<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended March 31, 2000
--------------
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Transition Period From ____________ to ____________
Commission File Number
----------------------
1-10290
DQE, Inc.
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(Exact name of registrant as specified in its charter)
Pennsylvania 25-1598483
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
Cherrington Corporate Center, Suite 100
500 Cherrington Parkway, Coraopolis, Pennsylvania 15108-3184
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(Address of principal executive offices)(Zip Code)
Registrant's telephone number, including area code: (412) 262-4700
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months and (2) has been subject to such filing requirements for
the past 90 days. Yes X No
----- -----
Indicate the number of shares outstanding of each of the issuer's classes of
common stock as of the latest practicable date:
DQE Common Stock, no par value - 70,137,636 shares outstanding as of March 31,
2000 and 67,717,138 shares outstanding as of April 30, 2000.
<PAGE>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.
DQE Condensed Statement of Consolidated Income (Unaudited)
<TABLE>
<CAPTION>
(Thousands of Dollars, Except Per Share Amounts)
-----------------------------------------------------------
Three Months Ended March 31,
-----------------------------------------------------------
2000 1999
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Operating Revenues:
Electricity sales $ 250,953 $ 266,755
Water sales 25,957 22,154
Other 38,151 24,592
- -------------------------------------------------------------------------------------------------------------
Total Operating Revenues 315,061 313,501
- -------------------------------------------------------------------------------------------------------------
Operating Expenses:
Fuel and purchased power 50,627 46,911
Other operating 98,981 97,237
Maintenance 17,689 20,337
Depreciation and amortization 70,396 57,281
Taxes other than income taxes 23,596 24,174
- -------------------------------------------------------------------------------------------------------------
Total Operating Expenses 261,289 245,940
- -------------------------------------------------------------------------------------------------------------
Operating Income 53,772 67,561
- -------------------------------------------------------------------------------------------------------------
Other Income 33,361 39,297
- -------------------------------------------------------------------------------------------------------------
Interest and Other Charges 33,523 36,487
- -------------------------------------------------------------------------------------------------------------
Income Before Income Taxes 53,610 70,371
- -------------------------------------------------------------------------------------------------------------
Income Taxes 8,506 21,906
- -------------------------------------------------------------------------------------------------------------
Net Income 45,104 48,465
- -------------------------------------------------------------------------------------------------------------
Dividends on Preferred Stock 411 392
- -------------------------------------------------------------------------------------------------------------
Earnings Available for Common Stock $ 44,693 $ 48,073
=============================================================================================================
Net Income 45,104 48,465
- -------------------------------------------------------------------------------------------------------------
Other Comprehensive Income:
Unrealized holding gains (losses) during the 8,357 (366)
quarter, net of tax of $5,927 and $(260)
- -------------------------------------------------------------------------------------------------------------
Total Other Comprehensive Income 8,357 (366)
- -------------------------------------------------------------------------------------------------------------
Comprehensive Income $ 53,461 $ 48,099
=============================================================================================================
Average Number of Common Shares Outstanding
(Thousands of Shares) 70,936 77,217
=============================================================================================================
Earnings Per Share of Common Stock:
Basic $ 0.63 $ 0.62
Diluted $ 0.62 $ 0.62
=============================================================================================================
Comprehensive Earnings Per Share of Common Stock:
Basic $ 0.75 $ 0.62
Diluted $ 0.74 $ 0.61
=============================================================================================================
Dividends Declared Per Share of Common Stock $ 0.40 $ 0.38
=============================================================================================================
</TABLE>
See notes to condensed consolidated financial statements.
2
<PAGE>
DQE Condensed Consolidated Balance Sheet (Unaudited)
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------
(Thousands of Dollars)
---------------------------
March 31, December 31,
ASSETS 2000 1999
- ----------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Current Assets:
Cash and temporary cash investments $ 12,404 $ 54,229
Receivables 176,197 184,248
Other current assets 137,296 137,180
- ----------------------------------------------------------------------------------------------------------------
Total Current Assets 325,897 375,657
- ----------------------------------------------------------------------------------------------------------------
Long-Term Investments 652,718 639,284
- ----------------------------------------------------------------------------------------------------------------
Property, Plant and Equipment 4,422,421 4,369,303
Less: Accumulated depreciation (2,557,038) (2,541,236)
- ----------------------------------------------------------------------------------------------------------------
Total Property, Plant and Equipment - Net 1,865,383 1,828,067
- ----------------------------------------------------------------------------------------------------------------
Other Non-Current Assets:
Transition costs 1,961,818 2,008,171
Divestiture costs 248,687 218,653
Regulatory assets 224,500 224,002
Other 312,355 315,158
- ----------------------------------------------------------------------------------------------------------------
Total Other Non-Current Assets 2,747,360 2,765,984
- ----------------------------------------------------------------------------------------------------------------
Total Assets $ 5,591,358 $ 5,608,992
================================================================================================================
CAPITALIZATION AND LIABILITIES
- ----------------------------------------------------------------------------------------------------------------
Current Liabilities:
Notes payable and current debt maturities $ 756,324 $ 812,052
Other current liabilities 139,031 171,590
- ----------------------------------------------------------------------------------------------------------------
Total Current Liabilities 895,355 983,642
- ----------------------------------------------------------------------------------------------------------------
Non-Current Liabilities:
Deferred income taxes - net 1,016,796 1,020,103
Deferred income 100,297 126,434
Other non-current liabilities 235,276 225,689
- ----------------------------------------------------------------------------------------------------------------
Total Non-Current Liabilities 1,352,369 1,372,226
- ----------------------------------------------------------------------------------------------------------------
Commitments and Contingencies (Note D)
- ----------------------------------------------------------------------------------------------------------------
Capitalization:
Long-Term Debt 1,782,587 1,633,077
- ----------------------------------------------------------------------------------------------------------------
Preferred Stock:
DQE preferred stock 41,618 42,170
Preferred stock of subsidiaries 212,608 215,608
Preference stock of subsidiaries 11,163 14,404
- ----------------------------------------------------------------------------------------------------------------
Total Preferred Stock 265,389 272,182
- ----------------------------------------------------------------------------------------------------------------
Common Shareholders' Equity:
Common stock - no par value (authorized - 187,500,000 shares; issued - 995,477 994,935
109,679,154 shares)
Retained earnings 970,384 953,785
Treasury stock (at cost) (39,541,518 and 37,912,995 shares) (679,809) (602,689)
Accumulated other comprehensive income 9,606 1,834
- ----------------------------------------------------------------------------------------------------------------
Total Common Shareholders' Equity 1,295,658 1,347,865
- ----------------------------------------------------------------------------------------------------------------
Total Capitalization 3,343,634 3,253,124
- ----------------------------------------------------------------------------------------------------------------
Total Liabilities and Capitalization $ 5,591,358 $ 5,608,992
================================================================================================================
</TABLE>
See notes to condensed consolidated financial statements.
3
<PAGE>
DQE Condensed Statement of Consolidated Cash Flows (Unaudited)
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------------
(Thousands of Dollars)
-------------------------------
Three Months Ended March 31,
-------------------------------
2000 1999
- ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Cash Flows From Operating Activities:
Operations $ 107,632 $ 105,374
Changes in working capital other than cash (31,414) 19,987
Other (10,931) (28,550)
- ------------------------------------------------------------------------------------------------------------------------------
Net Cash Provided from Operating Activities 65,287 96,811
- ------------------------------------------------------------------------------------------------------------------------------
Cash Flows From Investing Activities:
Acquisitions (32,000) (56,031)
Capital expenditures (29,530) (26,951)
Capitalized divestiture costs (19,607) --
Long-term investments (9,476) (5,763)
Proceeds from disposition of investments 15,736 11,402
Other 6,311 (2,789)
- ------------------------------------------------------------------------------------------------------------------------------
Net Cash Used in Investing Activities (68,566) (80,132)
- ------------------------------------------------------------------------------------------------------------------------------
Cash Flows From Financing Activities:
Issuance of debt 174,687 42,963
Dividends on common and preferred stock (28,505) (29,285)
Reduction of commercial paper (35,746) --
Reductions of long-term obligations - net (45,056) (4,808)
Repurchase of common stock (77,121) (46,957)
Other (26,805) (15,496)
- ------------------------------------------------------------------------------------------------------------------------------
Net Cash Used in Financing Activities (38,546) (53,583)
- ------------------------------------------------------------------------------------------------------------------------------
Net decrease in cash and temporary cash investments (41,825) (36,904)
Cash and temporary cash investments at beginning of period 54,229 108,790
- ------------------------------------------------------------------------------------------------------------------------------
Cash and temporary cash investments at end of period $ 12,404 $ 71,886
==============================================================================================================================
</TABLE>
See notes to condensed consolidated financial statements.
