10-Q 1 q10q0903.txt LG&E AND KU SEPT 2003 10Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2003 Or [_] TRANSITION REPORT PURSUANT 1TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission Registrant, State of Incorporation IRS Employer File Number Address, and Telephone Number Identification No. 2-26720 Louisville Gas and Electric Company 61-0264150 (A Kentucky Corporation) 220 West Main Street P.O. Box 32010 Louisville, KY 40232 (502) 627-2000 1-3464 Kentucky Utilities Company 61-0247570 (A Kentucky and Virginia Corporation) One Quality Street Lexington, KY 40507-1428 (859) 255-2100 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X. No _. Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes No X Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: Louisville Gas and Electric Company 21,294,223 shares, without par value, as of October 31, 2003, all held by LG&E Energy Corp. Kentucky Utilities Company 37,817,878 shares, without par value, as of October 31, 2003, all held by LG&E Energy Corp. This combined Form 10-Q is separately filed by Louisville Gas and Electric Company and Kentucky Utilities Company. Information contained herein related to any individual registrant is filed by such registrant on its own behalf. Each registrant makes no representation as to information related to the other registrants. TABLE OF CONTENTS PART I ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS LOUISVILLE GAS AND ELECTRIC COMPANY AND SUBSIDIARY STATEMENTS OF INCOME 1 BALANCE SHEETS 2 STATEMENT OF CASH FLOWS 4 STATEMENT OF RETAINED EARNINGS 5 STATEMENTS OF OTHER COMPREHENSIVE INCOME 6 KENTUCKY UTILITIES COMPANY AND SUBSIDIARY STATEMENTS OF INCOME 7 BALANCE SHEETS 8 STATEMENT OF CASH FLOWS 10 STATEMENT OF RETAINED EARNINGS 11 STATEMENTS OF OTHER COMPREHENSIVE INCOME 12 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 13 ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. 21 ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. 31 ITEM 4 CONTROLS AND PROCEDURES. 33 PART II ITEM 1 LEGAL PROCEEDINGS. 36 ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K 36 SIGNATURES 38 EXHIBITS 39 Part I. Financial Information - Item 1. Financial Statements Louisville Gas and Electric Company and Subsidiary Consolidated Statements of Income (Unaudited) (Thousands of $) Three Months Nine Months Ended Ended September 30, September 30, 2003 2002 2003 2002 OPERATING REVENUES (Note 5 and Note 8): Electric $230,174 $220,274 $591,110 $566,385 Gas 32,659 22,800 213,939 170,856 Total operating revenues 262,833 243,074 805,049 737,241 OPERATING EXPENSES: Fuel for electric generation 55,628 52,827 151,382 147,484 Power purchased (Note 8) 18,805 12,579 60,245 46,276 Gas supply expenses 19,509 11,098 151,579 112,911 Other operation expenses 51,890 51,269 158,797 154,486 Maintenance 12,526 18,869 42,109 46,441 Depreciation and amortization (Note 8) 28,429 28,196 85,866 79,363 Federal and state income taxes 23,707 22,083 45,062 43,655 Property and other taxes 4,659 4,501 12,848 13,815 Total operating expenses 215,153 201,422 707,888 644,431 NET OPERATING INCOME 47,680 41,652 97,161 92,810 Other income (expense) - net 287 156 (43) 90 Interest charges (Note 3) 8,096 7,604 22,227 22,497 NET INCOME $ 39,871 $ 34,204 $ 74,891 $ 70,403 The accompanying notes are an integral part of these consolidated financial statements. Page 1 Louisville Gas and Electric Company and Subsidiary Consolidated Balance Sheets (Unaudited) (Thousands of $) ASSETS September 30, December 31, 2003 2002 UTILITY PLANT: At original cost $3,752,179 $3,622,985 Less: reserve for depreciation 1,522,825 1,463,674 Net utility plant (Note 7) 2,229,354 2,159,311 OTHER PROPERTY AND INVESTMENTS - less reserve of $63 as of September 30, 2003 and December 31, 2002 611 764 CURRENT ASSETS: Cash 3,400 17,015 Accounts receivable - less reserve of $1,415 as of September 30, 2003 and $2,125 as of December 31, 2002 (Note 4) 55,241 68,440 Materials and supplies - at average cost: Fuel (predominantly coal) 25,099 36,600 Gas stored underground 69,634 50,266 Other 24,342 25,651 Prepayments and other 2,662 5,298 Total current assets 180,378 203,270 DEFERRED DEBITS AND OTHER ASSETS: Unamortized debt expense 6,334 6,532 Regulatory assets (Note 6) 139,829 153,446 Other 33,164 37,755 Total deferred debits and other assets 179,327 197,733 Total assets $2,589,670 $2,561,078 The accompanying notes are an integral part of these consolidated financial statements. Page 2 Louisville Gas and Electric Company and Subsidiary Consolidated Balance Sheets (Unaudited) (Thousands of $) CAPITALIZATION AND LIABILITIES September 30, December 31, 2003 2002 CAPITALIZATION: Common stock, without par value - Outstanding 21,294,223 shares $ 425,170 $ 425,170 Common stock expense (836) (836) Additional paid-in capital 40,000 40,000 Retained earnings 481,926 409,319 Accumulated other comprehensive loss (39,939) (40,512) Total common equity 906,321 833,141 Cumulative preferred stock 70,140 70,140 Manditorily redeemable preferred stock 22,500 23,750 Long-term debt 328,104 328,104 Long-term debt to associated company (Note 9) 200,000 - Total capitalization 1,527,065 1,255,135 CURRENT LIABILITIES: Current portion of manditorily redeemable preferred stock 1,250 1,250 Current portion of long-term debt 246,200 288,800 Notes payable to parent (Note 9) 75,132 193,053 Accounts payable 84,252 122,771 Accrued taxes 12,940 1,450 Other 20,245 19,536 Total current liabilities 440,019 626,860 DEFERRED CREDITS AND OTHER LIABILITIES: Accumulated deferred income taxes - net 344,281 313,225 Investment tax credit, in process of amortization 51,380 54,536 Accumulated provision for pensions and related benefits 127,496 224,703 Customer advances for construction 9,700 10,260 Asset retirement obligation (Note 8) 9,793 - Regulatory liabilities (Note 6) 43,715 52,424 Long-term derivative liability 16,464 17,115 Other 19,757 6,820 Total deferred credits and other liabilities 622,586 679,083 Total capital and liabilities $2,589,670 $2,561,078 The accompanying notes are an integral part of these consolidated financial statements. Page 3 Louisville Gas and Electric Company and Subsidiary Consolidated Statement of Cash Flows (Unaudited) (Thousands of $) Nine Months Ended September 30, 2003 2002 CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 74,891 $ 70,403 Items not requiring cash currently: Depreciation and amortization 85,866 79,363 Deferred income taxes - net 24,589 7,748 Investment tax credit - net (3,156) (3,100) Asset retirement obligations (Note 8) 4,108 - Other 26,104 33,595 Changes in current assets and liabilities (28,028) (63,348) Changes in accounts receivable securitization-net (Note 4) 11,600 32,200 Pension funding (Note 9) (89,125) - Gas supply clause (14,970) 5,331 Other 12,086 8,331 Net cash flows from operating activities $103,965 170,523 CASH FLOWS FROM INVESTING ACTIVITIES: Long-term investments 153 (239) Construction expenditures (153,064) (141,855) Net cash flows from investing activities (152,911) (142,094) CASH FLOWS FROM FINANCING ACTIVITIES: Long-term borrowings from associated company (Note 9) 200,000 - Short-term borrowings from parent (Note 9) 478,800 896,456 Repayment of short-term borrowings from parent (596,721) (861,500) Retirement of preferred stock (1,250) - Retirement of first mortgage bonds (42,600) - Issuance of pollution control bonds - 118,876 Retirement of pollution control bonds - (120,000) Payment of dividends (2,898) (49,225) Net cash flows from financing activities 35,331 (15,393) CHANGE IN CASH (13,615) 13,036 CASH AT BEGINNING OF PERIOD 17,015 2,112 CASH AT END OF PERIOD $ 3,400 $ 15,148 SUPPLEMENTAL DISCLOSURES: Cash paid during the period for: Income taxes $ 12,968 $ 46,925 Interest on borrowed money $ 17,204 $ 22,523 The accompanying notes are an integral part of these consolidated financial statements. Page 5 Louisville Gas and Electric Company and Subsidiary Consolidated Statement of Retained Earnings (Unaudited) (Thousands of $) Three Months Nine Months Ended Ended September 30, September 30, 2003 2002 2003 2002 Balance at beginning of period $442,498 $404,721 $409,319 $393,636 Net income 39,871 34,204 74,891 70,403 Subtotal 482,369 438,925 484,210 464,039 Cash dividends declared on stock: 5% cumulative preferred 269 269 807 807 Auction rate cumulative preferred 174 439 743 1,281 $5.875 cumulative preferred - 367 734 1,101 Common - 23,000 - 46,000 Subtotal 443 24,075 2,284 49,189 Balance at end of period $481,926 $414,850 $481,926 $414,850 The accompanying notes are an integral part of these consolidated financial statements. Page 5 Louisville Gas and Electric Company and Subsidiary Consolidated Statements of Other Comprehensive Income (Unaudited) (Thousands of $) Three Months Nine Months Ended Ended September 30, September 30, 2003 2002 2003 2002 Net income $39,871 $34,204 $74,891 $70,403 Gains (losses) on derivative instruments and hedging activities (Note 3) 3,539 (7,691) 955 (10,121) Income tax benefit (expense) related to items of other comprehensive income (1,416) 3,076 (382) 4,049 Other comprehensive income (loss), net of tax 2,123 (4,615) 573 (6,072) Other Ccomprehensive income $41,994 $29,589 $75,464 $64,331 The accompanying notes are an integral part of these consolidated financial statements. Page 6 Kentucky Utilities Company and Subsidiary Consolidated Statements of Income (Unaudited) (Thousands of $) Three Months Nine Months Ended Ended September 30, September 30, 2003 2002 2003 2002 OPERATING REVENUES (Note 5 and Note 8) $235,426 $235,059 $657,583 $640,103 OPERATING EXPENSES: Fuel for electric generation 75,300 80,380 201,264 196,018 Power purchased (Note 8) 31,702 27,912 106,550 95,203 Other operation expenses 35,603 38,151 112,622 108,874 Maintenance 13,031 12,439 49,400 39,385 Depreciation and amortization (Note 8) 24,751 24,449 76,663 71,023 Federal and state income taxes 18,196 17,011 32,263 38,759 Property and other taxes 4,067 3,689 12,230 11,565 Total operating expenses 202,650 204,031 590,992 560,827 NET OPERATING INCOME 32,776 31,028 66,591 79,276 Other income - net 2,145 5,466 6,948 8,789 Interest charges (Note 3) 4,611 5,409 17,209 19,871 NET INCOME $ 30,310 $ 31,085 $ 56,330 $ 68,194 The accompanying notes are an integral part of these consolidated financial statements. Page 7 Kentucky Utilities Company and Subsidiary Consolidated Balance Sheets (Unaudited) (Thousands of $) ASSETS September 30, December 31, 2003 2002 UTILITY PLANT: At original cost $3,527,901 $3,280,762 Less: reserve for depreciation 1,600,258 1,536,658 Net utility plant (Note 7) 1,927,643 1,744,104 OTHER PROPERTY AND INVESTMENTS - less reserve of $130 as of September 30, 2003 and December 31, 2002 17,176 14,358 CURRENT ASSETS: Cash 9,332 5,391 Accounts receivable - less reserve of $953 and $800 as of September 30, 2003 and December 31, 2002, respectively (Note 4) 51,082 49,588 Materials and supplies - at average cost: Fuel (predominantly coal) 33,560 46,090 Other 27,230 26,408 Prepayments and other 3,432 6,584 Total current assets 124,636 134,061 DEFERRED DEBITS AND OTHER ASSETS: Unamortized debt