SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q/A
Amendment No. 1
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 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
incorporation or organization) (I.R.S. Employer Identification No.)
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 September 10, 2004, was 14,556,206.
Explanatory Note
----------------
This Amendment No. 1 on Form 10-Q/A constitutes an amendment to our Quarterly
Report on Form 10-Q for the quarterly period ended March 31, 2004, which was
previously filed with the Securities and Exchange Commission on May 7, 2004.
We are amending the consolidated statement of cash flows for the quarterly
period ended March 31, 2003 as explained in Note B of Item 1. "Financial
Statements-Notes to the Consolidated Financial Statements" of this filing.
- 1 -
INDEX
PART I. FINANCIAL INFORMATION
PAGE
NUMBER
------
Item 1. Financial Statements.................................................3
Consolidated Statement of Income for the three months ended
March 31, 2004 and 2003............................................3
Consolidated Balance Sheet as of March 31, 2004 and
December 31, 2003..................................................4
Consolidated Statement of Cash Flows for the three months ended
March 31, 2004 and 2003............................................6
Notes to the Consolidated Financial Statements.......................7
- Statement of Accounting Policies...............................7
- Capitalization................................................11
- Regulatory Proceedings........................................13
- Short-term Credit Arrangements................................14
- Income Taxes..................................................15
- Supplementary Information.....................................17
- Pension and Other Benefits....................................18
- Commitments and Contingencies.................................19
- Other Commitments and Contingencies........................19
- Connecticut Yankee Atomic Power Company.................19
- Hydro-Quebec............................................21
- Environmental Concerns..................................21
- Site Decontamination, Demolition and Remediation Costs..21
- Electric System Work Center.............................22
- Claim of Enron Power Marketing, Inc.....................22
- Independent System Operator - New England...............23
- Cross-Sound Cable Company, LLC..........................23
- Xcelecom, Inc...........................................24
- Segment Information...........................................24
- Goodwill and Other Intangible Assets..........................25
- Discontinued Operations.......................................25
- Related Party Transactions....................................26
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations..........................................27
- Major Influences on Financial Condition.......................27
- UIL Holdings Corporation...................................27
- The United Illuminating Company............................27
- American Payment Systems, Inc..............................30
- Xcelecom, Inc..............................................31
- United Capital Investments, Inc............................33
- United Bridgeport Energy, Inc..............................35
- Liquidity and Capital Resources...............................36
- Contractual and Contingent Obligations.....................37
- Critical Accounting Policies..................................38
- Results of Operations.........................................39
Item 3. Quantitative and Qualitative Disclosures About Market Risk..........45
Item 4. Controls and Procedures.............................................45
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K....................................47
SIGNATURES..........................................................48
- 2 -
PART 1: FINANCIAL INFORMATION
ITEM 1: FINANCIAL STATEMENTS
UIL HOLDINGS CORPORATION
CONSOLIDATED STATEMENT OF INCOME
(Thousands except per share amounts)
(Unaudited)
Three Months Ended
March 31,
2004 2003
Operating Revenues (Note F)
Utility $ 181,843 $ 165,292
Non-utility businesses 67,584 68,947
---------------- ----------------
Total Operating Revenues 249,427 234,239
---------------- ----------------
Operating Expenses
Operation
Fuel and energy (Note F) 87,938 66,482
Operation and maintenance 116,728 111,404
Depreciation and amortization (Note F) 17,490 26,435
Taxes - other than income taxes (Note F) 10,745 10,888
---------------- ----------------
Total Operating Expenses 232,901 215,209
---------------- ----------------
Operating Income From Continuing Operations 16,526 19,030
---------------- ----------------
Other Income (Deductions), net (Note F) 1,400 (435)
---------------- ----------------
Interest Charges, net
Interest on long-term debt 5,110 6,534
Other interest, net (Note F) 722 267
---------------- ----------------
5,832 6,801
Amortization of debt expense and redemption premiums 336 309
---------------- ----------------
Total Interest Charges, net 6,168 7,110
---------------- ----------------
Income From Continuing Operations Before Income Taxes 11,758 11,485
---------------- ----------------
Income Taxes (Note E) 6,066 5,967
---------------- ----------------
Net Income From Continuing Operations 5,692 5,518
Discontinued Operations, Net of Tax (Note O) 1,443 (252)
---------------- ----------------
Net Income and Income Applicable to Common Stock $ 7,135 $ 5,266
================ ================
Average Number of Common Shares Outstanding - Basic 14,335 14,279
Average Number of Common Shares Outstanding - Diluted 14,426 14,279
Earnings Per Share of Common Stock - Basic:
Continuing Operations $ 0.40 $ 0.39
Discontinued Operations 0.10 (0.02)
---------------- ----------------
Net Earnings $ 0.50 $ 0.37
================ ================
Earnings Per Share of Common Stock - Diluted:
Continuing Operations $ 0.39 $ 0.39
Discontinued Operations 0.10 (0.02)
---------------- ----------------
Net Earnings $ 0.49 $ 0.37
================ ================
Cash Dividends Declared per share of Common Stock $ 0.72 $ 0.72
================ ================
The accompanying Notes to the Consolidated Financial
Statements are an integral part of the financial statements.
- 3 -
UIL HOLDINGS CORPORATION
CONSOLIDATED BALANCE SHEET
ASSETS
(Thousands of Dollars)
(Unaudited)
March 31, December 31,
2004 2003
---- ----
Current Assets
Unrestricted cash and temporary cash investments $ 29,039 $ 28,614
Restricted cash 1,418 1,384
Utility accounts receivable less allowance of $1,654 and $1,654 58,592 54,780
Other accounts receivable less allowance of $1,835 and $1,648 81,230 80,532
Unbilled revenues 37,213 32,246
Materials and supplies, at average cost 5,170 4,458
Deferred and refundable income taxes 20,081 24,944
Prepayments 6,513 1,451
Current assets of discontinued operations held for sale 98,704 103,697
Other 258 1,323
----------------- ------------------
Total Current Assets 338,218 333,429
----------------- ------------------
Other Property and Investments
Investment in United Bridgeport Energy facility 79,319 82,090
Other 20,139 20,283
----------------- ------------------
Total Other Property and Investments 99,458 102,373
----------------- ------------------
Property, Plant and Equipment at original cost
In service 793,191 784,409
Less, accumulated depreciation 279,268 272,082
----------------- ------------------
513,923 512,327
Construction work in progress 33,317 36,467
----------------- ------------------
Net Property, Plant and Equipment 547,240 548,794
----------------- ------------------
Regulatory Assets (future amounts due from customers
through the ratemaking process)
Nuclear plant investments-above market 431,394 436,505
Income taxes due principally to book-tax differences 97,541 98,116
Long-term purchase power contracts-above market 84,154 88,024
Connecticut Yankee 51,375 51,579
Unamortized redemption costs 19,125 19,325
Other 49,181 43,259
----------------- ------------------
Total Regulatory Assets 732,770 736,808
----------------- ------------------
Deferred Charges
Goodwill 68,635 68,554
Unamortized debt issuance expenses 7,062 6,670
Prepaid pension 43,927 43,927
Long-term receivable - Cross-Sound Cable Project 24,181 23,986
Other long-term receivable 14,450 13,575
Other 2,980 2,120
----------------- ------------------
Total Deferred Charges 161,235 158,832
----------------- ------------------
Long-term assets of discontinued operations held for sale 13,868 17,930
----------------- ------------------
Total Assets $ 1,892,789 $ 1,898,166
================= ==================
The accompanying Notes to the Consolidated Financial
Statements are an integral part of the financial statements.
