SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
------------ -------------
Commission file number 1-15995
UIL HOLDINGS CORPORATION
(Exact name of registrant as specified in its charter)
CONNECTICUT 06-1541045
(State or other jurisdiction of
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 October 29, 2004, was 14,556,206.
- 1 -
INDEX
PART I. FINANCIAL INFORMATION
PAGE
NUMBER
------
Item 1. Financial Statements - Unaudited.....................................4
Consolidated Statement of Income for the three and nine
months ended September 30, 2004 and 2003..........................4
Consolidated Statement of Comprehensive Income for the three
and nine months ended September 30, 2004 and 2003 ................4
Consolidated Balance Sheet as of September 30, 2004
and December 31, 2003.............................................5
Consolidated Statement of Cash Flows for the nine
months ended September 30, 2004 and 2003..........................7
Notes to the Consolidated Financial Statements.......................8
- Statement of Accounting Policies...............................8
- Capitalization................................................12
- Regulatory Proceedings........................................13
- Short-term Credit Arrangements................................16
- Income Taxes..................................................17
- Supplementary Information.....................................18
- Pension and Other Benefits....................................19
- Commitments and Contingencies.................................22
- Other Commitments and Contingencies........................22
- Connecticut Yankee Atomic Power Company.................22
- Hydro-Quebec............................................25
- Environmental Concerns..................................25
- Site Decontamination, Demolition and Remediation Costs..25
- Electric System Work Center.............................26
- Utility Operations......................................27
- Claim of Enron Power Marketing, Inc.....................27
- Independent System Operator - New England...............28
- Cross-Sound Cable Company, LLC..........................28
- Xcelecom, Inc...........................................29
- Segment Information...........................................30
- Goodwill and Other Intangible Assets..........................31
- Discontinued Operations.......................................32
- Related Party Transactions....................................33
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations...............................34
- Major Influences on Financial Condition.......................34
- UIL Holdings Corporation...................................34
- The United Illuminating Company............................34
- Xcelecom, Inc..............................................38
- United Capital Investments, Inc............................41
- United Bridgeport Energy, Inc..............................43
- American Payment Systems, Inc..............................44
- Liquidity and Capital Resources...............................44
- Contractual and Contingent Obligations.....................45
- Critical Accounting Policies..................................46
- Results of Operations.........................................47
Item 3. Quantitative and Qualitative Disclosures About Market Risk..........61
Item 4. Controls and Procedures.............................................61
- 2 -
PART II. OTHER INFORMATION
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.........62
Item 6. Exhibits............................................................62
SIGNATURES..........................................................63
- 3 -
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
UIL HOLDINGS CORPORATION
CONSOLIDATED STATEMENT OF INCOME
AND
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
CONSOLIDATED STATEMENT OF INCOME
(Thousands except per share amounts)
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
2004 2003 2004 2003
---- ---- ---- ----
Operating Revenues (Note F)
Utility $ 231,421 $ 194,948 $ 588,857 $ 516,323
Non-utility businesses 91,999 74,755 244,725 218,240
------------- -------------- ------------- -------------
Total Operating Revenues 323,420 269,703 833,582 734,563
------------- -------------- ------------- -------------
Operating Expenses
Operation
Fuel and energy (Note F) 119,748 77,394 289,014 206,242
Operation and maintenance 138,515 122,669 386,370 354,086
Depreciation and amortization (Note F) 18,189 22,056 51,826 70,097
Taxes - other than income taxes (Note F) 11,467 11,308 32,153 32,137
------------- -------------- ------------- -------------
Total Operating Expenses 287,919 233,427 759,363 662,562
------------- -------------- ------------- -------------
Operating Income From Continuing Operations 35,501 36,276 74,219 72,001
------------- -------------- ------------- -------------
Other Income (Deductions), net (Note F) 1,034 1,975 3,865 2,266
------------- -------------- ------------- -------------
Interest Charges, net
Interest on long-term debt 5,064 6,611 15,126 19,755
Other interest, net (Note F) (857) 950 633 1,528
------------- -------------- ------------- -------------
4,207 7,561 15,759 21,283
Amortization of debt expense and redemption premiums 377 316 1,090 941
------------- -------------- ------------- -------------
Total Interest Charges, net 4,584 7,877 16,849 22,224
------------- -------------- ------------- -------------
Income From Continuing Operations Before Income Taxes 31,951 30,374 61,235 52,043
Income Taxes (Note E) 15,632 13,809 28,858 24,984
------------- -------------- ------------- -------------
Income From Continuing Operations 16,319 16,565 32,377 27,059
Discontinued Operations, Net of Tax (Note O) 16 388 49,824 (539)
------------- -------------- ------------- -------------
Net Income $ 16,335 $ 16,953 $ 82,201 $ 26,520
============= ============== ============= =============
Average Number of Common Shares Outstanding - Basic 14,394 14,295 14,363 14,287
Average Number of Common Shares Outstanding - Diluted 14,436 14,303 14,411 14,295
Earnings Per Share of Common Stock - Basic:
Continuing Operations $ 1.13 $ 1.16 $ 2.25 $ 1.90
Discontinued Operations 0.00 0.03 3.47 (0.04)
------------- -------------- ------------- -------------
Net Earnings $ 1.13 $ 1.19 $ 5.72 $ 1.86
============= ============== ============= =============
Earnings Per Share of Common Stock - Diluted:
Continuing Operations $ 1.13 $ 1.16 $ 2.25 $ 1.90
Discontinued Operations 0.00 0.03 3.45 (0.04)
------------- -------------- ------------- -------------
Net Earnings $ 1.13 $ 1.19 $ 5.70 $ 1.86
============= ============== ============= =============
Cash Dividends Declared per share of Common Stock $ 0.72 $ 0.72 $ 2.16 $ 2.16
============= ============== ============= =============
- --------------------------------------------------------------------------------------------------------------------------
UIL HOLDINGS CORPORATION
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
(Thousands of Dollars)
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
2004 2003 2004 2003
---- ---- ---- ----
Net Income $ 16,335 $ 16,953 $ 82,201 $ 26,520
Other comprehensive income (loss), net of tax:
Minimum pension liability (Note A) 160 - (357) -
------------- -------------- ------------- -------------
Comprehensive Income (Note A) $ 16,495 $ 16,953 $ 81,844 $ 26,520
============= ============== ============= =============
The accompanying Notes to the Consolidated
Financial Statements are an integral part of the
financial statements.
- 4 -
UIL HOLDINGS CORPORATION
CONSOLIDATED BALANCE SHEET
ASSETS
(Thousands of Dollars)
(Unaudited)
September 30, December 31,
2004 2003
---- ----
Current Assets
Unrestricted cash and temporary cash investments $ 34,021 $ 28,614
Restricted cash 232 1,384
Utility accounts receivable less allowance of $1,654 and $1,654 81,004 54,780
Other accounts receivable less allowance of $1,618 and $1,648 92,423 80,532
Unbilled revenues 39,340 32,246
Materials and supplies, at average cost 5,555 4,458
Deferred and refundable income taxes 3,471 24,944
Prepayments 6,138 1,451
Current assets of discontinued operations held for sale - 103,697
Other 374 1,323
------------------ ------------------
Total Current Assets 262,558 333,429
------------------ ------------------
Investments
Investment in United Bridgeport Energy facility 77,710 82,090
Other 24,325 20,283
------------------ ------------------
Total Investments 102,035 102,373
------------------ ------------------
Property, Plant and Equipment at original cost
In service 786,656 784,409
Less, accumulated depreciation 279,708 272,082
------------------ ------------------
506,948 512,327
Construction work in progress 35,963 36,467
------------------ ------------------
Net Property, Plant and Equipment 542,911 548,794
------------------ ------------------
Regulatory Assets (future amounts due from customers
through the ratemaking process)
Nuclear plant investments-above market 421,171 436,505
Income taxes due principally to book-tax differences 96,101 98,116
Long-term purchase power contracts-above market 76,104 88,024
Connecticut Yankee 47,099 51,579
Unamortized redemption costs 18,724 19,325
Other 53,178 43,259
------------------ ------------------
Total Regulatory Assets 712,377 736,808
------------------ ------------------
Deferred Charges
Goodwill 69,605 68,554
Unamortized debt issuance expenses 6,676 6,670
Prepaid pension 53,540 43,927
Long-term receivable - Cross-Sound Cable Project 24,575 23,986
Other long-term receivable 14,944 13,575
Other 1,525 2,120
------------------ ------------------
Total Deferred Charges 170,865 158,832
------------------ ------------------
Long-term assets of discontinued operations held for sale - 17,930
------------------ ------------------
Total Assets $ 1,790,746 $ 1,898,166
================== ==================
The accompanying Notes to the Consolidated Financial Statements are
an integral part of the financial statements.
- 5 -
UIL HOLDINGS CORPORATION
CONSOLIDATED BALANCE SHEET
LIABILITIES AND CAPITALIZATION
(Thousands of Dollars)
(Unaudited)
September 30, December 31,
2004 2003
---- ----
Current Liabilities
Notes payable $ 6,785 $ 65,161
Current portion of long-term debt 4,286 -
Accounts payable 70,687 36,729
Dividends payable 10,379 10,299
Accrued liabilities 59,781 69,142
Deferred revenues - non-utility businesses 16,438 14,957
Interest accrued 4,560 6,358
Taxes accrued 7,986 -
Obligations under capital leases - 14,815
Current liabilities of discontinued operations held for sale - 94,267
----------------- -----------------
Total Current Liabilities 180,902 311,728
----------------- -----------------
Noncurrent Liabilities
Purchase power contract obligation 76,104 88,024
Pension accrued 8,777 8,166
Connecticut Yankee contract obligation 47,099 47,213
Long-term notes payable 2,501 10,478
Other 18,371 17,574
----------------- -----------------
Total Noncurrent Liabilities 152,852 171,455
----------------- -----------------
Deferred Income Taxes (future tax liabilities owed
to taxing authorities) 355,475 345,676
----------------- -----------------
Regulatory Liabilities (future amounts owed to customers
through the ratemaking process)
Accumulated deferred investment tax credits 12,495 12,813
Deferred gains on sale of property 30,655 33,679
Asset removal cost 7,714 14,071
Other 10,260 19,589
----------------- -----------------
Total Regulatory Liabilities 61,124 80,152
----------------- -----------------
Long-term liabilities of discontinued operations held for sale - 921
----------------- -----------------
Commitments and Contingencies (Note J)
Capitalization (Note B)
Net long-term debt 491,174 495,460
Common Stock Equity
Common Stock 300,431 297,321
Paid-in capital 6,633 4,413
Capital stock expense (2,170) (2,170)
Unearned employee stock ownership plan equity (4,749) (5,461)
Unearned compensation (730) (335)
Accumulated other comprehensive income (loss) (853) (496)
Retained earnings 250,657 199,502
----------------- -----------------
Net Common Stock Equity 549,219 492,774
Total Capitalization 1,040,393 988,234
----------------- -----------------
Total Liabilities and Capitalization $ 1,790,746 $ 1,898,166
================= =================
The accompanying Notes to the Consolidated Financial Statements are an
integral part of the financial statements.
- 6 -
UIL HOLDINGS CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOWS
(Thousands of Dollars)
(Unaudited)
Nine Months Ended
September 30,
2004 2003
---- ----
Cash Flows From Operating Activities
Net Income $ 82,201 $ 26,520
-------------- --------------
Adjustments to reconcile net income to net cash provided by operating
activities:
(Income) Loss from discontinued operations, net of tax (49,824) 539
Depreciation and amortization 35,774 53,062
Purchase power contract amortization (Note F) 17,142 17,976
Purchase power above market fuel expense credit (Note F) (17,142) (17,976)
Deferred income taxes 10,650 (7,396)
Deferred investment tax credits - net (318) (442)
Future tax benefits 6,800 34,800
Allowance for funds used during construction (1,251) (1,975)
Undistributed (earnings) losses of minority interest investments 4,354 1,670
Changes in:
Accounts receivable - net (38,923) 7,515
Materials and supplies (1,097) (886)
Prepayments (4,686) (2,459)
Accounts payable 32,874 (7,549)
Interest accrued (1,798) (507)
Taxes accrued 6,233 5,294
Other assets (10,159) (18,398)
Other liabilities (15,971) 6,199
-------------- --------------
Total Adjustments (27,342) 69,467
-------------- --------------
Cash provided by Continuing Operations 54,859 95,987
Cash provided by Discontinued Operations 3,375 3,442
-------------- --------------
Net Cash provided by Operating Activities 58,234 99,429
-------------- --------------
Cash Flows from Investing Activities
Loan to Cross-Sound Cable Project (589) (23,465)
Deferred payments in prior acquisitions (2,140) (2,757)
Acquisition of Electric System Work Center facility (16,210) -
Plant expenditures (21,448) (39,144)
Changes in restricted cash 1,152 3,928
-------------- --------------
Cash (used in) Continuing Operations (39,235) (61,438)
Cash provided by (used in) Discontinued Operations 77,408 (3,627)
-------------- --------------
Net Cash provided by (used in) Investing Activities 38,173 (65,065)
-------------- --------------
Cash Flows from Financing Activities
Issuances of Common stock 5,647 1,222
Sale of pollution control refunding revenue bonds - 25,000
Notes payable (65,620) (8,248)
Lease obligations - (351)
Payment of common stock dividend (30,968) (30,843)
-------------- --------------
Cash (used in) Continuing Operations (90,941) (13,220)
Cash provided by (used in) Discontinued Operations (59) 185
-------------- --------------
Net Cash (used in) Financing Activities (91,000) (13,035)
-------------- --------------
Cash and Temporary Cash Investments:
Net change for the period 5,407 21,329
Balance at beginning of period 28,614 18,910
-------------- --------------
Balance at end of period $ 34,021 $ 40,239
============== ==============
The accompanying Notes to the Consolidated Financial Statements are an
integral part of the financial statements.
- 7 -
UIL HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(A) STATEMENT OF ACCOUNTING POLICIES
BASIS OF PRESENTATION
UIL Holdings Corporation (UIL Holdings) was formed in July 2000 and is an exempt
public utility holding company under the provisions of the Public Utility
Holding Company Act of 1935. Through its various subsidiaries, UIL Holdings
operates in two principal lines of business: utility and non-utility. The
utility business consists of the electric transmission and distribution
operations of The United Illuminating Company (UI). The non-utility business
consists of the operations of Xcelecom, Inc. (Xcelecom), two entities which
indirectly support the operations of their respective passive investments,
United Capital Investments, Inc. (UCI) and United Bridgeport Energy, Inc. (UBE),
and until the completion of its sale to CheckFree Corporation (CheckFree) on
June 22, 2004, included the operations of American Payment Systems, Inc. (APS).
UIL Holdings is headquartered in New Haven, Connecticut, where its senior
management maintains offices and is responsible for overall planning, operating
and financial functions. UIL Holdings' Consolidated Financial Statements should
be read in conjunction with the restated consolidated financial statements and
the notes to the restated consolidated financial statements 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 nine
months ended September 30, 2004 are not necessarily indicative of the results
for the entire fiscal year ending December 31, 2004.
Certain amounts previously reported have been reclassified to conform to the
current presentation.
PROPERTY, PLANT AND EQUIPMENT
UI accrues for estimated costs of removal for certain of its plant-in-service.
Such removal costs are included in the approved rates used to depreciate these
assets. At the end of the service life of the applicable assets, the accumulated
depreciation in excess of the historical cost of the asset provides for the
estimated cost of removal. In accordance with Statement of Financial Accounting
Standards (SFAS) No. 143, "Accounting for Asset Retirement Obligations," UI's
accrued costs of removal have been reclassified to a regulatory liability. The
amount of accrued costs of removal reclassified to a regulatory liability as of
December 31, 2003 totaled $14.1 million and was based upon UI's best estimate
developed from its previous depreciation studies. In the third quarter of 2004,
a new independent third party study was completed to update UI's cost of removal
accrual and amounts to be accrued in future years. Based on the results of this
study and activity for the first nine months of 2004, accrued costs of removal
as of September 30, 2004 totaled $7.7 million.
- 8 -
UIL HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(UNAUDITED)
REVENUES
Prior to January 1, 2004, UI estimated its accrual for unbilled revenue based
upon its system requirements less an estimated loss factor. Beginning in the
first quarter of 2004, UI began utilizing a new customer accounting software
package integrated with the network meter reading system to estimate unbilled
revenue. This allows for the calculation of unbilled revenue on a
customer-by-customer basis, utilizing actual daily meter readings at the end of
each month to calculate consumption and pricing for each customer. Customers
aggregating to approximately 70% of utility retail kilowatt-hour consumption are
currently part of the network meter reading system. For those customers still
requiring manual meter readings, consumption is estimated based upon historical
usage and actual pricing for each customer. Conversion to the new methodology
resulted in a non-recurring increase to unbilled revenue of approximately $2.6
million and a non-recurring increase to consolidated earnings per share of
approximately $0.07 during the first quarter of 2004.
NOTES RECEIVABLE
In January 2004, all telephony assets of APS were transferred to one of UIL
Holdings' non-utility subsidiaries. One of the assets transferred was a loan
receivable related to the acquisition of Point of Sale Activation (POSA)
technology in 2002. In connection with the acquisition of the POSA technology,
APS loaned money to the vendor from which the technology was acquired.
Subsequently, the vendor defaulted under the loan and as part of the foreclosure
procedures the remaining loan balance was restructured. As consideration for an
accelerated payment schedule, APS agreed to forgive a portion of the outstanding
loan balance, bringing the restructured amount due to $1 million. As of June 30,
2004, the principal balance of the restructured loan was paid.
- 9 -
EARNINGS PER SHARE
The following tables present a reconciliation of the basic and diluted earnings
per share calculations for the three and nine months ended September 30, 2003
and 2004:
INCOME APPLICABLE TO AVERAGE NUMBER OF EARNINGS
COMMON STOCK SHARES OUTSTANDING PER SHARE
------------ ------------------ ---------
(In Thousands, except per share amounts)
NINE MONTHS ENDED SEPTEMBER 30:
2004
- ----
Basic earnings from continuing operations $32,377 14,363 $2.25
Basic earnings from discontinued operations 49,824 14,363 3.47
------------------------ ---------------------- -------------
Basic earnings 82,201 14,363 5.72
Effect of dilutive stock options (1) - 48 (0.02)
------------------------ ---------------------- -------------
Diluted earnings $82,201 14,411 $5.70
======================== ====================== =============
2003
- ----
Basic earnings from continuing operations $27,059 14,287 $1.90
Basic earnings from discontinued operations (539) 14,287 (0.04)
------------------------ ---------------------- -------------
Basic earnings 26,520 14,287 1.86
Effect of dilutive stock options - 8 -
------------------------ ---------------------- -------------
Diluted earnings $26,520 14,295 $1.86
======================== ====================== =============
THREE MONTHS ENDED SEPTEMBER 30:
2004
- ----
Basic earnings from continuing operations $16,319 14,394 $1.13
Basic earnings from discontinued operations 16 14,394 -
------------------------ ---------------------- -------------
Basic earnings 16,335 14,394 1.13
Effect of dilutive stock options (1) - 42 -
------------------------ ---------------------- -------------
Diluted earnings $16,335 14,436 $1.13
======================== ====================== =============
2003
- ----
Basic earnings from continuing operations $16,565 14,295 $1.16
Basic earnings from discontinued operations 388 14,295 0.03
------------------------ ---------------------- -------------
Basic earnings 16,953 14,295 1.19
Effect of dilutive stock options - 8 -
------------------------ ---------------------- -------------
Diluted earnings $16,953 14,303 $1.19
======================== ====================== =============
(1) Dilutive stock options do not impact the earnings from continuing
operations, but dilute the earnings from discontinued operations for
the nine months ended September 30, 2004 by $0.02 per share.
