<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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(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.
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(4) Date Filed:
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<PAGE>
PSI Energy, Inc. 1999 Information Statement and
Cinergy Corp. 1998 Financial Report
Information Statement &
Financial Report
<PAGE>
TABLE OF CONTENTS
Notice of 1999 Annual Meeting 2
Information Statement 3
Election of Directors 4
Appendix: 1998 Financial Report A-1
Cautionary Statements Regarding
Forward-Looking Information A-1
Review of Financial Condition
and Results of Operations A-2
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-50
Report of Independent Public Accountants A-51
Five Year Statistical Summary A-53
NOTICE OF ANNUAL MEETING OF SHAREHOLDERS TO BE HELD ON APRIL 21, 1999
To the Shareholders of PSI Energy, Inc.:
NOTICE IS HEREBY GIVEN that the Annual Meeting of Shareholders of PSI
Energy, Inc. will be held at the Omni Netherland Plaza Hotel (in the meeting
rooms designated as Salons B and C), 35 West Fifth Street, Cincinnati, Ohio, on
Wednesday, April 21, 1999 at 10:00 a.m., eastern daylight saving time, for
purposes of the election of six directors and the transaction of 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 22,
1999, 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 22, 1999
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"), Cinergy Global Resources, Inc. ("Global Resources") 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 Cinergy and
certain of its subsidiaries, including the Company. Cinergy conducts its
international business through Global Resources and its subsidiaries, and its
non-regulated businesses through Investments and its subsidiaries.
This Information Statement is first being mailed on or about March 22, 1999
to the shareholders of the Company in connection with its Annual Meeting of
Shareholders to be held on April 21, 1999, 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, 1998, 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 beneficially owns all of the 53,913,701 outstanding shares of the
Company's class of common stock. There remain outstanding 957,672 shares of the
Company's class of cumulative preferred stock as of the close of business on
February 22, 1999 (the "Record Date"), which also have certain voting rights (as
set forth in the following section under the heading "Voting Securities").
Because Cinergy's beneficial ownership represents more than 98% of the total
votes that could be cast at the Annual Meeting, and because 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
Only holders of record of the Company's voting securities at the close of
business on 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 four 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 639,748 1 vote
par value $25 per share 317,924 1/4 vote
</TABLE>
SECURITY OWNERSHIP OF CERTAIN
BENEFICIAL OWNERS AND MANAGEMENT
The only person or group known to the Company to be the beneficial owner of more
than 5% of the Company's class of cumulative preferred stock as of December 31,
1998, is set forth in the following table. This information is based on the most
recently available report filed with the Securities and Exchange Commission (the
"SEC") pursuant to the requirements of Sections 13(d) or 13(g) of the Securities
Exchange Act of 1934, as amended (the
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<PAGE>
"1934 Act"), and transmitted to the Company by the person or group named.
<TABLE>
<CAPTION>
Amount and Nature
Name and Address of of Beneficial Percent
Beneficial Owner Ownership of Class
<S> <C> <C>
- -------------------------------------------------------------
Lehman Brothers Holdings 89,000 shares (1) 9.3%
Inc.
3 World Financial Center
New York, NY 10285
</TABLE>
(1) Beneficial ownership consists entirely of the Company's 6.875% Series of
Cumulative Preferred Stock. Holder reports having sole voting and
dispositive powers with respect to all shares, and shared voting and
dispositive powers with respect to none of these shares.
The Company's director-nominees and named executive officers (as 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, 1998. 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, 1998, is set forth in the following table.
<TABLE>
<CAPTION>
Amount and Nature
Name of Beneficial of Beneficial Ownership
Owner (1) (2) Units (3)
<S> <C> <C>
- ------------------------------------------------------------
James K. Baker 23,605 shares 5,901
Michael G. Browning 28,835 shares 9,495
William J. Grealis 109,649 shares
John A. Hillenbrand 33,472 shares
II 9,542
John M. Mutz 113,145 shares
Jackson H. Randolph 209,609 shares
James E. Rogers 398,526 shares
Larry E. Thomas 131,737 shares
All directors and 1,306,603 shares
executive officers
as a
group
</TABLE>
(1) Beneficial ownership of directors and executive officers as a group
represents 0.824% of the outstanding shares of Cinergy common stock;
individual beneficial ownership by any director, nominee or executive
officer does not exceed 0.252% 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-10,000;
Mr. Browning-22,787; Mr. Grealis-73,237; Mr. Hillenbrand-10,000; Mr.
Mutz-80,000; Mr. Randolph-91,258; Mr. Rogers-195,629; Mr. Thomas-62,516; and
all directors and executive officers as a group-635,919.
(3) Each unit represents one share of Cinergy common stock credited to the
account of the respective director as of December 31, 1998 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 six 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 1998 annual meeting. All of the proposed
director-nominees have signified their willingness to serve, if elected.
The Company would like to acknowledge Mr. Van P. Smith, who is retiring after
17 years of combined service as a member of the boards of directors of the
Company and Cinergy. His support, valued counsel and many contributions during
his years of devoted and distinguished service to the Company and Cinergy are
immeasurable and greatly appreciated.
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 because Cinergy's beneficial ownership of the Company's voting
securities represents over 98% of the total votes that could be cast at the
Annual Meeting, the election of the 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 67.
Mr. Baker served as Vice Chairman of Arvin Industries, Inc., a worldwide
supplier of automotive parts, from February 1996 until his retirement in April
1998. 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., Geon Company and Tokheim
Corporation.
MICHAEL G. BROWNING
DIRECTOR OF THE COMPANY SINCE 1990. DIRECTOR OF CINERGY SINCE 1994. AGE 52.
Mr. Browning is Chairman and President of Browning Investments, Inc., which
is engaged in real estate ventures. He also served as President of
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<PAGE>
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 67.
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 63.
Mr. Mutz has served as President of the Company since October 1994, and he
served as President of the Company's former parent, PSI Resources, Inc., from
October 1993 until October 1994. He 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 Commissioner of
Agriculture. Mr. Mutz is a director of Conseco, Inc. and 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 68.
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; he previously served as President and
Chief Executive Officer of CG&E and ULH&P. Mr. Randolph is a director of
Cincinnati Financial Corporation and PNC Bank Corp.
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 51.
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 also has
served as Chief Executive Officer and Director of Global Resources since May
1998. Mr. Rogers 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 through November
1995. He also served 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., the Company's
former parent, from October 1993 until October 1994; he previously served as
Chairman, President and Chief Executive Officer. Mr. Rogers is a director of
Duke Realty Investments, Inc., Fifth Third Bancorp and The Fifth Third Bank.
MEETINGS AND COMMITTEES OF THE BOARD
During the calendar year ended December 31, 1998, the Board held five 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 and Hillenbrand), is currently also a
non-employee director of Cinergy. Directors who are also employees of Cinergy or
any of its subsidiaries
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<PAGE>
(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 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 are
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 are paid to the director at the
time of retirement from the appropriate board.
Cinergy has maintained the Retirement Plan for Directors under which
non-employee directors of the Company, Cinergy, Services or CG&E have accrued
retirement benefits based upon their years of service. Prior service by
non-employee directors of the Company, PSI Resources, Inc. or CG&E also was
credited under this plan. Under the terms of this unfunded plan, non-employee
directors with five or more years of service have been entitled to receive
annual retirement compensation in an amount equal to the applicable board of
directors' annual retainer fee in effect at the time of termination of service
as a director, plus the product of the fee paid for attendance at a board
meeting multiplied by five, with the compensation paid for as many years as the
person served as a director.
In December 1998, Cinergy's board of directors adopted the Amended and
Restated Retirement Plan for Directors, thereby eliminating future benefit
accruals under the aforementioned Retirement Plan for Directors. Cinergy's board
also adopted the Directors' Equity Compensation Plan, a new equity-based
compensation plan for non-employee directors of Cinergy intended to supersede
the Retirement Plan for Directors on a going-forward basis.
The Amended and Restated Retirement Plan for Directors is an unfunded plan
under which each participant who retires as a director, or dies while serving as
a director, after January 1, 1999, has elected either to have his accrued
benefit converted to units representing shares of Cinergy common stock, or to
receive an annual cash payment equal to the fees in effect on December 31, 1998.
Each participant who retired prior to January 1, 1999 will receive an annual
cash payment equal to the fees in effect on the date preceding his or her
retirement as a director.
The Directors' Equity Compensation Plan is an unfunded plan under which each
non-employee director of Cinergy will receive, beginning December 31, 1999, an
annual award equivalent to 450 shares of Cinergy common stock. Directors of the
Company are not eligible to participate in this plan. Although the plan permits
the payment of cash awards at the discretion of Cinergy's board of directors,
Cinergy's board fully anticipates that all awards under the Directors' Equity
Compensation Plan will be paid in shares of Cinergy common stock.
Each of the Amended and Restated Retirement Plan for Directors and the
Directors' Equity Compensation Plan is subject to approval by Cinergy's
shareholders at their annual meeting to be held on April 21, 1999.
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. During
1998, the Committee was composed of Messrs. Van P. Smith (Chairman), Michael G.
Browning, George C. Juilfs, and John J. Schiff, Jr., each of whom was an
independent, "non-employee director" (of Cinergy) within the meaning of Rule
16b-3 under 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 was 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.
This compensation program 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
6
<PAGE>
annually, and any increases are based on such factors as competitive industry
salaries, corporate financial results, and a subjective assessment of 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. 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 motivating 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 has implemented an executive long-term
incentive compensation program (the "LTIP") within the parameters of Cinergy's
1996 Long-Term Incentive Compensation Plan (the "Umbrella Plan"). The LTIP
combines the interests of Cinergy's shareholders, customers, and management to
enhance corporate value. (Specifics of the program are discussed below under the
heading "Long-Term Incentive Compensation and Stock Options.")
The Committee also has two non-qualified deferred compensation plans for
executive officers of Cinergy and its subsidiaries, including the Company, as
follows: (i) Cinergy's Deferred Incentive Compensation Plan allows deferral of
receipt of all or a portion of cash awards otherwise payable under Cinergy's
Annual Incentive Plan; and (ii) Cinergy's Excess 401(k) Plan allows deferral of
receipt of a portion of 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 425 management employees, including all executive officers, are
eligible to participate in Cinergy's Annual Incentive Plan. The plan provides
for incentive cash awards or bonuses tied to the achievement of pre-determined
corporate and individual goals. For 1998, the corporate goal was based on
earnings per share. Achievement of the corporate goal for 1998 and achievement
of individual goals each accounted for 50% of the total possible award.
For 1998, 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.
Although the corporate goal was not achieved for 1998, the Committee, in the
exercise of its discretion reserved under the plan, determined that awarding a
partial payout for corporate performance was appropriate. Upon reviewing
Cinergy's significant progress toward achieving its strategic mission (I.E., to
be one of the top five energy companies in five years in five key areas--market
capitalization, number of customers, electric and gas commodity trading,
international presence, and productivity) in 1998, the Committee determined that
the employees of Cinergy and its subsidiaries--both management and
non-management--should be rewarded for their commitment, dedication and
achievements. The Committee recognizes that Cinergy's mission is most
challenging in light of the numerous uncertainties facing the company and the
industry in this era of change.
Accomplishments in 1998 that were considered by the Committee included:
- A 10.3% return on equity;
- A 21.2% increase in total electric kwh sales over 1997 reflecting an
increase in energy marketing and trading volumes;
- Investments of more than $110 million in international markets;
- Sale of Cinergy's interest in Edesur SA, an electric distribution network
in Argentina;
- The agreement by Midlands Electricity, Cinergy's 50%-owned regional
electric distribution company located in England, to sell its supply
business to National Power plc;
- The acquisition of Producers Energy Marketing LLC, a major gas marketing
firm, thus adding physical gas supply and trading to Cinergy's commodity
portfolio;
- Agreements between Trigen-Cinergy Solutions and seven major corporations
and/or governmental entities for the supply of energy-related systems and
services;
- The implementation of electricity futures trading on the New York
Mercantile Exchange, with Cinergy as one of only four delivery points in
the United States;
- The SEC's approval of the retention of CG&E's natural gas business; and
7
<PAGE>
- Continued progress with respect to corporate cost reduction efforts.
For 1998, 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 ranged
from 2.75 to 3.0 on a scale ranging from 1.0 to 3.0. Individual performance
goals varied for each executive officer; however, all related to the achievement
of Cinergy's overall strategic vision of becoming a premier energy services
company.
For 1999, the Annual Incentive Plan corporate goal will again be based on
earnings per share. For all employees except business unit presidents, the
corporate goal will account for 40% of the total possible award and achievement
of individual key performance indicators will account for the remaining 60%. For
business unit presidents, 40% of the total possible award will be based on the
corporate goal, 10% will be based on business unit earnings per share targets,
and the remaining 50% will be based on individual key performance indicators.
LONG-TERM INCENTIVE COMPENSATION AND STOCK OPTIONS
The LTIP ties a significant portion of the participants' pay to long-term
corporate performance, provides a greater upside potential for outperforming
peer companies as well as downside risk for underperforming, focuses on creating
shareholder value through increasing total shareholder return, and provides a
significant portion of total compensation opportunity through the use of Cinergy
common stock to create an ownership mindset. Approximately 85 management
employees, including all executive officers except the chairman of the board,
are eligible for participation in the LTIP.
The LTIP consists of two elements: (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,
which commenced effective January 1, 1997, and continue effective each January 1
thereafter. 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
stock options vest three years from the date of grant. Information with respect
to stock options granted during 1998 to the named executive officers is set
forth in the Summary Compensation Table and the Option/SAR Grants Table.
The second portion of the LTIP consists of the Value Creation Plan. The Value
Creation Plan consists of a target 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.
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 earn some of the target
restricted shares or 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 following the end of a
performance cycle to receive any earned award. The earned target restricted
shares become unrestricted (or vested) as soon as practicable after the end of a
performance cycle, but no later than April 1 following the end of a performance
cycle. The earned performance shares
8
<PAGE>
(based on the added incremental value created during the cycle), if any, will be
paid in two equal, annual installments. One-half will be paid as soon as
practicable after the first anniversary date (I.E., January 1, 2001 with respect
to the performance cycle ending December 31, 1999), but no later than three
months subsequent to that anniversary date, following the end of a performance
cycle. The remaining half will be paid as soon as practicable after the second
anniversary date (I.E., January 1, 2002 with respect to the performance cycle
ending December 31, 1999), but no later than three months subsequent to that
anniversary date, following the end of a performance cycle.
Because grants under the Value Creation Plan are made at the beginning of the
three-year performance cycle, there were no grants made during 1998 to any of
the named executive officers.
CHIEF EXECUTIVE OFFICER
Mr. Rogers' 1998 base salary was determined by the Committee after giving
consideration to his employment agreement with Cinergy (see "Employment
Agreements and Severance Arrangements" on page 13), competitive salaries of
chief executive officers of both peer companies and general industry, and a
subjective assessment of his performance. For 1998, Mr. Rogers was awarded
incentive compensation under the Annual Incentive Plan in the amount of
$619,200. This was based, in part, upon the Committee's determination that a
partial payment under the plan was appropriate, even though the corporate target
goal was not achieved, and upon the Committee's determination of Mr. Rogers'
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, 1998, the Committee granted Mr. Rogers an option to
purchase 55,400 shares of Cinergy common stock, at the fair market value of
$38.59375 per share, as the second annual option grant under the first
performance period of the LTIP. Effective March 24, 1998, the Committee granted
Mr. Rogers an option to purchase 480,000 shares of Cinergy common stock, at the
fair market value of $36.875 per share, under the Stock Option Plan. The
Committee believed that the March 1998 grant signified Mr. Rogers' importance to
the current and future success of Cinergy and further demonstrated its support
and commitment to him. Information with respect to these grants is set forth in
the Summary Compensation Table and the Option/SAR Grants Table.
In September 1998, the Committee approved an amended and restated employment
agreement for Mr. Rogers, which incorporated previous amendments made to his
agreement and the substantive terms of his prior severance agreement. The
substantive terms of the restated employment agreement are discussed under
"Employment Agreements and Severance Arrangements."
CODE SECTION 162(M)
Code Section 162(m) generally limits the annual tax deduction to one million
dollars for compensation paid to each of the named executive officers. However,
the statute exempts qualifying performance-based compensation from the deduction
limit if certain conditions are met. The Committee currently intends under most
circumstances to structure performance-based compensation, including stock
option grants and restricted stock grants under the LTIP and a significant
portion of the award opportunity under the Annual Incentive Plan, to executive
officers who may be subject to Code Section 162(m) in a manner that satisfies
those requirements.
However, for 1998 the Committee exercised its discretion (as discussed above)
to permit a payout for the corporate goal portion of the Annual Incentive Plan
even though the minimum earnings per share goal was not achieved. The Committee
realizes that its action affects the tax deductibility of a part of Mr. Rogers'
compensation under Code Section 162(m).
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 other four most highly compensated executive officers (these
five executive officers are sometimes collectively referred to as the "named
executive officers") for services to Cinergy and its subsidiaries, including the
Company, during the calendar years ended December 31, 1998, 1997, and 1996.
<TABLE>
<CAPTION>
Long-Term Compensation
---------------------------------------
Annual Compensation
Awards Payouts
<S> <C> <C> <C> <C> <C> <C> <C>
----------------------------------- ---------------------------------------
(a) (b) (c) (d) (e) (f) (g) (h)
<CAPTION>
Other
Annual Restricted Securities
Compen- Stock Underlying LTIP
Name and Salary Bonus (1) sation Awards (2) Options/SARs Payouts (3)
Principal Position Year ($) ($) ($) ($) (#) ($)
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
James E. Rogers 1998 810,000 619,200 47,041 0 535,400 0
Vice Chairman and 1997 700,008 337,504 17,039 1,951,169 55,400 0
Chief Executive Officer 1996 625,000 607,518 3,697 0 0 849,750
Jackson H. Randolph 1998 585,000 321,750 13,405 0 0 0
Chairman of the Board 1997 585,000 321,750 14,575 0 0 0
1996 535,000 321,750 10,675 0 0 675,212
John M. Mutz 1998 415,188 199,290 5,574 0 21,700 0
President 1997 395,412 118,624 3,763 761,985 21,700 0
1996 376,584 150,634 2,431 0 0 339,108
William J. Grealis 1998 396,900 180,590 25,643 0 20,700 0
Vice President 1997 378,000 113,400 13,094 728,443 20,700 0
1996 343,200 205,920 8,828 0 0 246,048
Larry E. Thomas 1998 352,848 169,367 9,678 0 18,400 0
Vice President 1997 336,048 100,814 11,502 647,575 18,400 0
1996 294,350 176,610 5,030 0 0 252,285
<CAPTION>
<S> <C>
(a) (i)
All
Other
Compen-
Name and sation (4)
Principal Position ($)
- -------------------------------
<S> <C>
James E. Rogers 138,329
Vice Chairman and 126,956
Chief Executive Officer 108,108
Jackson H. Randolph 98,157
Chairman of the Board 88,181
120,512
John M. Mutz 23,611
President 22,162
14,993
William J. Grealis 34,313
Vice President 15,550
35,611
Larry E. Thomas 16,594
Vice President 15,809
36,162
</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 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, 1998, determined by multiplying the
number of shares by the year end closing market price, are as follows: Mr.
Rogers--58,462 shares ($2,009,631); Mr. Mutz--22,831 shares ($784,816); Mr.
Grealis-- 21,826 shares ($750,269); and Mr. Thomas--19,403 shares
($666,978). Dividends are 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 during the 1994-1997 and 1996-1999
performance cycles that were ended during 1996 in transition to the
Valuation Creation Plan.
(4) Amounts appearing in this column for 1998 include for Messrs. Rogers,
Randolph, Mutz, Grealis and Thomas, respectively: (i) employer matching
contributions under 401(k) plan and related excess benefit plan of $24,300,
$17,550, $12,456, $11,907 and $10,585; and (ii) insurance premiums paid with
respect to executive/group-term life insurance of $245, $752, $11,155,
$22,406 and $6,009. 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 $48,955 and $63,447, and benefits under split dollar life
insurance agreements of $14,829 and $16,408.
10
<PAGE>
OPTION/SAR GRANTS TABLE
The following table sets forth information concerning individual grants of
options to purchase the Company's common stock made to the named executive
officers during 1998.
<TABLE>
<CAPTION>
Potential Realizable
Value at Assumed
Annual Rates of Stock
Price Appreciation for
Individual Grants Option Term
- ------------------------------------------------------------------------------------- ------------------------
(a) (b) (c) (d) (e) (f) (g)
Number of % of
Securities Total
Underlying Options/SARs Exercise
Options/SARs Granted to or Base
Granted Employees in Price Expiration 5% 10%
Name (#) Fiscal Year ($/Sh) Date ($) ($)
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
James E. Rogers 55,400 5.82% 38.59375 1/1/2008 1,344,558 3,407,654
480,000 50.45% 36.875 3/24/2008 11,424,000 28,675,200
John M. Mutz 21,700 2.28% 38.59375 1/1/2008 526,659 1,334,767
William J. Grealis 20,700 2.18% 38.59375 1/1/2008 502,389 1,273,257
Larry E. Thomas 18,400 1.93% 38.59375 1/1/2008 446,568 1,131,784
</TABLE>
AGGREGATED OPTION/SAR EXERCISES AND YEAR END OPTION/SAR VALUES TABLE
The following table sets forth information concerning: (i) stock options
exercised by the named executive officers during 1998, including the value
realized (I.E., the spread between the exercise price and market price on the
date of exercise); and (ii) the numbers of shares for which options were held as
of December 31, 1998, including the value of "in-the-money" options (I.E., the
positive spread between the exercise prices of outstanding stock options and the
closing market price of Cinergy common stock on December 31, 1998, which was
$34.375 per share).
<TABLE>
<CAPTION>
(d)
Number of (e)
Securities Value of
Underlying Unexercised
Unexercised In-The-Money
Options/SARs at Options/SARs at
Year End Year End
(b) (c) (#) ($)
Shares Acquired Value ------------------ -----------------
(a) on Exercise Realized Exercisable/ Exercisable/
Name (#) ($) Unexercisable Unexercisable
<S> <C> <C> <C> <C>
- ----------------------------------------------------------------------------------------------------------------
James E. Rogers 0 N/A 195,629/640,800 2,249,734/623,475
Jackson H. Randolph 8,742 102,992 91,258/50,000 1,049,467/575,000
John M. Mutz 12,787 225,356 82,660/60,740 922,328/246,660
William J. Grealis 2,650 28,156 73,237/61,400 736,947/219,363
Larry E. Thomas 31,588 478,800 62,516/56,800 718,934/246,100
</TABLE>
11
<PAGE>
PENSION BENEFITS
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. Pension benefits
previously earned under the terms of the former CG&E and PSI pension plans are
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 plan participation
through 35 years, plus 1.4% of final average pay times the number of years of
plan participation over 35 years. Final average pay is the average annual
salary, based upon retirement 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 Internal
Revenue Service annually establishes a dollar limit, indexed to inflation, of
the amount of pay permitted for consideration under the terms of such plans,
which for 1998 was $160,000.
The Cinergy Excess Pension 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 Pension 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 is based upon credited service of 40 years and 4 years, respectively.
The estimated credited years of service at age 62 for each of the remaining
named executive officers are as follows: Mr. Rogers, 20 years; Mr. Grealis, 12
years; and Mr. Thomas, 37 years.
