UIL Holdings 10-Q 2009
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2009
For the transition period from to
Commission file number 1-15052
(Exact name of registrant as specified in its charter)
Registrant’s telephone number, including area code: 203-499-2000
(Former name, former address and former fiscal year, if changed since last report.)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes T No £
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulations S-T (§232.405 of this chapter) during the preceding 12 months (or for shorter period that the registrant was required to submit and post such files).
Yes £ No £
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes £ No T
The number of shares outstanding of the issuer’s only class of common stock, as of August 3, 2009 was 29,929,591.
PART I. FINANCIAL INFORMATION
PART II. OTHER INFORMATION
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UIL HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (UNAUDITED)
(A) STATEMENT OF ACCOUNTING POLICIES
Basis of Presentation
UIL Holdings Corporation (UIL Holdings) primarily operates its regulated utility business. The utility business consists of the electric transmission and distribution operations of The United Illuminating Company (UI). UI is also a 50-50 joint venturer with NRG Energy, Inc. (NRG) in GenConn Energy LLC (GenConn), which is building new peaking generation plants chosen by the Connecticut Department of Public Utility Control (DPUC) to help address the state’s growing need for more power generation during the heaviest load periods. UIL Holdings also has non-utility businesses consisting of an operating lease, a passive minority ownership interest in an investment fund, a heating and cooling facility and an entity that collects receivables, disburses payables and manages claims related to a divested mechanical contracting business. The non-utility businesses also included the operations of Xcelecom, Inc. (Xcelecom) until the substantial completion of the sale of that business effective December 31, 2006. UIL Holdings is headquartered in New Haven, Connecticut, where its senior management maintains offices and is responsible for overall planning, operating and financial functions. UIL Holdings’ Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and the Notes to the Consolidated Financial Statements included in UIL Holdings’ Annual Report on Form 10-K for the year ended December 31, 2008. Such notes are supplemented below.
The year-end balance sheet data was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America (GAAP). Certain information and footnote disclosures, which are normally included in financial statements prepared in accordance with GAAP, have been condensed or omitted in accordance with Securities and Exchange Commission (SEC) rules and regulations. UIL Holdings believes that the disclosures made are adequate to make the information presented not misleading. The information presented in the consolidated financial statements reflects all adjustments which, in the opinion of UIL Holdings, are necessary for a fair statement of the financial position and results of operations for the interim periods described herein. All such adjustments are of a normal and recurring nature. The results for the six months ended June 30, 2009 are not necessarily indicative of the results for the entire fiscal year ending December 31, 2009.
Certain amounts reported in the Consolidated Balance Sheet as well as the operating section of the Consolidated Statement of Cash Flows in previous periods have been reclassified to conform to the current presentation.
UIL Holdings has evaluated subsequent events through the issue date of its quarterly financial statements, August 5, 2009.
Discontinued Operations / Assets Held for Sale
Under Statement of Financial Accounting Standards (SFAS) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” a long-lived asset or group of assets (disposal group) is classified as discontinued operations when (1) the company commits to a plan to sell the long-lived asset (disposal group) within a 12-month period, (2) there will be no significant continuing involvement following the sale, and (3) certain other criteria set forth in the statement are satisfied. In such a case:
In April 2006, UIL Holdings classified its wholly-owned subsidiary, Xcelecom as held for sale. Major classes of assets and liabilities of the discontinued operations of Xcelecom consist of: net current assets of $5.0 million consisting primarily of receivables; and net current liabilities of $5.9 million, consisting mainly of accrued insurance payables.
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The following table presents a reconciliation of the basic and diluted earnings per share calculations for the three and six month periods ended June 30, 2009 and June 30, 2008:
As of June 30, 2009, options to purchase 379,152 and 359,152 shares of common stock were outstanding but not included in the three and six month respective computations of diluted earnings per share, because the options’ exercise prices were greater than the average market price of the common shares during the three and six month periods ended June 30, 2009. Options to purchase 324,368 and 316,035 shares of common stock were outstanding as of June 30, 2008 but not included in the three and six month respective computations of diluted earnings per share, because the options’ exercise prices were greater than the average market price of the common shares during the three and six month periods ended June 30, 2008.
