<PAGE>
SCHEDULE 14C INFORMATION
Information Statement Pursuant to Section 14(c) of
the Securities Exchange Act of 1934 (Amendment No. )
Check the appropriate box:
/ / Preliminary Information Statement
/ / Confidential, for Use of the Commission Only (as permitted by Rule
14c-5(d)(2))
/X/ Definitive Information Statement
PSI ENERGY INC.
- --------------------------------------------------------------------------------
(Name of Registrant As Specified In Its Charter)
Payment of Filing Fee (Check the appropriate box):
/X/ No fee required
/ / Fee computed on table below per Exchange Act Rules 14c-5(g) and 0-11
(1) Title of each class of securities to which transaction applies:
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(2) Aggregate number of securities to which transaction applies:
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(3) Per unit price or other underlying value of transaction computed
pursuant to Exchange Act Rule 0-11 (set forth the amount on which the
filing fee is calculated and state how it was determined):
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(4) Proposed maximum aggregate value of transaction:
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(5) Total fee paid:
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/ / Fee paid previously with preliminary materials.
/ / Check box if any part of the fee is offset as provided by Exchange Act Rule
0-11(a)(2) and identify the filing for which the offsetting fee was paid
previously. Identify the previous filing by registration statement number,
or the Form or Schedule and the date of its filing.
(1) Amount Previously Paid:
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(2) Form, Schedule or Registration Statement No.:
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(3) Filing Party:
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(4) Date Filed:
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PSI ENERGY, INC. 1998 INFORMATION STATEMENT AND
CINERGY CORP. 1997 FINANCIAL REPORT
BUILDING
A GROWTH ENERGY COMPANY
WORK IN PROGRESS
97
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
<S> <C>
Notice of Annual Meeting 2
PSI Energy, Inc. 1998 Information Statement 3
Appendix: 1997 Financial Report A-1
Review of Financial Condition and Results of Operations A-1
Consolidated Statements of Income A-20
Consolidated Balance Sheets A-21
Consolidated Statements of Changes in Common Stock Equity A-23
Consolidated Statements of Cash Flows A-24
Notes to Consolidated Financial Statements A-25
Responsibility for Financial Statements A-49
Report of Independent Public Accountants A-50
Five Year Statistical Summary A-51
</TABLE>
NOTICE OF ANNUAL MEETING OF SHAREHOLDERS TO BE HELD ON APRIL 22, 1998
To the Shareholders of PSI Energy, Inc.:
NOTICE IS HEREBY GIVEN that the Annual Meeting of Shareholders of PSI
Energy, Inc. will be held in the McKinley Room of the Westin Hotel at
Fountain Square, 21 East Fifth Street, Cincinnati, Ohio, on Wednesday, April
22, 1998 at 10:00 a.m., eastern daylight saving time, for the purposes of
electing seven directors and transacting such other business as may legally
come before the meeting, or any adjournment or postponement thereof.
Only shareholders of record at the close of business on Monday, February
23, 1998, will be entitled to vote at the meeting, or any adjournment or
postponement thereof.
Proxies will not be solicited for this meeting and you are requested not
to send us a proxy. Shareholders are welcome to attend the meeting in person
and cast their votes by ballot on the issues presented at the meeting.
By Order of the Board of Directors,
Cheryl M. Foley
Vice President,
General Counsel and Secretary
Dated: March 23, 1998
2
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PSI Energy, Inc.
1000 East Main Street
Plainfield, Indiana 46168
(317) 839-9611
INFORMATION STATEMENT
INTRODUCTION
PSI Energy, Inc., an Indiana corporation (the "Company"), is an operating
utility primarily engaged in providing electric service in north central,
central, and southern Indiana, and is a subsidiary of Cinergy Corp., a
Delaware corporation and registered holding company under the Public Utility
Holding Company Act of 1935, as amended ("Cinergy"). Cinergy is also the
parent company of The Cincinnati Gas & Electric Company ("CG&E"), Cinergy
Services, Inc. ("Services") and Cinergy Investments, Inc. ("Investments").
CG&E is an operating utility primarily engaged in providing electric and gas
service in the southwestern portion of Ohio and, through its principal
subsidiary, The Union Light, Heat and Power Company ("ULH&P"), in adjacent
areas in Kentucky. Services provides management, financial, administrative,
engineering, legal and other services to the Company, Cinergy, CG&E, and
Investments. Cinergy conducts its international and non-regulated businesses
through Investments and its subsidiaries.
This Information Statement is first being mailed on or about March 23,
1998 to the shareholders of the Company in connection with its Annual Meeting
of Shareholders to be held on April 22, 1998, or any adjournment or
postponement of such meeting (the "Annual Meeting"). Included as an Appendix
to this Information Statement are Cinergy's consolidated financial statements
and accompanying notes for the calendar year ended December 31, 1997, and
other information relating to Cinergy's financial results and position.
Cinergy's Summary Annual Report to Shareholders also accompanies the mailing
of this material.
The Company has engaged Corporate Investor Communications, Inc. ("CIC")
to assist with the forwarding of this material to the beneficial owners of
the Company's cumulative preferred stock held by such holders through
brokerage houses and other custodians, nominees and fiduciaries and,
accordingly, will reimburse CIC for its reasonable out-of-pocket expenses for
forwarding the materials.
Cinergy owns all of the 53,913,701 outstanding shares of the Company's
class of common stock. There remain outstanding 4,366,887 shares of the
Company's class of cumulative preferred stock as of the close of business on
February 23, 1998, which also have certain voting rights as set forth in the
next section.
Since Cinergy's ownership represents more than 97% of the total votes
that could be cast at the Annual Meeting, and since shareholders do not have
cumulative voting rights and Cinergy intends to vote in favor of all
director-nominees for election as directors to the Board of Directors of the
Company (the "Board"), the election of such director-nominees is assured.
Therefore, the Board considered it inappropriate to solicit proxies for the
Annual Meeting. Please be advised, therefore, that this is only an
Information Statement. WE ARE NOT ASKING YOU FOR A PROXY AND YOU ARE
REQUESTED NOT TO SEND US A PROXY. However, if you wish to vote your shares of
cumulative preferred stock, you may do so by attending the Annual Meeting in
person and casting your vote by a ballot which will be provided for that
purpose.
VOTING SECURITIES AND PRINCIPAL SHAREHOLDERS
Only holders of record of the Company's voting securities at the close of
business on February 23, 1998 (the "Record Date") will be entitled to vote
at the Annual Meeting. The outstanding voting securities of the Company are
divided into two classes: common stock and cumulative preferred stock. The
class of cumulative preferred stock has been further issued in five series.
The shares outstanding as of the Record Date, and the vote to which each
share is entitled, are as follows:
<TABLE>
<CAPTION>
Shares Votes
Class Outstanding Per Share
- ------------------------------------------------------------------------------
<S> <C> <C>
Common Stock 53,913,701 1 vote
(without par value)
Cumulative Preferred Stock
Par Value $100 per share 640,251 1 vote
Par Value $25 per share 3,726,636 1/4 vote
</TABLE>
Pursuant to Section 13(d) of the Securities Exchange Act of 1934, as
amended (the "1934 Act"), a beneficial owner of a security is any person who
directly or indirectly has or shares voting or investment power over such
security. No person or group is known by management of the Company to be the
beneficial owner of more than 5% of the Company's class of cumulative
preferred stock as of the Record Date.
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SECURITY OWNERSHIP OF MANAGEMENT
The Company's director-nominees and named executive officers (as the latter
term is defined on page 10) did not beneficially own any shares of any series
of the Company's class of cumulative preferred stock as of December 31, 1997.
The beneficial ownership of the outstanding shares of Cinergy common stock
held by each director-nominee and named executive officer, and of units
representing shares of Cinergy common stock paid as compensation to
non-employee directors, as of December 31, 1997, is set forth in the
following table.
<TABLE>
<CAPTION>
Amount and Nature
Name of Beneficial Owner(1) of Beneficial Ownership(2) Units(3)
- -------------------------------------------------------------------------------
<S> <C> <C>
James K. Baker 21,105 shares 4,257
Michael G. Browning 26,335 shares 7,765
John A. Hillenbrand II 35,759 shares 7,640
J. Wayne Leonard 140,961 shares
John M. Mutz 103,485 shares
Jackson H. Randolph 152,426 shares
James E. Rogers 339,254 shares
Van P. Smith 24,890 shares
Larry E. Thomas 130,366 shares
All directors and executive 1,176,174 shares(1)(2)
officers as a group
</TABLE>
(1) Beneficial ownership of directors and executive officers as a group
represents 0.746% of the outstanding shares of Cinergy common stock;
individual beneficial ownership by any director, nominee or executive
officer does not exceed 0.215% of the outstanding shares of Cinergy
common stock.
(2) Includes shares which there is a right to acquire within 60 days
pursuant to the exercise of stock options in the following amounts: Mr.
Baker - 20,287; Mr. Browning - 20,287; Mr. Hillenbrand - 20,287; Mr.
Leonard - 97,611; Mr. Mutz - 72,787; Mr. Randolph - 50,000; Mr. Rogers
-145,629; Mr. Smith - 20,287; Mr. Thomas - 74,104; and all directors and
executive officers as a group - 595,748.
(3) Each unit represents one share of Cinergy common stock credited to the
account of the respective directors as of December 31, 1997 under
Cinergy's Directors' Deferred Compensation Plan.
ELECTION OF DIRECTORS
In accordance with the By-Laws of the Company, the Board shall consist of not
less than one and not more than seven persons. The size of the Board is
currently fixed at seven and the Board has nominated the individuals listed
below for election as directors, all of whom are presently members of the
Board and were elected by shareholders at the 1997 annual meeting. All of the
proposed director-nominees have signified their willingness to serve, if
elected.
Directors will be elected at the Annual Meeting by a plurality of the
votes cast. As previously stated, Cinergy intends to vote all of the
outstanding shares of common stock of the Company in favor of the
director-nominees set forth below and, since Cinergy's ownership of such
common stock represents over 97% of the voting power of the Company, the
election of such director-nominees is assured.
Except as otherwise noted, the principal occupation or employment of
each individual set forth below has been such individual's principal
occupation or employment for the past five years. Each director-nominee, with
the exception of Messrs. Mutz, Randolph, and Rogers, is otherwise
unaffiliated with Cinergy and its subsidiaries, including the Company.
JAMES K. BAKER
DIRECTOR OF THE COMPANY SINCE 1986. DIRECTOR OF CINERGY SINCE 1994. AGE 66.
Mr. Baker has served as Vice Chairman of Arvin Industries, Inc., a
worldwide supplier of automotive parts, since February 1996. He served as
Chairman of the Board of Arvin Industries from November 1986 through January
1996 and as Chief Executive Officer from 1981 until June 1993. Mr. Baker is a
director of Amcast Industrial Corp., First Chicago NBD Corp., Geon Company,
and Tokheim Corporation.
MICHAEL G. BROWNING
DIRECTOR OF THE COMPANY SINCE 1990. DIRECTOR OF CINERGY SINCE 1994. AGE 51.
Mr. Browning is Chairman and President of Browning Investments, Inc.,
which is engaged in real estate ventures. He also served as President of
Browning Real Estate, Inc., the general partner of various real estate
investment partnerships, through December 30, 1994.
JOHN A. HILLENBRAND II
DIRECTOR OF THE COMPANY SINCE 1985. DIRECTOR OF CINERGY SINCE 1994. AGE 66.
Mr. Hillenbrand principally serves as Chairman, President and Chief
Executive Officer of Glynnadam, Inc., a personal investment holding company.
He is also Chairman of Able Body Corporation and Nambe' Mills, Inc., and Vice
Chairman of Pri-Pak, Inc. Mr. Hillenbrand is a director of Hillenbrand
Industries, Inc. and National City Bank, Indiana.
JOHN M. MUTZ
DIRECTOR OF THE COMPANY SINCE 1991; MEMBER OF THE EXECUTIVE COMMITTEE.
DIRECTOR OF INVESTMENTS SINCE 1995. AGE 62.
Mr. Mutz has served as President of the Company since October 1994. He
served as President of the Company's former parent, PSI Resources, Inc., from
October 1993 until October 1994, and previously served as president of the
Lilly Endowment, Inc. located in Indianapolis. Mr. Mutz served as lieutenant
governor of the State of Indiana from 1981 to 1988. While in office, he
served as president of the Indiana Senate, headed the Department of Commerce
and the Department of Employment and Training Services, and served as
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<PAGE>
Commissioner of Agriculture. Mr. Mutz is a director of Conseco, Inc. and of
National City Bank, Indiana.
JACKSON H. RANDOLPH
DIRECTOR OF THE COMPANY SINCE 1994; MEMBER OF THE EXECUTIVE COMMITTEE.
DIRECTOR OF CINERGY SINCE 1993 AND OF CG&E SINCE 1983. AGE 67.
Mr. Randolph has served as Chairman of the Board of the Company,
Cinergy, Investments, Services, CG&E, and ULH&P since December 1995. He
served as Chairman of the Board and Chief Executive Officer of the Company,
Cinergy, Investments, Services, and CG&E from October 1994 (and of ULH&P from
January 1995) through November 1995. Mr. Randolph was Chairman of the Board,
President and Chief Executive Officer of CG&E from May 1993 until October
1994 (and of ULH&P from June 1993 until January 1995); previously he served
as President and Chief Executive Officer of CG&E and ULH&P. Mr. Randolph is a
director of Cincinnati Financial Corporation, PNC Bank Corp., and PNC Bank,
Ohio, N.A.
JAMES E. ROGERS
DIRECTOR OF THE COMPANY SINCE 1988; CHAIRMAN OF THE EXECUTIVE COMMITTEE.
DIRECTOR OF CINERGY SINCE 1993 AND OF CG&E SINCE 1994. AGE 50.
Mr. Rogers has served as Vice Chairman and Chief Executive Officer of
the Company, CG&E, Investments, and ULH&P, and as Vice Chairman, President
and Chief Executive Officer of Cinergy and Services since December 1995. He
served as Vice Chairman and Chief Operating Officer of the Company, CG&E, and
Investments, and as Vice Chairman, President and Chief Operating Officer of
Cinergy and Services from October 1994 (and as Vice Chairman and Chief
Operating Officer of ULH&P from January 1995) through November 1995. Mr.
Rogers served as Chairman, President and Chief Executive Officer of the
Company from August 1990 until October 1994; he previously served as Chairman
and Chief Executive Officer. He also served as Chairman and Chief Executive
Officer of PSI Resources, Inc., former parent of the Company, from October
1993 until October 1994; he previously served as Chairman, President and
Chief Executive Officer. Mr. Rogers is a director of Bankers Life Holding
Corporation, Duke Realty Investments, Inc., Fifth Third Bancorp, and The
Fifth Third Bank.
VAN P. SMITH
DIRECTOR OF THE COMPANY SINCE 1986. DIRECTOR OF CINERGY SINCE 1994. AGE 69.
Mr. Smith is Chairman of the Board of Ontario Corporation, which
manufactures precision components for semiconductor process equipment,
provides custom hardware and software products, and operates commercial
testing laboratories. He is a director of each of the subsidiaries of Ontario
Corporation, and also a director of Lilly Industries, Inc., Meridian
Insurance Group, Inc., and Meridian Mutual Insurance Co.
MEETINGS AND COMMITTEES OF THE BOARD
During the calendar year ended December 31, 1997, the Board held six
meetings. All directors attended more than 75% of the aggregate number of
Board and committee meetings which they were eligible to attend. The
Executive Committee is the only standing committee of the Board.
COMPENSATION OF DIRECTORS
Directors who are not employees (the "non-employee directors") receive an
annual retainer fee of $8,000 plus a fee of $1,000 for each Board meeting
attended; however, any non-employee director of the Company who also serves
as a non-employee director of Cinergy or any of its affiliates shall neither
receive such annual retainer fee, nor any compensation for attendance at any
Board meeting that is held concurrently or consecutively with a meeting of
the board of directors of Cinergy. Each director-nominee, as a non-employee
director of the Company (Messrs. Baker, Browning, Hillenbrand and Smith), is
currently also a non-employee director of Cinergy. Directors who are also
employees of Cinergy or any of its subsidiaries (Messrs. Mutz, Randolph and
Rogers) receive no remuneration for their services as directors.
Under Cinergy's Directors' Deferred Compensation Plan, each non-employee
director of Cinergy or any of its subsidiaries may defer fees and have them
accrued either in cash or in units representing shares of Cinergy common
stock. If deferred in such units, dividends are credited to the individual
director's plan account and thereby acquire additional such units, at the
same time and rate as dividends are paid to holders of Cinergy common stock.
The deferred units will be distributed to the director as shares of Cinergy
common stock at the time of retirement from the appropriate board. Amounts
deferred in cash earn interest at the rate per annum, adjusted quarterly,
equivalent to the interest rate for a one-year certificate of deposit as
quoted in THE WALL STREET JOURNAL for the first business day of the calendar
quarter, and will be paid to the director at the time of retirement from the
appropriate board.
Under Cinergy's Retirement Plan for Directors, non-employee directors
with five or more years of service will receive annual retirement
compensation in an amount equal to the annual Board retainer fee in effect at
the time of termination of service as a director, plus
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<PAGE>
the product of the fee paid for attendance at a Board meeting multiplied by
five. Retirement compensation is paid for as many years as the director
served on the Board. This plan covers non-employee directors serving on the
boards of directors of the Company, Cinergy, Services, or CG&E. Prior service
by non-employee directors of the Company, PSI Resources, Inc., or CG&E is
credited under this plan.
BOARD COMPENSATION COMMITTEE REPORT ON EXECUTIVE COMPENSATION
The Compensation Committee of Cinergy's board of directors (the "Committee"):
(i) establishes the compensation policy; (ii) recommends, oversees and
administers compensation plans for executive officers and key employees;
(iii) determines compensation for the chief executive officer; and (iv)
reviews and approves compensation for the remaining executive officers, as
each of these items relates to Cinergy and its subsidiaries, including the
Company. The Committee is composed of Messrs. Van P. Smith (Chairman),
Michael G. Browning, George C. Juilfs, and John J. Schiff, Jr., each of whom
is an independent, "non-employee director" (of Cinergy) within the meaning of
Section 16(b) of the 1934 Act, and an "outside director" (of Cinergy) within
the meaning of Section 162(m) of the Internal Revenue Code of 1986, as
amended (the "Code"). Each of Messrs. Smith and Browning is also such an
independent, "non-employee", "outside director" of the Company.
COMPENSATION POLICY
The executive compensation program of Cinergy and its subsidiaries is
designed to attract, retain and motivate the high quality employees needed to
provide superior service to its customers and to maximize returns to its
shareholders. Compensation for executive officers consists of base salary,
annual cash incentives, and long-term incentives.
Base salaries for the executive group are targeted at the median of
comparably sized utility companies based on kilowatt-hours ("kwh") sold.
Because of Cinergy's low-cost position, kwh sales are considered to be a
better measure than revenues for constructing a comparative group. Base
salary levels are reviewed annually, and any increases are based on such
factors as corporate financial results, and each individual's performance,
role, and skills.
The executive compensation program also seeks to link executive and
shareholder interests through cash-based and equity-based incentive plans, in
order to reward corporate and individual performance and balance short-term
and long-term considerations. Annual and long-term incentive plans are
structured to provide opportunities that are competitive with general
industry companies.
This emphasis on incentive compensation results in a compensation mix
for the chief executive officer and the remaining executive officers
consisting of annual and long-term incentives accounting for at least 50% of
the employee's annual compensation. It is the Committee's view that
short-term and long-term incentive opportunities that distinguish between
short-term and long-term corporate goals can assist in appropriately
incentivizing the type of behavior crucial to managing successfully in an
increasingly competitive environment.
Consistent with its belief that a well-planned and well-implemented
executive incentive compensation program, with meaningful and measurable
performance targets and competitive award opportunities, sends a strong,
positive message to the financial markets, the Committee implemented a new
executive long-term incentive compensation program, effective January 1, 1997
(the "LTIP"). This new program was implemented within the parameters of
Cinergy's 1996 Long-Term Incentive Compensation Plan (the "Umbrella Plan").
The new program combines the interests of Cinergy's shareholders, customers,
and management to enhance corporate value. (Specifics of the new program are
discussed below under the heading "Long-Term Incentive Compensation and Stock
Options.")
Also, effective January 1, 1997, Cinergy adopted two non-qualified
deferred compensation plans for executive officers. Cinergy's Deferred
Incentive Compensation Plan allows executive officers of Cinergy and its
subsidiaries, including the Company, the opportunity to defer receipt of all
or a portion of cash awards otherwise payable under Cinergy's Annual
Incentive Plan. Cinergy's Excess 401(k) Plan allows such executive officers
to defer receipt of a portion of their base salaries that otherwise could not
be deferred under Cinergy's qualified 401(k) plan due to federal government
limitations on the amount of compensation that can be deferred into qualified
plans.
ANNUAL INCENTIVE COMPENSATION
Approximately 430 employees, consisting of executive officers and certain
others (i.e., managers, general managers or equivalent-level positions) of
Cinergy and its subsidiaries, are eligible to participate in Cinergy's Annual
Incentive Plan. Each participant is eligible to receive an incentive cash
award or bonus to the extent that certain pre-determined corporate and
individual goals are achieved. For 1997, the corporate goal was based on
earnings per share. Individual performance goals varied for each executive
officer; however, all related to Cinergy's overall strategic vision
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<PAGE>
of becoming a premier energy services company. Achievement of the corporate
goal for 1997 and achievement of individual goals each accounted for 50% of
the total possible award.
For 1997, the potential awards ranged from 2.5% to 90% of the
participant's annual base salary depending upon the achievement levels and
the participant's position. Graduated standards for achievement were
developed to encourage each employee's contribution. The Committee reviewed
and approved both the plan goals at the beginning of the year and the
achievements at the end of the year.
For 1997, the Committee determined that the corporate goal had not been
achieved. Therefore, none of the participants, including the named executive
officers (as defined on page10), received any credit toward payout under
Cinergy's Annual Incentive Plan with respect to the corporate goal measure.
For 1997, the Committee determined the achievement level for each named
executive officer, which involved an assessment of both individual objective
goals and subjective evaluation of individual performance. The Committee
believed that its assessment accurately measured the performance of each such
officer, and determined that the achievement level for individual goals was
at the 3.0 award level on a scale ranging from 1.0 to 3.0. Consideration was
given to accomplishments in 1997 that led to a total return to Cinergy's
shareholders of 21.2% (representing a 6% increase from 1996) and a 7%
increase in Cinergy's earnings per share (adjusted for the effects of weather
and non-comparable items). Other significant accomplishments by Cinergy
during 1997 included: (i) becoming a major participant in the marketing of
power resulting in a megawatt trading volume increase of 600%; (ii) a 25%
increase in electric generation productivity; (iii) a 14% reduction in the
price of coal and 68% reduction in coal inventories; (iv) acquisition of
Greenwich Energy Partners as a platform for gas commodity trading; (v)
becoming the first utility to gain membership on the New York Mercantile
Exchange; (vi) formation of the Cadence Network LLC joint venture (with two
other energy companies) which will provide a variety of innovative products
and services (e.g., consolidated billing, bill auditing, and rate and usage
analysis) to multi-site national accounts customers; (vii) acquisition of the
development team and all rights to future projects of Midlands Power
International (a power development subsidiary of Midlands Electricity plc,
Cinergy's 50%-owned regional electric distribution company located in
England) furthering international development plans; and (viii) continued
reengineering efforts and reductions to staff without layoffs. The relative
importance of these accomplishments was equal in the determination of awards.
For 1998, the parameters of Cinergy's Annual Incentive Plan will be the
same as those applicable for 1997. The corporate goal will account for 50% of
the total possible award and achievement of individual goals will account for
the remaining 50%. The corporate goal for 1998 will be based on earnings per
share.
LONG-TERM INCENTIVE COMPENSATION AND STOCK OPTIONS
The LTIP, the newly implemented long-term incentive compensation program, is
intended to tie a significant portion of the participants' pay to long-term
corporate performance, to provide a greater upside potential for
outperforming peer companies as well as downside risk for underperforming, to
focus on creating shareholder value through increasing total shareholder
return, and to provide a significant portion of total compensation
opportunity through the use of Cinergy common stock to create an ownership
mindset. Approximately 80 employees, consisting of executive officers (with
the exception of the chairman of the board) and certain others (i.e., general
managers or equivalent-level positions) of Cinergy and its subsidiaries, are
eligible for participation in the LTIP.
The LTIP consists of two components: (1) stock options, and (2)
performance-based restricted stock and performance shares (this second
portion is called the "Value Creation Plan"). "Performance-based restricted
stock" means grants of Cinergy common stock that are subject to transfer
restrictions and risk of forfeiture for a specified restriction period, and
the vesting of which are conditional upon the attainment of Performance
Measures. Stock options comprise 25% of the total award opportunity under the
plan, and the Value Creation Plan comprises the other 75%. The annualized
target award opportunity as a percent of base salary ranges from 15% to 100%
depending on the participant's position. With respect to the named executive
officers eligible for participation in the LTIP, the target LTIP award values
are 100% of base salary for the chief executive officer and 70% of the
respective base salary for each of the remaining named executive officers.
The LTIP operates on three-year, non-overlapping performance periods or
cycles. The first performance period covers October 1, 1996, through December
31, 1999.
The first portion of the LTIP consists of annual grants of stock options
beginning January 1, 1997, that vest every three years. The number of options
granted to a participant is determined by taking 25% of the participant's
target LTIP award value and dividing it by the projected stock price
appreciation of an option, to arrive at the number of options granted to a
participant for each year of the three-year cycle.
The second portion of the LTIP consists of the Value Creation Plan. The
Value Creation Plan consists of a tar-
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<PAGE>
get grant of performance-based restricted stock and performance shares, both
of which can be earned based on Cinergy's total shareholder return ("TSR")
vs. the TSR of the peer group. TSR is defined as share price appreciation
plus dividends. For the three-year performance cycle, Cinergy's average TSR
is measured against the average TSR of the peer group. The peer companies are
the 25 largest utility companies, based on kwh sales.
During 1997, participants were granted performance-based restricted
stock equal to their three-year target for the Value Creation Plan. Each
grant was determined by taking each participant's percentage of base salary
target for the Value Creation Plan and dividing it by the share price on the
last business day of the month preceding the date that the Committee actually
made grants under the LTIP.
At the end of the performance period, participants will earn an award
based upon Cinergy's performance relative to its peer group. If Cinergy's TSR
equals the TSR of the peer group, participants will earn the target number of
restricted shares. Participants will earn the target number of restricted
shares plus a greater number of non-restricted shares (called "performance
shares") if Cinergy's TSR exceeds that of the peer group. However, if
Cinergy's TSR is lower than that of the peer group, participants will not
vest in some of the target restricted shares (and the opportunity to receive
any performance shares) and could lose all of the restricted shares if
Cinergy's performance falls dramatically below that of the peer companies.
The maximum that can be earned under the Value Creation Plan by a participant
for the performance cycle is three times the total LTIP target value less the
value of any stock options.
Except in the case of disability, death, voluntary termination, or
retirement on or after age 50 during the three-year performance cycle, a
participant must be employed by Cinergy or its subsidiaries on January 1,
2000 to receive any earned award. The earned target restricted shares will be
released (become unrestricted or vested) as soon as practicable after the end
of the cycle, but no later than April 1, 2000. The earned performance shares,
if any, based on the added incremental value created during the cycle, will
be paid in two installments. One-half will be paid as soon as practicable
after January 1, 2001, but no later than April 1, 2001, and the other half
will be paid as soon as practicable after January 1, 2002, but no later than
April 1, 2002.
Information with respect to stock options and performance-based
restricted stock granted during 1997 to the named executive officers is set
forth in the Summary Compensation Table and/or the Option/SAR Grants Table.
As explained in footnote 2 to the Summary Compensation Table, column (f)
reports the dollar values of restricted stock awards, determined by
multiplying the number of shares in each award by the closing market price of
Cinergy common stock as of the effective date of grant. As explained above,
these officers will not become vested in the target shares unless Cinergy's
TSR meets or exceeds the median TSR of the peer group.
Prior to January 1, 1997, Cinergy sponsored a Performance Shares Plan
(the "Performance Shares Plan"), a long-term incentive compensation plan
designed to reward executive officers and other key employees for
contributing to long-term success by achieving corporate and individual goals
approved by the Committee. The LTIP described above is intended, in part, to
replace the Performance Shares Plan. Accordingly, as part of the transition
toward implementation of the LTIP, the Performance Shares Plan was amended
effective November 1, 1996, to preclude the commencement of any new
performance cycle subsequent to January 1, 1996, and to provide that the
fifth performance cycle covering 1994-1997 be shortened to three years, i.e.,
1994-1996, and that the sixth and final performance cycle covering 1996-1999
be shortened to one year, i.e., 1996. The amendments further provided that
payouts under the fourth performance cycle covering 1992-1995 would be paid
out as planned (one-half in 1996 and the other half in 1997), and that the
payouts for the two truncated cycles would be paid out in 1998 and 1999. In
recognition of the truncation of performance cycles and the ultimate
termination of the Performance Shares Plan, the Company has clarified its
reporting of payments earned and made under the Performance Shares Plan. This
restatement of prior years' disclosures is further explained in footnote 3 to
the Summary Compensation Table.
CHIEF EXECUTIVE OFFICER
Mr. Rogers' 1997 base salary was determined by the Committee after
considering his employment agreement with Cinergy (see Employment Agreements
and Severance Arrangements on page 13) and various surveys on chief executive
compensation of both peer companies and general industry. For 1997, Mr.
Rogers also earned incentive compensation under the Annual Incentive Plan in
the amount of $337,504, which was based entirely upon the Committee's
determination of his achievement of individual goals. Under the Annual
Incentive Plan, Mr. Rogers' maximum potential award is equal to 90% of his
annual base salary (including deferred compensation).
Effective January 1, 1997, the Committee granted to Mr. Rogers stock
options and performance-based restricted stock under the LTIP, the new
executive incentive compensation program discussed above, which provides him
with an annualized target award opportunity equal to 100% of his annual base
salary. Mr. Rogers received a stock option grant to acquire 55,400 shares of
Cinergy common stock at the fair
8
<PAGE>
market value of $33.50 per share, and also received a target grant of 58,462
performance-based restricted shares. Although Mr. Rogers has the right to
vote the performance-based restricted shares, this grant is subject to the
same Performance Measure as all other restricted stock grants made under the
LTIP: Cinergy's TSR vs. the TSR of the peer companies over the three-year
performance period. Mr. Rogers will become vested in the target grant of
performance-based restricted shares and the dividends on these shares only to
the extent that Cinergy's TSR over the three-year period meets or exceeds the
median TSR of the peer group.
