UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended March 31, 2001
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[X] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Transition Period From ____________ to ____________
Commission File Number
--------------------------
1-10290
DQE, Inc.
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(Exact name of registrant as specified in its charter)
Pennsylvania 25-1598483
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
Cherrington Corporate Center, Suite 100
500 Cherrington Parkway, Coraopolis, Pennsylvania 15108-3184
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(Address of principal executive offices)(Zip Code)
Registrant's telephone number, including area code: (412) 393-6000
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months and (2) has been subject to such filing requirements for
the past 90 days. Yes X No
Indicate the number of shares outstanding of each of the issuer's classes of
common stock as of the latest practicable date:
DQE Common Stock, no par value - 55,886,723 shares outstanding as of March 31,
2001.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.
DQE Condensed Statement of Consolidated Income (Unaudited)
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(Millions of Dollars, Except Per
Share Amounts)
------------------------------------
Three Months Ended March 31,
------------------------------------
2001 2000
- --------------------------------------------------------------------------------------------------
Operating Revenues:
Electricity sales $ 236.6 $ 246.0
Water sales 25.6 26.0
Other 58.3 42.5
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Total Operating Revenues 320.5 314.5
- --------------------------------------------------------------------------------------------------
Operating Expenses:
Fuel and purchased power 93.5 50.6
Other operating 93.9 103.4
Maintenance 5.5 17.7
Depreciation and amortization 87.8 69.3
Taxes other than income taxes 15.3 23.4
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Total Operating Expenses 296.0 264.4
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Operating Income 24.5 50.1
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Other Income 23.4 33.4
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Interest and Other Charges 28.4 33.5
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Income Before Income Taxes and Cumulative
Effect of a Change in Accounting Principle 19.5 50.0
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Income Taxes 7.3 7.1
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Income Before Cumulative Effect
of a Change in Accounting Principle 12.2 42.9
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Cumulative Effect of a Change in Accounting Principle - Net -- 15.5
- --------------------------------------------------------------------------------------------------
Net Income 12.2 58.4
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Dividends on Preferred Stock -- 0.4
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Earnings Available for Common Stock $ 12.2 $ 58.0
==================================================================================================
Other Comprehensive Income:
Unrealized holding gains (losses) during the quarter,
net of tax of $(5.9) and $5.9 (11.0) 8.4
- --------------------------------------------------------------------------------------------------
Total Other Comprehensive Income (11.0) 8.4
- --------------------------------------------------------------------------------------------------
Comprehensive Earnings for Common Stock $ 1.2 $ 66.4
==================================================================================================
Average Number of Common Shares
Outstanding (Millions of Shares) 55.9 70.9
==================================================================================================
Earnings Per Share of Common Stock:
Before cumulative effect of a change in accounting principle $ 0.22 $ 0.60
Cumulative effect of a change in accounting principle $ -- $ 0.22
- --------------------------------------------------------------------------------------------------
Basic Earnings Per Share of Common Stock $ 0.22 $ 0.82
==================================================================================================
Comprehensive Earnings Per Share of Common Stock $ 0.02 $ 0.94
==================================================================================================
Diluted Earnings Per Share of Common Stock:
Before cumulative effect of a change in accounting principle $ 0.22 $ 0.59
Cumulative effect of a change in accounting principle $ -- $ 0.21
- --------------------------------------------------------------------------------------------------
Diluted Earnings Per Share of Common Stock $ 0.22 $ 0.80
==================================================================================================
Diluted Comprehensive Earnings Per Share of Common Stock $ 0.03 $ 0.92
==================================================================================================
Dividends Declared Per Share of Common Stock $ 0.42 $ 0.40
==================================================================================================
See notes to condensed consolidated financial statements.
2
DQE Condensed Consolidated Balance Sheet (Unaudited)
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(Millions of Dollars)
-------------------------------------
March 31, December 31,
ASSETS 2001 2000
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Current Assets:
Cash and temporary cash investments $ 16.3 $ 15.8
Receivables 218.8 236.4
Other current assets 201.4 136.6
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Total Current Assets 436.5 388.8
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Long-Term Investments 760.1 773.9
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Property, Plant and Equipment 2,444.2 2,396.3
Less: Accumulated depreciation (743.1) (702.4)
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Total Property, Plant and Equipment - Net 1,701.1 1,693.9
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Other Non-Current Assets:
Transition costs 332.0 396.4
Regulatory assets 326.7 326.6
Other 289.7 286.4
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Total Other Non-Current Assets 948.4 1,009.4
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Total Assets $ 3,846.1 $ 3,866.0
===================================================================================================
CAPITALIZATION AND LIABILITIES
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Current Liabilities:
Notes payable and current debt maturities $ 117.2 $ 89.6
Other current liabilities 227.3 258.6
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Total Current Liabilities 344.5 348.2
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Non-Current Liabilities:
Deferred income taxes - net 865.1 852.7
Deferred income 114.1 116.8
Other non-current liabilities 170.3 171.4
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Total Non-Current Liabilities 1,149.5 1,140.9
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Commitments and Contingencies (Note D)
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Capitalization:
Long-Term Debt 1,350.2 1,351.7
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Preferred Stock:
DQE preferred stock 16.4 17.4
Preferred stock of subsidiaries 212.6 212.6
Preference stock of subsidiaries 12.1 11.4
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Total Preferred Stock 241.1 241.4
- ---------------------------------------------------------------------------------------------------
Common Shareholders' Equity:
Common stock - no par value (authorized - 187,500,000
shares; issued - 109,679,154 shares) 994.9 994.8
Retained earnings 995.9 1,007.7
Treasury stock (at cost) (53,792,431 and 53,793,330 shares) (1,247.5) (1,247.2)
Accumulated other comprehensive income 17.5 28.5
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Total Common Shareholders' Equity 760.8 783.8
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Total Capitalization 2,352.1 2,376.9
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Total Liabilities and Capitalization $ 3,846.1 $ 3,866.0
===================================================================================================
See notes to condensed consolidated financial statements.
3
DQE Condensed Statement of Consolidated Cash Flows (Unaudited)
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(Millions of Dollars)
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Three Months Ended March 31,
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2001 2000
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Cash Flows From Operating Activities:
Operations $ 110.3 $ 107.6
Changes in working capital other than cash (78.5) (31.4)
Other (0.2) (10.9)
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Net Cash Provided from Operating Activities 31.6 65.3
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Cash Flows From Investing Activities:
Capital expenditures (25.6) (29.5)
Long-term investments (5.3) (9.5)
Acquisitions (0.8) (32.0)
Capitalized divestiture costs -- (19.6)
Proceeds from disposition of investments 2.4 15.7
Other (4.8) 6.3
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Net Cash Used in Investing Activities (34.1) (68.6)
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Cash Flows From Financing Activities:
Commercial paper activity 29.0 (35.7)
Issuance of debt -- 174.7
Repurchase of common stock -- (77.1)
Reductions of long-term obligations - net (3.7) (45.1)
Dividends on common and preferred stock (24.0) (28.5)
Other 1.7 (26.8)
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Net Cash Used in Financing Activities 3.0 (38.5)
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Net decrease in cash and temporary cash investments 0.5 (41.8)
Cash and temporary cash investments at beginning of period 15.8 54.2
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Cash and temporary cash investments at end of period $ 16.3 $ 12.4
=========================================================================================================
See notes to condensed consolidated financial statements.
