Document/ExhibitDescriptionPagesSize 1: 10-K Duquesne Light Holdings/Duquesne Light Company HTML 954K 10-K/Fye 12-31-05
3: EX-10.11 Material Contract HTML 13K
4: EX-10.19 Material Contract HTML 13K
5: EX-10.22 Material Contract HTML 20K
6: EX-10.23 Material Contract HTML 22K
7: EX-10.25 Material Contract HTML 20K
8: EX-10.26 Material Contract HTML 22K
2: EX-10.5 Material Contract HTML 11K
9: EX-12.1 Statement re: Computation of Ratios HTML 20K
10: EX-12.2 Statement re: Computation of Ratios HTML 20K
11: EX-21.1 Subsidiaries of the Registrant HTML 23K
12: EX-23.1 Consent of Experts or Counsel HTML 11K
13: EX-23.2 Consent of Experts or Counsel HTML 10K
14: EX-31.1 Certification per Sarbanes-Oxley Act (Section 302) HTML 15K
15: EX-31.2 Certification per Sarbanes-Oxley Act (Section 302) HTML 15K
16: EX-31.3 Certification per Sarbanes-Oxley Act (Section 302) HTML 15K
17: EX-31.4 Certification per Sarbanes-Oxley Act (Section 302) HTML 15K
18: EX-32.1 Certification per Sarbanes-Oxley Act (Section 906) HTML 12K
19: EX-32.2 Certification per Sarbanes-Oxley Act (Section 906) HTML 13K
20: EX-32.3 Certification per Sarbanes-Oxley Act (Section 906) HTML 12K
21: EX-32.4 Certification per Sarbanes-Oxley Act (Section 906) HTML 13K
22: EX-99.1 Miscellaneous Exhibit HTML 59K
Securities registered pursuant to Section 12(b) of the Act:
Name of Each Exchange
Registrant
Title of Each Class
on Which Registered
Duquesne Light Holdings, Inc.
Common Stock (no par value)
New York Stock Exchange
Philadelphia Stock Exchange
Chicago Stock Exchange
Duquesne Light Company
Preferred Stock ($50 per share liquidation value)
New York Stock Exchange
3.75% Series
4.00% Series
4.10% Series
4.15% Series
4.20% Series
$2.10 Series
6.50% Series
6.7% Public Income Notes, due 2032
New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act:
Registrant
Title of Each Class
Duquesne Light Company
Preference Stock, Plan Series A
Indicate by check mark if either registrant is a well-known seasoned issuer, as defined in Rule 405
of the Securities Act.
Duquesne Light Holdings, Inc. Yes ž No o
Duquesne Light Company Yes o No ž
Indicate by check mark if either registrant is not required to file reports pursuant to Section 13
or Section 15(d) of the Act.
Duquesne Light Holdings, Inc. Yes o No ž
Duquesne Light Company Yes o No ž
Indicate by check mark whether each 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 and (2) has been subject to such
filing requirements for the past 90 days.
Duquesne Light Holdings, Inc. Yes ž No o
Duquesne Light Company Yes ž No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K
is not contained herein, and will not be contained, to the best of each registrant’s knowledge, in
definitive proxy or information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K.
Duquesne Light Holdings, Inc. ž
Duquesne Light Company ž
Indicate by check mark whether each registrant is a large accelerated filer, an accelerated filer,
or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in
Rule 12b-2 of the Exchange Act. (check one):
Duquesne Light Holdings, Inc. Large accelerated filer ž Accelerated filer o Non-accelerated filer o
Duquesne Light Company Large accelerated filer o Accelerated filer o Non-accelerated filer ž
Indicate by check mark whether either registrant is a shell company (as defined in Rule 12b-2 of
the Act).
Duquesne Light Holdings, Inc. Yes o No ž
Duquesne Light Company Yes o No ž
The aggregate market value of Duquesne Light Holdings, Inc. voting common stock held by
non-affiliates as of
June 30, 2005 (the last business day of its most recently completed second fiscal quarter) was
$1,435,007,239
based on the New York Stock Exchange closing price of $18.68 per share on that date.
No common stock of Duquesne Light Company was held by non-affiliates as of the last business day
of its most recently completed second fiscal quarter.
As of January 31, 2006, there were 78,162,741 shares of Duquesne Light Holdings, Inc.’s single
class of common stock outstanding.
As of January 31, 2006, there were 10 shares of Duquesne Light Company’s single class of common
stock outstanding, all held by Duquesne Light Holdings, Inc.
Documents incorporated by reference: Specified portions of the Duquesne Light Holdings, Inc. Proxy
Statement relating to the 2006 Annual Meeting of Shareholders, to be filed with the Commission not
later than 120 days after the close of such registrant’s fiscal year, are incorporated by reference
into Part III.
COMPETITIVE TRANSITION CHARGE (CTC) – During the electric utility restructuring from the
traditional Pennsylvania regulatory framework to customer choice, electric utilities have the
opportunity to recover transition costs from customers through this usage-based charge. As of
December 31, 2005, Duquesne Light has fully collected the CTC.
CUSTOMER CHOICE – The Pennsylvania Electricity Generation Customer Choice and Competition Act gives
consumers the right to contract for electricity at market prices from PUC-approved electric
generation suppliers.
DISTRIBUTION – Distribution is the flow of electricity from our substations to the ultimate
customer (businesses and homes).
ENERGY COMMODITY CONTRACTS – Contracts for the purchase or sale of electric energy and capacity
credits.
FEDERAL ENERGY REGULATORY COMMISSION (FERC) – The FERC is an independent five-member commission
within the United States Department of Energy. Among its many responsibilities, the FERC sets rates
and charges for the wholesale transportation and sale of electricity.
PENNSYLVANIA PUBLIC UTILITY COMMISSION (PUC) – The governmental body that regulates all utilities
(electric, gas, telephone, water, etc.) that do business in Pennsylvania.
PROVIDER OF LAST RESORT (POLR) – Under Customer Choice, the local distribution utility is required
to provide electricity for customers who do not choose an alternative generation supplier, or whose
supplier fails to deliver. (See Item 1, “Business,” for a description of our historical and current
POLR arrangements.)
REGIONAL TRANSMISSION ORGANIZATION (RTO) – Organization formed by transmission-owning utilities to
put transmission facilities within a region under common control. On January 1, 2005, Duquesne
Light joined PJM Interconnection, an RTO, which coordinates the movement of electricity in all or
parts of Delaware, Illinois, Indiana, Kentucky, Maryland, Michigan, New Jersey, North Carolina,
Ohio, Pennsylvania, Tennessee, Virginia, West Virginia and the District of Columbia.
REGULATORY ASSETS – Ratemaking practices grant regulated utilities exclusive geographic franchises
in exchange for the obligation to serve all customers. Under this system, certain prudently
incurred costs are approved by the regulators for deferral and future recovery. These deferred
costs are capitalized as regulatory assets by the regulated utility.
SEAMS ELIMINATION CHARGE ADJUSTMENT (SECA) – A transitional pricing mechanism put in place by the
FERC through March 2006 in order to compensate transmission owners for the estimated revenue lost
as a result of the elimination of the regional through and out rates (RTOR). SECA charges must be
paid by load-serving entities, including Duquesne Light and Duquesne Light Energy on a current
basis. The PUC granted a request by Duquesne Light to pass SECA charges through to its POLR
customers, effective for service beginning August 26, 2005.
TRANSITION COSTS – Transition costs are the net present value of a utility’s known or measurable
costs related to electric generation that are recoverable through the CTC.
TRANSMISSION– Transmission is the flow of electricity from generating stations over high voltage
lines to substations. The electricity then flows from the substations into our distribution
network.
Part I of this Annual Report on Form 10-K should be read in conjunction with Management’s
Discussion and Analysis of Financial Condition and Results of Operations, set forth in Part II,
Item 7, and with the audited consolidated financial statements, set forth in Part II, Item 8.
This combined Annual Report on Form 10-K presents information on both Duquesne Light Holdings,
Inc. (Holdings) and Duquesne Light Company (Duquesne Light). Information on Holdings and its
subsidiaries (not including Duquesne Light and its subsidiaries) shall not be deemed to be included
as part of Duquesne Light’s Annual Report on Form 10-K. Specifically, information on the Energy
Solutions, Financial and Communications business segments, the “all other” category, and
discontinued operations is not so included.
References in this report to “we,”“us” and “our” are to Holdings and its subsidiaries,
collectively. References to “Notes” are to the notes to the consolidated financial statements set
forth in Item 8.
Holdings is an energy services holding company formed in 1989 to serve as the holding company
for Duquesne Light and to engage in unregulated energy and related businesses.
Continuing Operations
Duquesne Light was formed in 1912 by the consolidation and merger of three constituent
companies. Duquesne Light is an electric utility engaged in the supply (through its
provider-of-last-resort service (POLR)), transmission and distribution of electric energy.
Under Pennsylvania ratemaking practice, electric utilities were granted exclusive geographic
franchises to sell electricity, in exchange for making investments and incurring obligations to
serve customers. Through the rate-making process, these prudently incurred costs were recovered,
along with a return on the investment, from customers. Additionally, certain operating costs were
approved for deferral for future recovery from customers. As a result of this process, utilities
had assets recorded on their balance sheets at above-market costs, creating transition costs. With
the 1996 passage of the Pennsylvania Electricity Generation Customer Choice and Competition Act,
electric generation was deregulated, allowing customers to purchase electricity at market prices
from a variety of electric generation suppliers. Under the Competition Act, utilities are permitted
to recover transition costs by collecting the competitive transition charge (CTC). Transmission
and delivery of electricity remain regulated in substantially the same manner as under historical
regulation.
In early 2000, Duquesne Light completed the divestiture of its generation assets, and applied
the net sale proceeds to reduce transition costs, thus accelerating its CTC collection period for
most customers. In conjunction with the sale of its generation assets, Duquesne Light entered into
POLR I, a full requirements arrangement with an unrelated vendor, which provided Duquesne Light the
necessary electricity to satisfy its provider of last resort obligation during the CTC collection
period. Although the CTC collection period ended during the third quarter of 2005, POLR I remains
in place for a few industrial customers under special contracts. In January 2002, Duquesne Light
began operating under POLR II, which extended the full requirements arrangement to service
customers from whom the CTC had already been fully collected. Unlike POLR I, which was income
neutral, the POLR II arrangement permitted Duquesne Light to collect a margin on the energy
supplied. POLR II expired on December 31, 2004.
POLR
III is Duquesne Light’s rate plan and related generation supply
plan for the period beginning January 1, 2005. Currently, most customers who do not choose an alternative generation supplier are served through POLR III. Under POLR III, residential and small commercial customers receive electric supply through December 31, 2007 at fixed rates approximately 11.5% above POLR II generation rates. For our large commercial and industrial customers, the current POLR III supply options are either a fixed price service based upon the
results of a competitive request-for-proposal process (available through May 31, 2006), or an hourly price service that passes through real-time spot market electricity prices. Duquesne Light receives an adder as compensation for costs and risks involved in providing energy to these customers. In January 2006, Duquesne Light requested and received approval from the PUC to extend the fixed-price service offering for an additional year. This offering will be subject to the results of another competitive wholesale request-for-proposal to be conducted. Concurrent with the beginning of POLR III, Duquesne
Light joined PJM Interconnection (PJM), as part of its commitment to ensuring reliability to its
customers.
Duquesne Power, LLC (formerly Duquesne Power, L.P.), an unregulated subsidiary, maintains a
portfolio of energy commodity contracts to provide full-requirements energy supply contracts for
both (i) Duquesne Light’s residential and small commercial POLR customers and (ii) Duquesne Light
Energy, LLC’s large commercial and industrial customers. These energy commodity contracts are with
unrelated parties and include payment guarantees from Holdings. Duquesne Power was a subsidiary of
Duquesne Light until December 31, 2005, at which time ownership
was transferred to another Holdings subsidiary. In 2003, Duquesne Power announced its agreement to purchase the Sunbury generation station to
serve Duquesne Light’s residential and small commercial customers as part of POLR III. However, in
September 2004, the planned acquisition was canceled.
Duquesne Light Energy, LLC (DLE) is an unregulated, competitive, retail electric generation
supplier that offers customized solutions tailored to meet its customers’ specific electricity
needs. DLE’s primary focus is on the large commercial and industrial
customer market segment in Duquesne Light’s service territory. DLE began operations in
November 2004.
Duquesne Energy Solutions, LLC (DES) is an energy facilities management company that provides
energy outsourcing solutions including operation and maintenance of synthetic fuel and energy
facilities. During 2005, DES sold its investments in three of six on-site energy facility
management projects.
DQE Financial Corp. owns, operates and maintains landfill gas collection and processing
systems, and is an investment and portfolio management organization focused on structured finance
and alternative energy investments.
DQE Communications, LLC owns, operates and maintains a high-speed, fiber optic based
metropolitan network, and leases dark fiber from the network to commercial, industrial and academic
customers.
DQE Capital Corporation provides financing to Holdings for use with its affiliates.
Proposed Acquisition
On November 14, 2005, Holdings entered into a Purchase and Sale Agreement to acquire Atlantic
City Electric Company’s (ACE) combined 108 megawatt ownership interests in the Keystone and
Conemaugh coal-fired power plants. The aggregate purchase price is approximately $176 million,
subject to adjustments based on, among other things, the transaction’s ultimate closing date.
Currently, the closing is anticipated to occur in mid-2006, subject to approvals from the New
Jersey Bureau of Public Utilities, the Pennsylvania Public Utility Commission (PUC) and other
regulatory entities. Both Keystone and Conemaugh are jointly owned by ACE and a consortium of
other companies. Holdings will be acquiring ACE’s undivided 2.47% interest, or 42 megawatts, in
Keystone and undivided 3.83% interest, or 66 megawatts, in Conemaugh, plus related inventories,
equipment and other property.
Service Areas and Customer Concentrations
Duquesne Light’s electric utility operations provide service to approximately 587,000 direct
customers in southwestern Pennsylvania (including in the City of Pittsburgh), a territory of
approximately 800 square miles.
Our other business lines have operations and investments in several states and Canada. Our
Canadian operations recognized revenue of $9.4 million, $11.9 million and $8.7 million in 2005,
2004 and 2003. Associated long-lived assets, excluding financial instruments, were zero, $4.2
million and $4.8 million as of December 31, 2005, 2004 and 2003. DES relies on a single customer,
that owns several synthetic fuel facilities, for substantially all of its revenues and earnings.
Regulation
Holdings and Duquesne Light are subject to the accounting and reporting requirements of the
Securities and Exchange Commission (SEC). Duquesne Light’s electricity delivery business is also
subject to regulation by the PUC and the Federal Energy Regulatory Commission (FERC) with respect
to rates for delivery of electric power, accounting and other matters.
Business Segments
This information is set forth in Item 7 under “Results of Operations” and in Note 20 to the
consolidated financial statements.
FORWARD-LOOKING STATEMENTS
We use forward-looking statements in this report. Statements that are not historical facts are
forward-looking statements, and are based on beliefs and assumptions of our management, and on
information currently available to management. Forward-looking statements include statements
preceded by, followed by or using such words as “believe,”“expect,”“anticipate,”“plan,”“estimate” or similar expressions. Such statements speak only as of the date they are made, and we
undertake no obligation to update publicly any of them in light of new information or future
events. Actual results may materially differ from those implied by forward-looking statements due
to known and unknown risks and uncertainties, some of which are discussed in Item 7.
EMPLOYEES
As of December 31, 2005, Holdings and its subsidiaries had approximately 1,600 employees.
Duquesne Light is party to a labor contract with the International Brotherhood of Electrical
Workers (IBEW), which represents 71% of Duquesne Light’s approximately 1,400 employees. Duquesne
Light and the IBEW are parties to a collective bargaining agreement which was renegotiated in 2005
and expires in September 2010.
ENVIRONMENTAL MATTERS
Legacy Liabilities
In 1992, the Pennsylvania Department of Environmental Protection (DEP) issued Residual Waste
Management Regulations governing the generation and management of non-hazardous residual waste,
such as coal ash. Following the generation asset divestiture, Duquesne Light retained certain
facilities which remain subject to these regulations. We have assessed our residual waste
management sites, and the DEP has approved our compliance strategies. As of December 31, 2005, we
expect the costs of compliance to be approximately $4 million with respect to sites we will
continue to own. These costs were recovered in the CTC.
Duquesne Light also owns the closed Warwick Mine, located along the Monongahela River in
Greene County, Pennsylvania. This property had been used in the electricity supply business
segment. Duquesne Light has been selling unused portions of the property and plans to continue to
do so. As of December 31, 2005, Duquesne Light’s current estimated liability for closing the
Warwick Mine, including final site reclamation, mine water treatment and certain health care
liabilities, is approximately $26 million.
These amounts are combined and included in legacy liabilities on both Holdings and Duquesne
Light’s consolidated balance sheets. Our operations are subject to environmental laws and
regulation by federal, state and local authorities. Due to the inherent uncertainties surrounding
the development of federal and state environmental and energy laws and regulations, we cannot
determine the impact such laws may have on our existing and future facilities.
Discontinued Operations
AquaSource Inc.’s (formerly our water resource management subsidiary) former water and
water-related operations were, and remain, subject to the Federal Safe Drinking Water Act, which
provides for uniform minimum national water quality standards, as well as governmental authority to
specify treatment processes to be used for drinking water. AquaSource’s former operations also
were, and remain, subject to the Federal Clean Water Act, which regulates the discharge of
pollutants into waterways. AquaSource is aware of various compliance issues at its former water and
wastewater facilities attributable to the period of time during which it owned these facilities.
AquaSource has agreed to indemnify the purchasers of these facilities for certain pre-closing
environmental liabilities.
Prior to divesting its former operations, AquaSource entered into various consent agreements
regarding certain environmental compliance matters. In connection with divesting its former
operations, AquaSource assigned these consent agreements to the relevant purchasers. AquaSource has
agreed to indemnify the purchasers of its former operations for certain pre-closing environmental
liabilities.
As part of the transaction, we retained certain obligations related to the business that was
sold to Aqua America, Inc., including responsibility for certain existing litigation matters as
well as a 10-year indemnity for certain pre-closing environmental claims. We purchased an
environmental liability policy to mitigate this indemnity.
We do not believe that any of AquaSource’s indemnity obligations described above will have a
material effect on Holdings’ financial position, results of operations or cash flows.
OTHER
Recent Accounting Pronouncements
On January 1, 2006, we adopted Statement of Financial Accounting Standards (SFAS) No. 123R,
“Share-Based Payment (revised December 2004),” using the modified prospective application method.
The use of this method will result in the recognition of compensation cost for all equity awards we
grant after the time of adoption and the recognition of the unvested portion of previously granted
equity awards that remain outstanding at the time of adoption as the requisite service is rendered.
The compensation cost will be based on the grant-date fair value of the equity award. The initial
adoption of SFAS No. 123R was not material to our financial statements.
We have applied Accounting Principles Board Opinion No. 25 “Accounting for Stock Issued to
Employees” and provided the required pro forma disclosures of SFAS No. 123 “Accounting for
Stock-Based Compensation” through December 31, 2005.
Proposed Accounting Standards
In July 2005, the Financial Accounting Standards Board (FASB) issued proposed FASB Staff
Position No. 13-a “Accounting for a Change or Projected Change in the Timing of Cash Flows Relating
to Income Taxes Generated by a Leveraged Lease Transaction” (FSP No. 13-a). The proposed changes
included in FSP No. 13-a are not yet in effect, but are expected
to be issued in 2006, and to be effective for the first annual period beginning after December 15, 2006. As the
December 2003 settlement with the Internal Revenue Service (IRS) regarding DQE Financial’s
structured lease and other similar investments modified our tax benefits under these leases, this
proposed staff position, if issued in its current form, would apply to us and would require
recognition of the modified tax benefits from the inception of the leases. As a result, upon
adoption of this standard, we would record an after-tax, cumulative effect charge of approximately
$85 million. We previously disclosed that the earnings volatility of the lease investments
was removed as a result of the settlement with the IRS, and the revised earnings of $3 million to
$4 million annually would be realized over the remaining lives of these leases. After adopting this
staff position, the amount of the cumulative effect
charge initially recorded would be recognized as additional lease earnings over the remaining lives
of these leases, which range from 23 to 31 years (with early buy-out periods ranging from 7 to 18
years). Our current and future cash flows would be unaffected by the adoption of this proposed FASB
Staff Position.
In July 2005, the FASB issued an exposure draft of a proposed interpretation of FASB Statement
No. 109 “Accounting for Uncertain Tax Positions.” The proposed changes are not yet in effect, but
are expected to be issued in the first quarter of 2006, and to be effective for the first annual
period beginning after December 31, 2006. We currently have certain tax disputes and are under
audit by both the Commonwealth of Pennsylvania and the IRS, as outlined in Note 10 to the
consolidated financial statements. This proposed interpretation, if issued in its current form,
would apply to both Holdings and Duquesne Light and would require recognition of a cumulative
effect upon adoption. We are currently evaluating the overall impact of this proposed
interpretation on both Holdings’ and Duquesne Light’s financial statements.
Pending Litigation
See Item 3, “Legal Proceedings,” for a discussion of pending litigation.
Available Information
Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and
amendments to these reports for both Holdings and Duquesne Light are available free of charge
through our website (www.duquesnelightholdings.com) when they become available on the SEC website.
EXECUTIVE OFFICERS OF THE REGISTRANTS
Set forth below are the names, ages as of December 31, 2005, and positions during the past
five years of the executive officers for Holdings and for Duquesne Light.
Ms. Hogel and Messrs. O’Brien, Belechak, Kaplan, Fields and Schott are executive officers of
both Holdings and Duquesne Light. Messrs. Schmitt and Wilson are executive officers only of
Holdings.
Morgan K. O’Brien, age 45. At Holdings: President and Chief Executive Officer since September
2001. Chief Operating Officer from August 2000 to September 2001. Executive Vice President -
Corporate Development from January 2000 to August 2000.
At Duquesne Light: Director since June 1999. President and Chief Executive Officer since
August 2003.
Joseph G. Belechak, age 46. At Holdings: Senior Vice President and Chief Operations Officer
since August 2003. Senior Vice President — Operations and Customer Service from December 2002 to
August 2003.
At Duquesne Light: Director since April 2003. Senior Vice President and Chief Operations
Officer since August 2003. Senior Vice President — Operations and Customer Service from October
2001 to August 2003. Vice President, Asset Management & Operations from August 2000 to October
2001.
Maureen L. Hogel, age 45. At Holdings: Senior Vice President and Chief Legal & Administrative
Officer since August 2003. Senior Vice President and Chief Administrative Officer from December
2002 to August 2003.
At Duquesne Light: Director since April 2003. Senior Vice President and Chief Legal &
Administrative Officer since August 2003. Senior Vice President and Chief Administrative Officer
from December 2002 to August 2003. Senior Vice President — Human Resources and Administration from
October 2001 through November 2002. Vice President — Development, Legal and Administrative Affairs
from January 2001 through October 2001.
Mark E. Kaplan, Age 44. At Holdings: Senior Vice President and Chief Financial Officer since
September 2005.
At Duquesne Light: Director, Senior Vice President and Chief Financial Officer since October
2005.
Previously: Managing Director of CLJ Consulting Group LLC (a management consulting firm) from
2004 until September 2005. From 1995 until 2004, served in various capacities with Weirton Steel
Corporation, including as President and Chief Financial Officer, Senior Vice President — Finance
and Administration, and Vice President and Controller. Also a director of WesMark Funds, an
open-end, management investment company.
William F. Fields, Age 55. At Holdings: Vice President and Treasurer since December 2002. At
DQE Financial: Treasurer since December 2002. President from June 2001 to August 2004.
At Duquesne Light: Vice President and Treasurer since December 2002.
John R. Schmitt, Age 42. At Holdings: Vice President since April 2005. At DQE Financial:
Vice President since August 2000. Also serves as Vice President of DQE Systems and Duquesne Energy
Solutions.
Stevan R. Schott, age 42. At Holdings: Vice President — Finance since September 2005. Senior
Vice President and Chief Financial Officer from August 2003 to September 2005. Vice President and
Controller from October 2001 to August 2003.
At Duquesne Light: Director from April 2003 to October 2005. Vice President — Finance since
October 2005. Senior Vice President and Chief Financial Officer from August 2003 to October 2005.
Vice President and Controller from October 2001 to August 2003. Vice President — Finance and
Customer Service from August 2000 to October 2001.
James E. Wilson, age 40. At Holdings: Vice President — Corporate Development since September
2005. Senior Vice President and Chief Strategic Officer from August 2003 to September 2005. Vice
President — Corporate Development and Rates from December 2002 to August 2003. Vice President -
Corporate Development from October 2001 to December 2002. Vice President and Controller from March
2000 to October 2001.
At Duquesne Light: Director from April 2003 to June 2004. Senior Vice President and Chief
Strategic Officer from August 2003 to June 2004. Vice President — Corporate Development and Rates
from December 2002 to July 2003. Vice President — Corporate Development from October 2001 to
November 2002. Vice President and Chief Accounting Officer from August 2000 to October 2001.
Item 1A. Risk Factors.
We are subject to substantial governmental regulation. If we receive unfavorable regulatory
treatment, our business could be negatively affected.
Our transmission and distribution businesses are subject to regulation by various federal,
state and local regulatory agencies that significantly affects our operations. The PUC regulates,
among other things, the rates we can charge retail customers for the delivery of electricity. In
addition, the FERC regulates, among other things, the rates that we can charge for electricity
transmission. We cannot change transmission or delivery rates without approval by the applicable
regulatory authority. While the approved transmission and delivery rates are intended to permit us
to recover costs of service and earn a reasonable rate of return, there is no guarantee that the
rates authorized by regulators will match our actual costs or provide a particular return on
capital at any given time. Additionally, we initiated a $500 million to $550 million capital
expenditure program for the years 2005 through 2007. While we will attempt to recover a portion of
our capital expenditures by passing these costs along to our customers, there is a risk that
governmental regulation of the rates we may charge to customers will prevent, hinder or delay our
recovery of these capital expenditures.
The FERC also regulates the rates that other utilities charge to us for wholesale sales of
electricity and can change the rates that other utilities charge for wholesale electricity sales.
Since electric generation is now deregulated, we may not be able to recover increased costs
associated with higher rates charged to us by electric generation suppliers.
We also are required to have numerous permits, approvals and certificates from governmental
agencies that regulate our business. We are unable to predict the impact of future regulatory
activities of any of these agencies on our business.
The Energy Policy Act of 2005 (the Energy Act) went into effect on August 8, 2005. The Energy
Act, among other things, repeals the Public Utility Holding Company Act of 1935 effective February
2006, amends certain provisions of the Federal Power Act and the Public Utility Regulatory Policies
Act of 1978, and expands the FERC’s authority to review mergers and acquisitions.
Changes in, or reinterpretations of, existing laws or regulations, or the imposition of new
laws or regulations, may require us to change the way we conduct our operations or may result in
substantial costs to us.
Shifting federal and state regulatory policies impose risks on our operations.
Our operations are subject to regulatory policies that are evolving as a result of various
initiatives, including initiatives regarding the deregulation of the production and sale of
electricity and changes in transmission regulation. Any new requirements arising from these actions
could lead to increased operating expenses and capital expenditures, the amount of which cannot be
predicted at this time.
Delays, discontinuations or reversals of electricity market restructurings in the markets in
which we operate, or may operate in the future, could have a material adverse effect on our results
of operations and financial condition. For instance, at this time the PUC has delayed the enactment
of final rules that will apply to the default generation service to be provided by Duquesne Light
after the expiration of its POLR III arrangements, which currently expire December 31, 2007. At a
minimum, these types of actions raise uncertainty concerning the continued development of
competitive power markets.
Our financial obligations under the Seams Elimination Charge Adjustment remain uncertain.
In addition to the regulatory risks described above, as a result of the FERC’s regulatory
efforts to implement a new long-term rate design for public utilities in the Midwest and
Mid-Atlantic regions, and specifically due to the FERC’s elimination of the regional through and
out rates (RTOR) for certain transmission services between the Midwest Independent System Operator
(MISO) and PJM, our transmission and distribution businesses may not fully recover their
transmission costs and may have costs shifted to them from other transmission owners. A
transitional pricing mechanism called the seams elimination charge adjustment (SECA) was put in
place through March 2006 in order to compensate transmission owners for the estimated revenue lost
as a result of the elimination of RTOR. The allocation of SECA charges has not yet been resolved.
Each PJM pricing zone, including the Duquesne Light zone, has been allocated a portion of the SECA
based on transmission services provided to that zone in 2002 and 2003. In February 2005, the FERC
issued an order accepting certain compliance filings that implemented the SECA for other (i.e.,
non-Duquesne Light) PJM pricing zones, subject to refund and surcharge, as appropriate, and set the
case in its entirety for a formal hearing. Also in February 2005, MISO filed with the FERC proposed
allocations of the SECAs to be collected from other transmission owners in PJM (including Duquesne
Light).
Total SECA charges for the Duquesne Light zone are currently expected to be approximately $39
million. In June 2005, the FERC accepted revised compliance filings implementing SECA charges among
load-serving entities within the Duquesne Light zone. Under that filing, Duquesne Light was
allocated approximately $11 million of the SECA charges. The other load-serving entities in the
Duquesne Light zone were allocated the remainder of such charges. DLE’s allocation of SECA charges
will depend on the amount of load it serves; based on the December 31, 2005 load, DLE’s allocation
is expected to be approximately $1.8 million.
The FERC is treating SECAs in the Duquesne Light zone in the same manner it has treated the
earlier SECA filings, and has consolidated Duquesne Light’s filing with the on-going hearing for
the other zones. While we anticipate that the case may take over a year to reach a final decision,
we cannot predict when it might be fully resolved.
The SECA charges must be paid by load-serving entities within the Duquesne Light zone on a
current basis. In June 2005, Duquesne Light filed a request with the PUC for permission to pass
SECA charges through to its POLR customers. This request was granted, subject to disposition of any
complaints filed against the request, by the PUC in August 2005. Duquesne Light put these charges
into effect for service beginning August 26, 2005. However, if the FERC ultimately adopts a SECA
level and allocation method that differs from the proposed charges initially accepted by the FERC
for billing purposes, refunds or surcharges will be used to compensate or charge the appropriate
entity for the difference between the amounts initially accepted by the FERC and the amounts
ultimately determined to be just and reasonable by the FERC. The final amount of our SECA
obligations therefore remains uncertain.
We may be required to make additional state tax payments for adjustments proposed by the
Pennsylvania Department of Revenue.
Our state income tax returns are subject to review by the relevant state taxing jurisdictions,
the Commonwealth of Pennsylvania being the most significant. The Pennsylvania Department of Revenue
(the “Department”) has issued assessments of additional tax for 1999 through 2002 primarily to
include income of an out-of-state subsidiary as Pennsylvania taxable income. If, as expected, the
Department asserts the same positions for 2003 through 2005, our total exposure for all years,
without interest or penalty, could approximate $78 million (net of associated federal benefit). We
do not agree with the Department on this matter, and have filed an appeal for the 1999 tax year
with the Pennsylvania Commonwealth Court. The assessments for the 2000, 2001 and 2002 tax years
have been appealed to various administrative levels within the Commonwealth of Pennsylvania.
Ultimately, we expect all years involved to be appealed to and decided at the Pennsylvania
Commonwealth Court.
It is not possible to predict if, when or to what extent any state income tax adjustments
ultimately proposed for the period 1999 through 2005 will be sustained. The ultimate resolution of
these state tax issues, depending on the extent and timing thereof, could have a material adverse
effect on cash flows for the period in which they are paid.