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UIL Holdings has a performance-based long-term incentive compensation arrangement pursuant to which certain members of management have the opportunity to earn a pre-determined number of performance shares, the number of which is predicated upon the achievement of various pre-defined performance measures. These performance shares were issued under the UIL Holdings 1999 Amended and Restated Stock Plan prior to 2009 and are now issued under the 2008 Stock and Incentive Compensation Plan (Plan). Performance shares vest at the end of the three-year cycle with the actual issuance of UIL Holdings common stock in respect of such shares following the end of each three-year cycle. A new three-year cycle begins in January of each year. UIL Holdings records compensation expense for these performance shares ratably over the three-year period, except in the case of retirement-eligible employees, for whom compensation expense is immediately recognized in accordance with SFAS No. 123 (Revised), “Share-Based Payment” (SFAS No. 123R), based on the value of the expected payout at the end of each year relative to the performance measures achieved. An additional $0.6 million of compensation expense was recorded in the first quarter of 2009 with respect to retirement-eligible employees based on the application of SFAS No. 123R retirement-eligible provisions.
A target amount of 104,320 performance shares was granted in March 2009; the average of the high and low market price on the date of grant was $22.34 per share. In March 2009, upon the vesting of performance shares previously granted, 28,188 shares were issued to members of management and receipt of 18,873 shares was deferred as stock units. The number of shares that ultimately will be issued is subject to the personal income tax elections of the applicable employees.
In March 2009, UIL Holdings granted a total of 3,333 shares of restricted stock to its President and Chief Executive Officer (CEO), James P. Torgerson, under the Plan and in accordance with his employment agreement; the average of the high and low market price on the date of grant was $22.34 per share. Compensation expense for this restricted stock is recorded ratably over the five-year vesting period for such restricted stock.
In March 2009, UIL Holdings granted a total of 44,020 shares of restricted stock to non-executive directors under the Plan; the average of the high and low market price on the date of grant was $22.34 per share. Compensation expense for this restricted stock is recorded ratably over the three-year vesting period for such restricted stock, except in the case of retirement-eligible directors, for whom compensation expense is immediately recognized in accordance with SFAS No. 123 (Revised), “Share-Based Payment” (SFAS No. 123R), based on the value of the expected payout at the end of each year. In March 2009, 18,000 shares of previously-granted restricted stock grants to directors vested, of which 10,000 shares were issued to directors who had not elected to have their vested shares deferred as stock units.
Total stock-based compensation expense for the six month periods ended June 30, 2009 and 2008 was $2.1 million and $2.3 million, respectively. Total stock-based compensation expense for the three month periods ended June 30, 2009 and 2008 was $0.8 million and $0.7 million, respectively.
Comprehensive income for the three and six month periods ended June 30, 2009 and 2008 was equal to net income, less an interest rate cap mark-to-market adjustment of an immaterial amount, after-tax, related to $64.5 million principal amount of Pollution Control Refunding Revenue Bonds. For further information regarding this interest rate cap transaction, see Note (B), “Capitalization – Long-Term Debt.”
In accordance with SFAS No. 109, “Accounting for Income Taxes,” UIL Holdings has provided deferred taxes for all temporary book-tax differences using the liability method. The liability method requires that deferred tax balances be adjusted to reflect enacted future tax rates that are anticipated to be in effect when the temporary differences reverse. In accordance with generally accepted accounting principles for regulated industries, UI has established a regulatory asset for the net revenue requirements to be recovered from customers for the related future tax expense associated with certain of these temporary differences. For ratemaking purposes, UI normalizes all investment tax credits (ITCs) related to recoverable plant investments.
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Under FIN No. 48, UIL Holdings may recognize the tax benefit of an uncertain tax position only if management believes it is more likely than not that the tax position will be sustained on examination by the taxing authority based upon the technical merits of the position. The tax benefits recognized in the financial statements from such a position should be measured based upon the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement. UIL Holdings adopted the provisions of FIN No. 48 on January 1, 2007, but has not recognized any additional liability for unrecognized tax benefits, or accrued any interest or penalties associated with uncertain tax benefits. As a result, as of June 30, 2009, UIL Holdings did not have any unrecognized tax benefits. The Company is not aware of any event that is likely to occur in the next twelve months that would cause the amount of unrecognized tax benefits to increase significantly.
UIL Holdings’ policy is to recognize interest accrued and penalties associated with uncertain tax positions as a component of operating expense. During the quarterly and year-to-date periods ended June 30, 2009 and 2008, no interest or penalties associated with uncertain tax positions was recognized and as of each of June 30, 2009 and December 31, 2008, no accrued interest or penalties are reflected in the Consolidated Balance Sheet.
