UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-Q
For the quarterly period ended
September 30, 2001
Commission File No. 1-6407
SOUTHERN UNION COMPANY
(Exact name of registrant as specified in its charter)
Delaware 75-0571592
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
504 Lavaca Street, Eighth Floor 78701
Austin, Texas (Zip Code)
(Address of principal executive offices)
Registrant's telephone number, including area code: (512) 477-5852
Securities Registered Pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange in which registered
------------------- -----------------------------------------
Common Stock, par value $1 per share New York Stock Exchange
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
----- -------
The number of shares of the registrant's Common Stock outstanding on November 5,
2001 was 52,145,009.
SOUTHERN UNION COMPANY AND SUBSIDIARIES
FORM 10-Q
September 30, 2001
Index
PART I. FINANCIAL INFORMATION Page(s)
-------
Item 1. Financial Statements
Consolidated statements of operations - three and
twelve months ended September 30, 2001 and 2000 2-3
Consolidated balance sheet - September 30, 2001 and
2000 and June 30, 2001 4-5
Consolidated statement of stockholders' equity -
three months ended September 30, 2001 and twelve
months ended June 30, 2001 6
Consolidated statements of cash flows - three and
twelve months ended September 30, 2001 and 2000 7-8
Notes to consolidated financial statements 9-19
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 20-27
Item 3. Quantitative and Qualitative Disclosures about
Market Risk 27
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
(See "COMMITMENTS and CONTINGENCIES" under
Notes to Consolidated Financial Statements) 16-19
Item 6. Exhibits and Reports on Form 8-K
Reports on Form 8-K
Date
Filed Description of Filing
---------- --------------------------------------------
07/17/01 Announcement of "Cash-Flow Improvement Plan"
to increase annualized pre-tax cash flow
from operations by at least $50 million by
the end of fiscal year 2002.
08/09/01 Announcement of operating performance for
the quarter and year ended June 30, 2001
and 2000 and filing, under Item 9, summary
statements of income of the Company for
the quarter and year ended June 30, 2001
and 2000 (unaudited) and notes thereto.
--------------------------------------------------------------------------------
1
SOUTHERN UNION COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
Three Months Ended September 30,
2001 2000
------------ ------------
(thousands of dollars, except
shares and per share amounts)
Operating revenues.......................... $ 173,969 $ 144,468
Cost of gas and other energy................ (92,987) (84,533)
Revenue-related taxes....................... (6,032) (5,079)
------------ ------------
Operating margin......................... 74,950 54,856
Operating expenses:
Operating, maintenance and general....... 53,104 37,017
Business restructuring charges........... 32,706 --
Depreciation and amortization............ 21,877 15,966
Taxes, other than on income and
revenues.............................. 8,309 4,860
------------ ------------
Total operating expenses........... 115,996 57,843
------------ ------------
Net operating loss................. (41,046) (2,987)
------------ ------------
Other income (expenses):
Interest ................................ (27,159) (16,306)
Dividends on preferred securities of
subsidiary trust...................... (2,370) (2,370)
Other, net............................... 23,596 (5,513)
------------ ------------
Total other expenses, net.......... (5,933) (24,189)
------------ ------------
Loss before income tax benefit and
change in accounting principle.. (46,979) (27,176)
Federal and state income tax benefit........ (16,576) (12,600)
------------ ------------
Loss before change in accounting principle.. (30,403) (14,576)
Change in accounting principle, net of tax.. -- 602
------------ ------------
Net loss attributable to common stock....... $ (30,403) $ (13,974)
============ ============
Net loss per share:
Basic:
Before change in accounting principle. $ (.58) $ (.28)
Change in accounting principle, net
of tax............................. -- .01
------------ ------------
$ (.58) $ (.27)
============ ============
Diluted:
Before change in accounting principle. $ (.58) $ (.28)
Change in accounting principle, net
of tax ............................ -- .01
------------ ------------
$ (.58) $ (.27)
============ ============
Weighted average shares outstanding:
Basic................................... 52,424,847 51,018,217
============ ============
Diluted................................. 52,424,847 51,018,217
============ ============
See accompanying notes.
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2
SOUTHERN UNION COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
Twelve Months Ended September 30,
2001 2000
------------ ------------
(thousands of dollars, except
shares and per share amounts)
Operating revenues........................ $ 1,962,314 $ 891,387
Cost of gas and other energy.............. (1,383,203) (542,955)
Revenue-related taxes..................... (69,755) (36,010)
------------ ------------
Operating margin....................... 509,356 312,422
Operating expenses:
Operating, maintenance and general..... 255,639 148,342
Business restructuring charges......... 32,706 --
Depreciation and amortization.......... 89,897 60,257
Taxes, other than on income and
revenues............................ 33,309 18,504
------------ ------------
Total operating expenses......... 414,551 227,103
------------ ------------
Net operating revenues........... 94,805 85,319
------------ ------------
Other income (expenses):
Interest .............................. (114,372) (59,434)
Dividends on preferred securities of
subsidiary trust.................... (9,480) (9,480)
Other, net............................. 105,928 (14,064)
------------ ------------
Total other expenses, net........ (17,924) (82,978)
------------ ------------
Earnings before income taxes and
change in accounting
principle..................... 76,881 2,341
Federal and state income taxes............ 36,025 972
------------ ------------
Earnings before change in accounting
principle.............................. 40,856 1,369
Change in accounting principle, net of
tax.................................... -- 602
------------ ------------
Net earnings available for common stock... $ 40,856 $ 1,971
============ ============
Net earnings per share:
Basic:
Before change in accounting
principle........................ $ .78 $ .03
Change in accounting principle, net
of tax........................... -- .01
------------ ------------
$ .78 $ .04
============ ============
Diluted:
Before change in accounting
principle........................ $ .74 $ .03
Change in accounting principle, net
of tax .......................... -- .01
------------ ------------
$ .74 $ .04
============ ============
Weighted average shares outstanding:
Basic.................................. 52,427,252 49,818,381
============ ============
Diluted................................ 55,469,754 52,063,738
============ ============
See accompanying notes.