We are subject to risks associated with our POLR III obligations.
Duquesne Light’s residential and small commercial customers may choose to receive their
electric energy from an alternative generation supplier. If such customers do not choose an
alternative generation supplier, they will be served through Duquesne Light’s POLR, or provider of
last resort, arrangements. Residential and small commercial customers who
select an alternative generation supplier pay for generation charges set by that supplier, and
pay Duquesne Light both transmission and distribution charges. In connection with these POLR III
transactions, Duquesne Light retains the risk that such customers will not pay for the POLR
generation supply. Duquesne Light procures the energy and capacity needed to serve these
residential and small commercial customers under a full-requirements contract with Duquesne Power.
Failure or delay by Duquesne Power to provide the energy and capacity anticipated in the contract
could require Duquesne Light to incur additional expenses to meet the needs of its POLR III
customers.
We are subject to risks associated with procuring energy and capacity for Duquesne Light’s
small customers and DLE’s customers.
In addition to supplying the energy and capacity needs of Duquesne Light’s small customers,
Duquesne Power also has a full-requirements contract with its affiliate DLE to provide all of its
large commercial and industrial customers’ energy and capacity needs. During 2004 and 2005,
Duquesne Power entered into wholesale power purchase contracts that have been structured primarily
to begin and end during the POLR III time period. The net result of these transactions is that, as
of December 31, 2005, Duquesne Power has secured a substantial portion of the combined expected
load obligation for its full-requirements contracts with Duquesne Light and DLE through 2007.
Actual load may differ from expected load due to weather, customer switching, economic and
other factors. If Duquesne Power did not
have sufficient supplies, Duquesne Power would be required to procure the requirements in the
energy markets. If market prices were higher than the rates to be paid by Duquesne Light and DLE to
Duquesne Power under the full-requirements contracts, Duquesne Power could potentially be acquiring
the energy or capacity at a loss, and any such losses could have a material adverse effect on our
consolidated results of operations and financial condition. Likewise, if Duquesne Power has
contracted for supplies in excess of its needs, Duquesne Power could potentially be selling energy
or capacity at a loss, and any such losses could have a material adverse effect on our consolidated
results of operations and financial condition. Duquesne Power’s
energy commodity contracts contain provisions designed to mitigate
potential losses by requiring that Duquesne Power post collateral
depending on changes in energy or capacity prices. Because Holdings
guarantees these contracts, any such collateral postings would reduce
cash and/or the availability under Holdings’ credit facility.
The pending acquisition of ownership interests in the Keystone and Conemaugh generation
stations will subject us to risks that we do not currently face.
The acquisition and ownership of an interest in a generation station involves numerous risks,
including:
•
the plants’ ability to operate at expected capacity factors;
•
unforeseen operating problems and capital and other expenditures, including unforeseen
environmental compliance costs;
•
equipment failures;
•
the ability to comply with applicable regulations;
•
unanticipated cost increases;
•
labor force matters;
•
weather-related incidents;
•
the impact of changes in environmental laws and regulations; and
•
the ability to finance the acquisition.
Any of these factors could give rise to lost revenues and/or increased expenses and/or capital
expenditures. In addition, the performance of an investment in the Keystone and Conemaugh
generation stations will depend on:
•
cost and availability of fuel; and
•
changes in market prices of power.
Events or circumstances that adversely affect our financial position could result in defaults
under our credit agreements.
Holdings and Duquesne Light are subject to financial covenants contained in their respective
credit agreements. For instance, our credit agreement requires us to maintain at all times a ratio
of consolidated debt to consolidated capital of not more than 0.65 to 1.0 and an interest coverage
ratio, with respect to each twelve-month period ending on the last day of each fiscal quarter, of
at least 2.0 to 1.0. Duquesne Light’s credit agreement requires Duquesne Light to maintain at all
times a ratio of indebtedness to total capitalization of not more than 0.65 to 1.0. As of December31, 2005 we were in compliance with those covenants. However, any events or circumstances
(including any charges to earnings) which have an effect, directly or indirectly, of reducing our
common equity, increasing our indebtedness or reducing interest coverage, in relative terms, could
result in non-compliance with these covenants. If we default under our credit agreements, our
lenders could elect to declare all amounts borrowed to be immediately due and payable, together
with accrued and unpaid interest; and/or terminate their commitments, if any, to make further
extensions of credit. Both credit agreements include cross-default provisions that would be
triggered if the borrower or any of its subsidiaries
defaults on any payment due under any indebtedness exceeding $50 million.
The cost of compliance with environmental laws is significant. The costs of compliance with
new environmental laws and the incurrence of environmental liabilities could adversely affect our
cash flow and profitability.
The operations of our subsidiaries are subject to extensive federal, state and local
environmental statutes, rules and regulations relating to air quality, water quality, waste
management, natural resources, site remediation, and health and safety. These statutes, rules and
regulations require us to commit significant resources and funds to, among other things, conduct
site remediation and perform environmental monitoring. We also may be required to pay significant
remediation costs with respect to third party sites in connection with previously divested assets.
If we fail to comply with applicable environmental statutes, rules and regulations, even if caused
by factors beyond our control, such failure could result in the assessment of civil or criminal
penalties and liabilities and the need to expend significant sums to come into compliance. Alleged
violations of environmental laws and regulations may require us to expend significant resources
defending ourselves against these claims.
New environmental statutes, rules and regulations, or amendments to or new interpretations of
existing statutes, rules and regulations, could impose additional or more stringent limitations on
our operations or require us to incur significant additional costs. Our current compliance strategy
may not successfully address the relevant standards and interpretations of the future.
Our operating results fluctuate on a seasonal basis and can be adversely affected by changes
in weather.
Our electric utility business is sensitive to variations in weather conditions and significant
variations from normal weather patterns can have a material impact on our operating performance.
Historically, demand for electricity is generally greater in the summer months associated with
cooling compared to other times of the year. Accordingly, we have generated less revenues and
income when weather conditions are cooler than usual in the summer.
Severe weather, such as tornadoes, hurricanes, storms, ice and droughts, may cause outages and
property damage which may require us to incur additional costs that may not be insured and that may
not be recoverable from customers.
Also, while Duquesne Light’s margin on residential and small commercial customers was
previously a fixed dollar amount per megawatt-hour (MWh), beginning in 2005, the margin has an
element of seasonality. Revenues per MWh, while fixed on an annual basis through 2007, are lowest
in the first and fourth quarters reflecting the discount rate offered to electric heating customers
in the November through April heating season. The revenues per MWh are then higher in the remaining
months. Similarly, costs per MWh are expected to have a seasonal element, being higher in the first
and third quarters reflecting the peak energy consumption in the heating and cooling seasons. As a
result, margins on residential and small commercial customer energy supply are anticipated to be
higher in the second and fourth quarters.
We may be adversely affected by economic conditions.
Periods of slowed economic activity generally result in decreased demand for power,
particularly as industrial customers reduce production during such economic downturns, resulting in
less consumption of electricity. Additionally, a general downturn in overall economic conditions
may result in an increased number of bankruptcy filings by our customers, which would restrict our
ability to collect revenue from these customers. As a consequence, recessions or other downturns in
the economy may result in decreased revenues and cash flows for us.
Our insurance coverage may not be sufficient to cover all casualty losses that we might incur.
We currently have insurance coverage for our facilities and operations in amounts and with
deductibles that we consider appropriate. However, there is no assurance that such insurance
coverage will be available in the future on commercially reasonable terms. In addition, some risks,
such as weather-related casualties, may not be insurable. In the case of loss or damage to
property, plant or equipment, there is no assurance that the insurance proceeds, if any, received
by us will be sufficient to cover the entire cost of replacement or repair.
Our transmission facilities are interconnected with the facilities of other transmission
facility owners whose actions may have a negative impact on our operations.
Our transmission facilities are directly interconnected with the transmission facilities of
contiguous utilities and as such are part of an interstate power transmission grid. The FERC has
approved certain Regional Transmission Organizations (RTOs) that coordinate and have operational
control of portions of the interstate transmission grid. PJM and the other regional transmission
operators have established sophisticated systems that are designed to ensure the
reliability of the operation of transmission facilities and prevent the operations of one
utility from having an adverse impact on the operations of the other utilities. The systems put in
place by PJM and the other RTOs may not, however, always be adequate to prevent problems at other
utilities from causing service interruptions in our transmission facilities. If we were to suffer
such a service interruption due to an unexpected or uncontrollable event occurring on the system of
another utility, it could have a negative impact on our business. Additionally, any changes in PJM
policies or market rules, including changes that may be under consideration by the FERC, could
adversely affect our business, financial condition or results of operations.
Physical limitations in the electricity transmission system may give rise to increases in
electric transmission congestion charges.
Energy pricing within PJM includes the costs or benefits of transmission congestion
experienced at each location within the region. This is known as locational marginal pricing (LMP).
LMP recognizes that the marginal price of electricity may be different at varying locations on the
system and at different times. Differences in prices between two locations in the region at the
same time reflect physical limitations in the transmission lines used to move power across the
system. These physical limitations may give rise to increases in electric transmission congestion
charges.
We are dependent on our ability to cost-effectively access capital markets. Our inability to
obtain capital on acceptable terms may adversely affect our business. A reduction in our credit
ratings could increase our borrowing costs.
We rely on access to both short-term debt markets and longer-term capital markets as a source
of liquidity and to satisfy our capital requirements in excess of cash flow from our operations.
Any inability to maintain our current credit ratings could affect, especially during times of
uncertainty in the capital markets, our ability to raise capital on favorable terms that, in turn,
could impact our ability to manage our business. Moody’s Investors Service, Inc., Standard & Poor’s
Ratings Services, and Fitch Ratings periodically assign credit ratings on our debt and preferred
securities. We raise capital primarily by issuing senior-unsecured debt (currently rated Baa3, BBB-
and BBB-, respectively) and bank borrowings. Duquesne Light raises capital primarily by issuing
first mortgage bonds (currently rated Baa1, BBB+ and BBB, respectively), preferred stock (currently
rated Ba1, BB+ and BBB-, respectively), senior-unsecured debt (currently rated Baa2, BBB- and BBB-,
respectively) and bank borrowings. Any downgrades in these ratings could have a negative impact on
our liquidity, our access to capital markets, our costs of financing and could increase the amount
of collateral required by energy-contract counterparties. Capital market disruptions could also
adversely affect our ability to access one or more financial markets.
Moody’s Investors Service has also stated that our rating could be impacted negatively if we
diverge from our current strategy of repositioning our business around our core regulated utility
and make investments in higher risk unregulated businesses that would increase overall business
risk. Additionally, Moody’s Investors Service has noted that a rating downgrade could also occur if
there is a sustained deterioration in our cash flows or an increase in leverage resulting in weaker
credit metrics that would include the ratio of funds from operations to consolidated debt being in
the low teens or below.
A rating is not a recommendation to buy, sell or hold the notes, inasmuch as such rating does
not comment as to market price or suitability for a particular investor. The ratings assigned to
the notes address the likelihood of payment of principal and interest on the notes pursuant to
their terms. A rating may be subject to revision or withdrawal at any time by the assigning rating
agency. Each rating should be evaluated independently of any other rating that may be assigned to
our securities.
We may have difficulty retaining our aging utility workforce or finding skilled personnel to
replace them.
Workforce demographic issues are a national phenomenon that is of particular concern to the
electric utility industry. The median age of utility workers is significantly higher than the
national average. Currently, nearly one-half of the utility workforce is age 45 or higher. As of
December 31, 2005, the median age of utility workers at Duquesne Light was 51.37. Consequently, the
utility industry generally faces, and we specifically face, the difficult challenge of finding ways
to retain our aging skilled workforce while recruiting new talent in the hopes of decreasing losses
in critical knowledge and skills due to retirements. Mitigating these risks may require additional
financial commitments.
Labor disputes may have a material adverse effect on our operations and profitability.
As of December 31, 2005, we, together with our various subsidiaries, had approximately 1,600
employees. Of this total, approximately 1,400 were employed by Duquesne Light. We collectively
bargain with a labor union that represents approximately 71% of these Duquesne Light employees.
When the current collective bargaining agreement expires September 30,
2010, failure to reach an agreement could result in strikes or other labor protests that could
disrupt our operations. If we were to experience a strike or work stoppage, it would be difficult
for us to find a sufficient number of employees with the necessary skills to replace these
employees. We cannot assure you that we will reach any such agreement or that we will not encounter
strikes or other types of conflicts with the labor union of our personnel. Such labor disputes
could have an adverse effect on our business, financial condition or results of operations, could
cause us to lose revenues and customers and might have permanent effects on our business.
Our revenues and results of operations are subject to other risks beyond our control,
including, but not limited to, accidents, storms, natural catastrophes and terrorism.
The lost revenues and cost of repairing damage to our facilities due to storms, natural
disasters, wars, terrorist acts and other catastrophic events may exceed reserves and/or insurance
coverage established for repairs necessitated by such events, which may adversely impact our
results of operations and financial condition. We cannot assure you that our facilities will not
face damage or disruptions from these or other events. In addition, in the current geopolitical
climate, enhanced concern regarding the risks of terrorism throughout the economy may impact our
operations in unpredictable ways. Insurance coverage may not cover risks of this nature adequately
or at all.
Changes in financial or regulatory accounting principles or policies could affect our future
earnings or cash flows.
See Item 1, “Proposed Accounting Standards,” for further discussion.
We may experience a significant reduction in our earnings as a result of the December 31, 2007
expiration or the earlier phase-out of certain tax credits related to our synthetic fuel and
landfill gas projects.
In addition to operating five of the six synthetic fuel plants owned by an unrelated third
party, we also hold a limited partnership interest in an entity that owns and operates plants that
produce and sell synthetic fuel. These synthetic fuel projects are important contributors to our
earnings. We also produce Section 29 tax credits from some of our landfill gas operations.
Section 29 tax credits are set to expire on December 31, 2007. Once such tax credits expire we
do not believe that there will be a market for the sale of the synthetic-fuel. We cannot guarantee
that we will be able to bridge the 2008 earnings gap that will result from the loss of earnings
from our synthetic-fuel and landfill-gas projects following the expiration of the tax credits.
Section 29 tax credits are
subject to a phase-out provision that could reduce or eliminate the tax credits if the average
annual wellhead price per barrel of domestic crude oil increases into an inflation-adjusted
phase-out range. The IRS publishes the phase-out range in April for the previous year.
We estimate that for 2005 the tax credits would have begun to phase out when the annual average
wellhead price of domestic crude oil exceeded $53 per barrel and would have completely phased out
if that price exceeded approximately $66 per barrel. For 2005, the estimated average wellhead price
was approximately $50 per barrel. The wellhead price per barrel of domestic crude oil in recent
years has averaged approximately 90% of the New York Mercantile Exchange price per barrel of
domestic crude oil. We cannot predict the phase-out range for future years.
If domestic crude oil prices stay at a high level in 2006 and/or 2007, the estimated annual
tax credits to be generated from DQE Financial’s landfill gas operations and its investment in a
synthetic fuel partnership of approximately $18 million, as well as DES’ estimated annual after-tax
earnings of approximately $20 million from its synthetic fuel facilities management contract, may
be substantially reduced or eliminated. Based upon our evaluation, we have thus far determined not
to enter into hedging arrangements to reduce this potential exposure.
Natural gas prices are volatile, and a decline in natural gas prices would significantly
affect our landfill gas business’ financial results and impede its growth.
Our landfill gas-related revenue, profitability and cash flow depend upon the prices and
demand for natural gas. The market for this commodity is very volatile and changes in prices can
affect our financial results. Prices for natural gas may fluctuate widely in response to relatively
minor changes in the supply of and demand for natural gas, market uncertainty and a variety of
additional factors that are beyond our control, such as:
•
weather conditions;
•
technological advances affecting energy consumption;
•
governmental regulations;
•
proximity and capacity of pipelines and other transportation facilities; and
•
the price and availability of alternative fuels.
Our significant indebtedness could adversely affect our business.
At December 31, 2005, Holdings had total indebtedness of approximately $999 million (including
approximately $638 million at Duquesne Light), which
could have important consequences. For example, it could:
•
make it more difficult for us to satisfy our obligations related to any such indebtedness;
•
increase our vulnerability to general adverse economic and industry conditions;
•
require us to dedicate a substantial portion of our cash flow from operations to payments
on our indebtedness, thereby reducing the availability of our cash flow to fund working
capital, capital expenditures, acquisitions and other general corporate purposes;
•
limit our flexibility in planning for, or reacting to, changes in our business and the
industries in which we operate;
•
place us at a disadvantage compared to competitors that have less debt; and
•
limit our ability to borrow additional funds or refinance existing debt.
Any of these consequences could have a material adverse effect on our ability to satisfy our
indebtedness. The indenture under which Duquesne Light’s first mortgage bonds are issued permits
Duquesne Light to issue additional first mortgage bonds from time to time if certain financial
requirements are satisfied. The terms of our credit agreements also do not prohibit us or our
subsidiaries from incurring additional indebtedness. As of December 31, 2005, approximately $180
million of unused commitments remain under Holdings’ credit agreements (including approximately $92
million at Duquesne Light), and our credit agreements would permit additional borrowings. If new
debt is added to our and our subsidiaries’ current debt levels, the leverage-related risks
described above could intensify.
Our ability to pay dividends or service indebtedness is largely dependent upon the earnings of
our subsidiaries and the distribution of such earnings to us.
We are a holding company, and substantially all of the assets shown on our consolidated
balance sheets are held by subsidiaries. Our operating cash flow and our ability to service our
indebtedness depend on the operating cash flow of our subsidiaries and the payment of funds by them
to us in the form of dividends or advances. Our indebtedness is not guaranteed by our subsidiaries
and our subsidiaries are separate and distinct legal entities. We hold no assets and have no
sources of revenue other than the ownership interests in our subsidiaries and the right to any
dividends thereon and the right to receive payments on any existing or future loans made to our
subsidiaries.
Our subsidiaries are separate and distinct legal entities and have no obligation to make
payments on their common stock, or to make any funds available for such payment. Our subsidiaries’
ability to make dividend payments or other distributions to us may be restricted by their
obligations to holders of their outstanding debt, their other creditors and holders of their
preferred and preference stock, and the availability of earnings and the needs of their businesses.
For instance, no dividends or distributions may be made on Duquesne Light’s common stock if it has
not paid dividends on its preferred or preference stock. Dividends on Duquesne Light stock may also
be effectively limited by the terms of certain financing arrangements. Further, under Duquesne
Light’s articles of incorporation, the aggregate amount of common stock dividend payments or
distributions may not exceed certain percentages of net income, if the ratio of total common
shareholder’s equity to total capitalization is less than specified percentages. No part of
Duquesne Light’s retained earnings was restricted at December 31, 2005.
In addition, as discussed above, Duquesne Light is regulated by the PUC, which generally
possesses broad powers to ensure that the needs of the utility customers are being met. To the
extent that the PUC attempts to impose restrictions on the ability of Duquesne Light to pay
dividends to us, it could adversely affect our ability to make payments on our indebtedness or
otherwise meet our financial obligations.
In the event of a bankruptcy, liquidation, winding-up, dissolution, receivership, insolvency,
reorganization, administration or similar proceeding relating to one of our subsidiaries, holders
of such subsidiaries’ indebtedness, trade creditors of such subsidiaries and holders of such
subsidiaries’ preferred and/or preference stock will generally be entitled to payment of their
claim from the assets of those subsidiaries before assets are made available for distribution to
us.
We cannot assure investors that future dividend payments will be made, or if made, in what
amounts they may be paid.
Our Board of Directors regularly evaluates our common stock dividend policy and sets the
amount each quarter. The level of dividends will continue to be influenced by many factors,
including, among other things, our earnings, financial condition and cash flows from subsidiaries,
as well as general economic and competitive conditions. We cannot assure investors that dividends
will be paid in the future, or that, if paid, dividends will be at the same amount or with the same
frequency as in the past.
Because Duquesne Light is a wholly owned subsidiary of Holdings, Holdings can exercise
substantial control over its dividend policy and business and operations.
All of the members of Duquesne Light’s board of directors and its executive officers are also
officers of Holdings. Among other decisions, the Duquesne Light board is responsible for decisions
regarding financing and capital raising activities, and acquisition and disposition of assets.
Within the limitations of applicable law, Duquesne Light’s articles of incorporation and subject to
the covenants under its outstanding debt instruments, the Duquesne Light board of directors will
base its business decisions on its earnings, cash flow and capital structure, but may also take
into account the business plans and financial requirements of Holdings and its other subsidiaries.
Item 1B. Unresolved Staff Comments
Not applicable.
Item 2. Properties.
Our principal properties consist of Duquesne Light’s facilities for both transmitting and
distributing electricity, and supplemental properties and appurtenances, located substantially in
Allegheny and Beaver counties in southwestern Pennsylvania. Substantially all of the electric
utility properties are subject to a lien under the Indenture of Mortgage and Deed of Trust dated as
of April 1, 1992.
Duquesne Light owns 527 substations, of which over 60% are located on customer-owned land and
are used to service that customer. Duquesne Light has 672 circuit-miles of transmission lines,
comprised of 345,000, 138,000 and 69,000 volt lines. Street lighting and distribution circuits of
23,000 volts and less include approximately 16,420 circuit-miles of lines and cable. These
properties are used in the electricity delivery business segment.
Our total investment in property, plant and equipment (PP&E) and the related accumulated
depreciation balances for major classes of property are as follows:
Holdings PP&E and Related Accumulated Depreciation
Duquesne Light electric plant includes: (1) distribution poles and equipment; (2) lower
voltage distribution wires used in delivering electricity to customers; (3) substations and
transformers; (4) high voltage transmission wires used in delivering electricity to substations;
(5) meters and automated meter reading assets; and (6) internal telecommunication equipment,
vehicles and office equipment, primarily used in our electricity delivery business segment. The
fiber optic network owned by DQE Communications is reported in our Communications business segment.
The other energy facilities and landfill gas equipment are used in our Energy Solutions and
Financial business segments, respectively. The other PP&E is comprised of office furniture and
fixtures.
We are involved in various legal proceedings and environmental matters. We believe that the
resolution of such proceedings and matters, in total, will not have a materially adverse effect on
our financial position, results of operations or cash flows.
Item 4.
Submission of Matters to a Vote of Security Holders.
No matters were submitted to a vote of Holdings’ shareholders during the fourth quarter of
2005.
Pursuant to a written consent of the sole stockholder dated October 31, 2005, the following
individuals were elected as the full board of directors of Duquesne Light: Morgan K. O’Brien,
Joseph G. Belechak, Maureen L. Hogel and Mark E. Kaplan. All 10 outstanding shares of Duquesne
Light common stock were voted in favor of each individual.
PART II
Item 5.
Market for Registrants’ Common Equity, Related Shareholder Matters and Issuer Purchases of
Equity Securities.
Information relating to the market price for Holdings common stock is set forth in Note 21 to
the consolidated financial statements hereto, and incorporated herein by reference.
Holdings has continuously paid dividends on its common stock since 1953. Dividends of $0.25
per share were declared and paid quarterly for the last two years. At January 31, 2006 there were
approximately 45,300 holders of record of our common stock. Holdings common stock is listed and
traded on the New York, Philadelphia and Chicago Stock Exchanges.
Duquesne Light common stock is not publicly traded; Holdings owns all 10 shares outstanding.
Quarterly dividends totaling $13 million and $58 million were declared in 2005 and 2004. Duquesne
Light paid common stock dividends of $20 million, $71 million and $69 million in 2005, 2004 and
2003. During 2005 Duquesne Light embarked on a significant capital expenditure program, and
therefore has been retaining more of its earnings than in prior years.
We have no program regarding the repurchase of Holdings common stock. However, we repurchase
shares in connection with the issuance of so-called “stock swap exercises” of employee stock
options or restricted stock in which shares are surrendered or deemed surrendered to Holdings to
pay the exercise price and/or to satisfy tax withholding obligations. The following table presents
information with respect to such repurchases that occurred during the quarter ended December 31,2005.
(a)
(b)
(c)
(d)
Total
number
Maximum
of shares
number of
purchased
shares that
as part of
may yet be
Total
Average
publicly
purchased
number
price
announced
under the
of shares
paid per
plans or
plans or
Period
purchased
share
programs
programs
Oct. 1-31
—
$
—
—
—
Nov. 1- 30
—
$
—
—
—
Dec. 1- 31
26,309
$
16.50
—
—
Total
26,309
$
16.50
—
—
For information regarding equity compensation plans, see Item 12.
Total operating revenues increased in 2005, primarily due to the higher average
generation rates charged, and the increase in pipeline quality landfill gas sales. Total
operating revenues declined from 2001 through 2004 due to the collection of Duquesne Light’s
allocated CTC balance.
(b)
Operating income in 2005 was positively impacted by the $16.1 million increase in the fair
value of certain derivative energy contracts, the $13.2 million gain on asset sales, and was
negatively impacted by the $6.7 million charge related to an energy facility management
project. (See Notes 3 and 4.) Results were negatively impacted by the $8.3 million Sunbury
acquisition termination cost in 2004. (See Note 3.) Results were negatively impacted by
asset impairment charges of $30.2 million and $67.3 million and restructuring charges of
$5.2 million and $27.9 million in 2002 and 2001. (See Note 9.)
(c)
Results in 2005 were positively impacted by $24.1 million of gains on asset and investment
sales. Results were negatively impacted by investment impairment charges of $33.7 million
and $61.7 million in 2002 and 2001.
(d)
Holdings changed its method of accounting for goodwill and other intangible assets in 2002.
(e)
Beginning in 2002, earnings per share were impacted by the public offering of approximately
17 million shares of common stock.
(f)
This reflects the 2004 issuance, at par, of $75 million of Duquesne Light preferred stock.
(See Note 15.)
(g)
Adoption of SFAS No. 150 required reclassification to long-term debt.
(h)
Proceeds from the sale of AquaSource were used to reduce long-term debt in 2003.
Company obligated mandatorily redeemable
preferred securities (g)
—
—
—
150.0
150.0
Long-term debt (g) (h)
636.5
956.4
857.7
959.5
1,061.1
Total Capitalization
$
1,413.6
$
1,633.7
$
1,457.5
$
1,700.3
$
1,806.0
Dividends declared (e)
$
13.0
$
58.0
$
65.0
$
75.0
$
52.7
(a)
Total operating revenues increased in 2005 due to the higher average generation rates
charged under the POLR III arrangement, partially offset by a decline in large commercial and
industrial customer retention. Total operating revenues declined from 2001 through 2004 due to
the collection of the allocated CTC balance.
(b)
Results were positively impacted by the $16.1 million increase in the fair value of certain
derivative energy contracts in 2005. (See Note 4.) Results were negatively impacted by the
$8.3 million Sunbury acquisition termination cost in 2004. (See Note 3.) Results were
negatively impacted by restructuring charges of $3.7 million and $10.8 million in 2002 and
2001. (See Note 9.)
(c)
During 2005, Duquesne Light embarked on a significant capital expenditure program.
(d)
This reflects the repayment from Holdings, of a $250 million loan in 2005.
(e)
As a result of the significant capital expenditure program started in 2005, Duquesne Light
has been retaining more of its earnings. During 2005, Duquesne Light received $82.5 million of
equity contributions from Holdings.
(f)
This reflects the 2004 issuance, at par, of $75 million of Duquesne Light preferred stock.
(See Note 15.)
(g)
Adoption of SFAS No. 150 required reclassification to long-term debt.
(h)
Duquesne Light used proceeds from the repayment of its loan to Holdings to reduce long-term
debt in 2005. (See Note 14.) Duquesne Light reduced its investment in the DQE Capital cash
pool to reduce long-term debt in 2003.
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Unless otherwise stated, the terms “earnings” and “loss” used in this Item 7 refer to
after-tax amounts.
BUSINESS STRATEGY
Our strategy is to continue to focus building on successes at our core, regulated utility
business. Our objective is to be an economical, reliable and safe provider of electric energy to
our customers while creating shareholder value through opportunities related to our core business.
We will maintain and enhance our position as a safe and reliable provider of electric energy by
making prudent investments in our transmission infrastructure and our distribution infrastructure,
in each case using the most cost efficient financing available. We will seek to recover our
increased costs of service and the cost of our infrastructure investments in a manner that results
in reasonable rates for our customers while providing the base for a fair return for our
shareholders through a stable stream of cash flows. Our business strategy is summarized as follows:
Duquesne Light:
•
Continue to make prudent investments in both our transmission infrastructure and distribution infrastructure.
•
Maintain our high standards for reliability and customer service.
Continue to actively manage supply requirements for both
Duquesne Light’s residential and small commercial POLR III
customers and DLE’s customers, through Duquesne Power or
our other unregulated subsidiaries, using sound risk
management policies.
•
Maximize large commercial and industrial customer retention
through our unregulated retail electric generation
supplier, DLE.
•
Strategically align our unregulated energy supply
subsidiaries outside Duquesne Light to provide greater
flexibility to capitalize on opportunities that may arise.
•
Proceed with closing the planned acquisition of the
interests in the Keystone and Conemaugh power plants,
providing a physical hedge to complement our portfolio of
energy commodity contracts for our supply plan.
•
Continue to evaluate additional power plant acquisitions.
Complementary Businesses:
•
Focus on expanding landfill gas and related businesses to
capitalize on current market conditions utilizing our
existing position within the marketplace, while helping to
solve a growing environmental challenge.
•
Identify and develop other unregulated investments that are
both closely aligned with our business strategy and that
provide reasonable prospects for a fair return and moderate
growth.
•
Continue to divest non-core investments that are not
consistent with our overall business strategy, while
maximizing sale proceeds.
Financing:
•
Use the most cost efficient sources of funds to finance the
continued infrastructure investment, proposed acquisition of
power plant interests, landfill gas investments and general
corporate purposes.
•
Continue to improve credit quality and maintain acceptable
levels of liquidity.
OVERVIEW OF BUSINESS SEGMENTS
Duquesne Light reports the following business segments: (1) transmission and distribution of
electricity (electricity delivery business segment), (2) supply of electricity by Duquesne Light
(Duquesne Light supply business segment), and (3) collection of transition costs (which were fully
collected as of December 31, 2005) (CTC business segment).
Holdings reports the following business segments: (1) transmission and distribution of
electricity (electricity delivery business segment), (2) supply of electricity (which includes the
Duquesne Light supply business segment and, beginning in 2005, supply by DLE) (electricity supply
business segment), (3) collection of transition costs (which were fully collected as of December31, 2005) (CTC business segment), (4) DES’ development, operation and maintenance of energy
facilities and, for a single customer, synthetic fuel facilities (Energy Solutions business
segment), (5) DQE Financial’s collection and processing of landfill gas and management of
structured finance and alternative energy investments (Financial business segment), and (6) DQE
Communications’ operation, maintenance and leasing of its fiber optic based network (Communications
business segment). We also report an “all other” category to include our other subsidiaries below
the quantitative threshold for disclosure. These subsidiaries provide corporate administrative
functions, financing, and insurance services for our various affiliates.
Note 20 to the consolidated financial statements shows the financial results of each principal
business segment in tabular form. Following is a discussion of these results.
