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, 2002
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[ ] 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
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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)
411 Seventh Avenue
Pittsburgh, Pennsylvania 15219
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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
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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 - 56,438,612 shares outstanding as of April 30,
2002.
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
DQE Condensed Consolidated Statements of Income (Unaudited)
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(Millions of Dollars,
Except Per Share Amounts)
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Three Months Ended March 31,
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2002 2001
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Operating Revenues:
Electricity sales $ 245.6 $ 239.2
Water sales 25.8 25.6
Other 36.7 55.7
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Total Operating Revenues 308.1 320.5
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Operating Expenses:
Purchased power 99.1 93.5
Other operating 79.0 93.9
Maintenance 5.4 5.5
Depreciation and amortization 80.4 87.8
Taxes other than income taxes 18.2 15.3
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Total Operating Expenses 282.1 296.0
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Operating Income 26.0 24.5
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Other Income 21.1 23.4
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Interest and Other Charges 21.8 28.4
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Income Before Income Taxes 25.3 19.5
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Income Taxes 8.6 7.3
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Net Income 16.7 12.2
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Dividends on Preferred Stock 0.2 -
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Earnings Available for Common Stock $ 16.5 $ 12.2
===================================================================================
Average Number of Common Shares
Outstanding (Millions of Shares) 56.2 55.9
===================================================================================
Basic Earnings Per Share of Common Stock $ 0.29 $ 0.22
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Diluted Earnings Per Share of Common Stock $ 0.29 $ 0.22
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Dividends Declared Per Share of Common Stock $ 0.42 $ 0.42
===================================================================================
See notes to condensed consolidated financial statements.
2
DQE Condensed Consolidated Balance Sheets (Unaudited)
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(Millions of Dollars)
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March 31, December 31,
ASSETS 2002 2001
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Current Assets:
Cash and temporary cash investments $ 0.6 $ 7.3
Receivables 192.8 193.0
Other current assets 129.7 123.6
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Total Current Assets 323.1 323.9
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Long-Term Investments 586.8 628.2
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Property, Plant and Equipment 2,461.1 2,448.0
Less: Accumulated depreciation (765.1) (759.7)
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Total Property, Plant and Equipment - Net 1,696.0 1,688.3
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Other Non-Current Assets:
Transition costs 76.6 134.3
Regulatory assets 267.9 267.2
Other 185.2 184.0
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Total Other Non-Current Assets 529.7 585.5
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Total Assets $ 3,135.6 $ 3,225.9
==========================================================================================
CAPITALIZATION AND LIABILITIES
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Current Liabilities:
Notes payable and current debt maturities $ 99.2 $ 151.4
Other current liabilities 256.7 235.4
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Total Current Liabilities 355.9 386.8
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Non-Current Liabilities:
Deferred income taxes - net 576.6 611.4
Deferred income 103.0 103.5
Other non-current liabilities 154.9 174.1
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Total Non-Current Liabilities 834.5 889.0
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Commitments and Contingencies (Note D)
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Capitalization:
Long-Term Debt 1,198.3 1,198.8
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DLC Obligated Mandatorily Redeemable Preferred Trust Securities 150.0 150.0
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Preferred Stock:
DQE preferred stock 16.4 16.4
Preferred stock of subsidiaries 62.6 62.6
Preference stock of subsidiaries 14.2 13.8
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Total Preferred Stock 93.2 92.8
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Common Shareholders' Equity:
Common stock - no par value (authorized - 187,500,000
shares; issued - 109,679,154 shares) 994.8 994.8
Retained earnings 751.4 759.7
Treasury stock (at cost) (53,468,398 and 53,770,877 shares) (1,239.7) (1,246.7)
Accumulated other comprehensive (loss) income (2.8) 0.7
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Total Common Shareholders'Equity 503.7 508.5
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Total Capitalization 1,945.2 1,950.1
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Total Liabilities and Capitalization $ 3,135.6 $ 3,225.9
==========================================================================================
See notes to condensed consolidated financial statements.
3
DQE Condensed Consolidated Statements of Cash Flows (Unaudited)
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(Millions of Dollars)
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Three Months Ended March 31,
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2002 2001
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Cash Flows From Operating Activities:
Operations $ 100.9 $ 110.3
Changes in working capital other than cash (34.0) (78.5)
Other 0.4 (0.2)
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Net Cash Provided from Operating Activities 67.3 31.6
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Cash Flows From Investing Activities:
Capital expenditures (27.9) (25.1)
Proceeds from disposition of investments 19.2 2.4
Collection of note receivable 7.0 -
Other (1.7) (11.4)
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Net Cash Used in Investing Activities (3.4) (34.1)
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Cash Flows From Financing Activities:
Commercial paper borrowings 98.0 29.0
Reductions of long-term obligations (150.0) (3.7)
Dividends on common and preferred stock (18.0) (24.0)
Other (0.6) 1.7
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Net Cash (Used in) Provided from Financing Activities (70.6) 3.0
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Net (decrease) increase in cash and temporary cash investments (6.7) 0.5
Cash and temporary cash investments at beginning of period 7.3 15.8
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Cash and temporary cash investments at end of period $ 0.6 $ 16.3
========================================================================================
See notes to condensed consolidated financial statements.
4
DQE CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
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(Millions of Dollars)
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Three Months Ended March 31,
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2002 2001
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Net income $ 16.7 $ 12.2
Other comprehensive loss:
Unrealized holding losses arising
during the year, net of tax of $(1.9) and $(5.9) (3.5) (11.0)
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Comprehensive Income $ 13.2 $ 1.2
=============================================================================
See notes to condensed consolidated financial statements.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
A. CONSOLIDATION AND ACCOUNTING POLICIES
CONSOLIDATION
DQE, Inc. delivers essential products and related services, including
electricity, water and communications, to more than one million customers
throughout the United States. Our subsidiaries are Duquesne Light Company;
AquaSource, Inc.; DQE Energy Services, LLC; DQE Financial Corp.; DQE
Enterprises, Inc.; DQE Communications, Inc.; ProAm, Inc.; 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 is a water resource management company that acquires, develops
and manages water and wastewater systems.
DQE Energy Services is an energy facilities management company that
provides energy outsourcing solutions including development, operation and
maintenance of energy and alternative fuel facilities.
DQE Financial owns and operates landfill gas collection and processing
systems, and is an investment and portfolio management organization focused on
structured finance and alternative energy investments.
DQE Enterprises manages our remaining electronic commerce, energy services
and technologies, and communications investment portfolios.
DQE Capital, a 100 percent-owned finance subsidiary, provides financing for
the operations of our subsidiaries other than Duquesne Light. We fully and
unconditionally guarantee payment of DQE Capital's debt securities, including
$100.0 million of Public Income Notes, due 2039, and a $200.0 million revolving
credit facility. At March 31, 2002 no borrowings were outstanding under the
credit facility.
Our other business lines include the following: propane distribution,
communications systems, and insurance services for DQE and various affiliates.
The consolidated financial statements include the accounts of DQE and our
wholly and majority owned subsidiaries. The equity method of accounting is used
when we have a 20 to 50 percent interest in other companies. Under the equity
method, original investments are recorded at cost and adjusted by our share of
undistributed earnings or losses of these companies. All material intercompany
balances and transactions have been eliminated in the consolidation.
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.
As a result of our PUC-approved restructuring plan, the electricity supply
segment does not meet the criteria of Statement of Financial Accounting
Standards (SFAS) No. 71, "Accounting for the Effects of Certain Types of
Regulation." Pursuant to the PUC's final restructuring order, and as provided
in the Pennsylvania Electricity Generation Customer Choice and Competition Act
(Customer Choice Act), generation-related transition costs are being recovered
through a competitive transition charge (CTC) collected in connection with
providing transmission and distribution services, and these assets have been
reclassified accordingly. The electricity delivery business segment continues
to meet SFAS No. 71 criteria, and accordingly reflects regulatory assets and
liabilities consistent with cost-based ratemaking regulations. The regulatory
assets represent probable future revenue, because provisions for these costs
are currently included, or are expected to be included, in charges to electric
utility customers through the ratemaking process. (See Note B.)
