-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, V8An1MkoOVp9qAjWF7rw9e4wKkbkmHaOeg/gzZVAoir7I2M8bg9eZKNfjMBpEOVY yIsmQeKJRFb9ti0jnMErdQ== 0000861388-04-000005.txt : 20040513 0000861388-04-000005.hdr.sgml : 20040513 20040513134953 ACCESSION NUMBER: 0000861388-04-000005 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 20040331 FILED AS OF DATE: 20040513 FILER: COMPANY DATA: COMPANY CONFORMED NAME: KENTUCKY UTILITIES CO CENTRAL INDEX KEY: 0000055387 STANDARD INDUSTRIAL CLASSIFICATION: ELECTRIC SERVICES [4911] IRS NUMBER: 610247570 STATE OF INCORPORATION: KY FISCAL YEAR END: 1229 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-03464 FILM NUMBER: 04802223 BUSINESS ADDRESS: STREET 1: ONE QUALITY ST CITY: LEXINGTON STATE: KY ZIP: 40507 BUSINESS PHONE: 6062552100 FILER: COMPANY DATA: COMPANY CONFORMED NAME: LOUISVILLE GAS & ELECTRIC CO /KY/ CENTRAL INDEX KEY: 0000060549 STANDARD INDUSTRIAL CLASSIFICATION: ELECTRIC & OTHER SERVICES COMBINED [4931] IRS NUMBER: 610264150 STATE OF INCORPORATION: KY FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-02893 FILM NUMBER: 04802222 BUSINESS ADDRESS: STREET 1: 220 W MAIN ST STREET 2: P O BOX 32030 CITY: LOUISVILLE STATE: KY ZIP: 40232 BUSINESS PHONE: 5026272000 MAIL ADDRESS: STREET 1: 220 WEST MAIN ST CITY: LUUISVILLE STATE: KY ZIP: 40232 10-Q 1 q10q0304.txt LG&E AND KU 1ST QUARTER 2004 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 March 31, 2004 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. 1-2893 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 April 30, 2004, all held by LG&E Energy LLC Kentucky Utilities Company 37,817,878 shares, without par value, as of April 30, 2004, all held by LG&E Energy LLC 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. - - New Page - TABLE OF CONTENTS PART I ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) LOUISVILLE GAS AND ELECTRIC COMPANY AND SUBSIDIARY STATEMENTS OF INCOME 1 STATEMENT OF RETAINED EARNINGS 1 BALANCE SHEETS 2 STATEMENT OF CASH FLOWS 4 STATEMENTS OF OTHER COMPREHENSIVE INCOME 5 KENTUCKY UTILITIES COMPANY AND SUBSIDIARY STATEMENTS OF INCOME 6 STATEMENT OF RETAINED EARNINGS 6 BALANCE SHEETS 7 STATEMENT OF CASH FLOWS 9 STATEMENTS OF OTHER COMPREHENSIVE INCOME 10 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 11 ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. 19 ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. 28 ITEM 4 CONTROLS AND PROCEDURES. 30 PART II ITEM 1 LEGAL PROCEEDINGS. 31 ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K 31 SIGNATURES 33 - New Page - Part I. Financial Information - Item 1. Consolidated Financial Statements (Unaudited) Louisville Gas and Electric Company and Subsidiary Consolidated Statements of Income (Unaudited) (Thousands of $) Three Months Ended March 31, 2004 2003 OPERATING REVENUES (Note 5): Electric $198,249 $187,020 Gas 163,714 139,824 Total operating revenues 361,963 326,844 OPERATING EXPENSES: Fuel for electric generation 52,524 49,477 Power purchased 28,888 24,128 Gas supply expenses 130,756 106,107 Other operation expenses 58,061 53,528 Maintenance 11,541 11,893 Depreciation and amortization 27,499 27,145 Federal and state income taxes 15,025 16,641 Property and other taxes 5,071 4,735 Total operating expenses 329,365 293,654 NET OPERATING INCOME 32,598 33,190 Other income (expense) - net (461) 1,060 Other income from affiliated company (Note 10) - 4 Interest expense (Note 3) 4,777 6,255 Interest expense to affiliated companies (Note 10) 3,141 735 NET INCOME $ 24,219 $ 27,264 Consolidated Statement of Retained Earnings (Unaudited) (Thousands of $) Three Months Ended March 31, 2004 2003 Balance at beginning of period $497,441 $409,319 Net income 24,219 27,264 Subtotal 521,660 436,583 Cash dividends declared on stock: 5% cumulative preferred 269 269 Auction rate cumulative preferred 187 300 $5.875 cumulative preferred - 367 Subtotal 456 936 Balance at end of period $521,204 $435,647 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 March 31, December 31, 2004 2003 UTILITY PLANT: At original cost $3,826,311 $3,804,183 Less: reserve for depreciation 1,339,855 1,319,768 Net utility plant (Note 7) 2,486,456 2,484,415 OTHER PROPERTY AND INVESTMENTS - less reserve of $63 as of March 31, 2004 and December 31, 2003 507 611 CURRENT ASSETS: Cash and cash equivalents 28,629 1,706 Accounts receivable - less reserve of $3,515 as of March 31, 2004 and December 31, 2003 (Note 4) 128,986 84,585 Notes receivable from affiliated companies 6,600 - Materials and supplies - at average cost: Fuel (predominantly coal) 22,081 25,260 Gas stored underground 24,756 69,884 Other 25,583 24,971 Prepayments and other 4,661 5,281 Total current assets 241,296 211,687 DEFERRED DEBITS AND OTHER ASSETS: Unamortized debt expense 8,718 8,468 Regulatory assets (Note 6) 122,534 142,772 Other 37,506 40,975 Total deferred debits and other assets 168,758 192,215 Total assets $2,897,017 $2,888,928 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 March 31, December 31, 2004 2003 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 Accumulated other comprehensive loss (41,743) (38,111) Retained earnings 521,204 497,441 Total common equity 943,795 923,664 Cumulative preferred stock 70,425 70,140 Mandatorily redeemable preferred stock (Note 8) 22,500 22,500 Long-term debt (Note 9) 328,104 328,104 Long-term debt to affiliated company (Note 9) 225,000 200,000 Total capitalization 1,589,824 1,544,408 CURRENT LIABILITIES: Current portion of mandatorily redeemable preferred stock (Note 8) 1,250 1,250 Current portion of long-term debt 246,200 246,200 Current portion of long-term debt to affiliated company (Note 9) 100,000 - Notes payable to affiliated companies (Note 9) - 80,332 Accounts payable 72,171 93,118 Accounts payable to affiliated companies (Note 10) 19,875 38,343 Accrued taxes 23,617 18,615 Customer deposits 10,578 10,493 Other 10,519 9,308 Total current liabilities 484,210 497,659 DEFERRED CREDITS AND OTHER LIABILITIES: Accumulated deferred income taxes - net 338,843 337,704 Investment tax credit, in process of amortization 49,278 50,329 Accumulated provision for pensions and related benefits 100,937 140,598 Customer advances for construction 10,020 9,890 Asset retirement obligation 9,911 9,747 Regulatory liabilities (Note 6): Accumulated cost of removal of utility plant 227,187 223,622 Other 50,584 51,822 Long-term derivative liability 22,041 15,966 Other 14,182 7,183 Total deferred credits and other liabilities 822,983 846,861 Total capital and liabilities $2,897,017 $2,888,928 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 $) Three Months Ended March 31, 2004 2003 CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 24,219 $ 27,264 Items not requiring cash currently: Depreciation and amortization 27,499 27,145 Deferred income taxes - net 276 5,510 Investment tax credit - net (1,051) (1,052) VDT amortization 7,534 7,696 Marked-to-market financial instruments 6,075 33 Other (2,992) 5,573 Changes in current assets and liabilities (29,225) 22,413 Changes in accounts receivable securitization -net (Note 4) - 11,800 Pension funding (Note 9) (34,492) (83,125) Provision for post-retirement benefits (5,169) (1,425) Gas supply clause 7,773 (19,353) Earnings sharing mechanism (ESM) 3,032 (1,147) Other 12,864 4,122 Net cash flows from operating activities 16,343 5,454 CASH FLOWS USED IN INVESTING ACTIVITIES: Proceeds from sales of securities 103 162 Construction expenditures (27,061) (71,255) Net cash flows used in investing activities (26,958) (71,093) CASH FLOWS FROM FINANCING ACTIVITIES: Long-term borrowings from affiliated company (Note 9) 125,000 - Short-term borrowings from affiliated company (Note 9) 131,200 229,200 Repayment of short-term borrowings from affiliated company (218,132) (173,741) Issuance expense of pollution control bonds (96) - Payment of dividends (434) (1,057) Net cash flows from financing activities 37,538 54,402 CHANGE IN CASH AND CASH EQUIVALENTS 26,923 (11,237) CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 1,706 17,015 CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 28,629 $ 5,778 SUPPLEMENTAL DISCLOSURES: Cash paid during the period for: Income taxes $ 5,241 $ (1,739) Interest on borrowed money $ 3,917 $ 6,700 Interest to affiliated companies on borrowed money $ 2,777 $ 698 The accompanying notes are an integral part of these consolidated financial statements. - - Page 4 - Louisville Gas and Electric Company and Subsidiary Consolidated Statements of Other Comprehensive Income (Unaudited) (Thousands of $) Three Months Ended March 31, 2004 2003 Net income $24,219 $27,264 Losses on derivative instruments and hedging activities - net of tax benefit/(expense) of $2,417 and $13 for 2004 and 2003, respectively (Note 3) (3,632) (20) Other comprehensive loss, net of tax (3,632) (20) Comprehensive income $20,587 $27,244 The accompanying notes are an integral part of these consolidated financial statements. - - Page 5 - Kentucky Utilities Company and Subsidiary Consolidated Statements of Income (Unaudited) (Thousands of $) Three Months Ended March 31, 2004 2003 OPERATING REVENUES (Note 5) $247,386 $224,983 OPERATING EXPENSES: Fuel for electric generation 69,884 66,323 Power purchased 41,307 41,199 Other operation expenses 38,454 38,889 Maintenance 11,884 28,966 Depreciation and amortization 25,249 24,150 Federal and state income taxes 21,101 6,601 Property