Effective January 1, 1999, the Cinergy Supplemental Retirement Plan was
amended, restated and renamed the Cinergy Supplemental Executive Retirement Plan
(the "SERP"). One part of the SERP, the "Mid-career Benefit," is designed to
provide coverage to executives who will not qualify for full retirement benefits
under the Cinergy Pension Plan. For retirement on or after age 62, the
Mid-career Benefit is an amount equal to that which a covered employee with 35
years of participation would have received under the Cinergy Pension Plan and
the Cinergy Excess Pension Plan, reduced by the actual benefit provided by these
plans, and further reduced by 50% of the employee's age 62 social security
benefit. Messrs. Rogers, Mutz and Grealis are covered under the terms of the
Mid-career Benefit portion of the SERP.
The second part of the SERP, the "Senior Executive Supplement," is designed
to provide selected senior officers of Cinergy and its subsidiaries, including
the Company, an opportunity to earn a retirement benefit that will replace 60%
of their final pay. Each participant accrues a retirement income replacement
percentage at the rate of 4% per year from date of hire (maximum of 15 years).
The Senior Executive Supplement is an amount equal to a maximum of
<TABLE>
<CAPTION>
Years of Service
- ----------------------------------------------------------------------------------------------------------------
Compensation 5 10 15 20 25 30 35 40
<S> <C> <C> <C> <C> <C> <C> <C> <C>
- ----------------------------------------------------------------------------------------------------------------
$ 500,000 $ 39,045 $ 78,085 $ 117,130 $ 156,170 $ 195,215 $ 234,255 $ 273,300 $ 312,340
600,000 47,045 94,085 141,130 188,170 235,215 282,255 329,300 376,340
700,000 55,045 110,085 165,130 220,170 275,215 330,255 385,300 440,340
800,000 63,045 126,085 189,130 252,170 315,215 378,255 441,300 504,340
900,000 71,045 142,085 213,130 284,170 355,215 426,255 497,300 568,340
1,000,000 79,045 158,085 237,130 316,170 395,215 474,255 553,300 632,340
1,100,000 87,045 174,085 261,130 348,170 435,215 522,255 609,300 696,340
1,200,000 95,045 190,085 285,130 380,170 475,215 570,255 665,300 760,340
1,300,000 103,045 206,085 309,130 412,170 515,215 618,255 721,300 824,340
1,400,000 111,045 222,085 333,130 444,170 555,215 666,255 777,300 888,340
1,500,000 119,045 238,085 357,130 476,170 595,215 714,255 833,300 952,340
1,600,000 127,045 254,085 381,130 508,170 635,215 762,255 889,300 1,016,340
1,700,000 135,045 270,085 405,130 540,170 675,215 810,255 945,300 1,080,340
1,800,000 143,045 286,085 429,130 572,170 715,215 858,255 1,001,300 1,144,340
</TABLE>
12
<PAGE>
60% of the employee's final average pay (as defined in the Cinergy Pension Plan)
or the final 12 months of base pay and Annual Incentive Plan pay, reduced by the
actual benefits provided under the Cinergy Pension Plan, the Cinergy Excess
Pension Plan and the Mid-career Benefit, and further reduced by 50% of the
employee's estimated age 62 social security benefit. Messrs. Rogers, Mutz,
Grealis and Thomas are covered under the terms of the Senior Executive
Supplement, and the estimated retirement income replacement percentage for each
is 60%, 20%, 48% and 60%, respectively.
Moreover, Mr. Randolph has a Supplemental Executive Retirement Income
Agreement under which he or his beneficiary will receive an annual supplemental
retirement benefit of $511,654, in monthly installments of $42,638 for 180
months beginning December 1, 2000.
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 50 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 of $15,000 per year.
EMPLOYMENT AGREEMENTS AND
SEVERANCE ARRANGEMENTS
Mr. Rogers has an employment agreement which was effective October 24, 1994, and
was amended and restated in its entirety effective September 22, 1998. Pursuant
to the terms of his agreement, 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 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 term of his agreement, Mr. Rogers receives a
minimum annual base salary of $810,000. Under the terms of his employment
agreement, Mr. Rogers was credited with 25 years of participation in the
Mid-career Benefit portion of the SERP as of his 50(th) birthday. He has been or
will be credited with an additional two years of participation on each birthday
through his 55(th), provided that he is employed by Cinergy as of each birthday.
Mr. Rogers' employment agreement also provides that if he retires on or after
age 55 he will be entitled to receive annual retirement income for his lifetime
equal to the greater of 60% of his final average pay, or 60% of his base pay and
Annual Incentive Plan pay for the final 12 months immediately preceding his
retirement.
Mr. Randolph has an employment agreement which commenced on October 24, 1994.
Pursuant to the terms of his 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, the expiration date
of his agreement. During the term of his agreement, Mr. Randolph receives a
minimum annual base salary of $465,000.
If the employment of Messrs. Rogers or Randolph (each sometimes individually
referred to as the "executive") is terminated 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. Mr. Rogers'
beneficiary will also receive an amount equal to his vested accrued benefit
under the Value Creation Plan. 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 Executive Supplemental Life Insurance
Program (and also including the Value Creation Plan in the case of Mr. Rogers),
(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, and
was amended most recently effective as of December 31, 1998.
13
<PAGE>
Pursuant to the terms of his agreement, Mr. Mutz serves as President, and is
nominated for election as a director, of the Company until May 31, 1999, the
expiration date of his agreement. During the term of his agreement, Mr. Mutz
receives a minimum annual base salary of $330,000. Under his employment
agreement, Mr. Mutz is fully vested in the Mid-career Benefit portion of the
SERP, without offset for prior employers' 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. Mr. Mutz's employment agreement
further provides that in connection with the Senior Executive Supplement portion
of the SERP, Mr. Mutz will be credited with a pay replacement percentage of 60%
as of his retirement date.
Mr. Grealis has an employment agreement which commenced on January 16, 1995,
and currently is automatically extended for an additional year on each January
1, unless either Cinergy or Mr. Grealis gives timely notice otherwise. During
the term of his agreement, Mr. Grealis receives a minimum annual base salary of
$288,000. Under his employment agreement, Mr. Grealis will receive annual
retirement income of no less than $283,000 payable as a straight-life annuity at
age 62.
Mr. Thomas has an employment agreement which currently is automatically
extended for an additional year on each January 1, unless either Cinergy or Mr.
Thomas gives timely notice otherwise. During the term of his agreement, Mr.
Thomas receives a minimum annual base salary of $240,000. Under his employment
agreement, if Mr. Thomas retires on or after age 55 he will be entitled to
receive annual retirement income equal to that which a covered employee with 35
years of participation would have received under Cinergy's Pension Plan and its
Excess Pension Plan.
If the employment of Messrs. Mutz, Grealis or Thomas (each sometimes
individually referred to as the "officer") is terminated as a result of 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 the Value Creation Plan (and also including the
Cinergy Pension Plan, Excess Pension Plan, and Mid-career Benefit portion of the
SERP 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
the Value Creation Plan and Executive Supplemental Life Insurance Program (and
also including the Cinergy Pension Plan, Excess Pension Plan, and Mid-career
Benefit portion of the SERP 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. In addition to the above, under Mr. Mutz's
employment agreement Cinergy has waived its right to challenge Mr. Mutz in the
event he elects to terminate his employment agreement for good reason.
Each of the named executive officers participates in Cinergy's Annual
Incentive Plan, Stock Option Plan, LTIP, Excess Pension Plan, SERP, and
Executive Supplemental Life Insurance Program (with the exception of Mr.
Randolph, who does not participate in the LTIP or SERP), participates in all
other retirement and welfare benefit plans applicable generally to Cinergy
employees and executives, and receives other fringe benefits.
If the employment of any named executive 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. In
addition to the above, Messrs. Rogers and Randolph will receive their benefits
under their deferred compensation agreements (discussed below) and split dollar
life insurance agreements.
14
<PAGE>
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 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 1998. On January 21, 1999,
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 1999. 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 AND BUSINESS BY SHAREHOLDERS
In order to be considered for inclusion in the Company's information statement
for the 2000 annual meeting of shareholders, proposals from shareholders must be
received by November 23, 1999. In addition, in order for a shareholder properly
to introduce business for action by shareholders at the Company's 2000 annual
meeting (other than business specified in the Notice of the meeting), the
Company must be given written notice, which complies with all requirements of
the Company's By-Laws, no earlier than February 7, 2000 and no later than March
2, 2000. Any proposal or notice should be directed to the Secretary of the
Company at 1000 East Main Street, Plainfield, Indiana 46168.
By Order of the Board of Directors,
Cheryl M. Foley
Vice President, General Counsel and Secretary
Dated: March 22, 1999
15
<PAGE>
APPENDIX: 1998 FINANCIAL REPORT
TABLE OF CONTENTS
<TABLE>
<S> <C>
Cautionary Statements Regarding
Forward-Looking Information A-1
Review of Financial Condition
and Results of Operations A-2
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-50
Report of Independent Public Accountants A-51
Five Year Statistical Summary A-53
</TABLE>
CAUTIONARY STATEMENTS
REGARDING FORWARD-LOOKING INFORMATION
Matters discussed in this report reflect and elucidate management'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. Forward-looking statements involve risks
and uncertainties which may cause actual results to differ materially from the
forward-looking statements. 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 affecting operations such as unusual weather conditions;
catastrophic weather-related damage; unscheduled generation outages; unusual
maintenance or repairs; unanticipated changes to fossil fuel costs, gas supply
costs, or availability constraints due to higher demand, shortages,
transportation problems or other developments; environmental incidents; or
electric transmission or gas pipeline system constraints.
- Legislative and regulatory initiatives regarding deregulation and
restructuring of the industry.
- The extent and timing of the entry of additional competition in electric or
gas markets and the effects of continued industry consolidation through the
pursuit of mergers, acquisitions, and strategic alliances.
- Challenges related to Year 2000 readiness, including success in
implementing the Cinergy Year 2000 Readiness Program, the effectiveness of the
Cinergy Year 2000 Readiness Program, and the Year 2000 readiness of outside
entities.
- Regulatory factors such as unanticipated changes in rate-setting policies
or procedures, recovery of investments made under traditional regulation, and
the frequency and timing of rate increases.
- Financial or regulatory accounting principles or policies imposed by the
Financial Accounting Standards Board ("FASB"), the Securities and Exchange
Commission ("SEC"), the Federal Energy Regulatory Commission ("FERC"), state
public utility commissions, state entities which regulate natural gas
transmission, gathering and processing, and similar entities with regulatory
oversight.
- Political, legal, and economic conditions and developments in the United
States ("US") and the foreign countries in which Cinergy Corp. ("Cinergy" or
"Company") or its subsidiaries or affiliates operate, including inflation rates
and monetary fluctuations.
- Changing market conditions and a variety of other factors associated with
physical energy and financial trading activities including, but not limited to,
price, basis, credit, liquidity, volatility, capacity, transmission, currency
exchange, interest rate, and warranty risks.
- The performance of projects undertaken by the non-traditional business and
the success of efforts to invest in and develop new opportunities.
- Availability or cost of capital, resulting from changes in: Cinergy and its
subsidiaries, interest rates, and securities ratings or market perceptions of
the utility industry and energy-related industries.
- Employee workforce factors, including changes in key executives, collective
bargaining agreements with union employees, or work stoppages.
- Legal and regulatory delays and other obstacles associated with mergers,
acquisitions, and investments in joint ventures.
- Costs and other effects of legal and administrative proceedings,
settlements, investigations, claims, and other matters, including, but not
limited to, those described in Note 12 of the Notes to Consolidated Financial
Statements.
- Changes in international, federal, state, or local legislative
requirements, such as changes in tax laws or rates; environmental laws and
regulations.
Cinergy undertakes no obligation to publicly update or revise any
forward-looking statements, whether as a result of changes in actual results,
changes in assumptions, or other factors affecting such statements.
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<PAGE>
REVIEW OF FINANCIAL
CONDITION AND RESULTS OF
OPERATIONS
THE COMPANY
Cinergy, a Delaware corporation, is a registered holding company under the
Public Utility Holding Company Act of 1935 ("PUHCA"). Cinergy was created in the
October 1994 merger of The Cincinnati Gas & Electric Company ("CG&E") and PSI
Resources, Inc. Cinergy is the parent holding company of PSI Energy, Inc.
("PSI"), CG&E, Cinergy Investments, Inc. ("Investments"), Cinergy Global
Resources, Inc. ("Global Resources"), and Cinergy Services, Inc. ("Services").
PSI is a public utility primarily engaged in providing electric service in north
central, central, and southern Indiana. CG&E is a public utility primarily
engaged in providing electric and gas service in the southwestern portion of
Ohio and through its subsidiaries in adjacent areas in Kentucky and Indiana.
CG&E's principal subsidiary, The Union Light, Heat and Power Company ("ULH&P"),
is an operating utility primarily engaged in providing electric and gas service
in northern Kentucky. Investments holds virtually all of Cinergy's domestic
non-utility businesses and interests. Global Resources, formed in 1998, holds
Cinergy's international businesses and certain other interests. Services
provides Cinergy companies with a variety of administrative, management, and
support services.
Cinergy conducts its operations through various subsidiaries and affiliates.
The Company is functionally organized into four business units through which
many of its activities are conducted: Energy Commodities Business Unit ("ECBU"),
Energy Delivery Business Unit ("EDBU"), Energy Services Business Unit ("ESBU"),
and the International Business Unit ("IBU"). The traditional,
vertically-integrated utility functions have been realigned into the ECBU, EDBU,
and ESBU. As the industry continues its evolution, Cinergy will continually
analyze its operating structure and make adjustments as appropriate. In early
1999, certain organizational changes were begun to further align the business
units to reflect Cinergy's strategic vision. Reference is made to Note 15 of the
Notes to Consolidated Financial Statements for a discussion on financial
information by business unit as of December 31, 1998.
FINANCIAL CONDITION
COMPETITIVE PRESSURES
ELECTRIC UTILITY INDUSTRY
INTRODUCTION The electric utility industry is continuing to transition from a
monopoly cost-of-service regulated environment to an industry in which companies
will ultimately compete to be the retail customers' energy provider. This
transition will continue to impact the operations, structure, and profitability
of Cinergy.
Energy companies are positioning themselves for full competition through the
pursuit of mergers and acquisitions, strategic alliances, and the development of
energy products and services. Cinergy's success in this transition is in large
part dependent on legislative and regulatory outcomes with respect to
electricity deregulation in its three franchise states: Ohio, Indiana, and
Kentucky, as well as other regions in the US where Cinergy chooses to compete in
the retail and wholesale markets.
RESTRUCTURING PROCESS
WHOLESALE MARKETS The wholesale electric markets have been open to
competition since 1996 when the FERC issued Orders 888 and 889. These rules
provided for mandatory filing of open access/comparability transmission tariffs,
functional unbundling of all services, utilities' use of these filed tariffs for
their own bulk power transactions, establishment of an electronic bulletin board
for transmission availability and pricing information, and establishment of a
contract-based approach to recover stranded investments as a result of customer
choice at the wholesale level.
Competitors within the wholesale market include traditional utilities and
non-utility competitors such as exempt wholesale generators ("EWGs"),
independent power producers, and power marketers. Cinergy, through its ECBU, is
involved in wholesale power marketing and trading.
During late June 1998, Midwestern wholesale electric power markets
experienced unprecedented price volatility due to several factors, including
unseasonably hot weather, unplanned generating unit outages, transmission
constraints, and defaults by certain power marketers on their supply
obligations. The simultaneous occurrence of these events resulted in temporary
but extreme price spikes in the Midwestern electricity markets. During this
period, Cinergy's subsidiaries met both their statutory obligation to serve
retail franchise customers and contractual obligations with wholesale customers.
Since the events of June 1998, the Midwestern markets have continued to
experience price volatility and illiquidity. For further discussion, see the
"Market Risk Sensitive Instruments and Positions" section herein.
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REVIEW OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
During 1998, the New York Mercantile Exchange ("NYMEX") began trading
contracts with delivery points located in the Midwest and Southern regions of
the country. Cinergy's transmission system is the delivery point for the Midwest
region and one of only four NYMEX delivery points in the US.
RETAIL MARKETS Regulation and the transition to competition at the retail
(i.e., end-user) level currently remains under the jurisdiction of individual
states. (See State Developments for a discussion on the current status of
customer choice in each of Cinergy's franchise states.) In most states where
restructuring legislation has been enacted, all customers have been given the
right to choose an electricity supplier. The incumbent utility has retained the
right and obligation to provide the distribution and transmission of
electricity, which continues to remain a regulated service. Significant issues
facing state legislators, regulators, and incumbent franchise utilities in the
restructuring to a competitive retail market include:
- The responsibility for unrecovered costs of the utilities in excess of the
amounts which would be recovered under competitive market prices and the
mechanism to recover these costs.
- The period allowed for transition to full competition.
- The extent to which incumbent utilities continue to have the obligation to
serve during the transition period, or in the alternative, the extent to which
competitive bidding for existing franchise customers is required or allowed.
- Default supplier responsibility following the transition period and the
compensation for the associated risk.
- The extent to which utilities are granted the flexibility to position
themselves for competition during the transition period, including the right to
sell assets and retain the proceeds from such sales.
- Resolution of potential market power issues either through forced
divestiture of generation and/or participation in a regional transmission
organization.
- The need for a power exchange or similar mechanism to establish a market
clearing price.
- Codes of conduct regarding the separation of the monopoly and non-monopoly
functions of a utility and the treatment of affiliate transactions.
- Restructuring of state tax laws applicable to utilities necessitated by the
disproportionate allocation of state tax liability to public utilities.
The anticipated restructuring of retail electric markets will create risks as
well as opportunities for utilities, e.g., the risks and opportunities arising
from the termination of the regulated Fuel Adjustment Clause, which provides
protection against escalation in fuel and purchased power costs. Additionally, a
number of implementation issues, including enhancements or replacements to
existing customer information and billing systems, will be required. Cinergy
will continue to focus on reducing costs and maintaining its status as a
low-cost provider of electricity as well as identifying and addressing the
likely implementation issues associated with retail customer choice.
Additionally, Cinergy will continue to execute its strategy of developing and
offering a portfolio of energy products and services for the retail market.
Cinergy continues to be an advocate of competition in retail electricity
markets and continues to pursue customer-choice legislation at both the state
and federal levels. Cinergy believes that the transition to competition can best
meet the interests of all stakeholders where the rules are prescribed to the
fullest extent possible in legislation that embodies the following:
- Price freezes that provide an opportunity for the utility to recover its
transition costs and provide immediate flexibility for the utility to
restructure its portfolio of supply assets in preparation for competition,
keeping any proceeds from the sale or other disposition of assets to offset
transition costs.
- A transition period with choice immediately available to all. During this
period customers can adapt to the rights and responsibilities associated with
choosing an alternative electricity supplier.
- Mitigation of market power issues through participation in a large,
regional transmission organization.
- Adequate recovery of regulatory assets.
STATE DEVELOPMENTS At present, a number of states have enacted legislation that
will lead to complete retail electric competition over the next several years.
These states generally have required up-front rate reductions and the
opportunity for all customer classes to choose an electricity provider in return
for recovery of utility stranded costs, including the ability to securitize
revenue streams associated with such stranded costs.
Every state that has passed legislation has included a mechanism for the
recovery of some stranded investment. However, states have varied on the
methodology to be applied in determining the level of stranded investment, with
divestiture of generating assets being one such method.
As discussed below, the three states in which Cinergy operates electric
utilities are in various stages of addressing customer choice. None of these
states has yet passed legislation, but policymakers and stakeholders continue to
work to resolve the issues.
INDIANA Customer-choice legislation was introduced in the Indiana General
Assembly in 1998 by a coalition of customer organizations and two investor-owned
utilities ("IOUs"), including Cinergy. After hearing and consideration by a
Senate committee, the bill was defeated in the full Senate.
A-3
<PAGE>
Legislation proposed by a group of large industrial customers was introduced
in January 1999. At present, Cinergy continues to work with IOUs in Indiana and
other stakeholders to develop customer-choice legislation that can be enacted
into law in Indiana. The outcome of this effort is uncertain.
OHIO Electric restructuring legislation was introduced in the Ohio
legislature during 1998. This legislation, "companion" electric restructuring
bills (SB 237 and HB 732), proposed to afford choice to all retail electric
customers in Ohio beginning January 1, 2000. Neither bill was passed during the
1998 legislative session.
During the third quarter of 1998, Ohio's IOUs, including CG&E, released a
draft bill that sets forth the utilities' proposed approach to comprehensive
electric restructuring in Ohio. Under the IOUs' proposal, choice to all retail
electric customers would be introduced by January 1, 2001. Rates would be frozen
during a transition period, a fixed charge for certain transition costs would
continue after the freeze period for a set time, and customers would be provided
a market-based "shopping credit" to stimulate the development of a competitive
market. The proposal also included a restructuring of the tax laws with respect
to electric utilities. In January 1999, a "place holder" bill was introduced in
both the House and Senate. These bills set forth a legislative intent to develop
comprehensive electric restructuring legislation in Ohio during 1999. Key
policymakers in the state continue to meet with the IOUs and other stakeholders
to see whether compromise legislation can be developed. It is uncertain whether
this effort will produce legislation in Ohio in 1999.
KENTUCKY House Joint Resolution 95, which required the formation of an
executive task force comprised of members from the Governor's office and the
Kentucky General Assembly to further study electric restructuring, was passed by
the Kentucky General Assembly and signed by the Governor in April 1998. Task
force members will study electric restructuring in anticipation of the next
legislative session, which occurs in January 2000.
UNITED KINGDOM Transition to full competition in the United Kingdom's ("UK")
electric utility industry began with the industry's privatization in 1991. As a
result of the transition plan, larger users of electricity have been free to
choose their supplier since as early as 1991. In September 1998, a phase-in of
choice for all remaining customers commenced and is to be completed by March
1999. The power suppliers sell power into a "pool" from which Regional Electric
Companies ("RECs") purchase power for their customers through the supply segment
of their business. Midlands Electricity plc ("Midlands") is one of twelve RECs
in the UK. In November 1998, Midlands entered into an agreement to sell its
power supply business to one of the UK's primary power generation companies. The
sale is contingent upon UK government and regulatory approvals. Midlands' power
supply business purchases, markets, and supplies electricity to 2.2 million
customers in the UK.
After the sale, Midlands will continue to own and operate its electric
distribution business, which will remain regulated by the Office of Electricity
Regulation. Midlands' electric distribution business accounted for approximately
90% of its net income before interest and income taxes for the fiscal year ended
March 1998. All the RECs, including Midlands, are in the process of a
distribution price review. This process occurs every five years and is scheduled
to take effect April 1, 2000. The public must be notified six months prior to
any price changes; therefore, prices must be set and announced by October 1,
1999. (See Note 10 of the Notes to Consolidated Financial Statements for an
additional discussion of Cinergy's investment in Midlands.)
OTHER MATTERS
MIDWEST ISO During 1998, the FERC approved the formation of a Midwest
Independent System Operator ("Midwest ISO"). The Midwest ISO is the result of
Cinergy's collaboration with other Midwestern utility companies to form an
Independent System Operator ("ISO") that will assume functional control of their
combined transmission systems and facilitate a reliable, efficient market for
electric power. The ISO will provide non-discriminatory open transmission access
consistent with FERC Order No. 888. The ISO will also be responsible for system
reliability and administration of a regional transmission tariff, which will
eliminate "pancaking" of transmission rates in the region. The Midwest ISO will
be governed by a recently-elected, disinterested Board of Directors.
