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 JUNE 30, 2004
OR
[ ] 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 1-15995
UIL HOLDINGS CORPORATION
(Exact name of registrant as specified in its charter)
CONNECTICUT 06-1541045
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
157 CHURCH STREET, NEW HAVEN, CONNECTICUT 06506
(Address of principal executive offices) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: 203-499-2000
NONE
(Former name, former address and former fiscal year,
if changed since last report.)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
YES X NO
--- ---
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
YES X NO
--- ---
The number of shares outstanding of the issuer's only class of common stock, as
of July 30, 2004, was 14,520,809.
INDEX
PART I. FINANCIAL INFORMATION
PAGE
NUMBER
Item 1. Financial Statements - Unaudited....................................4
Consolidated Statement of Income for the three
and six months ended June 30, 2004 and 2003....................4
Consolidated Statement of Comprehensive Income for the
three and six months ended June 30, 2004 and 2003..............4
Consolidated Balance Sheet as of June 30, 2004
and December 31, 2003..........................................5
Consolidated Statement of Cash Flows for the
six months ended June 30, 2004 and 2003........................7
Notes to the Consolidated Financial Statements......................8
- Statement of Accounting Policies..............................8
- Capitalization...............................................12
- Regulatory Proceedings.......................................14
- Short-term Credit Arrangements...............................16
- Income Taxes.................................................17
- Supplementary Information....................................19
- Pension and Other Benefits...................................20
- Commitments and Contingencies................................22
- Other Commitments and Contingencies.......................22
- Connecticut Yankee Atomic Power Company................22
- Hydro-Quebec...........................................25
- Environmental Concerns.................................25
- Site Decontamination, Demolition and
Remediation Costs....................................25
- Electric System Work Center............................26
- Claim of Enron Power Marketing, Inc....................26
- Independent System Operator - New England..............27
- Cross-Sound Cable Company, LLC.........................27
- Xcelecom, Inc..........................................28
- Segment Information..........................................29
- Goodwill and Other Intangible Assets.........................30
- Discontinued Operations......................................31
- Related Party Transactions...................................32
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations...........................33
- Major Influences on Financial Condition......................33
- UIL Holdings Corporation..................................33
- The United Illuminating Company...........................33
- Xcelecom, Inc.............................................37
- United Capital Investments, Inc...........................40
- United Bridgeport Energy, Inc.............................42
- American Payment Systems, Inc.............................42
- Liquidity and Capital Resources..............................43
- Contractual and Contingent Obligations....................44
- Critical Accounting Policies.................................45
- Results of Operations........................................46
Item 3. Quantitative and Qualitative Disclosures About Market Risk.........59
Item 4. Controls and Procedures............................................59
- 2 -
PART II. OTHER INFORMATION
Item 1. Legal Proceedings..................................................60
Item 4. Submission of Matters to Vote of Security Holders..................60
Item 6. Exhibits and Reports on Form 8-K...................................61
SIGNATURES.........................................................62
- 3 -
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
UIL HOLDINGS CORPORATION
CONSOLIDATED STATEMENT OF INCOME
(THOUSANDS EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
Three Months Ended Six Months Ended
June 30, June 30,
2004 2003 2004 2003
---- ---- ---- ----
OPERATING REVENUES (NOTE F)
Utility $ 175,593 $ 156,083 $ 357,436 $ 321,375
Non-utility businesses 85,142 74,538 152,726 143,485
------------- -------------- ------------- -------------
Total Operating Revenues 260,735 230,621 510,162 464,860
------------- -------------- ------------- -------------
OPERATING EXPENSES
Operation
Fuel and energy (Note F) 81,328 62,366 169,266 128,848
Operation and maintenance 131,127 120,013 247,855 231,417
Depreciation and amortization (Note F) 16,147 21,606 33,637 48,041
Taxes - other than income taxes (Note F) 9,941 9,941 20,686 20,829
------------- -------------- ------------- -------------
Total Operating Expenses 238,543 213,926 471,444 429,135
------------- -------------- ------------- -------------
OPERATING INCOME FROM CONTINUING OPERATIONS 22,192 16,695 38,718 35,725
------------- -------------- ------------- -------------
OTHER INCOME (DEDUCTIONS), NET (NOTE F) 1,431 726 2,831 291
------------- -------------- ------------- -------------
INTEREST CHARGES, NET
Interest on long-term debt 4,952 6,610 10,062 13,144
Other interest, net (Note F) 768 311 1,490 578
------------- -------------- ------------- -------------
5,720 6,921 11,552 13,722
Amortization of debt expense and redemption premiums 377 316 713 625
------------- -------------- ------------- -------------
Total Interest Charges, net 6,097 7,237 12,265 14,347
------------- -------------- ------------- -------------
INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES 17,526 10,184 29,284 21,669
INCOME TAXES (NOTE E) 7,160 5,208 13,226 11,175
------------- -------------- ------------- -------------
INCOME FROM CONTINUING OPERATIONS 10,366 4,976 16,058 10,494
DISCONTINUED OPERATIONS, NET OF TAX (NOTE O) 48,365 (675) 49,808 (927)
------------- -------------- ------------- -------------
NET INCOME $ 58,731 $ 4,301 $ 65,866 $ 9,567
============= ============== ============= =============
AVERAGE NUMBER OF COMMON SHARES OUTSTANDING - BASIC 14,359 14,286 14,347 14,283
AVERAGE NUMBER OF COMMON SHARES OUTSTANDING - DILUTED 14,392 14,302 14,386 14,290
EARNINGS PER SHARE OF COMMON STOCK - BASIC:
CONTINUING OPERATIONS $ 0.72 $ 0.35 $ 1.12 $ 0.74
DISCONTINUED OPERATIONS 3.37 (0.05) 3.47 (0.07)
------------- -------------- ------------- -------------
NET EARNINGS $ 4.09 $ 0.30 $ 4.59 $ 0.67
============= ============== ============= =============
EARNINGS PER SHARE OF COMMON STOCK - DILUTED:
CONTINUING OPERATIONS $ 0.72 $ 0.35 $ 1.12 $ 0.74
DISCONTINUED OPERATIONS 3.36 (0.05) 3.46 (0.07)
------------- -------------- ------------- -------------
NET EARNINGS $ 4.08 $ 0.30 $ 4.58 $ 0.67
============= ============== ============= =============
CASH DIVIDENDS DECLARED PER SHARE OF COMMON STOCK $ 0.72 $ 0.72 $ 1.44 $ 1.44
============= ============== ============= =============
- -------------------------------------------------------------------------------
UIL HOLDINGS CORPORATION
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
(THOUSANDS OF DOLLARS)
(UNAUDITED)
Three Months Ended Six Months Ended
June 30, June 30,
2004 2003 2004 2003
---- ---- ---- ----
NET INCOME $ 58,731 $ 4,301 $ 65,866 $ 9,567
OTHER COMPREHENSIVE INCOME (LOSS), NET OF TAX:
Minimum pension liability
(net of tax deferred benefit of $76) - - (517) -
------------- -------------- ------------- -------------
COMPREHENSIVE INCOME (NOTE A) $ 58,731 $ 4,301 $ 65,349 $ 9,567
============= ============== ============= =============
The accompanying Notes to the Consolidated Financial Statements
are an integral part of the financial statements.
- 4 -
UIL HOLDINGS CORPORATION
CONSOLIDATED BALANCE SHEET
ASSETS
(Thousands of Dollars)
(Unaudited)
June 30, December 31,
2004 2003
------ ------
Current Assets
Unrestricted cash and temporary cash investments $ 90,107 $ 28,614
Restricted cash 413 1,384
Utility accounts receivable less allowance of $1,654 and $1,654 60,470 54,780
Other accounts receivable less allowance of $1,801 and $1,648 90,092 80,532
Unbilled revenues 41,993 32,246
Materials and supplies, at average cost 5,264 4,458
Deferred and refundable income taxes 12,178 24,944
Prepayments 4,821 1,451
Current assets of discontinued operations held for sale - 103,697
Other 218 1,323
------------------ ------------------
Total Current Assets 305,556 333,429
------------------ ------------------
Investments
Investment in United Bridgeport Energy facility 78,478 82,090
Other 19,799 20,283
------------------ ------------------
Total Investments 98,277 102,373
------------------ ------------------
Property, Plant and Equipment at original cost
In service 801,180 784,409
Less, accumulated depreciation 286,026 272,082
------------------ ------------------
515,154 512,327
Construction work in progress 31,735 36,467
------------------ ------------------
Net Property, Plant and Equipment 546,889 548,794
------------------ ------------------
Regulatory Assets (future amounts due from customers
through the ratemaking process)
Nuclear plant investments-above market 426,282 436,505
Income taxes due principally to book-tax differences 97,271 98,116
Long-term purchase power contracts-above market 80,203 88,024
Connecticut Yankee 51,170 51,579
Unamortized redemption costs 18,924 19,325
Other 50,917 43,259
------------------ ------------------
Total Regulatory Assets 724,767 736,808
------------------ ------------------
Deferred Charges
Goodwill 69,569 68,554
Unamortized debt issuance expenses 6,869 6,670
Prepaid pension 43,927 43,927
Long-term receivable - Cross-Sound Cable Project 24,369 23,986
Other long-term receivable 14,754 13,575
Other 2,194 2,120
------------------ ------------------
Total Deferred Charges 161,682 158,832
------------------ ------------------
Long-term assets of discontinued operations held for sale - 17,930
------------------ ------------------
Total Assets $ 1,837,171 $ 1,898,166
================== ==================
The accompanying Notes to the Consolidated Financial Statements are
an integral part of the financial statements.
- 5 -
UIL HOLDINGS CORPORATION
CONSOLIDATED BALANCE SHEET
LIABILITIES AND CAPITALIZATION
(Thousands of Dollars)
(Unaudited)
June 30, December 31,
2004 2003
------ ------
Current Liabilities
Notes payable $ 859 $ 65,161
Current portion of long-term debt 4,286 -
Accounts payable 77,202 36,729
Dividends payable 10,343 10,299
Accrued liabilities 58,264 69,142
Deferred revenues - non-utility businesses 18,101 14,957
Interest accrued 5,797 6,358
Taxes accrued 34,700 -
Obligations under capital leases - 14,815
Current liabilities of discontinued operations held for sale - 94,267
---------------- -----------------
Total Current Liabilities 209,552 311,728
---------------- -----------------
Noncurrent Liabilities
Purchase power contract obligation 80,203 88,024
Pension accrued 13,558 8,166
Connecticut Yankee contract obligation 47,138 47,213
Long-term notes payable 8,693 10,478
Other 19,505 17,574
---------------- -----------------
Total Noncurrent Liabilities 169,097 171,455
---------------- -----------------
Deferred Income Taxes (future tax liabilities owed
to taxing authorities) 347,852 345,676
---------------- -----------------
Regulatory Liabilities (future amounts owed to customers
through the ratemaking process)
Accumulated deferred investment tax credits 12,608 12,813
Deferred gains on sale of property 31,248 33,679
Asset removal cost 14,493 14,071
Other 20,792 19,589
---------------- -----------------
Total Regulatory Liabilities 79,141 80,152
---------------- -----------------
Long-term liabilities of discontinued operations held for sale - 921
---------------- -----------------
Commitments and Contingencies (Note J)
Capitalization (Note B)
Net long-term debt 491,174 495,460
Common Stock Equity
Common Stock 299,117 297,321
Paid-in capital 5,526 4,413
Capital stock expense (2,170) (2,170)
Unearned employee stock ownership plan equity (4,986) (5,461)
Unearned compensation (819) (335)
Accumulated other comprehensive income (loss) (1,013) (496)
Retained earnings 244,700 199,502
---------------- -----------------
Net Common Stock Equity 540,355 492,774
Total Capitalization 1,031,529 988,234
---------------- -----------------
Total Liabilities and Capitalization $ 1,837,171 $ 1,898,166
================ =================
The accompanying Notes to the Consolidated Financial Statements are
an integral part of the financial statements.
- 6 -
UIL HOLDINGS CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOWS
(Thousands of Dollars)
(Unaudited)
Six Months Ended
June 30,
(Restated)
2004 2003
---- ----
Cash Flows From Operating Activities
Net Income $ 65,866 $ 9,567
-------------- -------------
Adjustments to reconcile net income to net cash provided
by operating activities:
(Income) Loss from discontinued operations, net of tax (49,808) 955
Depreciation and amortization 22,965 36,748
Purchase power contract amortization (Note F) 11,386 11,918
Purchase power above market fuel expense credit (Note F) (11,386) (11,918)
Deferred income taxes 1,555 (5,309)
Deferred investment tax credits - net (205) (295)
Future tax benefits 19,400
Allowance for funds used during construction (823) (1,299)
Undistributed (earnings) losses of minority interest investments 4,098 2,623
Changes in:
Accounts receivable - net (12,172) 13,500
Materials and supplies (806) (1,407)
Prepayments (3,368) (351)
Accounts payable 28,428 (10,538)
Interest accrued (561) (174)
Taxes accrued 9,388 2,915
Other assets (21,847) (10,937)
Other liabilities 20,097 3,409
-------------- -------------
Total Adjustments (3,059) 49,240
-------------- -------------
Cash provided by Continuing Operations 62,807 58,807
Cash provided by Discontinued Operations 3,375 470
-------------- -------------
Net Cash provided by Operating Activities 66,182 59,277
-------------- -------------
Cash Flows from Investing Activities
Loan to Cross-Sound Cable Project (383) (22,940)
Deferred payments in prior acquisitions (2,084) (2,757)
Acquisition of Electric System Work Center facility (16,210) -
Plant expenditures (12,005) (26,694)
Changes in restricted cash 971 3,374
-------------- -------------
Cash provided by (used in) Continuing Operations (29,711) (49,017)
Cash provided by (used in) Discontinued Operations 108,163 (3,473)
-------------- -------------
Net Cash provided by (used in) Investing Activities 78,452 (52,490)
-------------- -------------
Cash Flows from Financing Activities
Issuances of Common stock 2,898 677
Sale of pollution control refunding revenue bonds - 25,000
Notes payable (65,355) (26,479)
Lease obligations - (232)
Payment of common stock dividend (20,625) (20,557)
-------------- -------------
Cash (used in) Continuing Operations (83,082) (21,591)
Cash (used in) Discontinued Operations (59) 3,001
-------------- -------------
Net Cash (used in) Financing Activities (83,141) (18,590)
-------------- -------------
Cash and Temporary Cash Investments:
Net change for the period 61,493 (11,803)
Balance at beginning of period 28,614 18,910
-------------- -------------
Balance at end of period $ 90,107 $ 7,107
============== =============
The accompanying Notes to the Consolidated Financial
Statements are an integral part of the financial statements.
- 7 -
UIL HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(A) STATEMENT OF ACCOUNTING POLICIES
BASIS OF PRESENTATION
UIL Holdings Corporation (UIL Holdings) was formed in July 2000 and is an exempt
public utility holding company under the provisions of the Public Utility
Holding Company Act of 1935. Through its various subsidiaries, UIL Holdings
operates in two principal lines of business: utility and non-utility. The
utility business consists of the electric transmission and distribution
operations of The United Illuminating Company (UI). The non-utility business
consists of the operations of Xcelecom, Inc. (Xcelecom), two entities which
indirectly support the operations of their respective passive investments,
United Capital Investments, Inc. (UCI) and United Bridgeport Energy, Inc. (UBE),
and until the completion of its sale to CheckFree Corporation (CheckFree) on
June 22, 2004, included the operations of American Payment Systems, Inc. (APS).
UIL Holdings is headquartered in New Haven, Connecticut, where its senior
management maintains offices and is responsible for overall planning, operating
and financial functions. UIL Holdings' Consolidated Financial Statements should
be read in conjunction with the restated consolidated financial statements and
the notes to the restated consolidated financial statements which will be
included in UIL Holdings' Annual Report on Form 10-K/A for the year ended
December 31, 2003, which will be filed prior to September 30, 2004. Such notes
are supplemented below.
The year-end balance sheet data was derived from audited financial statements,
but does not include all disclosures required by accounting principles generally
accepted in the United States of America. Certain information and footnote
disclosures which are normally included in financial statements prepared in
accordance with generally accepted accounting principles have been condensed or
omitted pursuant to Securities and Exchange Commission rules and regulations.
UIL Holdings believes that the disclosures made are adequate to make the
information presented not misleading. The information presented in the
consolidated financial statements reflects all adjustments which, in the opinion
of UIL Holdings, are necessary for a fair presentation of the financial position
and results of operations for the interim periods set forth herein. All such
adjustments are of a normal and recurring nature. The results for the six months
ended June 30, 2004 are not necessarily indicative of the results for the entire
fiscal year ending December 31, 2004.
Certain amounts previously reported have been reclassified to conform to the
current presentation.
RESTATEMENT
See "Note (B) - Capitalization - Long Term Debt" for discussion of the
restatement of the consolidated statement of cash flows for the six month period
ended June 30, 2003 included in this Form 10-Q. Additionally, as a result of
such restatement as discussed in Note (B), UIL Holdings will be filing, prior to
September 30, 2004, restated financial statements for this matter of 1) an
amended Form 10-K for the year ended December 31, 2003 (such restatement
reflecting adjustments of the same amount and nature as discussed in Note (B)
for the consolidated balance sheet at December 31, 2002 and the consolidated
statement of cash flows for the years ended December 31, 2003 and 2002) and 2)
an amended Form 10-Q for the quarter ended March 31, 2004 (such restatements
reflecting adjustment of the consolidated statement of cash flows for the three
month period ended March 31, 2003).
- 8 -
UIL HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(UNAUDITED)
PROPERTY, PLANT AND EQUIPMENT
UI accrues for estimated costs of removal for certain of its plant-in-service.
Such removal costs are included in the approved rates used to depreciate these
assets. At the end of the service life of the applicable assets, the accumulated
depreciation in excess of the historical cost of the asset provides for the
estimated cost of removal. In accordance with Statement of Financial Accounting
Standards (SFAS) No. 143, "Accounting for Asset Retirement Obligations," UI's
accrued costs of removal have been reclassified to a regulatory liability. The
amount of accrued costs of removal reclassified to a regulatory liability as of
June 30, 2004 amounted to $14.5 million. This reclassification is based upon
UI's best estimate developed from its previous depreciation studies. UI has
contracted for a new independent study to update its cost of removal accrual and
amounts to be accrued in future years. The study is now underway and is expected
to be completed by the end of the third quarter of 2004.
REVENUES
Prior to January 1, 2004, UI estimated its accrual for unbilled revenue based
upon its system requirements less an estimated loss factor. Beginning in the
first quarter of 2004, UI began utilizing a new customer accounting software
package integrated with the network meter reading system to estimate unbilled
revenue. This allows for the calculation of unbilled revenue on a
customer-by-customer basis, utilizing actual daily meter readings at the end of
each month to calculate consumption and pricing for each customer. Customers
aggregating to approximately 70% of utility retail kilowatt-hour consumption are
currently part of the network meter reading system. For those customers still
requiring manual meter readings, consumption is estimated based upon historical
usage and actual pricing for each customer. Conversion to the new methodology
resulted in a non-recurring increase to unbilled revenue of approximately $2.6
million and a non-recurring increase to consolidated earnings per share of
approximately $0.07 during the first quarter of 2004.
NOTES RECEIVABLE
In January 2004, all telephony assets of APS were transferred to one of UIL
Holdings' non-utility subsidiaries. One of the assets transferred was a loan
receivable related to the acquisition of Point of Sale Activation (POSA)
technology in 2002. In connection with the acquisition of the POSA technology,
APS loaned money to the vendor from which the technology was acquired.
Subsequently, the vendor defaulted under the loan and as part of the foreclosure
procedures the remaining loan balance was restructured. As consideration for an
accelerated payment schedule, APS agreed to forgive a portion of the outstanding
loan balance, bringing the restructured amount due to $1 million. As of June 30,
2004 the principal balance of the restructured loan was paid.
- 9 -
EARNINGS PER SHARE
The following tables present a reconciliation of the basic and diluted earnings
per share calculations for the three and six months ended June 30, 2003 and
2004:
INCOME APPLICABLE TO AVERAGE NUMBER OF EARNINGS
COMMON STOCK SHARES OUTSTANDING PER SHARE
------------ ------------------ ---------
(In Thousands, except per share amounts)
SIX MONTHS ENDED JUNE 30:
2004
- ----
Basic earnings from continuing operations $16,058 14,347 $1.12
Basic earnings from discontinued operations 49,808 14,347 3.47
------------------------ ---------------------- -------------
Basic earnings 65,866 14,347 4.59
Effect of dilutive stock options (1) - 39 (0.01)
------------------------ ---------------------- -------------
Diluted earnings $65,866 14,386 $4.58
======================== ====================== =============
2003
- ----
Basic earnings from continuing operations $10,494 14,283 $0.74
Basic earnings from discontinued operations (927) 14,283 (0.07)
------------------------ ---------------------- -------------
Basic earnings 9,567 14,283 0.67
Effect of dilutive stock options - 7 -
------------------------ ---------------------- -------------
Diluted earnings $9,567 14,290 $0.67
======================== ====================== =============
THREE MONTHS ENDED JUNE 30:
2004
- ----
Basic earnings from continuing operations $10,366 14,359 $0.72
Basic earnings from discontinued operations 48,365 14,359 3.37
------------------------ ---------------------- -------------
Basic earnings 58,731 14,359 4.09
Effect of dilutive stock options (1) - 33 (0.01)
------------------------ ---------------------- -------------
Diluted earnings $58,731 14,392 $4.08
======================== ====================== =============
2003
- ----
Basic earnings from continuing operations $4,976 14,286 $0.35
Basic earnings from discontinued operations (675) 14,286 (0.05)
------------------------ ---------------------- -------------
Basic earnings 4,301 14,286 0.30
Effect of dilutive stock options - 16 -
------------------------ ---------------------- -------------
Diluted earnings $4,301 14,302 $0.30
======================== ====================== =============
(1) Dilutive stock options do not impact the earnings from continuing
operations, but dilute the earnings from discontinued operations by
$0.01 per share.
STOCK-BASED COMPENSATION
Effective January 1, 2003, UIL Holdings adopted the fair value recognition
provisions, under the prospective method, of SFAS No.148, "Accounting for
Stock-Based Compensation - Transition and Disclosure," an amendment of SFAS No.
