10-Q 1 vuhi_10q-sep04.txt VECTREN UTILITY HOLDINGS 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: 1-16739 VECTREN UTILITY HOLDINGS, INC. ------------------------------- (Exact name of registrant as specified in its charter) INDIANA 35-2104850 ------------------------------------- ------------------------------------ (State or other jurisdiction of (IRS Employer Identification No.) incorporation or organization) 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__ No |X| 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 10 October 31, 2004 ------------------------------- -- ---------------- Class Number of Shares Date Table of Contents Item Page Number Number PART I. FINANCIAL INFORMATION 1 Financial Statements (Unaudited) Vectren Utility Holdings, Inc 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 26 4 Controls and Procedures 26 PART II. OTHER INFORMATION 1 Legal Proceedings 26 6 Exhibits 26 Signatures 27 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 47702-0209 Vice President, Investor Relations sschein@vectren.com Definitions AFUDC: allowance for funds used during MMBTU: millions of British thermal 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 Board NOx: nitrogen oxide FERC: Federal Energy Regulatory Commission OUCC: Indiana Office of the Utility Consumer Counselor IDEM: Indiana Department of Environmental PUCO: Public Utilities Commission Management of Ohio IURC: Indiana Utility Regulatory Commission SFAS: Statement of Financial Accounting Standards MCF/MMCF/BCF: thousands/millions/billions of USEPA: United States Environmental cubic feet Protection Agency MDth/MMDth: thousands/millions of dekatherms Throughput: combined gas sales and gas transportation volumes PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS VECTREN UTILITY HOLDINGS, INC. AND SUBSIDIARY COMPANIES CONSOLIDATED CONDENSED BALANCE SHEETS (Unaudited - In millions) -------------------------------------------------------------------------------- September 30, December 31, 2004 2003 -------------------------------------------------------------------------------- ASSETS Current Assets Cash & cash equivalents $ 3.4 $ 8.1 Accounts receivable-less reserves of $1.4 & $3.1, respectively 75.9 114.0 Receivables due from other Vectren companies 0.3 1.7 Accrued unbilled revenues 38.7 128.7 Inventories 60.0 55.1 Recoverable fuel & natural gas costs 38.5 20.3 Prepayments & other current assets 154.7 131.3 -------------------------------------------------------------------------------- Total current assets 371.5 459.2 -------------------------------------------------------------------------------- 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 0.2 1.8 Other investments 19.7 20.6 Non-utility property - net 143.7 141.3 Goodwill - net 205.0 205.0 Regulatory assets 88.2 89.6 Other assets 5.5 3.9 -------------------------------------------------------------------------------- TOTAL ASSETS $ 2,941.1 $ 2,925.1 ================================================================================ The accompanying notes are an integral part of these consolidated condensed financial statements. VECTREN UTILITY HOLDINGS, INC. AND SUBSIDIARY COMPANIES CONSOLIDATED CONDENSED BALANCE SHEETS (Unaudited - In millions) -------------------------------------------------------------------------------- September 30, December 31, 2004 2003 -------------------------------------------------------------------------------- LIABILITIES & SHAREHOLDER'S EQUITY Current Liabilities Accounts payable $ 71.7 $ 63.0 Accounts payable to affiliated companies 51.3 80.3 Payables to other Vectren companies 12.5 13.3 Accrued liabilities 88.1 93.9 Short-term borrowings 211.0 185.2 Current maturities of long-term debt 15.2 15.0 Long-term debt subject to tender 10.0 13.5 -------------------------------------------------------------------------------- Total current liabilities 459.8 464.2 -------------------------------------------------------------------------------- Long-Term Debt - Net of Current Maturities & Debt Subject to Tender 951.4 960.5 Deferred Income Taxes & Other Liabilities Deferred income taxes 226.0 201.5 Regulatory liabilities & other removal costs 247.8 235.0 Deferred credits & other liabilities 81.4 83.9 -------------------------------------------------------------------------------- Total deferred credits & other liabilities 555.2 520.4 -------------------------------------------------------------------------------- Commitments & Contingencies (Notes 6 - 8) Cumulative, Redeemable Preferred Stock of a Subsidiary 0.1 0.2 Common Shareholder's Equity Common stock (no par value) 592.7 589.8 Retained earnings 381.9 390.0 -------------------------------------------------------------------------------- Total common shareholder's equity 974.6 979.8 -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- TOTAL LIABILITIES & SHAREHOLDER'S EQUITY $ 2,941.1 $ 2,925.1 ================================================================================ The accompanying notes are an integral part of these consolidated condensed financial statements. VECTREN UTILITY HOLDINGS, INC. 