In addition to the ISO concept, other utilities have proposed to transfer
their transmission assets to a "for profit" independent regional transmission
company ("Transco"). Although Cinergy is not opposed to the formation of
Transcos in the long run, it believes that an ISO is a more efficient and
effective interim measure to immediately address market power issues and improve
system reliability.
Currently, there are 10 utility members participating in the Midwest ISO. The
Midwest ISO consists of 45,000 miles of transmission lines and covers portions
of 11 states, and includes over $6.5 billion of transmission investment, forming
one of the largest ISOs in the country. The Midwest ISO plans on beginning
operations in the year 2000.
REPEAL OF THE PUHCA PUHCA limits registered public utility holding companies
such as Cinergy from competing for growth opportunities both domestically
A-4
<PAGE>
REVIEW OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
and internationally. Under PUHCA, registered public utility holding companies
are limited in the amount of foreign investments and in domestic investments in
generation they can make. It also restricts business combinations through its
requirement that the electric systems of combining entities be "integrated."
Past efforts to repeal PUHCA have not been successful. In February 1999, a
bill to repeal significant parts of PUHCA--S. 313, was introduced in the US
Senate. Recently, the bill was voted out of the Senate Banking Committee without
markup, and now goes to the full Senate. While it is uncertain whether this bill
will be enacted into law, Cinergy continues to support the repeal of this act
either as part of comprehensive reform of the electric industry or as separate
legislation.
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. 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, 1998, 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 and results of operations of
the Company.
GAS UTILITY INDUSTRY
CUSTOMER CHOICE Choice of gas supplier or pilot customer-choice programs are
operating in several states. CG&E currently participates in a gas customer-
choice program in Ohio. This program, which made customer choice available to
all residential and small commercial customers in November 1997, was extended
during 1998. Gas customers in approximately two-thirds of the state of Ohio are
now eligible to participate in this voluntary program. Large industrial,
commercial, and educational institution customers already had the ability to
select their own gas supplier. 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 gas transportation services for substantially all
customers within its franchise territory 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.
ACQUISITION OF PROENERGY In June 1998, Cinergy, through Cinergy Capital &
Trading, Inc. ("CC&T"), acquired Producers Energy Marketing, LLC ("ProEnergy")
from Apache Corporation ("Apache") and Oryx Energy Company ("Oryx"). ProEnergy
has exclusive marketing rights to North American gas production owned or
controlled by Apache and Oryx, which represents approximately 1.1 billion cubic
feet per day of dedicated natural gas supply. These supplies, combined with the
active marketing of third-party gas, are geographically diverse and are spread
through the Southwest, Rocky Mountains, Gulf Coast, Gulf of Mexico, and
Michigan. The acquisition was funded with cash and the issuance of 771,258 new
shares of Cinergy common stock.
SECURITIES RATINGS
The ratings as of February 28, 1999, provided by the major credit rating
agencies--Duff & Phelps Credit Rating Co. ("D&P"), Fitch IBCA ("Fitch"), Moody's
Investors Service ("Moody's"), and Standard & Poor's Ratings Services
("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+ BBB+ Baa1 BBB+
Junior Unsecured Debt BBB BBB+ Baa2 BBB+
Preferred Stock BBB BBB+ baa1 BBB
Commercial Paper D-1- F-1 P-2 Not rated
PSI
Secured Debt A- A A3 A-
Senior Unsecured Debt BBB+ A- Baa1 BBB+
Junior Unsecured Debt BBB BBB+ Baa2 BBB+
Preferred Stock BBB BBB+ baa1 BBB
Commercial Paper D-1- F-1 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.
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<PAGE>
RATE ORDERS AND OTHER REGULATORY MATTERS
INDIANA
INDIANA UTILITY REGULATORY COMMISSION ("IURC") ORDERS -- PSI'S RETAIL RATE ORDER
AND DEMAND-SIDE MANAGEMENT ("DSM") ORDER 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). The order reflects a return on common
equity of 11.0% and an overall rate of return on net original rate base of
8.21%. In settlement of a challenge by consumer groups to the September 1996
Order, the IURC approved a settlement agreement which reduced the original rate
increase by $2.1 million in August 1997.
In a separate order issued by the IURC in December 1996 ("December 1996 DSM
Order"), PSI was granted permission to recover $35 million per year for the four
years ending December 31, 2000, through a non-bypassable charge in PSI's retail
rates for previously incurred DSM costs and associated carrying costs. Further,
PSI is authorized to spend up to $8 million annually on ongoing DSM programs
through the year 1999 and to collect such amounts currently in retail rates.
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 expires 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 a previous coal supply agreement
between PSI and Exxon Coal and Minerals Company. The buyout charge, excluding
the portion applicable to joint owners, is being recovered through the wholesale
and retail fuel adjustment clauses, with carrying costs on unrecovered amounts,
through December 2002. (See Note 1(f) of the Notes to Consolidated Financial
Statements.)
COAL GASIFICATION CONTRACT BUYOUT COSTS In November 1995, PSI and Destec Energy
Inc. ("Destec") entered into a 25-year contractual agreement for the provision
of coal gasification services at PSI's Wabash River Generating Station. The
agreement requires PSI to pay Destec a base monthly fee including certain
monthly operating expenses. PSI received authorization in the September 1996
Order for the inclusion of these costs in retail rates. In addition, PSI
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. Over the next five years, the base monthly fees and
expenses for the coal gasification service agreement are expected to total $212
million.
In September 1998, PSI reached agreement with Dynegy Inc. (Dynegy Inc.
purchased Destec in June 1997) to purchase the remainder of its 25-year contract
for coal gasification services for approximately $266 million. The proposed
purchase, which is contingent upon regulatory approval satisfactory to PSI,
could be completed in 1999. PSI is investigating its financing alternatives. The
transaction, if approved as proposed, is not expected to have a material impact
on PSI's earnings.
Currently, natural gas prices have fallen to a level which causes the
synthetic gas supply taken under the current gasification services agreement to
be substantially above market. If the buyout of the gasification services
agreement is approved, the combustion turbine will be fired with natural gas, or
with synthetic gas if it can be produced at a cost competitive with natural gas.
In nominal dollars, it is estimated that the total savings, primarily as a
result of the purchase, would be approximately $270 million over the life of the
contract.
OHIO
PUBLIC UTILITIES COMMISSION OF OHIO ("PUCO") ORDER -- CG&E'S GAS RATE ORDER 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%. The PUCO disallowed certain of CG&E's
requests, including the requested working capital allowance, recovery of certain
capitalized information 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 basic, $.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.
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REVIEW OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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.
ULH&P has deferred its portion of Merger Costs incurred through December 31,
1996, for future recovery in customer rates.
SEC ORDER AUTHORIZING THE RETENTION OF GAS OPERATIONS
In its 1994 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 November 1998, the SEC
issued an order unconditionally approving the retention of CG&E's gas
businesses.
ENVIRONMENTAL ISSUES
CLEAN AIR ACT AMENDMENTS OF 1990 ("CAAA")
The 1990 revisions to the Clean Air Act require reductions in both sulfur
dioxide ("SO(2)") and nitrogen oxide ("NO(x)") 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 SO(2) 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
operated by the ECBU). Each allowance permits one ton of SO(2) 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.
All required modifications to Cinergy's generating units to implement the
Phase I compliance plans were completed prior to January 1, 1995. To comply with
Phase II SO(2) emission requirements, Cinergy's current strategy includes a
combination of switching to lower-sulfur coal blends and utilizing an emission
allowance banking strategy to the extent a viable emission allowance market
exists. This cost-effective strategy will allow for meeting the Phase II SO(2)
reduction requirements while maintaining optimal flexibility to meet changes in
output due to increased customer choice, as well as potentially significant
future environmental requirements. To meet NO(x) reductions required by Phase
II, additional burner modifications are planned on certain affected units in
addition to using a system-wide NO(x) emission averaging strategy.
Capital expenditures are forecast to be less than $10 million to comply with
the Phase II NO(x) reductions, substantially all of which are expected to be
incurred during 1999. These expenditures are included in the amounts provided in
the "Capital Requirements" section herein.
OZONE TRANSPORT RULEMAKING
In June 1997, the 37-state collaborative known as the Ozone Transport Assessment
Group made a wide range of recommendations to the EPA to address the impact of
ozone transport on serious nonattainment areas in the Northeast, Midwest, and
South. In late 1997, in response to this recommendation, the EPA published its
proposed call for revisions to State Implementation Plans ("SIPs") for statewide
reductions in NO(x) emissions. In October 1998, the EPA finalized its Ozone
Transport Rule ("NO(x) SIP Call"). It applies to 22 states in the eastern half
of the US, including the three states in which the Cinergy electric utilities
operate, and also proposes a model NO(x) trading program. This rule recommends
that states reduce NO(x) emissions from primarily industrial and utility sources
to a certain limit by May 2003. The EPA gave the affected states until September
30, 1999, to incorporate utility NO(x) reductions with a trading program into
their SIPs. If the states fail to revise their SIPs accordingly, the EPA has
proposed to implement a federal plan to accomplish NO(x) reductions by May 2003.
Ohio, Indiana, a number of other states, and various industry groups,
including some of which Cinergy is a member, filed legal challenges to the NO(x)
SIP Call in late 1998. Ohio and Indiana have also provided preliminary
indications that they will seek fewer NO(x) reductions from the utility sector
in their implementing regulations than the EPA has budgeted in its rulemaking.
The state implementing regulations will need the EPA's approval. The current
estimate of capital expenditures required for compliance with the EPA limits in
the new NO(x) SIP Call is between $500 million and $700 million (in 1998
dollars) between now and 2003. This estimate is significantly dependent on
several factors, including the final determination regarding both the timing and
stringency of the final required NO(x) reductions, the output of Cinergy's
generating units, the availability of adequate supplies of resources to
construct the necessary control equipment, and the extent to which a NO(x)
allowance trading market develops, if any.
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AMBIENT AIR STANDARDS AND REGIONAL HAZE
During 1997, the EPA revised the National Ambient Air Quality Standards for
ozone and fine particulate matter and proposed rules for regional haze. The EPA
is scheduled to finalize new regional haze rules by the summer of 1999 and
Congress, as part of the funding bill for the Surface Transportation Act,
combined the schedules for fine particulates and regional haze implementation.
These new rules increase the pressure for additional NO(x) and SO(2) emissions
reductions. Depending on the ultimate outcome of the NO(x) SIP Call, additional
NO(x) reductions may be required from states by 2007 to address the new
eight-hour ozone standard.
The EPA estimates it will take up to five years to collect sufficient ambient
air monitoring data to determine nonattainment areas. The states will then
determine the sources of these particulates and determine a regional emission
reduction plan. 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 SO(2) and NO(x) emissions from utility
sources. At this time, the exact amount and timing of required reductions cannot
be predicted.
GLOBAL CLIMATE CHANGE
In December 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. On November 12, 1998, the US signed the Kyoto
Protocol. However, 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. The Kyoto
Protocol, in its present form, is unlikely to be ratified by the US Senate since
it does not contain provisions requiring participation of developing countries.
Significant uncertainty exists concerning both 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. The ECBU believes
that voluntary programs, such as the US Department of Energy ("DOE") 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 they are negligible compared to global mercury emissions.
The EPA was unable to show a feasible mercury control technology for coal-fired
utilities. In November 1998, the EPA finalized its Mercury Information
Collection Request ("ICR"). Pursuant to the ICR, all generating units must
provide detailed information about coal use and mercury content. The EPA will
also select about 100 generating units for one-time stack sampling. At that
time, the EPA also announced that it would make its regulatory determination on
the need for additional regulation by the fourth quarter of 2000. It will
utilize the new information from the ICR, a new study by the National Academy of
Sciences, and other additional information. If more air toxics regulations are
issued, the compliance cost could be significant. The outcome or effects of the
EPA's determination cannot currently be predicted.
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 ("CERCLA") with respect to certain manufactured gas plant
("MGP") sites, and therefore is responsible for the costs of investigating and
remediating these sites.
In November 1998, NIPSCO, IGC, and PSI entered into an agreement which
settled the allocation of CERCLA liability for past and future costs among the
three companies, at seven MGP sites in Indiana. Similar agreements were reached
between IGC and PSI which allocate CERCLA liability at 14 MGP sites with which
NIPSCO had no involvement. These
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agreements conclude all CERCLA and similar claims between the three companies
relative to MGP sites. Pursuant to the agreements, the parties are continuing to
investigate and remediate the sites as appropriate. In the case of some sites,
the parties have applied to the Indiana Department of Environmental Management
for inclusion of such sites in the Indiana Voluntary Remediation Program.
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 Notes 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
The regulated businesses of Cinergy forecast construction expenditures for 1999
to be approximately $386 million and over the next five years (1999 - 2003) to
be approximately $1.7 billion. The timing and amount of investments by Cinergy's
non-regulated businesses is dependent upon the development and favorable
evaluation of opportunities.
The above forecast excludes the estimated expenditures necessary to comply
with the EPA's proposed stricter NO(x) emission control standards associated
with the 22-state NO(x) SIP Call. Cinergy estimates that the capital costs for
additional NO(x) controls at its facilities could range between $500 million and
$700 million (in 1998 dollars) over the next five years. The above forecast also
excludes any capital expenditures that may be required for the construction of
new generating facilities.
In order to meet the power supply demands of its customers, the ECBU must
constantly assess the adequacy of its supply portfolio and determine which
supply alternatives to pursue to most effectively meet demands, hedge risks, and
satisfy regulatory requirements. Supply alternatives include investments in
existing facilities, investments in new facilities, and/or acquisitions of power
supply from the market. In addition, Cinergy's present demand requirements could
be impacted if customer-choice legislation is passed in any of the states in
which Cinergy has a regulated franchise. (ALL FORECASTED AMOUNTS, EXCLUDING
NO(x) COMPLIANCE AMOUNTS, ARE IN NOMINAL DOLLARS 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.)
Cinergy's mission is to reach the top five in our industry within three years
on five key dimensions-- market capitalization, number of customers, electric
and gas commodity trading, international presence, and productivity. Cinergy has
entered into various growth initiatives in its pursuit of these goals. These
initiatives include, among others, energy marketing and trading, retail energy
products and services, and additional international investment. In addition,
Cinergy is working toward maximizing the value of its existing operations and
assets and continues to explore the potential for mergers, acquisitions, and
strategic alliances.
Certain legal and regulatory requirements, including PUHCA, limit Cinergy's
ability to invest in growth initiatives. PUHCA restricts the amount which can be
invested outside the regulated utility, including foreign utility company
("FUCO") investments and investments in domestic power plants that qualify as
"qualifying facilities" ("QFs") under the Public Utility Regulatory Policies Act
of 1978 or are certified as EWGs by the FERC. Under these restrictions, Cinergy
may invest or commit to invest (i) an amount equal to 100% of consolidated
retained earnings (defined under applicable SEC regulations as the average of
Cinergy's consolidated retained earnings for the four most recent quarterly
periods) in EWGs and FUCOs (equal to $949 million at December 31, 1998), and
(ii) an amount equal to 15% of consolidated capitalization ($942 million at
December 31, 1998) in QFs and other "energy-related" nonutility investments (as
defined in the applicable SEC regulation).
At December 31, 1998, under these SEC restrictions, Cinergy had available
capacity for additional EWG/FUCO investments of $332 million and available
capacity for additional QFs and "energy-related" nonutility investments of $524
million.
OTHER COMMITMENTS
SECURITIES REDEMPTIONS
Mandatory redemptions of long-term debt total $410 million during the period
1999 through 2003.
The maintenance and replacement fund provisions contained in PSI's first
mortgage bond indenture require cash payments, bond retirements, or pledges of
unfunded property additions each year based on an amount related to PSI's net
revenues. Cinergy will continue to evaluate opportunities for the refinancing
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of outstanding securities beyond mandatory redemption requirements.
GUARANTEES
At December 31, 1998, Cinergy had issued $286 million in guarantees primarily
related to the energy marketing and trading activities of its subsidiaries and
affiliates. In addition, Cinergy had guaranteed $258 million of the debt
securities of its subsidiaries and affiliates.
YEAR 2000
The Year 2000 issue generally exists because many computer systems and
applications, including those embedded in equipment and facilities, use two
digit rather than four digit date fields to designate an applicable year. As a
result, the systems and applications may not properly recognize dates including
and beyond the year 2000 or accurately process data in which such dates are
included, potentially causing data miscalculations and inaccuracies or
operational malfunctions and failures, which could materially affect a
business's financial condition, results of operations, and cash flows.
Cinergy has established a centrally-managed, company-wide initiative, known
as the Cinergy Year 2000 Readiness Program, to identify, evaluate, and address
Year 2000 issues. The Cinergy Year 2000 Readiness Program, which began in the
fourth quarter of 1996, is generally focused on three elements that are integral
to this initiative: (1) business continuity; (2) risk management; and (3)
regulatory compliance. Business continuity includes providing reliable electric
and gas supply and service in a safe and cost-effective manner. This element
encompasses mission-critical generation, transmission, and distribution systems
and related infrastructure, as well as operational and financial information
technology ("IT") systems and applications, end-user computing resources, and
building systems (such as security, elevator, and heating and cooling systems).
Risk management includes a review of the Year 2000 readiness efforts of
Cinergy's critical suppliers, key customers and other principal business
partners, and, as appropriate, the development of joint business support,
contingency plans, and the inclusion of Year 2000 concerns as a regular part of
the due diligence process in any new business venture. Regulatory compliance
includes communications with regulatory agencies, other utilities, and various
industry groups. While this initiative is broad in scope, it has been structured
to identify and prioritize efforts for mission-critical electric and gas systems
and services and key business partners.
Under the Cinergy Year 2000 Readiness Program, Cinergy has established a
target date of June 30, 1999, for the remediation and testing of its mission-
critical generation, transmission, and distribution systems (gas and electric).
An innovative remediation and testing effort which Cinergy has initiated
involves operating several electric-generating units with post Year 2000 dates.
Cinergy's experience has been that those units have continued to operate without
any material adverse result relating to a Year 2000 issue. Cinergy's progress to
date ranges from approximately 90% regarding IT systems to approximately 75%
regarding assessment of critical suppliers.
Cinergy has also reviewed its existing contingency and business continuity
plans and modified them in light of the Year 2000 issue. Contingency planning to
maintain and restore service in the event of natural and other disasters
(including software and hardware-related problems) has been part of Cinergy's
standard operation for many years, and Cinergy is working to leverage this
experience in the review of existing plans to address Year 2000-related
challenges. These reviews have assessed the potential for business disruption in
various scenarios, including the most reasonably likely worst-case scenario, and
to provide for key operational back-up, recovery, and restoration alternatives.
Cinergy cannot guarantee that third parties on whom it depends for essential
goods and services (those where the interruption of the supply of such goods and
services could lead to issues involving the safety of employees, customers, or
the public, the continued reliable delivery of gas and/or electricity, and the
ability to comply with applicable laws or regulations) will convert their
mission-critical systems and processes in a timely manner. Failure or delay by
any of these third parties could significantly disrupt business. However, to
address this issue, Cinergy has established a supplier compliance program, and
is working with its critical suppliers in an effort to minimize such risks.
In addition, Cinergy is coordinating its findings and other issues with other
utilities and various industry groups via the Electric Power Research Institute
Year 2000 Embedded Systems Project and the Year 2000 Readiness Assessment
Program of the North American Electric Reliability Council ("NERC"), acting at
the request of the DOE. The DOE has asked NERC to report on the integrity of the
transmission system for North America and to coordinate and assess the
preparation of the electric systems in North America for the Year 2000. NERC
submitted its initial quarterly status report and coordination plan to the DOE
in September 1998, and a second quarterly status report for the fourth quarter
of 1998 was submitted on January 11, 1999.
Cinergy currently estimates that the total cost of assessment, remediation,
testing, and upgrading its
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systems as a result of the Year 2000 effort is approximately $13 million.
Approximately $11 million in expenses have been incurred through December 31,
1998, for external labor, hardware and software upgrades, and for Cinergy
employees who are dedicated full-time to the Cinergy Year 2000 Readiness
Program. The timing of these expenses may vary and is not necessarily indicative
of readiness efforts or progress to date. Cinergy anticipates that a portion of
its Year 2000 expenses will not be incremental costs, but rather, will represent
the redeployment of existing IT resources. Since its formation, Cinergy has
incurred, and will continue to incur, significant capital improvement costs
related to planned system upgrades or replacements required in the normal course
of business. These costs have not been accelerated as a result of the Year 2000
issue.
The above information is based on Cinergy's current best estimates, which
were derived using numerous assumptions of future events, including the
availability and future costs of certain technological and other resources,
third-party modification actions, and other factors. Given the complexity of
these issues and possible unidentified risks, actual results may vary materially
from those anticipated and discussed above. Specific factors that might cause
such differences include, among others, the ability to locate and correct all
affected computer code, the timing and success of remedial efforts of
third-party suppliers, and similar uncertainties.
The above information is a Year 2000 Readiness Disclosure pursuant to the
Federal Year 2000 Information and Readiness Disclosure Act.
CAPITAL RESOURCES
The regulated businesses of Cinergy forecast that their need for external funds
during the 1999 through 2003 period will primarily be for the refinancing of
existing securities. It is currently expected that funds required to pursue the
various non-regulated growth initiatives underway will be obtained primarily
through short-term borrowing and the issuance of long-term debt and/or equity
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
Currently, a substantial portion 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 operations could be subject to a higher
degree of volatility than under the present regulatory structure.
COMMON STOCK
During 1998, 1997, and 1996, Cinergy issued approximately 194,000; 66,000; and
15,000 new shares, respectively, of common stock pursuant to various stock-based
employee plans. In addition, Cinergy purchased approximately 861,000 and 1.7
million shares on the open market to satisfy the majority of its 1998 and 1997
obligations, respectively, under these plans. Cinergy currently plans to
continue using market purchases of common stock to satisfy the majority of its
obligations under these plans; however, given its future capital requirements,
it will continue to re-evaluate this decision. In the event Cinergy begins
issuing shares of common stock to satisfy these obligations, it has authority
under PUHCA to issue and sell through December 31, 2000, up to approximately 22
million additional shares of Cinergy common stock.
SHORT-TERM DEBT
Cinergy has authority under PUHCA to issue and sell, through December 31, 2002,
short-term notes, long-term unsecured debentures, and commercial paper in an
aggregate principal amount not to exceed $2 billion. The entire amount may be
outstanding as short-term debt; however, long-term unsecured debentures
outstanding may not exceed $400 million at any time. In connection with this
authority, Cinergy has established committed and uncommitted lines of credit, of
which $305 million remained unused and available at December 31, 1998.
Also at year-end, Global Resources had $100 million available under its
revolving credit facility.
As of December 31, 1998, Cinergy's utility subsidiaries had regulatory
authority to borrow up to $853 million. Pursuant to this authority, committed
and uncommitted lines of credit have been established for CG&E and PSI of which,
$310 million and $249 million, respectively, remained unused and available at
December 31, 1998.
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For a detailed discussion of Cinergy's short-term indebtedness, refer to Note
5 of the Notes to Consolidated Financial Statements.
LONG-TERM DEBT
Under the authority mentioned above, Cinergy had long-term debt authorization of
$400 million, of which $200 million was issued and outstanding at December 31,
1998. CG&E has filed an application with the PUCO requesting authorization to
issue up to $200 million of additional long-term debt. As of December 31, 1998,
PSI and ULH&P had state regulatory authority for additional long-term debt
issuance of $350 million and $10 million, respectively. Regulatory approval to
issue additional amounts of securities will be requested as needed.