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UIL Holdings’ regulatory assets and liabilities as of June 30, 2009 and December 31, 2008 comprised the following:
New Accounting Standards
In June 2009, the FASB issued SFAS No. 168, “The FASB Accounting and Standards Codification and the Hierarchy of Generally Accepted Accounting Principles” (SFAS No. 168). SFAS No. 168 replaces FASB Statement No. 162, “The Hierarchy of Generally Accepted Accounting Principles” and establishes the FASB Accounting Standards Codification as the source of authoritative accounting principles recognized by the FASB to be applied by nongovernmental entities in the preparation of financial statements in conformity with generally
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accepted accounting principles. SFAS No. 168 is effective for financial statements issued for interim and annual periods ending after September 15, 2009 and will impact financial statement disclosures referencing authoritative accounting guidance starting in the third quarter of 2009. Such references will be in accordance with the new codification. There will be no impact on UIL Holdings’ consolidated financial statements.
In June 2009, the FASB issued SFAS No. 167, “Amendments to FASB Interpretation No. 46 (R)” (SFAS No. 167). SFAS No. 167 amends Interpretation 46 (R) to require an enterprise to perform an analysis to determine whether the enterprise’s variable interest or interests give it a controlling financial interest in a variable interest entity. SFAS No. 167 is effective as of the beginning of the first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period, and for interim and annual periods thereafter. This statement is not expected to have a material impact on UIL Holdings’ Consolidated Balance Sheet, Consolidated Statement of Income or Consolidated Statement of Cash Flows.
In June 2009, the FASB issued SFAS No. 166, “Accounting for Transfers of Financial Assets – an amendment of FASB No. 140” (SFAS No. 166). SFAS No. 166 must be applied as of the beginning of the first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period, and for interim and annual periods thereafter. This statement is not expected to have an impact on UIL Holdings’ consolidated financial statements.
In May 2009, the FASB issued SFAS No. 165, “Subsequent Events” (SFAS No. 165). SFAS No. 165 requires an entity to disclose the date through which subsequent events have been evaluated, as well as whether that date is the date the financial statements were issued or the date the financial statements were available to be issued. SFAS No. 165 is effective for interim or annual financial periods ending after June 15, 2009. This statement impacts disclosures and did not have an impact on UIL Holdings’ Consolidated Balance Sheet, Consolidated Statement of Income or Consolidated Statement of Cash Flows.
In December 2007, the FASB issued SFAS No. 141 (Revised), “Business Combinations” (SFAS No. 141 (R)). SFAS No. 141 (R) is a revision of SFAS No. 141, but retains the fundamental requirements that the acquisition method of accounting (purchase method) be used for all business combinations. SFAS No. 141 (R) defines the acquirer as the entity that obtains control of one or more businesses in the business combination and establishes the acquisition date as the date that the acquirer achieves control. SFAS No. 141 (R) requires an acquirer to recognize the assets acquired, the liabilities assumed, and any noncontrolling interest in the acquired entity to be measured at fair value at the acquisition date. In addition, acquisition-related costs must be expensed in the periods in which the costs are incurred and the services received. SFAS No. 141 (R) is effective for fiscal years beginning on or after December 15, 2008 and did not have an impact on UIL Holdings’ Consolidated Balance Sheet, Consolidated Statement of Income or Consolidated Statement of Cash Flows.
In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interest in Consolidated Financial Statements,” an amendment to Accounting Research Bulletin No. 51, “Consolidated Financial Statements” (SFAS No. 160). SFAS No. 160 requires noncontrolling interest or “minority interest” to be clearly identified in the equity section of the Consolidated Balance Sheet, and income attributable to the noncontrolling interest be presented separately on the face of the Consolidated Statement of Income (Loss). SFAS No. 160 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008, and did not have an impact on UIL Holdings’ Consolidated Balance Sheet, Consolidated Statement of Income or Consolidated Statement of Cash Flows.
In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities” (SFAS No. 161). SFAS No. 161 is an amendment of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” SFAS No. 161 requires enhanced disclosures about an entity’s derivative and hedging activities. SFAS No. 161 is effective for fiscal years beginning after November 15, 2008. This statement impacts disclosures and did not impact UIL Holdings’ Consolidated Balance Sheet, Consolidated Statement of Income or Consolidated Statement of Cash Flows. See Note (K), “Fair Value of Financial Instruments” for additional disclosures related to SFAS No. 161.