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 Other - 0.2 0.5 0.6 -------------------------------------------------------------------------------- Total operating revenues 214.7 210.7 1,052.3 1,043.6 -------------------------------------------------------------------------------- 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 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 Other income(expense)-net 2.3 2.3 3.8 1.0 Equity in earnings (losses) of unconsolidated affiliates - (0.1) 0.2 (0.5) -------------------------------------------------------------------------------- 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 ================================================================================ The accompanying notes are an integral part of these consolidated condensed financial statements. VECTREN UTILITY HOLDINGS, INC. 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 $ 51.9 $ 51.1 Adjustments to reconcile net income to cash from operating activities: Depreciation & amortization 94.5 88.8 Deferred income taxes & investment tax credits 28.6 17.4 Pension & postretirement periodic benefit cost 4.3 4.4 Equity in (earnings) losses of unconsolidated affiliates (0.2) 0.5 Net unrealized losses on derivative instruments 1.0 0.4 Other non-cash charges - net 7.2 13.8 Changes in working capital accounts: Accounts receivable, including to Vectren companies & accrued unbilled revenue 121.3 178.5 Inventories (5.4) 8.3 Recoverable fuel & natural gas costs (18.2) (9.4) Prepayments & other current assets (21.8) (80.7) Accounts payable, including to Vectren companies & affiliated companies (21.1) (128.8) Accrued liabilities (9.9) 3.7 Changes in noncurrent assets (5.4) (3.3) Changes in noncurrent liabilities (8.0) (3.4) -------------------------------------------------------------------------------- Net cash flows from operating activities 218.8 141.3 -------------------------------------------------------------------------------- CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from: Additional capital contribution 2.9 167.5 Long-term debt issuance - net of issuance costs & hedging proceeds - 202.9 Requirements for: Dividends to parent (60.0) (56.9) Redemption of preferred stock of subsidiary (0.1) (0.1) Retirement of long-term debt, including premiums paid (12.7) (121.9) Other financing activities - (1.7) Net change in short-term borrowings 25.8 (182.5) -------------------------------------------------------------------------------- Net cash flows from financing activities (44.1) 7.3 -------------------------------------------------------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES Proceeds from other investing activities 3.5 0.1 Requirements for: Capital expenditures, excluding AFUDC - equity (182.9) (153.5) Unconsolidated affiliate and other investments - (1.1) -------------------------------------------------------------------------------- Net cash flows from investing activities (179.4) (154.5) -------------------------------------------------------------------------------- Net decrease in cash & cash equivalents (4.7) (5.9) Cash & cash equivalents at beginning of period 8.1 10.5 -------------------------------------------------------------------------------- Cash & cash equivalents at end of period $ 3.4 $ 4.6 ================================================================================ The accompanying notes are an integral part of these consolidated condensed financial statements. VECTREN UTILITY HOLDINGS, INC. AND SUBSIDIARY COMPANIES NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (UNAUDITED) 1. Organization and Nature of Operations Vectren Utility Holdings, Inc. (VUHI or the Company), an Indiana corporation, serves as the intermediate holding company for Vectren Corporation's (Vectren) 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. Vectren is an energy and applied technology holding company headquartered in Evansville, Indiana. 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. 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. Subsidiary Guarantor and Consolidating Information The Company's three operating utility companies, SIGECO, Indiana Gas, and VEDO are guarantors of VUHI's $350.0 million in short-term credit facilities, of which $210.6 million is outstanding at September 30, 2004, and VUHI's $550.0 million unsecured senior notes outstanding at September 30, 2004. The guarantees are full and unconditional and joint and several, and VUHI has no subsidiaries other than the subsidiary guarantors. However, VUHI does have operations other than those of the subsidiary guarantors. Pursuant to Article 3-10 of Regulation S-X, disclosure of the results of operations and balance sheets of the subsidiary guarantors separate from the parent company's operations is required. Following are consolidating financial statements including information on the combined operations of the subsidiary guarantors separate from the other operations of the parent company. Consolidating Statement of Income for the three months ended September 30, 2004 (in millions): Subsidiary Parent Guarantors Company Eliminations Consolidated -------------------------- ----------- --------- ------------ ------------- OPERATING REVENUES Gas utility $ 112.4 $ - $ - $ 112.4 Electric utility 102.3 - - 102.3 Other - 