UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark one) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 1997 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission Registrant; State of Incorporation; IRS Employer File Number Address; and Telephone Number Identification No. 1-9187 IES INDUSTRIES INC. (an Iowa Corporation) 42-1271452 IES Tower, Cedar Rapids, Iowa 52401 319-398-4411 0-4117-1 IES UTILITIES INC. (an Iowa Corporation) 42-0331370 IES Tower, Cedar Rapids, Iowa 52401 319-398-4411 Indicate by check mark whether the registrants (1) have 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 registrants were required to file such reports), and (2) have been subject to such filing requirements for the past 90 days. Yes X No --- --- Indicate the number of shares outstanding of each of the registrants' classes of common stock, as of April 30, 1997. IES Industries Inc. Common Stock, no par value - 30,304,617 shares IES Utilities Inc. Common Stock, $2.50 par value - 13,370,788 shares IES INDUSTRIES INC. AND IES UTILITIES INC. INDEX Page No. Part I. Financial Information. Item 1. Consolidated Financial Statements. IES Industries Inc.: Consolidated Balance Sheets - March 31, 1997 and December 31, 1996 3 - 4 Consolidated Statements of Income - Three and Twelve Months Ended March 31, 1997 and 1996 5 Consolidated Statements of Cash Flows - Three and Twelve Months Ended March 31, 1997 and 1996 6 Notes to Consolidated Financial Statements 7 - 14 IES Utilities Inc.: Consolidated Balance Sheets - March 31, 1997 and December 31, 1996 15 - 16 Consolidated Statements of Income - Three and Twelve Months Ended March 31, 1997 and 1996 17 Consolidated Statements of Cash Flows - Three and Twelve Months Ended March 31, 1997 and 1996 18 Notes to Consolidated Financial Statements 19 Item 2. Management's Discussion and Analysis of the Results of Operations and Financial Condition. 20 - 32 Part II. Other Information. 33 - 35 Signatures. 36 - 37 PART I - FINANCIAL INFORMATION ITEM 1. - CONSOLIDATED FINANCIAL STATEMENTS IES INDUSTRIES INC. CONSOLIDATED BALANCE SHEETS March 31, 1997 December 31, ASSETS (in thousands) (Unaudited) 1996 Property, plant and equipment: Utility - Plant in service - Electric $ 2,015,838 $ 2,007,839 Gas 176,439 175,472 Other 132,421 126,850 2,324,698 2,310,161 Less - Accumulated depreciation 1,054,799 1,030,390 1,269,899 1,279,771 Leased nuclear fuel, net of amortization 31,468 34,725 Construction work in progress 48,726 43,719 1,350,093 1,358,215 Other, net of accumulated depreciation and amortization of $74,652 and $70,031, respectively 228,521 223,805 1,578,614 1,582,020 Current assets: Cash and temporary cash investments 26,625 8,675 Accounts receivable - Customer, less allowance for doubtful accounts of $1,165 and $1,087, respectively 34,826 50,821 Other 9,466 12,040 Income tax refunds receivable 9,428 8,890 Production fuel, at average cost 12,042 13,323 Materials and supplies, at average cost 23,992 22,842 Adjustment clause balances 0 10,752 Regulatory assets 32,067 26,539 Prepayments and other 19,698 24,169 168,144 178,051 Investments: Nuclear decommissioning trust funds 61,516 59,325 Investment in foreign entities 45,142 44,946 Investment in McLeod, Inc. 29,200 29,200 Cash surrender value of life insurance policies 11,562 11,217 Other 7,207 4,903 154,627 149,591 Other assets: Regulatory assets 196,096 201,129 Deferred charges and other 15,169 14,771 211,265 215,900 $ 2,112,650 $ 2,125,562 IES INDUSTRIES INC. CONSOLIDATED BALANCE SHEETS (CONTINUED) March 31, CAPITALIZATION AND LIABILITIES 1997 December 31, (in thousands, except share amounts) (Unaudited) 1996 Capitalization: Common stock - no par value - authorized 48,000,000 shares; outstanding 30,217,336 and 30,077,212 shares, respectively $ 412,143 $ 407,635 Retained earnings 215,703 219,246 Total common equity 627,846 626,881 Cumulative preferred stock of IES Utilities Inc. 18,320 18,320 Long-term debt (excluding current portion) 651,763 701,100 1,297,929 1,346,301 Current liabilities: Short-term borrowings 126,000 135,000 Capital lease obligations 14,047 15,125 Maturities and sinking funds 63,480 8,473 Accounts payable 62,142 99,861 Dividends payable 16,527 16,431 Accrued interest 11,041 8,985 Accrued taxes 71,599 43,926 Accumulated refueling outage provision 3,002 1,316 Adjustment clause balances 3,759 0 Environmental liabilities 5,679 5,679 Other 17,754 22,087 395,030 356,883 Long-term liabilities: Pension and other benefit obligations 43,852 39,643 Capital lease obligations 17,421 19,600 Environmental liabilities 47,560 47,502 Other 21,959 18,488 130,792 125,233 Deferred credits: Accumulated deferred income taxes 255,087 262,675 Accumulated deferred investment tax credits 33,812 34,470 288,899 297,145 Commitments and contingencies (Note 7) $ 2,112,650 $ 2,125,562 The accompanying Notes to Consolidated Financial Statements are an integral part of these statements. IES INDUSTRIES INC. CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) For the Three For the Twelve Months Ended Months Ended March 31 March 31 1997 1996 1997 1996 (in thousands, except per share amounts) Operating revenues: Electric $ 137,286 $ 125,368 $ 586,191 $ 569,262 Gas 84,106 90,024 268,060 215,381 Other 36,295 27,805 134,151 103,173 257,687 243,197 988,402 887,816 Operating expenses: Fuel for production 29,881 20,292 94,168 97,105 Purchased power 18,673 14,469 92,553 65,029 Gas purchased for resale 64,498 67,437 214,412 159,864 Other operating expenses 52,964 52,525 215,197 205,822 Maintenance 13,568 10,833 51,736 44,763 Depreciation and amortization 28,739 27,384 108,750 99,803 Taxes other than income taxes 13,295 13,262 48,203 48,836 221,618 206,202 825,019 721,222 Operating income 36,069 36,995 163,383 166,594 Interest expense and other: Interest expense 14,846 12,906 56,763 51,667 Allowance for funds used during construction -394 -690 -1,807 -2,999 Preferred dividend requirements of IES Utilities Inc. 229 229 914 914 Miscellaneous, net -244 -1,677 3,765 -4,489 14,437 10,768 59,635 45,093 Income before income taxes 21,632 26,227 103,748 121,501 Income taxes: Current 16,138 14,110 40,274 51,506 Deferred -6,163 -1,317 6,988 1,138 Amortization of investment tax credits -658 -661 -2,642 -2,674 9,317 12,132 44,620 49,970 Net income $ 12,315 $ 14,095 $ 59,128 $ 71,531 Average number of common shares outstanding 30,188 29,645 29,997 29,391 Earnings per average common share $ 0.41 $ 0.48 $ 1.97 $ 2.43 Dividends declared per common share $ 0.525 $ 0.525 $ 2.10 $ 2.10 The accompanying Notes to Consolidated Financial Statements are an integral part of these statements. IES INDUSTRIES INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) For the Three For the Twelve Months Ended Months Ended March 31 March 31 1997 1996 1997 1996 (in thousands) Cash flows from operating activities: Net income $ 12,315 $ 14,095 $ 59,128 $ 71,531 Adjustments to reconcile net income to net cash flows from operating activities - Depreciation and amortization 28,739 27,384 108,750 99,803 Amortization of principal under capital lease obligation 3,369 4,624 15,237 17,781 Deferred taxes and investment tax credits -6,821 -1,978 4,346 -1,536 Refueling outage provision 1,686 2,546 -7,234 3,569 Amortization of other assets 3,039 2,913 9,895 9,247 Other 2,279 1,104 2,078 1,040 Other changes in assets and liabilities - Accounts receivable 18,569 -7,131 3,546 -20,186 Sale of utility accounts receivable 0 0 7,000 -6,000 Production fuel, materials and supplies 916 1,351 687 3,744 Accounts payable -35,242 -8,620 -5,690 -4,064 Accrued taxes 27,135 16,293 -7,123 20,371 Provision for rate refunds 0 166 -272 -7,728 Adjustment clause balances 14,511 3,387 -2,776 3,733 Gas in storage 6,073 7,744 -2,825 2,798 Other 1,927 772 12,921 -4,456 Net cash flows from operating activities 78,495 64,650 197,668 189,647 Cash flows from financing activities: Dividends declared on common stock -15,858 -15,582 -63,015 -61,792 Proceeds from issuance of common stock 3,479 3,726 13,917 14,696 Purchase of treasury stock 0 0 -269 0 Net change in IES Diversified Inc. credit facility 5,695 -995 54,550 52,725 Proceeds from issuance of other long-term debt 0 0 60,000 50,007 Reductions in other long-term debt -79 -79 -15,454 -50,431 Net change in short-term borrowings -9,000 -9,000 34,000 64,000 Principal payments under capital lease obligations -2,296 -4,913 -16,491 -15,714 Other 96 -69 -292 -1,576 Net cash flows from financing activities -17,963 -26,912 66,946 51,915 Cash flows from investing activities: Construction and acquisition expenditures - Utility -19,758 -23,333 -138,684 -121,437 Other -13,423 -15,359 -94,183 -99,663 Oil and gas properties held for resale 0 9,843 0 0 Deferred energy efficiency expenditures -4,014 -3,667 -17,204 -18,159 Nuclear decommissioning trust funds -1,502 -1,502 -6,008 -6,219 Proceeds from disposition of assets 567 1,204 7,658 12,524 Other -4,452 -1,431 -3 -3,015 Net cash flows from investing activities -42,582 -34,245 -248,424 -235,969 Net increase in cash and temporary cash investments 17,950 3,493 16,190 5,593 Cash and temporary cash investments at beginning of period 8,675 6,942 10,435 4,842 Cash and temporary cash investments at end of period $ 26,625 $ 10,435 $ 26,625 $ 10,435 Supplemental cash flow information: Cash paid during the period for - Interest $ 12,308 $ 10,544 $ 54,811 $ 51,615 Income taxes $ -676 $ 8,471 $ 45,733 $ 32,215 Noncash investing and financing activities - Capital lease obligations incurred $ 112 $ 2,604 $ 11,790 $ 4,405 The accompanying Notes to Consolidated Financial Statements are an integral part of these statements. This document contains the Quarterly Reports on Form 10-Q for the quarter ended March 31, 1997 for each of IES Industries Inc. and IES Utilities Inc. Information contained herein relating to an individual registrant is filed by such registrant on its own behalf. Accordingly, except for its subsidiaries, IES Utilities Inc. makes no representation as to information relating to IES Industries Inc. or to any other companies affiliated with IES Industries Inc. IES Industries Inc. and its consolidated subsidiaries may collectively be referred to as "the Company". From time to time, the Company may make forward-looking statements within the meaning of the federal securities laws that involve judgments, assumptions and other uncertainties beyond the control of the Company. These forward-looking statements may include, among others, statements concerning revenue and cost trends, cost recovery, cost reduction strategies and anticipated outcomes, pricing strategies, changes in the utility industry, planned capital expenditures, financing needs and availability, statements of the Company's expectations, beliefs, future plans and strategies, anticipated events or trends and similar comments concerning matters that are not historical facts. Investors and other users of the forward-looking statements are cautioned that such statements are not a guarantee of future performance of the Company and that such forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those expressed in, or implied by, such statements. Some, but not all, of the risks and uncertainties include weather effects on sales and revenues, competitive factors, general economic conditions in the Company's service territory, federal and state regulatory or government actions, the operating of a nuclear facility and changes in the rate of inflation. IES INDUSTRIES INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) March 31, 1997 (1) GENERAL: The interim Consolidated Financial Statements have been prepared by IES Industries Inc. (Industries) and its consolidated subsidiaries, without audit, pursuant to the rules and regulations of the United States Securities and Exchange Commission (SEC). Industries' wholly-owned subsidiaries are IES Utilities Inc. (Utilities) and IES Diversified Inc. (Diversified). Industries is an investor-owned holding company whose primary operating company, Utilities, is engaged principally in the generation, transmission, distribution and sale of electric energy and the purchase, distribution, transportation and sale of natural gas. The Company's principal markets are located in the State of Iowa. The Company also has various non- utility subsidiaries which are primarily engaged in the energy-related, transportation and real estate development businesses. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations, although the Company believes that the disclosures are adequate to make the information presented not misleading. In the opinion of the Company, the Consolidated Financial Statements include all adjustments, which are normal and recurring in nature, necessary for the fair presentation of the results of operations and financial position. Certain prior period amounts have been reclassified on a basis consistent with the 1997 presentation. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect: 1) the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, and 2) the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. It is suggested that these Consolidated Financial Statements be read in conjunction with the Consolidated Financial Statements and the notes thereto included in the Company's Form 10-K for the year ended December 31, 1996. The accounting and financial policies relative to the following items have been described in those notes and have been omitted herein because they have not changed materially through the date of this report: Summary of significant accounting policies Leases Utility accounts receivable (other than discussed in Note 4) Income taxes Benefit plans Common, preferred and preference stock Debt (other than discussed in Note 6) Estimated fair value of financial instruments (other than discussed in Note 5) Derivative financial instruments Commitments and contingencies (other than discussed in Note 7) Jointly-owned electric utility plant Segments of business (2) PROPOSED MERGER OF THE COMPANY: On November 10, 1995, Industries, WPL Holdings, Inc. (WPLH) and Interstate Power Company (IPC) entered into an Agreement and Plan of Merger, as amended (Merger Agreement). At the 1996 annual meetings, the shareowners of all three companies approved the Merger Agreement. The merger is still subject to approval by several federal and state regulatory agencies. See Management's Discussion and Analysis of Financial Condition and Results of Operations for a further discussion. (3) RATE MATTERS: (a) Electric Price Announcements - Utilities and its Iowa-based proposed merger partner, IPC, announced in 1996 their intentions to hold retail electric prices to their current levels until at least January 1, 2000. The companies made the proposal as part of their testimony in the merger-related application filed with the Iowa Utilities Board (IUB). The proposal excludes price changes due to government-mandated programs, such as energy efficiency cost recovery, or unforeseen dramatic changes in operations. Utilities, Wisconsin Power & Light Company (WP&L) and IPC also proposed to freeze their wholesale electric prices for four years from the effective date of the merger as part of their merger filing with the Federal Energy Regulatory Commission (FERC). The Company does not expect the merger-related electric price proposals to have a material adverse effect on its financial position or results of operations. (b) Energy Efficiency Cost Recovery - Until recently, IUB rules mandated Utilities to spend 2% of electric and 1.5% of gas gross retail operating revenues for energy efficiency programs. Under provisions of the IUB rules, Utilities is currently recovering the energy efficiency costs incurred through 1993 for such programs, including its direct expenditures, carrying costs, a return on its expenditures and a reward. These costs are being recovered over a four-year period and the recovery began on June 1, 1995. In December 1996, under provisions of the IUB rules, the Company filed for recovery of the costs relating to its 1994 and 1995 programs. Utilities' proposed recovery was for approximately $53 million ($42 million electric and $11 million gas) and was composed of $34 million for direct expenditures and carrying costs, $10 million for a return on the expenditures over the recovery period and $9 million for a reward based on a sharing of the benefits of such programs. The Company expects to receive the final order in the proceeding in June 1997 with recovery of the allowed costs to commence in the third quarter of 1997. Iowa statutory changes enacted in 1996 have eliminated: 1) the 2% and 1.5% spending requirements described above in favor of IUB-determined energy savings targets, 2) the delay in recovery of energy efficiency costs by allowing recovery which is concurrent with spending and 3) the recovery of a sharing reward. The IUB commenced a rulemaking in January 1997 to implement the statutory change and a final order in this proceeding was issued in April 1997. The new rules provide that the Company will begin to recover its 1996 expenditures, and the 1997 expenditures incurred at such time, during the summer of 1997 over a time period yet to be determined. The Company would also begin concurrent recovery of its prospective expenditures at such time. The implementation of these changes will gradually eliminate the regulatory asset which exists under the current rate making mechanism as these costs are recovered. The Company has the following amounts of energy efficiency costs included in regulatory assets on its Consolidated Balance Sheets as follows (in thousands): March 31, December 31, 1997 1996 Costs incurred through 1993 $ 10,934 $ 12,834 Costs incurred in 1994-1995 33,612 33,161 Costs incurred from 1/1/96 - 3/31/97 18,651 15,087 $ 63,197 $ 61,082 The above amounts include the direct expenditures and carrying costs incurred by the Company but do not include any amounts for a return on its expenditures over the recovery period or for a reward. (4) UTILITY ACCOUNTS RECEIVABLE: Utilities has entered into an agreement, which expires in 1999, with a financial institution to sell, with limited recourse, an undivided fractional interest of up to $65 million in its pool of utility accounts receivable. At March 31, 1997, $65 million was sold under the agreement. SFAS 125, issued by the FASB in 1996 and effective for 1997, provides accounting and reporting standards for transfers and servicing of financial assets and extinguishment of liabilities. The accounting for Utilities' sale of accounts receivable agreement is impacted by this standard. As a result, the agreement was modified in the first quarter of 1997 to comply with the SFAS 125 requirements and thus the accounting and reporting for the sale of Utilities' receivables remains unchanged. (5) INVESTMENTS: (a) Foreign Entities - At March 31, 1997, the Company had $45.1 million of investments in foreign entities on its Consolidated Balance Sheet that included 1) investments in two New Zealand electric distribution entities, 2) a loan to a New Zealand company, 3) an investment in a cogeneration facility in China, and 4) an investment in an international venture capital fund. The Company accounts for the China investment under the equity method and the other investments under the cost method. The geographic concentration of the Company's investments in foreign entities at March 31, 1997, included investments of approximately $31.0 million in New Zealand, $13.7 million in China and $0.4 million in other countries. (b) McLeod, Inc. (McLeod) - At March 31, 1997, the Company had a $20.0 million investment in Class A common stock of McLeod and a $9.2 million investment in Class B common stock as well as vested options that, if exercised, would represent an additional investment of approximately $2.3 million. McLeod provides local, long-distance and other telecommunications services. McLeod completed an Initial Public Offering (IPO) of its Class A common stock in June 1996 and a secondary offering in November 1996. As of March 31, 1997, the Company was the beneficial owner of approximately 10.6 million total shares on a fully diluted basis. Class B shares are convertible at the option of the Company into Class A shares at any time on a one-for-one basis. The rights of McLeod Class A common stock and Class B common stock are substantially identical except that Class A common stock has 1 vote per share and Class B common stock has 0.40 vote per share. The Company currently accounts for this investment under the cost method. The Company has entered into an agreement with McLeod which provides that for two years commencing on June 10, 1996, the Company cannot sell or otherwise dispose of any of its securities of McLeod without the consent of the McLeod Board of Directors. This contractual sale restriction results in restricted stock under the provisions of Statement of Financial Accounting Standards No. 115 (SFAS No. 115), Accounting for Certain Investments in Debt and Equity Securities, until such time as the restrictions lapse and such shares became qualified for sale within a one year period. As a result, the Company currently carries this investment at cost. The closing price of the McLeod Class A common stock on March 31, 1997, on the Nasdaq National Market, was $17.75 per share. The current market value of the shares the Company beneficially owns (approximately 10.6 million shares) is impacted by, among other things, the fact that the shares cannot be sold for a period of time. It is not possible to estimate what the market value of the shares will be at the point in time such sale restrictions are lifted. In addition, any gain upon an eventual sale of this investment would likely be subject to a tax. The estimated fair value of the McLeod investment at March 31, 1997, based upon the closing price on March 31 of $17.75, was $185 million. Under the provisions of SFAS No. 115, the carrying value of the McLeod investment will be adjusted to estimated fair value at the time such shares become qualified for sale within a one year period; this will occur on June 10, 1997, which is one year before the contractual restrictions on sale are lifted. At that time, the adjustment to reflect the estimated fair value of this investment will be reflected as an increase in the investment carrying value with the unrealized gain reported as a net of tax amount in other common shareholders' equity until realized (i.e., until the shares are sold by the Company). (6) DEBT: (a) Long-Term Debt - In the second quarter of 1997, Utilities issued $55 million of Collateral Trust Bonds, 6.875%, due 2007. Holders thereof may elect to have their Collateral Trust Bonds redeemed, in whole but not in part, on May 1, 2002, at 100% of the principal amount thereof, plus accrued interest. The proceeds from the Collateral Trust Bonds were used to refinance $15 million of Series L, 7.875% First Mortgage Bonds, $30 million of Series M, 7.625% First Mortgage Bonds and $10 million of 7.375% First Mortgage Bonds. Diversified has a variable rate credit facility that extends through November 20, 1999, with two one-year extensions potentially available to Diversified. The unborrowed portion of the agreement is also used to support Diversified's commercial paper program. A combined maximum of $300 million of borrowings under the agreement and commercial paper program may be outstanding at any one time. Interest rates and maturities are set at the time of borrowing for direct borrowings under the agreement and for issuances of commercial paper. The interest rate options are based upon quoted market rates and the maturities are less than one