-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, RWL73etKxhNJIR3kakUmkz3mSNq/T1Fm/yw3iCVN4EbcJl0qH/utOVPP+2kcg56f KOQfKmu+SUENlt2IY/A0gA== 0001082510-04-000104.txt : 20040301 0001082510-04-000104.hdr.sgml : 20040301 20040301130453 ACCESSION NUMBER: 0001082510-04-000104 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 8 CONFORMED PERIOD OF REPORT: 20031231 FILED AS OF DATE: 20040301 FILER: COMPANY DATA: COMPANY CONFORMED NAME: UIL HOLDINGS CORP CENTRAL INDEX KEY: 0001082510 STANDARD INDUSTRIAL CLASSIFICATION: ELECTRIC SERVICES [4911] IRS NUMBER: 061541045 STATE OF INCORPORATION: CT FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 001-15052 FILM NUMBER: 04638312 BUSINESS ADDRESS: STREET 1: 157 CHURCH ST CITY: NEW HAVEN STATE: CT ZIP: 06510 BUSINESS PHONE: 2034992000 MAIL ADDRESS: STREET 1: 157 CHURCH ST CITY: NEW HAVEN STATE: CT ZIP: 06510 10-K 1 uil_10k2003.txt FORM 10-K FOR 2003 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED] FOR THE FISCAL YEAR ENDED DECEMBER 31, 2003 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED] For the transition period from to ------------- ----------- COMMISSION FILE NUMBER 1-15995 UIL HOLDINGS CORPORATION (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) CONNECTICUT 06-1541045 (State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.) 157 CHURCH STREET, NEW HAVEN, CONNECTICUT 06506 (Address of principal executive offices) (Zip Code) REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: 203-499-2000 ---------------------------------------------------------------- SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NAME OF EACH EXCHANGE ON REGISTRANT TITLE OF EACH CLASS WHICH REGISTERED --------- ------------------- ------------------------ UIL Holdings Corporation Common Stock, no par value New York Stock Exchange SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: NONE ----------------------------------------------------- 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 X No --- ---- Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes X No ----- ---- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] The aggregate market value of the registrant's voting stock held by non-affiliates on June 30, 2003 was $587,826,642 computed on the basis of the average of the high and low sale prices of said stock reported in the listing of composite transactions for New York Stock Exchange listed securities, published in The Wall Street Journal on July 1, 2003. The number of shares outstanding of the registrant's only class of common stock, as of February 25, 2004 was 14,487,295. DOCUMENTS INCORPORATED BY REFERENCE Part of this Form 10-K into Document which document is incorporated - --------------- ------------------------------ DEFINITIVE PROXY STATEMENT FOR ANNUAL MEETING OF THE SHAREHOLDERS TO BE HELD ON MAY 12, 2004 III UIL HOLDINGS CORPORATION FORM 10-K DECEMBER 31, 2003 TABLE OF CONTENTS PAGE Glossary.............................................................3 PART I Item 1. Business................................................6 General.......................................................6 Utility Business..............................................6 Franchises.................................................6 Regulation.................................................6 Rates......................................................7 Power Supply Arrangements..................................9 Arrangements with Other Industry Participants..............9 New England Power Pool and ISO-New England.............9 Hydro-Quebec..........................................10 Environmental Regulation..................................10 Non-Utility Businesses.......................................11 American Payment Systems, Inc.............................11 Xcelecom, Inc.............................................11 United Capital Investments, Inc...........................14 Cross-Sound Cable Company, LLC........................14 Zero Stage Capital....................................14 Ironbridge Mezzanine Fund.............................14 United Bridgeport Energy, Inc.............................14 Financing....................................................15 Employees....................................................15 Item 2. Properties.............................................15 Transmission and Distribution Plant..........................15 Administrative and Service Facilities........................15 Item 3. Legal Proceedings......................................16 Item 4. Submission of Matters to a Vote of Security Holders....16 Executive Officers...........................................16 PART II Item 5. Market for UIL Holdings' Common Equity and Related Stockholder Matters....................................17 Item 6. Selected Financial Data.................................19 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations....................20 Overview and Strategy........................................20 Major Influences on Financial Condition......................22 UIL Holdings Corporation..................................22 The United Illuminating Company...........................22 American Payment Systems, Inc.............................26 Xcelecom, Inc.............................................26 United Capital Investments, Inc...........................29 United Bridgeport Energy, Inc.............................31 Capital Expenditure Program..................................32 - 1 - TABLE OF CONTENTS (CONTINUED) PAGE PART II (CONTINUED) Liquidity and Capital Resources....................................33 Financial Covenants.............................................36 Contractual and Contingent Obligations..........................39 Critical Accounting Practices......................................40 Results of Operations..............................................44 Looking Forward....................................................60 Item 7a. Quantitative and Qualitative Disclosures About Market Risk.......................................... 63 Item 8. Financial Statements and Supplementary Data...................64 Consolidated Financial Statements..................................64 Statement of Income for the Years 2003, 2002 and 2001...........64 Statement of Comprehensive Income for the Years 2003, 2002 and 2001..................................64 Statement of Cash Flows for the Years 2003, 2002 and 2001.......65 Balance Sheet as of December 31, 2003 and 2002..................66 Statement of Changes in Shareholders' Equity for the Years 2003, 2002 and 2001..................................68 Notes to Consolidated Financial Statements.........................69 Statement of Accounting Policies................................69 Capitalization..................................................78 Regulatory Proceedings..........................................82 Short-Term Credit Arrangements..................................86 Income Taxes....................................................88 Supplementary Information.......................................91 Pension and Other Benefits......................................92 Unamortized Cancelled Nuclear Project...........................96 Lease Obligations...............................................96 Commitments and Contingencies...................................97 Other Commitments and Contingencies.........................97 Connecticut Yankee.......................................97 Hydro-Quebec.............................................98 Environmental Concerns...................................98 Site Decontamination, Demolition and Remediation Costs...99 Claim of Enron Power Marketing, Inc.....................100 Cross-Sound Cable Company, LLC..........................100 Fair Value of Financial Instruments............................101 Quarterly Financial Data (Unaudited)...........................102 Segment Information............................................103 Goodwill and Other Intangible Assets...........................104 Discontinued Operations........................................105 Report of Independent Auditors........................................106 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures........................108 Item 9a. Controls and Procedures.....................................108 PART III Item 10. Directors and Executive Officers............................108 Item 11. Executive Compensation......................................108 Item 12. Security Ownership of Certain Beneficial Owners and Management......................................109 Item 13. Certain Relationships and Related Transactions..............109 Item 14. Principal Accounting Fees and Services......................109 PART IV Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K........................................110 Signatures...............................................................115 - 2 - GLOSSARY OF TERMS AND ABBREVIATIONS ABO (Accumulated Benefit Obligation) - the actuarial present value of benefits - --- (whether vested or nonvested) attributed by the pension benefit formula to employee service rendered before a specified date and based on employee service and compensation prior to that date. The accumulated benefit obligation differs from the projected benefit obligation in that the ABO excludes consideration of future compensation levels. AFUDC (Allowance for Funds Used During Construction) - the cost of utility - ----- equity and debt funds used to finance construction projects that is capitalized as part of construction cost. C&LM (ASSESSMENT/CHARGE) (Conservation and Load Management) - statutory - ---- assessment on utility retail customer bills placed in a State of Connecticut fund used to support energy conservation and load management programs. CTA (Competitive transition assessment) - the component of electric utility - --- retail customer bills, in the state of Connecticut, to recover allowable Stranded Costs as determined by the DPUC. CDEP Connecticut Department of Environmental Protection. - ---- DISTRIBUTION DIVISION The operating division of the utility that provides - --------------------- distribution services to the utility's retail electric customers and manages all components including the C&LM, CTA, GSC, REI. Excludes transmission operations. DOE United States Department of Energy. - --- DPUC (Connecticut Department of Public Utility Control) - state agency that - ---- regulates certain ratemaking, services, accounting, plant and operations of Connecticut utilities. EPA United States Environmental Protection Agency. - --- EPS Earnings per share. - --- ESOP Employee Stock Ownership Plan. - ---- FASB (Financial Accounting Standards Board) - a rulemaking organization that - ---- establishes financial accounting and reporting standards. FERC (Federal Energy Regulatory Commission) - federal agency that regulates - ---- interstate transmission and wholesale sales of electricity and related matters. FIN FASB Interpretation Number. - --- GAAP Generally accepted accounting principles in the United States of America. - ---- GSC Generation services charge, as determined by the DPUC, represents the rate - --- charged to retail customers for the generation service purchased at wholesale and delivered by UI as part of fully bundled services. ISO-NE (ISO-New England Inc.) - an independent entity contracting with NEPOOL as - ------ an independent system operator to operate the regional bulk power system (generation and ancillary products, and transmission) in New England. ITC Investment tax credit. - --- KV (kilovolt) - 1000 volts. A volt is a unit of electromotive force. - -- - 3 - KVA (kilovoltampere) - 1,000 voltamperes. A voltampere is the basic unit of - --- apparent power of a circuit. KW (kilowatt) - 1,000 watts. - -- KWH (kilowatthour) - the basic unit of electric energy equal to one kilowatt of - --- power supplied to or taken from an electric circuit steadily for one hour. KSOP 401(k)/Employee Stock Ownership Plan. - ---- LIBOR London Interbank Offered Rate. - ----- MVA (megavoltampere) - 1,000 kilovoltamperes. - --- MW (Megawatt) - 1,000 kilowatts. - -- NEPOOL (New England Power Pool) - entity operating in accordance with the New - ------ England Power Pool Agreement, as amended, as approved by the FERC, to provide economic, reliable operation of the bulk power system in the New England region. NRC (Nuclear Regulatory Commission) - federal agency that regulates operation of - --- nuclear power facilities. O&M (Operation and maintenance) - Costs incurred in running the daily business - --- activities and maintaining the infrastructure. OPEB (Other Post-employment benefits) - Benefits (other than pension) consisting - ---- principally of health care and life insurance paid to retired employees and their dependents. PCB (Polychlorinated Biphenyl) - additive to oil used in certain electrical - --- equipment up to the late-1970s. Now classified as a hazardous chemical. POSA (Point-Of-Sale-Activation) - technology to provide real-time processing of - ---- prepaid transactions such as cellular and long distance telephone cards. PREPAID STORED VALUE CARDS Prepaid and re-loadable value cards that can be - -------------------------- purchased and re-loaded at APS agent locations and used at retail locations accepting credit cards and any ATM worldwide. PREPAID TELEPHONY PRODUCTS Prepaid telecommunication products offering the - -------------------------- services of nationally recognized providers, such as wireless, long distance, home dial tone, internet and phone cards. RCRA The federal Resource Conservation and Recovery Act. - ---- REI (Renewable Energy Investment) - statutory assessment on utility retail - --- customer bills which is transferred to a State of Connecticut fund to support renewable energy projects. RTO (Regional Transmission Organization) - organization proposed to be created - --- jointly by ISO-NE and the New England transmission owners to strengthen the independent oversight of the region's bulk power system and wholesale electricity marketplace. SMD (Standard market design) - marketplace changes implemented by ISO-NE - --- including the implementation of a transmission congestion management system and a multi-settlement system. SBC Systems benefits charge on utility retail customer bills representing public - --- policy costs such as generation decommissioning and displaced worker protection costs, as determined by the DPUC. - 4 - SEC United States Securities and Exchange Commission. - --- SFAS (Statement of Financial Accounting Standards) - accounting and financial - ---- reporting rules issued by the FASB. STANDARD OFFER UI's obligation under Connecticut Public Act 98-28 (the - -------------- Restructuring Act) to offer retail service to its customers under a regulated "standard offer" to each customer who does not choose an alternate electricity supplier. STRANDED COSTS Costs, as determined by the DPUC, including above-market - -------------- long-term purchased power obligations, regulatory assets, and above-market investments in power plants, that are recoverable from retail customers. TRANSMISSION DIVISION The operating division of the utility that provides - --------------------- transmission services and manages all related transmission operations. TSO (Transitional Standard Offer) - UI's obligation under Connecticut Public Act - --- 03-135, subsequently amended in part by Public Act 03-221, to offer a regulated "transitional standard offer" retail service to each customer who does not choose an alternate electricity supplier. VEBA (Voluntary Employee Benefit Association Trust) - trust accounts for health - ---- and welfare plans for future payments to employees, retirees or their beneficiaries. WATT - A unit of electrical power equal to one joule per second. - ---- - 5 - PART I ITEM 1. BUSINESS. GENERAL UIL Holdings Corporation (UIL Holdings) was formed in July 2000 and is an exempt public utility holding company under the provisions of the Public Utility Holding Company Act of 1935. Through its various subsidiaries, UIL Holdings operates in two principal lines of business: utility and non-utility. The utility business consists of the electric transmission and distribution operations of The United Illuminating Company (UI), while the non-utility businesses consist of the operations of American Payment Systems, Inc. (APS) and Xcelecom, Inc. (Xcelecom), and passive investments in United Capital Investments, Inc. (UCI), and United Bridgeport Energy, Inc. (UBE). UIL Holdings is headquartered in New Haven, Connecticut, where its senior management maintains offices and is responsible for overall planning, operating and financial functions. Information regarding UIL Holdings may be requested, viewed, or downloaded on-line at www.uil.com. Due to financial information required by Statement of Financial Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information," UIL Holdings has also divided its business into operating segments for financial reporting purposes. Information about the operating segments is incorporated by reference from Note (M), "Segment Information" of the Notes to Consolidated Financial Statements of this document. UTILITY BUSINESS UI is a regulated operating electric public utility established in 1899. It is engaged principally in the purchase, transmission, distribution and sale of electricity for residential, commercial and industrial purposes in a service area of about 335 square miles in the southwestern part of the State of Connecticut. The population of this area is approximately 730,000, which represents approximately 21% of the population of the State. The service area, largely urban and suburban, includes the principal cities of Bridgeport (population approximately 140,000) and New Haven (population approximately 124,000) and their surrounding areas. Situated in the service area are retail trade and service centers, as well as large and small industries producing a wide variety of products, including helicopters and other transportation equipment, electrical equipment, chemicals and pharmaceuticals. Of UI's 2003 retail electric revenues, approximately 45% were derived from residential sales, 40% from commercial sales, 13% from industrial sales and 2% from street lighting and other sales. UI's retail electric revenues are affected seasonally, primarily dependent upon the weather, with highest revenues typically in the third quarter of the year reflecting seasonal rates, hotter weather and air conditioning use. In connection with the 1998 restructuring legislation relating to the regulated electric utility industry in Connecticut, UI divested its ownership interests in generation facilities, a process which was completed in 2002 with the sale of UI's interests in the Seabrook Station nuclear generating plant. FRANCHISES UI has valid franchises to engage in the purchase, transmission, distribution and sale of electricity in the area served by it, the right to erect and maintain certain facilities over, on and under public highways and grounds, and the power of eminent domain. These franchises are subject to alteration, amendment or revocation by the Connecticut legislature, and revocation by the Connecticut Department of Public Utility Control (DPUC) under circumstances specified by statute, and subject to certain approvals, permits and consents of public authorities and others prescribed by statute. REGULATION UI is subject to regulation by several regulatory bodies, including the DPUC, which has jurisdiction with respect to, among other things, retail electric service rates, accounting procedures, certain dispositions of property and plant, mergers and consolidations, the issuance of securities, the condition of plant, equipment and the manner of operation in relation to the safety, adequacy and suitability to provide service to customers, including efficiency, and the - 6 - location and construction of certain electric facilities. The Federal Energy Regulatory Commission (FERC) approves UI's transmission revenue requirements, which are collected through UI's transmission retail rates. The location and construction of certain electric facilities, including electric transmission lines and bulk substations, is subject to regulation by the Connecticut Siting Council with respect to environmental compatibility and public need. UI is a "public utility" within the meaning of Part II of the Federal Power Act and is subject to regulation by the FERC, which has jurisdiction with respect to interconnection and coordination of facilities, wholesale electric service rates, transmission tariffs and accounting procedures, among other things. See "Arrangements with Other Industry Participants." Connecticut Yankee Atomic Power Company, in which UI has a 9.5% common stock ownership interest, is subject to the jurisdiction of the United States Nuclear Regulatory Commission and the FERC. The Connecticut Yankee nuclear unit was retired in 1996 and is currently being decommissioned. See PART II, Item 8, "Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - Note (J), Commitments and Contingencies - Other Commitments and Contingencies - Connecticut Yankee." RATES UI's retail electric service rates are subject to regulation by the DPUC. UI's present general retail rate structure consists of various rate and service classifications covering residential, commercial, industrial and street lighting services. Utilities are entitled by Connecticut law to charge rates that are sufficient to allow them an opportunity to cover their reasonable operating and capital costs, to attract needed capital and maintain their financial integrity, while also protecting relevant public interests. - 7 - The primary revenue components of UI's retail customer bills as of January 1, 2004 are as follows:
Authorized Average Return on Price Per Unbundled Revenue Component Description Equity KWH (10) - --------------------------------------------------------------------------------------------------------------------------- Distribution The process of delivering electricity through local 10.45% (1) $0.0355 lines to the customer's home or business. - --------------------------------------------------------------------------------------------------------------------------- Transmission The process of delivering electricity over high voltage 10.75% (2) $0.0054 lines to local distribution lines. - --------------------------------------------------------------------------------------------------------------------------- Competitive Transition Component of retail customer bills to recover Stranded 10.45% $0.0139 Assessment (CTA) (3) Costs as determined by the DPUC. - --------------------------------------------------------------------------------------------------------------------------- Generation Services Charge (GSC) (4) The rate charged, as determined by the DPUC, to retail None $0.0482 customers for the generation services purchased at wholesale by UI for transitional standard offer customers. - --------------------------------------------------------------------------------------------------------------------------- Bypassable Federally Mandated Federally mandated charge, as defined by Connecticut None $0.0095 Congestion Costs (BFMCC) (5) restructuring legislation, related to the supply of electricity. - --------------------------------------------------------------------------------------------------------------------------- Systems Benefits Charge (SBC) Charges on retail customer bills representing public 10.45% (6) $0.0005 policy costs such as generation decommissioning and displaced worker protection costs, as determined by the DPUC. - --------------------------------------------------------------------------------------------------------------------------- Conservation & Load Management Statutory assessment on retail customer bills placed in None $0.0030 (C&LM) (7) a State of Connecticut fund used to support energy conservation and load management programs. - --------------------------------------------------------------------------------------------------------------------------- Non-Bypassable Federally Mandated Federally mandated charge, as defined by Connecticut None $0.0015 Congestion Costs (NBFMCC) (8) restructuring legislation, related to the reliability of supply delivered by the electric system. - --------------------------------------------------------------------------------------------------------------------------- Renewable Energy Investment (REI) Statutory assessment on retail customer bills which is None $0.0010 (9) transferred to a State of Connecticut fund to support renewable energy projects. - ---------------------------------------------------------------------------------------------------------------------------
(1) DPUC authorized return on equity. As of the February 18, 2004 DPUC decision regarding UI's recovery of pension and postretirement benefits expenses, earnings above 10.45% will be shared 100% to customers in the form of accelerated amortization of stranded costs. (2) FERC authorized return on equity. (3) UI earns the authorized distribution return on equity on CTA rate base. UI defers or accrues additional amortization to achieve the authorized return on equity on unamortized CTA rate base. The DPUC has approved a financing order which, when the State of Connecticut issues rate reduction bonds, will increase the CTA, and decrease the C&LM and REI by an offsetting amount, with no impact on financial results. (4) This rate also includes a procurement fee to UI for providing transitional standard offer service and an opportunity to earn an additional incentive procurement fee if UI meets certain pricing thresholds. Except for the fees, GSC has no impact on financial results as revenue collected equals expense incurred ("pass through"). (5) BFMCC has no impact on financial results as BFMCC billing is a "pass through". It is "bypassable" because it may not be charged to customers if they choose to buy their electricity from an alternate supplier. (6) UI earns the authorized distribution return on equity on SBC rate base. UI defers or accrues additional amortization to achieve the authorized return on equity on unamortized SBC rate base. (7) UI has the opportunity to earn a nominal "incentive" for managing the C&LM programs. Except for the incentive, C&LM has no impact on financial results, as C&LM billing is a "pass through". (8) NBFMCC has no impact on financial results as NBFMCC billing is a "pass through". (9) REI has no impact on financial results as REI billing is a "pass through". (10) The total average price per KWH is $0.1185. - 8 - For further information refer to PART II, Item 8, "Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - Note (C), Regulatory Proceedings," of this Form 10-K which is hereby incorporated by reference. POWER SUPPLY ARRANGEMENTS Pursuant to Connecticut's 1998 electric industry restructuring legislation, UI's retail electricity customers are able to choose their electricity supplier. Through December 31, 2003, UI was required to offer fully bundled retail service under a regulated "standard offer" rate to each customer who did not choose an alternate electricity supplier, and to provide back-up power supply service to customers whose alternate electricity supplier failed to provide generation services for reasons other than the customers' failure to pay for such services. Beginning January 1, 2004 and continuing through December 31, 2006, UI is required to offer retail service under a regulated "transitional standard offer" rate to each customer who does not choose an alternate electricity supplier. On December 28, 2001, UI entered into an agreement with Virginia Electric and Power Company, subsequently assigned to its affiliate Dominion Energy Marketing (Dominion), for the supply of all of UI's standard offer generation service needs from January 1, 2002 through December 31, 2003. Dominion is also contracted to supply all of UI's generation service requirements through 2008 for certain customers who entered into long-term special contracts with UI prior to the 1998 legislation. On October 22, 2003, UI entered into an agreement with PSEG Energy Resources & Trade LLC (PSEG) for the supply of all of UI's transitional standard offer (TSO) generation service needs, excluding requirements for special contract customers, from January 1, 2004 through December 31, 2006, the end of the transitional standard offer period in Connecticut. For further information regarding power supply arrangements, refer to PART II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," which information is hereby incorporated by reference. ARRANGEMENTS WITH OTHER INDUSTRY PARTICIPANTS NEW ENGLAND POWER POOL AND ISO-NEW ENGLAND UI has been a member of the New England Power Pool (NEPOOL) since 1971. NEPOOL was formed to assure reliable and economic operation of the bulk power system in the New England region. The NEPOOL membership includes entities engaged in the electricity business in New England. NEPOOL has contracted with an independent entity, ISO New England Inc. (ISO-NE), for the operation of the regional bulk power system, to assure that the bulk power system will continue to be operated in accordance with the NEPOOL, the North America Reliability Council (NERC), and the Northeast Power Coordinating Council (NPCC) reliability objectives and also to assure that the wholesale power markets will be workably competitive and non-discriminatory. Various energy, capacity, and ancillary services products are purchased in the NEPOOL market; in addition, participants may enter into bilateral contracts for purchase/sale of these products. On March 1, 2003, NEPOOL and ISO-NE implemented substantial marketplace changes, referred to as standard market design (SMD), as approved by the FERC. These SMD changes included the implementation of a transmission congestion management system and a multi-settlement system. The SMD processes employed in New England are based on systems that are currently operational in the Pennsylvania-New Jersey-Maryland control area. On October 31, 2003, ISO-NE filed a joint proposal with the New England transmission owners at the FERC for the creation of a regional transmission organization (RTO). ISO-NE expects that the creation of an RTO for New England will strengthen the independent oversight of the region's bulk power system and wholesale electricity marketplace. UI is a signatory to the filing and, if the filing is approved by the FERC, UI would have the opportunity to join the New England RTO and become eligible for the FERC's transmission return on equity - 9 - joining incentive (50 basis points above the approved transmission return on equity). If approved, the RTO could become operational in 2004. HYDRO-QUEBEC UI is a participant in the Hydro-Quebec transmission tie facility linking New England and Quebec, Canada. UI has a 5.45% participating share in this facility, which has a maximum 2000 megawatt equivalent generation capacity value. ENVIRONMENTAL REGULATION The National Environmental Policy Act requires that detailed statements of the environmental effect of UI's facilities be prepared in connection with the issuance of various federal permits and licenses. Federal agencies are required by that Act to make an independent environmental evaluation of the facilities as part of their actions during proceedings with respect to these permits and licenses. Under the federal Toxic Substances Control Act (TSCA), the Environmental Protection Agency (EPA) has issued regulations that control the use and disposal of polychlorinated biphenyls (PCBs). PCBs had been widely used as insulating fluids in many electric utility transformers and capacitors manufactured before TSCA prohibited any further manufacture of such PCB equipment. Fluids with a concentration of PCBs higher than 500 parts per million and materials (such as electrical capacitors) that contain such fluids must be disposed of through burning in high temperature incinerators approved by the EPA. Presently, no transformers having fluids with levels of PCBs higher than 500 parts per million are known by UI to remain in service in its system. Under the federal Resource Conservation and Recovery Act (RCRA), the generation, transportation, treatment, storage and disposal of hazardous wastes are subject to regulations adopted by the EPA. Connecticut has adopted state regulations that parallel RCRA regulations but are more stringent in some respects. UI has complied with the notification and application requirements of present regulations, and the procedures by which UI handles, stores, treats and disposes of hazardous waste products have been revised, where necessary, to comply with these regulations. RCRA also regulates underground tanks storing petroleum products or hazardous substances, and Connecticut has adopted state regulations governing underground tanks storing petroleum and petroleum products that, in some respects, are more stringent than the federal requirements. UI currently owns eight underground storage tanks, which are used primarily for gasoline and fuel oil, that are subject to these regulations. A testing program has been installed to detect leakage from any of these tanks, and substantial costs may be incurred for future actions taken to prevent tanks from leaking, to remedy any contamination of groundwater, and to modify, remove and/or replace older tanks in compliance with federal and state regulations. In accordance with applicable regulations, UI has disposed of residues from operations at landfills. In recent years it has been determined that such disposal practices, under certain circumstances, can cause groundwater contamination. Although UI has no knowledge of the existence of any such contamination, if UI or regulatory agencies determine that remedial actions must be taken in relation to past disposal practices, UI may experience substantial costs prior to seeking regulatory recovery. In complying with existing environmental statutes and regulations and further developments in these and other areas of environmental concern, including legislation and studies in the fields of water and air quality, hazardous waste handling and disposal, toxic substances, and electric and magnetic fields, UI may incur substantial capital expenditures for equipment modifications and additions, monitoring equipment and recording devices, and it may incur additional operating expenses. Litigation expenditures may also increase as a result of ongoing scientific investigations, and speculation and debate, concerning the possibility of harmful health effects of electric and magnetic fields. The total amount of these expenditures is not now determinable. UI's January 2004 purchase of its Electric System Work Center property, located in Shelton, Connecticut, initiated a review by the Connecticut Department of Environmental Protection's (CDEP) Transfer Act Program. Under this review, the - 10 - CDEP has an opportunity to examine the current environmental conditions at the site and direct remediation, or further remediation, of any areas of concern. Possible areas of concern include locations where previous oil spills had been reported and remediated. The CDEP may investigate events that are currently listed as "closed" (meaning that the CDEP had previously determined that no further action was required). It is expected that the CDEP will complete its review by the end of the first quarter of 2004. UI sold property to Bridgeport Energy LLC (BE) on April 16, 1999. In connection with the sale of the property, UI entered into an environmental indemnity agreement with BE, in which UBE holds a minority interest, to provide indemnification related to certain environmental conditions specific to the site where BE's generation facilities were constructed. Because of soil management and other environmental remediation activities that were performed during construction of the generation facilities, UI does not regard its exposure under the environmental indemnity agreement as material. Additional discussion regarding environmental issues may be found in PART II, Item 8 of this Form 10-K under the caption, "Financial Statements and Supplementary Data" - Notes to Consolidated Financial Statements - Note (J), Commitments and Contingencies - Site Decontamination, Demolition and Remediation Costs", which information is hereby incorporated by reference. NON-UTILITY BUSINESSES UIL Holdings serves as the parent corporation for several non-utility businesses, each of which is incorporated separately to participate in business ventures that are intended to provide incremental earnings to UIL Holdings' shareowners. AMERICAN PAYMENT SYSTEMS, INC. APS provides a variety of financial products and services throughout the United States through its network of approximately 10,000 retailers (agents) in locations in grocery stores, pharmacies, banks and check-cashing stores in 47 states. APS' products and services are targeted at persons who do not have banking relationships or are infrequent users of non-cash methods of payment. These products and services include: (1) walk-in bill payments; (2) prepaid telephony products; and (3) prepaid stored value cards. On December 16, 2003, UIL Holdings entered into an agreement to sell APS to CheckFree Corporation (CheckFree), a leading provider of financial electronic commerce services and products. Under the terms of the agreement, and pending receipt of regulatory approvals and satisfaction of customary closing conditions, CheckFree will pay approximately $110 million in cash for the outstanding stock of APS. The transaction is expected to close during the second quarter of 2004, with the resulting gain on the sale to be recognized at that time. CheckFree will not acquire APS' telephony assets, which include APS' 51% ownership interest in CellCards of Illinois, LLC (CCI). Following execution of the agreement to sell APS, management determined that the telephony business is not part of UIL Holdings' overall strategic business focus, and therefore developed a plan to pursue the sale of APS' telephony assets. As part of that plan, CCI was sold for book value to an independent third party on February 13, 2004. As a result of the events described above, APS has been categorized as "held for sale" as of December 31, 2003 for financial accounting purposes, and as such, its results are included in discontinued operations in the accompanying consolidated statements of income included herein, for all periods presented. XCELECOM, INC. Xcelecom and its subsidiaries operate in two primary lines of business in certain regional markets of the Eastern United States. The specialty construction trade services line of business, which accounts for approximately 90% of Xcelecom's annual revenues, provides general and specialty electrical, mechanical and voice-data-video design, construction, and related services. The computer network system integration services line of business provides computer - 11 - system local and wide area network integration design, installation and consulting services. Xcelecom's subsidiaries include Allan Electric Co., Inc., Brite-Way Electrical Contractors, Inc., JBL Electric, Inc. and The Datastore, Incorporated, all in New Jersey, Orlando Diefenderfer Electrical Contractors, Inc., in Pennsylvania, 4Front Systems, Inc., in North Carolina, J. E. Richards, Inc. and Richards Electric, Inc., in Maryland, Terry's Electric, Inc., in Florida, and Johnson Electric Co., Inc., M. J. Daly & Sons, Inc., McPhee Electric Ltd., LLC and McPhee Utility Power and Signal, Ltd., all in Connecticut. Xcelecom also owns and operates two heating and cooling energy centers, through its Thermal Energies, Inc. subsidiary, providing service to two of New Haven, Connecticut's largest office and government complexes. Xcelecom is the eighth largest provider of electrical contracting services in the United States according to Engineering News Record Magazine. Xcelecom provides a broad range of services including designing, building, maintaining and servicing electrical, data communications and utilities systems for commercial, industrial and residential customers. Xcelecom's electrical contracting services include design of the electrical distribution systems within a building or complex, procurement and installation of wiring and connection to power sources, end-use equipment and fixtures, as well as long-term contract maintenance. Xcelecom's mechanical contracting services include the design, procurement and installation systems for heating, ventilation, air conditioning, refrigeration and clean room ventilation systems, along with plumbing, process and fire protection piping systems. Xcelecom's customer base is diverse and includes general contractors, property managers and developers, corporations, government agencies and municipalities, utilities, gaming facilities and homeowners. Xcelecom provides these specialty construction trade services in most major markets along the U.S. eastern seaboard. Demand for Xcelecom's specialty construction trade services is driven by construction and renovation activity levels, as well as changes to local and national electrical codes. Xcelecom's service and maintenance revenues are derived from service calls and routine maintenance contracts, which tend to be recurring and less sensitive to economic fluctuations. Service and maintenance is supplied on a long-term and per-call basis. Long-term service and maintenance is provided through contracts that require the customer to pay an annual or semi-annual fee for periodic diagnostic services at a specific discount from standard prices for repair and replacement services. Per-call service and maintenance is initiated when a customer requests emergency repair service. The computer network systems integration business line is a full-service provider of enterprise-wide network solutions. Specialties include design, installation, management and support of a variety of network needs ranging from point-to-point data and communications installations to complex Wide Area data and communication networks. Xcelecom's clients include medium size local and regional businesses, leading healthcare and educational facilities, and selected Fortune 100 technology, financial services and pharmaceutical companies. Xcelecom's computer network systems integration business operates primarily in certain regional markets in the Eastern United States. Xcelecom manages operations based on business lines. Within the specialty construction trade services business line, the subsidiaries are managed by two corporate-based senior operating officers reporting directly to Xcelecom's President. The computer network system integration services business line reports directly to a corporate-based senior operating officer, who in turn reports directly to the President. This operating structure provides a platform for strong operating and financial controls, allows for efficient management of the business, and fosters implementation of best practices across the organization. This structure also provides the ability to manage certain customer and vendor relationships above the local level. Utilizing this structure enables Xcelecom to continue to expand the services and expertise it offers in each market by using specialized technical and marketing skills to maintain and strengthen relationships with general contractors and other customers; build positive relationships with engineers, architects and key suppliers; and continuously improve project execution, sales, administrative, safety, and training practices. MARKET DATA Using the most recently available data from F. W. Dodge, the largest provider of project news, plans and analysis service for construction professionals in the United States and Canada, it is estimated that the electrical contracting - 12 - industry, Xcelecom's primary source of revenues, will generate annual revenues in excess of $80 billion in 2004. The electrical contracting industry is highly fragmented, with more than 70,000 companies, most of which are small, owner-operated businesses. The most recent ranking of U.S. electrical contractors by the Engineering News Record magazine indicates that there are only 12 U.S. electrical contractors with revenues in excess of $200 million. F. W. Dodge data indicates total non-residential construction industry revenues in the markets served by Xcelecom have grown at an average compound rate of approximately two percent from 1997 through 2003. This includes a decline in the market from 2001 to 2003 of over thirteen percent, where commercial and industrial construction spending was down due to the slowdown in the U.S. economy during that period. Xcelecom had a backlog of contractually obligated work to be completed as of December 31, 2003 of approximately $147 million, as compared with backlog of approximately $108 million as of December 31, 2002. This increase in backlog is predominantly due to a number of new contract awards in several local geographic markets in the latter part of 2003. However, because of increased competition, the overall expected gross margin related to the year end 2003 backlog is slightly lower, in percentage terms, than the expected gross margin percentage carried in the year end 2002 backlog balance. There has been a shift in the composition of backlog from time to time, based on market demand and economic trends in Xcelecom's geographic markets. During 2003, the backlog of work in progress for commercial and industrial work declined in the areas of commercial office buildings, hotels and condominiums, manufacturing facilities and transportation industry work, while areas of backlog growth included institutions, utility work and projects for state and local government. COMPETITION The specialty construction trade services and computer network systems integration industries are highly fragmented and competitive. In the specialty construction trade services business line, most of Xcelecom's competitors are small, owner-operated companies that typically operate in a limited geographic area. However, Xcelecom also faces competition from several larger regional and national firms, some of which are publicly owned. Competition is based primarily on price, technical capability, workforce size and ability, and experience and reputation. The computer network systems integration industry is intensely competitive. Competition is based primarily on price, product availability, speed of delivery, credit availability, the ability to tailor specific solutions to customer needs, and quality and breadth of product lines. Within the business line, there is also competition from numerous large publicly owned entities, including technology and telecommunications companies, along with smaller regional and local owner-operated entities. These marketers and resellers include national direct marketers and national and regional resellers, including value-added resellers and specialty retailers, aggregators, distributors, national computer retailers, computer superstores, Internet-only computer providers, consumer electronics and office supply superstores and mass merchandisers. Product manufacturers, in particular, have increased their efforts to sell directly to the business customer, particularly larger corporate customers and, thus, have become more of a competitive threat than in the past. Certain competitors have longer operating histories and greater financial, technical, marketing and other resources than Xcelecom. In addition, some of these competitors may be able to respond more quickly to new or changing opportunities, technologies and customer requirements. Many current and potential competitors also have greater name recognition and engage in more extensive promotional activities, offer more attractive terms to customers and adopt more aggressive pricing policies than Xcelecom does. Additionally, some of Xcelecom's competitors have lower operating cost structures, allowing them to profitably employ more aggressive pricing strategies. There can be no assurance that Xcelecom will be able to compete effectively with current or future competitors or that the competitive pressures will not have a material adverse effect on Xcelecom's business, results of operations and financial condition. Decreasing prices of Xcelecom's products and services offerings will require Xcelecom to sell a greater number of products and services to achieve the same level of net sales and gross profit, and to effectively manage its fixed and variable overhead costs to maintain a similar level of earnings before interest and taxes. In the future, competition may be encountered from new market entrants. - 13 - Further discussion regarding Xcelecom's business may be found in PART II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" of this Form 10-K, which information is hereby incorporated by reference. UNITED CAPITAL INVESTMENTS, INC. UCI was established to make passive or minority interest investments, and its investments include: CROSS-SOUND CABLE COMPANY, LLC (CROSS-SOUND) - UCI has a 25% interest in Cross-Sound, which owns and operates a 330-megawatt transmission line (cable) connecting Connecticut and Long Island under Long Island Sound. The value of UCI's share of the Cross-Sound cable project as of December 31, 2003 was $33 million. TransEnergieUS Ltd., the project developer and majority owner, is a Delaware corporation and a subsidiary of TransEnergie HQ Inc., the transmission affiliate of Hydro-Quebec (HQ). Cross-Sound has a twenty-year contract with the Long Island Power Authority for the entire capacity of the transmission line for its commercial operation. The cable has been installed and is operating under a Department of Energy (DOE) Emergency Order, although it has yet to achieve commercial operation status pending the resolution of permit issues. An interim operating agreement, structured similarly to the twenty-year contract, has been developed to cover operation until commercial status is achieved. See PART II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations - Major Influences on Financial Condition," for further information regarding Cross-Sound. ZERO STAGE CAPITAL - UCI has invested $3.2 million in Zero Stage VI, a Small Business Investment Company (SBIC) fund targeting the Northeast region of the United States. UCI has also funded $3.5 million of a $4 million commitment to Zero Stage VII, a national technology venture capital fund. UCI expects to invest the final $0.5 million in Zero Stage VII in 2004. Along with the opportunity to earn returns, UIL Holdings views these funds as a means of promoting local economic development. These funds have made no distributions to date. Due to the nature of its investments and market conditions, the carrying value of Zero Stage VI has decreased substantially over the past two years. The value of UCI's investments in Zero Stage VI and VII as of December 31, 2003 were $0.1 million and $2.9 million, respectively. IRONBRIDGE MEZZANINE FUND - In 2001, UCI committed $1 million to Ironbridge Mezzanine Fund, of which it has funded $0.5 million as of December 31, 2003. UCI expects to fund the remaining capital commitment over the next several years. Ironbridge is a regional SBIC fund committed to investing a portion of its capital in women and minority-owned businesses and businesses located in low and moderate income areas. The value of UCI's investment in Ironbridge Mezzanine Fund as of December 31, 2003 was $0.4 million. UCI has no current plans to make additional minority interest investments. UNITED BRIDGEPORT ENERGY, INC. UBE holds a 33 1/3% ownership interest, as a minority investor, in Bridgeport Energy LLC (BE), the owner of a gas-fired 520 MW merchant wholesale electric generating facility located in Bridgeport, Connecticut. The remainder of BE is owned, and the facility is operated by, an affiliate of Duke Energy. BE began commercial operation in 1999 and sells energy and generation capacity into the wholesale market. The plant has an agreement through August 2018 with Duke Energy Trading and Marketing (DETM), a joint venture between Duke Energy and Exxon Mobil, which gives DETM the right to deliver natural gas to the facility and market all of the electricity generated by the facility. DETM reimburses BE under a formula based on the difference between gas costs and electric prices. In January 2004, Duke Energy announced plans to wind down DETM as part of a plan to restructure its merchant energy business. UBE does not anticipate these plans to have a negative impact on the operations of BE. As of December 31, 2003, UBE's investment in BE had a carrying value of $82.1 million. - 14 - FINANCING Information regarding UIL Holdings' capital requirements and resources and its financings and financial commitments may be found in PART II, Item 7 of this Form 10-K under the caption, "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources," which information is hereby incorporated by reference. EMPLOYEES As of December 31, 2003, UIL Holdings and its subsidiaries had a total of 2,912 employees, consisting of 31 in UIL Holdings, 820 in UI and 2,061 in the non-utility subsidiaries. Of the 820 UI employees, 363 were members of Local 470-1, Utility Workers Union of America, AFL-CIO. UI and its unionized employees entered into a three-year agreement which expires on May 15, 2005. Of the 2,061 employees of the non-utility subsidiaries, 224 were employed by APS, 1,835 by Xcelecom and its subsidiaries, and 2 by UCI. Certain of Xcelecom's subsidiaries have collective bargaining agreements that cover, in the aggregate, approximately 932 employees. Substantially all of these collective bargaining agreements contain "no-strike" clauses. Xcelecom has not experienced any significant strikes or work stoppages. ITEM 2. PROPERTIES. TRANSMISSION AND DISTRIBUTION PLANT The transmission lines of UI consist of approximately 102 circuit miles of overhead lines and approximately 15 circuit miles of underground lines, all operated at 345 KV or 115 KV and located within or immediately adjacent to the territory served by UI. These transmission lines are part of the New England transmission grid. A major portion of UI's transmission lines is constructed on railroad right-of-way pursuant to two Transmission Line Agreements. One of the agreements expired in May 2000 and a new agreement was reached in June 2003 and applied retroactively. The new agreement expires in May 2030 and will be automatically extended for up to two successive renewal periods of fifteen years each, unless UI provides timely written notice of its election to reject the automatic extension. The other agreement will expire in May 2040. UI owns and operates 25 bulk electric supply substations with a capacity of 1,784 MVA, and 26 distribution substations with a capacity of 132 MVA. UI has 3,233 pole-line miles of overhead distribution lines and 130 conduit-bank miles of underground distribution lines. See PART II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations - Capital Expenditure Program" concerning the estimated cost of additions to UI's transmission and distribution facilities, which information is hereby incorporated by reference. ADMINISTRATIVE AND SERVICE FACILITIES Both UIL Holdings' and UI's corporate headquarters are located in New Haven, Connecticut. Additionally, UI occupies several facilities within its service territory for administrative and operational purposes. APS currently leases office space in Wallingford, Connecticut, which is the site of its corporate headquarters. Xcelecom leases office space in Hamden, Connecticut, which is the site of its corporate headquarters. Xcelecom's operating subsidiaries own or lease real property, buildings and equipment in Connecticut, Florida, Maryland, New Jersey, North Carolina and Pennsylvania necessary for the management and operation of their general and specialty electrical, mechanical and voice-data-video design, construction, systems integration and related services. - 15 - ITEM 3. LEGAL PROCEEDINGS. UCI has a 25% interest in Cross-Sound Cable Company, LLC (Cross-Sound), whose cable operation may be affected by the outcome of a request by the Connecticut Attorney General and the Connecticut Department of Environmental Protection to the United States Department of Energy (DOE) for stay or rehearing of the August 28 DOE Emergency Order that directed the Cross-Sound cable to operate. Neither UIL Holdings nor any of its subsidiaries is a party to the DOE proceeding. See Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations - Major Influences," for further discussion, which information is hereby incorporated by reference. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. There were no matters submitted to a vote of security holders, through the solicitation of proxies or otherwise, during the fourth quarter of the fiscal year ended December 31, 2003. EXECUTIVE OFFICERS The names and ages of all executive officers of UIL Holdings and all such persons chosen to become executive officers, all positions and offices with UIL Holdings held by each such person, and the period during which he or she has served as an officer in the office indicated, are as follows:
NAME AGE* POSITION EFFECTIVE DATE - ---- --- -------- -------------- Nathaniel D. Woodson 62 Chairman of the Board of Directors, President and March 22, 1999 Chief Executive Officer Louis J. Paglia 46 Executive Vice President and Chief Financial July 1, 2002 Officer Susan E. Allen 44 Vice President Investor Relations, Corporate August 28, 2000 Secretary and Assistant Treasurer Charles J. Pepe 55 Treasurer and Assistant Secretary August 28, 2000 Gregory W. Buckis 43 Controller June 30, 2003
- ----------------------- *As of December 31, 2003 There is no family relationship between any director, executive officer, or person nominated or chosen to become a director or executive officer of UIL Holdings. All executive officers of UIL Holdings hold office at the pleasure of UIL Holdings' Board of Directors. All of the above executive officers have entered into employment agreements. There is no arrangement or understanding between any executive officer of UIL Holdings and any other person pursuant to which such officer was selected as an officer. A brief account of the business experience during the past five years of each executive officer of UIL Holdings is as follows: NATHANIEL D. WOODSON. Mr. Woodson served as Chairman of the Board of Directors, President and Chief Executive Officer of The United Illuminating Company during the period January 1, 1999 to January 31, 2001. He has served as Chairman of the Board of Directors and Chief Executive Officer of The United Illuminating Company since February 1, 2001 and Chairman of the Board of Directors, President and Chief Executive Officer of UIL Holdings Corporation since its inception on March 22, 1999. LOUIS J. PAGLIA. Mr. Paglia served as Executive Vice President and Chief Financial Officer of ECredit.com, Inc. from 1999 to 2001. Mr. Paglia joined UIL Holdings Corporation in April 2002 and has served as Executive Vice President and Chief Financial Officer since July 1, 2002. - 16 - SUSAN E. ALLEN. Ms. Allen served as Manager of Financing and Corporate Secretary Administration of The United Illuminating Company during the period January 1, 1999 to June 30, 1999 and Director Finance and Corporate Secretary Administration of The United Illuminating Company from July 1, 1999 to June 25, 2000. She has served as Vice President Investor Relations, Corporate Secretary and Assistant Treasurer of The United Illuminating Company since June 26, 2000 and of UIL Holdings Corporation since August 28, 2000. CHARLES J. PEPE. Mr. Pepe served as Assistant Treasurer and Assistant Secretary of The United Illuminating Company during the period January 1, 1999 to June 25, 2000. He has served as Treasurer and Assistant Secretary of The United Illuminating Company since June 26, 2000 and of UIL Holdings Corporation since August 28, 2000. GREGORY W. BUCKIS. Mr. Buckis served as Vice President of Administration and Group Controller for Science Applications International Corporation from January 1, 1999 to September 11, 2000. He served as Vice President and Controller for the NASDAQ Stock Market Inc. from September 12, 2000 to June 29, 2003. He has served as Controller of UIL Holdings Corporation since June 30, 2003. PART II ITEM 5. MARKET FOR UIL HOLDINGS' COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. UIL Holdings' Common Stock is traded on the New York Stock Exchange, where the high and low closing sale prices during 2003 and 2002 were as follows: 2003 SALE PRICE 2002 SALE PRICE --------------- --------------- HIGH LOW HIGH LOW ---- --- ---- --- First Quarter $37.70 $31.01 $58.10 $51.65 Second Quarter 45.65 34.67 58.53 52.75 Third Quarter 40.77 34.98 56.35 35.35 Fourth Quarter 46.07 36.12 35.50 29.06 Quarterly dividends on the Common Stock have been paid since 1900. The quarterly cash dividends declared in 2003 and 2002 were at a rate of $0.72 per share. UIL Holdings expects to continue its policy of paying regular cash dividends, although there is no assurance as to the amount of future dividends because they depend on future earnings, capital requirements, and financial condition. Further information regarding payment of dividends is provided in Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources." As of December 31, 2003, there were 10,760 Common Stock shareowners of record. - 17 - EQUITY COMPENSATION PLAN INFORMATION
NUMBER OF SECURITIES REMAINING AVAILABLE FOR NUMBER OF SECURITIES TO FUTURE ISSUANCE UNDER BE ISSUED UPON EXERCISE WEIGHTED AVERAGE EQUITY COMPENSATION PLANS OF OUTSTANDING OPTIONS, EXERCISE PRICE OF (EXCLUDING SECURITIES WARRANTS AND RIGHTS OUTSTANDING OPTIONS, REFLECTED IN COLUMN (A)) (A) WARRANTS AND RIGHTS (C) PLAN CATEGORY (B) -------------------------- --------------------------- ------------------------- ---------------------------- Equity Compensation Plans Approved by Security Holders 884,535 $45.17 358,492 (1) Equity Compensation Plans Not Approved by Security Holders None - - Total 884,535 $45.17 358,492 (1)
(1) Includes 40,086 shares authorized for issuance under the UIL Holdings Deferred Compensation Plan, which is a non-qualified benefit plan. - 18 - ITEM 6. SELECTED FINANCIAL DATA
2003 2002 2001 2000 1999 =================================================================================================================================== FINANCIAL RESULTS OF OPERATION ($000'S) Sales of electricity Utility Retail Residential $ 273,230 $ 281,307 $ 266,585 $ 252,730 $ 271,605 Commercial 248,257 256,077 254,842 242,075 256,246 Industrial 82,087 91,129 95,250 96,955 100,437 Other 10,311 10,512 10,501 10,587 11,308 ------------ ------------- ------------ ------------- ------------- Total Retail 613,885 639,025 627,178 602,347 639,596 Wholesale 24,591 58,249 61,570 67,990 24,334 Other operating revenues 31,144 30,259 26,070 34,354 16,045 Non-utility businesses 294,057 310,063 312,642 138,491 35,510 ------------ ------------- ------------ ------------- ------------- Total operating revenues 963,677 1,037,596 1,027,460 843,182 715,485 ------------ ------------- ------------ ------------- ------------- Operating income 88,957 124,702 144,594 146,673 154,167 ------------ ------------- ------------ ------------- ------------- Income from Continuing Operations, net of tax 29,537 45,751 59,563 58,723 50,677 Discontinued Operations, net of tax (Note O) (6,251) (1,804) (200) 2,034 1,547 ------------ ------------- ------------ ------------- ------------- Net income 23,286 43,947 59,363 60,757 52,224 Premium (Discount) on preferred stock redemption - - - - 53 Preferred and preference stock dividends - - - - 66 ------------ ------------- ------------ ------------- ------------- Income applicable to common stock $ 23,286 $ 43,947 $ 59,363 $ 60,757 $ 52,105 =================================================================================================================================== FINANCIAL CONDITION ($000'S) Property, Plant and Equipment in service - net (1) $ 512,327 $ 471,670 $ 499,470 $ 503,340 $ 488,675 Deferred charges and regulatory assets 895,640 813,299 839,161 897,504 924,807 (2) Assets of discontinued operations 120,261 123,005 123,610 110,329 69,888 Total Assets (3) 1,879,074 1,793,759 1,876,264 1,880,076 1,808,717 Current portion of long-term debt - 100,000 100,000 - 25,000 Net long-term debt excluding current portion 495,460 395,432 498,557 522,221 518,228 Preferred stock & company-obligated mandatorily redeemable securities of subsidiaries holding solely parent debentures - - - - 50,000 Net common stock equity 492,774 482,352 499,995 479,045 458,298 =================================================================================================================================== COMMON STOCK DATA Average number of shares outstanding - basic (000's) 14,291 14,239 14,097 14,073 14,052 Number of shares outstanding at year-end (000's) 14,315 14,272 14,116 14,077 14,063 Earnings per share - basic: Continuing Operations $ 2.07 $ 3.22 $ 4.22 $ 4.18 $ 3.60 Discontinued Operations (Note O) $ (0.44) $ (0.13) $ (0.01) $ 0.14 $ 0.11 ------------ ------------- ------------ ------------- ------------- Net Earnings $ 1.63 $ 3.09 $ 4.21 $ 4.32 $ 3.71 Earnings per share - diluted Continuing Operations $ 2.07 $ 3.21 $ 4.20 $ 4.17 $ 3.60 Discontinued Operations (Note O) $ (0.44) $ (0.13) $ (0.01) $ 0.14 $ 0.11 ------------ ------------- ------------ ------------- ------------- Net Earnings $ 1.63 $ 3.08 $ 4.19 $ 4.31 $ 3.71 Book value per share $ 34.44 $ 33.80 $ 35.42 $ 34.03 $ 32.59 Dividends declared per share $ 2.88 $ 2.88 $ 2.88 $ 2.88 $ 2.88 Market Price: High $ 46.07 $ 58.53 $ 52.42 $ 55.13 $ 53.19 Low $ 31.01 $ 29.06 $ 44.25 $ 38.13 $ 39.31 Year-end $ 45.10 $ 34.87 $ 51.30 $ 49.75 $ 51.38 =================================================================================================================================== OTHER FINANCIAL AND STATISTICAL DATA (UTILITY ONLY) (UNAUDITED) Sales by class (millions of kWh's) Residential 2,262 2,247 2,120 2,057 2,054 Commercial 2,502 2,466 2,476 2,403 2,388 Industrial 952 1,022 1,082 1,146 1,162 Other 47 46 46 48 48 ------------ ------------- ------------ ------------- ------------- Total 5,763 5,781 5,724 5,654 5,652 ------------ ------------- ------------ ------------- ------------- Number of retail customers by class (average) Residential 288,405 287,632 286,331 284,955 282,986 Commercial 29,687 29,757 29,889 29,776 29,757 Industrial 1,595 1,630 1,707 1,725 1,746 Other 1,306 1,267 1,250 1,207 1,185 ------------ ------------ ------------- ------------- ------------- Total 320,993 320,286 319,177 317,663 315,674 ------------ ------------- ------------- ------------- ------------- Average price per kilowatt hour by class (cents) Residential 12.08 12.52 12.57 12.29 13.22 Commercial 9.92 10.39 10.29 10.07 10.73 Industrial 8.62 8.92 8.80 8.46 8.64 Revenues - retail sales per kWh 10.65 11.05 10.96 10.65 11.31 ===================================================================================================================================
(1) Reflects 1999 reclassification of $518.3 million of nuclear assets from plant in-service to regulatory asset, as well as reclassification of asset removal costs from accumulated depreciation to regulatory liabilities for all years presented. (2) Reflects reclassification of $518.3 million of nuclear assets from plant in-service to regulatory asset. (3) Reflects reclassification of asset removal costs from accumulated depreciation to regulatory liabilities for all years presented. - 19 - ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. CERTAIN STATEMENTS CONTAINED HEREIN, REGARDING MATTERS THAT ARE NOT HISTORICAL FACTS, ARE FORWARD-LOOKING STATEMENTS (AS DEFINED IN THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995). SUCH FORWARD-LOOKING STATEMENTS INCLUDE RISKS AND UNCERTAINTIES; CONSEQUENTLY, ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE EXPRESSED OR IMPLIED THEREBY, DUE TO IMPORTANT FACTORS INCLUDING, BUT NOT LIMITED TO, GENERAL ECONOMIC CONDITIONS, LEGISLATIVE AND REGULATORY CHANGES, DEMAND FOR ELECTRICITY AND OTHER PRODUCTS AND SERVICES, CHANGES IN ACCOUNTING PRINCIPLES, POLICIES OR GUIDELINES, AND OTHER ECONOMIC, COMPETITIVE, GOVERNMENTAL, AND TECHNOLOGICAL FACTORS AFFECTING THE OPERATIONS, MARKETS, PRODUCTS, SERVICES AND PRICES OF THE SUBSIDIARIES OF UIL HOLDINGS CORPORATION (UIL HOLDINGS). MOST OF THESE FACTORS ARE DIFFICULT TO PREDICT ACCURATELY AND ARE GENERALLY BEYOND OUR CONTROL. YOU SHOULD CONSIDER THE AREAS OF RISK DESCRIBED IN CONNECTION WITH ANY FORWARD-LOOKING STATEMENTS THAT MAY BE MADE HEREIN. READERS ARE CAUTIONED NOT TO PLACE UNDUE RELIANCE ON THESE FORWARD-LOOKING STATEMENTS, WHICH SPEAK ONLY AS OF THE DATE HEREOF. OVERVIEW AND STRATEGY UIL Holdings Corporation (UIL Holdings) operates in two principal lines of business: utility and non-utility. The utility business consists of the operations of The United Illuminating Company (UI), while the non-utility business consists of the direct operations of Xcelecom, Inc. (Xcelecom) and American Payment Systems, Inc. (APS; Discontinued Operations). The non-utility business also includes United Capital Investments, Inc. (UCI), and United Bridgeport Energy, Inc. (UBE), entities which indirectly support the operations of their respective passive investments. As a result of Connecticut's 1998 electric industry restructuring legislation, UI divested its ownership interests in generation facilities. Over the past four years UIL Holdings invested the proceeds of the sale of UI's generation facilities in non-utility businesses to offset the expected reduction in utility earnings resulting from this restructuring. Some of these investments have not generated expected results due to a number of factors including the following: a slow economy resulting in less construction business with lower margins for Xcelecom, poor investment market conditions offsetting the value of UCI's passive investments, high natural gas prices affecting the value of UBE, and contract issues related to certain Xcelecom projects. UIL Holdings' overall corporate strategy is to create shareholder value by actively managing the UI and Xcelecom operating businesses to maximize earnings and cash flow, while providing superior reliability and customer satisfaction within its service territory. UIL Holdings plans to improve the value of both the utility and non-utility businesses and investments through operating initiatives designed to improve results and strategic objectives designed to increase value. In particular, UIL Holdings plans to actively manage its costs, capitalize on synergies within the Xcelecom operating segment to improve performance, and evaluate the possible restructuring or refinancing of certain of the passive investments. THE UNITED ILLUMINATING COMPANY UI, the largest business unit of UIL Holdings, is a transmission and distribution electric utility whose primary objective is to provide reliable, cost-effective service to the customers in the seventeen towns or cities in which it operates. To provide reliable service, management will prudently invest in, and maintain, its transmission and distribution infrastructure. As such, UI, together with The Connecticut Light and Power Company (which also provides electric transmission and distribution service in Connecticut) has applied for siting approval to construct a major transmission upgrade in southwest Connecticut. UI plans to manage operating and maintenance costs to optimize return on equity, earnings and cash flow. While revenues are expected to remain level, earnings from UI's CTA component are expected to decline over time due to the planned amortization and resulting reduction in the stranded cost rate base. UI's investment in infrastructure may not offset the decline of the stranded cost rate base, as the opportunity to invest in transmission infrastructure is limited by the size of its service territory. XCELECOM, INC. Xcelecom, the second largest business unit of UIL Holdings, is an electrical and mechanical contractor and voice-data-video design company that operates in the eastern portion of the United States. Xcelecom was built through a series of - 20 - acquisitions over the past four years. Xcelecom's primary objective is to continue to improve its operating performance in the markets that it serves. Xcelecom expects to improve performance, in part, by capitalizing on synergies throughout its network of subsidiaries, including best practices for safety and risk management, project management and estimation, information systems, cross-sales development and cash management and banking. Through these and other initiatives, Xcelecom plans to manage operating costs to maximize earnings and cash flow that will be used to meet substantially all of the operating and most contractual commitments of its business. Over the last several years, Xcelecom has expanded its business by pursuing an aggressive acquisition program. Due to the effects of the economic downturn on Xcelecom's business, in addition to the lack of available and potentially desirable acquisitions, Xcelecom has curtailed its acquisition program. Xcelecom currently does not intend to grow materially through acquisitions in the foreseeable future; however, it will continually evaluate acquisition prospects that could complement and expand its existing business platforms. UNITED CAPITAL INVESTMENTS, INC. As a minority partner in Cross-Sound Cable Company, LLC (Cross-Sound), UCI will continue to work to maximize the value of its investment in Cross-Sound. To achieve this objective, UCI will support the majority owner and project developer, TransEnergieUS Ltd., in the efforts to get the interim operating contract between Cross-Sound and the Long Island Power Authority (LIPA) approved by all required authorities, as this contract provides Cross-Sound's compensation for operation of the cable under the Department of Energy Emergency Order enacted on August 28, 2003. UCI will also focus on resolving all permit issues so the cable can achieve commercial operation. UCI is a limited partner in three investment funds; its equity participation in such funds ranges from 3%-7%. Two funds are venture capital funds that invest in emerging growth companies, of which one is also licensed by the U.S. Small Business Administration (SBA) as a Small Business Investment Company (SBIC). The third fund is also a SBIC that focuses on mezzanine financing while also investing a portion of its capital in women and minority-owned small businesses and businesses located in low and moderate income areas. As a mezzanine fund, it provides growth and acquisition capital to privately held businesses committed to sustainable long-term growth; its focus on more mature companies means that UCI's investment is subject to less risk, and also smaller potential returns, in comparison to the venture capital funds. UNITED BRIDGEPORT ENERGY, INC. As a minority owner of Bridgeport Energy, LLC, (BE), UBE will continue to work to maximize the commercial value of the plant. To achieve this objective, UBE will work with the majority owner and project manager, a Duke Energy affiliate, to optimize factors affecting the plant. Two major factors of focus are the procurement of natural gas to be used by BE and maximizing the installed capacity market revenues. AMERICAN PAYMENT SYSTEMS, INC. APS is a walk-in bill payment and financial services company that operates in 47 states. Through UIL Holdings' investment, APS became a nationwide leader in the walk-in bill payment business. While APS was successful under UIL Holdings' ownership, management believes that a company specializing in payment processing or financial services, such as CheckFree Corporation (CheckFree), could accelerate the future success of APS. Accordingly, on December 16, 2003, UIL Holdings entered into an agreement to sell APS to CheckFree, a leading provider of financial electronic commerce services and products. Under the terms of the agreement, and pending receipt of regulatory approvals and satisfaction of customary closing conditions, CheckFree will pay approximately $110 million in cash for the outstanding stock of APS. The transaction is expected to close during the second quarter of 2004, with the resulting gain on sale to be recognized at that time. UIL Holdings currently plans to use the proceeds from the sale to pay down short-term debt and for general corporate purposes. CheckFree will not be acquiring APS' telephony assets, which includes APS' 51% ownership interest in CellCards of Illinois, LLC (CCI). Following execution of the agreement to sell APS, management determined that the telephony business is - 21 - not part of UIL Holdings' overall strategic business focus, and therefore developed a plan to pursue the sale of APS' telephony assets. As part of that plan, on February 13, 2004, CCI was sold for book value to an independent third party. The effects of the decision to dispose of APS' telephony assets, along with the agreements to sell APS and CCI, will eliminate the APS reporting segment. Accordingly, APS has been categorized as "held for sale" for financial accounting purposes as of December 31, 2003, and as such, its results are included in discontinued operations in the accompanying consolidated statements of operations for all periods presented. MAJOR INFLUENCES ON FINANCIAL CONDITION UIL HOLDINGS CORPORATION UIL Holdings' financial condition and financing capability will be dependent on many factors, including the level of income and cash flow of UIL Holdings' subsidiaries, conditions in the securities markets, economic conditions, interest rates, legislative and regulatory developments, and the ability to retain key personnel. The loss of key personnel or the inability to hire and retain qualified employees could have an adverse effect on the business, financial condition and results of operations for UIL Holdings' operating subsidiaries: UI, Xcelecom and APS. These operations depend on the continued efforts of their respective current and future executive officers, senior management and management personnel. Xcelecom has acquired a number of companies in the past. The success of these acquisitions is dependent on the continued involvement of the operating management of these entities. UIL Holdings cannot guarantee that any member of management at the corporate or subsidiary level will continue to serve in any capacity for any particular period of time. If UIL Holdings were to lose a number of key personnel, its operations could be adversely affected. THE UNITED ILLUMINATING COMPANY UI is an electric transmission and distribution utility whose structure and operations are significantly affected by legislation and regulation. UI's rates and authorized return on equity are regulated by the Federal Energy Regulation Commission (FERC) and the Connecticut Department of Public Utility Control (DPUC). Legislation and regulatory decisions implementing the legislation establish a framework for UI's operations. Primary factors affecting UI's financial results, in addition to legislation and regulation, are operational matters such as sales volume, major weather disturbances, ability to control expenses, and capital expenditures. UI expects significant growth in its capital investment in transmission, and has applied for siting approval to construct a major transmission project in southwest Connecticut. LEGISLATION State legislation has significantly restructured the electric utility industry in Connecticut. The primary restructuring legislation includes Public Act 98-28 (the 1998 Restructuring Legislation) and Public Act 03-135, as amended in part by Public Act 03-221 (the 2003 Restructuring Legislation). As a result of the 1998 Restructuring Legislation, UI divested its non-nuclear generation assets in 1999, and divested its nuclear generation assets in 2001 and 2002. Since 2000, UI's retail customers have been able to choose their electricity suppliers. During 2000-2003, the 1998 Restructuring Legislation required UI to offer retail service to its customers under a regulated "standard offer" rate to retail customers who did not choose an alternate electricity supplier. The 2003 Restructuring Legislation requires that UI offer a "transitional standard offer" rate during the period January 1, 2004 - December 31, 2006 to retail customers who do not choose an alternate electric supplier. The 2003 Restructuring Legislation provides for UI to recover its costs of acquiring and providing generation services, and directed the DPUC to establish each electric distribution company's transitional standard offer rates. As part of the restructuring pursuant to the 1998 Restructuring Legislation, UI's distribution and transmission rates were "unbundled" on customers' bills, which also included separate charges as of January 1, 2000 for a competitive - 22 - transition assessment (CTA), generation services charge (GSC), conservation and load management (C&LM) charge, renewable energy investment (REI) charge, and systems benefits charge (SBC). As of January 1, 2004, federally-mandated congestion costs, defined by the 2003 Restructuring Legislation to include the costs of regional standard market design, are also identified separately on customers' bills in accordance with the legislation. The 2003 Restructuring Legislation makes other changes to the 1998 Restructuring Legislation, such as the imposition of renewable portfolio standards, the support of the development of renewable energy resources, and supplier of last resort service after the transitional standard offer period ends, and a requirement that any new rate case filings include a four-year rate plan proposal. The 2003 Restructuring Legislation provides for UI to collect a fee of $0.0005/kilowatt-hour from transitional standard offer service customers, beginning January 1, 2004, as compensation for providing transitional standard offer service. This fee is included in the amounts charged to transitional standard offer customers, and is excluded by the legislation from determinations of whether UI's rates are just and reasonable. For 2004, this fee is expected to generate approximately $2.5 million to $3.0 million in revenue. The 2003 Restructuring Legislation also provides for the DPUC to establish an incentive plan for the procurement of long-term contracts for transitional standard offer service that compares UI's actual average contract price to a regional average price for electricity, making adjustments as deemed appropriate by the DPUC. If UI's price is lower than the average, the legislation provides for the plan to allocate $0.00025/kilowatt-hour of transitional standard offer service to the distribution company. The DPUC has not yet established an incentive plan or made any determination with respect to the incentive fee. REGULATION In December 2003, the DPUC established UI's transitional standard offer rates to be effective January 1, 2004, in accordance with the 2003 Restructuring Legislation. During 2004, it is expected that the DPUC will continue its implementation of other provisions of the 2003 Restructuring Legislation. The DPUC's decision establishing the transitional standard offer rates determined that UI's rates complied in all respects with the 2003 Restructuring Legislation. The transitional standard offer rates increase the GSC charged to customers for generation services compared to the standard offer GSC, modify the CTA (for some retail rates), and provide for the collection of federally-mandated congestion costs. The GSC rate changes reflect an increase, compared to the 2003 GSC, in the cost of generation services and related market costs, as well as a reduction in the "adder" included in the GSC (expected charge in excess of expected cost). The GSC for the transitional standard offer is designed to collect all of the costs of procuring and providing transitional standard offer service. Distribution and transmission rates remain unchanged from the levels established in September 2002. On September 26, 2002, the DPUC had reduced UI's customer rates in UI's retail customer ratemaking (Rate Case) proceeding. The DPUC's decision provided for a $30.9 million reduction in UI's annual revenue requirements, including (1) a $20.3 million reduction to UI's customer rates (a 3% reduction), (2) $2 million to be applied annually for additional funding of conservation programs, (3) $8.3 million to be applied annually for accelerated amortization to reduce stranded costs, and (4) $0.3 million to be applied to a combination of uncollectibles, taxes and rate base changes. The final Rate Case decision established rates on the basis of an authorized return on equity of 10.45%, excluding UI's investment in transmission rate base. The decision further provided that earnings above the authorized return would be shared 50% to customers and 50% to net income, with the customers' share divided equally between bill reductions and an accelerated amortization of stranded costs. The Rate Case decision recognizes that the revenue requirements determination for transmission, including the applicable return on equity, is within the jurisdiction of the FERC. UI's authorized return on equity for transmission is 10.75%. On March 26, 2003, the DPUC issued a decision granting UI's request to reopen the September 2002 Rate Case decision, to examine increased pension and postretirement benefits expenses of UI for 2003. On June 25, 2003, the DPUC issued a decision denying, without prejudice, UI's request for recovery of $15.5 million in increased pension and postretirement benefits expenses. On September 10, 2003, the DPUC granted UI's request to reopen the June 25, 2003 decision. On November 24, 2003, UI and