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 June 30, 2004
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________________ to __________________
Commission file number: 1-15467
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 75,970,183 July 30, 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 34
4 Controls and Procedures 34
PART II. OTHER INFORMATION
1 Legal Proceedings 35
4 Submission of Matters to a Vote of Security Holders 35
6 Exhibits and Reports on Form 8-K 36
Signatures 37
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 units
during construction
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 Accounting
Commission 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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June 30, December 31,
2004 2003
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ASSETS
Current Assets
Cash & cash equivalents $ 8.5 $ 15.3
Accounts receivable - less reserves of
$2.1 & $3.2, respectively 104.2 137.3
Accrued unbilled revenues 46.6 137.8
Inventories 53.9 70.4
Recoverable fuel & natural gas costs 21.9 20.3
Prepayments & other current assets 91.9 131.1
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Total current assets 327.0 512.2
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Utility Plant
Original cost 3,337.4 3,250.7
Less: accumulated depreciation
& amortization 1,275.3 1,247.0
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Net utility plant 2,062.1 2,003.7
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Investments in unconsolidated affiliates 174.2 176.1
Other investments 119.4 122.9
Non-utility property - net 220.3 222.3
Goodwill - net 205.0 205.0
Regulatory assets 84.7 89.6
Other assets 22.5 21.6
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TOTAL ASSETS $ 3,215.2 $ 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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June 30, December 31,
2004 2003
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LIABILITIES & SHAREHOLDERS' EQUITY
Current Liabilities
Accounts payable $ 64.8 $ 85.3
Accounts payable to affiliated companies 69.1 86.4
Accrued liabilities 114.1 109.3
Short-term borrowings 125.5 274.9
Current maturities of long-term debt 50.3 15.0
Long-term debt subject to tender 10.0 13.5
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Total current liabilities 433.8 584.4
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Long-term Debt - Net of Current Maturities &
Debt Subject to Tender 1,042.7 1,072.8
Deferred Income Taxes & Other Liabilities
Deferred income taxes 246.1 235.4
Regulatory liabilities & other removal costs 243.5 235.0
Deferred credits & other liabilities 157.2 153.6
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Total deferred credits & other liabilities 646.8 624.0
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Minority Interest in Subsidiary 0.4 0.3
Commitments & Contingencies (Notes 7-10)
Cumulative, Redeemable Preferred Stock
of a Subsidiary 0.1 0.2
Common Shareholders' Equity
Common stock (no par value) - issued
& outstanding 75.9 and 75.6 shares,
respectively 525.3 520.4
Retained earnings 577.5 562.4
Accumulated other comprehensive loss (11.4) (11.1)
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Total common shareholders' equity 1,091.4 1,071.7
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TOTAL LIABILITIES & SHAREHOLDERS' EQUITY $ 3,215.2 $ 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 Six Months
Ended June 30, Ended June 30,
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2004 2003 2004 2003
OPERATING REVENUES
Gas utility $ 154.1 $ 164.5 $ 659.3 $ 673.7
Electric utility 89.1 75.2 177.9 158.7
Energy services & other 33.5 28.1 84.9 61.7
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Total operating revenues 276.7 267.8 922.1 894.1
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OPERATING EXPENSES
Cost of gas sold 97.0 103.7 462.7 468.5
Fuel for electric generation 23.8 20.6 46.6 41.4
Purchased electric energy 6.8 3.8 11.2 8.3
Cost of energy services & other 23.1 19.1 63.1 44.6
Other operating 60.0 59.6 128.6 122.2
Depreciation & amortization 34.9 32.4 67.4 63.8
Taxes other than income taxes 10.7 11.1 33.4 33.1
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Total operating expenses 256.3 250.3 813.0 781.9
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OPERATING INCOME 20.4 17.5 109.1 112.2
OTHER INCOME (EXPENSE)
Equity in (losses) earnings of
unconsolidated affiliates (4.9) (0.1) 12.0 8.7
Other income (expense) - net 1.8 (1.1) (4.0) (2.2)
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Total other (expense) income (3.1) (1.2) 8.0 6.5
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Interest expense 18.8 18.2 38.1 37.1
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INCOME (LOSS) BEFORE INCOME TAXES (1.5) (1.9) 79.0 81.6
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Income taxes (4.8) (5.9) 20.9 21.8
Minority interest in & preferred dividend
requirements of subsidiaries - (0.1) - -
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NET INCOME $ 3.3 $ 4.1 $ 58.1 $ 59.8
======================================================================================
AVERAGE COMMON SHARES OUTSTANDING 75.6 67.8 75.5 67.7
DILUTED COMMON SHARES OUTSTANDING 75.8 68.1 75.9 68.0
EARNINGS PER SHARE OF COMMON STOCK:
BASIC $ 0.04 $ 0.06 $ 0.77 $ 0.88
DILUTED 0.04 0.06 0.77 0.88
DIVIDENDS DECLARED PER SHARE OF
COMMON STOCK $ 0.29 $ 0.28 $ 0.57 $ 0.55
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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Six Months Ended June 30,
2004 2003
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CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 58.1 $ 59.8
Adjustments to reconcile net income to cash
from operating activities:
Depreciation & amortization 67.4 63.8
Deferred income taxes & investment tax credits 10.1 4.3
Equity in earnings of unconsolidated affiliates (12.0) (8.7)
Net unrealized (gain) on derivative instruments (0.8) (0.8)
Pension & postretirement periodic benefit cost 8.3 7.0
Other non-cash charges - net 13.3 7.6
Changes in working capital accounts:
Accounts receivable & accrued unbilled
revenue 119.2 112.2
Inventories 14.6 15.8
Recoverable fuel & natural gas costs (1.6) 6.7
Prepayments & other current assets 45.3 0.3
Accounts payable, including to affiliated
companies (37.8) (81.0)
Accrued liabilities 6.7 (15.5)
Changes in noncurrent assets (5.1) 0.6
Changes in noncurrent liabilities (5.6) (1.6)
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Net cash flows from operating activities 280.1 170.5
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CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from stock option exercises & other
stock plans 3.9 3.6
Requirements for:
Dividends on common stock (43.0) (37.3)
Retirement of long-term debt - (40.9)
Redemption of preferred stock of subsidiary (0.1) (0.1)
Net change in short-term borrowings (149.4) (8.9)