year. At March 31, 1997, $28 million was borrowed under this facility, with interest rates ranging from 5.75% to 5.81%, maturing in the second quarter of 1997. Diversified had $149.8 million of commercial paper outstanding at March 31, 1997, with interest rates ranging from 5.47% to 5.56% and maturity dates in the second quarter of 1997. Diversified intends to continue borrowing under the renewal options of the facility and no conditions exist at March 31, 1997, that would prevent such borrowings. Accordingly, this debt is classified as long- term in the Consolidated Balance Sheets. (b) Short-Term Debt - At March 31, 1997, the Company had bank lines of credit aggregating $146.1 million. Utilities was using $126 million to support commercial paper (weighted average interest rate of 5.38%) and $11.1 million to support certain pollution control obligations. Commitment fees are paid to maintain these lines and there are no conditions which restrict the unused lines of credit. In addition to the above, Utilities has an uncommitted credit facility with a financial institution whereby it can borrow up to $40 million. Rates are set at the time of borrowing and no fees are paid to maintain this facility. At March 31, 1997, there were no borrowings outstanding under this facility. (7) CONTINGENCIES: (a) Environmental Liabilities - The Company has recorded environmental liabilities of approximately $53 million in its Consolidated Balance Sheets at March 31, 1997. The Company's significant environmental liabilities are discussed below. Former Manufactured Gas Plant (FMGP) Sites Utilities has been named as a Potentially Responsible Party (PRP) by various federal and state environmental agencies for 28 FMGP sites, but believes it is not responsible for two of these sites based on extensive reviews of the ownership records and historical information available for the two sites. Utilities has notified the appropriate regulatory agency that it believes it does not have any responsibility as relates to these two sites, but no response has been received from the agency on this issue. Utilities is also aware of six other sites that it may have owned or operated in the past and for which, as a result, it may be designated as a PRP in the future in the event that environmental concerns arise at these sites. Utilities is working pursuant to the requirements of the various agencies to investigate, mitigate, prevent and remediate, where necessary, damage to property, including damage to natural resources, at and around the sites in order to protect public health and the environment. Utilities believes it has completed the remediation of ten sites although it is in the process of obtaining final approval from the applicable environmental agencies on this issue for each site. Utilities is in various stages of the investigation and/or remediation processes for the remaining 16 sites and estimates the range of additional costs to be incurred for investigation, remediation and monitoring of the sites to be approximately $23 million to $54 million. Utilities has recorded environmental liabilities related to the FMGP sites of approximately $35 million (including $4.7 million as current liabilities) at March 31, 1997. These amounts are based upon Utilities' best current estimate of the amount to be incurred for investigation, remediation and monitoring costs for those sites where the investigation process has been or is substantially completed, and the minimum of the estimated cost range for those sites where the investigation is in its earlier stages. It is possible that future cost estimates will be greater than the current estimates as the investigation process proceeds and as additional facts become known. Regulatory assets of approximately $35 million, which reflect the future recovery that is being provided through Utilities' rates, have been recorded in the Consolidated Balance Sheets. Considering the current rate treatment allowed by the IUB, management believes that the clean-up costs incurred by Utilities for these FMGP sites will not have a material adverse effect on its financial position or results of operations. In April 1996, Utilities filed a lawsuit against certain of its insurance carriers seeking reimbursement for investigation, mitigation, prevention, remediation and monitoring costs associated with the FMGP sites. Settlement discussions are proceeding between Utilities and its insurance carriers regarding the recovery of these FMGP-related costs. Settlement has been reached with four carriers and an agreement in principle has been reached with two other carriers thus far. Amounts received from insurance carriers are being deferred pending a determination of the regulatory treatment of such recoveries. National Energy Policy Act of 1992 The National Energy Policy Act of 1992 requires owners of nuclear power plants to pay a special assessment into a "Uranium Enrichment Decontamination and Decommissioning Fund." The assessment is based upon prior nuclear fuel purchases and, for the Duane Arnold Energy Center (DAEC), averages $1.4 million annually through 2007, of which Utilities' 70% share is $1.0 million. Utilities is recovering the costs associated with this assessment through its electric fuel adjustment clauses over the period the costs are assessed. Utilities' 70% share of the future assessment, $9.9 million payable through 2007, has been recorded as a liability in the Consolidated Balance Sheets, including $0.9 million included in "Current liabilities - Environmental liabilities," with a related regulatory asset for the unrecovered amount. Oil and Gas Properties Dismantlement and Abandonment Costs Whiting Petroleum Corporation (Whiting), a wholly owned subsidiary under Diversified, is responsible for certain dismantlement and abandonment costs related to various off-shore oil and gas properties, the most significant of which is located off the coast of California. The Company estimates the total costs for these properties to be approximately $16 million and the expenditures are not expected to be incurred for approximately five years. Whiting accrues these costs as reserves are extracted and such costs are included in "Depreciation and amortization" in the Consolidated Statements of Income, resulting in a liability of $7.8 million at March 31, 1997, in the Consolidated Balance Sheets. (b) Air Quality Issues - The Clean Air Act Amendments of 1990 (Act) requires emission reductions of sulfur dioxide (SO2) and nitrogen oxides (NOx) to achieve reductions of atmospheric chemicals believed to cause acid rain. The provisions of the Act are being implemented in two phases; the Phase I requirements have been met and the Phase II requirements affect eleven other fossil units beginning in the year 2000. Utilities expects to meet the requirements of Phase II by switching to lower sulfur fuels, capital expenditures primarily related to fuel burning equipment and boiler modifications, and the possible purchase of SO2 allowances. Utilities estimates capital expenditures at approximately $12.9 million, including $0.6 million in 1997, in order to meet the acid rain requirements of the Act. The acid rain program under the Act also governs SO2 allowances. An allowance is defined as an authorization for an owner to emit one ton of SO2 into the atmosphere. Currently, Utilities receives a sufficient number of allowances annually to offset its emissions of SO2 from its Phase I units. It is anticipated that in the year 2000, Utilities may have an insufficient number of allowances annually to offset its estimated emissions and may have to purchase additional allowances, or make modifications to the plants or limit operations to reduce emissions. Utilities is reviewing its options to ensure that it will have sufficient allowances to offset its emissions in the future. Utilities believes that the potential cost of ensuring sufficient allowances will not have a material adverse effect on its financial position or results of operations. The Act and other federal laws also require the United States Environmental Protection Agency (EPA) to study and regulate, if necessary, additional issues that potentially affect the electric utility industry, including emissions relating to NOx, ozone transport, mercury and particulate control; toxic release inventories and modifications to the PCB rules. In December 1996, the EPA issued proposed rules that would tighten the National Ambient Air Quality Standards (NAAQS) for ozone and particulate matter emissions. Also in the fourth quarter of 1996, the EPA announced that it would issue a notice in March 1997 requiring the 37 states in the Ozone Transport Assessment Group (OTAG), which includes Iowa, to implement further controls on NOx. These proposals could result in the Company having to incur additional capital expenditures to further reduce its emissions of NOx, ozone and particulate matter. However, the March 1997 notice has not yet been issued and it now appears that Iowa may be one of several states removed from the OTAG process. The current developments in this process make the impacts of these potential regulations too speculative to quantify. In 1995, the EPA published the Sulfur Dioxide Network Design Review for Cedar Rapids, Iowa, which, based on the EPA's assumptions and worst- case modeling method suggests that the Cedar Rapids area could be classified as "nonattainment" for the NAAQS established for SO2. The worst-case modeling study suggested that two of Utilities' generating facilities contribute to the modeled exceedences and recommended that additional monitors be located near Utilities' sources to assess actual ambient air quality. As a result of exceedences at a relocated monitor, the EPA issued a letter in March 1997 to the Iowa Governor's Office directing the state to develop a plan of action within 120 days. The Governor of Iowa has since issued a letter to the EPA stating that a plan of action will be in place with local industry to avoid the area being declared nonattainment. In this regard, Utilities is entering into a Consent Agreement with the Iowa Department of Natural Resources. The intent of this agreement, as currently proposed, is to develop a three-year plan for a process to explore and implement options to modify one of Utilities fossil generating facilities to reduce SO2 emissions. In addition, Utilities is proposing to resolve the remainder of EPA's nonattainment concerns by modifying the current stacks or installing a new stack at the other generating facility contributing to the modeled exceedences, at a potential aggregate capital cost of up to $4.5 million over the next two years. Pursuant to a routine internal review of operations, Utilities determined that certain changes undertaken during the previous three years at one of its power plants may have required a federal Prevention of Significant Deterioration (PSD) permit. Utilities initiated discussions with its regulators on the matter, resulting in the submittal of a PSD permit application in February 1997. Utilities may be required to accept operational limits or to install additional controls and may be subject to liability for not having obtained the permit previously; however, Utilities believes that any likely actions resulting from this matter will not have a material adverse effect on its financial position or results of operations. IES UTILITIES INC. CONSOLIDATED BALANCE SHEETS March 31, 1997 December 31, ASSETS (in thousands) (Unaudited) 1996 Property, plant and equipment: Utility - Plant in service - Electric $ 2,015,838 $ 2,007,839 Gas 176,439 175,472 Other 132,421 126,850 2,324,698 2,310,161 Less - Accumulated depreciation 1,054,799 1,030,390 1,269,899 1,279,771 Leased nuclear fuel, net of amortization 31,468 34,725 Construction work in progress 