SUMMARY
The Committee's executive compensation policy is designed to provide
competitive levels of executive compensation that integrate compensation with
Cinergy's goals, reward superior corporate performance, recognize individual
initiative and achievement, and assist Cinergy in attracting and retaining
qualified and highly motivated executive employees. In utilizing long-term,
incentive-based compensation, i.e., as available under the LTIP, a greater
portion of executive compensation is placed at risk. The Committee believes
that ownership of stock assists in the attraction and retention of qualified
executive employees, and provides them with additional incentives to devote
their best efforts to pursue and sustain Cinergy's growth and profitability
through the accomplishment of corporate goals. The philosophy thus intends to
coalesce the interests of shareholders, customers, and management to enhance
overall corporate value.
Code Section 162(m) limits the tax deduction to one million dollars for
compensation paid to each of the named executive officers. However,
performance-based compensation that has been approved by shareholders is
excluded from the one million dollars limit if, among other requirements, the
compensation is payable only upon attainment of pre-established, objective
performance goals. Cinergy's Annual Incentive Plan and its Umbrella Plan have
been approved by its shareholders. Half of the award opportunity under the
Annual Incentive Plan is based on pre-established, objective corporate
performance goals, and a significant portion of the remaining award
opportunity is based on objective, individual performance goals. Both the
stock options and the restricted stock features of the recently implemented
LTIP (which itself was implemented under the auspices of the Umbrella Plan)
are performance-based.
The Committee will continue to review the applicability of the Internal
Revenue Service ("IRS") rules and regulations to future compensation.
Moreover, the Committee intends to continue basing its executive compensation
decisions primarily upon performance achieved, both corporate and individual,
but retains the right to make subjective decisions and to award compensation
that might be subject to the tax deductibility limitation under Code Section
162(m).
The tables which follow, and accompanying footnotes, reflect the
decisions covered by the above discussion.
CINERGY COMPENSATION COMMITTEE
Van P. Smith, Chairman
Michael G. Browning
George C. Juilfs
John J. Schiff, Jr.
9
<PAGE>
SUMMARY COMPENSATION TABLE
The following table sets forth the compensation of the chief executive
officer and each of the additional four most highly compensated executive
officers (these five executive officers sometimes hereinafter collectively
referred to as the "named executive officers") for services to Cinergy and
its subsidiaries during the calendar years ended December 31, 1997, 1996
and 1995.
<TABLE>
<CAPTION>
Long-Term Compensation
-------------------------------------
Annual Compensation Awards Payouts
---------------------------- -------------------------- --------
(a) (b) (c) (d) (e) (f) (g) (h) (i)
Other
Annual Restricted Securities All Other
Compen- Stock Underlying LTIP Compen-
Name and Salary Bonus(1) sation Awards(2) Options/SARs Payouts(3) sation
Principal Position Year ($) ($) ($) ($) (#) ($) ($)
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
James E. Rogers 1997 700,008 337,504 17,039 1,951,169 55,400 0 126,956(4)
Vice Chairman and 1996 625,000 607,518 3,697 0 0 849,750 108,108
Chief Executive Officer 1995 535,000 321,750 15,322 0 0 1,032,565 135,676
Jackson H. Randolph 1997 585,000 321,750 14,575 0 0 0 88,181(4)
Chairman of the Board 1996 535,000 321,750 10,675 0 0 675,212 120,512
1995 535,000 321,750 11,594 0 0 377,381 104,112
John M. Mutz 1997 395,412 118,624 3,763 761,985 21,700 0 22,162(4)
President 1996 376,584 150,634 2,431 0 0 339,108 14,993
1995 358,656 143,462 2,041 0 0 288,470 16,530
J. Wayne Leonard 1997 378,000 113,400 6,044 728,443 20,700 0 13,976(4)
Vice President 1996 317,720 190,632 53,985 0 0 273,141 34,220
1995 250,008 93,753 17,385 0 0 283,552 49,726
Larry E. Thomas 1997 336,048 100,814 11,502 647,575 18,400 0 15,809(4)
Vice President 1996 294,350 176,610 5,030 0 0 252,285 36,162
1995 240,000 90,000 1,794 0 0 279,436 29,464
</TABLE>
(1) Amounts appearing in this column reflect the Annual Incentive Plan award
earned during the year listed and paid in the following year.
(2) Amounts appearing in this column reflect the dollar values of restricted
stock awards, determined by multiplying the number of shares in each
award by the closing market price of Cinergy's common stock as of the
effective date of grant. The aggregate number of all restricted stock
holdings and values at calendar year ended December 31, 1997, determined
by multiplying the number of shares by the year end closing market
price, are as follows: Mr. Rogers - 58,462 shares ($2,239,825); Mr.
Mutz - 22,831 shares ($874,713); Mr. Leonard - 21,826 shares ($836,209);
and Mr. Thomas -19,403 shares ($743,377). Dividends will be retained by
Cinergy for the duration of the three-year performance cycle; upon
settlement of the restricted stock awards, dividends will be paid in
shares of Cinergy common stock based on the number of shares of
restricted stock actually earned and the fair market value of Cinergy
common stock on the settlement date.
(3) Amounts appearing in this column reflect the values of the shares earned
under Cinergy's Performance Shares Plan, which are earned following a
four-year performance cycle and paid out over a two-year period.
Amounts are reported on a "when earned," rather than a "when paid"
basis, and represent a restatement of prior years' disclosures (which
reported amounts "when paid" rather than "when earned"). Amounts
reported for 1996 were earned during the 1994-1997 and 1996-1999
performance cycles that were ended during 1996 in transition to the
Valuation Creation Plan, and amounts reported for 1995 were earned
during the 1992-1995 performance cycle.
(4) Amount includes for Messrs. Rogers, Randolph, Mutz, Leonard and Thomas,
respectively: employer matching contributions under 401(k) plan and
related excess benefit plan of $21,000, $17,550, $11,862, $11,340 and
$10,081; and insurance premiums paid with respect to
executive/group-term life insurance of $2,234, $688, $10,300, $2,636 and
$5,728. Also includes for Mr. Rogers deferred compensation in the
amount of $50,000, and for Messrs. Rogers and Randolph, respectively,
above-market interest on amounts deferred pursuant to deferred
compensation agreements of $38,178 and $52,681, and benefits under split
dollar life insurance agreements of $15,544 and $17,262.
10
<PAGE>
OPTION/SAR GRANTS TABLE
The following table sets forth information concerning individual grants of
options to purchase the Company's common stock made to the applicable named
executive officers during 1997.
<TABLE>
<CAPTION>
Potential Realizable
Value at Assumed
Annual Rates of
Stock Price Appreciation
Individual Grants for Option Term
- ------------------------------------------------------------------------------------ ------------------------
(a) (b) (c) (d) (e) (f) (g)
Number of
Securities % of Total
Underlying Options/SARs Exercise
Options/SARs Granted to or Base
Granted Employees in Price Expiration 5% 10%
Name (#) Fiscal Year ($/Sh) Date ($) ($)
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
James E. Rogers 55,400 12.18% 33.50 1/1/2007 512,450 1,132,930
John M. Mutz 21,700 4.77% 33.50 1/1/2007 200,725 443,765
J. Wayne Leonard 20,700 4.55% 33.50 1/1/2007 191,475 423,315
Larry E. Thomas 18,400 4.05% 33.50 1/1/2007 170,200 376,280
</TABLE>
AGGREGATED OPTION/SAR EXERCISES AND YEAR END OPTION/SAR VALUES TABLE
The following table sets forth information concerning stock options exercised
by the named executive officers during 1997, including the value realized for
such options exercised, which represent the positive spread between the
respective exercise price and market price on the date of exercise, and the
numbers of shares for which options were held as of December 31, 1997,
including the values for "in-the-money" options, which represent the positive
spread between the respective exercise prices of outstanding stock options
and the market price of the shares of Cinergy common stock as of December 31,
1997, which was $38.3125 per share.
<TABLE>
<CAPTION>
(a) (b) (c) (d) (e)
Number of Value of
Securities Underlying Unexercised
Unexercised In-The-Money
Options/SARs Options/SARs
at Year End at Year End
(#) ($)
Shares Acquired Value --------------------- -------------------
on Exercise Realized Exercisable/ Exercisable/
Name (#) ($) Unexercisable Unexercisable
- ---------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
James E. Rogers 0 N/A 145,629/155,400 2,248,148/1,810,363
Jackson H. Randolph 50,000 603,125 50,000/100,000 771,875/1,543,750
John M. Mutz 0 N/A 72,787/61,700 1,208,359/721,931
J. Wayne Leonard 0 N/A 97,611/60,700 1,744,507/717,119
Larry E. Thomas 0 N/A 74,104/58,400 1,245,699/706,050
</TABLE>
11
<PAGE>
PENSION BENEFITS
Effective January 1, 1998, the pension benefits payable at retirement to each
of the named executive officers are provided under the terms of the Cinergy
Corp. Non-Union Employees' Pension Plan, a non-contributory, defined benefit
pension plan (the "Cinergy Pension Plan"), plus certain supplemental plans or
agreements, with the accrual of pension benefits previously earned under the
terms of the applicable, former Company and CG&E pension plans being fully
preserved for participants under the terms of the Cinergy Pension Plan.
Under the terms of the Cinergy Pension Plan, the retirement income
payable to a pensioner is 1.1% of final average pay plus 0.5% of final
average pay in excess of covered compensation, times the number of years of
credited service through 35 years. Final average pay is the average annual
salary, based upon employment anniversary date, during the employee's three
consecutive years producing the highest such average within the last ten
anniversary years immediately preceding retirement, plus any short-term
incentive and/or deferred compensation. Covered compensation is the average
social security taxable wage base over a period of up to 35 years. The IRS
annually establishes a dollar limit, indexed to inflation, of the amount of
pay permitted for consideration under the terms of such plans, which for 1997
was $160,000.
The Cinergy Excess Benefit Plan is designed to restore pension benefits
to those individuals whose benefits under the Cinergy Pension Plan would
otherwise exceed the limits imposed by the Code. Each of the named executive
officers is covered under the terms of the Cinergy Excess Benefit Plan.
The pension plan table set forth below illustrates the estimated annual
benefits payable as a straight-life annuity under both Cinergy plans to
participants who retire at age 62. Such benefits are not subject to any
deduction for social security or other offset amounts.
The accrued annual benefit payable to Messrs. Randolph and Mutz upon
their retirement will be based upon credited service of 35 years and 3.39
years, respectively, and for Mr. Randolph will be the greater of the benefit
calculated under the terms of the Cinergy Pension Plan, or the former CG&E
plan and credited service of 37 years under this plan. The estimated credited
years of service at age 62 for each of the remaining named executive officers
are as follows: Mr. Rogers, 20.22 years; Mr. Leonard, 35 years; and Mr.
Thomas, 35 years.
Moreover, Cinergy and Mr. Randolph entered into an Amended and Restated
Supplemental Executive Retirement Income Agreement, which in effect freezes
as of December 31, 1994, the accrual of benefits payable to Mr. Randolph
under the former CG&E Supplemental Executive Retirement Plan upon his
retirement, death, or disability. Under the amended agreement, the annual
supplemental retirement benefit of $511,654 shall be paid to Mr. Randolph or
his beneficiary in monthly installments of $42,638 for 180 months beginning
December 1, 2000.
The Cinergy Supplemental Retirement Plan is designed to provide coverage
to employees who otherwise do not qualify for full retirement benefits under
the Cinergy Pension Plan. The benefit provided by the Cinergy Supplemental
Retirement Plan is an amount equal to that which a covered employee with
maximum permitted years of participation (35 years) would have received under
the Cinergy Pension Plan, reduced by the actual benefit provided by such Plan
and the Cinergy Excess Benefit Plan, and further reduced by benefits the
covered employee is eligible to receive from retirement plans from previous
self-employment and from previous employers. Messrs. Rogers and Mutz are
covered under the terms of the Cinergy Supplemental Retirement Plan, and the
estimated annual benefit payable at age 62 to each is $104,013 and $200,898,
respectively.
<TABLE>
<CAPTION>
Years of Service
- ----------------------------------------------------------------------------------------
Compensation 5 10 15 20 25 30 35
- ----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
$ 300,000 $ 23,095 $ 46,190 $ 69,285 $ 92,380 $115,475 $138,570 $161,665
400,000 31,095 62,190 93,285 124,380 155,475 186,570 217,665
500,000 39,095 78,190 117,285 156,380 195,475 234,570 273,665
600,000 47,095 94,190 141,285 188,380 235,475 282,570 329,665
700,000 55,095 110,190 165,285 220,380 275,475 330,570 385,665
800,000 63,095 126,190 189,285 252,380 315,475 378,570 441,665
900,000 71,095 142,190 213,285 284,380 355,475 426,570 497,665
1,000,000 79,095 158,190 237,285 316,380 395,475 474,570 553,665
1,100,000 87,095 174,190 261,285 348,380 435,475 522,570 609,665
1,200,000 95,095 190,190 285,285 380,380 475,475 570,570 665,665
1,300,000 103,095 206,190 309,285 412,380 515,475 618,570 721,665
1,400,000 111,095 222,190 333,285 444,380 555,475 666,570 777,665
1,500,000 119,095 238,190 357,285 476,380 595,475 714,570 833,665
1,600,000 127,095 254,190 381,285 508,380 635,475 762,570 889,665
</TABLE>
12
<PAGE>
The Cinergy Executive Supplemental Life Insurance Program provides key
management personnel, including the named executive officers, with additional
life insurance coverage during employment, and with post-retirement deferred
compensation. At the later of age 55 or retirement, the participant's life
insurance coverage under the program is canceled. At that time, the
participant receives the total amount of coverage in the form of deferred
compensation payable in ten equal annual installments. The annual benefit
payable, at the later of age 55 or retirement, to each of the named executive
officers is $15,000 per year over ten years.
EMPLOYMENT AGREEMENTS AND SEVERANCE ARRANGEMENTS
Cinergy entered into individual employment agreements with Mr. Randolph and
Mr. Rogers (each sometimes hereinafter individually referred to as the
"Executive") effective as of October 24, 1994.
Pursuant to his employment agreement, Mr. Randolph served as Chairman
and Chief Executive Officer of Cinergy until November 30, 1995, at which time
he relinquished the position of Chief Executive Officer; he will continue to
serve as Chairman of the Board of Cinergy until November 30, 2000. Mr. Rogers
served as Vice Chairman, President and Chief Operating Officer of Cinergy
until November 30, 1995, and, since that time, has served as Vice Chairman,
President and Chief Executive Officer. Mr. Rogers' agreement was for an
initial term of three years; it currently is automatically extended for an
additional year on each annual anniversary date, unless either Cinergy or Mr.
Rogers gives timely notice otherwise. During the terms of their agreements,
Messrs. Randolph and Rogers receive minimum annual base salaries of $465,000
and $422,722, respectively, and each is eligible to participate in all other
incentive, stock option, performance award, savings, retirement and welfare
benefit plans applicable generally to Cinergy employees and executives, and
to receive other fringe benefits.
If the Executive's employment terminates as a result of death, his
beneficiary will receive a lump sum cash amount equal to the sum of (a) the
Executive's annual base salary through the termination date to the extent not
previously paid, (b) a pro rata portion of the benefit under Cinergy's Annual
Incentive Plan calculated based upon the termination date, and (c) any
compensation previously deferred but not yet paid to the Executive (with
accrued interest or earnings thereon) and any unpaid accrued vacation pay. In
addition to these accrued amounts, if Cinergy terminates the Executive's
employment without "cause" or the Executive terminates his employment for
"good reason" (as each is defined in the employment agreements), Cinergy will
pay to the Executive (a) a lump sum cash amount equal to the present value of
his annual base salary and benefit under Cinergy's Annual Incentive Plan
payable through the end of the term of employment, at the rate and applying
the same goals and factors in effect at the time of notice of such
termination, (b) the value of all benefits to which the Executive would have
been entitled had he remained in employment until the end of the term of
employment under Cinergy's Performance Shares Plan and Executive Supplemental
Life Insurance Program, (c) the value of all deferred compensation and all
executive life insurance benefits whether or not then vested or payable, and
(d) medical and welfare benefits for the Executive and his family through the
end of the term of employment. If the Executive's employment is terminated
by Cinergy for cause or by the Executive without good reason, the Executive
will receive unpaid annual base salary accrued through the termination date
and any accrued deferred compensation.
Mr. Mutz has an employment agreement, which commenced on October 4,
1993, pursuant to which he serves as President, and is nominated for election
as a director, of the Company until October 4, 1998. During the term of his
agreement, Mr. Mutz receives a minimum annual base salary of $330,000, is
eligible to participate in all other incentive, stock option, performance
award, savings, retirement and welfare benefit plans applicable generally to
Cinergy employees and executives, and receives other fringe benefits. In
connection with his participation in the Cinergy Supplemental Retirement
Plan, Mr. Mutz's employment agreement provides that he is vested in his
benefit at a rate of 20% per year of service beginning in 1994 without offset
for other retirement benefits, and is guaranteed a benefit thereunder based
on its current terms even if the plan subsequently is amended to reduce
benefits or is terminated.
Cinergy has individual employment agreements with Messrs. Leonard and
Thomas that originally covered the term from October 24, 1994 through
December 31, 1997. Currently, each of their agreements is automatically
extended for an additional year on each January 1, unless either Cinergy or
Messrs. Leonard or Thomas, respectively, gives timely notice otherwise.
During the terms of their agreements, Messrs. Leonard and Thomas receive
minimum annual base salaries of $250,000 and $240,000, respectively, and each
is eligible to participate in all other incentive, stock option, performance
award, savings, retirement and welfare benefit plans applicable generally to
Cinergy employees and executives, and to receive other fringe benefits.
If the employment of Messrs. Mutz, Leonard or Thomas (each sometimes
hereinafter individually referred to as the "officer") is terminated as a
result of
13
<PAGE>
death, for cause, or by the officer without good reason, the officer or the
officer's beneficiary will be paid a lump sum cash amount equal to (a) the
officer's unpaid annual base salary through the termination date, (b) a pro
rata portion of the officer's award under Cinergy's Annual Incentive Plan,
(c) the officer's vested accrued benefits under Cinergy's Performance Shares
Plan (and also including the Cinergy Pension Plan, Excess Benefit Plan and
Supplemental Retirement Plan in the case of Mr. Mutz), and (d) any unpaid
deferred compensation (including accrued interest or earnings) and unpaid
accrued vacation pay. If, instead, the officer's employment is terminated
prior to a change in control (as defined) without cause or by the officer for
good reason, the officer will be paid (a) a lump sum cash amount equal to the
present value of the officer's annual base salary and target annual incentive
cash award payable through the end of the term of the agreement, at the rate
and applying the same goals and factors in effect at the time of notice of
such termination, (b) the present value of all benefits to which the officer
would have been entitled had the officer remained in employment until the end
of the term of the agreement under Cinergy's Performance Shares Plan and
Executive Supplemental Life Insurance Program (and also including the Cinergy
Pension Plan, Excess Benefit Plan, and Supplemental Retirement Plan in the
case of Mr. Mutz), (c) the value of all deferred compensation and all
executive life insurance benefits whether or not vested or payable, and (d)
continued medical and welfare benefits through the end of the term of the
agreement. Mr. Mutz's employment agreement was amended, effective August 30,
1996, wherein, among other things, Cinergy waived its right to challenge Mr.
Mutz in the event he elects to terminate his employment agreement for good
reason.
If the employment of any such officer is terminated after a change in
control, the officer will be paid a lump sum cash payment equal to the
greater of (i) three times the sum of his annual base salary immediately
prior to the date of his termination of employment or, if higher, the date of
the change in control, plus all incentive compensation or bonus plan amounts
in effect prior to the date of his termination of employment or, if higher,
prior to the change in control, and (ii) the present value of all annual base
salary, bonuses and incentive compensation and retirement benefits that would
otherwise be due under the agreement, plus deferred compensation and
executive life insurance benefits. In addition, the officer will be provided
life, disability, accident and health insurance benefits for thirty-six
months, reduced to the extent comparable benefits are received, without cost,
by the officer.
DEFERRED COMPENSATION AGREEMENTS
Mr. Randolph and CG&E, and Mr. Rogers and the Company, entered into deferred
compensation agreements effective as of January 1, 1992, which were assumed
by Cinergy effective as of October 24, 1994.
Pursuant to the terms of his deferred compensation agreement, Mr.
Randolph was credited annually with a $50,000 base salary increase in the
form of deferred compensation for the five-year period from January 1, 1992
through December 31, 1996, and when his employment terminates he will receive
an annual cash benefit of $179,000 payable for a 15-year period beginning
January 2001.
Pursuant to the terms of his deferred compensation agreement, Mr. Rogers
was credited annually with a $50,000 base salary increase in the form of
deferred compensation for the five-year period from January 1, 1992 through
December 31, 1996, and is credited annually the same amount for the
additional five-year period from January 1, 1997 through December 31, 2001.
Mr. Rogers' deferred compensation agreement further provides that when his
employment terminates for any reason, other than death, he will receive an
annual cash benefit over a 15-year period beginning the first January
following termination of his employment, but in no event earlier than January
2003 nor later than January 2010. The annual cash benefit amount payable for
such 15-year period ranges from $179,000 per year, if payment begins in
January 2003, to $554,400 per year if payment commences in January 2010.
Comparable amounts are payable to Mr. Rogers if he dies before commencement
of payment of the 15-year payments described above. In addition, if Mr.
Rogers' employment terminates before January 1, 2002 for any reason other
than death or disability, he will receive a lump sum cash payment equal to
the total amount deferred during the second five-year period described above
plus interest; if his employment terminates on or after January 1, 2002 for
any reason other than death or disability, he will receive an additional
annual benefit for a 15-year period beginning the first January following
termination of his employment, but in no event earlier than January 2008 nor
later than January 2010. The annual cash benefit amount payable for such
period ranges from $179,000 per year, if payment begins in January 2008, to
$247,000 per year if payment begins in January 2010. Comparable amounts are
payable to Mr. Rogers in the event his employment is terminated for
disability prior to January 1, 2002 or if he dies (i) prior to January 1,
2002 while employed or disabled, or (ii) on or after January 1, 2002 but
before commencement of payment
14
<PAGE>
of benefits; provided, however, if Mr. Rogers becomes disabled prior to the
completion of the second award period, his payments will be proportionately
reduced in the same manner as described above for disability during the first
award period.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Mr. Schiff, Chairman of the Board of Cincinnati Financial Corporation, an
insurance holding company, serves on the Cinergy Compensation Committee and
Mr. Randolph, Chairman of the Board of Cinergy and certain of its
subsidiaries, including the Company, serves on the board of directors of
Cincinnati Financial Corporation.
RELATIONSHIP WITH INDEPENDENT PUBLIC ACCOUNTANTS
Arthur Andersen LLP served as independent public accountants for Cinergy and
its subsidiaries, including the Company, for the year 1997. On January 28,
1998, upon recommendation of the Audit Committee of Cinergy's board of
directors, such board engaged Arthur Andersen LLP as independent public
accountants for Cinergy and its subsidiaries, including the Company, for the
year 1998. Representatives of Arthur Andersen LLP are expected to be present
at the Annual Meeting with the opportunity to make a statement if they desire
to do so, and will be available to respond to appropriate questions.
PROPOSALS BY SHAREHOLDERS
In order to be considered for inclusion in the Company's information
statement for the 1999 annual meeting of shareholders, proposals from
shareholders must be received by the Secretary of the Company at 1000 East
Main Street, Plainfield, Indiana 46168 not later than November 23, 1998.
By Order of the Board of Directors,
Cheryl M. Foley
Vice President, General Counsel and Secretary
Dated: March 23, 1998
15
<PAGE>
APPENDIX: 1997 FINANCIAL REPORT
TABLE OF CONTENTS
Review of Financial Condition
and Results of Operations A-1
Consolidated Statements of Income A-20
Consolidated Balance Sheets A-21
Consolidated Statements of Changes
in Common Stock Equity A-23
Consolidated Statements of Cash Flows A-24
Notes to Consolidated Financial Statements A-25
Responsibility for Financial Statements A-49
Report of Independent Public Accountants A-50
Five Year Statistical Summary A-51
CAUTIONARY STATEMENTS REGARDING
FORWARD-LOOKING INFORMATION
Matters discussed in this report (particularly in the Review of Financial
Condition) reflect and elucidate Cinergy's corporate vision of the future
and, as a part of that, outline goals and aspirations, as well as specific
projections. These goals and projections are considered forward-looking
statements and are based on management's beliefs, as well as certain
assumptions made by management. In addition to any assumptions and other
factors that are referred to specifically in connection with these
statements, other factors that could cause actual results to differ
materially from those indicated in any forward-looking statements include,
among others: Factors generally affecting utility operations - such as
unusual weather conditions, unusual maintenance or repairs, or unanticipated
changes in fuel costs; increased competition in the electric and gas utility
environment; regulatory factors, including the failure to obtain anticipated
regulatory approvals; changes in accounting principles or policies; adverse
economic conditions; changing market conditions; availability or cost of
capital; employee workforce factors; costs and effects of legal and
administrative proceedings; changes in legislative requirements; and other
risks indicated in filings with the Securities and Exchange Commission (SEC).
The SEC's rules do not require forward-looking statements to be revised or
updated, and Cinergy does not intend to do so.
REVIEW OF FINANCIAL
CONDITION AND RESULTS OF
OPERATIONS
THE COMPANY
Cinergy Corp., a Delaware corporation (Cinergy or Company), is a registered
holding company under the Public Utility Holding Company Act of 1935 (PUHCA).
Cinergy was created in the October 1994 merger of PSI Resources, Inc.
(Resources) and The Cincinnati Gas & Electric Company (CG&E). Cinergy is the
parent holding company of PSI Energy, Inc. (PSI), CG&E, Cinergy Investments,
Inc. (Investments), and Cinergy Services, Inc. CG&E is an operating utility
primarily engaged in providing electric and gas service in the southwestern
portion of Ohio and, through its principal subsidiary, The Union Light, Heat
and Power Company (ULH&P), in adjacent areas in Kentucky. PSI is an operating
utility primarily engaged in providing electric service in north central,
central, and southern Indiana. Services provides management, financial,
administrative, engineering, legal and other services to Cinergy, CG&E, PSI,
and Investments. Cinergy conducts its international and non-regulated
businesses through Investments and its subsidiaries.
FINANCIAL CONDITION
COMPETITIVE PRESSURES
ELECTRIC UTILITY INDUSTRY
INTRODUCTION The electric utility industry is transitioning from a monopoly
cost-of-service regulated environment to an industry in which companies will
ultimately compete to be the customers' energy provider. This transition will
continue to impact the operations, structure, and profitability of Cinergy.
The effects of competition are already being felt in the wholesale power
markets, where the increased numbers of power marketers and brokers are
reducing the margins previously experienced.
Energy companies are positioning themselves for full competition through
mergers and acquisitions, strategic alliances with other energy companies and
energy-related businesses, and through the development of new products and
services. Just as critical to Cinergy will be the regulatory outcome of the
deregulation process in each of its three franchise states, as well as the
outcome in other states where Cinergy plans to compete.
DEREGULATION PROCESS The Federal Energy Regulatory Commission (FERC) opened
up the wholesale electric markets to competition in 1996 with Orders 888 and
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889. The final rules provided for mandatory filing of open
access/comparability transmission tariffs, provided for functional unbundling
of all services, required utilities to use the filed tariffs for their own
bulk power transactions, established an electronic bulletin board for
transmission availability and pricing information, and established a contract-
based approach to recover any potential "stranded" investments (explained
below) as a result of customer choice at the wholesale level.
Customer choice at the end-user (i.e., retail) level currently remains
under the jurisdiction of individual states (see State Developments). The
deregulation process has varied greatly from state to state. Several states
have enacted customer choice legislation, while many states are in the early
stages of studying the issues. During the process of developing customer
choice legislation, utilities have been required to consider issues such as
the recovery of any stranded investment, ability to compete for incumbent
customers, and the potential forced divestiture of generating assets. Cinergy
continues to be an advocate of competition in the electric utility industry
and continues to pursue customer choice legislation at both the state and
Federal levels.
As the deregulation process has progressed, it has become clear that both
scale and diversity of business are critical factors for success. Scale is
critical for several reasons. A critical mass of customers allows the
development of new products and back-office capabilities in a cost-effective
manner. A larger balance sheet scale and diversity of commodities (i.e., gas
and electric) allow the trading business to market risk intermediation
products without taking excessive financial risks and to recover back-office
costs in a low margin business. Merger and acquisition activity in the energy
industry appears to be accelerating as companies attempt to create the
desired scale.
RECENT DEVELOPMENTS
STRANDED INVESTMENTS Due to excess capacity in the industry and the
declining cost of new technology, electricity prices in a competitive market
may not fully cover the costs of past commitments made by utilities while
under a cost-of-service regulated environment. Fixed costs which cannot be
recovered through electricity sales at market prices are referred to as
stranded investments. While the recovery of prudent past investments and
commitments has been supported by FERC in Order 888 and at least partially in
the states in which competition-related legislation has been passed, there is
no guarantee that Cinergy or any other utility will receive full recovery of
potential stranded investments. In addition, in those states which have
legislated open competition, many have required the divestiture of generating
assets in order to qualify and obtain recovery of stranded investments.
MIDWEST ISO During 1997, Cinergy collaborated with other Midwestern utility
companies on a plan to join the transmission systems of the participating
companies into a single regional system. The plan was filed with the FERC
early in 1998 for approval. If approved, the new system would be managed
independently by an Independent System Operator (ISO). The formation of a
Midwest ISO, as it has become known, would ensure non-discriminatory open
transmission access and system reliability, as well as the development of a
regional transmission tariff, which would help eliminate the "pancaking" of
transmission rates in a region. Currently, there are eight utilities
participating in the filing along with Cinergy. The proposed ISO consists of
32,000 miles of transmission lines and covers portions of eight Midwestern
states, forming one of the largest ISOs in the country. FERC's approval of
the plan is anticipated to come within a year.
REPEAL OF THE PUHCA Currently, PUHCA creates a number of restrictions that
make preparing for deregulation more difficult. PUHCA restricts the amount
which can be invested outside the regulated utility, including foreign
investments and investments in power plants. It also restricts potential
merger partners to those that meet certain integration requirements.
In 1995, the SEC endorsed recommendations for reform of PUHCA. The
recommendations called for repeal and, pending repeal, significant
administrative reform of the 62-year-old statute. Since the release of the
SEC's report, numerous bills have been introduced in both houses of the
United States (US) Congress providing for the repeal or significant amendment
of PUHCA. During 1997, a bill repealing PUHCA was introduced in the US Senate
but was never brought to a vote. Legislation repealing PUHCA is anticipated
to be reintroduced in the US Congress in 1998. Cinergy supports the repeal of
this act either as part of comprehensive reform of the electric industry or
as separate legislation.
FRANCHISE RIGHTS During 1997, several states enacted transition plans that
included a variety of measures designed to create a "level playing field" for
new competitors. In some cases, there has been a mandatory "divestiture" of
existing customers. In others, the plans provide incentives which may
encourage customers to switch suppliers by providing "above market" credits
to those who switch from the incumbent utility. Also, some states have put
varying restrictions on the incumbent utility's ability to compete for these
customers.
