-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, VsBXUM0w8OifXHk0eseQ9hlJYKtbJLXYBPN9QxiKudMTvmUM9SNw1p0wubfIIEcQ zXKUp1ddnuNMdr4CjJaheQ== 0001096385-04-000138.txt : 20041109 0001096385-04-000138.hdr.sgml : 20041109 20041109150935 ACCESSION NUMBER: 0001096385-04-000138 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 20040930 FILED AS OF DATE: 20041109 DATE AS OF CHANGE: 20041109 FILER: COMPANY DATA: COMPANY CONFORMED NAME: VECTREN CORP CENTRAL INDEX KEY: 0001096385 STANDARD INDUSTRIAL CLASSIFICATION: GAS & OTHER SERVICES COMBINED [4932] IRS NUMBER: 352086905 STATE OF INCORPORATION: IN FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-15467 FILM NUMBER: 041129184 BUSINESS ADDRESS: STREET 1: 20 NW FOURTH ST CITY: EVANSVILLE STATE: IN ZIP: 47708 BUSINESS PHONE: 8124914000 MAIL ADDRESS: STREET 1: 20 NW FOURTH ST CITY: EVANSVILLE STATE: IN ZIP: 47708 10-Q 1 vvc10q_sep04.txt VECTREN CORP 3RD QUARTER 10Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) |X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2004 OR [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from __________________ to __________________ Commission file number: 1-15467 VECTREN CORPORATION - ------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) INDIANA 35-2086905 - ---------------------------------- ---------------------- (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.) 20 N.W. 4th Street, Evansville, Indiana, 47708 ------------------------------------------------------------- (Address of principal executive offices) (Zip Code) 812-491-4000 ------------------------------------------------------- (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes |X| No __ Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes |X| No __ Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Common Stock - Without Par Value 75,981,012 October 31, 2004 -------------------------------- ---------------- ---------------- Class Number of Shares Date Table of Contents Item Page Number Number PART I. FINANCIAL INFORMATION 1 Financial Statements (Unaudited) Vectren Corporation and Subsidiary Companies Consolidated Condensed Balance Sheets 1-2 Consolidated Condensed Statements of Income 3 Consolidated Condensed Statements of Cash Flows 4 Notes to Unaudited Consolidated Condensed Financial Statements 5 2 Management's Discussion and Analysis of Results of Operations and Financial Condition 16 3 Quantitative and Qualitative Disclosures About Market Risk 35 4 Controls and Procedures 35 PART II. OTHER INFORMATION 1 Legal Proceedings 35 6 Exhibits 35 Signatures 36 Access to Information Vectren Corporation makes available all SEC filings and recent annual reports free of charge, including those of its wholly owned subsidiary, Vectren Utility Holdings, Inc., through its website at www.vectren.com, or by request, directed to Investor Relations at the mailing address, phone number, or email address that follows: Mailing Address: Phone Number: Investor Relations Contact: P.O. Box 209 (812) 491-4000 Steven M. Schein Evansville, Indiana Vice President, Investor Relations 47702-0209 sschein@vectren.com Definitions AFUDC: allowance for funds used MMBTU: millions of British thermal during construction units APB: Accounting Principles Board MW: megawatts EITF: Emerging Issues Task Force MWh/GWh: megawatt hours/thousands of megawatt hours (gigawatt hours) FASB: Financial Accounting Standards NOx: nitrogen oxide Board FERC: Federal Energy Regulatory OUCC: Indiana Office of the Utility Commission Consumer Counselor IDEM: Indiana Department of PUCO: Public Utilities Commission of Environmental Management Ohio IURC: Indiana Utility Regulatory SFAS: Statement of Financial Commission Accounting Standards MCF/MMCF/BCF: thousands/millions/ USEPA: United States Environmental billions of cubic feet Protection Agency MDth/MMDth: thousands/millions of Throughput: combined gas sales and gas dekatherms transportation volumes PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS VECTREN CORPORATION AND SUBSIDIARY COMPANIES CONSOLIDATED CONDENSED BALANCE SHEETS (Unaudited - In millions) - ------------------------------------------------------------------------------- September 30, December 31, 2004 2003 - ------------------------------------------------------------------------------- ASSETS Current Assets Cash & cash equivalents $ 7.8 $ 15.3 Accounts receivable - less reserves of $1.4 & $3.2, respectively 100.1 137.3 Accrued unbilled revenues 43.9 137.8 Inventories 75.0 70.4 Recoverable fuel & natural gas costs 38.5 20.3 Prepayments & other current assets 159.9 131.1 - ------------------------------------------------------------------------------- Total current assets 425.2 512.2 - ------------------------------------------------------------------------------- Utility Plant Original cost 3,401.5 3,250.7 Less: accumulated depreciation & amortization 1,294.2 1,247.0 - ------------------------------------------------------------------------------- Net utility plant 2,107.3 2,003.7 - ------------------------------------------------------------------------------- Investments in unconsolidated affiliates 175.7 176.1 Other investments 114.4 122.9 Non-utility property - net 222.3 222.3 Goodwill - net 205.0 205.0 Regulatory assets 88.2 89.6 Other assets 26.1 21.6 - ------------------------------------------------------------------------------- TOTAL ASSETS $ 3,364.2 $ 3,353.4 =============================================================================== The accompanying notes are an integral part of these consolidated condensed financial statements. VECTREN CORPORATION AND SUBSIDIARY COMPANIES CONSOLIDATED CONDENSED BALANCE SHEETS (Unaudited - In millions) - ------------------------------------------------------------------------------- September 30, December 31, 2004 2003 - ------------------------------------------------------------------------------- LIABILITIES & SHAREHOLDERS' EQUITY Current Liabilities Accounts payable $ 96.2 $ 85.3 Accounts payable to affiliated companies 54.5 86.4 Accrued liabilities 95.2 109.3 Short-term borrowings 308.2 274.9 Current maturities of long-term debt 15.7 15.0 Long-term debt subject to tender 10.0 13.5 - ------------------------------------------------------------------------------- Total current liabilities 579.8 584.4 - ------------------------------------------------------------------------------- Long-term Debt - Net of Current Maturities & Debt Subject to Tender 1,065.0 1,072.8 Deferred Income Taxes & Other Liabilities Deferred income taxes 236.9 235.4 Regulatory liabilities & other removal costs 247.8 235.0 Deferred credits & other liabilities 154.3 153.6 - ------------------------------------------------------------------------------- Total deferred credits & other liabilities 639.0 624.0 - ------------------------------------------------------------------------------- Minority Interest in Subsidiary 0.4 0.3 Commitments & Contingencies (Notes 7 -11) Cumulative, Redeemable Preferred Stock of a Subsidiary 0.1 0.2 Common Shareholders' Equity Common stock (no par value) - issued & outstanding 76.0 and 75.6 shares, respectively 526.9 520.4 Retained earnings 565.6 562.4 Accumulated other comprehensive loss (12.6) (11.1) - ------------------------------------------------------------------------------- Total common shareholders' equity 1,079.9 1,071.7 - ------------------------------------------------------------------------------- TOTAL LIABILITIES & SHAREHOLDERS' EQUITY $ 3,364.2 $ 3,353.4 =============================================================================== The accompanying notes are an integral part of these consolidated condensed financial statements.
VECTREN CORPORATION AND SUBSIDIARY COMPANIES CONSOLIDATED CONDENSED STATEMENTS OF INCOME (Unaudited - In millions, except per share data) - ------------------------------------------------------------------------------------------ Three Months Nine Months Ended September 30, Ended September 30, ------------------- --------------------- 2004 2003 2004 2003 - ------------------------------------------------------------------------------------------ OPERATING REVENUES Gas utility $ 112.4 $ 115.0 $ 771.6 $ 788.8 Electric utility 102.3 95.5 280.2 254.2 Energy services & other 39.7 29.1 124.6 90.8 - ------------------------------------------------------------------------------------------ Total operating revenues 254.4 239.6 1,176.4 1,133.8 - ------------------------------------------------------------------------------------------ OPERATING EXPENSES Cost of gas sold 67.2 71.3 529.8 539.9 Fuel for electric generation 25.8 24.8 72.4 66.2 Purchased electric energy 5.3 4.2 16.6 12.5 Cost of energy services & other 27.0 22.0 90.1 66.6 Other operating 59.2 57.2 187.8 179.4 Depreciation & amortization 36.2 32.9 103.6 96.7 Taxes other than income taxes 9.9 9.0 43.3 42.1 - ------------------------------------------------------------------------------------------ Total operating expenses 230.6 221.4 1,043.6 1,003.4 - ------------------------------------------------------------------------------------------ OPERATING INCOME 23.8 18.2 132.8 130.4 OTHER INCOME (EXPENSE) - NET Equity in earnings (losses) of unconsolidated affiliates 1.5 (2.3) 13.5 6.4 Other income (expense) - net 2.9 8.4 (0.9) 6.2 - ------------------------------------------------------------------------------------------ Total other (expense) income - net 4.4 6.1 12.6 12.6 - ------------------------------------------------------------------------------------------ Interest expense 19.4 19.6 57.5 56.7 - ------------------------------------------------------------------------------------------ INCOME BEFORE INCOME TAXES 8.8 4.7 87.9 86.3 - ------------------------------------------------------------------------------------------ Income taxes (0.9) (2.6) 20.0 19.2 Minority interest in & preferred dividend requirements of subsidiaries - - 0.1 - - ------------------------------------------------------------------------------------------ NET INCOME $ 9.7 $ 7.3 $ 67.8 $ 67.1 ========================================================================================== AVERAGE COMMON SHARES OUTSTANDING 75.6 71.6 75.5 69.0 DILUTED COMMON SHARES OUTSTANDING 76.0 71.9 75.9 69.3 EARNINGS PER SHARE OF COMMON STOCK: BASIC $ 0.13 $ 0.10 $ 0.90 $ 0.97 DILUTED 0.13 0.10 0.89 0.97 DIVIDENDS DECLARED PER SHARE OF COMMON STOCK $ 0.29 $ 0.28 $ 0.86 $ 0.83
The accompanying notes are an integral part of these consolidated condensed financial statements.
