EXHIBIT 13
21
CONSOLIDATED STATEMENTS OF INCOME AND RETAINED EARNINGS
- -----------------------------------------------------------------------------------------------------
For The Years Ended December 31, 1997 1996 1995
(millions, except per share amounts)
Operating revenues and income:
Virginia Power $5,079.0 $4,420.9 $4,351.9
East Midlands 1,970.1
Nonutility 628.5 433.1 281.2
----------------------------------
Total operating revenues and income 7,677.6 4,854.0 4,633.1
----------------------------------
Operating expenses:
Fuel, net 1,620.7 1,016.6 1,009.7
Purchased power capacity, net 717.5 700.6 688.4
Supply and distribution--East Midlands 1,466.1
Accelerated cost recovery 38.4 26.7
Restructuring 18.4 64.9 121.5
Other operation and maintenance 1,237.7 1,045.3 968.6
Depreciation, depletion and amortization 819.3 615.2 551.0
Other taxes 282.5 274.9 267.5
----------------------------------
Total operating expenses 6,200.6 3,744.2 3,606.7
----------------------------------
Operating income 1,477.0 1,109.8 1,026.4
----------------------------------
Other income and expense:
Virginia Power 14.2 6.8 10.0
East Midlands 10.9
Nonutility 8.6 17.8 13.6
Windfall profits tax--East Midlands (156.6)
----------------------------------
Total other income and expense (122.9) 24.6 23.6
----------------------------------
Income before fixed charges and income taxes 1,354.1 1,134.4 1,050.0
----------------------------------
Fixed charges:
Interest charges, net 627.4 387.0 381.7
Distributions--preferred securities of subsidiary trusts 12.1 10.9 3.7
Preferred dividends of Virginia Power 35.8 35.5 44.1
----------------------------------
Total fixed charges 675.3 433.4 429.5
----------------------------------
Income before provision for income taxes and minority interests 678.8 701.0 620.5
Provision for income taxes 233.0 219.3 187.1
Minority interests 46.6 9.6 8.4
----------------------------------
Net income $399.2 $472.1 $425.0
Retained earnings, January 1 1,437.9 1,427.6 1,455.2
Common dividends and other deductions:
Dividends (478.0) (460.1) (448.7)
Other deductions (5.1) (1.7) (3.9)
----------------------------------
Retained earnings, December 31 $1,354.0 $1,437.9 $1,427.6
----------------------------------
Earnings per common share $2.15 $2.65 $2.45
----------------------------------
Dividends paid per common share $2.58 $2.58 $2.58
----------------------------------
Average common shares outstanding 185.2 178.3 173.8
----------------------------------
The accompanying notes are an integral part of the Consolidated Financial
Statements.
22
MANAGEMENT'S DISCUSSION AND ANALYSIS OF OPERATIONS
(unaudited)
Introduction
In Management's Discussion and Analysis (MD&A) we explain the general financial
condition and the results of operations for Dominion Resources and its
subsidiaries. As you read this section, it may be helpful to refer to our
consolidated financial statements and notes. The MD&A is important when making
investment decisions about Dominion Resources.
In 1983, Dominion Resources began a diversification strategy to enable the
company to make investments in nonutility businesses. These diversified
businesses--Dominion Energy and Dominion Capital--operate in competitive
environments. There is no monopoly or regulated rate of return on investments as
you currently find in our core electric utility business, Virginia Power. Such a
move changes the risk profile of a company and provides the opportunity to
achieve returns above those found in a regulated business.
The investments outside of Virginia Power during 1997 accounted for
approximately 20 percent of the consolidated company's earnings from operations.
The recent acquisition of East Midlands Electricity plc (East Midlands) in the
U.K. adds a strong international utility to our portfolio of companies. East
Midlands is the principal operating subsidiary of our U.K. holding company,
Dominion U.K. Holding, Inc. (Dominion UK).
As the electric utility industry is significantly changing in many states
across the nation, Dominion Resources is working with its state legislators and
regulators to move the restructuring process towards a workable form of
competition in Virginia. The generation business of Virginia Power--representing
about 50 percent of its assets--may become deregulated at some point in the
future, depending on legislative and regulatory action. Customers in Virginia
and North Carolina currently have low electricity costs relative to regional and
national electricity prices. But management believes that competition can bring
benefits to both consumers and the company. These matters are discussed in more
detail on page 26 of the MD&A report.
Both Virginia Power and East Midlands enjoy above average customer growth
in their respective service areas. Virginia Power has strong plant operations
and is recognized as a leader in low-cost generation. East Midlands receives
approximately 85 percent of its operating profit from its regulated distribution
business--which is the transfer of electricity across its low voltage
distribution system to consumers. Virtually all of the remainder comes from its
supply business--purchasing electricity and arranging for its distribution to
end users. Management's strategy is to continue building on the fundamental
strengths at Virginia Power and East Midlands while growing its nonutility
businesses in power generation, natural gas production, and financial services.
Overview
Dominion Resources achieved earnings from operations of $555.8 million in 1997
or $3.00 per average common share, compared with earnings of $472.1 million in
1996 or $2.65 per share. The 1997 figure excludes a one-time windfall profits
tax of $156.6 million, or 85 cents per share, incurred at East Midlands. Below
we have provided a comparison of net income and earnings per share contributions
by company along with reasons for the changes in these contributions.
NET INCOME
- ---------------------------------------------------------------------------
1997 Change 1996 Change 1995
(millions)
Virginia Power $433.4 2.8% $421.8 8.5% $388.7
Dominion UK 46.9
Dominion Energy 45.0 38.5% 32.5 (7.1)% 35.0
Dominion Capital 45.1 58.2% 28.5 61.9% 17.6
Corporate (14.6) (36.4)% (10.7) 34.4% (16.3)
------ ------ ------
555.8 17.7% $472.1 11.1% $425.0
Windfall Profits Tax--
East Midlands (156.6)
------ ------ ------
Consolidated $399.2 (15.4)% $472.1 11.1% $425.0
------ ------ ------
Shares 185.2 3.9% 178.3 2.6% 173.8
--------------------------------------------------
EARNINGS PER SHARE
- ---------------------------------------------------------------------------
1997 Change 1996 Change 1995
Virginia Power $2.34 (1.3)% $2.37 5.8% $2.24
Dominion UK .25
Dominion Energy .24 33.3% .18 (10.0)% .20
Dominion Capital .24 50.0% .16 60.0% .10
Corporate (.07) (16.7)% (.06) 33.3% (.09)
------ ------ ------
$3.00 13.2% $2.65 8.2% $2.45
Windfall Profits Tax--
East Midlands (.85)
------ ------ ------
Consolidated $2.15 (18.9)% $2.65 8.2% $2.45
--------------------------------------------------
The 1997 results as compared to 1996 were affected by a number of factors
described below:
VIRGINIA POWER
Earnings were impacted by:
o mild weather which caused a decrease in electricity sales to retail
customers, partially offset by continued customer growth in the Virginia and
North Carolina service areas;
o an increase in sales from non-traditional businesses, including power
marketing, natural gas, and energy products and services;
o higher purchased power expenses as a result of increased power marketing and
higher operation and maintenance expenses, reflecting the growth in the
costs of products and services offered by the new energy services business;
o lower restructuring expenses;
o a reserve for potential adjustments to regulatory assets; and
o higher depreciation of plant and equipment, higher decommissioning expenses
for the future retirement of nuclear plants, and depreciation related to
Clover Unit 2--the company's newest coal-fired station.
23
DOMINION UK
Earnings were impacted by:
o an anticipated one-time windfall profits tax levied on East Midlands and
other utilities in Britain as part of the newly elected Labour Party's 1997
budget plan.
DOMINION ENERGY
Earnings were impacted by:
o an increase in natural gas production, resulting partly from the acquisition
of Wolverine Gas and Oil in Michigan, and overall higher natural gas prices;
and
o an increase in generation from its power plants in Latin America, resulting
from more normal water flows at its hydro plants and the acquisition of
power generation assets in Peru in the latter half of 1996.
DOMINION CAPITAL
Earnings were impacted by:
o an increase in loan production and securitizations from Saxon Mortgage, the
financial services business which originates non-conforming (or sub-prime)
residential mortgages and sells them--through securitization
transactions--to institutional investors.
o the purchase of the remaining 50 percent of First Source Financial, a
Chicago-based lender to middle-market industries.
Virginia Power
Results of Operations
Virginia Power's balance available for common stock for 1997 amounted to $433.4
million as compared to $421.8 million in 1996. The earnings were impacted by
customer growth and lower restructuring expenses, partially offset by higher
depreciation and amortization expenses and the provision of a reserve for
potential adjustments to regulatory assets. Virginia Power's contribution to
earnings per share in 1997 amounted to $2.34 compared to $2.37 in 1996 due to
the dilutive impact of common stock issuances by Dominion Resources during 1997.
In 1996, Virginia Power reported a $33.1 million increase in balance
available for common stock when compared to the 1995 results of $388.7 million.
The increase was primarily due to lower restructuring expenses in 1996.
- --------------------------------------------------------------------------------
1997 Change 1996 Change 1995
(millions)
Operating revenues $5,079.0 14.9% $4,420.9 1.6% $4,351.9
Operating expenses:
Fuel and purchased
power, net 2,338.2 36.2% 1,717.2 1.1% 1,698.1
Other operation and
maintenance 812.7 1.2% 803.1 (0.3)% 805.6
Accelerated cost
recovery 38.4 43.8% 26.7
Restructuring 18.4 (71.6)% 64.9 (45.0)% 117.9
Depreciation and
amortization 584.3 8.9% 536.4 6.5% 503.5
Other taxes 267.7 1.9% 262.6 3.0% 254.9
-------- -------- --------
Operating income 1,019.3 0.9% 1,010.0 3.9% 971.9
Other income 14.2 108.8% 6.8 (32.0)% 10.0
Fixed charges,
including preferred
dividends 350.8 (1.1)% 354.8 (3.0)% 365.7
Income taxes 249.3 3.8% 240.2 5.6% 227.5
-------- -------- --------
Balance available for
common stock $ 433.4 2.8% $ 421.8 8.5% $ 388.7
-------------------------------------------------------
As detailed in the chart on the next page, the overall growth in revenues in
1997 reflects strong wholesale power marketing and natural gas sales. Electric
service revenues increased slightly in spite of mild weather due to new customer
connections and an increase in fuel rates. The increase in fuel revenues is
primarily attributable to higher fuel rates which went into effect December 1,
1996, increasing recovery of fuel costs by approximately $48.2 million. In
addition, revenues increased as a result of the company's strategy to develop
non-traditional business opportunities designed to provide growth in revenues.
These include sales of energy products and services offered by Virginia Power's
energy services business and nuclear management and operations services offered
to other electric utilities.
Revenues increased in 1996, as compared to 1995, due to increased power
marketing, sales of natural gas and sales of other energy products and services
by Virginia Power's energy services business. This increase in revenues was
offset in part by a decrease in electric service revenues, resulting from the
effect of mild weather on the company's summer retail rates, which are designed
to reflect normal weather conditions. The reduction in revenues from the mild
weather was offset in part by revenues from new customers. Other electric
service revenues decreased primarily as a result of reduced sales to Old
Dominion Electric Cooperative (ODEC) due to the completion of Clover Units 1 and
2, of which ODEC owns a fifty percent interest.
24
Increase
(decrease)
OPERATING REVENUES from prior year
- ----------------------------------------------------------------------------
1997 1996
(millions)
Customer growth $ 55.8 $ 45.1
Weather (111.1) 4.4
Base rate variance (18.7) (35.5)
Fuel rate variance 44.1 (89.6)
Other, net 47.7 41.5
------- ------
Total retail 17.8 (34.1)
Other electric service 11.0 (49.8)
------- ------
Total electric service 28.8 (83.9)
------- ------
Wholesale power marketing 363.4 96.6
Natural gas 232.6 33.2
Other, including energy products and services 33.3 23.1
------- ------
Total other revenues 629.3 152.9
------- ------
Total revenues $ 658.1 $ 69.0
--------------------
During 1997, Virginia Power added 50,899 new customers, the largest number of
new connections since 1990, compared to 44,528 and 44,955 in 1996 and 1995,
respectively.
KILOWATT-HOUR SALES
- ---------------------------------------------------------------------------
1997 Change 1996 Change 1995
(millions)
Retail sales 61,997 (0.5)% 62,298 2.4% 60,865
Wholesale 23,965 117.5% 11,020 36.3% 8,088
------ ------ ------
Total sales 85,962 17.2% 73,318 6.3% 68,953
--------------------------------------------------
DEGREE-DAYS CHART
- ---------------------------------------------------------------------------
1997 1996 Normal
Cooling degree days 1,349 1,365 1,530
Percentage change compared to prior year (1.2)% (18.1)%
Heating degree days 3,787 4,131 3,726
Percentage change compared to prior year (8.3)% 9.0%
---------------------------
Fuel and purchased power, net increased due to higher volumes of purchased
power. Virginia Power has significantly increased its marketing efforts to
generate more sales of electric energy to wholesale customers and more sales of
natural gas.
Other operation and maintenance expenses increased in 1997 as a result of
the growth in sales by the company's energy services business. This increase was
partially offset by a reduction in expenses attributable to Virginia Power's
Vision 2000 initiatives to take costs out of the core (traditional) utility
business. Expenses in 1996 include high storm damage costs resulting from
destructive summer storms, including Hurricane Fran.
Virginia Power embarked on its Vision 2000 restructuring program in 1995
as part of an initiative to prepare for competition in the electric utility
industry. Charges of $18.4 million in 1997 primarily include employee severance
costs and costs to renegotiate contracts to purchase power from third parties.
Charges in 1996 and 1995 were $64.9 million and $117.9 million, respectively
(see Note N). Virginia Power estimates that its restructuring efforts will
result in future annual savings of $80 million to $90 million. However, such
savings are being offset by salary increases, outsourcing costs and increased
payroll costs associated with staffing for growth opportunities. While Virginia
Power may incur additional restructuring charges in 1998, the amounts are not
expected to be significant.
In this increasingly competitive environment, Virginia Power has concluded
that it may be appropriate to utilize available savings and cost reductions,
such as those from the Vision 2000 program, to accelerate the write-off of
unamortized regulatory assets and potentially stranded costs (see Note O). As of
December 31, 1997, Virginia Power has accumulated a reserve of $65.1 million.
Not only will this strategically position Virginia Power in anticipation of
competition, but it also reflects management's commitment to mitigate its
exposure to potentially stranded costs.
Depreciation and amortization increased in 1997, as compared to 1996, due
to additional depreciation and nuclear decommissioning expense and depreciation
related to Clover Unit 2 - the company's newest coal-fired station. Virginia
Power recorded additional depreciation and decommissioning expense consistent
with its proposal in the rate proceeding before the Virginia Commission (see
Note Q ).
Dominion UK
RESULTS OF OPERATIONS
Dominion UK earned $46.9 million, or 25 cents per share, in 1997. The 1997
figure excludes a one-time windfall profits tax of $156.6 million, or 85 cents
per share, incurred at East Midlands. The anticipated one-time windfall profits
tax was levied on East Midlands and other utility companies in Britain as part
of the newly elected Labour Party's 1997 budget plan. Including the windfall
profits tax, Dominion UK reported a net loss of $109.7 million, or 60 cents per
share.
- --------------------------------------------------------
1997
(millions)
Operating income:
Distribution $ 333.7
Supply 35.4
Other (122.5)
-------
Total operating income 246.6
-------
Other income and expense:
Other 10.8
Windfall profits tax (156.6)
Fixed charges 189.4
Income taxes 21.1
-------
Net income $(109.7)
-------
Dominion Energy
NEW BUSINESSES
Dominion Energy has expanded its oil and natural gas business through the
development of existing assets and the acquisition of Wolverine Gas and Oil
Company, now known as Dominion Midwest Energy, Inc., and the related entities
(Dominion Midwest), effective as of January 1997. Dominion Midwest is an oil and
gas production and operation company headquartered in Grand Rapids, Michigan.
25
Dominion Energy expects to expand its domestic power generation in the
first quarter of 1998 with the acquisition of the Kincaid generating station, an
1,108-megawatt facility located in Illinois. In addition, Dominion Energy
expects to expand its foreign power generation businesses with the completion of
certain capital expansion activities.
RESULTS OF OPERATIONS
Dominion Energy's net income amounted to $45.0 million as compared to $32.5
million in 1996. The increase in earnings was due primarily to net income from
power generation assets in Peru acquired in August 1996, generally higher
natural gas prices and greater production volumes due to the acquisition of
natural gas properties in the Gulf Coast area in March 1996, and in Michigan in
January 1997.
In 1996, net income decreased by $2.5 million when compared to 1995
primarily due to the sale of the Black Warrior Trust Units in 1995. The sale of
the units, which hold royalty interests in proven, developed natural gas
properties, provided a net gain of $5.4 million in 1995.
- ---------------------------------------------------------------------------
1997 Change 1996 Change 1995
(millions)
Operating income:
Oil and gas(1) $59.4 42.4% $41.7 68.1% $24.8
Domestic power
generation (3.4) (136.2)% 9.4 (40.5)% 15.8
Foreign power
generation 55.3 66.6% 33.2 16.5% 28.5
Corporate(2) (3.3) 77.6% (14.7) (90.9)% (7.7)
Adjustments(1) (25.3) 4.5% (26.5) 6.0% (28.2)
----- ----- -----
Total operating income $82.7 91.9% $43.1 29.8% $33.2
-------------------------------------------------
(1) Oil and gas Operating Income includes Nonconventional Fuels Tax Credits.
Such credits are reversed on the Adjustments line as they are not ordinarily
reported as a component of Operating Income.
(2) Represents corporate overhead charges.
OPERATING INCOME
Oil and gas operating income increased $17.7 million and $16.9 million for the
1997 and 1996 periods, respectively. The results reflect a significant increase
in the level of oil and gas produced due to the development and acquisition of
properties during 1997 and 1996. Natural gas production rose to 59.0 billion
cubic feet equivalent (Bcfe) in 1997, compared to 50.2 Bcfe in 1996, an 18
percent increase. At December 31, 1997, proved gas reserves totaled 460 Bcfe.
Proved gas reserves increased 60 Bcfe (15%) during 1997, primarily from the
development of existing acreage and the acquisition of Wolverine Gas and Oil.
The production results for 1997 reflect a $2.50 average gas sales price per
thousand cubic feet equivalent (Mcfe), which increased $.18 per Mcfe compared to
1996. The production results for 1996 reflect a $2.32 average gas sales price
per Mcfe, compared to $1.93 per Mcfe in 1995.
Domestic power generation operating income decreased in 1997 primarily due
to the write-down of Dominion Energy's investment in two of its California
projects. The 1996 results reflect lower income contributions from the two
geothermal projects in California due to scheduled ownership reductions.
Foreign power generation operating income increased $22.1 million and $4.7
million for the 1997 and 1996 periods, respectively. The 1997 increase results
from more normal water flows at hydro plants and the acquisition of an interest
in Egenor, a Peruvian power generation business, in August 1996. The 1996
increase results also from the Egenor acquisition and the acquisition of an
interest in Empresa Corani, a Bolivian power generation business, in July 1995.