4
Notes to Condensed Consolidated Financial Statements (Unaudited)
A. CONSOLIDATION, RECLASSIFICATION AND ACCOUNTING POLICIES
Consolidation
DQE, Inc. is a multi-utility delivery and services company. Our operating
subsidiaries are Duquesne Light Company; AquaSource, Inc.; DQE Energy Services,
Inc.; DQE Enterprises, Inc.; DQE Financial Corp.; DQE Communications, Inc.; and
ProAm, Inc. Our financial, non-operating subsidiaries are Cherrington Insurance,
Ltd. and DQE Capital Corporation.
Duquesne Light, our largest operating subsidiary, is an electric utility
engaged in the transmission and distribution of electric energy.
AquaSource, our second largest operating subsidiary, is a water resource
management company that acquires, develops and manages water and wastewater
systems and complementary businesses.
Our other business lines engage in a wide range of complementary initiatives,
including the following: the distribution of propane; the production of landfill
gas; investments in electronic commerce, energy-related technology and
communications systems; energy facility development and operation; and
independent power production. DQE Capital and Cherrington Insurance provide
financing and insurance services for DQE and various affiliates.
All material intercompany balances and transactions have been eliminated in
the preparation of the consolidated financial statements.
Strategic Review Process
As previously announced, we are currently engaged in a strategic and financial
review of our entire company, focusing on maximizing shareholder value. At this
point, we are evaluating the possible separation of our water utility and
financial and investment businesses from our electric utility and related
businesses. We are actively focused on the divestiture of certain businesses
and on structuring the separation in a manner that optimizes shareholder value.
We expect to complete this review process during the next few months.
Basis of Accounting
DQE and Duquesne Light are subject to the accounting and reporting
requirements of the Securities and Exchange Commission (SEC). Duquesne Light's
electricity delivery business is also subject to regulation by the Pennsylvania
Public Utility Commission (PUC) and the Federal Energy Regulatory Commission
(FERC) with respect to rates for delivery of electric power, accounting and
other matters. Additionally, AquaSource's water utility operations are
regulated by various authorities within the states where they operate as to
rates, accounting and other matters.
In the opinion of management, the unaudited condensed consolidated financial
statements included in this report reflect all adjustments that are necessary
for a fair presentation of the results of interim periods and the adjustments
are normal, recurring adjustments. Prior periods have been reclassified to
conform with current accounting presentations. In addition, the 2000 results of
operations by business segment have been revised to conform with our current
accounting presentations as a result of the PUC's final accounting order issued
in January 2001 regarding the proceeds of our generation asset sale.
These statements should be read with the financial statements and notes
included in our Annual Report on Form 10-K for the year ended December 31, 2000
filed with the SEC. The results of operations for the three months ended March
31, 2001, are not necessarily indicative of the results that may be expected for
the full year. The preparation of financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities, and disclosure of contingent assets and
liabilities, at the date of the financial statements. The reported amounts of
revenues and expenses during the reporting period also may be affected by the
estimates and assumptions management is required to make. Actual results could
differ from those estimates.
Earnings Per Share
In 2000, we began reporting comprehensive earnings per share, which includes
both basic earnings per share and the per share contribution of changes in
valuation of our investments in marketable securities.
Basic and comprehensive earnings per share are computed on the basis of the
weighted average number of common shares outstanding. Diluted basic and diluted
comprehensive earnings per share are computed on the basis of the weighted
average number of common shares outstanding, plus the effect of the outstanding
Employee Stock Ownership Plan shares, DQE preferred stock and stock options. The
treasury stock method is used in computing the dilutive effect of stock options.
This method assumes any proceeds obtained upon the exercise of options would be
used to purchase common stock at the average market price during the period. The
following table presents the numerators and denominators used in computing the
diluted basic and diluted comprehensive earnings per share for the first
quarters of 2001 and 2000.
5
Diluted Earnings Per Share
for the Quarter Ended March 31,
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2001 2000
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(Millions of Dollars)
Income before accounting change $12.2 $42.5
Comprehensive income before accounting change 1.2 50.9
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Cumulative effect of accounting change - net -- 15.5
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Earnings for common 12.2 58.0
Comprehensive earnings for common 1.2 66.4
Dilutive effect of:
ESOP dividends 0.5 0.4
Preferred stock dividends -- 0.4
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Diluted Basic Earnings for Common $12.7 $58.8
- ---------------------------------------------------------------------------
Diluted Comprehensive
Earnings for Common $ 1.7 $67.2
===========================================================================
(Millions of Shares)
Basic average shares 55.9 70.9
Dilutive effect of:
ESOP shares 0.9 1.0
DQE preferred stock 0.5 0.9
Stock options -- --
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Diluted average shares 57.3 72.8
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Diluted earnings per share:
Before accounting change $0.22 $0.59
Accounting change $ -- $0.21
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Diluted Earnings
Per Share $0.22 $0.80
===========================================================================
Diluted comprehensive earnings per share:
Before accounting change $0.03 $0.71
Accounting change $ -- $0.21
- ---------------------------------------------------------------------------
Diluted Comprehensive
Earnings Per Share $0.03 $0.92
===========================================================================
B. RATE MATTERS
Competition and the Customer Choice Act
The Pennsylvania Electricity Generation Customer Choice and Competition Act
(Customer Choice Act) enables Pennsylvania's electric utility customers to shop,
purchasing electricity at market prices from a variety of electric generation
suppliers (customer choice). As of March 31, 2001, approximately 21 percent of
Duquesne Light's customers had chosen alternative generation suppliers measured
on a kilowatt-hour basis, and approximately 26 percent on a non-coincident peak
load basis. The remaining customers are provided with electricity through our
provider of last resort service arrangement with Orion (discussed below). As
alternative generation suppliers enter and exit the retail supply business, the
number of customers participating in our provider of last resort service will
fluctuate.
Customers who select an alternative generation supplier pay for generation
charges set competitively by that supplier, and pay Duquesne Light for a
competitive transition charge (discussed below) and transmission and
distribution charges. Electricity delivery (including transmission, distribution
and customer service) remains regulated in substantially the same manner as
under historical regulation.
Competitive Transition Charge
In its final restructuring order issued in the second quarter of 1998, the PUC
determined that Duquesne Light should recover most of the above-market costs of
its generation assets, including plant and regulatory assets, through the
collection of the competitive transition charge (CTC) from electric utility
customers. On January 18, 2001, the PUC issued an order approving our final
accounting for the proceeds of our April 2000 generation asset sale, including
the net recovery of $276 million of sale-related transaction costs. Applying the
net generation asset sale proceeds to reduce transition costs, we now anticipate
termination of the CTC collection period in early 2002 for most major rate
classes. Rates are then expected to decrease 21 percent for residential
customers who continue to take provider of last resort service from Duquesne
Light pursuant to the second agreement with Orion discussed below. Once the CTC
collection period ends for all rate classes, rates are expected to decrease on
average 17 percent system-wide for provider of last resort customers. The
transition costs, as reflected on the consolidated balance sheet, are being
amortized over the same period that the CTC revenues are being recognized. For
regulatory purposes, the unrecovered balance of transition costs that remain
following the generation asset sale was approximately $343 million ($210 million
net of tax) at March 31, 2001, on which Duquesne Light is allowed to earn an 11
percent pre-tax return. A slightly lower amount is shown on the balance sheet
due to the accounting for unbilled revenues adopted during 2000.
