-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, UznFKShbGQTAMy4xwCl3203plp3mlfFToSkCV4+92BduDeOd+YALueOXDTpUqXrh +dL6N0dP52iJQiFOBqCO+Q== 0000018540-99-000101.txt : 19991117 0000018540-99-000101.hdr.sgml : 19991117 ACCESSION NUMBER: 0000018540-99-000101 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 10 CONFORMED PERIOD OF REPORT: 19990930 FILED AS OF DATE: 19991115 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CENTRAL & SOUTH WEST CORP CENTRAL INDEX KEY: 0000018540 STANDARD INDUSTRIAL CLASSIFICATION: ELECTRIC SERVICES [4911] IRS NUMBER: 510007707 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-01443 FILM NUMBER: 99753465 BUSINESS ADDRESS: STREET 1: 1616 WOODALL RODGERS FRWY CITY: DALLAS STATE: TX ZIP: 75202 BUSINESS PHONE: 2147771000 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CENTRAL POWER & LIGHT CO /TX/ CENTRAL INDEX KEY: 0000018734 STANDARD INDUSTRIAL CLASSIFICATION: ELECTRIC SERVICES [4911] IRS NUMBER: 740550600 STATE OF INCORPORATION: TX FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-12973 FILM NUMBER: 99753466 BUSINESS ADDRESS: STREET 1: 539 N CARANCAHUA ST CITY: CORPUS CHRISTI STATE: TX ZIP: 78401 BUSINESS PHONE: 5128815300 FILER: COMPANY DATA: COMPANY CONFORMED NAME: PUBLIC SERVICE CO OF OKLAHOMA CENTRAL INDEX KEY: 0000081027 STANDARD INDUSTRIAL CLASSIFICATION: ELECTRIC SERVICES [4911] IRS NUMBER: 730410895 STATE OF INCORPORATION: OK FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-12945 FILM NUMBER: 99753467 BUSINESS ADDRESS: STREET 1: 212 E 6TH ST CITY: TULSA STATE: OK ZIP: 74119 BUSINESS PHONE: 9185992000 MAIL ADDRESS: STREET 1: P O BOX 201 CITY: TULSA STATE: OK ZIP: 74119 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SOUTHWESTERN ELECTRIC POWER CO CENTRAL INDEX KEY: 0000092487 STANDARD INDUSTRIAL CLASSIFICATION: ELECTRIC SERVICES [4911] IRS NUMBER: 720323455 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-03146 FILM NUMBER: 99753468 BUSINESS ADDRESS: STREET 1: 428 TRAVIS ST CITY: SHREVEPORT STATE: LA ZIP: 71156 BUSINESS PHONE: 3182222141 MAIL ADDRESS: STREET 1: C/O SOUTHWESTERN ELECTRIC POWER CO STREET 2: 428 TRAVIS STREET CITY: SHREVEPORT STATE: LA ZIP: 71156-0001 FILER: COMPANY DATA: COMPANY CONFORMED NAME: WEST TEXAS UTILITIES CO CENTRAL INDEX KEY: 0000105860 STANDARD INDUSTRIAL CLASSIFICATION: ELECTRIC SERVICES [4911] IRS NUMBER: 750646790 STATE OF INCORPORATION: TX FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-00340 FILM NUMBER: 99753469 BUSINESS ADDRESS: STREET 1: 301 CYPRESS CITY: ABILENE STATE: TX ZIP: 79601 BUSINESS PHONE: 9156747000 10-Q 1 QUARTER ENDED SEPTEMBER 30, 1999 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (X) COMBINED QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarter Ended September 30, 1999 OR ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Transition Period from _____ to _____ Commission Registrant, State of Incorporation, I.R.S. Employer File Number Address and Telephone Number Identification No. 1-1443 Central and South West Corporation 51-0007707 (A Delaware Corporation) 1616 Woodall Rodgers Freeway Dallas, Texas 75202-1234 (214) 777-1000 0-346 Central Power and Light Company 74-0550600 (A Texas Corporation) 539 North Carancahua Street Corpus Christi, Texas 78401-2802 (512) 881-5300 0-343 Public Service Company of Oklahoma 73-0410895 (An Oklahoma Corporation) 212 East 6th Street Tulsa, Oklahoma 74119-1212 (918) 599-2000 1-3146 Southwestern Electric Power Company 72-0323455 (A Delaware Corporation) 428 Travis Street Shreveport, Louisiana 71156-0001 (318) 673-3000 0-340 West Texas Utilities Company 75-0646790 (A Texas Corporation) 301 Cypress Street Abilene, Texas 79601-5820 (915) 674-7000 Indicate by check mark whether the Registrants (1) have 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 Registrants were required to file such reports), and (2) have been subject to such filing requirements for the past 90 days. Yes X No__ Common Stock Outstanding at November 5, 1999 Shares Central and South West Corporation 212,648,293 Central Power and Light Company 6,755,535 Public Service Company of Oklahoma 9,013,000 Southwestern Electric Power Company 7,536,640 West Texas Utilities Company 5,488,560 This Combined Form 10-Q is separately filed by Central and South West Corporation, Central Power and Light Company, Public Service Company of Oklahoma, Southwestern Electric Power Company and West Texas Utilities Company. Information contained herein relating to any individual Registrant is filed by such Registrant on its own behalf. Each Registrant makes no representation as to information relating to the other Registrants. CENTRAL AND SOUTH WEST CORPORATION AND SUBSIDIARY COMPANIES TABLE OF CONTENTS TO QUARTERLY REPORT ON FORM 10-Q SEPTEMBER 30, 1999 GLOSSARY OF TERMS..............................................................3 FORWARD-LOOKING INFORMATION....................................................5 PART I. - FINANCIAL INFORMATION................................................6 ITEM 1. FINANCIAL STATEMENTS................................................6 CENTRAL AND SOUTH WEST CORPORATION.........................................6 CENTRAL POWER AND LIGHT COMPANY...........................................16 PUBLIC SERVICE COMPANY OF OKLAHOMA........................................24 SOUTHWESTERN ELECTRIC POWER COMPANY.......................................32 WEST TEXAS UTILITIES COMPANY..............................................40 NOTES TO FINANCIAL STATEMENTS.............................................49 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.......................................................68 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.........88 PART II. - OTHER INFORMATION..................................................90 ITEM 1. LEGAL PROCEEDINGS..................................................90 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K...................................90 SIGNATURES....................................................................91 2 GLOSSARY OF TERMS The following abbreviations or acronyms used in this text are defined below: Abbreviation or Acronym Definition AEP ....................American Electric Power Company, Inc. AEP Merger .............Proposed merger between AEP and CSW in which CSW would become a wholly-owned subsidiary of AEP ALJ ....................Administrative Law Judge Alpek ..................Alpek S.A. de C.V. Altamira................CSW International cogeneration project in Altamira, Tamaulipas, Mexico Arkansas Commission ....Arkansas Public Service Commission Btu ....................British thermal unit C3 Communications ......C3 Communications, Inc., Austin, Texas (formerly CSW Communications, Inc.) Cajun ..................Cajun Electric Power Cooperative, Inc. CLECO ..................Central Louisiana Electric Company, Inc. Court of Appeals .......Court of Appeals, Third District of Texas, Austin, Texas CPL ....................Central Power and Light Company, Corpus Christi, Texas CPL 1997 Final Order ...Final orders received from the Texas Commission in CPL's rate case Docket No., 14965, including both the order received on September 10, 1997 and the revised order received on October 16, 1997 CSW ....................Central and South West Corporation, Dallas, Texas CSW Credit .............CSW Credit, Inc., Dallas, Texas CSW Energy .............CSW Energy, Inc., Dallas, Texas CSW International ......CSW International, Inc., Dallas, Texas CSW Services ...........Central and South West Services, Inc., Dallas, Texas and Tulsa, Oklahoma CSW System .............CSW and its subsidiaries DHMV ...................Dolet Hills Mining Venture Diversified Electric ...CSW Energy and CSW International and their subsidiaries ECOM ...................Excess cost over market EITF 97-4...............Emerging Issues Task Force Consensus 97-4, Deregulation of the Pricing of Electricity - Issues Related to the Application of SFAS Nos. 71 and 101. EPA ....................United States Environmental Protection Agency ERCOT ..................Electric Reliability Council of Texas ESPS....................Electricity Supply Pension Scheme Exchange Act ...........Securities Exchange Act of 1934, as amended EWG ....................Exempt Wholesale Generator FCC.....................Federal Communications Commission FERC ...................Federal Energy Regulatory Commission Frontera................A 500 MW merchant power plant located near the city of Mission, Texas owned by CSW Energy FUCO ...................Foreign utility company as defined in the Holding Company Act FMBs....................First Mortgage Bonds Holding Company Act ....Public Utility Holding Company Act of 1935, as amended IBEW ...................International Brotherhood of Electrical Workers July 1999 SWEPCO Plan...The amended plan of reorganization for Cajun filed by the Members Committee and SWEPCO on July 28, 1999 with the U.S. Bankruptcy Court for the Middle District of Louisiana Legislative Joint Electric Utility Task Force............Task force created by the Oklahoma Legislature to study electric utility industry restructuring issues in the state of Oklahoma LIFO ...................Last-in first-out (inventory accounting method) Louisiana Commission ...Louisiana Public Service Commission MD&A ...................Management's Discussion and Analysis of Financial Condition and Results of Operations MDEQ ...................Mississippi Department of Environmental Quality MGP ....................Manufactured gas plant or coal gasification plant Mississippi Power ......Mississippi Power Company MMbtu ..................Million Btu MW .....................Megawatt MWH ....................Megawatt-hour National Grid Group ....National Grid Group plc National Power..........National Power plc Northeastern Power Station...............Northeastern Power Station, Oologah, Oklahoma NRC ....................Nuclear Regulatory Commission Numanco.................Nuvest, Inc., Numanco, LLC and Numanco, Inc. 3 GLOSSARY OF TERMS (continued) The following abbreviations or acronyms used in this text are defined below: Abbreviation or Acronym Definition OFGEM...................The Office of Gas and Electricity Markets, United Kingdom Oklahoma Commission ....Corporation Commission of the State of Oklahoma PCB ....................Polychlorinated biphenyl PRP ....................Potentially responsible party PSO ....................Public Service Company of Oklahoma, Tulsa, Oklahoma Registrant(s) ..........CSW, CPL, PSO, SWEPCO and WTU SEC ....................United States Securities and Exchange Commission SEEBOARD ...............SEEBOARD Group plc, Crawley, West Sussex, United Kingdom SEEBOARD USA............CSW's investment in SEEBOARD as consolidated and converted pursuant to U.S. Generally Accepted Accounting Principles SFAS ...................Statement of Financial Accounting Standards SFAS No. 34.............Capitalization of Interest Cost SFAS No. 52 ............Foreign Currency Translation SFAS No. 71 ............Accounting for the Effects of Certain Types of Regulation SFAS No. 101............Regulated Enterprises - Accounting for the Discontinuance of Application of SFAS No. 71 SFAS No. 121............Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of STP ....................South Texas Project nuclear electric generating station SWEPCO .................Southwestern Electric Power Company, Shreveport, Louisiana Texas Commission .......Public Utility Commission of Texas Texas Legislation.......Texas Senate Bill 7 relating to deregulation of electric utility industry Trust Preferred Securities............Collective term for securities issued by business trusts of CPL, PSO and SWEPCO classified on the balance sheet as Certain Subsidiary (or CPL/PSO/SWEPCO)-obligated, mandatorily redeemable preferred securities of subsidiary trusts holding solely Junior Subordinated Debentures of such Subsidiaries (or CPL/PSO/SWEPCO) U.K. Electric...........SEEBOARD USA U.S. Electric Operating Companies or U.S. Electric .....CPL, PSO, SWEPCO and WTU UWUA....................Utility Workers Union of America Vale ...................Empresa De Electricidade Vale Paranapanema S/A, a Brazilian Electric Distribution Company WTU ....................West Texas Utilities Company, Abilene, Texas Yorkshire ..............Yorkshire Electricity Group plc, a regional electricity company in the United Kingdom 4 FORWARD-LOOKING INFORMATION This report made by CSW and certain of its subsidiaries contains forward-looking statements within the meaning of Section 21E of the Exchange Act. Although CSW and each of its subsidiaries believe that their expectations are based on reasonable assumptions, any such statements may be influenced by factors that could cause actual outcomes and results to be materially different from those projected. Important factors that could cause actual results to differ materially from those in the forward-looking statements include, but are not limited to: - - the impact of general economic changes in the United States and in countries in which CSW either currently has made or in the future may make investments, - - the impact of the proposed AEP Merger including any regulatory conditions imposed on the merger, the inability to consummate the AEP Merger, or other merger and acquisition activity, - - increased competition and the restructuring of the electric utility industry in the United States, - - federal and state regulatory developments and changes in law which may have a substantial adverse impact on the value of CSW System generating and other assets, - - timing and adequacy of rate relief, - - adverse changes in electric load and customer growth, - - climatic changes or unexpected changes in weather patterns, - - changing fuel prices, generating plant and distribution facility performance, - - decommissioning costs associated with nuclear generating facilities, - - costs associated with any year 2000 computer related failure(s) either within the CSW System or supplier failures that adversely affect the CSW System, - - uncertainties in foreign operations and foreign laws affecting CSW's investments in those countries, - - the effects of retail competition in the natural gas and electricity distribution and supply businesses in the United Kingdom, - - the timing and success of efforts to develop domestic and international power projects, and - - risks associated with hedging and other risk management techniques. In the non-utility area, the previously mentioned factors apply and also include, but are not limited to: - - the ability to compete effectively in new areas, including telecommunications, power marketing and brokering, and other energy related services, and - - evolving federal and state regulatory legislation and policies that may adversely affect those industries generally or the CSW System's business in areas in which it operates. 5 CSW CENTRAL AND SOUTH WEST CORPORATION PART I. - FINANCIAL INFORMATION. ITEM 1. FINANCIAL STATEMENTS. 6 CSW Consolidated Statements of Income (unaudited) Central and South West Corporation - -------------------------------------------------------------------------------- Three Months Ended Nine Months Ended September 30, September 30, ---------------- ---------------- 1999 1998 1999 1998 ------- ------- ------ ------- (millions, except per share amounts) Operating Revenues U.S. Electric $1,170 $1,172 $2,758 $2,746 United Kingdom 354 352 1,192 1,288 Other diversified 94 57 212 148 ------- ------- ------ ------- 1,618 1,581 4,162 4,182 Operating Expenses and Taxes U.S. Electric fuel 386 388 908 939 U.S. Electric purchased power 54 39 119 86 United Kingdom cost of sales 211 224 747 879 Other operating 299 232 816 705 Maintenance 42 41 144 114 Depreciation and amortization 159 126 424 375 Taxes, other than income 39 44 152 145 Income taxes 93 143 162 218 ------- ------- ------ ------- 1,283 1,237 3,472 3,461 ------- ------- ------ ------- Operating Income 335 344 690 721 ------- ------- ------ ------- Other Income and (Deductions) Other 9 5 33 33 Non-operating income taxes (2) 3 (9) 2 ------- ------- ------ ------- 7 8 24 35 ------- ------- ------ ------- Income Before Interest and Other Charges 342 352 714 756 ------- ------- ------ ------- Interest and Other Charges Interest on long-term debt 74 78 227 238 Interest on short-term debt and other 29 33 83 92 Distributions on Trust Preferred Securities 7 7 20 20 Preferred dividend requirements of subsidiaries 2 1 6 6 (Gain)/loss on reacquired preferred stock -- -- -- 1 ------- ------- ------ ------- 112 119 336 357 Income Before Extraordinary Item 230 233 378 399 Extraordinary loss (net of tax of $5) (8) -- (8) -- ------- ------- ------ ------- Net Income for Common Stock $ 222 $ 233 $ 370 $ 399 ======= ======= ====== ======= Average Common Shares Outstanding 212.6 212.5 212.6 212.3 Basic & Diluted Earnings per Share before Extraordinary Item 1.08 1.10 1.78 1.88 Basic & Diluted Earnings per Share from Extraordinary Item (0.04) 0.00 (0.04) 0.00 ------- ------- ------ ------- Basic and Diluted Earnings per Share $ 1.04 $ 1.10 $ 1.74 $ 1.88 ======= ======= ====== ======= Dividends Paid per Share of Common Stock $0.435 $0.435 $1.305 $1.305 ======= ======= ====== ======= The accompanying notes to consolidated financial statements are an integral part of these statements. 7 CSW Consolidated Statements of Stockholders' Equity Central and South West Corporation (millions)
Accumulated Additional Other Common Paid-in Retained Comprehensive Stock Capital Earnings Income (Loss) Total ------------------------------------------- ------ (audited) Beginning Balance -- January 1, 1998 $743 $1,039 $1,751 $23 $3,556 Sale of common stock 1 10 -- -- 11 Common stock dividends -- -- (370) -- (370) Other -- -- 2 -- 2 ------- 3,199 Comprehensive Income: Foreign currency translation adjustment (net of tax of $2) -- -- -- 7 7 Unrealized loss on securities (net of tax of $8) -- -- -- (14) (14) Adjustment for gain included in net income(net of tax of $4) -- -- -- (7) (7) Minimum pension liability (net of tax of $0.6) -- -- -- (1) (1) Net Income -- -- 440 -- 440 ------- Total comprehensive income 425 Ending Balance -- December 31, 1998 $744 $1,049 $1,823 $8 $3,624 =========================================== ====== (unaudited) Beginning Balance -- January 1, 1999 $744 $1,049 $1,823 $8 $3,624 Sale of common stock -- 2 -- -- 2 Common stock dividends -- -- (277) -- (277) Other -- -- (1) -- (1) ------ 3,348 Comprehensive Income: Foreign currency translation adjustment (net of tax of $27) -- -- -- (50) (50) Unrealized gain on securities (net of tax of $5) -- -- -- 9 9 Net Income -- -- 370 -- 370 ------ Total comprehensive income 329 ------------------------------------------- ------ Ending Balance -- September 30, 1999 $744 $1,051 $1,915 ($33) $3,677 =========================================== ======
The accompanying notes to consolidated financial statements are an integral part of these statements. 8 CSW Consolidated Balance Sheets Central and South West Corporation September 30 December 31, 1999 1998 (unaudited) (audited) ------------ ------------ (millions) ASSETS Fixed Assets Electric Production $ 5,883 $ 5,887 Transmission 1,636 1,594 Distribution 4,843 4,681 General 1,418 1,380 Construction work in progress 214 166 Nuclear fuel 219 207 ------------ ------------ 14,213 13,915 Other diversified 452 333 ------------ ------------ 14,665 14,248 Less - Accumulated depreciation and amortization 5,941 5,652 ------------ ------------ 8,724 8,596 ------------ ------------ Current Assets Cash and temporary cash investments 160 157 Accounts receivable 1,462 1,110 Materials and supplies, at average cost 145 191 Electric utility fuel inventory 112 90 Under-recovered fuel costs 45 4 Notes receivable 119 109 Prepayments and other 126 90 ------------ ------------ 2,169 1,751 ------------ ------------ Deferred Charges and Other Assets Regulatory assets 1,251 1,266 Other non-utility investments 406 432 Securities available for sale 62 66 Goodwill 1,362 1,402 Other 457 384 ------------ ------------ 3,538 3,550 ------------ ------------ $14,431 $13,897 ============ ============ The accompanying notes to consolidated financial statements are an integral part of these statements. 9 CSW Consolidated Balance Sheets Central and South West Corporation
September 30, December 31, 1999 1998 (unaudited) (audited) ------------ ------------ CAPITALIZATION AND LIABILITIES (millions) Capitalization Common stock: $3.50 par value Authorized shares: 350.0 million Issued and outstanding shares: 212.6 million $ 744 $ 744 Paid-in capital 1,051 1,049 Retained earnings 1,915 1,823 Accumulated other comprehensive income/(loss) (33) 8 ------------ ------------ Total Common Stock Equity 3,677 46% 3,624 45% ------------ --- ------------ --- Preferred stock 176 2% 176 2% ------------ --- ------------ --- Certain Subsidiary-obligated, mandatorily redeemable preferred securities of subsidiary trusts holding solely Junior Subordinated Debentures of such Subsidiaries 335 4% 335 4% Long-term debt 3,804 48% 3,938 49% ------------ --- ------------ --- Total Capitalization 7,992 100% 8,073 100% ------------ --- ------------ --- Current Liabilities Long-term debt and preferred stock due within twelve months 223 169 Short-term debt 1,064 811 Short-term debt - CSW Credit 944 749 Loan notes 30 32 Accounts payable 501 624 Accrued taxes 280 190 Accrued interest 107 84 Customer deposits 78 80 Other 200 138 ------------ ------------ 3,427 2,877 ------------ ------------ Deferred Credits Accumulated deferred income taxes 2,406 2,410 Investment tax credits 257 267 Other 349 270 ------------ ------------ 3,012 2,947 ------------ ------------ $ 14,431 $ 13,897 ============ ============
The accompanying notes to consolidated financial statements are an integral part of these statements. 10 CSW Consolidated Statements of Cash Flows (unaudited) Central and South West Corporation - -------------------------------------------------------------------------------- Nine Months Ended September 30, ---------------- 1999 1998 ------- ------- OPERATING ACTIVITIES (millions) Net Income for Common Stock $ 370 $ 399 Non-cash Items and Adjustments Depreciation and amortization 444 436 Deferred income taxes and investment tax credits (17) (19) Preferred stock dividends included in Net Income for Common Stock 6 6 Loss on reacquired preferred stock -- 1 Extraordinary loss related to SFAS No. 71 8 -- Changes in Assets and Liabilities Accounts receivable (352) (486) Accounts payable (17) 62 Accrued taxes 97 211 Fuel inventory (22) (19) Fuel recovery (66) 73 Other 1 (40) ------- ------- 452 624 ------- ------- INVESTING ACTIVITIES Construction expenditures (439) (339) CSW Energy/CSW International projects (103) (143) Other (23) 1 ------- ------- (565) (481) ------- ------- FINANCING ACTIVITIES Common stock sold 2 8 Long-term debt sold 33 5 Reacquisition/retirement of long-term debt (202) (181) Reacquisition of preferred stock -- (28) Change in short-term debt 448 365 Payment of dividends (283) (279) Other 120 73 ------- ------- 118 (37) ------- ------- Effect of exchange rate changes on cash and cash equivalents (2) 2 Net Change in Cash and Cash Equivalents 3 108 Cash and Cash Equivalents at Beginning of Period 157 75 ------- ------- Cash and Cash Equivalents at End of Period $ 160 $ 183 ======= ======= SUPPLEMENTARY INFORMATION Interest paid less amounts capitalized $ 289 $ 249 ======= ======= Income taxes paid $ 105 $ 49 ======= ======= The accompanying notes to consolidated financial statements are an integral part of these statements. 11 CENTRAL AND SOUTH WEST CORPORATION AND SUBSIDIARY COMPANIES RESULTS OF OPERATIONS Set forth below is information concerning the consolidated results of operations of CSW for the three and nine month periods ended September 30, 1999 and September 30, 1998. For information concerning the results of operations for each of the U.S. Electric Operating Companies, see the discussion under the heading RESULTS OF OPERATIONS following the financial statements of each of the U.S. Electric Operating Companies. COMPARISON OF THE QUARTERS ENDED SEPTEMBER 30, 1999 AND 1998 CSW's net income for common stock decreased $11 million to $222 million in the third quarter of 1999 compared to $233 million in 1998. Earnings decreased due primarily to increased other operating expenses and higher depreciation and amortization. Partially offsetting these increased expenses were increased operating revenues from CSW Energy and lower income tax expense. See NOTE 2. LITIGATION AND REGULATORY PROCEEDINGS Electric Utility Restructuring Legislation for information affecting earnings due to restructuring legislation in Texas and Arkansas. Various factors affecting third quarter earnings are discussed below. In the third quarter of 1999, the U.S. Electric Operating Companies and U.K. Electric contributed the following percentages to CSW's results of operations. Corporate U.S. U.K. Total Items and Electric Electric Electric Other Total -------------------------------------------------- Operating Revenues 72% 22% 94% 6% 100% Operating Income 84% 13% 97% 3% 100% Income before Extraordinary Item 95% 9% 104% (4)% 100% Operating revenues increased $37 million or 2% in the third quarter of 1999 compared to the same period a year ago due primarily to an increase in other diversified revenue resulting from the Frontera plant beginning commercial operations. Although operating revenues from U.S. Electric operations for the third quarter of 1999 were virtually flat when compared to the third quarter of 1998, there were large changes in the components of operating revenue. Fuel related revenues increased $11 million due to higher combined fuel expense as discussed in the following paragraph and increased sales to wholesale customers. Non-fuel related revenues decreased $14 million. Although non-fuel revenues from wholesale customers increased $21 million due to increased demand, non-fuel revenue from retail customers decreased $17 million due to milder weather in the third quarter of 1999. Also contributing to the decrease, revenue from electric service rendered and not yet billed decreased $12 million, and other non-MWH revenue decreased $10 million due primarily to the charge to revenues to reflect the excess earnings provision under the Texas Legislation. See NOTE 2. LITIGATION AND REGULATORY PROCEEDINGS - Electric Utility Restructuring Legislation. Partially offsetting these decreases to non-fuel revenue, transmission related revenues increased $4 million primarily from changes to CSW's transmission coordination agreement. See NOTE 2. LITIGATION AND REGULATORY PROCEEDINGS - Transmission Coordination Agreement. U.S. Electric fuel expense decreased $2 million or 1% during the third quarter of 1999 compared to the same period a year ago due primarily to a decrease of $30 million in the recovery of deferred fuel costs resulting from a significant difference in fuel factors used to recover fuel expense from customers at PSO. The decrease was almost entirely offset by an increase in the 12 average unit fuel cost to $1.93 per MMbtu from $1.70 per MMbtu. The increase was due to higher spot market natural gas prices. Purchased power expense increased $15 million or 38% for the comparison periods due primarily to higher economy energy purchases and the unscheduled outage of a coal-fired generating power plant. United Kingdom cost of sales decreased $13 million or 6% in the third quarter of 1999 compared to the same period a year ago due primarily to fluctuation in exchange rates. Other operating expense increased $67 million or 29% in the third quarter of 1999 compared to the same period a year ago. Other operating expenses increased $28 million at SEEBOARD primarily as a result of additional operating costs related to SEEBOARD's Powerlink joint venture to operate and maintain the electricity assets for the London Underground Rail System as well as increased expenses associated with operating in the competitive electricity market in the United Kingdom. CSW Energy's operating expenses also increased $27 million as a result of increased business activity at several of its plants. Also contributing to the increase in other operating expense were increased transmission expenses at the U.S. Electric operating companies related to the 1999 transmission coordination agreement adjustments. See NOTE 2. LITIGATION AND REGULATORY PROCEEDINGS - Transmission Coordination Agreement. Depreciation and amortization expense increased $33 million or 26% in the third quarter of 1999 compared to the same period a year ago due primarily to the recording of accelerated capital recovery under the excess earnings provisions of the Texas Legislation. See NOTE 2. LITIGATION AND REGULATORY PROCEEDINGS - Electric Utility Restructuring Legislation. Taxes, other than income decreased $5 million or 11% in the third quarter of 1999 due to decreased ad valorem tax expense partially offset by higher state franchise taxes. Income taxes decreased $50 million or 35% in the third quarter of 1999 compared to the same period a year ago due to lower taxable income, the reclassification of income tax related regulatory assets amortization to depreciation and amortization expense consistent with the Texas Legislation at CPL, and prior year adjustments to prior year income taxes. See NOTE 2. LITIGATION AND REGULATORY PROCEEDINGS - Electric Utility Restructuring Legislation. Interest and other charges decreased $7 million or 6% in the third quarter of 1999 compared to the same period a year ago due primarily to the maturity and reacquisition of long-term debt during 1998 and 1999 which was partially offset by higher interest charges related to an increase in short-term borrowings. The extraordinary loss resulted from legislation passed in Texas and Arkansas under which the electricity generation portion of CPL's, SWEPCO's and WTU's business in those states to no longer meet the criteria to apply SFAS No. 71. These changes resulted in an extraordinary loss, which had a cumulative effect of decreasing net income by $8.0 million. See NOTE 2. LITIGATION AND REGULATORY PROCEEDINGS - Electric Utility Restructuring Legislation. COMPARISON OF THE NINE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998 Net income for common stock decreased $29 million to $370 million in the first nine months of 1999 from $399 million for the same period in 1998 due primarily to increased operations and maintenance expenses and higher depreciation and amortization. The decrease in earnings was offset in part by higher non-fuel revenue for U.S. Electric operations due primarily to increased off-system sales and customer usage and growth, which were partially offset by milder weather. Various factors affecting earnings are discussed below. 