VECTREN CORPORATION AND SUBSIDIARY COMPANIES CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS (Unaudited - In millions) - -------------------------------------------------------------------------------------------- Nine Months Ended September 30, 2004 2003 - -------------------------------------------------------------------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 67.8 $ 67.1 Adjustments to reconcile net income to cash from operating activities: Depreciation & amortization 103.6 96.7 Deferred income taxes & investment tax credits (5.4) 18.1 Equity in earnings of unconsolidated affiliates (13.5) (6.4) Net unrealized loss/(gain) on derivative instruments 1.0 (0.4) Pension & postretirement periodic benefit cost 12.3 10.5 Other non-cash charges - net 16.1 6.5 Changes in working capital accounts: Accounts receivable & accrued unbilled revenue 126.0 129.8 Inventories (7.0) 1.2 Recoverable fuel & natural gas costs (18.2) (9.4) Prepayments & other current assets (21.3) (77.7) Accounts payable, including to affiliated companies (22.5) (76.6) Accrued liabilities (12.8) (18.8) Changes in noncurrent assets (6.1) (2.2) Changes in noncurrent liabilities (13.4) (2.4) - ------------------------------------------------------------------------------------------- Net cash flows from operating activities 206.6 136.0 - ------------------------------------------------------------------------------------------- CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from: Stock option exercises & other stock plans 4.5 5.2 Long-term debt - net of issuance costs & hedging proceeds - 202.9 Common stock - net of issuance costs - 163.2 Requirements for: Dividends on common stock (64.6) (57.7) Retirement of long-term debt, including premiums paid (12.5) (121.9) Redemption of preferred stock of subsidiary (0.1) (0.1) Other financing activities - (1.7) Net change in short-term borrowings 34.9 (198.7) - ------------------------------------------------------------------------------------------- Net cash flows from financing activities (37.8) (8.8) - ------------------------------------------------------------------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES Proceeds from: Unconsolidated affiliate distributions 23.6 13.5 Notes receivable & other collections 8.9 15.3 Requirements for: Capital expenditures, excluding AFUDC equity (189.3) (150.7) Unconsolidated affiliate investments (15.7) (12.3) Notes receivable & other investments (3.8) (6.4) - ------------------------------------------------------------------------------------------- Net cash flows from investing activities (176.3) (140.6) - ------------------------------------------------------------------------------------------- Net decrease in cash & cash equivalents (7.5) (13.4) Cash & cash equivalents at beginning of period 15.3 25.1 - ------------------------------------------------------------------------------------------- Cash & cash equivalents at end of period $ 7.8 $ 11.7 ===========================================================================================
The accompanying notes are an integral part of these consolidated condensed financial statements. VECTREN CORPORATION AND SUBSIDIARY COMPANIES NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (UNAUDITED) 1. Organization and Nature of Operations Vectren Corporation (the Company or Vectren), an Indiana corporation, is an energy and applied technology holding company headquartered in Evansville, Indiana. The Company's wholly owned subsidiary, Vectren Utility Holdings, Inc. (VUHI), serves as the intermediate holding company for its three operating public utilities: Indiana Gas Company, Inc. (Indiana Gas or Vectren North), Southern Indiana Gas and Electric Company (SIGECO or Vectren South), and the Ohio operations. VUHI also has other assets that provide information technology and other services to the three utilities. Both Vectren and VUHI are exempt from registration pursuant to Section 3(a)(1) and 3(c) of the Public Utility Holding Company Act of 1935. Indiana Gas provides natural gas distribution and transportation services to a diversified customer base in 49 of Indiana's 92 counties. SIGECO provides electric generation, transmission, and distribution services to 8 counties in southwestern Indiana, including counties surrounding Evansville, and participates in the wholesale power market. SIGECO also provides natural gas distribution and transportation services to 9 counties in southwestern Indiana, including counties surrounding Evansville. Indiana Gas and SIGECO generally do business as Vectren Energy Delivery of Indiana, Inc. The Ohio operations, owned as a tenancy in common by Vectren Energy Delivery of Ohio, Inc. (VEDO), a wholly owned subsidiary, (53% ownership) and Indiana Gas (47% ownership), provide natural gas distribution and transportation services to 17 counties in west central Ohio, including counties surrounding Dayton. VUHI's consolidated operations are collectively referred to as the Utility Group. The Company is also involved in nonregulated activities in four primary business areas: Energy Marketing and Services, Coal Mining, Utility Infrastructure Services, and Broadband. Energy Marketing and Services markets natural gas and provides energy management services, including energy performance contracting services. Coal Mining mines and sells coal and generates IRS Code Section 29 tax credits relating to the production of coal-based synthetic fuels. Utility Infrastructure Services provides underground construction and repair, facilities locating, and meter reading services. Broadband has investments in broadband communication services such as analog and digital cable television, high-speed Internet and data services, and advanced local and long distance phone services. In addition, the Nonregulated Group has other businesses that invest in energy-related opportunities, real estate, and leveraged leases, among other activities. The Nonregulated Group supports the Company's regulated utilities pursuant to service contracts by providing natural gas supply services, coal, utility infrastructure services, and other services. These operations are collectively referred to as the Nonregulated Group. 2. Basis of Presentation The interim consolidated condensed financial statements included in this report have been prepared by the Company, without audit, as provided in the rules and regulations of the Securities and Exchange Commission. Certain information and note disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been omitted as provided in such rules and regulations. The Company believes that the information in this report reflects all adjustments necessary to fairly state the results of the interim periods reported. These consolidated condensed financial statements and related notes should be read in conjunction with the Company's audited annual consolidated financial statements for the year ended December 31, 2003, filed on Form 10-K. Because of the seasonal nature of the Company's utility operations, the results shown on a quarterly basis are not necessarily indicative of annual results. The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. 3. Share-Based Compensation The Company applies APB Opinion 25, "Accounting for Stock Issued to Employees" (APB 25) and related interpretations when measuring compensation expense for its share-based compensation plans. Stock Option Plans The exercise price of stock options awarded under the Company's stock option plans is equal to the fair market value of the underlying common stock on the date of grant. Accordingly, no compensation expense has been recognized for stock option plans. In January 2004, 219,000 options to purchase shares of common stock at an exercise price of $24.74 were issued to management. The grant vests over three years. Other Plans In addition to its stock option plans, the Company also maintains restricted stock and phantom stock plans for executives, employees, and non-employee directors. In January 2004, 133,500 restricted shares at a fair value of $24.74 per share were issued to management. The shares vest over four years. Compensation expense associated with these restricted stock and phantom stock plans for the three months ended September 30, 2004 and 2003, was $1.1 million ($0.6 million after tax) and $1.5 million ($0.9 million after tax), respectively, and for the nine months ended September 30, 2004 and 2003, was $2.4 million ($1.4 million after tax) and $2.9 million ($1.7 million after tax), respectively. The amount of expense is consistent with the amount of expense that would have been recognized if the Company used the fair value based method described in SFAS No. 123 "Accounting for Stock Based Compensation" (SFAS 123), as amended, to value these awards. Pro forma Information Following is the effect on net income and earnings per share as if the fair value based method described in SFAS 123 had been applied to all share-based compensation plans:
- --------------------------------------------------------------------------------------------- Three Months Nine Months Ended September 30, Ended September 30, ------------------- ------------------- (In millions, except per share amounts) 2004 2003 2004 2003 - --------------------------------------------------------------------------------------------- Net Income: As reported $ 9.7 $ 7.3 $ 67.8 $ 67.1 Add: Share-based employee compensation included in reported net income - net of tax 0.6 0.9 1.4 1.7 Deduct: Total share-based employee compensation expense determined under fair value based method for all awards - net of tax 0.8 1.2 1.9 2.7 - --------------------------------------------------------------------------------------------- Pro forma net income $ 9.5 $ 7.0 $ 67.3 $ 66.1 ============================================================================================= Basic Earnings Per Share: As reported $ 0.13 $ 0.10 $ 0.90 $ 0.97 Pro forma 0.13 0.10 0.89 0.96 Diluted Earnings Per Share: As reported $ 0.13 $ 0.10 $ 0.89 $ 0.97 Pro forma 0.13 0.10 0.89 0.96
4. Comprehensive Income Comprehensive income consists of the following:
- ---------------------------------------------------------------------------------------------- Three Months Nine Months Ended September 30, Ended September 30, ------------------- ------------------- (In millions) 2004 2003 2004 2003 - ---------------------------------------------------------------------------------------------- Net income $ 9.7 $ 7.3 $ 67.8 $ 67.1 Comprehensive (loss) income of unconsolidated affiliates- net of tax (1.2) 3.5 (1.5) 5.7 Minimum pension liability adjustment & other- net of tax - (0.5) - (0.1) - ---------------------------------------------------------------------------------------------- Total comprehensive income (loss) $ 8.5 $10.3 $ 66.3 $ 72.7 ==============================================================================================
Other comprehensive income arising from unconsolidated affiliates is the Company's portion of ProLiance Energy, LLC's and Reliant Services, LLC's accumulated other comprehensive income related to their use of cash flow hedges, including commodity contracts and interest rate swaps, and the Company's portion of Haddington Energy Partners, LP's accumulated other comprehensive income related to its unrealized gains and losses of "available for sale securities," as defined by SFAS 115, "Accounting for Certain Investments in Debt and Equity Securities." 5. Earnings Per Share Basic earnings per share is computed by dividing net income available to common shareholders by the weighted-average number of common shares outstanding for the period. Diluted earnings per share assumes the conversion of stock options into common shares and the lifting of restrictions on issued restricted shares using the treasury stock method to the extent the effect would be dilutive. The following table sets forth the computation of basic and diluted earnings per share calculations for the three and nine months ended September 30, 2004 and 2003:
- --------------------------------------------------------------------------------------------- Three Months Nine Months Ended September 30, Ended September 30, ------------------- ------------------- (In millions, except per share data) 2004 2003 2004 2003 - --------------------------------------------------------------------------------------------- Numerator: Numerator for basic and diluted EPS - Net income $ 9.7 $ 7.3 $ 67.8 $ 67.1 ============================================================================================= Denominator: Denominator for basic EPS - Weighted average common shares outstanding 75.6 71.6 75.5 69.0 Conversion of stock options and lifting of restrictions on issued restricted stock 0.4 0.3 0.4 0.3 - --------------------------------------------------------------------------------------------- Denominator for diluted EPS - Adjusted weighted average shares outstanding and assumed conversions outstanding 76.0 71.9 75.9 69.3 ============================================================================================= Basic earnings per share $ 0.13 $ 0.10 $ 0.90 $ 0.97 Diluted earnings per share $ 0.13 $ 0.10 $ 0.89 $ 0.97
For the three months ended September 30, 2004 and 2003, options to purchase an additional 22,274 and 110,663, respectively, shares of the Company's common stock were outstanding, but were not included in the computation of diluted earnings per share because their effect would be antidilutive. Exercise prices for options excluded from the computation ranged from $24.90 to $25.59 in 2004 and from $23.35 to $25.59 in 2003. For the nine months ended September 30, 2004 and 2003, options to purchase an additional 241,274 and 530,663, respectively, shares of the Company's common stock were outstanding, but were not included in the computation of diluted earnings per share because their effect would be antidilutive. Exercise prices for options excluded from the computation ranged from $24.74 to $25.59 in 2004 and from $23.19 to $25.59 in 2003. 6. Retirement Plans & Other Postretirement Benefits The Company maintains three qualified defined benefit pension plans, a nonqualified supplemental executive retirement plan (SERP), and three other postretirement benefit plans. The qualified pension plans and the SERP are aggregated under the heading "Pension Benefits." Other postretirement benefit plans are aggregated under the heading "Other Benefits." Net Periodic Benefit Costs A summary of the components of net periodic benefit cost follows: - -------------------------------------------------------------------------------- Three Months Ended September 30, Pension Benefits Other Benefits ---------------- --------------- (In millions) 2004 2003 2004 2003 - -------------------------------------------------------------------------------- Service cost $ 1.7 $ 1.5 $ 0.3 $ 0.2 Interest cost 3.4 3.4 1.5 1.4 Expected return on plan assets (3.4) (3.7) (0.2) (0.2) Amortization of prior service cost 0.2 0.2 - - Amortization of transitional (asset) obligation (0.1) (0.1) 0.7 0.7 Amortization of actuarial loss (gain) 0.3 0.1 (0.3) (0.1) - -------------------------------------------------------------------------------- Net periodic benefit cost $ 2.1 $ 1.4 $ 2.0 $ 2.0 ================================================================================ - -------------------------------------------------------------------------------- Nine Months Ended September 30, Pension Benefits Other Benefits ------------------ ---------------- (In millions) 2004 2003 2004 2003 - -------------------------------------------------------------------------------- Service cost $ 4.9 $ 4.4 $ 0.7 $ 0.7 Interest cost 10.1 10.2 4.4 4.1 Expected return on plan assets (10.1) (11.1) (0.5) (0.5) Amortization of prior service cost 0.7 0.6 - - Amortization of transitional (asset) obligation (0.2) (0.2) 2.2 2.2 Amortization of actuarial loss (gain) 0.7 0.5 (0.6) (0.4) - -------------------------------------------------------------------------------- Net periodic benefit cost $ 6.1 $ 4.4 $ 6.2 $ 6.1 ================================================================================ Employer Contributions to Qualified Pension Plans Through September 30, 2004, $7.7 million has been contributed to its pension plan trusts, and the Company does not expect to make any more contributions for the remainder of the year. FSP 106-2 On December 8, 2003, the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the "Medicare Act") was enacted. The Medicare Act introduces a Medicare prescription drug benefit, as well as a federal subsidy to sponsors of retiree health care benefit plans that provide a benefit that is at least "actuarially equivalent" to the Medicare benefit. In May 2004, FASB issued FASB Staff Position ("FSP") 106-2, "Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003," which supercedes FSP 106-1 of the same title issued in January 2004. FSP 106-2 provides guidance on the accounting and required disclosures for the effects of the Medicare Act for employers that sponsor postretirement health care plans that provide prescription drug benefits. FSP 106-2 becomes effective for the first interim or annual period beginning after June 15, 2004, with earlier adoption permitted. The Company elected to early adopt the accounting for the federal subsidy under the Medicare Act on April 1, 2004, and remeasured its obligation as of January 1, 2004, to incorporate the impact of the Medicare Act which resulted in a reduction to the accumulated benefit obligation of $10.4 million. For the three and nine months ended September 30, 2004, the remeasurement resulted in a reduction in net periodic postretirement benefit cost of $0.3 million and $0.6 million, respectively. The reduction is a component of amortization of actuarial loss (gain) in the chart above. The underlying determination of whether an employer's plan qualifies for the federal subsidy is still subject to clarifying federal regulations related to the Medicare Act. When this guidance is issued, the Company will reassess if its plans continue to qualify for the subsidy. 