48,726 43,719 1,350,093 1,358,215 Other, net of accumulated depreciation and amortization of $1,518 and $1,438, respectively 5,791 5,872 1,355,884 1,364,087 Current assets: Cash and temporary cash investments 21,833 11,608 Accounts receivable - Customer, less allowance for doubtful accounts of $623 and $546, respectively 25,049 22,461 Other 7,990 11,270 Income tax refunds receivable 2,117 2,664 Production fuel, at average cost 12,042 13,323 Materials and supplies, at average cost 22,888 21,716 Adjustment clause balances 0 10,752 Regulatory assets 32,067 26,539 Prepayments and other 13,558 18,705 137,544 139,038 Investments: Nuclear decommissioning trust funds 61,516 59,325 Cash surrender value of life insurance policies 4,457 4,281 Other 88 313 66,061 63,919 Other assets: Regulatory assets 196,096 201,129 Deferred charges and other 10,808 10,437 206,904 211,566 $ 1,766,393 $ 1,778,610 IES UTILITIES INC. CONSOLIDATED BALANCE SHEETS (CONTINUED) March 31, CAPITALIZATION AND LIABILITIES 1997 December 31, (in thousands, except share amounts) (Unaudited) 1996 Capitalization: Common stock - par value $2.50 per share - authorized 24,000,000 shares; 13,370,788 shares outstanding $ 33,427 $ 33,427 Paid-in surplus 279,042 279,042 Retained earnings 228,959 231,337 Total common equity 541,428 543,806 Cumulative preferred stock - par value $50 per share - authorized 466,406 shares; 366,406 shares outstanding 18,320 18,320 Long-term debt (excluding current portion) 462,389 517,334 1,022,137 1,079,460 Current liabilities: Short-term borrowings 126,000 135,000 Capital lease obligations 14,047 15,125 Maturities and sinking funds 63,140 8,140 Accounts payable 48,598 76,287 Accrued interest 10,886 8,839 Accrued taxes 68,620 40,953 Accumulated refueling outage provision 3,002 1,316 Adjustment clause balances 3,759 0 Environmental liabilities 5,517 5,517 Other 15,074 17,114 358,643 308,291 Long-term liabilities: Pension and other benefit obligations 29,383 25,826 Capital lease obligations 17,421 19,600 Environmental liabilities 39,565 40,299 Other 17,402 14,030 103,771 99,755 Deferred credits: Accumulated deferred income taxes 248,030 256,634 Accumulated deferred investment tax credits 33,812 34,470 281,842 291,104 Commitments and contingencies (Note 7) $ 1,766,393 $ 1,778,610 The accompanying Notes to Consolidated Financial Statements are an integral part of these statements. IES UTILITIES INC. CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) For the Three For the Twelve Months Ended Months Ended March 31 March 31 1997 1996 1997 1996 (in thousands) Operating revenues: Electric $ 137,286 $ 125,368 $ 586,191 $ 569,262 Gas 81,428 69,241 173,051 153,358 Other 7,684 4,159 23,367 13,135 226,398 198,768 782,609 735,755 Operating expenses: Fuel for production 29,881 20,292 94,168 97,105 Purchased power 18,673 14,469 92,553 65,029 Gas purchased for resale 60,791 47,369 117,298 100,434 Other operating expenses 36,296 38,358 147,939 149,196 Maintenance 12,806 9,992 48,684 41,899 Depreciation and amortization 23,470 22,024 86,421 80,820 Taxes other than income taxes 11,893 12,060 43,436 44,699 193,810 164,564 630,499 579,182 Operating income 32,588 34,204 152,110 156,573 Interest expense and other: Interest expense 12,306 10,893 45,128 44,895 Allowance for funds used during construction -394 -690 -1,807 -2,999 Miscellaneous, net -420 -963 5,835 -117 11,492 9,240 49,156 41,779 Income before income taxes 21,096 24,964 102,954 114,794 Federal and state income taxes: Current 17,082 13,361 39,051 48,812 Deferred -7,179 -1,864 5,093 1,409 Amortization of investment tax credits -658 -661 -2,642 -2,674 9,245 10,836 41,502 47,547 Net income 11,851 14,128 61,452 67,247 Preferred dividend requirements 229 229 914 914 Net income available for common stock $ 11,622 $ 13,899 $ 60,538 $ 66,333 The accompanying Notes to Consolidated Financial Statements are an integral part of these statements. IES UTILITIES INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) For the Three For the Twelve Months Ended Months Ended March 31 March 31 1997 1996 1997 1996 (in thousands) Cash flows from operating activities: Net income $ 11,851 $ 14,128 $ 61,452 $ 67,247 Adjustments to reconcile net income to net cash flows from operating activities - Depreciation and amortization 23,470 22,024 86,421 80,820 Amortization of principal under capital lease obligations 3,369 4,624 15,237 17,781 Deferred taxes and investment tax credits -7,837 -2,525 2,451 -1,265 Refueling outage provision 1,686 2,546 -7,234 3,569 Amortization of other assets 2,952 2,913 9,832 9,247 Other 280 0 545 447 Other changes in assets and liabilities - Accounts receivable 692 -7,459 -5,049 -17,302 Sale of utility accounts receivable 0 0 7,000 -6,000 Production fuel, materials and supplies 894 902 644 2,612 Accounts payable -25,211 -10,296 -2,033 -10,451 Accrued taxes 28,214 17,070 -90 16,638 Provision for rate refunds 0 166 -272 -7,728 Adjustment clause balances 14,511 3,387 -2,776 3,733 Gas in storage 5,470 7,744 -2,825 2,798 Other 5,266 1,506 11,047 -6,006 Net cash flows from operating activities 65,607 56,730 174,350 156,140 Cash flows from financing activities: Dividends declared on common stock -14,000 -10,000 -48,000 -40,000 Dividends declared on preferred stock -229 -229 -914 -914 Proceeds from issuance of long-term debt 0 0 60,000 50,000 Reductions in long-term debt 0 0 -15,140 -50,140 Net change in short-term borrowings -9,000 -14,647 30,759 51,697 Principal payments under capital lease obligations -2,296 -4,913 -16,491 -15,714 Other 0 -86 -333 -1,910 Net cash flows from financing activities -25,525 -29,875 9,881 -6,981 Cash flows from investing activities: Construction and acquisition expenditures - Utility -19,758 -23,374 -138,765 -121,833 Other -12 -197 -1,083 -2,965 Deferred energy efficiency expenditures -4,014 -3,667 -17,204 -18,159 Nuclear decommissioning trust funds -1,502 -1,502 -6,008 -6,219 Other -4,571 -415 228 -2,039 Net cash flows from investing activities -29,857 -29,155 -162,832 -151,215 Net increase (decrease) in cash and temporary cash investments 10,225 -2,300 21,399 -2,056 Cash and temporary cash investments at beginning of period 11,608 2,734 434 2,490 Cash and temporary cash investments at end of period $ 21,833 $ 434 $ 21,833 $ 434 Supplemental cash flow information: Cash paid during the period for - Interest $ 9,777 $ 8,530 $ 43,318 $ 44,845 Income taxes $ -546 $ 7,138 $ 37,699 $ 33,371 Noncash investing and financing activities - Capital lease obligations incurred $ 112 $ 2,604 $ 11,790 $ 4,405 The accompanying Notes to Consolidated Financial Statements are an integral part of these statements. IES UTILITIES INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Except as modified below, the IES Industries Inc. (Industries) Notes to Consolidated Financial Statements are incorporated by reference insofar as they relate to IES Utilities Inc. (Utilities). Industries' Note 5 does not relate to Utilities and, therefore, is not incorporated by reference. (1) GENERAL: The interim Consolidated Financial Statements have been prepared by IES Utilities Inc. (Utilities) and its consolidated subsidiaries, without audit, pursuant to the rules and regulations of the United States Securities and Exchange Commission (SEC). Utilities' only wholly- owned subsidiary is IES Ventures Inc. (Ventures), which is a holding company for unregulated investments. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE RESULTS OF OPERATIONS AND FINANCIAL CONDITION IES Industries Inc.'s Consolidated Financial Statements include the accounts of IES Industries Inc. (Industries) and its consolidated subsidiaries (collectively the Company). Industries' wholly-owned subsidiaries are IES Utilities Inc. (Utilities) and IES Diversified Inc. (Diversified). The information presented in this management's discussion and analysis addresses the financial statements of Industries and Utilities as presented in this joint filing. Information related to Utilities also relates to Industries' Consolidated Financial Statements. Information related to Diversified does not pertain to the discussion of the financial condition and results of operations of Utilities. The references to various Notes to Consolidated Financial Statements are all to Industries' Notes to Consolidated Financial Statements. COMPETITION Electric energy generation, transmission and distribution, are in a period of fundamental change in the manner in which customers obtain, and energy suppliers provide, energy services. As legislative, regulatory, economic and technological changes occur, electric utilities are faced with increasing pressure to become more competitive. Such competitive pressures could result in loss of customers and an incurrence of stranded costs (i.e., the cost of assets rendered unrecoverable as the result of competitive pricing). To the extent stranded costs cannot be recovered from customers, they would be borne by security holders. The National Energy Policy Act of 1992 addresses several matters designed to promote competition in the electric wholesale power generation market. In 1996, the Federal Energy Regulatory Commission (FERC) issued final rules (FERC Orders 888 and 889) requiring electric utilities to open their transmission lines to other wholesale buyers and sellers of electricity. The rules became effective in July 1996. Utilities filed conforming pro-forma open access transmission tariffs with the FERC which became effective in October 1995. In response to FERC Order 888, Utilities filed its final pro-forma tariffs with FERC in July 1996. The non-rate provisions of the tariffs were approved in November 1996. FERC has not yet ruled on the rate provisions of the tariffs. The geographic position of Utilities' transmission system could provide revenue opportunities in the open access environment. Industrial Energy Applications, Inc. (IEA), a wholly-owned subsidiary under Diversified, received approval in the 1995 FERC proceeding to market electric power at market based rates. The Company cannot predict the long-term consequences of these rules on its results of operations or financial condition. FERC does not have jurisdiction over retail distribution, and thus the final FERC rules do not provide for the recovery of stranded costs resulting from retail competition. The various states retain jurisdiction over the question of whether to permit retail competition, the terms of such retail competition and the recovery of any portion of stranded costs that are ultimately determined by FERC and the states to have resulted from retail competition. The Iowa Utilities Board (IUB) initiated a Notice of Inquiry (Docket No. NOI-95-1) in early 1995 on the subject of "Emerging Competition in the Electric Utility Industry" to address all forms of competition in the electric utility industry and to gather information and perspectives on electric competition from all persons or entities with an interest or stake in the issues. In January 1996, the IUB created its own timeline for evaluating industry restructuring in Iowa. Included in the IUB's process was the creation of a 22-member advisory panel, of which Utilities is a member. The IUB conducted public information meetings around the State of Iowa. The Staff's report in this docket was accepted by the IUB, finding, in part, that there is no compelling reason to move quickly into restructuring the electric utility industry in Iowa, based upon the current level of relative prices. However, they will continue the analysis and debate on restructuring and retail competition in Iowa. As part of Utilities' strategy for the emerging and competitive power markets, Utilities, Interstate Power Company (IPC) and Wisconsin Power and Light Company (WP&L) (the utility subsidiary of WPL Holdings, Inc. (WPLH)), and a number of other