7.4 (7.4) - -------------------------------------------------------------------------------- Total operating revenues 214.7 7.4 (7.4) 214.7 -------------------------------------------------------------------------------- OPERATING EXPENSES Cost of gas sold 67.2 - - 67.2 Fuel for electric generation 25.8 - - 25.8 Purchased electric energy 5.3 - - 5.3 Other operating 57.6 1.8 (7.4) 52.0 Depreciation & amortization 28.6 4.5 - 33.1 Taxes other than income taxes 9.4 0.2 - 9.6 ------------------------------------------------------------------------------- Total operating expenses 193.9 6.5 (7.4) 193.0 -------------------------------------------------------------------------------- OPERATING INCOME 20.8 0.9 - 21.7 OTHER INCOME (EXPENSE) - NET Equity in losses of consolidated companies - 3.1 (3.1) - Equity in earnings of unconsolidated affiliates - - - - Other income (expense) - net 1.3 9.2 (8.2) 2.3 -------------------------------------------------------------------------------- Total other income (expense)-net 1.3 12.3 (11.3) 2.3 -------------------------------------------------------------------------------- Interest expense 15.6 9.3 (8.2) 16.7 -------------------------------------------------------------------------------- INCOME BEFORE INCOME TAXES 6.5 3.9 (3.1) 7.3 -------------------------------------------------------------------------------- Income taxes 3.4 (0.6) - 2.8 -------------------------------------------------------------------------------- NET INCOME $ 3.1 $ 4.5 $ (3.1) $ 4.5 ================================================================================ Consolidating Statement of Income for the three months ended September 30, 2003 (in millions): Subsidiary Parent Guarantors Company Eliminations Consolidated --------------------------- ------------- -------- ------------ ------------- OPERATING REVENUES Gas utility $ 115.0 $ - $ - $ 115.0 Electric utility 95.5 - - 95.5 Other - 6.6 (6.4) 0.2 -------------------------------------------------------------------------------- Total operating revenues 210.5 6.6 (6.4) 210.7 -------------------------------------------------------------------------------- OPERATING EXPENSES Cost of gas sold 71.3 - - 71.3 Fuel for electric generation 24.8 - - 24.8 Purchased electric energy 4.2 - - 4.2 Other operating 57.6 0.2 (6.4) 51.4 Depreciation & amortization 26.1 4.3 - 30.4 Taxes other than income taxes 9.0 0.2 - 9.2 -------------------------------------------------------------------------------- Total operating expenses 193.0 4.7 (6.4) 191.3 -------------------------------------------------------------------------------- OPERATING INCOME 17.5 1.9 - 19.4 OTHER INCOME (EXPENSE) - NET Equity in losses of consolidated companies - 1.4 (1.4) - Equity in earnings of unconsolidated affiliates - (0.1) - (0.1) Other income (expense) - net 1.8 7.4 (6.9) 2.3 -------------------------------------------------------------------------------- Total other income (expense) - net 1.8 8.7 (8.3) 2.2 -------------------------------------------------------------------------------- Interest expense 15.7 8.3 (6.9) 17.1 -------------------------------------------------------------------------------- INCOME BEFORE INCOME TAXES 3.6 2.3 (1.4) 4.5 -------------------------------------------------------------------------------- Income taxes 2.2 (0.1) - 2.1 -------------------------------------------------------------------------------- NET INCOME (LOSS) $ 1.4 $ 2.4 $ (1.4) $ 2.4 ================================================================================ Consolidating Statement of Income for the nine months ended September 30, 2004 (in millions): Subsidiary Parent Guarantors Company Eliminations Consolidated --------------------------- ----------- ---------- ------------ ------------ OPERATING REVENUES Gas utility $ 771.6 $ - $ - $ 771.6 Electric utility 280.2 - - 280.2 Other - 25.5 (25.0) 0.5 -------------------------------------------------------------------------------- Total operating revenues 1,051.8 25.5 (25.0) 1,052.3 -------------------------------------------------------------------------------- OPERATING EXPENSES Cost of gas sold 529.8 - - 529.8 Fuel for electric generation 72.4 - - 72.4 Purchased electric energy 16.6 - - 16.6 Other operating 190.4 0.4 (25.0) 165.8 Depreciation & amortization 81.3 13.2 - 94.5 Taxes other than income taxes 41.6 0.8 - 42.4 -------------------------------------------------------------------------------- Total operating expenses 932.1 14.4 (25.0) 921.5 -------------------------------------------------------------------------------- OPERATING INCOME 119.7 11.1 - 130.8 OTHER INCOME (EXPENSE) - NET Equity in earnings of consolidated companies - 46.1 (46.1) - Equity in earnings of unconsolidated affiliates - 0.2 - 0.2 Other income (expense) - net 2.0 25.8 (24.0) 3.8 -------------------------------------------------------------------------------- Total other income (expense)-net 2.0 72.1 (70.1) 4.0 -------------------------------------------------------------------------------- Interest expense 46.8 27.4 (24.0) 50.2 -------------------------------------------------------------------------------- INCOME BEFORE INCOME TAXES 74.9 55.8 (46.1) 84.6 -------------------------------------------------------------------------------- Income taxes 28.8 3.9 - 32.7 -------------------------------------------------------------------------------- NET INCOME $ 46.1 $ 51.9 $ (46.1) $ 51.9 ================================================================================ Consolidating Statement of Income for the nine months ended September 30, 2003 (in millions): Subsidiary Parent Guarantors Company Eliminations Consolidated --------------------------- ---------- -------- ------------ ------------ OPERATING REVENUES Gas utility $ 788.8 $ - $ - $ 788.8 Electric utility 254.2 - - 254.2 Other - 19.8 (19.2) 0.6 -------------------------------------------------------------------------------- Total operating revenues 1,043.0 19.8 (19.2) 1,043.6 -------------------------------------------------------------------------------- OPERATING EXPENSES Cost of gas sold 539.9 - - 539.9 Fuel for electric generation 66.2 - - 66.2 Purchased electric energy 12.5 - - 12.5 Other operating 180.1 1.0 (19.2) 161.9 Depreciation & amortization 76.9 11.9 - 88.8 Taxes other than income taxes 41.1 0.7 - 41.8 -------------------------------------------------------------------------------- Total operating expenses 916.7 13.6 (19.2) 911.1 -------------------------------------------------------------------------------- OPERATING INCOME 126.3 6.2 - 132.5 OTHER INCOME (EXPENSE) - NET Equity in earnings of consolidated companies - 49.8 (49.8) - Equity in losses of unconsolidated affiliates - (0.5) - (0.5) Other income (expense)-net 2.0 19.2 (20.2) 1.0 -------------------------------------------------------------------------------- Total other income (expense) - net 2.0 68.5 (70.0) 0.5 -------------------------------------------------------------------------------- Interest expense 46.6 23.1 (20.2) 49.5 -------------------------------------------------------------------------------- INCOME BEFORE INCOME TAXES 81.7 51.6 (49.8) 83.5 -------------------------------------------------------------------------------- Income taxes 31.9 0.5 - 32.4 -------------------------------------------------------------------------------- NET INCOME $ 49.8 $ 51.1 $ (49.8) $ 51.1 ================================================================================ Consolidating Statement of Cash Flows for the nine months ended September 30, 2004 (in millions): Subsidiary Parent Guarantors Company Eliminations Consolidated -------------------------- ------------ -------- ------------ ------------ -------------------------------------------------------------------------------- NET CASH FLOWS FROM OPERATING ACTIVITIES $ 192.5 $ 16.5 $ 9.8 $ 218.8 -------------------------------------------------------------------------------- CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from additional capital contribution - 2.9 - 2.9 Requirements for: Dividends to parent (60.0) (60.0) 60.0 (60.0) Retirement of long-term debt (2.9) - (9.8) (12.7) Redemption of preferred stock of subsidiary (0.1) - - (0.1) Net change in short-term borrowings 30.4 26.2 (30.8) 25.8 -------------------------------------------------------------------------------- Net cash flows from financing activities (32.6) (30.9) 19.4 (44.1) -------------------------------------------------------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES Proceeds from: Consolidated subsidiary distributions - 60.0 (60.0) - Other investing activities 1.1 2.4 - 3.5 Requirements for: Capital expenditures, excluding AFUDC equity (167.1) (15.8) - (182.9) Net change in notes receivable to other Vectren companies - (30.8) 30.8 - -------------------------------------------------------------------------------- Net cash flows from investing activities (166.0) 15.8 (29.2) (179.4) -------------------------------------------------------------------------------- Net decrease in cash & cash equivalents (6.1) 1.4 (4.7) Cash & cash equivalents at beginning of period 7.4 0.7 8.1 -------------------------------------------------------------------------------- Cash & cash equivalents at end of period $ 1.3 $ 2.1 $ - $ 3.4 ================================================================================ Consolidating Statement of Cash Flows for the nine months ended September 30, 2003 (in millions): Subsidiary Parent Guarantors Company Eliminations Consolidated -------------------------- ------------ --------- ------------ ------------- -------------------------------------------------------------------------------- NET CASH FLOWS FROM OPERATING ACTIVITIES $ 114.2 $ 27.1 $ - $ 141.3 -------------------------------------------------------------------------------- CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from: Additional capital contribution 140.0 167.5 (140.0) 167.5 Long-term debt issuance- net of issuance costs & hedging proceeds 99.0 202.9 (99.0) 202.9 Requirements for: Retirement of long-term debt, including premiums paid (121.9) - - (121.9) Dividends to parent (56.9) (56.9) 56.9 (56.9) Redemption of preferred stock of subsidiary (0.1) - - (0.1) Other financing activities (1.7) - - (1.7) Net change in short-term borrowings (38.7) (192.0) 48.2 (182.5) -------------------------------------------------------------------------------- Net cash flows from