123, "Accounting for Stock-Based Compensation." Under this statement, UIL
Holdings has recorded compensation expense prospectively for stock options
granted, modified, or settled after January 1, 2003. There were 37,919 stock
options granted during the first half of 2004 at an average exercise price of
$47.44. All stock options granted during 2004 were granted pursuant to the
"reload" feature of the UIL Holdings 1999 Amended and Restated Stock Plan
(Plan). UIL Holdings records compensation expense related to stock options based
- 10 -
on the most recently available fair-value estimates calculated by an independent
party utilizing the binomial option-pricing model. In 2004, UIL Holdings
received updated calculations which more accurately reflected the fair-value
estimates of stock options granted throughout 2003 and 2004. As a result, UIL
Holdings recorded an adjustment in the first quarter of 2004 reducing
compensation expense by $0.2 million, after tax, to properly reflect the amount
of compensation expense which would have been recorded to date if the more
accurate fair-value estimates had been used since the date of grant. No
compensation expense was recorded prior to January 1, 2003 as UIL Holdings
accounted for employee stock-based compensation in accordance with Accounting
Principles Board (APB) No. 25, "Accounting for Stock Issued to Employees," as
permitted by SFAS No. 123.
Beginning in 2004, UIL Holdings will no longer grant new stock options, other
than new grants pursuant to the "reload" feature of the Plan. Although new stock
options will not be granted, compensation expense related to options granted
during 2003, as well as any new stock options granted under the "reload" feature
of the Plan, will continue to be recorded ratably over the vesting periods
associated with such options. In 2004, UIL Holdings implemented a
performance-based long term incentive arrangement under the Plan pursuant to
which certain members of management have the opportunity to earn no more than a
pre-determined number of "performance" shares of stock, the number of which is
predicated upon the achievement of various pre-defined performance measures.
These "performance" shares of stock vest over a three year cycle with the actual
issuance of stock following the end of each three year cycle. A new three year
cycle begins in January of each year. UIL Holdings records compensation expense
for these "performance" shares ratably over the three year period, based on the
value of the expected payout at the end of each year relative to the performance
measures achieved.
The following table illustrates the effect on net income and earnings per share
as if the fair value based method had been applied to all outstanding and
unvested awards in each period.
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
2004 2003 2004 2003
---- ---- ---- ----
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
Net Income, as reported $58,731 $4,301 $65,866 $9,567
Add: Stock-based compensation
expense included in reported
net income, net of related tax effects 181 97 181 97
Deduct: Total stock-based compensation
determined under fair value based
method for all stock grants, net of
related tax effect 353 286 503 476
---------------- ------------- --------------- ----------------
Pro forma net income $58,559 $4,112 $65,544 $9,188
================ ============= =============== ================
Earnings per share:
Basic - as reported $4.09 $0.30 $4.59 $0.67
================ ============= =============== ================
Basic - proforma $4.08 $0.29 $4.57 $0.64
================ ============= =============== ================
Diluted - as reported $4.08 $0.30 $4.58 $0.67
================ ============= =============== ================
Diluted - proforma $4.07 $0.29 $4.56 $0.64
================ ============= =============== ================
- 11 -
On March 22, 2004, UIL Holdings granted 13,200 shares of restricted stock to
directors. The average market price on the date of grant was $46.67 per share.
Compensation expense for this restricted stock is recorded ratably over the
three year vesting period for such restricted stock.
COMPREHENSIVE INCOME
Comprehensive income for the six months ended June 30, 2004 included net income
less a minimum pension liability adjustment of approximately $0.5 million,
after-tax, related to the non-qualified pension plans. Comprehensive income for
the three months ended June 30, 2004, as well as for the three and six months
ended June 30, 2003, was equal to net income as reported.
(B) CAPITALIZATION
COMMON STOCK
UIL Holdings had 14,515,822 shares of its common stock, without par value,
outstanding at June 30, 2004, of which 146,687 shares were unallocated shares
held by UI's 401(k)/Employee Stock Ownership Plan (KSOP) and not recognized as
outstanding for the purpose of calculating earnings per share.
UI has an arrangement under which it loaned $11.5 million to the KSOP. Prior to
the formation of UIL Holdings, the trustee for the KSOP used the funds to
purchase 328,300 shares of UI common stock in open market transactions. On July
20, 2000, effective with the formation of a holding company structure,
unallocated shares held by the KSOP were converted into shares of UIL Holdings'
common stock. The shares will be allocated to employees' KSOP accounts, as the
loan is repaid, to cover a portion of the required KSOP contributions.
Compensation expense is recorded when shares are committed to be allocated based
on the fair market value of the stock. The loan will be repaid by the KSOP over
a twelve-year period ending October 1, 2009, using employer contributions and
UIL Holdings' dividends paid on the unallocated shares of the stock held by the
KSOP. Dividends on allocated shares are charged to retained earnings. As of June
30, 2004, 146,687 shares, with a fair market value of $7.1 million, had been
purchased by the KSOP and had not been committed to be released or allocated to
KSOP participants.
LONG-TERM DEBT
On December 2, 2002, UI purchased $25 million principal amount of Pollution
Control Revenue Refunding Bonds, 1999 Series, due December 1, 2029 (the 1999
Series Bonds), issued by the Business Finance Authority of the State of New
Hampshire (BFA) in connection with a loan by the BFA to UI. Under a borrowing
agreement between UI and the BFA, UI is required to pay to the BFA, via a trust
established for such purpose, an amount equal to the principal and interest on
the 1999 Series Bonds. UI held the 1999 Series Bonds during the period when the
borrowing agreement between UI and the BFA was amended to provide UI more
remarketing flexibility. On February 5, 2003, the 1999 Series Bonds were sold to
investors at a fixed interest rate of 3.25% that will remain in effect until
December 3, 2007.
UIL Holdings originally accounted for the purchase of the 1999 Series Bonds as
an investment, and continued to carry a $25 million liability for the bonds.
Upon further review of this transaction, and in accordance with the provisions
of SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishment of Liabilities," UIL Holdings has determined that during the
period from December 2002 through February 2003 that the 1999 Series Bonds were
held by UI as an investment, it should have presented the transaction as an
extinguishment of debt, because UI is the primary obligor of the bonds. This
would have resulted in UI extinguishing the liability upon purchase of the
$25 million principal amount of BFA bonds, rather than showing both an
investment and offsetting liability for such amount. This change in presentation
would have had no impact on the results
- 12 -
of operations for either 2002 or 2003. The impact to the consolidated statement
of cash flows results in a reclassification of the use of $25 million for the
purchase of the bonds in December 2002, and the subsequent source of $25 million
when the bonds were sold to investors in February 2003, to a financing activity
as opposed to prior presentation as an investing activity. The consolidated
statement of cash flows presented herein reflects this reclassification.
The following table presents a reconciliation of the amounts originally reported
in the financing and investing sections of the consolidated statement of cash
flows to the amounts currently reported, as restated, for the six months ended
June 30, 2003:
SIX MONTHS ENDED SIX MONTHS ENDED
JUNE 30, 2003 JUNE 30, 2003
(AS ORIGINALLY REPORTED) RESTATEMENT (AS RESTATED)
-------------------------- --------------------- ----------------------
CASH FLOWS FROM INVESTING
ACTIVITIES:
Loan to Cross-Sound Cable Project $(22,940) $ - $(22,940)
Deferred payments in prior acquisitions (2,757) - (2,757)
Sale of pollution control refunding
revenue bonds 25,000 (25,000) -
Plant expenditures (26,694) (26,694)
-
Changes in restricted cash 3,374 - 3,374
-------------------------- --------------------- ----------------------
Cash used in Continuing Operations (24,017) (25,000) (49,017)
Cash used in Discontinued Operations (3,473) - (3,473)
-------------------------- --------------------- ----------------------
NET CASH USED IN INVESTING ACTIVITIES $(27,490) $(25,000) $(52,490)
========================== ===================== ======================
CASH FLOWS FROM FINANCING
ACTIVITIES:
Issuances of common stock $ 677 $ - $ 677
Sale of pollution control refunding
revenue bonds - 25,000 25,000
Notes payable (26,479) - (26,479)
Lease obligations (232) - (232)
Payment of common stock dividend (20,557) - (20,557)
-------------------------- --------------------- ----------------------
Cash used in Continuing Operations (46,591) 25,000 (21,591)
Cash provided by Discontinued
Operations 3,001 - 3,001
-------------------------- --------------------- ----------------------
NET CASH USED IN FINANCING ACTIVITIES $(43,590) $25,000 $(18,590)
========================== ===================== ======================
On February 2, 2004, the interest rate on $7.5 million principal amount of
Pollution Control Revenue Refunding Bonds, 1996 Series, due June 1, 2026, issued
by the Connecticut Development Authority (CDA), was reset from 4.35% to 3.00%.
The new interest rate will remain in effect for a five-year period to February
1, 2009. UI is obligated, under its borrowing agreement with the CDA, to pay to
the CDA an amount equal to the principal and interest on the bonds. Interest is
payable semi-annually on August 1st and February 1st.
On February 2, 2004, the interest rate on $98.5 million principal amount of
Pollution Control Revenue Refunding Bonds, 1997 Series, due July 1, 2027, issued
by the Business Finance Authority of the State of New Hampshire (BFA), was
reset. The interest rate on $27.5 million principal amount of the bonds was
reset from 3.75% to 2.05% for a one-year period to February 1, 2005. The
interest rate on $71 million principal amount of the bonds was reset from 4.55%
- 13 -
to 3.50% for a five-year period to February 1, 2009. UI is obligated, under its
borrowing agreement with the BFA, to pay the BFA an amount equal to the
principal and interest on the bonds. Interest is payable semi-annually on August
1st and February 1st.
(C) REGULATORY PROCEEDINGS
RATE CASE
On February 18, 2004, the Connecticut Department of Public Utility Control
(DPUC) issued a final decision related to UI's request for recovery of increased
pension and postretirement benefits expenses. The decision approved, with
DPUC-required modifications, a settlement agreement reached between UI and the
Prosecutorial Division of the DPUC providing for the annual recovery by UI of an
additional $5.2 million of expenses. The settlement also modified the earnings
sharing mechanism from 50% to shareholders and 50% to customers, to 100% to
customers, with the entire customer portion being utilized to reduce stranded
costs. The settlement agreement also stipulated that UI will not file a rate
case before January 1, 2005. Although $5.2 million is not sufficient to offset
the increased costs fully, it does provide for recovery of expenses above the
level previously included in rates. The recovery provided for in this decision
was provided prospectively and is reflected in the results of operations
effective as of the date of the decision.
On April 2, 2004, the Office of Consumer Counsel (OCC) appealed the DPUC
decision to the Connecticut Superior Court. In late April 2004, the DPUC, on
its own motion, reopened the docket related to UI's recovery of increased
pension costs, and at the end of June 2004, the DPUC issued an "interim draft
decision" that, if adopted as a final decision, states that it "rescinds" the
February 18, 2004 decision. Written exceptions have been filed by participants
in the docket. UI's written exceptions assert that the "interim draft decision"
could not lawfully be adopted, without change, as the final decision. Oral
arguments have been scheduled, and a final decision is expected to be issued in
the third quarter of 2004.
UI has taken substantial actions in 2003 and 2004 to mitigate the effect of
these increased pension and postretirement benefits expenses and also to reduce
the increases themselves through contributing $57 million in cash to the pension
plan since the docket was initially reopened in November 2002. These actions,
along with unanticipated sales growth, have allowed UI to mitigate the effect of
the increased pension and postretirement expenses to date. However, this issue
continues to generate administrative and court litigation, along with regulatory
uncertainty. As a result, in its written exceptions filed, UI has proposed that
the DPUC modify the February 18, 2004 decision to provide for a termination date
of the ratemaking set forth in that decision as of the date of the final
decision in this reopened docket. UI proposed that as of such date, UI's
ratemaking would return to the ratemaking in effect on February 17, 2004, the
day before the February 18, 2004 decision, effectively eliminating the
annualized $5.2 million of incremental recovery on a going forward basis. This
proposal would also include restoration of accelerated amortizations, sharing at
50% to customers and 50% retained by UI for earnings in excess of 10.45%, and no
restrictions regarding the filing of a rate case. The 50% sharing to customers
includes 25% used to reduce stranded costs and 25% returned to customers via
bill surcredits.
UI believes that any attempt by the DPUC to retroactively adjust such recoveries
would be unlawful. Draft decisions may change, and do not necessarily indicate
the ultimate outcome of the DPUC's final decision. As of June 30, 2004, UI has
recovered approximately $2 million in accordance with the February 18, 2004
decision, which equates to approximately $0.08 per share, after-tax.
- 14 -
SALE OF NUCLEAR GENERATION
Public Act 98-28 enacted by the Connecticut legislature (the Restructuring Act)
required that, in order for UI to recover any stranded costs, it must attempt to
divest its ownership interests in two nuclear-fueled power plants prior to 2004.
The sale of UI's 3.685% ownership interest in Millstone Unit 3 was consummated
on March 31, 2001. UI's share of the proceeds from the sale, including nuclear
fuel, was $34.4 million, before settlement of its decommissioning obligation. On
February 27, 2003, the DPUC issued a final decision on the Millstone Divestiture
Plan Disposition of Proceeds authorizing UI to reduce its stranded cost balances
by $15.4 million.
The sale of UI's 17.5% interest in Seabrook Station and the termination of the
sale/leaseback of a portion of its interest in Seabrook Unit 1 was consummated
on November 1, 2002. In compliance with the Connecticut electric industry
restructuring legislation, the net-of-tax gain on these transactions, after
adjusting for transaction costs and sale-related costs, was used to reduce UI's
stranded costs. In UI's compliance filing with the DPUC on April 30, 2003, UI
reported a net-of-tax gain of approximately $5 million. A final decision was
issued on March 3, 2004, approving UI's calculation without modification. As a
result, UI reduced its reserves by approximately $1.4 million during the first
quarter of 2004. In the second quarter of 2004, UI also reduced certain expense
reserves by $1.1 million related to the sale due to the resolution of tax and
other post-closing issues.
OTHER REGULATORY MATTERS
DEPARTMENT OF PUBLIC UTILITY CONTROL
UI generally has several regulatory proceedings open and pending at the DPUC at
any given time. Examples of such proceedings include an annual DPUC review and
reconciliation of UI's competitive transition assessment (CTA) and systems
benefits charge revenues and expenses, dockets to consider specific
restructuring or electricity market issues, consideration of specific rate or
customer issues, and review of conservation programs. In a specific
restructuring docket, the DPUC, on April 21, 2004, issued an interim decision
with respect to the framework for developing a process to lead to electric
suppliers' offering an alternative transition standard offer as contemplated in
Public Act 03-135. UI's management does not expect there to be any material
effect on UI's earnings or financial condition as a result of an alternative
transitional standard offer.
Public Act 03-6 of the June 30, 2003 special session and Public Act 03-1 of the
September 8, 2003 special session of the Connecticut General Assembly provide
for the period February 1, 2003 through July 31, 2005, for certain of the funds
collected by electric distribution companies from retail customers in the
Conservation and Load Management (C&LM) charge to be transferred to the general
funds of the state. The legislation provides that the transfer of funds would
not occur provided that the C&LM and Renewable Energy Investment (REI) funds are
securitized for two fiscal years beginning July 1, 2003, through the state's
issuance of rate reduction bonds secured by customer revenue streams. On October
28, 2003, the DPUC issued a financing order providing for the issuance of rate
reduction bonds by the State of Connecticut, adjustment of the C&LM and REI
charges, and an increase in the corresponding CTA charge on customers' bills.
The rate reduction bonds were issued by the state during the second quarter of
2004. The amounts collected through the CTA for servicing of the rate reduction
bonds will not be revenue to UI. As a result, the securitization will have the
effect of reducing UI's revenue by approximately $6.5 million annually, with
such amounts to be utilized for debt service for the state's rate reduction
bonds. Absent securitization, these amounts would otherwise have been utilized
for C&LM or REI and recorded as expense. UI's management does not expect there
to be any material effect on UI's earnings or financial condition as a result of
such securitization.
- 15 -
On June 23, 2004, the DPUC approved UI's request to amend its Purchase Power
Adjustment Clause to allow UI to apply the clause to special contract customers.
The DPUC also approved a Purchased Power Adjustment rate of $0.00264 per kWh to
be applied against special contract load to reflect the increased cost to serve
these customers. This will allow UI to recover changes in the cost to procure
energy as it relates to special contract customers. The decision does not
explicitly order the accounting for the increased costs of $0.8 million related
to UI's special contract customers for the period from January 1, 2004 through
June 22, 2004 (the day before the effective date of the final decision). These
actual costs to procure power for UI's special contract customers are being
accounted for as a generation services charge (GSC) expense, which will flow
through the annual CTA/SBC Reconciliation filing for 2004. This treatment is
consistent with the final decision in this regulatory docket and with the
statements in the 1998 and 2003 restructuring legislation (PA 98-28 and
PA 03-135, as amended in part by PA 03-221) that the distribution company is
entitled to recover its full cost of procuring power for customers who do not
choose an alternate supplier. UI has filed a request for clarification with the
DPUC regarding this treatment. This is not expected to impact net income as the
CTA and GSC are pass-through components.
FEDERAL ENERGY REGULATORY COMMISSION (FERC)
UI has constructed transmission facilities to connect the 330-megawatt
transmission cable, connecting Connecticut and Long Island under Long Island
Sound, owned by Cross-Sound Cable Company, LLC (Cross-Sound) to the New England
Power Pool (NEPOOL) transmission grid. Cross-Sound has paid UI $2.6 million for
the construction costs. The FERC has clarified that UI will not be required to
reimburse Cross-Sound for any of the construction monies received. A request by
Cross-Sound for a rehearing was rejected by the FERC. On March 31, 2004
Cross-Sound and UI reached a tentative settlement agreement on the annual
facilities charge issue. The settlement has been filed with the FERC and the
FERC staff has recommended commission approval.
REGIONAL TRANSMISSION ORGANIZATION FOR NEW ENGLAND
On March 24, 2004, the FERC conditionally approved ISO New England Inc.'s
(ISO-NE) joint proposal with the New England Transmission Owners for the
creation of a Regional Transmission Organization (RTO). ISO-NE expects that the
creation of an RTO for New England will strengthen the independent oversight of
the region's bulk power system and wholesale electricity marketplace. UI is a
signatory to the filing and has the opportunity to join the New England RTO and
become eligible for the FERC's transmission return on equity (ROE) joining
incentive (50 basis points above the approved transmission base return on
equity). The RTO could become operational by the end of 2004. The FERC has
scheduled hearing dates in the fourth quarter of 2004, for consideration of the
ROE of 12.8% requested by the Transmission Owners (TOs). The TOs will be allowed
to charge the requested ROE from the time the RTO becomes operational until the
final FERC decision, subject to refund. The TOs have filed a request for
clarification on several items in the FERC decision and a request for rehearing
regarding several others. The TOs have reached a tentative agreement, subject to
final contract language and FERC approval, with RTO opponents regarding a number
of outstanding issues.
(D) SHORT-TERM CREDIT ARRANGEMENTS
UIL Holdings has a money market loan arrangement with JPMorgan Chase Bank. This
is an uncommitted short-term borrowing arrangement under which JPMorgan Chase
Bank may make loans to UIL Holdings for fixed maturities from one day up to six
months. JPMorgan Securities, Inc. acts as an agent and sells the loans to
investors. The fixed interest rates on the loans are determined based on
conditions in the financial markets at the time of each loan. As of June 30,
2004, UIL Holdings did not have any borrowings outstanding under this
arrangement.
On July 29, 2004, UIL Holdings entered into a revolving credit agreement with a
group of banks that extends to July 28, 2007. The borrowing limit of this
facility is $100 million. The facility permits UIL Holdings to borrow funds at a
fluctuating interest rate determined by the prime lending market in New York,
- 16 -
and also permits UIL Holdings to borrow money for fixed periods of time
specified by UIL Holdings at fixed interest rates determined by the Eurodollar
interbank market in London (LIBOR). If a material adverse change in the
business, operations, affairs, assets or condition, financial or otherwise, or
prospects of UIL Holdings and its subsidiaries, on a consolidated basis, should
occur, the banks may decline to lend additional money to UIL Holdings under this
revolving credit agreement, although borrowings outstanding at the time of such
an occurrence would not then become due and payable. As of June 30, 2004, UIL
Holdings did not have any short-term borrowings outstanding under a revolving
credit agreement that expired on July 29, 2004.
On July 30, 2004, Xcelecom amended its existing revolving credit agreement with
two banks to extend the term to June 30, 2005. This agreement, as amended,
provides for a $30 million revolving loan facility available to meet working
capital needs, and up to $5 million in capital equipment needs, and to support
standby letters of credit issued by Xcelecom in the normal course of its
business. Capital equipment loans under this facility can be converted to
amortizing term loans with a maturity of up to four years. This agreement also
provides for the payment of interest at a rate, at the option of Xcelecom, based
on the agent bank's prime interest rate or LIBOR. All borrowings outstanding
under this agreement are secured solely by assets of Xcelecom and its
subsidiaries. As of June 30, 2004, Xcelecom did not have any borrowings
outstanding under the revolving working capital balance under this facility.
Xcelecom had $1.1 million of capital equipment funding that had been converted
to term notes outstanding and standby letters of credit of $5 million
outstanding at June 30, 2004 under the facility.
(E) INCOME TAXES
Three Months Ended Six Months Ended
June 30, June 30,
2004 2003 2004 2003
---- ---- ---- ----
(In Thousands) (In Thousands)
Income tax expense for continuing operations consists of:
Income tax provisions (benefit):
Current
Federal $5,404 $ 4,597 $8,252 $ 12,325
State 2,205 1,777 3,624 4,454
--------------- -------------- -------------- --------------
Total current 7,609 6,374 11,876 16,779
--------------- -------------- -------------- --------------
Deferred
Federal 334 (325) 2,503 (3,259)
State (683) (694) (948) (2,050)
--------------- -------------- -------------- --------------
Total deferred (349) (1,019) 1,555 (5,309)
--------------- -------------- -------------- --------------
Investment tax credits (100) (147) (205) (295)
--------------- -------------- -------------- --------------
Total income tax expense $7,160 $ 5,208 $13,226 $ 11,175
=============== ============== ============== ==============
Income tax components charged as follows:
Operating tax expense $9,080 $ 5,711 $14,800 $ 11,283
Nonoperating tax benefit (1,920) (503) (1,574) (108)
--------------- -------------- -------------- --------------
Total income tax expense $7,160 $ 5,208 $13,226 $ 11,175
=============== ============== ============== ==============
- 17 -
Legislation enacted in Connecticut on February 28, 2003 imposed a 20% surcharge
on the corporation business tax for the year 2003 only. This surcharge, which
was made retroactive to January 1, 2003, effectively increased the statutory
rate of the Connecticut corporation business tax from 7.5% to 9.0% for the year
2003. Due to this change, the combined effective federal and state income tax
rate for UIL Holdings' Connecticut-based entities was 40.85% for the year 2003.