the Prosecutorial Division of the DPUC (PRO) reached a settlement agreement, which was filed with the DPUC providing for the annual recovery by UI of an additional $10.5 million of expenses effective with final DPUC approval of the agreement. - 23 - The settlement also would have modified the earnings sharing mechanism from 50% to shareholders and 50% to customers, to 25% to shareholders and 75% to customers, with the entire customer portion being utilized to reduce stranded costs. The settlement agreement also stipulated that UI will not file a rate case before January 1, 2005. On February 9, 2004, the DPUC issued a draft decision that accepted the settlement agreement provided that UI and PRO agreed to reduce the $10.5 million annual recovery to $5.2 million and to increase the customer portion of shared earnings in excess of the authorized return to 100% from 75%. While UI believes $5.2 million is not sufficient to offset the increased costs, it will offer some level of relief above what is currently included in rates. As such, UI accepted the changes required by the draft decision. On February 18, 2004, the DPUC issued a final decision approving the settlement with the specified modifications. OPERATIONS In implementing the 1998 Restructuring Legislation, UI established a Distribution Division and other "unbundled" components for accounting purposes, to reflect other unbundled components on customer bills. Initially, the Distribution Division included both transmission and distribution. UI has now separated transmission from distribution into separate divisions for accounting purposes. Changes to income and expense items related to transmission and distribution have an immediate net income and earnings per share impact, while changes to items in "other unbundled utility components" do not. The other components are the CTA, the SBC, the GSC, the C&LM charge, and REI charge. The CTA and SBC both earned an 11.5% return on the equity portion of their respective rate bases until the September 26, 2002 effective date of the Rate Case decision, and 10.45% thereafter in accordance with that decision. Those returns were achieved either by accruing additional amortization expenses, or by deferring such expenses, as required to achieve the authorized return. Amortization expenses in the CTA and SBC components impact earnings indirectly through changes to rate base. The GSC, C&LM and REI are essentially pass-through components (revenues are matched to recover costs). Except for the procurement fee in GSC previously discussed, and a small management fee earned in the C&LM component, expenses are either accrued or deferred or revenues are transferred such that there is no net income associated with these three unbundled components. UI's CTA collection recovers costs that have been reasonably incurred, or will be incurred, to meet its public service obligations and that will likely not otherwise be recoverable in a competitive market. These "stranded costs" include above-market long-term purchased power contract obligations, regulatory asset recovery and above-market investments in power plants. Subject to future regulatory changes to the CTA rate or to the level of amortization, CTA revenues are expected to remain relatively constant, with amortization increasing over time as the allowed earnings trend downward due to the decreasing rate base. A significant amount of UI's earnings is generated by the authorized return on the equity portion of as yet unamortized stranded costs in the CTA rate base. The CTA rate base earns exactly that return, no more and no less, by adjustments made to amortization expense in each period. UI's earnings per share attributable to CTA for the years ended December 31, 2003, 2002 and 2001 were $1.00, $1.27, and $1.38, respectively. A significant portion of UI's cash flow from operations is also generated from those earnings and from the recovery of the CTA rate base. Cash flow from operations related to CTA for the years ended December 31, 2003, 2002 and 2001 amounted to $36 million, $45 million and $32 million, respectively. CTA rate base has declined from year to year for a number of reasons, including: amortization of stranded costs, the sale of the nuclear units, and any adjustments made through the annual DPUC review process. The original rate base component of stranded costs, as of January 1, 2000, was $433 million. It has since declined to $413 million at year-end 2000, $373 million at year-end 2001, $303 million at year-end 2002, and $279 million at year-end 2003. The 2003 result is subject to DPUC review, pursuant to an annual review of UI's CTA revenues and expenses, and may be adjusted in accordance with that review. During July 2003, the DPUC issued an order requiring that the reduction of CTA rate base utilizing excess GSC revenues be discontinued pursuant to the 2003 Restructuring Legislation. UI's CTA earnings will decrease while, based on UI's current projections, cash flow will remain fairly constant until stranded costs are fully amortized between 2014 and 2016, depending upon the DPUC's future decisions which could affect future rates of stranded cost amortization. The primary Distribution Division operational factors affecting UI's financial results are sales volume, ability to control expenses and capital expenditures. Retail electric sales volume can be significantly affected by economic growth and weather. The weather can also have an impact on expenses, dependent on the - 24 - level of work required as a result of storms or other extreme conditions. UI's major expense components are (1) purchased power, (2) amortization of stranded costs; (3) wages and benefits; (4) depreciation; and (5) regional network service (RNS) transmission costs. Purchased power expenses are a pass-through expense, collected from customers in the GSC and as federally mandated congestion costs. On October 22, 2003, UI entered into an agreement with PSEG Energy Resources & Trade LLC (PSEG) for the supply of all of UI's transitional standard offer generation service needs, excluding requirements for special contract customers, from January 1, 2004 through December 31, 2006, the end of the transitional standard offer period. UI continues to purchase generation services pursuant to a December 28, 2001 agreement with Dominion Energy Marketing (Dominion) to supply special contract customers through December 31, 2008. The contract with PSEG contains numerous financial assurances including a guaranty from PSEG's parent company, PSEG Power, various credit requirements including maintaining a minimum Moody's credit rating of Baa3 or equivalent, and a letter of credit to secure performance through the initial stages of the contract. UI is also required to maintain a minimum credit rating of Baa3 or equivalent. UI's current Moody's credit rating is A3, which is three levels above the required minimum. Prior to January 1, 2004, UI purchased generation services to supply standard offer service pursuant to the agreement with Dominion. UI's agreement with Dominion replaced an earlier wholesale power agreement and other related agreements with Enron Power Marketing, Inc. (EPMI). Refer to Note (J), "Commitments and Contingencies," of the Notes to Consolidated Financial Statements for further information. In order to maintain and improve its electricity delivery system and to provide quality customer service, UI is required to spend a significant amount each year on capital projects in the Distribution and Transmission Divisions. A large portion of the funds required for capital projects is provided internally through the recovery of depreciation and from amortization of stranded costs. The remainder must be financed externally. For more information, see "Capital Expenditure Program" and "Liquidity and Capital Resources" included later in this item of this Form 10-K. UI, together with The Connecticut Light and Power Company, has filed with the Connecticut Siting Council an application for a Certificate of Environmental Compatibility and Public Need to construct a 345-kiloVolt transmission line from Middletown, Connecticut to Norwalk, Connecticut. This approximately $600 million project is necessary to improve the reliability of the transmission system in southwest Connecticut. The two companies are working together for permitting, and will each construct, own and operate its respective portion of the transmission line and related facilities. UI will construct, own, and operate transmission and substation facilities comprising approximately 20% of the total project. A decision by the Connecticut Siting Council is presently expected in October 2004. Other governmental permitting, together with approvals from ISO-New England, will be required for the project, and the total project cost could change depending on final permit requirements and final specifications. UI's costs for the project are expected to be included in and recovered through transmission rates under FERC jurisdiction. RISK MANAGEMENT AND INSURANCE UI's primary risk management and insurance exposures include bodily injury, property damage, fiduciary responsibility, and injured workers' compensation. UI is insured for general liability, automobile liability, property loss, fiduciary liability and workers' compensation liability. UI's general liability and automobile liability programs provide insurance coverage for third party liability claims for bodily injury (including "pain and suffering") and property damage, subject to a deductible. Losses up to the deductible amounts are accrued based upon our estimates of the liability for claims incurred and an estimate of claims incurred but not reported. UI reviews the general liability reserves quarterly to ensure that UI is adequately reserved. The reserve is based on historical claims, business events, industry averages and actuarial studies. Insurance liabilities are difficult to assess and estimate due to unknown factors such as incidents incurred but not reported and awards greater than expected, therefore reserve adjustments may become necessary as cases unfold. UI insures its own property subject to deductibles depending on the type of property. UI's fiduciary liability program and workers' compensation program provides insurance coverage, subject to deductibles as well. - 25 - AMERICAN PAYMENT SYSTEMS, INC. As a result of the pending sale of APS to CheckFree, and management's decision to dispose of APS' telephony assets, there are now two principal risks affecting the financial condition of APS and UIL Holdings: operating risk and disposition risk. Operating risk relates to the risk factors inherent in APS' business operations, whereas disposition risk relates to the risk factors that could impact the outcome of the potential sale of APS, and separately the sale of APS' remaining telephony assets. The four primary operating risk factors affecting the financial results of APS and its subsidiaries are (1) the ability to recruit and retain agents, (2) the ability to manage and control agent fraud to ensure that the agents are depositing the funds collected from the consumers in a timely fashion (3) the maintenance of internal control systems and procedures to account for the movement of significant amounts of cash from the agents to APS and on to the biller, on whose behalf the funds are collected, and (4) compliance with increasingly complex regulatory requirements applicable to its business. APS has programs and procedures in place to mitigate the operating risk factors described above. These include a formal program to recruit and train agents, as well as processes to monitor cash movements and reconcile high dollar volume accounts on a daily basis. In addition, APS reviews its internal control systems and procedures to ensure that these controls are maintained in an effective manner and regularly evaluates, and when deemed appropriate implements new technologies to improve the existing internal control systems and procedures. These operating risks will no longer affect UIL Holdings upon closing of the sale of APS to CheckFree. There are significant disposition risks relating to the potential sale of APS to CheckFree. UIL Holdings and CheckFree made the required filings under the federal Hart-Scott-Rodino Antitrust Improvements Act, and as of January 30, 2004, the mandatory waiting periods thereunder expired. In addition, the parties have made notice filings or submitted applications for approval of the transaction to state regulatory authorities in more than thirty states in which APS holds licenses in connection with its money transmittal business. The sale of APS to CheckFree will not close until certain of those state regulatory authorities have approved the transaction. APS' telephony assets primarily consist of its 51% ownership interest in CCI, and point of sale activation (POSA) technology. CCI sells prepaid long distance telephone service, prepaid telephone calling cards and prepaid wireless telephone service in check cashing and convenience store locations nationwide, as well as through APS' network of agents. As part of management's plan to divest APS' telephony assets, CCI was sold for book value to an independent third party on February 13, 2004. As a result of the sale, neither APS, nor UIL Holdings will be subject to the put option previously in place with respect to CCI pursuant to which the other owners of CCI had a put option to require APS to purchase the remaining 49% of CCI beginning in May 2004. Separately, in connection with the acquisition of the POSA technology in 2002, APS loaned money to the vendor from which the technology was acquired. Subsequently the vendor defaulted under the loan and as part of the foreclosure procedures the remaining loan balance was restructured. As consideration for an accelerated payment schedule, APS agreed to forgive a portion of the outstanding loan balance, bringing the restructured amount due to $1 million. The accelerated payment schedule calls for three principal payments, all to be received within the first quarter of 2004. If any of the payments are delinquent, interest will be charged daily at graduated rates, beginning on the day after the payment was due. Any interest payments are due weekly, with full settlement of any delinquent principal due before the end of the second quarter of 2004. In January 2004, all POSA assets, including the aforementioned loan receivable, were transferred from APS to one of UIL Holdings' non-utility subsidiaries. XCELECOM, INC. The principal factors affecting the financial results of Xcelecom and its subsidiaries are (1) construction and technology spending; (2) competition; (3) fixed-priced contract estimation and bidding; (4) work-related hazards and insurance; (5) attracting and retaining management expertise; (6) overall liquidity and ability to obtain surety bonding, and (7) risks of attaining required labor productivity levels to meet or exceed contract estimates. Additional risk factors include general economic conditions, the pace of technological changes, recoverability and potential for impairment of goodwill, and collectibility of receivables. - 26 - More than half of Xcelecom's business involves the installation of electrical, mechanical and integrated network information systems in newly constructed and renovated buildings and plants. Downturns in levels of construction starts and business spending can have a material adverse effect on Xcelecom's business, financial condition and results of operations. In addition, Xcelecom's business is subject to seasonal variations in operations and demand that affect the construction business, particularly in new construction. Quarterly results may also be affected by regional economic conditions. Accordingly, Xcelecom's performance in any particular quarter may not be indicative of the results that can be expected for any other quarter or for the entire year. The competitive bidding process for new business contracts normally intensifies during economic downturns, leading to lower profit margins and an increased potential for project cost overruns or losses. Xcelecom's contracts are entered into principally on the basis of competitive bids. The final terms and prices of those contracts are frequently negotiated with the customer. Although contract terms vary considerably, most are made on either a fixed price or unit price basis in which Xcelecom agrees to do the work for a fixed amount for the entire project (fixed price) or for units of work performed (unit price), although services are sometimes performed on a cost-plus or time and materials basis. Xcelecom's most significant cost drivers are the cost of labor, including employee benefits, the cost of products and materials, and the cost of casualty insurance. These costs may vary from the costs originally estimated. Variations from estimated contract costs along with other risks inherent in performing fixed price and unit price contracts may result in actual revenue and gross profits for a project differing from those originally estimated and could result in losses on projects. Depending on the size of a particular project, variations from estimated project costs could have a significant impact on operating results for any fiscal quarter or year. Hazards related to Xcelecom's industry include, but are not limited to, electrocutions, fires, mechanical failures, and transportation accidents. These hazards can cause personal injury and loss of life, severe damage to or destruction of property and equipment, and may result in suspension of operations. Xcelecom's third-party insurance is subject to large deductibles for which reserves are established. Accordingly, Xcelecom self-insures for this exposure. Xcelecom believes its insurance and provisions for self-insurance of deductibles are adequate to cover reasonably foreseeable losses and liabilities. Losses impacting self-insurance provisions or exceeding insurance limits could impact Xcelecom's operating results. The loss of key personnel or the inability to hire and retain qualified employees could have an adverse effect on Xcelecom's business, financial condition and results of operations. Xcelecom's operations depend on the continued efforts of current and future executive officers, senior management and management personnel at the companies which have been acquired. Certain steps taken to mitigate the risk of loss of key personnel of acquired companies were the use of earn-out payments, promissory notes, and covenant not to compete agreements. A criterion used in evaluating acquisition candidates was the quality of their management. There is no guarantee that any member of management at the corporate or subsidiary level will continue in their capacity for any particular period of time. The loss of a group of key personnel could adversely affect Xcelecom's operations. Billings under fixed price contracts are generally based upon achieving certain benchmarks and will be accepted by the customer once it is demonstrated that those benchmarks have been met. If Xcelecom is unable to show the compliance with billing requests, or fails to issue a project billing, the likelihood of collection could be delayed or impaired, which could have a materially adverse effect on operations. An allowance for doubtful accounts for unknown collection issues is maintained, in addition to reserves for specific accounts receivable where collection is considered doubtful. Inherent in the assessment of the allowance for doubtful accounts are certain judgments and estimates including, among others, customers' access to capital, customers' willingness to pay, general economic conditions and the ongoing relationships with customers. Surety market conditions are currently difficult as a result of significant losses incurred by many sureties in recent periods, both in the construction industry as well as in certain larger corporate bankruptcies. As a result, less bonding capacity is available in the market and terms have become more restrictive. Further, under standard terms in the surety market, sureties issue bonds on a project by project basis, and can decline to issue bonds at any time. Historically, approximately one third of Xcelecom's construction related business has required bonds. While Xcelecom has enjoyed a longstanding relationship with its surety, current market conditions as well as changes in the surety's assessment of Xcelecom's operating and financial risk could cause - 27 - the surety to decline to issue bonds for work. If that were to occur, alternatives include doing more business that does not require bonds, posting other forms of collateral for project performance such as letters of credit or cash, and seeking bonding capacity from other sureties. There can be no assurance that such alternatives could be easily achieved. Accordingly, if Xcelecom were to experience an interruption in the availability of bonding capacity, its operating results could be adversely impacted. Xcelecom's business is primarily driven by labor. The ability to perform contracts at acceptable margins depends on the ability to deliver substantial labor productivity. It cannot be guaranteed that productivity will continue at acceptable levels for a particular period of time. The loss of productivity could adversely affect the margins on existing contracts or the ability to obtain new contracts. Historically, a significant amount of Xcelecom's growth has come through acquisitions. From July of 1999 to Xcelecom's last significant acquisition in April of 2002, Xcelecom made 12 acquisitions. Xcelecom currently does not intend to grow materially through acquisitions in the foreseeable future; however, it will continually evaluate acquisition prospects to complement and expand its existing business platforms. The timing, size or success of any acquisition effort and the associated potential capital commitments cannot be predicted. Each acquisition involves a number of risks. These risks include the diversion of management's attention from existing businesses to integrating the operations and personnel of the acquired business; possible adverse effects on operating results during the integration process; and possible inability to achieve the intended objectives of the combination. If future acquisitions do not perform as expected, Xcelecom may be required to write-off some or all of the value of any goodwill and intangible assets associated with the acquisitions. Financial results may also be impacted by the degree of integration of acquisitions, including the ability to achieve synergies over the network of subsidiaries. Xcelecom's revenue growth over the past several years has been generated principally through acquisitions. In the absence of economic improvement in the regional markets in which Xcelecom operates, Xcelecom does not expect any material revenue growth in 2004. The computer industry in general has felt the effects of the slowdown in the United States economy, and Xcelecom has specifically seen a decrease in demand for the products and services it sells. Sales can be dependent on specific product categories, and any change in demand for or supply of such products could have a material adverse effect on Xcelecom's sales if they failed to react in a timely manner to such changes. Operating results are also highly dependent upon the level of gross profit as a percentage of net sales which fluctuates due to numerous factors, including changes in prices from suppliers, reductions in the amount of supplier reimbursements that are made available, changes in customer mix, the relative mix of products sold during the period, general competitive conditions, the availability of opportunistic purchases and opportunities to increase market share. In addition, expense levels, including the costs and salaries incurred in connection with the hiring of sales and technical services personnel, are based, in part, on anticipated sales. Therefore, Xcelecom may not be able to reduce spending in a timely manner to compensate for any unexpected sales or margin shortfalls. As a result, comparisons of Xcelecom's quarterly financial results should not be relied upon as an indication of future performance. COST DRIVERS As a service business, Xcelecom's cost structure is highly variable. Primary costs include labor, materials and insurance. Approximately 40% of costs are derived from labor and related expenses. For the years ended December 31, 2001, 2002 and 2003, labor-related expenses totaled $105.9 million, $122.6 million and $122.7 million, respectively. Approximately 50% of Xcelecom's costs incurred are for materials installed on projects and equipment and other products sold to customers. This component of the expense structure is variable based on the demand for services. Costs are generally incurred for materials once work begins on a project or a customer order is received. Materials are ordered when needed, shipped directly to the jobsite or customer facility, and installed within 30 days. Materials consist of commodity-based items such as conduit, pipe, data cabling, wire and fuses as well as specialty items such as fixtures, switchgear, switches and routers, servers and control panels. For the years ended December 31, 2001, 2002 and 2003, material and equipment expenses totaled $177.7 million, $165.0 million and $149.7 million, respectively. - 28 - REGULATIONS Xcelecom's operations are subject to various federal, state and local laws and regulations, including: - - licensing requirements applicable to electricians, steamfitters and plumbers; - - building, mechanical and electrical codes; - - regulations relating to consumer protection, including those governing residential service agreements; and - - regulations relating to worker safety and protection of the environment. Xcelecom believes they have all licenses required to conduct operations and are in substantial compliance with applicable regulatory requirements. Failure to comply with applicable regulations could result in substantial fines or revocation of operating licenses or an inability to perform government work. Many state and local regulations governing electricians, steamfitters and plumbers require permits and licenses to be held by individuals. In some cases, a required permit or license held by a single individual may be sufficient to authorize specified activities for all employees who work in the state or county that issued the permit or license. It is Xcelecom's policy to ensure that, where possible, any permits or licenses that may be material to its operations in a particular geographic area are held by multiple Xcelecom employees within that area. RISK MANAGEMENT AND INSURANCE The primary risks in Xcelecom's operations include health, bodily injury, property damage and injured workers' compensation. Xcelecom is insured for workers' compensation, automobile liability, general liability and employee-related health care claims, subject to large deductibles. A general liability program provides coverage for bodily injury and property damage neither expected nor intended. Losses up to the deductible amounts are accrued based upon our estimates of the liability for claims incurred and an estimate of claims incurred but not reported. The accruals are derived from actuarial studies, known facts, historical trends and industry averages utilizing the assistance of an actuary to determine the best estimate of the ultimate expected loss. Xcelecom believes such accruals to be adequate. However, insurance liabilities are difficult to assess and estimate due to unknown factors, including the severity of an injury, the determination of liability in proportion to other parties, the number of incidents not reported and the effectiveness of Xcelecom's safety programs. Therefore, if actual experience differs from the assumptions used in the actuarial valuation, adjustments to the reserve may be required and would be recorded in the period that the experience becomes known. UNITED CAPITAL INVESTMENTS, INC. UCI's investments in the venture funds described at "Overview and Strategy" were viewed as an opportunity to earn reasonable returns and promote local economic development. Due to the nature of its investments and market conditions, the value of the Zero Stage VI fund has decreased substantially since the end of 2000. The other two funds have been established more recently and are not yet fully invested. Excluding the effects of fund management fees and syndication costs, these funds have retained their market value. The Cross-Sound project has been opposed on environmental, safety, and economic concerns by a number of public officials and private groups who have participated actively in governmental permitting proceedings relative to the project. In January 2002, the Connecticut Siting Council (CSC) granted a certificate of environmental compatibility and public need to construct the cable. The Connecticut Attorney General appealed the CSC's decision without success to the Connecticut Superior Court. He also appealed the Superior Court's decision to the Connecticut Supreme Court, but in September 2003 withdrew the appeal, leaving intact the Superior Court's decision upholding the CSC approval. The project received all necessary permits prior to the cable being installed in the spring of 2002. After installation, it was determined that several sections of the cable in New Haven Harbor were not buried to the depths required by the permits. The authorized depth was not achieved due to the obstruction of rock ledge, sediment and other more movable types of obstruction, such as tree stumps and metal plate debris. The Connecticut - 29 - Department of Environmental Protection (CDEP) and United States Army Corp of Engineers have raised no environmental or navigational concerns related to operation of the cable as currently buried; however, the CDEP has indicated that under the current permit, the permit depth must be reached before commercial operation can begin. Cross-Sound is developing proposals for achieving the required burial depth. On June 12, 2003 Cross-Sound submitted a new Permit Application to the CDEP requesting that the CDEP issue a permit to allow Cross-Sound to operate the cable as installed in its current location through December 31, 2007. A Connecticut legislative moratorium on installing new gas and utility lines across Long Island Sound through early June 2004 has been enacted. This moratorium has impacted the permitting process. Cross-Sound expects the CDEP to act on Cross-Sound's new permit application no later than when the moratorium expires. On August 14, 2003, the day of the blackout that affected the Northeast and the Upper Midwest areas of the United States as well as portions of Canada, the Department of Energy (DOE) declared a federal emergency and issued an Emergency Order to allow immediate operation of the Cross-Sound cable through September 1, 2003. On August 28, 2003 the DOE issued a new Order for the cable to operate until all of the appropriate actions that should be taken to prevent future power outages in the region have been identified and implemented. On August 29, 2003, the Connecticut Attorney General and the CDEP filed a request for stay or rehearing to the DOE of the August 28 DOE Emergency Order. Briefs were filed in October and November 2003 and a decision by the DOE is expected sometime in the first half of 2004. On September 23, 2003, the Connecticut Attorney General also filed an appeal to the Federal Circuit Court of Appeals in New York of the August 28 DOE Emergency Order. This appeal cannot proceed before the DOE issues its decision on stay or rehearing. The range of outcomes from the DOE decision and future court, agency and legislative actions that may affect the operation of the cable, includes: (1) the DOE order continues in effect, and the cable continues to operate; (2) the DOE order is revoked, and Connecticut's moratorium is extended and not struck down on legal grounds, thus preventing operation; (3) the DOE order is revoked, and the CDEP grants a permit modification or approves remediation, enabling the cable to operate; and (4) federal legislation requires that the cable be permitted to continue to operate. On October 31, 2003, the CDEP issued a request for proposal to hire an independent consultant to compare the environmental impacts of cable operation in the current location with the impacts that would result from reburying the cable to the permitted depth. The study results are due by June 25, 2004. UCI expects the study results will show that the cable, operating in its current location, poses no harm to the environment. Such conclusion could potentially help Cross-Sound achieve commercial operation at a faster pace. UCI's 25% share of the estimated total final cost of the project is $34.4 million. As of December 31, 2003, UCI's 25% share of the actual project cost for the Cross-Sound cable was $33 million. UCI has provided an equity infusion of $10 million to Cross-Sound and UIL Holdings loaned $23.5 million to Cross-Sound. In addition, a guarantee of $3.8 million, in support of Hydro-Quebec's guarantees to third parties in connection with the construction of the project has been provided. It is expected that any obligations of Cross-Sound that are supported by the guarantee would be funded by capital contributions from the owners, who are affiliates of the guarantors, in amounts in proportion of their respective ownership shares of Cross-Sound. No liability was recorded related to the guarantee, as the likelihood of UIL Holdings having to perform under the guarantee is remote. Upon commercial operation, the loan from UIL Holdings is expected to be refinanced with external project financing. UCI will be responsible for 25% of any additional cost of project completion over the estimated amount. UCI has recorded $0.1 million in income for the project in 2003 under the provisions of an interim operating contract that covers Cross-Sound's compensation for the operation of the cable under the Emergency Order. Although the terms of the interim contract have been approved by the Long Island Power Authority's (LIPA) board of trustees, approval by the New York State Comptroller's office is still required. In addition, FERC approval is required for the interim operating contract. Resolution of permit issues for commercial operation of the cable is still pending. - 30 - UNITED BRIDGEPORT ENERGY, INC. The principal factors which affect the financial condition of UBE are natural gas prices, maintenance costs, installed capability (ICAP) revenues, and intercompany financing costs. As UBE holds a minority interest in BE, there are additional risk factors associated with the activities of the majority owner, an affiliate of Duke Energy. Results at UBE continue to be hampered by high natural gas prices that drive down both margins and sales volumes at BE. Although natural gas prices have remained at elevated levels in recent years, DOE Annual Energy Outlook projections show improving conditions in the future. Based on these projections no conditions were noted to give rise to an impairment with respect to the current $82.1 million carrying value of the investment in BE. UBE will continue to monitor its investment in BE for recoverability, as changes in the assumptions noted could have a negative impact on the carrying value of the investment in the future. Although routine maintenance is performed on the plant on a regular basis, from time to time the plant must be brought offline for a major overhaul. The 2003 results did not include any significant major overhaul expenses. The next major overhaul is planned for 2005. Under the current contract, the plant has begun incurring some of these costs, and they are being accrued until the outage occurs. BE has sufficient cash to fund these costs in 2004, however, based on the current 2004 earnings estimate, BE will require additional capital calls from the owners to cover the additional costs in 2005 when the outage occurs. Based on current projections, UBE's additional capital call could be as great as $7 million. The ICAP market is designed to offer an incentive to developers to build adequate generating capacity. BE receives ICAP revenues based on the plant's installed capacity. The plant began initial operation with a multi-year contract for ICAP. Since the contract ended in 2002, BE has only been able to sell its ICAP in the forward month market at a much lower price, reducing ICAP revenues by approximately 75% to 85%. FERC has directed ISO-NE to develop a Locational Installed Capacity Market, with the intent to provide higher capacity payments to generators within designated congestion areas; this is scheduled to enter the market in June 2004. The full impact that Locational ICAP will have is not known at this time, although it is expected to have a positive effect on BE. Through the end of 2003, any capital requirements, including amounts which were invested in BE, that exceeded UBE's available cash were provided by UIL Holdings in the form of capital contributions and intercompany loans. Any amounts loaned to UBE by UIL Holdings were interest bearing. Due to the relatively low amounts of cash available at UBE to pay interest, the intercompany loans have been restructured to 100% equity in 2004. The majority owner of BE, an affiliate of Duke Energy, has a 60% interest in Duke Energy Trading and Marketing (DETM) which is a joint venture with Exxon Mobil Corporation. BE has an agreement through August 2018 with DETM that gives DETM the right to deliver natural gas to the facility and market all the electricity generated by the facility. DETM reimburses BE under a formula based on the difference between gas costs and electric prices. In early January 2004, Duke Energy announced it plans to wind down DETM as part of a plan to restructure its merchant energy business. UBE does not anticipate these plans to have a negative impact on the operations of BE at this time. - 31 - CAPITAL EXPENDITURE PROGRAM UIL Holdings' 2004-2008 estimated capital expenditure program is budgeted as follows:
2004 2005 2006 2007 2008 TOTAL ---- ---- ---- ---- ---- ----- (In Millions) UI Distribution $25.7 $18.9 $26.8 $26.3 $30.7 $128.4 Transmission 4.9 7.7 5.4 3.0 7.4 28.4 Southwest Connecticut Reliability Project (1) 8.9 31.9 40.2 27.6 - 108.6 Information Technology 9.7 3.0 1.2 6.9 3.1 23.9 Real Estate (2) 19.8 5.0 - 2.2 14.8 41.8 Other 3.7 1.9 5.5 3.3 1.7 16.1 ---------- ---------- ---------- ---------- --------- ---------- Total UI 72.7 68.4 79.1 69.3 57.7 347.2 Non-Utility Xcelecom Capital Expenditures 2.2 2.3 2.4 2.5 2.5 11.9 Earn-Out Payments (3) 1.4 3.8 1.3 2.3 - 8.8 Promissory Note Payments (4) 3.3 3.3 - 0.2 - 6.8 Non-Compete Payments (5) 1.1 1.1 0.2 0.1 - 2.5 ---------- ---------- ---------- ---------- --------- ---------- Xcelecom Subtotal 8.0 10.5 3.9 5.1 2.5 30.0 UBE Capital Call - net (6) - 3.1 - - 1.2 4.3 UCI Other 0.8 0.2 - - - 1.0 ---------- ---------- ---------- ---------- --------- ---------- Subtotal Continuing Operations 81.5 82.2 83.0 74.4 61.4 382.5 Discontinued Operations Capital Expenditures (7) 2.1 - - - - 2.1 ---------- ---------- ---------- ---------- --------- ---------- Total UIL Holdings $83.6 $82.2 $83.0 $74.4 $61.4 $384.6 ========== ========== ========== ========== ========= ==========
(1) These amounts represent UI's current estimates based upon the proposed configuration of the transmission lines. There has been opposition to the planned configuration as proposed, particularly the overhead portions, and it has yet to be approved by the Connecticut Siting Council. If the project is approved in a form different than proposed, these estimates will change accordingly. (2) In January 2004, UI exercised the $16 million purchase option in connection with its capital lease for the Electric System Work Center property located in Shelton, Connecticut. UI is considering the replacement of this property in 2008, but the potential sale of the existing property is not included in the above amounts. (3) Xcelecom's earn-out payments are payable to the former owners of certain acquired companies and are contingent on various future financial results of each company. The actual payments may vary widely from these estimated amounts. (4) Xcelecom's promissory note payments are amounts payable to the former owners of certain acquired companies. Several of the promissory notes have indemnification provisions that may cause the principal balance to change. (5) Xcelecom's non-compete payments are amounts payable to the former owners of certain acquired companies. (6) The net capital calls at UBE are payable in the years when the plant is scheduled for major overhaul work. (7) Represents required capital expenditures of APS, primarily computer related equipment, through the first half of 2004. The APS sale transaction is expected to close by the end of the second quarter of 2004, at which time any future capital expenditure obligations would transfer to the new owner. - 32 - LIQUIDITY AND CAPITAL RESOURCES UIL Holdings' capital requirements are presently projected as follows:
2004 2005 2006 2007 2008 ---- ---- ---- ---- ---- (In Millions) Unrestricted Cash and Temporary Cash Investments on Hand-Beginning of Year (1) $35.3 $9.0 $ - $ - $ - Short Term Debt - Beginning of Year (2) 64.5 - 17.4 48.9 76.5 Funds from Operations before Dividends (3) UI 96.3 75.9 97.9 90.6 96.8 Xcelecom 2.8 6.4 3.9 6.4 3.4 Minority Interest Investment & Other 1.2 0.5 1.0 1.1 0.3 UIL Corporate (unallocated) (3.8) (5.4) (5.6) (5.5) (5.6) --------- -------- -------- --------- --------- Subtotal from Operating 96.5 77.4 97.2 92.6 94.9 Discontinued Operations (2.5) - - - - -------- -------- --------- --------- --------- Total Funds from Operations before Dividends 94.0 77.4 97.2 92.6 94.9 --------- -------- -------- --------- --------- Less: Capital Expenditures and Investing Activities (3) UI 72.7 68.4 79.1 69.3 57.7 Xcelecom 8.0 10.5 3.9 5.1 2.5 Minority Interest Investment & Other - - - - - UIL Corporate (unallocated) 0.8 3.3 - - 1.2 --------- -------- -------- --------- --------- Subtotal from Operating 81.5 82.2 83.0 74.4 61.4 Discontinued Operations 2.1 - - - - --------- -------- -------- --------- --------- Total Capital Expenditures 83.6 82.2 83.0 74.4 61.4 Proceeds from Cross-Sound Cable Project Loan - (24.0) - - - --------- -------- --------- --------- ------- Total Capital Expenditures and Investing Activities 83.6 58.2 83.0 74.4 61.4 --------- -------- -------- --------- --------- Plus: Intercompany Dividends UI (4) (41.3) (41.3) (41.4) (41.5) (41.6) UCI (1.1) (0.6) (0.7) (0.7) (0.1) UIL Corporate (unallocated) 42.4 41.9 42.1 42.2 42.2 --------- -------- -------- --------- --------- Total Intercompany Dividends - - - - 0.5 Less Common Dividends to Shareowners 41.3 41.3 41.4 41.5 41.6 Plus Net Cash (after-tax) from APS Sale and Telephony Assets Sale 69.1 - - - - --------- -------- -------- --------- --------- Cash Available (Required) to pay Debt Maturities and Redemptions 73.5 (13.1) (27.2) (23.3) (7.6) Less: Maturities and Mandatory Redemptions - UIL - 4.3 4.3 4.3 4.3 Maturities and Mandatory Redemptions - UI - - - 74.0 100.0 --------- -------- -------- --------- --------- External Financing Requirements (Surplus) (3) (73.5) 17.4 31.5 101.6 111.9 --------- -------- -------- --------- --------- Plus: Issuance of Long-term Debt - - - 74.0 100.0 --------- -------- -------- --------- --------- Increase (Decrease) in Short-Term Borrowings (73.5) 17.4 31.5 27.6 11.9 --------- -------- -------- --------- --------- Short Term Borrowings/(Temp Cash Investments) UI End of Year (5) (15.6) 17.9 40.5 59.9 62.3 UIL Corporate and Other End of Year (2) 6.6 (0.5) 8.4 16.6 26.1 --------- -------- -------- --------- --------- Total End of Year Balance ($9.0) $17.4 $48.9 $76.5 $88.4 ========= ======== ======== ========= =========
(1) Excludes restricted cash in UI of $1.1 million, Xcelecom of $0.3 million and APS (Discontinued Operations) of $25.4 million. The Unrestricted Cash and Temporary Cash Investments on Hand at the beginning of 2004 include $0.1 million at UIL Corporate, $24.5 at UI, $6.7 million at APS and $4.0 million at Xcelecom. - 33 - (2) The short-term borrowing balance at December 31, 2003 was $64.5 million, all of it borrowings by UIL Corporate. (3) "Funds from Operations before Dividends", "Capital Expenditures and Investing Activities" and "External Financing Requirements (Surplus)" are estimates based on current earnings, dividend levels and cash flow projections. All of these estimates are subject to continual review by the UIL Holdings' Board of Directors and change due to future events and conditions that may be substantially different from those used in developing the projections. (4) The ability of UI to maintain the shareholder level of dividends to UIL Holdings, while maintaining its service and reliability levels to its customers, depends on UI's free cash flow (cash flow from operation activities less capital expenditures), and, to some extent, UI's net income level. If UI continues to pay dividends to UIL Holdings that are in excess of UI's net income, then UI's equity capitalization ratio, ultimately used to determine the equity portion of UI's regulated rate base and, therefore, UI's regulated earnings for common stock, will continue to decline. Under that circumstance, UI can avoid a decrease in its equity ratio only if it generates enough cash to pay the dividend and to reduce long term debt by a proportionate amount. The ability of UI to achieve such results cannot be assured. See the "Major Influences on Financial Condition" section for more information. (5) UI will issue short term debt to finance a portion of its SWCT Reliability project. During the construction period, UI would earn AFUDC on the construction work-in-process balance for this project. When the project is completed and placed in service, currently anticipated in 2008, UI would likely procure permanent financing for the asset. In 2005 and beyond, UI is currently expected to continue to pay dividends to UIL Holdings in the amount necessary for UIL Holdings to pay a dividend to shareholders, approximately $41-$42 million ($2.88 per share). This amount is not as much as the $80 million and $51 million UI provided in 2002 and 2003, respectively. In those years, UI was generating more cash than it needed, primarily through the CTA, and UI was able to dividend extra amounts to UIL Holdings while maintaining an appropriate equity capitalization ratio because UI eliminated approximately $128 million of long-term debt through the termination of the Seabrook Sale/Leaseback agreement at the time of the sale of the plant. Primarily due to UI's projected capital expenditure program, particularly for transmission projects, UI may have to borrow additional funds in 2005 and beyond. Also, the currently expected future dividend amounts from UI to UIL Holdings, at the rate of UIL Holdings' external dividend payments, could be in excess of UI's expected earnings for those years. This could reduce UI's equity capitalization ratio from the current 47%. These factors could impact UI's ability to continue providing, through dividends from earnings to UIL Holdings, the amount of UIL Holdings' dividends to shareholders. Additionally, UIL Corporate will continue to be entirely dependent on dividends from its subsidiaries and from external borrowings to provide the cash necessary for debt service, to pay administrative costs, to meet other contractual obligations that cannot be met by the non-utility subsidiaries, and to pay common dividends to UIL Holdings' shareholders. The amount of UIL Holdings' cash dividends in 2005 and beyond is expected to be equal to the current dividend of $2.88 per share, with the number of shares growing slightly, through the issuance of ESOP shares, from the 14.3 million shares outstanding at year-end 2003. Maintenance of the dividend beyond 2004, both from a payout ratio perspective and from a cash flow perspective, will be dependent on the ability of UI and/or UIL Holdings' non-utility businesses to generate cash and pay dividends to UIL Holdings at an appropriate level, and to improve earnings to a level above the dividend, as well as UIL Holdings' ability to borrow for capital needs. UIL Holdings' current strategy for Xcelecom and its minority interest investments calls for those entities to be largely cash self-sufficient going forward. However, the ability of these entities, particularly the minority interest investments, to improve earnings, cash flow, and their ability to dividend cash to UIL Holdings without causing harm to their own operations or financial conditions cannot be assured. See the "Major Influences on Financial Condition" section of this item for more information. UIL Holdings and its subsidiaries will continue their efforts to improve the earnings and cash flow position of UIL Holdings, to strengthen its financial position, and improve its dividend to earnings payout ratio to a more robust level. - 34 - All capital requirements that exceed available cash will have to be provided by external financing. Although there is no commitment to provide such financing from any source of funds, other than a $100 million revolving credit agreement that UIL Holdings has with a group of banks, and a $25 million revolving credit agreement that Xcelecom has with two banks, future external financing needs are expected to be satisfied by the issuance of additional short-term and long-term debt. The continued availability of these methods of financing will be dependent on many factors, including conditions in the securities markets, economic conditions, and future income and cash flow. See Item 8, "Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - Note (B), Capitalization and Note (D), Short-Term Credit Arrangements" for a discussion of UIL Holdings' credit arrangements. At December 31, 2003, UIL Holdings had $28.6 million of unrestricted cash and temporary cash investments, excluding $6.7 million of cash held by APS which has been categorized as current assets of discontinued operations held for sale in the accompanying Consolidated Balance Sheet. This represents an increase of $9.7 million from the corresponding balance at December 31, 2002. The components of this increase, which are detailed in the Consolidated Statement of Cash Flows, are summarized as follows: (In Millions) Balance, December 31, 2002 $18.9 -------------- Net cash provided by operating activities of continuing operations 88.5 Net cash provided by (used in) investing activities of continuing operations: - - Loan to Cross-Sound Cable Project (24.0) - - Cash invested in plant (52.3) - - Proceeds from sale of pollution control refunding revenue bonds 25.0 - - Changes in restricted cash (1) 4.6 - - Deferred payments in prior acquisitions (2.8) -------------- (49.5) -------------- Net cash provided by (used in) financing activities of continuing operations: - - Financing activities, excluding dividend payments 12.0 - - Dividend payments (41.1) -------------- (29.1) Net cash provided by (used in) discontinued operations: - - Net cash provided by discontinued operations 4.8 - - Change in unrestricted cash balance of discontinued operations (5.0) -------------- (0.2) Net Change in Cash 9.7 -------------- Balance, December 31, 2003 $28.6 ============== (1) As of December 31, 2003, UIL Holdings had $1.4 million in restricted cash, representing $1.1 million held in escrow to cover operating expenses accrued at the time of the sale of Seabrook Station, and $0.3 million related to future debt payments of Xcelecom. XCELECOM The primary source of liquidity for Xcelecom has been, and is expected to continue to be, cash generated by operating activities. Xcelecom maintains a revolving credit facility that may be utilized, among other things, to meet short-term liquidity needs in the event cash generated by operating activities is insufficient. Xcelecom may also increase liquidity through additional - 35 - infusions of equity or inter-company debt from UIL Holdings. In general, Xcelecom is not expected to dividend funds to UIL Holdings. Short-term changes in macroeconomic trends may have an effect, positively or negatively, on liquidity. Short-term liquidity is also impacted by the type and length of construction contracts in place. During economic downturns, such as the 2001 through 2003 period, construction contracts trend away from short-cycle contracts toward larger long-term infrastructure and public sector contracts. Performance of long duration contracts typically require working capital until initial billing milestones are achieved. While Xcelecom strives to maintain a net over-billed position with its customers, there can be no assurance that a net over-billed position can be maintained. Xcelecom's net over-billings, defined as the balance sheet accounts billings in excess of costs and estimated earnings on uncompleted contracts less cost and estimated earnings in excess of billings on uncompleted contracts, was $7.0 million and $12.9 million as of December 31, 2003 and December 31, 2002, respectively. Xcelecom believes that current cash balances and borrowing capacity available under lines of credit, combined with cash expected to be generated from operations, will be sufficient to provide short-term and foreseeable long-term liquidity and meet expected capital expenditure requirements. However, Xcelecom's ability to generate positive cash flow at its historical levels in the future could be adversely impacted by numerous risks, including economic cycles, competition, cost overruns on fixed price projects, and reductions in collections. Such reductions in cash flow, together with the financial and other covenants in Xcelecom's credit facility agreements, could limit its ability to borrow additional funds. Additionally, failing to comply with those covenants could result in an event of default, which, if not cured or waived, could have a material adverse affect on Xcelecom. Long-term liquidity requirements can be expected to be met through cash generated from operating activities, the revolving credit facility, and if necessary long term capitalization efforts of UIL Holdings. Over the long term, Xcelecom's primary revenue risk factor continues to be the level of demand for non-residential construction services, which is in turn influenced by macroeconomic trends including interest rates and governmental economic policy. In order to provide protection against negative demand cycles in private sector construction services, Xcelecom has increased its participation, and its backlog of contracts, in the public sector, and continues efforts to expand its computer systems network integration business line and the service content of all business lines. Many customers require subcontractors to post performance and payment bonds issued by a surety. These bonds provide a guarantee to the customer that Xcelecom will perform under the terms of a contract and that it will pay subcontractors and vendors. If Xcelecom fails to perform under a contract or to pay subcontractors and vendors, the customer may demand that the surety make payments or provide services under the bond. Xcelecom must reimburse the surety for any expenses or outlays it incurs. Xcelecom has maintained a relationship with the same surety since inception in 1999. To date, Xcelecom has not had any situation in which its surety has been required to incur expenses on Xcelecom's behalf. As of December 31, 2003, the expected cost to complete projects covered by surety bonds was approximately $67.2 million. Some of the underwriters of our casualty insurance programs require Xcelecom to post letters of credit as collateral. This is common in the insurance industry. To date, Xcelecom has not had a situation where an underwriter has had reasonable cause to effect payment under a letter of credit. At December 31, 2003, letters of credit in place to collateralize insurance programs amounted to $4.6 million. FINANCIAL COVENANTS UIL Holdings and its subsidiaries are required to comply with certain covenants in connection with their respective loan agreements. The covenants are normal and customary in bank and loan agreements. The covenants below describe only the financial covenants in the agreements. - 36 - UIL HOLDINGS Under the Note Purchase Agreement in connection with the 7.23% Senior Notes, Series A, due February 15, 2011, in the principal amount of $30 million, and 7.38% Senior Notes, Series B, due February 15, 2011, in the principal amount of $45 million, issued by UIL Holdings, UIL Holdings is required to (i) maintain a ratio of consolidated debt to consolidated capital of not greater than 65% (debt ratio); (ii) maintain a ratio of consolidated earnings available for interest charges to consolidated interest charges for any period of four consecutive fiscal quarters of at least 2.00 to 1.00 (interest coverage ratio); and (iii) maintain consolidated net worth of at least $345 million plus 25% of consolidated net income on a cumulative basis for each fiscal quarter for which consolidated net income is positive. At December 31, 2003, UIL Holdings' debt ratio was 55%; its interest coverage ratio was 2.72 to 1.00; and it had consolidated net worth in excess of the requirement in the amount of $116.1 million. Under the terms of the Note Purchase Agreement, an event of default shall occur if UIL Holdings, UI, APS, Xcelecom, or the direct parent of the non-utility subsidiaries defaults on indebtedness in the aggregate principal amount of at least $10 million due to (i) a default in payment or payments due on the indebtedness, or (ii) default in the performance of or compliance with any term or condition of the indebtedness, which could result in the requirement that such indebtedness be repaid, or (iii) the occurrence of any event or condition that could require the purchase or repayment of the indebtedness prior to maturity. The revolving credit agreement described in Part II, Item 8, "Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - Note (D), Short-Term Credit Arrangements," requires that UIL Holdings (i) maintain a ratio of consolidated debt to consolidated capital, as of the last day of each March, June, September and December, of not greater than 0.65 to 1.00; and (ii) shall not cause the debt of UIL Holdings (excluding debt of its subsidiaries) to exceed $200 million in the aggregate principal amount outstanding at any time. At December 31, 2003, UIL Holdings' consolidated debt to consolidated capital ratio was 0.55 to 1.00; and its aggregate principal debt outstanding (excluding debt of its subsidiaries) was $152.8 million (including an inter-company loan from UI to UIL Holdings). Under the terms of the Revolving Credit Agreement, an event of default shall occur if UIL Holdings, UI or the direct parent of the non-utility subsidiaries defaults on indebtedness in the aggregate principal amount of at least $10 million due to (i) a default in payment or payments due on the indebtedness, or (ii) default in the performance of or compliance with any term or condition of the indebtedness, which could result in the requirement that such indebtedness be repaid, or (iii) the occurrence of any event or condition that could require the purchase or repayment of the indebtedness prior to maturity. There are no dividend restrictions or ratings triggers in connection with the above agreements. UI Under the Note Purchase Agreement in connection with the 4.42% Senior Notes, Series A, due December 12, 2007, in the principal amount of $74 million, and 4.89% Senior Notes, Series B, due December 12, 2009, in the principal amount of $51 million, and the Note Purchase Agreement in connection with the 3.95% Senior Notes, due December 9, 2008, in the principal amount of $100 million, UI is required to (i) maintain a ratio of consolidated debt to consolidated capital of not greater than 65% (debt ratio); and (ii) maintain a ratio of consolidated earnings available for interest charges to consolidated interest charges for any period of four consecutive fiscal quarters of at least 2.00 to 1.00 (interest coverage ratio). As of December 31, 2003, UI's debt ratio was 54%; and its interest coverage ratio was 4.36 to 1.00. Under the terms of the Note Purchase Agreement, an event of default shall occur if UI defaults on indebtedness in the aggregate principal amount of at least $10 million due to (i) a default in payment or payments due on the indebtedness, or (ii) default in the performance of or compliance with any term or condition of the indebtedness, which could result in the requirement that such indebtedness be repaid, or (iii) the occurrence of any event or condition that could require the purchase or repayment of the indebtedness prior to maturity. There are no ratings triggers in connection with the above agreements. - 37 - XCELECOM The revolving credit agreement Xcelecom has described in Part II, Item 8, "Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - Note (D), Short-Term Credit Arrangements," was renegotiated to amend certain financial covenant requirements for the quarters ending December 31, 2003, March 31, 2004, and June 30, 2004, respectively. The new covenants require that Xcelecom maintain the following financial coverage ratios: (1) the ratio of consolidated earnings before interest, taxes, depreciation and amortization (EBITDA) to consolidated fixed charges (fixed charge coverage ratio) of at least 3.00 to 1.00; (2) the ratio of consolidated liabilities to consolidated net worth (liabilities to net worth ratio) of 1.00 to 1.00 or less; (3) the ratio of consolidated debt, including inter-company debt, to consolidated EBITDA (leverage ratio) of 3.00 to 1.00 or less; and (4) the ratio of consolidated debt to consolidated EBITDA (senior leverage ratio) of 1.75 to 1.00 or less. At December 31, 2003, Xcelecom's fixed charge coverage ratio was 3.30 to 1.00; liabilities to net worth ratio was 0.32 to 1.00; leverage ratio was 2.10 to 1.00; and senior leverage ratio was 1.16 to 1.00. All borrowings outstanding under this agreement are secured solely by assets of Xcelecom and its subsidiaries. There are no ratings triggers in connection with the above agreement. DISCONTINUED OPERATIONS APS had a revolving credit agreement that expired on April 11, 2003, at which time APS repaid all borrowings outstanding under the agreement. The funds for the repayment were provided by UIL Holdings. All short-term capital requirements that exceed available cash from operations are currently provided by UIL Holdings, under a short-term loan arrangement. Any outstanding balance under this short-term loan arrangement will be paid to UIL Holdings in connection with the closing of the APS sale transaction. As of December 31, 2003, the outstanding balance under this arrangement was $3.5 million. - 38 - CONTRACTUAL AND CONTINGENT OBLIGATIONS The following are contractual and contingent obligations of UIL Holdings and its subsidiaries as of December 31, 2003.
(IN MILLIONS) 2004 2005 2006 2007 2008 THEREAFTER TOTAL ---- ---- ---- ---- ---- ---------- ----- Debt Maturities: UIL Holdings $ - $4.3 $4.3 $ 4.3 $ 4.3 $ 57.8 $ 75.0 UI - - - 74.0 100.0 246.5 420.5 -------- --------- -------- -------- -------- ------------- --------- Total $ - $4.3 $4.3 $78.3 $104.3 $304.3 $495.5 ======== ========= ======== ======== ======== ============= ========= Contractual Obligations: UI Lease Payments (1) $25.4 $10.4 $10.5 $11.3 $11.4 $41.6 $110.6 Pension Contribution (2) 11.2 11.2 UCI Zero Stage 0.5 - - - - - 0.5 Ironbridge 0.3 0.2 - - - - 0.5 Xcelecom Earn-Out Payments (3) 1.4 3.8 1.3 2.3 - - 8.8 Promissory Note Payments (4) 3.3 3.3 - 0.2 - - 6.8 Non-Compete Payments (5) 1.1 1.1 0.2 0.1 - - 2.5 Notes Payable 1.0 0.8 0.5 0.3 0.3 0.7 3.6 Lease Payments 2.2 2.0 1.2 0.8 0.8 0.4 7.4 Discontinued Operations Lease Payments (6) 0.7 - - - - - 0.7 -------- --------- -------- -------- -------- ------------- --------- Total $47.1 $21.6 $13.7 $15.0 $12.5 $42.7 $152.6 ======== ========= ======== ======== ======== ============= =========
As of December 31, 2003 ----------------------- (In Millions) Guarantees: UI-Hydro-Quebec $3.8 UCI-Hydro-Quebec (7) $3.8 Letters of Credit: Xcelecom (8) $4.6 Cross-Sound (9) $0.3 (1) Includes purchase option payment of $16 million in 2004 in connection with the Electric System Work Center property. (2) The pension contribution for 2004 is estimated at $11.2 million depending on the allowed maximum contribution for tax purposes and fluctuations in the discount rate and return on plan assets. Contribution projections beyond 2004 are not provided due to the volatility of the factors mentioned. (3) Xcelecom's earn-out payments are payable to the former owners of certain acquired companies and are contingent on various future financial results of each company. The actual payments may vary from these estimated amounts. (4) Xcelecom's promissory note payments are amounts payable to the former owners of certain acquired companies. Several of the promissory notes have indemnification provisions that may cause the principal balance to change. (5) Xcelecom's non-compete payments are amounts payable to the former owners of certain acquired companies. (6) Reflects lease payments through the second quarter of 2004, as future lease obligations will not be retained by UIL Holdings subsequent to the closing of the APS sale transaction. (7) This amount represents UCI's and UIL Holdings' collective guarantee to Hydro-Quebec in support of Hydro-Quebec's guarantees to third parties in connection with the construction of the project. - 39 - (8) This amount represents Xcelecom's letters of credit that support certain insurance and acquisition related obligations, $2.0 million of which is recorded on the Consolidated Balance Sheet and included in Promissory Note Payments above, $1.4 million of which is included in the Consolidated Balance Sheet under the caption Accrued Liabilities, and $1.7 million of which supports contingent obligations for potential growth in insurance claim reserves for which Xcelecom is obligated and certain potential deferred performance based payments, included in the Earn-out Payments above, for one of Xcelecom's acquisitions. See Item 8, "Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - Note (D), Short-Term Credit Arrangements," which information is hereby incorporated by reference. (9) This amount represents UCI's participating share of Cross-Sound's letter of credit to regulatory agencies. In general, UI purchases all of the electric power it sells to customers from two fixed price (per KWH) sources, PSEG and Dominion. UI expects that these suppliers will be adequate to meet the requirements of its customers. The power to be purchased from 2004 to 2008 is estimated to cost approximately $1.1 billion. UI will be obligated to pay only for power actually delivered by its suppliers. UI recovers prudently incurred purchase power costs pursuant to rate provisions approved by the DPUC. UI does not foresee any material risks from the terms of the contract and rate structure to recover costs. Refer to Part I, Item 1, "Business - Power Supply Arrangements," for further information. CRITICAL ACCOUNTING POLICIES The discussion of Results of Operations and financial condition relies on UIL Holdings' Consolidated Financial Statements that are prepared based on certain critical accounting policies that require management to make judgments and estimates that are subject to varying degrees of uncertainty. UIL Holdings believes that investors need to be aware of these policies and how they impact UIL Holdings' financial reporting to gain a more complete understanding of UIL Holdings' Consolidated Financial Statements as a whole, as well as management's related discussion and analysis presented herein. While UIL Holdings believes that these accounting policies are grounded on sound measurement criteria, actual future events can and often do result in outcomes that can be materially different from these estimates or forecasts. ACCOUNTING FOR REGULATED PUBLIC UTILITIES - SFAS NO. 71 Generally accepted accounting principles for regulated entities in the United States of America allow UI to give accounting recognition to the actions of regulatory authorities in accordance with the provisions of Statement of Financial Accounting Standards (SFAS) No. 71, "Accounting for the Effects of Certain Types of Regulation." In accordance with SFAS No. 71, UI has deferred recognition of costs (a regulatory asset) or has recognized obligations (a regulatory liability) if it is probable that such costs will be recovered or obligations relieved in the future through the ratemaking process. In addition to the Regulatory Assets and Liabilities separately identified on the Consolidated Balance Sheet, there are other regulatory assets and liabilities such as certain deferred tax assets and liabilities. UI also has obligations under long-term power contracts, the recovery of which is subject to regulation. If UI, or a portion of its assets or operations, were to cease meeting the criteria for application of these accounting rules, accounting standards for businesses in general would become applicable and immediate recognition of any previously deferred costs, or a portion of deferred costs, would be required in the year in which the criteria are no longer met, if such deferred costs are not recoverable in the portion of the business that continues to meet the criteria for application of SFAS No. 71. ACCOUNTING FOR PENSIONS AND OTHER POSTRETIREMENT BENEFITS UIL Holdings accounts for its pension and postretirement benefit plans in accordance with SFAS No. 87, "Employers' Accounting for Pensions" and SFAS No. 106, "Employers' Accounting for Postretirement Benefits other than Pensions." In applying these accounting practices, assumptions are made regarding the valuation of benefit obligations and the performance of plan assets. Delayed recognition of differences between actual results and those assumed allows for a smoothed recognition of changes in benefit obligations and plan performance over the working lives of the employees who benefit under the plans. The primary assumptions are as follows: - 40 - o Discount rate - this rate is used to determine the current value of future benefits. This rate is adjusted based on movement of long-term interest rates. o Expected return on plan assets - the expected return is based upon a combination of historical performance and anticipated future returns for a portfolio reflecting the mix of equity, debt and other investments included in plan assets. o Average wage increase - projected annual pay increases, which are used to determine the wage base used to project employees' pension benefits at retirement. o Health care cost trend rate - projections of expected increases in health care costs. These assumptions are the responsibility of management, in consultation with its outside actuarial and investment advisors. A variance in the discount rate, expected return on assets or average wage increase could have a significant impact on pension costs, assets and obligations recorded under SFAS No. 87. A variance in the health care cost trend assumption could have a significant impact on postretirement medical expense recorded under SFAS 106. As of December 31, 2003, UIL Holdings changed its discount rate from 6.75% to 6.00% to reflect the reduction in the rate of return for long-term fixed-income securities, which serves as the basis for this assumption. UIL Holdings plans to monitor the expected return on plan assets of 8.0% for 2004, based on projections of future expected performance developed in conjunction with UIL Holdings actuaries and investment advisors. There is a significant possibility that the assumptions listed above will be revised over time as economic and market conditions change. Changes in those assumptions could have a material impact on pension and postretirement expenses. For example, if there is a plus or minus 1/4% change in the discount rate assumed at 6%, the pension expense would change by minus or plus $0.8 million, respectively. If there were a 1% change in the expected return on assets, the pension expense would change by plus or minus $2.5 million. The projected, long-term average wage increase is being maintained at 4.5% in 2004. Due to increases in projected health care costs, UIL Holdings increased its health care cost trend rate to 13%, declining by 1.0% annually to a steady-state growth rate of 5.0%. For 2002, the health care cost trend rate assumption was a 7% growth rate, declining by 0.5% annually to a long-term rate of 4.5%. UIL Holdings' 2003 pension and postretirement benefits expenses were $17.5 million and $5.2 million, respectively. The assumptions are used to predict the net periodic expense on a look-forward basis. To the extent actual investment earnings, actual wage increases and other items differ from the assumptions, a gain or loss is created, and subsequently amortized into expense. GOODWILL AND OTHER INTANGIBLE ASSETS Effective January 1, 2002, UIL Holdings adopted SFAS No. 142, "Goodwill and Other Intangible Assets." This statement modified the accounting and reporting of goodwill and intangible assets. Under this new standard, UIL Holdings is no longer amortizing its existing goodwill. In addition, UIL Holdings is required to measure goodwill for impairment annually or more frequently if circumstances indicate possible impairment. SFAS No. 142 requires goodwill to be allocated to reporting units (Xcelecom and APS) and measured for impairment under a two-step test at least annually unless another event triggers an earlier assessment. Goodwill attributable to each of UIL Holdings' reporting units was tested for impairment by comparing the fair value of each reporting unit with its carrying value. Fair value was determined by applying discounted cash flows to revenue and profit forecasts and comparing those estimated fair values with carrying values which includes the allocated goodwill. If the estimated fair value is less than the carrying value, a second step is performed to compute the amount of impairment by determining an "implied fair value" of goodwill. Implied fair value is determined by allocating the - 41 - assets and liabilities with anything left unallocated being goodwill. As of December 31, 2003, such testing indicated that there was no impairment related to the Xcelecom reporting unit. A 1% change in the discount rate impacts the implied fair value of goodwill at December 31, 2003 for Xcelecom by approximately $2 million. This level of change in valuation would not trigger an impairment charge. Significant estimates used in the methodologies include estimates of future cash flows, future short-term and long-term growth rates, weighted average cost of capital and estimates of market multiples for each of the reportable units. UIL Holdings subjected the testing analysis to a broad range of possible outcomes and scenarios, and in each case the determinations noted above were confirmed. A goodwill impairment charge of $7.2 million was recorded during the fourth quarter of 2003 to bring the carrying value of goodwill associated with APS' telephony assets in line with estimated fair value. This charge is included in the results of discontinued operations in the accompanying consolidated statement of income. Under SFAS No. 142, entities are also required to determine the useful life of other intangible assets and amortize the value over the useful life. Such intangible assets are required to be tested for impairment in a manner similar to goodwill. In accordance with SFAS No. 142, UIL Holdings has determined the useful life of other intangible assets and is amortizing the value over the useful life. In 2003, other intangible assets were tested and no impairment was found. UNBILLED REVENUE At the end of each accounting period, UI accrues an estimated amount for services rendered but not billed. The calculation is primarily based upon UI's system requirements or kilowatt-hour usage less distribution losses and company use for a given period, reduced by kilowatt-hours already billed to customers. Certain factors are taken into account in the calculation of unbilled revenue, any of which can have a significant impact, such as changes in or problems with metering, the number of days in a billing cycle, seasonality, price changes and billing adjustments. ACCOUNTING FOR RECEIVABLES DUE FROM APS' AGENTS Given the substantial amounts of cash transferred in APS' bill payment business, agent losses is a significant risk. While APS maintains controls to monitor and manage the risk of agent losses, the possibility of such losses exists. Insurance coverage for such risks is prohibitively expensive or unavailable. Therefore, APS self-insures this risk. A loss reserve equal to the estimate of expected annual loss due to agent losses is developed based on past history and APS management's expectation of future results. Receivables due from APS' agents are included in the assets of discontinued operations held for sale. PERCENT-OF-COMPLETION ACCOUNTING Xcelecom believes its most critical accounting policy is revenue recognition from long-term contracts for which Xcelecom uses the percentage-of-completion method of accounting. Percentage-of-completion accounting is one of the prescribed methods of accounting for long-term contracts in accordance with accounting principles generally accepted in the United States of America and, accordingly, the primary method used for revenue recognition within Xcelecom's industry. Percentage-of-completion is measured principally by the percentage of costs incurred to date for each contract to the estimated total costs for each contract at completion. Provisions for estimated losses on uncompleted contracts are made in the period in which such losses become known. Application of percentage-of-completion accounting results in the recognition of costs and estimated earnings in excess of billings on uncompleted contracts within the balance sheet. Costs and estimated earnings in excess of billings on uncompleted contracts reflected on the balance sheet arise when revenues have been recognized but the amounts cannot be billed under the terms of the contracts. Such amounts are recoverable from customers based on various measures of performance, including achievement of certain milestones, completion of specified units, or completion of the contract. Due to uncertainties inherent within estimates employed to apply percentage-of-completion accounting, it is possible that estimates will be revised as project work progresses. Application - 42 - of percentage-of-completion accounting requires that the impact of those revised estimates be reported in the financial statements prospectively. Xcelecom completes most projects within one year. Service and maintenance work is frequently provided under agreements which are renewable annually. Revenues are recognized on service and time and material work when services are performed. Work performed under a construction contract generally provides that the customers accept completion of progress to date and provide compensation for services rendered measured in terms of units installed, hours expended or some other measure of progress. Revenues from construction contracts are recognized on the percentage-of-completion method as described above. In general contracts are considered to be substantially complete upon departure from the work site and acceptance by the customer. Contract costs include all direct material and labor costs and those indirect costs related to specific contract performance, such as indirect labor, supplies, and tools. Changes in job performance, job conditions, estimated contract costs and profitability and final contract settlements may result in revisions to costs and income and the effects of these revisions are recognized in the period in which the revisions are determined. Provisions for total estimated losses on uncompleted contracts are made in the period in which such losses are determined. IMPAIRMENT OF LONG-LIVED ASSETS Based on the significant amount of assets recorded for both the utility and non-utility businesses, monitoring of these assets for impairment losses is critical. SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," requires the recognition of impairment losses on long-lived assets when the book value of an asset exceeds the sum of the expected future undiscounted cash flows that result from the use of the asset and its eventual disposition. This standard also requires that rate-regulated companies recognize an impairment loss when a regulator excludes all or part of a cost from rates, even if the regulator allows the company to earn a return on the remaining costs allowed. Under this standard, the probability of recovery and the recognition of regulatory assets under the criteria of SFAS No. 71 must be assessed on an ongoing basis. As described in "Accounting for Regulated Public Utilities - SFAS No. 71" earlier in this section, determination that certain regulatory assets no longer qualify for accounting as such could have a material impact on both UI's and UIL Holdings' financial condition. At December 31, 2003 and December 31, 2002, UI did not have any assets that were impaired under this standard. With respect to long-lived assets of the non-utility businesses, certain assumptions must be made to project the future undiscounted cash flows resulting from the use and eventual disposition of such long-lived assets. Examples of such assumptions include the estimated useful life of the asset, projections of future revenues and costs associated with the asset, projections of certain market conditions, estimates of future commodity prices, and assumptions regarding the outcome of certain legislative and regulatory processes. Although management believes the assumptions made measuring the recoverability of assets were reasonable based on the most currently available data at the time, no guarantee can be made that actual results will equal estimates. Differences in the actual outcome of events, as compared to the assumptions made, could have a material effect on financial condition. The most significant long-lived assets of the non-utility businesses are UBE's $82.1 million investment in BE, and UCI's $33 million share of the Cross-Sound cable project. Both assets were reviewed for impairment as of December 31, 2003. With respect to UBE, based on natural gas and electricity forward price projections derived from the most recent DOE Annual Energy Outlook report, no conditions were noted to give rise to an impairment. UCI's share of the Cross-Sound cable project was evaluated for impairment under the assumption that all pending permit issues surrounding the cable would be resolved, thus allowing for commercial operation of the cable. Cross-Sound has a twenty year contract in place for the entire capacity of the cable once commercial operation is achieved, the expected cash flows from which are in excess of the carrying value of the asset. For further discussion regarding BE and Cross-Sound, refer to "Management's Discussion and Analysis of Financial Condition and Results of Operations - Major Influences". - 43 - RESULTS OF OPERATIONS UIL HOLDINGS CORPORATION RESULTS OF OPERATIONS: 2003 ACTUAL EARNINGS VS. - ------------------------------------------------------------------------- ORIGINAL ESTIMATE - ----------------- Net income for UIL Holdings was $23.3 million in 2003, or $1.63 per share. This was lower than the $2.45-$2.65 per share range originally estimated in UIL Holdings' Form 10-K for the year ended December 31, 2002. As indicated in revised earnings guidance projections throughout 2003, the primary reason for the decline from the original earnings estimate was performance related to UIL Holdings' non-utility businesses. Results at Xcelecom were lower than originally forecast due to a large project loss, executive severance costs and the effects of an economic downturn in Xcelecom's markets. One-time charges incurred by APS, primarily the revaluing of the telephony assets, was another major factor for the shortfall from the original earnings guidance. These declines were partially offset by slightly better than expected results at UI, as UI was able to mitigate the effects of increased pension and postretirement benefits costs due to the positive impact of weather and other short-term actions taken by UI. 2003 VS. 2002 - ------------- UIL HOLDINGS CORPORATION RESULTS OF OPERATIONS: 2003 VS. 2002 - -------------------------------------------------------------- UIL Holdings' earnings from continuing operations for 2003 decreased by $16.2 million, or $1.15 per share, compared to 2002. The net loss from discontinued operations increased by $4.4 million, or $0.31 per share, from the 2002 net loss of $1.8 million, or $0.13 per share. Total earnings for 2003, including discontinued operations, decreased by $20.6 million, or $1.46 per share. Several major factors contributed to the decline in earnings from continuing operations, including the absence of income from the nuclear division due to the sale of the Seabrook nuclear generating station (Seabrook) in November 2002, effects of the DPUC's 2002 Rate Case decision for UI, increased pension and postretirement benefits costs, and a slow economic recovery affecting the non-utility businesses. Results of discontinued operations were affected by an impairment charge of $4.9 million, after-tax, taken in the fourth quarter of 2003. This impairment charge was mainly a result of UIL Holdings' reassessment of the value of APS' telephony assets as a stand-alone operation after announcing the pending sale of APS, excluding the telephony assets. - 44 - The table below presents a comparison of UIL Holdings' Net Income and Earnings Per Share (EPS) for 2003 and 2002.