Dominion Capital
NEW BUSINESSES
There were two significant enhancements to Dominion Capital's diversified
financial services strategy. In early 1997, Dominion Capital acquired the
remaining 50% of First Source Financial. It is anticipated that First Source
Financial, the Chicago-based lender to middle market industries, will increase
funded loans and loan commitments as a result of this transaction. Late in 1997,
Dominion Capital formed First Dominion Capital, an integrated merchant banking
and asset management business. First Dominion Capital expands Dominion Capital's
growth in financial services and is based in New York City.
RESULTS OF OPERATIONS
Dominion Capital's net income for 1997 amounted to $45.1 million as compared to
$28.5 million in 1996. The increase in earnings was primarily due to residential
mortgage loan securitizations performed by Saxon Mortgage and the acquisition of
the remaining 50 percent of First Source Financial that it did not already own.
In 1996, Dominion Capital reported an increase in net income of $10.9
million when compared to the 1995 results. The results were primarily due to
residential mortgage loan securitizations performed by Saxon Mortgage.
- ---------------------------------------------------------------------------
1997 Change 1996 Change 1995
(millions)
Operating income:
Financial services $143.5 103.5% $70.5 103.2% $34.7
Vidalia & real estate 13.6 40.2% 9.7 (34.5)% 14.8
------ ----- -----
Total operating
income $157.1 95.9% $80.2 62.0% $49.5
--------------------------------------------------
OPERATING INCOME
Financial services operating income increased by $73.0 million and $35.8 million
in the 1997 and 1996 periods, respectively. Both Saxon Mortgage and First Source
Financial benefitted from the healthy regional and national economies. Loan
volumes at Saxon were $1.8 billion in 1997, up from $754 million in 1996. In
addition, Dominion Capital purchased the remaining 50 percent interest in the
Chicago-based First Source Financial at the beginning of 1997. Funded and
committed loans at First Source Financial have grown to $1.4 billion at the end
of 1997, compared to $1.1 billion at the end of 1996. Financial services
operating income improved in 1996 compared to 1995 primarily due to the
acquisition of Saxon Mortgage.
26
Vidalia and real estate operating income increased in 1997 over 1996 by
$3.9 million due to higher water flow and improved real estate operations.
Operating income decreased in 1996 compared to 1995 primarily due to higher real
estate project costs.
Nonoperating Income and Expenses
OTHER INCOME AND EXPENSE
The windfall profits tax of $156.6 million resulted in a decline in net income
in 1997 by the same amount.
FIXED CHARGES
Interest charges increased in 1997 as a result of the additional debt associated
with the $2.2 billion acquisition of East Midlands. While Dominion Resources
financed the purchase with 100 percent interim debt, the final capital structure
calls for approximately 60 percent of the acquisition cost to be financed with
long-term debt (see "East Midlands Financing" on page 37).
Future Issues
This section discusses information that may have an impact on future operating
results. The Securities and Exchange Commission encourages companies to provide
forward-looking information because it provides investors with an insight into
management's outlook for the future. It should be noted that any forward-looking
information is expressly covered by the safe harbor rule for projections. For a
more detailed description of some of the uncertainties associated with
forward-looking information, please refer to the Forward-Looking Information
section on page 33.
VIRGINIA POWER
Competition in the Electric Industry--General
For most of this century, the structure of the electric industry in Virginia
Power's service territory and throughout the United States has been relatively
stable. Virginia Power has recently seen, however, federal and state
developments toward increased competition. Electric utilities have been required
to open up their transmission systems for use by potential wholesale
competitors. In addition, nonutility power producers now compete with electric
utilities in the wholesale generation market. At the federal level, retail
competition is under consideration. Some states have enacted legislation
requiring retail competition.
Today, Virginia Power faces competition in the wholesale market.
Currently, there is no general retail competition in Virginia Power's principal
service area. To the extent that competition is permitted, Virginia Power's
ability to sell power at prices that will allow it to recover its
prudently-incurred costs may be an issue. See Competition--Exposure to
Potentially Stranded Costs on page 28.
In response to competition, Virginia Power has successfully renegotiated
long term contracts with wholesale and large federal government customers. In
addition, the company has obtained regulatory approval of innovative pricing
proposals for large industrial customers. Rate concessions resulting from these
contract negotiations and innovative pricing proposals are expected to reduce
the company's 1998 revenues by approximately $40 million. To date, the company
has not experienced any material loss of load.
Virginia Power is actively participating in the legislative and regulatory
processes relating to industry restructuring. The company has also responded to
these trends toward competition by cutting its costs, re-engineering its core
business processes, and pursuing innovative approaches to servicing traditional
markets and future markets. In addition, Virginia Power is developing
"non-traditional" businesses designed to provide growth in future earnings.
These include the following businesses: wholesale power marketing, nuclear
management and operations services, telecommunications services and energy
services.
Competition--Wholesale
During 1997, sales to wholesale customers represented approximately 17 percent
of Virginia Power's total revenues from electric sales. Approximately 73 percent
of wholesale revenues resulted from Virginia Power's wholesale power marketing
efforts.
In July 1997, Virginia Power filed amendments to its existing rate tariff
with the Federal Energy Regulatory Commission (FERC) so it could make wholesale
sales at market-based rates. Under a FERC order conditionally accepting the
company's rates, Virginia Power began making market-based sales in 1997. FERC
set for hearing in June 1998 the issue of whether transmission constraints
limiting the transfer of power into the company's service territory provide
Virginia Power with generation dominance in localized markets. If FERC finds
that transmission constraints give Virginia Power generation dominance, it could
either revoke or limit the scope of the market-based rate authority.
Virginia Power has successfully negotiated a new power supply arrangement
with its largest wholesale customer. The new arrangement provides for a
transition from cost-based rates to market-based rates, subject to FERC
approval. Virginia Power estimates the reduced rates, offset in part by other
revenues which may be earned under the agreement, will decrease income before
taxes by approximately $38 million through 2005. Virginia Power anticipates that
additional contract negotiations with other wholesale customers will take place
in the future.
Competition--Retail
Currently, Virginia Power has the exclusive right to provide electricity at
retail within its assigned service territories in Virginia and North Carolina.
As a result, Virginia Power now only faces competition for retail sales if
certain of its business customers move into another utility service territory,
use other energy sources instead of electric power, or generate their own
electricity. However, both Virginia and North Carolina are considering
implementing retail competition.
27
Competition--Legislative Initiatives
Federal: The U.S. Congress is expected to consider federal legislation in the
near future authorizing or requiring retail competition. Virginia Power cannot
predict what, if any, definitive actions the Congress may take.
Virginia: The company is actively supporting, and the Virginia General Assembly
is actively considering in its current session, legislative proposals that would
address:
o specific dates for wholesale and retail competition in the state;
o establishment of a regional power exchange (RPX) to conduct competitive
auctions for the sale of electricity;
o establishment of an independent system operator (ISO) to control
transmission systems and ensure nondiscriminatory access to the transmission
grid;
o continued regulation of the distribution of electricity in assigned service
territories;
o deregulation of the generation of electricity;
o recovery of prudently incurred stranded costs; and
o consumer protection issues.
The General Assembly is scheduled to be in session through mid-March. The
company is unable to predict at this time whether or when any of the bills now
before the legislature will be enacted.
North Carolina: The 1997 Session of the North Carolina General Assembly created
a Study Commission on the Future of Electric Service in North Carolina. An
interim report is expected in 1998, with final recommendations to be made to the
1999 session of the North Carolina General Assembly.
Competition--Regulatory Initiatives
The Virginia Commission has also been actively interested in industry
restructuring and competition.
In 1995, the Commission instituted an ongoing generic investigation on
restructuring, resulting in a number of reports by its Staff covering such
issues as retail wheeling experiments and the status of wholesale power markets.
The Staff also submitted a report to the General Assembly calling for a
cautious, two-phase, five-year period to address restructuring issues. The
report acknowledged the need for direction from the Virginia legislature
concerning policy issues surrounding competition in the electric industry.
In late 1996 the Commission ordered Virginia Power to file studies and
reports on possible restructuring of the electric industry in Virginia. The
Commission also invited Virginia Power to submit a proposed alternative
regulatory plan with its filing. In March 1997, Virginia Power filed a two-phase
alternative regulatory plan (ARP). The plan as filed requested a five-year
freeze of existing base rates with earnings above a certain range to be used to
accelerate the write-off of generation-related regulatory assets and to mitigate
the costs associated with payments to nonutility generators under power purchase
contracts. Virginia Power also sought approval in principle of the recovery of
prudently incurred costs beyond 2002 through a non-bypassable transition cost
charge. The filing presented an illustrative estimate of potentially stranded
costs based on hypothetical market prices. When the company filed its ARP, the
Commission consolidated its consideration of the ARP with its consideration of
the company's 1995 Annual Informational Filing. For a discussion of the 1995
Annual Informational Filing, see Future Issues--Rate Proceeding.
In December 1997, Virginia Power sought to withdraw its ARP, having
concluded that resolution of the cost recovery issues raised by the ARP was
unlikely without General Assembly action. The Commission has agreed that the
company may withdraw its support of the ARP, but has reserved the right to
continue consideration of the ARP as well as other regulatory alternatives. In
addition, the Commission will continue to consider the issues arising out of the
1995 Annual Informational Filing. See Future Issues--Rate Proceeding on page 28.
Competition--SFAS 71
Virginia Power's financial statements reflect assets and costs under cost-based
rate regulation in accordance with Statement of Financial Accounting Standards
(SFAS) No. 71, "Accounting for the Effects of Certain Types of Regulation." SFAS
71 provides that certain expenses normally reflected in income are deferred on
the balance sheet as regulatory assets and are recognized as the related amounts
are included in rates and recovered from customers. The presence of increasing
competition that limits the utility's ability to charge rates that recover its
costs or a change in the method of regulation could result in the discontinued
applicability of SFAS 71.
Rate-regulated companies are required to write off regulatory assets
against earnings whenever those assets no longer meet the criteria for
recognition as defined by SFAS 71. In addition, SFAS 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,"
requires a review of long-lived assets for impairment whenever events or changes
in circumstances indicate that the carrying amount of an asset may not be
recoverable. Thus, events or changes in circumstances that cause the
discontinuance of SFAS 71, and write off of regulatory assets, may also require
a review of utility plant assets for possible impairment. If the review
indicates utility plant assets are impaired, the carrying amount of affected
assets would be written down. This would result in a loss being charged to
earnings, unless recovery of the loss is provided through operations that remain
regulated.
Virginia Power's regulated operations currently satisfy the SFAS 71
criteria. However, if events or circumstances should change so that those
criteria are no longer satisfied, management believes that a material adverse
effect on Virginia Power's results of operations and financial position may
result. The form of cost-based rate regulation under which Virginia Power
operates is likely to evolve as a result of various legislative or regulatory
initiatives. At this time, management can predict neither the ultimate outcome
of regulatory reform in the electric utility industry nor the impact such
changes would have on Virginia Power.
28
Competition--Exposure to Potentially Stranded Costs
Under traditional cost-based regulation, utilities have generally had an
obligation to serve supported by an implicit promise of the opportunity to
recover prudently incurred costs. The most significant potential adverse effect
of competition is "stranded costs." Stranded costs are those costs incurred or
commitments made by utilities under cost-based regulation that may not be
reasonably expected to be recovered in a competitive market.
Virginia Power's potential exposure to stranded costs is composed of the
following:
o long-term purchased power contracts that may be above market (see Note Q);
o costs pertaining to certain generating plants that may become uneconomic in
a deregulated environment;
o regulatory assets for items such as income tax benefits previously
flowed-through to customers, deferred losses on reacquired debt, and other
costs (See Note C); and
o unfunded obligations for nuclear plant decommissioning and postretirement
benefits not yet recognized in the financial statements (See Notes A and M).
Any forecast of potentially stranded costs is extremely sensitive to the
various assumptions made. Such assumptions include:
o the timing and extent of customer choice in the market for electric service;
o estimates of future competitive market prices;
o stranded cost recovery mechanisms; and other factors.
Certain combinations of these assumptions as applied to Virginia Power
would produce little to no stranded costs; under other scenarios Virginia
Power's exposure to potentially stranded costs could be substantial.
Virginia Power has assessed the reasonableness of various possible
assumptions, but it has not been able to settle on any particular combination
thereof. Thus, Virginia Power's maximum exposure to potentially stranded costs
is uncertain. Management believes that recovery of any potentially stranded
costs is appropriate and will vigorously pursue such recovery with the
regulatory commissions having jurisdiction over its operations. However,
Virginia Power cannot predict the extent to which such costs, if any, will be
recoverable from customers. Also, in an effort to mitigate the amount at risk,
Virginia Power will continue to implement cost reduction measures.
Rate Proceeding
In March 1997, the Virginia Commission issued an order that Virginia Power's
base rates be made interim and subject to refund as of March 1, 1997. This order
was the result of the Commission Staff's report on its review of Virginia
Power's 1995 Annual Informational Filing which concluded that Virginia Power's
present rates would cause Virginia Power to earn in excess of its authorized
return on equity. The Staff found that, for purposes of establishing rates
prospectively, a rate reduction of $95.6 million may be necessary in order to
realign rates to the authorized level. In March 1997, Virginia Power filed its
alternative regulatory plan (ARP) based on 1996 financial information.
Subsequently, the Commission consolidated the proceeding concerned with the 1995
Annual Informational Filing with the proceeding that includes the ARP proposed
by the company. Opposing parties in the rate proceeding have made filings
recommending rate reductions in excess of $200 million. Virginia Power is
currently studying the filings of these parties. The Commission Staff is
scheduled to make further filings in late February 1998. Hearings are scheduled
to begin in late April.
Environmental Matters
Virginia Power is subject to rising costs resulting from a steadily increasing
number of federal, state and local laws and regulations designed to protect
human health and the environment. These laws and regulations can result in
increased capital, operating and other costs as a result of compliance,
remediation, containment, and monitoring obligations of Virginia Power. These
costs have been historically recovered through the ratemaking process; however,
should material costs be incurred and not recovered through rates, Virginia
Power's results of operations and financial condition could be adversely
impacted.
Virginia Power incurred expenses of $70.4 million, $71.1 million, and
$68.3 million (including depreciation) during 1997, 1996, and 1995,
respectively, in connection with the use of environmental protection facilities
and expects these expenses to be approximately $69.1 million in 1998. In
addition, capital expenditures to limit or monitor hazardous substances were
$24.6 million, $22.4 million, and $23.4 million for 1997, 1996, and 1995,
respectively. The amount estimated for 1998 for these expenditures is $10.0
million.
The Clean Air Act, as amended in 1990, requires Virginia Power to reduce
its emissions of sulfur dioxide (SO2) and nitrogen oxides (NOx). \The Clean Air
Act's SO2 reduction program is based on the issuance of a limited number of SO2
emission allowances, each of which may be used as a permit to emit one ton of
SO2 into the atmosphere or may be sold to someone else. Virginia Power's
compliance plans may include switching to lower sulfur coal, purchasing emission
allowances and installing SO2 control equipment.
Virginia Power began complying with Clean Air Act Phase I NOx limits at
eight of its units in Virginia in 1997, three years earlier than otherwise
required. As a result, the units will not be subject to more stringent Phase II
limits until 2008.
From 1994 through 1997, Virginia Power invested over $160 million to
install and upgrade emission control equipment at its Mt. Storm and Possum Point
power stations. Capital expenditures related to Clean Air Act compliance over
the next five years are projected to be approximately $40 million. Changes in
the regulatory environment, availability of allowances, and emissions control
technology could substantially impact the timing and magnitude of compliance
expenditures.
In November 1997, the EPA proposed new requirements for 22 states,
including North Carolina, Virginia and West Virginia, to reduce and cap
emissions of NOx. Although the proposal leaves it up to each state to determine
how to achieve the required reduction in emissions, the caps were calculated
based on emission limits for utility boilers. If the states in which Virginia
Power operates choose to impose this limit, major additional emission control
equipment, with attendant significant capital and operating costs, could be
required. The EPA will issue a final rule by September 1998.
29
Global Climate Change
In 1993, the United Nation's Global Warming Treaty became effective. The
objective of the treaty is the stabilization of greenhouse gas concentrations at
a level that would prevent manmade emissions from interfering with the climate
system. To further this objective, an international Protocol was formulated on
December 10, 1997 in Kyoto, Japan. This Protocol calls for the United States to
reduce greenhouse emissions by 7% from 1990 baseline levels by the period
2008-2012. The Protocol will not constitute a binding commitment unless
submitted to and approved by the Senate. Emission reductions of the magnitude
included in the Protocol, if adopted, would likely result in a substantial
financial impact on companies that consume or produce fossil fuel-derived
electric power, including Virginia Power.
Nuclear Operations
On September 10, 1997, the Nuclear Regulatory Commission (NRC) published a
proposed rule for financial assurance requirements related to nuclear
decommissioning. If the NRC's proposed rule were implemented without further
clarification or modification, Virginia Power might have to either pre-fund or
provide acceptable security for a portion of the decommissioning obligation.
DOMINION UK
East Midlands operates in three strategic business lines--distribution, supply,
and other. East Midland's distribution and supply businesses are subject to
extensive regulation. The distribution business involves the transfer of
electricity across its low voltage distribution system to customers. The supply
business encompasses purchasing electricity and arranging for its distribution
to end users.
Regulation of Distribution
East Midland's distribution business is fully regulated and accounts for
approximately 85% of its operating profit. The focus in the distribution
business is on the continuance of cost reductions and efficiency improvements.
The revenues which East Midlands derives from its distribution business are
controlled by a specified formula. The elements in the formula are established
for a five year period. Portions of the formula are subject to review at the end
of each five year period and at other times at the discretion of the regulator.
An initial annual increase was established by the regulator for the five year
period ending March 31, 1995. Since then, the regulator has on two separate
occasions decreased East Midland's regulated distribution prices which it may
charge its customers through the fiscal year ending March 31, 2000. There can be
no assurance that the regulator will not perform further unscheduled
distribution price reviews, or that any future distribution price review,
whether scheduled or unscheduled, will not result in price reductions or changes
in the formula which could materially adversely affect East Midlands.
Supply Competition
East Midlands currently has the sole right to supply electricity to
substantially all of the customers in its authorized area, except where the
customer's demand is above 100kW. Competition is currently scheduled to be
phased into the national electricity market for small customers whose demand is
below 100kW, referred to as the domestic customers, beginning in September 1998.
East Midlands is getting ready for competition by building customer loyalty. It
will accomplish this goal by;
o offering competitive prices,
o providing superior customer service,
o providing reliable distribution service, and
o being responsive in dealing with billing and other matters.
There can be no assurance that competition among suppliers of electricity
will not adversely affect East Midlands and Dominion Resources.
In its supply business, East Midlands is focused on taking advantage of
the major opportunity in the domestic gas supply business. Adding gas sales will
complement its electric supply sales to domestic, small- to medium-sized
commercial and industrial customers.
