amortization of goodwill relating to the acquisition of the Ohio
operations, which approximates $5.0 million per year, will cease on January 1,
2002. The company has not determined the potential impact of initial impairment
reviews to be performed within six months of adoption of SFAS 142.
Also in July 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations" (SFAS 143). SFAS 143 requires entities to record the
fair value of a liability for an asset retirement obligation in the period in
which it is incurred. When the liability is initially recorded, the entity
capitalizes a cost by increasing the carrying amount of the related long-lived
asset. Over time, the liability is accreted to then its present value, and the
capitalized cost is depreciated over the useful life of the related asset. Upon
settlement of the liability, an entity either settles the obligation for its
recorded amount or incurs a gain or loss upon settlement. SFAS 143 is effective
for fiscal years beginning after June 15, 2002, with earlier application
encouraged. Vectren is currently evaluating the impact that SFAS 143 will have
on its operations.
Forward-Looking Information
A "safe harbor" for forwarding-looking statements is provided by the Private
Securities Litigation Reform Act of 1995 (Reform Act of 1995). The Reform Act of
1995 was adopted to encourage such forward-looking statements without the threat
of litigation, provided those statements are identified as forward-looking and
are accompanied by meaningful cautionary statements identifying important
factors that could cause the actual results to differ materially from those
projected in the statement. Certain matters described in Management's Discussion
and Analysis of Results of Operations and Financial Condition, including, but
not limited to Vectren's realization of net merger savings and ProLiance, are
forward-looking statements. Such statements are based on management's beliefs,
as well as assumptions made by and information currently available to
management. When used in this filing, the words "believe," "anticipate,"
"endeavor," "estimate," "expect," "objective," "projection," "forecast," "goal,"
and similar expressions are intended to identify forward-looking statements. In
addition to any assumptions and other factors referred to specifically in
connection with such forward-looking statements, factors that could cause
Vectren and its subsidiaries' actual results to differ materially from those
contemplated in any forward-looking statements included, among others, the
following:
|X| Factors affecting utility operations such as unusual weather
conditions; catastrophic weather-related damage; unusual maintenance
or repairs; unanticipated changes to fossil fuel costs; unanticipated
changes to gas supply costs, or availability due to higher demand,
shortages, transportation problems or other developments;
environmental or pipeline incidents; transmission or distribution
incidents; unanticipated changes to electric energy supply costs, or
availability due to demand, shortages, transmission problems or other
developments; or electric transmission or gas pipeline system
constraints.
42
|X| Increased competition in the energy environment including effects of
industry restructuring and unbundling.
|X| Regulatory factors such as unanticipated changes in rate-setting
policies or procedures, recovery of investments and costs made under
traditional regulation, and the frequency and timing of rate
increases.
|X| Financial or regulatory accounting principles or policies imposed by
the Financial Accounting Standards Board, the Securities and Exchange
Commission, the Federal Energy Regulatory Commission, state public
utility commissions, state entities which regulate natural gas
transmission, gathering and processing, and similar entities with
regulatory oversight.
|X| Economic conditions including inflation rates and monetary
fluctuations.
|X| Changing market conditions and a variety of other factors associated
with physical energy and financial trading activities including, but
not limited to, price, basis, credit, liquidity, volatility, capacity,
interest rate, and warranty risks.
|X| Availability or cost of capital, resulting from changes in Vectren
Corporation and its subsidiaries, interest rates, and securities
ratings or market perceptions of the utility industry and
energy-related industries.
|X| Employee workforce factors including changes in key executives,
collective bargaining agreements with union employees, or work
stoppages.
|X| Legal and regulatory delays and other obstacles associated with
mergers, acquisitions, and investments in joint ventures.
|X| Costs and other effects of legal and administrative proceedings,
settlements, investigations, claims, and other matters, including, but
not limited to, those described in Management's Discussion and
Analysis of Results of Operations and Financial Condition.
|X| Changes in federal, state or local legislature requirements, such as
changes in tax laws or rates, environmental laws and regulations.
Vectren and its subsidiaries undertake no obligation to publicly update or
revise any forward-looking statements, whether as a result of changes in actual
results, changes in assumptions, or other factors affecting such statements.
43
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Vectren is exposed to market risks associated with commodity prices, interest
rates, and counterparty credit. These financial exposures are monitored and
managed by the company as an integral part of its overall risk management
program.
