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 September 30, 2003
Or
[_] TRANSITION REPORT PURSUANT 1TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission Registrant, State of Incorporation IRS Employer
File Number Address, and Telephone Number Identification No.
2-26720 Louisville Gas and Electric Company 61-0264150
(A Kentucky Corporation)
220 West Main Street
P.O. Box 32010
Louisville, KY 40232
(502) 627-2000
1-3464 Kentucky Utilities Company 61-0247570
(A Kentucky and Virginia Corporation)
One Quality Street
Lexington, KY 40507-1428
(859) 255-2100
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes X. No _.
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes No X
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date:
Louisville Gas and Electric Company
21,294,223 shares, without par value, as of October 31, 2003,
all held by LG&E Energy Corp.
Kentucky Utilities Company
37,817,878 shares, without par value, as of October 31, 2003,
all held by LG&E Energy Corp.
This combined Form 10-Q is separately filed by Louisville Gas and Electric
Company and Kentucky Utilities Company. Information contained herein
related to any individual registrant is filed by such registrant on its own
behalf. Each registrant makes no representation as to information related
to the other registrants.
TABLE OF CONTENTS
PART I
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
LOUISVILLE GAS AND ELECTRIC COMPANY AND SUBSIDIARY
STATEMENTS OF INCOME 1
BALANCE SHEETS 2
STATEMENT OF CASH FLOWS 4
STATEMENT OF RETAINED EARNINGS 5
STATEMENTS OF OTHER COMPREHENSIVE INCOME 6
KENTUCKY UTILITIES COMPANY AND SUBSIDIARY
STATEMENTS OF INCOME 7
BALANCE SHEETS 8
STATEMENT OF CASH FLOWS 10
STATEMENT OF RETAINED EARNINGS 11
STATEMENTS OF OTHER COMPREHENSIVE INCOME 12
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 13
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS. 21
ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. 31
ITEM 4 CONTROLS AND PROCEDURES. 33
PART II
ITEM 1 LEGAL PROCEEDINGS. 36
ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K 36
SIGNATURES 38
EXHIBITS 39
Part I. Financial Information - Item 1. Financial Statements
Louisville Gas and Electric Company and Subsidiary
Consolidated Statements of Income
(Unaudited)
(Thousands of $)
Three Months Nine Months
Ended Ended
September 30, September 30,
2003 2002 2003
2002
OPERATING REVENUES (Note 5 and Note 8):
Electric $230,174 $220,274 $591,110 $566,385
Gas 32,659 22,800 213,939 170,856
Total operating revenues 262,833 243,074 805,049 737,241
OPERATING EXPENSES:
Fuel for electric generation 55,628 52,827 151,382 147,484
Power purchased (Note 8) 18,805 12,579 60,245 46,276
Gas supply expenses 19,509 11,098 151,579 112,911
Other operation expenses 51,890 51,269 158,797 154,486
Maintenance 12,526 18,869 42,109 46,441
Depreciation and amortization
(Note 8) 28,429 28,196 85,866 79,363
Federal and state income taxes 23,707 22,083 45,062 43,655
Property and other taxes 4,659 4,501 12,848 13,815
Total operating expenses 215,153 201,422 707,888 644,431
NET OPERATING INCOME 47,680 41,652 97,161 92,810
Other income (expense) - net 287 156 (43) 90
Interest charges (Note 3) 8,096 7,604 22,227 22,497
NET INCOME $ 39,871 $ 34,204 $ 74,891 $ 70,403
The accompanying notes are an integral part of these consolidated financial
statements.
Page 1
Louisville Gas and Electric Company and Subsidiary
Consolidated Balance Sheets
(Unaudited)
(Thousands of $)
ASSETS
September 30, December 31,
2003 2002
UTILITY PLANT:
At original cost $3,752,179 $3,622,985
Less: reserve for depreciation 1,522,825 1,463,674
Net utility plant (Note 7) 2,229,354 2,159,311
OTHER PROPERTY AND INVESTMENTS -
less reserve of $63 as of September 30, 2003
and December 31, 2002 611 764
CURRENT ASSETS:
Cash 3,400 17,015
Accounts receivable -
less reserve of $1,415 as of September 30, 2003
and $2,125 as of December 31, 2002 (Note 4) 55,241 68,440
Materials and supplies - at average cost:
Fuel (predominantly coal) 25,099 36,600
Gas stored underground 69,634 50,266
Other 24,342 25,651
Prepayments and other 2,662 5,298
Total current assets 180,378 203,270
DEFERRED DEBITS AND OTHER ASSETS:
Unamortized debt expense 6,334 6,532
Regulatory assets (Note 6) 139,829 153,446
Other 33,164 37,755
Total deferred debits and other assets 179,327 197,733
Total assets $2,589,670 $2,561,078
The accompanying notes are an integral part of these consolidated financial
statements.
Page 2
Louisville Gas and Electric Company and Subsidiary
Consolidated Balance Sheets
(Unaudited)
(Thousands of $)
CAPITALIZATION AND LIABILITIES
September 30, December 31,
2003 2002
CAPITALIZATION:
Common stock, without par value -
Outstanding 21,294,223 shares $ 425,170 $ 425,170
Common stock expense (836) (836)
Additional paid-in capital 40,000 40,000
Retained earnings 481,926 409,319
Accumulated other comprehensive loss (39,939) (40,512)
Total common equity 906,321 833,141
Cumulative preferred stock 70,140 70,140
Manditorily redeemable preferred stock 22,500 23,750
Long-term debt 328,104 328,104
Long-term debt to associated company (Note 9) 200,000
- -
Total capitalization 1,527,065 1,255,135
CURRENT LIABILITIES:
Current portion of manditorily
redeemable preferred stock 1,250 1,250
Current portion of long-term debt 246,200 288,800
Notes payable to parent (Note 9) 75,132 193,053
Accounts payable 84,252 122,771
Accrued taxes 12,940 1,450
Other 20,245 19,536
Total current liabilities 440,019 626,860
DEFERRED CREDITS AND OTHER LIABILITIES:
Accumulated deferred income taxes - net 344,281 313,225
Investment tax credit, in process of amortization 51,380 54,536
Accumulated provision for pensions
and related benefits 127,496 224,703
Customer advances for construction 9,700 10,260
Asset retirement obligation (Note 8) 9,793 -
Regulatory liabilities (Note 6) 43,715 52,424
Long-term derivative liability 16,464 17,115
Other 19,757 6,820
Total deferred credits and other liabilities 622,586 679,083
Total capital and liabilities $2,589,670 $2,561,078
The accompanying notes are an integral part of these consolidated financial
statements.
Page 3
Louisville Gas and Electric Company and Subsidiary
Consolidated Statement of Cash Flows
(Unaudited)
(Thousands of $)
Nine Months
Ended
September 30,
2003 2002
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 74,891 $ 70,403
Items not requiring cash currently:
Depreciation and amortization 85,866 79,363
Deferred income taxes - net 24,589 7,748
Investment tax credit - net (3,156) (3,100)
Asset retirement obligations (Note 8) 4,108 -
Other 26,104 33,595
Changes in current assets and liabilities (28,028) (63,348)
Changes in accounts receivable
securitization-net (Note 4) 11,600 32,200
Pension funding (Note 9) (89,125) -
Gas supply clause (14,970) 5,331
Other 12,086 8,331
Net cash flows from operating activities $103,965 170,523
CASH FLOWS FROM INVESTING ACTIVITIES:
Long-term investments 153 (239)
Construction expenditures (153,064) (141,855)
Net cash flows from investing activities (152,911) (142,094)
CASH FLOWS FROM FINANCING ACTIVITIES:
Long-term borrowings from
associated company (Note 9) 200,000 -
Short-term borrowings from parent (Note 9) 478,800 896,456
Repayment of short-term borrowings from parent (596,721) (861,500)
Retirement of preferred stock (1,250) -
Retirement of first mortgage bonds (42,600) -
Issuance of pollution control bonds - 118,876
Retirement of pollution control bonds - (120,000)
Payment of dividends (2,898) (49,225)
Net cash flows from financing activities 35,331 (15,393)
CHANGE IN CASH (13,615) 13,036
CASH AT BEGINNING OF PERIOD 17,015 2,112
CASH AT END OF PERIOD $ 3,400 $ 15,148
SUPPLEMENTAL DISCLOSURES:
Cash paid during the period for:
Income taxes $ 12,968 $ 46,925
Interest on borrowed money $ 17,204 $ 22,523
The accompanying notes are an integral part of these consolidated financial
statements.
Page 5
Louisville Gas and Electric Company and Subsidiary
Consolidated Statement of Retained Earnings
(Unaudited)
(Thousands of $)
Three Months Nine Months
Ended Ended
September 30, September 30,
2003 2002 2003 2002
Balance at beginning of period $442,498 $404,721 $409,319 $393,636
Net income 39,871 34,204 74,891 70,403
Subtotal 482,369 438,925 484,210 464,039
Cash dividends declared on stock:
5% cumulative preferred 269 269 807 807
Auction rate cumulative preferred 174 439 743 1,281
$5.875 cumulative preferred - 367 734 1,101
Common - 23,000 - 46,000
Subtotal 443 24,075 2,284 49,189
Balance at end of period $481,926 $414,850 $481,926 $414,850
The accompanying notes are an integral part of these consolidated financial
statements.
Page 5
Louisville Gas and Electric Company and Subsidiary
Consolidated Statements of Other Comprehensive Income
(Unaudited)
(Thousands of $)
Three Months Nine Months
Ended Ended
September 30, September 30,
2003 2002 2003 2002
Net income $39,871 $34,204 $74,891 $70,403
Gains (losses) on
derivative instruments and
hedging activities (Note 3) 3,539 (7,691) 955 (10,121)
Income tax benefit (expense) related
to items of other comprehensive
income (1,416) 3,076 (382) 4,049
Other comprehensive income (loss),
net of tax 2,123 (4,615) 573 (6,072)
Other Ccomprehensive income $41,994 $29,589 $75,464 $64,331
The accompanying notes are an integral part of these consolidated financial
statements.
Page 6
Kentucky Utilities Company and Subsidiary
Consolidated Statements of Income
(Unaudited)
(Thousands of $)
Three Months Nine Months
Ended Ended
September 30, September 30,
2003 2002 2003 2002
OPERATING REVENUES
(Note 5 and Note 8) $235,426 $235,059 $657,583 $640,103
OPERATING EXPENSES:
Fuel for electric generation 75,300 80,380 201,264 196,018
Power purchased (Note 8) 31,702 27,912 106,550 95,203
Other operation expenses 35,603 38,151 112,622 108,874
Maintenance 13,031 12,439 49,400 39,385
Depreciation and amortization
(Note 8) 24,751 24,449 76,663 71,023
Federal and state income taxes 18,196 17,011 32,263 38,759
Property and other taxes 4,067 3,689 12,230 11,565
Total operating expenses 202,650 204,031 590,992 560,827
NET OPERATING INCOME 32,776 31,028 66,591 79,276
Other income - net 2,145 5,466 6,948 8,789
Interest charges (Note 3) 4,611 5,409 17,209 19,871
NET INCOME $ 30,310 $ 31,085 $ 56,330 $ 68,194
The accompanying notes are an integral part of these consolidated financial
statements.