DOMINION ENERGY
The financial performance of Dominion Energy's natural gas and oil operations
depends to a certain degree on future market prices which are influenced by many
factors outside the control of the company.
Much of Dominion Energy's gas reserves have production-based tax credits.
This tax credit is due to expire on December 31, 2002. The expiration of this
tax credit will have an impact on the company's future profitability. To replace
these earnings, the company continues to grow its reserve base through the
drilling and acquisition of oil and gas properties which do not qualify for the
credit.
In its foreign power businesses, there are commitments to add generating
capacity. Egenor, the company's Peruvian power generation business, has a
commitment to add 100 Mw by the end of 1999. Corani, the company's Bolivian
business, has a commitment to invest substantial capital to increase generation
capacity in Bolivia by the end of 1998. Both expansion projects are currently
progressing on schedule. Foreign operations are also subject to political and
economic risks. Dominion Energy seeks to manage these risks by limiting its
exposure in any single country and by limiting its investments to those
countries and regions where the company believes these risks are less
significant.
DOMINION CAPITAL
The financial performance of Dominion Capital's diversified financial services
business depends to a certain degree on the movement of interest rates, overall
economic conditions, and increasing competition. Dominion Capital intends to
manage the effect of these issues by reacting quickly to changing economic
market factors, maintaining underwriting and credit quality, expanding
origination channels and focusing on specialized markets (see Note P).
30
RECENTLY ISSUED ACCOUNTING STANDARDS
During 1997, the Financial Accounting Standards Board (FASB) issued SFAS No. 130
"Reporting Comprehensive Income" and SFAS No. 131 "Disclosure About Segments of
an Enterprise." Each of these statements is effective for fiscal years beginning
after December 15, 1997.
At this time, Dominion Resources does not expect the implementation of
these standards to have a material impact on its results of operations and
financial condition.
YEAR 2000 COMPLIANCE
Dominion Resources is taking an aggressive approach regarding computer issues
associated with the onset of the new millennium--specifically, the impact of
possible failure of computer systems and computer-driven equipment due to the
rollover to the year 2000. The year 2000 problem is pervasive and complex as
virtually every computer operation could be affected in some way by the rollover
of the two-digit year value from 99 to 00. The issue is whether computer systems
will properly recognize date-sensitive information when the year changes to
2000. Systems that do not properly recognize such information could generate
erroneous data or cause a system to fail.
If not properly addressed, the year 2000 computer problem could result in
failures in company computer systems and the computer systems of third parties
with whom the company deals on transactions worldwide. Such failures of the
company's and/or third parties' computer systems could have a material impact on
the company's ability to conduct business.
Since January 1997, the company has organized formal year 2000 project
teams to identify, correct or reprogram and test the systems for year 2000
compliance. At this time, a majority of the project teams has completed their
preliminary assessment. Based on their evaluation, testing and conversion of
system application costs are projected to be within the range of $100 million to
$150 million. The range is a function of our ongoing evaluation as to whether
certain systems and equipment will be corrected or replaced, which is dependent
on information yet to be obtained from suppliers and other external sources.
Maintenance or modification costs will be expensed as incurred, while the costs
of new software will be capitalized and amortized over the software's useful
life.
At this time, Dominion Resources is actively pursuing solutions to year
2000-related computer problems in order to ensure that foreseeable situations
related to company computer systems, etc., are effectively addressed.
The company cannot estimate or predict the potential adverse consequences,
if any, that could result from a third party's failure to effectively address
this issue.
BUSINESS OPPORTUNITIES
Because the worldwide electric power industry is rapidly changing, especially in
the U.S., there are many opportunities for acquisitions of electric power assets
and business combinations. We investigate any of the opportunities we learn
about that may increase shareholder value or build on our existing businesses.
Any acquisitions or combinations may result in transactions involving cash, debt
or equity securities, and may involve payment of a premium over book and market
values. Such transactions or payments could dilute the interests of holders of
common stock.
Market Rate Sensitive Instruments and Risk Management
Dominion Resources is subject to market risk as a result of its use of various
financial instruments, derivative financial instruments and derivative commodity
instruments. Interest rate risk generally is associated with the company's and
its subsidiaries' outstanding debt as well as its commercial, consumer, and
mortgage lending activities. Currency risk exists principally through the
company's investments in the United Kingdom and some debt denominated in
European currencies associated with the company's investment in South and
Central America. The company is exposed to equity price risk through various
portfolios of equity securities.
The company uses derivative commodity instruments to hedge exposures of
underlying electric, gas production, and gas procurement operations and is also
involved in trading activities which use these instruments. However, the fair
value of these derivative commodity instruments at December 31, 1997 and the
potential near term losses in future earnings, fair values, or cash flows
resulting from reasonably possible near term changes in market prices are not
anticipated to be material to the results of operations, cash flows or financial
position of the company.
The following analysis does not include the price risks associated with
the nonfinancial assets and liabilities of power production operations,
including underlying fuel requirements and natural gas operations.
31
INTEREST-RATE RISK: NON-TRADING ACTIVITIES
In managing interest-rate risk, the company enters into interest-rate sensitive
derivatives. The following table presents descriptions of the financial
instruments and derivative financial instruments that are held by the company at
December 31, 1997 and that are sensitive to interest rate change in some way.
Weighted average variable rates are based on implied forward rates derived
from appropriate annual spot rate observations as of the balance sheet date. For
interest rate derivatives, notional amounts have been used to calculate the cash
flows to be exchanged under the contract.
EXPECTED MATURITY DATE
- ---------------------------------------------------------------------------------------------------------------------------
Fair
1998 1999 2000 2001 2002 Thereafter Total Value
(millions of US$)
ASSETS
Loans Receivable:
Variable rate $ 39.6 $ 73.7 $119.7 $226.0 $281.4 $ 207.2 $ 947.6 $ 974.5
Average interest rate 8.8% 8.9% 8.9% 8.8% 8.7% 8.4%
Fixed rate $ 0.2 $ 3.5 $ 2.4 $ 0.2 $ 0.1 $ 5.0 $ 11.4 $ 11.4
Average interest rate 12.4% 12.4% 12.5% 11.7% 9.9% 8.7%
Nuclear decommissioning
trusts' investments $ 17.7 $ 5.3 $ 2.1 $ 7.1 $ 3.1 $ 165.0 $ 200.3 $ 190.7
Average interest rate(1) 5.5% 5.5% 5.5% 5.5% 5.5% 5.5%
Mortgage loans in warehouse $ 88.2 $ 88.2 $ 91.4
Average interest rate 9.6%
--------------------------------------------------------------------------------
LIABILITIES
Fixed-rate debt $ 497.1 $335.6 $260.1 $175.8 $731.4 $ 3,255.5 $5,255.5 $5,596.9
Average interest rate 6.5% 7.8% 6.1% 6.0% 5.1% 6.9%
Variable rate debt $1,501.8 $490.2 $ 88.8 $256.6 $366.5 $ 876.3 $3,580.2 $3,580.2
Average interest rate 6.1% 6.0% 5.6% 5.7% 5.5% 4.9%
Preferred securities of subsidiary trusts $135.0 $ 250.0 $ 385.0 $ 387.7
Average interest rate 7.9% 7.9% 7.9% 7.9% 7.9% 7.9%
Short-term debt $ 375.1 $ 375.1 $ 375.1
Average interest rate 6.1%
Mandatorily redeemable preferred stock $180.0 $ 180.0 $ 186.6
Average dividend rate $ 6.2 $ 6.2 $ 6.2
Off balance sheet
Loan commitments $ 672.9 $ 672.9 $ 675.9
Average interest rate 9.3%
--------------------------------------------------------------------------------
INTEREST-RATE DERIVATIVES (2)
Forwards
Notional amount $ 54.0 $ 54.0
Average strike price 102.142
Average market price 102.177
--------------------------------------------------------------------------------
Futures contracts
Notional amount $ 498.9 $ 498.9 $ (0.6)
Average strike price 99.077
Average market price 99.268
--------------------------------------------------------------------------------
(1) Interest rates are based on average coupon rates for entire portfolio at
12/31/97.
(2) Dominion Capital's use of interest rate swaps to mitigate interest rate risk
exposure in its residential and commercial lending businesses is immaterial.
32
INTEREST RATE RISK: TRADING ACTIVITIES
Dominion Capital, though its indirectly owned subsidiary Saxon Mortgage, Inc.,
retains ownership in the residual classes of the asset backed securities
utilized to sell home equity loans originated and purchased by Saxon Mortgage.
These assets are classified as Trading securities on the balance sheet and total
$189.1 million as of December 31, 1997.
The residual securities represent the net present value of the excess of
the interest payments upon the underlying mortgage collateral net of interest
payments to outstanding bond holders, servicing costs, over-collateralization
requirements, and credit losses. Fair value of the residual is analyzed
quarterly by Saxon Mortgage to determine whether prepayment experience, losses
and changes in the interest rate environment have had an impact on the
valuation. Expected cash flows of the underlying loans sold are reviewed based
upon current economic conditions and the type of loans originated and are
revised as necessary. As the securities represent a net present value of future
cash flows, changes in the discount rate will result in valuation changes to the
underlying securities. The discount rate utilized for the December 31, 1997
fair-market value determination is 11% and is derived from a spread over the
prevailing 5-year Treasury interest rate. Should interest rates increase by one
percent, Saxon Mortgage could experience a loss of approximately $7.4 million.
FOREIGN-EXCHANGE RISK MANAGEMENT
Dominion Resource's exposure to foreign currency exchange rates or cross
currency exposure results from debt which is denominated in a currency different
from the company's functional currency, the U.S. dollar. In this situation, the
company is subject to gains and losses due to the relative change in the foreign
currency rate of the debt versus the U.S. dollar. The company uses currency
swaps to minimize this exposure. The table below provides information about the
company's foreign currency-sensitive financial instruments and derivative
financial instruments. For debt, the table presents principal amounts and
related weighted average interest rates by expected maturity dates. The
principal cash flows are translated into U.S. dollars based on implied forward
currency rates at the reporting date. For currency swaps, the table presents the
notional amounts, the weighted average pay rates, and the weighted average
receive rates by maturity dates.
EXPECTED MATURITY DATE
- ----------------------------------------------------------------------------------------------------------------------
Fair
1998 1999 2000 2001 2002 Thereafter Total Value
(millions)
LIABILITIES
Long-term debt denominated in foreign
currencies (US$ functional currency)
Unit of Currency--Inter American
Development Bank
Variable rate $ 1.6 $ 1.6 $ 1.6 $ 1.6 $ 1.6 $ 13.4 $ 21.4 $ 21.4
Average interest rate 6.8% 6.7% 6.5% 6.3% 6.3% 6.5%
Foreign exchange rate $1.53 $1.37 $1.49 $1.53 $ 1.49 $ 1.48
Unit of Currency-German Mark
Fixed rate $ .7 $.7 $.7 $.7 $.7 $ 20.3 $ 23.8 $ 22.6
Average interest Rate 4.5% 4.5% 4.5% 4.5% 4.5% 4.5%
Foreign exchange rate $1.79 $1.77 $1.76 $1.75 $ 1.74 $ 1.76
(GBP functional currency)
Unit of Currency-US$
Fixed rate $409.5 $ 409.5 $819.0 $852.4
Average interest rate 7.3% 7.3% 7.3% 7.3% 7.3% 7.5%
Foreign exchange rate $1.60 $1.58 $1.57 $1.56 $ 1.56 $ 1.55
Currency swap agreements related
to long-term debt
Notional amount $409.5 $ 409.5 $819.0 $(26.8)
Average pay price 8.2% 8.6%
Average receive price 7.1% 7.5%
Foreign exchange rate $ 1.56 $ 1.55
----------------------------------------------------------------------------
33
EQUITY PRICE RISK MANAGEMENT
The following table presents descriptions of the equity securities that are held
by the company at December 31, 1997. As prescribed by the FASB, the marketable
securities are reported on the balance sheet at fair market value. The company's
securities consist of trading (short-term) and available-for-sale securities.
- -----------------------------------------------------------------------------
Fair
Cost Value
(millions of US$)
Trading:
Short-term marketable securities $240.7 $240.7
Other than trading:
Marketable securities $185.3 $190.8
Nuclear decommissioning trusts' investments $219.4 $360.4
-----------------
OTHER RISK MANAGEMENT FACTORS AND MATTERS
On a company-wide basis, the company is sensitive to interest rate risk. The
company minimizes interest rate risk through a proper mix of fixed and variable
rate debt.
As mentioned earlier, a significant portion of the company's operations
are located in foreign countries. These operations have acquired debt in
denominations different than the local functional currency. As a result, the
company's foreign financial results could be significantly affected by factors
such as changes in exchange rates. To mitigate the effect of changes in currency
exchange rates in the United Kingdom, Dominion UK has instituted a for eign
currency swap. The swap is associated with senior notes denominated in U.S.
dollars.
Dominion Capital
Dominion Capital's operations are affected by a number of risks. Its lending
institutions are concerned with credit, interest rate, operation reserve, and
market price of gas risks. Credit risk is managed in the following ways:
o through its experienced management and underwriting professionals;
o by minimizing the size of the loan;
o spreading the risk over a diversified client base, both geographically and
industry wide;
o having first position on the collateralized assets;
o offsetting the credit risk of the customers with lower loan to value and
higher interest rates;
o and retaining only a residual interest in the mortgage loans through the
securitization process.
Dominion Capital is also concerned with interest rate risk. This risk is
managed by making floating rate loans, loan securitizations which transfer most
of the risk to investors, prepayment penalties and hedging programs for
presecuritized loans. This period is relatively short because the loan
portfolios are securitized every 90 days.
Dominion Capital's mortgage investments are adversely impacted by
increases in the rate at which home equity loans prepay. Accordingly, Dominion
Capital actively manages this risk by 1) imposing prepayment penalties on many
of the underlying home equity loans 2) aggressively enforcing premium recapture
provisions with correspondent sellers of mortgage collateral, 3) limiting the
acquisition of adjustable rate mortgage collateral with below market start rate
(i.e., teaser rates), and 4) actively monitoring trends in historical prepayment
speeds and using prudent residual prepayment speed assumptions. Changes in
interest rates are not considered to have a material impact upon prepayment
speeds on the underlying home equity loan collateral as the credit impaired
borrowers which make up the majority of the underlying collateral have not
proven to be sensitive to changes in interest rates during past periods of
interest rate volatility.
Forward-Looking Information
As we have pointed out earlier in this annual report, we have included certain
information about the future for us and our subsidiaries. We have talked about
our expectations and plans and, when we felt we were able to make reasonable
predictions, tried to estimate the impact of known trends and uncertainties that
our businesses are subject to. None of our statements about the future, also
referred to as "forward-looking statements", are guarantees of future results or
outcomes. Any statement of this type necessarily involves assumptions and
uncertainties which could cause actual results or outcomes to be substantially
different from those we have suggested. In many cases, the matter will be
outside of our control. In addition to specific issues discussed in other parts
of this report, some of the factors that could make a significant difference in
the forward-looking statements we have made include: legislative and regulatory
actions, both domestic and international; deregulation and increased competition
in our industry; our operation of nuclear power facilities and related
decommissioning costs; our acquisition or disposition of assets or facilities;
outcomes in legal proceedings, including rate proceedings; changes in
environmental requirements and costs of compliance; unanticipated changes in
operating expenses and capital expenditures; development project delays or
changes in project costs; and competition for new energy development
opportunities. We are also influenced by more general economic and geographic
factors such as: weather conditions and catastrophic weather related damage;
political and economic risks (particularly those associated with international
development and operations, including currency fluctuations); pricing and
transportation costs of commodities; the level of market demand for energy;
inflation; and capital market conditions.
34
CONSOLIDATED BALANCE SHEETS
Assets
- ------------------------------------------------------------------------------------------
At December 31, 1997 1996
(millions)
Current assets:
Cash and cash equivalents (Notes A and G) $ 321.6 $ 110.8
Trading securities (Notes A, F and G) 240.7 16.4
Customer accounts receivable, net 601.0 354.8
Other accounts receivable 336.5 174.9
Accrued unbilled revenues 245.2 162.8
Materials and supplies at average cost or less:
Plant and general 163.3 148.7
Fossil fuel 67.4 76.8
Mortgage loans in warehouse (Notes A and G) 88.2 65.8
Other 209.1 209.5
--------------------------
2,273.0 1,320.5
--------------------------
Investments:
Investments in affiliates (Note A) 404.0 448.3
Available-for-sale securities (Notes A, F and G) 190.8 692.4
Nuclear decommissioning trust funds (Notes A and G) 569.1 443.3
Loans receivable, net (Notes A and G) 959.0
Investments in real estate 101.5 107.7
Other 191.6 234.2
--------------------------
2,416.0 1,925.9
--------------------------
Property, plant and equipment (Note A):
(includes plant under construction of $240.9 [1996-$180.1]) 19,519.2 16,815.8
Less accumulated depreciation, depletion and amortization 6,986.6 6,306.4
--------------------------
12,532.6 10,509.4
--------------------------
Deferred charges and other assets:
Goodwill (Note A) 1,932.0 179.1
Regulatory assets (Note C) 776.6 773.9
Other 262.5 187.6
--------------------------
2,971.1 1,140.6
--------------------------
Total assets $20,192.7 $14,896.4
==========================
The accompanying notes are an integral part of the Consolidated Financial
Statements.
35
Liabilities and Shareholders' Equity
- -------------------------------------------------------------------------------------------------------------
At December 31, 1997 1996
(millions)
Current liabilities:
Securities due within one year (Note H) $ 1,613.6 $ 431.0
Short-term debt (Notes E and G) 375.1 378.2
Accounts payable, trade 679.3 410.6
Accrued interest 185.1 107.3
Accrued payroll 107.2 73.1
Severance costs accrued (Note N) 29.7 50.2
Customer deposits 44.6 50.0
Other 591.1 155.4
------------------------
3,625.7 1,655.8
------------------------
Long-term debt (Notes G and H):
Virginia Power 3,514.6 3,579.4
Nonrecourse-nonutility 707.8 825.4
Dominion UK 2,673.6 342.5
Other 300.0 300.0
------------------------
7,196.0 5,047.3
------------------------
Deferred credits and other liabilities:
Deferred income taxes (Notes A and B) 2,018.4 1,743.3
Investment tax credits (Note A) 238.4 255.3
Other 596.8 162.5
------------------------
2,853.6 2,161.1
------------------------
Total liabilities 13,675.3 8,864.2
------------------------
Minority interest 402.9 293.0
------------------------
Commitments and contingencies (Note Q)
Virginia Power and Dominion Resources obligated mandatorily redeemable preferred
securities of subsidiary trusts* (Notes G and K) 385.0 135.0
------------------------
Preferred stock (Notes G and L):
Virginia Power stock subject to mandatory redemption 180.0 180.0
------------------------
Virginia Power stock not subject to mandatory redemption 509.0 509.0
------------------------
Common shareholders' equity:
Common stock--no par authorized 300,000,000 shares,
outstanding--187,799,443 shares at 1997 and
181,220,746 shares at 1996 (Note I) 3,673.6 3,471.4
Retained earnings 1,354.0 1,437.9
Accumulated translation adjustments (Note A) (10.6) (9.2)
Allowance on available-for-sale securities, net of tax (Note A) 7.3 (1.1)
Other paid-in capital 16.2 16.2
------------------------
5,040.5 4,915.2
------------------------
Total liabilities and shareholders' equity $20,192.7 $14,896.4
========================
* As described in Note K, the 7.83% and 8.05% Junior and Subordinated Notes
totaling $232.7 and $139.2 million principal amounts constitute 100% of the
Trusts' assets. The accompanying notes are an integral part of the
Consolidated Financial Statements.