financing activities 19.7 121.5 (133.9) 7.3 -------------------------------------------------------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES Proceeds from: Consolidated subsidiary distributions - 56.9 (56.9) - Unconsolidated affiliate distributions - 0.1 - 0.1 Requirements for: Capital expenditures, excluding AFUDC equity (146.6) (6.9) - (153.5) Consolidated subsidiary investments - (140.0) 140.0 - Unconsolidated affiliate and other investments - (1.1) - (1.1) Net change in notes receivable to other Vectren companies 8.5 (59.3) 50.8 - -------------------------------------------------------------------------------- Net cash flows from investing activities (138.1) (150.3) 133.9 (154.5) -------------------------------------------------------------------------------- Net decrease in cash & cash equivalents (4.2) (1.7) (5.9) Cash & cash equivalents at beginning of period 10.2 0.3 10.5 -------------------------------------------------------------------------------- Cash & cash equivalents at end of period $ 6.0 $ (1.4) $ - $ 4.6 ================================================================================ Consolidating Balance Sheet as of September 30, 2004 (in millions): ASSETS Subsidiary Parent ------ Guarantors Company Eliminations Consolidated ---------- --------- ------------ ------------- Current Assets Cash & cash equivalents $ 1.3 $ 2.1 $ - $ 3.4 Accounts receivable- less reserves 75.8 9.9 (9.8) 75.9 Receivables due from other Vectren companies 0.3 7.3 (7.3) 0.3 Accrued unbilled revenues 38.7 - - 38.7 Inventories 60.0 - - 60.0 Recoverable fuel & natural gas costs 38.5 - - 38.5 Prepayments & other current assets 155.9 3.0 (4.2) 154.7 -------------------------------------------------------------------------------- Total current assets 370.5 22.3 (21.3) 371.5 -------------------------------------------------------------------------------- Utility Plant Original cost 3,401.5 - - 3,401.5 Less: accumulated depreciation & amortization 1,294.2 - - 1,294.2 -------------------------------------------------------------------------------- Net utility plant 2,107.3 - - 2,107.3 -------------------------------------------------------------------------------- Investments in consolidated subsidiaries - 942.3 (942.3) - Notes receivable from consolidated subsidiaries - 654.2 (654.2) - Investments in unconsolidated affiliates 0.2 - - 0.2 Other investments 13.2 6.5 - 19.7 Non-utility property - net 5.4 138.3 - 143.7 Goodwill - net 205.0 - - 205.0 Regulatory assets 82.3 5.9 - 88.2 Other assets 4.6 0.9 - 5.5 -------------------------------------------------------------------------------- TOTAL ASSETS $ 2,788.5 $ 1,770.4 $ (1,617.8) $ 2,941.1 ================================================================================ LIABILITIES & SHAREHOLDER'S EQUITY ---------------------------------- Subsidiary Parent Guarantors Company Eliminations Consolidated ---------- -------- ------------ ------------ Current Liabilities Accounts payable $ 69.5 $ 2.2 $ - $ 71.7 Accounts payable to affiliated companies 51.2 0.1 - 51.3 Payables to other Vectren companies 19.8 - (7.3) 12.5 Accrued liabilities 82.2 12.8 (6.9) 88.1 Short-term borrowings 0.4 210.6 - 211.0 Short-term borrowings from other Vectren companies 208.4 - (208.4) - Current maturities of long-term debt 15.2 - - 15.2 Long-term debt subject to tender 10.0 - - 10.0 -------------------------------------------------------------------------------- Total current liabilities 456.7 225.7 (222.6) 459.8 -------------------------------------------------------------------------------- Long-Term Debt Long-term debt - net of current maturities & debt subject to tender 413.4 547.8 (9.8) 951.4 Long-term debt due to VUHI 443.1 - (443.1) - -------------------------------------------------------------------------------- Total long-term debt - net 856.5 547.8 (452.9) 951.4 -------------------------------------------------------------------------------- Deferred Income Taxes & Other Liabilities Deferred income taxes 213.1 12.9 - 226.0 Regulatory liabilities & other removal costs 242.1 5.7 - 247.8 Deferred credits & other liabilities 77.7 3.7 - 81.4 -------------------------------------------------------------------------------- Total deferred credits & other liabilities 532.9 22.3 - 555.2 -------------------------------------------------------------------------------- Cumulative, Redeemable Preferred Stock of a Subsidiary 0.1 - - 0.1 Common Shareholder's Equity Common stock ( no par value) 611.3 592.7 (611.3) 592.7 Retained earnings 331.0 381.9 (331.0) 381.9 -------------------------------------------------------------------------------- Total common shareholder's equity 942.3 974.6 (942.3) 974.6 -------------------------------------------------------------------------------- TOTAL LIABILITIES & SHAREHOLDER'S EQUITY $ 2,788.5 $ 1,770.4 $ (1,617.8) $ 2,941.1 ================================================================================ Consolidating Balance Sheet as of December 31, 2003 (in millions): ASSETS Subsidiary Parent ------ Guarantors Company Eliminations Consolidated ---------- --------- ------------ ------------ Current Assets Cash & cash equivalents $ 7.4 $ 0.7 $ - $ 8.1 Accounts receivable - less reserves 