expense 4,832 4,991 Regulatory assets (Note 6) 53,676 63,776 Long-term derivative asset 15,917 16,928 Other 23,449 20,165 Total deferred debits and other assets 97,874 105,860 Total assets $2,167,329 $1,998,383 The accompanying notes are an integral part of these consolidated financial statements. Page 8 Kentucky Utilities Company and Subsidiary Consolidated Balance Sheets (cont.) (Unaudited) (Thousands of $) CAPITALIZATION AND LIABILITIES September 30, December 31, 2003 2002 CAPITALIZATION: Common stock, without par value - Outstanding 37,817,878 shares $ 308,140 $ 308,140 Common stock expense (322) (322) Additional paid-in capital 15,000 15,000 Retained earnings 556,662 502,024 Accumulated other comprehensive loss (10,280) (10,462) Total common equity 869,200 814,380 Cumulative preferred stock 39,727 39,727 Long-term debt (Note 9) 346,782 346,562 Long-term debt to associated company (Note 9) 175,000 - Total capitalization 1,430,709 1,200,669 CURRENT LIABILITIES: Current portion of long-term debt 91,930 153,930 Notes payable to parent (Note 9) 98,730 119,490 Accounts payable 68,193 95,374 Accrued taxes 10,558 4,955 Other 24,765 21,442 Total current liabilities 294,176 395,191 DEFERRED CREDITS AND OTHER LIABILITIES: Accumulated deferred income taxes - net 260,488 241,184 Investment tax credit, in process of amortization 6,519 8,500 Accumulated provision for pensions and related benefits 96,995 110,927 Asset retirement obligation (Note 8) 19,393 - Regulatory liabilities (Note 6) 21,003 29,876 Other 38,046 12,036 Total deferred credits and other liabilities 442,444 402,523 Total capital and liabilities $2,167,329 $1,998,383 The accompanying notes are an integral part of these consolidated financial statements. Page 9 Kentucky Utilities Company and Subsidiary Consolidated Statement of Cash Flows (Unaudited) (Thousands of $) Nine Months Ended September 30, 2003 2002 CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 56,330 $ 68,194 Items not requiring cash currently: Depreciation and amortization 76,663 71,023 Deferred income taxes - net 10,277 (2,180) Investment tax credit - net (1,981) (2,216) Asset retirement obligations (Note 8) 9,460 - Other 16,074 18,358 Changes in current assets and liabilities (4,888) (23,631) Changes in accounts receivable securitization-net (Note 4) - 4,900 Pension funding (Note 9) (9,515) (16,011) Other 27,690 16,870 Net cash flows from operating activities 180,110 135,307 CASH FLOWS FROM INVESTING ACTIVITIES: Long-term investments (2,818) (4,137) Construction expenditures (263,899) (164,766) Net cash flows from investing activities (266,717) (168,903) CASH FLOWS FROM FINANCING ACTIVITIES: Long-term borrowings from associated company (Note 9) 175,000 - Short-term borrowings from parent (Note 9) 520,840 390,200 Repayment of short-term borrowings from parent (541,600) (350,300) Retirement of first mortgage bonds (62,000) - Issuance of pollution control bonds - 36,813 Retirement of pollution control bonds - (37,930) Payment of dividends (1,692) (1,692) Net cash flows from financing activities 90,548 37,091 CHANGE IN CASH 3,941 3,495 CASH AT BEGINNING OF PERIOD 5,391 3,295 CASH AT END OF PERIOD $ 9,332 $ 6,790 SUPPLEMENTAL DISCLOSURES: Cash paid during the period for: Income taxes $ 19,012 $ 59,070 Interest on borrowed money $ 12,681 $ 22,419 The accompanying notes are an integral part of these consolidated financial statements. Page 10 Kentucky Utilities Company and Subsidiary Consolidated Statement of Retained Earnings (Unaudited) (Thousands of $) Three Months Nine Months Ended Ended September 30, September 30, 2003 2002 2003 2002 Balance at beginning of period $526,916 $446,877 $502,024 $410,896 Net income 30,310 31,085 56,330 68,194 Subtotal 557,226 477,962 558,354 479,090 Cash dividends declared on stock: 4.75% cumulative preferred 237 237 711 711 6.53% cumulative preferred 327 327 981 981 Subtotal 564 564 1,692 1,692 Balance at end of period $556,662 $477,398 $556,662 $477,398 The accompanying notes are an integral part of these consolidated financial statements. Page 11 Kentucky Utilities Company and Subsidiary Consolidated Statements of Other Comprehensive Income (Unaudited) (Thousands of $) Three Months Nine Months Ended Ended September 30, September 30, 2003 2002 2003 2002 Net income $30,310 $31,085 $56,330 $68,194 Gains (losses) on derivative instruments and hedging activities (Note 3) 303 (4,475) 303 (2,647) Income tax benefit (expense) related to Items of other comprehensive income (121) 1,790 (121) 1,059 Other comprehensive income (loss), net of tax 182 (2,685) 182 (1,588) Comprehensive income $30,492 $28,400 $56,512 $66,606 The accompanying notes are an integral part of these consolidated financial statements. Page 12 Louisville Gas and Electric Company and Subsidiary Kentucky Utilities Company and Subsidiary Notes to Consolidated Financial Statements (Unaudited) 1. The unaudited consolidated financial statements include the accounts of Louisville Gas and Electric Company and Subsidiary and Kentucky Utilities Company and Subsidiary ("LG&E" and "KU" or the "Companies"). The common stock of each of LG&E and KU is wholly-owned by LG&E Energy Corp. ("LG&E Energy"). In the opinion of management, the unaudited interim data includes all adjustments, consisting only of normal recurring adjustments, necessary for a fair statement of consolidated financial position, results of operations, comprehensive income and cash flows for the periods indicated. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to Securities and Exchange Commission ("SEC") rules and regulations, although the Companies believe that the disclosures are adequate to make the information presented not misleading. See LG&E's and KU's current report on Form 8-K dated November 12, 2003, for information relevant to the accompanying financial statements, including information as to the significant accounting policies of the Companies. The accompanying financial statements for the three months and nine months ended September 30, 2002, have been revised to conform with certain reclassifications in the current three months and nine months ended September 30, 2003. These reclassifications had no effect on net income, total assets, or total capital and liabilities as previously reported. 2. On December 11, 2000, LG&E Energy was acquired by Powergen plc, now known as Powergen Limited ("Powergen"), for cash of approximately $3.2 billion or $24.85 per share and the assumption of all of LG&E Energy's debt. As a result of the acquisition, LG&E Energy became a wholly- owned indirect subsidiary of Powergen and LG&E and KU became indirect subsidiaries of Powergen. The utility operations (LG&E and KU) of LG&E Energy continued their separate identities and continue to serve customers in Kentucky, Virginia and Tennessee under their existing names. The preferred stock and debt securities of the utility operations were not affected by this transaction and the utilities continue to file SEC reports. Following the acquisition, Powergen became a registered holding company under the Public Utility Holding Company Act of 1935 ("PUHCA"), and LG&E and KU, as subsidiaries of a registered holding company, became subject to additional regulation under PUHCA. As a result of the Powergen acquisition and in order to comply with PUHCA, LG&E Energy Services Inc. ("LG&E Services") was formed as a subsidiary of LG&E Energy and became operational on January 1, 2001. LG&E Services provides certain services to affiliated entities, including LG&E and KU, at cost, as required under PUHCA. On January 1, 2001, approximately 1,000 employees, primarily from LG&E Energy, LG&E and KU, were moved to LG&E Services. On July 1, 2002, a German company, E.ON AG ("E.ON"), completed its acquisition of Powergen. E.ON had announced its pre-conditional cash offer of 5.1 billion pounds sterling ($7.3 billion) for Powergen on April 9, 2001. Following the acquisition, LG&E and KU became indirect subsidiaries of E.ON and E.ON became a registered holding company under PUHCA. As contemplated in their regulatory filings in connection with the E.ON acquisition, E.ON, Powergen and LG&E Energy have completed an administrative reorganization to move the LG&E Energy group from an indirect Powergen subsidiary to an indirect E.ON subsidiary. This reorganization was effective in March 2003. Page 13 No costs associated with the Powergen acquisition or the E.ON acquisition nor any of the effects of purchase accounting have been reflected in the financial statements of LG&E or KU. 3. The Companies use interest rate swaps to hedge exposure to market fluctuations in certain of their debt instruments. Pursuant to the Companies' policies, use of these financial instruments is intended to mitigate risk, earnings and cash flow volatility and is not speculative in nature. Management has designated all of the Companies' interest rate swaps as hedge instruments. Financial instruments designated as cash flow hedges have resulting gains and losses recorded within other comprehensive income and stockholders' equity. To the extent a financial instrument or the underlying item being hedged is prematurely terminated or the hedge becomes ineffective, the resulting gains or losses are reclassified from other comprehensive income to net income. Financial instruments designated as fair value hedges are periodically marked to market with the resulting gains and losses recorded directly into net income to correspond with income or expense recognized from changes in market value of the items being hedged. As of September 30, 2003, LG&E had fixed rate swaps covering $100.3 million in notional amounts of variable rate debt and with fixed rates ranging from 4.309% to 5.495%. The average variable rate on the debt during the three months and nine months ended September 30, 2003 was .93% and 1.09%, respectively. The swaps have been designated as cash flow hedges and expire on various dates from February 2005 through November 2020. The hedges were deemed to be fully effective resulting in a pretax gain for the three months and nine months ended September 30, 2003 of $3.2 million and $.7 million, respectively, recorded in other comprehensive income. Upon expiration of these hedges, the amount recorded in other comprehensive income will be reclassified into earnings. The amount expected to be reclassified from other comprehensive income to earnings in the next twelve months is immaterial due to the long-term nature of the swaps. As of September 30, 2003, KU had variable rate swaps covering $153.0 million in notional amounts of fixed rate debt. The average variable rate on these swaps during the three months and nine months ended September 30, 2003 was 1.76% and 1.88%, respectively. The underlying debt has fixed rates ranging from 5.75% to 7.92%. The swaps have been designated as fair value hedges and expire on various dates from May 2007 through September 2025. During the three months and nine months ended September 30, 2003, the effect of marking these financial instruments and the underlying debt to market resulted in a pretax gain of $0.8 million and a pretax loss of $1.2 million, respectively, recorded as a decrease/increase in interest expense. 