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires us to
make estimates and assumptions with respect to values and conditions 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 we are required to make. We
evaluate these estimates on an ongoing basis, using historical experience,
consultation with experts and other methods we consider reasonable in the
particular circumstances. Nevertheless, actual results may differ significantly
from our estimates.
5
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, 2001
filed with the SEC. The results of operations for the three months ended March
31, 2002, are not necessarily indicative of the results that may be expected
for the full year.
EARNINGS PER SHARE
Basic earnings per share are computed on the basis of the weighted average
number of common shares outstanding. Diluted 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 earnings per share for the first quarters of 2002
and 2001.
DILUTED EARNINGS PER SHARE FOR THE QUARTER ENDED MARCH 31,
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2002 2001
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(Millions of Dollars)
Earnings for common $ 16.5 $ 12.2
Dilutive effect of:
ESOP dividends 0.4 0.5
Preferred stock dividends 0.2 -
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Diluted Earnings for Common $ 17.1 $ 12.7
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(Millions of Shares)
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Basic average shares 56.2 55.9
Dilutive effect of:
ESOP shares 0.8 0.9
DQE preferred stock 0.8 0.5
Stock options 0.2 -
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Diluted average shares 58.0 57.3
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Diluted Earnings Per Share $ 0.29 $ 0.22
=============================================================================
RECENT ACCOUNTING PRONOUNCEMENTS
On January 1, 2002, we adopted Statement of Financial Accounting Standards
(SFAS) No. 141, "Business Combinations," and SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets," the impact of which was not
significant to our financial statements.
In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS
No. 142 "Goodwill and Other Intangible Assets," which establishes financial
accounting and reporting for acquired goodwill and other intangible assets.
This standard requires that goodwill and intangible assets that have indefinite
useful lives not be amortized but, instead, be tested at least annually for
impairment, and more frequently if certain indicators appear.
We adopted this standard effective January 1, 2002, and accordingly ceased
amortization of goodwill, as that is our only intangible asset with an
indefinite useful life. As of December 31, 2001, our goodwill (net of
accumulated amortization of $11.3 million) was $142.1 million. The required
test for impairment consists of a two-step process that begins with an
estimation of the fair value of our reporting units. The first step is a screen
for potential impairment and the second measures the amount of impairment, if
any. The new standard requires that we complete the first step of the goodwill
impairment test by June 30, 2002. Our goodwill relates to both our water
distribution ($111.5 million) and propane delivery ($30.6 million) businesses,
which were formed through the acquisition of numerous smaller companies over a
relatively short period of time. To date, the synergies anticipated from these
acquisitions have not been fully realized. Because of the extensive effort
needed to complete this assessment for these entities, we have neither
determined whether there is any indication that goodwill is impaired, nor
estimated the amount of any potential impairment.
To the extent that an indication of impairment exists upon completion of
the first step, we must perform a second test to measure the amount of the
impairment. The second test must be performed as soon as possible, but no later
than December 31, 2002. Any impairment measured as of the date of adoption will
be recognized as the cumulative effect of a change in accounting principle.
The following table reconciles the prior year's reported net income and
earnings per share, adjusted to exclude goodwill amortization expense which is
no longer recorded under the provisions of SFAS No. 142.
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Three Months Ended
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March 31, March 31,
2002 2001
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Reported net income $16.7 $12.2
Goodwill amortization -
(net of tax) water distribution - 1.4
Goodwill amortization -
(net of tax) propane delivery (a) - 0.2
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Adjusted net income $16.7 $13.8
=============================================================================
Basic earnings per share:
Reported earnings per share $ 0.29 $ 0.22
Adjusted earnings per share $ 0.29 $ 0.25
Diluted earnings per share:
Reported earnings per share $ 0.29 $ 0.22
Adjusted earnings per share $ 0.29 $ 0.25
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(a) The propane delivery business is included in the all other category. (See
Note E.)
6
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations," which addresses financial accounting and reporting for
obligations associated with the retirement of tangible long-lived assets and
the associated asset retirement costs. Specifically, this standard requires
entities to record the fair value of a liability for an asset retirement
obligation in the period in which it is incurred, if a reasonable estimate of
fair value can be made. The entity is required to capitalize the cost by
increasing the carrying amount of the related long-lived asset. The
capitalized cost is then depreciated over the useful life of the related asset.
Upon settlement of the liability, an entity either settles the obligation for
its recorded amount or incurs a gain or loss. The standard is effective for
fiscal years beginning after June 15, 2002. We are currently evaluating, but
have yet to determine, the impact that the adoption of SFAS No. 143 will have
on our financial statements.
RECLASSIFICATION
The 2001 condensed consolidated financial statements have been reclassified
to conform with the 2002 presentation.
B. RATE MATTERS
COMPETITION AND THE CUSTOMER CHOICE ACT
The Customer Choice Act enables electric utility customers to purchase
electricity at market prices from a variety of electric generation suppliers.
As of March 31, 2002, approximately 78.4 percent of Duquesne Light's customers
measured on a KWH basis and approximately 77.9 percent on a noncoincident peak
load basis received electricity through our provider of last resort service
arrangement (discussed below). The remaining customers are provided with
electricity through alternative generation suppliers. The number of customers
participating in our provider of last resort service will fluctuate depending
on market prices and the number of alternative generation suppliers in the
retail supply business.
Customers who select an alternative generation supplier pay for generation
charges set competitively by that supplier, and pay Duquesne Light CTC
(discussed below) and/or transmission and distribution charges. Electricity
delivery (including transmission, distribution and customer service) remains
regulated in substantially the same manner as under historical regulation.
In November 2001, the Pennsylvania Department of Revenue established an
increased revenue neutral reconciliation tax (RNR) in order to recover a
current shortfall that resulted from electricity generation deregulation. Since
January 2002, Duquesne Light's customer bills have reflected an approximately
two percent increase to recover its costs related to the RNR. (See Note D.)
REGIONAL TRANSMISSION ORGANIZATION
FERC Order No. 2000 calls on transmission owning utilities such as Duquesne
Light to join regional transmission organizations (RTOs). Duquesne Light is
committed to ensuring a stable, plentiful supply of electricity for its
customers. Toward that end, Duquesne Light anticipates joining the PJM West
RTO, which is currently in the final stages of approval before the FERC. In
late 2001 and early 2002, Duquesne Light entered into agreements with two
generation suppliers to provide the electric capacity required to meet Duquesne
Light's anticipated capacity credit obligations in PJM West through 2004.
Duquesne Light's participation in the PJM West RTO is conditioned upon PUC
approval of the recovery of the cost of capacity under these agreements. We
have petitioned the PUC for such approval, asking for a decision by August 14,
2002; if we do not receive approval by that date, one of the agreements will
terminate, unless an extension is agreed to, and the other agreement will not
become effective. Duquesne Light's inclusion in the PJM West RTO would put the
region's transmission facilities under common control to enhance reliability to
customers.
COMPETITIVE TRANSITION CHARGE
In its final restructuring order, 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 CTC from
electric utility customers. Following our application of net generation asset
sale proceeds to reduce transition costs, the CTC was fully collected in March
2002 for most of our residential customers. We anticipate full CTC collection
by mid-year 2002 for most of our remaining major rate classes. 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 was
approximately $83.4 million ($50.8 million net of tax) at March 31, 2002, on
which Duquesne Light is allowed to earn an 11 percent pre-tax return. A lower
amount is shown on the balance sheet due to the accounting for unbilled
revenues.
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, a third party agreed to supply all of the electric energy necessary to
satisfy Duquesne Light's provider of last resort obligations during the CTC
collection period. Duquesne Light has extended the arrangement (and the
PUC-approved rates for the supply of electricity) beyond the final CTC
collection through
7
December 31, 2004 (POLR II). The agreement also permits Duquesne Light,
following CTC collection for each rate class, an average margin of 0.5 cents
per KWH supplied through this arrangement. Except for this margin, these
agreements, in general, effectively transfer to the supplier 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
In connection with POLR II, 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.