utilities have proposed the creation of an independent system operator (ISO) for the companies' power transmission grid. The companies would retain ownership and control of the facilities, but the ISO would set rates for access and assure fair treatment for all companies seeking access. The proposal requires approval from state regulators and the FERC. Various other proposals for ISO's have been made by other companies, and Utilities is monitoring all such proposals. Membership in an ISO could become a condition of merger approval by the various regulatory bodies. Utilities is subject to the provisions of Statement of Financial Accounting Standards No. 71, "Accounting for the Effects of Certain Types of Regulation" (SFAS 71). If a portion of Utilities' operations become no longer subject to the provisions of SFAS 71, as a result of competitive restructurings or otherwise, a write-down of related regulatory assets would be required, unless some form of transition cost recovery is established by the appropriate regulatory body which would meet the requirements under generally accepted accounting principles for continued accounting as regulatory assets during such recovery period. In addition, the Company would be required to determine any impairment to other assets and write-down such assets to their fair value. Utilities believes that it still meets the requirements of SFAS 71. The Company cannot predict the long-term consequences of these competitive issues on its results of operations or financial condition. The Company's strategy for dealing with these emerging issues includes seeking growth opportunities, continuing to offer quality customer service, ongoing cost reductions and productivity enhancements, the major objective of which is to allow Utilities to better prepare for a competitive, deregulated electric utility industry. In this connection, Utilities is in the final stages of a significant process improvement program to improve its service levels, reduce its cost structure and become more market-focused and customer oriented. (The Company's continuous improvement efforts, in general, will be an ongoing effort, however). PROPOSED MERGER OF THE COMPANY Industries, WPLH and IPC have entered into an Agreement and Plan of Merger, as amended, dated November 10, 1995, which provides for the combination of all three companies. The new company will be named Interstate Energy Corporation (IEC). WPLH is a holding company headquartered in Madison, Wisconsin, and is the parent company of WP&L and Heartland Development Corporation (HDC). WP&L supplies electric and gas service to approximately 385,000 and 150,000 customers, respectively, in south and central Wisconsin. HDC and its principal subsidiaries are engaged in businesses in three major areas: environmental engineering and consulting, affordable housing and energy services. IPC, an operating public utility headquartered in Dubuque, Iowa, supplies electric and gas service to approximately 165,000 and 49,000 customers, respectively, in northeast Iowa, northwest Illinois and southern Minnesota. The proposed merger, which will be accounted for as a pooling of interests, was approved by the respective shareowners on September 5, 1996. The merger is conditioned on the receipt of approvals of several federal and state agencies. Updates to the status of these approvals are as follows (for additional information regarding the merger please refer to the Company's 1996 Annual Report on Form 10-K): The FERC issued an order on January 15, 1997, finding no substantial market-power concerns with the merger. Some limited issues were set for hearings which began on April 23, 1997 and ended on May 2, 1997. A final decision is expected in the third or fourth quarter of 1997. On May 7, 1997, the Illinois Commerce Commission issued and order approving the proposed merger. On March 24, 1997, the Minnesota Public Utilities Commission issued an order approving the merger without hearings, subject to a number of technical conditions which the parties are willing to meet. Included is a 4-year rate freeze for IEC's Minnesota customers. A hearing regarding the merger is expected to begin July 14, 1997, before the Iowa Utilities Board. On May 7, 1997, WP&L filed testimony with the Public Service Commission of Wisconsin proposing a retail electric, gas and water rate freeze from the date of the merger approval through calendar year 2000. The companies expect to receive all necessary regulatory approvals relating to the merger by the third or fourth quarter of 1997. Refer to Note 3(a) of the Notes to Consolidated Financial Statements for a discussion of merger-related retail and wholesale price proposals that Utilities has announced. RESULTS OF OPERATIONS OF THE COMPANY The following discussion analyzes significant changes in the components of net income and financial condition from the prior periods for the Company. The Company's net income decreased ($1.8) million and ($12.4) million during the three and twelve month periods, respectively. Earnings per average common share decreased ($0.07) and ($0.46) for the respective periods. Utilities' net income available for common stock decreased ($2.3) million and ($5.8) million during the three and twelve month periods, respectively. The impact of weather on Utilities' electric and gas sales contributed significantly to the decrease in earnings for both periods. Weather conditions in the first quarter of 1997 were milder than normal and weather conditions in the first quarter of 1996 were colder than normal. In addition, the twelve month periods were impacted by cooler weather conditions during the summer of 1996 than the summer of 1995. Accordingly, in comparing the three and twelve month periods, the Company estimates that weather impacted earnings by approximately ($0.06) per share and ($0.28) per share, respectively. The decrease in earnings for the twelve month period was also impacted by costs incurred relating to the successful defense of the hostile takeover attempt mounted by MidAmerican Energy Company (MAEC) in the third quarter of 1996 and a higher effective income tax rate. The Company estimates that the cost of the hostile takeover defense reduced earnings for the twelve month period by ($0.15) per share. Increased operating expenses and interest expense also contributed to the earnings decrease for both periods. Increased electric and steam sales to industrial customers at Utilities and increased earnings at the Company's oil and gas subsidiary, Whiting Petroleum Corporation (Whiting), partially offset these items each period. The Company's operating income decreased ($0.9) million and ($3.2) million during the three and twelve month periods, respectively, while Utilities' operating income decreased ($1.6) million and ($4.5) million during the same periods. Electric Operations Electric margins and Kwh sales for Utilities for the three months ended March 31 were as follows: Revenues and Costs Kwhs Sold (In thousands) (In thousands) 1997 1996 1997 1996 Residential and rural $ 52,816 $ 49,852 691,010 709,412 General service 23,820 22,276 310,588 314,491 Large general service 51,100 41,598 1,411,096 1,275,964 Sales for resale and other 7,677 6,961 143,143 149,979 Total, excluding off- system sales 135,413 120,687 2,555,837 2,449,846 Off-system sales 1,873 4,681 46,895 256,557 Total 137,286 125,368 2,602,732 2,706,403 Fuel for production (excluding steam) 24,893 18,163 Purchased power 18,673 14,469 Margin $ 93,720 $ 92,736 The electric margin increased $1.0 million during the three month period primarily due to higher large general service Kwh sales relating to continuing industrial growth in Utilities' service territory. This increase was partially offset by lower Kwh sales to residential and rural and general service customers, largely due to the impact of weather. Under historically normal weather conditions, total Kwh sales (excluding off-system sales) for the three month period would have increased 5.6%, as compared to the actual increase of 4.3%. Electric margins and Kwh sales for Utilities for the twelve months ended March 31 were as follows: Revenues and Costs Kwhs Sold (In thousands) (In thousands) 1997 1996 1997 1996 Residential and rural $ 215,763 $ 219,683 2,615,302 2,720,333 General service 99,741 101,672 1,227,212 1,256,724 Large general service 222,724 204,130 5,635,739 5,350,033 Sales for resale and other 31,281 25,327 580,942 586,996 Total, excluding off- system sales 569,509 550,812 10,059,195 9,914,086 Off-system sales 16,682 18,450 1,021,636 1,084,190 Total 586,191 569,262 11,080,831 10,998,276 Fuel for production (excluding steam) 81,338 90,680 Purchased power 92,553 65,029 Margin $ 412,300 $ 413,553 The electric margin decreased ($1.3) million during the twelve month period primarily due to lower Kwh sales to residential and rural and general service customers and a true-up adjustment to unbilled sales recorded in 1995. In addition to the weather conditions for the three month period mentioned previously, the twelve month period Kwh sales for residential and rural and general service customers were also impacted by cooler weather conditions during the summer of 1996 as compared to the summer of 1995. These decreases were partially offset by continued large general service Kwh sales growth and lower purchased power capacity costs. Under historically normal weather conditions, total sales (excluding off-system sales) for the twelve month period would have increased 4.1%, as compared to the actual increase of 1.5%. Refer to Notes 3(a) and 3(b) of the Notes to Consolidated Financial Statements for a discussion of merger-related retail and wholesale electric price proposals that Utilities has announced and the energy efficiency cost recoveries, respectively. Utilities' electric tariffs include energy adjustment clauses (EAC) that are designed to currently recover the costs of fuel and the energy portion of purchased power billings. Gas Operations Gas margins and dekatherm (Dth) sales for Utilities and IEA for the three months ended March 31 were as follows: Revenues and Costs Dths Sold (In thousands) (In thousands) 1997 1996 1997 1996 Utilities - Residential $ 50,587 $ 44,428 7,638 8,511 Commercial 25,575 21,186 4,333 4,762 Industrial 4,240 2,807 835 841 Transportation and other 1,026 820 2,764 2,826 Total Utilities 81,428 69,241 15,570 16,940 IEA 2,678 20,783 975 8,487 Total 84,106 90,024 16,545 25,427 Gas purchased for resale 64,498 67,437 Margin $ 19,608 $ 22,587 Total gas margin decreased ($3.0) million during the three month period due to lower gas margins at both Utilities and IEA. The decrease in Utilities' margin was primarily due to lower Dth sales, resulting from the milder weather conditions in 1997. Under historically normal weather conditions, Utilities' gas sales and transported volumes would have decreased (2.8%) during the three month period, as compared to the actual decrease of (8.1%). IEA's reported Dth gas sales were significantly lower as a result of IEA contributing substantially all of its gas marketing business to a joint venture, effective January 1, 1997, in exchange for a partial interest in the joint venture. The investment in the joint venture is accounted for under the equity accounting method and IEA's allocated portion of gas revenues and gas expenses resulting from the joint venture are recorded in "Miscellaneous, net" on Industries' Consolidated Statements of Income. Fluctuations in gas prices and the competitiveness of the gas marketing business also contributed to the lower margin at IEA. Gas margins and Dth sales for Utilities and IEA for the twelve months ended March 31 were as follows: Revenues and Costs Dths Sold (In thousands) (In thousands) 1997 1996 1997 1996 Utilities - Residential $ 103,866 $ 95,569 16,807 17,595 