13 In the first nine months of 1999, the U.S. Electric Operating Companies and U.K. Electric contributed the following percentages to CSW's results of operations. Corporate U.S. U.K. Total Items and Electric Electric Electric Other Total ------------------------------------------------- Operating Revenues 66% 29% 95% 5% 100% Operating Income 79% 19% 98% 2% 100% Income before Extraordinary Item 91% 18% 109% (9)% 100% Operating revenues decreased $20 million in the first nine months of 1999 compared to the same period in 1998 due to lower revenues from United Kingdom operations. U.K. Electric revenues decreased $96 million in the first nine months of 1999 compared to the same period a year ago due primarily to lower sales volumes in the business market and the loss of domestic customers following the opening of the electricity market to competition. Also contributing to the decrease in U.K. Electric revenues were the absence of revenues in 1999 from SEEBOARD's retail business, which was sold in June 1998, and unfavorable British pound to U.S. dollar exchange rate movements, partially offset by revenues from SEEBOARD's new Powerlink joint venture. Partially offsetting the decrease in operating revenues was an increase in other diversified revenues of $64 million for the comparison periods due primarily to increased business activity at CSW Energy. Also partially offsetting the decline in operating revenues was higher U.S. Electric fuel revenues due to higher combined fuel expense as discussed in the following paragraph and increased sales to wholesale customers. Further offsetting the decrease in operating revenues was higher non-fuel revenues of $4 million at the U.S. Electric Operating Companies due primarily to increased customer usage and growth and increased off-system sales. U.S. Electric fuel expense decreased $31 million or 3% during the first nine months of 1999 compared to the same period a year ago due primarily to a $41 million decrease in the recovery of deferred fuel costs that resulted from a significant difference in fuel factors used to recover fuel expense from customers at PSO. The decrease in fuel expense was offset in part by an increase in the average unit fuel cost to $1.78 per MMbtu in 1999 from $1.71 per MMbtu in 1998. The increase resulted primarily from higher natural gas and coal prices. Purchased power expenses increased $33 million or 38% for the comparison periods primarily at CPL and WTU. Purchased power expense increased at CPL due primarily to the refueling and 10-year inspection of STP Unit 1 as well as increased short-term economy energy purchases. Purchased power expense increased at WTU due primarily to an unscheduled outage at a coal-fired generating plant. United Kingdom cost of sales decreased $132 million or 15% in the first nine months of 1999 compared to the same period a year ago. The decrease was due primarily to a lower level of sales of electricity, the absence in 1999 of cost of sales for SEEBOARD's retail business and a lower British pound to U.S. dollar exchange rate compared to 1998. Other operating expense increased $111 million or 16% in the first nine months of 1999 compared to the same period a year ago due primarily to increased expenses of $51 million at SEEBOARD. Expenses increased at SEEBOARD as a result of additional operating costs related to SEEBOARD's Powerlink joint venture to operate and maintain the electricity assets for the London Underground Rail System as well as increased expenses associated with operating in the competitive electricity market in the United Kingdom. CSW Energy's operating expenses also increased $30 million as a result of increased business activity at several of its plants. Also contributing to the increase in other operating expense were increased transmission expenses at the U.S. Electric operating companies related to the 1999 transmission coordination agreement adjustments. See NOTE 2. LITIGATION AND REGULATORY PROCEEDINGS - Transmission Coordination Agreement. Maintenance expense increased $30 million or 26% due primarily to increased expenses associated with the 10-year inspection of STP Unit 1, as well as scheduled maintenance at other CSW System power plants. 14 Depreciation and amortization expense increased $49 million or 13% in the first nine months of 1999 compared to the same period a year ago due to the recording of accelerated capital cost recovery under the excess earnings provisions of the Texas Legislation and to higher levels of depreciable plant. See NOTE 2. LITIGATION AND REGULATORY PROCEEDINGS - Electric Utility Restructuring Legislation. Taxes, other than income increased $7 million or 5% in the first nine months of 1999 compared to the same period a year ago due primarily to higher Texas state franchise taxes. Operating income taxes decreased $56 million or 26% due primarily to lower taxable income, the reclassification of income tax related regulatory assets amortization to depreciation and amortization expense consistent with the Texas Legislation at CPL, and prior year adjustments to prior year income taxes. See NOTE 2. LITIGATION AND REGULATORY PROCEEDINGS - Electric Utility Restructuring Legislation. Interest and other charges decreased $21 million or 6% in the first nine months of 1999 compared to the same period a year ago. This resulted primarily from lower interest expense on long-term debt in the amount of $11 million related to the maturity and reacquisition of long-term debt. Also contributing to the decrease in Interest and other charges was lower Interest on short-term debt and other of $9 million due primarily to the absence in 1999 of the interest expense related to the CPL 1998 bonded rate refund and lower interest rates on short-term financing. The extraordinary loss resulted from legislation passed in Texas and Arkansas under which the electricity generation portion of CPL's, SWEPCO's and WTU's business in those states to no longer meet the criteria to apply SFAS No. 71. These changes resulted in an extraordinary loss, which had a cumulative effect of decreasing net income by $8.0 million. See NOTE 2. LITIGATION AND REGULATORY PROCEEDINGS - Electric Utility Restructuring Legislation. 15 CPL CENTRAL POWER AND LIGHT COMPANY PART I. - FINANCIAL INFORMATION. ITEM 1. FINANCIAL STATEMENTS. 16 CPL Consolidated Statement of Income (unaudited) Central Power and Light Company Three Months Ended Nine Months Ended September 30, September 30, ------------------ ------------------ 1999 1998 1999 1998 -------- -------- --------- --------- (thousands) Electric Operating Revenues $495,653 $454,403 $1,161,714 $1,092,506 -------- -------- --------- --------- Operating Expenses and Taxes Fuel 138,020 121,129 312,333 302,406 Purchased power 24,229 12,198 53,624 28,733 Other operating 68,947 55,276 196,471 178,030 Maintenance 13,615 15,361 48,797 42,886 Depreciation and amortization 68,160 42,903 154,531 126,892 Taxes, other than income 14,899 14,664 61,194 55,719 Income taxes 40,062 64,369 80,382 104,541 -------- -------- --------- --------- 367,932 325,900 907,332 839,207 -------- -------- --------- --------- Operating Income 127,721 128,503 254,382 253,299 -------- -------- --------- --------- Other Income and (Deductions) Allowance for equity funds used during construction (1) 59 (1) 51 Other (539) (3,141) (1,919) (592) Non-operating income taxes 2,620 1,964 6,147 3,055 -------- -------- --------- --------- 2,080 (1,118) 4,227 2,514 -------- -------- --------- --------- Income Before Interest Charges 129,801 127,385 258,609 255,813 -------- -------- --------- --------- Interest Charges Interest on long-term debt 21,006 23,331 65,433 70,397 Distributions on Trust Preferred Securities 3,000 3,000 9,000 9,000 Interest on short-term debt and other 2,430 1,200 13,494 16,025 Allowance for borrowed funds used during construction (846) (607) (2,464) (1,948) -------- -------- --------- --------- 25,590 26,924 85,463 93,474 -------- -------- --------- --------- Net Income 104,211 100,461 173,146 162,339 Less: Preferred stock dividends 1,979 1,320 5,527 4,929 -------- -------- --------- --------- Net Income for Common Stock $102,232 $99,141 $167,619 $157,410 ======== ======== ========= ========= The accompanying notes to consolidated financial statements as they relate to CPL are an integral part of these statements. 17 CPL Consolidated Balance Sheets Central Power and Light Company September 30, December 31, 1999 1998 (unaudited) (audited) ------------- ------------- (thousands) ASSETS Electric Utility Plant Production $3,150,632 $ 3,146,269 Transmission 547,040 527,146 Distribution 1,133,759 1,090,175 General 298,247 298,352 Construction work in progress 100,626 67,300 Nuclear fuel 218,571 206,949 ------------- ------------- 5,448,875 5,336,191 ------------- ------------- Less - Accumulated depreciation 2,230,908 2,072,686 ------------- ------------- 3,217,967 3,263,505 ------------- ------------- Current Assets Cash and temporary investments 12,460 5,195 Accounts receivable from affiliates 13,678 5,276 Accounts receivable 46,941 45,780 Materials and supplies, at average cost 57,937 59,814 Fuel inventory, at LIFO cost 23,383 20,340 Under-recovered fuel cost 22,676 -- Accumulated deferred income taxes -- 713 Prepayments and other 10,269 2,952 ------------- ------------- 187,344 140,070 ------------- ------------- Deferred Charges and Other Assets Regulatory assets 1,184,066 1,099,631 Nuclear decommissioning trust 76,948 65,972 Other 107,331 167,011 ------------- ------------- 1,368,345 1,332,614 ------------- ------------- $4,773,656 $ 4,736,189 ============= ============= The accompanying notes to consolidated financial statements as they relate to CPL are an integral part of these statements. 18 CPL Consolidated Balance Sheets Central Power and Light Company
September 30, December 31, 1999 1998 (unaudited) (audited) ------------ ------------ CAPITALIZATION AND LIABILITIES (thousands) Capitalization Common stock: $25 par value Authorized: 12,000,000 shares Issued and outstanding: 6,755,535 shares $168,888 $ 168,888 Paid-in capital 405,000 405,000 Retained earnings 795,651 739,031 ------------ ------------ Total Common Stock Equity 1,369,539 49% 1,312,919 46% ------------ ---- ------------ ---- Preferred stock 163,203 6% 163,204 6% CPL-obligated, mandatorily redeemable preferred securities of subsidiary trust holding solely Junior Subordinated Debentures of CPL 150,000 5% 150,000 5% Long-term debt 1,101,136 40% 1,225,706 43% ------------ ---- ------------ ---- Total Capitalization 2,783,878 100% 2,851,829 100% ------------ ---- ------------ ---- Current Liabilities Long-term debt due within twelve months 125,000 125,000 Advances from affiliates 251,692 160,298 Payables to affiliates 19,027 38,331 Accounts payable 98,555 86,998 Customer deposits 11,621 9,272 Accrued interest 27,255 27,036 Accrued taxes 74,789 46,855 Accumulated deferred income taxes 3,973 -- Over-recovered fuel costs -- 9,135 Other 11,721 9,547 ------------ ------------ 623,633 512,472 ------------ ------------ Deferred Credits Accumulated deferred income taxes 1,220,732 1,221,561 Investment tax credits 134,608 138,513 Other 10,805 11,814 ------------ ------------ 1,366,145 1,371,888 ------------ ------------ $ 4,773,656 $ 4,736,189 ============ ============
The accompanying notes to consolidated financial statements as they relate t CPL are an integral part of these statements. 19 CPL Consolidated Statements of Cash Flows (unaudited) Central Power and Light Company Nine Months Ended September 30, ------------------------ 1999 1998 --------- --------- (thousands) OPERATING ACTIVITIES Net Income $173,146 $162,339 Non-cash Items Included in Net Income Depreciation and amortization 169,023 181,237 Deferred income taxes and investment tax credits (6,142) (3,886) Refund due customers -- (63,713) Changes in Assets and Liabilities Accounts receivable (9,563) (40,844) Fuel inventory (3,043) (4,279) Material and supplies 1,877 6,822 Accounts payable (8,041) 10 Accrued taxes 27,935 85,068 Fuel recovery (31,811) 49,413 Other (23,337) (29,735) --------- --------- 290,044 342,432 --------- --------- INVESTING ACTIVITIES Construction expenditures (138,506) (84,348) Other 5,810 (6,400) --------- --------- (132,696) (90,748) --------- --------- FINANCING ACTIVITIES Payment of dividends (116,476) (172,684) Retirement of long-term debt (125,000) (64,000) Redemption of preferred stock (1) -- Change in advances from affiliates 91,394 (15,000) --------- --------- (150,083) (251,684) --------- --------- Net Change in Cash and Cash Equivalents 7,265 -- Cash and Cash Equivalents at Beginning of Year 5,195 -- --------- --------- Cash and Cash Equivalents at End of Period $ 12,460 $ -- ========= ========= SUPPLEMENTARY INFORMATION Interest paid less amounts capitalized (includes distributions on Trust Preferred Securities) $ 75,012 $ 88,021 ========= ========= Income taxes paid $ 50,798 $ 19,364 ========= ========= The accompanying notes to consolidated financial statements as they relate to CPL are an integral part of these statements. 20 CENTRAL POWER AND LIGHT COMPANY RESULTS OF OPERATIONS COMPARISON OF THE QUARTERS ENDED SEPTEMBER 30, 1999 AND 1998 CPL's net income for common stock for the third quarter of 1999 was $102.2 million, which was $3.1 million higher than the comparable period in 1998. The increase was primarily the result of higher non-fuel related revenues and lower tax expenses which were partially offset by an increase in other operating expenses and higher depreciation and amortization expenses. Electric operating revenues for the third quarter of 1999 were $495.7 million, which was $41.3 million or 9% higher than the comparable period in 1998. The increase was attributable to higher fuel-related revenue of $30.4 million due to higher combined fuel expense and purchased power expense as discussed in the following paragraph. The $10.9 million increase in non-fuel related revenue was primarily the result of changes to CSW's transmission coordination agreement of $21.0 million which were offset in part by a decrease in revenue from electric services rendered and not yet billed as well as a decrease in retail MWH sales attributable to milder weather in 1999. See NOTE 2. LITIGATION AND REGULATORY PROCEEDINGS - Transmission Coordination Agreement. Fuel expense during the third quarter of 1999 was $138.0 million, which was $16.9 million or 14% higher than the comparable period in 1998. The average unit fuel cost for the quarter increased from $1.60 per MMbtu in 1998 to $1.94 per MMbtu in 1999, which was the result of higher spot market natural gas and coal prices. Purchased power expense during the third quarter of 1999 was $24.2 million, which was $12.0 million or 99% higher than the comparable period in 1998. The increase was due primarily to an increase in short-term economy energy purchases. Other operating expenses for the third quarter of 1999 were $68.9 million, which was $13.7 million or 25% higher than the same period in 1998. The increase was due primarily to higher outside service expenses, as well as higher transmission expenses. The increase in transmission expense was due to the absence in 1999 of a transmission service agreement adjustment made in 1998 related to the final order in Texas Commission Docket No. 17285. See NOTE 2. LITIGATION AND REGULATORY PROCEEDINGS - CPL and WTU Complaint Versus Texas Utilities Electric Company (Docket No. 17285). Depreciation and amortization expenses increased $25.3 million or 59% for the third quarter of 1999 due primarily to the recording of accelerated capital recovery under the provisions of the Texas Legislation. See NOTE 2. LITIGATION AND REGULATORY PROCEEDINGS Electric Utility Restructuring Legislation. Income tax expense associated with utility operations were $40.1 million, which was $24.3 million lower than the third quarter of 1998 as a result of lower taxable income for the third quarter of 1999, the reclassification of income tax related regulatory assets amortization to depreciation and amortization expense consistent with the Texas Legislation, and prior year adjustments to prior year income taxes. See NOTE 2. LITIGATION AND REGULATORY PROCEEDINGS - Electric Utility Restructuring Legislation. Interest charges during the third quarter of 1999 were $25.6 million, which was $1.3 million or 5% lower than the comparable period in 1998. The 21 decrease was due primarily to the maturity and reacquisition of long-term debt during 1998 and 1999 which was partially offset by higher interest charges related to an increase in short-term borrowings. COMPARISON OF THE NINE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998 CPL's net income for common stock for the nine months ended September 30, 1999 was $167.6 million, which was $10.2 million or 6% higher than the comparable period in 1998. The increase resulted from higher non-fuel related revenues and lower tax expenses partially offset by an increase in other operating expenses, maintenance expenses, as well as higher depreciation and amortization expenses. Electric operating revenues for the nine months ended September 30, 1999 were $1,161.7 million, which was $69.2 million or 6% higher than the comparable period in 1998. The increase was attributable to higher fuel-related revenue of $36.4 million due to higher combined fuel expense and purchased power expense as discussed in the following paragraph. The $32.8 million increase in non-fuel related revenue was primarily the result of changes to CSW's transmission coordination agreement of $21.0 million offset in part by revenue from electric services rendered and not yet billed. See NOTE 2. LITIGATION AND REGULATORY PROCEEDINGS - Transmission Coordination Agreement. Additionally, non-fuel related revenues increased $14.5 million due primarily to a 3% increase in retail MWH sales for higher customer demand. Fuel expense for the nine months ended September 30, 1999 was $312.3 million, which was $9.9 million or 3% higher than the comparable period in 1998. The average unit fuel cost for the nine months increased from $1.61 per MMbtu in 1998 to $1.69 per MMbtu in 1999 which was the result of higher spot market natural gas and coal prices. Purchased power expense for the nine months ended September 30, 1999 was $53.6 million, which was $24.9 million or 87% higher than the comparable period in 1998. The increase resulted primarily from a combination of several scheduled power plant outages for routine maintenance, including STP Unit 1 for refueling and 10-year inspection, and short-term economy energy purchases. Other operating expense for the nine months ended September 30, 1999 was $196.5 million, which was $18.4 million or 10% higher than the comparable period in 1998. The increase was due primarily to higher outside service expense, as well as, higher transmission expenses. The increase in transmission expenses was due to the absence in 1999 of a transmission service agreement adjustment made in 1998 related to the final order in Texas Commission Docket No. 17285. See NOTE 2. LITIGATION AND REGULATORY PROCEEDINGS - CPL AND WTU Complaint versus Texas Utilities Electric Company (Docket No. 17285). Maintenance expense for the nine months ended September 30, 1999 was $48.8 million, which was $5.9 million or 14% higher than the comparable period in 1998. This was largely due to scheduled power plant repairs and maintenance, including the refueling and 10-year inspection of STP Unit 1. Depreciation and amortization expenses increased $27.6 million or 22% for the nine months ended September 30, 1999 due primarily to the recording of accelerated capital recovery under the excess earnings provisions of Texas Legislation. See NOTE 2. LITIGATION AND REGULATORY PROCEEDINGS - Electric Utility Restructuring Legislation. Taxes, other than income for the nine months ended September 30, 1999 were $61.2 million, which was $5.5 million or 10% higher than the comparable period of 1998. The increase was primarily attributable to higher state franchise taxes. 22 Income tax expense associated with utility operations was $80.4 million, which was $24.2 million or 23% lower than the comparable period of 1998 as a result of lower taxable income for 1999, the reclassification of income tax related regulatory assets amortization to depreciation and amortization expense consistent with the Texas Legislation, and prior year adjustments to prior year income taxes. See NOTE 2. LITIGATION AND REGULATORY PROCEEDINGS - Electric Utility Restructuring Legislation. Interest charges for the nine months ended September 30, 1999 were $85.5 million, which was $8.0 million or 9% lower than the comparable period of 1998. The decrease was due primarily to the reacquisition and maturity of long-term debt during 1998 and 1999. In addition, interest charges in 1998 were higher related to the one time 1998 bonded rate refund which were partially offset by higher interest charges related to an increase in short-term borrowings in 1999. 23 PSO PUBLIC SERVICE COMPANY OF OKLAHOMA PART I. - FINANCIAL INFORMATION. ITEM 1. FINANCIAL STATEMENTS. 24 PSO Consolidated Statements of Income (unaudited) Public Service Company of Oklahoma Three Months Ended Nine Months Ended September 30, September 30, ------------------- ------------------- 1999 1998 1999 1998 -------- -------- -------- -------- (thousands) Electric Operating Revenues $258,656 $279,833 $588,385 $623,110 -------- -------- -------- -------- Operating Expenses and Taxes Fuel 82,076 104,704 208,873 242,891 Purchased power 20,278 17,594 50,450 44,891 Other operating 35,533 20,102 88,083 75,478 Maintenance 8,768 8,014 30,695 23,899 Depreciation and amortization 18,558 18,202 55,557 54,358 Taxes, other than income 7,591 7,363 23,810 22,583 Income taxes 27,995 40,282 37,173 52,564 -------- -------- -------- -------- 200,799 216,261 494,641 516,664 -------- -------- -------- -------- Operating Income 57,857 63,572 93,744 106,446 -------- -------- -------- -------- Other Income and (Deductions) Allowance for equity funds used during construction 125 293 206 519 Other 157 242 (1,638) 24 Non-operating income taxes 1,148 56 2,352 430 -------- -------- -------- -------- 1,430 591 920 973 -------- -------- -------- -------- Income Before Interest Charges 59,287 64,163 94,664 107,419 -------- -------- -------- -------- Interest Charges Interest on long-term debt 6,809 7,287 20,031 22,524 Distributions on Trust Preferred Securities 1,500 1,500 4,500 4,500 Interest on short-term debt and other 1,072 736 3,749 3,200 Allowance for borrowed funds used during construction (488) (281) (1,072) (943) -------- -------- -------- -------- 8,893 9,242 27,208 29,281 -------- -------- -------- -------- Net Income 50,394 54,921 67,456 78,138 Less: Preferred stock dividends 54 54 160 160 -------- -------- -------- -------- Net Income for Common Stock $ 50,340 $ 54,867 $ 67,296 $ 77,978 ======== ======== ======== ======== The accompanying notes to consolidated financial statements as they relate to PSO are an integral part of these statements. 25 PSO Consolidated Balance Sheets Public Service Company of Oklahoma - -------------------------------------------------------------------------------- September 30, December 31, 1999 1998 (unaudited) (audited) ---------------- -------------- (thousands) ASSETS Electric Utility Plant Production $ 914,073 $ 913,083 Transmission 390,500 378,719 Distribution 877,664 855,277 General 214,645 211,124 Construction work in progress 39,295 33,519 ---------------- -------------- 2,436,177 2,391,722 Less - Accumulated depreciation 1,104,846 1,082,081 ---------------- -------------- 1,331,331 1,309,641 ---------------- -------------- Current Assets Cash 3,792 4,670 Accounts receivable 24,840 32,916 Materials and supplies, at average cost 33,426 33,006 Fuel inventory, at LIFO cost 17,631 16,441 Under-recovered fuel costs 9,555 -- Accumulated deferred income taxes 22,003 11,789 Prepayments and other 6,783 2,881 ---------------- -------------- 118,030 101,703 ---------------- -------------- Deferred Charges and Other Assets 82,117 71,384 ---------------- -------------- $ 1,531,478 $ 1,482,728 ================ ============== The accompanying notes to consolidated financial statements as they relate to PSO are an integral part of these statements. 26 PSO Consolidated Balance Sheets Public Service Company of Oklahoma - --------------------------------------------------------------------------------
September 30, December 31, 1999 1998 (unaudited) (audited) ------------ ----------- CAPITALIZATION AND LIABILITIES (thousands) Capitalization Common stock: $15 par value Authorized: 11,000,000 shares Issued 10,482,000 shares and outstanding 9,013,000 shares $157,230 $157,230 Paid-in capital 180,000 180,000 Retained earnings 166,922 144,626 ------------ ----------- Total Common Stock Equity 504,152 53% 481,856 51% ------------ --------- ----------- ----- Preferred stock 5,286 -- % 5,287 -- % PSO-obligated, mandatorily redeemable preferred securities of subsidiary trust holding solely Junior Subordinated Debentures of PSO 75,000 8% 75,000 8% Long-term debt 374,440 39% 384,064 41% ------------ --------- ----------- ----- Total Capitalization 958,878 100% 946,207 100% ------------ --------- ----------- ----- Current Liabilities Long-term debt due within twelve months 10,000 -- Advances from affiliates 20,392 15,892 Payables to affiliates 23,201 33,489 Accounts payable 46,444 52,888 Customer deposits 17,671 17,368 Accrued interest 10,184 7,606 Accrued taxes 38,858 23,095 Over-recovered fuel costs -- 15,240 Other 9,376 6,599 ------------ ----------- 176,126 172,177 ------------ ----------- Deferred Credits Accumulated deferred income taxes 304,273 277,181 Investment tax credits 38,022 39,365 Income tax related regulatory liabilities, net 31,438 35,818 Other 22,741 11,980 ------------ ----------- 396,474 364,344 ------------ ----------- $ 1,531,478 $1,482,728 ============ ===========
The accompanying notes to consolidated financial statements as they relate to PSO are an integral part of these statements. 27 PSO Consolidated Statements of Cash Flows (unaudited) Public Service Company of Oklahoma Nine Months Ended September 30, ------------------------ 1999 1998 -------- -------- (thousands) OPERATING ACTIVITIES Net Income $ 67,456 $ 78,138 Non-cash Items Included in Net Income Depreciation and amortization 56,290 56,616 Deferred income taxes and investment tax credits 11,155 7,864 Changes in Assets and Liabilities Accounts receivable (1,479) (564) Fuel inventory (1,190) (2,050) Prepayments and other (3,902) 2,339 Equity and other investments (5,802) (2,146) Accounts payable (21,869) (10,108) Payables to affiliates (10,288) (23,633) Accrued taxes 15,763 49,696 Other deferred credits 10,761 5,979 Other 245 3,822 -------- -------- 117,140 165,953 -------- -------- INVESTING ACTIVITIES Construction expenditures (73,204) (45,004) Other (3,711) (4,966) -------- -------- (76,915) (49,970) -------- -------- FINANCING ACTIVITIES Payment of dividends (45,159) (42,159) Change in advances from affiliates 4,500 (4,874) Reacquisition of long-term debt (33,700) (55,231) Issuance of long-term debt 33,257 -- Redemption of preferred stock (1) -- -------- -------- (41,103) (102,264) -------- -------- Net Change in Cash and Cash Equivalents (878) 13,719 Cash and Cash Equivalents at Beginning of Year 4,670 2,171 -------- -------- Cash and Cash Equivalents at End of Period $ 3,792 $ 15,890 ======== ======== SUPPLEMENTARY INFORMATION Interest paid less amounts capitalized (includes distributions on Trust Preferred Securities) $ 23,454 $ 26,713 ======== ======== Income taxes paid $ 16,614 $ 6,606 ======== ======== The accompanying notes to consolidated financial statements as they relate to PSO are an integral part of these statements. 28 PUBLIC SERVICE COMPANY OF OKLAHOMA RESULTS OF OPERATIONS COMPARISON OF THE QUARTERS ENDED SEPTEMBER 30, 1999 AND 1998 PSO's net income for common stock for the third quarter of 1999 was $50.3 million, which was $4.5 million or 8% lower than the comparable period in 1998. The decrease resulted primarily from lower non-fuel related revenues and higher other operating expenses which was partially offset by lower tax expenses. Electric operating revenues during the third quarter of 1999 were $258.7 million, which was $21.2 or 8% lower than the comparable period in 1998. Fuel related revenues decreased $19.0 million due to lower combined fuel expense and purchased power expense as discussed in the following paragraph. Non-fuel related revenues decreased $2.2 million due primarily to an 8% decrease in residential MWH sales attributable to milder weather in 1999. The decrease in operating revenues was partially offset by an increase in demand for non-affiliated wholesale energy. Additionally there was a $3.2 million decrease in non-MWH related revenues for electric service rendered and not yet billed, offset in part by a $3.7 million increase in transmission related revenues resulting from changes to CSW's transmission coordination agreement. See NOTE 2. LITIGATION AND REGULATORY PROCEEDINGS - Transmission Coordination Agreement. Fuel expense during the third quarter of 1999 was $82.1 million, which was $22.6 million or 22% lower than the comparable period in 1998. This decline was due primarily to a $30.4 million decrease in the recovery of deferred fuel costs resulting from a significant difference in fuel factors used to recover fuel expense from customers. The decrease in fuel expense was offset in part by higher average unit fuel costs. The average unit cost of fuel for the quarter increased from $1.82 per MMbtu in 1998 to $2.12 per MMbtu in 1999 due primarily to higher spot market natural gas prices. Purchased power expense during the third quarter of 1999 was $20.3 million, which was $2.7 million or 15% higher than the comparable period in 1998 due primarily to an increase in economy energy purchases. Other operating expense during the third quarter of 1999 was $35.5 million, which was $15.4 million or 77% higher than the comparable period in 1998. The increase was due primarily to higher transmission expenses resulting from a $5.9 million change in the CSW transmission coordination agreement, and the absence in 1999 of $6.2 million transmission service agreement adjustment related to the final order in Texas Commission Docket No. 17285. See NOTE 2. LITIGATION AND REGULATORY PROCEEDINGS - Transmission Coordination Agreement and CPL and WTU Complaint versus Texas Utilities Electric Company (Docket No. 17285). Income tax expense associated with utility operations during the third quarter of 1999 was $28.0 million, which was $12.3 million or 31% lower than the comparable period in 1998 due primarily to lower taxable income in the third quarter of 1999 and prior year adjustments to prior year income taxes. 