AQUASOURCE RATE APPLICATIONS
In June 2000, AquaSource filed consolidated, statewide water and sewer rate
change applications with the Texas Natural Resource Conservation Commission
(TNRCC) and 17 municipalities. As previously reported, four municipalities
denied or altered the rate increase, and AquaSource appealed. The parties have
since entered into a settlement agreement which provides for, among other
things, the following: the establishment of AquaSource's rate base; the
establishment of four regional rates for service areas within the TNRCC's
original jurisdiction, and three separate rates for the four municipalities who
appealed; and the phase-in of the rates beginning January 1 of 2002, 2003 and
2004 (with the first phase being retroactive to the initial application filing
date of July 17, 2000). AquaSource has also agreed not to file another rate
case application for a rate increase that would be effective prior to July 1,
2004, unless the utility encounters financial hardship. In addition, the
decision on whether AquaSource may recover costs related to acquiring its
companies through its rates has been deferred until the next rate case.
AquaSource expects the revised rate increase will result, ultimately, in
additional annual water and sewer revenues of approximately $5.0 million.
Substantially all of this rate increase has been implemented, subject to
refund, pending final TNRCC approval of the settlement agreement, which is
expected by mid-year 2002.
In March 2001, AquaSource also filed a rate increase petition with the
Indiana Utility Regulatory Commission (IURC) regarding water and sewer rates
for its Utility Center, Inc. subsidiary (AquaSource's largest regulated
subsidiary). Hearings were held in January 2002. We currently anticipate a
final order from the IURC in the third quarter of 2002. If the petition is
approved, annual water and sewer revenues for Utility Center 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, December 31,
2002 2001
- ------------------------------------------------------------------------
Electric customers $ 97.0 $ 97.1
Water customers 17.1 14.8
Unbilled revenue accrual 40.5 44.9
Other utility 3.3 3.2
Other 44.7 42.9
Less: Allowance for
uncollectible accounts (9.8) (9.9)
- ------------------------------------------------------------------------
Total $ 192.8 $ 193.0
========================================================================
D. COMMITMENTS AND CONTINGENCIES
CONSTRUCTION
We estimate that in 2002 we will spend, excluding the allowance for funds
used during construction, approximately $70.0 million for electric utility
construction; $53.0 million for water utility construction; and $10.0 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. The notional amount of such
guarantees at March 31, 2002, was $80.5 million. 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.
LEGAL PROCEEDINGS
In October and November 2001, a number of putative class action
lawsuits were filed by purported shareholders of DQE against DQE and
David Marshall, DQE's former chairman, chief executive officer and
president, in the United States District Court for the Western
District of Pennsylvania. These cases were consolidated under the
caption In re DQE, Inc. Securities Litigation, Master File No.
01-1851 (W.D. Pa.), and the plaintiffs filed a second consolidated
amended complaint on April 15,
8
2002. The complaint alleges violations of Section 10(b) of the
Securities Exchange Act of 1934 (the "Exchange Act") and Rule 10b-5
promulgated thereunder, and Section 12(a)(2) of the Securities Act of
1933 (the "Securities Act"). The complaint also alleges controlling
person liability under Section 20(a) of the Exchange Act and Section
15 of the Securities Act. The complaint alleges that between December
6, 2000 and April 30, 2001, the defendants issued a number of
materially false and misleading statements concerning investments
made by our subsidiary, DQE Enterprises, and the impact that these
investments would have on our current and future financial results.
More particularly, the complaint alleges that DQE and Marshall stated
their expectation that certain companies in which DQE Enterprises had
invested would undertake initial public offerings of their shares,
with the result that our earnings would be positively impacted by the
public market valuation of DQE Enterprises' interests in these
companies, but failed to disclose allegedly adverse facts that made
the possibility of successful public offerings of the securities of
these companies unlikely. The complaint seeks an award of unspecified
compensatory damages, and an order permitting class members who
purchased DQE shares through a dividend reinvestment plan to rescind
those purchases, pre- and post-judgment interest, attorneys' fees and
expenses of litigation and unspecified equitable and injunctive
relief.
In February 2001, 39 former and current employees of our
subsidiary AquaSource, Inc., all minority investors in AquaSource,
commenced an action against DQE, AquaSource and others in the
District Court of Harris County, Texas. The complaint alleges that
the defendants fraudulently induced the plaintiffs to agree to sell
their AquaSource Class B stock back to AquaSource by falsely
promising orally that DQE would invest $1 billion or more in
AquaSource, which, plaintiffs allege, would have permitted them to
realize significant returns on their investments in AquaSource. The
complaint also alleges that the defendants mismanaged AquaSource, and
thus decreased the value of plaintiffs' AquaSource stock. Plaintiffs
seek, among other relief, an order rescinding their agreements to
sell their stock back to AquaSource, an award of actual damages not
to exceed $100 million and exemplary damages not to exceed $400
million.
In the first quarter of 2002, DQE and AquaSource filed
counterclaims alleging that 10 plaintiffs who held key AquaSource
management positions engaged in deceptive practices designed to
obtain funding for acquisitions and to make those acquisitions appear
to meet certain return on investment requirements, and that all
plaintiffs were unjustly enriched by these wrongful actions. DQE,
AquaSource and AquaSource Utility, Inc. also filed a counterclaim
against two plaintiffs alleging claims for breach of contract, breach
of warranty, indemnification, fraud and unjust enrichment in
connection with the acquisition of various water and wastewater
companies from these two plaintiffs.
Although we cannot predict the ultimate outcome of these cases or
estimate the range of any potential loss that may be incurred in the
litigation, we believe that the lawsuits are without merit,
strenuously deny all of the plaintiffs' allegations of wrongdoing and
believe we have meritorious defenses to the plaintiffs' claims. We
intend to vigorously defend these lawsuits.
As discussed elsewhere in this report, Duquesne Light requested
and received PUC approval to recover approximately $13.0 million of
costs we will incur in 2002 due to the RNR. On November 19, 2001, the
Pennsylvania Office of Consumer Advocate (OCA) filed a complaint with
the PUC, objecting to the recovery approval and stating various
matters, such as rate of return and offsetting savings, that should
be considered before allowing RNR recovery in excess of rate caps. An
initial hearing on the OCA's complaint was held May 2, 2002 before a
PUC administrative law judge, who denied the OCA's objections.
However, on May 9, 2002, the PUC ordered that Duquesne Light's
quarterly earnings may be considered in the RNR proceedings. An
additional hearing has been scheduled for May 21, 2002, and we
anticipate a final decision in the third quarter of 2002.
Although we cannot predict the ultimate outcome of this matter, we believe
the final resolution will not significantly affect our results of operations or
cash flows.
INCOME TAXES
The annual Federal corporate income tax returns have been audited
by the Internal Revenue Service (IRS) and are closed for the tax
years through 1993. The IRS examination of the 1994 tax year has been
completed, and the IRS issued a notice of proposed adjustment
increasing our 1994 income tax liability in the approximate amount of
$22.0 million (including penalties and interest) with respect to
certain structured leasing transactions. We have protested and paid
the proposed IRS adjustments for 1994; that protest is currently
pending with the IRS Appeals Office. The IRS is currently auditing
our 1995 through 1997 tax returns, and the tax years 1998 through
2001 remain subject to IRS review. The IRS has indicated that it is
considering proposing adjustments to our reporting for 1995 through
1997 of the same structured transactions that were the subject of the
1994 proposed adjustment, as well as other similar transactions. If
the IRS were to propose adjustments to such transactions for the
years 1995 through 2001 similar to those made for 1994, we would
project that the proposed assessment of
9
additional tax would be approximately $175.0 million (to which
interest would be, and penalties may be, added). In addition, the IRS
has indicated that it may challenge other structured leasing
transactions entered into during the 1995 through 1997 period but has
not yet proposed any adjustments, and we are unable to quantify what
those adjustments might be. While it is impossible to predict whether
or to what extent any IRS proposed adjustments for the period 1994
through 2001 will be sustained, we do not believe that the ultimate
resolution of any of our Federal income tax liability for the years
1994 through 2001 will have a material adverse effect on our financial
position, results of operations or cash flows.