Commercial 51,356 45,098 9,894 10,168 Industrial 13,689 9,195 3,790 3,076 Transportation and other 4,140 3,496 10,279 10,908 Total Utilities 173,051 153,358 40,770 41,747 IEA 95,009 62,023 35,542 33,284 Total 268,060 215,381 76,312 75,031 Gas purchased for resale 214,412 159,864 Margin $ 53,648 $ 55,517 Total gas margin decreased ($1.9) million during the twelve month period due to a lower margin at IEA which was partially offset by an increased margin at Utilities. While IEA's Dth gas sales increased during this time period, their margins actually decreased due to fluctuations in gas prices, the competitiveness of the gas marketing business and the formation of the joint venture, as discussed above. The increase in Utilities' margin was primarily due to the impact of an annual increase of $6.3 million in Utilities' gas rates that was implemented in the fourth quarter of 1995. This was partially offset by lower Dth sales, largely due to the milder weather conditions. Under historically normal weather conditions, Utilities' gas sales and transported volumes would have decreased (1.0%) during the twelve month period, as compared to the actual decrease of (2.3%). Utilities' gas tariffs include purchased gas adjustment clauses (PGA) that are designed to currently recover the cost of gas sold. Other Revenues The Company's other revenues increased $8.5 million and $31.0 million during the three and twelve month periods, respectively ($3.5 million and $10.2 million at Utilities). The increase for both periods was primarily because of increased steam revenues at Utilities, increased operating activities at IEA and increased oil and gas revenues at Whiting. Steam revenues at Utilities increased during both periods due to an increase in volumes sold resulting from the addition of new industrial customers. The increase in Whiting revenues during both periods was primarily due to increases in oil and gas prices. Operating Expenses The Company's other operating expenses increased $0.4 million and $9.4 million during the three and twelve month periods, respectively (($2.1) million and ($1.3) million at Utilities). The increase for both periods was primarily due to costs relating to the increased operating activities at IEA and higher information technology costs. These increases were partially offset by decreases in costs relating to the Company's process improvement programs and decreased operating expenses at the Duane Arnold Energy Center (DAEC), Utilities' nuclear generating facility. Lower operating expenses at Whiting also partially offset the three month increase. Increases in costs relating to the pending merger and higher operating expenses at Whiting also contributed to the twelve month increase. The Company's maintenance expenses increased $2.7 million and $7.0 million during the three and twelve month periods, respectively ($2.8 million and $6.8 million at Utilities). The increase for both periods was primarily due to increased maintenance activities at Utilities' fossil-fueled generating stations. The twelve month increase was partially offset by lower maintenance expenses at the DAEC. The Company's depreciation and amortization expense increased $1.4 million and $8.9 million during the three and twelve month periods, respectively ($1.4 million and $5.6 million at Utilities), primarily because of increases in utility plant in service. The twelve month increase was also due to increases in amortization costs relating to the future dismantlement and abandonment of Whiting's offshore oil and gas properties. Depreciation and amortization expenses for both periods include a provision for decommissioning the DAEC, which is collected through rates. The current annual recovery level is $6.0 million. During the first quarter of 1996, the Financial Accounting Standards Board (FASB) issued an Exposure Draft on Accounting for Liabilities Related to Closure and Removal of Long-Lived Assets which deals with, among other issues, the accounting for decommissioning costs. If current electric utility industry accounting practices for such decommissioning are changed: (1) annual provisions for decommissioning could increase and (2) the estimated cost for decommissioning could be recorded as a liability, rather than as accumulated depreciation, with recognition of an increase in the recorded amount of the related DAEC plant. If such changes are required, Utilities believes that there would not be an adverse effect on its financial position or results of operations based on current rate making practices. Interest Expense and Other The Company's interest expense increased $1.9 million and $5.1 million during the three and twelve month periods, respectively ($1.4 million and $0.2 million at Utilities), primarily because of increases in the average amount of short-term debt outstanding at Utilities, the average amount of borrowings under Diversified's credit facility and a higher amount of long-term debt outstanding at Utilities. The twelve month increase was partially offset by lower average interest rates, rate refund interest recorded in 1995 at Utilities and the effects of an interest rate swap agreement at Diversified. Miscellaneous, net for the Company reflects a comparative decrease in income of ($8.3) million during the twelve month period (($6.0) million at Utilities), primarily due to approximately $7.8 million in costs incurred relating to the successful defense of the hostile takeover attempt mounted by MAEC and certain property write-downs at Diversified. Dividends received from the two New Zealand entities in which the company has equity investments partially offset these items. Income Taxes The Company's income tax expense decreased ($2.8) million and ($5.4) million during the three and twelve month periods, respectively (($1.6) million and ($6.0) million at Utilities), primarily due to lower pretax income. Also contributing to the decrease for the three month period was a reserve recorded in the first quarter of 1996 related to an Internal Revenue Service (IRS) audit for tax years 1991- 1993. The decrease for both periods was partially offset by the incurrence of certain merger-related expenses which are not tax deductible. The decrease for the twelve month period was partially offset due to the recording of additional tax expense for the settlement of the IRS audit in the fourth quarter of 1996. LIQUIDITY AND CAPITAL RESOURCES The Company's capital requirements are primarily attributable to Utilities' construction programs, its debt maturities and the level of Diversified's business opportunities. The Company's pretax ratio of times interest earned was 2.84 and 3.37 for the twelve months ended March 31, 1997 and March 31, 1996, respectively. Cash flows from operating activities for the twelve months ended March 31, 1997 and March 31, 1996 were $198 million and $190 million, respectively. The Company anticipates that future capital requirements will be met by cash generated from operations and external financing. The level of cash generated from operations is partially dependent upon economic conditions, legislative activities, environmental matters and timely regulatory recovery of Utilities' costs. See Notes 3 and 7 of the Notes to Consolidated Financial Statements as well as the Company's 1996 Annual Report on Form 10-K. Access to the long-term and short-term capital and credit markets, and costs of external financing, are dependent on the Company's creditworthiness. The Company's debt ratings are as follows: Moody's Standard & Poor's Utilities - Long-term debt A2 A - Commercial paper P1 A1 Diversified - Commercial paper P2 A2 The Company's liquidity and capital resources will be affected by environmental, regulatory and competitive issues, including the ultimate disposition of remediation issues surrounding the Company's environmental liabilities and the Clean Air Act as amended, as discussed in Note 7 of the Notes to Consolidated Financial Statements and the Company's 1996 Annual Report on Form 10-K, and emerging competition in the electric utility industry as discussed in the Competition section. Consistent with rate making principles of the IUB, management believes that the costs incurred for the above matters will not have a material adverse effect on the financial position or results of operations of the Company. At March 31, 1997, Utilities had approximately $63 million of energy efficiency program costs recorded as regulatory assets. See Note 3(b) of the Notes to Consolidated Financial Statements for a discussion of the timing of the filings for the recovery of these costs under IUB rules and Iowa statutory changes recently enacted relating to these programs. At March 31, 1997, the Company had a $20.0 million investment in Class A common stock of McLeod, Inc. (McLeod) and a $9.2 million investment in Class B common stock as well as vested options that, if exercised, would represent an additional investment of approximately $2.3 million. McLeod provides local, long-distance and other telecommunications services. See Note 5(b) of the Notes to Consolidated Financial Statements for further information on the Company's investment in McLeod. The Company has financial guarantees amounting to $23.0 million outstanding at March 31, 1997, which are not reflected in the consolidated financial statements. Such guarantees are generally issued to support third-party borrowing arrangements and similar transactions. The Company believes that any possible cash payments associated with these agreements will not have a material adverse effect on the financial position or results of operations of the Company. At March 31, 1997, the Company had approximately $45 million of investments in foreign entities (see Note 5(a) of the Notes to Consolidated Financial Statements for a further discussion). In addition, the Company also continues to explore other international investment opportunities. Such investments may carry a higher level of risk than the Company's traditional utility investments or Diversified's domestic investments. Such risks could include foreign government actions, foreign economic and currency risks and others. The Company may also incur business development expenses for potential projects pursued by the Company that may never materialize. The Company is striving to select international investments where these risks are both understood and minimized. The Resale Power Group of Iowa (RPGI), consisting of virtually all of Utilities' wholesale customers, has notified Utilities that it will not purchase its power supply from Utilities after December 31, 1998. It is possible that certain RPGI customers will drop out of RPGI in order to remain as Utilities' customers; to-date, two customers have signed contracts to remain with Utilities. All RPGI customers will continue to purchase transmission services from Utilities after December 31, 1998. While the Company cannot determine the outcome of this issue at this time, the result will not have a material adverse effect on its financial position or results of operations given 1) Utilities' wholesale sales only account for approximately 5% of Utilities' total electric sales, excluding off-system sales; 2) Utilities currently has to supplement its generating capability with purchased power to meet its sales load; 3) Utilities' annual electric sales growth rate continues to be strong; and 4) Utilities will continue to realize transmission revenues from such customers. Under provisions of the Merger Agreement, there are restrictions on the amount of common stock and long-term debt the Company can issue pending the merger. The Company does not expect the restrictions to have a material effect on its ability to meet its future capital requirements. CONSTRUCTION AND ACQUISITION PROGRAM The Company's construction and