7. Transactions with ProLiance Energy, LLC ProLiance Energy, LLC (ProLiance), a nonregulated energy marketing affiliate of Vectren and Citizens Gas and Coke Utility, provides natural gas and related services to the Company's regulated utilities and nonregulated gas retail operations. ProLiance's primary businesses include gas marketing, gas portfolio optimization, and other portfolio and energy management services. ProLiance's primary customers are its members' utilities and other large end-use customers. Transactions with ProLiance Purchases from ProLiance for resale, for injections into storage, and for prepaid gas delivery service for the three months ended September 30, 2004 and 2003, totaled $171.6 million and $154.1 million, respectively, and for the nine months ended September 30, 2004 and 2003, totaled $621.5 million and $589.0 million, respectively. Amounts owed to ProLiance at September 30, 2004, and December 31, 2003, for those purchases were $51.3 million and $86.0 million, respectively, and are included in Accounts payable to affiliated companies. Amounts charged by ProLiance for gas supply services are established by supply agreements with each utility. ProLiance Contingency There is currently a lawsuit pending in the United States District Court for the Northern District of Alabama filed by the City of Huntsville, Alabama d/b/a Huntsville Utilities, Inc. (Huntsville Utilities) against ProLiance. Huntsville Utilities asserts claims based on negligent provision of portfolio services and/or pricing advice, fraud, fraudulent inducement, and other theories. These claims relate generally to several basic arguments: 1) negligence in providing advice and/or administering portfolio arrangements, 2) alleged promises to provide gas at a below-market rate, 3) the creation and repayment of a "winter levelizing program" instituted by ProLiance in conjunction with the manager of Huntsville's Gas Utility, to allow Huntsville Utilities to pay its gas bills over an extended period of time coupled with the alleged ignorance about the program on the part of Huntsville Utilities' Gas Board, and, 4) the sale of Huntsville Utilities' gas storage supplies to repay the balance owed on the winter levelizing program and the authority of Huntsville Utilities' gas manager to approve those sales. In a press conference on May 21, 2002, Huntsville Utilities asserted its monetary damages to be approximately $10 million, and seeks to treble that amount. ProLiance has made counterclaims asserting breach of contract, among others, based on Huntsville Utilities' refusal to take gas under fixed price agreements. Both parties have denied the charges contained in the respective claims. In 2003, ProLiance established reserves for amounts due from Huntsville Utilities due to uncertainties surrounding collection. ProLiance believes its actions were proper under the contract and amendments signed by the manager of Huntsville's Gas Utility, and is vigorously defending the suit. ProLiance is insured under a policy providing defense costs which may provide in whole or in part, indemnification within the policy limits for claims asserted against ProLiance. Accordingly, no other loss contingencies have been recorded at this time. However, it is not possible to predict or determine the outcome of this litigation and accordingly there can be no assurance that ProLiance will prevail. It is not currently expected that costs associated with this matter will have a material adverse effect on Vectren's consolidated financial position or liquidity but an unfavorable outcome could possibly be material to Vectren's earnings. 8. Commitments & Contingencies Legal Proceedings The Company is party to various legal proceedings arising in the normal course of business. In the opinion of management, there are no legal proceedings pending against the Company that are likely to have a material adverse effect on its financial position or results of operations. See Note 7 regarding the ProLiance contingency and Note 9 regarding environmental matters. IRS Section 29 Tax Credit Recent Developments Vectren's Coal Mining operations are comprised of Vectren Fuels, Inc. (Fuels), which includes its coal mines and related operations and Vectren Synfuels, Inc. (Synfuels). Synfuels holds one limited partnership unit (an 8.3% interest) in Pace Carbon Synfuels Investors, LP (Pace Carbon), a Delaware limited partnership formed to develop, own, and operate four projects to produce and sell coal-based synthetic fuel utilizing Covol technology. Under Section 29 of the Internal Revenue Code, manufacturers such as Pace Carbon receive a tax credit for every ton of synthetic fuel sold. To qualify for the credits, the synthetic fuel must meet three primary conditions: 1) there must be a significant chemical change in the coal feedstock, 2) the product must be sold to an unrelated person, and 3) the production facility must have been placed in service before July 1, 1998. In past rulings, the Internal Revenue Service (IRS) has concluded that the synthetic fuel produced at the Pace Carbon facilities should qualify for Section 29 tax credits. The IRS issued a private letter ruling with respect to the four projects on November 11, 1997, and subsequently issued an updated private letter ruling on September 23, 2002. As a partner in Pace Carbon, Vectren has reflected total tax credits under Section 29 in its consolidated results from the inception of the partnership through September 30, 2004, of approximately $52.2 million. To date, Vectren has been in a position to fully utilize the credits generated. During June 2001, the IRS began a tax audit of Pace Carbon for the 1998 tax year and later expanded the audit to include tax years 1999, 2000, and 2001. In May 2004, the IRS completed its audit of the 1998 to 2001 tax returns of Pace Carbon requesting only minor modifications to previously filed returns. There were no changes to any of the filed Section 29 tax credit calculations. The Permanent Subcommittee on Investigations of the U.S. Senate's Committee on Governmental Affairs, however, has an ongoing investigation on the subject of these income tax credits. Vectren believes it is justified in its reliance on the private letter rulings and recent IRS audit results for the Pace Carbon facilities. However, at this time, Vectren cannot provide any assurance as to the outcome that these uncertainties may have on Vectren's consolidated financial position or liquidity. SEC Inquiry regarding PUHCA Exemption In July 2004, the Company received a letter from the SEC regarding its exempt status under the Public Utility Holding Company Act of 1935 (PUHCA). The letter asserts that Vectren's out of state electric power sales exceed the amount previously determined by the SEC to be acceptable in order to qualify for the exemption. Vectren claims exemption from registration under Section 3(a)(1) of PUHCA by rule 2. As required by the rule, Vectren files an annual statement on SEC Form U-3A-2. The Company has responded to the SEC inquiry and filed an amended Form U-3A-2 for the year ended December 31, 2003. Guarantees & Product Warranties Vectren issues guarantees to third parties on behalf of its unconsolidated affiliates. Such guarantees allow those affiliates to execute transactions on more favorable terms than the affiliate could obtain without such a guarantee. Guarantees may include posted letters of credit, leasing guarantees, and performance guarantees. As of September 30, 2004, guarantees issued and outstanding on behalf of unconsolidated affiliates approximated $10 million. The Company has also issued a guarantee approximating $4 million related to the residual value of an operating lease that expires in 2006. Vectren has accrued no liabilities for these guarantees as they relate to guarantees issued among related parties, are not material, or such guarantees were executed prior to the adoption of FASB Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others." Liabilities accrued for, and activity related to, product warranties are not significant. 9. Environmental Matters NOx SIP Call Matter The Company has initiated steps toward compliance with Indiana's State Implementation Plan (SIP) of the Clean Air Act (the Act). These steps include installing Selective Catalytic Reduction (SCR) systems at Culley Generating Station Unit 3 (Culley), Warrick Generating Station Unit 4, and A.B. Brown Generating Station Units 1 and 2. SCR systems reduce flue gas NOx emissions to atmospheric nitrogen and water using ammonia in a chemical reaction. This technology is known to currently be the most effective method of reducing nitrogen oxide (NOx) emissions where high removal efficiencies are required. The IURC has issued orders that approve: >> the Company's project to achieve environmental compliance by investing in clean coal technology; >> a total capital cost investment for this project up to $244 million (excluding AFUDC), subject to periodic review of the actual costs incurred; >> a mechanism whereby, prior to an electric base rate case, the Company may recover through a rider that is updated every six months, an eight percent return on its weighted capital costs for the project; and >> ongoing recovery of operating costs, including depreciation and purchased emission allowances through a rider mechanism, related to the clean coal technology once the facility is placed into service. Based on the level of system-wide emissions reductions required and the control technology utilized to achieve the reductions, the current estimated construction cost is consistent with amounts approved in the IURC's orders. Through September 30, 2004, $207 million has been expended, and three of the four SCR's are operational. After the equipment is installed and operational, related annual operating expenses, including depreciation expense, are estimated to be between $24 million and $27 million. The Company is recovering the operational costs associated with the SCR's and related technology. The 8 percent return on capital investment approximates the return authorized in the Company's last electric rate case in 1995 and includes a return on equity. The Company has achieved timely compliance through the reduction of the Company's overall NOx emissions to levels compliant with Indiana's NOx emissions budget allotted by the USEPA. Therefore, the Company has recorded no accrual for potential penalties that may result from noncompliance. Manufactured Gas Plants In the past, Indiana Gas, SIGECO, and others operated facilities for the manufacture of gas. Given the availability of natural gas transported by pipelines, these facilities have not been operated for many years. Under currently applicable environmental laws and regulations, Indiana Gas, SIGECO, and others may now be required to take remedial action if certain byproducts are found above the regulatory thresholds at these sites. Indiana Gas has identified the existence, location, and certain general characteristics of 26 gas manufacturing and storage sites for which it may have some remedial responsibility. Indiana Gas has completed a remedial investigation/feasibility study (RI/FS) at one of the sites under an agreed order between Indiana Gas and the IDEM, and a Record of Decision was issued by the IDEM in January 2000. Although Indiana Gas has not begun an RI/FS at additional sites, Indiana Gas has submitted several of the sites to the IDEM's Voluntary Remediation Program (VRP) and is currently conducting some level of remedial activities, including groundwater monitoring at certain sites, where deemed appropriate, and will continue remedial activities at the sites as appropriate and necessary. In conjunction with data compiled by environmental consultants, Indiana Gas has accrued the estimated costs for further investigation, remediation, groundwater monitoring, and related costs for the sites. While the total costs that may be incurred in connection with addressing these sites cannot be determined at this time, Indiana Gas has recorded costs that it reasonably expects to incur totaling approximately $20.4 million. The estimated accrued costs are limited to Indiana Gas' proportionate share of the remediation efforts. Indiana Gas has arrangements in place for 19 of the 26 sites with other potentially responsible parties (PRP), which serve to limit Indiana Gas' share of response costs at these 19 sites to between 20% and 50%. With respect to insurance coverage, Indiana Gas has received and recorded settlements from all known insurance carriers in an aggregate amount approximating $20.4 million. Environmental matters related to manufactured gas plants have had no material impact on earnings since costs recorded to date approximate PRP and insurance settlement recoveries. While Indiana Gas has recorded all costs which it presently expects to incur in connection with activities at these sites, it is possible that future events may require some level of additional remedial activities which are not presently foreseen. In October 2002, the Company received a formal information request letter from the IDEM regarding five manufactured gas plants owned and/or operated by SIGECO and not currently enrolled in the IDEM's VRP. In response, SIGECO submitted to the IDEM the results of preliminary site investigations conducted in the mid-1990's. These site investigations confirmed that based upon the conditions known at the time, the sites posed no risk to human health or the environment. Follow up reviews have been initiated by the Company to confirm that the sites continue to pose no such risk. On October 6, 2003, SIGECO filed applications to enter four of the manufactured gas plant sites in IDEM's VRP. The remaining site is currently being addressed in the VRP by another Indiana utility. SIGECO added those four sites into the renewal of the global Voluntary Remediation Agreement that Indiana Gas has in place with IDEM for its manufactured gas plant sites. That renewal was approved by the IDEM on February 24, 2004. On July 13, 2004, SIGECO filed a declaratory judgment action against its insurance carriers seeking a judgment finding its carriers liable under the policies for coverage of further investigation and any necessary remediation costs that SIGECO may accrue under the VRP program. The total investigative costs, and if necessary, costs of remediation at the four SIGECO sites, as well as the amount of any PRP or insurance recoveries, cannot be determined at this time. Jacobsville Superfund Site On July 22, 2004, the USEPA listed the Jacobsville Neighborhood Soil Contamination site in Evansville, Indiana, on the National Priorities List under the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA). The USEPA has identified four sources of historic lead contamination. These four sources shut down manufacturing operations years ago. When drawing up the boundaries for the listing, the USEPA included a 250 acre block of properties surrounding the Jacobsville neighborhood, including Vectren's Wagner Operations Center. Vectren's property has not been named as a source of the lead contamination, nor does the USEPA's soil testing to date indicate that the Vectren property contains lead contaminated soils. Vectren's own soil testing, completed during the construction of the Operations Center did not indicate that the Vectren property contains lead contaminated soils. At this time, Vectren anticipates only additional soil testing, if required by the USEPA. 10. Rate & Regulatory Matters Vectren South (SIGECO) Gas Base Rate Settlement On March 12, 2004, Vectren South filed a petition with the IURC to adjust its base rates and charges for its gas distribution business in southwestern Indiana to recover the ongoing cost of operating and maintaining the approximately 3,000-mile distribution and storage system used to serve more than 110,000 customers. On June 30, 2004, the IURC approved a $5.7 million base rate increase for Vectren South's gas distribution business in southwestern Indiana. The rate settlement only addresses Vectren South's "non-gas" costs which are incurred to build, operate, and maintain the pipelines, other equipment and systems that are used to deliver gas across Vectren South's system to its customers. The base rate change was implemented on July 1, 2004. The order also permits Vectren South to recover the on-going costs associated with Vectren South's compliance with the federal Pipeline Safety Improvement Act of 2002. Implementation of these compliance activities will include additional patrols, leakage surveys and direct observation of approximately 90 miles of Vectren South's transmission pipeline system. The Pipeline Safety Improvement Tracker provides for the recovery of up to $750,000 the first year and $500,000 thereafter, subject to OUCC review and IURC approval that the costs are prudently incurred. Any costs incurred in excess of these levels will be deferred for future recovery. Vectren North (Indiana Gas) Pending Base Rate Settlement On March 19, 2004, Vectren North filed a petition with the IURC to adjust its base rates and charges for its gas distribution business in a 49 county region covering central and southeastern Indiana. On October 12, 2004, the Company announced a settlement agreement with several parties, including the Indiana Office of Utility Consumer Counselor, the Indiana Gas Industrial Group, and the Citizens Action Coalition of Indiana, Inc. The settlement agreement provides for a $24 million increase in Vectren North's base distribution rates to cover the ongoing cost of operating, maintaining, and expanding the approximately 12,000-mile distribution and storage system used to serve more than 545,000 customers. Once implemented, the new rate design will include a larger service charge, which is intended to address to some extent earnings volatility related to weather. The settlement also permits Vectren North to recover the on-going costs associated with the federal Pipeline Safety Improvement Act of 2002. The Pipeline Safety Improvement Tracker provides for the recovery of incremental non-capital dollars, capped at $2.5 million per year. Costs in excess of the annual cap are to be deferred for future recovery. The IURC will hold a hearing on the settlement on November 22, 2004, and Commission action is expected shortly thereafter. VEDO Pending Base Rate Filing On April 16, 2004, VEDO issued a pre-filing notice to the PUCO of a request to adjust base rates and charges for VEDO's gas distribution business in a 17-county region covering west central Ohio. On May 24, 2004, the official application and Standard Filing Requirements were filed with the PUCO. If the filing is approved, VEDO expects to increase base rates up to $25 million to recover the ongoing cost of operating, maintaining and expanding the approximately 5,200-mile distribution system used to serve more than 310,000 customers. VEDO's request is subject to review and approval by the PUCO. The petition only addresses VEDO's "non-gas costs," which are incurred to build, operate and maintain pipelines, other equipment and systems that are used to deliver gas across VEDO's system to its customers. The filing also includes a proposed conservation tariff, which, if approved, will enable the Company to proactively support conservation and promote home weatherization and the reduction of energy consumption. Based on the PUCO's regulatory process, the PUCO staff report relating to the Company's request is expected to be submitted in November 2004. Based upon the PUCO's actions in other proceedings, the Company would expect a Commission order in this case late in the first quarter of 2005. Gas Cost Recovery (GCR) Audit Proceedings There is an Ohio requirement that Ohio gas utilities undergo a biannual audit of their gas acquisition practices in connection with the gas cost recovery (GCR) mechanism. In the case of VEDO, the two-year audit period ended in November 2002. The audit provides the initial review of the portfolio administration arrangement between VEDO and ProLiance. The external auditor retained by the PUCO staff submitted an audit report in the fall of 2003 wherein it recommended a disallowance of approximately $7 million of previously recovered gas costs. The Company believes a large portion of the third party auditor recommendations is without merit. A hearing has been held, and the PUCO staff has recommended an approximate $6 million disallowance. The Ohio Consumer Counselor has recommended an approximate $12 million disallowance, which includes interest. For this PUCO audit period, any disallowance relating to the Company's ProLiance arrangement will be shared by the Company's joint venture partner. Based on a review of the matters, the Company has recorded $1.9 million for its estimated share of any potential disallowance. A PUCO decision on this matter is yet to be issued. The Company is also unable to determine the effects that a PUCO decision may have on results in audit periods beginning after November 2002. 