OTHER
DQE Financial maintains a limited partnership investment in a
waste-to-energy facility. In January 2002, Moody's Investor Service
downgraded the general partner's credit rating. The general partner's
credit condition led to an event of default under the partnership's
service agreement to operate the underlying waste-to-energy facility
for the local authority. The local authority has issued a notice to
terminate the services agreement effective May 30, 2002. On April 1,
2002, the general partner and the partnership filed for bankruptcy
protection under Chapter 11 of the U.S. Bankruptcy Code. Subsequent
to the bankruptcy filing, the general partner obtained
debtor-in-possession financing to meet ongoing cash needs and has
obtained a non-binding letter of intent to be acquired upon emergence
from Chapter 11. DQE Financial is currently assessing the effect of
these events on the recoverability of its asset carrying value, which
is approximately $15.7 million as of March 31, 2002.
E. BUSINESS SEGMENTS AND RELATED INFORMATION
We report the results of our business segments, determined by
products, services and regulatory environment as follows: (1)
Duquesne Light's transmission and distribution of electricity
(electricity delivery business segment), (2) Duquesne Light's supply
of electricity (electricity supply business segment), (3) Duquesne
Light's collection of transition costs (CTC business segment), (4)
AquaSource's management of water systems (water distribution business
segment), (5) DQE Energy Services' development, operation and
maintenance of energy and alternative fuel facilities (Energy
Services business segment), (6) DQE Financial's collection and
processing of landfill gas and management of structured finance and
alternative energy investments (Financial business segment) and (7)
DQE Enterprises' management of electronic commerce, energy services
and technologies, and communications investment portfolios
(Enterprises business segment).
We also report an "all other" category, to include our other
subsidiaries below the quantitative threshold for disclosure, and
corporate administrative functions, financing, and insurance services
for our various affiliates. Operating revenues in our "all other"
category are comprised of revenues from our propane delivery and
telecommunications business lines.
10
Business Segments for the Three Months Ended:
- -----------------------------------------------------------------------------------------------------------------------------
(Millions of Dollars)
-----------------------------------------------------------------------------------------
Electricity Electricity Water Energy
Delivery Supply CTC Distribution Services Financial Enterprises Other
-----------------------------------------------------------------------------------------
March 31, 2002
- -----------------------------------------------------------------------------------------------------------------------------
Operating revenues $ 80.2 $ 104.2 $65.0 $ 25.8 $ 10.8 $ 4.0 $ 0.5 $ 18.0
Operating expenses 33.8 103.6 2.9 23.1 6.3 12.0 0.6 20.8
Depreciation and amortization 14.2 - 60.1 2.5 0.5 1.6 0.1 1.4
- -----------------------------------------------------------------------------------------------------------------------------
Operating income (loss) 32.2 0.6 2.0 0.2 4.0 (9.6) (0.2) (4.2)
Other income 12.2 - - 0.9 0.4 15.0 0.2 0.2
Interest and other charges 18.9 - - 0.2 0.1 0.2 - 8.7
- -----------------------------------------------------------------------------------------------------------------------------
Income (loss) before taxes 25.5 0.6 2.0 0.9 4.3 5.2 - (12.7)
Income taxes 10.2 0.2 0.7 0.4 1.4 0.1 - (4.4)
- -----------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 15.3 $ 0.4 $ 1.3 $ 0.5 $ 2.9 $ 5.1 $ - $ (8.3)
=============================================================================================================================
Assets $1,839.5 $ - $76.6 $ 386.1 $ 34.4 $ 608.5 $ 22.5 $ 168.0
=============================================================================================================================
Capital expenditures $ l3.9 $ - $ - $ 10.4 $ 0.2 $ 1.9 $ - $ 1.5
=============================================================================================================================
Business Segments for the Three Months Ended:
- -----------------------------------------------------------------------------------------------------------------------------
-----------------------
Elimina- Consoli-
tions dated
-----------------------
March 31, 2002
- -----------------------------------------------------------
Operating revenues $ (0.4) $ 308.1
Operating expenses (1.4) 201.7
Depreciation and amortization - 80.4
- -----------------------------------------------------------
Operating income (loss) 1.0 26.0
Other income (7.8) 21.1
Interest and other charges (6.3) 21.8
- -----------------------------------------------------------
Income (loss) before taxes (0.5) 25.3
Income taxes - 8.6
- -----------------------------------------------------------
Net income (loss) $ (0.5) $ 16.7
===========================================================
Assets $ - $3,135.6
===========================================================
Capital expenditures $ - $ 27.9
===========================================================
11
Business Segments for the Three Months Ended:
- --------------------------------------------------------------------------------------------------------------------
(Millions of Dollars)
---------------------------------------------------------------------------------------
Electricity Electricity Water Energy
Delivery Supply CTC Distribution Services Financial Enterprises
----------------------------------------------------------------------------------------
March 31, 2001
- ---------------------------------------------------------------------------------------------------------------------
Operating revenues $ 73.7 $ 97.6 $ 74.1 $ 25.6 $ 3.9 $ 9.0 $ 6.0
Operating expenses 40.8 97.6 3.3 22.0 3.9 12.0 5.5
Depreciation and amortization 14.8 - 64.3 4.6 0.4 1.2 0.9
- ---------------------------------------------------------------------------------------------------------------------
Operating income (loss) 18.1 - 6.5 (1.0) (0.4) (4.2) (0.4)
Other income 10.3 - - 1.5 1.8 17.1 1.0
Interest and other charges 20.3 - - 0.2 0.1 2.2 0.1
- ---------------------------------------------------------------------------------------------------------------------
Income (loss) before taxes 8.1 - 6.5 0.3 1.3 10.7 0.5
Income taxes 3.3 - 2.3 0.4 0.4 0.6 (0.2)
- ---------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 4.8 $ - $ 4.2 $ (0.1) $ 0.9 $ 10.1 $ 0.7
=====================================================================================================================
Assets(1) $1,702.5 $ - $ 134.3 $ 389.7 $35.2 $623.6 $ 35.2
=====================================================================================================================
Capital expenditures $ 11.1 $ - $ - $ 9.2 $ 0.7 $ 3.1 $ -
=====================================================================================================================
Business Segments for the Three Months Ended:
- --------------------------------------------------------------
(Millions of Dollars)
-------------------------------
Elimina- Consoli-
Other tions dated
-------------------------------
March 31, 2001
- --------------------------------------------------------------
Operating revenues $ 33.7 $ (3.1) $ 320.5
Operating expenses 28.4 (5.3) 208.2
Depreciation and amortization 1.6 - 87.8
- --------------------------------------------------------------
Operating income (loss) 3.7 2.2 24.5
Other income 2.3 (10.6) 23.4
Interest and other charges 13.4 (7.9) 28.4
- --------------------------------------------------------------
Income (loss) before taxes (7.4) (0.5) 19.5
Income taxes 0.5 - 7.3
- --------------------------------------------------------------
Net income (loss) $ (7.9) $ (0.5) $ 12.2
==============================================================
Assets(1) $305.4 $ - $3,225.9
==============================================================
Capital expenditures $ 1.0 $ - $ 25.1
==============================================================
(1) Relates to assets as of December 31,2001.
12
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,
2001 filed with the Securities and Exchange Commission (SEC), and the condensed
consolidated financial statements, which are set forth in Part I, Item 1 of
this Report.
DQE, Inc. delivers essential products and related services, including
electricity, water and communications, to more than one million customers
throughout the United States. Our subsidiaries are Duquesne Light Company;
AquaSource, Inc.; DQE Energy Services, LLC; DQE Financial Corp.; DQE
Enterprises, Inc.; DQE Communications, Inc.; ProAm, Inc.; Duquesne Power Inc.;
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 is a water resource management company that acquires, develops
and manages water and wastewater systems and complementary businesses.
DQE Energy Services is an energy facilities management company that
provides energy outsourcing solutions including development, operation and
maintenance of energy and alternative fuel facilities.
DQE Financial owns and operates landfill gas collection and processing
systems, and is an investment and portfolio management organization focused on
structured finance and alternative energy investments.