acquisition program anticipates expenditures of approximately $225 million for 1997, of which approximately $147 million represents expenditures at Utilities and approximately $78 million represents expenditures at Diversified. Of the $147 million of Utilities' expenditures, 39% represents expenditures for electric transmission and distribution facilities, 21% represents electric generation expenditures, 21% represents information technology expenditures and 5% represents gas expenditures. The remaining 14% represents miscellaneous electric, steam and general expenditures. Diversified's anticipated expenditures include approximately $75 million for domestic and international energy-related construction and acquisition expenditures. The Company had construction and acquisition expenditures of approximately $33 million for the three months ended March 31, 1997, including approximately $20 million of utility expenditures and $13 million of non-utility expenditures. The Company's levels of construction and acquisition expenditures are projected to be $208 million in 1998, $212 million in 1999, $182 million in 2000 and $198 million in 2001. It is estimated that virtually all of Utilities' construction and acquisition expenditures will be provided by cash from operating activities (after payment of dividends) for the five-year period 1997-2001. Financing plans for Diversified's construction and acquisition program will vary, depending primarily on the level of energy-related acquisitions. Capital expenditure and investment and financing plans are subject to continual review and change. The capital expenditure and investment programs may be revised significantly as a result of many considerations including changes in economic conditions, variations in actual sales and load growth compared to forecasts, requirements of environmental, nuclear and other regulatory authorities, acquisition and business combination opportunities, the availability of alternate energy and purchased power sources, the ability to obtain adequate and timely rate relief, escalations in construction costs and conservation and energy efficiency programs. Under provisions of the Merger Agreement, there are restrictions on the amount of construction and acquisition expenditures the Company can make pending the merger. The Company does not expect the restrictions to have a material effect on its ability to implement its anticipated construction and acquisition program. LONG-TERM FINANCING Other than Utilities' periodic sinking fund requirements, which Utilities intends to meet by pledging additional property, the following long-term debt (excluding the $55 million of First Mortgage Bonds retired prior to maturity in the second quarter of 1997) will mature prior to December 31, 2001: (in millions) Utilities $ 192.2 Diversified's credit facility 177.8 Other subsidiaries' debt 11.1 $ 381.1 The Company intends to refinance the majority of the debt maturities with long-term securities. In the second quarter of 1997, Utilities issued $55 million of Collateral Trust Bonds, 6.875%, due 2007. Holders thereof may elect to have their Collateral Trust Bonds redeemed, in whole but not in part, on May 1, 2002, at 100% of the principal amount thereof, plus accrued interest. The proceeds from the Collateral Trust Bonds were used to refinance $15 million of Series L, 7.875% First Mortgage Bonds, $30 million of Series M, 7.625% First Mortgage Bonds and $10 million of 7.375% First Mortgage Bonds. Utilities has entered into an Indenture of Mortgage and Deed of Trust dated September 1, 1993 (New Mortgage). The New Mortgage provides for, among other things, the issuance of Collateral Trust Bonds upon the basis of First Mortgage Bonds being issued by Utilities. The lien of the New Mortgage is subordinate to the lien of Utilities' first mortgages until such time as all bonds issued under the first mortgages have been retired and such mortgages satisfied. Accordingly, to the extent that Utilities issues Collateral Trust Bonds on the basis of First Mortgage Bonds, it must comply with the requirements for the issuance of First Mortgage Bonds under Utilities' first mortgages. Under the terms of the New Mortgage, Utilities has covenanted not to issue any additional First Mortgage Bonds under its first mortgages except to provide the basis for issuance of Collateral Trust Bonds. The indentures pursuant to which Utilities issues First Mortgage Bonds constitute direct first mortgage liens upon substantially all tangible public utility property and contain covenants which restrict the amount of additional bonds which may be issued. At March 31, 1997, such restrictions would have allowed Utilities to issue at least $241 million of additional First Mortgage Bonds. In order to provide an instrument for the issuance of unsecured subordinated debt securities, Utilities entered into an Indenture dated December 1, 1995 (Subordinated Indenture). The Subordinated Indenture provides for, among other things, the issuance of unsecured subordinated debt securities. Any debt securities issued under the Subordinated Indenture are subordinate to all senior indebtedness of Utilities, including First Mortgage Bonds and Collateral Trust Bonds. Utilities has received authority from the FERC and the Securities and Exchange Commission (SEC) to issue up to $250 million of long-term debt, and has $135 million of remaining authority under the current FERC docket through April 1998, and $85 million of remaining authority under the current SEC shelf registration. Diversified has a variable rate credit facility that extends through November 20, 1999, with two one-year extensions potentially available to Diversified. Refer to Note 6(a) of the Notes to Consolidated Financial Statements for a further discussion of this credit facility. The Articles of Incorporation of Utilities authorize and limit the aggregate amount of additional shares of Cumulative Preference Stock and Cumulative Preferred Stock that may be issued. At March 31, 1997, Utilities could have issued an additional 700,000 shares of Cumulative Preference Stock and 100,000 additional shares of Cumulative Preferred Stock. In addition, Industries had 5,000,000 shares of Cumulative Preferred Stock, no par value, authorized for issuance, none of which were outstanding at March 31, 1997. The Company's capitalization ratios at March 31, 1997 were as follows: Long-term debt 52% Preferred stock 1 Common equity 47 100% The ratios include $55 million of long-term debt due in less than one-year because the Company refinanced the debt with long-term securities in the second quarter of 1997. Under provisions of the Merger Agreement, there are restrictions on the amount of common stock and long-term debt the Company can issue pending the merger. The Company does not expect the restrictions to have a material effect on its ability to meet its future capital requirements. SHORT-TERM FINANCING For interim financing, Utilities is authorized by the FERC to issue, through 1998, up to $200 million of short-term notes. In addition to providing for ongoing working capital needs, this availability of short-term financing provides Utilities flexibility in the issuance of long-term securities. At March 31, 1997, Utilities had outstanding short-term borrowings of $126 million. Utilities has an agreement, which expires in 1999, with a financial institution to sell, with limited recourse, an undivided fractional interest of up to $65 million in its pool of utility accounts receivable. At March 31, 1997, Utilities had sold $65 million under the agreement. At March 31, 1997, the Company had bank lines of credit aggregating $146.1 million. Utilities was using $126 million to support commercial paper (weighted average interest rate of 5.38%) and $11.1 million to support certain pollution control obligations. Commitment fees are paid to maintain these lines and there are no conditions which restrict the unused lines of credit. In addition to the above, Utilities has an uncommitted credit facility with a financial institution whereby it can borrow up to $40 million. Rates are set at the time of borrowing and no fees are paid to maintain this facility. At March 31, 1997, there were no borrowings outstanding under this facility. ENVIRONMENTAL MATTERS Utilities has been named as a Potentially Responsible Party (PRP) by various federal and state environmental agencies for 28 Former Manufactured Gas Plant (FMGP) sites. Utilities has recorded environmental liabilities related to the FMGP sites of approximately $35 million (including $4.7 million as current liabilities) at March 31, 1997. Regulatory assets of approximately $35 million, which reflect the future recovery that is being provided through Utilities' rates, have been recorded in the Consolidated Balance Sheets. Considering the current rate treatment allowed by the IUB, management believes that the clean-up costs incurred by Utilities for these FMGP sites will not have a material adverse effect on its financial position or results of operations. Refer to Note 7(a) of the Notes to Consolidated Financial Statements for a further discussion, including a discussion of a lawsuit filed by Utilities seeking recovery of FMGP-related costs from its insurance carriers. The Clean Air Act Amendments of 1990 (Act) requires emission reductions of sulfur dioxide (SO2) and nitrogen oxides (NOx) to achieve reductions of atmospheric chemicals believed to cause acid rain. The acid rain program under the Act also governs SO2 allowances. The Act and other federal laws also require the United States Environmental Protection Agency (EPA) to study and regulate, if necessary, additional issues that potentially affect the electric utility industry, including emissions relating to NOx, ozone transport, mercury and particulate control; toxic release inventories and modifications to the PCB rules. In 1995, the EPA published the Sulfur Dioxide Network Design Review for Cedar Rapids, Iowa, which, based on the EPA's assumptions and worst- case modeling method suggests that the Cedar Rapids area could be classified as "nonattainment" for the National Ambient Air Quality Standards established for SO2. The worst-case modeling study suggested that two of Utilities' generating facilities contribute to the modeled exceedences. Pursuant to a routine review of operations, Utilities determined that certain changes undertaken during the previous three years at one of its power plants may have required a federal Prevention of Significant Deterioration (PSD) permit. Refer to Note 7(b) of the Notes to Consolidated Financial Statements for a further discussion of the above mentioned air quality issues. The National Energy Policy Act of 1992 requires owners of nuclear power plants to pay a special assessment into a "Uranium Enrichment Decontamination and Decommissioning Fund." Refer to Note 7(a) of the Notes to Consolidated Financial Statements for a further discussion. The Nuclear Waste Policy Act of 1982 assigned responsibility to the U.S. Department of Energy (DOE) to establish a facility for the ultimate disposition of high level waste and spent nuclear fuel and authorized the DOE to enter into contracts with parties for the disposal of such material beginning in January 1998. Utilities entered into such a contract and has made the agreed payments to the Nuclear Waste Fund (NWF) held by the U.S. Treasury, however, Utilities has since been formally notified by the DOE that they anticipate being unable to begin acceptance of spent nuclear fuel by January 31, 1998. Furthermore, the DOE has experienced significant delays in its efforts and material acceptance is now expected to occur no earlier than 2010 with the possibility of further delay being likely. Utilities has been storing spent nuclear fuel on-site since