STOCK-BASED COMPENSATION
Effective January 1, 2003, UIL Holdings adopted the fair value recognition
provisions, under the prospective method, of SFAS No.148, "Accounting for
Stock-Based Compensation - Transition and Disclosure," an amendment of SFAS No.
123, "Accounting for Stock-Based Compensation." Under this statement, UIL
Holdings has recorded compensation expense prospectively for stock options
granted, modified, or settled after January 1, 2003. There were 80,987 stock
options granted during the first nine months of 2004 at an average exercise
price of $47.90. Nearly all of the stock options granted during 2004 were
granted pursuant to the "reload" feature of the UIL Holdings 1999 Amended and
Restated Stock Plan (Plan). UIL Holdings records compensation expense related to
- 10 -
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.
In the first quarter 2004, UIL Holdings decided to cease granting new stock
options, other than new grants pursuant to the "reload" feature of the Plan.
Although new stock options will not be granted, compensation expense related to
options granted after January 1, 2003, including any new stock options granted
under the "reload" feature of the Plan, will continue to be recorded ratably
over the vesting periods associated with such options. In 2004, UIL Holdings
implemented a performance-based long-term incentive arrangement under the Plan
pursuant to which certain members of management have the opportunity to earn no
more than a pre-determined number of "performance" shares of stock, the number
of which is predicated upon the achievement of various pre-defined performance
measures. These "performance" shares of stock vest over a three year cycle with
the actual issuance of stock following the end of each three year cycle. A new
three year cycle begins in January of each year. UIL Holdings records
compensation expense for these "performance" shares ratably over the three year
period, based on the value of the expected payout at the end of each year
relative to the performance measures achieved.
The following table illustrates the effect on net income and earnings per share
as if the fair value based method had been applied to all outstanding and
unvested awards in each period.
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2004 2003 2004 2003
---- ---- ---- ----
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
Net Income, as reported $16,335 $16,953 $82,201 $26,520
Add: Stock-based compensation
expense included in reported
net income, net of related tax effects 591 145 1,217 242
Deduct: Total stock-based compensation
determined under fair value based
method for all stock grants, net of
related tax effect 736 336 1,684 812
---------------- ------------- --------------- ----------------
Pro forma net income $16,190 $16,762 $81,734 $25,950
================ ============= =============== ================
Earnings per share:
Basic - as reported $1.13 $1.19 $5.72 $1.86
================ ============= =============== ================
Basic - proforma $1.12 $1.17 $5.69 $1.82
================ ============= =============== ================
Diluted - as reported $1.13 $1.19 $5.70 $1.86
================ ============= =============== ================
Diluted - proforma $1.12 $1.17 $5.67 $1.82
================ ============= =============== ================
- 11 -
On March 22, 2004, UIL Holdings granted 13,200 shares of restricted stock to
directors. The average market price on the date of grant was $46.67 per share.
Compensation expense for this restricted stock is recorded ratably over the
three year vesting period for such restricted stock.
COMPREHENSIVE INCOME
Comprehensive income for the three months ended September 30, 2004 included net
income plus a minimum pension liability adjustment associated with the
non-qualified pension plan of approximately $0.2 million to adjust the deferred
tax benefit related to the minimum pension liability associated with the
non-qualified pension plan. Comprehensive income for the nine months ended
September 30, 2004 included net income less an after-tax minimum pension
liability adjustment of approximately $0.4 million (net of $0.2 million deferred
tax benefit) related to the non-qualified pension plans. Comprehensive income
for the three and nine months ended September 30, 2003 was equal to net income
as reported.
(B) CAPITALIZATION
COMMON STOCK
UIL Holdings had 14,556,206 shares of its common stock, without par value,
outstanding at September 30, 2004, of which 139,702 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
September 30, 2004, 139,702 shares, with a fair market value of $6.9 million,
had been purchased by the KSOP and had not been committed to be released or
allocated to KSOP participants.
LONG-TERM DEBT
On February 2, 2004, the interest rate on $7.5 million principal amount of
Pollution Control Revenue Refunding Bonds, 1996 Series, due June 1, 2026, issued
by the Connecticut Development Authority (CDA), was reset from 4.35% to 3.00%.
The new interest rate will remain in effect for a five-year period to February
1, 2009. UI is obligated, under its borrowing agreement with the CDA, to pay to
the CDA an amount equal to the principal and interest on the bonds. Interest is
payable semi-annually on August 1st and February 1st.
On February 2, 2004, the interest rate on $98.5 million principal amount of
Pollution Control Revenue Refunding Bonds, 1997 Series, due July 1, 2027, issued
by the Business Finance Authority of the State of New Hampshire (BFA), was
reset. The interest rate on $27.5 million principal amount of the bonds was
reset from 3.75% to 2.05% for a one-year period to February 1, 2005. The
interest rate on $71 million principal amount of the bonds was reset from 4.55%
to 3.50% for a five-year period to February 1, 2009. UI is obligated, under its
borrowing agreement with the BFA, to pay the BFA an amount equal to the
principal and interest on the bonds. Interest is payable semi-annually on August
1st and February 1st.
- 12 -
(C) REGULATORY PROCEEDINGS
RATE CASE
On February 18, 2004, the Connecticut Department of Public Utility Control
(DPUC) issued a final decision related to UI's request for recovery of increased
pension and post-retirement 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 would not file a rate
case before January 1, 2005.
On April 2, 2004, the Office of Consumer Counsel (OCC) appealed the DPUC
decision to the Connecticut Superior Court. In late April 2004, the DPUC, on its
own motion, reopened the docket related to UI's recovery of increased pension
costs, and on August 11, 2004 issued a final decision which reversed the
February 18, 2004 decision. As a result of an October 2004 court order issued by
the State Superior Court in the appeal of the February 18th decision, UI has
ceased recovery of the increased pension and post-retirement benefits expenses
effective June 24, 2004. In addition, the sharing mechanism for any UI earnings
in excess of its allowed equity return of 10.45% has returned to 50% to
customers and 50% to shareholders and there will be no restrictions on UI's
ability to file a rate case. In accordance with the DPUC decision and Superior
Court enforcement order, UI recorded a pre-tax adjustment of approximately $0.1
million in the third quarter of 2004 to reverse recovery for increased pension
and postretirement benefits expenses previously recorded for the period June 24,
2004 through June 30, 2004. On October 26, 2004, the OCC formally withdrew its
appeal.
UI has taken substantial actions since December 2002 to mitigate the effect of
these increased pension and postretirement benefits expenses and also to reduce
the increases itself through contributing $74 million in cash to the pension
plan since the docket was initially reopened in November 2002. These actions,
along with unanticipated sales growth, have allowed UI to mitigate the effect of
the increased pension and postretirement expenses to date. Through June 24,
2004, UI had recovered approximately $1.8 million in accordance with the
February 18, 2004 decision, which equates to approximately $0.08 per share,
after-tax.
SALE OF NUCLEAR GENERATION
Public Act 98-28 enacted by the Connecticut legislature (the Restructuring Act)
required that, in order for UI to recover any stranded costs, it must attempt to
divest its ownership interests in two nuclear-fueled power plants prior to 2004.
The sale of UI's 3.685% ownership interest in Millstone Unit 3 was consummated
on March 31, 2001. UI's share of the proceeds from the sale, including nuclear
fuel, was $34.4 million, before settlement of its decommissioning obligation. On
February 27, 2003, the DPUC issued a final decision on the Millstone Divestiture
Plan Disposition of Proceeds authorizing UI to reduce its stranded cost balances
by $15.4 million.
The sale of UI's 17.5% interest in Seabrook Station and the termination of the
sale/leaseback of a portion of its interest in Seabrook Unit 1 was consummated
on November 1, 2002. In compliance with the Connecticut electric industry
restructuring legislation, the net-of-tax gain on these transactions, after
adjusting for transaction costs and sale-related costs, was used to reduce UI's
stranded costs. In UI's compliance filing with the DPUC on April 30, 2003, UI
reported a net-of-tax gain of approximately $5 million. A final decision was
issued on March 3, 2004, approving UI's calculation without modification. As a
result, UI reduced its reserves by approximately $1.4 million during the first
quarter of 2004. In the second quarter of 2004, UI also reduced certain expense
- 13 -
reserves by $1.1 million related to the sale due to the resolution of tax and
other post-closing issues. These true-ups and other subsequent post-closing
adjustments will be included in the 2004 annual competitive transition
assessment (CTA)/ systems benefits charge (SBC) reconciliation for approval.
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 CTA and SBC 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 October 20, 2004, issued a final 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.
On October 20, 2004, the DPUC issued a final decision requiring electric
distribution companies to enter into contracts for the purchase of long-term
renewable energy. In accordance with the terms of this decision, UI will be
required to enter into such contracts by July 1, 2007, and will be required to
provide status reports to the DPUC at defined intervals beginning in July 2005,
until such time that at least 100 megawatts of renewable energy has been
procured statewide. This is not expected to have a material impact on UI's
results of operations or financial condition.
On October 25, 2004, UI filed a request with the DPUC seeking to reopen the
regulatory docket in which the non-bypassable Federally Mandated Congestion
Costs (NBFMCC) charge was established by the DPUC. The NBFMCC charge relates to
"congestion costs" associated with not having adequate transmission
infrastructure to move energy into the state from outside the state. Because the
purpose of the NBFMCC charge is for the electric distribution company to recover
its actual NBFMCC costs on a pass-through basis, the DPUC decision provided for
a true-up of NBFMCC costs and revenues on a semi-annual basis and an adjustment
of the associated amounts deferred for future recovery. The charge established
for 2004 was based upon estimates that were made in 2003, and reflects estimated
NBFMCC lower than have actually been incurred. UI's filing proposes to increase
the NBFMCC charge from $0.001652 per kWh to $0.008251 per kWh, effective
November 1, 2004. This will enable UI to recover both the forecasted ongoing
NBFMCC costs and the deficit that has resulted from the current charge being
below the incurred costs. UI's proposal would collect the accumulated deficit
over the November 2004 - June 2005 time period.
Public Act 03-6 of the June 30, 2003 special session and Public Act 03-1 of the
September 8, 2003 special session of the Connecticut General Assembly provide
for the period February 1, 2003 through July 31, 2005, for certain of the funds
collected by electric distribution companies from retail customers in the
Conservation and Load Management (C&LM) charge to be transferred to the general
funds of the state. The legislation provides that the transfer of funds would
not occur provided that the C&LM and Renewable Energy Investment (REI) funds are
securitized for two fiscal years beginning July 1, 2003, through the state's
issuance of rate reduction bonds secured by customer revenue streams. On October
28, 2003, the DPUC issued a financing order providing for the issuance of rate
reduction bonds by the State of Connecticut, adjustment of the C&LM and REI
charges, and an increase in the corresponding CTA charge on customers' bills.
The rate reduction bonds were issued by the state during the second quarter of
2004. The amounts collected through the CTA for servicing of the rate reduction
bonds are not revenue to UI. As a result, the securitization will have the
effect of reducing UI's revenue by approximately $6.5 million annually, with
- 14 -
such amounts to be utilized for debt service for the state's rate reduction
bonds. Absent securitization, these amounts would otherwise have been utilized
for C&LM or REI expenditures. 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.
On June 23, 2004, the DPUC approved UI's request to amend its Purchased Power
Adjustment Clause to allow UI to apply the clause to special contract customers.
The DPUC also approved a Purchased Power Adjustment rate of $0.00264 per kWh to
be applied against special contract load to reflect the increased cost to serve
these customers. This will allow UI to recover changes in the cost to procure
energy as it relates to special contract customers through the generation
services charge (GSC). The decision does not explicitly order the accounting for
the increased costs of $0.8 million related to UI's special contract customers
for the period from January 1, 2004 through June 22, 2004 (the day before the
effective date of the final decision). The actual costs for that period to
procure power for UI's special contracts will flow through the annual CTA/SBC
Reconciliation filing for 2004. The 1998 and 2003 restructuring legislation (PA
98-28 and PA 03-135, as amended in part by PA 03-221) provides that the
distribution company is entitled to recover its full cost of procuring power for
customers who do not choose an alternate supplier.
FEDERAL ENERGY REGULATORY COMMISSION (FERC)
UI has constructed transmission facilities to connect the 330-megawatt
transmission cable, connecting Connecticut and Long Island under Long Island
Sound, owned by Cross-Sound Cable Company, LLC (Cross-Sound) to the New England
Power Pool (NEPOOL) transmission grid. Cross-Sound has paid UI $2.6 million for
the construction costs. The FERC has clarified that UI will not be required to
reimburse Cross-Sound for any of the construction monies received. A request by
Cross-Sound for a rehearing was rejected by the FERC. In September 2004, the
FERC approved a settlement agreement reached by Cross-Sound and UI related to
annual facilities charges. Cross-Sound has paid all amounts outstanding related
to construction and the settlement agreement.
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 FERC has scheduled hearing dates in the fourth quarter of 2004, for
consideration of the ROE of 12.8% requested by the Transmission Owners (TOs).
The TOs will be allowed to charge the requested ROE from the time the RTO
becomes operational until the final FERC decision, subject to refund. The TOs
have filed a request for clarification on several items in the FERC decision and
a request for rehearing regarding several others. ISO-NE, NEPOOL, and the TOs
reached a settlement agreement that was submitted to the FERC on
September 14, 2004 and was approved subject to conditions by the FERC on
November 3, 2004. The settlement agreement, as conditioned, resolves many of
the outstanding issues before the FERC. While the FERC order does not determine
the ROE, which continues to be scheduled for hearing, the order does make
comments on aspects of the ROE calculation. The RTO could become operational
by the end of 2004.
- 15 -
(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 September
30, 2004, UIL Holdings did not have any borrowings outstanding under this
arrangement.
On July 29, 2004, UIL Holdings entered into a revolving credit agreement with a
group of banks that extends to July 28, 2007. The borrowing limit of this
facility is $100 million. The facility permits UIL Holdings to borrow funds at a
fluctuating interest rate determined by the prime lending market in New York,
and also permits UIL Holdings to borrow money for fixed periods of time
specified by UIL Holdings at fixed interest rates determined by the Eurodollar
interbank market in London (LIBOR). If a material adverse change in the
business, operations, affairs, assets or condition, financial or otherwise, or
prospects of UIL Holdings and its subsidiaries, on a consolidated basis, should
occur, the banks may decline to lend additional money to UIL Holdings under this
revolving credit agreement, although borrowings outstanding at the time of such
an occurrence would not then become due and payable. As of September 30, 2004,
UIL Holdings did not have any short-term borrowings outstanding under this
arrangement.
On July 30, 2004, Xcelecom amended its existing revolving credit agreement with
two banks to extend the term to June 30, 2005. This agreement, as amended,
provides for a $30 million revolving loan facility available to meet working
capital needs, and up to $5 million in capital equipment needs, and to support
standby letters of credit issued by Xcelecom in the normal course of its
business. Capital equipment loans under this facility can be converted to
amortizing term loans with a maturity of up to four years. This agreement also
provides for the payment of interest at a rate, at the option of Xcelecom, based
on the agent bank's prime interest rate or LIBOR. All borrowings outstanding
under this agreement are secured solely by assets of Xcelecom and its
subsidiaries. As of September 30, 2004, Xcelecom had $0.1 million of borrowings
outstanding under the revolving working capital balance under this facility.
Xcelecom had $1 million of capital equipment funding that had been converted to
term notes outstanding and standby letters of credit of $5 million outstanding
at September 30, 2004 under the facility.
- 16 -
(E) INCOME TAXES
Three Months Ended Nine Months Ended
September 30, September 30,
2004 2003 2004 2003
---- ---- ---- ----
(In Thousands) (In Thousands)
Income tax expense for continuing operations consists of:
Income tax provisions (benefit):
Current
Federal $4,641 $12,153 $12,893 $24,478
State 2,009 3,890 5,633 8,344
--------------- -------------- -------------- --------------
Total current 6,650 16,043 18,526 32,822
--------------- -------------- -------------- --------------
Deferred
Federal 7,302 (1,235) 9,805 (4,494)
State 1,793 (852) 845 (2,902)
--------------- -------------- -------------- --------------
Total deferred 9,095 (2,087) 10,650 (7,396)
--------------- -------------- -------------- --------------
Investment tax credits (113) (147) (318) (442)
--------------- -------------- -------------- --------------
Total income tax expense $15,632 $13,809 $28,858 $24,984
=============== ============== ============== ==============
Income tax components charged as follows:
Operating tax expense $15,609 $14,994 $30,409 $26,277
Non-operating tax expense (benefit) 23 (1,185) (1,551) (1,293)
--------------- -------------- -------------- --------------
Total income tax expense $15,632 $13,809 $28,858 $24,984
=============== ============== ============== ==============
Legislation enacted in Connecticut on February 28, 2003 imposed a 20% surcharge
on the corporation business tax for the year 2003 only. This surcharge, which
was made retroactive to January 1, 2003, effectively increased the statutory
rate of the Connecticut corporation business tax from 7.5% to 9.0% for the year
2003. Due to this change, the combined effective federal and state income tax
rate for UIL Holdings' Connecticut-based entities was 40.85% for the year 2003.
In addition, legislation was also enacted in Connecticut on August 16, 2003
which imposes a 25% surcharge on the corporation business tax for the year 2004.
This surcharge increases the statutory rate of Connecticut corporation business
tax from 7.5% to 9.375% for the year 2004 only. Due to this change, the combined
effective statutory federal and state income tax rate for UIL Holdings'
Connecticut based entities increases slightly from 40.85% for the year 2003 to
41.094% for the year 2004.
The effective income tax rates for the three and nine months ended September 30,
2004 were 48.9% and 47.1%, respectively, as compared to 45.5% and 48% for the
three and nine months ended September 30, 2003, respectively. The changes in the
2004 rates are due primarily to (1) adjustments to deferred income tax reserves
associated with CTA and (2) differences in the amounts of book depreciation in
excess of non-normalized tax depreciation.