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Net cash flows from financing activities (188.6) (83.6)
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CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from:
Unconsolidated affiliate distributions 21.0 7.6
Notes receivable & other collections 1.0 9.4
Requirements for:
Capital expenditures, excluding AFUDC equity (111.3) (99.9)
Unconsolidated affiliate investments (9.0) (8.6)
Notes receivable & other investments - (4.1)
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Net cash flows from investing activities (98.3) (95.6)
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Net decrease in cash & cash equivalents (6.8) (8.7)
Cash & cash equivalents at beginning of period 15.3 25.1
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Cash & cash equivalents at end of period $ 8.5 $ 16.4
=====================================================================================
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 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 June 30, 2004 and 2003, was $0.5 million ($0.3
million after tax) and $0.7 million ($0.4 million after tax), respectively, and
for the six months ended June 30, 2004 and 2003, was $1.3 million ($0.8 million
after tax) and $1.4 million ($0.9 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 Six Months
Ended June 30, Ended June 30,
-------------------------------
(In millions, except per share amounts) 2004 2003 2004 2003
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Net Income:
As reported $ 3.3 $ 4.1 $ 58.1 $ 59.8
Add: Share-based employee compensation
included in reported net income -
net of tax 0.3 0.4 0.8 0.9
Deduct: Total share-based employee
compensation expense determined
under fair value based method
for all awards - net of tax 0.7 0.9 1.1 1.6
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Pro forma net income $ 2.9 $ 3.6 $ 57.8 $ 59.1
==============================================================================
Basic Earnings Per Share:
As reported $ 0.04 $ 0.06 $ 0.77 $ 0.88
Pro forma 0.04 0.05 0.77 0.87
Diluted Earnings Per Share:
As reported $ 0.04 $ 0.06 $ 0.77 $ 0.88
Pro forma 0.04 0.05 0.77 0.87
4. Comprehensive Income
Comprehensive income consists of the following:
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Three Months Six Months
Ended June 30, Ended June 30,
---------------- ------------------
(In millions) 2004 2003 2004 2002
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Net income $ 3.3 $ 4.1 $ 58.1 $ 59.8
Comprehensive (loss) income of
unconsolidated affiliates-
net of tax (2.5) (5.2) (0.3) 2.2
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Total comprehensive income (loss) $ 0.8 $ (1.1) $ 57.8 $ 62.0
=============================================================================
Accumulated 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 six months ended June 30, 2004 and 2003:
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Three Months Six Months
Ended June 30, Ended June 30,
----------------- ----------------
(In millions, except per share data) 2004 2003 2004 2003
- -------------------------------------------------------------------------------
Numerator:
Numerator for basic and diluted
EPS-Net income $ 3.3 $ 4.1 $ 58.1 $ 59.8
===============================================================================
Denominator:
Denominator for basic EPS - Weighted
average common shares outstanding 75.6 67.8 75.5 67.7
Conversion of stock options and
lifting of restrictions on issued
restricted stock 0.2 0.3 0.4 0.3
- -------------------------------------------------------------------------------
Denominator for diluted EPS - Adjusted
weighted average shares outstanding
and assumed conversions outstanding 75.8 68.1 75.9 68.0
===============================================================================
Basic earnings per share $ 0.04 $ 0.06 $ 0.77 $ 0.88
Diluted earnings per share $ 0.04 $ 0.06 $ 0.77 $ 0.88
For the three months ended June 30, 2004 and 2003, options to purchase an
additional 241,274 and 87,963, 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 $24.05 to $25.59 in 2003.
For the six months ended June 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 June 30,
Pension Benefits Other Benefits
---------------- ----------------
(In millions) 2004 2003 2004 2003
- ----------------------------------------------------------------------------
Service cost $ 1.6 $ 1.6 $ 0.3 $ 0.2
Interest cost 3.3 3.5 1.5 1.4
Expected return on plan assets (3.3) (3.7) (0.2) (0.2)
Amortization of prior service cost 0.2 0.2 - -
Amortization of transitional
(asset) obligation - (0.1) 0.7 0.7
Amortization of actuarial loss (gain) 0.2 0.1 (0.3) (0.1)
- ----------------------------------------------------------------------------
Net periodic benefit cost $ 2.0 $ 1.6 $ 2.0 $ 2.0
============================================================================
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Six Months Ended June 30,
Pension Benefits Other Benefits
--------------- -----------------
(In millions) 2004 2003 2004 2003
- ----------------------------------------------------------------------------
Service cost $ 3.2 $ 3.1 $ 0.6 $ 0.4
Interest cost 6.6 6.9 3.0 2.8
Expected return on plan assets (6.6) (7.4) (0.4) (0.4)
Amortization of prior service cost 0.4 0.4 - -
Amortization of transitional
(asset) obligation - (0.2) 1.4 1.4
Amortization of actuarial loss (gain) 0.4 0.2 (0.3) (0.2)
- ----------------------------------------------------------------------------
Net periodic benefit cost $ 4.0 $ 3.0 $ 4.3 $ 4.0
============================================================================
Employer Contributions to Qualified Pension Plans
Currently, the Company expects to contribute approximately $6.6 million to its
pension plan trusts for 2004. Through June 30, 2004, $2.6 million has been
contributed to its pension plan trusts.
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. The
remeasurement resulted in a $0.3 million reduction in net periodic
postretirement benefit cost for the three and six months ended June 30, 2004.
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 may be required to
adjust previously reported information.
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 utilities and other large end use customers.
Transactions with ProLiance
Purchases from ProLiance for resale and for injections into storage for the
three months ended June 30, 2004 and 2003, totaled $202.0 million and $169.2
million, respectively, and for the six months ended June 30, 2004 and 2003
totaled $449.9 million and $434.9 million, respectively. Amounts owed to
ProLiance at June 30, 2004, and December 31, 2003, for those purchases were
$67.6 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 through June 30, 2004, of approximately
$48 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 and has done so for the year ended December 31, 2003. The
Company is in the process of responding to the SEC inquiry.