Twelve Months Twelve Months 2003 more (less) than 2002 Ended Ended -------------------------- Dec. 31, 2003 Dec. 31, 2002 Amount Percent ------------------ ------------------ ---------------- ------------ NET INCOME (IN MILLIONS EXCEPT PERCENTS) UI $38.7 $48.1 ($9.4) (20)% Nuclear Division - 5.8 (5.8) (100)% Non-Utility (9.2) (8.2) (1.0) (12)% -------- -------- ----- TOTAL NET INCOME FROM CONTINUING OPERATIONS $29.5 $45.7 $(16.2) (35)% Discontinued Operations (6.2) (1.8) (4.4) (244)% -------- -------- ----- TOTAL NET INCOME $23.3 $43.9 $20.6 (47)% EPS UI $2.71 $3.38 $(0.67) (20)% Nuclear Division - 0.41 (0.41) (100)% Non-Utility (0.64) (0.57) (0.07) (12)% ------ ------ ------ TOTAL EPS FROM CONTINUING OPERATIONS - BASIC $2.07 $3.22 $(1.15) (35)% Discontinued Operations (0.44) (0.13) (0.31) (238)% ------ ------ ------ TOTAL EPS - BASIC $1.63 $3.09 $(1.46) (47)% ==== ==== ====== TOTAL EPS - DILUTED (NOTE A) $1.63 $3.08 $(1.45) (47)% ==== ==== ======
Note A: Reflecting the effect of unexercised dilutive stock options. - 45 - The following table presents a line-by-line breakdown of revenue and expenses from UIL Holdings' Consolidated Statement of Income by subsidiary, including comparisons between 2003 and 2002. Significant variances are explained in the discussion and analysis of individual subsidiary results that follow.
YEAR ENDED DECEMBER 31, 2003 MORE (IN MILLIONS) 2003 2002 (LESS) THAN 2002 - ------------- ---- ---- ---------------- OPERATING REVENUE UI from operations, before sharing $669.6 $691.3 $(21.7) UI sharing from operations - (6.6) 6.6 Nuclear - 42.8 (42.8) Xcelecom 294.0 310.0 (16.0) Minority Interest Investment & Other 0.1 0.1 - ------------ ------------- ------------------- TOTAL OPERATING REVENUE $963.7 $1,037.6 $(73.9) ============ ============= =================== FUEL AND ENERGY EXPENSE UI $272.7 $263.1 $9.6 Nuclear - 6.1 (6.1) ------------ ------------- ------------------- TOTAL FUEL AND ENERGY EXPENSE $272.7 $269.2 $3.5 ============ ============= =================== OPERATION AND MAINTENANCE EXPENSE UI $185.5 $176.7 $8.8 Nuclear - 23.8 (23.8) Xcelecom 290.0 301.1 (11.1) Minority Interest Investment & Other 3.2 3.6 (0.4) ------------ ------------- ------------------- TOTAL OPERATION AND MAINTENANCE EXPENSE $478.7 $505.2 $(26.5) ============ ============= =================== DEPRECIATION AND AMORTIZATION UI $28.3 $27.4 $0.9 Nuclear - 1.2 (1.2) Xcelecom 3.5 3.2 0.3 Minority Interest Investment & Other 0.1 - 0.1 ------------ ------------- ------------------- Subtotal depreciation 31.9 31.8 0.1 Amortization of regulatory assets (UI) 49.2 59.5 (10.3) Amortization Xcelecom 1.2 1.3 (0.1) ------------ ------------- ------------------- TOTAL DEPRECIATION AND AMORTIZATION $82.3 $92.6 $(10.3) ============ ============= =================== TAXES - OTHER THAN INCOME TAXES UI - State gross earnings tax $25.8 $28.3 $(2.5) UI - other 13.5 15.8 (2.3) Nuclear - other - 0.4 (0.4) Xcelecom 1.8 1.5 0.3 ------------- ------------ -------------------- TOTAL TAXES - OTHER THAN INCOME TAXES $41.1 $46.0 $(4.9) ============= ============ ====================
- 46 -
YEAR ENDED DECEMBER 31, 2003 MORE (IN MILLIONS) 2003 2002 (LESS) THAN 2002 - ------------- ---- ---- ---------------- OTHER INCOME AND (DEDUCTIONS) UI $5.6 $3.7 $1.9 Xcelecom 0.5 0.7 (0.2) Minority Interest Investment & Other (2.8) (6.7) 3.9 ------------ ------------- ------------------ TOTAL OTHER INCOME AND (DEDUCTIONS) $3.3 ($2.3) $5.6 ============ ============= ================== EARNINGS BEFORE INTEREST AND TAXES (EBIT) UI $100.2 $117.6 $(17.4) Nuclear - 11.3 (11.3) Xcelecom (2.0) 3.6 (5.6) Minority Interest Investments & Other (6.0) (10.2) 4.2 ------------ ------------- ------------------- TOTAL EBIT FROM CONTINUING OPERATIONS $92.2 $122.3 $(30.1) ============ ============= =================== INTEREST CHARGES UI $20.7 $33.8 $(13.1) UI - Interest on Seabrook obligation bonds owned by UI - (5.1) 5.1 UI - Amortization: debt expense, redemption premiums 1.3 1.9 (0.6) Nuclear - 1.5 (1.5) Xcelecom 0.6 1.3 (0.7) Minority Interest Investment & Other 6.6 5.7 0.9 ------------ ------------- ------------------ TOTAL INTEREST CHARGES $29.2 $39.1 $(9.9) ============ ============= ================== INCOME TAXES UI $39.5 $38.9 $0.6 Nuclear - 4.0 (4.0) Xcelecom (0.9) 0.9 (1.8) Minority Interest Investment & Other (5.1) (6.3) 1.2 ------------ ------------- ------------------ TOTAL INCOME TAXES $33.5 $37.5 $(4.0) ============ ============= ================== NET INCOME UI $38.7 $48.1 $(9.4) Nuclear - 5.8 (5.8) Xcelecom (1.7) 1.4 (3.1) Minority Interest Investment & Other (7.5) (9.6) 2.1 ------------ ------------- ------------------ SUBTOTAL NET INCOME FROM CONTINUING OPERATIONS 29.5 45.7 (16.2) Discontinued Operations (6.2) (1.8) (4.4) ------------ ------------- ------------------ TOTAL NET INCOME $23.3 $43.9 $(20.6) ============ ============= ==================
- 47 - THE UNITED ILLUMINATING COMPANY RESULTS OF OPERATIONS: 2003 VS. 2002 - ---------------------------------------------------------------------
Twelve Months Twelve Months 2003 more (less) than 2002 Ended Ended -------------------------- Dec. 31, 2003 Dec. 31, 2002 Amount Percent ----------------- ------------------ ---------------- ------------ EPS FROM OPERATIONS UI before Nuclear Division and Sharing $2.71 $3.90 $(1.19) (31)% Sharing 0.00 (0.52) 0.52 100% ------ ---- ---- Subtotal UI excluding Nuclear 2.71 3.38 (0.67) (20)% Nuclear Division 0.00 0.41 (0.41) (100)% ---- ---- ------ Total UI EPS from operations - basic $2.71 $3.79 $(1.08) (29)% ===== ==== ====== Total UI EPS from operations - diluted (Note A) $2.71 $3.78 $(1.07) (28)% ===== ==== ====== RETAIL SALES (MILLIONS OF KWH) 5,763 5,781 (18) -
Note A: Reflecting the effect of unexercised dilutive stock options. UI EXCLUDING THE NUCLEAR DIVISION Excluding the Nuclear Division, UI's net income was $38.7 million, or $2.71 per share, in 2003, compared to $48.1 million, or $3.38 per share, in 2002. The 2002 earnings of $3.38 per share included an adjustment of $0.78 per share for earnings which were in excess of the allowed 11.50% return on equity. In accordance with the DPUC earnings sharing mechanism, the $0.78 per share was allocated, or "shared", equally between shareowners, customers, and to reduce stranded costs, resulting in a reduction of 2002 net income by $0.52 per share. On a pre-sharing basis, earnings per share decreased by $1.19 per share, primarily due to effects of the DPUC's 2002 Rate Case decision, which reduced authorized return on utility common stock equity by the DPUC from 11.50% to 10.45%, effective September 26, 2002, reduced overall rates by 3%, and increased stranded cost amortization. UI has also been affected by increased pension and postretirement benefit costs that have not to date been included for recovery in rates. The effect of these additional costs on earnings was mitigated by the positive impact of weather on revenues and by short-term actions taken by UI. See discussion included in Item 7, "Major Influences On Financial Condition - The United Illuminating Company," for further information regarding recovery of increased pension and postretirement benefit costs. - 48 - Overall, UI's total revenue decreased by $15.1 million, from $684.7 million in 2002 to $669.6 million in 2003. Details of this change in revenue are as follows: From In Millions Operations - -------------------------------------------------------------------------------- 2003 Revenues more (less) than 2002 Revenues - -------------------------------------------------------------------------------- REVENUE FROM DISTRIBUTION DIVISION: Estimate of operating Distribution Division component of "weather normalized" retail sales growth $(0.3) Estimate of operating Distribution Division component of weather effect on retail sales (20.2) Sharing (2002) 6.6 Impact of rate decrease, mix of sales on average price and other (2.8) ----- TOTAL RETAIL REVENUE FROM DISTRIBUTION DIVISION (16.7) RETAIL REVENUE FROM OTHER UTILITY DIVISIONS (8.5) ----- TOTAL UI RETAIL REVENUE (25.2) OTHER OPERATING REVENUE INCREASE (DECREASE) NEPOOL transmission revenues 0.7 Other 0.2 --- TOTAL UI OTHER OPERATING REVENUES 0.9 UI WHOLESALE REVENUE 9.2 ----- TOTAL UI REVENUES $(15.1) ====== Retail fuel and energy expense increased by $9.2 million in 2003, compared to 2002. UI received electricity to satisfy its standard offer retail customer service requirements through a fixed-price purchased power agreement. These costs are recovered through the GSC portion of UI's unbundled retail customer rates. UI's financial results are not materially affected by its customers' selection of alternate suppliers to provide generation service. UI's wholesale energy expense increased by $0.4 million, but these costs are recovered from customers through the CTA. UI's O&M expenses increased by $8.8 million, from $176.7 million in 2002 to $185.5 million in 2003. The increase was due primarily to increased pension and postretirement expenses of $13.0 million, offset by decreased environmental remediation costs of $3.2 million and a decrease in other expenses of $1.0 million. Amortization of regulatory assets decreased by $10.3 million in 2003 compared to 2002. The primary reasons for the reduction were due to the DPUC order in July 2003 requiring that the amortization of CTA rate base utilizing excess GSC revenues be discontinued until further determination and the absence of 2002 sharing amortization. Other taxes (excluding State gross earnings tax) decreased by $2.3 million, from $15.8 million in 2002 to $13.5 million in 2003. The decrease was due to lower property taxes in 2003 as a result of the sale of Seabrook Station in November 2002. Other income increased by $1.9 million in 2003, compared to 2002, primarily due to interest income due to a higher level of short-term investments throughout 2003. Interest charges decreased by $8.6 million, from $30.6 million in 2002 to $22 million in 2003. Overall, the decrease was due to the refinancing of certain UI debt issues and the termination of the Seabrook Lease Obligation Bonds in connection with the sale of UI's interest in Seabrook Station on November 1, 2002. - 49 - NUCLEAR DIVISION The remaining operation assets of the Nuclear Division (Seabrook Station) were sold on November 1, 2002. The Nuclear Division contributed net income of $5.8 million, or $0.41 per share, in 2002. NON-UTILITY BUSINESSES RESULTS OF OPERATIONS: 2003 VS. 2002 - ------------------------------------------------------------
Twelve Months Twelve Months 2003 more (less) than 2002 Ended Ended -------------------------- Dec. 31, 2003 Dec. 31,2002 Amount Percent ----------------- ---------------- ----------------- ----------- EPS Operating Business Xcelecom $(0.12) $0.10 $(0.22) (220)% Minority Interest Investments UBE (0.15) (0.07) (0.08) (114)% UCI (0.05) (0.31) 0.26 84% ---- ---- ---- Subtotal Minority Interest Investments (0.20) (0.38) 0.18 47% UIL Corporate (Note A) (0.32) (0.29) (0.03) (10)% ---- ---- ---- TOTAL NON-UTILITY EPS FROM CONTINUING OPERATIONS (0.64) (0.57) (0.07) (12)% Discontinued Operations (0.44) (0.13) (0.31) (238)% ------ ------ ---- TOTAL NON-UTILITY EPS - BASIC $(1.08) $(0.70) $(0.38) (54)% ====== ====== ==== TOTAL NON-UTILITY EPS - DILUTED (NOTE B) $(1.08) $(0.70) $(0.38) (54)% ====== ====== ====
Note A: Includes interest charges on intercompany debt and strategic and administrative costs of the non-utility holding company. Note B: Reflecting the effect of unexercised dilutive stock options. The consolidated non-utility businesses reported a loss from continuing operations, including unallocated holding company costs, of $9.2 million, or $0.64 per share, in 2003, an increased loss of $1.0 million, or $0.07 per share, compared to a loss of about $8.2 million, or $0.57 per share, in 2002. The slow economic recovery in the east coast region continued to have a negative impact on the results of Xcelecom, which was the primary driver for the decrease in earnings from continuing operations as compared to 2002. Results at UBE were hampered by the effects of high natural gas prices, and lower installed capability revenues. The decreases at Xcelecom and UBE were partially offset by lower losses from continuing operations at UCI for 2003, due to the absence of an impairment charge which affected 2002, and improved valuations of minority interest investments. Results from discontinued operations for 2003 amounted to a loss of $6.2 million, or $0.44 per share, compared to a loss of $1.8 million, or $0.13 per share in 2002. The increased loss from discontinued operations was mainly due to an impairment charge recognized in the fourth quarter of 2003 related to APS' telephony assets. Operating revenue for the non-utility businesses decreased by $16 million, or 5%. All of the decrease in revenues came from Xcelecom. Total operating expenses for the non-utility businesses decreased by $10.9 million, or 3%, due to the decrease in business at Xcelecom. Other deductions of $2.3 million in 2003 decreased from 2002 by $3.7 million, or 61%, due to lower valuation losses on minority interest investments and the absence of an impairment charge recognized in 2002. The results of each of the non-utility subsidiaries for 2003 and 2002, as presented below, reflect the allocation of debt costs from the parent based on a capital structure, including an equity component, and an interest rate deemed appropriate for that type of business. The targeted capital structures for each of the non-utility subsidiaries are: 100% equity for APS and UCI, 65% equity and - 50 - 35% debt for Xcelecom for all periods prior to the second quarter of 2002 and 100% equity beginning in the second quarter of 2002, and 30% equity and 70% debt for UBE through the end of 2003 and 100% equity beginning in 2004. UIL Holdings absorbs interest charges on the equity portion of its investments in its subsidiaries to the extent those investments are financed with debt. UIL Holdings may incur other corporate level expenses necessary to manage its investments from time to time. The following is a detailed explanation of the change in results between 2002 and 2003 for each of UIL Holdings' non-utility businesses. NON-UTILITY BUSINESSES XCELECOM, INC. Xcelecom lost $1.7 million, or $0.12 per share, in 2003, compared to earnings of $1.4 million, or $0.10 per share in 2002. A slow economic recovery in the east coast region has been the primary driver for the lower results in 2003. This has caused contract postponements and cancellations, increased competition for fewer jobs, and decreasing project margins. Executive severance costs also affected performance at Xcelecom in 2003 (by approximately $0.03 per share). Additionally, the completion of several large, profitable non-recurring contracts in 2002 that have not been replaced with comparable contracts in 2003 has contributed to the earnings decline. The negative earnings impact of these items was partly offset by improved performance in the systems integration division in 2003 compared to 2002. MINORITY INTEREST INVESTMENTS UNITED BRIDGEPORT ENERGY, INC. UBE owns a 33 1/3% interest in Bridgeport Energy, LLC (BE). UBE lost $2.2 million, or $0.15 per share in 2003, compared to losses of $1.0 million, or $0.07 per share in 2002. UBE results were hampered by high natural gas prices which kept both margins and sales levels low in 2003, resulting in a $0.06 per share decline in earnings from energy revenues as compared to 2002. Installed capability (ICAP) revenues reduced 2003 earnings by $0.21 per share compared to 2002. A non-recurring insurance benefit of $0.05 per share recognized in 2002 also contributed to the decline in earnings from the prior year. These decreases were partially offset by the absence of major overhaul expenses in 2003, which amounted to $0.25 per share in 2002. UNITED CAPITAL INVESTMENTS, INC. UCI lost $0.6 million, or $0.05 per share in 2003, compared to a loss of $4.4 million, or $0.31 per share in 2002. An impairment of UCI's investment in Gemini Networks, Inc., (Gemini) a broadband fiber-optic business, caused a one-time charge of $0.16 per share in 2002. The remaining improvement in earnings from 2002 of $0.15 per share was due to better performance of minority interest investments and reduced administrative costs. UCI recorded $0.1 million in income from the Cross-Sound Cable project in 2003 based on the terms of an interim operating agreement. The cable will achieve commercial operation when all pending permit issues are resolved. See PART II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," for further discussion regarding Cross-Sound. UIL CORPORATE UIL Holdings retains certain costs at the holding company level which are not allocated to the various non-utility subsidiaries. These costs generally include interest charges and strategic and other administrative costs. UIL Holdings' unallocated costs amounted to $4.7 million, after-tax, or $0.32 per share, in 2003, compared to $4.2 million, or $0.29 per share, in 2002. The increase in expenses was due to increased administrative costs in 2003. - 51 - DISCONTINUED OPERATIONS On December 16, 2003, UIL Holdings entered into an agreement to sell APS to CheckFree Corporation (CheckFree), a leading provider of financial electronic commerce services and products. Under the terms of the agreement, and pending receipt of regulatory approvals and satisfaction of customary closing conditions, CheckFree will pay approximately $110 million in cash for the outstanding stock of APS. The transaction is expected to close during the second quarter of 2004, with the resulting gain on the sale, net of transaction costs, to be recognized at that time. CheckFree will not acquire APS' telephony assets, which include APS' 51% ownership interest in CellCards of Illinois, LLC (CCI). Following execution of the agreement to sell APS, management determined that the telephony business is not part of UIL Holdings' overall strategic business focus, and therefore authorized the sale of APS' telephony assets. Accordingly, APS, inclusive of the telephony business, has been categorized as "held for sale" as of December 31, 2003 for financial accounting purposes, and as such, its results are included in discontinued operations for all periods presented. Net loss from discontinued operations amounted to $6.2 million, or $0.44 per share in 2003, compared to a net loss of $1.8 million, or $0.13 per share in 2002. The results of 2003 were affected by an after-tax impairment charge of $4.9 million, or $0.34 per share. This impairment charge was a result of UIL Holdings' reassessment of the value of APS' telephony assets as a stand-alone operation after announcing the pending sale of the remainder of APS. In addition to the impairment charge, transaction costs incurred in 2003 associated with the sale of APS amounted to $0.2 million, after-tax, or $0.01 per share. The results of 2003 were also affected by other non-recurring charges totaling $1.0 million, after-tax, or $0.07 per share. These charges were comprised of a write-down of equipment values, a liability associated with vacated leased property, and a loss on the sale of the investment in Bill Matrix. In accordance with SFAS No. 144, depreciation of assets classified as "held for sale" was ceased as of December 16, 2003. As such, 2003 depreciation and amortization expense was $0.1 million, after-tax, lower than it would have been if the assets of APS had been depreciated through the end of 2003. - 52 - 2002 VS. 2001 - ------------- UIL HOLDINGS CORPORATION RESULTS OF OPERATIONS: 2002 VS. 2001 - -------------------------------------------------------------- UIL Holdings' earnings from continuing operations for 2002 decreased by $13.9 million, or $1.00 per share, compared to 2001. The net loss from discontinued operations for 2002 was $1.8 million, or $0.13 per share, an increased loss of $1.6 million, or $0.12 per share, from 2001. The decrease in earnings from continuing operations was due to a $0.74 per share decrease in the non-utility businesses, a $0.03 per share decrease at UI, excluding the Nuclear Division, and a $0.23 per share decrease in Nuclear Division earnings. The table below presents a comparison of UIL Holdings' Net Income and Earnings Per Share (EPS) for 2002 and 2001.
Twelve Months Twelve Months 2002 more (less) than 2001 Ended Ended -------------------------- Dec. 31, 2002 Dec. 31, 2001 Amount Percent ------------------ ------------------ ---------------- ------------ NET INCOME (IN MILLIONS EXCEPT PERCENTS) UI $48.1 $48.0 $ 0.1 -- Nuclear Division 5.8 9.1 (3.3) (36)% Non-Utility (8.2) 2.5 (10.7) (428)% -------- ------ ------ TOTAL NET INCOME FROM CONTINUING OPERATIONS $45.7 $59.6 $(13.9) (23)% Discontinued Operations (1.8) (0.2) (1.6) (800)% -------- -------- ----- TOTAL NET INCOME $43.9 $59.4 $(15.5) (26)% EPS UI $3.38 $3.41 $(0.03) (1)% Nuclear Division 0.41 0.64 (0.23) (36)% Non-Utility (0.57) 0.17 (0.74) (435)% ------ ---- ------ TOTAL EPS FROM CONTINUING OPERATIONS - BASIC $3.22 $4.22 $(1.00) (24)% Discontinued Operations (0.13) (0.01) (0.12) (1,200)% ------ ------ ------ TOTAL EPS - BASIC $3.09 $4.21 $(1.12) (27)% ==== ==== ====== TOTAL EPS - DILUTED (NOTE A) $3.08 $4.19 $(1.11) (26)% ==== ==== ======
Note A: Reflecting the effect of unexercised dilutive stock options. - 53 - The following table presents a line-by-line breakdown of certain line items from UIL Holdings' Consolidated Statement of Income by subsidiary, including comparisons between 2002 and 2001. Significant variances are explained in the discussion and analysis of individual subsidiary results that follow.
YEAR ENDED DECEMBER 31, 2002 MORE (IN MILLIONS) 2002 2001 (LESS) THAN 2001 - ------------- ---- ---- ---------------- OPERATING REVENUE UI from operations, before sharing $691.3 $669.5 $21.8 UI sharing from operations (6.6) (3.9) (2.7) Nuclear 42.8 49.2 (6.4) Xcelecom 310.0 312.6 (2.6) Minority Interest Investment & Other 0.1 0.1 0.0 ----------------------------------------------- TOTAL OPERATING REVENUE $1,037.6 $1,027.5 $10.1 =============================================== FUEL AND ENERGY EXPENSE UI $263.1 $265.0 ($1.9) Nuclear 6.1 6.9 (0.8) ------------------------------------------------ TOTAL FUEL AND ENERGY EXPENSE $269.2 $271.9 ($2.7) ================================================ OPERATION AND MAINTENANCE EXPENSE UI $176.7 $154.5 $22.2 Nuclear 23.8 22.7 1.1 Xcelecom 301.1 292.2 8.9 Minority Interest Investment & Other 3.6 3.7 (0.1) ----------------------------------------------- TOTAL OPERATION AND MAINTENANCE EXPENSE $505.2 $473.1 $32.1 =============================================== DEPRECIATION AND AMORTIZATION UI $27.4 $27.4 $0.0 Nuclear 1.2 1.5 (0.3) Xcelecom 3.2 1.7 1.5 Minority Interest Investment & Other 0.0 1.0 (1.0) ---------------------------------------------- Subtotal depreciation 31.8 31.6 0.2 Amortization of regulatory assets (UI) 59.5 58.9 0.6 Amortization Xcelecom 1.3 3.7 (2.4) Amortization Minority Interest Investment & Other 0.0 (0.9) 0.9 ---------------------------------------------- TOTAL DEPRECIATION AND AMORTIZATION $92.6 $93.3 $(0.7) ============================================== TAXES - OTHER THAN INCOME TAXES UI - State gross earnings tax $28.3 $26.7 $1.6 UI - other 15.8 15.4 0.4 Nuclear - other 0.4 1.2 (0.8) Xcelecom 1.5 1.5 0.0 Minority Interest Investment & Other 0.0 (0.2) 0.2 ----------------------------------------------- TOTAL TAXES - OTHER THAN INCOME TAXES $46.0 $44.6 $1.4 ===============================================
- 54 -
YEAR ENDED DECEMBER 31, 2002 MORE (IN MILLIONS) 2002 2001 (LESS) THAN 2001 - ------------- ---- ---- ---------------- OTHER INCOME AND (DEDUCTIONS) UI $ 3.7 $3.5 $0.2 Nuclear 0.0 0.2 (0.2) Xcelecom 0.7 0.7 0.0 Minority Interest Investment & Other (6.7) 2.3 (9.0) --------------------------------------------- TOTAL OTHER INCOME AND (DEDUCTIONS) ($2.3) $6.7 ($9.0) ============================================= EARNINGS BEFORE INTEREST AND TAXES (EBIT) UI $117.6 $121.3 ($3.7) Nuclear 11.3 17.0 (5.7) Xcelecom 3.6 14.2 (10.6) Minority Interest Investments & Other (10.2) (1.2) (9.0) --------------------------------------------- TOTAL EBIT FROM CONTINUING OPERATIONS $122.3 $151.3 ($29.0) ============================================= INTEREST CHARGES UI $33.8 $37.5 ($3.7) UI - Interest on Seabrook obligation bonds owned by UI (5.1) (6.3) 1.2 UI - Amortization: debt expense, redemption premiums 1.9 2.2 (0.3) Nuclear 1.5 1.9 (0.4) Xcelecom 1.3 3.3 (2.0) Minority Interest Investment & Other 5.7 4.9 0.8 --------------------------------------------- TOTAL INTEREST CHARGES $39.1 $43.5 ($4.4) ============================================= INCOME TAXES UI $38.9 $39.8 ($0.9) Nuclear 4.0 6.1 (2.1) Xcelecom 0.9 4.7 (3.8) Minority Interest Investment & Other (6.3) (2.4) (3.9) --------------------------------------------- TOTAL INCOME TAXES $37.5 $48.2 ($10.7) ============================================= NET INCOME UI $48.1 $48.0 $0.1 Nuclear 5.8 9.1 (3.3) Xcelecom 1.4 6.2 (4.8) Minority Interest Investment & Other (9.6) (3.7) (5.9) --------------------------------------------- SUBTOTAL NET INCOME FROM CONTINUING OPERATIONS 45.7 59.6 (13.9) Discontinued Operations (1.8) (0.2) (1.6) --------------------------------------------- TOTAL NET INCOME $43.9 $59.4 ($15.5) =============================================
- 55 - THE UNITED ILLUMINATING COMPANY RESULTS OF OPERATIONS: 2002 VS. 2001 - ---------------------------------------------------------------------
Twelve Months Twelve Months 2002 more (less) than 2001 Ended Ended -------------------------- Dec. 31, 2002 Dec. 31, 2001 Amount Percent ----------------- ------------------ ---------------- ------------ EPS FROM OPERATIONS UI before Nuclear Division and Sharing $3.90 $3.72 $0.18 5% Sharing (0.52) (0.31) (0.21) (68)% ---- ---- ---- Subtotal UI excluding Nuclear 3.38 3.41 (0.03) (1)% Nuclear Division 0.41 0.64 (0.23) (36)% ---- ---- ------ Total UI EPS from operations - basic $3.79 $4.05 $(0.26) (6)% ==== ==== ====== Total UI EPS from operations - diluted $3.78 $4.03 $(0.25) (6)% ==== ==== ====== RETAIL SALES (MILLIONS OF KWH) 5,781 5,724 57 1%
UI EXCLUDING THE NUCLEAR DIVISION Excluding the Nuclear Division, UI's net income was $48.1 million, or $3.38 per share, in 2002, compared to $48.0 million, or $3.41 per share, in 2001. The decrease of $0.03 per share was due to the increase in the average number of shares outstanding. On a pre-sharing basis, earnings per share increased by $0.18 per share, reflecting higher revenues and lower amortization expense, partially offset by higher expenses. Higher sharing, reflected in a revenue reduction and increased accelerated amortization reduced earnings by $0.21 per share. Overall, UI's total revenue increased by $19.1 million, from $665.6 million in 2001 to $684.7 million in 2002. Details of this change in revenue are as follows: From In Millions Operations - -------------------------------------------------------------------------------- 2002 Revenues more (less) than 2001 Revenues - -------------------------------------------------------------------------------- REVENUE FROM DISTRIBUTION DIVISION: Estimate of operating Distribution Division component of "weather normalized" retail sales growth, 0.6% $1.3 Estimate of operating Distribution Division component of weather effect on retail sales, 1.1% 3.0 Impact of mix of sales on average price and other 6.1 Sharing (2.7) --- TOTAL RETAIL REVENUE FROM DISTRIBUTION DIVISION 7.7 RETAIL REVENUE FROM OTHER UTILITY DIVISIONS (NOTE A) 4.1 ---- TOTAL UI RETAIL REVENUE 11.8 OTHER OPERATING REVENUE INCREASE (DECREASE) NEPOOL transmission revenues 4.0 Other 0.2 --- TOTAL UI OTHER OPERATING REVENUES 4.2 UI WHOLESALE REVENUE 3.1 ---- TOTAL UI REVENUES $19.1 ==== Note A: The impact of increased retail sales on the retail revenues of the other utility divisions was partially offset by a 0.7% reduction in electricity sales and a corresponding $2.4 million revenue reduction resulting from the resolution of a station service dispute with a generating plant owner. - 56 - Retail fuel and energy expense decreased by $4.1 million in 2002, compared to 2001. UI received through 2003, electricity to satisfy its standard offer retail customer service requirements through a fixed-price purchased power agreement. These costs are recovered through the GSC portion of UI's unbundled retail customer rates. It should be noted that a small number of customers had selected alternate suppliers to provide generation services, but this had no effect on UI's financial results. UI's wholesale energy expense increased by $2.2 million, but these costs are recovered from customers through the CTA. UI's O&M expenses increased by $22.2 million, from $154.5 million in 2001 to $176.7 million in 2002. The principal components of these expense changes included: Increase/ In Millions (Decrease) - ------------------------------------------------------------------------- Operating Division: - ------------------------------------------------------------------------- Net pension expense and post retirement benefits (Note A) $6.6 Environmental remediation 3.2 NEPOOL transmission expense 2.4 Other 5.9 --- TOTAL OPERATING DISTRIBUTION DIVISION $18.1 NON-DISTRIBUTION O&M 4.1 --- TOTAL O&M EXPENSE $22.2 ==== Note A: The increase in pension expense reflected the lower returns being generated since approximately the beginning of 2000 by the equity investments held by the UI pension plan, a portion of which must be recognized immediately with the remainder deferred and amortized over time. These returns, when combined with the lower market value of the assets in the pension fund and the increase in projected liabilities caused by lower discount rates, may, depending on the actual performance of the fund, require increased cash contributions to the pension fund in the future. Amortization of regulatory assets, as booked, increased by $0.6 million in 2002 compared to 2001. The principal components of these changes were: Increase (Decrease) In Millions As Booked After-tax - -------------------------------------------------------------------------------- AMORTIZATION OF REGULATORY ASSETS: - -------------------------------------------------------------------------------- Accelerated amortization in Distribution Division $(9.5) $(8.3) Sharing amortization in Distribution Division 1.9 1.5 Amortization in CTA and SBC 8.2 4.7 --- --- TOTAL AMORTIZATION OF REGULATORY ASSETS $0.6 $(2.1) === ==== Note: "As booked" presents amounts as they appear on the income statement. After-tax amounts are provided because only part of the as booked amounts are tax deductible. Other pre-tax income increased by $0.3 million in 2002 compared to 2001. Interest charges decreased by $2.7 million in 2002 compared to 2001. About $1.5 million of this decrease was due to the net redemption of the Seabrook lease obligation bonds resulting from the sale of Seabrook Station on November 1, 2002. - 57 - NUCLEAR DIVISION The Nuclear Division contributed net income of $5.8 million, or $0.41 per share, in 2002 compared to $9.1 million, or $0.64 per share, in 2001. The overall earnings decline was $0.23 per share. The Seabrook nuclear generating unit was sold on November 1, 2002. The absence of two months of earnings (post sale) reduced earnings by $0.14 per share compared to 2001. The combination of the accounting treatment of certain nuclear disposition expenses, improved unit performance and lower general O&M expense in October of 2002 compared to October 2001 reduced earnings by $0.09 per share. NON-UTILITY BUSINESSES RESULTS OF OPERATIONS: 2002 VS. 2001 - ------------------------------------------------------------
Twelve Months Twelve Months 2002 more (less) than 2001 Ended Ended -------------------------- Dec. 31, 2002 Dec. 31,2001 Amount Percent ----------------- ---------------- ----------------- ----------- EPS Operating Business Xcelecom $0.10 $0.44 $(0.34) (77)% Minority Interest Investments UBE (0.07) 0.26 (0.33) (127)% UCI (0.31) (0.28) (0.03) (11)% ---- ---- ------ Subtotal Minority Interest Investments (0.38) (0.02) (0.36) (1,800)% UIL Corporate (Note A) (0.29) (0.25) (0.04) (16)% ---- ---- TOTAL NON-UTILITY EPS FROM CONTINUING OPERATIONS (0.57) 0.17 (0.74) (435)% Discontinued Operations (0.13) (0.01) (0.12) (1,200)% ------ ------ TOTAL NON-UTILITY EPS - BASIC $(0.70) $0.16 $(0.86) (538)% ====== ==== ====== TOTAL NON-UTILITY EPS - DILUTED (Note B) $(0.70) $0.16 $(0.86) (538)% ====== ==== ======
Note A: Includes interest charges on intercompany debt and strategic and administrative costs of the non-utility holding company. Note B: Reflecting the effect of unexercised dilutive stock options. Overall, the consolidated non-utility businesses had losses from continuing operations of approximately $8.2 million, or $0.57 per share, in 2002, compared to earnings of about $2.5 million, or $0.17 per share, in 2001. Operating revenue for the non-utility businesses decreased by $2.6 million, or 1%. All of the decrease in revenues came from Xcelecom. Expenses for the non-utility businesses, including losses on minority interest investments, but excluding income taxes, increased by $15.9 million, and income taxes decreased by $7.7 million. The results of each of the non-utility subsidiaries for 2002 and 2001, as presented below, reflect the allocation of debt costs from the parent based on a capital structure, including an equity component, and an interest rate deemed appropriate for that type of business. The targeted capital structures for each of the non-utility subsidiaries are: 100% equity for APS and UCI, 65% equity and 35% debt for Xcelecom for all periods prior to the second quarter of 2002 and 100% equity beginning in the second quarter of 2002, and 30% equity and 70% debt for UBE. See the Xcelecom section for an explanation on the change to Xcelecom's capital structure. UIL Holdings absorbs interest charges on the equity portion of its investments in its subsidiaries to the extent those investments are financed with debt. URI may incur other expenses necessary to manage its investments from time to time. The following is a detailed explanation of the change in results between 2001 and 2002 for UIL Holdings' non-utility businesses. - 58 - NON-UTILITY BUSINESSES XCELECOM, INC. Xcelecom earned $1.4 million, or $0.10 per share, in 2002, compared to $6.2 million, or $0.44 per share in 2001. Higher loss reserve charges relating to projects at several Xcelecom subsidiaries reduced earnings by about $0.05 per share in 2002 compared to 2001. Also, as with other companies in the construction and systems integration industries, there was a very evident decline in economic activity in Xcelecom's markets. Xcelecom also experienced customer postponements and cancellations of projects, reductions in new project orders, a continued slowdown in spending for technology by its customers, and increased competition for fewer jobs, resulting in both lower demand and lower margins. Additionally, the completion of several large, non-recurring contracts in 2001 that were not replaced contributed to the earnings decline. The negative earnings impact of these items, about $0.57 per share in 2002 compared to 2001, was partly offset by an increase of about $0.06 per share from acquisitions made during 2001 and 2002, and an increase of $0.15 per share due to the change in accounting for goodwill mandated by SFAS No. 142, "Goodwill and Other Intangible Assets." The negative impact was also partly offset by the conversion, in the second quarter of 2002, to a 100% equity capital structure from the 65% equity and 35% intercompany debt structure used previously. This conversion contributed $0.07 per share to Xcelecom in 2002, but was offset by an earnings decrease in URI Headquarters, which received less interest income from Xcelecom. MINORITY INTEREST INVESTMENTS UNITED BRIDGEPORT ENERGY, INC. UBE owns a 33 1/3% interest in Bridgeport Energy, LLC (BE). UBE lost $1.0 million, or $0.07 per share in 2002, compared to earnings of $3.7 million, or $0.26 per share in 2001. Of the $0.33 per share decrease, $0.13 was due to lower energy sales revenues, $0.04 was due to lower installed capability (ICAP) revenues, about $0.25 was due to overhaul costs in 2002, and $0.04 was due to higher operating expenses. Offsetting the negative earnings impact of these items was an improvement of $0.08 per share due to lower interest and administrative charges, and a non-recurring benefit of $0.05 per share due to an insurance credit. In 2001, UBE had an agreement with Duke Energy Trading and Marketing (an affiliate of the majority owner) that effectively eliminated UBE's operating and margin risks. There was no such agreement in 2002. UNITED CAPITAL INVESTMENTS, INC. UCI lost $4.4 million, or $0.31 per share in 2002, compared to a loss of $3.9 million, or $0.28 per share in 2001. An impairment of UCI's investment in Gemini Networks, Inc., (Gemini) a broadband fiber-optic business, caused a $0.16 per share loss. That write-off reflected the generally depressed economic conditions in the telecommunications industry that worsened in the second quarter of 2002, and an associated inability of Gemini to access capital markets to continue its network build-out. The offsetting variance was due to lower losses on other minority ownership interest investments. UIL CORPORATE UIL Holdings incurred unallocated costs of $4.2 million, after-tax, or $0.29 per share, in 2002, compared to unallocated costs of $3.4 million, after-tax, or $0.25 per share, in 2001. The results of each of the non-utility subsidiaries, as presented above, reflect interest expense on allocated debt from UIL Holdings, based on a capital structure, including an equity component, and an interest rate deemed appropriate for that type of business. Some unallocated interest charges and strategic and administrative costs for the non-utility subsidiaries are retained UIL Holdings. The increase in unallocated costs at UIL Holdings reflects additional administrative expenses incurred for managing investments. Lower interest income from the reclassification of Xcelecom's intercompany debt to equity, beginning in the second quarter of 2002, was mostly offset by lower interest charges from reduced interest rates. - 59 - DISCONTINUED OPERATIONS APS lost $1.8 million, or $0.13 per share, in 2002, compared to a loss of $0.2 million, or $0.01 per share, in 2001. The increased loss of $0.12 per share was due to expenses that were incurred to expand the infrastructure of the organization in order to enhance the bill payment business and introduce and sell new products and services, such as prepaid stored value cards and prepaid telephony products, partly offset by an increase of $0.02 per share due to the change in accounting for goodwill mandated by Statement of Financial Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible Assets." In addition, APS incurred infrastructure and installation costs associated with a multi-year contract with BellSouth, and a $0.05 per share loss recorded in the fourth quarter of 2002 to write down a portion of an outstanding loan APS had made to the entities from which APS acquired the point of sale activation technology. LOOKING FORWARD UIL HOLDINGS' CONSOLIDATED EARNINGS ESTIMATES FOR 2004 AND CASH FLOW DISCUSSION UIL Holdings estimates that earnings per share from continuing operations for 2004 will be $2.40-$2.60 per share, compared to 2003 results of $2.07 per share. UIL Holdings' previous earnings estimate of $2.20-$2.40 was provided in UIL Holdings' earnings release of January 26, 2004. The increase is due to the increase in the C&LM incentive approved by the DPUC in February 2004 and the effect of the DPUC's decision regarding UI's pension and postretirement expenses described below. These amounts exclude the impact of discontinued operations, based on the expected closing of the sale of APS by the end of June 2004. The primary reasons for the expected increase in earnings from operations is an expected improvement at UIL Holdings' non-utility subsidiary, Xcelecom and reduced interest charges resulting from the application of the proceeds from the APS sale to reduce UIL Holdings' short-term debt. On February 18, 2004, the DPUC issued a decision approving a modified settlement regarding UI's request for recovery of increased pension and postretirement expenses. The DPUC approved recovery of an annualized $5.2 million, as opposed to the original proposed settlement amount of $10.5 million, and increased from 75% to 100% the customers' share of any Distribution Division earnings in excess of UI's allowed return on utility common equity of 10.45%. UIL Holdings' current earnings range estimate for 2004 is less than its current dividend rate of $2.88 per common share. However, UIL Holdings continues to have sufficient positive cash flow to pay the dividend from operating activities, and generated $89 million of cash from operating activities in 2003, after making a pension fund contribution of $45 million. This cash flow for the dividend comes from UI, and includes, in addition to positive cash flow from the Distribution Division, the recovery of stranded costs in the CTA rate base. See the sections below for more information on funding the dividend and other UIL Corporate expenses. Approximately $26.8 million of the 2003 cash flow from operating activities for UIL Holdings was due to the use of net operating losses, which reduced cash tax payments, and the receipt of tax refunds. At the end of 2003, there were net operating loss carryforwards of $51 million, the taxes on which are expected to be recovered in 2004. THE UNITED ILLUMINATING COMPANY UI is expected to earn $2.75-$2.85 per share in 2004, as compared to $2.71 per share earned in 2003. The 2004 estimate includes the effect of recent decisions from the DPUC regarding the increase to the 2003 C&LM incentive program, and the recovery of a portion of increased pension and postretirement expenses. Absent other actions or abnormal weather, UI is not expected to achieve the authorized return on the equity portion of its Distribution Division rate base. Implementation of the February 18, 2004 DPUC decision will reduce accelerated amortization in the Distribution Division in 2004. It will not have an impact on UI's cash flow, or on prices charged to UI's retail customers. - 60 - The major sources of UI's earnings in 2003 were the Distribution and Transmission Divisions and the CTA. In 2003, the CTA earned $1.00 per share on the equity portion of UI's average rate base of approximately $290 million. The remaining $1.71 per share, except for immaterial amounts earned for CL&M and SBC, was earned by the Distribution and Transmission Divisions. The CTA is expected to earn approximately $0.95 per share in 2004, the Distribution and Transmission Divisions combined are expected to earn $1.68-$1.78 per share, and the GSC is expected to earn $0.12 per share from the $0.0005 per kilowatt-hour procurement fee provided for in Public Act 03-135. Earnings from the Distribution Division are expected to increase in 2004 compared to 2003 primarily due to the regulatory relief supplied by the DPUC, and an expected decrease in interest charges. Those improvements will be partly offset by increases in other expenses. Depreciation expenses are increasing due to increases in plant-in-service balances, particularly UI's new customer information system. O&M expenses are expected to increase due to higher internal and external labor costs, partly as a result of shifting internal workload from temporary assignment on capital projects back to expense activities, and increases in general expenses. Retail sales were enhanced in 2003 due to abnormal weather. Sales estimated for 2004 are weather normalized. Earnings from the CTA are expected to continue to decline beyond 2004 as the CTA rate base is amortized. Currently, it is estimated that the CTA rate base will be fully amortized between 2014 and 2016, at which time revenues and earnings from the CTA will be eliminated. This estimate is predicated on the DPUC maintaining the current CTA retail rate charged to customers until the CTA rate base is fully amortized, and assumptions about a number of other factors that could impact the rate of amortization. Therefore, no assurance can be given that revenues and earnings from the CTA will continue as expected. The CTA produces significant cash flow for UI. Funds collected for the CTA from retail customers cover the amortization of CTA rate base, the return earned on the equity portion of that rate base, and other mostly cash stranded cost expenses. In 2001, 2002 and 2003, the CTA produced approximately $32 million, $45 million, and $36 million respectively of funds from operations, and it is expected to produce approximately $20 million in 2004. Beginning in 2000 and continuing through December 2003, UI collected GSC revenues from customers, as approved by the DPUC, that were greater than the cost of purchased power costs for standard offer service. The DPUC provided this higher pricing and additional revenues to provide customers with an incentive to switch from standard offer service to independent suppliers. These revenues did not result in earnings for UI. Through June of 2003, the excess GSC revenue amounts were transferred to the CTA for accounting purposes, allowing for faster amortization of CTA stranded cost rate base balances, and contributing to CTA cash flow. The DPUC required UI to defer such transfers beginning in July 2003. In 2004, and through the TSO period, purchased power costs will be higher under UI's contract with PSEG than they were previously, and the GSC retail rates charged to customers will more closely match those costs and the procurement fees that UI will earn, eliminating most of that source of cash. CTA should continue to produce cash flow at the 2004 level in future years, if the pricing factors in the CTA and GSC, and other factors beyond UI's control do not change. Once the CTA rate base is fully amortized, the CTA will cease to generate cash flow. UI is currently expected to dividend to UIL Holdings, in 2004, the cash necessary for UIL Holdings to pay a dividend to shareholders equal to that paid in 2003, approximately $41-$42 million ($2.88 per share). This amount is not currently expected to require UI to borrow additional funds in 2004, primarily because UI had about $24 million of cash on hand at the end of 2003. Since UI's earnings range estimate for 2004 is expected to be only slightly less than the external dividend amount, UI's equity ratio is expected to be close, at the end of 2004, to the 47% ratio used for ratemaking. This ratio was 47% at year-end 2003. For additional information, see the "Liquidity and Capital Resources" section of this item. XCELECOM Xcelecom is expected to earn $0.05-$0.15 per share in 2004, compared to a loss of $0.12 per share in 2003, reflecting anticipated improvement in certain of Xcelecom's markets in 2004. As with other companies in the construction and systems-integration industries, Xcelecom has experienced contract postponements and cancellations of projects, a slowdown in spending for technology by its customers, and increased competition for fewer jobs, resulting in both lower demand and lower margins. Xcelecom has taken actions to reduce the negative impact of these items by working to reduce operating and overhead related costs. Generally, the economic activity of the non-residential construction markets in - 61 - which Xcelecom participates lags the general economy by six to eighteen months, both in economic downturns and recoveries. Activity levels in Xcelecom operations in the southeast and mid-Atlantic states are improving, but Xcelecom continues to observe depressed levels of activity in the northeast, and increased competition for less work. Xcelecom's backlog of contractually obligated work to be completed at the end of December 2003 was $147 million, compared to a December 2002 backlog of $108 million, an increase of 36%. This backlog is expected to have some positive effect on results for 2004, even though, due to increased competition, the overall expected gross margin related to the backlog at the end of 2003 is slightly lower, in percentage terms, than the expected gross margin percentage carried in the year end 2002 backlog balance. Xcelecom is expected to generate enough cash from operations in 2004 to fund its operating activity, pay for capital expenditures, and fund some of its contractual obligations, but is not expected to pay dividends to UIL Holdings. Certain other contractual obligations, related to acquisitions made by Xcelecom in previous years, are paid for by UIL Holdings. Xcelecom maintains a revolving credit facility that may be utilized, among other things, to meet short-term liquidity needs in the event cash generated by operating activities is insufficient. UIL Holdings may also make infusions of capital to enhance Xcelecom's liquidity. MINORITY INTEREST INVESTMENT & OTHER UNITED BRIDGEPORT ENERGY, INC. The earnings estimate for UBE for 2004 is a loss of $0.05-$0.15 per share, compared to a loss of $0.15 per share in 2003. The expected improvement relates to the 2004 restructuring of UIL Holdings' intercompany loan to UBE to 100% equity. The improvements recognized at UBE will be offset by reduced intercompany interest income at UIL Corporate; thus, this restructuring will have no effect on UIL Holdings' consolidated results. Results at UBE continue to be hampered by high natural gas prices, keeping both margins and sales levels low. The 2004 estimate also reflects low installed capability (ICAP) revenues, and the absence of any major overhaul expenses. Although natural gas prices have remained at elevated levels in recent years, DOE Annual Energy Outlook projections show improving conditions in the future. Based on this information, UBE expects its $82.1 million investment in Bridgeport Energy to be fully recoverable, but will continue to monitor the investment. UBE is expected to be cash neutral in 2004. UNITED CAPITAL INVESTMENTS, INC. UCI is expected to breakeven in 2004, compared to a loss of $0.05 per share in 2003. Part of the expected improvement relates to the expectation of a minor amount of income from the Cross-Sound investment which will offset administrative costs. Cross-Sound continues to operate under federal emergency orders and is producing some income for UIL Holdings based on a LIPA approved interim operating agreement. UCI's $33 million share of the Cross-Sound cable project would be negatively impacted if the Cross-Sound cable does not achieve commercial operation. Refer to the "Major Influences on Financial Condition - United Capital Investments, Inc." section of this item for additional information regarding the Cross-Sound cable permit issues. Income from UCI's other passive investments is not expected at this time. UCI, including Cross-Sound, is expected to be cash neutral in 2004. UIL CORPORATE UIL Corporate will report unallocated corporate administrative costs and unallocated interest charges. UIL Corporate is expected to lose $0.25-$0.35 per share in 2004, compared to a loss of $0.32 per share in 2003. Administrative costs are expected to be similar in 2004 as in 2003. Interest charges are expected to decrease in the second half of 2004 when UIL Holdings expects to pay down a portion of its short-term borrowings with the proceeds from the APS sale, which is currently planned in the second quarter of 2004. UIL Corporate has, and will continue to have, negative cash flow from operating activities. UIL Corporate is entirely dependent on dividends from its subsidiaries and from external borrowings to provide the cash necessary to service debt, to pay administrative costs, to meet other contractual obligations not funded by UIL Holdings' subsidiaries, and to pay cash dividends to UIL Holdings' shareholders. In 2004, UI is expected to dividend to UIL Holdings the - 62 - amount necessary to pay a cash dividend to UIL Holdings' shareholders equal to that paid in 2003, approximately $41-$42 million ($2.88 per share). This amount is not enough to cover UIL Corporate's other expenses. The remaining funding requirements for UIL Corporate are expected to come from external borrowings, under UIL Holdings' short-term revolving credit agreement and from the proceeds of the sale of APS. See the "Liquidity and Capital Resources" section of this Item for more information, including UIL Holdings' debt retirement schedule. Based on current cash projections for 2004, including the net proceeds from the pending sale of APS of $65-$70 million, UIL Holdings expects that, at its quarterly reviews of the dividend, maintenance of the annual dividend of $2.88 per share will be justified, absent adverse events that materially affect projected results. EARNINGS FROM DISCONTINUED OPERATIONS UIL Holdings expects the sale of APS to close in the second quarter of 2004, subject to the receipt of regulatory approvals. Discontinued operations, including the gain on the sale, are expected to contribute $3.00-$3.10 per share in 2004. Exclusive of the proceeds from the pending sale of APS and the sale of CCI, Discontinued Operations are expected to be cash neutral in 2004. The sale of APS is expected to produce pre-tax proceeds, net of sale transaction costs, of $95-$100 million for UIL Holdings. The pre-tax gain from the sale of APS is expected to be $70-$75 million, and will be treated as a capital gain for income tax purposes. Capital losses, if any, incurred by UIL Holdings either in 2004 or the following three years could be utilized as an offset to the APS capital gain. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK. UIL Holdings and UI's primary market risk is the interest rate risk that occurs in the refinancing of fixed rate debt at maturity and in the remarketing of multi-annual tax-exempt bonds. The weighted average remaining fixed rate period of outstanding long-term debt obligations of UIL Holdings and UI is 4.2 years at an average interest rate of 4.0%. Given the term of the fixed rate debt, UIL Holdings believes that it has no material quantitative or qualitative exposure to market risk. In addition, historically, UI has been able to include its interest costs in revenue requirements for recovery through rates. UIL Holdings and Xcelecom have short-term revolving credit agreements that permit borrowings for fixed periods of time at fixed interest rates determined by the London Interbank Offered Rate (LIBOR), and also borrowings at fluctuating interest rates determined by the prime lending market. Changes in LIBOR or the prime lending market will have an impact on interest expense, but due to the relatively low level of short-term borrowings under these credit facilities, the impact of changes in short-term interest rates is not expected to be material. Market risk also represents the risks of changes in the value of a financial instrument, derivative or non-derivative, caused by fluctuation in interest rates, and equity prices. UIL Holdings does not have any derivative instruments or any material investments in financial instruments at this time. - 63 - ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. UIL HOLDINGS CORPORATION CONSOLIDATED STATEMENT OF INCOME FOR THE YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001 (THOUSANDS EXCEPT PER SHARE AMOUNTS)
2003 2002 2001 ---- ---- ---- OPERATING REVENUES (NOTE F) Utility $ 669,620 $ 727,533 $ 714,818 Non-utility businesses 294,057 310,063 312,642 ---------- ----------- ----------- Total Operating Revenues 963,677 1,037,596 1,027,460 ---------- ----------- ----------- OPERATING EXPENSES Operation Fuel and energy (Note F) 272,673 269,195 271,907 Operation and maintenance 478,720 505,162 473,080 Depreciation and amortization (Note F) 82,239 92,567 93,306 Taxes - other than income taxes (Note F) 41,088 45,970 44,573 ---------- ----------- ----------- Total Operating Expenses 874,720 912,894 882,866 ---------- ----------- ----------- OPERATING INCOME FROM CONTINUING OPERATIONS 88,957 124,702 144,594 ---------- ----------- ----------- OTHER INCOME AND (DEDUCTIONS), NET (NOTE F) 3,290 (2,327) 6,700 ---------- ----------- ----------- INCOME FROM CONTINUING OPERATIONS BEFORE INTEREST CHARGES AND INCOME TAXES 92,247 122,375 151,294 ---------- ----------- ----------- INTEREST CHARGES, NET Interest on long-term debt 25,590 40,582 42,848 Interest on Seabrook Lease Obligation Bonds owned by UI - (5,122) (6,319) Other interest, net (Note F) 2,403 1,717 4,831 ---------- ----------- ----------- 27,993 37,177 41,360 Amortization of debt expense and redemption premiums 1,267 1,969 2,156 ---------- ----------- ----------- Interest Charges, net 29,260 39,146 43,516 ---------- ----------- ----------- INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES 62,987 83,229 107,778 ---------- ----------- ----------- INCOME TAXES (NOTE E) 33,450 37,478 48,215 ---------- ----------- ----------- NET INCOME FROM CONTINUING OPERATIONS 29,537 45,751 59,563 DISCONTINUED OPERATIONS, NET OF TAX (NOTE O) (6,251) (1,804) (200) ---------- ----------- ----------- NET INCOME AND INCOME APPLICABLE TO COMMON STOCK $ 23,286 $ 43,947 $ 59,363 ========== =========== =========== AVERAGE NUMBER OF COMMON SHARES OUTSTANDING - BASIC 14,291 14,239 14,097 AVERAGE NUMBER OF COMMON SHARES OUTSTANDING - DILUTED 14,304 14,282 14,159 EARNINGS PER SHARE OF COMMON STOCK - BASIC: CONTINUING OPERATIONS $ 2.07 $ 3.22 $ 4.22 DISCONTINUED OPERATIONS $(0.44) $(0.13) $(0.01) ---------- ----------- ----------- NET EARNINGS $ 1.63 $ 3.09 $ 4.21 EARNINGS PER SHARE OF COMMON STOCK - DILUTED: CONTINUING OPERATIONS $ 2.07 $ 3.21 $ 4.20 DISCONTINUED OPERATIONS $(0.44) $(0.13) $(0.01) ---------- ----------- ----------- NET EARNINGS $ 1.63 $ 3.08 $ 4.19 CASH DIVIDENDS DECLARED PER SHARE OF COMMON STOCK $ 2.88 $ 2.88 $ 2.88 - ---------------------------------------------------------------------------------------------------------------- UIL HOLDINGS CORPORATION CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME FOR THE YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001 (THOUSANDS OF DOLLARS) 2003 2002 2001 ---- ---- ---- NET INCOME $ 23,286 $ 43,947 $ 59,363 OTHER COMPREHENSIVE INCOME (LOSS), NET OF TAX: Unrealized gain (loss) on marketable securities (net of tax benefit (expense) of $344) (519) 519 Minimum pension liability (net of tax deferred benefit (expense) of $(18,802) and $17,703) 26,198 (26,694) - ---------- ----------- ----------- OTHER COMPREHENSIVE INCOME (LOSS) 26,198 (27,213) 519 ---------- ----------- ----------- COMPREHENSIVE INCOME (NOTE A) $ 49,484 $ 16,734 $ 59,882 ========== =========== ===========
The accompanying Notes to the Consolidated Financial Statements are an integral part of the financial statements. - 64 - UIL HOLDINGS CORPORATION CONSOLIDATED STATEMENT OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001 (THOUSANDS OF DOLLARS)
2003 2002 2001 ---- ---- ---- CASH FLOWS FROM OPERATING ACTIVITIES Income from continuing operations $ 29,537 $ 45,751 $ 59,563 ------------ ------------ ------------ Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 59,472 65,972 63,851 Purchase power contract amortization (Note F) 24,034 24,014 26,114 Purchase Power above market fuel expense credit (Note F) (24,034) (24,014) (26,114) Deferred income taxes 17,715 67,716 (18,053) Future tax benefits (Note E) 36,976 (45,192) - Deferred investment tax credits - net (387) (564) (658) Amortization of nuclear fuel - 4,640 5,497 Allowance for funds used during construction (2,491) (2,220) (1,913) Changes in: Accounts receivable - net 8,529 14,307 (23,336) Materials and supplies (425) 100 (2,722) Prepayments 521 998 (187) Accounts payable (7,492) 1,878 (13,335) Interest accrued (1,098) 3,139 2,591 Taxes accrued (14,100) 1,767 1,755 Prepaid Pension (45,000) - - Other assets and liabilities 6,781 (18,916) 18,360 ------------ ------------ ------------ Total Adjustments 59,001 93,625 31,850 ------------ ------------ ------------ Cash provided by Continuing Operations 88,538 139,376 91,413 Cash provided by (used in) Discontinued Operations (403) 8,249 10,533 ----------- ------------ ------------ NET CASH PROVIDED BY OPERATING ACTIVITIES 88,135 147,625 101,946 ----------- ------------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES Acquisition of businesses, net of cash acquired - (7,691) (15,532) Non-utility passive investments - (5,126) (3,773) Net proceeds from sale of generation facilities - 79,214 32,314 Loan to Cross-Sound Cable Project (23,986) - - Deferred payments in prior acquisitions (2,757) (4,967) (1,475) Plant expenditures, including nuclear fuel (52,309) (52,909) (43,615) Purchase / sale of pollution control refunding revenue bonds 25,000 (25,000) - Redemption of investment in Seabrook Lease Obligation Bonds - 80,794 1,928 Investment (retirement) in debt securities, net - 5,043 (3,090) Changes in restricted cash 4,595 (2,348) (365) ------------ ------------ ------------ Cash provided by (used in) Continuing Operations (49,457) 67,010 (33,608) Cash (used in) Discontinued Operations (119) (10,824) (11,218) ------------ ------------ ------------ NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES (49,576) 56,186 (44,826) ------------ ------------ ------------ CASH FLOWS FROM FINANCING ACTIVITIES Issuances of: Common stock 2,099 6,132 2,536 Long-term debt 98,711 125,000 75,000 Notes payable 14,411 7,195 (78,741) Long-term debt securities redeemed and retired (100,000) (100,000) (665) Termination of Seabrook Lease Obligation - (208,900) - Expenses of issuances (2,765) (526) (825) Lease obligations (473) (509) (405) Payment of common stock dividend (41,137) (40,917) (40,576) ------------ ------------ ------------ Cash (used in) Continuing Operation (29,154) (212,525) (43,676) Cash provided by Discontinued Operations 299 2,575 685 ------------ ------------ ------------ NET CASH (USED IN) FINANCING ACTIVITIES (28,855) (209,950) (42,991) ------------ ------------ ------------ CASH AND TEMPORARY CASH INVESTMENTS: NET CHANGE FOR THE PERIOD 9,704 (6,139) 14,129 BALANCE AT BEGINNING OF PERIOD 18,910 25,049 10,920 ------------ ------------ ------------ BALANCE AT END OF PERIOD $ 28,614 $ 18,910 $ 25,049 ============ ============ ============ CASH PAID DURING THE PERIOD FOR: Interest (net of amount capitalized) $ 28,079 $ 36,782 $ 37,980 ============ ============ ============ Income taxes $ 3,000 $ 12,800 $ 64,300 ============ ============ ============
The accompanying Notes to the Consolidated Financial Statements are an integral part of the financial statements. - 65 - UIL HOLDINGS CORPORATION CONSOLIDATED BALANCE SHEET DECEMBER 31, 2003 AND 2002 ASSETS (Thousands of Dollars)
2003 2002 ---- ---- Current Assets Unrestricted cash and temporary cash investments $ 28,614 $ 18,910 Restricted cash 1,384 5,979 Utility accounts receivable less allowance of $1,654 and $1,654 54,780 58,171 Other accounts receivable less allowance of $1,648 and $1,530 80,532 85,683 Unbilled revenues 32,246 38,403 Materials and supplies, at average cost 4,458 4,033 Prepayments 8,669 1,973 Current assets of discontinued operations held for sale 102,331 97,912 Other 1,323 1,095 ----------------- ---------------- Total Current Assets 314,337 312,159 ----------------- ---------------- Other Property and Investments Investment in United Bridgeport Energy facility 82,090 83,677 Investment in debt securities - 25,000 Other 20,283 13,450 ----------------- ---------------- Total Other Property and Investments 102,373 122,127 ----------------- ---------------- Property, Plant and Equipment at original cost In service 784,409 727,867 Less, accumulated depreciation 272,082 256,197 ----------------- ---------------- 512,327 471,670 Construction work in progress 36,467 49,411 ----------------- ---------------- Net Property, Plant and Equipment 548,794 521,081 ----------------- ---------------- Regulatory Assets (FUTURE AMOUNTS DUE FROM CUSTOMERS THROUGH THE RATEMAKING PROCESS) Nuclear plant investments-above market 436,505 456,950 Income taxes due principally to book-tax differences 98,116 69,115 Long-term purchase power contracts-above market 88,024 100,379 Connecticut Yankee 51,579 33,821 Unamortized redemption costs 19,325 18,245 Other 43,259 40,804 ----------------- ---------------- Total Regulatory Assets 736,808 719,314 ----------------- ---------------- Deferred Charges Goodwill 68,554 66,957 Unamortized debt issuance expenses 6,670 4,509 Prepaid Pension 43,927 - Long-term receivable - Cross-Sound Cable Project 23,986 - Other long-term receivable 13,575 10,766 Other 2,120 11,753 ----------------- ---------------- Total Deferred Charges 158,832 93,985 ----------------- ---------------- Long-term assets of discontinued operations held for sale 17,930 25,093 ----------------- ---------------- Total Assets $ 1,879,074 $ 1,793,759 ================= ================
The accompanying Notes to the Consolidated Financial Statements are an integral part of the financial statements. - 66 - UIL HOLDINGS CORPORATION CONSOLIDATED BALANCE SHEET DECEMBER 31, 2003 AND 2002 LIABILITIES AND CAPITALIZATION (Thousands of Dollars)
2003 2002 ---- ---- Current Liabilities Notes payable $ 65,161 $ 43,055 Current portion of long-term debt - 100,000 Accounts payable 36,729 44,007 Dividends payable 10,299 10,275 Accrued liabilities 62,639 62,524 Deferred revenues - non-utility businesses 14,957 25,553 Taxes accrued 1,214 8,096 Interest accrued 6,358 7,457 Obligations under capital leases 14,815 473 Current liabilities of discontinued operations held for sale 92,901 95,336 --------------- --------------- Total Current Liabilities 305,073 396,776 --------------- --------------- Noncurrent Liabilities Purchase power contract obligation 88,024 100,379 Pension accrued 8,166 44,857 Connecticut Yankee contract obligation 47,213 28,442 Long-term notes payable 10,478 14,408 Obligations under capital leases - 14,815 Other 17,574 13,596 --------------- --------------- Total Noncurrent Liabilities 171,455 216,497 --------------- --------------- Deferred Income Taxes, Net (FUTURE TAX LIABILITIES OWED TO TAXING AUTHORITIES) 333,239 225,928 --------------- --------------- Regulatory Liabilities (FUTURE AMOUNTS OWED TO CUSTOMERS THROUGH THE RATEMAKING PROCESS) Accumulated deferred investment tax credits 12,813 13,201 Deferred gains on sale of property 33,679 33,130 Customer refund 5 6,820 Asset removal cost 14,071 12,948 Other 19,584 10,615 --------------- --------------- Total Regulatory Liabilities 80,152 76,714 --------------- --------------- Long-term liabilities of discontinued operations held for sale 921 60 --------------- --------------- Commitments and Contingencies (Note L) Capitalization (Note B) Net long-term debt 495,460 395,432 Common Stock Equity Common stock (no par value, 14,314,599 and 14,272,080 shares outstanding at December 31, 2003 and 2002) 297,321 296,501 Paid-in capital 4,413 3,749 Capital stock expense (2,170) (2,170) Unearned employee stock ownership plan equity (5,461) (6,411) Unearned compensation (335) - Accumulated other comprehensive loss (496) (26,694) Retained earnings 199,502 217,377 --------------- --------------- Net Common Stock Equity 492,774 482,352 Total Capitalization 988,234 877,784 --------------- --------------- Total Liabilities and Capitalization $ 1,879,074 $ 1,793,759 =============== ===============
The accompanying Notes to the Consolidated Financial Statements are an integral part of the financial statements. - 67 - UIL HOLDINGS CORPORATION CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY DECEMBER 31, 2003, 2002 AND 2001 (THOUSANDS OF DOLLARS)
ACCUMULATED CAPITAL UNEARNED OTHER COMMON STOCK PAID-IN STOCK ESOP UNEARNED COMPREHENSIVE RETAINED SHARES (A) AMOUNT CAPITAL EXPENSE EQUITY COMPENSATION INCOME (LOSS) EARNINGS TOTAL - ------------------------------------------------------------------------------------------------------------------------------------ Balance as of December 31, 2000 14,076,697 $291,342 $2,483 ($2,170) ($8,310) $ - $ - $195,700 $479,045 - ------------------------------------------------------------------------------------------------------------------------------------ Net income for 2001 59,363 59,363 Cash dividends on common stock - $2.88 per share (40,604) (40,604) Issuance of 11,144 shares common stock - no par value 11,144 446 40 486 Unrealized gain on investment (net of tax expense of $344) 519 519 Allocation of benefits - ESOP 27,940 237 949 1,186 - ------------------------------------------------------------------------------------------------------------------------------------ Balance as of December 31, 2001 14,115,781 291,788 2,760 (2,170) (7,361) - 519 214,459 499,995 - ------------------------------------------------------------------------------------------------------------------------------------ Net income for 2002 43,947 43,947 Cash dividends on common stock - $2.88 per share (41,029) (41,029) Issuance of 128,359 shares common stock - no par value 128,359 4,713 764 5,477 Unrealized loss on investment (net of tax benefit of $344) (519) (519) Minimum pension liability adjustment (net of deferred tax benefit of $17,703) (26,694) (26,694) Allocation of benefits - ESOP 27,940 225 950 1,175 - ------------------------------------------------------------------------------------------------------------------------------------ Balance as of December 31, 2002 14,272,080 296,501 3,749 (2,170) (6,411) - (26,694) 217,377 482,352 - ------------------------------------------------------------------------------------------------------------------------------------ Net income for 2003 23,286 23,286 Cash dividends on common stock - $2.88 per share (41,161) (41,161) Issuance of 14,579 shares common stock - no par value 14,579 820 24 844 Stock compensation earned 611 611 Unearned stock compensation (335) (335) Minimum pension liability adjustment (net of deferred tax expense of $18,802) 26,198 26,198 Allocation of benefits - ESOP 27,940 29 950 979 - ------------------------------------------------------------------------------------------------------------------------------------ Balance as of December 31, 2003 14,314,599 $297,321 $4,413 ($2,170) ($5,461) ($335) ($496) $199,502 $492,774 - ------------------------------------------------------------------------------------------------------------------------------------