Electricity Delivery Business. In our continued effort to provide a stable, reliable source
of electric energy for our customers, we have embarked on a significant investment program to
upgrade both our transmission infrastructure and our distribution infrastructure. Capital
expenditures related to the program were approximately $150 million in 2005 and we expect to spend
an additional $350 to $400 million through 2007. The cost of these infrastructure investments is to
be funded through operating cash flows, equity infusions from Holdings, bank debt and the possible
sale of low cost pollution control revenue bonds (PCRBs) in 2006 as part of our overall financing
plan. In addition, effective January 1, 2005 we successfully integrated our transmission operations
into those of PJM as a part of our commitment to ensuring reliability.
The net income from our regulated electricity delivery business was lower in 2005, as
expected, due to higher operating costs related to customer assistance programs, increased labor
costs and the realignment of certain revenues and expenses related to ancillary energy services
that are now reflected in our supply segment. These changes more than offset the increased revenue
generated from favorable weather conditions during 2005. In 2006 we expect to file a distribution
rate case with the PUC and a transmission rate case with the FERC to recover our increased costs of
service and to receive a fair return on our investments. Duquesne Light last filed such rate cases
in 1987.
Supply Business. The factors impacting the Duquesne Light supply business segment have
significantly changed when compared to prior periods. From the time that Duquesne Light sold its
generation assets in April 2000 through December 31, 2004, the default energy supply requirement
for all customers had been met through a full requirements contract with one supplier. From the
time that Duquesne Light completed its stranded cost recovery (different by each rate class, but
generally during the 2002 to 2003 time period) through December 31, 2004, Duquesne Light had earned
a margin on each megawatt-hour (MWh) supplied.
Effective January 1, 2005, residential and small commercial customers remaining on POLR
service saw an average increase of 11.5% above their POLR II generation rates, reflecting the
increase in market energy prices in the time since the POLR II rates were established. Despite this
increase in rates, residential and small commercial customer retention has increased to 75% in 2005
from 74% in 2004.
Also effective January 1, 2005, Duquesne Light has been meeting its POLR III energy supply
requirements for residential and small commercial customers through Duquesne Power’s portfolio of
energy and capacity supply contracts with multiple investment-grade counter-parties as well as
through transactions with PJM. This change in energy supply strategy is designed to provide the
opportunity to earn a larger margin in the supply business. While taking on increased commodity
price risk, we have decreased our supplier credit/default risk. The increased commodity price risk
has been managed at a prudent level through the portfolio of energy commodity contracts. Because
some of these contracts are not settled at the Duquesne Light zone, the normal exemption is not
applicable and they are accounted for on a mark-to-market basis, with changes in the fair value of
these contracts recorded currently in earnings unless certain hedge accounting criteria are met.
During the year ended December 31, 2005, earnings were positively impacted by a $7.9 million
after-tax increase in the fair value of mark-to-market derivative energy contracts, whose duration
varies, but extends no later than December 31, 2007. While it is impossible to determine how the
value of these contracts will change during 2006 and 2007, the fair value of these contracts will
be zero by the latest expiration date of December 31, 2007. Contracts accounted for as cash flow
hedges differ from those accounted for as mark-to-market, in that the fair value of these contracts
is generally not recognized currently in earnings, but rather as the contracts are settled.
While previously Duquesne Light’s margin on residential and small commercial customers was a
fixed dollar amount per MWh, beginning in 2005 the margin has an element of seasonality. Revenues
per MWh, while fixed on an annual basis through 2007, are lowest in the first and fourth quarters
reflecting the discount rate offered to electric heating customers in the November through April
heating season. The revenues per MWh are then higher in the remaining months. Similarly, costs per
MWh are expected to have a seasonal element, being higher in the first and third quarters
reflecting the peak energy consumption in the heating and cooling seasons. As a result, margins on
residential and small commercial customer energy supply are anticipated to be higher in the second
and fourth quarters.
For large business customers, effective January 1, 2005, the POLR energy supply product is a
fluctuating hourly-priced service. Additionally, through May 31, 2006, Duquesne Light offers a
fixed-price service whose rate reflects the results of a competitive wholesale
request-for-proposal. In January 2006, Duquesne Light requested and received approval from the PUC
to extend the fixed-price service offering for an additional year. This offering will be subject to
the results of another competitive wholesale request-for-proposal to be conducted. Duquesne Light
continues to meet its POLR energy supply requirement for large customers through interactions with
PJM and with full requirements contracts, now with two investment-grade suppliers. Because of the
uncertainty inherent in hourly-priced POLR service and the increase in the fixed-price rates, POLR
retention for large commercial and industrial customers has decreased from 58% in 2004 to 19% in
2005. As of December 31, 2005, the POLR retention rate for large commercial and industrial
customers was less than 10%, and is expected to remain at approximately this level throughout 2006.
Under the POLR II arrangement that ended December 31, 2004, Duquesne Light earned a margin on
each MWh sold to its large commercial and industrial customers. During the twelve months ended
December 31, 2004, Duquesne Light earned net income of $4.6 million in the supply business related
to sales to its large commercial and industrial customers. Under the POLR III arrangement that
became effective January 1, 2005, Duquesne Light no longer earns a margin in the supply business on
these sales.
In response to the change in large customer POLR service, DLE has begun to offer competitive
electric generation (EGS) service to customers in the Duquesne Light service territory. Duquesne
Power manages the DLE supply requirements together with the Duquesne Light residential and small
commercial customer POLR III supply requirements.
2006 Supply Business Realignment. Effective December 31, 2005, Duquesne Power was transferred
from Duquesne Light to another Holdings subsidiary. The operations of Duquesne Power
will only be reported as part of the Holdings electricity supply segment beginning January 1, 2006. The
transfer of Duquesne Power was completed to strategically align our unregulated businesses outside
of Duquesne Light in order to provide flexibility to capitalize on future supply opportunities. The
transfer will effectively eliminate the net income included in Duquesne Light’s supply segment.
If this transfer had taken place on January 1, 2003, the net effect to Duquesne Light’s
earnings would have been an increase of $0.1 million in 2003 and $6.0 million in 2004. Earnings in
2005 would have decreased $27.2 million. In 2003, Duquesne Power was just being formed and had
minimal activity. The 2003 increase would have been caused by a decrease in other operating and
maintenance expense. The 2004 increase would have been caused by the removal of the acquisition
termination cost associated with the cancelled Sunbury acquisition and other costs. The 2005
decrease would have been caused primarily by the removal of some revenue and an increase in
operating expenses, the effect of which would eliminate Duquesne Power’s margin on its sales to
Duquesne Light and DLE.
Changes to the balance sheets would have been immaterial in 2003 and 2004. There would be no
change to the 2005 balance sheet as the transfer took place at close of business on December 31,2005.
Landfill
Gas Business. Our landfill gas business (a part of our Financial
business segment) is comprised of investments in
20 landfill sites around the country and the ownership of Waste Energy Technologies, LLC (WET),
which was acquired in the fourth quarter of 2004. WET has provided landfill gas collection system
engineering, design and construction services to the landfill business for over 20 years. Our 20
sites are comprised of three that currently produce pipeline quality gas sold at market rates; five
sites where unprocessed landfill gas production is currently sold at significantly lower unit
prices than pipeline quality gas, but due to lower operating costs and capital requirements, still
provide the opportunity to earn modest returns, and 12 passive investment sites we do not project
to be involved with beyond 2007 due to the scheduled expiration of Section 29 tax credits.
We have made small, strategic capital investments to maximize our existing production
capacities and improve the throughput of the landfill gas processing sites we expect to continue to
operate, and have focused our efforts to streamline and minimize our operating costs. These sites
also have sufficient quantities of available gas to remain viable beyond the expiration of Section
29 tax credits on December 31, 2007.
We are a significant producer of pipeline quality landfill gas in the United States. The
majority of our earnings from our landfill gas business are derived from the three pipeline quality
production sites. Our contract at one of these sites located in New York City is scheduled to
terminate on June 30, 2006; our earnings for 2005 included $7.4 million related to this site. We
expect to operate our other two pipeline quality landfill gas sites for approximately 15 more
years. In December 2005, we have also entered into a price swap agreement for approximately 60% of
our anticipated 2006 pipeline quality landfill gas sales in order to lock in the recent
unprecedented increases in natural gas prices.
We continue to evaluate opportunities to expand this business. In December 2005, we entered
into a joint venture agreement to develop a liquefied natural gas application at one of our five
fixed-price sites, while at another of these sites we reached agreement for the expansion of our
existing gas rights and extended the agreement through 2020. We will continue to invest in new
landfill gas sites, or expand at existing sites that meet our investment criteria.
Energy Solutions Business. The primary operations of this business segment in 2006 will be
the operation and maintenance of synthetic fuel facilities for a single customer, from which we
earn fees based on production. Given that synthetic fuel qualifies for Section 29 tax credits,
which are set to expire on December 31, 2007, we expect our operation and maintenance of the
synthetic fuel facilities to cease at that time. In addition, Section 29 tax credits are subject to
a phase-out provision that could reduce tax credits if the average annual wellhead price per barrel
of domestic crude oil increases into an inflation-adjusted phase-out range. As such, it is possible
that operations at these facilities could be curtailed or terminated prior to December 31, 2007.
Asset Divestitures. We continue to divest businesses that we have determined not to be in
line with our core business strategies. In 2005 and 2004 our Financial business segment sold all or
portions of tax-advantaged limited partnership investments to generate current cash benefits
instead of increasing Holdings significant tax credit carryforward position. We also sold
investments in two leveraged lease transactions.
In 2005, our Energy Solutions business segment entered into agreements to ultimately sell our
investments in five energy facility management projects. We have closed on three of the projects in
2005 and anticipate closing the remaining two in early 2006. These energy facility management
projects did not significantly contribute to the earnings of the Energy Solutions business segment.
RESULTS OF OPERATIONS
Overall Performance
2005 Compared to 2004
Our net income was $114.2 million, or $1.47 basic earnings per share in 2005, compared to
$87.0 million, or $1.14 basic earnings per share in 2004. The average shares outstanding increased
1.3 million, or 1.7%, compared to 2004. Our income from continuing operations was $112.9 million,
or $1.45 basic earnings per share in 2005, compared to $87.2 million, or $1.14 basic earnings per
share in 2004, an increase of $25.7 million, or 29.5%.
Duquesne Light’s earnings available for common stock were $65.0 million in 2005, compared to
$61.2 million in 2004, an increase of $3.8 million, or 6.2%. Earnings from Duquesne Light’s supply
business segment increased $14.7 million from the prior year, primarily as a result of a $9.4
million after-tax increase in earnings resulting from certain changes in the fair value of the
derivative energy contracts at Duquesne Power since December 31, 2004, and a $4.8 million after-tax
charge included in the 2004 results related to the termination of the acquisition of the Sunbury
generation station. Earnings from the electricity delivery business segment decreased $10.6 million
from the prior year, primarily as a result of an increase in operating expenses, which includes
$3.9 million of additional after-tax administrative expenses previously borne by Holdings prior to
the sale of several non-complementary businesses.
Earnings from continuing operations at Holdings were also affected by the following:
•
DES’ earnings increased $13.2 million, primarily as a result of $19.4 million in
after-tax gains on the sale of investments in three energy facility management projects
during 2005, partially offset by $6.7 million of charges related to another energy facility
management project.
•
Earnings from DQE Financial increased $3.8 million, primarily as a result of a $4.9
million increase in earnings from operations related to pipeline quality landfill gas.
•
DQE Communications earnings increased $0.8 million, as a result of increased revenues
from new and existing customers.
•
Holdings earnings also include a $2.4 million after-tax gain resulting from the
settlement of an interest rate lock agreement during 2005, the reduction of $3.9 million in
after-tax administrative costs discussed above, partially offset by increased operating
expenses associated with the current IRS audit.
2004 Compared to 2003
Our 2004 earnings available for common stock were $87.0 million, or $1.14 basic earnings per
share, compared to $175.5 million, or $2.34 basic earnings per share, for 2003. The average shares
outstanding increased 1.4 million, or 1.9%.
Our earnings from continuing operations available for common stock were $87.2 million, or
$1.14 basic earnings per share, in 2004, compared to $92.8 million, or $1.24 basic earnings per
share, in 2003.
Duquesne Light’s earnings available for common stock were $61.2 million in 2004, compared to
$66.4 million in 2003. The $5.2 million decrease in earnings at Duquesne Light is primarily due to
the $4.8 million after-tax charge for the write-off of deposits and deferred costs related to the
termination of the Sunbury acquisition.
Earnings from continuing operations at Holdings were also affected by the following:
•
Earnings from DQE Financial decreased $6.8 million from
2003, primarily due to a $9.7 million decrease in earnings
from structured lease investments primarily as a result of the
IRS settlement and a $7.0 million after-tax gain, recognized
in 2003, on the sale of an investment in a natural gas
operating partnership. These decreases were partially offset
by an $8.2 million increase in earnings related to our
landfill gas business.
•
Earnings from DES increased $2.4 million primarily due to
lower employee compensation costs.
•
Earnings from DQE Communications increased $0.9 million
primarily due to revenue growth from new and existing
customers.
The 2004 loss from discontinued operations was $0.2 million, or zero basic earnings per share,
compared to income of $82.7 million, or $1.10 basic earnings per share, in 2003. The 2003 income
included a $66.6 million tax benefit related to the use of capital losses generated in connection
with the sale of the AquaSource subsidiaries and an $11.5 million after-tax gain related to the
increase in fair value of AquaSource’s investor-owned utilities as a result of the sale of these
utilities to Aqua America, Inc. (See Note 17.)
RESULTS OF OPERATIONS BY BUSINESS SEGMENT
2005 Compared to 2004
Electricity Delivery Business Segment. This segment reported $36.5 million of earnings in
2005, compared to $47.1 million in 2004, a decrease of $10.6 million or 22.5%. This decrease was
primarily due to increased operating expenses in 2005.
Operating revenues are primarily derived from the delivery of electricity, including related
excise taxes. Sales to residential and commercial customers are primarily influenced by weather
conditions. Warmer summer and colder winter seasons lead to increased customer use of electricity
for cooling and heating. Commercial sales also are affected by regional development. Sales to
industrial customers are influenced by national and global economic and competitive conditions.
The following table sets forth the MWh delivered to electric utility customers.
MWh Delivered
(In Thousands)
2005
2004
Change
Residential
4,134
3,886
6.4
%
Commercial
6,635
6,522
1.7
%
Industrial
3,128
3,229
(3.1
%)
13,897
13,637
1.9
%
Operating revenues decreased $1.2 million, or 0.3%, compared to 2004. The decrease was
primarily due to ancillary services revenue being reported in the Duquesne Light supply segment in
2005. This reclassification of ancillary revenue ($11.8 million in 2004) offset the $3.2 million of
revenue collected in 2005 to recover SECA charges. It also offset the increased delivery revenues
to residential and commercial customers resulting from the higher megawatt-hour (MWh) sales in 2005
due to the warmer summer weather as compared to 2004.
Operating expenses consist primarily of costs of operation and maintenance of the transmission
systems and distribution systems; meter reading, billing and collection; customer service;
administrative expenses; and non-income taxes such as gross receipts, property and payroll taxes.
Operating expenses increased $13.5 million, or 8.2%, compared to 2004. Following the sale of
several of Holding’s non-complementary businesses, approximately $6.5 million of additional costs
were borne by this segment in 2005 compared to 2004. Included in this amount was $3.4 million
related to insurance. Rising energy prices in 2005 placed a strain on the budgets of the elderly
and low-income customers. Duquesne Light attempted to balance this impact with sound business
practices through increased participation in customer assistance programs. This had the effect of a
$7.2 million increase in uncollectible accounts expense. In addition, $4.9 million of increased
labor costs were incurred in 2005. These increases were partially offset by a $6.5 million decrease
in the costs of ancillary services, because the majority of this cost is now being reported in the
Duquesne Light supply segment as a result of the POLR III arrangement.
Depreciation and amortization expense includes depreciation on property, plant and equipment
and amortization of intangibles. Depreciation and amortization expense increased $4.8 million, or
7.7%, compared to 2004. The increase was primarily due to $3.0 million of amortization expense
recognized in 2005 relating to SECA, as discussed in the revenue section above.
Dividends on preferred and preference stock reflect the annual payments made to preferred and
preference shareholders. Preferred dividends increased $1.4 million, or 21.2%, compared to the
prior year due to the $75 million of 6.5% preferred stock issued in April 2004. Dividends on all
issues of Duquesne Light’s preferred stock are included in interest and other charges in the
Holdings presentation of the electricity delivery business segment.
Duquesne Light Supply Business Segment. As previously discussed, the factors
impacting this segment in 2005 have changed significantly compared to the prior year. The following
table summarizes the earnings from this segment.
Earnings
(In Millions)
2005
2004
Change
Residential and small
commercial
$
19.0
$
13.9
$
5.1
Large commercial
and industrial
—
4.6
(4.6
)
Derivative energy
contracts
9.4
—
9.4
Acquisition termination
cost
—
(4.8
)
4.8
Total Earnings
$
28.4
$
13.7
$
14.7
Under the POLR II arrangement in 2004, the margin on sales to residential and small
commercial customers was a fixed dollar amount per MWh supplied, while under the POLR III
arrangement in 2005, the margin on these customers is no longer fixed.
The $5.1 million increase in the earnings from the residential and small commercial customers
reflects the higher POLR III rates. Under the POLR II arrangement, Duquesne Light earned a margin per
MWh on sales to large commercial and industrial customers. However, there is no margin under the
POLR III arrangement associated with these customers, which accounts for a $4.6 million decrease in
earnings from 2004. In addition, some of the energy contracts entered into by Duquesne Power are
derivative instruments, the accounting for which results in certain changes in the fair value of
these contracts being recorded currently in earnings. As shown above, there was a $9.4 million
increase in earnings in 2005 resulting from certain changes in the fair value of these energy
contracts since December 31, 2004. The results for 2004 included the $4.8 million after-tax charge
related to the termination of the Sunbury acquisition.
Operating revenues are derived primarily from the supply of electricity to POLR retail
customers. Retail energy requirements fluctuate as the number of customers choosing alternative
generation suppliers changes. Energy requirements for residential and commercial customers are also
influenced by weather conditions; temperature extremes lead to changes in customer use of
electricity for cooling and heating. Commercial energy requirements are also affected by regional
economic development. Energy requirements for industrial customers are primarily influenced by
national and global economic conditions.
In addition, operating revenues include, to a lesser extent, the supply of electricity to
wholesale customers. Beginning in 2005, these sales are primarily comprised of sales to DLE by
Duquesne Power under its full-requirements energy supply contract. In 2004, these sales primarily
consisted of short-term sales to other utilities that were made at market rates, and resulted
primarily from excess daily energy deliveries to Duquesne Light’s electricity delivery system.
Operating revenues increased $9.3 million, or 2.1%, compared to 2004. The combination of
the higher average generation rate charged to residential and small commercial customers under the
POLR III arrangement and the addition of the ancillary services revenue that is being reported in
this segment in 2005 caused an approximate $51 million increase in operating revenues in 2005
compared to the prior year. This was augmented by an approximate $12 million increase in retail
revenue from increased MWh sales due to the warmer summer weather that occurred in 2005 and an
increase in the number of customers being served under the POLR III arrangement. In addition, there
was an approximate $39 million increase in wholesale sales of electricity in 2005, due primarily to
sales to DLE. As shown in the tables above, there has been a significant decrease in the MWh
supplied to large commercial and industrial customers as a higher percentage of these customers
chose an alternative generation supplier in 2005. This resulted in an approximate $92 million
decrease in operating revenues compared to 2004.
In 2005, operating expenses consisted of (i) costs to obtain energy and capacity for Duquesne
Light’s POLR service and to supply DLE, (ii) certain changes in the fair value of derivative energy
contracts, (iii) administrative expenses at Duquesne Power, and (iv) gross receipts tax. In 2004,
operating expenses consisted primarily of costs to obtain energy for our POLR service and gross
receipts tax, both of which fluctuated directly with operating revenues. Beginning in the third
quarter of 2004, operating expenses also included administrative expenses at Duquesne Power.
Operating expenses decreased $8.0 million, or 2.0%, compared to 2004. The primary reason for
the decrease was a $15.2 million decrease in purchased power expense, primarily due to certain
increases in the fair value of the derivative energy contracts. Partially offsetting this decrease
was a $2.7 million increase in administrative costs, and increased gross receipts taxes.
CTC Business Segment. Collection of the CTC was completed in the third quarter of 2005.
Changes in revenue and expenses between 2005 and 2004 reflect the full collection of this
regulatory asset in 2005.
Electricity Supply Business Segment. Earnings from this segment include the results for the
Duquesne Light supply segment and, beginning January 1, 2005, the results of Holdings’ unregulated
retail electric generation supplier, DLE.
The revenues and energy and capacity costs relating to the full-requirements contract between
Duquesne Power (which are included in the Duquesne Light supply segment) and DLE are eliminated and
instead DLE’s retail sales to its large commercial and industrial customers are presented. As a
result, overall earnings and operating revenues and expenses of this segment are substantially
unchanged from corresponding amounts discussed in the Duquesne Light supply segment above.
The following tables set forth the retail MWh supplied to the electricity supply business
segment customers.
MWh Supplied
(In Thousands)
2005
2004
Duquesne Light
6,821
9,065
DLE
932
—
Total Retail
7,753
9,065
Energy Solutions Business Segment. This segment reported income of $35.9 million in
2005, compared to $22.7 million in 2004, an increase of $13.2 million, or 58.1%. The increase is
primarily due to the $19.4 million of after-tax gains on the sale of investments in certain energy
facility management projects partially offset by $6.7 million of charges related to another energy
facility management project.
Operating revenues are derived primarily from the facility management services for synthetic
fuel, industrial and airport customers. Operating revenues for 2005 increased $0.2 million, or
0.3%, compared to 2004. Revenues for the synthetic fuel facilities increased $3.2 million from 2004
due to an approximate 5% increase in production. This
increase was partially offset by a cumulative reduction to revenue recognized in 2005 relating to a
contract dispute with the counter-party of another energy facility management project.
Operating expenses consist of the operating and maintenance costs to manage the facilities, as
well as general corporate overhead and other gains and losses associated with the operations of the
facilities. Operating expenses decreased $7.5 million, or 23.1%, compared to 2004, primarily due to
the $13.2 million pre-tax gain on the sale of two energy facilities in the fourth quarter of 2005,
partially offset by a $3.9 million impairment charge associated with another energy facility
management project and a $3.3 million increase in energy commodity costs related to the energy
facility operations.
Other income consists of income from an equity investment in an energy facility operating
partnership (which was sold in the third quarter of 2005) and various other gains and losses. Other
income increased $17.7 million from 2004 primarily as a result of an $18 million pre-tax gain on
the sale of our equity investment as previously discussed.
Financial Business Segment. This segment reported income of $30.2 million in 2005, compared
to $26.4 million in 2004, an increase of $3.8 million, or 14.4%, primarily due to a $4.9 million
increase in earnings from operations related to pipeline quality landfill gas.
Operating revenues are derived primarily from the sale of landfill gas and landfill gas
site-related services. Operating revenues for 2005 increased $16.2 million, or 49.4%, compared to
2004. The increase is primarily the result of a $9.8 million increase in pipeline quality landfill
gas sales (as a result of an approximate 35% increase in the average price of pipeline quality
landfill gas sold in 2005 as compared to 2004) and a $6.6 million increase in revenues related to
the consolidation of WET for an entire year in 2005 as a result of our purchase of the remaining
50% interest in the company in the fourth quarter of 2004.
Operating expenses consist of various costs to operate and maintain the landfill gas sites, as
well as expenses related to alternative fuel investments. Operating expenses increased $8.9
million, or 21.9%, compared to 2004, primarily due to a $5.8 million increase in net operating
expenses related to the consolidation of WET, and increased royalty expenses attributable to
pipeline quality landfill gas operations as a result of the increased revenues.
Other income consists of income from structured leases and affordable housing and equity
investments, and various other gains and losses. Other income for 2005 increased $3.1 million, or
32.6%, compared to 2004, primarily due to incremental net pre-tax gains of $5.9 million related to
the sales of various non-core investments during 2005, partially offset by a $2.4 million
decrease in other income in 2005 due to the full year effect in 2005 of the consolidation of the
affordable housing investments as described below.
The benefit from limited partners’ interest reflects the portion of the losses related to the
affordable housing guarantee funds that are not owned by the DQE Financial subsidiary as a result
of the consolidation of the affordable housing investments effective March 31, 2004.
Income taxes consist of our provision for federal income taxes as well as the tax credits
generated from our synthetic fuel limited partnership, landfill gas and affordable housing
investments. The income tax benefit for 2005 decreased $10.7 million, or 43.1%, compared to 2004,
due to a $4.3 million decrease in tax credits generated in 2005, primarily due to the sale of 50%
of our investment in the synthetic fuel partnership as previously discussed, and the increase in
pre-tax earnings in 2005 as compared to 2004.
Communications Business Segment. This segment reported income of $2.5 million in 2005,
compared to $1.7 million in 2004, an increase of $0.8 million, or 47.1%. The increase is primarily
due to increases in revenues from new and existing customers.
All Other. The all other category reported a loss of $19.6 million in 2005, compared to a
loss of $24.2 million in 2004, an improvement of $4.6 million, or 19.0%. The improvement is
primarily due to a $2.4 million after-tax gain recorded at Holdings resulting from the favorable
settlement of an interest rate lock arrangement in 2005 and the reduction of $3.9 million in
after-tax administrative costs allocated to Duquesne Light. These improvements were partially
offset by a $1.7 million after-tax increase in operating expenses related to the current IRS audit.
2004 Compared to 2003
Electricity Delivery Business Segment. This segment reported $47.1 million of earnings in
2004, compared to $46.1 million in 2003, an increase of $1.0 million, or 2.2%. This increase was
primarily due to higher revenue and lower interest and other charges, partially offset by higher
operating expenses in 2004.
The following table sets forth MWh delivered to electric utility customers.
Operating revenues increased $6.3 million, or 1.9%, compared to 2003. The increase is
primarily due to a 2.1% increase in megawatt-hours (MWh) sales from 2003. Residential and
commercial sales increased compared to 2003, as the effect of the hotter summer and the extra day
due to leap year in 2004 more than offset the warmer 2004 winter.
In 2003, we recognized a $4.9 million charge related to vacant leased office space. Operating
expenses increased by $7.4 million, or 4.7%, compared to 2003 ($12.3 million after considering the
2003 lease charge). Reasons for this increase include a $7.2 million increase in labor, pension and
other fringe benefit costs, a $1.7 million increase in insurance costs, and a $1.7 million increase
in billing and collection costs.
Interest and other charges include interest on long-term debt and other interest. Interest and
other charges decreased $14.2 million, or 23.5%, due to (i) $200 million of debt retirements in
late 2003, which reduced interest expense by $11.6 million, and (ii) $151.5 million of 8.375%
subordinated debenture redemptions in the first six months of 2004, which reduced interest expense
$9.6 million. These reductions were partially offset by the $7.1 million increase in interest
expense resulting from the issuance of $200 million of 5.7% debt in May 2004.
Dividends on preferred and preference stock increased $3.4 million, or 106.3%, due to the $75
million of 6.5% preferred stock issued in April 2004.
Duquesne Light Supply and Electricity Supply Business Segments. In 2004, these segments
reported earnings of $13.7 million, compared with $19.7 million in 2003. The decrease of $6.0
million, or 30.5%, is primarily due to the $4.8 million after-tax charge ($8.3 million pre-tax)
incurred by Duquesne Power related to the termination of the Sunbury acquisition.
The following tables set forth MWh supplied for POLR customers.
MWh Supplied
(In Thousands)
2004
POLR I
POLR II
Total
Residential
—
2,886
2,886
Commercial
84
3,707
3,791
Industrial
1,538
850
2,388
Total
1,622
7,443
9,065
POLR Retention (MWh basis)
66
%
MWh Supplied
(In Thousands)
2003
POLR I
POLR II
Total
Residential
57
2,673
2,730
Commercial
242
4,110
4,352
Industrial
1,641
931
2,572
Total
1,940
7,714
9,654
POLR Retention (MWh basis)
72
%
Operating revenues decreased $15.7 million, or 3.5%, compared to 2003, due to the 6.1%
decline in POLR MWh. The decline resulted from a higher percentage of our commercial and industrial
customers choosing alternative generation suppliers.
Operating expenses decreased $13.7 million, or 3.3%, compared to 2003, primarily due to an
$11.7 million decrease in purchased power expense. This decrease was caused by the decline in the
POLR MWh supplied to customers.
CTC Business Segment. Operating revenues are derived by billing electric delivery customers
for generation-related transition costs. Duquesne Light is allowed to earn an 11% pre-tax return
on the net of tax CTC balance. As revenues are billed to customers on a monthly basis, we amortize
the CTC balance. The resulting decrease in the CTC balance causes a decline in the return earned
by Duquesne Light.
This segment reported earnings of $0.4 million in 2004, compared to $0.6 million in 2003, a
decrease of $0.2 million, or 33.3%.
Energy Solutions Business Segment. This segment reported earnings of $22.7 million in 2004,
compared to $20.3 million in 2003, an increase of $2.4 million, or 11.8%. The 2004 results were
positively impacted by reductions in incentive compensation costs paid to former executives of this
subsidiary.
Operating revenues increased $4.9 million, or 7.7%, compared to 2003. The increase was
primarily due to a $2.6 million increase in revenues related to
the energy facility operations, and a $2.0 million revenue adjustment in 2003 related to a
scale calibration deficiency identified and corrected at one of the synthetic fuel facilities.
Operating expenses decreased $0.6 million, or 1.8%, compared to 2003, primarily due to a $4.2
million decrease in the incentive compensation costs discussed above. This decrease was partially
offset by increased energy commodity costs related to the energy facility operations.
Financial Business Segment. This segment reported earnings of $26.4 million in 2004, compared
to $33.2 million in 2003, a decrease of $6.8 million, or 20.5%. This decrease was due in part to a
$9.7 million decrease in 2004 earnings recognized from the structured lease investments as a result
of the IRS settlement and a $7.0 million after-tax gain recognized in 2003 on the sale of an
investment in a natural gas operating partnership. The 2004 decrease was partially offset by a $4.0
million increase in earnings related to operations at the Fresh Kills landfill site that were
affected by the settlement reached with the City of New York, increased earnings from equity
investments, and higher earnings from increased sales revenues related to landfill gas.
Operating revenues increased $5.0 million, or 18%, compared to 2003. The increase is the
result of a $3.4 million increase in landfill gas sales primarily as a result of an 11.6% increase
in average price and a 9% increase in volumes of pipeline quality landfill gas sold in 2004, as
compared to 2003. In addition, $1.6 million of revenues are included in the 2004 results that are
related to the consolidation of operations of WET as a result of our purchase of the remaining 50%
interest in the company in the fourth quarter of 2004. Prior to the purchase, we owned 50% of the
company and accounted for the investment using the equity method.
Operating expenses decreased $4.7 million, or 10.4%, compared to 2003, primarily due to a $3.6
million decrease in operating expenses at the landfill sites, and a $3.5 million decrease in
expenses related to our limited partnership investment in a synthetic fuel partnership as a result
of the sale of 50% of our investment in this partnership in the fourth quarter of 2004. In
addition, there was a $1.7 million decrease in legal fees related to the settlement of the Fresh
Kills litigation. These decreases were partially offset by a $2.4 million expense recognized for a
fee due under a contract with an unrelated party, and the consolidation of $1.0 million in
operating expenses related to the purchase of WET.
