UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
|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: 1-15467
VECTREN CORPORATION
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(Exact name of registrant as specified in its charter)
INDIANA 35-2086905
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(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
20 N.W. 4th Street, Evansville, Indiana, 47708
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(Address of principal executive offices)
(Zip Code)
812-491-4000
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(Registrant's telephone number, including area code)
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 __
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Common Stock - Without Par Value 75,981,012 October 31, 2004
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Class Number of Shares Date
Table of Contents
Item Page
Number Number
PART I. FINANCIAL INFORMATION
1 Financial Statements (Unaudited)
Vectren Corporation and Subsidiary Companies
Consolidated Condensed Balance Sheets 1-2
Consolidated Condensed Statements of Income 3
Consolidated Condensed Statements of Cash Flows 4
Notes to Unaudited Consolidated Condensed Financial
Statements 5
2 Management's Discussion and Analysis of Results of
Operations and Financial Condition 16
3 Quantitative and Qualitative Disclosures About
Market Risk 35
4 Controls and Procedures 35
PART II. OTHER INFORMATION
1 Legal Proceedings 35
6 Exhibits 35
Signatures 36
Access to Information
Vectren Corporation makes available all SEC filings and recent annual reports
free of charge, including those of its wholly owned subsidiary, Vectren Utility
Holdings, Inc., through its website at www.vectren.com, or by request, directed
to Investor Relations at the mailing address, phone number, or email address
that follows:
Mailing Address: Phone Number: Investor Relations Contact:
P.O. Box 209 (812) 491-4000 Steven M. Schein
Evansville, Indiana Vice President, Investor Relations
47702-0209 sschein@vectren.com
Definitions
AFUDC: allowance for funds used MMBTU: millions of British thermal
during construction units
APB: Accounting Principles Board MW: megawatts
EITF: Emerging Issues Task Force MWh/GWh: megawatt hours/thousands of
megawatt hours (gigawatt hours)
FASB: Financial Accounting Standards NOx: nitrogen oxide
Board
FERC: Federal Energy Regulatory OUCC: Indiana Office of the Utility
Commission Consumer Counselor
IDEM: Indiana Department of PUCO: Public Utilities Commission of
Environmental Management Ohio
IURC: Indiana Utility Regulatory SFAS: Statement of Financial
Commission Accounting Standards
MCF/MMCF/BCF: thousands/millions/ USEPA: United States Environmental
billions of cubic feet Protection Agency
MDth/MMDth: thousands/millions of Throughput: combined gas sales and gas
dekatherms transportation volumes
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
VECTREN CORPORATION AND SUBSIDIARY COMPANIES
CONSOLIDATED CONDENSED BALANCE SHEETS
(Unaudited - In millions)
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September 30, December 31,
2004 2003
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ASSETS
Current Assets
Cash & cash equivalents $ 7.8 $ 15.3
Accounts receivable - less reserves of
$1.4 & $3.2, respectively 100.1 137.3
Accrued unbilled revenues 43.9 137.8
Inventories 75.0 70.4
Recoverable fuel & natural gas costs 38.5 20.3
Prepayments & other current assets 159.9 131.1
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Total current assets 425.2 512.2
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Utility Plant
Original cost 3,401.5 3,250.7
Less: accumulated depreciation &
amortization 1,294.2 1,247.0
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Net utility plant 2,107.3 2,003.7
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Investments in unconsolidated affiliates 175.7 176.1
Other investments 114.4 122.9
Non-utility property - net 222.3 222.3
Goodwill - net 205.0 205.0
Regulatory assets 88.2 89.6
Other assets 26.1 21.6
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TOTAL ASSETS $ 3,364.2 $ 3,353.4
===============================================================================
The accompanying notes are an integral part of these consolidated condensed
financial statements.
VECTREN CORPORATION AND SUBSIDIARY COMPANIES
CONSOLIDATED CONDENSED BALANCE SHEETS
(Unaudited - In millions)
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September 30, December 31,
2004 2003
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LIABILITIES & SHAREHOLDERS' EQUITY
Current Liabilities
Accounts payable $ 96.2 $ 85.3
Accounts payable to affiliated companies 54.5 86.4
Accrued liabilities 95.2 109.3
Short-term borrowings 308.2 274.9
Current maturities of long-term debt 15.7 15.0
Long-term debt subject to tender 10.0 13.5
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Total current liabilities 579.8 584.4
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Long-term Debt - Net of Current Maturities &
Debt Subject to Tender 1,065.0 1,072.8
Deferred Income Taxes & Other Liabilities
Deferred income taxes 236.9 235.4
Regulatory liabilities & other removal costs 247.8 235.0
Deferred credits & other liabilities 154.3 153.6
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Total deferred credits & other liabilities 639.0 624.0
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Minority Interest in Subsidiary 0.4 0.3
Commitments & Contingencies (Notes 7 -11)
Cumulative, Redeemable Preferred Stock of a
Subsidiary 0.1 0.2
Common Shareholders' Equity
Common stock (no par value) - issued &
outstanding 76.0 and 75.6 shares,
respectively 526.9 520.4
Retained earnings 565.6 562.4
Accumulated other comprehensive loss (12.6) (11.1)
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Total common shareholders' equity 1,079.9 1,071.7
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TOTAL LIABILITIES & SHAREHOLDERS' EQUITY $ 3,364.2 $ 3,353.4
===============================================================================
The accompanying notes are an integral part of these consolidated condensed
financial statements.
VECTREN CORPORATION AND SUBSIDIARY COMPANIES
CONSOLIDATED CONDENSED STATEMENTS OF INCOME
(Unaudited - In millions, except per share data)
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Three Months Nine Months
Ended September 30, Ended September 30,
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2004 2003 2004 2003
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OPERATING REVENUES
Gas utility $ 112.4 $ 115.0 $ 771.6 $ 788.8
Electric utility 102.3 95.5 280.2 254.2
Energy services & other 39.7 29.1 124.6 90.8
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Total operating revenues 254.4 239.6 1,176.4 1,133.8
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OPERATING EXPENSES
Cost of gas sold 67.2 71.3 529.8 539.9
Fuel for electric generation 25.8 24.8 72.4 66.2
Purchased electric energy 5.3 4.2 16.6 12.5
Cost of energy services & other 27.0 22.0 90.1 66.6
Other operating 59.2 57.2 187.8 179.4
Depreciation & amortization 36.2 32.9 103.6 96.7
Taxes other than income taxes 9.9 9.0 43.3 42.1
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Total operating expenses 230.6 221.4 1,043.6 1,003.4
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OPERATING INCOME 23.8 18.2 132.8 130.4
OTHER INCOME (EXPENSE) - NET
Equity in earnings (losses) of
unconsolidated affiliates 1.5 (2.3) 13.5 6.4
Other income (expense) - net 2.9 8.4 (0.9) 6.2
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Total other (expense) income - net 4.4 6.1 12.6 12.6
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Interest expense 19.4 19.6 57.5 56.7
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INCOME BEFORE INCOME TAXES 8.8 4.7 87.9 86.3
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Income taxes (0.9) (2.6) 20.0 19.2
Minority interest in & preferred dividend
requirements of subsidiaries - - 0.1 -
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NET INCOME $ 9.7 $ 7.3 $ 67.8 $ 67.1
==========================================================================================
AVERAGE COMMON SHARES OUTSTANDING 75.6 71.6 75.5 69.0
DILUTED COMMON SHARES OUTSTANDING 76.0 71.9 75.9 69.3
EARNINGS PER SHARE OF COMMON STOCK:
BASIC $ 0.13 $ 0.10 $ 0.90 $ 0.97
DILUTED 0.13 0.10 0.89 0.97
DIVIDENDS DECLARED PER SHARE OF
COMMON STOCK $ 0.29 $ 0.28 $ 0.86 $ 0.83
The accompanying notes are an integral part of these consolidated condensed
financial statements.
VECTREN CORPORATION AND SUBSIDIARY COMPANIES
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited - In millions)
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Nine Months Ended September 30,
2004 2003
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CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 67.8 $ 67.1
Adjustments to reconcile net income to cash from
operating activities:
Depreciation & amortization 103.6 96.7
Deferred income taxes & investment tax credits (5.4) 18.1
Equity in earnings of unconsolidated affiliates (13.5) (6.4)
Net unrealized loss/(gain) on derivative instruments 1.0 (0.4)
Pension & postretirement periodic benefit cost 12.3 10.5
Other non-cash charges - net 16.1 6.5
Changes in working capital accounts:
Accounts receivable & accrued unbilled revenue 126.0 129.8
Inventories (7.0) 1.2
Recoverable fuel & natural gas costs (18.2) (9.4)
Prepayments & other current assets (21.3) (77.7)
Accounts payable, including to affiliated companies (22.5) (76.6)
Accrued liabilities (12.8) (18.8)
Changes in noncurrent assets (6.1) (2.2)
Changes in noncurrent liabilities (13.4) (2.4)
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Net cash flows from operating activities 206.6 136.0
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CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from:
Stock option exercises & other stock plans 4.5 5.2
Long-term debt - net of issuance costs &
hedging proceeds - 202.9
Common stock - net of issuance costs - 163.2
Requirements for:
Dividends on common stock (64.6) (57.7)
Retirement of long-term debt, including premiums paid (12.5) (121.9)
Redemption of preferred stock of subsidiary (0.1) (0.1)
Other financing activities - (1.7)
Net change in short-term borrowings 34.9 (198.7)
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Net cash flows from financing activities (37.8) (8.8)
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CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from:
Unconsolidated affiliate distributions 23.6 13.5
Notes receivable & other collections 8.9 15.3
Requirements for:
Capital expenditures, excluding AFUDC equity (189.3) (150.7)
Unconsolidated affiliate investments (15.7) (12.3)
Notes receivable & other investments (3.8) (6.4)
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Net cash flows from investing activities (176.3) (140.6)
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Net decrease in cash & cash equivalents (7.5) (13.4)
Cash & cash equivalents at beginning of period 15.3 25.1
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Cash & cash equivalents at end of period $ 7.8 $ 11.7
===========================================================================================
The accompanying notes are an integral part of these consolidated condensed
financial statements.
VECTREN CORPORATION AND SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
1. Organization and Nature of Operations
Vectren Corporation (the Company or Vectren), an Indiana corporation, is an
energy and applied technology holding company headquartered in Evansville,
Indiana. The Company's wholly owned subsidiary, Vectren Utility Holdings, Inc.
(VUHI), serves as the intermediate holding company for its three operating
public utilities: Indiana Gas Company, Inc. (Indiana Gas or Vectren North),
Southern Indiana Gas and Electric Company (SIGECO or Vectren South), and the
Ohio operations. VUHI also has other assets that provide information technology
and other services to the three utilities. Both Vectren and VUHI are exempt from
registration pursuant to Section 3(a)(1) and 3(c) of the Public Utility Holding
Company Act of 1935.
Indiana Gas provides natural gas distribution and transportation services to a
diversified customer base in 49 of Indiana's 92 counties. SIGECO provides
electric generation, transmission, and distribution services to 8 counties in
southwestern Indiana, including counties surrounding Evansville, and
participates in the wholesale power market. SIGECO also provides natural gas
distribution and transportation services to 9 counties in southwestern Indiana,
including counties surrounding Evansville. Indiana Gas and SIGECO generally do
business as Vectren Energy Delivery of Indiana, Inc. The Ohio operations, owned
as a tenancy in common by Vectren Energy Delivery of Ohio, Inc. (VEDO), a wholly
owned subsidiary, (53% ownership) and Indiana Gas (47% ownership), provide
natural gas distribution and transportation services to 17 counties in west
central Ohio, including counties surrounding Dayton. VUHI's consolidated
operations are collectively referred to as the Utility Group.
The Company is also involved in nonregulated activities in four primary business
areas: Energy Marketing and Services, Coal Mining, Utility Infrastructure
Services, and Broadband. Energy Marketing and Services markets natural gas and
provides energy management services, including energy performance contracting
services. Coal Mining mines and sells coal and generates IRS Code Section 29 tax
credits relating to the production of coal-based synthetic fuels. Utility
Infrastructure Services provides underground construction and repair, facilities
locating, and meter reading services. Broadband has investments in broadband
communication services such as analog and digital cable television, high-speed
Internet and data services, and advanced local and long distance phone services.
In addition, the Nonregulated Group has other businesses that invest in
energy-related opportunities, real estate, and leveraged leases, among other
activities. The Nonregulated Group supports the Company's regulated utilities
pursuant to service contracts by providing natural gas supply services, coal,
utility infrastructure services, and other services. These operations are
collectively referred to as the Nonregulated Group.
2. Basis of Presentation
The interim consolidated condensed financial statements included in this report
have been prepared by the Company, without audit, as provided in the rules and
regulations of the Securities and Exchange Commission. Certain information and
note disclosures normally included in financial statements prepared in
accordance with accounting principles generally accepted in the United States
have been omitted as provided in such rules and regulations. The Company
believes that the information in this report reflects all adjustments necessary
to fairly state the results of the interim periods reported. These consolidated
condensed financial statements and related notes should be read in conjunction
with the Company's audited annual consolidated financial statements for the year
ended December 31, 2003, filed on Form 10-K. Because of the seasonal nature of
the Company's utility operations, the results shown on a quarterly basis are not
necessarily indicative of annual results.
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the statements
and the reported amounts of revenues and expenses during the reporting periods.
Actual results could differ from those estimates.
3. Share-Based Compensation
The Company applies APB Opinion 25, "Accounting for Stock Issued to Employees"
(APB 25) and related interpretations when measuring compensation expense for its
share-based compensation plans.
Stock Option Plans
The exercise price of stock options awarded under the Company's stock option
plans is equal to the fair market value of the underlying common stock on the
date of grant. Accordingly, no compensation expense has been recognized for
stock option plans. In January 2004, 219,000 options to purchase shares of
common stock at an exercise price of $24.74 were issued to management. The grant
vests over three years.
Other Plans
In addition to its stock option plans, the Company also maintains restricted
stock and phantom stock plans for executives, employees, and non-employee
directors. In January 2004, 133,500 restricted shares at a fair value of $24.74
per share were issued to management. The shares vest over four years.