Provider of Last Resort
Although no longer a generation supplier, as the provider of last resort for
all customers in its service territory, Duquesne Light must provide electricity
for any customer who does not choose an alternative generation supplier, or
whose supplier fails to deliver. As part of the generation asset sale, Orion
agreed to supply Duquesne Light with all of the electric energy necessary to
satisfy Duquesne Light's provider of last resort obligations during the CTC
collection period. On December 20, 2000, the PUC approved a second agreement
that extends Orion's provider of last resort arrangement (and the PUC-approved
rates for the supply of electricity) beyond the final CTC collection through
2004 (POLR II). The agreement also allows Duquesne Light, following the CTC
collection, an average margin of 0.5 cents per kilowatt-hour (KWH) supplied
through this arrangement. Except
6
for this margin, these agreements, in general, effectively transfer to Orion the
financial risks and rewards associated with Duquesne Light's provider of last
resort obligations. While we retain the collection risk for the electricity
sales, a component of our regulated delivery rates is designed to cover the cost
of a normal level of uncollectible accounts.
Rate Freeze
An overall four-and-one-half-year rate cap from January 1, 1997, was
originally imposed on the transmission and distribution charges of Pennsylvania
electric utility companies under the Customer Choice Act. As part of a
settlement regarding recovery of deferred fuel costs, Duquesne Light agreed to
extend this rate cap for an additional six months through the end of 2001.
Subsequently, in connection with the POLR II agreement described above, Duquesne
Light negotiated a rate freeze for generation, transmission and distribution
rates. The rate freeze fixes new generation rates for retail customers who take
electricity under the extended provider of last resort arrangement, and
continues the transmission and distribution rates for all customers at current
levels through at least 2003. Under certain circumstances, affected interests
may file a complaint alleging that, under these frozen rates, Duquesne Light has
exceeded reasonable earnings, in which case the PUC could make adjustments to
rectify such earnings.
Regional Transmission Organization
FERC Order No. 2000 calls on transmission-owning utilities such as Duquesne
Light to voluntarily join regional transmission organizations. The goal of the
order is to put transmission facilities in a region under common control in an
effort to reduce costs. Duquesne Light is actively negotiating with the
Pennsylvania-New Jersey-Maryland Interconnection to establish the PJM West
regional transmission organization. Duquesne Light's ultimate decision will
depend in part on the outcome of the strategic review process.
AquaSource Rate Applications
AquaSource has filed consolidated, statewide water and sewer rate change
applications with the Texas Natural Resource Conservation Commission (TNRCC) and
17 municipalities. The requested rate increases were to be phased in over twelve
months, becoming effective on July 17, 2000 and 2001. AquaSource proposes, among
other things, to replace the more than 100 separate tariffs of its acquired
companies with a single water tariff and a single sewer tariff using uniform,
system-wide rates. If this request is approved, annual water and sewer revenues
in Texas will increase by approximately $7 million after the phase-in period is
completed.
Subject to possible suspension by a later interim or final rate order,
AquaSource's proposed rates were implemented on the July 17, 2000 effective date
and are being charged (subject to refund with interest) pending the final order
on each application by the regulatory authority having jurisdiction. Included in
2001 revenues is approximately $1.1 million related to this rate increase, of
which $0.3 million was deferred, for accounting purposes, for potential
disallowance.
Thirteen of the municipalities have either approved the requested rate
increase or failed to act on a timely basis, and therefore the increase is
deemed approved in those locations. However, three municipalities have denied
the proposed increase outright, and a fourth has established rates significantly
lower than requested. AquaSource has appealed these municipal rate orders to the
TNRCC. It is customary for the TNRCC to consolidate all municipal appeals with
the general rate case and to issue one uniform rate order affecting all service
areas. The TNRCC held a preliminary hearing on November 29, 2000, setting the
schedule for discovery and filing testimony. Hearings are next scheduled for
September 2001. The four municipalities are resisting efforts to consolidate
their appeals. While there is no statutory deadline for a decision, AquaSource
expects the TNRCC's final order to be issued by early 2002.
On March 31, 2001, AquaSource also filed a rate increase petition with the
Indiana Utility Regulatory Commission (IURC) regarding its water and sewer rates
in Indiana. We currently anticipate a final order from the IURC in early 2002.
If this request is approved, annual water and sewer revenues in Indiana will
increase by approximately $2.7 million.
C. RECEIVABLES
The components of receivables for the periods indicated are as follows:
(Millions of Dollars)
-----------------------------------
March 31, March 31, December 31,
2001 2000 2000
- --------------------------------------------------------------------------
Electric customers $ 88.9 $ 74.6 $ 87.0
Unbilled revenue accrual 36.3 36.5 47.2
Water customers 15.9 22.3 17.3
Other utility 13.1 24.7 16.6
Other 75.6 64.3 80.2
Less: (Allowance for
uncollectible accounts) (11.0) (9.7) (11.9)
- --------------------------------------------------------------------------
Total $218.8 $212.7 $236.4
==========================================================================
7
D. COMMITMENTS AND CONTINGENCIES
Construction
We estimate that in 2001 we will spend, excluding the allowance for funds used
during construction, approximately $60 million for electric utility
construction; $50 million (including $30 million for environmental compliance)
for water utility construction; $40 million for construction at our landfill gas
sites; and $10 million for construction by our other business lines.
Guarantees
As part of our investment portfolio in affordable housing, we have received
fees in exchange for guaranteeing a minimum defined yield to third-party
investors. A portion of the fees received has been deferred to absorb any
required payments with respect to these transactions. Based on an evaluation of
and recent experience with the underlying housing projects, we believe that such
deferrals are sufficient for this purpose.
In connection with DQE Energy Services' sale, through a subsidiary, of its
alternative fuel facilities, DQE agreed to guarantee the subsidiary's obligation
under the sales agreement to indemnify the purchaser against breach of
warranties, representations or covenants. We do not believe this guarantee will
have any material impact on our results of operations, financial position or
cash flows.
Other
In February 2001, 39 former and current employees of AquaSource, all minority
investors in AquaSource, commenced an action against DQE, AquaSource and others.
The action is currently before the U.S. District Court for the Southern District
of Texas, Houston Division. The complaint alleges that the defendants
fraudulently induced the plaintiffs to agree to sell their Class B AquaSource
shares back to AquaSource, and that defendants took actions intended to decrease
the value of these Class B shares. Plaintiffs seek, among other things, an award
of actual damages not to exceed $100 million and exemplary damages not to exceed
$400 million.
Although we cannot predict the ultimate outcome of the case or estimate the
range of any potential loss that may be incurred in the litigation, we believe
the lawsuit is frivolous and without merit, strenuously deny all allegations of
wrongdoing asserted by plaintiffs, and believe we have meritorious defenses to
plaintiffs' claims. We intend to vigorously defend the lawsuit.
We are involved in various other legal proceedings and environmental matters.
We believe that the resolution of such proceedings and matters, in total, will
not have a materially adverse effect on our financial position, results of
operations or cash flows.
E. BUSINESS SEGMENTS AND RELATED INFORMATION
We report our results by the following four principal business segments,
determined by products, services and regulatory environment: (1) the
transmission and distribution by Duquesne Light of electricity (electricity
delivery business segment), (2) the supply by Duquesne Light of electricity
(electricity supply business segment), (3) the collection by Duquesne Light of
transition costs (CTC business segment), and (4) the management by AquaSource of
water systems (water distribution business segment). With the completion of our
generation asset sale in April 2000, the electricity supply business segment is
now comprised solely of provider of last resort service. We also report an "all
other" category, to include our expanded business lines which are investments
below the quantitative threshold for separate disclosure.