(a) There were 30,000,000 shares authorized in 2003, 2002 and 2001. The accompanying Notes to Consolidated Financial Statements are an integral part of the financial statements. - 68 - UIL HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (A) STATEMENT OF ACCOUNTING POLICIES UIL Holdings Corporation (UIL Holdings) was formed in July 2000 and is an exempt public utility holding company under the provisions of the Public Utility Holding Company Act of 1935. Through its various subsidiaries, UIL Holdings operates in two principal lines of business: utility and non-utility. The utility business consists of the electric transmission and distribution operations of The United Illuminating Company (UI), while the non-utility businesses consist of the operations of American Payment Systems, Inc. (APS) and Xcelecom, Inc. (Xcelecom), and passive investments in United Capital Investments, Inc. (UCI) and United Bridgeport Energy, Inc. (UBE). UIL Holdings is headquartered in New Haven, Connecticut, where its senior management maintains offices and is responsible for overall planning, operating and financial functions. ACCOUNTING RECORDS The accounting records for UI are maintained in accordance with the uniform systems of accounts prescribed by the Federal Energy Regulatory Commission (FERC) and the Connecticut Department of Public Utility Control (DPUC). The accounting records of UIL Holdings' non-utility subsidiaries are maintained in conformity with accounting principles generally accepted in the United States of America. BASIS OF PRESENTATION The Consolidated Financial Statements include the accounts of UIL Holdings and its subsidiaries. Intercompany accounts and transactions have been eliminated in consolidation. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to use 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 and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Certain amounts previously reported have been reclassified to conform to the current year presentation. REGULATORY ACCOUNTING Generally accepted accounting principles for regulated entities in the United States of America allow UI to give accounting recognition to the actions of regulatory authorities in accordance with the provisions of Statement of Financial Accounting Standards (SFAS) No. 71, "Accounting for the Effects of Certain Types of Regulation." In accordance with SFAS No. 71, UI has deferred recognition of costs (a regulatory asset) or has recognized obligations (a regulatory liability) if it is probable that such costs will be recovered or obligations relieved in the future through the ratemaking process. The Restructuring Act enacted in Connecticut in 1998 provides for UI to recover previously deferred costs through ongoing assessments to be included in future regulated service rates. See Note (C), "Regulatory Proceedings" for a discussion of the recovery of UI's stranded costs associated with the generation portion of its assets and operations, as well as a discussion of the regulatory decisions that provide for such recovery. In addition to the Regulatory Assets and Liabilities separately identified on the Consolidated Balance Sheet, there are other regulatory assets and liabilities such as certain deferred tax liabilities. UI also has obligations under long-term power contracts, the recovery of which is subject to regulation. If UI, or a portion of its assets or operations, were to cease meeting the criteria for application of these accounting rules, accounting standards for businesses in general would become applicable and immediate recognition of any previously deferred costs, or a portion of deferred costs, would be required in the year in which the criteria are no longer met, if such deferred costs are not recoverable in the - 69 - UIL HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) portion of the business that continues to meet the criteria for application of SFAS No. 71. UI expects to continue to meet the criteria for application of SFAS No. 71 for the foreseeable future. If a change in accounting were to occur, it could have a material adverse effect on UI's earnings and retained earnings in that year and could have a material adverse effect on UI's ongoing financial condition as well. PROPERTY, PLANT AND EQUIPMENT The cost of additions to property, plant and equipment and the cost of renewals and betterments are capitalized. Cost consists of labor, materials, services and certain indirect construction costs, including an allowance for funds used during construction in the case of utility plant. The cost of current repairs and minor replacements is charged to appropriate operating expense accounts. The original cost of utility property, plant and equipment retired or otherwise disposed of and the cost of removal, less salvage, are charged to the accumulated provision for depreciation. Upon disposal or retirement of depreciable non-utility businesses' property, the appropriate plant accounts and accumulated depreciation are reduced by the related costs. Any resulting gain or loss is recognized in the income statement. UIL Holdings' property, plant and equipment as of December 31, 2003 and 2002 was comprised as follows: 2003 2002 ---- ---- (In Thousands) Utility: Transmission plant $141,870 $151,674 Distribution plant 497,233 460,590 General plant 59,662 52,605 Software 51,147 30,271 Other plant 1,847 1,841 ------------ ------------- Subtotal 751,759 696,981 Non-utility business units 32,650 30,886 ------------ ------------- $784,409 $727,867 ============ ============= DEPRECIATION Provisions for depreciation on utility plant for book purposes are computed on a straight-line basis, using estimated service lives determined by independent engineers and subject to review and approval by the DPUC. One-half year's depreciation is taken in the year of addition and disposition of utility plant, except in the case of major operating units on which depreciation commences in the month they are placed in service and ceases in the month they are removed from service. The aggregate annual provisions for depreciation for the years 2003, 2002 and 2001 were approximately 4.5%, 3.8%, and 3.1%, respectively, of the original cost of depreciable property. Depreciation on non-utility businesses' plant for book purposes is recorded on a straight-line basis over the estimated useful lives of the assets, which range from three to seven years. Depreciation of assets classified as "held for sale" ceases on the date the assets meet the criteria to be classified as such (see Discontinued Operations section of this footnote, and Note (O)). INCOME TAXES 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 - 70 - UIL HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) 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 (ITC) related to recoverable plant investments except for the ITC related to Seabrook Unit 1, which was taken into income in accordance with provisions of a 1990 DPUC retail rate decision. REVENUES Regulated utility revenues for UI are based on authorized rates applied to each customer's use of electricity. These retail rates are approved by the DPUC and can be changed only through formal proceedings. Transmission revenues are federally regulated by the FERC. At the end of each accounting period, the estimated amount of revenues for services rendered but not billed is accrued. Revenues from construction contracts entered into by Xcelecom are recognized on a percentage-of-completion method. Under this method, revenue is recognized based on the percentage of costs incurred and accrued to date to the estimated total cost to complete these contracts. Provisions for estimated losses on uncompleted contracts are made in the period in which such losses are determined. Revenues generated by other business units are recognized when earned, generally when the earnings process is complete and an exchange has taken place. CASH AND TEMPORARY CASH INVESTMENTS For cash flow purposes, UIL Holdings considers all highly liquid debt instruments with a maturity of three months or less at the date of purchase to be cash and temporary cash investments. RESTRICTED CASH Prior to the sale of its 17.5% ownership interest in Seabrook Station, UI was required to maintain an operating deposit with the project disbursing agent for operating expenses. With the sale, these funds were placed in escrow to cover operating expenses accrued at the time of sale. Such funds are restricted for use and totaled $1.1 million and $5.6 million at December 31, 2003 and 2002, respectively. Xcelecom maintained restricted cash, related to future debt payments, of $0.3 million and $0.4 million at December 31, 2003 and 2002, respectively. INVESTMENTS UI's investment in the Connecticut Yankee Atomic Power Company, a retired nuclear generating company in which UI has a 9.5% stock interest, is accounted for on an equity basis. This net investment amounted to $4.4 million and $5.4 million at December 31, 2003 and 2002, respectively, and is included on the Consolidated Balance Sheet as a regulatory asset. The Connecticut Yankee nuclear unit was retired in 1996 and is currently being decommissioned. See Note (J), "Commitments and Contingencies - Other Commitments and Contingencies - Connecticut Yankee." UIL Holdings (through UCI and UBE) accounts for certain minority interest investments, such as Cross-Sound Cable Company, LLC, Bridgeport Energy, LLC (BE), Zero Stage and Ironbridge, using the equity accounting method. The results of operations of these investments are reflected in Other Income and (Deductions) on the Consolidated Statement of Income. - 71 - UIL HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) On December 2, 2002, UI purchased the $25 million principal amount of Pollution Control Revenue Refunding Bonds, 1999 Series, due December 1, 2029, issued by the Business Finance Authority of the State of New Hampshire. See Note (B), "Capitalization" for further discussion. MARKETABLE SECURITIES UIL Holdings accounts for its investment securities in accordance with SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities." This statement requires the classification of debt and equity securities into one of three categories: held to maturity, available for sale, or trading. The statement also provides guidelines on accounting for debt and equity securities in accordance with their classifications. During 2001, Anthem Insurance Companies, Inc. (Anthem) completed a conversion from a mutual company, owned by policyholders, to a publicly traded company, owned by shareholders. As a result of this conversion, UIL Holdings received 62,435 shares of Anthem common stock, a portion of which was allocated to employees based on the employees' share of the premiums paid to Anthem during the period used to determine the number of shares issued to UIL Holdings. At December 31, 2001, the closing price for Anthem common stock was $49.50 per share. UIL Holdings recorded an investment and realized a gain of approximately $3.1 million, which represented the value of the shares at December 31, 2001. In January 2002, UIL Holdings sold the 62,435 shares of Anthem common stock at a price of $50.66 and recorded a realized gain of approximately $72,000. On August 9, 2001, APS entered into a secured convertible note agreement with Q Comm International, Inc. (Q Comm), in the amount of $0.2 million. As of December 31, 2001, APS recorded an investment and unrealized gain of approximately $0.9 million in comprehensive income, which represented the difference between the market price of the shares as of December 31, 2001 and the conversion price. The secured convertible note was repaid in May 2002. GOODWILL AND OTHER INTANGIBLE ASSETS Effective January 1, 2002, UIL Holdings adopted SFAS No. 142, "Goodwill and Other Intangible Assets." This statement modifies the accounting and reporting of goodwill and intangible assets. Under this standard, UIL Holdings is no longer amortizing its existing goodwill. In addition, UIL Holdings is required to measure goodwill for impairment annually or more frequently if circumstances indicate a possible impairment. SFAS No. 142 requires goodwill to be allocated to reporting units (Xcelecom and APS) and measured for impairment under a two-step test. UIL Holdings has completed the necessary tests to determine if impairment existed under the prescribed standard and has determined that there was no goodwill impairment related to Xcelecom. A goodwill impairment charge of $7.2 million was recorded during the fourth quarter of 2003 to bring the carrying value of goodwill associated with APS' telephony assets in line with estimated fair value. This impairment charge is included in the results of discontinued operations. Under SFAS No. 142, UIL Holdings has determined the useful life of other intangible assets and is amortizing the value over the useful life. Other intangible assets are required to be tested for impairment in a manner similar to goodwill. In 2003 and 2002, other intangible assets were not impaired. For further information regarding this standard, see Note (N), "Goodwill and Other Intangible Assets," to the consolidated financial statements. - 72 - UIL HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) RESEARCH AND DEVELOPMENT COSTS Research and development costs, including environmental studies, are charged to expense as incurred. PENSION AND OTHER POSTRETIREMENT BENEFITS UIL Holdings accounts for pension plan costs in accordance with the provisions of SFAS No. 87, "Employers' Accounting for Pensions." UIL Holdings accounts for other postretirement benefits, consisting principally of health and life insurance, under the provisions of SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions." URANIUM ENRICHMENT OBLIGATION Under the Energy Policy Act of 1992 (Energy Act), UI was assessed for its proportionate share of the costs of the decontamination and decommissioning of uranium enrichment facilities operated by the Department of Energy (DOE). The Energy Act imposes an overall cap of $2.25 billion on the obligation assessed to the nuclear utility industry and limits the annual assessment to $150 million each year over a 15-year period. UI recovered these assessments in rates as a component of fuel expense. Accordingly, UIL Holdings recognized the unrecovered costs as a regulatory asset on its Consolidated Balance Sheet. As a result of the sale of UI's ownership and leasehold interest in Seabrook Station on November 1, 2002, the buyer is obligated to pay such decontamination and decommissioning fund fees, including but not limited to all annual special invoices issued on and after the closing date by the DOE, as contemplated by its regulation at 10 C.F.R. part 766 implementing sections 1801, 1802, and 1803 of the Atomic Energy Act. NUCLEAR DECOMMISSIONING TRUSTS External trust funds were maintained to fund the estimated future decommissioning costs of the nuclear generating units in which UI had an ownership interest. These costs were accrued as a charge to depreciation expense over the estimated service lives of the units and were recovered in rates on a current basis. UI paid $2.2 million and $3.3 million into the decommissioning trust fund for Seabrook Unit 1 in 2002 and 2001, respectively. The sale of UI's interest in Seabrook Station was consummated on November 1, 2002. UI's share of the Seabrook decommissioning trust funds was transferred to the buyer, along with UI's decommissioning and decommissioning fund obligation, at the closing of the sale. UI made payments totaling $18.7 million to extinguish its decommissioning obligations in 2002. - 73 - UIL HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) IMPAIRMENT OF LONG-LIVED ASSETS SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," requires the recognition of impairment losses on long-lived assets when the book value of an asset exceeds the sum of the expected future undiscounted cash flows that result from the use of the asset and its eventual disposition. If an impairment arises, then the amount of any impairment is measured based on discounted cash flows. This standard also requires that rate-regulated companies recognize an impairment loss when a regulator excludes all or part of a cost from rates, even if the regulator allows the company to earn a return on the remaining costs allowed. Under this standard, the probability of recovery and the recognition of regulatory assets under the criteria of SFAS No. 71 must be assessed on an ongoing basis. At December 31, 2003 and December 31, 2002, UI did not have any assets that were impaired under this standard. Based on natural gas and electricity forward price projections derived from the most recent Department of Energy Annual Outlook report, no conditions were noted to give rise to an impairment of UBE's $82.1 million investment in BE. As of December 31, 2003, UCI had $33 million invested in Cross-Sound. There was no impairment related to this investment as of December 31, 2003 or 2002 as there is a twenty-year contract in place for the entire capacity of the cable once commercial operation is achieved. Cash flow projections based on this contract exceed the carrying value of the investment. These projections are based on the assumption that all permit issues regarding the Cross-Sound cable will be resolved and the cable will achieve commercial operation. A pre-tax impairment loss of $1.0 million was recorded during the fourth quarter of 2003 to bring the carrying value of APS' telephony assets in line with their estimated fair value. In accordance with the provisions of SFAS No. 144, this impairment charge excludes goodwill, which is accounted for under the requirements of SFAS No. 142 (see "Goodwill and Other Intangible Assets" section of Note (A) and Note (N)). This impairment loss is included in the results of discontinued operations. DISCONTINUED OPERATIONS SFAS No. 144 also addresses the accounting for and disclosure of long-lived assets to be disposed of by sale. Under SFAS No. 144, when a long-lived asset or group of assets (disposal group) meets certain criteria set forth in the statement, including a commitment by the company to a plan to sell the long-lived asset (disposal group) within one year: o the long lived-asset (disposal group) will be measured at the lower of its carrying value or fair value less costs to sell, and will be classified as held for sale on the Consolidated Balance Sheet; o the long-lived asset (disposal group) shall not be depreciated (amortized) while it is classified as held for sale; and o the related operations of the long-lived asset (disposal group) will be reported as discontinued operations in the consolidated statement of operations, with all comparable periods restated. At December 31, 2003, APS met the criteria set forth in SFAS No. 144 to be classified as held for sale (see Note (O)). - 74 - UIL HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) EARNINGS PER SHARE The following table presents a reconciliation of the basic and diluted earnings per share calculations for the years 2003, 2002 and 2001:
INCOME APPLICABLE TO AVERAGE NUMBER OF EARNINGS COMMON STOCK SHARES OUTSTANDING PER SHARE ------------ ------------------ --------- (In Thousands, except per share amounts) 2003 - ---- Basic earnings from continuing operations $29,537 14,291 $2.07 Basic earnings from discontinued operations (6,251) 14,291 (0.44) ------------------------ ---------------------- ------------- Basic earnings 23,286 14,291 1.63 Effect of dilutive stock options (1) - 13 - ------------------------ ---------------------- ------------- Diluted earnings $23,286 14,304 $1.63 ======================== ====================== ============= 2002 - ---- Basic earnings from continuing operations $45,751 14,239 $3.22 Basic earnings from discontinued operations (1,804) 14,239 (0.13) ------------------------ ---------------------- ------------- Basic earnings 43,947 14,239 3.09 Effect of dilutive stock options (1) - 43 (0.01) ------------------------ ---------------------- ------------- Diluted earnings $43,947 14,282 $3.08 ======================== ====================== ============= 2001 - ---- Basic earnings from continuing operations $59,563 14,097 $4.22 Basic earnings from discontinued operations (200) 14,097 (0.01) ------------------------ ---------------------- ------------- Basic earnings 59,363 14,097 4.21 Effect of dilutive stock options (1) - 62 (0.02) ------------------------ ---------------------- ------------- Diluted earnings $59,363 14,159 $4.19 ======================== ====================== =============
(1) Dilutive stock options only impact the earnings from continuing operations. STOCK-BASED COMPENSATION Effective January 1, 2003, UIL Holdings adopted the fair value recognition provisions, under the prospective method, of SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure," an amendment of SFAS No. 123, "Accounting for Stock-Based Compensation." Under this statement, UIL Holdings has recorded compensation expense prospectively for stock options granted after January 1, 2003. There were 310,964 stock options granted during 2003 at an average exercise price of $36.26, and, as a result, compensation expense was recorded in the determination of net income for the year ended December 31, 2003. Of the total 310,964 stock options granted during 2003, 3,104 were "reloaded" options, as allowed by the plan. According to SFAS No. 123, options granted using a reload feature should be accounted for as new options granted on the reload date at the current market price. No compensation expense was recorded prior to 2003, as UIL Holdings accounted for employee stock-based compensation in accordance with Accounting Principles Board (APB) No. 25, "Accounting for Stock Issued to Employees," as permitted by SFAS No. 123. The following table illustrates the effect on net income and earnings per share as if the fair-value-based method had been applied to all outstanding and unvested awards in each period. - 75 - UIL HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) STOCK-BASED COMPENSATION
YEAR ENDED DECEMBER 31, 2003 2002 2001 --------------- ----------------- -------------------- (IN THOUSANDS EXCEPT PER SHARE AMOUNTS) Net Income, as reported $23,286 $43,947 $59,363 Add: Stock-based compensation expense included in reported net income, net of related tax effects 362 - - Deduct: Total stock-based compensation determined under fair value based method for all stock option grants, net of related tax effect (930) (1,764) (631) --------------- ----------------- -------------------- Pro forma net income $22,718 $42,183 $58,732 --------------- ----------------- -------------------- Earnings per share: Basic - as reported $1.63 $3.09 $4.21 --------------- ----------------- -------------------- Basic - proforma $1.59 $2.96 $4.17 --------------- ----------------- -------------------- Diluted - as reported $1.63 $3.08 $4.19 --------------- ----------------- -------------------- Diluted - proforma $1.59 $2.95 $4.15 --------------- ----------------- --------------------
The board of directors of UIL Holdings granted 13,200 shares of restricted stock to directors on March 25, 2003. Such shares were granted pursuant to the amendment to the 1999 Stock Option Plan that was approved by shareowners at the UIL Holdings Annual Meeting on May 14, 2003 (details of this amendment are discussed in Note (B), "Capitalization"). The average market price on the date of grant was $34.11, resulting in expense of $0.1 million recognized during 2003. COMPREHENSIVE INCOME Comprehensive income for 2003 included the reversal of approximately $26.2 million, after-tax, of a minimum pension liability adjustment recorded in 2002. UIL Holdings was able to reverse this adjustment as the market value of the UI Pension Plan assets exceeded the accumulated benefit obligation of the plan at the end of 2003, primarily due to a $45 million contribution made to the pension plan on December 31, 2003. The remaining $0.5 million other comprehensive loss was unable to be reversed, as it relates to the non-qualified pension plan which cannot be funded due to personal tax consequences to its participants. Comprehensive income in 2002 included a pre-tax loss of $44.4 million (after-tax $26.7 million) representing the minimum pension liability regarding the UI pension plans, calculated in accordance with the requirements of SFAS No. 87. In addition, UIL Holdings reversed an unrealized pre-tax gain of $0.9 million (after-tax $0.5 million) recorded in 2001 on a convertible note receivable that was repaid in May 2002. Comprehensive income for 2001 included an unrealized pre-tax gain of $0.9 million (after-tax $0.5 million) on APS' convertible note receivable (see "Marketable Securities"). - 76 - UIL HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) NEW ACCOUNTING STANDARDS The FASB has issued interpretation No. 46 (FIN 46), "Consolidation of Variable Interest Entities," an interpretation of Accounting Research Bulletin (ARB) 51 which is effective immediately for variable interest entities as defined in ARB 51, or interests therein, established after January 31, 2003. Additionally, variable interest entities or interests therein established prior to February 1, 2003 will be subject to the provisions of FIN 46 at a future point in time to be determined by the FASB upon issuance of final guidance. The primary objectives of FIN 46 are to provide guidance on the identification of entities for which control is achieved through means other than through voting rights (variable interest entities or VIEs) and how to determine when and which business enterprise should consolidate the VIE (the primary beneficiary). UIL Holdings does not have any VIEs, and therefore the adoption of this standard has not, and is not expected to, have any impact on UIL Holdings' consolidated financial position, results of operations or liquidity. UIL Holdings adopted the provisions of SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity" which became effective as of July 2003. This accounting standard requires accounting for minority interests in limited-life subsidiaries to be reclassified to liabilities and measured at settlement value. Many of the characteristics include financial instruments in the form of shares that are mandatorily redeemable, share repurchase agreements and required share issuances. The adoption of this standard has not had any impact on UIL Holdings' consolidated financial position, results of operations or liquidity, as no such instruments are currently held by UIL Holdings or its subsidiaries. The FASB has issued a new staff position FAS 106-1, "Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003," which permits a sponsor of a postretirement health care plan that provides a prescription drug benefit to make a one-time election to defer accounting for the effects of the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the Act). The Act introduces prescription drug benefits under Medicare (Medicare Part D), as well as a federal subsidy to sponsors of retiree health care benefit plans that provide a benefit that is at least actuarially equivalent to Medicare Part D. The Act introduces a subsidy of 28 percent of an individual beneficiary's annual prescription drug cost between $250 and $5,000 subject to allowable retiree Medicare costs. The Act is effective for claims on or after January 15, 2006. However, UI's Periodic Postretirement benefits costs in the financial statements or accompanying notes do not reflect the effect of the Act on the plan because the authoritative guidance on the accounting for the federal subsidy is pending and that guidance, when issued, could require UI to change previously reported information. This will not have any material financial impact because UI does not cover prescriptions for Medicare eligible employees in its postretirement healthcare plans. The FASB issued SFAS No. 132 (Revised), "Employer's Disclosure about Pensions and Other Postretirement Benefits," which replaces the previously issued SFAS No. 132. The statement retains the disclosures required under the original SFAS No. 132, but also requires additional disclosures about the assets, obligations, cash flows, and net periodic benefit cost of defined benefit pension plans and other defined benefit postretirement plans. Specifically, companies are required to include information describing the types of plan assets, investment strategy, measurement date(s), plan obligations, and components of net periodic benefit cost recognized during interim periods. This statement is effective for fiscal years ending after December 15, 2003. UIL Holdings has adopted the provisions of this standard and the required disclosures are included in Note (G), "Pension and Other Benefits." SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities," requires companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of commitment to an exit or disposal plan. Costs covered by the standard include lease termination costs and certain employee severance costs that are associated with a restructuring, discontinued operation, plant closing, or other exit or disposal activity. SFAS No. 146 is to be applied prospectively to exit or disposal activities initiated after December 31, 2002. UIL Holdings has adopted this standard effective January 1, 2003. A charge of approximately $0.5 million - 77 - UIL HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) was recognized in the results of discontinued operations under this standard in 2003 due to relocation of APS' headquarters. The FASB has issued SFAS No. 143, "Accounting for Asset Retirement Obligations" (SFAS 143). This statement, which is effective for fiscal years beginning after June 15, 2002, requires that an asset retirement obligation be recognized at the time when an entity faces a legal obligation to retire an asset. UI accrues for estimated costs of removal for certain of its plant-in-service. Such removal costs are included in the approved rates used to depreciate these assets. At the end of the service life of the applicable assets, the accumulated depreciation in excess of the historical cost of the asset provides for the estimated cost of removal. In accordance with SFAS No. 143, UI's accrued costs of removal have been reclassified to a regulatory liability. This reclassification is based upon UI's best estimate developed from previous depreciation studies. In 2004, UI will contract for a new independent study to update its cost of removal accrual and amounts to be accrued in future years. In December 2003, the Staff of the Securities and Exchange Commission issued Staff Accounting Bulletin (SAB) No. 104, "Revenue Recognition," which supercedes SAB No. 101, "Revenue Recognition in Financial Statements." SAB No. 104's primary purpose is to rescind accounting guidance contained in SAB No. 101 related to multiple element revenue arrangements. UIL Holdings does not generally enter into multiple element revenue arrangements, and as such, has determined SAB No. 104 does not have a material impact on UIL Holdings' consolidated statement of financial position, results of operations or liquidity. (B) CAPITALIZATION COMMON STOCK UIL Holdings had 14,475,259 shares of its common stock, no par value, outstanding at December 31, 2003 and 14,460,680 shares of its common stock, no par value, outstanding at December 31, 2002, of which 160,660 shares and 188,600 shares were unallocated shares held by UI's 401(k)/Employee Stock Ownership Plan (KSOP) and not recognized as outstanding for accounting purposes as of December 31, 2003 and 2002, respectively. UI has an arrangement under which it loaned $11.5 million to the KSOP. Prior to the formation of UIL Holdings, the trustee for the KSOP used the funds to purchase 328,300 shares of UI common stock in open market transactions. On July 20, 2000, effective with the formation of a holding company structure, unallocated shares held by the KSOP were converted into shares of UIL Holdings' common stock. The shares will be allocated to employees' KSOP accounts, as the loan is repaid, to cover a portion of the required KSOP contributions. The loan will be repaid by the KSOP over a twelve-year period ending October 1, 2009, using employer contributions and UIL Holdings' dividends paid on the unallocated shares of the stock held by the KSOP. As of December 31, 2003, 160,660 shares, with a fair market value of $7.2 million, had been purchased by the KSOP and had not been committed to be released or allocated to KSOP participants. On June 28, 1999, UI's shareowners approved a stock option plan for directors, officers and key employees of UI, providing for the awarding of options to purchase up to 650,000 shares of common stock over periods from one to ten years following the dates when the options are granted. The exercise price of each option cannot be less than the market value of the stock on the date of the grant. Effective with the formation of the holding company structure on July 20, 2000, all options were converted into options to purchase shares of UIL Holdings' common stock. On March 25, 2002, the Board of Directors recommended to the shareowners that the plan be amended to increase the maximum number of shares of UIL Holdings' common stock for which stock options may be granted from 650,000 to 1,350,000, and to increase the limit on the number of shares that may be covered by options granted in any one year to any employee from 50,000 to - 78 - UIL HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) 150,000. The shareowners approved this amendment at the UIL Holdings Annual Meeting on May 15, 2002. On March 24, 2003, the Board of Directors recommended to the shareowners that the 1999 Stock Option Plan be amended and restated as the UIL Holdings Corporation 1999 Amended and Restated Stock Plan (Stock Plan). Under the Stock Plan, a maximum of 1,350,000 shares of UIL Holdings' common stock is authorized for issuance upon exercise or granting of stock options, stock appreciation rights (SARS), restricted stock, restricted stock units, performance shares and other awards (collectively, Awards). No more than 200,000 shares of stock may be issued pursuant to Awards of restricted stock, restricted stock units and performance share awards. Shareowners approved the Stock Plan at the UIL Holdings Annual Meeting on May 14, 2003. Stock option transactions for 2003, 2002 and 2001 are as follows:
WEIGHTED AVERAGE NUMBER OPTION PRICE EXERCISE OF OPTIONS PER SHARE PRICE ---------- ------------ ---------- Balance - December 31, 2000 332,730 $30.00-$53.13 $41.00 Granted 176,633 (1) $43.22-$49.84 $45.30 Forfeited (5,333) $39.41-$43.22 $40.48 Exercised (12,023) $39.41-$43.22 $41.00 -------------- Balance - December 31, 2001 492,007 $30.00-$53.13 $42.55 Granted 302,017 (1) $52.16-$57.99 $56.30 Forfeited (21,633) $39.41-$56.61 $50.66 Exercised (185,937) $30.00-$45.18 $41.18 -------------- Balance - December 31, 2002 586,454 $39.41-$57.99 $49.77 Granted 310,964 (1) $36.13-$44.65 $36.26 Forfeited - - - Exercised (12,883) $39.41 $39.41 -------------- Balance - December 31, 2003 884,535 $36.13-$57.99 $45.17 ============== Exercisable at December 31, 2001 186,822 $30.00-$53.13 $41.38 Exercisable at December 31, 2002 223,698 $39.41-$57.99 $46.37 Exercisable at December 31, 2003 374,249 $39.41-$57.99 $47.84
(1) One-third of the options granted became exercisable on each of the first three anniversaries of the grant date. The fair value of stock options granted has been estimated on the date of grant using the binomial option-pricing model for 2003 and 2002 and the Black-Scholes option-pricing model for 2001 using the assumptions below. The binomial option-pricing model is more appropriate for valuing options on stocks with high dividend yields, such as UIL Holdings. In 2002, UIL Holdings changed its method of option valuation. The Black-Scholes option-pricing model, if used for 2002, would have produced a lower option value. 2003 2002 2001 ---- ---- ---- Risk-free interest rate 4.31% 5.40% 5.75% Expected volatility 24.65% 22.53% 21.92% Expected lives 7.20 years 6.80 years 7.59 years Expected dividend yield 6.37% 6.01% 6.11% - 79 - UIL HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) The weighted average fair value of options granted during 2003, 2002 and 2001 were $6.25, $9.71, and $6.09 per share, respectively. As of December 31, 2003, 2002 and 2001, the weighted average remaining contractual lives for those options outstanding were 7.2 years, 6.8 years, and 7.6 years, respectively. On February 23, 1998, UI's Board of Directors granted 80,000 "phantom" stock options to Nathaniel D. Woodson upon his appointment as President of UI. Effective with the formation of the holding company structure on July 20, 2000, all outstanding phantom stock options were converted to UIL Holdings' phantom stock options. At December 31, 2003, 80,000 phantom stock options were exercisable and can be exercised at any time within Mr. Woodson's period of employment with UI by means of UI paying him the difference between the prevailing market price for each share of UIL Holdings' common stock and the phantom stock option price of $45.16 per share. On February 23, 2008 any unexercised phantom stock options will expire. During 2002 $448,000 was recognized as income with regard to phantom stock options due to a decrease in the stock price during 2002, which resulted in a reduction in previously recognized cumulative expense. There was no income or expense recognized in 2003 related to these phantom stock options. LONG-TERM DEBT
DECEMBER 31, 2003 2002 ---- ---- (In Thousands) Pollution Control Revenue Refunding Bonds: 4.35%, 1996 Series, due June 1, 2026 (1) $ 7,500 $ 7,500 5 7/8%, 1993 Series, due October 1, 2033 - 64,460 3.75%, 1997 Series, due July 1, 2027 (2) 27,500 27,500 4.55%, 1997 Series, due July 1, 2027 (1) 71,000 71,000 3.25%, 1999 Series, due December 1, 2029 (3) 25,000 25,000 Auction Rate, 2003 Series, due October 1, 2033 (4) 64,460 - Notes: 6.00%, 1998 Series J, due December 15, 2003 - 100,000 4.42% Senior Notes, Series A, due December 12, 2007 74,000 74,000 3.95% Senior Notes, due December 9, 2008 100,000 - 4.89% Senior Notes, Series B, due December 12, 2009 51,000 51,000 7.23% Senior Notes, Series A, due February 15, 2011 30,000 30,000 7.38% Senior Notes, Series B, due February 15, 2011 45,000 45,000 --------------- --------------- Long-Term Debt 495,460 495,460 Unamortized debt discount less premium - (28) --------------- --------------- 495,460 495,432 Less: Current portion of long-term debt - 100,000 --------------- --------------- Net Long-Term Debt $495,460 $395,432 =============== ===============
- 80 - UIL HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) (1) The interest rate on these Bonds was fixed on February 1, 1999 for the five-year period ending February 1, 2004. On February 2, 2004, the interest rate was reset for a five-year period ending February 1, 2009. (2) The interest rate on these Bonds was fixed on February 1, 2002 for the two-year period ending February 1, 2004. On February 2, 2004, the interest rate was reset for a one-year period ending February 1, 2005. (3) The interest rate on these Bonds was fixed on February 5, 2003 for a four-year, ten-month period ending December 3, 2007. (4) The interest rate on these Bonds will be reset through an auction held every 35 days. On December 31, 2003, the interest rate on the Bonds was 1.1%. On December 2, 2002, UI purchased $25 million principal amount of Pollution Control Revenue Refunding Bonds, 1999 Series, due December 1, 2029 (the 1999 Series Bonds), issued by the Business Finance Authority of the State of New Hampshire (BFA). The 1999 Series Bonds were held by UI as an investment while the borrowing agreement with the BFA was amended to provide more remarketing flexibility. On February 5, 2003, the 1999 Series Bonds were sold to investors and the interest rate was fixed at 3.25%. The new interest rate will remain in effect for a four-year ten-month period to December 3, 2007. UI is obligated, under its borrowing agreement with the BFA, to pay the interest on the Bonds. Interest is payable semi-annually on June 1st and December 1st. On September 4, 2003, $64.5 million principal amount of Pollution Control Revenue Refunding Bonds, 2003 Series, due October 1, 2033 (the 2003 Bonds), were issued by the BFA. The 2003 Bonds were issued to refinance $64.5 million principal amount of 5 7/8%, Pollution Control Revenue Refunding Bonds, 1993 Series, due October 1, 2033, which were redeemed on October 6, 2003. The 2003 Bonds were issued in an "Auction Rate Mode," and the interest rate will be reset through an auction held every 35 days. The interest rate on the 2003 Bonds, as of December 31, 2003, was 1.1%. UI is obligated, under its borrowing agreement with the BFA, to pay interest on the 2003 Bonds. On December 9, 2003, UI issued and sold $100 million of Senior Notes to several institutional investors in a private sale. The Senior Notes must be repaid on December 9, 2008. Interest due under the Senior Notes is payable semi-annually on June 9th and December 9th. The net proceeds of the sale were used to repay the maturing 6% Notes, 1998 Series J, due December 15, 2003. On February 2, 2004, the interest rate on $7.5 million principal amount of Pollution Control Revenue Refunding Bonds, 1996 Series, due June 1, 2026, issued by the Connecticut Development Authority (CDA), was reset from 4.35% to 3.00%. The new interest rate will remain in effect for a five-year period to February 1, 2009. UI is obligated, under its borrowing agreement with the CDA, to pay the interest on the Bonds. Interest is payable semi-annually on August 1st and February 1st. On February 2, 2004, the interest rate on $98.5 million principal amount of Pollution Control Revenue Refunding Bonds, 1997 Series, due July 1, 2027, issued by the BFA, was reset. The interest rate on $27.5 million principal amount of the Bonds was reset from 3.75% to 2.05% for a one-year period to February 1, 2005. The interest rate on $71 million principal amount of the Bonds was reset from 4.55% to 3.50% for a five-year period to February 1, 2009. UI is obligated, under its borrowing agreement with the BFA, to pay the interest on the Bonds. Interest is payable semi-annually on August 1st and February 1st. The expenses to issue long-term debt are deferred and amortized over the life of the respective debt issue. Maturities and mandatory redemptions/repayments are set forth below: 2004 2005 2006 2007 2008 ---- ---- ---- ---- ---- (In Thousands) Maturities $ - $4,286 $4,286 $78,286 $104,286 - 81 - UIL HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) (C) REGULATORY PROCEEDINGS RATE CASE On September 26, 2002, the DPUC issued a final decision in UI's retail customer ratemaking (Rate Case) proceeding. The decision provides for a $30.9 million reduction in UI's annual revenue requirements, including (1) a $20.3 million reduction to UI's customer rates, (2) $2.0 million to be applied annually for additional funding of conservation programs, (3) $8.3 million to be applied annually to reduce stranded costs, and (4) $0.3 million to be applied to a combination of uncollectibles, taxes and rate base changes. In accordance with the decision, and after converting from a revenue requirements basis to stranded cost treatment, UI recorded accelerated amortization of stranded costs of $5.6 million before-tax ($4.7 million after-tax) in the fourth quarter of 2002, and reduced customer rates by 3% overall and is continuing accelerated amortization at $1.4 million before-tax ($1.2 million after-tax) per quarter as of January 1, 2003. The rate reductions, approved by the DPUC, are applied with no significant rate design changes, although the generation services charge (GSC) component of customers' rates was increased and the competitive transition assessment (CTA) component was decreased in a dollar amount equal to the GSC increase. The final Rate Case decision established rates on the basis of an authorized return on equity of 10.45% for non-transmission rate base. Earnings above the authorized return are to be shared 50% to customers and 50% to net income, with the customers' share divided equally between bill reductions and an accelerated amortization of stranded costs. The Rate Case decision recognizes that the revenue requirements determination for transmission, including the applicable return on equity, is within the jurisdiction of the FERC. UI's authorized return on equity for transmission is 10.75%. On January 8, 2003, in a reopened proceeding requested by UI, the DPUC issued a decision making a technical change to the Rate Case decision, approving UI's proposed revenue transfer of $3.9 million annually from CTA to the delivery component of rates beginning with the September 26, 2002 effective date and continuing until the decision in UI's next rate case proceeding. On March 26, 2003, the DPUC issued a decision granting UI's request to reopen the September 2002 Rate Case decision, to examine increased pension and postretirement benefits expenses of UI for 2003. On June 25, 2003, the DPUC issued a decision denying, without prejudice, UI's request for recovery of $15.5 million in increased pension and postretirement benefits expenses. On September 10, 2003, the DPUC granted UI's request to reopen the June 25, 2003 decision. On November 24, 2003, UI and the Prosecutorial Division of the DPUC (PRO) reached a settlement agreement, which was filed with the DPUC providing for the annual recovery by UI of an additional $10.5 million of expenses effective with final DPUC approval of the agreement. The settlement also would have modified the earnings sharing mechanism from 50% to shareholders and 50% to customers, to 25% to shareholders and 75% to customers, with the entire customer portion being utilized to reduce stranded costs. The settlement agreement also stipulated that UI will not file a rate case before January 1, 2005. On February 9, 2004, the DPUC issued a draft decision that accepted the settlement agreement provided that UI and PRO agreed to reduce the $10.5 million annual recovery to $5.2 million and to increase the customer portion of shared earnings in excess of the authorized return to 100% from 75%. While UI believes $5.2 million is not sufficient to offset the increased costs, it will offer some level of relief above what is currently included in rates. As such, UI accepted the changes required by the draft decision. On February 18, 2004, the DPUC issued a final decision approving the settlement with the specified modifications. PUBLIC ACT 98-28 In April 1998, the Connecticut legislature enacted Public Act 98-28 (the Restructuring Act), a statute designed to restructure the regulated electric utility industry. As a result of the Restructuring Act, the business of selling - 82 - UIL HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) electricity directly to consumers has been opened to competition since January 2000. The business of delivering electricity remains with the incumbent franchised utility companies (including UI). A major component of the Restructuring Act is the collection, by distribution companies, of a "competitive transition assessment," a "systems benefits charge," an "energy conservation and load management program charge" and a "renewable energy investment charge." The competitive transition assessment represents costs that have been reasonably incurred, or will be incurred, by distribution companies to meet their public service obligations, and that will likely not otherwise be recoverable in a competitive generation and supply market. These costs include above-market long-term purchased power contract obligations, regulatory asset recovery and above-market investments in power plants (stranded costs). The systems benefits charge represents public policy costs, such as generation decommissioning and displaced worker protection costs. Beginning in 2000, UI has collected the competitive transition assessment, the systems benefits charge, the energy conservation and load management program charge and the renewable energy investment charge from customers. The DPUC has an annual proceeding to review UI's collection of the competitive transition assessment and systems benefits charge for the prior year, and to establish the applicable competitive transition assessment charge and systems benefits charge for the next year. Because of overcollection of systems benefits charge revenues in 2002, and an expectation that such revenues will exceed systems benefits charge costs in 2003 and 2004, the DPUC has ordered that UI's systems benefits charge on customers' bills be reduced for 2004. Under the Restructuring Act, all Connecticut electricity customers are able to choose their electricity suppliers. Through December 31, 2003, UI was required to offer retail service to its customers under a regulated "standard offer" rate to each customer who did not choose an alternate electricity supplier, even though UI is no longer in the business of power generation. UI was also required under the Restructuring Act to provide back-up power supply service to customers whose alternate electricity supplier failed to provide power supply services for reasons other than the customers' failure to pay for such services. On December 28, 2001, UI entered into an agreement with Virginia Electric and Power Company, which was subsequently assigned to its affiliate Dominion Energy Marketing, for the supply of all of UI's standard offer generation service needs from January 1, 2002 through December 31, 2003, and for the supply of all of UI's generation service requirements for special contract customers through 2008. In June 2003, the Connecticut General Assembly enacted Public Act 03-135, subsequently amended in part by Public Act 03-221, to provide for electric distribution companies to provide "transitional standard offer service," beginning January 1, 2004 and continuing through December 31, 2006, to each customer who does not choose an alternate energy supplier. On October 22, 2003, UI entered into an agreement with PSEG Energy Resources & Trade LLC (PSEG) for the supply of all of UI's transitional standard offer generation service needs, excluding requirements for special contract customers, from January 1, 2004 through December 31, 2006, the end of the transitional standard offer period in Connecticut. The 2003 legislation also makes other changes to restructuring on a going forward basis, including a provision for information on "federally mandated congestion costs" to be on customer bills. In addition, the legislation requires that any new rate case filings include a four-year rate plan. The legislation also provides for the electric distribution companies to recover their costs of procuring and providing transitional standard offer service. Public Act 03-135 provides for a fee of $0.0005 per kilowatt-hour to be collected by the electric distribution company as further compensation for the procurement of transitional standard offer supply. Renewable energy portfolio standards will be in effect as of January 1, 2004, pursuant to the legislation, for generation services provided to retail customers. UI has included the requirement to meet these standards for transitional standard offer customers in its power supply agreement, consistent with statutory requirements. The legislation is being implemented through several DPUC proceedings. In December 2003, the DPUC established UI's transitional standard offer rates to be effective January 1, 2004, in accordance with the 2003 Restructuring Legislation. - 83 - UIL HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) SALE OF NUCLEAR GENERATION The Restructuring Act required that, in order for UI to recover any stranded costs, it must attempt to divest its ownership interests in two nuclear-fueled power plants prior to 2004. On October 1, 1998, in its "unbundling plan" filing with the DPUC under the Restructuring Act, and in other regulatory dockets, UI stated that it planned to divest its nuclear generation ownership and leasehold interests (17.5% of Seabrook Station in New Hampshire and 3.685% of Millstone Unit 3 in Connecticut) by the end of 2003, in accordance with the Restructuring Act. The sale of UI's ownership in Millstone Unit 3 was consummated on March 31, 2001. UI's share of the proceeds from the sale, including nuclear fuel, was $34.4 million, before settlement of its decommissioning obligation. On February 27, 2003, the DPUC issued a final decision on the Millstone Divestiture Plan Disposition of Proceeds authorizing UI to reduce its stranded cost balances by $15.4 million. The sale of UI's investment in Seabrook Station and the termination of the sale/leaseback of a portion of its interest in Seabrook Unit 1 was consummated on November 1, 2002. In compliance with the Connecticut electric industry restructuring legislation, the net-of-tax gain on these transactions, after adjusting for transaction costs and sale-related costs, was used to reduce UI's stranded costs. In UI's compliance filing with the DPUC on April 30, 2003, UI reported a net-of-tax gain of approximately $5.0 million. A draft decision was issued on February 3, 2004, approving UI's calculation without modification. A final decision is scheduled for the beginning of March 2004. OTHER REGULATORY MATTERS DEPARTMENT OF PUBLIC UTILITY CONTROL UI generally has several regulatory proceedings open and pending at the DPUC at any given time. Examples of such proceedings include an annual DPUC review and reconciliation of UI's competitive transition assessment and systems benefits charge revenues and expenses, dockets to consider specific restructuring or electricity market issues, consideration of specific rate or customer issues, and review of conservation programs. Public Act 03-6 of the June 30, 2003 special session and Public Act 03-1 of the September 8, 2003 special session of the Connecticut General Assembly provides for the period February 1, 2003 through July 31, 2005, for certain of the funds collected by electric distribution companies from retail customers in the Conservation and Load Management (C&LM) charge to be transferred to the general funds of the state. The legislation provides that the transfer of funds would not occur provided that the C&LM and Renewable Energy Investment (REI) funds are securitized for two fiscal years beginning July 1, 2003, through the state's issuance of rate reduction bonds secured by customer revenue streams. On October 28, 2003, the DPUC issued a financing order providing for the issuance of rate reduction bonds, adjustment of the C&LM and REI charges, and an increase in the corresponding CTA charge on customers' bills. The rate reduction bonds are expected to be issued by the state by the end of the first quarter of 2004. The amounts collected through the CTA for servicing of the rate reduction bonds will not be revenue to UI. As a result, the securitization will have the effect of reducing UI's revenue by approximately $6.5 million annually. Absent securitization, these amounts would otherwise have been utilized for C&LM or REI and recorded as expense. UI's management does not expect there to be any material effect on UI's earnings or financial conditions as a result of such securitization. TAX CREDITS RELATED TO THE SALE OF GENERATION On March 3, 2003, the Internal Revenue Service (IRS) issued proposed regulations that would allow electric utilities to return certain tax benefits pertaining to divested generation assets to customers. Specifically, these regulations deal - 84 - UIL HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) with accumulated deferred investment tax credits (ADITC) and excess deferred federal income taxes (EDFIT) associated with generation assets. UI had been previously ordered by the DPUC to seek a Private Letter Ruling (PLR) from the IRS requesting permission to immediately flow-through to customers $3.2 million of ADITC and $0.2 million of EDFIT relating to its formerly owned fossil-fueled generating stations. In addition to the sale of its fossil-fueled generating stations, UI also had ADITC in the amount of $4.7 million relating to the sale of its ownership interest in the Millstone Unit 3 nuclear generating facility. While the proposed regulations, as written, do allow electric utilities to return ADITC and EDFIT to customers, the utility may do so only at the same rate that would have been permitted if the generation assets remained public utility property, not immediately, as had been sought in UI's PLR request. Although the IRS has not officially responded to UI's PLR request, these proposed regulations provide authoritative guidance with respect to the IRS' position as to the treatment of these tax benefits. The IRS allowed for the submission of written comments during a public comment period ended June 2, 2003, as well as at a public hearing that was held at the IRS National Office on June 25, 2003. To date, the IRS has not issued final regulations with respect to this matter. In the event the final regulations remain in their current form, there would be no resulting material impact on UI's earnings or cash flow. BRIDGEPORT RESCO GENERATING FACILITY Effective January 1, 2003, UI began selling its energy entitlement from its long-term purchase power contract with the Bridgeport RESCO generating facility into the New England wholesale market at market prices. To the extent that UI receives revenue from these sales that exceed the amount it pays to Bridgeport RESCO for this energy on a cumulative basis, the difference is used to adjust the above market portion of purchase power expense recovered through UI's CTA. This methodology has been approved by the DPUC, with all relevant data and calculations subject to review in the annual CTA reconciliation docket. To the extent that expenses paid for this energy exceed revenues on a cumulative basis, UI would advise the DPUC and propose an alternative recovery mechanism. EXCESS GSC Public Act 03-135 requires the DPUC to allocate the proceeds of the electric distribution company's retail adder (excess GSC revenues over GSC costs) to the utility's cost of procuring power, then to mitigate the increase in cost relative to the existing standard offer that would be recovered from the customer and then to stranded cost recovery. As a result, the DPUC ordered UI to cease any further application of the retail adder toward accelerated stranded cost reduction, pending DPUC determination of the use of the funds in future proceedings. Until such review, UI was to "bank" such excess GSC amounts in a liability account. As of December 31, 2003, $7.5 million was recorded as a liability for excess GSC. On December 18, 2003, the DPUC issued a final decision on the Transitional Standard Offer docket which, among other things, ordered UI to amortize $3.6 million of the banked amount over the next three years, with the remainder to be used to offset temporary cash flow shortfalls resulting from the difference between the GSC collected from customers through rates and the monthly cost for transitional standard offer supply. FEDERAL ENERGY REGULATORY COMMISSION UI has constructed transmission facilities to connect the 330-megawatt transmission cable, connecting Connecticut and Long Island under Long Island Sound, owned by Cross Sound Cable Company, LLC (Cross-Sound) to the New England Power Pool (NEPOOL) transmission grid. Cross-Sound has paid UI $2 million for the construction costs. The FERC has clarified its recent order directing UI to reclassify a portion of this construction as transmission network upgrades noting UI will not be required to reimburse Cross-Sound for any of the construction monies received. Cross-Sound has requested the FERC for a rehearing - 85 - UIL HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) of the Commission's latest order. A FERC response to Cross-Sound's rehearing request is expected soon. The annual facilities charge will continue to be reviewed by the FERC. UI is required to file information regarding Regional Network Service transmission on an annual basis with the FERC. REGIONAL TRANSMISSION ORGANIZATION FOR NEW ENGLAND On October 31, 2003, ISO New England Inc. (ISO-NE) filed a joint proposal with the New England Transmission Owners at the FERC for the creation of a Regional Transmission Organization (RTO). ISO-NE expects that the creation of an RTO for New England will strengthen the independent oversight of the region's bulk power system and wholesale electricity marketplace. UI is a signatory to the filing and, if approved by the FERC, would have the opportunity to join the New England RTO and become eligible for the FERC's transmission return on equity joining incentive (50 basis points above the approved transmission return on equity). If approved, the RTO could become operational in 2004. (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 maturities from one day up to six months. JPMorgan Securities, Inc. acts as an agent and sells the loans to investors. The fixed interest rates on the loans are determined based on conditions in the financial markets at the time of each loan. As of December 31, 2003, UIL Holdings had $24.5 million outstanding under this arrangement. UIL Holdings has a revolving credit agreement with a group of banks that was amended July 31, 2003 and extended to July 29, 2004. The borrowing limit of this facility is $100 million. The facility permits UIL Holdings to borrow funds at a fluctuating interest rate determined by the prime lending market in New York, and also permits UIL Holdings to borrow money for fixed periods of time specified by UIL Holdings at fixed interest rates determined by the Eurodollar interbank market in London (LIBOR). If a material adverse change in the business, operations, affairs, assets or condition, financial or otherwise, or prospects of UIL Holdings and its subsidiaries, on a consolidated basis, should occur, the banks may decline to lend additional money to UIL Holdings under this revolving credit agreement, although borrowings outstanding at the time of such an occurrence would not then become due and payable. As of December 31, 2003, UIL Holdings had $40.0 million in short-term borrowings outstanding under this facility. Xcelecom has a revolving credit agreement with two banks that expires on June 30, 2004. This agreement provides for a $25 million revolving loan facility, available to meet working capital needs and up to $5 million in capital equipment needs, and to support standby letters of credit issued by Xcelecom in the normal course of its business. Capital equipment loans under this facility can be converted to amortizing term loans with a maturity of up to four years. This agreement also provides for the payment of interest at a rate, at the option of Xcelecom, based on the agent bank's prime interest rate or LIBOR. As of December 31, 2003, there were no borrowings outstanding on the revolving working capital balance of this facility. Xcelecom had $1.4 million of capital equipment funding that had been converted to term notes outstanding and standby letters of credit of $4.6 million outstanding at December 31, 2003. All borrowings outstanding under this agreement are secured solely by assets of Xcelecom and its subsidiaries. APS had a revolving credit agreement with a bank that expired on April 11, 2003, at which time APS repaid all borrowings outstanding under the agreement. The funds for the repayment were provided by UIL Holdings. All short-term capital requirements that exceed available cash from operations are currently provided by UIL Holdings, under a short-term loan arrangement. In connection with the - 86 - UIL HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) close of the APS sale transaction, UIL Holdings will be paid any amounts due under this short-term loan arrangement. As of December 31, 2003, the outstanding balance under this arrangement was $3.5 million. Information with respect to short-term borrowings of UIL Holdings and Xcelecom are as follows:
2003 2002 2001 ---- ---- ---- (In Thousands) UIL HOLDINGS - ------------ Maximum aggregate principal amount of short-term borrowings outstanding at any month-end $64,500 $50,000 $129,000 Average aggregate short-term borrowings outstanding during the year* $32,471 $19,771 $43,421 Weighted average interest rate* 1.8% 2.3% 5.8% Principal amounts outstanding at year-end $64,500 $39,000 $18,000 Annualized interest rate on principal amounts outstanding at year-end 1.9% 2.1% 2.9% Fees* $462 $365 $297 XCELECOM - -------- Maximum aggregate principal amount of short-term borrowings outstanding at any month-end $4,740 $13,965 $13,800 Average aggregate short-term borrowings outstanding during the year* $2,175 $6,804 $7,746 Weighted average interest rate* 2.5% 2.6% 3.3% Principal amounts outstanding at year-end - $3,050 $12,930 Annualized interest rate on principal amounts outstanding at year-end - 3.1% 2.7% Fees* $157 $119 $25
* Average short-term borrowings represent the sum of daily borrowings outstanding, weighted for the number of days outstanding and divided by the number of days in the period. The weighted average interest rate is determined by dividing interest expense by the amount of average borrowings. Fees are excluded from the calculation of the weighted average interest rate. - 87 - UIL HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) (E) INCOME TAXES
2003 2002 2001 ---- ---- ---- (In Thousands) Income tax expense for continuing operations consists of: Income tax provisions: Current Federal $ 11,151 $ (24,524) $ 55,814 State 4,971 (5,150) 11,112 -------------- -------------- -------------- Total current 16,122 (29,674) 66,926 -------------- -------------- -------------- Deferred Federal 16,401 56,363 (14,083) State 1,314 11,353 (3,970) -------------- -------------- -------------- Total deferred 17,715 67,716 (18,053) -------------- -------------- -------------- Investment tax credits (387) (564) (658) -------------- -------------- -------------- Total income tax expense for continuing operations $ 33,450 $ 37,478 $ 48,215 ============== ============== ============== Income tax components charged as follows: Operating tax expense $ 36,130 $ 39,455 $ 52,392 Nonoperating tax expense (2,680) (1,976) (4,177) -------------- -------------- -------------- Total income tax expense $ 33,450 $ 37,479 $ 48,215 ============== ============== ============== The following table details the components of the deferred income taxes: Gain on sale of utility property (51) (280) (9,680) Seabrook sale/leaseback transaction - 8,525 (2,546) Seabrook lease buyout - 28,156 - Seabrook II Sale - (1,885) - Pension benefits 11,238 2,189 729 Accelerated depreciation 6,646 (335) (2,891) Tax depreciation on unrecoverable plant investment - 34,805 202 Unit overhaul and replacement power costs - - 939 Conservation and load management (107) (107) (107) Displaced worker protection costs (353) (956) (333) Bond redemption costs (1,026) (1,026) (1,026) Cancelled nuclear project (300) (467) (467) Restructuring costs (538) (538) (538) Regulatory deferrals 2,345 1,570 804 Other - net (139) (1,935) (3,139) -------------- -------------- -------------- Deferred income taxes - net $ 17,715 $ 67,716 $ (18,053) ============== ============== ==============
- 88 - UIL HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) Total income taxes differ from the amounts computed by applying the federal statutory tax rate to income before taxes. The reasons for the differences are as follows:
2003 2002 2001 ---- ---- ---- (In Thousands) Computed tax at federal statutory rate $22,046 $29,130 $37,733 Increases (reductions) resulting from: ITC taken into income (387) (564) (658) Allowance for equity funds used during construction (531) (433) (393) Amortization of regulatory asset 7,925 11,345 14,000 Book depreciation in excess of non-normalized tax depreciation (150) (3,000) (3,445) State income taxes, net of federal income tax benefits 4,085 4,033 4,642 Other items - net 462 (3,033) (3,664) ---------------- ---------------- ---------------- Total income tax expense $33,450 $37,478 $48,215 ================ ================ ================ Book income before income taxes $62,987 $83,229 $107,778 ================ ================ ================ Effective income tax rates 53.1% 45.0% 44.7% ================ ================ ================
As a result of the sale of UI's interests in Seabrook Station and the termination of the associated Seabrook Lease Obligation on November 1, 2002, UIL Holdings incurred a net operating loss for federal income tax purposes for the year 2002 of approximately $78 million that was carried forward to the year 2003. On December 31, 2003, UIL Holdings made a $45 million contribution to the pension plan. This contribution will be claimed as a current income tax deduction for the year 2003 and thereby takes the place of $45 million of the 2002 net operating loss carry forward which otherwise would have been utilized in 2003. Therefore, during the year 2003 only approximately $27 million of the net operating loss carry forward was utilized, leaving a balance of $51 million of unutilized net operating losses to be carried forward and utilized against future taxable income. Legislation enacted in Connecticut on February 28, 2003 imposed a 20% surcharge on the corporation business tax for the year 2003 only. This surcharge, which was made retroactive to January 1, 2003, effectively increased the statutory rate of Connecticut corporation business tax from 7.5% to 9.0% for the year 2003. Due to this change, the combined effective statutory federal and state income tax rate for UIL Holdings' Connecticut-based entities will increase slightly from 39.875% to 40.85% for the year 2003. In addition, legislation was also enacted in Connecticut on August 16, 2003 which imposes a 25% surcharge on the corporation business tax for the year 2004, which will increase the statutory rate of Connecticut corporation business tax from 7.5% to 9.375% for the year 2004 only. Due to this change, the combined effective statutory federal and state income tax rate for UIL Holdings' Connecticut based entities will increase slightly from 40.85% to 41.094% for the year 2004. The effective income tax rate for the year ended December 31, 2003 was 53.1% as compared to 45.0% for the year ended December 31, 2002. The increase in the 2003 rates is due primarily to: (1) the imposition of a 20% surcharge on the Connecticut corporation business tax for the year 2003, (2) one-time adjustments to deferred income tax reserves associated with CTA, and (3) differences in the amounts of book depreciation in excess of non-normalized tax depreciation. - 89 - UIL HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) At December 31, 2003, UIL Holdings had deferred tax liabilities for taxable temporary differences of $359 million and deferred tax assets for deductible temporary differences of $26 million, resulting in a net deferred tax liability of $333 million. Significant components of deferred tax liabilities and assets were as follows: tax liabilities on book/tax plant basis differences and on the cumulative amount of income taxes on temporary differences previously flowed through to ratepayers, $198 million, tax liabilities on accelerated depreciation timing differences, $113 million, and tax assets on 2002 net operating loss carryforward, $8 million. - 90 - UIL HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) (F) SUPPLEMENTARY INFORMATION - CONTINUING OPERATIONS
2003 2002 2001 ---- ---- ---- (In Thousands) OPERATING REVENUES - ------------------ Utility Retail $ 613,885 $ 639,025 $ 627,178 Wholesale 24,591 58,249 61,570 Other 31,144 30,259 26,070 Non-utility business unit revenues Xcelecom 294,036 310,044 312,556 Other 21 19 86 ----------- ----------- ----------- Total Operating Revenues $ 963,677 $1,037,596 $1,027,460 =========== =========== =========== SALES BY CLASS (MEGAWATT-HOURS) - UNAUDITED - ------------------------------------------- Retail Residential 2,261,954 2,247,196 2,119,976 Commercial 2,501,996 2,465,711 2,476,027 Industrial 951,746 1,021,586 1,082,394 Other 47,356 46,517 46,073 ----------- ----------- ----------- 5,763,052 5,781,010 5,724,470 Wholesale 478,185 1,812,540 2,030,365 ----------- ----------- ----------- Total Sales by Class 6,241,237 7,593,550 7,754,835 =========== =========== =========== FUEL AND ENERGY - --------------- Fuel and Energy Expense (1) $ 296,707 $ 293,209 $ 298,021 Purchase Power above market fuel expense credit (24,034) (24,014) (26,114) ----------- ----------- ----------- Total Fuel and Energy Expense $ 272,673 $ 269,195 $ 271,907 =========== =========== =========== DEPRECIATION AND AMORTIZATION - ----------------------------- Utility property, plant, and equipment $ 28,274 $ 26,336 $ 25,549 Non-utility business property, plant and equipment 3,540 3,155 1,696 Nuclear Decommissioning - 2,241 3,384 ----------- ----------- ----------- Total Depreciation 31,814 31,732 30,629 ----------- ----------- ----------- Amortization of nuclear plant regulatory assets 20,197 30,690 15,657 Amortization of purchase power contracts (1) 24,034 24,014 26,114 Amortization of other CTA regulatory assets 1,109 1,336 1,196 Amortization of cancelled plant 850 1,172 1,172 ----------- ----------- ----------- Subtotal CTA Amortization 46,190 57,212 44,139 Amortization of intangibles 1,236 1,297 3,816 Amortization of other regulatory assets 2,999 2,326 14,722 ----------- ----------- ----------- Total Amortization 50,425 60,835 62,677 ----------- ----------- ----------- Total Depreciation and Amortization $ 82,239 $ 92,567 $ 93,306 =========== =========== =========== TAXES - OTHER THAN INCOME TAXES - ------------------------------- Operating: Connecticut gross earnings $ 25,842 $ 28,293 $ 26,661 Local real estate and personal property 9,027 11,726 12,278 Payroll taxes 6,219 5,951 5,634 ----------- ----------- ----------- Total Taxes - Other than Income Taxes $ 41,088 $ 45,970 $ 44,573 =========== =========== =========== OTHER INCOME AND (DEDUCTIONS), NET - ---------------------------------- Interest income $ 1,197 $ 679 $ 1,249 Allowance for funds used during construction 2,491 2,220 1,913 Equity earnings from Connecticut Yankee 317 818 288 Non-utility business passive income (expense) (2,385) (5,299) 4,734 Non-utility business opportunities - - (403) Miscellaneous other income and (deductions) - net 1,670 (745) (1,081) ----------- ----------- ----------- Total Other Income and (Deductions), net $ 3,290 $ (2,327) $ 6,700 =========== =========== =========== OTHER INTEREST, NET - ------------------- Notes Payable $ 612 $ 459 $ 2,507 Other 1,791 1,258 2,324 ----------- ----------- ----------- Total Other Interest, net $ 2,403 $ 1,717 $ 4,831 =========== =========== ===========
(1) The amortization of this regulatory asset is a cash neutral item, as there is an offsetting liability which is relieved through a credit to fuel and energy expense. - 91 - UIL HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) (G) PENSION AND OTHER BENEFITS UI's qualified pension plan covers substantially all of its employees, the employees of UIL Holdings and APS, and certain management employees of Xcelecom and UCI. APS and Xcelecom employees no longer benefit from contributions under the plan, but any benefits accrued to them, through April 2003 for APS, and December 2003 for Xcelecom, remain in the plan. UI also has a non-qualified supplemental plan for certain executives and a non-qualified retiree-only plan for certain early retirement benefits. The net pension expense for these plans for 2003, 2002 and 2001 was $17.5 million, $6.7 million, and $0.8 million, respectively. According to SFAS No. 132 (Revised), "Employer's Disclosure about Pensions and Other Postretirement Benefits" disclosures have been increased to include investment strategy, asset allocation mix, contributions, the assumptions for the expected rate of return on assets, measurement dates and accumulated benefit obligation levels for all pension plans. The below discussion pertains to The United Illuminating Company Pension Plan (the "Plan"). UI set forth an investment policy to delegate the oversight and management of pension assets and procedures for monitoring and control. UI has engaged Frank Russell Trust Company as the trustee and investment manager to assist in areas of asset allocation and rebalancing, portfolio strategy implementation, and performance monitoring and evaluation. The goals of the asset investment strategy are to: o Achieve long-term capital growth while maintaining sufficient liquidity to provide for current benefit payments and Plan operating expenses. o Provide a total return that, over the long-term, provides sufficient assets to fund its liabilities subject to an appropriate level of risk, contributions and pension expense. o Maximize the return on assets, over the long-term, by investing primarily in equities. The inclusion of additional asset classes with differing rates of return, volatility and correlation are utilized to reduce risk by providing diversification relative to equities. o Diversify investments within asset classes to maximize preservation of principal and minimize over-exposure to any one investment, thereby minimizing the impact of losses in single investments. The Plan will maintain compliance with the Employee Retirement Income Security Act 1974 (ERISA) as amended, and any applicable regulations and laws. The Pension Committee of the board of directors that oversees the investment of Plan assets in conjunction with management has conducted a review of the Investment Strategies and Policies of Plan in the fourth quarter of 2003. This included a review of the strategic asset allocation, including the relationship of Plan assets to Plan liabilities and portfolio structure. The Pension Committee has adopted a target asset allocation with ranges as follows for both pension and other postretirement employee benefit funds: Low Target High --- ------ ---- Equity securities 68% 70% 72% Debt securities 28% 30% 32% The above allocations may be revised by the Pension Committee of the board of directors. The Pension Committee of the board of directors recently approved an asset allocation change to shift 5% from equity and debt to alternative strategies which would include hedge funds. This change will become effective during the first quarter of 2004. - 92 - UIL HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) Funding policy for the qualified plan is to make annual contributions that satisfy the minimum funding requirements of ERISA but that do not exceed the maximum deductible limits of the Internal Revenue Code. These amounts are determined each year as a result of an actuarial valuation of the plan. In 2001, $2.6 million was contributed for 2000 funding requirements. Due to IRS limitations regarding tax deductibility, UI did not make a contribution for the 2001 plan year. In 2002, $12.2 million was contributed for the 2002 funding requirements. In 2003, a $45 million contribution was made to the plan which increased the total plan assets to a level which exceeded the accumulated benefit obligations and thereby reduced the Other Comprehensive Loss of $26.5 million, after-tax, recorded in 2002. UI has established a supplemental retirement benefit trust and through this trust purchased life insurance policies on officers of UI to fund the future liability under the non-qualified supplemental plan. The cash surrender value of these policies is included in Other Property and Investments on the Consolidated Balance Sheet. The contribution to the pension plan for 2004 is expected to be $11.2 million, assuming that the amount will be equal to, or less than, the maximum contribution allowable per the Internal Revenue Code. The Accumulated Benefit Obligation for the qualified and nonqualified plans is $254.6 million and $6.6 million, respectively. UIL Holdings has the option to contribute an additional amount to the plan for the 2003 tax year, prior to filing its 2003 federal income tax return. If there is a plus or minus 1/4% change in the discount rate assumed at 6%, the pension expense would change by minus or plus $0.8 million, respectively. If there were a 1% change in the expected return on assets, the pension expense would change by plus or minus $2.5 million. In addition to providing pension benefits, UI also provides other postretirement benefits (OPEB), consisting principally of health care and life insurance benefits, for retired employees and their dependents. Employees whose sum of age and years of service at time of retirement is equal to or greater than 85 (or who are 62 with at least 20 years of service) are eligible for benefits partially subsidized by UI. The amount of benefits subsidized by UI is determined by age and years of service at retirement. For funding purposes, UI established a Voluntary Employees' Benefit Association Trust (VEBA) to fund OPEB for UI's union employees. The funding strategy for the VEBA is to select funds that most clearly mirror the pension allocation strategy. Approximately 43% of UI's employees are represented by Local 470-1, Utility Workers Union of America, AFL-CIO, for collective bargaining purposes. UI established a 401(h) account in connection with the qualified pension plan to fund OPEB for UI's non-union employees who retire on or after January 1, 1994. In accordance with this policy, UI did not make contributions to the union VEBA in 2003, 2002, or 2001. In 2002, UI contributed $0.8 million to the 401(h) account. UI did not make a contribution to the 401(h) account in 2001 or 2003. Plan assets for the union VEBA consist primarily of equity and fixed-income securities. If there is a plus or minus 1/4% change in the discount rate assumed, the OPEB plans expenses would change by plus or minus $0.1 million. If there were a 1% change in the expected return on VEBA assets, the OPEB plans expenses would change by plus or minus $0.2 million. The 401(h) account was closed at the end of 2003, as the contribution payouts became so frequent that the account effectively became a revolving account. To develop the expected long-term rate of return on assets assumption, UI considered the current level of expected returns on risk free investments (primarily government bonds), the historical level of the risk premium associated with the other asset classes in which the portfolio is invested and the expectations for future returns of each asset class. The expected return for each asset class was then weighted based on the target asset allocation to develop the expected long-term rate of return on assets assumption for the portfolio. This resulted in the selection of the 8.0% return on plan assets. - 93 - UIL HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) The following table represents the change in benefit obligation, change in plan assets and the respective funded status of UI's pension and postretirement plans as of December 31, 2003 and 2002.