<TABLE>
<S> <C> <C>
Non-Cash Investing and Financing Activities:
Preferred stock issued in conjunction with long-term investments $ -- $ 3,408
==============================================================================================================================
Capital lease obligations recorded $ -- $ 5,984
==============================================================================================================================
</TABLE>
4
<PAGE>
Notes to Condensed Consolidated Financial Statements (Unaudited)
A. CONSOLIDATION, RECLASSIFICATION AND ACCOUNTING POLICIES
Consolidation
DQE, Inc. is a multi-utility delivery and services company. Our subsidiaries
are Duquesne Light Company; AquaSource, Inc.; DQE Capital Corporation; DQE
Energy Services, Inc.; DQE Enterprises, Inc.; DQE Financial Corp.; and DQE
Systems, Inc.
Duquesne Light, our largest operating subsidiary, is an electric utility
engaged in the transmission, distribution and sale of electric energy. On April
28, 2000, Duquesne Light completed the Pennsylvania Public Utility Commission
(PUC)-approved sale of our generation assets to Orion Power MidWest, L.P. (See
"Generation Asset Sale" discussion, Note B, on page 6.)
AquaSource, our second largest operating subsidiary, is a water resource
management company that acquires, develops and manages water and wastewater
utilities, bottled water operations and complementary businesses.
Our expanded business lines engage in a wide range of initiatives, including:
the distribution of propane; the production of landfill gas and synthetic fuels;
investments in electronic commerce, energy-related technology and communications
systems; energy facility development and operation; and independent power
production. DQE Capital provides financing for DQE and various affiliates.
All material intercompany balances and transactions have been eliminated in
the preparation of the consolidated financial statements.
In the opinion of management, the unaudited condensed consolidated financial
statements included in this report reflect all adjustments that are necessary
for a fair presentation of the results of interim periods and are normal,
recurring adjustments. Prior periods have been reclassified to conform with
current accounting presentations.
These statements should be read with the financial statements and notes
included in our Annual Report on Form 10-K for the year ended December 31, 1999
filed with the Securities and Exchange Commission (SEC). The results of
operations for the three months ended March 31, 2000, are not necessarily
indicative of the results that may be expected for the full year. The
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements. The
reported amounts of revenues and expenses during the reporting period may also
be affected by the estimates and assumptions management is required to make.
Actual results could differ from those estimates.
DQE and Duquesne Light are subject to the accounting and reporting
requirements of the SEC. In addition, Duquesne Light's electric utility
operations are subject to regulation by the PUC and the Federal Energy
Regulatory Commission (FERC) with respect to rates for interstate sales,
transmission of electric power, accounting and other matters.
As a result of our PUC-approved restructuring plan (see "Rate Matters," Note
B, below), the electricity supply segment does not meet the criteria of
Statement of Financial Accounting Standards (SFAS) No. 71, Accounting for the
Effects of Certain Types of Regulation (SFAS No. 71). Pursuant to the PUC's
final restructuring order, generation-related regulatory assets are being
recovered through a competitive transition charge (CTC) collected in connection
with providing transmission and distribution services, and these assets have
been reclassified accordingly. The balance of transition costs will be adjusted
by receipt of the generation asset sale proceeds. The electricity delivery
business segment continues to meet SFAS No.71 criteria, and accordingly reflects
regulatory assets and liabilities consistent with cost-based ratemaking
regulations. The regulatory assets represent probable future revenue, because
provisions for these costs are currently included, or are expected to be
included, in charges to electric utility customers through the ratemaking
process. (See "Rate Matters," Note B, below.) These regulatory assets consist of
a regulatory tax receivable, unamortized debt costs and deferred employee costs.
B. RATE MATTERS
Competition and the Customer Choice Act
Under Pennsylvania ratemaking practice, regulated electric utilities were
granted exclusive geographic franchises to sell electricity, in exchange for
making investments and incurring obligations to serve customers under the then-
existing regulatory framework. Through the ratemaking process, those prudently
incurred costs were recovered from customers, along with a return on the
investment. Additionally, certain operating costs were approved for deferral
for future recovery from customers (regulatory assets). As a result of this
process, utilities had assets recorded on their balance sheets at above-market
costs, thus creating transition costs.
The Pennsylvania Electricity Generation Customer Choice and Competition Act
(Customer Choice Act) enables Pennsylvania's electric utility customers to
purchase electricity at market prices from a variety of electric generation
suppliers (customer choice). All customers now have customer choice. As of
April 30, 2000, approximately 24.3 percent of Duquesne Light's customers had
chosen alternative generation suppliers, repre-
5
<PAGE>
senting approximately 33.7 percent of Duquesne Light's non-coincident peak load.
As of April 28, 2000, the remaining customers are provided with electricity
through our provider of last resort service agreement with Orion (discussed
below). Customers pay their electricity generation supplier for generation
charges, and pay Duquesne Light the CTC and charges for transmission and
distribution. Electricity delivery (including transmission, distribution and
customer service) remains regulated in substantially the same manner as under
historical regulation.
Rate Cap
An overall four-and-one-half-year rate cap from January 1, 1997, was
originally imposed on the transmission and distribution charges of Pennsylvania
electric utility companies under the Customer Choice Act. As part of a
settlement regarding recovery of deferred fuel costs, we have agreed to extend
this rate cap for an additional six months through the end of 2001.
Provider of Last Resort
Duquesne Light is required not only to deliver electricity, but also to serve
as the provider of last resort for all customers in its service territory.
Although no longer a generation supplier, as the provider of last resort,
Duquesne Light must provide electricity for any customer who cannot or does not
choose an alternative electric generation supplier, or whose supplier fails to
deliver. While collecting the CTC, Duquesne Light may charge only PUC-approved
rates for the supply of electricity as the provider of last resort. As part of
the generation asset sale, Orion has agreed to supply Duquesne Light, under a
provider of last resort service agreement, with all of the electric energy
necessary to satisfy Duquesne Light's provider of last resort obligations during
the CTC collection period. This agreement, which expires upon Duquesne Light's
final collection of the CTC, in general effectively transfers to Orion the
financial risks and rewards associated with Duquesne Light's provider of last
resort obligations. While we retain the collection risk for the electricity
sales, a component of our regulated delivery rates is designed to cover the cost
of a normal level of uncollectible accounts. In April 2000, Duquesne Light and
Orion entered into an agreement that would, subject to PUC and other approvals,
extend this provider of last resort arrangement beyond the final CTC collection.
Generation Asset Sale
In its May 29, 1998, final restructuring order, the PUC determined that
Duquesne Light should recover most of the above-market costs of its generation
assets, including plant and regulatory assets, through the collection of the CTC
from electric utility customers. The $1.49 billion of transition costs, net of
tax, was originally to be recovered over a seven-year period ending in 2005.
However, by applying the approximately $1.1 billion of net proceeds of the
generation asset sale to Orion to reduce transition costs, we currently
anticipate early termination of the CTC collection period in 2001 for most major
rate classes. In addition, the transition costs as reflected on the consolidated
balance sheet are being amortized over the same period that the CTC revenues are
being recognized. Duquesne Light is allowed to earn an 11 percent pre-tax return
on approximately $275 million of unrecovered, net of tax balance of transition
costs, that remain following the generation asset sale. This amount remains
subject to PUC review. We will be filing our recovery request during the second
quarter.
On April 28, 2000, Duquesne Light completed the sale of our generation assets
to Orion. Orion purchased the wholly owned Cheswick, Elrama, Phillips and
Brunot Island power stations, as well as the stations received from FirstEnergy
Corp. in the December 3, 1999 power station exchange, for approximately $1.7
billion ($1.1 billion, net of tax and transaction expenses).