DQE Enterprises manages our remaining electronic commerce, energy services
and technologies, and communications investment portfolios.
Duquesne Power Inc. was formed in April 2002 to explore various
alternative generation supply options, including the construction of a
gas-turbine electric generating facility. Our other business lines include the
following: propane distribution, communications systems, and financing and
insurance services for DQE and various affiliates.
SERVICE AREAS
Duquesne Light's electric utility operations provide service to
approximately 586,000 direct customers in southwestern Pennsylvania (including
in the City of Pittsburgh), a territory of approximately 800 square miles.
AquaSource's water utility operations currently provide service to more
than 520,000 water and wastewater customer connections in 18 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 Securities and Exchange Commission (SEC). Duquesne Light's
electric 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.
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.
FORWARD-LOOKING STATEMENTS
We use forward-looking statements in this report. Statements that are not
historical facts are forward-looking statements, and are based on beliefs and
assumptions of our management, and on information currently available to
management. Forward-looking statements include statements preceded by,
followed by or using such words as "believe," "expect," "anticipate," "plan,"
"estimate" or similar expressions. Such statements speak only as of the date
they are made, and we undertake no obligation to update publicly any of them in
light of new information or future events. Actual results may materially differ
from those implied by forward-looking statements due to known and unknown risks
and uncertainties, some of which are discussed below.
. DQE cash flow, earnings, earnings growth
and dividends will depend on the performance
of our subsidiaries, the effectiveness of the divestiture of non-core
businesses, the implementation of our growth strategy, and board policy.
. Demand for and pricing of electric, water and telecommunications utility
services and landfill gas, changing market conditions and weather
conditions could affect earnings levels at DQE and each subsidiary.
. The number of customers who choose to receive electric generation
through POLR II will affect Duquesne Light's earnings.
. Customer energy demand, fuel costs and plant operations will affect DQE
Energy Services' earnings.
. The outcome of the previously reported shareholder litigation initiated
against both DQE and AquaSource may affect our performance.
13
. Stock market volatility and business conditions with respect to energy
technology and electronic commerce may affect our ability to monetize our
non-core energy technology and electronic commerce portfolio.
. Market conditions and demand for services affect our ability to monetize
our non-core and financial investments, and unregulated businesses.
. The tragic events of September 11, 2001 have created broad uncertainty
in the global economy, and we continue to assess the impact on our
businesses, including but not limited to DQE Financial.
. Overall performance by DQE and our affiliates could be affected by
economic, competitive, regulatory, governmental (including tax) and
technological factors affecting operations, markets, products, services
and prices, as well as the factors discussed in our SEC filings made to
date.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001 the Financial Accounting Standards Board (FASB) issued two
new accounting standards, Statement of Financial Accounting Standards (SFAS)
No. 142, "Goodwill and Other Intangibles," and SFAS No. 143, "Accounting for
Asset Retirement Obligations."
SFAS No. 142 establishes financial accounting and reporting for acquired
goodwill and other intangible assets. This standard requires that goodwill and
intangible assets that have indefinite useful lives not be amortized but,
instead, be tested at least annually for impairment, and more frequently if
certain indicators appear.
We adopted this standard effective January 1, 2002, and accordingly ceased
amortization of goodwill, as that is our only intangible asset with an
indefinite useful life.
The required test for impairment consists of a two-step process that
begins with an estimation of the fair value of our reporting units. The first
step is a screen for potential impairment and the second measures the amount of
impairment, if any. The new standard requires that we complete the first step
of the goodwill impairment test by June 30, 2002. Our goodwill relates to both
our water distribution ($111.5 million) and propane delivery ($30.6 million)
businesses, which were formed through the acquisition of numerous smaller
companies over a relatively short period of time. To date, the synergies
anticipated from these acquisitions have not been fully realized. Because of
the extensive effort needed to complete this assessment for these entities, we
have neither determined whether there is any indication that goodwill is
impaired, nor estimated the amount of any potential impairment.
To the extent that an indication of impairment exists upon completion of
the first step, we must perform a second test to measure the amount of the
impairment. The second test must be performed as soon as possible, but no later
than December 31, 2002. Any impairment measured as of the date of adoption will
be recognized as the cumulative effect of a change in accounting principle.
SFAS No. 143 addresses financial accounting and reporting for obligations
associated with the retirement of tangible long-lived assets and the associated
asset retirement costs. Specifically, this standard requires entities to record
the fair value of a liability for an asset retirement obligation in the period
in which it is incurred, if a reasonable estimate of fair value can be made.
The entity is required to capitalize the cost by increasing the carrying amount
of the related long-lived asset. The capitalized cost is then depreciated over
the useful life of the related asset. Upon settlement of the liability, an
entity either settles the obligation for its recorded amount or incurs a gain
or loss. The standard is effective for fiscal years beginning after June 15,
2002. We are currently evaluating, but have yet to determine, the impact that
the adoption of SFAS No. 143 will have on our financial statements.
RESULTS OF OPERATIONS
OVERALL PERFORMANCE
Basic earnings per share were $0.29 in the first quarter of 2002 compared
to $0.22 in the first quarter of 2001, an increase of 31.8 percent. The average
shares outstanding increased 0.3 million, or 0.5 percent. Earnings available
for common shareholders increased from $12.2 million in the first quarter of
2001 to $16.5 million in the first quarter of 2002, an increase of 35.2
percent. This increase is primarily due to decreased operating expenses, which
are a result of the corporate restructuring that occurred in the fourth quarter
of 2001 as well as our cost reduction initiatives, which continue to generate
incremental cost savings. Other items that positively affected available
earnings include lower amortization, which is a result of the implementation of
SFAS No. 142 and the impairment charges taken in 2001; and lower interest
expense, which is a result of lower debt levels as well as lower interest rates
on our variable rate, tax-exempt debt. Partially offsetting these items was a
charge of $3.5 million related to the write-off of a receivable from a
telecommunications customer who filed for bankruptcy in March 2002.
14
RESULTS OF OPERATIONS BY BUSINESS SEGMENT
We report the results of our business segments, determined by products,
services and regulatory environment as follows: (1) Duquesne Light's
transmission and distribution of electricity (electricity delivery business
segment), (2) Duquesne Light's supply of electricity (electricity supply
business segment), (3) Duquesne Light's collection of transition costs (CTC
business segment), (4) AquaSource's management of water systems (water
distribution business segment), (5) DQE Energy Services' development, operation
and maintenance of energy and alternative fuel facilities (Energy Services
business segment), (6) DQE Financial's collection and processing of landfill
gas and the management of structured finance and alternative energy investments
(Financial business segment), and (7) DQE Enterprises' management of electronic
commerce, energy services and technologies, and communications investment
portfolios (Enterprises business segment).
We also report an "all other" category to include our other subsidiaries
below the quantitative threshold for disclosure, and corporate administrative
functions, financing, and insurance services for our various affiliates.
We have restated prior periods where appropriate to present segment
information consistent with the manner that is currently utilized by
management. Note E shows the financial results of each principal business
segment in tabular form. Following is a discussion of these results.
Electricity Delivery Business Segment. The electricity delivery business
segment contributed $15.3 million to net income in the first quarter of 2002
compared to $4.8 million in the first quarter of 2001, an increase of $10.5
million, or 218.8 percent. This improvement is a result of lower operating
expenses due to the corporate restructuring that occurred in the fourth quarter
of 2001 as well as our cost reduction initiatives, which continue to generate
incremental cost savings. Net income was also positively impacted by higher
other income, due to the $0.8 million after-tax gain recognized on the sale of
securities in 2002, and lower interest charges, due to lower interest rates in
the first quarter of 2002 on the tax-exempt, variable rate debt.
Operating revenues for this business segment are primarily derived from
the delivery of electricity. Sales to residential and commercial customers are
primarily 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
residential, commercial and industrial customers are influenced by national and
global economic conditions.
Operating revenues increased by $6.5 million or 8.8 percent compared to
the first quarter of 2001. The increase can be primarily attributed to the
$3.9 million increase in revenue due to the increased RNR tax rate, which
became effective January 1, 2002. Pennsylvania electric distribution companies,
such as Duquesne Light, are permitted to recover this cost from consumers on a
current basis. (See "Legal Proceedings.")