29 COMPARISON OF THE NINE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998 PSO's net income for common stock for the nine months ended September 30, 1999 was $67.3 million, which was $10.7 million or 14% lower than the comparable period in 1998. The decrease resulted primarily from lower non-fuel related revenues and higher other operating and maintenance expenses which were offset in part by lower tax expense and interest charges. Electric operating revenues for the nine months ended September 30, 1999 were $588.4 million, which was $34.7 million or 6% lower than the comparable period in 1998. Fuel related revenues decreased $28.9 million for the nine months of 1999 compared to 1998 due to lower combined fuel expense and purchased power expense as discussed in the following paragraph. Non-fuel related revenues decreased $5.8 million due primarily to a 6% decrease in residential MWH sales attributable to milder weather in 1999. The decrease in operating revenues was partially offset by an increase in demand for non-affiliated wholesale energy. Additionally, there was a $6.6 million decrease in non-MWH related revenues for electric service rendered and not yet billed which was offset in part by a $3.1 million increase in transmission related revenues resulting from changes to CSW's transmission coordination agreement. See NOTE 2. LITIGATION AND REGULATORY PROCEEDINGS - Transmission Coordination Agreement. Fuel expense for the nine months ended September 30, 1999 was $208.9 million, which was $34.0 million or 14% lower than the comparable period in 1998. This decline resulted primarily from a $41.3 million decrease in the recovery of deferred fuel costs due to a significant difference in fuel factors used to recover fuel expense from customers. The decrease in fuel expense was offset in part by higher average unit fuel costs. The average unit cost of fuel increased from $1.80 per MMbtu in 1998 to $1.93 per MMbtu in 1999 due primarily to higher spot market natural gas prices. Purchased power expense for the nine months ended September 30, 1999 was $50.5 million, which was $5.6 million or 12% higher than the comparable period in 1998 due primarily to an increase in economy energy and firm contract purchases. Other operating expenses for the nine months ended September 30, 1999 were $88.1 million, which was $12.6 million or 17% higher than the comparable period in 1998. The increase was due primarily to higher transmission expenses resulting from a $5.9 million change in the CSW transmission coordination agreement, and the absence in 1999 of a $4.1 million transmission service agreement adjustment related to the final order in Texas Commission Docket No. 17285. See NOTE 2. LITIGATION AND REGULATORY PROCEEDINGS Transmission Coordination Agreement and CPL and WTU Complaint versus Texas Utilities Electric Company (Docket No. 17285). Maintenance expense for the nine months ended September 30, 1999 was $30.7 million, which was $6.8 million or 28% higher than the comparable period in 1998 due primarily to higher production and distribution maintenance expenses. The production maintenance expense increase related to scheduled power plant maintenance as well as the restart of a power plant generating unit and an unscheduled outage. The distribution maintenance expense increase was due primarily to an increase in tree trimming activities in 1999. Taxes, other than income for the nine months ended September 30, 1999 was $23.8 million, which was $1.2 million or 5% higher than the comparable period in 1998 as a result of higher ad valorem tax expenses. Income tax expense associated with utility operations for the nine months ended September 30, 1999 was $37.2 million, which was $15.4 million or 29% lower than the comparable period in 1998 due primarily to lower taxable income in 1999 and prior year adjustments to prior year income taxes. 30 Interest charges for the nine months ended September 30, 1999 were $27.2 million, which was $2.1 million or 7% lower than the comparable period in 1998. This decrease was due primarily to the reacquisition of $55 million of FMBs during the third quarter of 1998. 31 SWEPCO SOUTHWESTERN ELECTRIC POWER COMPANY PART I. - FINANCIAL INFORMATION. ITEM 1. FINANCIAL STATEMENTS. 32 SWEPCO Consolidated Statements of Income (unaudited) Southwestern Electric Power Company Three Months Ended Nine Months Ended September 30, September 30, --------------------- ----------------- 1999 1998 1999 1998 --------- --------- -------- -------- (thousands) Electric Operating Revenues $312,035 $311,549 $751,987 $756,044 --------- --------- -------- -------- Operating Expenses and Taxes Fuel 124,737 124,210 292,698 298,530 Purchased power 10,130 12,230 26,895 30,234 Other operating 41,623 36,168 104,694 100,490 Maintenance 15,598 12,341 49,860 35,770 Depreciation and amortization 25,464 24,675 76,988 74,303 Taxes, other than income 8,148 14,239 39,733 43,320 Income taxes 24,548 28,164 37,476 45,416 --------- --------- -------- -------- 250,248 252,027 628,344 628,063 --------- --------- -------- -------- Operating Income 61,787 59,522 123,643 127,981 --------- --------- -------- -------- Other Income and (Deductions) Allowance for equity funds used during construction (4) 219 38 925 Other (6,019) (462) (6,932) (564) Non-operating income taxes 2,961 522 4,617 1,734 --------- --------- -------- -------- (3,062) 279 (2,277) 2,095 --------- --------- -------- -------- Income Before Interest Charges 58,725 59,801 121,366 130,076 --------- --------- -------- -------- Interest Charges Interest on long-term debt 9,598 9,808 29,201 29,426 Distributions on Trust Preferred Securities 2,166 2,166 6,497 6,497 Interest on short-term debt and other 2,322 1,566 7,485 5,763 Allowance for borrowed funds used during construction (515) (369) (1,254) (1,066) --------- --------- -------- -------- 13,571 13,171 41,929 40,620 --------- --------- -------- -------- Income Before Extraordinary Item 45,154 46,630 79,437 89,456 Extraordinary loss (net of tax of $1,621) (3,011) -- (3,011) -- --------- --------- -------- -------- Net Income 42,143 46,630 76,426 89,456 Less: Preferred stock dividends 57 57 172 648 Loss on reacquired preferred stock -- -- -- (855) --------- --------- -------- -------- Net Income for Common Stock $ 42,086 $ 46,573 $ 76,254 $ 87,953 ========= ========= ======== ======== The accompanying notes to consolidated financial statements as they relate to SWEPCO are an integral part of these statements. 33 SWEPCO Consolidated Balance Sheets Southwestern Electric Power Company - -------------------------------------------------------------------------- September 30, December 31, 1999 1998 (unaudited) (audited) ------------ ---------- (thousands) ASSETS Electric Utility Plant Production $ 1,393,236 $1,397,924 Transmission 480,520 474,035 Distribution 945,639 916,293 General 329,626 321,136 Construction work in progress 55,101 48,523 ------------ ---------- 3,204,122 3,157,911 Less - Accumulated depreciation 1,368,345 1,317,057 ------------ ---------- 1,835,777 1,840,854 ------------ ---------- Current Assets Cash 3,032 4,444 Accounts receivable 56,478 33,014 Accounts receivable from affiliates 18,258 7,416 Materials and supplies, at average cost 26,211 25,135 Fuel inventory, at average cost 55,566 40,238 Accumulated deferred income taxes 2,548 4,869 Prepayments and other 18,264 16,651 ------------ ---------- 180,357 131,767 ------------ ---------- Deferred Charges and Other Assets 94,964 108,770 ------------ ---------- $ 2,111,098 $2,081,391 ============ ========== The accompanying notes to consolidated financial statements as they relate to SWEPCO are an integral part of these statements. 34 SWEPCO Consolidated Balance Sheets Southwestern Electric Power Company - --------------------------------------------------------------------------------
September 30, December 31, 1999 1998 (unaudited) (audited) ----------- ----------- CAPITALIZATION AND LIABILITIES (thousands) Capitalization Common stock: $18 par value Authorized: 7,600,000 shares Issued and outstanding: 7,536,640 shares $135,660 $ 135,660 Paid-in capital 245,000 245,000 Retained earnings 295,846 300,592 ----------- ----------- Total Common Stock Equity 676,506 53% 681,252 51% ----------- --------- ----------- ----- Preferred stock 4,706 --% 4,707 --% SWEPCO-obligated, mandatorily redeemable preferred securities of subsidiary trust holding solely Junior Subordinated Debentures of SWEPCO 110,000 9% 110,000 8% Long-term debt 496,114 38% 543,741 41% ----------- --------- ----------- ----- Total Capitalization 1,287,326 100% 1,339,700 100% ----------- --------- ----------- ----- Current Liabilities Long-term debt due within twelve months 47,807 43,932 Advances from affiliates 88,075 40,705 Payables to affiliates 40,643 37,795 Accounts payable 64,820 73,507 Customer deposits 13,860 13,316 Accrued interest 12,816 14,275 Accrued taxes 58,600 23,189 Over-recovered fuel costs 5,155 5,378 Other 14,716 12,538 ----------- ----------- 346,492 264,635 ----------- ----------- Deferred Credits Accumulated deferred income taxes 381,765 398,664 Investment tax credits 58,790 62,213 Other 36,725 16,179 ----------- ----------- 477,280 477,056 ----------- ----------- $2,111,098 $2,081,391 =========== ===========
The accompanying notes to consolidated financial statements as they relate to SWEPCO are an integral part of these statements. 35 SWEPCO Consolidated Statements of Cash Flows (unaudited) Southwestern Electric Power Company Nine Months Ended September 30, ---------------------------- 1999 1998 --------- --------- (thousands) OPERATING ACTIVITIES Net Income $ 76,426 $ 89,456 Non-cash Items Included in Net Income Depreciation and amortization 81,122 78,353 Deferred income taxes and investment tax credits (19,077) (8,237) Extraordinary loss related to SFAS No. 71 3,011 -- Changes in Assets and Liabilities Accounts receivable (34,306) (6,048) Fuel inventory (15,328) (11,501) Accounts payable (8,624) (2,403) Payables to affiliates 2,848 (9,878) Accrued taxes 35,411 44,209 Other deferred credits 20,546 6,196 Other 10,821 5,359 --------- --------- 152,850 185,506 --------- --------- INVESTING ACTIVITIES Construction expenditures (73,127) (55,690) Other (3,545) (4,456) --------- --------- (76,672) (60,146) --------- --------- FINANCING ACTIVITIES Payment of dividends (81,172) (79,126) Change in advances from affiliates 47,370 (13,258) Retirement of long-term debt (43,787) (2,209) Redemption of preferred stock (1) (27,988) --------- --------- (77,590) (122,581) --------- --------- Net Change in Cash and Cash Equivalents (1,412) 2,779 Cash and Cash Equivalents at Beginning of Year 4,444 2,298 --------- --------- Cash and Cash Equivalents at End of Period $ 3,032 $ 5,077 ========= ========= SUPPLEMENTARY INFORMATION Interest paid less amounts capitalized (includes distributions on Trust Preferred Securities) $ 40,056 $ 39,257 ========= ========= Income taxes paid $ 32,812 $ 30,849 ========= ========= The accompanying notes to consolidated financial statements as they relate to SWEPCO are an integral part of these statements. 36 SOUTHWESTERN ELECTRIC POWER COMPANY RESULTS OF OPERATIONS COMPARISON OF THE QUARTERS ENDED SEPTEMBER 30, 1999 AND 1998 SWEPCO's net income for common stock for the third quarter of 1999 was $42.1 million, which was $4.5 million or 10% lower than the comparable period in 1998. The decrease resulted primarily from increased other operating and maintenance expenses, the write-off of Cajun acquisition expense and the effect of the extraordinary loss. Electric operating revenues for the third quarter of 1999 increased $0.5 million to $312.0 million when compared to the same period of 1998. Revenues were affected by increased sales for resale to other utilities of $16.2 million as a result of increased demand. Revenues also increased due to an unfavorable $3.7 million transmission service agreement adjustment in 1998 related to the final order in Texas Commission Docket No. 17285. See NOTE 2. LITIGATION AND REGULATORY PROCEEDINGS - CPL and WTU Complaint versus Texas Utilities Electric Company (Docket No. 17285). These increases in revenues were offset in part by decreased fuel related revenues of $4.5 million, decreased non-fuel related retail revenues of $5.9 million and an unfavorable adjustment of $9.0 million adjustment related to changes to CSW's transmission coordination agreement. See NOTE 2. LITIGATION AND REGULATORY PROCEEDINGS - Transmission Coordination Agreement. The decrease in fuel related revenues was due to lower combined fuel expense and purchased power expense as discussed in the following paragraph. Non-fuel related retail revenues were affected by a 3% decrease in retail MWH sales due primarily to a decrease in weather related customer demand. Fuel and purchased power expenses had a net decrease for the third quarter of 1999 compared to the same period in 1998. Fuel expense increased slightly to $124.7 million resulting primarily from an increase in average unit fuel costs. Average unit fuel costs increased from $1.68 per MMbtu in 1998 to $1.73 per MMbtu in 1999 due to higher spot market natural gas prices. Fuel expense was affected by the absence in 1999 of a 1998 transmission service agreement adjustment related to the final order in Texas Commission Docket No. 17285. See NOTE 2. LITIGATION AND REGULATORY PROCEEDINGS - CPL and WTU Complaint versus Texas Utilities Electric Company (Docket No. 17285). Purchased power expenses for the third quarter of 1999 decreased $2.1 million or 17% compared to the same period in 1998 due primarily to a decrease in economy energy purchases. Other operating expenses for the third quarter of 1999 were $41.6 million, an increase of $5.5 million or 15% compared to the same period of 1998 as a result of increased transmission expenses. The increase in transmission expense was due to the absence in 1999 of a transmission service agreement adjustment in 1998 related to the final order in Texas Commission Docket No. 17285. See NOTE 2. LITIGATION AND REGULATORY PROCEEDINGS - CPL and WTU Complaint versus Texas Utilities Electric company (Docket No. 17285). Transmission expenses were also affected by changes related to CSW's transmission coordination agreement. See NOTE 2. LITIGATION AND REGULATORY PROCEEDINGS Transmission Coordination Agreement. Maintenance expenses increased during the third quarter of 1999 to $15.6 million, which was $3.3 million or 26% higher than the comparable period in 1998 as a result of increased tree trimming maintenance activities. 37 Taxes, other than income for the third quarter of 1999 were $8.1 million, a $6.1 million or 43% decrease compared to $14.2 million for the third quarter of 1998 due primarily to decreased ad valorem tax expense. Income tax expenses associated with utility operations during the third quarter of 1999 were $24.5 million, which was $3.6 million or 13% lower than the comparable period in 1998 due to lower taxable income and prior year adjustments to prior year income taxes. Other income and deductions decreased as a result of the after tax write-off of Cajun acquisition expense of $3.7 million. See NOTE 3. COMMITMENTS AND CONTINGENT LIABILITIES - Withdrawal of SWEPCO Cajun Asset Proposal. The extraordinary loss resulted from legislation passed in Texas and Arkansas under which the electricity generation portion of SWEPCO's business in those states no longer meets the criteria to apply SFAS No. 71. These changes resulted in an extraordinary loss, which decreased net income by $3.0 million. See NOTE 2. LITIGATION AND REGULATORY PROCEEDINGS - Electric Utility Restructuring Legislation. COMPARISON OF THE NINE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998 SWEPCO's net income for common stock for the nine months ended September 30, 1999 was $76.3 million, which was $11.7 million or 13% lower than the comparable period in 1998. This decrease resulted primarily from increased other operating and maintenance expenses, the write-off of Cajun acquisition expenses and the effect of the extraordinary loss. Electric operating revenues for the nine months ended September 30, 1999 were $752.0 million, which was $4.1 million lower than the comparable period in 1998. This decrease resulted from decreased fuel related revenues of $13.3 million due to lower combined fuel expense and purchased power expense as discussed in the following paragraph, decreased non-fuel related revenues of $7.5 million and a $9.0 million increase related to changes to CSW's transmission coordination agreement. See NOTE 2. LITIGATION AND REGULATORY PROCEEDINGS - Transmission Coordination Agreement. Non-fuel related retail revenues were affected by a 3% decrease in retail MWH sales due primarily to decreased weather-related customer demand. These reductions were partially offset by increased sales for resale to other utilities of $16.2 million as a result of increased demand and the absence in 1999 of a $3.7 million transmission service agreement adjustment in 1998 related to the final order in Texas Commission Docket No. 17285. See NOTE 2. LITIGATION AND REGULATORY PROCEEDINGS - CPL and WTU Complaint versus Texas Utilities Electric Company (Docket No. 17285). Additionally, the reductions in revenue were offset in part by the absence in 1999 of a 1998 provision for rate refund of $2.6 million primarily in connection with the annual determination of cost of service formula rates for SWEPCO's wholesale customers. Also affecting revenues is the absence in 1999 of a 1998 reduction in fuel revenues of $3.2 million in accordance with a Texas Commission order in SWEPCO's fuel reconciliation regarding transmission equalization expense recovery. Fuel and purchased power expense decreased for the nine months ended September 30, 1999 when compared to the same period in 1998. Fuel expense decreased $5.8 million or 2% due primarily to a decrease in average unit fuel costs for coal and lignite which were partially offset by increased generation. The change in average unit fuel costs resulted from lower spot market coal and lignite prices. Fuel expense also decreased due in part to the absence in 1999 of a 1998 transmission service agreement adjustment related to the final order in Texas Commission Docket No. 17285. See NOTE 2. LITIGATION AND REGULATORY PROCEEDINGS - CPL and WTU Complaint versus Texas Utilities Electric Company 38 (Docket No. 17285). Purchased power expenses for the nine months ended September 30, 1999 decreased $3.3 million or 11% compared to the same period of 1998 due primarily to a decrease in economy energy purchases. Other operating expenses for the nine months ended September 30, 1999 were $104.7 million, an increase of $4.2 million or 4% compared to the same period of 1998 as a result of increased transmission expenses. The increase in transmission expenses was due to the absence in 1999 of a transmission service agreement adjustment in 1998 related to the final order in Texas Commission Docket No. 17285. See NOTE 2. LITIGATION AND REGULATORY PROCEEDINGS - CPL and WTU Complaint versus Texas Utilities Electric Company (Docket No. 17285). The increase in other operating expenses was partially offset by transmission expenses related to changes in CSW's transmission coordination agreement. See NOTE 2. LITIGATION AND REGULATORY PROCEEDINGS - Transmission Coordination Agreement. Maintenance expenses for the nine months ended September 30, 1999 were $49.9 million, which was $14 million or 39% higher than the comparable period in 1998. This was due to increased power station maintenance, increased tree-trimming maintenance and increased overhead line maintenance. Taxes, other than income for the nine months ended September 30, 1999,were $39.7 million, a decrease of $3.6 million or 8% compared to the same period in 1998. This decrease was due to lower ad valorem taxes. Income tax expenses associated with utility operations during the nine months ended September 30, 1999 were $37.5 million, which was $7.9 million or 18% lower than the comparable period in 1998 due to lower taxable income and prior year adjustments to prior year income taxes. Other income and deductions decreased as a result of the write-off of the Cajun acquisition expenses of $3.7 million, net of tax. See NOTE 3. COMMITMENTS AND CONTENGENT LIABILTIES - SWEPCO Cajun Asset Proposal. The extraordinary loss was a result of legislation passed in Texas and Arkansas where the electricity generation portion of SWEPCO's business in those states no longer meets the criteria to apply SFAS No. 71. These accounting changes resulted in an extraordinary loss, which decreased net income by $3.0 million, net of tax. See NOTE 2. LITIGATION AND REGULATORY PROCEEDINGS - Electric Utility Restructuring Legislation. 39 WTU WEST TEXAS UTILITIES COMPANY PART I. - FINANCIAL INFORMATION. ITEM 1. FINANCIAL STATEMENTS. 40 WTU Statements of Income (unaudited) West Texas Utilities Company Three Months Ended Nine Months Ended September 30, September 30, --------------------- --------------------- 1999 1998 1999 1998 --------- --------- --------- ---------- (thousands) Electric Operating Revenues $ 154,304 $ 147,343 $ 343,138 $ 335,644 --------- --------- --------- ---------- Operating Expenses and Taxes Fuel 41,478 38,546 93,821 95,231 Purchased power 28,328 17,169 49,096 37,831 Other operating 24,652 19,637 64,824 62,496 Maintenance 4,284 4,911 14,744 11,816 Depreciation and amortization 10,934 10,719 32,558 32,108 Taxes, other than income 6,464 5,827 21,049 18,008 Income taxes 11,064 16,623 16,076 21,705 --------- --------- --------- ---------- 127,204 113,432 292,168 279,195 --------- --------- --------- ---------- Operating Income 27,100 33,911 50,970 56,449 --------- --------- --------- ---------- Other Income and (Deductions) Allowance for equity funds used during construction 138 193 234 421 Other 544 (22) 194 1,476 Non-operating income taxes (350) 259 76 282 --------- --------- --------- ---------- 332 430 504 2,179 --------- --------- --------- ---------- Income Before Interest Charges 27,432 34,341 51,474 58,628 --------- --------- --------- ---------- Interest Charges Interest on long-term debt 5,088 5,088 15,264 15,264 Interest on short-term debt and other 1,027 1,319 3,558 3,405 Allowance for borrowed funds used during construction (166) (182) (466) (469) --------- --------- --------- ---------- 5,949 6,225 18,356 18,200 --------- --------- --------- ---------- Income Before Extraordinary Item 21,483 28,116 33,118 40,428 Extraordinary loss (net of tax of $2,941) (5,461) -- (5,461) -- --------- --------- --------- ---------- Net Income 16,022 28,116 27,657 40,428 Less: Preferred stock dividends 26 26 78 78 --------- --------- --------- ---------- Net Income for Common Stock $ 15,996 $ 28,090 $ 27,579 $ 40,350 ========= ========= ========= ========== The accompanying notes to financial statements as they relate to WTU are an integral part of these statements. 41 WTU Balance Sheets West Texas Utilities Company September 30, December 31, 1999 1998 (unaudited) (audited) ------------- ------------ (thousands) ASSETS Electric Utility Plant Production $ 425,231 $ 429,896 Transmission 217,614 213,630 Distribution 396,938 382,373 General 112,851 108,878 Construction work in progress 19,243 11,805 ------------- ------------ 1,171,877 1,146,582 ------------- ------------ Less - Accumulated depreciation 489,856 473,503 ------------- ------------ 682,021 673,079 ------------- ------------ Current Assets Cash 5,217 2,093 Advances to affiliates 12,751 -- Accounts receivable from affiliates 3,855 2,998 Accounts receivable 27,075 28,691 Materials and supplies, at average cost 13,564 14,191 Fuel inventory, at LIFO cost 15,191 13,186 Accumulated deferred income taxes -- 366 Under-recovered fuel costs 13,032 3,980 Prepayments and other 10,664 5,988 ------------- ------------ 101,349 71,493 ------------- ------------ Deferred Charges and Other Assets Deferred Oklaunion costs 9,285 14,910 Other 66,851 60,330 ------------- ------------ 76,136 75,240 ------------- ------------ $ 859,506 $ 819,812 ============= ============ The accompanying notes to financial statements as they relate to WTU are an integral part of these statements. 42 WTU Balance Sheets West Texas Utilities Company
September 30, December 31, 1999 1998 (unaudited) (audited) ------------ ------------ CAPITALIZATION AND LIABILITIES (thousands) Capitalization Common stock: $25 par value Authorized: 7,800,000 shares Issued and outstanding: 5,488,560 shares $ 137,214 $ 137,214 Paid-in capital 2,236 2,236 Retained earnings 123,769 117,189 ------------ ------------ Total Common Stock Equity 263,219 50% 256,639 46% ------------ ---- ------------ ---- Preferred stock 2,482 --% 2,482 --% Long-term debt 263,644 50% 303,519 54% ------------ ---- ------------ ---- Total Capitalization 529,345 100% 562,640 100% ------------ ---- ------------ ---- Current Liabilities Long-term debt due within twelve months 40,000 -- Advances from affiliates -- 4,573 Payables to affiliates 16,584 19,917 Accounts payable 44,422 31,473 Accrued taxes 17,446 10,031 Accrued interest 7,955 4,125 Customer deposits 2,327 2,076 Accumulated deferred income taxes 735 -- Other 12,323 1,721 ------------ ------------ 141,792 73,916 ------------ ------------ Deferred Credits Accumulated deferred income taxes 145,671 140,731 Investment tax credits 25,641 26,597 Income tax related regulatory liabilities, net 13,093 12,088 Other 3,964 3,840 ------------ ------------ 188,369 183,256 ------------ ------------ $ 859,506 $ 819,812 ============ ============
The accompanying notes to financial statements as they relate to WTU are an integral part of these statements. 43 WTU Statements of Cash Flows (unaudited) West Texas Utilities Company Nine Months Ended September 30, ----------------------- 1999 1998 --------- --------- (thousands) OPERATING ACTIVITIES Net Income $ 27,657 $ 40,428 Non-cash Items Included in Net Income Depreciation and amortization 32,558 32,890 Deferred income taxes and investment tax credits 7,309 (7,377) Extraordinary loss related to SFAS No. 71 5,461 -- Changes in Assets and Liabilities Accounts receivable 759 (32,177) Accounts payable 12,949 (313) Payables to affiliates (3,333) (1,652) Accrued taxes 7,415 13,761 Fuel recovery (9,052) 1,371 Other (1,925) (1,589) --------- --------- 79,798 45,342 --------- --------- INVESTING ACTIVITIES Construction expenditures (35,444) (33,049) Other (2,828) 2,950 --------- --------- (38,272) (30,099) --------- --------- FINANCING ACTIVITIES Payment of dividends (21,078) (18,078) Change in advances from affiliates (4,573) -- --------- --------- (25,651) (18,078) --------- --------- Net Change in Cash and Cash Equivalents 15,875 (2,835) Cash and Cash Equivalents at Beginning of Year 2,093 20,613 --------- --------- Cash and Cash Equivalents at End of Period $ 17,968 $17,778 ========= ========= SUPPLEMENTARY INFORMATION Interest paid less amounts capitalized $ 10,067 $ 9,813 ========= ========= Income taxes paid $ 1,749 $15,042 ========= ========= The accompanying notes to financial statements as they relate to WTU are an integral part of these statements. 44 WEST TEXAS UTILITIES COMPANY RESULTS OF OPERATIONS COMPARISON OF THE QUARTERS ENDED SEPTEMBER 30, 1999 AND 1998 WTU's net income for common stock for the third quarter of 1999 was $16.0 million, which was $12.1 million or 43% lower than the comparable period in 1998. The decrease was primarily the result of higher other operating expenses and the effect of the extraordinary loss and a charge against earnings relating to the Texas Legislation partially offset by increased transmission related revenue and lower income tax expense. Electric operating revenues for the quarter ended September 30, 1999 were $154.3 million, which was $7.0 million or 5% higher than the comparable period in 1998. Fuel related revenues increased $5.4 million due to higher combined fuel expense and purchased power expense as discussed in the following paragraph. Non-fuel related revenues increased $1.6 million due to an increase in non-MWH related revenues for service rendered and not yet billed as well as an increase in transmission related revenues including changes to CSW's transmission coordination agreement which were partially offset by the charge to reflect the excess earnings provision under the Texas Legislation. See NOTE 2. LITIGATION AND REGULATORY PROCEEDINGS - Transmission Coordination Agreement and Electric Utility Restructuring Legislation. Fuel expense during the third quarter of 1999 was $41.5 million, which was $2.9 million or 8% higher than the comparable period in 1998. The average unit fuel costs for the quarter increased from $1.81 per MMbtu in 1998 to $2.17 per MMbtu in 1999 which was the result of higher spot market natural gas prices. Purchased power expense during the third quarter of 1999 was $28.3 million, which was $11.2 million or 65% higher than the comparable period in 1998 due primarily to an 8% decrease in generation. The decrease in generation was mainly attributable to the unscheduled outage of a coal-fired generating power plant. Other operating expenses for the third quarter of 1999 were $24.7 million, which was $5.0 million or 26% higher than the comparable period in 1998 due primarily to higher transmission expenses. The increase in transmission expense was due mainly to the absence in 1999 of a transmission service agreement adjustment made in 1998 related to the final order in Texas Commission Docket No. 17285. See NOTE 2. LITIGATION AND REGULATORY PROCEEDINGS - CPL and WTU Complaint versus Texas Utilities Electric Company (Docket No. 17285). Income taxes for the third quarter of 1999 decreased to $11.1 million, which was $5.6 million or 33% lower than the comparable period in 1998 as a result of lower taxable income for 1999 and prior year adjustments to prior year income taxes. The extraordinary loss resulted from legislation passed in Texas under which the electricity generation portion of WTU's business in Texas no longer meets the criteria to apply SFAS No. 71. These changes resulted in an extraordinary loss which decreased net income by $5.5 million, net of tax. See NOTE 2. LITIGATION AND REGULATORY PROCEEDINGS Electric Utility Restructuring Legislation. 