Termination of the AYE Merger
On October 5, 1998, we announced our unilateral termination of our merger
agreement with Allegheny Energy, Inc. (AYE). AYE filed suit in the United
States District Court for the Western District of Pennsylvania, seeking to
compel us to proceed with the merger, or in the alternative seeking an
unspecified amount of money damages. After holding a trial from October 20
through 28, 1999, the District Court ruled on December 3, 1999, that we had
properly terminated the merger agreement without breach, and granted judgment in
our favor on all claims and all requests for injunctive relief. On December 14,
1999, AYE appealed this ruling to the Third Circuit. Argument was heard on
March9, 2000, and a decision is pending. We cannot determine the ultimate
outcome of AYE's appeal at this time.
6
<PAGE>
C. RECEIVABLES
The components of receivables for the periods indicated are as follows:
<TABLE>
<CAPTION>
(Thousands of Dollars)
-----------------------------------------
March 31, March 31, December 31,
2000 1999 1999
- ---------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Electric customers $ 74,557 $ 88,970 $ 82,314
Water customers 22,345 16,093 21,352
Other utility 24,656 33,941 32,582
Other 64,295 81,626 57,280
Less: (Allowance for uncollectible accounts) (9,656) (10,073) (9,280)
- ---------------------------------------------------------------------------------------------
Receivables - net 176,197 210,557 184,248
Less: Receivables sold -- (50,000) --
- ---------------------------------------------------------------------------------------------
Total $ 176,197 $ 160,557 $ 184,248
=============================================================================================
</TABLE>
Duquesne Light and an unaffiliated corporation have an agreement that entitles
Duquesne Light to sell and the corporation to purchase, on an ongoing basis, up
to $50 million of accounts receivable. The accounts receivable sales agreement,
which expires in February 2001, is one of many sources of funds available to us.
We may elect to extend the agreement upon expiration, replace it with a similar
facility, or terminate it.
D. COMMITMENTS AND CONTINGENCIES
Construction
We estimate that in 2000 we will spend, excluding the allowance for funds used
during construction, approximately $85 million (including $5 million for
generation) for electric utility construction, and $45 million for water
utility construction.
Guarantees
As part of our investment portfolio in affordable housing, we have received
fees in exchange for guaranteeing a minimum defined yield to third-party
investors. A portion of the fees received has been deferred to absorb any
required payments with respect to these transactions. Based on an evaluation of
and recent experience with the underlying housing projects, we believe that such
deferrals are ample for this purpose.
Other
We are involved in various other legal proceedings and environmental matters.
We believe that such proceedings and matters, in total, will not have a
materially adverse effect on our financial position, results of operations or
cash flows.
E. BUSINESS SEGMENTS AND RELATED INFORMATION
We report our results by the following four principal business segments,
determined by products, services and regulatory environment: (1) the
transmission and distribution by Duquesne Light of electricity (electricity
delivery business segment), (2) the supply by Duquesne Light of electricity
(electricity supply business segment), (3)the collection by Duquesne Light of
transition costs (CTC business segment), and (4) the distribution by AquaSource
of water (water distribution business segment). We also report an "all other"
category, which includes our expanded business lines and Duquesne Light
investments below the quantitative threshold for separate disclosure.
Intercompany charges include costs for certain administrative functions as
well as interest charges on borrowings from DQE Capital.
7
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Business Segments for the Three Months Ended:
<TABLE>
<CAPTION>
(Millions of Dollars)
--------------------------------------------------------------------------------------
Electricity Electricity Water All Elimina- Consoli-
Delivery Supply CTC Distribution Other tions dated
--------------------------------------------------------------------------------------
March 31, 2000
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Operating revenues $ 87.4 $ 78.8 $ 96.4 $ 26.0 $ 29.6 $ (3.1) $ 315.1
Operating expenses 38.7 89.6 4.2 23.4 38.1 (3.1) 190.9
Depreciation and amortization
expense 9.1 5.2 46.0 3.7 6.4 -- 70.4
- --------------------------------------------------------------------------------------------------------------------------
Operating income (loss) 39.6 (16.0) 46.2 (1.1) (14.9) -- 53.8
Other income 2.4 4.0 -- 1.3 27.2 (1.6) 33.3
Interest and other charges 11.2 2.2 11.4 0.3 9.4 (1.0) 33.5
- --------------------------------------------------------------------------------------------------------------------------
Income before taxes 30.8 (14.2) 34.8 (0.1) 2.9 (0.6) 53.6
Income taxes 5.9 (9.4) 14.4 -- 0.3 (2.7) 8.5
- --------------------------------------------------------------------------------------------------------------------------
Income (loss) before intercompany
charges 24.9 (4.8) 20.4 (0.1) 2.6 2.1 45.1
Intercompany charges - net (1.5) (0.9) -- (3.0) 8.1 (2.7) --
- --------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 23.4 $ (5.7) $ 20.4 $ (3.1) $ 10.7 $ (0.6) $ 45.1
==========================================================================================================================
Assets $1,527.8 $ 424.4 $2,206.8 $ 460.3 $ 972.1 $ -- $5,591.4
==========================================================================================================================
Capital expenditures $ 11.4 $ -- $ -- $ 13.7 $ 4.4 $ -- $ 29.5
==========================================================================================================================
</TABLE>
<TABLE>
<CAPTION>
(Millions of Dollars)
--------------------------------------------------------------------------------------
Electricity Electricity Water All Elimina- Consoli-
Delivery Supply CTC Distribution Other tions dated
--------------------------------------------------------------------------------------
March 31, 1999
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Operating revenues $ 82.3 $ 106.6 $ 93.0 $ 22.1 $ 13.8 $ (4.3) $ 313.5
Operating expenses 39.0 109.7 4.1 19.2 20.9 (4.3) 188.6
Depreciation and amortization expense 14.3 8.9 29.6 1.6 2.9 -- 57.3
- ---------------------------------------------------------------------------------------------------------------------------
Operating income (loss) 29.0 (12.0) 59.3 1.3 (10.0) -- 67.6
Other income 1.2 2.4 -- 1.0 35.9 (1.2) 39.3
Interest and other charges 8.9 11.7 11.7 0.6 4.2 (0.6) 36.5
- ---------------------------------------------------------------------------------------------------------------------------
Income before taxes 21.3 (21.3) 47.6 1.7 21.7 (0.6) 70.4
Income taxes 7.7 (10.4) 19.8 0.6 6.0 (1.8) 21.9
- ---------------------------------------------------------------------------------------------------------------------------
Income (loss)before intercompany
charges 13.6 (10.9) 27.8 1.1 15.7 1.2 48.5
Intercompany charges - net (0.2) (0.3) -- -- 2.3 (1.8) --
- ---------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 13.4 $ (11.2) $ 27.8 $ 1.1 $ 18.0 $ (0.6) $ 48.5
===========================================================================================================================
Assets (1) $1,535.4 $ 425.7 $2,226.8 $ 446.1 $ 975.0 $ -- $5,609.0
===========================================================================================================================
Capital expenditures $ 13.4 $ 3.0 $ -- $ 6.6 $ 4.0 $ -- $ 27.0
===========================================================================================================================
</TABLE>
(1) Relates to assets as of December 31, 1999.
8
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Part I, Item 2 of this Quarterly Report on Form 10-Q should be read in
conjunction with our Annual Report on Form 10-K for the year ended December 31,
1999 filed with the Securities and Exchange Commission (SEC), and the condensed
consolidated financial statements, which are set forth on pages 2 through 8 in
Part I, Item 1 of this Report.
DQE, Inc. is a multi-utility delivery and services company. Our subsidiaries
are Duquesne Light Company; AquaSource, Inc.; DQE Capital Corporation; DQE
Energy Services, Inc.; DQE Enterprises, Inc.; DQE Financial Corp.; and DQE
Systems, Inc.