Page 7
Kentucky Utilities Company and Subsidiary
Consolidated Balance Sheets
(Unaudited)
(Thousands of $)
ASSETS
September 30, December 31,
2003 2002
UTILITY PLANT:
At original cost $3,527,901 $3,280,762
Less: reserve for depreciation 1,600,258 1,536,658
Net utility plant (Note 7) 1,927,643 1,744,104
OTHER PROPERTY AND INVESTMENTS -
less reserve of $130 as of September 30, 2003 and
December 31, 2002 17,176 14,358
CURRENT ASSETS:
Cash 9,332 5,391
Accounts receivable - less reserve of $953 and $800
as of September 30, 2003 and December 31, 2002,
respectively (Note 4) 51,082 49,588
Materials and supplies - at average cost:
Fuel (predominantly coal) 33,560 46,090
Other 27,230 26,408
Prepayments and other 3,432 6,584
Total current assets 124,636 134,061
DEFERRED DEBITS AND OTHER ASSETS:
Unamortized debt expense 4,832 4,991
Regulatory assets (Note 6) 53,676 63,776
Long-term derivative asset 15,917 16,928
Other 23,449 20,165
Total deferred debits and other assets 97,874 105,860
Total assets $2,167,329 $1,998,383
The accompanying notes are an integral part of these consolidated financial
statements.
Page 8
Kentucky Utilities Company and Subsidiary
Consolidated Balance Sheets (cont.)
(Unaudited)
(Thousands of $)
CAPITALIZATION AND LIABILITIES
September 30, December 31,
2003 2002
CAPITALIZATION:
Common stock, without par value -
Outstanding 37,817,878 shares $ 308,140 $ 308,140
Common stock expense (322) (322)
Additional paid-in capital 15,000 15,000
Retained earnings 556,662 502,024
Accumulated other comprehensive loss (10,280) (10,462)
Total common equity 869,200 814,380
Cumulative preferred stock 39,727 39,727
Long-term debt (Note 9) 346,782 346,562
Long-term debt to associated company (Note 9) 175,000 -
Total capitalization 1,430,709 1,200,669
CURRENT LIABILITIES:
Current portion of long-term debt 91,930 153,930
Notes payable to parent (Note 9) 98,730 119,490
Accounts payable 68,193 95,374
Accrued taxes 10,558 4,955
Other 24,765 21,442
Total current liabilities 294,176 395,191
DEFERRED CREDITS AND OTHER LIABILITIES:
Accumulated deferred income taxes - net 260,488 241,184
Investment tax credit, in process of
amortization 6,519 8,500
Accumulated provision for pensions and
related benefits 96,995 110,927
Asset retirement obligation (Note 8) 19,393 -
Regulatory liabilities (Note 6) 21,003 29,876
Other 38,046 12,036
Total deferred credits and other liabilities 442,444 402,523
Total capital and liabilities $2,167,329 $1,998,383
The accompanying notes are an integral part of these consolidated financial
statements.
Page 9
Kentucky Utilities Company and Subsidiary
Consolidated Statement of Cash Flows
(Unaudited)
(Thousands of $)
Nine Months
Ended
September 30,
2003 2002
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 56,330 $ 68,194
Items not requiring cash currently:
Depreciation and amortization 76,663 71,023
Deferred income taxes - net 10,277 (2,180)
Investment tax credit - net (1,981) (2,216)
Asset retirement obligations (Note 8) 9,460 -
Other 16,074 18,358
Changes in current assets and liabilities (4,888) (23,631)
Changes in accounts receivable
securitization-net (Note 4) - 4,900
Pension funding (Note 9) (9,515) (16,011)
Other 27,690 16,870
Net cash flows from operating activities 180,110 135,307
CASH FLOWS FROM INVESTING ACTIVITIES:
Long-term investments (2,818) (4,137)
Construction expenditures (263,899) (164,766)
Net cash flows from investing activities (266,717) (168,903)
CASH FLOWS FROM FINANCING ACTIVITIES:
Long-term borrowings from
associated company (Note 9) 175,000 -
Short-term borrowings from parent (Note 9) 520,840 390,200
Repayment of short-term borrowings from parent (541,600) (350,300)
Retirement of first mortgage bonds (62,000) -
Issuance of pollution control bonds - 36,813
Retirement of pollution control bonds - (37,930)
Payment of dividends (1,692) (1,692)
Net cash flows from financing activities 90,548 37,091
CHANGE IN CASH 3,941 3,495
CASH AT BEGINNING OF PERIOD 5,391 3,295
CASH AT END OF PERIOD $ 9,332 $ 6,790
SUPPLEMENTAL DISCLOSURES:
Cash paid during the period for:
Income taxes $ 19,012 $ 59,070
Interest on borrowed money $ 12,681 $ 22,419
The accompanying notes are an integral part of these consolidated financial
statements.
Page 10
Kentucky Utilities Company and Subsidiary
Consolidated Statement of Retained Earnings
(Unaudited)
(Thousands of $)
Three Months Nine Months
Ended Ended
September 30, September 30,
2003 2002 2003 2002
Balance at beginning of period $526,916 $446,877 $502,024 $410,896
Net income 30,310 31,085 56,330 68,194
Subtotal 557,226 477,962 558,354 479,090
Cash dividends declared on stock:
4.75% cumulative preferred 237 237 711 711
6.53% cumulative preferred 327 327 981 981
Subtotal 564 564 1,692 1,692
Balance at end of period $556,662 $477,398 $556,662 $477,398
The accompanying notes are an integral part of these consolidated financial
statements.
Page 11
Kentucky Utilities Company and Subsidiary
Consolidated Statements of Other Comprehensive Income
(Unaudited)
(Thousands of $)
Three Months Nine Months
Ended Ended
September 30, September 30,
2003 2002 2003 2002
Net income $30,310 $31,085 $56,330 $68,194
Gains (losses) on derivative
instruments and
hedging activities (Note 3) 303 (4,475) 303 (2,647)
Income tax benefit (expense) related to
Items of other comprehensive income (121) 1,790 (121) 1,059
Other comprehensive income (loss),
net of tax 182 (2,685) 182 (1,588)
Comprehensive income $30,492 $28,400 $56,512 $66,606
The accompanying notes are an integral part of these consolidated financial
statements.
Page 12
Louisville Gas and Electric Company and Subsidiary
Kentucky Utilities Company and Subsidiary
Notes to Consolidated Financial Statements
(Unaudited)
1. The unaudited consolidated financial statements include the accounts of
Louisville Gas and Electric Company and Subsidiary and Kentucky
Utilities Company and Subsidiary ("LG&E" and "KU" or the "Companies").
The common stock of each of LG&E and KU is wholly-owned by LG&E Energy
Corp. ("LG&E Energy"). In the opinion of management, the unaudited
interim data includes all adjustments, consisting only of normal
recurring adjustments, necessary for a fair statement of consolidated
financial position, results of operations, comprehensive income and
cash flows for the periods indicated. Certain information and footnote
disclosures normally included in financial statements prepared in
accordance with generally accepted accounting principles have been
condensed or omitted pursuant to Securities and Exchange Commission
("SEC") rules and regulations, although the Companies believe that the
disclosures are adequate to make the information presented not
misleading.
See LG&E's and KU's current report on Form 8-K dated November 12, 2003,
for information relevant to the accompanying financial statements,
including information as to the significant accounting policies of the
Companies.
The accompanying financial statements for the three months and nine
months ended September 30, 2002, have been revised to conform with
certain reclassifications in the current three months and nine months
ended September 30, 2003. These reclassifications had no effect on net
income, total assets, or total capital and liabilities as previously
reported.
2. On December 11, 2000, LG&E Energy was acquired by Powergen plc, now
known as Powergen Limited ("Powergen"), for cash of approximately $3.2
billion or $24.85 per share and the assumption of all of LG&E Energy's
debt. As a result of the acquisition, LG&E Energy became a wholly-
owned indirect subsidiary of Powergen and LG&E and KU became indirect
subsidiaries of Powergen. The utility operations (LG&E and KU) of LG&E
Energy continued their separate identities and continue to serve
customers in Kentucky, Virginia and Tennessee under their existing
names. The preferred stock and debt securities of the utility
operations were not affected by this transaction and the utilities
continue to file SEC reports. Following the acquisition, Powergen
became a registered holding company under the Public Utility Holding
Company Act of 1935 ("PUHCA"), and LG&E and KU, as subsidiaries of a
registered holding company, became subject to additional regulation
under PUHCA.
As a result of the Powergen acquisition and in order to comply with
PUHCA, LG&E Energy Services Inc. ("LG&E Services") was formed as a
subsidiary of LG&E Energy and became operational on January 1, 2001.
LG&E Services provides certain services to affiliated entities,
including LG&E and KU, at cost, as required under PUHCA. On January 1,
2001, approximately 1,000 employees, primarily from LG&E Energy, LG&E
and KU, were moved to LG&E Services.
On July 1, 2002, a German company, E.ON AG ("E.ON"), completed its
acquisition of Powergen. E.ON had announced its pre-conditional cash
offer of 5.1 billion pounds sterling ($7.3 billion) for Powergen on
April 9, 2001. Following the acquisition, LG&E and KU became indirect
subsidiaries of E.ON and E.ON became a registered holding company under
PUHCA. As contemplated in their regulatory filings in connection with
the E.ON acquisition, E.ON, Powergen and LG&E Energy have completed an
administrative reorganization to move the LG&E Energy group from an
indirect Powergen subsidiary to an indirect E.ON subsidiary. This
reorganization was effective in March 2003.
Page 13
No costs associated with the Powergen acquisition or the E.ON
acquisition nor any of the effects of purchase accounting have been
reflected in the financial statements of LG&E or KU.
3. The Companies use interest rate swaps to hedge exposure to market
fluctuations in certain of their debt instruments. Pursuant to the
Companies' policies, use of these financial instruments is intended to
mitigate risk, earnings and cash flow volatility and is not speculative
in nature. Management has designated all of the Companies' interest
rate swaps as hedge instruments. Financial instruments designated as
cash flow hedges have resulting gains and losses recorded within other
comprehensive income and stockholders' equity. To the extent a
financial instrument or the underlying item being hedged is prematurely
terminated or the hedge becomes ineffective, the resulting gains or
losses are reclassified from other comprehensive income to net income.