113.6 0.4 - 114.0 Receivables due from other Vectren companies 0.2 10.5 (9.0) 1.7 Accrued unbilled revenues 128.7 - - 128.7 Inventories 55.1 - - 55.1 Recoverable fuel & natural gas costs 20.3 - - 20.3 Prepayments & other current assets 138.2 0.9 (7.8) 131.3 -------------------------------------------------------------------------------- Total current assets 463.5 12.5 (16.8) 459.2 -------------------------------------------------------------------------------- Utility Plant Original cost 3,250.7 - - 3,250.7 Less: accumulated depreciation & amortization 1,247.0 - - 1,247.0 -------------------------------------------------------------------------------- Net utility plant 2,003.7 - - 2,003.7 -------------------------------------------------------------------------------- Investments in consolidated subsidiaries - 956.2 (956.2) - Notes receivable from consolidated subsidiaries - 623.4 (623.4) - Investments in unconsolidated affiliates 0.2 1.6 - 1.8 Other investments 14.3 6.3 - 20.6 Non-utility property - net 5.6 135.7 - 141.3 Goodwill - net 205.0 - - 205.0 Regulatory assets 83.4 6.2 - 89.6 Other assets 3.9 - - 3.9 -------------------------------------------------------------------------------- TOTAL ASSETS $ 2,779.6 $ 1,741.9 $ (1,596.4) $ 2,925.1 ================================================================================ LIABILITIES & SHAREHOLDER'S EQUITY ---------------------------------- Subsidiary Parent Guarantors Company Eliminations Consolidated ----------- -------- ------------ ------------- Current Liabilities Accounts payable $ 57.5 $ 5.5 $ - $ 63.0 Accounts payable to affiliated companies 80.2 0.1 - 80.3 Payables to other Vectren companies 22.3 - (9.0) 13.3 Accrued liabilities 95.7 8.8 (10.6) 93.9 Short-term borrowings 0.8 184.4 - 185.2 Short-term borrowings from other Vectren companies 177.6 - (177.6) - Current maturities of long-term debt 15.0 - - 15.0 Long-term debt subject to tender 13.5 - - 13.5 -------------------------------------------------------------------------------- Total current liabilities 462.6 198.8 (197.2) 464.2 -------------------------------------------------------------------------------- Long-Term Debt Long-term debt - net of current maturities & debt subject to tender 412.9 547.6 - 960.5 Long-term debt due to VUHI 443.0 - (443.0) - -------------------------------------------------------------------------------- Total long-term debt - net 855.9 547.6 (443.0) 960.5 -------------------------------------------------------------------------------- Deferred Income Taxes & Other Liabilities Deferred income taxes 194.8 6.7 - 201.5 Regulatory liabilities & other removal costs 228.8 6.2 - 235.0 Deferred credits & other liabilities 81.1 2.8 - 83.9 -------------------------------------------------------------------------------- Total deferred credits & other liabilities 504.7 15.7 - 520.4 -------------------------------------------------------------------------------- Cumulative, Redeemable Preferred Stock of a Subsidiary 0.2 - - 0.2 Common Shareholder's Equity Common stock (no par value) 611.3 589.8 (611.3) 589.8 Retained earnings 344.9 390.0 (344.9) 390.0 -------------------------------------------------------------------------------- Total common shareholder's equity 956.2 979.8 (956.2) 979.8 -------------------------------------------------------------------------------- TOTAL LIABILITIES & SHAREHOLDER'S EQUITY $ 2,779.6 $ 1,741.9 $ (1,596.4) $ 2,925.1 ================================================================================ 4. Transactions with Other Vectren Companies Support Services and Purchases Vectren and certain subsidiaries of Vectren provide corporate and general and administrative services to the Company including legal, finance, tax, risk management, human resources, which includes charges for restricted stock compensation and for pension and other postretirement benefits not directly charged to subsidiaries. These costs have been allocated using various allocation techniques, primarily number of employees, number of customers and/or revenues. Allocations are based on cost. VUHI received corporate allocations totaling $17.0 million and $18.0 million for the three months ended September 30, 2004 and 2003, respectively. VUHI received corporate allocations totaling $59.2 million and $52.6 million for the nine months ended September 30, 2004 and 2003, respectively. Vectren Fuels, Inc., a wholly owned subsidiary of Vectren, owns and operates coal mines from which SIGECO purchases fuel used for electric generation. Amounts paid for such purchases for the three months ended September 30, 2004 and 2003, totaled $22.0 million and $20.5 million, respectively. Amounts paid for such purchases for the nine months ended September 30, 2004 and 2003, totaled $61.1 million and $58.7 million, respectively. Share-Based Incentive Plans VUHI does not have share-based compensation plans separate from Vectren. An insignificant number of VUHI's employees participate in Vectren's share-based compensation plans. 5. 