45 COMPARISON OF THE NINE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998 WTU's net income for common stock for the nine months ended September 30, 1999 was $27.6 million, which was $12.8 million or 32% lower than the comparable period in 1998. The decrease was primarily the result of an increase in other operating expense, maintenance expense and taxes, other than income as well as a decrease in other income and deductions and the effect of the extraordinary loss. The decrease in earnings was partially offset by a reduction in income tax expense and increased transmission related revenue. Electric operating revenues for the nine months ended September 30, 1999 were $343.1 million, which was $7.5 million or 2% higher than the comparable period in 1998. Fuel related revenues increased $8.6 million due to higher net fuel and purchased power expense as discussed below. Non-fuel related revenues decreased $1.1 million due to a decrease in electric service rendered and not yet billed as well as a charge to reflect the excess earnings provision of the Texas Legislation and a 4% decrease in residential MWH sales due primarily to decreased customer demand. The decrease in revenues was offset in part by higher transmission related revenues including changes to CSW's transmission coordination agreement and a 13% increase in sales for resale to other utilities as a result of increased demand. See NOTE 2. LITIGATION AND REGULATORY PROCEEDINGS - Transmission Coordination Agreement and Electric Utility Restructuring Legislation. Fuel expense for the nine months ended September 30, 1999 was $93.8 million, which was $1.4 million or 1% lower than the comparable period in 1998 due primarily to a 4.6% decrease in generation. Purchased power for the nine months ended September 30, 1999 was $49.1 million, which was $11.3 million or 30% higher than the comparable period in 1998 due primarily to an unscheduled outage at a coal-fired generating plant. Maintenance expense for the nine months ended September 30, 1999 was $14.7 million, which was $2.9 million or 25% higher than the comparable period in 1998 due primarily to increased power plant maintenance, overhead line maintenance and tree trimming maintenance. Other operating expenses for the nine months ended September 30, 1999 were $64.8 million, which was $2.3 million or 4% higher than the comparable period in 1998 due to higher transmission expenses. The increase in transmission expense was due to the absence in 1999 of a transmission service agreement adjustment made in 1998 related to the final order in Texas Commission Docket No. 17285. See NOTE 2. LITIGATION AND REGULATORY PROCEEDINGS - CPL and WTU Complaint versus Texas Utilities Electric Company (Docket No. 17285). Taxes, other than income, for the nine months ended September 30, 1999 were $21.0 million, which was $3.0 million or 17% higher than the comparable period in 1998 primarily attributable to higher state franchise taxes. Income taxes associated with utility operations for the nine months ended September 30, 1999 were $16.1 million, which was $5.6 million or 26% lower than the comparable period in 1998 as a result of lower taxable income for 1999 and prior year adjustments to prior year income taxes. Other income and deductions for the nine months ended September 30, 1999 decreased $1.7 million from the comparable period in 1998. The decrease was a result of a decline in interest income from a lower balance of under-recovered fuel costs, as well as a decline in income from merchandise operations. 46 The extraordinary loss resulted from legislation passed in Texas under which the electricity generation portion of WTU's business in Texas no longer meets the criteria to apply SFAS No. 71. These changes resulted in an extraordinary loss which decreased net income by $5.5 million, net of tax. See NOTE 2. LITIGATION AND REGULATORY PROCEEDINGS Electric Utility Restructuring Legislation. 47 INDEX TO APPLICABLE NOTES TO FINANCIAL STATEMENTS BY REGISTRANT NOTE 1. PRINCIPLES OF PREPARATION CSW, CPL, PSO, SWEPCO, WTU NOTE 2. LITIGATION AND REGULATORY PROCEEDINGS CSW, CPL, PSO, SWEPCO, WTU NOTE 3. COMMITMENTS AND CONTINGENT LIABILITIES CSW, CPL, PSO, SWEPCO, WTU NOTE 4. COMMON STOCK AND DIVIDENDS CSW, CPL, PSO, SWEPCO, WTU NOTE 5. PROPOSED AEP MERGER CSW, CPL, PSO, SWEPCO, WTU NOTE 6. BUSINESS SEGMENTS CSW NOTE 7. SOUTH AMERICAN INVESTMENTS CSW NOTE 8. LONG-TERM DEBT CSW, CPL, PSO 48 NOTES TO FINANCIAL STATEMENTS (Unaudited) 1. PRINCIPLES OF PREPARATION General The condensed financial statements of the Registrants have been prepared by each Registrant pursuant to the rules and regulations of the SEC. Certain information and note disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations, although each Registrant believes that the disclosures are adequate to make the information presented not misleading. These condensed financial statements should be read in conjunction with the financial statements and the notes included in the Registrants' Combined Annual Report on Form 10-K for the year ended December 31, 1998 and the Registrants' Combined Quarterly Reports on Form 10-Q for the quarters ended March 31, 1999 and June 30, 1999. The unaudited financial information reflects all adjustments of a normal recurring nature which are, in the opinion of management of each Registrant, necessary for a fair statement of the results of operations for the interim periods. Information for quarterly periods is affected by seasonal variations in sales, rate changes, timing of fuel expense recovery and other factors. CPL Nuclear Decommissioning of STP At the end of STP's service life, decommissioning is expected to be accomplished using the decontamination method, which is one of the techniques accepted by the NRC. Using this method, the decontamination activities occur as soon as possible after the end of plant operations. Contaminated equipment is cleaned and removed to a permanent disposal location, and the site is generally returned to its original condition. CPL's decommissioning costs are accrued and paid to an external trust over the expected service life of the STP units. The existing NRC operating licenses permit the operation of STP Unit 1 until 2027 and Unit 2 until 2028. CPL pays annual decommissioning costs based on the estimated future cost to decommission STP, including escalation for expected inflation to the expected time of decommissioning. CPL estimates its portion of the costs of decommissioning STP to be $289 million in 1999 dollars based on a study completed this year. CPL is accruing and recovering decommissioning costs through rates based on the service life of STP using a rate of $8.2 million per year. The funds are deposited with a trustee under the terms of an irrevocable trust and are reflected in CPL's consolidated balance sheets as Nuclear decommissioning trust with a corresponding amount accrued in Accumulated depreciation. On CSW's consolidated balance sheets the irrevocable trust is included in Deferred Charges and Other Assets, Other, with a corresponding amount accrued in Accumulated depreciation. In CSW's and CPL's consolidated statements of income, the income related to the irrevocable trust is recorded in Other Income and Deductions, Other. In CPL's consolidated statements of income the interest expense related to the irrevocable trust is recorded in Interest Charges, Interest on short-term debt and other. In CSW's consolidated statements of income the interest expense related to the irrevocable trust is recorded in Interest and Other Charges, Interest on short-term debt and other. On September 30, 1999, the nuclear trust balance was $76.9 million. Regulatory Assets and Liabilities The financial statements of the U.S. Electric Operating Companies have historically reflected regulatory assets and liabilities under cost-based rate regulation in accordance with SFAS No. 71. Rate-regulated companies are generally required to write off regulatory assets and liabilities against 49 current earnings whenever changes in facts and circumstances cause SFAS No. 71 to no longer apply. As a result of legislation passed in Texas and Arkansas, the electricity generation business in those jurisdictions for CPL, SWEPCO and WTU no longer meet the criteria to apply SFAS No. 71. Instead, the principles of SFAS No. 101, as interpreted by EITF 97-4, have been applied. See NOTE 2. LITIGATION AND REGULATORY - Electric Utility Restructuring Legislation. Foreign Currency Translation The financial statements of SEEBOARD USA, which are included in CSW's consolidated financial statements, have been translated from British pounds to U.S. dollars in accordance with SFAS No. 52. All balance sheet accounts are translated at the exchange rate at the end of the period, and all income statement items are translated at the weighted average exchange rate for the applicable period. All the resulting translation adjustments are recorded directly to Accumulated other comprehensive income on CSW's Consolidated Balance Sheets. Cash flow statement items are translated at a combination of average, historical and current exchange rates. The non-cash impact of the changes in exchange rates on cash and cash equivalents, resulting from the translation of items at the different exchange rates, is shown on CSW's Consolidated Statements of Cash Flows in Effect of exchange rate changes on cash and cash equivalents. One British pound equals the following U.S. dollar amounts: 1999 1998 ------------- -------------- At September 30 $1.65 $1.70 Weighted average for 3 months ended September $1.64 $1.65 30 Weighted average for 9 months ended September $1.62 $1.65 30 See NOTE 7. SOUTH AMERICAN INVESTMENTS for information regarding CSW's investments in Brazil. Risk Management CSW has, at times, been exposed to currency and interest rate risks which reflect the floating exchange rate that exists between the U.S. dollar and the British pound. CSW utilizes certain risk management tools, including cross currency swaps, foreign currency futures and foreign currency options, to manage adverse changes in exchange rates and to facilitate financing transactions resulting from CSW's acquisition of SEEBOARD. SEEBOARD has entered into contracts for differences to reduce exposure to fluctuations in the price of electricity purchased from the United Kingdom's electricity power pool. This pool was established upon privatization of the United Kingdom's electric industry for the bulk trading of electricity between generators and suppliers. CSW also utilizes a variety of other derivatives instruments including swaps, forwards and options. CSW accounts for these transactions as hedge transactions and any gains or losses associated with the risk management tools are recognized in the financial statements at the time the hedge transactions are settled. CSW believes its credit risk in these contracts is negligible. Reclassifications Certain financial statement items for prior periods have been reclassified to conform to the 1999 presentation. 50 2. LITIGATION AND REGULATORY PROCEEDINGS See the Registrants' Combined Annual Report on Form 10-K for the year ended December 31, 1998 and the Registrants' Combined Quarterly Reports on Form 10-Q for the quarters ended March 31, 1999 and June 30, 1999 for additional discussion of litigation and regulatory proceedings. Reference is also made to NOTE 3. COMMITMENTS AND CONTINGENT LIABILITIES and ITEM 2. MD&A - RATES AND REGULATORY MATTERS for additional discussion of litigation and regulatory matters. Electric Utility Restructuring Legislation On June 18, 1999, legislation was signed into law in Texas that will restructure the electric utility industry in the state. The new law, among other things: gives Texas customers of investor-owned utilities the opportunity to choose their electric provider beginning January 1, 2002; provides for the recovery of stranded costs which are defined as the excess of net book value of generation assets over the defined market value of those assets; requires reductions in nitrogen oxide and sulfur dioxide emissions; provides a rate freeze until January 1, 2002 followed by a 6% rate reduction for residential and small commercial customers, additional rate reduction for low income customers and a number of customer protections and sets certain limits on capacity owned and controlled by power generation companies. Rural electric cooperatives and municipal electric systems can choose whether to participate in retail competition. Delivery of the electricity will continue to be the responsibility of the local electric transmission and distribution utility company at regulated prices. Each utility must unbundle its business activities into a retail electric provider, a power generation company and a transmission and distribution utility. CPL, SWEPCO and WTU will file their business separation or "unbundling" plans with the Texas Commission in January 2000. During 1999, legislation was also enacted in Arkansas that will ultimately restructure the electric utility industry in that state. SWEPCO will file a business unbundling plan in Arkansas in the first quarter of 2000 as required by the legislation. The financial statements of the U.S. Electric Operating Companies have historically reflected the effects of applying the requirements of SFAS No. 71. Pursuant to those requirements, the U.S. Electric Operating Companies have recorded regulatory assets and liabilities (probable future revenues and refunds) to reflect the economic effect of cost-based regulation. When a company determines that its operations or a segment of its operations no longer meets the criteria for applying SFAS No. 71, it is required to apply the requirements of SFAS No. 101. Pursuant to those requirements and further guidance provided in EITF 97-4, a company is required to write off regulatory assets and liabilities related to deregulated operations, unless recovery of such amounts is provided through rates to be collected in a continuing regulated portion of the company's operations. Additionally, it is required to determine if any plant assets are impaired under SFAS No. 121. As a result of the scheduled deregulation of generation in Texas and Arkansas, CSW has concluded that it should discontinue the application of SFAS No. 71 for the Texas generation portion of the business for CPL and WTU and the Texas and Arkansas jurisdictional portions of the generation business for SWEPCO. Consequently, WTU recorded an extraordinary charge to earnings of $5.5 million and SWEPCO recorded an extraordinary charge to earnings of $3.0 million to reflect the effects of discontinuing the application of SFAS No. 71 and to write off net of regulatory assets that are not probable of recovery. The discontinuance of SFAS No. 71 for CPL did not result in a net charge to earnings as such net regulatory assets, pursuant to the legislation, are expected to be recovered from transmission and distribution customers through rates that will continue to be regulated. 51 Electric utilities under the Texas Legislation are allowed to recover generation-related regulatory assets and stranded costs that otherwise may not be recoverable in the future competitive market. All or a majority of those costs can be refinanced through securitization, which is a financing structure designed to provide lower financing costs than is available through the conventional utility cost of capital model. The securitized amounts are then recovered through a non-bypassable transmission charge. On October 18, 1999, CPL filed an application with the Texas Commission to securitize approximately $1.27 billion of its retail generation-related regulatory assets and approximately $47 million in other qualified costs. If approval is received from the Texas Commission, CPL expects to issue the securitization bonds in March or April 2000, depending on market conditions and the timing of an order from the Texas Commission. A second phase of securitization relating to additional plant related stranded costs should occur in 2001 depending upon market conditions, timing and Texas Commission approvals. A non-bypassable charge may be used to recover additional unsecuritized stranded cost amounts. Under the provisions of EITF 97-4, CPL's generation-related net regulatory assets were transferred to the transmission and distribution portion of the business and will be amortized as they are recovered through charges to customers. Management currently believes all regulatory and stranded costs related to generation assets for CPL will be recovered as provided under Texas Legislation. CPL believes it will have stranded costs related to its generation assets in excess of the $1.27 billion of costs contained in its securitization filing made with the Texas Commission on October 18, 1999. If future events were to occur that made the recovery of these assets no longer probable, CPL would write off any non-recoverable portion of such assets as a non-cash charge to earnings. CPL's amount of regulatory assets and stranded costs are subject to a final determination by the Texas Commission in 2004. The Texas Legislation provides that all such finally determined stranded costs will be recovered. Since SWEPCO and WTU are not expected to have net stranded costs, all generation-related non-recoverable net regulatory assets were written off and reflected on the statement of income as an extraordinary item. Additionally, CPL, SWEPCO and WTU performed an accounting impairment analysis of generation assets under SFAS No. 121 at September 30, 1999 and concluded there was no impairment of generation assets at that time. An impairment analysis involves estimating future net cash flows arising from the use of an asset. If the net cash flows exceed the net book value of the asset, then there is no impairment of the asset for accounting purposes. CPL, SWEPCO and WTU will continue to review their assets for potential impairment if events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. The Texas Legislation also provides that each year during the 1999 through 2001 rate freeze period, utilities with stranded costs are required to apply any earnings in excess of the most recently approved cost of capital in a company's last rate case (if issued on or after January 1, 1992) to reduce stranded costs. As a result, CPL recorded a net charge to earnings of $4.6 million to reflect the impact of this provision. Utilities without stranded costs must either flow such amounts back to customers or make capital expenditures, at no charge to customers, to improve transmission or distribution facilities or to improve air quality. As a result, WTU recorded a charge to earnings of $6.4 million from the effect of the earnings cap under the Texas Legislation. The charges were based on estimates for the current year and are subject to final determination by the Texas Commission. Following CPL's discontinuation of SFAS No. 71, it is expected that any future excess earnings will only be applied to reduce stranded costs for regulatory purposes. The discontinuance of SFAS No. 71 for CPL's and WTU's Texas generation business and SWEPCO's Texas and Arkansas generation business requires that these businesses no longer defer costs or recognize liabilities strictly resulting from the actions of a regulator. For example, operations and maintenance expenditures will be expensed as incurred regardless of regulatory treatment. In addition, the equity component of allowance for funds used during construction can no longer be accrued for generation-related capital projects. Instead, the 52 businesses will be required to follow the interest capitalization rules in SFAS No. 34. CSW continues to analyze the impact of the electric utility industry restructuring legislation on the U.S. Electric Operating Companies. The Texas Commission has established numerous task forces, including representatives from CPL, SWEPCO and WTU, to address various issues associated with the Texas Legislation and to provide guidance regarding implementation of restructuring. Based on the overall framework and objective of the Texas Legislation regarding recovery of stranded costs and regulatory assets, and additional guidance obtained through participation in various task force workshop sessions, certain adjustments were recorded by CSW in the third quarter of 1999 to recognize the estimated effect of the legislation. CSW also recorded certain adjustments for the Arkansas jurisdictional portion of SWEPCO's generation business as a result of legislation enacted in Arkansas. As previously discussed, as a result of the Texas Legislation, CPL filed its application for securitization on October 18, 1999 with the Texas Commission. CPL, SWEPCO and WTU expect to make additional filings with the Texas Commission for business separation plans in January 2000, earnings cap reports in March 2000, cost unbundling plans in April 2000 and the ECOM reports in April 2000. Also see ITEM 2. MD&A - RECENT DEVELOPMENTS AND TRENDS, Electric Utility Restructuring Legislation for a discussion on restructuring legislation. CPL Rate Review - Docket No. 14965 In November 1995, CPL filed with the Texas Commission a request to increase its retail base rates by $71 million. On October 16, 1997, the Texas Commission issued the CPL 1997 Final Order which lowered the annual retail base rates of CPL by approximately $19 million or 2.5% from CPL's rate level existing prior to May 1996. The Texas Commission also included a "glide path" rate reduction methodology in the CPL 1997 Final Order pursuant to which CPL's annual rates were reduced by $13 million on May 1, 1998 with an additional reduction of $13 million on May 1, 1999. CPL filed an appeal of the CPL 1997 Final Order to the State District Court of Travis County to raise several issues related to the rate case. The primary issues include: (i) the classification of $800 million of invested capital in STP as ECOM which was assigned a lower return on equity than non-ECOM property; (ii) the Texas Commission's application of the "glide path" rate reduction methodology applied on May 1, 1998 and May 1, 1999; and (iii) the $18 million of disallowed affiliate expenses from CSW Services. As part of the appeal, CPL sought a temporary injunction to prohibit the Texas Commission from implementing the "glide path" rate reduction methodology. The court denied the temporary injunction, and the "glide path" rate reductions were implemented in May 1998 and May 1999. Hearings on the appeal were held during the third quarter of 1998, and a judgment was issued in February 1999 affirming the Texas Commission order, except for a consolidated tax issue in the amount of $6 million, which was remanded to the Texas Commission. CPL filed an appeal of this most recent order to the Court of Appeals and management is unable to predict how the final resolution of these issues will ultimately affect CSW's and CPL's results of operations and financial condition. On May 4, 1999, AEP and CSW announced that they had reached a stipulated agreement with the General Counsel of the Texas Commission and other intervenors in the state of Texas related to the AEP/CSW merger case. The Texas Commission approved the AEP Merger in early November 1999. If the AEP Merger is ultimately consummated, CSW will withdraw its appeal with respect to the "glide path" rate reduction methodology as discussed above as issue "(ii)" but will continue seeking the appeal of issues "(i) and (iii)" also discussed above. See NOTE 5. PROPOSED AEP MERGER and ITEM 2. MD&A - PROPOSED AEP MERGER for a discussion on the stipulated agreement. 53 Also see ITEM 2. MD&A - RATES AND REGULATORY MATTERS, CPL Rate Review - Docket No. 14965 for a discussion of the CPL 1997 Final Order. CPL Fuel Proceeding On December 31, 1998, CPL filed with the Texas Commission an application to reconcile fuel costs and to request authority to carry the reconciled balance forward into the next reconciliation period. During the reconciliation period of July 1, 1995 through June 30, 1998, CPL incurred $828.5 million of eligible fuel and fuel-related expenses. The Texas jurisdictional allocation of such fuel and fuel-related expenses is $783.4 million. In addition to requesting reconciliation of its fuel and fuel-related expenses for the reconciliation period, CPL requested authority from the Texas Commission to recover the reward earned during the reconciliation period under the performance standard adopted in the 1997 CPL Final Order for CPL's share of STP. The Texas Commission adopted a three-year average capacity factor of 83% performance standard for STP in that order. During the reconciliation period, STP operated at a net capacity factor of 93.1%, resulting in a reward of $19.2 million. CPL requested authority to recover the Texas portion of 50% of the reward by including 1/36th of this amount in Texas retail eligible fuel expense each month for the three-year period following the Texas Commission's order in the fuel reconciliation case. CPL further requested authority to apply the amounts of the reward recovered through Texas retail eligible fuel expense toward additional amortization of its STP deferred accounting regulatory asset. The remaining 50% of the reward would be "banked" to be used against potential future penalties or other disallowance of fuel costs. Hearings were held before an ALJ in June 1999. In July 1999, all parties reached a settlement in principle. The settlement resolves all disputed issues and includes a disallowance of $7.44 million recorded in the third quarter of 1999 and no STP performance reward either now or in the future. The Texas Commission issued its final order on September 23, 1999 in accordance with the stipulation of the parties. CPL and WTU Complaint vs. Texas Utilities Electric Company (Docket No. 17285) A joint complaint filed by CPL and WTU with the Texas Commission asserted that since January 1, 1997, Texas Utilities Electric Company had been effectively double charging for transmission service within ERCOT. A proposal for decision in February 1998 recommended approval of a proposal by CPL and WTU to reduce by $15.5 million annually their payments to Texas Utilities Electric Company. The Texas Commission approved the proposal in September 1998. Although Texas Utilities Electric Company has appealed the Texas Commission final order, it refunded $26.6 million to CPL and WTU in November 1998. Prior to the Texas Commission's September 1998 decision, the $15.5 million annual payment to Texas Utilities Electric Company had been allocated to the U.S. Electric Operating Companies. As a result of this order, the payment will continue to be recorded on CPL's and WTU's books as a reduction of ERCOT transmission expense, and there will be no future expenses recorded on the books of PSO and SWEPCO. Transmission Coordination Agreement The transmission coordination agreement provides the means by which the U.S. Electric Operating Companies plan, operate and maintain the four separate transmission systems as a single unit. The agreement also establishes the method by which the U.S. Electric Operating Companies allocate revenues received under open access transmission tariffs. In August 1998, the FERC accepted the transmission coordination agreement for filing, suspended it for a nominal period, and made it effective retroactive to January 1, 1997, subject to refund and investigation. In the fourth quarter of 1998, the U.S. Electric Operating 54 Companies and supporting intervenor signatories filed an uncontested offer of settlement. The FERC issued an order on June 18, 1999, accepting the offer of settlement. The FERC further ordered that appropriate refunds be made to reflect the terms of the revised transmission coordination agreement. In the second quarter of 1999, the FERC also issued an order accepting the U.S. Electric Operating Companies' compliance filing of their open access transmission tariff. The FERC previously had ordered the compliance filing to review the method by which certain open access transmission tariff customers were to be charged for transmission service. As a result of that order, certain changes were made in the transmission coordination agreement related to the allocation of certain open access transmission tariff revenues. Each U.S. Electric Operating Company will be allocated revenue in proportion to the company's respective revenue requirement for the service it provides under the revised open access transmission tariff. The U.S. Electric Operating Companies requested and received from the FERC a deferral of their refund obligation until the FERC issues an order accepting the revised transmission coordination agreement. On October 29, 1999, CSW filed with the FERC a revised transmission coordination agreement. The revised transmission coordination agreement includes changes to the original transmission coordination agreement to ensure the above mentioned allocation of revenues to each U.S. Electric Operating Company. In the third quarter of 1999, each of the U.S. Electric Operating Companies recorded the estimated impact of the reallocation of open access transmission tariff revenues, which increased CSW's income before taxes by approximately $8.75 million. PSO PCB Cases PSO was named a defendant in petitions filed in state court in Oklahoma in February and August 1996. The petitions allege that the plaintiffs suffered personal injury and fear future injury as a result of contamination by PCBs from a transformer malfunction that occurred in April 1982 at the Page Belcher Federal Building in Tulsa, Oklahoma. Each of the plaintiffs seeks actual and punitive damages in excess of $10,000. Other claims arising from this incident were settled and the suits dismissed. During the third quarter of 1999, all but 12 of the cases were settled for a nominal amount covered by PSO's insurance. Management believes that PSO has defenses to the remaining complaints and intends to defend the suits vigorously. Management believes that the remaining claims, excluding claims for punitive damages, are also covered by insurance. Management also believes that the ultimate resolution of the remaining lawsuits will not have a material effect on CSW's or PSO's results of operations or financial condition. SWEPCO Louisiana Rate Review In December 1997, the Louisiana Commission announced it would review SWEPCO's rates and service. The Louisiana Commission has selected consultants and legal counsel to perform a review of SWEPCO's rates and charges and to review SWEPCO's quality of service. The Louisiana Commission's legal counsel issued a report in June 1999, reflecting Louisiana revenues in excess of $28 million. SWEPCO believes the report contained significant theoretical and mathematical errors and filed its rebuttal testimony on August 10, 1999. In October 1999, SWEPCO and the Staff of the Louisiana Commission reached an Agreement and Stipulation, which was filed on October 14, 1999. In support of the Agreement and Stipulation, supplemental testimony was also filed. The provisions of the Agreement and Stipulation are: - - SWEPCO's Louisiana retail jurisdictional revenues are reduced by $11 million, effective with the December 1999 billing cycle; - - SWEPCO will be allowed to earn an 11.1% return on common equity; - - SWEPCO will recover certain regulatory assets totaling $7.1 million; - - SWEPCO will be subject to a two-year base rate freeze, which will be subject to force majeure provisions and; - - Increased depreciation rates for transmission, distribution and general plant. 