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In December 2008, the FASB issued FASB Staff Position No. FAS 132(R)-1, “Employers’ Disclosures about Postretirement Benefit Plan Assets” (FSP FAS 132(R)-1) which amends SFAS No. 132 (revised 2003), “Employers’ Disclosures about Plan Assets of a defined benefit pension or other postretirement Plan”. FSP FAS 132(R)-1 requires enhanced disclosures about postretirement benefit plan assets and is effective for fiscal years ending after December 31, 2009. This statement is not expected to have a material impact on UIL Holdings’ Consolidated Balance Sheet, Consolidated Statement of Income or Consolidated Statement of Cash Flows.
On May 20, 2009, UIL Holdings priced a public offering of 4,000,000 shares of common stock at $21.00 per share. On May 29, 2009, the underwriters of this public offering of common stock exercised their over-allotment option to purchase an additional 600,000 common shares on the same terms. Net proceeds of the offering, including the over-allotment option, were $91.4 million, after expenses and underwriting discounts and were accounted for as an addition to common stock on the consolidated balance sheet. The Company used these proceeds to pay down short-term debt and for general corporate purposes.
UIL Holdings had 29,929,591 shares of its common stock, no par value, outstanding at June 30, 2009, of which (1) 11,642 were unallocated shares held by UI’s 401(k)/Employee Stock Ownership Plan (KSOP) and (2) 79,121 were shares of restricted stock. The unallocated shares held by the KSOP and shares of restricted stock are not recognized as outstanding for purposes of calculating basic earnings per share. UI loaned $11.5 million to the KSOP to purchase shares in open market transactions. The shares are allocated to employees’ KSOP accounts as the loan is repaid and compensation expense is recorded upon allocation based on the fair market value of the stock. The loan is being repaid by the KSOP over a 12-year period ending October 1, 2009, using employer contributions and dividends paid on the unallocated shares of the stock held by the KSOP. Dividends on allocated shares are charged to retained earnings. As of June 30, 2009, 11,642 shares, with a fair market value of $0.3 million, had not been allocated to KSOP participants.
UI remarketed $78.5 million of tax-exempt bonds in February 2009, $7.5 million of which were remarketed at a fixed interest rate of 5.75% for three-years and $71 million of which were remarketed for a fixed interest rate of 7.125% for three years. In December 2008, UI also redeemed $25 million of tax-exempt bonds which were reissued without insurance in March 2009 at a fixed interest rate of 6.875% for approximately three years.
On April 27, 2009, UI closed on a bank financing in the amount of $121.5 million with a syndicate of banks (the Equity Bridge Loan or EBL), the proceeds of which will be used by UI during GenConn’s construction to fund its commitments as a 50% owner of GenConn. UI expects that GenConn will direct approximately $57 million of such amount to GenConn Devon LLC (GenConn Devon) and approximately $64.5 million to GenConn Middletown LLC (GenConn Middletown), each of which is a wholly owned subsidiary of GenConn, for use in the construction of peaking generation facilities by those entities. UI will draw on this facility as needed to fund its commitments to GenConn as construction progresses. UI does not have any further funding commitments to GenConn at this time and does not guarantee any of GenConn’s obligations. Borrowings under this facility as of June 30, 2009 were $69.3 million.
GenConn obtained project financing on April 27, 2009 in a separate transaction that makes $243 million available to GenConn for construction and related activities, and $48 million available under a working capital facility (collectively, the Project Financing). UI expects that those funds, together with the funds committed by UI and GenConn’s other 50% owner, NRG Energy, will be sufficient to allow GenConn to complete the construction of its planned peaking generation facilities.
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The EBL must be repaid upon the earlier of its maturity date or the attainment of commercial operation, which is expected to be June 2010 for GenConn Devon and June 2011 for GenConn Middletown. The initial maturity date of the loan is April 27, 2010, and may be extended to June 1, 2011, so long as on the date of extension project construction is continuing and the Project Financing is not due and payable.
As a result of GenConn obtaining the Project Financing, UIL Holdings’ obligations under guarantee agreements it had made with an affiliate of General Electric Company (GE) in connection with the purchase of GE turbines by GenConn Devon and GenConn Middletown were terminated.