- 4 -
UIL HOLDINGS CORPORATION
CONSOLIDATED BALANCE SHEET
LIABILITIES AND CAPITALIZATION
(Thousands of Dollars)
(Unaudited)
March 31, December 31,
2004 2003
---- ----
Current Liabilities
Notes payable $ 68,472 $ 65,161
Current portion of long-term debt 4,286 -
Accounts payable 64,352 36,729
Dividends payable 10,325 10,299
Accrued liabilities 58,103 69,142
Deferred revenues - non-utility businesses 15,489 14,957
Interest accrued 6,217 6,358
Obligations under capital leases - 14,815
Current liabilities of discontinued operations held for sale 91,286 94,267
----------------- -----------------
Total Current Liabilities 318,530 311,728
----------------- -----------------
Noncurrent Liabilities
Purchase power contract obligation 84,154 88,024
Pension accrued 10,789 8,166
Connecticut Yankee contract obligation 47,176 47,213
Long-term notes payable 9,232 10,478
Other 18,904 17,574
----------------- -----------------
Total Noncurrent Liabilities 170,255 171,455
----------------- -----------------
Deferred Income Taxes (future tax liabilities owed
to taxing authorities) 347,209 345,676
----------------- -----------------
Regulatory Liabilities (future amounts owed to customers
through the ratemaking process)
Accumulated deferred investment tax credits 12,709 12,813
Deferred gains on sale of property 31,261 33,679
Asset removal cost 14,162 14,071
Other 18,736 19,589
----------------- -----------------
Total Regulatory Liabilities 76,868 80,152
----------------- -----------------
Long-term liabilities of discontinued operations held for sale 612 921
----------------- -----------------
Commitments and Contingencies (Note L)
Capitalization (Note B)
Net long-term debt 491,174 495,460
Common Stock Equity
Common Stock 298,578 297,321
Paid-in capital 4,666 4,413
Capital stock expense (2,170) (2,170)
Unearned employee stock ownership plan equity (5,224) (5,461)
Unearned compensation (908) (335)
Accumulated other comprehensive income (loss) (1,013) (496)
Retained earnings 194,212 199,502
----------------- -----------------
Net Common Stock Equity 488,141 492,774
Total Capitalization 979,315 988,234
----------------- -----------------
Total Liabilities and Capitalization $ 1,892,789 $ 1,898,166
================= =================
The accompanying Notes to the Consolidated Financial
Statements are an integral part of the financial statements.
- 5 -
UIL HOLDINGS CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOWS
(Thousands of Dollars)
(Unaudited)
Three Months Ended
March 31,
(Restated)
2004 2003
---- ----
Cash Flows From Operating Activities
Net Income $ 7,135 $ 5,266
-------------- --------------
Adjustments to reconcile net income
to net cash provided by operating activities:
(Income) Loss from discontinued operations, net of tax (1,443) 252
Depreciation and amortization 12,133 20,818
Purchase power contract amortization (Note F) 5,693 5,926
Purchase power above market fuel expense credit (Note F) (5,693) (5,926)
Deferred income taxes 1,904 (4,290)
Deferred investment tax credits - net (105) (148)
Allowance for funds used during construction (467) (656)
Undistributed (earnings) losses of minority interest investments 2,900 2,089
Changes in:
Accounts receivable - net (4,492) (8,494)
Materials and supplies (712) (415)
Prepayments (5,062) (2,330)
Accounts payable 27,708 (8,223)
Interest accrued (142) 1,263
Taxes accrued 3,103 9,146
Other assets (9,052) 5,067
Other liabilities (5,784) (10,661)
-------------- --------------
Total Adjustments 20,489 3,418
-------------- --------------
Cash provided by Continuing Operations 27,624 8,684
Cash provided by Discontinued Operations 1,225 1,852
-------------- --------------
Net Cash provided by Operating Activities 28,849 10,536
-------------- --------------
Cash Flows from Investing Activities
Loan to Cross-Sound Cable Project (194) -
Deferred payments in prior acquisitions (1,140) (2,297)
Acquisition of Electric System Work Center facility (16,210) -
Plant expenditures (4,548) (10,753)
Changes in restricted cash (34) 3,246
-------------- --------------
Cash provided by (used in) Continuing Operations (22,126) (9,804)
Cash provided by (used in) Discontinued Operations 30 (1,843)
-------------- --------------
Net Cash provided by (used in) Investing Activities (22,096) (11,647)
-------------- --------------
Cash Flows from Financing Activities
Issuances of Common stock 1,174 236
Sale of pollution control refunding revenue bonds - 25,000
Notes payable 4,297 (11,771)
Lease obligations - (115)
Payment of common stock dividend (10,299) (10,276)
-------------- --------------
Cash (used in) Continuing Operations (4,828) 3,074
Cash (used in) Discontinued Operations (1,500) (10)
-------------- --------------
Net Cash (used in) Financing Activities (6,328) 3,064
-------------- --------------
Cash and Temporary Cash Investments:
Net change for the period 425 1,953
Balance at beginning of period 28,614 18,910
-------------- --------------
Balance at end of period $ 29,039 $ 20,863
============== ==============
The accompanying Notes to the Consolidated Financial
Statements are an integral part of the financial statements.
- 6 -
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
includes the operations of Xcelecom, Inc. (Xcelecom) and American Payment
Systems, Inc. (APS), and two entities which indirectly support the operations of
their respective passive investments, United Capital Investments, Inc. (UCI) and
United Bridgeport Energy, Inc. (UBE). 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 included in UIL Holdings' Annual Report on
Form 10-K/A for the year ended December 31, 2003. 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 three
months ended March 31, 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 three month period ended
March 31, 2003 included in this Amendment No. 1 on Form 10-Q/A. As a result of
the restatement discussed in Note (B), UIL Holdings filed restated financial
statements for this matter in Amendment No. 1 on Form 10-K/A 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).
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. 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 expected to be completed by the end of the third quarter of 2004.
- 7 -
REVENUES
Historically, UI has estimated its accrual for unbilled revenue based upon its
system requirements less an estimated loss factor. Beginning in 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 for the quarter.
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. At the end of
the first quarter of 2004, the vendor was in default under the restructured
agreement, as only $0.1 million in principal had been paid. On March 31, 2004,
the vendor and one of UIL Holdings' non-utility subsidiaries entered into a
forbearance agreement, where UIL Holdings' non-utility subsidiary agreed to
forbear any collection actions. As consideration for such forbearance, the
vendor made a principal payment of $0.3 million on April 2, 2004 and agreed to
have the remaining outstanding loan balance secured by real property owned by
one of the vendor's affiliated companies.
- 8 -
EARNINGS PER SHARE
The following table presents a reconciliation of the basic and diluted earnings
per share calculations for the quarters ended March 31:
INCOME APPLICABLE TO AVERAGE NUMBER OF EARNINGS
COMMON STOCK SHARES OUTSTANDING PER SHARE
------------ ------------------ ---------
(In Thousands, except per share amounts)
2004
Basic earnings from continuing operations $5,692 14,335 $0.40
Basic earnings from discontinued operations 1,443 14,335 0.10
------------------------ ---------------------- -------------
Basic earnings 7,135 14,335 0.50
Effect of dilutive stock options (1) - 91 (0.01)
------------------------ ---------------------- -------------
Diluted earnings $7,135 14,426 $0.49
======================== ====================== =============
2003
Basic earnings from continuing operations $5,518 14,279 $0.39
Basic earnings from discontinued operations (252) 14,279 (0.02)
------------------------ ---------------------- -------------
Basic earnings 5,266 14,279 0.37
Effect of dilutive stock options (1) - - -
------------------------ ---------------------- -------------
Diluted earnings $5,266 14,279 $0.37
======================== ====================== =============
(1) Dilutive stock options only impact the earnings from continuing operations.
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 after January 1, 2003. There were 37,919 stock options granted during
the first quarter of 2004 at an average exercise price of $47.44. UIL Holdings
records compensation expense related to stock options based 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.
- 9 -
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
MARCH 31,
2004 2003
(In thousands, except
per share amounts)
Net Income, as reported $7,135 $5,266
Add: Stock-based compensation expense included in reported
net income, net of related tax effects - -
Deduct: Total stock-based compensation determined under fair
value based method for all stock grants, net of related tax effect (150) (190)
----------- ------------
Pro forma net income $6,985 $5,076
----------- ------------
Earnings per share:
Basic - as reported $0.50 $0.37
----------- ------------
Basic - proforma $0.48 $0.36
----------- ------------
Diluted - as reported $0.49 $0.37
----------- ------------
Diluted - proforma $0.48 $0.36
----------- ------------
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.