and other taxes 4,253 4,195 Total operating expenses 212,132 210,323 NET OPERATING INCOME 35,254 14,660 Other income - net 1,462 2,106 Other income from affiliated company (Note 10) 10 3 Interest expense (Note 3) 735 4,531 Interest expense to affiliated companies (Note 10) 3,547 377 NET INCOME $ 32,444 $ 11,861 Consolidated Statement of Retained Earnings (Unaudited) (Thousands of $) Three Months Ended March 31, 2004 2003 Balance at beginning of period $591,170 $502,024 Net income 32,444 11,861 Subtotal 623,614 513,885 Cash dividends declared on stock: 4.75% cumulative preferred 237 237 6.53% cumulative preferred 327 327 Subtotal 564 564 Balance at end of period $623,050 $513,321 The accompanying notes are an integral part of these consolidated financial statements. - - Page 6 - Kentucky Utilities Company and Subsidiary Consolidated Balance Sheets (Unaudited) (Thousands of $) ASSETS March 31, December 31, 2004 2003 UTILITY PLANT: At original cost $3,612,033 $3,596,657 Less: reserve for depreciation 1,351,851 1,350,165 Net utility plant (Note 7) 2,260,182 2,246,492 OTHER PROPERTY AND INVESTMENTS - less reserve of $131 and $130 as of March 31, 2004 and December 31, 2003, respectively 18,564 17,862 CURRENT ASSETS: Cash and cash equivalents 8,072 4,869 Accounts receivable - less reserve of $673 and $672 as of March 31, 2004 and December 31, 2003, respectively (Note 4) 83,596 49,289 Materials and supplies - at average cost: Fuel (predominantly coal) 38,125 45,538 Other 27,235 27,094 Prepayments and other 13,045 13,100 Total current assets 170,073 139,890 DEFERRED DEBITS AND OTHER ASSETS: Unamortized debt expense 4,410 4,481 Regulatory assets (Note 6) 63,556 70,785 Long-term derivative asset 12,163 12,223 Other 18,499 23,449 Total deferred debits and other assets 98,628 110,938 Total assets $2,547,447 $2,515,182 The accompanying notes are an integral part of these consolidated financial statements. - - Page 7 - Kentucky Utilities Company and Subsidiary Consolidated Balance Sheets (cont.) (Unaudited) (Thousands of $) CAPITALIZATION AND LIABILITIES March 31, December 31, 2004 2003 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 Accumulated other comprehensive loss (6,018) (6,031) Retained earnings 623,050 591,170 Total common equity 939,850 907,957 Cumulative preferred stock 39,727 39,727 Long-term debt (Note 9) 312,027 312,646 Long-term debt to affiliated company (Note 9) 333,000 283,000 Total capitalization 1,624,604 1,543,330 CURRENT LIABILITIES: Current portion of long-term debt 91,930 91,930 Notes payable to affiliated company (Note 9) 40,731 43,231 Accounts payable 53,545 69,947 Accounts payable to affiliated companies (Note 10) 9,601 26,426 Accrued taxes 24,198 8,809 Customer deposits 13,672 13,453 Other 14,521 11,654 Total current liabilities 248,198 265,450 DEFERRED CREDITS AND OTHER LIABILITIES: Accumulated deferred income taxes - net 267,908 261,258 Investment tax credit, in process of amortization 5,345 5,859 Accumulated provision for pensions and related benefits 57,629 103,101 Customer advances for construction 1,576 1,564 Asset retirement obligation 20,023 19,698 Regulatory liabilities (Note 6): Accumulated cost of removal of utility plant 269,127 266,832 Other 34,157 38,027 Other 18,880 10,063 Total deferred credits and other liabilities 674,645 706,402 Total capital and liabilities $2,547,447 $2,515,182 The accompanying notes are an integral part of these consolidated financial statements. - - Page 7 - Kentucky Utilities Company and Subsidiary Consolidated Statement of Cash Flows (Unaudited) (Thousands of $) Three Months Ended March 31, 2004 2003 CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 32,444 $ 11,861 Items not requiring cash currently: Depreciation and amortization 25,249 24,150 Deferred income taxes - net 6,022 913 Investment tax credit - net (513) (660) VDT amortization 2,938 3,106 Marked-to-market financial instruments (560) 726 Other 842 14,324 Changes in current assets and liabilities (41,734) (6,371) Pension funding (Note 9) (43,409) (3,503) Provision for post-retirement benefits (2,062) (1,311) ESM 3,318 3,010 Other 13,008 4,866 Net cash flows from operating activities (4,457) 51,111 CASH FLOWS USED IN INVESTING ACTIVITIES: Long-term investments (702) (485) Construction expenditures (38,582) (103,317) Net cash flows used in investing activities (39,284) (103,802) CASH FLOWS FROM FINANCING ACTIVITIES: Long-term borrowings from affiliated company (Note 9) 50,000 - Short-term borrowings from affiliated company (Note 9) 128,000 444,011 Repayment of short-term borrowings from affiliated company (130,500) (388,970) Refund on issuance expense of pollution control bonds 8 - Payment of dividends (564) (564) Net cash flows from financing activities 46,944 54,477 CHANGE IN CASH AND CASH EQUIVALENTS 3,203 1,786 CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 4,869 5,391 CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 8,072 $ 7,177 SUPPLEMENTAL DISCLOSURES: Cash paid during the period for: Income taxes $ 966 $ (5,110) Interest on borrowed money $ 1,577 $ 1,764 Interest to affiliated companies on borrowed money $ 2,160 $ 366 The accompanying notes are an integral part of these consolidated financial statements. - - Page 9 - Kentucky Utilities Company and Subsidiary Consolidated Statements of Other Comprehensive Income (Unaudited) (Thousands of $) Three Months Ended March 31, 2004 2003 Net income $32,444 $11,861 Gains on derivative instruments and hedging activities - net of tax benefit/(expense) of $(13) for 2004 13 - Other comprehensive income, net of tax 13 - Comprehensive income $32,457 $11,861 The accompanying notes are an integral part of these consolidated financial statements. - - Page 10 - Louisville Gas and Electric Company and Subsidiary Kentucky Utilities Company and Subsidiary Notes to Consolidated Financial Statements (Unaudited) 1. General The unaudited consolidated financial statements include the accounts of Louisville Gas and Electric Company and Subsidiary and Kentucky Utilities Company and Subsidiary (each "LG&E" and "KU", or the "Companies"). The common stock of each of LG&E and KU is wholly-owned by LG&E Energy LLC ("LG&E Energy"). In the opinion of management, the unaudited interim financial statements include 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 Annual Reports on Form 10-K for the year ended December 31, 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 ended March 31, 2003, have been revised to conform to certain reclassifications in the current three months ended March 31, 2004. These reclassifications had no impact on the balance sheet net assets or net income, as previously reported. 2. Mergers and Acquisitions LG&E and KU are each subsidiaries of LG&E Energy. In July 2002, E.ON AG ("E.ON"), a German company, completed its acquisition of Powergen Limited ("Powergen"), the former parent company of LG&E Energy. As a result, LG&E and KU became indirect subsidiaries of E.ON. E.ON had announced its pre-conditional cash offer of 5.1 billion pounds sterling ($7.3 billion) for Powergen in April 2001. Following the purchase of Powergen by E.ON, E.ON became a registered holding company under the Public Utility Holding Company Act of 1935 ("PUHCA"). As a result, E.ON, its utility subsidiaries, including LG&E and KU, and certain of its non-utility subsidiaries are subject to extensive regulation by the SEC under PUHCA with respect to issuances and sales of securities, acquisitions and sales of certain utility properties, and intra-system sales of certain goods and services. In addition, PUHCA generally limits the ability of registered holding companies to acquire additional public utility systems and to acquire and retain businesses unrelated to the utility operations of the holding company. LG&E and KU believe that they have adequate authority (including financing authority) under existing SEC orders and regulations to conduct their business. LG&E and KU will seek additional authorization when necessary. As contemplated in their regulatory filings in connection with the E.ON acquisition, E.ON, Powergen and LG&E Energy 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. In early 2004, LG&E Energy began direct reporting arrangements to E.ON. - - Page 11 - The utility operations (LG&E and KU) of LG&E Energy have 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 LG&E and KU were not affected by these transactions and LG&E and KU continue to file SEC reports. Effective December 30, 2003, LG&E Energy LLC became the successor, by assignment and subsequent merger, to all the assets and liabilities of LG&E Energy Corp. Following the conversion, LG&E Energy became a registered holding company under PUHCA. 