(C) REGULATORY PROCEEDINGS
Department of Public Utility Control (DPUC)
2008 Rate Case
On February 4, 2009, the DPUC issued its final decision regarding UI’s application requesting an increase in distribution rates (the “2009 Decision”), the results of which included a $6.13 million increase in revenue requirements for 2009, compared to 2008. Because a larger, previously approved increase in revenue requirements for 2009 had gone into effect January 1, 2009, UI returned approximately $0.97 million to ratepayers through a one-time adjustment in April 2009. The 2009 Decision provides for an allowed distribution return on equity of 8.75%, a decrease from the previously approved 9.75%, and a capital structure of 50% equity and 50% debt compared to the previously approved 48% equity and 52% debt. The 2009 Decision continues the prior earnings sharing mechanism structure, applying to the new 8.75% allowed return, whereby 50% of the earnings over the allowed twelve month level is returned to customers and 50% is retained by UI. The 2009 Decision provides for recovery of updated pension and postretirement expense for 2010, based upon a December 31, 2009 valuation. The 2009 Decision also provides for an additional increase in distribution revenue requirements of $19.14 million for 2010.
The 2009 Decision also provides for the establishment of a regulatory asset to address the portion of the actual increase in pension and postretirement expense for 2009 and 2010 that is not included in rates; a provision for decoupling of distribution revenues from sales; and a partial reconciliation for the as-issued cost of new debt.
On February 18, 2009, UI filed a request for reconsideration with the DPUC regarding clarification on various technical issues related to the debt cost tracker, the full decoupling provision and other matters. The DPUC reopened the proceeding to consider UI’s request and on June 3, 2009, issued a final decision that corrected certain technical issues, clarified other issues raised by UI and increased UI's revenue requirements by $0.7 million in 2009 and an incremental $0.3 million in 2010.
On March 13, 2009, UI requested a further reopening of the rate case decision to address the decision’s allowed distribution return on equity of 8.75%. On May 18, 2009, UI withdrew this request.
In December 2008, the DPUC issued a letter ruling to address changes to all of UI’s rate components effective as of January 1, 2009. The letter ruling approved requested changes to UI’s distribution charges as well as changes to UI’s transmission, Systems Benefits Charge (SBC), and Non-Bypassable Federally Mandated Congestion Charges (NBFMCC). The letter ruling also approved Generation Services Charge (GSC) rates for 2009, and last resort service GSC rates for the January 1, 2009 through March 31, 2009 time period.
On February 20, 2009, UI received a letter ruling from the DPUC approving last resort service GSC rates for the April 1, 2009 through June 30, 2009 time period. On June 26, 2009, UI received a letter ruling approving last resort service GSC rates for the July 1, 2009 through September 30, 2009 time period.
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Approval of the Issuance of Debt
UI has received approval from the DPUC to issue not more than $375 million principal amount of debt securities (the Proposed Notes) at interest rates representing a maximum authorized spread of 400 basis points above the comparable U.S. Treasury rate during the period from 2007 through 2009. The proceeds from the sales of the Proposed Notes may be used by UI for the following purposes: (1) to refinance $225 million principal amount of maturing existing debt; (2) to finance capital expenditures; (3) for general corporate purposes; (4) to repay short-term borrowings incurred to temporarily fund these requirements; and (5) to pay issuance costs related to the Proposed Notes. UI issued $150 million and $175 million of debt in 2008 and 2007, respectively. UI may issue $50 million of debt in 2009, according to the terms and conditions approved by the DPUC.
On February 18, 2009, the DPUC approved an application filed by UI to afford UI additional flexibility to market outstanding tax-exempt bonds in the municipal bond market. Specifically, UI requested approval to redeem and reissue, without insurance, $25.0 million, $27.5 million and $64.5 million principal amount of tax-exempt bonds outstanding that were insured by Ambac Assurance Corporation (Ambac). In December 2008, UI redeemed $25.0 million principal amount of tax-exempt bonds which were reissued, without insurance, in March 2009. UI has $27.5 million principal amount of a tax-exempt bonds that are due to be remarketed in February 2010, at which time UI plans to redeem and reissue the bonds without insurance. UI also has $64.5 million principal amount of adjustable rate tax exempt bonds, which UI plans to redeem and reissue, dependent upon municipal bond market conditions.
GenConn is a 50-50 joint venture of UI and NRG. In 2008, the DPUC selected two projects proposed by GenConn to help address Connecticut’s growing need for more power generation during the heaviest load periods.