11. Impact of Recently Issued Accounting Guidance SFAS No. 132 (Revised 2003) In December 2003, FASB issued SFAS No. 132 (revised 2003), "Employers' Disclosures about Pensions and Other Postretirement Benefits" (SFAS 132), to improve financial statement disclosures for defined benefit and other postretirement benefit plans. The incremental annual disclosure requirements were reflected in the Company's Form 10-K for the year ended December 31, 2003. The adoption did not impact the Company's results of operations or financial condition. The incremental interim disclosure requirements are included in these financial statements in Note 6. FIN 46/46R (Revised in December 2003) In January 2003, the FASB issued Interpretation 46, "Consolidation of Variable Interest Entities" (FIN 46). FIN 46 addresses consolidation by business enterprises of variable interest entities (VIE) and significantly changes the consolidation requirements for those entities. FIN 46 is intended to achieve more consistent application of consolidation policies related to VIE's and thus improves comparability between enterprises engaged in similar activities when those activities are conducted through VIE's. In December 2003, the FASB completed its deliberations of proposed modifications to FIN 46 and decided to codify both the proposed modifications and other decisions previously issued through certain FASB Staff Positions into one document that was issued as a revision to the original Interpretation (FIN 46R). FIN 46R currently applies to VIE's created after January 31, 2003, and to VIE's in which an enterprise obtains an interest after that date. For entities created prior to January 31, 2003, FIN 46R is to be adopted no later than the end of the first interim or annual reporting period ending after March 15, 2004. The Company has neither created nor obtained an interest in a VIE since January 31, 2003. Certain other entities that the Company was involved with prior to that date have been evaluated and determined to be VIE's. The Company has investments in partnership-like structures as a limited partner or as a subordinated lender. The activities of these entities are to purchase or construct as well as operate multifamily housing and office properties. The Company's exposure to loss is limited to its investment which as of September 30, 2004, and December 31, 2003, totaled $16.2 million and $17.1 million, respectively, of Investments in unconsolidated affiliates, and $16.7 million and $20.9 million, respectively, of Other investments. The Company is also the equity owner in three leveraged leases where its exposure to loss is limited to its net investment which as of September 30, 2004, and December 31, 2003, totaled $6.9 million and $6.0 million, respectively. The Company did not consolidate any of these entities upon adoption of FIN 46R. EITF 03-01 In March 2004, the EITF issued a consensus on Issue No. 03-01, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments" (EITF 03-01). In EITF 03-01, the Task Force developed a basic model for evaluating whether investments within the scope of EITF 03-01, which includes cost method and equity method investments, have other-than-temporary impairment. The basic model includes three steps: 1) determine if there is impairment; 2) if there is impairment, decide whether it is temporary or other than temporary; and 3) if it is other than temporary, recognize it in earnings. EITF 03-01 also requires certain qualitative and quantitative disclosure of material impairments judged to be temporary. The EITF has yet to finalize Steps 2 and 3. Step 1 and the disclosure requirements are currently effective, and the adoption of those portions of the EITF did not have a material effect on the Company. During 2004, the Company has incurred an other-than-temporary impairment charge associated with its cost method investment in SIGECOM, LLC, totaling $3.8 million and impairment charges associated with other broadband-related notes totaling $2.2 million. The Company is continuing to assess strategic alternatives for its broadband investments. While it currently believes that the book value of those investments approximates fair value, further changes in estimated fair value may occur. 12. Segment Reporting The Company segregates its operations into three groups: 1) Utility Group, 2) Nonregulated Group, and 3) Corporate and Other. The Utility Group is comprised of Vectren Utility Holdings, Inc.'s operations, which consist of the Company's regulated operations (the Gas Utility Services and Electric Utility Services operating segments), and other operations that provide information technology and other support services to those regulated operations. In total, there are three operating segments of the Utility Group as defined by SFAS 131 "Disclosure About Segments of an Enterprise and Related Information" (SFAS 131). Gas Utility Services provides natural gas distribution and transportation services to nearly two-thirds of Indiana and to west central Ohio. Electric Utility Services provides electricity primarily to southwestern Indiana, and includes the Company's power generating and marketing operations. For these regulated operations the Company uses after tax operating income as a measure of profitability, consistent with regulatory reporting requirements. The Company cross manages its regulated operations as separated between Energy Delivery, which includes the gas and electric transmission and distribution functions, and Power Supply, which includes the power generating and marketing operations. For the Utility Group's other operations, net income is used as the measure of profitability. The Nonregulated Group is comprised of one operating segment as defined by SFAS 131 that includes various subsidiaries and affiliates offering and investing in energy marketing and services, coal mining, utility infrastructure services, and other energy-related and broadband opportunities. Corporate and other includes unallocated corporate expenses such as branding and charitable contributions, among other activities, that benefit the Company's other operating segments. Information related to the Company's business segments is summarized below:
- ---------------------------------------------------------------------------------- Three Months Nine Months Ended September 30, Ended September 30, ------------------- ------------------- (In millions) 2004 2003 2004 2003 - ---------------------------------------------------------------------------------- Revenues Utility Group Gas Utility Services $ 112.4 $ 115.0 $ 771.6 $ 788.8 Electric Utility Services 102.3 95.5 280.2 254.2 Other Operations 7.4 6.6 25.5 19.8 Eliminations (7.4) (6.4) (25.0) (19.2) - ---------------------------------------------------------------------------------- Total Utility Group 214.7 210.7 1,052.3 1,043.6 - ---------------------------------------------------------------------------------- Nonregulated Group 61.8 50.2 186.3 151.1 Corporate & Other - 0.4 - 0.8 Eliminations (22.1) (21.7) (62.2) (61.7) - ---------------------------------------------------------------------------------- Consolidated Revenues $ 254.4 $ 239.6 $1,176.4 $1,133.8 ================================================================================== Profitability Measure Utility Group: Regulated Operating Income (Operating Income Less Applicable Income Taxes) Gas Utility Services $ (4.2) $ (6.0) $ 43.0 $ 45.4 Electric Utility Services 21.7 21.3 48.2 49.0 - ---------------------------------------------------------------------------------- Total Regulated Operating Income 17.5 15.3 91.2 94.4 - ---------------------------------------------------------------------------------- Regulated other income - net 1.3 1.8 1.8 2.0 Regulated interest expense & preferred dividends (15.7) (15.7) (46.9) (46.6) - ---------------------------------------------------------------------------------- Regulated Net Income 3.1 1.4 46.1 49.8 - ---------------------------------------------------------------------------------- Other Operations Net Income 1.4 1.0 5.8 1.3 - ---------------------------------------------------------------------------------- Utility Group Net Income 4.5 2.4 51.9 51.1 - ---------------------------------------------------------------------------------- Nonregulated Group Net Income 5.9 5.7 17.2 17.6 Corporate & Other Net Loss (0.7) (0.8) (1.3) (1.6) - ---------------------------------------------------------------------------------- Consolidated Net Income $ 9.7 $ 7.3 $ 67.8 $ 67.1 ==================================================================================
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Description of the Business Vectren Corporation (the Company or Vectren), an Indiana corporation, is an energy and applied technology holding company headquartered in Evansville, Indiana. The Company's wholly owned subsidiary, Vectren Utility Holdings, Inc. (VUHI), serves as the intermediate holding company for its three operating public utilities: Indiana Gas Company, Inc. (Indiana Gas or Vectren North), Southern Indiana Gas and Electric Company (SIGECO or Vectren South), and the Ohio operations. VUHI also has other assets that provide information technology and other services to the three utilities. Both Vectren and VUHI are exempt from registration pursuant to Section 3(a)(1) and 3(c) of the Public Utility Holding Company Act of 1935. Indiana Gas provides natural gas distribution and transportation services to a diversified customer base in 49 of Indiana's 92 counties. SIGECO provides electric generation, transmission, and distribution services to 8 counties in southwestern Indiana, including counties surrounding Evansville, and participates in the wholesale power market. SIGECO also provides natural gas distribution and transportation services to 9 counties in southwestern Indiana, including counties surrounding Evansville. Indiana Gas and SIGECO generally do business as Vectren Energy Delivery of Indiana, Inc. The Ohio operations, owned as a tenancy in common by Vectren Energy Delivery of Ohio, Inc. (VEDO), a wholly owned subsidiary, (53% ownership) and Indiana Gas (47% ownership), provide natural gas distribution and transportation services to 17 counties in west central Ohio, including counties surrounding Dayton. VUHI's consolidated operations are collectively referred to as the Utility Group. The Company is also involved in nonregulated activities in four primary business areas: Energy Marketing and Services, Coal Mining, Utility Infrastructure Services, and Broadband. Energy Marketing and Services markets natural gas and provides energy management services, including energy performance contracting services. Coal Mining mines and sells coal and generates IRS Code Section 29 tax credits relating to the production of coal-based synthetic fuels. Utility Infrastructure Services provides underground construction and repair, facilities locating, and meter reading services. Broadband has investments in broadband communication services such as analog and digital cable television, high-speed Internet and data services, and advanced local and long distance phone services. In addition, the Nonregulated Group has other businesses that invest in energy-related opportunities, real estate, and leveraged leases, among other activities. The Nonregulated Group supports the Company's regulated utilities pursuant to service contracts by providing natural gas supply services, coal, utility infrastructure services, and other services. These operations are collectively referred to as the Nonregulated Group. The Utility Group generates revenue primarily from the delivery of natural gas and electric service to its customers. The primary source of cash flow for the Utility Group results from the collection of customer bills and the payment for goods and services procured for the delivery of gas and electric services. The results of the Utility Group are impacted by weather patterns in its service territory and general economic conditions both in its service territory as well as nationally. The Nonregulated Group generates revenue or earnings from the provision of services to customers. The activities of the Nonregulated Group are closely linked to the utility industry, and the results of those operations are generally impacted by factors similar to those impacting the overall utility industry. The Company has in place a disclosure committee that consists of senior management as well as financial management. The committee is actively involved in the preparation and review of the Company's SEC filings. Executive Summary of Consolidated Results of Operations The following discussion and analysis should be read in conjunction with the unaudited condensed consolidated financial statements and notes thereto. - ------------------------------------------------------------------------------- Three Months Nine Months Ended September 30, Ended September 30, ------------------- ------------------- (In millions, except per share data) 2004 2003 2004 2003 - ------------------------------------------------------------------------------- Net income $ 9.7 $ 7.3 $ 67.8 $ 67.1 Attributed to: Utility Group $ 4.5 $ 2.4 $ 51.9 $ 51.1 Nonregulated Group 5.9 5.7 17.2 17.6 Corporate & Other (0.7) (0.8) (1.3) (1.6) - ------------------------------------------------------------------------------- Basic earnings per share $ 0.13 $ 0.10 $ 0.90 $ 0.97 Attributed to: Utility Group $ 0.06 $ 0.03 $ 0.69 $ 0.74 Nonregulated Group 0.08 0.08 0.23 0.26 Corporate & Other (0.01) (0.01) (0.02) (0.03) Results For the three months ended September 30, 2004, net income was $9.7 million, or $0.13 per share compared to net income of $7.3 million, or $0.10 per share for the same period last year. For the nine months ended September 30, 2004, reported earnings were $67.8 million, or $0.90 per share compared to $67.1 million, or $0.97 per share, for the same period in 2003. Of the reduction in year-to-date earnings per share, $0.08 per share was attributable to an increase in weighted average shares outstanding, resulting primarily from an equity offering in August 2003. Utility Group earnings were $4.5 million for the quarter compared to $2.4 million for the same period last year. The $2.1 million increase was primarily due to the recovery of NOx related environmental expenditures, increased gas base rates in the Vectren South territory, increased demand in large electric customer margins, and higher earnings from wholesale power marketing operations. Utility Group earnings were $51.9 million for the nine months ended September 30, 2004, compared to $51.1 million in the prior year. Earnings increased due to the return on additional NOx related environmental expenditures which were partially offset by reduced wholesale power activities. The Company estimates that mild weather unfavorably impacted third quarter earnings by $2.2 million after tax, or $0.03 per share, and year-to-date earnings by approximately $6.4 million after tax, or $0.09 per share over the prior year periods. Nonregulated Group earnings were $5.9 million for the quarter, an increase of $0.2 million over the prior year. The Company's three core nonregulated businesses, Energy Marketing and Services, Coal Mining and Utility Infrastructure Services, each improved their earnings contribution from 2003. Improved nonregulated operating results exceeded the impact from the sale of the Company's investment in Genscape, Inc. for $2.6 million after tax recorded in the third quarter of 2003. Nonregulated earnings for the nine months ended September 30, 2004, were $17.2 million compared to $17.6 million in the prior year. The Company's three core nonregulated businesses, Energy Marketing and Services, Coal Mining, and Utility Infrastructure Services, contributed $21.5 million in 2004, compared to $18.1 million in 2003. The 2004 nine month earnings reflect charges of $6.0 million related to the write-down of the Company's broadband businesses, which were partially offset by net gains from the Company's investment in Haddington Energy Partners. The 2003 nine month earnings reflect after-tax gains on the divesture of businesses, including Genscape, totaling $1.4 million. Dividends Dividends declared for the three months ended September 30, 2004, were $0.285 per share compared to $0.275 per share for the same period in 2003. Dividends declared for the nine months ended September 30, 2004, were $0.855 per share compared to $0.825 per share for the same period in 2003. In October 2004, the Board of Directors of Vectren Corporation (NYSE: VVC) declared a quarterly dividend of $0.295 per share of common stock, an increase of 3.5%. The dividend will be payable December 1, 2004 to shareholders of record at the close of business on November 15, 2004. Detailed Discussion of Results of Operations Following is a more detailed discussion of the results of operations of the Company's Utility Group and Nonregulated Group. The detailed results of operations for the Utility Group and Nonregulated Group are presented and analyzed before the reclassification and elimination of certain intersegment transactions necessary to consolidate those results into the Company's Consolidated Condensed Statements of Income. The operations of the Corporate and Other Group are not significant. Results of Operations of the Utility Group The Utility Group is comprised of Vectren Utility Holdings, Inc.'s operations, which consist of the Company's regulated operations (the Gas Utility Services and Electric Utility Services operating segments), and other operations that provide information technology and other support services to those regulated operations. Gas Utility Services provides natural gas distribution and transportation services in nearly two-thirds of Indiana and to west central Ohio. Electric Utility Services provides electricity primarily to southwestern Indiana, and includes the Company's power generating and marketing operations. Results of operations of the Utility Group before certain intersegment eliminations and reclassifications for the three and nine months ended September 30, 2004 and 2003, are summarized below: - ------------------------------------------------------------------------------ Three Months Nine Months Ended September 30, Ended September 30, -------------------- ---------------------- (In millions, except per share amounts) 2004 2003 2004 2003 - ------------------------------------------------------------------------------ OPERATING REVENUES Gas revenues $ 112.4 $ 115.0 $ 771.6 $ 788.8 Electric revenues 102.3 95.5 280.2 254.2 Other revenues - 0.2 0.5 0.6 - ------------------------------------------------------------------------------ Total operating revenues 214.7 210.7 1,052.3 1,043.6 - ------------------------------------------------------------------------------ OPERATING EXPENSES Cost of gas 67.2 71.3 529.8 539.9 Fuel for electric generation 25.8 24.8 72.4 66.2 Purchased electric energy 5.3 4.2 16.6 12.5 Other operating 52.0 51.4 165.8 161.9 Depreciation & amortization 33.1 30.4 94.5 88.8 Taxes other than income taxes 9.6 9.2 42.4 41.8 - ------------------------------------------------------------------------------ Total operating expenses 193.0 191.3 921.5 911.1 - ------------------------------------------------------------------------------ OPERATING INCOME 21.7 19.4 130.8 132.5 OTHER INCOME (EXPENSE) - NET Equity in earnings (losses) of unconsolidated affiliates - (0.1) 0.2 (0.5) Other income (expense) - net 2.3 2.3 3.8 1.0 - ------------------------------------------------------------------------------ Total other income (expense) - net 2.3 2.2 4.0 0.5 - ------------------------------------------------------------------------------ Interest expense 16.7 17.1 50.2 49.5 - ------------------------------------------------------------------------------ INCOME BEFORE INCOME TAXES 7.3 4.5 84.6 83.5 - ------------------------------------------------------------------------------ Income taxes 2.8 2.1 32.7 32.4 - ------------------------------------------------------------------------------ NET INCOME $ 4.5 $ 2.4 $ 51.9 $ 51.1 ============================================================================== BASIC EARNINGS PER SHARE $ 0.06 $ 0.03 $ 0.69 $ 0.74 ============================================================================== Utility Group earnings were $4.5 million for the quarter compared to $2.4 million for the same period last year. The $2.1 million increase was primarily due to the recovery of NOx related environmental expenditures, increased gas base rates in the Vectren South territory, increased demand in large electric customer margins, and higher earnings from wholesale power marketing operations. Utility Group earnings were $51.9 million for the nine months ended September 30, 2004, compared to $51.1 million in the prior year. Earnings increased due to the return on additional NOx related environmental expenditures which were partially offset by reduced wholesale power activities. The Company estimates that mild weather unfavorably impacted third quarter earnings by $2.2 million after tax, or $0.03 per share, and year-to-date earnings by approximately $6.4 million after tax, or $0.09 per share over the prior year periods. Throughout this discussion, the terms Gas Utility margin and Electric Utility margin are used. Gas Utility margin and Electric Utility margin could be considered non-GAAP measures of income. Gas Utility margin is calculated as Gas Utility revenues less the Cost of gas. Electric Utility margin is calculated as Electric Utility revenues less Fuel for electric generation and Purchased electric energy. These measures exclude Other operating expenses, Depreciation and amortization, and Taxes other than income taxes, which are included in the calculation of operating income. The Company believes Gas Utility and Electric Utility margins are better indicators of relative contribution than revenues since gas prices and fuel costs can be volatile and are generally collected on a dollar for dollar basis from customers. Margins should not be considered an alternative to, or a more meaningful indicator of operating performance than, operating income or net income as determined in accordance with accounting principles generally accepted in the United States. Significant Fluctuations Utility Group Margin Margin generated from the sale of natural gas and electricity to residential and commercial customers is seasonal and impacted by weather patterns in the Company's service territory. Margin generated from sales to large customers (generally industrial, other contract, and firm wholesale customers) is impacted primarily by overall economic conditions. Margin is also impacted by the collection of state mandated taxes, which fluctuate with gas costs, and is also impacted by some level of price sensitivity in volumes sold. Electric generating asset optimization activities are primarily affected by market conditions, the level of excess generating capacity, and electric transmission availability. Following is a discussion and analysis of margin generated from regulated utility operations. Gas Utility Margin (Gas Utility Revenues less Cost of Gas Sold) Gas Utility margin and throughput by customer type follows: - -------------------------------------------------------------------------------- Three Months Nine Months Ended September 30, Ended September 30, ------------------- ------------------- (In millions) 2004 2003 2004 2003 - -------------------------------------------------------------------------------- Residential & Commercial $ 35.5 $ 34.8 $ 198.8 $ 207.4 Contract 9.7 9.7 38.6 37.9 Other - (0.8) 4.4 3.6 - -------------------------------------------------------------------------------- Total gas utility margin $ 45.2 $ 43.7 $ 241.8 $ 248.9 ================================================================================ Sold & transported volumes in MMDth: To residential & commercial customers 6.7 7.0 76.1 82.5 To contract customers 17.5 18.1 65.3 66.9 - -------------------------------------------------------------------------------- Total throughput 24.2 25.1 141.4 149.4 =============================================================================== Gas utility margins were $45.2 million and $241.8 million for the three and nine months ended September 30, 2004. This represents an increase in gas utility margin in the third quarter, a non-heating base load usage quarter, of $1.5 million or 3%, and a decrease year-to-date of $7.1 million or 3%. The quarterly increase is primarily due to increased base rates in the Vectren South service territory. The 2003 quarter results also reflect a $0.7 million charge associated with a PUCO GCR audit proceeding. These increases are offset by the effects of weather which decreased gas utility margin an estimated $1.4 million. Heating weather for the nine months ended September 30, 2004 was 9% warmer than normal and 13% warmer than last year and had an estimated unfavorable impact on gas utility margin of $11.7 million. The effects of weather have been partially offset by residential and commercial customer growth and increased large customer margins. Gas sold and transported volumes were 5% less for the nine months ended September 30, 2004, compared to the prior year. The decreased throughput was primarily attributable to weather and partially offset by customer growth. The average cost per dekatherm of gas purchased for the nine months ended September 30, 2004, was $6.76 compared to $6.44 in 2003. Electric Utility Margin (Electric Utility Revenues less Fuel for Electric Generation and Purchased Electric Energy) Electric Utility margin by revenue type follows: - ------------------------------------------------------------------------------- Three Months Nine Months Ended September 30, Ended September 30, - ------------------------------------------------------------------------------- (In millions) 2004 2003 2004 2003 - ------------------------------------------------------------------------------- Residential & commercial $ 46.4 $ 45.0 $ 122.0 $ 107.7 Industrial 16.2 13.3 46.5 38.4 Municipalities & other 4.3 5.5 13.1 14.6 - ------------------------------------------------------------------------------- Total retail & firm wholesale 66.9 63.8 181.6 160.7 - ------------------------------------------------------------------------------- Asset optimization 4.3 2.7 9.6 14.8 - ------------------------------------------------------------------------------- Total electric utility margin $ 71.2 $ 66.5 $ 191.2 $ 175.5 =============================================================================== Retail & Firm Wholesale Margin Electric retail and firm wholesale utility margins were $66.9 million and $181.6 million for the three and nine months ended September 30, 2004. This represents an increase over the same period last year of $3.1 million and $20.9 million, respectively. Margins increased $4.5 million quarter over quarter and $12.4 million for the nine month period due to an increase in retail electric rates related to the recovery of NOx related expenditures. Margin from residential and commercial customers (excluding the effects of NOx) decreased $2.5 million for the quarter due primarily to the estimated effect of weather and increased $5.2 million year to date due to both weather and increased usage. Excluding the effects of NOx recovery, margins from industrial customers increased $1.2 million for the quarter and $3.9 million for the nine month period compared to 2003, which reflects some economic recovery. Weather for the quarter was 24% cooler than normal and 18% cooler than last year. Weather for the nine month period was 10% cooler than normal and 11% warmer than last year. The estimated decrease in margin due to weather was $2.3 million for the quarter, and the estimated increase in margin for the nine month period was $1.0 million. As the recovery under the NOx rider is a volumetric charge, it is also estimated that mild weather has reduced the level of NOx recovery by approximately $0.5 million for the year to date. Due to the above factors, volumes sold increased 5% to 4.76 GWh for the nine months ended September 30, 2004, compared to 4.53 GWh in 2003. Margin from Asset Optimization Activities Periodically, generation capacity is in excess of that needed to serve native load and firm wholesale customers. The Company markets this unutilized capacity to optimize the return on its owned generation assets. Substantially all of the margin from these activities is generated from contracts that are integrated with portfolio requirements around power supply and delivery and are short-term purchase and sale transactions that expose the Company to limited market risk. Following is a reconciliation of asset optimization activity:
- --------------------------------------------------------------------------------------------- Three Months Nine Months Ended September 30, Ended September 30, -------------------- -------------------- (In millions) 2004 2003 2004 2003 - --------------------------------------------------------------------------------------------- Beginning of Period Net Asset Optimization Position $ 2.2 $ 0.1 $ (0.4) $ (0.7) Statement of Income Activity Net mark-to-market (losses) gains realized (1.8) (0.5) (1.0) 0.4 Net realized gains recognized 6.1 3.2 10.6 14.4 - --------------------------------------------------------------------------------------------- Asset optimization margin 4.3 2.7 9.6 14.8 - --------------------------------------------------------------------------------------------- Net cash received & other adjustments (6.8) (2.8) (9.5) (14.1) - --------------------------------------------------------------------------------------------- End of Period Net Asset Optimization Position $(0.3) $ - $ (0.3) $ - =============================================================================================
Net wholesale margins increased $1.6 million and decreased $5.2 million for the three and nine month periods compared to last year. The change in margin both for the quarter and nine month period is due largely to availability of excess capacity. The year-to-date decrease in wholesale margins is attributable to an increase in demand by native load customers due to both weather and increased usage. Scheduled outages of owned generation, related to the installation of environmental compliance equipment, has also reduced the year-over-year availability of excess capacity. Following is information regarding asset optimization activities included in Electric utility revenues and Fuel for electric generation in the Statements of Income: - ------------------------------------------------------------------------------ Three Months Nine Months Ended September 30, Ended September 30, ---------------------------------- (In millions) 2004 2003 2004 2003 - ------------------------------------------------------------------------------ Activity related to: Sales contracts $ 64.5 $ 42.7 $ 107.2 $ 110.9 Purchase contracts (56.8) (38.0) (90.9) (89.7) Net mark-to-market (losses) gains realized (1.8) (0.5) (1.0) 0.4 - ------------------------------------------------------------------------------ Net asset optimization revenue 5.9 4.2 15.3 21.6 - ------------------------------------------------------------------------------ Fuel for electric generation 1.6 1.5 5.7 6.8 - ------------------------------------------------------------------------------ Asset optimization margin $ 4.3 $ 2.7 $ 9.6 $ 14.8 ============================================================================== Utility Group Operating Expenses Other operating expenses and depreciation expense for the three and nine months ended September 30, 2004, collectively increased $3.3 million and $9.6 million, respectively, compared to 2003. For the quarter, NOx related operating expenses increased $2.7 million (other operating expenses of $0.8 million and depreciation of $1.9 million). For the nine months, NOx related operating expenses increased $6.7 million (other operating expenses of $2.9 million and depreciation of $3.8 million). The year-to-date remaining increase in other operating expenses is primarily due to higher labor and benefit costs. The remaining increases in depreciation expense are primarily due to normal additions to utility plant. Utility Group Total Other Income (Expense) For the nine months ended September 30, 2004, total other income (expense) increased $3.5 million compared to 2003. The increase was primarily attributable to 2003 write-downs of the Company's investments in BABB International, which totaled $3.9 million for the nine month period. Utility Group Interest Expense For the nine months ended September 30, 2004, interest expense increased $0.7 million compared to 2003. The increase reflects the July 2003 issuance of long-term debt which included conversion of short-term variable rate debt to fixed rate higher coupon long-term debt. Environmental Matters NOx SIP Call Matter The Company has initiated steps toward compliance with Indiana's State Implementation Plan (SIP) of the Clean Air Act (the Act). These steps include installing Selective Catalytic Reduction (SCR) systems at Culley Generating Station Unit 3 (Culley), Warrick Generating Station Unit 4, and A.B. Brown Generating Station Units 1 and 2. SCR systems reduce flue gas NOx emissions to atmospheric nitrogen and water using ammonia in a chemical reaction. This technology is known to currently be the most effective method of reducing nitrogen oxide (NOx) emissions where high removal efficiencies are required. The IURC has issued orders that approve: >> the Company's project to achieve environmental compliance by investing in clean coal technology; >> a total capital cost investment for this project up to $244 million (excluding AFUDC), subject to periodic review