3. Financial Instruments 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 designated as a cash flow hedge 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 March 31, 2004, LG&E was party to various interest rate swap agreements with aggregate notional amounts of $228.3 million. Under these swap agreements, LG&E paid fixed rates averaging 4.38% and received variable rates based on LIBOR or the Bond Market Association's municipal swap index averaging 0.94% at March 31, 2004. The swap agreements in effect at March 31, 2004 have been designated as cash flow hedges and mature on dates ranging from 2005 to 2033. The hedges have been deemed to be fully effective resulting in a pretax loss of $6.1 million for the three months ended March 31, 2004, recorded in other comprehensive income. Upon expiration of these hedges, the amount recorded in other comprehensive income will be reclassified into earnings. The amounts expected to be reclassified from other comprehensive income to earnings in the next twelve months is immaterial. As of March 31, 2004, KU was party to various interest rate swap agreements with aggregate notional amounts of $103 million. Under these swap agreements, KU paid variable rates based on either LIBOR or the Bond Market Association's municipal swap index averaging 2.09%, and received fixed rates averaging 7.74% at March 31, 2004. The swap agreements in effect at March 31, 2004 have been designated as fair value hedges and mature on dates ranging from 2007 to 2025. For 2004, the effect of marking these financial instruments and the underlying debt to market resulted in immaterial pretax gains recorded in interest expense. Interest rate swaps hedge interest rate risk on the underlying debt. Under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, in addition to swaps being marked to market, the item being hedged using a fair value hedge must also be marked to market. Consequently at March 31, 2004, KU's debt reflects a $14.1 million mark- to-market adjustment. In February 2004, KU terminated the swap it had in place related to the Series 9 pollution control bonds. The notional amount of the terminated swap was $50 million and KU received a payment of $2.0 million as part of the termination. - - Page 12 - 4. Accounts Receivable Securitization Programs In February 2001, LG&E and KU implemented accounts receivable securitization programs. The purpose of these programs was to enable LG&E and KU to accelerate the receipt of cash from the collection of retail accounts receivable, thereby reducing dependence upon more costly sources of working capital. In January 2004, LG&E and KU terminated their accounts receivable securitization programs and replaced them with intercompany loans from an E.ON affiliate. LG&E and KU anticipate dissolving their inactive accounts receivable securitization-related subsidiaries during 2004. 5. Segment of Business LG&E's revenues and net income by business segment for the three months ended March 31, 2004 and 2003, follow: Three Months Ended March 31, 2004 (in thousands) Revenues Net Income LG&E electric $198,249 $15,943 LG&E gas 163,714 8,276 Total $361,963 $24,219 Three Months Ended March 31, 2003 (in thousands) Revenues Net Income LG&E electric $187,020 $18,051 LG&E gas 139,824 9,213 Total $326,844 $27,264 6. Regulatory Assets and Liabilities The following regulatory assets and liabilities were included in LG&E's balance sheets as of March 31, 2004 and December 31, 2003: Louisville Gas and Electric (Unaudited) March 31, December 31, (in thousands) 2004 2003 Value delivery team (VDT) costs $ 60,276 $ 67,810 Gas supply adjustments due from customers 13,896 22,077 Unamortized loss on bonds 21,068 21,333 Earnings sharing mechanism (ESM) provision 9,327 12,359 Merger surcredit 5,874 6,220 Manufactured gas sites 1,377 1,454 Asset retirement obligation (ARO) 6,209 6,015 Gas performance-based ratemaking (PBR) 4,502 5,480 Other 5 24 Total regulatory assets $ 122,534 $ 142,772 Accumulated cost of removal of utility plant $(227,187) $(223,622) Deferred income taxes - net (40,319) (41,180) Gas supply adjustments due to customers (6,397) (6,805) ARO (107) (85) ESM provision (16) (79) Environmental cost recovery (ECR) (1,076) (17) Fuel adjustment clause (FAC) (210) (1,950) Demand side management (DSM) (2,459) (1,706) Total regulatory liabilities $(277,771) $(275,444) LG&E currently earns a return on all regulatory assets except for gas supply adjustments, ESM, gas performance-based ratemaking, and other, - Page 13 - all of which are separate rate mechanisms with recovery within twelve months. Additionally, no current return is earned on the ARO regulatory asset. This regulatory asset will be offset against the associated regulatory liability, ARO asset, and ARO liability at the time the underlying asset is retired. The following regulatory assets and liabilities were included in KU's balance sheets as of March 31, 2004 and December 31, 2003: Kentucky Utilities (Unaudited) March 31, December 31, (in thousands) 2004 2003 VDT costs $ 23,512 $ 26,451 Unamortized loss on bonds 10,309 10,511 ESM provision 9,064 12,382 FAC 3,305 4,298 Merger surcredit 4,547 4,815 ARO 11,692 11,322 Post-retirement and pension 1,127 1,006 Total regulatory assets $ 63,556 $ 70,785 Accumulated cost of removal of utility plant $(269,127) $(266,832) Deferred income taxes - net (23,430) (24,058) ARO (1,225) (1,162) Spare parts (1,064) (1,055) ECR (6,604) (9,189) FAC (134) (1,000) DSM (1,700) (1,563) Total regulatory liabilities $(303,284) $(304,859) KU currently earns a return on all regulatory assets except for ESM and FAC, all of which are separate recovery mechanisms with recovery within twelve months. Additionally, no current return is earned on the ARO regulatory asset. This regulatory asset will be offset against the associated regulatory liability, ARO asset, and ARO liability at the time the underlying asset is retired. 7. Utility Plant KU retired two steam generating units, Green River Units 1 and 2, in the amount of $17.2 million, from its books as of March 31, 2004. Approximately $4 million in common assets, which are shared by Green River Units 3 and 4, remain on KU's books. The common assets will remain on KU's books until the final retirement of Green River Units 3 and 4. The following data represents shares of jointly-owned additions to the Trimble County plant for four combustion turbines as of March 31, 2004: LG&E KU Total Ownership % 37% 63% 100% Mw capacity 237 403 640 Plant under construction ($mill) $73 $124 $197 Depreciation - - - Net book value $73 $124 $197 - - Page 14 - 8. New Accounting Pronouncements In January 2003, the Financial Accounting Standards Board ("FASB") issued Financial Accounting Standards Board Interpretation No. 46, Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51 (FIN 46). FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 was effective immediately for all new variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN 46 must have been applied for the first interim or annual period beginning after June 15, 2003. In December 2003, FIN 46 was revised, delaying the effective dates for certain entities created before February 1, 2003, and making other amendments to clarify application of the guidance. For potential variable interest entities other than special purpose entities, the revised FIN 46 (FIN 46R) is now required to be applied no later than the end of the first fiscal year or interim reporting period ending after March 15, 2004. For all special purpose entities created prior to February 1, 2003, FIN 46R is now required to be applied at the end of the first interim or annual reporting period ending after December 15, 2003. FIN 46R may be applied prospectively with a cumulative- effect adjustment as of the date it is first applied, or by restating previously issued financial statements with a cumulative-effect adjustment as of the beginning of the first year restated. FIN 46R also requires certain disclosures of an entity's relationship with variable interest entities. Both LG&E and KU hold investment interests in the Ohio Valley Electric Corporation ("OVEC"), and KU holds an investment interest in Electric Energy, Inc. ("EEI"). Neither LG&E nor KU are the primary beneficiary of OVEC or EEI, and thus neither are consolidated into the financial statements of LG&E or KU. LG&E, KU and ten other electric utilities are participating owners of OVEC, located in Piketon, Ohio. OVEC owns and operates two power plants that burn coal to generate electricity, Kyger Creek Station in Ohio and Clifty Creek Station in Indiana. LG&E's share is 7%, representing approximately 155 Mw of generation capacity and KU's share is 2.5%, approximately 55 Mw of generation capacity. LG&E's and KU's original investment in OVEC was made in 1952. LG&E's investment in OVEC is the equivalent of 4.9% of OVEC's common stock and KU's investment is the equivalent of 2.5% of OVEC's common stock. LG&E's and KU's investment in OVEC is accounted for on the cost method of accounting. As of March 31, 2004, LG&E's and KU's investment in OVEC totaled $0.5 million and $0.3 million, respectively. LG&E's and KU's maximum exposure to loss as a result of their involvement with OVEC is limited to the value of their investment. In the event of the inability of OVEC to fulfill its power provision requirements, LG&E and KU would substitute such power supply with either owned generation or market purchases and would recover any associated incremental costs through regulatory rate mechanisms. See Part II, Item 1, for further discussion of current legal proceedings regarding LG&E's and KU's ownership interests and power purchase rights. KU owns 20% of the common stock of EEI, which owns and operates a 1,000- Mw generating station in southern Illinois. KU is entitled to take 20% of the available capacity of the station. Purchases from EEI are made under a contractual formula which has resulted in costs which were and are expected to be comparable to the cost of other power purchased or generated by KU. Such power equated to approximately 9% of KU's net generation system output in 2003. - - Page 15 - KU's original investment in EEI was made in 1953. KU's investment in EEI is accounted for on the equity method of accounting. As of March 31, 2004, KU's investment in EEI totaled $11.4 million. KU's maximum exposure to loss as a result of its involvement with EEI is limited to the value of its investment. In the event of the inability of EEI to fulfill its power provision requirements, KU would substitute such power supply with either owned generation or market purchases and would recover any associated incremental costs through regulatory rate mechanisms. In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. SFAS No. 150 was effective immediately for financial instruments entered into or modified after May 31, 2003, and otherwise was effective for interim reporting periods beginning after June 15, 2003. LG&E has 237,500 shares of $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 the remaining 187,500 shares on July 15, 2008 at $100 per share. Beginning with the three months ended September 30, 2003, LG&E reclassified its $5.875 series preferred stock as long-term debt with the minimum shares mandatorily redeemable within one year classified as current. 