Commodity Price Risk. Vectren's regulated operations have limited exposure to
commodity price risk for purchases and sales of natural gas and electric energy
for its retail customers due to current Indiana and Ohio regulations, which
subject to compliance with applicable state regulations, allow for recovery of
such purchases through natural gas and fuel cost adjustment mechanisms.
(See Note 13 Rate and Regulatory Matters.)
Vectren does engage in limited, wholesale power marketing and natural gas
marketing activities that may expose the company to commodity price risk
associated with fluctuating electric power and natural gas commodity prices.
Vectren's non-regulated wholesale power marketing activities manage the
utilization of its available electric generating capacity. Vectren's wholesale
natural gas marketing activities purchase and sell natural gas to meet customer
demands. Both operations enter into forward contracts that commit the company to
purchase and sell commodities in the future.
Commodity price risk results from forward sales contracts that commit Vectren to
deliver either electric power or natural gas on specified future dates. Power
marketing uses planned unutilized generation capability and forward purchase
contracts to protect certain sales transactions from unanticipated fluctuations
in the price of electric power, and periodically, will use derivative financial
instruments to protect its interests from unplanned outages and shifts in
demand. Additionally, gas marketing uses natural gas stored inventory and
forward purchase contracts to protect certain sales transactions from
unanticipated fluctuations in the price of natural gas.
Open positions in terms of price, volume and specified delivery points may occur
to a limited extent and are managed using methods described above and frequent
management reporting.
Market risk is measured by management as the potential impact of pre tax
earnings resulting from a 10% adverse change in the forward price of electricity
and natural gas on market sensitive financial instruments (all contracts not
expected to be settled by physical receipt or delivery). For the three and six
months ended June 30, 2001, a 10% adverse change in the forward prices of
electricity and natural gas on market sensitive financial instruments would have
decreased pre tax earnings by approximately $0.6 million and $1.4 million,
respectively.
Commodity Price Risk from Equity Investment. ProLiance Energy, LLC (ProLiance),
a 50 % owned, non-regulated, energy marketing affiliate of Vectren , engages in
energy hedging activities to manage pricing decisions, minimize the risk of
price volatility, and minimize price risk exposure in the energy markets.
ProLiance's market exposure arises from storage inventory, imbalances and
fixed-price forward purchase and sale contracts, which are entered into to
support ProLiance's operating activities. Currently, ProLiance buys and sells
physical commodities and utilizes financial instruments to hedge its market
exposure. However, net open positions in terms of price, volume and specified
delivery point do occur. ProLiance manages open positions with policies which
limit its exposure to market risk and require reporting potential financial
exposure to its management and its members. As a result of ProLiance's risk
management policies, management believes that ProLiance's exposure to market
risk will not result in material earnings or cash flow loss to the company.
44
Interest Rate Risk. The company is exposed to interest rate risk associated with
its short-term borrowings and adjustable rate long term debt. Its risk
management program seeks to reduce the potentially adverse effects that market
volatility may have on operations.
Under normal circumstances, the company tries to limit the amount of short-term
debt and adjustable rate long-term debt outstanding to a maximum of 25% of total
debt. However, there are times when this targeted level of interest rate
exposure may be exceeded. To manage this exposure, the company may periodically
use derivative financial instruments to reduce earnings fluctuations caused by
interest rate volatility.
At June 30, 2001, Vectren's short-term debt, represented 47% of the company's
total debt portfolio, due primarily to financing the approximate $465 million
acquisition of the Ohio operations initially with short-term debt and the
increased working capital requirements resulting from higher gas costs. The
short-term debt utilized for the Ohio operations acquisition is being replaced
over time with permanent financing (see Liquidity and Capital Resources).
Market risk is estimated as the potential impact resulting from fluctuations in
interest rates on short-term borrowings, including bank notes, lines of credit
and commercial paper. At June 30, 2001 and December 31, 2000, the combined
borrowings under these facilities totaled $612.5 million and $759.9 million,
respectively. Based upon average borrowing rates under these facilities during
the three months ended June 30, 2001 and 2000, an increase of 100 basis points
(1 %) in the rates would have increased interest expense by $1.5 million and
$0.5 million, respectively. For the six months ended June 30, 2001 and 2000, an
increase of 100 basis points in rates would have increased interest expense by
$3.2 million and $1.0 million, respectively. Approximately $0.4 million of the
three month ended June 30, 2001 decrease and $0.8 million of the six months
ended June 30, 2001 decrease would be offset by changes in the company's
interest rate swap.