plant operations began in 1974 and has current on-site capability to store spent fuel until 2001. Utilities is aggressively reviewing options for expanding on-site storage and according to their current analysis, construction of an on-site storage facility with dry cask modular capability is the most favorable option. Utilities continues to evaluate these and other courses of action to protect the interests of its customers and its rights under the DOE contract. Utilities is also evaluating legislation proposed to the Congress addressing this issue. In July 1996, the IUB initiated a Notice of Inquiry (NOI) on spent nuclear fuel. In April 1997, IUB staff recommendations were accepted by the IUB and concluded that a state mandated escrowing of utility payments was inappropriate. The IUB also endorsed the feasibility of Utilities' plans for additional spent fuel storage in the state of Iowa. These recommendations are consistent with Utilities' comments in the NOI proceeding. The Low-Level Radioactive Waste Policy Amendments Act of 1985 mandated that each state must take responsibility for the storage of low- level radioactive waste produced within its borders. The State of Iowa has joined the Midwest Interstate Low-Level Radioactive Waste Compact Commission (Compact), which is planning a storage facility to be located in Ohio to store waste generated by the Compact's six member states. At March 31, 1997, Utilities had prepaid costs of approximately $1.1 million to the Compact for the building of such a facility. A Compact disposal facility is anticipated to be in operation in approximately ten years after approval of new enabling legislation by the member states. Such legislation was approved in 1996 by all six states that are members of the Compact. Final approval by the U.S. Congress is now required. On-site storage capability currently exists for low-level radioactive waste expected to be generated until the Compact facility is able to accept waste materials. In addition, the Barnwell, South Carolina disposal facility has reopened for an indefinite time period and Utilities currently intends to ship to this facility the waste it produces as long as the Barnwell site remains open, thereby minimizing the amount of low-level waste stored on-site. Whiting is responsible for certain dismantlement and abandonment costs related to various off-shore oil and gas properties. Refer to Note 7(a) of the Notes to Consolidated Financial Statements for a further discussion. OTHER MATTERS Labor Issues Utilities has six collective bargaining agreements, covering approximately 54% of its workforce. None of the agreements expires in 1997. Financial Derivatives The Company has a policy that financial derivatives are to be used only to mitigate business risks and not for speculative purposes. Derivatives have been used by the Company on a very limited basis. At March 31, 1997, the only material financial derivatives outstanding for the Company were an interest rate swap agreement at Diversified and gas futures contracts at IEA. Accounting Pronouncements SFAS 128, Earnings Per Share, was issued by the FASB in the first quarter of 1997. SFAS 128 deals with, among other issues, the computation and disclosure of earnings per share amounts when a company has stock options, warrants and/or convertible securities outstanding. SFAS 128 is effective for periods ending after December 15, 1997, and is not expected to have a material impact upon adoption. Inflation The Company does not expect the effects of inflation at current levels to have a significant effect on its financial position or results of operations. PART II - OTHER INFORMATION Item 1. Legal Proceedings. On April 30, 1996, Utilities filed suit, IES Utilities Inc. v. Home Ins. Co., et al., No. 4-96-CV-10343 (S.D. Iowa filed Apr. 30, 1996), against various insurers who had sold comprehensive general liability policies to Iowa Southern Utilities Company (ISU) and Iowa Electric Light and Power Company (IE) (Utilities was formed as the result of a merger of ISU and IE). The suit seeks judicial determination of the respective rights of the parties, a judgment that each defendant is obligated under its respective insurance policies to pay in full all sums that Utilities has become or may become obligated to pay in connection with its defense against allegations of liability for property damage at and around Former Manufactured Gas Plant (FMGP) sites, and indemnification for all sums that it has or may become obligated to pay for the investigation, mitigation, prevention, remediation and monitoring of damage to property, including damage to natural resources like groundwater, at and around the FMGP sites. Settlement discussions are proceeding between Utilities and its insurance carriers regarding the recovery of these FMGP-related costs. Settlement has been reached with four carriers and an agreement in principle has been reached with two other carriers thus far. Amounts received from insurance carriers are being deferred pending a determination of the regulatory treatment of such recoveries. Industries, Diversified, IES Energy Inc. (a wholly-owned subsidiary of Diversified), MicroFuel Corporation (the Corporation) now known as Ely, Inc. in which IES Energy has a 69.40% equity ownership, and other parties have been sued in Linn County District Court in Cedar Rapids, Iowa, by Allen C. Wiley. Mr. Wiley claims money damages on various tort and contract theories arising out of the 1992 sale of the assets of the Corporation, of which Mr. Wiley was a director and shareholder. All of the defendants in Mr. Wiley's suit answered the complaint and denied liability. Industries and Diversified were dismissed from the suit in a motion for summary judgment. In addition, a grant of summary judgment has reduced Mr. Wiley's claims against the remaining parties to breach of fiduciary duty. A separate motion for summary judgment, which was filed seeking dismissal of the remaining claims against the remaining parties, was overruled on September 20, 1996, and the trial has been set for May 1998. All of the defendants are vigorously contesting the claims. The Corporation commenced a separate suit to determine the fair value of Mr. Wiley's shares under Iowa Code section 490. A decision was issued on August 31, 1994, by the Linn County District Court ruling that the value of Mr. Wiley's shares was $377,600 based on a 40 cent per share valuation. The Corporation contended that the value of Mr. Wiley's shares was 2.5 cents per share. The Decision was appealed to the Iowa Supreme Court by the Corporation on a number of issues, including the Corporation's position that the trial court erred as a matter of law in discounting the testimony of the Corporation's expert witness. The Iowa Supreme Court assigned the case to the Iowa Court of Appeals. On February 2, 1996, the Iowa Court of Appeals reversed the District Court ruling after determining the District Court erred in discounting the expert testimony. The case was remanded back to the District Court for consideration of the expert testimony, but with no additional evidence taken. The District Court re-affirmed its original decision on August 28, 1996, and the Corporation has again appealed to the Iowa Supreme Court. On October 3, 1996, Lambda Energy Marketing Company, L. C. (Lambda) filed a request with the IUB that the IUB initiate formal complaint proceedings against Utilities. Lambda alleges that Utilities is discriminating against it by refusing to enter into contracts with it for remote displacement service and by favoring IEA, a subsidiary of the Company, in such matters. On October 17, 1996, Utilities filed a Response which denied the allegations, and alleged, inter alia, that Lambda is unlawfully attempting to provide retail electrical services in Utilities' exclusive service territory. The IUB hearings were held in March 1997. A decision is expected in the second quarter of 1997. On October 9, 1996, the Company filed a civil suit in the Iowa District Court in and for Linn County against Lambda, Robert Latham, Louie Ervin, and David Charles (collectively the "Defendants", including three former employees of the Company and/or its subsidiaries) alleging, inter alia, violations of Iowa's trade secret act and interference with existing and prospective business advantage. On November 1, 1996, the Defendants filed their Answer and Counterclaims alleging, inter alia, violation of Iowa competition law, tortious interference and commercial disparagement. The Defendants therewith also filed a Third-Party Petition against Utilities, IEA and Lee Liu, Chairman of the Board & Chief Executive Officer of Industries and Utilities, alleging, inter alia, tortious interference and commercial disparagement. On April 9, 1997, Utilities amended its suit to include Central Iowa Power Cooperative alleging that it, too, inter alia had violated Iowa's trade secret act, and had tortiously interfered with existing and prospective business advantage. Reference is made to Notes 3 and 7 of Industries' Notes to Consolidated Financial Statements for a discussion of Utilities' rate proceedings and the Company's environmental matters, respectively, and Item 2. Management's Discussion and Analysis of the Results of Operations and Financial Condition - Environmental Matters. Item 2. Changes in the Rights of the Company's Security Holders. None. Item 3. Default Upon Senior Securities. None. Item 4. Results of Votes of Security Holders. None. Item 5. Other Information. (a) IES Utilities Inc. has calculated their ratio of earnings to fixed charges pursuant to Item 503 of Regulation S-K of the Securities and Exchange Commission as follows: For the twelve months ended: March 31, 1997 3.09 December 31, 1996 3.23 December 31, 1995 3.04 December 31, 1994 3.18 December 31, 1993 3.41 December 31, 1992 2.49 (b) Leland Cox joined Utilities in April 1997 as Vice President, Sales and Service. Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits - *4(a) Fifth Supplemental Indenture, dated as of April 1, 1997, supplementing Utilities' Indenture of Mortgage and Deed of Trust, dated September 1, 1993. *4(b) Sixty-third Supplemental Indenture, dated as of April 1, 1997, supplementing Utilities' Indenture of Mortgage and Deed of Trust, dated August 1, 1940. *4(c) Commercial Paper Dealer Agreement, dated as of November 9, 1994, between IES Diversified Inc. and Citicorp Securities, Inc. *4(d) First Amendment, dated as of March 24, 1997, to the Commercial Paper Dealer Agreement, dated as of November 9, 1994, between IES Diversified Inc. and Citicorp Securities, Inc. *10(a) Receivables Purchase and Sale Agreement dated as of June 30, 1989, as Amended and Restated as of February 28, 1997, among IES Utilities Inc. (as Seller) and CIESCO L.P. (as the Investor) and Citicorp North America, Inc. (as Agent). *12 Ratio of Earnings to Fixed Charges (IES Utilities Inc.) *27(a) Financial Data Schedule (IES Industries Inc.) *27(b) Financial Data Schedule (IES Utilities Inc.) * Exhibits designated by an asterisk are filed herewith. (b) Reports on Form 8-K - IES Industries Inc. None. IES Utilities Inc. Items Reported Financial Statements Date of Report 5 None April 28, 1997 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. IES INDUSTRIES INC. (Registrant) Date: May 14, 1997 By /s/ Thomas M. Walker (Signature) Thomas M. Walker Executive Vice President & Chief Financial Officer By /s/ John E. Ebright (Signature) John E. Ebright Controller & Chief Accounting Officer 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. IES UTILITIES INC. (Registrant) Date: May 14, 1997 By /s/ Thomas M. Walker (Signature) Thomas M. Walker Executive Vice President & Chief Financial Officer By /s/ John E. Ebright (Signature) John E. Ebright Controller & Chief Accounting Officer