- 17 -
(F) SUPPLEMENTARY INFORMATION
Three Months Ended Nine Months Ended
September 30, September 30,
2004 2003 2004 2003
---- ---- ---- -----
(In Thousands) (In Thousands)
Operating Revenues
Utility
Retail $ 209,389 $ 180,295 $ 537,137 $ 473,376
Wholesale 5,711 6,053 18,069 19,024
Other 16,321 8,600 33,651 23,923
Non-utility businesses
Xcelecom 91,993 74,750 244,661 218,224
Other 6 5 64 16
--------------- -------------- -------------- ----------------
Total Operating Revenues $ 323,420 $ 269,703 $ 833,582 $ 734,563
=============== ============== ============== ================
Sales by Class (megawatt-hours)
Retail (1)
Residential 636,279 658,757 1,782,609 1,732,779
Commercial 711,811 693,967 1,982,955 1,906,079
Industrial 262,392 254,426 731,776 718,761
Other 10,142 10,176 31,541 32,649
--------------- -------------- -------------- ----------------
1,620,624 1,617,326 4,528,881 4,390,268
Wholesale 122,925 124,001 356,339 355,928
--------------- -------------- -------------- ----------------
Total Sales by Class 1,743,549 1,741,327 4,885,220 4,746,196
=============== ============== ============== ================
Fuel and Energy
Fuel and Energy Expense $ 125,504 $ 83,452 $ 306,156 $ 224,218
Purchase Power above market fuel expense credit (2) (5,756) (6,058) (17,142) (17,976)
--------------- -------------- -------------- ----------------
Total Fuel and Energy Expense $ 119,748 $ 77,394 $ 289,014 $ 206,242
=============== ============== ============== ================
Depreciation and Amortization
Utility property, plant, and equipment $ 7,238 $ 7,276 $ 21,995 $ 21,061
Non-utility business property, plant and equipment 903 872 2,659 2,596
--------------- -------------- -------------- ----------------
Total Depreciation 8,141 8,148 24,654 23,657
--------------- -------------- -------------- ----------------
Amortization of nuclear plant regulatory assets 3,414 5,867 7,532 22,391
Amortization of purchase power contracts (2) 5,756 6,058 17,142 17,976
Amortization of other CTA regulatory assets 283 283 849 826
Amortization of cancelled plant - 263 - 849
--------------- -------------- -------------- ----------------
Subtotal CTA Amortization 9,453 12,471 25,523 42,042
Amortization of intangibles 311 294 935 969
Amortization of other regulatory assets 284 1,143 714 3,429
--------------- -------------- -------------- ----------------
Total Amortization 10,048 13,908 27,172 46,440
--------------- -------------- -------------- ----------------
Total Depreciation and Amortization $ 18,189 $ 22,056 $ 51,826 $ 70,097
=============== ============== ============== ================
Taxes - Other than Income Taxes
Operating:
Connecticut gross earnings $ 7,355 $ 7,791 $ 19,560 $ 20,307
Local real estate and personal property 2,785 2,370 7,824 7,573
Payroll taxes 1,327 1,147 4,769 4,257
--------------- -------------- -------------- ----------------
Total Taxes - Other than Income Taxes $ 11,467 $ 11,308 $ 32,153 $ 32,137
=============== ============== ============== ================
Other Income (Expense), net
Interest income $ 526 $ 291 $ 1,250 $ 800
Allowance for funds used during construction 428 676 1,251 1,975
Equity earnings from Connecticut Yankee 59 77 190 233
Non-utility business passive expense (389) 875 (4,544) (1,903)
Seabrook reserve reduction - - 2,477 -
Miscellaneous other income and (expense) - net 410 56 3,241 1,161
--------------- -------------- -------------- ----------------
Total Other Income (Expense), net $ 1,034 $ 1,975 $ 3,865 $ 2,266
=============== ============== ============== ================
Other Interest, net
Notes payable $ 136 $ 151 $ 998 $ 878
Other (993) 799 (365) 650
--------------- -------------- -------------- ----------------
Total Other Interest, net $ (857) $ 950 $ 633 $ 1,528
=============== ============== ============== ================
(1) Includes 46,000 megawatt hour non-recurring adjustment associated with a
change in accounting estimate to unbilled revenue recognized in the first
quarter of 2004.
(2) The amortization of this regulatory asset is a cash neutral item, as there
is an offsetting liability which is relieved through a credit to fuel and
energy expense.
- 18 -
(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 accrue benefits under the plan,
but any benefits accrued to them, through April 2003 for APS, and December 2003
for Xcelecom, remain in the plan. Effective on June 22, 2004 with the completion
of the sale of APS, those active APS employees who had not vested in the amount
of their benefits accrued through April 2003 were granted full vesting in those
benefits. UI also has a non-qualified supplemental plan for certain executives
and a non-qualified retiree-only plan for certain early retirement benefits.
The funding policy for the qualified plan is to make annual contributions that
satisfy the minimum funding requirements of ERISA but that do not exceed the
maximum deductible limits of the Internal Revenue Code. These amounts are
determined each year as a result of an actuarial valuation of the plan. In
September 2004, UI contributed $16.7 million to the qualified pension plan, the
entire amount of which is attributable to the 2003 plan year for income tax
purposes.
There is potential variability to the pension expense calculation depending on
changes in certain assumptions: if there were a 1/4% change in the discount rate
assumed at 6%, the pension expense would increase or decrease inversely by $0.8
million; if there were a 1% change in the expected return on assets, the pension
expense would increase or decrease inversely by $2.5 million.
In addition to providing pension benefits, UI also provides other
post-retirement 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. In September 2004, UI contributed $1.9 million to this
fund. There is potential variability in the calculation of OPEB plan expenses
depending on changes in certain assumptions: if there were a 1/4% change in the
discount rate assumed, the OPEB plan expenses would increase or decrease
inversely by $0.1 million; if there were a 1% change in the expected return on
VEBA assets, the OPEB plan expenses would increase or decrease inversely by $0.2
million.
- 19 -
The following tables represent the components of net periodic benefit cost for
the pension and OPEB for the 2004 plan projections.
THREE MONTHS ENDED SEPTEMBER 30,
PENSION BENEFITS OTHER POST-RETIREMENT BENEFITS
2004 2003 2004 2003
---- ---- ---- ----
(In Thousands)
Components of net periodic benefit cost:
Service cost $1,290 $1,553 $230 $195
Interest cost 4,495 4,455 763 787
Expected return on plan assets (5,012) (3,545) (328) (302)
Amortization of:
Prior service costs 263 294 (45) (45)
Transition obligation (asset) (263) (263) 264 264
Actuarial (gain) loss 1,441 1,878 426 409
Settlements and curtailments - - - -
-------------- -------------- ---------------- -----------------
Net periodic benefit cost $2,214 $4,372 $1,310 $1,308
============== ============== ================ =================
The following actuarial weighted average assumptions were used in calculating
net periodic benefit cost:
Discount rate 6.00% 6.75% 6.00% 6.75%
Average wage increase 4.50% 4.50% N/A N/A
Return on plan assets 8.00% 8.00% 8.00% 8.00%
Pre-65 health care trend rate (current year) N/A N/A 13.00% 14.00%
Pre-65 health care trend rate (2012+) N/A N/A 5.50% 5.50%
Post-65 health care trend rate (current year) N/A N/A 7.00% 7.50%
Post-65 health care trend rate (2009+) N/A N/A 5.00% 5.00%
N/A - not applicable
- 20 -
NINE MONTHS ENDED SEPTEMBER 30,
PENSION BENEFITS OTHER POST-RETIREMENT BENEFITS
2004 2003 2004 2003
---- ---- ---- ----
(In Thousands)
Components of net periodic benefit cost:
Service cost $4,462 $4,661 $692 $583
Interest cost 13,511 13,365 2,291 2,365
Expected return on plan assets (15,036) (10,635) (982) (908)
Amortization of:
Prior service costs 795 884 (135) (135)
Transition obligation (asset) (791) (791) 794 794
Actuarial (gain) loss 4,773 5,636 1,270 1,223
Settlements and curtailments - - - -
-------------- -------------- ---------------- -----------------
Net periodic benefit cost $7,714 $13,120 $3,930 $3,922
============== ============== ================ =================
The following actuarial weighted average assumptions were used in calculating
net periodic benefit cost:
Discount rate 6.00% 6.75% 6.00% 6.75%
Average wage increase 4.50% 4.50% N/A N/A
Return on plan assets 8.00% 8.00% 8.00% 8.00%
Pre-65 health care trend rate (current year) N/A N/A 13.00% 14.00%
Pre-65 health care trend rate (2012+) N/A N/A 5.50% 5.50%
Post-65 health care trend rate (current year) N/A N/A 7.00% 7.50%
Post-65 health care trend rate (2009+) N/A N/A 5.00% 5.00%
N/A - not applicable
- 21 -
(J) COMMITMENTS AND CONTINGENCIES
OTHER COMMITMENTS AND CONTINGENCIES
CONNECTICUT YANKEE ATOMIC POWER COMPANY
UI has a 9.5% stock ownership share in the Connecticut Yankee Atomic Power
Company (Connecticut Yankee), the carrying value of which was $4.1 million as of
September 30, 2004. On December 4, 1996, the Board of Directors of Connecticut
Yankee voted unanimously to retire the Connecticut Yankee nuclear plant (the
Connecticut Yankee Unit) from commercial operation. 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%. Connecticut Yankee may recover 9.5% of these costs from
UI.
Connecticut Yankee updates its cost to decommission the unit annually, or as
needed, and provides UI with a projected recovery schedule depicting annual
costs expected to be billed to UI, including a return on investment over the
term of the projected recovery period. The present value of these costs is
calculated using UI's weighted average cost of capital and, after consideration
of recoverability, recorded as a Connecticut Yankee Contract Obligation and a
corresponding regulatory asset. At September 30, 2004, UI has regulatory
approval to recover in future rates $22.6 million of its regulatory asset for
Connecticut Yankee over a term ending in 2007. The remaining portion of the
regulatory asset, as of September 30, 2004, was $24.5 million, which consists of
costs subject to a regulatory review and approval process and reflects the
present value of the revenue requirements to fund the increased costs described
in the following paragraphs. The regulatory review and approval process may
extend the recovery period beyond 2007. Although UI believes full regulatory
recovery is probable because these costs are similar in nature to the costs
already afforded regulatory treatment, the actual amounts subject to recovery
may be different.
CURRENT COST ESTIMATE
- ---------------------
As part of the Connecticut Yankee April 2000 rate case settlement with the FERC,
remaining decommissioning costs were originally estimated at $436 million. The
original estimate was updated in November 2002 to increase the estimated
decommissioning costs by approximately $130 million. The $130 million increase
stemmed primarily from additional security costs, as well as the corollary
economic impacts of increased insurance costs and other factors. In December
2003 the estimate was increased by $265 million, reflecting the fact that
Connecticut Yankee is now directly managing the work necessary to complete
decommissioning of the plant following termination of the contractor that had
been managing such work in July 2003. Consequently, the total current cost
estimate of approximately $831 million (2003 Estimate) represents an aggregate
increase of approximately $395 million over the April 2000 FERC rate case
settlement. The above financial information has been adjusted to 2003 dollars.
UI's share of the estimated increased cost of $395 million over the 2000 FERC
settlement is approximately $37.5 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.
If the outcome is not favorable, there could be a negative material impact to
UI's results of operations.
- 22 -
BECHTEL LITIGATION
- ------------------
Connecticut Yankee terminated its decommissioning contract with Bechtel Power
Corporation (Bechtel) in July 2003 due to Bechtel's history of incomplete and
untimely performance of 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. Connecticut
Yankee is now managing the decommissioning process and continues to prosecute
its counterclaims for excess completion costs and other damages against Bechtel
in Connecticut Superior Court. Discovery is underway and a trial has been
scheduled for May 2006. The 2003 Estimate does not include any allowance for
cost recovery in this matter.
On June 18, 2004, Bechtel filed a Pre-Judgment Remedy Application ("PJR")
requesting a $93 million garnishment of the Decommissioning Trust ("Trust"),
Connecticut Yankee shareholder payments to the Trust and any proceeds from the
fuel disposal contract litigation pending between Connecticut Yankee and the U.
S. Department of Energy (DOE), as well as attachment of any Connecticut Yankee
assets, including real property located in Haddam Neck, Connecticut. On July 16,
2004, Connecticut Yankee filed its objection to the PJR, including challenging
the legal availability of the remedies requested by Bechtel. On July 20, 2004
the Court allowed the DPUC to intervene in the PJR proceeding for the limited
purpose of objecting to Bechtel's requested garnishment of the Trust and related
payments. On August 26, 2004, the Court held oral arguments on the legal
availability of the remedies requested by Bechtel but has not issued a decision.
An evidentiary hearing on the other PJR issues began on October 19, 2004. On
November 1, 2004, the Judge in the PJR proceedings signed a Stipulation reached
between Connecticut Yankee and Bechtel. In the Stipulation Bechtel agrees:
(a) to waive and relinquish its right to seek prejudgment attachment of the
Trust or any future payments into the Trust, including any proceeds of
Connecticut Yankee's currently pending litigation with the DOE regarding spent
fuel storage costs; and (b) not to file in any forum any additional or amended
applications for prejudgment remedy or other preliminary relief seeking to
attach or garnish any assets of Connecticut Yankee or of any of its shareholders
or power purchasers. Further, Bechtel amends its Application to provide that it
seeks only: (i) to attach real property owned by Connecticut Yankee in
Connecticut with a value of up to $7.9 million; and (ii) to garnish a portion
of the stream of monthly payments to be made through June 2007 to Connecticut
Yankee under the wholesale power contracts between Connecticut Yankee and its
power purchasers, up to an aggregate amount of $41.7 million. In the proposed
Stipulation it is further agreed that any attachment of the real property
authorized by the Court will not prevent Connecticut Yankee from continuing
plant decommissioning, and Connecticut Yankee will be entitled to continue with
all deconstruction, demolition, decontamination, remediation and related
activities. This Stipulation does not constitute an admission of liability by
Connecticut Yankee, nor an acknowledgement of any damage calculation in any
respect, and is not admissible in any subsequent legal or administrative
proceeding not related to enforcement of the Application, including any
alternative dispute resolution proceedings. The parties have not reached
agreement as to whether the real property and the purchaser payments referenced
above may be lawfully attached or garnished. Connecticut Yankee and the DPUC
continue to dispute that the assets may be lawfully attached or garnished and
the parties agree to submit these legal issues to the Court for decision.
FERC MATTERS
- ------------
2004 RATE CASE FILING
- ---------------------
Connecticut Yankee filed the 2003 Estimate with the FERC as part of a July 1,
2004 rate application (the Filing) seeking additional funding to complete the
decommissioning project and for storage of spent fuel through 2023. The Filing
was required as part of the terms of Connecticut Yankee's April 2000 rate case
settlement agreement with the FERC and requests that new rates take effect on
- 23 -
January 1, 2005. The Filing includes proposed increased decommissioning charges,
based on the 2003 Estimate, as well as $4.0 million and $2.4 million of new
charges for pension and post-retirement benefits (other than pensions),
respectively. The proposed $93 million annual decommissioning collection
represents a significant increase in annual charges compared to the existing
FERC-approved decommissioning collection rate of $16.7 million per year that had
been approved as part of the April 2000 rate case settlement. The Filing
proposes extending the collection period for decommissioning from June 30, 2007
to December 31, 2010.
Notices of intervention or protest were filed in July and August at the FERC by
several utility parties and by non-utility parties including the DPUC, the OCC,
the Massachusetts Attorney General, the Massachusetts Department of
Telecommunications and Energy, the Rhode Island Attorney General, and the Maine
Public Advocate. Bechtel Power Corporation also filed a motion to intervene and
protest.
On August 30, 2004, FERC issued an order: (1) accepting for filing Connecticut
Yankee's proposed new charges for decommissioning, pension expense and
post-retirement benefits (other than pensions) expense; (2) suspending the
revised charges for a period of five months, to February 1, 2005 at which time
the proposed rates will go into effect subject to refund; (3) establishing
hearing procedures, to commence with a pre-hearing conference before an
administrative law judge (ALJ) in September; (4) denying the request of the DPUC
and OCC for an accelerated hearing schedule and for a bond or other security for
potential refunds; (5) denying the declaratory ruling requested by the DPUC and
OCC (see paragraph below), and (6) granting Bechtel's motion to intervene as
well as allowing the interventions by the other applying parties including UI
and the other Connecticut Yankee power purchasers. At the pre-hearing conference
on September 21, 2004, the ALJ issued a schedule for the docket leading up to a
hearing commencing on May 16, 2005. The process of resolving the matters in the
Filing is likely to be contentious and lengthy.
FERC ORDER ON REQUEST FOR DECLARATORY ORDER
- -------------------------------------------
On June 10, 2004, the DPUC and the OCC filed a petition (Petition) with FERC
seeking a declaratory order that Connecticut Yankee can recover all
decommissioning costs from its wholesale purchasers, but that those purchasers
may not recover in their retail rates any costs that FERC might determine to
have been imprudently incurred. Connecticut Yankee, as well as its wholesale
purchasers, responded in opposition to the Petition, indicating that the order
sought by the DPUC and OCC would violate the Federal Power Act and decisions of
the U.S. Supreme Court, other federal and state courts, and the FERC. As noted
above, the FERC rejected this petition as part of its initial ruling on
Connecticut Yankee's rate filing. The DPUC and OCC filed a petition for
rehearing on the matter which is pending before the FERC. Connecticut Yankee
filed a motion on October 14, 2004 requesting permission to respond, as well as
a response to the rehearing petition.
DOE LITIGATION
- --------------
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
DOE and several utilities and states. Under the Nuclear Waste Policy Act of 1982
(the Act), the DOE is required to design, license, construct and operate a
permanent repository for high-level radioactive waste and spent nuclear fuel.
The Act requires the DOE to provide for the disposal of spent nuclear fuel and
high-level waste from commercial nuclear plants through contracts with the
owners. In return for payment of established disposal fees, the federal
government was required to take title to and dispose of the utilities'
high-level waste and spent nuclear fuel beginning no later than January 1998.
After the DOE announced that its first high-level waste repository will not be
in operation earlier than 2010, several utilities and states obtained a judicial
declaration that the DOE has a statutory responsibility to take title to and
dispose of high-level waste and spent nuclear fuel beginning in January 1998.
Although the federal government now concedes that its failure to begin disposing
of high-level waste and spent nuclear fuel in January 1998 constituted a breach
of contract, it continues to dispute that the entities with which it had
contracts are entitled to damages.
- 24 -
Connecticut Yankee, together with two other New England-based owners of shutdown
nuclear generating plants, is seeking recovery of damages stemming from the
breach by the DOE under the 1983 contracts that were mandated by the U.S.
Congress under the High Level Waste Act for purposes of disposal of spent fuel
and high-level waste, including greater than class C waste. The trial for the
damage claim, which had been pending in the Federal Court of Claims since March
1998, commenced on July 12, 2004 and ended August 31, 2004. The post-trial
schedule includes a briefing schedule that concludes with final oral arguments
on January 14, 2005.
The amount of the claim for damages incurred through 2010, net of adjustments
made as part of the trial record, is approximately $186-198 million depending on
the discount rate applied. In addition, incremental continuing damages that will
be incurred for periods beyond 2010 are being sought based on an annual dollar
value. The 2003 Estimate discussed above does not include an allowance for
recovery of damages in this matter. The Department of Justice submitted a motion
to the court during the damage trial which raises the issue of whether
Connecticut Yankee's pre-1983 spent fuel fee obligation of approximately $155
million should be treated as an offset to any payment of damages. The Court's
ruling on that matter is expected to be issued in the same time frame as its
overall ruling in the case, which is expected in the Spring of 2005.
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 September 30, 2004, UI's guarantee for this debt was
approximately $3.4 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, except for capping contaminated
soils that are legally allowed to remain on site, assuming a zero sales value.
Final costs will be offset by any sale price realized, and will be subject to
regulatory true-up upon disposition of the property. UI is also replacing
portions of the bulkhead at the Steel Point Station property. The work is
expected to cost approximately $7.4 million and is currently expected to be
completed in 2005. These costs are estimates based on the most current
information available. Actual remediation and bulkhead replacement costs may be
higher, or lower, than what is currently estimated. UI is entitled to
reimbursement of these costs from the City of Bridgeport pursuant to UI's
contract with the City.