Compensation expense associated with these restricted stock and phantom stock
plans for the three months ended September 30, 2004 and 2003, was $1.1 million
($0.6 million after tax) and $1.5 million ($0.9 million after tax),
respectively, and for the nine months ended September 30, 2004 and 2003, was
$2.4 million ($1.4 million after tax) and $2.9 million ($1.7 million after tax),
respectively. The amount of expense is consistent with the amount of expense
that would have been recognized if the Company used the fair value based method
described in SFAS No. 123 "Accounting for Stock Based Compensation" (SFAS 123),
as amended, to value these awards.
Pro forma Information
Following is the effect on net income and earnings per share as if the fair
value based method described in SFAS 123 had been applied to all share-based
compensation plans:
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Three Months Nine Months
Ended September 30, Ended September 30,
------------------- -------------------
(In millions, except per share amounts) 2004 2003 2004 2003
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Net Income:
As reported $ 9.7 $ 7.3 $ 67.8 $ 67.1
Add: Share-based employee compensation
included in reported net income -
net of tax 0.6 0.9 1.4 1.7
Deduct: Total share-based employee compensation
expense determined under fair value
based method for all awards - net of tax 0.8 1.2 1.9 2.7
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Pro forma net income $ 9.5 $ 7.0 $ 67.3 $ 66.1
=============================================================================================
Basic Earnings Per Share:
As reported $ 0.13 $ 0.10 $ 0.90 $ 0.97
Pro forma 0.13 0.10 0.89 0.96
Diluted Earnings Per Share:
As reported $ 0.13 $ 0.10 $ 0.89 $ 0.97
Pro forma 0.13 0.10 0.89 0.96
4. Comprehensive Income
Comprehensive income consists of the following:
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Three Months Nine Months
Ended September 30, Ended September 30,
------------------- -------------------
(In millions) 2004 2003 2004 2003
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Net income $ 9.7 $ 7.3 $ 67.8 $ 67.1
Comprehensive (loss) income of
unconsolidated affiliates- net of tax (1.2) 3.5 (1.5) 5.7
Minimum pension liability adjustment &
other- net of tax - (0.5) - (0.1)
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Total comprehensive income (loss) $ 8.5 $10.3 $ 66.3 $ 72.7
==============================================================================================
Other comprehensive income arising from unconsolidated affiliates is the
Company's portion of ProLiance Energy, LLC's and Reliant Services, LLC's
accumulated other comprehensive income related to their use of cash flow hedges,
including commodity contracts and interest rate swaps, and the Company's portion
of Haddington Energy Partners, LP's accumulated other comprehensive income
related to its unrealized gains and losses of "available for sale securities,"
as defined by SFAS 115, "Accounting for Certain Investments in Debt and Equity
Securities."
5. Earnings Per Share
Basic earnings per share is computed by dividing net income available to common
shareholders by the weighted-average number of common shares outstanding for the
period. Diluted earnings per share assumes the conversion of stock options into
common shares and the lifting of restrictions on issued restricted shares using
the treasury stock method to the extent the effect would be dilutive. The
following table sets forth the computation of basic and diluted earnings per
share calculations for the three and nine months ended September 30, 2004 and
2003:
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Three Months Nine Months
Ended September 30, Ended September 30,
------------------- -------------------
(In millions, except per share data) 2004 2003 2004 2003
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Numerator:
Numerator for basic and diluted
EPS - Net income $ 9.7 $ 7.3 $ 67.8 $ 67.1
=============================================================================================
Denominator:
Denominator for basic EPS - Weighted average
common shares outstanding 75.6 71.6 75.5 69.0
Conversion of stock options and lifting of
restrictions on issued restricted stock 0.4 0.3 0.4 0.3
- ---------------------------------------------------------------------------------------------
Denominator for diluted EPS - Adjusted weighted
average shares outstanding and assumed
conversions outstanding 76.0 71.9 75.9 69.3
=============================================================================================
Basic earnings per share $ 0.13 $ 0.10 $ 0.90 $ 0.97
Diluted earnings per share $ 0.13 $ 0.10 $ 0.89 $ 0.97
For the three months ended September 30, 2004 and 2003, options to purchase an
additional 22,274 and 110,663, respectively, shares of the Company's common
stock were outstanding, but were not included in the computation of diluted
earnings per share because their effect would be antidilutive. Exercise prices
for options excluded from the computation ranged from $24.90 to $25.59 in 2004
and from $23.35 to $25.59 in 2003.
For the nine months ended September 30, 2004 and 2003, options to purchase an
additional 241,274 and 530,663, respectively, shares of the Company's common
stock were outstanding, but were not included in the computation of diluted
earnings per share because their effect would be antidilutive. Exercise prices
for options excluded from the computation ranged from $24.74 to $25.59 in 2004
and from $23.19 to $25.59 in 2003.
6. Retirement Plans & Other Postretirement Benefits
The Company maintains three qualified defined benefit pension plans, a
nonqualified supplemental executive retirement plan (SERP), and three other
postretirement benefit plans. The qualified pension plans and the SERP are
aggregated under the heading "Pension Benefits." Other postretirement benefit
plans are aggregated under the heading "Other Benefits."
Net Periodic Benefit Costs
A summary of the components of net periodic benefit cost follows:
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Three Months Ended September 30,
Pension Benefits Other Benefits
---------------- ---------------
(In millions) 2004 2003 2004 2003
- --------------------------------------------------------------------------------
Service cost $ 1.7 $ 1.5 $ 0.3 $ 0.2
Interest cost 3.4 3.4 1.5 1.4
Expected return on plan assets (3.4) (3.7) (0.2) (0.2)
Amortization of prior service cost 0.2 0.2 - -
Amortization of transitional (asset)
obligation (0.1) (0.1) 0.7 0.7
Amortization of actuarial loss (gain) 0.3 0.1 (0.3) (0.1)
- --------------------------------------------------------------------------------
Net periodic benefit cost $ 2.1 $ 1.4 $ 2.0 $ 2.0
================================================================================
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Nine Months Ended September 30,
Pension Benefits Other Benefits
------------------ ----------------
(In millions) 2004 2003 2004 2003
- --------------------------------------------------------------------------------
Service cost $ 4.9 $ 4.4 $ 0.7 $ 0.7
Interest cost 10.1 10.2 4.4 4.1
Expected return on plan assets (10.1) (11.1) (0.5) (0.5)
Amortization of prior service cost 0.7 0.6 - -
Amortization of transitional (asset)
obligation (0.2) (0.2) 2.2 2.2
Amortization of actuarial loss (gain) 0.7 0.5 (0.6) (0.4)
- --------------------------------------------------------------------------------
Net periodic benefit cost $ 6.1 $ 4.4 $ 6.2 $ 6.1
================================================================================
Employer Contributions to Qualified Pension Plans
Through September 30, 2004, $7.7 million has been contributed to its pension
plan trusts, and the Company does not expect to make any more contributions for
the remainder of the year.
FSP 106-2
On December 8, 2003, the Medicare Prescription Drug, Improvement and
Modernization Act of 2003 (the "Medicare Act") was enacted. The Medicare Act
introduces a Medicare prescription drug benefit, as well as a federal subsidy to
sponsors of retiree health care benefit plans that provide a benefit that is at
least "actuarially equivalent" to the Medicare benefit. In May 2004, FASB issued
FASB Staff Position ("FSP") 106-2, "Accounting and Disclosure Requirements
Related to the Medicare Prescription Drug, Improvement and Modernization Act of
2003," which supercedes FSP 106-1 of the same title issued in January 2004. FSP
106-2 provides guidance on the accounting and required disclosures for the
effects of the Medicare Act for employers that sponsor postretirement health
care plans that provide prescription drug benefits. FSP 106-2 becomes effective
for the first interim or annual period beginning after June 15, 2004, with
earlier adoption permitted.
The Company elected to early adopt the accounting for the federal subsidy under
the Medicare Act on April 1, 2004, and remeasured its obligation as of January
1, 2004, to incorporate the impact of the Medicare Act which resulted in a
reduction to the accumulated benefit obligation of $10.4 million. For the three
and nine months ended September 30, 2004, the remeasurement resulted in a
reduction in net periodic postretirement benefit cost of $0.3 million and $0.6
million, respectively. The reduction is a component of amortization of actuarial
loss (gain) in the chart above.
The underlying determination of whether an employer's plan qualifies for the
federal subsidy is still subject to clarifying federal regulations related to
the Medicare Act. When this guidance is issued, the Company will reassess if its
plans continue to qualify for the subsidy.
7. Transactions with ProLiance Energy, LLC
ProLiance Energy, LLC (ProLiance), a nonregulated energy marketing affiliate of
Vectren and Citizens Gas and Coke Utility, provides natural gas and related
services to the Company's regulated utilities and nonregulated gas retail
operations. ProLiance's primary businesses include gas marketing, gas portfolio
optimization, and other portfolio and energy management services. ProLiance's
primary customers are its members' utilities and other large end-use customers.
Transactions with ProLiance
Purchases from ProLiance for resale, for injections into storage, and for
prepaid gas delivery service for the three months ended September 30, 2004 and
2003, totaled $171.6 million and $154.1 million, respectively, and for the nine
months ended September 30, 2004 and 2003, totaled $621.5 million and $589.0
million, respectively. Amounts owed to ProLiance at September 30, 2004, and
December 31, 2003, for those purchases were $51.3 million and $86.0 million,
respectively, and are included in Accounts payable to affiliated companies.
Amounts charged by ProLiance for gas supply services are established by supply
agreements with each utility.
ProLiance Contingency
There is currently a lawsuit pending in the United States District Court for the
Northern District of Alabama filed by the City of Huntsville, Alabama d/b/a
Huntsville Utilities, Inc. (Huntsville Utilities) against ProLiance. Huntsville
Utilities asserts claims based on negligent provision of portfolio services
and/or pricing advice, fraud, fraudulent inducement, and other theories. These
claims relate generally to several basic arguments: 1) negligence in providing
advice and/or administering portfolio arrangements, 2) alleged promises to
provide gas at a below-market rate, 3) the creation and repayment of a "winter
levelizing program" instituted by ProLiance in conjunction with the manager of
Huntsville's Gas Utility, to allow Huntsville Utilities to pay its gas bills
over an extended period of time coupled with the alleged ignorance about the
program on the part of Huntsville Utilities' Gas Board, and, 4) the sale of
Huntsville Utilities' gas storage supplies to repay the balance owed on the
winter levelizing program and the authority of Huntsville Utilities' gas manager
to approve those sales. In a press conference on May 21, 2002, Huntsville
Utilities asserted its monetary damages to be approximately $10 million, and
seeks to treble that amount. ProLiance has made counterclaims asserting breach
of contract, among others, based on Huntsville Utilities' refusal to take gas
under fixed price agreements. Both parties have denied the charges contained in
the respective claims.
In 2003, ProLiance established reserves for amounts due from Huntsville
Utilities due to uncertainties surrounding collection. ProLiance believes its
actions were proper under the contract and amendments signed by the manager of
Huntsville's Gas Utility, and is vigorously defending the suit. ProLiance is
insured under a policy providing defense costs which may provide in whole or in
part, indemnification within the policy limits for claims asserted against
ProLiance. Accordingly, no other loss contingencies have been recorded at this
time. However, it is not possible to predict or determine the outcome of this
litigation and accordingly there can be no assurance that ProLiance will
prevail. It is not currently expected that costs associated with this matter
will have a material adverse effect on Vectren's consolidated financial position
or liquidity but an unfavorable outcome could possibly be material to Vectren's
earnings.
8. Commitments & Contingencies
Legal Proceedings
The Company is party to various legal proceedings arising in the normal course
of business. In the opinion of management, there are no legal proceedings
pending against the Company that are likely to have a material adverse effect on
its financial position or results of operations. See Note 7 regarding the
ProLiance contingency and Note 9 regarding environmental matters.
IRS Section 29 Tax Credit Recent Developments
Vectren's Coal Mining operations are comprised of Vectren Fuels, Inc. (Fuels),
which includes its coal mines and related operations and Vectren Synfuels, Inc.
(Synfuels). Synfuels holds one limited partnership unit (an 8.3% interest) in
Pace Carbon Synfuels Investors, LP (Pace Carbon), a Delaware limited partnership
formed to develop, own, and operate four projects to produce and sell coal-based
synthetic fuel utilizing Covol technology.
Under Section 29 of the Internal Revenue Code, manufacturers such as Pace Carbon
receive a tax credit for every ton of synthetic fuel sold. To qualify for the
credits, the synthetic fuel must meet three primary conditions: 1) there must be
a significant chemical change in the coal feedstock, 2) the product must be sold
to an unrelated person, and 3) the production facility must have been placed in
service before July 1, 1998.
In past rulings, the Internal Revenue Service (IRS) has concluded that the
synthetic fuel produced at the Pace Carbon facilities should qualify for Section
29 tax credits. The IRS issued a private letter ruling with respect to the four
projects on November 11, 1997, and subsequently issued an updated private letter
ruling on September 23, 2002.
As a partner in Pace Carbon, Vectren has reflected total tax credits under
Section 29 in its consolidated results from the inception of the partnership
through September 30, 2004, of approximately $52.2 million. To date, Vectren has
been in a position to fully utilize the credits generated.
During June 2001, the IRS began a tax audit of Pace Carbon for the 1998 tax year
and later expanded the audit to include tax years 1999, 2000, and 2001. In May
2004, the IRS completed its audit of the 1998 to 2001 tax returns of Pace Carbon
requesting only minor modifications to previously filed returns. There were no
changes to any of the filed Section 29 tax credit calculations. The Permanent
Subcommittee on Investigations of the U.S. Senate's Committee on Governmental
Affairs, however, has an ongoing investigation on the subject of these income
tax credits.
Vectren believes it is justified in its reliance on the private letter rulings
and recent IRS audit results for the Pace Carbon facilities. However, at this
time, Vectren cannot provide any assurance as to the outcome that these
uncertainties may have on Vectren's consolidated financial position or
liquidity.