Financial instruments designated as fair value hedges are periodically
marked to market with the resulting gains and losses recorded directly
into net income to correspond with income or expense recognized from
changes in market value of the items being hedged.
As of September 30, 2003, LG&E had fixed rate swaps covering $100.3
million in notional amounts of variable rate debt and with fixed rates
ranging from 4.309% to 5.495%. The average variable rate on the debt
during the three months and nine months ended September 30, 2003 was
.93% and 1.09%, respectively. The swaps have been designated as cash
flow hedges and expire on various dates from February 2005 through
November 2020. The hedges were deemed to be fully effective resulting
in a pretax gain for the three months and nine months ended September
30, 2003 of $3.2 million and $.7 million, respectively, recorded in
other comprehensive income. Upon expiration of these hedges, the amount
recorded in other comprehensive income will be reclassified into
earnings. The amount expected to be reclassified from other
comprehensive income to earnings in the next twelve months is
immaterial due to the long-term nature of the swaps.
As of September 30, 2003, KU had variable rate swaps covering
$153.0 million in notional amounts of fixed rate debt. The average
variable rate on these swaps during the three months and nine months
ended September 30, 2003 was 1.76% and 1.88%, respectively. The
underlying debt has fixed rates ranging from 5.75% to 7.92%. The swaps
have been designated as fair value hedges and expire on various dates
from May 2007 through September 2025. During the three months and nine
months ended September 30, 2003, the effect of marking these financial
instruments and the underlying debt to market resulted in a pretax gain
of $0.8 million and a pretax loss of $1.2 million, respectively,
recorded as a decrease/increase in interest expense.
4. LG&E and KU participate in accounts receivable securitization programs.
The purpose of these programs is to enable the utilities to accelerate
the receipt of cash from the collection of retail accounts receivable,
thereby reducing dependence upon more costly sources of working
capital. The securitization programs allow for a percentage of
eligible receivables to be sold. Eligible receivables are generally
all receivables associated with retail sales that have standard terms
and are not past due. LG&E and KU are able to terminate these programs
at any time without penalty. If there is a significant deterioration
in the payment record of the receivables by retail customers or if the
Companies fail to meet certain covenants of the programs, the programs
may terminate at the election of the financial institutions. In this
case, payments from retail customers would first be used to repay the
financial institutions participating in the programs, and would then be
available for use by the Companies.
As part of these programs, in February 2001, LG&E and KU sold retail
accounts receivables to wholly-owned subsidiaries, LG&E Receivables LLC
("LG&E R") and KU Receivables LLC ("KU R"). Simultaneously, LG&E R and
KU R entered into two separate three-year accounts receivable
securitization facilities with two financial institutions and their
Page 14
affiliates whereby LG&E R and KU R can sell, on a revolving basis, an
undivided interest in certain of their receivables and receive up to
$75 million and $50 million, respectively, from an unrelated third
party purchaser. The effective cost of the receivables programs is
comparable to the Companies' lowest cost source of capital, and is
based on prime rated commercial paper. LG&E and KU retain servicing
rights of the sold receivables through separate servicing agreements
with the third party purchasers. LG&E and KU have obtained opinions
from independent legal counsel indicating these transactions qualify as
true sales of receivables. As of September 30, 2003 and December 31,
2002, LG&E's outstanding program balances were $74.8 million and $63.2
million, respectively, and KU's balance for both periods was $49.3
million. These programs expire in February 2004.
The allowance for doubtful accounts associated with the eligible
securitized receivables was $1.4 million at September 30, 2003 and $2.1
million at December 31, 2002 for LG&E, and $0.5 million for KU at
September 30, 2003 and December 31, 2002. Management believes that the
risk of uncollectibility associated with the sold receivables is
minimal.
5. External and intersegment revenues (related party transactions between
LG&E and KU) and income by business segment for the three and nine
months ended September 30, 2003, follow (in thousands of $):
Three Months Ended September 30, 2003
External Intersegment
Revenues Revenues Net Income (Loss)
LG&E electric $218,194 $11,980 $41,924
LG&E gas 32,659 - (2,053)
Total $250,853 $11,980 $39,871
KU electric $224,426 $11,000 $30,310
Nine Months Ended September 30, 2003
External Intersegment
Revenues Revenues Net Income
LG&E electric $549,630 $41,480 $69,413
LG&E gas 213,939 - 5,478
Total $763,569 $41,480 $74,891
KU electric $624,334 $33,249 $56,330
External and intersegment revenues (related party transactions between
LG&E and KU) and income by business segment for the three and nine
months ended September 30, 2002, follow (in thousands of $):
Three Months Ended September 30, 2002
External Intersegment
Revenues Revenues Net Income (Loss)
LG&E electric $215,458 $ 4,816 $38,024
LG&E gas 22,800 - (3,820)
Total $238,258 $ 4,816 $34,204
KU electric $228,776 $ 6,283 $31,085
Page 15
Nine Months Ended September 30, 2002
External Intersegment
Revenues Revenues Net Income
LG&E electric $538,666 $27,719 $66,774
LG&E gas 170,856 - 3,629
Total $709,522 $27,719 $70,403
KU electric $610,944 $29,159 $68,194
6. The following regulatory assets and liabilities were included in the
balance sheet of LG&E and KU as of September 30, 2003 and December 31,
2002 (in thousands of $):
Louisville Gas and Electric
(Unaudited)
September 30, December 31,
2003 2002
REGULATORY ASSETS:
Value Delivery Team (VDT) costs $ 75,344 $ 98,044
Unamortized loss on bonds 18,004 18,843
Gas supply adjustments due from customers 29,086 13,714
Earnings sharing mechanism provision 6,311 12,500
Asset retirement obligation 5,772 -
LG&E/KU merger costs - 1,815
One utility costs - 954
Manufactured gas sites 1,530 1,757
Other 3,782 5,819
Total $139,829 $153,446
REGULATORY LIABILITIES:
Deferred income taxes - net $ 39,191 $ 45,536
Gas supply adjustments due to customers 3,555 3,154
Other 969 3,734
Total $ 43,715 $ 52,424
Kentucky Utilities
(Unaudited)
September 30, December 31,
2003 2002
REGULATORY ASSETS:
Value Delivery Team (VDT) costs $29,389 $38,375
Unamortized loss on bonds 8,835 9,456
Earnings sharing mechanism provision 5,792 13,500
Asset retirement obligation 10,064 -
LG&E/KU merger costs - 2,046
One utility costs - 873
Other (404) (474)
Total $53,676 $63,776
REGULATORY LIABILITIES:
Deferred income taxes - net 19,949 28,854
Other 1,054 1,022
Total $21,003 $29,876
Merger Surcredit
As part of the LG&E Energy merger with KU Energy in 1998, LG&E Energy
estimated non-fuel savings over a ten-year period following the merger.
Costs to achieve these savings of $50.2 million for LG&E and $42.3
million for KU were recorded in the second quarter of 1998. Of these
amounts $18.1 million for LG&E and $20.5 million for KU was deferred
and amortized over a five-year period pursuant to regulatory orders.
Primary components of the merger costs were separation benefits,
relocation costs, and transaction fees, the majority of which were paid
by December 31, 1998. LG&E and KU expensed the remaining costs
associated with the merger ($32.1 million and $21.8 million,
respectively) in the second quarter of 1998.
In approving the merger, the Kentucky Commission adopted the Companies'
proposal to reduce its retail customers' bills based on one-half of the
estimated merger-related savings, net of deferred and amortized
amounts, over a five-year period. The surcredit mechanism provided
that 50% of the net non-fuel cost savings estimated to be achieved from
the merger be provided to ratepayers through a monthly bill credit, and
50% be retained by the Companies, over a five-year period. The
surcredit was allocated 53% to KU and 47% to LG&E. In that same order,
the Kentucky Commission required LG&E and KU, after the end of the five-
year period, to present a plan for sharing with customers the then-
projected non-fuel savings associated with the merger. The Companies
submitted this filing on January 13, 2003, proposing to continue to
share with customers, on a 50%/50% basis, the estimated fifth-year
gross level of non-fuel savings associated with the merger.
On October 16, 2003, the Kentucky Commission approved a merger
surcredit settlement whereby the surcredit mechanism will remain in
place for an additional five-year period at a levelized amount per year
calculated from the originally estimated non-fuel savings for years six
through ten. Customers and shareholders will continue to equally share
merger savings on a 50%/50% basis and LG&E's customers will continue to
be allocated 47%, and KU's customers will continue to be allocated 53%,
of the customers' portion of the merger savings. As a part of the
settlement, certain customers, in lieu of receiving monthly credits,
will receive the present value of their estimated surcredits in up-
front payments. These payments, $6.9 million for LG&E and $5.3 million
for KU, will be deferred and amortized over the five-year period
starting July 1, 2003, pursuant to the order. Remaining LG&E and KU
customers will receive credits totaling $18.0 million and $17.9
million, respectively, in each of the five years beginning July 1,
2003.
7. The following data represent shares of jointly owned additions to the
Trimble County plant for four combustion turbines as of September 30,
2003:
LG&E KU Total
Ownership % 37% 63% 100%
Mw capacity 237 403 640
Plant under construction ($mill) $63 $108 $171
Depreciation - - -
Net book value $63 $108 $171
8. Statement of Financial Accounting Standard (SFAS) No. 143, Accounting
for Asset Retirement Obligations, was issued in 2001. SFAS No. 143
establishes accounting and reporting standards for obligations
associated with the retirement of tangible long-lived assets and the
associated asset retirement costs.
The effective implementation date for SFAS No. 143 was January 1, 2003
and the associated FERC final rule, Accounting, Financial Reporting,
and Rate Filing Requirements for Asset Retirement Obligations, was
issued April 9, 2003. As of September 30, 2003, LG&E recorded asset
retirement obligation (ARO) assets in the amount of $4.5 million and
liabilities of $9.8 million. LG&E recorded offsetting regulatory
assets of $5.8 million, pursuant to regulatory treatment prescribed
under SFAS No. 71, Accounting for the Effects of Certain Types of
Regulation. As of September 30, 2003, KU recorded ARO assets in the
amount of $8.6 million and liabilities of $19.4 million. KU recorded
Page 17
offsetting regulatory assets of $10.0 million, pursuant to regulatory
treatment prescribed under SFAS No. 71. LG&E and KU AROs are primarily
related to final retirement of assets associated with generating units.