Guarantees & Product Warranties
Vectren Corporation 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 June 30, 2004, guarantees issued
and outstanding on behalf of unconsolidated affiliates approximated $6 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 Corporation has accrued no liabilities for these guarantees as they
relate to guarantees issued among related parties or 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 June 30, 2004, $180.2 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 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 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 having only to conduct further 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 Filing
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. If the filing is approved, Indiana
Gas expects to increase its base rates by approximately $47 million to recover
the ongoing cost of operating, maintaining and expanding the approximately
12,000-mile distribution and storage system used to serve more than 525,000
customers. The petition only addresses Vectren North'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 North's system to its
customers. The filing also includes a request to implement a normal temperature
adjustment mechanism to partially reduce the impact on customer bills caused by
variations in weather. On July 19 and 20, the Company presented its case in a
public hearing before the IURC. The public and interveners' cases are scheduled
to be filed in mid-September, and the Company's rebuttal and any other final
evidentiary filings will be made in early October. The final public hearing is
scheduled for mid-October, and the briefing will be concluded in early December.
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 late October. Based upon the PUCO's actions in other proceedings, the Company
would expect a litigated resolution of this case 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 period began in November 2000,
coincident with the Company's acquisition of the Ohio operations and
commencement of service in Ohio. 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 last fall 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. There are two elements of the
recommendations relating to the treatment of a pipeline refund and a penalty
collectively totaling $1.2 million, which VEDO does not oppose. A hearing has
been held, and the PUCO staff has recommended a $6.1 million disallowance. The
Ohio Consumer Counselor has recommended an $11.5 million disallowance. 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 reserved $1.1 million for its estimated
share of a potential disallowance. The Company believes that these proceedings
will not likely have a material effect on the Company's operating results or
financial condition. However, the Company can provide no assurance as to the
ultimate outcome of this proceeding. The Company anticipates the PUCO's decision
will be issued later this year.
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 June 30,
2004, and December 31, 2003, totaled $16.6 million and $17.1 million,
respectively, of Investments in unconsolidated affiliates, and $20.9 million at
both dates 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 June 30, 2004, and December 31, 2003, totaled $6.5 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 this consensus, the Task Force required certain quantitative
and qualitative disclosures related to debt and marketable equity securities
classified as "available-for-sale" or "held-to-maturity" that are in an
unrealized loss position at the balance sheet date but for which an
other-than-temporary impairment has not been recognized. In addition, the Task
Force developed a basic model in evaluating whether investments within the scope
of EITF 03-01 have other-than-temporary impairment. The Company is required to
adopt the recognition and measurement provisions of EITF 03-01 in the third
quarter of fiscal 2004. The Company is assessing the impact EITF 03-01 may have
on its operations.
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 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.
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
broadband communications, among other energy-related 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 Six Months
Ended June 30, Ended June 30,
------------------ ------------------
(In millions) 2004 2003 2004 2003
- -----------------------------------------------------------------------------
Revenues
Utility Group
Gas Utility Services $ 154.1 $ 164.5 $ 659.3 $ 673.7
Electric Utility Services 89.1 75.2 177.9 158.7
Other Operations 8.7 6.6 18.1 13.2
Eliminations (8.5) (6.4) (17.6) (12.8)
- -----------------------------------------------------------------------------
Total Utility Group 243.4 239.9 837.7 832.8
- -----------------------------------------------------------------------------
Nonregulated Group 54.1 47.7 124.5 100.9
Corporate & Other - 0.2 - 0.4
Eliminations (20.8) (20.0) (40.0) (40.0)
- -----------------------------------------------------------------------------
Consolidated Revenues $ 276.7 $ 267.8 $ 922.1 $ 894.1
=============================================================================
Profitability Measure
Utility Group: Regulated Operating
Income(Operating Income Less
Applicable Income Taxes)
Gas Utility Services $ 1.1 $ 3.9 $ 47.2 $ 51.3
Electric Utility Services 13.2 10.6 26.5 27.7
- -----------------------------------------------------------------------------
Total Regulated
Operating Income 14.3 14.5 73.7 79.0
- -----------------------------------------------------------------------------
Regulated other income - net 1.2 0.8 0.5 0.3
Regulated interest expense
& preferred dividends (15.5) (15.4) (31.2) (30.9)
- -----------------------------------------------------------------------------
Regulated Net Income - (0.1) 43.0 48.4
- -----------------------------------------------------------------------------
Other Operations Net Income 2.8 1.5 4.4 0.3
- -----------------------------------------------------------------------------
Utility Group Net Income 2.8 1.4 47.4 48.7
- -----------------------------------------------------------------------------
Nonregulated Group Net Income 0.7 3.4 11.3 11.9
Corporate & Other Net Loss (0.2) (0.7) (0.6) (0.8)
- -----------------------------------------------------------------------------
Consolidated Net Income $ 3.3 $ 4.1 $ 58.1 $ 59.8
=============================================================================
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 Six Months
Ended June 30, Ended June 30,
----------------- ------------------
(In millions, except per share data) 2004 2003 2004 2003
- -------------------------------------------------------------------------------
Net income $ 3.3 $ 4.1 $ 58.1 $ 59.8
Attributed to:
Utility Group $ 2.8 $ 1.4 $ 47.4 $ 48.7
Nonregulated Group 0.7 3.4 11.3 11.9
Corporate & Other (0.2) (0.7) (0.6) (0.8)
- -------------------------------------------------------------------------------
Basic earnings per share $ 0.04 $ 0.06 $ 0.77 $ 0.88
Attributed to:
Utility Group $ 0.04 $ 0.02 $ 0.63 $ 0.72
Nonregulated Group 0.01 0.05 0.15 0.18
Corporate & Other (0.01) (0.01) (0.01) (0.02)
Results
For the three months ended June 30, 2004, net income was $3.3 million, or $.04
per share, compared to net income of $4.1 million, or $0.06 per share for the
same period last year. For the six months ended June 30, 2004, reported earnings
were $58.1 million, or $0.77 per share, compared to $59.8 million, or $0.88 per
share, for the same period in 2003. Of the reduction in year-to-date earnings
per share, $0.02 per share is due to the decline in net income and $0.09 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 $2.8 million for the quarter, compared to $1.4
million in the prior year. Electric margins increased 15% due to the recovery of
NOx related expenditures and increased demand in native load and large electric
customer margins. This was partially offset by lower earnings from wholesale
power marketing operations of $3.4 million after tax, compared to the same
period last year. Utility Group earnings were $47.4 million for the six months
ended June 30, 2004, compared to $48.7 million in the prior year. The $1.3
million decrease in year-to-date Utility Group earnings was primarily due to
mild heating weather and lower margins from wholesale power activities. This
decrease was partially offset by the return on additional NOx related
expenditures and increased electric customer usage. The Company estimates that
weather favorably impacted second quarter earnings by approximately $0.8 million
after tax and unfavorably impacted year-to-date results by $4.2 million after
tax as compared to the same periods in 2003.