Duquesne Light, our largest operating subsidiary, is an electric utility
engaged in the transmission, distribution and sale of electric energy. On April
28, 2000, Duquesne Light completed the Pennsylvania Public Utility Commission
(PUC)-approved sale of our generation assets to Orion Power MidWest, L.P. (See
"Generation Asset Sale" discussion on page 14.)
AquaSource, our second largest operating subsidiary, is a water resource
management company that acquires, develops and manages water and wastewater
utilities, bottled water operations and complementary businesses.
Our expanded business lines engage in a wide range of initiatives, including:
the distribution of propane; the production of landfill gas and synthetic fuels;
investments in electronic commerce, energy-related technology and communications
systems; energy facility development and operation; and independent power
production. DQE Capital provides financing for DQE and various affiliates.
Service Areas
Duquesne Light's electric utility operations provide service to approximately
580,000 direct customers in southwestern Pennsylvania (including in the City of
Pittsburgh), a territory of approximately 800 square miles. Before completing
the generation asset sale, we also historically sold electricity to other
utilities. (See "Generation Asset Sale" discussion on page 14.)
AquaSource's water operations currently provide service to approximately
430,000 water and wastewater customer connections in 18 states.
Our expanded business lines have operations and investments in several states
and Canada.
Regulation
DQE and Duquesne Light are subject to the accounting and reporting
requirements of the SEC. In addition, Duquesne Light's electric utility
operations are subject to regulation by the PUC and the Federal Energy
Regulatory Commission (FERC) with respect to rates for interstate sales,
transmission of electric power, accounting and other matters.
As a result of our PUC-approved restructuring plan (see "Rate Matters" on page
13), the electricity supply segment does not meet the criteria of Statement of
Financial Accounting Standards (SFAS) No. 71, Accounting for the Effects of
Certain Types of Regulation (SFAS No. 71). Pursuant to the PUC's final
restructuring order, generation-related regulatory assets are being recovered
through a competitive transition charge (CTC) collected in connection with
providing transmission and distribution services, and these assets have been
reclassified accordingly. The balance of transition costs will be adjusted by
receipt of the proceeds from the generation asset sale. The electricity delivery
business segment continues to meet SFAS No. 71 criteria, and accordingly
reflects regulatory assets and liabilities consistent with cost-based ratemaking
regulations. The regulatory assets represent probable future revenue, because
provisions for these costs are currently included, or are expected to be
included, in charges to electric utility customers through the ratemaking
process. (See "Rate Matters" on page 13.)
On December 15, 1999, the FERC issued its Order No.2000, which calls on
transmission-owning utilities such as Duquesne Light to voluntarily join
regional transmission organizations. The goal of the order is to put
transmission facilities in a region under common control in an effort to reduce
costs. The order requires utilities to file a proposal for a regional
transmission organization, a description of efforts to join one, or reasons for
not joining one, by October 15, 2000. We are currently studying Order No. 2000,
and have not yet determined our response.
AquaSource's water utility operations are subject to regulation by the utility
regulatory bodies in their respective states. AquaSource is in the process of
filing a consolidated rate case in Texas, the state with its largest investment
level.
Business Segments
For the purposes of complying with SFAS No. 131, Disclosures about Segments of
an Enterprise and Related Information (SFAS No. 131), we are required to
disclose information about our business segments separately. This information is
set forth in "Results of Operations" below and in "Business Segments and Related
Information," Note E to our condensed consolidated financial statements on
page 7.
RESULTS OF OPERATIONS
Overall Performance
Basic earnings per share were $0.63 in the first quarter of 2000 compared to
$0.62 in the first quarter of 1999, an increase of 1.6 percent. The average
shares of outstanding common stock declined by 6.3 million, or 8.1 percent. The
9
<PAGE>
lower average shares outstanding reflect the 1.8 million shares of common stock
we repurchased during the first quarter of 2000 and 5.7 million we repurchased
in 1999. Net income decreased from $48.5 million in the first quarter of 1999 to
$45.1 million in the first quarter of 2000, a decrease of 7.0 percent.
Comprehensive income consists of net income plus unrealized holding gains in
marketable securities. Comprehensive income was $53.5 million in the first
quarter of 2000 compared to $48.1 million in the first quarter of 1999, an
increase of $5.4 million or 11.2 percent. This increase was due substantially to
the 213 percent share price appreciation during the first quarter of SatCon
Technology Inc., one of our energy-related technology investments. Although
SatCon's share price has recently decreased, the price at April 30, 2000
represented a 119 percent appreciation from the end of 1999.
Results of Operations by Business Segment
Historically, Duquesne Light was treated as a single integrated business
segment, due to its regulated operating environment. The PUC authorized a
combined rate for supplying and delivering electricity to customers, that was
(1) cost-based, (2) designed to recover operating expenses and investment in
electric utility assets, and (3) designed to provide a return on the investment.
As a result of the Pennsylvania Electricity Generation Customer Choice and
Competition Act (Customer Choice Act), supply of electricity is deregulated and
charged at a separate rate from the delivery of electricity. For the purposes of
complying with SFAS No. 131, Disclosures about Segments of an Enterprise and
Related Information, we are required to disclose information about our business
segments separately.
We report our results by the following four principal business segments,
determined by products, services and regulatory environment: (1) the
transmission and distribution by Duquesne Light of electricity (electricity
delivery business segment), (2) the supply by Duquesne Light of electricity
(electricity supply business segment), (3) the collection by Duquesne Light of
transition costs (CTC business segment), and (4) the distribution by AquaSource
of water (water distribution business segment). With the completion of our
generation asset sale on April 28, 2000, the electricity supply business segment
is now comprised solely of provider of last resort service. We also report an
"all other" category, which includes our expanded business lines and Duquesne
Light investments below the quantitative threshold for separate disclosure.
Revenues in the "all other" category are comprised of energy facility
operations, landfill gas operations and propane and other operating investments.
Income from financial investments is included in other income. Assets in the
"all other" category are comprised of financial investments, energy facility
assets, landfill gas recovery and processing assets and propane distribution
assets. Intercompany eliminations primarily relate to intercompany sales of
electricity, property rental and dividends. Intercompany charges include costs
for certain administrative functions as well as interest charges on borrowings
from DQE Capital.
Additional information on our business segments is set forth in Note E,
"Business Segments and Related Information," in the Notes to the Consolidated
Financial Statements on page 7.
Electricity Delivery Business Segment. The electricity delivery business
segment contributed $23.4 million to net income in the first quarter of 2000
compared to $13.4 million in the first quarter of 1999, an increase of
$10.0 million or 74.6 percent.
Operating revenues for this business segment are primarily derived from the
delivery of electricity. Sales to residential and commercial customers are
influenced by weather conditions. Warmer summer and colder winter seasons lead
to increased customer use of electricity for cooling and heating. Commercial
sales also are affected by regional development. Sales to industrial customers
are influenced primarily by national and global economic conditions.
Operating revenues increased by $5.1 million or 6.2 percent compared to the
first quarter of 1999 due to an increase in sales to electric utility customers
of 3.6 percent in the first quarter of 2000. This increase is due to higher
industrial sales due to increased consumption by steel manufacturers. The
following table sets forth kilowatt-hours (KWH) delivered to electric utility
customers.
<TABLE>
<CAPTION>
KWH Delivered
-------------------
(In Millions)
-------------------
First Quarter 2000 1999 Change
- ---------------------------------------------------------
<S> <C> <C> <C>
Residential 904 917 (1.4)%
Commercial 1,485 1,440 3.1 %
Industrial 934 851 9.8 %
- -------------------------------------------------
Sales to Electric
Utility Customers 3,323 3,208 3.6 %
=========================================================
</TABLE>
Operating expenses for the electricity delivery business segment primarily are
made up of costs to operate and maintain the transmission and distribution
system; meter reading and billing costs; customer service; collection;
administrative expenses; and non-income taxes, such as gross receipts, property
and payroll taxes. Operating expenses were relatively consistent in the first
quarters of 2000 and 1999.
Depreciation and amortization expense decreased $5.2 million or 36.4 percent
in the first quarter of 2000 compared to the first quarter of 1999. This
decrease can be attributed to a depreciation study completed in the second
quarter of 1999 which reduced the composite depreciation rate of the
transmission and distribution assets.