COMPREHENSIVE INCOME
Comprehensive income for the three months ended March 31, 2004 and 2003 was
equal to net income as reported.
- 10 -
UIL HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(B) CAPITALIZATION
COMMON STOCK
UIL Holdings had 14,496,319 shares of its common stock, without par value,
outstanding at March 31, 2004, of which 153,670 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
March 31, 2004, 153,670 shares, with a fair market value of $7.4 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 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.
- 11 -
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 three months ended
March 31, 2003:
THREE MONTHS ENDED THREE MONTHS ENDED
MARCH 31, 2003 MARCH 31, 2003
(AS ORIGINALLY REPORTED) RESTATEMENT (AS RESTATED)
-------------------------- ------------------- ------------------------
(in thousands)
CASH FLOWS FROM INVESTING
ACTIVITIES:
Deferred payments in prior acquisitions $ (2,297) $ - $ (2,297)
Sale of pollution control refunding
revenue bonds 25,000 (25,000) -
Plant expenditures (10,753) - (10,753)
Changes in restricted cash 3,246 - 3,246
-------------------------- ------------------- ------------------------
Cash provided by (used in) Continuing
Operations 15,196 (25,000) (9,804)
Cash used in Discontinued Operations (1,843) - (1,843)
-------------------------- ------------------- ------------------------
NET CASH PROVIDED BY (USED IN)
INVESTING ACTIVITIES $13,353 $(25,000) $(11,647)
========================== =================== ========================
CASH FLOWS FROM FINANCING
ACTIVITIES:
Issuances of common stock $ 236 $ - $ 236
Sale of pollution control refunding
revenue bonds - 25,000 25,000
Notes payable (11,771) - (11,771)
Lease obligations (115) - (115)
Payment of common stock dividend (10,276) - (10,276)
-------------------------- ------------------- ------------------------
Cash provided by (used in) Continuing (21,926) 25,000 3,074
Operations
Cash used in Discontinued Operations (10) - (10)
-------------------------- ------------------- ------------------------
NET CASH PROVIDED BY (USED IN)
FINANCING ACTIVITIES $(21,936) $25,000 $3,064
========================== =================== ========================
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 the
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%
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 interest on the bonds. Interest is
payable semi-annually on August 1st and February 1st.
- 12 -
(C) REGULATORY PROCEEDINGS
RATE CASE
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. 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 appealed the DPUC decision to the Connecticut
Superior Court. In late April 2004, the DPUC reopened the docket related to UI's
recovery of increased pension costs.
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.
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 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 provides
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
- 13 -
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 competitive transition assessment
(CTA) charge on customers' bills.
The rate reduction bonds are expected to be 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. 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.
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 its recent order directing UI to
reclassify a portion of this construction as transmission network upgrades
noting 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 and settlement
documents are being prepared for filing with the FERC. The settlement agreement,
if approved by the FERC, will not have a material impact on UI's results of
operation or financial condition.
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 in the third quarter 2004. The FERC
has sent to mediation the base ROE requested by the Transmission Owners (TOs),
including UI, of 12.88%. If mediation is not successfully completed, the issue
will go to hearing. 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 expect to file a request for rehearing regarding several
others.
(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 March 31,
2004, UIL Holdings had $32 million outstanding under this arrangement.
UIL Holdings has a revolving credit agreement with a group of banks that was
amended July 31, 2003 and extended to July 29, 2004. 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,
and also permits UIL Holdings to borrow money for fixed periods of time
- 14 -
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 March 31, 2004, UIL
Holdings had $35 million in short-term borrowings outstanding under this
facility.
Xcelecom has a revolving credit agreement with two banks that expires on June
30, 2004. This agreement provides for a $25 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. As
of March 31, 2004, there was $0.5 million outstanding on the revolving working
capital balance under this facility. In addition, Xcelecom had $0.8 million of
capital equipment funding that had been converted to term notes outstanding and
standby letters of credit of $5 million outstanding at March 31, 2004. All
borrowings outstanding under this agreement are secured solely by assets of
Xcelecom and its subsidiaries. Xcelecom is currently exploring the options of
either extending or replacing the current credit facility.
APS owed UIL Holdings $2 million as of March 31, 2004 under a short-term loan
arrangement. In April 2004, APS paid the balance owed to UIL Holdings in full.
(E) INCOME TAXES
Three Months Ended
March 31,
2004 2003
---- ----
(In Thousands)
Income tax expense consists of:
Income tax provisions (benefit):
Current
Federal $ 2,848 $ 7,728
State 1,419 2,677
------------- --------------
Total current 4,267 10,405
------------- --------------
Deferred
Federal 2,169 (2,934)
State (265) (1,356)
------------- --------------
Total deferred 1,904 (4,290)
------------- --------------
Investment tax credits (105) (148)
------------- --------------
Total income tax expense $ 6,066 $ 5,967
============= ==============
Income tax components charged as follows:
Operating tax expense $ 5,720 $ 5,572
Nonoperating tax expense 346 395
------------- --------------
Total income tax expense $ 6,066 $ 5,967
============= ==============
Legislation was 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 has increased slightly from 40.85% to 41.094% for the year 2004.
- 15 -
Differences in the treatment of certain transactions for book and tax purposes
occur which cause the rate of UIL Holdings' reported income tax expense to
differ from the statutory tax rate described above. The effective book income
tax rate for the quarter ended March 31, 2004 was 52.1% as compared to 51.3% for
the quarter ended March 31, 2003. The increase in the 2004 rates is due
primarily to: (1) the imposition of the 25% surcharge described above, and (2)
differences in the amounts of book depreciation in excess of non-normalized tax
depreciation.
- 16 -
UIL HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
(F) SUPPLEMENTARY INFORMATION
Three Months Ended
March 31,
2004 2003
(In Thousands)
Operating Revenues
Utility
Retail $ 167,771 $ 149,974
Wholesale 6,214 7,562
Other 7,859 7,756
Non-utility businesses
Xcelecom 67,548 68,942
Other 35 5
----------- -----------
Total Operating Revenues $ 249,427 $ 234,239
=========== ===========
Sales by Class (megawatt-hours)
Retail
Residential 638,286 600,633
Commercial 637,811 608,387
Industrial 234,970 226,925
Other 11,881 12,833
---------- ----------
1,522,948 1,448,778
Wholesale 110,649 114,664
---------- ----------
Total Sales by Class 1,633,597 1,563,442
========== ==========
Fuel and Energy
Fuel and Energy Expense $93,631 $72,408
Purchase Power above market fuel expense credit (1) (5,693) (5,926)
---------- ----------
Total Fuel and Energy Expense $ 87,938 $ 66,482
========== ==========
Depreciation and Amortization
Utility property, plant, and equipment $ 7,495 $ 7,006
Non-utility business property, plant and equipment 872 871
---------- ----------
Total Depreciation 8,367 7,877
---------- ----------
Amortization of nuclear plant regulatory assets 2,647 10,601
Amortization of purchase power contracts (1) 5,693 5,926
Amortization of other CTA regulatory assets ` 283 260
Amortization of cancelled plant - 293
---------- ----------
Subtotal CTA Amortization 8,623 17,080
Amortization of intangibles 313 335
Amortization of other regulatory assets 187 1,143
---------- ----------
Total Amortization 9,123 18,558
---------- ----------
Total Depreciation and Amortization $ 17,490 $ 26,435
========== ==========
Taxes - Other than Income Taxes
Operating:
Connecticut gross earnings $ 6,026 $ 6,421
Local real estate and personal property 2,542 2,592
Payroll taxes 2,177 1,875
---------- ----------
Total Taxes - Other than Income Taxes $ 10,745 $ 10,888
========== ==========
Other Income (Expense), net
Interest income $ 373 $ 189
Allowance for funds used during construction 466 656
Equity earnings from Connecticut Yankee 66 85
Non-utility business passive expense (2,937) (2,146)
Seabrook reserve reduction 1,355 -
Miscellaneous other income and (expense) - net 2,077 781
---------- ----------
Total Other Income (Expense), net $ 1,400 $ (435)
========== ==========
Other Interest, net
Notes payable $ 291 $ 124
Other 431 143
---------- ----------
Total Other Interest, net $ 722 $ 267
========== ==========
(1) 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.