4. LG&E and KU participate in accounts receivable securitization programs. The purpose of these programs is to enable the utilities to accelerate the receipt of cash from the collection of retail accounts receivable, thereby reducing dependence upon more costly sources of working capital. The securitization programs allow for a percentage of eligible receivables to be sold. Eligible receivables are generally all receivables associated with retail sales that have standard terms and are not past due. LG&E and KU are able to terminate these programs at any time without penalty. If there is a significant deterioration in the payment record of the receivables by retail customers or if the Companies fail to meet certain covenants of the programs, the programs may terminate at the election of the financial institutions. In this case, payments from retail customers would first be used to repay the financial institutions participating in the programs, and would then be available for use by the Companies. As part of these programs, in February 2001, LG&E and KU sold retail accounts receivables to wholly-owned subsidiaries, LG&E Receivables LLC ("LG&E R") and KU Receivables LLC ("KU R"). Simultaneously, LG&E R and KU R entered into two separate three-year accounts receivable securitization facilities with two financial institutions and their Page 14 affiliates whereby LG&E R and KU R can sell, on a revolving basis, an undivided interest in certain of their receivables and receive up to $75 million and $50 million, respectively, from an unrelated third party purchaser. The effective cost of the receivables programs is comparable to the Companies' lowest cost source of capital, and is based on prime rated commercial paper. LG&E and KU retain servicing rights of the sold receivables through separate servicing agreements with the third party purchasers. LG&E and KU have obtained opinions from independent legal counsel indicating these transactions qualify as true sales of receivables. As of September 30, 2003 and December 31, 2002, LG&E's outstanding program balances were $74.8 million and $63.2 million, respectively, and KU's balance for both periods was $49.3 million. These programs expire in February 2004. The allowance for doubtful accounts associated with the eligible securitized receivables was $1.4 million at September 30, 2003 and $2.1 million at December 31, 2002 for LG&E, and $0.5 million for KU at September 30, 2003 and December 31, 2002. Management believes that the risk of uncollectibility associated with the sold receivables is minimal. 5. External and intersegment revenues (related party transactions between LG&E and KU) and income by business segment for the three and nine months ended September 30, 2003, follow (in thousands of $): Three Months Ended September 30, 2003 External Intersegment Revenues Revenues Net Income (Loss) LG&E electric $218,194 $11,980 $41,924 LG&E gas 32,659 - (2,053) Total $250,853 $11,980 $39,871 KU electric $224,426 $11,000 $30,310 Nine Months Ended September 30, 2003 External Intersegment Revenues Revenues Net Income LG&E electric $549,630 $41,480 $69,413 LG&E gas 213,939 - 5,478 Total $763,569 $41,480 $74,891 KU electric $624,334 $33,249 $56,330 External and intersegment revenues (related party transactions between LG&E and KU) and income by business segment for the three and nine months ended September 30, 2002, follow (in thousands of $): Three Months Ended September 30, 2002 External Intersegment Revenues Revenues Net Income (Loss) LG&E electric $215,458 $ 4,816 $38,024 LG&E gas 22,800 - (3,820) Total $238,258 $ 4,816 $34,204 KU electric $228,776 $ 6,283 $31,085 Page 15 Nine Months Ended September 30, 2002 External Intersegment Revenues Revenues Net Income LG&E electric $538,666 $27,719 $66,774 LG&E gas 170,856 - 3,629 Total $709,522 $27,719 $70,403 KU electric $610,944 $29,159 $68,194 6. The following regulatory assets and liabilities were included in the balance sheet of LG&E and KU as of September 30, 2003 and December 31, 2002 (in thousands of $): Louisville Gas and Electric (Unaudited) September 30, December 31, 2003 2002 REGULATORY ASSETS: Value Delivery Team (VDT) costs $ 75,344 $ 98,044 Unamortized loss on bonds 18,004 18,843 Gas supply adjustments due from customers 29,086 13,714 Earnings sharing mechanism provision 6,311 12,500 Asset retirement obligation 5,772 - LG&E/KU merger costs - 1,815 One utility costs - 954 Manufactured gas sites 1,530 1,757 Other 3,782 5,819 Total $139,829 $153,446 REGULATORY LIABILITIES: Deferred income taxes - net $ 39,191 $ 45,536 Gas supply adjustments due to customers 3,555 3,154 Other 969 3,734 Total $ 43,715 $ 52,424 Kentucky Utilities (Unaudited) September 30, December 31, 2003 2002 REGULATORY ASSETS: Value Delivery Team (VDT) costs $29,389 $38,375 Unamortized loss on bonds 8,835 9,456 Earnings sharing mechanism provision 5,792 13,500 Asset retirement obligation 10,064 - LG&E/KU merger costs - 2,046 One utility costs - 873 Other (404) (474) Total $53,676 $63,776 REGULATORY LIABILITIES: Deferred income taxes - net 19,949 28,854 Other 1,054 1,022 Total $21,003 $29,876 Merger Surcredit As part of the LG&E Energy merger with KU Energy in 1998, LG&E Energy estimated non-fuel savings over a ten-year period following the merger. Costs to achieve these savings of $50.2 million for LG&E and $42.3 million for KU were recorded in the second quarter of 1998. Of these amounts $18.1 million for LG&E and $20.5 million for KU was deferred and amortized over a five-year period pursuant to regulatory orders. Primary components of the merger costs were separation benefits, relocation costs, and transaction fees, the majority of which were paid by December 31, 1998. LG&E and KU expensed the remaining costs associated with the merger ($32.1 million and $21.8 million, respectively) in the second quarter of 1998. In approving the merger, the Kentucky Commission adopted the Companies' proposal to reduce its retail customers' bills based on one-half of the estimated merger-related savings, net of deferred and amortized amounts, over a five-year period. The surcredit mechanism provided that 50% of the net non-fuel cost savings estimated to be achieved from the merger be provided to ratepayers through a monthly bill credit, and 50% be retained by the Companies, over a five-year period. The surcredit was allocated 53% to KU and 47% to LG&E. In that same order, the Kentucky Commission required LG&E and KU, after the end of the five- year period, to present a plan for sharing with customers the then- projected non-fuel savings associated with the merger. The Companies submitted this filing on January 13, 2003, proposing to continue to share with customers, on a 50%/50% basis, the estimated fifth-year gross level of non-fuel savings associated with the merger. On October 16, 2003, the Kentucky Commission approved a merger surcredit settlement whereby the surcredit mechanism will remain in place for an additional five-year period at a levelized amount per year calculated from the originally estimated non-fuel savings for years six through ten. Customers and shareholders will continue to equally share merger savings on a 50%/50% basis and LG&E's customers will continue to be allocated 47%, and KU's customers will continue to be allocated 53%, of the customers' portion of the merger savings. As a part of the settlement, certain customers, in lieu of receiving monthly credits, will receive the present value of their estimated surcredits in up- front payments. These payments, $6.9 million for LG&E and $5.3 million for KU, will be deferred and amortized over the five-year period starting July 1, 2003, pursuant to the order. Remaining LG&E and KU customers will receive credits totaling $18.0 million and $17.9 million, respectively, in each of the five years beginning July 1, 2003. 7. The following data represent shares of jointly owned additions to the Trimble County plant for four combustion turbines as of September 30, 2003: LG&E KU Total Ownership % 37% 63% 100% Mw capacity 237 403 640 Plant under construction ($mill) $63 $108 $171 Depreciation - - - Net book value $63 $108 $171 8. Statement of Financial Accounting Standard (SFAS) No. 143, Accounting for Asset Retirement Obligations, was issued in 2001. SFAS No. 143 establishes accounting and reporting standards for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. The effective implementation date for SFAS No. 143 was January 1, 2003 and the associated FERC final rule, Accounting, Financial Reporting, and Rate Filing Requirements for Asset Retirement Obligations, was issued April 9, 2003. As of September 30, 2003, LG&E recorded asset retirement obligation (ARO) assets in the amount of $4.5 million and liabilities of $9.8 million. LG&E recorded offsetting regulatory assets of $5.8 million, pursuant to regulatory treatment prescribed under SFAS No. 71, Accounting for the Effects of Certain Types of Regulation. As of September 30, 2003, KU recorded ARO assets in the amount of $8.6 million and liabilities of $19.4 million. KU recorded Page 17 offsetting regulatory assets of $10.0 million, pursuant to regulatory treatment prescribed under SFAS No. 71. LG&E and KU AROs are primarily related to final retirement of assets associated with generating units. Assets with associated AROs will no longer include a cost of removal component within their depreciation rate. Assets without associated AROs will continue to be depreciated including a cost of removal component within the depreciation rate. The Companies are in the process of calculating the amount of the costs of removal embedded in accumulated depreciation. Had SFAS No. 143 been in effect for the 2002 reporting period, the Companies would have established asset retirement obligations as described in the following table (in thousands of $): LG&E KU Provision at January 1, 2002 $8,752 $17,331 Accretion expense 578 1,146 Provision at December 31, 2002 $9,330 $18,477 For the three months and nine months ended September 30, 2003, LG&E recorded ARO accretion expense of $154,000 and $462,000, respectively, ARO depreciation expense of $29,000 and $88,000, respectively, and an offsetting regulatory credit in the income statement of $185,000 and $550,000, respectively. For the three months and nine months ended September 30, 2003, KU recorded ARO accretion expense of $306,000 and $916,000, respectively, ARO depreciation expense of $44,000 and $131,000, respectively, and an offsetting regulatory credit in the income statement of $350,000 and $1.0 million, respectively. The recording of the regulatory credit is pursuant to regulatory treatment prescribed under SFAS No. 71. SFAS No. 143 has no impact on the results of the operation of the Companies. The Companies adopted EITF No. 98-10, Accounting for Energy Trading and Risk Management Activities, effective January 1, 1999. This pronouncement required that energy trading contracts be marked to market on the balance