AT DECEMBER 31, PENSION BENEFITS OTHER POSTRETIREMENT BENEFITS 2003 2002 2003 2002 ---- ---- ---- ---- (In Thousands) CHANGE IN BENEFIT OBLIGATION Benefit obligation at beginning of year $272,938 $247,992 $48,341 $34,187 Service cost 6,214 5,043 777 528 Interest cost 17,820 17,768 3,154 2,811 Amendments (1,333) 1,312 - (2,118) Actuarial (gain) loss 30,318 19,836 4,124 16,154 Settlements, curtailments and other (98) (1,146) - - Benefits paid (including expenses) (16,686) (17,867) (3,884) (3,221) -------------- -------------- ---------------- ----------------- Benefit obligation at end of year $309,173 $272,938 $52,512 $48,341 ============== ============== ================ ================= CHANGE IN PLAN ASSETS Fair value of plan assets at beginning of year $186,613 $212,000 $16,388 $19,327 Actual return on plan assets 44,251 (19,957) 3,085 (1,342) Employer contributions 45,233 12,437 1,373 1,624 Benefits paid (including expenses) (16,687) (17,867) (3,883) (3,221) -------------- -------------- ---------------- ----------------- Fair value of plan assets at end of year $259,410 $186,613 $16,963 $16,388 ============== ============== ================ ================= Funded Status at December 31: Projected benefits (less than) greater than plan assets $49,763 $86,325 $(35,549) $31,953 Unrecognized prior service cost (7,701) (10,213) (1,557) 1,737 Unrecognized transition asset 1,578 2,632 8,819 (9,878) Unrecognized net gain (loss) from past experience (81,318) (88,684) 16,927 (16,308) -------------- -------------- ---------------- ----------------- (Prepaid)/accrued benefit obligation $(37,678) $(9,940) $(11,360) $7,504 ============== ============== ================ ================= Amounts recognized in the Consolidated Balance Sheet consist of: Prepaid benefit cost $(43,927) $ - $ - $ - Accrued benefit liability 8,166 44,857 (11,360) 7,504 Intangible asset (1,093) (10,400) - - Accumulated other comprehensive income (824) (44,397) - - -------------- -------------- ---------------- ----------------- Net amount recognized $(37,678) $(9,940) $(11,360) $7,504 ============== ============== ================ ================= The following actuarial weighted average assumptions were used in calculating the benefit obligations at December 31: Discount rate 6.00% 6.75% 6.00% 6.75% Average wage increase 4.50% 4.50% N/A N/A
- 94 - UIL HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) The components of net periodic benefit cost are:
FOR THE YEAR ENDED DECEMBER 31, PENSION BENEFITS OTHER POSTRETIREMENT BENEFITS 2003 2002 2003 2002 ---- ---- ---- ---- (In Thousands) Components of net periodic benefit cost: Service cost $ 6,214 $5,043 $ 777 $ 528 Interest cost 17,820 17,768 3,154 2,811 Expected return on plan assets (14,180) (19,311) (1,211) (1,810) Amortization of: Prior service costs 1,179 1,125 (180) (122) Transition obligation (asset) (1,054) (1,054) 1,058 1,058 Actuarial (gain) loss 7,514 2,527 1,631 493 Settlements and curtailments 1 653 - - -------------- -------------- ---------------- ----------------- Net periodic benefit cost $17,494 $6,751 $5,229 $2,958 ============== ============== ================ ================= The following actuarial weighted average assumptions were used in calculating net periodic benefit cost: Discount rate 6.75% 6.75% 6.75% 6.75% Average wage increase 4.50% 4.50% N/A N/A Return on plan assets 8.00% 9.50% 8.00% 9.50%
A one percentage point change in the assumed health care cost trend rate would have the following effects: 1% INCREASE 1% DECREASE ----------- ----------- (In Thousands) Aggregate service and interest cost components $583 $(465) Accumulated postretirement benefit obligation $6,639 $(5,372) UI has a 401(k)/Employee Stock Ownership Plan (KSOP) in which substantially all of its employees and the employees of UIL Holdings, APS and UCI, are eligible to participate. The KSOP enables employees to defer receipt of a portion of their compensation, up to statutory limits, and to invest such funds in a number of investment alternatives. Matching contributions are made to the KSOP, in the form of UIL Holdings' common stock, based on each employee's salary deferrals in the KSOP. Through December 31, 2002, the matching contribution equaled fifty cents for each dollar of the employee's compensation deferred, but not more than 3 3/8% of the employee's annual salary. As of January 1, 2003, the matching contribution to the KSOP is 100% of the first 3% of employee compensation deferred and 50% of the next 2% deferred. The maximum match is 4% of annual salary and all matching contributions continue to be made in the form of UIL Holdings' common stock. Matching contributions to the KSOP during 2003, 2002 and 2001 were $2.1 million, $1.7 million and $1.6 million, respectively. UIL Holdings pays dividends on the shares of stock in the KSOP to the participant and UIL Holdings receives a tax deduction for the dividends paid. Prior to 2003, to distribute this tax benefit to participants, contributions made to the KSOP were equal to 25% of the dividends paid to each participant. These contributions amounted to $0.3 million in 2002 and 2001. Commencing in 2003, UIL Holdings ceased making such contributions and does not plan to make such contributions in the future. - 95 - UIL HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) Certain of Xcelecom's subsidiaries make contributions to union-administered benefit funds, which cover the majority of the subsidiaries' union employees. Governmental regulations require that, in the event of plan termination or employer withdrawal, an employer may be liable for a portion of the plan's unfunded vested benefits, if any. Xcelecom is not aware of any liabilities resulting from unfunded vested benefits related to union-administered benefit plans. Xcelecom does not anticipate withdrawal from the plans, nor is Xcelecom aware of any expected plan terminations. In December of 2001, Xcelecom established the Xcelecom, Inc. 401(k) Plan. Upon establishment, Xcelecom merged each of the separate subsidiary non-union retirement plans into this single company-wide plan in a staged manner. Beginning on January 1, 2002, Xcelecom non-union employees in subsidiaries merged into this plan are eligible to participate upon completing six months of service and attaining age twenty-one. Participants become vested in matching contributions immediately upon entry into the plan. Xcelecom makes matching contributions equal to 100% of the first 3% of employee salary deferred and 50% of any salary deferrals that exceed 3% but do not exceed 5% of the participant's compensation. Certain of Xcelecom's subsidiaries maintained separate defined contribution employee retirement plans for part or all of 2002, pending merger into Xcelecom's 401(k) Plan. These plans are open to certain employees after various lengths of service. Employee contributions and employer matching contributions occur at different rates, and the matched portions of the funds vest over a period of years. Contributions for the profit sharing portion of the Plans are generally at the discretion of the individual subsidiary. (H) UNAMORTIZED CANCELLED NUCLEAR PROJECT From December 1984 through December 1992, UI had been recovering its investment in Seabrook Unit 2, a partially constructed nuclear generating unit that was cancelled in 1984, over a regulatory approved ten-year period without a return on its unamortized investment. In a 1992 rate decision, the DPUC adopted a proposal by UI to write off its remaining investment in Seabrook Unit 2, beginning January 1, 1993, over a 24-year period, corresponding with the flowback of certain Connecticut Corporation Business Tax (CCBT) credits. This decision allows UI to retain the Seabrook Unit 2/CCBT amounts for ratemaking purposes, with the accumulated CCBT credits not deducted from rate base during the 24-year period of amortization in recognition of a longer period of time for amortization of the Seabrook Unit 2 balance. Unit 2 was sold on November 1, 2002. As a result of reducing its remaining unamortized investment in Seabrook Unit 2 with related proceeds from the sale, UI's investment has been fully amortized. A draft decision was issued on February 3, 2004, approving UI's calculation without modification. A final decision is scheduled for the beginning of March 2004. (I) LEASE OBLIGATIONS UIL Holdings and its wholly-owned direct and indirect subsidiaries have lease arrangements for data processing equipment, office equipment, vehicles and office space, including the lease of the Electric System Work Center (ESWC) facility that is recognized as a capital lease. On January 20, 2004, UI exercised the $16 million purchase option in connection with the capital lease for the ESWC facility. The gross amount of assets recorded under the capital lease and the related obligation of this lease as of December 31, 2003 are recorded on the Consolidated Balance Sheet. Capitalization of leases on UI's books has no impact on income, since the sum of the amortization of a leased asset and the interest on the lease obligation equals the rental expense allowed for ratemaking purposes. Operating leases, which are charged to operating expense, consist principally of leases of office space and facilities and a wide variety of equipment. The most significant operating lease is that of UI and UIL Holdings' corporate - 96 - UIL HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) headquarters. Operating leases of discontinued operations have been excluded from the following table. The future minimum lease payments under these operating leases is estimated to be as follows: (In Thousands) 2004 $ 11,639 2005 12,311 2006 11,712 2007 12,010 2008 - after 54,294 ---------------- Total $101,966 ================ Rental payments charged to operating expenses in 2003, 2002 and 2001, including rental payments for its corporate headquarters, were $13.8 million, $13.0 million, and $12.4 million, respectively. (J) COMMITMENTS AND CONTINGENCIES OTHER COMMITMENTS AND CONTINGENCIES CONNECTICUT YANKEE On December 4, 1996, the Board of Directors of the Connecticut Yankee Atomic Power Company (Connecticut Yankee) voted unanimously to retire the Connecticut Yankee nuclear plant (the Connecticut Yankee Unit) from commercial operation. UI has a 9.5% stock ownership share in Connecticut Yankee. The power purchase contract under which UI had purchased its 9.5% entitlement to the Connecticut Yankee Unit's power output permits Connecticut Yankee to recover 9.5% of all of its costs from UI. A decision by the FERC that became effective on August 1, 2000 allows Connecticut Yankee to collect through the power contracts with the unit's owners the FERC-approved decommissioning costs, other costs associated with the permanent shutdown of the Connecticut Yankee Unit, the unrecovered investment in the Connecticut Yankee Unit, and a return on equity of 6%. As part of an ongoing review process, management of Connecticut Yankee has prepared an updated estimate of the cost of decommissioning its nuclear unit, as part of its transition to self performance of decommissioning. Connecticut Yankee's updated cost estimate includes an increase of approximately $273 million over the cost estimate reported in November 2002. The $273 million increase in the decommissioning cost estimate primarily reflects the impacts of the termination of the turnkey decommissioning contractor, Bechtel Power Corporation, (Bechtel) in July 2003. Connecticut Yankee terminated its decommissioning contract with Bechtel in July 2003 due to Bechtel's history of incomplete and untimely performance and refusal to perform remaining decommissioning work. In June 2003, Bechtel filed a complaint against Connecticut Yankee in Connecticut Superior Court asserting a number of claims, including wrongful termination. In August, 2003, Connecticut Yankee filed a counterclaim, including counts for breach of contract, negligent misrepresentation and breach of duty of good faith and fair dealing. Bechtel has departed the site and the decommissioning responsibility has been transitioned to Connecticut Yankee, which has recommenced the decommissioning process. As part of the Connecticut Yankee April 2000 rate case settlement with the FERC, remaining decommissioning costs were originally estimated at $410 million. The original estimate was updated in November 2002 to increase the estimated decommissioning costs by approximately $140 million. The $140 million increase stemmed primarily from additional security costs, as well as the corollary economic impacts of increased insurance costs and other factors. Consequently, the total current cost estimate of approximately $823 million represents an - 97 - UIL HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) aggregate increase of approximately $413 million over the April 2000 FERC rate case settlement. Connecticut Yankee is required to update its decommissioning cost estimate through a filing with the FERC by no later than July 1, 2004. UI's share of the estimated increased cost of $273 million over the estimate reported in November 2002 would be approximately $25.9 million. This increase will not impact current period earnings as the amounts will be deferred on the balance sheet pending resolution of the litigation and regulatory proceedings described herein. Ultimately, if this issue is resolved favorably, the costs will be recovered and therefore would not likely have a financial impact on the results of operations. Connecticut Yankee is seeking recovery of additional decommissioning costs and other damages from Bechtel and, if necessary, its surety. In addition to pursuing this recovery through pending litigation, Connecticut Yankee is also preparing a rate application with the FERC, with any resulting Connecticut Yankee rate increase being charged to its wholesale power customers (including UI, which is responsible for 9.5% of the costs of the Connecticut Yankee nuclear unit). In turn, UI would seek to recover any FERC-allowed rate increase from its retail customers through appropriate regulatory proceedings. The timing, amount and outcome of such regulatory proceedings cannot be predicted at this time. To the extent that the new estimates described above are related to spent fuel storage, they could be affected by the outcome of an ongoing dispute between the federal Department of Energy (DOE) and several utilities and states. Under the Nuclear Waste Policy Act of 1982 (the Act), the DOE is required to design, license, construct and operate a permanent repository for high-level radioactive waste and spent nuclear fuel. The Act requires the DOE to provide for the disposal of spent nuclear fuel and high-level waste from commercial nuclear plants through contracts with the owners. In return for payment of established disposal fees, the federal government was required to take title to and dispose of the utilities' high-level waste and spent nuclear fuel beginning no later than January 1998. After the DOE announced that its first high-level waste repository will not be in operation earlier than 2010, several utilities and states obtained a judicial declaration that the DOE has a statutory responsibility to take title to and dispose of high-level waste and spent nuclear fuel beginning in January 1998. Although the federal government now concedes that its failure to begin disposing of high-level waste and spent nuclear fuel in January 1998 constituted a breach of contract, it continues to dispute that the entities with which it had contracts are entitled to damages. HYDRO-QUEBEC UI is a participant in the Hydro-Quebec transmission tie facility linking New England and Quebec, Canada. UI has a 5.45% participating share in this facility, which in aggregate have a maximum 2000 megawatt equivalent generation capacity value. UI is obligated to furnish a guarantee for its participating share of the debt financing for one phase of this facility. As of December 31, 2003, UI's guarantee liability for this debt was approximately $3.8 million. ENVIRONMENTAL CONCERNS In complying with existing environmental statutes and regulations and further developments in areas of environmental concern, including legislation and studies in the fields of water quality, hazardous waste handling and disposal, toxic substances, and electric and magnetic fields, UIL Holdings and its wholly-owned direct and indirect subsidiaries may incur substantial capital expenditures for equipment modifications and additions, monitoring equipment and recording devices, and it may incur additional operating expenses. The total amount of these expenditures is not now determinable. Environmental damage claims may also arise from the operations of UIL Holdings' subsidiaries. Significant environmental issues known to UIL Holdings at this time are described below. - 98 - UIL HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) SITE DECONTAMINATION, DEMOLITION AND REMEDIATION COSTS As a result of a 1992 DPUC retail rate decision, since January 1, 1993, UI had been recovering through retail rates $1.1 million per year of environmental remediation costs for the demolition and decontaminating of its Steel Point Station property in Bridgeport. As a result of the Rate Case decision dated September 26, 2002, UI will recover the remaining $3 million of these costs ratably during the 2002 through 2004 time period. This amount reflects the remaining cost of cleaning up the property, assuming a zero sales value. Final costs will be offset by any sale price realized, and will be subject to regulatory true-up upon disposition of the property. UI is also replacing portions of the bulkhead at the Steel Point Station property. The work is expected to cost approximately $6.4 million and is currently expected to be completed in 2004. UI is entitled to reimbursement of these costs from the City of Bridgeport pursuant to UI's contract with the City. Subsequent to the demolition of Steel Point Station, the adjacent East Main Street Substation was removed at the request of the City of Bridgeport. UI will undertake an environmental subsurface investigation of the former substation site, but potential environmental remediation costs, if any, cannot be estimated at this time. Concurrent with the removal of the East Main Street Substation in 2000, the Congress Street Substation was expanded to replace it. As of December 31, 2003, $9.2 million of the total cost is reimbursable from the City of Bridgeport. An additional $1.4 million of costs related to the Substation are transmission assets recoverable through regional transmission rates. UI is currently negotiating with the City of Bridgeport to settle all outstanding issues between the parties. In the event that an agreement cannot be reached, UI will move forward with previously initiated arbitration proceedings to collect these funds from the City of Bridgeport. UI has completed the replacement of the bulkhead surrounding a site, bordering the Mill River in New Haven, that contains transmission facilities and deactivated generation facilities, at a cost of $13.5 million. Of this amount, $4.2 million represents the portion of the costs to protect UI's transmission facilities and has been capitalized as plant in service; the remaining estimated cost of $9.3 million has been expensed. UI has conveyed to an unaffiliated entity, Quinnipiac Energy LLC (QE), this entire site, reserving to UI permanent easements for the operation of its transmission facilities on the site. UI has also funded 61% (approximately $1.2 million) of the estimated environmental remediation costs that will be incurred by QE to bring the site into compliance with applicable minimum Connecticut environmental standards. The City of New Haven is currently considering foreclosing on the property, as QE is not current with property tax payments. If the City of New Haven forecloses on the property and it is determined that QE has not performed appropriate environmental remediation at the site, UI could be required by applicable environmental laws to finish remediating any contamination at the site. The scope of any required remediation efforts by UI is not now determinable. On April 16, 1999, UI closed on the sale of its Bridgeport Harbor Station and New Haven Harbor Station generating plants in compliance with Connecticut's electric utility industry restructuring legislation. Environmental assessments performed in connection with the marketing of these plants indicate that substantial remediation expenditures will be required in order to bring the plant sites into compliance with applicable minimum Connecticut environmental standards. The purchaser of the plants has agreed to undertake and pay for the remediation of the purchased properties. With respect to the portion of the New Haven Harbor Station site that UI has retained, UI has performed an additional environmental analysis and estimates that approximately $3.2 million in remediation expenses will be incurred. The required remediation is virtually all on transmission-related property; and UI accrued these estimated expenses during the third quarter of 2002. From 1961 to 1976, UI owned a parcel of property in Derby, Connecticut, on which it operated an oil-fired electric generating unit. For several years, the Connecticut Department of Environmental Protection has been remediating a migration of fuel oil contamination from a neighboring parcel of property into the adjacent Housatonic River. Although, based on its own investigation to date, UI believes it has no responsibility for this contamination, if regulatory - 99 - UIL HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) agencies determine that UI is responsible for the cost of these remediation activities, UI may experience substantial costs, no estimate of which is currently available. CLAIM OF ENRON POWER MARKETING, INC. UI has an agreement for standard offer generating service with Dominion Energy Marketing (Dominion), assignee of Virginia Electric and Power Company (VEPCO). The Dominion/VEPCO agreement replaced an earlier wholesale power agreement and other related agreements with Enron Power Marketing, Inc. (EPMI), originally intended to supply all of the power needed to meet UI's standard offer obligations until the end of the standard offer period (the Agreements). Following EPMI's bankruptcy filing on December 2, 2001, UI terminated the Agreements in accordance with their terms, effective January 1, 2002, in reliance upon provisions of the Bankruptcy Code that permit termination of such contracts. The Agreements permitted UI to calculate its gains and losses resulting from the termination, and globally to net these gains and losses against one another, and against any other amounts that UI owed to EPMI under the Agreements, to arrive at a single sum. EPMI, however, commenced on January 31, 2003 an adversary proceeding against UI and UIL Holdings in the EPMI bankruptcy. UIL Holdings was sued as the guarantor of UI's financial obligations under the Agreements. EPMI contends that UI was not entitled to offset, against any losses UI suffered from the termination of the Agreements, any amounts owing to EPMI for power delivered to UI after the date EPMI filed for bankruptcy. The amount of the allegedly improper setoff that EPMI seeks to recover in the adversary proceeding is approximately $8.2 million, plus interest and attorneys' fees. The bankruptcy court has referred this and other similar cases to mediation and stayed the cases while mediation is conducted. Following the initial mediation session, EPMI indicated it is considering theories for increasing the amount it claimed from UI. In the event that UI is determined to owe EPMI a portion or all of the amount claimed, UI will seek recovery of such amount through the regulatory process. CROSS-SOUND CABLE COMPANY, LLC UCI's 25% share of the estimated total final cost of the Cross-Sound project is $34.4 million. As of December 31, 2003, UCI's 25% share of the actual project cost for the Cross-Sound cable was $33 million. UCI has provided an equity infusion of $10 million to Cross-Sound and UIL Holdings loaned $23.5 million to Cross-Sound. In addition, a guarantee of $3.8 million, in support of Hydro-Quebec's guarantees to third parties in connection with the construction of the project has been provided. It is expected that any obligations of Cross-Sound that are supported by the guarantee would be funded by capital contributions from the owners, who are affiliates of the guarantors, in amounts in proportion to their respective ownership shares of Cross-Sound. No liability was recorded related to the guarantee, as the likelihood of UIL Holdings having to perform under the guarantee is remote. Although commercial operation has not yet been achieved, the cable has been operating under a DOE Emergency Order since the August 14, 2003 blackout and is expected to remain operational under this order until such time as the Emergency identified in the Order ceases to exist. Upon commercial operation, the loan from UIL Holdings is expected to be refinanced with external project financing. UCI will be responsible for 25% of any additional cost of project completion over the estimated amount. - 100 - UIL HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) (K) FAIR VALUE OF FINANCIAL INSTRUMENTS The estimated fair values of UIL Holdings' financial instruments are as follows:
2003 2002 ---- ---- CARRYING FAIR CARRYING FAIR AMOUNT VALUE AMOUNT VALUE -------- ----- ------ ----- (In Thousands) (In Thousands) Unrestricted cash and temporary cash investments $28,614 $28,614 $18,910 $18,910 Long-term debt (1)(2) $495,460 $511,184 $495,432 $512,297
(1) The fair value of UIL Holdings' long-term debt is estimated by investment bankers based on market conditions at December 31, 2003 and 2002, respectively. (2) See Note (B), "Capitalization - Long-Term Debt." - 101 - UIL HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) (L) QUARTERLY FINANCIAL DATA (UNAUDITED) Selected quarterly financial data for 2003 and 2002 are set forth below:
1ST 2ND 3RD 4TH QUARTER QUARTER QUARTER QUARTER -------------------------------------------------- (In Thousands Except Per Share Amounts) 2003 - ---- Operating Revenues $234,239 $230,621 $269,703 $229,114 Operating Income from Continuing Operations 19,030 16,694 36,277 16,956 Income from Continuing Operations 5,518 5,005 16,601 2,413 Income from Discontinued Operations (252) (703) 351 (5,647) Net Income 5,266 4,302 16,952 (3,234) Earnings Per Share on Common Stock - Basic: (1) Continued Operations $ 0.39 $ 0.35 $ 1.16 $ 0.17 Discontinued Operations (0.02) (0.05) 0.03 (0.40) Net Earnings $ 0.37 $ 0.30 $ 1.19 $ (0.23) Earnings Per Share on Common Stock - Diluted: (1) Continued Operations $ 0.39 $ 0.35 $ 1.16 $ 0.17 Discontinued Operations (0.02) (0.05) 0.03 (0.40) Net Earnings $ 0.37 $ 0.30 $ 1.19 $ (0.23) 2002 - ---- Operating Revenues $236,645 $260,628 $298,392 $241,931 Operating Income from Continuing Operations 28,092 32,232 47,172 17,206 Income from Continuing Operations 9,571 9,439 21,959 4,782 Income from Discontinued Operations (2) (299) (152) (1,351) Net Income 9,569 9,140 21,807 3,431 Earnings Per Share on Common Stock - Basic: (1) Continued Operations $ 0.68 $ 0.66 $ 1.54 $ 0.34 Discontinued Operations - (0.02) (0.01) (0.10) Net Earnings $ 0.68 $ 0.64 $ 1.53 $ 0.24 Earnings Per Share on Common Stock - Diluted: (1) Continued Operations $ 0.67 $ 0.66 $ 1.54 $ 0.34 Discontinued Operations - (0.02) (0.01) (0.10) Net Earnings $ 0.67 $ 0.64 $ 1.53 $ 0.24
(1) Based on weighted average number of shares outstanding each quarter. - 102 - UIL HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) (M) SEGMENT INFORMATION As described in Note (O), "Discontinued Operations," to the consolidated financial statements, APS has been classified as "held for sale" and its results of operations are reported as discontinued operations. Accordingly, UIL Holdings now has two segments, UI, its regulated electric utility business engaged in the purchase, transmission, distribution and sale of electricity, and Xcelecom, its non-utility, indirect, wholly-owned subsidiary, which provides specialized contracting services in the electrical, mechanical, communications and data network infrastructure industries. Revenues from inter-segment transactions are not material. All of UIL Holdings' revenues are derived in the United States. The following table reconciles certain segment information with that provided in UIL Holdings' Consolidated Financial Statements. In the table, Other includes the information for the remainder of UIL Holdings' non-utility businesses and inter-segment eliminations. 2003 2002 ---- ---- Total Assets (In Thousands) - ------------ UI $1,465,859 $1,403,283 Xcelecom 176,759 195,721 Assets of discontinued operations held for sale 120,261 123,005 Other 102,124 58,802 --------------------------- Total UIL Holdings $1,865,003 $1,780,811 =========================== 2003 2002 2001 ---- ---- ---- Revenues from External Customers (In Thousands) - -------------------------------- UI $669,620 $727,533 $714,818 Xcelecom 294,036 310,044 312,556 Other 21 19 86 --------------------------------------------- Total UIL Holdings $963,677 $1,037,596 $1,027,460 ============================================= 2003 2002 2001 ---- ---- ---- Income (Loss) from Continuing Operations (In Thousands) - ---------------------------------------- before Income Taxes - ------------------ UI $78,188 $96,865 $102,971 Xcelecom (2,618) 2,387 10,869 Other (12,583) (16,023) (6,062) --------------------------------------- Total UIL Holdings $62,987 $83,229 $107,778 ======================================= - 103 - UIL HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) (N) GOODWILL AND OTHER INTANGIBLE ASSETS As of December 31, 2003, and 2002, UIL Holdings maintains $68.6 million and $67 million, respectively, of goodwill related to Xcelecom that is no longer being amortized, and $2.7 million and $1.7 million, at December 31, 2003 and 2002, respectively, of identifiable intangible assets that continue to be amortized. A summary of UIL Holdings' goodwill as of December 31, 2003 is as follows: (Thousands of Dollars) Total -------------- Balance, January 1, 2002 $56,974 Goodwill acquired during the year ended December 31, 2002 9,983 -------------- Balance, December 31, 2002 66,957 Goodwill acquired during the year ended December 31, 2003 1,597 -------------- Balance, December 31, 2003 $68,554 ============== An impairment charge of $7.2 million was recognized during the fourth quarter of 2003 to bring the goodwill balance associated with APS' telephony assets in line with the estimated fair value. This impairment loss is included in the results of discontinued operations. The remaining APS goodwill balance of $2.1 million is reported as long-term assets of discontinued operations held for sale in the accompanying Consolidated Balance Sheet. There were no other impairments to the goodwill balances recognized during the year ended December 31, 2003. As of December 31, 2003 and 2002, UIL Holdings' intangible assets and related accumulated amortization consisted of the following: As of December 31, 2003 ------------------------------------------ Accumulated Net (Thousands of Dollars) Gross Amortization Balance ------------------------------------------ Intangible assets subject to amortization: Non-compete agreements $2,485 $2,178 $307 Backlog 256 256 - ------------------------------------------ Total $2,741 $2,434 $307 ========================================== As of December 31, 2002 ------------------------------------------ Accumulated Net (Thousands of Dollars) Gross Amortization Balance ------------------------------------------ Intangible assets subject to amortization: Non-compete agreements $1,485 $1,057 $428 Backlog 256 214 42 ------------------------------------------ Total $1,741 $1,271 $470 ========================================== The intangible asset balance is included in Other Deferred Charges on the Consolidated Balance Sheet. - 104 - UIL HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) UIL Holdings recorded amortization expense of $1.2 million for 2003 related to these intangible assets. Assuming there are no acquisitions or dispositions that occur in the future, the estimated amortization expense for the years 2004 through 2008 is as follows: 2004 2005 2006 2007 2008 ---- ---- ---- ---- ---- (In Thousands) $307 - - - - For 2001, UIL Holdings' net income, adjusted to exclude the effect of amortization of goodwill during those periods, was $61.6 million. Basic and diluted earnings per share for UIL Holdings, adjusted to exclude the effect of amortization of goodwill during 2001, were $4.37 and $4.35 per share, respectively. (O) DISCONTINUED OPERATIONS On December 16, 2003, UIL Holdings entered into an agreement to sell APS to CheckFree Corporation (CheckFree), a leading provider of financial electronic commerce services and products. Under the terms of the agreement, and pending receipt of regulatory approvals and satisfaction of customary closing conditions, CheckFree will pay approximately $110 million in cash for the outstanding stock of APS. The transaction is expected to close during the second quarter of 2004, with any resulting gain on sale, net of transaction costs, to be recognized at that time. CheckFree will not acquire APS' telephony assets, which include APS' 51% ownership interest in CellCards of Illinois, LLC (CCI). Following execution of the agreement to sell APS, management determined that the telephony business is not part of UIL Holdings' overall strategic business focus, and therefore authorized the sale of APS' telephony assets. On February 13, 2004, CCI was sold for book value to an independent third party. As a result of the aforementioned events, the APS segment is considered to be a "disposal group" held for sale as defined in SFAS No. 144. Accordingly, the assets and liabilities of APS have been categorized as "held for sale" in the accompanying Consolidated Balance Sheet and the assets of APS are no longer being depreciated. The related asset carrying values were adjusted, if appropriate, to reflect the lower of either the carrying amounts or the current estimated fair values less costs to sell. The results of operations of APS for all periods presented, as well as the write-downs to estimated fair values less costs to sell, have been reported as discontinued operations in the accompanying Consolidated Statements of Income and Consolidated Statements of Cash Flows. A summary of the discontinued operations of APS for the years ended December 31 follows (in thousands): 2003 2002 2001 ---- ---- ---- Net operating revenues $109,570 $93,426 $58,386 ===================================== Impairment loss $ (8,220) $ - $ - ===================================== Operating income (loss) $ 1,082 $(3,376) $ 111 ===================================== Loss before income taxes $(10,249) $(3,019) $ (224) Income tax benefit 3,998 1,215 24 ------------------------------------- Net loss from discontinued operations $ (6,251) $(1,804) $ (200) ===================================== - 105 - PRICEWATERHOUSE COOPERS - ------------------------------------------------------------------------------- PricewaterhouseCoopers LLP 1301 Avenue of the Americas New York, NY 10019-6013 Telephone (646) 471 4000 Facsimile (646) 394 5324 REPORT OF INDEPENDENT AUDITORS To the Board of Directors and Shareholders of UIL Holdings Corporation: In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, comprehensive income, changes in shareholders' equity and cash flows present fairly, in all material respects, the financial position of UIL Holdings Corporation and its subsidiaries (the "Company") at December 31, 2003 and 2002, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2003 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. As discussed in Note A to the financial statements, the Company changed its accounting for goodwill and other intangible assets as of January 1, 2002. /s/ PricewaterhouseCoopers LLP January 26, 2004 - 106 - PRICEWATERHOUSE COOPER - ------------------------------------------------------------------------------- PricewaterhouseCoopers LLP 1301 Avenue of the Americas New York, NY 10019-6013 Telephone (646) 471 4000 Facsimile (646) 394 5324 REPORT OF INDEPENDENT AUDITORS ON FINANCIAL STATEMENT SCHEDULES To the Board of Directors and Shareholders of UIL Holdings Corporation: Our audits of the consolidated financial statements referred to in our report dated January 26, 2004 appearing in the 2003 Annual Report on Form 10-K also included an audit of the financial statement schedules listed in Item 15(a)(2) of this Form 10-K. In our opinion, these financial statement schedules present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. /s/ PricewaterhouseCoopers LLP January 26, 2004 - 107 - ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES. Not Applicable ITEM 9A. CONTROLS AND PROCEDURES. UIL Holdings Corporation (UIL Holdings) maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in its periodic reports to the Securities and Exchange Commission (SEC) is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, and that such information is accumulated and communicated to UIL Holdings' management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure based closely on the definition of "disclosure controls and procedures" in Rule 13a-14(c). In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Also, through United Capital Investments, Inc. and United Bridgeport Energy, Inc., UIL Holdings has minority investments in certain other entities. As UIL Holdings does not control or manage these entities, its disclosure controls and procedures with respect to such entities are necessarily substantially more limited than those it maintains with respect to its subsidiaries. UIL Holdings carried out an evaluation, under the supervision and with the participation of its management, including its Chief Executive Officer and its Chief Financial Officer, of the effectiveness of the design and operation of UIL Holdings' disclosure controls and procedures as of December 31, 2003. Based on the foregoing, UIL Holdings' Chief Executive Officer and Chief Financial Officer concluded that its disclosure controls and procedures were effective. There have been no changes in UIL Holdings' internal control over financial reporting during the quarter ended December 31, 2003 that have materially affected, or are reasonably likely to materially affect UIL Holdings' internal control over financial reporting. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS. The information appearing under the captions "NOMINEES FOR ELECTION AS DIRECTORS" AND "SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE" in UIL Holdings Corporation's (UIL Holdings') definitive Proxy Statement for the Annual Meeting of the Shareowners to be held on May 12, 2004, which Proxy Statement will be filed with the Securities and Exchange Commission on or about April 9, 2004, is incorporated by reference in partial answer to this item. See also "EXECUTIVE OFFICERS", following Part I, Item 4 herein. The UIL Holdings Code of Ethics for the Chief Executive Officer, Presidents, and Senior Financial Officers is available on UIL Holdings' website (www.uil.com), and a copy has also been filed as Exhibit 14 to this filing on Form 10-K. ITEM 11. EXECUTIVE COMPENSATION. The information appearing under the captions "EXECUTIVE COMPENSATION," "OPTIONS/SAR GRANTS IN LAST FISCAL YEAR," "STOCK OPTION EXERCISES IN 2003 AND YEAR-END OPTION VALUES," "RETIREMENT PLANS," "BOARD OF DIRECTORS COMPENSATION AND EXECUTIVE DEVELOPMENT COMMITTEE REPORT ON EXECUTIVE COMPENSATION," "COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION," "DIRECTOR COMPENSATION" and "SHAREOWNER RETURN PRESENTATION" in UIL Holdings' definitive Proxy Statement for the Annual Meeting of the Shareowners to be held on May 12, 2004, which Proxy Statement will be filed with the Securities and Exchange Commission on or about April 9, 2004, is incorporated by reference in answer to this item. - 108 - ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. The information appearing under the captions "PRINCIPAL SHAREOWNERS" and "STOCK OWNERSHIP OF DIRECTORS AND OFFICERS" in UIL Holdings' definitive Proxy Statement for the Annual Meeting of the Shareowners to be held on May 12, 2004, which Proxy Statement will be filed with the Securities and Exchange Commission on or about April 9, 2004, is incorporated by reference in answer to this item. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. Under a lease agreement dated May 7, 1991, The United Illuminating Company (UI) leased its corporate headquarters offices in New Haven from Connecticut Financial Center Associates Limited Partnership (CFCALP). CFCALP is a limited partnership controlled by the David T. Chase family, including Arnold L. Chase, a Director of UIL Holdings since June 28, 1999, and members of his immediate family. During 2003, UI's lease payments to CFCALP totaled $8.7 million. A subsidiary of UIL Holdings, Inc., United Capital Investments, Inc. (UCI), invested $3.9 million in 2000 and 2001 to purchase a minority ownership interest in Gemini Networks, Inc. (Gemini). Gemini proposes to develop, build, and operate an open-access, hybrid fiber coaxial communications network serving business and residential customers in the northeastern United States. Gemini is a corporation controlled by the David T. Chase family, and Arnold L. Chase is the President and a Director of Gemini. In June 2002, UCI wrote its investment in Gemini down to one dollar, because the telecommunications sector had suffered substantial losses in value, and because UCI concluded that Gemini was unlikely to continue its network development in the absence of additional financing. In December 2003, Gemini completed a restructuring transaction in connection with which the Chase family came to own 100% of the equity of Gemini. In connection with that transaction, UCI is entitled to a cash payment of approximately $17,500 in exchange for its ownership interest in Gemini, and expects to receive that amount in the first quarter of 2004. Since January 1, 2002, there has been no other transaction, relationship or indebtedness of the kinds described in Item 404 of Regulation S-K. ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES. The information appearing under the captions "BOARD OF DIRECTORS REPORT OF THE AUDIT COMMITTEE" in UIL Holdings' definitive Proxy Statement for the Annual Meeting of the Shareowners to be held on May 12, 2004, which Proxy Statement will be filed with the Securities and Exchange Commission on or about April 9, 2004, is incorporated by reference in answer to this item. - 109 - PART IV ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. (a) The following documents are filed as a part of this report: Financial Statements (see Item 8): Consolidated statement of income for the years ended December 31, 2003, 2002 and 2001 Consolidated statement of comprehensive income for the years ended December 31, 2003, 2002 and 2001 Consolidated statement of cash flows for the years ended December 31, 2003, 2002 and 2001 Consolidated Balance Sheet, December 31, 2003 and 2002 Consolidated statement of changes in shareholders' equity for the years ended December 31, 2003, 2002 and 2001 Notes to consolidated financial statements Report of independent auditors Financial Statement Schedule (see S-1) Schedule II - Valuation and qualifying accounts for the years ended December 31, 2003, 2002 and 2001. - 110 - Exhibits: Pursuant to Rule 12b-32 under the Securities Exchange Act of 1934, certain of the following listed exhibits, which are annexed as exhibits to previous statements and reports filed by UIL Holdings Corporation (Commission File Number 1-5995) (UIL) and/or The United Illuminating Company (Commission File Number 1-6788) (UI), are hereby incorporated by reference as exhibits to this report. Such statements and reports are identified by reference numbers as follows: (1) Filed with UI and UIL Quarterly Report (Form 10-Q) for fiscal quarter ended September 30, 2000. (2) Filed with UIL Quarterly Report (Form 10-Q) for fiscal quarter ended June 30, 2002. (3) Filed with UI Registration Statement No. 33-40169, effective August 12, 1991. (4) Filed with UI Registration Statement No. 2-57275, effective October 19, 1976. (5) Filed with UI Annual Report (Form 10-K) for fiscal year ended December 31, 1995. (6) Filed with UI Annual Report (Form 10-K) for fiscal year ended December 31, 1996. (7) Filed with UI Registration Statement No. 2-60849, effective July 24, 1978. (8) Filed with UI Annual Report (Form 10-K) for fiscal year ended December 31, 1991. (9) Filed with UI Quarterly Report (Form 10-Q) for fiscal quarter ended June 30, 1997. (10) Filed with UIL Quarterly Report (Form 10-Q) for fiscal quarter ended September 30, 2002. (11) Filed with UI Quarterly Report (Form 10-Q) for fiscal quarter ended September 30, 1997. (12) Filed with UI Annual Report (Form 10-K) for fiscal year ended December 31, 1999. (13) Filed with UI Quarterly Report (Form 10-Q) for fiscal quarter ended June 30, 2001. (14) Filed with UI Quarterly Report (Form 10-Q) for fiscal quarter ended March 31, 1998. (15) Filed with UI Quarterly Report (Form 10-Q) for fiscal quarter ended June 30, 1999. (16) Filed with UIL Quarterly Report (Form 10-Q) for fiscal quarter ended September 30, 2001. (17) Filed with UI Annual Report (Form 10-K) for fiscal year ended December 31, 2000. (18) Filed with UIL Quarterly Report (Form 10-Q) for fiscal quarter ended March 31, 2003. - 111 - The exhibit number in the statement or report referenced is set forth in the parenthesis following the description of the exhibit. Those of the following exhibits not so identified are filed herewith.
Exhibit Table Exhibit Reference Item No. No. No. Description - ------- ------- --------- ----------- (2) 2** Copy of Stock Purchase Agreement by and among UIL Holdings Corporation, United Resources, Inc. and CheckFree Corporation, dated December 16, 2003. (3) 3.1 (1) Copy of Certificate of Incorporation of UIL Holdings Corporation, as amended through July 20, 2000. (Exhibit 3.3) (3) 3.2 (2) Copy of Bylaws of UIL Holdings Corporation, as amended through July 22, 2002. (Exhibit 3.2a) (4) 4.1 (3) Copy of Indenture, dated as of August 1, 1991, from The United Illuminating Company to The Bank of New York, Trustee. (Exhibit 4) (10) 10.1 (4) Copy of Stockholder Agreement, dated as of July 1, 1964, among the various stockholders of Connecticut Yankee Atomic Power Company, including The United Illuminating Company. (Exhibit 5.1-1) (10) 10.2a (4) Copy of Power Contract, dated as of July 1, 1964, between Connecticut Yankee Atomic Power Company and The United Illuminating Company. (Exhibit 5.1-2) (10) 10.2b (5) Copy of Additional Power Contract, dated as of April 30, 1984, between Connecticut Yankee Atomic Power Company and The United Illuminating Company. (Exhibit 10.2f) (10) 10.2c (6) Copy of 1987 Supplementary Power Contract, dated as of April 1, 1987, supplementing Exhibits 10.2a and 10.2b. (Exhibit 10.2c) (10) 10.2d (6) Copy of 1996 Amendatory Agreement, dated as of December 4, 1996, amending Exhibits 10.2b and 10.2c. (Exhibit 10.2d) (10) 10.2e (6) Copy of First Supplement to 1996 Amendatory Agreement, dated as of February 10, 1997, supplementing Exhibit 10.2d. (Exhibit 10.2e) (10) 10.3 (4) Copy of Capital Funds Agreement, dated as of September 1, 1964, between Connecticut Yankee Atomic Power Company and The United Illuminating Company. (Exhibit 5.1-3) (10) 10.4 (7) Copy of Capital Contributions Agreement, dated October 16, 1967, between The United Illuminating Company and Connecticut Yankee Atomic Power Company. (Exhibit 5.1-5) (10) 10.5a (7) Copy of Transmission Line Agreement, dated January 13, 1966, between the Trustees of the Property of The New York, New Haven and Hartford Railroad Company and The United Illuminating Company. (Exhibit 5.4) (10) 10.5b (8) Notice, dated April 24, 1978, of The United Illuminating Company's intention to extend term of Transmission Line Agreement dated January 13, 1966, Exhibit 10.5a. (Exhibit 10.9b) (10) 10.5c (8) Copy of Letter Agreement, dated March 28, 1985, between The United Illuminating Company and National Railroad Passenger Corporation, supplementing and modifying Exhibit 10.5a. (Exhibit 10.9c) (10) 10.5d (9) Copy of Notice, dated April 22, 1997, of The United Illuminating Company's intention to extend term of Transmission Line Agreement, Exhibit 10.5a, as supplemented and modified by Exhibit 10.5c. (Exhibit 10.9d) (10) 10.5e Copy of Transmission Line Agreement, dated May 15, 2003, between the State of Connecticut Department of Transportation and The United Illuminating Company, amending and restating Exhibit 10.5a.
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Exhibit Table Exhibit Reference Item No. No. No. Description - ------- ------- --------- ----------- (10) 10.6a (10) Copy of Agreement and Supplemental Agreement, effective June 9, 2002, between The United Illuminating Company and Local 470-1, Utility Workers Union of America, AFL-CIO. (Exhibit 10.7d) (10) 10.7a* (11) Copy of Employment Agreement, dated as of March 1, 1997, between The United Illuminating Company and Charles J. Pepe. (Exhibit 10.31) (10) 10.7b* (12) Copy of First Amendment to Employment Agreement between The United Illuminating Company and Charles J. Pepe, dated as of December 13, 1999. (Exhibit 10.19b*) (10) 10.7c* (13) Copy of Third Amendment to Employment Agreement between The United Illuminating Company and Charles J. Pepe, dated as of June 1, 2001. (Exhibit 10.11c*) (10) 10.8a* (14) Copy of Employment Agreement, dated as of February 23, 1998, between The United Illuminating Company and Nathaniel D. Woodson. (Exhibit 10.28) (10) 10.8b* (12) Copy of First Amendment to Employment Agreement between The United Illuminating Company and Nathaniel D. Woodson, dated as of December 13, 1999. (Exhibit 10.20b*) (10) 10.9a* (14) Copy of The United Illuminating Company Phantom Stock Option Agreement, dated as of February 23, 1998, between The United Illuminating Company and Nathaniel D. Woodson. (Exhibit 10.29) (10) 10.9b* (1) Copy of First Amendment, made as of the close of business on July 20, 2000, to The United Illuminating Company Phantom Stock Option Agreement, dated as of February 28, 1998, between The United Illuminating Company and Nathaniel D. Woodson. (Exhibit 10.21b+) (10) 10.10* (1) Copy of Employment Agreement, made as of June 26, 2000, between The United Illuminating Company and Susan E. Allen. (Exhibit 10.29+) (10) 10.11* (1) Copy of Resolution adopted by the Board of Directors of The United Illuminating Company on June 26, 2000, and effective at the close of business on July 20, 2000, amending Section 7 of each of the Employment Exhibits 10.7a*, 10.8a* and 10.10*. (Exhibit 10.30+) (10) 10.12* (2) Copy of Employment Agreement, dated as of April 22, 2002, between UIL Holdings Corporation and Louis J. Paglia. (Exhibit 10.22+) (10) 10.13a* (6) Copy of The United Illuminating Company 1990 Stock Option Plan, as amended on December 20, 1993, January 24, 1994 and August 22, 1994. (Exhibit 10.18*) (10) 10.13b* (1) Copy of First Amendment to The United Illuminating Company 1990 Stock Option Plan, as previously amended through August 22, 1994, effective immediately prior to the close of business on July 20, 2000. (Exhibit 10.23b+) (10) 10.13c* (1) Copy of Instrument of Assumption of Stock Option Plans, made as of July 21, 2000, between UIL Holdings Corporation and The United Illuminating Company, with respect to Exhibits 10.13a* and 10.13b*. (Exhibit 10.23c+ and 10.24a+) (10) 10.14* (18) Copy of UIL Holdings Corporation 1999 Amended and Restated Stock Plan, as Amended and Restated effective March 24, 2003. (Exhibit 10.16c*) (10) 10.15* (16) Copy of UIL Holdings Corporation Change In Control Severance Plan (As Amended and Restated Effective September 24, 2001). (Exhibit 10.21+) (10) 10.16* (17) Copy of Non-Employee Directors' Common Stock and Deferred Compensation Plan of UIL Holdings Corporation, as amended through December 31, 2000. (Exhibit 10.19*) (10) 10.17* (1) Copy of UIL Holdings Corporation Non-Employee Directors Change in Control Severance Plan. (Exhibit 10.32+)
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Exhibit Table Exhibit Reference Item No. No. No. Description - ------- ------- --------- ----------- (10) 10.18* (18) Copy of UIL Holdings Corporation Deferred Compensation Plan, as originally adopted effective January 27, 2003, reflecting amendments through March 24, 2003. (Exhibit 10.20*) (14) 14 Copy of UIL Holdings Corporation Code of Ethics for the Chief Executive Officer, Presidents, and Senior Financial Officers. (21) 21 (2) List of subsidiaries of UIL Holdings Corporation. (Exhibit 21a) (23) 23 Consent of Independent Accountants. (31) 31.1 Certification of Periodic Financial Report. (31) 31.2 Certification of Periodic Financial Report. (32) 32 Certification of Periodic Financial Report.