10
<PAGE>
Interest and other charges include interest on long-term debt, other interest
and preferred stock dividends of Duquesne Light. In the first quarter of 2000,
there was $2.3 million or 25.8 percent more interest and other charges allocated
to the electricity delivery business segment compared to the first quarter of
1999. The increase was the result of additional short-term borrowings at
Duquesne Light. Given the recently completed generation asset sale to Orion, all
remaining Duquesne Light financing costs after recapitalization will be borne by
the electricity delivery business segment.
For the first quarter of 2000, Duquesne Light's effective tax rate decreased
to 21 percent, from 36 percent in the first quarter of 1999, due to the
accounting for the generation asset sale. The effect on the delivery business
was a reduction in income tax expense of $1.8 million despite a $9.5 million
increase in income before taxes.
Electricity Supply and CTC Business Segments. In the first quarter of 2000,
the electricity supply and CTC business segments reported net income of $14.7
million compared to $16.6 million in the first quarter of 1999, a decrease of
$1.9 million or 11.4 percent.
For the electricity supply and CTC business segments, operating revenues are
derived primarily from the supply of electricity for delivery to retail
customers, the supply of electricity to wholesale customers and the collection
of generation-related transition costs from electricity delivery customers.
Energy requirements for our retail electric utility customers are reduced as
more customers participate in customer choice. Energy requirements for
residential and commercial customers are also influenced by weather conditions.
Warmer summer and colder winter seasons lead to increased customer use of
electricity for cooling and heating. Commercial energy requirements are also
affected by regional development. Energy requirements for industrial customers
are primarily influenced by national and global economic conditions.
Short-term sales to other utilities are made at market rates. Fluctuations in
electricity sales to other utilities are related to customer energy
requirements, the energy market and transmission conditions, and the
availability of generating stations. We no longer make short-term sales to
other utilities now that the generation asset sale is completed.
Operating revenues decreased by $24.4 million or 12.2 percent compared to the
first quarter of 1999. The decrease in revenues resulted primarily from 13.9
percent less energy supplied to electric utility customers due to greater
participation in customer choice. In addition, there was a 25.3 percent decrease
in energy supplied to other utilities in the first quarter of 2000 compared to
the first quarter of 1999, due to our decision to make 600 megawatts available
during the first six months of 1999 to licensed generation suppliers to
stimulate competition. The following table sets forth KWH supplied for customers
who have not chosen an alternative generation supplier.
<TABLE>
<CAPTION>
KWH Supplied
-------------------
(In Millions)
-------------------
First Quarter 2000 1999 Change
- -----------------------------------------------------------------
<S> <C> <C> <C>
Residential 682 823 (17.1)%
Commercial 879 1,152 (23.7)%
Industrial 849 823 3.2 %
- ---------------------------------------------------------
Sales to Electric Utility Customers 2,410 2,798 (13.9)%
- ---------------------------------------------------------
Sales to Other Utilities 495 663 (25.3)%
- ---------------------------------------------------------
Total Sales 2,905 3,461 (16.1)%
=================================================================
</TABLE>
Operating expenses for the electricity supply business segment are primarily
made up of energy costs; costs to operate and maintain the power stations;
administrative expenses; and non-income taxes, such as gross receipts, property
and payroll taxes.
Fluctuations in energy costs generally result from changes in the cost of
fuel; total KWH supplied; and generating station availability. In the first
quarter of 1999, fluctuations also resulted from the mix between coal, nuclear
generation and purchased power.
Operating expenses decreased $20.0 million or 17.6 percent from the first
quarter of 1999, as a result of lower power production costs due to the power
station exchange in December 1999.
Depreciation and amortization expense includes the depreciation of the power
stations' plant and equipment, amortization of transition costs and, in the
first quarter of 1999, accrued nuclear decommissioning costs. There was an
increase of $12.7 million or 33.0 percent compared to the first quarter of 1999.
This increase was due to a higher level of transition cost amortization in the
first quarter of 2000.
Interest and other charges include interest on debt, other interest and
preferred stock dividends of Duquesne Light. In the first quarter of 2000 there
was a $9.8 million or 41.9 percent decrease in interest and other charges
compared to the first quarter of 1999. The decrease reflects $9.6 million of
Beaver Valley Unit 2 lease-related costs in the first quarter of 1999, which
were eliminated with the lease cancellation in December 1999.
For the first quarter of 2000, Duquesne Light's effective tax rate decreased
to 21 percent, from 36 percent in the first quarter of 1999, due to the
accounting for the generation asset sale. The effect on the supply business was
a reduction in income tax expense of $4.4 million on a $5.7 million reduction in
income before taxes.
11
<PAGE>
Water Distribution Business Segment. The water distribution business segment
had a $3.1 million net loss in the first quarter of 2000, compared to $1.1
million of net income in the first quarter of 1999.
During the first quarter of 2000, there was an increase in intercompany
charges stemming from increased borrowings from DQE Capital and increased use of
corporate administrative services. Before intercompany charges, net income
declined $1.2 million from the first quarter of 1999.
Operating revenues for this business segment are derived from the following:
billings related to water and sewer services for utilities owned by AquaSource
and utilities for which AquaSource is a contract operator; bottled water
delivery sales; and water-related construction and engineering projects.
Operating revenues increased by $3.9 million during the first quarter of 2000.
The increase was primarily the result of increased revenues from utility
customers and increased contract operations due to acquisitions in the second
quarter of 1999.
Operating expenses for the water distribution business segment are primarily
made up of costs to operate and maintain the water distribution systems; bottled
water costs; administrative expenses; and non-income taxes, such as property and
payroll taxes. Operating expenses increased by $4.2 million as a result of the
second quarter 1999 acquisitions.
Depreciation and amortization expense includes depreciation of utility
delivery systems and the amortization of goodwill on acquisitions. The $2.1
million increase was attributable to increases in both depreciation and
amortization related to the larger size of the business.
All Other. The all other category contributed $10.7 million to net income in
the first quarter of 2000 compared to $18.0 million in the first quarter of
1999, a decrease of $7.3 million or 40.6 percent.
Operating revenues increased in the first quarter of 2000 by $15.8 million or
114.5 percent compared to the first quarter of 1999. This increase was primarily
the result of increased revenues from our propane delivery business
acquisitions.
In the first quarter of 2000, operating expenses increased $17.2 million or
82.3 percent over the first quarter of 1999. This increase was primarily the
result of increased expenses from our propane delivery business acquisitions and
the growth of the expanded business lines' start-up and developmental
activities.
Depreciation and amortization expense primarily includes the depreciation of
the expanded business lines' plant and equipment and amortization of certain
investments. In the first quarter of 2000, depreciation and amortization expense
increased by $3.5 million, primarily due to the acquisition of propane delivery
companies during the last half of 1999.
Other income primarily includes gains on investment dispositions, long-term
investment income, and interest and dividend income related to the expanded
business lines. Other income in the first quarter of 2000 was $8.7 million or
24.2 percent lower than in the first quarter of 1999. The decrease is related to
the nature of our leasing investments, where income decreases over the lease
life. Also contributing to the decrease from the first quarter of 1999 were one-
time gains not repeated in the first quarter of 2000.
Interest and other charges are made up of interest on long-term debt, other
interest and preferred stock dividends of the expanded business lines. An
increase of $5.2 million in the first quarter of 2000 was the result of higher
long-term debt interest expense, primarily related to the growth in our expanded
business lines.
LIQUIDITY AND CAPITAL RESOURCES
We estimate that during 2000 we will spend, excluding the allowance for funds
used during construction, approximately $85 million for electric utility
construction, including $5 million for generation, and approximately $45 million
for water utility construction. During the first three months of 2000, we have
spent approximately $30 million on capital expenditures, which consist of
approximately $11 million at Duquesne Light, $14 million at AquaSource and the
remaining $5 million on other.
Acquisitions and Dispositions
On March 31, 2000, Duquesne Light purchased from Itron, Inc. the Customer
Advanced Reliability System (CARS), the automated electronic meter reading
system developed by Itron for use with our electric utility customers. We had
previously leased these assets.