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. Short-Term and Long-Term Debt Under the provisions for LG&E's variable-rate pollution control bonds, Series S, T, U, BB, CC, DD and EE, and KU's variable-rate pollution control bonds Series 10, 12, 13, 14, and 15, 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 in the Consolidated Balance Sheets. The average annualized interest rate for these bonds during the three months ending March 31, 2004 was 1.10% for the LG&E bonds and 1.07% for the KU bonds. In January 2004, LG&E entered into a long-term loan from Fidelia Corporation ("Fidelia"), an E.ON financing subsidiary, totaling $25 million with an interest rate of 4.33% that matures in January 2012, and a one-year loan totaling $100 million with an interest rate of 1.53%. The loans are secured by a lien subordinated to the first mortgage bond lien. The proceeds were used to fund a pension contribution and to repay other debt obligations. In April 2004, LG&E prepaid $50 million of the $100 million 1.53% note payable to Fidelia. The prepayment was paid out of cash balances and there was no prepayment fee. In January 2004, KU entered into an unsecured long-term loan from Fidelia totaling $50 million with an interest rate of 4.39% that matures in January 2012. The proceeds were used to fund a pension contribution and to repay other debt obligations. LG&E maintains five bilateral lines of credit totaling $185 million that mature in 2004. There was no outstanding balance under these facilities at March 31, 2004. Management expects to renew these facilities as they expire. LG&E and KU participate in an intercompany money pool agreement wherein LG&E Energy and KU make funds available to LG&E at market-based rates (based on an index of highly rated commercial paper issues as of the prior month end) up to $400 million. Likewise, LG&E Energy and LG&E - - Page 16 - make funds available to KU at market-based rates up to $400 million. LG&E had no money pool loan from LG&E Energy (shown as "Notes payable to affiliate") at March 31, 2004, and had a balance of $248.5 million at an average rate of 1.25% at March 31, 2003. The balance of the money pool loans from LG&E Energy and LG&E to KU (shown as "Notes payable to affiliate") was $40.7 million at an average rate of 0.98% and $174.5 million at an average rate of 1.25% at March 31, 2004 and 2003, respectively. The amount available to LG&E under the money pool agreement at March 31, 2004 was $400 million. The amount available to KU under the money pool agreement at March 31, 2004 was $359.3 million. LG&E Energy maintains a revolving credit facility totaling $150 million with an affiliate to ensure funding availability for the money pool. LG&E Energy had no outstanding balance under this facility as of March 31, 2004 and availability of $150 million remained. 10.Related Party Transactions LG&E, KU, subsidiaries of LG&E Energy and other subsidiaries of E.ON engage in related-party transactions. Prior to the termination of the accounts receivable securitization programs at LG&E and KU in January 2004, transactions between LG&E and its accounts receivable subsidiary, LG&E Receivables LLC ("LG&E R"), were eliminated upon consolidation with LG&E. Transactions between KU and its accounts receivable subsidiary, KU Receivables LLC ("KU R"), were eliminated upon consolidation with KU. Transactions among LG&E, KU and LG&E Energy subsidiaries are eliminated upon consolidation of LG&E Energy. Transactions between LG&E or KU and E.ON subsidiaries are eliminated upon consolidation of E.ON. These transactions are generally performed at cost and are in accordance with the SEC regulations under the PUHCA and the applicable Kentucky Public Service Commission ("Kentucky Commission") regulations. Accounts payable to and receivable from related parties are netted and presented as accounts payable to affiliated companies on the balance sheets of LG&E and KU, as allowed due to the right of offset. Obligations related to intercompany debt arrangements with LG&E Energy and Fidelia are presented as separate line items on the balance sheet, as appropriate. The significant related-party transactions are disclosed below. Electric Purchases LG&E and KU intercompany electric revenues and purchased power expense (including LG&E Energy Marketing Inc. ("LEM")) for the three months ended March 31, 2004 and 2003 were as follows: (in thousands) 2004 2003 LG&E Electric operating revenues from KU $22,077 $16,969 Electric operating revenues from LEM 728 7,149 Purchased power from KU 21,585 14,464 KU Electric operating revenues from LG&E $21,585 $14,464 Electric operating revenues from LEM 160 1,782 Purchased power from LG&E 22,077 16,969 Interest Charges LG&E intercompany interest income and expense for the three months ended March 31, 2004 and 2003 were as follows: (in thousands) 2004 2003 Interest on money pool loans $ 48 $732 Interest on Fidelia loans 3,082 - Interest expense paid to KU 10 3 Interest income received from KU - 4 KU intercompany interest income and expense for the three months ended March 31, 2004 and 2003 were as follows: (in thousands) 2004 2003 Interest on money pool loans $ 144 $373 Interest on Fidelia loans 3,403 - Interest expense paid to LG&E - 4 Interest income received from LG&E 10 3 - - Page 17 - Other Intercompany Billings Other intercompany billings (including LG&E Energy Services Inc. ("LG&E Services")) related to LG&E and KU for the three months ended March 31, 2004 and 2003 were as follows: (in thousands) 2004 2003 LG&E Services billings to LG&E $38,161 $26,630 LG&E Services billing to KU 30,575 21,494 LG&E billings to LG&E Services 3,035 4,862 KU billings to LG&E Services 2,818 7,094 LG&E billings to KU 16,559 18,710 KU billings to LG&E 8,663 4,664 11.Commitments and Contingencies In December 2003, LG&E and KU filed applications with the Kentucky Commission requesting increases in LG&E's and KU's electric rates and LG&E's gas rates. The Companies requested general adjustments in electric rates and LG&E requested general adjustments in gas rates based on the twelve-month test year ended September 30, 2003. The revenue increases requested by LG&E were $63.8 million for electric and $19.1 million for gas. The revenue increase requested by KU was $58.3 million. The Kentucky Commission has suspended the effective date of the proposed new tariffs for five months, so that the rates may go into effect subject to refund by July 1, 2004. The Kentucky Commission established a procedural schedule for the cases pertaining to discovery and hearings. The Companies filed their final 2003 ESM calculations with the Kentucky Commission on March 1, 2004, and applied for recovery of $16.2 million related to KU and $13.0 million related to LG&E. Based upon estimates, the Companies previously accrued $9.3 million at KU and $8.9 million at LG&E for the 2003 ESM as of December 31, 2003. The Companies have not booked or accrued to date the respective increases of $6.9 million and $4.1 million, pending resolution of ongoing Kentucky Commission proceedings regarding aspects of the ESM mechanism, including allowable recoverable amounts. On March 31, 2004, the Kentucky Commission issued orders consolidating the prior ESM cases into the general LG&E and KU proceedings regarding increases in base rates. During May 2004, the Kentucky Commission held hearings on the applications for rate increases. On May 12, the Companies and all intervenors filed a partial settlement agreement, stipulation and recommendation with the Kentucky Commission providing for settlement of all outstanding issues, except electric revenue requirements. All intervenors except the Kentucky Attorney General entered a stipulation on the electric revenue requirements. Testimony for the utilities and the Attorney General was presented on electric revenues. All testimony of all other intervenors and testimony of the Attorney General on other issues was withdrawn. The agreement and stipulation provides for increases in annual base electric rates of $43.4 million for LG&E and $46.1 million for KU, and in annual gas rates of $11.9 million for LG&E and provides