Other Risks. By using forward purchase contracts and derivative financial
instruments to manage risk, the company exposes itself to counterparty credit
risk and market risk. The company manages this exposure to counterparty credit
risk by entering into contracts with financially sound companies that can be
expected to fully perform under the terms of the contract. The company attempts
to manage exposure to market risk associated with commodity contracts and
interest rates by establishing and monitoring parameters that limit the types
and degree of market risk that may be undertaken.
45
VECTREN CORPORATION AND SUBSIDIARY COMPANIES
PART II. OTHER ITEMS
ITEM 1. LEGAL PROCEEDINGS
Vectren is party to various legal proceedings arising in the normal course of
business. In the opinion of management, with the exception litigation matters
related to the Culley Generating Station Investigation Matter (See Note 12) and
ProLiance Energy, LLC (See Note 14), there are no legal proceedings pending
against Vectren that are likely to have a material adverse effect on the
financial position or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
Vectren's Annual Meeting of Stockholders was held on April 25, 2001.
At said Annual Meeting, the stockholders voted on the following two proposals:
1) To elect four directors of the Company to serve for a term of three years
or until their successors are duly qualified and elected;
a) The stock holders elected the Directors by the following votes
Director Votes For Votes Against Abstentions
-------------------- ----------- -------------- -----------
John D. Engelbrecht 59,244,130 0 762,677
William G. Mays 59,208,652 0 798,155
J. Timothy McGinley 59,230,963 0 775,844
Richard P. Rechter 59,265,101 0 741,706
b) The terms of office of John M. Dunn, Niel C. Ellerbrook, Lawrence A.
Ferger, Anton H. George, Andrew E. Goebel , Robert L. Koch II, Donald
A. Rausch, Ronald G. Reherman, James C. Shook, Richard W. Shymanski,
and Jean L. Wojtowicz will expire in 2002 or 2003
2) To approve the Company's At-Risk Compensation Plan (the Plan);
The stockholders approved the Plan by the following votes:
Votes For Votes Against Abstentions Broker Non-Votes
------------- -------------- ----------- ----------------
40,694,393 5,238,171 1,450,962 12,623,281
46
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
Exhibits
EX - 10.01 Vectren Corporation At Risk Compensation Plan. (Filed and
designated in Schedule 14A Definitive Proxy Statement on March
16, 2001, File 1-15467, in Appendix B)
Reports on Form 8-K
On April 2, 2001 Vectren Corporation (Vectren) filed a Current Report on Form
8-K with respect to the creation of a common name for Vectren's regulated
distribution businesses in the state of Indiana. Indiana Gas Company, Inc.
(Indiana Gas) and Southern Indiana Gas and Electric Company (SIGECO) will begin
doing business as Vectren Energy Delivery of Indiana effective April 1, 2001.
Vectren's power generation and wholesale power marketing functions will transact
business under the name Vectren Power Supply.
Item 5. Other Matters
Item 7. Exhibits
99.1 - Press release, dated March 30, 2001
99.2 - Forward Looking Statements
On April 26, 2001, Vectren Corporation filed a Current Report on Form 8-K with
respect to the release of financial information to the investment community
regarding the company's results of operations, financial position and cash flows
for the three and twelve month periods ended March 31, 2001. The financial
information was released to the public through this filing.
Item 5. Other Events
Item 7. Exhibits
99.1 - Press Release - First Quarter 2001 Vectren Earnings
99.2 - Cautionary Statement for Purposes of the "Safe
Harbor" Provisions of the Private Securities
Litigation Reform Act of 1995
On May 22, 2001, Vectren Corporation filed a Current Report on Form 8-K with
respect to a corrected Consent of Independent Public Accountants of Arthur
Andersen LLP dated May 17, 2001. This Consent should replace the Arthur Andersen
LLP Consent of Independent Public Accountants previously filed with the
Registration Statement on May 18, 2001 (Form S-8, File No. 333-61252), which
contained an error.
Item 5. Other Events
Item 7. Financial Statements and Exhibits
Exhibit 23 - Consent of Independent Public Accountants of
Arthur Andersen LLP dated May 17, 2001
47
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
VECTREN CORPORATION
Registrant
August 14, 2001 /s/Jerome A. Benkert, Jr.
-------------------------
Jerome A. Benkert, Jr.
Executive Vice President and
Chief Financial Officer
/s/M. Susan Hardwick
----------------------------
M. Susan Hardwick
Vice President and Controller