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 and for injections into storage for the three months ended September 30, 2004 and 2003, totaled $160.7 million and $148.3 million, respectively, and for the nine months ended September 30, 2004 and 2003, totaled $562.9 million and $575.8 million, respectively. Amounts owed to ProLiance at September 30, 2004, and December 31, 2003, for those purchases were $48.1 million and $79.9 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. 6. 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 environmental matters. 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 VUHI'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. VUHI claims exemption from registration under Section 3(a)(1) of PUHCA by rule 2. As required by the rule, VUHI 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. 7. 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. 8. 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. 9. Impact of Recently Issued Accounting Guidance 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. Adoption of FIN 46R did not have a material impact on the Company's results of operations or financial position. 10.Segment Reporting VUHI's operations consist of 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, VUHI has three operating segments 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 VUHI's other operations, net income is used as the measure of profitability. 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 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) -------------------------------------------------------------------------------- Consolidated Revenues $ 214.7 $ 210.7 $ 1,052.3 $ 1,043.6 ================================================================================ Profitability Measure 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 -------------------------------------------------------------------------------- Consolidated Net Income $ 4.5 $ 2.4 $ 51.9 $ 51.1 ================================================================================ ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Description of the Business Vectren Utility Holdings, Inc. (VUHI or the Company), an Indiana corporation, serves as the intermediate holding company for Vectren Corporation's (Vectren) 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. Vectren is an energy and applied technology holding company headquartered in Evansville, Indiana. 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 generates revenue primarily from the delivery of natural gas and electric service to its customers. The Company's primary source of cash flow results from the collection of customer bills and the payment for goods and services procured for the delivery of gas and electric services. The Company's results are impacted by weather patterns in its service territory and general economic conditions both in its service territory as well as nationally. 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. Earnings for the three months ended September 30, 2004 were $4.5 million 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 and year-to-date earnings by approximately $6.4 million after tax 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 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 ================================================================================ 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. 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. 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. 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 VUHI'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. VUHI claims exemption from registration under Section 3(a)(1) of PUHCA by rule 2. As required by the rule, VUHI 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 utility operations. Vectren does not guarantee VUHI's debt. VUHI's outstanding long-term and short-term borrowing arrangements are jointly and severally guaranteed by Indiana Gas, SIGECO, and VEDO. The guarantees are full and unconditional and joint and several, and VUHI has no subsidiaries other than the subsidiary guarantors. Information about the subsidiary guarantors as a group is included in Note 3 to the condensed consolidated financial statements. 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. VUHI's operations have historically funded almost all of Vectren's common stock dividends. 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. 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% of total permanent capitalization, including current maturities of long-term debt and long-term debt subject to tender, at both 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 $218.8 million and $141.3 million, respectively. The increase of $77.5 million is primarily the result of favorable changes in working capital accounts and increased earnings before non-cash charges. Financing Cash Flow Although working capital requirements are generally funded by cash flow from operations, the Company uses short-term borrowings to supplement working capital needs when accounts receivable balances are at their highest and gas storage is refilled. Additionally, short-term borrowings are required for capital projects and investments until they are permanently financed. Cash flow required for financing activities of $44.1 million for the nine months ended September 