SALE OF ACCOUNTS RECEIVABLE
For a detailed discussion of the sale of accounts receivable, refer to Note 6 of
the Notes to Consolidated Financial Statements.
MARKET RISK SENSITIVE
INSTRUMENTS AND POSITIONS
ENERGY COMMODITIES SENSITIVITY
The transactions associated with the energy marketing and trading activities
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. These
operations subject Cinergy to the risks and volatilities associated with the
energy commodities (primarily electricity and natural gas) which it markets and
trades. The wholesale energy marketing and trading business continues to be very
competitive. As the ECBU continues to develop and expand its energy marketing
and trading business, its exposure to movements in the price of electricity and
other energy commodities will become greater. As a result, Cinergy is likely to
be subject to future earnings volatility.
The energy marketing and trading activities of the ECBU principally consist
of CG&E's and PSI's power marketing and trading operation which markets and
trades over-the-counter contracts for the purchase and sale of electricity
primarily in the Midwest region of the US, where owned generation is located.
These activities are conducted by Services on behalf of CG&E and PSI. The power
marketing and trading operation consists of both physical and trading
activities. Transactions are designated as physical when there is intent and
ability to physically deliver the power from company-owned generation. All other
transactions are considered trading transactions. Substantially all of the
contracts in both the physical and trading portfolios commit Cinergy, CG&E,
and/or PSI to purchase or sell electricity at fixed prices in the future (i.e.,
fixed-price forward purchase and sales contracts, full requirements contracts).
The ECBU also markets and trades over-the-counter option contracts.
Substantially all of the contracts in the physical portfolio require settlement
by physical delivery of electricity. Contracts within the trading portfolio
generally require settlement by physical delivery or are netted out in
accordance with industry trading standards. The use of these types of physical
commodity instruments is designed to allow the ECBU to manage and hedge
contractual commitments, reduce exposure relative to the volatility of cash
market prices, and take advantage of selected arbitrage opportunities.
The ECBU 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, a net open position is created or allowed to
continue when it is believed future changes in prices and market conditions will
make the positions profitable. Position imbalances may also occur because of the
basic lack of liquidity in the wholesale power market. To the extent net open
positions exist, there is the risk that fluctuating market prices of electric
power may potentially impact Cinergy's financial condition or results of
operations adversely if prices do not move in the manner or direction expected.
The ECBU measures the risk inherent in the trading portfolio utilizing
value-at-risk analysis and other methodologies, which utilize forward price
curves in electric power markets to quantify estimates of the magnitude and
probability of potential future losses related to open contract positions.
Predominantly all of the contracts in the physical portfolio require physical
delivery of electricity and generally do not allow for net cash settlement.
Therefore, these contracts are not included in the value-at-risk analysis. The
value-at-risk expresses the potential loss in fair value of the trading
portfolio over a particular period of time, with a specified likelihood of
occurrence, due to an adverse market movement. The value-at-risk is reported as
a percentage of operating income, based on a 95% confidence interval, utilizing
one-day holding periods. On a one day basis as of December 31, 1998, the
value-at-risk for the power trading activities was less than 1% of Cinergy's
1998 Consolidated Operating Income. The average value-at-risk, on a one-day
basis at the end of each quarter in 1998, for the power trading portfolio was
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less than 2% of Cinergy's 1998 Consolidated Operating Income. The daily
value-at-risk for the power trading portfolio as of December 31, 1997, was also
less than 2% of Cinergy's 1998 Consolidated Operating Income. 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.
The ECBU, through Cinergy's acquisitions of ProEnergy and Greenwich Energy
Partners, in 1998 and 1997, respectively, actively markets physical natural gas
and actively trades derivative commodity instruments, customarily settled in
cash, including futures, forwards, swaps, and options. The ESBU, through CRI,
utilizes derivative commodity instruments, customarily settled in cash,
primarily to hedge purchases and sales of natural gas. The aggregated
value-at-risk amounts associated with these trading and hedging activities,
utilizing 95% confidence intervals and one-day holding periods, were less than
$1 million as of December 31, 1998 and 1997. The market risk exposures of these
trading activities is not considered 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 the ESBU's trade accounts
receivable from electric and gas retail customers is limited due to the large
number of customers and diversified customer base of residential, commercial,
and industrial customers. Contracts within the physical portfolio of the ECBU's
power marketing and trading operations are primarily with traditional electric
cooperatives and municipalities and other IOUs.
Contracts within the trading portfolio of the power marketing and trading
operations are primarily with power marketers and other IOUs. As of December 31,
1998, approximately 73% of the activity within the trading portfolio represents
commitments with 10 counterparties. The majority of these contracts are for
terms of one year or less. As a result of the extreme volatility experienced in
the Midwest power markets during 1998, several new entrants into the market
began experiencing financial difficulties and failed to perform their
contractual obligations. As a result, the bad debt provisions of approximately
$13 million with respect to settled transactions were recorded during the year.
Counterparty credit exposure within the power trading portfolio is routinely
factored into the mark-to-market valuation. At December 31, 1998, credit
exposure within the power trading portfolio is not believed to be significant.
Prior to 1998, credit exposure due to nonperformance by counterparties was not
significant. As the competitive electric power market continues to develop,
counterparties will increasingly include new market entrants, such as other
power marketers, brokers, and commodity traders. This increased level of new
market entrants, as well as competitive pressures on existing market
participants, could increase the ECBU's exposure to credit risk with respect to
its power marketing and trading operation. As of December 31, 1998,
approximately 37% of the activity within the ECBU's physical gas marketing and
trading portfolio represents commitments with 10 counterparties. Credit risk
losses related to the ECBU's gas and other commodity physical and trading
operations have not been significant. Based on the types of counterparties and
customers with which transactions are executed, credit exposure within the gas
and other commodity trading portfolios at December 31, 1998, is not believed to
be significant.
Cinergy has established a risk management function and has implemented active
risk management policies and procedures to manage and minimize corporate and
business unit 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 guarantees 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 energy marketing and trading transactions subject to parameters established
by Cinergy's Risk Policy Committee. Market and credit risks are monitored by the
risk management and credit function, which operates separately from the business
units which originate or actively manage the market and credit risk exposures,
to ensure compliance with Cinergy's stated risk management policies and
procedures. These policies and procedures are periodically reviewed and
monitored 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.
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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.
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 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/pound 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 "Accumulated other comprehensive
loss", 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 semi-annual interest on the dollar
notional amount. At December 31, 1998, the estimated fair value of this swap was
$(59) million. This was partially offset by a $46 million currency translation
gain to date on Cinergy's investment in Midlands.
Cinergy also has exposure to fluctuations in the US dollar/Czech koruna
exchange rate through its investments in the Czech Republic. Cinergy has hedged
the exchange rate exposure related to certain of its Czech koruna ("CZK")
denominated investments through foreign exchange forward contracts. The
contracts require Cinergy to exchange 1,447 million Czech korunas for $40
million. When the Czech koruna strengthens relative to the dollar, the dollar
value of Cinergy's investment increases; however, the value of the foreign
exchange forward contracts decreases, offsetting the increase in the investment.
The reverse is true when the Czech koruna declines relative to the dollar.
Translation losses related to the contracts are recorded in "Accumulated other
comprehensive loss", which is reported as a separate component of common stock
equity in the Consolidated Financial Statements. At December 31, 1998, the
estimated aggregate fair value of these foreign exchange forward contracts was
$(7) million.
Cinergy has investments in various other countries where the net investments
are not hedged. The Company does have exposure to fluctuations in exchange rates
between the US dollar and the currencies of these countries. At December 31,
1998, Cinergy does not believe it has a material exposure to the currency risk
attributable to these investments.
The following table summarizes the details of the swap and the foreign
exchange forward contracts. (For presentation purposes, the pound sterling
payment obligation has been converted to US dollars using the dollar/pound
sterling spot exchange rate at December 31, 1998, of 1.66000. The interest rates
are based on the six-month LIBOR implied forward rates at December 31, 1998.)
A-14
<PAGE>
REVIEW OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
<TABLE>
<CAPTION>
Expected Maturity Date
($US Equivalent in millions) 1999 2000 2001 2002 2003 Thereafter
<S> <C> <C> <C> <C> <C> <C>
- -----------------------------------------------------------------------------------------------------------------------------
CURRENCY SWAP
Receive principal ($US) $ - $ - $ - $ 500 $ - $ -
Average interest receive rate (variable) -% -% -% 5.3% -% -%
Pay principal (LUK) $ - $ - $ - $ 548 $ - $ -
Average interest pay rate (partially
variable, partially fixed) -% -% -% 6.0% -% -%
FOREIGN EXCHANGE FORWARD CONTRACTS
Receive $US/Pay CZK $ 40 $ - $ - $ - $ - $ -
Average contractual exchange rate
(CZK/$US) 36.2 - - - - -
<CAPTION>
($US Equivalent in millions) Total
<S> <C>
- ----------------------------------------
CURRENCY SWAP
Receive principal ($US) $ 500
Average interest receive rate (variable) 5.3%
Pay principal (LUK) $ 548
Average interest pay rate (partially
variable, partially fixed) 6.0%
FOREIGN EXCHANGE FORWARD CONTRACTS
Receive $US/Pay CZK $ 40
Average contractual exchange rate
(CZK/$US) 36.2
</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, 1998, this included (i)
short-term bank loans and commercial paper totaling $637 million, (ii) $267
million of pollution control related debt which is classified as "Notes payable
and other short-term obligations" on Cinergy's Consolidated Balance Sheets, and
(iii) a $253 million sale of accounts receivable (Cinergy's Consolidated Balance
Sheets are net of amounts sold). 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 "Notes payable
and 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 the amounts sold). At December 31, 1998 and 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,
1998:
<TABLE>
<CAPTION>
Expected Maturity Date
(in millions) 1999 2000 2001 2002 2003 Thereafter Total
<S> <C> <C> <C> <C> <C> <C> <C>
- ---------------------------------------------------------------------------------------------------------------------------
LIABILITIES
Long-term Debt (a)
Fixed rate $ 137 $ 32 $ 90(d) $ 124 $ 177(e) $ 2 097 $ 2 657
Average interest rate(b) 6.0% 5.7% 5.2% 7.3% 6.2% 7.0% 6.8%
Other(c) $ - $ - $ - $ - $ - $ 100 $ 100
Average interest rate(b) -% -% -% -% -% 6.5% 6.5%
Capital Lease
Variable rate $ - $ - $ 22 $ - $ - $ - $ 22
Average interest rate(b) -% -% 5.3% -% -% -% 5.3%
<CAPTION>
(in millions) Fair Value
<S> <C>
- -------------------------------
LIABILITIES
Long-term Debt (a)
Fixed rate $ 2 830
Average interest rate(b)
Other(c) $ 104
Average interest rate(b)
Capital Lease
Variable rate $ 22
Average interest rate(b)
</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 1998. 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.
(d) 6.00% Debentures due December 14, 2016, reflected as maturing in 2001 as the
interest rate resets on December 14, 2001.
(e) 6.35% Debentures due June 15, 2038, reflected as maturing in 2003 as the
interest rate resets on June 15, 2003.
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 one interest rate swap agreement, Cinergy has effectively fixed the
interest rate on the pound sterling denominated obligation created by the
currency swap discussed above. This contract requires Cinergy to pay
semi-annually a fixed rate and receive a floating rate through February 2002.
The notional amount of the swap is 280 million pounds sterling.
A-15
<PAGE>
The fair value of the swap was approximately $(19) million at December 31, 1998.
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, 1998, the fair value of
this swap decreased from $(3) million at December 31, 1997 primarily due to a
projected decline in the average variable interest rate received on the dollar
denominated leg of the swap over its remaining term.
At December 31, 1998, CG&E had an interest rate swap agreement outstanding
related to its sale of accounts receivable. The contract has a notional amount
of $100 million and requires CG&E to pay a fixed rate and receive a floating
rate. PSI had three interest rate swap agreements outstanding with notional
amounts of $100 million each. One contract, with two years remaining of a
four-year term, requires PSI to pay a floating rate and receive a fixed rate.
The other two contracts, with six-month terms, require PSI to pay a fixed rate
and receive a floating rate. The floating rate is based on applicable LIBOR. At
December 31, 1998 and 1997, the fair values of these interest rate swaps were
not significant. The following table presents notional principal amounts and
weighted average interest rates by contractual maturity dates for the interest
rate swaps of Cinergy, CG&E, and PSI. The variable rates are the average implied
forward rates during the contracts based on a December 31, 1998 one month
commercial paper index yield curve for CG&E and the six month LIBOR yield curve
at December 31, 1998 for Cinergy and PSI. Although Cinergy's swaps require
payments to be made in pounds sterling, the table reflects the dollar equivalent
notional amounts based on spot market foreign currency exchange rates at
December 31, 1998.
<TABLE>
<CAPTION>
Expected Maturity Date
($US Equivalent in millions) 1999 2000 2001 2002 2003 Thereafter Total
<S> <C> <C> <C> <C> <C> <C> <C>
- ----------------------------------------------------------------------------------------------------------------------------
INTEREST RATE DERIVATIVES
Interest Rate Swaps
Receive fixed/pay variable
($US) $ - $ 100 $ - $ - $ - $ - $ 100
Average pay rate 5.2% 5.1% -% -% -% -% 5.1%
Average receive rate 6.1% 6.1% -% -% -% -% 6.1%
Receive variable/pay fixed
($US) $ 200 $ - $ - $ - $ - $ - $ 200
Average pay rate 5.5% -% -% -% -% -% 5.5%
Average receive rate 5.1% -% -% -% -% -% 5.1%
Receive variable/pay fixed
(LUK) $ - $ - $ - $ 465(a) $ - $ - $ 465(a)
Average pay rate -% -% -% 7.1% -% -% 7.1%
Average receive rate -% -% -% 6.0% -% -% 6.0%
<CAPTION>
($US Equivalent in millions) Fair Value
<S> <C>
- -------------------------------
INTEREST RATE DERIVATIVES
Interest Rate Swaps
Receive fixed/pay variable
($US) $ 2
Average pay rate
Average receive rate
Receive variable/pay fixed
($US) $ (1)
Average pay rate
Average receive rate
Receive variable/pay fixed
(LUK) $ (19)
Average pay rate
Average receive rate
</TABLE>
(a) Notional converted to US dollars using the Sterling spot exchange rate at
December 31, 1998, of 1.66000.
ACCOUNTING CHANGES
During the second quarter of 1998, the FASB issued Statement of Financial
Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging
Activities ("Statement 133"). Statement 133 requires companies to record
derivative instruments, as defined in Statement 133, as assets or liabilities,
measured at fair value. The statement requires that changes in the derivative's
fair value be recognized currently in earnings unless specific hedge accounting
criteria are met. Special accounting for qualifying hedges allows a derivative's
gains and losses to offset related results on the hedged item in the income
statement, and requires that a company must formally document, designate, and
assess the effectiveness of transactions that receive hedge accounting. The
standard is effective for fiscal years beginning after June 15, 1999, and
Cinergy expects to adopt the provisions of Statement 133 in the first quarter of
2000. The Company has not yet quantified the impact of adopting Statement 133 on
its consolidated financial statements. However, Statement 133 could increase
volatility in earnings and other comprehensive income.
A-16
<PAGE>
REVIEW OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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
OPERATING REVENUES
ELECTRIC OPERATING REVENUES
The components of electric operating revenues and the related kilowatt-hour
("kwh") sales are shown below:
<TABLE>
<CAPTION>
REVENUE KWH SALES
($ and kwh in ------------------------------- -------------------------------
millions) 1998 1997 1996 1998 1997 1996
<S> <C> <C> <C> <C> <C> <C>
- --------------------------------------------------------------------------------
Retail $ 2 553 $ 2 455 $ 2 438 46 983 45 327 45 121
Sales for
resale 2 140 1 368 297 77 558 57 454 12 399
Other 54 39 34 -- -- --
- --------------------------------------------------------------------------------
Total $ 4 747 $ 3 862 $ 2 769 124 541 102 781 57 520
</TABLE>
Electric operating revenues increased $885 million (23%) for 1998, when
compared to 1997. This increase was primarily due to increased volumes and a
higher average price per kwh received on non-firm power sales for resale
transactions related to the energy marketing and trading operations. There was
also an increase in the average price per kwh paid for the corresponding
purchases of purchased and exchanged power described below. Also contributing to
the increase were higher retail kwh sales due to the warmer weather during 1998
when compared to 1997 and growth in the average number of residential and
commercial customers.
Higher non-firm power sales for resale due to increased activity in the
energy marketing and trading operations significantly contributed to the $1.1
billion (39%) increase in electric operating revenues in 1997, when compared to
1996. Also contributing to the increase was a full year's effects of PSI's
retail rate increases approved in the September 1996 Order, as amended in August
1997, the December 1996 DSM Order, and the return of approximately $13 million
to customers in 1996 in accordance with an order issued in February 1995 by the
IURC. This order required all retail operating income above a certain rate of
return to be refunded to customers. Partially offsetting these increases was the
reduction in fuel revenue due to a lower average cost of fuel used in electric
production.
GAS OPERATING REVENUES
The components of gas operating revenues and the related thousand cubic feet
("mcf") sales are shown below:
<TABLE>
<CAPTION>
REVENUE MCF SALES
($ and mcf in ------------------------------- -------------------------------
millions) 1998 1997 1996 1998 1997 1996
<S> <C> <C> <C> <C> <C> <C>
- ----------------------------------------------------------------------------------
Sales for resale $ 659 $ -- $ -- 338 -- --
Retail 357 454 440 55 69 75
Transportation 41 32 28 58 54 49
Other 4 5 6 -- -- --
- ----------------------------------------------------------------------------------
Total $ 1 061 $ 491 $ 474 451 123 124
</TABLE>
Gas operating revenues increased $570 million in 1998, as compared to 1997.
This increase was primarily due to the gas operating revenues of ProEnergy,
which was acquired in June 1998. Partially offsetting this increase was a
decline in retail sales due to lower mcf volumes reflecting, in part, the milder
weather during the first quarter of 1998, and a reduction in the average number
of full-service residential, commercial and industrial customers. Transportation
revenues increased as full-service customers continued the move away from full
service to purchasing gas directly from suppliers, using transportation services
provided by CG&E.
The gas rate increase of 2.5% (approximately $9 million annually) approved by
the PUCO in the December 1996 Order and a higher average cost per mcf of gas
purchased contributed to the $17 million (4%) increase in gas operating revenues
in 1997, as compared to 1996. These increases were partially offset by a decline
in retail sales due to lower mcf volumes reflecting milder weather during 1997.
OTHER REVENUES
Other revenues increased $34 million in 1998, as compared to 1997. This increase
was primarily the result of increased sales and new initiatives by the
non-regulated businesses operated by the various business units.
A-17
<PAGE>
OPERATING EXPENSES
FUEL AND PURCHASED AND EXCHANGED POWER
The components of fuel and purchased and exchanged power are shown below:
<TABLE>
<CAPTION>
(in millions) 1998 1997 1996
<S> <C> <C> <C>
- --------------------------------------------------------------------
Fuel $ 723 $ 693 $ 713
Purchased and exchanged power 2 123 1 220 159
- --------------------------------------------------------------------
Total $ 2 846 $ 1 913 $ 872
</TABLE>
Electric fuel costs increased $30 million (4%) in 1998, when compared to
1997, and declined $20 million (3%) in 1997, when compared to 1996.
An analysis of these fuel costs is shown below:
<TABLE>
<CAPTION>
(in millions) 1998 1997
<S> <C> <C>
- ------------------------------------------------------------------
Previous year's fuel expense $ 693 $ 713
Increase (Decrease) due to change in:
Price of fuel (23) 7
Deferred fuel cost 22 (55)
Kwh generation 28 28
Other 3 --
- ------------------------------------------------------------------
Current year's fuel expense $ 723 $ 693
</TABLE>
Purchased and exchanged power expense increased $903 million (74%) and $1.1
billion in 1998 and 1997, respectively. These increases primarily reflect
increased purchases of non-firm power for resale to others as a result of
increased activity in the energy marketing and trading operations and an
increase in the average price paid per kwh. Also recorded in 1998 were $135
million of unrealized losses related to the 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 energy marketing and trading operations.)
GAS PURCHASED
Gas purchased increased $591 million in 1998, as compared to 1997. This is
primarily due to the gas purchased expenses of ProEnergy, which was acquired in
June 1998. Slightly offsetting this increase was a decrease in the volumes of
gas purchased by CG&E, due to lower demand, and a lower average cost per mcf of
gas purchased by CG&E.
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.
OTHER OPERATION AND MAINTENANCE
The components of other operation and maintenance expenses are shown below:
<TABLE>
<CAPTION>
(in millions) 1998 1997 1996
<S> <C> <C> <C>
- -------------------------------------------------------------------
Other operation $ 814 $ 693 $ 644
Maintenance 192 177 194
- -------------------------------------------------------------------
Total $ 1 006 $ 870 $ 838
</TABLE>
Other operation expenses increased $121 million (17%) in 1998, as compared to
1997. This increase is primarily due to the one-time charge of $80 million
recorded during the second quarter of 1998, reflecting the implementation of a
1989 settlement of a dispute with the Wabash Valley Power Association, Inc.
("WVPA"). (See Note 18 of the Notes to Consolidated Financial Statements.) This
increase was also the result of increased growth and new initiatives by the
non-regulated businesses operated by the various business units. Maintenance
expenses increased $15 million (8%) in 1998, as compared to 1997. This increase
is due to an increase in boiler plant maintenance, an increase in general plant
expenses, and an increase in distribution line maintenance costs resulting from
storm damage during the second quarter of 1998.
Other operation expenses increased $49 million (8%) in 1997, as compared to
1996. This increase is primarily due to higher other operation expenses relating
to the PSI 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. The effect of discontinuing deferral of
certain DSM-related costs also added to the increase. Maintenance expenses
decreased $17 million (9%) in 1997, as compared to 1996. This decrease is
primarily attributable to reduced outage related charges and other maintenance
costs associated with the electric production facilities. Reduced maintenance
costs associated with the electric transmission and distribution facilities in
the PSI territory also contributed to the decrease for 1997.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization increased $19 million (6%) in 1998, as compared to
1997. This increase is primarily attributable to amortization of phase-in
deferrals reflecting the PUCO ordered phase-in plan for the William H. Zimmer
Generating Station ("Zimmer"). (See Note 1(f) of the Notes to Consolidated
Financial Statements.)
A-18
<PAGE>
REVIEW OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
EQUITY IN EARNINGS OF UNCONSOLIDATED SUBSIDIARIES
The decrease in equity in earnings of unconsolidated subsidiaries of $9 million
(15%) for 1998, as compared to 1997, is partially due to a decline in the
earnings of Midlands, as a result of milder weather conditions and a penalty
imposed on each electric distribution company caused by the delay in opening the
electricity supply business to competition.
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 INCOME AND (EXPENSES) -- NET
The $12 million change in other income and (expenses)--net for 1998, as compared
to 1997, is primarily due to a gain on the sale of Cinergy's interest in a
foreign subsidiary. This gain is partially offset by a litigation settlement.
The $15 million change in other income and (expenses)--net for 1997, as
compared to 1996, is due, in part, to charges in 1996 of approximately $14
million associated with the disallowance of information system costs related to
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.
INTEREST
The $21 million (10%) increase in interest expense in 1997, as compared to 1996,
is due to higher short-term borrowings used to fund the redemption of first
mortgage bonds by CG&E and Cinergy's investments in non-regulated companies,
including Avon Energy.