Residential sales decreased 1.0 percent, primarily due to warmer winter
weather in 2002. Commercial sales increased 1.8 percent due to an increase in
the number of commercial customers, while industrial sales decreased 2.0
percent due to decreased consumption by steel manufacturers, as well as
customers in the chemical industry. The following table sets forth
kilowatt-hours (KWH) delivered to electric utility customers.
- -----------------------------------------------------------------------------
KWH Delivered
-----------------------------------
(In Millions)
-----------------------------------
First Quarter 2002 2001 Change
- -----------------------------------------------------------------------------
Residential 892 901 (1.0)%
Commercial 1,513 1,486 1.8 %
Industrial 820 837 (2.0)%
- -----------------------------------------------------------------------------
Sales to Electric
Utility Customers 3,225 3,224 - %
=============================================================================
Operating expenses for the electricity delivery business segment consist
primarily of costs to operate and maintain the transmission and distribution
system; meter reading, billing and collection costs; customer service;
administrative expenses; and non-income taxes, such as gross receipts, property
and payroll taxes. Operating expenses decreased by $7.0 million or 17.2 percent
compared to the first quarter of 2001, due to the corporate restructuring that
occurred in the fourth quarter of 2001 as well as our cost reduction
initiatives, which continue to generate incremental cost savings.
Depreciation and amortization expense includes the depreciation of
electric delivery-related plant and equipment. There was a decrease of $0.6
million or 4.1 percent compared to the first quarter of 2001.
Other income increased $1.9 million or 18.4 percent compared to the first
quarter of 2001, primarily due to a $1.3 million pre-tax gain recognized on the
sale of certain securities during the first quarter of 2002.
Interest and other charges include interest on long-term debt, other
interest and preferred stock dividends of Duquesne Light. In the first quarter
of 2002, there was $1.4 million or 6.9 percent less interest and other charges
compared to the first quarter of 2001, primarily due to $2.0 million less
interest because of the favorable interest rates on the $418.0 million of
variable rate, tax-exempt debt, partially offset by commercial paper borrowings
made in January 2002.
15
Electricity Supply Business Segment. In the first quarter of 2002, the
electricity supply business segment reported net income of $0.4 million,
compared with net income of zero in the first quarter of 2001. For the period
April 28, 2000 through December 31, 2001, this segment's financial results
reflected our initial provider of last resort service arrangement, which was
designed to be income neutral to Duquesne Light. During the first quarter of
2002, Duquesne Light began operating under the POLR II arrangement, which
extends the provider of last resort service (and the PUC-approved rates for the
supply of electricity) beyond the final CTC collection through December 31,
2004. This arrangement also permits Duquesne Light, following CTC collection
for each rate class, an average margin of 0.5 cents per KWH supplied.
Operating revenues for this business segment are derived primarily from
the supply of electricity for delivery to retail customers and, to a much
lesser extent, the supply of electricity to wholesale customers. Retail energy
requirements fluctuate as the number of customers participating in customer
choice changes. Energy requirements for residential and commercial customers
are also influenced by weather conditions; temperature extremes lead to
increased customer use of electricity for cooling and heating. Commercial
energy requirements are also affected by regional development. Energy
requirements for industrial customers are primarily influenced by national and
global economic conditions.
Short-term sales to other utilities are made at market rates.
Fluctuations result primarily from excess daily energy deliveries to Duquesne
Light's electricity delivery system.
Operating revenues increased $6.6 million or 6.8 percent compared to the
first quarter of 2001. The increase is due to a 9.3 percent higher average
generation rate charged to customers, as well as a slightly larger percentage
of customers who receive electricity through our provider of last resort
service arrangement.
The following table sets forth KWH supplied for customers who had not
chosen an alternative generation supplier.
- -----------------------------------------------------------------------------
KWH Supplied
------------------------------
(In Millions)
------------------------------
First Quarter 2002 2001 Change
- -----------------------------------------------------------------------------
Residential 643 621 3.5 %
Commercial 1,134 1,137 (0.3) %
Industrial 749 749 - %
- -----------------------------------------------------------------
KWH Sales 2,526 2,507 0.8 %
Sales to Other Utilities 63 155 (59.4)%
- -----------------------------------------------------------------
Total Sales 2,589 2,662 (2.7)%
=============================================================================
Operating expenses for the electricity supply business segment consist of
costs to obtain energy for our provider of last resort service and gross
receipts tax, both of which fluctuate in direct relation to operating revenues.
Operating expenses increased $6.0 million or 6.1 percent compared to the first
quarter of 2001. As a result of the higher average generation rate charged to
customers in the first quarter of 2002, the resulting cost of energy increased
due to the pass-through nature of the provider of last resort agreements.
CTC Business Segment. For the CTC business segment, operating revenues are
derived by billing electric delivery customers for generation-related
transition costs. Duquesne Light is allowed to earn an 11 percent pre-tax
return on the net of tax CTC balance. As revenues are billed to customers on a
monthly basis, we amortize the CTC balance. The resulting decrease in the CTC
balance causes a decline in the return earned by Duquesne Light.
In the first quarter of 2002, the CTC business segment reported net income
of $1.3 million compared to $4.2 million during the same period in 2001, a
decrease of $2.9 million or 69.0 percent.
Operating revenues decreased $9.1 million or 12.3 percent, due to a 6.1
percent decrease in the average CTC rate charged to customers from 2001 to
2002, as well as the full collection of the allocated CTC balance for most of
our residential customers during the first quarter of 2002.
Operating expenses consist solely of gross receipts tax, which fluctuates
in direct relation to operating revenues. Operating expenses decreased $0.4
million or 12.1 percent compared to the first quarter of 2001.
Depreciation and amortization expense consists of the amortization of
transition costs. There was a decrease of $4.2 million or 6.5 percent compared
to the first quarter of 2001, primarily due to the full collection of the
allocated CTC balance for most of our residential customers. We anticipate full
CTC collection by mid-year 2002 for most of our remaining major rate classes.
Water Distribution Business Segment. The water distribution business
segment contributed $0.5 million to net income in the first quarter of 2002
compared to a net loss of $0.1 million in the first quarter of 2001, an
increase of $0.6 million, primarily attributable to decreased depreciation and
amortization expense.
Operating revenues for this business segment are derived from the
following: billings related to water and sewer services for utilities (both
owned and contract-operated by AquaSource) and water-related construction and
engineering projects. Customer water use depends on weather conditions.
16
Operating expenses for the water distribution segment mainly consist of
costs to operate and maintain the water distribution systems, administrative
expenses and non-income taxes, such as property and payroll taxes. Operating
expenses increased $1.1 million or 5.0 percent compared to the first quarter of
2001.
Depreciation and amortization expense includes depreciation of utility
delivery systems and, in 2001, the amortization of goodwill on acquisitions.
Depreciation and amortization expense decreased $2.1 million or 45.7 percent,
primarily due to the adoption of SFAS No. 142, which ceased the amortization of
goodwill. (See Note A.)
Energy Services Business Segment. In the first quarter of 2002, the Energy
Services business segment reported net income of $2.9 million, compared to net
income of $0.9 million in the first quarter of 2001. The $2.0 million increase
is due to increased facility management income from service contracts entered
into after the first quarter of 2001.
Operating revenues for this business segment are primarily derived from
facility management services for industrial, airport and alternative fuel
customers. Operating revenues increased $6.9 million or 176.9 percent compared
to the first quarter of 2001. This increase is due to increased facility
management revenue from the new service contracts.
Operating expenses for the Energy Services business segment consist of the
operating and maintenance costs to manage the facilities. Operating expenses
increased $2.4 million or 61.5 percent from the first quarter of 2001,
primarily due to the new service contracts.
Other income was $1.4 million lower in the first quarter of 2002, due
primarily to a gain recognized on the sale of real property in 2001.