Nonregulated Group earnings were $0.7 million for the quarter, compared to $3.4
million in the prior year. A write-down of the Company's share of an investment
held by Haddington Energy Partners (Nations Energy Holdings), totaling $5.9
million, or $3.5 million after tax, is the primary contributor to the decline in
Nonregulated earnings. Nonregulated earnings for the six months ended June 30,
2004 were $11.3 million, compared to $11.9 million in the prior year. The six
months earnings reflect the $6.0 million after tax write downs and other charges
related to the Company's broadband business and investments. Haddington Energy
Partners' results, which are accounted for using the equity method, have
increased $2.3 million over 2003 due to its sale of SAGO Energy, LP in the first
quarter of 2004, offset by the second quarter write-down of Nations Energy
Holdings. For both the quarter and year-to-date periods, earnings have been
positively impacted by utility infrastructure operations, performed through
Reliant Services, LLC, a 50% owned joint venture, wholly owned gas retail
operations of Vectren Source, and mining operations of Vectren Fuels.
Dividends
Dividends declared for the three months ended June 30, 2004, were $0.285 per
share compared to $0.275 per share for the same period in 2003. Dividends
declared for the six months ended June 30, 2004 were $0.570 per share compared
to $0.550 per share for the same period in 2003.
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 six months ended June 30,
2004 and 2003 are summarized below:
- --------------------------------------------------------------------------------
Three Months Six Months
Ended June 30, Ended June 30,
------------------ ------------------
(In millions, except per share amounts) 2004 2003 2004 2003
- --------------------------------------------------------------------------------
OPERATING REVENUES
Gas revenues $ 154.1 $ 164.5 $ 659.3 $ 673.7
Electric revenues 89.1 75.2 177.9 158.7
Other revenues 0.2 0.2 0.5 0.4
- --------------------------------------------------------------------------------
Total operating revenues 243.4 239.9 837.7 832.8
- --------------------------------------------------------------------------------
OPERATING EXPENSES
Cost of gas 97.0 103.7 462.7 468.5
Fuel for electric generation 23.8 20.6 46.6 41.4
Purchased electric energy 6.8 3.8 11.2 8.3
Other operating 53.7 53.9 113.8 110.5
Depreciation & amortization 31.8 29.6 61.5 58.4
Taxes other than income taxes 10.4 10.9 32.7 32.6
- --------------------------------------------------------------------------------
Total operating expenses 223.5 222.5 728.5 719.7
- --------------------------------------------------------------------------------
OPERATING INCOME 19.9 17.4 109.2 113.1
OTHER INCOME (EXPENSE) - NET
Equity in earnings (losses) of
unconsolidated affiliates 0.1 0.1 0.2 (0.4)
Other - net 1.4 0.2 1.3 (1.3)
- --------------------------------------------------------------------------------
Total other income (expense) - net 1.5 0.3 1.5 (1.7)
- --------------------------------------------------------------------------------
Interest expense 16.5 15.9 33.4 32.4
- --------------------------------------------------------------------------------
INCOME BEFORE INCOME TAXES 4.9 1.8 77.3 79.0
- --------------------------------------------------------------------------------
Income taxes 2.1 0.4 29.9 30.3
- --------------------------------------------------------------------------------
NET INCOME $ 2.8 $ 1.4 $ 47.4 $ 48.7
================================================================================
BASIC EARNINGS PER SHARE $ 0.04 $ 0.02 $ 0.63 $ 0.72
================================================================================
Utility Group earnings for the second period of 2004 were $2.8 million,
compared to $1.4 million for the same quarter last year. The $1.4 million
increase was primarily due to the return on additional NOx related environmental
expenditures. Results from wholesale power activities were down for the quarter
but were offset by increased electric customer usage. Weather for the quarter
compared to the same period last year had a slight favorable impact. Utility
Group earnings were $47.4 million for the six months ended June 30, 2004,
compared to $48.7 million in the prior year. The $1.3 million decrease was
primarily due to mild heating weather and lower margins from wholesale power
activities. This decrease was partially offset by the return on additional NOx
related expenditures totaling $2.1 million and increased electric customer
usage. The Company estimates that weather favorably impacted second quarter
earnings by approximately $0.8 million after tax and unfavorably impacted
year-to-date results by $4.2 million after tax compared to the same periods
in 2003.