INCOME TAXES
Income taxes decreased $96 million (45%) in 1998, as compared to 1997, due to a
decrease in taxable income over the prior year and the increased utilization of
foreign tax credits.
PREFERRED DIVIDEND REQUIREMENTS OF SUBSIDIARIES
The decrease in preferred dividend requirements of subsidiaries of $6 million
(48%) for 1998, as compared to 1997, is primarily attributable to PSI's
redemption of all outstanding shares of its 7.44% Series Cumulative Preferred
Stock on March 1, 1998.
Preferred dividend requirements of subsidiaries decreased $11 million (46%)
in 1997, when compared to 1996. This decrease is 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
Extraordinary item-equity share of windfall profits tax represents the one-time
charge for the windfall profits tax levied against Midlands as recorded in 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) 1998 1997 1996
<S> <C> <C> <C>
- ----------------------------------------------------------------------------------------------
OPERATING REVENUES
Electric $4 747 235 $3 861 698 $2 768 706
Gas 1 060 664 491 145 474 035
Other 68 395 34 258 33 446
- ----------------------------------------------------------------------------------------------
5 876 294 4 387 101 3 276 187
OPERATING EXPENSES
Fuel and purchased and exchanged power 2 846 323 1 912 793 872 088
Gas purchased 857 010 266 158 249 116
Other operation and maintenance 1 006 382 869 867 838 218
Depreciation and amortization 325 515 306 922 294 852
Taxes other than income taxes 274 635 265 693 258 375
- ----------------------------------------------------------------------------------------------
5 309 865 3 621 433 2 512 649
OPERATING INCOME 566 429 765 668 763 538
EQUITY IN EARNINGS OF UNCONSOLIDATED SUBSIDIARIES 51 484 60 392 25 430
OTHER INCOME AND (EXPENSES)--NET 10 346 (1 534) (16 652)
INTEREST 243 587 236 319 215 603
- ----------------------------------------------------------------------------------------------
INCOME BEFORE TAXES 384 672 588 207 556 713
INCOME TAXES (Note 11) 117 187 213 000 198 736
PREFERRED DIVIDEND REQUIREMENTS OF SUBSIDIARIES 6 517 12 569 23 180
- ----------------------------------------------------------------------------------------------
NET INCOME BEFORE EXTRAORDINARY ITEM $ 260 968 $ 362 638 $ 334 797
EXTRAORDINARY ITEM--EQUITY SHARE OF WINDFALL PROFITS TAX
(LESS APPLICABLE INCOME TAXES OF $0) (Note 17) -- (109 400) --
- ----------------------------------------------------------------------------------------------
NET INCOME $ 260 968 $ 253 238 $ 334 797
AVERAGE COMMON SHARES OUTSTANDING 158 238 157 685 157 678
EARNINGS PER COMMON SHARE (Note 16)
Net income before extraordinary item $1.65 $2.30 $2.00
Net income $1.65 $1.61 $2.00
EARNINGS PER COMMON SHARE--ASSUMING
DILUTION (Note 16)
Net income before extraordinary item $1.65 $2.28 $1.99
Net income $1.65 $1.59 $1.99
DIVIDENDS DECLARED PER COMMON SHARE $1.80 $1.80 $1.74
</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 1998 1997
<S> <C> <C>
- --------------------------------------------------------------------------------------------
ASSETS
CURRENT ASSETS
Cash and temporary cash investments $ 100 154 $ 53 310
Restricted deposits 3 587 2 319
Notes receivable 64 110
Accounts receivable less accumulated provision for doubtful
accounts of $25,622 at December 31, 1998, and $10,382 at
December 31, 1997 (Note 6) 580 305 413 516
Materials, supplies, and fuel - at average cost 202 747 163 156
Prepayments and other 74 849 38 171
Energy risk management assets (Note 1(c)) 969 000 -
- --------------------------------------------------------------------------------------------
1 930 706 670 582
UTILITY PLANT - ORIGINAL COST
In service
Electric 9 222 261 8 981 182
Gas 786 188 746 903
Common 186 364 186 078
- --------------------------------------------------------------------------------------------
10 194 813 9 914 163
Accumulated depreciation 4 040 247 3 800 322
- --------------------------------------------------------------------------------------------
6 154 566 6 113 841
Construction work in progress 189 883 183 262
- --------------------------------------------------------------------------------------------
Total utility plant 6 344 449 6 297 103
OTHER ASSETS
Regulatory assets (Note 1(f)) 970 767 1 076 851
Investments in unconsolidated subsidiaries (Note 10) 574 401 537 720
Other 478 472 275 897
- --------------------------------------------------------------------------------------------
2 023 640 1 890 468
$10 298 795 $8 858 153
- --------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
A-21
<PAGE>
<TABLE>
<CAPTION>
(dollars in thousands) December 31 1998 1997
<S> <C> <C>
- --------------------------------------------------------------------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 668 860 $ 488 716
Accrued taxes 228 347 187 033
Accrued interest 51 679 46 622
Notes payable and other short-term obligations (Note 5) 903 700 1 114 028
Long-term debt due within one year (Note 4) 136 000 85 000
Energy risk management liabilities (Note 1(c)) 1 117 146 -
Other 93 376 79 193
- --------------------------------------------------------------------------------------------
3 199 108 2 000 592
NON-CURRENT LIABILITIES
Long-term debt (Note 4) 2 604 467 2 150 902
Deferred income taxes (Note 11) 1 091 075 1 248 543
Unamortized investment tax credits 156 757 166 262
Accrued pension and other postretirement benefit costs (Note 9) 315 147 297 142
Other 298 370 277 523
- --------------------------------------------------------------------------------------------
4 465 816 4 140 372
Total liabilities 7 664 924 6 140 964
CUMULATIVE PREFERRED STOCK OF SUBSIDIARIES (Note 3)
Not subject to mandatory redemption 92 640 177 989
COMMON STOCK EQUITY (Note 2)
Common stock - $.01 par value; authorized shares - 600,000,000;
outstanding shares - 158,664,532 in 1998 and 157,744,658 in 1997 1 587 1 577
Paid-in capital 1 595 237 1 573 064
Retained earnings 945 214 967 420
Accumulated other comprehensive loss (807) (2 861)
- --------------------------------------------------------------------------------------------
Total common stock equity 2 541 231 2 539 200
COMMITMENTS AND CONTINGENCIES (Note 12)
$10 298 795 $8 858 153
- --------------------------------------------------------------------------------------------
</TABLE>
A-22
<PAGE>
CONSOLIDATED STATEMENTS OF CHANGES IN COMMON STOCK EQUITY
<TABLE>
<CAPTION>
Accumulated
Other Total
Common Paid-in Retained Comprehensive Comprehensive Total Common
(dollars in thousands) Stock Capital Earnings Loss Income Stock Equity
<S> <C> <C> <C> <C> <C> <C>
- ---------------------------------------------------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 1995 $ 1 577 $ 1 597 050 $ 951 290 $ (1 074) $ 2 548 843
Comprehensive income
Net income 334 797 $ 334 797 334 797
Other comprehensive income, net of tax
effect of $179
Foreign currency translation
adjustment (131) (131)
Minimum pension liability adjustment (179) (179)
-------------
Other comprehensive loss total (310) (310)
-------------
Comprehensive income total $ 334 487
-------------
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 C-20
for per share amounts) (274 358) (274 358)
Costs of reacquisition of preferred
stock of subsidiary (18 391) (18 391)
Other (338) 188 (150)
----------- ----------- ---------- ------------- -------------
BALANCE AT DECEMBER 31, 1996 $ 1 577 $ 1 590 735 $ 993 526 $ (1 384) $ 2 584 454
Comprehensive income
Net income 253 238 $ 253 238 253 238
Other comprehensive income, net of tax
effect of $1,595
Foreign currency translation
adjustment (394) (394)
Minimum pension liability adjustment (1 083) (1 083)
-------------
Other comprehensive loss total (1 477) (1 477)
-------------
Comprehensive income total $ 251 761
-------------
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 C-20
for per share amounts) (283 866) (283 866)
Other (267) 4 522 4 255
----------- ----------- ---------- ------------- -------------
BALANCE AT DECEMBER 31, 1997 $ 1 577 $ 1 573 064 $ 967 420 $ (2 861) $ 2 539 200
COMPREHENSIVE INCOME
NET INCOME 260 968 $ 260 968 260 968
OTHER COMPREHENSIVE INCOME, NET OF TAX
EFFECT OF $(1,813)
FOREIGN CURRENCY TRANSLATION
ADJUSTMENT 2 160 2 160
MINIMUM PENSION LIABILITY ADJUSTMENT (106) (106)
-------------
OTHER COMPREHENSIVE INCOME TOTAL 2 054 2 054
-------------
COMPREHENSIVE INCOME TOTAL $ 263 022
-------------
ISSUANCE OF 919,874 SHARES OF COMMON
STOCK - NET 10 30 225 30 235
TREASURY SHARES PURCHASED (3) (15 426) (15 429)
TREASURY SHARES REISSUED 3 7 325 7 328
DIVIDENDS ON COMMON STOCK (see page C-20
for per share amounts) (284 703) (284 703)
OTHER 49 1 529 1 578
----------- ----------- ---------- ------------- -------------
BALANCE AT DECEMBER 31, 1998 $ 1 587 $ 1 595 237 $ 945 214 $ (807) $ 2 541 231
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
A-23
<PAGE>
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
(in thousands) 1998 1997 1996
<S> <C> <C> <C>
- ------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net income $ 260 968 $ 253 238 $ 334 797
Items providing or (using) cash currently:
Depreciation and amortization 325 515 306 922 294 852
Wabash Valley Power Association, Inc. settlement 80 000 - (80 000)
Deferred income taxes and investment tax credits - net (107 835) 67 638 47 912
Unrealized loss from energy risk management activities 135 000 15 000 -
Equity in earnings of unconsolidated subsidiaries (45 374) (35 239) (25 430)
Extraordinary item - equity share of windfall profits tax - 109 400 -
Allowance for equity funds used during construction (1 668) (98) (1 225)
Regulatory assets - net 46 856 33 605 (17 135)
Changes in current assets and current liabilities
Restricted deposits (1 268) (598) (358)
Accounts and notes receivable (45 811) (217 157) 132 749
Materials, supplies, and fuel (33 484) 21 817 44 005
Accounts payable 44 535 183 296 37 281
Accrued taxes and interest 46 371 (21 414) (1 289)
Other current assets and liabilities (9 495) (36 582) 52 749
Other items - net 29 698 53 750 (8 161)
- ------------------------------------------------------------------------------------------------
Net cash provided by operating activities 724 008 733 578 810 747
FINANCING ACTIVITIES
Change in short-term debt (245 413) 191 811 572 417
Issuance of long-term debt 785 554 100 062 150 217
Redemption of long-term debt (384 520) (336 312) (237 183)
Funds on deposit from issuance of long-term debt - - 973
Retirement of preferred stock of subsidiaries (85 299) (16 269) (212 487)
Issuance of common stock 3 724 2 066 311
Dividends on common stock (283 884) (283 866) (274 358)
- ------------------------------------------------------------------------------------------------
Net cash used in financing activities (209 838) (342 508) (110)
INVESTING ACTIVITIES
Construction expenditures (less allowance for equity funds
used during construction) (368 609) (328 055) (323 013)
Acquisition of businesses (net of cash acquired) (63 412) - -
Investments in unconsolidated subsidiaries (35 305) (29 032) (503 349)
- ------------------------------------------------------------------------------------------------
Net cash used in investing activities (467 326) (357 087) (826 362)
Net increase (decrease) in cash and temporary cash
investments 46 844 33 983 (15 725)
Cash and temporary cash investments at beginning of period 53 310 19 327 35 052
- ------------------------------------------------------------------------------------------------
Cash and temporary cash investments at end of period $ 100 154 $ 53 310 $ 19 327
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid during the year for:
Interest (net of amount capitalized) $ 229 501 $ 235 948 $ 207 393
Income taxes 179 677 140 655 141 917
- ------------------------------------------------------------------------------------------------
</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 The Cincinnati Gas & Electric
Company ("CG&E") and PSI Resources, Inc. ("Resources"). Cinergy's utility
subsidiaries are CG&E and PSI Energy, Inc. ("PSI"). CG&E, an Ohio combination
electric and gas public utility company, and its five wholly-owned utility
subsidiaries (including The Union Light, Heat and Power Company, a Kentucky
combination electric and gas utility ("ULH&P")), 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 public 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 is
derived from the sale of electricity and the sale and transportation of natural
gas.
Cinergy's non-utility subsidiaries are Cinergy Investments, Inc.
("Investments"), Cinergy Services, Inc. ("Services"), and Cinergy Global
Resources, Inc. ("Global Resources"). Investments, a Delaware corporation, is a
non-utility subholding company that holds virtually all of Cinergy's domestic
non-utility businesses and interests. Services, a Delaware corporation, is the
service company for the Cinergy system, providing member companies with a
variety of administrative, management, and support services. Global Resources, a
Delaware corporation, was formed in May 1998, and holds Cinergy's international
businesses and certain other interests.
Cinergy conducts its operations through various subsidiaries and affiliates.
The Company is functionally organized into four business units through which
many of its activities are conducted: Energy Commodities Business Unit ("ECBU"),
Energy Delivery Business Unit ("EDBU"), Energy Services Business Unit ("ESBU"),
and the International Business Unit ("IBU"). The traditional,
vertically-integrated utility functions have been realigned into the ECBU, EDBU,
and ESBU. Each of these business units is described in detail along with certain
financial information by business unit as of December 31, 1998, in Note 15. As
the industry continues its evolution, Cinergy will continually analyze its
operating structure and make adjustments as appropriate. In early 1999, certain
organizational changes were begun to further align the business units to reflect
Cinergy's strategic vision.
(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. These estimates and assumptions affect the reported amounts of
assets and liabilities and the disclosures 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.
The Consolidated Statements of Income have been reclassified in order to
present the operations of all consolidated, non-regulated entities as a
component of operating income. Prior to this reclassification, the operations of
such entities were reflected in "Other Income and Expenses - Net." Similarly,
"Income Taxes" now includes the income taxes associated with the non-regulated
entities. These changes had no effect on net income. Additionally, the
Consolidated Balance Sheets have been reformatted. Prior years' data has been
reclassified to conform to the current year's presentation.
(c) ENERGY MARKETING AND TRADING
Cinergy's energy marketing and trading operations, conducted primarily through
its ECBU, markets and trades electricity, natural gas, and other energy-related
products. The power marketing and trading operation has both physical and
trading activities. Generation not required to meet native load requirements is
available to be sold to third parties, either under long-term contracts, such as
full requirements transactions or firm forward sales contracts, or in short-term
and spot market transactions. When transactions are entered into, each
transaction is designated as either a physical or trading transaction. In order
for a transaction to be designated as physical, there must be intent and ability
to physically deliver the power from company-owned generation. Physical
transactions are accounted for on a settlement basis. All other transactions are
considered trading transactions and
A-25
<PAGE>
are accounted for using the mark-to-market method of accounting. Under the
mark-to-market method of accounting, these trading transactions are reflected at
fair value as "Energy risk management assets" and "Energy risk management
liabilities". Changes in fair value, resulting in unrealized gains and losses,
are reflected in "Fuel and purchased and exchanged power". Revenues and costs
for all transactions are recorded gross in the Consolidated Statements of Income
as contracts are settled. Revenues are recognized in "Operating
Revenues - Electric" and costs are recorded in "Fuel and purchased and exchanged
power".
Although physical transactions are entered with the intent and ability to
settle the contract with company-owned generation, it is likely, that from time
to time, due to numerous factors such as generating station outages, native load
requirements, and weather, power used to settle the physical transactions will
be required to be purchased on the open market. Depending on the factors giving
rise to these open market purchases, the cost of such purchases could be in
excess of the associated revenues. Losses such as this will be recognized as the
power is delivered. In addition, physical contracts are subject to permanent
impairment tests. At December 31, 1998, management has concluded that no
physical contracts are impaired.
At December 31, 1998, the trading portfolio consisted of "Energy risk
management assets" of $969 million and "Energy risk management liabilities" of
$1,117 million. Prior to December 31, 1998, the transactions now included in the
trading portfolio were accounted for and valued at the aggregate lower of cost
or market. Under this method, only the net value of the entire portfolio was
recorded as a liability in the Consolidated Balance Sheets. The net liability
was not significant at December 31, 1997.
Contracts in the trading portfolio are valued at end-of-period market prices,
utilizing factors such as closing exchange prices, broker and over-the-counter
quotations, and model pricing. Model pricing considers time value and volatility
factors underlying any options and contractual commitments. Management expects
that some of these obligations, even though considered as trading contracts,
will ultimately be settled from time to time by using company-owned generation.
The cost of this generation is typically below the market prices at which the
trading portfolio has been valued.
Because of the volatility currently experienced in the power markets, and the
factors discussed above pertaining to both the physical and trading activities,
volatility in future earnings (losses) from period to period in the ECBU is
likely.
As a result of the acquisitions of Producers Energy Marketing, LLC
("ProEnergy") in 1998 and Greenwich Energy Partners in 1997, the ECBU also
physically markets natural gas and trades natural gas and other energy-related
products. All of these operations are accounted for on the mark-to-market method
of accounting. Revenues and costs from physical marketing are recorded gross in
the Consolidated Statements of Income as contracts are settled due to the
exchanging of title to the natural gas throughout the earnings process. Realized
revenues for 1998 were approximately $650 million. There were no such revenues
prior to 1998. All non-physical transactions are recorded net in the
Consolidated Statements of Income. Energy risk management assets and liabilities
and gross margins from trading activities were not significant at December 31,
1998 and 1997 or for each of the three years ended December 31, 1998.
(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.
Cinergy and its subsidiaries utilize foreign exchange forward contracts and
currency swaps to hedge certain of their net investments in foreign operations.
Accordingly, any translation gains or losses related to the foreign exchange
forward contracts or the principal exchange on the currency swaps are recorded
in "Accumulated other comprehensive loss", which is a separate component of
Common Stock Equity. Aggregate translation losses related to these instruments
are reflected in Current Liabilities 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" as realized over the life of the agreement.
A-26
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(e) 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.
(f) REGULATION
Cinergy, its utility subsidiaries, 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, 1998, 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. The regulatory assets of CG&E and its
utility subsidiaries and PSI as of December 31 are as follows:
<TABLE>
<CAPTION>
1998 1997
- -------------------------------------------------------------------------------------------------------------------------
(in millions) CG&E(1) PSI CINERGY CG&E(1) PSI Cinergy
<S> <C> <C> <C> <C> <C> <C>
- -------------------------------------------------------------------------------------------------------------------------
Amounts due from customers - income taxes(2) $331 $ 26 $357 $350 $ 24 $ 374
Post-in-service carrying costs and deferred operating expenses 128 43 171 135 44 179
Coal contract buyout costs - 99 99 - 122 122
Deferred demand-side management ("DSM") costs 40 43 83 39 71 110
Phase-in deferred return and depreciation(3) 75 - 75 90 - 90
Deferred merger costs 16 69 85 16 74 90
Unamortized costs of reacquiring debt 34 29 63 36 30 66
Coal gasification services expenses - 19 19 - 22 22
Other 3 16 19 2 22 24
- -------------------------------------------------------------------------------------------------------------------------
Total $627 $344 $971 $668 $409 $1 077
</TABLE>
(1) Includes $11 million related to ULH&P (for DSM, unamortized costs of
reacquiring debt and other regulatory assets) at both December 31, 1998, and
1997.
(2) Income tax provisions reflected in customer rates are regulated by the
various regulatory commissions overseeing the regulated business operations
of CG&E and its utility subsidiaries and PSI. In accordance with the
provisions of Statement 71, Cinergy, CG&E, and PSI have recorded a net
regulatory asset representing the probable recovery from customers of
additional income taxes established under Statement 109. ULH&P has recorded
a regulatory liability representing the probable repayment to customers of
income taxes established under Statement 109 to the extent deferred income
taxes recovered in rates exceed amounts payable in future periods.
(3) Pursuant to an order from the Public Utilities Commission of Ohio, CG&E is
recovering this asset over a seven-year period which began in May 1995.
A-27
<PAGE>
CG&E has previously received regulatory orders authorizing the recovery of
$553 million of its total regulatory assets at December 31, 1998. PSI has
previously received regulatory orders authorizing the recovery of $334 million
of its total regulatory assets at December 31, 1998. The recovery of these
assets is being reflected in rates charged to customers over a period ranging
from 1 to 33 years. Both CG&E and PSI will request recovery of additional
amounts in future proceedings. These proceedings, if any, may be related to the
transition to customer choice in each applicable jurisdiction.
(g) 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.
(h) AFUDC
In accordance with the uniform systems of accounts prescribed by regulatory
authorities, Cinergy's utility subsidiaries capitalize AFUDC, a non-cash income
item, which is defined 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." The borrowed funds component of AFUDC, which
is recorded on a pre-tax basis was $7.5 million, $5.4 million, and $6.2 million
for 1998, 1997, and 1996, respectively. AFUDC accrual rates are compounded
semi-annually and averaged 6.6% in 1998, 6.3% in 1997, and 7.1% in 1996.
(i) 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>
1998 1997 1996
<S> <C> <C> <C>
- -------------------------------------------------------------------------
CG&E and its utility subsidiaries
Electric 2.9% 2.9% 2.9%
Gas 2.9 2.9 2.8
Common 2.6 3.0 3.0
PSI 3.0 3.0 3.0
</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.
(j) OPERATING REVENUES
AND FUEL COSTS
Cinergy's utility subsidiaries record revenues for electric and gas service
provided during the month, including sales unbilled at the end of each month.
The costs of electricity and gas purchased and fuel used in electric production
are expensed as recovered through revenues and any portion of these costs
recoverable or refundable in future periods is deferred in either "Accounts
receivable" or "Accounts payable" in the accompanying Balance Sheets. Indiana
law subjects the recovery of fuel costs to a determination that such recovery
will not result in earning a return in excess of that allowed by the Indiana
Utility Regulatory Commission ("IURC") in its last general rate order.
(k) 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 and Note 18 for information
concerning a non-cash financing transaction.
(l) TRANSLATION OF FOREIGN CURRENCY
All assets and liabilities reported in the balance sheets of foreign
subsidiaries whose functional currency is other than the United States ("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 recorded in
"Accumulated other comprehensive loss", which is a separate component of common
stock equity.
A-28
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(m) ACCOUNTING CHANGES
Effective with the first quarter of 1998, Cinergy and its subsidiaries adopted
the provisions of Statement of Financial Accounting Standards No. 130, Reporting
Comprehensive Income ("Statement 130"). Statement 130 establishes standards for
reporting and displaying comprehensive income and its components in a full set
of general-purpose financial statements. Comprehensive income per Statement 130
is defined as "the change in equity of a business enterprise during a period
from transactions and other events and circumstances from nonowner sources."
In December 1998, the Company implemented the provisions of the Emerging
Issues Task Force Issue No. 98-10, "Accounting for Contracts Involved in Energy
Trading and Risk Management Activities." For a detailed discussion of the
Company's energy trading and risk management activities, refer to Note 1(c).
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, 1998, and shares issued in 1998, 1997, and 1996 for the
Company's stock-based plans.