36
CONSOLIDATED STATEMENTS OF CASH FLOWS
- -----------------------------------------------------------------------------------------------------------
For The Years Ended December 31, 1997 1996 1995
(millions)
Cash flows from (used in) operating activities:
Net income $ 399.2 $ 472.1 $ 425.0
Adjustments to reconcile net income to net cash:
Depreciation, depletion and amortization 905.7 694.4 633.5
Deferred income taxes 13.8 84.1 26.4
Investment tax credits, net (16.9) (16.9) (16.9)
Deferred fuel expense 9.6 (54.4) 6.2
Deferred capacity expense (41.2) (9.2) 6.4
Restructuring expense 12.5 29.6 96.2
Accelerated cost recovery 38.4 26.7
Purchase of mortgage loans (1,713.7) (769.2)
Proceeds from sale and principal collections of mortgage loans 1,672.6 703.4
Changes in current assets and liabilities:
Accounts receivable (111.3) (47.0) (38.7)
Accrued unbilled revenues (64.9) 17.6 (27.7)
Materials and supplies 15.9 6.0 61.1
Accounts payable, trade 113.8 73.8 (37.6)
Accrued interest and taxes 118.6 (17.5) 33.6
Other changes (89.9) (161.3) 3.8
------------------------------------
Net cash flows from operating activities 1,262.2 1,032.2 1,171.3
------------------------------------
Cash flows from (used in) financing activities:
Issuance of common stock 176.2 169.7 161.7
Preferred securities of subsidiary trust 250.0 135.0
Issuance of long-term debt:
Virginia Power 270.0 24.5 240.0
East Midlands 1,898.5 342.5
Nonrecourse-nonutility 4,113.0 434.5 54.3
Issuance (repayment) of short-term debt (98.5) 134.5 101.1
Repayment of long-term debt and preferred stock (4,377.0) (336.5) (553.0)
Common dividend payments (478.0) (460.1) (448.7)
Other 74.6 (4.5) (20.5)
------------------------------------
Net cash flows from (used in) financing activities 1,828.8 304.6 (330.1)
------------------------------------
Cash flows from (used in) investing activities:
Utility capital expenditures (648.7) (484.0) (577.5)
Acquisition of natural gas and independent power properties (52.6) (271.2) (128.5)
Loan originations (1,147.2)
Repayments of loan originations 1,077.2
Purchase of East Midlands (1,901.5) (342.5)
Sale of businesses 123.3
Purchase of fixed assets (124.4) (34.8) (27.4)
Purchase of marketable securities (8.5) (8.8) (61.8)
Sale of marketable securities 127.7
Additions to mortgage investments (138.4) (58.3)
Acquisitions of businesses (144.5) (19.5) (52.4)
Other investments (42.6) (73.6) (73.6)
------------------------------------
Net cash flows used in investing activities (2,880.2) (1,292.7) (921.2)
------------------------------------
Increase (decrease) in cash and cash equivalents $ 210.8 $ 44.1 $ (80.0)
Cash and cash equivalents at beginning of the year 110.8 66.7 146.7
------------------------------------
Cash and cash equivalents at end of the year $ 321.6 $ 110.8 $ 66.7
------------------------------------
The accompanying notes are an integral part of the Consolidated Financial
Statements.
37
MANAGEMENT'S DISCUSSION AND ANALYSIS OF CASH FLOWS AND
FINANCIAL CONDITION (unaudited)
Introduction
In Management's Discussion and Analysis of Cash Flows and Financial Condition,
Dominion Resources' and its subsidiaries' general financial condition and
changes in financial condition are discussed by addressing the following topics:
o What our capital expenditures were for the year 1997 and what we project
them to be for the year 1998. In addition, we will disclose trends that may
have a material effect on our financial condition over the next couple of
years.
o The sources of funds utilized to pay for the expenditures incurred during
1997 and the anticipated future capital expenditures.
Consolidated Financing Activity
Dominion Resources funds its operations and supports the financing needs of its
subsidiaries primarily as follows: (1) A $950 million shelf registration through
which the company may, over the next two years, sell any combination of debt,
preferred or common securities up to the $950 million limit. (2) The company
continues to raise capital from sales of common stock through its equity plans.
The company has raised over $100 million in each of the last nine years from
sales through these plans. (3) The company also sells commercial paper backed by
lines of credit and provides the proceeds to its subsidiaries under intercompany
credit agreements.
Our 1997 financing activities were focused on the acquisition of East
Midlands and the related refinancings. A discussion of these activities follows:
EAST MIDLANDS FINANCING
Dominion Resources, through wholly owned UK financing subsidiaries, initially
financed 100 percent of the 1.3 billion pounds sterling ($2.2 billion)
acquisition of East Midlands with interim debt. The funds necessary for the
purchase were obtained in part from borrowings of approximately 640 million
pounds sterling ($1 billion) under a short-term credit agreement and borrowings
of 700 million pounds sterling ($1.2 billion) under a five-year revolving credit
agreement, both guaranteed by Dominion Resources.
During 1997, the entire short-term credit agreement and a portion of the
five-year revolving credit agreement were refinanced with 800 million pounds
sterling ($1.3 billion) raised from three bond offerings and one private bank
facility, all on a non-recourse basis to Dominion Resources. The final target
capital structure calls for the remaining 40 percent of the acquisition cost,
currently financed on an interim basis with the 5-year revolving credit
facility, to be refinanced with equity or equity equivalents.
In December of 1997, $250 million (150 million pounds sterling) in Capital
Securities were issued by Dominion Resources Capital Trust I as the first part
of the equity capitalization of the East Midlands acquisition. In January of
1998, Dominion Resources raised an additional $275 million (168 million pounds
sterling) through the issue of 6.8 million shares of common stock (see Note S),
also as a part of the program to capitalize the East Midlands acquisition. The
remaining portion of the five-year revolving credit agreement is expected to be
refinanced with equity or equity equivalents during the remainder of its
five-year term. The capital markets will continue to dictate the timing and
methods of completing the equity capitalization of East Midlands.
EQUITY PLANS
Dominion Resources raised capital from sales of common stock through the
following plans:
o Automatic Dividend Reinvestment and Stock Purchase Plan;
o Customer Stock Purchase Plan;
o Dominion Direct Investment; and
o Employee Savings Plan.
On July 8, 1996, the company established Dominion Direct Investment.
Dominion Direct Investment continues and expands the Automatic Dividend
Reinvestment and Stock Purchase Plan. Dominion Resources will continue to raise
capital through the Dominion Direct Investment and the Employee Savings Plans in
1998. Proceeds from these plans were (in millions): 1997-$176.2; 1996-$164.2;
and 1995-$136.9. Reflected in the amounts of the proceeds from these plans were
the repurchases of 136,800 shares of common stock in 1996 for an aggregate price
of $5.5 million and 685,500 shares of common stock in 1995 for an aggregate
price of $24.8 million.
COMMERCIAL PAPER
Dominion Resources' nonutility subsidiaries may finance their working capital
for operations from the proceeds from Dominion Resources commercial paper sales.
Dominion Resources sells its commercial paper in regional and national markets
and provides the proceeds to the nonutility subsidiaries under the terms of
intercompany credit agreements. At the end of 1997, Dominion Resources supported
these borrowings through bank lines of credit totaling $500.8 million. The
nonutility subsidiaries repay Dominion Resources through cash flows from
operations and proceeds from permanent financings. Virginia Power has a
commercial paper program with a limit of $500 million. The program is supported
by $500 million of revolving credit facilities and is used primarily to finance
working capital for operations. East Midlands has a commercial paper program
with a limit of 200 million pounds sterling. The program is supported by a 200
million
38
pounds sterling five-year revolving credit facility and is utilized principally
to fund its operations.
Virginia Power
LIQUIDITY AND CAPITAL RESOURCES
Operating activities continue to be a strong source of cash flow, providing
$1,091 million in 1997 compared to $1,115 million in 1996. The decrease of $24
million (or 2 percent) from the previous year is attributable to normal business
fluctuations. Over the past three years, cash flow from operating activities
has, on average, covered 134 percent of its total construction requirements and
provided 81 percent of its total cash requirements. Virginia Power's remaining
cash needs are met generally with proceeds from the sale of securities and
short-term borrowings.
Cash from (used in) financing activities was as follows:
- --------------------------------------------------------------------------
1997 1996 1995
(millions)
Issuance of long-term debt $ 270.0 $ 24.5 $ 240.0
Repayment of long-term debt
and preferred stock (311.3) (284.1) (439.0)
Issuance of securities of
subsidiary trust 135.0
Issuance (repayment) of
short-term debt (86.2) 143.4 169.0
Common dividend payments (379.9) (385.8) (394.3)
Other (49.2) (48.8) (58.0)
---------------------------------
Total $(556.6) $(550.8) $(347.3)
---------------------------------
Financing activities have represented a net outflow of cash in recent years as
strong cash flow from operations and the absence of major construction programs
have reduced Virginia Power's reliance on debt financing.
Virginia Power has taken advantage of declining interest rates by issuing
new debt at lower rates as higher-rate debt has matured. For example, in 1997,
$311.3 million of Virginia Power's long-term debt securities matured with an
average effective rate of 8.08%. As a partial replacement for this maturing
debt, Virginia Power issued $270 million of long-term debt securities during the
year with an average effective rate of 6.84%.
Virginia Power currently has three shelf registration statements effective
with the Securities and Exchange Commission from which it can obtain additional
debt capital: $400 million of Junior Subordinated Debentures filed in January
1997, $575 million of First and Refunding Mortgage Bonds, and $200 million of
Medium-Term Notes, Series F. The remaining principal amount of debt that can be
issued under these registrations totals $915 million. An additional capital
resource of $100 million in preferred stock is also registered with the
Securities and Exchange Commission.
Cash (used in) investing activities was as follows:
- --------------------------------------------------------------------------
1997 1996 1995
(millions)
Utility plant expenditures $(397.0) $(393.8) $(519.9)
Nuclear fuel (84.8) (90.2) (57.6)
Nuclear decommissioning
contributions (36.2) (36.2) (28.5)
Sale of accounts receivable, net (160.0)
Purchase of assets (19.8) (13.7)
Other (8.3) (12.5) (11.1)
---------------------------------
Total $(546.1) $(546.4) $(777.1)
---------------------------------
Investing activities in 1997 resulted in a net cash outflow of $546.1 million,
primarily due to $397.0 million of construction expenditures and $84.8 million
of nuclear fuel expenditures. The construction expenditures included
approximately $252.4 million for transmission and distribution projects, $52.1
million for production projects, $49.7 million for information technology
projects and $42.8 million for other projects.
CAPITAL REQUIREMENTS
CAPACITY - Virginia Power anticipates that kilowatt-hour sales will grow
approximately 2.4 percent each year through 2000. We will continue to pursue
capacity acquisition plans to meet the anticipated load growth and maintain a
high degree of service reliability. The additional capacity may be purchased
from others or built by Virginia Power if we can build capacity at a lower
overall cost. Virginia Power has long-term purchase agreements with Hoosier (400
Mw) and AEP (500 Mw) which will expire on December 31, 1999. The company
presently anticipates adding 584 Mw of market purchases beginning in the year
2000 to meet future load growth.
FIXED ASSETS - Virginia Power's construction and nuclear fuel expenditures
during 1998, 1999 and 2000 are expected to total $588.1 million, $476.2 million
and $395.1 million, respectively. Virginia Power has adopted a plan to improve
customer service and is spending in excess of $100 million. Virginia Power
estimates that all of these expenditures will be met through cash flow from
operations.
LONG-TERM DEBT - Virginia Power will require $333.5 million to meet maturities
of long-term debt in 1998, which it expects to meet with cash flow from
operations and refinancing of debt maturities. Other capital requirements will
be met through a combination of sales of securities and short-term borrowings.
39
Dominion UK
LIQUIDITY AND CAPITAL RESOURCES
Dominion UK funds its capital requirements through cash from operations, long-
and short-term debt facilities, and equity contributions from Dominion
Resources. In 1997, Dominion UK funded the acquisition of East Midlands and the
first of two installments of the windfall profits tax. While the entire windfall
profits tax was expensed in 1997, the cash payments are to be made in two
installments, half in December 1997 and half in December 1998.
Cash flows from operations at East Midlands for 1997 were $(83.4) million
and were due primarily to operating profit and working capital management. A
comparison is not made to the year 1996 or 1995 because East Midlands did not
become a part of Dominion Resources' consolidated entity until 1997.
Cash from (used in) financing activities was as follows:
- -----------------------------------------------------
1997
(millions)
Contribution from parent $254.3
Issuance of long-term debt 1,898.5
Other 47.6
--------
Total $2,200.4
========
During 1997, cash from financing activities was primarily due to the funding of
the acquisition of East Midlands by contributions from Dominion Resources ($254
million) and the issuance of the following debt:
o 321 million pounds sterling ($528 million) under a revolving credit
agreement and 200 million pounds sterling ($329 million) under a private
bank facility, the proceeds of which were used to fund the purchase of East
Midlands, and
o $819 million of five- and ten-year Senior notes and 100 million pounds
sterling ($165 million) of Eurobonds, which were used to pay down debt
borrowed under a short-term credit agreement.
o In addition, $54 million was borrowed to fund the acquisition of an
additional 40% interest in the Corby Power Station.
Cash from (used in ) investing activities was as follows:
- -----------------------------------------------------
1997
(millions)
Utility plant expenditures $ (166.9)
Purchase of fixed assets (67.3)
Purchase of East Midlands (1,901.5)
Other 0.3
---------
Total $(2,135.4)
=========
During 1997, cash flows used in investing activities was utilized primarily to
acquire the outstanding shares of stock in East Midlands, fund the investment in
fixed assets, principally on the distribution network, and acquire an additional
40% interest in the Corby Power Station.
CAPITAL REQUIREMENTS
The projected 1998 capital requirements of Dominion UK include approximately
$229 million for capital expenditures, predominantly for the electricity
distribution network and the completion of new systems and facilities required
for the opening up of competition in the electricity and gas markets. Interest
payments are expected to be $216 million and approximately $80 million will also
be required for the second and final installment of the windfall profits tax.
The capital requirements are expected to be funded by cash generated from
operations and other existing financing sources.
The company anticipates approximately $300 million of equity contributions
from the parent during 1998. To the extent these sources are available, they
will be used to repay acquisition debt.
Dominion Energy
LIQUIDITY AND CAPITAL RESOURCES
Dominion Energy funds its capital requirements through cash from operations,
equity contributions by Dominion Resources, an intercompany credit agreement
with Dominion Resources and bank revolving credit agreements.
Net cash provided by operating activities increased by $59.8 million in
1997, as compared to 1996, primarily due to: net income from power generation
assets in Peru acquired in August 1996; generally higher natural gas prices; and
greater production volumes due to the acquisition of natural gas properties in
the Gulf Coast area in March 1996 and in Michigan in January 1997. Net cash
provided by operating activities increased by $52.1 million in 1996, as compared
to 1995, primarily due to cash generated by operations of acquired companies and
assets and from normal operations.
Cash from (used in ) financing activities was as follows:
- -------------------------------------------------------------------
1997 1996 1995
(millions)
Contribution from parent $ 75.0 $149.3
Issuance of long-term debt $ 107.9 221.7
Repayment of debt (212.7) (8.9) (72.5)
Common dividend payments (48.3) (43.3) (31.6)
Issuance of intercompany debt 21.9 19.7 32.4
Other 0.2 10.0 9.5
-----------------------------
Total $(131.0) $274.2 $ 87.1
-----------------------------
40
Cash from (used in) investing activities was as follows:
- -------------------------------------------------------------------
1997 1996 1995
(millions)
Purchase of fixed assets $(11.7) $ (15.8) $ (25.1)
Purchase of independent power
properties (32.3)
Purchase of natural gas properties (52.6) (93.3) (71.1)
Sale of business 123.3
Sale of trust units 16.4
Acquisition of business (28.0) (228.2)
Other (21.2) (16.7) (24.1)
-----------------------------
Total $ 9.8 $(354.0) $(136.2)
-----------------------------
During 1997, the major source of cash flows from investing activities was
the sale of a portion of Dominion Energy's generating business in Peru for
$123.3 million. These funds were used primarily to pay down long-term debt.
CAPITAL REQUIREMENTS
Capital requirements for Dominion Energy in 1998 are forecasted to be
approximately $388 million. These requirements consist of: oil and gas
expenditures of $52 million and power generation expenditures of $336 million
(including the Kincaid acquisition).
Sources for these capital requirements will be nonrecourse debt, cash
flows from operations, borrowings from the revolving credit facility and, if
necessary, equity from Dominion Resources.
It should be noted that amounts enumerated above are estimates;
consequently, actual amounts may differ.
Dominion Capital
LIQUIDITY AND CAPITAL RESOURCES
Dominion Capital funds its capital requirements through cash from operations, an
intercompany credit agreement with Dominion Resources, equity contributions from
Dominion Resources, a medium-term note facility, bank revolving credit
agreements, term loans and a commercial paper program. Cash flows used in
operations for 1997 increased by $138.7 million as compared to 1996 primarily
due to a decrease in the net cash outflow of mortgage loan activity for Saxon
Mortgage.
Net cash provided by operating activities decreased by $179.1 million in
1996 as compared to 1995, primarily as a result of the funding of mortgage loans
prior to the securitization of such loans in its financial services business.
Cash from (used in) financing activities was as follows:
- -------------------------------------------------------------------
1997 1996 1995
(millions)
Contribution from parent $162.0 $ 85.0 $150.0
Issuance of long-term debt 3,910.7 104.7 16.1
Repayment of long-term debt (3,865.3) (52.4) (41.5)
Common dividend payments (43.1) (30.7) (22.7)
Issuance (repayment) of
intercompany debt 29.0 79.6 (52.1)
Other 32.7 (0.4) (4.5)
-----------------------------
Total $226.0 $185.8 $ 45.3
-----------------------------
During 1997, cash flows from financing activities were $226 million, primarily
due to the acquisition of the remaining 50 percent interest in First Source
Financial, loan originations and investment in marketable debt securities. Cash
from (used in) investing activities was as follows:
- -------------------------------------------------------------------
1997 1996 1995
(millions)
Investments in affiliates $ (96.0) $(19.5) $(52.4)
Loan originations, net (70.0)
Other (27.2) (23.9) (32.9)
-----------------------------
Total $(193.2) $(43.4) $(85.3)
-----------------------------
During 1997, cash flows used in investing activities increased primarily due to
the acquisition of the remaining 50 percent interest in First Source Financial
and net investment in marketable securities.