Other income decreased $19.9 million, or 67.7%, compared to 2003, primarily due to a $14.9
million decrease in pre-tax earnings from the structured lease investments as a result of the IRS
settlement, the 2003 pre-tax gain of $10.8 million related to the sale of the investment in a
natural gas partnership previously discussed, and a $6.8 million decrease in other income in 2004
due to the consolidation of the affordable housing investments resulting from the adoption of FASB
Interpretation No. 46R, “Consolidation of Variable Interest Entities” (revised December 2003) (FIN
46R) (see below). These decreases were partially offset by $5.9 million of pre-tax earnings
primarily from the debt forgiveness related to the Fresh Kills settlement, a $3.8 million increase
in pre-tax earnings from equity investments, and lower expenses related to the affordable housing
investments in 2004, as compared to 2003.
As of March 31, 2004, we adopted FIN 46R and accordingly consolidated the seven low-income
housing development guarantee funds in which a DQE Financial subsidiary owns a 1% general partner
interest. The losses from these investments were recorded in other income, and the benefit from
limited partners’ interest reflects the portion of the losses related to the affordable housing
guarantee funds that are not owned by the DQE Financial subsidiary.
The income tax benefit decreased $4.8 million, or 16.2%, compared to 2003, due primarily to a
$2.9 million decrease in tax credits generated in 2004 from our investment in the synthetic fuel
partnership in which we sold 50% of our investment in the fourth quarter of 2004, as discussed
above, and a $2.4 million decrease in 2004 tax credits from the Fresh Kills landfill site as the
February 2004 settlement reached with the City of New York eliminated our ability to claim future
tax credits from this site.
Communications Business Segment. This segment reported earnings of $1.7 million in 2004,
compared to $0.8 million in 2003, an increase of $0.9 million, or 112.5%. The increase is primarily
due to increases in revenues from new and existing customers.
All Other. The all other category reported a loss of $24.2 million in 2004, compared with a
$26.0 million loss in 2003.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of financial statements in conformity with accounting principles generally
accepted in the United States of America requires us to make estimates and assumptions with respect
to
values and conditions that affect the reported amounts of assets and liabilities, and disclosure of
contingent assets and liabilities, at the date of the financial statements. The reported amounts of
revenues and expenses during the reporting period also may be affected by the estimates and
assumptions we are required to make. We evaluate these estimates on an ongoing basis, using
historical experience, consultation with experts and other methods we consider reasonable in the
particular circumstances. Nevertheless, actual results may differ significantly from our estimates.
In preparing our financial statements and related disclosures, we have adopted the following
accounting policies which management believes are particularly important to the financial
statements and that require the use of estimates and assumptions in the financial preparation
process.
Accounting for the Effects of Regulation. Duquesne Light prepares its financial statements in
accordance with the provisions of SFAS No. 71, “Accounting for the Effects of Certain Types of
Regulation,” which differs in certain respects from the application of accounting principles
generally accepted in the United States of America by non-regulated businesses. In general, SFAS
No. 71 recognizes that accounting for rate-regulated enterprises should reflect the economic
effects of regulation. As a result, a regulated utility is required to defer the recognition of
costs (a regulatory asset) if it is probable that, through the rate-making process, there will be a
corresponding increase in future rates. Accordingly, Duquesne Light defers certain costs, which
will be amortized over future periods. To the extent that collection of such costs is no longer
probable as a result of changes in regulation or competitive position, the associated regulatory
assets are charged to expense. (See Note 1.)
Unbilled Electricity Revenues. Holdings and Duquesne Light record revenues related to the
sale of electricity when delivery is made to customers. However, the determination of such sales to
individual customers is based on the reading of their meters, which Duquesne Light reads on a
systematic basis throughout the month. At the end of each month, Holdings and Duquesne Light
estimate the amount of electricity delivered to customers since the date of the last meter reading
based on actual daily meter reads or, alternatively, estimated daily use based on rate-specific,
statistically estimated, hourly consumption patterns. Unbilled revenues are estimated each month
based on the rate class-specific unbilled electricity sales and the corresponding average retail
rate.
Impairment of Long-Lived Assets and Investments. We evaluate long-lived assets (including
other intangibles) of identifiable business activities and investments for impairment when events
or changes in circumstances indicate, in management’s judgment, that the carrying value of such
assets may not be recoverable. For long-lived assets to be held and used, these computations use
judgments and assumptions inherent in management’s estimate of undiscounted future cash flows to
determine recoverability of the assets. It is possible that a computation under a “held for sale”
situation for certain of these long-lived assets could result in a significantly different
assessment because of market conditions, specific transaction terms or a buyer’s different
viewpoint of future cash flows. For investments, we considered our investee’s cash on-hand,
financing abilities, customers, contracts and overall ability to continue as a going concern.
Pension and Other Postretirement Benefit Plan Assumptions. We provide pension benefit plans
covering substantially all of our full-time employees. We also provide postretirement benefits for
some retired employees. The retiree medical benefits terminate when retirees reach age 65. We
account for these benefits in accordance with SFAS No. 87, “Employers’ Accounting for Pensions” and
SFAS No. 106, “Employers’ Accounting for Postretirement Benefits Other Than Pensions.” We record
amounts related to our pension and other postretirement benefit plans based on actuarial
valuations. Inherent in those valuations are key assumptions including discount rates, expected
returns on plan assets, compensation increases, and health care cost trend rates. These actuarial
assumptions are reviewed annually and modified as appropriate. Changes in these assumptions could
have a significant effect on our non-cash pension income or expense or on our postretirement
benefit costs. The effect of changes in these assumptions is generally recorded or amortized over
future periods.
We discounted our future pension and other postretirement plan obligations using a rate of
5.70% as of December 31, 2005, compared to 5.75% as of December 31, 2004. The discount rate is
determined by (i) considering the timing and amount of projected future benefit payments and (ii)
using an outside advisor to produce a yield curve model that represents the yields on high-quality
corporate bonds. When applied to our projected future benefit payments, this model determines the
weighted-
average discount rate. Both the pension and other postretirement plan obligations and related
expense increase as the discount rate is reduced.
The assumed rate of return on plan assets in the pension plans is the weighted average of
long-term returns forecast for the type of investments held by the plans. As the expected rate of
return on plan assets increases, the pension plan expense decreases, however the postretirement
plan expense is unaffected as this plan has no assets. For 2003, the assumed rate of return on plan
assets in the pension plans was 7.5%. We revised this assumption to 8.0% for both 2004 and 2005 to
more closely align with our actual and expected long-term rate of return on plan assets.
Due to changes in health care costs over recent years, the health care trend assumption used
in the development of the fiscal 2006 expense will be adjusted to better reflect the current and
future cost environment. The health care trend assumption reflected in the December 31, 2005, SFAS
No. 106 year-end disclosure, which will also be used in the development of fiscal 2006 expense, is
9.50%, decreasing 0.75% per year to an ultimate rate of 4.75% (reached in 2013).
We believe the assumptions used in recording obligations under the plans are reasonable based
on our prior experience, market conditions, and the advice of plan actuaries. See Note 12 to the
consolidated financial statements for information about these assumptions, actual performance,
amortization of investment and other actuarial gains and losses and calculated plan costs for the
past three years.
As of December 31, 2005, the fair value of the pension plan assets of $759.8 million
represented approximately 91% of the projected benefit obligation of our pension plans.
Our pension gain for 2005 was $0.4 million and our expected pension cost for 2006 is $3.4
million. Our expense or gain for actual pension benefits in future periods will depend upon actual
returns on plan assets and the key assumptions we use for future periods.
We were not required to make cash contributions to our pension plans in 2005, nor will we be
required to do so in 2006, due to a sufficient credit balance as determined by actuarial
valuations. In accordance with current funding rules, this credit balance can be applied against
the minimum funding requirements. In January 2005, Duquesne Light met its obligation, pursuant to
the January 18, 2001 PUC order regarding Duquesne Light’s final generation asset sale proceeds
accounting, by contributing $32.1 million to the pension plans.
Also, in January and February of 2006, Duquesne
Light made aggregate discretionary contributions of $20 million to the pension plans.
Income Taxes. In accordance with SFAS No. 109, “Accounting for Income Taxes,” we use the
liability method in computing deferred taxes on all differences between book and tax bases of
assets and liabilities. These book/tax differences occur when events and transactions recognized
for financial reporting purposes are not recognized in the same period for tax purposes. The
deferred tax liability or asset is also adjusted in the period of enactment for the effect of
changes in tax laws or rates. Our overall effective tax rate is significantly reduced by the income
tax credits generated from our synthetic fuel, landfill gas and affordable housing investments.
We file a consolidated U.S. federal income tax return with our subsidiaries, all of whom
participate in an intercompany tax sharing arrangement which generally provides that taxable income
for each subsidiary be calculated as if it filed a separate return.
Duquesne Light recognizes a regulatory asset for deferred tax liabilities that are expected to
be recovered through rates. The difference in the provision for deferred income taxes related to
depreciation of electric plant in service and the amount that otherwise would be recorded under
generally accepted accounting principles is deferred and included in regulatory assets on the
consolidated balance sheets. (See Note 1.)
Derivative Instruments. In the normal course of business, we have entered into various
contracts to mitigate risks associated with fluctuations in market prices of electricity supply,
pipeline quality landfill gas sales and interest rates that are accounted for as derivatives under
the provisions of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as
amended and interpreted. The contracts are in compliance with a Board-approved risk management
policy that permits transactions for the prudent management of market related risks, and precludes
any speculative transactions. The contracts that are determined to fall within the scope of SFAS
No. 133, and that are required to be recorded at fair value, are included as derivative assets and
liabilities on the consolidated balance sheets. Changes in fair value, except those related to
derivative instruments designated as cash flow hedges, are accounted for using mark-to-market
accounting and are included currently in earnings in
each reporting period until the contracts are ultimately settled.
Management’s expectations and intentions are key factors in determining the appropriate
accounting for a derivative instrument, and as a result, such expectations and intentions are
formally documented at inception. Management continues to evaluate these initial expectations and
intentions as they relate to the underlying contract on an ongoing basis. Cash flow hedge
accounting treatment may be used for contracts used to buy or sell a commodity at a fixed price for
future delivery corresponding with anticipated physical sales or purchases or to lock in current
interest rates on existing or planned debt issuances. Fair value hedge accounting may be used to
hedge the risk that the fair value of specific assets and liabilities or specific firm commitments
may change between inception and anticipated delivery date. To the extent that the hedge is fully
effective in offsetting the transaction being hedged, there is no impact on earnings prior to
settlement of the hedge. In addition, we apply the normal purchases and sales exemption, provided
by SFAS No. 133, to certain contracts. The normal purchases and sales exemption provides that no
recognition of the contract’s fair value in the consolidated financial statements is required until
the settlement of the contract.
The fair values of contracts are estimated through the use of valuation models using quoted
market prices, when available. Such estimates require significant judgment as to assumptions and
valuation methodologies deemed appropriate by management. Actual future results may vary from those
assumptions utilized in the valuation models. See Item 7A “Quantitative and Qualitative Disclosures
About Market Risk” for additional information regarding the fair value of derivative instruments.
Contingent Liabilities. We establish reserves for estimated loss contingencies when it is
management’s assessment that a loss is probable and the amount can be reasonably estimated.
Reserves for contingent liabilities are based upon management’s assumptions and estimates, advice
of legal counsel, or other third parties regarding the probable outcomes of the matter. Should
additional information become known, or circumstances change with respect to the likelihood or
amount of loss indicating that the ultimate outcome will differ from the estimates, revisions to
the estimated reserves for contingent liabilities would be recognized in income in that period.
Such contingent liabilities include, but are not limited to, restructuring liabilities (see Note
9), income tax matters (see Note 10), and other commitments and contingencies (see Note 13).
LIQUIDITY AND CAPITAL RESOURCES
Our cash and temporary cash investments increased $16.5 million, or 26.3%, from $62.7 million
at December 31, 2004 to $79.2 million at December 31, 2005. Duquesne Light had a $135.8 million
investment in the DQE Capital cash pool at December 31, 2004, exited the cash pool during 2005, and
as of December 31, 2005, had cash of $76.1 million. We require cash principally for day-to-day
operations, energy purchases, debt service, capital expenditures and dividends. We have
historically financed our cash needs primarily from cash from operations, debt and equity
issuances, asset sales and bank or commercial paper borrowings. Duquesne Light has historically
financed its cash needs with cash from operations, capital contributions received from Holdings,
debt issuances, and bank or commercial paper borrowings.
Cash Flows from Operating Activity. Cash flows from operating activities at Holdings were
$119.7 million in 2005, compared to $178.3 million in 2004. Cash flows from operating activities at
Duquesne Light were $81.9 million in 2005, compared to $112.2 million in 2004. Net cash provided
from operating activities in 2005 was reduced by the $32.1 million contribution Duquesne Light made
to its pension plans in the first quarter of 2005.
Cash Flows from Investing Activity. In 2005, 2004 and 2003, Duquesne Light’s capital
expenditures were $153.9 million (with $21.7 million of this amount reflected as a non-cash
increase in accounts payable), $83.5 million and $76.1 million for electric utility construction.
In addition, Holdings’ incremental capital expenditures were $3.7 million, $2.9 million and $1.9
million in 2005, 2004 and 2003 relating to our other business lines and other investments.
During 2005, we received $61 million of proceeds from dispositions of investments/assets,
primarily leverage lease investments and energy facility management projects.
Duquesne Light received $250 million from Holdings as repayment of an intercompany note during
2005, and exited the DQE Capital cash pool.
Cash Flows from Financing Activity. During August 2005, Holdings issued $200 million of 5.5%
senior notes due August 15, 2015 and $120 million of 6.25% senior notes due August 15, 2035.
Proceeds
were used to repay the $250 million intercompany loan with Duquesne Light and approximately $37
million of variable rate borrowings under Holdings’ credit facility. The remaining balance was used
for general corporate purposes. As of December 31, 2005, Holdings had $40 million of borrowings
outstanding under the revolving credit facility.
Duquesne Light used the proceeds received from the repayment of Holdings’ intercompany loan
plus available cash to purchase at par upon mandatory tender $320.1 million of variable rate
Pollution Control Revenue Refunding Bonds (PCRBs) with maturity dates ranging from 2020 to 2033.
This purchase was in accordance with SFAS 140, “Accounting for Transfers and Servicing of Financial
Assets and Extinguishments of Liabilities,” and is presented on Duquesne Light’s balance sheet as
an extinguishment of debt, because Duquesne Light is the primary obligor of the PCRBs. Duquesne
Light plans to sell all of the PCRBs at future dates to refinance higher cost securities, fund
infrastructure investments, and for general corporate purposes.
Holdings paid cash dividends on common and preferred stock of $67.1 million, $66.0 million and
$64.4 million in 2005, 2004, and 2003. These amounts are net of the cash received back from our
shareholders who participate in our dividend reinvestment plan.
Duquesne Light paid cash dividends on common and preferred stock of $28.4 million, $76.9
million, and $72.8 million in 2005, 2004 and 2003. During 2005, Duquesne Light embarked on a
significant capital expenditure program, and began retaining more of its earnings than in prior
years. Also during 2005, Holdings contributed $82.5 million to Duquesne Light Company in support of
the capital expenditure program.
Financing Plan
We estimate that for the period from 2006 through 2007, Duquesne Light’s capital expenditures
will be approximately $350 to $400 million for electric utility construction related to
transmission and distribution infrastructure. During 2006 through 2007, Holdings is expected to
spend approximately $200 million to $250 million, primarily related to investments in the Keystone
and Conemaugh power stations (including acquisition costs) and landfill gas facilities.
We plan to issue debt and equity securities and to borrow under our credit facilities to
provide equity contributions to Duquesne Light and to fund our investments. Duquesne Light plans to
use a combination of parent equity contributions, sale of debt securities and credit-facility
borrowings to fund its capital expenditures and cash needs.
On October 18, 2005, we filed a shelf registration statement for up to $400 million of
preferred stock, common stock, stock purchase contracts, stock purchase units, warrants and debt
securities, to be issued from time to time. Our ability to issue such securities will depend on,
among other things, market demand, interest rates, and corporate strategy. We expect to use a
substantial portion of the registered securities during 2006 to fund our planned expenditures.
Liquidity
We believe that cash on hand, access to debt and equity capital markets, and bank borrowing
capacity continue to provide sufficient resources to fund our ongoing operating requirements,
capital expenditures and investments.
Available cash at all subsidiaries, including Duquesne Light, has historically been deposited
in the DQE Capital cash pool. Duquesne Light’s investments in or withdrawals from this cash pool
have been reflected as cash flows from investing activities on its consolidated statements of cash
flows. Duquesne Light began investing its cash outside of the cash pool during the fourth quarter
of 2005.
Bank Credit Facilities. Prior to July 27, 2005 Holdings and Duquesne Light maintained
unsecured credit facilities (Prior Revolvers) expiring in September 2007, Holdings for $175 million
and Duquesne Light for $100 million. On July 27, 2005 the Prior Revolvers were amended and extended
to July 2010 (2005 Revolvers). Holdings 2005 Revolver was for $200 million and Duquesne Light’s
2005 Revolver was for $100 million. Both 2005 Revolvers permit borrowings at interest rates of
LIBOR (plus a margin of 0.40% to 1.00%) or an alternate base rate, as defined in the credit
facilities. Both 2005 Revolvers have commitment fees applicable to the remaining available amount.
Interest rates and commitment fees are based on the borrower’s then-current senior unsecured credit
rating. Both 2005 Revolvers are subject to cross-default if the borrower or any of its subsidiaries
defaults on any payment due under any indebtedness exceeding $50 million. Undrawn
amounts under both 2005 Revolvers are fully available for the issuance of letters of credit.
Under our Prior Revolvers and 2005 Revolvers, we are subject to financial covenants requiring
each of Holdings and Duquesne Light to maintain a debt-
to-capitalization ratio of not more than 65%, as defined in the facilities. In addition, Holdings
is required to maintain a minimum interest coverage ratio of 2-to-1, as defined in the facilities.
As of December 31, 2005, we were in compliance with the applicable covenants.
As of December 31, 2005, our total borrowing capacity under our 2005 Revolvers and the use of
this borrowing capacity were as follows:
Committed
LOCs
Available
Capacity
Borrowed
Issued
Capacity
Holdings
$
200.0
$
40.0
$
71.4
$
88.6
Duquesne
Light
100.0
—
8.2
91.8
Total
$
300.0
$
40.0
$
79.6
$
180.4
During 2005, the maximum amount of credit facility borrowings outstanding was $50 million
(all at Holdings), the average daily borrowings were $4.8 million and the weighted average daily
interest rate was 4.2%. As of December 31, 2005, Holdings had $18.2 million of outstanding letters
of credit (LOCs) (including $12.7 million at Duquesne Light) unrelated to the credit facilities.
On January 31, 2006, Holdings and Duquesne Light amended their credit facilities, increasing the
borrowing capacity of each by $50 million. As of January 31, 2006, our total borrowing capacity
under our credit facilities and the use of this borrowing capacity were as follows:
Committed
LOCs
Available
Capacity
Borrowed
Issued
Capacity
Holdings
$
250.0
$
60.0
$
76.4
$
113.6
Duquesne
Light
150.0
—
8.2
141.8
Total
$
400.0
$
60.0
$
84.6
$
255.4
In addition, as of January 31, 2006, Holdings had $18.2 million of outstanding LOCs
(including $12.7 million at Duquesne Light) unrelated to the credit facilities.
Current Maturities of Long-Term Debt. None of Duquesne Light’s long-term debt is scheduled to
mature before 2008. The Holdings’ current maturities represent scheduled principal payments on
other long-term debt.
Ratings Triggers. Holdings and its subsidiaries do not have material liquidity exposures
caused by a ratings downgrade below “investment grade” that would accelerate the due dates of
borrowings or cause collateral to be posted under Duquesne Power’s power purchase agreements. Under
one of its surety bond agreements, Holdings has a requirement to post letters of credit in the
event its debt ratings fall below investment grade. At December 31, 2005, the letters of credit
posting requirement would have been approximately $28 million if our ratings had been below
investment grade.
OFF-BALANCE SHEET ARRANGEMENTS
Except for the guarantees discussed in Note 13, neither Holdings nor Duquesne Light has any
material off-balance sheet arrangements. As a wholly owned subsidiary of Holdings, Duquesne Light
is involved in various transactions with affiliates. (See Notes 1 and 18.)
As of December 31, 2005, we have certain contractual obligations and commitments that extend
into and beyond 2006, the amounts of which are set forth in the following table:
Payments Due By Period
(Millions of Dollars)
Less than
More than
Total
1 Year
1-3 Years
3-5 Years
5 Years
Short-Term Borrowings
$
40.0
$
40.0
$
—
$
—
$
—
Long-Term Debt – Principal
Duquesne Light
637.9
—
40.0
—
597.9
Holdings and Other Affiliates (a)
321.6
0.3
0.6
0.6
320.1
Long-Term Debt — Interest
Duquesne Light
389.9
38.2
74.2
71.2
206.3
Holdings and Other Affiliates
323.6
18.6
37.1
37.0
230.9
Energy Commodity Contracts
799.4
421.7
377.7
—
—
Operating Leases
Duquesne Light
23.8
4.6
8.1
7.6
3.5
Other Affiliates
3.1
0.5
1.1
1.0
0.5
IRS Settlement Payment
53.6
53.6
—
—
—
Landfill Gas Contractual Obligation
7.4
7.4
—
—
—
Legacy Liability Obligations – Duquesne Light
29.8
1.6
2.4
2.0
23.8
Restructuring – Duquesne Light
0.8
0.8
—
—
—
Total
$
2,630.9
$
587.3
$
541.2
$
119.4
$
1,383.0
(a)
Includes current maturities.
RATE MATTERS
Distribution Rate Case and Transmission Rate Case
As a regulated utility, Duquesne Light may only change its distribution rates or transmission
rates by applying, through the rate case process, to the PUC or the FERC for approval. The goal of
a rate case is to establish customer rates such that the utility (i) recovers its costs of
providing the service, (ii) recovers its costs of investing in the transmission and/or distribution
infrastructure, and (iii) earns a reasonable and fair return on that investment. During a rate
case, the utility must prove that its proposed rate increase is needed by showing its costs during
a given test year. The utility’s costs and expenditures are reviewed and challenged during this
process. A rate case also considers a utility’s rate of return on its investment, as well as its
costs of financing, in order to derive its annual revenue requirement. The rates ultimately set
are intended to give the utility a reasonable chance to achieve its revenue requirement.
Since customer choice was instituted in Pennsylvania in 1996, rate caps have prevented
recovery of any new investment in transmission and distribution. The last Duquesne Light rate case
involving transmission and distribution costs dates back to 1987. Our transmission and
distribution rate freeze expired at the end of 2003. Duquesne Light expects to file a request for a
distribution rate increase with the PUC in March 2006. The PUC has nine months from the date of the
filing to render a decision. If approved, the new distribution rates are expected to go into effect
in January 2007. Duquesne Light cannot predict the amount of the rate increase that will ultimately
be approved by the PUC. We also plan to file a transmission rate case with the FERC later in 2006.
Seams Elimination Charge Adjustment
See Item 1A. Risk Factors, “Our financial obligations under the Seams Elimination Charge
Adjustment remain uncertain.”
FORWARD-LOOKING STATEMENTS
The preceding sections of “Management’s Discussion and Analysis of Financial Condition and
Results of Operations” contain forward-looking statements, the results of which may materially
differ from those implied due to known and unknown risks
and uncertainties, some of which are discussed below.
•
Cash flow, earnings, earnings growth, capitalization, capital expenditures and dividends
will depend on the performance of Holdings’ subsidiaries, and board policy.
•
Demand for and pricing of electricity and landfill gas, changing market conditions, and
weather conditions could affect earnings levels.
•
Duquesne Light’s earnings will be affected by the number of customers who choose to
receive electric generation through POLR III, by our ability to negotiate appropriate terms
with suitable generation suppliers, and by the performance of these suppliers.
•
Projected POLR supply requirements will depend on POLR customer retention, which in turn
may depend on market generation prices, as well as the marketing efforts of competing
generation suppliers.
•
Distribution rate base and earnings will depend on the ultimate structure of our
distribution rate case, which in turn will be subject to PUC review and approval.
Transmission rate base and earnings will depend on the ultimate structure of our transmission
rate case, which in turn will be subject to FERC review and approval. Earnings will also be
affected by rate base, equity and allowed return levels.
•
RTO rules and FERC-mandated transmission charges could affect earnings.
•
Changes in electric energy prices could affect earnings as the fair value of our energy
commodity contracts fluctuates.
•
The amount and timing of any debt reduction or refinancing will depend on the availability
of cash flows and appropriate replacement or refinancing vehicles.
•
The amount and timing of any securities issuance (debt or equity) will depend on financial
market performance and the need for funds.
•
The credit ratings received from the rating agencies could affect the cost of borrowing,
access to capital markets and liquidity.
•
Changes in synthetic fuel plant operations owned by a single customer could affect DES’
earnings.
•
Competition, operating costs and gas prices could affect earnings and expansion plans in
our landfill gas business, as well as the anticipated operating life of our landfill gas
sites.
•
Earnings with respect to synthetic fuel operations, landfill gas and affordable housing
investments will depend, in part, on the continued availability of, and compliance with the
requirements for, applicable federal tax credits. The availability of synthetic fuel and
landfill gas tax credits depends in part on the average well-head price per barrel of
domestic crude oil.
•
Demand for dark fiber will affect DQE Communications’ earnings.
•
The final resolution of proposed adjustments regarding state income tax liabilities (which
could depend on negotiations with the appropriate authorities) could affect financial
position, earnings, and cash flows.
•
Overall performance by Holdings and its affiliates could be affected by economic,
competitive, regulatory, governmental and technological factors affecting operations,
markets, products, services and prices, as well as the factors discussed in Holdings’ SEC
filings made to date.
Item 7A.
Quantitative and Qualitative
Disclosures About Market Risk.
Market risk represents the risk of financial loss that may impact our consolidated financial
position, results of operations or cash flows due to adverse changes in market prices and rates.
Both Holdings and Duquesne Light have potential market risk exposures to interest rate risk
and credit/default risk. Holdings also faces the risks related to commodity prices and the
potential of Section 29 tax credit phase-out. Holdings and Duquesne Light have risk management
procedures to monitor and assist in controlling these market risks and may use derivative and other
instruments to manage some of these exposures.
Interest Rate Risk.
Currently, neither Holdings nor Duquesne Light have any variable interest rate debt
outstanding. As of December 31, 2004, the variable interest rate debt
for Holdings and for Duquesne Light was $320.1 million, which
represented approximately 33.5% of both Holdings’ and Duquesne
Light’s long-term debt. This variable rate debt was low-cost,
tax-exempt debt with an average variable interest rate of 1.6% for the
year ended December 31, 2004. A 10% increase in interest rates would
have affected both Holdings’ and Duquesne Light’s variable rate
debt obligations by increasing interest expense by approximately $0.6 million for the year ended December 31, 2004. We manage our interest rate risk by retiring and issuing debt from time to time and by
maintaining a range of maturity dates. A 10% reduction in interest rates would have increased the
market value of fixed-rate debt by approximately $47.2 million for Holdings and $27.9 million for
Duquesne Light as of December 31, 2005 and approximately $29
million for both Holdings and Duquesne Light as of December 31, 2004. Such changes would not have had a significant near-term
effect on our future earnings or cash flows.
Commodity Price Risk.
We are exposed to commodity price risk arising from market price fluctuations in electricity
supply and for sales of pipeline quality landfill gas. We manage these risks by entering into
various fixed price contracts as part of our overall board approved risk management strategy.
Electricity Supply. We mitigate this risk by entering into energy commodity contracts,
principally through Duquesne Power, for anticipated electricity supply obligations within a range
of probabilities based on historical customer retention rates and switching trends along with
projected forward energy prices.
The energy commodity contracts have primarily been structured to begin and end during the POLR
III time period. The net result of these transactions is that, as of December 31, 2005, Duquesne
Power had secured a substantial portion of the combined expected load obligation for its
full-requirements contracts with Duquesne Light and DLE.
If Duquesne Power does not enter into contracts for the remaining portion of its anticipated
obligations, it will acquire the necessary supply through spot market purchases, and will therefore
be exposed to market risk. Assuming Duquesne Power were to make such spot market purchases, we
performed a sensitivity analysis using a hypothetical 10% change in the projected forward market
prices of electricity supply in our valuation model. The analysis indicated that such market
movements would change the projected cost of acquiring electricity
supply by approximately $13
million as of December 31, 2005 and approximately $12 million as of
December 31, 2004 for the POLR III period through 2007. The projected forward market prices used in our
valuation model are derived from broker quotes for the applicable delivery points for both on-peak
and off-peak power. Our valuation model seasonalizes annual or quarterly prices based on
historical trends. Actual costs in the future may differ significantly from our analysis, however,
based on changes in the timing and amount of commodity price fluctuations and our actual exposures.
The fair value of the sale contracts and certain purchase contracts that are classified as
derivative instruments, is recorded as derivative assets or liabilities in the consolidated
financial statements.
The derivative energy contracts are exposed to commodity price risk based on price changes in
the forward energy market. Therefore, as the forward market prices change, so will the fair value
of these contracts. A hypothetical 10% change in the projected forward market prices of
electricity supply would increase or decrease the fair value of our derivative energy contracts by
approximately $13 million (including $2 million related to our
mark-to-market energy contracts) as of December 31, 2005 and
approximately $20 million (all mark-to-market energy contracts) as of
December 31, 2004. The amounts related to our mark-to-market
energy contracts would also result in an increase or decrease to purchased power expense.
As a result of fixed POLR prices for our residential and small commercial customers through
December 31, 2007, and customers being able to initiate switches to and from POLR service, we have
an additional risk of loss. Specifically, customers could opt for POLR service in a period of high
energy prices or leave POLR service for an alternative generation supplier in a period of low
energy prices. Significant changes in customer switching behavior could cause Duquesne Power’s
energy supply portfolio to be disproportionate to its full requirements obligations to Duquesne
Light and DLE. Accordingly, Duquesne Power could be required to purchase or sell power in periods
of high or low prices which could result in a loss.
During the third quarter of 2005, one alternative supplier notified Duquesne Light that their
customers would be returning to POLR service beginning in the fourth quarter of 2005. Had these
customers been served under the POLR arrangement during 2005, the POLR retention for residential
and small commercial customers would have increased approximately one percentage point. Now that
these customers have returned to POLR service, one alternative supplier serves essentially all of
the residential customers that are not currently on POLR service. This supplier recently announced
a significant increase in its rates. Should all of these residential customers return to POLR
service, the POLR retention for residential and small commercial customers would increase
approximately ten percentage points.
Landfill Gas Sales. Revenues from our pipeline quality landfill gas operations are based on
current market prices of natural gas as calculated by the terms of the individual contracts. Recent
increases in natural gas prices over historical levels have resulted in the realization of
increased profits from this line of business. In order to mitigate this exposure to fluctuations in
market prices of natural gas, during 2005 we entered into a cash flow hedge for a portion of our
anticipated 2006 sales. For the remaining anticipated 2006 sales, a hypothetical 10% change in the
projected forward market prices of natural gas in our valuation model would not materially change
projected revenues from pipeline quality landfill gas for 2006. The forward market prices used in
our valuation model are derived from quoted market prices for the applicable pricing points. Actual
costs in the future may differ significantly from our analysis, however, based on changes in the
timing and amount of commodity price fluctuations and our actual exposures.
Credit/Default Risk.
Our credit risk is the exposure to the possibility of economic loss that would occur as a
result of
nonperformance by counter-parties of their contractual obligations.