sheet, with the gains and losses shown net in the income statement. Effective January 1, 2003, the Companies adopted EITF No. 02-03, Issues Involved in Accounting for Derivative Contracts Held for Trading Purposes and Contracts Involved in Energy Trading and Risk Management Activities. EITF No. 02-03 established the following: - Rescinded EITF No. 98-10, - Contracts that do not meet the definition of a derivative under SFAS No. 133 should not be marked to fair market value, and - Revenues should be shown in the income statement net of costs associated with trading activities, whether or not the trades are physically settled. With the rescission of EITF No. 98-10, energy trading contracts that do not also meet the definition of a derivative under SFAS No. 133 must be accounted for as executory contracts. Contracts previously recorded at fair value under EITF No. 98-10 that are not also derivatives under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, must be restated to historical cost through a cumulative effect adjustment. The rescission of this standard had no impact on financial position or results of operations of the Companies since all contracts marked to market under EITF No. 98-10 are also within the scope of SFAS No. 133. As a result of EITF No. 02-03, the Companies have netted the power purchased expense for trading activities against electric operating revenue to reflect this accounting change. The Companies applied this guidance to all prior periods, which had no impact on previously reported net income or common equity. Page 18 Three Months Nine Months Ended Ended September 30, September 30, 2003 2002 2003 2002 LG&E: Gross electric operating revenues $230,174 $223,017 $591,110 $581,076 Less costs reclassified from power purchased - 2,743 - 14,691 Net electric operating revenues reported $230,174 $220,274 $591,110 $566,385 KU: Gross electric operating revenues $235,426 $239,020 $657,583 $657,744 Less costs reclassified from power purchased - 3,961 - 17,641 Net electric operating revenues reported $235,426 $235,059 $657,583 $640,103 Three Months Nine Months Ended Ended September 30, September 30, 2003 2002 2003 2002 LG&E: Gross power purchased $ 18,805 $ 15,322 $ 60,245 $ 60,967 Less costs reclassified to revenues - 2,743 - 14,691 Net power purchased reported $ 18,805 $ 12,579 $ 60,245 $ 46,276 KU: Gross power purchased $ 31,702 $ 31,873 $106,550 $112,844 Less costs reclassified to revenues - 3,961 - 17,641 Net power purchased reported $ 31,702 $ 27,912 $106,550 $ 95,203 In May 2003, the Financial Accounting Standards Board issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. SFAS No. 150 is effective immediately for financial instruments entered into or modified after May 31, 2003, and otherwise is effective for interim reporting periods beginning after June 15, 2003, except for certain instruments and certain entities which have been deferred by the FASB. Such deferrals do not affect LG&E and KU.. LG&E has existing $5.875 series mandatorily redeemable preferred stock outstanding having a current redemption price of $100 per share. The preferred stock has a sinking fund requirement sufficient to retire a minimum of 12,500 shares on July 15 of each year commencing with July 15, 2003, and a minimum of 187,500 shares on July 15, 2008 at $100 per share. LG&E redeemed 12,500 shares in accordance with these provisions on July 15, 2003, leaving 237,500 shares currently outstanding. Beginning with the three months ended September 30, 2003, LG&E reclassified, at fair value, its $5.875 series preferred stock as long- term debt with the minimum shares mandatorily redeemable within one year classified as current portion of long-term debt. Dividends accrued beginning July 1, 2003 are charged as interest expense. KU has no financial instruments that fall within the scope of SFAS No. 150. 9. In October 2003, KU issued a redemption notice to holders of Series P, 8.55% first mortgage bonds ($33.0 million). These bonds will be redeemed on November 25, 2003. The redemption will be funded with long- term loans from an E.ON affiliate. On August 15, 2003, LG&E borrowed $100 million from an E.ON affiliate for a ten-year term at 5.31%. The loan is secured by a second lien on substantially all of LG&E's assets. The proceeds were used to repay a maturing first mortgage bond of $42.6 million and to repay notes payable to affiliates. Page 19 On August 15, 2003, KU borrowed $75 million from an E.ON affiliate for a ten-year term at 5.31%. The loan is secured by a second lien on substantially all of KU's assets. The proceeds were used to repay notes payable to affiliates, some of which were the result of the repayment of a $62 million first mortgage bond. During July 2003, LG&E entered into five revolving lines of credit with third-party financial institutions totaling $185 million. These credit facilities expire in June 2004, and there was no outstanding balance under any of these facilities at September 30, 2003. The Companies participate in a money pool whereby LG&E Energy can make available up to $400 million at market-based rates for each of LG&E and KU. LG&E Energy maintains a facility totaling $150 million with an E.ON affiliate to ensure funding availability for the money pool. There was $46.0 million outstanding under E.ON affiliates' line as of September 30, 2003, leaving $104.0 million available. LG&E Energy had outstanding loans to LG&E and KU through the money pool that totaled $75.1 million and $98.7 million, respectively, as of September 30, 2003. These borrowings carried a thirty-day average interest rate of 1.06% at September 30, 2003, based on an index of highly rated commercial paper issuers as of the prior month end. LG&E and KU had available under the money pool, $324.9 million and $301.3 million, respectively, as of September 30, 2003. In August 2003, LG&E and KU contributed an additional $6.0 million each to their respective pension plans. 10.In the normal course of business, lawsuits, claims, environmental actions, and various non-ratemaking governmental proceedings arise against LG&E and KU. To the extent that damages are assessed in any of these lawsuits, LG&E and KU believe that their insurance coverage is adequate. Management, after consultation with legal counsel, and based upon the present status of these items, does not anticipate that liabilities arising out of other currently pending or threatened lawsuits and claims of the type referenced above will have a material adverse effect on LG&E's or KU's consolidated financial position or results of operations. LG&E Employment Discrimination Case As previously reported, in October 2001, approximately 30 employees or former employees filed a complaint against LG&E claiming past and current instances of employment discrimination. LG&E has moved the case to the U.S. District Court for the Western District of Kentucky and filed an answer denying all plaintiffs' claims. Discovery has commenced in the matter. The court has ordered mediation and certain plaintiffs have settled for immaterial amounts as a result of that process. In addition, certain other plaintiffs have sought administrative review before the U.S. Equal Employment Opportunity Commission which has, to date, declined to proceed to litigation on any claims reviewed. Previously amended pleadings, while reducing the size of the plaintiff and defendant groups and eliminating certain prior demands, contain a claimed damage amount of $100 million as well as requests for injunctive relief. During mediation in 2003, additional settlements for immaterial amounts were reached with a number of plaintiffs, including a settlement with the lead plaintiff, which reduced the number of remaining plaintiffs to nine. LG&E intends to continue to defend itself vigorously in the remaining action and management does not anticipate that the outcome will have a material impact on LG&E's operations or financial condition. Combustion Turbine Litigation In October 2003, LG&E and KU and third parties completed a settlement agreement to dismiss the Companies' previously reported lawsuit in the U.S. District Court for the Eastern District of Kentucky against Alstom Power, Inc. (formerly ABB Power Generation, Inc.). The suit concerned Page 20 operational deficiencies of two combustion turbines supplied by Alstom during 1999, installed at KU's E.W. Brown plant and jointly owned by LG&E and KU. The settlement agreement provides for $20 million reimbursement in two installments to be paid in January and April 2004 to LG&E and KU for the Companies' expenditures incurred regarding the turbines. The parties also entered into a long-term service agreement, whereby Alstom will provide to LG&E and KU certain future inspections, repairs and services for the turbines. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. General The following discussion and analysis by management focuses on those factors that had a material effect on LG&E's and KU's financial results of operations and financial condition during the three and nine month periods ended September 30, 2003, and should be read in connection with the financial statements and notes thereto. Some of the following discussion may contain forward-looking statements that are subject to certain risks, uncertainties and assumptions. Such forward-looking statements are intended to be identified in this document by the words "anticipate," "expect," "estimate," "objective," "possible," "potential" and similar expressions. Actual results may vary materially. Factors that could cause actual results to differ materially include: general economic conditions; business and competitive conditions in the energy industry; changes in federal or state legislation; unusual weather; actions by state or federal regulatory agencies; and other factors described from time to time in LG&E's and KU's reports to the Securities and Exchange Commission, including the current report on Form 8-K dated November 12, 2003. Results of Operations The results of operations for LG&E and KU are affected by seasonal fluctuations in temperature and other weather-related factors. Because of these and other factors, the results of one interim period are not necessarily indicative of results or trends to be expected for the full year. Three Months Ended September 30, 2003, Compared to Three Months Ended September 30, 2002 LG&E Results: LG&E's net income increased $5.7 million (17%) for the three months ended September 30, 2003, as compared to the three months ended September 30, 2002 primarily because of increased wholesale electric sales offset by decreased retail electric sales. A comparison of LG&E's revenues for the three months ended September 30, 2003, with the three months ended September 30, 2002, reflects increases and (decreases) which have been segregated by the following principal causes (in thousands of $): Electric Gas Cause Revenues Revenues Retail sales: Fuel and gas supply adjustments $ 3,481 $ 7,171 Environmental cost recovery surcharge (2,560) - Demand side management cost recovery 398 (17) LG&E/KU