CAPITAL REQUIREMENTS
Dominion Capital's principal focus is growing its financial services companies.
First Source Financial will increase its loan portfolio from $970 million to
approximately $1.2 billion in 1998. Saxon Mortgage plans to generate over $2
billion in loan originations primarily in the sub-prime credit arena during
1998. Cambrian, a merchant banking enterprise for emerging independent oil and
natural gas producers, will expand its loan portfolio to approximately $110
million in 1998. To finance these expansion plans in 1998, Dominion Capital
plans to utilize approximately $75 million in new equity and intercompany debt.
The remaining capital requirements will come from the reinvestment of cash from
operations, harvesting capital from existing real estate and other assets, and
various third party credit sources.
41
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A Significant Accounting Policies
- --------------------------------------------------------------------------------
GENERAL Dominion Resources, Inc. is a holding company headquartered in Richmond,
Virginia. Its primary business is Virginia Power, which is a regulated public
utility engaged in the generation, transmission, distribution and sale of
electric energy within a 30,000 square mile area in Virginia and northeastern
North Carolina. It sells electricity to retail customers (including governmental
agencies) and to wholesale customers such as rural electric cooperatives,
municipalities, power marketers and other utilities. The Virginia service area
comprises about 65 percent of Virginia's total land area, but accounts for over
80 percent of its population.
Dominion Resources recently acquired East Midlands in 1997, which is
primarily a distribution and supply company. East Midlands operates a
distribution system serving a region of some 6,200 square miles in east central
England and it supplies electricity to 2.3 million customers, including
businesses across the country.
The company also operates business subsidiaries active in independent
power production, the acquisition and sale of natural gas reserves, financial
services, and real estate. Some of the independent power and natural gas
projects are located in foreign countries. Net investments of approximately
$374.6 million are involved in independent power production operations in
Central and South America.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Dominion Resources is currently exempt from regulation as a registered
holding company under the Public Utility Holding Company Act of 1935.
Accounting for the utility business conforms with generally accepted
accounting principles as applied to regulated public utilities and as prescribed
by federal agencies and the commissions of the states in which the utility
business operates.
The Consolidated Financial Statements include the accounts of Dominion
Resources and its subsidiaries. In consolidation, all significant intercompany
transactions and accounts have been eliminated.
OPERATING REVENUES AND INCOME Utility revenues are recorded on the basis of
services rendered, commodities delivered or contracts settled. Dividend income
on securities owned is recognized on the ex-dividend date. Interest income is
accrued on the unpaid principal balance.
INVESTMENTS IN AFFILIATES Investments in common stocks of affiliates
representing 20 percent to 50 percent ownership, and joint ventures and
partnerships representing generally 50 percent or less ownership interests, are
accounted for under the equity method.
Costs in excess of net assets acquired from equity investments are
amortized over periods not to exceed 40 years.
GAIN ON SALE OF LOANS Gain on sale of loans represents the present value of the
difference between the interest rate received on the mortgage loans and the
interest rate received by the investor in the securities after considering the
effects of estimated prepayments, costs to service the mortgage loans and
non-refundable fees and premiums on loans sold. These gains on the sale of loans
are recognized on the settlement date and are based on the relative fair market
value of the portion sold and retained. Concurrently with recognizing such gain
on sale, a corresponding asset representing interest-only strips retained at
securitization is recorded on the balance sheet in an initial amount equal to
the net present value of the projected cash flows. The asset recorded which is
classified as trading is amortized in proportion to the income estimated to be
received during the life.
PROPERTY, PLANT AND EQUIPMENT Utility plant at Virginia Power and East Midlands
is recorded at original cost, which includes labor, materials, services, and
other indirect costs.
The cost of acquisition, exploration and development of natural resource
properties is accounted for under the successful efforts method.
Interest is capitalized in connection with the construction of major
facilities. The capitalized interest is recorded as part of the asset to which
it relates and is amortized over the asset's estimated useful life. In 1997,
1996, and 1995, $3.5 million, $6.3 million, and $14.1 million of interest cost
was capitalized, respectively.
Major classes of property, plant and equipment and their respective
balances are:
- -----------------------------------------------------------------
At December 31, 1997 1996
(millions)
UTILITY:
Production $ 7,973.9 $ 7,691.9
Transmission 1,415.7 1,386.5
Distribution 6,210.7 4,385.4
Other electric 1,127.1 862.9
Plant under construction 240.9 180.1
Nuclear fuel 854.3 843.8
-------------------------
Total utility 17,822.61 5,350.6
-------------------------
NONUTILITY:
Natural gas properties 521.8 492.4
Independent power properties 920.3 869.2
Other 254.5 103.6
-------------------------
Total nonutility 1,696.6 1,465.2
-------------------------
Total property, plant and equipment $ 19,519.2 $ 16,815.8
-------------------------
DEPRECIATION, DEPLETION AND AMORTIZATION Depreciation of utility plant (other
than nuclear fuel) is computed using the straight-line method based on projected
useful service lives. The cost of depreciable utility plant retired and the cost
of removal, less salvage, are charged to accumulated depreciation. The provision
for depreciation provides for the recovery of the cost of assets and the
estimated cost of removal, net of salvage, and is based on the weighted average
depreciable plant using a rate of 3.2 percent for 1997, 1996 and 1995.
42
Owned nuclear fuel is amortized on a unit-of-production basis sufficient
to amortize fully, over the estimated service life, the cost of the fuel plus
permanent storage and disposal costs.
Surry North Anna
- -----------------------------------------------------------------------
Unit 1 Unit 2 Unit 1 Unit 2
NRC license expiration year 2012 2013 2018 2020
Method of decommissioning DECON DECON DECON DECON
(millions)
Current cost estimate
(1994) dollars $272.4 $274.0 $247.0 $253.6
External trusts balance
at December 31, 1997 156.51 151.81 134.2 126.6
1997 contribution to
external trusts 10.6 10.8 7.6 7.2
-----------------------------------------
When Virginia Power's nuclear units cease operations, it is obligated to
decontaminate or remove radioactive contaminants so that the property will not
require Nuclear Regulatory Commission (NRC) oversight. This phase of a nuclear
power plant's life cycle is termed decommissioning. While the units are
operating, Virginia Power collects from ratepayers amounts that, when combined
with investment earnings, will be used to fund this future obligation.
The amount being accrued for decommissioning is equal to the amount being
collected from ratepayers and is included in depreciation, depletion and
amortization expense. The decommissioning collections were $45.8 million, $36.2
million and $28.5 million in 1997, 1996 and 1995, respectively. These dollars
are deposited into external trusts through which the funds are invested. Net
earnings of the trusts' investments are included in Other Income. In 1997, 1996
and 1995 net earnings were $20.5 million, $16 million and $15.9 million,
respectively. The accretion of the decommissioning obligation is equal to the
trusts' net earnings and is also recorded in Other Income. Thus, the net impact
of the trusts on Other Income is zero.
The accumulated provision for decommissioning, which is included in
Accumulated Depreciation, Depletion and Amortization in the company's
Consolidated Balance Sheets, includes the accrued expense and accretion
described above and any unrealized gains and losses on the trusts' investments.
At December 31, 1997, the net unrealized gains were $149.5 million, which is an
increase of $69 million over the December 31, 1996 amount of $80.5 million. The
total accumulated provision for decommissioning at December 31, 1997 was $578.7
million. It was $443.3 million at December 31, 1996.
The total estimated cost to decommission Virginia Power's four nuclear
units is $1 billion based upon a site-specific study that was completed in 1994.
Virginia Power plans to update this estimate in 1998. The cost estimate assumes
that the method of completing decommissioning activities is prompt
dismantlement. This method assumes that dismantlement and other decommissioning
activities will begin shortly after cessation of operations, which under current
operating licenses will begin in 2012 as detailed in the table.
The FASB is reviewing the accounting for nuclear plant decommissioning. In
1996, FASB tentatively determined that the estimated cost of decommissioning
should be reported as a liability rather than as accumulated depreciation and
that a substantial portion of the decommissioning obligation should be
recognized earlier in the operating life of the nuclear unit. If the industry's
accounting were changed to reflect FASB's tentative proposal, then the annual
provisions for nuclear decommissioning would increase.
During its deliberations, the FASB expanded the scope of the project to
include similar unavoidable obligations to perform closure and post-closure
activities for non-nuclear power plants. Therefore, any forthcoming standard may
also change industry plant depreciation practices. Any impact related to other
company assets cannot be determined at this time.
Independent power properties and East Midland's fixed assets are
depreciated using the straight-line method based on estimated useful lives
ranging from 30 to 40 years. Natural gas properties are depleted using the
units-of-production method.
FEDERAL INCOME TAXES Dominion Resources and its subsidiaries file a consolidated
federal income tax return.
Deferred income taxes are provided for all significant temporary
differences between the financial and tax basis of assets and liabilities using
presently enacted tax rates in accordance with SFAS No. 109, "Accounting for
Income Taxes." Temporary differences occur when events and transactions
recognized for financial reporting result in taxable or tax-deductible amounts
in future periods. The regulatory treatment of temporary differences can differ
from the requirements of SFAS No. 109. Accordingly, Virginia Power recognizes a
regulatory asset if it is probable that future revenues will be provided for the
payment of those deferred tax liabilities. Similarly, in the event a deferred
tax liability is reduced to reflect changes in tax rates, a regulatory liability
is established if it is probable that a future reduction in revenue will result.
Due to regulatory requirements, Virginia Power accounts for investment tax
credits under the "deferral method" which provides for the amortization of these
credits over the service lives of the property giving rise to the credits.
FOREIGN CURRENCY TRANSLATION Dominion Resources translates foreign currency
financial statements by adjusting balance sheet accounts using the exchange rate
at the balance sheet date and income statement accounts using the average
exchange rate for the year. Translation gains and losses are recorded in
shareholder's equity. Gains and losses resulting from the settlement of
transactions in a currency other than the functional currency are reflected in
income.
DEFERRED CAPACITY AND FUEL EXPENSES Approximately 90 percent of Virginia Power's
fuel expenses and 80 percent of its purchased power capacity expenses incurred
as part of providing regulated electric service are subject to deferral
accounting. Under this method, the difference between reasonably incurred actual
expenses and the level of expenses included in current rates is deferred and
matched against future revenues.
43
GOODWILL Goodwill is the excess of the cost of net assets acquired in business
combinations over their fair value. It is amortized on a straight-line basis
over periods ranging from 25 to 40 years. The company evaluates goodwill for
impairment at least annually.
AMORTIZATION OF DEBT ISSUANCE COSTS Dominion Resources defers and amortizes any
expenses incurred in the issuance of long-term debt including premiums and
discounts associated with such debt over the lives of the respective issues. Any
gains or losses resulting from the refinancing of Virginia Power debt are also
deferred and amortized over the lives of the new issues of long-term debt as
permitted by the appropriate regulatory commission. At Virginia Power, gains or
losses resulting from the redemption of debt without refinancing are amortized
over the remaining lives of the redeemed issues.
INVESTMENT SECURITIES Dominion Resources accounts for and classifies investments
in equity securities that have readily determinable fair values and for all
investments in debt securities based on management's intent. The investments are
classified into three categories and accounted for in the following manner.
Debt securities which are intended to be held to maturity are classified
as held-to-maturity securities and reported at amortized cost. Debt and equity
securities purchased and held with the intent of selling them in the current
period are classified as trading securities. They are reported at fair value and
unrealized gains and losses are included in earnings. Debt and equity securities
that are neither held-to-maturity or trading are classified as
available-for-sale securities. These are reported at fair value with unrealized
gains and losses reported in shareholders' equity, net of tax.
MORTGAGE LOANS IN WAREHOUSE Mortgage loans in warehouse consist of mortgage
loans secured by single family residential properties. Any price premiums or
discounts on mortgage loans including any capitalized costs or deferred fees on
originated loans are deferred as an adjustment to the cost of the loans and are
therefore included in the determination of any gains or losses on sales of the
related loans. Mortgage loans in warehouse are carried at the lower of cost or
market value.
LOANS RECEIVABLE, NET Loans receivable are stated at their outstanding principal
balance net of the allowance for credit losses and any deferred fees or costs.
Origination fees net of certain direct origination costs are deferred and
recognized as an adjustment of the yield of the related loans receivable.
The allowance for credit losses is established through provisions for
credit losses charged against income. Loans deemed to be uncollectible are
charged against the allowance for credit losses, and subsequent recoveries, if
any, are credited to the allowance. At December 31, 1997, the allowance for
credit losses was $17.5 million.
MORTGAGE INVESTMENTS In accordance with SFAS No. 125, "Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities," mortgage
investments, which had been held entirely as available for sale as defined by
SFAS No. 115, "Accounting for Certain Investments in Debt and Equity
Securities," were reclassified as trading securities. Changes in the fair value
of the mortgage investments are reported in operating results in the current
period. No material gain or loss resulted from the reclassification.
NONRECOURSE-NONUTILITY FINANCINGS Dominion Resources' nonutility subsidiaries
issue debt to finance their operations and obtain financings that generally are
secured by the assets of the nonutility subsidiaries. However, Dominion
Resources may be required to provide contingent equity support or to maintain a
minimum net worth at the nonutility subsidiaries. These financings have been
segregated on the accompanying financial statements to distinguish their
nonrecourse nature.
DERIVATIVES AND FUTURES-OTHER THAN TRADING Dominion Resources utilizes futures
and forward contracts and derivative instruments, including swaps, caps and
collars, to manage exposure to fluctuations in interest rates, foreign currency
exchange rates and natural gas and electricity prices.
These futures, forwards and derivative instruments are deemed effective
hedges when the item being hedged and the underlying financial or commodity
instrument show strong historical correlation. Dominion Resources uses deferral
accounting to account for futures, forwards and derivative instruments which are
designated as hedges. Under this method, gains and losses (including the payment
of any premium) related to effective hedges of existing assets and liabilities
are recorded on the balance sheet and recognized in earnings in conjunction with
earnings of the designated asset or liability. Gains and losses related to
effective hedges of firm commitments and anticipated transactions are included
in the measurement of the subsequent transaction. Cash flows from derivatives
designed as hedges are reported in Net Cash Flows from Operating Activities.
DERIVATIVES AND FUTURES-TRADING The fair value method, which is used for those
derivative transactions which do not qualify for settlement or deferral
accounting, requires that derivatives are carried on the balance sheet at fair
value with changes in that value recognized in earnings or stockholder's equity.
Virginia Power uses this method for its wholesale power group's trading
activities.
Options, exchange-for-physical contracts, basis swaps and futures
contracts are marked to market with resulting gains and losses reported in
earnings. Fixed price forward contracts, initiated for trading purposes, are
also marked to market with resulting gains and losses reported in earnings. For
exchange-for-physical contracts, basis swaps, fixed price forward contracts, and
options which require physical delivery of the underlying commodity, market
value reflects management's best estimates considering over-the-counter
quotations, time value and volatility factors of the underlying commitments.
Futures contracts and options on futures contracts are marked to market based on
closing exchange prices. Gains and losses resulting from marking positions to
mar-
44
ket are reported in Other Income and Expense. Net gains and losses resulting
from futures contracts and options on futures contracts and settlement of basis
swaps are included in Operating Expenses. Amortization of option premiums
associated with sales and purchases are included in Operating Revenues and
Income and Operating Expenses, respectively.
Purchased options and options sold are reported in Deferred Charges and
Other Assets and in Deferred Credits and Other Liabilities, respectively, until
exercise or expiration. Gains and losses are reported in Other Income and
Expense. Electric options exercised are reflected in the recording of related
purchases or sales of electricity as operating expenses and operating revenues,
respectively. Upon expiration, electric options written are recognized in
operating revenues and options purchased are recognized in Operating Expenses.
Cash flows from trading activities are reported in Net Cash Flows from Operating
Activities.
CASH Current banking arrangements generally do not require checks to be funded
until actually presented for payment. At December 31, 1997 and 1996, the
company's accounts payable included the net effect of checks outstanding but not
yet presented for payment of $62.3 million and $72.6 million, respectively.
For purposes of the Consolidated Statements of Cash Flows, Dominion
Resources considers cash and cash equivalents to include cash on hand and
temporary investments purchased with a maturity of three months or less.
SUPPLEMENTARY CASH FLOWS INFORMATION:
- --------------------------------------------------------------------
1997 1996 1995
(millions)
CASH PAID DURING THE
YEAR FOR:
Interest (reduced for net costs
of borrowed funds capitalized) $ 439.6 $ 373.0 $ 376.0
Federal income taxes 190.0 169.8 159.6
NON-CASH TRANSACTIONS
FROM INVESTING AND
FINANCING ACTIVITIES:
Note issued in acquisition of business 18.4 47.5
Exchange of securities 51.9 12.1 12.3
Equity contribution for
Wolverine acquisition 21.4
RECLASSIFICATION Certain amounts in the 1996 and 1995 Consolidated Financial
Statements have been reclassified to conform to the 1997 presentation.
NOTE B Taxes
- --------------------------------------------------------------------------------
Income before provision for income taxes, classified by source of income, before
minority interests was as follows:
- --------------------------------------------------------------------
1997 1996 1995
(millions)
U.S. $ 712.7 $ 683.5 $ 609.5
Non-U.S (33.9) 17.5 11.0
---------------------------
Total $ 678.8 $ 701.0 $ 620.5
---------------------------
The provision for income taxes, classified by the timing and location of
payment, was as follows:
- --------------------------------------------------------------------
1997 1996 1995
(millions)
CURRENT
U.S. $ 221.9 $ 153.7 $ 178.4
State 9.1 3.0 0.9
Non-U.S 24.7 4.3 1.7
---------------------------
Total Current 255.7 161.0 181.0
---------------------------
DEFERRED
U.S. 22.1 71.9 19.2
State 0.1 3.3 3.8
Non-U.S (28.0)
---------------------------
Total Deferred (5.8) 75.2 23.0
---------------------------
Amortization of deferred
investment tax credits net (16.9) (16.9) (16.9)
---------------------------
Total Provision $ 233.0 $ 219.3 $ 187.1
---------------------------
The components of deferred income tax expense are as follows:
- --------------------------------------------------------------------
1997 1996 1995
(millions)
Liberalized depreciation $ 4.1 $ 53.8 $ 56.6
Indirect construction costs 4.9 3.4 (13.8)
Other plant related items 5.1 12.6 12.1
Deferred fuel (3.3) 19.1 (2.2)
Separation costs 6.5 (2.6) (12.4)
MBS basis differences 24.6
Deferred capacity 14.4 3.2 (3.8)
Contingent claims (25.9) (0.1) (1.2)
Tax rate change (16.6)
Deferred state taxes 0.1 3.3 3.8
Other, net (19.7) (17.5) (16.1)
---------------------------
Total $ (5.8) $ 75.2 $ 23.0
---------------------------
The statutory U.S. federal income tax rate reconciles to the effective income
tax rates as follows:
- --------------------------------------------------------------------
1997 1996 1995
U.S. statutory rate 35% 35% 35%
Preferred dividends of Virginia Power 1.8 1.8 2.5
Amortization of investment tax credits (2.5) (2.4) (2.7)
Nonconventional fuel credit (3.7) (3.8) (4.5)
Benefits and taxes related to
foreign operations 4.3 0.2 0.3
State taxes net of federal benefit 0.9 0.6 0.5
Other, net (1.5) (0.1) (0.9)
---------------------------
Effective tax rate 34.3% 31.3% 30.2%
---------------------------
45
The effective income tax rate includes state and foreign income taxes.