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 small customers
(generally residential and commercial customers) is seasonal and impacted by
weather patterns in its service territory. Margin generated from sales to large
customers (generally industrial and other contract and firm wholesale customers)
is impacted by overall economic conditions. Margin is also impacted by the
collection of state mandated taxes which fluctuate with gas costs and also some
level of price sensitive fluctuation 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 Six Months
Ended June 30, Ended June 30,
---------------- ------------------
(In millions) 2004 2003 2004 2003
- ------------------------------------------------------------------------------
Residential & Commercial $ 44.8 $ 48.2 $ 163.3 $ 172.6
Contract 10.9 9.7 28.9 28.2
Other 1.4 2.9 4.4 4.4
- ------------------------------------------------------------------------------
Total gas utility margin $ 57.1 $ 60.8 $ 196.6 $ 205.2
==============================================================================
Sold & transported volumes in MMDth:
To residential & commercial customers 12.2 14.1 69.5 75.9
To contract customers 18.6 18.1 47.8 48.4
- ------------------------------------------------------------------------------
Total throughput 30.8 32.2 117.3 124.3
==============================================================================
Gas utility margins were $57.1 million and $196.6 million for the three and six
months ended June 30, 2004. This represents a decrease compared to prior periods
of $3.7 million and $8.6 million, respectively. Heating weather for the quarter
was 27% warmer than normal and 21% warmer than last year. Weather for the six
months was 8% warmer than normal and 12% warmer than last year. The estimated
decline in margin due to weather was $2.6 million and $10.3 million for the
three and six month periods, compared to the prior year. Gas sold and
transported volumes were 4% less for the second quarter of 2004 compared to the
prior year and 6% less for the six months ended June 30, 2004, compared to the
prior year. The decreased throughput was primarily attributable to weather and
partially offset by customer growth for both periods and a 3% increase in large
volume contract throughput for the second quarter 2004, compared to 2003. The
average cost per dekatherm of gas purchased for the six months ended June 30,
2004, was $6.72 compared to $6.51 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 Six Months
Ended June 30, Ended June 30,
- -------------------------------------------------------------------------------
(In millions) 2004 2003 2004 2003
- -------------------------------------------------------------------------------
Residential & commercial $ 40.2 $ 29.4 $ 75.7 $ 62.7
Industrial 15.7 12.8 30.2 25.1
Municipalities & other 4.3 4.6 8.9 9.1
- -------------------------------------------------------------------------------
Total retail & firm wholesale 60.2 46.8 114.8 96.9
Asset optimization (1.7) 4.0 5.3 12.1
- -------------------------------------------------------------------------------
Total electric utility margin $ 58.5 $ 50.8 $ 120.1 $ 109.0
===============================================================================
Retail & Firm Wholesale Margin
Electric retail and firm wholesale utility margins were $60.2 million and $114.8
million for the three and six months ended June 30, 2004. This represents an
increase over the same period last year of $13.4 million and $17.9 million,
respectively. Margins increased $3.9 million quarter over quarter and $7.6
million for the six month period due primarily to an increase in retail electric
rates related to the recovery of NOx related expenditures. Excluding the effects
of NOx recovery, margins from industrial customers increased $1.8 million for
the quarter and $2.8 million for the year to date over 2003, which reflects some
economic recovery. Margin from small customers (excluding the effects of NOx)
increased over $8 million for both the quarter and year to date due to weather
and increased usage. Weather for the quarter was 20% warmer than normal and 111%
warmer than last year. Weather for the six months was also 20% warmer than
normal and 114% warmer than last year. The estimated increase in margin due to
weather was $4.0 million and $3.3 million for the three and six month periods,
respectively, compared to the prior year. Due to the above factors, volumes sold
increased 9% to 3.1 GWh for the six months ended June 30, 2004 compared to 2.8
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
these contracts 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 Six Months
Ended June 30, Ended June 30,
---------------- ----------------
(In millions) 2004 2003 2004 2003
- -------------------------------------------------------------------------
Beginning of Period Net Asset
Optimization Position $ 3.4 $(0.4) $(0.4) $ (0.7)
Statement of Income Activity
Net mark-to-market (losses)
gains realized (2.0) (0.1) 0.8 0.8
Net realized gains recognized 0.3 4.1 4.5 11.3
- --------------------------------------------------------------------------
Asset optimization margin (1.7) 4.0 5.3 12.1
- --------------------------------------------------------------------------
Net cash paid (received)
& other adjustments 0.5 (3.5) (2.7) (11.3)
- --------------------------------------------------------------------------
End of Period Net Asset
Optimization Position $ 2.2 $ 0.1 $ 2.2 $ 0.1
==========================================================================
Net wholesale margins declined $5.7 million and $6.8 million for the three and
six month periods compared to last year. The decrease in margin both for the
quarter and year-to-date is due largely to less excess capacity. Increases in
demand by native load customers and scheduled outages of owned generation
related to the installation of environmental compliance equipment reduced the
availability of excess power.
Following is information regarding asset optimization activities included in
Electric utility revenues and Fuel for electric generation in the Statements of
Income:
- --------------------------------------------------------------------------------
Three Months Six Months
Ended June 30, Ended June 30,
------------------- ------------------
(In millions) 2004 2003 2004 2003
- --------------------------------------------------------------------------------
Activity related to:
Sales contracts $ 30.8 $ 21.0 $ 42.7 $ 68.2
Purchase contracts (28.1) (14.9) (34.1) (51.6)
Net mark-to-market (losses)
gains realized (2.0) (0.1) 0.8 0.8
- --------------------------------------------------------------------------------
Net asset optimization revenue 0.7 6.0 9.4 17.4
- --------------------------------------------------------------------------------
Fuel for electric generation 2.4 2.0 4.1 5.3
- --------------------------------------------------------------------------------
Asset optimization margin $ (1.7) $ 4.0 $ 5.3 $ 12.1
================================================================================
Utility Group Operating Expenses
Other operating expenses and depreciation expense for the three and six months
ended June 30, 2004 collectively increased $2.0 million and $6.4 million,
respectively, compared to 2003. For the quarter, additional NOx related
operating expenses were $2.2 million (other operating expenses of $1.6 million
and depreciation of $0.6 million). For the six months, additional operating NOx
related operating expenses were $4.1 million (other operating expenses of $2.2
million and depreciation of $1.9 million). The remaining increase in other
operating expenses is primarily due to higher labor and benefit costs. The
remaining increase in depreciation expense is primarily due to normal additions
to utility plant.
Utility Group Total Other Income (Expense)
For the three and six months ended June 30, 2004, total other income (expense)
increased $1.2 million and $3.2 million, respectively, compared to 2003. The
increase was primarily attributable to 2003 charges related to the Company's
investments in BABB International, which totaled $1.9 million for the quarter
and $3.9 million for the six month period.