STATE DEVELOPMENTS As previously mentioned, certain states have enacted
legislation which will lead to complete retail competition within the next
several years. These states generally have required up-front rate reductions
and the opportunity for all customer classes to
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choose an electricity provider. A few states have phased-in customer choice,
but still provided for immediate rate reductions.
All states passing legislation have included some mechanism for recovery of
stranded investment. However, states have varied on the methodology to be
applied in determining the level of stranded investment, and divestiture of
generation assets has been required in a few states.
As discussed below, the three states in which Cinergy operates public
utility companies have all had legislation introduced which would provide for
full retail customer choice. None of these states has yet passed legislation,
but policymakers and stakeholders continue to work to resolve issues with an
eye toward passage.
INDIANA A customer choice bill (SB427) was introduced during the 1997
Indiana legislative session, with support from a coalition made up of
Cinergy, the Indiana Manufacturers Association, the Indiana Industrial Energy
Consumers, Inc., and one other Indiana investor-owned electric utility. After
amendments were made, essentially stripping the bill of most of its
provisions and turning it into a bill calling for the study of deregulation
by a legislative committee known as the Regulatory Flexibility Committee
(Study Committee), SB427 passed the legislature and was signed by the
governor.
The Indiana Utility Regulatory Commission (IURC) issued a report titled
"Energy Report: Public Policy Considerations" (Report) to the Study Committee
in November 1997. The scope and purpose of the Report was to provide
information to the Study Committee which would enable them to answer the
question of whether retail customer choice was in the best interest of
Indiana. Public policy issues listed by the Report for the Study Committee to
consider were: jurisdiction over retail transmission; recovery of stranded
investments; estimation methodology of any stranded investments allowed to be
recovered; method for recovery of stranded investments; low-income and
environmental programs; and impact of deregulation on state and local taxes.
The Report's conclusion was: "In the long run, competition in the electricity
market could be in the best interest of Indiana. Experience in other states
has shown that the best outcomes and smoothest process to bring about
customer choice in the electric industry have resulted from a cooperative
effort led by the governor, the legislature and the state commission working
together with all stakeholders. Indiana should be prepared to respond to
competition created by other states, especially those surrounding Indiana,
and to any federal legislation that requires nationwide competition in the
electricity market." As a result of the IURC report and other testimony to
the Study Committee, the Study Committee recommended that they continue to
study changes in the electric industry.
Another customer choice bill (SB431), sponsored by, among others, those who
supported the customer choice bill during 1997, was introduced in the Indiana
Senate in January 1998. In the House of Representatives, House Bill 1190
(HB1190) was introduced. This bill calls for a study by the IURC of the
effects deregulation would have on Indiana. Although the legislature is much
more knowledgeable on the customer choice issues as a result of the Study
Committee's report and debating the 1997 customer choice bill, neither SB431
or HB1190 was passed during the 1998 legislative session.
OHIO Although the Ohio legislature did not pass customer choice legislation
during 1997, it did create the Joint Select Committee on Electric Industry
Deregulation (Committee) to examine competition and restructuring issues. The
Committee heard testimony from a variety of stakeholders on various customer
choice issues throughout the spring of 1997. In December 1997, the
Committee's chairpersons unveiled the outline of a plan designed to bring
competition into Ohio's retail electric industry in the year 2000. The
chairpersons' plan is based on five basic policies: all customers, including
residential, can participate from the outset; the cost of electricity will
decrease from the outset and continue to decrease at an accelerating rate for
all customers during the transition period; current low-income assistance
programs will be continued; current reliability and quality of service will
be maintained; and open free markets will be established with lower prices
driven by competition. The plan would provide for competition among utilities
to begin January 1, 2000, with a five-year transition period.
Furthermore, the plan addresses the tax consequences of a deregulated
environment through the creation of a revenue-neutral system. The current tax
structure of Ohio subjects Ohio electric utility companies to certain state
taxes which would not be paid by out-of-state competitors selling power in
Ohio retail markets. The new system attempts to remedy this disadvantage
while not diminishing the amount of tax revenues currently being collected by
state and local governments.
The chairpersons were not able to get their plan adopted by the full
committee. Some of the primary concerns that have been expressed are that the
plan does not adequately address utilities' stranded investment concerns, and
that the proposal to create retail marketing areas, or "buying pools,"
throughout the state during the transition period would be unduly disruptive
in that customers who did not affirmatively elect to remain with their
incumbent utility would be assigned to the buying pool under a Public
Utilities Commission of Ohio (PUCO) designed and administered bidding
process. The chairpersons have announced intentions to introduce a bill in
1998.
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Also in Ohio, a bill was introduced in November 1997 (HB 625) authorizing
the issuance of electric utility rate reduction bonds that would permit
utilities to securitize certain assets. The bill itself does not provide for
retail competition but, rather, specifies financing issues a utility may
engage in to prepare for competition. It is uncertain whether this bill or
any bill providing for retail competition will be passed in Ohio in 1998.
KENTUCKY In January 1998, the House Chairman of the Tourism, Development
and Energy Committee introduced a customer choice bill (HB 443). The bill
would allow persons and businesses in participating service areas to choose
their supplier of electricity beginning January 1, 2000. It would also ensure
a rate cap to prevent any increase in generation energy prices for six years,
with certain exceptions. Because of its low electric rates, Kentucky has not
to date been moving aggressively toward retail customer choice. It is
uncertain whether HB 443 will be passed in Kentucky in 1998.
UNITED KINGDOM Transition to full competition in the United Kingdom's (UK)
electric utility industry began with the industry's privatization in 1991.
When the industry was privatized, the generation, transmission, and regional
distribution businesses were, in effect, unbundled into separate companies.
The regional distribution companies, including Midlands Electricity plc
(Midlands) (Cinergy, through a joint venture owns a 50% interest in Midlands,
see Note 1(e) of the Notes to Consolidated Financial Statements), own no
transmission facilities and are limited as to the amount of generation they
may own. Third-party access to the transmission and local distribution
systems was also put in place, enabling licensed suppliers to use these
networks.
As a result of the transition plan, larger users of electricity have been
free to choose their supplier since 1994 or earlier. Full competition for all
customers was scheduled to be phased in beginning in April 1998. However, due
to delays with the design and testing of information systems, the phase-in to
full competition has been delayed to September 1998. Midlands' service
territory is now scheduled to begin open competition in October 1998.
To date, new entrants to the industry have been limited to independent
power producers, who compete with the formerly state-run generators by using
new, efficient technology. There have been no major new entrants into the
supply business from outside the industry. However, new entrants are expected
to emerge as full competition opens.
A substantial portion of Midlands' operating profit is related to the
distribution business, which will remain a regulated monopoly. Midlands
intends to market both gas and electric service in the supply business, as
all customers gain the ability to choose suppliers.
GAS UTILITY INDUSTRY
CUSTOMER CHOICE The PUCO approved CG&E's gas customer choice program during
1997. The plan, which made customer choice available to all residential and
small commercial customers, went into effect in November 1997. As of January
30, 1998, approximately 7,300 customers have opted to participate in this
program. Large industrial, commercial, and educational institution customers
already had the ability to select their own gas supplier. In 1997, the PUCO
approved two other gas customer choice programs in the state. Cinergy
Resources, Inc. (CRI), Cinergy's gas retail marketing subsidiary, is one of
many entities competing for customer gas supply business in these programs.
CG&E continues to provide the gas transportation service for all customers
on its system without regard to the supplier of the gas commodity. CG&E
receives a transportation charge from customers which is based on its current
regulated rates.
LOSS OF TRANSPORTATION CUSTOMER Late in 1997, AK Steel, Cinergy's largest
natural gas transportation customer, informed CG&E that it plans to build its
own pipeline to connect directly to an interstate natural gas pipeline. The
interruptible contract with CG&E, which represents approximately $7 million
of annual revenues, will expire at the end of 1998. Under that contract, AK
Steel purchases gas directly from other suppliers but uses CG&E's pipelines
to deliver the gas. AK Steel is able to pursue this alternative because of
its close proximity to an existing interstate pipeline. With few customers
being similarly situated, Cinergy and CG&E do not currently anticipate others
proceeding in a similar manner.
CINERGY'S RESPONSE TO THE CHANGING
COMPETITIVE ENVIRONMENT
Cinergy believes competition will benefit electric customers individually and
the economy as a whole. Cinergy has taken steps to prepare not only for the
changing environment, but to assure fairness and consistency in the setting
of rules and regulations in the various markets in which Cinergy competes.
Cinergy's basic approach to the deregulation environment is to have set a
goal to be a top five utility in five measures of scale and productivity
within five years. Examples of steps taken to achieve this goal include the
following:
* Cinergy reorganized its operations into four strategic business units.
This functional unbundling separated Cinergy's business into Energy Services,
Energy Delivery, Energy Commodities, and International business units. Each
business unit is responsible for business expansion in its own markets.
* Cinergy enhanced its international presence in 1996 by acquiring its
interest in Midlands, an electricity
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distribution company located in the UK. In 1997, Cinergy furthered its
international development plans by acquiring the development team and all
rights to future projects of Midlands Power International, a power
development subsidiary of Midlands.
* Cinergy formed a joint venture with Trigen Energy Corporation (Trigen) to
develop and operate cogeneration and trigeneration facilities throughout the
US and Canada which enables Cinergy to compete for customers outside its own
franchise territory prior to and following the arrival of retail competition.
* Cinergy has partnered with two other energy companies to form Cadence
Network LLC which will provide a variety of innovative products and services
to multi-site national accounts customers. These services include
consolidated billing, bill auditing, and rate and usage analysis.
* Cinergy has become a major participant in the marketing of power,
resulting in megawatt sales volume increases of 600% and 80% in 1997 and
1996, respectively.
* In 1997, Cinergy acquired Greenwich Energy Partners (Greenwich).
Greenwich is a small proprietary trader of energy commodities. Through its
acquisition of Greenwich, Cinergy became the first utility company to hold a
seat on the New York Mercantile Exchange (NYMEX). The NYMEX is the world's
largest physical commodity futures exchange and preeminent trading forum for
energy and precious metals.
* In 1996, the NYMEX began trading electricity futures and options
contracts with contract delivery points in the western US. During the first
half of 1998, the NYMEX will begin trading contracts with delivery points
located in the Midwest, Mid-Atlantic, and Southern regions of the country.
Cinergy's transmission system was selected as the delivery point for the
Midwest region. Cinergy's acquisition of the NYMEX seat and its selection as
a delivery point for electricity futures trading demonstrates Cinergy's
participation as a leader in the evolving power markets.
SUBSTANTIAL ACCOUNTING IMPLICATIONS
Historically, regulated utilities have applied the provisions of Statement of
Financial Accounting Standards No. 71, Accounting for the Effects of Certain
Types of Regulation (Statement 71). The accounting afforded regulated
utilities in Statement 71 is based on the fundamental premise that rates
authorized by regulators allow recovery of a utility's costs in its
generation, transmission, and distribution operations. These principles have
allowed the deferral of costs (i.e., regulatory assets) based on assurances
of a regulator as to the future recoverability of the costs in rates charged
to customers. Certain criteria must be met for the continued application of
the provisions of Statement 71, including regulated rates designed to recover
the specific utility's costs. Failure to satisfy the criteria in Statement 71
would eliminate the basis for recognition of regulatory assets.
Based on Cinergy's current regulatory orders and the regulatory environment
in which it currently operates, the recognition of its regulatory assets as
of December 31, 1997, is fully supported. However, in light of recent trends
in customer choice legislation, the potential for future losses resulting
from discontinuance of Statement 71 does exist. Such potential losses, if
any, cannot be determined until such time as a legislated plan has been
approved by each state in which Cinergy operates a franchise territory.
Cinergy intends to continue its pursuit of competitive strategies which
mitigate the potential impact of these issues on the financial condition of
the Company.
SECURITIES RATINGS
The current ratings provided by the major credit rating agencies; Duff &
Phelps Credit Rating Co. (D&P), Fitch Investors Service, LP (Fitch), Moody's
Investors Service (Moody's), and Standard and Poor's (S&P) are included in
the following table:
<TABLE>
<CAPTION>
D&P Fitch Moody's S&P
- --------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
CINERGY
Corporate Credit BBB+ BBB+ Baa2 BBB+
Commercial Paper D-2 F-2 P-2 A-2
CG&E
Secured Debt A- A- A3 A-
Senior Unsecured Debt BBB+ Not rated Baa1 BBB+
Junior Unsecured Debt BBB Not rated Baa2 BBB+
Preferred Stock BBB BBB+ baa1 BBB+
Commercial Paper D-1- F-2 P-2 Not rated
PSI
Secured Debt A- A A3 A-
Unsecured Debt BBB+ A- Baa1 BBB+
Preferred Stock BBB BBB+ baa1 BBB+
Commercial Paper D-1- F-2 P-2 Not rated
ULH&P
Secured Debt A- Not rated A3 A-
Unsecured Debt Not rated Not rated Baa1 BBB+
</TABLE>
THESE SECURITIES RATINGS MAY BE REVISED OR WITHDRAWN AT ANY TIME, AND EACH
RATING SHOULD BE EVALUATED INDEPENDENTLY OF ANY OTHER RATING.
REGULATORY MATTERS
INDIANA
IURC ORDERS -- PSI'S RETAIL RATE PROCEEDING AND DEMAND-SIDE MANAGEMENT (DSM)
PROCEEDING In September 1996, the IURC issued an order (September 1996
Order) approving an overall average retail rate increase for PSI of 7.6%
($75.7 million annually).
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Among other things, the IURC authorized the inclusion in rates of the costs
of a 262-mw clean coal power generating facility located at Wabash River
Generating Station (Clean Coal Project) and the costs of a scrubber at Gibson
Generating Station. The order also reflects a return on common equity of
11.0%, before the 100 basis points additional common equity return allowed as
a merger savings sharing mechanism in the IURC's February 1995 order
(February 1995 Order) discussed further herein, with an 8.21% overall rate of
return on net original cost rate base.
In October 1996, The Office of the Utility Consumer Counselor (UCC) and the
Citizens Action Coalition of Indiana, Inc. (CAC) filed a Joint Petition for
Reconsideration and Rehearing of the September 1996 Order with the IURC. A
settlement agreement with the UCC and CAC was approved in its entirety by the
IURC in August 1997. This settlement agreement reduced the original rate
increase by $2.1 million (.2%). Major provisions of the settlement agreement
include: a) a $4.1 million increase in the annual amortization of certain
regulatory assets; b) a retail rate reduction of $1 million annually; c) a
$.9 million reduction in retail rates to reflect an August 31, 1995, cut-off
date for costs to achieve merger savings instead of an October 31, 1996,
cut-off date; and d) authorization to defer for subsequent recovery costs to
achieve merger savings incurred between September 1, 1995, and October 31,
1996.
A settlement agreement between PSI and certain intervenors, in a proceeding
established to review PSI's current and proposed DSM programs, was approved
by the IURC in December 1996 (December 1996 DSM Order). Beginning January 1,
1997, and continuing through December 31, 2000, the settlement agreement
allows PSI to recover $35 million per year through a non-bypassable charge in
PSI's retail rates. The $35 million is designed to recover all previously
incurred, but as yet unrecovered, DSM costs and all costs related to
satisfying remaining commitments associated with a previous DSM settlement
agreement. The $35 million also includes recovery of carrying costs. Further,
the agreement authorizes PSI to spend up to $8 million annually on ongoing
DSM programs through the year 1999 and to collect such amounts currently in
retail rates.
FEBRUARY 1995 ORDER -- RETAIL RATE PROCEEDING AND MERGER SAVINGS ALLOCATION
PLAN The IURC's February 1995 Order approved a settlement agreement among
PSI and certain intervenors authorizing PSI to increase retail rates $33.6
million before credits to base rates of $4.4 million in 1995 and an
additional $2.2 million and $2.4 million in 1996 and 1997, respectively, to
reflect the sharing with customers of non-fuel operation and maintenance
expense merger savings (Non-fuel Merger Savings).
Additionally, the February 1995 Order provided PSI an opportunity to earn
up to an additional 100 basis points above the common equity return
authorized in the September 1996 Order until December 31, 1997. To be
eligible for such additional earnings, PSI had to meet certain
performance-related standards. PSI met those standards, which were measured
in conjunction with quarterly fuel adjustment clause filings. Beginning
January 1, 1998, the 100 basis point increment to the authorized common
equity return will be phased out over a twelve-month period.
Effective with this order, PSI began recovering carrying costs on certain
environmental-related projects under construction. This recovery continues
until the date of an approved rate order reflecting such projects in rates.
Through this mechanism, revenues were increased by $9 million, $18 million,
and $2 million on an annual basis in February 1995, March 1995, and January
1996, respectively.
COAL CONTRACT BUYOUT COSTS In August 1996, PSI entered into a coal supply
agreement with Eagle Coal Company (Eagle) for the supply of approximately
three million tons of coal per year. The agreement, which terminates December
31, 2000, provides for a buyout fee of $179 million (including interest) to
be included in the price of coal to PSI over the term of the contract. This
fee represents the costs to Eagle of the buyout of the coal supply agreement
between PSI and Exxon Coal and Minerals Company. The retail jurisdictional
portion of the buyout charge, excluding the portion applicable to joint
owners, is being recovered through the quarterly fuel adjustment clause, with
carrying costs on unrecovered amounts, through December 2002. PSI has also
filed a petition at the FERC for recovery of the wholesale jurisdictional
portion of the buyout costs through the wholesale fuel adjustment clause.
Generally, the FERC will allow recovery if the utility can demonstrate there
will be net benefits to customers during the buyout cost recovery period. The
FERC is expected to issue an order on PSI's petition early in 1998. (See Note
1(i) of the Notes to Consolidated Financial Statements.)
OHIO
PUCO ORDER -- CG&E'S GAS RATE PROCEEDING In December 1996, the PUCO issued
an order (December 1996 Order) approving an overall average increase in gas
revenues for CG&E of 2.5% ($9.3 million annually). The PUCO established an
overall rate of return of 9.7%, including a return on common equity of 12.0%.
In developing this return on common equity, the PUCO considered, among other
things, CG&E's efforts to reduce costs and increase operating efficiency and
its proposals to allow residential customers to choose their natural gas
supplier. The PUCO disallowed certain of CG&E's requests, including the
requested working capital allowance, recovery of certain capitalized
infor-
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mation systems development costs, and certain merger-related costs. These
disallowances resulted in a pretax charge to earnings during the fourth
quarter of 1996 of $20 million ($15 million net of taxes or $.10 per share,
$.09 per share diluted). CG&E's request for a rehearing on the disallowed
information systems costs and other aspects of the order was denied.
In April 1997, CG&E filed a notice of appeal with the Supreme Court of Ohio
challenging the disallowance of information systems costs and the imputation
of certain revenues. Cinergy and CG&E cannot predict what action the Supreme
Court of Ohio may take with respect to this appeal.
OTHER In April 1994, the PUCO issued an order approving a settlement
agreement among CG&E and certain intervenors which, among other things,
resolved outstanding issues related to the merger. As part of this
settlement, CG&E agreed to a moratorium on increases in base electric rates
until January 1, 1999 (except under certain circumstances). In return, CG&E
is allowed to retain all PUCO electric jurisdictional Non-fuel Merger Savings
until 1999.
Consistent with the provisions of the settlement agreement and the December
1996 Order, CG&E expensed merger transaction costs and costs to achieve
merger savings (Merger Costs) applicable to its PUCO jurisdiction of $5
million and $41 million (including $6 million as a result of the December
1996 Order) in 1995 and 1996, respectively. CG&E and its utility subsidiaries
have deferred a portion of the Merger Costs incurred through December 31,
1996, for future recovery in customer rates.
Additionally, in December 1996, the PUCO issued an order applicable to
CG&E's DSM programs. The order requires CG&E to spend up to one-half of the
annual $5 million currently included in retail rates on PUCO-sanctioned
low-income residential programs. The remaining portion of the $5 million is
to be applied to the recovery of DSM cost deferrals. CG&E's participation in
the low-income programs will be a factor considered by the PUCO in setting
future rates of return and approving competitive transition plans.
KENTUCKY
In exchange for the Kentucky Public Service Commission's (KPSC) support of
the merger, in May 1994, ULH&P accepted the KPSC's request for an electric
rate moratorium commencing after ULH&P's next retail rate case (which has not
yet been filed) and extending to January 1, 2000. In addition, the KPSC has
authorized concurrent recovery of costs related to various DSM programs of
ULH&P.
POTENTIAL DIVESTITURE OF GAS OPERATIONS
Under the PUHCA, the divestiture of CG&E's gas operations may be required.
The key question under the relevant PUHCA standards is the amount of
increased operating costs, if any, that would result from the gas operations
being divested and operated on a stand-alone basis.
In its order approving the merger, the SEC reserved judgment over
Cinergy's ownership of CG&E's gas operations for three years, at the end of
which period Cinergy would be required to address the matter. In February
1998, Cinergy made a filing with the SEC setting forth its rationale for
retention of the gas operations. The filing includes, among other things, a
study showing that, if divested and operated on a stand-alone basis, the gas
operations would bear significant increased operating costs, greater than
those cited by the SEC in two 1997 cases permitting electric registered
holding companies to acquire and retain gas properties. For these and other
reasons stated in Cinergy's filing, Cinergy believes its retention of CG&E's
gas properties meets all relevant standards under the PUHCA.
ENVIRONMENTAL ISSUES
CLEAN AIR ACT AMENDMENTS OF 1990 (CAAA)
The 1990 revisions to the Clean Air Act require reductions in both sulfur
dioxide (SO2) and nitrogen oxide (NOx) emissions from utility sources.
Reductions of these emissions are to be accomplished in two phases.
Compliance under Phase I was required by January 1, 1995, and Phase II
compliance is required by January 1, 2000. To achieve the SO2 reduction
objectives of the CAAA, emission allowances have been allocated by
the US Environmental Protection Agency (EPA) to affected sources (e.g.,
Cinergy's electric generating units). Each allowance permits one ton of SO2
emissions. The CAAA allows compliance to be achieved on a national level,
which provides companies the option to achieve this compliance by reducing
emissions and/or purchasing emission allowances.
Cinergy's operating strategy for Phase I was based upon the compliance
plans developed by PSI and CG&E and approved by the IURC and the PUCO,
respectively. All required modifications to Cinergy's generating units to
implement the compliance plans were completed prior to January 1, 1995.
To comply with Phase II SO2 emission requirements, Cinergy's current
strategy includes a combination of switching to lower-sulfur coal blends and
utilizing an emission allowance banking strategy. This cost-effective
strategy will allow Cinergy to meet Phase II SO2 reduction requirements while
maintaining optimal flexibility to meet changes in output due to
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increased customer choice, as well as potentially significant future
environmental requirements. Cinergy intends to utilize an emission allowance
banking strategy to the extent a viable emission allowance market exists.
However, the availability and economic value of emission allowances over the
long-term is still uncertain. In the event the market price for emission
allowances or lower-sulfur coal increases substantially from the current
forecast, Cinergy could be forced to consider high capital cost options.
To meet NOx reductions required by Phase II, Cinergy may install
additional low NOx burners on certain affected units in addition to the use
of a system-wide NOx emission averaging strategy.
Cinergy is forecasting CAAA compliance capital expenditures of $19 million
during the 1998 through 2002 period. These expenditures are included in the
amounts provided in the "Capital Requirements" section herein. In addition,
operating costs may increase due to higher fuel costs (e.g., higher-quality,
lower-sulfur coal; increased use of natural gas) and maintenance expenses.
AMBIENT AIR STANDARDS
The EPA recently revised the National Ambient Air Quality Standards for ozone
and fine particulate matter. These new rules increase the pressure for
additional emissions reductions. On September 23, 1997, Cinergy announced a
proposal to reduce its NOx emissions rate by two-thirds to 0.25 pounds of NOx
per one million British thermal units (MMBtu). At that time, Cinergy's
preliminary cost estimate for the two-thirds reduction was between $74
million and $204 million (stated in 1997 dollars). Subsequent to Cinergy's
announcement, the EPA announced on October 10, 1997, its proposed call for
revisions to State Implementation Plans (SIPs) for statewide reductions in
NOx emissions, proposing utility NOx emissions at a rate of 0.15 pounds per
MMBtu. The EPA's schedule calls for all reductions to be in place as early as
2002. These initiatives will force significant reductions in NOx emissions
from many sources. The EPA has stated that electric utility generating
facilities specifically are targeted. The final total level of NOx reductions
will depend upon the outcome of the SIP revision process. Cinergy estimates
that the capital costs for additional NOx controls at its facilities at the
0.15 pounds of NOx per MMBtu rate proposed by the EPA could exceed $524
million (stated in 1997 dollars) over the next five years depending upon the
final level of reductions, details of a NOx trading program, and the time
frame for implementation.
In February 1998, Cinergy joined with various utilities, labor groups, and
other organizations from several Midwest, Great Lakes, Mid-Atlantic, and
Southeast states in forming the Alliance for Constructive Air Policy (ACAP).
This coalition is committed to working with policymakers to find cost-
effective, equitable approaches for reducing ozone pollution in key regions
of the country. The ACAP is developing an alternative to the EPA's proposed
call for SIPs revisions to reduce NOx emissions (see discussion above). The
ACAP's proposal is a two-step process to achieve reductions in NOx emissions.
The first step involves NOx emission reductions of 55 percent from 1990
levels, or a reduction in the NOx emission rate to 0.35 pounds of NOx per
MMBtu, whichever is less stringent, by 2004. The second step involves the
development of enhanced subregional air quality modeling that would be used
to determine if any additional reductions are necessary to reach local
attainment. These additional reductions, if needed, would be implemented by
2007. The ACAP is also promoting the establishment of a subregional trading
market for NOx emissions. This system would allow for a market-based approach
to limiting emissions and would produce cost savings and incentives for the
development of new technologies to improve air quality. Capital costs
required for Cinergy to be in compliance under the ACAP's proposals would be
significantly less than those under the current EPA proposal. But as stated
above, final costs of compliance depend on the final level of reductions
required, details of a NOx trading program, and the time frame for
implementation and compliance.
The impact of the particulate standards cannot be determined at this time.
The EPA estimates it will take up to five years to collect sufficient ambient
air monitoring data. The states will then determine the sources of these
particulates and determine a reduction strategy. The ultimate effect of the
new standard could be requirements for newer and cleaner technologies and
additional controls on conventional particulates and/or reductions in SO2 and
NOx emissions from utility sources. Since these studies and determinations
have not been made, Cinergy cannot predict the outcome or effect of the new
particulate standards.
GLOBAL CLIMATE CHANGE
On December 11, 1997, delegates to the United Nations' climate summit in
Japan adopted a landmark environmental treaty (Kyoto Protocol) to deal with
global warming. The Kyoto Protocol establishes legally binding greenhouse gas
emission targets for developed nations. The Kyoto Protocol framework lacks
details related to definitions, implementation, and enforcement plans. For
the Kyoto Protocol to enter into force within the US it will have to be
ratified by a two-thirds vote of the US Senate. In July 1997, the US Senate
passed a resolution advising the Clinton Administration that they would not
favorably consider a protocol which did not include commitments for all
nations of the world, or that would cause harm to the US economy. The Kyoto
Protocol, in its
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REVIEW OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
present form, is unlikely to be ratified by the US Senate since it does not
meet the requirements of this resolution.
Significant uncertainty exists concerning the science of climate change,
and the Clinton Administration's environmental and energy policies and how it
intends to reduce greenhouse gas emissions. Cinergy's plan for managing the
potential risk and uncertainty of climate change includes: (1) implementing
cost-effective greenhouse gas emission reduction and offsetting activities;
(2) encouraging the use of alternative fuels for transportation vehicles (a
major source of greenhouse gases); (3) funding research of more efficient and
alternative electric generating technologies; (4) funding research to better
understand the causes and consequences of climate change; and (5) encouraging
a global discussion of the issues and how best to manage them. Cinergy
believes that voluntary programs, such as the US Department of Energy Climate
Challenge Program, which Cinergy joined in 1995, are the most cost-effective
means to limit greenhouse gas emissions.
AIR TOXICS
The air toxics provisions of the CAAA exempted fossil-fueled steam utility
plants from mandatory reduction of air toxics until the EPA completed a
study. The final report issued in February 1998, confirmed utility air toxic
emissions pose little risk to public health. It stated mercury is the
pollutant with the greatest potential threat, while others require further
study. A Mercury Study Report issued in December 1997, stated that mercury is
not a risk to the average American and expressed uncertainty whether
reductions in current domestic sources would reduce human mercury exposure.
US utilities are a large domestic source, but negligible compared to global
mercury emissions. The EPA was unable to show a feasible mercury control
technology for coal-fired utilities. The EPA must determine the need for
regulation by April 15, 1998. If more air toxics regulations are issued, the
compliance cost could be significant. Cinergy cannot predict the outcome or
effects of the EPA's determination.
OTHER
As more fully discussed in Note 12(b)(ii) of the Notes to Consolidated
Financial Statements, PSI has received claims from Indiana Gas Company, Inc.
(IGC) and Northern Indiana Public Service Company (NIPSCO) that PSI is a
Potentially Responsible Party under the Comprehensive Environmental Response,
Compensation and Liability Act with respect to certain manufactured gas plant
(MGP) sites, and therefore responsible for the costs of investigating and
remediating these sites.
In August 1997, NIPSCO filed suit against PSI seeking recovery from PSI of
NIPSCO's past and future costs of investigating and remediating MGP related
contamination at the Goshen, Indiana, MGP site. NIPSCO alleged that it has
already incurred about $400,000 in response costs at the site and that
remediation of the site will cost about $2.7 million. PSI denied liability in
its answer to the complaint. The parties are currently engaged in the
discovery process and the case has not yet been scheduled for trial.
Also, in August 1997, PSI reached an agreement with IGC settling IGC's
claims that PSI should contribute to IGC's response costs related to 13 of
the 19 MGP sites conveyed by PSI to IGC in 1945. This agreement requires PSI
and IGC to share past and future response costs equally (50%/50%) at the 13
sites. Further, the parties must jointly approve future management of the
sites and the decision to spend additional funds. The settlement does not
address five sites PSI acquired from NIPSCO and subsequently sold to IGC.
It is premature, at this time, to predict the nature, extent, and ultimate
costs of, or PSI's responsibility for, environmental investigations and
remediations at MGP sites owned or previously owned by PSI or its
predecessors. PSI continues to gather information pertaining to each of these
MGP sites, including the 13 sites which are the subject of the agreement with
IGC and the Goshen site which is the subject of NIPSCO's complaint. Reserves
recorded, based on information currently available, are not material to
Cinergy's financial condition or results of operations. However, as further
investigation and remediation activities are undertaken at these sites, the
potential liability for MGP sites could be material to Cinergy's financial
condition or results of operations.
Refer to Note 12(b) and (c) of the Notes to Consolidated Financial
Statements for a more detailed discussion of the status of certain
environmental issues.