55 Hearings were held before an ALJ on October 19, 1999. To meet the December 1999 implementation date contemplated in the Agreement and Stipulation, an order from the Louisiana Commission must be received in November 1999. The Louisiana Commission is scheduled to vote on the Agreement and Stipulation at its November 17, 1999 meeting. SWEPCO Arkansas Rate Review In June 1998, the Arkansas Commission indicated that it would conduct a review of SWEPCO's earnings. The review began in July 1998. SWEPCO entered into a settlement agreement with the general staff of the Arkansas Commission and the Arkansas Attorney General's Office. The settlement agreement was filed on July 30, 1999 and reduces revenues by $5.4 million or 3%. Additionally, the Stipulation and Settlement Agreement provides for a 10.75% return on common equity, an increase in depreciation rates, and an agreement by SWEPCO not to seek recovery of generation related stranded costs. On August 20, 1999, SWEPCO filed a Supplemental Stipulation and Settlement Agreement, which was reached with the one remaining party. The Supplemental Stipulation and Settlement Agreement did not alter or replace any of the original monetary terms of the Stipulation and Settlement Agreement filed on July 30, 1999. On September 23, 1999, the Arkansas Commission issued an order approving the Stipulation and Settlement Agreement and the Supplemental Stipulation and Settlement Agreement. On October 25, 1999, SWEPCO filed compliance rate tariffs with the Arkansas Commission, which are consistent with the Arkansas Commission order. After a review of the compliance rate tariffs by the Staff of the Arkansas Commission, new rates will be implemented. SWEPCO anticipates implementing the new rates with the December 1999 billing cycle. SWEPCO Interim Fuel Refund On August 24, 1999, SWEPCO filed an application at the Texas Commission to make an interim refund of fuel cost over-recoveries of $7.5 million received by SWEPCO from its Texas retail jurisdictional customers. The application requested that the refund be made in October 1999. On September 20, 1999, a stipulation between all parties was filed with the Texas Commission, which preserved SWEPCO's application to refund $7.5 million to SWEPCO's Texas retail customers. An order granting interim approval to make the refund in October 1999 was issued by the hearings examiner on September 24, 1999. SWEPCO began implementing the refund on customer bills during the first billing cycle of October 1999. On October 21, 1999, the Texas Commission issued a final order which affirmed approval to refund the fuel cost over-recoveries. SWEPCO Lignite Mining Agreement Litigation SWEPCO and CLECO are each a 50% owner of Dolet Hills Power Station Unit 1 and jointly own lignite reserves in the Dolet Hills area of northwestern Louisiana. In 1982, SWEPCO and CLECO entered into a lignite mining agreement with the DHMV, a partnership for the mining and delivery of lignite from a portion of these reserves. On April 15, 1997, SWEPCO and CLECO sued DHMV and its partners in the United States District Court for the Western District of Louisiana seeking to enforce various obligations of DHMV to SWEPCO and CLECO under the lignite mining agreement, including provisions relating to the quality of the delivered lignite, pricing, and mine reclamation practices. On June 15, 1997, DHMV filed an answer denying the allegations in the suit and filed a counterclaim asserting various contract-related claims against SWEPCO and CLECO. SWEPCO and CLECO have denied the allegations contained in the counterclaims. On January 8, 1999, SWEPCO and CLECO amended the claims against DHMV in the lawsuit to include a 56 request that the lignite mining agreement be terminated. The trial date has been reset to May 22, 2000 to allow settlement discussions. Although SWEPCO cannot predict the ultimate outcome of this matter, management believes that the resolution of this matter will not have a material effect on SWEPCO's results of operations or financial condition. WTU Fuel Factor and Interim Fuel Surcharge Filing In September 1999, WTU filed with the Texas Commission an Application for Authority to Implement an increase in fuel factors of $13.5 million or 12.2% on an annual basis. Additionally, WTU proposed to implement an interim fuel surcharge of $6.5 million, including accumulated interest over a six-month period to collect its under-recovered fuel costs. WTU proposed to implement the revised fuel factors with its December 1999 billing cycle. On November 4, 1999, the Texas Commission approved WTU's application. The order allows an increase in fuel factors of 12.2% on an annual basis beginning in the billing cycle for December 1999 and to surcharge customers to recover $6.5 million of under-recovered fuel costs and associated interest for six months beginning in the billing cycle for January 2000. Regulatory Draft Price Proposal for SEEBOARD On October 8, 1999, OFGEM published its revised draft price proposals and results from its current United Kingdom electricity distribution review. OFGEM has recommended revenue reductions in SEEBOARD's distribution business. In addition, OFGEM has proposed the reallocation of a further 12%, or $45 million of pre-tax costs out of SEEBOARD's distribution business into its supply business. If adopted, these proposals would reduce SEEBOARD's net income in the year 2000 by $40 million, and by $60 million on an annual basis thereafter, depending upon the level of further cost reductions that can be achieved. CSW's net income from SEEBOARD USA, its United Kingdom business segment, was $95 million for the twelve months ended September 30, 1999. SEEBOARD continues to analyze the revised draft recommendations and their potential effects on earnings and to seek further changes in OFGEM's proposed recommendations to mitigate their effect on net income. SEEBOARD is also currently analyzing future potential cost reductions that would partially mitigate the impact of these proposals. OFGEM is expected to finalize its recommendations in early December 1999, which would take effect in April 2000 for five years. SEEBOARD cannot predict whether the draft price proposals ultimately will be adopted by OFGEM and, if they are adopted, the final form of the proposals. If OFGEM's draft price proposals for SEEBOARD ultimately were adopted without change, implementation of the price proposals would have a material adverse effect on the future results of operations of SEEBOARD USA and CSW. In addition, implementation of the price proposals as drafted could adversely affect the financial condition of SEEBOARD USA, but would not be expected to adversely affect the financial condition of CSW. OFGEM has published draft price proposals for the electricity supply businesses. OFGEM has recommended that the price cap for charges levied to electricity supply domestic and small business customers should be extended for two years from April 2000. If adopted, the proposals are expected to be broadly neutral on the results of operations of SEEBOARD USA. 57 3. COMMITMENTS AND CONTINGENT LIABILITIES PSO Guarantee of Numanco Obligations In April 1999, PSO received an order from the SEC authorizing an increase in its guarantee authority related to the outstanding debt of Numanco, a PSO business venture. On November 3, 1999, PSO sold its investment in Numanco to CSW Energy Services, Inc., another CSW subsidiary. Prior to the sale, PSO had guaranteed obligations for Numanco in the amount of $29 million. The PSO guarantee obligation was released upon the sale. There are no other guarantees in place for Numanco by any of the CSW companies. SWEPCO Henry W. Pirkey Power Plant In connection with the South Hallsville lignite-mining contract for its Henry W. Pirkey Power Plant, SWEPCO agreed, under certain conditions, to assume the obligations of the mining contractor. As of September 30, 1999, the amount SWEPCO may have to assume is approximately $68 million, which is the contractor's actual obligation outstanding at September 30, 1999. SWEPCO South Hallsville Lignite Mine As part of the process to receive a renewal of a Texas Railroad Commission permit for lignite mining at the South Hallsville lignite mine and expansion into the Marshall South lignite project area, SWEPCO agreed to guarantee the costs of mine reclamation up to $85 million in the event the work is not completed by the third party miner. At September 30, 1999, the cost to reclaim the mine is estimated to be approximately $36 million. Withdrawal of SWEPCO Cajun Asset Proposal Cajun filed a petition for reorganization under Chapter 11 of the United States Bankruptcy Code on December 21, 1994 under the supervision of the United States Bankruptcy Court for the Middle District of Louisiana. Both SWEPCO and Louisiana Generating LLC had filed competing plans of reorganization for the non-nuclear assets of Cajun with the bankruptcy court. On August 26, 1999, SWEPCO, together with the Cajun Members Committee and Washington-St. Tammany Electric Cooperative, reached a settlement agreement to withdraw the jointly filed July 1999 SWEPCO Plan to acquire all of the non-nuclear assets of Cajun during a settlement conference ordered by the United States District Court in Baton Rouge, Louisiana. SWEPCO had deferred approximately $13.0 million in costs related to the Cajun acquisition on its consolidated balance sheet. Under the settlement agreement, SWEPCO received $7.5 million on November 8, 1999. The after tax loss reflected in the third quarter of 1999 was $3.7 million. SWEPCO Biloxi, Mississippi MGP Site SWEPCO was notified by Mississippi Power in 1994 that it may be a PRP at a MGP site in Biloxi, Mississippi. Since then, SWEPCO has worked with Mississippi Power investigating the extent of contamination at the site. The sampling results indicate contamination at the property as well as the possible contamination of an adjacent property. After submitting a risk assessment, the MDEQ requested that a future residential exposure scenario be evaluated for comparison with commercial and industrial exposure scenarios. However, Mississippi Power and SWEPCO do not believe that cleanup to a residential scenario is appropriate since the site has been an industrial/commercial site for more than 100 years, and Mississippi Power plans to continue this type of usage. Mississippi Power and SWEPCO presented a report to the MDEQ demonstrating that the ground water on the site is not potable and that cleanup to residential standards is not necessary. Resolution of this issue is still pending. 58 Currently, a feasibility study is being conducted to evaluate remedial strategies for the property. The feasibility study process will require public input prior to a final decision and will result in a remediation strategy and a projection of the cost to remediate the property. SWEPCO has incurred costs of approximately $200,000 for its portion of the cleanup of this site and based on preliminary estimates, anticipates that an additional $2 million may be incurred. Accordingly, SWEPCO has accrued an additional $2 million for the cleanup of the site. SWEPCO Wilkes Power Plant Copper Limit Compliance The EPA has cited SWEPCO's Wilkes power plant in an administrative order for wastewater permit violations related to copper level limits. Planned compliance activities, including activities that have been conducted to determine the source of copper, were presented by SWEPCO to the EPA during an administrative meeting, held on August 13, 1998. SWEPCO and the EPA negotiated a $41,500 penalty pending final approval. SEEBOARD London Underground Commitment In 1998, SEEBOARD, through its subsidiary SEEBOARD Powerlink, signed a $1.6 billion, 30 year contract as a joint venture partner to operate, maintain, finance and renew the high-voltage power distribution network of the London Underground transportation system. Power Asset Development Company, an associate of SEEBOARD, has committed (pound)62 million or $102 million for costs associated with its contract related to the London Underground transportation system. SEEBOARD Third Party Pension Litigation In the U.K., National Grid Group and National Power have been involved in continuing litigation regarding their use of actuarial surpluses set forth in the electricity industry's occupational pension plan, the ESPS. A High Court decision in favor of the National Grid Group and National Power was appealed. On February 10, 1999, the U.K. Court of Appeal ruled that the particular arrangements made by these corporations to dispose of part of the surplus were invalid due to procedural defects. This decision was confirmed at a later hearing of the U.K. Court of Appeal held in May 1999, although an opportunity for an appeal to be taken to the House of Lords, the highest court of appeal in the U.K., was granted. SEEBOARD employees are members of the ESPS, and SEEBOARD has made similar use of its actuarial surplus. As a result of subsequent legal clarification of certain issues arising from the hearing held in May 1999, the potential impact of the ruling on SEEBOARD has increased. The amount of the payments cancelled by SEEBOARD, both for past and future liabilities, amounts, in the aggregate, to approximately $78 million, excluding interest. The U.K. Court of Appeal did not order the National Grid Group or National Power to make payment into the ESPS, and the court indicated that any requirement to make such payments would be extreme since the ESPS already is in surplus. In the event that the court finally decides a payment by SEEBOARD into the ESPS is necessary, such a payment is likely to create additional pension fund surplus, which the company should then be able to utilize over the next several years to reduce pension expense. The National Grid Group has indicated its intention to appeal to the House of Lords. The final outcome of this appeal cannot presently be determined. Management is unable currently to predict the amount of any payment that it may be required to make to ESPS or the effect, if any, of the ultimate outcome of the appeal on CSW's results of operations and financial condition. 59 Diversified Electric Loans and Commitments CSW Energy began construction in August 1998 of a 500 MW power plant, known as Frontera, in the Rio Grande Valley, near the city of Mission, Texas. The Frontera project is being built as a merchant power plant. Frontera is expected to supply power to the rapidly growing Rio Grande Valley and to supply customers throughout Texas. In addition to funds already spent, at September 30, 1999, CSW Energy has committed costs of approximately $15 million, including development, construction and financing costs. The natural gas-fired facility began simple cycle operation of 330 MW in July 1999 and is scheduled to commence combined cycle operation by early 2000. Pursuant to AEP's and CSW's stipulated settlement with several intervenors in the state of Texas related to the AEP Merger, CSW Energy will sell 250 MW of Frontera after completion of the merger. See NOTE 5. PROPOSED AEP MERGER and ITEM 2. MD&A, PROPOSED AEP MERGER. CSW Energy has entered into an agreement with Eastman Chemical Company to construct and operate a 440 MW cogeneration facility in Longview, Texas. This facility will be known as the Eastex Cogeneration Project. Construction of the facility is scheduled to begin in the fourth quarter of 1999, with expected operation in 2001. Excess electricity generated by the plant will be sold by CSW Energy in the wholesale electricity market. Since Eastex will be built as a qualifying facility, CSW Energy will be required to sell 50% of the plant prior to commercial operation. In October 1999, GE Capital Structured Finance Group's purchased 50 percent of the equity ownership of Sweeny Cogeneration Limited Partnership. CSW Energy's after-tax earnings from the proceeds of the transaction will be approximately $33 million and will be recorded in the fourth quarter of 1999. The agreement between CSW Energy and GE Capital Structured Finance Group also provides for additional payments subject to completion of a planned expansion of the Sweeny cogeneration facility. CSW International and its 50% partner, Scottish Power plc, have entered into a joint venture to construct and operate the South Coast power project, a 400-MW combined cycle gas turbine power station in Shoreham, United Kingdom. CSW International has guaranteed approximately (pound)19 million of the (pound)190 million projected construction costs, and the permanent financing is unconditionally guaranteed by the project. Construction of the project began in March 1999, and commercial operation is expected to begin in 2000. CSW, CSW Energy and CSW International have provided letters of credit and guarantees on behalf of independent power projects totaling approximately $29 million, $56 million, and $235 million, respectively, as of September 30, 1999. 4. COMMON STOCK AND DIVIDENDS CSW's basic earnings per share of common stock for a period are computed by dividing net income for common stock by the average number of common shares outstanding for the period. CSW's dividends per common share reflect the dividend paid for each period. At September 30, 1999, approximately $1.9 billion of CSW's subsidiary companies' retained earnings were available for payment of cash dividends to CSW. The amount of retained earnings available for dividends from each of the U.S. Electric Operating Companies at September 30, 1999 was as follows: CPL - $796 million PSO - $167 million SWEPCO - $296 million WTU - $124 million 60 5. PROPOSED AEP MERGER On December 22, 1997, CSW and AEP announced that their boards of directors had approved a definitive merger agreement for a tax-free, stock-for-stock transaction. The combined company would serve more than 4.6 million customers in 11 states and approximately 4 million customers outside the United States. On May 27, 1998, AEP shareholders approved the issuance of the additional shares of stock required to complete the merger. On May 28, 1998, CSW stockholders approved the merger. Under the merger agreement, each common share of CSW will be converted into 0.6 share of AEP common stock. CSW stockholders will own approximately 40% of the combined company. CSW plans to continue to pay dividends on its common stock until the closing of the AEP Merger at approximately the same times and rates per share as in 1998, subject to continuing evaluation of CSW's financial condition, earnings, prospects and other factors by the CSW board of directors. Under the merger agreement, there will be no changes required with respect to the public debt issues, the outstanding preferred stock or the Trust Preferred Securities of CSW's subsidiaries. AEP and CSW anticipate net savings related to the merger of approximately $2 billion over a 10-year period from the elimination of duplication in corporate and administrative programs, greater efficiencies in operations and business processes, increased purchasing efficiencies and the combination of the two work forces. AEP and CSW continue to seek opportunities for additional savings. At the same time, the companies expect to continue their commitment to high quality, reliable service. Job reductions related to the merger are expected to be approximately 1,050 out of a total domestic workforce of approximately 25,000. The combined company expects to use a combination of growth, reduced hiring and attrition to minimize the need for employee separations. Transition teams of employees from both companies will make organizational and staffing recommendations. The electric systems of AEP and CSW will operate on an integrated and coordinated basis as required by the Holding Company Act. AEP and CSW project fuel savings of approximately $98 million over a 10-year period resulting from the coordinated operation of the combined company, which will be passed through to customers. The merger agreement contains covenants and agreements that restrict the manner in which the parties may operate their respective businesses until the time of closing of the merger. In particular, without the prior written consent of AEP, CSW may not engage in a number of activities that could affect its sources and uses of funds. Pending closing of the merger, CSW's and its subsidiaries' strategic investment activity, capital expenditures and non-fuel operating and maintenance expenditures are limited to specific agreed upon projects and in agreed upon amounts. In addition, prior to consummation of the merger, CSW and its subsidiaries are restricted from: (i) issuing shares of common stock other than pursuant to employee benefit plans; (ii) issuing shares of preferred stock or similar securities other than to refinance existing obligations or to fund permitted investment or capital expenditures; and (iii) incurring indebtedness other than pursuant to existing credit facilities, in the ordinary course of business, or to fund permitted projects or capital expenditures. These limitations do not preclude CSW and its subsidiaries from making investments and expenditures in amounts previously budgeted. Cook Nuclear Plant On June 25, 1999, AEP announced a comprehensive plan to restart the idle Cook nuclear power plant. Unit 2 is scheduled to return to service in April 2000, and Unit 1 is scheduled to return to service in September 2000. AEP stated that its announcement follows a comprehensive systems readiness review of all operating systems at Cook nuclear power plant and a cost/benefit analysis of whether to restart the plant or shut it down completely. Plant officials originally shut down both units of the facility, located in Bridgman, Michigan, 61 in September 1997 because of questions raised during a design inspection by the NRC. AEP estimated that its costs to restart the idle plant should be approximately $574 million of which $280 million has been spent through September 1999. Merger Regulatory Approvals The merger is conditioned, among other things, upon the approval of several state and federal regulatory agencies. General Testimony submitted in the filings in Arkansas, Louisiana, Oklahoma, Texas and at the FERC outlined the expected company-wide benefits of the merger to AEP and CSW customers and shareholders. FERC On April 30, 1998, AEP and CSW jointly filed a request with the FERC for approval of their proposed merger. On May 25, 1999, AEP and CSW announced they had reached a settlement with the FERC trial staff resolving competition and rate issues relating to the proposed merger. On July 13, 1999, AEP and CSW reached an additional settlement with the FERC trial staff resolving additional issues. The settlement has been submitted to the FERC for approval. Under the terms of the settlements, in June 1999 AEP filed with the FERC a regional transmission organization proposal whereby it will transfer the operation and control of AEP's bulk transmission facilities to an undetermined independent system operator. The transmission facilities subject to this commitment are located in Indiana, Kentucky, Michigan, Ohio, Tennessee, Virginia and West Virginia. The settlements also cover rates for transmission services and ancillary services as well as resolving issues related to the system integration agreement, the transmission reassignment tariff and the system transmission integration agreement. The settlements confirm, subject to FERC guidance on certain elements, that the proposed generation divestiture will satisfy the market power concerns of the FERC staff. In their merger filing with the FERC, AEP and CSW proposed divesting ownership of 300 MW of generation capacity at PSO's Northeastern Power Station Units 3 and 4 in Oklahoma and 250 MW of generation capacity at the Frontera power plant, a merchant plant constructed in Texas by a CSW subsidiary. On June 28, 1999, AEP and CSW filed a motion asking the FERC to waive the requirement for a post-hearing decision by the ALJ and consideration of the matter by the FERC based on the hearing record and briefs. The FERC subsequently issued an order requiring the ALJ to issue an initial decision as soon as possible, but no later than November 24, 1999. The FERC order also set a procedural schedule that should allow the FERC to issue a final order in the first quarter of 2000. AEP and CSW have reached settlements with the Missouri Public Service Commission and various wholesale customers and intervenors in the FERC merger proceeding. Hearings at the FERC concluded on July 19, 1999. Arkansas On June 12, 1998, AEP and CSW jointly filed a request with the Arkansas Commission for approval of the proposed merger. The Arkansas Commission issued an order approving the merger on August 13, 1998, subject to approval of the associated regulatory plan. On December 17, 1998, the Arkansas Commission issued a final order granting conditional approval of a stipulated agreement related to a proposed merger regulatory plan. The stipulated agreement calls for SWEPCO to 62 reduce rates through a net merger savings rider for its Arkansas retail customers by $6 million over the five-year period following completion of the merger. The Arkansas Commission order notes the possibility of decisions in other jurisdictions adversely affecting provisions of the stipulated agreement. Consequently, the Arkansas Commission conditioned its final order on its consideration of approval of the merger in other state and federal jurisdictions. Louisiana On May 15, 1998, AEP and CSW jointly filed a request with the Louisiana Commission for approval of the proposed merger and for a finding that the merger is in the public interest. On September 27, 1999, the Louisiana Commission issued a final order granting conditional approval of the pending merger between AEP and CSW. In granting approval, the Louisiana Commission also approved a stipulated settlement with the Louisiana Commission staff. Under the stipulated settlement, AEP and CSW have agreed to share with SWEPCO's Louisiana customers merger savings created as a result of the merger over the eight years following its completion. A savings mechanism will be implemented to calculate merger savings annually. AEP and CSW estimate that the customer rate credits in Louisiana will total more than $18 million during that eight-year period. During the second year following completion of the merger, customers will begin receiving a monthly rate credit for 50% of calculated merger savings. This credit will be updated annually and continue for the remainder of the eight-year period following the merger's completion. Oklahoma On August 14, 1998, AEP and CSW jointly filed a request with the Oklahoma Commission for approval of their proposed merger. An amended application was filed with the Oklahoma Commission on February 25, 1999. On May 11, 1999, the Oklahoma Commission approved the proposed merger between AEP and CSW. The approval follows a partial settlement between the Oklahoma Commission Utility Division Staff, the Oklahoma Commission Consumer Services Division, the Office of the Attorney General for Oklahoma, PSO, AEP and CSW. The Oklahoma Commission order was appealed by the Municipal Electric Systems of Oklahoma, Inc. and the Oklahoma Association of Electric Cooperatives. On October 13, 1999, the Oklahoma Supreme Court dismissed the appeal of the Oklahoma Association of Electric Cooperatives. The Municipal Electric System of Oklahoma, Inc. withdrew its appeal and the Oklahoma Association of Electric Cooperatives filed a motion to dismiss its appeal of the Oklahoma Commission order approving the merger. Under the partial settlement agreement, AEP and CSW would: (i) share merger savings with Oklahoma customers as well as AEP shareholders, effective with the merger closing; (ii) not increase Oklahoma base rates prior to January 1, 2003; (iii) file by December 31, 2001 with the FERC an application to join a regional transmission organization; and (iv) establish additional quality of service standards for PSO's retail customers. Oklahoma's share of the $50.2 million in guaranteed net merger savings over the first five years after the merger is consummated would be split between Oklahoma customers and AEP shareholders, with customers receiving approximately 55% of the savings. The Oklahoma Commission has withdrawn its opposition to the merger at the FERC. Texas On April 30, 1998, AEP and CSW jointly filed a request with the Texas Commission for a finding that the merger is in the public interest. On May 4, 1999, AEP and CSW announced a proposed settlement with several intervenor groups for the proposed merger between AEP and CSW. The settlement would result in combined rate reductions totaling $221 million over a six-year 63 period for Texas customers of the three CSW Texas electric operating companies (CPL, SWEPCO and WTU) if the merger is completed as planned and issues are resolved associated with CPL, SWEPCO and WTU rate and fuel reconciliation proceedings. The settlement was reached with the General Counsel of the Texas Commission, the State of Texas, the Texas Industrial Energy Consumers, the Low Income Intervenors, the Office of Public Utility Counsel of Texas and the steering committee of the Cities of McAllen, Corpus Christi, Victoria, Abilene, Big Lake, Vernon and Paducah. The settlement expands upon a previous Texas settlement announced on November 12, 1998, with the Office of Public Utility Counsel of Texas and the cities' steering committee. That prior settlement agreement provided for Texas retail rate reductions of $180 million over the six years following completion of the merger. The new settlement agreement proposes additional rate reductions totaling $41 million for a total of $221 million. The settlement also calls for the divestiture of a total of 1,604 MW of existing and proposed generating capacity within Texas. The first rate-reduction rider provides for $84.4 million in net-merger savings. The amounts are to be credited to Texas customers' bills through a net-merger-savings rate-reduction rider over six years following completion of the merger. Additional rate-reduction riders will be implemented to resolve issues associated with CPL, WTU and SWEPCO rate and fuel reconciliation proceedings and court appeals in Texas. The settlement provides for an additional reduction of $136.6 million, which will be implemented over the six years following completion of the merger. Hearings on the merger in Texas began August 9, 1999 and concluded on August 10, 1999. As the hearings began, settlements were reached with all but one of the parties in the case. The settling parties are all wholesale electric customers of the three CSW Texas electric operating companies, and the settlements call for the withdrawal of their opposition to the merger in all regulatory approval proceedings. On October 1, 1999, an ALJ for the Texas State Office of Administrative Hearings issued a proposal for decision recommending that the Texas Commission approve the pending merger between AEP and CSW. In the proposal for decision, the ALJ determined that, consistent with the terms of the proposed settlement, the merger is in the public interest. On November 2, 1999, the Texas Commission approved the proposed merger with AEP. NRC On June 19, 1998, CPL filed a license transfer application with the NRC requesting the NRC's consent to the indirect transfer of control of CPL's interests in the NRC licenses issued for STP from CSW to AEP. CPL would continue to own its 25.2% interest in STP, and CPL's name would remain on the NRC operating license. On November 5, 1998, the NRC approved the license transfer application with a condition that the merger must be completed by December 31, 1999. CPL will request an extension of the license transfer with the NRC in the fourth quarter of 1999. Other Federal On October 13, 1998, AEP and CSW jointly filed an application with the SEC for approval of the proposed merger. The SEC merger filing is similar to requests currently pending before other jurisdictions and outlines the expected combined company benefits of the merger to AEP and CSW customers and shareholders. Since then, AEP and CSW have filed several amendments to the application. Several parties have filed petitions opposing the proposed merger at the SEC. On July 23, 1999, AEP and CSW filed a brief in response to the intervenor petitions at the SEC. AEP and CSW will file a further amendment to the application in the fourth quarter of 1999. 