for settlement of other issues such as various tariff provisions, implementation of a pilot real-time pricing program, implementation of a home energy assistance program and others. The agreement provides that the rate increases would be effective commencing July 1, 2004. The Companies and the intervenors, including the Attorney General, also filed proposed settlements regarding the ESM mechanisms of LG&E and KU. Under the ESM settlements, LG&E and KU would continue to collect approximately $13.0 million and $16.2 million, respectively, of previously requested 2003 ESM revenue amounts through March 2005. As part of the settlement, the parties agreed to a termination of the ESM mechanism relating to all periods after 2003. - - Page 18 - The potential settlements are subject to Kentucky Commission approval. Final Kentucky Commission orders in the rate case and related proceedings, including the tendered settlements, are anticipated before July 1, 2004. The Companies can provide no assurance regarding the Commission's final decision regarding the partial agreement, stipulation and recommendation of the parties or the ESM settlement. Regulatory proceedings are also continuing concerning the Midwest Independent Transmission System Operator ("MISO"). LG&E and KU obtained membership in the MISO in 1998 in response to federal policy initiatives. During March and April 2004, the Kentucky Commission held hearings in the proceedings examining the cost and benefits of MISO membership, including rate treatment of MISO costs and continued LG&E and KU participation. A final order in the proceedings is anticipated in mid-2004. 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 or other appropriate reserves are 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. Except as discussed in this Quarterly Report on Form 10-Q, material changes have not occurred in the current status of various commitments or contingent liabilities from that discussed in the Companies' Annual Report on Form 10-K for the year ended December 31, 2003 (including in Notes 3 and 11 to the financial statements of LG&E and KU contained therein and incorporated herein by reference). 12.Pension and Other Post-retirement Benefit Plans The following table provides the components of net periodic benefit cost for pension and other benefit plans for the three months ended March 31, 2004: (in thousands) LG&E KU Pension and Other Benefit Plans: Components of net period benefit cost Service cost $ 2,088 $ 2,386 Interest cost 10,524 7,650 Expected return on plan assets (9,585) (6,909) Amortization of prior service cost 2,003 583 Amortization of transition (asset) or obligation (5) 319 Recognized actuarial (gain) or loss 1,105 839 $ 6,130 $ 4,868 In January 2004, LG&E and KU made discretionary contributions to their pension plans in the amounts of $34.5 million and $43.4 million, respectively. No contributions are required for 2004 for either LG&E or KU and no further discretionary contributions are planned. 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 month period ended March 31, 2004, and should be read in connection with the financial statements and notes thereto. - - Page 19 - 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 SEC, including the Annual Reports on Form 10-K for the year ended December 31, 2003. Executive Summary LG&E's net income for the three months ended March 31, 2004 was $24.2 million ($3.0 million lower than the three months ended March 31, 2003). The decrease was primarily related to higher operation expenses (MISO- related costs and data conversion costs), somewhat offset by higher wholesale electric revenues. Electric sales volumes increased due to higher wholesale sales while gas volumes decreased due to milder weather. KU's net income for the three months ended March 31, 2004 was $32.4 million ($20.6 million higher than the three months ended March 31, 2003). The increase was primarily due to higher electric revenues in both the retail and wholesale sectors and lower maintenance expense (KU experienced unusually high maintenance costs in the first quarter of 2003 due to a major ice storm). As regulated utilities, LG&E and KU's financial performance is greatly impacted by regulatory proceedings. In December 2003, LG&E and KU filed applications with the Kentucky Commission requesting an adjustment in LG&E's electric and gas rates and KU's electric rates. LG&E applied for revenue increases of $63.8 million for electric and $19.1 million for gas. KU applied for revenue increases of $58.3 million. During May 2004, the Kentucky Commission held hearings on the applications on rate increases. On May 12, the Companies and all intervenors filed a partial settlement agreement, stipulation and recommendation with the Kentucky Commission providing for settlement of all outstanding issues, except electric revenue requirements. All intervenors except the Kentucky Attorney General entered a stipulation on the electric revenue requirements. Testimony for the utilities and the Attorney General was presented on electric revenues. All testimony of all other intervenors and testimony of the Attorney General on other issues was withdrawn. The agreement and stipulation provides for increases in annual base electric rates of $43.4 million for LG&E and $46.1 million for KU, and in annual gas rates of $11.9 million for LG&E and provides for settlement of other issues such as various tariff provisions, implementation of a pilot real-time pricing program, implementation of a home energy assistance program and others. The agreement provides that the rate increases would be effective commencing July 1, 2004. The Companies and the intervenors, including the Attorney General, also filed proposed settlements regarding the ESM mechanisms of LG&E and KU. Under the ESM settlements, LG&E and KU would continue to collect approximately $13.0 million and $16.2 million, respectively, of previously requested 2003 ESM revenue amounts through March 2005. As part of the settlement, the parties agreed to a termination of the ESM mechanism relating to all periods after 2003. Previously, on March 31, 2004, the Kentucky Commission had issued orders consolidating the prior ESM cases into the general LG&E and KU proceedings regarding increases in base rates. The potential settlements are subject to Kentucky Commission approval. Final Kentucky Commission orders in the rate case and related proceedings, including the tendered settlements, are anticipated before July 1, 2004. The Companies can provide no assurance regarding the Commission's final decision regarding the partial agreement, stipulation and recommendation of the parties or the ESM settlement. - - Page 20 - 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 March 31, 2004, Compared to Three Months Ended March 31, 2003 LG&E Results: LG&E's net income decreased $3.0 million (11%) for the three months ended March 31, 2004, as compared to the three months ended March 31, 2003, primarily due to higher other operation expenses and higher interest expenses, partially offset by higher electric revenues. A comparison of LG&E's revenues for the three months ended March 31, 2004, with the three months ended March 31, 2003, reflects increases and (decreases) which have been segregated by the following principal causes: Cause Electric Gas (in thousands) Revenues Revenues Retail sales: Fuel and gas supply adjustments $ (2,805) $ 37,631 Environmental cost recovery surcharge 2,398 - Earnings sharing mechanism 3,256 - Demand side management cost recovery 184 (299) LG&E/KU merger surcredit (472) - Value delivery surcredit (181) - Weather normalization - 2,686 Variation in sales volume and other (1,307) (16,468) Total retail sales 1,073 23,550 Wholesale sales 12,116 755 Gas transportation - net - (69) Provision for rate collections (refunds) (3,999) - Other 2,039 (346) Total $ 11,229 $ 23,890 Electric revenues increased $11.2 million primarily due to an increase in wholesale sales volumes of 22%. Gas revenues increased $23.9 million primarily as a result of increased gas prices billed to customers through the gas supply clause, partially offset by 11% lower gas sales volumes resulting from warmer weather as heating degree days declined 12.3% from the previous year. 