- ---------------------- * Management contract or compensatory plan or arrangement. ** UIL Holdings agrees to furnish supplementary a copy of any omitted schedules to this Agreement to the Securities and Exchange Commission upon request. The foregoing list of exhibits does not include instruments defining the rights of the holders of certain long-term debt of UIL Holdings Corporation and its subsidiaries where the total amount of securities authorized to be issued under the instrument does not exceed ten (10%) of the total assets of UIL Holdings Corporation and its subsidiaries on a consolidated basis; and UIL Holdings Corporation hereby agrees to furnish a copy of each such instrument to the Securities and Exchange Commission on request. (b) Reports on Form 8-K. Item Financial Reported Statements Date of Report -------- ---------- -------------- 7,9 None October 24, 2003 5,7,9 None November 24, 2003 (Amended November 26, 2003) 5 None December 5, 2003 5,7 None December 16, 2003 - 114 - SIGNATURES Pursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, UIL Holdings has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. UIL HOLDINGS CORPORATION By /s/ Nathaniel D. Woodson ---------------------------------------------- Nathaniel D. Woodson Chairman of the Board of Directors, President and Chief Executive Officer DATE: MARCH 1, 2004 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. SIGNATURE TITLE DATE --------- ----- ---- Director, Chairman of the Board of Directors, President /s/ Nathaniel D. Woodson and Chief Executive Officer March 1, 2004 - ------------------------------ (Nathaniel D. Woodson) (Principal Executive Officer) Executive Vice President and /s/ Louis J. Paglia Chief Financial Officer March 1, 2004 - ------------------------------ (Louis J. Paglia) (Principal Financial and Accounting Officer) /s/ John F. Croweak Director March 1, 2004 - ------------------------------- (John F. Croweak) /s/ F. Patrick McFadden, Jr. Director March 1, 2004 - ------------------------------- (F. Patrick McFadden, Jr.) /s/ Betsy Henley-Cohn Director March 1, 2004 - ------------------------------- (Betsy Henley-Cohn) /s/ James A. Thomas Director March 1, 2004 - ------------------------------- (James A. Thomas) /s/ David E.A. Carson Director March 1, 2004 - ------------------------------- (David E.A. Carson) /s/ John L. Lahey Director March 1, 2004 - ------------------------------- (John L. Lahey) /s/ Marc C. Breslawsky Director March 1, 2004 - ------------------------------- (Marc C. Breslawsky) - 115 - SIGNATURE TITLE DATE --------- ----- ---- /s/ Thelma R. Albright Director March 1, 2004 - ------------------------------- (Thelma R. Albright) /s/ Arnold L. Chase Director March 1, 2004 - ------------------------------- (Arnold L. Chase) /s/ Daniel J. Miglio Director March 1, 2004 - ------------------------------- (Daniel J. Miglio) /s/ William F. Murdy Director March 1, 2004 - ------------------------------- (William F. Murdy) - 116 - UIL HOLDINGS CORPORATION SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS FOR THE YEAR ENDED DECEMBER 31, 2003 AND 2002 (Thousands of Dollars)
COL. A. COL. B. COL. C COL. D. COL. E. ------- ------- ------ ------- ------- Additions ------------------------------- Balance at Charged to Charged to Balance at Beginning Costs and Other End Classification of Period Expenses Accounts Deductions of Period - ---------------------------------- --------- -------- -------- ---------- --------- RESERVE DEDUCTION FROM ASSETS TO WHICH IT APPLIES: Reserve for uncollectible accounts (consolidated): 2003 $ 3,184 $ 6,253 $ - $ 6,135 $ 3,302 2002 $ 2,669 $ 6,320 $ - $ 5,805 (A) $ 3,184
NOTE: (A) Accounts written off, less recoveries. S-1 EX-2 3 uil_exh2checkfreet.txt CHECKFREE STOCK PURCHASE AGREEMENT STOCK PURCHASE AGREEMENT BY AND AMONG UIL HOLDINGS CORPORATION UNITED RESOURCES, INC. AND CHECKFREE CORPORATION FOR ALL OF THE OUTSTANDING STOCK OF AMERICAN PAYMENT SYSTEMS, INC. DECEMBER 16, 2003 Table of Contents 1. DEFINITIONS............................................................1 ----------- 2. PURCHASE AND SALE OF THE COMPANY SHARES................................7 --------------------------------------- (A) BASIC TRANSACTION......................................................7 ----------------- (B) PURCHASE PRICE.........................................................7 -------------- (i) AMOUNT PAID AT CLOSING..............................................7 (ii) POST CLOSING ADJUSTMENTS............................................8 (iii)DISPUTE RESOLUTION PROCEDURES.......................................8 (iv) CLOSING DISTRIBUTIONS; REPAYMENT OF INTER-COMPANY DEBT..............9 (C) THE CLOSING............................................................9 ----------- (D) DELIVERIES AT THE CLOSING.............................................10 ------------------------- 3. REPRESENTATIONS AND WARRANTIES CONCERNING THE SELLER ENTITIES ------------------------------------------------------------- AND THE BUYER.........................................................10 ------------- (A) REPRESENTATIONS AND WARRANTIES OF THE SELLER ENTITIES.................10 ----------------------------------------------------- (i) ORGANIZATION.......................................................10 (ii) AUTHORIZATION OF TRANSACTION.......................................10 (iii)NONCONTRAVENTION...................................................10 (iv) BROKERS' FEES......................................................11 (v) COMPANY SHARES.....................................................11 (vi) LITIGATION.........................................................11 (vii)LEGAL COMPLIANCE...................................................11 (B) REPRESENTATIONS AND WARRANTIES OF THE BUYER...........................11 ------------------------------------------- (i) ORGANIZATION OF THE BUYER..........................................11 (ii) AUTHORIZATION OF TRANSACTION.......................................11 (iii)NONCONTRAVENTION...................................................12 (iv) BROKERS' FEES......................................................12 (v) INVESTMENT.........................................................12 (vi) ACCREDITED INVESTOR................................................12 (vii)LITIGATION; COMPLIANCE WITH LAWS...................................12 (viii)DISCLAIMER; INVESTIGATION BY THE BUYER; THE SELLER'S LIABILITY....13 (ix) LEGAL COMPLIANCE...................................................13 (x) ADEQUATE FUNDS.....................................................14 4. REPRESENTATIONS AND WARRANTIES CONCERNING COMPANY.....................14 ------------------------------------------------- (A) ORGANIZATION OF THE COMPANY...........................................14 --------------------------- (B) CAPITALIZATION........................................................14 -------------- (i) COMPANY............................................................14 (ii) SUBSIDIARIES.......................................................15 (C) NONCONTRAVENTION......................................................15 ---------------- (D) BROKERS' FEES.........................................................16 ------------- (E) TITLE TO ASSETS; SUFFICIENCY OF ASSETS................................16 -------------------------------------- (F) FINANCIAL STATEMENTS..................................................16 -------------------- (G) UNDISCLOSED LIABILITIES...............................................16 ----------------------- (H) EVENTS SUBSEQUENT TO MOST RECENT FISCAL QUARTER END...................17 --------------------------------------------------- (I) LEGAL COMPLIANCE......................................................17 ---------------- (J) TAX MATTERS...........................................................17 ----------- (K) REAL PROPERTY.........................................................19 ------------- (L) INTELLECTUAL PROPERTY.................................................20 --------------------- (M) CONTRACTS.............................................................22 --------- (N) GUARANTIES............................................................24 ---------- (O) TANGIBLE ASSETS.......................................................24 --------------- (P) LITIGATION............................................................24 ---------- (Q) EMPLOYEES.............................................................24 --------- (R) EMPLOYEE BENEFITS.....................................................25 ----------------- (S) ENVIRONMENTAL, HEALTH, AND SAFETY MATTERS.............................27 ----------------------------------------- (T) NOTES AND ACCOUNTS RECEIVABLE.........................................28 ----------------------------- (U) POWERS OF ATTORNEY....................................................28 ------------------ (V) INSURANCE.............................................................28 --------- (W) DISCLOSURE............................................................28 ---------- (X) DISCLAIMER OF OTHER REPRESENTATIONS AND WARRANTIES....................28 -------------------------------------------------- 5. PRE-CLOSING COVENANTS.................................................29 --------------------- (A) GENERAL...............................................................29 ------- (B) REGULATORY MATTERS....................................................29 ------------------ (C) OPERATION OF BUSINESS.................................................30 --------------------- (D) PRESERVATION OF BUSINESS..............................................31 ------------------------ (E) FULL ACCESS...........................................................31 ----------- (F) NOTICE OF DEVELOPMENTS................................................31 ---------------------- (G) EXCLUSIVITY...........................................................32 ----------- (H) TERMINATION OF AGREEMENTS.............................................32 ------------------------- (I) FINANCIALS............................................................32 ---------- (J) TRANSFER OF DIVESTED ITEMS............................................33 -------------------------- (K) AMENDMENT OR CANCELLATION OF CERTAIN AGREEMENTS.......................33 ----------------------------------------------- 6. POST-CLOSING COVENANTS................................................33 ---------------------- (A) GENERAL...............................................................33 ------- (B) LITIGATION SUPPORT....................................................33 ------------------ (C) TRANSITION............................................................34 ---------- (D) EMPLOYEES.............................................................34 --------- (E) EMPLOYEE BENEFIT PLANS................................................34 ---------------------- (F) CONFIDENTIALITY.......................................................36 --------------- (G) COVENANT NOT TO COMPETE...............................................36 ----------------------- (H) INSURANCE.............................................................36 --------- (I) ACCESS TO INFORMATION.................................................37 --------------------- (J) NONASSIGNABLE CONTRACTS AND PERMITS...................................37 ----------------------------------- (K) GUARANTEE.............................................................37 --------- 7. CONDITIONS TO OBLIGATION TO CLOSE.....................................37 --------------------------------- (A) CONDITIONS TO OBLIGATION OF THE BUYER.................................37 ------------------------------------- (B) CONDITIONS TO OBLIGATION OF THE SELLER................................39 -------------------------------------- 8. REMEDIES FOR BREACHES OF THIS AGREEMENT...............................40 --------------------------------------- (A) SURVIVAL..............................................................40 -------- (B) INDEMNIFICATION PROVISIONS FOR BENEFIT OF THE BUYER...................40 --------------------------------------------------- (C) INDEMNIFICATION PROVISIONS FOR BENEFIT OF THE SELLER ENTITIES ------------------------------------------------------------- AND ITS AFFILIATES....................................................41 ------------------ (D) LIMITATIONS...........................................................41 ----------- (E) OTHER LIMITATIONS.....................................................42 ----------------- (F) LOSSES NET OF INSURANCE, ETC..........................................42 ---------------------------- (G) TERMINATION OF INDEMNIFICATION........................................43 ------------------------------ (H) PROCEDURES RELATING TO INDEMNIFICATION................................43 -------------------------------------- (I) EXCLUSIVE REMEDY......................................................44 ---------------- (J) MITIGATION............................................................44 ---------- 9. TAX MATTERS...........................................................44 ----------- (A) CONSOLIDATED RETURN...................................................44 ------------------- (B) TAX PERIODS ENDING ON OR BEFORE THE CLOSING DATE......................45 ------------------------------------------------ (C) TAX PERIODS BEGINNING BEFORE AND ENDING AFTER THE CLOSING DATE........45 -------------------------------------------------------------- (D) REFUNDS AND TAX BENEFITS..............................................46 ------------------------ (E) COOPERATION ON TAX MATTERS............................................46 -------------------------- (F) TAX SHARING AGREEMENTS................................................47 ---------------------- (G) CERTAIN TAXES.........................................................47 ------------- (H) REPRESENTATION........................................................47 -------------- (I) CONFIDENTIALITY.......................................................48 --------------- (J) SECTION 1445..........................................................48 ------------ (K) SECTION 338 ELECTION..................................................47 -------------------- (L) PHANTOM STOCK OPTION PLAN.............................................48 ------------------------- (M) PURCHASE PRICE ADJUSTMENT.............................................49 ------------------------- 10. TERMINATION........................................................50 ----------- (A) TERMINATION OF AGREEMENT..............................................50 ------------------------ (B) EFFECT OF TERMINATION.................................................51 --------------------- 11. MISCELLANEOUS......................................................51 ------------- (A) PRESS RELEASES AND PUBLIC ANNOUNCEMENTS...............................51 --------------------------------------- (B) NO THIRD-PARTY BENEFICIARIES..........................................51 ---------------------------- (C) ENTIRE AGREEMENT......................................................51 ---------------- (D) SUCCESSION AND ASSIGNMENT.............................................52 ------------------------- (E) COUNTERPARTS..........................................................52 ------------ (F) HEADINGS..............................................................52 -------- (G) NOTICES...............................................................52 ------- (H) GOVERNING LAW.........................................................53 ------------- (I) VENUE.................................................................53 ----- (J) WAIVER OF JURY TRIAL..................................................53 -------------------- (K) AMENDMENTS AND WAIVERS................................................53 ---------------------- (L) SEVERABILITY..........................................................53 ------------ (M) EXPENSES..............................................................53 -------- (N) CONSTRUCTION..........................................................53 ------------ (O) INCORPORATION OF EXHIBITS AND SCHEDULES...............................54 --------------------------------------- 56 STOCK PURCHASE AGREEMENT STOCK PURCHASE AGREEMENT, entered as of December 16, 2003, by and among CheckFree Corporation, a Delaware corporation or its permitted assignee (the "Buyer"), UIL Holdings Corporation, a Connecticut corporation (the "Parent") and United Resources, Inc., a Connecticut corporation (the "Seller" and together with the Parent, the "Seller Entities"). The Buyer and the Seller Entities are referred to collectively herein as the "Parties" and individually as a "Party". WHEREAS, this Agreement contemplates a transaction in which the Buyer will purchase from the Seller, and the Seller will sell to the Buyer, all of the outstanding capital stock of American Payment Systems, Inc., a Connecticut corporation (the "Company") in return for the consideration set forth herein. NOW, THEREFORE, in consideration of the premises and the mutual promises herein made, and in consideration of the representations, warranties and covenants herein contained, the Parties agree as follows. 1. DEFINITIONS. "Adjustment Statement" has the meaning set forth in Section 2(b)(iii) below. "Adverse Consequences" means all actions, suits, proceedings, hearings,investigations, charges, complaints, claims, demands, injunctions, judgments,orders, decrees, rulings, damages, dues, penalties, fines, costs, reasonable amounts paid in settlement, liabilities, obligations, taxes, liens, losses,expenses, and fees, including court costs and reasonable attorneys' fees and expenses. "Agreement" means this Stock Purchase Agreement. "Affiliate" has the meaning set forth in Rule 12b-2 of the regulations promulgated under the Securities Exchange Act. "Affiliate Plan" has the meaning set forth in Section 4(r)(ii) below. "Affiliated Group" means any affiliated group within the meaning of Code ss.1504(a) or any similar group defined under a similar provision of state, local, or foreign law. "APS-Cal" has the meaning set forth in Section 4(b)(ii) below. "Basket Amount" has the meaning set forth in Section 8(d)(i) below. "BellSouth" has the meaning set forth in Section 6(k) below. "Buyer" has the meaning set forth in the preface above. "Buyer Excluded Provisions" has the meaning set forth in Section 8(d)(i) below. "CCI" has the meaning set forth in Section 4(b)(ii) below. "Closing" has the meaning set forth in Section 2(c) below. "Closing Date" has the meaning set forth in Section 2(c) below. "Closing Date Balance Sheet" has the meaning set forth in Section 2(b)(ii) below. "Closing Date Net Working Capital" has the meaning set forth in Section 2(b)(ii) below. "Closing Payment" has the meaning set forth in Section 2(b)(i) below. "Code" means the Internal Revenue Code of 1986, as amended. "Collateral Source" has the meaning set forth in Section 8(f) below. "Company" has the meaning set forth in the preface above. "Company Balance Sheet" means a periodic balance sheet produced by the Company in accordance with past procedures and practices. "Company Confidential Information" means any Confidential Information relating to or concerning the business of the Company. "Company Share" means any share of the common stock, par value $100 per share, of the Company. "Confidential Information" means any written, oral or visual information in any medium concerning the businesses and affairs of the Company or any Party that is not already generally available to the public or, under the circumstances, should reasonably be considered confidential or proprietary. "Contested Adjustments" has the meaning set forth in Section 2(b)(iii) below. "Contested Adjustment Notice" has the meaning set forth in Section 2(b)(iii) below. "Contested Adjustment Dispute" has the meaning set forth in Section 2(b)(iii) below. "December Balance Sheet" the meaning set forth in Section 5(i)(ii) below. "December Fixed Asset Amount" the meaning set forth in Section 5(i)(ii) below. "Disclosure Schedule" means the disclosure schedules attached hereto. "Divested Items" means (i) all ownership interests in CCI owned by the Company and all ownership interests in BillMatrix Corporation owned by the Company, including without limitation any beneficial ownership interest of the Company in shares of BillMatrix Corporation held by an Affiliate of the Company, (ii) the assets related to the prepaid telephony business acquired from Paysmart America, Inc. and any liabilities related thereto, which assets and liabilities are described in Section 5(j) of the Disclosure Schedule and (iii) all assets and liabilities relating to CCI, BillMatrix Corporation and Paysmart America, Inc. and owned by the Company, which assets and liabilities are described in Section 5(j) of the Disclosure Schedule. "Employee" has the meaning set forth in Section 4(r)(i) below. "Employee Benefit Plan" has the meaning set forth in Section 4(r)(i) below. "Environmental, Health, and Safety Requirements" shall mean all federal, state, local and foreign statutes, regulations, ordinances and similar provisions having the force or effect of law and all judicial and administrative orders and determinations concerning public health and safety, worker health and safety, and pollution or protection of the environment, including without limitation all those relating to the presence, use, production, generation, handling, transportation, treatment, storage, disposal, distribution, labeling, testing, processing, discharge, release, threatened release, control, or cleanup of any Hazardous Substances. "ERISA" means the Employee Retirement Income Security Act of 1974, as amended. "ERISA Affiliate" has the meaning set forth in Section 4(r)(ii) below. "Financial Statements" has the meaning set forth in Section 4(f) below. "GAAP" means United States generally accepted accounting principles as in effect from time to time. "Guarantee" has the meaning set forth in Section 6(k) below. "Hazardous Substances" shall have the meaning set forth in Section 101(14) of the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended by the Superfund Amendments and Reauthorization Act ("CERCLA"), 42 U.S.C. Section 9601(14). "HSR Act" means the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, and the rules and regulations promulgated thereunder. "Income Tax" means any federal, state, local, or foreign income or franchise tax, including any interest, penalty, or addition thereto, whether disputed or not. "Income Tax Return" means any return, declaration, report, claim for refund, or information return or statement relating to Income Taxes, including any schedule or attachment thereto, and including any amendment thereof. "Indemnified Party" has the meaning set forth in Section 8(h) below. "Indemnifying Party" has the meaning set forth in Section 8(h) below. "Independent Accountant" means a senior-level certified public accountant of Ernst & Young LLP, resident in the office of such firm located in Stamford, Connecticut. "Intellectual Property" means, in respect of the Company, (a) all inventions (whether patentable or unpatentable and whether or not reduced to practice), all improvements thereto, and all patents, patent applications, and patent disclosures, together with all reissuances, continuations, continuations-in-part, revisions, extensions, and reexaminations thereof, (b) all trademarks, service marks, trade dress, logos, trade names, and corporate names, together with all translations, adaptations, derivations, and combinations thereof and including all goodwill associated therewith, and all applications, registrations, and renewals in connection therewith, (c) all copyrightable works, all copyrights, and all applications, registrations, and renewals in connection therewith, (d) all Internet domain names and universal resource locators ("URLs"), (e) all mask works and all applications, registrations, and renewals in connection therewith, (f) all trade secrets and confidential business information (including ideas, research and development, know-how, formulas, compositions, manufacturing and production processes and techniques, technical data, designs, drawings, specifications, customer and supplier lists, pricing and cost information, and business and marketing plans and proposals), (g) all computer software (including data and related documentation), and (h) all copies and tangible embodiments thereof (in whatever form or medium) owned or held by the Company. "Knowledge," or phrases of similar import, with respect to an individual, means an individual shall be deemed to have knowledge of a particular fact or other matter if (a) that individual is actually aware of that fact or matter; or (b) a prudent individual should be aware of such fact or matter in the ordinary course of performing his or her duties, without conducting any special inquiry. With respect to a Person, other than an individual, "Knowledge," or phrases of similar import, means a Person shall be deemed to have knowledge of a particular fact or other matter if any individual who is serving as a director or executive officer of that Person (or in any similar capacity) has knowledge of that fact or other matter (as set forth in (a) and (b) above), except that the Parent shall be deemed to have knowledge of a fact or other matter if the chief executive officer or chief financial officer of the Parent has knowledge of such fact or other matter (as set forth in (a) and (b) above) or if any of Paul Rocheleau, John Frank, Richard Bucchi, Paul Lavoie, Corey Stone, Carol Boedicker and Donna Estelle has knowledge of a fact or other matter (as set forth in (a) and (b) above). "Loss" has the meaning set forth in Section 8(b)(i) below. "MADSP" has the meaning set forth in Section 9(k)(i) below. "Material Adverse Effect" means, with respect to any of the Buyer, a Seller Entity, the Company or APS-Cal, any change, occurrence or effect (direct or indirect) which might reasonably be expected to have a material adverse effect on (a) the business, operations, properties (including tangible properties), condition (financial or otherwise), assets, obligations or liabilities (whether absolute, contingent or otherwise and whether due or to become due) of such Party or (b) the ability of such Party to timely perform its obligations under the Agreement or otherwise to consummate the transactions contemplated by this Agreement, other than any fact, circumstance, event or thing (i) generally affecting the financial services industry, or resulting from general economic or market conditions (including changes in interest rates) or changes in accounting principles or changes in law, regulations, or regulatory policies of general applicability (or interpretations thereof), (ii) resulting from actions or omissions of a Party taken with the prior written consent of the other Parties in contemplation of the transactions contemplated hereby, or (iii) resulting from the announcement or execution of this Agreement or the transactions contemplated herein. "Most Recent Financial Statements" has the meaning set forth in Section 4(f) below. "Most Recent Fiscal Quarter End" has the meaning set forth in Section 4(f) below. "Multiemployer Plan" has the meaning set forth in ERISA ss.3(37). "Net Working Capital Shortfall" has the meaning set forth in Section 2(b)(ii) below. "Net Working Capital Surplus" has the meaning set forth in Section 2(b)(ii) below. "Ordinary Course of Business" means the ordinary course of business consistent with past custom and practice (including with respect to quantity and frequency). "Overlap Period" has the meaning set forth in Section 9(c) below. "Parent" has the meaning set forth in the preface above. "Parent Consolidated Group" has the meaning set forth in Section 4(j)(i) below. "Party" or "Parties" has the meaning set forth in the preface above. "Person" means an individual, a governmental entity (or any department, agency, or political subdivision thereof), or a partnership, limited liability company, limited liability partnership, corporation, association, joint stock company, trust, joint venture, unincorporated organization or similar entity. "Purchase Price" has the meaning set forth in Section 2(b)(i) below. "Real Property" has the meaning set forth in Section 4(k)(i) below. "Representatives" has the meaning set forth in Section 3(b)(viii) below. "Requisite Consents" has the meaning set forth in Section 7(a)(v) below. "Restricted Items" means all funds that are the property of any client of the Company (including, without limitation, any restricted cash, settlement assets or settlement obligations) and all inter-company liabilities related thereto. "Securities Act" means the Securities Act of 1933, as amended. "Securities Exchange Act" means the Securities Exchange Act of 1934, as amended. "Security Interest" means any mortgage, pledge, lien, encumbrance, charge, or other security interest, other than (a) mechanic's, materialmen's, and similar liens, (b) liens for taxes not yet due and payable or for taxes that the taxpayer is contesting in good faith through appropriate proceedings, (c) purchase money liens and liens securing rental payments under capital lease arrangements, and (d) other liens arising in the Ordinary Course of Business and not incurred in connection with the borrowing of money, all of which are set forth in Section 4(e) of the Disclosure Schedule. "Seller" has the meaning set forth in the preface above. "Seller Entities" has the meaning set forth in the preface above. "Seller Excluded Provisions" has the meaning set forth in Section 8(d)(i) below. "Seller 401(k) Plan" means the United Illuminating Company 401(k) Employee Stock Ownership Plan. "September Balance Sheet" means the unaudited balance sheet of the Company, as of September 30, 2003, attached hereto as Section 2(b)(ii) of the Disclosure Schedule which depicts: in column (A), the unaudited, consolidated balance sheet of the Company as of September 30, 2003; in columns (B) through (E), the Divested Items and all assets and liabilities related thereto; and in column (F), the adjusted, unaudited balance sheet of the Company as of September 30, 2003, excluding the Divested Items and all assets and liabilities related thereto. "September Net Working Capital" means "Total Current Assets" less "Total Current Liabilities," as such items are described in column (F) of the September Balance Sheet attached hereto as Section 2(b)(ii) of the Disclosure Schedule, which reflects such amount as $1,855,537.32. "Subsidiary" means any corporation (or other entity) with respect to which a specified Person or a Subsidiary thereof owns a majority of the common stock (or analogous equity interest, as applicable) or has the power to vote or direct the voting of sufficient securities to elect a majority of members of the board of directors (or analogous governing body, as applicable). "Successor 401(k) Plan" has the meaning set forth in Section 6(e)(ii) below. "Tax Returns" means federal, state, foreign and local Tax reports, returns, declarations, claims for refund, information returns and other documents, including any schedules or attachments thereto and including any amendments thereto. "Taxes" or "Tax" shall mean all taxes, assessments, charges, duties, fees, levies or other governmental charges, including, without limitation, all federal, state, local, foreign and other income, franchise, profits, capital gains, capital stock, transfer, sales, use, occupation, property, excise, severance, windfall profits, stamp, license, payroll, withholding and other taxes, assessments, charges, duties, fees, levies or other governmental charges of any kind whatsoever (whether payable directly or by withholding and whether or not requiring the filing of a Tax Return), all estimated taxes, deficiency assessments, additions to tax, penalties and interest and shall include any liability for such amounts as a result either of being a member of a combined, consolidated, unitary or Affiliated Group or of a contractual obligation to indemnify any Person. "Taxing Authorities" means the Internal Revenue Service and any other federal, state or local authority which has the right to impose Taxes on the Company, the Parent Consolidated Group or a Seller Entity. "Third Party Claim" has the meaning set forth in Section 8(h) below. "Transferred Employee" has the meaning set forth in Section 6(d) below. "Wallingford Condition" means the conditions described in Section 6.20.5, Section 6.20.8, and the first two paragraphs under the heading "Significant Interior Observations and Issues" in Section 10.00 of the Phase I Environmental Site Assessment Report regarding 15 Sterling Drive, Wallingford, CT, File 42859, dated October 2002, which report has been furnished to the Buyer. "338 Indemnity Amount" has the meaning set forth in Section 9(k)(iii) -------------------- below. "338(h)(10) Election" has the meaning set forth in Section 9(k)(i) below. 2. PURCHASE AND SALE OF THE COMPANY SHARES. (A)......BASIC TRANSACTION. On and subject to the terms and conditions of this Agreement, the Buyer agrees to purchase from the Seller, and the Seller agrees to sell to the Buyer, all of its Company Shares for the consideration specified below in this Section 2. (B)......PURCHASE PRICE. (i) AMOUNT PAID AT CLOSING. The Buyer agrees to pay to the Seller at Closing One Hundred Ten Million and 00/100 Dollars ($110,000,000.00), subject to adjustment pursuant to Section 2(b) (ii) below (the "Purchase Price"). At the Closing, the Buyer shall deliver to the Seller in immediately available funds One Hundred Ten Million Dollars ($110,000,000.00) by certified check or wire transfer to the Seller's designated account(s) (the "Closing Payment"). (ii) POST CLOSING ADJUSTMENTS. As soon as practicable, but no later than thirty (30) days after the Closing Date, the Independent Accountant, on behalf of the Parties and pursuant to an engagement agreement reasonably acceptable to the Buyer and the Seller, shall prepare and deliver to the Buyer and the Seller an unaudited balance sheet of the Company as of the close of business on the Closing Date (the "Closing Date Balance Sheet") in substantially the form of the September Balance Sheet attached hereto as Section 2(b)(ii) of the Disclosure Schedule. The Closing Date Balance Sheet shall include a calculation of the net working capital of the Company as of the close of business on the Closing Date (the "Closing Date Net Working Capital") which shall be made, and presented on the Closing Date Balance Sheet, in the same manner as the calculation of the September Net Working Capital is made and presented on the September Balance Sheet attached hereto as Section 2(b)(ii) of the Disclosure Schedule. The Closing Date Balance Sheet shall be prepared by the Independent Accountant in accordance with GAAP, as modified by the accounting principles used in preparing the September Balance Sheet (as reflected in Section 2(b)(ii) of the Disclosure Schedule). For the avoidance of doubt, the calculation of the September Net Working Capital does not, and the calculation of the Closing Date Net Working Capital shall not, include any of the assets or liabilities identified in columns (B) through (E) of the September Balance Sheet attached hereto as Section 2(b)(ii) of the Disclosure Schedule. The Independent Accountant shall also make available to the Buyer and the Seller copies of all work papers and other documents and data as were used to prepare the Closing Date Balance Sheet (and any items therein) and the Closing Date Net Working Capital calculation. The Buyer and the Seller shall have the right to dispute the Closing Date Balance Sheet (and any items therein) and the Closing Date Net Working Capital calculation and make any proposed adjustments thereto as provided in Section 2(b) (iii) hereto. (A) If it is determined by the Independent Accountant that the Closing Date Net Working Capital is more than the September Net Working Capital (such surplus being a "Net Working Capital Surplus"), then the Buyer shall, subject to Section 2(b) (iii), deliver to the Seller cash in an amount equal to such Net Working Capital Surplus, if any, within ten (10) days of receipt of the Independent Accountant's determination; or (B) If it is determined by the Independent Accountant that the Closing Date Net Working Capital is less than the September Net Working Capital (such shortfall being a "Net Working Capital Shortfall"), then the Seller shall, subject to Section 2(b) (iii), deliver to the Buyer cash in an amount equal to such Net Working Capital Shortfall, if any, within ten (10) days of receipt of the Independent Accountant's determination. (iii) DISPUTE RESOLUTION PROCEDURES. The Buyer and the Seller shall have until ten (10) days after the delivery of the Closing Date Net Working Capital calculation prepared by the Independent Accountant to review the calculation set forth therein and propose any adjustments thereto. All adjustments proposed by the Buyer or the Seller shall be set out in detail in a written statement delivered to the other Party and the Independent Accountant (an "Adjustment Statement") and shall be incorporated into the Closing Date Balance Sheet, unless the other Party shall object in writing to such proposed adjustments to the proposing Party within ten (10) days of delivery of the Adjustment Statement (the proposed adjustment or adjustments to which either Party objects are referred to herein as the "Contested Adjustments" and the objection notice is referred to herein as the "Contested Adjustment Notice"). If either Party delivers a Contested Adjustment Notice, the Seller and the Buyer shall attempt in good faith to resolve their dispute (a "Contested Adjustment Dispute") regarding the Contested Adjustments, but if a final resolution thereof is not obtained within ten (10) days after delivery of said Contested Adjustment Notice, the Independent Accountant shall resolve any remaining disputes concerning the Contested Adjustments. If the Independent Accountant is requested to resolve a Contested Adjustment Dispute, then (A) the Buyer and the Seller shall each submit to the Independent Accountant in writing, not later than ten (10) days after the Independent Accountant is retained for such purpose, their respective positions with respect to the Contested Adjustments, together with such supporting documentation as they deem necessary or as the Independent Accountant reasonably requests, and (B) the Independent Accountant shall, within ten (10) days after receiving the positions of both the Buyer and the Seller and all supplementary supporting documentation requested by the Independent Accountant, render its decision as to the Contested Adjustments, which decision shall be final and binding on, and non-appealable by, the Parties. Each of the Seller and the Buyer shall pay fifty percent (50%) of the fees and expenses of the Independent Accountant related to the preparation and delivery of a Closing Date Balance Sheet and the calculation of the Closing Date Net Working Capital. The fees and expenses of the Independent Accountant related to the resolution of Contested Adjustments shall be paid by the Party whose estimate of the Closing Date Net Working Capital is farthest from the Independent Accountant's final calculation of the Closing Date Net Working Capital. The decision of the Independent Accountant shall also include a certificate of the Independent Accountant setting forth the final Closing Date Net Working Capital calculation. The Closing Date Balance Sheet shall be deemed to include all proposed adjustments not disputed by either Party and those adjustments accepted or made by the decision of the Independent Accountant in resolving the Contested Adjustments. (iv) CLOSING DISTRIBUTIONS; REPAYMENT OF INTER-COMPANY DEBT. The Buyer acknowledges and agrees that prior to the Closing Date the Company shall have the right, in its sole discretion, to (i) distribute all or some of its cash on hand to the Seller and/or (ii) repay all or some principal and interest on any inter-company debt. The Buyer agrees that if there is any inter-company debt outstanding with respect to any Restricted Items as of the Closing, then the Buyer shall cause the Company to repay the amount of such debt to the Parent promptly after the receipt of payment to the Company in respect of such Restricted Item, but in any event not later than five (5) days after the Closing Date. (C)......THE CLOSING. The closing of the transactions contemplated by this Agreement (the "Closing") shall take place at the offices of Wiggin & Dana LLP in Stamford, CT, commencing at 9:00 a. m. local time, on the fifth (5th) business day immediately following the date on which the last condition set forth in Section 7 hereof is fulfilled or waived in writing. or such other date as the Buyer and the Seller may mutually determine in writing (the "Closing Date"). (D)......DELIVERIES AT THE CLOSING. At the Closing, (i) the Seller will deliver to the Buyer the various certificates, instruments, and documents referred to in Section 7(a) below, (ii) the Buyer will deliver to the Seller the various certificates, instruments, and documents referred to in Section 7(b) below, (iii) the Seller will deliver to the Buyer stock certificates representing all of the Company Shares, endorsed in blank or accompanied by duly executed assignment documents, and (iv) the Buyer will deliver to the Seller the Closing Payment. 3. REPRESENTATIONS AND WARRANTIES CONCERNING THE SELLER ENTITIES AND THE BUYER. (A) .....REPRESENTATIONS AND WARRANTIES OF THE SELLER ENTITIES. Each of the Seller Entities jointly and severally represents and warrants to the Buyer that except as set forth in the Disclosure Schedule, the statements contained in this Section 3(a) are correct and complete as of the date hereof. (i) ORGANIZATION. Each of the Seller Entities is a corporation duly organized, validly existing, and in good standing under the laws of the jurisdiction of its incorporation. (ii) AUTHORIZATION OF TRANSACTION. Each of the Seller Entities has full power and authority (including full corporate power and authority) to execute and deliver this Agreement and to perform its obligations hereunder. The execution, delivery and performance of this Agreement and all other agreements and transactions contemplated hereby have been duly authorized by all required corporate proceedings of each of the Seller Entities and no other corporate proceedings are necessary to authorize this Agreement and such agreements contemplated hereby and transactions contemplated hereby and thereby. This Agreement constitutes the valid and legally binding obligation of each of the Seller Entities, enforceable in accordance with its terms and conditions, except to the extent that enforceability may be limited by bankruptcy, insolvency, moratorium, reorganization and other laws affecting the enforcement of creditors' rights generally and by general principles of equity. Except as required by the HSR Act and as set forth in Section 3(a) (ii) of the Disclosure Schedule, neither Seller Entity is required to give any notice to, make any filing with, or obtain any authorization, consent, or approval of any government or governmental agency in connection with the transactions contemplated by this Agreement. (iii) NON-CONTRAVENTION. Neither the execution and the delivery of this Agreement, nor the consummation of the transactions contemplated hereby, will (A) violate any constitution, statute, regulation, rule, injunction, judgment, order, decree, ruling, charge, or other restriction of any government, governmental agency, or court to which a Seller Entity is subject or any provision of the charter or bylaws of a Seller Entity or (B) conflict with, result in a breach of, constitute a default under, result in the acceleration of, create in any party the right to accelerate, terminate, modify, or cancel, or require any notice under any agreement, contract, lease, license, instrument, or other arrangement to which a Seller Entity may be a party or by which it is bound or to which its assets are subject. (iv) BROKERS' FEES. Neither Seller Entity has any liability or obligation to pay any fees or commissions to any broker, finder, or agent with respect to the transactions contemplated by this Agreement, other than certain fees to Morgan Stanley & Co. Incorporated for which the Seller Entities shall be wholly responsible. (v) COMPANY SHARES. The Seller holds of record and owns beneficially the number of Company Shares set forth in Section 4(b) below, free and clear of any restrictions on transfer (other than any restrictions under the Securities Act and state securities laws), taxes, Security Interests, options, warrants, purchase rights, contracts, or commitments. Neither Seller Entity is a party to any option, warrant, purchase right, or other contract or commitment that could require the Seller to sell, transfer, or otherwise dispose of any capital stock of the Company (other than this Agreement). Neither Seller Entity is a party to any voting trust, proxy, or other agreement or understanding with respect to the voting of any capital stock of the Company. (vi) LITIGATION. There is no action, suit, investigation or proceeding pending, or to the Knowledge of the Seller Entities, threatened against or affecting the Seller Entities before any court or arbitrator or any governmental body, agency or official which in any manner challenges or seeks to prevent, enjoin, alter or delay the consummation of the transactions contemplated by this Agreement. (vii) LEGAL COMPLIANCE. The Seller Entities do not reasonably anticipate any material impediments to their obtaining all required permits, license, approval or authorizations of governmental authorities listed in Section 3(a)(ii) of the Disclosure Schedule required to consummate the transactions contemplated hereunder. (B)......REPRESENTATIONS AND WARRANTIES OF THE BUYER. The Buyer represents and warrants to the Seller Entities that except as set forth in the Disclosure Schedule, the statements contained in this Section 3(b) are correct and complete as of the date hereof. (i) ORGANIZATION OF THE BUYER. The Buyer is a corporation duly organized, validly existing, and in good standing under the laws of the jurisdiction of its incorporation. (ii) AUTHORIZATION OF TRANSACTION. The Buyer has full power and authority (including full corporate power and authority) to execute and deliver this Agreement and to perform its obligations hereunder. The execution, delivery and performance of this Agreement and all other agreements and transactions contemplated hereby, have been duly authorized by all required corporate proceedings of the Buyer, and no other corporate proceedings are necessary to authorize this Agreement and such agreements contemplated hereby and the transactions contemplated hereby and thereby. This Agreement constitutes the valid and legally binding obligation of the Buyer, enforceable in accordance with its terms and conditions, except to the extent that enforceability may be limited by bankruptcy, insolvency, moratorium, reorganization and other laws affecting the enforcement of creditors' rights generally and by general principles of equity. Except as required by the HSR Act and as set forth in Section 3(b) (ii) of the Disclosure Schedule, the Buyer need not give any notice to, make any filing with, or obtain any authorization, consent, or approval of any government or governmental agency in connection with the transactions contemplated by this Agreement. (iii) NON-CONTRAVENTION. Neither the execution and the delivery of this Agreement, nor the consummation of the transactions contemplated hereby, will (A) violate any constitution, statute, regulation, rule, injunction, judgment, order, decree, ruling, charge, or other restriction of any government, governmental agency, or court to which the Buyer is subject or any provision of its charter or bylaws or (B) conflict with, result in a breach of, constitute a default under, result in the acceleration of, create in any party the right to accelerate, terminate, modify, or cancel, or require any notice under any agreement, contract, lease, license, instrument, or other arrangement to which the Buyer is a party or by which it is bound or to which any of its assets is subject. (iv) BROKERS' FEES. The Buyer has no liability or obligation to pay any fees or commissions to any broker, finder, or agent with respect to the transactions contemplated by this Agreement. (v) INVESTMENT. The Buyer is purchasing the Company Shares for its own account and is not acquiring the Company Shares with a view to or for sale in connection with any distribution thereof within the meaning of the Securities Act. The Buyer has no present intention of selling, granting any participation in, or otherwise distributing the Company Shares. None of the Buyer or its Affiliates has entered into any contract, undertaking, agreement or arrangement with any Person for resale of the Company Shares. The Buyer acknowledges that the offering of the Company Shares pursuant to this Agreement has not been and will not be registered under the Securities Act or any state securities or blue sky laws on the grounds that the offering and sale of the Company Shares contemplated by this Agreement is exempt from registration pursuant to exemptions available under such laws, and that the Seller's reliance upon such exemptions is predicated in part upon the Buyer's representations set forth in this Agreement. (vi) ACCREDITED INVESTOR. The Buyer is an "accredited investor" within the meaning of Regulation D promulgated under the Securities Act, and has the knowledge and experience necessary to evaluate the merits and risks of an investment in the Company Shares and the consummation of the transactions contemplated hereby. (vii) LITIGATION; COMPLIANCE WITH LAWS. There is no action, suit, investigation or proceeding pending against, or to the Knowledge of the Buyer, threatened against or affecting the Buyer before any court or arbitrator or any governmental body, agency or official which in any manner challenges or seeks to prevent, enjoin, alter or delay the consummation of the transactions contemplated by this Agreement. (viii) DISCLAIMER; INVESTIGATION BY THE BUYER; THE SELLER'S LIABILITY. The Buyer acknowledges that none of the Parent, the Seller, the Company or any of their Affiliates has made any representation, warranty or agreement except as expressly set forth in this Agreement. The Buyer is not relying on any statement, document, record, report, material or information made or provided by the Parent, the Seller, the Company or any of their Affiliates, representatives or agents, except as expressly set forth in this Agreement, the Disclosure Schedule and any certificates delivered at Closing. The Buyer has conducted its own independent investigation, review and analysis of the business, operations, assets, liabilities, results of operations, financial condition, software, technology and prospects of the Company, which investigation, review and analysis was done by the Buyer and its Affiliates and, to the extent the Buyer deemed appropriate, by the officers, directors, employees, accountants, counsel, investment bankers, financial advisors and other representatives (collectively, "Representatives") of Buyer. The Buyer acknowledges that it and its Representatives have been provided adequate access to the personnel, properties, premises and records of the Company for such purpose. In entering into this Agreement, the Buyer acknowledges that it has relied solely upon the aforementioned investigation, review and analysis and not on any factual representations of the Parent, the Seller, the Company or the Representatives thereof (except the specific representations and warranties set forth in this Agreement). The Buyer agrees, to the fullest extent permitted by law, that none of the Parent, the Seller, the Company, or any of their respective directors, officers, employees, shareholders, Affiliates, controlling Persons, agents, advisors or Representatives shall have any liability or responsibility whatsoever to the Buyer or its directors, officers, employees, affiliates, controlling Persons, agents or Representatives on any basis (including in contract or tort, under federal or state securities laws or otherwise) other than for fraud or intentional misconduct, based upon any information provided or made available, or statements made (including in materials furnished in any data room, in presentations by management of the Parent, the Seller or the Company, on site visits or otherwise) to the Buyer or its directors, officers, employees, affiliates, controlling Persons, advisors, agents or Representatives (or any omissions therefrom); PROVIDED, HOWEVER, that the foregoing limitations (A) shall not apply to the Seller Entities insofar as the Seller Entities make the specific representations and warranties set forth in this Agreement, but always subject to the limitations and restrictions contained in Section 8 and (B) shall not otherwise limit Buyer's rights under Section 8 hereof. (ix) LEGAL COMPLIANCE. To the Knowledge of the Buyer, the Buyer has taken all necessary actions to be in compliance with all applicable laws (including rules, regulations, codes, plans, injunctions, judgments, orders, decrees, rulings, and charges thereunder) of federal, state, and local governments (and all agencies thereof), except where the failure to comply would not have a Material Adverse Effect upon the Buyer. To the Knowledge of the Buyer, except as set forth in Section 3(b)(ix) of the Disclosure Schedule, the Buyer holds and is in compliance with all permits, licenses, approvals, and authorizations of governmental authorities, required for the conduct of its business as currently conducted, except to the extent that any failure to hold or comply would not reasonably be expected to have a Material Adverse Effect on the Buyer or the Company following the Closing. The Buyer does not reasonably anticipate any material impediments to its obtaining all required permits, licenses, approvals or authorizations of governmental authorities listed in Section 3(b) (ii) of the Disclosure Schedule required to consummate the transactions contemplated hereunder. (x) ADEQUATE FUNDS. The Buyer has available funds to pay the entire Purchase Price at the Closing. 4. REPRESENTATIONS AND WARRANTIES CONCERNING COMPANY. The Parent and the Seller jointly and severally represent and warrant to the Buyer that except as set forth in the Disclosure Schedule, each of the statements contained in this Section 4 is correct and complete in all material respects as of the date of this Agreement. The exceptions, modifications and disclosures made in any Section of the Disclosure Schedule are made for all purposes of this Agreement or in any agreement or instrument delivered pursuant to or in connection with this Agreement notwithstanding the fact that no express cross-reference is made; PROVIDED, HOWEVER, that the applicability of any particular exception, modification or disclosure to a particular section of the Disclosure Schedule must be reasonably clear from the description thereof. (A)......ORGANIZATION OF THE COMPANY. The Company is a corporation duly organized, validly existing, and in good standing under the laws of Connecticut. Complete and accurate copies of the certificate of incorporation and bylaws of the Company have been made available to the Buyer. The Company is duly authorized to conduct business and is in good standing under the laws of each jurisdiction where such qualification is required, except where the lack of such qualification would not have a Material Adverse Effect on the Company. The Company has full corporate power and authority to carry on the businesses in which it is engaged in the manner in which they are currently conducted and to own and use the properties owned and used by it in the manner in which they are currently used. (B) CAPITALIZATION. (i) COMPANY. The entire authorized capital stock of the Company consists of 5,000 Company Shares, of which 10 Company Shares are issued and outstanding. All of the issued and outstanding Company Shares have been duly authorized, are validly issued, fully paid, and nonassessable, and are held beneficially and of record by the Seller free and clear of all Security Interests. There are no outstanding or authorized options, warrants, purchase rights, pre-emptive rights, subscription rights, conversion rights, exchange rights, or other contracts or commitments that could require the Company to issue, sell, repurchase or otherwise cause to become outstanding any of its capital stock or other securities convertible or exchangeable for stock of the Company, or grant to any Person a right to subscribe for capital stock. There are no outstanding or authorized stock appreciation, phantom stock, profit participation, or similar rights with respect to the capital stock of the Company. (ii) SUBSIDIARIES. Other than as set forth in Section 4(b)(ii) of the Disclosure Schedule and other than CellCards of Illinois, LLC, an Illinois limited liability company ("CCI") and American Payment Systems of California, Inc. ("APS-Cal"), the Company has no Subsidiaries and does not otherwise own or control, directly or indirectly, any equity or similar interest or any interest convertible into or exchangeable or exercisable for any equity or similar interest in any Person. For the last five (5) years, the Company has owned no Subsidiaries other than as set forth in Section 4(b)(ii) of the Disclosure Schedule and other than CCI and APS-Cal. APS- Cal is a corporation duly organized, validly existing, and in good standing under the laws of California. Complete and accurate copies of the articles of incorporation and bylaws of APS-Cal have been made available to the Buyer. APS-Cal is duly authorized to conduct business and is in good standing under the laws of each jurisdiction where such qualification is required, except where the lack of such qualification would not have a Material Adverse Effect on APS-Cal. APS-Cal has full corporate power and authority to carry on the business in which it is engaged in the manner in which it is currently conducted and to own and use the properties owned and used by it. The authorized capital of CCI consists of 100,000 units of ownership interests of which 100,000 units are issued and outstanding and owned as set forth in Section 4(b) (ii) of the Disclosure Schedule. The authorized capital stock of APS-Cal consists of 10,000 shares of common stock of which 1,000 are issued and outstanding and owned by the Company. Except as set forth in Section 4(b)(ii) of the Disclosure Schedule: (A) there are no options, warrants, convertible securities or other contracts of any kind, nature or description obligating the Company, CCI or APS-Cal to issue or sell any units of ownership of or any other interest in CCI or APS-Cal, as the case may be; (B) none of the issued and outstanding units of ownership of CCI or APS-Cal was issued in violation of any preemptive rights; (C) there are no outstanding obligations to repurchase, redeem or otherwise acquire any shares of capital stock of the Company, CCI or APS-Cal, or to provide funds to or make any investment in any other Person; (D) there are no voting trusts, shareholder agreements, proxies, or other contracts in effect with respect to the voting or transfer of any shares of capital stock of or any other interests in CCI or APS-Cal. (C) NON-CONTRAVENTION. Except as set forth in Section 4(c) of the Disclosure Schedule, neither the execution and the delivery of this Agreement, nor the consummation of the transactions contemplated hereby, will (i) violate any constitution, statute, regulation, rule, injunction, judgment, order, decree, ruling, charge, or other restriction of any government, governmental agency, or court to which the Company or APS-Cal is subject or any provision of the charter or bylaws of the Company or APS-Cal or (ii) conflict with, result in a breach of, constitute a default under, or result in the acceleration of any agreement, create in any party the right to accelerate, terminate, modify or cancel, or require any notice under any contract, lease, license, instrument or other arrangement to which the Company or APS-Cal is a party or by which it is bound or to which any of its assets is subject, except where the violation, conflict, breach, default, or acceleration would not have a Material Adverse Effect on the Company or APS-Cal or on the ability of the Parties to consummate the transactions contemplated by this Agreement. To the Knowledge of the Seller Entities and except as set forth in Section 4(c) of the Disclosure Schedule, neither the Company nor APS-Cal is required to give any notice to, make any filing with, or obtain any authorization, consent, or approval of any government or governmental agency in connection with the transactions contemplated by this Agreement. (D) BROKERS' FEES. Neither the Company nor APS-Cal has any liability or obligation to pay any fees or commissions to any broker, finder, or agent with respect to the transactions contemplated by this Agreement. (E) TITLE TO ASSETS; SUFFICIENCY OF ASSETS. The Company and APS-Cal have good and marketable title to, or a valid leasehold interest in, the properties and assets used by them, located on their premises, or shown on the Most Recent Financial Statements, free and clear of all Security Interests, except for properties and assets disposed of in the Ordinary Course of Business since the date of the Most Recent Financial Statements. Such assets consist of all of the assets reasonably necessary to conduct the businesses in which the Company and APS-Cal are engaged as currently conducted. The assets of the Company described as "POSA Technology" on Section 5(j) of the Disclosure Schedule, are utilized by the Company exclusively in connection with its pre-paid telephony business. None of the software licenses, source code or hardware, including servers and routers, described on Section 5(j) of the Disclosure Schedule are used by the Company other than in connection with the pre-paid telephony business of the Company. (F) FINANCIAL STATEMENTS. Copies of the following financial statements (collectively the "Financial Statements") have been made available to the Buyer: (i) the audited, consolidated balance sheets and statements of income, shareholder equity, and cash flows as of and for the fiscal years ended December 31, 2000, 2001, and 2002 for the Company and its Subsidiaries; and (ii) an unaudited, consolidated balance sheet and statements of income, shareholder equity and cash flows (the "Most Recent Financial Statements"), as of and for the nine (9) months ended September 30, 2003 (the "Most Recent Fiscal Quarter End") for the Company and its Subsidiaries and (iii) the September Balance Sheet. The Financial Statements (including the notes thereto) have been prepared in accordance with GAAP, except as set forth therein or in Section 4(f) of the Disclosure Schedule. The Financial Statements present fairly, in all material respects, the financial condition of the Company and its Subsidiaries as of such dates and the results of operations and cash flows of the Company and its Subsidiaries for such periods in accordance with GAAP except as set forth therein or in Section 4(f) of the Disclosure Schedule; PROVIDED, HOWEVER, that the Most Recent Financial Statements are subject to normal year-end adjustments (which will not be material individually or in the aggregate) and lack footnotes and other presentation items. (G) UNDISCLOSED LIABILITIES. Neither the Company nor APS-Cal has any material liability (whether known or unknown, whether asserted or unasserted, whether absolute or contingent, whether accrued or unaccrued, whether liquidated or unliquidated, and whether due or to become due), except for (i) liabilities set forth in the Most Recent Financial Statements (rather than in any notes, if any, thereto) and (ii) liabilities which have arisen after the date of the Most Recent Financial Statements in the Ordinary Course of Business in accordance with past practices, which individually or in the aggregate are not material to the Company or APS-Cal, as the case may be, or the operation of the business of the Company or APS-Cal, as the case may be. (H) EVENTS SUBSEQUENT TO MOST RECENT FISCAL QUARTER END. Since the date of the Most Recent Financial Statements, (i) there has not been any change in the business or results of operations or the financial condition of the Company or APS-Cal that would have a Material Adverse Effect on the Company and APS-Cal taken as a whole and (ii) the Company and APS-Cal have conducted their businesses in the Ordinary Course of Business. Without limiting the generality of the foregoing and except as otherwise contemplated by this Agreement, since the date of the Most Recent Financial Statements, neither the Company nor APS-Cal has (A) sold, assigned or otherwise transferred any of its material assets or properties, other than in the Ordinary Course of Business and other than in connection with the Divested Items, (B) made any acquisition of all of the capital stock (whether by merger or otherwise) or all or substantially all of the assets of any Person, (C) subjected any of its material assets to a Security Interest, (D) amended or authorized any amendment to its certificate of incorporation or by-laws, (E) borrowed or refinanced any amount from any non-affiliated Person or incurred any liabilities (contingent or otherwise) in excess of $50,000, other than trade payables incurred in the Ordinary Course of Business in accordance with past practices, (F) declared or made any payment or distribution to stockholders, (G) made any changes to its accounting policies, principles or practices, (H) made any loans to any Persons, (I) entered into, adopted, amended or terminated any bonus, profit sharing, compensation or stock option/ownership plan, severance or other Employee Benefit Plan or other arrangement for the benefit of any director, officer or employee, or increased in any manner the compensation or fringe benefits of any director or officer, (J) waived any right in any contract listed in Section 4(m) of the Disclosure Schedule, the waiver of which would reasonably be expected to materially detract from the value of such contract to the Company or APS-Cal, as the cause may be, or (K) become obligated to take any of the actions specified in subparagraphs (A) through (J) above. (I)......LEGAL COMPLIANCE. To the Knowledge of the Seller Entities, each of the Company and APS-Cal is currently conducting business in compliance in all material respects with all applicable laws (including rules, regulations, codes, plans, injunctions, judgments, orders, decrees, rulings, and charges thereunder) of federal, state, and local governments (and all agencies thereof). To the Knowledge of the Seller Entities, except as set forth in Section 4(i) of the Disclosure Schedule, each of the Company and APS-Cal holds and is in compliance in all material respects with all permits, licenses, approvals, and authorizations of governmental authorities, required for the conduct of its business as currently conducted. (J) TAX MATTERS.. (i) The Company has at all times since its incorporation been a member of an Affiliated Group filing a consolidated federal Income Tax Return in which the Parent was the common parent (the "Parent Consolidated Group"). Except as set forth in Section 4(j) (i) of the Disclosure Schedule, all Tax Returns required to be filed in respect of the Company, APS-Cal and the Parent Consolidated Group have been filed and all Taxes have been paid (whether or not shown on such Tax Returns), except where the failure to file Tax Returns or to pay Taxes would not have a Material Adverse Effect on the Company or APS-Cal. All such Tax Returns were correct and complete in all material respects. All Taxes owed by a Seller Entity, the Company or APS-Cal (whether or not shown on any Tax Return) have been paid, except where the failure to pay such Tax would not have a Material Adverse Effect on such Seller Entity, the Company or APS-Cal, as applicable. Except as described above in this subparagraph (i), neither the Parent, the Seller, the Company nor APS-Cal is currently the beneficiary of any extension of time within which to file any Tax Return. No written claim has ever been made by an authority in a jurisdiction where the Company or APS-Cal does not file Tax Returns that such entity is or may be subject to taxation by that jurisdiction and neither the Company nor APS-Cal has been informed in writing that it is subject to Tax in any jurisdiction where it has not filed a Tax Return. To the Knowledge of the Seller Entities, neither the Company nor APS-Cal is subject to Tax in any jurisdiction where it has not filed a Tax Return. There are no Security Interests on any of the assets of the Company or APS-Cal that arose in connection with any failure (or alleged failure) to pay any Tax. (ii) Each of the Company and APS-Cal has filed all state and local Income Tax Returns that it was required to file prior to the date hereof, and has paid or has reserved adequate funds for the payment of all Income Taxes shown thereon as owing. (iii) Neither the Company nor APS-Cal has waived any statute of limitations in respect of Income Taxes or agreed to any extension of time with respect to an Income Tax assessment or deficiency. (iv) Each of the Company and APS-Cal has withheld and paid all Taxes required to have been withheld and paid by the Company or APS-Cal, as applicable, except payroll taxes which are not due as of the Closing Date and which have been appropriately reflected as liabilities on the Most Recent Financial Statements. (v) There is no dispute or claim concerning any material liability in respect of any Tax of a Seller Entity, the Company or APS-Cal either (A) claimed or raised by any authority in writing or (B) as to which the Seller Entities have Knowledge. (vi) Neither the Parent, the Seller, the Company nor APS-Cal has filed a consent under Code ss. 341(f) concerning collapsible corporations or any corresponding provision of state, local or foreign Income Tax law. Neither the Parent, the Seller, the Company nor APS-Cal has been a United States real property holding corporation within the meaning of Code ss. 897(c)(2) during the applicable period specified in Code ss.897(c)(1)(A)(ii) and the Buyer is not required to withhold tax on the purchase of the stock of the Company by reason of Section 1445 of the Code. Each of the Seller Entities, APS-Cal and the Company has disclosed on their respective federal income Tax Returns all positions taken therein that could give rise to a substantial understatement of federal income Tax within the meaning of Code ss. 6662. Neither the Parent, the Seller, the Company nor APS-Cal is a party to any Tax allocation or sharing agreement which will not be terminated on or before the Closing Date. Neither the Company nor APS-Cal is a party to any safe harbor lease within the meaning of Section 168(f)(8) of the Code. Except as set forth in Section 4(j)(vi) of the Disclosure Schedule, neither the Company nor APS-Cal has entered into any compensatory agreements with respect to the performance of services which payment thereunder would result in a nondeductible expense to the Parent Consolidated Group pursuant to Sections 162(m) or 280G of the Code. Neither the Company nor APS-Cal has been the "distributing corporation" within the meaning of Section 355(c)(2) of the Code with respect to a transaction described in Section 355 of the Code within the three (3) year period ending as of the date of this Agreement. Neither the Company nor APS-Cal has participated in an international boycott as defined in Section 999 of the Code. Neither the Company nor APS-Cal has agreed, nor is either such entity required to make, any adjustment under Section 263A or 481(a) of the Code by reason of a change in accounting method or otherwise. Neither the Company nor APS-Cal has a permanent establishment in any foreign country, as defined in any applicable Tax treaty or convention between the United States of America and such foreign country. (vii) The unpaid Taxes of the Company and APS-Cal did not, as of the Most Recent Fiscal Quarter End, materially exceed the reserve for Tax Liability (rather than any reserve for deferred Taxes established to reflect timing differences between book and Tax income) set forth on the face of the Most Recent Financial Statements (rather than in any notes thereto). (viii) Neither the Company nor APS-Cal has any liability for Taxes of any Person other than the Company or APS-Cal under Treasury Regulation Section 1.1502-6 (or any similar provision of state, local or foreign law) (ix) To the Knowledge of the Seller Entities, the basis of the assets of the Company for federal Tax purposes as of September 30, 2003 is as set forth in Section 4(j)(ix) of the Disclosure Schedules, and the basis of the Company Shares for federal Tax purposes as of September 30, 2003 is as set forth in Section 4(j)(ix) of the Disclosure Schedules. (x) To the Knowledge of the Seller Entities, the Seller Entities are eligible to make a joint 338(h)(10) Election with the Buyer with respect to the Company. (K) REAL PROPERTY. (i) Neither the Company nor APS-Cal currently owns or has ever owned any real property (the "Real Property"). (ii) Section 4(k) (ii) of the Disclosure Schedule lists and describes briefly all parcels of Real Property leased or subleased to the Company or APS-Cal by any other Person. The Seller Entities have made available to the Buyer correct and complete copies of the leases and subleases listed in Section 4(k)(ii) of the Disclosure Schedule and: (A) each such lease or sublease is legal, valid, binding, in good standing, enforceable, and in full force and effect with respect to the Company or APS-Cal, as the case may be, and to the Knowledge of the Seller Entities, each such lease or sublease is legal, valid, binding, in good standing, enforceable, and in full force and effect with regard to each other party thereto, except in each case where the illegality, invalidity, non-binding nature, unenforceability, or ineffectiveness would not reasonably be deemed to have a Material Adverse Effect on the Company or APS-Cal, as the case may be; (B) the consummation of the transactions contemplated hereby is not an event of default under any such lease or sublease; (C) neither the Company nor APS-Cal is in breach or default of any such lease or sublease and no event has occurred which, with notice or lapse of time, would constitute a breach or default by the Company or APS-Cal or permit termination, modification, or acceleration thereunder; (D) To the Knowledge of the Seller Entities, no counterparty to any lease or sublease is in breach or default of any such lease or sublease, and no event has occurred which, with notice or lapse of time, would constitute a breach or default by the counterparty or permit termination, modification, or acceleration thereunder; (E) the Company has received no actual notice that any party to any such lease or sublease has repudiated any provision thereof; (F) there are no oral agreements or forbearance programs in effect as to any such lease or sublease and neither the Company nor APS-Cal has assigned, subleased, transferred, conveyed, mortgaged, deeded in trust, or encumbered any interest in the leasehold or subleasehold. (L) INTELLECTUAL PROPERTY. (i) The Company and APS-Cal either own, hold valid licenses for, or otherwise possess the valid and enforceable right to use all Intellectual Property that is used or reasonably necessary for the conduct of the business of the Company or APS-Cal as currently conducted. (ii) To the Knowledge of the Seller Entities, neither the Company nor APS-Cal has interfered with, infringed upon, misappropriated, or violated any material Intellectual Property rights of third parties in any material respect. To the Knowledge of the Seller Entities, neither Seller Entity has received any charge, complaint, claim, demand, or notice alleging any such interference, infringement, misappropriation, or violation (including any claim that the Company or APS-Cal must license or refrain from using any Intellectual Property rights of any third party). To the Knowledge of the Seller Entities, no third party has interfered with, infringed upon, misappropriated, or violated any material Intellectual Property rights of the Company or APS-Cal in any material respect. (iii) Section 4(l)(iii) of the Disclosure Schedule identifies each patent or registration which has been issued to the Company or APS-Cal with respect to any of its Intellectual Property, identifies each pending patent application or application for registration which the Company or APS-Cal has made with respect to any of its Intellectual Property, and identifies each material license, agreement, or other permission (as amended to date) to which the Company or APS-Cal is the licensee or by which the Company or APS-Cal has granted to any third party a license with respect to any of its Intellectual Property (together with any exceptions). Section 4(l) (iii) of the Disclosure Schedule also identifies each material trade name or unregistered trademark owned and/or used by the Company or APS-Cal in connection with any of its businesses. With respect to each item of Intellectual Property required to be identified in Section 4(l) (iii) of the Disclosure Schedule: (A) the Company and APS-Cal possess all right, title, and interest in and to the item, free and clear of any Security Interest, license, or other restriction; (B) the item is not subject to any outstanding injunction, judgment, order, decree, ruling, or charge; (C) no action, suit, proceeding, hearing, investigation, charge, complaint, claim, or demand is pending or, to the Knowledge of the Seller Entities, is threatened which challenges the legality, validity, enforceability, use, or ownership of the item; and (D) neither the Company nor APS-Cal has ever agreed to indemnify any Person for or against any interference, infringement, misappropriation, or other conflict with respect to the item other than in the Ordinary Course of Business. (iv) Section 4(l) (iv) of the Disclosure Schedule lists and briefly describes all licenses, sublicenses, agreements, and permissions (as amended to date), with respect to each material item of Intellectual Property that any third party owns and that the Company or APS-Cal presently use pursuant to license, sublicense, agreement, or permission except for "Shrink-wraps" and similar widely available binary code and commercial end-user licenses, including public or open technology. With respect to each item of Intellectual Property required to be identified in Section 4(l) (iv) of the Disclosure Schedule: (A) the license, sublicense, agreement, or permission covering the item is legal, valid, binding, enforceable, and in full force and effect, except where the illegality, invalidity, non-binding nature, unenforceability, or ineffectiveness would not reasonably be deemed to have a Material Adverse Effect on the Company; (B) neither the Company nor APS-Cal is, and to the Knowledge of the Seller Entities, no other party to the license, sublicense, agreement, or permission is in material breach or default, and no event has occurred which with notice or lapse of time would constitute a material breach or default or permit termination, modification, or acceleration thereunder; (C) neither APS-Cal nor the Company has, and to the Knowledge of the Seller Entities, no other party to the license, sublicense, agreement, or permission has repudiated any material provision thereof; and (D) neither the Company nor APS-Cal has granted any sublicense or similar right with respect to such license, sublicense, agreement, or permission other than in the Ordinary Course of Business. (v) All Intellectual Property created at the Company, APS-Cal or any predecessor in interest, or by any employee or consultant working for the Company or APS-Cal, has been assigned to the Company and such assignor is contractually obligated to assist the Company in registering any such Intellectual Property rights. (M) CONTRACTS. With respect to each of the contracts listed in Section 4(m) of the Disclosure Schedule: (A) the agreement is legal, valid, binding, enforceable, and in full force and effect in all material respects as to the Company and APS-Cal, as the case may be; (B) none of the Company, APS-Cal or to the Knowledge of the Seller Entities, any other party is in material breach or default, and no event has occurred which with notice or lapse of time would constitute a material breach or default, or permit termination, modification, or acceleration, under the agreement; and (C) neither APS-Cal nor the Company has, and to the Knowledge of the Seller Entities, no other party has repudiated any material provision of the agreement and (D) correct and complete copies of the agreement have been provided or made available to the Buyer. Section 4(m) of the Disclosure Schedule lists all of the contracts to which the Company or APS-Cal is a party of the type described below: (i) any agreement (or group of related agreements) for the lease of real or personal property to or from any Person providing for lease payments in excess of $50,000 per annum; (ii) any agreement (or group of related agreements) for the purchase or sale of raw materials, commodities, supplies, products, or other personal property, or for the furnishing or receipt of services, the performance of which will extend over a period of more than one (1) year or involve consideration in excess of $50,000; (iii) any agreement concerning a partnership or joint venture; (iv) any agreement (or group of related agreements) under which the Company has created, incurred, assumed, or guaranteed any indebtedness for borrowed money, or any capitalized lease obligation, in excess of $50,000 or under which it has imposed a Security Interest on any of its assets, tangible or intangible; (v) any agreement concerning confidentiality not entered into in the Ordinary Course of Business or any agreement which involves any prohibition on the Company conducting business in a geographical area or performing any service or restricts the Company's ability to operate in the Ordinary Course of Business or grants to any party thereto other than the Company or APS-Cal the exclusive right to perform any service; (vi) any agreement with a Seller Entity or another Affiliate of the Company; (vii) any profit sharing, stock option, stock purchase, stock appreciation, deferred compensation, severance, or other plan or arrangement for the benefit of its current or former directors, officers, and employees; (viii) any collective bargaining agreement or agreement with a labor union or other association representing or purporting to represent a group of employees; (ix) any agreement for the employment of any individual on a full-time, part-time, consulting, or other basis providing annual compensation in excess of $100,000 or providing material severance benefits; (x) any agreement with any officer or director of the Company or APS-Cal, including without limitation, any agreement under which it has advanced or loaned any amount to any of its directors, officers, and employees outside the Ordinary Course of Business; (xi) any agreement under which the consequences of a default or termination could have a Material Adverse Effect on the Company; (xii) any other agreement (or group of related agreements) the performance of which involves consideration in excess of $50,000 in the aggregate; (xiii)Any agreement requiring capital expenditures or the disposal or acquisition of assets in excess of $50,000; (xiv) any agreement pursuant to which the Company or APS-Cal grants the right to act as its agent to a Person that is among the Company's largest forty (40) agents having (5) five or more locations (calculated by the volume of transactions conducted in the twelve (12) months ended September 30, 2003); (xv) Any agreement regarding payments to any governmental entities, other than filing, registration, or similar fees made in the Ordinary Course of Business; or (xvi) Any agreement not entered into in the Ordinary Course of Business or which is material to the conduct of the business of the Company or APS-Cal or to the financial condition or results of operation of the Company or APS-Cal and not otherwise listed in subparagraphs (i) through (xv) above. (N) GUARANTIES. Neither the Company nor APS-Cal is a guarantor and is not otherwise liable for any Liability or obligation (including indebtedness) of any other Person. (O) TANGIBLE ASSETS. The Company and APS-Cal own or lease all buildings, machinery, equipment, and other tangible assets reasonably necessary for the conduct of its business as presently conducted. (P) LITIGATION. Section 4(p) of the Disclosure Schedule sets forth each instance in which the Company or APS-Cal (i) is subject to any outstanding injunction, judgment, order, decree, ruling, or charge or (ii) is a party to any action, suit, proceeding, hearing, or investigation of, in, or before any court or quasi-judicial or administrative agency of any federal, state, or local jurisdiction. To the Knowledge of the Seller Entities, there is no action, suit, proceeding, hearing, or investigation (other than an investigation conducted