Duquesne Power has entered into fixed-price energy contracts and unforced capacity credit
agreements. As of December 31, 2005 all of the suppliers are investment grade.
As of December 31, 2005, Duquesne Power has contracted to purchase from one supplier
approximately 37% and 33% of the notional values of the energy commodity contracts for the years
ended December 31, 2006 and 2007. Duquesne Power has also contracted to purchase from one
additional supplier approximately 27% of the notional value of the energy commodity contracts for
2007. No other supplier represents as much as 20% for each of the respective years.
Duquesne Power’s energy commodity contracts contain certain provisions designed to mitigate
potential losses by requiring collateral to be posted by either party depending on changes in
energy or capacity prices. As of January 31, 2006, no collateral was required to be posted under
these contracts.
Duquesne Light purchases energy and capacity, beginning January 1, 2005, under a
full-requirements contract from two investment grade suppliers for sale to its large commercial and
industrial customers receiving fixed-price POLR III service. Duquesne Light’s contracts only
require collateral to be posted by the counter-party. As of January 31, 2006, no collateral was
required to be posted under these contracts.
In addition to collateral postings, supplier default risk is further mitigated by accelerated
damage payment terms. If a supplier fails to deliver the contracted power, we may exercise our
right to force the supplier to compensate us for the difference between the market price and the
contracted price of power. If such supplier would fail to make the accelerated damage payments, the
supplier would be in default and we would be permitted to apply any funds due that supplier against
our excess energy costs.
Other than large commercial and industrial POLR III customers on hourly-priced service,
Duquesne Light is obligated to serve its POLR III customers at fixed rates. Duquesne Power is also
contractually obligated to serve its customers, Duquesne Light and DLE, at fixed rates. If an
energy supplier to Duquesne Light or Duquesne Power were to default on its contract, we could
potentially be acquiring energy and/or capacity at a cost in excess of our revenues, resulting in a
loss, if the collateral provisions were not sufficient to cover such excess.
If this would occur it is uncertain, under the current PUC-approved POLR III arrangement, that
Duquesne Light could pass any additional costs related to these energy and capacity purchases on to
its customers.
Tax Credit Phase-Out.
Section 29 tax credits are subject to a phase-out provision that reduces tax credits as the
average annual wellhead price per barrel of domestic crude oil increases into an inflation-adjusted
phase-out range.
The 2005 phase-out range will be calculated using inflation rates published in 2006 by the
IRS, but based on the average wellhead price to date we do not anticipate that there will be a
phase-out of tax credits in 2005.There was no phase-out in 2004.
If domestic crude oil prices stay at a high level in 2006 and/or 2007, the estimated annual
tax credits to be generated from DQE Financial’s landfill gas operations and investment in a
synthetic fuel partnership of approximately $18 million, as well as Duquesne Energy Solutions’
estimated annual after-tax earnings of approximately $20 million from its synthetic fuel facilities
management contract may be substantially reduced or eliminated. However, due to significant levels
of tax credit carry-forwards existing at Holdings, the potential phase-out of DQE Financial’s tax
credits in 2006 and 2007 would not adversely impact our cash flow in those years. Based upon our
evaluation, we have thus far determined not to enter into hedging arrangements to reduce this
potential exposure.
In addition, as of December 31, 2005, we have certain tangible and intangible assets related
to DQE Financial’s landfill gas operations with a net book value of approximately $5.4 million that
may become impaired if domestic crude oil prices continue to increase in the future. As of December31, 2005, we have no net book value related to synthetic fuel assets or investments.
Item 8.
Consolidated Financial Statements
and Supplementary Data.
REPORTS OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of
Duquesne Light Holdings, Inc.:
We have audited the accompanying consolidated balance sheets of Duquesne Light Holdings, Inc.
and subsidiaries (the “Company”) as of December 31, 2005 and 2004, and the related consolidated
statements of income, common shareholders’ equity, comprehensive income and cash flows for each of
the three years in the period ended December 31, 2005. Our audits also included the financial
statement schedules listed in the Index at Item 15. These financial statements and financial
statement schedules are the responsibility of the Company’s management. Our responsibility is to
express an opinion on the financial statements and financial
statement schedules based on our
audits.
We conducted our audits in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, such consolidated financial statements present fairly, in all material
respects, the financial position of Duquesne Light Holdings, Inc. and subsidiaries at December 31,2005 and 2004, and the results of their operations and their cash flows for each of the three years
in the period ended December 31, 2005, in conformity with accounting principles generally accepted
in the United States of America. Also, in our opinion, such financial
statement schedules, when
considered in relation to the basic consolidated financial statements taken as a whole, present
fairly, in all material respects, the information set forth therein.
We have also audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the effectiveness of the Company’s internal control over financial
reporting as of December 31, 2005, based on the criteria established in Internal Control—Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our
report dated March 6, 2006 expressed an unqualified opinion on management’s assessment of the
effectiveness of the Company’s internal control over financial reporting and an unqualified opinion
on the effectiveness of the Company’s internal control over financial reporting.
To the Board of Directors and Shareholder of
Duquesne Light Company:
We have audited the accompanying consolidated balance sheets of Duquesne Light Company and
subsidiaries (the “Company”) as of December 31, 2005 and 2004, and the related consolidated
statements of income, common shareholder’s equity, comprehensive income and cash flows for each of
the three years in the period ended December 31, 2005. Our audits also included the financial
statement schedule listed in the Index at Item 15. These financial statements and financial
statement schedule are the responsibility of the Company’s management. Our responsibility is to
express an opinion on the financial statements and financial statement schedule based on our
audits.
We conducted our audits in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, such consolidated financial statements present fairly, in all material
respects, the financial position of Duquesne Light Company and subsidiaries at December 31, 2005
and 2004, and the results of their operations and their cash flows for each of the three years in
the period ended December 31, 2005, in conformity with accounting principles generally accepted in
the United States of America. Also, in our opinion, such financial statement schedule, when
considered in relation to the basic consolidated financial statements
taken as a whole, presents
fairly, in all material respects, the information set forth therein.
We have also audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the effectiveness of
the Company’s internal control over financial reporting as of December 31, 2005, based on the
criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission and our report dated March 6, 2006 expressed an
unqualified opinion on management’s assessment of the effectiveness of the Company’s internal
control over financial reporting and an unqualified opinion on the effectiveness of the Company’s
internal control over financial reporting.
The following Notes present information on both Duquesne Light Holdings, Inc. (Holdings) and
Duquesne Light Company (Duquesne Light). Information on Holdings and its subsidiaries (not
including Duquesne Light and its subsidiaries) shall not be deemed to be included as part of
Duquesne Light’s Notes. Specifically, information on the Energy Solutions, Financial and
Communications business segments, the all other category, and discontinued operations is not so
included.
References in the Notes to “we,”“us” and “our” are to Holdings and its subsidiaries,
collectively.
1. Accounting Policies
CONSOLIDATION
Holdings is an energy services holding company. Our subsidiaries include those discussed
below.
The consolidated financial statements of Holdings and Duquesne Light include their accounts
and their wholly and majority owned subsidiaries. The equity method of accounting is used for 20%
to 50% interests in other companies. Under the equity method, original investments are recorded at
cost and adjusted by our share of undistributed earnings or losses of these companies. All material
intercompany balances and transactions have been eliminated in the consolidation.
In addition, effective March 31, 2004, we consolidate variable interest entities for which we
are the primary beneficiary in accordance with Financial Accounting Standards Board (FASB)
Interpretation No. 46R, “Consolidation of Variable Interest Entities” (revised December 2003) (FIN
46R), regardless of the ownership percentage held by us.
Continuing Operations
Duquesne Light is an electric utility engaged in the supply (through its
provider-of-last-resort service (POLR)), transmission and distribution of electric energy.
Duquesne Power, LLC (formerly Duquesne Power, L.P.), an unregulated subsidiary, maintains a
portfolio of energy commodity contracts to provide full-requirements energy supply contracts for
both (i) Duquesne Light’s residential and small commercial POLR customers and (ii) Duquesne Light
Energy, LLC’s large commercial and industrial customers. These energy commodity contracts are with
unrelated parties and include payment guarantees from Holdings. This entity was a subsidiary of
Duquesne Light until December 31, 2005, at which time ownership was transferred to another Holdings subsidiary.
The transfer of Duquesne Power, at recorded book value, was completed to strategically align our
unregulated businesses outside of Duquesne Light in order to provide flexibility to capitalize on
future supply opportunities. The transfer will effectively eliminate the net income included in
Duquesne Light’s supply segment. The Holdings supply segment will not be affected by the
realignment.
Duquesne Light Energy, LLC (DLE) is an unregulated, competitive, retail electric generation
supplier that offers customized solutions tailored to meet its customers’ specific electricity
needs. DLE’s primary focus is on the large commercial and industrial customer market segment in
Duquesne Light’s service territory.
Duquesne Energy Solutions, LLC (DES) is an energy facilities management company that provides
energy outsourcing solutions including operation and maintenance of synthetic fuel and energy
facilities. During 2005, DES sold three investments in on-site energy facility management
projects.
DQE Financial Corp. owns, operates and maintains landfill gas collection and processing
systems, and is an investment and portfolio management organization focused on structured finance
and alternative energy investments.
DQE Communications, Inc. owns, operates and maintains a high-speed, fiber optic based
metropolitan network, and leases dark fiber from the network to commercial, industrial and academic
customers.
DQE Capital Corporation provides financing to Holdings for use with its affiliates.
Discontinued Operations
During 2003, AquaSource, Inc. (formerly our water resource management subsidiary) completed
the sale of its assets, pursuant to agreements entered into in 2002. We sold the propane
distribution business of our subsidiary, Pro Am, Inc. in December 2002. (See Note 17.)
BASIS OF ACCOUNTING
Holdings and Duquesne Light are subject to the accounting and reporting requirements of the
Securities and Exchange Commission (SEC). Duquesne Light’s electricity delivery business is also
subject to regulation by the Pennsylvania Public Utility Commission (PUC) and the Federal Energy
Regulatory Commission (FERC) with respect to rates
for delivery of electric power, accounting and other matters.
As a result of Duquesne Light’s PUC-approved restructuring plan in 1998, the electricity
supply segment does not meet the criteria of Statement of Financial Accounting Standards (SFAS) No.
71, “Accounting for the Effects of Certain Types of Regulation.” Pursuant to the PUC’s final
restructuring order, and as provided in the Pennsylvania Electricity Generation Customer Choice and
Competition Act (Customer Choice Act), generation-related transition costs were being recovered
through a competitive transition charge (CTC) collected in connection with providing transmission
and distribution services. This collection period ended in the third quarter of 2005 when the
remaining CTC balance was collected from the last customer class. The electricity delivery business
segment continues to meet SFAS No. 71 criteria, and accordingly reflects regulatory assets and
liabilities consistent with cost-based ratemaking regulations. The regulatory assets represent
probable future revenue, because provisions for these costs are currently included, or are expected
to be included, in charges to electric utility customers through the ratemaking process. (See Note
2.)
Regulatory Assets as of December 31,
(Millions of Dollars)
2005
2004
Regulatory tax receivables
$
224.7
$
218.5
Unamortized debt costs
48.8
49.3
Transition costs
—
4.7
Deferred employee costs
11.5
11.3
SECA charges (a)
6.4
—
Other
8.6
11.3
Total
$
300.0
$
295.1
(a)
Seams elimination charge adjustment
The majority of these assets are currently being recovered over a period of approximately 30
years and are not earning a rate of return.
The preparation of financial statements in conformity with accounting principles generally
accepted in the United States of America requires management to make estimates and assumptions with
respect to values and conditions that affect the reported amounts of assets and liabilities, and
disclosure of contingent assets and liabilities, at the date of the financial statements. The
reported amounts of revenues and expenses during the reporting period also may be affected by the
estimates and assumptions management is required to make. Management evaluates these estimates on
an ongoing basis, using historical experience and other methods considered reasonable in the
particular circumstances. Nevertheless, actual results may differ significantly from these
estimates.
CUSTOMER CONCENTRATIONS
Duquesne Light’s electric utility operations provide service to approximately 587,000 direct
customers in southwestern Pennsylvania (including in the City of Pittsburgh), a territory of
approximately 800 square miles.
DES relies on a single customer, who owns several synthetic fuel facilities for substantially
all of its revenues and earnings.
REVENUES FROM UTILITY SALES
Duquesne Light’s meters are read monthly, and electric utility customers are billed on the
same basis. Revenues reflect actual customer usage in an accounting period, regardless of when
billed.
Electricity sales revenue includes related excise and other taxes, primarily gross receipts
taxes, that are collected from ratepayers and remitted to the appropriate taxing agency. These
taxes are recorded in a taxes payable account at the time of sale and as an expense in taxes other
than income taxes. The payable is relieved when payment is made to the appropriate taxing agency.
The excise and other taxes recorded in Holdings revenue were approximately $42 million, $42 million
and $43 million in 2005, 2004 and 2003 and $39 million, $42 million and $43 million at Duquesne
Light for the same period.
OTHER OPERATING REVENUES
Duquesne Light’s other operating revenues include rental fees from third parties who have
cable or other equipment attached to its utility poles and transmission towers, or who have cable
included in its underground ducts. Also included are transmission fees charged to others that use
Duquesne Light’s transmission system and late payment and other customer fees. Duquesne Light’s
other operating revenues also include short-term sales to other utilities made at market rates
resulting from excess daily deliveries to Duquesne Light’s electricity delivery system, and in
2005, sales of electricity from Duquesne Power to Duquesne Light Energy under its full requirements
contract, which are eliminated in consolidation at Holdings.
Holdings’ other operating revenues also include revenues from the sale of landfill gas and
landfill gas site related services, revenues from facility management services for synthetic fuel,
industrial
and airport customers and revenues from the rental of dark fiber from our fiber optic based
network.
OTHER INCOME
Duquesne Light’s other income consists primarily of interest income from the loan receivable
from Holdings, until its repayment in the third quarter of 2005, and the investment in the DQE
Capital cash pool (discussed below) until November 2005. This interest income is eliminated in the
consolidated statements of income of Holdings with the associated interest expense of Holdings and
DQE Capital. Gains or losses resulting from the disposition of certain assets are also included
here.
Holdings other income consists primarily of income from long-term investments, and various
other gains or losses, including gains and losses related to the disposition of certain assets. On
March 31, 2004, we adopted FIN 46R and began consolidating seven low-income housing development
guarantee funds, in which we own a 1% general partner interest. Beginning April 1, 2004, the
results of these seven funds are included in our consolidated results and are reflected as a
decrease in other income offset by the benefit from limited partners’ interest.
STOCK-BASED COMPENSATION
We continue to account for stock-based employee compensation using the intrinsic value method
under the recognition and measurement principles of Accounting Principles Board (APB) No. 25,
“Accounting for Stock Issued to Employees,” and related Interpretations. Accordingly, compensation
cost is measured as the excess, if any, of the quoted market price of Holdings common stock at the
date of the grant over the amount an employee must pay to acquire the stock and is spread over the
vesting period, as applicable. For stock-based compensation with specified performance criteria,
compensation cost is generally recognized as the excess, if any, of the quoted market price of
Holdings common stock at the date the specified criteria are met, over the amount an employee must
pay to acquire the stock, and is spread over the vesting period, as applicable. The following
tables illustrate the effect on reported income and earnings per share if we had applied the fair
value recognition provisions of SFAS No. 123, “Accounting for Stock-Based Compensation,” as
required under SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure –
an amendment of FASB Statement No. 123.”
Depreciation expense of $71.0 million, $69.3 million and $70.9 million was recorded at
Holdings in 2005, 2004 and 2003. Depreciation expense of $64.1 million, $61.6 million and $60.0
million was recorded at Duquesne Light in 2005, 2004 and 2003. Depreciation of property, plant and
equipment is recorded on a straight-line basis over the estimated remaining useful lives of
properties, which is approximately 30 years for both the transmission and distribution portions of
electric plant in service. Depreciation of other property, plant and equipment is recorded on a
straight-line basis over the estimated useful lives of properties, which are between 3 and 30
years.
Amortization expense of $11.3 million, $14.1 million and $16.4 million was recorded at
Holdings in 2005, 2004 and 2003. Amortization expense of $7.7 million, $9.8 million and $16.4
million was recorded at Duquesne Light in 2005, 2004 and 2003. Amortization of gas rights and
depreciation of related property is on a straight-line basis over the estimated remaining useful
lives. Amortization of transition costs represents the difference between CTC revenues billed to
customers (net of gross receipts tax) and the allowed 11% pre-tax return on the unrecovered net of
tax transition cost balance. Amortization expense of $4.7 million, $9.1 million and $15.7 million
was recorded at Duquesne Light related to the CTC in 2005, 2004 and 2003. SECA is amortized as it
is billed to customers, with $3.0 million of amortization recorded at Duquesne Light in 2005.
EARNINGS PER SHARE
Basic earnings per share are computed on the basis of the weighted average number of common
shares outstanding. Diluted earnings per share are computed on the basis of the weighted average
number of common shares outstanding, plus the effect of the outstanding Employee Stock Ownership
Plan shares, Holdings preferred stock, stock options and other types of stock-based compensation
discussed in Note 12, unless the inclusion of these shares would be anti-dilutive. The treasury
stock method is used in computing the dilutive effect of stock options. This method assumes any
proceeds obtained upon the exercise of options would be used to purchase common stock at the
average market price during the period. The following table presents the numerators and
denominators used in computing the Holdings diluted earnings per share.
Holdings Diluted Earnings Per Share for the Year
Ended December 31,
(Millions of Dollars)
2005
2004
2003
Income from
continuing operations
$
112.9
$
87.2
$
93.2
Less: Preferred dividends
—
—
0.4
Earnings from
continuing operations
for common stock
112.9
87.2
92.8
Dilutive effect of:
ESOP dividends
1.1
1.2
1.4
Preferred stock
dividends
—
0.4
0.8
Diluted Earnings
from Continuing
Operations for
Common Stock
$
114.0
$
88.8
$
95.0
(Millions of Shares)
2005
2004
2003
Basic average shares
77.7
76.4
75.0
Dilutive effect of:
ESOP shares
0.8
0.8
1.2
Holdings preferred stock
—
0.5
1.4
Performance share
awards and stock options
—
0.3
—
Diluted average shares
78.5
78.0
77.6
Diluted Earnings
Per Share from
Continuing Operations
$
1.45
$
1.14
$
1.22
Note: In 2005, 2004 and 2003, 0.2 million, 0.2 million and 1.4 million options are not
included because the exercise price of these options exceeds the average stock price.
TEMPORARY CASH INVESTMENTS
Temporary cash investments are short-term, highly liquid investments with original maturities
of three or fewer months. They are stated at cost, which approximates market. We consider temporary
cash investments to be cash equivalents.
DQE CAPITAL CASH POOL
As of December 31, 2005, Holdings and its subsidiaries, excluding Duquesne Light, participate
in a cash pool arrangement with their affiliate DQE Capital. Through this arrangement, available
cash is deposited with DQE Capital and interest is earned daily at a market rate. DQE Capital from
time to time lends funds from the pool, on a demand basis, to Holdings which, in turn, makes loans
and/or capital contributions to its other subsidiaries to provide funds for capital expenditures,
new investments or operating expenses. An investor in the pool is entitled
to withdraw its investment at any time, and, to the extent that sufficient cash is not then on
deposit, DQE Capital would have to demand full or partial repayment by Holdings of the loan to it.
In order to repay DQE Capital, Holdings may be required to borrow under its revolving credit
facility. (See Note 8.) If the amount of the facility would be insufficient to satisfy this
repayment, Holdings would be required to access the equity or debt markets. Until November 2005,
Duquesne Light participated in the cash pool arrangement and its investment in the pool was shown
on its consolidated balance sheets as investment in DQE Capital cash pool.
RECEIVABLES
Receivables on the consolidated balance sheets are comprised of outstanding billings for
electric customers, other utilities, and amounts related to unbilled revenues. In addition,
Duquesne Light has certain transactions with affiliates that give rise to receivables. (See Note
18.) At Holdings, receivables include the outstanding billings of our other business lines.
INVESTMENT IN HOLDINGS STOCK
As of December 31, 2005 and 2004, the fair market value of Duquesne Light’s investment in
Holdings common stock was $19.7 million and $22.8 million, and the cost of the investment was $24.6
million in both years. This investment is eliminated in the consolidated balance sheets of Holdings
with the related shares and cost reflected as treasury stock.
This investment was in a continuous unrealized loss position for more than 12 months as of
December 31, 2005, with a total unrealized loss of $4.9 million. If the unrealized loss is
determined to be other than temporary, it will be written off and an impairment charge will be
recognized on the statement of income.
PROPERTY, PLANT AND EQUIPMENT
The asset values of Duquesne Light’s utility properties are stated at original construction
cost, which includes labor costs, related payroll taxes, pensions and other fringe benefits, as
well as administrative costs. Also included in original construction cost is an allowance for funds
used during construction (AFC), which represents the estimated cost of debt and equity funds used
to finance construction.
Additions to, and replacements of, property units are charged to plant accounts. Maintenance,
repairs and replacement of minor items of property are recorded as expenses when they are incurred.
The costs of electricity delivery business segment properties that are retired (plus removal costs
and less any salvage value) are charged to accumulated depreciation and amortization.
Substantially all of the electric utility properties are subject to the lien of Duquesne
Light’s first mortgage indenture.
We review long-lived assets for impairment whenever events or changes in circumstances
indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to
be held and used is measured by a comparison of the carrying amount of an asset to future net cash
flows expected to be generated by the asset. If such assets are considered to be impaired, the
impairment recognized is measured by the amount by which the carrying amount of the assets exceeds
the fair value of the assets.
GOODWILL AND INTANGIBLE ASSETS
We account for acquired goodwill and other intangible assets in accordance with SFAS No. 142,
“Goodwill and Other Intangible Assets,” which requires that goodwill and intangible assets with
indefinite useful lives not be amortized but, instead, be tested at least annually for impairment,
and more frequently if certain indicators appear.
In November 2004, as a result of our purchase of the remaining 50% interest in Waste Energy
Technology, LLC (WET), we allocated amounts to separately identifiable intangible assets for
customer related intangibles and certain covenant not-to-compete contracts with estimated lives
between 2 and 14 years. We also allocated amounts for goodwill and the WET trade name which have
indefinite useful lives. (See Note 7.)
INCOME TAXES
In accordance with SFAS No. 109, “Accounting for Income Taxes,” Holdings and Duquesne Light
use the liability method in computing deferred taxes on all differences between book and tax bases
of assets and liabilities. These book/tax differences occur when events and transactions recognized
for financial reporting purposes are not recognized in the same period for tax purposes. The
deferred tax liability or asset is also adjusted in the period of enactment for the effect of
changes in tax laws or rates. Valuation allowances are provided against deferred tax assets for
amounts which are not considered “more likely than not” to be realized. Holdings’ overall effective
tax rate is significantly reduced by the income tax credits generated from our synthetic fuel,
landfill gas and affordable housing investments.
We file a consolidated U.S. federal income tax return with our subsidiaries, all of whom
participate in an intercompany tax sharing arrangement which generally provides that taxable income
for each subsidiary be calculated as if it filed a separate return. The federal tax liability for
Duquesne Light is reflected in payable to affiliates on its consolidated balance sheets. (See Note
18.)
Duquesne Light recognizes a regulatory asset for deferred tax liabilities that are expected to
be recovered through rates. The difference in the provision for deferred income taxes related to
depreciation of electric plant in service and the amount that otherwise would be recorded under
generally accepted accounting principles is deferred and included in regulatory assets on the
consolidated balance sheets.
PENSION AND OTHER POSTRETIREMENT BENEFITS
See Note 12 for a discussion of the accounting for pension and other postretirement benefits.
CONTINGENT LIABILITIES
Holdings and Duquesne Light establish reserves for estimated loss contingencies when it is
management’s assessment that a loss is probable and the amount can be reasonably estimated.
Reserves for contingent liabilities are based upon management’s assumptions and estimates, advice
of legal counsel, or other third parties regarding the probable outcomes of the matter. Should
additional information become known, or circumstances change with respect to the likelihood or
amount of loss indicating that the ultimate outcome will differ from the estimates, revisions to
the estimated reserves for contingent liabilities would be recognized in income in that period.
Such contingent liabilities include, but are not limited to, restructuring liabilities (see Note
9), income tax matters (see Note 10), and other commitments and contingencies (see Note 13).
GUARANTEES
In the normal course of business, Holdings and certain subsidiaries enter into various
agreements providing financial or performance assurance to third parties on behalf of certain
subsidiaries. Such agreements include, for example, guarantees, stand-by letters of credit and
surety bonds. These agreements are entered into primarily to support or enhance the
creditworthiness otherwise attributed to a subsidiary on a stand-alone basis, thereby facilitating
the extension of sufficient credit to accomplish the subsidiaries’ intended business purposes. To
determine if there is a liability, and its fair value, we use a probabilistic model to assess the
possibilities of future payments under the indemnifications. We discount these future cash payments
using estimated interest rate values and, if necessary, record a liability. (See Note 13.)
DERIVATIVE INSTRUMENTS
Holdings and Duquesne Light account for derivative instruments in accordance with SFAS No.
133, “Accounting for Derivative Instruments and Hedging Activities,” as amended and interpreted.
Our derivative instruments consist of energy purchase and sale contracts, interest rate lock
agreements and a natural gas price swap agreement. A
Board-approved risk management policy permits transactions for the prudent management of
market related risks, and precludes any speculative transactions. All derivative instruments that
do not qualify for accrual accounting under the normal purchase and sale exemption are recorded at
fair value as derivative assets and liabilities.
When a derivative instrument is entered into, management also determines if the derivative
qualifies as either a cash flow hedge (a hedge of variable cash flows of a single transaction or a
group of similar transactions) or as a fair value hedge (a hedge of the fair value of specific
assets and liabilities or specific firm commitments), in accordance with SFAS No. 133. This process
includes formally documenting (i) the hedging relationships and its risk-management objective and
strategy for undertaking the hedge transactions, (ii) the hedging instrument, (iii) the hedged item
or transaction, (iv) the nature of the risk being hedged, (v) how the hedging instrument’s
effectiveness in offsetting the hedged risk will be assessed, and (vi) a description of the method
of measuring ineffectiveness. Management also formally assesses, both at the hedge’s inception and
on an ongoing basis, whether the derivatives that are used in hedging transactions are highly
effective in offsetting changes in cash flows or fair values of hedged items.
Changes in the fair value of a derivative designated as a cash flow hedge that is determined
to be highly effective are recorded in the statement of comprehensive income, net of tax, and are
recognized in earnings as the hedged item affects income. The ineffective portion of the change in
fair
value of a derivative instrument that qualifies as a cash flow hedge is recognized currently in
earnings. Changes in the fair value of a derivative designated as a fair value hedge that is
determined to be highly effective, along with the corresponding gain or loss on the hedged item,
are recognized currently in earnings.
When it is determined that a derivative has ceased to be a highly effective hedge, hedge
accounting is discontinued prospectively. When hedge accounting is discontinued for cash flow
hedges, the derivative asset or liability remains on the consolidated balance sheet at its fair
value, and gains and losses that were in accumulated other comprehensive income are recognized in
earnings as the hedge transactions affect income. When hedge accounting is discontinued for fair
value hedges, the derivative asset or liability remains on the consolidated balance sheet at its
fair value and the hedged asset or liability is no longer adjusted for changes in its fair value.
(See Note 4).
DIVIDENDS
Holdings’ practice has been for its subsidiaries to dividend their earnings on a quarterly
basis, if cash is available. In addition, special dividends are declared periodically related to
proceeds from asset sales and other special circumstances. During the years ended December 31,2005, 2004 and 2003, Duquesne Light declared cash dividends on common stock of approximately $13
million, $58 million and $65 million to Holdings. Duquesne Light also declared a $17.7 million
non-cash dividend to Holdings in 2005 related to the transfer of a subsidiary. During 2005 Duquesne
Light embarked on a significant capital expenditure program, and therefore has been retaining more
of its earnings than in prior years. (See Note 16.)
RECLASSIFICATION
The 2004 and 2003 consolidated financial statements have been reclassified to conform with the
2005 presentation.
RECENT ACCOUNTING PRONOUNCEMENTS
Accounting for Conditional Asset Retirement Obligations
In December 2005, we adopted Financial Interpretation No. 47, “Accounting for Conditional
Asset Retirement Obligations – an interpretation of FASB Statement No. 143” (FIN 47), which
clarifies that the term “conditional asset retirement obligation” refers to a legal obligation to
perform an asset retirement activity. This interpretation also states that the fair value of a
liability for the conditional asset obligation should be recognized when incurred. The initial
adoption of FIN 47 was not material to our financial statements.
Share-Based Payments
In December 2004, the FASB issued SFAS No. 123R, “Share-Based Payment (revised December
2004),” which will eliminate the use of APB No. 25. SFAS No. 123R requires entities to recognize
the cost of employee services received in exchange for awards of equity instruments based on the
grant-date fair value of those awards. This standard is effective at the beginning of the first
fiscal year that begins after June 15, 2005. The initial adoption of SFAS No. 123R was not material
to our financial statements.
2. Rate Matters
Duquesne Light customers may choose to receive their electric energy from an alternative
generation supplier; otherwise they will be served through Duquesne Light’s POLR arrangements.
Customers who select an alternative generation supplier pay for generation charges set by that
supplier, and pay Duquesne Light both transmission and distribution charges.
COMPETITIVE TRANSITION CHARGE AND POLR I AND II
The POLR I arrangement began in early 2000 in conjunction with Duquesne Light’s divestiture of
its generation assets and was designed to be an income neutral arrangement. As of December 31,2005, although the CTC has been fully collected, a few industrial customers under special contracts
continue to receive electric generation through Duquesne Light’s POLR I supply arrangement. Until
December 31, 2004, POLR customers from whom the CTC had been fully collected received their
generation supply through POLR II. Duquesne Light earned a margin per MWh supplied under POLR II.
In connection with POLR II, Duquesne Light accepted a rate freeze for generation, transmission
and distribution rates. The rate freeze fixed generation rates for retail POLR II customers
through December 31, 2004, and continued the transmission and distribution rates for all customers
at then-current levels through 2003.
Currently, most customers who do not choose an alternative generation supplier are served
through Duquesne Light’s POLR III plan, which became effective January 1, 2005. Under POLR III,
residential and small commercial customers receive electric supply through December 31, 2007 at
fixed rates approximately 11.5% above POLR II generation rates. For our large commercial and
industrial customers, the current POLR III supply options are either a fixed price service based
upon the results of a competitive request-for-proposal process (available through May 31, 2006), or
an hourly price service that passes through real-time spot market electricity prices. Duquesne
Light receives an adder as compensation for costs and risks involved in providing energy to these
customers. In January 2006, Duquesne Light requested and received approval from the PUC to extend
the fixed-price service offering for an additional year. This offering will be subject to the
results of another competitive wholesale request-for-proposal to be conducted.
There are certain safeguards in our POLR III arrangements and our energy commodity contracts
designed to mitigate losses in the event that suppliers default on their performance under the
arrangements. Contractually, both Duquesne Power and Duquesne Light have various credit
enhancements to address market exposure, e.g., collateral may be required to be posted by their
counterparties depending on changes in energy or capacity prices. In addition to collateral
postings, supplier default risk is further mitigated by accelerated damage payment terms. If a
supplier fails to deliver the contracted power, we may exercise our right to force the supplier to
compensate us for the difference between the market price and the contracted price of power. If
such supplier would fail to make the accelerated damage payments, the supplier would be in default
and we would be permitted to apply any funds due that supplier against our excess energy costs.