- 17 -
(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. 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 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 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.
- 18 -
The following table represents the components of net periodic benefit cost for
the pension and OPEB for the 2004 plan projections.
FOR THE QUARTER ENDED MARCH 31,
PENSION BENEFITS OTHER POSTRETIREMENT BENEFITS
Q1 2004 Q1 2003 Q1 2004 Q1 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% 6.00% 6.00% 6.00%
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 (2004) N/A N/A 13.00% 13.00%
Pre-65 health care trend rate (2012+) N/A N/A 5.50% 5.50%
Post-65 health care trend rate (2004) N/A N/A 7.00% 7.00%
Post-65 health care trend rate (2009+) N/A N/A 5.00% 5.00%
(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 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 includes an increase of approximately $273
million over the cost estimate reported in November 2002.
The $273 million increase in the decommissioning cost estimate primarily
reflects the impacts of the termination of the turnkey decommissioning
- 19 -
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.
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. Connecticut Yankee is required to update its decommissioning
cost estimate through a filing with the FERC by no later than July 1, 2004.
UI's share of the estimated increased cost of $273 million over the estimate
reported in November 2002 would be approximately $25.9 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.
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 are
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 March 31, 2004, UI has regulatory approval to
recover in future rates $23.9 million of its regulatory asset for Connecticut
Yankee over a term ending in 2007. The remaining portion of the regulatory
asset, as of March 31, 2004, was $27.5 million, consisting of $4.2 million of
equity investment and $23.3 million of costs subject to a regulatory review and
approval process in 2004. The $23.3 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. UI believes full
regulatory recovery is probable because these costs are similar in nature to
the costs already afforded regulatory treatment. 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.
Connecticut Yankee is seeking recovery of additional decommissioning costs and
other damages from Bechtel and, if necessary, its surety. In addition to
pursuing this recovery through pending litigation, Connecticut Yankee is also
preparing a rate application with the FERC, with any resulting Connecticut
Yankee rate increase being charged to its wholesale power customers (including
UI, which is responsible for 9.5% of the costs of the Connecticut Yankee nuclear
unit). In turn, 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.
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
- 20 -
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.
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 March 31, 2004, UI's guarantee for this debt was
approximately $3.7 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 $6.4 million and is currently expected to be
completed in 2004. 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 December
31, 2003, $9.2 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
- 21 -
easements for the operation of its transmission facilities on the site. UI has
also funded 61% (approximately $1.2 million) of the estimated environmental
remediation costs that will be incurred by QE to bring the site into compliance
with applicable minimum Connecticut environmental standards. 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.
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. 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 has an opportunity to examine the current environmental conditions at the
site and direct remediation, or further remediation, of any areas of concern.
Possible areas of concern include locations where previous oil spills had been
previously reported and remediated. The CDEP may reinvestigate historical events
that are currently listed as "closed" (meaning that the CDEP had previously
determined that no further action was required). It is expected that the CDEP
will complete its review in the second quarter of 2004.
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
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 recovery of such amount through the regulatory process.
- 22 -
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 has been signed by the parties and was filed with the
FERC on April 27, 2004. The filing requests expedited approval and a decision is
expected by the end of May 2004. As part of the agreement, UI will initially be
required to provide credit assurance of $720,000 in the form of a guarantee,
letter of credit or escrow account, in the event UI is unable to reduce demand
when requested by ISO-NE.
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 March 31, 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 $23.4 million to
Cross-Sound. In addition, two guarantees, in the amounts of $2.5 million and
$1.3 million, have been provided in support of Hydro-Quebec's (HQ) guarantees to
third parties in connection with the construction of the project.
The $2.5 million guarantee is in support of an HQ guarantee to the Long Island
Power Authority (LIPA) to provide for damages in the event of a delay in the
date of achieving commercial operation. Although there is currently a delay in
achieving commercial operation status, the guarantee does not require
performance if the delay is due to an event beyond HQ's or Cross-Sound's
reasonable control, which has been defined to include, among other items,
"action or inaction of governmental, regulatory, or judicial bodies." The
Connecticut legislative moratorium on installing new gas and utility lines
across the Long Island Sound qualifies as an event beyond reasonable control as
defined in the contract. No liability has been recorded related to this
guarantee as Cross-Sound has filed a new permit application to allow for
commercial operation of the cable at its current depth and expects the
application to be acted upon once the moratorium is lifted.
The $1.3 million guarantee is in support of an agreement for 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. No liability has been recorded in UIL
Holdings' consolidated balance sheet, as UCI does not believe it will have to
perform under this guarantee. As the cable continues to operate under a federal
DOE Emergency Order, sufficient income is being provided to support the payments
to the shell fisherman. In addition, once the cable achieves commercial
operation, Cross-Sound will be compensated under the terms of a twenty-year
contract with LIPA, which will also provide sufficient funding to make the
payments to shell fisherman.
In the event that Cross-Sound could not meet any obligations that are supported
by the previously mentioned guarantees, it is expected that such obligations
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 either
guarantee.
Although commercial operation has not yet been achieved, the cable has been
operating under a DOE Emergency Order since the August 14, 2003 blackout and is
expected to remain operational under this order until such time as the Emergency
identified in the Order ceases to exist. Upon commercial operation, 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.For further discussion regarding the Cross-Sound
cable, see "Management's Discussion and Analysis - Major Influences - United
Capital Investments, Inc."
- 23 -
XCELECOM, INC.
Xcelecom, through one of its subsidiaries, has filed suit in the District Court
for New Jersey against Paquet, a general contractor doing business in the state
of New Jersey. Xcelecom contends that it is owed approximately $2 million in
overdue payments and back charges related to the electrical work for the
construction of a bridge in New Jersey. The defendant has asserted a
counterclaim against Xcelecom for an unspecified amount. Pleadings are not yet
closed and discovery is just beginning. Xcelecom intends to vigorously pursue
its suit against the defendant and defend against its counterclaim. 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 of this receivable, either
directly from Paquet, or through Paquet's surety.
(M) SEGMENT INFORMATION
As described in Note (O), "Discontinued Operations," to the consolidated
financial statements, APS has been classified as "held for sale" 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.
MARCH 31, 2004 DECEMBER 31, 2003
-------------- -----------------
Total Assets (In Thousands)
- ------------
UI $1,491,096 $1,492,144
Xcelecom 179,576 178,906
Assets of discontinued operations held
for sale 112,572 121,627
Other 109,545 105,489
----------------------------------------------
Total UIL Holdings $1,892,789 $1,898,166
==============================================
THREE MONTHS THREE MONTHS
ENDED ENDED
MARCH 31, 2004 MARCH 31, 2003
-------------- --------------
Revenues from External Customers (In Thousands)
- --------------------------------
UI $181,843 $165,292
Xcelecom 67,548 68,942
Other 36 5
----------------------------------------------
Total UIL Holdings $249,427 $234,239
==============================================
Income (Loss) from Continuing Operations before
Income Taxes
UI $18,441 $16,450
Xcelecom (1,028) (477)
Other (5,655) (4,488)
----------------------------------------------
Total UIL Holdings $11,758 $11,485
==============================================
- 24 -
(N) GOODWILL AND OTHER INTANGIBLE ASSETS
As of March 31, 2004 and December 31, 2003, UIL Holdings maintains $68.6 million
of goodwill related to Xcelecom that is no longer being amortized, and $3.7
million and $2.7 million, at March 31, 2004 and December 31, 2003, respectively,
of identifiable intangible assets that continue to be amortized.