In addition, legislation was also enacted in Connecticut on August 16, 2003
which imposes a 25% surcharge on the corporation business tax for the year 2004.
This surcharge increases the statutory rate of Connecticut corporation business
tax from 7.5% to 9.375% for the year 2004 only. Due to this change, the combined
effective statutory federal and state income tax rate for UIL Holdings'
Connecticut based entities increases slightly from 40.85% for the year 2003 to
41.094% for the year 2004.
The effective income tax rates for the three and six months ended June 30, 2004
were 40.60% and 45.16%, respectively, as compared to 51.00% and 51.50% for the
three and six months ended June 30, 2003, respectively. The decreases in the
2004 rates are due primarily to (1) adjustments to deferred income tax reserves
associated with CTA and (2) differences in the amounts of book depreciation in
excess of non-normalized tax depreciation.
- 18 -
UIL HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
(Unaudited)
(F) SUPPLEMENTARY INFORMATION
Three Months Ended Six Months Ended
June 30, June 30,
2004 2003 2004 2003
---- ---- ---- ----
(In Thousands) (In Thousands)
Operating Revenues
- ------------------
Utility
Retail $ 159,977 $ 143,107 $ 327,748 $ 293,081
Wholesale 6,144 5,409 12,358 12,971
Other 9,472 7,567 17,330 15,323
Non-utility businesses
Xcelecom 85,119 74,532 152,668 143,474
Other 23 6 58 11
---------- --------- ---------- ----------
Total Operating Revenues $ 260,735 $ 230,621 $ 510,162 $ 464,860
=========== ========= ========== ==========
Sales by Class (megawatt-hours)
- -------------------------------
Retail (1)
Residential 508,044 473,389 1,146,330 1,074,022
Commercial 633,333 603,725 1,271,144 1,212,112
Industrial 234,414 237,410 469,384 464,335
Other 9,518 9,640 21,399 22,473
----------- --------- ---------- ----------
1,385,309 1,324,164 2,908,257 2,772,942
Wholesale 122,765 117,263 233,414 231,927
----------- --------- ---------- ----------
Total Sales by Class 1,508,074 1,441,427 3,141,671 3,004,869
=========== ========= ========== ==========
Fuel and Energy
- ---------------
Fuel and Energy Expense $87,021 $68,358 $180,652 $140,766
Purchase Power above market fuel expense credit (2) (5,693) (5,992) (11,386) (11,918)
----------- ---------- --------- ----------
Total Fuel and Energy Expense $ 81,328 $ 62,366 $ 169,266 $ 128,848
=========== ========== ========= ==========
Depreciation and Amortization
- -----------------------------
Utility property, plant, and equipment $ 7,262 $ 6,779 $ 14,757 $ 13,785
Non-utility business property, plant and equipment 884 853 1,756 1,724
---------- ---------- --------- ----------
Total Depreciation 8,146 7,632 16,513 15,509
---------- ---------- --------- ----------
Amortization of nuclear plant regulatory assets 1,471 5,923 4,118 16,524
Amortization of purchase power contracts (2) 5,693 5,992 11,386 11,918
Amortization of other CTA regulatory assets 283 283 566 543
Amortization of cancelled plant - 293 - 586
---------- ---------- --------- ----------
Subtotal CTA Amortization 7,447 12,491 16,070 29,571
Amortization of intangibles 311 340 624 675
Amortization of other regulatory assets 243 1,143 430 2,286
---------- ---------- --------- ----------
Total Amortization 8,001 13,974 17,124 32,532
---------- ---------- --------- ----------
Total Depreciation and Amortization $ 16,147 $ 21,606 $ 33,637 $ 48,041
========== ========== ========= ==========
Taxes - Other than Income Taxes
- -------------------------------
Operating:
Connecticut gross earnings $ 6,179 $ 6,095 $ 12,205 $ 12,516
Local real estate and personal property 2,497 2,611 5,039 5,203
Payroll taxes 1,265 1,235 3,442 3,110
---------- ---------- --------- ----------
Total Taxes - Other than Income Taxes $ 9,941 $ 9,941 $ 20,686 $ 20,829
========== ========== ========= ==========
Other Income (Expense), net
- ---------------------------
Interest income $ 351 $ 320 $ 724 $ 509
Allowance for funds used during construction 357 643 823 1,299
Equity earnings from Connecticut Yankee 65 71 131 156
Non-utility business passive expense (1,218) (632) (4,155) (2,778)
Seabrook reserve reduction 1,122 - 2,477 -
Miscellaneous other income and (expense) - net 754 324 2,831 1,105
---------- ---------- --------- ----------
Total Other Income (Expense), net $ 1,431 $ 726 $ 2,831 $ 291
========== ========== ========= ==========
Other Interest, net
- -------------------
Notes payable $ 246 $ 146 $ 537 $ 270
Other 522 165 953 308
---------- ---------- --------- ----------
Total Other Interest, net $ 768 $ 311 $ 1,490 $ 578
========== ========== ========= ==========
(1) Includes 46 thousand megawatt hour non-recurring adjustment associated with
a change in accounting estimate to unbilled revenue recognized in the first
quarter of 2004.
(2) The amortization of this regulatory asset is a cash neutral item, as there
is an offsetting liability which is relieved through a credit to fuel and
energy expense.
- 19 -
(G) PENSION AND OTHER BENEFITS
UI's qualified pension plan covers substantially all of its employees, the
employees of UIL Holdings and APS, and certain management employees of Xcelecom
and UCI. APS and Xcelecom employees no longer benefit from contributions under
the plan, but any benefits accrued to them, through April 2003 for APS, and
December 2003 for Xcelecom, remain in the plan. Effective on June 22, 2004 with
the completion of the sale of APS, those active APS employees who had not vested
in the amount of their benefits accrued through April 2003 were granted full
vesting in those benefits. UI also has a non-qualified supplemental plan for
certain executives and a non-qualified retiree-only plan for certain early
retirement benefits.
The funding policy for the qualified plan is to make annual contributions that
satisfy the minimum funding requirements of ERISA but that do not exceed the
maximum deductible limits of the Internal Revenue Code. These amounts are
determined each year as a result of an actuarial valuation of the plan. The
contribution to the pension plan for 2004 is expected to be $11.2 million.
There is potential variability to the pension expense calculation depending on
changes in the pension rate components: if there were a plus or minus 1/4%
change in the discount rate assumed at 6%, the pension expense would change by
minus or plus $0.8 million, respectively; if there were a 1% change in the
expected return on assets, the pension expense would change by plus or minus
$2.5 million.
In addition to providing pension benefits, UI also provides other postretirement
benefits (OPEB), consisting principally of health care and life insurance
benefits, for retired employees and their dependents. Employees whose sum of age
and years of service at time of retirement is equal to or greater than 85 (or
who are 62 with at least 20 years of service) are eligible for benefits
partially subsidized by UI. The amount of benefits subsidized by UI is
determined by age and years of service at retirement. For funding purposes, UI
established a Voluntary Employees' Benefit Association Trust (VEBA) to fund OPEB
for UI's union employees. No contribution is expected in 2004 for this fund.
There is potential variability in the calculation of OPEB plan expenses
depending on changes in the major rate components of the VEBA: if there were a
plus or minus 1/4% change in the discount rate assumed, the OPEB plan expenses
would change by plus or minus $0.1 million; if there were a 1% change in the
expected return on VEBA assets, the OPEB plan expenses would change by plus or
minus $0.2 million.
- 20 -
The following tables represent the components of net periodic benefit cost for
the pension and OPEB for the 2004 plan projections.
THREE MONTHS ENDED JUNE 30,
PENSION BENEFITS OTHER POSTRETIREMENT BENEFITS
2004 2003 2004 2003
---- ---- ---- ----
(In Thousands)
Components of net periodic benefit cost:
Service cost $1,586 $1,554 $ 231 $ 194
Interest cost 4,508 4,455 764 789
Expected return on plan assets (5,012) (3,545) (327) (303)
Amortization of:
Prior service costs 266 295 (45) (45)
Transition obligation (asset) (264) (264) 265 265
Actuarial (gain) loss 1,666 1,879 422 407
Settlements and curtailments - - - -
-------------- -------------- ---------------- -----------------
Net periodic benefit cost $2,750 $4,374 $1,310 $1,307
============== ============== ================ =================
The following actuarial weighted average assumptions were used in calculating
net periodic benefit cost:
Discount rate 6.00% 6.75% 6.00% 6.75%
Average wage increase 4.50% 4.50% N/A N/A
Return on plan assets 8.00% 8.00% 8.00% 8.00%
Pre-65 health care trend rate (current year) N/A N/A 13.00% 14.00%
Pre-65 health care trend rate (2012+) N/A N/A 5.50% 5.50%
Post-65 health care trend rate (current year) N/A N/A 7.00% 7.50%
Post-65 health care trend rate (2009+) N/A N/A 5.00% 5.00%
N/A - not applicable.
- 21 -
SIX MONTHS ENDED JUNE 30,
PENSION BENEFITS OTHER POSTRETIREMENT BENEFITS
2004 2003 2004 2003
---- ---- ---- ----
(In Thousands)
Components of net periodic benefit cost:
Service cost $3,172 $3,108 $ 462 $ 388
Interest cost 9,016 8,910 1,528 1,578
Expected return on plan assets (10,024) (7,090) (654) (606)
Amortization of:
Prior service costs 532 590 (90) (90)
Transition obligation (asset) (528) (528) 530 530
Actuarial (gain) loss 3,332 3,758 844 814
Settlements and curtailments - - - -
-------------- -------------- ---------------- -----------------
Net periodic benefit cost $5,500 $8,748 $2,620 $2,614
============== ============== ================ =================
The following actuarial weighted average assumptions were used in calculating
net periodic benefit cost:
Discount rate 6.00% 6.75% 6.00% 6.75%
Average wage increase 4.50% 4.50% N/A N/A
Return on plan assets 8.00% 8.00% 8.00% 8.00%
Pre-65 health care trend rate (current year) N/A N/A 13.00% 14.00%
Pre-65 health care trend rate (2012+) N/A N/A 5.50% 5.50%
Post-65 health care trend rate (current year) N/A N/A 7.00% 7.50%
Post-65 health care trend rate (2009+) N/A N/A 5.00% 5.00%
N/A - not applicable.
(J) COMMITMENTS AND CONTINGENCIES
OTHER COMMITMENTS AND CONTINGENCIES
CONNECTICUT YANKEE ATOMIC POWER COMPANY
On December 4, 1996, the Board of Directors of the Connecticut Yankee Atomic
Power Company (Connecticut Yankee) voted unanimously to retire the Connecticut
Yankee nuclear plant (the Connecticut Yankee Unit) from commercial operation. UI
has a 9.5% stock ownership share in Connecticut Yankee, the value of which was
$4 million as of June 30, 2004. The power purchase contract under which UI had
purchased its 9.5% entitlement to the Connecticut Yankee Unit's power output
permits Connecticut Yankee to recover 9.5% of all of its costs from UI. A
decision by the FERC that became effective on August 1, 2000 allows Connecticut
Yankee to collect through the power contracts with the unit's owners the
FERC-approved decommissioning costs, other costs associated with the permanent
shutdown of the Connecticut Yankee Unit, the unrecovered investment in the
Connecticut Yankee Unit, and a return on equity of 6%.
As part of an ongoing review process, management of Connecticut Yankee has
prepared an updated estimate of the cost of decommissioning its nuclear unit, as
part of its transition to self performance of decommissioning. Connecticut
Yankee's updated cost estimate (2003 Estimate) includes an increase of
approximately $273 million over the cost estimate reported in November 2002.
- 22 -
The $273 million increase in the decommissioning cost estimate primarily
reflects the impacts of the termination of the turnkey decommissioning
contractor, Bechtel Power Corporation, (Bechtel) in July 2003. Connecticut
Yankee terminated its decommissioning contract with Bechtel in July 2003 due to
Bechtel's history of incomplete and untimely performance and refusal to perform
remaining decommissioning work. In June 2003, Bechtel filed a complaint against
Connecticut Yankee in Connecticut Superior Court asserting a number of claims,
including wrongful termination. In August 2003, Connecticut Yankee filed a
counterclaim, including counts for breach of contract, negligent
misrepresentation and breach of duty of good faith and fair dealing. Bechtel has
departed the site and the decommissioning responsibility has been transitioned
to Connecticut Yankee, which has recommenced the decommissioning process.
Connecticut Yankee continues to prosecute its counterclaims for excess
completion costs and other damages against Bechtel in Connecticut Superior
Court. Discovery is underway and a trial has been scheduled for May 2006. The
2003 Estimate does not include any allowance for cost recovery in this matter.
On June 18, 2004, Bechtel filed a Pre-Judgment Remedy Application (PJR)
requesting a $93 million garnishment of the Decommissioning Trust (Trust),
Connecticut Yankee shareholder payments to the Trust and any proceeds from the
fuel disposal contract litigation pending between Connecticut Yankee and the
U.S. Department of Energy as well as attachment of any Connecticut Yankee
assets, including the Haddam Neck real property. On July 16, 2004, Connecticut
Yankee filed its Objection to the PJR, which include a challenge to the legal
availability of the remedies requested by Bechtel. On July 20, 2004 the court
allowed the DPUC to intervene in the PJR proceeding for the limited purpose of
objecting to Bechtel's requested garnishment of the Trust and related payments.
The court scheduled an August 26, 2004 hearing on the legal availability of the
remedies requested by Bechtel. A hearing on the other PJR issues, if necessary,
has been scheduled to begin on October 19, 2004.
As part of the Connecticut Yankee April 2000 rate case settlement with the FERC,
remaining decommissioning costs were originally estimated at $410 million. The
original estimate was updated in November 2002 to increase the estimated
decommissioning costs by approximately $140 million. The $140 million increase
stemmed primarily from additional security costs, as well as the corollary
economic impacts of increased insurance costs and other factors. Consequently,
the total current cost estimate of approximately $823 million represents an
aggregate increase of approximately $413 million over the April 2000 FERC rate
case settlement. In addition, prior to the approval of the cost estimate in the
2000 FERC settlement, Connecticut Yankee had incurred approximately $184 million
of decommissioning costs in the 1997-1999 time period.
UI's share of the estimated increased cost of $413 million over the estimate
reported in November 2002 would be approximately $39.2 million. This increase
will not impact current period earnings as the amounts will be deferred on the
balance sheet pending resolution of the litigation and regulatory proceedings
described herein. Ultimately, if this issue is resolved favorably, the costs
will be recovered and therefore would not likely have a financial impact on the
results of operations.
The 2003 Estimate has now been filed with the FERC as part of a July 1, 2004
rate application (the Filing) seeking additional funding to complete the
decommissioning project and for storage of spent fuel through 2023. The filing
(docket ER04-981), which was required to be made as part of the terms of the
April 2000 rate case settlement agreement, requested that new rates take effect
on January 1, 2005 (after suspension). The filing includes proposed increased
decommissioning charges, based on the 2003 Estimate, as well as new annual
charges for pension expense and costs of funding post-employment benefits other
than pensions. The proposed $93 million annual decommissioning collection
represents a significant increase in annual charges compared to the existing
FERC approved decommissioning collection rate of $16.7 million per year. The
FERC issued a notice of the Filing on July 6, 2004 indicating initially that
intervention and protest filings would be due by July 22; however that date was
extended to July 30, at the request of the DPUC. As of the date of this
statement three non-utility interventions have been filed at the FERC by the
DPUC, the OCC and the Massachusetts Attorney General. The process of resolving
the matters in the Filing is likely to be contentious and lengthy.
- 23 -
On June 10, 2004, the DPUC and the OCC filed a petition (Petition) with the FERC
seeking a declaratory order that Connecticut Yankee can recover all
decommissioning costs from wholesale purchasers, including UI, but that those
purchasers may not recover in their retail rates any costs that FERC might
determine to have been imprudently incurred. UI, as well as Connecticut Yankee's
other wholesale purchasers, have responded in opposition to the Petition,
indicating that the order sought by the DPUC and OCC would violate the Federal
Power Act and decisions of the U.S. Supreme Court, other federal and state
courts, and FERC. The New Hampshire Public Service Commission filed an
intervention notice in support of the Petition and Bechtel has filed an AMICUS
brief in support of the Petition. The FERC has not acted on the Petition. UI
would seek to recover any FERC-allowed rate increase from its retail customers
through appropriate regulatory proceedings. The timing, amount and outcome of
such regulatory proceedings cannot be predicted at this time.
Connecticut Yankee updates its cost to decommission the unit annually, or as
needed, and provides UI with a projected recovery schedule depicting annual
costs expected to be billed to UI, including a return on investment over the
term of the projected recovery period. The present value of these costs is
calculated using UI's weighted average cost of capital and, after consideration
of recoverability, booked as a Connecticut Yankee Contract Obligation and a
corresponding regulatory asset. At June 30, 2004, UI has regulatory approval to
recover in future rates $23.8 million of its regulatory asset for Connecticut
Yankee over a term ending in 2007. The remaining portion of the regulatory
asset, as of June 30, 2004, was $27.4 million, consisting of $4 million of
equity investment and $23.4 million of costs subject to a regulatory review and
approval process in 2004. The $23.4 million subject to regulatory review and
approval includes the present value of the revenue requirements to fund the
increased costs described in the preceding paragraphs. The regulatory review and
approval process may extend the recovery period beyond 2007. Although UI
believes full regulatory recovery is probable because these costs are similar in
nature to the costs already afforded regulatory treatment, the actual amounts
subject to recovery may be different and will result from the legal and
regulatory proceeding described herein. Such costs include increased security
and insurance costs as a result of the terrorist attacks of September 11, 2001,
as well as other cost increases to complete the decommissioning of the plant.
To the extent that the new estimates described above are related to spent fuel
storage, they could be affected by the outcome of an ongoing dispute between the
federal Department of Energy (DOE) and several utilities and states. Under the
Nuclear Waste Policy Act of 1982 (the Act), the DOE is required to design,
license, construct and operate a permanent repository for high-level radioactive
waste and spent nuclear fuel. The Act requires the DOE to provide for the
disposal of spent nuclear fuel and high-level waste from commercial nuclear
plants through contracts with the owners. In return for payment of established
disposal fees, the federal government was required to take title to and dispose
of the utilities' high-level waste and spent nuclear fuel beginning no later
than January 1998. After the DOE announced that its first high-level waste
repository will not be in operation earlier than 2010, several utilities and
states obtained a judicial declaration that the DOE has a statutory
responsibility to take title to and dispose of high-level waste and spent
nuclear fuel beginning in January 1998. Although the federal government now
concedes that its failure to begin disposing of high-level waste and spent
nuclear fuel in January 1998 constituted a breach of contract, it continues to
dispute that the entities with which it had contracts are entitled to damages.
Connecticut Yankee, together with two other New England based owners of shutdown
nuclear generating plants, is seeking recovery of damages stemming from the
breach by the U.S. Department of Energy under the 1983 contracts that were
mandated by the U.S. Congress under the High Level Waste Act for purposes of
disposal of spent fuel and high level waste including greater than class C
waste. The trial for the damage claim, which had been pending in the Federal
Court of Claims since March 1998, commenced on July 12, 2004 and is expected to
continue for at least seven weeks. The amount of the claim for damages incurred
through 2010 is approximately $197-$210 million depending on the discount rate
applied. In addition, damages that will be incurred for periods beyond 2010 are
being sought based on an annual dollar value for those incremental damages. The
2003 Estimate discussed above does not include any allowance for recovery of
damages in this matter.
- 24 -
HYDRO-QUEBEC
UI is a participant in the Hydro-Quebec transmission tie facility linking New
England and Quebec, Canada. UI has a 5.45% participating share in this facility,
which in aggregate has a maximum 2000 megawatt equivalent generation capacity
value. UI is obligated to furnish a guarantee for its participating share of the
debt financing for one phase of this facility. The original guarantee was
entered into in April 1991 in the amount of $11.7 million. The amount of this
guarantee is reduced monthly, proportionate with principal paid on the
underlying debt. As of June 30, 2004, UI's guarantee for this debt was
approximately $3.5 million.
ENVIRONMENTAL CONCERNS
In complying with existing environmental statutes and regulations and further
developments in areas of environmental concern, including legislation and
studies in the fields of water quality, hazardous waste handling and disposal,
toxic substances, and electric and magnetic fields, UIL Holdings and its
wholly-owned direct and indirect subsidiaries may incur substantial capital
expenditures for equipment modifications and additions, monitoring equipment and
recording devices, and it may incur additional operating expenses. The total
amount of these expenditures is not now determinable. Environmental damage
claims may also arise from the operations of UIL Holdings' subsidiaries.
Significant environmental issues known to UIL Holdings at this time are
described below.
SITE DECONTAMINATION, DEMOLITION AND REMEDIATION COSTS
As a result of a 1992 DPUC retail rate decision, since January 1, 1993, UI had
been recovering through retail rates $1.1 million per year of environmental
remediation costs for the demolition and decontamination of its Steel Point
Station property in Bridgeport. As a result of the Rate Case decision dated
September 26, 2002, UI will recover the remaining $3 million of these costs
ratably during the 2002 through 2004 time period. This amount reflects the
remaining cost of cleaning up the property, assuming a zero sales value. Final
costs will be offset by any sale price realized, and will be subject to
regulatory true-up upon disposition of the property. UI is also replacing
portions of the bulkhead at the Steel Point Station property. The work is
expected to cost approximately $7.4 million and is currently expected to be
completed in 2005. These costs are estimates based on the most current
information available. Actual remediation and bulkhead replacement costs may be
higher, or lower, than what is currently estimated. UI is entitled to
reimbursement of these costs from the City of Bridgeport pursuant to UI's
contract with the City.
Subsequent to the demolition of Steel Point Station, the adjacent East Main
Street Substation was removed at the request of the City of Bridgeport. UI will
undertake an environmental subsurface investigation of the former substation
site, but potential environmental remediation costs, if any, cannot be estimated
at this time. Concurrent with the removal of the East Main Street Substation in
2000, the Congress Street Substation was expanded to replace it. As of June 30,
2004, $8.9 million of the total cost is reimbursable from the City of
Bridgeport. An additional $1.4 million of costs related to the Substation are
transmission assets recoverable through regional transmission rates. UI is
currently negotiating with the City of Bridgeport to settle all outstanding
issues between the parties. In the event that an agreement cannot be reached, UI
will move forward with previously initiated arbitration proceedings to collect
these funds from the City of Bridgeport.