Other than large commercial and industrial POLR III customers on hourly-priced service,
Duquesne Light is obligated to serve its POLR III customers at fixed rates. Duquesne Power is also
contractually obligated to serve its customers, Duquesne Light and DLE, at fixed rates. If an
energy supplier to Duquesne Light or Duquesne Power were to default on its contract, we could
potentially be acquiring energy and/or capacity at a cost in excess of our revenues, resulting in a
loss, if the contractual provisions were not sufficient to cover such excess. If this were to
occur it is uncertain, under the current PUC-approved POLR III arrangement, that Duquesne Light
could pass any additional costs related to these energy and capacity purchases onto its customers.
Seams Elimination Charge Adjustment
Effective January 1, 2005, concurrent with the beginning of POLR III, Duquesne Light joined
PJM, becoming (along with other electric generation suppliers) a load-serving entity within PJM.
As previously reported, the FERC has issued a series of orders eliminating the regional
through and out rates (RTOR) for certain transmission services between the Midwest Independent
System Operator (MISO) and PJM effective December 1, 2004. A transitional pricing mechanism called
SECA has been put in place through March 2006 in order to compensate transmission owners for the
estimated revenue lost as a result of the elimination of the RTOR. Total SECA charges for the
Duquesne Light zone are expected to be approximately $39 million. The FERC has accepted revised
compliance filings implementing SECA charges among load-serving entities within the Duquesne Light
zone. Under that filing, Duquesne Light was allocated approximately $11 million of the SECA
charges. The other load-serving entities in the Duquesne Light zone were allocated the remainder of
such charges. DLE’s allocation of SECA charges will depend on the amount of load it serves; based
on the December 31, 2005 load, DLE’s allocation is expected to be approximately $1.8 million.
The SECA charges must be paid by load-serving entities within the Duquesne Light zone on a
current basis. In June 2005, Duquesne Light filed a request with the PUC for permission to pass
SECA charges through to its POLR customers. This request was granted, subject to disposition of any
complaints filed against the request, by the PUC in August 2005. Duquesne Light put these charges
into effect for service beginning August 26, 2005. However, if the FERC ultimately adopts a SECA
level and allocation method that differs from the proposed charges initially accepted by the FERC
for billing purposes, refunds or surcharges will be used to compensate or charge the appropriate
entity for the difference between the amounts initially accepted by the FERC and the amounts
ultimately determined to be just and reasonable by the FERC. The final amount of our SECA
obligations therefore remains uncertain.
Distribution Rate Case and Transmission Rate Case
As a regulated utility, Duquesne Light may only change its distribution rates or transmission
rates by
applying, through the rate case process, to the PUC or the FERC for approval. The goal of a rate
case is to establish customer rates such that the utility (i) recovers its costs of providing the
service, (ii) recovers its costs of investing in the transmission and/or distribution
infrastructure, and (iii) earns a reasonable and fair return on that investment. During a rate
case, the utility must prove that its proposed rate increase is needed by showing its costs during
a given test year. The utility’s costs and expenditures are reviewed and challenged during this
process. A rate case also considers a utility’s rate of return on its investment, as well as its
costs of financing, in order to derive its annual revenue requirement. The rates ultimately set
are intended to give the utility a reasonable chance to achieve its revenue requirement.
Since customer choice was instituted in Pennsylvania in 1996, rate caps have prevented
recovery of any new investment in transmission and distribution. The last Duquesne Light rate case
involving transmission and distribution costs dates back to 1987. Our transmission and
distribution rate freeze expired at the end of 2003.
3. Acquisitions and Dispositions
In September 2005, DQE Financial sold its investment in a leveraged lease involving a gas
processing facility, received $9.9 million in cash and recorded a pre-tax loss of $1.3 million in
other income on Holdings consolidated statement of income.
In August 2005, DES entered into agreements to sell its investments in up to six on-site
energy facility management projects to DTE Energy Services for expected aggregate cash proceeds of
between $35 and $40 million, subject to working capital adjustments. In 2005, DES closed on the
sale of three of the energy facility management projects, received $34.6 million in cash and the
assumption by the buyer of certain lease related liabilities and recognized pre-tax gains
of $18.0 million in other income and $13.2 million recorded as a reduction to other operating
expenses on Holdings consolidated statement of income.
In October 2005, DES agreed to terminate the agreement to sell one of the six energy facility
management projects entered into in August 2005. The termination of this agreement does not
materially change the total expected proceeds resulting from these sales. Subsequent to the
termination of the agreement, we determined based on future expected cash flows associated with the
project that the fair value of the long-lived assets was less than the carrying value of the
assets. Therefore, we have recorded a $3.9 million impairment charge in other operating expenses on
Holdings consolidated statement of income in 2005.
In October 2004, DQE Financial sold 50% of a limited partnership investment in a synthetic
fuel partnership and received $0.8 million in cash at closing and recognized a pre-tax gain in
other income on Holdings consolidated statement of income. During 2005, DQE Financial received $3.4
million in additional cash sales proceeds related to the sale, and has recognized an additional
pre-tax gain in other income on Holdings consolidated statement of income. Additional sale proceeds
may be received through December 2007, but are contingent upon the generation of qualified tax
credits related to synthetic fuel production of the partnership.
In September 2004, DQE Financial sold an investment in a landfill gas operation; received $2.9
million of cash at closing; and recognized a pre-tax loss of $2.1 million in other income on
Holdings consolidated statement of income. A portion of the sale was contingent upon a favorable
ruling from the Internal Revenue Service (IRS) on the qualification of the tax credits to be
generated. In August 2005, DQE Financial determined that no additional proceeds were to be
received related to the contingent portion of this sale, and therefore recognized an additional
pre-tax loss of $3.1 million in other income on Holdings consolidated statement of income related
to the basis in the assets that were subject to the contingent portion of the sale.
In January 2005, DQE Financial sold its investment in a natural gas operating partnership for
$12.7 million in cash and recognized a pre-tax gain of $7.1 million in other income on Holdings
consolidated statement of income.
In November 2004, DQE Financial acquired the remaining 50% membership interest in WET for $8.4
million in cash (net of cash received of $0.9 million). Prior to November 15, 2004, DQE Financial
owned a 50% membership interest in WET with a net book value of $9.0 million and accounted for the
investment using the equity method of accounting. The results of operations for WET have been
included in the consolidated financial statements since the acquisition date.
In November 2004, DQE Financial agreed to an early termination of a leveraged lease, received
net proceeds of $9.6 million and recorded a pre-tax gain of $1.3 million in other income on
Holdings consolidated statement of income.
In October 2003, Duquesne Power announced an agreement to purchase WPS Resources Corporation’s
(WPS) Sunbury generation station for approximately $120 million. When the PUC ordered that the POLR
III period would end December 31, 2007 (instead of 2010), Duquesne Power terminated the Sunbury
acquisition agreement on September 30, 2004, and recorded an $8.3 million pre-tax ($4.8 million
after-tax) charge related to the write-off of deferred costs and deposits made.
In 2003, DQE Financial sold a limited partnership investment in a natural gas operating
partnership for $18.5 million and recognized a pre-tax gain of $10.8 million in other income on
Holdings consolidated statement of income. DQE Enterprises received $2.5 million for the sale of
stock in three publicly traded companies and recognized a pre-tax gain of $1.0 million in other
income on Holdings consolidated statement of income. Duquesne Light sold its 50% investment in a
small mining operation for $1.4 million ($1.0 million of which was a note receivable), which
resulted in a pre-tax gain of $0.6 million recognized in other income on its consolidated statement
of income.
4. Derivative Instruments
The following table summarizes the derivative assets, liabilities and related accumulated
other comprehensive income (AOCI) that are included in the consolidated balance sheets for Holdings
as of December 31, 2005, and for both Holdings and Duquesne Light as of December 31, 2004:
Duquesne Power is responsible for providing all of the energy requirements for both (i)
residential and small commercial POLR customers and (ii) any customers with whom DLE contracts. To
meet this obligation, Duquesne Power entered into energy commodity contracts with multiple
investment-grade suppliers for a substantial portion of our expected customer requirements. These
purchase contracts are designed to provide for the delivery of energy as needed to supply customer
usage. The energy commodity contracts have primarily been structured to end by December 31, 2007.
The accounting for these contracts considers the provisions of SFAS No. 133, “Accounting for
Derivative Instruments and Hedging Activities,” as amended and interpreted. Under the terms of the
contracts, some of the energy purchases are delivered to the Duquesne Light zone as defined by PJM.
These purchases qualify for the normal purchase and sale exemption under SFAS No. 133 and are
reflected as purchased power expense in the consolidated statements of income at their wholesale
price upon delivery to us. As of December 31, 2005, the remaining notional value of these contracts
was $372.7 million.
We also entered into certain purchase contracts that are for delivery to points other than the
Duquesne Light zone within PJM. Because these contracts are not settled at the Duquesne Light zone,
they do not qualify for the normal purchase and sale exemption and are recorded in the consolidated
financial statements at fair value. Subsequent changes in the fair value of these contracts are
recorded currently in earnings unless certain hedge accounting criteria are met. The remaining
notional amount of these contracts as of December 31, 2005, is $405.3 million. This includes
contracts with aggregate notional values of $139.3 million that have been designated as cash flow
hedges. To the extent the hedges are determined to be effective, and certain other criteria are
met, the changes in the value of these contracts are included in the statement of comprehensive
income, net of deferred taxes. Amounts recorded in the statement of comprehensive income related to
cash flow hedges will be recognized in earnings as the related contracts are settled.
We entered into sales contracts maturing through 2007 that are accounted for on a
mark-to-market basis. The remaining notional amount of these sales contracts was $300.0 million as
of December 31, 2005. These contracts were entered into primarily for the purpose of offsetting
volatility associated with the mark-to-market accounting for the purchase contracts maturing in
2006 and 2007, as described above. We record the revenue associated with our mark-to-market
contracts on a net basis in purchased power expense in our consolidated statements of income.
The change in the net derivative assets, for contracts not accounted for as cash flow hedges,
of $13.6 million for the year ended December 31, 2005, has been recorded as an offset to purchased
power expense in the consolidated statements of income for both Holdings and Duquesne Light. In
addition, for the year ended December 31, 2005, a benefit of $2.5 million related to hedge
ineffectiveness of energy contracts has been recorded as an offset to purchased power expense in
the consolidated statements of income for both Holdings and Duquesne Light.
Duquesne Power also contracted to secure unforced capacity credits for the POLR III period
with notional amounts of $21.4 million for 2006 and 2007. The capacity contracts were evaluated
under SFAS No. 133 and deemed not to be derivative instruments.
Interest Rate Locks
In anticipation of the August 2005 issuance of $320 million of senior unsecured debt, Holdings
entered into a series of interest rate lock agreements during the second quarter of 2005 to hedge
exposure to interest rate fluctuations for $250 million of the senior unsecured debt. These
agreements were designated as cash flow hedges under SFAS No. 133. Holdings settled the rate lock
agreements in conjunction with the issuance of the debt and received $7.4 million in cash, which
will be recognized as a reduction of interest expense over the term of the debt. Holdings
recognized a $0.1 million reduction of interest expense related to the interest rate lock
agreements in 2005.
On February 9, 2005, we entered into an interest-rate lock agreement for $100 million of
senior unsecured debt that we originally planned to issue in the first quarter of 2005. The
interest-rate lock was designated as a cash flow hedge under SFAS No. 133. Changes in our cash
requirements resulted in the postponement of the debt offering. On March 30, 2005, we unwound the
interest-rate lock agreement, resulting in a $4.0 million pre-tax gain that was recorded in other
income on Holdings consolidated statements of income.
Natural Gas Price Swap
Revenues from our pipeline quality landfill gas operations are based on current market prices
of natural gas as calculated by the terms of the individual contracts. In order to mitigate this
exposure to fluctuations in market prices of natural gas, in December 2005, we entered into a price
swap agreement which exchanges the floating price for a fixed price that has been designated as a
cash flow hedge under SFAS No. 133, for a portion of our anticipated 2006 sales. No amounts related
to hedge ineffectiveness have been recorded in the consolidated statements of income in 2005.
5. Long-Term Investments
DQE Financial participates in selected structured and leveraged lease transactions and
maintains investments in landfill gas rights and equity investments in alternative fuel, natural
gas reserve and affordable housing partnerships. Also, Duquesne Light holds an investment in
Holdings stock. (See Note 1.)
Leases
As of December 31, 2005, we maintain investments in seven structured lease transactions
involving a waste-to-energy facility, high-speed ferries and electric generating equipment. In
September 2005, we sold our investment in a leveraged lease involving a gas processing facility.
In November 2004, we had agreed to an early termination of an
existing leveraged lease involving
mining equipment. (See Note 3.) The remaining leases expire in various years beginning in 2029
through 2037. Holdings recognized $5.8 million and $5.9 million of
pre-tax lease income, with associated
tax expense of $2.0 million and $2.1 million, for the years ended
December 31, 2005 and 2004, related to
these leases. In 2003, we reached an agreement with the IRS regarding the tax treatment of our
leases. (See Note 10.)
The aggregate structured lease investment represents approximately 20% of the total aggregate
transaction. The remaining 80% was financed by non-recourse debt, which is substantially defeased.
Equity in these transactions is protected by a combination of defeasance accounts, letters of
credit and lessee guarantees.
Net Lease Investments as of December 31,
(Millions of Dollars)
2005
2004
Rentals receivable – net
$
593.7
$
601.0
Estimated residual value
—
8.0
Less: Unearned Income
(87.9
)
(96.9
)
Lease investments
505.8
512.1
Less: Deferred taxes
(239.7
)
(238.6
)
Net Lease Investments
$
266.1
$
273.5
Gas Rights and Related Investments
Our gas rights and related investments represent investments in landfill gas rights at 20
landfills and limited partnership investments. The following table illustrates the net book values
of these investments on Holdings consolidated balance sheets as of December 31, 2005 and 2004.
(Millions of Dollars)
2005
2004
Landfill gas rights, net
$
9.1
$
12.3
Landfill gas equity investment
0.8
—
Natural gas equity investment
—
4.6
Total
$
9.9
$
16.9
Landfill gas rights are amortized on a straight-line basis over the estimated remaining useful
life. Holdings recognized amortization expense of $3.2 million, $4.2 million and $2.8 million for
the years ended December 31, 2005, 2004 and 2003 related to the landfill gas rights.
We also own a limited partnership interest in a synthetic fuel operating partnership, with no
book value as of December 31, 2005 and 2004.
Affordable Housing
Our affordable housing investments include equity investments in affordable housing guarantee
funds.
6. Property, Plant and Equipment
Property, plant and equipment at Duquesne Light includes: (1) distribution poles and
equipment; (2) lower voltage distribution wires used in delivering electricity to customers; (3)
substations and transformers; (4) high voltage transmission wires used in delivering electricity to
substations; (5) meters and automated meter reading assets; and (6) internal telecommunication
equipment, vehicles and office equipment, primarily used in the electricity delivery business
segment.
Property, plant and equipment at Holdings consists of energy facilities used in our Energy
Solutions business segment, the fiber optic network used in our Communications business segment and
landfill gas equipment used in our Financial business segment.
Neither the adoption, nor the continued application, of accounting standards related to asset
retirement obligations had a material impact on our financial statements.
7. Intangible Assets
Pension
As a result of the recognition of an additional minimum pension liability in 2005 and 2004, we
recorded a corresponding $42.7 million and $5.8 million intangible asset on both Holdings and
Duquesne Light’s consolidated balance sheets as of December 31, 2005 and 2004. If the required
additional minimum pension liability changes in the future, the amount of the intangible asset will
also change. (See Note 12.)
Purchased Intangibles
As a result of the purchase price allocation related to DQE Financial’s purchase of WET in
November 2004, a portion of the purchase price has been allocated to intangible assets with both
definite and indefinite lives, including goodwill, on Holdings consolidated balance sheets as
follows.
Intangible Assets Subject to Amortization. Intangible assets with definite lives are subject
to amortization over their estimated useful lives. The assets included in this category are related
to existing customer relationships for both construction and operations customers and covenants
not-to-compete in the employment contracts with WET’s key executives. The weighted average useful
life is approximately 13 years. The amortization expense related to these intangibles was $0.5
million for the year ended December 31, 2005. Estimated aggregate amortization expense for each of
the succeeding five years is $0.4 million.
Goodwill and Indefinite Lived Intangible Assets. Goodwill is the cost of an acquisition over
the fair value of the net assets acquired. The other indefinite lived intangible asset relates to
the WET trade name. These assets are not amortized, but are evaluated for impairment at least
annually. During 2005, we finalized the purchase price allocation of WET, which resulted in the
reduction of amounts classified as goodwill by $0.3 million.
8.
Short-Term Borrowing and
Revolving Credit Arrangements
On January 31, 2006, Holdings and Duquesne Light amended their revolvers, increasing the
borrowing capacity of each by $50 million. Holdings’ revolver capacity is now $250 million and
Duquesne Light’s is now $150 million. All other terms of the revolvers remain in effect.
Prior to July 27, 2005, Holdings and Duquesne Light maintained unsecured credit facilities
(Prior Revolvers) expiring in September 2007, Holdings for $175 million and Duquesne Light for $100
million. On July 27, 2005, the Prior Revolvers were amended and extended to July 2010 (2005
Revolvers). Holdings 2005 Revolver was for $200 million and Duquesne Light’s 2005 Revolver was for
$100 million. Both 2005 Revolvers permit borrowings at interest rates of LIBOR (plus a margin of
0.40% to 1.00%) or an alternate base rate, as defined in the credit facilities. Both 2005 Revolvers
have commitment fees applicable to the remaining available amount. Interest rates and commitment
fees are based on the borrower’s then-current senior unsecured credit rating. Both 2005 Revolvers
are subject to cross-default if the borrower or any of its subsidiaries defaults on any payment due
under any indebtedness exceeding $50 million. Undrawn amounts under both 2005 Revolvers
are fully available for the issuance of letters of credit.
Under our Prior Revolvers and 2005 Revolvers, we are subject to financial covenants requiring
each of Holdings and Duquesne Light to maintain a debt-to-capitalization ratio of not more than
65%, as defined in the facilities. In addition, Holdings is required to maintain a minimum interest
coverage ratio of 2-to-1, as defined in the facilities. As of December 31, 2005, we were in
compliance with the applicable covenants.
As of December 31, 2005, our total borrowing capacity under our 2005 Revolvers and the use of
this borrowing capacity were as follows:
Committed
LOCs
Available
Capacity
Borrowed
Issued
Capacity
Holdings
$
200.0
$
40.0
$
71.4
$
88.6
Duquesne
Light
100.0
—
8.2
91.8
Total
$
300.0
$
40.0
$
79.6
$
180.4
Holdings. As of December 31, 2005, we had $40 million of short-term debt outstanding and
$0.3 million of current debt maturities. During 2005, the maximum amount of credit facility
borrowings outstanding was $50 million, the average daily borrowings were $4.8 million and the
weighted average daily interest rate was 4.2%. As of December 31, 2005, we had $18.2 million of
outstanding letters of credit (LOCs) unrelated to the credit facilities.
As of December 31, 2004, we had no short-term debt outstanding and $0.2 million of current
debt maturities. During 2004, the maximum amount of bank loans outstanding was $120 million, the
amount of average daily borrowings was $18.6 million and the weighted average daily interest rate
was 2.3%.
Duquesne Light. As of December 31, 2005, Duquesne Light had no short-term debt outstanding or
current debt maturities. During 2005, there were no bank loans or short-term borrowings
outstanding. As of December 31, 2005, we had $12.7 million of outstanding LOCs unrelated to the
credit facilities.
As of December 31, 2004, Duquesne Light had no short-term debt outstanding or current debt
maturities. During 2004, the maximum amount of bank loans outstanding was $120 million, the amount
of average daily borrowings was $18.6 million and the weighted average daily interest rate was
2.3%.
9. Restructuring Charges
In 2001, we recorded a pre-tax restructuring charge of $27.9 million (including $10.8 million
at Duquesne Light) related to (1) the consolidation and reduction of certain administrative and
back-office functions through an involuntary termination plan; (2) the abandonment of certain
office facilities; and (3) the write-off of certain leasehold-improvements related to those office
facilities. Approximately 170 employees (96 at Duquesne Light) were terminated in connection with
this restructuring.
In 2002, we recorded a pre-tax restructuring charge of $4.2 million (including $3.7 million at
Duquesne Light) related to further consolidation and centralization of certain administrative
functions. The 2002 restructuring charge primarily included severance costs for 20 executive,
management, professional and administrative personnel (14 at Duquesne Light), who were terminated
in connection with this restructuring.
The following table summarizes the restructuring activities for the Holdings 2001 and 2002
restructuring plans.
Excludes $2.3 million, $0.9 million, $0.1 million and zero of restructuring liabilities as
of December 31, 2002, 2003, 2004 and 2005 that are included in discontinued operations.
The Holdings $0.8 million combined remaining restructuring liability as of December 31,2005 is included in other current liabilities on the consolidated balance sheets. We believe that the
remaining provision is adequate to complete the restructuring plan. We expect that the
restructuring liability will be paid on a monthly basis through 2006.
The following table summarizes the restructuring activities for the Duquesne Light 2001 and
2002 restructuring plans.
The Duquesne Light $0.8 million combined remaining restructuring liability as of December 31,2005 is included in other current liabilities on the consolidated balance sheets. Duquesne Light believes
that the remaining provision is adequate to complete the restructuring plan and expects that the
restructuring liability will be paid on a monthly basis through 2006.
10. Income Taxes
The IRS has audited all federal corporate tax returns for years through 1997 and these years
are closed. In December 2003, we reached a settlement agreement with the IRS regarding DQE
Financial’s structured lease transactions and other similar investments that had been under review
as a result of an IRS audit. The tax liability associated with
the settlement was determined for the years 1994 through 1997. In addition, treatment of the
structured lease transactions has been agreed to for all future years affected by the transactions.
As a result of the confidential agreement, achieved through the IRS’ fast track settlement program,
we agreed to make additional cash payments for the tax years 1999 through 2002 of $84.3 million,
net of the $12.4 million tax benefit associated with the interest due. We paid $48.6 million in
December 2003. There was no earnings impact in 2003 from this resolution. The balance, including
interest, due to the IRS, of $53.6 million and $50.9 million as of December 31, 2005 and 2004 is
included in accrued taxes on the Holdings consolidated balance sheets.
Section 29 of the Internal Revenue Code provides tax credits through 2007 for the production
and sale of non-conventional fuels, including solid synthetic fuels and landfill gas. Holdings
recognizes Section 29 credits from DQE Financial’s landfill gas operations and an investment in a
synthetic fuel partnership.
To qualify for the Section 29 tax credits from synthetic fuel, the synthetic fuel must meet
three primary conditions: (i) there must be a significant chemical change in the coal feedstock,
(ii) the product must be sold to an unaffiliated entity, and (iii) the production facility must
have been placed in service before July 1, 1998. In recent years the synthetic fuel industry has
been the focus of increased scrutiny by the IRS. Most recently the IRS has heightened its review of
the “placed in service” dates of synthetic fuel plants, and some producers have indicated that the
IRS has challenged whether their plants were placed in service by the required date in order to
qualify for Section 29 tax credits.
The IRS is currently auditing the 1998 through 2002 tax years. During that period, one of our
subsidiaries constructed and operated six synthetic fuel facilities, which were subsequently sold
in the year 2000 to a third party. DES currently operates five of these six facilities under an
agreement with the third party purchaser. In July 2005, the IRS issued a Notice of Proposed
Adjustment in which it asserted that five of these six facilities were not placed in service by the
required June 30, 1998 date and, therefore, the Section 29 tax credits for these five facilities
should be disallowed. In February 2006, the IRS indicated in a letter to us, that upon further
review, they have concluded that all six facilities were placed in service by the required June 30,1998 date. Their letter also indicated that they would be withdrawing their Notice of Proposed
Adjustment.
The synthetic fuel partnership that DQE Financial has invested in was audited by the IRS for
the tax years 1998 through 2001. All of the relevant criteria for claiming the Section 29 credit
from solid synthetic fuels has been accepted by the IRS.
During 2003, we sold the remainder of our investment in AquaSource. Due to this divestiture,
capital losses were generated which were carried back against prior capital gains. In 2003, the
results of discontinued operations reflect the tax benefit of approximately $67 million resulting
from the carryback claim.
Our state income tax returns are subject to review by the relevant taxing
jurisdictions, Pennsylvania being the most significant. The Pennsylvania Department of Revenue has
issued assessments of additional tax for 1999 through 2002 primarily to
include income of a Duquesne Light out of state subsidiary corporation in Pennsylvania taxable
income. Although treatment of taxable income related to the out-of-state subsidiary remains in
dispute, in January 2006, we reached a tentative settlement with the Pennsylvania Department of
Revenue on all other matters disputed in our 1997 through 2003 tax returns. Pursuant to the terms
of this agreement, Duquesne Light will withdraw refund claims in excess of assessments and pay an
immaterial amount of cash. The result of this agreement reduces our total net exposure for the tax
years at issue by approximately $18 million. If, as expected, the Department asserts the same
positions related to the out of state subsidiary for 2003 through 2005, Duquesne Light’s total
exposure for all years, without interest or penalty, could approximate $78 million (net of
associated federal benefit). Our cash flow exposure related to this issue should ultimately be
reduced by approximately $10 million due to refunds currently held by the state that could
be applied against this issue. Ultimately, Duquesne Light expects all years involved to be appealed
to and decided at the Pennsylvania Commonwealth Court.
It is not possible to predict if, when or to what extent any state income tax adjustments
ultimately proposed for the period 1999 through 2005 will be sustained. Duquesne Light does not
believe that the ultimate resolution of its state tax issue for this period will have a material
adverse effect on its financial position or results of operation. However, the resolution,
depending on the extent and timing thereof, could have a material adverse effect on cash flows for
the period in which they are paid.
In connection with the above examinations, both Holdings and Duquesne Light have established
tax reserves, which are included primarily in other current and non-current liabilities on the
consolidated balance sheets. We believe these reserves are adequate in relation to the above
matters. We regularly assess the likelihood of additional assessments resulting from these and
subsequent years’ examinations. Once established, reserves are adjusted only when there is more
information available or when an event occurs that necessitates a change to the reserves.
Duquesne
Light Holdings
Deferred Tax Assets (Liabilities) as of
December 31,
(Millions of Dollars)
2005
2004
Restructuring charges
and impairments
$
3.2
$
4.0
Tax credit
carryforward (a)
121.1
118.3
Capital loss carryforward
17.5
17.5
Legacy liabilities
12.0
12.3
Pension and benefit costs
48.6
43.5
Other
32.6
26.0
Deferred tax assets
235.0
221.6
Property depreciation
(276.5
)
(276.4
)
Lease investments
(239.7
)
(238.6
)
Loss on reacquired debt
unamortized
(19.2
)
(15.6
)
Regulatory assets
(93.0
)
(90.7
)
Derivative
instruments
(16.2
)
—
Other
(12.9
)
(8.5
)
Deferred tax liabilities
(657.5
)
(629.8
)
Net
$
(422.5
)
$
(408.2
)
-
(a)
The 2005 amount includes $57.5 million of general business tax credit
carryforwards that expire in varying amounts between 2012 and
2025.
Total income taxes differ from the amount computed by applying the statutory federal income
tax rate to income before income taxes, as set forth in the following table.
Total income taxes differ from the amount computed by applying the statutory federal income
tax rate to income before income taxes (after deducting dividends on preferred and preference
stock), as set forth in the following table.
Future minimum lease payments for operating leases are related principally to certain
corporate offices. Future minimum capital lease payments relate to a building.
12. Employee Benefits
PENSION BENEFITS
We maintain several qualified retirement plans and one unqualified plan to provide pensions
for all eligible full-time employees. Upon retirement, an eligible employee receives a monthly
pension based on his or her length of service and compensation. The cost of funding the pension
plan is determined by the unit credit actuarial cost method. Our policy is to record this cost as
an expense and to fund the pension plans by an amount that is at least equal to the minimum funding
requirements of the Employee Retirement Income Security Act of 1974, but which does not exceed the
maximum tax-deductible amount for the year. Pension costs charged (credited) to expense or
construction were $(0.4) million for 2005, $2.3 million for 2004 and ($2.0) million for 2003.
During 2005, we approved amendments to the pension plans which broadened the cash balance
feature in the qualified plans, and updated the past service window period used in the calculation
of pension benefits. These amendments caused an increase in the projected benefit obligation of
$10.6 million as of December 31, 2005. As of December 31, 2005, we changed our assumption regarding the age at which certain terminated vested participants would elect to receive benefits under our pension plans based on our expectation that our historical experience would continue. The result was an increase in the projected benefit obligation of approximately $49 million.
In January 2005, Duquesne Light met its obligation, pursuant to the January 18, 2001 PUC order
regarding Duquesne Light’s final generation asset sale proceeds accounting, by contributing $32.1
million to the pension plans. We made no cash contributions to our pension plans in 2004. In
January and February of 2006, Duquesne Light made aggregate discretionary contributions of $20 million to the pension
plans.
POSTRETIREMENT BENEFITS
In addition to pension benefits, we provide certain health care benefits and life insurance
for some retired employees. The life insurance plan is non-contributory. Participating retirees
make contributions, which may be adjusted annually, to the health care plan. Health care benefits
terminate when retirees reach age 65. We fund actual expenditures for obligations under the plans
on a “pay-as-you-go” basis. We have the right to modify or terminate the plans.
We accrue the actuarially determined costs of the postretirement benefits over the period from
the date of hire until the date the employee becomes fully eligible for benefits. We have elected
to amortize the transition obligation over a 20-year period.
The health care trend assumption used in the development of the fiscal 2005 expense was 9.5%,
decreasing each year to an ultimate rate of 4.75% (reached in 2015). The health care trend
assumption reflected in the December 31, 2005, SFAS No. 106 year-end disclosure, which will also be
used in the development of fiscal 2006 expense, is 9.5%, decreasing 0.75% per year to an ultimate
rate of 4.75% (reached in 2013). A 0.95% spread between the discount rate (5.7% for 2006 expense)
and the ultimate health care cost trend rate will be maintained.