The 1997 budget of the new Labour government in the United Kingdom reduced
the corporate income tax rate to 31% effective April 1, 1997. Income tax expense
from continuing operations has been reduced by $16.6 million to reflect the
decrease in deferred tax liabilities resulting from the 2 percent decrease in
the corporate tax rate.
Dominion Resources net noncurrent deferred tax liability is attributable
to:
- ------------------------------------------------------------
1997 1996
(millions)
ASSETS:
Deferred investment tax credits $ 84.4 $ 90.3
Other 192.3
-------------------
Total deferred income tax asset 276.7 90.3
-------------------
LIABILITIES:
Depreciation method and plant
basis differences 1,924.2 1,463.5
Income taxes recoverable through
future rates 169.5 168.8
Partnership basis differences 126.4 130.3
Other 75.0 71.0
-------------------
Total deferred income tax liability 2,295.1 1,833.6
-------------------
Net deferred income tax liability $2,018.4 $1,743.3
-------------------
NOTE C Regulatory Assets
- --------------------------------------------------------------------------------
Certain expenses normally reflected in income are deferred on the balance sheet
as regulatory assets and are recognized in income as the related amounts are
included in rates and recovered from customers. Virginia Power's regulatory
assets included the following:
- -------------------------------------------------------------------------
At December 31, 1997 1996
(millions)
Deferred capacity expenses $ 47.3 $ 6.1
Income taxes recoverable through future rates 478.9 477.0
Cost of decommissioning DOE uranium
enrichment facilities 67.6 73.5
Deferred losses on reacquired debt, net 85.4 91.5
North Anna Unit 3 project termination costs 42.3 73.1
Other 55.1 52.7
-------------------
Total $ 776.6 $ 773.9
-------------------
The costs of decommissioning the Department of Energy's (DOE) uranium enrichment
facilities have been deferred and represent the unamortized portion of Virginia
Power's required contributions to a fund for decommissioning and decontaminating
the DOE's uranium enrichment facilities. Virginia Power is making such
contributions over a 15-year period with escalation for inflation. These costs
are being recovered in fuel rates.
The construction of North Anna Unit 3 was terminated in November 1982. All
retail jurisdictions have permitted recovery of the incurred costs. For Virginia
and FERC jurisdictional customers, the amounts deferred are being amortized from
the date termination costs were first includible in rates.
The incurred costs underlying these regulatory assets may represent
expenditures by Virginia Power or may represent the recognition of liabilities
that ultimately will be settled at some time in the future. For some of those
regulatory assets representing past expenditures that are not included in
Virginia Power's rate base or used to adjust Virginia Power's capital structure,
Virginia Power is not allowed to earn a return on the unrecovered balance. Of
the $776.6 million of regulatory assets at December 31, 1997, Virginia Power
does not earn a return on $15.4 million of regulatory assets, effectively
excluded from rate base, to be recovered over various recovery periods up to 21
years, depending on the nature of the deferred costs.
In addition, Virginia Power's depreciation practices for early retirements
of plant and equipment and cost of removal, along with changing operating plant
scenarios, have resulted in an accumulated depreciation reserve deficiency
estimated to be $235 million at December 31, 1997. The reserve deficiency
results from deferral of costs in conformity with regulatory depreciation
practices authorized by regulatory commissions having jurisdiction over Virginia
Power's operations. Currently, Virginia Power is allowed to amortize reserve
deficiencies over estimated remaining functional plant lives in all of the
regulatory jurisdictions it serves.
NOTE D Jointly Owned Plants
- --------------------------------------------------------------------------------
The following information relates to Virginia Power's proportionate share of
jointly owned plants at December 31, 1997.
- --------------------------------------------------------------------
Bath
County North
Pumped Anna Clover
Storage Power Power
Station Station Station
Ownership interest 60.0% 88.4% 50.0%
(millions)
Utility plant in service $1,072.9 $1,819.4 $ 533.3
Accumulated depreciation 229.1 819.2 26.3
Nuclear fuel 403.6
Accumulated amortization of
nuclear fuel 383.4
Construction work in progress 0.1 61.2 1.1
---------------------------
46
The co-owners are obligated to pay their share of all future construction
expenditures and operating costs of the jointly owned facilities in the same
proportions as their respective ownership interest. Virginia Power's share of
operating costs is classified in the appropriate expense category in the
Consolidated Statements of Income.
NOTE E Short-Term Debt
- --------------------------------------------------------------------------------
Dominion Resources and its subsidiaries have credit agreements with various
expiration dates. These agreements provided for maximum borrowings of $5,402.6
million and $3,882.4 million at December 31, 1997 and 1996, respectively. At
December 31, 1997 and 1996, $1,907.3 million and $714.5 million, respectively,
was borrowed under such agreements and classified as long-term debt.
Dominion Resources credit agreements supported $403.4 million and $308
million of Dominion Resources commercial paper at December 31, 1997 and 1996,
respectively.
Virginia Power has an established commercial paper program with a maximum
borrowing capacity of $500 million which is supported by two credit facilities.
One is a $300 million, five-year credit facility that was effective on June 7,
1996 and expires on June 7, 2001. The other is a $200 million credit facility,
also effective June 7, 1996, with an initial term of 364 days and provisions for
subsequent 364-day extensions. It was renewed on June 6, 1997 for 364 days. The
total amount of commercial paper outstanding was $226.2 million and $312.4
million at December 31, 1997 and 1996, respectively.
A subsidiary of Dominion Capital also had $85.5 million and $91 million of
nonrecourse commercial paper outstanding at December 31, 1997 and 1996,
respectively. East Midlands has a commercial paper program with a limit of 200
million pounds sterling ($329 million). The program is supported by 200 million
pounds sterling ($329 million) five-year revolving credit facility and is
utilized principally to fund its operations. There was no commercial paper
outstanding at December 31, 1997. A total of $385.5 million and $390 million of
the commercial paper was classified as long-term debt at December 31, 1997 and
1996, respectively. The commercial paper is supported by revolving credit
agreements that have expiration dates extending beyond one year. Dominion
Resources and its subsidiaries pay fees in lieu of compensating balances in
connection with these credit agreements. A summary of short-term debt
outstanding at December 31 follows:
- -------------------------------------------------------------
Weighted
Amount Average
Outstanding Interest Rate
(millions, except percentages)
1997
Commercial paper $329.6 5.8%
Term-notes 45.5 7.3%
------
Total $375.1
======
1996
Commercial paper $320.5 5.5%
Term-notes 57.7 7.4%
------
Total $378.2
======
NOTE F Investment Securities
- --------------------------------------------------------------------------------
Securities classified as available-for-sale as of December 31 follow:
- -------------------------------------------------------------------------
Gross Gross
Security Unrealized Unrealized Aggregate
Type Cost Gains Losses Fair Value
(millions)
1997
Equity $185.3 $10.9 $ 5.4 $190.8
e996
Equity $635.8 $ 8.2 $10.1 $633.9
Debt 58.5 58.5
---------------------------------------------------
Debt securities held at December 31, 1996 do not have stated contractural
maturities because borrowers may have the right to call or repay obligations
with or without call or prepayment penalties.
For the years ended December 31, 1997 and 1996, the proceeds from the
sales of available-for-sale securities were $122.2 million and $33.4 million,
respectively. The gross realized gains and losses were $12.8 million and $0.5
million for 1997 and $2.4 million and $1 million for 1996, respectively. The
basis on which the cost of these securities was determined is specific
identification. The changes in net unrealized holding gain or loss on
available-for-sale securities has resulted in an increase in the separate
component of shareholders equity during the years ended December 31, 1997 and
1996 of $8.4 million, net of tax, and $5.6 million, net of tax, respectively.
The gross realized gains and losses included in earnings from transfers of
securities from the available-for-sale category into the trading category was $5
million and $3.6 million, respectively. The changes in net realized holding gain
or loss on trading securities increased earnings during the years ended December
31, 1997 and 1996 by $0.6 million and $3.1 million, respectively.
47
NOTE G Fair Value of Financial Instruments
- --------------------------------------------------------------------------------
The fair value amounts of Dominion Resources' financial instruments have been
determined using available market information and valuation methodologies deemed
appropriate in the opinion of management. However, considerable judgment is
required to interpret market data to develop the estimates of fair value.
Accordingly, the estimates presented herein are not necessarily indicative of
the amounts that the company could realize in a current market exchange. The use
of different market assumptions and/or estimation assumptions may have a
material effect on the estimated fair value amounts.
Carrying Amount Estimated Fair Value
- -----------------------------------------------------------------------------------------------------------
December 31, 1997 1996 1997 1996
(millions)
ASSETS:
Cash and cash equivalents $ 321.6 $ 110.8 $ 321.6 $ 110.8
Trading securities 240.7 16.4 240.7 16.4
Mortgage loans in warehouse 88.2 65.8 91.4 67.9
Available-for-sale securities 190.8 692.4 190.8 692.4
Loans receivable 959.0 987.3
Nuclear decommissioning trust funds 569.1 443.3 569.1 443.3
LIABILITIES:
Short-term debt $ 375.1 $ 378.2 $ 375.1 $ 378.2
Long-term debt 8,809.6 5,478.3 9,151.0 5,560.3
PREFERRED SECURITIES OF SUBSIDIARY TRUSTS $ 385.0 $ 135.0 $ 387.7 $ 135.0
PREFERRED STOCK $ 180.0 $ 180.0 $ 186.6 $ 185.8
LOAN COMMITMENTS $ 675.9 $ 547.0
DERIVATIVES--RELATING TO:
Foreign currency risk $ 9.8 $ (26.8) $ 9.8
Natural gas options in a net receivable (payable) position $ 0.1 $ 0.6 $ 0.8 $ (0.6)
------------------------------------------
CASH AND CASH EQUIVALENTS The carrying amount of these items is a reasonable
estimate of their fair value.
INVESTMENT SECURITIES AND NUCLEAR DECOMMISSIONING TRUST FUNDS The estimated fair
value is determined based on quoted market prices, dealer quotes, and prices
obtained from independent pricing sources.
MORTGAGE LOANS IN WAREHOUSE The fair value of mortgage loans in warehouse is
based on outstanding commitments from investors.
LOANS RECEIVABLE The carrying value approximates fair value due to the variable
rate or term structure of the notes receivable.
SHORT-TERM DEBT AND LONG-TERM DEBT Market values are used to determine the fair
value for debt securities for which a market exists. For debt issues that are
not quoted on an exchange, interest rates currently available to the company for
issuance of debt with similar terms and remaining maturities are used to
estimate fair value. The carrying amount of debt issues with short-term
maturities and variable rates that are refinanced at current market rates is a
reasonable estimate of their fair value.
PREFERRED SECURITIES OF SUBSIDIARY TRUSTS The fair value is based on market
quotations.
PREFERRED STOCK The fair value of the fixed-rate preferred stock subject to
mandatory redemption was estimated by discounting the dividend and principal
payments for a representative issue of each series over the average remaining
life of the series.
LOAN COMMITMENTS The fair value of commitments is estimated using the fees
currently charged to enter into similar agreements, taking into account the
remaining terms of the agreements and the present creditworthiness of the
counterparties.
FOREIGN CURRENCY CONTRACTS The fair value of foreign currency contracts is
estimated by obtaining quotes from brokers.
INTEREST RATE SWAPS The fair value of interest rate swaps (used for hedging
purposes) is the estimated amount that the company would receive or pay to
terminate the swap agreements at the reporting date, taking into account current
interest rates and the current creditworthiness of the swap counterparties. Net
market value at December 31, 1997 and 1996 was immaterial.
NATURAL GAS OPTIONS The fair value of natural gas options (used for hedging
purposes) is estimated by obtaining quotes from bankers.
FUTURES CONTRACTS Derivatives used as hedging instruments are off-balance sheet
items marked-to-market with any unrealized gains or losses deferred until the
related loans are securitized or sold. Net market value at December 31, 1997 and
1996 was immaterial.
48
NOTE H Long-Term Debt
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
At December 31, 1997 1996
(millions)
VIRGINIA POWER FIRST AND
REFUNDING MORTGAGE BONDS(1):
Series U, 5.125%, due 1997 $49.3
1992 Series B, 7.25%, due 1997 250.0
1988 Series A, 9.375%, due 1998 $150.0 150.0
1992 Series F, 6.25%, due 1998 75.0 75.0
1989 Series B, 8.875%, due 1999 100.0 100.0
1993 Series C, 5.875%, due 2000 135.0 135.0
Various series, 6.75%-7.625%, due 2007 415.0 215.0
Various series, 6%-8%, due 2001-2004 805.0 805.0
Various series, 5.45%-8.75%, due 2021-2025 1,144.5 1,144.5
------------------
TOTAL FIRST AND REFUNDING
MORTGAGE BONDS 2,824.5 2,923.8
------------------
OTHER LONG-TERM DEBT:
DOMINION RESOURCES:
Commercial paper(2) 300.0 300.0
VIRGINIA POWER:
Term notes, fixed interest rate, 6.15%-10%,
due 1996-2003 551.1 503.1
Tax exempt financings(3):
Money market municipals, due 2007-2027(4) 488.6 488.6
Convertible interest rate, due 2022 10.0
DOMINION UK:
Eurobonds, fixed rate, 8.125%-12%,
due 2006-2016 643.2
Senior notes, fixed rate, 7.10%-7.45%,
due 2002-2007 822.6
Revolving credit agreement, due 2001(5) 857.1 342.5
Term loan, due 2002(6) 329.0
Loan notes, due 2007(7) 19.6
Revolving credit agreement, due 1998(8) 27.1
Revolving credit agreement, due 2002(9) 28.0
Finance lease(10) 255.5
Other borrowings(11) 16.4
------------------
TOTAL OTHER LONG-TERM DEBT 4,348.2 1,634.2
------------------
NONRECOURSE--NONUTILITY:
DOMINION RESOURCES:
Bank loans, 9.25%, due 2008 19.7 20.8
DOMINION ENERGY:
Revolving credit agreements, due 2001(12) 255.0 320.0
Term loan, fixed rate, 5.445%, due 1998 15.0 35.0
Bank loans, fixed rate, 9.70%-9.92%, due 2005 20.0 32.5
Bank loans, 4.5%-6.64%, due 1996-2024 45.2 53.0
Term loan, due 2002(13) 8.0
DOMINION CAPITAL:
Senior notes:(14)
Fixed rate, 6.12%, due 2000 50.0 50.0
Fixed rate, 7.60%, due 2003 46.0 46.0
Term note, fixed rate, 12.1%, due 2006 44.6 44.1
Line of Credit, due 1998(15) 57.7 57.2
Note payable, fixed rate, 6.04%, due 2002 50.0 26.8
Term loan, fixed rate, 6.00%, due 1996-1997 5.0
Commercial paper(16) 85.5 90.0
Term loan, fixed rate, 6.5%, due 2001 38.0 47.2
Medium term notes, fixed rates, 4.93%-6.25%,
due 1996-1998 134.0 104.0
Term loan, fixed rates, 6.5%-11.25%, due 1996-2001 13.0 13.5
Term loan, due 2008(17) 99.2
Revolving credit agreement(18) 6.8
Revolving credit agreement(19) 675.3
------------------
TOTAL--NONUTILITY DEBT 1,663.0 945.1
------------------
LESS AMOUNTS DUE WITHIN
ONE YEAR:
First and refunding mortgage bonds 225.0 299.3
Loans 433.4 12.0
Nonrecourse--nonutility 955.2 119.7
------------------
TOTAL AMOUNT DUE WITHIN
ONE YEAR 1,613.6 431.0
------------------
LESS UNAMORTIZED DISCOUNT,
NET OF PREMIUM 26.1 24.8
------------------
TOTAL LONG-TERM DEBT $7,196.0 $5,047.3
------------------
(1) Substantially all of Virginia Power's property is subject to the lien of
the mortgage, securing its First and Refunding Mortgage Bonds.
(2) See Note E to the Consolidated Financial Statements.
(3) Certain pollution control equipment at Virginia Power's generating
facilities has been pledged or conveyed to secure these financings.
(4) Interest rates vary based on short-term tax-exempt market rates. For 1997
and 1996, the weighted average daily interest rates were 3.74% and 3.57%,
respectively. Although these bonds are re-marketed within a one year
period, they are classified as long-term debt because Virginia Power
intends to maintain the debt and it is supported by long-term bank
commitments.
(5) The weighted average interest rate was 6.9% during 1997.
(6) The weighted average interest rate was 7.56% during 1997.
(7) The weighted average interest rate was 5.81% during 1997.
(8) The weighted average interest rate was 7.66% during 1997.
(9) The weighted average interest rate was 7.76% during 1997.
(10) The weighted average interest rate was 4.6% during 1997.
(11) The weighted average interest rate was 7.58% during 1997.
(12) The weighted average interest rates during 1997 and 1996 were 6.06% and
5.89%, respectively.
(13) The weighted average interest rate was 3.94% during 1997.
(14) The Rincon Securities common stock owned by Dominion Capital is pledged as
collateral to secure the loan.
(15) The weighted average interest rates during 1997 and 1996 were 6.24% and
6.24%, respectively.
(16) The weighted average interest rates during 1997 and 1996 were 5.57% and
5.37%, respectively.
(17) The weighted average interest rate was 7.67% during 1997.
(18) The weighted average interest rate was 5.63% during 1997.
(19) The weighted average interest rate was 6.19% during 1997.
Maturities (including sinking fund obligations) through 2002 are as follows (in
millions): 1998-$1,613.6; 1999-$826; 2000-$349.1; 2001-$432.6; and
2002-$1,098.3.