CAPITAL REQUIREMENTS
CONSTRUCTION AND OTHER INVESTING ACTIVITIES
Construction expenditures for the Cinergy system are forecasted to be
approximately $375 million for 1998, and over the next five years (1998 -
2002), are forecasted to aggregate approximately $1.7 billion. Substantially
all of these expenditures are for capital improvements to and expansion of
Cinergy's operating facilities.
Cinergy is forecasting no investments in new generating facilities under
the belief that excess supply in the market will continue in the near term.
If deregulation of the generation component of the electric utility industry
does not occur in the manner or in the time frame anticipated, and depending
on capacity constraints, franchise demand requirements, and the regulatory
requirements dictated for Integrated Resource Planning, Cinergy
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could be forced to make capital investments in new generating facilities
in lieu of relying upon the existing market for its energy needs. (ALL
FORECASTED AMOUNTS ARE IN NOMINAL DOLLARS, EXCLUDE CAPITAL COSTS FOR
ADDITIONAL NOX CONTROLS AT CINERGY'S FACILITIES (SEE "AMBIENT AIR STANDARDS"
IN THE "ENVIRONMENTAL ISSUES" SECTION HEREIN), AND REFLECT ASSUMPTIONS AS TO
THE ECONOMY, CAPITAL MARKETS, CONSTRUCTION PROGRAMS, LEGISLATIVE AND
REGULATORY ACTIONS, FREQUENCY AND TIMING OF RATE INCREASES, AND OTHER RELATED
FACTORS, ALL OR ANY OF WHICH MAY CHANGE SIGNIFICANTLY.)
As discussed in the "Competitive Pressures" section, during 1996, Cinergy
acquired a 50% interest in Midlands. Cinergy and GPU, Inc. (GPU) formed Avon
Energy Partners Holdings (Avon Energy), a 50%/50% joint venture, and acquired
the outstanding common stock of Midlands through Avon Energy's wholly-owned
subsidiary for approximately $2.6 billion. Cinergy and GPU have each invested
approximately $500 million in Avon Energy. Cinergy funded its investment
through its credit facility. Avon Energy funded the remainder of the purchase
price through the issuance of non-recourse debt (see Note 1(e) of the Notes
to Consolidated Financial Statements).
During 1996, Cinergy and Trigen formed a joint venture, Trigen-Cinergy
Solutions LLC (Trigen-Cinergy). Cinergy may invest up to $100 million and
provide guaranties of debt and other obligations in an aggregate amount not
to exceed $250 million at any one time with respect to energy-related
products and services, including those undertaken by Trigen-Cinergy. (See the
"Competitive Pressures" section herein.)
With respect to international development, subject to identifying projects
which meet Cinergy's investment objectives, Cinergy may invest or commit up
to $100 million during 1998. Funding of these investments
or commitments will be provided through additional debt borrowings. (See the
"Competitive Pressures" section herein.)
Cinergy's net cash used in investing activities was $377 million in 1997,
compared to $871 million and $363 million in 1996 and 1995, respectively. The
decrease in 1997 was primarily attributable to the effect of Cinergy's
investment in Midlands during 1996.
OTHER COMMITMENTS
SECURITIES REDEMPTIONS
Mandatory redemptions of long-term debt total $501 million during the period
1998 through 2002. On January 29, 1998, PSI gave notice of its intention to
redeem on March 1, 1998, all outstanding shares of its 7.44% Series
Cumulative Preferred Stock at a redemption price of $25 per share. On
February 27, 1998, CG&E announced its intention to redeem on March 29, 1998,
$41 million principal amount of its 7 3/8% Series First Mortgage Bonds (due
November 1, 2001) at a redemption price of 100.30% and to redeem on March 30,
1998, the entire $100 million principal amount of its 8 1/2% Series First
Mortgage Bonds (due September 1, 2022) at a redemption price of 100%, both
through the maintenance and replacement fund (M&R Fund) provision of CG&E's
first mortgage bond indenture. Additionally, on the same date, CG&E announced
its intention to redeem on March 30, 1998, the remaining $19 million
principal amount of its 7 3/8% Series First Mortgage Bonds (due November 1,
2001) at a redemption price of 100.87%. Cinergy will continue to evaluate
opportunities for the refinancing of outstanding securities beyond mandatory
redemption requirements.
M&R Fund provisions contained in CG&E's, PSI's, and ULH&P's first mortgage
bond indentures require cash payments, bond retirements, or pledges of
unfunded property additions each year based on an amount related to the net
revenues of the respective company.
WINDFALL PROFITS TAX
During the third quarter of 1997, a windfall profits tax was levied against
Midlands. Cinergy's share of the tax to be paid by Midlands in two equal
installments, due December 1, 1997, and 1998, is approximately 67 million
pounds sterling ($109 million or $.69 per share, basic and diluted). Midlands
borrowed the funds to finance the first installment. Cinergy expects Midlands
will borrow funds as necessary to pay the final installment. As Cinergy's
management believes this charge to be unusual in nature, and does not expect
such a charge to recur, the tax was recorded as an extraordinary item in
Cinergy's Consolidated Statement of Income during the third quarter of 1997.
No related tax benefit was recorded for the charge as the windfall profits
tax is not deductible for corporate income tax purposes in the UK, and
Cinergy expects that benefits, if any, derived for US Federal income taxes
will not be significant.
YEAR 2000 COSTS
Cinergy, like most owners of information systems, will be required to modify
significant portions of its systems to accommodate requirements brought about
by the turn of the century. During 1997, Cinergy incurred costs of
approximately $5 million to modify existing computer systems and
applications. Preliminary estimates of the remaining total costs to be
incurred prior to 2000 are approximately $8 million. Maintenance or
modification costs will be expensed as incurred, while the costs of new
software will be capitalized and amortized over the software's useful life.
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REVIEW OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
CAPITAL RESOURCES
Cinergy forecasts that its need for external funds during the 1998 through
2002 period will primarily be for the refinancing of existing securities.
(THIS FORECAST REFLECTS NOMINAL DOLLARS AND ASSUMPTIONS AS TO THE ECONOMY,
CAPITAL MARKETS, CONSTRUCTION PROGRAMS, LEGISLATIVE AND REGULATORY ACTIONS,
FREQUENCY AND TIMING OF RATE INCREASES, AND OTHER RELATED FACTORS, ALL OR ANY
OF WHICH MAY CHANGE SIGNIFICANTLY.)
INTERNAL FUNDS
GENERAL
Currently, the majority of Cinergy's revenues and corresponding cash flows
are derived from cost-of-service regulated operations. Cinergy believes it is
likely that the generation component of the electric utility industry will
ultimately be deregulated. However, the timing and nature of the deregulation
and restructuring of the industry is uncertain. In the interim, revenues
provided by cost-of-service regulated operations are anticipated to continue
as the primary source of funds for Cinergy. As a result of its low-cost
position and market strategy, over the long term, Cinergy believes it will be
successful in a more competitive environment. However, as the industry
becomes more competitive, future cash flows from Cinergy's operations could
be subject to a higher degree of volatility than under the present regulatory
structure.
For the year ended December 31, 1997, Cinergy's cash provided from
operating activities was $753 million compared to $855 million and $736
million in 1996 and 1995, respectively. The decrease in 1997 was primarily
due to CG&E's and ULH&P's sales of accounts receivable during 1996. The
decrease was offset, in part, by PSI's payment in 1996 of $80 million in
accordance with a 1989 settlement agreement between PSI and Wabash Valley
Power Association, Inc. (See Notes 6 and 12(e) of the Notes to Consolidated
Financial Statements.)
MERGER SAVINGS
As previously discussed in the "Regulatory Matters" section, CG&E currently
has a regulatory order in effect which provides a mechanism for the retention
of a portion of net Non-fuel Merger Savings.
COMMON STOCK
During 1997, 1996, and 1995, Cinergy issued 66 thousand, 15 thousand, and 2.6
million new shares, respectively, of common stock pursuant to its dividend
reinvestment and stock purchase plan and various stock-based employee plans.
In addition, Cinergy purchased 1.7 million and 1.2 million shares on the open
market to satisfy substantially all of its 1997 and 1996 obligations,
respectively, under these plans. Cinergy plans to continue using market
purchases of common stock to satisfy all or at least a portion of its
obligations under these plans.
LONG-TERM DEBT
As of December 31, 1997, CG&E, PSI, and ULH&P had state regulatory authority
for long-term debt issuances of $300 million, $300 million, and $50 million,
respectively. Regulatory approval to issue additional amounts of securities
will be requested as needed.
SHORT-TERM DEBT
In 1997, Cinergy amended its existing credit facility. At year-end, Cinergy
had two separate credit facilities, a $350 million acquisition commitment and
a $400 million revolving credit facility, which provides credit support for
Cinergy's newly instituted commercial paper program (see below). As of
December 31, 1997, approximately $111 million of the $400 million revolving
facility, excluding the amount reserved for commercial paper support,
remained unused and available.
Cinergy's newly instituted commercial paper program is limited to a
maximum outstanding principal amount of $200 million. As of December 31,
1997, approximately $161 million of commercial paper was outstanding under
this program. The majority of the proceeds were used to reduce the
acquisition commitment to the year-end level of $350 million. The entire $350
million was utilized to fund the acquisition of Midlands through Avon Energy
and its wholly-owned subsidiary. CG&E and PSI also have the capability to
issue commercial paper which must be supported by committed lines (unsecured
lines of credit) of the respective company. Neither CG&E nor PSI issued
commercial paper in 1997 or 1996.
Cinergy's utility subsidiaries had regulatory authority to borrow up to
$853 million as of December 31, 1997. In connection with this authority,
committed lines have been established which permit borrowings of up to $270
million, of which $140 million remained unused and available at December 31,
1997. Also, pursuant to this authority, uncommitted lines (short-term
borrowings with various banks on an "as offered" basis) have been
established. Under these arrangements, $154 million was unused and available
at December 31, 1997.
In addition, Cinergy UK, Inc., a subsidiary of Investments, which holds
Cinergy's 50% investment in Avon Energy, entered into a $40 million non-
recourse credit agreement in 1996, which was terminated in October of 1997.
This agreement was replaced by a one year $115 million non-recourse revolving
credit agreement, which had $81 million unused as of December 31, 1997.
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Net cash used in financing activities totaled $343 million in 1997, as
compared to $110 thousand and $410 million in 1996 and 1995, respectively.
The change in cash flow from financing activities for 1997 primarily resulted
from Cinergy borrowing under its credit facility in 1996 to fund the
acquisition of Midlands.
On January 20, 1998, the SEC issued an order under the PUHCA permitting
Cinergy to issue and sell from time to time through December 31, 2002: 1)
Short-term notes and commercial paper in an aggregate principal amount not to
exceed $2 billion outstanding at any time; and 2) up to approximately 30
million additional shares of Cinergy common stock. Cinergy intends to use the
net proceeds from the issuance and sales of the above mentioned securities
for general corporate purposes.
SALE OF ACCOUNTS RECEIVABLE
In January 1996, CG&E, PSI, and ULH&P entered into an agreement to sell, on a
revolving basis, undivided percentage interests in certain of their accounts
receivable up to an aggregate maximum of $350 million, of which $252 million,
net of reserves, has been sold as of December 31, 1997. The Consolidated
Balance Sheets are net of $252 million and $246 million sold at December 31,
1997 and 1996, respectively.
MARKET RISK SENSITIVE INSTRUMENTS AND POSITIONS
The following discussions about Cinergy's market risk sensitive instruments
and positions and risk management activities include forward-looking
information and statements that involve risks and uncertainties. The forward-
looking information and statements presented are only estimates of what may
occur in the future, assuming certain adverse market conditions, due to their
dependence on model characteristics and assumptions. As a result, actual
future results may differ materially from those presented. These disclosures
are not precise indicators of expected future losses, rather they merely
present indications of reasonably possible losses.
ENERGY COMMODITIES SENSITIVITY
During 1996 Cinergy functionally reorganized its operations into four
strategic business units, including an energy commodities business unit. The
energy commodities business unit includes Cinergy's power marketing and
trading function, which was formally established in 1995 and was the natural
successor of CG&E's and PSI's existing bulk power operations.
At present, the competitive electric power market is dominated by a small
number of large participants (primarily utilities and a few power marketers),
trading liquidity is limited, and pricing is not transparent. However,
similar to the development of natural gas markets, the market for trading
electricity is expected to develop rapidly and Cinergy plans to be a major
participant.
The transactions associated with Cinergy's power marketing and trading
function give rise to various risks, including market risk. Market risk
represents the potential risk of loss from changes in the market value of a
particular commitment arising from adverse changes in market rates and
prices. Cinergy's power marketing and trading operations are actively
conducted in all regions of the US. These operations subject Cinergy to the
risks and volatilities associated with the energy commodities (e.g.,
primarily electricity) which it markets and trades. The wholesale power
marketing and trading business continues to be very competitive and, as a
result, margins have declined throughout the year. As Cinergy continues to
develop and expand its power marketing and trading business (and due to its
substantial investment in generating assets), its exposure to movements in
the price of electricity and other energy commodities will become greater. As
a result, Cinergy may be subject to increased earnings volatility.
Cinergy's power marketing and trading activities principally consist of
marketing and trading over-the-counter contracts for the purchase and sale of
electricity. The majority of these contracts commit Cinergy to purchase or
sell electricity at fixed prices in the future (i.e., fixed-price forward
purchase and sales contracts). Cinergy also markets and trades over-the-
counter option contracts. The majority of these forward and option contracts
require settlement by physical delivery of electricity or are netted out in
accordance with industry trading standards. The use of these types of
physical commodity instruments is designed to allow Cinergy to manage and
hedge its contractual commitments, reduce its exposure relative to the
volatility of cash market prices, and take advantage of selected arbitrage
opportunities. The use of derivative commodity instruments intended to be
settled in cash was not significant during 1997.
Cinergy values its portfolio of over-the-counter forward and option
contracts using the aggregate lower of cost or market method. To the extent
there are estimated net aggregate losses in the portfolio, Cinergy reserves
for such losses. As these contracts are settled, actual gains and losses may
differ from the estimated gains and losses utilized in calculating the
aggregate lower of cost or market reserve due to changing market conditions.
Cinergy structures and modifies its net position to capture expected
changes in future demand, seasonal market pricing characteristics, overall
market sentiment, and price relationships between different time periods and
trading regions. Therefore, at times, Cinergy creates a net open position or
allows a net open position to continue when it believes future changes in
prices and market conditions will make the positions profitable. Position
imbalances may also occur because of the
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REVIEW OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
basic lack of liquidity in the wholesale power market itself. To the
extent net open positions exist, Cinergy is exposed to the risk that
fluctuating market prices of electric power may potentially impact its
financial condition or results of operations adversely if prices do not move
in the manner or direction expected.
Cinergy measures the risk inherent in its portfolio utilizing value-at-
risk analysis and other methodologies, which simulate forward price curves in
electric power markets to quantify estimates of the magnitude and probability
of potential future losses related to open contract positions. Cinergy's
value-at-risk expresses the potential loss in fair value of its forward
contract and option position over a particular period of time, with a
specified likelihood of occurrence, due to an adverse market movement.
Cinergy reports value-at-risk as a percentage of its earnings, based on a 95%
confidence interval, utilizing one day holding periods. On a one day basis as
of December 31, 1997, Cinergy's value-at-risk for its power marketing and
trading activities was less than 2% of Cinergy's "Income Before Interest And
Other Charges". The value-at-risk model uses the variance-covariance
statistical modeling technique and historical volatilities and correlations
over the past 200 day period. The estimated market prices used to value these
transactions for value-at-risk purposes reflect the use of established
pricing models and various factors including quotations from exchanges and
over-the-counter markets, price volatility factors, the time value of money,
and location differentials.
Cinergy Capital & Trading, Inc. (CC&T), a subsidiary of Investments,
specializing in energy risk management, marketing, and proprietary arbitrage
trading, actively trades derivative commodity instruments, customarily
settled in cash, including futures, forwards, swaps, and options. CRI also
utilizes derivative commodity instruments, customarily settled in cash, to
hedge purchases and sales of natural gas. The trading and hedging activities
of CC&T and the hedging activities of CRI were not significant to Cinergy's
financial condition or results of operations.
Credit risk represents the risk of loss which would occur as a result of
nonperformance by counterparties pursuant to the terms of their contractual
obligations with the Company. Concentrations of credit risk relate to
significant customers or counterparties, or groups of customers or
counterparties, possessing similar economic or industry characteristics that
would cause their ability to meet contractual obligations to be similarly
affected by changes in economic or other conditions.
Concentration of credit risk with respect to Cinergy's trade accounts
receivable from electric and gas retail customers is limited due to Cinergy's
large number of customers and diversified customer base of residential,
commercial, and industrial customers. Sales for resale customers on Cinergy's
electric system include traditional electric cooperatives and municipalities
with which CG&E and PSI have long-standing relationships. Contracts for sales
of electricity for resale outside of Cinergy's system are principally with
power marketers, other investor owned utilities, electric cooperatives, and
municipalities. As of December 31, 1997, approximately 65% of Cinergy's power
marketing and trading activity represents commitments with 10 counterparties.
The majority of these contracts are for terms of one year or less. As the
competitive electric power market expands, counterparties will increasingly
include new market entrants, such as other power marketers, brokers, and
commodities traders. This increased level of new market entrants, as well as
competitive pressures on the utility market participants, could increase
Cinergy's exposure to credit risk. As of December 31, 1997, Cinergy's
management believes nonperformance of contractual obligations by any one
counterparty of Cinergy's power marketing and trading function would not
result in losses which are significant to the financial condition or results
of operations of Cinergy.
Cinergy's energy commodities business unit has established a risk
management function and has implemented active risk management policies and
procedures to manage and minimize its exposure to price risks and associated
volatilities, other market risks, and credit risk. Cinergy maintains credit
policies with regard to its counterparties in order to manage and minimize
its exposure to credit risk. These policies include requiring parent company
guaranties and various forms of collateral under certain circumstances and
the use of mutual netting/closeout agreements. Cinergy manages, on a
portfolio basis, the market risks inherent in its power marketing and trading
transactions subject to parameters established by Cinergy's Risk Policy
Committee. Market risks are monitored by the Risk Management Group of
Cinergy's energy commodities business unit, which operates separately from
the units which originate or actively manage the market risk exposures, to
ensure compliance with Cinergy's stated risk management policies and
procedures. These policies and procedures are reviewed and monitored on a
continuous basis to ensure their responsiveness to changing market and
business conditions. In addition, efforts are ongoing to develop systems to
improve the timeliness and quality of market and credit risk information.
EXCHANGE RATE SENSITIVITY
Cinergy has exposure to fluctuations in the US dollar/UK pound sterling
exchange rate through its investment in Midlands. Cinergy used dollar
denominated variable interest rate debt to fund this investment, and has
hedged the exchange rate exposure related to this transaction through a
currency swap executed in February 1997. Under the swap, Cinergy exchanged
$500 million for 330 million pounds sterling. When the swap terminates in the
year 2002, these amounts will be re-exchanged; that is, Cinergy will be
repaid $500 million and will be obligated to repay to the counterparty 330
million pounds sterling. To fund this repayment, Cinergy could buy 330
million pounds sterling in the
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foreign exchange market at the prevailing spot rate or enter into a new
currency swap.
The purpose of this swap is to hedge the value of Cinergy's investment in
Midlands against changes in the dollar/sterling exchange rate. When the pound
sterling weakens relative to the dollar, the dollar value of Cinergy's
investment in Midlands as shown on its books declines; however, the value of
the swap increases, offsetting the decline in the investment. The reverse is
true when the pound sterling appreciates relative to the dollar. The
translation gains and losses related to the principal exchange on the swap
and on Cinergy's original investment in Midlands are recorded in the
cumulative foreign currency translation adjustment which is reported as a
separate component of common stock equity in the Consolidated Financial
Statements.
In connection with this swap, Cinergy must pay semi-annual interest on its
pound sterling obligation and will receive interest on the dollar notional
amount. At December 31, 1997, the fair value of this swap, reflecting the
semi-annual interest obligations through February 2002, and the final
principal exchange, was $(48) million. This was largely offset by a $41
million currency translation gain to date on Cinergy's investment in
Midlands.
The following table summarizes the details of the swap. (For presentation
purposes, the pound sterling payment obligation has been converted to US
dollars using the dollar/sterling spot exchange rate at December 31, 1997, of
1.64515. The interest rates are based on the six-month London Interbank
Offered Rate (LIBOR) implied forward rates at December 31, 1997.)
<TABLE>
<CAPTION>
Expected Maturity Date
($US equivalent in millions) 1998 1999 2000 2001 2002 Thereafter Total
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
CURRENCY SWAP
Receive principal ($US) $- $- $- $- $500 $- $500
Average interest receive rate -% -% -% -% 6.1% -% 6.1%
Pay principal (LUK) $- $- $- $- $543 $- $543
Average interest pay rate -% -% -% -% 7.0% -% 7.0%
</TABLE>
INTEREST RATE SENSITIVITY
Cinergy's net exposure to changes in interest rates primarily consists of
short-term debt instruments with floating interest rates that are benchmarked
to US short-term money market indices. At December 31, 1997, this included
(i) short-term bank loans and commercial paper totaling $870 million, (ii)
$244 million of pollution control related debt which is classified as other
short-term obligations on Cinergy's Consolidated Balance Sheets, and (iii) a
$252 million sale of accounts receivable (Cinergy's Consolidated Balance
Sheets are net of this sale). At December 31, 1997, interest rates on bank
loans, commercial paper, and the sale of accounts receivable approximated 6%,
and the interest rate on the pollution control debt approximated 4%. Current
forward yield curves project no significant change in applicable short-term
interest rates over the next five years.
The following table presents the principal cash repayments and related
weighted average interest rates by maturity date for Cinergy's long-term
fixed-rate debt, other debt and capital lease obligations as of December 31,
1997:
<TABLE>
<CAPTION>
Expected Maturity Date
Fair
(In millions) 1998 1999 2000 2001 2002 Thereafter Total Value
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
LIABILITIES
Long-term Debt(a)
Fixed rate $35 $186 $31 $100 $149 $1 650 $2 151 $2 240
Average interest rate(b) 5.3% 6.3% 5.7% 6.1% 7.3% 7.2% 7.1%
Other(c) $ - $ - $ - $ - $ - $ 100 $ 100 $ 97
Average interest rate(b) -% -% -% -% -% 6.5% 6.5%
Capital Lease
Variable rate $ - $ - $ - $ 22 $ - $ - $ 22 $ 22
Average interest rate(b) -% -% -% 5.6% -% -% 5.6%
</TABLE>
(a) Includes amounts reflected as long-term debt due within one year.
(b) For the long-term debt obligations, the weighted average interest rate is
based on the coupon rates of the debt that is maturing in the year reported.
For the capital lease, the interest rate is based on a spread over 3-month
LIBOR, and averaged to be approximately 6% in 1997. For the variable rate
Liquid Asset Notes with Coupon Exchange (LANCEs), the current forward yield
curve suggests the interest rate on these notes would be fixed at 6.50%
commencing October 1, 1999.
(c) Variable rate LANCEs.
A-14
<PAGE>
REVIEW OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
To manage Cinergy's exposure to fluctuations in interest rates and to
lower funding costs, Cinergy constantly evaluates the use of, and has entered
into, several interest rate swaps. Under these swaps, Cinergy or its
subsidiaries agree with counterparties to exchange, at specified intervals,
the difference between fixed-rate and floating-rate interest amounts
calculated on an agreed notional amount. This interest differential paid or
received is recognized in the Consolidated Statements of Income as a
component of interest expense.
Through two interest rate swap agreements, Cinergy has effectively fixed
the interest rate on the pound sterling denominated obligation created by the
currency swap discussed above. Each contract requires Cinergy to pay semi-
annually a fixed rate and receive a floating rate through February 2002. The
combined notional amount of both swaps is 330 million pounds sterling.
Translation gains and losses related to Cinergy's interest obligation, which
is payable in pounds sterling, are recognized as a component of interest
expense in the Consolidated Statements of Income.
At December 31, 1997, PSI had two interest rate swap agreements
outstanding with notional amounts of $100 million each. One contract, with
three years remaining of a four-year term, requires PSI to pay a floating
rate and receive a fixed rate. The second contract, with a six-month term,
requires PSI to pay a fixed rate and receive a floating rate. In both cases,
the floating rate is based on applicable LIBOR. The following table presents
notional principal amounts and weighted average interest rates by contractual
maturity dates for the interest rate swaps of Cinergy and PSI. The variable
rates are the average implied forward rates during the contract based on the
six month LIBOR yield curve at December 31, 1997. Although Cinergy's swaps
require payments to be made in pounds sterling, the table reflects the dollar
equivalent notional amounts based on spot market foreign currency exchange
rates at December 31, 1997.
<TABLE>
<CAPTION>
Expected Maturity Date
Fair
($US Equivalent in millions) 1998 1999 2000 2001 2002 Thereafter Total Value
- ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
INTEREST RATE DERIVATIVES
Interest Rate Swaps
Receive fixed/pay
variable ($US) $ - $ - $100 $- $ - $- $100 $ -
Average pay rate 5.9% 6.0% 6.1% -% -% -% 6.0%
Average receive rate 6.1% 6.1% 6.1% -% -% -% 6.1%
Receive variable/
pay fixed ($US) $100 $ - $ - $- $ - $- $100 $ -
Average pay rate 6.0% -% -% -% -% -% 6.0%
Average receive rate 5.9% -% -% -% -% -% 5.9%
Receive variable/
pay fixed (LUK) $ - $ - $ - $- $543(a) $- $543(a) $(3)
Average pay rate -% -% -% -% 7.1% -% 7.1%
Average receive rate -% -% -% -% 6.9% -% 6.9%
</TABLE>
(a) Notional converted to US dollars using the Sterling spot exchange rate at
December 31, 1997, of 1.64515.
INFLATION
Cinergy believes that the recent inflation rates do not materially affect its
financial condition or results of operations. However, under existing
regulatory practice, only the historical cost of plant is recoverable from
customers. As a result, cash flows designed to provide recovery of historical
plant costs may not be adequate to replace plant in future years.
DIVIDEND RESTRICTIONS
See Note 2(b) of the Notes to Consolidated Financial Statements.
RESULTS OF OPERATIONS
KILOWATT-HOUR (KWH) SALES
Increased activity in Cinergy's power marketing and trading operations led to
higher non-firm power sales for resale and significantly contributed to the
increase
A-15
<PAGE>
in total kwh sales of 78.7%, as compared to 1996. The increase in retail
sales, which reflects a higher average number of commercial and industrial
customers, was partially offset by a decline in residential sales as a result
of mild weather. (See Note 1(c) of the Notes to Consolidated Financial
Statements and the "Market Risk Sensitive Instruments and Positions" section
for discussions on Cinergy's power marketing and trading operations.)
Cinergy's total kwh sales in 1996, as compared to 1995, increased 11.0%
reflecting an increase in sales to all customer classes. Increased activity
in Cinergy's power marketing and trading operations led to higher non-firm
power sales for resale. The increase in retail sales which reflects a higher
average number of residential and commercial customers was partially offset
by the return to more normal weather in 1996. The increase in industrial
sales was due to growth in the primary metals sector.
As compared to 1994, total kwh sales in 1995 increased 4.1% reflecting
higher sales to all retail customer classes. Contributing significantly to
this increase were higher residential and commercial sales due to warmer
weather during the 1995 summer cooling season and colder weather during the
fourth quarter of 1995. Additionally, increased sales to industrial
customers, reflecting growth in the primary metals and chemicals sectors,
contributed to the increased kwh sales level. These increases were offset, in
part, by a decline in non-firm power sales for resale.
Year-to-year changes in kwh sales for each major class of customers are
shown below:
<TABLE>
<CAPTION>
Increase (Decrease)
from Prior Year
1997 1996 1995
- --------------------------------------------------------------------------
<S> <C> <C> <C>
Retail
Residential (3.8)% 2.4% 5.8%
Commercial 1.6 1.3 4.3
Industrial 2.9 3.3 4.6
Total retail .3 2.4 4.9
Sales for resale
Firm power obligations 15.5 10.5 1.7
Non-firm power transactions 460.3 82.0 (1.3)
Total sales for resale 363.9 59.6 (.4)
Total sales 78.7 11.0 4.1
</TABLE>
Cinergy currently forecasts a 2% annual compound growth rate in kwh sales
over the 1998 through 2002 period. This forecast excludes non-firm power
sales for resale and any potential new off-system, long-term firm power
sales.
THOUSAND CUBIC FEET (MCF) SALES AND TRANSPORTATION
The milder weather experienced in 1997 contributed to a decrease in
residential and commercial gas sales volumes and led to an 8.2% decrease in
total sales volumes and a 1.1% decrease in total sales and transportation
volumes, as compared to 1996. An increase in gas transportation volumes and a
decline in industrial sales resulted from customers electing to purchase gas
directly from suppliers using transportation services provided by Cinergy.
Mcf gas sales and transportation volumes increased 8.4% in 1996, as
compared to 1995. Colder weather in the first half of 1996 led to increased
gas sales to residential and commercial customers. Also contributing to the
increase in total sales was an increase in the number of residential and
commercial customers. Industrial sales decreased and gas transported
increased as customers continued to purchase gas directly from suppliers.
Total gas sales and transportation volumes increased 8.6% in 1995, as
compared to 1994. Increased sales to residential customers, resulting from
colder weather during the fourth quarter of 1995 and an increase in the
number of customers, contributed to the higher sales levels. Additionally,
increases in commercial and industrial transportation volumes, which resulted
from customers electing to purchase gas directly from suppliers, more than
offset declines in industrial and commercial sales.
Year-to-year changes in Mcf sales for each major class of customers and
Mcf transportation volumes are shown below:
<TABLE>
<CAPTION>
Increase (Decrease)
from Prior Year
1997 1996 1995
- -------------------------------------------------------------------------
<S> <C> <C> <C>
Retail
Residential (6.4)% 3.6% 10.5%
Commercial (9.7) 7.8 (2.0)
Industrial (8.8) (13.3) (26.6)
Total sales (8.2) 2.1 1.5
Gas transported 10.1 19.8 24.4
Total gas sold and transported (1.1) 8.4 8.6
</TABLE>
OPERATING REVENUES
ELECTRIC OPERATING REVENUES
Increased kwh sales, as previously discussed, a full year's effects of PSI's
retail rate increases approved in the September 1996 Order, as amended in
August 1997, and the December 1996 DSM Order significantly contributed to the
$1 billion (39%) increase in electric operating revenues, when compared to
1996. Also contributing to the increase was the return of approximately $13
million to customers in 1996 in accordance
A-16
<PAGE>
REVIEW OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
with the February 1995 Order. The February 1995 Order required all retail
operating income above a certain rate of return to be refunded to customers.
Partially offsetting these increases was the operation of CG&E's fuel
adjustment clauses reflecting a lower average cost of fuel used in electric
production.