SEC Inquiry regarding PUHCA Exemption
In July 2004, the Company received a letter from the SEC regarding its exempt
status under the Public Utility Holding Company Act of 1935 (PUHCA). The letter
asserts that Vectren's out of state electric power sales exceed the amount
previously determined by the SEC to be acceptable in order to qualify for the
exemption. Vectren claims exemption from registration under Section 3(a)(1) of
PUHCA by rule 2. As required by the rule, Vectren files an annual statement on
SEC Form U-3A-2. The Company has responded to the SEC inquiry and filed an
amended Form U-3A-2 for the year ended December 31, 2003.
Guarantees & Product Warranties
Vectren issues guarantees to third parties on behalf of its unconsolidated
affiliates. Such guarantees allow those affiliates to execute transactions on
more favorable terms than the affiliate could obtain without such a guarantee.
Guarantees may include posted letters of credit, leasing guarantees, and
performance guarantees. As of September 30, 2004, guarantees issued and
outstanding on behalf of unconsolidated affiliates approximated $10 million. The
Company has also issued a guarantee approximating $4 million related to the
residual value of an operating lease that expires in 2006.
Vectren has accrued no liabilities for these guarantees as they relate to
guarantees issued among related parties, are not material, or such guarantees
were executed prior to the adoption of FASB Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others." Liabilities accrued for, and activity
related to, product warranties are not significant.
9. Environmental Matters
NOx SIP Call Matter
The Company has initiated steps toward compliance with Indiana's State
Implementation Plan (SIP) of the Clean Air Act (the Act). These steps include
installing Selective Catalytic Reduction (SCR) systems at Culley Generating
Station Unit 3 (Culley), Warrick Generating Station Unit 4, and A.B. Brown
Generating Station Units 1 and 2. SCR systems reduce flue gas NOx emissions to
atmospheric nitrogen and water using ammonia in a chemical reaction. This
technology is known to currently be the most effective method of reducing
nitrogen oxide (NOx) emissions where high removal efficiencies are required.
The IURC has issued orders that approve:
>> the Company's project to achieve environmental compliance by investing
in clean coal technology;
>> a total capital cost investment for this project up to $244 million
(excluding AFUDC), subject to periodic review of the actual costs
incurred;
>> a mechanism whereby, prior to an electric base rate case, the Company
may recover through a rider that is updated every six months, an eight
percent return on its weighted capital costs for the project; and
>> ongoing recovery of operating costs, including depreciation and
purchased emission allowances through a rider mechanism, related to the
clean coal technology once the facility is placed into service.
Based on the level of system-wide emissions reductions required and the control
technology utilized to achieve the reductions, the current estimated
construction cost is consistent with amounts approved in the IURC's orders.
Through September 30, 2004, $207 million has been expended, and three of the
four SCR's are operational. After the equipment is installed and operational,
related annual operating expenses, including depreciation expense, are estimated
to be between $24 million and $27 million. The Company is recovering the
operational costs associated with the SCR's and related technology. The 8
percent return on capital investment approximates the return authorized in the
Company's last electric rate case in 1995 and includes a return on equity.
The Company has achieved timely compliance through the reduction of the
Company's overall NOx emissions to levels compliant with Indiana's NOx emissions
budget allotted by the USEPA. Therefore, the Company has recorded no accrual for
potential penalties that may result from noncompliance.
Manufactured Gas Plants
In the past, Indiana Gas, SIGECO, and others operated facilities for the
manufacture of gas. Given the availability of natural gas transported by
pipelines, these facilities have not been operated for many years. Under
currently applicable environmental laws and regulations, Indiana Gas, SIGECO,
and others may now be required to take remedial action if certain byproducts are
found above the regulatory thresholds at these sites.
Indiana Gas has identified the existence, location, and certain general
characteristics of 26 gas manufacturing and storage sites for which it may have
some remedial responsibility. Indiana Gas has completed a remedial
investigation/feasibility study (RI/FS) at one of the sites under an agreed
order between Indiana Gas and the IDEM, and a Record of Decision was issued by
the IDEM in January 2000. Although Indiana Gas has not begun an RI/FS at
additional sites, Indiana Gas has submitted several of the sites to the IDEM's
Voluntary Remediation Program (VRP) and is currently conducting some level of
remedial activities, including groundwater monitoring at certain sites, where
deemed appropriate, and will continue remedial activities at the sites as
appropriate and necessary.
In conjunction with data compiled by environmental consultants, Indiana Gas has
accrued the estimated costs for further investigation, remediation, groundwater
monitoring, and related costs for the sites. While the total costs that may be
incurred in connection with addressing these sites cannot be determined at this
time, Indiana Gas has recorded costs that it reasonably expects to incur
totaling approximately $20.4 million.
The estimated accrued costs are limited to Indiana Gas' proportionate share of
the remediation efforts. Indiana Gas has arrangements in place for 19 of the 26
sites with other potentially responsible parties (PRP), which serve to limit
Indiana Gas' share of response costs at these 19 sites to between 20% and 50%.
With respect to insurance coverage, Indiana Gas has received and recorded
settlements from all known insurance carriers in an aggregate amount
approximating $20.4 million.
Environmental matters related to manufactured gas plants have had no material
impact on earnings since costs recorded to date approximate PRP and insurance
settlement recoveries. While Indiana Gas has recorded all costs which it
presently expects to incur in connection with activities at these sites, it is
possible that future events may require some level of additional remedial
activities which are not presently foreseen.
In October 2002, the Company received a formal information request letter from
the IDEM regarding five manufactured gas plants owned and/or operated by SIGECO
and not currently enrolled in the IDEM's VRP. In response, SIGECO submitted to
the IDEM the results of preliminary site investigations conducted in the
mid-1990's. These site investigations confirmed that based upon the conditions
known at the time, the sites posed no risk to human health or the environment.
Follow up reviews have been initiated by the Company to confirm that the sites
continue to pose no such risk.
On October 6, 2003, SIGECO filed applications to enter four of the manufactured
gas plant sites in IDEM's VRP. The remaining site is currently being addressed
in the VRP by another Indiana utility. SIGECO added those four sites into the
renewal of the global Voluntary Remediation Agreement that Indiana Gas has in
place with IDEM for its manufactured gas plant sites. That renewal was approved
by the IDEM on February 24, 2004. On July 13, 2004, SIGECO filed a declaratory
judgment action against its insurance carriers seeking a judgment finding its
carriers liable under the policies for coverage of further investigation and any
necessary remediation costs that SIGECO may accrue under the VRP program. The
total investigative costs, and if necessary, costs of remediation at the four
SIGECO sites, as well as the amount of any PRP or insurance recoveries, cannot
be determined at this time.
Jacobsville Superfund Site
On July 22, 2004, the USEPA listed the Jacobsville Neighborhood Soil
Contamination site in Evansville, Indiana, on the National Priorities List under
the Comprehensive Environmental Response, Compensation and Liability Act
(CERCLA). The USEPA has identified four sources of historic lead contamination.
These four sources shut down manufacturing operations years ago. When drawing up
the boundaries for the listing, the USEPA included a 250 acre block of
properties surrounding the Jacobsville neighborhood, including Vectren's Wagner
Operations Center. Vectren's property has not been named as a source of the lead
contamination, nor does the USEPA's soil testing to date indicate that the
Vectren property contains lead contaminated soils. Vectren's own soil testing,
completed during the construction of the Operations Center did not indicate that
the Vectren property contains lead contaminated soils. At this time, Vectren
anticipates only additional soil testing, if required by the USEPA.
10. Rate & Regulatory Matters
Vectren South (SIGECO) Gas Base Rate Settlement
On March 12, 2004, Vectren South filed a petition with the IURC to adjust its
base rates and charges for its gas distribution business in southwestern Indiana
to recover the ongoing cost of operating and maintaining the approximately
3,000-mile distribution and storage system used to serve more than 110,000
customers. On June 30, 2004, the IURC approved a $5.7 million base rate increase
for Vectren South's gas distribution business in southwestern Indiana. The rate
settlement only addresses Vectren South's "non-gas" costs which are incurred to
build, operate, and maintain the pipelines, other equipment and systems that are
used to deliver gas across Vectren South's system to its customers. The base
rate change was implemented on July 1, 2004.
The order also permits Vectren South to recover the on-going costs associated
with Vectren South's compliance with the federal Pipeline Safety Improvement Act
of 2002. Implementation of these compliance activities will include additional
patrols, leakage surveys and direct observation of approximately 90 miles of
Vectren South's transmission pipeline system. The Pipeline Safety Improvement
Tracker provides for the recovery of up to $750,000 the first year and $500,000
thereafter, subject to OUCC review and IURC approval that the costs are
prudently incurred. Any costs incurred in excess of these levels will be
deferred for future recovery.
Vectren North (Indiana Gas) Pending Base Rate Settlement
On March 19, 2004, Vectren North filed a petition with the IURC to adjust its
base rates and charges for its gas distribution business in a 49 county region
covering central and southeastern Indiana. On October 12, 2004, the Company
announced a settlement agreement with several parties, including the Indiana
Office of Utility Consumer Counselor, the Indiana Gas Industrial Group, and the
Citizens Action Coalition of Indiana, Inc. The settlement agreement provides for
a $24 million increase in Vectren North's base distribution rates to cover the
ongoing cost of operating, maintaining, and expanding the approximately
12,000-mile distribution and storage system used to serve more than 545,000
customers. Once implemented, the new rate design will include a larger service
charge, which is intended to address to some extent earnings volatility related
to weather. The settlement also permits Vectren North to recover the on-going
costs associated with the federal Pipeline Safety Improvement Act of 2002. The
Pipeline Safety Improvement Tracker provides for the recovery of incremental
non-capital dollars, capped at $2.5 million per year. Costs in excess of the
annual cap are to be deferred for future recovery. The IURC will hold a hearing
on the settlement on November 22, 2004, and Commission action is expected
shortly thereafter.
VEDO Pending Base Rate Filing
On April 16, 2004, VEDO issued a pre-filing notice to the PUCO of a request to
adjust base rates and charges for VEDO's gas distribution business in a
17-county region covering west central Ohio. On May 24, 2004, the official
application and Standard Filing Requirements were filed with the PUCO. If the
filing is approved, VEDO expects to increase base rates up to $25 million to
recover the ongoing cost of operating, maintaining and expanding the
approximately 5,200-mile distribution system used to serve more than 310,000
customers. VEDO's request is subject to review and approval by the PUCO. The
petition only addresses VEDO's "non-gas costs," which are incurred to build,
operate and maintain pipelines, other equipment and systems that are used to
deliver gas across VEDO's system to its customers. The filing also includes a
proposed conservation tariff, which, if approved, will enable the Company to
proactively support conservation and promote home weatherization and the
reduction of energy consumption. Based on the PUCO's regulatory process, the
PUCO staff report relating to the Company's request is expected to be submitted
in November 2004. Based upon the PUCO's actions in other proceedings, the
Company would expect a Commission order in this case late in the first quarter
of 2005.
Gas Cost Recovery (GCR) Audit Proceedings
There is an Ohio requirement that Ohio gas utilities undergo a biannual audit of
their gas acquisition practices in connection with the gas cost recovery (GCR)
mechanism. In the case of VEDO, the two-year audit period ended in November
2002. The audit provides the initial review of the portfolio administration
arrangement between VEDO and ProLiance. The external auditor retained by the
PUCO staff submitted an audit report in the fall of 2003 wherein it recommended
a disallowance of approximately $7 million of previously recovered gas costs.
The Company believes a large portion of the third party auditor recommendations
is without merit. A hearing has been held, and the PUCO staff has recommended an
approximate $6 million disallowance. The Ohio Consumer Counselor has recommended
an approximate $12 million disallowance, which includes interest. For this PUCO
audit period, any disallowance relating to the Company's ProLiance arrangement
will be shared by the Company's joint venture partner. Based on a review of the
matters, the Company has recorded $1.9 million for its estimated share of any
potential disallowance. A PUCO decision on this matter is yet to be issued. The
Company is also unable to determine the effects that a PUCO decision may have on
results in audit periods beginning after November 2002.
11. Impact of Recently Issued Accounting Guidance
SFAS No. 132 (Revised 2003)
In December 2003, FASB issued SFAS No. 132 (revised 2003), "Employers'
Disclosures about Pensions and Other Postretirement Benefits" (SFAS 132), to
improve financial statement disclosures for defined benefit and other
postretirement benefit plans. The incremental annual disclosure requirements
were reflected in the Company's Form 10-K for the year ended December 31, 2003.
The adoption did not impact the Company's results of operations or financial
condition. The incremental interim disclosure requirements are included in these
financial statements in Note 6.
FIN 46/46R (Revised in December 2003)
In January 2003, the FASB issued Interpretation 46, "Consolidation of Variable
Interest Entities" (FIN 46). FIN 46 addresses consolidation by business
enterprises of variable interest entities (VIE) and significantly changes the
consolidation requirements for those entities. FIN 46 is intended to achieve
more consistent application of consolidation policies related to VIE's and thus
improves comparability between enterprises engaged in similar activities when
those activities are conducted through VIE's. In December 2003, the FASB
completed its deliberations of proposed modifications to FIN 46 and decided to
codify both the proposed modifications and other decisions previously issued
through certain FASB Staff Positions into one document that was issued as a
revision to the original Interpretation (FIN 46R). FIN 46R currently applies to
VIE's created after January 31, 2003, and to VIE's in which an enterprise
obtains an interest after that date. For entities created prior to January 31,
2003, FIN 46R is to be adopted no later than the end of the first interim or
annual reporting period ending after March 15, 2004.
The Company has neither created nor obtained an interest in a VIE since January
31, 2003. Certain other entities that the Company was involved with prior to
that date have been evaluated and determined to be VIE's. The Company has
investments in partnership-like structures as a limited partner or as a
subordinated lender. The activities of these entities are to purchase or
construct as well as operate multifamily housing and office properties. The
Company's exposure to loss is limited to its investment which as of September
30, 2004, and December 31, 2003, totaled $16.2 million and $17.1 million,
respectively, of Investments in unconsolidated affiliates, and $16.7 million and
$20.9 million, respectively, of Other investments. The Company is also the
equity owner in three leveraged leases where its exposure to loss is limited to
its net investment which as of September 30, 2004, and December 31, 2003,
totaled $6.9 million and $6.0 million, respectively. The Company did not
consolidate any of these entities upon adoption of FIN 46R.