Assets with associated AROs will no longer include a cost of removal
component within their depreciation rate. Assets without associated
AROs will continue to be depreciated including a cost of removal
component within the depreciation rate. The Companies are in the
process of calculating the amount of the costs of removal embedded in
accumulated depreciation.
Had SFAS No. 143 been in effect for the 2002 reporting period, the
Companies would have established asset retirement obligations as
described in the following table (in thousands of $):
LG&E KU
Provision at January 1, 2002 $8,752 $17,331
Accretion expense 578 1,146
Provision at December 31, 2002 $9,330 $18,477
For the three months and nine months ended September 30, 2003, LG&E
recorded ARO accretion expense of $154,000 and $462,000, respectively,
ARO depreciation expense of $29,000 and $88,000, respectively, and an
offsetting regulatory credit in the income statement of $185,000 and
$550,000, respectively. For the three months and nine months ended
September 30, 2003, KU recorded ARO accretion expense of $306,000 and
$916,000, respectively, ARO depreciation expense of $44,000 and
$131,000, respectively, and an offsetting regulatory credit in the
income statement of $350,000 and $1.0 million, respectively. The
recording of the regulatory credit is pursuant to regulatory treatment
prescribed under SFAS No. 71. SFAS No. 143 has no impact on the results
of the operation of the Companies.
The Companies adopted EITF No. 98-10, Accounting for Energy Trading and
Risk Management Activities, effective January 1, 1999. This
pronouncement required that energy trading contracts be marked to
market on the balance sheet, with the gains and losses shown net in the
income statement.
Effective January 1, 2003, the Companies adopted EITF No. 02-03, Issues
Involved in Accounting for Derivative Contracts Held for Trading
Purposes and Contracts Involved in Energy Trading and Risk Management
Activities. EITF No. 02-03 established the following:
- Rescinded EITF No. 98-10,
- Contracts that do not meet the definition of a derivative under
SFAS No. 133 should not be marked to fair market value, and
- Revenues should be shown in the income statement net of costs
associated with trading activities, whether or not the trades
are physically settled.
With the rescission of EITF No. 98-10, energy trading contracts that do
not also meet the definition of a derivative under SFAS No. 133 must be
accounted for as executory contracts. Contracts previously recorded at
fair value under EITF No. 98-10 that are not also derivatives under
SFAS No. 133, Accounting for Derivative Instruments and Hedging
Activities, must be restated to historical cost through a cumulative
effect adjustment. The rescission of this standard had no impact on
financial position or results of operations of the Companies since all
contracts marked to market under EITF No. 98-10 are also within the
scope of SFAS No. 133.
As a result of EITF No. 02-03, the Companies have netted the power
purchased expense for trading activities against electric operating
revenue to reflect this accounting change. The Companies applied this
guidance to all prior periods, which had no impact on previously
reported net income or common equity.
Page 18
Three Months Nine Months
Ended Ended
September 30, September 30,
2003 2002 2003 2002
LG&E:
Gross electric operating revenues $230,174 $223,017 $591,110 $581,076
Less costs reclassified
from power purchased - 2,743 - 14,691
Net electric operating
revenues reported $230,174 $220,274 $591,110 $566,385
KU:
Gross electric operating revenues $235,426 $239,020 $657,583 $657,744
Less costs reclassified
from power purchased - 3,961 - 17,641
Net electric operating
revenues reported $235,426 $235,059 $657,583 $640,103
Three Months Nine Months
Ended Ended
September 30, September 30,
2003 2002 2003 2002
LG&E:
Gross power purchased $ 18,805 $ 15,322 $ 60,245 $ 60,967
Less costs reclassified to revenues - 2,743 - 14,691
Net power purchased reported $ 18,805 $ 12,579 $ 60,245 $ 46,276
KU:
Gross power purchased $ 31,702 $ 31,873 $106,550 $112,844
Less costs reclassified to revenues - 3,961 - 17,641
Net power purchased reported $ 31,702 $ 27,912 $106,550 $ 95,203
In May 2003, the Financial Accounting Standards Board issued SFAS No.
150, Accounting for Certain Financial Instruments with Characteristics
of both Liabilities and Equity. SFAS No. 150 is effective immediately
for financial instruments entered into or modified after May 31, 2003,
and otherwise is effective for interim reporting periods beginning
after June 15, 2003, except for certain instruments and certain
entities which have been deferred by the FASB. Such deferrals do not
affect LG&E and KU..
LG&E has existing $5.875 series mandatorily redeemable preferred stock
outstanding having a current redemption price of $100 per share. The
preferred stock has a sinking fund requirement sufficient to retire a
minimum of 12,500 shares on July 15 of each year commencing with July
15, 2003, and a minimum of 187,500 shares on July 15, 2008 at $100 per
share. LG&E redeemed 12,500 shares in accordance with these provisions
on July 15, 2003, leaving 237,500 shares currently outstanding.
Beginning with the three months ended September 30, 2003, LG&E
reclassified, at fair value, its $5.875 series preferred stock as long-
term debt with the minimum shares mandatorily redeemable within one
year classified as current portion of long-term debt. Dividends
accrued beginning July 1, 2003 are charged as interest expense.
KU has no financial instruments that fall within the scope of SFAS No.
150.
9. In October 2003, KU issued a redemption notice to holders of Series P,
8.55% first mortgage bonds ($33.0 million). These bonds will be
redeemed on November 25, 2003. The redemption will be funded with long-
term loans from an E.ON affiliate.
On August 15, 2003, LG&E borrowed $100 million from an E.ON affiliate
for a ten-year term at 5.31%. The loan is secured by a second lien on
substantially all of LG&E's assets. The proceeds were used to repay a
maturing first mortgage bond of $42.6 million and to repay notes
payable to affiliates.
Page 19
On August 15, 2003, KU borrowed $75 million from an E.ON affiliate for
a ten-year term at 5.31%. The loan is secured by a second lien on
substantially all of KU's assets. The proceeds were used to repay notes
payable to affiliates, some of which were the result of the repayment
of a $62 million first mortgage bond.
During July 2003, LG&E entered into five revolving lines of credit
with third-party financial institutions totaling $185 million. These
credit facilities expire in June 2004, and there was no outstanding
balance under any of these facilities at September 30, 2003.
The Companies participate in a money pool whereby LG&E Energy can make
available up to $400 million at market-based rates for each of LG&E and
KU. LG&E Energy maintains a facility totaling $150 million with an
E.ON affiliate to ensure funding availability for the money pool. There
was $46.0 million outstanding under E.ON affiliates' line as of
September 30, 2003, leaving $104.0 million available. LG&E Energy had
outstanding loans to LG&E and KU through the money pool that totaled
$75.1 million and $98.7 million, respectively, as of September 30,
2003. These borrowings carried a thirty-day average interest rate of
1.06% at September 30, 2003, based on an index of highly rated
commercial paper issuers as of the prior month end. LG&E and KU had
available under the money pool, $324.9 million and $301.3 million,
respectively, as of September 30, 2003.
In August 2003, LG&E and KU contributed an additional $6.0 million each
to their respective pension plans.
10.In the normal course of business, lawsuits, claims, environmental
actions, and various non-ratemaking governmental proceedings arise
against LG&E and KU. To the extent that damages are assessed in any of
these lawsuits, LG&E and KU believe that their insurance coverage is
adequate. Management, after consultation with legal counsel, and based
upon the present status of these items, does not anticipate that
liabilities arising out of other currently pending or threatened
lawsuits and claims of the type referenced above will have a material
adverse effect on LG&E's or KU's consolidated financial position or
results of operations.
LG&E Employment Discrimination Case
As previously reported, in October 2001, approximately 30 employees or
former employees filed a complaint against LG&E claiming past and
current instances of employment discrimination. LG&E has moved the
case to the U.S. District Court for the Western District of Kentucky
and filed an answer denying all plaintiffs' claims. Discovery has
commenced in the matter. The court has ordered mediation and certain
plaintiffs have settled for immaterial amounts as a result of that
process. In addition, certain other plaintiffs have sought
administrative review before the U.S. Equal Employment Opportunity
Commission which has, to date, declined to proceed to litigation on any
claims reviewed. Previously amended pleadings, while reducing the size
of the plaintiff and defendant groups and eliminating certain prior
demands, contain a claimed damage amount of $100 million as well as
requests for injunctive relief. During mediation in 2003, additional
settlements for immaterial amounts were reached with a number of
plaintiffs, including a settlement with the lead plaintiff, which
reduced the number of remaining plaintiffs to nine. LG&E intends to
continue to defend itself vigorously in the remaining action and
management does not anticipate that the outcome will have a material
impact on LG&E's operations or financial condition.
Combustion Turbine Litigation
In October 2003, LG&E and KU and third parties completed a settlement
agreement to dismiss the Companies' previously reported lawsuit in the
U.S. District Court for the Eastern District of Kentucky against Alstom
Power, Inc. (formerly ABB Power Generation, Inc.). The suit concerned
Page 20
operational deficiencies of two combustion turbines supplied by Alstom
during 1999, installed at KU's E.W. Brown plant and jointly owned by
LG&E and KU. The settlement agreement provides for $20 million
reimbursement in two installments to be paid in January and April 2004
to LG&E and KU for the Companies' expenditures incurred regarding the
turbines. The parties also entered into a long-term service agreement,
whereby Alstom will provide to LG&E and KU certain future inspections,
repairs and services for the turbines.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
General
The following discussion and analysis by management focuses on those
factors that had a material effect on LG&E's and KU's financial results of
operations and financial condition during the three and nine month periods
ended September 30, 2003, and should be read in connection with the
financial statements and notes thereto.
Some of the following discussion may contain forward-looking statements
that are subject to certain risks, uncertainties and assumptions. Such
forward-looking statements are intended to be identified in this document
by the words "anticipate," "expect," "estimate," "objective," "possible,"
"potential" and similar expressions. Actual results may vary materially.
Factors that could cause actual results to differ materially include:
general economic conditions; business and competitive conditions in the
energy industry; changes in federal or state legislation; unusual weather;
actions by state or federal regulatory agencies; and other factors
described from time to time in LG&E's and KU's reports to the Securities
and Exchange Commission, including the current report on Form 8-K
dated November 12, 2003.
Results of Operations
The results of operations for LG&E and KU are affected by seasonal
fluctuations in temperature and other weather-related factors. Because of
these and other factors, the results of one interim period are not
necessarily indicative of results or trends to be expected for the full
year.
Three Months Ended September 30, 2003, Compared to
Three Months Ended September 30, 2002
LG&E Results:
LG&E's net income increased $5.7 million (17%) for the three months ended
September 30, 2003, as compared to the three months ended September 30,
2002 primarily because of increased wholesale electric sales offset by
decreased retail electric sales.