UI has completed the replacement of the bulkhead surrounding a site, bordering
the Mill River in New Haven, that contains transmission facilities and
deactivated generation facilities, at a cost of $13.5 million. Of this amount,
$4.2 million represents the portion of the costs to protect UI's transmission
facilities and has been capitalized as plant in service; the remaining estimated
cost of $9.3 million has been expensed. UI has conveyed to an unaffiliated
entity, Quinnipiac Energy LLC (QE), this entire site, reserving to UI permanent
easements for the operation of its transmission facilities on the site. UI has
also jointly funded (61%) with QE a remediation fund for the purpose of bringing
the site into environmental compliance. The funds were placed into an escrow
- 25 -
account to ensure they were used for only remediation purposes. In addition, UI
required that QE obtain an insurance policy, with UI named an additional
insured, to provide coverage for limited remediation cost overruns. The City of
New Haven is currently foreclosing on the property, as QE is not current with
property tax payments. If it is determined that QE has not performed appropriate
environmental remediation at the site, UI could be required by applicable
environmental laws to finish remediating any contamination at the site. The
scope of any required remediation efforts by UI is not now determinable. The
escrow fund and insurance policy proceeds would be used for this purpose.
On April 16, 1999, UI closed on the sale of its Bridgeport Harbor Station and
New Haven Harbor Station generating plants in compliance with Connecticut's
electric utility industry restructuring legislation. Environmental assessments
performed in connection with the marketing of these plants indicate that
substantial remediation expenditures will be required in order to bring the
plant sites into compliance with applicable minimum Connecticut environmental
standards. The purchaser of the plants has agreed to undertake and pay for the
remediation of the purchased properties. With respect to the portion of the New
Haven Harbor Station site that UI has retained, UI has performed an additional
environmental analysis and estimates that approximately $3.2 million in
remediation expenses will be incurred. These costs are estimates based on the
most current information available. Actual remediation costs may be higher, or
lower, than what is currently estimated. The required remediation is virtually
all on transmission-related property; and UI accrued these estimated expenses
during the third quarter of 2002.
From 1961 to 1976, UI owned a parcel of property in Derby, Connecticut, on which
it operated an oil-fired electric generating unit. For several years, the
Connecticut Department of Environmental Protection has been remediating a
migration of fuel oil contamination from a neighboring parcel of property into
the adjacent Housatonic River. Although, based on its own investigation to date,
UI believes it has no responsibility for this contamination, if regulatory
agencies determine that UI is responsible for the cost of these remediation
activities, UI may experience substantial costs, no estimate of which is
currently available.
ELECTRIC SYSTEM WORK CENTER
UI's January 2004 purchase of its Electric System Work Center property, located
in Shelton, Connecticut, initiated a review under the Connecticut Department of
Environmental Protection's (CDEP) Transfer Act Program. Under this review, the
CDEP had an opportunity to examine the current environmental conditions at the
site and direct remediation, or further remediation, of any areas of concern. At
the conclusion of its review, the CDEP elected not to oversee any further site
investigation or remediation at the site and directed UI to undertake any
necessary evaluation and/or remediation (verification work) using an independent
Licensed Environmental Professional (LEP). UI has hired an LEP and has submitted
a schedule to the CDEP for the verification work. Implementation of the
verification work is not expected to have a material impact on the financial
condition of UI.
CLAIM OF ENRON POWER MARKETING, INC.
UI had a wholesale power agreement and other related agreements with Enron Power
Marketing, Inc. (EPMI), originally intended to supply all of the power needed to
meet UI's standard offer obligations until December 31, 2003, the end of the
standard offer period (the Agreements). Following EPMI's bankruptcy filing on
December 2, 2001, UI terminated the Agreements in accordance with their terms,
effective January 1, 2002, in reliance upon provisions of the Bankruptcy Code
that permit termination of such contracts. The Agreements permitted UI to
calculate its gains and losses resulting from the termination, and globally to
net these gains and losses against one another, and against any other amounts
that UI owed to EPMI under the Agreements, to arrive at a single sum. EPMI,
however, commenced on January 31, 2003 an adversary proceeding against UI and
UIL Holdings in the EPMI bankruptcy. UIL Holdings was sued as the guarantor of
UI's financial obligations under the Agreements. EPMI contends that UI was not
entitled to offset, against any losses UI suffered from the termination of the
Agreements, any amounts owing to EPMI for power delivered to UI after the date
- 26 -
EPMI filed for bankruptcy. The amount of the allegedly improper setoff that EPMI
seeks to recover in the adversary proceeding is approximately $8.2 million, plus
interest and attorneys' fees. The bankruptcy court has referred this and other
similar cases to mediation and stayed the cases while mediation is conducted.
Following the initial mediation session, EPMI indicated it is considering
theories for increasing the amount of its claims against UI. In the event that
UI is determined to owe EPMI a portion or all of the amount claimed, UI will
seek appropriate treatment of such amount through the regulatory process.
INDEPENDENT SYSTEM OPERATOR - NEW ENGLAND
On April 16, 2004, UI announced its participation in the ISO-NE program to
secure emergency energy resources in Southwestern Connecticut. Under the
four-year contract, UI has committed to a load reduction of 30 megawatts when
requested by ISO-NE. UI has partnered with several large customers who have
agreed to reduce their electricity demand when the region's electric grid is
stressed. The agreement was approved by the FERC in May 2004. As part of the
agreement, UI has provided a performance guarantee for the commitment of $0.7
million in the form of a letter of credit in the event UI is unable to reduce
demand when requested by ISO-NE. The letter of credit expires on October 31,
2004, at which time it will be replaced by a new letter of credit in the amount
of $0.4 million. No liability has been recorded in the UIL Holdings'
consolidated balance sheet as of June 30, 2004 for this guarantee provided under
this letter of credit. The probability that the letter of credit would be
utilized is very low due to the fact that the customers that UI has partnered
with for this program are among UI's largest, thus reducing the likelihood of
nonperformance in terms of both the requested kWh reductions and the ability to
pay any financial penalties. Furthermore, if the letter of credit were to be
utilized to cover nonperformance of UI's customers, the amount paid by UI would
be recovered directly from the customers who did not perform by deducting the
amount from the funds that would be remitted to such customers for their
performance in this program.
CROSS-SOUND CABLE COMPANY, LLC
UCI's 25% share of the estimated total final cost of the Cross-Sound project is
$35 million. As of June 30, 2004, UCI's 25% share of the actual project cost for
the Cross-Sound cable was $34.3 million. UCI has provided an equity infusion of
$10 million to Cross-Sound and UIL Holdings loaned $24.4 million, including
capitalized interest, to Cross-Sound.
In addition to the funding noted above, a guarantee, in the amount of $1.3
million, has been provided by UIL Holdings and UCI in support of Hydro-Quebec's
(HQ) guarantee to third parties in connection with the construction of the
project. The guarantee is in support of an agreement under which Cross-Sound is
providing compensation to shell fisherman for loss of income as a result of the
installation of the cable. The payments to the fisherman are being made over a
10 year period, and the obligation under this guarantee reduces proportionately
with each payment made. As of June 30, 2004, the remaining amount of the
guarantee was $1.2 million. UIL Holdings has completed a probability weighted
analysis based on the likelihood of certain events occurring which would cause
UIL Holdings to be required to perform under this guarantee. The result of this
analysis resulted in a liability amount that was inconsequential, and as such,
no liability has been recorded in UIL Holdings' consolidated balance sheet as of
June 30, 2004.
In the event that Cross-Sound could not meet any obligations that are supported
by the previously mentioned guarantee, it is expected that such obligation would
be funded by capital contributions from the owners, who are affiliates of the
guarantors, in amounts in proportion to their respective ownership shares of
Cross-Sound. As such, UCI does not expect to be required to perform under the
guarantee.
On June 24, 2004, Cross-Sound reached a settlement agreement with various
regulatory authorities and other parties with an interest in the cable that
allowed for immediate commercial operation of the cable. In connection with that
settlement agreement, the existing contract Cross-Sound has with the Long Island
Power Authority (LIPA) for the entire capacity of the transmission line is being
reviewed and negotiations are taking place to increase the overall term of the
agreement from 20 years to 28 years by means of adding an initial three year
- 27 -
period at reduced rates, and an additional five years to the end of the contract
term, at full rates. As part of this amendment, the $2.5 million guarantee in
support of an HQ guarantee to LIPA to provide for damages in the event of a
delay in the date of achieving commercial operation is proposed to be
eliminated.
Although the settlement agreement allows for commercial operation of the cable,
such status is contingent upon the satisfaction of certain provisions set forth
in the agreement. In particular, Cross-Sound must bring the cable into
compliance with permit conditions as directed by the CDEP. This remediation
consists primarily of achieving the originally required burial depth in those
areas deemed as "soft spots", meaning the obstructions which originally
prevented achievement of such depth can generally be removed without the use of
techniques such as blasting. The costs of this remediation are currently
estimated at $1 million and are within the estimated final cost of the project.
Additionally, the settlement agreement calls for the parties to fund a
collective amount of $6 million, of which Cross-Sound's commitment is $2
million, to a research and restoration fund for the Long Island Sound. For a
complete description of the settlement agreement, as well as additional
discussion regarding the Cross-Sound cable, see "Management's Discussion and
Analysis - Major Influences - United Capital Investments, Inc."
Upon satisfaction of all provisions of the settlement agreement, the loan from
UIL Holdings is expected to be refinanced with external project financing. UCI
will be responsible for 25% of any additional cost of project completion over
the estimated amount.
XCELECOM, INC.
Xcelecom, through one of its subsidiaries, has filed suit in New Jersey Superior
Court against M. J. Paquet (Paquet), a general contractor doing business in the
state of New Jersey, and Paquet's surety, United States Fidelity & Guaranty
Company. Paquet is the general contractor on a project with the New Jersey
Department of Transportation which is in the final stages of completion, where
one of Xcelecom's subsidiary is the electrical subcontractor. Xcelecom's portion
of the project is expected to be substantially complete by the end of the summer
of 2004. Xcelecom alleges in its suit, among other causes of action, breach of
contract, failure to comply with New Jersey's Prompt Pay Act, and breach of
trust. Xcelecom seeks to recover approximately $2 million in overdue payments,
plus damages for delay and failure by Paquet to comply with New Jersey state
law. Paquet has asserted numerous defenses to the suit, as well as various
counterclaims. Pleadings are closed and discovery is in process. Xcelecom
intends to vigorously pursue its suit against Paquet and its surety, and to
defend against Paquet's counterclaims. Paquet has recently announced it was
ceasing operations and the State of New Jersey recently withdrew two contracts
it awarded to Paquet earlier in the year. No amount has been accrued for this
matter in the financial statements. There has been no reserve established
against the receivable of approximately $2 million, as Xcelecom expects to
collect the entire amount due on this contract, either directly from Paquet, or
through Paquet's surety.
- 28 -
(M) SEGMENT INFORMATION
As described in Note (O), "Discontinued Operations," to the consolidated
financial statements, the sale of APS was completed in June of 2004 and its
results of operations are reported as discontinued operations. Accordingly, UIL
Holdings now has two segments, UI, its regulated electric utility business
engaged in the purchase, transmission, distribution and sale of electricity, and
Xcelecom, its non-utility, indirect, wholly-owned subsidiary, which provides
specialized contracting services in the electrical, mechanical, communications
and data network infrastructure industries. Revenues from inter-segment
transactions are not material. All of UIL Holdings' revenues are derived in the
United States.
The following table reconciles certain segment information with that provided in
UIL Holdings' Consolidated Financial Statements. In the table, "Other" includes
the information for the remainder of UIL Holdings' non-utility businesses,
including minority interest investments, administrative costs, and inter-segment
eliminations.
JUNE 30, 2004 DECEMBER 31, 2003
------------- -----------------
Total Assets (In Thousands)
------------
UI $1,507,412 $1,492,144
Xcelecom 185,969 178,906
Assets of discontinued operations held
for sale - 121,627
Other 143,790 105,489
----------------------- ----------------------
Total UIL Holdings $1,837,171 $1,898,166
======================= ======================
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
2004 2003 2004 2003
---- ---- ---- ----
Revenues from External Customers (In Thousands)
- --------------------------------
UI $175,593 $156,083 $357,436 $321,375
Xcelecom 85,119 74,532 152,668 143,474
Other 23 6 58 11
------------------ ----------------- ------------------- ------------------
Total UIL Holdings $260,735 $230,621 $510,162 $464,860
================== ================= =================== ==================
Income (Loss) from Continuing
Operations before Income Taxes
UI $21,654 $15,256 $40,095 $31,706
Xcelecom (147) (1,631) (1,175) (2,108)
Other (3,981) (3,441) (9,636) (7,929)
------------------ ----------------- ------------------ ------------------
Total UIL Holdings $17,526 $10,184 $29,284 $21,669
================== ================= =================== ==================
- 29 -
(N) GOODWILL AND OTHER INTANGIBLE ASSETS
As of June 30, 2004 and December 31, 2003, UIL Holdings maintains $69.6 million
and $68.6 million, respectively, of goodwill related to Xcelecom that is no
longer being amortized, and $3.7 million and $2.7 million, at June 30, 2004 and
December 31, 2003, respectively, of identifiable intangible assets that continue
to be amortized.
A summary of UIL Holdings' goodwill as of June 30, 2004 is as follows:
(Thousands of Dollars) Total
--------------
Balance, January 1, 2004 $68,554
Goodwill acquired during the six months
ended June 30, 2004 1,015
--------------
Balance, June 30, 2004 $69,569
==============
There were no impairments to the goodwill balances recognized during the six
months ended June 30, 2004 and 2003.
As of June 30, 2004 and December 31, 2003, UIL Holdings' intangible assets and
related accumulated amortization consisted of the following:
As of June 30, 2004
--------------------------------------------
Accumulated Net
(Thousands of Dollars) Gross Amortization Balance
------------ ------------------ ------------
Intangible assets subject to
amortization:
Non-compete agreements $3,435 $2,802 $633
Backlog 256 256 -
------------ ------------------ ------------
Total $3,691 $3,058 $633
============ ================== ============
As of December 31, 2003
--------------------------------------------
Accumulated Net
(Thousands of Dollars) Gross Amortization Balance
------------ ------------------ ------------
Intangible assets subject to
amortization:
Non-compete agreements $2,485 $2,178 $307
Backlog 256 256 -
------------ ------------------ ------------
Total $2,741 $2,434 $307
============ ================== ============
The intangible asset balance is included in Other Deferred Charges on the
Consolidated Balance Sheet.
UIL Holdings recorded amortization expense of $0.6 million for the six months
ended June 30, 2004 and 2003, respectively related to these intangible assets.
Assuming there are no acquisitions or dispositions that occur in the future, the
remaining intangible assets will be fully amortized in 2004.
- 30 -
(O) DISCONTINUED OPERATIONS
On June 22, 2004, UIL Holdings completed the sale of APS to CheckFree
Corporation (CheckFree), a leading provider of financial electronic commerce
services and products, pursuant to the purchase agreement entered into between
the parties on December 16, 2003. Accordingly, the results of discontinued
operations for the three and six months ended June 30, 2004 included the
after-tax gain, net of transaction costs, of $46.5 million and $46.2 million,
respectively, recognized from the sale of APS. The overall after-tax gain on the
sale of APS, net of transaction costs, was $46 million and was calculated based
upon the purchase price of $110 million and estimates relating to certain
post-closing adjustments. The difference in the reported gain for each of the
aforementioned periods is due to transaction costs incurred in the fourth
quarter of 2003 and first quarter of 2004. Total transaction costs associated
with the sale of APS amounted to approximately $14 million and include $8
million of payments to be made to employees of APS based on a long-term
incentive plan and retention bonuses, both of which will be paid by CheckFree,
but funded by UIL Holdings. The payments to be made to APS employees are subject
to the completion of post-closing procedures, and in the case of the retention
bonuses, payments will only be made if the employees are still employed by APS
at the end of a transition period. UIL Holdings has recorded a liability of $8
million for these payments in the consolidated balance sheet and the amount will
be paid to APS upon satisfaction of the previously mentioned conditions.
CheckFree did not acquire APS' telephony assets, which included a 51% ownership
interest in CellCards of Illinois, LLC (CCI). Following execution of the
agreement to sell APS, management determined that the telephony business was not
part of UIL Holdings' overall strategic business focus, and therefore authorized
the sale of APS' telephony assets. On February 13, 2004, CCI was sold for book
value, excluding transaction costs, to an independent third party.
As a result of the aforementioned events, the APS segment was considered to be a
"disposal group" held for sale as defined in SFAS No. 144 "Accounting for the
Impairment of Long-Lived Assets." Accordingly, the assets and liabilities of APS
have been categorized as "held for sale" in the accompanying Consolidated
Balance Sheet and the assets of APS ceased being depreciated as of December 16,
2003. The related asset carrying values were not required to be adjusted, as the
carrying amounts were lower than the estimated fair values less costs to sell.
The results of operations of APS for all periods presented have been reported as
discontinued operations in the accompanying Consolidated Statements of Income
and Consolidated Statements of Cash Flows.
- 31 -
A summary of the discontinued operations of APS follows (in thousands):
Three Months Ended Six Months Ended
June 30, June 30,
2004 2003 2004 2003
--------------- --------------- -------------- -----------------
Net operating revenues $14,468 $31,531 $36,659 $60,921
=============== =============== ============== =================
Operating income (loss) (1) 3,077 $ (1,180) 5,643 $ (1,744)
=============== =============== ============== =================
Income (loss) before income taxes (1) 2,356 $ (1,093) 5,076 $ (1,504)
Income tax (expense) benefit (1) (518) 418 (1,524) 577
--------------- --------------- -------------- -----------------
Income (loss) from discontinued operations,
net of tax, excluding gain on sale 1,838 (675) 3,552 (927)
Gain on sale of discontinued operations,
net of tax (2) 46,527 - 46,256 -
--------------- --------------- -------------- -----------------
Net income (loss) from discontinued operations $48,365 $ (675) $49,808 $ (927)
=============== =============== ============== =================
(1) Excludes transaction costs and related income tax impact, which are included
in the gain on sale of discontinued operations.
(2) Gain on sale of discontinued operations is reported net of transaction costs
of $14 million and net of income taxes of $32 million.
(P) RELATED PARTY TRANSACTIONS
Arnold L. Chase, a Director of UIL Holdings since June 28, 1999, holds a
beneficial interest in the building known as 157 Church Street, where UI leases
office space for its corporate headquarters. UI's lease payments for this office
space for the six months ended June 30, 2004 and 2003 totaled $4.8 million and
$4.2 million, respectively and for the three months ended June 30, 2004 and 2003
totaled $2.6 and $2.2, respectively.
UCI invested a total of $3.9 million in 2000 and 2001 to purchase a minority
ownership interest in Gemini Networks, Inc. (Gemini). Gemini proposes to
develop, build, and operate an open-access, hybrid fiber coaxial communications
network serving business and residential customers in the northeastern United
States. Gemini is a corporation controlled by the David T. Chase family, and
Arnold L. Chase is the President and a Director of Gemini. In June 2002, UCI
wrote its investment in Gemini down to one dollar, because the
telecommunications sector had suffered substantial losses in value, and because
UCI concluded that Gemini was unlikely to continue its network development in
the absence of additional financing. In December 2003, Gemini completed a
restructuring transaction in connection with which the Chase family came to own
100% of the equity of Gemini. In connection with that transaction, UCI received
a cash payment in May 2004 of approximately $17,500 in exchange for its
ownership interest in Gemini.
Cross-Sound, in which UCI holds a 25% minority interest investment, leases a
parcel of land from UI. Cross-Sound's lease payments to UI for this parcel
amount to $0.1 million on an annual basis.
In connection with certain of the acquisitions of Xcelecom, certain of
Xcelecom's subsidiaries have entered into a number of related party lease
arrangements for facilities with the former owners of companies acquired (or
persons or entities related thereto), some of whom are current employees of
Xcelecom. These lease agreements are for periods generally ranging from three to
five years. Xcelecom's payments related to these lease arrangements totaled $0.8
million and $0.7 for the six months ended June 30, 2004 and 2003, respectively,
and $0.4 and $0.3 for the three months ended June 30, 2004 and 2003,
respectively.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
CERTAIN STATEMENTS CONTAINED HEREIN, REGARDING MATTERS THAT ARE NOT HISTORICAL
FACTS, ARE FORWARD-LOOKING STATEMENTS (AS DEFINED IN THE PRIVATE SECURITIES
LITIGATION REFORM ACT OF 1995). THESE INCLUDE STATEMENTS REGARDING MANAGEMENT'S
INTENTIONS, PLANS, BELIEFS, EXPECTATIONS OR FORECASTS FOR THE FUTURE. SUCH
FORWARD-LOOKING STATEMENTS ARE BASED ON THE CORPORATION'S EXPECTATIONS AND
INVOLVE RISKS AND UNCERTAINTIES; CONSEQUENTLY, ACTUAL RESULTS MAY DIFFER
MATERIALLY FROM THOSE EXPRESSED OR IMPLIED IN THE STATEMENTS. SUCH RISKS AND
UNCERTAINTIES INCLUDE, BUT ARE NOT LIMITED TO, GENERAL ECONOMIC CONDITIONS,
LEGISLATIVE AND REGULATORY CHANGES, CHANGES IN DEMAND FOR ELECTRICITY AND OTHER
PRODUCTS AND SERVICES, UNANTICIPATED WEATHER CONDITIONS, CHANGES IN ACCOUNTING
PRINCIPLES, POLICIES OR GUIDELINES, AND OTHER ECONOMIC, COMPETITIVE,
GOVERNMENTAL, AND TECHNOLOGICAL FACTORS AFFECTING THE OPERATIONS, MARKETS,
PRODUCTS, SERVICES AND PRICES OF THE CORPORATION'S SUBSIDIARIES. THE FOREGOING
AND OTHER FACTORS ARE DISCUSSED AND SHOULD BE REVIEWED IN THE CORPORATION'S MOST
RECENT ANNUAL REPORT ON FORM 10-K AND OTHER SUBSEQUENT PERIODIC FILINGS WITH THE
SECURITIES AND EXCHANGE COMMISSION. FORWARD-LOOKING STATEMENTS INCLUDED HEREIN
SPEAK ONLY AS OF THE DATE HEREOF AND THE CORPORATION UNDERTAKES NO OBLIGATION TO
REVISE OR UPDATE SUCH STATEMENTS TO REFLECT EVENTS OR CIRCUMSTANCES AFTER THE
DATE HEREOF OR TO REFLECT THE OCCURRENCE OF UNANTICIPATED EVENTS OR
CIRCUMSTANCES.