49
NOTE I Common Stock
- --------------------------------------------------------------------------------
During 1996 the company purchased on the open market and retired 136,800 shares
of common stock for an aggregate price of $5.5 million. On July 8, 1996, the
company established Dominion Direct Investment which continues and expands the
Automatic Dividend Reinvestment and Stock Purchase Plan. From 1995 through 1997,
the following changes in common stock occurred:
1997 1996 1995
- ----------------------------------------------------------------------------------------------------------------------------------
Shares Shares Shares
Outstanding Amount Outstanding Amount Outstanding Amount
(millions)
Balance at January 1 181.2 $3,471.4 176.4 $3,303.5 172.4 $3,157.6
Changes due to:
Dominion Direct Investment 3.7 142.2 1.9 70.9
Automatic Dividend Reinvestment and Stock Purchase Plan 1.4 55.1 2.9 107.6
Stock Purchase Plan for Customers of Virginia Power 1.0 23.2 1.4 45.8
Employee Savings Plan 0.9 34.0 0.5 20.5 0.2 8.3
Wolverine acquisition 1.9 21.4
Stock repurchase and retirement (0.1) (5.5) (0.7 (24.8)
Other 0.1 4.6 0.1 3.7 0.2 9.0
-----------------------------------------------------------------
Balance at December 31 187.8 $3,673.6 181.2 $3,471.4 176.4 $3,303.5
-----------------------------------------------------------------
NOTE J Long-Term Incentive Plan
- --------------------------------------------------------------------------------
A long-term incentive plan (the Plan) provides for the granting of nonqualified
stock options and restricted stock to certain employees of Dominion Resources
and its affiliates. The aggregate number of shares of common stock that may be
issued pursuant to the Plan is 3,750,000. The changes in share and option awards
under the Plan were as follows:
- -------------------------------------------------------------------------------------------------
Restricted Weighted Stock Weighted Shares
Shares Average Price Options Average Price Exercisable
Balance at December 31, 1994 41,186 $41.05 11,076 $29.36 11,076
============================================================
Awards granted--1995 25,320 $37.63
Exercised/distributed (21,576) $38.60
------------------------------------------------------------
Balance at December 31, 1995 44,930 $40.92 11,076 $29.36 11,076
============================================================
Awards granted--1996 79,784 $41.76
Exercised/distributed (29,433) $39.94 (475) $29.63
------------------------------------------------------------
Balance at December 31, 1996 95,281 $41.61 10,601 $29.34 10,601
============================================================
Awards granted--1997 53,884 $35.24
Exercised/distributed/forfeited (44,399) $39.42 (4,800) $29.25
------------------------------------------------------------
Balance at December 31, 1997 104,766 $39.29 5,801 $29.42 5,801
============================================================
In 1995, the FASB issued SFAS No. 123, "Accounting for Stock Based
Compensation." However, the company continues to apply Accounting Principles
Board Opinion No. 25, "Accounting for Stock Issued to Employees," and related
interpretations in accounting for the plan. Accordingly, no compensation expense
has been recognized for stock options awarded. Had compensation cost for the
company's plan been determined consistent with the methodology prescribed under
SFAS No. 123 there would have been no significant impact on the company's
operations for the years ended December 31, 1997 and 1996.
East Midlands launched sharesave plans in December 1997 under which
employees, who enter into Inland Revenue approved savings contract for periods
of three or five years, are granted options to purchase shares in Dominion
Resources common stock. Under these arrangements options were granted on
December 22, 1997, on 149,881 shares to 918 employees under the three year plan
and on 514,947 shares to 1,511 employees under the five year plan.
No charge has been made to the income statement for the year ended
December 31, 1997 with respect to the 20% discount on the market price of the
options on their date of issue. The discount will be recorded as compensation
expense over the periods of the plans.
50
NOTE K Obligated Mandatorily Redeemable
Preferred Securities of Dominion Resources
and Virginia Power Subsidiary Trusts
- --------------------------------------------------------------------------------
In December 1997, Dominion Resources established Dominion Resources Capital
Trust I (DR Capital Trust). DR Capital Trust sold 250,000 shares of Capital
Securities for $250 million, representing preferred beneficial interests and 97
percent beneficial ownership in the assets held by DR Capital Trust. Dominion
Resources issued $257.7 million of 7.83% Junior Subordinated Debentures
(Debentures) in exchange for the $250 million realized from the sale of the
Capital Securities and $7.7 million of common securities of DR Capital Trust.
The common securities represent the remaining 3 percent beneficial ownership
interest in the assets held by DR Capital Trust. The Debentures constitute 100
percent of DR Capital Trust assets. The Debentures are due December 1, 2027. The
distribution rate on the Capital Securities and the interest rate on the
Debentures are each subject to increase if Dominion Resources and DR Capital
Trust do not comply with an agreement they made to exchange the Capital
Securities and the Debentures, which were not registered under the securities
laws at the time of issuance, for registered substantially identical securities
within 180 days after the date of original issuance. Dominion Resources may
redeem the Debentures prior to December 1, 2007 under certain conditions at a
specified redemptive price. The Debentures may be redeemed on or after December
1, 2007 at another redemptive price. The Capital Securities are subject to
mandatory redemption upon repayment of the Debentures at maturity or earlier
redemption. At redemption, each Capital Security shall be entitled to receive a
liquidation amount of $1,000 plus accumulated distributions from December 8,
1997.
VP Capital Trust I (VP Capital Trust) was established as a subsidiary of
Virginia Power for the sole purpose of selling $135 million of preferred
securities (5.4 million shares at $25 par) in 1995. These securities represent
preferred beneficial interests and 97 percent beneficial ownership in the assets
held by VP Capital Trust. Virginia Power concurrently issued $139.2 million of
its 1995 Series A, 8.05% Junior Subordinated Notes (the Notes) in exchange for
the $135 million realized from the sale of the preferred securities and $4.2
million of common securities of VP Capital Trust. The preferred securities and
the common securities represent the total beneficial ownership interest in the
assets held by VP Capital Trust. The Notes are the sole assets of VP Capital
Trust.
The preferred securities are subject to mandatory redemption upon
repayment of the Notes at a liquidation amount of $25 plus accrued and unpaid
distributions, including interest. The Notes are due September 30, 2025.
However, that date may be extended up to an additional ten years if certain
conditions are satisfied.
NOTE L Preferred Stock
- --------------------------------------------------------------------------------
Dominion Resources is authorized to issue up to 20,000,000 shares of preferred
stock; however, no such shares are issued and outstanding.
Virginia Power has authorized 10,000,000 shares of preferred stock, $100
liquidation preference. Upon involuntary liquidation, dissolution or winding-up
of Virginia Power, each share is entitled to receive $100 per share plus accrued
dividends. Dividends are cumulative. Virginia Power preferred stock subject to
mandatory redemption at December 31, 1997 was as follows:
- ------------------------------------------
Shares
Series Outstanding
$5.58 400,000(1)(2)
$6.35 1,400,000(1)(3)
---------------
Total 1,800,000
===============
(1) Shares are non-callable prior to redemption.
(2) All shares to be redeemed on 3/1/00.
(3) All shares to be redeemed on 9/1/00.
There were no redemptions of preferred stock during 1997 and 1996. In 1995
Virginia Power redeemed 417,319 shares of its $7.30 dividend preferred stock
subject to mandatory redemption.
At December 31, 1997 Virginia Power preferred stock not subject to
mandatory redemption, $100 liquidation preference, is listed in the table below.
- -------------------------------------------------
Issued and Entitled Per
Outstanding Share Upon
Dividend Shares Redemption
$5.00 106,677 $112.50
4.04 12,926 102.27
4.20 14,797 102.50
4.12 32,534 103.73
4.80 73,206 101.00
7.05 500,000 105.00(1)
6.98 600,000 105.00(2)
MMP 1/87(3) 500,000 100.00
MMP 6/87(3) 750,000 100.00
MMP 10/88(3) 750,000 100.00
MMP 6/89(3) 750,000 100.00
MMP 9/92 series A(3) 500,000 100.00
MMP 9/92 series B(3) 500,000 100.00
---------
Total 5,090,140
=========
(1) Through 7/31/03 and thereafter to amounts declining in steps to $100.00
after 7/31/13.
(2) Through 8/31/03 and thereafter to amounts declining in steps to $100.00
after 8/31/13.
(3) Money Market Preferred (MMP) dividend rates are variable and are set every
49 days via an auction. The weighted average rates for these series in
1997, 1996, and 1995, including fees for broker/dealer agreements, were
4.71%, 4.48%, and 4.93%, respectively.
During the years 1995 through 1997, the following shares were redeemed:
- ------------------------------------------------------
Year Dividend Shares
1995 $7.45 400,000
1995 7.20 450,000
----------------
51
NOTE M Retirement Plan, Postretirement
Benefits and Other Benefits
- --------------------------------------------------------------------------------
RETIREMENT PLAN Dominion Resources' Retirement Plan covers virtually all
employees of Dominion Resources and its subsidiaries except for its U.K.
subsidiary, East Midlands. The benefits are based on years of service and the
employee's compensation. Dominion Resources funding policy is to contribute
annually an amount that is in accordance with the provisions of the Employment
Retirement Income Security Act of 1974. The majority of East Midlands' employees
joined a pension plan that is administered for the United Kingdom's electricity
industry. The assets of this plan are held in a separate trustee-administered
fund that is actuarially valued every three years. East Midlands and its
participating employees contribute to their pension plan.
The components of the provision for net periodic pension expense were as
follows:
1997 1996 1995
- --------------------------------------------------------------------------
Non
Total U.S. U.S. U.S. U.S.
Year ending December 31, Plans Plan Plan Plan Plan
(millions)
Service costs benefits
earned during the year $ 50.1 $ 27.5 $ 22.6 $ 26.7 $ 23.4
Interest cost on projected
benefit obligation 147.2 64.2 83.0 61.1 54.9
Actual return on
plan assets (231.0) (136.1) (94.9) (92.9) (172.3)
Net amortization
and deferral 65.9 65.9 30.6 114.9
---------------------------------------------
Net periodic pension cost $ 32.2 $ 21.5 $ 10.7 $ 25.5 $ 20.9
---------------------------------------------
The following table sets forth the Plan's funded status:
1997 1996
- -------------------------------------------------------------------------------
Non
Total U.S U.S. U.S.
As of December 31, Plans Plan Plan Plan
(millions)
Actuarial present value of
benefit obligations:
Accumulated benefit obligation:
Vested $1,730.9 $646.6 $1,084.3 $586.7
Non Vested 79.0 77.5 1.5 73.3
----------------------------------------
$1,809.9 $724.1 $1,085.8 $660.0
----------------------------------------
Projected benefit obligation for
service rendered to date 2,111.7 945.3 1,166.4 852.2
Plan assets at fair value,
primarily listed stocks and
corporate bonds 2,299.6 966.4 1,333.2 845.0
----------------------------------------
Plan assets in excess of (less than)
projected benefit obligation 187.9 21.1 166.8 (7.2)
Unrecognized net loss from past
experience different from that
assumed and effects of changes
in assumptions (73.9) 15.8 (89.7) 40.4
Unrecognized prior service cost 4.1 4.1 4.7
Unrecognized net asset at January 1,
being recognized over 16 years
beginning 1986 (18.5) (18.5) (21.8)
----------------------------------------
Prepaid pension cost included in
other assets $99.6 $22.5 $77.1 $16.1
----------------------------------------
Significant assumptions used in determining net periodic pension cost and the
projected benefit obligation were:
1997 1996
- ---------------------------------------------------------------------------
Non
U.S. U.S. U.S.
As of December 31, Plan Plan Plan
Discount rates 7.75% 6.75% 8.0%
Rates of increase in compensation levels 5.0% 4.75% 5.0%
Expected long-term rate of return 9.5% 7.00% 9.5%
------------------------
POSTRETIREMENT BENEFITS Dominion Resources and its subsidiaries provide retiree
health care and life insurance benefits through insurance companies with annual
premiums based on benefits paid during the year. From time to time in the past,
Dominion Resources and its subsidiaries have changed benefits. Some of these
changes have reduced benefits. Under the terms of their benefit plans, the
companies reserve the right to change, modify or terminate the plans. Net
periodic postretirement benefit expense for 1997 and 1996 was as follows:
- ----------------------------------------------------------------------------
Year ending December 31, 1997 1996
(millions)
Service cost $ 12.7 $ 12.3
Interest cost 25.4 24.2
Return on plan assets (25.3) (16.6)
Amortization of transition obligation 12.1 12.1
Net amortization and deferral 13.4 7.2
------------------
Net periodic postretirement benefit expense $ 38.3 $ 39.2
------------------
The following table sets forth the funded status of the plan:
- ----------------------------------------------------------------------------
As of December 31, 1997 1996
(millions)
Fair value of plan assets $176.6 $133.0
------------------
Accumulated postretirement benefit obligation:
Retirees $225.5 $202.7
Active plan participants 139.4 125.0
------------------
Accumulated postretirement
benefit obligation 364.9 327.7
------------------
Accumulated postretirement
benefit obligation in excess of plan assets (188.3) (194.7)
Unrecognized transition obligation 181.9 194.1
Unrecognized net experience gain (1.3) (3.0)
------------------
Accrued postretirement benefit cost $ (7.7) $ (3.6)
------------------
52
A one percent increase in the health care cost trend rate would result in an
increase of $5.1 million in the service and interest cost components and a $39.9
million increase in the accumulated postretirement benefit obligation.
Significant assumptions used in determining the postretirement benefit
obligation were:
- ---------------------------------------------------------------------------
1997 1996
Discount rates 7.75% 8.0%
Assumed return on plan assets 9.0% 9.0%
Medical cost trend rate 6% for first year 7% for first year
5% for second year 6% for second year
Scaling down to Scaling down to
4.75% beginning in 4.75% beginning in
the year 2000 the year 2000
------------------------------------------
Virginia Power is recovering these costs in rates on an accrual basis in all
material respects, in all jurisdictions. The funds being collected for other
postretirement benefits accrual in rates, in excess of other postretirement
benefits actually paid during the year, are contributed to external benefit
trusts under Virginia Power's current funding policy. Employer provided health
care benefits are not common in the United Kingdom due to the country's national
health care system. Accordingly, East Midlands does not provide health care
benefits to the majority of its employees.
NOTE N Restructuring
- --------------------------------------------------------------------------------
In March 1995, Virginia Power announced the implementation phase of its Vision
2000 program. During this phase, Virginia Power began reviewing operations with
the objective of outsourcing services where economical and appropriate, and
re-engineering the remaining functions to streamline operations. The
re-engineering process has resulted in outsourcing, decentralization,
reorganization and downsizing for portions of Virginia Power's operations. As
part of this process, Virginia Power has evaluated its utilization of capital
resources in its operations to identify further opportunities for operational
efficiencies through outsourcing or re-engineering of its processes.
Restructuring charges of $18.4 million, $64.9 million and $117.9 million
in 1997, 1996 and 1995, respectively, included severance costs, purchased power
contract restructuring and negotiated settlement costs, capital project
cancellation costs, and other costs incurred directly as a result of the Vision
2000 initiatives. While Virginia Power may incur additional charges for
severance in 1998, the amounts are not expected to be significant.
In 1995, Virginia Power established a comprehensive involuntary severance
package for salaried employees who may no longer be employed as a result of
these initiatives. Virginia Power is recognizing the cost associated with
employee terminations as management identifies the positions to be eliminated.
Severance payments are being made over a period not to exceed twenty months.
Through December 31, 1997, management had identified 1,977 positions to be
eliminated. The recognition of severance costs resulted in a charge to
operations in 1997, 1996 and 1995 of $12.5 million, $49.2 million and $51.2
million, respectively. At December 31, 1997, 1,619 employees have been
terminated and severance payments totaling $74 million have been paid. Virginia
Power estimates that these staffing reductions will result in annual savings in
the range of $80 million to $90 million for its restructured operations.
However, such savings are being offset by salary increases, outsourcing costs
and increased payroll costs associated with staffing for growth opportunities.
In an effort to minimize its exposure to potential stranded investment,
Virginia Power is evaluating its long-term purchased power contracts and
negotiating modifications to their terms, including cancellations, where it is
determined to be economically advantageous to do so. Virginia Power also
negotiated settlements with several other parties to terminate their rights to
sell power to Virginia Power. The cost of contract modifications, contract
cancellations and negotiated settlements was $3.8 million, $7.8 million and $8.1
million in 1997, 1996 and 1995, respectively. Virginia Power estimated that its
annual future purchased power costs, including energy payments, would be reduced
by up to $0.8 million, $5.8 million and $147 million for the 1997, 1996 and 1995
transactions, respectively. The cost of alternative sources of power that might
ultimately be required as a result of these settlements is expected to be
significantly less than the estimated reduction in purchased power costs.
Restructuring charges reported in 1995 included $37.3 million for the
cancellation of a project to construct a facility to handle low level
radioactive waste at Virginia Power's North Anna Power Station. Virginia Power
concluded that the facility should not be completed due to the additional
capital investment required, decreased Virginia Power volumes of low level
radioactive waste resulting from improvements in station procedures and the
availability of more economical offsite processing.
NOTE O Accelerated Cost Recovery
- --------------------------------------------------------------------------------
In this increasingly competitive environment, Virginia Power has concluded that
it is appropriate to utilize available savings and cost reductions, such as
those generated by the Vision 2000 program (see Note N), to accelerate the
write-off of existing unamortized regulatory assets. Not only will this
strategically position Virginia Power in anticipation of competition, but it
also reflects Virginia Power's commitment to mitigate its exposure to
potentially stranded costs. Virginia Power identified savings of $38.4 million
in 1997 and $26.7 million in 1996 which were used to establish a reserve for
expected adjustments to regulatory assets. (See Note Q).
NOTE P Derivative Transactions
- --------------------------------------------------------------------------------
Dominion Resources uses derivative financial instruments for the purposes of
managing interest rate, natural gas price and foreign currency risks.
53
INTEREST RATE RISKS Saxon Mortgage, enters into forward delivery contracts,
financial futures and options contracts for the purpose of reducing exposure to
the effects of changes in interest rates on mortgage loans which the company has
funded or has committed to fund. Gains and losses on such contracts relating to
mortgage loans are recognized when the loans are sold. If the counterparties to
the hedging transactions are unable to perform according to the terms of the
contracts, the company may incur losses upon selling the mortgage loans at
prevailing prices. As of December 31, 1997, Saxon has outstanding liabilities
related to its hedging positions with certain counter parties a notional amount
of $552.9 million. The deferred hedging losses, net, at December 31, 1997 and
1996 were immaterial.
FOREIGN CURRENCY RISKS In May 1997, Dominion UK issued $819 million of Yankee
bonds. The bonds are denominated in U.S. dollars, exposing the company to
foreign currency risk. Coincident with the issuance of the debt, Dominion UK
acquired cross currency swaps to mitigate the foreign currency risk. The swaps
are in effect until the debt matures in five and ten years, respectively. The
cash settlement and the periodic payments under the hedge are treated as yield
adjustments to the underlying debt and recognized over the period the bonds are
outstanding. The notional amount of these swaps at December 31, 1997 was $819
million and the deferred hedging losses, net as of December 31, 1997 were
immaterial.
NOTE Q Commitments and Contingencies
- --------------------------------------------------------------------------------
As the result of issues generated in the course of daily business, the company
is involved in legal, tax and regulatory proceedings before various courts,
regulatory commissions and governmental agencies. While some of the proceedings
involve substantial amounts of money, management believes that the final
disposition of these proceedings will not have an adverse material effect on
operations or the financial position of the company.