EITF 03-01
In March 2004, the EITF issued a consensus on Issue No. 03-01, "The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments"
(EITF 03-01). In EITF 03-01, the Task Force developed a basic model for
evaluating whether investments within the scope of EITF 03-01, which includes
cost method and equity method investments, have other-than-temporary impairment.
The basic model includes three steps: 1) determine if there is impairment; 2) if
there is impairment, decide whether it is temporary or other than temporary; and
3) if it is other than temporary, recognize it in earnings. EITF 03-01 also
requires certain qualitative and quantitative disclosure of material impairments
judged to be temporary. The EITF has yet to finalize Steps 2 and 3. Step 1 and
the disclosure requirements are currently effective, and the adoption of those
portions of the EITF did not have a material effect on the Company.
During 2004, the Company has incurred an other-than-temporary impairment charge
associated with its cost method investment in SIGECOM, LLC, totaling $3.8
million and impairment charges associated with other broadband-related notes
totaling $2.2 million. The Company is continuing to assess strategic
alternatives for its broadband investments. While it currently believes that the
book value of those investments approximates fair value, further changes in
estimated fair value may occur.
12. Segment Reporting
The Company segregates its operations into three groups: 1) Utility Group, 2)
Nonregulated Group, and 3) Corporate and Other.
The Utility Group is comprised of Vectren Utility Holdings, Inc.'s operations,
which consist of the Company's regulated operations (the Gas Utility Services
and Electric Utility Services operating segments), and other operations that
provide information technology and other support services to those regulated
operations. In total, there are three operating segments of the Utility Group as
defined by SFAS 131 "Disclosure About Segments of an Enterprise and Related
Information" (SFAS 131). Gas Utility Services provides natural gas distribution
and transportation services to nearly two-thirds of Indiana and to west central
Ohio. Electric Utility Services provides electricity primarily to southwestern
Indiana, and includes the Company's power generating and marketing operations.
For these regulated operations the Company uses after tax operating income as a
measure of profitability, consistent with regulatory reporting requirements. The
Company cross manages its regulated operations as separated between Energy
Delivery, which includes the gas and electric transmission and distribution
functions, and Power Supply, which includes the power generating and marketing
operations. For the Utility Group's other operations, net income is used as the
measure of profitability.
The Nonregulated Group is comprised of one operating segment as defined by SFAS
131 that includes various subsidiaries and affiliates offering and investing in
energy marketing and services, coal mining, utility infrastructure services, and
other energy-related and broadband opportunities.
Corporate and other includes unallocated corporate expenses such as branding and
charitable contributions, among other activities, that benefit the Company's
other operating segments. Information related to the Company's business segments
is summarized below:
- ----------------------------------------------------------------------------------
Three Months Nine Months
Ended September 30, Ended September 30,
------------------- -------------------
(In millions) 2004 2003 2004 2003
- ----------------------------------------------------------------------------------
Revenues
Utility Group
Gas Utility Services $ 112.4 $ 115.0 $ 771.6 $ 788.8
Electric Utility Services 102.3 95.5 280.2 254.2
Other Operations 7.4 6.6 25.5 19.8
Eliminations (7.4) (6.4) (25.0) (19.2)
- ----------------------------------------------------------------------------------
Total Utility Group 214.7 210.7 1,052.3 1,043.6
- ----------------------------------------------------------------------------------
Nonregulated Group 61.8 50.2 186.3 151.1
Corporate & Other - 0.4 - 0.8
Eliminations (22.1) (21.7) (62.2) (61.7)
- ----------------------------------------------------------------------------------
Consolidated Revenues $ 254.4 $ 239.6 $1,176.4 $1,133.8
==================================================================================
Profitability Measure
Utility Group: Regulated Operating
Income (Operating Income Less
Applicable Income Taxes)
Gas Utility Services $ (4.2) $ (6.0) $ 43.0 $ 45.4
Electric Utility Services 21.7 21.3 48.2 49.0
- ----------------------------------------------------------------------------------
Total Regulated Operating Income 17.5 15.3 91.2 94.4
- ----------------------------------------------------------------------------------
Regulated other income - net 1.3 1.8 1.8 2.0
Regulated interest expense &
preferred dividends (15.7) (15.7) (46.9) (46.6)
- ----------------------------------------------------------------------------------
Regulated Net Income 3.1 1.4 46.1 49.8
- ----------------------------------------------------------------------------------
Other Operations Net Income 1.4 1.0 5.8 1.3
- ----------------------------------------------------------------------------------
Utility Group Net Income 4.5 2.4 51.9 51.1
- ----------------------------------------------------------------------------------
Nonregulated Group Net Income 5.9 5.7 17.2 17.6
Corporate & Other Net Loss (0.7) (0.8) (1.3) (1.6)
- ----------------------------------------------------------------------------------
Consolidated Net Income $ 9.7 $ 7.3 $ 67.8 $ 67.1
==================================================================================
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
Description of the Business
Vectren Corporation (the Company or Vectren), an Indiana corporation, is an
energy and applied technology holding company headquartered in Evansville,
Indiana. The Company's wholly owned subsidiary, Vectren Utility Holdings, Inc.
(VUHI), serves as the intermediate holding company for its three operating
public utilities: Indiana Gas Company, Inc. (Indiana Gas or Vectren North),
Southern Indiana Gas and Electric Company (SIGECO or Vectren South), and the
Ohio operations. VUHI also has other assets that provide information technology
and other services to the three utilities. Both Vectren and VUHI are exempt from
registration pursuant to Section 3(a)(1) and 3(c) of the Public Utility Holding
Company Act of 1935.
Indiana Gas provides natural gas distribution and transportation services to a
diversified customer base in 49 of Indiana's 92 counties. SIGECO provides
electric generation, transmission, and distribution services to 8 counties in
southwestern Indiana, including counties surrounding Evansville, and
participates in the wholesale power market. SIGECO also provides natural gas
distribution and transportation services to 9 counties in southwestern Indiana,
including counties surrounding Evansville. Indiana Gas and SIGECO generally do
business as Vectren Energy Delivery of Indiana, Inc. The Ohio operations, owned
as a tenancy in common by Vectren Energy Delivery of Ohio, Inc. (VEDO), a wholly
owned subsidiary, (53% ownership) and Indiana Gas (47% ownership), provide
natural gas distribution and transportation services to 17 counties in west
central Ohio, including counties surrounding Dayton. VUHI's consolidated
operations are collectively referred to as the Utility Group.
The Company is also involved in nonregulated activities in four primary business
areas: Energy Marketing and Services, Coal Mining, Utility Infrastructure
Services, and Broadband. Energy Marketing and Services markets natural gas and
provides energy management services, including energy performance contracting
services. Coal Mining mines and sells coal and generates IRS Code Section 29 tax
credits relating to the production of coal-based synthetic fuels. Utility
Infrastructure Services provides underground construction and repair, facilities
locating, and meter reading services. Broadband has investments in broadband
communication services such as analog and digital cable television, high-speed
Internet and data services, and advanced local and long distance phone services.
In addition, the Nonregulated Group has other businesses that invest in
energy-related opportunities, real estate, and leveraged leases, among other
activities. The Nonregulated Group supports the Company's regulated utilities
pursuant to service contracts by providing natural gas supply services, coal,
utility infrastructure services, and other services. These operations are
collectively referred to as the Nonregulated Group.
The Utility Group generates revenue primarily from the delivery of natural gas
and electric service to its customers. The primary source of cash flow for the
Utility Group results from the collection of customer bills and the payment for
goods and services procured for the delivery of gas and electric services. The
results of the Utility Group are impacted by weather patterns in its service
territory and general economic conditions both in its service territory as well
as nationally.
The Nonregulated Group generates revenue or earnings from the provision of
services to customers. The activities of the Nonregulated Group are closely
linked to the utility industry, and the results of those operations are
generally impacted by factors similar to those impacting the overall utility
industry.
The Company has in place a disclosure committee that consists of senior
management as well as financial management. The committee is actively involved
in the preparation and review of the Company's SEC filings.
Executive Summary of Consolidated Results of Operations
The following discussion and analysis should be read in conjunction with the
unaudited condensed consolidated financial statements and notes thereto.
- -------------------------------------------------------------------------------
Three Months Nine Months
Ended September 30, Ended September 30,
------------------- -------------------
(In millions, except per share data) 2004 2003 2004 2003
- -------------------------------------------------------------------------------
Net income $ 9.7 $ 7.3 $ 67.8 $ 67.1
Attributed to:
Utility Group $ 4.5 $ 2.4 $ 51.9 $ 51.1
Nonregulated Group 5.9 5.7 17.2 17.6
Corporate & Other (0.7) (0.8) (1.3) (1.6)
- -------------------------------------------------------------------------------
Basic earnings per share $ 0.13 $ 0.10 $ 0.90 $ 0.97
Attributed to:
Utility Group $ 0.06 $ 0.03 $ 0.69 $ 0.74
Nonregulated Group 0.08 0.08 0.23 0.26
Corporate & Other (0.01) (0.01) (0.02) (0.03)
Results
For the three months ended September 30, 2004, net income was $9.7 million, or
$0.13 per share compared to net income of $7.3 million, or $0.10 per share for
the same period last year. For the nine months ended September 30, 2004,
reported earnings were $67.8 million, or $0.90 per share compared to $67.1
million, or $0.97 per share, for the same period in 2003. Of the reduction in
year-to-date earnings per share, $0.08 per share was attributable to an increase
in weighted average shares outstanding, resulting primarily from an equity
offering in August 2003.
Utility Group earnings were $4.5 million for the quarter compared to $2.4
million for the same period last year. The $2.1 million increase was primarily
due to the recovery of NOx related environmental expenditures, increased gas
base rates in the Vectren South territory, increased demand in large electric
customer margins, and higher earnings from wholesale power marketing operations.
Utility Group earnings were $51.9 million for the nine months ended September
30, 2004, compared to $51.1 million in the prior year. Earnings increased due to
the return on additional NOx related environmental expenditures which were
partially offset by reduced wholesale power activities. The Company estimates
that mild weather unfavorably impacted third quarter earnings by $2.2 million
after tax, or $0.03 per share, and year-to-date earnings by approximately $6.4
million after tax, or $0.09 per share over the prior year periods.
Nonregulated Group earnings were $5.9 million for the quarter, an increase of
$0.2 million over the prior year. The Company's three core nonregulated
businesses, Energy Marketing and Services, Coal Mining and Utility
Infrastructure Services, each improved their earnings contribution from 2003.
Improved nonregulated operating results exceeded the impact from the sale of the
Company's investment in Genscape, Inc. for $2.6 million after tax recorded in
the third quarter of 2003. Nonregulated earnings for the nine months ended
September 30, 2004, were $17.2 million compared to $17.6 million in the prior
year. The Company's three core nonregulated businesses, Energy Marketing and
Services, Coal Mining, and Utility Infrastructure Services, contributed $21.5
million in 2004, compared to $18.1 million in 2003. The 2004 nine month earnings
reflect charges of $6.0 million related to the write-down of the Company's
broadband businesses, which were partially offset by net gains from the
Company's investment in Haddington Energy Partners. The 2003 nine month earnings
reflect after-tax gains on the divesture of businesses, including Genscape,
totaling $1.4 million.
Dividends
Dividends declared for the three months ended September 30, 2004, were $0.285
per share compared to $0.275 per share for the same period in 2003. Dividends
declared for the nine months ended September 30, 2004, were $0.855 per share
compared to $0.825 per share for the same period in 2003. In October 2004, the
Board of Directors of Vectren Corporation (NYSE: VVC) declared a quarterly
dividend of $0.295 per share of common stock, an increase of 3.5%. The dividend
will be payable December 1, 2004 to shareholders of record at the close of
business on November 15, 2004.
Detailed Discussion of Results of Operations
Following is a more detailed discussion of the results of operations of the
Company's Utility Group and Nonregulated Group. The detailed results of
operations for the Utility Group and Nonregulated Group are presented and
analyzed before the reclassification and elimination of certain intersegment
transactions necessary to consolidate those results into the Company's
Consolidated Condensed Statements of Income. The operations of the Corporate and
Other Group are not significant.
Results of Operations of the Utility Group
The Utility Group is comprised of Vectren Utility Holdings, Inc.'s operations,
which consist of the Company's regulated operations (the Gas Utility Services
and Electric Utility Services operating segments), and other operations that
provide information technology and other support services to those regulated
operations. Gas Utility Services provides natural gas distribution and
transportation services in nearly two-thirds of Indiana and to west central
Ohio. Electric Utility Services provides electricity primarily to southwestern
Indiana, and includes the Company's power generating and marketing operations.