- 25 -
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 has
undertaken an environmental subsurface investigation of the former substation
site and the estimated environmental remediation cost is $0.2 million.
Concurrent with the removal of the East Main Street Substation in 2000, the
Congress Street Substation was expanded to replace it. As of September 30, 2004,
$8.9 million 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, at a cost of $13.5 million, of the bulkhead
surrounding a site on the Mill River in New Haven, containing transmission
facilities and deactivated generation facilities. Of this amount, $4.2 million
represents the portion of the costs to protect UI's transmission facilities and
has been capitalized as plant in service; the remaining estimated cost of $9.3
million has been expensed. UI has conveyed to an unaffiliated entity, Quinnipiac
Energy LLC (QE), this entire site, reserving to UI permanent easements for the
operation of its transmission facilities on the site. UI has also jointly funded
(61%) with QE a remediation fund for the purpose of bringing the site into
environmental compliance. The funds were placed into an escrow account to ensure
they were used for only remediation purposes. In addition, UI required that QE
obtain an insurance policy, with UI named as an additional insured, to provide
coverage for limited remediation cost overruns. The City of New Haven is
currently foreclosing on the property, as QE is not current with property tax
payments. If it is determined that QE has not performed appropriate
environmental remediation at the site, UI could be required by applicable
environmental laws to finish remediating any contamination at the site. The
scope of any required remediation efforts by UI is not now determinable. The
amount remaining in the escrow fund, as well as any insurance policy proceeds
received, would be used for this purpose.
On April 16, 1999, UI closed on the sale of its Bridgeport Harbor Station and
New Haven Harbor Station generating plants in compliance with Connecticut's
electric utility industry restructuring legislation. Environmental assessments
performed in connection with the marketing of these plants indicate that
substantial remediation expenditures will be required in order to bring the
plant sites into compliance with applicable minimum Connecticut environmental
standards. The purchaser of the plants 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 retained, UI has performed an additional
environmental analysis and estimates that approximately $3.2 million in
remediation expenses will be incurred. These costs are estimates based on the
most current information available. Actual remediation costs may be higher, or
lower, than what is currently estimated. The required remediation is virtually
all on transmission-related property; and UI accrued these estimated expenses
during the third quarter of 2002.
From 1961 to 1976, UI owned a parcel of property in Derby, Connecticut, on which
it operated an oil-fired electric generating unit. For several years, the
Connecticut Department of Environmental Protection (CDEP) 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, caused a review under the CDEP's Transfer Act Program.
Under this review, the CDEP had an opportunity to examine the current
environmental conditions at the site and direct remediation, or further
remediation, of any areas of concern. At the conclusion of its review, the CDEP
elected not to oversee any further site investigation or remediation at the site
- 26 -
and directed UI to undertake any necessary evaluation and/or remediation
(verification work) using an independent Licensed Environmental Professional
(LEP). UI has hired an LEP and has submitted a schedule to the CDEP for the
verification work. Implementation of the verification work is not expected to
have a material impact on the financial condition of UI.
UTILITY OPERATIONS
With respect to UI's general operations, UI has received a Notice of Violation
(NOV) from the CDEP, dated September 22, 2004. This NOV alleges that UI is not
in compliance with inspection, recordkeeping and labeling requirements under
certain state and federal waste and used oil regulations. UI has corrected the
deficiencies and believes it is in compliance with the cited regulations.
Although the CDEP may elect to seek penalties for the alleged violations, which
can be up to $25,000, per incident, per day for non-compliance, UI has no reason
to believe that the CDEP will pursue penalty assessment under a consent order in
connection with the NOV. No fines have been assessed in connection with this
NOV. Any such financial penalties related to this NOV, if pursued by the CDEP,
are not expected to have a material impact on the financial condition of UI.
CLAIM OF ENRON POWER MARKETING, INC.
UI had a wholesale power agreement and other agreements with Enron Power
Marketing, Inc. (EPMI) (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.
During mediation sessions, EPMI indicated it has theories for increasing the
amount of its claims against UI. In the event that UI is determined to owe EPMI
a portion or all of the amount claimed, UI will seek appropriate treatment of
such amount through the regulatory process.
- 27 -
INDEPENDENT SYSTEM OPERATOR - NEW ENGLAND
On April 16, 2004, UI announced its participation in the ISO-NE program to
secure emergency energy resources in Southwestern Connecticut. Under the
four-year contract, UI has committed to a load reduction of 30 megawatts when
requested by ISO-NE. UI has partnered with several large customers who have
agreed to reduce their electricity demand when the region's electric grid is
stressed. The agreement was approved by the FERC in May 2004. As part of the
agreement, UI provided a performance guarantee for the commitment of $0.7
million in the form of a letter of credit in the event UI was unable to reduce
demand when requested by ISO-NE. Through the end of October 2004, UI was not
required to perform under the $0.7 million letter of credit. In October 2004,
the letter of credit was reduced to $0.4 million, representing UI's remaining
performance guarantee under the agreement, and the term was extended until
October 31, 2005. No liability has been recorded in the UIL Holdings'
consolidated balance sheet as of September 30, 2004 for this guarantee provided
under this letter of credit. The probability that the letter of credit would be
utilized is very low due to the fact that the customers that UI has partnered
with for this program are among UI's largest, thus reducing the likelihood of
nonperformance in terms of both the requested kWh reductions and the ability to
pay any financial penalties. Furthermore, if the letter of credit were to be
utilized to cover nonperformance of UI's customers, the amount paid by UI would
be recovered directly from the customers who did not perform by deducting the
amount from the funds that would be remitted to such customers for their
performance in this program.
CROSS-SOUND CABLE COMPANY, LLC
UCI's 25% share of the actual project cost for the Cross-Sound cable was $34.3
million as of September 30, 2004. UCI has provided an equity infusion of $10
million to Cross-Sound and UIL Holdings loaned $24.6 million, including
capitalized interest, 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. As discussed below, on June 24, 2004
Cross-Sound executed a settlement agreement allowing for immediate commercial
operation of the cable. Although retaining commercial operating status is
contingent upon the satisfaction of certain provisions of the settlement
agreement, no liability has been recorded related to this guarantee as UIL
Holdings expects all provisions to be satisfied in accordance with the
agreement.
The $1.3 million guarantee is in support of an agreement under which Cross-Sound
is providing compensation to shell fishermen for loss of income as a result of
the installation of the cable (Shellfish Agreement). The payments to the
fishermen are being made over a 10 year period, and the obligation under this
guarantee reduces proportionately with each payment made. As of
September 30, 2004, the remaining amount of the guarantee was $1.2 million.
UIL Holdings has completed a probability weighted analysis based on the
likelihood of certain events occurring that would cause UIL Holdings to be
required to perform under this guarantee. The result of this analysis resulted
in a liability amount that was inconsequential, and as such, no liability has
been recorded in UIL Holdings' consolidated balance sheet as of
September 30, 2004. In late October 2004, one of the parties to the Shellfish
Agreement interfered with remediation work activities being conducted by Cross-
Sound. On November 1, 2004, Cross-Sound sought a temporary restraining order to
prevent continued interference. One of the shell fishermen has in turn
requested a temporary injunction against use of certain equipment being employed
in the remediation work. Cross-Sound will seek a court order permitting the
remediation work to continue.
In the event that Cross-Sound could not meet any obligations that are supported
by the previously mentioned guarantee, it is expected that such obligation would
be funded by capital contributions from the owners, who are affiliates of the
guarantors, in amounts in proportion to their respective ownership shares of
Cross-Sound. As such, UCI does not expect to be required to perform under the
guarantee.
- 28 -
On June 24, 2004, Cross-Sound reached a settlement agreement with various
regulatory authorities and other parties with an interest in the cable that
allowed for immediate commercial operation of the cable. In connection with that
settlement agreement, the existing contract Cross-Sound has with the LIPA for
the entire capacity of the transmission line is being reviewed and negotiations
are taking place to increase the overall term of the agreement from 20 years to
28 years by means of adding an initial three year period at the current reduced
rates, and an additional five years to the end of the contract term, at full
rates.
Although the settlement agreement allows for commercial operation of the cable,
such status is contingent upon the satisfaction of certain provisions set forth
in the agreement. In particular, Cross-Sound must bring the cable into
compliance with permit conditions as directed by the CDEP. This remediation
consists primarily of achieving the originally required burial depth in those
areas deemed as "soft spots," meaning the obstructions which originally
prevented achievement of such depth can generally be removed without the use of
techniques such as blasting. The costs of this remediation are currently
estimated at $1.5 million and are within the estimated final cost of the
project. Additionally, the settlement agreement calls for the parties to fund a
collective amount of $6 million, of which Cross-Sound's commitment is $2
million, to a research and restoration fund for the Long Island Sound. For a
complete description of the settlement agreement, as well as additional
discussion regarding the Cross-Sound cable, see "Management's Discussion and
Analysis - Major Influences - United Capital Investments, Inc."
Upon satisfaction of all provisions of the settlement agreement, the loan from
UIL Holdings is expected to be refinanced with external project financing. UCI
will be responsible for 25% of any additional cost of project completion over
the estimated amount.
XCELECOM, INC.
Xcelecom, through one of its subsidiaries, has filed suit in New Jersey Superior
Court against M. J. Paquet (Paquet), a general contractor doing business in the
state of New Jersey, and Paquet's surety, United States Fidelity & Guaranty
Company. Paquet is the general contractor on a project with the New Jersey
Department of Transportation which is in the final stages of completion, where
one of Xcelecom's subsidiaries is the electrical subcontractor. Xcelecom's
portion of the project is not yet complete, as the general contractor continues
to experience delays completing its work, which has, in turn, delayed Xcelecom's
ability to complete its contract work. Xcelecom's portion of the project is
expected to be substantially complete by the end of 2004. Xcelecom alleges in
its suit, among other causes of action, breach of contract, failure to comply
with New Jersey's Prompt Pay Act, and breach of trust. Xcelecom seeks to recover
approximately $2 million in overdue payments, plus damages for delay and failure
by Paquet to comply with New Jersey state law. Paquet has asserted numerous
defenses to the suit, as well as various counterclaims. Pleadings are closed and
discovery is in process. Xcelecom intends to vigorously pursue its suit against
Paquet and its surety, and to defend against Paquet's counterclaims. Paquet has
recently announced it was ceasing operations and the State of New Jersey
recently withdrew two contracts it awarded to Paquet earlier in the year.
Xcelecom does not believe there is a likelihood of an adverse outcome as a
result of Paquet's counterclaims, and as such, no amount has been accrued for
this matter in the financial statements. There has been no reserve established
against the receivable of approximately $2 million, as Xcelecom expects to
collect the entire amount due on this contract, either directly from Paquet, or
through the payment and performance bonds of Paquet's surety.
- 29 -
(M) SEGMENT INFORMATION
As described in Note (O), "Discontinued Operations," to the consolidated
financial statements, the sale of APS was completed in June of 2004 and its
results of operations are reported as discontinued operations. Accordingly, UIL
Holdings now has two segments, UI, its regulated electric utility business
engaged in the purchase, transmission, distribution and sale of electricity, and
Xcelecom, its non-utility, indirect, wholly-owned subsidiary, which provides
specialized contracting services in the electrical, mechanical, communications
and data network infrastructure industries. Revenues from inter-segment
transactions are not material. All of UIL Holdings' revenues are derived in the
United States.
The following table reconciles certain segment information to 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.
SEPTEMBER 30, 2004 DECEMBER 31, 2003
------------------ -----------------
Total Assets (In Thousands)
------------
UI $1,487,704 $1,492,144
Xcelecom 190,454 178,906
Assets of discontinued operations held for sale - 121,627
Other 112,588 105,489
------------------ -----------------
Total UIL Holdings $1,790,746 $1,898,166
================== =================
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2004 2003 2004 2003
---- ---- ---- ----
Revenues from External Customers (In Thousands)
- --------------------------------
UI $231,421 $194,948 $588,857 $516,323
Xcelecom 91,994 74,750 244,661 218,224
Other 5 5 64 16
------------------ ----------------- ------------------- ------------------
Total UIL Holdings $323,420 $269,703 $833,582 $734,563
================== ================= =================== ==================
Income (Loss) from Continuing
Operations before Income Taxes
- ------------------------------
UI $34,009 $32,412 $74,104 $64,118
Xcelecom 1,048 (170) (126) (2,278)
Other (3,106) (1,868) (12,743) (9,797)
------------------ ----------------- ------------------- ------------------
Total UIL Holdings $31,951 $30,374 $61,235 $52,043
================== ================= =================== ==================
- 30 -
(N) GOODWILL AND OTHER INTANGIBLE ASSETS
As of September 30, 2004 and December 31, 2003, UIL Holdings maintains $69.6
million and $68.6 million, respectively, of goodwill related to Xcelecom that is
no longer being amortized, and $3.7 million and $2.7 million, at September 30,
2004 and December 31, 2003, respectively, of identifiable intangible assets that
continue to be amortized.
A summary of UIL Holdings' goodwill as of September 30, 2004 is as follows:
(Thousands of Dollars) Total
-------------
Balance, January 1, 2004 $68,554
Goodwill acquired during the nine months
ended September 30, 2004 1,051
-------------
Balance, September 30, 2004 $69,605
=============
There were no impairments to the goodwill balances recognized during the nine
months ended September 30, 2004 and 2003.
As of September 30, 2004 and December 31, 2003, UIL Holdings' intangible assets
and related accumulated amortization consisted of the following:
As of September 30, 2004
--------------------------------------------
Accumulated Net
(Thousands of Dollars) Gross Amortization Balance
------------ ------------------ ------------
Intangible assets subject to
amortization:
Non-compete agreements $3,455 $3,122 $333
Backlog 256 256 -
------------ ------------------ ------------
Total $3,711 $3,378 $333
============ ================== ============
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 $0.9 million for the nine months
ended September 30, 2004 and 2003, respectively, related to these intangible
assets. Assuming there are no acquisitions or dispositions that occur in the
future, the remaining intangible assets will be fully amortized in 2005. The
estimated annual amortization expense is shown in the table below.
2004 2005 2006 2007 2008
---- ---- ---- ---- ----
(In Thousands)
$1,264 $13 - - -
- 31 -
(O) DISCONTINUED OPERATIONS
On June 22, 2004, UIL Holdings completed the sale of APS to CheckFree
Corporation (CheckFree), a leading provider of financial electronic commerce
services and products, pursuant to the purchase agreement entered into between
the parties on December 16, 2003. Accordingly, the results of discontinued
operations for the nine months ended September 30, 2004 included the after-tax
gain, net of transaction costs and post-closing adjustments, of $46.2 million
recognized from the sale of APS. Post-closing review procedures were completed
during the third quarter of 2004 and the resulting adjustments net to an
insignificant increase in the gain on the sale of APS. The difference between
the overall gain and the reported gain for the nine months ended September 30,
2004 was due to transaction costs incurred in the fourth quarter of 2003. Total
transaction costs associated with the sale of APS amounted to approximately $14
million and included $8.1 million paid to cover amounts owed to employees of APS
based on a long-term incentive plan and retention bonuses.
CheckFree did not acquire APS' telephony assets, which included a 51% ownership
interest in CellCards of Illinois, LLC (CCI). Following execution of the
agreement to sell APS, management determined that the telephony business was not
part of UIL Holdings' overall strategic business focus, and therefore authorized
the sale of APS' telephony assets. On February 13, 2004, CCI was sold for book
value, excluding transaction costs, to an independent third party.
As a result of the aforementioned events, the APS segment was considered to be a
"disposal group" held for sale as defined in SFAS No. 144, "Accounting for the
Impairment of Long-Lived Assets." Accordingly, the assets and liabilities of APS
have been categorized as "held for sale" in the accompanying Consolidated
Balance Sheet and the assets of APS ceased being depreciated as of December 16,
2003. The related asset carrying values were not required to be adjusted, as the
carrying amounts were lower than the estimated fair values less costs to sell.
The results of operations of APS for all periods presented have been reported as
discontinued operations in the accompanying Consolidated Statements of Income
and Consolidated Statements of Cash Flows.
A summary of the discontinued operations of APS follows (in thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
2004 2003 2004 2003
--------------- --------------- -------------- -----------------
Net operating revenues $ - $ 22,405 $ 36,659 $ 83,326
=============== =============== ============== =================
Operating income (loss) (1) $ (135) $ 489 $ 5,508 $ (1,255)
=============== =============== ============== =================
Income (loss) before income taxes (1) $ (135) $ 612 $ 4,941 $ (892)
Income tax (expense) benefit (1) $ 55 (224) (1,469) 353
--------------- --------------- -------------- -----------------
Income (loss) from discontinued operations,
net of tax, excluding gain on sale (80) 388 3,472 (539)
Gain on sale of discontinued operations, net
of tax (2) 96 - 46,352 -
--------------- --------------- -------------- -----------------
Net income (loss) from discontinued operations $ 16 $ 388 $ 49,824 $ (539)
=============== =============== ============== =================
(1) Excludes transaction costs and related income tax impact, which are included
in the gain on sale of discontinued operations.
(2) Gain on sale of discontinued operations is reported net of transaction
costs of $14 million and net of income taxes of $32 million.
- 32 -
(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 nine months ended September 30, 2004 and 2003 totaled $7.1 million
and $6.5 million, respectively and for the three months ended September 30, 2004
and 2003 totaled $2.3 and $2.2, respectively.
UCI invested a total of $3.9 million in 2000 and 2001 to purchase a minority
ownership interest in Gemini Networks, Inc. (Gemini). Gemini proposes to
develop, build, and operate an open-access, hybrid fiber coaxial communications
network serving business and residential customers in the northeastern United
States. Gemini is a corporation controlled by the David T. Chase family, and
Arnold L. Chase is the President and a Director of Gemini. In June 2002, UCI
wrote its investment in Gemini down to one dollar, because the
telecommunications sector had suffered substantial losses in value, and because
UCI concluded that Gemini was unlikely to continue its network development in
the absence of additional financing. In December 2003, Gemini completed a
restructuring transaction in connection with which the Chase family came to own
100% of the equity of Gemini. In connection with that transaction, UCI received
a cash payment in May 2004 of approximately $17,500 in exchange for its
ownership interest in Gemini.
Cross-Sound, in which UCI holds a 25% minority interest investment, leases a
parcel of land from UI. Cross-Sound's lease payments to UI for this parcel
amount to $0.1 million on an annual basis.
In connection with certain of the acquisitions of Xcelecom, certain of
Xcelecom's subsidiaries have entered into a number of related party lease
arrangements for facilities with the former owners of companies acquired (or
persons or entities related thereto), some of whom are current employees of
Xcelecom. These lease agreements are for periods generally ranging from three to
five years. Xcelecom's payments related to these lease arrangements totaled $1.1
million for the nine months ended September 30, 2004 and 2003, respectively, and
$0.4 million for the three months ended September 30, 2004 and 2003,
respectively.