Utility Group Interest Expense
For the three and six months ended June 30, 2004, interest expense increased
$0.6 million and $1.0 million, respectively, 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 June 30, 2004, $180.2 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 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 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 having only to conduct further 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 Filing
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. If the filing is approved, Indiana
Gas expects to increase its base rates by approximately $47 million to recover
the ongoing cost of operating, maintaining and expanding the approximately
12,000-mile distribution and storage system used to serve more than 525,000
customers. The petition only addresses Vectren North'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 North's system to its
customers. The filing also includes a request to implement a normal temperature
adjustment mechanism to partially reduce the impact on customer bills caused by
variations in weather. On July 19 and 20, the Company presented its case in a
public hearing before the IURC. The public and interveners' cases are scheduled
to be filed in mid-September, and the Company's rebuttal and any other final
evidentiary filings will be made in early October. The final public hearing is
scheduled for mid-October, and the briefing will be concluded in early December.
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 late October. Based upon the PUCO's actions in other proceedings, the Company
would expect a litigated resolution of this case 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 period began in November 2000,
coincident with the Company's acquisition of the Ohio operations and
commencement of service in Ohio. 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 last fall 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. There are two elements of the
recommendations relating to the treatment of a pipeline refund and a penalty
collectively totaling $1.2 million, which VEDO does not oppose. A hearing has
been held, and the PUCO staff has recommended a $6.1 million disallowance. The
Ohio Consumer Counselor has recommended an $11.5 million disallowance. 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 reserved $1.1 million for its estimated
share of a potential disallowance. The Company believes that these proceedings
will not likely have a material effect on the Company's operating results or
financial condition. However, the Company can provide no assurance as to the
ultimate outcome of this proceeding. The Company anticipates the PUCO's decision
will be issued later this year.
Results of Operations of the Nonregulated 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. The results of operations
of the Nonregulated Group before certain intersegment eliminations and
reclassifications for the three and six months ended June 30, 2004 and 2003,
follow:
- ------------------------------------------------------------------------------
Three Months Six Months
Ended June 30, Ended June 30,
----------------- --------------------
(In millions, except per share amounts) 2004 2003 2004 2003
- -------------------------------------------------------- --------------------
Energy services & other revenues $ 54.1 $ 47.7 $ 124.5 $ 100.9
Operating expenses:
Cost of energy services
& other revenues 43.4 38.2 102.3 82.9
Operating expenses 10.0 9.3 22.0 18.4
- ------------------------------------------------------------------------------
Total expenses 53.4 47.5 124.3 101.3
- ------------------------------------------------------------------------------
OPERATING INCOME (LOSS) 0.7 0.2 0.2 (0.4)
Other income (expense):
Equity in (losses) earnings of
unconsolidated affiliates (4.9) (0.2) 11.8 9.1
Other income (expense) - net 0.7 (1.1) (3.9) -
- ------------------------------------------------------------------------------
Total other income (expense) - net (4.2) (1.3) 7.9 9.1
- ------------------------------------------------------------------------------
Interest expense 2.6 2.4 5.4 4.8
- ------------------------------------------------------------------------------
INCOME (LOSS) BEFORE TAXES (6.1) (3.5) 2.7 3.9
Income tax (6.8) (6.9) (8.6) (8.1)
Minority interest in consolidated
subsidiaries - - - 0.1
- ------------------------------------------------------------------------------
NET INCOME $ 0.7 $ 3.4 $ 11.3 $ 11.9
==============================================================================
BASIC EARNINGS PER SHARE $ 0.01 $ 0.05 $ 0.15 $ 0.18
==============================================================================
NET INCOME (LOSS) ATTRIBUTED TO:
Energy Marketing & Services $ 1.0 $ 1.1 $ 8.0 $ 9.2
Coal Mining 3.8 4.6 7.4 6.9
Utility Infrastructure 0.5 (0.2) (0.1) (1.2)
Broadband 0.1 (1.2) (3.3) (1.2)
Other Businesses (4.7) (0.9) (0.7) (1.8)
Nonregulated Group earnings were $0.7 million for the quarter, compared to $3.4
million in the prior period. A write-down of the Company's share of an
investment held by Haddington Energy Partners (Nations Energy Holdings),
totaling $5.9 million, or $3.5 million after tax, is the primary contributor to
the decline in Nonregulated earnings. Nonregulated earnings for the six months
ended June 30, 2004 were $11.3 million, compared to $11.9 million in the prior
year. The six months earnings reflect $6.0 million after tax write
downs and other charges related to the Company's broadband business and
investments. Haddington Energy Partners' results, which are accounted for using
the equity method, have increased $2.3 million over 2003 due to its sale of SAGO
Energy, LP in the first quarter of 2004, offset by the second quarter write-down
of Nations Energy Holdings. For both the quarter and year-to-date periods,
earnings have been positively impacted by utility infrastructure operations,
performed through Reliant Services, LLC, a 50% owned joint venture, wholly owned
gas retail operations of Vectren Source, and mining operations of Vectren Fuels.
Energy Marketing & Services
Energy Marketing and Services is comprised of the Company's gas marketing
operations, performance contracting operations, and its retail gas supply and
other related products and services 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 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 approximately 88,000
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 service territory.
Net income generated by Energy Marketing and Services for the three months ended
June 30, 2004, was $1.0 million, as compared to $1.1 million in 2003. Net income
generated by Energy Marketing and Services for the six months ended June 30,
2004, was $8.0 million, compared to $9.2 million in 2003. Gas marketing
operations, performed through ProLiance, contributed quarterly earnings of $1.7
million in 2004, compared to $1.6 million in 2003. Year-to-date earnings from
ProLiance in 2004 were $8.6 million in 2004, compared to $10.1 million in
2003. The six month decrease results principally from unprecedented volatility
in gas prices in March 2003. Vectren Source operations have contributed earnings
increases for the quarterly and year-to-date periods of $0.7 million and $1.3
million, respectively. The increases are principally due to increased customers
and margins per unit of throughput. Earnings from performance contracting
operations, performed through ESG, have decreased both for the quarter and
year-to-date by $0.3 million and $0.8 million, respectively, due to the timing
of projects year over year; however, current backlog stands at record levels.
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 June 30, 2004, was $3.8
million, compared to $4.6 million in 2003. Coal Mining net income for the six
months ended June 30, 2004, was $7.4 million, compared to $6.9 million in 2003.