A summary of UIL Holdings' goodwill as of December 31, 2003 is as follows:
(Thousands of Dollars) Total
--------------
Balance, January 1, 2004 $68,554
Goodwill acquired during the quarter
ended March 31, 2004 81
--------------
Balance, March 31, 2004 $68,635
==============
There were no impairments to the goodwill balances recognized during the
quarters ended March 31, 2004 and 2003.
As of March 31, 2004 and December 31, 2003, UIL Holdings' intangible assets and
related accumulated amortization consisted of the following:
As of March 31, 2004
--------------------------------------------
Accumulated Net
(Thousands of Dollars) Gross Amortization Balance
------------ ------------------ ------------
Intangible assets subject to amortization:
Non-compete agreements $3,435 $2,491 $944
Backlog 256 256 -
------------ ------------------ ------------
Total $3,691 $2,747 $944
============ ================== ============
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 $0.3 million for both the three
months ended March 31, 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.
(O) DISCONTINUED OPERATIONS
On December 16, 2003, UIL Holdings entered into an agreement to sell APS to
CheckFree Corporation (CheckFree), a leading provider of financial electronic
commerce services and products. Under the terms of the agreement, and pending
receipt of regulatory approvals and satisfaction of customary closing
- 25 -
conditions, CheckFree will pay approximately $110 million in cash for the
outstanding stock of APS. The transaction is expected to close during the second
quarter of 2004, with the resulting gain on sale, net of transaction costs, to
be recognized at that time.
CheckFree will 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 is 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 are no longer being depreciated. The related
asset carrying values were adjusted, if appropriate, to reflect the lower of
either the carrying amounts or the current 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.
A summary of the discontinued operations of APS for the periods ended March 31
follows (in thousands):
2004 2003
---- ----
Net operating revenues $21,191 $29,390
============== ==============
Operating income (loss) $2,106 $ (564)
============== ==============
Income (loss) before income taxes $2,260 $ (411)
Income tax (expense) benefit (817) 159
-------------- --------------
Net income (loss) from discontinued operations $1,443 $ (252)
============== ==============
(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 quarters ended March 31, 2004 and 2003 totaled $2.2 million and $2
million, 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.
- 26 -
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). SUCH FORWARD-LOOKING STATEMENTS INCLUDE RISKS
AND UNCERTAINTIES; CONSEQUENTLY, ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE
EXPRESSED OR IMPLIED THEREBY, DUE TO IMPORTANT FACTORS INCLUDING, BUT NOT
LIMITED TO, GENERAL ECONOMIC CONDITIONS, LEGISLATIVE AND REGULATORY CHANGES,
DEMAND FOR ELECTRICITY AND OTHER PRODUCTS AND SERVICES, 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 SUBSIDIARIES OF UIL HOLDINGS CORPORATION
(UIL HOLDINGS). MOST OF THESE FACTORS ARE DIFFICULT TO PREDICT ACCURATELY AND
ARE GENERALLY BEYOND OUR CONTROL. YOU SHOULD CONSIDER THE AREAS OF RISK
DESCRIBED IN CONNECTION WITH ANY FORWARD-LOOKING STATEMENTS THAT MAY BE MADE
HEREIN. READERS ARE CAUTIONED NOT TO PLACE UNDUE RELIANCE ON THESE
FORWARD-LOOKING STATEMENTS, WHICH SPEAK ONLY AS OF THE DATE HEREOF.
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' operating subsidiaries: UI, Xcelecom and
APS. These operations depend on the continued efforts of their respective
current and future executive officers, senior management and management
personnel. In an effort to minimize the loss of key personnel as a result of the
announced sale of APS, select employees will receive retention bonuses if they
are still employed by APS at the end of a transition period following the sale.
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. If UIL Holdings were to lose a number of key personnel, its
operations could be adversely affected.
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
- 27 -
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 appealed the DPUC decision to the Connecticut
Superior Court. In late April 2004, the DPUC reopened the docket related to UI's
recovery of increased pension costs.
OPERATIONS
In implementing the 1998 Restructuring Legislation, UI established a
Distribution Division and other "unbundled" components for accounting purposes,
- 28 -
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
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 quarters ended March 31, 2004 and
2003 were $0.24 and $0.26, 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 quarters
ended March 31, 2004 and 2003 amounted to $7 million and $11 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 $278 as
of March 31, 2004. The 2003 result is subject to an annual review by the DPUC of
UI's CTA revenues and expenses, and may be adjusted in accordance with that
review. 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.
Purchased power expenses are a pass-through expense, collected from customers in
the GSC and as federally mandated congestion 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, 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
- 29 -
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
approximately $600 million 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 project. The CSC has issued a press release proposing that a final
decision be rescheduled to December 2004. Other governmental permitting,
together with approvals from ISO-New England, will be required for the project,
and the total project cost 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 adequately 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 incidents 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.
AMERICAN PAYMENT SYSTEMS, INC.
As a result of the pending sale of APS to CheckFree, and management's decision
to dispose of APS' telephony assets, there are now two principal risks affecting
the financial condition of APS and UIL Holdings: operating risk and disposition
risk. Operating risk relates to the risk factors inherent in APS' business
operations, whereas disposition risk relates to the risk factors that could
impact the outcome of the potential sale of APS.
The four primary operating risk factors affecting the financial results of APS
and its subsidiaries are (1) the ability to recruit and retain agents, (2) the
ability to manage and control agent fraud to ensure that the agents are
depositing the funds collected from the consumers in a timely fashion (3) the
maintenance of internal control systems and procedures to account for the
movement of significant amounts of cash from the agents to APS and on to the
biller, on whose behalf the funds are collected, and (4) compliance with
increasingly complex regulatory requirements applicable to its business. APS has
programs and procedures in place to mitigate the operating risk factors
described above. These include a formal program to recruit and train agents, as
well as processes to monitor cash movements and reconcile high dollar volume
accounts on a daily basis. In addition, APS reviews its internal control systems
and procedures to ensure that these controls are maintained in an effective
manner and regularly evaluates, and when deemed appropriate implements new
- 30 -
technologies to improve the existing internal control systems and procedures.
These operating risks will no longer affect UIL Holdings upon closing of the
sale of APS to CheckFree.
There are significant disposition risks relating to the potential sale of APS to
CheckFree. UIL Holdings and CheckFree made the required filings under the
federal Hart-Scott-Rodino Antitrust Improvements Act, and as of January 30,
2004, the mandatory waiting periods thereunder expired. In addition, the parties
have made notice filings or submitted applications for approval of the
transaction to state regulatory authorities in more than thirty states in which
APS holds licenses in connection with its money transmittal business. The sale
of APS to CheckFree will not close until certain of those state regulatory
authorities have approved the transaction.
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.
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 which have been acquired. 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
- 31 -
quality of their management. There is no guarantee that any member of management
at the corporate or subsidiary level 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 be accepted by the customer once it is demonstrated that
those benchmarks have been met. If Xcelecom is unable to show the 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 work. 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,
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
- 32 -
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 50% of costs are
derived from labor and related expenses. For the periods ended March 31, 2004
and 2003, labor-related expenses totaled $35.7 million and $37.4 million,
respectively.
Approximately 35% 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 periods ended March 31, 2004 and 2003,
material and equipment expenses totaled $22.3 million and $22.6 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
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 incidents 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, 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,
- 33 -
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. Cross-Sound is developing proposals for
achieving the required burial depth. 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.
Currently there is a Connecticut legislative moratorium on installing new gas
and utility lines across Long Island Sound through early June 2004. In early
May 2004 the Connecticut General Assembly passed a bill, subject to approval by
the Governor, extending the moratorium for another year to early June 2005.