of the actual costs incurred; >> a mechanism whereby, prior to an electric base rate case, the Company may recover through a rider that is updated every six months, an eight percent return on its weighted capital costs for the project; and >> ongoing recovery of operating costs, including depreciation and purchased emission allowances through a rider mechanism, related to the clean coal technology once the facility is placed into service. Based on the level of system-wide emissions reductions required and the control technology utilized to achieve the reductions, the current estimated construction cost is consistent with amounts approved in the IURC's orders. Through September 30, 2004, $207 million has been expended, and three of the four SCR's are operational. After the equipment is installed and operational, related annual operating expenses, including depreciation expense, are estimated to be between $24 million and $27 million. The Company is recovering the operational costs associated with the SCR's and related technology. The 8 percent return on capital investment approximates the return authorized in the Company's last electric rate case in 1995 and includes a return on equity. The Company has achieved timely compliance through the reduction of the Company's overall NOx emissions to levels compliant with Indiana's NOx emissions budget allotted by the USEPA. Therefore, the Company has recorded no accrual for potential penalties that may result from noncompliance. Manufactured Gas Plants In the past, Indiana Gas, SIGECO, and others operated facilities for the manufacture of gas. Given the availability of natural gas transported by pipelines, these facilities have not been operated for many years. Under currently applicable environmental laws and regulations, Indiana Gas, SIGECO, and others may now be required to take remedial action if certain byproducts are found above the regulatory thresholds at these sites. Indiana Gas has identified the existence, location, and certain general characteristics of 26 gas manufacturing and storage sites for which it may have some remedial responsibility. Indiana Gas has completed a remedial investigation/feasibility study (RI/FS) at one of the sites under an agreed order between Indiana Gas and the IDEM, and a Record of Decision was issued by the IDEM in January 2000. Although Indiana Gas has not begun an RI/FS at additional sites, Indiana Gas has submitted several of the sites to the IDEM's Voluntary Remediation Program (VRP) and is currently conducting some level of remedial activities, including groundwater monitoring at certain sites, where deemed appropriate, and will continue remedial activities at the sites as appropriate and necessary. In conjunction with data compiled by environmental consultants, Indiana Gas has accrued the estimated costs for further investigation, remediation, groundwater monitoring, and related costs for the sites. While the total costs that may be incurred in connection with addressing these sites cannot be determined at this time, Indiana Gas has recorded costs that it reasonably expects to incur totaling approximately $20.4 million. The estimated accrued costs are limited to Indiana Gas' proportionate share of the remediation efforts. Indiana Gas has arrangements in place for 19 of the 26 sites with other potentially responsible parties (PRP), which serve to limit Indiana Gas' share of response costs at these 19 sites to between 20% and 50%. With respect to insurance coverage, Indiana Gas has received and recorded settlements from all known insurance carriers in an aggregate amount approximating $20.4 million. Environmental matters related to manufactured gas plants have had no material impact on earnings since costs recorded to date approximate PRP and insurance settlement recoveries. While Indiana Gas has recorded all costs which it presently expects to incur in connection with activities at these sites, it is possible that future events may require some level of additional remedial activities which are not presently foreseen. In October 2002, the Company received a formal information request letter from the IDEM regarding five manufactured gas plants owned and/or operated by SIGECO and not currently enrolled in the IDEM's VRP. In response, SIGECO submitted to the IDEM the results of preliminary site investigations conducted in the mid-1990's. These site investigations confirmed that based upon the conditions known at the time, the sites posed no risk to human health or the environment. Follow up reviews have been initiated by the Company to confirm that the sites continue to pose no such risk. On October 6, 2003, SIGECO filed applications to enter four of the manufactured gas plant sites in IDEM's VRP. The remaining site is currently being addressed in the VRP by another Indiana utility. SIGECO added those four sites into the renewal of the global Voluntary Remediation Agreement that Indiana Gas has in place with IDEM for its manufactured gas plant sites. That renewal was approved by the IDEM on February 24, 2004. On July 13, 2004, SIGECO filed a declaratory judgment action against its insurance carriers seeking a judgment finding its carriers liable under the policies for coverage of further investigation and any necessary remediation costs that SIGECO may accrue under the VRP program. The total investigative costs, and if necessary, costs of remediation at the four SIGECO sites, as well as the amount of any PRP or insurance recoveries, cannot be determined at this time. Jacobsville Superfund Site On July 22, 2004, the USEPA listed the Jacobsville Neighborhood Soil Contamination site in Evansville, Indiana, on the National Priorities List under the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA). The USEPA has identified four sources of historic lead contamination. These four sources shut down manufacturing operations years ago. When drawing up the boundaries for the listing, the USEPA included a 250 acre block of properties surrounding the Jacobsville neighborhood, including Vectren's Wagner Operations Center. Vectren's property has not been named as a source of the lead contamination, nor does the USEPA's soil testing to date indicate that the Vectren property contains lead contaminated soils. Vectren's own soil testing, completed during the construction of the Operations Center did not indicate that the Vectren property contains lead contaminated soils. At this time, Vectren anticipates only additional soil testing, if required by the USEPA. Rate & Regulatory Matters Vectren South (SIGECO) Gas Base Rate Settlement On March 12, 2004, Vectren South filed a petition with the IURC to adjust its base rates and charges for its gas distribution business in southwestern Indiana to recover the ongoing cost of operating and maintaining the approximately 3,000-mile distribution and storage system used to serve more than 110,000 customers. On June 30, 2004, the IURC approved a $5.7 million base rate increase for Vectren South's gas distribution business in southwestern Indiana. The rate settlement only addresses Vectren South's "non-gas" costs which are incurred to build, operate, and maintain the pipelines, other equipment and systems that are used to deliver gas across Vectren South's system to its customers. The base rate change was implemented on July 1, 2004. The order also permits Vectren South to recover the on-going costs associated with Vectren South's compliance with the federal Pipeline Safety Improvement Act of 2002. Implementation of these compliance activities will include additional patrols, leakage surveys and direct observation of approximately 90 miles of Vectren South's transmission pipeline system. The Pipeline Safety Improvement Tracker provides for the recovery of up to $750,000 the first year and $500,000 thereafter, subject to OUCC review and IURC approval that the costs are prudently incurred. Any costs incurred in excess of these levels will be deferred for future recovery. Vectren North (Indiana Gas) Pending Base Rate Settlement On March 19, 2004, Vectren North filed a petition with the IURC to adjust its base rates and charges for its gas distribution business in a 49 county region covering central and southeastern Indiana. On October 12, 2004, the Company announced a settlement agreement with several parties, including the Indiana Office of Utility Consumer Counselor, the Indiana Gas Industrial Group, and the Citizens Action Coalition of Indiana, Inc. The settlement agreement provides for a $24 million increase in Vectren North's base distribution rates to cover the ongoing cost of operating, maintaining and expanding the approximately 12,000-mile distribution and storage system used to serve more than 545,000 customers. Once implemented, the new rate design will include a larger service charge, which is intended to address to some extent earnings volatility related to weather. The settlement also permits Vectren North to recover the on-going costs associated with the federal Pipeline Safety Improvement Act of 2002. The Pipeline Safety Improvement Tracker provides for the recovery of incremental non-capital dollars, capped at $2.5 million per year. Costs in excess of the annual cap are to be deferred for future recovery. The IURC will hold a hearing on the settlement on November 22, 2004, and Commission action is expected shortly thereafter. VEDO Pending Base Rate Filing On April 16, 2004, VEDO issued a pre-filing notice to the PUCO of a request to adjust base rates and charges for VEDO's gas distribution business in a 17-county region covering west central Ohio. On May 24, 2004, the official application and Standard Filing Requirements were filed with the PUCO. If the filing is approved, VEDO expects to increase base rates up to $25 million to recover the ongoing cost of operating, maintaining and expanding the approximately 5,200-mile distribution system used to serve more than 310,000 customers. VEDO's request is subject to review and approval by the PUCO. The petition only addresses VEDO's "non-gas costs," which are incurred to build, operate and maintain pipelines, other equipment and systems that are used to deliver gas across VEDO's system to its customers. The filing also includes a proposed conservation tariff, which, if approved, will enable the Company to proactively support conservation and promote home weatherization and the reduction of energy consumption. Based on the PUCO's regulatory process, the PUCO staff report relating to the Company's request is expected to be submitted in November 2004. Based upon the PUCO's actions in other proceedings, the Company would expect a Commission order in this case late in the first quarter of 2005. Gas Cost Recovery (GCR) Audit Proceedings There is an Ohio requirement that Ohio gas utilities undergo a biannual audit of their gas acquisition practices in connection with the gas cost recovery (GCR) mechanism. In the case of VEDO, the two-year audit period ended in November 2002. The audit provides the initial review of the portfolio administration arrangement between VEDO and ProLiance. The external auditor retained by the PUCO staff submitted an audit report in the fall of 2003 wherein it recommended a disallowance of approximately $7 million of previously recovered gas costs. The Company believes a large portion of the third party auditor recommendations is without merit. A hearing has been held, and the PUCO staff has recommended an approximate $6 million disallowance. The Ohio Consumer Counselor has recommended an approximate $12 million disallowance, which includes interest. For this PUCO audit period, any disallowance relating to the Company's ProLiance arrangement will be shared by the Company's joint venture partner. Based on a review of the matters, the Company has recorded $1.9 million for its estimated share of any potential disallowance. A PUCO decision on this matter is yet to be issued. The Company is also unable to determine the effects that a PUCO decision may have on results in audit periods beginning after November 2002. Results of Operations of the Nonregulated Group The Company is also involved in nonregulated activities in three primary business areas: Energy Marketing and Services, Coal Mining, and Utility Infrastructure Services. Energy Marketing and Services markets natural gas and provides energy management services, including energy performance contracting services. Coal Mining mines and sells coal and generates IRS Code Section 29 investment tax credits relating to the production of coal-based synthetic fuels. Utility Infrastructure Services provides underground construction and repair, facilities locating, and meter reading services. In addition, the Nonregulated Group has other businesses and investments that provide broadband communication services and utility services and that invest in energy-related opportunities, real estate, and leveraged leases. The Nonregulated Group supports the Company's regulated utilities pursuant to service contracts by providing natural gas supply services, coal, utility infrastructure services, and other services. The results of operations of the Nonregulated Group before certain intersegment eliminations and reclassifications for the three and nine months ended September 30, 2004 and 2003, follow:
- ---------------------------------------------------------------------------------- Three Months Nine Months Ended September 30, Ended September 30, -------------------- ------------------- (In millions, except per share amounts) 2004 2003 2004 2003 - ---------------------------------------------------------------------------------- Energy services & other revenues $ 61.8 $ 50.2 $ 186.3 $ 151.1 Operating expenses: Cost of energy services & other revenues 49.1 42.4 151.3 125.3 Operating expenses 10.5 8.8 32.7 27.2 - ---------------------------------------------------------------------------------- Total expenses 59.6 51.2 184.0 152.5 - ---------------------------------------------------------------------------------- OPERATING INCOME (LOSS) 2.2 (1.0) 2.3 (1.4) OTHER INCOME (EXPENSE) - NET Equity in (losses) earnings of unconsolidated affiliates 1.5 (2.2) 13.3 6.9 Other income (expense) - net 1.2 6.9 (2.7) 6.9 - ---------------------------------------------------------------------------------- Total other income (expense) 2.7 4.7 10.6 13.8 - ---------------------------------------------------------------------------------- Interest expense 2.8 2.5 8.1 7.3 - ---------------------------------------------------------------------------------- INCOME BEFORE TAXES 2.1 1.2 4.8 5.1 Income tax (3.8) (4.5) (12.5) (12.6) Minority interest in consolidated subsidiaries - - 0.1 0.1 - ---------------------------------------------------------------------------------- NET INCOME $ 5.9 $ 5.7 $ 17.2 $ 17.6 ================================================================================== BASIC EARNINGS PER SHARE $ 0.08 $ 0.08 $ 0.23 $ 0.26 ================================================================================== NET INCOME (LOSS) ATTRIBUTED TO: Energy Marketing & Services $ 1.1 $ 0.2 $ 9.1 $ 9.4 Coal Mining 3.7 2.8 11.1 9.7 Utility Infrastructure 1.4 0.2 1.3 (1.0) Broadband - - (3.3) (1.2) Other Businesses (0.3) 2.5 (1.0) 0.7
Nonregulated Group earnings were $5.9 million for the quarter, an increase of $0.2 million over the prior year. The Company's three core nonregulated businesses, Energy Marketing and Services, Coal Mining and Utility Infrastructure Services, each improved their earnings contribution from 2003. Improved nonregulated operating results exceeded the impact from the sale of the Company's investment in Genscape, Inc. for $2.6 million after tax recorded in the third quarter of 2003. Nonregulated earnings for the nine months ended September 30, 2004, were $17.2 million compared to $17.6 million in the prior year. The Company's three core nonregulated businesses, Energy Marketing and Services, Coal Mining, and Utility Infrastructure Services, contributed $21.5 million in 2004, compared to $18.1 million in 2003. The 2004 nine month earnings reflect charges of $6.0 million related to the write-down of the Company's broadband businesses, which were partially offset by net gains from the Company's investment in Haddington Energy Partners. The 2003 nine month earnings reflect after-tax gains on the divesture of businesses, including Genscape, totaling $1.4 million. Energy Marketing & Services Energy Marketing and Services is comprised of the Company's gas marketing operations, performance contracting operations, and its retail gas supply operations. Gas marketing operations are performed through the Company's investment in ProLiance Energy LLC (ProLiance), a nonregulated energy marketing affiliate of Vectren and Citizens Gas and Coke Utility. ProLiance provides natural gas and related services to the Company's regulated utilities and nonregulated gas retail operations. ProLiance's primary businesses include gas marketing, gas portfolio optimization, and other portfolio and energy management services. ProLiance's primary customers are its members' utilities and other large end-use customers. Energy Systems Group, LLC (ESG) provides energy performance contracting and facility upgrades through its design and installation of energy-efficient equipment throughout the Midwest. ESG recently acquired Progress Energy Solutions, expanding its operations throughout the Southeast and Mid-Atlantic United States. Vectren Retail, LLC (d/b/a Vectren Source) provides natural gas and other related products and services in Ohio and Indiana, serving just over 90,000 customers opting for choice among energy providers. In June, Vectren Source was certified by the Georgia Public Service Commission and has begun initial marketing efforts in the Atlanta Gas Light Company service territory. Net income generated by Energy Marketing and Services for the three months ended September 30, 2004, was $1.1 million compared to $0.2 million in 2003. Net income generated by Energy Marketing and Services for the nine months ended September 30, 2004, was $9.1 million compared to $9.4 million in 2003. Gas marketing operations, performed through ProLiance, contributed quarterly earnings of $1.6 million in 2004 compared to $0.6 