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 Commission. Fuel for electric generation increased $3.0 million (6%) for the three months ended March 31, 2004, due to 7% higher megawatt hour ("MWH") generation resulting in a $3.4 million volume variance, offset by 1% lower fuel costs per MWH, resulting in a ($0.4) million price variance. Gas supply expenses increased $24.6 million (23%) due to 9% higher gas prices per million cubic feet ("MCF"), resulting in a $37.0 million price variance, and $0.2 million in higher costs due to the impact of the gas PBR mechanism, partially offset by 11% lower volumes, resulting in a ($12.7) million volume variance. - - Page 21 - Power purchased increased $4.8 million (20%) due to 20% higher MWH purchases, resulting in a $5.2 million volume variance. The cost per MWH of purchased power decreased 1% resulting in a ($0.4) million price variance. Other operation expenses increased $4.5 million (9%) due primarily to higher transmission expense of $3.1 million due to increased MISO expense resulting from higher off-system sales and higher MISO administrative fees. Electric distribution expense increased $1.4 million primarily due to data conversion costs related to a distribution systems project. Variances in income tax expense are largely attributable to changes in pre- tax income. Three Months Three Months Ended Ended March 31, 2004 March 31, 2003 Effective Rate Statutory federal income tax rate 35.0% 35.0% State income taxes net of federal benefit 5.6 5.6 Amortization of investment and other tax credits (2.7) (2.4) Other differences (0.1) (0.4) Effective income tax rate 37.8% 37.8% In total, interest expense increased $0.9 million (13%) in 2004. Interest expense decreased $1.5 million due to a $2.3 million decrease in interest expense on long-term debt related to lower variable rates (including the $102 million Series V and $26 million Series W pollution control bonds which were refinanced from higher fixed rates to lower variable rates in November 2003). This decrease was partially offset by an increase of $0.9 million primarily due to new interest rate swaps related to the refinancing of Series V and W. Interest expense to affiliated companies increased $2.4 million due to $3.1 million related to new loans from Fidelia which were only in effect for 2004, partially offset by a decrease of $0.7 million due to lower borrowing levels from the money pool. The weighted average interest rate on variable-rate bonds for the three months ended March 31, 2004, was 1.03%, compared to 1.22% for the comparable period in 2003. In total, other income (expense) - net decreased $1.5 million (143%). Mark- to-market income from energy trading contracts was $0.6 million lower in 2004 and other non-operating expense was $1.1 million higher, offset by taxes $0.2 million lower. KU Results: KU's net income increased $20.6 million (174%) for the three months ended March 31, 2004, as compared to the three months ended March 31, 2003. The increase was primarily due to higher electric revenues and lower maintenance expense. A comparison of KU's revenues for the three months ended March 31, 2004, with the three months ended March 31, 2003, reflects increases and (decreases) which have been segregated by the following principal causes: Cause Electric (in thousands) Revenues Retail sales: Fuel supply adjustments $ 2,889 Environmental cost recovery surcharge 451 Earnings sharing mechanism 3,909 Demand side management cost recovery (243) LG&E/KU merger surcredit (757) Value delivery surcredit (79) Variation in sales volume and other 2,510 Total retail sales 8,680 Wholesale sales 6,555 Provision for rate collections (refunds) 4,169 Other 2,999 Total $22,403 - - Page 22 - Electric revenues increased $22.4 million primarily due to increased wholesale prices and 12% higher volumes, increased billings for the earnings sharing mechanism and fuel cost recovery, increased retail sales volumes of 2% and an increase in the provision for rate collections. 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 ("FERC"). Fuel for electric generation increased $3.6 million (5%) for the three months ended March 31, 2004, due to 5% higher fuel costs per MWH, resulting in a $0.3 million price variance, and 0.4% higher MWH generation, resulting in a $3.3 million volume variance. Power purchased increased $0.1 million (0.3%) due to 8% higher MWH purchases, resulting in a $3.4 million volume variance, partially offset by 7% lower cost per MWH purchased, resulting in a ($3.3) million price variance. Maintenance expense decreased $17.1 million (59%). An ice storm in the KU service territory in 2003 resulted in increased expenses of $15.9 million for the three months ended March 31, 2003, for repairs to electric distribution equipment. Steam maintenance expense was $2.6 million lower in 2004 due to the timing of outages and other maintenance projects. Variations in income tax expense are largely attributable to changes in pretax income. Three Months Three Months Ended Ended March 31, 2004 March 31, 2003 Effective Rate Statutory federal income tax rate 35.0% 35.0% State income taxes net of federal benefit 5.8 6.9 Amortization of investment and other tax credits (1.0) (3.7) Other differences (1.6) (4.1) Effective income tax rate 38.2% 34.1% In total, other income - net decreased $0.6 million (30%) in 2004 primarily due to lower mark-to-market income from energy trading contracts of $0.6 million and $1.0 million higher other non-operating expenses, partially offset by a decrease in taxes ($0.6 million) and higher allowances for funds used during construction ($0.3 million). In total, interest expense decreased $0.6 million (13%) for the three months ended March 31, 2004 as compared to the three months ended March 31, 2003. Interest expense to affiliated companies increased $3.4 million due to loans from Fidelia, which were only in effect for 2004, partially offset by a decrease of $0.2 million due to lower borrowing levels from the money pool. Interest expense on other long-term debt decreased $1.8 million due to a decrease in variable rates, and interest on interest rate swaps decreased $1.6 million, primarily resulting from the February 2004 termination of a swap related to the Series 9 pollution control bonds. In addition, interest decreased $0.2 million due to the termination of the accounts receivable securitization program in January 2004. The weighted average interest rate on variable-rate bonds for the three months ended March 31, 2004, was 1.04% and the corresponding rate for the three months ended March 31, 2003, was 1.17%. 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 are - - Page 23 - 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 three months ended March 31, 2004 for LG&E and KU amounted to $27.1 million and $38.6 million, respectively. Such expenditures include construction to meet nitrogen oxide (NOx) emission standards and the acquisition of combustion turbines to meet peak power demands. Expenditures for the three months ended March 31, 2004, by LG&E and KU for NOx construction were $1.8 million and $12.5 million, respectively. Expenditures for the three months ended March 31, 2004, for Trimble County combustion turbines, Units 7 through 10, by LG&E and KU were $3.3 million and $5.6 million, respectively. The expenditures were financed with internally generated funds and intercompany loans from affiliates. LG&E's cash balance increased $26.9 million during the three months ended March 31, 2004, primarily due to increased borrowings from affiliated companies, partially offset by pension funding and construction expenditures. KU's cash balance increased $3.2 million during the three months ended March 31, 2004. The increase reflects increased borrowings from affiliated companies, partially offset by pension funding and construction expenditures. 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 increase in accounts receivable at LG&E and KU was primarily due to the termination of the accounts receivable securitization programs in January 2004, offset by the impact of decreased electric and gas sales in March 2004 compared with December 2003. The decrease in LG&E's gas stored underground relates to seasonal uses of gas. The decrease in the fuel inventory at KU was due to lower purchases due to unit outages. The decrease at LG&E was due to seasonal fluctuations. Interest rate swaps are used to hedge LG&E's and KU's underlying variable- rate debt obligations. These swaps hedge specific debt issuances and, consistent with management's designation, are accorded hedge accounting treatment. As of March 31, 2004, LG&E had swaps with a combined notional value of $228.3 million and KU had swaps with a combined notional value of $103 million. LG&E's swaps exchange floating-rate interest payments for fixed rate interest payments to reduce the impact of interest rate changes on LG&E's pollution control bonds. KU's swaps effectively convert fixed rate obligations on KU's first mortgage bonds Series P and R to variable- rate obligations. In February 2004, KU terminated the swap it had in place at December 31, 2003 related to the Series 9 pollution control bonds. The notional amount of the terminated swap was $50 million and KU received a payment of $2.0 million as part of the termination. At March 31, 2004, LG&E's and KU's percentage of long-term debt having a variable rate, including the impact of interest rate swaps, was 33.2% at $306.0 million and 43.1% at $318.0 million, respectively. Under the provisions for LG&E's variable-rate pollution control bonds, Series S, T, U, BB, CC, DD and EE, and KU's variable-rate pollution control bonds Series 10, 12, 13, 14, and 15, 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 in the Consolidated Balance Sheets. The average annualized interest rate for these bonds during the three months ending March 31, 2004 was 1.10% for the LG&E bonds and 1.07% for the KU bonds. - - Page 24 - In January 2004, LG&E entered into a long-term loan with Fidelia totaling $25 million with an interest rate of 4.33% that matures in January 2012, and a one-year loan totaling $100 million with Fidelia. The interest rate on the loan is 1.53%. The loans are secured by a lien subordinated to the first mortgage bond lien. The proceeds were used to fund a pension contribution and to repay other debt obligations. In April 2004, LG&E prepaid $50 million of the $100 million 1.53% note payable to Fidelia. The prepayment was paid out of cash balances