Virginia Power
REGULATORY MATTERS In March, 1997, the Virginia Commission issued an order that
Virginia Power's base rates be made interim and subject to refund as of March 1,
1997. This order was the result of the Commission Staff's report on its review
of Virginia Power's 1995 Annual Information Filing which concluded that the
company's present rates would cause Virginia Power to earn in excess of its
authorized return on equity. The Staff found that, for purposes of establishing
rates prospectively, a rate reduction of $95.6 million may be necessary in order
to realign rates to the authorized level.
Virginia Power filed an Alternative Rate Plan (ARP) in March 1997 based on
1996 financial information. Subsequently, the Commission consolidated the
proceeding concerned with the 1995 Annual Informational Filing with the
proceeding that includes the ARP proposed by the company. Opposing parties in
the rate proceeding have made filings recommending rate reductions in excess of
$200 million. The company is currently studying the filings of those parties.
The Commission Staff is scheduled to make further filings in late February 1998.
Hearings are scheduled to begin in late April 1998.
CONSTRUCTION PROGRAM Virginia Power has made substantial commitments in
connection with its construction program and nuclear fuel expenditures, which
are estimated to total $588.1 million (excluding AFC) for 1998. Virginia Power
presently estimates that all of its 1998 construction expenditures, including
nuclear fuel, will be met through cash flow from operations.
PURCHASED POWER CONTRACTS Since 1984, Virginia Power has entered into contracts
for the long-term purchase of capacity and energy from other utilities,
qualifying facilities and independent power producers. As of December 31, 1997,
there were 57 nonutility generating facilities under contract to provide
Virginia Power 3,277 megawatts of dependable summer capacity. The following
table shows the minimum commitments as of December 31, 1997 for power purchases
from utility and nonutility suppliers.
Commitments
- -----------------------------------------------------
(millions) Capacity Other
1998 $ 813.5 $154.9
1999 816.7 156.7
2000 723.8 92.0
2001 716.0 83.7
2002 721.1 81.5
After 2002 9,069.6 388.2
--------------------
Total $12,860.7 $957.0
--------------------
Present value of the total $ 5,878.0 $553.3
--------------------
In addition to the commitments listed above, under some contracts, Virginia
Power may purchase, at its option, additional power as needed. Payments for
purchased power (including economy, emergency, limited-term, short-term, and
long-term purchases) for the years 1997, 1996, and 1995 were $1,381 million,
$1,183 million, and $1,093 million, respectively. For discussion of Virginia
Power's efforts to restructure certain purchased power contracts (see Note N).
FUEL PURCHASE COMMITMENTS Virginia Power's estimated fuel purchase commitments
for the next five years for system generation are as follows (millions):
1998-$293; 1999-$233; 2000-$144; 2001-$144; and 2002-$127.
ENVIRONMENTAL MATTERS Environmental costs have been historically recovered
through the ratemaking process; however, should material costs be incurred and
not recovered through rates, Virginia Power's results of operations and
financial condition could be adversely impacted.
The EPA has identified Virginia Power and several other entities as
Potentially Responsible Parties (PRPs) at two Superfund sites located in
Kentucky and Pennsylvania. The estimated future remediation costs for the sites
are in the range of $61.5 million to $72.5 million. Virginia Power's
proportionate share of the costs is expected to be in the range of $1.7 million
to $2.5 million, based upon allocation formulas and the volume of waste shipped
to the
54
sites. As of December 31, 1997, Virginia Power had accrued a reserve of $1.7
million to meet its obligations at these two sites. Based on a financial
assessment of the PRPs involved at these sites, Virginia Power has determined
that it is probable that the PRPs will fully pay the costs apportioned to them.
Virginia Power generally seeks to recover its costs associated with
environmental remediation from third-party insurers. At December 31, 1997
pending claims were not recognized as an asset or offset against recorded
obligations.
NUCLEAR INSURANCE The Price-Anderson Act limits the public liability of an owner
of a nuclear power plant to $8.9 billion for a single nuclear incident. The
Price-Anderson Amendments Act of 1988 allows for an inflationary provision
adjustment every five years. Virginia Power has purchased $200 million of
coverage from commercial insurance pools with the remainder provided through a
mandatory industry risk-sharing program. In the event of a nuclear incident at
any licensed nuclear reactor in the United States, Virginia Power could be
assessed up to $81.7 million (including a 3 percent insurance premium tax for
Virginia) for each of its four licensed reactors not to exceed $10.3 million
(including a 3 percent insurance premium tax for Virginia) per year per reactor.
There is no limit to the number of incidents for which this retrospective
premium can be assessed.
Nuclear liability coverage for claims made by nuclear workers first hired
on or after January 1, 1988, except those arising out of an extraordinary
nuclear occurrence, is provided under the Master Worker insurance program.
(Those first hired into the nuclear industry prior to January 1, 1988 are
covered by the policy discussed above.) The aggregate limit of coverage for the
industry is $400 million ($200 million policy limit with automatic
reinstatements of an additional $200 million). Virginia Power's maximum
retrospective assessment is approximately $12.3 million (including a 3 percent
insurance premium tax for Virginia).
Virginia Power's current level of property insurance coverage ($2.55
billion for North Anna and $2.4 billion for Surry) exceeds the NRC's minimum
requirement for nuclear power plant licensees of $1.06 billion per reactor site,
and includes coverage for premature decommissioning and functional total loss.
The NRC requires that the proceeds from this insurance be used first to return
the reactor to and maintain it in a safe and stable condition, and second to
decontaminate the reactor and station site in accordance with a plan approved by
the NRC. Virginia Power's nuclear property insurance is provided by Nuclear
Mutual Limited (NML) and Nuclear Electric Insurance Limited (NEIL), two mutual
insurance companies, and is subject to retrospective premium assessments in any
policy year in which losses exceed the funds available to these insurance
companies. The maximum assessment for the current policy period is $37 million.
Based on the severity of the incident, the boards of directors of Virginia
Power's nuclear insurers have the discretion to lower the maximum retrospective
premium assessment or eliminate either or both completely. For any losses that
exceed the limits, or for which insurance proceeds are not available because
they must first be used for stabilization and decontamination, Virginia Power
has the financial responsibility.
Virginia Power purchases insurance from NEIL to cover the cost of
replacement power during the prolonged outage of a nuclear unit due to direct
physical damage of the unit. Under this program, Virginia Power is subject to a
retrospective premium assessment for any policy year in which losses exceed
funds available to NEIL. The current policy period's maximum assessment is $8.7
million.
As a joint owner of the North Anna Power Station, ODEC is responsible for
its proportionate share (11.6 percent) of the insurance premiums applicable to
that station, including any retrospective premium assessments and any losses not
covered by insurance.
Dominion Resources
Under the terms of an investment agreement, Dominion Resources must provide
contingent equity support to Dominion Energy in the amount of $47.4 million.
Management believes the possibility of such support to Dominion Energy is
remote.
Dominion Resources is guarantor to Dominion UK's revolving credit
agreement. The revolving credit agreement is with Union Bank of Switzerland and
various lending institutions. The total commitment of the agreement is 700
million pounds sterling ($1.2 billion). Under the agreement, Dominion Resources
has guaranteed the prompt payment in full of amounts outstanding. In addition,
if Dominion UK fails to pay when due any of the amounts outstanding, Dominion
Resources is obligated to promptly pay the amount outstanding. This agreement
expires on November 12, 2001.
Dominion UK
Dominion UK's indirect subsidiary, Corby Power Limited, has entered into
long-term commitments to purchase gas. The contract commenced on October 1, 1993
and terminates on September 30, 2008. The following table shows the net present
value of the commitments as of December 31, 1997.
- -------------------------------------------
Commitments
(millions)
1998 $ 82.3
1999 82.3
2000 88.8
2001 92.1
2002 93.8
After 2002 605.3
--------
Total $1,044.6
--------
Present value of the total $ 683.5
========
Dominion Energy
Dominion Energy, through certain wholly-owned subsidiaries, has general
partnership interests in certain of its energy ventures. Accordingly, such
subsidiaries may be called upon to fund future operation of these investments to
the extent operating cash flow is insufficient.
In addition, Dominion Energy may be required to make payments under
certain agreements on behalf of its energy ventures. As of December 31, 1997 no
payments have been required.
55
Dominion Capital
At December 31, 1997, Dominion Capital had commitments to fund loans of
approximately $672.9 million.
NOTE R Acquisitions
- --------------------------------------------------------------------------------
EAST MIDLANDS ACQUISITION AND FINANCING In the first quarter of 1997, Dominion
Resources acquired 100% indirect ownership of East Midlands by means of a cash
tender offer commenced on November 22, 1996. Total consideration for the
acquisition was $2.2 billion. The acquisition has been accounted for using the
purchase method of accounting. The excess of the purchase price over the net
assets acquired resulted in goodwill of $1.7 billion. (Net assets acquired
consists of the fair value of tangible and identifiable intangible assets less
the fair value of liabilities assumed by the purchaser.) The goodwill is being
amortized over a 40-year period.
The following unaudited pro forma combined results of operations for the
twelve months ended December 31, 1996 has been prepared assuming the acquisition
of East Midlands had occurred at the beginning of the period. The pro forma
results are provided for information only. The results are not necessarily
indicative of the actual results that would have been realized had the
acquisition occurred on the indicated dates, nor are they necessarily indicative
of future results of operations of the combined companies.
Twelve Months Ended
December 31,
- -------------------------------------------------------------------------
1997 1996
As As
Reported Reported Pro Forma
CONSOLIDATED RESULTS
(millions, except earnings
per share amounts)
Revenues $7,677.6 $4,854.0 $6,924.2
Net income* $ 399.2 $ 472.1 $ 598.8
Earnings per share* $ 2.15 $ 2.65 $ 3.36
--------------------------------
*1997 results include ($156.6) windfall profits tax ($0.85 per share).
NOTE S Subsequent Events
- --------------------------------------------------------------------------------
On January 21, 1998, Dominion Resources issued 6.5 million shares of common
stock. On January 27, 1998, the company sold an additional 275 thousand shares.
Proceeds from the sale amounted to approximately $275 million. A portion of the
funds was used to pay down part of the five-year revolving credit facility used
to finance the purchase of East Midlands.
NOTE T Business Segments
- --------------------------------------------------------------------------------
The company's principal business segments include Virginia Power, Dominion UK,
Dominion Energy, Dominion Capital and corporate. The company's business segment
information was:
BUSINESS SEGMENTS
- ------------------------------------------------------------------------------
1997 1996 1995
(millions, except identifiable
assets amounts)
OPERATING REVENUES
AND INCOME
Virginia Power $5,079.0 $4,420.9 $4,351.9
Dominion UK 1,970.1
Dominion Capital 295.7 177.5 105.4
Dominion Energy 332.8 255.6 175.8
--------------------------------------
Consolidated $7,677.6 $4,854.0 $4,633.1
--------------------------------------
OPERATING INCOME
Virginia Power $1,019.3 $1,010.0 $971.9
Dominion UK 246.6
Dominion Capital 157.1 81.9 50.2
Dominion Energy 71.4 36.6 35.3
Corporate (17.4) (18.7) (31.0)
--------------------------------------
Consolidated $1,477.0 $1,109.8 $1,026.4
--------------------------------------
IDENTIFIABLE ASSETS
(billions)
Virginia Power $ 12.0 $ 11.8 $ 11.8
Dominion UK 4.4
Dominion Capital 2.1 1.1 0.9
Dominion Energy 1.6 1.6 1.1
Corporate 6.1 5.6 5.0
Eliminations (6.0) (5.2) (4.9)
--------------------------------------
Consolidated $ 20.2 $ 14.9 $ 13.9
--------------------------------------
DEPRECIATION AND
AMORTIZATION
Virginia Power $ 584.3 $ 536.4 $ 503.5
Dominion UK 131.3
Dominion Capital 17.5 6.8 3.0
Dominion Energy 85.0 69.9 42.6
Corporate 1.2 2.1 1.9
--------------------------------------
Consolidated $ 819.3 $ 615.2 $ 551.0
--------------------------------------
CAPITAL EXPENDITURES
Virginia Power $ 481.8 $ 484.0 $ 577.5
Dominion UK 234.2
Dominion Capital 7.8 17.7 1.9
Dominion Energy 11.7 176.0 25.1
Corporate 17.7 1.3 0.4
--------------------------------------
Consolidated $ 753.2 $ 679.0 $ 604.9
--------------------------------------
56
NOTE U Quarterly Financial and
Common Stock Data (unaudited)
- --------------------------------------------------------------------------------
The following amounts reflect all adjustments, consisting of only normal
recurring accruals (except as disclosed below), necessary in the opinion of
Dominion Resources' management for a fair statement of the results for the
interim periods.
QUARTERLY FINANCIAL AND COMMON STOCK
DATA--UNAUDITED
- ------------------------------------------------------------------------------
1997 1996
(millions, except per share amounts)
REVENUES AND INCOME
First Quarter $1,891.4 $1,223.9
Second Quarter 1,655.1 1,088.3
Third Quarter 2,094.3 1,327.3
Fourth Quarter 2,036.8 1,214.5
-----------------------------
Year $7,677.6 $4,854.0
-----------------------------
INCOME BEFORE PROVISION
FOR INCOME TAXES AND
MINORITY INTERESTS
First Quarter $ 255.0 $ 224.2
Second Quarter 124.3 144.3
Third Quarter 153.2 244.9
Fourth Quarter 146.3 87.6
-----------------------------
Year $ 678.8 $ 701.0
-----------------------------
NET INCOME
First Quarter $ 169.9 $ 150.2
Second Quarter 79.1 94.2
Third Quarter 50.4 162.2
Fourth Quarter 99.8 65.5
-----------------------------
Year $ 399.2 $ 472.1
-----------------------------
EARNINGS PER SHARE
First Quarter $ 0.92 $ 0.85
Second Quarter 0.43 0.53
Third Quarter 0.27 0.91
Fourth Quarter 0.53 0.36
-----------------------------
Year $ 2.15 $ 2.65
-----------------------------
DIVIDENDS PER SHARE
First Quarter $ 0.645 $ 0.645
Second Quarter 0.645 0.645
Third Quarter 0.645 0.645
Fourth Quarter 0.645 0.645
-----------------------------
Year $ 2.58 $ 2.58
-----------------------------
STOCK PRICE RANGE
First Quarter 413/8-351/2 443/8-375/8
Second Quarter 363/4-331/4 401/4-370/0
Third Quarter 381/4-355/16 40-367/8
Fourth Quarter 427/8-347/8 41-371/8
-----------------------------
Year 427/8-331/4 443/8-367/8
-----------------------------
In the third quarter of 1997, East Midlands recorded a liability of
approximately $157 million to reflect the anticipated one-time windfall tax
levied by the UK government. The tax was levied on regional electric companies
in the United Kingdom and is based on the privatized utilities' excess profits.
East Midlands paid one-half of the tax levy in December 1997. The remaining
payment is due in December 1998.
Certain accruals were recorded in 1997 and 1996 that are not ordinary,
recurring adjustments, consisting of restructuring (see Note N) and accelerated
costs recovery (see Note O).
Restructuring--Virginia Power expensed $0, $6.3 million, $1.4 million and
$10.7 million during the first, second, third and fourth quarters of 1997,
respectively, and $5.4 million, $19.3 million, $4.6 million and $35.6 million
during the same periods in 1996.
Accelerated cost recovery--Amounts reserved for accelerated cost recovery
were $0, $2.7 million, $28.3 million and $7.3 million during the first, second,
third and fourth quarters of 1997, respectively, and $26.7 million during the
fourth quarter of 1996.
Charges for restructuring and accelerated cost recovery reduced Balance
Available for Common Stock by $0, $5.8 million, $19.3 million, and $11.7 million
for the first, second, third, and fourth quarters of 1997, respectively and $3.5
million, $12.5 million, $3.0 million and $40.6 million for the same periods in
1996.
57
REPORT OF MANAGEMENT'S RESPONSIBILITIES
The management of Dominion Resources, Inc. is responsible for all information
and representations contained in the Consolidated Financial Statements and other
sections of the annual report. The Consolidated Financial Statements, which
include amounts based on estimates and judgments of management, have been
prepared in conformity with generally accepted accounting principles. Other
financial information in the annual report is consistent with that in the
Consolidated Financial Statements.
Management maintains a system of internal accounting controls designed to
provide reasonable assurance, at a reasonable cost, that Dominion Resources' and
its subsidiaries' assets are safeguarded against loss from unauthorized use or
disposition and that transactions are executed and recorded in accordance with
established procedures. Management recognizes the inherent limitations of any
system of internal accounting control, and therefore cannot provide absolute
assurance that the objectives of the established internal accounting controls
will be met.
This system includes written policies, an organizational structure
designed to ensure appropriate segregation of responsibilities, careful
selection and training of qualified personnel, and internal audits. Management
believes that during 1997 the system of internal control was adequate to
accomplish the intended objectives.
The Consolidated Financial Statements have been audited by Deloitte &
Touche LLP, independent auditors, whose designation by the Board of Directors
was ratified by the shareholders. Their audits were conducted in accordance with
generally accepted auditing standards and include a review of Dominion
Resources' and its subsidiaries' accounting systems, procedures and internal
controls, and the performance of tests and other auditing procedures sufficient
to provide reasonable assurance that the Consolidated Financial Statements are
not materially misleading and do not contain material errors.
The Audit Committees of the Boards of Directors, composed entirely of
directors who are not officers or employees of Dominion Resources or its
subsidiaries, meet periodically with independent auditors, the internal auditors
and management to discuss auditing, internal accounting control and financial
reporting matters and to ensure that each is properly discharged. Both
independent auditors and the internal auditors periodically meet alone with the
Audit Committees and have free access to the Committees at any time.
Management recognizes its responsibility for fostering a strong ethical
climate so that Dominion Resources' affairs are conducted according to the
highest standards of personal corporate conduct. This responsibility is
characterized and reflected in Dominion Resources' Code of Ethics, which
addresses potential conflicts of interest, compliance with all domestic and
foreign laws, the confidentiality of proprietary information, and full
disclosure of public information.
Dominion Resources, Inc.
/s/ Thos. E. Capps /s/ James L. Trueheart
Thos. E. Capps James L. Trueheart
Chairman, President and Vice President and
Chief Executive Officer Controller
REPORT OF INDEPENDENT AUDITORS
TO THE SHAREHOLDERS AND BOARD OF DIRECTORS OF DOMINION RESOURCES, INC.
We have audited the accompanying consolidated balance sheets of Dominion
Resources, Inc. and subsidiaries as of December 31, 1997 and 1996 and the
related consolidated statements of income and retained earnings and of cash
flows for each of the three years in the period ended December 31, 1997. These
Consolidated Financial Statements are the responsibility of the company's
management. Our responsibility is to express an opinion on these Consolidated
Financial Statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such Consolidated Financial Statements present fairly, in
all material respects, the consolidated financial position of Dominion
Resources, Inc. and subsidiaries as of December 31, 1997 and 1996 and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1997 in conformity with generally accepted
accounting principles.
/s/ Deloitte & Touche LLP
Richmond, Virginia
February 9, 1998