million in 2003. Earnings from ProLiance for the nine months ended September 30, 2004 were $10.2 million compared to $10.7 million in 2003. Quarterly earnings from ProLiance have increased due to gains from storage optimization and reserves established in 2003 for the contingency described below. The nine month decrease results principally from unprecedented volatility in gas prices in March 2003. For the nine months ended September 30, 2004, Vectren Source's operations have operated at a loss of $0.9 million, an improvement of $1.1 million compared to 2003. The increases are principally due to increased customers and margins per unit of throughput. Earnings from performance contracting operations, performed through ESG, have increased for the quarter by $0.6 million and are relatively unchanged year over year. Current backlog remains at a high level. ProLiance Contingency There is currently a lawsuit pending in the United States District Court for the Northern District of Alabama filed by the City of Huntsville, Alabama d/b/a Huntsville Utilities, Inc. (Huntsville Utilities) against ProLiance. Huntsville Utilities asserts claims based on negligent provision of portfolio services and/or pricing advice, fraud, fraudulent inducement, and other theories. These claims relate generally to several basic arguments: 1) negligence in providing advice and/or administering portfolio arrangements; 2) alleged promises to provide gas at a below-market rate; 3) the creation and repayment of a "winter levelizing program" instituted by ProLiance in conjunction with the manager of Huntsville's Gas Utility, to allow Huntsville Utilities to pay its gas bills over an extended period of time coupled with the alleged ignorance about the program on the part of Huntsville Utilities' Gas Board, and; 4) the sale of Huntsville Utilities' gas storage supplies to repay the balance owed on the winter levelizing program and the authority of Huntsville Utilities' gas manager to approve those sales. In a press conference on May 21, 2002, Huntsville Utilities asserted its monetary damages to be approximately $10 million, and seeks to treble that amount. ProLiance has made counterclaims asserting breach of contract, among others, based on Huntsville Utilities' refusal to take gas under fixed price agreements. Both parties have denied the charges contained in the respective claims. In 2003, ProLiance established reserves for amounts due from Huntsville Utilities due to uncertainties surrounding collection. ProLiance believes its actions were proper under the contract and amendments signed by the manager of Huntsville's Gas Utility, and is vigorously defending the suit. ProLiance is insured under a policy providing defense costs which may provide in whole or in part, indemnification within the policy limits for claims asserted against ProLiance. Accordingly, no other loss contingencies have been recorded at this time. However, it is not possible to predict or determine the outcome of this litigation and accordingly there can be no assurance that ProLiance will prevail. It is not currently expected that costs associated with this matter will have a material adverse effect on Vectren's consolidated financial position or liquidity but an unfavorable outcome could possibly be material to Vectren's earnings. Coal Mining The Coal Mining Group mines and sells coal to the Company's utility operations and to other third parties through its wholly owned subsidiary Vectren Fuels, Inc. (Fuels). The Coal Mining Group also generates IRS Code Section 29 tax credits relating to the production of coal-based synthetic fuels through its 8.3% ownership interest in Pace Carbon Synfuels, LP (Pace Carbon). Pace Carbon developed, owns, and operates four projects to produce and sell coal-based synthetic fuel (synfuel) utilizing Covol technology. Vectren accounts for is investment in Pace Carbon using the equity method. In addition, Fuels receives synfuel-related fees from synfuel producers unrelated to Pace Carbon for a portion of its coal production. Coal Mining net income for the three months ended September 30, 2004, was $3.7 million compared to $2.8 million in 2003. Coal Mining net income for the nine months ended September 30, 2004, was $11.1 million compared to $9.7 million in 2003. Mining operations have increased earnings for the quarter and year-to-date by $1.0 million and $1.8 million, respectively. The increases were primarily due to improved affiliate pricing, improved market prices for coal, and better mining conditions. Synfuel-related results for the quarter, which include earnings from Pace Carbon and synfuel processing fees earned by Fuels, were generally flat for the quarter and have decreased $0.4 million year-to-date due to the production of less synthetic fuel compared to 2003 by Pace Carbon due to feed stock problems at one of the four plants, which is currently being relocated. Section 29 tax credits are recorded in Income taxes. IRS Section 29 Tax Credit Recent Developments Under Section 29 of the Internal Revenue Code, manufacturers such as Pace Carbon receive a tax credit for every ton of synthetic fuel sold. To qualify for the credits, the synthetic fuel must meet three primary conditions: 1) there must be a significant chemical change in the coal feedstock, 2) the product must be sold to an unrelated person, and 3) the production facility must have been placed in service before July 1, 1998. In past rulings, the Internal Revenue Service (IRS) has concluded that the synthetic fuel produced at the Pace Carbon facilities should qualify for Section 29 tax credits. The IRS issued a private letter ruling with respect to the four projects on November 11, 1997, and subsequently issued an updated private letter ruling on September 23, 2002. As a partner in Pace Carbon, Vectren has reflected total tax credits under Section 29 in its consolidated results through September 30, 2004, of approximately $52.2 million. To date, Vectren has been in a position to fully utilize the credits generated. During June 2001, the IRS began a tax audit of Pace Carbon for the 1998 tax year and later expanded the audit to include tax years 1999, 2000, and 2001. In May 2004, the IRS completed its audit of the 1998 to 2001 tax returns of Pace Carbon requesting only minor modifications to previously filed returns. There were no changes to any of the filed Section 29 tax credit calculations. The Permanent Subcommittee on Investigations of the U.S. Senate's Committee on Governmental Affairs, however, has an ongoing investigation on the subject of these income tax credits. Vectren believes it is justified in its reliance on the private letter rulings and recent IRS audit results for the Pace Carbon facilities. However, at this time, Vectren cannot provide any assurance as to the outcome that these uncertainties may have on Vectren's consolidated financial position or liquidity. Further, Section 29 tax credits are only available when the price of oil is less than prices specified by the tax code, as adjusted for inflation. The Company does not believe that credits realized in 2004 and prior years will be affected by the limitation, but an average annual wellhead price in the lower $50 per barrel range, could limit Section 29 tax credits in 2005 and beyond. Utility Infrastructure Services Utility Infrastructure Services provides underground construction and repair to gas, water, electric and telecommunications companies primarily through its investment in Reliant Services, LLC (Reliant) and Reliant's 100% ownership in Miller Pipeline. Reliant is a 50% owned strategic alliance with an affiliate of Cinergy Corp. and is accounted for using the equity method of accounting. Infrastructure's income for the quarter was $1.4 million, an improvement of $1.2 million from 2003. Infrastructure's results year-to-date were $1.3 million, an improvement of $2.3 million over 2003. The increases are primarily driven by continued increases in utility and municipal waste water construction and repair spending during the second and third quarters of 2004. Broadband and Other Businesses Activities within the Broadband and Other Businesses Groups decreased earnings for the quarter and year-to-date by $2.8 million and $3.8 million, respectively. These decreases result primarily from the Company's broadband-related investments and its 2003 sale of Genscape, offset in the year-to-date period by earnings from the Haddington Energy Partnerships. During 2004, the Company continued to evaluate strategic alternatives for its broadband investments and concluded that it is unlikely that it would be making additional investments in its franchises in the Indianapolis and Dayton markets. As a result, the Company recorded impairment charges for its investment in Utilicom related activities, totaling $3.6 million after tax. Consistent with long-term strategic objectives, the Company ceased operations of Vectren Communications Services, Inc., a municipal broadband consulting business, during the second quarter of 2004. This resulted in year-to-date losses of $2.4 million after tax primarily from inventory write downs, cessation accruals, and other costs. In total, charges associated with broadband related businesses and investments totaled $6.0 million after tax for the nine months ended September 30, 2004. The nine months ended September 30, 2003, also includes a $1.2 million after tax loss resulting from the sale of First Mile Technologies. In the third quarter of 2003, the Company sold its investment in Genscape, a company that provides real-time power plant and transmission line status information using wireless technology, for $5.4 million in proceeds to an unrelated party, resulting in an after tax gain of approximately $2.6 million. In total, year over year earnings have decreased $7.4 million resulting from current year broadband-related write downs and charges and prior year divestitures. Haddington Energy Partnerships, a component of the Other Businesses Group, are equity method investments that invest in energy-related ventures. During the nine months ended September 30, 2004, these partnerships sold their investments in SAGO Energy, LP, (SAGO) for cash. The Company recognized its portion of the pre-tax gain totaling $9.0 million ($5.3 million after tax). These earnings were partially offset by Haddington's write-down of Nations Energy Holdings, of which Vectren's portion was $5.9 million ($3.5 million after tax). In total, earnings from Haddington for the nine months ended September 30, 2004, are $2.1 million compared to a loss of $0.5 million in 2003. Significant Fluctuations of Consolidated Operations Revenues and Cost of Revenues For the three months ended September 30, 2004, nonregulated revenues and cost of revenues increased $11.6 million and $6.7 million, respectively, compared to 2003. For the nine months ended September 30, 2004, nonregulated revenues and cost of revenues increased $35.2 million and $26.0 million, respectively. The principal reason for the increases in quarterly amounts is due to the timing of performance contracting operations and increased coal mining activity. The operations of Vectren Source contributed to the majority of the increase in revenues and costs year over year due to increased customers, consumption, and average selling prices. For the nine months ended September 30, 2004, Vectren Source's revenues increased $26.3 million to $51.4 million and its cost of revenues increased $22.5 million to $44.9 million. The remaining year-to-date increases are due principally to mining operations. Margins from gas retail operations and coal mining operations increased $3.9 million to $6.5 million and $5.7 million to $17.7 million, respectively, for the nine months ended September 30, 2004, compared to 2003. Operating Expenses For the three and nine months ended September 30, 2004, operating expenses increased $1.7 million and $5.5 million, respectively, compared to 2003. The quarterly increase is primarily attributable to increased gas retail marketing expenses due to the entry into the Georgia market and higher amortization of mine development costs. The year-to-date increase not only includes higher marketing costs and mine development amortization, but also includes broadband-related charges for inventory write downs, cessation charges, and other costs. Significant Fluctuations of Unconsolidated Affiliates and Investments Equity in Earnings of Unconsolidated Affiliates The primary components of equity in earnings of unconsolidated affiliates involve the results of ProLiance, Reliant, the Haddington partnerships, and Pace Carbon. For the three months ended September 30, 2004, the Company's portion of ProLiance's earnings was $2.7 million compared to $1.1 million in 2003. For the nine months ended September 30, 2004, the Company's portion of ProLiance's earnings was $17.3 million compared to $18.0 million in 2003. For the three months ended September 30, 2004, the Company's portion of Reliant's earnings was $1.7 million compared to $0.5 million in 2003. For the nine months ended September 30, 2004, the Company's portion of Reliant's earnings was $2.1 million compared to breakeven in 2003. For the three months ended September 30, 2004, the Company's portion of the Haddington Partnerships' earnings was $0.4 million compared to breakeven in 2003. For the nine months ended September 30, 2004, the Company's portion of the Haddington partnerships' earnings was $4.2 million compared to a loss of $0.2 million in 2003. For the three months ended September 30, 2004 and 2003, the Company's portion of Pace Carbon losses was $2.9 million in both periods. For nine months ended September 30, 2004 and 2003, the Company's portion of Pace Carbon losses was $9.5 million and $9.3 million, respectively. Other Income (Expense) - Net Other income (expense) - net reflects $6.0 million of impairment charges associated with the broadband-related investments incurred during the nine months ended September 30, 2004 and a $2.0 million loss associated with the sale of First Mile in the nine months ended September 30, 2003. The three and nine months ended September 30, 2003, includes $5.4 million in proceeds resulting from the sale of Genscape. Impact of Recently Issued Accounting Guidance SFAS No. 132 (Revised 2003) In December 2003, FASB issued SFAS No. 132 (revised 2003), "Employers' Disclosures about Pensions and Other Postretirement Benefits" (SFAS 132), to improve financial statement disclosures for defined benefit and other postretirement benefit plans. The incremental annual disclosure requirements were reflected in the Company's Form 10-K for the year ended December 31, 2003. The adoption did not impact the Company's results of operations or financial condition. The incremental interim disclosure requirements are included in these financial statements in Note 6. FIN 46/46R (Revised in December 2003) In January 2003, the FASB issued Interpretation 46, "Consolidation of Variable Interest Entities" (FIN 46). FIN 46 addresses consolidation by business enterprises of variable interest entities (VIE) and significantly changes the consolidation requirements for those entities. FIN 46 is intended to achieve more consistent application of consolidation policies related to VIE's and thus improves comparability between enterprises engaged in similar activities when those activities are conducted through VIE's. In December 2003, the FASB completed its deliberations of proposed modifications to FIN 46 and decided to codify both the proposed modifications and other decisions previously issued through certain FASB Staff Positions into one document that was issued as a revision to the original Interpretation (FIN 46R). FIN 46R currently applies to VIE's created after January 31, 2003, and to VIE's in which an enterprise obtains an interest after that date. For entities created prior to January 31, 2003, FIN 46R is to be adopted no later than the end of the first interim or annual reporting period ending after March 15, 2004. The Company has neither created nor obtained an interest in a VIE since January 31, 2003. Certain other entities that the Company was involved with prior to that date have been evaluated and determined to be VIE's. The Company has investments in partnership-like structures as a limited partner or as a subordinated lender. The activities of these entities are to purchase or construct as well as operate multifamily housing and office properties. The Company's exposure to loss is limited to its investment which as of September 30, 2004, and December 31, 2003, totaled $16.2 million and $17.1 million, respectively, of Investments in unconsolidated affiliates, and $16.7 million and $20.9 million, respectively, of Other investments. The Company is also the equity owner in three leveraged leases where its exposure to loss is limited to its net investment which as of September 30, 2004, and December 31, 2003, totaled $6.9 million and $6.0 million, respectively. The Company did not consolidate any of these entities upon adoption of FIN 46R. EITF 03-01 In March 2004, the EITF issued a consensus on Issue No. 03-01, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments" (EITF 03-01). In EITF 03-01, the Task Force developed a basic model for evaluating whether investments within the scope of EITF 03-01, which includes cost method and equity method investments, have other-than-temporary impairment. The basic model includes three steps: 1) determine if there is impairment; 2) if there is impairment, decide whether it is temporary or other than temporary; and 3) if it is other than temporary, recognize it in earnings. EITF 03-01 also requires certain qualitative and quantitative disclosure of material impairments judged to be temporary. The EITF has yet to finalize Steps 2 and 3. Step 1 and the disclosure requirements are currently effective, and the adoption of those portions of the EITF did not have a material effect on the Company. During 2004, the Company has incurred an other-than-temporary impairment charge associated with its cost method investment in SIGECOM, LLC, totaling $3.8 million and impairment charges associated with other broadband-related notes totaling $2.2 million. The Company