The $156 million (6%) increase in 1996 electric operating revenues, as
compared to 1995, is due, in large part, to the increase in kwh sales as
previously discussed. Also contributing to the increase was the effect of
PSI's September 1996 Order, as well as, a full year's effect of PSI's 4.3%
retail rate increase approved in the February 1995 Order and PSI's 1.9%
increase for carrying costs on construction work in progress property which
was approved by the IURC in March 1995. These rate increases were offset by
the return of approximately $10 million to PSI's customers in accordance with
the February 1995 Order, the operation of CG&E's fuel adjustment clauses
reflecting a lower average cost of fuel used in electric production, and a
decrease in ULH&P's electric rates reflecting a reduction in the cost of
electricity purchased from CG&E.
Higher retail kwh sales, PSI's electric rate increases which became
effective in February 1995 and March 1995, and a full year's effect of CG&E's
electric rate increase which became effective in May 1994, significantly
contributed to the $167 million (7%) increase in electric operating revenues
for 1995, when compared to 1994.
An analysis of electric operating revenues for the past three years is
shown below:
<TABLE>
<CAPTION>
(dollars in millions) 1997 1996 1995
- ---------------------------------------------------------------------------------
<S> <C> <C> <C>
Previous year's electric
operating revenues $2 769 $2 613 $2 446
Increase (Decrease) due to change in:
Price per kwh
Retail 9 (1) 54
Sales for resale
Firm power obligations (10) (4) (1)
Non-firm power transactions 113 - 4
- ---------------------------------------------------------------------------------
Total change in price per kwh 112 (5) 57
Kwh sales
Retail 7 56 109
Sales for resale
Firm power obligations 14 9 1
Non-firm power transactions 956 94 (1)
- ---------------------------------------------------------------------------------
Total change in kwh sales 977 159 109
Other 4 2 1
- ---------------------------------------------------------------------------------
Current year's electric
operating revenues $3862 $2769 $2613
</TABLE>
GAS OPERATING REVENUES
The increasing trend of industrial customers purchasing gas directly from
producers and using CG&E facilities to transport the gas (see the "Mcf Sales
and Transportation" section) continues to put downward pressure on gas
operating revenues. Since providing transportation services does not
necessitate recovery of the cost of gas purchased, the revenue per Mcf
transported is less than the revenue per Mcf sold. As a result, a higher
relative volume of gas transported to gas sold translates into lower gas
operating revenues.
CG&E's gas rate increase of 2.5% ($9 million annually) approved by the PUCO
in the December 1996 Order and the operation of a gas cost recovery
mechanism, reflecting a higher average cost per Mcf of gas purchased,
contributed to the $17 million (4%) increase in gas operating revenues as
compared to 1996. These increases were partially offset by the previously
discussed changes in Mcf gas sales.
In 1996, gas operating revenues increased $63 million (15%), as compared to
1995. This increase is attributable to the increase in gas sales and
transportation volumes. Also contributing to the increase was the operation
of fuel adjustment clauses, reflecting a higher average cost per Mcf of gas
purchased.
Gas operating revenues declined $32 million (7%) in 1995, as compared to
1994, as a result of the aforementioned trend toward increased transportation
services and the operation of fuel adjustment clauses, reflecting a lower
average cost per Mcf of gas purchased.
OPERATING EXPENSES
FUEL
FUEL USED IN ELECTRIC PRODUCTION Electric fuel costs declined $20 million
(3%) when compared to 1996.
An analysis of fuel costs for the past three years is shown below:
<TABLE>
<CAPTION>
(dollars in millions) 1997 1996 1995
- -------------------------------------------------------------------------------
<S> <C> <C> <C>
Previous year's fuel expense $713 $717 $713
Increase (Decrease) due to change in:
Price of fuel 7 (48) (23)
Deferred fuel cost (55) 42 (2)
Kwh generation 28 2 29
- -------------------------------------------------------------------------------
Current year's fuel expense $693 $713 $717
</TABLE>
GAS PURCHASED The increase in gas purchased expense of $17 million (7%) in
1997, as compared to 1996, reflects a higher average cost per Mcf of gas
purchased. This increase was partially offset by a decline in the volumes of
gas purchased.
Gas purchased increased $43 million (21%) in 1996, as compared to 1995, due
to an increase in volumes purchased and a higher average cost per Mcf of gas
purchased.
In 1995, gas purchased expense decreased $42 million (17%), as compared to
1994, primarily reflecting a decline in the average cost per Mcf of gas
purchased.
A-17
<PAGE>
PURCHASED AND EXCHANGED POWER
Purchased and exchanged power increased $1.1 billion and $111 million in 1997
and 1996, respectively. These increases primarily reflect increased purchases
of non-firm power for resale to others as a result of increased activity in
Cinergy's power marketing and trading operations. (See Note 1(c) of the Notes
to Consolidated Financial Statements and the "Market Risk Sensitive
Instruments and Positions" section for discussions on Cinergy's power
marketing and trading operations.)
OTHER OPERATION
Other operation expenses increased $40 million (7%) in 1997, as compared to
1996. This increase is primarily due to higher other operation expenses of
PSI relating to the Clean Coal Project, amortization of deferred DSM
expenses, and amortization of deferred expenses associated with the Clean
Coal Project, all of which are being recovered in revenues pursuant to either
the September 1996 Order or the December 1996 DSM Order. The effect of PSI
discontinuing deferral of certain DSM-related costs in accordance with
provisions of the December 1996 DSM Order also added to the increase. Further
contributing to the increase is the effect of CG&E curtailing certain
deferrals associated with its DSM programs for new participants after
December 31, 1996, due to the December 1996 Order that changed the
benefit/cost tests that DSM programs must surpass in Ohio in order for
certain DSM-related costs to be eligible for deferral. These increases were
partially offset by the effect of charges in 1996 for early retirement and
severance programs and the December 1996 Order (see below).
Other operation expenses increased $78 million (15%) in 1996, as compared
to 1995. This increase is due to a number of factors, including increased
administrative and general expenses reflecting, in part, charges of $35
million for voluntary early retirement and severance programs and charges
totaling $6 million related to the December 1996 Order.
In 1995, other operation expenses decreased $29 million (5%), as compared
to 1994. Charges of $62 million in 1994 for Merger Costs and other
expenditures which cannot be recovered from customers under the merger
savings sharing mechanisms authorized by regulators significantly contributed
to the decrease. In addition, emphasis on achieving merger savings and other
cost reductions led to lower operating costs for 1995. These decreases were
partially offset by the recognition of postretirement benefit costs on an
accrual basis, an increase in the ongoing level of DSM expenses, and the
amortization of deferred postretirement benefit costs, deferred Merger Costs,
and deferred DSM costs, all of which are being recovered in revenues pursuant
to the February 1995 Order.
MAINTENANCE
In 1997, maintenance costs decreased $17 million (9%), as compared to 1996.
This decrease is primarily attributable to reduced outage related charges and
other maintenance costs associated with PSI's and CG&E's electric production
facilities. Reduced maintenance costs associated with PSI's electric
transmission and distribution facilities also contributed to the decrease for
1997.
An increase of $12 million (6%) in maintenance costs for 1996, as compared
to 1995, is primarily attributable to increased maintenance associated with
the Clean Coal Project which began commercial operation in November 1995.
Increased transmission and distribution expenses also contributed to the
higher level of maintenance expense.
Maintenance costs decreased $19 million (9%) in 1995, as compared to 1994,
primarily due to improved scheduling of routine maintenance on electric
generating units. Lower maintenance costs on gas and electric distribution
facilities also contributed to this decrease.
DEPRECIATION
In 1995, depreciation expense decreased $15 million (5%), when compared to
1994, due in large part to the adoption of lower depreciation rates for PSI
effective in March 1995. This decrease was partially offset by the effect of
additions to utility plant.
AMORTIZATION OF PHASE-IN DEFERRALS AND PHASE-IN DEFERRED RETURN
Amortization of phase-in deferrals and phase-in deferred return reflect the
PUCO-ordered phase-in plan for the Wm. H. Zimmer Generating Station. (See
Note 1(k) of the Notes to Consolidated Financial Statements.)
POST-IN-SERVICE DEFERRED OPERATING EXPENSES - NET
Post-in-service deferred operating expenses - net reflect various deferrals
of depreciation, operation and maintenance expenses (exclusive of fuel
costs), and property taxes on certain generating units and other utility
plant from the in-service date until the related plant is reflected in retail
rates, net of amortization of these deferrals as they are recovered through
retail rates. (See Note 1(h) of the Notes to Consolidated Financial
Statements.)
A-18
<PAGE>
TAXES OTHER THAN INCOME TAXES
Taxes other than income taxes increased $12 million (5%) in 1995, primarily
due to increased property taxes resulting from a greater investment in
taxable property and higher property tax rates.
OTHER INCOME AND EXPENSES - NET
POST-IN-SERVICE CARRYING COSTS
Post-in-service carrying costs reflect the deferral of carrying costs on
certain generating units and other utility plant from the in-service date
until the related plant is reflected in retail rates. (See Note 1(h) of the
Notes to Consolidated Financial Statements.)
EQUITY IN EARNINGS OF UNCONSOLIDATED SUBSIDIARIES
The increase in equity in earnings of unconsolidated subsidiaries of $35
million for 1997, as compared to 1996, primarily reflects a full year's
effect of the investment in Midlands. Midlands was purchased during the
second quarter of 1996.
OTHER - NET
The $9 million change in other - net for 1997, as compared to 1996, is due,
in part, to charges in 1996 of approximately $14 million associated with the
December 1996 Order, a gain of approximately $4 million in 1997 on the sale
of a PSI investment, and a loss of approximately $5 million in 1996 on the
sale of a foreign subsidiary. These items were partially offset by gains of
approximately $6 million in 1996 related to the sale of certain CG&E assets,
approximately $2 million of increased expenses in 1997 associated with the
sales of accounts receivable for PSI, CG&E, and ULH&P, and expenses of
approximately $4 million resulting from the inclusion of the Greenwich
acquisition in 1997.
In 1996, other - net changed $37 million, as compared to 1995, due to a
number of factors including $4 million of interest received in 1995 on an
income tax refund related to prior years, charges totaling $14 million
associated with the December 1996 Order, expenses associated with CG&E's and
ULH&P's sales of accounts receivable in 1996, and the effect of a $10 million
gain in 1995 on the sale of Cinergy's investment in an Argentine utility.
The $31 million change in other - net in 1995, as compared to 1994, is due,
in part, to interest on the income tax refund and the $10 million gain
discussed above and charges of $17 million in 1994 for merger-related and
other expenditures which cannot be recovered from customers.
INTEREST AND OTHER CHARGES
INTEREST ON LONG-TERM DEBT
Interest on long-term debt decreased $23 million (11%) in 1996, as compared
to 1995, due to the refinancing and redemptions of long-term debt by CG&E,
PSI, and ULH&P during 1995 and 1996.
OTHER INTEREST
The $29 million increase in other interest, as compared to 1996, is primarily
due to interest expense on increased short-term borrowings used to fund
CG&E's redemption of first mortgage bonds and Cinergy's investments in non-
regulated companies, including Avon Energy.
In 1996, other interest increased $10 million (50%), as compared to 1995,
primarily reflecting increased interest expense on short-term borrowings used
to fund Cinergy's investment in Avon Energy.
PREFERRED DIVIDEND REQUIREMENTS OF SUBSIDIARIES
Preferred dividend requirements of subsidiaries decreased $11 million (46%)
and $8 million (25%) in 1997 and 1996, respectively. These decreases were
primarily attributable to the reacquisition of approximately 90% of the
outstanding preferred stock of CG&E, pursuant to Cinergy's tender offer. (See
Note 3(b) of the Notes to Consolidated Financial Statements.)
EXTRAORDINARY ITEM - EQUITY SHARE OF WINDFALL PROFITS TAX
Extraordinary item - equity share of windfall profits tax represents the one-
time charge for the windfall profits tax levied against Midlands as recorded
in the third quarter of 1997. (See Note 17 of the Notes to Consolidated
Financial Statements.)
A-19
<PAGE>
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
(in thousands, except per share amounts) 1997 1996 1995
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
OPERATING REVENUES
Electric $3 861 698 $2 768 706 $2 612 579
Gas 491 145 474 034 410 852
- -----------------------------------------------------------------------------------------------------------
4 352 843 3 242 740 3 023 431
OPERATING EXPENSES
Fuel used in electric production 693 435 713 250 716 754
Gas purchased 266 158 249 116 206 250
Purchased and exchanged power 1 219 358 158 838 47 632
Other operation 637 945 598 434 520 590
Maintenance 176 471 193 908 182 180
Depreciation 289 077 282 763 279 759
Amortization of phase-in deferrals 13 483 13 598 9 091
Post-in-service deferred operating expenses - net 4 362 (1 509) (2 500)
Income taxes (Note 11) 248 937 218 269 221 429
Taxes other than income taxes 265 024 257 815 255 533
- -----------------------------------------------------------------------------------------------------------
3 814 250 2 684 482 2 436 718
OPERATING INCOME 538 593 558 258 586 713
OTHER INCOME AND EXPENSES - NET
Allowance for equity funds used during construction 98 1 225 1 964
Post-in-service carrying costs - 1 223 3 186
Phase-in deferred return 8 008 8 372 8 537
Equity in earnings of unconsolidated subsidiaries (Note 1(e)) 60 392 25 430 -
Income taxes (Note 11) 35 937 19 536 7 358
Other - net (31 502) (40 464) (3 051)
- -----------------------------------------------------------------------------------------------------------
72 933 15 322 17 994
INCOME BEFORE INTEREST AND OTHER CHARGES 611 526 573 580 604 707
INTEREST AND OTHER CHARGES
Interest on long-term debt 181 772 190 617 213 911
Other interest 59 947 31 169 20 826
Allowance for borrowed funds used during construction (5 400) (6 183) (8 065)
Preferred dividend requirements of subsidiaries 12 569 23 180 30 853
- -----------------------------------------------------------------------------------------------------------
248 888 238 783 257 525
NET INCOME BEFORE EXTRAORDINARY ITEM $ 362 638 $ 334 797 $ 347 182
EXTRAORDINARY ITEM - EQUITY SHARE OF WINDFALL PROFITS
TAX (LESS APPLICABLE INCOME TAXES OF $0) (Note 17) (109 400) - -
- -----------------------------------------------------------------------------------------------------------
NET INCOME $ 253 238 $ 334 797 $ 347 182
AVERAGE COMMON SHARES OUTSTANDING 157 685 157 678 156 620
EARNINGS PER COMMON SHARE (Note 16)
Net income before extraordinary item $2.30 $2.00 $2.22
Net income $1.61 $2.00 $2.22
EARNINGS PER COMMON SHARE - ASSUMING DILUTION (Note 16)
Net income before extraordinary item $2.28 $1.99 $2.20
Net income $1.59 $1.99 $2.20
DIVIDENDS DECLARED PER COMMON SHARE $1.80 $1.74 $1.72
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
A-20
<PAGE>
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
(dollars in thousands) December 31 1997 1996
- --------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS
Utility Plant - Original Cost
In service
Electric $8 981 182 $8 809 786
Gas 746 903 713 829
Common 186 078 185 255
- --------------------------------------------------------------------------------------------
9 914 163 9 708 870
Accumulated depreciation 3 800 322 3 591 858
- --------------------------------------------------------------------------------------------
6 113 841 6 117 012
Construction work in progress 183 262 172 614
- --------------------------------------------------------------------------------------------
Total utility plant 6 297 103 6 289 626
CURRENT ASSETS
Cash and temporary cash investments 53 310 19 327
Restricted deposits 2 319 1 721
Accounts receivable less accumulated provision for doubtful
accounts of $10,382 in 1997 and $10,618 in 1996 (Note 6) 413 626 199 361
Materials, supplies, and fuel - at average cost
Fuel for use in electric production 57 916 71 730
Gas stored for current use 29 174 32 951
Other materials and supplies 76 066 80 292
Prepayments and other 38 171 37 049
- --------------------------------------------------------------------------------------------
670 582 442 431
OTHER ASSETS
Regulatory assets (Note 1(f))
Amounts due from customers - income taxes 374 456 377 194
Post-in-service carrying costs and deferred operating expenses 178 504 186 396
Coal contract buyout costs 122 485 138 171
Deferred demand-side management costs 109 596 134 742
Phase-in deferred return and depreciation 89 689 95 163
Deferred merger costs 90 346 93 999
Unamortized costs of reacquiring debt 66 242 70 518
Other 45 533 72 483
Investments in unconsolidated subsidiaries (Note 1(e)) 537 720 592 660
Other 275 897 231 551
- --------------------------------------------------------------------------------------------
1 890 468 1 992 877
$8 858 153 $8 724 934
- --------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
A-21
<PAGE>
<TABLE>
<CAPTION>
(dollars in thousands) December 31 1997 1996
- ---------------------------------------------------------------------------------------------------
<S> <C> <C>
CAPITALIZATION AND LIABILITIES
COMMON STOCK EQUITY (Note 2)
Common stock - $.01 par value; authorized shares - 600,000,000;
outstanding shares - 157,744,658 in 1997 and 157,679,129 in 1996 $ 1 577 $ 1 577
Paid-in capital 1 573 064 1 590 735
Retained earnings 965 084 992 273
Cumulative foreign currency translation adjustment (525) (131)
- ---------------------------------------------------------------------------------------------------
Total common stock equity 2 539 200 2 584 454
CUMULATIVE PREFERRED STOCK OF SUBSIDIARIES (Note 3)
Not subject to mandatory redemption 177 989 194 232
LONG-TERM DEBT (Note 4) 2 150 902 2 326 378
- ---------------------------------------------------------------------------------------------------
Total capitalization 4 868 091 5 105 064
CURRENT LIABILITIES
Long-term debt due within one year (Note 4) 85 000 140 000
Notes payable and other short-term obligations (Note 5) 1 114 028 922 217
Accounts payable 488 716 305 420
Accrued taxes 187 033 199 479
Accrued interest 46 622 55 590
Other 79 193 114 653
- ---------------------------------------------------------------------------------------------------
2 000 592 1 737 359
OTHER LIABILITIES
Deferred income taxes (Note 11) 1 248 543 1 146 263
Unamortized investment tax credits 166 262 175 935
Accrued pension and other postretirement benefit
costs (Notes 9 and 10) 297 142 263 319
Other 277 523 296 994
- ---------------------------------------------------------------------------------------------------
1 989 470 1 882 511
Commitments and Contingencies (Note 12)
$8 858 153 $8 724 934
- ---------------------------------------------------------------------------------------------------
</TABLE>
A-22
<PAGE>
CONSOLIDATED STATEMENTS OF CHANGES IN COMMON STOCK EQUITY
<TABLE>
<CAPTION>
Cumulative
Foreign
Currency
Common Paid-in Retained Translation Total Common
(dollars in thousands) Stock Capital Earnings Adjustment Stock Equity
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
BALANCE DECEMBER 31, 1994 $1 552 $1 535 658 $877 061 $ - $2 414 271
Net income 347 182 347 182
Issuance of 2,472,103 shares
of common stock - net 25 60 343 60 368
Common stock issuance expenses (229) (229)
Dividends on common stock (see
page A-20 for per share amounts) (268 851) (268 851)
Other 1 278 (5 176) (3 898)
- -----------------------------------------------------------------------------------------------------------------
BALANCE DECEMBER 31, 1995 1 577 1 597 050 950 216 - 2 548 843
Net income 334 797 334 797
Issuance of 8,988 shares
of common stock - net 311 311
Treasury shares purchased (4) (14 887) (14 891)
Treasury shares reissued 4 8 599 8 603
Dividends on common stock (see
page A-20 for per share amounts) (274 358) (274 358)
Translation adjustments (131) (131)
Costs of reacquisition of preferred
stock of subsidiary (18 391) (18 391)
Other (338) 9 (329)
- -----------------------------------------------------------------------------------------------------------------
BALANCE DECEMBER 31, 1996 1 577 1 590 735 992 273 (131) 2 584 454
NET INCOME 253 238 253 238
ISSUANCE OF 65,529 SHARES OF
COMMON STOCK - NET 2 066 2 066
TREASURY SHARES PURCHASED (11) (46 199) (46 210)
TREASURY SHARES REISSUED 11 26 729 26 740
DIVIDENDS ON COMMON STOCK (see
page A-20 for per share amounts) (283 866) (283 866)
TRANSLATION ADJUSTMENTS (394) (394)
OTHER (267) 3 439 3 172
- -----------------------------------------------------------------------------------------------------------------
BALANCE DECEMBER 31, 1997 $1 577 $1 573 064 $965 084 $(525) $2 539 200
- -----------------------------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
A-23
<PAGE>
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands) 1997 1996 1995
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income $253 238 $334 797 $347 182
Items providing or (using) cash:
Depreciation 289 077 282 763 279 759
Deferred income taxes and investment tax credits - net 67 638 47 912 28 411
Equity in earnings of unconsolidated subsidiaries (35 239) (25 430) -
Extraordinary item - equity share of windfall profits tax 109 400 - -
Allowance for equity funds used during construction (98) (1 225) (1 964)
Regulatory assets - net 71 310 39 282 33 324
Changes in current assets and current liabilities
Restricted deposits (598) (358) (1 035)
Accounts receivable, net of reserves on receivables sold (217 157) 132 749 (71 641)
Materials, supplies, and fuel 21 817 44 005 51 214
Accounts payable 183 296 37 281 1 672
Litigation settlement - (80 000) -
Accrued taxes and interest (21 414) (1 289) 52 233
Other items - net 32 175 44 604 16 538
- ---------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 753 445 855 091 735 693
FINANCING ACTIVITIES
Issuance of common stock 2 066 311 60 139
Issuance of long-term debt 100 062 150 217 260 280
Funds on deposit from issuance of long-term debt - 973 9 987
Retirement of preferred stock of subsidiaries (16 269) (212 487) (93 466)
Redemption of long-term debt (336 312) (237 183) (398 833)
Change in short-term debt 191 811 572 417 20 900
Dividends on common stock (283 866) (274 358) (268 851)
- ---------------------------------------------------------------------------------------------------------------
Net cash used in financing activities (342 508) (110) (409 844)
INVESTING ACTIVITIES
Construction expenditures (less allowance for
equity funds used during construction) (328 055) (323 013) (324 905)
Deferred demand-side management costs (19 867) (44 344) (57 571)
Investments in unconsolidated subsidiaries (29 032) (503 349) -
Equity investments in Argentine utilities - - 19 799
- ---------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (376 954) (870 706) (362 677)
Net increase (decrease) in cash and temporary cash investments 33 983 (15 725) (36 828)
Cash and temporary cash investments at beginning of period 19 327 35 052 71 880
- ---------------------------------------------------------------------------------------------------------------
Cash and temporary cash investments at end of period $ 53 310 $ 19 327 $ 35 052
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid during the year for:
Interest (net of amount capitalized) $235 948 $207 393 $218 357
Income taxes $140 655 $141 917 $140 189
- ---------------------------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
A-24
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES
(a) NATURE OF OPERATIONS
Cinergy Corp., a Delaware corporation, (Cinergy or Company), is a registered
holding company under the Public Utility Holding Company Act of 1935 (PUHCA).
Cinergy was created in the October 1994 merger of PSI Resources, Inc.
(Resources) and The Cincinnati Gas & Electric Company (CG&E). Cinergy's
utility subsidiaries are CG&E and PSI Energy, Inc. (PSI). CG&E, an Ohio
combination electric and gas utility, and its five wholly-owned utility
subsidiaries, are primarily engaged in the production, transmission,
distribution, and sale of electric energy and/or the sale and transportation
of natural gas in the southwestern portion of Ohio and adjacent areas in
Kentucky and Indiana. PSI, an Indiana electric utility and previously
Resources' utility subsidiary, is engaged in the production, transmission,
distribution, and sale of electric energy in north central, central, and
southern Indiana. The majority of Cinergy's operating revenues are derived
from the sale of electricity and the sale and transportation of natural gas.
Cinergy's non-utility subsidiaries are Cinergy Investments, Inc.
(Investments) and Cinergy Services, Inc. (Services). Investments, a Delaware
corporation, is a non-utility subholding company that was formed to hold and
operate Cinergy's non-utility businesses and interests. Investments'
principal activities include investments in Midlands Electricity plc
(Midlands), Cinergy Global Power, Inc., and Trigen-Cinergy Solutions LLC
(Trigen-Cinergy). (See Note 1(e) for a further discussion of Midlands.)
Services, a Delaware corporation, is the service company for the Cinergy
system, providing member companies with a variety of administrative,
management, and support services.
(b) PRESENTATION
The accompanying Consolidated Financial Statements include the accounts of
Cinergy and its wholly-owned subsidiaries. Investments in business entities
in which the Company does not have control, but has the ability to exercise
significant influence over operating and financial policies (generally, 20%
to 50% ownership) are accounted for using the equity method. All significant
intercompany transactions and balances have been eliminated.
The preparation of financial statements in conformity with generally
accepted accounting principles (GAAP) requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities
and the disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those estimates. (See
Note 12.)
Certain reclassifications of prior years' data have been made to conform
with the current year's presentation.
(c) POWER MARKETING AND TRADING
Cinergy's power marketing and trading function actively markets and trades
over-the-counter forward and option contracts for the purchase and sale of
electricity. The majority of these contracts are settled via physical
delivery of electricity or netted out in accordance with industry trading
standards. Option premiums are deferred and included in the Consolidated
Balance Sheets and amortized to "Operating Revenues - Electric" or "Purchased
and exchanged power" in the Consolidated Statements of Income over the term
of the option contract. Cinergy values its portfolio of over-the-counter
forward and option contracts using the aggregate lower of cost or market
method. To the extent there are net aggregate losses in the portfolio,
Cinergy reserves for such losses. Net gains are recognized when realized. Due
to the lack of liquidity and the volatility currently experienced in the
power markets, significant assumptions must be made by the Company when
estimating current market values for purposes of the aggregate lower of cost
or market comparison. It is possible that the actual gains and losses from
the Company's power marketing and trading activities could differ
substantially from the gains and losses estimated currently.
(d) FINANCIAL DERIVATIVES
Cinergy and its subsidiaries use derivative financial instruments to hedge
exposures to foreign currency exchange rates, lower funding costs, and manage
exposures to fluctuations in interest rates. Instruments used as hedges must
be designated as a hedge at the inception of the contract and must be
effective at reducing the risk associated with the exposure being hedged.
Accordingly, changes in market values of designated hedge instruments must be
highly correlated with changes in market values of the underlying hedged
items at inception of the hedge and over the life of the hedge contract.
A-25
<PAGE>
Cinergy utilizes a currency swap to hedge its pound sterling denominated
net investment in Avon Energy Partners Holdings (Avon Energy). Accordingly,
any translation gains or losses related to the principal exchange on the
currency swap are recorded in the cumulative foreign currency translation
adjustment which is a separate component of common stock equity. Aggregate
translation losses related to the principal exchange of the currency swap are
reflected in "Current Liabilities - Other" in the Consolidated Balance
Sheets.
Interest rate swaps are accounted for under the accrual method.
Accordingly, gains and losses based on any interest differential between
fixed-rate and floating-rate interest amounts, calculated on agreed upon
notional principal amounts, are recognized in the Consolidated Statements of
Income as a component of interest expense as realized over the life of the
agreement.
(e) INVESTMENTS IN UNCONSOLIDATED SUBSIDIARIES
Except for Cinergy's investment in Avon Energy, investments in unconsolidated
subsidiaries are not significant. In May 1996, Cinergy and GPU, Inc. (GPU), a
Pennsylvania corporation, entered into a 50%/50% joint venture agreement and
formed Avon Energy, incorporated in London, England. Avon Energy, through a
wholly-owned subsidiary, immediately began acquiring the outstanding common
stock of Midlands, a United Kingdom (UK) regional electric company. During
the third quarter of 1996, Avon Energy completed the acquisition of
substantially all of the outstanding common stock of Midlands. The total
consideration paid by Avon Energy was approximately 1.7 billion pounds
sterling ($2.6 billion at then existing currency exchange rates). The funds
for the acquisition were obtained from Cinergy's and GPU's investment in Avon
Energy of approximately 330 million pounds sterling each ($500 million each),
with the remainder being obtained by Avon Energy through the issuance of non-
recourse debt. As a result of the allocation of the purchase price, Avon
Energy has recorded goodwill of approximately 1.4 billion pounds sterling ($2
billion) in connection with its acquisition of Midlands. The goodwill is
being amortized on a straight-line basis over 40 years.
Summarized financial information for Avon Energy is as follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1997
(in millions) AVON ENERGY
- --------------------------------------------------------------------
<S> <C>
ASSETS
Property, plant, and equipment $ 1890
Current assets 676
Other assets 2148
- --------------------------------------------------------------------
Total assets $ 4714
CAPITALIZATION AND LIABILITIES
Total common shareholders' equity $ 1006
Long-term debt 1533
Other liabilities 2175
- --------------------------------------------------------------------
Total capitalization and liabilities $ 4714
CINERGY'S INVESTMENTS IN
UNCONSOLIDATED SUBSIDIARIES:
AVON ENERGY $ 505
OTHER COMPANIES 33
- --------------------------------------------------------------------
TOTAL INVESTMENTS IN UNCONSOLIDATED SUBSIDIARIES $ 538
<CAPTION>
YEAR ENDED
DECEMBER 31, 1997
(in millions) AVON ENERGY
- --------------------------------------------------------------------
Operating revenues $ 2176
Net income before extraordinary item $ 127
Extraordinary item - windfall profits tax
(less applicable income taxes of $0) $ (219)
Net loss $ (92)
CINERGY'S EQUITY IN EARNINGS OF AVON ENERGY
BEFORE EXTRAORDINARY ITEM $ 63
CINERGY'S EQUITY IN EXTRAORDINARY ITEM $ (109)
- --------------------------------------------------------------------
CINERGY'S EQUITY IN EARNINGS OF: AVON ENERGY $ (46)
OTHER COMPANIES (3)
- --------------------------------------------------------------------
TOTAL EQUITY IN THE EARNINGS OF
UNCONSOLIDATED SUBSIDIARIES $ (49)
</TABLE>
During 1997, Cinergy received $25 million of dividends from Avon Energy.
The pro forma financial information for 1996 presented below assumes 100%
of Midlands was acquired on January 1, 1996. The pro forma adjustments
include recognition of equity in the estimated earnings of Avon Energy, an
adjustment for interest expense on debt associated with Cinergy's investment
in Avon Energy, and related income taxes. The estimated earnings of Avon
Energy include the historical earnings of Midlands prior to its acquisition
by Avon Energy, adjusted for the estimated effect of purchase accounting
(including the amortization of goodwill) and conversion to United States (US)
GAAP, interest expense on debt issued by Avon Energy associated with the
acquisition, and related income taxes. The equity in earnings of Avon Energy
has been converted from pounds sterling to dollars using the average exchange
rate for 1996 of $1.53/L.