Mining operations were generally flat for the quarter and increased $0.8 million
for the six months, compared to 2003 results. The increase was primarily due to
improved pricing and better mining conditions. Synfuel-related results for the
quarter, which include earnings from Pace Carbon and synfuel processing fees
earned by Fuels, contributed $3.2 million in earnings in 2004, compared to $4.1
million in 2003. Synfuel-related results for the six months contributed $6.1
million in earnings in 2004, compared to $6.4 million in 2003. During the second
quarter of 2004, Pace Carbon produced less synthetic fuel compared to 2003 due
to feed stock problems at one of the four plants. 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 June 30, 2004, of approximately
$48 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.
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.
Construction and repair activity improved in the second quarter due to the
seasonal change in weather and continued increases in utility work.
Infrastructure's income for the quarter was $0.5 million, an improvement of $0.7
million from 2003. Infrastructure's results were flat for the six months ended
June 30, 2004, an improvement of $1.1 million over 2003.
Broadband and Other Businesses
During the first quarter of 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, a municipal broadband consulting
business, during the second quarter of 2004. For the six months ended June 30,
2004, VCS incurred losses totaling $2.4 million after tax, resulting primarily
from inventory write downs, cessation accruals, and other costs. Inventory write
downs recorded in the first quarter totaled $0.9 million after tax. In total,
charges associated with broadband related businesses and investments totaled
$6.0 million after tax for the six months ended June 30, 2004.
Broadband results for the six months ended June 30, 2004, were a $3.3 million
after tax loss, compared to a $1.2 million after tax loss in 2003. The second
quarter of 2003 includes a $1.2 million loss on the sale of its investment in
First Mile Technologies. Vectren is an investor in SIGECOM Holdings, Inc.,
located in Evansville, Indiana, and in convertible debt at its parent, Utilicom
Networks. SIGECOM provides broadband service to over 28,000 customers, averaging
nearly 3 revenue generating units per customer and continues to increase its
positive EBITDA. Vectren Communications Services results are reported in Other
Businesses
Haddington Energy Partnerships, a component of the Other Businesses Group, are
equity method investments that invest in energy-related ventures. In March 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), or $0.07 per share in March 2004. During the second
quarter, the SAGO gain was partially offset by the 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 six months ended June 30, 2004 are
$2.0 million, compared to a loss of $0.3 million in 2003.
The Company's Other Business Group reported a net loss of $4.7 million for the
three months ended June 30, 2004, compared to net losses of $0.9 million in
2003. For the six months ended June 30, 2004, the Other Businesses Group
reported net losses of $0.7 million, compared to net losses of $1.8 million in
2003. These results reflect the net effect of Haddington's sale of SAGO Energy
in the first quarter of 2004 and the write down of Nations Energy in the second
quarter, and the VCS-related charges described above.
Significant Fluctuations of Consolidated Operations
Revenues and Cost of Revenues
For the three months ended June 30, 2004, nonregulated revenues and cost of
revenues increased $6.4 million and $5.2 million, respectively, compared to
2003. For the six months ended June 30, 2004 and 2003, nonregulated revenues and
cost of revenues increased $23.6 million and $19.4 million, respectively. The
principal reason for the increases is due to Vectren Source's operations.
Vectren Source's revenues were $11.0 million for the three months ended June 30,
2004, compared to $4.7 million in 2003 and its costs of revenues were $9.4
million for 2004 compared to $4.3 million in 2003. Vectren Source's revenues
were $45.8 million for the six months ended June 30, 2004, compared to $20.6
million in 2003 and its costs of revenues were $39.8 million for 2004 compared
to $18.3 million in 2003. The increased revenues and costs resulted from
additional customers, increased customer consumption, and increased average
selling prices. Margins from Vectren Source increased $1.3 million to $1.6
million for the three months ended June 30, 2004, compared to 2003. Margins from
Vectren Source increased $3.6 million to $6.0 million for the six months ended
June 30, 2004, compared to 2003.
Operating Expenses
For the three and six months ended June 30, 2004, operating expenses increased
$0.7 million and $3.6 million, respectively, compared to 2003. The increases
result primarily from charges related to VCS 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 relate
to the earnings of the Haddington partnerships, earnings of ProLiance, and
losses incurred by Pace Carbon. For the three months ended June 30, 2004, the
Company's portion of the Haddington partnerships' results was a loss of $5.5
million compared to breakeven results in 2003. For the six months ended June 30,
2004, the Company's portion of the Haddington partnerships' earnings was $3.8
million compared to a loss of $0.1 million in 2003.
For the three months ended June 30, 2004, the Company's portion of ProLiance's
earnings was $3.0 million compared to $2.7 million in 2003. For the six months
ended June 30, 2004, the Company's portion of ProLiance's earnings was $14.6
million compared to $16.9 million in 2003.
For the three months ended June 30, 2004 and 2003, the Company's portion of Pace
Carbon losses was $3.1 million and $2.9 million, respectively. For six months
ended June 30, 2004 and 2003, the Company's portion of Pace Carbon losses was
$6.5 million and $6.4 million, respectively.
Other Income (Expense) - Net
Other income (expense) - net reflects $6.0 million of impairment charges
associated with the Broadband operations incurred during the six months ended
June 30, 2004, and a $2.0 million loss associated with the sale of First Mile in
the second quarter of 2003.
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 June 30,
2004, and December 31, 2003, totaled $16.6 million and $17.1 million,
respectively, of Investments in unconsolidated affiliates, and $20.9 million at
both dates 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 June 30, 2004, and December 31, 2003, totaled $6.5 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 this consensus, the Task Force required certain quantitative
and qualitative disclosures related to debt and marketable equity securities
classified as "available-for-sale" or "held-to-maturity" that are in an
unrealized loss position at the balance sheet date but for which an
other-than-temporary impairment has not been recognized. In addition, the Task
Force developed a basic model in evaluating whether investments within the scope
of EITF 03-01 have other-than-temporary impairment. The Company is required to
adopt the recognition and measurement provisions of EITF 03-01 in the third
quarter of fiscal 2004. The Company is assessing the impact EITF 03-01 may have
on its operations.