On April 28, 2000, Duquesne Light completed the sale of our generation assets
to Orion for approximately $1.7 billion dollars ($1.1 billion, net of tax and
transaction costs). (See "Generation Asset Sale" discussion on page 14.)
We disposed of affordable housing investments in the first quarter of 2000 for
$15.7 million, resulting in an after-tax gain of $2.1 million.
In the first three months of 1999 we issued 34,077 shares of DQE Preferred
Stock, as part of a total investment of approximately $220 million in water
companies.
In the first quarter of 1999, we disposed of our interest in leased coal-
mining equipment with proceeds of $11.4 million and an after-tax gain of $2.9
million.
Financing
During the first quarter, in addition to capital provided from operations, we
raised capital to finance a portion of the CARS acquisition and continue our
recapitalization program in connection with the generation divestiture. In the
first quarter we repurchased 1.8 million shares of DQE common stock on
12
<PAGE>
the open market for approximately $78 million. Additional capital was required
for the maturity of $45 million of first mortgage bonds, the repurchase of
approximately $0.5 million of DQE Preferred Stock and the payment of $29 million
of dividends.
During January 2000, we issued $150 million of floating rate two-year notes,
callable in July 2000. The proceeds of this issuance were used to reduce the
amount of outstanding commercial paper.
At March 31, 2000, we had $307 million of commercial paper borrowings
outstanding, and $449 million of current debt maturities. During the quarter,
the maximum amount of bank loans and commercial paper borrowings outstanding was
$373 million, the amount of average daily borrowings was $40.3 million, and the
weighted average daily interest rate was 5.98 percent. In the first quarter we
issued $25 million of first mortgage bonds to fund a portion of the CARS
acquisition, all of which were retired in May 2000.
Future Capital Requirements and Availability
Having completed our generation asset sale, we are using the proceeds to
recapitalize. This process includes the retirement of short-term debt, the
redemption of long-term debt and the continued aggressive repurchase of
outstanding common stock. Through April 30, 2000 we have repurchased 4.2 million
shares of DQE common stock for approximately $172 million and 5,520 shares of
DQE Preferred Stock for approximately $0.5 million. Using proceeds from the
generation asset sale, Duquesne Light acquired the $359 million ($9 million of
which was current debt) of 8.7 percent collateralized lease bonds previously
assumed as part of the Beaver Valley Unit 2 lease termination in December 1999.
We retired an additional $410 million of current debt, including $40 million
related to our receivables facility, and reduced our notes payable by $311
million in the second quarter. We also paid $48 million of related interest and
transaction expenses.
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------
Use of Sale Proceeds
- -----------------------------------------------------------------------
(In Millions)
<S> <C> <C>
Total proceeds $1,705
- -----------------------------------------------------------------------
Current debt maturities 419
Notes payable 311
Long term debt 350
Interest and transaction expenses 48
- -----------------------------------------------------------------------
Total 1,128
- -----------------------------------------------------------------------
Remaining Proceeds $ 577
=======================================================================
</TABLE>
The remaining proceeds will be used to pay taxes, additional transaction
expenses, additional stock repurchases and other investments. Additionally, $65
million of term loans will mature in the fourth quarter of 2000.
We maintain two separate revolving credit agreements, one for $250 million
expiring in June 2000 and one for $225 million expiring in September 2000. We
have the option to convert each revolver into a term loan facility for a period
of one or two years, respectively, for any amounts then outstanding upon
expiration of the revolving credit period. Interest rates can, in accordance
with the option selected at the time of the borrowing, be based on one of
several indicators, including prime, Eurodollar, or certificate of deposit
rates. Facility fees are based on the unborrowed amount of the commitment. At
March 31, 2000, no borrowings were outstanding. Related to these and other
credit facilities, we are subject to financial covenants requiring certain cash
coverage and debt-to-capital ratios. At March 31, 2000, we were in compliance
with all of our financial covenants.
Duquesne Light and an unaffiliated corporation have an agreement that entitles
Duquesne Light to sell, and the corporation to purchase, on an ongoing basis, up
to $50 million of accounts receivable. At various times during the first
quarter, Duquesne Light had sold receivables under the facility. No amounts were
outstanding at March 31, 2000. At March 31, 1999 we had sold $50 million of
receivables. The accounts receivable sales agreement, which expires in February
2001, is one of many sources of funds available to us. We may elect to extend
the agreement upon expiration, replace it with a similar facility, or terminate
it.
With customer choice fully in effect, and our generation asset divestiture
complete, all our electric utility customers are now buying their generation
directly from alternative suppliers or indirectly from Orion (who supplies
generation to Duquesne Light pursuant to our provider of last resort service
agreement). Customer revenues from Duquesne Light's operations have been reduced
by an amount equal to the generation rate previously applicable to those
customers using alternative generation suppliers. A further impact on customer
revenues is expected to occur when the CTC has been fully collected, which is
currently expected to occur in 2001 for most major rate classes; elimination of
the CTC will reduce customer rates.
RATE MATTERS
Competition and the Customer Choice Act
Under Pennsylvania ratemaking practice, regulated electric utilities were
granted exclusive geographic franchises to sell electricity, in exchange for
making investments and incurring obligations to serve customers under the then-
existing regulatory framework. Through the ratemaking process, those prudently
incurred costs were recovered from customers, along with a return on the
investment. Additionally, certain operating costs were approved for deferral
for future recovery from customers (regulatory assets). As a result of this
process, utilities had assets recorded on their balance sheets at above-market
costs, thus creating transition costs.
13
<PAGE>
The Pennsylvania Electricity Generation Customer Choice and Competition Act
(Customer Choice Act) enables Pennsylvania's electric utility customers to
purchase electricity at market prices from a variety of electric generation
suppliers (customer choice). All customers now have customer choice. As of
April 30, 2000, approximately 24.3 percent of Duquesne Light's customers had
chosen alternative generation suppliers, representing approximately 33.7 percent
of Duquesne Light's non-coincident peak load. As of April 28, 2000, the
remaining customers are provided with electricity through our provider of last
resort service agreement with Orion (discussed below). Customers pay their
electricity generation supplier for generation charges, and pay Duquesne Light
the CTC and charges for transmission and distribution. Electricity delivery
(including transmission, distribution and customer service) remains regulated in
substantially the same manner as under historical regulation.
Rate Cap
An overall four-and-one-half-year rate cap from January 1, 1997, was
originally imposed on the transmission and distribution charges of Pennsylvania
electric utility companies under the Customer Choice Act. As part of a
settlement regarding recovery of deferred fuel costs, we have agreed to extend
this rate cap for an additional six months through the end of 2001.
Provider of Last Resort
Duquesne Light is required not only to deliver electricity, but also to serve
as the provider of last resort for all customers in its service territory.
Although no longer a generation supplier, as the provider of last resort,
Duquesne Light must provide electricity for any customer who cannot or does not
choose an alternative electric generation supplier, or whose supplier fails to
deliver. While collecting the CTC, Duquesne Light may charge only PUC-approved
rates for the supply of electricity as the provider of last resort. As part of
the generation asset sale, Orion has agreed to supply Duquesne Light, under a
provider of last resort service agreement, with all of the electric energy
necessary to satisfy Duquesne Light's provider of last resort obligations during
the CTC collection period. This agreement, which expires upon Duquesne Light's
final collection of the CTC, in general effectively transfers to Orion the
financial risks and rewards associated with Duquesne Light's provider of last
resort obligations. While we retain the collection risk for the electricity
sales, a component of our regulated delivery rates is designed to cover the cost
of a normal level of uncollectible accounts. In April 2000, Duquesne Light and
Orion entered into an agreement that would, subject to PUC and other approvals,
extend this provider of last resort arrangement beyond the final CTC collection.
Generation Asset Sale
In its May 29, 1998, final restructuring order, the PUC determined that
Duquesne Light should recover most of the above-market costs of its generation
assets, including plant and regulatory assets, through the collection of the CTC
from electric utility customers. The $1.49 billion of transition costs, net of
tax, was originally to be recovered over a seven-year period ending in 2005.