is continuing to assess strategic alternatives for its broadband investments. While it currently believes that the book value of those investments approximates fair value, further changes in estimated fair value may occur. SEC Inquiry regarding PUHCA Exemption In July 2004, the Company received a letter from the SEC regarding its exempt status under the Public Utility Holding Company Act of 1935 (PUHCA). The letter asserts that Vectren's out of state electric power sales exceed the amount previously determined by the SEC to be acceptable in order to qualify for the exemption. Vectren claims exemption from registration under Section 3(a)(1) of PUHCA by rule 2. As required by the rule, Vectren files an annual statement on SEC Form U-3A-2. The Company has responded to the SEC inquiry and filed an amended Form U-3A-2 for the year ended December 31, 2003. Financial Condition Within Vectren's consolidated group, VUHI funds the short-term and long-term financing needs of the Utility Group operations, and Vectren Capital Corp. (Vectren Capital) funds short-term and long-term financing needs of the Nonregulated Group and corporate operations. Vectren Corporation guarantees Vectren Capital's debt, but does not guarantee VUHI's debt. Vectren Capital's long-term and short-term obligations outstanding at September 30, 2004, totaled $113.0 million and $97.1 million, respectively. VUHI's outstanding long-term and short-term borrowing arrangements are jointly and severally guaranteed by Indiana Gas, SIGECO, and VEDO. VUHI's long-term and short-term obligations outstanding at September 30, 2004, totaled $550.0 million and $210.6 million, respectively. Additionally, prior to VUHI's formation, Indiana Gas and SIGECO funded their operations separately, and therefore, have long-term debt outstanding funded solely by their operations. The Company's common stock dividends are primarily funded by utility operations. Nonregulated operations have demonstrated sustained profitability, and the ability to generate cash flows. These cash flows are used to fund a portion of the Company's dividends, are reinvested in other nonregulated ventures, and from time to time may be reinvested in utility operations or used for corporate expenses. VUHI's and Indiana Gas' credit ratings on outstanding senior unsecured debt at September 30, 2004, are A-/Baa1 as rated by Standard and Poor's Ratings Services (Standard and Poor's) and Moody's Investors Service (Moody's), respectively. SIGECO's credit ratings on outstanding senior unsecured debt are BBB+/Baa1. SIGECO's credit ratings on outstanding secured debt are A-/A3. VUHI's commercial paper has a credit rating of A-2/P-2. Vectren Capital's senior unsecured debt is rated BBB+/Baa2. Moody's current outlook is stable while Standard and Poor's current outlook is negative. The ratings of Moody's and Standard and Poor's are categorized as investment grade and are unchanged from December 31, 2003. A security rating is not a recommendation to buy, sell, or hold securities. The rating is subject to revision or withdrawal at any time, and each rating should be evaluated independently of any other rating. Standard and Poor's and Moody's lowest level investment grade rating is BBB- and Baa3, respectively. The Company's consolidated equity capitalization objective is 45-55% of total capitalization. This objective may have varied, and will vary, depending on particular business opportunities, capital spending requirements, and seasonal factors that affect the Company's operation. The Company's equity component was 50% and 49% of total capitalization, including current maturities of long-term debt and long-term debt subject to tender, at September 30, 2004, and December 31, 2003, respectively. Sources & Uses of Liquidity Operating Cash Flow The Company's primary and historical source of liquidity to fund working capital requirements has been cash generated from operations, which for the nine months ended September 30, 2004 and 2003, was $206.6 million and $136.0 million, respectively. The increase of $70.6 million is primarily the result of favorable changes in working capital accounts offset by decreased earnings before non-cash charges. The decreased earnings before non-cash charges result principally from expected payments of alternative minimum taxes, which can be carried forward to offset future tax liabilities. Financing Cash Flow Although working capital requirements are generally funded by cash flow from operations, the Company uses short-term borrowings to supplement working capital needs when accounts receivable balances are at their highest and gas storage is refilled. Additionally, short-term borrowings are required for capital projects and investments until they are permanently financed. Cash flow required for financing activities of $37.8 million for the nine months ended September 30, 2004, includes a net increase of short-term borrowings of $34.9 million and increased common stock dividends compared to 2003. In 2003, the Company issued common equity and long-term debt and used the proceeds to retire higher rate debt and permanently finance short-term borrowings for plant construction projects. Investing Cash Flow Cash flow required for investing activities was $176.3 million for the nine months ended September 30, 2004, compared to $140.6 million 2003. The increase in investing activities results primarily from capital expenditures, which totaled $189.3 million in 2004 compared to $150.7 million in 2003. Available Sources of Liquidity At September 30, 2004, the Company has $615 million of short-term borrowing capacity, including $355 million for the Utility Group and $260 million for the wholly owned Nonregulated Group and corporate operations, of which approximately $144 million is available for the Utility Group operations and approximately $163 million is available for the wholly owned Nonregulated Group and corporate operations. VUHI's short-term credit facility was renewed on June 24, 2004 at $350 million, a slight increase from the previous year's renewal level of $346 million. Instead of the traditional 364-day facility, the facility was renewed for a 5-year period ending June 2009. Vectren Capital renewed its existing $200 million credit facility early, increased the committed capacity, and obtained a multi-year commitment on that facility as well, rather than the traditional 364-day facility. On September 30, 2004 the new Vectren Capital credit facility was closed at the $255 million level for a 5-year period ending September 2009. Potential Uses of Liquidity Planned Capital Expenditures & Investments Investments in nonregulated unconsolidated affiliates and total company capital expenditures for the remainder of 2004 are estimated to be approximately $80 million. For 2005, capital expenditures and investments in nonregulated unconsolidated affiliates are estimated at approximately $300 million. Ratings Triggers At September 30, 2004, $113.0 million of Vectren Capital's senior unsecured notes were subject to cross-default and ratings trigger provisions that would require the full balance outstanding be subject to prepayment if the ratings of Indiana Gas' or SIGECO's most senior securities declined to BBB/Baa2. In addition, accrued interest and a make whole amount based on the discounted value of the remaining payments due on the notes would also become payable. The credit rating of Indiana Gas' senior unsecured debt and SIGECO's secured debt remain one level and two levels, respectively, above the ratings trigger. Other Guarantees and Letters of Credit In the normal course of business, Vectren issues guarantees to third parties on behalf of its consolidated subsidiaries and unconsolidated affiliates. Such guarantees allow those subsidiaries and affiliates to execute transactions on more favorable terms than the subsidiary or affiliate could obtain without such a guarantee. Guarantees may include posted letters of credit, leasing guarantees, and performance guarantees. As of September 30, 2004, guarantees issued and outstanding on behalf of unconsolidated affiliates approximated $10 million. In addition, the Company has also issued a guarantee approximating $4 million related to the residual value of an operating lease that expires in 2006. Through September 30, 2004, the Company has not been called upon to satisfy any obligations pursuant to its guarantees. Forward-Looking Information A "safe harbor" for forward-looking statements is provided by the Private Securities Litigation Reform Act of 1995 (Reform Act of 1995). The Reform Act of 1995 was adopted to encourage such forward-looking statements without the threat of litigation, provided those statements are identified as forward-looking and are accompanied by meaningful cautionary statements identifying important factors that could cause the actual results to differ materially from those projected in the statement. Certain matters described in Management's Discussion and Analysis of Results of Operations and Financial Condition are forward-looking statements. Such statements are based on management's beliefs, as well as assumptions made by and information currently available to management. When used in this filing, the words "believe," "anticipate," "endeavor," "estimate," "expect," "objective," "projection," "forecast," "goal," and similar expressions are intended to identify forward-looking statements. In addition to any assumptions and other factors referred to specifically in connection with such forward-looking statements, factors that could cause the Company's actual results to differ materially from those contemplated in any forward-looking statements include, among others, the following: o Factors affecting utility operations such as unusual weather conditions; catastrophic weather-related damage; unusual maintenance or repairs; unanticipated changes to fossil fuel costs; unanticipated changes to gas supply costs, or availability due to higher demand, shortages, transportation problems or other developments; environmental or pipeline incidents; transmission or distribution incidents; unanticipated changes to electric energy supply costs, or availability due to demand, shortages, transmission problems or other developments; or electric transmission or gas pipeline system constraints. o Increased competition in the energy environment including effects of industry restructuring and unbundling. o Regulatory factors such as unanticipated changes in rate-setting policies or procedures, recovery of investments and costs made under traditional regulation, and the frequency and timing of rate increases. o Financial or regulatory accounting principles or policies imposed by the Financial Accounting Standards Board; the Securities and Exchange Commission; the Federal Energy Regulatory Commission; state public utility commissions; state entities which regulate electric and natural gas transmission and distribution, natural gas gathering and processing, electric power supply; and similar entities with regulatory oversight. o Economic conditions including the effects of an economic downturn, inflation rates, commodity prices, and monetary fluctuations. o Changing market conditions and a variety of other factors associated with physical energy and financial trading activities including, but not limited to, price, basis, credit, liquidity, volatility, capacity, interest rate, and warranty risks. o The performance of projects undertaken by the Company's nonregulated businesses and the success of efforts to invest in and develop new opportunities, including but not limited to, the realization of Section 29 income tax credits and the Company's coal mining, gas marketing, and broadband strategies. o Direct or indirect effects on our business, financial condition or liquidity resulting from a change in our credit rating, changes in interest rates, and/or changes in market perceptions of the utility industry and other energy-related industries. o Employee or contractor workforce factors including changes in key executives, collective bargaining agreements with union employees, or work stoppages. o Legal and regulatory delays and other obstacles associated with mergers, acquisitions, and investments in joint ventures. o Costs and other effects of legal and administrative proceedings, settlements, investigations, claims, and other matters, including, but not limited to, those described in Management's Discussion and Analysis of Results of Operations and Financial Condition. o Changes in Federal, state or local legislature requirements, such as changes in tax laws or rates, environmental laws and regulations. The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of changes in actual results, changes in assumptions, or other factors affecting such statements. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company is exposed to various business risks associated with commodity prices, interest rates, and counter-party credit. These financial exposures are monitored and managed by the Company as an integral part of its overall risk management program. The Company's risk management program includes, among other things, the use of derivatives to mitigate risk. The Company also executes derivative contracts in the normal course of operations while buying and selling commodities to be used in operations and optimizing its generation assets. These risks are not significantly different from the information set forth in Item 7A. Quantitative and Qualitative Disclosures About Market Risk included in the Vectren 2003 Form 10-K and is therefore not presented herein. ITEM 4. CONTROLS AND PROCEDURES Changes in Internal Controls over Financial Reporting In preparation for required reporting under the Sarbanes Oxley Act of 2002, Section 404, the Company is conducting a thorough review of its internal controls over financial reporting, including disclosure controls and procedures. Based on this review, the Company has made internal control enhancements, and will continue to make future enhancements, to its internal controls over financial reporting some of which may be material; however, during the quarter ended September 30, 2004, there have been no changes to the Company's internal controls over financial reporting that have materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting. Evaluation of Disclosure Controls and Procedures As of September 30, 2004, the Company carried out an evaluation under the supervision and with the participation of the Chief Executive Officer and Chief Financial Officer of the effectiveness and the design and operation of the Company's disclosure controls and procedures. Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer have concluded that the Company's disclosure controls and procedures are effective at providing reasonable assurance that material information relating to the Company required to be disclosed by the Company in its filings under the Securities Exchange Act of 1934 (Exchange Act) is brought to their attention on a timely basis. PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS The Company is party to various legal proceedings arising in the normal course of business. In the opinion of management, there are no legal proceedings pending against the Company that are likely to have a material adverse effect on its financial position or results of operations. See Notes 7 and 9 of its unaudited consolidated condensed financial statements included in Part 1 Item 1 Financial Statements regarding the ProLiance contingency and Clean Air Act and related legal proceedings. ITEM 6. EXHIBITS 31.1 Certification Pursuant To Section 302 of The Sarbanes-Oxley Act Of 2002- Chief Executive Officer 31.2 Certification Pursuant To Section 302 of The Sarbanes-Oxley Act Of 2002- Chief Financial Officer 32 Certification Pursuant To Section 906 of The Sarbanes-Oxley Act Of 2002 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. VECTREN CORPORATION Registrant November 9, 2004 /s/ Jerome A. Benkert, Jr. ---------------------------- Jerome A. Benkert, Jr. Executive Vice President & Chief Financial Officer (Principal Financial Officer) /s/ M. Susan Hardwick ----------------------------- M. Susan Hardwick Vice President & Controller (Principal Accounting Officer) EX-31.1 2 vvc10q_ex31-1.txt SARBANES OXLEY COMPLIANCE EX: 31-1 CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 CHIEF EXECUTIVE OFFICER CERTIFICATION I, Niel C. Ellerbrook, certify that: 1. I have reviewed this Form 10-Q of Vectren Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: November 9, 2004 /s/ Niel C. Ellerbrook ----------------------------- Niel C. Ellerbrook Chairman, President, & Chief Executive Officer EX-31.2 3 vvc10q_ex31-2.txt SARBANES OXLEY COMPLIANCE EX 31-2 CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 CHIEF FINANCIAL OFFICER CERTIFICATION I, Jerome A. Benkert, Jr., certify that: 1. I have reviewed this Form 10-Q of Vectren Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: November 9, 2004 /s/ Jerome A. Benkert, Jr. ---------------------------- Jerome A. Benkert, Jr. Executive Vice President & Chief Financial Officer EX-32 4 vvc10q_ex32.txt SARBANES OXLEY COMPLIANCE EX 32 CERTIFICATION PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 CERTIFICATION By signing below, each of the undersigned officers hereby certifies pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to his or her knowledge, (i) this report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and (ii) the information contained in this report fairly presents, in all material respects, the financial condition and results of operations of Vectren Corporation. Signed this 9th day of November, 2004. /s/ Jerome A. Benkert, Jr. /s/ Niel C. Ellerbrook - --------------------------------- -------------------------------------- (Signature of Authorized Officer) (Signature of Authorized Officer) Jerome A. Benkert, Jr. Niel C. Ellerbrook - --------------------------------- -------------------------------------- (Typed Name) (Typed Name) Executive Vice President & Chairman, President, & Chief Financial Officer Chief Executive Officer - --------------------------------- -------------------------------------- (Title) (Title) -----END PRIVACY-ENHANCED MESSAGE-----