- 33 -
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
CERTAIN STATEMENTS CONTAINED HEREIN, REGARDING MATTERS THAT ARE NOT HISTORICAL
FACTS, ARE FORWARD-LOOKING STATEMENTS (AS DEFINED IN THE PRIVATE SECURITIES
LITIGATION REFORM ACT OF 1995). THESE INCLUDE STATEMENTS REGARDING MANAGEMENT'S
INTENTIONS, PLANS, BELIEFS, EXPECTATIONS OR FORECASTS FOR THE FUTURE. SUCH
FORWARD-LOOKING STATEMENTS ARE BASED ON THE CORPORATION'S EXPECTATIONS AND
INVOLVE RISKS AND UNCERTAINTIES; CONSEQUENTLY, ACTUAL RESULTS MAY DIFFER
MATERIALLY FROM THOSE EXPRESSED OR IMPLIED IN THE STATEMENTS. SUCH RISKS AND
UNCERTAINTIES INCLUDE, BUT ARE NOT LIMITED TO, GENERAL ECONOMIC CONDITIONS,
LEGISLATIVE AND REGULATORY CHANGES, CHANGES IN DEMAND FOR ELECTRICITY AND OTHER
PRODUCTS AND SERVICES, UNANTICIPATED WEATHER CONDITIONS, CHANGES IN ACCOUNTING
PRINCIPLES, POLICIES OR GUIDELINES, AND OTHER ECONOMIC, COMPETITIVE,
GOVERNMENTAL, AND TECHNOLOGICAL FACTORS AFFECTING THE OPERATIONS, MARKETS,
PRODUCTS, SERVICES AND PRICES OF THE CORPORATION'S SUBSIDIARIES. THE FOREGOING
AND OTHER FACTORS ARE DISCUSSED AND SHOULD BE REVIEWED IN THE CORPORATION'S MOST
RECENT ANNUAL REPORT ON FORM 10-K AND OTHER SUBSEQUENT PERIODIC FILINGS WITH THE
SECURITIES AND EXCHANGE COMMISSION. FORWARD-LOOKING STATEMENTS INCLUDED HEREIN
SPEAK ONLY AS OF THE DATE HEREOF AND THE CORPORATION UNDERTAKES NO OBLIGATION TO
REVISE OR UPDATE SUCH STATEMENTS TO REFLECT EVENTS OR CIRCUMSTANCES AFTER THE
DATE HEREOF OR TO REFLECT THE OCCURRENCE OF UNANTICIPATED EVENTS OR
CIRCUMSTANCES.
MAJOR INFLUENCES ON FINANCIAL CONDITION
UIL HOLDINGS CORPORATION
UIL Holdings' financial condition and financing capability will be dependent on
many factors, including the level of income and cash flow of UIL Holdings'
subsidiaries, conditions in the securities markets, economic conditions,
interest rates, legislative and regulatory developments, and the ability to
retain key personnel.
The loss of key personnel or the inability to hire and retain qualified
employees could have an adverse effect on the business, financial condition and
results of operations for UIL Holdings and its operating subsidiaries, UI and
Xcelecom. These operations depend on the continued efforts of their respective
current and future executive officers, senior management and management
personnel. UIL Holdings cannot guarantee that any member of management at the
corporate or subsidiary level will continue to serve in any capacity for any
particular period of time. In an effort to enhance UIL Holdings' ability to
attract and retain qualified personnel, UIL Holdings continually evaluates the
overall compensation packages offered to all levels of employees.
THE UNITED ILLUMINATING COMPANY
UI is an electric transmission and distribution utility whose structure and
operations are significantly affected by legislation and regulation. UI's rates
and authorized return on equity are regulated by the Federal Energy Regulation
Commission (FERC) and the Connecticut Department of Public Utility Control
(DPUC). Legislation and regulatory decisions implementing the legislation
establish a framework for UI's operations. Primary factors affecting UI's
financial results, in addition to legislation and regulation, are operational
matters such as sales volume, major weather disturbances, ability to control
expenses, and capital expenditures. UI expects significant growth in its capital
investment in transmission, and has applied for siting approval to construct a
major transmission line 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
the period January 1, 2004 - December 31, 2006 to retail customers who do not
- 34 -
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, the DPUC has continued 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 (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 post-retirement 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 would
not file a rate case before January 1, 2005.
On April 2, 2004, the Office of Consumer Counsel (OCC) appealed the DPUC
decision to the Connecticut Superior Court. In late April 2004, the DPUC, on its
own motion, reopened the docket related to UI's recovery of increased pension
costs, and on August 11, 2004 issued a final decision which reversed the
February 18, 2004 decision. As a result of an October 2004 court order issued by
the State Superior Court in the appeal of the February 18th decision, UI has
ceased recovery of the increased pension and post-retirement benefits expenses
effective June 24, 2004. In addition, the sharing mechanism for any UI earnings
in excess of its authorized equity return of 10.45% has returned to 50% to
- 35 -
customers and 50% to shareholders and there are no restrictions on UI's ability
to file a rate case. In accordance with the DPUC decision and Superior Court
enforcement order, UI recorded a pre-tax adjustment of approximately $0.1
million in the third quarter of 2004 to reverse recovery for increased pension
and postretirement benefits expenses previously recorded for the period June 24,
2004 through June 30, 2004. On October 26, 2004, the OCC formally withdrew its
appeal.
UI has taken substantial actions in 2003 and 2004 to mitigate the effect of
these increased pension and postretirement benefits expenses and also to reduce
the increases themselves through contributing $74 million in cash to the pension
plan since the docket was initially reopened in November 2002. These actions,
along with unanticipated sales growth, have allowed UI to mitigate the effect of
the increased pension and postretirement expenses to date. Through June 24,
2004, UI had recovered approximately $1.8 million in accordance with the
February 18, 2004 decision, which equates to approximately $0.08 per share,
after-tax.
On June 23, 2004, the DPUC approved UI's request to amend its Purchased Power
Adjustment Clause to allow UI to apply the clause to special contract customers.
The DPUC also approved a Purchased Power Adjustment rate of $0.00264 per kWh to
be applied against special contract load to reflect the increased cost to serve
these customers. This will allow UI to recover changes in the cost to procure
energy as it relates to special contract customers through the GSC. The decision
does not explicitly order the accounting for the increased costs of $0.8 million
related to UI's special contract customers for the period from January 1, 2004
through June 22, 2004 (the day before the effective date of the final decision).
The actual costs for that period to procure power for UI's special contracts
will flow through the annual CTA/SBC Reconciliation filing for 2004. The 1998
and 2003 restructuring legislation (PA 98-28 and PA 03-135, as amended in part
by PA 03-221) provides that the distribution company is entitled to recover its
full cost of procuring power for customers who do not choose an alternate
supplier.
On October 25, 2004, UI filed a request with the DPUC seeking to reopen the
regulatory docket in which the non-bypassable Federally Mandated Congestion
Costs (NBFMCC) charge was established by the DPUC. The NBFMCC charge relates to
"congestion costs" associated with not having adequate transmission
infrastructure to move energy into the state from outside the state. Because the
purpose of the NBFMCC charge is for the electric distribution company to recover
its actual NBFMCC costs on a pass-through basis, the DPUC decision provided for
a true-up of NBFMCC costs and revenues on a semi-annual basis and an adjustment
of the associated amounts deferred for future recovery. The charge established
for 2004 was based upon estimates that were made in 2003, and reflects estimated
NBFMCC lower than have actually been incurred. UI's filing proposes to increase
the NBFMCC charge from $0.001652 per kWh to $0.008251 per kWh, effective
November 1, 2004. This will enable UI to recover both the forecasted ongoing
NBFMCC costs and the deficit that has resulted from the current charge being
below the incurred costs. UI's proposal would collect the accumulated deficit
over the November 2004 - June 2005 time period.
OPERATIONS
In implementing the 1998 Restructuring Legislation, UI established a
Distribution Division and other "unbundled" components for accounting purposes,
to reflect other unbundled components on customer bills. Initially, the
Distribution Division included both transmission and distribution. UI has now
separated transmission from distribution into separate divisions for accounting
purposes. Changes to income and expense items related to transmission and
distribution have an immediate net income and earnings per share impact, while
changes to items in "other unbundled utility components" do not. The other
components are the CTA, the SBC, the GSC, the C&LM charge, and REI charge. The
CTA and SBC are both allowed to earn a 10.45% return on the equity portion of
their respective rate bases in accordance with the Rate Case decision that
became effective on September 26, 2002. Those returns are achieved either by
accruing additional amortization expenses, or by deferring such expenses, as
required to achieve the authorized return. Amortization expenses in the CTA and
SBC components impact earnings indirectly through changes to rate base. The GSC,
C&LM and REI are essentially pass-through components (revenues are matched to
recover costs). Except for the procurement fee in GSC previously discussed, and
a small management fee earned in the C&LM component, expenses are either accrued
or deferred or revenues are transferred such that there is no net income
associated with these three unbundled components.
UI's CTA collection recovers costs that have been reasonably incurred, or will
be incurred, to meet its public service obligations and that will likely not
otherwise be recoverable in a competitive market. These "stranded costs" include
- 36 -
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 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 nine months ended September 30, 2004 and
2003 were $0.71 and $0.76, 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 nine months
ended September 30, 2004 and 2003 amounted to $19.9 million and $29.1 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 $273
million as of September 30, 2004. In July 2004, the DPUC issued a final decision
approving the year-end 2003 CTA rate base component of stranded costs. During
July 2003, the DPUC issued an order requiring that the reduction of CTA rate
base utilizing excess GSC revenues be discontinued pursuant to the 2003
Restructuring Legislation. UI's CTA earnings will decrease while, based on UI's
current projections, cash flow will remain fairly constant until stranded costs
are fully amortized. Stranded costs are expected to be fully amortized between
2013 and 2015, depending primarily upon the DPUC's future decisions which could
affect future rates of stranded cost amortization.
The primary Distribution Division operational factors affecting UI's financial
results are sales volume, ability to control expenses and capital expenditures.
Retail electric sales volume can be significantly affected by economic
conditions and weather. The level of economic growth can be reflected in many
ways; job growth or workforce reductions, plant relocations into or out of UI
territory, and facilities expansions or contractions, all of which can affect
demand for electricity. The weather can also have an impact on expenses,
dependent on the level of work required as a result of storms or other extreme
conditions. UI's major expense components are (1) purchased power, (2)
amortization of stranded costs; (3) wages and benefits; (4) depreciation; and
(5) regional network service transmission costs.
On October 22, 2003, UI entered into an agreement with PSEG Energy Resources &
Trade LLC (PSEG) for the supply of all of UI's transitional standard offer
generation service needs, excluding requirements for special contract customers,
from January 1, 2004 through December 31, 2006, the end of the transitional
standard offer period. UI continues to purchase generation services pursuant to
a December 28, 2001 agreement with Dominion Energy Marketing (Dominion) to
supply special contract customers through December 31, 2008. While purchased
power expenses are a pass-through expense in terms of the regulatory methodology
which facilitates how customers fund these costs (collected from customers in
the GSC and as federally mandated congestion costs), UI is a principal in its
relationships with these suppliers, and is the primary obligor in these
arrangements. The contract with PSEG contains numerous financial assurances,
including a guaranty from PSEG's parent company, PSEG Power, various credit
requirements including maintaining a minimum Moody's credit rating of Baa3 or
equivalent, and a letter of credit to secure performance through the initial
stages of the contract. UI is also required to maintain a minimum credit rating
of Baa3 or equivalent. UI's current Moody's credit rating is Baa2, which is one
level 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 (CL&P), has filed with
the Connecticut Siting Council (CSC) an application for a Certificate of
Environmental Compatibility and Public Need to construct a 345-kiloVolt
transmission line from Middletown, Connecticut to Norwalk, Connecticut. This
project is necessary to improve the reliability of the transmission system in
southwest Connecticut. The two companies are working together for permitting,
- 37 -
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. UI's current estimate for its share of the project cost is
approximately $112 million (excluding allowance for funds used during
construction). The CSC has requested, and UI and CL&P have granted, a six month
extension of the date for the final decision to April 2005. Based on the
original projected schedule of construction, and barring any delays in approval
by the CSC, the project would be completed by the end of 2007, although a
decision closer to the end of the extension period could delay the project
completion into 2008. Other governmental permitting, together with approvals
from ISO-New England, will be required for the project. The total project cost
and timing of completion could change depending on final CSC decision
specifications and timing and other permit requirements. UI's costs for the
project are expected to be included in and recovered through transmission rates
under FERC jurisdiction.
UI is dependent on the knowledge, training and abilities of its workforce.
Retaining key employees and maintaining the ability to attract new employees are
important to both UI's operational and financial performance. A significant
portion of UI's workforce, including many workers with specialized skills
maintaining and servicing the electrical infrastructure, will be eligible to
retire over the next five years. Such highly skilled individuals cannot be
quickly replaced due to the technically complex work they perform and the time
it takes to hire and train replacements. The inability to retain or replace
these employees could have an adverse effect on UI's financial condition and
results of operations. In recognition of this situation, UI has several
recruiting and training initiatives underway to mitigate the expected future
attrition and maintain the skill sets required to service customers.
RISK MANAGEMENT AND INSURANCE
UI's primary risk management and insurance exposures include bodily injury,
property damage, fiduciary responsibility, and injured workers' compensation. UI
is insured for general liability, automobile liability, property loss, fiduciary
liability and workers' compensation liability. UI's general liability and
automobile liability programs provide insurance coverage for third party
liability claims for bodily injury (including "pain and suffering") and property
damage, subject to a deductible. Losses up to the deductible amounts are accrued
based upon our estimates of the liability for claims incurred and an estimate of
claims incurred but not reported. UI reviews the general liability reserves
quarterly to ensure that UI is appropriately reserved. The reserve is based on
historical claims, business events, industry averages and actuarial studies.
Insurance liabilities are difficult to assess and estimate due to unknown
factors such as claims incurred but not reported and awards greater than
expected, therefore reserve adjustments may become necessary as cases unfold. UI
insures its property subject to deductibles depending on the type of property.
UI's fiduciary liability program and workers' compensation program provides
insurance coverage, subject to deductibles as well. As with other companies, UI
has seen significant increases in its workers' compensation premiums from its
carrier since the terrorist attacks of September 11, 2001.
XCELECOM, INC.
The principal factors affecting the financial results of Xcelecom and its
subsidiaries are (1) construction and technology spending; (2) competition; (3)
fixed-priced contract estimation and bidding; (4) work-related hazards and
insurance; (5) attracting and retaining management expertise; (6) overall
liquidity and ability to obtain surety bonding, and (7) risks of attaining
required labor productivity levels to meet or exceed contract estimates.
Additional risk factors include general economic conditions, the pace of
technological changes, recoverability and potential for impairment of goodwill,
and collectibility of receivables.
More than half of Xcelecom's business involves the installation of electrical,
mechanical and integrated network information systems in newly constructed and
renovated buildings and plants. Downturns in levels of construction starts and
business spending can have a material adverse effect on Xcelecom's business,
financial condition and results of operations. In addition, Xcelecom's business
is subject to seasonal variations in operations and demand that affect the
construction business, particularly in new construction. Quarterly results may
also be affected by regional economic conditions. Accordingly, Xcelecom's
performance in any particular quarter may not be indicative of the results that
can be expected for any other quarter or for the entire year. The competitive
bidding process for new business contracts normally intensifies during economic
downturns, leading to lower profit margins and an increased potential for
project cost overruns or losses. One of Xcelecom's subsidiaries serves the
region affected by the recent hurricanes in the Southeast. As a result of the
- 38 -
hurricane damage in the region, certain projects have been delayed due to the
necessity for commercial and residential repair work. The near and long-term
impact of the hurricane damage on this market will not be known for some time.
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 exposure
related to insurance deductibles. 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. One of Xcelecom's
subsidiaries has been affected by the recent hurricanes in Florida and expects
full recovery from insurance policies for physical premises damage and is
pursuing claims for business interruption.
The loss of key personnel or the inability to hire and retain qualified
employees could have an adverse effect on Xcelecom's business, financial
condition and results of operations. Xcelecom's operations depend on the
continued efforts of current and future executive officers, senior management
and management personnel at the companies acquired by Xcelecom. Certain steps
taken to mitigate the risk of loss of key personnel of acquired companies were
the use of earn-out payments, promissory notes, and covenant not to compete
agreements. A criterion used in evaluating acquisition candidates was the
quality of their management. There is no guarantee that any member of management
of Xcelecom or any of its subsidiaries will continue in their capacity for any
particular period of time. The loss of a group of key personnel could adversely
affect Xcelecom's operations.
Billings under fixed price contracts are generally based upon achieving certain
benchmarks and will only be accepted by the customer once it is demonstrated
that those benchmarks have been met. If Xcelecom is unable to show compliance
with billing requests, or fails to issue a timely project billing, the
likelihood of collection could be delayed or impaired, which could have a
material adverse effect on operations. An allowance for doubtful accounts for
unknown collection issues is maintained, in addition to reserves for specific
accounts receivable where collection is considered doubtful. Inherent in the
assessment of the allowance for doubtful accounts are certain judgments and
estimates including, among others, customers' access to capital, customers'
willingness to pay, general economic conditions and the ongoing relationships
with customers.
Surety market conditions are currently difficult as a result of significant
losses incurred by many sureties in recent periods, both in the construction
industry as well as in certain large corporate bankruptcies. As a result, less
bonding capacity is available in the market and terms have become more
restrictive. Further, under standard terms in the surety market, sureties issue
bonds on a project by project basis, and can decline to issue bonds at any time.
Historically, approximately one third of Xcelecom's construction related
business has required bonds. While Xcelecom has enjoyed a longstanding
relationship with its surety, current market conditions as well as changes in
the surety's assessment of Xcelecom's operating and financial risk could cause
the surety to decline to issue bonds for future projects. If that were to occur,
alternatives include doing more business that does not require bonds, posting
other forms of collateral for project performance such as letters of credit or
cash, and seeking bonding capacity from other sureties. There can be no
assurance that such alternatives could be easily achieved. Accordingly, if
Xcelecom were to experience an interruption in the availability of bonding
capacity, its operating results could be adversely impacted.
- 39 -
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 technology industry in general has begun to see the start of an
improving business environment in the United States. Xcelecom's systems
integration business generally experiences the positive effects of an economic
rebound prior to Xcelecom's other lines of business. Xcelecom sales can be
dependent on demand for specific technology categories offered through
particular vendor partners, and any change in demand for, or supply of, such
technology or change in relationships with such partners, could have a material
adverse effect on Xcelecom's sales if it fails to react in a timely manner to
such changes or manage such relationships. One crucial measure of performance,
gross profit as a percentage of net sales, can fluctuate due to numerous
factors, including changes in prices from suppliers, reductions in the amount of
supplier reimbursements that are made available, changes in customer mix, the
relative mix of products sold during the period, general competitive conditions,
the availability of opportunistic purchases and opportunities to increase market
share. In addition, expense levels, including the costs and salaries incurred in
connection with the hiring of sales and technical services personnel, are based,
in part, on anticipated sales. Therefore, Xcelecom may not be able to reduce
spending in a timely manner to compensate for any unexpected sales or margin
shortfalls. As a result, comparisons of Xcelecom's quarterly financial results
should not be relied upon as an indication of future performance.
COST DRIVERS
As a service business, Xcelecom's cost structure is highly variable. Primary
costs include labor, materials and insurance. Approximately 50% of costs are
derived from labor and related expenses. For the nine months ended September 30,
2004 and 2003, labor-related expenses totaled $122 million and $113.4 million,
respectively.
Approximately 34% of Xcelecom's costs incurred are for materials installed on
projects and equipment and other products sold to customers. This component of
the expense structure is variable based on the demand for services. Costs are
generally incurred for materials once work begins on a project or a customer
order is received. Materials are ordered when needed, shipped directly to the
jobsite or customer facility, and installed within 30 days. Materials consist of
commodity-based items such as conduit, pipe, data cabling, wire and fuses as
well as specialty items such as fixtures, switchgear, switches and routers,
servers and control panels. For the nine months ended September 30, 2004 and
2003, material and equipment expenses totaled $83.6 million and $72.3 million,
respectively.