merger surcredit (947) - Value delivery surcredit (1,111) (127) Variation in sales volume and other (10,339) 2,737 Total retail sales (11,078) 9,764 Page 21 Wholesale sales 20,793 - Gas transportation - net - (71) Other 185 166 Total $ 9,900 $ 9,859 Electric revenues increased primarily due an increase in wholesale sales (volumes increased 135%, resulting in $24.4 million higher revenues) and higher fuel supply cost billed to customers, partially offset by a decrease in retail volumes sold due to a 29% decrease in cooling degree days. Gas revenues increased primarily as a result of higher gas supply costs billed to customers through the gas supply clause and increased volumes sold. Fuel for electric generation and gas supply expenses comprise a large component of LG&E's total operating expenses. LG&E's electric and gas rates contain a fuel adjustment clause and a gas supply clause, respectively, whereby increases or decreases in the cost of fuel and gas supply are reflected in retail rates, subject to the approval of the Kentucky Public Service Commission (Kentucky Commission). Fuel for electric generation increased $2.8 million (5%) for the three months ended September 30, 2003, due to an increase in in the quantity of fuel consumed for generation to supply wholesale sales ($5.0 million), partially offset by a decrease in the cost of coal burned ($2.2 million). Gas supply expenses increased $8.4 million (76%) due to an increase in net gas supply cost ($7.8 million) and an increase in the volume of retail gas delivered to the distribution system ($0.6 million). Power purchased increased $6.2 million (49%) due to increased purchases for higher off-system sales (49% higher volumes resulted in a $6.2 million volume variance). Maintenance expense decreased $6.3 million (34%) due to a decrease in expenses related to steam power production as a result of decreased plant outages ($4.3 million) and fewer gas main repairs ($2.0 million) in 2003 as compared to 2002. Although income tax expense increased due to higher pre-tax income, prior year adjustments booked in the third quarter of 2003 reduced tax expense in the period and lowered the effective tax rate. Three Months Three Months Ended Ended September 30, 2003September 30, 20 02 Effective Rate Statutory federal income tax rate 35.0% 35.0% State income taxes net of federal benefit 4.9 5.5 Amortization of investment and other tax credits (1.7) (1.8) Other differences (2.4) (0.1) Effective income tax rate 35.8% 38.6% Interest charges increased $.5 million (6%) in 2003 primarily due to $.3 million in additional interest expense related to preferred dividends reclassified as debt in accordance with SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity. The weighted average interest rate on variable-rate bonds for the three months ended September 30, 2003, was 0.99%, compared to 1.42% for the comparable period in 2002. KU Results: KU's net income decreased $.8 million (2%) for the three months ended September 30, 2003, as compared to the three months ended September 30, 2002. The decrease was primarily due to decreased other income, partially offset by decreased other operation expenses. Page 22 A comparison of KU's revenues for the three months ended September 30, 2003, with the three months ended September 30, 2002, reflects increases and (decreases) which have been segregated by the following principal causes (in thousands of $): Electric Cause Revenues Retail sales: Fuel supply adjustments $ 4,167 Environmental cost recovery surcharge 840 LG&E/KU merger surcredit (491) Value delivery surcredit (464) Variation in sales volume and other (8,956) Total retail sales (4,904) Wholesale sales 4,182 Other 1,089 Total $ 367 Higher wholesale revenues, due to an increase in wholesale sales volumes, and higher fuel costs billed to customers, were offset by lower retail sales volumes due to a 33% decrease in cooling degree days. Fuel for electric generation comprises a large component of KU's total operating expenses. KU's electric rates contain a fuel adjustment clause, whereby increases or decreases in the cost of fuel are reflected in retail rates, subject to the approval of the Kentucky Commission, the Virginia State Corporation Commission, and the Federal Energy Regulatory Commission. Fuel for electric generation decreased $5.1 million (6%) for the quarter because of a 7% decrease in the quantity of fuel consumed for generation ($6.0 million) due to a decrease in native load requirements, partially offset by an increase in the cost of coal burned ($.9 million) due to higher purchases of compliance coal. Power purchased increased $3.8 million (14%) due to a 34% increase in the volume purchased ($9.5 million), partially offset by a decrease in the price of power purchased ($5.7 million). The increase in volumes is attributable to higher intercompany purchases from LG&E. Other operation expenses decreased $2.5 million (7%) due primarily to a decrease in the amortization of prior "KU/LG&E Merger" and "One Utility" workforce reduction programs expenses ($1.9 million) and lower injury and liability claims from third parties ($.6 million). Variations in income tax expense are largely attributable to changes in pretax income. The change in other differences is due to the change in KU's equity earnings from a minority interest. Three Months Three Months Ended Ended September 30, 2003 September 30,2002 Effective Rate Statutory federal income tax rate 35.0% 35.0% State income taxes net of federal benefit 5.0 4.9 Amortization of investment and other tax credits (1.4) (1.6) Other differences (2.9) (4.3) Effective income tax rate 35.7% 34.0% Other income - net decreased $3.3 million (61%) in 2003 primarily due to a decrease in minority interest earnings, $3.8 million, partially offset by lower taxes. Page 23 Interest charges decreased $.8 million (15%) for the three months ended September 30, 2003 as compared to the three months ended September 30, 2002, due primarily to lower interest rates on variable-rate debt and the replacement of fixed-rate debt with variable-rate debt. The weighted average interest rate on variable-rate bonds for the three months ended September 30, 2003, was 0.91% and the corresponding rate for the three months ended September 30, 2002, was 1.57%. Nine Months Ended September 30, 2003, Compared to Nine Months Ended September 30, 2002 LG&E Results: LG&E's net income increased $4.5 million (6%) for the nine months ended September 30, 2003, as compared to the nine months ended September 30, 2002, primarily because of an increase in wholesale electric sales and gas retail sales partially offset by a decrease in retail electric sales and an increase in purchased power costs. A comparison of LG&E's revenues for the nine months ended September 30, 2003, with the nine months ended September 30, 2002, reflects increases and (decreases) which have been segregated by the following principal causes (in thousands of $): Electric Gas Cause Revenues Revenues Retail sales: Fuel and gas supply adjustments $ 8,071 $32,005 Environmental cost recovery surcharge (1,283) - Demand side management cost recovery 1,068 380 LG&E/KU merger surcredit (1,396) - Value delivery surcredit (2,627) (956) Earnings sharing mechanism 972 - Weather normalization - (2,509) Variation in sales volume and other (16,114) 20,357 Total retail sales (11,309) 49,277 Wholesale sales 34,381 (6,141) Gas transportation - net - (82) Other 1,653 29 Total $24,725 $43,083 Electric revenues increased primarily due to an increase in wholesale sales prices ($16.2 million), an increase in wholesale sales volumes ($18.2 million) and higher fuel supply costs billed to customers. Retail volumes decreased due to a 33% decrease in cooling degree days. Gas revenues increased primarily as a result of higher gas supply costs billed to customers through the gas supply clause and increased volumes sold due to an increase in heating degree days (20%), partially offset by a decrease in wholesale sales. Fuel for electric generation increased $3.9 million (3%) for the nine months due to an increase in the quantity of fuel consumed for generation ($4.8 million) partially offset by a decrease in the cost of coal burned ($.9 million). Gas supply expenses increased $38.7 million (34%) due to an increase in net gas supply cost ($33.5 million) and an increase in the volume of retail gas delivered to the distribution system ($9.9 million), partially offset by decreased wholesale gas expenses ($4.7 million). Power purchased increased $14.0 million (30%) due to an increase in the price of power purchased ($10.3 million) and an increase in the volume of purchases ($3.7 million) related to wholesale sales. Page 24 Other operation expenses increased $4.3 million (3%) primarily due to higher costs demand-side management programs ($2.1 million) and increased benefit costs ($2.2 million). Maintenance expenses decreased $4.3 million (9%) due to a decrease in expenses related to steam power production as a result of decreased plant outages ($3.9 million), fewer transmission and distribution line repairs ($1.1 million), and fewer gas main repairs ($1.4 million) partially offset by an increase in communications maintenance expense ($2.5 million). Depreciation and amortization expense increased $6.5 million (8%) due to additional utility plant in service. Although income tax expense increased due to higher pre-tax income, prior year adjustments booked in the third quarter of 2003 for reduced tax expense in the period and lowered the effective tax rate. Nine Months Ended Nine Months Ended September 30, 2003 September 30, 20 02 Effective Rate Statutory federal income tax rate 35.0% 35.0% State income taxes net of federal benefit 5.3 5.3 Amortization of investment and other tax credits (2.7) (2.8) Other differences (1.6) (0.1) Effective income tax rate 36.0% 37.4% Interest charges decreased $.3 million (1%) due primarily to lower interest rates on variable-rate debt. The weighted average interest rate on variable-rate bonds for the nine months ended September 30, 2003 was 1.12%, compared to 1.55% for the comparable period in 2002. KU Results: KU's net income decreased $11.9 million (17%) for the nine months ended September 30, 2003, as compared to the nine months ended September 30, 2002. The decrease was primarily due to an increase in operations, maintenance, and depreciation expenses partially offset by increased sales to retail and wholesale customers. A comparison of KU's revenues for the nine months ended September 30, 2003, with the nine months ended September 30, 2002, reflects increases and (decreases) which have been segregated by the following principal causes (in thousands of $): Electric Cause Revenues Retail sales: Fuel supply adjustments $17,317 Environmental cost recovery surcharge (49) Demand side management cost recovery 350 LG&E/KU merger surcredit (856) Value delivery surcredit (1,323) Earnings sharing mechanism (1,901) Variation in sales volume and other (3,296) Total retail sales 10,242 Wholesale sales 4,693 Other 2,545 Total $17,480 Page 25 