<TABLE>
<CAPTION>
SHARES
RESERVED AT Shares Issued
DEC. 31, 1998 1998 1997 1996
<S> <C> <C> <C> <C>
- -----------------------------------------------------------------------------------------------------------------------
1996 Long-term Incentive Compensation Plan ("LTIP") 6 956 386 - 43 614 -
Stock Option Plan 4 366 186 192 591 22 219 15 007
Performance Shares Plan ("PSP") 771 301 - - 492
Employee Stock Purchase and Savings Plan 1 931 378 1 006 - -
401(k) Savings Plans 6 469 373 - - -
Dividend Reinvestment and Stock Purchase Plan 1 798 486 - - -
Directors' Deferred Compensation Plan 200 000 - - -
</TABLE>
Cinergy retired 44,981; 304; and 6,511 shares of common stock in 1998, 1997,
and 1996, respectively, primarily representing shares tendered as payment for
the exercise of previously granted stock options.
In June 1998, Cinergy issued 771,258 shares of new common stock to acquire
ProEnergy.
(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 1998, 1997,
and 1996, compensation cost related to Cinergy's stock-based compensation plans,
before income taxes, recognized in the Consolidated Statements of Income was $1
million, $6 million, and $2 million, respectively.
A-29
<PAGE>
Net income and earnings per share ("EPS") for 1998, 1997, and 1996, 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) 1998 1997 1996
<S> <C> <C> <C> <C>
- -----------------------------------------------------------
Net income - as reported $ 261 $ 253 $ 335
- pro forma $ 258 $ 251 $ 334
EPS - as reported $ 1.65 $ 1.61 $ 2.00
- pro forma $ 1.63 $ 1.59 $ 1.99
Diluted EPS - as reported $ 1.65 $ 1.59 $ 1.99
- pro forma $ 1.62 $ 1.58 $ 1.99
</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 EPS 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.
(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
with the exception of participants that retire. Their shares become vested upon
retirement. Participants' shares that are not vested become forfeited when the
participant leaves Cinergy. 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 1998 and 1997, 41,129 and 425,938 performance-based restricted shares
at a weighted average price of $34.69 and $29.95, respectively, were granted to
certain key employees. As of December 31, 1998, Cinergy held a total of 442,941
performance-based restricted shares. 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 1998 and 1997 is summarized as follows:
<TABLE>
<CAPTION>
1998 1997
----------------- -----------------
WEIGHTED Weighted
AVERAGE Average
EXERCISE Exercise
NUMBER PRICE Number Price
<S> <C> <C> <C> <C>
- --------------------------------------------------------------------------
Outstanding, beginning of year 369 600 $33.60 - -
Granted 471 400 38.19 369 600 $33.60
Forfeited (68 000) 36.06 - -
- -------------------------------------------- -------
Outstanding, end of year 773 000 $36.19 369 600 $33.60
- -------------------------------------------- -------
Exercisable, end of year 11 600 $36.05 - -
Weighted average fair value of
options granted during the year $4.68 $3.54
</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>
1998 1997
<S> <C> <C>
- ---------------------------------------------------------------------
Risk-free interest rate 5.6% 6.2%
Expected dividend yield 4.8% 5.4%
Expected lives 5.6 YRS 5.4yrs.
Expected common stock variance 1.8% 1.7%
</TABLE>
The price range for the options outstanding under the LTIP at December 31,
1998, was $33.50 - $38.59 and the weighted average contractual life was 8.7
years.
(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. The
activity under this plan has predominantly consisted of the issuance of stock
options. Options are granted at the fair market value of the shares on the date
of grant. Options generally 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-30
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Stock Option Plan activity for 1998, 1997, and 1996 is summarized as follows:
<TABLE>
<CAPTION>
1998 1997 1996
---------------------------------------------------------------
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 2 954 475 $23.79 3 334 637 $23.57 3 653 085 $22.47
Granted 480 000 36.88 - - 220 000 29.75
Exercised (430 961) 21.62 (380 162) 21.71 (513 448) 18.16
Forfeited (100 000) 26.92 - - (25 000) -
- ------------------------------------------------------------------ --------- ---------
Outstanding, end of year 2 903 514 $26.17 2 954 475 $23.79 3 334 637 $23.57
- ------------------------------------------------------------------ --------- ---------
Exercisable, end of year 1 535 514 $23.61 1 389 975 $22.58 1 131 637 $21.34
Weighted average fair value of options
granted during the year $4.53 $ - $3.07
</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 1998 and
1996 (no options were granted during 1997), were as follows:
<TABLE>
<CAPTION>
1998 1996
<S> <C> <C>
- ---------------------------------------------------------------------
Risk-free interest rate 5.6% 6.3%
Expected dividend yield 4.8% 5.8%
Expected lives 6.5 YRS 6.5yrs.
Expected common stock variance 2.0% 1.8%
</TABLE>
Price ranges, along with certain other information, for options outstanding
under the Stock Option Plan at December 31, 1998, 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>
- ------------------------------------------------------------ -------------------
$13.15 - $17.35.......... 99 638 $15.35 1.1 YRS. 99 638 $15.35
$22.88 - $25.19.......... 2 034 213 $23.61 6.0 YRS. 1 286 213 $23.73
$28.44 - $36.88.......... 769 663 $29.15 7.1 YRS. 149 663 $34.00
</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-31
<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 5%. 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.
The current offering period began January 1, 1997, and ended February 28, 1999.
The purchase price for all shares under this offering is $31.83. The previous
offering period ended December 31, 1996, with a purchase price of $21.73. 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 1998, 1997, and 1996 is
summarized as follows:
<TABLE>
<CAPTION>
1998 1997 1996
-------------------------------------------------------------------------
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 326 367 $ 31.83 - $ - 490 787 $ 21.73
Granted - 31.83 338 947 31.83 - -
Exercised (3 342) 31.83 (95) 31.83 (414 284) 21.73
Forfeited (25 651) 31.83 (12 485) 31.83 (76 503) 21.73
- ----------------------------------------------------------------- ---------- ----------
Outstanding, end of year 297 374 $ 31.83 326 367 $ 31.83 - $ -
- ----------------------------------------------------------------- ---------- ----------
Weighted average fair value of options granted during
the year $ - $3.08 $ -
</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 5.9%
Expected dividend yield 5.4%
Expected lives 2.0yrs.
Expected common stock variance 1.6%
</TABLE>
A-32
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3. PREFERRED STOCK OF SUBSIDIARIES
(a) SCHEDULE OF CUMULATIVE PREFERRED STOCK
<TABLE>
<CAPTION>
(dollars in thousands) December 31 1998 1997
<S> <C> <C> <C> <C> <C> <C> <C>
- --------------------------------------------------------------------------------------------------------------------------
Not subject to mandatory Par value $100 per share - authorized 6,000,000
CG&E redemption shares - outstanding
4% Series 169,834 shares in 1998 and 1997 $16 983 $ 16 983
shares in 1998 and 38,096 shares in
4 3/4% Series 37,335 1997 3 734 3 810
-----------------------------------------------------------------------------------
Total 20 717 20 793
Not subject to mandatory Par value $25 per share - authorized 5,000,000
PSI redemption shares - outstanding
4.32% Series 169,161 shares in 1998 and 1997 4 229 4 229
4.16% Series 148,763 shares in 1998 and 1997 3 719 3 719
7.44% Series 3,408,712 shares in 1997 - 85 218
Par value $100 per share - authorized 5,000,000
shares - outstanding
shares in 1998 and 40,302 shares in
3 1/2% Series 39,748 1997 3 975 4 030
6 7/8% Series 600,000 shares in 1998 and 1997 60 000 60 000
-----------------------------------------------------------------------------------
Total 71 923 157 196
TOTAL - CINERGY
Total not subject to mandatory
redemption $92 640 $177 989
</TABLE>
(b) CHANGES IN CUMULATIVE PREFERRED STOCK OUTSTANDING
<TABLE>
<CAPTION>
Shares
(dollars in thousands) Retired Par Value
<S> <C> <C> <C> <C> <C> <C>
- -----------------------------------------------------------------------------------------------------
NOT SUBJECT TO MANDATORY
1998 REDEMPTION PAR VALUE $100 PER SHARE
CG&E 4 3/4% SERIES 761 $ 76
PSI 3 1/2% SERIES 554 55
PAR VALUE $25 PER SHARE
PSI 7.44% SERIES 3 408 712 85 218
Not Subject to Mandatory
1997 Redemption Par value $100 per share
CG&E 4% Series 1 $ 1
4 3/4% Series 3 525 352
PSI 7.15% Series 158 640 15 864
3 1/2% Series 265 26
Par value $25 per share
PSI 4.32% Series 1 -
Not Subject to Mandatory
1996 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
</TABLE>
A-33
<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, made a capital contribution to CG&E of all
the shares, and CG&E subsequently 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 EPS applicable to common stock.
4. LONG-TERM DEBT
(a) SCHEDULE OF LONG-TERM DEBT (EXCLUDING AMOUNTS REFLECTED IN CURRENT
LIABILITIES)
<TABLE>
<CAPTION>
(dollars in thousands) December 31 1998 1997
<S> <C> <C> <C> <C> <C>
- -----------------------------------------------------------------------------------------------------------------------------
CINERGY
Other Long-term Debt 6.53% Debentures due December 16, 2008 $ 200 000 $ -
(87) -
Unamortized Discount
------------------------------------------------------------------------------
Total - Cinergy 199 913 -
GLOBAL RESOURCES
Other Long-term Debt 6.20% Debentures due November 3, 2008 150 000 -
Other 9 443 -
------------------------------------------------------------------------------
Total Other Long-term Debt 159 443 -
(326) -
Unamortized Premium and
Discount - Net
------------------------------------------------------------------------------
Total - Global Resources 159 117 -
CG&E AND SUBSIDIARIES
CG&E
First Mortgage Bonds 5.80% Series due February 15, 1999 - 110 000
7 3/8% Series due May 1, 1999 - 50 000
7 3/8% Series due November 1, 2001 - 60 000
7 1/4% Series due September 1, 2002 100 000 100 000
6.45% Series due February 15, 2004 110 000 110 000
8 1/2% Series due September 1, 2022 - 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 604 700 924 700
Pollution Control Notes 6.50% due November 15, 2022 12 721 12 721
Other Long-term Debt 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 6.50%
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 6.50% FIXED RATE
TO A
LONDON INTERBANK OFFERED RATE
("LIBOR")-BASED
FLOATING RATE AT ANY INTEREST RATE PAYMENT
DATE
BETWEEN OCTOBER 1, 1999 AND OCTOBER 1, 2002) 100 000 100 000
6.40% Debentures due April 1, 2008 100 000 -
6.90% Debentures due June 1, 2025
(REDEEMABLE AT THE OPTION OF THE HOLDERS ON
JUNE 1, 2005) 150 000 150 000
Junior Subordinated Debentures due July 1,
8.28% 2025 100 000 100 000
6.35% Debentures due June 15, 2038 100 000 -
------------------------------------------------------------------------------
Total Other Long-term Debt 550 000 350 000
(3 396) (8 860)
Unamortized Premium and
Discount - Net
------------------------------------------------------------------------------
Total - CG&E 1 164 025 1 278 561
</TABLE>
A-34
<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 1998 1997
<S> <C> <C> <C> <C> <C>
- -----------------------------------------------------------------------------------------------------------------------------
ULH&P First Mortgage Bonds 6 1/2% Series due August 1, 1999 - 20 000
8% Series due October 1, 2003 - 10 000
----------------------------------------------------------------------------------------------
Total First Mortgage Bonds - 30 000
Other Long-term Debt 6.11% Debentures due December 8, 2003 20 000 -
6.50% Debentures due April 30, 2008 20 000 -
7.65% Debentures due July 15, 2025 15 000 15 000
----------------------------------------------------------------------------------------------
Total Other Long-term Debt 55 000 15 000
Unamortized Premium
and Discount - Net (447) (329)
----------------------------------------------------------------------------------------------
Total - ULH&P 54 553 44 671
LAWRENCEBURG GAS
COMPANY First Mortgage Bonds 9 3/4% Series due October 1, 2001 1 200 1 200
----------------------------------------------------------------------------------------------
Total - CG&E and Subsidiaries 1 219 778 1 324 432
First Mortgage
PSI Bonds Series S, 7%, due January 1, 2002 - 26 429
Series Y, 7 5/8%, due January 1, 2007 - 24 140
Series QQ, 8 1/4%, due June 15, 2013 (Pollution Control) - 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 154 195 227 764
Secured
Medium-term
Notes Series A, 7.15% to 8.88%, due January 6, 1999 to June 1, 2022 284 000 290 000
to 8.26%, due September 19, 2000 to August 22,
Series B, 5.22% 2022 195 000 195 000
(SERIES A AND B, 7.83% WEIGHTED AVERAGE INTEREST
RATE
AND 14 YEAR WEIGHTED AVERAGE REMAINING LIFE)
-----------------------------------------------------------------------------------------------
Total Secured Medium-term Notes 479 000 485 000
Other Long-
term Debt Series 1994A Promissory Note, non-interest bearing, due January 3, 19 825 19 825
2001
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
6.35%
Debentures due December 14, 2016 (REDEEMABLE IN
WHOLE OR IN PART AT THE OPTION OF THE HOLDERS ON
DECEMBER 14, 2001) 50 000 -
6.00%
Synthetic Putable Yield Securities due August 1,
2026 50 000 -
6.50%
Junior Maturing Principal Securities due March
15, 2028 100 000 -
7.25%
Rural Utilities Service ("RUS") Obligation
payable in annual installments 85 620 -
6.00%
-----------------------------------------------------------------------------------------------
Total Other Long-term Debt 405 445 119 825
Unamortized Premium
and Discount - Net (12 981) (6 119)
-----------------------------------------------------------------------------------------------
Total - PSI 1 025 659 826 470
-----------------------------------------------------------------------------------------------
Total - Cinergy and Subsidiaries $ 2 604 467 $ 2 150 902
-----------------------------------------------------------------------------------------------
TOTAL - CINERGY CORP.
CONSOLIDATED
First Mortgage Bonds $ 760 095 $ 1 183 664
Secured Medium-term Notes 479 000 485 000
Pollution Control Notes 12 721 12 721
Other Long-term Debt 1 369 888 484 825
Unamortized Premium and Discount - Net (17 237) (15 308)
-----------------------------------------------------------------------------------------------
Total Long-term Debt $ 2 604 467 $ 2 150 902
</TABLE>
A-35
<PAGE>
(b) MANDATORY REDEMPTION AND OTHER REQUIREMENTS
Long-term debt maturities for the next five years (excluding callable and/or
putable debt) are as follows:
<TABLE>
<CAPTION>
(in Mandatory
millions) Redemptions
<S> <C>
- ------------------------
1999 $137
2000 32
2001 40
2002 124
2003 77
-----------
$410
</TABLE>
Maintenance and replacement fund provisions contained in PSI's first mortgage
bond indenture require cash payments, bond retirements, or pledges of unfunded
property additions each year based on an amount related to PSI's net revenues.
5. NOTES PAYABLE AND OTHER SHORT-TERM OBLIGATIONS
Notes payable and other short-term obligations and weighted average interest
rates were as follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1998 December 31, 1997
- -----------------------------------------------------------------------------------------------------------------------------------
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 $ 160 $ 160 5.61% $ 350 $ 350 6.25%
Revolving line 600 245 5.68 400 89 6.27
Commercial paper - 50 5.78 - 161 6.19
Uncommitted lines 45 50* 5.84 - - -
Utility subsidiaries
Committed lines 300 - - 270 30 6.09
Uncommitted lines 410 95 5.90 360 206 6.19
Pollution control notes 267 267 3.83 244 244 4.08
Non-utility subsidiary 138 37 13.11 115 34 7.20
----------- ----- ----------- -----------
Total $ 1 920 $ 904 5.20% $ 1 739 $ 1 114 5.78%
</TABLE>
* Excess over Established Line represents amount sold by dealers to other
investors.
Cinergy and its utility subsidiaries have arranged committed lines
("unsecured lines of credit"), as well as uncommitted lines (short-term
borrowings on an "as offered" basis) with various banks. The established
committed lines include $106 million designated as backup for certain of the
uncommitted lines at December 31, 1998. Further, the committed lines are
maintained by commitment fees, which were immaterial during the 1996 through
1998 period.
Cinergy's committed lines are comprised of an acquisition line and a
revolving line. The established revolving line also provides credit support for
Cinergy's commercial paper program, which is limited to a maximum outstanding
principal amount of $400 million. The proceeds from the commercial paper sales
were used for general corporate purposes. Proceeds from the sale of Cinergy's
6.53% debentures were used to reduce the acquisition line to the year-end level
of $160 million.
Global Resources established a $100 million revolving credit agreement in
1998, which is due to expire in March 1999.
CG&E and PSI also have the capacity to issue commercial paper that must be
supported by committed lines of the respective company. Neither CG&E nor PSI
issued commercial paper in 1998 or 1997.
Amounts outstanding under the committed lines for Cinergy, the utility
subsidiaries, and the non-utility subsidiary 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-36
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
6. SALE OF ACCOUNTS RECEIVABLE
In 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. As of December 31, 1998, $253 million,
net of reserves, has been sold. The Consolidated Balance Sheets are net of the
amounts sold at December 31, 1998 and 1997.
7. LEASES
(a) OPERATING LEASES
Cinergy and its subsidiaries have entered into operating lease agreements
covering various facilities and properties, including computer, communications,
and transportation equipment and office space. Total rental payments on
operating leases were $42 million for 1998, $36 million for 1997, and $31
million for 1996.
Future minimum lease payments required under operating leases with remaining,
non-cancelable lease terms in excess of one year as of December 31, 1998, are as
follows:
<TABLE>
<S> <C>
Minimum
(in millions) Payments
- ----------------------------------------------------------
1999 $ 38
2000 31
2001 22
2002 14
2003 10
After 2003 36
- ----------------------------------------------------------
Total $151
</TABLE>
(b) CAPITAL LEASE
In 1996, CG&E entered into a sale-leaseback agreement for certain equipment at
Woodsdale Generating Station. 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 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, included in
Non-Current Liabilities, 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. Cinergy has also hedged certain of its net investments in the Czech
Republic utilizing foreign exchange forward contracts. Translation gains and
losses related to the forward foreign exchange contracts and the principal
exchange on the currency swap have primarily been recorded in "Accumulated other
comprehensive loss", which is reported as a separate component of common stock
equity in the Consolidated Financial Statements. At December 31, 1998, aggregate
translation losses of approximately $49 million, related to the foreign exchange
forward contracts and the principal exchange of the currency swap, have been
reflected in Current Liabilities in the Consolidated Balance Sheets. At December
31, 1998, the fair value of these contracts was approximately $(66) million.
(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. Cinergy has effectively fixed the interest rate applicable to the pound
sterling denominated leg of its currency swap for its remaining term through an
interest rate swap agreement. This contract requires Cinergy to pay a fixed rate
and receive a floating rate. This contract has a total notional principal amount
of 280 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. The fair value of this interest rate swap agreement at December 31,
1998, was approximately $(19) million.
At December 31, 1998, CG&E had an interest rate swap agreement outstanding
related to its sale of accounts receivable. The contract has a notional
A-37
<PAGE>
amount of $100 million and requires CG&E to pay a fixed rate and receive a
floating rate. PSI had three interest rate swap agreements outstanding with
notional amounts of $100 million each. One contract, with two years remaining of
a four-year term, requires PSI to pay a floating rate and receive a fixed rate.
The other two contracts, with six-month terms, require PSI to pay a fixed rate
and receive a floating rate. The floating rate is based on applicable LIBOR. At
December 31, 1998, the fair values of these interest rate swap agreements 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, 1998 December 31, 1997
- ------------------------------------------------------------------------------
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) $2 740 $2 934 $2 236 $2 337
</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 New York Stock Exchange, 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 the ESBU's trade accounts
receivable from electric and gas retail customers is limited due to the large
number of customers and diversified customer base of residential, commercial,
and industrial customers. Contracts within the physical power portfolio of the
ECBU's power marketing and trading operations are primarily with traditional
electric cooperatives and municipalities and other investor-owned utilities.
Contracts within the trading portfolio of the power marketing and trading
operations are primarily with power marketers and other investor-owned
utilities. As of December 31, 1998, approximately 73% of the activity within the
trading portfolio represents commitments with 10 counterparties. The majority of
these contracts are for terms of one year or less. As a result of the extreme
volatility experienced in the Midwest power markets during 1998, several new
entrants into the market began experiencing financial difficulties and failed to
perform their contractual obligations. As a result, the bad debt provisions of
approximately $13 million with respect to settled transactions were recorded
during the year. Counterparty credit exposure within the power trading portfolio
is routinely factored into the mark-to-market valuation. At December 31, 1998,
credit exposure within the power trading portfolio is not believed to be
significant. Prior to 1998, credit exposure due to nonperformance by
counterparties was not significant. As the competitive electric power market
continues to develop, counterparties will increasingly include new market
entrants, such as other power marketers, brokers, and commodity traders. This
increased level of new market entrants, as well as competitive pressures on
existing market participants, could increase the ECBU's exposure to credit risk
with respect to its power marketing and trading operation. As of December 31,
1998, approximately 37% of the activity within the ECBU's physical gas marketing
and trading portfolio represents commitments with 10 counterparties. Credit risk
losses related to the ECBU's gas and other commodity physical and trading
operations have not been significant. Based on the types of counterparties and
customers with which transactions are executed, credit exposure within the gas
and other commodity trading portfolios is not believed to be significant.
Potential exposure to credit risk also exists from Cinergy's use of financial
derivatives such as currency swaps, foreign exchange forward contracts, 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-38
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
9. PENSION AND OTHER
POSTRETIREMENT BENEFITS
Cinergy's defined benefit pension plans cover substantially all US 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.
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. The
reconfiguration of the pension plans did not have a significant impact on the
Company's financial condition or results of operations.
Cinergy's pension plan funding policy for US employees is to contribute
annually 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. The pension plans' assets consist of
investments in equity and fixed income securities.
Cinergy provides certain health care and life insurance benefits to retired
US employees and their eligible dependents, if the retiree has met minimum age
and service requirements. 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 US 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. CG&E does not pre-fund its obligations for these
postretirement benefits. PSI is pre-funding its obligations as authorized by the
IURC.
Cinergy's benefit plans' cost for 1998, 1997, and 1996 included the following
components:
<TABLE>
<CAPTION>
Other
Pension Postretirement
Benefits Benefits
- ------------------------------------------------------------- -------------------
(in millions) 1998 1997 1996 1998 1997 1996
<S> <C> <C> <C> <C> <C> <C>
- ----------------------------------------------------------------------------------
Service cost $21.8 $19.8 $21.2 $ 4.1 $ 3.1 $ 5.8
Interest cost 71.6 67.8 61.6 16.1 16.3 18.7
Expected return on plans' assets (66.9) (62.8) (61.2) - - -
Amortization of transition
obligation/(asset) (1.3) (1.3) (1.3) 5.0 5.0 8.4
Amortization of prior service cost 4.4 4.4 4.5 - - -
Recognized actuarial loss - (.3) (.3) .4 .3 .3
- ----------------------------------------------------------------------------------
Net periodic benefit cost $29.6 $27.6 $24.5 $25.6 $24.7 $33.2
</TABLE>
During 1996, CG&E and its subsidiaries (including ULH&P) recognized an
additional $31 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
("Statement 88"). Additionally, during 1996, PSI recognized an additional $30
million of accrued pension cost in accordance with Statement 88. These amounts
represent the costs associated with additional benefits extended in connection
with voluntary workforce reduction programs.