Results of operations of the Utility Group before certain intersegment
eliminations and reclassifications for the three and nine months ended September
30, 2004 and 2003, are summarized below:
- ------------------------------------------------------------------------------
Three Months Nine Months
Ended September 30, Ended September 30,
-------------------- ----------------------
(In millions, except per share amounts) 2004 2003 2004 2003
- ------------------------------------------------------------------------------
OPERATING REVENUES
Gas revenues $ 112.4 $ 115.0 $ 771.6 $ 788.8
Electric revenues 102.3 95.5 280.2 254.2
Other revenues - 0.2 0.5 0.6
- ------------------------------------------------------------------------------
Total operating revenues 214.7 210.7 1,052.3 1,043.6
- ------------------------------------------------------------------------------
OPERATING EXPENSES
Cost of gas 67.2 71.3 529.8 539.9
Fuel for electric generation 25.8 24.8 72.4 66.2
Purchased electric energy 5.3 4.2 16.6 12.5
Other operating 52.0 51.4 165.8 161.9
Depreciation & amortization 33.1 30.4 94.5 88.8
Taxes other than income taxes 9.6 9.2 42.4 41.8
- ------------------------------------------------------------------------------
Total operating expenses 193.0 191.3 921.5 911.1
- ------------------------------------------------------------------------------
OPERATING INCOME 21.7 19.4 130.8 132.5
OTHER INCOME (EXPENSE) - NET
Equity in earnings (losses) of
unconsolidated affiliates - (0.1) 0.2 (0.5)
Other income (expense) - net 2.3 2.3 3.8 1.0
- ------------------------------------------------------------------------------
Total other income (expense)
- net 2.3 2.2 4.0 0.5
- ------------------------------------------------------------------------------
Interest expense 16.7 17.1 50.2 49.5
- ------------------------------------------------------------------------------
INCOME BEFORE INCOME TAXES 7.3 4.5 84.6 83.5
- ------------------------------------------------------------------------------
Income taxes 2.8 2.1 32.7 32.4
- ------------------------------------------------------------------------------
NET INCOME $ 4.5 $ 2.4 $ 51.9 $ 51.1
==============================================================================
BASIC EARNINGS PER SHARE $ 0.06 $ 0.03 $ 0.69 $ 0.74
==============================================================================
Utility Group earnings were $4.5 million for the quarter compared to $2.4
million for the same period last year. The $2.1 million increase was primarily
due to the recovery of NOx related environmental expenditures, increased gas
base rates in the Vectren South territory, increased demand in large electric
customer margins, and higher earnings from wholesale power marketing operations.
Utility Group earnings were $51.9 million for the nine months ended September
30, 2004, compared to $51.1 million in the prior year. Earnings increased due to
the return on additional NOx related environmental expenditures which were
partially offset by reduced wholesale power activities. The Company estimates
that mild weather unfavorably impacted third quarter earnings by $2.2 million
after tax, or $0.03 per share, and year-to-date earnings by approximately $6.4
million after tax, or $0.09 per share over the prior year periods.
Throughout this discussion, the terms Gas Utility margin and Electric Utility
margin are used. Gas Utility margin and Electric Utility margin could be
considered non-GAAP measures of income. Gas Utility margin is calculated as Gas
Utility revenues less the Cost of gas. Electric Utility margin is calculated as
Electric Utility revenues less Fuel for electric generation and Purchased
electric energy. These measures exclude Other operating expenses, Depreciation
and amortization, and Taxes other than income taxes, which are included in the
calculation of operating income. The Company believes Gas Utility and Electric
Utility margins are better indicators of relative contribution than revenues
since gas prices and fuel costs can be volatile and are generally collected on a
dollar for dollar basis from customers. Margins should not be considered an
alternative to, or a more meaningful indicator of operating performance than,
operating income or net income as determined in accordance with accounting
principles generally accepted in the United States.
Significant Fluctuations
Utility Group Margin
Margin generated from the sale of natural gas and electricity to residential and
commercial customers is seasonal and impacted by weather patterns in the
Company's service territory. Margin generated from sales to large customers
(generally industrial, other contract, and firm wholesale customers) is impacted
primarily by overall economic conditions. Margin is also impacted by the
collection of state mandated taxes, which fluctuate with gas costs, and is also
impacted by some level of price sensitivity in volumes sold. Electric generating
asset optimization activities are primarily affected by market conditions, the
level of excess generating capacity, and electric transmission availability.
Following is a discussion and analysis of margin generated from regulated
utility operations.
Gas Utility Margin (Gas Utility Revenues less Cost of Gas Sold) Gas Utility
margin and throughput by customer type follows:
- --------------------------------------------------------------------------------
Three Months Nine Months
Ended September 30, Ended September 30,
------------------- -------------------
(In millions) 2004 2003 2004 2003
- --------------------------------------------------------------------------------
Residential & Commercial $ 35.5 $ 34.8 $ 198.8 $ 207.4
Contract 9.7 9.7 38.6 37.9
Other - (0.8) 4.4 3.6
- --------------------------------------------------------------------------------
Total gas utility margin $ 45.2 $ 43.7 $ 241.8 $ 248.9
================================================================================
Sold & transported volumes in MMDth:
To residential & commercial customers 6.7 7.0 76.1 82.5
To contract customers 17.5 18.1 65.3 66.9
- --------------------------------------------------------------------------------
Total throughput 24.2 25.1 141.4 149.4
===============================================================================
Gas utility margins were $45.2 million and $241.8 million for the three and nine
months ended September 30, 2004. This represents an increase in gas utility
margin in the third quarter, a non-heating base load usage quarter, of $1.5
million or 3%, and a decrease year-to-date of $7.1 million or 3%. The quarterly
increase is primarily due to increased base rates in the Vectren South service
territory. The 2003 quarter results also reflect a $0.7 million charge
associated with a PUCO GCR audit proceeding. These increases are offset by the
effects of weather which decreased gas utility margin an estimated $1.4 million.
Heating weather for the nine months ended September 30, 2004 was 9% warmer than
normal and 13% warmer than last year and had an estimated unfavorable impact on
gas utility margin of $11.7 million. The effects of weather have been partially
offset by residential and commercial customer growth and increased large
customer margins. Gas sold and transported volumes were 5% less for the nine
months ended September 30, 2004, compared to the prior year. The decreased
throughput was primarily attributable to weather and partially offset by
customer growth. The average cost per dekatherm of gas purchased for the nine
months ended September 30, 2004, was $6.76 compared to $6.44 in 2003.
Electric Utility Margin (Electric Utility Revenues less Fuel for Electric
Generation and Purchased Electric Energy) Electric Utility margin by revenue
type follows:
- -------------------------------------------------------------------------------
Three Months Nine Months
Ended September 30, Ended September 30,
- -------------------------------------------------------------------------------
(In millions) 2004 2003 2004 2003
- -------------------------------------------------------------------------------
Residential & commercial $ 46.4 $ 45.0 $ 122.0 $ 107.7
Industrial 16.2 13.3 46.5 38.4
Municipalities & other 4.3 5.5 13.1 14.6
- -------------------------------------------------------------------------------
Total retail & firm wholesale 66.9 63.8 181.6 160.7
- -------------------------------------------------------------------------------
Asset optimization 4.3 2.7 9.6 14.8
- -------------------------------------------------------------------------------
Total electric utility margin $ 71.2 $ 66.5 $ 191.2 $ 175.5
===============================================================================
Retail & Firm Wholesale Margin
Electric retail and firm wholesale utility margins were $66.9 million and $181.6
million for the three and nine months ended September 30, 2004. This represents
an increase over the same period last year of $3.1 million and $20.9 million,
respectively. Margins increased $4.5 million quarter over quarter and $12.4
million for the nine month period due to an increase in retail electric rates
related to the recovery of NOx related expenditures. Margin from residential and
commercial customers (excluding the effects of NOx) decreased $2.5 million for
the quarter due primarily to the estimated effect of weather and increased $5.2
million year to date due to both weather and increased usage. Excluding the
effects of NOx recovery, margins from industrial customers increased $1.2
million for the quarter and $3.9 million for the nine month period compared to
2003, which reflects some economic recovery. Weather for the quarter was 24%
cooler than normal and 18% cooler than last year. Weather for the nine month
period was 10% cooler than normal and 11% warmer than last year. The estimated
decrease in margin due to weather was $2.3 million for the quarter, and the
estimated increase in margin for the nine month period was $1.0 million. As the
recovery under the NOx rider is a volumetric charge, it is also estimated that
mild weather has reduced the level of NOx recovery by approximately $0.5 million
for the year to date. Due to the above factors, volumes sold increased 5% to
4.76 GWh for the nine months ended September 30, 2004, compared to 4.53 GWh in
2003.
Margin from Asset Optimization Activities
Periodically, generation capacity is in excess of that needed to serve native
load and firm wholesale customers. The Company markets this unutilized capacity
to optimize the return on its owned generation assets. Substantially all of the
margin from these activities is generated from contracts that are integrated
with portfolio requirements around power supply and delivery and are short-term
purchase and sale transactions that expose the Company to limited market risk.
Following is a reconciliation of asset optimization activity:
- ---------------------------------------------------------------------------------------------
Three Months Nine Months
Ended September 30, Ended September 30,
-------------------- --------------------
(In millions) 2004 2003 2004 2003
- ---------------------------------------------------------------------------------------------
Beginning of Period Net Asset Optimization
Position $ 2.2 $ 0.1 $ (0.4) $ (0.7)
Statement of Income Activity
Net mark-to-market (losses) gains realized (1.8) (0.5) (1.0) 0.4
Net realized gains recognized 6.1 3.2 10.6 14.4
- ---------------------------------------------------------------------------------------------
Asset optimization margin 4.3 2.7 9.6 14.8
- ---------------------------------------------------------------------------------------------
Net cash received & other adjustments (6.8) (2.8) (9.5) (14.1)
- ---------------------------------------------------------------------------------------------
End of Period Net Asset Optimization Position $(0.3) $ - $ (0.3) $ -
=============================================================================================
Net wholesale margins increased $1.6 million and decreased $5.2 million for the
three and nine month periods compared to last year. The change in margin both
for the quarter and nine month period is due largely to availability of excess
capacity. The year-to-date decrease in wholesale margins is attributable to an
increase in demand by native load customers due to both weather and increased
usage. Scheduled outages of owned generation, related to the installation of
environmental compliance equipment, has also reduced the year-over-year
availability of excess capacity.
Following is information regarding asset optimization activities included in
Electric utility revenues and Fuel for electric generation in the Statements of
Income:
- ------------------------------------------------------------------------------
Three Months Nine Months
Ended September 30, Ended September 30,
----------------------------------
(In millions) 2004 2003 2004 2003
- ------------------------------------------------------------------------------
Activity related to:
Sales contracts $ 64.5 $ 42.7 $ 107.2 $ 110.9
Purchase contracts (56.8) (38.0) (90.9) (89.7)
Net mark-to-market (losses)
gains realized (1.8) (0.5) (1.0) 0.4
- ------------------------------------------------------------------------------
Net asset optimization revenue 5.9 4.2 15.3 21.6
- ------------------------------------------------------------------------------
Fuel for electric generation 1.6 1.5 5.7 6.8
- ------------------------------------------------------------------------------
Asset optimization margin $ 4.3 $ 2.7 $ 9.6 $ 14.8
==============================================================================
Utility Group Operating Expenses
Other operating expenses and depreciation expense for the three and nine months
ended September 30, 2004, collectively increased $3.3 million and $9.6 million,
respectively, compared to 2003. For the quarter, NOx related operating expenses
increased $2.7 million (other operating expenses of $0.8 million and
depreciation of $1.9 million). For the nine months, NOx related operating
expenses increased $6.7 million (other operating expenses of $2.9 million and
depreciation of $3.8 million). The year-to-date remaining increase in other
operating expenses is primarily due to higher labor and benefit costs. The
remaining increases in depreciation expense are primarily due to normal
additions to utility plant.
Utility Group Total Other Income (Expense)
For the nine months ended September 30, 2004, total other income (expense)
increased $3.5 million compared to 2003. The increase was primarily attributable
to 2003 write-downs of the Company's investments in BABB International, which
totaled $3.9 million for the nine month period.
Utility Group Interest Expense
For the nine months ended September 30, 2004, interest expense increased $0.7
million compared to 2003. The increase reflects the July 2003 issuance of
long-term debt which included conversion of short-term variable rate debt to
fixed rate higher coupon long-term debt.
Environmental Matters
NOx SIP Call Matter
The Company has initiated steps toward compliance with Indiana's State
Implementation Plan (SIP) of the Clean Air Act (the Act). These steps include
installing Selective Catalytic Reduction (SCR) systems at Culley Generating
Station Unit 3 (Culley), Warrick Generating Station Unit 4, and A.B. Brown
Generating Station Units 1 and 2. SCR systems reduce flue gas NOx emissions to
atmospheric nitrogen and water using ammonia in a chemical reaction. This
technology is known to currently be the most effective method of reducing
nitrogen oxide (NOx) emissions where high removal efficiencies are required.
The IURC has issued orders that approve:
>> the Company's project to achieve environmental compliance by investing
in clean coal technology;
>> a total capital cost investment for this project up to $244 million
(excluding AFUDC), subject to periodic review of the actual costs
incurred;
>> a mechanism whereby, prior to an electric base rate case, the Company
may recover through a rider that is updated every six months, an eight
percent return on its weighted capital costs for the project; and
>> ongoing recovery of operating costs, including depreciation and
purchased emission allowances through a rider mechanism, related to the
clean coal technology once the facility is placed into service.
Based on the level of system-wide emissions reductions required and the control
technology utilized to achieve the reductions, the current estimated
construction cost is consistent with amounts approved in the IURC's orders.
Through September 30, 2004, $207 million has been expended, and three of the
four SCR's are operational. After the equipment is installed and operational,
related annual operating expenses, including depreciation expense, are estimated
to be between $24 million and $27 million. The Company is recovering the
operational costs associated with the SCR's and related technology. The 8
percent return on capital investment approximates the return authorized in the
Company's last electric rate case in 1995 and includes a return on equity.
The Company has achieved timely compliance through the reduction of the
Company's overall NOx emissions to levels compliant with Indiana's NOx emissions
budget allotted by the USEPA. Therefore, the Company has recorded no accrual for
potential penalties that may result from noncompliance.
Manufactured Gas Plants
In the past, Indiana Gas, SIGECO, and others operated facilities for the
manufacture of gas. Given the availability of natural gas transported by
pipelines, these facilities have not been operated for many years. Under
currently applicable environmental laws and regulations, Indiana Gas, SIGECO,
and others may now be required to take remedial action if certain byproducts are
found above the regulatory thresholds at these sites.
Indiana Gas has identified the existence, location, and certain general
characteristics of 26 gas manufacturing and storage sites for which it may have
some remedial responsibility. Indiana Gas has completed a remedial
investigation/feasibility study (RI/FS) at one of the sites under an agreed
order between Indiana Gas and the IDEM, and a Record of Decision was issued by
the IDEM in January 2000. Although Indiana Gas has not begun an RI/FS at
additional sites, Indiana Gas has submitted several of the sites to the IDEM's
Voluntary Remediation Program (VRP) and is currently conducting some level of
remedial activities, including groundwater monitoring at certain sites, where
deemed appropriate, and will continue remedial activities at the sites as
appropriate and necessary.