- 40 -
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 claims incurred but not reported and
the effectiveness of Xcelecom's safety programs. Therefore, if actual experience
differs from the assumptions used in the actuarial valuation, adjustments to the
reserve may be required and would be recorded in the period that the experience
becomes known.
UNITED CAPITAL INVESTMENTS, INC.
UCI has a 25% interest in Cross-Sound Cable Company, LLC (Cross-Sound), which
owns and operates a 330-megawatt transmission line (cable) connecting
Connecticut and Long Island under the Long Island Sound. In January 2002, the
CSC granted a certificate of environmental compatibility and public need to
construct the cable. In the spring of 2002 the cable was installed, and 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 issued. The
authorized depth was not achieved due to the obstruction of rock ledge,
sediment and other more movable types of obstruction.
In June 2003 Cross-Sound submitted a request for a certificate of permission to
modify the existing permit and filed a new permit application with the
Connecticut Department of Environmental Protection (CDEP) seeking to operate
the cable as installed in its current location through December 31, 2007. Also
in June 2003, a Connecticut legislative moratorium on installing new gas and
utility lines across Long Island Sound was enacted, which precluded the CDEP
from considering applications related to submarine cables under Long Island
Sound for a year, until June 2004.
The federal Department of Energy (DOE) issued an Emergency Order following the
August 2003 blackout that affected the Northeast region of the United States
allowing immediate operation of the Cross-Sound cable, and subsequently issued a
new Order for the cable to operate until all of the appropriate actions that
should be taken to prevent future power outages in the region have been
identified and implemented. The cable operated pursuant to the Emergency Order
until it was terminated in May 2004. The cable then ceased operations for
approximately seven weeks.
- 41 -
In June 2004, legislation was signed into law extending the moratorium for
another year to early June 2005. This legislation also allowed for a waiver of
the moratorium by means of an applicant receiving unanimous approval from
certain specified legislative and regulatory officials. In June 2004,
Cross-Sound obtained a waiver of the Connecticut moratorium by means of a
settlement agreement that was executed by Cross-Sound, the CDEP, the DPUC, Long
Island Power Authority, Long Island Lighting Company d/b/a LIPA (LILCO/LIPA),
and Northeast Utilities Service Company, as agent for The Connecticut Light and
Power Company (CL&P). This allowed immediate commercial operation of the cable.
Continuation of commercial operation is contingent upon the satisfaction of
certain conditions in the settlement agreement which include: (1) Cross-Sound
coming into compliance with permit conditions as directed by the CDEP; (2)
LILCO/LIPA and CL&P reaching an agreement by October 1, 2004 for the replacement
of an existing transmission line (the "1385 line" which is otherwise unrelated
to the Cross-Sound cable) and implementing such replacement on a schedule
approved by the CDEP; and (3) Cross-Sound, CL&P and LILCO/LIPA committing a
collective amount of $6 million, of which Cross-Sound's commitment is $2
million, to a research and restoration fund for the Long Island Sound to be
administered jointly by the States of New York and Connecticut.
On June 25, 2004, Cross-Sound submitted a request for a certificate of
permission to the CDEP in which it sought permission to change its methods of
burying the cable so as to fully achieve the currently required burial depth.
The CDEP approved the request, and on June 28, 2004, the Cross-Sound cable began
transmitting power in accordance with the settlement agreement.
Cross-Sound is working to satisfy the provisions of the agreement for which it
is responsible. Specifically, in October 2004 remediation work began in the
federal navigation channel in New Haven Harbor to bring the Cross-Sound cable
into compliance with the permit conditions set forth by the CDEP. The
remediation required consists of achieving the originally required burial depth
in those areas deemed as "soft spots," meaning the obstructions which originally
prevented achievement of such depth can generally be removed without the use of
techniques such as blasting. The cost of this remediation is currently estimated
at $1.5 million and is within the estimated final cost of the project. The
Cross-Sound cable is being brought off-line for approximately 12 hours each day,
to allow for remediation activities. The remediation work is expected to be
completed during the fourth quarter of 2004. The permit conditions do not
require the original burial depth to be achieved in those areas where rock ledge
obstruction prevented meeting the original burial depth until such time, if any,
that the United States Army Corp of Engineers is authorized to deepen the
federal navigation channel in the New Haven Harbor.
During the third quarter of 2004, CL&P and LILCO/LIPA reached the necessary
agreements, as required by the settlement agreement, for the replacement of the
existing 1385 line. Such agreements included a schedule for implementation which
has been approved by the CDEP.
In late September 2004, Cross-Sound funded its $2 million commitment to the
research and restoration fund for the Long Island Sound, as required by the
settlement agreement. CL&P has also funded its $2 million commitment, and
LILCO/LIPA has received approval from its Board of Trustees to fund its $2
million commitment.
UCI's 25% share of the actual project cost for the Cross-Sound cable was $34.3
million as of September 30, 2004. UCI has provided an equity contribution of
$10 million to Cross-Sound and UIL Holdings loaned $24.6 million, including
capitalized interest, 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).
Upon satisfaction of all provisions of the settlement agreement for which
Cross-Sound is responsible, the loan from UIL Holdings is expected to be
refinanced with external project financing. UCI will be responsible for 25% of
any additional cost of project completion over the estimated amount.
In connection with the settlement agreement, the existing contract Cross-Sound
has with the Long Island Power Authority for the entire capacity of the
transmission line is being reviewed and negotiations are taking place to
increase the overall term of the agreement from 20 years to 28 years by means
of adding an initial three year period at the current reduced rates, and an
additional five years to the end of the contract term, at full rates.
- 42 -
UCI's investments in the venture funds in which it holds equity interests were
viewed as an opportunity to earn reasonable returns and promote local economic
development. Due to the nature of its investments and market conditions, the
value of the Zero Stage VI fund has decreased substantially since the end of
2000. In fact, the liabilities of the fund are currently in excess of the market
value of its assets, and as such, UCI wrote down its investment in Zero Stage VI
to zero in the first quarter of 2004. In July 2004, UCI funded its remaining
capital commitment of $0.5 million to Zero Stage VII. There has been no material
change since December 31, 2003 in the value of the Ironbridge Mezzanine fund,
which is the other venture fund in which UCI holds an equity interest.
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, Connecticut energy 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 $77.7 million carrying value of UBE's investment in BE. UBE will
continue to monitor its investment in BE for recoverability, as changes in the
projections considered could have a negative impact on the carrying value of the
investment in the future.
Although routine maintenance is performed on the plant on a regular basis, from
time to time the plant must be brought offline for a major overhaul. The next
major overhaul is planned for 2005. Under an existing maintenance contract, the
plant has begun incurring some of these costs, and they are being accrued until
the outage occurs. BE has sufficient cash to fund these costs in 2004, however,
based on the current 2004 earnings estimate, BE will require additional capital
from the owners to cover the additional costs in 2005 when the outage occurs.
Based on current projections, UBE's additional capital requirements could be as
great as $7 million. Under the terms of the BE LLC agreement, if UBE does not
meet a capital call the sole recourse of the other owner, is the right, but not
the obligation, to fund the capital for UBE and to adjust each entity's
ownership interest in BE accordingly.
The ICAP market is designed to offer an incentive to developers to build
adequate generating capacity. BE receives ICAP revenues from energy marketers
based on the plant's installed capacity. The plant began initial operation with
a multi-year contract for ICAP. Since the contract ended in 2002, BE has only
been able to sell its ICAP in the forward month market at a much lower price,
reducing ICAP revenues by approximately 75% to 85%. The FERC has directed ISO-NE
to develop a Locational ICAP Market, with the intent to provide higher capacity
payments to generators within designated congestion areas. The FERC has delayed
the decision on Locational ICAP until January 2006 to allow more time to study
the issue. The full impact that Locational ICAP will have is not known at this
time.
The majority owner of BE, an affiliate of Duke Energy, has a 60% interest in
Duke Energy Trading and Marketing (DETM) which is a joint venture with Exxon
Mobil Corporation. BE has an agreement through August 2018 with DETM that gives
DETM the right to deliver natural gas to the facility and market all the
electricity generated by the facility. DETM reimburses BE under a formula based
on the difference between gas costs and electric prices. In early January 2004,
Duke Energy announced it plans to wind down DETM as part of a plan to
restructure its merchant energy business. UBE is currently in negotiations with
Duke Energy and DETM to restructure the DETM agreement to more accurately
reflect the current energy market. UBE does not anticipate at this time that
these plans, or the potential changes to the DETM agreement, will have a
negative impact on the operations of BE.
As the majority owner of BE, Duke Energy's affiliate is responsible for the
daily operations and administration of the plant, including all accounting and
financial reporting functions of BE. As a minority interest owner, UBE relies on
the financial reports provided by BE to record its appropriate share of income
or losses of BE. During 2004, results at BE have been negatively impacted by a
number of accounting adjustments related to prior years. The impact of these
- 43 -
adjustments on UBE's results for the nine months ended September 30, 2004 was
$0.4 million. In the third quarter of 2004 Duke Energy paid UBE $0.3 million to
reimburse UBE for the impact of an adjustment related to property taxes which
dated back to a period in which UBE was only a 4% owner of BE. The completion of
the annual independent audit of BE's 2003 financial statements is still pending
and there could be additional adjustments as a result of the audit.
AMERICAN PAYMENT SYSTEMS, INC.
As a result of the completion of the sale of APS to CheckFree on June 22, 2004,
UIL Holdings is no longer subject to the operating risk factors that affected
the financial results of APS in prior reporting periods. UIL Holdings' exposure
regarding APS is now governed by the indemnity provisions of the Stock Purchase
Agreement pursuant to which APS was sold to CheckFree. Those provisions require
UIL Holdings to indemnify CheckFree for breaches of the representations and
warranties contained in the agreement (subject to certain limitations), as well
as certain specified matters relating to the operations of APS prior to the
sale.
LIQUIDITY AND CAPITAL RESOURCES
There have been no material changes in UIL Holdings' capital resources or
capital requirements from those reported in UIL Holdings' Annual Report on Form
10-K for the fiscal year ended December 31, 2003.
Moody's Investors Service (Moody's) downgraded UIL Holdings' Issuer Rating from
Baa2 to Baa3 in September 2004. Moody's also downgraded UI's Issuer Rating and
senior unsecured debt rating from Baa1 to Baa2. In the first quarter of 2004,
Moody's had downgraded UIL Holdings' Issuer Rating from Baa1 to Baa2 and had
also downgraded UI's Issuer Rating and senior unsecured debt rating from A3 to
Baa1. Moody's has stated that the outlook for the ratings of both UIL Holdings
and UI is stable. The financial impact of this action is minimal. Other than the
re-pricing of $27.5 million of pollution control revenue bonds on February 1,
2005, neither UIL Holdings nor UI expect to issue or refinance any long-term
debt prior to December 2007.
The amount of UIL Holdings' quarterly per share cash dividend in 2004 is
expected to be equal to the cash dividend of $0.72 per share paid in each
quarter of 2003. UIL Corporate will continue to be entirely dependent on
dividends from its subsidiaries and from external borrowings to provide the cash
necessary for debt service, to pay administrative costs, to meet other
contractual obligations that cannot be met by the non-utility subsidiaries, and
to pay common stock dividends to UIL Holdings' shareholders. As UIL Corporate's
sources of cash are limited to dividends from its subsidiaries and external
borrowings, the ability to maintain future cash dividends at the level currently
paid to shareholders will be dependent upon 1) growth in the earnings of UI, 2)
the ability of Xcelecom and UIL Holdings' minority interest investments to begin
providing dividends to UIL Corporate, or 3) a reduction in the number of shares
outstanding. In order to achieve long-term growth in earnings, UI will need to
increase its rate base through capital investments, as without substantial
additions to the rate base, UI's earnings would gradually decline over time due
to the amortization of the CTA rate base. UIL Holdings' current strategy for
Xcelecom and the minority interest investments calls for those entities to be
largely cash self-sufficient going forward. However, the ability of these
entities, particularly the minority interest investments, to improve earnings,
cash flow, and their ability to dividend cash to UIL Corporate without causing
harm to their own operations or financial conditions cannot be assured. UIL
Holdings does not expect to receive dividends from Xcelecom or its minority
interest investments in 2004. See the "Major Influences on Financial Condition"
section of this Item 2 for more information.
UIL Holdings and its subsidiaries will continue their efforts to improve the
earnings and cash flow position of UIL Holdings, to strengthen its financial
position, and improve its dividend to earnings payout ratio.
All capital requirements that exceed available cash will have to be provided by
external financing. Although there is no commitment to provide such financing
from any source of funds, other than a $100 million revolving credit agreement
that UIL Holdings has with a group of banks, and a $30 million revolving credit
agreement that Xcelecom has with two banks, future external financing needs are
expected to be satisfied by the issuance of additional short-term and long-term
debt. The continued availability of these methods of financing will be dependent
on many factors, including conditions in the securities markets, economic
- 44 -
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 September 30, 2004, UIL Holdings had $34 million of unrestricted cash and
temporary cash investments. This represents an increase of $5.4 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 54.8
Net cash provided by (used in) investing activities
of continuing operations:
- Acquisition of Electric System Work Center facility (16.2)
- Cash invested in plant (21.5)
- Changes in restricted cash (1) 1.2
- Deferred payments in prior acquisitions (2.1)
- Loan to Cross-Sound Cable Project (0.6)
--------------
(39.2)
Net cash (used in) financing activities of continuing operations:
- Financing activities, excluding dividend payments (59.9)
- Dividend payments (31.0)
--------------
(90.9)
Net cash provided by discontinued operations 80.7
Net Change in Cash 5.4
--------------
Balance, September 30, 2004 $34.0
==============
(1) As of September 30, 2004, UIL Holdings had $0.2 million in restricted cash
related to future debt payments of Xcelecom.
The net change in UIL Holdings' unrestricted cash position at September 30,
2004, as compared to December 31, 2003, was due to a combination of cash
provided by operating activities of continuing operations, as well as the
proceeds provided by discontinued operations due to the completion of the sale
of APS in June 2004. Cash provided by operating activities of continuing
operations was driven mainly by the utility business and was sufficient to cover
the payment of UIL Holdings' quarterly dividends amounting to $31 million,
funding of $18.6 million to the UI pension and post-retirement plans, and
various investing activities, including UI's purchase of the Electric System
Work Center facility for $16.2 million in January 2004. Cash provided by
discontinued operations was primarily due to $112 million of proceeds received
for the sale of APS, which was utilized to payoff $65 million in short-term
borrowings, to pay for $14 million of costs associated with the sale of APS and
to fund the $23.8 million portion of the estimated income tax payments made in
September 2004 related to the gain on the sale of APS. In the event that UIL
Holdings were to incur capital losses during the next three years that could not
be offset with current period capital gains, such losses could be carried back
to 2004 for income tax purposes and applied against the APS capital gain. This
scenario would result in UIL Holdings receiving a refund of 2004 income taxes
paid. Based on the level of the current cash balance and projected cash
requirements, UIL Holdings' projected short-term borrowings (if any) are not
expected to be significant through the end of 2004.
CONTRACTUAL AND CONTINGENT OBLIGATIONS
At September 30, 2004 there was no material change in UIL Holdings' and its
subsidiaries contractual and contingent obligations from those reported in UIL
Holdings' Annual Report on Form 10-K for the fiscal year ended December 31,
2003.
- 45 -
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 September 30, 2004, there have been no material changes to any
of the Critical Accounting Policies contained therein, with the exception of
UI's calculation of unbilled revenue as described below:
UNBILLED REVENUE
At the end of each accounting period, UI accrues an estimated amount for
services rendered but not billed. Through the end of 2003, the calculation was
based upon UI's system requirements or kilowatt-hour usage less distribution
losses and UI use for a given period, reduced by kilowatt-hours already billed
to customers (requirements method). Beginning in the first quarter of 2004, UI
began utilizing a new customer accounting software package integrated with the
network meter reading system to estimate unbilled revenue (installation method).
This allows for the calculation of unbilled revenue on a customer-by-customer
basis, utilizing actual daily meter readings at the end of each month to
calculate consumption and pricing for each customer. Customers aggregating to
approximately 70% of utility retail kilowatt-hour consumption are currently part
of the network meter reading system. For those customers still requiring manual
meter readings, consumption is estimated based upon historical usage and actual
pricing for each customer.
This implementation of the new system addressed above provides a more precise
method of calculating estimated unbilled revenue at the customer level in that
the system can consider changes to rates, prices, devices, registers, meter
reading results and other installation specific data. It also mitigates the
potential variability inherent in the requirements method from estimating
distribution losses. The installation method remains sensitive to numerous
factors, any of which can have a significant impact on the estimate of unbilled
revenue, such as estimated consumption for those customers not a part of the
network meter reading system, changes in or problems with metering, seasonality,
price changes and billing adjustments. Conversion to the new system resulted in
a change in estimate that yielded a non-recurring increase to unbilled revenue
of approximately $2.6 million and consolidated earnings per share of
approximately $0.07 during the first quarter of 2004.
- 46 -
RESULTS OF OPERATIONS
THIRD QUARTER 2004 VS. THIRD QUARTER 2003
- -----------------------------------------
UIL HOLDINGS CORPORATION RESULTS OF OPERATIONS: THIRD QUARTER 2004 VS.
- -----------------------------------------------------------------------
THIRD QUARTER 2003
- ------------------
UIL Holdings' earnings from continuing operations for the third quarter of 2004
decreased by $0.3 million, or $0.03 per share, compared to the third quarter of
2003. Net income from discontinued operations, decreased by $0.4 million, or
$0.03 per share, in the third quarter of 2004 as compared to the same period of
the prior year due to the the sale of APS in June 2004. Total earnings for the
third quarter of 2004, including discontinued operations, decreased by $0.7
million, or $0.06 per share, from the same period of 2003.
Improved performance at Xcelecom and UCI was offset by poor performance at UBE.
Results at UI benefited from an increase in kilowatt-hour consumption, excluding
the effects of weather, as compared to the same period of 2003, but was offset
by the impact of the cooler summer in 2004 as compared to 2003 and higher
uncollectible customer accounts.
The table below represents a comparison of UIL Holdings' Net Income and Earnings
per Share (EPS) for the third quarter of 2004 and the third quarter of 2003.
2004 more (less) than 2003
----------------------------
Quarter Ended Quarter Ended
September 30, September 30,
2004 2003 Amount Percent
- ------------------------------------------------- ------------------ ------------------ ---------------- ------------
NET INCOME (IN MILLIONS EXCEPT PERCENTS AND PER
SHARE AMOUNTS)
UI $17.6 $17.8 $(0.2) (1)%
Non-Utility (1.3) (1.2) (0.1) (8)%
------ ------ ------
TOTAL NET INCOME FROM CONTINUING
OPERATIONS $16.3 $16.6 $(0.3) (2)%
Discontinued Operations 0.0 0.4 (0.4) (100)%
------ ------ ------
TOTAL NET INCOME $16.3 $17.0 $(0.7) (4)%
====== ====== ======
EPS
UI $1.23 $1.25 $(0.02) (2)%
Non-Utility (0.10) (0.09) (0.01) (11)%
------ ------ ------
TOTAL EPS FROM CONTINUING
OPERATIONS - BASIC $1.13 $1.16 $(0.03) (3)%
Discontinued Operations 0.00 0.03 (0.03) (100)%
------ ------ ------
TOTAL EPS - BASIC $1.13 $1.19 $(0.06) (5)%
====== ====== ======
TOTAL EPS - DILUTED (NOTE A) $1.13 $1.19 $(0.06) (5)%
====== ====== ======
Note A: Reflecting the effect of unexercised dilutive stock options.