<TABLE>
<CAPTION>
Other
Pension Postretirement
Benefits Benefits
<S> <C> <C> <C> <C> <C> <C>
- ----------------------------------------------------------- -----------------
(in millions) 1998 1997 1996 1998 1997 1996
- ------------------------------------------------------------------------------
Actuarial Assumptions:
Discount rate 6.75% 7.5% 8.0% 6.75% 7.5% 8.0%
Rate of future compensation increase 3.75% 4.5% 5.0% N/A n/a n/a
Rate of return on plans' assets 9.00% 9.0% 9.0% N/A n/a n/a
</TABLE>
For measurement purposes, a 7% annual rate of increase in the per capita cost
of covered health care benefits was assumed for 1999. The rate was assumed to
decrease gradually to 5% for 2004 and remain at that level thereafter.
A-39
<PAGE>
The following table provides a reconciliation of the changes in the plans'
benefit obligations and fair value of assets over the two-year period ended
December 31, 1998, and a statement of the funded status as of December 31 of
both years.
<TABLE>
<CAPTION>
Other Postretirement
Pension Benefits Benefits
- --------------------------------------------------------------------------------------------------------- --------------------
(in millions) 1998 1997 1998 1997
<S> <C> <C> <C> <C>
- -------------------------------------------------------------------------------------------------------------------------------
CHANGE IN BENEFIT OBLIGATION
Benefit obligation at beginning of period $ 960.3 $ 877.4 $ 221.9 $ 211.0
Service cost 21.8 19.8 4.1 3.1
Interest cost 71.6 67.8 16.1 16.3
Amendments 1.0 - - -
Actuarial gain 53.6 65.4 17.4 3.7
Benefits paid (56.2) (70.1) (13.0) (12.2)
- -------------------------------------------------------------------------------------------------------------------------------
Benefit obligation at end of period 1 052.1 960.3 246.5 221.9
- -------------------------------------------------------------------------------------------------------------------------------
CHANGE IN PLAN ASSETS
Fair value of plan assets at beginning of period 888.1 764.1 - -
Actual return on plan assets 9.9 186.6 - -
Employer contribution 23.5 7.5 13.0 12.2
Benefits paid (56.2) (70.1) (13.0) (12.2)
- -------------------------------------------------------------------------------------------------------------------------------
Fair value of plan assets at end of period 865.3 888.1 - -
- -------------------------------------------------------------------------------------------------------------------------------
FUNDED STATUS (186.8) (72.2) (246.5) (221.9)
Unrecognized prior service cost 43.3 46.6 - -
Unrecognized net actuarial (gain)/loss (24.1) (134.6) 40.3 22.6
Unrecognized net plan assets (7.1) (8.5) 65.8 70.9
- -------------------------------------------------------------------------------------------------------------------------------
Accrued benefit cost at December 31 $ (174.7) $ (168.7) $ (140.4) $ (128.4)
</TABLE>
Assumed health care cost trend rates have a significant effect on the amounts
reported for the health care plans. A one-percentage-point change in assumed
health care cost trend rates would have the following effects:
<TABLE>
<CAPTION>
1-Percentage- 1-Percentage-
(in millions) Point Increase Point Decrease
<S> <C> <C>
- -------------------------------------------------------------------------
Effect on total of service and interest
cost components $ 2.8 $(2.4)
Effect on postretirement benefit
obligation 26.7 (23.7)
</TABLE>
In addition, the Company sponsors non-qualified pension plans that cover
officers, certain other key employees, and non-employee directors. Cinergy's
non-qualified pension plans are not currently funded. Cinergy may begin to fund
certain of these plans through a rabbi trust in 1999.
The pension benefit obligations and pension expense under these plans were:
<TABLE>
<S> <C> <C>
(in millions) 1998 1997
- -----------------------------------------------------------------
Pension benefit obligations $ 31.4 $ 24.6
Pension expense 4.5 4.1
</TABLE>
A-40
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
10. INVESTMENTS IN UNCONSOLIDATED SUBSIDIARIES
Except for Cinergy's 50% investment in Avon Energy Partners Holdings ("Avon
Energy"), which holds Midlands Electricity plc ("Midlands"), investments in
unconsolidated subsidiaries are not significant.
Summarized financial information for Avon Energy is as follows:
<TABLE>
<CAPTION>
December 31
(in millions) 1998 1997
<S> <C> <C>
- --------------------------------------------------------------
ASSETS
Current assets $ 568 $ 676
Property, plant, and equipment 1 974 1 890
Other assets 2 111 2 148
- --------------------------------------------------------------
Total assets $ 4 653 $ 4 714
LIABILITIES AND SHAREHOLDERS' EQUITY
Other liabilities $ 1 639 $ 2 175
Long-term debt 1 896 1 533
Total common shareholders' equity 1 118 1 006
- --------------------------------------------------------------
Total liabilities and shareholders'
equity $ 4 653 $ 4 714
CINERGY'S INVESTMENTS IN UNCONSOLIDATED
SUBSIDIARIES:
AVON ENERGY $ 556 $ 505
OTHER COMPANIES 18 33
- --------------------------------------------------------------
TOTAL INVESTMENTS IN UNCONSOLIDATED
SUBSIDIARIES $ 574 $ 538
</TABLE>
<TABLE>
<CAPTION>
December 31
(in millions) 1998 1997 1996
<S> <C> <C> <C>
- ----------------------------------------------------------------
Operating revenues $ 2 406 $ 2 176 $ 1 132
Net income before extraordinary
item $ 105 $ 127 $ 50
Extraordinary item - windfall
profits tax (less applicable
income taxes of $0) $ - $ (219) $ -
Net income (loss) $ 105 $ (92) $ 50
CINERGY'S EQUITY IN EARNINGS OF
AVON ENERGY BEFORE
EXTRAORDINARY ITEM $ 57 $ 63 $ 25
CINERGY'S EQUITY IN
EXTRAORDINARY ITEM - (109) -
- ----------------------------------------------------------------
CINERGY'S EQUITY IN EARNINGS
OF:
AVON ENERGY $ 57 $ (46) $ 25
OTHER COMPANIES (6) (3) -
- ----------------------------------------------------------------
TOTAL EQUITY IN THE EARNINGS OF
UNCONSOLIDATED SUBSIDIARIES $ 51 $ (49) $ 25
</TABLE>
During 1997 Cinergy received $25 million of dividends from Avon Energy.
In November 1998, Midlands announced the sale of its electric supply business
to National Power PLC ("National Power"). National Power will acquire all of the
assets of Midlands' supply business and assume its liabilities, including
obligations under all Midlands power purchase agreements for approximately $300
million, plus an adjustment for working capital at financial closing. The sale
is subject to approval by Great Britain's Department of Trade and Industry and
Office of Electricity Regulation and is expected in the second quarter of 1999.
Midlands will continue to own and operate its distribution business as well as
interests in various generation stations.
11. INCOME TAXES
The significant components of Cinergy's net deferred income tax liability at
December 31, 1998, and 1997, are as follows:
<TABLE>
<CAPTION>
(in millions) 1998 1997
<S> <C> <C>
- ---------------------------------------------------------------
DEFERRED INCOME TAX LIABILITY
Utility plant $ 1 104.2 $ 1 076.8
Unamortized costs of reacquiring debt 21.2 24.4
Deferred operating expenses and
carrying costs 73.3 75.0
Amounts due from customers - income
taxes 121.7 129.4
Deferred DSM costs 22.8 31.7
Investments in unconsolidated
subsidiaries - 55.0
Other 51.0 47.9
- ---------------------------------------------------------------
Total deferred income tax liability 1 394.2 1 440.2
DEFERRED INCOME TAX ASSET
Unamortized investment tax credits 57.0 60.5
Accrued pension and other benefit costs 89.0 63.3
Net energy risk management liabilities 54.5 -
RUS obligations 29.5 3.8
Investments in unconsolidated
subsidiaries 13.1 -
Other 60.0 64.1
- ---------------------------------------------------------------
Total deferred income tax asset 303.1 191.7
NET DEFERRED INCOME TAX LIABILITY $ 1 091.1 $ 1 248.5
</TABLE>
Cinergy and its subsidiaries will participate in the filing of a consolidated
federal income tax return for the year ended December 31, 1998. The current tax
liability is allocated among the members of the group pursuant to a tax sharing
agreement consistent with Rule 45(c) of the PUHCA.
A-41
<PAGE>
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) 1998 1997 1996
<S> <C> <C> <C>
- --------------------------------------------------------------------
CURRENT INCOME TAXES
Federal $ 209.0 $ 133.3 $ 143.4
State 16.9 12.1 7.5
- --------------------------------------------------------------------
Total current income taxes 225.9 145.4 150.9
DEFERRED INCOME TAXES
Federal
Depreciation and other utility
plant-related items 25.3 26.7 61.6
DSM costs (8.8) (8.5) (1.9)
Pension and other benefit costs (3.3) .9 (28.2)
Litigation settlement - 1.8 26.2
RUS obligations (22.5) (3.5) -
Unrealized energy risk
management losses (49.4) (1.5) -
Fuel costs (1.0) 4.4 8.8
Other items - net (32.0) 54.5 (15.4)
- --------------------------------------------------------------------
Total deferred federal income
taxes (91.7) 74.8 51.1
State (7.4) 2.4 6.5
Total deferred income taxes (99.1) 77.2 57.6
- --------------------------------------------------------------------
INVESTMENT TAX CREDITS - NET (9.6) (9.6) (9.8)
- --------------------------------------------------------------------
TOTAL INCOME TAXES $ 117.2 $ 213.0 $ 198.7
</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) 1998 1997 1996
<S> <C> <C> <C>
- --------------------------------------------------------------------
Statutory federal income tax
provision $ 129.0 $ 196.4 $ 181.8
Increases (Reductions) in taxes
resulting from:
Amortization of investment tax
credits (9.6) (9.6) (9.8)
Depreciation and other utility
plant-related differences 10.4 11.7 14.1
Preferred dividend requirements
of subsidiaries 2.3 4.4 8.5
Foreign tax adjustments (20.0) (13.2) (11.1)
Other - net (4.4) 8.8 1.2
- --------------------------------------------------------------------
Federal income tax expense $ 107.7 $ 198.5 $ 184.7
</TABLE>
12. COMMITMENTS AND CONTINGENCIES
(a) CONSTRUCTION
Construction expenditures for the 1999 through 2003 period are forecast to be
approximately $1.7 billion. These forecasted amounts exclude the estimated
expenditures necessary to comply with the stricter nitrogen oxide ("NO(x)")
emission control standards proposed by the United States Environmental
Protection Agency ("EPA").
(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. PSI acquired four of the
sites from Northern Indiana Public Service Company ("NIPSCO") in 1931 and at the
same time it sold NIPSCO the sites located in Goshen and Warsaw, Indiana. In
1945, PSI sold 19 of these sites (including the four it acquired from NIPSCO) to
Indiana Gas and Water Company, Inc. (now Indiana Gas Company, Inc. ("IGC")). One
of the 19 sites, the one located in Rochester, Indiana, was later sold by IGC to
NIPSCO.
IGC and NIPSCO both made claims against PSI, contending that PSI is a
Potentially Responsible Party under the Comprehensive Environmental Response,
Compensation and Liability Act ("CERCLA") with respect to the 21 MGP sites, and
therefore legally responsible for the costs of investigating and remediating
these sites. Moreover, in August 1997, NIPSCO filed suit against PSI in federal
court, 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.
In November 1998, NIPSCO, IGC, and PSI entered into a Site Participation and
Cost Sharing Agreement by which they settled allocation of CERCLA liability for
past and future costs, among the three companies, at seven MGP sites in Indiana.
Pursuant to this agreement, NIPSCO's lawsuit against PSI was dismissed. The
parties have assigned one of the parties lead responsibility for managing
further investigation and remediation activities at each of the sites. Similar
agreements were reached between IGC and PSI which allocate CERCLA liability at
14 MGP sites with which NIPSCO had no involvement. These agreements conclude all
CERCLA and similar claims between the three companies relative to MGP sites.
Pursuant to the agreements and applicable laws, the parties are continuing to
investigate and remediate the sites as appropriate. Investigation and cleanup of
some of the sites is subject to oversight by the Indiana Department of
Environmental Management ("IDEM").
A-42
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
PSI has placed its insurance carriers on notice of IGC's, NIPSCO's, and the
IDEM's claims related to MGP sites. In April 1998, PSI filed suit in Hendricks
County Circuit Court against its general liability insurance carriers seeking,
among other matters, a declaratory judgment that its insurance carriers are
obligated to defend MGP claims against PSI or pay PSI's costs of defense and to
indemnify PSI for its costs of investigating, preventing, mitigating, and
remediating damage to property and paying claims associated with MGP sites. PSI
cannot predict the outcome of this litigation.
Based upon the work performed to date, PSI has accrued costs for the sites
related to investigation, remediation, and groundwater monitoring. Estimated
costs of certain remedial activities are accrued when such costs are reasonably
estimable. PSI does not believe it can provide an estimate of the reasonably
possible total remediation costs for any site prior to completion of a remedial
investigation/feasibility study and the development of some sense of the timing
for the implementation of the potential remedial alternatives, to the extent
such remediation may be required. Accordingly, the total costs that may be
incurred in connection with the remediation of all sites, to the extent
remediation is necessary, cannot be determined at this time. These future costs
at the 21 Indiana MGP sites, 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 the 21 MGP sites could be material to Cinergy's and
PSI's financial condition or results of operations.
(iii) CG&E AND ITS UTILITY SUBSIDIARIES
CG&E and its utility subsidiaries are aware of potential sites where MGP
activities 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
these MGP sites.
(c) OZONE TRANSPORT RULEMAKING
In October 1998, the EPA finalized its Ozone Transport Rule ("NO(x) SIP Call").
It applies to 22 states in the eastern half of the US, including the three
states in which the Cinergy electric utilities operate. This rule recommends
that states reduce NO(x) emissions from primarily industrial and utility sources
to a certain limit by May 2003. Ohio, Indiana, a number of other states, and
various industry groups, including some of which Cinergy is a member, filed
legal challenges to the NO(x) SIP Call in late 1998. Ohio and Indiana have also
provided preliminary indications that they will seek fewer NO(x) reductions from
the utility sector in their implementing regulations than the EPA has budgeted
in its rulemaking. The state implementing regulations will need the EPA's
approval. Under the current provisions of the NO(x) SIP Call, the estimate for
compliance with the EPA limits is currently $500 million to $700 million (in
1998 dollars) between now and 2003. This estimate is significantly dependent on
several factors, including the final determination regarding both the timing and
stringency of the final required NO(x) reductions, the output of CG&E's and
PSI's generating units, the availability of an adequate supply of resources to
construct the necessary control equipment, and the extent to which a NO(x)
allowance trading market develops, if any.
A-43
<PAGE>
(d) UCH PROJECT
Midlands (of which the Company owns 50%) has a 40% ownership interest in a 586
megawatts ("MW") power project in Pakistan ("Uch project" or "Uch") which was
originally scheduled to begin commercial operation in late 1998. In July 1998,
the Pakistani government-owned utility issued a notice of intent to terminate
certain key project agreements relative to the Uch project. The notice asserts
that various forms of corruption were involved in the original granting of the
agreements to the Uch investors by a predecessor government. The Company
believes that this notice is similar to notices received by a number of other
independent power projects in Pakistan.
The Uch investors, including a subsidiary of Midlands, strongly deny the
allegations and have pursued all available legal options to enforce their
contractual rights under the project agreements. Physical construction of the
project is complete; however, commercial operations have been delayed pending
resolution of the dispute. In December 1998, the Pakistani government offered to
withdraw its notice.
Through its 50% ownership of Midlands, the Company's current investment in
the Uch project is approximately $32 million. In addition, project lenders could
require investors to make additional capital contributions to the project under
certain conditions. The Company's share of these additional contributions is
approximately $12 million. At the present time, the Company cannot predict the
ultimate outcome of this matter.
(e) EXPIRATION OF BARGAINING AGREEMENT
Our collective-bargaining agreement with the International Brotherhood of
Electrical Workers Local No. 1393, covering approximately 1,470 employees, will
expire on May 1, 1999. Management has developed contingency plans for service to
continue in the event of a work stoppage. In the unlikely event of a work
stoppage, incremental related costs would be incurred, but would not be expected
to have a material impact on operating income.
13. JOINTLY-OWNED PLANT
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. PSI is a joint owner of Gibson Generating
Station ("Gibson") Unit 5 with Wabash Valley Power Association, Inc. ("WVPA")
and 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 transmission and distribution
systems which are operated and maintained by PSI. The Consolidated Statements of
Income reflect CG&E's and PSI's portions of all operating costs associated with
the jointly-owned facilities.
CG&E's and PSI's investments in jointly-owned plant are as follows:
<TABLE>
<CAPTION>
1998
- ----------------------------------------------------------------------------------------------------------
UTILITY CONSTRUCTION
PLANT IN ACCUMULATED WORK IN
(DOLLARS IN MILLIONS) SHARE SERVICE DEPRECIATION PROGRESS
<S> <C> <C> <C> <C>
- ----------------------------------------------------------------------------------------------------------
CG&E
PRODUCTION
MIAMI FORT STATION (UNITS 7 AND 8) 64.00% $ 216 $ 120 $ 4
W.C. BECKJORD STATION (UNIT 6) 37.50 41 26 1
J.M. STUART STATION 39.00 273 128 2
CONESVILLE STATION (UNIT 4) 40.00 73 39 2
WILLIAM H. ZIMMER STATION 46.50 1 218 275 5
EAST BEND STATION 69.00 333 172 2
KILLEN STATION 33.00 187 91 -
TRANSMISSION VARIOUS 64 32 1
PSI
PRODUCTION
GIBSON (UNIT 5) 50.05 206 102 3
TRANSMISSION AND LOCAL FACILITIES 94.62 2 1 -
</TABLE>
A-44
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
14. QUARTERLY FINANCIAL DATA (unaudited)
<TABLE>
<CAPTION>
(in millions, except per share
amounts)
- -----------------------------------------------------------------------------------------------------
Basic Diluted
Earnings Earnings
Net (Loss) (Loss)
Operating Operating Income Per Per
Quarter Ended Revenues(a) Income(a) (Loss) Share Share
<S> <C> <C> <C> <C> <C>
- -----------------------------------------------------------------------------------------------------
1998
MARCH 31 $1 348 $226 $ 106 $ .67 $ .67
JUNE 30 1 168 3(b,d) (25) (b,d) (.16) (b,d) (.16) (b,d)
SEPTEMBER 30 1 976 204(e) 109(e) (.69e) (.69e)
DECEMBER 31 1 384 133(f) 71(f) (.45f) (.45f)
- -----------------------------------------------------------------------------------------------------
TOTAL $5 876 $566 $ 261 $ 1.65 $ 1.65
1997
March 31 $1 039 $215 $ 114 $ .72 $ .72
June 30 872 142 56 .35 .34
September 30 1 361 183 (27) (c) (.16) (c) (.17) (c)
December 31 1 115 226 110 .70 .70
- -----------------------------------------------------------------------------------------------------
Total $4 387 $766 $ 253 $ 1.61 $ 1.59
</TABLE>
(a) For a discussion of the reclassification of amounts disclosed in prior
reports, see Note 1(b).
(b) In the second quarter of 1998, Cinergy recorded charges of $65 million,
pretax related to power marketing and trading operations which constitutes,
after tax, $.26 per share, basic and diluted. For a discussion of the energy
marketing and trading operations, see Note 1(c).
(c) For a discussion of the windfall profits tax levied against Midlands, which
was recorded in the third quarter of 1997 as an extraordinary item, see Note
17. Net income, basic EPS, and diluted EPS during the third quarter of 1997,
before the extraordinary item, were $83 million, $.53, and $.52,
respectively. Total net income, basic EPS, and diluted EPS for 1997, before
the extraordinary item, were $363 million, $2.30, and $2.28, respectively.
(d) In the second quarter of 1998, Cinergy, through PSI, recorded a charge
against earnings of $80 million ($50 million after tax or $.32 per share
basic and diluted) for a settlement related to the Marble Hill nuclear
project. For a discussion of this settlement, see Note 18.
(e) In the third quarter of 1998, Cinergy recorded charges of $20 million,
pretax related to power marketing and trading operations which constitutes,
after tax, $.08 per share, basic and diluted. For a discussion of the energy
marketing and trading operations, see Note 1(c).
(f) In the fourth quarter of 1998, Cinergy recorded charges of $50 million,
pretax related to power marketing and trading operations which constitutes,
after tax, $.20 per share, basic and diluted. For a discussion of the energy
marketing and trading operations, see Note 1(c).
15. FINANCIAL INFORMATION BY BUSINESS SEGMENT
During 1998, Cinergy and its subsidiaries adopted the provisions of Statement of
Financial Accounting Standards No. 131, Disclosures about Segments of an
Enterprise and Related Information ("Statement 131"). Statement 131 requires
disclosure about reportable operating segments in annual and interim condensed
financial statements. These operating segments are based on products and
services, geography, legal structure, management structure or any manner in
which management disaggregates a company.
Cinergy's reportable segments are strategic business units which were formed
during the second half of 1996 and began operating as separately identifiable
business units in 1997. Each business unit has its own management structure,
headed by a business unit president who reports directly to the chief executive
officer of Cinergy. Each business unit and their responsibilities as of December
31, 1998, is described in detail below.
The ECBU operates and maintains, exclusive of certain jointly-owned plant,
all of the Company's domestic electric generation facilities. In addition to the
production of electric power, all energy risk management, marketing, and
proprietary arbitrage trading, with the exception of electric and gas retail
sales, is conducted through the ECBU. Revenues from external customers are
derived from the ECBU's marketing, trading, and risk management activities.
Intersegment revenues are derived from the sale of electric power to the ESBU.
The EDBU plans, constructs, operates, and maintains the Company's
transmission and distribution systems. Revenues from customers other than
end-users are primarily derived from the transmission of electric power through
the Company's transmission system. Intersegment revenues are derived from sale
of electric and gas transmission and distribution services to the ESBU.
A-45
<PAGE>
The ESBU provides gas and electric energy as well as gas supply risk
management services to end-users. The ESBU also manages the development and the
sales and marketing of new end-use energy-related products and services. All of
the ESBU's revenues are derived from the sales of such services and products to
external customers. All electric energy sold to end-users is purchased from the
ECBU. In addition to energy-related products and services, the ESBU also sells
other end-use products and services, such as telephone services, through
joint-venture affiliates. Other products and services offered through
joint-venture affiliates include the construction and sale or lease of
cogeneration and trigeneration facilities to large commercial/industrial
customers and energy management services to third parties.
The IBU directs and manages all of the Company's international business
holdings, which include wholly-owned subsidiaries and equity investments.
Revenues and equity earnings from unconsolidated companies are primarily derived
from energy-related businesses.
Transfer pricing for sales of electric energy and sales of electric and gas
transmission and distribution services between the ECBU, ESBU, and EDBU are
derived from the operating utilities' retail and wholesale rate structures.