Financial Business Segment. In the first quarter of 2002, the Financial
business segment reported net income of $5.1 million, compared to net income of
$10.1 million in the first quarter of 2001. The $5.0 million decrease is
primarily due to significantly lower landfill gas sales prices, which declined
by 63.4 percent, and less income from the affordable housing portfolio, most of
which had been sold by the end of the first quarter of 2002.
Operating revenues for this business segment are primarily derived from
the sale of landfill gas. Operating revenues decreased $5.0 million or 55.6
percent compared to the first quarter of 2001, due to lower landfill gas prices.
Operating expenses for the Financial business segment consist of the
various costs to operate and maintain the landfill gas sites. Operating
expenses were consistent with the first quarter of 2001.
Other income consists of income from leveraged lease and affordable
housing investments, tax credits generated from the landfill and natural gas
investments, and gains recognized on the sales of investments. Other income
decreased $2.1 million or 12.3 percent as compared to the first quarter of
2001, due to the loss of income from the affordable housing portfolio, as well
as the loss of tax credits from landfill gas projects abandoned in 2001.
Interest and other charges decreased $2.0 million or 90.9 percent as
compared to 2001, due to the retirement of $85.0 million of medium term notes
beginning in the second quarter of 2001.
Enterprise Business Segment. The Enterprises business segment did not
generate any net income in the first quarter of 2002, compared to net income of
$0.7 million in the first quarter of 2001. We are in the process of an orderly
divestiture of the remaining investments of this business segment as
opportunities arise and market conditions permit.
All Other. The all other category had an $8.3 million net loss in the
first quarter of 2002 compared to a $7.9 million net loss in the first quarter
of 2001.
In the first quarter of 2002, operating revenues decreased by $15.7
million or 46.6 percent compared to the first quarter of 2001. This decrease
was primarily the result of decreased revenues of $5.9 million due to the sale
of our bottled water business in May 2001, and $7.4 million due to lower
propane prices and propane sales.
Operating expenses decreased in the first quarter of 2002 by $7.6 million
or 26.8 percent compared to the first quarter of 2001. This decrease was
primarily the result of a $6.2 million decrease in expenses due to the sale of
our bottled water business in 2001. In the first quarter of 2002, we also
experienced $5.9 million of lower cost of goods sold for the propane business,
which was offset by the write-off of a receivable from a telecommunications
customer who filed for bankruptcy in March 2002.
Interest and other charges include interest on long-term debt, other
interest, and preferred stock dividends of our other business lines. A decrease
of $4.7 million in the first quarter of 2002 was primarily due to lower
short-term borrowing levels.
LIQUIDITY AND CAPITAL RESOURCES
CAPITAL EXPENDITURES
We estimate that during 2002 we will spend, excluding the
allowances for funds used during construction, approximately $70.0
million for electric utility construction; $53.0 million for water
utility construction; and $10.0 million for construction by our other
business lines.
17
During the first three months of 2002, we have spent approximately
$27.9 million on capital expenditures, consisting of approximately
$13.9 million at Duquesne Light, $10.4 million at Aquasource and the
remaining $3.6 million on other.
ASSET DISPOSITIONS
In the first quarter of 2002, we sold a significant portion of
our remaining affordable housing portfolio, receiving proceeds of
approximately $17.0 million, which approximated book value. We also
sold a wastewater facility and real property and received proceeds of
approximately $0.9 million and $0.8 million, respectively, which
approximated book value. We received approximately $1.3 million
from the sale of securities and recognized an after-tax gain of
$0.8 million.
FINANCING AND CAPITAL AVAILABILITY
On April 5, 2002, we filed a shelf registration statement for up
to $500.0 million of preferred stock, common stock, stock purchase
contracts, stock purchase units, warrants, DQE debt securities and
DQE Capital debt securities, to be issued from time to time. Our
ability to issue such securities will depend on, among other things,
market demand, interest rates, and corporate strategy.
On April 15, 2002, Duquesne Light issued $200.0 million of 6.7
percent first mortgage bonds due 2012. On April 30, 2002, Duquesne
Light issued $100.0 million of 6.7 percent first mortgage Public
Income Notes due 2032. In each case it used the proceeds to call and
refund existing debt.
In the first quarter of 2002, Moody's Investor Service, Standard
& Poor's, and Fitch Ratings assessed our short and long-term credit
profiles. The ratings reflect the agencies' opinion of our overall
financial strength. Ratings impact our ability to access capital
markets for investment and capital requirements, as well as the
relative costs related to such liquidity capability. In general, the
agencies reduced our long-term credit ratings, although staying
within the range considered to be investment grade. The agencies
maintained the existing credit ratings for Duquesne Light's
short-term debt. However Moody's and Fitch reduced DQE Capital's
short-term debt rating by one level, thereby restricting DQE Capital
from accessing the short-term commercial paper market. DQE Capital is
exploring alternative ways to fund its short-term liquidity needs.
This ratings downgrade does not limit our ability to access our revolving
credit facilities; it does, however, impact the cost of maintaining
the credit facilities and the cost of any new debt. These ratings are
not a recommendation to buy, sell or hold any securities of DQE or
our subsidiaries, may be subject to revisions or withdrawal by the
agencies at any time, and should be evaluated independently of each
other and any other rating that may be assigned to our securities.
In January 2002, we refinanced $150.0 million of matured DQE
Capital floating rate notes through the issuance of commercial paper,
primarily at Duquesne Light. This commercial paper may, in turn, be
refunded through other debt instruments available to us.
At March 31, 2002, we had $98.0 million of commercial paper
borrowings outstanding, and $1.2 million of current debt maturities.
During the quarter, the maximum amount of bank loans and commercial
paper borrowings outstanding was $155.0 million, the amount of
average daily borrowings was $118.3 million, and the weighted average
daily interest rate was 2.4 percent.
We maintain two seperate revolving credit agreements, one for
$200.0 million and one for $150.0 million, both expiring in October
2002. We may convert the $150.0 million revolver into a term loan
facility for a one-year period, for any amounts then outstanding upon
expiration of the revolving credit period. Interest rates on both
facilities can, in accordance with the option selected at the time of
the borrowing, be based on one of several indicators, including prime
and Eurodollar rates. Fees are based on the unborrowed amount of the
commitment. We plan to extend both facilities prior to their
expiration. At March 31, 2002 no borrowings were outstanding.
Under our credit facilities, we are subject to financial
covenants requiring each of DQE and Duquesne Light to maintain a
maximum debt-to-capitalization ratio of 65.0 percent. In addition,
DQE is required to maintain a minimum cash coverage ratio of
2-to-1. At March 31, 2002 we were in compliance with these covenants,
having debt-to-capitalization ratios of approximately 63.5 percent
at DQE and approximately 60.7 percent at Duquesne Light, and a cash
coverage ratio of approximately 2.7-to-1 at DQE.
CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS
As of March 31, 2002, we have certain contractual obligations and
commercial commitments that extend beyond this year, as set forth in the
following tables:
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Payments Due By Period
- ----------------------------------------------------------------------------------------------------
(In Millions)
--------------------------------------------------------------
2002 2003 2004 2005 After Total
--------------------------------------------------------------
Long-Term Debt $ - $ 100.9 $101.4 $ 1.5 $1,000.8 $ 1,204.6
Notes Payable and Current Maturities 99.2 - - - - 99.2
Capital Lease Obligations 0.7 0.7 0.7 0.7 1.6 4.4
Operating Leases 5.7 5.7 5.5 3.8 24.1 44.8
- ----------------------------------------------------------------------------------------------------
Total Contractual Cash Obligations $105.6 $ 107.3 $107.6 $ 6.0 $1,026.5 $ 1,353.0
====================================================================================================
Other Commercial Commitments
- ----------------------------------------------------------------------------------------------------
(In Millions)
--------------------------------------------------------------
2002 2003 2004 2005 After Total
--------------------------------------------------------------
Revolving Credit Agreements (a) $200.0 $ 150.0 $ - $ - $ - $ 350.0
Standby Letters of Credit (a) 75.9 - - - - 75.9
Surety Bonds (b)
Commercial 88.1 - - - - 88.1
Contract 27.8 - - - - 27.8
Guarantees (See Note D) - - - - 80.5 80.5
- ----------------------------------------------------------------------------------------------------
Total Commercial Commitments $391.8 $ 150.0 $ - $ - $ 80.5 $ 622.3
====================================================================================================
(a) Revolving Credit Agreements and Letters of Credit are typically for a
364-day period and are renewed annually.