A-26
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Year Ended
December 31, 1996
- -------------------------------------------------------------------------------
(in millions, except Net Earnings Per Share (1)
per share amounts) Income Basic Diluted
- -------------------------------------------------------------------------------
<S> <C> <C> <C>
Cinergy $335 $2.00(2) $1.99(2)
Pro forma adjustments:
Equity in earnings
of Avon Energy 20
Interest expense (14)
Income taxes 6
- -------------------------------------------------------------------------------
Pro forma results $347 $2.08 $2.06
</TABLE>
(1)See Note 16.
(2)Earnings per share after a charge of $.12 per share for the cost
of reacquiring preferred stock of CG&E through a tender offer.
(f) REGULATION
Cinergy, its utility subsidiaries (CG&E, together with its subsidiaries, and
PSI), and certain of its non-utility subsidiaries are subject to regulation
by the Securities and Exchange Commission (SEC) under the PUHCA. Cinergy's
utility subsidiaries are also subject to regulation by the Federal Energy
Regulatory Commission (FERC) and the state utility commissions of Indiana,
Kentucky, and Ohio.
The accounting policies of Cinergy's utility subsidiaries conform to the
accounting requirements and ratemaking practices of these regulatory
authorities and to GAAP, including the provisions of Statement of Financial
Accounting Standards No. 71, Accounting for the Effects of Certain Types of
Regulation (Statement 71).
Under the provisions of Statement 71, regulatory assets represent
probable future revenue associated with deferred costs to be recovered from
customers through the ratemaking process. Certain criteria must be met for
regulatory assets to be recorded and for the continued application of the
provisions of Statement 71, including regulated rates designed to recover the
specific utility's costs. Failure to satisfy the criteria in Statement 71
would eliminate the basis for recognition of regulatory assets.
Based on Cinergy's current regulatory orders and the regulatory
environment in which it currently operates, the recognition of its regulatory
assets as of December 31, 1997, is fully supported. The regulatory assets of
PSI and CG&E and its utility subsidiaries as of December 31 are as follows:
<TABLE>
<CAPTION>
1997 1996
- -----------------------------------------------------------------------------------------------------------------------
(in millions) PSI CG&E CINERGY PSI CG&E Cinergy
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Amounts due from customers - income taxes (Note 1(g)) $ 24 $350 $ 374 $ 33 $344 $ 377
Post-in-service carrying costs and deferred operating
expenses (Note 1(h)) 44 135 179 45 141 186
Coal contract buyout costs (Note 1(i)) 122 - 122 138 - 138
Deferred demand-side management (DSM) costs (Note 1(j)) 71 39 110 102 33 135
Phase-in deferred return and depreciation (Note 1(k)) - 90 90 - 95 95
Deferred merger costs (Note 1(l)) 74 16 90 76 18 94
Unamortized costs of reacquiring debt (Note 1(m)) 30 36 66 32 39 71
Coal gasification services expenses (Note 1(n)) 22 - 22 25 - 25
Other 22 2 24 28 20 48
- -----------------------------------------------------------------------------------------------------------------------
Total $409 $668 $1,077 $479 $690 $1,169
</TABLE>
A-27
<PAGE>
PSI has previously received regulatory orders authorizing the recovery
of $399 million of its total regulatory assets at December 31, 1997. CG&E has
previously received regulatory orders authorizing the recovery of $595
million of its total regulatory assets at December 31, 1997. Both PSI and
CG&E will request recovery of additional amounts in future proceedings, which
could include proceedings, if any, related to transition to customer choice
in each applicable jurisdiction.
(g) FEDERAL AND STATE INCOME TAXES
Under the provisions of Statement of Financial Accounting Standards No. 109,
Accounting for Income Taxes (Statement 109), deferred tax assets and
liabilities are recognized for the income tax consequences of transactions
treated differently for financial reporting and tax return purposes, measured
on the basis of statutory tax rates. Investment tax credits utilized to
reduce Federal income taxes payable have been deferred for financial
reporting purposes and are being amortized over the useful lives of the
property which gave rise to such credits.
Income tax provisions reflected in customer rates are regulated by the
various regulatory commissions overseeing the regulated business operations
of PSI, CG&E, and CG&E's utility subsidiaries. In accordance with the
provisions of Statement 71, Cinergy has recorded a regulatory asset, "Amounts
due from customers - income taxes," representing the probable recovery from
customers of additional income taxes established under Statement 109.
(h) POST-IN-SERVICE CARRYING COSTS AND DEFERRED OPERATING EXPENSES
CG&E received various orders from the Public Utilities Commission of Ohio
(PUCO) which permitted the deferral of carrying costs and non-fuel operating
expenses (including depreciation) for the Wm. H. Zimmer Generating Station
(Zimmer) and Woodsdale Generating Station (Woodsdale) units. Effective with
the dates of the PUCO's orders reflecting the units in customer rates, the
deferrals of post-in-service carrying costs are being recovered over the
lives of the applicable units and the deferred non-fuel operating expenses
are being recovered over a 10-year period.
PSI received authority from the Indiana Utility Regulatory Commission
(IURC) for the accrual of the debt component of carrying costs (to the extent
not recovered currently in retail rates) and the deferral of depreciation
expense on certain major projects which are primarily environmental in
nature. These projects include a 262-megawatt clean coal power generating
facility located at the Wabash River Generating Station (Clean Coal Project)
and a scrubber at Gibson Generating Station (Gibson). In a February 1995
order (February 1995 Order) and a September 1996 order (September 1996
Order), the IURC authorized the recovery of deferred costs incurred prior to
August 31, 1995. These deferred costs are to be recovered over the remaining
lives of the related assets. Deferrals incurred after this date will be
requested for recovery in future proceedings. These proceedings could include
proceedings, if any, related to transition to customer choice.
(i) COAL CONTRACT BUYOUT COSTS
In August 1996, PSI entered into a coal supply agreement with Eagle Coal
Company (Eagle) for the supply of approximately three million tons of coal
per year. The agreement, which terminates December 31, 2000, provides for a
buyout fee of $179 million (including interest) to be included in the price
of coal to PSI over the term of the contract. This fee represents the costs
to Eagle of the buyout of the coal supply agreement between PSI and Exxon
Coal and Minerals Company. The retail jurisdictional portion of the buyout
charge, excluding the portion applicable to joint owners, is being recovered
through the quarterly fuel adjustment clause, with carrying costs on
unrecovered amounts, through December 2002. PSI has also filed a petition at
the FERC for recovery of the wholesale jurisdictional portion of the buyout
costs through the wholesale fuel adjustment clause. Generally, the FERC will
allow recovery if the utility can demonstrate there will be net benefits to
customers during the buyout cost recovery period. The FERC is expected to
issue an order on PSI's petition early in 1998.
(j) DSM
A settlement agreement between PSI and certain intervenors, in a proceeding
established to review PSI's current and proposed DSM programs, was approved
by the IURC in December 1996. Beginning January 1, 1997, and continuing
through December 31, 2000, the settlement agreement allows PSI to recover $35
million per year through a non-bypassable charge in PSI's retail rates. The
$35 million is designed to recover all previously incurred, but as yet
unrecovered, DSM costs and all costs related to satisfying remaining
commitments associated with a previous DSM settlement agreement. The $35
million also includes recovery of carrying costs. Further, the agreement
authorizes PSI to spend up to $8 million annually on ongoing DSM programs
through the year 1999 and to collect such amounts currently in retail rates.
A-28
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Additionally, in December 1996, the PUCO issued an order applicable to
CG&E's DSM programs. The order requires CG&E to spend up to one-half of the
annual $5 million currently included in retail rates on PUCO-sanctioned
low-income residential programs. The remaining portion of the $5 million is
to be applied to the recovery of DSM cost deferrals. CG&E's participation in
the low-income programs will be a factor considered by the PUCO in setting
future rates of return and approving competitive transition plans.
The Kentucky Public Service Commission has authorized concurrent
recovery of costs related to various DSM programs of The Union Light, Heat
and Power Company (ULH&P).
(k) PHASE-IN DEFERRED RETURN AND DEPRECIATION
In May 1992, the PUCO issued an order (May 1992 Order) establishing a rate
phase-in plan for Zimmer. In the first three years of the rate phase-in plan,
rates charged to customers did not fully recover depreciation expense and
return on investment. In accordance with the provisions of the May 1992
Order, this deficiency has been recognized as a regulatory asset and is being
recovered over a seven-year period which began in May 1995.
(l) DEFERRED MERGER COSTS
CG&E and its utility subsidiaries have deferred a portion of merger
transaction costs and costs to achieve merger savings (collectively, Merger
Costs) incurred through December 31, 1996, for future recovery in customer
rates.
In accordance with various IURC orders, PSI has deferred Merger Costs
incurred through October 31, 1996, and is recovering $44 million of these
deferred costs incurred through August 31, 1995, over a ten-year period.
CG&E and PSI completed voluntary workforce reduction and severance
programs in 1996 with total pre-tax costs of $77 million. Of the $77 million,
approximately $35 million was expensed and $42 million was deferred. As
further discussed in Note 9, the associated pension benefits accounted for
approximately $61 million of the total costs.
(m) DEBT DISCOUNT, PREMIUM, AND ISSUANCE EXPENSES AND COSTS OF REACQUIRING
DEBT
Debt discount, premium, and issuance expenses on outstanding long-term debt
of Cinergy's utility subsidiaries are amortized over the lives of the
respective issues.
In accordance with established ratemaking practices, Cinergy's utility
subsidiaries have deferred costs (principally call premiums) from the
reacquisition of long-term debt and are amortizing such amounts over periods
ranging from one to 24 years.
(n) COAL GASIFICATION SERVICES EXPENSES
In November 1995, upon commercial operation of the Clean Coal Project, PSI
and Destec Energy, Inc. (Destec) began a 25-year contractual agreement for
the provision of coal gasification services. The agreement requires PSI to
pay Destec a base monthly fee including certain monthly operating expenses.
Over the next five years (1998 through 2002), the base monthly fees and
expenses are expected to total $201 million. PSI received authorization in
the September 1996 Order for the inclusion of the costs of the Clean Coal
Project in retail rates. PSI also received authorization to defer, for
subsequent recovery in retail rates, the base monthly fees and expenses
incurred prior to the effective date of the September 1996 Order.
(o) UTILITY PLANT
Utility plant is stated at the original cost of construction, which includes
an allowance for funds used during construction (AFUDC) and a proportionate
share of overhead costs. Construction overhead costs include salaries,
payroll taxes, fringe benefits, and other expenses.
Substantially all utility plant is subject to the lien of each
applicable company's first mortgage bond indenture.
(p) AFUDC
Cinergy's utility subsidiaries capitalize AFUDC, a non-cash income item,
which is defined in the regulatory system of accounts prescribed by the FERC
as including "the net cost for the period of construction of borrowed funds
used for construction purposes and a reasonable rate on other funds when so
used." AFUDC accrual rates averaged 6.3% in 1997, 7.1% in 1996, and 7.9% in
1995.
A-29
<PAGE>
(q) DEPRECIATION AND MAINTENANCE
Provisions for depreciation are determined by using the straight-line method
applied to the cost of depreciable plant in service. The rates are based on
periodic studies of the estimated service lives and net cost of removal of
the properties. The average depreciation rates for utility plant are:
<TABLE>
<CAPTION>
1997 1996 1995
- ---------------------------------------------------------------------------------
<S> <C> <C> <C>
PSI 3.0% 3.0% 3.1%
CG&E and its utility subsidiaries
Electric 2.9 2.9 2.9
Gas 2.9 2.8 2.8
Common 3.0 3.0 3.4
</TABLE>
For Cinergy's utility subsidiaries, maintenance and repairs of property
units and replacements of minor items of property are charged to maintenance
expense. The costs of replacements of property units are capitalized. The
original cost of the property retired and the related costs of removal, less
salvage recovered, are charged to accumulated depreciation.
(r) OPERATING REVENUES AND FUEL COSTS
Cinergy's utility subsidiaries recognize revenues for electric and gas
service rendered during the month, including revenues associated with sales
unbilled at the end of each month. The costs of electricity and gas purchased
and the cost of fuel used in electric production are expensed as recovered
through revenues. Any portion of these costs which are recoverable or
refundable in future periods is deferred in the accompanying Consolidated
Balance Sheets. PSI's recovery of fuel costs is subject to a determination
that such recovery will not result in PSI earning a return in excess of that
allowed in the September 1996 Order. Prior to January 1, 1998, this earnings
test was calculated in accordance with the settlement agreement approved in
the February 1995 Order and the Indiana statute in effect at the time of the
settlement agreement. Effective January 1, 1998, PSI will follow the
provisions of the current Indiana statute, which are generally less stringent
with regard to the earnings test.
(s) ORDER 636
In 1992, the FERC issued order 636 (Order 636). CG&E and certain of its
utility subsidiaries are subject to Order 636 which restructured operations
between interstate gas pipelines and their customers for gas sales and
transportation services. Order 636 also allowed pipelines to recover from
customers transition costs incurred in complying with the order. In July
1994, the PUCO issued an order approving a stipulation between CG&E and its
residential and industrial customer groups providing for recovery of these
pipeline transition costs. CG&E is presently recovering its Order 636
transition costs pursuant to a PUCO-approved tariff. CG&E's utility
subsidiaries, including ULH&P, recover such costs through their gas cost
recovery mechanisms. These costs are deferred as incurred by CG&E and its
applicable utility subsidiaries and amortized as recovered from customers.
(t) CONSOLIDATED STATEMENTS OF CASH FLOWS
All temporary cash investments with maturities of three months or less, when
acquired, are reported as cash equivalents. See Note 8(a)(i) for information
concerning non-cash investing transactions during 1996.
(u) TRANSLATION OF FOREIGN CURRENCY
All assets and liabilities reported in the balance sheets of foreign
subsidiaries whose functional currency is other than the US dollar are
translated at year-end exchange rates; income and expense items are
translated at the average exchange rate prevailing during the month the
respective transactions occur. Translation gains and losses are accumulated
as a separate component of common stock equity.
A-30
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. COMMON STOCK
(a) CHANGES IN COMMON STOCK OUTSTANDING
The following table reflects the shares of Cinergy common stock reserved for
issuance at December 31, 1997, and shares issued in 1997, 1996, and 1995 for
the Company's stock-based plans.
<TABLE>
<CAPTION>
SHARES
RESERVED AT Shares Issued
DEC. 31, 1997 1997 1996 1995
- -------------------------------------------------------------------- --------------------------------------
<S> <C> <C> <C> <C>
401(k) Savings Plans 6 469 373 -- -- 1 222 379
Dividend Reinvestment and Stock Purchase Plan 1 798 486 -- -- 935 711
Directors' Deferred Compensation Plan 200 000 -- -- --
Performance Shares Plan (PSP) 771 301 -- 492 28 207
Employee Stock Purchase and Savings Plan 1 932 384 -- -- 1 010
Stock Option Plan 4 558 777 22 219 15 007 403 997
1996 Long-term Incentive Compensation Plan (LTIP) 6 956 386 43 614 -- --
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
Cinergy retired 304, 6,511, and 119,211 shares of common stock in 1997,
1996, and 1995, respectively, primarily representing shares tendered as
payment for the exercise of previously granted stock options. In 1995,
Cinergy issued 10 shares of common stock, representing the remainder of a
non-officer employee award program granted in 1994.
(b) DIVIDEND RESTRICTIONS
Cinergy owns all of the common stock of CG&E and PSI. The ability of Cinergy
to pay dividends to holders of its common stock is principally dependent on
the ability of CG&E and PSI to pay common dividends to Cinergy. CG&E and PSI
cannot purchase or otherwise acquire for value or pay dividends on their
common stock if dividends are in arrears on their preferred stock. The amount
of common stock dividends that each company can pay also may be limited by
certain capitalization and earnings requirements. Currently, these
requirements do not impact the ability of either company to pay dividends on
common stock.
(c) STOCK-BASED COMPENSATION PLANS
Cinergy has four stock-based compensation plans: the LTIP, the Stock Option
Plan, the PSP, and the Employee Stock Purchase and Savings Plan. Cinergy
ceased accrual of incentive compensation under the PSP as of December 31,
1996, and on January 1, 1997, implemented the LTIP.
Cinergy accounts for its stock-based compensation plans under Accounting
Principles Board Opinion No. 25, Accounting for Stock Issued to Employees,
under which stock option-type awards are recorded at intrinsic value. For
1997, 1996, and 1995, compensation cost related to Cinergy's stock-based
compensation plans, before income taxes, recognized in the Consolidated
Statements of Income was $6 million, $2 million, and $1 million, respectively.
Net income and earnings per share for 1997, 1996, and 1995, assuming
compensation cost for these plans had been determined at fair value,
consistent with the provisions of Statement of Financial Accounting Standards
No. 123, Accounting for Stock-Based Compensation (Statement 123), would have
been as follows:
<TABLE>
<CAPTION>
(in millions, except per share amounts) 1997 1996 1995
- --------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net income - as reported $ 253 $ 335 $ 347
- pro forma $ 251 $ 334 $ 346
Earnings per share - as reported $1.61 $2.00 $2.22
- pro forma $1.59 $1.99 $2.21
Diluted earnings per share
- as reported $1.59 $1.99 $2.20
- pro forma $1.58 $1.99 $2.20
</TABLE>
In accordance with the provisions of Statement 123, in estimating the pro
forma amounts, the fair value method of accounting was not applied to options
granted prior to January 1, 1995. As a result, the pro forma effect on net
income and earnings per share may not be representative of future years. In
addition, the pro forma amounts reflect certain assumptions used in
estimating fair values. These fair value assumptions are described under each
applicable plan discussion below.
A-31
<PAGE>
(i) LTIP
In 1996, Cinergy adopted the LTIP. Under this plan, certain key employees may
be granted stock options and restricted shares of Cinergy common stock. Stock
options are granted at the fair market value of the shares on the date of
grant. These options vest in three years and expire in 10 years from the date
of grant. None of the stock options were exercisable as of December 31, 1997.
Restricted shares are granted at the fair market value of the shares on the
date of grant, discounted to reflect the inability to sell the shares during
the three-year restriction period. In addition to the stock options and
restricted shares, participants may earn additional shares if Cinergy's Total
Shareholder Return (TSR) exceeds that of the average annual median TSR of a
selected peer group. Conversely, if Cinergy's TSR falls below that of the
peer group, participants would lose some or all of the restricted shares.
Dividends on any restricted stock awards and additional performance shares
will be paid in shares of common stock during the payout period in the years
2000 to 2002. No stock-based awards were made under the LTIP prior to 1997.
In 1997, 425,938 performance-based restricted shares at a weighted average
price of $29.95 and 369,600 stock options at a weighted average exercise
price of $33.60 were granted to certain key employees. The number of shares
of common stock to be awarded under the LTIP is limited in the aggregate to
7,000,000 shares.
LTIP stock option activity for 1997 is summarized as follows:
<TABLE>
<CAPTION>
1997
-------------------------
WEIGHTED
AVERAGE
EXERCISE
NUMBER PRICE
- --------------------------------------------------------------------------------
<S> <C> <C>
Outstanding, beginning of year -- --
Granted 369 600 $33.60
- --------------------------------------------------------------------------------
Outstanding, end of year 369 600 $33.60
Exercisable, end of year -- --
Weighted average fair value of
options granted during the year $ 3.71
</TABLE>
The fair values of options granted were estimated as of the date of grant
using a Black-Scholes option pricing model. The weighted averages for the
assumptions used in determining the fair values of options granted were as
follows:
<TABLE>
<CAPTION>
1997
- ---------------------------------------------------------------------------------
<S> <C>
Risk-free interest rate 6.2%
Expected dividend yield 5.4%
Expected lives 6.5 yrs.
Expected common stock variance 1.7%
</TABLE>
(ii) STOCK OPTION PLAN
The Cinergy Stock Option Plan is designed to align executive compensation
with shareholder interests. Under the Stock Option Plan, incentive and
non-qualified stock options, stock appreciation rights (SARs), and SARs in
tandem with stock options may be granted to key employees, officers, and
outside directors. Options are granted at the fair market value of the shares
on the date of grant. Options vest over five years at a rate of 20% per year
and expire 10 years from the date of grant. The total number of shares of
common stock available under the Stock Option Plan may not exceed 5,000,000
shares. No stock options may be granted under the plan after October 24, 2004.
A-32
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Stock Option Plan activity for 1997, 1996, and 1995 is summarized as
follows (no SARs have been granted under this plan):
<TABLE>
<CAPTION>
1997 1996 1995
------------------------------------------------------------------------
WEIGHTED Weighted Weighted
AVERAGE Average Average
EXERCISE Exercise Exercise
NUMBER PRICE Number Price Number Price
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Outstanding, beginning of year 3 359 508 $23.61 3 652 956 $22.47 2 409 453 $19.74
Granted - - 220 000 29.75 1 672 500 24.91
Exercised (380 162) 21.71 (513 448) 18.16 (403 997) 16.16
Forfeited - - - - (25 000) 24.31
- ---------------------------------------------------- --------- ---------
Outstanding, end of year 2 979 346 $23.85 3 359 508 $23.61 3 652 956 $22.47
- ---------------------------------------------------- --------- ---------
Exercisable, end of year 1 259 859 $22.62 989 021 $21.12 895 456 $17.47
Weighted average fair value of options
granted during the year $ - $3.07 $2.41
</TABLE>
The fair values of options granted were estimated as of the date of
grant using a Black-Scholes option pricing model. The weighted averages for
the assumptions used in determining the fair values of options granted in
1996 and 1995 (no options were granted during 1997), were as follows:
<TABLE>
<CAPTION>
1996 1995
- --------------------------------------------------------------
<S> <C> <C>
Risk-free interest rate 6.3% 7.3%
Expected dividend yield 5.8% 6.9%
Expected lives 6.5 yrs. 6.5 yrs.
Expected common stock variance 1.8% 1.8%
</TABLE>
Price ranges, along with certain other information, for options
outstanding under the Stock Option Plan at December 31, 1997, are as follows:
<TABLE>
<CAPTION>
OUTSTANDING EXERCISABLE
------------------------------------- --------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE CONTRACTUAL EXERCISE
PRICE RANGE NUMBER PRICE LIFE NUMBER PRICE
- -------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$13.14 - $17.35 234 179 $15.13 2.0 yrs. 234 179 $15.13
$22.88 - $25.19 2 311 744 $23.72 7.0 yrs. 897 257 $23.63
$28.81 - $31.56 433 423 $29.29 8.1 yrs. 128 423 $29.13
</TABLE>
(iii) PSP
Cinergy's PSP is a long-term incentive plan developed to reward officers and
other key employees for achieving corporate and individual goals. Under the
PSP, participants are granted contingent shares of common stock. A percentage
of these contingent shares is earned with respect to each participant based
on the level of goal attainment at the completion of a performance cycle.
Performance cycles consist of overlapping four-year periods, beginning every
two years. Awards earned under the PSP are paid in two installments: one-half
of the award is paid in the year immediately following the end of the
performance cycle and one-half of the award is paid in the subsequent year.
The most recently commenced four-year performance cycle under the PSP began
January 1, 1996, and was scheduled to end December 31, 1999. As previously
discussed, Cinergy implemented the LTIP effective January 1, 1997, and ceased
accrual of incentive compensation under the PSP as of December 31, 1996. The
total number of shares of common stock available under this plan may not
exceed 800,000 shares. Final payouts for performance cycle four that began
January 1, 1992, were made in 1997. Final payouts for cycles five and six,
which began in January 1994 and January 1996, respectively, will be made in
1999.
The following table provides certain information regarding contingent
shares granted under the PSP for the performance cycle which began January 1,
1996:
<TABLE>
<CAPTION>
1996
- ---------------------------------------------------------------
<S> <C>
Number of contingent shares granted 166 280
Fair value at date of grant (dollars in thousands) $3 508
Weighted average per share amounts $24.47
</TABLE>
The fair values of contingent shares and the weighted average per share
amounts are measured at the market price of a share of common stock as if it
were vested and issued on the date of grant, adjusted for expected
forfeitures and the estimated present value of dividends foregone during the
related performance cycle.
A-33
<PAGE>
(iv) EMPLOYEE STOCK PURCHASE AND SAVINGS PLAN
Cinergy's Employee Stock Purchase and Savings Plan allows essentially all
full-time, regular employees to purchase shares of common stock pursuant to a
stock option feature. Under the Employee Stock Purchase and Savings Plan,
after-tax funds are withheld from a participant's compensation during a
26-month offering period and are deposited in an interest-bearing account. At
the end of the offering period, participants may apply amounts deposited in
the account, plus interest, toward the purchase of shares of common stock at
a purchase price equal to the fair market value of a share of common stock on
the first date of the offering period, less five percent. Any funds not
applied toward the purchase of shares are returned to the participant. A
participant may elect to terminate participation in the plan at any time.
Participation also will terminate if the participant's employment with
Cinergy ceases. Upon termination of participation, all funds, including
interest, are returned to the participant without penalty. A new offering
period began January 1, 1997, and will end February 28, 1999. The purchase
price under this offering is $31.825. The most recently completed offering
period ended December 31, 1996. The purchase price under this offering was
$21.7312. The total number of shares of common stock available under the
Employee Stock Purchase and Savings Plan may not exceed 2,000,000.
Employee Stock Purchase and Savings Plan activity for 1997, 1996, and 1995
is summarized as follows:
<TABLE>
<CAPTION>
1997 1996 1995
- ----------------------------------------------------------------------------------------------------
WEIGHTED Weighted Weighted
AVERAGE Average Average
EXERCISE Exercise Exercise
NUMBER PRICE Number Price Number Price
- ----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Outstanding, beginning of year - $ - 490 787 $21.73 217 604 $21.73
Granted 338 947 31.83 - - 328 362 21.73
Exercised (95) 31.83 (414 284) 21.73 (1 010) 21.73
Forfeited (12 485) 31.83 (76 503) 21.73 (54 169) 21.73
- ------------------------------------------ -------- -------
Outstanding, end of year 326 367 $31.83 - $ - 490 787 $21.73
- ------------------------------------------ -------- -------
Weighted average fair value of
options granted during the year $3.08 $ - $2.42
</TABLE>
The fair values of options granted were estimated as of the date of
grant using a Black-Scholes option pricing model. The weighted averages for
the assumptions used in determining the fair values of options granted were
as follows:
<TABLE>
<CAPTION>
1997 1995
- ------------------------------------------------------------------------------------
<S> <C> <C>
Risk-free interest rate 5.9% 7.7%
Expected dividend yield 5.4% 7.3%
Expected lives 2.0 yrs. 2.0 yrs.
Expected common stock variance 1.6% 1.7%
</TABLE>
A-34
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3. PREFERRED STOCK OF SUBSIDIARIES
(a) SCHEDULE OF CUMULATIVE PREFERRED STOCK
<TABLE>
<CAPTION>
(dollars in thousands) December 31 1997 1996
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
CG&E
Authorized 6,000,000 shares
Not subject to mandatory redemption Par value $100 per share - outstanding
4% Series 169,834 shares in 1997 and 169,835 shares in 1996 $ 16 983 $ 16 984
4 3/4% Series 38,096 shares in 1997 and 41,621 shares in 1996 3 810 4 162
-----------------------------------------------------------------------------------------
Total 20 793 21 146
PSI Not subject to mandatory redemption Par value $25 per share - authorized 5,000,000 shares - outstanding
4.32% Series 169,161 shares in 1997 and 169,162 shares in 1996 4 229 4 229
4.16% Series 148,763 shares in 1997 and 1996 3 719 3 719
7.44% Series 3,408,712 shares in 1997 and 1996 85 218 85 218
Par value $100 per share - authorized 5,000,000 shares - outstanding
3 1/2% Series 40,302 shares in 1997 and 40,567 shares in 1996 4 030 4 056
6 7/8% Series 600,000 shares in 1997 and 1996 60 000 60 000
7.15% Series 158,640 shares in 1996 - 15 864
-----------------------------------------------------------------------------------------
Total 157 196 173 086
TOTAL - CINERGY
Total not subject to mandatory redemption $177 989 $194 232
- ----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
(b) CHANGES IN CUMULATIVE PREFERRED STOCK OUTSTANDING
Changes in cumulative preferred stock outstanding during 1997, 1996, and
1995, were as follows:
<TABLE>
<CAPTION>
Shares Par
(dollars in thousands) Retired Value
- ----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
1997 NOT SUBJECT TO MANDATORY REDEMPTION PAR VALUE $100 PER SHARE
CG&E 4% SERIES 1 $ 1
4 3/4% SERIES 3 525 352
PSI 3 1/2% SERIES 265 26
7.15% SERIES 158 640 15 864
PAR VALUE $25 PER SHARE
PSI 4.32% SERIES 1 -
1996 Not subject to mandatory redemption Par value $100 per share
CG&E 4% Series 100 165 $10 016
4 3/4% Series 88 379 8 838
PSI 3 1/2% Series 276 29
Par value $25 per share
PSI 7.44% Series 591 288 14 782
Subject to mandatory redemption Par value $100 per share
CG&E 7 7/8% Series 800 000 80 000
7 3/8% Series 800 000 80 000
1995 Not subject to mandatory redemption Par value $100 per share
CG&E 7.44% Series 400 000 $40 000
PSI 3 1/2% Series 329 32
Subject to mandatory redemption Par value $100 per share
CG&E 9.15% Series 500 00 0 50 000
- ----------------------------------------------------------------------------------------------
</TABLE>
A-35
<PAGE>
During the third quarter of 1996, Cinergy commenced an offer to purchase
any and all outstanding shares of preferred stock of CG&E. Cinergy purchased
1,788,544 shares of preferred stock and made a capital contribution to CG&E
of all the shares it acquired and CG&E canceled the shares. The cost of
reacquiring the preferred stock, totaling $18 million, represents the
difference between the par value of the preferred stock purchased and the
price paid (including fees paid to tender agents) and is reflected as a
charge to "Retained Earnings" in the Consolidated Statements of Changes in
Common Stock Equity and as a deduction from "Net Income" in the Consolidated
Statements of Income for purposes of determining net income and earnings per
share applicable to common stock. The 4 3/4% Series no longer meets listing
requirements of the New York Stock Exchange (NYSE) and has been delisted.