The following financial information by business unit, product and service,
and geographic area for the years ending December 31, 1998, 1997, and 1996, is
as follows:
BUSINESS UNITS
<TABLE>
<CAPTION>
(in millions)
- -----------------------------------------------------------------------------------------------------------------------------
1998
- -----------------------------------------------------------------------------------------------------------------------------
CINERGY BUSINESS UNITS
----------------------------------------------------- ALL RECONCILING
ECBU EDBU ESBU IBU TOTAL OTHER(1) ELIMINATIONS(2) CONSOLIDATED
<S> <C> <C> <C> <C> <C> <C> <C> <C>
- -----------------------------------------------------------------------------------------------------------------------------
OPERATING
REVENUES - EXTERNAL
CUSTOMERS $ 2 726 $ 34 $ 3 107 $ 9 $ 5 876 $ - $ - $ 5 876
INTERSEGMENT REVENUES 1 782 724 - - 2 506 - (2 506) -
DEPRECIATION AND
AMORTIZATION(3) 197 123 4 2 326 - - 326
EQUITY IN EARNINGS OF
UNCONSOLIDATED
SUBSIDIARIES (1) - (4) 56 51 - - 51
INTEREST EXPENSE (NET)(4) 95 88 3 51 237 7 - 244
INCOME TAXES - - - - - 117 - 117
SEGMENT PROFIT (LOSS) 151 225 4 16 396 (135) - 261
TOTAL SEGMENT ASSETS 5 476 3 754 275 751 10 256 43 - 10 299
INVESTMENTS IN
UNCONSOLIDATED
SUBSIDIARIES - - 8 566 574 - - 574
TOTAL EXPENDITURES FOR
LONG-LIVED ASSETS 109 227 17 - 353 17 - 370
</TABLE>
(1) The all other category represents miscellaneous corporate items, including
income taxes, which are not allocated to business units for purposes of
segment profit measurement.
(2) The reconciling eliminations category eliminates the intersegment revenues
of the ECBU and the EDBU.
(3) The components of Depreciation and Amortization include depreciation of
fixed assets, amortization of intangible assets, amortization of phase-in
deferrals, and amortization of post-in-service deferred operating expenses.
(4) Interest income is deemed immaterial.
A-46
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
(in millions)
- ----------------------------------------------------------------------------------------------------------------------
1997
- ----------------------------------------------------------------------------------------------------------------------
Cinergy Business Units
----------------------------------------------------- All Reconciling
ECBU EDBU ESBU IBU Total Other(1) Eliminations(2)
<S> <C> <C> <C> <C> <C> <C> <C>
- ----------------------------------------------------------------------------------------------------------------------
Operating Revenues - External
Customers $ 1 287 $ 27 $ 3 071 $ 2 $ 4 387 $ - $ -
Intersegment Revenues 1 688 727 - - 2 415 - (2 415)
Depreciation and Amortization(3) 184 118 5 - 307 - -
Equity in Earnings of
Unconsolidated Subsidiaries - - (3) 63 60 - -
Interest Expense (net)(4) 108 86 4 38 236 - -
Income Taxes - - - - - 213 -
Segment Profit (Loss) Before
Extraordinary Item 330 224 4 22 580 (217) -
Extraordinary Item(5) - - - (109) (109) - -
Segment Profit (Loss) 330 224 4 (87) 471 (217) -
Total Segment Assets 4 380 3 617 279 562 8 838 20 -
Investments in Unconsolidated
Subsidiaries - - 3 535 538 - -
Total Expenditures for Long-Lived
Assets 79 224 12 - 315 13 -
<CAPTION>
(in millions)
- ---------------------------------
- ---------------------------------
Consolidated
<S> <C>
- ---------------------------------
Operating Revenues - External
Customers $ 4 387
Intersegment Revenues -
Depreciation and Amortization(3) 307
Equity in Earnings of
Unconsolidated Subsidiaries 60
Interest Expense (net)(4) 236
Income Taxes 213
Segment Profit (Loss) Before
Extraordinary Item 363
Extraordinary Item(5) (109)
Segment Profit (Loss) 254
Total Segment Assets 8 858
Investments in Unconsolidated
Subsidiaries 538
Total Expenditures for Long-Lived
Assets 328
</TABLE>
(1) The all other category represents miscellaneous corporate items, including
income taxes, which are not allocated to business units for purposes of
segment profit measurement.
(2) The reconciling eliminations category eliminates the intersegment revenues
of the ECBU and the EDBU.
(3) The components of Depreciation and Amortization include depreciation of
fixed assets, amortization of intangible assets, amortization of phase-in
deferrals, and amortization of post-in-service deferred operating expenses.
(4) Interest income is deemed immaterial.
(5) Windfall Profits Tax (see Note 17).
<TABLE>
<CAPTION>
(in millions)
- -----------------------------------------------------------------------------------------------------------------------
1996
- -----------------------------------------------------------------------------------------------------------------------
Cinergy Business Units
----------------------------------------------------- All Reconciling
ECBU EDBU ESBU IBU Total Other(1) Eliminations(2)
<S> <C> <C> <C> <C> <C> <C> <C>
- -----------------------------------------------------------------------------------------------------------------------
Operating Revenues - External
Customers $ 210 $ 23 $ 3 043 $ - $ 3 276 $ - $ -
Intersegment Revenues 1 678 733 - - 2 411 - (2 411)
Depreciation and Amortization(3) 175 115 5 - 295 - -
Equity in Earnings of
Unconsolidated Subsidiaries - - - 25 25 - -
Interest Expense (net)(4) 101 91 6 18 216 - -
Income Taxes - - - - - 199 -
Segment Profit (Loss) 308 208 16 7 539 (204) -
Total Segment Assets 4 399 3 424 283 605 8 711 14 -
Investments in Unconsolidated
Subsidiaries - - - 593 593 - -
Total Expenditures for Long-Lived
Assets 100 206 17 593 916 1 -
<CAPTION>
(in millions)
- ----------------------------------
- ----------------------------------
Consolidated
<S> <C>
- ----------------------------------
Operating Revenues - External
Customers $ 3 276
Intersegment Revenues -
Depreciation and Amortization(3) 295
Equity in Earnings of
Unconsolidated Subsidiaries 25
Interest Expense (net)(4) 216
Income Taxes 199
Segment Profit (Loss) 335
Total Segment Assets 8 725
Investments in Unconsolidated
Subsidiaries 593
Total Expenditures for Long-Lived
Assets 917
</TABLE>
(1) The all other category represents miscellaneous corporate items, including
income taxes, which are not allocated to business units for purposes of
segment profit measurement.
(2) The reconciling eliminations category eliminates the intersegment revenues
of the ECBU and the EDBU.
(3) The components of Depreciation and Amortization include depreciation of
fixed assets, amortization of intangible assets, amortization of phase-in
deferrals, and amortization of post-in-service deferred operating expenses.
(4) Interest income is deemed immaterial.
A-47
<PAGE>
PRODUCTS AND SERVICES
<TABLE>
<CAPTION>
(in millions)
- --------------------------------------------------------------------------------------------------------------------
Revenues
----------------------------------------------------------------------------------------------
Traditional Utility Energy Marketing and Trading Other
--------------------------------- --------------------------------- -----
Year Electric Gas Total Electric Gas Total Consolidated
<S> <C> <C> <C> <C> <C> <C> <C> <C>
- --------------------------------------------------------------------------------------------------------------------
1998 $ 2 696 $ 435 $ 3 131 $ 2 066 $ 665 $ 2 731 $ 14 $ 5 876
1997 2 579 519 3 098 1 283 - 1 283 6 4 387
1996 2 568 505 3 073 200 - 200 3 3 276
</TABLE>
Cinergy's core products and services focus on providing traditional utility
services (the supply of electric energy and gas supply) and energy marketing and
trading services.
GEOGRAPHIC AREAS AND LONG-LIVED ASSETS
<TABLE>
<CAPTION>
(in millions)
- -----------------------------------------------------------------------------------------------------------------------
Revenues
---------------------------------------------------------------
International
-------------------------------------
Year Domestic UK All Other(1) Total Consolidated
<S> <C> <C> <C> <C> <C>
- -----------------------------------------------------------------------------------------------------------------------
1998 $ 5 867 $ - $ 9 $ 9 $ 5 876
1997 4 385 - 2 2 4 387
1996 3 276 - - - 3 276
</TABLE>
<TABLE>
<CAPTION>
(in millions)
- ------------------------------------------------------------------------------------------------------------------------
Long-Lived Assets
--------------------------------------------------
International
-------------------------------------
Year Domestic UK All Other(1) Total
<S> <C> <C> <C> <C>
- ------------------------------------------------------------------------------------------------------------------------
1998 $ 7 302 $ 501 $ 209 $ 710
1997 7 267 505 42 547
1996 7 302 593 10 603
<CAPTION>
(in millions)
- --------------------------------------------------------------------
Year Consolidated
<S> <C>
- --------------------------------------------------------------------
1998 $ 8 012
1997 7 814
1996 7 905
</TABLE>
(1) During 1998, the IBU acquired the assets of two district heating plants
(approximately 816 MW combined) in the Czech Republic. The assets and the
results of operations of these international investments are consolidated
into the company's financial statements, while the remaining international
long-lived assets of the IBU are accounted for as equity method investments.
As a result, revenues from the IBU are not significant.
Cinergy's core service territory and asset base is located in the
southwestern portion of Ohio, including adjacent areas in Kentucky, and the
north central, central, and southern regions of Indiana. Cinergy's energy
marketing and trading function provides energy risk management, marketing, and
trading services throughout the US. Abroad, Cinergy owns a 50% interest in
Midlands, a regional electric company located in the United Kingdom ("UK"). In
addition to its ownership interest in Midlands, Cinergy also has other equity
investments in Europe, Africa, and Asia and is actively developing other
energy-related projects.
A-48
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
16. EARNINGS PER SHARE
A reconciliation of earnings per common share ("basic EPS") to earnings per
common share assuming dilution ("diluted EPS") is presented below:
<TABLE>
<CAPTION>
Income Shares
(in millions, except per share amounts) (Numerator) (Denominator) EPS
<S> <C> <C> <C>
- ------------------------------------------------------------------------------------------------------------------------------
1998
EARNINGS PER COMMON SHARE: NET INCOME $ 261 158 $ 1.65
EFFECT OF DILUTIVE SECURITIES: COMMON STOCK OPTIONS 1
- ------------------------------------------------------------------------------------------------------------------------------
EPS - ASSUMING DILUTION: NET INCOME PLUS ASSUMED CONVERSIONS $ 261 159 $ 1.65
1997
Earnings per common share: Net income before extraordinary item(a) $ 363 158 $ 2.30
Effect of dilutive securities: Common stock options 1
- ------------------------------------------------------------------------------------------------------------------------------
EPS - assuming dilution: Net income before extraordinary item plus assumed
conversions(a) $ 363 159 $ 2.28
1996
Net income $ 335
Less: costs of reacquisition of preferred stock of subsidiary 18
- ------------------------------------------------------------------------------------------------------------------------------
Earnings per common share: Net income applicable to common stock 317 158 $ 2.00
Effect of dilutive securities: Common stock options 1
- ------------------------------------------------------------------------------------------------------------------------------
EPS - assuming dilution: Net income applicable to common stock plus assumed
conversions $ 317 159 $ 1.99
</TABLE>
(a) The after-tax EPS impact of the extraordinary item - equity share of
windfall profits tax in 1997 was $.69 for both basic and diluted EPS.
Options to purchase shares of common stock are excluded from the calculation of
EPS-assuming dilution when the exercise prices of these options are greater than
the average market price of the common shares during the year. For 1998,
approximately one million shares, with an average exercise price of
approximately $38.00 per share, were excluded from the EPS-assuming dilution
calculation. For 1997 and 1996, shares excluded for this calculation were
immaterial.
17. EXTRAORDINARY ITEM -
EQUITY SHARE OF WINDFALL
PROFITS TAX
During the third quarter of 1997, a windfall profits tax was enacted into law in
Great Britain. This tax was levied against a limited number of British
companies, including Midlands, which had previously been owned and operated by
the government. The tax was intended to be a recovery of funds by the government
due to the undervaluing of companies, such as Midlands, when they were
privatized by the government via public stock offerings several years ago.
Cinergy's share of the tax was approximately 67 million pounds sterling ($109
million or $.69 per share, basic and diluted). 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 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.
18. WVPA SETTLEMENT
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. During
1998, PSI reached agreement on all matters with the relevant parties and, as a
result, recorded a liability to the RUS. PSI will repay the obligation to the
RUS with interest over a 35-year term. The net proceeds from a 35-year power
sales agreement with WVPA will be used to fund the principal and interest on the
obligation to the RUS. Assumption of the liability (recorded as long-term debt
in the Consolidated Balance Sheet) resulted in a charge against earnings of $80
million ($50 million after tax or $.32 per share basic and diluted) in the
second quarter of 1998.
A-49
<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/ CHARLES J. WINGER]
Charles J. Winger
Vice President and
Chief Financial Officer
A-50
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors of Cinergy Corp.:
We have audited the accompanying consolidated balance sheets of Cinergy Corp.
(a Delaware Corporation) and its subsidiary companies as of December 31, 1998
and 1997, 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, 1998. 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, 1998 and 1997, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1998, in conformity with generally accepted accounting principles.
As explained in Note 1 to the consolidated financial statements, the Company
changed its method of accounting for its energy trading and risk management
activities effective December 31, 1998.
Arthur Andersen LLP
Cincinnati, Ohio,
January 28, 1999
A-51
<PAGE>
[This page intentionally left blank.]
A-52
<PAGE>
FIVE YEAR STATISTICAL SUMMARY
<TABLE>
<CAPTION>
FINANCIAL 1998 1997 1996 1995 1994
<S> <C> <C> <C> <C> <C> <C>
- -------------------------------------------------------------------------------------------------------------------------------
OPERATING REVENUES (thousands) $ 5 876 294 $4 387 101 $3 276 187 $3 023 431 $2 888 447
- -------------------------------------------------------------------------------------------------------------------------------
NET INCOME (thousands) $ 260 968 $ 253 238 $ 334 797 $ 347 182 $ 191 142
- -------------------------------------------------------------------------------------------------------------------------------
TOTAL ASSETS (thousands) $10 298 795 $8 858 153 $8 724 934 $8 103 242 $8 037 422
- -------------------------------------------------------------------------------------------------------------------------------
CONSTRUCTION EXPENDITURES (INCLUDING AFUDC) (thousands) $ 370 277 $ 328 153 $ 324 238 $ 326 869 $ 486 734
- -------------------------------------------------------------------------------------------------------------------------------
CAPITALIZATION Common Equity $ 2 541 231 $2 539 200 $2 584 454 $2 548 843 $2 414 271
($ - thousands) Preferred Stock(a)
Subject to Mandatory Redemption - - - 160 000 210 000
Not Subject to Mandatory Redemption 92 640 177 989 194 232 227 897 267 929
Long-term Debt(a) 2 604 467 2 150 902 2 326 378 2 346 766 2 615 269
------------------------------------------------------------------------------------------------------
Total Capitalization $ 5 238 338 $4 868 091 $5 105 064 $5 283 506 $5 507 469
- -------------------------------------------------------------------------------------------------------------------------------
OTHER COMMON Avg. Shares Outstanding (millions) 158 158 158 157 147
STOCK DATA Avg. Shares Outstanding - 159 159 159 158 148
Assuming Dilution (millions)
Earnings Per Share $ 1.65 $ 1.61(c) $ 2.00(b) $ 2.22 $ 1.30
Earnings Per Share - Assuming $ 1.65 $ 1.59(c) $ 1.99(b) $ 2.20 $ 1.29
Dilution
Dividends Declared Per Share $ 1.80 $ 1.80 $ 1.74 $ 1.72 $ 1.50
Payout Ratio(d) 109.1% 111.8%(c) 87.0%(b) 77.5% 115.4%
Book Value Per Share (year-end) $ 16.02 $ 16.10 $ 16.39 $ 16.17 $ 15.56
- -------------------------------------------------------------------------------------------------------------------------------
DEGREE DAY DATA CG&E Heating (30-year 4 282 5 271 5 611 5 323 4 937
average - 5,248)
Cooling (30-year average - 996) 1 235 851 916 1 216 1 026
PSI Heating (30-year 4 440 5 680 5 891 5 578 5 194
average - 5,609)
Cooling (30-year average - 1,014) 1 250 871 989 1 214 1 057
- -------------------------------------------------------------------------------------------------------------------------------
EMPLOYEE DATA Number of Employees (year-end) 8 794 7 609 7 973 8 602 8 868
- -------------------------------------------------------------------------------------------------------------------------------
GAS OPERATIONS
- -------------------------------------------------------------------------------------------------------------------------------
GAS REVENUES Residential $ 240 297 $ 284 516 $ 272 303 $ 237 576 $ 242 415
(thousands) Commercial 87 583 121 345 118 994 99 708 114 854
Industrial 17 320 31 168 30 409 28 979 43 490
Other 12 888 18 554 20 133 19 740 23 483
------------------------------------------------------------------------------------------------------
Total Sales 358 088 455 583 441 839 386 003 424 242
Gas Transported 41 050 32 456 27 679 20 934 13 496
------------------------------------------------------------------------------------------------------
Total Sales & Transported 399 138 488 039 469 518 406 937 437 738
Total ProEnergy 658 771 - - - -
Other Gas Revenues 2 755 3 106 4 517 3 915 4 660
------------------------------------------------------------------------------------------------------
Total Gas $ 1 060 664 $ 491 145 $ 474 035 $ 410 852 $ 442 398
- -------------------------------------------------------------------------------------------------------------------------------
GAS SALES Residential 36 256 41 846 44 721 43 153 39 065
(million cu. ft.) Commercial 13 999 19 141 21 199 19 664 20 070
Industrial 2 941 5 240 5 746 6 624 9 025
Other 2 449 3 162 3 947 4 584 4 803
------------------------------------------------------------------------------------------------------
Total Sales 55 645 69 389 75 613 74 025 72 963
Gas Transported 57 881 53 448 48 560 40 543 32 579
Total ProEnergy 338 343 - - - -
------------------------------------------------------------------------------------------------------
Total Sales, Transported, & 451 869 122 837 124 173 114 568 105 542
ProEnergy
- -------------------------------------------------------------------------------------------------------------------------------
GAS CUSTOMERS Residential 404 417 407 128 397 660 389 165 379 953
(avg.) Commercial 39 332 41 915 41 499 40 897 40 545
Industrial 1 569 1 960 1 961 1 959 2 076
Other 1 227 1 505 1 518 1 558 1 520
Transportation 15 626 1 205 829 599 56
ProEnergy 147 - - - -
------------------------------------------------------------------------------------------------------
Total 462 318 453 713 443 467 434 178 424 150
- -------------------------------------------------------------------------------------------------------------------------------
SYSTEM MAXIMUM DAY SENDOUT (million cu. ft.) 788 932 861 813 955
- -------------------------------------------------------------------------------------------------------------------------------
AVG. COST PER MCF PURCHASED (cents) 364.43(E) 380.41 326.50 277.92 335.60
- -------------------------------------------------------------------------------------------------------------------------------
LOAD FACTOR - GAS 39.5% 36.1% 39.5% 38.7% 30.3%
- -------------------------------------------------------------------------------------------------------------------------------
</TABLE>
Certain amounts in prior years have been reclassified to conform to the 1998
presentation.
(a) Excludes amounts due within one year.
(b) Includes $.12 per share for the cost of reacquiring 90% of CG&E's preferred
stock through a tender offer.
(c) Includes $.69 per share for an extraordinary item (Midlands windfall profits
tax).
(d) Based on basic earnings per share.
(e) Excludes ProEnergy purchases. Had the purchases been included, the Avg. Cost
Per Mcf Purchased (cents) would have been 217.99 in 1998.
A-53
<PAGE>
<TABLE>
<CAPTION>
ELECTRIC OPERATIONS 1998 1997 1996 1995 1994
<S> <C> <C> <C> <C> <C> <C>
- -------------------------------------------------------------------------------------------------------------------
ELECTRIC REVENUES (thousands) Residential $1 028 314 $ 984 891 $ 996 959 $ 965 278 $ 898 763
Commercial 722 292 689 091 673 181 661 496 626 333
Industrial 702 208 669 464 657 563 637 090 598 126
Other 100 017 111 867 110 003 118 458 96 247
-------------------------------------------------------------------------------------
Total Retail 2 552 831 2 455 313 2 437 706 2 382 322 2 219 469
Sales For Resale 2 140 431 1 367 897 296 600 197 943 194 734
Other 53 973 38 488 34 400 32 314 31 846
-------------------------------------------------------------------------------------
Total Electric $4 747 235 $3 861 698 $2 768 706 $2 612 579 $2 446 049
- -------------------------------------------------------------------------------------------------------------------
ELECTRIC SALES (million kwh) Residential 14 551 14 147 14 705 14 366 13 578
Commercial 12 524 12 034 11 802 11 648 11 167
Industrial 18 093 17 321 16 803 16 264 15 547
Other 1 815 1 825 1 811 1 795 1 723
-------------------------------------------------------------------------------------
Total Retail 46 983 45 327 45 121 44 073 42 015
Sales For Resale 77 558 57 454 12 399 7 769 7 801
-------------------------------------------------------------------------------------
Total Electric 124 541 102 781 57 520 51 842 49 816
- -------------------------------------------------------------------------------------------------------------------
ELECTRIC CUSTOMERS (avg.) Residential 1 257 853 1 236 974 1 215 782 1 195 323 1 174 705
Commercial 153 674 151 093 149 015 147 888 144 766
Industrial 6 473 6 472 6 470 6 424 6 345
Other 6 500 6 372 6 265 6 008 5 779
-------------------------------------------------------------------------------------
Total 1 424 500 1 400 911 1 377 532 1 355 643 1 331 595
- -------------------------------------------------------------------------------------------------------------------
SYSTEM CAPABILITY - SUMMER
(mw)(a)(b) Consolidated 10 936 10 936 11 037 11 133 10 990
CG&E 5 075 5 075 5 175 5 271 5 271
PSI 5 861 5 861 5 862 5 862 5 719
- -------------------------------------------------------------------------------------------------------------------
SYSTEM PEAK LOAD (mw) CG&E 4 725 4 638 4 452 4 509 4 326
PSI 5 708 5 313 5 227 5 274 4 869
- -------------------------------------------------------------------------------------------------------------------
ANNUAL LOAD FACTOR - ELECTRIC CG&E 59.0% 58.4% 60.5% 58.8% 58.7%
PSI 59.7% 59.2% 59.0% 57.4% 59.0%
ELECTRICITY OUTPUT (million
kwh) Generated - Net
CG&E 26 069 25 329 25 844 23 959 22 432
PSI 30 851 29 521 26 815 28 499 27 898
Purchased(c) 3 718 4 073 7 990 2 576 2 449
- -------------------------------------------------------------------------------------------------------------------
SOURCE OF ENERGY SUPPLY (%) Coal 90.73% 90.74% 85.69% 93.93% 94.40%
Hydro 0.57% 0.72% 0.56% 0.66% 0.58%
Oil & Gas 2.56% 1.63% 0.58% 0.73% 0.38%
Purchased 6.13% 6.91% 13.17% 4.68% 4.64%
- -------------------------------------------------------------------------------------------------------------------
FUEL COST Per Million Btu $ 1.24 $ 1.25 $ 1.35 $ 1.37 $ 1.41
- -------------------------------------------------------------------------------------------------------------------
HEAT RATE (Btu per kwh
sendout) Consolidated 10 274 10 190 10 113 10 035 10 095
CG&E 10 110 9 984 9 816 9 832 9 853
PSI 10 414 10 369 10 403 10 207 10 292
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
Certain amounts in prior years have been reclassified to conform to the 1998
presentation.
(a) Includes amounts to be purchased, subject to availability, pursuant to
agreements with other utilities.
(b) Excludes foreign capacity.
(c) Excludes purchases related to Cinergy's power marketing and trading
function.
A-54
<PAGE>
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<PAGE>
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<PAGE>
[LOGO]
PSI Energy, Inc.
1000 East Main St.
Plainfield, Indiana 46168
[LOGO] Printed on recycled paper.