- 47 -
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 third quarter of 2004 and the third 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) SEP. 30, 2004 SEP. 30, 2003 THAN 2003
- ------------- ------------- ------------- ---------
OPERATING REVENUES
UI from operations $231.5 $194.9 $36.6
Xcelecom 92.0 74.8 17.2
Minority Interest Investment & Other (0.1) 0.0 (0.1)
------ ------ ------
TOTAL OPERATING REVENUES $323.4 $269.7 $53.7
====== ====== ======
FUEL AND ENERGY EXPENSES - UI $119.7 $77.4 $42.3
====== ====== ======
OPERATION AND MAINTENANCE EXPENSES
UI $48.1 $48.5 $(0.4)
Xcelecom 89.3 73.3 16.0
Minority Interest Investment & Other 1.2 0.8 0.4
------ ------ ------
TOTAL OPERATION AND MAINTENANCE EXPENSES $138.6 $122.6 $16.0
====== ====== ======
DEPRECIATION AND AMORTIZATION EXPENSES
UI $7.2 $7.3 $(0.1)
Xcelecom 1.0 0.9 0.1
------ ------ ------
Subtotal depreciation 8.2 8.2 0.0
Amortization of regulatory assets (UI) 9.7 13.6 (3.9)
Amortization Xcelecom 0.3 0.3 0.0
------ ------ ------
TOTAL DEPRECIATION AND AMORTIZATION EXPENSES $18.2 $22.1 $(3.9)
====== ====== ======
TAXES - OTHER THAN INCOME TAXES
UI - State gross earnings tax $7.4 $7.8 $(0.4)
UI - other 3.7 3.1 0.6
Xcelecom 0.4 0.4 0.0
------ ------ ------
TOTAL TAXES - OTHER THAN INCOME TAXES $11.5 $11.3 $0.2
====== ====== ======
- 48 -
QUARTER ENDED QUARTER ENDED 2004 MORE (LESS)
(IN MILLIONS) SEP. 30, 2004 SEP. 30, 2003 THAN 2003
- ------------- ------------- ------------- ---------
OTHER INCOME (DEDUCTIONS)
UI $1.0 $1.1 $(0.1)
Xcelecom 0.1 0.1 0.0
Minority Interest Investment & Other 0.0 0.8 (0.8)
------ ------ ------
TOTAL OTHER INCOME (DEDUCTIONS) $1.1 $2.0 $(0.9)
====== ====== ======
INTEREST CHARGES
UI $2.3 $5.6 $(3.3)
UI - Amortization: debt expense, redemption premiums 0.4 0.3 0.1
Xcelecom 0.1 0.1 0.0
Minority Interest Investment & Other 1.8 1.9 (0.1)
------ ------ ------
TOTAL INTEREST CHARGES $4.6 $7.9 $(3.3)
====== ====== ======
INCOME TAXES
UI $16.4 $14.6 $1.8
Xcelecom 0.4 0.0 0.4
Minority Interest Investment & Other (1.1) (0.8) (0.3)
------ ------ ------
TOTAL INCOME TAXES $15.7 $13.8 $1.9
====== ====== ======
NET INCOME
UI $17.6 $17.8 $(0.2)
Xcelecom 0.6 (0.1) 0.7
Minority Interest Investment & Other (1.9) (1.1) (0.8)
------ ------ ------
SUBTOTAL NET INCOME FROM CONTINUING OPERATIONS 16.3 16.6 (0.3)
Discontinued Operations 0.0 0.4 (0.4)
------ ------ ------
TOTAL NET INCOME $16.3 $17.0 $(0.7)
====== ====== ======
- 49 -
THE UNITED ILLUMINATING COMPANY RESULTS OF OPERATIONS: THIRD QUARTER OF 2004
- -----------------------------------------------------------------------------
VS. THIRD QUARTER OF 2003
- -------------------------
2004 more (less) than 2003
----------------------------
Quarter Ended Quarter Ended
September 30, September 30,
2004 2003 Amount Percent
- -------------------------------------------------- ----------------- ------------------ ---------------- ------------
EPS FROM OPERATIONS
Total UI - basic $1.23 $1.25 $(0.02) (2)%
====== ====== ======
Total UI - diluted (Note A) $1.23 $1.25 $(0.02) (2)%
====== ====== ======
RETAIL SALES* 1,621 1,617 4 -
WEATHER IMPACT* (NOTE B) (11) (50) 39 3%
- -------------------------------------------------- ----------------- ------------------ ---------------- ------------
RETAIL SALES - NORMALIZED* 1,610 1,567 43 3%
- -------------------------------------------------- ----------------- ------------------ ---------------- ------------
* Millions of kilowatt-hours
Note A: Reflecting the effect of unexercised dilutive stock options.
Note B: Percentage change reflects the impact to total retail sales.
UI's net income was $17.6 million, or $1.23 per share, in the third quarter of
2004, compared to $17.8 million, or $1.25 per share, in the third quarter of
2003. UI's third quarter results were positively impacted by economic growth and
unanticipated increased kilowatt-hour volume consumption, excluding the effects
of weather, as compared to the same period of 2003. UI also benefited from lower
interest charges in the third quarter of 2004, as compared to the third quarter
of 2003, due to the refinancing of certain debt issues late in 2003 at lower
interest rates and the reversal of certain reserves following the resolution of
prior year Internal Revenue Service audits. The favorable impact of economic
growth during the quarter was mitigated by the relatively cool summer in 2004
compared to 2003, largely offsetting the kilowatt-hour growth compared to the
same period in 2003.
Overall UI's revenue increased by $36.6 million, from $194.9 million in the
third quarter of 2003, to $231.5 million in the third quarter of 2004. Retail
revenue increased $29.2 million due mainly to the impact of an average 9.9%
price increase effective January 1, 2004 resulting from the transitional
standard offer final decision (see "Major Influences on Financial Condition -
The United Illuminating Company - Regulation," for further discussion). The
price increase allowed UI to collect certain federally mandated charges from
customers to offset higher costs of procuring energy (see fuel and energy
expense discussion below). Economic growth in the third quarter of 2004 resulted
in increased kilowatt-hour volume of approximately 3% as compared to the prior
year, although this increase was largely offset by the effects of the relatively
cool summer in 2004, as compared to 2003. Wholesale revenue decreased by $0.3
million, as compared to the third quarter of 2003. Other revenues increased $7.7
million as compared to the third quarter of 2003. This was primarily due to a
reclassification of $8.2 million from retail to other revenue representing net
activity reducing the GSC "bank" for the year as such revenues do not relate to
actual retail sales of kilowatt-hours during the period and are more properly
reported as other.
Retail fuel and energy expense increased by $42.0 million in the third quarter
of 2004, compared to the same period of 2003. The increase was primarily due to
increased supplier costs for 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 third quarter of 2004 increased by $0.3 million
compared to the same period of 2003.
UI's operation and maintenance (O&M) expenses decreased by $0.4 million, from
$48.5 million in the third quarter of 2003 to $48.1 million in the third quarter
of 2004. The net decrease was primarily attributable to lower pension expense in
the third quarter of 2004 as compared to the same period of 2003, as UI
contributed $45 million to the qualified plan at the end of 2003 and received
the favorable amortization of last year's actual asset performance above
assumed. This was partially offset by higher uncollectible customer accounts and
other employee benefit expenses. The increase in uncollectible customer accounts
has been largely driven by higher customer bills due to kilowatt-hour
consumption and rates, along with the difficulties many customers are facing in
dealing with higher energy costs.
- 50 -
Amortization of regulatory assets decreased by $3.9 million in the third 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.
Interest charges decreased by $3.2 million in the third 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 and the reversal of approximately
$1.7 million of reserves due to the resolution of prior year Internal Revenue
Service audits.
Other income was negatively impacted by the write-off of a net operating loss
receivable from the State of New Hampshire of approximately $0.6 million in the
third quarter of 2004.
NON-UTILITY RESULTS OF OPERATIONS: THIRD QUARTER 2004 VS. THIRD QUARTER 2003
- -----------------------------------------------------------------------------
2004 more (less) than 2003
---------------------------
Quarter Ended Quarter Ended
September 30, September 30,
2004 2003 Amount Percent
- ------------------------------------------------------ ------------------- ------------------ --------------- -----------
EPS
Operating Business
Xcelecom $0.04 $(0.01) $0.05 500%
Minority Interest Investments
UBE (0.02) 0.04 (0.06) (150)%
UCI 0.00 (0.03) 0.03 100%
------ ------ ------
Subtotal Minority Interest
Investments (0.02) 0.01 (0.03) (300)%
UIL Corporate (Note A) (0.12) (0.09) (0.03) (33)%
------ ------ ------
TOTAL NON-UTILITY EPS FROM CONTINUING
OPERATIONS (0.10) (0.09) (0.01) (11)%
Discontinued Operations 0.00 0.03 (0.03) (100)%
------ ------ ------
TOTAL NON-UTILITY EPS - BASIC $(0.10) $(0.06) $(0.04) (67)%
====== ====== ======
TOTAL NON-UTILITY EPS - DILUTED (NOTE B) $(0.10) $(0.06) $(0.04) (67)%
====== ====== ======
- ------------------------------------------------------ ------------------- ------------------ --------------- -----------
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 $1.3 million, or
$0.10 per share, in the third quarter of 2004, a decrease of $0.1 million, or
$0.01 per share, compared to the same period of 2003. The improved results at
Xcelecom were attributable to performance of the electrical contracting
business. Net income from discontinued operations, decreased by $0.4 million, or
$0.03 per share, in the third quarter of 2004 from the third quarter 2003, as
APS was sold in June 2004.
Operating revenue for the non-utility businesses increased by $17.1 million, or
23% compared to the third quarter of 2003. The increase in revenues was
primarily from Xcelecom. Third quarter 2004 operating expenses for the
non-utility businesses increased $16.5 million, or 22% from the same period of
- 51 -
2003, as expenses at Xcelecom rose due to the increase in business. Other income
of $0.1 million in the third quarter of 2004 was $0.8 million, or 89% lower than
the third quarter of 2003, as the favorable impact of income at UCI from
Cross-Sound was offset by poor results at UBE due to the effect of high natural
gas prices on the results of BE.
The results of each of the non-utility subsidiaries for the third quarter of
2004 and the third 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.
NON-UTILITY BUSINESS
XCELECOM, INC.
Xcelecom reported net income of $0.6 million, or $0.04 per share, in the third
quarter of 2004, compared to a loss of $0.1 million, or $0.01 per share in the
third quarter of 2003. The improvement in earnings from prior year was mainly
due to an increase in sales among all regions of the electrical contracting
business of $19 million. While the majority of Xcelecom's operating entities
have been profitable, some operating entities are not meeting profit targets.
Xcelecom has been able to reduce administrative costs by enhancing operating
efficiencies. These increases were partially offset by lagging performance in
Xcelecom's systems integration business.
Xcelecom's backlog of work to be completed as of September 30, 2004 amounted to
$215.5 million, an increase of $87.7 million, or 69%, from the same period of
2003. While backlog has grown significantly, Xcelecom continues to experience
pressure on gross margin. Additionally, the composition of this backlog is
weighted towards larger projects, which have historically produced lower margins
than smaller projects. On a project size basis, 17% of the backlog is
attributable to projects with values of $0.5 million or less, 57% is
attributable to projects with values between $0.5 million and $5 million, and
26% is attributable to projects with values in excess of $5 million. On a
regional basis, 78% of this backlog is attributable to the Northeast, with the
remaining 22% attributable to the mid-Atlantic and Southeast regions.
MINORITY INTEREST INVESTMENTS
UNITED BRIDGEPORT ENERGY, INC.
UBE owns a 33 1/3% interest in Bridgeport Energy, LLC (BE). UBE lost $0.3
million, or $0.02 per share, in the third quarter of 2004, compared to earnings
of $0.6 million, or $0.04 per share, in the third quarter of 2003. UBE results
continue to be hampered by high natural gas prices and low energy prices in
Connecticut, which continue to depress both margins and sales levels at BE. The
relatively cooler summer in 2004, as compared to 2003, also had a negative
impact on UBE's results for the third quarter of 2004. These factors were
partially offset by the elimination of interest expenses in 2004 as a result of
the restructuring of UIL Holdings' intercompany loan to UBE to 100% equity
beginning in 2004. The improvements recognized at UBE related to this
restructuring had no effect on overall UIL Holdings' results, as all
intercompany transactions are eliminated in consolidation.
UNITED CAPITAL INVESTMENTS, INC.
UCI broke even in the third quarter of 2004, compared to a loss of $0.4 million,
or $0.03 per share, in the third quarter of 2003. The improvement from prior
year was mainly due to income from Cross-Sound of $0.2 million, after-tax, or
$0.01 per share, and lower valuation losses of other minority interest
investments. UCI received an ordinary course of business distribution of $0.1
from Zero Stage VII in the third quarter of 2004.
- 52 -
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 $0.12 per share, in
the third quarter of 2004, compared to $1.3 million, after-tax, or $0.09 per
share, in 2003. The increased costs were mainly due to administrative expenses
such as stock option expense and costs associated with complying with Sarbanes
Oxley requirements. Unallocated costs at UIL Corporate were partially offset by
interest income earned on the loan to Cross-Sound totaling $0.1 million
after-tax, or $0.01 per share, for both the quarters ended September 30, 2004
and 2003, respectively. See the "Major Influences on Financial Condition -
United Capital Investments" section of this Item 2 for more information
regarding the loan to Cross-Sound.
DISCONTINUED OPERATIONS
On June 22, 2004, UIL completed the sale of APS to CheckFree, pursuant to the
purchase agreement entered into between the parties on December 16, 2003. APS,
and its 51% ownership interest in CellCards of Illinois, LLC (CCI), were
classified as discontinued operations in the fourth quarter of 2003. On February
13, 2004, CCI was sold to an independent third party for book value, excluding
transaction costs.
Post-closing review procedures related to the sale of APS were completed during
the third quarter of 2004 and the resulting adjustments net to an insignificant
increase in the gain on the sale of APS. Net income from discontinued operations
for the second quarter of 2003 was $0.4 million, or $0.03 per share.
- 53 -
FIRST NINE MONTHS 2004 VS. FIRST NINE MONTHS 2003
- -------------------------------------------------
UIL HOLDINGS CORPORATION RESULTS OF OPERATIONS: FIRST NINE MONTHS 2004
- -----------------------------------------------------------------------
VS. FIRST NINE MONTHS 2003
- --------------------------
UIL Holdings' earnings from continuing operations for the first nine months of
2004 increased by $5.4 million, or $0.35 per share, compared to the first nine
months of 2003. Net income from discontinued operations, including the gain on
the sale of APS, increased by $50.3 million, or $3.51 per share, in the first
nine months of 2004 compared to the net loss of $0.5 million, or $0.04 per
share, in the first nine months 2003. Total earnings for the first nine months
of 2004, including discontinued operations, increased by $55.7 million, or $3.86
per share, from the same period of 2003.
The increase in earnings from continuing operations was mainly due to
non-recurring gains at UI related to a change in accounting estimate adjustment
to unbilled revenues, a settlement by ISO-NE related to a review of the
allocation of New England Power Pool transmission revenues to member companies,
the resolution of tax and other post-closing issues related to UI's sale of
Seabrook Station, and the impact of final decisions by the DPUC regarding the
disposition of proceeds from UI's investment in nuclear generating facilities.
Results at UI also benefited from lower interest charges, the DPUC's decision
allowing partial recovery of increased pension and postretirement benefits
expenses from February 18, 2004 through June 24, 2004, and an increase in
kilowatt-hour consumption as compared to the same period of 2003. Improved
results from Xcelecom's electrical contracting business also contributed to the
increase in earnings from the first nine months of 2003.
The table below represents a comparison of UIL Holdings' Net Income and Earnings
per Share (EPS) for the first nine months of 2004 and the first nine months of
2003.
2004 more (less) than 2003
-----------------------------
Nine Months Nine Months
Ended Ended
September 30, September 30,
2004 2003 Amount Percent
- ------------------------------------------------- ------------------ ------------------ ---------------- ------------
NET INCOME (IN MILLIONS EXCEPT PERCENTS AND PER
SHARE AMOUNTS)
UI $39.5 $34.4 $5.1 15%
Non-Utility (7.1) (7.4) 0.3 4%
------ ------ ------
TOTAL NET INCOME FROM CONTINUING
OPERATIONS $32.4 $27.0 $5.4 20%
Discontinued Operations 49.8 (0.5) 50.3 10,060%
------ ------ ------
TOTAL NET INCOME $82.2 $26.5 $55.7 210%
====== ====== ======
EPS
UI $2.75 $2.41 $0.34 14%
Non-Utility (0.50) (0.51) 0.01 2%
------ ------ ------
TOTAL EPS FROM CONTINUING
OPERATIONS - BASIC $2.25 $1.90 $0.35 18%
Discontinued Operations 3.47 (0.04) 3.51 8,775%
------ ------ ------
TOTAL EPS - BASIC $5.72 $1.86 $3.86 208%
====== ====== ======
TOTAL EPS - DILUTED (NOTE A) $5.70 $1.86 $3.84 206%
====== ====== ======
Note A: Reflecting the effect of unexercised dilutive stock options. Such
dilution does not impact the earnings from continuing operations, but dilutes
the 2004 earnings from discontinued operations by $0.02 per share.
- 54 -
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 nine months of 2004 and the first nine months of
2003. Significant variances are explained in the discussion and analysis of
individual subsidiary results that follow.