4. LONG-TERM DEBT
(a) SCHEDULE OF LONG-TERM DEBT (EXCLUDING AMOUNTS REFLECTED IN CURRENT
LIABILITIES)
<TABLE>
<CAPTION>
(dollars in thousands) December 31 1997 1996
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
CG&E AND SUBSIDIARIES
CG&E First Mortgage Bonds 5.80% Series due February 15, 1999 $ 110 000 $ 110 000
7 3/8% Series due May 1, 1999 50 000 50 000
7 3/8% Series due November 1, 2001 60 000 60 000
7 1/4% Series due September 1, 2002 100 000 100 000
8 1/8% Series due August 1, 2003 - 60 000
6.45% Series due February 15, 2004 110 000 110 000
8.95% Series due December 15, 2021 - 100 000
8 1/2% Series due September 1, 2022 100 000 100 000
7.20% Series due October 1, 2023 300 000 300 000
5.45% Series due January 1, 2024 (Pollution Control) 46 700 46 700
5 1/2% Series due January 1, 2024 (Pollution Control) 48 000 48 000
-----------------------------------------------------------------------------------
Total first mortgage bonds 924 700 1 084 700
Pollution Control Notes 6.50% due November 15, 2022 12 721 12 721
Other Long-term Debt 6.90% Debentures due June 1, 2025
(REDEEMABLE AT THE OPTION OF THE
HOLDERS ON JUNE 1, 2005) 150 000 150 000
8.28% Junior subordinated debentures due July 1, 2025 100 000 100 000
Variable rate Liquid Asset Notes with Coupon
Exchange (LANCEs) due October 1, 2007
(REDEEMABLE AT THE OPTION OF CG&E)
(VARIABLE INTEREST RATE SETS AT 6.5% COMMENCING
OCTOBER 1, 1999)
(HOLDERS OF NOT LESS THAN 66 2/3% IN AN AGGREGATE
PRINCIPAL AMOUNT OF THE LANCES HAVE THE ONE-TIME
RIGHT TO CONVERT FROM THE 6.5% FIXED RATE TO A
LIBOR-BASED FLOATING RATE AT ANY INTEREST RATE
PAYMENT DATE BETWEEN OCTOBER 1, 1999
AND OCTOBER 1, 2002) 100 000 -
-----------------------------------------------------------------------------------
Total other long-term debt 350 000 250 000
Unamortized Premium
and Discount - Net (8 860) (12 130)
-----------------------------------------------------------------------------------
Total - CG&E 1 278 561 1 335 291
ULH&P First Mortgage Bonds 6 1/2% Series due August 1, 1999 20 000 20 000
8% Series due October 1, 2003 10 000 10 000
-----------------------------------------------------------------------------------
Total first mortgage bonds 30 000 30 000
Other Long-term Debt 7.65% Debentures due July 15, 2025 15 000 15 000
Unamortized Premium
and Discount - Net (329) (383)
-----------------------------------------------------------------------------------
Total - ULH&P 44 671 44 617
LAWRENCEBURG GAS
COMPANY (LAWRENCEBURG)
First Mortgage Bonds 9 3/4% Series due October 1, 2001 1 200 1 200
-----------------------------------------------------------------------------------
Total - CG&E and subsidiaries $1 324 432 $1 381 108
</TABLE>
A-36
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(a) SCHEDULE OF LONG-TERM DEBT (EXCLUDING AMOUNTS REFLECTED IN CURRENT
LIABILITIES) - CONTINUED
<TABLE>
<CAPTION>
(dollars in thousands) December 31 1997 1996
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
PSI First Mortgage Bonds Series S, 7%, due January 1, 2002 $ 26 429 $ 26 429
Series Y, 7 5/8%, due January 1, 2007 24 140 24 140
Series NN, 7.60%, due March 15, 2012 (Pollution Control) - 35 000
Series QQ, 8 1/4%, due June 15, 2013 (Pollution Control) 23 000 23 000
Series TT, 7 3/8%, due March 15, 2012 (Pollution Control) 10 000 10 000
Series UU, 7 1/2%, due March 15, 2015 (Pollution Control) 14 250 14 250
Series YY, 5.60%, due February 15, 2023 (Pollution Control) 29 945 29 945
Series ZZ, 5 3/4%, due February 15, 2028 (Pollution Control) 50 000 50 000
Series AAA, 7 1/8%, due February 1, 2024 50 000 50 000
-----------------------------------------------------------------------------------------------
Total first mortgage bonds 227 764 262 764
Secured Medium-
term Notes Series A, 7.15% to 8.88%, due January 6, 1999 to June 1, 2022 290 000 290 000
Series B, 5.22% to 8.26%, due September 17, 1998 to August 22, 2022 195 000 230 000
(SERIES A AND B, 7.66% WEIGHTED AVERAGE
INTEREST RATE AND 14 YEAR WEIGHTED AVERAGE
REMAINING LIFE)
-----------------------------------------------------------------------------------------------
Total secured medium-term notes 485 000 520 000
Other Long-term Debt Series 1994A Promissory Note, non-interest bearing,
due January 3, 2001 19 825 19 825
6.25%, due December 15, 2005
(NOTES ARE CALLABLE AND/OR PUTABLE ON DECEMBER 15, 1998) - 50 000
6.35% Debentures due November 15, 2006
(REDEEMABLE IN WHOLE OR IN PART AT THE OPTION OF THE
HOLDERS ON NOVEMBER 15, 2000) 100 000 100 000
-----------------------------------------------------------------------------------------------
Total other long-term debt 119 825 169 825
Unamortized Premium
and Discount - Net (6 119) (7 319)
-----------------------------------------------------------------------------------------------
Total - PSI $ 826 470 $ 945 270
TOTAL - CINERGY First Mortgage Bonds $1 183 664 $1 378 664
Secured Medium-term Notes 485 000 520 000
Pollution Control Notes 12 721 12 721
Other Long-term Debt 484 825 434 825
Unamortized Premium
and Discount - Net (15 308) (19 832)
-----------------------------------------------------------------------------------------------
Total long-term debt $2 150 902 $2 326 378
</TABLE>
(b) MANDATORY REDEMPTION AND OTHER REQUIREMENTS
Cinergy's long-term debt maturities for the next five years are $35 million
in 1998, $186 million in 1999, $31 million in 2000, $99.5 million in 2001,
and $149.4 million in 2002. These maturities do not reflect the $50 million
of 6.25% notes, due December 15, 2005, which are callable and/or putable on
December 15, 1998.
On February 27, 1998, CG&E announced its intention to redeem on March
29, 1998, $41 million principal amount of its 7 3/8% Series First Mortgage
Bonds (due November 1, 2001) at a redemption price of 100.30% and to redeem
on March 30, 1998, the entire $100 million principal amount of its 8 1/2%
Series First Mortgage Bonds (due September 1, 2022) at a redemption price of
100%, both through the maintenance and replacement fund (M&R Fund) provision
of CG&E's first mortgage bond indenture. Additionally, on the same date, CG&E
announced its intention to redeem on March 30, 1998, the remaining $19
million principal amount of its 7 3/8% Series First Mortgage Bonds (due
November 1, 2001) at a redemption price of 100.87%. M&R Fund provisions
contained in CG&E's, PSI's, and ULH&P's first mortgage bond indentures
require cash payments, bond retirements, or pledges of unfunded property
additions each year based on an amount related to the net revenues of the
respective company.
A-37
<PAGE>
5. NOTES PAYABLE AND OTHER SHORT-TERM OBLIGATIONS
Obligations representing notes payable and other short-term obligations and
weighted average interest rates were as follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1997 December 31, 1996
- ---------------------------------------------------------------------------------------------------------------------
WEIGHTED Weighted
ESTABLISHED AVERAGE Established Average
(in millions) LINES OUTSTANDING RATE Lines Outstanding Rate
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Cinergy
Committed lines
Acquisition line $ 350 $ 350 6.25% $ 500 $477 5.96%
Revolving line 400 89 6.27 100 32 5.95
Commercial paper - 161 6.19 - - -
Utility subsidiaries
Committed lines 270 30 6.09 280 99 5.92
Uncommitted lines 360 206 6.19 285 78 6.03
Pollution control notes 244 244 4.08 209 209 3.96
Cinergy UK, Inc. 115 34 7.20 40 27 6.91
------- ------- ------ ----
Total notes payable and other
short-term obligations $1 739 $1 114 5.78% $1 414 $922 5.53%
</TABLE>
Cinergy's committed lines are comprised of an acquisition line and a
revolving line and are maintained by commitment fees which were immaterial
during the 1995 through 1997 period. The established revolving line (as shown
in the above table) also provides credit support for the newly instituted
commercial paper program. Such program is limited to a maximum outstanding
principal amount of $200 million. The majority of the proceeds from the
commercial paper sales were used to reduce the acquisition line to the
year-end level of $350 million. CG&E and PSI also have the capacity to issue
commercial paper that must be supported by committed lines (unsecured lines
of credit) of the respective company. Neither CG&E nor PSI issued commercial
paper in 1997 or 1996.
Cinergy's utility subsidiaries had regulatory authority to borrow up to
$853 million as of December 31, 1997. In connection with this authority,
committed lines, as well as, uncommitted lines (short-term borrowings with
various banks on an "as offered" basis) have been arranged. The established
committed lines (as shown in the above table) includes $100 million
designated as backup for certain of the uncommitted lines at December 31,
1997. Further, the committed lines are maintained by commitment fees, which
were immaterial during the 1995 through 1997 period.
In addition, Cinergy UK, Inc. (Cinergy UK), a subsidiary of Investments,
which holds Cinergy's 50% investment in Avon Energy, entered into a $40
million non-recourse credit agreement in 1996, which was terminated in
October of 1997. This agreement was replaced by a one-year $115 million
non-recourse revolving credit agreement. The commitment fees paid for these
lines were immaterial for the 1996 through 1997 period.
Amounts outstanding of the committed lines for Cinergy, the utility
subsidiaries, and Cinergy UK would become immediately due upon an event of
default which includes non-payment, default under other agreements governing
company indebtedness, bankruptcy, or insolvency. Certain of the uncommitted
lines have similar default provisions.
Both CG&E and PSI have issued variable rate pollution control notes.
Holders of these pollution control notes have the right to put their notes on
any business day. Accordingly, these issuances are reflected in the
Consolidated Balance Sheets as "Notes payable and other short-term
obligations."
A-38
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
6. SALE OF ACCOUNTS RECEIVABLE
In January 1996, CG&E, PSI, and ULH&P entered into an agreement to sell, on a
revolving basis, undivided percentage interests in certain of their accounts
receivable up to an aggregate maximum of $350 million, of which $252 million,
net of reserves, has been sold as of December 31, 1997. The Consolidated
Balance Sheets are net of the $252 million and $246 million sold at December
31, 1997 and 1996, respectively.
7. LEASES
(a) OPERATING LEASES
Cinergy and its subsidiaries have entered into operating lease agreements
covering various facilities and properties, including office space and
computer, communications, and transportation equipment. Total rental payments
on operating leases were $36 million for 1997, $31 million for 1996, and $36
million for 1995. Future minimum lease payments required under operating
leases with remaining, non-cancelable lease terms in excess of one year as of
December 31, 1997, are as follows:
<TABLE>
<CAPTION>
(in millions) Minimum
Year Ended December 31 Payments
- ---------------------------------------------------------------
<S> <C>
1998 $ 36
1999 29
2000 22
2001 13
2002 7
After 2002 26
- ---------------------------------------------------------------
Total $133
</TABLE>
(b) CAPITAL LEASE
In November 1996, CG&E entered into a sale-leaseback agreement for certain
equipment at Woodsdale. The lease is a capital lease with an initial lease
term of five years. At the end of the initial lease term, the lease may be
renewed at mutually agreed upon terms or the equipment may be repurchased by
CG&E at the original sale amount. The monthly lease payment, comprised of
interest only, is based on the applicable London Interbank Offered Rate
(LIBOR) and, therefore, the capital lease obligation will not be amortized
over the initial lease term. The property under the capital lease is
depreciated at the same rate as if the property were still owned by CG&E.
CG&E recorded a capital lease obligation of $22 million, which represented
the net book value of the equipment at the beginning of the lease.
8. FINANCIAL INSTRUMENTS
(a) FINANCIAL DERIVATIVES
Cinergy has entered into financial derivative contracts for the purposes
described below.
(i) FOREIGN EXCHANGE HEDGING ACTIVITY
Cinergy has hedged its pound sterling denominated investment in Midlands
through a currency swap. The currency swap requires Cinergy to exchange a
series of pound sterling denominated cash flows for a series of dollar
denominated cash flows based on Cinergy's initial exchange of $500 million
for 330 million pounds sterling. Translation gains and losses related to the
principal exchange on the currency swap have been recorded in the cumulative
foreign currency translation adjustment which is reported as a separate
component of common stock equity in the Consolidated Financial Statements. At
December 31, 1997, translation losses of approximately $43 million related to
the principal exchange of the currency swap have been reflected in "Current
Liabilities - Other" in the Consolidated Balance Sheets.
(ii) INTEREST RATE RISK MANAGEMENT
Cinergy and its subsidiaries enter into interest rate swaps to lower funding
costs and manage exposures to fluctuations in interest rates. Under these
interest rate swaps, Cinergy and its subsidiaries agree with counterparties
to exchange, at specified intervals, the difference between fixed-rate and
floating-rate interest amounts calculated on an agreed notional principal
amount. At December 31, 1997, Cinergy has effectively fixed the interest rate
applicable to the pound sterling denominated leg of its currency swap through
two interest rate swap agreements. These contracts require Cinergy to pay a
fixed rate and receive a floating rate. Both of the interest rate swaps are
forward starting swaps that effectively fix the interest rate applicable to
the ensuing four year period of the currency swap. These contracts have a
total notional principal amount of 330 million pounds sterling. Translation
gains and losses related to Cinergy's interest obligation, which is payable
in pounds sterling, are recognized as a component of interest expense in the
Consolidated Statements of Income. At December 31, 1997, PSI had two interest
rate swap agreements outstanding with notional amounts of $100 million each.
One contract, with three years remaining from a four-year term, requires PSI
to pay a floating rate and receive a fixed rate. The second contract, with a
six-month term, requires PSI to pay a fixed rate and
A-39
<PAGE>
receive a floating rate. In all cases, the floating rate is based on the
applicable LIBOR and the interest differential paid or received is recognized
in the Consolidated Statements of Income as a component of interest expense.
The fair values of the interest rate swap agreements at December 31, 1997,
were not significant.
(b) FAIR VALUE OF OTHER FINANCIAL INSTRUMENTS
The estimated fair values of Cinergy's and its subsidiaries' other financial
instruments were as follows (this information does not purport to be a
valuation of the companies as a whole):
<TABLE>
<CAPTION>
DECEMBER 31, 1997 December 31, 1996
- ------------------------------------------------------------------------------------
CARRYING FAIR Carrying Fair
(in millions) AMOUNT VALUE Amount Value
- ------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
FINANCIAL INSTRUMENTS
First mortgage bonds
and other long-term
debt (includes amounts
reflected as long-term
debt due within one
year) $2 236 $2 337 $2 466 $2 472
</TABLE>
The following methods and assumptions were used to estimate the fair values
of each major class of financial instruments:
CASH AND TEMPORARY CASH INVESTMENTS, RESTRICTED DEPOSITS, AND NOTES
PAYABLE AND OTHER SHORT-TERM OBLIGATIONS Due to the short period to
maturity, the carrying amounts reflected on the Consolidated Balance Sheets
approximate fair values.
FIRST MORTGAGE BONDS AND OTHER LONG-TERM DEBT The fair values of long-term
debt issues were estimated based on the latest quoted market prices or, if
not listed on the NYSE, on the present value of future cash flows. The
discount rates used approximate the incremental borrowing costs for similar
instruments.
(c) CONCENTRATIONS OF CREDIT RISK
Credit risk represents the risk of loss which would occur as a result of
nonperformance by counterparties pursuant to the terms of their contractual
obligations with the Company. Concentrations of credit risk relate to
significant customers or counterparties, or groups of customers or
counterparties, possessing similar economic or industry characteristics that
would cause their ability to meet contractual obligations to be similarly
affected by changes in economic or other conditions.
Concentration of credit risk with respect to Cinergy's trade accounts
receivable from electric and gas retail customers is limited due to Cinergy's
large number of customers and diversified customer base of residential,
commercial, and industrial customers. Sales for resale customers on Cinergy's
electric system include traditional electric cooperatives and municipalities
with which CG&E and PSI have long-standing relationships. Contracts for sales
of electricity for resale outside of Cinergy's system are principally with
power marketers, other investor owned utilities, electric cooperatives, and
municipalities. As of December 31, 1997, approximately 65% of Cinergy's power
marketing and trading activity represents commitments with 10 counterparties.
The majority of these contracts are for terms of one year or less. As the
competitive electric power market expands, counterparties will increasingly
include new market entrants, such as other power marketers, brokers, and
commodities traders. This increased level of new market entrants, as well as
competitive pressures on the utility market participants, could increase
Cinergy's exposure to credit risk. As of December 31, 1997, Cinergy's
management believes nonperformance of contractual obligations by any one
counterparty of Cinergy's power marketing and trading function would not
result in losses which are significant to the financial condition or results
of operations of Cinergy.
Potential exposure to credit risk also exists from Cinergy's use of
financial derivatives such as currency swaps and interest rate swaps. Because
these financial instruments are transacted only with highly rated financial
institutions, Cinergy does not anticipate nonperformance by any of the
counterparties.
A-40
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
9. PENSION PLANS
Cinergy's defined benefit pension plans cover substantially all employees
meeting certain minimum age and service requirements. Plan benefits are
determined under a final average pay formula with consideration of years of
participation, age at retirement, and the applicable average Social Security
wage base or benefit amount.
Cinergy's funding policy is to contribute annually to the plans an amount
which is not less than the minimum amount required by the Employee Retirement
Income Security Act of 1974 and not more than the maximum amount deductible
for income tax purposes. Contributions applicable to the last three plan
years are: $8 million for 1997, $7 million for 1996, and $18 million for
1995. The plans' assets consist of investments in equity and fixed income
securities.
Effective January 1, 1998, Cinergy reconfigured its defined benefit
pension plans. The reconfigured plans cover the same employees as the
previous plans and established a uniform final average pay formula for all
employees. When an employee retires, he or she will receive the greater of
the benefit accrued under the previous plan as of December 31, 1997, or the
benefit accrued under the new plan as of the retirement date. The
reconfiguration of the pension plans is not expected to have a significant
impact on the Company's financial condition or results of operations.
Cinergy's pension cost for 1997, 1996, and 1995 included the following
components:
<TABLE>
<CAPTION>
(in millions) 1997 1996 1995
- ------------------------------------------------------------------------
<S> <C> <C> <C>
Benefits earned during the period $ 19.8 $ 21.2 $ 18.5
Interest accrued on projected
benefit obligations 67.8 61.6 61.4
Return on Plans' assets
Actual (186.6) (75.6) (119.3)
Deferred gain 123.8 14.4 58.8
Net amortizations 2.8 2.9 2.3
- ------------------------------------------------------------------------
Net periodic pension cost $ 27.6 $ 24.5 $ 21.7
</TABLE>
During 1996, Cinergy recognized an additional $61 million of accrued
pension cost in accordance with Statement of Financial Accounting Standards
No. 88, Employers' Accounting for Settlements and Curtailments of Defined
Benefit Pension Plans and for Termination Benefits. This amount represents
the costs associated with additional benefits extended in connection with
voluntary workforce reduction programs (see Note 1(l)).
<TABLE>
<CAPTION>
1997 1996 1995
- ------------------------------------------------------------------------
<S> <C> <C> <C>
Actuarial Assumptions:
For determination of projected
benefit obligations
Discount rate 7.5% 8.0% 7.5%
Rate of increase in
future compensation 4.5 5.0 4.5
For determination of pension cost
Rate of return on plans' assets 9.0 9.0 9.0 - 9.5
</TABLE>
The following table reconciles the plans' funded status with amounts
recorded in the Consolidated Financial Statements. Under the provisions of
Statement of Financial Accounting Standards No. 87, Employers' Accounting for
Pensions (Statement 87), certain assets and obligations of the plans are
deferred and recognized in the Consolidated Financial Statements in later
years.
<TABLE>
<CAPTION>
1997 1996
- ----------------------------------------------------------------- ----------------------------
Plan's
Plans' Plans' Accumulated
Assets Exceed Assets Exceed Benefits
Accumulated Accumulated Exceed
(in millions) Benefits Benefits Assets
- ------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Actuarial present value of benefits
Vested benefits $(731.6) $(423.1) $(241.6)
Non-vested benefits (35.5) (33.5) (10.1)
- ------------------------------------------------------------------------------------------------
Accumulated benefit obligations (767.1) (456.6) (251.7)
Effect of future compensation increases (193.2) (121.7) (53.3)
- ------------------------------------------------------------------------------------------------
Projected benefit obligations (960.3) (578.3) (305.0)
Plans' assets at fair value 888.1 531.6 234.1
- ------------------------------------------------------------------------------------------------
Projected benefit obligations in excess of
plans' assets (72.2) (46.7) (70.9)
Remaining balance of plans' net assets existing
at date of initial application of Statement 87
to be recognized as a reduction of pension
cost in future periods (8.5) (6.7) (3.1)
Unrecognized net gain resulting from experience
different from that assumed and effects of
changes in assumptions (134.6) (48.4) (28.1)
Prior service cost not yet recognized in net
periodic pension cost 46.6 33.6 23.2
- ------------------------------------------------------------------------------------------------
Accrued pension cost at December 31 $(168.7) $ (68.2) $ (78.9)
</TABLE>
A-41
<PAGE>
10. OTHER POSTRETIREMENT BENEFITS
Cinergy provides certain health care and life insurance benefits to retired
employees who have met minimum age and service requirements and their
eligible dependents. The health care benefits include medical coverage,
dental coverage, and prescription drugs and are subject to certain
limitations, such as deductibles and co-payments. Prior to January 1, 1997,
CG&E and PSI employees were covered under separate plans. Effective January
1, 1997, all Cinergy active employees are eligible to receive essentially the
same postretirement health care benefits. Certain classes of employees, based
on age, as well as all retirees, have been grandfathered under benefit
provisions in place prior to January 1, 1997. Neither CG&E and its
subsidiaries nor PSI currently pre-fund their obligations for these
postretirement benefits; however, PSI, in connection with the settlement
which resulted in the February 1995 Order, agreed to begin pre-funding.
Implementation of pre-funding is subject to the outcome of negotiations with
The Office of the Utility Consumer Counselor and approval by the IURC.
Postretirement benefit cost for 1997, 1996, and 1995 included the
following components:
<TABLE>
<CAPTION>
Health Life
(in millions) Care Insurance Total
- -----------------------------------------------------------------------------
<S> <C> <C> <C>
1997
BENEFITS EARNED DURING THE PERIOD $ 3.0 $ .1 $ 3.1
INTEREST ACCRUED ON ACCUMULATED
POSTRETIREMENT BENEFIT
OBLIGATION (APBO) 14.1 2.2 16.3
NET AMORTIZATION AND DEFERRAL .2 .1 .3
AMORTIZATION OF TRANSITION
OBLIGATIONS 4.7 .3 5.0
- ------------------------------------------------------------------------------
NET PERIODIC POSTRETIREMENT
BENEFIT COST $ 22.0 $ 2.7 $ 24.7
1996
Benefits earned during the period $ 5.7 $ .1 $ 5.8
Interest accrued on APBO 16.5 2.2 18.7
Net amortization and deferral .3 - .3
Amortization of transition obligations 8.1 .3 8.4
- ------------------------------------------------------------------------------
Net periodic postretirement benefit cost $ 30.6 $ 2.6 $ 33.2
1995
Benefits earned during the period $ 4.4 $ .1 $ 4.5
Interest accrued on APBO 15.6 2.2 17.8
Amortization of transition obligations 8.1 .3 8.4
- ------------------------------------------------------------------------------
Net periodic postretirement benefit cost $ 28.1 $ 2.6 $ 30.7
</TABLE>
The following table reconciles the APBO of the health care and life
insurance plans with amounts recorded in the Consolidated Financial
Statements. Under the provisions of Statement of Financial Accounting
Standards No. 106, Employers' Accounting for Postretirement Benefits Other
Than Pensions, certain obligations of the plans are deferred and recognized
in the Consolidated Financial Statements in later years.
<TABLE>
<CAPTION>
Health Life
(in millions) Care Insurance Total
- -------------------------------------------------------------------------------
<S> <C> <C> <C>
1997
ACTUARIAL PRESENT VALUE OF BENEFITS
FULLY ELIGIBLE ACTIVE PLAN
PARTICIPANTS $ (9.9) $ (2.3) $ (12.2)
OTHER ACTIVE PLAN PARTICIPANTS (66.3) (1.1) (67.4)
RETIREES AND BENEFICIARIES (113.6) (28.7) (142.3)
- -------------------------------------------------------------------------------
PROJECTED APBO (189.8) (32.1) (221.9)
UNAMORTIZED TRANSITION OBLIGATIONS 70.7 .2 70.9
UNRECOGNIZED NET LOSS
RESULTING FROM EXPERIENCE
DIFFERENT FROM THAT ASSUMED
AND EFFECTS OF CHANGES IN
ASSUMPTIONS 21.1 1.5 22.6
- -------------------------------------------------------------------------------
ACCRUED POSTRETIREMENT
BENEFIT OBLIGATIONS AT
DECEMBER 31, 1997 $ (98.0) $ (30.4) $(128.4)
1996
Actuarial present value of benefits
Fully eligible active plan
participants $ (13.7) $ (1.6) $ (15.3)
Other active plan participants (49.8) (1.5) (51.3)
Retirees and beneficiaries (118.0) (26.4) (144.4)
- -------------------------------------------------------------------------------
Projected APBO (181.5) (29.5) (211.0)
Unamortized transition obligations 75.4 .4 75.8
Unrecognized net loss (gain) resulting
from experience different from
that assumed and effects of
changes in assumptions 19.5 (.5) 19.0
- -------------------------------------------------------------------------------
Accrued postretirement benefit
obligations at December 31, 1996 $ (86.6) $ (29.6) $(116.2)
</TABLE>
The following assumptions were used to determine the APBO:
<TABLE>
<CAPTION>
1997 1996 1995
- -------------------------------------------------------------------------------
<S> <C> <C> <C>
Discount rate 7.5% 8.0% 7.5%
Health care cost
trend rate, gradually
declining to 5%
CG&E 7.0-8.0% 7.0-9.0% 8.0-11.0%
PSI 7.0-8.0 7.0-9.0 8.0-10.0
Year ultimate trend
rates achieved
CG&E 2004 2004 2002
PSI 2004 2004 2007
</TABLE>
Increasing the health care cost trend rate by one percentage point in each
year would increase the APBO by approximately $24 million for 1997 and $21
million for 1996, and the aggregate of the service and interest cost
components of the postretirement benefit cost by approximately $2 million for
1997, $4 million for 1996, and $3 million for 1995.
A-42
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. INCOME TAXES
Cinergy complies with the provisions of Statement 109. Statement 109 requires
recognition of deferred tax assets and liabilities for the expected future
tax consequences of existing differences between the financial reporting and
tax reporting bases of assets and liabilities.
The significant components of Cinergy's net deferred income tax liability
at December 31, 1997, and 1996, are as follows:
<TABLE>
<CAPTION>
(in millions) 1997 1996
- -------------------------------------------------------------------------------
<S> <C> <C>
DEFERRED INCOME TAX LIABILITY
Utility plant $1 076.8 $1 061.3
Unamortized costs of reacquiring debt 24.4 23.2
Deferred operating expenses
and carrying costs 70.4 73.5
Amounts due from customers - income taxes 129.4 129.4
Deferred DSM costs 31.7 43.4
Investment in unconsolidated subsidiary 55.0 13.5
Other 47.9 41.3
- -------------------------------------------------------------------------------
Total deferred income tax liability 1 435.6 1 385.6
DEFERRED INCOME TAX ASSET
Unamortized investment tax credits 60.5 63.9
Deferred fuel costs - 12.9
Accrued pension and other benefit costs 63.3 60.4
Other 63.3 102.1
- -------------------------------------------------------------------------------
Total deferred income tax asset 187.1 239.3
NET DEFERRED INCOME TAX LIABILITY $1 248.5 $1 146.3
</TABLE>
A summary of Federal and state income taxes charged (credited) to income
and the allocation of such amounts is as follows:
<TABLE>
<CAPTION>
(in millions) 1997 1996 1995
- ----------------------------------------------------------------------------------
<S> <C> <C> <C>
CURRENT INCOME TAXES
Federal $133.3 $143.4 $175.3
State 12.1 7.5 10.4
- ----------------------------------------------------------------------------------
Total current income taxes 145.4 150.9 185.7
DEFERRED INCOME TAXES
Federal
Depreciation and other
utility plant-related items 26.7 61.6 53.8
DSM costs (8.5) (1.9) 12.0
Pension and other benefit costs .9 (28.2) (21.8)
Litigation settlement 1.8 26.2 -
Fuel costs 4.4 8.8 .3
Other items - net 49.5 (15.4) (7.5)
- ----------------------------------------------------------------------------------
Total deferred Federal
income taxes 74.8 51.1 36.8
State 2.4 6.5 1.7
- ----------------------------------------------------------------------------------
Total deferred income taxes 77.2 57.6 38.5
INVESTMENT TAX CREDITS - NET (9.6) (9.8) (10.1)
- ----------------------------------------------------------------------------------
TOTAL INCOME TAXES $213.0 $198.7 $214.1
ALLOCATED TO:
Operating income $248.9 $218.2 $221.4
Other income and expenses - net (35.9) (19.5) (7.3)
- ----------------------------------------------------------------------------------
$213.0 $198.7 $214.1
</TABLE>
Federal income taxes, computed by applying the statutory Federal income
tax rate to book income before extraordinary item and Federal income tax, are
reconciled to Federal income tax expense reported in the Consolidated
Statements of Income as follows:
<TABLE>
<CAPTION>
(in millions) 1997 1996 1995
- -------------------------------------------------------------------------------
<S> <C> <C> <C>
Statutory Federal income tax
provision $196.4 $181.8 $192.2
Increases (Reductions) in taxes
resulting from:
Amortization of investment
tax credits (9.6) (9.8) (10.1)
Depreciation and other utility
plant-related differences 11.7 14.1 9.0
Preferred dividend requirements
of subsidiaries 4.4 8.5 10.8
Foreign tax adjustments (13.2) (11.1) -
Other - net 8.8 1.2 .1
- -------------------------------------------------------------------------------
Federal income tax expense $198.5 $184.7 $202.0
</TABLE>
12. COMMITMENTS
AND CONTINGENCIES
(a) CONSTRUCTION
Cinergy currently forecasts the aggregate expenditures for its construction
program for the 1998 through 2002 period to be $1.7 billion.
(b) MANUFACTURED GAS PLANT (MGP) SITES
(i) GENERAL
Prior to the 1950s, gas was produced at MGP sites through a process that
involved the heating of coal and/or oil. The gas produced from this process
was sold for residential, commercial, and industrial uses.
(ii) PSI
Coal tar residues, related hydrocarbons, and various metals associated with
MGP sites have been found at former MGP sites in Indiana, including at least
21 MGP sites which PSI or its predecessors previously owned. In 1945, PSI
sold 19 of these sites to Indiana Gas and Water Company, Inc. (now Indiana
Gas Company, Inc. (IGC)), including the Shelbyville and Lafayette sites
(discussed below). PSI or its predecessors acquired seven of the 21 MGP sites
from Northern Indiana Public Service Company (NIPSCO), five of which were
among the 19 sites PSI sold to IGC. The other two sites acquired from NIPSCO
are located in Goshen (discussed below) and Warsaw, Indiana.
PSI has received claims from IGC and NIPSCO that PSI is a Potentially
Responsible Party (PRP)
A-43
<PAGE>
under the Comprehensive Environmental Response, Compensation and Liability
Act (CERCLA) with respect to the 21 MGP sites, and therefore responsible for
the costs of investigating and remediating these sites.