This legislation would also allow for a waiver of the moratorium by means of an
applicant submitting a petition to the following: the chairpersons and ranking
members of the joint standing committees of the General Assembly having
cognizance of matters relating to energy and the environment, the chairman of
the CSC, the chairperson of the DPUC, the Commissioner of the CDEP, and any
other state agency head with jurisdiction over the subject of the petition.
Under the legislation (upon its effective date), a waiver can only be granted
upon receiving unanimous approval of the petition. This moratorium has
prevented Cross-Sound from resolving its permitting issues. Once this bill
becomes law, Cross-Sound expects to prepare a petition to state agencies for
waiver as set forth in the legislation in an effort to resolve permitting
issues and gain commercial operation status. Cross-Sound expects the
CDEP to begin processing Cross-Sound's new permit application when the
moratorium expires or is otherwise no longer in effect.
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 AG and the CDEP challenged the
DOE Emergency Order by filing a request for stay or rehearing with the DOE. A
decision by the DOE is expected sometime in 2004. Furthermore, the AG filed a
petition for review and a motion for stay with the Federal Second Circuit Court
of Appeals in New York of the August 28, 2003 DOE Emergency Order. The DOE
simultaneously filed a motion with the same court to dismiss the AG's petition
on the grounds that the judicial appeal should not proceed before the AG
exhausts his administrative remedies before the DOE. Currently briefs are being
submitted on both motions and oral arguments are scheduled for early May 2004.
The range of outcomes from the DOE decision and future court, agency and
legislative actions that may affect the operation of the cable, includes, but
is not limited to: (1) the DOE order continues in effect, and the cable
continues to operate; (2) the DOE order is revoked, and Connecticut's
moratorium is extended and not struck down on legal grounds, thus preventing
operation; (3) the DOE order is revoked, and the CDEP grants a permit
modification or approves remediation, enabling the cable to operate; (4) the
DOE order is revoked, the moratorium is not extended, and the CDEP denies a
permit modification or remediation, preventing cable operation; and (5) federal
legislation requires that the cable be permitted to continue to operate.
Since mid-August 2003 and pursuant to an Emergency Order issued by the DOE, the
Cross-Sound cable has been operating full time, either transferring power, or
available to transfer power, across the Long Island Sound. Cross-Sound has
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 has
provided reactive power voltage support and has responded automatically to
system instability caused by lightning strikes and equipment outages.
- 34 -
On October 31, 2003, the CDEP issued a request for proposal (RFP) to hire an
independent consultant to compare the environmental and navigational impacts of
cable operation in the current location with the impacts that would result from
reburying the cable to the permitted depth. Although the study results,
according to the RFP, are due by June 25, 2004, to this date a consultant has
not been hired. A recent environmental monitoring survey of the Long Island
Sound seabed on and around the cable system, conducted as part of state and
federal permit requirements, has shown that cable operation causes no harm to
the environment, and does not impact navigation. Accordingly, UCI expects the
results of the independent study to show that the cable, operating in its
current location, poses no harm to the environment, and does not impact
navigation. Such conclusion could potentially help Cross-Sound achieve
commercial operation at a faster pace.
UCI's 25% share of the estimated total final cost of the project is $35
million. As of March 31, 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 $23.4 million to
Cross-Sound. In addition, two guarantees totaling $3.8 million, in support of
Hydro-Quebec's guarantees to third parties in connection with the construction
of the project have been provided (see "Notes to the Consolidated Financial
Statements - Note (J), Commitments and Contingencies - Cross Sound Cable
Company, LLC", for further discussion of these guarantees). 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 did not record a liability related to the guarantee,
as the likelihood of UIL Holdings having to perform under the guarantee is
remote. Upon commercial operation, 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.
UCI has recorded $0.1 million in income for the project in the first quarter of
2004 under the provisions of an interim operating contract that covers
Cross-Sound's compensation for the operation of the cable under the 2004
Emergency Order. The interim operating contract has received all required
approvals. In addition to the interim operating contract, a settlement agreement
relating to Cross-Sound's compensation for a 2002 DOE Emergency Order has been
approved by the Long Island Power Authority's board of trustees and the New York
State Comptroller's office, however, FERC approval is still required for the
settlement agreement.
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 has written its investment in Zero Stage
VI to zero as of March 31, 2004. There have been no material changes since
December 31, 2003 in the values of the other venture funds in which UCI holds
equity interests.
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 $79.3 million carrying value of the 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.
- 35 -
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 the current 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%. 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; this is scheduled to enter the market in
June 2004. The full impact that Locational ICAP will have is not known at this
time, although it is expected to have a positive effect on BE.
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 does not anticipate these plans,
or the potential changes to the DETM agreement, to have a negative impact on the
operations of BE at this time.
LIQUIDITY AND CAPITAL RESOURCES
Moody's Investors Service recently downgraded UIL Holdings' Issuer Rating from
Baa1 to Baa2. 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. Also, the downgrade will increase the interest rate on short-term
borrowings under the revolving credit facility that UIL Holdings has with a
group of banks by 7.5 basis points. UIL Holdings plans to pay down short-term
borrowings once the APS sale transaction is complete. Based on projected cash
requirements, UIL Holdings' projected short-term borrowings (if any) are not
expected to be significant through the end of 2004.
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 dividends to
UIL Holdings' shareholders. UIL Holdings' current strategy for Xcelecom and its
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. See the "Major
Influences on Financial Condition" section of this item 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 to a more robust
level.
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 $25 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
- 36 -
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.
At March 31, 2004, UIL Holdings had $29 million of unrestricted cash and
temporary cash investments, excluding $6.4 million of cash held by APS which has
been categorized as current assets of discontinued operations held for sale in
the accompanying Consolidated Balance Sheet. This represents an increase of $0.4
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 27.6
Net cash (used in) investing activities of continuing operations:
- Loan to Cross-Sound Cable Project (0.2)
- Acquisition of Electric System Work Center facility (16.2)
- Cash invested in plant (4.6)
- Changes in restricted cash (1) (0.1)
- Deferred payments in prior acquisitions (1.1)
--------------
(22.2)
Net cash (used in) financing activities of continuing operations:
- Financing activities, excluding dividend payments 5.5
- Dividend payments (10.3)
--------------
(4.8)
Net cash provided by (used in) discontinued operations (0.2)
Net Change in Cash 0.4
--------------
Balance, March 31, 2004 $29.0
==============
(1) As of March 31, 2004, UIL Holdings had $1.4 million in restricted cash,
representing $1.1 million held in escrow to cover certain expenses accrued
at the time of the sale of Seabrook Station, and $0.3 million related to
future debt payments of Xcelecom.
The net change in UIL Holdings' unrestricted cash position at March 31, 2004, as
compared to December 31, 2003, was minimal. Cash provided by operating
activities was utilized to fund a variety of investing and financing activities
including UI's purchase of the Electric System Work Center facility for $16.2
million under the purchase option of the capital lease previously in place for
that facility, the payment of UIL Holdings' quarterly dividend amounting to
$10.3 million, and $1.1 million of deferred payments related to prior
acquisitions made by Xcelecom.
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.
CONTRACTUAL AND CONTINGENT OBLIGATIONS
At March 31, 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.
- 37 -
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 March 31, 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 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 for the quarter.
- 38 -
RESULTS OF OPERATIONS
FIRST QUARTER 2004 VS. FIRST QUARTER 2003
- -----------------------------------------
UIL HOLDINGS CORPORATION RESULTS OF OPERATIONS: FIRST QUARTER 2004 VS.
- -----------------------------------------------------------------------
FIRST QUARTER 2003
- -------------------
UIL Holdings' earnings from continuing operations for the first quarter of 2004
increased by $0.1 million, or $0.01 per share, compared to the first quarter of
2003. Net income from discontinued operations increased by $1.7 million, or
$0.12 per share, in the first quarter of 2004 from the first quarter 2003 net
loss of $0.3 million, or $0.02 per share. Total earnings for the first quarter
of 2004, including discontinued operations, increased by $1.8 million, or $0.13
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, as well as the impact of final decisions by the DPUC
regarding the disposition of proceeds from UI's investment in nuclear generating
facilities. The impact of these gains was diminished by the effect of high
natural gas prices affecting UBE and the continued slow economic recovery in
certain regions affecting Xcelecom.