In conjunction with data compiled by environmental consultants, Indiana Gas has
accrued the estimated costs for further investigation, remediation, groundwater
monitoring, and related costs for the sites. While the total costs that may be
incurred in connection with addressing these sites cannot be determined at this
time, Indiana Gas has recorded costs that it reasonably expects to incur
totaling approximately $20.4 million.
The estimated accrued costs are limited to Indiana Gas' proportionate share of
the remediation efforts. Indiana Gas has arrangements in place for 19 of the 26
sites with other potentially responsible parties (PRP), which serve to limit
Indiana Gas' share of response costs at these 19 sites to between 20% and 50%.
With respect to insurance coverage, Indiana Gas has received and recorded
settlements from all known insurance carriers in an aggregate amount
approximating $20.4 million.
Environmental matters related to manufactured gas plants have had no material
impact on earnings since costs recorded to date approximate PRP and insurance
settlement recoveries. While Indiana Gas has recorded all costs which it
presently expects to incur in connection with activities at these sites, it is
possible that future events may require some level of additional remedial
activities which are not presently foreseen.
In October 2002, the Company received a formal information request letter from
the IDEM regarding five manufactured gas plants owned and/or operated by SIGECO
and not currently enrolled in the IDEM's VRP. In response, SIGECO submitted to
the IDEM the results of preliminary site investigations conducted in the
mid-1990's. These site investigations confirmed that based upon the conditions
known at the time, the sites posed no risk to human health or the environment.
Follow up reviews have been initiated by the Company to confirm that the sites
continue to pose no such risk.
On October 6, 2003, SIGECO filed applications to enter four of the manufactured
gas plant sites in IDEM's VRP. The remaining site is currently being addressed
in the VRP by another Indiana utility. SIGECO added those four sites into the
renewal of the global Voluntary Remediation Agreement that Indiana Gas has in
place with IDEM for its manufactured gas plant sites. That renewal was approved
by the IDEM on February 24, 2004. On July 13, 2004, SIGECO filed a declaratory
judgment action against its insurance carriers seeking a judgment finding its
carriers liable under the policies for coverage of further investigation and any
necessary remediation costs that SIGECO may accrue under the VRP program. The
total investigative costs, and if necessary, costs of remediation at the four
SIGECO sites, as well as the amount of any PRP or insurance recoveries, cannot
be determined at this time.
Jacobsville Superfund Site
On July 22, 2004, the USEPA listed the Jacobsville Neighborhood Soil
Contamination site in Evansville, Indiana, on the National Priorities List under
the Comprehensive Environmental Response, Compensation and Liability Act
(CERCLA). The USEPA has identified four sources of historic lead contamination.
These four sources shut down manufacturing operations years ago. When drawing up
the boundaries for the listing, the USEPA included a 250 acre block of
properties surrounding the Jacobsville neighborhood, including Vectren's Wagner
Operations Center. Vectren's property has not been named as a source of the lead
contamination, nor does the USEPA's soil testing to date indicate that the
Vectren property contains lead contaminated soils. Vectren's own soil testing,
completed during the construction of the Operations Center did not indicate that
the Vectren property contains lead contaminated soils. At this time, Vectren
anticipates only additional soil testing, if required by the USEPA.
Rate & Regulatory Matters
Vectren South (SIGECO) Gas Base Rate Settlement
On March 12, 2004, Vectren South filed a petition with the IURC to adjust its
base rates and charges for its gas distribution business in southwestern Indiana
to recover the ongoing cost of operating and maintaining the approximately
3,000-mile distribution and storage system used to serve more than 110,000
customers. On June 30, 2004, the IURC approved a $5.7 million base rate increase
for Vectren South's gas distribution business in southwestern Indiana. The rate
settlement only addresses Vectren South's "non-gas" costs which are incurred to
build, operate, and maintain the pipelines, other equipment and systems that are
used to deliver gas across Vectren South's system to its customers. The base
rate change was implemented on July 1, 2004.
The order also permits Vectren South to recover the on-going costs associated
with Vectren South's compliance with the federal Pipeline Safety Improvement Act
of 2002. Implementation of these compliance activities will include additional
patrols, leakage surveys and direct observation of approximately 90 miles of
Vectren South's transmission pipeline system. The Pipeline Safety Improvement
Tracker provides for the recovery of up to $750,000 the first year and $500,000
thereafter, subject to OUCC review and IURC approval that the costs are
prudently incurred. Any costs incurred in excess of these levels will be
deferred for future recovery.
Vectren North (Indiana Gas) Pending Base Rate Settlement
On March 19, 2004, Vectren North filed a petition with the IURC to adjust its
base rates and charges for its gas distribution business in a 49 county region
covering central and southeastern Indiana. On October 12, 2004, the Company
announced a settlement agreement with several parties, including the Indiana
Office of Utility Consumer Counselor, the Indiana Gas Industrial Group, and the
Citizens Action Coalition of Indiana, Inc. The settlement agreement provides for
a $24 million increase in Vectren North's base distribution rates to cover the
ongoing cost of operating, maintaining and expanding the approximately
12,000-mile distribution and storage system used to serve more than 545,000
customers. Once implemented, the new rate design will include a larger service
charge, which is intended to address to some extent earnings volatility related
to weather. The settlement also permits Vectren North to recover the on-going
costs associated with the federal Pipeline Safety Improvement Act of 2002. The
Pipeline Safety Improvement Tracker provides for the recovery of incremental
non-capital dollars, capped at $2.5 million per year. Costs in excess of the
annual cap are to be deferred for future recovery. The IURC will hold a hearing
on the settlement on November 22, 2004, and Commission action is expected
shortly thereafter.
VEDO Pending Base Rate Filing
On April 16, 2004, VEDO issued a pre-filing notice to the PUCO of a request to
adjust base rates and charges for VEDO's gas distribution business in a
17-county region covering west central Ohio. On May 24, 2004, the official
application and Standard Filing Requirements were filed with the PUCO. If the
filing is approved, VEDO expects to increase base rates up to $25 million to
recover the ongoing cost of operating, maintaining and expanding the
approximately 5,200-mile distribution system used to serve more than 310,000
customers. VEDO's request is subject to review and approval by the PUCO. The
petition only addresses VEDO's "non-gas costs," which are incurred to build,
operate and maintain pipelines, other equipment and systems that are used to
deliver gas across VEDO's system to its customers. The filing also includes a
proposed conservation tariff, which, if approved, will enable the Company to
proactively support conservation and promote home weatherization and the
reduction of energy consumption. Based on the PUCO's regulatory process, the
PUCO staff report relating to the Company's request is expected to be submitted
in November 2004. Based upon the PUCO's actions in other proceedings, the
Company would expect a Commission order in this case late in the first quarter
of 2005.
Gas Cost Recovery (GCR) Audit Proceedings
There is an Ohio requirement that Ohio gas utilities undergo a biannual audit of
their gas acquisition practices in connection with the gas cost recovery (GCR)
mechanism. In the case of VEDO, the two-year audit period ended in November
2002. The audit provides the initial review of the portfolio administration
arrangement between VEDO and ProLiance. The external auditor retained by the
PUCO staff submitted an audit report in the fall of 2003 wherein it recommended
a disallowance of approximately $7 million of previously recovered gas costs.
The Company believes a large portion of the third party auditor recommendations
is without merit. A hearing has been held, and the PUCO staff has recommended an
approximate $6 million disallowance. The Ohio Consumer Counselor has recommended
an approximate $12 million disallowance, which includes interest. For this PUCO
audit period, any disallowance relating to the Company's ProLiance arrangement
will be shared by the Company's joint venture partner. Based on a review of the
matters, the Company has recorded $1.9 million for its estimated share of any
potential disallowance. A PUCO decision on this matter is yet to be issued. The
Company is also unable to determine the effects that a PUCO decision may have on
results in audit periods beginning after November 2002.
Results of Operations of the Nonregulated Group
The Company is also involved in nonregulated activities in three primary
business areas: Energy Marketing and Services, Coal Mining, and Utility
Infrastructure Services. Energy Marketing and Services markets natural gas and
provides energy management services, including energy performance contracting
services. Coal Mining mines and sells coal and generates IRS Code Section 29
investment tax credits relating to the production of coal-based synthetic fuels.
Utility Infrastructure Services provides underground construction and repair,
facilities locating, and meter reading services. In addition, the Nonregulated
Group has other businesses and investments that provide broadband communication
services and utility services and that invest in energy-related opportunities,
real estate, and leveraged leases. The Nonregulated Group supports the Company's
regulated utilities pursuant to service contracts by providing natural gas
supply services, coal, utility infrastructure services, and other services. The
results of operations of the Nonregulated Group before certain intersegment
eliminations and reclassifications for the three and nine months ended September
30, 2004 and 2003, follow:
- ----------------------------------------------------------------------------------
Three Months Nine Months
Ended September 30, Ended September 30,
-------------------- -------------------
(In millions, except per share amounts) 2004 2003 2004 2003
- ----------------------------------------------------------------------------------
Energy services & other revenues $ 61.8 $ 50.2 $ 186.3 $ 151.1
Operating expenses:
Cost of energy services & other
revenues 49.1 42.4 151.3 125.3
Operating expenses 10.5 8.8 32.7 27.2
- ----------------------------------------------------------------------------------
Total expenses 59.6 51.2 184.0 152.5
- ----------------------------------------------------------------------------------
OPERATING INCOME (LOSS) 2.2 (1.0) 2.3 (1.4)
OTHER INCOME (EXPENSE) - NET
Equity in (losses) earnings of
unconsolidated affiliates 1.5 (2.2) 13.3 6.9
Other income (expense) - net 1.2 6.9 (2.7) 6.9
- ----------------------------------------------------------------------------------
Total other income (expense) 2.7 4.7 10.6 13.8
- ----------------------------------------------------------------------------------
Interest expense 2.8 2.5 8.1 7.3
- ----------------------------------------------------------------------------------
INCOME BEFORE TAXES 2.1 1.2 4.8 5.1
Income tax (3.8) (4.5) (12.5) (12.6)
Minority interest in consolidated
subsidiaries - - 0.1 0.1
- ----------------------------------------------------------------------------------
NET INCOME $ 5.9 $ 5.7 $ 17.2 $ 17.6
==================================================================================
BASIC EARNINGS PER SHARE $ 0.08 $ 0.08 $ 0.23 $ 0.26
==================================================================================
NET INCOME (LOSS) ATTRIBUTED TO:
Energy Marketing & Services $ 1.1 $ 0.2 $ 9.1 $ 9.4
Coal Mining 3.7 2.8 11.1 9.7
Utility Infrastructure 1.4 0.2 1.3 (1.0)
Broadband - - (3.3) (1.2)
Other Businesses (0.3) 2.5 (1.0) 0.7
Nonregulated Group earnings were $5.9 million for the quarter, an increase of
$0.2 million over the prior year. The Company's three core nonregulated
businesses, Energy Marketing and Services, Coal Mining and Utility
Infrastructure Services, each improved their earnings contribution from 2003.
Improved nonregulated operating results exceeded the impact from the sale of the
Company's investment in Genscape, Inc. for $2.6 million after tax recorded in
the third quarter of 2003. Nonregulated earnings for the nine months ended
September 30, 2004, were $17.2 million compared to $17.6 million in the prior
year. The Company's three core nonregulated businesses, Energy Marketing and
Services, Coal Mining, and Utility Infrastructure Services, contributed $21.5
million in 2004, compared to $18.1 million in 2003. The 2004 nine month earnings
reflect charges of $6.0 million related to the write-down of the Company's
broadband businesses, which were partially offset by net gains from the
Company's investment in Haddington Energy Partners. The 2003 nine month earnings
reflect after-tax gains on the divesture of businesses, including Genscape,
totaling $1.4 million.
Energy Marketing & Services
Energy Marketing and Services is comprised of the Company's gas marketing
operations, performance contracting operations, and its retail gas supply
operations.
Gas marketing operations are performed through the Company's investment in
ProLiance Energy LLC (ProLiance), a nonregulated energy marketing affiliate of
Vectren and Citizens Gas and Coke Utility. ProLiance provides natural gas and
related services to the Company's regulated utilities and nonregulated gas
retail operations. ProLiance's primary businesses include gas marketing, gas
portfolio optimization, and other portfolio and energy management services.
ProLiance's primary customers are its members' utilities and other large end-use
customers.
Energy Systems Group, LLC (ESG) provides energy performance contracting and
facility upgrades through its design and installation of energy-efficient
equipment throughout the Midwest. ESG recently acquired Progress Energy
Solutions, expanding its operations throughout the Southeast and Mid-Atlantic
United States.
Vectren Retail, LLC (d/b/a Vectren Source) provides natural gas and other
related products and services in Ohio and Indiana, serving just over 90,000
customers opting for choice among energy providers. In June, Vectren Source was
certified by the Georgia Public Service Commission and has begun initial
marketing efforts in the Atlanta Gas Light Company service territory.
Net income generated by Energy Marketing and Services for the three months ended
September 30, 2004, was $1.1 million compared to $0.2 million in 2003. Net
income generated by Energy Marketing and Services for the nine months ended
September 30, 2004, was $9.1 million compared to $9.4 million in 2003. Gas
marketing operations, performed through ProLiance, contributed quarterly
earnings of $1.6 million in 2004 compared to $0.6 million in 2003. Earnings from
ProLiance for the nine months ended September 30, 2004 were $10.2 million
compared to $10.7 million in 2003. Quarterly earnings from ProLiance have
increased due to gains from storage optimization and reserves established in
2003 for the contingency described below. The nine month decrease results
principally from unprecedented volatility in gas prices in March 2003. For the
nine months ended September 30, 2004, Vectren Source's operations have operated
at a loss of $0.9 million, an improvement of $1.1 million compared to 2003. The
increases are principally due to increased customers and margins per unit of
throughput. Earnings from performance contracting operations, performed through
ESG, have increased for the quarter by $0.6 million and are relatively unchanged
year over year. Current backlog remains at a high level.