Electric revenues increased primarily due to higher fuel supply costs billed to customers and higher wholesale sales due to 12% higher volumes ($6.0 million). Fuel for electric generation increased $5.2 million (3%) for the nine months ended September 30, 2003, due to an increase in the cost of coal burned ($14.2 million), offset by a decrease in the quantity of fuel consumed for generation ($9.0 million). Power purchased increased $11.3 million (12%) due to an increase in the volume purchased ($13.6 million) as a result of temporary plant outages, partially offset by the price of power purchased ($2.3 million). Other operation expenses increased $3.7 million (3%) due to increased benefit costs ($2.6 million), and increased property insurance ($1.1 million). Maintenance expenses increased $10.0 million (25%) due to repairs to electric distribution equipment due to an ice storm ($4.1 million, net of $8.9 million in insurance recoveries), timing of annual maintenance of steam production equipment occurring in second quarter 2003 vs. fourth quarter 2002 ($2.0 million), an insurance recovery in 2002 ($.9 million), a major unit outage in 2003 ($1.0 million), and an increase in communications maintenance expense ($2.0 million). Depreciation and amortization expense increased $5.6 million (8%) due to additional utility plant in service. Variations in income tax expense are largely attributable to changes in pretax income. Nine Months Ended Nine Months Ended September 30, 2003 September 30, 2002 Effective Rate Statutory federal income tax rate 35.0% 35.0% State income taxes net of federal benefit 5.8 5.7 Amortization of investment and other tax credits (2.3) (2.6) Other differences (3.6) (3.6) Effective income tax rate 34.9% 34.5% Other income - net decreased $1.8 million (21%) primarily due to a decrease in minority interest earnings ($3.3 million), partially offset by higher allowance for funds used during construction ($.9 million). Interest charges decreased $2.7 million (13%) due primarily to lower interest rates on variable-rate debt and the replacement of fixed-rate debt with variable-rate debt. The weighted average interest rate on variable- rate bonds for the nine months ended September 30, 2003, was 1.08% and the corresponding rate for the nine months ended September 30, 2002, was 1.57%. Liquidity and Capital Resources LG&E and KU's needs for capital funds are largely related to the construction of plant and equipment necessary to meet the needs of electric and gas utility customers. Internal and external lines of credit and the accounts receivable securitization programs are maintained to fund short-term capital requirements. LG&E and KU believe that such sources of funds will be sufficient to meet the needs of the business in the foreseeable future. Construction expenditures for the nine months ended September 30, 2003 for LG&E and KU amounted to $153.1 million and $264 million, respectively. Such expenditures related primarily to construction to meet nitrogen oxide (NOx) emission standards and the acquisition of combustion turbines to meet Page 26 peak power demands. Expenditures for the nine months ended September 30, 2003, by LG&E and KU for NOx construction were $23.7 million and $78.5 million, respectively. Expenditures for the nine months ended September 30, 2003, for Trimble County combustion turbines, Units 7 through 10, by LG&E and KU were $63.5 million and $108.4 million, respectively. The expenditures were financed with internally generated funds, intercompany loans from affiliates, and accounts receivable securitization program funds. See Note 4 of Notes to Financial Statements concerning accounts receivable securitization. LG&E's cash balance decreased $13.6 million during the nine months ended September 30, 2003, primarily due to a pension contribution and the purchase of an interest in the four Trimble County combustion turbines financed with intercompany loans. KU's cash balance increased $3.9 million during the nine months ended September 30, 2003. The increase reflects cash flows from operations and intercompany loans, partially offset by construction expenditures, including the purchase of an interest in the four Trimble County combustion turbines. Variations in accounts receivable, accounts payable and materials and supplies are generally not significant indicators of LG&E's and KU's liquidity. Such variations are primarily attributable to seasonal fluctuations in weather, which have a direct effect on sales of electricity and natural gas. The decrease in accounts receivable at LG&E resulted primarily from lower gas sales. The increase in accounts receivable for KU resulted primarily from timing of payments. The increase in LG&E's gas stored underground relates to higher prices on injections to inventory. The decrease in the fuel inventory at both LG&E and KU resulted from seasonal fluctuations. On August 15, 2003, LG&E borrowed $100 million from an E.ON affiliate for a ten-year term at 5.31%. The loan is secured by a second lien on substantially all of LG&E's assets. The proceeds were used to repay a maturing first mortgage bond of $42.6 million and to repay notes payable to affiliates. On August 15, 2003, KU borrowed $75 million from an E.ON affiliate for a ten-year term at 5.31%. The loan is secured by a second lien on substantially all of KU's assets. The proceeds were used to repay notes payable to affiliates, some of which were the results of the repayment of a $62 million first mortgage bond. During July 2003, LG&E entered into five revolving lines of credit totaling $185 million. These credit facilities expire in June 2004, and there was no outstanding balance under any of these facilities at September 30, 2003. The Companies participate in a money pool whereby LG&E Energy can make up to $400 million available at market-based rates for each of LG&E and KU. LG&E Energy maintains a facility totaling $150.0 million with an E.ON affiliate to ensure funding availability for the money pool. There was $46.0 million outstanding under the E.ON affiliates' line as of September 30, 2003, leaving $104.0 million available. LG&E Energy had outstanding loans to LG&E and KU through the money pool that totaled $75.1 million and $98.7 million, respectively, as of September 30, 2003. These borrowings carried a thirty-day average interest rate of 1.06% at September 30, 2003, based on an index of highly rated commercial paper issuers as of the prior month end. LG&E and KU had available, under the money pool, $324.9 million and $301.3 million, respectively, as of September 30, 2003. In October 2003, KU issued a redemption notice to holders of Series P, 8.55% first mortgage bonds ($33.0 million). These bonds will be redeemed on November 25, 2003. The redemption will be funded with long-term loans from an E.ON affiliate. Under the provisions of variable-rate pollution control bonds totaling $246.2 million for LG&E and $91.9 million for KU, the bonds are subject to tender for purchase at the option of the holder and to mandatory tender for purchase upon the occurrence of certain events, causing the bonds to be classified as current portion of long-term debt. Should any of the bonds be put to LG&E or KU, funds from the money pool could be used to reacquire the bonds. Page 27 LG&E's security ratings as of September 30, 2003, were: Moody's S&P Fitch First mortgage bonds A1 A- A+ Preferred stock Baa1 BBB- A- Commercial paper P-1 A-2 F-1 KU's security ratings as of September 30, 2003, were: Moody's S&P Fitch First mortgage bonds A1 A A+ Preferred stock Baa1 BBB- A- Commercial paper P-1 A-2 F-1 These ratings reflect the views of Moody's, S&P and Fitch. A security rating is not a recommendation to buy, sell or hold securities and is subject to revision or withdrawal at any time by the rating agency. Fitch withdrew its ratings on LG&E and KU securities effective October 14, 2003. LG&E's capitalization ratios at September 30, 2003, and December 31, 2002, follow: Sept. 30, Dec. 31, 2003 2002 Long-term debt (including current portion) 43.1% 35.5% Notes payable 4.1 11.1 Preferred stock 3.8 5.5 Common equity 49.0 47.9 Total 100.0% 100.0% KU's capitalization ratios at September 30, 2003, and December 31, 2002, follow: Sept. 30, Dec. 31, 2003 2002 Long-term debt (including current portion) 37.8% 34.0% Notes payable 6.1 8.1 Preferred stock 2.5 2.7 Common equity 53.6 55.2 Total 100.0% 100.0% New Accounting Pronouncements SFAS No. 143, Accounting for Asset Retirement Obligations, was issued in 2001. SFAS No. 143 establishes accounting and reporting standards for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. The effective implementation date for SFAS No. 143 was January 1, 2003, and the associated FERC final rule, Accounting, Financial Reporting, and Rate Filing Requirements for Asset Retirement Obligations, was issued April 9, 2003. As of September 30, 2003, LG&E recorded asset retirement obligation Page 28 (ARO) assets in the amount of $4.5 million and liabilities of $9.8 million. LG&E recorded offsetting regulatory assets of $5.8 million, pursuant to regulatory treatment prescribed under SFAS No. 71, Accounting for the Effects of Certain Types of Regulation. As of September 30, 2003, KU recorded ARO assets in the amount of $8.6 million and liabilities of $19.4 million. KU recorded offsetting regulatory assets of $10.0 million, pursuant to regulatory treatment prescribed under SFAS No. 71. LG&E and KU AROs are primarily related to the final retirement of assets associated with generating units. Assets with associated AROs will no longer include a cost of removal component within their depreciation rate. Assets without associated AROs will continue to be depreciated including a cost of removal component within the depreciation rate. The Companies are in the process of calculating the amount of the costs of removal embedded in accumulated depreciation. Had SFAS No. 143 been in effect for the 2002 reporting period, the Companies would have established asset retirement obligations as described in the following table ($000): LG&E KU Provision at January 1, 2002 $8,752 $17,331 Accretion expense 578 1,146 Provision at December 31, 2002 $9,330 $18,477 For the three months and nine months ended September 30, 2003, LG&E recorded ARO accretion expense of $154,000 and $462,000, respectively, ARO depreciation expense of $29,000 and $88,000, respectively, and an offsetting regulatory credit in the income statement of $185,000 and $550,000, respectively. For the three months and nine months ended September 30, 2003, KU recorded ARO accretion expense of $306,000 and $916,000, respectively, ARO depreciation expense of $44,000 and $131,000, respectively, and an offsetting regulatory credit in the income statement of $350,000 and $1.0 million, respectively. The recording of the regulatory credit is pursuant to regulatory treatment prescribed under SFAS No. 71. SFAS No. 143 has no impact on the results of the operation of the Companies. The Companies adopted EITF No. 98-10, Accounting for Energy Trading and Risk Management Activities, effective