MAJOR INFLUENCES ON FINANCIAL CONDITION
UIL HOLDINGS CORPORATION
UIL Holdings' financial condition and financing capability will be dependent on
many factors, including the level of income and cash flow of UIL Holdings'
subsidiaries, conditions in the securities markets, economic conditions,
interest rates, legislative and regulatory developments, and the ability to
retain key personnel.
The loss of key personnel or the inability to hire and retain qualified
employees could have an adverse effect on the business, financial condition and
results of operations for UIL Holdings and its operating subsidiaries, UI and
Xcelecom. These operations depend on the continued efforts of their respective
current and future executive officers, senior management and management
personnel. Xcelecom has acquired a number of companies in the past. The success
of these acquisitions is dependent on the continued involvement of the operating
management of these entities. UIL Holdings cannot guarantee that any member of
management at the corporate or subsidiary level will continue to serve in any
capacity for any particular period of time. In an effort to enhance UIL
Holdings' ability to attract and retain qualified personnel, UIL Holdings
continually evaluates the overall compensation packages offered to all levels of
employees.
THE UNITED ILLUMINATING COMPANY
UI is an electric transmission and distribution utility whose structure and
operations are significantly affected by legislation and regulation. UI's rates
and authorized return on equity are regulated by the Federal Energy Regulation
Commission (FERC) and the Connecticut Department of Public Utility Control
(DPUC). Legislation and regulatory decisions implementing the legislation
establish a framework for UI's operations. Primary factors affecting UI's
financial results, in addition to legislation and regulation, are operational
matters such as sales volume, major weather disturbances, ability to control
expenses, and capital expenditures. UI expects significant growth in its capital
investment in transmission, and has applied for siting approval to construct a
major transmission project in southwest Connecticut.
LEGISLATION
State legislation has significantly restructured the electric utility industry
in Connecticut. The primary restructuring legislation includes Public Act 98-28
(the 1998 Restructuring Legislation) and Public Act 03-135, as amended in part
by Public Act 03-221 (the 2003 Restructuring Legislation). Since 2000, UI's
retail customers have been able to choose their electricity suppliers. UI's
financial results are not materially affected by its customers' selection of
alternate suppliers to provide generation service. The 2003 Restructuring
Legislation requires that UI offer a "transitional standard offer" rate during
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the period January 1, 2004 - December 31, 2006 to retail customers who do not
choose an alternate electric supplier. The 2003 Restructuring Legislation
provides for UI to recover its costs of acquiring and providing generation
services, and directed the DPUC to establish each electric distribution
company's transitional standard offer rates.
As part of the restructuring pursuant to the 1998 Restructuring Legislation,
UI's distribution and transmission rates were "unbundled" on customers' bills,
which also included separate charges as of January 1, 2000 for a competitive
transition assessment (CTA), generation services charge (GSC), conservation and
load management (C&LM) charge, renewable energy investment (REI) charge, and
systems benefits charge (SBC). As of January 1, 2004, federally-mandated
congestion costs, defined by the 2003 Restructuring Legislation to include the
costs of regional standard market design, are also identified separately on
customers' bills in accordance with the legislation. The 2003 Restructuring
Legislation makes other changes to the 1998 Restructuring Legislation, such as
the imposition of renewable portfolio standards, the support of the development
of renewable energy resources, and supplier of last resort service after the
transitional standard offer period ends, and a requirement that any new rate
case filings include a four-year rate plan proposal.
The 2003 Restructuring Legislation provides for UI to collect a fee of
$0.0005/kilowatt-hour from transitional standard offer service customers,
beginning January 1, 2004, as compensation for providing transitional standard
offer service. This fee is included in the amounts charged to transitional
standard offer customers, and is excluded by the legislation from determinations
of whether UI's rates are just and reasonable. For 2004, this fee is expected to
generate approximately $2.5 million to $3 million in revenue. The 2003
Restructuring Legislation also provides for the DPUC to establish an incentive
plan for the procurement of long-term contracts for transitional standard offer
service that compares UI's actual average contract price to a regional average
price for electricity, making adjustments as deemed appropriate by the DPUC. If
UI's price is lower than the average, the legislation provides for the plan to
allocate $0.00025/kilowatt-hour of transitional standard offer service to the
distribution company. The DPUC has not yet established an incentive plan or made
any determination with respect to the incentive fee.
REGULATION
In December 2003, the DPUC established UI's transitional standard offer rates
that became effective January 1, 2004, in accordance with the 2003 Restructuring
Legislation. During 2004, it is expected that the DPUC will continue its
implementation of other provisions of the 2003 Restructuring Legislation.
The DPUC's decision establishing the transitional standard offer rates
determined that UI's rates complied in all respects with the 2003 Restructuring
Legislation. The transitional standard offer rates increased the GSC charged to
customers for generation services compared to the standard offer GSC, modified
the CTA (for some retail rates), and provided for the collection of
federally-mandated congestion costs. The GSC rate changes reflect an increase,
compared to the 2003 GSC, in the cost of generation services and related market
costs, as well as a reduction in the "adder" included in the GSC (expected
charge in excess of expected cost). The GSC for the transitional standard offer
is designed to collect all of the costs of procuring and providing transitional
standard offer service. Distribution and transmission rates remain unchanged
from the levels established in September 2002.
On February 18, 2004, the DPUC issued a final decision related to UI's request
for recovery of increased pension and postretirement benefits expenses. The
decision approved, with DPUC-required modifications, a settlement agreement
reached between UI and the Prosecutorial Division of the DPUC providing for the
annual recovery by UI of an additional $5.2 million of expenses. The settlement
also modified the earnings sharing mechanism from 50% to shareholders and 50% to
customers, to 100% to customers, with the entire customer portion being utilized
to reduce stranded costs. The settlement agreement also stipulated that UI will
not file a rate case before January 1, 2005. Although $5.2 million is not
sufficient to offset the increased costs fully, it does provide for recovery of
expenses above the level previously included in rates.
On April 2, 2004, the Office of Consumer Counsel (OCC) appealed the DPUC
decision to the Connecticut Superior Court. In late April 2004, the DPUC, on
its own motion, reopened the docket related to UI's recovery of increased
pension costs. At the end of June 2004, the DPUC issued an "interim draft
decision" that, if adopted as a final decision, states that it "rescinds" the
February 18, 2004 decision. Written exceptions have been filed by participants
- 34 -
in the docket. UI's written exceptions assert that the "interim draft decision"
could not lawfully be adopted, without change, as the final decision. Oral
arguments have been scheduled, and a final decision is expected to be issued in
the third quarter of 2004.
UI has taken substantial actions in 2003 and 2004 to mitigate the effect of
these increased pension and postretirement benefits expenses and also to reduce
the increases themselves through contributing $57 million in cash to the pension
plan since the docket was initially reopened in November 2002. These actions,
along with unanticipated sales growth, have allowed UI to mitigate the effect of
the increased pension and postretirement expenses to date. However, this issue
continues to generate administrative and court litigation, along with regulatory
uncertainty. As a result, in its written exceptions, UI has proposed that the
DPUC modify the February 18, 2004 decision to provide for a termination date of
the ratemaking set forth in that decision as of the date of the final decision
in this reopened docket. UI proposed that, as of such date, UI's ratemaking
would return to the ratemaking in effect on February 17, 2004, the day before
the February 18, 2004 decision, effectively eliminating the annualized $5.2
million of incremental recovery on a going forward basis. This proposal would
also include restoration of accelerated amortizations, sharing at 50% to
customers and 50% retained by UI for earnings in excess of 10.45%, and no
restrictions regarding the filing of a rate case. The 50% sharing to customers
includes 25% used to reduce stranded costs and 25% returned to customers via
bill surcredits.
UI believes that any attempt by the DPUC to retroactively adjust such recoveries
would be unlawful. Draft decisions may change, and do not necessarily indicate
the ultimate outcome of the DPUC's final decision. As of June 30, 2004, UI has
recovered approximately $2 million in accordance with the February 18, 2004
decision, which equates to approximately $0.08 per share, after-tax.
On June 23, 2004, the DPUC approved UI's request to amend its Purchase Power
Adjustment Clause to allow UI to apply the clause to special contract customers.
The DPUC also approved a Purchased Power Adjustment rate of $0.00264 per kWh to
be applied against special contract load to reflect the increased cost to serve
these customers. This will allow UI to recover changes in the cost to procure
energy as it relates to special contract customers. The decision does not
explicitly order the accounting for the increased costs of $0.8 million related
to UI's special contract customers for the period from January 1, 2004 through
June 22, 2004 (the day before the effective date of the final decision). These
actual costs to procure power for UI's special contract customers are being
accounted for as a GSC expense, which will flow through the annual CTA/SBC
Reconciliation filing for 2004. This treatment is consistent with the final
decision in this regulatory docket and with the statements in the 1998 and 2003
restructuring legislation (PA 98-28 and PA 03-135, as amended in part by
PA 03-221) that the distribution company is entitled to recover its full cost
of procuring power for customers who do not choose an alternate supplier. UI
has filed a request for clarification with the DPUC regarding this treatment.
This is not expected to impact net income as the CTA and GSC are pass-through
components.
OPERATIONS
In implementing the 1998 Restructuring Legislation, UI established a
Distribution Division and other "unbundled" components for accounting purposes,
to reflect other unbundled components on customer bills. Initially, the
Distribution Division included both transmission and distribution. UI has now
separated transmission from distribution into separate divisions for accounting
purposes. Changes to income and expense items related to transmission and
distribution have an immediate net income and earnings per share impact, while
changes to items in "other unbundled utility components" do not. The other
components are the CTA, the SBC, the GSC, the C&LM charge, and REI charge. The
CTA and SBC are both allowed to earn a 10.45% return on the equity portion of
their respective rate bases in accordance with the Rate Case decision that
became effective on September 26, 2002. Those returns are achieved either by
accruing additional amortization expenses, or by deferring such expenses, as
required to achieve the authorized return. Amortization expenses in the CTA and
SBC components impact earnings indirectly through changes to rate base. The GSC,
C&LM and REI are essentially pass-through components (revenues are matched to
recover costs). Except for the procurement fee in GSC previously discussed, and
a small management fee earned in the C&LM component, expenses are either accrued
or deferred or revenues are transferred such that there is no net income
associated with these three unbundled components.
UI's CTA collection recovers costs that have been reasonably incurred, or will
be incurred, to meet its public service obligations and that will likely not
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otherwise be recoverable in a competitive market. These "stranded costs" include
above-market long-term purchased power contract obligations, regulatory asset
recovery and above-market investments in power plants. Subject to future
regulatory changes to the CTA rate, significant load growth, or to the level of
amortization, CTA revenues are expected to remain relatively constant, with
amortization increasing over time as the allowed earnings trend downward due to
the decreasing rate base. A significant amount of UI's earnings is generated by
the authorized return on the equity portion of as yet unamortized stranded costs
in the CTA rate base. The CTA rate base earns exactly that return, no more and
no less, by adjustments made to amortization expense in each period. UI's
earnings per share attributable to CTA for the six months ended June 30, 2004
and 2003 were $0.48 and $0.51, respectively. A significant portion of UI's cash
flow from operations is also generated from those earnings and from the recovery
of the CTA rate base. Cash flow from operations related to CTA for the six
months ended June 30, 2004 and 2003 amounted to $13 million and $20 million,
respectively. CTA rate base has declined from year to year for a number of
reasons, including: amortization of stranded costs, the sale of the nuclear
units, and adjustments made through the annual DPUC review process. The original
rate base component of stranded costs, as of January 1, 2000, was $433 million.
It has since declined to $413 million at year-end 2000, $373 million at year-end
2001, $303 million at year-end 2002, $279 million at year-end 2003 and $276
million as of June 30, 2004. In July 2004, the DPUC issued a final decision
approving the year-end 2003 rate base component of stranded costs. During
July 2003, the DPUC issued an order requiring that the reduction of CTA rate
base utilizing excess GSC revenues be discontinued pursuant to the 2003
Restructuring Legislation. UI's CTA earnings will decrease while, based on UI's
current projections, cash flow will remain fairly constant until stranded costs
are fully amortized. Stranded costs are expected to be fully amortized between
2014 and 2016, depending upon the DPUC's future decisions which could affect
future rates of stranded cost amortization.
The primary Distribution Division operational factors affecting UI's financial
results are sales volume, ability to control expenses and capital expenditures.
Retail electric sales volume can be significantly affected by economic
conditions and weather. The level of economic growth can be reflected in many
ways; job growth or workforce reductions, plant relocations into or out of UI
territory, and facilities expansions or contractions, all of which can affect
demand for electricity. The weather can also have an impact on expenses,
dependent on the level of work required as a result of storms or other extreme
conditions. UI's major expense components are (1) purchased power, (2)
amortization of stranded costs; (3) wages and benefits; (4) depreciation; and
(5) regional network service transmission costs.
On October 22, 2003, UI entered into an agreement with PSEG Energy Resources &
Trade LLC (PSEG) for the supply of all of UI's transitional standard offer
generation service needs, excluding requirements for special contract customers,
from January 1, 2004 through December 31, 2006, the end of the transitional
standard offer period. UI continues to purchase generation services pursuant to
a December 28, 2001 agreement with Dominion Energy Marketing (Dominion) to
supply special contract customers through December 31, 2008. While purchased
power expenses are a pass-through expense in terms of the regulatory methodology
which facilitates how customers fund these costs (collected from customers in
the GSC and as federally mandated congestion costs), UI is a principal in its
relationships with these suppliers, and is the primary obligor in these
arrangements. The contract with PSEG contains numerous financial assurances
including a guaranty from PSEG's parent company, PSEG Power, various credit
requirements including maintaining a minimum Moody's credit rating of Baa3 or
equivalent, and a letter of credit to secure performance through the initial
stages of the contract. UI is also required to maintain a minimum credit rating
of Baa3 or equivalent. UI's current Moody's credit rating is Baa1, which is two
levels above the required minimum.
In order to maintain and improve its electricity delivery system and to provide
quality customer service, UI is required to spend a significant amount each year
on capital projects in the Distribution and Transmission Divisions. A large
portion of the funds required for capital projects is provided internally
through the recovery of depreciation and from amortization of stranded costs.
The remainder must be financed externally.
UI, together with The Connecticut Light and Power Company, has filed with the
Connecticut Siting Council (CSC) an application for a Certificate of
Environmental Compatibility and Public Need to construct a 345-kiloVolt
transmission line from Middletown, Connecticut to Norwalk, Connecticut. This
project is necessary to improve the reliability of the transmission system in
southwest Connecticut. The two companies are working together for permitting,
and will each construct, own and operate its respective portion of the
transmission line and related facilities. UI will construct, own, and operate
transmission and substation facilities comprising approximately 20% of the total
- 36 -
project. UI's current estimate for its share of the project cost is
approximately $112 million (excluding allowance for funds used during
construction). The CSC has issued a press release proposing that a final
decision be rescheduled to December 2004. Based on the currently projected
schedule of construction, the project would be completed by the end of 2007.
Other governmental permitting, together with approvals from ISO-New England,
will be required for the project, and the total project cost and timing of
completion could change depending on final permit requirements and final
specifications. UI's costs for the project are expected to be included in and
recovered through transmission rates under FERC jurisdiction.
RISK MANAGEMENT AND INSURANCE
UI's primary risk management and insurance exposures include bodily injury,
property damage, fiduciary responsibility, and injured workers' compensation. UI
is insured for general liability, automobile liability, property loss, fiduciary
liability and workers' compensation liability. UI's general liability and
automobile liability programs provide insurance coverage for third party
liability claims for bodily injury (including "pain and suffering") and property
damage, subject to a deductible. Losses up to the deductible amounts are accrued
based upon our estimates of the liability for claims incurred and an estimate of
claims incurred but not reported. UI reviews the general liability reserves
quarterly to ensure that UI is appropriately reserved. The reserve is based on
historical claims, business events, industry averages and actuarial studies.
Insurance liabilities are difficult to assess and estimate due to unknown
factors such as claims incurred but not reported and awards greater than
expected, therefore reserve adjustments may become necessary as cases unfold. UI
insures its property subject to deductibles depending on the type of property.
UI's fiduciary liability program and workers' compensation program provides
insurance coverage, subject to deductibles as well. As with other companies, UI
has seen significant increases in its workers' compensation premiums from its
carrier since the terrorist attacks of September 11, 2001.
XCELECOM, INC.
The principal factors affecting the financial results of Xcelecom and its
subsidiaries are (1) construction and technology spending; (2) competition; (3)
fixed-priced contract estimation and bidding; (4) work-related hazards and
insurance; (5) attracting and retaining management expertise; (6) overall
liquidity and ability to obtain surety bonding, and (7) risks of attaining
required labor productivity levels to meet or exceed contract estimates.
Additional risk factors include general economic conditions, the pace of
technological changes, recoverability and potential for impairment of goodwill,
and collectibility of receivables.
More than half of Xcelecom's business involves the installation of electrical,
mechanical and integrated network information systems in newly constructed and
renovated buildings and plants. Downturns in levels of construction starts and
business spending can have a material adverse effect on Xcelecom's business,
financial condition and results of operations. In addition, Xcelecom's business
is subject to seasonal variations in operations and demand that affect the
construction business, particularly in new construction. Quarterly results may
also be affected by regional economic conditions. Accordingly, Xcelecom's
performance in any particular quarter may not be indicative of the results that
can be expected for any other quarter or for the entire year. The competitive
bidding process for new business contracts normally intensifies during economic
downturns, leading to lower profit margins and an increased potential for
project cost overruns or losses.
Xcelecom's contracts are entered into principally on the basis of competitive
bids. The final terms and prices of those contracts are frequently negotiated
with the customer. Although contract terms vary considerably, most are made on
either a fixed price or unit price basis in which Xcelecom agrees to do the work
for a fixed amount for the entire project (fixed price) or for units of work
performed (unit price), although services are sometimes performed on a cost-plus
or time and materials basis. Xcelecom's most significant cost drivers are the
cost of labor, including employee benefits, the cost of products and materials,
and the cost of casualty insurance. These costs may vary from the costs
originally estimated. Variations from estimated contract costs along with other
risks inherent in performing fixed price and unit price contracts may result in
actual revenue and gross profits for a project differing from those originally
estimated and could result in losses on projects. Depending on the size of a
particular project, variations from estimated project costs could have a
significant impact on operating results for any fiscal quarter or year.
- 37 -
Hazards related to Xcelecom's industry include, but are not limited to,
electrocutions, fires, mechanical failures, and transportation accidents. These
hazards can cause personal injury and loss of life, severe damage to or
destruction of property and equipment, and may result in suspension of
operations. Xcelecom's third-party insurance is subject to large deductibles for
which reserves are established. Accordingly, Xcelecom self-insures for this
exposure. Xcelecom believes its insurance and provisions for self-insurance of
deductibles are adequate to cover reasonably foreseeable losses and liabilities.
Losses impacting self-insurance provisions or exceeding insurance limits could
impact Xcelecom's operating results.
The loss of key personnel or the inability to hire and retain qualified
employees could have an adverse effect on Xcelecom's business, financial
condition and results of operations. Xcelecom's operations depend on the
continued efforts of current and future executive officers, senior management
and management personnel at the companies acquired by Xcelecom. Certain steps
taken to mitigate the risk of loss of key personnel of acquired companies were
the use of earn-out payments, promissory notes, and covenant not to compete
agreements. A criterion used in evaluating acquisition candidates was the
quality of their management. There is no guarantee that any member of management
of Xcelecom or any of its subsidiaries will continue in their capacity for any
particular period of time. The loss of a group of key personnel could adversely
affect Xcelecom's operations.
Billings under fixed price contracts are generally based upon achieving certain
benchmarks and will only be accepted by the customer once it is demonstrated
that those benchmarks have been met. If Xcelecom is unable to show compliance
with billing requests, or fails to issue a timely project billing, the
likelihood of collection could be delayed or impaired, which could have a
material adverse effect on operations. An allowance for doubtful accounts for
unknown collection issues is maintained, in addition to reserves for specific
accounts receivable where collection is considered doubtful. Inherent in the
assessment of the allowance for doubtful accounts are certain judgments and
estimates including, among others, customers' access to capital, customers'
willingness to pay, general economic conditions and the ongoing relationships
with customers.
Surety market conditions are currently difficult as a result of significant
losses incurred by many sureties in recent periods, both in the construction
industry as well as in certain large corporate bankruptcies. As a result, less
bonding capacity is available in the market and terms have become more
restrictive. Further, under standard terms in the surety market, sureties issue
bonds on a project by project basis, and can decline to issue bonds at any time.
Historically, approximately one third of Xcelecom's construction related
business has required bonds. While Xcelecom has enjoyed a longstanding
relationship with its surety, current market conditions as well as changes in
the surety's assessment of Xcelecom's operating and financial risk could cause
the surety to decline to issue bonds for future projects. If that were to occur,
alternatives include doing more business that does not require bonds, posting
other forms of collateral for project performance such as letters of credit or
cash, and seeking bonding capacity from other sureties. There can be no
assurance that such alternatives could be easily achieved. Accordingly, if
Xcelecom were to experience an interruption in the availability of bonding
capacity, its operating results could be adversely impacted.
Xcelecom's business is primarily driven by labor. The ability to perform
contracts at acceptable margins depends on the ability to deliver substantial
labor productivity. It cannot be guaranteed that productivity will continue at
acceptable levels for a particular period of time. The loss of productivity
could adversely affect the margins on existing contracts or the ability to
obtain new contracts.
Historically, a significant amount of Xcelecom's growth has come through
acquisitions. From July of 1999 to Xcelecom's last significant acquisition in
April of 2002, Xcelecom made 12 acquisitions. Xcelecom currently does not intend
to grow materially through acquisitions in the foreseeable future; however, it
will continually evaluate acquisition prospects to complement and expand its
existing business platforms. The timing, size or success of any acquisition
effort and the associated potential capital commitments cannot be predicted.