The Shelbyville MGP site has been the subject of an investigation and
cleanup enforcement action by the Indiana Department of Environmental
Management (IDEM) against IGC and PSI. Pursuant to an agreement, PSI and IGC
have conducted investigation and remediation activities at the Shelbyville
site and are sharing the costs of these activities. In 1997, PSI and IGC
submitted a proposed agreed order to IDEM relative to the Shelbyville site,
which, if accepted by IDEM, will result in a determination of whether the
activities previously undertaken at the site are sufficient to adequately
protect human health and the environment. Based upon environmental
investigations and remediation completed to date, PSI believes that any
further investigation and remediation required for this site will not have a
material adverse effect on its financial condition or results of operations.
In 1992, the IDEM issued an order to IGC, naming IGC as a PRP as defined
in the CERCLA, which requires investigation and remediation of the Lafayette
MGP site. IGC entered into an agreed order with the IDEM for the removal of
MGP contamination at that site.
In August 1997, NIPSCO filed suit against PSI in the United States
District Court for the Northern District of Indiana, South Bend Division,
claiming, pursuant to CERCLA, recovery from PSI of NIPSCO's past and future
costs of investigating and remediating MGP related contamination at the
Goshen MGP site. NIPSCO alleged that it has already incurred about $400,000
in response costs at the site and that remediation of the site will cost
about $2.7 million. PSI denied liability in its answer to the complaint. The
parties are currently engaged in the discovery process and the case has not
yet been scheduled for trial.
Also, in August 1997, PSI reached an agreement with IGC settling IGC's
claims that PSI contribute to IGC's response costs related to 13 of the 19
MGP sites conveyed by PSI to IGC in 1945. This agreement requires PSI and
IGC to share past and future response costs equally (50%/50%) at the 13
sites. Further, the parties must jointly approve future management of the
sites and the decisions to spend additional funds. The settlement does not
address the five sites PSI acquired from NIPSCO and subsequently sold to IGC
(including the Lafayette site).
PSI has placed its insurance carriers on notice of IGC's, NIPSCO's, and
IDEM's claims.
In May 1995, the IURC denied IGC's request for recovery of costs incurred
in complying with Federal, state, and local environmental regulations related
to MGP sites in which IGC has an interest, including sites acquired from PSI.
IGC appealed this decision, which IGC contended was contrary to decisions
made by other state utility commissions with respect to this issue. In
January 1997, the Indiana Court of Appeals (Court of Appeals) affirmed the
IURC's decision denying IGC's request for recovery of MGP costs. IGC
petitioned the Indiana Supreme Court to review the Court of Appeals decision.
In August 1997, the Indiana Supreme Court denied transfer of this case.
Accordingly, the IURC's decision denying rate recovery for these costs by IGC
remains intact. The IURC granted PSI's motion establishing a sub-docket to
PSI's last retail rate proceeding, in which the IURC issued an order in
September 1996, to consider its request for rate recovery of any MGP site-
related costs it may incur. PSI is unable to predict the extent to which it
will be able to recover through rates any MGP site investigation and
remediation costs ultimately incurred.
PSI continues to gather information pertaining to each of these MGP sites,
including the 13 sites which are the subject of the agreement with IGC and
the Goshen site which is the subject of NIPSCO's complaint. Reserves
recorded, based on information currently available, are not material to
Cinergy's financial condition or results of operations. However, as further
investigation and remediation activities are undertaken at these sites, the
potential liability for MGP sites could be material to Cinergy's financial
condition or results of operations.
(iii) CG&E AND ITS UTILITY SUBSIDIARIES
Lawrenceburg, a wholly-owned subsidiary of CG&E, also has a MGP site. In May
1995, Lawrenceburg and the IDEM reached an agreement to include the
Lawrenceburg MGP site in the IDEM's voluntary cleanup program. Lawrenceburg
implemented a remediation plan, and, on September 20, 1996, received a
certificate of completion on the cleanup from the IDEM. The total costs
incurred for the cleanup program were approximately $273,000.
CG&E and its utility subsidiaries are aware of other potential sites where
MGP activities may have occurred at some time in the past. None of these
sites is known to present a risk to the environment. CG&E and its utility
subsidiaries have undertaken preliminary site assessments to obtain more
information about some of the other potential MGP sites.
(c) UNITED SCRAP LEAD SITE
The United States Environmental Protection Agency (EPA) alleges that CG&E is
a PRP under the CERCLA liable for cleanup of the United Scrap Lead site in
Troy, Ohio. CG&E was one of approximately 200 companies so named. CG&E
believes it is not a PRP and should not be responsible for cleanup of the
site. Under the CERCLA, CG&E could be jointly and severally liable for
A-44
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
costs incurred in cleaning up the site, estimated by the EPA to be
$27 million, of which CG&E estimates its portion to be immaterial to its
financial condition or results of operations. In January 1998, CG&E executed
a de minimis settlement agreement, which if accepted by the Federal District
Court will resolve CG&E's potential liability for the site. Action on the
proposed settlement is expected by the end of 1998.
(d) ENERTECH ASSOCIATES, INC. (ENERTECH) LITIGATION
In October 1995, a suit was filed in the Federal District Court for the
Southern District of Ohio by three former employees of Enertech, formerly
named Power International, Inc., a subsidiary of Investments, naming as
defendants Enertech, Cinergy, Investments, CG&E, PSI, James E. Rogers, and
William J. Grealis. (Mr. Rogers and/or Mr. Grealis are officers and/or
directors of the foregoing companies.) The lawsuit, which stems from the
termination of employment of the three former employees, alleges that they
entered into employment contracts with Enertech based on the opportunity to
participate in potential profits from future investments in energy projects
in central and eastern Europe. The suit alleges causes of action based upon,
among other theories, breach of contract related to the events surrounding
the termination of their employment and fraud and misrepresentation related
to the level of financial support for future projects. The suit alleges
compensatory damages of $154 million based upon assumed future success of
potential future investments and punitive damages of three times that amount.
All defendants are vigorously defending against the charges based upon
meritorious defenses. Cinergy is currently unable to predict the outcome of
this litigation.
(e) WABASH VALLEY POWER ASSOCIATION, INC. (WVPA)
In February 1989, PSI and WVPA entered into a settlement agreement to resolve
all claims related to Marble Hill, a nuclear project canceled in 1984.
Implementation of the settlement was contingent upon a number of events,
including the conclusion of WVPA's bankruptcy proceeding, negotiation of
certain terms and conditions with WVPA, the Rural Utilities Service (RUS),
and the National Rural Utilities Cooperative Finance Corporation (CFC), and
certain regulatory approvals. In December 1996, following the resolution of
issues associated with WVPA's bankruptcy proceeding, PSI, on behalf of itself
and its officers, paid $80 million on behalf of WVPA to the RUS and the CFC.
The $80 million obligation, net of insurance proceeds, other credits, and
applicable income tax effects, was charged to income in 1988. In January
1997, an order dismissing the WVPA litigation against PSI and its officers
with prejudice was entered by the United States District Court for the
Southern District of Indiana. Negotiations among PSI, WVPA, the RUS, and the
CFC continue regarding certain additional terms and conditions of the
settlement agreement. Based on the current status of negotiations, the
Company believes it has adequately reserved for any loss that would be
material to its financial condition or results of operations. However, the
Company cannot currently predict the outcome of these negotiations. Depending
on the form of the final negotiated terms and conditions and the form of any
regulatory approvals, the Company could be required to recognize additional
losses of up to $90 million for accounting purposes. The recognition of this
loss is not expected to have an immediate impact on Cinergy's cash flow. The
Company believes that negotiations could be concluded and the final terms and
conditions determined during 1998.
(f) POTENTIAL DIVESTITURE OF GAS OPERATIONS
Under the PUHCA, the divestiture of CG&E's gas operations may be required.
The key question under the relevant PUHCA standards is the amount of
increased operating costs, if any, that would result from the gas operations
being divested and operated on a stand-alone basis.
In its order approving the merger, the SEC reserved judgment over
Cinergy's ownership of CG&E's gas operations for three years, at the end of
which period Cinergy would be required to address the matter. In February
1998, Cinergy made a filing with the SEC setting forth its rationale for
retention of the gas operations. The filing includes, among other things, a
study showing that, if divested and operated on a stand-alone basis, the gas
operations would bear significant increased operating costs, greater than
those cited by the SEC in two 1997 cases permitting electric registered
holding companies to acquire and retain gas properties. For these and other
reasons stated in Cinergy's filing, Cinergy believes its retention of CG&E's
gas properties meets all relevant standards under the PUHCA.
13. JOINTLY OWNED PLANT
PSI is a joint owner of Gibson Unit 5 with WVPA and the Indiana Municipal
Power Agency (IMPA). Additionally, PSI is a co-owner with WVPA and IMPA of
certain transmission property and local facilities. These facilities
constitute part of the integrated trans-
A-45
<PAGE>
mission and distribution systems which are operated and maintained by PSI.
CG&E, Columbus Southern Power Company, and The Dayton Power and Light Company
have constructed electric generating units and related transmission
facilities on varying common ownership bases. The Consolidated Statements of
Income reflect PSI's and CG&E's portions of all operating costs associated
with the commonly owned facilities.
PSI's and CG&E's investments in jointly owned plant are as follows:
<TABLE>
<CAPTION>
1997
- -----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
CONSTRUCTION
UTILITY PLANT ACCUMULATED WORK IN
(DOLLARS IN MILLIONS) SHARE IN SERVICE DEPRECIATION PROGRESS
- -----------------------------------------------------------------------------------------------------------------------------
PSI
PRODUCTION
GIBSON (UNIT 5) 50.05% $ 205 $ 97 $ 1
TRANSMISSION AND LOCAL FACILITIES 94.28 1 918 673 32
CG&E
PRODUCTION
MIAMI FORT STATION (UNITS 7 AND 8) 64 208 117 4
W.C. BECKJORD STATION (UNIT 6) 37.5 41 25 1
J.M. STUART STATION 39 273 121 1
CONESVILLE STATION (UNIT 4) 40 72 37 2
ZIMMER 46.5 1 216 239 5
EAST BEND STATION 69 330 164 2
KILLEN STATION 33 187 85 -
TRANSMISSION VARIOUS 63 31 1
- -----------------------------------------------------------------------------------------------------------------------------
14. QUARTERLY FINANCIAL DATA (unaudited)
(in millions, except per share amounts)
- -----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Net Basic Diluted
Operating Operating Income Earnings (Loss) Earnings (Loss)
Quarter Ended Revenues Income (Loss) Per Share Per Share
- ------------------------------------------------------------------------------------------------------------------------------
1997
MARCH 31 $1 030 $152 $114 $ .72 $ .71
JUNE 30 865 105 55 .35 .35
SEPTEMBER 30 1 355 140 (27)(a) (.16)(a) (.17)(a)
DECEMBER 31 1 103 142 111 .70 .70
- ------------------------------------------------------------------------------------------------------------------------------
TOTAL $4 353 $539 $253(a) $1.61(a) $1.59(a)
1996
March 31 $ 884 $169 $110 $ .70 $ .69
June 30 717 113 56(b) .35(b) .35(b)
September 30 766 150 98 .51(c) .51(c)
December 31 876 126 71(b) .44(b) .44(b)
- ------------------------------------------------------------------------------------------------------------------------------
Total $3 243 $558 $335(b) $2.00(b)(c) $1.99(b)(c)
</TABLE>
(a) For a discussion of the windfall profits tax levied against Midlands,
which was recorded in the third quarter as an extraordinary item, see
Note 17. Net income, basic earnings per share and diluted earnings per
share during the third quarter of 1997, before the extraordinary
item, were $83 million, $.53 and $.52, respectively. Total net income,
basic earnings per share, and diluted earnings per share for 1997,
before the extraordinary item, were $363 million, $2.30, and $2.28,
respectively.
(b) In 1996, Cinergy recognized charges to earnings of approximately $55
million ($38 million, net of taxes or $.24 per share, basic and diluted)
primarily for charges related to voluntary early retirement and severance
programs and disallowances associated with the PUCO's December 1996 Order
in CG&E's gas rate proceeding. Of these charges, approximately
$11 million, net of taxes or $.07 per share(basic and diluted), was
recognized in the second quarter, and approximately $27 million, net of
taxes or $.17 per share (basic and diluted), was recognized in the fourth
quarter. Of the total $55 million charge, $41 million is reflected in
"Operating Expenses - Other operation" and $14 million is reflected in
"Other Income and Expenses - Net."
(c) In the third quarter of 1996, Cinergy incurred costs of $18 million or
$.12 per share (basic and diluted), related to the reacquisition of 90%
of CG&E's preferred stock through a tender offer. (See Note 3(b).)
A-46
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
15. FINANCIAL INFORMATION BY BUSINESS SEGMENT
<TABLE>
<CAPTION>
(in millions)
- ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Operating
Operating Operating Income Provision For Construction
Year Ended Revenues Income Taxes Depreciation Expenditures
- ------------------------------------------------------------------------------------------------------------------------------
1997
ELECTRIC $3 862 $505 $229 $266 $247
GAS 491 34 20 23 44
- ------------------------------------------------------------------------------------------------------------------------------
TOTAL $4 353 $539 $249 $289 $291
1996
Electric $2 769 $520 $204 $260 $276
Gas 474 38 14 23 32
- ------------------------------------------------------------------------------------------------------------------------------
Total $3 243 $558 $218 $283 $308
1995
Electric $2 612 $548 $209 $258 $286
Gas 411 39 12 22 36
- ------------------------------------------------------------------------------------------------------------------------------
Total $3 023 $587 $221 $280 $322
(in millions) December 31 1997 1996 1995
- ------------------------------------------------------------------------------------------------------------------------------
Property, Plant, and Equipment - net
Electric $5 724 $5 737 $5 718
Gas 573 553 532
- ------------------------------------------------------------------------------------------------------------------------------
6 297 6 290 6 250
Other Corporate Assets 2 561 2 435 1 853
- ------------------------------------------------------------------------------------------------------------------------------
Total Assets $8 858 $8 725 $8 103
</TABLE>
For a discussion of the potential divestiture of CG&E's gas operations, see
Note 12(f).
A-47
<PAGE>
16. EARNINGS PER SHARE
Effective December 31, 1997, Cinergy adopted the provisions of Statement of
Financial Accounting Standards No. 128, Earnings Per Share (Statement 128).
Statement 128 replaces the calculation of primary and fully diluted earnings
per share under previous accounting standards with basic and diluted earnings
per share amounts. Previously reported earnings per share amounts have been
restated to comply with the provisions of Statement 128.
The after-tax earnings per share impact of the extraordinary item - equity
share of windfall profits tax in 1997 was $.69 for both basic and diluted
earnings per share.
Presented below is a reconciliation of earnings per common share (basic
EPS) and earnings per common share assuming dilution (diluted EPS).
<TABLE>
<CAPTION>
Income Shares Earnings
(In thousands, except per share amounts) (Numerator) (Denominator) Per Share
- ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
1997
EARNINGS PER COMMON SHARE: NET INCOME BEFORE EXTRAORDINARY ITEM $362 638 157 685 $2.30
EFFECT OF DILUTIVE SECURITIES: COMMON STOCK OPTIONS 928
CONTINGENTLY ISSUABLE COMMON STOCK 204
- ------------------------------------------------------------------------------------------------------------------------------
EPS-ASSUMING DILUTION: NET INCOME BEFORE
EXTRAORDINARY ITEM PLUS ASSUMED CONVERSIONS $362 638 158 817 $2.28
1996
Net income $334 797
Less: costs of reacquisition of preferred stock of subsidiary 18 391
- ------------------------------------------------------------------------------------------------------------------------------
Earnings per common share: Net income applicable to common stock $316 406 157 678 $2.00
Effect of dilutive securities: Common stock options 923
Contingently issuable common stock 314
- ------------------------------------------------------------------------------------------------------------------------------
EPS-assuming dilution: Net income applicable to
common stock plus assumed conversions $316 406 158 915 $1.99
1995
Earnings per common share: Net income $347 182 156 620 $2.22
Effect of dilutive securities: Common stock options 586
Contingently issuable common stock 316
- ------------------------------------------------------------------------------------------------------------------------------
EPS-assuming dilution: Net income plus assumed conversions $347 182 157 522 $2.20
- ------------------------------------------------------------------------------------------------------------------------------
</TABLE>
Options to purchase shares of common stock that were excluded from the
calculation of EPS-assuming dilution because the exercise prices of these
options were greater than the average market price of the common shares
during the year are summarized below:
<TABLE>
<CAPTION>
Average
Exercise
Year Shares Price
- ------------------------------------------------------
<S> <C> <C>
1997 22 300 $35.25
1996 45 000 31.56
1995 215 000 28.81
</TABLE>
17. EXTRAORDINARY ITEM - EQUITY SHARE OF WINDFALL PROFITS TAX
In May 1997, general elections were held in Great Britain which resulted in
the Labour Party gaining control of the government. In July 1997, the Labour
Government announced a windfall profits tax to be levied against a limited
number of British companies, including Midlands, which had previously been
owned and operated by the government. The tax, which was enacted into law
during the third quarter of 1997, was intended to be a recovery of funds by
the government due to the undervaluing of the companies subject to the tax
when they were privatized by the government via public stock offerings
several years ago.
Cinergy's share of the tax to be paid by Midlands in two equal
installments, due December 1, 1997 and 1998, is approximately 67 million
pounds sterling ($109 million or $.69 per share, basic and diluted).
Midlands borrowed the funds to finance the first installment. Cinergy
expects Midlands will borrow funds as necessary to pay the final installment.
As Cinergy's management believes this charge to be unusual in nature, and
does not expect such a charge to recur, the tax was recorded as an
extraordinary item in Cinergy's Consolidated Statement of Income during the
third quarter of 1997. No related tax benefit was recorded for the charge as
the windfall profits tax is not deductible for corporate income tax purposes
in the UK, and Cinergy expects that benefits, if any, derived for US Federal
income taxes will not be significant.
A-48
<PAGE>
RESPONSIBILITY FOR FINANCIAL STATEMENTS
Management is responsible for the accuracy, objectivity, and consistency of
the financial statements presented in this report. The Consolidated Financial
Statements of Cinergy Corp. (Cinergy) conform to generally accepted
accounting principles and have also been prepared to comply with accounting
policies and principles prescribed by the applicable regulatory authorities.
To assure the reliability of Cinergy's financial statements, management
maintains a system of internal controls. This system is designed to provide
reasonable assurance that assets are safeguarded, that transactions are
executed with management's authorization, and that transactions are properly
recorded so financial statements can be prepared in accordance with the
policies and principles previously described.
Cinergy has established policies intended to ensure that employees adhere
to the highest standards of business ethics. Management also takes steps to
assure the integrity and objectivity of Cinergy's accounts by careful
selection of managers, division of responsibilities, delegation of authority,
and communication programs to assure that policies and standards are
understood.
An internal auditing program is used to evaluate the adequacy of and
compliance with internal controls. Although no cost effective internal
control system will preclude all errors and irregularities, management
believes that Cinergy's system of internal controls provides reasonable
assurance that material errors or irregularities are prevented, or would be
detected within a timely period.
Cinergy's Consolidated Financial Statements have been audited by Arthur
Andersen LLP, which has expressed its opinion with respect to the fairness of
the statements. The auditors' examination included a review of the system of
internal controls and tests of transactions to the extent they considered
necessary to render their opinion.
The Board of Directors, through its audit committee of outside directors,
meets periodically with management, internal auditors, and independent
auditors to assure that they are carrying out their respective
responsibilities. The audit committee has full access to the internal and
independent auditors, and meets with them, with and without management
present, to discuss auditing and financial reporting matters.
/s/ James E. Rogers
James E. Rogers
President and
Chief Executive Officer
/s/ Madeleine W. Ludlow
Madeleine W. Ludlow
Vice President and
Chief Financial Officer
A-49
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors of Cinergy Corp.:
We have audited the consolidated balance sheets of Cinergy Corp. (a
Delaware Corporation) and its subsidiary companies as of December 31, 1997
and 1996, and the related consolidated statements of income, changes in
common stock equity and cash flows for each of the three years in the period
ended December 31, 1997. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on
these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. 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, the financial statements referred to above present fairly,
in all material respects, the financial position of Cinergy Corp. and its
subsidiary companies as of December 31, 1997 and 1996, and the results of
their operations and their cash flows for each of the three years in the
period ended December 31, 1997, in conformity with generally accepted
accounting principles.
Arthur Andersen LLP
Cincinnati, Ohio,
January 27, 1998
A-50
<PAGE>
<TABLE>
<CAPTION>
FIVE YEAR STATISTICAL SUMMARY
FINANCIAL 1997 1996 1995 1994 1993
- ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
OPERATING REVENUES (thousands) $4 352 843 $3 242 740 $3 023 431 $2 888 447 $2 833 440
- ------------------------------------------------------------------------------------------------------------------------------
NET INCOME (thousands) $ 253 238 $ 334 797 $ 347 182 $ 191 142 $ 62 547(a)
- ------------------------------------------------------------------------------------------------------------------------------
TOTAL ASSETS (thousands) $8 858 153 $8 724 934 $8 103 242 $8 037 422 $7 696 489
- ------------------------------------------------------------------------------------------------------------------------------
CONSTRUCTION EXPENDITURES (INCLUDING AFUDC)
(thousands) $ 317 153 $ 324 238 $ 326 869 $ 486 734 $ 563 355
- ------------------------------------------------------------------------------------------------------------------------------
CAPITALIZATION Common Equity $2 539 200 $2 584 454 $2 548 843 $2 414 271 $2 221 681
($ - thousands) Preferred Stock(b)
Subject to Mandatory Redemption - - 160 000 210 000 210 000
Not Subject to Mandatory Redemption 177 989 194 232 227 897 267 929 307 989
Long-term Debt(b) 2 150 902 2 326 378 2 346 766 2 615 269 2 545 213
Total Capitalization $4 868 091 $5 105 064 $5 283 506 $5 507 469 $5 284 883
- ------------------------------------------------------------------------------------------------------------------------------
OTHER COMMON Avg. Shares Outstanding (thousands) 157 685 157 678 156 620 147 426 144 226
STOCK DATA Avg. Shares Outstanding -
Assuming Dilution (thousands) 158 817 158 915 157 522 148 006 144 832
Earnings Per Share $ 1.61(d) $ 2.00(c) $ 2.22 $ 1.30 $0.43(a)
Earnings Per Share -
Assuming Dilution $ 1.59(d) $ 1.99(c) $ 2.20 $ 1.29 $0.43(a)
Dividends Declared Per Share $ 1.80(d) $ 1.74(a) $ 1.72 $ 1.50 $1.46(a)
Payout Ratio(e) 111.8% 87.0%(c) 77.5% 115.4% 339.5%
Book Value Per Share (year-end) $ 16.10 $ 16.39 $ 16.17 $ 15.56 $ 15.17
- ------------------------------------------------------------------------------------------------------------------------------
DEGREE DAY DATA CG&E Heating
(30-year average - 5 248) 5 271 5 611 5 323 4 937 5 326
- ------------------------------------------------------------------------------------------------------------------------------
Cooling (30-year average - 996) 851 916 1 216 1 026 1 156
PSI Heating (30-year average - 5 609) 5 680 5 891 5 578 5 194 5 656
Cooling (30-year average - 1 014) 871 989 1 214 1 057 1 056
- ------------------------------------------------------------------------------------------------------------------------------
EMPLOYEE DATA Number of Employees (year-end) 7 609 7 973 8 602 8 868 9 227
- ------------------------------------------------------------------------------------------------------------------------------
GAS OPERATIONS
- ------------------------------------------------------------------------------------------------------------------------------
GAS REVENUES Residential $ 284 516 $ 272 303 $ 237 576 $ 242 415 $ 269 684
(thousands) Commercial 121 345 118 994 99 708 114 854 114 957
Industrial 31 168 30 409 28 979 43 490 47 403
Other 18 554 20 133 19 740 23 483 21 573
- ------------------------------------------------------------------------------------------------------------------------------
Total Sales 455 583 441 839 386 003 424 242 453 617
Gas Transported 32 456 27 679 20 934 13 496 11 331
- ------------------------------------------------------------------------------------------------------------------------------
Total Sales & Transported 488 039 469 518 406 937 437 738 464 948
Other Gas Revenues 3 106 4 516 3 915 4 660 4 348
- ------------------------------------------------------------------------------------------------------------------------------
Total Gas $ 491 145 $ 474 034 $ 410 852 $ 442 398 $ 469 296
- ------------------------------------------------------------------------------------------------------------------------------
GAS SALES Residential 41 846 44 721 43 153 39 065 43 514
(million cu. ft.) Commercial 19 141 21 199 19 664 20 070 20 370
Industrial 5 240 5 746 6 624 9 025 10 011
Other 3 162 3 947 4 584 4 803 4 303
- ------------------------------------------------------------------------------------------------------------------------------
Total Sales 69 389 75 613 74 025 72 963 78 198
Gas Transported 53 448 48 560 40 543 32 579 28 593
- ------------------------------------------------------------------------------------------------------------------------------
Total Sales & Transported 122 837 124 173 114 568 105 542 106 791
- ------------------------------------------------------------------------------------------------------------------------------
GAS CUSTOMERS Residential 407 128 397 660 389 165 379 953 373 494
(avg.) Commercial 41 915 41 499 40 897 40 545 40 348
Industrial 1 960 1 961 1 959 2 076 2 176
Other 1 505 1 518 1 558 1 520 1 472
- ------------------------------------------------------------------------------------------------------------------------------
Total 452 508 442 638 433 579 424 094 417 490
- ------------------------------------------------------------------------------------------------------------------------------
SYSTEM MAXIMUM DAY SENDOUT (million cu. ft.) 932 861 813 955 843
- ------------------------------------------------------------------------------------------------------------------------------
AVG. COST PER MCF PURCHASED (cents) 380.41 326.50 277.92 335.60 353.74
- ------------------------------------------------------------------------------------------------------------------------------
LOAD FACTOR - GAS 36.1% 39.5% 38.7% 30.3% 34.7%
- ------------------------------------------------------------------------------------------------------------------------------
</TABLE>
Certain amounts in prior years have been reclassified to conform to the 1997
presentation.
(a) Includes the write-off of a portion of Zimmer.
(b) Excludes amounts due within one year.
(c) Includes $.12 per share for the cost of reacquiring 90% of CG&E's
preferred stock through a tender offer.
(d) Includes $.69 per share for an extraordinary item (Midlands windfall
profits tax).
(e) Based on basic earnings per share.
A-51
<PAGE>
<TABLE>
<CAPTION>
ELECTRIC OPERATIONS 1997 1996 1995 1994 1993
- ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
ELECTRIC REVENUES (thousands) Residential $ 984 891 $ 996 959 $ 965 278 $ 898 763 $ 893 089
Commercial 688 301 673 181 661 496 626 333 608 407
Industrial 669 130 657 563 637 090 598 126 584 382
Other 111 867 110 003 118 458 96 247 68 364(a)
-----------------------------------------------------------------------------------------
Total Retail 2 454 189 2 437 706 2 382 322 2 219 469 2 154 242
Sales For Resale 1 369 021 296 600 197 943 194 734 177 754
Other 38 488 34 400 32 314 31 846 32 148
-----------------------------------------------------------------------------------------
Total Electric $3 861 698 $2 768 706 $2 612 579 $2 446 049 $2 364 144(a)
- ------------------------------------------------------------------------------------------------------------------------------
ELECTRIC SALES (million kwh) Residential 14 147 14 705 14 366 13 578 13 818
Commercial 11 993 11 802 11 648 11 167 10 963
Industrial 17 296 16 803 16 264 15 547 14 860
Other 1 825 1 811 1 795 1 723 1 732
-----------------------------------------------------------------------------------------
Total Retail 45 261 45 121 44 073 42 015 41 373
Sales For Resale 57 520 12 399 7 769 7 801 7 063
-----------------------------------------------------------------------------------------
Total Electric 102 781 57 520 51 842 49 816 48 436
- ------------------------------------------------------------------------------------------------------------------------------
ELECTRIC CUSTOMERS (avg.) Residential 1 236 974 1 215 782 1 195 323 1 174 705 1 160 513
Commercial 151 093 149 015 147 888 144 766 142 767
Industrial 6 472 6 470 6 424 6 345 6 263
Other 6 372 6 265 6 008 5 779 5 721
-----------------------------------------------------------------------------------------
Total 1 400 911 1 377 532 1 355 643 1 331 595 1 315 264
- ------------------------------------------------------------------------------------------------------------------------------
SYSTEM CAPABILITY - SUMMER (mw)(b) Consolidated 10 936 11 037 11 133 10 990 10 997
CG&E 5 075 5 175 5 271 5 271 5 271
PSI 5 861 5 862 5 862 5 719 5 726
- ------------------------------------------------------------------------------------------------------------------------------
SYSTEM PEAK LOAD (mw) CG&E 4 638 4 452 4 509 4 326 4 493
PSI 5 313 5 227 5 274 4 869 4 812
- ------------------------------------------------------------------------------------------------------------------------------
ANNUAL LOAD FACTOR - ELECTRIC CG&E 58.4% 60.5% 58.8% 58.7% 55.8%
PSI 59.2% 59.0% 57.4% 59.0% 58.0%
ELECTRICITY OUTPUT (million kwh) Generated - Net
CG&E 25 329 25 844 23 959 22 432 22 338
PSI 29 521 26 815 28 499 27 898 26 740
Purchased (c) 4 073 7 990 2 576 2 449 2 075
- ------------------------------------------------------------------------------------------------------------------------------
SOURCE OF ENERGY SUPPLY (%) Coal 90.74% 85.69% 93.93% 94.40% 95.15%
Hydro 0.72% 0.56% 0.66% 0.58% 0.60%
Oil & Gas 1.63% 0.58% 0.73% 0.38% 0.19%
Purchased 6.91% 13.17% 4.68% 4.64% 4.06%
- ------------------------------------------------------------------------------------------------------------------------------
FUEL COST Per Million Btu $ 1.25 $ 1.35 $ 1.37 $ 1.41 $ 1.50
- ------------------------------------------------------------------------------------------------------------------------------
HEAT RATE (Btu per kwh sendout) Consolidated 10 190 10 113 10 035 10 095 9 909
CG&E 9 984 9 816 9 832 9 853 9 801
PSI 10 369 10 403 10 207 10 292 10 232
- ------------------------------------------------------------------------------------------------------------------------------
</TABLE>
Certain amounts in prior years have been reclassified to conform to the 1997
presentation.
(a) 1993 reflects the refund of $31 million applicable to the IURC's April
1990 rate order.
(b) Includes amounts to be purchased, subject to availability, pursuant to
agreements with other utilities.
(c) Excludes purchases related to Cinergy's power marketing and trading
function.
A-52
<PAGE>
[LOGO]
PSI ENERGY, INC.
1000 East Main Street
Plainfield, Indiana 46168