Intercompany charges include costs for certain administrative functions as well
as interest charges on borrowings from DQE Capital.
8
Business Segments for the Three Months Ended:
- -------------------------------------------------------------------------------
(Millions of Dollars)
--------------------------------------------------------------------------------------
Electricity Electricity Water All Elimina- Consoli-
Delivery Supply CTC Distribution Other tions dated
--------------------------------------------------------------------------------------
March 31, 2001
- -----------------------------------------------------------------------------------------------------------------------------------
Operating revenues $ 73.7 $ 97.6 $ 74.1 $ 25.6 $ 52.6 $ (3.1) $ 320.5
Operating expenses 39.7 97.6 3.3 21.7 49.0 (3.1) 208.2
Depreciation and amortization expense 14.8 -- 64.3 4.6 4.1 -- 87.8
- -----------------------------------------------------------------------------------------------------------------------------------
Operating income (loss) 19.2 -- 6.5 (0.7) (0.5) -- 24.5
Other income 5.3 -- -- 1.5 17.2 (0.6) 23.4
Interest and other charges 20.2 -- -- 0.3 8.0 (0.1) 28.4
- -----------------------------------------------------------------------------------------------------------------------------------
Income before taxes 4.3 -- 6.5 0.5 8.7 (0.5) 19.5
Income taxes 1.8 -- 2.3 0.4 2.2 0.6 7.3
- -----------------------------------------------------------------------------------------------------------------------------------
Income (loss) before
intercompany charges 2.5 -- 4.2 0.1 6.5 (1.1) 12.2
Intercompany charges - net 2.3 -- -- (0.2) (2.7) 0.6 --
- -----------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 4.8 $ -- $ 4.2 $ (0.1) $ 3.8 $ (0.5) $ 12.2
===================================================================================================================================
Assets $2,161.4 $ -- $ 332.0 $ 436.2 $ 916.5 $ -- $3,846.1
===================================================================================================================================
Capital expenditures $ 10.9 $ -- $ -- $ 9.2 $ 5.5 $ -- $ 25.6
===================================================================================================================================
(Millions of Dollars)
--------------------------------------------------------------------------------------
Electricity Electricity Water All Elimina- Consoli-
Delivery Supply CTC Distribution Other tions dated
--------------------------------------------------------------------------------------
March 31, 2000
- -----------------------------------------------------------------------------------------------------------------------------------
Operating revenues $ 76.0 $ 95.6 $ 86.4 $ 26.0 $ 33.6 $ (3.1) $ 314.5
Operating expenses 51.2 78.7 3.8 23.4 41.1 (3.1) 195.1
Depreciation and amortization expense 13.9 1.6 44.9 3.7 5.2 -- 69.3
- -----------------------------------------------------------------------------------------------------------------------------------
Operating income (loss) 10.9 15.3 37.7 (1.1) (12.7) -- 50.1
Other income 6.4 3.6 -- 1.3 22.8 (0.7) 33.4
Interest and other charges 9.0 15.9 -- 0.3 8.4 (0.1) 33.5
- -----------------------------------------------------------------------------------------------------------------------------------
Income (loss) before taxes, cumulative
effect and intercompany charges 8.3 3.0 37.7 (0.1) 1.7 (0.6) 50.0
Income taxes 3.1 (6.7) 13.2 0.3 (2.8) -- 7.1
- -----------------------------------------------------------------------------------------------------------------------------------
Income (loss) before cumulative effect
and intercompany charges 5.2 9.7 24.5 (0.4) 4.5 (0.6) 42.9
Intercompany charges - net (1.0) (1.6) -- (2.7) 5.3 -- --
- -----------------------------------------------------------------------------------------------------------------------------------
Income (loss) before
cumulative effect 4.2 8.1 24.5 (3.1) 9.8 (0.6) 42.9
Cumulative effect - net 7.3 8.2 -- -- -- -- 15.5
- -----------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 11.5 $ 16.3 $ 24.5 $ (3.1) $ 9.8 $ (0.6) $ 58.4
===================================================================================================================================
Assets (1) $2,124.1 $ -- $ 396.4 $ 427.4 $ 918.1 $ -- $3,866.0
===================================================================================================================================
Capital expenditures $ 11.4 $ -- $ -- $ 13.7 $ 4.4 $ -- $ 29.5
===================================================================================================================================
(1) Relates to assets as of December 31, 2000.
9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Part I, Item 2 of this Quarterly Report on Form 10-Q should be read in
conjunction with our Annual Report on Form 10-K for the year ended December 31,
2000 filed with the Securities and Exchange Commission (SEC), and the condensed
consolidated financial statements, which are set forth on pages 2 through 9 in
Part I, Item 1 of this Report.
DQE, Inc. is a multi-utility delivery and services company. Our operating
subsidiaries are Duquesne Light Company; AquaSource, Inc.; DQE Energy Services,
Inc.; DQE Enterprises, Inc.; DQE Financial Corp.; DQE Communications, Inc.; and
ProAm, Inc. Our financial, non-operating subsidiaries are Cherrington Insurance,
Ltd. and DQE Capital Corporation.
Duquesne Light, our largest operating subsidiary, is an electric utility
engaged in the transmission and distribution of electric energy. On April 28,
2000, Duquesne Light sold its generation assets to Orion Power MidWest, L.P. for
approximately $1.7 billion. (See "Competitive Transition Charge" discussion on
page 14.)
AquaSource, our second largest operating subsidiary, is a water resource
management company that acquires, develops and manages water and wastewater
systems and complementary businesses.
Our other business lines engage in a wide range of complementary initiatives,
including the following: the distribution of propane; the production of landfill
gas; investments in electronic commerce, energy-related technology and
communications systems; energy facility development and operation; and
independent power production. DQE Capital and Cherrington Insurance provide
financing and insurance services for DQE and various affiliates.
Strategic Review Process
As previously announced, we are currently engaged in a strategic and financial
review of our entire company, focusing on maximizing shareholder value. At this
point, we are evaluating the possible separation of our water utility and
financial and investment businesses from our electric utility and related
businesses. We are actively focused on the divestiture of certain businesses
and on structuring the separation in a manner that optimizes shareholder value.
We expect to complete this review process during the next few months.
Service Areas
Duquesne Light's electric utility operations provide service to approximately
580,000 direct customers in southwestern Pennsylvania (including in the City of
Pittsburgh), a territory of approximately 800 square miles. Before completing
the generation asset sale, we historically sold electricity to other utilities.
(See "Competitive Transition Charge" discussion on page 14.)
AquaSource's water utility operations currently provide service to more than
400,000 water and wastewater customer connections in 20 states.
ProAm, our propane delivery business, provides service to over 70,000
customers in seven states.
Our other business lines have operations and investments in several states and
Canada.
Regulation
DQE and Duquesne Light are subject to the accounting and reporting
requirements of the SEC. Duquesne Light's electricity delivery business is also
subject to regulation by the Pennsylvania Public Utility Commission (PUC) and
the Federal Energy Regulatory Commission (FERC) with respect to rates for
delivery of electric power, accounting and other matters. Additionally,
AquaSource's water utility operations are subject to regulation by various
authorities within the states where they operate as to rates, accounting and
other matters. (See "AquaSource Rate Applications" discussion on page 15.)