A comparison of LG&E's revenues for the three months ended September 30,
2003, with the three months ended September 30, 2002, reflects increases
and (decreases) which have been segregated by the following principal
causes (in thousands of $):
Electric Gas
Cause Revenues Revenues
Retail sales:
Fuel and gas supply adjustments $ 3,481 $ 7,171
Environmental cost recovery surcharge (2,560) -
Demand side management cost recovery 398 (17)
LG&E/KU merger surcredit (947) -
Value delivery surcredit (1,111) (127)
Variation in sales volume and other (10,339) 2,737
Total retail sales (11,078) 9,764
Page 21
Wholesale sales 20,793 -
Gas transportation - net - (71)
Other 185 166
Total $ 9,900 $ 9,859
Electric revenues increased primarily due an increase in wholesale sales
(volumes increased 135%, resulting in $24.4 million higher revenues) and
higher fuel supply cost billed to customers, partially offset by a decrease
in retail volumes sold due to a 29% decrease in cooling degree days. Gas
revenues increased primarily as a result of higher gas supply costs billed
to customers through the gas supply clause and increased volumes sold.
Fuel for electric generation and gas supply expenses comprise a large
component of LG&E's total operating expenses. LG&E's electric and gas
rates contain a fuel adjustment clause and a gas supply clause,
respectively, whereby increases or decreases in the cost of fuel and gas
supply are reflected in retail rates, subject to the approval of the
Kentucky Public Service Commission (Kentucky Commission). Fuel for
electric generation increased $2.8 million (5%) for the three months ended
September 30, 2003, due to an increase in in the quantity of fuel consumed
for generation to supply wholesale sales ($5.0 million), partially offset
by a decrease in the cost of coal burned ($2.2 million). Gas supply
expenses increased $8.4 million (76%) due to an increase in net gas supply
cost ($7.8 million) and an increase in the volume of retail gas delivered
to the distribution system ($0.6 million).
Power purchased increased $6.2 million (49%) due to increased purchases for
higher off-system sales (49% higher volumes resulted in a $6.2 million
volume variance).
Maintenance expense decreased $6.3 million (34%) due to a decrease in
expenses related to steam power production as a result of decreased plant
outages ($4.3 million) and fewer gas main repairs ($2.0 million) in 2003 as
compared to 2002.
Although income tax expense increased due to higher pre-tax income, prior
year adjustments booked in the third quarter of 2003 reduced tax expense in
the period and lowered the effective tax rate.
Three Months Three Months
Ended Ended
September 30, 2003September 30, 20
02
Effective Rate
Statutory federal income tax rate 35.0% 35.0%
State income taxes net of federal benefit 4.9 5.5
Amortization of investment and other tax credits (1.7) (1.8)
Other differences (2.4) (0.1)
Effective income tax rate 35.8% 38.6%
Interest charges increased $.5 million (6%) in 2003 primarily due to $.3
million in additional interest expense related to preferred dividends
reclassified as debt in accordance with SFAS No. 150, Accounting for
Certain Financial Instruments with Characteristics of Both Liabilities and
Equity. The weighted average interest rate on variable-rate bonds for the
three months ended September 30, 2003, was 0.99%, compared to 1.42% for the
comparable period in 2002.
KU Results:
KU's net income decreased $.8 million (2%) for the three months ended
September 30, 2003, as compared to the three months ended September 30,
2002. The decrease was primarily due to decreased other income, partially
offset by decreased other operation expenses.
Page 22
A comparison of KU's revenues for the three months ended September 30,
2003, with the three months ended September 30, 2002, reflects increases
and (decreases) which have been segregated by the following principal
causes (in thousands of $):
Electric
Cause Revenues
Retail sales:
Fuel supply adjustments $ 4,167
Environmental cost recovery surcharge 840
LG&E/KU merger surcredit (491)
Value delivery surcredit (464)
Variation in sales volume and other (8,956)
Total retail sales (4,904)
Wholesale sales 4,182
Other 1,089
Total $ 367
Higher wholesale revenues, due to an increase in wholesale sales volumes,
and higher fuel costs billed to customers, were offset by lower retail
sales volumes due to a 33% decrease in cooling degree days.
Fuel for electric generation comprises a large component of KU's total
operating expenses. KU's electric rates contain a fuel adjustment clause,
whereby increases or decreases in the cost of fuel are reflected in retail
rates, subject to the approval of the Kentucky Commission, the Virginia
State Corporation Commission, and the Federal Energy Regulatory Commission.
Fuel for electric generation decreased $5.1 million (6%) for the quarter
because of a 7% decrease in the quantity of fuel consumed for generation
($6.0 million) due to a decrease in native load requirements, partially
offset by an increase in the cost of coal burned ($.9 million) due to
higher purchases of compliance coal.
Power purchased increased $3.8 million (14%) due to a 34% increase in
the volume purchased ($9.5 million), partially offset by a decrease in the
price of power purchased ($5.7 million). The increase in volumes is
attributable to higher intercompany purchases from LG&E.
Other operation expenses decreased $2.5 million (7%) due primarily to a
decrease in the amortization of prior "KU/LG&E Merger" and "One Utility"
workforce reduction programs expenses ($1.9 million) and lower injury and
liability claims from third parties ($.6 million).
Variations in income tax expense are largely attributable to changes in
pretax income. The change in other differences is due to the change in
KU's equity earnings from a minority interest.
Three Months Three Months
Ended Ended
September 30, 2003 September 30,2002
Effective Rate
Statutory federal income tax rate 35.0% 35.0%
State income taxes net of
federal benefit 5.0 4.9
Amortization of investment and
other tax credits (1.4) (1.6)
Other differences (2.9) (4.3)
Effective income tax rate 35.7% 34.0%
Other income - net decreased $3.3 million (61%) in 2003 primarily due to a
decrease in minority interest earnings, $3.8 million, partially offset by
lower taxes.
Page 23
Interest charges decreased $.8 million (15%) for the three months ended
September 30, 2003 as compared to the three months ended September 30,
2002, due primarily to lower interest rates on variable-rate debt and the
replacement of fixed-rate debt with variable-rate debt. The weighted
average interest rate on variable-rate bonds for the three months ended
September 30, 2003, was 0.91% and the corresponding rate for the three
months ended September 30, 2002, was 1.57%.
Nine Months Ended September 30, 2003, Compared to
Nine Months Ended September 30, 2002
LG&E Results:
LG&E's net income increased $4.5 million (6%) for the nine months ended
September 30, 2003, as compared to the nine months ended September 30,
2002, primarily because of an increase in wholesale electric sales and gas
retail sales partially offset by a decrease in retail electric sales and an
increase in purchased power costs.
A comparison of LG&E's revenues for the nine months ended September 30,
2003, with the nine months ended September 30, 2002, reflects increases and
(decreases) which have been segregated by the following principal causes
(in thousands of $):
Electric Gas
Cause Revenues Revenues
Retail sales:
Fuel and gas supply adjustments $ 8,071 $32,005
Environmental cost recovery surcharge (1,283) -
Demand side management cost recovery 1,068 380
LG&E/KU merger surcredit (1,396) -
Value delivery surcredit (2,627) (956)
Earnings sharing mechanism 972 -
Weather normalization - (2,509)
Variation in sales volume and other (16,114) 20,357
Total retail sales (11,309) 49,277
Wholesale sales 34,381 (6,141)
Gas transportation - net - (82)
Other 1,653 29
Total $24,725 $43,083
Electric revenues increased primarily due to an increase in wholesale sales
prices ($16.2 million), an increase in wholesale sales volumes ($18.2
million) and higher fuel supply costs billed to customers. Retail volumes
decreased due to a 33% decrease in cooling degree days. Gas revenues
increased primarily as a result of higher gas supply costs billed to
customers through the gas supply clause and increased volumes sold due to
an increase in heating degree days (20%), partially offset by a decrease in
wholesale sales.
Fuel for electric generation increased $3.9 million (3%) for the nine
months due to an increase in the quantity of fuel consumed for generation
($4.8 million) partially offset by a decrease in the cost of coal burned
($.9 million). Gas supply expenses increased $38.7 million (34%) due to an
increase in net gas supply cost ($33.5 million) and an increase in the
volume of retail gas delivered to the distribution system ($9.9 million),
partially offset by decreased wholesale gas expenses ($4.7 million).
Power purchased increased $14.0 million (30%) due to an increase in the
price of power purchased ($10.3 million) and an increase in the volume of
purchases ($3.7 million) related to wholesale sales.
Page 24
Other operation expenses increased $4.3 million (3%) primarily due to
higher costs demand-side management programs ($2.1 million) and increased
benefit costs ($2.2 million).
Maintenance expenses decreased $4.3 million (9%) due to a decrease in
expenses related to steam power production as a result of decreased plant
outages ($3.9 million), fewer transmission and distribution line repairs
($1.1 million), and fewer gas main repairs ($1.4 million) partially offset
by an increase in communications maintenance expense ($2.5 million).
Depreciation and amortization expense increased $6.5 million (8%) due to
additional utility plant in service.
Although income tax expense increased due to higher pre-tax income, prior
year adjustments booked in the third quarter of 2003 for reduced tax
expense in the period and lowered the effective tax rate.
Nine Months Ended Nine Months Ended
September 30, 2003 September 30, 20
02
Effective Rate
Statutory federal income tax rate 35.0% 35.0%
State income taxes
net of federal benefit 5.3 5.3
Amortization of investment
and other tax credits (2.7) (2.8)
Other differences (1.6) (0.1)
Effective income tax rate 36.0% 37.4%
Interest charges decreased $.3 million (1%) due primarily to lower interest
rates on variable-rate debt. The weighted average interest rate on
variable-rate bonds for the nine months ended September 30, 2003 was 1.12%,
compared to 1.55% for the comparable period in 2002.
KU Results:
KU's net income decreased $11.9 million (17%) for the nine months ended
September 30, 2003, as compared to the nine months ended September 30,
2002. The decrease was primarily due to an increase in operations,
maintenance, and depreciation expenses partially offset by increased sales
to retail and wholesale customers.
A comparison of KU's revenues for the nine months ended September 30, 2003,
with the nine months ended September 30, 2002, reflects increases and
(decreases) which have been segregated by the following principal causes
(in thousands of $):
Electric
Cause Revenues
Retail sales:
Fuel supply adjustments $17,317
Environmental cost recovery surcharge (49)
Demand side management cost recovery 350
LG&E/KU merger surcredit (856)
Value delivery surcredit (1,323)
Earnings sharing mechanism (1,901)
Variation in sales volume and other (3,296)
Total retail sales 10,242
Wholesale sales 4,693
Other 2,545
Total $17,480
Page 25
Electric revenues increased primarily due to higher fuel supply costs
billed to customers and higher wholesale sales due to 12% higher volumes
($6.0 million).