Two peaking generation projects, each with a nominal capacity of 200 megawatt (MW), are to be built at NRG’s existing Connecticut plants in Devon and Middletown. The Devon peaking plant, which is scheduled to be in commercial operation by June 1, 2010, and the Middletown plant, which is scheduled to be in commercial operation by June 1, 2011, will be owned by GenConn. GenConn recovers its costs under a contract for differences (CfD) agreement which is cost of service based. GenConn has signed CfDs for both projects with CL&P. The cost of the contracts will be paid by customers and will be subject to a cost-sharing agreement whereby 20% of the cost is borne by UI customers and 80% by CL&P customers.
As a result of changed market conditions and updated cost information, GenConn estimates that project costs, including financing costs, may increase over the proposal it had originally submitted to the DPUC. The increase is driven primarily by increased financing costs and the cost to build interconnection facilities at the Middletown site. The DPUC has ruled that reasonable financing costs and interconnection costs will be treated as pass-through costs, which GenConn expects to recover in DPUC-approved future revenues. Once approved, GenConn revenue requirements will come from the ISO New England Markets in which GenConn participates. The CfD will provide for a true-up of DPUC approved revenue requirements to any over or under collections from the ISO markets.
Pension and Postretirement Expenses
In response to the Internal Revenue Service (IRS) mandated change in mortality tables utilized for certain Employee Retirement Income Security Act of 1974 (ERISA)-related liability calculations, effective January 1, 2007, the DPUC allowed regulatory treatment for the change in pension and postretirement expenses resulting from the use of the new mortality tables. In the 2009 Decision, the DPUC approved the recovery of these expenses over a four-year period beginning in 2009. As of June 30, 2009, the remaining regulatory asset was approximately $3.7 million. The 2009 Decision also provides for the establishment of an annual regulatory asset to address a portion of the actual increase in pension and postretirement expense for both 2009 and 2010. For 2009, a $10.2 million regulatory asset will be established. The amount of the regulatory asset to be established in 2010 will be determined at the beginning of the 2010 rate year based upon the fair value of the pension assets and the discount rate as evaluated at the end of 2009. As of June 30, 2009, UI has recorded a regulatory asset of approximately $4.7 million.
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Power Supply Arrangements
UI’s retail electricity customers are able to choose their electricity supplier. Since January 1, 2007, UI has been required to offer standard service to those of its customers who do not choose a retail electric supplier and have a maximum demand of less than 500 kilowatts. In addition, UI is required to offer supplier of last resort service to customers who are not eligible for standard service and who do not choose to purchase electric generation service from a retail electric supplier licensed in Connecticut.
UI must procure its standard service power pursuant to a procurement plan approved by the DPUC. The procurement plan must provide for a portfolio of service agreements procured in an overlapping pattern over fixed time periods (a “laddering” approach). In June 2006, the DPUC approved a procurement plan for UI. As required by the Connecticut statute, a third party consultant retained by the DPUC works closely with UI in the procurement process and to provide a joint recommendation to the DPUC as to selected bids.
UI has wholesale power supply agreements in place for the supply of all of UI’s standard service customers for all of 2009, 90% for 2010 and 50% for 2011. Supplier of last resort service is procured on a quarterly basis. UI determined that its contracts for standard service and supplier of last resort service are derivatives under SFAS No. 133 and elected the “normal purchase, normal sale” exception under SFAS No. 133. As such, UI regularly assesses the accounting treatment for its power supply contracts.
As a result of an April 2008 DPUC decision, UI is permitted to seek long-term contracts for up to 20% of standard service requirements. UI is in the process of exploring long-term contract options, the goal of which is to obtain long-term energy supply contracts and CT Class I Renewable Energy Certificates for UI’s standard service customers that will result in economic benefit to ratepayers, both in terms of risk and cost mitigation. Negotiations with potential suppliers are on-going, but no agreements have been executed.
Contracts for Differences
Pursuant to Connecticut’s 2005 Energy Independence Act (EIA), the DPUC initiated a process to solicit bids to create new or incremental capacity resources in order to reduce federally mandated congestion charges, and selected four new capacity resources. To facilitate the transactions between selected resources and Connecticut electric customers, and provide the commitment necessary for these resources to obtain financing, the DPUC required that UI and CL&P execute long-term contracts with the selected resources. In August 2007, the DPUC approved four CfDs under which each contract specifies a capacity quantity and a monthly settlement that reflects the difference between a forward market price and the contract price. As directed by the DPUC, UI executed two of the contracts and CL&P executed the other two contracts. In addition, UI has executed a sharing agreement with CL&P whereby UI pays 20% of the costs and obtains 20% of the benefits of the contracts.