Business Segments
This information is set forth in "Results of Operations" below and in
"Business Segments and Related Information," Note E to our condensed
consolidated financial statements on page 8. As a result of the PUC's final
accounting order issued in January 2001, the allocations between business
segments in 2000 have been revised to conform with our current accounting
presentation.
RESULTS OF OPERATIONS
Overall Performance
Basic earnings per share before cumulative effect of accounting change was
$0.22 in the first quarter of 2001 compared to $0.60 in the first quarter of
2000, a decrease of 63 percent. The average shares of outstanding common stock
declined by 15 million, or 21 percent. The lower average shares outstanding
reflect approximately 16 million shares we repurchased in 2000 as part of our
recapitalization program, done in conjunction with the sale of our generation
assets. We have temporarily suspended our common stock repurchase strategy in
2001 during our strategic review process.
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Earnings for common shareholders decreased from $58.0 million in the first
quarter of 2000 to $12.2 million in the first quarter of 2001, a decrease of 79
percent. This decrease included $15.5 million for the one-time cumulative effect
of a change in accounting principle for unbilled revenues in 2000.
Income before the cumulative effect of a change in accounting principle
decreased $30.7 million compared to the first quarter of 2000. This decrease was
due primarily to a $20.3 million reduction in earnings in conjunction with
decreased average CTC balance during 2001, and $11.6 million related to a lower
effective tax rate utilized in the first quarter of 2000 in anticipation of the
generation divestiture transaction. Subsequent to the generation asset sale, and
until the POLR II period begins (currently anticipated in the first quarter of
2002), the electricity supply business segment consists solely of our provider
of last resort obligation, which by PUC-approved treatment is designed to break
even. (See "Provider of Last Resort" discussion on page 14.) These factors were
partially offset by increased contributions to net income from our propane
delivery, fiber optic network leasing, and landfill gas operations.
Comprehensive income consists of net income plus unrealized holding gains or
losses on investments in marketable securities. Comprehensive income was $1.2
million in the first quarter of 2001 compared to $66.8 million in the first
quarter of 2000, a decrease of $65.6 million or 98 percent.
In addition to the one-time effect of the change in accounting principle, the
decrease in comprehensive income included a $19.4 million decrease in other
comprehensive income related to market price decreases in DQE Enterprises'
investments in marketable securities.
Results of Operations by Business Segment
We report our results by the following four principal business segments,
determined by products, services and regulatory environment: (1) the
transmission and distribution by Duquesne Light of electricity (electricity
delivery business segment), (2) the supply by Duquesne Light of electricity
(electricity supply business segment), (3) the collection by Duquesne Light of
transition costs (CTC business segment), and (4) the management by AquaSource of
water systems (water distribution business segment). With the completion of our
generation asset sale in April 2000, the electricity supply business segment is
now comprised solely of provider of last resort service. We also report an "all
other" category to include our expanded business lines which are investments
below the quantitative threshold for separate disclosure. Revenues and assets in
the "all other" category are comprised of energy facility operations, landfill
gas operations, propane operations, fiber optic network leases and other
operating investments, as well as financial investments. Income from financial
investments is included in other income. Intercompany charges include costs for
certain administrative functions as well as interest charges on borrowings from
DQE Capital. Intercompany eliminations primarily relate to intercompany sales of
electricity, property rental and dividends.
Additional information on our business segments is set forth on page 8 in Note
E, "Business Segments and Related Information," in the Notes to the Consolidated
Financial Statements.
Electricity Delivery Business Segment. The electricity delivery business
segment contributed $2.5 million to income before cumulative effect of
accounting change and intercompany transactions in the first quarter of 2001
compared to $5.2 million in the first quarter of 2000, a decrease of $2.7
million or 52 percent.
Operating revenues for this business segment are primarily derived from the
delivery of electricity. Sales to residential and commercial customers are
influenced by weather conditions. Warmer summer and colder winter seasons lead
to increased customer use of electricity for cooling and heating. Commercial
sales also are affected by regional development. Sales to industrial customers
are influenced primarily by national and global economic conditions.
Operating revenues decreased by $2.3 million or 3.0 percent compared to the
first quarter of 2000, due to a decrease in sales to electric utility customers
of 1.8 percent. This decrease is primarily due to lower industrial sales to
steel manufacturers. The following table sets forth kilowatt-hours (KWH)
delivered to electric utility customers.
- ---------------------------------------------------------------------
KWH Delivered
---------------------------------
(In Millions)
---------------------------------
First Quarter 2001 2000 Change
- ---------------------------------------------------------------------
Residential 901 872 3.3 %
Commercial 1,467 1,462 0.3 %
Industrial 856 948 (9.7)%
- -----------------------------------------------------------
Sales to Electric
Utility Customers 3,224 3,282 (1.8)%
=====================================================================
Operating expenses for the electricity delivery business segment primarily are
made up of costs to operate and maintain the transmission and distribution
system; automated meter reading and billing costs; customer service; collection;
administrative expenses; and non-income taxes, such as gross receipts, property
and payroll taxes. Operating expenses decreased $11.5 million or 22.5 percent
compared to 2000, primarily due to cost savings realized from DQE's corporate
center excellence and Duquesne
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Light's Best-in-Class initiatives begun in late 2000, and a $3.2 million
reduction to vegetation management expenses.
Depreciation and amortization expense increased $0.9 million or 6.5 percent in
the first quarter of 2001 compared to the first quarter of 2000. This increase
can be primarily attributed to depreciation expense on the automated meter
reading system purchased at the end of the first quarter 2000.
Interest and other charges include interest on long-term debt, other interest
and preferred stock dividends of Duquesne Light. Interest expense in the first
quarter of 2001 was $28.4 million, a 15 percent decrease from the first quarter
of 2000. This decrease reflects the results of our recapitalization program. In
the first quarter of 2001, there was $11.2 million or 124.4 percent more
interest and other charges allocated to the electricity delivery business
segment compared to the first quarter of 2000. Although Duquesne Light retired
debt with generation asset sale proceeds, thus reducing its overall level of
interest expense, all remaining interest costs after recapitalization are borne
by the electricity delivery business segment.
Income tax expense decreased $1.3 million due to $4.0 million less of taxable
income compared to the first quarter of 2000.
Electricity Supply Business Segment. Subsequent to the April 2000 generation
asset sale and until the POLR II period begins, the electricity supply business
segment is currently designed to break even in accordance with PUC-approved
accounting treatment. This segment consists solely of our provider of last
resort obligation to customers who cannot or do not choose to shop for an
alternative generation supplier. During the POLR II period, Duquesne Light will
be allowed to earn an average margin of 0.5 cents per KWH supplied to customers
not shopping.
By comparison, in the first quarter of 2000, the electricity supply business
segment earned $16.3 million, the result of $3.0 million of generation-related
income before intercompany charges; a $7.8 million tax benefit recorded in
anticipation of the pending generation asset sale; and $8.2 million related to
the non-recurring cumulative effect of a change in accounting principle for
unbilled revenues.
CTC Business Segment. Duquesne Light earns an 11 percent pre-tax return on its
net unrecovered transition cost balance. With the successful completion of the
generation asset sale in April 2000, we recovered approximately $1.0 billion of
our PUC-approved transition costs. As a result, our average after-tax transition
cost balance decreased from approximately $1.4 billion in the first quarter of
2000 to approximately $235 million in the first quarter of 2001, resulting in a
$20.3 million decrease in earnings for this segment.