Fuel for electric generation increased $5.2 million (3%) for the nine
months ended September 30, 2003, due to an increase in the cost of coal
burned ($14.2 million), offset by a decrease in the quantity of fuel
consumed for generation ($9.0 million).
Power purchased increased $11.3 million (12%) due to an increase in the
volume purchased ($13.6 million) as a result of temporary plant outages,
partially offset by the price of power purchased ($2.3 million).
Other operation expenses increased $3.7 million (3%) due to increased
benefit costs ($2.6 million), and increased property insurance
($1.1 million).
Maintenance expenses increased $10.0 million (25%) due to repairs to
electric distribution equipment due to an ice storm ($4.1 million, net of
$8.9 million in insurance recoveries), timing of annual maintenance of
steam production equipment occurring in second quarter 2003 vs. fourth
quarter 2002 ($2.0 million), an insurance recovery in 2002 ($.9 million), a
major unit outage in 2003 ($1.0 million), and an increase in
communications maintenance expense ($2.0 million).
Depreciation and amortization expense increased $5.6 million (8%) due to
additional utility plant in service.
Variations in income tax expense are largely attributable to changes in
pretax income.
Nine Months Ended Nine Months Ended
September 30, 2003 September 30, 2002
Effective Rate
Statutory federal income tax rate 35.0% 35.0%
State income taxes net of
federal benefit 5.8 5.7
Amortization of investment
and other tax credits (2.3) (2.6)
Other differences (3.6) (3.6)
Effective income tax rate 34.9% 34.5%
Other income - net decreased $1.8 million (21%) primarily due to a decrease
in minority interest earnings ($3.3 million), partially offset by higher
allowance for funds used during construction ($.9 million).
Interest charges decreased $2.7 million (13%) due primarily to lower
interest rates on variable-rate debt and the replacement of fixed-rate debt
with variable-rate debt. The weighted average interest rate on variable-
rate bonds for the nine months ended September 30, 2003, was 1.08% and the
corresponding rate for the nine months ended September 30, 2002, was 1.57%.
Liquidity and Capital Resources
LG&E and KU's needs for capital funds are largely related to the
construction of plant and equipment necessary to meet the needs of electric
and gas utility customers. Internal and external lines of credit and the
accounts receivable securitization programs are maintained to fund
short-term capital requirements. LG&E and KU believe that such sources of
funds will be sufficient to meet the needs of the business in the foreseeable
future.
Construction expenditures for the nine months ended September 30, 2003 for
LG&E and KU amounted to $153.1 million and $264 million, respectively.
Such expenditures related primarily to construction to meet nitrogen oxide
(NOx) emission standards and the acquisition of combustion turbines to meet
Page 26
peak power demands. Expenditures for the nine months ended September 30,
2003, by LG&E and KU for NOx construction were $23.7 million and $78.5
million, respectively. Expenditures for the nine months ended September
30, 2003, for Trimble County combustion turbines, Units 7 through 10, by
LG&E and KU were $63.5 million and $108.4 million, respectively. The
expenditures were financed with internally generated funds, intercompany
loans from affiliates, and accounts receivable securitization program
funds. See Note 4 of Notes to Financial Statements concerning accounts
receivable securitization.
LG&E's cash balance decreased $13.6 million during the nine months ended
September 30, 2003, primarily due to a pension contribution and the
purchase of an interest in the four Trimble County combustion turbines
financed with intercompany loans. KU's cash balance increased $3.9 million
during the nine months ended September 30, 2003. The increase reflects
cash flows from operations and intercompany loans, partially offset by
construction expenditures, including the purchase of an interest in the
four Trimble County combustion turbines.
Variations in accounts receivable, accounts payable and materials and
supplies are generally not significant indicators of LG&E's and KU's
liquidity. Such variations are primarily attributable to seasonal
fluctuations in weather, which have a direct effect on sales of electricity
and natural gas. The decrease in accounts receivable at LG&E resulted
primarily from lower gas sales. The increase in accounts receivable for KU
resulted primarily from timing of payments. The increase in LG&E's gas
stored underground relates to higher prices on injections to inventory.
The decrease in the fuel inventory at both LG&E and KU resulted from
seasonal fluctuations.
On August 15, 2003, LG&E borrowed $100 million from an E.ON affiliate for a
ten-year term at 5.31%. The loan is secured by a second lien on
substantially all of LG&E's assets. The proceeds were used to repay a
maturing first mortgage bond of $42.6 million and to repay notes payable to
affiliates.
On August 15, 2003, KU borrowed $75 million from an E.ON affiliate for a
ten-year term at 5.31%. The loan is secured by a second lien on
substantially all of KU's assets. The proceeds were used to repay notes
payable to affiliates, some of which were the results of the repayment of a
$62 million first mortgage bond.
During July 2003, LG&E entered into five revolving lines of credit totaling
$185 million. These credit facilities expire in June 2004, and there was
no outstanding balance under any of these facilities at September 30, 2003.
The Companies participate in a money pool whereby LG&E Energy can make up
to $400 million available at market-based rates for each of LG&E and KU.
LG&E Energy maintains a facility totaling $150.0 million with an E.ON
affiliate to ensure funding availability for the money pool. There was
$46.0 million outstanding under the E.ON affiliates' line as of September
30, 2003, leaving $104.0 million available. LG&E Energy had outstanding
loans to LG&E and KU through the money pool that totaled $75.1 million and
$98.7 million, respectively, as of September 30, 2003. These borrowings
carried a thirty-day average interest rate of 1.06% at September 30,
2003, based on an index of highly rated commercial paper issuers as of the
prior month end. LG&E and KU had available, under the money pool, $324.9
million and $301.3 million, respectively, as of September 30, 2003.
In October 2003, KU issued a redemption notice to holders of Series P,
8.55% first mortgage bonds ($33.0 million). These bonds will be redeemed
on November 25, 2003. The redemption will be funded with long-term loans
from an E.ON affiliate.
Under the provisions of variable-rate pollution control bonds totaling
$246.2 million for LG&E and $91.9 million for KU, the bonds are subject to
tender for purchase at the option of the holder and to mandatory tender for
purchase upon the occurrence of certain events, causing the bonds to be
classified as current portion of long-term debt. Should any of the bonds
be put to LG&E or KU, funds from the money pool could be used to reacquire
the bonds.
Page 27
LG&E's security ratings as of September 30, 2003, were:
Moody's S&P Fitch
First mortgage bonds A1 A- A+
Preferred stock Baa1 BBB- A-
Commercial paper P-1 A-2 F-1
KU's security ratings as of September 30, 2003, were:
Moody's S&P Fitch
First mortgage bonds A1 A A+
Preferred stock Baa1 BBB- A-
Commercial paper P-1 A-2 F-1
These ratings reflect the views of Moody's, S&P and Fitch. A security
rating is not a recommendation to buy, sell or hold securities and is
subject to revision or withdrawal at any time by the rating agency. Fitch
withdrew its ratings on LG&E and KU securities effective October 14, 2003.
LG&E's capitalization ratios at September 30, 2003, and December 31, 2002,
follow:
Sept. 30, Dec. 31,
2003 2002
Long-term debt (including current portion) 43.1% 35.5%
Notes payable 4.1 11.1
Preferred stock 3.8 5.5
Common equity 49.0 47.9
Total 100.0% 100.0%
KU's capitalization ratios at September 30, 2003, and December 31, 2002,
follow:
Sept. 30, Dec. 31,
2003 2002
Long-term debt (including current portion) 37.8% 34.0%
Notes payable 6.1 8.1
Preferred stock 2.5 2.7
Common equity 53.6 55.2
Total 100.0% 100.0%
New Accounting Pronouncements
SFAS No. 143, Accounting for Asset Retirement Obligations, was issued in
2001. SFAS No. 143 establishes accounting and reporting standards for
obligations associated with the retirement of tangible long-lived assets
and the associated asset retirement costs.
The effective implementation date for SFAS No. 143 was January 1, 2003, and
the associated FERC final rule, Accounting, Financial Reporting, and Rate
Filing Requirements for Asset Retirement Obligations, was issued April 9,
2003. As of September 30, 2003, LG&E recorded asset retirement obligation
Page 28
(ARO) assets in the amount of $4.5 million and liabilities of $9.8 million.
LG&E recorded offsetting regulatory assets of $5.8 million, pursuant to
regulatory treatment prescribed under SFAS No. 71, Accounting for the
Effects of Certain Types of Regulation. As of September 30, 2003, KU
recorded ARO assets in the amount of $8.6 million and liabilities of $19.4
million. KU recorded offsetting regulatory assets of $10.0 million,
pursuant to regulatory treatment prescribed under SFAS No. 71. LG&E and KU
AROs are primarily related to the final retirement of assets associated
with generating units. Assets with associated AROs will no longer include
a cost of removal component within their depreciation rate. Assets without
associated AROs will continue to be depreciated including a cost of removal
component within the depreciation rate. The Companies are in the process
of calculating the amount of the costs of removal embedded in accumulated
depreciation.
Had SFAS No. 143 been in effect for the 2002 reporting period, the
Companies would have established asset retirement obligations as described
in the following table ($000):
LG&E KU
Provision at January 1, 2002 $8,752 $17,331
Accretion expense 578 1,146
Provision at December 31, 2002 $9,330 $18,477
For the three months and nine months ended September 30, 2003, LG&E
recorded ARO accretion expense of $154,000 and $462,000, respectively, ARO
depreciation expense of $29,000 and $88,000, respectively, and an
offsetting regulatory credit in the income statement of $185,000 and
$550,000, respectively. For the three months and nine months ended
September 30, 2003, KU recorded ARO accretion expense of $306,000 and
$916,000, respectively, ARO depreciation expense of $44,000 and $131,000,
respectively, and an offsetting regulatory credit in the income statement
of $350,000 and $1.0 million, respectively. The recording of the
regulatory credit is pursuant to regulatory treatment prescribed under SFAS
No. 71. SFAS No. 143 has no impact on the results of the operation of the
Companies.
The Companies adopted EITF No. 98-10, Accounting for Energy Trading and
Risk Management Activities, effective January 1, 1999. This pronouncement
required that energy trading contracts be marked to market on the balance
sheet, with the gains and losses shown net in the income statement.
Effective January 1, 2003, the Companies adopted EITF No. 02-03, Issues
Involved in Accounting for Derivative Contracts Held for Trading Purposes
and Contracts Involved in Energy Trading and Risk Management Activities.
EITF No. 02-03 established the following:
- - Rescinded EITF No. 98-10,
- - Contracts that do not meet the definition of a derivative under
SFAS No. 133 should not be marked to fair market value, and
- - Revenues should be shown in the income statement net of costs
associated with trading activities, whether or not the trades are
physically settled.