and there was no prepayment fee. In January 2004, KU entered into an unsecured long-term loan from Fidelia totaling $50 million with an interest rate of 4.39% that matures in January 2012. The proceeds were used to fund a pension contribution and to repay other debt obligations. LG&E maintains five bilateral lines of credit totaling $185 million that mature in 2004. There was no outstanding balance under these facilities at March 31, 2004. Management expects to renew these facilities as they expire. LG&E and KU participate in an intercompany money pool agreement wherein LG&E Energy and KU make funds available to LG&E at market-based rates (based on an index of highly rated commercial paper issues as of the prior month end) up to $400 million. Likewise, LG&E Energy and LG&E make funds available to KU at market-based rates up to $400 million. LG&E had no money pool loan from LG&E Energy (shown as "Notes payable to affiliate") at March 31, 2004, and $248.5 million at an average rate of 1.25% at March 31, 2003. The balance of the money pool loans from LG&E Energy and LG&E to KU (shown as "Notes payable to affiliate") was $40.7 million at an average rate of .98% and $174.5 million at an average rate of 1.25% at March 31, 2004 and 2003, respectively. The amount available to LG&E under the money pool agreement at March 31, 2004 was $400 million. The amount available to KU under the money pool agreement at March 31, 2004 was $359.3 million. LG&E Energy maintains a revolving credit facility totaling $150 million with an affiliate to ensure funding availability for the money pool. LG&E Energy had no outstanding balance under LG&E Energy's facility as of March 31, 2004 and availability of $150 million remained. In January 2004, LG&E and KU made discretionary contributions to their pension plans of $34.5 million and $43.4 million, respectively. No contributions are required for 2004 and no further discretionary contributions are planned. LG&E's security ratings as of March 31, 2004, were: Moody's S&P First mortgage bonds A1 A- Preferred stock Baa1 BBB- Commercial paper P-1 A-2 KU's security ratings as of March 31, 2004, were: Moody's S&P First mortgage bonds A1 A Preferred stock Baa1 BBB- Commercial paper P-1 A-2 These ratings reflect the views of Moody's and S&P. 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. - - Page 25 - LG&E's capitalization ratios at March 31, 2004, and December 31, 2003, follow: March 31, December 31, 2004 2003 Long-term debt (including current portion) 30.9% 31.9% Long-term debt to affiliated company (including current portion) 16.8 10.7 Notes payable to affiliated companies - 4.3 Preferred stock 3.6 3.8 Common equity 48.7 49.3 Total 100.0% 100.0% KU's capitalization ratios at March 31, 2004, and December 31, 2003, follow: March 31, December 31, 2004 2003 Long-term debt (including current portion) 23.0% 24.1% Long-term debt to affiliated company (including current portion) 18.9 16.8 Notes payable to affiliated companies 2.3 2.6 Preferred stock 2.3 2.4 Common equity 53.5 54.1 Total 100.0% 100.0% New Accounting Pronouncements In January 2003, the Financial Accounting Standards Board ("FASB") issued Financial Accounting Standards Board Interpretation No. 46, Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51 (FIN 46). FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 was effective immediately for all new variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN 46 must have been applied for the first interim or annual period beginning after June 15, 2003. In December 2003, FIN 46 was revised, delaying the effective dates for certain entities created before February 1, 2003, and making other amendments to clarify application of the guidance. For potential variable interest entities other than special purpose entities, the revised FIN 46 (FIN 46R) is now required to be applied no later than the end of the first fiscal year or interim reporting period ending after March 15, 2004. For all special purpose entities created prior to February 1, 2003, FIN 46R is now required to be applied at the end of the first interim or annual reporting period ending after December 15, 2003. FIN 46R may be applied prospectively with a cumulative-effect adjustment as of the date it is first applied, or by restating previously issued financial statements with a cumulative-effect adjustment as of the beginning of the first year restated. FIN 46R also requires certain disclosures of an entity's relationship with variable interest entities. Both LG&E and KU hold investment interests in OVEC and KU holds an investment interest in EEI. Neither LG&E nor KU are the primary beneficiary of OVEC or EEI, and thus neither are consolidated into the financial statements of LG&E or KU. LG&E, KU and ten other electric utilities are participating owners of OVEC, located in Piketon, Ohio. OVEC owns and operates two power plants that burn coal to generate electricity, Kyger Creek Station in Ohio and Clifty Creek Station in Indiana. LG&E's share is 7%, representing approximately 155 Mw of generation capacity and KU's share is 2.5%, approximately 55 Mw of generation capacity. - - Page 26 - LG&E's and KU's original investment in OVEC was made in 1952. LG&E's investment in OVEC is the equivalent of 4.9% of OVEC's common stock and KU's investment is the equivalent of 2.5% of OVEC's common stock. LG&E's and KU's investment in OVEC is accounted for on the cost method of accounting. As of March 31, 2004, LG&E's and KU's investment in OVEC totaled $0.5 million and $0.3 million, respectively. LG&E's and KU's maximum exposure to loss as a result of their involvement with OVEC is limited to the value of their investment. In the event of the inability of OVEC to fulfill its power provision requirements, LG&E and KU would substitute such power supply with either owned generation or market purchases and would recover any associated incremental costs through regulatory rate mechanisms. See Part II, Item 1, for further discussion of current legal proceedings regarding LG&E's and KU's ownership interests and power purchase rights. KU owns 20% of the common stock of EEI, which owns and operates a 1,000-Mw generating station in southern Illinois. KU is entitled to take 20% of the available capacity of the station. Purchases from EEI are made under a contractual formula which has resulted in costs which were and are expected to be comparable to the cost of other power purchased or generated by KU. Such power equated to approximately 9% of KU's net generation system output in 2003. KU's original investment in EEI was made in 1953. KU's investment in EEI is accounted for on the equity method of accounting. As of March 31, 2004, KU's investment in EEI totaled $11.4 million. KU's maximum exposure to loss as a result of its involvement with EEI is limited to the value of its investment. In the event of the inability of EEI to fulfill its power provision requirements, KU would substitute such power supply with either owned generation or market purchases and would recover any associated incremental costs through regulatory rate mechanisms. In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. SFAS No. 150 was effective immediately for financial instruments entered into or modified after May 31, 2003, and otherwise was effective for interim reporting periods beginning after June 15, 2003. LG&E has 237,500 shares of $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 the remaining 187,500 shares on July 15, 2008 at $100 per share. Beginning with the three months ended September 30, 2003, LG&E reclassified its $5.875 series preferred stock as long-term debt with the minimum shares mandatorily redeemable within one year classified as current. 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 LG&E's and KU's Annual Reports on Form 10-K for the year ended December 31, 2003; and to Part II - Item 1, Legal Proceedings herein. Electric and Gas Rate Cases In December 2003, LG&E and KU filed applications with the Kentucky Commission requesting increases in LG&E's and KU's electric rates and LG&E's gas rates. The Companies requested general adjustments in electric rates and LG&E requested general adjustments in gas rates based on the - - Page 27 - twelve-month test year ended September 30, 2003. The revenue increases requested by LG&E were $63.8 million for electric and $19.1 million for gas. The revenue increase requested by KU was $58.3 million. The Kentucky Commission has suspended the effective date of the proposed new tariffs for five months, so that the rates may go into effect subject to refund by July 1, 2004. The Kentucky Commission established a procedural schedule for the cases pertaining to discovery and hearings. The Companies filed their final 2003 ESM calculations with the Kentucky Commission on March 1, 2004, and applied for recovery of $16.2 million related to KU and $13.0 million related to LG&E. Based upon estimates, the Companies previously accrued $9.3 million at KU and $8.9 million at LG&E, for the 2003 ESM as of December 31, 2003. The Companies have not booked or accrued to date the respective increases of $6.9 million and $4.1 million, pending resolution of ongoing Kentucky Commission proceedings regarding aspects of the ESM mechanism, including allowable recoverable amounts. On March 31, 2004, the Kentucky Commission issued orders consolidating the prior ESM cases into the