64 On July 29, 1999, applications were made with the FCC to authorize the transfer of control of licenses of several CSW entities to AEP. The granting of such authority is expected by the end of 1999 and will be effective upon completion of the proposed merger. On July 26, 1999, AEP and CSW submitted filings to the Department of Justice under the Hart-Scott-Rodino Antitrust Improvements Act of 1976. On August 26, 1999, AEP and CSW received a request for additional information from the Department of Justice. AEP and CSW plan to file the additional information with the Department of Justice in the fourth quarter of 1999. United Kingdom CSW has a 100% interest in SEEBOARD and AEP has a 50% interest in Yorkshire. The proposed merger of CSW into AEP would result in common ownership of the United Kingdom entities. Although the merger of CSW into AEP is not subject to approval of United Kingdom regulatory authorities, the common ownership of the United Kingdom entities could be referred by the United Kingdom Secretary of State for Trade and Industry for an investigation by the United Kingdom Competition Commission. CSW is unable to predict the ultimate outcome of any such regulatory proceeding. AEP On April 20, 1999, AEP reached a settlement with the Indiana Utility Regulatory Commission staff addressing matters pertinent to Indiana regarding the proposed merger. The Indiana Utility Regulatory Commission approved the settlement on April 26, 1999. The settlement agreement resulted from an investigation of the proposed merger between AEP and CSW initiated by the Indiana Utility Regulatory Commission. On April 21, 1999, AEP and CSW announced that they had reached separate settlements with six wholesale customers that address issues related to the proposed merger. On April 28, 1999, AEP and CSW announced that they ratified a settlement agreement with local unions of the IBEW representing employees of AEP and CSW. The settlement agreement covered issues related to the pending merger between AEP and CSW. As part of the settlement, the IBEW local unions have withdrawn their opposition to the merger. On May 26, 1999, AEP and CSW announced that they had reached a settlement agreement with the Kentucky Attorney General and several AEP customers in Kentucky addressing matters pertinent to Kentucky regarding the pending merger between AEP and CSW. The Kentucky Public Service Commission has approved the settlement. On August 6, 1999, AEP announced that it had ratified a settlement agreement with local unions of the UWUA representing employees of AEP. The settlement agreement covered issues raised in the pending merger between AEP and CSW. As part of the settlement, the UWUA local unions will not oppose the merger. On October 21, 1999, the Public Utility Commission of Ohio issued a decision stating that it will notify the FERC that it is no longer opposed to AEP's proposed merger with CSW and that it will no longer seek conditions to the merger. 65 Completion of the Merger AEP and CSW have targeted consummation of the AEP Merger in the second quarter of 2000. The merger is conditioned, among other things, upon the approval of several state and federal regulatory agencies. The transaction must satisfy many conditions, including the condition that it must be accounted for as a pooling of interests. The parties may not waive some of these conditions. AEP and CSW continue the process of seeking regulatory approvals, but there can be no assurance as to when, on what terms or whether the required approvals will be received or whether there will be any regulatory proceedings in the United Kingdom. After December 31, 1999, either CSW or AEP may terminate the merger agreement if all of the conditions to its obligation to close have not been satisfied, provided that either party may extend the merger agreement, under certain circumstances, through June 30, 2000. There can be no assurance that the AEP Merger will be consummated. Merger Costs As of September 30, 1999, CSW had deferred $38.6 million in costs related to the AEP Merger on its consolidated balance sheet, which will be charged to expense if AEP and CSW are not successful in completing their proposed merger. 6. BUSINESS SEGMENTS CSW's business segments include the U.S. Electric and U.K. Electric segments. The U.S. Electric segment is comprised of CSW's four domestic electric operating companies, CPL, PSO, SWEPCO and WTU. The U.K. Electric segment is comprised of CSW's foreign electric operating company, SEEBOARD USA. The U.S. Electric segment's primary business is the generation, transmission and distribution of electricity. The U.K. Electric segment's primary business is the supply and distribution of electricity. Financial data for each business segment for the three-month and nine-month periods ended September 30, 1999 and 1998, respectively, covered is set forth below. U.S. U.K. Other and CSW Electric Electric Reconciling Consolidated ---------------------------------------------- (millions) Three months ended September 30, 1999 Operating Revenues $1,170 $354 $94 $1,618 Income/(Loss) before Extraordinary Item 221 19 (10) 230 Three months ended September 30, 1998 Operating Revenues $1,172 $352 $57 $1,581 Income/(Loss) before Extraordinary Item 230 31 (28) 233 U.S. U.K. Other and CSW Electric Electric Reconciling Consolidated ---------------------------------------------- (millions) Nine months ended September 30, 1999 Operating Revenues $2,758 $1,192 $212 $4,162 Income/(Loss) before Extraordinary Item 353 63 (38) 378 Total Assets at September 30, 1999 8,999 3,089 2,343 14,431 Total Assets at December 31, 1998 8,994 3,032 1,871 13,897 Nine months ended September 30, 1998 Operating Revenues $2,746 $1,288 $148 $4,182 Income/(Loss) before Extraordinary Item 370 85 (56) 399 Total Assets at September 30, 1998 9,117 3,136 2,008 14,261 Total Assets at December 31, 1997 9,186 2,931 1,499 13,616 66 7. SOUTH AMERICAN INVESTMENTS Through September 30, 1999, CSW International had purchased a 36% equity interest in Vale for $80 million. CSW International also extended $100 million of debt to Vale. CSW International anticipates converting $69 million of the debt to equity by the end of 1999 with the remainder to be converted over the next two years. Currently, CSW International accounts for its $80 million investment in Vale on the equity method of accounting, and the $100 million of debt as a loan. In mid-January 1999, amid market instability, the Brazilian government abandoned its policy of pegging the Brazilian Real in a broad range against the dollar. This action resulted in a 45% devaluation of the Brazilian currency by the end of September 1999. Vale is unfavorably affected by the devaluation due primarily to the revaluation of foreign denominated debt. CSW International has a put option, which, if exercised, requires Vale to purchase its shares from CSW International at a minimum price equal to the purchase price paid for the shares by CSW International. As a result of the put option arrangement, management has concluded that CSW International's investment carrying amount will not be reduced below the put option value unless there is deemed to be a permanent impairment. Pursuant to the put option arrangement, CSW International will not recognize its proportionate share of any future earnings until its proportionate share of any losses of Vale are recognized. At September 30, 1999, CSW International had deferred losses, after tax, of approximately $23 million related to its Vale investment. CSW International views its investment in Vale as a long-term investment, which has significant long-term value. Management will continue to closely evaluate the changes in the Brazilian economy and its impact on CSW International's investment in Vale. As of September 30, 1999, CSW International had invested $110 million in stock of a Chilean electric company. The investment is classified as securities available for sale and accounted for by the cost method. Based on the market value of the shares and foreign exchange rates, the value of the investment at September 30, 1999 was $62 million. The reduction in the carrying value of this investment has been reflected in Other Comprehensive Income in CSW's Consolidated Statements of Stockholders' Equity. Management views its investment in Chile as a long-term investment strategy and believes this investment continues to have significant long-term value and that it is recoverable. Management will continue to closely evaluate the changes in the South American economy and its impact on CSW International's investment in the Chilean electric company. 8. LONG-TERM DEBT In November 1999, Matagorda County Navigation District No. 1 (Texas) will sell for the benefit of CPL $111.7 million of 4.90% Series 1999A and $50.0 million of 4.95% Series 1999B unsecured tax exempt pollution control revenue refunding bonds. The bonds mature in 2030 but will be subject to remarketing and an interest rate reset in two years. The proceeds will be used to refund $111.7 million aggregate principal amount of outstanding Matagorda 7-1/2% Series 1984A bonds due December 15, 2014 and $50.0 million aggregate principal amount of outstanding 7-1/2% Matagorda Series 1990 bonds due March 21, 2020. In July 1999, the Oklahoma Development Finance Authority sold for the benefit of PSO $33.7 million of 4-7/8% unsecured tax exempt pollution control revenue refunding bonds. The bonds mature in fifteen years but will be subject to remarketing and an interest rate reset in five years. In late August 1999, the proceeds were used to refund $33.7 million aggregate principal amount of outstanding Oklahoma Environmental Finance Authority (PSO Project) 5.9% Series A bonds due December 1, 2007. 67 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Reference is made to Management's Discussion and Analysis of Financial Condition and Results of Operations included in the Registrants' Combined Annual Report on Form 10-K for the year ended December 31, 1998 and the Registrants' Combined Quarterly Reports on Form 10-Q for the quarters ended March 31, 1999 and June 30, 1999. Reference is also made to each Registrant's unaudited Financial Statements and related Notes to Financial Statements included in this document. The information should be read in conjunction with, and is essential to understanding, the following discussion and analysis. RESULTS OF OPERATIONS Reference is made to ITEM 1. FINANCIAL STATEMENTS for each of the Registrants' RESULTS OF OPERATIONS for the three month and nine month periods ended September 30, 1999. LIQUIDITY AND CAPITAL RESOURCES Overview of CSW Operating, Investing, and Financing Activities Net cash inflows from operating activities decreased $172 million to $452 million for the nine month period ended September 30, 1999 compared to the same period last year due primarily to decreased fuel recoveries from customers. Also contributing to the decrease in cash flows from operating activities was a decrease in accrued taxes for the comparison periods due primarily to lower pre-tax income and a larger refund received in 1998. Further contributing to the decrease in cash flows from operating activities were increased payments on accounts payable. Partially offsetting the decrease in cash flows from operating activities was a lower change in accounts receivable balance in 1999 compared to 1998 resulting from more favorable collections. Further offsetting the decrease in cash flows from operating activities was the absence in 1999 of a refund paid to CPL customers in the first six months of 1998. Net cash outflows from investing activities increased $84 million to $565 million during the first nine months of 1999 compared to the same period a year ago. The increase in net cash outflows from investing activities resulted primarily from higher levels of spending in 1999 for CSW Energy projects, U.S. Electric Operating Companies' construction expenditures and U.K. Electric's construction expenditures. Also contributing to the increase in net cash outflows from investing activities was the assumption in 1998 by CSW International's Altamira partner, Alpek, of a 50% obligation related to a power plant project, which was not present in 1999. Partially offsetting the increase in cash outflows from investing activities was the absence in 1999 of additional CSW International loans to Vale and lower construction expenditures in 1999 at C3 Communications. Net cash inflows from financing activities increased $155 million to $118 million for the first nine months of 1999 compared to the same period in 1998. The increase was due primarily to the absence in 1999 of the repayment of a $60 million variable rate bank loan at CSW Services and the redemption of $28 million of preferred stock at SWEPCO. Also contributing to the increase in cash flows from financing activities was a lower change in short-term debt due primarily to lower interest rates and the absence in 1999 of the CPL 1998 bonded rate refund. Partially offsetting the increase in net cash inflows was a higher level of long-term maturities and reacquisitions in 1999 compared to 1998. Construction Expenditures CSW's construction expenditures, including allowance for funds used during construction, totaled $549 million for the nine months ended September 30, 1999. Such expenditures for the U.S. Electric Operating Companies totaled $141 68 million, $74 million, $74 million and $36 million, for CPL, PSO, SWEPCO and WTU, respectively. Construction expenditures at the U.S. Electric Operating Companies were due primarily to improvements to existing production, transmission and distribution facilities. The improvements are required to meet the needs of new customers and the changing requirements of existing customers. CSW anticipates that substantially all funds required for construction for the remainder of the year will be provided from internal sources. Other Financing Issues The CSW System uses short-term debt to meet fluctuations in working capital requirements and other interim capital needs. CSW has established a system money pool to coordinate short-term borrowings for certain of its subsidiaries, primarily the U.S. Electric Operating Companies. In addition, CSW also incurs borrowings for other subsidiaries that are not included in the money pool. As of September 30, 1999, CSW had revolving credit facilities totaling $1.4 billion to back up its commercial paper program. On June 25, 1999, CSW Credit closed its third amended and restated secured revolving credit agreement. The $1.2 billion facility will expire on June 23, 2000. On April 2, 1999, C3 Communications announced a major expansion of C3 Networks, its long haul fiber network division. C3 Networks plans to invest over $26 million in existing routes and new construction in 1999, of which $13 million was spent through September 30, 1999. C3 Networks delivers networking and services in Texas and Louisiana and plans to expand the network to Oklahoma. In November 1999, Matagorda County Navigation District No. 1 (Texas) will sell for the benefit of CPL $111.7 million of 4.90% Series 1999A and $50.0 million of 4.95% Series 1999B unsecured tax exempt pollution control revenue refunding bonds. The bonds mature in 2030 but will be subject to remarketing and an interest rate reset in two years. The proceeds will be used to refund $111.7 million aggregate principal amount of outstanding Matagorda 7-1/2% Series 1984A bonds due December 15, 2014 and $50.0 million aggregate principal amount of outstanding 7-1/2% Matagorda Series 1990 bonds due March 21, 2020. In July 1999, the Oklahoma Development Finance Authority sold for the benefit of PSO $33.7 million of 4-7/8% unsecured tax-exempt pollution control revenue refunding bonds. The bonds mature in fifteen years but will be subject to remarketing and an interest rate reset in five years. In August 1999, the proceeds were used to refund $33.7 million aggregate principal amount outstanding of Oklahoma Environmental Finance Authority (PSO Project) 5.9% Series A bonds due December 1, 2007. The foregoing discussion of liquidity and capital resources contains forward-looking information within the meaning of Section 21E of the Exchange Act. Actual results may differ materially from such projected information due to changes in the underlying assumptions. See FORWARD-LOOKING INFORMATION. PROPOSED AEP MERGER On December 22, 1997, CSW and AEP announced that their boards of directors had approved a definitive merger agreement for a tax-free, stock-for-stock transaction. The combined company would serve more than 4.6 million customers in 11 states and approximately 4 million customers outside the United States. On May 27, 1998, AEP shareholders approved the issuance of the additional shares of stock required to complete the merger. On May 28, 1998, CSW stockholders approved the merger. Under the merger agreement, each common share of CSW will be converted into 0.6 share of AEP common stock. CSW stockholders will own approximately 40% of the combined company. CSW plans to continue to pay dividends on its common stock until the closing of the AEP Merger at approximately the same times and 69 rates per share as in 1998, subject to continuing evaluation of CSW's financial condition, earnings, prospects and other factors by the CSW Board of Directors. Under the merger agreement, there will be no changes required with respect to the public debt issues, the outstanding preferred stock or the Trust Preferred Securities of CSW's subsidiaries. AEP and CSW anticipate net savings related to the merger of approximately $2 billion over a 10-year period from the elimination of duplication in corporate and administrative programs, greater efficiencies in operations and business processes, increased purchasing efficiencies and the combination of the two work forces. AEP and CSW continue to seek opportunities for additional savings. At the same time, the companies expect to continue their commitment to high quality, reliable service. Job reductions related to the merger are expected to be approximately 1,050 out of a total domestic workforce of approximately 25,000. The combined company expects to use a combination of growth, reduced hiring and attrition to minimize the need for employee separations. Transition teams of employees from both companies will make organizational and staffing recommendations. The electric systems of AEP and CSW will operate on an integrated and coordinated basis as required by the Holding Company Act. AEP and CSW project fuel savings of approximately $98 million over a 10-year period resulting from the coordinated operation of the combined company, which will be passed through to customers. The merger agreement contains covenants and agreements that restrict the manner in which the parties may operate their respective businesses until the time of closing of the merger. In particular, without the prior written consent of AEP, CSW may not engage in a number of activities that could affect its sources and uses of funds. Pending closing of the merger, CSW's and its subsidiaries' strategic investment activity, capital expenditures and non-fuel operating and maintenance expenditures are limited to specific agreed upon projects and in agreed upon amounts. In addition, prior to consummation of the merger, CSW and its subsidiaries are restricted from: (i) issuing shares of common stock other than pursuant to employee benefit plans; (ii) issuing shares of preferred stock or similar securities other than to refinance existing obligations or to fund permitted investment or capital expenditures; and (iii) incurring indebtedness other than pursuant to existing credit facilities, in the ordinary course of business, or to fund permitted projects or capital expenditures. These limitations do not preclude CSW and its subsidiaries from making investments and expenditures in amounts previously budgeted. Cook Nuclear Plant On June 25, 1999, AEP announced a comprehensive plan to restart the idle Cook nuclear power plant. Unit 2 is scheduled to return to service in April 2000, and Unit 1 is scheduled to return to service in September 2000. AEP stated that its announcement follows a comprehensive systems readiness review of all operating systems at Cook nuclear power plant and a cost/benefit analysis of whether to restart the plant or shut it down completely. Plant officials originally shut down both units of the facility, located in Bridgman, Michigan, in September 1997 because of questions raised during a design inspection by the NRC. AEP estimated that its costs to restart the idle plant should be approximately $574 million of which $280 million has been spent through September 1999. Merger Regulatory Approvals The merger is conditioned, among other things, upon the approval of several state and federal regulatory agencies. General Testimony submitted in the filings in Arkansas, Louisiana, Oklahoma, Texas and at the FERC outlined the expected company-wide benefits of the merger to AEP and CSW customers and shareholders. 70 FERC On April 30, 1998, AEP and CSW jointly filed a request with the FERC for approval of their proposed merger. On May 25, 1999, AEP and CSW announced they had reached a settlement with the FERC trial staff resolving competition and rate issues relating to the proposed merger. On July 13, 1999, AEP and CSW reached an additional settlement with the FERC trial staff resolving additional issues. The settlement has been submitted to the FERC for approval. Under the terms of the settlements, in June 1999 AEP filed with the FERC a regional transmission organization proposal whereby it will transfer the operation and control of AEP's bulk transmission facilities to an undetermined independent system operator. The transmission facilities subject to this commitment are located in Indiana, Kentucky, Michigan, Ohio, Tennessee, Virginia and West Virginia. The settlements also cover rates for transmission services and ancillary services as well as resolving issues related to the system integration agreement, the transmission reassignment tariff and the system transmission integration agreement. The settlements confirm, subject to FERC guidance on certain elements, that the proposed generation divestiture will satisfy the market power concerns of the FERC staff. In their merger filing with the FERC, AEP and CSW proposed divesting ownership of 300 MW of generation capacity at PSO's Northeastern Power Station Units 3 and 4 in Oklahoma and 250 MW of generation capacity at the Frontera power plant, a merchant plant being constructed in Texas by a CSW subsidiary. On June 28, 1999, AEP and CSW filed a motion asking the FERC to waive the requirement for a post-hearing decision by the ALJ and consideration of the matter by the FERC based on the hearing record and briefs. The FERC subsequently issued an order requiring the ALJ to issue an initial decision as soon as possible, but no later than November 24, 1999. The FERC order also set a procedural schedule that should allow the FERC to issue a final order in the first quarter of 2000. AEP and CSW have reached settlements with the Missouri Public Service Commission and various wholesale customers and intervenors in the FERC merger proceeding. Hearings at the FERC concluded July 19, 1999. Arkansas On June 12, 1998, AEP and CSW jointly filed a request with the Arkansas Commission for approval of the proposed merger. The Arkansas Commission issued an order approving the merger on August 13, 1998, subject to approval of the associated regulatory plan. On December 17, 1998, the Arkansas Commission issued a final order granting conditional approval of a stipulated agreement related to a proposed merger regulatory plan. The stipulated agreement calls for SWEPCO to reduce rates through a net merger savings rider for its Arkansas retail customers by $6 million over the five-year period following completion of the merger. The Arkansas Commission order notes the possibility of decisions in other jurisdictions adversely affecting provisions of the stipulated agreement. Consequently, the Arkansas Commission conditioned its final order on its consideration of approval of the merger in other state and federal jurisdictions. Louisiana On May 15, 1998, AEP and CSW jointly filed a request with the Louisiana Commission for approval of the proposed merger and for a finding that the merger is in the public interest. 71 On September 27, 1999, the Louisiana Commission issued a final order granting conditional approval of the pending merger between AEP and CSW. In granting approval, the Louisiana Commission also approved a stipulated settlement with the Louisiana Commission staff. Under the stipulated settlement, AEP and CSW have agreed to share with SWEPCO's Louisiana customers merger savings created as a result of the merger over the eight years following its completion. A savings mechanism will be implemented to calculate merger savings annually. AEP and CSW estimate that the customer rate credits in Louisiana will total more than $18 million during that eight-year period. During the second year following completion of the merger, customers will begin receiving a monthly rate credit for 50% of calculated merger savings. This credit will be updated annually and continue for the remainder of the eight-year period following the merger's completion. Oklahoma On August 14, 1998, AEP and CSW jointly filed a request with the Oklahoma Commission for approval of their proposed merger. An amended application was filed with the Oklahoma Commission on February 25, 1999. On May 11, 1999, the Oklahoma Commission approved the proposed merger between AEP and CSW. The approval follows a partial settlement between the Oklahoma Commission Utility Division Staff, the Oklahoma Commission Consumer Services Division, the Office of the Attorney General for Oklahoma, PSO, AEP and CSW. The Oklahoma Commission order was appealed by the Municipal Electric Systems of Oklahoma, Inc. and the Oklahoma Association of Electric Cooperatives. On October 13, 1999, the Oklahoma Supreme Court dismissed the appeal of the Oklahoma Association of Electric Cooperatives. The Oklahoma Association of Electric Cooperatives filed a motion to dismiss its appeal of the Oklahoma Commission order approving the merger. Under the partial settlement agreement, AEP and CSW would: (i) share merger savings with Oklahoma customers as well as AEP shareholders, effective with the merger closing; (ii) not increase Oklahoma base rates prior to January 1, 2003; (iii) file by December 31, 2001 with the FERC an application to join a regional transmission organization; and (iv) establish additional quality of service standards for PSO's retail customers. Oklahoma's share of the $50.2 million in guaranteed net merger savings over the first five years after the merger is consummated would be split between Oklahoma customers and AEP shareholders, with customers receiving approximately 55% of the savings. The Oklahoma Commission has withdrawn its opposition to the merger at the FERC. Texas On April 30, 1998, AEP and CSW jointly filed a request with the Texas Commission for a finding that the merger is in the public interest. On May 4, 1999, AEP and CSW announced a proposed settlement with several intervenor groups for the proposed merger between AEP and CSW. The settlement would result in combined rate reductions totaling $221 million over a six-year period for Texas customers of the three CSW Texas electric operating companies (CPL, SWEPCO and WTU) if the merger is completed as planned and issues are resolved associated with CPL, SWEPCO and WTU rate and fuel reconciliation proceedings. The settlement was reached with the General Counsel of the Texas Commission, the State of Texas, the Texas Industrial Energy Consumers, the Low Income Intervenors, the Office of Public Utility Counsel of Texas and the steering committee of the cities of McAllen, Corpus Christi, Victoria, Abilene, Big Lake, Vernon and Paducah. The settlement expands upon a previous Texas settlement announced on November 12, 1998, with the Office of Public Utility Counsel of Texas and the cities' steering committee. That prior settlement agreement provided for Texas retail rate reductions of $180 million over the six 72 years following completion of the merger. The new settlement agreement proposes additional rate reductions totaling $41 million for a total of $221 million. The settlement also calls for the divestiture of a total of 1,604 MW of existing and proposed generating capacity within Texas. The first rate-reduction rider provides for $84.4 million in net-merger savings. The amounts are to be credited to Texas customers' bills through a net-merger-savings rate-reduction rider over six years following completion of the merger. Additional rate-reduction riders will be implemented to resolve issues associated with CPL, WTU and SWEPCO rate and fuel reconciliation proceedings and court appeals in Texas. The settlement provides for an additional reduction of $136.6 million, which will be implemented over the six years following completion of the merger. Hearings on the merger in Texas began August 9, 1999 and concluded on August 10, 1999. As the hearings began, settlements were reached with all but one of the parties in the case. The settling parties are all wholesale electric customers of the three CSW Texas electric operating companies, and the settlements call for the withdrawal of their opposition to the merger in all regulatory approval proceedings. On October 1, 1999, an ALJ for the Texas State Office of Administrative Hearings issued a proposal for decision recommending that the Texas Commission approve the pending merger between AEP and CSW. In the proposal for decision, the ALJ determined that, consistent with the terms of the proposed settlement, the merger is in the public interest. On November 2, 1999, the Texas Commission approved the proposed merger with AEP. NRC On June 19, 1998, CPL filed a license transfer application with the NRC requesting the NRC's consent to the indirect transfer of control of CPL's interests in the NRC licenses issued for STP from CSW to AEP. CPL would continue to own its 25.2% interest in STP, and CPL's name would remain on the NRC operating license. On November 5, 1998, the NRC approved the license transfer application with a condition that the merger must be completed by December 31, 1999. CPL will request an extension for a license transfer with the NRC in the fourth quarter of 1999. Other Federal On October 13, 1998, AEP and CSW jointly filed an application with the SEC for approval of the proposed merger. The SEC merger filing is similar to requests currently pending before other jurisdictions and outlines the expected combined company benefits of the merger to AEP and CSW customers and shareholders. AEP and CSW have filed several amendments to the application. Several parties have filed petitions opposing the proposed merger at the SEC. On July 23, 1999, AEP and CSW filed a brief in response to the intervenor petitions at the SEC. AEP and CSW will file an amendment to the application in the fourth quarter of 1999. On July 29, 1999, applications were made with the FCC to authorize the transfer of control of licenses of several CSW entities to AEP. The granting of such authority is expected by the end of 1999 and will be effective upon completion of the proposed merger. On July 26, 1999, AEP and CSW submitted filings to the Department of Justice under the Hart-Scott-Rodino Antitrust Improvements Act of 1976. On August 26, 1999, AEP and CSW received a request for additional information from the Department of Justice. AEP and CSW plan to file the additional information with the Department of Justice in the fourth quarter of 1999. 