Water Distribution Business Segment. The water distribution business segment
had $0.1 million of income before intercompany charges in the first quarter of
2001, compared to a $0.4 million loss in the first quarter of 2000.
Operating revenues for this business segment are derived from billings related
to water and sewer services for utilities owned by AquaSource and from utilities
for which AquaSource is a contract operator, and water-related construction and
engineering projects. Operating revenues decreased by $0.4 million during the
first quarter of 2001. The decrease was primarily the result of the sale of
certain non-strategic water utilities in the fourth quarter of 2000.
Operating expenses for the water distribution business segment are primarily
made up of costs to operate and maintain the water distribution systems;
administrative expenses; and non-income taxes, such as property and payroll
taxes. Operating expenses decreased by $1.7 million as a result of efforts to
reduce duplicate functions and consolidate operations.
Depreciation and amortization expense includes depreciation of utility
delivery systems and the amortization of goodwill on acquisitions. The $0.9
million increase was attributable to increases in depreciation from capital
additions during 2000.
The water distribution business segment also had a $2.5 million decrease in
net intercompany charges compared to the first quarter of 2000. This decrease is
primarily due to DQE's providing a capital contribution to AquaSource to enable
it to retire its intercompany debt. Therefore, intercompany charges do not
include interest expense on borrowings during 2001.
All Other. The all other category contributed $6.5 million to income before
intercompany charges in the first quarter of 2001 compared to $4.5 million in
the first quarter of 2000, an increase of $2.0 million or 44.4 percent.
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Operating revenues increased in the first quarter of 2001 by $19.0 million or
57 percent compared to the first quarter of 2000. This increase was primarily
the result of increased revenues of $7.9 million from propane delivery sales,
$2.7 million from fiber optic lease transactions, and $6.2 million from landfill
gas operations.
In the first quarter of 2001, operating expenses increased $7.9 million or 19
percent over the first quarter of 2000. This increase was primarily the result
of increased expenses from our propane delivery business and landfill gas
operations.
Depreciation and amortization expense primarily includes the depreciation of
the expanded business lines' plant and equipment and amortization of certain
investments. In the first quarter of 2001, depreciation and amortization expense
decreased by $1.1 million, primarily due to the sale of certain non-strategic
assets during 2000.
Other income primarily includes gains on investment dispositions, long-term
investment income, and interest and dividend income related to our other
business lines. Other income in the first quarter of 2001 was $5.6 million or 25
percent lower than in the first quarter of 2000. The decrease is related to the
nature of our leasing investments, where income decreases over the lease life.
Also contributing to the decrease was a $4.0 million pre-tax gain on the sale of
certain non-strategic assets in the first quarter of 2000.
Interest and other charges are made up of interest on long-term debt, other
interest and preferred stock dividends of the expanded business lines. A
decrease of $0.4 million in the first quarter of 2001 was primarily due to lower
short-term borrowing activity compared to the first quarter 2000.
LIQUIDITY AND CAPITAL RESOURCES
We estimate that during 2001 we will spend, excluding the allowance for funds
used during construction, approximately $60 million for electric utility
construction; $50 million (including $30 million for environmental compliance)
for water utility construction; $40 million for construction at our landfill gas
sites; and $10 million for construction by our other business lines. During the
first three months of 2001, we have spent approximately $25.6 million on capital
expenditures, consisting of approximately $10.9 million at Duquesne Light, $9.2
million at AquaSource, $3.1 million at DQE Financial and the remaining $2.4
million on other.
Acquisitions and Dispositions
In the first quarter of 2001, AquaSource acquired three water companies for
approximately $0.8 million. As part of our strategic review process, AquaSource
has also continued to negotiate the sale of its bottled water assets. Due
diligence is continuing and a sale is anticipated to occur by June 2001.
The Allegheny County Airport has signed a termsheet agreement to repurchase
the Pittsburgh International Airport energy facility from a DQE Enterprises
subsidiary, as well as to enter into an operations and maintenance agreement
regarding the facility with DQE Energy Services. The transaction is expected to
close in the second quarter of 2001.
In the first quarter of 2000, Duquesne Light purchased from Itron, Inc. the
Customer Advanced Reliability System (CARS), the automated electronic meter
reading system developed by Itron for use with our electric utility customers.
We had previously leased these assets.
We disposed of affordable housing investments in the first quarter of 2000 for
$15.7 million, resulting in an after-tax gain of $2.1 million.
Financing
In the first quarter of 2001 we repurchased approximately 10,000 shares of DQE
preferred stock for approximately $830,000.
At March 31, 2001, we had $29 million of commercial paper borrowings
outstanding, and $88.2 million of current debt maturities. During the quarter,
the maximum amount of bank loans and commercial paper borrowings outstanding was
$41 million, the amount of average daily borrowings was $9.4 million, and the
weighted average daily interest rate was 6.1 percent.
Future Capital Requirements and Availability
We have $85 million of term notes maturing in 2001. We maintain two separate
revolving credit agreements, one for $300 million expiring in June 2001 and one
for $225 million expiring in September 2001. We have the option to convert
each revolver into a term loan facility for a period of one or two years,
respectively, for any amounts then outstanding upon expiration of the revolving
credit period. Interest rates can, in accordance with the option selected at the
time of the borrowing, be based on one of several indicators, including prime,
Eurodollar, or certificate of deposit rates. Facility fees are based on the
unborrowed amount of the commitment. At March 31, 2001, no borrowings were
outstanding. Related to these and other credit facilities, we are subject to
financial covenants requiring certain cash coverage and debt-to-capital ratios.
At March 31, 2001, we were in compliance with all of our financial covenants.
With customer choice fully in effect, and our generation asset divestiture
complete, all of our electric utility customers are now buying their generation
directly from
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alternative suppliers or indirectly from Orion through the Duquesne Light
provider of last resort service arrangement. Customer revenues on the income
statement include revenues from provider of last resort customers. Although we
collect these revenues, we pass them on (net of gross receipts tax) to Orion. In
addition, rates for residential customers are expected to drop by 21 percent
with the final CTC collection. Duquesne Light also agreed to freeze its
generation rates through 2004 and its transmission and distribution rates
through 2003. However, Duquesne Light expects to realize incremental margin
through its extended provider of last resort arrangement. (See "Provider of
Last Resort" and "Rate Freeze" discussions below.)
RATE MATTERS
Competition and the Customer Choice Act
The Customer Choice Act enables Pennsylvania's electric utility customers to
shop, purchasing electricity at market prices from a variety of electric
generation suppliers (customer choice). As of March 31, 2001, approximately 21
percent of Duquesne Light's customers had chosen alternative generation
suppliers measured on a kilowatt-hour basis, and approximately 26 percent on a
non-coincident peak load basis. The remaining customers are provided with
electricity through our provider of last resort service arrangement with Orion
(discussed below). As alternative generation suppliers enter and exit the retail
supply business, the number of customers participating in our provider of last
resort service will fluctuate.
Customers who select an alternative generation supplier pay for generation
charges set competitively by that supplier, and pay Duquesne Light a competitive
transition charge (discussed below) and transmission and distribution charges.
Electricity delivery (including transmission, distribution and customer service)
remains regulated in substantially the same manner as under historical
regulation.