With the rescission of EITF No. 98-10, energy trading contracts that do not
also meet the definition of a derivative under SFAS No. 133 must be
accounted for as executory contracts. Contracts previously recorded at
fair value under EITF No. 98-10 that are not also derivatives under SFAS
No. 133, Accounting for Derivative Instruments and Hedging Activities, must
be restated to historical cost through a cumulative effect adjustment. The
rescission of this standard had no impact on financial position or results
of operations of the Companies since all contracts marked to market under
EITF No. 98-10 are also within the scope of SFAS No. 133.
As a result of EITF No. 02-03, the Companies have netted the power
purchased expense for trading activities against electric operating revenue
to reflect this accounting change. The Companies applied this guidance to
Page 29
all prior periods, which had no impact on previously reported net income or
shareholders' equity. The following tables present the impact of this
reclassification (in thousands of $):
Three Months Nine Months
Ended Ended
September 30, September 30,
2003 2002 2003 2002
LG&E:
Gross electric operating revenues $230,174 $223,017 $591,110 $581,076
Less costs reclassified
from power purchased - 2,743 - 14,691
Net electric operating
revenues reported $230,174 $220,274 $591,110 $566,385
KU:
Gross electric operating revenues $235,426 $239,020 $657,583 $657,744
Less costs reclassified
from power purchased - 3,961 - 17,641
Net electric operating
revenues reported $235,426 $235,059 $657,583 $640,103
Three Months Nine Months
Ended Ended
September 30, September 30,
2003 2002 2003 2002
LG&E:
Gross power purchased $ 18,805 $ 15,322 $ 60,245 $ 60,967
Less costs reclassified to revenues - 2,743 - 14,691
Net power purchased reported $ 18,805 $ 12,579 $ 60,245 $ 46,276
KU:
Gross power purchased $ 31,702 $ 31,873 $106,550 $112,844
Less costs reclassified to revenues - 3,961 - 17,641
Net power purchased reported $ 31,702 $ 27,912 $106,550 $ 95,203
In May 2003, the Financial Accounting Standards Board issued Statement of
SFAS No. 150, Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity. SFAS No. 150 is effective
immediately for financial instruments entered into or modified after May
31, 2003, and otherwise is effective for interim reporting periods
beginning after September 15, 2003.
LG&E has existing $5.875 series mandatorily redeemable preferred stock with
250,000 shares outstanding having a current redemption price of $100 per
share. The preferred stock has a sinking fund requirement sufficient to
retire a minimum of 12,500 shares on July 15 of each year commencing with
July 15, 2003, and a minimum of 187,500 shares on July 15, 2008 at $100 per
share. Beginning with the three months ended September 30, 2003, LG&E
reclassified, at fair value, its $5.875 series preferred stock as long-term
debt with the minimum shares mandatorily redeemable within one year
classified as current portion of long-term debt. Dividends accrued
beginning July 1, 2003 are charged as interest expense.
KU has no financial instruments that fall within the scope of SFAS No. 150.
Contingencies
For a description of significant contingencies that may affect LG&E and KU,
reference is made to Part I, Item 3, Legal Proceedings in LGE's and KU's
Annual Reports on Form 10-K for the year ended December 31, 2002; and
Note 11 to the financial statements contained in LG&E's and KU's
current report on Form 8-K dated November 12, 2003; and to
Part II - Item 1, Legal Proceedings herein.
Merger Surcredit
As part of the LG&E Energy merger with KU Energy in 1998, LG&E Energy
estimated non-fuel savings over a ten-year period following the merger.
Costs to achieve these savings of $50.2 million for LG&E and of $42.3
million for KU were recorded in the second quarter of 1998. Of these
Page 30
amounts $18.1 million for LG&E and $20.5 million for KU was deferred and
amortized over a five-year period pursuant to regulatory orders. Primary
components of the merger costs were separation benefits, relocation costs,
and transaction fees, the majority of which were paid by December 31, 1998.
LG&E and KU expensed the remaining costs associated with the merger ($32.1
million and $21.8 million, respectively) in the second quarter of 1998.
In approving the merger, the Kentucky Commission adopted the Companies'
proposal to reduce its retail customers' bills based on one-half of the
estimated merger-related savings, net of deferred and amortized amounts,
over a five-year period. The surcredit mechanism provided that 50% of the
net non-fuel cost savings estimated to be achieved from the merger be
provided to ratepayers through a monthly bill credit, and 50% be retained
by the Companies, over a five-year period. The surcredit was allocated 53%
to KU and 47% to LG&E. In that same order, the Kentucky Commission
required LG&E and KU, after the end of the five-year period, to present a
plan for sharing with customers the then-projected non-fuel savings
associated with the merger. The Companies submitted this filing on January
13, 2003, proposing to continue to share with customers, on a 50%/50%
basis, the estimated fifth-year gross level of non-fuel savings associated
with the merger.
On October 16, 2003, the Kentucky Commission approved a merger surcredit
settlement whereby the surcredit mechanism will remain in place for an
additional five-year period at a levelized amount per year calculated from
the originally estimated non-fuel savings for years six through ten.
Customers and shareholders will continue to equally share merger savings on
a 50%/50% basis and LG&E's customers will continue to be allocated 47%, and
KU's customers will continue to be allocated 53%, of the customers' portion
of the merger savings. As a part of the settlement, certain customers, in
lieu of receiving monthly credits, will receive the present value of their
estimated surcredits in up-front payments. These payments, $6.9 million
for LG&E and $5.3 million for KU, will be deferred and amortized over the
five-year period starting July 1, 2003, pursuant to the order. Remaining
LG&E and KU customers will receive credits totaling $18.0 million and $17.9
million, respectively, in each of the five years beginning July 1, 2003.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
LG&E and KU are exposed to market risks. Both operations are exposed to
market risks from changes in interest rates and commodity prices. To
mitigate changes in cash flows attributable to these exposures, the
Companies have entered into various derivative instruments. Derivative
positions are monitored using techniques that include market value and
sensitivity analysis.
The Companies use interest rate swaps to hedge exposure to market
fluctuations in certain of their debt instruments. Pursuant to the
Companies' policies, use of these financial instruments is intended to
mitigate risk and earnings volatility and is not speculative in nature.
Management has designated all of the Companies' interest rate swaps as
hedge instruments. Financial instruments designated as cash flow hedges
have resulting gains and losses recorded within other comprehensive income
and stockholders' equity. To the extent a financial instrument or the
underlying item being hedged is prematurely terminated or the hedge becomes
ineffective, the resulting gains or losses are reclassified from other
comprehensive income to net income. Financial instruments designated as
fair value hedges are periodically marked to market with the resulting
gains and losses recorded directly into net income to correspond with
income or expense recognized from changes in market value of the items
being hedged.
The potential change in interest expense associated with a 1% change in
base interest rates of LG&E's and KU's unswapped debt is estimated at $4.6
million and $5.0 million, respectively, at September 30, 2003. LG&E's
exposure to floating interest rates decreased $89.3 million and KU's
exposure to floating interest rates decreased $20.8 million during the
first nine months of 2003. The potential changes in the fair values of the
Companies' interest-rate swaps resulting from changes in interest rates and
the yield curve also did not change materially during the first nine months
of 2003.
Page 31
Pension Risk
LG&E's and KU's costs of providing defined-benefit pension retirement plans
are dependent upon a number of factors, such as the rates of return on plan
assets, discount rate, and contributions made to the plans. The market
value of LG&E and KU plan assets is affected by increases and
decreases in the equity market. As a result, at
December 31, 2002, LG&E and KU were required to recognize an additional
minimum liability as prescribed by SFAS No. 87, Employers' Accounting for
Pensions. The liability was recorded as a reduction to other comprehensive
income, and did not affect net income for 2002. The amount of the
liabilities depended upon the asset returns experienced in 2002 and
contributions made by LG&E and KU to the plans during 2002. Also, pension
cost and cash contributions to the plans could increase in future years
without a substantial recovery in the equity markets. If the fair value of
the plans' assets exceeds the accumulated benefit obligation, the recorded
liabilities will be reduced and other comprehensive income will be restored
in the consolidated balance sheets.
During 2002, the combination of poor market performance and historically
low corporate bond rates created a divergence in the potential value of the
pension liabilities and the actual value of the pension assets.
Year-to-date 2003 market performance has been favorable. Should
poor market conditions return, these conditions could result in an increase
in LG&E's and KU's funded accumulated benefit obligations and future
pension expense. The primary assumptions that drive the value of the
unfunded accumulated benefit obligations are the discount rate and expected
return on plan assets.
In January 2003, LG&E and KU made contributions to their pension plans of
$83.1 million and $3.5 million, respectively. In August 2003, LG&E and KU
contributed an additional $6.0 million each to their respective pension
plans.
Energy Trading & Risk Management Activities
LG&E and KU conduct energy trading and risk management activities to
maximize the value of power sales from physical assets they own, in
addition to the wholesale sale of excess asset capacity. Certain energy
trading activities are accounted for on a mark-to-market basis in
accordance with SFAS No. 133, Accounting for Derivative Instruments and
Hedging Activities, and SFAS No. 138, Accounting for Certain Derivative
Instruments and Certain Hedging Activities. Wholesale sales of excess
asset capacity are treated as normal sales under SFAS No. 133 and SFAS No.
138 and are not marked to market.
The rescission of EITF No. 98-10 for fiscal periods ending after December
15, 2002, had no impact on LG&E's or KU's energy trading and risk
management reporting as all contracts marked to market under EITF No. 98-10
are also within the scope of SFAS No. 133.
The table below summarizes LG&E's and KU's energy trading and risk
management activities for the three months and nine months ended September
30, 2003, and 2002(in thousands of $). Trading volumes are allocated
evenly between LG&E and KU.
Three Months Nine Months
Ended Ended
September 30, September 30,
2003 2002 2003 2002
Fair value of contracts at beginning of
period, net asset/(liability) $318 $ 26 $ (156) $(186)
Fair value of contracts when entered
into during the period (30) (5) 2,590 (62)
Contracts realized or otherwise
settled during the period (356) 6 (639) 341
Changes in fair value due to changes
in assumptions 148 (193) (1,715) (259)
Fair value of contracts at end of period,
net asset/(liability) $ 80 $(166) $ 80 $(166)
Page 32
No changes to valuation techniques for energy trading and risk management
activities occurred during 2003 or 2002. Changes in market pricing,
interest rate and volatility assumptions were made during all periods. All
contracts outstanding at September 30, 2003, have a maturity of less than
one year and are valued using prices actively quoted for proposed or
executed transactions or quoted by brokers.