in the Ordinary Course of Business by any federal or state licensing or similar authorities) threatened against the Company or APS-Cal. Section 4(p) of the Disclosure Schedule sets forth all injunctions, judgments, orders, decrees, rulings or charges against the Company or APS-Cal within the last two (2) years. Section 4(p) also sets forth all worker's compensation and OSHA complaints made against the Company or APS-Cal within the last two (2) years. (Q) EMPLOYEES. (i) Except as provided in Section 4(q)(i) of the Disclosure Schedule, there is no charge, action, or proceeding pending against the Company or APS-Cal, and there is no written complaint, or to the Knowledge of the Seller Entities oral complaint, pending against the Company or APS-Cal, relating to the alleged material violation of any applicable state or federal labor or employment law or regulation, including any charge or complaint filed by any employee or labor organization with the National Labor Relations Board, the Equal Employment Opportunities Commission, or any other administrative governmental agency, nor is there pending against the Company any material grievance by any employee or labor organization under any collective bargaining agreement or other agreement with an association representing a group of employees with respect to employees of the Company or APS-Cal. (ii) There is no pending strike, slow-down, picketing, or work stoppage by employees of the Company or APS-Cal, nor is there any pending lockout by the Company or APS-Cal of any its employees and no such lockout is contemplated by the Company or APS-Cal. (iii) There is no pending organizing activity or petition for certification by or on behalf of any labor organization with respect to employees of the Company or APS-Cal, and there is no agreement with any labor organization or any other association representing or purporting to represent any group of employees with respect to employees of the Company or APS-Cal. (iv) All employees currently employed by the Company are listed in Section 4(q) (iv) of the Disclosure Schedule, which includes the salary level of each such employee. (R) EMPLOYEE BENEFITS. (i) Attached hereto in Section 4(r) of the Disclosure Schedule is a true and complete list of each "employee benefit plan," (as defined in Section 3(3) of ERISA) as well as every other bonus, incentive, profit sharing, deferred compensation, pension, retirement, excess benefit, supplemental retirement, change-in-control, employment contract, stock purchase, stock ownership, stock option, stock appreciation, supplemental unemployment, medical, dental, vision, disability, life insurance, death benefit, disability, cafeteria, vacation, sick-day, severance and other material employee benefit or fringe benefit plan, program or arrangement, whether or not covered by ERISA, that provides benefits or compensation in respect of any employee or former employee of the Company or the beneficiaries or the dependents of any such employee or former employee (hereinafter individually, an "Employee" and collectively, the "Employees") or under which any Employee is or may become eligible to participate or derive a benefit and that is or has been maintained or established by the Company, or to which the Company contributes or is or has been obligated or required to contribute (collectively, the "Employee Benefit Plans"). (ii) In addition, for purposes of this Agreement, the following terms shall have the following meanings: "ERISA Affiliate" means any other person, trade or business, or entity that is or was treated as a single employer with the Company under Section 414(b), (c), (m) or (o) of the Code or Section 4001(a)(14) or (b)(1) of ERISA. "Affiliate Plan" shall mean each "employee benefit plan," (as defined in Section 3(3) of ERISA) as well as every other bonus, incentive, profit sharing, deferred compensation, pension, retirement, excess benefit, supplemental retirement, change-in-control, employment contract, stock purchase, stock ownership, stock option, stock appreciation, supplemental unemployment, medical, dental, vision, disability, life insurance, death benefit, disability, cafeteria, vacation, sick-day, severance and other material employee benefit or fringe benefit plan, program or arrangement, whether or not covered by ERISA, that is or has been at any time within the last six (6) years sponsored, administered, maintained or established by any ERISA Affiliate, or to which any ERISA Affiliate contributes or is or has been within the last six (6) years obligated or required to contribute and that provides benefits or compensation in respect of any Employee or any employee or former employee of any ERISA Affiliate or the beneficiaries or the dependents thereof or under which any of the foregoing is or may become eligible to participate or derive a benefit. (iii) A copy of each Employee Benefit Plan listed in Section 4(r) of the Disclosure Schedule, the summary plan descriptions and in the case of an unwritten Employee Benefit Plan, a written description thereof, determination letters received from the Internal Revenue Service, the most recent annual report (IRS Form 5500), and all related trust agreements, insurance contracts, and other funding arrangements which implement each such Employee Benefit Plan has been furnished or made available to the Buyer. (iv) Each Employee Benefit Plan that is intended to be a tax-qualified deferred compensation plan under Section 401(a) of the Code has received a determination letter from the Internal Revenue Service to the effect that it meets the requirements of said Code section, and that its related trust is exempt from taxation under Section 501(a) of the Code. (v) Each of the Employee Benefit Plans listed in Section 4(r) of the Disclosure Schedule (A) complies in all material respects with the requirements of all applicable laws, including, without limitation, ERISA and the Code, and (B) has at all times been maintained and operated in compliance with its terms and the requirements of all applicable laws, including without limitation ERISA and the Code, except to the extent as would reasonably be expected not to have a Material Adverse Effect on the Company. The Company has no commitment, intention or understanding to create, modify or terminate any Employee Benefit Plan listed in Section 4(r) of the Disclosure Schedule, and no condition or circumstance exists that would prevent the amendment or termination of any Employee Benefit Plan listed in Section 4(r) of the Disclosure Schedule. Except as set forth in Section 4(r)(v) of the Disclosure Schedule, and except as may arise in connection with the consummation of the transactions contemplated by this Agreement, there is no pending or threatened litigation, arbitration, or disputed claim with respect to any Transferred Employee involving any Employee Benefit Plan or Affiliate Plan or any fiduciary or administrator thereof in their capacities as such. (vi) Full payment has been made of all amounts which the Company and any ERISA Affiliate are required to have paid as contributions to or benefits under any Employee Benefit Plan and any Affiliate Plan as of the end of the most recent plan year thereof, except to the extent as would reasonably be expected not to have a Material Adverse Effect on the Company. (vii) The Company and all ERISA Affiliates have complied with all reporting and disclosure obligations to all governmental entities and all participants and beneficiaries with respect to each Employee Benefit Plan required by the terms of such Employee Benefit Plan, any statutes, orders, rules or regulations, including but not limited to ERISA, the Code and the Sarbanes-Oxley Act of 2002, to the extent that the failure to do so would have a Material Adverse Effect on the Company. (viii) Except as required by Section 4908B of the Code and Title I, Part 6 of ERISA, the Company has no liability for any obligation to provide post-retirement health or medical benefits for retired or former Employees of the Company. (ix) With respect to the Employee Benefit Plans which are "group health plans" under Section 4980B of the Code or Section 607(1) of ERISA, the Company has timely complied in all material respects with all requirements imposed under Section 4980B of the Code and Part 6 of Title I of ERISA. Neither the Company nor any ERISA Affiliate has any liability, loss, assessment, tax penalty, or other sanction with respect to any failure to comply with such requirements. (x) Other than as disclosed in Section 4(r)(x) of the Disclosure Schedule, the Company has no liability related to any obligations under any stock option plans of the Company, the Seller Entities or any ERISA Affiliate. (S) ENVIRONMENTAL, HEALTH, AND SAFETY MATTERS. (i) Except as disclosed in Section 4(s) of the Disclosure Schedule, the Company has complied in all material respects with all Environmental, Health, and Safety Requirements. (ii) To the Knowledge of the Seller Entities, none of the following exists at any property or facility owned, leased or operated by the Company or APS-Cal: (1) underground storage tanks, (2) friable asbestos or friable-asbestos-containing material, (3) materials or equipment containing polychlorinated biphenyls, or (4) landfills, surface impoundments, or disposal areas. (iii) To the Knowledge of the Seller Entities, neither the Company nor APS-Cal has treated, stored, disposed of, arranged for or permitted the disposal of, transported, handled, or released any substance the treatment, storage, disposal, arrangement for or permission of disposal, transport, handling or release of which is governed or otherwise regulated by any Environmental, Safety or Health Requirement, including without limitation any Hazardous Substance. (iv) To the Knowledge of the Seller Entities, neither the Company nor APS-Cal owns, leases or operates, nor have they owned, leased or operated any property or facility contaminated by any substance referred to in Section 4(s) (iii) above, such as to give rise to Adverse Consequences, including any liability for response costs, corrective action costs, personal injury, property damage, natural resources damages or attorney fees, pursuant to CERCLA or any other Environmental, Health, and Safety Requirements. (v) No employee or other Person has ever made a written, or to the Knowledge of the Seller Entities, oral claim or demand against the Company or APS-Cal based on alleged damage to health caused by any Hazardous Substance, and to the Knowledge of the Seller Entities, no such claim is threatened. (vi) The Seller Entities have provided or made available to the Buyer all environmental reports, notes, documents or findings in their possession that relate to any property or facility owned, leased or operated by the Company or APS-Cal. (T) NOTES AND ACCOUNTS RECEIVABLE. All notes and accounts receivable of the Company are reflected properly on their books and records, arose from bona fide transactions in the Ordinary Course of Business in accordance with past practices and are subject to reserves which are reasonable in light of the Company's historical collection experience. To the Knowledge of the Seller Entities, the methodology used in the calculation of such reserves is reasonable in light of the nature of the Company's outstanding accounts receivable. (U) POWERS OF ATTORNEY. There are no outstanding powers ------------------ of attorney executed on behalf of the Company or APS-Cal. (V) INSURANCE. Section 4(v) of the Disclosure Schedule lists each insurance policy of the Company and APS-Cal (including policies providing property, casualty, liability, and workers' compensation coverage and bond and surety arrangements) and the following information with respect to each insurance policy to which the Company has been a party, a named insured, or otherwise the beneficiary of coverage at any time within the past five (5) years: (i) the name, address, and telephone number of the agent; (ii) the name of the insurer, the name of the policyholder, and the name of each covered insured; (iii) the policy number and the period of coverage; (iv) the scope (including an indication of whether the coverage was on a claims made, occurrence, or other basis) and amount (including a description of how deductibles and ceilings are calculated and operate) of coverage; and (v) a description of any retroactive premium adjustments or other loss-sharing arrangements. Copies of each insurance policy listed on Section 4(v) of the Disclosure Schedule have been made available to the Buyer. The Company has been covered during the past five (5) years by insurance in scope and amount customary and reasonable for the businesses in which it has engaged during the aforementioned period. Section 4(v) of the Disclosure Schedule describes any self-insurance arrangements affecting the Company. (W) DISCLOSURE. The representations and warranties contained in this Section 4 do not intentionally contain any untrue statement of a material fact or omit to state any material fact necessary in order to make the statements and information contained in this Section 4 not misleading. (X) DISCLAIMER OF OTHER REPRESENTATIONS AND WARRANTIES. Except as expressly set forth in this Agreement, neither the Seller Entities nor any of their respective Affiliates make any representation or warranty, express or implied, at law or in equity, with respect to any of its or their respective assets, liabilities or operations, including, without limitation, representations and warranties of merchantability or fitness for any particular purpose, title, or non-infringement, and any such other representations or warranties are hereby expressly disclaimed. 5. PRE-CLOSING COVENANTS. The Parties agree as follows with respect to the period between the execution of this Agreement and the Closing. (A) GENERAL. Each of the Parties will use its commercially reasonable best efforts to take all action and to do all things necessary, proper, or advisable in order to consummate and make effective the transactions contemplated by this Agreement (including satisfaction, but not waiver, of the Closing conditions set forth in Section 7 below). (B) REGULATORY MATTERS. The Seller Entities and the Buyer shall cooperate and use all commercially reasonable efforts to promptly prepare and file all necessary documentation, effect all necessary applications, notices, petitions and filings and obtain all necessary permits, consents, approvals and authorizations of all governmental authorities necessary or advisable to obtain all required statutory approvals, including, without limitation, those described in Section 3(b)(ii) of the Disclosure Schedule and pursuant to the HSR Act. In furtherance of the foregoing, the Seller Entities and the Buyer shall cooperate and use all commercially reasonable efforts to prepare and file any such applications, notices, petitions, filings and other documents no later than ten (10) business days from the date hereof or as soon thereafter as practicable and shall thereafter cooperate to diligently prosecute all such applications, notices, petitions, filings and other documents. Each Party shall, consistent with applicable law, before making any applications, notices, petitions or filings, provide a copy thereof to the other Parties for their review and shall consider incorporating the comments of any other Party in good faith. Without limiting the generality of the foregoing, the Buyer shall not take any action, directly or indirectly, that could reasonably be expected to cause any governmental authority to withhold or deny any permit, consent, approval or authorization set forth in Section 3(b)(ii) of the Disclosure Schedule. The Seller Entities and the Buyer shall (i) respond as promptly as practicable to any inquiries received from a governmental authority for additional information or documentation, and (ii) not extend any waiting period under the HSR Act or enter into any agreement with a governmental authority not to consummate the transactions contemplated by this Agreement, except with the prior written consent of the other Parties hereto. The Buyer shall defend through litigation on the merits (including appeals) any claim asserted in any court or quasi-judicial or administrative agency of any federal, state, local, or foreign jurisdiction or before any arbitrator wherein an unfavorable injunction, judgment, order, decree, ruling, or charge would (A) prevent or materially delay consummation of any of the transactions contemplated by this Agreement, (B) cause any of the transactions contemplated by this Agreement to be rescinded following consummation. Each Party shall (i) promptly notify the other Party of any written communication to that Party from any governmental authority and, subject to applicable law, permit the other Party to review in advance any proposed written communication to any of the foregoing; (ii) not agree to participate in any substantive meeting or discussion with any governmental authority in respect of any filings, investigation or inquiry concerning this Agreement or the transactions contemplated hereby, unless it consults with the other Party in advance and, to the extent permitted by such governmental authority, gives the other Party the opportunity to attend and participate thereat; and (iii) furnish the other Party with copies of all correspondence, filings, and communications (and memoranda setting forth the substance thereof) between it and its Affiliates and their respective representatives on the one hand, and any government or regulatory authority or members or their respective staffs on the other hand, with respect to this Agreement. (C) OPERATION OF BUSINESS. The Seller Entities will not cause or permit the Company to engage in any practice, take any action, or enter into any transaction outside the Ordinary Course of Business in accordance with past practices; PROVIDED, HOWEVER, that the Seller may cause the Company to dividend or otherwise distribute all or some of the cash of the Company prior to the Closing and/or cancel or pay all or some of any inter-company indebtedness; and PROVIDED, FURTHER, that the Seller may cause the Company to establish a credit facility with a nationally recognized financial institution pursuant to documentation reasonably acceptable to the Buyer and borrow funds thereunder for working capital purposes or to repay all or some of any inter-company indebtedness. Without limiting the generality of the foregoing, except as contemplated by the foregoing sentence or as otherwise contemplated by this Agreement, the Seller Entities will cause the Company and APS-Cal not to: (i) become legally obligated to sell, assign or otherwise transfer any of their material assets or properties, other than in the Ordinary Course of Business and other than in connection with the transfer of the Divested Items; (ii) make any acquisition of all of the capital stock (whether by merger or otherwise) or all or substantially all of the assets of any Person; (iii) subject any material asset to a Security Interest; (iv) amend or authorize any amendment to its certificate of incorporation or bylaws; (v) borrow or refinance any amount from a non-affiliated Person or incur any liability (contingent or otherwise) in excess of $50,000, other than trade payables incurred in the Ordinary Course of Business in accordance with past practices; (vi) declare or make any payment or distribution to shareholders other than as contemplated by Section 2 (b)(iv) or in connection with the distribution of proceeds from the transfer of the Divested Items; (vii) issue, sell, pledge, dispose of, or encumber any shares of, or securities convertible into or exchangeable or exercisable for, or options, warrants, calls, commitments or rights of any kind to acquire any shares of the capital stock of the Company or APS-Cal; (viii) make any change to its accounting policies, principles or practices other than as required by law or changes in GAAP; (ix) make any loans to any Persons; (x) enter into, adopt, amend or terminate any bonus, profit sharing, compensation or stock option/ownership plan, severance or other Employee Benefit Plan or other arrangement for the benefit of any director, officer or employee, or increase in any manner the compensation or fringe benefits of any director or officer other than (A) amendments to the employment agreements listed in Section 4(m)(ix) of the Disclosure Schedule solely to extend the term thereof to a date not more than three (3) months after the Closing Date and (B) amendments contemplated in Section 5(k); or (xi) waive any right in any contract listed in Section 4(m) of the Disclosure Schedule, the waiver of which would reasonably be expected to materially detract from the value of such contract to the Company or APS-Cal, as the case may be; or (xii) become obligated to take any of the actions specified in subparagraphs (i) through (xi) above. (D) PRESERVATION OF BUSINESS. The Seller Entities will cause the Company to use its commercially reasonable efforts to keep its business and properties substantially intact, including its present operations, physical facilities, working conditions, and relationships with lessors, licensors, suppliers, customers, and employees. (E) FULL ACCESS. The Seller Entities will permit, and the Seller Entities will cause the Company to permit, representatives of the Buyer to have full access at all reasonable times, and in a manner so as not to interfere with the normal business operations of the Company, to all premises, properties, personnel, books, records (including Tax records), contracts, and documents of or pertaining to the Company. The Buyer and its representatives will treat and hold as such any Company Confidential Information it receives from the Seller Entities and the Company in the course of the reviews contemplated by this Section 5(e), will not use or disclose any of the Company Confidential Information except in connection with this Agreement, and, if this Agreement is terminated for any reason whatsoever, promptly will return to the Seller Entities and the Company all tangible embodiments (and all copies, notes or summaries) of the Company Confidential Information which are in its possession; PROVIDED, HOWEVER, that in granting such access the Seller Entities and the Company shall not be required to take any action that would constitute a waiver of any legal privilege, including the attorney-client privilege. (F) NOTICE OF DEVELOPMENTS. The Seller Entities will give prompt written notice to the Buyer upon becoming aware of any material adverse development causing a breach of any of the representations and warranties in Section 4 above. Each Party will give prompt written notice to the others upon becoming aware of any material adverse development causing a breach of any of its own representations and warranties in Section 3 above. No disclosure by any Party pursuant to this Section 5(f), however, shall be deemed to amend or supplement the Disclosure Schedule or to prevent or cure any misrepresentation, breach of warranty, or breach of covenant. (G) EXCLUSIVITY. Until this Agreement has been terminated in accordance with its terms, neither the Parent, the Seller nor any of their Affiliates will (and the Seller Entities will not cause or permit the Company to) (i) solicit, initiate, or encourage the submission of any proposal or offer from any Person relating to the acquisition of any capital stock or other voting securities, or any substantial portion of the assets, of the Company (including any acquisition structured as a merger, consolidation, or share exchange) or (ii) participate in any discussions or negotiations regarding, furnish any information with respect to, assist or participate in, or facilitate in any other manner any effort or attempt by any Person to do or seek any of the foregoing. Until this Agreement has been terminated in accordance with its terms, the Seller will not vote its Company Shares in favor of any such acquisition. (H) TERMINATION OF AGREEMENTS. Except as set forth in Section 5(h) of the Disclosure Schedule, the Seller and the Parent shall, prior to the Closing, terminate or cause to be terminated all Contracts between the Company, on the one hand, and the Seller or any Affiliate of the Seller, on the other hand, and the Company shall retain no obligations under such Contract. (I) FINANCIALS. (i) The Seller Entities shall cause the Company to audit its financial statements for fiscal year 2003 in the Ordinary Course of Business and deliver such audited financial statements to the Buyer. (ii) At such time, the Seller Entities shall also deliver to the Buyer an unaudited balance sheet of the Company as of the close of business on December 31, 2003 (the "December Balance Sheet") in substantially the form of the September Balance Sheet attached hereto as Section 2(b)(ii) of the Disclosure Schedule. The Seller Entities shall prepare the December Balance Sheet in the same manner used to prepare the September Balance Sheet. The Parties hereby acknowledge and agree that the September Balance Sheet sets forth the total fixed assets of the Company, adjusted to exclude the Divested Items (in column F and the row labeled "Total Fixed Assets, Net") as $9,086,445.81 as of September 30, 2003. If the total fixed assets of the Company, adjusted to exclude the Divested Items, as set forth on the December Balance Sheet (the "December Fixed Asset Amount") is less than $9,086,445.81, then the Seller Entities shall deliver to the Buyer cash in an amount equal to the amount of any such shortfall immediately after the Closing. (iii) The Buyer shall have the right to dispute the calculation of the December Fixed Asset Amount, by delivering a written notice of objection to the Seller within twenty (20) days of delivery of the December Balance Sheet. The Buyer and Seller shall thereupon attempt in good faith to resolve their dispute. If the Buyer and the Seller do not agree upon the December Fixed Asset Amount within twenty (20) days of the delivery of the Buyer's notice of objection, then the Independent Accountant shall determine the December Fixed Asset Amount. If the Independent Accountant is requested to determine the December Fixed Asset Amount, then (A) the Buyer and the Seller shall each submit to the Independent Accountant in writing, not later than ten (10) days after the Independent Accountant is retained for such purpose, their respective positions with respect to the December Fixed Asset Amount, together with such supporting documentation as they deem necessary or as the Independent Accountant reasonably requests, and (B) the Independent Accountant shall, within ten (10) days after receiving the positions of both the Buyer and the Seller and all supplementary supporting documentation requested by the Independent Accountant, render its decision as to the December Fixed Asset Amount, which decision shall be final and binding on, and non-appealable by, the Parties. The fees and expenses of the Independent Accountant related to the resolution of the December Fixed Asset Amount shall be paid by the Party whose estimate of the December Fixed Asset Amount is farthest from the Independent Accountant's final calculation of thereof. (J) TRANSFER OF DIVESTED ITEMS. Prior to the Closing, the Seller Entities will cause the Company to transfer all of the Divested Items to the Seller. (K) AMENDMENT OR CANCELLATION OF CERTAIN AGREEMENTS. The Company and the Seller Entities shall use their best efforts to have caused, at or before Closing, each of Donna Estelle, Paul Rocheleau and Corey Stone to cancel his or her existing employment/severance agreement, to relinquish any rights he or she might have under the UIL Holdings Corporation Change in Control Severance Plan, and to enter into a new employment/severance agreement, in form and substance reasonably satisfactory to the Buyer; PROVIDED, HOWEVER, that if the Company and the Seller Entities are unable, despite their best efforts, to cause any such individual to cancel his or her existing employment/severance agreement, to relinquish any rights he or she might have under the UIL Holdings Corporation Change in Control Severance Plan, and to enter into a new employment/severance agreement, in form and substance reasonably satisfactory to the Buyer, the Seller Entities shall satisfy any termination liabilities associated therewith prior to the Closing. 6. POST-CLOSING COVENANTS. The Parties agree as follows with respect to the period following the Closing. (A) GENERAL. In case at any time after the Closing any further action is necessary or desirable to carry out the purposes of this Agreement, each of the Parties will take such further action (including the execution and delivery of such further instruments and documents) as any other Party may request, all at the sole cost and expense of the requesting Party (unless the requesting Party is entitled to indemnification therefor under Section 8 below). The Company and the Seller Entities acknowledge and agree that from and after the Closing, the Buyer will be entitled to possession of all documents, books, records, agreements, and financial data of any sort relating to the Company, other than items described in Section 6(a) of the Disclosure Schedule. The Buyer agrees to provide the Seller with reasonable access to all documents, books and records of the Company for purposes of the preparation of any Tax Returns by the Seller Entities after the Closing and for any other reasonable purpose. (B) LITIGATION SUPPORT. In the event and for so long as any Party actively is contesting or defending against any action, suit, proceeding, hearing, investigation, charge, complaint, claim or demand in connection with (i) any transaction contemplated under this Agreement or (ii) any fact, situation, circumstance, status, condition, activity, practice, plan, occurrence, event, incident, action, failure to act or transaction which arises within two (2) years after the Closing Date and involving the Company, each of the other Parties will cooperate with such Party, its Affiliates and their counsel in the contest or defense, make available their personnel and provide such testimony and access to their books and records as shall be reasonably necessary in connection with the contest or defense, all at the sole cost and expense of the contesting or defending Party (unless the contesting or defending Party is entitled to indemnification therefor under Section 8 below). (C) TRANSITION. The Seller Entities will refer all customer inquiries relating to the Company to the Buyer from and after the Closing. (D) EMPLOYEES. Effective as of the Closing, the Buyer shall cause the Company to continue the employment of all active Employees and of all Employees who are on vacation, disability, family leave, layoff or other approved leave from active employment with the Company as of the Closing Date, and who in any case where they are not actively employed on the Closing Date actually return to active service with the Company within twelve (12) months (such Employees being referred to as "Transferred Employees"). Upon and after the Closing Date, the Buyer shall (i) cause the Company to continue the Transferred Employees' employment at a wage or salary level (including short-term incentive compensation) that is substantially equivalent to the level provided to the Transferred Employees immediately prior to the Closing and (ii) cause the Company to continue to honor only those employment agreements and employment letters specifically listed in Section 4(m)(ix) of the Disclosure Schedule (as such agreements and letters may be amended, restated or supplemented in accordance with the terms of this Agreement). If any Transferred Employee's employment is terminated within twelve (12) months after the Closing, the Buyer shall pay severance as described in Section 6(d) of the Disclosure Schedule (or pursuant to such Transferred Employee's employment agreement, if applicable). (E) EMPLOYEE BENEFIT PLANS. (i) Effective as of the Closing Date, the Buyer shall either cause the Company to provide, or itself shall provide, to the Transferred Employees, benefit programs that are comparable and equivalent in all material respects to the benefits provided to the other employees of the Buyer, either through inclusion of the Transferred Employees in the Buyer's benefit programs, or through a combination of the foregoing and of continuation of certain existing Employee Benefit Plans. (ii) As of the Closing Date, the Buyer shall cause the Company to maintain a defined contribution plan for the benefit of Transferred Employees (which plan may be an existing plan or plans of the Buyer) (a "Successor 401(k) Plan") and shall take all necessary actions, if any, to qualify such plan under the applicable provisions of the Code and shall make any and all appropriate filings and submissions to the appropriate governmental agencies. As of the Closing Date or as soon thereafter as administratively feasible, the Seller Entities shall cause the Transferred Employees who are participants in the Seller 401(k) Plan to become fully vested in their accounts under such plan, to the extent they are not already fully vested, and shall permit the Transferred Employees who are participants in the Seller 401(k) Plan to elect to receive a distribution of their vested accounts. The Buyer shall cause the Successor 401(k) Plan to take all necessary actions to permit the Transferred Employees to elect to directly roll over their accounts under the Seller 401(k) Plan into the Successor 401(k) Plan, including any participant loans outstanding (other than those loans that are in default); PROVIDED, HOWEVER, that the Successor 401(k) Plan shall not accept rollovers of any shares of capital stock of the Parent or any non-cash amounts other than notes related to participant loans. The Buyer and the Seller Entities shall cooperate fully in facilitating such rollovers. (iii) The Buyer shall, or shall cause the Company to, (1) waive any limitations to pre-existing conditions, exclusions and waiting periods with respect to participation and coverage requirements applicable to the Transferred Employees under any welfare benefit plan in which such employees may be eligible to participate after the Closing to the extent that such limitations did not apply or had been satisfied by Transferred Employees and their covered dependents, (2) provide each Transferred Employee with credit for any co-payments and deductibles paid prior to the Closing for the year in which the Closing occurs in satisfying any applicable deductible or out-of- pocket requirements under any welfare benefit plan in which such employees may be eligible to participate after the Closing, and (3) recognize all service of the Transferred Employees rendered as employees of the Company prior to the Closing, and during the period that the Company and any Subsidiary of the Company were subsidiaries of the Parent, for all purposes (including, without limitation, purposes of eligibility to participate, vesting credit, entitlement for benefits, and benefit accrual) in any employee benefit plan in which such employees may be eligible to participate after the Closing. (iv) Effective as of the Closing Date, the Transferred Employees shall cease to participate actively in any of the employee benefit plans of the Parent, and the Company shall cease to be a contributing employer under any such Employee Benefit Plan; PROVIDED, HOWEVER, that the Company shall make any employer contribution required to be made with respect to its own Employee Benefit Plans and its participation in the Employee Benefit Plans of the Parent up through the Closing Date, provided that such contributions are made in the Ordinary Course of Business. Neither The United Illuminating Company nor the Seller Entities shall transfer any assets or liabilities with respect to any Transferred Employee who has an accrued benefit under The United Illuminating Company Pension Plan. (v) After the Closing, the Seller Entities shall be responsible for providing contribution coverage required under Section 4980B of the Code and Title I, Part 6 of ERISA to all former employees of the Company who terminated employment on or before such date or in connection with the transactions contemplated by this Agreement. (vi) After the Closing, the Seller Entities shall take such actions as are necessary to ensure that neither the Company, the Buyer nor any Affiliate of the Buyer has any liability whatsoever related to any Affiliate Plan, including but not limited to any "defined benefit plan", as defined in Section 3(35), any Multiemployer Plan, any other plan subject to Title IV of ERISA, and any post-retirement health or medical plan. (vii) As soon as practicable after the determination of the Purchase Price pursuant to Section 2(b)(ii) above, the Company shall satisfy the obligations under the American Payment Systems, Inc. 2001 Phantom Stock Plan by paying all participants in the Plan such amounts that are due and payable under such plan as a result of the transactions contemplated by this Agreement and the related cancellation of such plan. The Buyer will cause the Company to issue an invoice to the Seller Entities for such amounts, including all applicable payroll and withholding Taxes, and the Seller Entities shall reimburse the Company for such expense within ten (10) days of receipt thereof. (F) CONFIDENTIALITY. The Parties will treat and hold as such all of the Confidential Information of the other Parties, refrain from using any such Confidential Information except in connection with this Agreement, and deliver promptly to the Buyer or the Seller, as the case may be, or destroy (and certify the destruction in writing), at the request and option of the Buyer or the Seller, as applicable, all tangible embodiments (and all notes, summaries and copies) of such Confidential Information which are in its possession. In the event that any Party is requested or required (by oral question or request for information or documents in any legal proceeding, interrogatory, subpoena, civil investigative demand, or similar process) to disclose any Confidential Information of another Party, that Party will notify the applicable Party promptly of the request or requirement so that the applicable Party may seek an appropriate protective order or waive compliance with the provisions of this Section 6(f). If, in the absence of a protective order or the receipt of a waiver hereunder, any Party is, on the advice of counsel, compelled to disclose any Confidential Information to any tribunal, that Party may disclose the Confidential Information to the tribunal; PROVIDED, HOWEVER, that the disclosing Party shall use his or its reasonable best efforts to obtain, at the reasonable request of the applicable Party, an order or other assurance that confidential treatment will be accorded to such portion of the Confidential Information required to be disclosed as the applicable Party shall designate. (G) COVENANT NOT TO COMPETE. For a period of five (5) years from and after the Closing Date, the Seller Entities will not engage directly or indirectly in any business that the Company conducts as of the Closing Date in North America. If the final judgment of a court of competent jurisdiction declares that any term or provision of this Section 6(g) is invalid or unenforceable, the Parties agree that the court making the determination of invalidity or unenforceability shall have the power to reduce the scope, duration, or area of the term or provision, to delete specific words or phrases, or to replace any invalid or unenforceable term or provision with a term or provision that is valid and enforceable and that comes closest to expressing the intention of the invalid or unenforceable term or provision, and this Agreement shall be enforceable as so modified after the expiration of the time within which the judgment may be appealed. (H) INSURANCE. The Buyer shall maintain liability insurance in respect of all products sold and services rendered by the Company in such amounts and in such forms as deemed reasonable by the Buyer. (I) ACCESS TO INFORMATION. For a period of four (4) years after the Closing Date, upon reasonable notice, the Buyer, the Company and the Seller Entities agree to furnish or cause to be furnished to each other and their representatives access, during normal business hours, to such information (including records pertinent to the Company) and assistance relating to the Company as is reasonably necessary for financial reporting and accounting matters, the valuation of any claim for indemnification under Section 8 hereof, the preparation and filing of any Tax Returns, reports or forms or the defense of any Tax claim or assessment; PROVIDED, HOWEVER, that such access does not unreasonably disrupt the normal operations of the Party or Parties furnishing cooperation; PROVIDED FURTHER, HOWEVER, that the Party requesting cooperation shall pay the reasonable out-of-pocket costs incurred by the Party or Parties furnishing cooperation. (J) NONASSIGNABLE CONTRACTS AND PERMITS. To the extent that any contract or permit (including any consent, approval or authorization of any governmental authority) for which assignment to the Buyer is provided for in this Agreement is not assignable without the consent of another Person, including an applicable governmental authority, this Agreement shall not constitute an assignment or an attempted assignment thereof if such assignment or attempted assignment would constitute a breach thereof. The Seller Entities and Buyer shall continue to use their commercially reasonable best efforts to obtain the consent of such other Person to the assignment of any such contract or permit to the Buyer in all cases in which such consent is or may be required for such assignment. If such consent shall not be obtained, the Seller Entities and the Buyer shall cooperate with each other in any reasonable arrangement designed to provide the Buyer with the benefits under any such contract or permit to the extent lawful and the Buyer shall be obligated to perform the obligation with respect thereto, any other provision of this Agreement to the contrary notwithstanding. (K) GUARANTEE. The Parties acknowledge that (i) the Company is party to that certain Walk-In Payment Agency Agreement between the Company and BellSouth Affiliate Services Corporation ("BellSouth") dated as of August 9, 2002 and (ii) the Seller has guaranteed certain of the Company's obligations under such agreement pursuant to that certain Guarantee dated as of August 9, 2002 (the "Guarantee"). The Parties hereby agree to use commercially reasonable efforts to cause BellSouth to agree to terminate the Guarantee prior to the Closing. 7. CONDITIONS TO OBLIGATION TO CLOSE. (A) CONDITIONS TO OBLIGATION OF THE BUYER. The obligation of the Buyer to consummate the transactions to be performed by it in connection with the Closing is subject to satisfaction of the following conditions: (i) the representations and warranties set forth in Section 3(a) and Section 4 above shall be true and correct in all material respects at and as of the Closing Date; (ii) the Seller Entities shall have performed and complied in all material respects with all of the covenants of the Seller Entities hereunder that are required to be performed or complied with prior to the Closing; (iii) no action, suit, or proceeding (other than any action, suit or proceeding to which Sections 5(b) or 7(a)(v) refer or relate) shall be pending before any court or quasi-judicial or administrative agency of any federal, state, local, or foreign jurisdiction or before any arbitrator wherein an unfavorable injunction, judgment, order, decree, ruling, or charge would (A) prevent or materially delay consummation of any of the transactions contemplated by this Agreement, (B) cause any of the transactions contemplated by this Agreement to be rescinded following consummation, (C) materially and adversely affect the right of the Buyer to own the Company Shares and to control the Company, or (D) materially and adversely affect the right of the Company to own its assets and to operate its businesses (and no such injunction, judgment, order, decree, ruling, or charge shall be in effect); (iv) the Seller shall have delivered to the Buyer a certificate to the effect that each of the conditions specified above in Section 7(a) (i) - (iii) is satisfied in all respects; (v) the Parties and the Company shall have received all of the authorizations, consents, and approvals of governments and governmental agencies pursuant to the HSR Act and as set forth in Section 7(a)(v) of the Disclosure Schedule (collectively, the "Requisite Consents"); PROVIDED, HOWEVER, that the foregoing condition to the obligation of the Buyer shall not apply to any failure to obtain any such authorization, consent or approval that arises from the Buyer's breach of any representation, warranty or covenant hereunder or the Buyer's withdrawal of its application for any such authorization, consent or approval; (vi) Any Person required in connection with the transactions contemplated hereby to file a notification and report form in compliance with the HSR Act shall have filed such form. (vii) the Buyer shall have received from counsel to the Seller an opinion in form and substance as set forth in Exhibit B attached hereto, addressed to the Buyer, and dated as of the Closing Date; (viii) all certificates, opinions, instruments, and other documents required to effect the transactions contemplated hereby will be reasonably satisfactory in form and substance to the Buyer; (ix) the Buyer shall have received the current updated corporate record book, including without limitation the Company bylaws, stock transfer ledger, minutes, resolutions, consents, and all other corporate documents; and (x) the Seller Entities shall have caused the Company to transfer all of the Divested Items to the Seller. The Buyer may waive any condition specified in this Section 7(a) if it executes a writing so stating at or prior to the Closing. (B) CONDITIONS TO OBLIGATION OF THE SELLER. The obligation of the Seller Entities to consummate the transactions to be performed by them in connection with the Closing is subject to satisfaction of the following conditions: (i) the representations and warranties set forth in Section 3(b) above shall be true and correct in all material respects at and as of the Closing Date; (ii) the Buyer shall have performed and complied in all material respects with all of the covenants of the Buyer hereunder that are required to be performed or complied with prior to the Closing; (iii) no action, suit, or proceeding (other than any action, suit or proceeding to which Sections 5(b) or 7(b)(v) refer or relate) shall be pending before any court or quasi-judicial or administrative agency of any federal, state, local, or foreign jurisdiction or before any arbitrator wherein an unfavorable injunction, judgment, order, decree, ruling, or charge would (A) prevent or materially delay consummation of any of the transactions contemplated by this Agreement or (B) cause any of the transactions contemplated by this Agreement to be rescinded following consummation (and no such injunction, judgment, order, decree, ruling, or charge shall be in effect); (iv) the Buyer shall have delivered to the Seller a certificate to the effect that each of the conditions specified above in Section 7(b) (i) - (iii) is satisfied in all respects; (v) the Parties and the Company shall have received all of the Requisite Consents; PROVIDED, HOWEVER, that the foregoing condition to the obligation of the Seller Entities shall not apply to any failure to obtain any such authorization, consent or approval that arises from the Seller Entities' breach of any representation, warranty or covenant hereunder or the Seller Entities' withdrawal of its application for any such authorization, consent or approval; (vi) Any Person required in connection with the transactions contemplated hereby to file a notification and report form in compliance with the HSR Act shall have filed such form; (vii) the Seller Entities shall have received from counsel to the Buyer an opinion in form and substance as set forth in Exhibit C attached hereto, addressed to the Seller, and dated as of the Closing Date; and (viii) all certificates, opinions, instruments, and other documents required to effect the transactions contemplated hereby will be reasonably satisfactory in form and substance to the Seller Entities. The Seller Entities may waive any condition specified in this Section 7(b) if they execute a writing so stating at or prior to the Closing. 8. REMEDIES FOR BREACHES OF THIS AGREEMENT. (A) SURVIVAL. Unless otherwise specifically provided herein, all of the covenants, representations and warranties of the Seller Entities contained in this Agreement shall survive the Closing and continue in full force and effect for a period of two (2) years thereafter, provided that the representations and warranties contained in Section 3(a)(i) (Organization of the Seller Entities), Section 3(a)(iii)(A) (Non-contravention), Section 3(a)(v) (Company Shares), Section 3(b)(i) (Organization of the Buyer), Section 3(b)(iii)(A) (Non-contravention), Section 4(a) (Organization of the Company), Section 4(b) (Capitalization) and Section 4(c)(i) (Non-contravention) shall survive indefinitely, and the representations and warranties contained in Section 4(j) (Tax Matters), shall continue in full force and effect until the expiration of the applicable statute of limitation with respect to such matters. The covenants, representations and warranties of the Buyer contained in this Agreement shall survive the Closing and continue in full force and effect for a period of two (2) years thereafter. This Section 8 shall survive so long as any covenant, representation, warranty or indemnification obligation of any Party survives hereunder. (B) INDEMNIFICATION PROVISIONS FOR BENEFIT OF THE BUYER. (i) Subject to the limitations contained in this Section 8, after Closing, the Seller Entities hereby jointly and severally agree to indemnify the Buyer and its officers and directors, shareholders and Affiliates against and hold them harmless from any loss, liability, claim, damage or expense (including reasonable legal fees and expenses) other than punitive damages, lost profit, or consequential or incidental damages (a "Loss") suffered or incurred by any such indemnified party caused by, resulting from arising out of or relating to (A) any breach of any representation or warranty of the Seller Entities contained in this Agreement (B) any breach of any covenant of the Seller Entities contained in this Agreement which by its terms requires performance after the Closing Date, (C) any Taxes of the Company or APS-Cal attributable to taxable periods ending prior to or on the Closing Date, including liabilities of the Company under consolidated, combined or unitary income or franchise Tax Returns and liabilities related to the Tax Returns of the Seller Entities or members of the Parent Consolidated Group but excluding any Taxes for which there is an adequate accrual or reserve on the Closing Date Balance Sheet or any Taxes attributable to transactions not in the Ordinary Course of Business occurring after the Closing which are effectuated or initiated by the Buyer or the Company after the Closing, (D) the Divested Items and (E) the Wallingford Condition. (ii) The Buyer acknowledges and agrees that neither the Seller Entities nor any of their Affiliates shall have any liability under any provision of this Agreement for any Loss to the extent that such Loss relates to actions taken by or omitted to be taken by the Buyer or the Company after the Closing Date or such Loss arises in the conduct of the business of the Company by the Buyer or the Company after the Closing Date, provided that such Loss is not a direct result of any action taken by the Seller Entities after the Closing. (C) INDEMNIFICATION PROVISIONS FOR BENEFIT OF THE SELLER ENTITIES AND ITS AFFILIATES. Subject to the limitations contained in this Section 8, after the Closing, the Buyer and the Company hereby jointly and severally agree to indemnify the Parent, the Seller and their respective officers, directors, shareholders and Affiliates against, and hold them harmless from, any Loss suffered or incurred by any such indemnified party caused by, resulting from, arising out of, or relating to (i) any breach of any representation or warranty of the Buyer contained in this Agreement which by the terms of this Section 8 survives the Closing, (ii) any breach of any covenant of the Buyer contained in this Agreement which by its terms requires performance after the Closing Date, (iii) any claim, proceeding or suit under any local, state, federal or foreign law, which relates to actions taken by the Buyer or the Company at any time after the Closing with regard to the employment of the Company's employees; (iv) the operation of the business of the Company and the ownership of the assets of the Company following the Closing Date, provided that such Loss is not a direct result of any action taken by the Seller Entities after the Closing; (v) any Tax attributable to (A) the Taxable periods that begin after the Closing Date, (B) the portion of any Tax attributable to the Overlap Period to the extent allocable to the period commencing after the Closing Date as set forth in Section 9(c) and (C) any Tax periods that end on or before the Closing Date if such Tax is attributable to transactions not in the Ordinary Course of Business occurring after the Closing Date which are effectuated or initiated after the Closing Date by the Buyer or the Company and (vi) if the Parties are not able to cause BellSouth to agree to terminate the Guarantee, any Loss in respect of the Guarantee. (D) LIMITATIONS. (i) No Party shall be liable under Section 8 for Losses hereunder, unless the aggregate of all Losses for which any Party would, but for this Section 8(d), be liable on a cumulative basis is an amount equal to or in excess of $1,500,000 (the "Basket Amount") and then only for amounts in excess of the Basket Amount; PROVIDED, HOWEVER, that the foregoing limitation shall not apply to claims for indemnification made by the Buyer pursuant to (A) Section 8(b)(i)(A) in respect of any breach of any representation or warranty made in Section 4(j) above, (B) Section 8(b)(i)(B) in respect of the obligations of the Seller Entities to reimburse the Company under Section 5(i)(ii) above and 6(e)(vii) above, (C) Section 8(b)(i)(C), (D) Section 8(b)(i)(D) and (E) Section 8(b)(i)(E) (the provisions described in the foregoing clauses (A) through (E), the "Buyer Excluded Provisions"); and PROVIDED, FURTHER, that the foregoing limitation shall not apply to claims for indemnification made by the Seller Entities pursuant to (x) Section 8(c)(ii) in respect of the obligation of the Buyer to pay the Purchase Price under Section 2(b) above, (y) Section 8(c)(v) and (z) Section 8(c)(vi) (the provisions described in the foregoing clauses (x) through (z), the "Seller Excluded Provisions"). (ii) Absent fraud or knowing and intentional material misrepresentations, the aggregate amount of Losses for which any Party shall be liable pursuant to Section 8(b) or Section 8(c) above shall not exceed an amount equal to thirty-five percent (35%) of the Purchase Price, as adjusted pursuant to Section 2(b) above; PROVIDED, HOWEVER, that the foregoing limitation shall not apply to claims for indemnification made (A) by the Buyer pursuant to the Buyer Excluded Provisions, and (B) by the Seller Entities pursuant to the Seller Excluded Provisions. (iii) In determining the amount of any Loss to be indemnified pursuant to Section 8(b) or Section 8(c), any qualifications or exceptions relating to Material Adverse Effect and/or materiality shall be disregarded, it being understood that such qualification or exceptions are applicable only to the determination of whether a breach has occurred. (E) OTHER LIMITATIONS. From and after the Closing, no claim for indemnity shall be made by either the Buyer or the Seller Entities if such claim is based on or related to an event or facts disclosed to such Party in this Agreement. (F) LOSSES NET OF INSURANCE, ETC. The amount of any Loss for which indemnification is provided under this Section 8 shall be net of (i) in the case of Section 8(b), any accruals or reserves on the Closing Date Balance Sheet, (ii) any amounts recovered by the Indemnified Party pursuant to any indemnification by or indemnification agreement with any third party and (iii) any insurance proceeds or other cash receipts or sources of reimbursement received as an offset against such Loss, except to the extent that any such insurance is provided under fronting, captive or retrospectively rated policies that would ultimately result in such claims being borne by the Indemnified Party (and no right of subrogation shall accrue to any insurer or third party indemnitor hereunder) (each such source named in clauses (i), (ii) and (iii), a "Collateral Source"). If the amount to be netted hereunder from any payment required under Sections 8(b) or 8(c) is determined after payment by the indemnifying party of any amount otherwise required to be paid to an Indemnified Party pursuant to this Section 8, the Indemnified Party shall repay to the indemnifying party, promptly after such determination, any amount that the indemnifying party would not have had to pay pursuant to this Section 8 had such determination been made at the time of such payment. The amount of any Loss for which indemnification is provided under this Section 8 shall include all costs incurred by the Indemnified Party in seeking recovery from Collateral Sources if the Indemnifying Party has demanded such action in accordance with this Section 8(f). In the event that an Indemnified Party makes a claim for indemnification under this Section 8, the Indemnifying Party shall have the option, in its sole discretion, to demand that the Indemnified Party seek recovery from any Collateral Source for such claim. Any Indemnifying Party may, in its sole discretion, require any Indemnified Party to grant an assignment of the right of such Indemnified Party to assert a claim against any Collateral Source if the Indemnifying Party has first fully satisfied the claim by the Indemnified Party. In the event of such assignment, the Indemnifying Party will pursue such claim at its own expense. (G) TERMINATION OF INDEMNIFICATION. The obligations to indemnify and hold harmless a Person hereto pursuant to Section 8(b) and Section 8(c), shall terminate when the applicable representation or warranty terminates pursuant to Section 8(a), PROVIDED, HOWEVER, that as to clauses (b) and (c) above, such obligations to indemnify and hold harmless shall not terminate with respect to any item as to which the Person to be indemnified shall have, before the expiration of the applicable period, previously made a claim by delivering a notice (stating in reasonable detail the basis of such claim) to the Party providing the indemnification, PROVIDED, FURTHER, that any such claim shall be deemed to have been withdrawn and waived two (2) years after being made, unless (A) court proceedings shall have commenced with respect to such claim within such two (2) year period, or (B) such claim shall have been waived or satisfied within such two (2) year period. (H) PROCEDURES RELATING TO INDEMNIFICATION. A Party seeking indemnification pursuant to Section 8(b) and Section 8(c), (an "Indemnified Party") shall give prompt notice to the Party from whom such indemnification is sought (the "Indemnifying Party") of the assertion of any claim or assessment, or the commencement of any action, suit, audit or proceeding, by a third party in respect of which indemnity may be sought hereunder (a "Third Party Claim") and will give the Indemnifying Party such information with respect thereto as the Indemnifying Party may reasonably request; PROVIDED, HOWEVER, that no failure to give such notice shall relieve the Indemnifying Party of any liability hereunder (except to the extent the Indemnifying Party has suffered actual prejudice thereby). Thereafter, the Indemnified Party shall deliver to the Indemnifying Party, within ten (10) business days after the Indemnified Party's receipt thereof, copies of all notices and documents (including court papers) received by the Indemnified Party relating to the Third Party Claim. The Indemnifying Party shall have the right, exercisable by written notice to the Indemnified Party within thirty (30) days of receipt of notice from the Indemnified Party of the commencement of or assertion of any Third Party Claim, to assume and control the defense of such Third Party Claim, using counsel selected by the Indemnifying Party and reasonably acceptable to the Indemnified Party. Should the Indemnifying Party so elect to assume the defense of a Third Party Claim, the Indemnifying Party will not be liable to the Indemnified Party for legal expenses subsequently incurred by the Indemnified Party in connection with the defense thereof. Regardless of whether the Indemnifying Party elects to assume the defense of any such Third Party Claim, the Indemnified Party shall not admit any liability with respect to, or settle, compromise or discharge, such Third Party Claim without the Indemnifying Party's prior written consent, which shall not be unreasonably withheld, delayed or conditioned and the Indemnifying Party will not admit any liability, consent to the entry of any judgment or enter into any settlement or compromise with respect to such Third Party Claim, without the prior written consent of the Indemnified Party, which shall not be unreasonably withheld, delayed or conditioned unless such settlement or judgment involved only the payment of money damages by the Indemnifying Party and does not involve an injunction or other equitable relief that may affect an Indemnified Party and includes an unconditional release of the Indemnified Party. The Indemnifying Party or the Indemnified Party, as the case maybe, shall in any event have the right to participate, at its own expense, in the defense of any Third Party Claim which the other is defending. Whether or not the Indemnifying Party chooses to defend or prosecute any claim involving a third party, all the Parties hereto shall cooperate in the defense or prosecution thereof and shall furnish such records, information and testimony, and attend such conferences, discovery proceedings, hearings, trials and appeals as may be reasonably requested in connection therewith. Such cooperation shall include reasonable access during normal business hours afforded to the Indemnifying Party to, and reasonable retention by the Indemnified Party of, records and information which are reasonably relevant to such Third Party Claim, and making employees available on a mutually convenient basis to provide additional information and explanation of any material provided hereunder, and the Indemnifying Party shall reimburse the Indemnified Party for all its reasonable out-of-pocket expenses in connection therewith. (I) EXCLUSIVE REMEDY. Each of the Parties hereto agrees that its sole and exclusive remedy after the Closing with respect to any and all claims relating to this Agreement, the Company, the events giving rise to this Agreement and the transactions provided for herein or contemplated hereby, other than for fraud or intentional misconduct shall be pursuant to the indemnification provisions contained in this Section 8. Without limiting the generality or effect of the foregoing, as a material inducement to the other Parties hereto entering into this Agreement, each of the Buyer and the Seller hereby waive, from and after the Closing, any claim or cause of action, known and unknown, foreseen and unforeseen, which it or any of its Affiliates (including after the Closing, the Company) may have against the other Parties hereto, including without limitation under the common law or federal or state securities laws, trade regulation laws or other laws (including CERCLA and any other Environmental Laws), by reason of this Agreement, the events giving rise to this Agreement and the transactions provided for herein or contemplated hereby or thereby, except for claims or causes of action brought under and subject to the terms and conditions of the indemnification provisions contained in this Section 8. (J) MITIGATION. Notwithstanding any other provision of this Agreement to the contrary, any Indemnified Party shall use commercially reasonable efforts to mitigate all Losses, relating to a claim under these indemnification provisions, including availing itself of any defenses, limitations, rights of contribution, and other rights at law or equity. The Indemnified Party's commercially reasonable efforts shall include the reasonable expenditure of money to mitigate or otherwise reduce or eliminate any Loss for which indemnification would otherwise be due, and the Indemnifying Party shall, to the extent that an Indemnified Party's Loss exceeds the Basket Amount, reimburse the Indemnified Party for its reasonable expenditures (except for any portion of the wages, salary, benefits, overhead or other costs attributable to the Indemnified Party and its officers, directors, employees, agents) in undertaking the mitigation and shall, to such extent, take such expenses into account in calculating the aggregate amount of the Seller's liability for the Buyer's indemnifiable Losses or the Buyer's liability for the Seller's indemnifiable Losses, as the case may be. 9. TAX MATTERS. The following provisions shall govern the allocation of responsibility as between the Buyer and the Seller Entities for certain tax matters following the Closing Date: (A) CONSOLIDATED RETURN. The Seller Entities shall cause the Company to be included in the consolidated Income Tax Returns of the Parent Consolidated Group for all periods ending on or prior to the Closing Date for which the Company is required or permitted to be so included and shall pay the Taxes attributable to such Tax Returns. The Seller Entities shall cause to be prepared and timely filed any other federal, state, foreign or local Income Tax Return required or permitted to be filed by the Company for all periods ending on or prior to the Closing Date and pay the Taxes attributable to such Tax Returns. Any such Income Tax Returns that include periods ending on or before the Closing Date shall, insofar as they relate to the Company, be on a basis consistent with the last previous such Tax Returns filed with respect to the Company (based on a closing of the Company books), unless the Buyer or the Seller Entities conclude that there is no reasonable basis for such position under applicable law. Neither the Seller Entities nor the Company (prior to the Closing Date) shall file or cause to be filed any amended Tax Return or claims for refund or settle any audit with respect to the Company without the prior written consent of the Buyer, which consent shall not be unreasonably withheld or delayed. Neither the Buyer nor the Company (after the Closing Date) shall file or cause to be filed any amended Tax Return or claims for refund with respect to any period ending on or before the Closing Date without the prior written consent of the Seller Entities, which consent shall not be unreasonably withheld or delayed. (B) TAX PERIODS ENDING ON OR BEFORE THE CLOSING DATE. The Buyer shall prepare or cause to be prepared and file or cause to be filed all Tax Returns for the Company for all periods ending on or prior to the Closing Date which are required to be filed after the Closing Date other than Income Tax Returns. The Buyer shall provide the Seller Entities with a draft of each such Tax Return described in the preceding sentence at least thirty (30) days prior to the due date for filing such Tax Returns. At least fifteen (15) days prior to the due date for the filing of such Tax Returns, the Seller Entities shall notify the Buyer of the existence of any reasonable objection the Seller Entities may have to any items set forth on such draft Tax Returns. If after consulting in good faith the Seller Entities and the Buyer are unable to resolve such objections, such objections shall be resolved by treating items on such returns in a manner consistent with the past practices of the Company with respect to such items unless otherwise required by law. Notwithstanding any other provision in this Agreement to the contrary, the Seller Entities shall reimburse the Buyer for Taxes of the Company with respect to such periods within fifteen (15) days after payment by the Buyer or the Company of such Taxes to the extent such Taxes are not reserved on the Closing Date Balance Sheet. (C) TAX PERIODS BEGINNING BEFORE AND ENDING AFTER THE CLOSING DATE. The Buyer shall prepare or cause to be prepared and filed or cause to be filed any Tax Returns of the Company for Tax periods which begin before the Closing Date and end after the Closing Date (the "Overlap Period"), and the Buyer shall pay, or cause to be paid, all Taxes shown as due on any such Tax Returns. The Buyer shall provide the Seller Entities with a draft of such Overlap Period Tax Returns at least thirty (30) days prior to the due date for filing such Tax Returns. At least fifteen (15) days prior to the due date for the filing of such Tax Returns, the Seller Entities shall notify the Buyer of the existence of any reasonable objection the Seller Entities may have to any items set forth on such draft Tax Returns. If after consulting in good faith the Seller Entities and the Buyer are unable to resolve such objections, such objections shall be resolved by treating items on such returns in a manner consistent with the past practices of the Company with respect to such items unless otherwise required by law. The Seller Entities shall pay to the Buyer within thirty (30) days after the date on which Taxes are paid with respect to such periods an amount equal to the portion of such Taxes which relates to the portion of such taxable period ending on the Closing Date to the extent such Taxes are not reserved on the Closing Date Balance Sheet. For purposes of this Section 9, in the case of any Taxes that are imposed on a periodic basis and are payable for an Overlap Period, the portion of such Tax which relates to the portion of such taxable period ending on the Closing Date shall in the case of any Taxes other than Income Taxes or sales and use Taxes, be deemed to be the amount of such Tax for the entire taxable period multiplied by a fraction the numerator of which is the number of days in the taxable period ending on the Closing Date and the denominator of which is the number of days in the entire taxable period, and in the case of any Tax based upon or related to Income Tax or sales and use Tax be deemed equal to the amount which would be payable if the relevant taxable period ended on the Closing Date. Any credits relating to a taxable period that begins before and ends after the Closing Date shall be taken into account as though the relevant taxable period ended on the Closing Date. All determinations necessary to give effect to the foregoing allocations shall be made in a manner consistent with prior practice of the Company. (D) REFUNDS AND TAX BENEFITS. Any Tax refunds that are received by the Buyer or the Company, and any amounts credited against Tax to which the Buyer or the Company become entitled, that relate to Tax periods or portions thereof ending on or before the Closing Date shall be for the account of the Seller, and the Buyer shall pay over to the Seller any such refund or the amount of any such credit within thirty (30) days after receipt or entitlement thereto. In addition, to the extent that a claim for refund or a proceeding results in a payment or credit against Tax by a Taxing Authority to the Buyer or the Company of any amount accrued on the Closing Balance Sheet, the Buyer shall pay such amount to the Seller within thirty (30) days after receipt or entitlement thereto. (E) COOPERATION ON TAX MATTERS. (i) The Buyer, the Company and the Seller Entities shall cooperate fully, as and to the extent reasonably requested by the other Parties, in connection with the filing of Tax Returns pursuant to this Section 9 and any audit, litigation or other proceeding with respect to Taxes. Such cooperation shall include the retention and (upon another Party's request) the provision of records and information which are reasonably relevant to any such audit, litigation or other proceeding and making employees available on a mutually convenient basis to provide additional information and explanation of any material provided hereunder. The Company and the Seller Entities agree (A) to retain all books and records with respect to Tax matters pertinent to the Company relating to any taxable period beginning before the Closing Date until the expiration of the statute of limitations (and, to the extent notified by the Buyer or the Seller Entities, any extensions thereof) of the respective taxable periods, and to abide by all record retention agreements entered into with any Taxing Authority, and (B) to give the other Parties reasonable written notice prior to transferring, destroying or discarding any such books and records and, if another Party so requests, the Company or the Seller Entities, as the case may be, shall allow the such Party to take possession of such books and records. (ii) The Buyer and the Seller Entities further agree, upon request, to use their commercially reasonable best efforts to obtain any certificate or other document from any Taxing Authority or any other Person as may be necessary to mitigate, reduce or eliminate any Tax that could be imposed (including, but not limited to, with respect to the transactions contemplated hereby). (iii) The Buyer and the Seller Entities further agree, upon request, to provide the other Parties with all information that such Parties may be required to report pursuant to Section 6043 of the Code and all Treasury Department Regulations promulgated thereunder. (F) TAX SHARING AGREEMENTS. All tax sharing agreements or similar agreements with respect to or involving the Company shall be terminated as of the Closing Date and, after the Closing Date, the Company shall not be bound thereby or have any liability thereunder. (G) CERTAIN TAXES. All transfer, documentary, sales, use, stamp, registration and other such Taxes and fees (including any penalties and interest) incurred in connection with this Agreement (including any state gains tax, transfer tax and any similar tax imposed in any state or subdivision), shall be paid by the Buyer when due, and the Buyer will, at its own expense, file all necessary Tax Returns and other documentation with respect to all such transfer, documentary, sales, use, stamp, registration and other Taxes and fees, and, if required by applicable law, the Buyer will, and will cause its Affiliates to, join in the execution of any such Tax Returns and other documentation. (H) REPRESENTATION. (i) The Seller Entities shall have the right to represent the interests of the Company in any Tax audit or administrative or court proceeding relating to Tax Returns for any periods or portions thereof ending on or prior to the Closing Date. Following the Closing, in the event of an audit of any Tax Return of the Seller Entities or with respect to which either of the Seller Entities has any liability, the Buyer shall promptly notify the Seller Entities of such audit and the Buyer shall execute, or cause the Company to execute, powers of attorney under applicable laws authorizing the designated representative of the Seller Entities to represent the Company with respect thereto. The Buyer shall make available or shall cause the Company to make available to the Seller Entities, at the expense of the Seller Entities, any and all books and records of the Company and other documents requested by the Seller Entities and shall make available employees of the Company reasonably necessary to enable the Seller Entities to defend any audit or other preceding with respect to any such Tax Returns. (ii) The Seller Entities shall not enter into any settlement of or otherwise compromise any Tax matter that materially affects or may materially affect the Tax liability of the Buyer or the Company for any period ending after the Closing Date, including the portion of the Overlap Period that is after the Closing Date, without the prior written consent of the Buyer, which consent shall not be unreasonably withheld or delayed. The Seller Entities shall keep the Buyer fully and timely informed with respect to the commencement, status and nature of any Tax matter. The Seller Entities shall, in good faith, allow the Buyer, at its sole expense, to make comments to the representative of the Seller Entities, regarding the conduct of or positions taken in any such proceeding. (iii) Except as otherwise provided above, the Buyer shall have the sole right to control any audit or examination by any Taxing Authority, initiate any claim for refund or amend any Tax Return, and contest, resolve and defend against any assessment for additional Taxes, notice of Tax deficiency or other adjustment of Taxes of, or relating to, the income, assets or operations of the Company for all taxable periods ending after the Closing Date; PROVIDED, HOWEVER, that the Buyer shall not, and shall cause its Affiliates (including the Company) not to, enter into any settlement of any contest or otherwise compromise any issue with respect to the portion of the Overlap Period ending on or prior to the Closing Date and shall not amend any Tax Return with respect to any period ending on or prior to the Closing Date without the prior written consent of one of the Seller Entities, which consent shall not be unreasonably withheld or delayed. (I) CONFIDENTIALITY. Any information obtained under this Section 9 shall be kept confidential, except as may be otherwise necessary in connection with filing any Tax Return (or amended Tax Return) or refund claim, determining any Tax liability or right to a refund, conducting or defending any audit or other proceeding with respect to Taxes or otherwise effectuating the terms of this Agreement. Notwithstanding anything herein to the contrary, any Party hereto (and any employee, representative or other agent of the Party) may disclose to any and all persons, without limitation of any kind, the U.S. federal income tax treatment and U.S. federal income tax structure of the transactions contemplated by this Agreement and all materials of any kind (including opinions or other tax analyses) that are provided to it relating to such tax treatment and tax structure; PROVIDED, HOWEVER, that such information relating to the tax treatment or tax structure is required to be kept confidential to the extent necessary to comply with any applicable federal or state securities laws. (J) SECTION 1445. The Seller shall furnish to the Buyer on or before the Closing Date a non-foreign person affidavit as required by Section 1445 of the Code. (K) SECTION 338 ELECTION. (i) At the sole election of the Buyer, to be exercised within ninety (90) days after the Closing Date (or such other time specified by the Buyer, but subject to the time limitations set forth below), the Seller and/or the Parent, as appropriate, and the Buyer will jointly complete and make an election under Section 338(h)(10) (with respect to the Company and/or its Subsidiaries) of the Code (the "338(h)(10) Election") on Form 8023 or in such other manner as may be required by rule or regulation of the Internal Revenue Service, and at the sole election of the Buyer, the Seller and/or the Parent, as appropriate, will jointly make an election in the manner required under any analogous provisions of state or local law as the Buyer will designate or as will be required, concerning the transactions contemplated by this Agreement. The Buyer will, with the assistance and cooperation of the Seller, prepare all such Section 338(h) (10) forms required as attachments to Form 8023 (and all forms under analogous provisions of state or local law) in accordance with applicable Tax laws, and Buyer will deliver such forms and related documents to the Seller at least forty-five (45) days prior to the due date of filing. The Seller will deliver to the Buyer at least fifteen (15) days prior to the due date of filing copies of such completed and fully executed forms as are required to be filed under Section 338(h)(10) of the Code (and analogous provisions of state and local law). The Buyer will timely file such forms with the appropriate Tax authorities. The Buyer and the Seller will use their best efforts to agree, as soon as practicable after Closing but in no event later than one hundred twenty (120) days following the Closing Date, on the computation of the modified aggregate deemed sale price ("MADSP") (as defined under U.S. Department of Treasury Regulations). The Buyer and the Seller shall each file a consistent Form 8883 within the time period required pursuant to the Code and regulations thereunder. The Seller agrees to cooperate with the Buyer in making the required elections and filing the applicable forms with respect to the Section 338(h)(10) Election and required state and local filings. (ii) The Seller and Buyer agree that Buyer will perform or cause to be performed an initial valuation of assets and allocation of the Purchase Price for purposes of Section 338 of the Code at the sole cost and expense of the Buyer. The Buyer will provide the Seller with drafts of such valuation of assets and allocation of MADSP (which will be prepared on a basis consistent with this Section 9(k) hereto) and the proposed Form 8883 within one hundred twenty (120) days after the Closing Date. Seller will have forty-five (45) days to provide the Buyer with any objections to such drafts. If the Seller objects to the computation or allocation by the Buyer of such amounts, and the Buyer and Seller are unable to reach agreement on the computation or allocation within thirty (30) business days after notification by the Seller of its objection, the Buyer and the Seller will jointly engage an independent national accounting firm to resolve the disagreement (such resolution to be final and binding upon the Parties) within ten (10) days thereafter. Any fee payable to the independent accounting firm engaged by the Buyer and the Seller as provided above will be shared equally by the Seller and the Buyer. The valuation and allocations determined pursuant to this Section 9(k) will be used for purposes of all relevant Tax Returns, reports and filings. In the event of a 338(h)(10) Election, the gain or loss from the deemed asset sale will be included in the Parent Consolidated Group's Income Tax Return. (iii) In the event the Buyer decides to make an election pursuant to Section 338 of the Code (or any subdivision thereof) or any election pursuant to comparable state statutes with respect to the purchase of the Stock, then the Buyer hereby agrees, notwithstanding any representation, warranty or other provision in this Agreement to the contrary to indemnify and hold the Seller harmless from any incremental tax liability imposed upon the Seller as a result of such election. The amount of the indemnity (the "338 Indemnity Amount") shall be equal to the amount that the Purchase Price must be increased to result in the Seller receiving the same after-Tax cash benefit (prior to any reduction for a consolidated return net operating loss) as would result if the Section 338 election was not made, taking into account the consequences of such election with respect to both federal and state Taxes. Buyer shall pay the 338 Indemnity Amount within thirty (30) days of receipt of notice by Seller of the calculation of the 338 Indemnity Amount. Notwithstanding any provision in this Agreement to the contrary, the 338 Indemnity Amount shall not exceed $500,000.00. (L) PHANTOM STOCK OPTION PLAN. Pursuant to the Company's 2001 Phantom Stock Option Plan, the vesting of all outstanding phantom stock options will accelerate as a result of the transactions contemplated by this Agreement, and the award payments to the holders of phantom stock options will be paid out pursuant to Section 6(e)(vii). Any deduction attributable to the payment of such awards pursuant to Section 6(e)(vii) shall be treated as pre-Closing Tax items and shall be included in the Tax Return of the Parent Consolidated Group for the period ending on, or including, the Closing Date. (M) PURCHASE PRICE ADJUSTMENT. Unless otherwise specifically provided for in this Agreement, any (i) indemnity payments, pursuant to Section 8 or otherwise, and (ii) any adjustments to the Purchase Price, pursuant to Section 2(b), Section 5(i) or otherwise, shall be treated for all Tax purposes as adjustments to the Purchase Price to the maximum extent permitted under the Code (or other applicable Tax law). 