January 1, 1999. This pronouncement required that energy trading contracts be marked to market on the balance sheet, with the gains and losses shown net in the income statement. Effective January 1, 2003, the Companies adopted EITF No. 02-03, Issues Involved in Accounting for Derivative Contracts Held for Trading Purposes and Contracts Involved in Energy Trading and Risk Management Activities. EITF No. 02-03 established the following: - Rescinded EITF No. 98-10, - Contracts that do not meet the definition of a derivative under SFAS No. 133 should not be marked to fair market value, and - Revenues should be shown in the income statement net of costs associated with trading activities, whether or not the trades are physically settled. With the rescission of EITF No. 98-10, energy trading contracts that do not also meet the definition of a derivative under SFAS No. 133 must be accounted for as executory contracts. Contracts previously recorded at fair value under EITF No. 98-10 that are not also derivatives under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, must be restated to historical cost through a cumulative effect adjustment. The rescission of this standard had no impact on financial position or results of operations of the Companies since all contracts marked to market under EITF No. 98-10 are also within the scope of SFAS No. 133. As a result of EITF No. 02-03, the Companies have netted the power purchased expense for trading activities against electric operating revenue to reflect this accounting change. The Companies applied this guidance to Page 29 all prior periods, which had no impact on previously reported net income or shareholders' equity. The following tables present the impact of this reclassification (in thousands of $): Three Months Nine Months Ended Ended September 30, September 30, 2003 2002 2003 2002 LG&E: Gross electric operating revenues $230,174 $223,017 $591,110 $581,076 Less costs reclassified from power purchased - 2,743 - 14,691 Net electric operating revenues reported $230,174 $220,274 $591,110 $566,385 KU: Gross electric operating revenues $235,426 $239,020 $657,583 $657,744 Less costs reclassified from power purchased - 3,961 - 17,641 Net electric operating revenues reported $235,426 $235,059 $657,583 $640,103 Three Months Nine Months Ended Ended September 30, September 30, 2003 2002 2003 2002 LG&E: Gross power purchased $ 18,805 $ 15,322 $ 60,245 $ 60,967 Less costs reclassified to revenues - 2,743 - 14,691 Net power purchased reported $ 18,805 $ 12,579 $ 60,245 $ 46,276 KU: Gross power purchased $ 31,702 $ 31,873 $106,550 $112,844 Less costs reclassified to revenues - 3,961 - 17,641 Net power purchased reported $ 31,702 $ 27,912 $106,550 $ 95,203 In May 2003, the Financial Accounting Standards Board issued Statement of SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. SFAS No. 150 is effective immediately for financial instruments entered into or modified after May 31, 2003, and otherwise is effective for interim reporting periods beginning after September 15, 2003. LG&E has existing $5.875 series mandatorily redeemable preferred stock with 250,000 shares outstanding having a current redemption price of $100 per share. The preferred stock has a sinking fund requirement sufficient to retire a minimum of 12,500 shares on July 15 of each year commencing with July 15, 2003, and a minimum of 187,500 shares on July 15, 2008 at $100 per share. Beginning with the three months ended September 30, 2003, LG&E reclassified, at fair value, its $5.875 series preferred stock as long-term debt with the minimum shares mandatorily redeemable within one year classified as current portion of long-term debt. Dividends accrued beginning July 1, 2003 are charged as interest expense. KU has no financial instruments that fall within the scope of SFAS No. 150. Contingencies For a description of significant contingencies that may affect LG&E and KU, reference is made to Part I, Item 3, Legal Proceedings in LGE's and KU's Annual Reports on Form 10-K for the year ended December 31, 2002; and Note 11 to the financial statements contained in LG&E's and KU's current report on Form 8-K dated November 12, 2003; and to Part II - Item 1, Legal Proceedings herein. Merger Surcredit As part of the LG&E Energy merger with KU Energy in 1998, LG&E Energy estimated non-fuel savings over a ten-year period following the merger. Costs to achieve these savings of $50.2 million for LG&E and of $42.3 million for KU were recorded in the second quarter of 1998. Of these Page 30 amounts $18.1 million for LG&E and $20.5 million for KU was deferred and amortized over a five-year period pursuant to regulatory orders. Primary components of the merger costs were separation benefits, relocation costs, and transaction fees, the majority of which were paid by December 31, 1998. LG&E and KU expensed the remaining costs associated with the merger ($32.1 million and $21.8 million, respectively) in the second quarter of 1998. In approving the merger, the Kentucky Commission adopted the Companies' proposal to reduce its retail customers' bills based on one-half of the estimated merger-related savings, net of deferred and amortized amounts, over a five-year period. The surcredit mechanism provided that 50% of the net non-fuel cost savings estimated to be achieved from the merger be provided to ratepayers through a monthly bill credit, and 50% be retained by the Companies, over a five-year period. The surcredit was allocated 53% to KU and 47% to LG&E. In that same order, the Kentucky Commission required LG&E and KU, after the end of the five-year period, to present a plan for sharing with customers the then-projected non-fuel savings associated with the merger. The Companies submitted this filing on January 13, 2003, proposing to continue to share with customers, on a 50%/50% basis, the estimated fifth-year gross level of non-fuel savings associated with the merger. On October 16, 2003, the Kentucky Commission approved a merger surcredit settlement whereby the surcredit mechanism will remain in place for an additional five-year period at a levelized amount per year calculated from the originally estimated non-fuel savings for years six through ten. Customers and shareholders will continue to equally share merger savings on a 50%/50% basis and LG&E's customers will continue to be allocated 47%, and KU's customers will continue to be allocated 53%, of the customers' portion of the merger savings. As a part of the settlement, certain customers, in lieu of receiving monthly credits, will receive the present value of their estimated surcredits in up-front payments. These payments, $6.9 million for LG&E and $5.3 million for KU, will be deferred and amortized over the five-year period starting July 1, 2003, pursuant to the order. Remaining LG&E and KU customers will receive credits totaling $18.0 million and $17.9 million, respectively, in each of the five years beginning July 1, 2003. Item 3. Quantitative and Qualitative Disclosures About Market Risk. LG&E and KU are exposed to market risks. Both operations are exposed to market risks from changes in interest rates and commodity prices. To mitigate changes in cash flows attributable to these exposures, the Companies have entered into various derivative instruments. Derivative positions are monitored using techniques that include market value and sensitivity analysis. The Companies use interest rate swaps to hedge exposure to market fluctuations in certain of their debt instruments. Pursuant to the Companies' policies, use of these financial instruments is intended to mitigate risk and earnings volatility and is not speculative in nature. Management has designated all of the Companies' interest rate swaps as hedge instruments. Financial instruments designated as cash flow hedges have resulting gains and losses recorded within other comprehensive income and stockholders' equity. To the extent a financial instrument or the underlying item being hedged is prematurely terminated or the hedge becomes ineffective, the resulting gains or losses are reclassified from other comprehensive income to net income. Financial instruments designated as fair value hedges are periodically marked to market with the resulting gains and losses recorded directly into net income to correspond with income or expense recognized from changes in market value of the items being hedged. The potential change in interest expense associated with a 1% change in base interest rates of LG&E's and KU's unswapped debt is estimated at $4.6 million and $5.0 million, respectively, at September 30, 2003. LG&E's exposure to floating interest rates decreased $89.3 million and KU's exposure to floating interest rates decreased $20.8 million during the first nine months of 2003. The potential changes in the fair values of the Companies' interest-rate swaps resulting from changes in interest rates and the yield curve also did not change materially during the first nine months of 2003. Page 31 Pension Risk LG&E's and KU's costs of providing defined-benefit pension retirement plans are dependent upon a number of factors, such as the rates of return on plan assets, discount rate, and contributions made to the plans. The market value of LG&E and KU plan assets is affected by increases and decreases in the equity market. As a result, at December 31, 2002, LG&E and KU were required to recognize an additional minimum liability as prescribed by SFAS No. 87, Employers' Accounting for Pensions. The liability was recorded as a reduction to other comprehensive income, and did not affect net income for 2002. The amount of the liabilities depended upon the asset returns experienced in 2002 and contributions made by LG&E and KU to the plans during 2002. Also, pension cost and cash contributions to the plans could increase in future years without a substantial recovery in the equity markets. If the fair value of the plans' assets exceeds the accumulated benefit obligation, the recorded liabilities will be reduced and other comprehensive income will be restored in the consolidated balance sheets. During 2002, the combination of poor market performance and historically low corporate bond rates created a divergence in the potential value of the pension liabilities and the actual value of the pension assets. Year-to-date 2003 market performance has been favorable. Should poor market conditions return, these conditions could result in an increase in LG&E's and KU's funded accumulated benefit obligations and future pension expense. The primary assumptions that drive the value of the unfunded accumulated benefit obligations are the discount rate and expected return on plan assets. In January 2003, LG&E and KU made contributions to their pension plans of $83.1 million and $3.5 million, respectively. In August 2003, LG&E and KU contributed an additional $6.0 million each to their respective pension plans. Energy Trading & Risk Management Activities LG&E and KU conduct energy trading and risk management activities to maximize the value of power sales from physical