However, by applying the approximately $1.1 billion of net proceeds of the
generation asset sale to Orion to reduce transition costs, we currently
anticipate early termination of the CTC collection period in 2001 for most major
rate classes. In addition, the transition costs as reflected on the consolidated
balance sheet are being amortized over the same period that the CTC revenues are
being recognized. Duquesne Light is allowed to earn an 11 percent pre-tax return
on approximately $275 million of unrecovered, net of tax balance of transition
costs, that remain following the generation asset sale. This amount remains
subject to PUC review. We will be filing our recovery request during the second
quarter.
On April 28, 2000, Duquesne Light completed the sale of our generation assets
to Orion. Orion purchased the wholly owned Cheswick, Elrama, Phillips and Brunot
Island power stations, as well as the stations received from FirstEnergy Corp.
in the December 3, 1999 power station exchange, for approximately $1.7 billion
($1.1 billion, net of tax and transaction expenses).
Termination of the AYE Merger
On October 5, 1998, we announced our unilateral termination of our merger
agreement with Allegheny Energy, Inc. (AYE). AYE filed suit in the United
States District Court for the Western District of Pennsylvania, seeking to
compel us to proceed with the merger, or in the alternative seeking an
unspecified amount of money damages. After holding a trial from October 20
through 28, 1999, the District Court ruled on December 3, 1999, that we had
properly terminated the merger agreement without breach, and granted judgment in
our favor on all claims and all requests for injunctive relief. On December 14,
1999, AYE appealed this ruling to the Third Circuit. Argument was heard on
March9, 2000, and a decision is pending. We cannot determine the ultimate
outcome of AYE's appeal at this time.
OUTLOOK
Following the generation asset sale, the electricity business will be a much
smaller part of DQE than it has been historically. Among the challenges we face
is changing the role of our administrative infrastructure. While the number of
electricity customers that we serve will not change, our margins from these
customers will decline to reflect the fact that we are
14
<PAGE>
providing only the delivery service and not the electricity itself. Our reduced
margins will necessitate a lower level of support costs at the electricity
delivery business. We expect to retrain and redeploy some of our administrative
employees, but we also must reduce our overall administrative costs to maintain
profitability. We have initiated a corporate center excellence project designed
to consolidate administrative resources and significantly reduce administrative
costs by the end of 2001.
Additionally, we will be looking for opportunities to provide new services to
our existing customer base and to new customers. For example, through an
alliance with Enermetrix.com, we are offering commercial and industrial
customers the ability to participate in a reverse auction process for their gas
and electricity supply requirements via a secure website. Also, with the CARS
acquisition in the first quarter we expect not only to reduce operating costs,
but to position ourselves to offer additional products to our customers and
telemetry services to other utilities.
Also related to the generation divestiture, we will be changing the capital
structure of Duquesne Light. With the proceeds from the sale, we have retired
higher-cost series of outstanding debt, reduced the level of equity and will
continue to recapitalize accordingly to create a capital structure appropriate
for an electricity delivery company. Through April 30, 2000, we repurchased
approximately $172 million of DQE common stock and expect to continue to
aggressively repurchase DQE shares throughout the remainder of the year.
While transforming Duquesne Light, we continue to focus on realizing operating
efficiencies in our other delivery businesses. AquaSource is evaluating the sale
of its non-core investments, including bottled water. In the second quarter we
plan to announce the profitable sale of AquaSource's bottled water operations.
Proceeds from these types of dispositions will be used to acquire utilities
within our regional clusters to further achieve cost reductions and synergies
from our aggregation strategy. In addition to streamlining operations,
AquaSource is leveraging DQE's corporate support services to attain targeted
cost levels and is installing comprehensive customer and financial information
systems. In this regard, AquaSource continues to work with a partnership formed
by DQE Enterprises and Itron to provide automated meter reading technologies to
reduce costs. AquaSource is also in the process of filing a consolidated rate
case in Texas, the state with our largest investment level. We are seeking
consistent, statewide rates, increased to reflect upgrades for environmental
compliance and other system improvements. During the fourth quarter we expect to
file a rate case in Indiana, another state with a substantial level of
investment. With the success of these initiatives, we expect to achieve our
targeted return on investment of 8 percent by the end of 2000. At that point we
will look for opportunities to continue to grow our water delivery business in a
disciplined manner.
DQE Systems' propane delivery business, ProAm, also is continuing to focus on
achieving cost reductions and synergies through an aggregation strategy. The
propane business is cyclical, with the first and fourth quarters providing the
bulk of the annual earnings as residential heating represents the majority of
ProAm's load. During the first quarter of 2000, sales were hampered by warmer
than normal weather in Texas, where the majority of our investments are
clustered. ProAm is focusing acquisitions in two additional distinct geographic
regions as a means of mitigating the weather risk inherent in the business. We
are also instituting a supply management strategy as a means of mitigating
commodity price risk. First quarter margins were adversely affected by an
unexpected spike in propane supply prices. As competitors had more low cost
reserves in place, we were not able to pass price increases along to customers
as rapidly as incurred. DQE Systems' other primary business line is DQE
Communications, which recently has completed a 50,000 fiber-mile metropolitan
network. This network is operational and presently is being leased. With a full
year's operating improvements in ProAm and the execution of DQE Communications'
growth opportunities, we expect to achieve our targeted return on investment of
10 percent by the end of 2001.
In addition to service-oriented delivery companies and an efficient support
infrastructure, another integral component of our multi-utility vision is the
use of electronic commerce channels to more efficiently offer products and
services to our growing customer base. DQE Enterprises continues to add to its
portfolio of electronic commerce and energy technology businesses. In addition
to continuing to develop its current businesses, DQE Enterprises expects to make
investments in at least 10 new, principally early-stage companies during 2000.
Additionally, several of the companies within the current portfolio are
expected to undertake additional capital raising activities during the year. One
business, H Power Corporation, filed a registration statement in April for an
initial public offering. DQE Enterprises anticipates other such opportunities
for market valuation of its investments to occur during the third and fourth
quarters.
Our other complementary businesses also continue to develop. While we are
completing negotiations for the sale of our synthetic fuel facilities, we
continue to focus on the operation of traditional energy facilities for airports
and for other industrial companies. Furthermore, we expect to continue to grow
our landfill and alternative energy niche businesses through disciplined
investment in additional opportunities as they are identified.
In summary, we continue to expect that 2000 will be an evolutionary year for
DQE's businesses. We are now fully out of the electricity generation business
and are taking steps to solidify returns in our delivery businesses. We expect
that
15
<PAGE>
by year-end, we will have implemented the plans necessary to achieve our
targeted returns. In the interim, we expect to be able to continue to deliver
earnings growth through the recognition of value creation in our technology
investments and through the continued recognition of gains from the disposition
of non-core investments.
The foregoing paragraphs in this "Outlook" section contain forward-looking
statements regarding our plans to continue repurchasing our common stock;
AquaSource's planned disposition of its bottled water operations; AquaSource's
planned rate cases in Texas and Indiana; the projected return on our AquaSource
and DQE Systems investments; DQE Enterprises' plans to make additional
technology company investments and the possibility of certain of its businesses
undertaking initial public offerings in 2000. Actual results may materially
differ from those implied by such statements due to known and unknown risks and
uncertainties, including, but not limited to, the following: fluctuations in
the price for our common stock could affect our repurchasing plans; the outcome
of negotiations with purchasers could affect the sale of bottled water; the
timing and outcome of the rate case filings are dependent on determinations made
by the public utility commissions in Texas and Indiana; changing market
conditions, weather conditions and demand for utility services with respect to
water and propane companies and the availability of appropriate investment
opportunities in those industries, as well as changing market conditions and
demand for utility services with respect to telecommunications companies, could
affect projected returns on investments by AquaSource and DQE Systems; the
availability of appropriate investment opportunities could affect plans for
additional technology company investments; the volatility of the stock markets,
as well as general business and economic conditions, could affect the potential
for initial public offerings being made at any time by the companies in which we
invest; and other risks discussed in our filings with the SEC.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
Market Risk
Market risk represents the risk of financial loss that may impact our
consolidated financial position, results of operations or cash flows due to
adverse changes in market prices and rates.
We manage our interest rate risk by balancing our exposure between fixed and
variable rates while attempting to minimize our interest costs. Currently, our
variable interest rate debt is approximately 25 percent of long-term borrowings.