Competitive Transition Charge
In its final restructuring order issued in the second quarter of 1998, the PUC
determined that Duquesne Light should recover most of the above-market costs of
its generation assets, including plant and regulatory assets, through the
collection of the competitive transition charge (CTC) from electric utility
customers. On January 18, 2001, the PUC issued an order approving our final
accounting for the proceeds of our April 2000 generation asset sale, including
the net recovery of $276 million of sale-related transaction costs. Applying the
net generation asset sale proceeds to reduce transition costs, we now anticipate
termination of the CTC collection period in early 2002 for most major rate
classes. Rates are then expected to decrease 21 percent for residential
customers who continue to take provider of last resort service from Duquesne
Light pursuant to the second agreement with Orion discussed below. Once the CTC
collection period ends for all rate classes, rates are expected to decrease on
average 17 percent system-wide for provider of last resort customers. The
transition costs, as reflected on the consolidated balance sheet, are being
amortized over the same period that the CTC revenues are being recognized. For
regulatory purposes, the unrecovered balance of transition costs that remain
following the generation asset sale was approximately $343 million ($210 million
net of tax) at March 31, 2001, on which Duquesne Light is allowed to earn an 11
percent pre-tax return. A slightly lower amount is shown on the balance sheet
due to the accounting for unbilled revenues adopted during 2000.
Provider of Last Resort
Although no longer a generation supplier, as the provider of last resort for
all customers in its service territory, Duquesne Light must provide electricity
for any customer who does not choose an alternative generation supplier, or
whose supplier fails to deliver. As part of the generation asset sale, Orion
agreed to supply Duquesne Light with all of the electric energy necessary to
satisfy Duquesne Light's provider of last resort obligations during the CTC
collection period. On December 20, 2000, the PUC approved a second agreement
that extends Orion's provider of last resort arrangement (and the PUC-approved
rates for the supply of electricity) beyond the final CTC collection through
2004 (POLR II). The agreement also permits Duquesne Light, following
CTC collection, an average margin of 0.5 cents per KWH supplied through this
arrangement. Except for this margin, these agreements, in general, effectively
transfer to Orion the financial risks and rewards associated with Duquesne
Light's provider of last resort obligations. While we retain the collection risk
for the electricity sales, a component of our regulated delivery rates is
designed to cover the cost of a normal level of uncollectible accounts.
Rate Freeze
An overall four-and-one-half-year rate cap from January 1, 1997, was
originally imposed on the transmission and distribution charges of Pennsylvania
electric utility companies under the Customer Choice Act. As part of a
settlement regarding recovery of deferred fuel costs, Duquesne Light agreed to
extend this rate cap for an additional six months through the end of 2001.
Subsequently, in connection with the POLR II agreement described above, Duquesne
Light negotiated a rate freeze for generation, transmission and distribution
rates. The rate freeze fixes new generation rates for retail customers who take
electricity under the extended provider of last
14
resort arrangement, and continues the transmission and distribution rates for
all customers at current levels through at least 2003. Under certain
circumstances, affected interests may file a complaint alleging that, under
these frozen rates, Duquesne Light has exceeded reasonable earnings, in which
case the PUC could make adjustments to rectify such earnings.
Regional Transmission Organization
FERC Order No. 2000 calls on transmission-owning utilities such as Duquesne
Light to voluntarily join regional transmission organizations. The goal of the
order is to put transmission facilities in a region under common control in an
effort to reduce costs. Duquesne Light is actively negotiating with the
Pennsylvania-New Jersey-Maryland Interconnection to establish the PJM West
regional transmission organization. Duquesne Light's ultimate decision will
depend in part on the outcome of the strategic review process.
AquaSource Rate Applications
AquaSource has filed consolidated, statewide water and sewer rate change
applications with the Texas Natural Resource Conservation Commission (TNRCC) and
17 municipalities. The requested rate increases were to be phased in over twelve
months, becoming effective on July 17, 2000 and 2001. AquaSource proposes, among
other things, to replace the more than 100 separate tariffs of its acquired
companies with a single water tariff and a single sewer tariff using uniform,
system-wide rates. If this request is approved, annual water and sewer revenues
in Texas will increase by approximately $7 million after the phase-in period is
completed.
Subject to possible suspension by a later interim or final rate order,
AquaSource's proposed rates were implemented on the July 17, 2000 effective date
and are being charged (subject to refund with interest) pending the final order
on each application by the regulatory authority having jurisdiction. Included in
2001 revenues is approximately $1.1 million related to this rate increase, of
which $0.3 million was deferred for accounting purposes for potential
disallowance.
Thirteen of the municipalities have either approved the requested rate
increase or failed to act on a timely basis, and therefore the increase is
deemed approved in those locations. However, three municipalities have denied
the proposed increase outright, and a fourth has established rates significantly
lower than requested. AquaSource has appealed these municipal rate orders to the
TNRCC. It is customary for the TNRCC to consolidate all municipal appeals with
the general rate case and to issue one uniform rate order affecting all service
areas. The TNRCC held a preliminary hearing on November 29, 2000, setting the
schedule for discovery and filing testimony. Hearings are next scheduled for
September 2001. The four municipalities are resisting efforts to consolidate
their appeals. While there is no statutory deadline for a decision, AquaSource
expects the TNRCC's final order to be issued by early 2002.
On March 31, 2001, AquaSource also filed a rate increase petition with the
Indiana Utility Regulatory Commission (IURC) regarding its water and sewer rates
in Indiana. We currently anticipate a final order from the IURC in early 2002.
If this request is approved, annual water and sewer revenues in Indiana will
increase by approximately $2.7 million.
Outlook
Duquesne Light continues to focus on its Best-in-Class service improvement and
cost reduction initiatives undertaken in conjunction with its exit from the
generation business. While Duquesne Light's earnings are expected to be
substantially lower than in prior years as a result of the sale of its
generation assets (60 percent of total assets) in April 2000, it is expected to
earn solid utility returns in 2001; returns in 2002 and beyond are expected to
be enhanced with the inclusion of the POLR II margin. We now anticipate a higher
than previously expected level of operating income from POLR II, due to less
customer shopping as a result of higher wholesale energy prices. During 2002,
incremental earnings from POLR II margins are expected to contribute
approximately $.30 per share.
DQE Energy Services continues to be successful in further penetrating its
niche markets of energy facility operation and maintenance projects that meet
the needs of industrial and commercial customers. All current construction-
phase projects are on schedule and on budget and current operational-phase
projects are profitable. DQE Communications continues to experience a high
level of demand for its open access fiber optic network in southwestern
Pennsylvania and expects to continue to lease dark fiber in accordance with its
plan. DQE Communications is also exploring options to expand its customer
services, and to use its excess fiber capacity in other ventures. Each of these
businesses is expected to provide a double-digit return on their modest capital
investment with substantial upside possible from the use of DQE Communications'
excess fiber.
AquaSource continues to focus on realizing operating efficiencies as the
result of its integration initiatives. The improvements made to date at
AquaSource had a positive impact on first quarter earnings and, combined with
ongoing improvement efforts, are expected to have a more significant impact
throughout the remainder of the year. Business development activities currently
under way are expected to increase 2002 earnings by approximately $.20 per share
beyond the 2001 level.