73 United Kingdom CSW has a 100% interest in SEEBOARD and AEP has a 50% interest in Yorkshire. The proposed merger of CSW into AEP would result in common ownership of the United Kingdom entities. Although the merger of CSW into AEP is not subject to approval of United Kingdom regulatory authorities, the common ownership of the United Kingdom entities could be referred by the United Kingdom Secretary of State for Trade and Industry for an investigation by the United Kingdom Competition Commission. CSW is unable to predict the ultimate outcome of any such regulatory proceeding. AEP On April 20, 1999, AEP reached a settlement with the Indiana Utility Regulatory Commission staff addressing matters pertinent to Indiana regarding the proposed merger. The Indiana Utility Regulatory Commission approved the settlement on April 26, 1999. The settlement agreement resulted from an investigation of the proposed merger between AEP and CSW initiated by the Indiana Utility Regulatory Commission. On April 21, 1999, AEP and CSW announced that they had reached separate settlements with six wholesale customers that address issues related to the proposed merger. On April 28, 1999, AEP and CSW announced that they ratified a settlement agreement with local unions of the IBEW representing employees of AEP and CSW. The settlement agreement covered issues related to the pending merger between AEP and CSW. As part of the settlement, the IBEW local unions have withdrawn their opposition to the merger. On May 26, 1999, AEP and CSW announced that it had reached a settlement agreement with the Kentucky Attorney General and several AEP customers in Kentucky addressing matters pertinent to Kentucky regarding the pending merger between AEP and CSW. The Kentucky Public Service Commission has approved the settlement. On August 6, 1999, AEP announced that they ratified a settlement agreement with local unions of the UWUA representing employees of AEP. The settlement agreement covered issues raised in the pending merger between AEP and CSW. As part of the settlement, the UWUA local unions will not oppose the merger. On October 21, 1999, the Public Utility Commission of Ohio issued a decision stating that it will notify the FERC that it is no longer opposed to AEP's proposed merger with CSW and that it will no longer seek conditions on the merger. Completion of the Merger AEP and CSW have targeted consummation of the AEP Merger to occur in the second quarter of 2000. The merger is conditioned, among other things, upon the approval of several state and federal regulatory agencies. The transaction must satisfy many conditions, including the condition that it must be accounted for as a pooling of interests. The parties may not waive some of these conditions. AEP and CSW have initiated the process of seeking regulatory approvals, but there can be no assurance as to when, on what terms or whether the required approvals will be received or whether there will be any regulatory proceedings in the United Kingdom. After December 31, 1999, either CSW or AEP may terminate the merger agreement if all of the conditions to its obligation to close have not been satisfied, provided that either party may extend the merger agreement, under certain circumstances, through June 30, 2000. There can be no assurance that the AEP Merger will be consummated. 74 Merger Costs As of September 30, 1999, CSW had deferred $38.6 million in costs related to the AEP Merger on its consolidated balance sheet, which will be charged to expense if AEP and CSW are not successful in completing their proposed merger. RECENT DEVELOPMENTS AND TRENDS Industry restructuring and legislative initiatives in the U.S. Congress Several bills have been introduced in the 106th U.S.Congress which provide for the restructuring and/or deregulating of the electric utility industry. Most of the bills seek to clarify state authority to mandate retail choice, repeal the Holding Company Act, repeal prospectively the Public Utility Regulatory Policies Act of 1978, expand FERC authority over public power entities, address transmission reliability, and other issues. Recently, HR 2944 "The Electricity Competition and Reliability Act" was reported by the House Commerce Subcommittee on Energy and Power on October 27, 1999. Among other provisions, if enacted, the legislation would repeal the Holding Company Act twelve months after the bill is signed into law and clarifies that states have the authority to order retail competition without a federal mandate. Management cannot predict the ultimate outcome of any legislative initiatives. Industry Restructuring Legislation in Texas, Louisiana, Oklahoma and Arkansas Several initiatives to restructure the electric utility industry and enact retail competition have been undertaken in the four states in which the U.S. Electric Operating Companies operate. Legislation was enacted in Oklahoma in 1997 and 1998, and in Texas and Arkansas in 1999. CSW will make business unbundling plan filings in Texas and Arkansas in the first quarter of 2000 as required by the legislation. Legislative activity in Louisiana has, to date, stopped short of any such definitive action. Oklahoma In 1997, the Oklahoma Legislature passed restructuring legislation providing for retail access by July 1, 2002. That legislation called for a number of studies to be completed on a variety of restructuring issues, including independent system operator issues, technical issues, financial issues, transition issues and consumer issues. The study on independent system operator issues was completed in January 1998. In 1998, the Oklahoma Legislature passed Senate Bill 888, which accelerated the schedule for completion of the remaining studies to October 1999. Those studies were conducted under the direction of the Legislative Joint Electric Utility Task Force, rather than by the Oklahoma Commission as the previous legislation required. The task force organized the study effort into several working groups, which were directed to evaluate assigned issues. On October 1, 1999, the task force completed its report to the Oklahoma Legislature based on the work performed by these working groups. The report primarily is a compilation of the positions taken by the various parties participating in the working groups. The information in the report is expected to be used in the development of additional industry legislation during the 2000 legislative session. Management is unable to predict the ultimate impact of the report or the effects of any 2000 industry restructuring legislation on the results of operations and financial condition of CSW and PSO. Louisiana In 1998, a special legislative committee created by the Louisiana Senate studied the impact of retail competition on the state of Louisiana. No legislation has been enacted as a result of that effort. In addition, during 1998 and 1999, the Louisiana Commission conducted a proceeding to study restructuring and retail competition. Since the Louisiana Commission is a constitutionally created body, it can implement industry restructuring on its own without additional legislation. Parties submitted comments, and hearings 75 were held on a number of specific restructuring topics. Also, as a part of that proceeding, utilities filed rate unbundling information with the Louisiana Commission staff. As a result of that proceeding, the Louisiana Commission staff released its report on industry restructuring, including its recommendations regarding retail competition in Louisiana. In its report, the Louisiana Commission staff recommended that electric industry restructuring should not proceed at this time because it is not in the public interest. However, the Louisiana Commission staff proposed a restructuring plan as an alternative, in the event the Louisiana Commission decides to move forward with the electric industry restructuring and retail competition. The Louisiana Commission voted to begin additional study and analysis of the issues associated with restructuring and has adopted a procedural schedule that will result in a final restructuring plan by January 1, 2001. Other Management cannot predict the ultimate outcome of the initiatives concerning restructuring and retail competition in Arkansas, Louisiana, Texas and Oklahoma, or their ultimate impact on the results of operations, financial condition, or competitive position of CSW and the U.S. Electric Operating Companies. The foregoing discussion constitutes forward-looking information within the meaning of Section 21E of the Exchange Act. Actual results may differ materially from such projected information. See FORWARD -LOOKING INFORMATION. SEEBOARD Third Party Pension Litigation In the U.K., National Grid Group and National Power have been involved in continuing litigation regarding their use of actuarial surpluses set forth in the electricity industry's occupational pension plan, the ESPS. A High Court decision in favor of the National Grid Group and National Power was appealed. On February 10, 1999, the U.K. Court of Appeal ruled that the particular arrangements made by these corporations to dispose of part of the surplus were invalid due to procedural defects. This decision was confirmed at a later hearing of the U.K. Court of Appeal held in May 1999, although an opportunity for an appeal to be taken to the House of Lords, the highest court of appeal in the U.K., was granted. SEEBOARD employees are members of the ESPS, and SEEBOARD has made similar use of its actuarial surplus. As a result of subsequent legal clarification of certain issues arising from the hearing held in May 1999, the potential impact of the ruling on SEEBOARD has increased. The amount of the payments cancelled by SEEBOARD, both for past and future liabilities, amounts, in the aggregate, to approximately $78 million, excluding interest. The U.K. Court of Appeal did not order the National Grid Group or National Power to make payment into the ESPS, and the court indicated that any requirement to make such payments would be extreme since the ESPS already is in surplus. In the event that the court finally decides a payment by SEEBOARD into the ESPS is necessary, such a payment is likely to create additional pension fund surplus, which the company should then be able to utilize over the next several years to reduce pension expense. The National Grid Group has indicated its intention to appeal to the House of Lords. The final outcome of this appeal cannot presently be determined. Management is unable currently to predict the amount of any payment that it may be required to make to ESPS or the effect, if any, of the ultimate outcome of the appeal on CSW's results of operations and financial condition. The foregoing discussion constitutes forward-looking information within the meaning of Section 21E of the Exchange Act. Actual results may differ materially from such projected information. See FORWARD -LOOKING INFORMATION. 76 RATES AND REGULATORY MATTERS Electric Utility Restructuring Legislation On June 18, 1999, legislation was signed into law in Texas that will restructure the electric utility industry in the state. The new law, among other things: gives Texas customers of investor-owned utilities the opportunity to choose their electric provider beginning January 1, 2002; provides for the recovery of stranded costs which are defined as the excess of net book value of generation assets over the defined market value of those assets; requires reductions in nitrogen oxide and sulfur dioxide emissions; provides a rate freeze until January 1, 2002 followed by a 6% rate reduction for residential and small commercial customers, additional rate reduction for low income customers and a number of customer protections and sets certain limits on capacity owned and controlled by power generation companies. Rural electric cooperatives and municipal electric systems can choose whether to participate in retail competition. Delivery of the electricity will continue to be the responsibility of the local electric transmission and distribution utility company at regulated prices. Each utility must unbundle its business activities into a retail electric provider, a power generation company and a transmission and distribution utility. CPL, SWEPCO and WTU will file their business separation or "unbundling" plans with the Texas Commission in January 2000. During 1999, legislation was also enacted in Arkansas that will ultimately restructure the electric utility industry in that state. SWEPCO will file a business unbundling plan in Arkansas in the first quarter of 2000 as required by the legislation. The financial statements of the U.S. Electric Operating Companies have historically reflected the effects of applying the requirements of SFAS No. 71. Pursuant to those requirements, the U.S. Electric Operating Companies have recorded regulatory assets and liabilities (probable future revenues and refunds) to reflect the economic effect of cost-based regulation. When a company determines that its operations or a segment of its operations no longer meets the criteria for applying SFAS No. 71, it is required to apply the requirements of SFAS No. 101. Pursuant to those requirements and further guidance provided in EITF 97-4, a company is required to write off regulatory assets and liabilities related to deregulated operations, unless recovery of such amounts is provided through rates to be collected in a continuing regulated portion of the company's operations. Additionally, it is required to determine if any plant assets are impaired under SFAS No. 121. As a result of the scheduled deregulation of generation in Texas and Arkansas, CSW has concluded that it should discontinue the application of SFAS No. 71 for the Texas generation portion of the business for CPL and WTU and the Texas and Arkansas jurisdictional portions of the generation business for SWEPCO. Consequently, WTU recorded an extraordinary charge to earnings of $5.5 million and SWEPCO recorded an extraordinary charge to earnings of $3.0 million to reflect the effects of discontinuing the application of SFAS No. 71 and to write off net of regulatory assets that are not probable of recovery. The discontinuance of SFAS No. 71 for CPL did not result in a net charge to earnings as such net regulatory assets, pursuant to the legislation, are expected to be recovered from transmission and distribution customers through rates that will continue to be regulated. Electric utilities under the Texas Legislation are allowed to recover generation-related regulatory assets and stranded costs that otherwise may not be recoverable in the future competitive market. All or a majority of those costs can be refinanced through securitization, which is a financing designed to provide lower financing costs than is available through the conventional utility cost of capital model. The securitized amounts are then recovered through a non-bypassable charge. On October 18, 1999, CPL filed an application with the Texas Commission to securitize approximately $1.27 billion of its retail 77 generation-related regulatory assets and approximately $47 million in other qualified costs. If approval is received from the Texas Commission, CPL expects to issue the securitization bonds in March or April 2000, depending on market conditions and the timing of an order from the Texas Commission. A second phase of securitization relating to additional plant related stranded costs should occur in 2001 depending upon market conditions, timing and Texas Commission approvals. A non-bypassable charge may be used to recover additional unsecuritized stranded cost amounts. Under the provisions of EITF 97-4, CPL's generation-related net regulatory assets were transferred to the transmission and distribution portion of the business and will be amortized as they are recovered through charges to customers. Management currently believes all regulatory and stranded costs related to generation assets for CPL will be recovered as provided under Texas Legislation. CPL believes it will have stranded costs related to its generation assets in excess of the $1.27 billion of costs contained in its securitization filing made with the Texas Commission on October 18, 1999. If future events were to occur that made the recovery of these assets no longer probable, CPL would write off any non-recoverable portion of such assets as a non-cash charge to earnings. CPL's amount of regulatory assets and stranded costs are subject to a final determination by the Texas Commission in 2004. The Texas Legislation provides that all such finally determined stranded costs will be recovered. Since SWEPCO and WTU are not expected to have net stranded costs, all generation-related non-recoverable net regulatory assets were written off and reflected on the statement of income as an extraordinary item. Additionally, CPL, SWEPCO and WTU performed an accounting impairment analysis of generation assets under SFAS No. 121 at September 30, 1999 and concluded there was no impairment of generation assets at this time. An impairment analysis involves estimating future net cash flows arising from the use of an asset. If the net cash flows exceed the net book value of the asset, then there is no impairment of the asset for accounting purposes. CPL, SWEPCO and WTU will continue to review their assets for potential impairment if events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. The Texas Legislation also provides that each year during the 1999 through 2001 rate freeze period, utilities with stranded costs are required to apply any earnings in excess of the most recently approved cost of capital in a company's last rate case (if issued on or after January 1, 1992) to reduce stranded costs. As a result, CPL recorded a net charge to earnings of $4.6 million to reflect the impact of this provision. Utilities without stranded costs must either flow such amounts back to customers or make capital expenditures, at no charge to customers, to improve transmission or distribution facilities or to improve air quality. As a result, WTU recorded a charge to earnings of $6.4 million from the effect of the earnings cap under the Texas Legislation. The charges were based on estimates for the current year and are subject to final determination by the Texas Commission. Following CPL's discontinuation of SFAS No. 71, it is expected that any future excess earnings will only be applied to reduce stranded costs for regulatory purposes. The discontinuance of SFAS No. 71 for CPL's and WTU's Texas generation business and SWEPCO's Texas and Arkansas generation business requires that these businesses no longer defer costs or recognize liabilities strictly resulting from the actions of a regulator. For example, operations and maintenance expenditures will be expensed as incurred regardless of regulatory treatment. In addition, the equity component of allowance for funds used during construction can no longer be accrued for generation-related capital projects. Instead, the businesses will be required to follow the interest capitalization rules in SFAS No. 34. CSW continues to analyze the impact of the electric utility industry restructuring legislation on the U.S. Electric Operating Companies. The Texas Commission has established numerous task forces, including representatives from CPL, SWEPCO and WTU, to address various issues associated with the Texas Legislation and to provide guidance regarding implementation of restructuring. Based on the overall framework and objective of the Texas Legislation regarding 78 recovery of stranded costs and regulatory assets, and additional guidance obtained through participation in various task force workshop sessions, certain adjustments were recorded by CSW in the third quarter of 1999 to recognize the estimated effect of the legislation. CSW also recorded certain adjustments for the Arkansas jurisdictional portion of SWEPCO's generation business as a result of legislation enacted in Arkansas. As previously discussed, as a result of the Texas Legislation, CPL filed its application for securitization on October 18, 1999 with the Texas Commission. CPL, SWEPCO and WTU expect to make additional filings with the Texas Commission for business separation plans in January 2000, earnings cap reports in March 2000, cost unbundling plans in April 2000 and the ECOM reports in April 2000. The foregoing discussion constitutes forward-looking information within the meaning of Section 21E of the Exchange Act. Actual results may differ materially from such projected information. See FORWARD -LOOKING INFORMATION. Also see ITEM 2. MD&A - RECENT DEVELOPMENTS AND TRENDS, Texas for a discussion on legislation. CPL Rate Review - Docket No. 14965 In November 1995, CPL filed with the Texas Commission a request to increase its retail base rates by $71 million. On October 16, 1997, the Texas Commission issued the CPL 1997 Final Order. The CPL 1997 Final Order lowered the annual retail base rates of CPL by approximately $19 million or 2.5% from CPL's rate level existing prior to May 1996. The Texas Commission also included a "glide path" rate reduction methodology in the CPL 1997 Final Order pursuant to which CPL's annual rates would be reduced by $13 million on May 1, 1998 and an additional $13 million on May 1, 1999. CPL filed an appeal of the CPL 1997 Final Order to the State District Court of Travis County to raise several issues related to the rate case. The primary issues include: (i) the classification of $800 million of invested capital in STP as ECOM which was assigned a lower return on equity than non-ECOM property; (ii) the Texas Commission's application of the "glide path" rate reduction methodology applied on May 1, 1998 and May 1, 1999; and (iii) the $18 million of disallowed affiliate expenses from CSW Services. As part of the appeal, CPL sought a temporary injunction to prohibit the Texas Commission from implementing the "glide path" rate reduction methodology. The court denied the temporary injunction, and the "glide path" rate reductions were implemented in May 1998 and May 1999. Hearings on the appeal were held during the third quarter of 1998, and a judgment was issued in February 1999 affirming the Texas Commission order, except for a consolidated tax issue in the amount of $6 million, which was remanded to the Texas Commission. CPL filed an appeal of this most recent order to the Court of Appeals and management is unable to predict how the final resolution of these issues will ultimately affect CSW's and CPL's results of operations and financial condition. On May 4, 1999, AEP and CSW announced that they had reached a stipulated agreement with the General Counsel of the Texas Commission and other intervenors in the state of Texas related to the AEP/CSW merger case. The Texas Commission approved the AEP Merger in early November 1999. If the AEP Merger is ultimately consummated, CSW will withdraw its appeal with respect to the "glide path" rate reduction methodology as discussed above as issue "(ii)" but will continue seeking the appeal of issues "(i) and (iii)" also discussed above.. See NOTE 5. PROPOSED AEP MERGER and ITEM 2. MD&A - PROPOSED AEP MERGER for a discussion on the stipulated agreement. Also see ITEM 1 - NOTE 2. LITIGATION AND REGULATORY PROCEEDINGS, CPL Rate Review Docket No. 14965 for a discussion of the CPL 1997 Final Order. 79 SWEPCO Louisiana Rate Review In December 1997, the Louisiana Commission announced it would review SWEPCO's rates and service. The Louisiana Commission has selected consultants and legal counsel to perform a review of SWEPCO's rates and charges and to review SWEPCO's quality of service. The Louisiana Commission's legal counsel issued a report in June 1999, reflecting a Louisiana revenue excess of $28 million. SWEPCO believed the report contained significant theoretical and mathematical errors and filed its rebuttal testimony on August 10, 1999. In October 1999, SWEPCO and the Staff of the Louisiana Commission reached an Agreement and Stipulation, which was filed on October 14, 1999. In support of the Agreement and Stipulation, supplemental testimony was also filed. The provisions of the Agreement and Stipulation are: - - SWEPCO's Louisiana retail jurisdictional revenues are reduced by $11 million, effective with the December 1999 billing cycle; - - SWEPCO will be allowed to earn an 11.1% return on common equity; - - SWEPCO will recover certain regulatory assets totaling $7.1 million; - - SWEPCO will be subject to a two-year base rate freeze, which will be subject to force majeure provisions and; - - Increased depreciation rates for transmission, distribution and general plant. Hearings were held before an ALJ on October 19, 1999. To meet the December 1999 implementation date contemplated in the Agreement and Stipulation, an order from the Louisiana Commission must be received in November 1999. The Louisiana Commission is scheduled to vote on the Agreement and Stipulation at its November 17, 1999 meeting. SWEPCO Arkansas Rate Review In June 1998, the Arkansas Commission indicated that it would conduct a review of SWEPCO's earnings. The review began in July 1998. SWEPCO entered into a settlement with the general staff of the Arkansas Commission and the Arkansas Attorney General's Office. The settlement was filed on July 30, 1999 and reduces revenues $5.4 million or 3%. Additionally, the Stipulation and Settlement Agreement provides for a 10.75% return on common equity, an increase in depreciation rates, and an agreement by SWEPCO not to seek recovery of generation related stranded costs. On August 20, 1999, SWEPCO filed a Supplemental Stipulation and Settlement Agreement, which was reached with the one remaining party. The Supplemental Stipulation and Settlement Agreement did not alter or replace any of the original monetary terms of the Stipulation and Settlement Agreement filed on July 30, 1999. On September 23, 1999, the Arkansas Commission issued an order approving the Stipulation and Settlement Agreement and the Supplemental Stipulation and Settlement Agreement. On October 25, 1999, SWEPCO filed compliance rate tariffs with the Arkansas Commission, which are consistent with the Arkansas Commission order. After review of the compliance rate tariffs by the Staff of the Arkansas Commission, new rates will be implemented. SWEPCO anticipates implementing the new rates with the December 1999 billing cycle. Regulatory Draft Price Proposal for SEEBOARD On October 8, 1999, OFGEM published its revised draft price proposals and results from its current United Kingdom electricity distribution review. OFGEM has recommended revenue reductions in SEEBOARD's distribution business. In addition, OFGEM has proposed the reallocation of a further 12%, or $45 million 80 of pre-tax costs out of SEEBOARD's distribution business into its supply business. If adopted, these proposals would reduce net income for SEEBOARD in the year 2000 by $40 million, and by $60 million on an annual basis, dependent upon the level of further cost reductions that can be achieved. CSW's net income from SEEBOARD USA, its United Kingdom business segment, was $95 million for the twelve months ended September 30, 1999. SEEBOARD continues to analyze the draft recommendations and their potential effects on earnings and to seek a reduction in the severity of OFGEM's proposed recommendations. SEEBOARD is also currently analyzing future potential cost reductions that can partially mitigate the impact of these proposals. OFGEM is expected to finalize its recommendations in early December 1999, which would take effect in April 2000 for five years. SEEBOARD cannot predict whether the draft price proposals ultimately will be adopted by OFGEM and, if they are adopted, the final form of the proposals. If OFGEM's draft price proposals for SEEBOARD ultimately were adopted without change, implementation of the price proposals would have a material adverse effect on the future results of operations of SEEBOARD USA and CSW. In addition, implementation of the price proposals as drafted could adversely affect the financial condition of SEEBOARD USA, but would not be expected to adversely affect the financial condition of CSW. OFGEM has published draft price proposals for the electricity supply businesses. OFGEM has recommended that the price cap for charges levied to electricity supply domestic and small business customers should be extended for two years from April 2000. If adopted, the proposals are expected to have a broadly neutral effect on the results of SEEBOARD USA. The foregoing discussion constitutes forward-looking information within the meaning of Section 21E of the Exchange Act. Actual results may differ materially from such projected information. See FORWARD -LOOKING INFORMATION. Other Reference is made to NOTE 2 LITIGATION AND REGULATORY PROCEEDINGS for information regarding fuel proceedings at CPL, SWEPCO and WTU. ENVIRONMENTAL Clean Air Provisions of the Texas Legislation The Texas Legislation requires that grandfathered electric generating facilities be permitted, reduce emission levels 50% and provide for a cost recovery mechanism for companies with stranded costs. Final regulations are expected by January 1, 2000. The total costs to comply with the expected regulations for CPL, SWEPCO and WTU are expected to range from $3 million to $10 million. Expenditures at the high end of the range are estimated to be $4.2 million for CPL, $4.8 million for SWEPCO and $1.0 million for WTU. Expenditures have begun to meet the requirements of the legislation. Although CPL could seek recovery of these costs, there is no mechanism for SWEPCO and WTU to recover these costs under the Texas Legislation. Proposed Regional Control Strategy Regulations The Texas Natural Resource Conservation Commission is expected to release for comment proposed regulations that, if adopted as proposed, would require reductions in nitrogen oxide emissions for existing permited electric generating facilities in the East Texas Region in addition to the Clean Air Provisions of the Texas Legislation discussed above. The final regulations could be issued in April 2000 with an implementation date of May 2003. The current estimate for 81 compliance with the proposed rules could be as much as $38 million for CPL and $151 million for SWEPCO in capital project costs and as much as $3 million for CPL and $11 million for SWEPCO in additional annual operating costs. The foregoing discussion constitutes forward-looking information within the meaning of Section 21E of the Exchange Act. Actual results may differ materially from such projected information. See FORWARD -LOOKING INFORMATION. DIVERSIFIED ELECTRIC CSW Energy CSW Energy presently owns interests in seven operating power projects totaling 1,308 MW which are located in Colorado, Florida and Texas. CSW Energy began construction in August 1998 of a 500 MW merchant power plant, known as Frontera, in the Rio Grande Valley, near the city of Mission, Texas. The natural gas-fired facility began simple cycle operation of 330 MW in July 1999 and is scheduled to commence combined cycle operation by the end of 1999. Pursuant to AEP's and CSW's stipulated agreement with several intervenors in the state of Texas related to the AEP Merger, CSW Energy will sell 250 MW of Frontera upon completion of the merger. See ITEM 1. - NOTE 5. PROPOSED AEP MERGER and MD&A-PROPOSED AEP MERGER for a discussion including timing of the sale. CSW Energy has entered into an agreement with Eastman Chemical Company to construct and operate a 440 MW cogeneration facility in Longview, Texas. This facility will be known as the Eastex Cogeneration Project. Construction of the facility is scheduled to begin in the fourth quarter of 1999, with expected operation in 2001. Excess electricity generated by the plant will be sold by CSW Energy in the wholesale electricity market. Since Eastex will be built as a qualifying facility, CSW Energy will be required to sell 50% of the plant prior to commercial operation. In addition to these projects, CSW Energy has other projects in various stages of development. In October 1999, GE Capital Structured Finance Group purchased 50 percent of the equity ownership of Sweeny Cogeneration Limited Partnership. CSW Energy's after-tax earnings from the proceeds of the transaction will be approximately $33 million and will be recorded in the fourth quarter of 1999. The agreement between CSW Energy and GE Capital Structured Finance Group also provides for additional payments subject to completion of a planned expansion of the Sweeny cogeneration facility. The preceding discussion contains forward-looking information within the meaning of Section 21E of the Exchange Act. Actual results may differ materially from such projected information. See FORWARD-LOOKING INFORMATION. CSW International CSW International was organized to pursue investment opportunities in EWGs and FUCOs and currently holds investments in the United Kingdom, Mexico and South America. CSW International and its 50% partner, Scottish Power plc, have entered into a joint venture to construct and operate the South Coast power project, a 400-MW combined cycle gas turbine power station in Shoreham, United Kingdom. CSW International has guaranteed approximately (pound)19 million of the (pound)190 million construction financing, and the permanent financing is unconditionally guaranteed by the project. Construction of the project began in March 1999 and commercial operation is expected to begin in 2000. 