ProLiance Contingency
There is currently a lawsuit pending in the United States District Court for the
Northern District of Alabama filed by the City of Huntsville, Alabama d/b/a
Huntsville Utilities, Inc. (Huntsville Utilities) against ProLiance. Huntsville
Utilities asserts claims based on negligent provision of portfolio services
and/or pricing advice, fraud, fraudulent inducement, and other theories. These
claims relate generally to several basic arguments: 1) negligence in providing
advice and/or administering portfolio arrangements; 2) alleged promises to
provide gas at a below-market rate; 3) the creation and repayment of a "winter
levelizing program" instituted by ProLiance in conjunction with the manager of
Huntsville's Gas Utility, to allow Huntsville Utilities to pay its gas bills
over an extended period of time coupled with the alleged ignorance about the
program on the part of Huntsville Utilities' Gas Board, and; 4) the sale of
Huntsville Utilities' gas storage supplies to repay the balance owed on the
winter levelizing program and the authority of Huntsville Utilities' gas manager
to approve those sales. In a press conference on May 21, 2002, Huntsville
Utilities asserted its monetary damages to be approximately $10 million, and
seeks to treble that amount. ProLiance has made counterclaims asserting breach
of contract, among others, based on Huntsville Utilities' refusal to take gas
under fixed price agreements. Both parties have denied the charges contained in
the respective claims.
In 2003, ProLiance established reserves for amounts due from Huntsville
Utilities due to uncertainties surrounding collection. ProLiance believes its
actions were proper under the contract and amendments signed by the manager of
Huntsville's Gas Utility, and is vigorously defending the suit. ProLiance is
insured under a policy providing defense costs which may provide in whole or in
part, indemnification within the policy limits for claims asserted against
ProLiance. Accordingly, no other loss contingencies have been recorded at this
time. However, it is not possible to predict or determine the outcome of this
litigation and accordingly there can be no assurance that ProLiance will
prevail. It is not currently expected that costs associated with this matter
will have a material adverse effect on Vectren's consolidated financial position
or liquidity but an unfavorable outcome could possibly be material to Vectren's
earnings.
Coal Mining
The Coal Mining Group mines and sells coal to the Company's utility operations
and to other third parties through its wholly owned subsidiary Vectren Fuels,
Inc. (Fuels). The Coal Mining Group also generates IRS Code Section 29 tax
credits relating to the production of coal-based synthetic fuels through its
8.3% ownership interest in Pace Carbon Synfuels, LP (Pace Carbon). Pace Carbon
developed, owns, and operates four projects to produce and sell coal-based
synthetic fuel (synfuel) utilizing Covol technology. Vectren accounts for is
investment in Pace Carbon using the equity method. In addition, Fuels receives
synfuel-related fees from synfuel producers unrelated to Pace Carbon for a
portion of its coal production.
Coal Mining net income for the three months ended September 30, 2004, was $3.7
million compared to $2.8 million in 2003. Coal Mining net income for the nine
months ended September 30, 2004, was $11.1 million compared to $9.7 million in
2003. Mining operations have increased earnings for the quarter and year-to-date
by $1.0 million and $1.8 million, respectively. The increases were primarily due
to improved affiliate pricing, improved market prices for coal, and better
mining conditions. Synfuel-related results for the quarter, which include
earnings from Pace Carbon and synfuel processing fees earned by Fuels, were
generally flat for the quarter and have decreased $0.4 million year-to-date due
to the production of less synthetic fuel compared to 2003 by Pace Carbon due to
feed stock problems at one of the four plants, which is currently being
relocated. Section 29 tax credits are recorded in Income taxes.
IRS Section 29 Tax Credit Recent Developments
Under Section 29 of the Internal Revenue Code, manufacturers such as Pace Carbon
receive a tax credit for every ton of synthetic fuel sold. To qualify for the
credits, the synthetic fuel must meet three primary conditions: 1) there must be
a significant chemical change in the coal feedstock, 2) the product must be sold
to an unrelated person, and 3) the production facility must have been placed in
service before July 1, 1998.
In past rulings, the Internal Revenue Service (IRS) has concluded that the
synthetic fuel produced at the Pace Carbon facilities should qualify for Section
29 tax credits. The IRS issued a private letter ruling with respect to the four
projects on November 11, 1997, and subsequently issued an updated private letter
ruling on September 23, 2002.
As a partner in Pace Carbon, Vectren has reflected total tax credits under
Section 29 in its consolidated results through September 30, 2004, of
approximately $52.2 million. To date, Vectren has been in a position to fully
utilize the credits generated.
During June 2001, the IRS began a tax audit of Pace Carbon for the 1998 tax year
and later expanded the audit to include tax years 1999, 2000, and 2001. In May
2004, the IRS completed its audit of the 1998 to 2001 tax returns of Pace Carbon
requesting only minor modifications to previously filed returns. There were no
changes to any of the filed Section 29 tax credit calculations. The Permanent
Subcommittee on Investigations of the U.S. Senate's Committee on Governmental
Affairs, however, has an ongoing investigation on the subject of these income
tax credits.
Vectren believes it is justified in its reliance on the private letter rulings
and recent IRS audit results for the Pace Carbon facilities. However, at this
time, Vectren cannot provide any assurance as to the outcome that these
uncertainties may have on Vectren's consolidated financial position or
liquidity.
Further, Section 29 tax credits are only available when the price of oil is less
than prices specified by the tax code, as adjusted for inflation. The Company
does not believe that credits realized in 2004 and prior years will be affected
by the limitation, but an average annual wellhead price in the lower $50 per
barrel range, could limit Section 29 tax credits in 2005 and beyond.
Utility Infrastructure Services
Utility Infrastructure Services provides underground construction and repair to
gas, water, electric and telecommunications companies primarily through its
investment in Reliant Services, LLC (Reliant) and Reliant's 100% ownership in
Miller Pipeline. Reliant is a 50% owned strategic alliance with an affiliate of
Cinergy Corp. and is accounted for using the equity method of accounting.
Infrastructure's income for the quarter was $1.4 million, an improvement of $1.2
million from 2003. Infrastructure's results year-to-date were $1.3 million, an
improvement of $2.3 million over 2003. The increases are primarily driven by
continued increases in utility and municipal waste water construction and repair
spending during the second and third quarters of 2004.
Broadband and Other Businesses
Activities within the Broadband and Other Businesses Groups decreased earnings
for the quarter and year-to-date by $2.8 million and $3.8 million, respectively.
These decreases result primarily from the Company's broadband-related
investments and its 2003 sale of Genscape, offset in the year-to-date period by
earnings from the Haddington Energy Partnerships.
During 2004, the Company continued to evaluate strategic alternatives for its
broadband investments and concluded that it is unlikely that it would be making
additional investments in its franchises in the Indianapolis and Dayton markets.
As a result, the Company recorded impairment charges for its investment in
Utilicom related activities, totaling $3.6 million after tax. Consistent with
long-term strategic objectives, the Company ceased operations of Vectren
Communications Services, Inc., a municipal broadband consulting business, during
the second quarter of 2004. This resulted in year-to-date losses of $2.4 million
after tax primarily from inventory write downs, cessation accruals, and other
costs. In total, charges associated with broadband related businesses and
investments totaled $6.0 million after tax for the nine months ended September
30, 2004. The nine months ended September 30, 2003, also includes a $1.2 million
after tax loss resulting from the sale of First Mile Technologies.
In the third quarter of 2003, the Company sold its investment in Genscape, a
company that provides real-time power plant and transmission line status
information using wireless technology, for $5.4 million in proceeds to an
unrelated party, resulting in an after tax gain of approximately $2.6 million.
In total, year over year earnings have decreased $7.4 million resulting from
current year broadband-related write downs and charges and prior year
divestitures.
Haddington Energy Partnerships, a component of the Other Businesses Group, are
equity method investments that invest in energy-related ventures. During the
nine months ended September 30, 2004, these partnerships sold their investments
in SAGO Energy, LP, (SAGO) for cash. The Company recognized its portion of the
pre-tax gain totaling $9.0 million ($5.3 million after tax). These earnings were
partially offset by Haddington's write-down of Nations Energy Holdings, of which
Vectren's portion was $5.9 million ($3.5 million after tax). In total, earnings
from Haddington for the nine months ended September 30, 2004, are $2.1 million
compared to a loss of $0.5 million in 2003.
Significant Fluctuations of Consolidated Operations
Revenues and Cost of Revenues
For the three months ended September 30, 2004, nonregulated revenues and cost of
revenues increased $11.6 million and $6.7 million, respectively, compared to
2003. For the nine months ended September 30, 2004, nonregulated revenues and
cost of revenues increased $35.2 million and $26.0 million, respectively. The
principal reason for the increases in quarterly amounts is due to the timing of
performance contracting operations and increased coal mining activity. The
operations of Vectren Source contributed to the majority of the increase in
revenues and costs year over year due to increased customers, consumption, and
average selling prices. For the nine months ended September 30, 2004, Vectren
Source's revenues increased $26.3 million to $51.4 million and its cost of
revenues increased $22.5 million to $44.9 million. The remaining year-to-date
increases are due principally to mining operations. Margins from gas retail
operations and coal mining operations increased $3.9 million to $6.5 million and
$5.7 million to $17.7 million, respectively, for the nine months ended September
30, 2004, compared to 2003.
Operating Expenses
For the three and nine months ended September 30, 2004, operating expenses
increased $1.7 million and $5.5 million, respectively, compared to 2003. The
quarterly increase is primarily attributable to increased gas retail marketing
expenses due to the entry into the Georgia market and higher amortization of
mine development costs. The year-to-date increase not only includes higher
marketing costs and mine development amortization, but also includes
broadband-related charges for inventory write downs, cessation charges, and
other costs.
Significant Fluctuations of Unconsolidated Affiliates and Investments
Equity in Earnings of Unconsolidated Affiliates
The primary components of equity in earnings of unconsolidated affiliates
involve the results of ProLiance, Reliant, the Haddington partnerships, and Pace
Carbon.
For the three months ended September 30, 2004, the Company's portion of
ProLiance's earnings was $2.7 million compared to $1.1 million in 2003. For the
nine months ended September 30, 2004, the Company's portion of ProLiance's
earnings was $17.3 million compared to $18.0 million in 2003.
For the three months ended September 30, 2004, the Company's portion of
Reliant's earnings was $1.7 million compared to $0.5 million in 2003. For the
nine months ended September 30, 2004, the Company's portion of Reliant's
earnings was $2.1 million compared to breakeven in 2003.
For the three months ended September 30, 2004, the Company's portion of the
Haddington Partnerships' earnings was $0.4 million compared to breakeven in
2003. For the nine months ended September 30, 2004, the Company's portion of the
Haddington partnerships' earnings was $4.2 million compared to a loss of $0.2
million in 2003.
For the three months ended September 30, 2004 and 2003, the Company's portion of
Pace Carbon losses was $2.9 million in both periods. For nine months ended
September 30, 2004 and 2003, the Company's portion of Pace Carbon losses was
$9.5 million and $9.3 million, respectively.
Other Income (Expense) - Net
Other income (expense) - net reflects $6.0 million of impairment charges
associated with the broadband-related investments incurred during the nine
months ended September 30, 2004 and a $2.0 million loss associated with the sale
of First Mile in the nine months ended September 30, 2003. The three and nine
months ended September 30, 2003, includes $5.4 million in proceeds resulting
from the sale of Genscape.
Impact of Recently Issued Accounting Guidance
SFAS No. 132 (Revised 2003)
In December 2003, FASB issued SFAS No. 132 (revised 2003), "Employers'
Disclosures about Pensions and Other Postretirement Benefits" (SFAS 132), to
improve financial statement disclosures for defined benefit and other
postretirement benefit plans. The incremental annual disclosure requirements
were reflected in the Company's Form 10-K for the year ended December 31, 2003.
The adoption did not impact the Company's results of operations or financial
condition. The incremental interim disclosure requirements are included in these
financial statements in Note 6.
FIN 46/46R (Revised in December 2003)
In January 2003, the FASB issued Interpretation 46, "Consolidation of Variable
Interest Entities" (FIN 46). FIN 46 addresses consolidation by business
enterprises of variable interest entities (VIE) and significantly changes the
consolidation requirements for those entities. FIN 46 is intended to achieve
more consistent application of consolidation policies related to VIE's and thus
improves comparability between enterprises engaged in similar activities when
those activities are conducted through VIE's. In December 2003, the FASB
completed its deliberations of proposed modifications to FIN 46 and decided to
codify both the proposed modifications and other decisions previously issued
through certain FASB Staff Positions into one document that was issued as a
revision to the original Interpretation (FIN 46R). FIN 46R currently applies to
VIE's created after January 31, 2003, and to VIE's in which an enterprise
obtains an interest after that date. For entities created prior to January 31,
2003, FIN 46R is to be adopted no later than the end of the first interim or
annual reporting period ending after March 15, 2004.
The Company has neither created nor obtained an interest in a VIE since January
31, 2003. Certain other entities that the Company was involved with prior to
that date have been evaluated and determined to be VIE's. The Company has
investments in partnership-like structures as a limited partner or as a
subordinated lender. The activities of these entities are to purchase or
construct as well as operate multifamily housing and office properties. The
Company's exposure to loss is limited to its investment which as of September
30, 2004, and December 31, 2003, totaled $16.2 million and $17.1 million,
respectively, of Investments in unconsolidated affiliates, and $16.7 million and
$20.9 million, respectively, of Other investments. The Company is also the
equity owner in three leveraged leases where its exposure to loss is limited to
its net investment which as of September 30, 2004, and December 31, 2003,
totaled $6.9 million and $6.0 million, respectively. The Company did not
consolidate any of these entities upon adoption of FIN 46R.