The DPUC has determined that costs associated with these CfDs will be recoverable by UI and CL&P, and in accordance with SFAS No. 71, “Accounting for the Effects of Certain Types of Regulation,” UI has deferred recognition of costs (a regulatory asset) or has recognized obligations (a regulatory liability). The above contracts are derivatives and are marked-to-market in accordance with SFAS No. 133. For those contracts signed by CL&P, UI records its 20% portion of CL&P’s derivative, pursuant to the sharing agreement noted above. As of June 30, 2009, UI has recorded a derivative asset of $11.4 million ($6.5 million related to its portion of CL&P’s derivative assets), a regulatory asset of $102.1 million, a derivative liability of $107.0 million ($101.0 million related to its portion of CL&P’s derivative liabilities) and a regulatory liability of $6.5 million in the accompanying Consolidated Balance Sheet.
Pursuant to Connecticut’s 2007 Act Concerning Electricity and Energy Efficiency, the DPUC initiated a process to create new peaking generation resources to address the state’s shortage of fast-start peaking generation that is needed to provide energy reserves. As with the CfDs entered into pursuant to the EIA, the DPUC required that UI and CL&P execute long-term contracts with the selected peaking resources to facilitate the transactions and provide the commitment necessary for the peaking resources to obtain financing. During 2008, CL&P executed three
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peaking generation CfDs, one with GenConn relating to its Devon facility, one with GenConn relating to its Middletown facility and the other with PSEG Power Connecticut LLC (“PSEG”), to which the sharing agreement also applies. These contracts are not considered to be derivatives under SFAS No. 133 and are being accounted for on an accrual basis.
New Renewable Source Generation
Under Connecticut law, electric distribution companies are required to enter into contracts to purchase the output of new renewable source generation totaling at least 150 MW in the future statewide, at prices and upon terms approved by the DPUC in accordance with statutory requirements. In 2007, one contract was approved by the DPUC. UI was not a party to that contract but, as directed by the DPUC, UI has executed a sharing agreement with CL&P whereby UI pays approximately 20% of the costs and obtains approximately 20% of the benefits of the contract. This contract will be accounted for on an accrual basis. In January 2008, the DPUC issued a decision approving seven projects; UI is a party to contracts relating to two of these projects. UI signed a contract for 4.8 MW for one of the projects to purchase, over a fifteen year time period, 100% of the delivered products generated by the Stamford Hospital Fuel Cell Combined Heat and Power Project. This contract will be accounted for as an operating lease. In addition, UI signed the other contract for another of the projects for 30 MW to purchase, over a fifteen year time period, 84.5% of the delivered products generated by the South Norwalk Bio-Fuel Project, which will be accounted for on an accrual basis. In April 2009, the DPUC approved five additional fuel cell projects to which accrual accounting will be applied and for which contracts were executed in July 2009. All of these contracts will be subject to the cost sharing agreement with CL&P. UI’s costs associated with all such contracts, whether UI is a direct party or pursuant to the sharing agreement, are recoverable.
Transmission Return on Equity (ROE)>
UI’s transmission and wholesale sales of electricity are regulated by the Federal Energy Regulatory Commission (FERC). The FERC also establishes allowable ROEs for various types of transmission assets.
Based on a March 2008 FERC Rehearing Order, the ROE applicable to UI’s transmission business, is as follows:
(1) ROE available for new Pool Transmission Facilities (PTF) identified by Independent System Operator – New England (ISO-NE) in its Regional System Plan for assets that were complete and on line prior to December 31, 2008. For projects placed in service after December 31, 2008, incentives may be available on a project specific basis
In May 2008, several public entities, including the DPUC, filed a petition with the United States Court of Appeals for the District of Columbia Circuit (U.S. Court of Appeals) seeking judicial review of the Rehearing Order. In particular, the petitioners seek review of FERC’s approval of a 100 basis point ROE adder for new transmission investment, FERC’s approval of the updated going forward ROE in general and FERC’s reliance on U. S. Treasury bond yields as a basis for the going forward adjustment. Briefing in the judicial review proceeding is on-going. UI is unable to predict the outcome of these proceedings at this time.
UI’s overall transmission ROE will be determined by the mix of UI’s transmission rate base between new and existing transmission assets, and whether such assets are PTF or non-PTF. UI’s transmission assets are primarily PTF. For 2009, UI estimates an overall allowed weighted-average ROE range for its transmission business of 12.30% to 12.50%.