Each acquisition involves a number of risks. These risks include the diversion
of management's attention from existing businesses to integrating the operations
and personnel of the acquired business; possible adverse effects on operating
results during the integration process; and possible inability to achieve the
intended objectives of the combination. If acquisitions do not perform as
expected, Xcelecom may be required to write-off some or all of the value of any
goodwill and intangible assets associated with the acquisitions. Financial
results may also be impacted by the degree of integration of acquisitions,
- 38 -
including the ability to achieve synergies over the network of subsidiaries.
Xcelecom's revenue growth over the past several years has been generated
principally through acquisitions. In the absence of economic improvement in the
regional markets in which Xcelecom operates, Xcelecom does not expect any
material revenue growth in 2004.
The computer industry in general has felt the effects of the slowdown in the
United States economy, and Xcelecom has specifically seen a decrease in demand
for the products and services it sells. Xcelecom sales can be dependent on
demand for specific product categories, and any change in demand for, or supply
of, such products could have a material adverse effect on Xcelecom's sales if it
fails to react in a timely manner to such changes. One crucial measure of
performance, gross profit as a percentage of net sales, can fluctuate due to
numerous factors, including changes in prices from suppliers, reductions in the
amount of supplier reimbursements that are made available, changes in customer
mix, the relative mix of products sold during the period, general competitive
conditions, the availability of opportunistic purchases and opportunities to
increase market share. In addition, expense levels, including the costs and
salaries incurred in connection with the hiring of sales and technical services
personnel, are based, in part, on anticipated sales. Therefore, Xcelecom may not
be able to reduce spending in a timely manner to compensate for any unexpected
sales or margin shortfalls. As a result, comparisons of Xcelecom's quarterly
financial results should not be relied upon as an indication of future
performance.
COST DRIVERS
As a service business, Xcelecom's cost structure is highly variable. Primary
costs include labor, materials and insurance. Approximately 51% of costs are
derived from labor and related expenses. For the six months ended June 30, 2004
and 2003, labor-related expenses totaled $78.4 million and $75.4 million,
respectively.
Approximately 34% of Xcelecom's costs incurred are for materials installed on
projects and equipment and other products sold to customers. This component of
the expense structure is variable based on the demand for services. Costs are
generally incurred for materials once work begins on a project or a customer
order is received. Materials are ordered when needed, shipped directly to the
jobsite or customer facility, and installed within 30 days. Materials consist of
commodity-based items such as conduit, pipe, data cabling, wire and fuses as
well as specialty items such as fixtures, switchgear, switches and routers,
servers and control panels. For the six months ended June 30, 2004 and 2003,
material and equipment expenses totaled $53 million and $47.6 million,
respectively.
REGULATIONS
Xcelecom's operations are subject to various federal, state and local laws and
regulations, including:
- - licensing requirements applicable to electricians, steamfitters and plumbers;
- - building, mechanical and electrical codes;
- - regulations relating to consumer protection, including those governing
residential service agreements; and
- - regulations relating to worker safety and protection of the environment.
Xcelecom believes it has all licenses required to conduct operations and is in
substantial compliance with applicable regulatory requirements. Failure to
comply with applicable regulations could result in substantial fines or
revocation of operating licenses or an inability to perform government work.
Many state and local regulations governing electricians, steamfitters and
plumbers require permits and licenses to be held by individuals. In some cases,
a required permit or license held by a single individual may be sufficient to
authorize specified activities for all employees who work in the state or county
that issued the permit or license. It is Xcelecom's policy to ensure that, where
possible, any permits or licenses that may be material to its operations in a
particular geographic area are held by multiple Xcelecom employees within that
area.
RISK MANAGEMENT AND INSURANCE
The primary risks in Xcelecom's operations include health, bodily injury,
property damage and injured workers' compensation. Xcelecom is insured for
workers' compensation, automobile liability, general liability and
employee-related health care claims, subject to large deductibles. A general
liability program provides coverage for bodily injury and property damage
neither expected nor intended. Losses up to the deductible amounts are accrued
- 39 -
based upon our estimates of the liability for claims incurred and an estimate of
claims incurred but not reported. The accruals are derived from actuarial
studies, known facts, historical trends and industry averages utilizing the
assistance of an actuary to determine the best estimate of the ultimate expected
loss. Xcelecom believes such accruals to be adequate. However, insurance
liabilities are difficult to assess and estimate due to unknown factors,
including the severity of an injury, the determination of liability in
proportion to other parties, the number of claims incurred but not reported and
the effectiveness of Xcelecom's safety programs. Therefore, if actual experience
differs from the assumptions used in the actuarial valuation, adjustments to the
reserve may be required and would be recorded in the period that the experience
becomes known.
UNITED CAPITAL INVESTMENTS, INC.
UCI has a 25% interest in Cross-Sound Cable Company, LLC (Cross-Sound), which
owns and operates a 330-megawatt transmission line (cable) connecting
Connecticut and Long Island under the Long Island Sound. The Cross-Sound
project has been opposed on environmental, safety, and economic grounds by a
number of public officials and private groups who have participated actively in
governmental permitting proceedings relative to the project. In January 2002,
the CSC granted a certificate of environmental compatibility and public need to
construct the cable. The Connecticut Attorney General (AG) appealed the CSC's
decision without success to the Connecticut Superior Court. He also appealed
the Superior Court's decision to the Connecticut Supreme Court, but in
September 2003 withdrew the appeal, leaving intact the Superior Court's
decision upholding the CSC approval.
The project received all necessary permits prior to the cable being installed
in the spring of 2002. After installation, it was determined that several
sections of the cable in New Haven Harbor were not buried to the depths
required by the permits. The authorized depth was not achieved due to the
obstruction of rock ledge, sediment and other more movable types of
obstruction, such as tree stumps and metal plate debris. The Connecticut
Department of Environmental Protection (CDEP) and United States Army Corp of
Engineers have raised no environmental or navigational concerns related to
operation of the cable as currently buried; however, the CDEP has indicated
that under the current permit, the permit depth must be reached before
commercial operation can begin. On June 12, 2003 Cross-Sound submitted a new
permit application to the CDEP requesting that the CDEP issue a permit to allow
Cross-Sound to operate the cable as installed in its current location through
December 31, 2007.
On August 14, 2003, the day of the blackout that affected the Northeast and the
Upper Midwest areas of the United States as well as portions of Canada, the
federal Department of Energy (DOE) declared a federal emergency and issued an
Emergency Order to allow immediate operation of the Cross-Sound cable, and
subsequently issued a new Order for the cable to operate until all of the
appropriate actions that should be taken to prevent future power outages in the
region have been identified and implemented. The cable operated full time
pursuant to the Emergency Order until May 2004, either transferring power, or
available to transfer power, across the Long Island Sound. During the operation
under the Emergency Order, Cross-Sound responded to frequent requests by ISO-New
England and ISO-New York to help maintain a steady operating voltage in their
respective systems. It also provided reactive power voltage support and
responded automatically to system instability caused by lightning strikes and
equipment outages. On May 7, 2004, the DOE issued Order No. 202-03-4 which
terminated the Emergency Order. In this Order, the DOE noted that the final
report issued by the U.S. - Canada Power System Outage Task Force that
investigated the August 14, 2003 outage did not identify any particular role
that the Cross-Sound cable would have played in preventing the outage, or
stopping the spread of the outage, had the cable been in operation on August 14,
2003. Pursuant with the Order, the cable ceased operations.
There has been a Connecticut legislative moratorium on installing new gas and
utility lines across Long Island Sound which had prevented Cross-Sound from
resolving outstanding permitting issues. In early May 2004, the Connecticut
General Assembly passed a bill extending the moratorium for another year to
early June 2005. This legislation also allowed for a waiver of the moratorium by
means of an applicant receiving unanimous approval of a petition to certain
specified legislative and regulatory officials. In June 2004, Cross-Sound
obtained a waiver of the Connecticut Legislative moratorium on installing new
gas and utility lines across Long Island Sound. In addition, a settlement
agreement was executed by Cross-Sound, the CDEP, the DPUC, Long Island Power
Authority, Long Island Lighting Company d/b/a LIPA (LILCO/LIPA), and Northeast
- 40 -
Utilities Service Company, as agent for The Connecticut Light and Power Company
(CL&P), which allowed for immediate commercial operation of the cable. Retention
of commercial operation is contingent upon the satisfaction of certain
provisions of the settlement agreement which include: (1) Cross-Sound coming
into compliance with permit conditions as directed by the CDEP; (2) LILCO/LIPA
and CL&P reaching an agreement by October 1, 2004 for the replacement of an
existing transmission line (the "1385 line" which is operationally unrelated to
the Cross-Sound cable) and implementing such agreed upon replacement on a
schedule approved by the Commissioner of Environmental Protection; and (3)
Cross-Sound, CL&P and LILCO/LIPA committing a collective amount of $6 million,
of which Cross-Sound's commitment is $2 million, to a research and restoration
fund for the Long Island Sound to be administered jointly by the entities of New
York and Connecticut. On June 28, 2004, the Cross-Sound cable began transmitting
power in accordance with the settlement agreement.
The remediation required to bring the Cross-Sound cable in compliance with the
permit conditions as directed by the CDEP consists primarily of achieving the
originally required burial depth in those areas deemed as "soft spots", meaning
the obstructions which originally prevented achievement of such depth can
generally be removed without the use of techniques such as blasting. The costs
of this remediation are currently estimated at $1 million and are within the
estimated final cost of the project. The remediation work is scheduled to begin
in the fourth quarter of 2004. The permit conditions do not require the
original burial depth to be achieved in those areas where rock ledge
obstruction prevented meeting the original burial depth.
UCI's 25% share of the estimated total final cost of the Cross-Sound project is
$35 million. As of June 30, 2004, UCI's 25% share of the actual project cost
for the Cross-Sound cable was $34.3 million. UCI has provided an equity
infusion of $10 million to Cross-Sound. Additionally, UIL Holdings loaned $24.4
million, including capitalized interest, to Cross-Sound. A guarantee of $1.3
million, in support of a Hydro-Quebec guarantee to third parties in connection
with the construction of the project has also been provided (see "Notes to the
Consolidated Financial Statements - Note (J), Commitments and Contingencies -
Cross-Sound Cable Company, LLC", for further discussion of this guarantee). It
is expected that any obligations of Cross-Sound that are supported by the
guarantee would be funded by capital contributions from the owners, who are
affiliates of the guarantors, in amounts in proportion of their respective
ownership shares of Cross-Sound. UIL Holdings has completed a probability
weighted analysis based on the likelihood of certain events occurring which
would cause UIL Holdings to be required to perform under this guarantee. The
result of this analysis resulted in a liability amount that was
inconsequential, and as such, no liability has been recorded in UIL Holdings'
consolidated balance sheet as of June 30, 2004.
Upon satisfaction of all provisions of the settlement agreement, the loan from
UIL Holdings is expected to be refinanced with external project financing. UCI
will be responsible for 25% of any additional cost of project completion over
the estimated amount.
In connection with the settlement agreement, the existing contract Cross-Sound
has with the Long Island Power Authority for the entire capacity of the
transmission line is being reviewed and negotiations are taking place to
increase the overall term of the agreement from 20 years to 28 years by means
of adding an initial three year period at reduced rates, and an additional five
years to the end of the contract term, at full rates.
UCI's investments in the venture funds in which it holds equity interests were
viewed as an opportunity to earn reasonable returns and promote local economic
development. Due to the nature of its investments and market conditions, the
value of the Zero Stage VI fund has decreased substantially since the end of
2000. In fact, the liabilities of the fund are currently in excess of the market
value of its assets, and as such, UCI wrote down its investment in Zero Stage VI
to zero in the first quarter of 2004. In July 2004, UCI funded its remaining
capital commitment of $0.5 million to Zero Stage VII. There have been no
material changes since December 31, 2003 in the values of the other venture
funds in which UCI holds equity interests.
- 41 -
UNITED BRIDGEPORT ENERGY, INC.
UBE holds a 33 1/3% ownership interest in Bridgeport Energy LLC (BE), the owner
of a gas-fired 520 MW merchant wholesale electric generating facility located in
Bridgeport, Connecticut. The principal factors which affect the financial
condition of UBE are natural gas prices, maintenance costs and installed
capability (ICAP) revenues. As UBE holds a minority interest in BE, there are
additional risk factors associated with the activities of the majority owner, an
affiliate of Duke Energy.
Results at UBE continue to be hampered by high natural gas prices that drive
down both margins and sales volumes at BE. Although natural gas prices have
remained at elevated levels in recent years, DOE Annual Energy Outlook
projections show improving conditions in the future. Based on these projections,
no conditions were noted to give rise to an impairment with respect to the
current $78.5 million carrying value of UBE's investment in BE. UBE will
continue to monitor its investment in BE for recoverability, as changes in the
projections considered could have a negative impact on the carrying value of the
investment in the future.
Although routine maintenance is performed on the plant on a regular basis, from
time to time the plant must be brought offline for a major overhaul. The next
major overhaul is planned for 2005. Under an existing maintenance contract, the
plant has begun incurring some of these costs, and they are being accrued until
the outage occurs. BE has sufficient cash to fund these costs in 2004, however,
based on the current 2004 earnings estimate, BE will require additional capital
from the owners to cover the additional costs in 2005 when the outage occurs.
Based on current projections, UBE's additional capital requirements could be as
great as $7 million.
The ICAP market is designed to offer an incentive to developers to build
adequate generating capacity. BE receives ICAP revenues based on the plant's
installed capacity. The plant began initial operation with a multi-year contract
for ICAP. Since the contract ended in 2002, BE has only been able to sell its
ICAP in the forward month market at a much lower price, reducing ICAP revenues
by approximately 75% to 85%. The FERC has directed ISO-NE to develop a
Locational ICAP Market, with the intent to provide higher capacity payments to
generators within designated congestion areas. The FERC has delayed the decision
on Locational ICAP until January 2006 to allow more time to study the issue. The
full impact that Locational ICAP will have is not known at this time.
The majority owner of BE, an affiliate of Duke Energy, has a 60% interest in
Duke Energy Trading and Marketing (DETM) which is a joint venture with Exxon
Mobil Corporation. BE has an agreement through August 2018 with DETM that gives
DETM the right to deliver natural gas to the facility and market all the
electricity generated by the facility. DETM reimburses BE under a formula based
on the difference between gas costs and electric prices. In early January 2004,
Duke Energy announced it plans to wind down DETM as part of a plan to
restructure its merchant energy business. UBE is currently working with Duke
Energy and DETM to restructure the DETM agreement to more accurately reflect the
current energy market. UBE does not anticipate at this time that these plans, or
the potential changes to the DETM agreement, will have a negative impact on the
operations of BE.
As the majority owner of BE, Duke Energy's affiliate is responsible for the
daily operations and administration of the plant, including all accounting and
financial reporting functions of BE. As a minority interest owner, UBE relies on
the financial reports provided by BE to record its appropriate share of income
or losses of BE. During 2004, results at BE have been negatively impacted by a
number of accounting adjustments related to prior years. The impact of these
adjustments on UBE's results for the six months ended June 30, 2004 was $0.4
million.
AMERICAN PAYMENT SYSTEMS, INC.
As a result of the completion of the sale of APS to CheckFree on June 22, 2004,
UIL Holdings is no longer subject to the operating risk factors that affected
the financial results of APS in prior reporting periods. UIL Holdings' exposure
regarding APS is now governed by the indemnity provisions of the Stock Purchase
Agreement pursuant to which APS was sold to CheckFree. Those provisions require
UIL Holdings to indemnify CheckFree for breaches of the representations and
warranties contained in the agreement (subject to certain limitations), as well
as certain specified matters relating to the operations of APS prior to the
sale.
- 42 -
LIQUIDITY AND CAPITAL RESOURCES
There have been no material changes in UIL Holdings' capital resources or
capital requirements from those reported in UIL Holdings' Annual Report on Form
10-K for the fiscal year ended December 31, 2003.
Moody's Investors Service downgraded UIL Holdings' Issuer Rating from Baa1 to
Baa2 in the first quarter of 2004. Moody's also downgraded UI's Issuer Rating
and senior unsecured debt rating from A3 to Baa1. Moody's has stated that the
ratings of both UIL Holdings and UI remain under review for possible further
downgrade. The financial impact of this action is minimal. Other than the
re-pricing of $27.5 million of pollution control revenue bonds on February 1,
2005, neither UIL Holdings nor UI expect to issue or refinance any long-term
debt prior to December 2007.
The amount of UIL Holdings' quarterly cash dividends in 2004 is expected to be
equal to the cash dividend of $0.72 per share paid in each quarter of 2003. UIL
Corporate will continue to be entirely dependent on dividends from its
subsidiaries and from external borrowings to provide the cash necessary for debt
service, to pay administrative costs, to meet other contractual obligations that
cannot be met by the non-utility subsidiaries, and to pay common stock dividends
to UIL Holdings' shareholders. As UIL Corporate's sources of cash are limited to
dividends from its subsidiaries and external borrowings, the ability to maintain
future cash dividends at the level currently paid to shareholders will be
dependent upon 1) growth in the earnings of UI, 2) the ability of Xcelecom and
UIL Holdings' minority interest investments to begin providing dividends to UIL
Corporate, or 3) a reduction in the number of shares outstanding. In order to
achieve growth in earnings, UI will need to increase its rate base through
capital investments, as without substantial additions to the rate base, UI's
earnings would gradually decline over time due to the amortization of the CTA
rate base. UIL Holdings' current strategy for Xcelecom and the minority interest
investments calls for those entities to be largely cash self-sufficient going
forward. However, the ability of these entities, particularly the minority
interest investments, to improve earnings, cash flow, and their ability to
dividend cash to UIL Corporate without causing harm to their own operations or
financial conditions cannot be assured. UIL Holdings does not expect to receive
dividends from Xcelecom or its minority interest investments in 2004. See the
"Major Influences on Financial Condition" section of this Item 2 for more
information.
UIL Holdings and its subsidiaries will continue their efforts to improve the
earnings and cash flow position of UIL Holdings, to strengthen its financial
position, and improve its dividend to earnings payout ratio.
All capital requirements that exceed available cash will have to be provided by
external financing. Although there is no commitment to provide such financing
from any source of funds, other than a $100 million revolving credit agreement
that UIL Holdings has with a group of banks, and a $30 million revolving credit
agreement that Xcelecom has with two banks, future external financing needs are
expected to be satisfied by the issuance of additional short-term and long-term
debt. The continued availability of these methods of financing will be dependent
on many factors, including conditions in the securities markets, economic
conditions, and future income and cash flow. See Item 1, "Financial Statements -
Notes to Consolidated Financial Statements - Note (B), Capitalization and Note
(D), Short-Term Credit Arrangements" for a discussion of UIL Holdings' credit
arrangements.
- 43 -
At June 30, 2004, UIL Holdings had $90.1 million of unrestricted cash and
temporary cash investments. This represents an increase of $61.5 million from
the corresponding balance at December 31, 2003. The components of this increase,
which are detailed in the Consolidated Statement of Cash Flows, are summarized
as follows:
(In Millions)
Balance, December 31, 2003 $28.6
--------------
Net cash provided by operating activities
of continuing operations 62.8
Net cash (used in) investing activities of
continuing operations:
- Acquisition of Electric System Work Center facility (16.2)
- Cash invested in plant (12.0)
- Changes in restricted cash (1) 1.0
- Deferred payments in prior acquisitions (2.1)
- Loan to Cross-Sound Cable Project (0.4)
--------------
(29.7)
Net cash (used in) financing activities
of continuing operations:
- Financing activities, excluding dividend payments (62.5)
- Dividend payments (20.6)
--------------
(83.1)
Net cash provided by (used in) discontinued operations 111.5
Net Change in Cash 61.5
--------------
Balance, June 30, 2004 $90.1
==============
(1) As of June 30, 2004, UIL Holdings had $0.4 million in restricted cash
related to future debt payments of Xcelecom.
The net change in UIL Holdings' unrestricted cash position at June 30, 2004, as
compared to December 31, 2003, was due to a combination of cash provided by
operating activities of continuing operations, as well as the proceeds provided
by discontinued operations due to the completion of the sale of APS in June
2004. Cash provided by operating activities of continuing operations was driven
mainly by the utility business and was more than sufficient to cover the payment
of UIL Holdings' quarterly dividends amounting to $20.6 million, as well as a
variety of investing activities including UI's purchase of the Electric System
Work Center facility for $16.2 million in January 2004. UIL Holdings' cash
position as of June 30, 2004 was bolstered by the $109 million of proceeds
received from the completion of the sale of APS in June 2004, a portion of which
was used to payoff $65 million of short-term borrowings. Based on the level of
the current cash balance and projected cash requirements, UIL Holdings'
projected short-term borrowings (if any) are not expected to be significant
through the end of 2004.
CONTRACTUAL AND CONTINGENT OBLIGATIONS
At June 30, 2004 there was no material change in UIL Holdings' and its
subsidiaries contractual and contingent obligations from those reported in UIL
Holdings' Annual Report on Form 10-K for the fiscal year ended December 31,
2003.
- 44 -
CRITICAL ACCOUNTING POLICIES
UIL Holdings' Consolidated Financial Statements are prepared based on certain
critical accounting policies that require management to make judgments and
estimates that are subject to varying degrees of uncertainty. UIL Holdings
believes that investors need to be aware of these policies and how they impact
UIL Holdings' financial reporting to gain a more complete understanding of UIL
Holdings' Consolidated Financial Statements as a whole, as well as management's
related discussion and analysis presented herein. While UIL Holdings believes
that these accounting policies are grounded on sound measurement criteria,
actual future events can and often do result in outcomes that can be materially
different from these estimates or forecasts. The accounting policies and related
risks described in UIL Holdings' Annual Report on Form 10-K for the fiscal year
ended December 31, 2003 are those that depend most heavily on these judgments
and estimates. At June 30, 2004, there have been no material changes to any of
the Critical Accounting Policies contained therein, with the exception of UI's
calculation of unbilled revenue as described below:
UNBILLED REVENUE
At the end of each accounting period, UI accrues an estimated amount for
services rendered but not billed. Through the end of 2003, the calculation was
based upon UI's system requirements or kilowatt-hour usage less distribution
losses and UI use for a given period, reduced by kilowatt-hours already billed
to customers (requirements method). Beginning in the first quarter of 2004, UI
began utilizing a new customer accounting software package integrated with the
network meter reading system to estimate unbilled revenue (installation method).
This allows for the calculation of unbilled revenue on a customer-by-customer
basis, utilizing actual daily meter readings at the end of each month to
calculate consumption and pricing for each customer. Customers aggregating to
approximately 70% of utility retail kilowatt-hour consumption are currently part
of the network meter reading system. For those customers still requiring manual
meter readings, consumption is estimated based upon historical usage and actual
pricing for each customer.