LG&E and KU maintain policies intended to minimize credit risk and revalue
credit exposures daily to monitor compliance with those policies. As of
September 30, 2003, 100% of the trading and risk management commitments
were with counterparties rated BBB-/Baa3 equivalent or better.
Deregulation
The electricity industry in Virginia is currently undergoing deregulation
which will enable customers to choose their own energy suppliers after
January 2004. On March 19, 2003, the Governor of Virginia signed House
Bill 2367, the "Electric Utility Restructuring Suspension," which suspends
Kentucky Utilities/Old Dominion Power from Virginia electric utility
restructuring until such time as retail choice is offered to other
customers in KU's other service territories.
Employee and Labor Relations
In August 2003, KU and employees represented by IBEW Local 2100 entered
into a three-year collective bargaining agreement expiring August 2006,
with certain annual wage or benefit re-opener provisions. In October 2003,
LG&E and employees represented by IBEW 2100 completed primary wage and
benefits re-opener negotiations providing for certain enhanced or modified
wage and benefit provisions. The term of this collective bargaining
agreement expires in November 2005.
Item 4. Controls and Procedures.
LG&E and KU maintain a system of disclosure controls and procedures
designed to ensure that information required to be disclosed by the
Companies in reports they file or submit under the Securities Exchange Act
of 1934 is recorded, processed, summarized and reported, within the time
periods specified in the Securities and Exchange Commission rules and
forms. LG&E and KU conducted an evaluation of such controls and procedures
under the supervision and with the participation of the Companies'
management, including the Chairman, President and Chief Executive Officer
("CEO") and the Chief Financial Officer ("CFO"). Based upon that
evaluation, the CEO and CFO are of the conclusion that the Companies'
disclosure controls and procedures are effective as of the end of the
period covered by this report. There has been no change in the Companies'
internal control over financial reporting that occurred during the fiscal
quarter ended September 30, 2003, that has materially affected, or is
reasonably likely to materially affect, the Companies' internal control
over financial reporting.
Page 33
Part II. Other Information
Item 1. Legal Proceedings.
For a description of the significant legal proceedings involving LG&E and
KU, reference is made to the information under the following items and
captions of LG&E's and KU's (A) respective combined Annual Report on Form
10-K for the year ended December 31, 2002: Item 1, Business; Item 3, Legal
Proceedings; Item 7, Management's Discussion and Analysis of Financial
Condition and Results of Operations; and (B) current report on Form 8-K
dated November 12, 2003: Notes 3 and 11 of LG&E's Notes to Financial
Statements under Item 8 and Notes 3 and 11 of KU's Notes to Financial
Statements under Item 8; and (BC) respective combined Quarterly Report on
Form 10-Q for the quarter ended June 30, 2003: Item 1 of Part II Legal
Proceedings. Except as described herein, to date, the proceedings reported
in LG&E's and KU's respective combined Annual Report on Form 10-K have not
changed materially.
LG&E Employment Discrimination Case
As previously reported, in October 2001, approximately 30 employees or
former employees filed a complaint against LG&E claiming past and current
instances of employment discrimination. LG&E has removed the case to the
U.S. District Court for the Western District of Kentucky and filed an
answer denying all plaintiffs' claims. Discovery has commenced in the
matter. The court has ordered mediation and certain plaintiffs have
settled for immaterial amounts as a result of that process. In
addition, certain other plaintiffs have sought administrative review before
the U.S. Equal Employment Opportunity Commission which has, to date,
declined to proceed to litigation on any claims reviewed. Previously
amended pleadings, while reducing the size of the plaintiff and defendant
groups and eliminating certain prior demands, contain a claimed damage
amount of $100 million as well as requests for injunctive relief. During
mediation in 2003, additional settlements for immaterial amounts were
reached with a number of plaintiffs, including a settlement with the lead
plaintiff, which reduced the number of remaining plaintiffs to nine. LG&E
intends to continue to defend itself vigorously in the remaining action and
management does not anticipate that the outcome will have a material impact
on LG&E's operations or financial condition.
Combustion Turbine Litigation
In October 2003, LG&E and KU and third parties completed a settlement
agreement to dismiss the Companies' previously reported lawsuit in the U.S.
District Court for the Eastern District of Kentucky against Alstom Power,
Inc. (formerly ABB Power Generation, Inc.). The suit concerned operational
deficiencies of two combustion turbines supplied by Alstom during 1999,
installed at KU's E.W. Brown plant and jointly owned by LG&E and KU. The
settlement agreement provides for $20 million reimbursement in two
installments to be paid in January and April 2004 to LG&E and KU for the
Companies' expenditures incurred regarding the turbines. The parties also
entered into a long-term service agreement, whereby Alstom will provide to
LG&E and KU certain future inspections, repairs and services for the
turbines.
Item 6. Exhibits and Reports on Form 8-K.
6(a) Applicable to Form
10-Q of
Exhibit
No. LG&E KU Description
31 X X Certification - Section 302 of Sarbanes-Oxley Act of 2002
31.1 X Certification of Chairman of the Board, President and Chief
Executive Officer, pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
31.2 X Certification of Chief Financial Officer, pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
Page 34
31.3 X Certification of Chairman of the Board, President and Chief
Executive Officer, pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
31.4 X Certification of Chief Financial Officer, pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
32 X X Certification pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
6(b). Reports on Form 8-K.
None
Page 35
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Louisville Gas and Electric Company
Registrant
Date: November 12, 2003 /s/ S. Bradford Rives
S. Bradford Rives
Chief Financial Officer
(On behalf of the registrant in his
capacities as Principal Financial Officer
and Principal
Accounting Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Kentucky Utilities Company
Registrant
Date: November 12, 2003 /s/ S. Bradford Rives
S. Bradford Rives
Chief Financial Officer
(On behalf of the registrant in his
capacities as Principal Financial Officer
and Principal
Accounting Officer)
Page 36
Exhibit 31 - CERTIFICATIONS
Exhibit 31.1
Louisville Gas and Electric Company
I, Victor A. Staffieri, Chairman of the Board, President and Chief
Executive Officer, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Louisville
Gas and Electric Company;
2. Based on my knowledge, this report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this report;
3. Based on my knowledge, the financial statements, and other
financial information included in this report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
report;
4. The registrant's other certifying officer(s) and I are responsible
for establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant
and have:
(a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures and presented in this report our conclusions
about the effectiveness of the disclosure controls and procedures, as
of the end of the period covered by this report based on such
evaluation; and
(c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
most recent fiscal quarter (the registrant's fourth fiscal quarter in
the case of an annual report) that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting; and
5. The registrant's other certifying officer(s) and I have disclosed,
based on our most recent evaluation of internal control over financial
reporting, to the registrant's auditors and the audit committee of the
registrant's board of directors (or persons performing the equivalent
functions):
(a) All significant deficiencies and material weaknesses in the design
or operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
Date: November 12, 2003
/s/ Victor A. Staffieri
Victor A. Staffieri
Chairman of the Board, President and Chief Executive Officer
Page 37
Exhibit 31.2
Louisville Gas and Electric Company
I, S. Bradford Rives, Chief Financial Officer, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Louisville
Gas and Electric Company;
2. Based on my knowledge, this report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this report;
3. Based on my knowledge, the financial statements, and other
financial information included in this report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
report;
4. The registrant's other certifying officer(s) and I are responsible
for establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant
and have:
(a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
(c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
most recent fiscal quarter (the registrant's fourth fiscal quarter in
the case of an annual report) that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting; and
5. The registrant's other certifying officer(s) and I have disclosed,
based on our most recent evaluation of internal control over financial
reporting, to the registrant's auditors and the audit committee of the
registrant's board of directors (or persons performing the equivalent
functions):
(a) All significant deficiencies and material weaknesses in the design
or operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
Date: November 12, 2003
/s/ S. Bradford Rives
S. Bradford Rives
Chief Financial Officer
Page 38
Exhibit 31.3
Kentucky Utilities Company
I, Victor A. Staffieri, Chairman of the Board, President and Chief
Executive Officer, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Kentucky
Utilities Company;
2. Based on my knowledge, this report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this report;
3. Based on my knowledge, the financial statements, and other
financial information included in this report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
report;
4. The registrant's other certifying officer(s) and I are responsible
for establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant
and have:
(a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
(c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
most recent fiscal quarter (the registrant's fourth fiscal quarter in
the case of an annual report) that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting; and
5. The registrant's other certifying officer(s) and I have disclosed,
based on our most recent evaluation of internal control over financial
reporting, to the registrant's auditors and the audit committee of the
registrant's board of directors (or persons performing the equivalent
functions):
(a) All significant deficiencies and material weaknesses in the design
or operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
Date: November 12, 2003
/s/ Victor A. Staffieri
Victor A. Staffieri
Chairman of the Board, President and Chief Executive Officer
Page 39
Exhibit 31.4
Kentucky Utilities Company
I, S. Bradford Rives, Chief Financial Officer, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Kentucky
Utilities Company;
2. Based on my knowledge, this report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this report;
3. Based on my knowledge, the financial statements, and other
financial information included in this report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
report;
4. The registrant's other certifying officer(s) and I are responsible
for establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant
and have:
(a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
(c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
most recent fiscal quarter (the registrant's fourth fiscal quarter in
the case of an annual report) that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting; and
5. The registrant's other certifying officer(s) and I have disclosed,
based on our most recent evaluation of internal control over financial
reporting, to the registrant's auditors and the audit committee of the
registrant's board of directors (or persons performing the equivalent
functions):
(a) All significant deficiencies and material weaknesses in the design
or operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
Date: November 12, 2003
/s/ S. Bradford Rives
S. Bradford Rives
Chief Financial Officer
Page 40
Exhibit 32
Certification Pursuant to 18 U.S.C. Section 1350
As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
In connection with the Quarterly Report of Louisville Gas and
Electric Company and Kentucky Utilities Company (the "Companies") on Form
10-Q for the period ended September 30, 2003, as filed with the Securities
and Exchange Commission (the "Report"), each of the undersigned does hereby
certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002, that, to such officer's knowledge,
1) The Report fully complies with the requirements of Section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
2) The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations of the
Companies as of the dates and for the period expressed in the Report.
November 12, 2003
/s/ Victor A. Staffieri
Chairman of the Board, President
and Chief Executive Officer
Louisville Gas and Electric Company
Kentucky Utilities Company
/s/ S. Bradford Rives
Chief Financial Officer
Louisville Gas and Electric Company
Kentucky Utilities Company
The foregoing certification is being furnished solely pursuant to 18 U.S.C.
Section 1350 and is not being filed as part of the Report or as a separate
disclosure document.
Page 41