We use a December 31 measurement date for all of our pension and postretirement plans. All of
our plans for postretirement benefits, other than pensions, have no plan assets. The following
tables apply to both Holdings and Duquesne Light, and provide a reconciliation of the changes in
the pension and postretirement plans’ benefit obligations and fair value of plan assets over the
two-year period ended December 31, 2005, a statement of the funded status as of December 31, 2005
and 2004, and a summary of assumptions used in the measurement of our benefit obligations:
Funded Status of the Pension and Postretirement Benefit Plans as of December 31,
(Millions of Dollars)
Pension
Postretirement
2005
2004
2005
2004
Change in benefit obligation:
Benefit obligation at beginning of year
$
750.3
$
694.0
$
52.7
$
52.6
Service cost
8.9
8.1
1.4
1.1
Interest cost
42.6
42.2
3.4
3.0
Plan participants’ contributions
—
—
0.5
0.5
Actuarial loss (gain)
62.4
43.5
(2.4
)
(0.5
)
Benefits paid
(38.4
)
(37.5
)
(4.7
)
(4.0
)
Plan amendments
10.6
—
—
—
Benefit obligation at end of year
836.4
750.3
50.9
52.7
Change in plan assets:
Fair value of plan assets at beginning of year
715.8
679.0
—
—
Actual return on plan assets
50.3
74.3
—
—
Plan participants’ contributions
—
—
0.5
0.5
Employer contributions
32.1
—
4.2
3.5
Benefits paid
(38.4
)
(37.5
)
(4.7
)
(4.0
)
Fair value of plan assets at end of year
759.8
715.8
—
—
Funded status
(76.6
)
(34.5
)
(50.9
)
(52.7
)
Unrecognized net actuarial loss (gain)
45.5
(21.9
)
0.1
2.9
Unrecognized prior service cost
32.6
25.4
5.2
6.2
Unrecognized net transition obligation
—
—
4.9
5.5
Accrued benefit gain (cost)
$
1.5
$
(31.0)
$(40.7)
$(38.1
)
The following table summarizes the presentation of the accrued benefit cost related to the
pension plans on the consolidated balance sheets of both Holdings and Duquesne Light as of December
31,
Effect of a One Percent Change in Health Care Cost Trend Rates as of December 31, 2005
(Millions of Dollars)
One Percent
One Percent
Increase
Decrease
Effect on total of service and interest cost components of net
periodic postretirement health care benefit cost
$
0.5
$
(0.4
)
Effect on the health care component of the accumulated
postretirement benefit obligation
3.5
(3.2
)
Expected Rate of Return On Plan Assets and Investment Policy
We used an 8.00% expected long-term rate of return on plan assets in determining the 2005 net
periodic benefit cost. We developed the long-term rate of return using a building block approach,
taking into account the target asset class allocations contained in the table below as well as the
investment management mix. Under this approach, current market factors such as inflation, interest
rates, asset class risks and asset class returns are evaluated and considered before long-term
capital market assumptions are determined. Long-term historical returns and relationships between
the asset classes are reviewed to verify reasonability and appropriateness. The long-term rate of
return is established through this building block approach with proper consideration of
diversification to reduce volatility of expected return.
Target Investment
Asset Category
Allocation
Equity securities
25% - 70
%
Fixed income securities
25% - 55
%
Real estate investments
0% - 15
%
Other investments
0% - 10
%
Pension Plan Assets
The pension plan weighted-average asset allocations by asset category are as follows:
Plan Assets as of December 31,
Asset Category
2005
2004
Equity securities
60.5
%
57.2
%
Fixed income securities
25.5
%
30.8
%
Real estate investments
11.4
%
10.5
%
Other investments
2.6
%
1.5
%
Total
100.0
%
100.0
%
Pension plan assets as of December 31, 2005 and 2004, do not include any common stock of
either Holdings or Duquesne Light.
Expected Benefit Payments for Future Years
The following benefit payments (shown net of postretirement plan participants’ contributions),
which reflect expected future service as appropriate, are expected to be paid:
(Millions of Dollars)
Year
Pension
Postretirement
2006
$
39.7
$
3.4
2007
41.3
3.6
2008
43.4
3.8
2009
45.5
4.1
2010
48.7
4.5
2011 - 2015
293.1
25.3
RETIREMENT SAVINGS PLANS
There are separate 401(k) retirement savings plans for our management and IBEW-represented
employees.
The Holdings 401(k) Retirement Savings Plan provides for employer contributions that vary by
Holdings subsidiary. These contributions may include one or more of the following: a participant
base match, a participant incentive match and automatic contributions. The incentive match was
achieved in 2004 and 2003 but not in 2005. We are funding our automatic and matching contributions
to this plan through an ESOP established in December 1991. (See Note 15.) Compensation costs
charged to expense or construction related to the 401(k) plan were $0.9 million, $1.3 million and
$0.9 million in 2005, 2004 and 2003 at Holdings and $0.7 million, $1.2 million and $0.5 million in
2005, 2004 and 2003 at Duquesne Light.
The Duquesne Light 401(k) Retirement Savings Plan for IBEW Represented Employees provides
that Duquesne Light will match employee contributions with a base match and an additional
incentive match (paid in Holdings common stock), if certain targets are met. The incentive match
was achieved in 2004 and 2003 but not in 2005. Duquesne Light recognized compensation expense of
$0.4 million, $1.0 million and $0.3 million in 2005, 2004 and 2003 related to this plan.
STOCK OPTIONS
In 2004, our shareholders approved amendments to the Holdings 2002 Long-Term Incentive Plan
(the 2002 Plan). Under the Amended Incentive Plan the aggregate number of shares of common stock
authorized for issuance increased from 2,690,468 to 3,690,468, and of this total, up to 700,000
shares, versus 500,000 shares under the previous terms, may be issued as restricted shares.
Additionally, the amendments expanded the eligibility provisions to permit the grant of all types
of awards available under the Amended Incentive Plan to non-employee directors, added a provision
permitting grants of unrestricted shares of common stock to be made to non-employee directors as
part of the regular compensation package of non-employee directors and/or Board Chairman, Vice
Chairman, and Committee Chairman, and eliminated the provisions of the 2002 Plan requiring only
specific stock option grants to non-employee directors. The Amended Incentive Plan also includes
restricted stock units as another type of award that may be granted, permits Holdings to change how
dividend equivalent accounts and dividends accumulated on restricted shares are paid, and
authorizes dividend equivalent accounts to be established in connection with performance awards.
The original 2002 Plan became effective as of January 1, 2002, and replaced the prior
Long-Term Incentive Plan (the Prior Plan). Under the 2002 Plan, management may grant stock option
awards, alternative stock appreciation rights and dividend equivalent accounts; restricted share
awards; performance awards; and beginning in 2004, as described previously, restricted stock unit
awards. Stock options awarded to eligible employees will be granted at an option price not less
than 100% of the fair market value of our common stock on the date of grant. All stock options to
directors will be granted at an option price equal to 100% of the fair market value of our common
stock on the date of grant. Any stock options granted prior to January 1, 2002 are not affected by
the adoption of the 2002 Plan, and are administered according to the Prior Plan. No new options
may be granted under the Prior Plan. The 2002 Plan will terminate on December 31, 2011.
No stock option awards were granted in 2005 or 2004 to either employees or non-employee
directors.
During 2003, 34,232 Holdings stock options were issued to non-employee directors, and as of
December 31, 2003, were fully vested.
During December 2002, 774,500 stock options were granted to employees under the 2002 Plan with
an exercise price of $15.015 per share. Due to cancellations, forfeitures, and exercises, only
154,411 of these options remain outstanding as of December 31, 2005, all of which are exercisable
and fully vested. They will expire on December 15, 2012. No compensation expense related to the
December 2002 grant was recognized at either Holdings or Duquesne Light in 2005. Compensation
expense related to the December 2002 grant of $0.4 million was recognized in 2004, of which $0.1
million was recorded at Duquesne Light.
During December 2001, 787,300 stock options were granted to employees under the Prior Plan
with an exercise price of $16.90 per share. Due to cancellations, forfeitures, and exercises, only
161,714 of these options remain as of December 31, 2005, all of which are exercisable, fully
vested, and expire on December 10, 2011. No compensation expense related to this award was
recognized in 2004 or 2005. In 2003, compensation expense related to the December 2001 grant of
$0.2 million was recognized.
The following tables summarize the transactions of our stock option plans for the three-year
period ended December 31, 2005, and certain information about outstanding stock options as of
December 31, 2005:
No stock appreciation rights (SARS) were issued during 2005, 2004 or 2003. As of December31, 2005, 2004 and 2003, previously issued SARS were outstanding in connection with 98,719; 115,107;
and 607,734 of options outstanding with weighted average exercise
prices of $39.03, $39.53 and $38.56. No SARS were exercised in 2005.
During 2004 and 2003, 147,247 and 37,755 SARS were exercised.
Outstanding
Exercisable
Number of
Average
Weighted
Number of
Weighted
Options
Remaining
Average
Options
Average
Exercise Price Range
(In Millions)
Life
Exercise Price
(In Millions)
Exercise Price
(In Years)
Under $20
0.4
6.5
$
16.12
0.4
$
16.12
$20 - $30
—
—
—
—
—
$30 - $40
—
—
—
—
—
Over $40
0.1
4.2
$
42.57
0.1
$
42.57
Options, End of Year
0.5
0.5
The fair value of the options granted during 2003 was estimated on the date of grant using
the Black-Scholes option pricing model. The estimated weighted average assumptions used and the
fair values are as follows:
2003
Expected dividend yield
6.16
%
Risk-free interest rate
3.34
%
Expected stock price volatility
30.91
%
Expected term until exercise (years)
10.0
Weighted average fair value
$
2.40
OTHER STOCK-BASED COMPENSATION
On January 1, 2003, 58,500 shares of Holdings stock were issued to officers as part of a
performance award. As of December 31, 2005, all shares were forfeited as Holdings’ total
shareholder return (TSR) did not achieve its required TSR rank
against the TSR of its peer group.
On November 10, 2003, 198,417 shares of nonvested Holdings stock with voting and dividend
rights were issued to officers of Holdings. In 2005, an additional 14,000 shares were issued to
officers of Holdings. The right to the shares is subject to continued employment. An equal portion
of the total shares for each issuance are earned each year over the vesting period ending on
December 31, 2006. Due to forfeitures, only 200,417 shares remain as of December 31, 2005, of which
127,178 shares are vested. The market value of the nonvested stock at the grant dates was charged
to stockholders’ equity and reflected as unearned compensation on the consolidated balance sheets
of Holdings. This unearned compensation will be charged evenly to expense over the vesting period.
In 2005 and 2004, total compensation expense of $1.1 million and $1.0 million was recognized, of
which $0.6 million and $0.5 million was recorded at Duquesne Light.
On November 10, 2003, 387,400 shares of Holdings stock were issued to the same officers under
a performance-based deferred stock unit award. In 2005, an additional 33,367 of Holdings shares
were issued under the same award. Due to forfeitures, only 396,567 shares remain to be earned as of
December 31, 2005. The right to the shares is subject to the achievement of specified performance
goals related to earnings per share (EPS) from continuing operations and TSR over the defined
performance periods. The EPS performance period
commenced on January 1, 2004 and ends on December 31, 2006. The TSR performance period commenced on
October 20, 2003 and ends on December 31, 2006. At the end of the performance period, shares may
vest within a range of 0% to 100%, with no more than 50% of the shares subject to each performance
target. Holdings did not record compensation expense for the deferred stock unit award in 2003,
2004 or 2005.
On January 1, 2004, 56,427 shares of Holdings common stock were granted to non-officers of
Holdings under a performance-based restricted stock unit award. As of December 31, 2005, due to
forfeitures, only 52,390 shares remain to be earned. These shares are earned based upon Holdings’
TSR rank against the TSR of its peer group, as defined, over a three-year performance period ending
December 31, 2006. Holdings did
not record compensation expense related to this award in 2004 or 2005.
On June 3, 2004 and June 2, 2005, under the Amended Incentive Plan, 2,500 shares of Holdings’
nonvested stock with voting and dividends rights were granted to each of the then eight
non-employee directors for a total of 20,000 shares awarded at each grant date. The shares vest
over a two-year period ending on June 3, 2006 and June 2, 2007. On July 14, 2005 an additional
2,292 shares of Holdings nonvested stock were granted to a new non-employee director. These shares
vest over a two-year period ending July 14, 2007. The market value of the nonvested stock at the
grant dates was charged to stockholders’ equity and reflected as unearned compensation on the
consolidated balance sheets of Holdings. This unearned compensation will be charged evenly to
expense over the vesting periods. In 2005 and 2004, total compensation expense recognized on these
shares was $0.3 million and $0.1 million.
On both June 3, 2004 and June 2, 2005, under the Amended Incentive Plan, 3,897 shares of
Holdings common stock were issued to non-employee directors. In 2005 and 2004, the total
compensation expense recognized on these shares was $0.1 million and $0.1 million.
13. Commitments and Contingencies
GUARANTEES
As part of DQE Financial’s investment portfolio in seven affordable housing funds, we have
received fees in exchange for guaranteeing a minimum defined yield to third-party investors. We
entered into these transactions between 1995 and 1999 because of the attractive risk/reward
characteristics available to guarantors. This group of guarantees will expire by 2015. In the event
the underlying affordable housing properties do not generate the necessary minimum yield before
their expiration, we will make cash payments necessary to achieve the minimum yield. The original
amount guaranteed was approximately $250 million, and has declined as investors have earned the
guaranteed returns. We estimate the maximum potential amount of undiscounted future payments that
we could be required to make under the guarantees if the investors earn no future returns was $38.6
million at December 31, 2005.
In connection with the sale of six synthetic fuel facilities in 2000 by our indirect
subsidiary, Duquesne Energy, Inc., we agreed to guarantee the subsidiary’s obligation under the
sales agreement to indemnify the purchaser against breach of warranties, representations or
covenants. The guarantee generally extends up to six years or otherwise as stipulated under statute
of limitations, based on the expiration of the underlying warranty, representation, or covenant. We
have determined our exposure to be limited, as both legal and factual representations and
warranties have been primarily limited to matters within the control and knowledge of our
subsidiary. As such, no liability has been recorded on the consolidated balance sheets.
In connection with DES’s sale of an investment in an energy facility management project, DES
provided the buyer with a guarantee that DES will repay a portion of the purchase price if the
counterparty to the management contract terminates the contract for convenience, as defined by the
agreement (the Repayment Guarantee). As of December 31, 2005, the maximum Repayment Guarantee
amount is approximately $3.6 million. The Repayment Guarantee is reduced daily, based on the
passage of time, through January 1, 2016, at which time the Repayment Guarantee expires. The
estimated liability for the fair value of the Repayment Guarantee is not material.
Holdings has guaranteed portions of the obligations of Duquesne Power under its energy
commodity contracts in order to use Holdings’ stronger credit profile to obtain better pricing and
contract terms for Duquesne Power. In general, if Duquesne Power is required to make a payment
under these contracts and fails to do so, Holdings would be required to make such payment. The
notional value of the contracts (and consequently the guarantee amounts) changes as additional
energy commodities are bought or sold, and as Duquesne
Power pays for its energy commodity deliveries. As of December 31, 2005, the maximum amount of
Holdings’ payment guarantee related to the purchase and capacity obligations totaled $687.1
million, or approximately 86%, of the total remaining notional value under these contracts. In
addition, Holdings guarantees Duquesne Power’s obligations to deliver energy under the energy sales
contracts, to the extent that Duquesne Power would be obligated to compensate the counterparty for
the difference in the counterparty’s cost to procure the energy and the contract price. As of
December 31, 2005, no guarantee amount has been recorded as a liability on the consolidated balance
sheets. In addition, Holdings posts collateral on behalf of Duquesne Power as needed under the
energy commodity contracts. As of December 31, 2005, no collateral was outstanding.
In conjunction with certain transactions, primarily divestitures, we provide routine
indemnifications (e.g., retention of previously existing environmental, tax and employee
liabilities) whose terms range in duration and often are not explicitly defined. Where appropriate,
an obligation for such indemnifications is recorded as a liability. Because the obligated amounts
of these types of indemnifications often are not explicitly stated, the overall maximum amount of
the obligation under such indemnifications cannot be reasonably estimated. Other than obligations
recorded as liabilities at the time of divestiture, historically we have not made significant
payments for these indemnifications.
EMPLOYEES
Duquesne Light is a party to a labor contract with the International Brotherhood of Electrical
Workers, which represents more than 71% of Duquesne Light’s approximately 1,400 employees. This
contract expires in September 2010.
LEGAL PROCEEDINGS
Shareholder Class Action. In October and November 2001, a number of putative class action
lawsuits were filed by purported shareholders of Holdings against Holdings and David Marshall, our
former chairman, chief executive officer and president, in the United States District Court for the
Western District of Pennsylvania. These cases were consolidated under the caption In re DQE, Inc.
Securities Litigation, Master File No. 01-1851 (W.D. Pa.), and the plaintiffs filed a second
consolidated amended complaint on April 15, 2002. The complaint alleged violations of Section 10(b)
of the Securities Exchange Act of 1934 (the “Exchange Act”) and Rule 10b-5 promulgated thereunder,
and Section 12(a)(2) of the Securities Act of 1933 (the “Securities Act”). The complaint also
alleged controlling person liability under Section 20(a) of the Exchange Act and Section 15 of the
Securities Act. The complaint alleged that between December 6, 2000 and April 30, 2001, the
defendants issued a number of materially false and misleading statements concerning investments
made by our subsidiary, DQE Enterprises, Inc., and the impact that these investments would have on
our current and future financial results.
In March 2005, we reached an oral agreement in principle with counsel for the plaintiffs to
settle all claims of the class and sub-class. In October 2005, the court approved a settlement of
all claims of the class and sub-class. The settlement was covered in full by our insurance.
SECTION 29 TAX CREDITS AND SYNTHETIC FUEL
Holdings recognizes Section 29 credits from DQE Financial’s landfill gas operations and an
investment in a synthetic fuel partnership. DES operates synthetic fuel facilities for a single
customer, earning fees based on production.
Section 29 tax credits are subject to a phase-out provision that could reduce tax credits as
the average annual wellhead price per barrel of domestic crude oil increases into an
inflation-adjusted phase-out range. For 2004, the tax credit would have begun to phase-out if the
annual average wellhead price per barrel of domestic crude oil exceeded $51.35 per barrel and would
have been completely phased out if the annual average wellhead price of domestic crude oil reached
$64.47 per barrel. The 2005 inflation adjustment has not been published by the IRS, but based on
the prices of oil during the year, we do not believe that a phase-out of the credit for 2005 will
occur. We cannot predict the level of domestic crude oil prices for 2006, nor whether a phase-out
of the credit is likely to occur.
Absent any efforts to mitigate market price exposure, if domestic crude oil prices continue to
stay at a high level in 2006 and/or 2007, tax credits and net income may be reduced substantially
due to the phase-out. Based on our evaluation, as of December 31, 2005, we have not entered into
hedging arrangements to reduce this exposure.
During 2005, we recorded $20.2 million of Section 29 tax credits on Holdings consolidated
statement of income. In addition, as of December 31, 2005, we have certain tangible and intangible
assets related to DQE Financial’s landfill gas operations with a net book value of approximately
$5.4 million that may
become impaired if domestic crude oil prices continue to increase in the future. As of December 31,2005, we have no net book value related to synthetic fuel assets or investments.
OTHER
Proposed Acquisition
On November 14, 2005, Holdings Inc. entered into a Purchase and Sale Agreement to acquire
Atlantic City Electric Company’s (ACE) combined 108 megawatt ownership interests in the Keystone
and Conemaugh coal-fired power plants. The aggregate purchase price is approximately $176 million,
subject to adjustments based on, among other things, the transaction’s ultimate closing date.
Currently, the closing is anticipated to occur in mid-2006, subject to approvals from the New
Jersey Bureau of Public Utilities, the Pennsylvania Public Utility Commission (PUC) and other
regulatory entities. Both Keystone and Conemaugh are jointly owned by ACE and a consortium of
other companies. Holdings will be acquiring ACE’s undivided 2.47% interest, or 42 megawatts, in
Keystone and undivided 3.83% interest, or 66 megawatts, in Conemaugh, plus related inventories,
equipment and other property.
Legacy Liabilities
In 1992, the Pennsylvania Department of Environmental Protection (DEP) issued Residual Waste
Management Regulations governing the generation and management of non-hazardous residual waste,
such as coal ash. Following the generation asset divestiture, Duquesne Light retained certain
facilities that remain subject to these regulations. As of December 31, 2005, we have assessed our
residual waste management sites, and the DEP has approved our compliance strategies. As of December31, 2005 and 2004, the expected costs of compliance were approximately $4 million and $5 million
with respect to sites we continue to own. These costs were recovered in the CTC.
Duquesne Light also owns the closed Warwick Mine, located along the Monongahela River in
Greene County, Pennsylvania. This property had been used in the electricity supply business
segment. Duquesne Light has been selling unused portions of the property and will continue to do
so. As of December 31, 2005 and 2004, Duquesne Light’s estimated liability for closing the Warwick
Mine, including final site reclamation, mine water treatment and certain healthcare liabilities,
was approximately $26 million and $27 million.
These amounts are combined and included in legacy liabilities on both Holdings and Duquesne
Light’s consolidated balance sheets.
Discontinued Operations
AquaSource’s former water and water-related operations were, and remain, subject to the
Federal Safe Drinking Water Act, which provides for uniform minimum national water quality
standards, as well as governmental authority to specify treatment processes to be used for drinking
water. AquaSource’s former operations were also, and remain, subject to the Federal Clean Water
Act, which regulates the discharge of pollutants into waterways. AquaSource is aware of various
compliance issues at its former water and wastewater facilities attributable to the period of time
during which it owned these facilities. AquaSource has agreed to indemnify the purchasers of these
facilities for certain pre-closing environmental liabilities.
Prior to divesting its former operations, AquaSource entered into various consent agreements
regarding certain environmental compliance matters. In connection with divesting its former
operations, AquaSource assigned these consent agreements to the relevant purchasers. AquaSource has
agreed to indemnify the purchasers of its former operations for certain pre-closing environmental
liabilities.
As part of the transaction, we retained certain obligations related to the business that was
sold to Aqua America, Inc., including responsibility for certain existing litigation matters as
well as a 10-year indemnity for certain pre-closing environmental claims. We purchased an
environmental liability policy to mitigate this indemnity. We also had a maximum three-year
indemnity obligation for certain other pre-closing liabilities that was limited by a $15 million
indemnity cap. Because Aqua America had not made the minimum required threshold of indemnification
requests during the first year after closing, this indemnity obligation was reduced to a $7.5
million cap over a two year period. We have notified Aqua America that with the passage of the
second anniversary of the closing of the transaction, the indemnification has terminated, and no
further claims can be made under the indemnity obligation.
We do not believe that any of AquaSource’s indemnity obligations described above will have a
material effect on Holdings’ financial position, results of operations or cash flows.
Less: Unamortized debt discount and premium — net (d)
(1.4
)
(1.6
)
Current maturities
(0.3
)
(0.2
)
Total Long-Term Debt
$
957.8
$
958.0
(a)
Excludes first mortgage bonds issued to secure pollution control notes.
(b)
Secured by an equal principal amount of first mortgage bonds.
(c)
These adjustable interest rates averaged 2.4%, 1.6% and 1.1% in 2005, 2004 and 2003.
(d)
Relates to Duquesne Light debt.
Holdings. As of December 31, 2005, maturities of long-term debt outstanding for the
next five years were $0.3 million, $0.3 million, $40.3 million, $0.3 million, and $0.3 million in
2006 through 2010.
Total interest and other charges were $62.6 million in 2005, $63.0 million in 2004 and $74.4
million in 2003. Interest costs attributable to debt were $55.3 million, $57.2 million and $65.4
million in 2005, 2004 and 2003. Included in the interest costs attributable to debt is $3.1 million
in 2004 and $12.6 million in 2003 related to the 8 3/8% Monthly Income Preferred Securities (MIPS).
Of the interest costs attributable to debt, $0.7 million, $0.8 million and $0.5 million in 2005,
2004 and 2003 were capitalized as AFC. Debt discount or premium and related issuance expenses are
amortized over the lives of the applicable issues. (See Note 1.)
As of December 31, 2005, the fair value of long-term debt, including current maturities,
estimated on the basis of quoted market prices for the same or similar issues, or current rates
offered for debt of the same remaining maturities, was $988.0 million. The principal amount,
excluding unamortized discounts and premiums, is $959.5 million as of December 31, 2005.
As of December 31, 2005 and 2004, we were in compliance with all of our debt covenants.
During August 2005, Holdings issued $200 million of 5.5% senior notes due August 15, 2015 and
$120 million of 6.25% senior notes due August 15, 2035. Proceeds were used to repay the $250
million intercompany loan with Duquesne Light and approximately $37 million of variable rate
borrowings under Holdings’ credit facility. The remaining balance was used for general corporate
purposes.
In October 2004, DQE Capital fully redeemed its $100 million of 8.375% Public Income Notes,
due 2039, at par. A $1.9 million after-tax charge related to the write-off of the unamortized,
original issue costs was recorded.
Duquesne Light As of December 31, 2005, maturities of long-term debt outstanding for the next
five years were zero in 2006 and 2007, $40.0 million in 2008 and zero in 2009 and 2010.
Total interest and other charges were $48.0 million 2005, $46.2 million in 2004 and $54.1
million in 2003. Interest costs attributable to debt were $47.4 million, $45.6 million and $53.1
million in 2005, 2004 and 2003. Included in the interest costs attributable to debt is $3.1 million
in 2004 and $6.3 million in 2003 related to the MIPS. Prior to the July 2003 adoption of SFAS No.
150, MIPS dividend requirements were shown separately on the consolidated statements of income. Of
the interest costs attributable to debt, $0.7 million in 2005, $0.8 million in 2004 and $0.5
million in 2003 were capitalized as AFC. The unamortized debt discount is amortized over the lives
of the applicable issues. (See Note 1.)
As of December 31, 2005, the fair value of long-term debt, including current maturities,
estimated on the basis of quoted market prices for the same or similar issues, or current rates
offered for debt of the same remaining maturities, was $665.2 million. The principal amount,
excluding unamortized discounts
In the third quarter of 2005, Duquesne Light used the proceeds received from the repayment of
the Holdings’ intercompany loan plus available cash to purchase at par upon mandatory tender $320.1
million of variable rate Pollution Control Revenue Refunding Bonds with maturity dates ranging from
2020 to 2033. The purchased bonds are presented as extinguished debt in conformity with SFAS No.
140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities.” The bonds have not been sold as of December 31, 2005.
In May 2004, Duquesne Light issued $200 million of 5.7% first mortgage bonds (due 2014).
Proceeds were used to redeem $75 million of MIPS, repay $40 million of outstanding revolving credit
facility borrowings and replenish working capital.
During 2004, pursuant to the terms of MIPS, Duquesne Light redeemed $151.5 million of its 8
3/8% Subordinated Deferrable Interest Debentures, Series A, due May 31, 2044 (Subordinated
Debentures) held by Duquesne Capital, L.P., a special purpose subsidiary of Duquesne Light.
Duquesne Capital simultaneously redeemed $150 million principal amount of its MIPS.
In August 2003, Duquesne Light redeemed at par $100 million principal amount of its 7 3/8%
first mortgage bonds due 2038.
15. Preferred and Preference Stock
In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity.” This standard requires that an issuer classify a
financial instrument that falls within its scope as a liability, or as an asset in some
circumstances. This standard was adopted effective July 1, 2003.
Holdings Series A Preferred Stock (Holdings preferred stock) fell within the scope of SFAS No.
150 due to its mandatory conversion feature, and the fact that the monetary value of the obligation
was based solely on a fixed monetary amount that is known at inception. Dividends paid on the stock
were classified as interest and other charges, rather than dividends, effective July 1, 2003.
Prior to the adoption of SFAS No. 150, Holdings preferred stock was reflected as preferred
stock on the consolidated balance sheets of Holdings. Upon adoption, we began classifying Holdings
preferred stock as both current and non-current liabilities based upon conversion dates.
As of December 31, 2005 and 2004, zero and 66,149 shares of Holdings preferred stock with
recorded values of zero and $6.6 million were outstanding. These balances reflect (i) the
conversions in 2005 and 2004 of 66,149 and 76,984 shares and (ii) the repurchase of 8,667 shares
for $98.00 per share in 2004.
4,000,000 authorized shares; $50 par value; cumulative; $50 per share involuntary
liquidation value.
(b)
1,500 authorized shares; $100,000 par value; $100,000 involuntary liquidation value; if
declared, holders entitled to 6.5 % annual dividend each September; $100,000 redemption price
per share. EnviroGas is a DQE Financial subsidiary.
(c)
8,000,000 authorized shares; $1 par value; cumulative; $35.50 per share liquidation value;
annual dividends of $2.80 per share.
In April 2004, Duquesne Light issued 1.5 million shares of 6.5% non-convertible
preferred stock ($50 par and liquidation value), receiving net proceeds of approximately $73
million. The holders of the preferred stock are entitled to cumulative quarterly dividends
beginning on July 1, 2004. This stock is callable at par, plus accrued dividends, on or after April1, 2009.
The Duquesne Light preferred stock ranks senior to Duquesne Light preference and common stock
as to payment of dividends and the distribution of assets on liquidation, dissolution or winding-up
of Duquesne Light.
Holders of Duquesne Light’s preferred stock are entitled to cumulative quarterly dividends. If
four quarterly dividends on any series of preferred stock are in arrears, holders of the preferred
stock are entitled to elect a majority of Duquesne Light’s board of directors until all dividends
have been paid.
Holders of Duquesne Light’s preference stock are entitled to receive cumulative quarterly
dividends, if dividends on all series of preferred stock are paid. If six quarterly dividends on
any series of preference stock are in arrears, holders of the preference stock are entitled to
elect two of Duquesne Light’s directors until all dividends have been paid. As of December 31,2005, Duquesne Light had made all dividend payments.
Outstanding Duquesne Light preferred stock is generally callable on notice of not less than 30
days, at stated prices plus accrued dividends. The outstanding preference stock is callable at the
liquidation price plus accrued dividends. None of the Duquesne Light preferred or preference stock
issues has mandatory purchase requirements.
Preferred and preference dividends of Holdings and its affiliates included in interest and
other charges were $8.0 million, $6.9 million and $3.5 million in 2005, 2004, 2003. Total preferred
and preference stock had involuntary liquidation values of $149.8 million and $151.0 million, which
exceeded par by $12.9 million and $14.1 million as of December 31, 2005 and 2004.
Preferred and preference dividends of Duquesne Light were $8.0 million, $6.6 million and $3.2
million in 2005, 2004 and 2003. Total preferred and preference stock had involuntary liquidation
values of $148.8 million and $150.0 million, which exceeded par by $12.9 million and $14.1 million
as of December 31, 2005 and 2004.
We have an Employee Stock Ownership Plan (ESOP) to provide matching contributions for the
Holdings 401(k) Retirement Savings Plan. (See
Note 12.) We issued and sold 845,070 shares of Duquesne Light preference stock, plan
series A, to the trustee of the ESOP. As consideration for the stock, we received a note valued at
$30 million from the trustee. The preference stock has an annual dividend rate of $2.80 per share,
and each share of the preference stock is exchangeable for the greater of one and one-half shares
of Holdings common stock or $35.50 worth of Holdings common stock. Dividends on the preference
stock and cash contributions from Holdings are used to fund the repayment of the ESOP note. We made
cash contributions of approximately $0.2 million, $0.5 million and $0.3 million for 2005, 2004 and,
2003. These cash contributions were the difference between the ESOP debt service and the amount of
dividends on ESOP shares ($1.1 million, $1.2 million and $1.3 million in 2005, 2004 and 2003). As
shares of preference stock are allocated to the accounts of participants in the ESOP, we recognize
compensation expense, and the amount of the deferred compensation benefit is amortized.
16. Equity
Holdings.
Changes in the Number of Shares of Holdings Common Stock Outstanding as of December 31,
(Millions of Shares)
2005
2004
2003
January 1
77.0
75.4
74.3
Issuances
1.0
1.6
1.1
December 31
78.0
77.0
75.4
Once all dividends on Holdings preferred stock have been paid, dividends may be paid on
Holdings common stock as permitted by law and as declared by the board of directors. Since we are a
holding company, substantially all of the assets shown on our consolidated balance sheets are held
by our subsidiaries. Accordingly, our earnings and cash flow, and our ability to meet our
obligations, are largely dependent upon the earnings and cash flows of such subsidiaries and the
distribution or other payment of such earnings to us in the form of dividends, loans or advances,
and repayment of loans and advances from us. Our subsidiaries are separate and distinct legal
entities and have no obligation to pay any amounts due on our securities or to make any funds
available for such payments. Our subsidiaries’ ability to make dividend payments or other
distributions to us may be restricted by their obligations to holders of their outstanding debt and
preferred securities and to their creditors, the availability of earnings and the needs of their
businesses.