(b) Surety bonds are renewed annually. Some of the commercial bonds cover
regulatory and contractual obligations which exceed a one-year period.
RATE MATTERS
COMPETITION AND THE CUSTOMER CHOICE ACT
The Pennsylvania Electricity Generation Customer Choice and Competition
Act (Customer Choice Act) enables electric utility customers to purchase
electricity at market prices from a variety of electric generation suppliers.
As of March 31, 2002, approximately 78.4 percent of Duquesne Light's customers
measured on a KWH basis, and approximately 77.9 percent on a non-coincident
peak load basis received electricity through our provider of last resort
service arrangement. The remaining customers are provided with electricity
through alternative generation suppliers. The number of customers participating
in our provider of last resort service will fluctuate depending on market
prices and the number of alternative generation suppliers in the retail supply
business.
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/or transmission and
distribution charges. Electricity delivery (including transmission,
distribution and customer service) remains regulated in substantially the
same manner as under historical regulation.
In November 2001, the Pennsylvania Department of Revenue established an
increased revenue neutral reconciliation tax (RNR) in order to recover a
current shortfall that resulted from electricity generation deregulation.
Since January 2002, Duquesne Light's customer bills have reflected an
approximately two percent increase to recover its costs related to the RNR.
(See "Legal Proceedings.")
REGIONAL TRANSMISSION ORGANIZATION
FERC Order No. 2000 calls on transmission-owning utilities such as
Duquesne Light to join regional transmission organizations (RTOs). Duquesne
Light is committed to ensuring a stable, plentiful supply of electricity for
its customers. Toward that end, Duquesne Light anticipates joining the PJM West
RTO, which is currently in the final stages of approval before the FERC. In
late 2001 and early 2002, Duquesne Light entered into agreements with two
generation suppliers to provide the electric capacity required to meet Duquesne
Light's anticipated capacity credit obligations in PJM West through 2004.
Duquesne Light's participation in the PJM West RTO is conditioned upon PUC
approval of the recovery of the cost of capacity under these agreements. We
have petitioned the PUC for such approval, asking for a decision by August
14, 2002; if we do not receive approval by that date, one of the agreements
will terminate, unless an extension is agreed to, and the other agreement will
not become effective. Duquesne Light's inclusion in the PJM West RTO would put
the region's transmission facilities under common control to enhance
reliability to customers.
COMPETITIVE TRANSITION CHARGE
In its final restructuring order, 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. Following
our application of net generation asset sale proceeds to reduce transition
costs, the CTC was fully
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collected in March 2002 for most of our residential customers. We anticipate
full CTC collection by mid-year 2002 for most of our remaining major rate
classes. 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 was
approximately $83.4 million ($50.8 million net of tax) at March 31, 2002, on
which Duquesne Light is allowed to earn an 11.0 percent pre-tax return. A lower
amount is shown on the balance sheet due to the accounting for unbilled
revenues.
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, a third party agreed to supply all of the electric energy necessary to
satisfy Duquesne Light's provider of last resort obligations during the CTC
collection period. Duquesne Light has extended the arrangement (and the
PUC-approved rates for the supply of electricity) beyond the final CTC
collection through December 31, 2004 (POLR II). The agreement also permits
Duquesne Light, following CTC collection for each rate class, an average margin
of 0.5 cents per KWH supplied through this arrangement. Except for this margin,
these agreements, in general, effectively transfer to the supplier 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.
Duquesne Light is evaluating options to provide electricity for its
provider of last resort customers after POLR II expires. Such options include
one or more of the following: negotiating an extension to POLR II ,
negotiating a similar arrangement with another generation supplier, and
entering into alternative supply arrangements, such as constructing a
gas-turbine electric generating facility (either independently or with
partners). Although no final decision has been made, later in May 2002,
Duquesne Power plans to file permits with the Pennsylvania Department of
Environmental Protection for the construction of an electric-generating
facility of up to 1,200 megawatts in Beaver County, Pennsylvania. After
selecting the most prudent supply option, Duquesne Light plans to file a
specific proposal with the PUC by August 2002. We expect this proposal will
include a request for a fixed generation rate plan beyond 2004 for customers
who do not choose an alternative generation supplier.
RATE FREEZE
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.
AQUASOURCE RATE APPLICATIONS
In June 2000, AquaSource filed consolidated, statewide water and sewer rate
change applications with the Texas Natural Resource Conservation Commission
(TNRCC) and 17 municipalities. As previously reported, four municipalities
denied or altered the rate increase, and AquaSource appealed. The parties have
since entered into a settlement agreement which provides for, among other
things, the following: the establishment of AquaSource's rate base; the
establishment of four regional rates for service areas within the TNRCC's
original jurisdiction, and three separate rates for the four municipalities who
appealed; and the phase-in of the rates beginning January 1 of 2002, 2003 and
2004 (with the first phase being retroactive to the initial application filing
date of July 17, 2000). AquaSource has also agreed not to file another rate case
application for a rate increase that would be effective prior to July 1, 2004,
unless the utility encounters financial hardship. In addition, the decision on
whether AquaSource may recover costs related to acquiring its companies through
its rates has been deferred until the next rate case. AquaSource expects the
revised rate increase will result, ultimately, in additional annual water and
sewer revenues of approximately $5.0 million. Substantially all of this rate
increase has been implemented, subject to refund, pending final TNRCC approval
of the settlement agreement, which is expected by mid-year 2002.
In March 2001, AquaSource also filed a rate increase petition with the
Indiana Utility Regulatory Commission (IURC) regarding water and sewer rates
for its Utility Center, Inc. subsidiary (Aquasource's largest regulated
subsidiary). Hearings were held in January 2002. We currently anticipate a
final order from the IURC in the third quarter of 2002. If the petition is
approved, annual water and sewer revenues for Utility Center will increase by
approximately $2.7 million.
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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 $418.0 million or 34.9 percent
of long-term debt. 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 $0.2
million for the three months ended March 31, 2002 and $0.6 million for the
three months ended March 31, 2001. A 10 percent reduction in interest rates
would have increased the market value of our fixed-rate debt by approximately
$52.8 million and $53.9 million as of March 31, 2002 and March 31, 2001. Such
changes would not have had a significant near-term effect on our future
earnings or cash flows.
____________________
PART II. OTHER INFORMATION.
ITEM 1. LEGAL PROCEEDINGS.
As discussed elsewhere in this report, Duquesne Light requested and
received PUC approval to recover approximately $13.0 million of costs we
will incur in 2002 due to the RNR. On November 19, 2001, the Pennsylvania
Office of Consumer Advocate (OCA) filed a complaint with the PUC, objecting to
the recovery approval and stating various matters, such as rate of return and
offsetting savings, that should be considered before allowing RNR recovery in
excess of rate caps. An initial hearing on the OCA's complaint was held May 2,
2002 before a PUC administrative law judge, who denied the OCA's objections.
However, on May 9, 2002, the PUC ordered that Duquesne Light's quarterly
earnings may be considered in the RNR proceedings. An additional hearing has
been scheduled for May 21, 2002, and we anticipate a final decision in the
third quarter of 2002.
Although we cannot predict the ultimate outcome of this matter, we believe
the final resolution will not significantly affect our results of operations or
cash flows.
We are also involved in various other legal proceedings. (See Note D.)
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 a report on Form 8-K on April 5, 2002, to report (i) Duquesne
Light's announcement of its exploration of generation supply options
following POLR II, and (ii) the filing of our shelf registration statement.
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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 15, 2002 /s/ Frosina C. Cordisco
------------ ------------------------
(Signature)
Frosina C. Cordisco
Vice President and Treasurer
(Principal Financial Officer)
Date May 15, 2002 /s/ Stevan R. Schott
------------ ------------------------
(Signature)
Stevan R. Schott
Vice President and Controller
(Principal Accounting Officer)
22