This implementation of the new system addressed above provides a more precise
method of calculating estimated unbilled revenue at the customer level in that
the system can consider changes to rates, prices, devices, registers, meter
reading results and other installation specific data. It also mitigates the
potential variability inherent in the requirements method from estimating
distribution losses. The installation method remains sensitive to numerous
factors, any of which can have a significant impact on the estimate of unbilled
revenue, such as estimated consumption for those customers not a part of the
network meter reading system, changes in or problems with metering, seasonality,
price changes and billing adjustments. Conversion to the new system resulted in
a change in estimate that yielded a non-recurring increase to unbilled revenue
of approximately $2.6 million and consolidated earnings per share of
approximately $0.07 during the first quarter of 2004.
- 45 -
RESULTS OF OPERATIONS
SECOND QUARTER 2004 VS. SECOND QUARTER 2003
- -------------------------------------------
UIL HOLDINGS CORPORATION RESULTS OF OPERATIONS: SECOND QUARTER 2004
- --------------------------------------------------------------------
VS. SECOND QUARTER 2003
- ------------------------
UIL Holdings' earnings from continuing operations for the second quarter of 2004
increased by $5.4 million, or $0.37 per share, compared to the second quarter of
2003. Net income from discontinued operations, including the gain on the sale of
APS, increased by $49.1 million, or $3.42 per share, in the second quarter of
2004 from the second quarter 2003 net loss of $0.7 million, or $0.05 per share.
Total earnings for the second quarter of 2004, including discontinued
operations, increased by $54.5 million, or $3.79 per share, from the same period
of 2003.
The increase in earnings from continuing operations was mainly due to
non-recurring gains at UI from a settlement by ISO-NE related to a review of the
allocation of New England Power Pool transmission revenues to member companies,
and the resolution of tax and other post-closing issues related to UI's sale of
Seabrook Station. Results at UI also benefited from an increase in kilowatt-hour
consumption as compared to the same period of 2003. Improved results from
Xcelecom's electrical contracting business also contributed to the increase in
earnings from the second quarter of 2003.
The table below represents a comparison of UIL Holdings' Net Income and Earnings
per Share (EPS) for the second quarter of 2004 and the second quarter of 2003.
Quarter Ended Quarter Ended 2004 more (less) than 2003
June 30, 2004 June 30, 2003 Amount Percent
------------------ ------------------ ---------------- ------------
NET INCOME (IN MILLIONS EXCEPT PERCENTS AND PER
SHARE AMOUNTS)
UI $12.3 $8.0 $4.3 54%
Non-Utility (1.9) (3.0) 1.1 37%
----- ----- ---
TOTAL NET INCOME FROM CONTINUING
OPERATIONS $10.4 $5.0 $5.4 108%
Discontinued Operations 48.4 (0.7) 49.1 7,000%
---- ----- ----
TOTAL NET INCOME $58.8 $4.3 $54.5 1,267%
==== === ====
EPS
UI $0.85 $0.56 $0.29 52%
Non-Utility (0.13) (0.21) 0.08 38%
------ ------ ----
TOTAL EPS FROM CONTINUING
OPERATIONS - BASIC $0.72 $0.35 $0.37 106%
Discontinued Operations 3.37 (0.05) 3.42 6,840%
---- ------ ----
TOTAL EPS - BASIC $4.09 $0.30 $3.79 1,263%
==== ==== ====
TOTAL EPS - DILUTED (NOTE A) $4.08 $0.30 $3.78 1,260%
==== ==== ====
Note A: Reflecting the effect of unexercised dilutive stock options. Such
dilution does not impact the earnings from continuing operations, but dilutes
the earnings from discontinued operations by $0.01 per share.
- 46 -
The following table presents a line-by-line breakdown of revenue and expenses
from UIL Holdings' Consolidated Statement of Income by subsidiary, including
comparisons between the second quarter of 2004 and the second quarter of 2003.
Significant variances are explained in the discussion and analysis of individual
subsidiary results that follow.
QUARTER ENDED QUARTER ENDED 2004 MORE (LESS)
(IN MILLIONS) JUN. 30, 2004 JUN. 30, 2003 THAN 2003
- ------------- ------------- ------------- ---------
OPERATING REVENUES
UI from operations $175.6 $156.1 $19.5
Xcelecom 85.1 74.6 10.5
Minority Interest Investment & Other 0.1 (0.1) 0.2
--- ---- ---
TOTAL OPERATING REVENUES $260.8 $230.6 $30.2
====== ======= =====
FUEL AND ENERGY EXPENSES - UI $81.4 $62.3 $19.1
===== ====== =====
OPERATION AND MAINTENANCE EXPENSES
UI $46.2 $44.3 $1.9
Xcelecom 83.8 74.6 9.2
Minority Interest Investment & Other 1.1 1.0 0.1
--- ---- ---
TOTAL OPERATION AND MAINTENANCE EXPENSES $131.1 $119.9 $11.2
====== ======= =====
DEPRECIATION AND AMORTIZATION EXPENSES
UI $7.3 $6.8 $0.5
Xcelecom 0.8 0.8 0.0
--- ---- ---
Subtotal depreciation 8.1 7.6 0.5
Amortization of regulatory assets (UI) 7.7 13.7 (6.0)
Amortization Xcelecom 0.3 0.4 (0.1)
--- ---- -----
TOTAL DEPRECIATION AND AMORTIZATION EXPENSES $16.1 $21.7 $(5.6)
====== ====== ======
TAXES - OTHER THAN INCOME TAXES
UI - State gross earnings tax $6.2 $6.1 $0.1
UI - other 3.4 3.4 0.0
Xcelecom 0.4 0.4 0.0
--- ---- ---
TOTAL TAXES - OTHER THAN INCOME TAXES $10.0 $9.9 $0.1
===== ===== ====
- 47 -
QUARTER ENDED QUARTER ENDED 2004 MORE (LESS)
(IN MILLIONS) JUN. 30, 2004 JUN. 30, 2003 THAN 2003
- ------------- ------------- ------------- ---------
OTHER INCOME (DEDUCTIONS)
UI $2.4 $1.3 $1.1
Xcelecom 0.2 0.2 0.0
Minority Interest Investment & Other (1.2) (0.8) (0.4)
----- ----- -----
TOTAL OTHER INCOME (DEDUCTIONS) $1.4 $0.7 $0.7
==== ==== ====
INTEREST CHARGES
UI $3.8 $5.3 $(1.5)
UI - Amortization: debt expense, redemption premiums 0.4 0.3 0.1
Xcelecom 0.2 0.2 0.0
Minority Interest Investment & Other 1.6 1.5 0.1
--- ---- ---
TOTAL INTEREST CHARGES $6.0 $7.3 $(1.3)
==== ===== ======
INCOME TAXES
UI $9.3 $7.2 $2.1
Xcelecom (0.1) (0.6) 0.5
Minority Interest Investment & Other (2.1) (1.3) (0.8)
----- ----- -----
TOTAL INCOME TAXES $7.1 $5.3 $1.8
==== ===== ====
NET INCOME
UI $12.3 $8.0 $4.3
Xcelecom (0.1) (1.0) 0.9
Minority Interest Investment & Other (1.8) (2.0) 0.2
----- ----- ---
SUBTOTAL NET INCOME FROM CONTINUING OPERATIONS 10.4 5.0 5.4
Discontinued Operations 48.4 (0.7) 49.1
---- ----- ----
TOTAL NET INCOME $58.8 $4.3 $54.5
===== ===== =====
- 48 -
THE UNITED ILLUMINATING COMPANY RESULTS OF OPERATIONS: SECOND QUARTER OF 2004
- -------------------------------------------------------------------------------
VS. SECOND QUARTER OF 2003
--------------------------
Quarter Ended Quarter Ended 2004 more (less) than 2003
June 30, 2004 June 30, 2003 Amount Percent
----------------- ------------------ ---------------- ------------
EPS FROM OPERATIONS
Total UI - basic $0.85 $0.56 $0.29 52%
==== ==== ====
Total UI - diluted (Note A) $0.85 $0.56 $0.29 52%
==== ==== ====
RETAIL SALES (MILLIONS OF KWH) 1,385 1,324 61 5%
Note A: Reflecting the effect of unexercised dilutive stock options.
UI's net income was $12.3 million, or $0.85 per share, in the second quarter of
2004, compared to $8 million, or $0.56 per share, in the second quarter of 2003.
The increase from the second quarter of 2003 was due to a variety of factors
including non-recurring gains from a settlement by ISO-NE related to a review of
the allocation of New England Power Pool transmission revenues to member
companies, and the resolution of tax and other post-closing issues related to
UI's sale of Seabrook Station, as well as increased sales volume and lower
interest expenses. In addition, the improvement was due in part to the DPUC's
decision allowing partial recovery of increased pension and postretirement
benefits expenses, partially offset by higher operating expenses and increases
in uncollectible accounts over the comparable period of 2003.
Overall UI's revenue increased by $19.5 million, from $156.1 million in the
second quarter of 2003, to $175.6 million in the second quarter of 2004. Retail
revenue increased $16.9 million due mainly to an overall increase in
kilowatt-hour volume of 5%, along with the impact of an average 9.9% price
increase effective January 1, 2004 resulting from the transitional standard
offer final decision (see "Major Influences on Financial Condition - The United
Illuminating Company - Regulation", for further discussion). The price increase
allowed UI to collect certain federally mandated charges from customers to
offset higher costs of procuring energy (see fuel and energy expense discussion
below). The impact of weather as compared to the same period of 2003 was
minimal. Wholesale revenue increased by $0.7 million, as compared to the second
quarter of 2003. Other revenues increased $1.9 million as compared to the second
quarter of 2003, primarily due to the settlement adjustment from ISO-NE.
Retail fuel and energy expense increased by $18.2 million in the second quarter
of 2004, compared to the same period of 2003. The increase was primarily due to
increased supplier costs providing transitional standard offer service. UI
received electricity to satisfy its transitional standard offer retail customer
service requirements through a fixed-price purchased power agreement. These
costs are recovered through the GSC portion of UI's unbundled retail customer
rates. UI's wholesale energy expense in the second quarter of 2004 increased by
$0.9 million compared to the same period of 2003. Wholesale energy costs are
recovered from customers through the CTA.
UI's operation and maintenance (O&M) expenses increased by $1.9 million, from
$44.3 million in the second quarter of 2003 to $46.2 million in the second
quarter of 2004. The increase was attributable to a variety of factors including
increases in labor, benefits, legal and bad debt expenses.
Amortization of regulatory assets decreased by $6 million in the second quarter
2004 compared to the same period of 2003. The primary reason for the reduction
was due to a DPUC order in July 2003 requiring that the amortization of CTA rate
base utilizing excess GSC revenues be discontinued. Pursuant to the DPUC final
decision in the transitional standard offer proceedings, such excess GSC
revenues are now banked and used primarily to offset monthly working capital
differences between the cost of providing transitional standard offer service
and the revenue collected from customers.
Other income increased by $1.1 million in the second quarter of 2004, compared
to the second quarter of 2003, due to the reduction of reserves based on the
resolution of tax and other post-closing issues related to UI's sale of Seabrook
Station.
Interest charges decreased by $1.4 million in the second quarter of 2004, as
compared to the same period of 2003, due to the refinancing of certain UI debt
issues late in 2003 at lower interest rates.
- 49 -
NON-UTILITY RESULTS OF OPERATIONS: SECOND QUARTER 2004 VS. SECOND QUARTER 2003
- -------------------------------------------------------------------------------
Quarter Ended Quarter Ended 2004 more (less) than 2003
June 30, 2004 June 30, 2003 Amount Percent
---------------- ---------------- -------------- ------------
EPS
Operating Business
Xcelecom $(0.01) $(0.07) $0.06 86%
Minority Interest Investments
UBE (0.04) (0.04) - -
UCI (0.02) (0.01) (0.01) (100)%
------ ------
Subtotal Minority Interest
Investments (0.06) (0.05) (0.01) (20)%
UIL Corporate (Note A) (0.06) (0.09) 0.03 33%
------ ------ ----
TOTAL NON-UTILITY EPS FROM CONTINUING
OPERATIONS (0.13) (0.21) 0.08 38%
Discontinued Operations 3.37 (0.05) 3.42 6,840%
---- ------ ----
TOTAL NON-UTILITY EPS - BASIC $3.24 $(0.26) $3.50 1,346%
==== ====== ====
TOTAL NON-UTILITY EPS - DILUTED (NOTE B) $3.23 $(0.26) $3.49 1,342%
==== ====== ====
Note A: Includes interest charges on intercompany debt and strategic and
administrative costs of the non-utility holding company.
Note B: Reflecting the effect of unexercised dilutive stock options. Such
dilution does not impact the earnings from continuing operations, but
dilutes the earnings from discontinued operations by $0.01 per share.
The consolidated non-utility businesses reported a loss from continuing
operations, including unallocated holding company costs, of $1.9 million, or
$0.13 per share, in the second quarter of 2004, an improvement of $1.1 million,
or $0.08 per share, compared to the same period of 2003. The improved results at
Xcelecom were attributable to performance of the electrical contracting
business. Net income from discontinued operations for the second quarter of
2004, including the gain on the sale of APS, amounted to $48.4 million, or $3.37
per share, compared to a loss of $0.7 million, or $0.05 per share, in the second
quarter of 2003. Excluding the $46.5 million after-tax gain on the sale of APS,
net of transaction costs, results of discontinued operations for the second
quarter of 2004 improved by approximately $0.18 per share as compared to the
same period of 2003. The improved results from discontinued operations,
excluding the gain on the sale of APS, were mainly the result of increased
stored value card and non-contracted bill payment business of APS, as well as
the implementation of cost reduction initiatives in the second quarter of 2004.
Operating revenue for the non-utility businesses increased by $10.7 million, or
14% compared to the second quarter of 2003. The increase in revenues was
primarily from Xcelecom. Second quarter 2004 operating expenses for the
non-utility businesses increased $9.3 million, or 12% from the same period of
2003, as expenses at Xcelecom rose due to the increase in business. Other
deductions of $1 million in the second quarter of 2004 were $0.4 million, or 67%
higher than the second quarter of 2003, as the favorable impact of the
elimination of interest charges at UBE in 2004 was offset by the effect of high
natural gas prices on the results of BE.
The results of each of the non-utility subsidiaries for the second quarter of
2004 and the second quarter of 2003, as presented below, reflect the allocation
of debt costs from the parent based on a capital structure, including an equity
component, and an interest rate deemed appropriate for that type of business.
The capital structure for all of the non-utility subsidiaries is 100% equity as
of January 1, 2004. In 2003 the capital structure of UBE was 70% debt. UIL
- 50 -
Holdings absorbs interest charges on the equity portion of its investments in
its subsidiaries to the extent those investments are financed with debt. UIL
Holdings may incur other corporate level expenses necessary to manage its
investments from time to time.
The following is a detailed explanation of the quarterly variances for each of
UIL Holdings' non-utility businesses.
NON-UTILITY BUSINESS
XCELECOM, INC.
Xcelecom lost $0.1 million, or $0.01 per share, in the second quarter of 2004,
compared to a loss of $1.0 million, or $0.07 per share in the second quarter of
2003. The improvement in earnings from prior year was mainly due to the absence
of $0.05 per share of project losses incurred in the prior year. Xcelecom has
also seen increases in sales among all regions of the electrical contracting
business. These increases were partially offset by lagging performance in the
systems integration business.
Xcelecom's backlog of work to be completed as of June 30, 2004 amounted to $205
million, an increase of $80 million, or 64%, from the same period of 2003. While
backlog has grown significantly, Xcelecom continues to experience pressure on
gross margin. Additionally, the composition of this backlog is weighted towards
larger projects, which have historically produced lower margins than smaller
projects. On a project size basis, 17% of the backlog is attributable to
projects with values of $0.5 million or less, 60% is attributable to projects
with values between $0.5 million and $5 million, and 23% is attributable to
projects with values in excess of $5 million. On a regional basis, 75% of this
backlog is attributable to the Northeast, with the remaining 25% attributable to
the mid-Atlantic and Southeast regions.
MINORITY INTEREST INVESTMENTS
UNITED BRIDGEPORT ENERGY, INC.
UBE owns a 33 1/3% interest in Bridgeport Energy, LLC (BE). UBE lost $0.6
million, or $0.04 per share, in the second quarter of 2004, compared to a loss
of $0.7 million, or $0.04 per share in the second quarter of 2003. UBE results
continue to be hampered by high natural gas prices which continue to depress
both margins and sales levels at BE. This was offset by the elimination of
interest expenses in 2004 as a result of the restructuring of UIL Holdings'
intercompany loan to UBE to 100% equity beginning in 2004. The improvements
recognized at UBE related to this restructuring had no effect on overall UIL
Holdings' results, as all intercompany transactions are eliminated in
consolidation.
UNITED CAPITAL INVESTMENTS, INC.
UCI lost $0.3 million, or $0.02 per share, in the second quarter of 2004,
compared to a loss of $0.1 million, or $0.01 per share in the second quarter of
2003. The decline in earnings was mainly due to decreased revenues and increased
legal fees at Cross-Sound during the second quarter of 2004, resulting from a
May 7, 2004 order by the federal Department of Energy terminating the Emergency
Order under which the Cross-Sound cable had been operating. See the "Major
Influences on Financial Condition" section of Item 2 for more information.
UIL CORPORATE
UIL Holdings retains certain costs at the holding company level which are not
allocated to the various non-utility subsidiaries. These costs generally include
interest charges and strategic and other administrative costs. UIL Holdings'
unallocated costs amounted to $0.9 million, after-tax, or $0.06 per share, in
the second quarter of 2004, compared to $1.2 million, after-tax, or $0.09 per
share, in 2003. The improvement from the prior year was due to the realization
of deferred tax benefits of $0.03 per share in the second quarter of 2004.
- 51 -
DISCONTINUED OPERATIONS
On June 22, 2004, UIL completed the sale of APS to CheckFree, pursuant to the
purchase agreement entered into between the parties on December 16, 2003. APS,
and its 51% ownership interest in CellCards of Illinois, LLC (CCI), were
classified as discontinued operations in the fourth quarter of 2003. On February
13, 2004, CCI was sold to an independent third party for book value, excluding
transaction costs.
The results of discontinued operations for the second quarter of 2004 include
the gain on the sale of APS. The overall after-tax gain on the sale, net of all
transaction costs incurred was $46 million, or $3.21 per share. However, the
after-tax effect of the sale, net of transaction costs, for the second quarter
of 2004 was $3.24 per share, as certain transaction costs were incurred in the
fourth quarter of 2003 and the first quarter of 2004. Excluding the gain on the
sale, net income from discontinued operations for the second quarter of 2004 was
$1.8 million, or $0.13 per share, compared to a net loss of $0.7 million, or
$0.05 per share, in the same period of 2003. The improvement was mainly due to
APS' increased stored value card and non-contracted bill payment business and
the implementation of cost reduction initiatives in 2004. Also, in accordance
with SFAS 144, the assets of APS, including the telephony assets, ceased being
depreciated when it was categorized as "held for sale," which resulted in
increased earnings of $1.1 million, or $0.08 per share, as compared to the
second quarter of 2003.
FIRST SIX MONTHS 2004 VS. FIRST SIX MONTHS 2003
- -----------------------------------------------
UIL HOLDINGS CORPORATION RESULTS OF OPERATIONS: FIRST SIX MONTHS 2004
- ----------------------------------------------------------------------
VS. FIRST SIX MONTHS 2003
-------------------------
UIL Holdings' earnings from continuing operations for the first six months of
2004 increased by $5.6 million, or $0.38 per share, compared to the first six
months of 2003. Net income from discontinued operations, including the gain on
the sale of APS, increased by $50.7 million, or $3.54 per share, in the first
six months of 2004 compared to the net loss of $0.9 million, or $0.07 per share,
in the first six months 2003. Total earnings for the first six months of 2004,
including discontinued operations, increased by $56.3 million, or $3.92 per
share, from the same period of 2003.
The increase in earnings from continuing operations was mainly due to
non-recurring gains at UI related to a change in accounting estimate adjustment
to unbilled revenues, a settlement by ISO-NE related to a review of the
allocation of New England Power Pool transmission revenues to member companies,
the resolution of tax and other post-closing issues related to UI's sale of
Seabrook Station, and the impact of final decisions by the DPUC regarding the
disposition of proceeds from UI's investment in nuclear generating facilities.
Results at UI also benefited from the DPUC's decision allowing partial recovery
of increased pension and postretirement benefits expenses, as well as an
increase in kilowatt-hour consumption as compared to the same period of 2003.
Improved results from Xcelecom's electrical contracting business also
contributed to the increase in earnings from the first six months of 2003.
- 52 -
The table below represents a comparison of UIL Holdings' Net Income and Earnings
per Share (EPS) for the first six months of 2004 and the first six months of
2003.
Six Months Ended Six Months Ended 2004 more (less) than 2003
June 30, 2004 June 30, 2003 Amount Percent
------------------ ------------------ ---------------- ------------
NET INCOME (IN MILLIONS EXCEPT PERCENTS AND PER
SHARE AMOUNTS)
UI $21.9 $16.5 $5.4 33%
Non-Utility (5.8) (6.0) 0.2 3%
----- ----- ---
TOTAL NET INCOME FROM CONTINUING
OPERATIONS $16.1 $10.5 $5.6 53%
Discontinued Operations 49.8 (0.9) 50.7 5,633%
---- ----- ----
TOTAL NET INCOME $65.9 $9.6 $56.3 586%
==== === ====
EPS
UI $1.52 $1.16 $0.36 31%
Non-Utility (0.40) (0.42) 0.02 5%
------ ------ ----
TOTAL EPS FROM CONTINUING
OPERATIONS - BASIC $1.12 $0.74 $0.38 51%
Discontinued Operations 3.47 (0.07) 3.54 5,057%
---- ------ ----
TOTAL EPS - BASIC $4.59 $0.67 $3.92 585%
==== ==== ====
TOTAL EPS - DILUTED (NOTE A) $4.58 $0.67 $3.91 584%
==== ==== ====
Note A: Reflecting the effect of unexercised dilutive stock options. Such
dilution does not impact the earnings from continuing operations, but dilutes
the earnings from discontinued operations by $0.01 per share.
- 53 -
The following table presents a line-by-line breakdown of revenue and expenses
from UIL Holdings' Consolidated Statement of Income by subsidiary, including
comparisons between the first six months of 2004 and the first six months of
2003. Significant variances are explained in the discussion and analysis of
individual subsidiary results that follow.