This variable rate debt is low-cost, tax-exempt debt. We also manage our
interest rate risk by retiring and issuing debt from time to time and by
maintaining a balance of short-term, medium-term and long-term debt. A 10
percent increase in interest rates would have affected our variable rate debt
obligations by increasing interest expense by approximately $0.7 million for the
three months ended March 31, 2000 and $0.4 million for the three months ended
March 31, 1999. A 10 percent reduction in interest rates would have increased
the market value of our fixed rate debt by approximately $36.0 million and $19.8
million as of March 31, 2000 and March 31, 1999. Such changes would not have had
a significant near-term effect on our future earnings or cash flows.
--------------------
Except for historical information contained herein, the matters discussed in
this report are forward-looking statements that involve risks and uncertainties
including, but not limited to: the final outcome of AYE's merger-related
litigation; economic and business conditions with respect to Internet and energy
technology companies; economic, competitive, regulatory, governmental and
technological factors affecting operations, markets, products, services and
prices; and other risks discussed in "Outlook" above and our filings with the
SEC.
16
<PAGE>
PART II. OTHER INFORMATION.
Item 1. Legal Proceedings.
Termination of the AYE Merger
On October 5, 1998, we announced our unilateral termination of our merger
agreement with Allegheny Energy, Inc. (AYE). We believe that AYE suffered a
material adverse effect as a result of the PUC's final restructuring order
regarding AYE's utility subsidiary, West Penn Power Company. AYE filed suit in
the United States District Court for the Western District of Pennsylvania,
seeking to compel us to proceed with the merger, or in the alternative seeking
an unspecified amount of money damages. On October 28, 1998, the judge ruled in
our favor regarding termination of the merger agreement. AYE appealed to the
United States Court of Appeals for the Third Circuit, who on March 11, 1999,
remanded the case to the District Court for further proceedings. Trial was held
from October 20 through 28, 1999. On December 3, 1999, the District Court ruled
that we had properly terminated the merger agreement without breach, and granted
judgment in our favor on all claims and all requests for injunctive relief. On
December 14, 1999, AYE appealed this decision to the Third Circuit. Argument
was heard on March 9, 2000, and a decision is pending. We will continue to
defend ourselves vigorously against AYE's claims. The ultimate outcome of the
appeal cannot be determined at this time.
Item 6. Exhibits and Reports on Form 8-K
a. Exhibits:
EXHIBIT 12.1 - Calculation of Ratio of Earnings to
Fixed Charges and Preferred and
Preference Stock Dividend
Requirements.
EXHIBIT 27.1 - Financial Data Schedule
b. A report on Form 8-K was filed May 8, 2000, which
included the DQE earnings release for the quarter
ended March 31, 2000.
A report on Form 8-K was filed May 12, 2000,
to report the completion of the sale of Duquesne
Light's power plants and provider of last resort service.
Pro forma financial statements were filed with this
report.
17
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant identified below has duly caused this report to be signed on its
behalf by the undersigned thereunto duly authorized.
DQE, Inc.
------------------------------------------
(Registrant)
Date May 15, 2000 /s/ Morgan K. O'Brien
------------ -------------------------------------------
(Signature)
Morgan K. O'Brien
Executive Vice President,
Corporate Development
(Principal Financial Officer)
Date May 15, 2000 /s/ James E. Wilson
------------ -------------------------------------------
(Signature)
James E. Wilson
Vice President and Controller
(Principal Accounting Officer)
18
<PAGE>
DQE Exhibit 12.1
DQE and Subsidiaries
Calculation of Ratio of Earnings to Fixed Charges
and Preferred and Preference Stock Dividend Requirements
(Thousands of Dollars)
<TABLE>
<CAPTION>
Three Months
Ended Year Ended
March 31, December 31,
2000 1999 1998 1997 1996 1995
----------------------- --------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
FIXED CHARGES:
Interest on long-term debt $19,806 $ 79,454 $ 81,076 $ 87,420 $ 88,478 $ 95,391
Other interest 10,652 28,212 14,556 13,823 10,926 7,033
Portion of lease payments
representing an interest
factor 1,884 42,973 44,146 44,208 44,357 44,386
Dividend requirement 3,489 14,684 15,612 21,649 14,385 7,374
----------------------- --------------------------------------------------------------
Total Fixed Charges $35,831 $165,323 $155,390 $167,100 $158,146 $154,184
----------------------- --------------------------------------------------------------
EARNINGS:
Income from continuing
operations $45,104 $201,416 $196,688 $199,101 $179,138 $170,563
Income taxes 8,506 110,722* 100,982* 95,805* 87,388* 96,661
Fixed charges as above 35,831 165,323 155,390 167,100 158,146 154,184
----------------------- --------------------------------------------------------------
Total Earnings $89,441 $477,461 $453,060 $462,006 $424,672 $421,408
----------------------- --------------------------------------------------------------
RATIO OF EARNINGS TO FIXED
CHARGES 2.50 2.89 2.92 2.76 2.69 2.73
======================= ==============================================================
</TABLE>
*Earnings related to income taxes reflect a $3.0 million, $12.0 million, $17.0
million, $12.0 million and $13.5 million decrease for the twelve months ended
December 31, 1999, 1998, 1997, 1996 and 1995, respectively, due to a financial
statement reclassification related to Statement of Financial Accounting
Standards No. 109, Accounting for Income Taxes. The ratio of earnings to fixed
charges, absent this reclassification equals 2.86, 2.99, 2.87, 2.76 and 2.82 for
the twelve months ended December 31, 1999, 1998, 1997, 1996 and 1995,
respectively.
<TABLE> <S> <C>
<PAGE>
<ARTICLE> UT
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-2000
<PERIOD-START> JAN-01-2000
<PERIOD-END> MAR-31-2000
<BOOK-VALUE> PER-BOOK
<TOTAL-NET-UTILITY-PLANT> 1,484,579
<OTHER-PROPERTY-AND-INVEST> 1,033,522
<TOTAL-CURRENT-ASSETS> 325,897
<TOTAL-DEFERRED-CHARGES> 2,747,360
<OTHER-ASSETS> 0
<TOTAL-ASSETS> 5,591,358
<COMMON> 73,119
<CAPITAL-SURPLUS-PAID-IN> 931,964
<RETAINED-EARNINGS> 970,384
<TOTAL-COMMON-STOCKHOLDERS-EQ> 1,295,658<F1>
1,500
263,889<F2>
<LONG-TERM-DEBT-NET> 1,782,587
<SHORT-TERM-NOTES> 0
<LONG-TERM-NOTES-PAYABLE> 0
<COMMERCIAL-PAPER-OBLIGATIONS> 307,058
<LONG-TERM-DEBT-CURRENT-PORT> 448,532
0
<CAPITAL-LEASE-OBLIGATIONS> 15,649
<LEASES-CURRENT> 734
<OTHER-ITEMS-CAPITAL-AND-LIAB> 1,475,751
<TOT-CAPITALIZATION-AND-LIAB> 5,591,358
<GROSS-OPERATING-REVENUE> 315,061
<INCOME-TAX-EXPENSE> 8,506<F3>
<OTHER-OPERATING-EXPENSES> 261,289
<TOTAL-OPERATING-EXPENSES> 261,289
<OPERATING-INCOME-LOSS> 53,772
<OTHER-INCOME-NET> 33,361
<INCOME-BEFORE-INTEREST-EXPEN> 87,133
<TOTAL-INTEREST-EXPENSE> 33,523<F4>
<NET-INCOME> 45,104
411
<EARNINGS-AVAILABLE-FOR-COMM> 44,693
<COMMON-STOCK-DIVIDENDS> 28,093
<TOTAL-INTEREST-ON-BONDS> 19,806
<CASH-FLOW-OPERATIONS> 65,287
<EPS-BASIC> 0.63
<EPS-DILUTED> 0.62
<FN>
<F1>Includes $(679,809) of treasury stock at cost.
<F2>Includes $11,163 of Preference Stock.
<F3>Non-operating expense.
<F4>Includes $3,998 of Preferred and Preference Stock dividends.
</FN>
</TABLE>