82 Through June 30, 1999, CSW International had purchased a 36% equity interest in Vale for $80 million. CSW International also extended $100 million of debt to Vale. CSW International anticipates converting $69 million of the $100 million to equity by the end of 1999, with the remaining $31 million to be converted over the next two years. Currently, CSW International accounts for its $80 million investment in Vale on the equity method of accounting, and the $100 million of debt as a loan. In mid-January 1999, amid market instability, the Brazilian government abandoned its policy of pegging the Brazilian Real in a broad range against the dollar. This action resulted in a 60% devaluation of the Brazilian currency by the end of September 1999. Vale is unfavorably affected by the devaluation due primarily to the revaluation of foreign denominated debt. CSW International has a put option, which, if exercised, requires Vale to purchase CSW International shares at a minimum price equal to the purchase price for Vale. As a result of the put option arrangement, management has concluded that CSW International's investment carrying amount will not be reduced below the put option value unless there is deemed to be a permanent impairment. Pursuant to the put option arrangement, CSW International will not recognize its proportionate share of any future earnings until its proportionate share of any losses of Vale are recognized. At September 30, 1999, CSW International had deferred losses, after tax, of approximately $23 million related to its Vale investment. CSW International views its investment in Vale as a long-term investment, which has significant long-term value. Management will continue to closely evaluate the changes in the Brazilian economy and its impact on CSW International's investment in Vale. As of September 30, 1999, CSW International had invested $110 million in stock of a Chilean electric company. The investment is classified as securities available for sale and accounted for by the cost method. Based on the market value of the shares and foreign exchange rates, the value of the investment at September 30, 1999 is $62 million. The reduction in the carrying value of this investment has been reflected in Other Comprehensive Income in CSW's Consolidated Statements of Stockholders' Equity. Management views its investment in Chile as a long-term investment strategy and believes this investment continues to have significant long-term value and that it is recoverable. Management will continue to closely evaluate the changes in the South American economy and its impact on CSW International's investment in the Chilean electric company. In addition to these projects, CSW International has other projects in various stages of development. The preceding discussion contains forward-looking information within the meaning of Section 21E of the Exchange Act. Actual results may differ materially from such projected information. See FORWARD-LOOKING INFORMATION. OTHER MATTERS Year 2000 On a system-wide basis, CSW initiated a year 2000 project to prepare internal computer systems and applications for the year 2000. These systems and applications include management information systems that support business operations such as customer billing, payroll, inventory and maintenance. Other systems with computer-based controls such as telecommunications, elevators, building environmental management, metering, plant, transmission, distribution and substations are included in this project as well. CSW considers year 2000 readiness a top priority. The formal project was initiated in late 1996 at which time an executive sponsor and project manager were named and a centralized project management office was formed. More than 30 readiness teams were initiated and they have completed the readiness activities 83 for critical systems. Those teams represent the equivalent of about 90 full-time employee positions working on year 2000 readiness. The teams used a formal approach that included inventory, assessment, remediation, testing of systems and development of contingency plans. Formal progress checkpoints continue on a biweekly basis. An executive oversight council comprised of the functional vice presidents continues to convene monthly to review progress and address issues. The project executive sponsor provides updates to top management on a weekly basis and at every Board of Directors' Audit Committee meeting. CSW completed a comprehensive review of its year 2000 project in 1998. External consultants assisted in the review. The review covered assessment of the project plans and processes to ensure that any risks to CSW associated with the year 2000 would be prudently managed. Several changes were incorporated into the year 2000 project as a result of the 1998 review findings. After completing the year 2000 readiness processes on all critical systems in June 1999, the internal audit and project management teams reviewed the remediation and testing process, continuing readiness processes, and the contingency plans. The post-review was conducted to determine if year 2000 related risks had been mitigated. The review findings indicated that risk had been mitigated, solid processes were in place to maintain readiness, and the contingency plans would minimize the impact of any year 2000 computer problems. State of Readiness Key milestones for the CSW system-wide year 2000 program, excluding SEEBOARD and Vale, are listed below: - - Readiness teams completed a detailed inventory and assessment of critical control systems in the third quarter of 1998. The systems include switchboards, elevators, environmental controls, vehicles, metering systems, and embedded logic or real time control systems in support of generation and delivery of electricity. The findings indicate that less than 15% of installed controls have microprocessors, very few have date logic and over 90% of those with date logic already process new millennium dates correctly. The need for additional functionality in the early 1990's resulted in the modernization of several electric operation systems that has reduced the conversion requirements. On June 2, 1999, CSW announced that it completed year 2000 readiness activities within its critical power production and delivery systems at the U.S. Electric Operating Companies. - - Readiness teams completed inventory and assessment of business applications and vendor-supplied software in the first quarter of 1997. Only 25% of the business application programs were determined to require remediation by December 1999. - - Readiness teams completed plans for modification and certification testing of business application software in the third quarter of 1997. - - Readiness teams established and initiated remediation plans and schedules for business applications in the fourth quarter of 1997. As of June 30, 1999, these teams had converted and certified all business critical applications of the U.S. Electric Operating Companies and shared services organizations. SEEBOARD completed an inventory of date dependent assets including, but not limited to, embedded chip technology, software, hardware, applications, telecommunications, access and security systems in the third quarter of 1998. SEEBOARD completed an assessment of all critical systems in January 1999. SEEBOARD completed remediation and testing of mission critical distribution and safety systems in March 1999. SEEBOARD completed the remediation and testing of all critical path systems in August 1999. 84 Vale completed an inventory of date dependent assets and critical systems in the fourth quarter of 1998. As of June 30, 1999, Vale had also completed the remediation and testing of all critical systems. Vale also completed contingency plans for its critical systems in the third quarter of 1999. Cost to Address Year 2000 Issues A combination of internal and external resources perform the work related to the year 2000 project. CSW's budget includes the funds for year 2000 project expenditures. The costs related to the project are expensed as incurred. As of September 30, 1999, cost incurred to date for the year 2000 project amounts to $27 million, including $17 million in the first nine months of 1999. Remaining activities are expected to cost an additional $9 million over the next 6 months. Redeployment of existing labor resources accounts for approximately 40% of the project cost. Outside contract labor makes up approximately 35% of the project cost. Computer hardware and software purchases account for the remaining 25% of the project cost. In the first quarter of 1999, a software version upgrade to provide contract management features to the materials management information system was deferred until calendar year 2000 in order to minimize risk. The financial impact of this deferral is minimal, as minor enhancements to the current design have provided an alternative, interim solution for the needed functionality. No other planned CSW computer information system projects have been affected by the year 2000 project, but that may change as the year 2000 approaches and change freezes are implemented to further minimize risk. Accordingly, no estimate has been made for the financial impact of any future projects foregone due to resources allocated to the year 2000 project. Risk of Year 2000 Issues The greatest financial risk to the CSW domestic operation would be a total inability to generate and deliver electricity. Many primary systems and backup systems would have to fail in order for that total inability to occur. On May 31, 1999, CSW completed year 2000 readiness activities within its critical power production and delivery systems at its U.S. Electric Operating Companies and no year 2000 issues were found that would have caused power plants to fail. Risk of power plant failure is limited because 50% of power plant controls do not operate with date sensitive logic. Additionally, the year 2000 issues, which were identified in the plants, are generally minor issues typically affecting reporting systems. The vast majority of the transmission and distribution system consists of wires, poles, transformers, switches and fuses for which year 2000 is not an issue. Fewer than 15% of control systems that operate transmission and distribution equipment are micro-processor based, and of those, 95% were found to process year 2000 dates correctly. The standard residential meter is not affected; however, about 10% of industrial and large commercial meters have microprocessors. Most of those microprocessors process dates correctly and those that did not have been modified and certified year 2000 ready. The systems that required the greatest amount of work are the software applications that support business functions such as customer billing and accounting. CSW completed all year 2000 readiness activities on these critical business support systems on June 30, 1999. If CSW's domestic operations encountered a total inability to generate and deliver electricity, CSW estimates that it would lose approximately 24 hours of revenues and would incur additional costs to restart power plants in a worst case scenario. The greatest risk to SEEBOARD is that it is part of a large supplier chain. While SEEBOARD is confident of its ability to ensure that there will be no year 2000 impact to the distribution network, it is reliant upon both the generators and the National Grid in the U.K. However, the risk is considered minimal. 85 To date at SEEBOARD, the year 2000 testing on embedded chip technology revealed a less than 2% failure rate. Contingency Plans Contingency plans have been in place in CSW's domestic electric operation for years to address problems resulting from weather. These plans have been updated to include year 2000 issues. Contingency planning is engineered into the transmission and distribution systems as it is designed with the capability to bypass failed equipment. A margin of power generation reserve above what is needed is normally maintained. This reserve is a customary operating contingency plan that allows CSW to operate normally even when a power plant unexpectedly quits operating. Backup supplies of fuels are normally maintained at CSW power plants. Natural gas plants have fuel oil as a backup and multiple pipelines provide redundant supplies. At coal plants about 40-45 days of extra coal is kept on hand. The North American Electric Reliability Council has coordinated with all national power regions to assess the risks and to develop contingency plans within the national electric delivery system. During the fourth quarter of 1998, CSW developed first drafts of the contingency plans to address year 2000 issues. These contingency plans were completed in the second quarter of 1999. CSW participated in an industry-wide drill focused on sustaining reliable operations with a simulated partial loss of voice and data communications on April 9, 1999. The drill results clearly demonstrated CSW's ability to successfully sustain reliable operations while using backup or alternative communication means. Additionally, CSW participated in an industry-wide drill to test its operational preparedness in the third quarter of 1999. This drill was a rehearsal of December 31, 1999 and January 1, 2000 operations and further validated the contingency plans and communication and coordination processes. Another drill is planned for the mid-November 1999 time frame to help ensure the communication and coordination processes are effective before transition to the new millennium. The CSW supply chain has contacted over 6,000 suppliers to determine their organization readiness and over 70% responded. Approximately 250 of those 6,000 are mission critical suppliers, of which 100% have responded that their organizations are either ready for the year 2000 or will be before December 31, 1999. Contingency plans have been developed to cover the possible failure of any critical suppliers that may not achieve their readiness goals on time. Additionally, mission critical inventories will be increased. Like CSW's U.S. operations, SEEBOARD also has contingency plans that have been in place for years to address problems resulting from weather. These plans are covered effectively within the distribution and customer service business areas and are being updated to include year 2000 scenarios. Each service provider group within SEEBOARD has presented its plans for coverage over the millennium period to the rest of the organization. The business contingency planners appointed within each business are now incorporating this information in the business continuity plans. These plans are continually being reviewed by SEEBOARD's year 2000 central team. SEEBOARD is working with other utilities through interest groups and the national grid on interface contingency plans and testing. In addition to contingency plans, business areas are identifying key tasks that will be performed during the year-end roll-over period to ensure continuity of business. In view of a pending merger, the CSW and AEP year 2000 project management teams engage in frequent communication to share best practices and to exchange information on progress, obstacles and issues relative to the year 2000 efforts. Under the present schedule, it does not appear that the merger will occur before the transition to year 2000 is complete. There are no plans to consolidate or convert existing computer systems before the AEP Merger closes. 86 Portions of the preceding discussion contains forward-looking information within the meaning of Section 21E of the Exchange Act. Actual results may differ materially from such projected information due to changes in the underlying assumptions. See FORWARD-LOOKING INFORMATION. 87 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK In 1997, CSW's Board of Directors adopted a risk management resolution authorizing CSW to engage in currency, interest rate and energy spot and forward transactions and related derivative transactions on behalf of CSW with foreign and domestic parties as deemed appropriate by executive officers of CSW. The risk management program is necessary to meet the growing demands of CSW's customers for competitive prices and price stability, to enable CSW to compete in a deregulated power industry, to manage the risks associated with domestic and foreign investments and to take advantage of strategic investment opportunities. The U.S. Electric Operating Companies experience commodity price exposures related to the purchase of fuel supplies for the generation of electricity and for the sale and purchase of energy. Contracts that provide for the future delivery of these commodities may contain spot and forward pricing, volume and/or derivative terms designed to manage price exposure for the benefit of customers and to take advantage of strategic opportunities. In response to the development of a more competitive electric energy market, CSW has received regulatory approval which authorizes the U.S. Electric Operating Companies to conduct a pilot program involving power sales agreements at tariffed rates with a fixed fuel cost. To offset the commodity price risk associated with these contracts, CSW has entered into natural gas swaps and futures contracts. These agreements cover natural gas deliveries through December 31, 2000. Natural gas volumes purchased to perform these contracts for which CSW has secured swap agreements represents approximately 1% of annual natural gas purchases. The table below provides information about CSW's contracts that are sensitive to changes in commodity prices. The swaps hedge commodity price exposure through the year 2000. Cash outflows on the swap agreements should be offset by increased margins on electricity sales to customers under tariffed rates with fixed fuel costs. The electricity forward contracts hedge a portion of CSW's energy requirements through 2000. The average contract price for forward power purchases is $33 per MWH, and the average contract price for forward power sales is $70 per MWH. Also, the average contract price for forward fuel purchases is $2.90 per MMbtu. Contractual commitments at September 30, 1999 are as follows: Net Notional Fair Value of Fair Value of Products Amount Assets Liabilities ---------------------------------------------------------------------------- (thousands) Swaps 7,440,000 MMbtu $1,539 $-- Forwards: Purchases 2,730,000 MMbtu -- 297 Purchases 252,000 MWH 159 -- Sales 86,400 MWH 268 -- Futures: Purchases 190,000 MMbtu 40 -- Sales 100,000 MMbtu -- 4 CSW has, at times, been exposed to currency and interest rate risks which reflect the floating exchange rate that exists between the U.S. dollar and the British pound. CSW has utilized certain risk management tools to manage adverse changes in exchange rates and to facilitate financing transactions resulting from CSW's acquisition of SEEBOARD. At September 30, 1999, CSW had positions in two cross currency swap contracts, which were used to eliminate currency fluctuations in respect of the $400 million of debt. The following table presents information relating to these contracts. The market value represents the foreign exchange/interest rate terms inherent in the cross currency swaps at 88 current market pricing. CSW expects to hold these contracts to maturity. At exchange rates on September 30, 1999, this liability is included in long-term debt on the balance sheet at a carrying value of approximately $425 million. Expected Expected Cash Cash Inflows Outflows Contract Maturity Date (Maturity Value) (Market Value) - ------------------------------------------------------------------------------ Cross currency swaps August 1, 2001 $200 million $215.3 million Cross currency swaps August 1, 2006 $200 million $228.2 million For information related to currency risk in South America see ITEM 1. - NOTE 7. SOUTH AMERICAN INVESTMENTS. The preceding discussion constitutes forward-looking information within the meaning of Section 21E of the Exchange Act. Actual results may differ materially from such projected information. See FORWARD-LOOKING INFORMATION. 89 PART II. - OTHER INFORMATION For background and earlier developments relating to PART II information, reference is made to the Registrants' Combined Annual Report on Form 10-K for the year ended December 31, 1998 and Combined Quarterly Report on Form 10-Q for the quarters ended March 31, 1999 and June 30, 1999. ITEM 1. LEGAL PROCEEDINGS. Other Legal Claims and Proceedings The CSW System is party to various other legal claims and proceedings arising in the normal course of business. Management does not expect disposition of these matters to have a material adverse effect on the Registrants' results of operations or financial condition. See PART I. - NOTE 2. LITIGATION AND REGULATORY PROCEEDINGS and NOTE 3. COMMITMENTS AND CONTINGENT LIABILITIES. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) EXHIBITS: (12) Computation of Ratio of Earnings to Fixed Charges CPL - (Exhibit 12.1), filed herewith. PSO - (Exhibit 12.2), filed herewith. SWEPCO - (Exhibit 12.3), filed herewith. WTU - (Exhibit 12.4), filed herewith. (27) Financial Data Schedules CSW - (Exhibit 27.1), filed herewith. CPL - (Exhibit 27.2), filed herewith. PSO - (Exhibit 27.3), filed herewith. SWEPCO - (Exhibit 27.4), filed herewith. WTU - (Exhibit 27.5), filed herewith. (b) REPORTS FILED ON FORM 8-K: CSW and SWEPCO Date of earliest event reported: August 27, 1999 Date of report: September 1, 1999 Item 5. Other Events and Item 7 Financial Statements and Exhibits, reporting SWEPCO's withdrawal of its joint plan to acquire the non-nuclear assets of Cajun. CSW Date of earliest event reported: October 8, 1999 Date of report: October 18, 1999 Item 5. Other Events and Item 7 Financial Statements and Exhibits, news release related to the sale of 50% equity interest in the Sweeny electric generating plant. 90 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, each Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. The signature for each undersigned Registrant shall be deemed to relate only to matters having reference to such Registrant or its subsidiaries. CENTRAL AND SOUTH WEST CORPORATION Date: November 15, 1999 /s/ Lawrence B. Connors ------------------------ Lawrence B. Connors Controller and Chief Accounting Officer (Principal Accounting Officer) CENTRAL POWER AND LIGHT COMPANY PUBLIC SERVICE COMPANY OF OKLAHOMA SOUTHWESTERN ELECTRIC POWER COMPANY WEST TEXAS UTILITIES COMPANY Date: November 15, 1999 /s/ R. Russell Davis ------------------------ R. Russell Davis Controller and Chief Accounting Officer (Principal Accounting Officer) 91 EX-99.12.1 2 EXHIBIT 12.1 EXHIBIT 12.1 CENTRAL POWER AND LIGHT COMPANY (CONSOLIDATED) RATIO OF EARNINGS TO FIXED CHARGES FOR THE TWELVE MONTHS ENDED SEPTEMBER 30, 1999 (Thousands Except Ratio) (Unaudited) Operating Income $284,009 Adjustments: Income taxes 101,742 Provision for deferred income taxes (9,159) Deferred investment tax credits (5,207) Other income and deductions 2,472 Allowance for borrowed and equity funds used during construction 3,286 --------- Earnings $377,143 ========= Fixed Charges: Interest on long-term debt $ 88,337 Interest on short-term debt and other 16,975 Distributions on Trust Preferred Securities 12,000 --------- Fixed Charges $117,312 ========= Ratio of Earnings to Fixed Charges 3.21 ========= 92 EX-99.12.2 3 EXHIBIT 12.2 EXHIBIT 12.2 PUBLIC SERVICE COMPANY OF OKLAHOMA (CONSOLIDATED) RATIO OF EARNINGS TO FIXED CHARGES FOR THE TWELVE MONTHS ENDED SEPTEMBER 30, 1999 (Thousands Except Ratio) (Unaudited) Operating Income $ 102,306 Adjustments: Income taxes 31,891 Provision for deferred income taxes 1,593 Deferred investment tax credits (1,791) Other income and deductions (691) Allowance for borrowed and equity funds used during construction 1,845 ----------- Earnings $ 135,153 =========== Fixed Charges: Interest on long-term debt $ 26,643 Interest on short-term debt and other 4,656 Distributions on Trust Preferred Securities 6,000 ----------- Fixed Charges $ 37,299 =========== Ratio of Earnings to Fixed Charges 3.62 =========== 93 EX-99.12.3 4 EXHIBIT 12.3 EXHIBIT 12.3 SOUTHWESTERN ELECTRIC POWER COMPANY (CONSOLIDATED) RATIO OF EARNINGS TO FIXED CHARGES FOR THE TWELVE MONTHS ENDED SEPTEMBER 30, 1999 (Thousands Except Ratio) (Unaudited) Operating Income $146,449 Adjustments: Income taxes 62,611 Provision for deferred income taxes (22,739) Deferred investment tax credits (4,581) Other income and deductions (2,370) Allowance for borrowed and equity funds used during construction 1,988 Interest portion of financing leases 414 ----------- Earnings $181,772 =========== Fixed Charges: Interest on long-term debt $39,008 Interest on short-term debt and other 10,313 Distributions on Trust Preferred Securities 8,662 Interest portion of financing leases 414 ----------- Fixed Charges $58,397 =========== Ratio of Earnings to Fixed Charges 3.11 =========== 94 EX-99.12.4 5 EXHIBIT 12.4 EXHIBIT 12.4 WEST TEXAS UTILITIES COMPANY RATIO OF EARNINGS TO FIXED CHARGES FOR THE TWELVE MONTHS ENDED SEPTEMBER 30, 1999 (Thousands Except Ratio) (Unaudited) Operating Income $ 53,886 Adjustments: Income taxes 7,981 Provision for deferred income taxes 8,072 Deferred investment tax credits (1,286) Other income and deductions 546 Allowance for borrowed and equity funds used during construction 1,157 ----------- Earnings $ 70,356 =========== Fixed Charges: Interest on long-term debt $20,352 Interest on short-term debt and other 4,733 ----------- Fixed Charges $ 25,085 =========== Ratio of Earnings to Fixed Charges 2.80 =========== EX-27.1 6
UT 0000018540 CENTRAL AND SOUTH WEST CORPORTION 001 CENTRAL AND SOUTH WEST CORPORATION 1,000,000 9-MOS Dec-31-1999 Sep-30-1999 PER-BOOK 8,275 449 2,169 1,251 2,287 14,431 744 1,051 1,882 3,677 0 176 4,099 0 40 2,008 221 0 0 2 4,208 14,431 4,162 162 3,310 3,472 690 24 714 336 370 6 370 277 149 452 1.74 1.74
EX-27.2 7
UT 0000018734 CENTRAL POWER AND LIGHT COMPANY 003 CENTRAL POWER AND LIGHT COMPANY 1,000 9-MOS DEC-31-1999 SEP-30-1999 PER-BOOK 3,217,967 2,465 187,344 26,165 1,339,715 4,773,656 168,888 405,000 795,651 1,369,539 0 163,203 1,251,136 251,692 0 0 125,000 0 0 0 1,613,086 4,773,656 1,161,714 80,382 826,950 907,332 254,382 4,227 258,609 85,463 173,146 5,527 167,619 111,000 65,433 290,044 0.00 0.00
EX-27.3 8
UT 0000081027 PUBLIC SERVICE COMPANY OF OKLAHOMA 004 PUBLIC SERVICE COMPANY OF OKLAHOMA 1,000 9-MOS DEC-31-1999 SEP-30-1999 PER-BOOK 1,331,331 25,466 118,030 5,265 51,386 1,531,478 157,230 180,000 166,922 504,152 0 5,286 419,440 20,392 30,000 0 10,000 0 0 0 542,208 1,531,478 588,385 37,173 457,468 494,641 93,744 920 94,664 27,208 67,456 160 67,296 45,000 18,209 117,140 0.00 0.00
EX-27.2 9
UT 0000092487 SOUTHWESTERN ELECTRIC POWER COMPANY 005 SOUTHWESTERN ELECTRIC POWER COMPANY 1,000 9-MOS DEC-31-1999 SEP-30-1999 PER-BOOK 1,835,777 5,912 180,357 4,784 84,268 2,111,098 135,660 245,000 295,846 676,506 0 4,706 606,114 88,075 0 0 45,595 0 0 2,212 687,890 2,111,098 751,987 37,476 590,868 628,344 123,643 (2,277) 121,366 41,929 76,426 172 76,254 81,000 29,201 152,850 0.00 0.00
EX-27.5 10
UT 0000105860 WEST TEXAS UTILITIES COMPANY 006 WEST TEXAS UTILITIES COMPANY 1,000 9-MOS DEC-31-1999 SEP-30-1999 PER-BOOK 682,021 852 101,349 32,339 42,945 859,506 137,214 2,236 123,769 263,219 0 2,482 263,644 0 0 0 40,000 0 0 0 290,161 859,506 343,138 16,076 276,092 292,168 50,970 504 51,474 18,356 27,657 78 27,579 21,000 15,264 79,798 0 0
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