general LG&E and KU proceedings regarding increases in base rates. During May 2004, the Kentucky Commission held hearings on the applications for rate increases. On May 12, the Companies and all intervenors filed a partial settlement agreement, stipulation and recommendation with the Kentucky Commission providing for settlement of all outstanding issues, except electric revenue requirements. All intervenors except the Kentucky Attorney General entered a stipulation on the electric revenue requirements. Testimony for the utilities and the Attorney General was presented on electric revenues. All testimony of all other intervenors and testimony of the Attorney General on other issues was withdrawn. The agreement and stipulation provides for increases in annual base electric rates of $43.4 million for LG&E and $46.1 million for KU, and in annual gas rates of $11.9 million for LG&E and provides for settlement of other issues such as various tariff provisions, implementation of a pilot real-time pricing program, implementation of a home energy assistance program and others. The agreement provides that the rate increases would be effective commencing July 1, 2004. The Companies and the intervenors, including the Attorney General, also filed proposed settlements regarding the ESM mechanisms of LG&E and KU. Under the ESM settlements, LG&E and KU would continue to collect approximately $13.0 million and $16.2 million, respectively, of previously requested 2003 ESM revenue amounts through March 2005. As part of the settlement, the parties agreed to a termination of the ESM mechanism relating to all periods after 2003. The potential settlements are subject to Kentucky Commission approval. Final Kentucky Commission orders in the rate case and related proceedings, including the tendered settlements, are anticipated before July 1, 2004. The Companies can provide no assurance regarding the Commission's final decision regarding the partial agreement, stipulation and recommendation of the parties or the ESM settlement. 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. - - Page 28 - 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 $3.0 million and $3.4 million, respectively, at March 31, 2004. LG&E's exposure to floating interest rates decreased $1.45 million and KU's exposure to floating interest rates decreased $1.02 million during the first three months of 2004. The potential loss in fair value of LG&E's interest rate swaps resulting from a hypothetical 1% change in base interest rates is estimated at approximately $28.7 million as of March 31, 2004. The potential loss in fair value of KU's interest rate swaps resulting from a hypothetical 1% change in base interest rates is estimated at approximately $3.3 million as of March 31, 2004. These estimates are derived from third-party valuations. Changes in the market values of these swaps, if held to maturity, will have no affect on LG&E's or KU's net income or cash flow. Pension Risk LG&E's and KU's costs of providing defined-benefit pension retirement plans is dependent upon a number of factors, such as the rates of return on plan assets, discount rate, and contributions made to the plan. At December 31, 2002, LG&E was 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. The amount of the liability depended upon the asset returns experienced in 2002 and contributions made by LG&E to the plan during 2002. If the fair value of the plan assets exceeds the accumulated benefit obligation, the recorded liability will be reduced and other comprehensive income will be restored in the consolidated balance sheet. A 1% increase or decrease in the assumed discount rate could have an approximate $41 million positive or negative impact to the accumulated benefit obligation of LG&E. A 1% increase or decrease in the assumed discount rate could have an approximate $27 million positive or negative impact to the accumulated benefit obligation of KU. In January 2004, LG&E and KU made contributions to their pension plans of $34.5 million and $43.4 million, respectively. Energy Trading & Risk Management Activities The table below summarizes LG&E's and KU's energy trading and risk management activities for the three months ended March 31, 2004, and 2003. Trading volumes are allocated evenly between LG&E and KU. Three Months Ended March 31, 2004 2003 (in thousands) Fair value of contracts at beginning of period, net asset/(liability) $ 572 $ (156) Fair value of contracts when entered into during the period - 2,620 Contracts realized or otherwise settled during the period (150) (57) Changes in fair value due to changes in assumptions 181 (2,004) Fair value of contracts at end of period, net asset/(liability) $ 603 $ 403 No changes to valuation techniques for energy trading and risk management activities occurred during 2004 or 2003. Changes in market pricing, interest rate and volatility assumptions were made during all periods. All contracts outstanding at March 31, 2004, have a maturity of less than one year and are valued using prices actively quoted for proposed or executed transactions or quoted by brokers. - - Page 29 - LG&E and KU maintain policies intended to minimize credit risk and revalue credit exposures daily to monitor compliance with those policies. As of March 31, 2004, 100% of the trading and risk management commitments were with counterparties rated BBB-/Baa3 equivalent or better. 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 March 31, 2004, that has materially affected, or is reasonably likely to materially affect, the Companies' internal control over financial reporting. - - Page 30 - 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 respective combined Annual Report on Form 10-K for the year ended December 31, 2003: Item 1, Business; Item 3, Legal Proceedings; Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, and Item 8, Financial Statements and Supplementary Data. 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. Electric and Gas Rate Cases During May 2004, the Kentucky Commission held hearings on the applications filed by LG&E and KU for increases in base rates. For a description of developments in these cases, see Note 11 of the Notes to Consolidated Financial Statements in Part 1, Item 1 of this Quarterly Report on Form 10- Q. Final orders in the proceedings are expected before July 2004. MISO During March and April 2004, the Kentucky Commission held hearings in the proceedings examining the cost and benefits of MISO membership, including rate treatment of MISO costs and continued LG&E and KU participation. A final order in the proceedings is anticipated in mid-2004. OVEC Power Agreement and Related Matter On April 30, 2004, OVEC and its shareholders, including LG&E and KU, entered into an Amended and Restated Inter-Company Power Agreement, to be effective beginning March 2006, upon the expiration of the current power contract among the parties. Under the new contract, which has a 20-year term from its effective date, LG&E and KU have purchase rights for 5.63% and 2.5%, respectively, of OVEC power at marginal cost-based rates. LG&E and KU are entitled to 7% and 2.5% of OVEC power, respectively, under the current contract. In addition, LG&E will purchase from American Electric Power Company Inc. ("AEP") an additional 0.73% interest in OVEC for a purchase price of approximately $104,000, resulting in an increase in LG&E ownership in OVEC from 4.9% to 5.63%. The share purchase transaction is anticipated to be completed during 2004, subject to receipt of certain regulatory approvals. 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 31.1X Certification of Chairman of the Board, President and Chief Executive Officer, pursuant to Section 302 of the Sarbanes- Oxley Act of 2002 31.2X Certification of Chief Financial Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 31.3 X Certification of Chairman of the Board, President and Chief Executive Officer, pursuant to Section 203 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 - - Page 31 - Certain instruments defining the rights of holders of certain long-term debt of LG&E and KU have not been filed with the SEC but will be furnished to the SEC upon request. 6(b). Reports on Form 8-K. None. - - Page 32 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: May 13, 2004 /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: May 13, 2004 /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) EX-31 2 q10q0304ex31.txt EXHIBIT 31 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: May 13, 2004 /s/ Victor A. Staffieri Victor A. Staffieri Chairman of the Board, President and Chief Executive Officer - - Page 1 - 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: May 13, 2004 /s/ S. Bradford Rives S. Bradford Rives Chief Financial Officer - - Page 2 - 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: May 13, 2004 /s/ Victor A. Staffieri Victor A. Staffieri Chairman of the Board, President and Chief Executive Officer - - Page 3 - 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: May 13, 2004 /s/ S. Bradford Rives S. Bradford Rives Chief Financial Officer - - Page 4 - EX-32 3 q10q0304ex32.txt EXHIBIT 32 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 March 31, 2004, 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. May 13, 2004 /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. -----END PRIVACY-ENHANCED MESSAGE-----