The table below represents a comparison of UIL Holdings' Net Income and Earnings
per Share (EPS) for the first quarter of 2004 and the first quarter of 2003.
2004 more (less) than 2003
------------------------------
Quarter Ended Quarter Ended
March 31, 2004 March 31, 2003 Amount Percent
---------------- ----------------- ---------------- ------------
NET INCOME (IN MILLIONS EXCEPT PERCENTS AND PER
SHARE AMOUNTS)
UI $9.6 $8.5 $1.1 13%
Non-Utility (3.9) (2.9) (1.0) (34)%
----- ----- -----
TOTAL NET INCOME FROM CONTINUING OPERATIONS $5.7 $5.6 $0.1 2%
Discontinued Operations 1.4 (0.3) 1.7 566%
--- ----- ---
TOTAL NET INCOME $7.1 $5.3 $1.8 34%
=== === ===
EPS
UI $0.67 $0.60 $0.07 12%
Non-Utility (0.27) (0.21) (0.06) (29)%
------ ------ ------
TOTAL EPS FROM CONTINUING OPERATIONS - BASIC $0.40 $0.39 $0.01 3%
Discontinued Operations 0.10 (0.02) 0.12 600%
---- ------ ----
TOTAL EPS - BASIC $0.50 $0.37 $0.13 35%
==== ==== ====
TOTAL EPS - DILUTED (NOTE A) $0.49 $0.37 $0.12 32%
==== ==== ====
Note A: Reflecting the effect of unexercised dilutive stock options.
- 39 -
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 quarter of 2004 and the first 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) MAR. 31, 2004 MAR. 31, 2003 THAN 2003
- ------------- ------------- ------------- ---------
OPERATING REVENUES
UI from operations $181.8 $165.3 $16.5
Xcelecom 67.6 68.9 (1.3)
------ ------ ------
TOTAL OPERATING REVENUES $249.4 $234.2 $15.2
====== ====== ======
FUEL AND ENERGY EXPENSES - UI $87.9 $66.5 $21.4
====== ====== ======
OPERATION AND MAINTENANCE EXPENSES
UI $48.4 $43.0 $5.4
Xcelecom 66.9 67.7 (0.8)
Minority Interest Investment & Other 1.4 0.7 0.7
------ ------ ------
TOTAL OPERATION AND MAINTENANCE EXPENSES $116.7 $111.4 $5.3
====== ====== ======
DEPRECIATION AND AMORTIZATION EXPENSES
UI $7.5 $7.0 $0.5
Xcelecom 0.9 0.9 0.0
------ ------ ------
Subtotal depreciation 8.4 7.9 0.5
Amortization of regulatory assets (UI) 8.8 18.2 (9.4)
Amortization Xcelecom 0.3 0.3 0.0
------ ------ ------
TOTAL DEPRECIATION AND AMORTIZATION EXPENSES $17.5 $26.4 $(8.9)
====== ====== ======
TAXES - OTHER THAN INCOME TAXES
UI - State gross earnings tax $6.0 $6.4 $(0.4)
UI - other 4.0 3.9 0.1
Xcelecom 0.7 0.6 0.1
------ ------ ------
TOTAL TAXES - OTHER THAN INCOME TAXES $10.7 $10.9 $(0.2)
====== ====== ======
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QUARTER ENDED QUARTER ENDED 2004 MORE (LESS)
(IN MILLIONS) MAR. 31, 2004 MAR. 31, 2003 THAN 2003
- ------------- ------------- ------------- ---------
OTHER INCOME (DEDUCTIONS)
UI $3.7 $1.7 $2.0
Xcelecom 0.3 0.2 0.1
Minority Interest Investment & Other (2.6) (2.3) (0.3)
------ ------ ------
TOTAL OTHER INCOME (DEDUCTIONS) $1.4 $(0.4) $1.8
====== ====== ======
EARNINGS BEFORE INTEREST AND TAXES (EBIT)
UI $22.9 $22.0 $0.9
Xcelecom (0.9) (0.4) (0.5)
Minority Interest Investment & Other (4.0) (3.0) (1.0)
------ ------ ------
TOTAL EBIT FROM CONTINUING OPERATIONS 18.0 18.6 (0.6)
Discontinued Operations 2.3 (0.4) 2.7
------ ------ ------
TOTAL EBIT $20.3 $18.2 $2.1
====== ====== ======
INTEREST CHARGES
UI $4.1 $5.2 $(1.1)
UI - Amortization: debt expense, redemption premiums 0.3 0.3 0.0
Xcelecom 0.1 0.1 0.0
Minority Interest Investment & Other 1.7 1.5 0.2
------ ------ ------
TOTAL INTEREST CHARGES $6.2 $7.1 $(0.9)
====== ====== ======
INCOME TAXES
UI $8.9 $8.0 $0.9
Xcelecom (0.4) (0.2) (0.2)
Minority Interest Investment & Other (2.4) (1.9) (0.5)
------ ------ ------
TOTAL INCOME TAXES $6.1 $5.9 $0.2
====== ====== ======
NET INCOME
UI $9.6 $8.5 $1.1
Xcelecom (0.6) (0.3) (0.3)
Minority Interest Investment & Other (3.3) (2.6) (0.7)
------ ------ ------
SUBTOTAL NET INCOME FROM CONTINUING OPERATIONS 5.7 5.6 0.1
Discontinued Operations 1.4 (0.3) 1.7
------ ------ ------
TOTAL NET INCOME $7.1 $5.3 $1.8
====== ====== ======
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THE UNITED ILLUMINATING COMPANY RESULTS OF OPERATIONS: FIRST QUARTER OF 2004 VS. FIRST QUARTER OF 2003
- -------------------------------------------------------------------------------------------------------------
2004 more (less) than 2003
Quarter Ended Quarter Ended
March 31, 2004 March 31, 2003 Amount Percent
-------------- ---------------- ------------- ------------
EPS FROM OPERATIONS
Total UI - basic $0.67 $0.60 $0.07 12%
==== ==== ====
Total UI - diluted (Note A) $0.67 $0.60 $0.07 12%
==== ==== ====
RETAIL SALES (MILLIONS OF KWH) 1,523 1,449 74 5%
Note A: Reflecting the effect of unexercised dilutive stock options.
UI's net income was $9.6 million, or $0.67 per share, in the first quarter of
2004, compared to $8.5 million, or $0.60 per share, in the first quarter of
2003. The increase from the first quarter of 2003 was mainly attributable to
non-recurring gains associated with a change in accounting estimate adjustment
to unbilled revenues and the impact of final decisions by the DPUC regarding the
disposition of proceeds from UI's investment in nuclear generating facilities.
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 $16.5 million, from $165.3 million in the
first quarter of 2003 to $181.8 million in the first quarter of 2004. Retail
revenue increased $17.8 million due mainly to an overall increase in
kilowatt-hour volume of 5.1%, 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 - The Untied 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). Approximately
3.2%, or 46 million kilowatt-hours, of this increase was attributable to the
non-recurring adjustment associated with a change in accounting estimate to
unbilled revenue. The impact of weather as compared to the same period of 2003
was minimal. Wholesale revenue decreased by $1.3 million, as compared to the
first quarter of 2003, due to lower volume and lower market prices in the New
England wholesale market.
Retail fuel and energy expense increased by $22.3 million in the first 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 first quarter of 2004 decreased 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 $5.4 million, from
$43 million in the first quarter of 2003 to $48.4 million in the first 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 $9.4 million in the first 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 $2 million in the first quarter of 2004, compared to
the first quarter of 2003, mainly due to the reduction of reserves associated
with UI's investment in Seabrook Station resulting from a March 2004 DPUC
decision.
Interest charges decreased by $1.1 million in the first 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.