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 and has done so for the year ended December 31, 2003. The
Company is in the process of responding to the SEC inquiry.
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 June 30, 2004, totaled
$113.0 million and $70.1 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 June 30, 2004, totaled $550.0 million and $54.8 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
June 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 June 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 six months
ended June 30, 2004 and 2003, was $280.1 million and $170.5 million,
respectively. The increase of $109.6 million is primarily the result of
favorable changes in working capital accounts and increased earnings before
non-cash charges.
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 $188.6 million for the six months
ended June 30, 2004, includes a net decrease of short-term borrowings of
approximately $149.4 million and increased common stock dividends compared to
2003. Short-term borrowings were retired with greater operating cash flow. In
2003, $40.9 million of long-term debt was retired.
Investing Cash Flow
Cash flow required for investing activities was $98.3 million for the six
months ended June 30, 2004, and was comparable to 2003. For the six months ended
June 30, 2004 and 2003, requirements for capital expenditures were $111.3
million and $99.9 million, respectively.
Available Sources of Liquidity
At June 30, 2004, the Company has $560 million of short-term borrowing capacity,
including $355 million for the Utility Group and $205 million for the wholly
owned Nonregulated Group and corporate operations, of which approximately $300
million is available for the Utility Group operations and approximately $135
million is available for the wholly owned Nonregulated Group and corporate
operations.
Beginning in 2003, the Company began issuing new shares to satisfy dividend
reinvestment plan requirements. During the six months ended June 30, 2004 and
2003, new issues from stock plans added additional liquidity of approximately of
$3.9 million and $3.6 million, respectively.
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 $169
million.
Ratings Triggers
At June 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 Corporation 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 June 30, 2004,
guarantees issued and outstanding on behalf of unconsolidated affiliates
approximated $6 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 June 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, 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 Control 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 control
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 financing
reporting some of which may be material; however, during the quarter ended June
30, 2004, there have been no changes to the Company's internal control over
financial reporting that has 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 June 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 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Vectren's Annual Meeting of Stockholders was held on April 28, 2004.
At said Annual Meeting, the stockholders voted on the following three proposals:
1. The election of four directors of the Company, each to serve for up to a
three-year term or until their successors are duly qualified and elected:
Director Votes For Abstentions
----------------------------- --------------------- ---------------
John D. Engelbrecht 62,387,100 1,029,292
William G. Mays 60,364,456 3,051,936
J. Timothy McGinley 62,510,717 905,675
Richard P. Rechter 62,255,974 1,160,418
The terms of office of Ronald G. Reherman, R. Daniel Sadlier, Richard W.
Shymanski, and Jean L. Wojtowicz will expire in 2005. The terms of office of
John M. Dunn, Niel C. Ellerbrook, Anton H. George, and Robert L. Koch II will
expire in 2006. As required by Section 4.15 of the Company's Code of By-Laws,
and Section 1.I. of the Corporate Governance Guidelines, a director shall retire
from the board at the end of the month during which he or she reaches the age of
seventy. Accordingly, Lawrence A. Ferger retired effective May 31, 2004.
2. The reappointment of Deloitte & Touche LLP (Deloitte) as the independent
accountants for the Company and its subsidiaries for 2004:
The stockholders approved Deloitte as the independent accountants by the
following votes:
Votes For Votes Against Abstentions Broker Non-Votes
--------------- --------------- --------------- ----------------
62,297,698 718,351 400,342 -
3. A proposal to expense stock options:
The stockholders defeated the proposal by the following votes:
Votes For Votes Against Abstentions Broker Non-Votes
--------------- --------------- --------------- ----------------
20,519,993 24,677,985 1,817,896 16,400,517
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Certifications
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
(b) Reports On Form 8-K During The Last Calendar Quarter
On April 19, 2004, Vectren Corporation filed a Current Report on Form 8-K with
respect to the announcement of a pre-filing notice by it wholly owned
subsidiary, Vectren Energy Delivery of Ohio (VEDO), with the Public Utilities
Commission of Ohio (PUCO) for a request to adjust base rates and charges for
VEDO's gas distribution business in a 17 county region covering west central
Ohio.
Item 9. Regulation FD Disclosure
Index to Exhibits
99-1 - Press Release - Vectren Energy Delivery of Ohio seeks
approval of new natural gas base rates
99-2 - Cautionary Statement for Purposes of the "Safe Harbor"
Provisions of the Private Securities Litigation Reform
Act of 1995
On April 29, 2004, Vectren Corporation filed a Current Report on Form 8-K with
respect to the release of financial information to the investment community
regarding the Company's results of operations for the three and twelve month
periods ended March 31, 2004. The financial information was released to the
public through this filing.
Item 12. Results of Operations and Financial Condition
Index to Exhibits
99-1 - Press Release - Vectren Corporation Reports First
Quarter 2004 Results
99-2 - Cautionary Statement for Purposes of the "Safe Harbor"
Provisions of the Private Securities Litigation Reform
Act of 1995
On May 10, 2004, Vectren Corporation filed a Current Report on Form 8-K with
respect to the announcement of filings by its wholly owned subsidiaries, Indiana
Gas and SIGECO with the SEC deregistering their respective debt and equity
securities.
Item 5. Other Events and Regulation FD Disclosure
Index to Exhibits
99-1 - SIGECO's Form 15 with respect to its Common Stock -
Without Par
99-2 - SIGECO's Form 15 with respect to its First Mortgage
Bonds
99-3 - Indiana Gas' Form 15 with respect to its Common Stock
- Without Par
99-4 - Indiana Gas' Form 15 with respect to its Senior
Unsecured Notes
On July 1, 2004, Vectren Corporation filed a Current Report on Form 8-K with
respect to the announcement by the IURC approving a $5.7 million base rate
increase for the natural gas operations of its wholly owned utility subsidiary
(SIGECO or Vectren South).
Item 9. Regulation FD Disclosure
Index to Exhibits
99-1 - Press Release - Vectren South Gas Rate Order Approved
99-2 - Cautionary Statement for Purposes of the "Safe Harbor"
Provisions of the Private Securities Litigation Reform
Act of 1995
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
August 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)