assets they own, in addition to the wholesale sale of excess asset capacity. Certain energy trading activities are accounted for on a mark-to-market basis in accordance with SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, and SFAS No. 138, Accounting for Certain Derivative Instruments and Certain Hedging Activities. Wholesale sales of excess asset capacity are treated as normal sales under SFAS No. 133 and SFAS No. 138 and are not marked to market. The rescission of EITF No. 98-10 for fiscal periods ending after December 15, 2002, had no impact on LG&E's or KU's energy trading and risk management reporting as all contracts marked to market under EITF No. 98-10 are also within the scope of SFAS No. 133. The table below summarizes LG&E's and KU's energy trading and risk management activities for the three months and nine months ended September 30, 2003, and 2002(in thousands of $). Trading volumes are allocated evenly between LG&E and KU. Three Months Nine Months Ended Ended September 30, September 30, 2003 2002 2003 2002 Fair value of contracts at beginning of period, net asset/(liability) $318 $ 26 $ (156) $(186) Fair value of contracts when entered into during the period (30) (5) 2,590 (62) Contracts realized or otherwise settled during the period (356) 6 (639) 341 Changes in fair value due to changes in assumptions 148 (193) (1,715) (259) Fair value of contracts at end of period, net asset/(liability) $ 80 $(166) $ 80 $(166) Page 32 No changes to valuation techniques for energy trading and risk management activities occurred during 2003 or 2002. Changes in market pricing, interest rate and volatility assumptions were made during all periods. All contracts outstanding at September 30, 2003, have a maturity of less than one year and are valued using prices actively quoted for proposed or executed transactions or quoted by brokers. LG&E and KU maintain policies intended to minimize credit risk and revalue credit exposures daily to monitor compliance with those policies. As of September 30, 2003, 100% of the trading and risk management commitments were with counterparties rated BBB-/Baa3 equivalent or better. Deregulation The electricity industry in Virginia is currently undergoing deregulation which will enable customers to choose their own energy suppliers after January 2004. On March 19, 2003, the Governor of Virginia signed House Bill 2367, the "Electric Utility Restructuring Suspension," which suspends Kentucky Utilities/Old Dominion Power from Virginia electric utility restructuring until such time as retail choice is offered to other customers in KU's other service territories. Employee and Labor Relations In August 2003, KU and employees represented by IBEW Local 2100 entered into a three-year collective bargaining agreement expiring August 2006, with certain annual wage or benefit re-opener provisions. In October 2003, LG&E and employees represented by IBEW 2100 completed primary wage and benefits re-opener negotiations providing for certain enhanced or modified wage and benefit provisions. The term of this collective bargaining agreement expires in November 2005. Item 4. Controls and Procedures. LG&E and KU maintain a system of disclosure controls and procedures designed to ensure that information required to be disclosed by the Companies in reports they file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission rules and forms. LG&E and KU conducted an evaluation of such controls and procedures under the supervision and with the participation of the Companies' management, including the Chairman, President and Chief Executive Officer ("CEO") and the Chief Financial Officer ("CFO"). Based upon that evaluation, the CEO and CFO are of the conclusion that the Companies' disclosure controls and procedures are effective as of the end of the period covered by this report. There has been no change in the Companies' internal control over financial reporting that occurred during the fiscal quarter ended September 30, 2003, that has materially affected, or is reasonably likely to materially affect, the Companies' internal control over financial reporting. Page 33 Part II. Other Information Item 1. Legal Proceedings. For a description of the significant legal proceedings involving LG&E and KU, reference is made to the information under the following items and captions of LG&E's and KU's (A) respective combined Annual Report on Form 10-K for the year ended December 31, 2002: Item 1, Business; Item 3, Legal Proceedings; Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations; and (B) current report on Form 8-K dated November 12, 2003: Notes 3 and 11 of LG&E's Notes to Financial Statements under Item 8 and Notes 3 and 11 of KU's Notes to Financial Statements under Item 8; and (BC) respective combined Quarterly Report on Form 10-Q for the quarter ended June 30, 2003: Item 1 of Part II Legal Proceedings. Except as described herein, to date, the proceedings reported in LG&E's and KU's respective combined Annual Report on Form 10-K have not changed materially. LG&E Employment Discrimination Case As previously reported, in October 2001, approximately 30 employees or former employees filed a complaint against LG&E claiming past and current instances of employment discrimination. LG&E has removed the case to the U.S. District Court for the Western District of Kentucky and filed an answer denying all plaintiffs' claims. Discovery has commenced in the matter. The court has ordered mediation and certain plaintiffs have settled for immaterial amounts as a result of that process. In addition, certain other plaintiffs have sought administrative review before the U.S. Equal Employment Opportunity Commission which has, to date, declined to proceed to litigation on any claims reviewed. Previously amended pleadings, while reducing the size of the plaintiff and defendant groups and eliminating certain prior demands, contain a claimed damage amount of $100 million as well as requests for injunctive relief. During mediation in 2003, additional settlements for immaterial amounts were reached with a number of plaintiffs, including a settlement with the lead plaintiff, which reduced the number of remaining plaintiffs to nine. LG&E intends to continue to defend itself vigorously in the remaining action and management does not anticipate that the outcome will have a material impact on LG&E's operations or financial condition. Combustion Turbine Litigation In October 2003, LG&E and KU and third parties completed a settlement agreement to dismiss the Companies' previously reported lawsuit in the U.S. District Court for the Eastern District of Kentucky against Alstom Power, Inc. (formerly ABB Power Generation, Inc.). The suit concerned operational deficiencies of two combustion turbines supplied by Alstom during 1999, installed at KU's E.W. Brown plant and jointly owned by LG&E and KU. The settlement agreement provides for $20 million reimbursement in two installments to be paid in January and April 2004 to LG&E and KU for the Companies' expenditures incurred regarding the turbines. The parties also entered into a long-term service agreement, whereby Alstom will provide to LG&E and KU certain future inspections, repairs and services for the turbines. Item 6. Exhibits and Reports on Form 8-K. 6(a) Applicable to Form 10-Q of Exhibit No. LG&E KU Description 31 X X Certification - Section 302 of Sarbanes-Oxley Act of 2002 31.1 X Certification of Chairman of the Board, President and Chief Executive Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 31.2 X Certification of Chief Financial Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 Page 34 31.3 X Certification of Chairman of the Board, President and Chief Executive Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 31.4 X Certification of Chief Financial Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32 X X Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 6(b). Reports on Form 8-K. None Page 35 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Louisville Gas and Electric Company Registrant Date: November 12, 2003 /s/ S. Bradford Rives S. Bradford Rives Chief Financial Officer (On behalf of the registrant in his capacities as Principal Financial Officer and Principal Accounting Officer) Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Kentucky Utilities Company Registrant Date: November 12, 2003 /s/ S. Bradford Rives S. Bradford Rives Chief Financial Officer (On behalf of the registrant in his capacities as Principal Financial Officer and Principal Accounting Officer) Page 36 Exhibit 31 - CERTIFICATIONS Exhibit 31.1 Louisville Gas and Electric Company I, Victor A. Staffieri, Chairman of the Board, President and Chief Executive Officer, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Louisville Gas and Electric Company; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: November 12, 2003 /s/ Victor A. Staffieri Victor A. Staffieri Chairman of the Board, President and Chief Executive Officer Page 37 Exhibit 31.2 Louisville Gas and Electric Company I, S. Bradford Rives, Chief Financial Officer, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Louisville Gas and Electric Company; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: November 12, 2003 /s/ S. Bradford Rives S. Bradford Rives Chief Financial Officer Page 38 Exhibit 31.3 Kentucky Utilities Company I, Victor A. Staffieri, Chairman of the Board, President and Chief Executive Officer, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Kentucky Utilities Company; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: November 12, 2003 /s/ Victor A. Staffieri Victor A. Staffieri Chairman of the Board, President and Chief Executive Officer Page 39 Exhibit 31.4 Kentucky Utilities Company I, S. Bradford Rives, Chief Financial Officer, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Kentucky Utilities Company; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: November 12, 2003 /s/ S. Bradford Rives S. Bradford Rives Chief Financial Officer Page 40 Exhibit 32 Certification Pursuant to 18 U.S.C. Section 1350 As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 In connection with the Quarterly Report of Louisville Gas and Electric Company and Kentucky Utilities Company (the "Companies") on Form 10-Q for the period ended September 30, 2003, as filed with the Securities and Exchange Commission (the "Report"), each of the undersigned does hereby certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to such officer's knowledge, 1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Companies as of the dates and for the period expressed in the Report. November 12, 2003 /s/ Victor A. Staffieri Chairman of the Board, President and Chief Executive Officer Louisville Gas and Electric Company Kentucky Utilities Company /s/ S. Bradford Rives Chief Financial Officer Louisville Gas and Electric Company Kentucky Utilities Company The foregoing certification is being furnished solely pursuant to 18 U.S.C. Section 1350 and is not being filed as part of the Report or as a separate disclosure document. Page 41