- 42 -
NON-UTILITY RESULTS OF OPERATIONS: FIRST QUARTER 2004 VS. FIRST QUARTER 2003
- -----------------------------------------------------------------------------
2004 more (less) than 2003
Quarter Ended Quarter Ended --------------------------
March 31, 2004 March 31, 2003 Amount Percent
----------------- ---------------- ------------- -----------
EPS
Operating Business
Xcelecom $(0.04) $(0.02) $(0.02) (100)%
Minority Interest Investments
UBE (0.11) (0.11) - -
UCI (0.01) (0.01) - -
------ ------
Subtotal Minority Interest
Investments (0.12) (0.12) - -
UIL Corporate (Note A) (0.11) (0.07) (0.04) (57)%
------ ------ ------
TOTAL NON-UTILITY EPS FROM CONTINUING
OPERATIONS (0.27) (0.21) (0.06) (29)%
Discontinued Operations 0.10 (0.02) 0.12 600%
---- ------ ----
TOTAL NON-UTILITY EPS - BASIC $(0.17) $(0.23) $0.06 26%
====== ====== ====
TOTAL NON-UTILITY EPS - DILUTED (NOTE B) $(0.18) $(0.23) $0.05 22%
====== ====== ====
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.
The consolidated non-utility businesses reported a loss from continuing
operations, including unallocated holding company costs, of $3.9 million, or
$0.29 per share, in the first quarter of 2004, an increased loss of $1 million,
or $0.06 per share, compared to the same period of 2003. The results of Xcelecom
were hampered by the continued slow economic recovery in the Northeast. UBE
continues to be affected by high natural gas prices, which drive down results at
BE. Net income from discontinued operations for the first quarter of 2004
amounted to $1.4 million, or $0.10 per share, compared to a loss of $0.3
million, or $0.02 per share, in the first quarter of 2003. The improved results
from discontinued operations 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 quarter of 2004.
Operating revenue for the non-utility businesses decreased by $1.3 million, or
2% compared to the first quarter of 2003. All of the decrease in revenues came
from Xcelecom. First quarter 2004 operating expenses for the non-utility
businesses were flat with the same period of 2003, as lower expenses at
Xcelecom, due to the decrease in business, were offset by higher administrative
costs at UIL Corporate. Other deductions of $2.6 million in the first quarter of
2004 were $0.3 million, or 13% higher than the first quarter of 2003, as the
favorable impact of decreased interest charges at UBE 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 quarter of
2004 and the first 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
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.
- 43 -
NON-UTILITY BUSINESSES
XCELECOM, INC.
Xcelecom lost $0.6 million, or $0.04 per share, in the first quarter of 2004,
compared to a loss of $0.3 million, or $0.02 per share in the first quarter of
2003. A continued slow economic recovery in the Northeast, as well as soft
demand for the computer network systems integration services business, are the
primary drivers of the lower results in the first quarter of 2004. The first
quarter of 2003 also included income related to the completion of a large
project. The effect of these items was partially offset by improved sales in the
Southeast region. Although demand for Xcelecom's computer network systems
integration services, as well as demand for Xcelecom's construction services in
the Northeast, has been soft, there are signs of improving conditions.
Xcelecom's backlog of work to be completed as of March 31, 2004 amounted to $171
million, an increase of $51 million, or 43%, from the same period of 2003.
MINORITY INTEREST INVESTMENTS
UNITED BRIDGEPORT ENERGY, INC.
UBE owns a 33 1/3% interest in Bridgeport Energy, LLC (BE). UBE lost $1.6
million, or $0.11 per share, in the first quarter of 2004, compared to a loss of
$1.5 million, or $0.11 per share in the first quarter of 2003. UBE results
continue to be hampered by high natural gas prices which kept both margins and
sales levels low at BE in the first quarter of 2004. This was offset by lower
interest expenses 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 $0.1 million, or $0.01 per share, in the first quarter of 2004,
compared to a loss of $0.1 million, or $0.01 per share in the first quarter of
2003. The increase in valuation losses of UCI's venture funds as compared to the
first quarter of 2003 was offset by income from Cross-Sound. Cross-Sound is
currently being compensated for the operation of the cable under the Emergency
Order under the provisions of an interim operating contract. See the "Major
Influences on Financial Condition" section of this item 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 $1.6 million, after-tax, or $0.11 per share, in
the first quarter of 2004, compared to $1 million, after-tax, or $0.07 per
share, in 2003. The increase in expenses was mainly due to increased
administrative costs in 2004.
DISCONTINUED OPERATIONS
On December 16, 2003, UIL Holdings entered into an agreement to sell APS to
CheckFree Corporation (CheckFree), a leading provider of financial electronic
commerce services and products. Under the terms of the agreement, and pending
receipt of regulatory approvals and satisfaction of customary closing
conditions, CheckFree will pay approximately $110 million in cash for the
outstanding stock of APS. The transaction is expected to close during the second
quarter of 2004, with the resulting gain on the sale, net of transaction costs,
to be recognized at that time.
CheckFree will 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 is not
part of UIL Holdings' overall strategic business focus, and therefore authorized
- 44 -
the sale of APS' telephony assets. As part of that plan, on February 13, 2004
CCI was sold for book value, excluding transaction costs, to an independent
third party. Accordingly, APS, inclusive of the telephony business, has been
categorized as "held for sale" since December 31, 2003 for financial accounting
purposes, and as such, its results are included in discontinued operations for
all periods presented.
Net income from discontinued operations amounted to $1.4 million, or $0.10 per
share, compared to a net loss of $0.3 million, or $0.02 per share, in the same
period of 2003. The improvement was mainly due to increased stored value card
and non-contracted bill payment business of APS and the implementation of cost
reduction initiatives in the first quarter of 2004. Also, in accordance with
SFAS No. 144, the assets of APS ceased being depreciated when it was categorized
as "held for sale", which has resulted in increased earnings of $0.5 million, or
$0.03 per share, as compared to the first quarter of 2003. Transaction costs
associated with the sale of APS reduced first quarter 2004 earnings from
discontinued operations by $0.3 million, or $0.02 per share.
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
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.
- 45 -
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 March 31, 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 March 31, 2004 that have materially affected,
or are reasonably likely to materially affect UIL Holdings' internal control
over financial reporting.
In December 2002, the United Illuminating Company (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. 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, because the bonds were technically issued by the BFA, not UI. Upon
further review of this transaction, and in accordance with the provisions of
Statement of Financial Accounting Standards (SFAS) No. 140, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishment of Liabilities,"
UIL Holdings determined that during the period in which the 1999 Series Bonds
were held by UI as an investment (December 2002 through February 2003), it
should have presented the transaction as an extinguishment of debt, because UI
is the primary obligor of the bonds. See Note B of Item 1. "Financial Statements
- - Notes to Consolidated Financial Statements" of this filing for additional
information.
Although UIL Holdings has determined that the transaction noted above was not
properly accounted for in accordance with SFAS No. 140, UIL Holdings does not
believe the error affects the overall conclusion that its disclosure controls
and procedures are effective as of December 31, 2003. The aforementioned
transaction occurred in 2002, subsequent to which UIL Holdings strengthened its
internal controls over accounting pronouncement applications and interpretations
by forming a Corporate Controller Department, under which the research,
interpretation and application of accounting pronouncements is now centralized.
- 46 -
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
Exhibit
Table Item Exhibit
Number Number Description
(10) 10.19* Copy of UIL Holdings Corporation Senior
Executive Incentive Compensation Program**
(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.
**Filed on May 7, 2004 with UIL Quarterly Report (Form 10-Q) for fiscal quarter
ended March 31, 2004.
(b) Reports on Form 8-K.
Item Financial
Reported Statements Date of Report
-------- ---------- --------------
7,12 None January 13, 2004
7,12 None January 26, 2004
5,7 None February 18, 2004
- 47 -
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 09/27/2004 /s/ Louis J. Paglia
----------------------- -----------------------------------------
Louis J. Paglia
Executive Vice President
and Chief Financial Officer
- 48 -