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Middletown/Norwalk Transmission Project
In December 2008, the 345-kV transmission line from Middletown, Connecticut, to Norwalk, Connecticut (the Project) was completed and the transmission assets were placed in service.
Prior to the assets being placed in service, for project costs incurred before August 8, 2005, the FERC allowed UI to include 50% of Construction Work In Progress (CWIP) expenditures in the rate base and earn a return on that portion of UI’s investment before the Project was completed. Effective as of May 23, 2007, for project costs incurred after August 8, 2005, the FERC allowed UI to include 100% of CWIP expenditures in rate base. Several public entities sought rehearing of the order granting incentives, but on January 16, 2009, the FERC denied those requests. On January 29, 2009, the DPUC and the Attorney General of Connecticut filed a petition with the U.S. Court of Appeals seeking judicial review of the FERC’s May 22, 2007 and January 16, 2009 orders. UI is unable to predict the outcome of these efforts at this time.
(D) SHORT-TERM CREDIT ARRANGEMENTS
UIL Holdings has a money market loan arrangement with JPMorgan Chase Bank. This is an uncommitted short-term borrowing arrangement under which JPMorgan Chase Bank may make loans to UIL Holdings for fixed periods, depending on UIL Holdings’ credit rating, the Bank’s credit requirements, and conditions in the financial markets. JPMorgan Securities, Inc. acts as an agent and sells the loans to investors. As of June 30, 2009, UIL Holdings had no short-term borrowings outstanding under this arrangement.
UIL Holdings and UI have a revolving credit agreement with a group of banks that extends to December 22, 2011. The borrowing limit under the facility for UI is $175 million, with $50 million of the limit available for UIL Holdings. The facility permits borrowings at fluctuating interest rates determined by reference to Citibank’s New York base rate and the Federal Funds Rate (as defined in the facility), and also permits borrowings for fixed periods up to six months as specified by UI and UIL Holdings at fixed interest rates determined by the Eurodollar interbank market in London (LIBOR). The facility also permits the issuance of letters of credit up to $50 million.
As of June 30, 2009, UI had $9 million outstanding under the facility. UIL Holdings had a standby letter of credit outstanding in the amount of $1 million that expired on January 31, 2009, but was and will continue to be automatically extended for one year from the expiration date (or any future expiration date), unless the issuer bank elects not to extend. Available credit under this facility at June 30, 2009 for UI and UIL Holdings in the aggregate was $165 million. UIL Holdings records borrowings under this facility as short-term debt, but the agreement has longer term commitments from banks allowing the Company to borrow and reborrow funds, at its option, to December 22, 2011, thus affording it flexibility in managing its working capital requirements.
In November 2008, UI entered into a revolving credit agreement (the Agreement) with Union Bank, N.A., formerly Union Bank of California, N.A., with a borrowing limit of $25 million. UI terminated the Agreement on April 27, 2009.
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(E) INCOME TAXES
The combined statutory federal and state income tax rate for UIL Holdings’ Connecticut-based entities for the three and six month periods ended June 30, 2009 and 2008 was 39.9%. Differences in the treatment of certain transactions for book and tax purposes occur which cause the rate of UIL Holdings’ reported income tax expense to differ from the statutory tax rate described above. The effective book income tax rate for the three and six month periods ended June 30, 2009 were 39.9% and 40.6%, as compared to 42.6% and 44.0% for the three and six month periods ended June 30, 2008. The decrease in the 2009 effective book income tax rates from those for the 2008 periods were due primarily to the absence in 2009 of allowance for borrowed funds used during construction on construction work in progress included in rate base.
UIL Holdings and its subsidiaries are subject to the United States federal income tax statutes administered by the Internal Revenue Service (IRS). UIL Holdings and its subsidiaries are also subject to the income tax statutes of the State of Connecticut and those of other states in which UIL Holdings’ subsidiaries have operated and transacted business in the past. As of June 30, 2009, the tax years 2005, 2006 and 2007 remain open and subject to audit for state income tax purposes. For federal income tax purposes, the IRS recently closed examinations of the tax years 2004, 2005 and 2006, and a separate examination of tax year 2007. The IRS examination of the tax years 2004, 2005, and 2006 resulted in an immaterial assessment to the Company. The examination of tax year 2007 resulted in no additional assessment or refund to the Company.
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(F) SUPPLEMENTARY INFORMATION