10. TERMINATION. (A) TERMINATION OF AGREEMENT. Certain of the Parties may terminate this Agreement as provided below: (i) the Buyer on the one hand and the Seller Entities on the other may terminate this Agreement by mutual written consent at any time prior to the Closing; (ii) the Buyer may terminate this Agreement by giving written notice to the Seller Entities at any time prior to the Closing (A) in the event a Seller Entity has breached any material representation, warranty or covenant contained in this Agreement in any material respect, the Buyer has notified the Seller Entities of the breach, and the breach has continued without cure for a period of ten (10) days after the notice of breach; (B) if the Closing shall not have occurred on or before June 30, 2004 (unless the condition precedent to Closing set forth in Section 7(a)(v) is the only condition precedent of the Buyer that remains unsatisfied on such date, in which case the Buyer may not terminate this Agreement until July 31, 2004); or (C) by reason of the failure of any condition precedent under Section 7(a) hereof (unless the failure results from the Buyer itself breaching any material representation, warranty or covenant contained in this Agreement); PROVIDED, HOWEVER, that notwithstanding any language to the contrary contained in this Agreement, if any breach by a Seller Entity of any material representation, warranty or covenant can be cured by the payment of money (including any breach that constitutes or would constitute a Material Adverse Effect), any Seller Entity shall have the option, but not the obligation, to cure such breach by either, at the option of the Seller Entity, (i) making payment to the Person entitled to payment (e.g., a governmental authority) and/or (ii) agreeing to a reduction of the Purchase Price in an amount equal to the amount to be paid to such Person. Upon any election by a Seller Entity in accordance with the foregoing sentence, the Buyer shall not be entitled to terminate this Agreement on account of the applicable breach and further, in the case of an election pursuant to clause (ii) of the foregoing sentence, promptly after the Closing, the Buyer shall pay or cause the Company to pay the Person entitled to such payment; PROVIDED FURTHER, that in no event shall any of the Seller Entities be required to expend any monies in connection with the Buyer's breach of any material representation, warranty or covenant under this Agreement or with respect to the Buyer's compliance or noncompliance with any applicable law (including rules, regulations, codes, plans, injunctions, judgments, orders, decrees, rulings, and charges thereunder) of federal, state and local governments (and all agencies thereof) whether arising before or after the Closing; and (iii) the Seller Entities may terminate this Agreement by giving written notice to the Buyer at any time prior to the Closing (A) in the event the Buyer has breached any material representation, warranty or covenant contained in this Agreement in any material respect, a Seller Entity has notified the Buyer of the breach, and the breach has continued without cure for a period of ten (10) days after the notice of breach; (B) if the Closing shall not have occurred on or before June 30, 2004 (unless the condition precedent to Closing set forth in Section 7(b)(v) is the only condition precedent of the Seller Entities that remains unsatisfied on such date, in which case the Seller Entities may not terminate this Agreement until July 31, 2004); or (C) by reason of the failure of any condition precedent under Section 7(b) hereof (unless the failure results primarily from a Seller Entity itself breaching any material representation, warranty, or covenant contained in this Agreement). (B) EFFECT OF TERMINATION. If any Party terminates this Agreement pursuant to Section 10(a) above, all rights and obligations of the Parties hereunder shall terminate without any liability of any Party to any other Party (except for any liability of any Party then in breach); PROVIDED, HOWEVER, that the confidentiality provisions contained in Sections 6(f) and Section 9(i) above shall survive termination indefinitely. 11. MISCELLANEOUS. (A) PRESS RELEASES AND PUBLIC ANNOUNCEMENTS. No Party shall issue any press release or make any public announcement relating to the subject matter of this Agreement, prior to the Closing, without the prior written approval of the Buyer and the Seller Entities; PROVIDED, HOWEVER, that any Party may make any public disclosure it believes in good faith is required by applicable law or any listing or trading agreement concerning its publicly-traded securities (in which case the disclosing Party will use its reasonable best efforts to advise the other Parties prior to making the disclosure). (B) NO THIRD-PARTY BENEFICIARIES. This Agreement shall not confer any rights or remedies upon any Person other than the Parties and their respective successors and permitted assigns. (C) ENTIRE AGREEMENT. This Agreement (including the documents referred to herein) constitutes the entire agreement among the Parties and supersedes any prior understandings, agreements, or representations by or among the Parties, written or oral, to the extent they related in any way to the subject matter hereof. (D) SUCCESSION AND ASSIGNMENT. This Agreement shall be binding upon and inure to the benefit of the Parties named herein and their respective successors and permitted assigns. No Party may assign either this Agreement or any of his or its rights, interests, or obligations hereunder without the prior written approval of the Buyer and the Seller Entities; PROVIDED, however, that the Buyer may (i) assign any or all of its rights and interests hereunder to one or more of its Affiliates and (ii) designate one or more of its Affiliates to perform its obligations hereunder (in any or all of which cases the Buyer nonetheless shall remain responsible for the performance of all of its obligations hereunder). (E) COUNTERPARTS. This Agreement may be executed in one or more counterparts, each of which shall be deemed an original but all of which together will constitute one and the same instrument. (F) HEADINGS. The section headings contained in this Agreement are inserted for convenience only and shall not affect in any way the meaning or interpretation of this Agreement. (G) NOTICES. All notices, requests, demands, claims, and other communications hereunder will be in writing. Any notice, request, demand, claim, or other communication hereunder shall be deemed duly given if (and then two business days after) it is sent by registered or certified mail, return receipt requested, postage prepaid, and addressed to the intended recipient as set forth below: If to the Parent or the Seller: Copy to: Louis Paglia William A. Perrone Chief Financial Officer Wiggin & Dana LLP UIL Holdings Corporation 400 Atlantic Street 157 Church Street Stamford, CT 06901 New Haven, CT 06510 If to the Buyer: Copy to: ---------------- -------- Mark A. Johnson Laura E. Binion Vice Chairman General Counsel CheckFree Corporation CheckFree Corporation 4411 East Jones Bridge Road 4411 East Jones Bridge Road Norcross, GA 30092 Norcross, GA 30092 Any Party may send any notice, request, demand, claim, or other communication hereunder to the intended recipient at the address set forth above using any other means (including personal delivery, expedited courier, messenger service, telecopy, telex, ordinary mail, or electronic mail), but no such notice, request, demand, claim, or other communication shall be deemed to have been duly given unless and until it actually is received by the intended recipient. Any Party may change the address to which notices, requests, demands, claims, and other communications hereunder are to be delivered by giving the other Parties notice in the manner herein set forth. (H) GOVERNING LAW. This Agreement shall be governed by and construed in accordance with the domestic laws of the State of New York without giving effect to any choice or conflict of law provision or rule (whether of the State of New York or any other jurisdiction) that would cause the application of the laws of any jurisdiction other than the State of New York. (I) VENUE. EACH OF THE PARTIES HERETO (A) CONSENTS TO SUBMIT ITSELF TO THE EXCLUSIVE PERSONAL JURISDICTION OF ANY FEDERAL OR STATE COURT LOCATED IN AND FOR NEW YORK, NEW YORK IN THE EVENT ANY DISPUTE ARISES OUT OF THIS AGREEMENT, (B) AGREES THAT IT SHALL NOT ATTEMPT TO DENY OR DEFEAT SUCH PERSONAL JURISDICTION BY MOTION OR OTHER REQUEST FOR LEAVE FROM ANY SUCH COURT AND (C) AGREES THAT IT SHALL NOT BRING ANY ACTION RELATING TO THIS AGREEMENT IN ANY COURT OTHER THAN A FEDERAL OR STATE COURT SITTING IN AND FOR NEW YORK, NEW YORK. (J) WAIVER OF JURY TRIAL. EACH PARTY TO THIS AGREEMENT WAIVES, TO THE FULLEST EXTENT PERMITTED BY APPLICABLE LAW, ANY RIGHT IT MAY HAVE TO A TRIAL BY JURY IN RESPECT OF ANY ACTION, SUIT OR PROCEEDING ARISING OUT OF OR RELATING TO THIS AGREEMENT. (K) AMENDMENTS AND WAIVERS. No amendment of any provision of this Agreement shall be valid unless the same shall be in writing and signed by the Buyer and the Seller Entities. No waiver by any Party of any default, misrepresentation, or breach of warranty or covenant hereunder, whether intentional or not, shall be deemed to extend to any prior or subsequent default, misrepresentation, or breach of warranty or covenant hereunder or affect in any way any rights arising by virtue of any prior or subsequent such occurrence. (L) SEVERABILITY. Any term or provision of this Agreement that is invalid or unenforceable in any situation in any jurisdiction shall not affect the validity or enforceability of the remaining terms and provisions hereof or the validity or enforceability of the offending term or provision in any other situation or in any other jurisdiction. (M) EXPENSES. Each of the Parties and the Company will bear his or its own costs and expenses (including legal fees and expenses) incurred in connection with this Agreement and the transactions contemplated hereby, except that the Seller Entities and the Buyer shall each pay one-half of all filing fees incurred under the HSR Act. (N) CONSTRUCTION. The Parties have participated jointly in the negotiation and drafting of this Agreement. In the event an ambiguity or question of intent or interpretation arises, this Agreement shall be construed as if drafted jointly by the Parties and no presumption or burden of proof shall arise favoring or disfavoring any Party by virtue of the authorship of any of the provisions of this Agreement. Any reference to any federal, state, local, or foreign statute or law shall be deemed also to refer to all rules and regulations promulgated thereunder, unless the context requires otherwise. The word "including" shall mean "including without limitation". (O) INCORPORATION OF EXHIBITS AND SCHEDULES. The Exhibits and Disclosure Schedules identified in this Agreement and any certificates delivered at Closing pursuant to Section 7 hereof are incorporated herein by reference and made a part hereof. [SIGNATURE PAGE FOLLOWS] IN WITNESS WHEREOF, the Parties hereto have executed this Agreement on the date first above written. CHECKFREE CORPORATION By: /s/ Mark A Johnson Name: Mark A. Johnson Title: Vice Chairman UIL HOLDINGS CORPORATION By: /s/ Nathaniel D. Woodson Name: Nathaniel D. Woodson Title: Chairman, President & CEO UNITED RESOURCES, INC. By: /s/ Nathaniel D. Woodson Name: Nathaniel D. Woodson Title: Chairman & President EX-10 4 uil_exh10-5e.txt TRANS LINE AGMNT 5/15/03 BETW UI & CT-DOT EXHIBIT 10.5e RECORDED IN FAIRFIELD LAND RECORDS AT VOLUME _______, pAGE ________ RECORDED IN BRIDGEPORT LAND RECORDS AT VOLUME _______, PAGE ________ RECORDED IN STRATFORD LAND RECORDS AT VOLUME _______, PAGE ________ RECORDED IN MILFORD LAND RECORDS AT VOLUME _______, PAGE ________ RECORDED IN ORANGE LAND RECORDS AT VOLUME _______, PAGE ________ RECORDED IN WEST HAVEN LAND RECORDS AT VOLUME _______, PAGE ________ RECORDED IN NEW HAVEN LAND RECORDS AT VOLUME _______, PAGE ________ Agreement No. 5.15-99(03) -------------- TRANSMISSION LINE AGREEMENT BETWEEN STATE OF CONNECTICUT, DEPARTMENT OF TRANSPORTATION AND THE UNITED ILLUMINATING COMPANY TO OPERATE A TRANSMISSION SYSTEM ON THE NEW HAVEN LINE FROM FAIRFIELD TO NEW HAVEN RAIL FILE NO. (50) 7001-MISC-143 This TRANSMISSION LINE AGREEMENT (the "Agreement") concluded at Newington, Connecticut, as of the 15th day of May, 2003, by and ---- --------- between the STATE OF CONNECTICUT, DEPARTMENT OF TRANSPORTATION, James F. Byrnes, Jr., Commissioner, acting herein by Harry P. Harris, Bureau Chief, Bureau of Public Transportation, duly authorized (the "State"), and THE UNITED ILLUMINATING COMPANY, a specially chartered Connecticut corporation, having its principal place of business at 157 Church Street, P.O. Box 1564, New Haven, Connecticut 06506-0901, acting herein by Anthony J. Vallillo, its President and Chief Operating Officer, hereunto duly authorized (the "Power Company"). WITNESSETH THAT: WHEREAS, in accordance with the provisions of a certain Transmission Line Agreement dated January 13, 1966, between Richard Joyce Smith, William J. Kirk and Harry W. Dorigan, as 1 Trustees of the Property of the New York, New Haven and Hartford Railroad Company, Debtor in proceedings for reorganization under Section 77 of the Bankruptcy Act (hereinafter called "Railroad Company") and The United Illuminating Company (hereinafter called "Power Company"), Power Company has installed and is now operating an electric power transmission system on, above and under land used in the operation of a railroad from a point west of the Fairfield-Westport Town Line to a point in New Haven (hereinafter called the "New Haven Line"); and RECITALS: a. WHEREAS, The Trustees in Bankruptcy of The New York, New Haven, and Hartford Railroad Company entered into a Transmission Line Agreement with the Power Company dated January 13, 1966, for which a Notice of Lease was recorded in the City of New Haven Land Records at Volume 2302, Page 1; the Town of West Haven Land Records at Volume 480, Page 78; the Town of Orange Land Records at Volume 215, Page 61; the Town of Milford Land Records at Volume 566, Page 322; the Town of Stratford Land Records at Volume 422, Page 55; the City of Bridgeport Land Records at Volume 1332, Page 117; and the Town of Fairfield Land Records at Volume 497, Page 185 (the "Agreement"). b. The State is the present owner of the New Haven Rail Line which extends from the New York State border (Greenwich, Connecticut) to New Haven, Connecticut. The State acquired fee ownership by quitclaim deed on October 31, 1985 from Penn Central Corporation. Said deed was recorded in the Westport Land Records in Volume 763, Pages 247-250; Fairfield Land Records in Volume 756, Page 551; Bridgeport Land Records in Volume 1975, Pages 277-282; Stratford Land Records in Volume 621, Pages 65-70; Milford Land Records in Volume 2 1406, Pages 299-304; Orange Land Records in Volume 299, Pages 360-365; and New Haven Land Records in Volume 3371, Pages 335-340. c. Metro-North Commuter Railroad Company is operating commuter railroad services over said land encumbered by the 1966 Agreement pursuant to the Amended & Restated Service Agreement among the State, Metropolitan Transportation Authority and Metro-North Commuter Railroad Company ("Metro-North") dated as of June 21, 1985 (the "Metro-North Service Agreement"), a true and complete copy of which has been previously delivered by the State to the Power Company. (Metro-North and any successors thereto in operating the railroad for the State are hereinafter referred to as the "State's Designee".) Pursuant to that agreement, Metro-North maintains and operates for the State the trackage and other railroad facilities located on the said land. d. Pursuant to the 1966 Agreement, the Power Company constructed, maintains and operates a 115-KV electric transmission line that is, for the most part, located on the north side of the railroad tracks and a 115-KV electric transmission line that is located on the south side of the railroad tracks. e. The original term of the 1966 Agreement ended on May 4, 1980, but the Power Company properly exercised its option to extend the term of the 1966 Agreement to May 4, 2000. f. The State and the Power Company have agreed to amend and restate the 1966 Agreement to further extend its term to provide for an increase in the rent, to define a process for the determination of the rent at various future times, and to make other amendments. g. The State has statutory authority to enter into this Agreement pursuant to Conn. Gen. Stat. Sections 13b-23 and 13b-36(b) which states in pertinent part that the Commissioner of 3 Transportation "... may sell, lease, convey or enter into any other arrangement for the use of such property for the operation of transportation services, or for such other purposes as the commissioner determines to be consistent with the best interests of the state." NOW, THEREFORE, in consideration of the mutual covenants and agreements herein contained, and to amend and restate the 1966 Agreement, the State and the Power Company agree as follows: ARTICLE I. GRANT ----- (a) The State grants to the Power Company the right to construct, repair, maintain, replace, reconstruct, relocate, inspect and remove from time to time and operate at its own expense and, except as otherwise specifically set forth herein, without expense to the State and the State's Designee, upon certain of the State's structures, both those now in existence and those which may hereafter be erected that are located within the limits of the Use Area that is hereinafter described in subparagraph (1) (the "State's Structures"), and on, above or under certain of its land used in the operation of its railroad, located as follows: (1) between the Fairfield-Westport Town Line and New Haven, situated generally between catenary structures Nos. 647 and 1052, inclusive, which is 122,217+/- lineal feet, or 23.147 miles, between station 1913+83, which is approximately catenary 647, up to station 3136+00, which is approximately catenary 1052, of the monumented four-track center line of the New Haven Line, hereinafter referred to as the ("Use Area") a transmission system that is hereinafter described in Article II with the supporting structures and other appurtenances thereto (the 4 "Transmission System"), together with the right to erect such new structures on said land as may be necessary for the support thereof. (b) The State grants to the Power Company the right to construct, repair, maintain, replace, reconstruct, relocate, inspect and remove from time to time and operate at its sole cost and expense, connecting lines (the "Connecting Lines") on, above or under the land owned and used by the State or State's Designee in the operation of its railroad from the Transmission System to the generating plants, stations, substations and lines which the Power Company owns or may hereafter construct along its Transmission System, and to generating plants, stations, substations and lines of other parties, together with the right to erect such new structures on said land as may be necessary for the support thereof. (c) State or its Assignees further leases and grants to Power Company the right to continue to operate all of the connecting lines heretofore installed and presently being operated by Power Company and to install from time to time and operate additional or substituted connecting lines from the transmission system to facilities of Power Company now or hereafter to be located on the Bridgeport Harbor station property which was conveyed to it by deed of the Railroad Company, dated July 28, 1952 and recorded in the Bridgeport Land Records in Volume 1025, at Pages 219-228, on, above or under a certain parcel of land used by State or its Assignees in the operation of its or their railroad which is delineated and shown as "Easement Area" on a certain map, entitled "EASEMENT AREA FOR TRANSMISSION LINES OF THE UNITED ILLUMINATING COMPANY AND AREA TO BE RELEASED BY THE UNITED ILLUMINATING COMPANY - BRIDGEPORT, CONN. - DWG. NO. 410-11-4-9-63" (a duplicate of which was found in the Town Clerk of Bridgeport on February 5, 1964 in Volume 1280, Page 523 of the Bridgeport Land Records), said parcel of land being hereinafter called the 5 "easement area" and to construct, maintain, inspect, repair, replace and remove such poles, wires, cables, conduits, duct lines, pipes and other structures as may be necessary or appropriate in connection with such connecting lines, it being understood that such connecting lines, poles, wires, cables, conduits, duct lines, pipes and other structures hereafter installed shall be placed at such locations within the easement area as the State or State's Designee and Power Company mutually agree, and to construct, maintain, inspect, repair, relocate, reconstruct, replace and remove such supporting wires, guywires and anchors outside of the easement area as the parties may hereafter from time to time agree are advisable in connection with such Connecting Lines. (When the construction and installation of any Connecting Line is completed, it will thereafter be deemed to be part of the Transmission System for the purposes of this Agreement.) ARTICLE II. TRANSMISSION SYSTEM ------------------- (a) The Power Company's Transmission System shall include everything installed by Power Company above the bonnet of State's Catenary Structure and shall consist of not more than two three-phase sixty cycle circuits which may be constructed together or at different times, of such kinds and sizes of wire as may be found necessary or desirable by the Power Company's engineers and approved by the State and the State's Designee, operated at voltages up to one hundred fifteen thousand (115,000) volts, with the insulators, fastenings and other appurtenances necessary to attach them to the supporting structures, together with lightning shield wires, ground wires of suitable size, structure foundations, additions to State's Structures and material and communication facilities for the Power Company's operations. Exhibits A and B attached hereto are typical examples of Power Company's installations above the bonnet of the State's Catenary Structures). The Power Company's Transmission System shall further include all pre-existing, 6 freestanding 65-foot poles located adjacent to State's Catenary Structures as depicted in Exhibit C attached hereto. (b) The Transmission System along the Use Area shall be carried upon suitable additions to or modifications of the State's Structures which now or which may hereafter carry the power distribution system and other appurtenances of the State or upon independent supporting structures, or the Transmission System may be placed underground, or partly on the State's Structures, partly on independent supporting structures and partly underground. ARTICLE III. OBLIGATIONS OF POWER COMPANY ---------------------------- The Power Company agrees: (a) To notify the State or State's Designee when it shall determine to proceed after the date hereof with the construction, replacement or reconstruction of the Transmission System, to erect any new supports required, and to make any necessary modifications of existing structures; to furnish all labor, material and tools necessary therefor, and to pay to the State's Designee the established rates customarily charged by the State's Designee for equipment which it may desire to rent from the State's Designee. (b) That simultaneously with the execution and delivery of this Agreement, to pay to the State the net Base Rent for the period from May 5, 2000 (the commencement of the 30-Year Term) to November 4, 2002. Thereafter, all payments of Base Rent will be payable quarterly, in advance, on the fifth day of each succeeding August, November, February and May commencing with November 5, 2002. The Base Rent for each lease year of the 30-Year Term will be $650,000.00, or $162,500.00 per quarter subject to adjustments at the 6th, 11th, 16th, 21st and 26th 7 anniversaries of the commencement of the 30-Year Term, as further described in paragraph (d) of this Article III. (c) That commencing on the first day of each renewal period of the Extended Term, as hereinafter defined in Article VII(b), the rent for the first year of each of such periods will be equal to the then fair market rent for the premises leased herein as determined by the appraisal process set forth in Article XV hereof subject to adjustments at the 6th and 11th anniversaries of the 15-Year Renewal Term, as further described in paragraph (d) of this Article III. (The rent as so determined by said appraisal process at the beginning of any renewal period is hereinafter also called the "Base Rent".) (d) That the Base Rent for the 30-Year Term will be adjusted at the sixth (6th), eleventh (11th), sixteenth (16th), twenty-first (21st) and twenty-sixth (26th) anniversaries of the commencement of the 30-Year Term by multiplying said Base Rent by a fraction that has as its denominator the Consumer Price Index [(the "CPI")], for March, 2000, and as its numerator the CPI for the month of March of each of said adjustment years. In the event the Power Company does not reject one or both of its renewal options, the Base Rent for the appropriate renewal period will be adjusted at the sixth (6th) and eleventh (11th) anniversaries of the commencement of the relevant renewal period by multiplying the Base Rent for said renewal period by a fraction that has as its denominator the CPI for the month of March of the first year of the renewal period, and as its numerator the CPI for the month of March of said adjustment years. (e) That the term "CPI" shall be deemed to mean the Consumer Price Index (1982-84=100) prepared by the Bureau of Labor Statistics of the United States Department of Labor for Northeast "A" for New York, New Jersey, Long Island, (New York, New Jersey, Connecticut) New York - Northeastern, New Jersey for All Urban Consumers. However, if at the time 8 required for the determination of the increase, if any, in the Base Rent, said index is no longer published or issued, the parties shall use such other index as is then generally recognized and accepted for similar determinations of purchasing power. If the parties are unable to agree on the selection of an index that would most accurately carry out the intent hereof, or if there is a dispute with respect to the computation of the increase, if any, to the Base Rent as herein provided, then the issue with respect thereto shall be determined by dispute resolution, as provided in Article XIV hereof. (f) That the foregoing CPI adjustments to Base Rent during the 30-Year Term and/or during any renewal period shall produce an increase of at least three percent (3%) per year (not compounded) over the amount of said Base Rent at the beginning of the 30-Year Term or the applicable renewal period, but in no event will said increases be greater than six and one-half percent (6.5%) per year (not compounded) over the amount of said Base Rent at the beginning of the 30-Year Term or the applicable renewal period. (g) To pay to the State an annual rent for any additional Connecting Lines that may be installed by the Power Company after the date of this Agreement, pursuant to the provisions of Section (b) of Article I of this Agreement, which annual rent will be equal to the product of the number of linear feet of such Connecting Lines (to the extent they are located on, above or under land of the State and as measured from the point of connection of the Connecting Line with the Transmission System to the boundary of the State's land) times (i) fifty percent (50%) of the number of dollars per annum per linear foot of conductor that the Power Company is obligated to pay as rent to the State under the provisions of Article III(b) of this Lease; and (ii) during any renewal period, if the Power Company has not exercised its right to reject the same, the annual fair market rent per linear foot of Connecting Line as determined under Article XV of this 9 Agreement; such rent to be paid quarterly and to begin on the date of the next regular quarterly payment of Basic Rent, the first installment of which will be prorated to the date when construction thereof starts. (h) To make all payments under this Agreement to the State by check, made payable to "The Treasurer, State of Connecticut" and addressed to the "Accounts Receivable Unit, Connecticut Department of Transportation, P.O. Box 317546, Newington, Connecticut, 06131-7546". (i) To reimburse the State or the State's Designee for any expenses which they may incur (1) in connection with the reconstruction, repair, maintenance, replacement, relocation or removal by the Power Company of any portion of the Transmission System, including but not limited to, the necessary protection, grounding railroad circuits, flagging trains, supervision and inspection; and (2) in connection with the maintenance and repair by the Power Company of the Transmission System and the additions to the present structures made necessary by the installation thereof; and (3) in connection with such special testing and inspecting thereof. It being understood that the State or the State's Designee shall not charge the Power Company for normal patrolling or inspecting the Transmission System performed in connection with patrolling or inspecting its own power system. (j) To reimburse the State or the State's Designee for any expenses which they may incur or for any material they may supply in connection with (i) the installation, construction or reconstruction by the Power Company after the date hereof of any portion of the Transmission System, or (ii) changes in the supporting structures or in the telephone, fiber optics, signal, power or other facilities of the State which, in the opinion of the State, are necessary as a result of said future installation or construction or reconstruction by the Power Company after the date hereof 10 of the Transmission System within the Use Area. The Power Company agrees to (1) notify the State when it shall determine to proceed with any such future installation or construction or reconstruction of the Transmission System, to erect any new supports required, and/or to make any modifications of existing structures; (2) furnish all labor, material and tools necessary therefor; and (3) pay to the State or to the State's Designee the established rates customarily charged by them for equipment which the Power Company may desire to rent. It is understood that this Section (j) does not apply (i) to any such changes to the State's facilities that are not directly made necessary by said future installation, construction or reconstruction of the Transmission System by the Power Company after the date hereof, or (ii) to the replacement of the State's supporting structures or circuits made necessary by normal wear and tear or other causes not directly connected with the Transmission System; nor does it apply (except to the extent provided in the following Section (k)) to any such changes in the fiber optics signal system of the State within the Use Area made necessary as a result of the occupancy of railroad property by the Transmission System, unless made necessary by future modification in the design, construction or operation of the system of the Power Company or power systems connected therewith. (k) To reimburse the State or the State's Designee for all reasonable and necessary costs which may result from any physical or operational changes to the Transmission System made after the date of this Agreement by the Power Company to protect the signal system of the State as provided in Article XI of this Agreement. (l) To maintain and repair the Transmission System in a safe, prudent manner, at its sole cost and expense, and if the Power Company fails to do so, the same shall be considered a default under the provisions of Article XVI(a)(2) hereof. In the event the Power Company fails 11 to cure such default in accordance with the provisions of said subparagraph, the State may give written notice to the Power Company specifying such event or events of default and stating that the State or the State's Designee will, at the expense of the Power Company, cure such default by taking such appropriate actions as it deems reasonably necessary. Upon the completion of such work, the Power Company shall reimburse the State for its costs and expenses in connection therewith within thirty (30) days after receipt of a notice therefor from the State, together with reasonable documentation supporting its costs and expenses. (m) To remove the Transmission System to the reasonable satisfaction of the State not later than twelve (12) months after the termination or expiration of this Agreement, provided, however, the ground wires, the structure foundations and the additions to the State's Structures, which are parts of the Transmission System and other parts of it that the State agrees may remain, shall be abandoned in place by the Power Company and will thereafter be the property of the State. If the Power Company is in default of performing these obligations under Article XVI hereof, the Power Company shall reimburse the State or State's Designee for the expense to remove the Transmission System from its structures if the Power Company fails to remove the same within said twelve (12) months after the termination of this Agreement. (n) To permit the State to repair, maintain, replace, inspect and remove, from time to time, at its own expense, and without expense to the Power Company, the attachments and facilities of the State that are now attached to the Power Company's independent structures located within the Use Area pursuant to this Agreement (the "State's Facilities"). Notwithstanding any other provisions in this Agreement to the contrary, the obligations of the Power Company to repair, maintain, replace, relocate or remove any of its facilities that have State Facilities attached thereto will be subject to the prior obligation of the State or the State's 12 Designee to remove or relocate, as appropriate, its facilities at its expense, and any delay in the State's or the State's Designee's completion of its work will be deemed to extend the period of time within which the Power Company is obligated to complete its work by a period of time that is equal to the period of delay in the completion of the State's work. Any additions by the State or the State's Designee to the structures of the Power Company that are made after the date hereof shall only be made after a written request therefor is submitted to the Power Company and a permit therefor is issued by the Power Company to the State containing such terms, charges and conditions that are mutually acceptable to the State and the Power Company. (o) To secure and maintain for the duration of this Agreement, including any supplements thereto and all renewals thereof, if any, with the State and the State's Designee being named additional insured parties, the following minimum insurance coverages regarding the Use Area at no cost to the State or the State's Designee. Each insurance policy shall state that the insurance company or companies shall agree to investigate and defend the insured against all claims for damages, even if groundless. In the event the Power Company secures excess/umbrella liability insurance to meet the minimum requirements specified in paragraphs (i) and/or (ii) below, the State and the State's Designee shall be named as additional insureds. (i) Commercial General Liability Insurance, including Contractual Liability Insurance, providing for a total limit of not less than One Million Dollars ($1,000,000) for all damages arising out of bodily injuries to or death of all persons in any one accident or occurrence, and for all damages arising out of injury to or destruction of property in any one accident or occurrence, and, subject to that limit per accident, a total (or aggregate) limit of Two Million Dollars ($2,000,000) for all damages arising out of bodily injuries to or death of all 13 persons in all accidents or occurrences and out of injury to or destruction of property during the policy period. (ii) The operation of all motor vehicles, including those hired or borrowed, used by the Power Company and its subcontractors in connection with this Agreement, shall be covered by automobile liability insurance providing for a total limit of One Million Dollars ($1,000,000.00) for all damages arising out of bodily injuries to or death of all persons in any one accident or occurrence, and for all damages arising out of injury to or destruction of property in any one accident or occurrence. In cases where an insurance policy shows an aggregate limit as part of the automobile liability coverage, the aggregate limit must be at least Two Million Dollars ($2,000,000.00). (iii) With respect to all operations the Power Company performs under this Agreement, and all those performed for the Power Company by subcontractors, the Power Company and subcontractors shall carry workers' compensation insurance, and, as applicable, insurance required in accordance with the U.S. Longshore and Harbor Workers' Compensation Act, in accordance with the requirements of the laws of the State of Connecticut, and of the laws of the United States, respectively. In conjunction with the above coverage(s), the Power Company agrees to furnish to the State on the form or forms supplied by the State, a Certificate of Insurance (CON-32), fully executed by an insurance company or companies satisfactory to the State, for the insurance policy or polices required hereinabove, which policy or policies shall be in accordance with the terms of said Certificate of Insurance. For the workers' compensation insurance and, as applicable, U.S. 14 Longshore and Harbor Workers' Compensation Act coverage, the policy number(s) and term of the policy(ies) shall be indicated on the CON-32. While the Transmission System is being constructed, altered, relocated, maintained, replaced, repaired, reconstructed or removed from the Use Area, the Power Company shall carry, with respect to the operations it or its subcontractors perform under this Agreement, Railroad Protective Liability Insurance for and on behalf of the State's Designee as named insured, and the State named as additional insured, providing for coverage limits of (1) not less than Two Million Dollars ($2,000,000.00) for all damages arising out of any one accident or occurrence, in connection with bodily injury or death and/or injury to or destruction of property; and (2) subject to this limit per accident, a total (or aggregate) limit of Six Million Dollars ($6,000,000.00) for all injuries to persons or property during the policy period. The Power Company shall obtain and submit the minimum coverage indicated above to the State prior to the commencement of such installation, construction, alteration, replacement, repair, relocation, reconstruction, maintenance and/or removal of its facilities from the right-of-way and shall maintain said coverage until such work and/or activities are completed. Proof of such insurance shall be provided on a CON-32 form. The Power Company shall have the right to self-insure portions of the foregoing insurance requirements up to those limits that it determines, from time to time, to be acceptable to it, provided that said self-insurance limits apply to substantially all properties then owned or leased by the Power Company. ARTICLE IV. OBLIGATIONS OF THE STATE ------------------------ The State agrees: 15 (a) To permit (i) the construction, installing, repairing, maintaining, replacing, reconstructing, relocating, inspecting and removing of any portions of the Transmission System undertaken from time to time by the Power Company to proceed as rapidly as conditions will permit, including without limit, arranging to have the State's Designee cooperate in such efforts, and (ii) the Power Company to patrol the Transmission System. (b) To use its best endeavors to allow the proper and uninterrupted service of the Transmission System at all times consistent with the operating requirements of the railroad, it being understood that any interruption of such service may seriously affect the Power Company's ability to furnish electric current to its customers and that it is of the utmost importance to the Power Company that any interruptions or outages be minimized so far as possible. (c) To permit representatives of the Power Company, while accompanied by a representative of the State or State's Designee, at mutually convenient times, once during the spring and once during the fall of each year, to visually inspect the insulators upon those portions of the Transmission System carried upon the State's Structures; provided, however, that the State or State's Designee shall not be responsible for the wages or salary of the Power Company's representative(s); and provided further that the Power Company agrees to indemnify and hold harmless the State from and against any and all claims, demands, suits, or judgments, on account of injury to or death of any representative of the Power Company during or resulting from any of such inspections. (d) To permit representatives of the Power Company, but without expenses to the State or State's Designee and subject to approval of the State or State's Designee as to time and method, to patrol, inspect, test and repair those portions of the Transmission System not carried upon the State's Structures, and any independent structures upon which such portions may be 16 carried, and for the purpose of such patrolling, inspecting, testing and repairing, representatives of the Power Company shall have the right to pass and repass over and upon property of the State; provided however, that the Power Company agrees to indemnify and hold harmless the State and State's Designee from and against any and all claims, demands, suits or judgments, on account of injury to or death of any representative of the Power Company during or resulting from such patrolling, inspecting, testing and repairing. (e) To keep in repair and in good condition during the continuance of this Agreement the State's Structures which shall support the Transmission System, at no expense to the Power Company, except the additions to the State's Structures made necessary by the installation of the Transmission System and except such new structures as may be erected by the Power Company and used solely for the support of the Transmission System. (f) To permit the removal of the Transmission System, except ground wires, from the State's Structures and the removal of independent structures erected by the Power Company if such removal takes place not later than twelve (12) months after termination or expiration of this Agreement. (g) To hereafter not grant permission or rights to any third person, firm or corporation to perform any acts or to construct or place any structures over, under or upon the Use Area until it shall have first notified and received the written approval of the Power Company, which approval shall not be withheld unless, in the reasonable opinion of the Power Company, the exercise of any such permission or rights will endanger or interfere with the construction, reconstruction, operation or maintenance of any part of the Transmission System, whether or not erected or constructed at the time such approval is requested. 17 (h) To hereafter not grant permission or rights to any third person, firm or corporation that will endanger or unduly interfere with the construction, reconstruction, operation or maintenance of any part of the State's transportation rail system or the Transmission System. ARTICLE V. APPROVAL -------- (a) The design, specifications, construction and installation of future modifications to the Transmission System, any Connecting Lines and the supporting structures; modification of existing supporting structures hereafter used or made; all apparatus, including circuit breakers, switches, transformers and other facilities used or to be used in making additional connections referred to in Article I; all future changes in the Transmission System, its supporting structures and connecting apparatus; and the location of connections and of any independent supporting structures, shall be subject to approval by the State or State's Designee in all respects prior to installation and construction of same. (b) Approval of the State or State's Designee shall not be required with respect to any such apparatus installed, or any such changes in the Transmission System made, on property other than property used in the operation of the railroad except with respect to such apparatus or changes as may affect fault currents or protection of the Transmission System or the telephone, fiber optics, signal, power or other facilities of the State. (c) All work shall be done without material interference with railroad operations and by such methods and at such times as may be mutually and reasonably agreed upon by the parties hereto. Before any work is undertaken by the Power Company, it shall submit to and secure the approval of the State or State's Designee of the plan and method of doing the work to insure the safety of the State's Structures and operations. 18 (d) Wherever in this Agreement reference is made to or provision for the approval by the State or State's Designee of the Transmission System or any part thereof or any other approval by the State or State's Designee is required, it is understood and agreed that such approval shall not be unreasonably withheld, but it is agreed that the safety of train operation is paramount and that the State or State's Designee shall be the sole judge with reference to all construction procedures applicable to work by the Power Company under this Agreement. When approval is given by the State or State's Designee or by a person designated from time to time by the State or State's Designee, in writing, to the Power Company as its representative, such approval shall be final and conclusive upon the State or State's Designee. ARTICLE VI. EXPENSES -------- (a) When referring to expenses incurred by the State or the State's Designee, "expenses" shall mean all direct expenses incurred by the State or the State's Designee, including amounts paid to subcontractors, materials and labor costs, expenses for supervision and inspection to the extent hereinbefore provided, train protection, de-energizing and grounding of railroad circuits, field or office engineering work, use of trains, tools and other equipment and facilities, transportation of men and equipment, and the overheads covering expenses not directly allowable i.e., Railroad Retirement and Unemployment Taxes, Vacation Allowance, Holiday Allowance, Health Welfare Allowance, 10% Supervision of Labor, including vacation and holidays, and 15% of materials to cover handling, provided however, such costs, expenses and overheads will be substantially the same as those charged from time to time by the State or the State's Designee to other parties under similar circumstances. 19 (b) The State or the State's Designee shall render a statement of the expenses incurred for each month in which such expenses are incurred, which shall be payable by the Power Company not later than fifteen (15) business days after receipt of such statement by the Power Company. (c) The State or the State's Designee agrees to consult, advise and provide information to the Power Company before incurring any substantial expense which may be chargeable to the Power Company, and before making any substantial changes under the provisions of the Agreement which will necessitate changes in the Transmission System at the expense of the Power Company. ARTICLE VII. TERM ---- (a) The term of this Agreement is hereby extended for an additional period of thirty (30) years from May 5, 2000 to May 4, 2030 (the "30-Year Term"). (b) In addition, the term of this Agreement will be automatically extended for up to two (2) successive renewal periods of fifteen (15) years each (the "Extended Term"), unless, at least eighteen (18) months prior to the expiration of the 30-Year Term, or any successive renewal period thereof, the Power Company shall have given to the State written notice of its election to reject the pending automatic renewal of this Agreement, in which case, upon the expiration of the 30-Year Term or the relevant successive renewal period, the term of this Agreement shall cease and terminate. If the Power Company does not give such notice of rejection, then, upon the expiration of the 30-Year Term or the initial renewal period, the term of this Agreement shall be automatically renewed and extended for a further term of fifteen (15) years commencing upon the expiration of the 30-Year Term or the then expiring renewal period, under the same covenants, 20 agreements, terms, conditions, limitations, exceptions and reservations contained in this Agreement, except as to rent which will be governed by the relevant provisions of Article III hereof. ARTICLE VIII. TITLE ----- Title to the Transmission System and to the Connecting Lines, if any, shall be and remain in the name of the Power Company. Title to additions to the State's Structures and to independent structures erected by the Power Company on the property of the State shall be and remain in the name of the Power Company, but at the end or termination of this Agreement, title to such additions and structures shall pass to the State with the State's written permission and acceptance. Title to the State's Facilities shall be and always remain in the name of the State. ARTICLE IX. WAIVER AND INDEMNITY -------------------- It is understood between the parties hereto that the operation of the railroad by the State or State's Designee in close proximity to the Transmission System involves some risk to the Transmission System and the Power Company hereby releases and waives any right to ask for, demand or receive damages from the State or the State's Designee for or on account of loss of or injury to the Transmission System, including the loss of or interference with service, and whether attributable to the fault, or negligence of the State or State's Designee or its representatives, or otherwise. Power Company agrees to indemnify, protect and save harmless the State or State's Designee from and against all cost or expense resulting from any and all loss or damage to the property of the State or State's Designee and from any and all loss of life or property, or injury or 21 damage to the person or property of any third person, firm or corporation (including the officers, agents and employees of either party hereto), and from any and all claims, demands or actions for such loss, injury or damage directly or indirectly caused by the presence or use or the construction, installation, maintenance, removal, change or relocation and subsequent removal of the Transmission System and appurtenances thereto, excepting such loss, damage or injury as shall be due solely to the negligence of the agents or servants of the State or State's Designee. ARTICLE X. FUTURE CHANGES -------------- (a) The Power Company agrees to make, or cause to be made, such changes in its Transmission System, including without limit, the additions to the State's Structures, and the independent structures erected by Power Company, as may be required from time to time to conform to changes in railroad facilities with which the location of the Transmission System may interfere, provided that (i) such changes are in compliance with the applicable provisions of the National Electric Safety Code and (ii) except as hereafter set forth in subparagraph (b), such changes shall be made without cost or expense to the Power Company, including without limit, the Power Company shall not be liable for any cost or expense of such changes resulting from the desire or need of the State to repair, replace or reconstruct the State's Structures; place or permit others to place additional wires on the State's Structures or in any other way alter or increase its use of the State's Structures; even though any of the foregoing might have been more easily and economically accomplished were it not for the existence of the Power Company's Transmission System. (b) Notwithstanding the provisions of the foregoing subparagraph (a), the Power Company and the State will share on an equal basis the costs for one relocation of the Transmis- 22 sion System at the Devon Bridge over the Housatonic River, the new Fairfield Railroad Station at Black Rock, and the new railroad station in Orange/West Haven, provided (i) the State will provide, on its property, all temporary rights and locations for the Power Company's overhead and underground electric facilities during each relocation of the Transmission System; (ii) the State will be solely responsible for the costs of relocating, rebuilding or restoring railroad facilities without any sharing or reimbursement from the Power Company; and (iii) the cost to be shared by the Power Company and State will be net of any federal reimbursement or assistance. (c) It is understood and agreed that the Power Company, with the approval of the State, may from time to time make such changes in the Transmission System as it may deem necessary or advisable in view of changes or improvements in the methods or technique of transmitting electrical current or to keep abreast of changes in the art, provided changes do not exceed the voltages permitted from time to time under Articles I and II of this Agreement. (d) If the State should hereafter propose to permanently abandon the use of its structures in the Use Area for the purpose of supporting any wires other than the Transmission System, it shall give the Power Company at least two (2) years prior written notice of such proposed abandonment, which written notice shall state the date of such proposed abandonment. In the event of such abandonment, from and after the date stated in such written notice, if this Agreement shall then be in effect, the Power Company shall cease to have the right to use, for the support of Power Company's transmission system, the structures of the State theretofore used by the State or State's Designee in the operation of its railroad provided, however, that if and so long as the continued use of such structures by the Power Company shall not interfere with the operations of the railroad, the Power Company may continue to use such structures upon 23 the assumption by the Power Company or as otherwise agreed, to of all of the duties theretofore imposed on the State with respect to repairing and keeping in good condition such structures. In the event of such abandonment, if this Agreement shall then be in effect, all of the rights, powers and privileges granted to the Power Company under the provisions of this Agreement (including, but without limitation, the right to erect new supporting structures for the Transmission System and the right to place the Transmission System underground) shall continue in full force and effect, and thereupon; (1) Rent payable under the provisions of this Agreement shall be revised to such lesser amount as shall be agreed upon by the parties hereto based upon the changed use of the property of the State by the Power Company or upon the changed obligations and duties of the respective parties hereunder, or both, as the case may be; (2) The State and State's Designee shall be released from its obligations under the provisions of Sections (c) and (e) of Article IV and said provisions shall be of no further force or effect; (3) The Power Company shall have the right, but without expense to the State and State's Designee, and subject to the approval of the State as to time and method, to patrol, inspect, test and repair the Transmission System, the structures, if any, which it may have erected or may erect to support such system and the State's Structures, if at that time the Power Company has the right to continue to use such structures, and for the purpose of such patrolling, inspecting, testing and repairing, 24 representatives of the Power Company shall have the right to pass and repass over and upon property of the State; (4) The Power Company, without expense to the State and State's Designee, will remove the Transmission System (except for buried ground wires and foundations and those parts thereof which the State agrees need not be removed) from the structures of the State when and if the Power Company, under the provisions of this Section (d), shall cease to have the right to use such State's Structures; (5) Such other provisions of this Agreement, including, but not limited to, Article IX, as may be inconsistent with the provisions of this Section (d), shall be modified and revised insofar as may be necessary in such manner as may be agreed upon by the parties hereto; (6) If the parties shall not agree as to the amount of rent payable by the Power Company under the provisions of the foregoing Paragraph (1) or as to any other matter arising under the provisions of this Section (d), the parties shall attempt to resolve such matters in accordance with the provisions of Article XIV; (7) If the Power Company should hereafter propose to permanently abandon any of its independent structures on which the State's Facilities are located, it shall give the State at least two (2) years prior written notice of such proposed abandonment stating the date of such proposed abandonment, which shall not be prior to May 4, 2030. 25 (e) In the event of such abandonment, from and after the date stated in such written notice, the State shall cease any longer to have the right to use the Power Company's independent structures for the support of the State's Facilities; provided, however, that (i) if this Lease shall then be in effect and (ii) if and so long as the continued use of the Power Company's independent structures by the State shall not interfere with the operation of the Transmission Line, the State may continue to use such independent structures upon the assumption by it, or as otherwise agreed to, of all of the duties of the Power Company to repair, keep such structures in good condition and remove the same upon the termination of this Agreement. ARTICLE XI. INDUCTIVE INTERFERENCE AND HAZARD TO RAILROAD FACILITIES -------------------------------------------------------- The Power Company agrees that the telephone, telegraph, fiber optics, power or other facilities of the State and State's Designee within the Use Area shall be protected against inductive interference or physical hazard and damage, or both, brought about by physical or operational changes to the Transmission System made after the date of this Agreement, and further agrees that, after consultation between the State, the State's Designee and Power Company, such changes shall be made, at the expense of the Power Company, in the Transmission System including additional transposition, or in said facilities as may be necessary to eliminate any such inductive effects or physical hazard and damage or both to said facilities. ARTICLE XII. COOPERATION ----------- The State agrees that its engineers and the State's Designee will cooperate with such engineers and contractors that the Power Company may from time to time employ in connection with the installation, construction, maintenance, repair or reconstruction of the Transmission 26 System, and any Connecting Lines, so as to secure the best and most satisfactory results for both parties hereto. ARTICLE XIII. ASSIGNMENT ---------- The Power Company shall not assign this Agreement without the written consent of the State, provided that this shall not be construed to prevent the Power Company from making a general mortgage in the usual form of any or all of its property, rights, privileges and franchises, including this Agreement, or from entering into any merger or consolidation, or from selling all or substantially all of its transmission assets to another entity, and in case of foreclosure of such mortgage or of any such merger, consolidation or sale, the rights and obligations of the Power Company hereunder shall pass to and be acquired and assumed by the foreclosing mortgagee, or the merging, consolidated or purchasing company, as the case may be, provided all governmental approvals necessary for such merger, consolidation or purchase have been obtained, including without limit, any such necessary approvals from the Department of Public Utility Control and/or the Federal Energy Regulatory Commission. The State and its successors in interest shall have the right to assign this Agreement as part of a sale by the State of the Use Area, subject to all of the obligations, duties, agreements and approvals of the State hereunder. ARTICLE XIV. DISPUTE RESOLUTION ------------------ The State, the State's Designee and the Power Company shall attempt to resolve all controversies or disputes arising under this Agreement through negotiations pursued diligently in good faith. As part of this obligation, each party will submit each controversy or dispute, except 27 on-site construction disputes that require a prompt resolution, to a member of each party's management team (defined to be at the Manager's level or above for the Power Company and at the Rail Administrator level or above for the State and the State's Designee). ARTICLE XV. APPRAISAL --------- The appraisal process to determine the Base Rent for renewal periods shall be started at least eighteen (18) months prior to the anticipated effective date of such renewal. The appraisal process will be conducted as follows: (a) The Power Company will designate an appraiser and the State will designate an appraiser. Each appraiser acting independently of the other will express, in writing, his opinion of the fair market rent and the State and the Power Company will exchange copies of the appraisals. If the appraisers determine values that are within ten percent (10%) of each other, the average of the two appraisals will be deemed to be the fair market rent. If the appraisals differ by more than ten percent (10%), the Power Company and the State will try to resolve the divergence of opinion by mutual negotiations conducted in good faith. (b) All appraisers must be State certified general appraisers, must be recognized as competent in the field as an appraiser for the purpose of establishing such values and must be either on the State or Power Company lists of approved appraisers or otherwise acceptable to both the Power Company and the State. (c) For the purposes of the appraisals, the premises leased herein shall be deemed to consist of two air rights corridors, one of which is located on the north side of the railroad tracks, and the other of which is located on the south side of the railroad tracks. The width and location 28 of each of these corridors for purposes of the appraisals will be as shown on Power Company drawings. (d) Each appraisal shall determine a fee value for the land of the State that is included in this Agreement, based on the assumption that the abutting zoning also applies to said State land. A percentage, to be determined by the appraiser, will be applied to the resulting fee value to reflect the current value of the rights in the two corridors. An appropriate rate of return, also to be determined by the appraiser, will then be applied to said current value of the rights to then determine the annual fair market rent. (e) Each appraisal shall also express an annual fair market rent, as so determined, per linear foot of Connecting Line, which will be used for the purpose of any rent computations under subparagraph (g) of Article III of this Agreement. (f) Each appraiser shall be given the same scope of work and the requisite maps, drawings and other pertinent information or data. It is contemplated that each appraiser will complete his work within six (6) months after the receipt of the foregoing. ARTICLE XVI. DEFAULTS -------- (a) Each of the following shall be deemed to be a default by the Power Company hereunder: (1) The Power Company's failure to make due and punctual payment of any rents payable under this Agreement when and as the same shall become due and payable, and such default in payment continues for a period of thirty (30) days after written notice thereof from the State to the Power Company; or 29 (2) The Power Company's failure in the performance of or compliance with any of its obligations under the covenants, agreements, terms, or provisions contained in this Agreement, other than those referred to in the foregoing subsection (1), and such default continues for a period of ninety (90) days after written notice thereof from the State to the Power Company, except that in connection with a default that is not susceptible of being cured with due diligence within ninety (90) days, the time the Power Company has to cure the same shall be extended for such time as may be necessary to cure the same with all due diligence, provided the Power Company commences promptly and proceeds diligently to cure the same; and (3) The issuance of a lien (other than the lien of any mortgage as referred to in Article XIII hereof) or attachment, arising out of acts of the Power Company, against the State to the extent the same encumbers the premises leased herein, unless (i) the same shall be vacated, bonded or otherwise discharged within one hundred eighty (180) days from the date the Power Company receives notice thereof or (ii) within said period of one hundred eighty (180) days, the Power Company commences an action to vacate or remove the same and thereafter proceeds diligently with said action. Then and in any such event, the State may, while such default is continuing, give written notice to the Power Company specifying such event or events of default and stating that this Agreement shall expire and 30 terminate on the date specified in such notice, which date shall be not less than ninety (90) days after the giving of such notice, unless the Power Company has cured such default or defaults prior to the date specified in such notice, and this Agreement shall expire and terminate. (b) If the State defaults in the performance of or compliance with any of its obligations under the covenants, agreements, terms or provisions contained in this Agreement and such default continues for a period of ninety (90) days after written notice thereof from the Power Company to the State, except that in connection with a default that is not susceptible of being cured with due diligence within ninety (90) days, the time the State has to cure the same shall be extended for such time as may be necessary to cure the same with all due diligence, provided the State commences promptly and proceeds diligently to cure the same. If any default is not so cured, the Power Company may, while such default is continuing, give written notice to the State specifying such event or events of default and stating that the Power Company will, at the expense of the State, cure such default by taking such appropriate actions as it deems reasonably necessary. Upon the completion of such work, the State shall reimburse the Power Company for its costs and expenses in connection thereof within thirty (30) days after receipt of a notice therefor from the Power Company, together with reasonable documentation supporting its costs and expenses. In the event of a dispute regarding such reimbursement, the parties shall negotiate diligently in good faith pursuant to Article XIV. ARTICLE XVII. NOTICE ------ It is mutually understood and agreed by the parties hereto that any official notice from one such party to the other such party, in order for such notice to be binding thereon, shall: 31 (a) be in writing addressed to: (1) when the State is to receive such notice - Commissioner of Transportation Connecticut Department of Transportation P. O. Box 317546 Newington, Connecticut 06131-7546; (2) when the Power Company is to receive such notice - The United Illuminating Company 157 Church Street P.O. Box 1564 New Haven, Connecticut 06506-0901 Attention: Its President and Chief Operating Officer (b) be delivered in person or be mailed United States Postal Service "Certified Mail - Return Receipt Requested" to the address recited herein as being the address of the party to receive such notice, at which time said notice shall be deemed to have been received; and (c) contain complete and accurate information in sufficient detail to properly and adequately identify and describe the subject matter thereof. The term "official notice", as used herein, shall be construed to include, but not be limited to, any request, demand, authorization, direction, waiver, and/or consent of the party as well as any document(s) provided, permitted, or required for the making or ratification of any change, revision, addition to or deletion from this Lease. Further, it is understood and agreed that nothing hereinabove contained shall preclude the parties hereto from subsequently agreeing, in writing, to designate alternate persons (by name, title, and affiliation) to which such notice(s) is(are) to be addressed; alternate means of conveying such notice(s) to the particular party; and/or alternate locations to which the delivery of such notice(s) is(are) to be made, provided such subsequent agreement(s) is(are) concluded pursuant hereto. 32 ARTICLE XVIII. QUIET ENJOYMENT --------------- If and so long as the Power Company pays the rent due hereunder and performs and observes all of the agreements and provisions hereof that are its obligations, the Power Company shall quietly enjoy the premises and rights leased herein during the term of this Agreement. ARTICLE XIX. MISCELLANEOUS ------------- (a) The parties acknowledge that the State's Designee is not a party to this Agreement, but as long as it does not conflict with the terms and conditions of the Metro-North Service Agreement, the State shall use its best efforts to cause the State's Designee to comply with all obligations imposed on it by the terms and conditions of this Agreement, including without limit, the provisions of Article XIV as long as such provisions are in compliance with the Metro-North Service Agreement. (b) This Agreement shall inure to and be binding upon the parties hereto and their successors and assigns, but subject to the provisions of Article XIII hereof. (c) The Power Company shall record within one (1) year and give State documentation of recording this Agreement, including any supplements hereto and all renewals thereof, if any, in the land records of Fairfield, Bridgeport, Stratford, Milford, Orange, West Haven and New Haven, at no expense to the State. The recording of this Agreement by the Power Company shall be done as soon as practical (but in no event later than one year from the date of completion by the State of the following) upon delivery by the State to the Power Company of (i) this Agreement duly executed in quadruplicate by the State and (ii) written notification by the State that the Agreement has been duly executed and approved on behalf of 33 the State. Failure of the Power Company to record this Agreement as specified herein, shall be deemed to be a default hereunder and the rights of the State will be as set forth in Article XVI hereof. (d) It is further mutually understood and agreed by the parties hereto that this Agreement shall not be effective until said Agreement has been approved by the Attorney General of the State of Connecticut. (e) The Agreement, when fully executed by both parties, shall constitute the entire agreement between the parties hereto and shall supersede all previous communications, representations, or agreements, either oral or written, between the parties hereto with respect to the subject matter hereof, including without limit, the 1966 Agreement; and no agreement or understanding varying or extending the same shall be binding upon either party hereto unless in writing signed by both parties hereto; and nothing contained in the terms or provisions of this Agreement shall be construed as waiving any of the rights of the State under the laws of the State of Connecticut. (f) If any of the provisions of this Agreement, or the application thereof to any person or circumstances, shall, to any extent, be invalid or unenforceable, the remainder of this Agreement, or the application of such provision or provisions to persons or circumstances other than those as to whom or which it is held invalid or unenforceable, shall not be affected thereby, and every other provision of this Agreement shall be valid and enforceable to the fullest extent permitted by law. (g) This Agreement shall be governed in all respects by the laws of the State of Connecticut. 34 (h) This Agreement will be executed in four or more counterparts, each of which shall be deemed an original, but all of which together shall constitute but one and the same Agreement. (i) The parties hereto agree that each has played a material role in the negotiation and drafting of this Agreement and that the document shall not be construed against any party merely because of that party's role in the drafting thereof. ARTICLE XX. POWER COMPANY TERMINATION RIGHTS -------------------------------- (a) The Power Company shall have the right to terminate this Agreement during the Extended Term only, if the option to reject shall not have been exercised, at any time on at least three (3) year's prior written notice to the State. (b) The Power Company shall have the right, exercisable during the 30-Year Term and during the Extended Term, if the option to reject shall not have been exercised, at any time and from time to time on at least three (3) year's prior written notice to the State, to abandon, with respect to all or any portion of the State's Structures or land, or both, situated within the Use Area, all or any portion of the rights leased and granted to the Power Company in Article 1. In the event all of the rights leased and granted herein to the Power Company are so abandoned with respect to all the State's Structures and land that are situated within the limits designated in such notice, the annual rent payable hereunder shall be reduced by the product of the rent per linear foot then payable hereunder and the number of linear feet between such limits, such reduced rent to commence with the first quarterly payment after such abandonment and the completion of the removal of the Power Company's Transmission System as set forth below. In the event of the abandonment of a portion of such rights only with respect to designated structures or land, or 35 both, of the State, the rent payable thereafter under the provisions of this Agreement shall be revised to an amount to be agreed upon by the parties hereto, taking into consideration the rights so abandoned by the Power Company. If the parties shall not agree as to the amount of rent payable by the Power Company under the provisions of this Section (b), the parties shall attempt to resolve such matters in accordance with the provisions of Article XIV. To the extent that such partial abandonment by the Power Company involves an abandonment of its right to use, for its Transmission System, any portion or portions of the structures or land, or both, of the State, the Power Company shall thereupon remove from such State Structures or land, or both, as the case may be, to the satisfaction of the State, the portion of the Transmission System on such portion or portions of such State Structures or land, except for buried ground wires and foundations and those parts of the Transmission System which the State agrees may remain, and, if the Power Company is in default of performing these obligations under Article XVI hereof, the Power Company shall reimburse the State or State's Designee for any expenses to which the State or State's Designee may incur removing the Transmission System from such State Structures and from such portion or portions of such land. ARTICLE XXI. ATTACHMENTS ----------- Attached to this Agreement are the "Standard Railroad License Specifications & Covenants For Wire, Pipe and/or Cable Transverse Crossings and/or Longitudinal Occupations Within the Railroad Right of Way" dated October 1, 2001 (the "Specifications & Covenants"), the terms and provisions of which, as amended, are incorporated into this Agreement and hereby made a part hereof with the following changes: 36 (a) All references therein to "Facilities" and "FACILITIES" shall be deemed to mean the "Transmission System" and any Connecting Lines; and (b) All references to "Licensee" shall be deemed to mean the "Power Company". In the event of any conflict between the terms and provisions set forth in the body of this Agreement with those in the Specifications & Covenants, such conflict shall be resolved in favor of the terms and provisions in the body of this Agreement. 37 Agreement No. 5.15-99(03) --------------- IN WITNESS WHEREOF, the parties hereto have set their hands and seals as of the day and year first above written. WITNESSES: STATE OF CONNECTICUT DEPARTMENT OF TRANSPORTATION James F. Byrnes, Jr., Commissioner /s/ Elizabeth A. Mosca By: /s/ Harry P. Harris (Seal) - ----------------------------- ------------------------------- Name: Elizabeth A. Mosca Harry P. Harris Bureau Chief Bureau of Public Transportation /s/ Laurie Lint May 15, 2003 ------------------------ ------------------------------- Name: Laurie Lint Date: WITNESSES: THE UNITED ILLUMINATING COMPANY /s/ Talaine R. Fraser By: /s/ Anthony J. Vallillo (Seal) ---------------------------- ------------------------------ Name: Talaine R. Fraser Anthony J. Vallillo Its President and Chief Operating Officer /s/ Bernice L. Herring 5/06/03 ------------------------ ----------------------------- Name: Bernice L. Herring Date: 38 Agreement No. 5.15-99(03) --------------- STATE OF CONNECTICUT) ) ss. Newington May 15, A.D., 2003 COUNTY OF HARTFORD ) Personally appeared for the State, Harry P. Harris, Signer and Sealer of the foregoing Instrument and acknowledged the same to be the free act and deed of the State of Connecticut, Department of Transportation, and his free act and deed as Bureau Chief, Bureau of Public Transportation, before me. Elizabeth H. Mosca /s/ Elizabeth H. Mosca Notary Public ------------------------------- My Commission Expires Notary Public Nov. 30, 2007 My Commission Expires: STATE OF CONNECTICUT) ) ss. New Haven May 6, A.D., 2003 COUNTY OF NEW HAVEN ) Personally appeared for The United Illuminating Company, Anthony J. Vallillo, Signer and Sealer of the foregoing Instrument and acknowledged the same to be the free act and deed of The United Illuminating Company and his free act and deed as President and Chief Operating Officer, before me. /s/ Theodore R. Grave --------------------------------- Notary Public: Theodore R. Grave My Commission Expires: 9/30/06 APPROVED AS TO FORM: Attorney General Date: June 2, 2003 State of Connecticut 39 [GRAPHIC OMITTED] [GRAPHIC OMITTED] EX-14 5 uil_exh14.txt CODE OF ETHICS EXHIBIT 14 UIL HOLDINGS CORPORATION CODE OF ETHICS FOR THE CHIEF EXECUTIVE OFFICER, PRESIDENTS, AND SENIOR FINANCIAL OFFICERS PREFACE The Chief Executive Officer (CEO), the Presidents, and the Senior Financial Officers,* hold key roles in corporate governance at UIL Holdings Corporation's (UIL) and its subsidiaries. As part of the Corporate Leadership Team, they are vested with both the responsibility and authority to protect, balance, and preserve the interests of all of UIL stakeholders, including shareholders, clients, employees, suppliers, and citizens of the communities in which business is conducted. The CEO and the Presidents set the tone, and the Senior Financial Officers fulfill this responsibility by prescribing and enforcing the policies and procedures employed in the operation of the UIL's financial organization, and by demonstrating the following: I. HONEST AND ETHICAL CONDUCT The CEO, the Presidents, and the Senior Financial Officers exhibit and promote the highest standards of honest and ethical conduct through the establishment and operation of policies and procedures that: o Encourage and reward professional integrity in all aspects of the financial organization, by eliminating inhibitions and barriers to responsible behavior, such as coercion, fear of reprisal, or alienation from the financial organization or UIL itself. o Prohibit and eliminate the appearance or occurrence of conflicts between what is in the best interest of UIL and what could result in material personal gain for a member of the organization, including the CEO, the Presidents, or the Senior Financial Officers. o Provide a mechanism for members of the financial organization to inform senior management of deviations in practice from policies and procedures governing honest and ethical behavior. - -------------------- *The term "Senior Financial Officers" includes: o UIL: CFO; Treasurer; Controller; Vice President Investor Relations, Corporate Secretary, and Chief Compliance Officer; Directors of Corporate Planning, Audit Services, and Corporate Tax o The United Illuminating Company: CFO; Process Leaders of Compliance, Planning, and Supply Chain; and the Electric Systems Business Manager o American Payment Services: CFO, Controller, CellCards of Illinois Controller, Director of Planning and Analysis, and employees in the Banking organization at the Director level and above o Xcelecom: CFO, Controller, and employees at the operating entities performing the duties of Controller o United Capital Investments/United Bridgeport Energy: Manager, Capital Projects o Demonstrate their personal support for such policies and procedures through periodic communication reinforcing these ethical standards throughout the financial organization. II. FINANCIAL RECORDS AND PERIODIC REPORTS The CEO and the Presidents set the tone, and the Senior Financial Officers establish and manage UIL's transaction and reporting systems and procedures to ensure that: o Business transactions are properly authorized and completely and accurately recorded on the books and records in accordance with Generally Accepted Accounting Principles (GAAP) and established UIL financial policies. o The retention or proper disposal of company records is in accordance with established UIL financial policies and applicable legal and regulatory requirements. o Periodic financial communications and reports, including the Securities and Exchange Commission and other public communications, are delivered in a manner that facilitates the highest degree of clarity of content and meaning so that readers and users will quickly and accurately determine their significance and consequence; and disclosures are full, fair, accurate, and timely. III. COMPLIANCE WITH APPLICABLE LAWS, RULES AND REGULATIONS The CEO, the Presidents, and the Senior Financial Officers establish and maintain mechanisms to: o Educate members of the financial organization about any federal, state or local statute, regulation or administrative procedure that affects the operation of the financial organization and UIL generally. o Monitor the compliance of the financial organization with any applicable federal, state or local statute, regulation or administrative rule. o Identify, report, and correct in a swift and certain manner, any detected deviations from applicable federal, state, or local statute or regulation to the Chief Compliance Officer or to the Audit Committee. EX-23 6 uil_exh23.txt CONSENT OF INDEPENDENT AUDITORS EXHIBIT 23 PRICEWATERHOUSE COOPERS - ------------------------------------------------------------------------------- PricewaterhouseCoopers LLP 1301 Avenue of the Americas New York, NY 10019-6013 Telephone (646) 471 4000 Facsimile (646) 394 5324 CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the incorporation by reference in the Registration Statements on Forms S-8 (Nos. 333-107021, 333-107020 and 33-38890) of UIL Holdings Corporation of our reports dated January 26, 2004 relating to the financial statements and the financial statement schedule, which appears in this Form 10-K. /s/ PricewaterhouseCoopers LLP Stamford, Connecticut February 27, 2004 EX-31 7 uil_exh31-1.txt CERTIF SEC 302 OF THE SARBANES-OXLEY ACT OF 2002 EXHIBIT 31.1 CERTIFICATION I, Nathaniel D. Woodson, certify that: 1. I have reviewed this annual report on Form 10-K of UIL Holdings Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: March 1, 2004 /s/ Nathaniel D. Woodson ------------------------------------- Nathaniel D. Woodson Chairman of the Board of Directors, President and Chief Executive Officer EX-31.2 8 uil_exh31-2.txt CERTIF SEC 302 OF THE SARBANES-OXLEY ACT OF 2002 EXHIBIT 31.2 CERTIFICATION I, Louis J. Paglia, certify that: 1. I have reviewed this annual report on Form 10-K of UIL Holdings Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: March 1, 2004 /s/ Louis J. Paglia ---------------------------- Louis J. Paglia Executive Vice President and Chief Financial Officer EX-32 9 uil_exh32.txt CERTIF SEC 906 OF THE SARBANES-OXLEY ACT OF 2002 EXHIBIT 32 CERTIFICATION OF PERIODIC FINANCIAL REPORT ------------------------------------------ Pursuant to 18 U.S.C. 1350, the undersigned, Nathaniel D. Woodson and Louis J. Paglia, the chief executive officer and chief financial officer, respectively, of UIL Holdings Corporation (the "issuer"), do each hereby certify that the report on Form 10-K to which this certification is attached as an exhibit (the "report") fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m or 78o(d)) and that information contained in the report fairly presents, in all material respects, the financial condition and results of operations of the issuer. /s/ Nathaniel D. Woodson - ---------------------------------------------------- Nathaniel D. Woodson Chairman of the Board of Directors, President and Chief Executive Officer (chief executive officer) UIL Holdings Corporation March 1, 2004 /s/ Louis J. Paglia - ---------------------------------------------------- Louis J. Paglia Executive Vice President and Chief Financial Officer (chief financial officer) UIL Holdings Corporation March 1, 2004 -----END PRIVACY-ENHANCED MESSAGE-----