EITF 03-01
In March 2004, the EITF issued a consensus on Issue No. 03-01, "The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments"
(EITF 03-01). In EITF 03-01, the Task Force developed a basic model for
evaluating whether investments within the scope of EITF 03-01, which includes
cost method and equity method investments, have other-than-temporary impairment.
The basic model includes three steps: 1) determine if there is impairment; 2) if
there is impairment, decide whether it is temporary or other than temporary; and
3) if it is other than temporary, recognize it in earnings. EITF 03-01 also
requires certain qualitative and quantitative disclosure of material impairments
judged to be temporary. The EITF has yet to finalize Steps 2 and 3. Step 1 and
the disclosure requirements are currently effective, and the adoption of those
portions of the EITF did not have a material effect on the Company.
During 2004, the Company has incurred an other-than-temporary impairment charge
associated with its cost method investment in SIGECOM, LLC, totaling $3.8
million and impairment charges associated with other broadband-related notes
totaling $2.2 million. The Company is continuing to assess strategic
alternatives for its broadband investments. While it currently believes that the
book value of those investments approximates fair value, further changes in
estimated fair value may occur.
SEC Inquiry regarding PUHCA Exemption
In July 2004, the Company received a letter from the SEC regarding its exempt
status under the Public Utility Holding Company Act of 1935 (PUHCA). The letter
asserts that Vectren's out of state electric power sales exceed the amount
previously determined by the SEC to be acceptable in order to qualify for the
exemption. Vectren claims exemption from registration under Section 3(a)(1) of
PUHCA by rule 2. As required by the rule, Vectren files an annual statement on
SEC Form U-3A-2. The Company has responded to the SEC inquiry and filed an
amended Form U-3A-2 for the year ended December 31, 2003.
Financial Condition
Within Vectren's consolidated group, VUHI funds the short-term and long-term
financing needs of the Utility Group operations, and Vectren Capital Corp.
(Vectren Capital) funds short-term and long-term financing needs of the
Nonregulated Group and corporate operations. Vectren Corporation guarantees
Vectren Capital's debt, but does not guarantee VUHI's debt. Vectren Capital's
long-term and short-term obligations outstanding at September 30, 2004, totaled
$113.0 million and $97.1 million, respectively. VUHI's outstanding long-term and
short-term borrowing arrangements are jointly and severally guaranteed by
Indiana Gas, SIGECO, and VEDO. VUHI's long-term and short-term obligations
outstanding at September 30, 2004, totaled $550.0 million and $210.6 million,
respectively. Additionally, prior to VUHI's formation, Indiana Gas and SIGECO
funded their operations separately, and therefore, have long-term debt
outstanding funded solely by their operations.
The Company's common stock dividends are primarily funded by utility operations.
Nonregulated operations have demonstrated sustained profitability, and the
ability to generate cash flows. These cash flows are used to fund a portion of
the Company's dividends, are reinvested in other nonregulated ventures, and from
time to time may be reinvested in utility operations or used for corporate
expenses.
VUHI's and Indiana Gas' credit ratings on outstanding senior unsecured debt at
September 30, 2004, are A-/Baa1 as rated by Standard and Poor's Ratings Services
(Standard and Poor's) and Moody's Investors Service (Moody's), respectively.
SIGECO's credit ratings on outstanding senior unsecured debt are BBB+/Baa1.
SIGECO's credit ratings on outstanding secured debt are A-/A3. VUHI's commercial
paper has a credit rating of A-2/P-2. Vectren Capital's senior unsecured debt is
rated BBB+/Baa2. Moody's current outlook is stable while Standard and Poor's
current outlook is negative. The ratings of Moody's and Standard and Poor's are
categorized as investment grade and are unchanged from December 31, 2003. A
security rating is not a recommendation to buy, sell, or hold securities. The
rating is subject to revision or withdrawal at any time, and each rating should
be evaluated independently of any other rating. Standard and Poor's and Moody's
lowest level investment grade rating is BBB- and Baa3, respectively.
The Company's consolidated equity capitalization objective is 45-55% of total
capitalization. This objective may have varied, and will vary, depending on
particular business opportunities, capital spending requirements, and seasonal
factors that affect the Company's operation. The Company's equity component was
50% and 49% of total capitalization, including current maturities of long-term
debt and long-term debt subject to tender, at September 30, 2004, and December
31, 2003, respectively.
Sources & Uses of Liquidity
Operating Cash Flow
The Company's primary and historical source of liquidity to fund working capital
requirements has been cash generated from operations, which for the nine months
ended September 30, 2004 and 2003, was $206.6 million and $136.0 million,
respectively. The increase of $70.6 million is primarily the result of favorable
changes in working capital accounts offset by decreased earnings before non-cash
charges. The decreased earnings before non-cash charges result principally from
expected payments of alternative minimum taxes, which can be carried forward to
offset future tax liabilities.
Financing Cash Flow
Although working capital requirements are generally funded by cash flow from
operations, the Company uses short-term borrowings to supplement working capital
needs when accounts receivable balances are at their highest and gas storage is
refilled. Additionally, short-term borrowings are required for capital projects
and investments until they are permanently financed.
Cash flow required for financing activities of $37.8 million for the nine months
ended September 30, 2004, includes a net increase of short-term borrowings of
$34.9 million and increased common stock dividends compared to 2003. In 2003,
the Company issued common equity and long-term debt and used the proceeds to
retire higher rate debt and permanently finance short-term borrowings for plant
construction projects.
Investing Cash Flow
Cash flow required for investing activities was $176.3 million for the nine
months ended September 30, 2004, compared to $140.6 million 2003. The increase
in investing activities results primarily from capital expenditures, which
totaled $189.3 million in 2004 compared to $150.7 million in 2003.
Available Sources of Liquidity
At September 30, 2004, the Company has $615 million of short-term borrowing
capacity, including $355 million for the Utility Group and $260 million for the
wholly owned Nonregulated Group and corporate operations, of which approximately
$144 million is available for the Utility Group operations and approximately
$163 million is available for the wholly owned Nonregulated Group and corporate
operations.
VUHI's short-term credit facility was renewed on June 24, 2004 at $350 million,
a slight increase from the previous year's renewal level of $346 million.
Instead of the traditional 364-day facility, the facility was renewed for a
5-year period ending June 2009.
Vectren Capital renewed its existing $200 million credit facility early,
increased the committed capacity, and obtained a multi-year commitment on that
facility as well, rather than the traditional 364-day facility. On September 30,
2004 the new Vectren Capital credit facility was closed at the $255 million
level for a 5-year period ending September 2009.
Potential Uses of Liquidity
Planned Capital Expenditures & Investments
Investments in nonregulated unconsolidated affiliates and total company capital
expenditures for the remainder of 2004 are estimated to be approximately $80
million. For 2005, capital expenditures and investments in nonregulated
unconsolidated affiliates are estimated at approximately $300 million.
Ratings Triggers
At September 30, 2004, $113.0 million of Vectren Capital's senior unsecured
notes were subject to cross-default and ratings trigger provisions that would
require the full balance outstanding be subject to prepayment if the ratings of
Indiana Gas' or SIGECO's most senior securities declined to BBB/Baa2. In
addition, accrued interest and a make whole amount based on the discounted value
of the remaining payments due on the notes would also become payable. The credit
rating of Indiana Gas' senior unsecured debt and SIGECO's secured debt remain
one level and two levels, respectively, above the ratings trigger.
Other Guarantees and Letters of Credit
In the normal course of business, Vectren issues guarantees to third parties on
behalf of its consolidated subsidiaries and unconsolidated affiliates. Such
guarantees allow those subsidiaries and affiliates to execute transactions on
more favorable terms than the subsidiary or affiliate could obtain without such
a guarantee. Guarantees may include posted letters of credit, leasing
guarantees, and performance guarantees. As of September 30, 2004, guarantees
issued and outstanding on behalf of unconsolidated affiliates approximated $10
million. In addition, the Company has also issued a guarantee approximating $4
million related to the residual value of an operating lease that expires in
2006. Through September 30, 2004, the Company has not been called upon to
satisfy any obligations pursuant to its guarantees.
Forward-Looking Information
A "safe harbor" for forward-looking statements is provided by the Private
Securities Litigation Reform Act of 1995 (Reform Act of 1995). The Reform Act of
1995 was adopted to encourage such forward-looking statements without the threat
of litigation, provided those statements are identified as forward-looking and
are accompanied by meaningful cautionary statements identifying important
factors that could cause the actual results to differ materially from those
projected in the statement. Certain matters described in Management's Discussion
and Analysis of Results of Operations and Financial Condition are
forward-looking statements. Such statements are based on management's beliefs,
as well as assumptions made by and information currently available to
management. When used in this filing, the words "believe," "anticipate,"
"endeavor," "estimate," "expect," "objective," "projection," "forecast," "goal,"
and similar expressions are intended to identify forward-looking statements. In
addition to any assumptions and other factors referred to specifically in
connection with such forward-looking statements, factors that could cause the
Company's actual results to differ materially from those contemplated in any
forward-looking statements include, among others, the following:
o Factors affecting utility operations such as unusual weather conditions;
catastrophic weather-related damage; unusual maintenance or repairs;
unanticipated changes to fossil fuel costs; unanticipated changes to gas
supply costs, or availability due to higher demand, shortages,
transportation problems or other developments; environmental or pipeline
incidents; transmission or distribution incidents; unanticipated changes to
electric energy supply costs, or availability due to demand, shortages,
transmission problems or other developments; or electric transmission or
gas pipeline system constraints.
o Increased competition in the energy environment including effects of
industry restructuring and unbundling.
o Regulatory factors such as unanticipated changes in rate-setting policies
or procedures, recovery of investments and costs made under traditional
regulation, and the frequency and timing of rate increases.
o Financial or regulatory accounting principles or policies imposed by the
Financial Accounting Standards Board; the Securities and Exchange
Commission; the Federal Energy Regulatory Commission; state public utility
commissions; state entities which regulate electric and natural gas
transmission and distribution, natural gas gathering and processing,
electric power supply; and similar entities with regulatory oversight.
o Economic conditions including the effects of an economic downturn,
inflation rates, commodity prices, and monetary fluctuations.
o Changing market conditions and a variety of other factors associated with
physical energy and financial trading activities including, but not limited
to, price, basis, credit, liquidity, volatility, capacity, interest rate,
and warranty risks.
o The performance of projects undertaken by the Company's nonregulated
businesses and the success of efforts to invest in and develop new
opportunities, including but not limited to, the realization of Section 29
income tax credits and the Company's coal mining, gas marketing, and
broadband strategies.
o Direct or indirect effects on our business, financial condition or
liquidity resulting from a change in our credit rating, changes in interest
rates, and/or changes in market perceptions of the utility industry and
other energy-related industries.
o Employee or contractor workforce factors including changes in key
executives, collective bargaining agreements with union employees, or work
stoppages.
o Legal and regulatory delays and other obstacles associated with mergers,
acquisitions, and investments in joint ventures.
o Costs and other effects of legal and administrative proceedings,
settlements, investigations, claims, and other matters, including, but not
limited to, those described in Management's Discussion and Analysis of
Results of Operations and Financial Condition.
o Changes in Federal, state or local legislature requirements, such as
changes in tax laws or rates, environmental laws and regulations.
The Company undertakes no obligation to publicly update or revise any
forward-looking statements, whether as a result of changes in actual results,
changes in assumptions, or other factors affecting such statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to various business risks associated with commodity
prices, interest rates, and counter-party credit. These financial exposures are
monitored and managed by the Company as an integral part of its overall risk
management program. The Company's risk management program includes, among other
things, the use of derivatives to mitigate risk. The Company also executes
derivative contracts in the normal course of operations while buying and selling
commodities to be used in operations and optimizing its generation assets.
These risks are not significantly different from the information set forth in
Item 7A. Quantitative and Qualitative Disclosures About Market Risk included in
the Vectren 2003 Form 10-K and is therefore not presented herein.
ITEM 4. CONTROLS AND PROCEDURES
Changes in Internal Controls over Financial Reporting
In preparation for required reporting under the Sarbanes Oxley Act of 2002,
Section 404, the Company is conducting a thorough review of its internal
controls over financial reporting, including disclosure controls and procedures.
Based on this review, the Company has made internal control enhancements, and
will continue to make future enhancements, to its internal controls over
financial reporting some of which may be material; however, during the quarter
ended September 30, 2004, there have been no changes to the Company's internal
controls over financial reporting that have materially affected, or is
reasonably likely to materially affect, the Company's internal control over
financial reporting.
Evaluation of Disclosure Controls and Procedures
As of September 30, 2004, the Company carried out an evaluation under the
supervision and with the participation of the Chief Executive Officer and Chief
Financial Officer of the effectiveness and the design and operation of the
Company's disclosure controls and procedures. Based on that evaluation, the
Chief Executive Officer and the Chief Financial Officer have concluded that the
Company's disclosure controls and procedures are effective at providing
reasonable assurance that material information relating to the Company required
to be disclosed by the Company in its filings under the Securities Exchange Act
of 1934 (Exchange Act) is brought to their attention on a timely basis.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is party to various legal proceedings arising in the normal course
of business. In the opinion of management, there are no legal proceedings
pending against the Company that are likely to have a material adverse effect on
its financial position or results of operations. See Notes 7 and 9 of its
unaudited consolidated condensed financial statements included in Part 1 Item 1
Financial Statements regarding the ProLiance contingency and Clean Air Act and
related legal proceedings.
ITEM 6. EXHIBITS
31.1 Certification Pursuant To Section 302 of The Sarbanes-Oxley Act Of 2002-
Chief Executive Officer
31.2 Certification Pursuant To Section 302 of The Sarbanes-Oxley Act Of 2002-
Chief Financial Officer
32 Certification Pursuant To Section 906 of The Sarbanes-Oxley Act Of 2002
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.
VECTREN CORPORATION
Registrant
November 9, 2004 /s/ Jerome A. Benkert, Jr.
----------------------------
Jerome A. Benkert, Jr.
Executive Vice President &
Chief Financial Officer
(Principal Financial Officer)
/s/ M. Susan Hardwick
-----------------------------
M. Susan Hardwick
Vice President & Controller
(Principal Accounting Officer)