No part of the retained earnings of Holdings was restricted at December 31, 2005.
During 2005, we paid total common stock dividends of $78.7 million (including $1.2 million
paid to Duquesne Light), and of this amount, $10.4 million was reinvested to purchase approximately
570,000 shares of treasury stock for those shareholders who participated in our Dividend
Reinvestment and Direct Stock Purchase Plan (DRIP).
Also during 2005, we issued approximately 199,000 shares of treasury stock for purchases made
by shareholders under our DRIP and 352,244 shares as a result of the conversion of Holdings
preferred stock.
During 2004, we paid total common stock dividends of $76.1 million (including $1.2 million
paid to Duquesne Light), and of this amount, $10.5 million was reinvested to purchase approximately
556,000 shares of treasury stock for those shareholders who participated in our DRIP.
Also during 2004, we issued approximately 191,000 shares of treasury stock for purchases made
by shareholders under our DRIP and 406,000 shares as a result of the conversion of Holdings
preferred stock.
During 2003, we paid total common stock dividends of $75.1 million (including $1.2 million
paid to Duquesne Light), and of this amount, $10.7 million was reinvested to purchase approximately
737,000 shares of treasury stock for those shareholders who participated in our DRIP.
Also during 2003, we issued approximately 241,000 shares of treasury stock for purchases made
by shareholders under our DRIP and 72,794 shares as a result of the conversion of Holdings
preferred stock.
When treasury stock is issued, the difference between the market price of our common stock, or
the option exercise price, and the average cost of the treasury stock causes an increase or
decrease in the value of common stock on the consolidated balance sheets.
Accumulated other comprehensive income consists of unrealized holding gains and losses on
interest rate and cash flow hedging instruments and adjustments to the minimum pension liability.
Duquesne Light. In July 1989, Duquesne Light became a wholly owned subsidiary of Holdings,
whose common stock replaced the outstanding
shares of Duquesne Light’s common stock, except for the 10 shares Holdings owns.
Payments of dividends on Duquesne Light common stock may be restricted by obligations to
holders of its preferred and preference stock, pursuant to its Restated Articles of Incorporation.
No dividends or distributions may be made on Duquesne Light’s common stock if it has not paid
dividends on its preferred or preference stock. Dividends may also be effectively limited by the
terms of certain financing agreements. Further, the aggregate amount of common stock dividend
payments or distributions may not exceed certain percentages of net income, if the ratio of total
common shareholder’s equity to total capitalization is less than specified percentages. No part of
Duquesne Light’s retained earnings was restricted at December 31, 2005.
During 2005, 2004 and 2003, Duquesne Light paid dividends on common stock to Holdings of $20
million, $71 million and $69 million.
During 2005, Holdings made equity contributions to Duquesne Light totaling $82.5 million.
Accumulated other comprehensive income consists of unrealized gains or losses on available for
sale investments and adjustments to the minimum pension liability.
17. Discontinued Operations
Pursuant to agreements entered into as well as our subsequent sale of our investments in
AquaSource and Pro Am, these subsidiaries have been reflected as discontinued operations in the
consolidated financial statements.
AQUASOURCE
In July 2003, AquaSource closed the sale of its investor-owned water utilities (and certain
related contract operations) to Aqua America for a purchase price of approximately $178 million in
cash, after working capital and purchase price adjustments, including the one described below. Aqua
America also assumed $10.4 million of debt associated with the business.
Unable to resolve purchase price adjustment issues regarding rate base and customer
connections, AquaSource and Aqua America agreed to arbitrate their dispute. In August 2004, the
arbitration panel found in Aqua America’s favor, reducing the final purchase price by approximately
$12 million. The resulting payment to Aqua America had been reserved for, and accordingly did not
have a material adverse effect on our financial position or results of operations.
In May 2004, AquaSource repurchased the minority interest held by an unrelated party for
approximately $8.2 million.
Due to the earlier than anticipated closing of this sale, we were not required to make certain
expenditures, thereby increasing the net recorded value of AquaSource by approximately $11.5
million after-tax, which was recorded in June 2003. The 2003 income also included a $66.6 million
tax benefit related to the use of capital losses generated in connection with the sale of the
AquaSource subsidiaries. (See Note 10.)
In 2003, AquaSource sold various other operations for $17.7 million, though subsequent
purchase price adjustments reduced the net amount to $16.3 million. Of the total purchase price,
$3.3 million was in the form of a personally guaranteed promissory note, which was paid in full in
January 2005. Also during 2003, we spent approximately $16.8 million for water utility construction
prior to the sale of AquaSource.
In connection with the assignment of certain rights to a previous construction contract,
AquaSource received $1.7 million in January 2006 in settlement of a receivable that had been
previously fully reserved. This amount is included on Holdings’ consolidated balance sheet as a
current asset from discontinued operations as of December 31, 2005.
PRO AM
On December 13, 2002, we sold Pro Am’s propane distribution business to Ferrellgas Partners,
L.P., for approximately $42 million, $32 million of which was paid in cash at the closing. We
received an unsecured note for the remaining $10 million, which matured on December 13, 2003. We
have collected $9.4 million in full settlement of this note.
The following table summarizes income statement data from discontinued operations:
Operating Results,
net of tax of $—,
$0.5, and $1.8
$
—
$
(0.9
)
$
(1.5
)
Gain from sale,
net of tax of $0.8,
$0.4, and $(71.6)
1.3
0.7
84.2
Income (Loss) from
Discontinued
Operations
$
1.3
$
(0.2
)
$
82.7
18. Duquesne Light Transactions
With Affiliates
As a wholly owned subsidiary of Holdings, Duquesne Light has various transactions with its
parent company and affiliates.
Duquesne Light generally pays quarterly dividends to Holdings. During 2005, Duquesne Light
embarked on a significant capital expenditure program, and began retaining more of its earnings
than in prior years. As of December 31, 2005 and 2004, Duquesne Light’s dividend payable to
Holdings was zero and $7 million and was included in payable to affiliates on Duquesne Light’s
consolidated balance sheets.
Duquesne Light participates in a tax sharing arrangement with Holdings to provide, among other
things, for the payment of taxes for periods during which Holdings and Duquesne Light are included
in the same consolidated group for federal tax purposes. Duquesne Light shares in the consolidated
tax liability to the extent of its income or loss for the year. (See Note 10.) As of December 31,2005 and 2004, Duquesne Light’s tax liability to (receivable from) Holdings under this arrangement
was $(6.0) million and $(2.6) million and was included in payable to affiliates on Duquesne
Light’s consolidated balance sheets.
Following the sale of generation assets in 2000, Duquesne Light loaned $250 million of the
sale proceeds to Holdings. Duquesne Light recorded interest income from Holdings on this note until
its redemption in 2005. On January 1, 2002, the interest rate charged on the note was lowered to
reflect then-current market rates. The PUC had questioned this decrease, and in February 2006 we
reached an agreement with the PUC, requiring Holdings to contribute approximately $27.6 million to
Duquesne Light, which represents the difference in interest that would have been charged to
Holdings had this interest rate not been lowered.
Duquesne Light participated in a cash pool arrangement with DQE Capital, until November 2005,
and earned interest income on available cash that was deposited with DQE Capital. As a holder of
Holdings common stock, Duquesne Light receives dividend income from Holdings.
Duquesne Light charges an administrative fee to Holdings and its affiliates based on an
allocation method that considers the cost of actual or estimated services performed and other
expenses incurred on behalf of Holdings or its affiliates. Following the sale of several of Holdings’ non-complementary businesses,
administrative cost allocations to affiliates is lower in 2005 as compared to 2004 and 2003.
Duquesne Light collects pole and duct revenue from its communications affiliate and pays the
same affiliate for the rental of communication fiber. Duquesne Light purchases energy for its
internal use from Duquesne Light Energy, and collects transmission revenues from the same
affiliate.
During 2005, Duquesne Light’s former subsidiary, Duquesne Power, made wholesale sales of
energy to Duquesne Light Energy and incurred interest expense to Holdings on a working capital
note. On December 31, 2005, Duquesne Light made a $17.7 million non-cash dividend to Holdings
through the transfer of its subsidiary, Duquesne Power. This entity was subsequently distributed to
another Holdings subsidiary. This transfer will effectively eliminate the net income
included in Duquesne Light’s supply segment. As of December31, 2005, Duquesne Light’s payable to Duquesne Power for energy supplied under the
full-requirements contract was $46.2 million and was included in payable to affiliates on Duquesne
Light’s consolidated balance sheets.
Certain of Duquesne Light’s revenues and expenses relate to transactions with Holdings and its
affiliates, including the following:
Allocated labor charges include the associated fringe benefits, including pension and health
care costs.
19. Supplemental Cash Flow Disclosure
Non-cash investing activity in 2005 at both Holdings and Duquesne Light consisted of a $21.7
million increase in accounts payable related to construction expenditures. Non-cash financing
activity in 2005 at Duquesne Light consisted of a $17.7 million non-cash dividend of a subsidiary
to Holdings. The subsidiary’s balance sheet consists primarily of derivative assets and liabilities
and the related deferred tax liabilities and accumulated other comprehensive income.
Non-cash activity related to the pension plans in 2005 consisted of a $5.1 million increase in
prepaid pension costs, a $36.9 million increase in pension intangible assets, a $82.4 million
increase in pension liabilities, a $16.8 million decrease in deferred income taxes and a $23.6
million decrease in accumulated other comprehensive income.
Non-cash activity related to the pension plans in 2004 consisted of a $4.5 million increase in
prepaid pension costs, a $5.8 million increase in pension intangible assets and a $10.3 million
increase in pension liabilities.
Non-cash activity related to the pension plans in 2003 consisted
of a $4.7 million increase in prepaid pension costs and a $4.7 million increase in pension
liabilities.
Holdings Changes in Working Capital Other than Cash (a) for the Year Ended December 31,
(Millions of Dollars)
2005
2004
2003
Receivables
$
(16.1
)
$
(10.1
)
$
1.1
Other current assets
6.6
3.4
8.9
Accounts payable
(20.4
)
(11.2
)
(2.8
)
Other current
liabilities
13.9
8.9
(19.1
)
Total
$
(16.0
)
$
(9.0
)
$
(11.9
)
(a)
The amounts shown exclude the effects of acquisitions, dispositions and restructuring
charges.
Duquesne Light Changes in Working Capital Other than Cash (a) for the Year Ended December 31,
(Millions of Dollars)
2005
2004
2003
Receivables
$
(18.7
)
$
(5.7
)
$
12.8
Other current assets
(4.3
)
3.4
(4.5
)
Accounts payable
(20.7
)
(3.8
)
(26.0
)
Other current
liabilities
5.3
(48.7
)
(34.4
)
Total
$
(38.4
)
$
(54.8
)
$
(52.1
)
(a)
The amounts shown exclude the effects of restructuring charges and the transfer of the
subsidiary.
20. Business Segments and Related
Information
Duquesne Light reports the following business segments: (1) transmission and distribution of
electricity (electricity delivery business segment), (2) supply of electricity by Duquesne Light
(Duquesne Light supply business segment), and (3) collection of transition costs (which were fully
collected by December 31, 2005) (CTC business segment).
Holdings reports the following business segments: (1) transmission and distribution of
electricity (electricity delivery business segment), (2) supply of electricity (which includes the
Duquesne Light supply business segment and, beginning in 2005, supply by DLE) (electricity supply
business segment), (3) collection of transition costs (which were fully collected by December 31,2005) (CTC business segment), (4) DES’ development, operation and maintenance of energy facilities
and, for a single customer, synthetic fuel facilities (Energy Solutions
business segment), (5) DQE Financial’s collection and processing of landfill gas and management of
structured finance and alternative energy investments (Financial business segment), and (6) DQE
Communications’ operation, maintenance and leasing of its fiber optic based network (Communications
business segment). We also report an “all other” category to include our other subsidiaries below
the quantitative threshold for disclosure. These subsidiaries provide corporate administrative
functions, financing, and insurance services for our various affiliates.
Summary of Selected Quarterly Financial Data Duquesne Light Holdings
(Millions of Dollars, Except Per Share Amounts)
2005 (a)
First Quarter
Second Quarter
Third Quarter
Fourth Quarter
Operating revenues
$
218.7
$
221.9
$
263.3
$
218.3
Operating income
47.1
38.7
58.8
33.7
Income from continuing operations
34.6
(b)
21.6
43.5
(b)
13.2
(b)
Income (loss) from discontinued operations
0.4
(0.1
)
0.1
0.9
Net income
35.0
21.5
43.6
14.1
Basic earnings (loss) per share:
Continuing operations
0.45
0.28
0.56
0.17
Discontinued operations
—
—
—
0.01
Total
0.45
0.28
0.56
0.18
Stock price:
High
19.17
19.25
19.43
17.40
Low
17.43
17.30
17.17
16.14
2004 (a)
First Quarter
Second Quarter
Third Quarter
Fourth Quarter
Operating revenues
$
217.1
$
218.9
$
242.8
$
218.5
Operating income
35.2
36.4
40.2
(c)
38.9
Income from continuing operations
21.7
23.0
23.4
19.1
Income (loss) from discontinued operations
0.1
0.4
0.2
(0.9
)
Net income
21.8
23.4
23.6
18.2
Basic earnings (loss) per share:
Continuing operations
0.29
0.30
0.31
0.25
Discontinued operations
—
0.01
—
(0.01
)
Total
0.29
0.31
0.31
0.24
Stock price:
High
20.44
19.70
19.62
19.25
Low
18.05
17.71
17.96
17.01
(a)
The quarterly data reflect seasonal weather variations in the electric utility’s service
territory. Stock prices reflect New York Stock Exchange data.
(b)
First quarter results include a $8.3 million increase in the fair value of certain derivative
energy contracts at Duquesne Light and a $4.6 million gain on the sale of an investment at DQE
Financial. Third quarter results include a $11.7 million gain on the sale of an energy
facility management project at DES and an $6.5 million increase in the fair value of certain
derivative energy contracts at Duquesne Light. Fourth quarter results include a $7.8 million
gain on the sale of two energy facility management projects at DES, a $3.7 million decrease in
the fair value of certain derivative energy contracts at Duquesne Light and $6.7 million of
charges related to an energy facility management project.
(c)
Third quarter results include a pre-tax charge of $8.3 million at Duquesne Light for
the write-off of deposits and deferred costs related to the termination of the acquisition of
a generation station. (See Note 3.)
The quarterly data reflect seasonal weather variations in our service territory.
(b)
First quarter results include a $8.3 million increase in the fair value of certain derivative
energy contracts. Third quarter results include an $6.5 million increase in the fair value of
certain derivative energy contracts. Fourth quarter results include a $3.7 million decrease in
the fair value of certain derivative energy contracts.
(c)
Third quarter results include an $8.3 million pre-tax charge for the write-off of deposits
and deferred costs related to the termination of the acquisition of a generation station. (See
Note 3.)
Item 9. Changes In and Disagreements With Accountants On Accounting and Financial Disclosure.
None.
Item 9A. Controls and Procedures.
Disclosure Controls and Procedures
Management of both Holdings and Duquesne Light, with the participation of each entity’s Chief
Executive Officer and the Chief Financial Officer, has evaluated their respective disclosure
controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange
Act of 1934, as amended) as of the end of the period covered by this report. Each entity’s Chief
Executive Officer and the Chief Financial Officer have concluded that these controls and procedures
are effective to ensure that the information required to be disclosed in Holdings’ and Duquesne
Light’s reports under the Securities Exchange Act of 1934 is recorded, processed, summarized and
reported within the time periods specified in the rules and forms of the SEC.
Management’s Report on Internal Control Over Financial Reporting
Management of both Holdings and Duquesne Light is responsible for establishing and maintaining
adequate internal control over financial reporting. These internal control systems are designed to
provide reasonable assurance to each entity’s management and board of directors regarding the
preparation and fair presentation of published financial statements.
All internal control systems, no matter how well designed, implemented, and executed have
inherent limitations. Therefore, even those systems determined to be effective can provide only
reasonable assurance with respect to financial statement preparation and presentation.
Management of both entities assessed the effectiveness of their respective internal control
over financial reporting as of December 31, 2005. In making these assessments, each entity used the
criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO)
in Internal Control-Integrated Framework. Our assessment included reviewing the documentation of
our controls, evaluating their design effectiveness, and testing their operating effectiveness.
Based on our assessment, management of each entity believes that, as of December 31, 2005, the
respective entity’s internal control over financial reporting is effective based on those criteria.
The independent auditors for Holdings and Duquesne Light have issued the below attestation
reports on each entity’s assessment of its internal control over financial reporting.
Changes in Internal Control Over Financial Reporting
There has been no change in Holdings’ or Duquesne Light’s internal control over financial
reporting that occurred during the fourth quarter that has materially affected, or is reasonably
likely to
materially affect, such internal control over financial reporting.
REPORTS OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of Duquesne Light Holdings, Inc.:
We have audited management’s assessment, included in the accompanying Management’s Report on
Internal Control Over Financial Reporting, that Duquesne Light Holdings, Inc. and subsidiaries (the
“Company”) maintained effective internal control over financial reporting as of December 31, 2005,
based on the criteria established in Internal Control—Integrated Framework issued by the Committee
of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible
for maintaining effective internal control over financial reporting and for its assessment of the
effectiveness of internal control over financial reporting. Our responsibility is to express an
opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal
control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether effective internal control over financial reporting was
maintained in all material respects. Our audit included obtaining an understanding of internal
control over financial reporting, evaluating management’s assessment, testing and evaluating the
design and operating effectiveness of internal control, and performing such other procedures as we
considered necessary in the circumstances. We believe that our audit provides a reasonable basis
for our opinions.
A company’s internal control over financial reporting is a process designed by, or under the
supervision of, the company’s principal executive and principal financial officers, or persons
performing similar functions, and effected by the company’s board of directors, management, and
other personnel to provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance with generally
accepted accounting principles. A company’s internal control over financial reporting includes
those policies and procedures that (1) pertain to the maintenance of records that, in reasonable
detail, accurately and fairly reflect the transactions and dispositions of the assets of the
company; (2) provide reasonable assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with generally accepted accounting principles,
and that receipts and expenditures of the company are being made only in accordance with
authorizations of management and directors of the company; and (3) provide reasonable assurance
regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the
company’s assets that could have a material effect on the financial statements.
Because of the inherent limitations of internal control over financial reporting, including
the possibility of collusion or improper management override of controls, material misstatements
due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any
evaluation of the effectiveness of the internal control over financial reporting to future periods
are subject to the risk that the controls may become inadequate because of changes in conditions,
or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management’s assessment that the Company maintained effective internal control
over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based
on the criteria established in Internal Control—Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission. Also in our opinion, the Company maintained,
in all material respects, effective internal control over financial reporting as of December 31,2005, based on the criteria established in Internal Control—Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission.
We have also audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the consolidated financial statements and financial statement
schedules as of and for the year ended December 31, 2005 of the Company and our report dated
March 6, 2006 expressed an unqualified opinion on those financial statements and financial
statement schedules.
To the Board of Directors and Shareholder of
Duquesne Light Company:
We have audited management’s assessment, included in the accompanying Management’s Report on
Internal Control Over Financial Reporting, that Duquesne Light Company and subsidiaries (the
“Company”) maintained effective internal control over financial reporting as of December 31, 2005,
based on the criteria established in Internal Control—Integrated Framework issued by the Committee
of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible
for maintaining effective internal control over financial reporting and for its assessment of the
effectiveness of internal control over financial reporting. Our responsibility is to express an
opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal
control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether effective internal control over financial reporting was
maintained in all material respects. Our audit included obtaining an understanding of internal
control over financial reporting, evaluating management’s assessment, testing and evaluating the
design and operating effectiveness of internal control, and performing such other procedures as we
considered necessary in the circumstances. We believe that our audit provides a reasonable basis
for our opinions.
A company’s internal control over financial reporting is a process designed by, or under the
supervision of, the company’s principal executive and principal financial officers, or persons
performing similar functions, and effected by the company’s board of directors, management, and
other personnel to provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance with generally
accepted accounting principles. A company’s internal control over financial reporting includes
those policies and procedures that (1) pertain to the maintenance of records that, in reasonable
detail, accurately and fairly reflect the transactions and dispositions of the assets of the
company; (2) provide reasonable assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with generally accepted accounting principles,
and that receipts and expenditures of the company are being made only in accordance with
authorizations of management and directors of the company; and (3) provide reasonable assurance
regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the
company’s assets that could have a material effect on the financial statements.
Because of the inherent limitations of internal control over financial reporting, including
the possibility of collusion or improper management override of controls, material misstatements
due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any
evaluation of the effectiveness of the internal control over financial reporting to future periods
are subject to the risk that the controls may become inadequate because of changes in conditions,
or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management’s assessment that the Company maintained effective internal control
over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based
on the criteria established in Internal Control—Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission. Also in our opinion, the Company maintained,
in all material respects, effective internal control over financial reporting as of December 31,2005, based on the criteria established in Internal Control—Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission.
We have also audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the consolidated financial statements and financial statement
schedule as of and for the year ended December 31, 2005 of the Company and our report dated
March 6, 2006 expressed an unqualified opinion on those financial statements and financial
statement schedule.
Item 10. Directors and Executive Officers of the Registrants.
Information relating to Holdings’ executive officers and Duquesne Light’s executive officers
and directors is set forth in Part I of this Report under the caption “Executive Officers of the
Registrant.” All other information about Holdings required under this Item 10 is set forth in and
incorporated by reference from the 2006 Proxy Statement. All other information about Duquesne Light
required under this Item 10 is set forth in and incorporated by reference from Exhibit 99.1.
Because Holdings lists its common stock on the New York Stock Exchange (NYSE), Holdings’ Chief
Executive Officer is required to make, and has made, an annual certification to the NYSE stating
that he was not aware of any violation by Holdings of the corporate governance listing standards of
the NYSE. Holdings’ Chief Executive Officer made his annual certification to that effect to the
NYSE as of June 8, 2005. Because Duquesne Light lists only debt and preferred securities on the
NYSE, it is not required to make such annual certifications.
Both Holdings and Duquesne Light have filed, as exhibits to this combined Annual Report on
Form 10-K, the Chief Executive Officer and Chief Financial Officer certifications required under
Section 302 of the Sarbanes-Oxley Act of 2002 regarding the quality of our public disclosure.
Item 11. Executive Compensation.
Information relating to executive compensation for Holdings is set forth in and incorporated
by reference from the 2006 Proxy Statement. Information relating to executive compensation for Duquesne Light is
set forth in and incorporated by reference from Exhibit 99.1.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
Information relating to the ownership of Holdings equity securities by Holdings’ directors,
officers and certain beneficial owners is set forth in and incorporated by reference from the 2006
Proxy Statement.
Information relating to the ownership of Holdings equity securities by Duquesne Light
directors, officers and certain beneficial owners is set forth in and incorporated by reference
from Exhibit 99.1.
The following table gives information about our common stock that may be issued upon the
exercise of options, warrants and rights under all of our existing compensation plans as of
December 31, 2005:
(a)
(b)
(c)
Number of
securities
remaining available
Number of
for future issuance
securities to be
under equity
issued upon
Weighted average
compensation plans
exercise of
exercise price of
(excluding
outstanding
outstanding
securities
options, warrants
options, warrants
reflected in column
Plan Category
and rights (1)
and rights
(a)) (2)
Equity compensation
plans approved by
security holders
1,130,602
$
23.10
2,622,280
Equity compensation
plans not approved
by security holders
—
—
—
Total
1,130,602
$
23.10
2,622,280
(1)
Includes 352,373 shares of common stock issuable upon exercise of options granted under
our prior Long-Term Incentive Plan (discontinued in 2002) and 199,631 shares of common
stock issuable upon exercise of options granted under our current Incentive Plan. Reflects
363,200 and 33,367 deferred stock units awarded in 2003 and 2005, which may or may not be
earned depending on our achieving cumulative total shareholder return and earnings per
share goals through 2006. Awardees may earn up to 100% of the amounts awarded. Reflects
52,390 restricted stock units awarded in 2004, which may or may not be earned depending on
our achieving cumulative total shareholder return goals through 2006. Awardees may earn up
to 100% of the amounts awarded. Reflects 186,417; 20,000; and 36,292 restricted shares
issued in 2003, 2004 and 2005.
(2)
All of these shares are available under our current Incentive Plan.
Item 13. Certain Relationships and Related Transactions.
None.
Item 14. Principal Accounting Fees and Services.
Information regarding Deloitte & Touche LLP’s fees and services is set forth in and
incorporated by reference from the 2006 Proxy Statement. Such fees and services apply to Deloitte &
Touche LLP’s work for all of Holdings’ consolidated subsidiaries, including Duquesne Light.
PART IV
Item 15. Exhibits and Financial Statement Schedules
(a)(1) The following information is set forth in Part II, Item 8:
Reports of Independent Registered Public Accounting Firm.
Holdings Consolidated Statements of Income for the Three Years Ended December 31, 2005.
I — Condensed Financial Information of Registrant (Holdings)
II — Valuation and Qualifying Accounts (Holdings)
II — Valuation and Qualifying Accounts (Duquesne
Light)
The remaining schedules are omitted because of the absence of the conditions under which they
are required or because the information called for is shown in the financial statements or notes to
the consolidated financial statements.
(a)(3) Exhibits are set forth in the Exhibit Index below, incorporated here by reference. Documents
other than those designated as being filed here are incorporated here by reference. Documents
incorporated by reference to a Holdings Annual Report on Form 10-K, a Quarterly Report on Form 10-Q
or a Current Report on Form 8-K are at Securities and Exchange Commission File
No. 1-10290. Documents incorporated by reference to a Duquesne Light Annual Report on Form 10-K, a
Quarterly Report on Form 10-Q or a Current Report on Form 8-K are at Securities and Exchange
Commission File No. 1-956.
The Exhibits include the management contracts and compensatory plans or arrangements required to be
filed as exhibits to this Form 10-K by Item 601(b)(10)(iii) of Regulation S-K.
Exhibit 3.6 to the Holdings Form
10-K for the year ended December31, 2002.
3.7
Holdings Statement with respect to the Preferred Stock, Series A (Convertible).
Exhibit 3.1 to the Holdings Form
10-Q for the quarter ended
September 30, 1997.
3.8
Duquesne Light Restated Articles of Incorporation currently in effect.
Exhibit 3.1 to the Duquesne
Light Form 10-Q for the quarter
ended
June 30, 1999.
3.9
Holdings By-Laws, as amended through September 30, 2003, and as currently in effect.
Exhibit 3.1 to the Holdings Form
10-Q for the quarter ended
September 30, 2003.
3.10
Duquesne Light By-Laws, as amended through October 13, 2003, and as currently in
effect.
Exhibit 3.1 to the Duquesne
Light Form 10-Q for the quarter
ended September 30, 2003.
3.11
Form of Duquesne Light Statement with respect to the 6.50% Preferred Stock.
Exhibit 3.3 to Registration
Statement (Form S-3) No.
333-112929.
4.1
Indenture of Mortgage and Deed of Trust dated as of April 1, 1992, between Duquesne
Light Company and JP Morgan Chase (a restatement of the Indenture in its entirety as
amended through 2004).
Exhibit 4.1 to the Holdings Form
10-K for the year ended December31, 2004.
4.2
Indenture dated as of August 16, 2005 between Holdings and
J.P. Morgan Trust Company, National Association, as Trustee.
Schedule to Exhibit 10.4 listing substantially identical agreements with Joseph G.
Belechak, Maureen L. Hogel, Mark E. Kaplan, Stevan R. Schott and James E. Wilson.
Filed here.
10.6
Employment Agreement dated as of September 14, 2001 between Holdings and Morgan K.
O’Brien.
Exhibit 10.8 to the Holdings Form
10-K for the year ended December31, 2001.
Holdings’ Amended and Restated $200 Million Credit Agreement dated as of July 27,2005.
Exhibit 10.1 to the Holdings
Form 10-Q for the quarter ended
June 30, 2005.
10.22
Increasing Lender Agreement between Holdings and Union Bank of California, N.A.,
dated January 31, 2006, modifying Holdings’ Amended and Restated $200 Million Credit
Agreement, together with a schedule listing substantially identical agreements with
the other lenders.
Filed here.
10.23
Accession and Amendment Agreement between Holdings and Keybank National Association,
dated January 31, 2006, including Keybank as a lender under Holdings’ Amended and
Restated $200 Million Credit Agreement.
Duquesne Light’s Third Amended and Restated $100 Million Credit Agreement dated as
of July 27, 2005.
Exhibit 10.2 to the Duquesne
Light Form 8-K dated July 27,2005.
10.25
Increasing Lender Agreement between Duquesne Light and JPMorgan Chase, N.A., dated
January 31, 2006, modifying Duquesne Light’s Third Amended and Restated $100 Million
Credit Agreement, together with a schedule listing substantially identical
agreements with the other lenders.
Filed here.
10.26
Accession and Amendment Agreement between Duquesne Light and Keybank National
Association, dated January 31, 2006, including Keybank as a lender under Duquesne
Light’s Third Amended and Restated $100 Million Credit Agreement.
Filed here.
10.27
POLR Agreement, dated as of September 24, 1999 by and between Duquesne Light Company
and Orion Power Holdings, Inc.
Copies of the exhibits listed above will be furnished, upon request, to holders or beneficial
owners of any class of our stock as of January 31, 2006, subject to payment in advance of the
cost of reproducing the exhibits requested.
SCHEDULE I
Condensed Financial Information of Registrant (Parent Company)
Duquesne Light Holdings, Inc.
Schedule I — Condensed Financial Information of Registrant (Parent Company)
Schedule I — Condensed Financial Information of Registrant (Parent Company)
Notes to Condensed Financial Statements
1. Basis of Presentation
Pursuant to rules and regulations of the Securities and Exchange Commission, the
unconsolidated condensed financial statements of Duquesne Light
Holdings, Inc. (Holdings) do
not reflect all of the information and notes normally included with financial statements prepared
in accordance with accounting principles generally accepted in the United States of America.
Therefore, these financial statements should be read in conjunction with the consolidated financial
statements and related notes included in Item 8 in Holdings’ annual report on Form 10-K.
Accounting for subsidiaries—Holdings has accounted for the earnings of its subsidiaries
under the equity method in the unconsolidated condensed financial statements.
Income
taxes—Income taxes are computed for Holdings in accordance
with Statement of Financial Accounting Standards No. 109,
“Accounting for Income Taxes”, and reflect the assets and
liabilities of Holdings on a stand-alone basis. Holdings also records the effect of filing consolidated federal
tax returns with its subsidiaries.
2. Restricted Net Assets of Subsidiaries
As of December 31, 2005, Holdings’ proportionate share of net assets from subsidiaries which may
not be transferred to Holdings in the form of loans, advances or cash dividends without the consent
of a third party was $234.3 million.
Valuation and Qualifying Accounts
For the Years Ended December 31, 2005, 2004 and 2003 Reserve deducted from the Asset to which it applies: Allowance for uncollectible accounts
Pursuant to the requirements of Section 13 or 15(d) 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.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant and in the capacities and on the
dates indicated.
Pursuant to the requirements of Section 13 or 15(d) 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.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant and in the capacities and on the
dates indicated.