30, 2004, includes a net increase of short-term borrowings of approximately $25.8 million and increased dividends paid to its parent company compared to 2003. In 2003, Vectren infused common equity into utility operations and VUHI issued 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 $179.4 million for the nine months ended September 30, 2004, an increase of $24.9 million over 2003. The increase in investing activities results primarily from capital expenditures, which totaled $182.9 million in 2004 compared to $153.5 million in 2003. Available Sources of Liquidity 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. At September 30, 2004, the Company has $355 million of short-term borrowing capacity, of which approximately $144 million is available. Potential Uses of Liquidity Planned Capital Expenditures & Investments Capital expenditures for the remainder of 2004 are estimated to be approximately $73 million. For 2005, capital expenditures are estimated at approximately $205 million. Forward-Looking Information A "safe harbor" for forward-looking statements is provided by the Private Securities Litigation Reform Act of 1995 (Reform Act of 1995). The Reform Act of 1995 was adopted to encourage such forward-looking statements without the threat of litigation, provided those statements are identified as forward-looking and are accompanied by meaningful cautionary statements identifying important factors that could cause the actual results to differ materially from those projected in the statement. Certain matters described in Management's Discussion and Analysis of Results of Operations and Financial Condition are forward-looking statements. Such statements are based on management's beliefs, as well as assumptions made by and information currently available to management. When used in this filing, the words "believe," "anticipate," "endeavor," "estimate," "expect," "objective," "projection," "forecast," "goal," and similar expressions are intended to identify forward-looking statements. In addition to any assumptions and other factors referred to specifically in connection with such forward-looking statements, factors that could cause the Company's actual results to differ materially from those contemplated in any forward-looking statements include, among others, the following: o Factors affecting utility operations such as unusual weather conditions; catastrophic weather-related damage; unusual maintenance or repairs; unanticipated changes to fossil fuel costs; unanticipated changes to gas supply costs, or availability due to higher demand, shortages, transportation problems or other developments; environmental or pipeline incidents; transmission or distribution incidents; unanticipated changes to electric energy supply costs, or availability due to demand, shortages, transmission problems or other developments; or electric transmission or gas pipeline system constraints. o Increased competition in the energy environment including effects of industry restructuring and unbundling. o Regulatory factors such as unanticipated changes in rate-setting policies or procedures, recovery of investments and costs made under traditional regulation, and the frequency and timing of rate increases. o Financial or regulatory accounting principles or policies imposed by the Financial Accounting Standards Board; the Securities and Exchange Commission; the Federal Energy Regulatory Commission; state public utility commissions; state entities which regulate electric and natural gas transmission and distribution, natural gas gathering and processing, electric power supply; and similar entities with regulatory oversight. o Economic conditions including the effects of an economic downturn, inflation rates, and monetary fluctuations. o Changing market conditions and a variety of other factors associated with physical energy and financial trading activities including, but not limited to, price, basis, credit, liquidity, volatility, capacity, interest rate, and warranty risks. o 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 Company's 2003 Form 10-K and is therefore not presented herein. ITEM 4. CONTROLS AND PROCEDURES Changes in Internal Control over Financial Reporting In preparation for required reporting under the Sarbanes Oxley Act of 2002, Section 404, the Company is conducting a thorough review of its internal control over financial reporting, including disclosure controls and procedures. Based on this review, the Company has made internal control enhancements, and will continue to make future enhancements, to its internal controls over financing reporting some of which may be material; however, during the quarter ended September 30, 2004, there have been no changes to the Company's internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting. Evaluation of Disclosure Controls and Procedures As of 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 Note 7 of its unaudited consolidated condensed financial statements included in Part 1 Item 1 Financial Statements regarding the 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 UTILITY HOLDINGS, INC. Registrant November 12, 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)