NINE MONTHS NINE MONTHS 2004 MORE (LESS)
ENDED ENDED
(IN MILLIONS) SEP. 30, 2004 SEP. 30, 2003 THAN 2003
- ------------- ------------- ------------- ---------
OPERATING REVENUES
UI from operations $588.9 $516.3 $72.6
Xcelecom 244.7 218.2 26.5
Minority Interest Investment & Other 0.0 0.1 (0.1)
------ ------ ------
TOTAL OPERATING REVENUES $833.6 $734.6 $99.0
====== ====== ======
FUEL AND ENERGY EXPENSES - UI $289.0 $206.2 $82.8
====== ====== ======
OPERATION AND MAINTENANCE EXPENSES
UI $142.7 $135.8 $6.9
Xcelecom 240.0 215.6 24.4
Minority Interest Investment & Other 3.7 2.7 1.0
------ ------ ------
TOTAL OPERATION AND MAINTENANCE EXPENSES $386.4 $354.1 $32.3
====== ====== ======
DEPRECIATION AND AMORTIZATION EXPENSES
UI $22.0 $21.1 $0.9
Xcelecom 2.7 2.6 0.1
------ ------ ------
Subtotal depreciation 24.7 23.7 1.0
Amortization of regulatory assets (UI) 26.2 45.5 (19.3)
Amortization Xcelecom 0.9 1.0 (0.1)
------ ------ ------
TOTAL DEPRECIATION AND AMORTIZATION EXPENSES $51.8 $70.2 $(18.4)
====== ====== ======
TAXES - OTHER THAN INCOME TAXES
UI - State gross earnings tax $19.6 $20.3 $(0.7)
UI - other 11.1 10.5 0.6
Xcelecom 1.5 1.3 0.2
------ ------ ------
TOTAL TAXES - OTHER THAN INCOME TAXES $32.2 $32.1 $0.1
====== ====== ======
- 55 -
NINE MONTHS NINE MONTHS
ENDED ENDED 2004 MORE (LESS)
(IN MILLIONS) SEP. 30, 2004 SEP. 30, 2003 THAN 2003
- ------------- ------------- ------------- ---------
OTHER INCOME (DEDUCTIONS)
UI $7.1 $4.2 $2.9
Xcelecom 0.6 0.4 0.2
Minority Interest Investment & Other (3.8) (2.4) (1.4)
------ ------ ------
TOTAL OTHER INCOME (DEDUCTIONS) $3.9 $2.2 $1.7
====== ====== ======
INTEREST CHARGES
UI $10.2 $16.4 $(6.2)
UI - Amortization: debt expense, redemption premiums 1.1 0.6 0.5
Xcelecom 0.4 0.4 0.0
Minority Interest Investment & Other 5.1 4.8 0.3
------ ------ ------
TOTAL INTEREST CHARGES $16.8 $22.2 $(5.4)
====== ====== ======
INCOME TAXES
UI $34.6 $29.7 $4.9
Xcelecom (0.1) (0.8) 0.7
Minority Interest Investment & Other (5.6) (4.0) (1.6)
------ ------ ------
TOTAL INCOME TAXES $28.9 $24.9 $4.0
====== ====== ======
NET INCOME
UI $39.5 $34.4 $5.1
Xcelecom (0.1) (1.5) 1.4
Minority Interest Investment & Other (7.0) (5.9) (1.1)
------ ------ ------
SUBTOTAL NET INCOME FROM CONTINUING OPERATIONS 32.4 27.0 5.4
Discontinued Operations 49.8 (0.5) 50.3
------ ------ ------
TOTAL NET INCOME $82.2 $26.5 $55.7
====== ====== ======
- 56 -
THE UNITED ILLUMINATING COMPANY RESULTS OF OPERATIONS: FIRST NINE MONTHS OF
- ----------------------------------------------------------------------------
2004 VS. FIRST NINE MONTHS OF 2003
- ----------------------------------
2004 more (less) than 2003
-----------------------------
Nine Months Nine Months
Ended Ended
September 30, September 30,
2004 2003 Amount Percent
- -------------------------------------------------- ----------------- ------------------ ---------------- ------------
EPS FROM OPERATIONS
Total UI - basic $2.75 $2.41 $0.34 14%
====== ====== ======
Total UI - diluted (Note A) $2.75 $2.41 $0.34 14%
====== ====== ======
- -------------------------------------------------- ----------------- ------------------ ---------------- ------------
RETAIL SALES* 4,529 4,390 139 3%
UNBILLED ADJUSTMENT* (NOTE B) (46) - (46) (1)%
LEAP YEAR ADJUSTMENT* (NOTE C) (16) - (16) -
WEATHER IMPACT* (NOTE D) (13) (54) 41 1%
- -------------------------------------------------- ----------------- ------------------ ---------------- ------------
RETAIL SALES - NORMALIZED* 4,454 4,336 118 3%
- -------------------------------------------------- ----------------- ------------------ ---------------- ------------
* Millions of kilowatt-hours
Note A: Reflecting the effect of unexercised dilutive stock options.
Note B: 46 million kilowatt-hour non-recurring adjustment associated with a
change in accounting estimate to unbilled revenue recognized in the
first quarter of 2004. Percentage change reflects impact to total
retail sales.
Note C: 16 million kilowatt-hour adjustment to reflect the impact of leap year
in 2004. Percentage change reflects impact to total retail sales.
Note D: Percentage change reflects impact to total retail sales.
UI's net income was $39.5 million, or $2.75 per share, in the first nine months
of 2004, compared to $34.4 million, or $2.41 per share, in the first nine months
of 2003. The results for the first nine months of 2004 were improved as compared
to the same period in 2003 due to economic growth and an unanticipated increase
in kilowatt-hour volume consumption. As indicated above in connection with third
quarter results of operations, the benefits of this growth were mitigated by
milder weather in 2004 as compared to the same period in 2003. The results of
the first nine months of 2004 also benefited from various non-recurring gains
attributable to (1) a change in the accounting estimate for unbilled revenues
resulting from the implementation of a new integrated software package which
provides a more precise estimate of unbilled revenue, $0.07 per share, (2) a
settlement by ISO-NE related to a review of the allocation of New England Power
Pool transmission revenues to member companies, $0.09 per share, and (3) the
resolution of post-closing issues and DPUC decisions related to UI's sale of
Seabrook Station, $0.08 per share. UI also benefited from lower interest charges
for the first nine months of 2004 as compared to the first nine months of 2003,
due to the refinancing of certain debt issues late in 2003 at lower interest
rates and the reversal of reserves due to the resolution of prior year Internal
Revenue Service audits. These favorable variances were partially offset by
higher operating expenses and increases in uncollectible customer accounts over
the comparable period in 2003.
Overall, UI's revenue increased by $72.6 million, from $516.3 million in the
first nine months of 2003 to $588.9 million in the first nine months of 2004.
Retail revenue increased $63.7 million due mainly to an overall increase in
kilowatt-hour volume of 3%, along with the impact of an average 9.9% price
increase effective January 1, 2004 resulting from the transitional standard
offer final decision (see "Major Influences on Financial Condition - The United
Illuminating Company - Regulation," for further discussion). The price increase
allowed UI to collect certain federally mandated charges from customers to
offset higher costs of procuring energy (see fuel and energy expense discussion
below). Of the overall 3% increase in kilowatt-hour volume, approximately 1%, or
46 million kilowatt-hours, is attributable to the non-recurring adjustment
associated with a change in accounting estimate to unbilled revenue recognized
in the first quarter of 2004. The impact of weather as compared to the same
period of 2003 was minimal. Wholesale revenue decreased by $0.9 million, as
compared to the first nine months of 2003, due to lower market prices in the New
England wholesale market. Other revenues increased $9.8 million as compared to
the first nine months of 2003, primarily due to the settlement adjustment from
ISO-NE and the reclassification of $8.2 million from retail to other revenue
representing net activity reducing the GSC "bank" for the year.
- 57 -
Retail fuel and energy expense increased by $82.5 million in the first nine
months of 2004, compared to the same period of 2003. The increase was primarily
due to increased supplier costs providing transitional standard offer service.
UI received electricity to satisfy its transitional standard offer retail
customer service requirements through a fixed-price purchased power agreement.
These costs are recovered through the GSC portion of UI's unbundled retail
customer rates. UI's wholesale energy expense in the first nine months of 2004
increased by $0.3 million compared to the same period of 2003.
UI's operation and maintenance (O&M) expenses increased by $6.9 million, from
$135.8 million in the first nine months of 2003 to $142.7 million in the first
nine months of 2004. The increase was attributable to a variety of factors
including increases in labor, employee benefits, GSC procurement fees and bad
debt expenses, partially offset by lower pension expense. The increase in bad
debt expense has been largely driven by higher customer bills due to
kilowatt-hour consumption and rates, along with the difficulties many customers
are facing in dealing with higher energy costs.
Amortization of regulatory assets decreased by $19.3 million in the first nine
months of 2004 compared to the same period of 2003. The primary reason for the
reduction was due to a DPUC order in July 2003 requiring that the amortization
of CTA rate base utilizing excess GSC revenues be discontinued. Pursuant to the
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 $2.9 million in the first nine months of 2004,
compared to the first nine months of 2003, mainly due to the reduction of
reserves associated with UI's investment in Seabrook Station resulting from a
March 2004 DPUC decision and the resolution of tax and other post-closing issues
related to its sale.
Interest charges decreased by $5.7 million in the first nine months of 2004, as
compared to the same period of 2003, due to the refinancing of certain UI debt
issues late in 2003 at lower interest rates and the reversal of reserves due to
the resolution of prior year Internal Revenue Service audits.
- 58 -
NON-UTILITY RESULTS OF OPERATIONS: FIRST NINE MONTHS 2004 VS. FIRST
- --------------------------------------------------------------------
NINE MONTHS 2003
- ----------------
2004 more (less) than 2003
---------------------------
Nine Months Ended Nine Months Ended
September 30, 2004 September 30,
2003 Amount Percent
- ------------------------------------------------------ ------------------- ------------------ --------------- -----------
EPS
Operating Business
Xcelecom $(0.01) $(0.10) $0.09 90%
Minority Interest Investments
UBE (0.17) (0.11) (0.06) (55)%
UCI (0.03) (0.05) 0.02 40%
------ ------
Subtotal Minority Interest
Investments (0.20) (0.16) (0.04) (25)%
UIL Corporate (Note A) (0.29) (0.25) (0.04) (16)%
------ ------ ------
TOTAL NON-UTILITY EPS FROM CONTINUING
OPERATIONS (0.50) (0.51) 0.01 2%
Discontinued Operations 3.47 (0.04) 3.51 8,775%
------ ------ ------
TOTAL NON-UTILITY EPS - BASIC $2.97 $(0.55) $3.52 640%
====== ====== ======
TOTAL NON-UTILITY EPS - DILUTED (NOTE B) $2.95 $(0.55) $3.50 636%
====== ====== ======
- ------------------------------------------------------ ------------------- ------------------ --------------- -----------
Note A: Includes interest charges on intercompany debt and strategic and
administrative costs of the non-utility holding company.
Note B: Reflecting the effect of unexercised dilutive stock options. Such
dilution does not impact the earnings from continuing operations, but
dilutes the 2004 earnings from discontinued operations by $0.02 per
share.
The consolidated non-utility businesses reported a loss from continuing
operations, including unallocated holding company costs, of $7.1 million, or
$0.50 per share, in the first nine months of 2004, an improvement of $0.3
million, or $0.01 per share, compared to the same period of 2003. The improved
results at Xcelecom were attributable to the performance of the electrical
contracting business. Net income from discontinued operations for the first nine
months of 2004, including the $46.2 million after-tax gain on the sale of APS,
net of transaction costs, amounted to $49.8 million, or $3.47 per share,
compared to a loss of $0.5 million, or $0.04 per share, in the first nine months
of 2003.
Operating revenue for the non-utility businesses increased by $26.4 million, or
12% compared to the first nine months of 2003. The increase in revenues was
primarily from Xcelecom. Operating expenses in the first nine months of 2004 for
the non-utility businesses increased $25.6 million, or 11% from the same period
of 2003, as expenses at Xcelecom rose due to the increase in business. Other
deductions of $3.2 million in the first nine months of 2004 were $1.2 million,
or 60% higher than the first nine months of 2003, as the favorable impact of the
elimination of interest charges at UBE in 2004 was offset by the effect of high
natural gas prices on the results of BE.
The results of each of the non-utility subsidiaries for the first nine months of
2004 and the first nine months of 2003, as presented below, reflect the
allocation of debt costs from the parent based on a capital structure, including
an equity component, and an interest rate deemed appropriate for that type of
- 59 -
business. The capital structure for all of the non-utility subsidiaries is 100%
equity as of January 1, 2004. In 2003 the capital structure of UBE was 70% debt.
UIL Holdings absorbs interest charges on the equity portion of its investments
in its subsidiaries to the extent those investments are financed with debt. UIL
Holdings may incur other corporate level expenses necessary to manage its
investments from time to time.
The following is a detailed explanation of the variances for each of UIL
Holdings' non-utility businesses.
NON-UTILITY BUSINESS
XCELECOM, INC.
Xcelecom lost $0.1 million, or $0.01 per share, in the first nine months of
2004, compared to a loss of $1.5 million, or $0.10 per share in the first nine
months of 2003. The improvement in earnings from prior year was mainly due to
the absence of $0.08 per share on losses for two large projects incurred in the
prior year, partially offset by income in the prior year related to the
completion of a large contract. Activity in the Northeast, which had been
affected by a slow economic recovery earlier in the year, continues to improve.
See the "Results of Operations: Third Quarter of 2004 vs. Third Quarter of 2003
- - Xcelecom" section of Item 2 for discussion of Xcelecom's backlog as of
September 30, 2004.
MINORITY INTEREST INVESTMENTS
UNITED BRIDGEPORT ENERGY, INC.
UBE owns a 33 1/3% interest in Bridgeport Energy, LLC (BE). UBE lost $2.5
million, or $0.17 per share, in the first nine months of 2004, compared to a
loss of $1.6 million, or $0.11 per share, in the same period of 2003. UBE
results continue to be hampered by high natural gas prices and low energy prices
in Connecticut, which continue to depress both margins and sales levels at BE.
The relatively cooler summer in 2004, as compared to 2003, also had a negative
impact on UBE for the first nine months of 2004. Results for the first nine
months of 2004 have also been affected by approximately $0.4 million of pre-tax
accounting adjustments related to prior years. These factors were partially
offset by the elimination of interest expenses in 2004 as a result of the
restructuring of UIL Holdings' intercompany loan to UBE to 100% equity beginning
in 2004. The improvements recognized at UBE related to this restructuring had no
effect on overall UIL Holdings' results, as all intercompany transactions are
eliminated in consolidation.
Although energy and gas prices continue to hamper the results of BE, the plant
has been able to manage cash flow and has not required any capital contributions
from UBE through the first nine months of 2004.
UNITED CAPITAL INVESTMENTS, INC.
UCI lost $0.4 million, or $0.03 per share, in the first nine months of 2004,
compared to a loss of $0.6 million, or $0.05 per share in the first nine months
of 2003. The improvement in earnings was mainly due to lower valuation losses
from passive investments. For the first nine months of 2004, income from
Cross-Sound was break even, as results were affected by decreased revenues and
increased legal fees at Cross-Sound during the second quarter of 2004, resulting
from a May 7, 2004 order by the federal Department of Energy terminating the
Emergency Order under which the Cross-Sound cable had been operating. See the
"Major Influences on Financial Condition" section of this Item 2 for more
information.
Cross-Sound has not required additional capital funding from its owners for the
first nine months of 2004.
- 60 -
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 $4.1million, after-tax, or $0.29 per share, in the
first nine months of 2004, compared to $3.6 million, after-tax, or $0.25 per
share, in 2003. The increased costs were mainly due to administrative expenses
such as stock option expense and costs associated with complying with Sarbanes
Oxley requirements. Unallocated costs at UIL Corporate were partially offset by
after-tax interest income earned on the loan to Cross-Sound totaling $0.4
million, or $0.02 per share, and $0.3 million, or $0.02 per share, as of
September 30, 2004 and 2003, respectively. See the "Major Influences on
Financial Condition - United Capital Investments" section of this Item 2 for
more information regarding the loan to Cross-Sound.
DISCONTINUED OPERATIONS
On June 22, 2004, UIL completed the sale of APS to CheckFree, pursuant to the
purchase agreement entered into between the parties on December 16, 2003. APS,
and its 51% ownership interest in CellCards of Illinois, LLC (CCI), were
classified as discontinued operations in the fourth quarter of 2003. On February
13, 2004, CCI was sold to an independent third party for book value, excluding
transaction costs.
The results of discontinued operations for the first nine months of 2004,
including the gain on the sale of APS, amounted to earnings of $49.8 million, or
$3.47 per share. The overall after-tax gain on the sale, net of all transaction
costs incurred was $46 million, or $3.21 per share. However, the after-tax
effect of the sale, net of transaction costs, for the first nine months of 2004
was $3.22 per share, as certain transaction costs were incurred in the fourth
quarter of 2003. Post-closing review procedures related to the sale were
completed during the third quarter of 2004 and the resulting adjustments net to
an insignificant increase in the gain on the sale of APS. Discontinued
operations reported a loss of $0.5 million, or $0.04 per share, in the first
nine months of 2003.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
UIL Holdings' and UI's primary market risk is the interest rate risk associated
with the need to refinance fixed rate debt at maturity and the remarketing of
multi-annual tax-exempt bonds. The weighted average remaining fixed rate period
of outstanding long-term debt obligations of UIL Holdings and UI is 3.5 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
- 61 -
evaluating the disclosure controls and procedures, management recognized that
any controls and procedures, no matter how well designed and operated, can
provide only reasonable assurance of achieving the desired control objectives,
and management necessarily was required to apply its judgment in evaluating the
cost-benefit relationship of possible controls and procedures. Also, through
United Capital Investments, Inc. and United Bridgeport Energy, Inc., UIL
Holdings has minority investments in certain other entities. As UIL Holdings
does not control or manage these entities, its disclosure controls and
procedures with respect to such entities are necessarily substantially more
limited than those it maintains with respect to its subsidiaries.
UIL Holdings carried out an evaluation, under the supervision and with the
participation of its management, including its Chief Executive Officer and its
Chief Financial Officer, of the effectiveness of the design and operation of UIL
Holdings' disclosure controls and procedures as of September 30, 2004. Based on
the foregoing, UIL Holdings' Chief Executive Officer and Chief Financial Officer
concluded that its disclosure controls and procedures were effective.
There have been no changes in UIL Holdings' internal control over financial
reporting during the quarter ended September 30, 2004 that have materially
affected, or are reasonably likely to materially affect UIL Holdings' internal
control over financial reporting.
PART II. OTHER INFORMATION
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
From time to time UIL Holdings issues unregistered shares pursuant to its
Non-Employee Director Common Stock and Deferred Compensation Plan. On July 14,
2004, UIL Holdings Corporation (UIL Holdings) issued 702 unregistered shares of
UIL Holdings' common stock, which qualified as an exempt private placement
transaction pursuant to Section 4 (2) of the Securities Act of 1933, to a former
director of The United Illuminating Company (UI) to satisfy the provisions of a
deferred compensation arrangement. The shares issued were obtained by UIL
Holdings through open market transactions, as noted in the table below.
- ------------- -------------------- -------------------- ---------------------- ----------------------
TOTAL NUMBER OF MAXIMUM NUMBER OF
SHARES PURCHASED AS SHARES THAT MAY YET
TOTAL NUMBER OF AVERAGE PRICE PAID PART OF PUBLICLY BE PURCHASED UNDER
PERIOD SHARES PURCHASED* PER SHARE ANNOUNCED PLANS THE PLANS
- ------------- -------------------- -------------------- ---------------------- ----------------------
July 702 $47.82 None None
- ------------- -------------------- -------------------- ---------------------- ----------------------
August - - None None
- ------------- -------------------- -------------------- ---------------------- ----------------------
September - - None None
- ------------- -------------------- -------------------- ---------------------- ----------------------
Total 702 $47.82 None None
- ------------- -------------------- -------------------- ---------------------- ----------------------
*All shares were purchased in open market transactions by UIL Holdings' to
satisfy the provisions of a deferred compensation arrangement with a former
director of UI. The effects of this transaction did not change the number of
outstanding shares of UIL Holdings common stock.
ITEM 6. EXHIBITS
Exhibits.
Exhibit
Table Item Exhibit
Number Number Description
--------- ------ -----------
(31) 31.1 Certification of Periodic Financial Report.
(31) 31.2 Certification of Periodic Financial Report.
(32) 32 Certification of Periodic Financial Report.
- 62 -
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 11/04/2004 /s/ Louis J. Paglia
----------------------- ------------------------------------
Louis J. Paglia
Executive Vice President
and Chief Financial Officer
- 63 -