15
ProAm's business is seasonal, with a large portion of customer usage coming
from residential heating. During the first quarter of 2001, ProAm was able to
maintain strong margins and produce sound financial results. The second and
third quarters are expected to be break-even quarters with the fourth quarter
returning to profitability. For the year, earnings are expected to be on target
(10 percent return on investment). ProAm is also reviewing opportunities to
take advantage of further consolidation in its industry, which could produce
higher returns.
DQE Financial's landfill gas and alternative energy businesses performed well
in the first quarter, taking advantage of higher margins on gas sales. The
level of gas prices throughout 2001 is expected to be a significant factor in
the financial results throughout the remainder of the year. Investment activity
during the year will be focused in these areas. Earnings from the leasing
portfolio are scheduled to drop off substantially from prior years, reflective
of the earnings pattern of a leasing portfolio without new investments.
DQE Enterprises continues to be hampered by weak equity markets. The market
value of its existing public investments performed in line with the broader
technology-related markets during the first quarter; opportunities for further
investment and monetization of its private investments, as previously projected
for 2001, are unclear in the current equity market environment. As a result, we
no longer expect that gains from initial public offerings, asset sales and
improvements in market valuations would be a significant source of earnings in
2001.
Overall, DQE's 2001 basic earnings were expected to decline substantially
from the 2000 level. This decline reflects the effects of Duquesne Light's
generation asset sale in April 2000, which reduced earning assets by $1 billion,
as had been expected. While our future earnings would be on a significantly
lower base of assets than historical levels, our recapitalization program and
cost reduction initiatives would lessen the effect of this earnings decline.
Improving earnings from DQE's other businesses, particularly AquaSource, are
also expected to mitigate this decline to some extent; however, given the
outlook for DQE Enterprises, it is no longer likely that we will meet our
comprehensive earnings aspirations in 2001.
We had previously projected comprehensive earnings for 2001 in the range of
$2.96 to $3.36 per share, contingent upon equity market performance. Included in
this projection was $1.82 to $2.22 of earnings projected from DQE Enterprises'
investments. Based upon the current outlook for the market, we do not expect to
realize the previously projected earnings associated with these investments in
the near term. With our core utility businesses performing well, we project 2001
basic earnings, excluding gains from the monetization of DQE Enterprises'
investments, in the $1.25 to $1.30 per share range. Earnings from our core
businesses include approximately $.95 per share from Duquesne Light and related
businesses (communications and energy services) and $0.30 per share from
AquaSource. The remaining $.05 per share is attributable to DQE's other
businesses and parent debt expenses.
Although our reported earnings are expected to decline from the 2000 level,
particularly at Duquesne Light, operating cash flow is expected to continue to
be strong. During the year we expect to collect the majority of our remaining
$210 million of transition costs (after tax) from electric utility customers.
In addition, all of our businesses are currently generating positive cash flows
from their operations, a trend that we project to continue. Although we have
temporarily suspended our stock repurchase program during the strategic review
process, we may resume the program after further evaluation.
This "Outlook" section contains forward-looking statements, the results of
which may materially differ from those implied due to known and unknown risks
and uncertainties. These statements, and certain of the risks and uncertainties
that may affect the results, are discussed below. DQE earnings will depend on
the performance of our subsidiaries, on the outcome of our strategic review
process, on our ability to sell select, non-strategic assets such as our bottled
water operations, and on the effectiveness of our administrative resource
reduction. Demand for electric, water, gas, propane and telecommunications
utility services, and the availability of appropriate investment opportunities
in those industries, as well as changing market and weather conditions, will
affect cash flow, returns on investment and earnings levels at DQE and each of
our subsidiaries. Energy prices will affect the number of customers using our
provider of last resort service, which in turn will affect earnings from POLR II
margins. AquaSource's returns will depend in part on the outcome of its rate
filings in Texas and Indiana, which in turn depend on the determinations of each
state's public utility commission. The availability of suitable partners will
affect ProAm's ability to carry out a consolidation strategy. Gas price levels
will have an obvious impact on DQE Financial's earnings levels. Stock market
volatility will affect earnings at DQE Enterprises. Overall performance by DQE
and its subsidiaries will also be affected by economic, competitive, regulatory,
governmental and technological factors affecting operations, markets, products,
services and prices, as well as the factors discussed in our SEC filings made to
date.
16
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
Market risk represents the risk of financial loss that may impact our
consolidated financial position, results of operations or cash flows due to
adverse changes in market prices and rates.
We manage our interest rate risk by balancing our exposure between fixed and
variable rates while attempting to minimize our interest costs. Currently, our
variable interest rate debt is approximately $568 million or 42 percent of long-
term borrowings. Most of this variable rate debt is low-cost, tax-exempt debt.
We also manage our interest rate risk by retiring and issuing debt from time to
time and by maintaining a balance of short-term, medium-term and long-term debt.
A 10 percent increase in interest rates would have affected our variable rate
debt obligations by increasing interest expense by approximately $2.4 million
for the three months ended March 31, 2001 and $0.7 million for the three months
ended March 31, 2000. A 10 percent reduction in interest rates would have
increased the market value of our fixed rate debt by approximately $54 million
and $36 million as of March 31, 2001 and March 31, 2000. Such changes would not
have had a significant near-term effect on our future earnings or cash flows.
--------------------
Except for historical information contained herein, the matters discussed in
this annual report are forward-looking statements that involve risks and
uncertainties including, but not limited to: the outcome of our strategic review
process; economic and business conditions with respect to electronic commerce
and energy technology companies; the outcome of AquaSource's rate applications
and shareholder litigation; economic, competitive, governmental and
technological factors affecting operations, markets, products, services and
prices; and other risks discussed in "Outlook" above and our filings with the
Securities and Exchange Commission.
PART II. OTHER INFORMATION.
Item 1. Legal Proceedings.
In February 2001, 39 former and current employees of AquaSource, all minority
investors in AquaSource, commenced an action against DQE, AquaSource and others.
The action is currently before the U.S. District Court for the Southern District
of Texas, Houston Division. The complaint alleges that the defendants
fraudulently induced the plaintiffs to agree to sell their Class B AquaSource
shares back to AquaSource, and that defendants took actions intended to decrease
the value of these Class B shares. Plaintiffs seek, among other things, an award
of actual damages not to exceed $100 million and exemplary damages not to exceed
$400 million.
Although we cannot predict the ultimate outcome of the case or estimate the
range of any potential loss that may be incurred in the litigation, we believe
the lawsuit is frivolous and without merit, strenuously deny all allegations of
wrongdoing asserted by plaintiffs, and believe we have meritorious defenses to
plaintiffs' claims. We intend to vigorously defend the lawsuit.
Item 6. Exhibits and Reports on Form 8-K
a. Exhibits:
EXHIBIT 12.1 - Calculation of Ratio of Earnings to
Fixed Charges and Preferred and
Preference Stock Dividend
Requirements.
b. We filed no reports on Form 8-K during the quarter
ended March 31, 2001.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant identified below has duly caused this report to be signed on its
behalf by the undersigned thereunto duly authorized.
DQE, Inc.
------------------------------
(Registrant)
Date May 1, 2001 /s/ Morgan K. O'Brien
--------------- ------------------------------
(Signature)
Morgan K. O'Brien
Chief Operating Officer
(Principal Financial Officer)
Date May 1, 2001 /s/ James E. Wilson
--------------- ------------------------------
(Signature)
James E. Wilson
Vice President and Controller
(Principal Accounting Officer)
18