SIX MONTHS ENDED SIX MONTHS ENDED 2004 MORE (LESS)
(IN MILLIONS) JUN. 30, 2004 JUN. 30, 2003 THAN 2003
- ------------- ------------- ------------- ---------
OPERATING REVENUES
UI from operations $357.4 $321.4 $36.0
Xcelecom 152.7 143.5 9.2
Minority Interest Investment & Other 0.1 (0.1) 0.2
--- --- ---
TOTAL OPERATING REVENUES $510.2 $464.8 $45.4
====== ======= =====
FUEL AND ENERGY EXPENSES - UI $169.3 $128.8 $40.5
====== ======= =====
OPERATION AND MAINTENANCE EXPENSES
UI $94.6 $87.3 $7.3
Xcelecom 150.7 142.3 8.4
Minority Interest Investment & Other 2.5 1.7 0.8
--- --- ---
TOTAL OPERATION AND MAINTENANCE EXPENSES $247.8 $231.3 $16.5
====== ======= =====
DEPRECIATION AND AMORTIZATION EXPENSES
UI $14.8 $13.8 $1.0
Xcelecom 1.7 1.7 0.0
--- --- ---
Subtotal depreciation 16.5 15.5 1.0
Amortization of regulatory assets (UI) 16.5 31.9 (15.4)
Amortization Xcelecom 0.6 0.7 (0.1)
--- --- ---
TOTAL DEPRECIATION AND AMORTIZATION EXPENSES $33.6 $48.1 $(14.5)
====== ====== =======
TAXES - OTHER THAN INCOME TAXES
UI - State gross earnings tax $12.2 $12.5 $(0.3)
UI - other 7.4 7.3 0.1
Xcelecom 1.1 1.0 0.1
--- --- ---
TOTAL TAXES - OTHER THAN INCOME TAXES $20.7 $20.8 $(0.1)
===== ====== ======
- 54 -
SIX MONTHS ENDED SIX MONTHS ENDED 2004 MORE (LESS)
(IN MILLIONS) JUN. 30, 2004 JUN. 30, 2003 THAN 2003
- ------------- ------------- ------------- ---------
OTHER INCOME (DEDUCTIONS)
UI $6.1 $3.0 $3.1
Xcelecom 0.5 0.4 0.1
Minority Interest Investment & Other (3.8) (3.1) (0.7)
--- --- ---
TOTAL OTHER INCOME (DEDUCTIONS) $2.8 $0.3 $2.5
==== ==== ====
INTEREST CHARGES
UI $7.9 $10.5 $(2.6)
UI - Amortization: debt expense, redemption premiums 0.7 0.6 0.1
Xcelecom 0.3 0.3 0.0
Minority Interest Investment & Other 3.3 3.0 0.3
--- --- ---
TOTAL INTEREST CHARGES $12.2 $14.4 $(2.2)
===== ====== ======
INCOME TAXES
UI $18.2 $15.2 $3.0
Xcelecom (0.5) (0.8) 0.3
Minority Interest Investment & Other (4.5) (3.1) (1.4)
--- --- ---
TOTAL INCOME TAXES $13.2 $11.3 $1.9
===== ====== ====
NET INCOME
UI $21.9 $16.5 $5.4
Xcelecom (0.7) (1.3) 0.6
Minority Interest Investment & Other (5.1) (4.7) (0.4)
--- --- ---
SUBTOTAL NET INCOME FROM CONTINUING OPERATIONS 16.1 10.5 5.6
Discontinued Operations 49.8 (0.9) 50.7
--- --- ---
TOTAL NET INCOME $65.9 $9.6 $56.3
===== ===== =====
- 55 -
THE UNITED ILLUMINATING COMPANY RESULTS OF OPERATIONS: FIRST SIX MONTHS OF 2004
- -------------------------------------------------------------------------------
VS. FIRST SIX MONTHS OF 2003
- ----------------------------
Six Months Ended Six Months Ended 2004 more (less) than 2003
June 30, 2004 June 30, 2003 Amount Percent
----------------- ------------------ ---------------- ------------
EPS FROM OPERATIONS
Total UI - basic $1.52 $1.16 $0.36 31%
==== ==== ====
Total UI - diluted (Note A) $1.52 $1.16 $0.36 31%
==== ==== ====
RETAIL SALES - ADJUSTED (MILLIONS OF KWH)
(NOTE B) 2,862 2,773 89 3%
Note A: Reflecting the effect of unexercised dilutive stock options.
Note B: Excludes 46 million KWH non-recurring adjustment associated with a
change in accounting estimate to unbilled revenue recognized in the first
quarter of 2004. Including this adjustment KWH volume increased by approximately
135 million KWH, or 5% from the same period of 2003.
UI's net income was $21.9 million, or $1.52 per share, in the first six months
of 2004, compared to $16.5 million, or $1.16 per share, in the first six months
of 2003. The increase from the first six months of 2003 was mainly attributable
to non-recurring gains associated with a change in accounting estimate
adjustment to unbilled revenues, a settlement by ISO-NE related to a review of
the allocation of New England Power Pool transmission revenues to member
companies, the resolution of tax and other post-closing issues related to UI's
sale of Seabrook Station, and the impact of final decisions by the DPUC
regarding the disposition of proceeds from UI's investment in nuclear generating
facilities. Results at UI also benefited from an increased sales volume as
compared to the same period of 2003. In addition, the improvement was due in
part to the DPUC's decision allowing partial recovery of increased pension and
postretirement benefits expenses, partially offset by higher operating expenses
and increases in uncollectible accounts over the comparable period of 2003.
Overall, UI's revenue increased by $36 million, from $321.4 million in the first
six months of 2003 to $357.4 million in the first six months of 2004. Retail
revenue increased $34.6 million due mainly to an overall increase in
kilowatt-hour volume of 5%, along with the impact of an average 9.9% price
increase effective January 1, 2004 resulting from the transitional standard
offer final decision (see "Major Influences on Financial Condition - The United
Illuminating Company - Regulation", for further discussion). The price increase
allowed UI to collect certain federally mandated charges from customers to
offset higher costs of procuring energy (see fuel and energy expense discussion
below). Of the overall 5% increase in kilowatt-hour volume, approximately 1.7%,
or 46 million kilowatt-hours, is attributable to the non-recurring adjustment
associated with a change in accounting estimate to unbilled revenue recognized
in the first quarter of 2004. The impact of weather as compared to the same
period of 2003 was minimal. Wholesale revenue decreased by $0.6 million, as
compared to the first six months of 2003, due to lower market prices in the New
England wholesale market. Other revenues increased $2 million as compared to the
first six months of 2003, primarily due to the settlement adjustment from
ISO-NE.
Retail fuel and energy expense increased by $40.4 million in the first six
months of 2004, compared to the same period of 2003. The increase was primarily
due to increased supplier costs providing transitional standard offer service.
UI received electricity to satisfy its transitional standard offer retail
customer service requirements through a fixed-price purchased power agreement.
These costs are recovered through the GSC portion of UI's unbundled retail
customer rates. UI's wholesale energy expense in the first six months of 2004
increased by $0.1 million compared to the same period of 2003. Wholesale energy
costs are recovered from customers through the CTA.
UI's operation and maintenance (O&M) expenses increased by $7.3 million, from
$87.3 million in the first six months of 2003 to $94.6 million in the first six
months of 2004. The increase was attributable to a variety of factors including
increases in labor, benefits, legal and bad debt expenses.
Amortization of regulatory assets decreased by $15.4 million in the first six
months of 2004 compared to the same period of 2003. The primary reason for the
reduction was due to a DPUC order in July 2003 requiring that the amortization
of CTA rate base utilizing excess GSC revenues be discontinued. Pursuant to the
- 56 -
DPUC final decision in the transitional standard offer proceedings, such excess
GSC revenues are now banked and used primarily to offset monthly working capital
differences between the cost of providing transitional standard offer service
and the revenue collected from customers.
Other income increased by $3.1 million in the first six months of 2004, compared
to the first six months of 2003, mainly due to the reduction of reserves
associated with UI's investment in Seabrook Station resulting from a March 2004
DPUC decision and the resolution of tax and other post-closing issues related to
its sale.
Interest charges decreased by $2.5 million in the first six months of 2004, as
compared to the same period of 2003, due to the refinancing of certain UI debt
issues late in 2003 at lower interest rates.
NON-UTILITY RESULTS OF OPERATIONS: FIRST SIX MONTHS 2004
- ----------------------------------------------------------
VS. FIRST SIX MONTHS 2003
- --------------------------
Six Months Ended Six Months Ended 2004 more (less) than 2003
June 30, 2004 June 30, 2003 Amount Percent
------------------- ------------------ --------------- -----------
EPS
Operating Business
Xcelecom $(0.05) $(0.09) $0.04 44%
Minority Interest Investments
UBE (0.15) (0.15) - -
UCI (0.03) (0.02) (0.01) (50)%
------ ------
Subtotal Minority Interest
Investments (0.18) (0.17) (0.01) (6)%
UIL Corporate (Note A) (0.17) (0.16) (0.01) (6)%
------ ------ ------
TOTAL NON-UTILITY EPS FROM CONTINUING
OPERATIONS (0.40) (0.42) 0.02 5%
Discontinued Operations 3.47 (0.07) 3.54 5,057%
---- ------ ----
TOTAL NON-UTILITY EPS - BASIC $3.07 $(0.49) $3.56 727%
==== ====== ====
TOTAL NON-UTILITY EPS - DILUTED (NOTE B) $3.06 $(0.49) $3.55 724%
==== ====== ====
Note A: Includes interest charges on intercompany debt and strategic and
administrative costs of the non-utility holding company.
Note B: Reflecting the effect of unexercised dilutive stock options. Such
dilution does not impact the earnings from continuing operations, but
dilutes the earnings from discontinued operations by $0.01 per share.
The consolidated non-utility businesses reported a loss from continuing
operations, including unallocated holding company costs, of $5.8 million, or
$0.40 per share, in the first six months of 2004, an improvement of $0.2
million, or $0.02 per share, compared to the same period of 2003. The improved
results at Xcelecom were attributable to the performance of the electrical
contracting business. Net income from discontinued operations for the first six
months of 2004, including the gain on the sale of APS, amounted to $49.8
million, or $3.47 per share, compared to a loss of $0.9 million, or $0.07 per
share, in the first six months of 2003. Excluding the $46.2 million after-tax
gain on the sale of APS, net of transaction costs, results of discontinued
operations for the first six months of 2004 improved by approximately $0.32 per
share as compared to the same period of 2003. The improved results from
discontinued operations, excluding the gain on the sale of APS, were mainly the
result of increased stored value card and non-contracted bill payment business
of APS, as well as the implementation of cost reduction initiatives in the first
six months of 2004.
- 57 -
Operating revenue for the non-utility businesses increased by $9.4 million, or
7% compared to the first six months of 2003. The increase in revenues was
primarily from Xcelecom. Operating expenses in the first six months of 2004 for
the non-utility businesses increased $9.2 million, or 6% from the same period of
2003, as expenses at Xcelecom rose due to the increase in business. Other
deductions of $3.3 million in the first six months of 2004 were $0.6 million, or
22% higher than the first six months of 2003, as the favorable impact of the
elimination of interest charges at UBE in 2004 was offset by the effect of high
natural gas prices on the results of BE.
The results of each of the non-utility subsidiaries for the first six months of
2004 and the first six months of 2003, as presented below, reflect the
allocation of debt costs from the parent based on a capital structure, including
an equity component, and an interest rate deemed appropriate for that type of
business. The capital structure for all of the non-utility subsidiaries is 100%
equity as of January 1, 2004. In 2003 the capital structure of UBE was 70% debt.
UIL Holdings absorbs interest charges on the equity portion of its investments
in its subsidiaries to the extent those investments are financed with debt. UIL
Holdings may incur other corporate level expenses necessary to manage its
investments from time to time.
The following is a detailed explanation of the variances for each of UIL
Holdings' non-utility businesses.
NON-UTILITY BUSINESS
XCELECOM, INC.
Xcelecom lost $0.7 million, or $0.05 per share, in the first six months of 2004,
compared to a loss of $1.3 million, or $0.09 per share in the first six months
of 2003. The improvement in earnings from prior year was mainly due to the
absence of $0.08 per share of project losses incurred in the prior year,
partially offset by income in the prior year related to the completion of a
large contract. The slow economic recovery in the Northeast, as well as soft
demand for the computer network systems integration services business, continued
to hamper the results for the first six months of 2004 as compared to the same
period of 2003, although there have been signs of improving conditions in the
second quarter of 2004 as evidenced by the level of backlog attributable to the
Northeast. See the "Results of Operations: Second Quarter of 2004 vs. Second
Quarter of 2003 - Xcelecom" section of Item 2 for discussion of Xcelecom's
backlog as of June 30, 2004.
MINORITY INTEREST INVESTMENTS
UNITED BRIDGEPORT ENERGY, INC.
UBE owns a 33 1/3% interest in Bridgeport Energy, LLC (BE). UBE lost $2.2
million, or $0.15 per share, in the first six months of 2004, which was equal to
the loss reported in the same period of 2003. UBE results continue to be
hampered by high natural gas prices which continue to depress both margins and
sales levels at BE. Results for the first six months of 2004 have also been
affected by approximately $0.4 million of pre-tax accounting adjustments related
to prior years. This was offset by the elimination of interest expenses in 2004
as a result of the restructuring of UIL Holdings' intercompany loan to UBE to
100% equity beginning in 2004. The improvements recognized at UBE related to
this restructuring had no effect on overall UIL Holdings' results, as all
intercompany transactions are eliminated in consolidation.
UNITED CAPITAL INVESTMENTS, INC.
UCI lost $0.4 million, or $0.03 per share, in the first six months of 2004,
compared to a loss of $0.2 million, or $0.02 per share in the first six months
of 2003. The decline in earnings was mainly due to decreased revenues and
increased legal fees at Cross-Sound during the second quarter of 2004, resulting
from a May 7, 2004 order by the federal Department of Energy terminating the
Emergency Order under which the Cross-Sound cable had been operating. See the
"Major Influences on Financial Condition" section of this Item 2 for more
information.
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UIL CORPORATE
UIL Holdings retains certain costs at the holding company level which are not
allocated to the various non-utility subsidiaries. These costs generally include
interest charges and strategic and other administrative costs. UIL Holdings'
unallocated costs amounted to $2.5 million, after-tax, or $0.17 per share, in
the first six months of 2004, compared to $2.3 million, after-tax, or $0.16 per
share, in 2003. Higher administrative costs in 2004 were partially offset by the
realization of deferred tax benefits of $0.03 per share in the second quarter of
2004.
DISCONTINUED OPERATIONS
On June 22, 2004, UIL completed the sale of APS to CheckFree, pursuant to the
purchase agreement entered into between the parties on December 16, 2003. APS,
and its 51% ownership interest in CellCards of Illinois, LLC (CCI), were
classified as discontinued operations in the fourth quarter of 2003. On February
13, 2004, CCI was sold to an independent third party for book value, excluding
transaction costs.
The results of discontinued operations for the first six months of 2004 include
the gain on the sale of APS. The overall after-tax gain on the sale, net of all
transaction costs incurred was $46 million, or $3.21 per share. However, the
after-tax effect of the sale, net of transaction costs, for the first six months
of 2004 was $3.22 per share, as certain transaction costs were incurred in the
fourth quarter of 2003. Excluding the gain on the sale, net income from
discontinued operations for the first six months of 2004 was $3.5 million, or
$0.25 per share, compared to a net loss of $0.9 million, or $0.07 per share, in
the same period of 2003. The improvement was mainly due to APS' increased stored
value card and non-contracted bill payment business and the implementation of
cost reduction initiatives in 2004. Also, in accordance with SFAS 144, the
assets of APS, including the telephony assets, ceased being depreciated when it
was categorized as "held for sale," which resulted in increased earnings of $1.6
million, or $0.11 per share, as compared to the first six months of 2003.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
UIL Holdings' and UI's primary market risk is the interest rate risk associated
with the need to refinance fixed rate debt at maturity and the remarketing of
multi-annual tax-exempt bonds. The weighted average remaining fixed rate period
of outstanding long-term debt obligations of UIL Holdings and UI is 4.2 years at
an average interest rate of 4%. Given the term of the fixed rate debt, UIL
Holdings believes that it has no material quantitative or qualitative exposure
to market risk in the near term. In addition, historically, UI has been able to
include its interest costs in revenue requirements for recovery through rates.
UIL Holdings and Xcelecom have short-term revolving credit agreements that
permit borrowings for fixed periods of time at fixed interest rates determined
by the London Interbank Offered Rate (LIBOR), and also borrowings at fluctuating
interest rates determined by the prime lending market. Changes in LIBOR or the
prime lending market will have an impact on interest expense, but due to the
relatively low level of short-term borrowings under these credit facilities, the
impact of changes in short-term interest rates is not expected to be material.
UIL Holdings does not have any derivative instruments or any material
investments in financial instruments at this time.
ITEM 4. CONTROLS AND PROCEDURES.
UIL Holdings maintains disclosure controls and procedures that are designed to
ensure that information required to be disclosed in its periodic reports to the
Securities and Exchange Commission (SEC) is recorded, processed, summarized and
reported within the time periods specified in the SEC's rules and forms, and
that such information is accumulated and communicated to UIL Holdings'
management, including its Chief Executive Officer and Chief Financial Officer,
as appropriate, to allow timely decisions regarding required disclosure based on
the definition of "disclosure controls and procedures" in Rule 13a-15(e) and
Rule 15d-15(e) under the Securities Exchange Act of 1934. In designing and
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evaluating the disclosure controls and procedures, management recognized that
any controls and procedures, no matter how well designed and operated, can
provide only reasonable assurance of achieving the desired control objectives,
and management necessarily was required to apply its judgment in evaluating the
cost-benefit relationship of possible controls and procedures. Also, through
United Capital Investments, Inc. and United Bridgeport Energy, Inc., UIL
Holdings has minority investments in certain other entities. As UIL Holdings
does not control or manage these entities, its disclosure controls and
procedures with respect to such entities are necessarily substantially more
limited than those it maintains with respect to its subsidiaries.
UIL Holdings carried out an evaluation, under the supervision and with the
participation of its management, including its Chief Executive Officer and its
Chief Financial Officer, of the effectiveness of the design and operation of UIL
Holdings' disclosure controls and procedures as of June 30, 2004. Based on the
foregoing, UIL Holdings' Chief Executive Officer and Chief Financial Officer
concluded that its disclosure controls and procedures were effective.
There have been no changes in UIL Holdings' internal control over financial
reporting during the quarter ended June 30, 2004 that have materially affected,
or are reasonably likely to materially affect UIL Holdings' internal control
over financial reporting.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
UCI has a 25% interest in Cross-Sound Cable Company, LLC (Cross-Sound), whose
cable operation was the subject of a request by the Connecticut Attorney General
(AG) and the Connecticut Department of Environmental Protection (CDEP) to the
United States Department of Energy (DOE) for stay or rehearing of the August 28,
2003 DOE Emergency Order that directed the Cross-Sound cable to operate. In May
of 2004, the DOE terminated the Emergency Order under which the cable had been
operating, thus making moot the request by the AG and CDEP for a stay or
rehearing of the Emergency Order. Neither UIL Holdings nor any of its
subsidiaries was a party to the DOE proceeding.
See Part I, Item 2, "Management's Discussion and Analysis of Financial Condition
and Results of Operations - Major Influences," for further discussion, which
information is hereby incorporated by reference.
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS.
The Annual Meeting of the Shareowners of UIL Holdings was held on May 12, 2004,
for the purpose of electing a Board of Directors for the ensuing year, voting on
approval of the employment of PricewaterhouseCoopers LLP as the firm of
independent public accountants to audit the books and affairs of UIL Holdings
for the fiscal year 2004, and voting on approval of the UIL Holdings Corporation
Senior Executive Incentive Compensation Program.
All of the nominees for election as Directors listed in UIL Holdings' proxy
statement for the meeting were elected by the following votes:
NUMBER OF SHARES
---------------------------
VOTED NOT
NOMINEE "FOR" VOTED
------- ----- -----
Thelma R. Albright 12,046,578 194,256
Marc C. Breslawsky 11,999,299 241,536
David E. A. Carson 11,964,553 276,282
Arnold L. Chase 11,944,412 296,420
John F. Croweak 11,964,692 276,143
Betsy Henley-Cohn 11,960,157 280,675
John L. Lahey 12,031,408 209,426
F. Patrick McFadden, Jr. 11,964,655 276,182
Daniel J. Miglio 12,034,401 206,432
William F. Murdy 12,046,206 194,689
James A. Thomas 11,964,865 275,971
Nathaniel D. Woodson 11,950,141 290,695
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The employment of PricewaterhouseCoopers LLP as the firm of independent public
accountants to audit the books and affairs of UIL Holdings for the fiscal year
2004 was ratified by the following vote:
NUMBER OF SHARES
---------------------------------------
VOTED VOTED NOT
"FOR" "AGAINST" VOTED
------------ ------------- -----------
12,008,823 170,894 69,112
The proposal to adopt the UIL Holdings Corporation Senior Executive Incentive
Compensation Program was approved by the following vote:
NUMBER OF SHARES
---------------------------------------
VOTED VOTED NOT
"FOR" "AGAINST" VOTED
-------------- ------------ -----------
10,904,198 1,064,416 272,202
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
Exhibit
Table Item Exhibit
Number Number Description
----------- --------- ------------
(2) 2.1a First Amendment to Stock Purchase Agreement by and
among UIL Holdings Corporation, United Resources, Inc.
and CheckFree Corporation, dated December 16, 2003
(2) 2.1b Second Amendment to Stock Purchase Agreement by and
among UIL Holdings Corporation, United Resources, Inc.
and CheckFree Corporation, dated December 16, 2003
(31) 31.1 Certification of Periodic Financial Report.
(31) 31.2 Certification of Periodic Financial Report.
(32) 32 Certification of Periodic Financial Report.
*Management contract or compensatory plan or arrangement.
(b) Reports on Form 8-K.
Item Financial
Reported Statements Date of Report
--------- ---------- ---------------
7,12 None April 26, 2004
5 None May 10, 2004
2,7 None June 22, 2004
5 None June 24, 2004
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
UIL HOLDINGS CORPORATION
Date 08/06/2004 /s/ Louis J. Paglia
- --------------------------- ----------------------------------
Louis J. Paglia
Executive Vice President
and Chief Financial Officer
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