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3
SOUTHERN UNION COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
ASSETS
September 30, June 30,
-----------------------
2001 2000 2001
---------- ---------- ----------
(thousands of dollars)
Property, plant and equipment:
Plant in service.................. $2,201,146 $2,129,828 $2,201,975
Construction work in progress..... 27,523 28,100 25,520
---------- ---------- ----------
2,228,669 2,157,928 2,227,495
Less accumulated depreciation and
amortization................... (784,713) (732,097) (771,170)
---------- ---------- ----------
Net property, plant and
equipment................ 1,443,956 1,425,831 1,456,325
---------- ---------- ----------
Current assets:
Cash and cash equivalents......... -- 2,690 1,219
Accounts receivable, billed and
unbilled, net.................. 139,148 109,524 218,912
Inventories, principally at
average cost................... 173,729 119,497 106,505
Deferred gas purchase costs....... 65,582 23,849 65,171
Investment securities available
for sale....................... 8,052 288,628 29,447
Prepayments and other............. 54,895 33,480 14,778
---------- ---------- ----------
Total current assets........ 441,406 577,668 436,032
Goodwill, net........................ 721,252 723,971 724,620
Deferred charges..................... 161,315 229,724 209,644
Investment securities, at cost....... 19,226 7,608 19,081
Real estate.......................... 2,474 11,018 2,506
Other................................ 39,267 32,348 41,872
---------- ---------- ----------
Total............................. $2,828,896 $3,008,168 $2,890,080
========== ========== ==========
See accompanying notes.
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4
SOUTHERN UNION COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET (Continued)
STOCKHOLDERS' EQUITY AND LIABILITIES
September 30, June 30,
-----------------------
2001 2000 2001
---------- ---------- ----------
(thousands of dollars)
Common stockholders' equity:
Common stock, $1 par value;
authorized 200,000,000 shares;
issued 54,667,917 shares....... $ 54,668 $ 51,904 $ 54,553
Premium on capital stock.......... 677,206 625,455 676,324
Less treasury stock, 1,152,036
shares at cost................. (18,055) (15,554) (15,869)
Less common stock held in Trust... (18,502) (17,364) (19,196)
Deferred compensation plans....... 7,499 858 7,499
Accumulated other comprehensive
income......................... (57) 181,257 13,443
Retained earnings (deficit)....... (25,300 (13,974) 5,103
---------- ---------- ----------
Total common stockholders'
equity......................... 677,459 812,582 721,857
Company-obligated mandatorily redeem-
able preferred securities of sub-
sidiary trust holding solely sub-
ordinated notes of Southern Union. 100,000 100,000 100,000
Long-term debt and capital lease
obligation........................ 842,866 1,325,105 1,329,631
---------- ---------- ----------
Total capitalization.............. 1,620,325 2,237,687 2,151,488
Current liabilities:
Long-term debt and capital lease
obligation due within one year. 490,470 8,004 5,913
Notes payable..................... 193,000 135,453 190,600
Accounts payable.................. 90,025 104,451 103,623
Federal, state and local taxes.... 13,767 7,493 32,342
Accrued interest.................. 16,540 19,654 16,105
Accrued dividends on preferred
securities of subsidiary trust. 2,370 2,370 2,370
Customer deposits................. 20,180 21,080 20,285
Other............................. 63,051 67,052 67,383
---------- ---------- ----------
Total current liabilities...... 889,403 365,557 438,621
---------- ---------- ----------
Deferred credits and other .......... 126,635 141,870 96,650
Accumulated deferred income taxes.... 192,533 263,054 203,291
Commitments and contingencies........ -- -- --
---------- ---------- ----------
Total.......................... $2,828,896 $3,008,168 $2,890,080
========== ========== ==========
See accompanying notes.
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5
SOUTHERN UNION COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
Accumu-
lated
Common Premium Common Other
Stock, on Treasury Stock Compre- Retained
$1 Par Capital Stock, Held in hensive Earnings/
Value Stock at Cost Trust Income (Deficit) Total
------- -------- --------- --------- ---------- --------- ----------
(thousands of dollars)
Balance
July 1,
2000...... $50,521 $599,835 $(15,554) $(14,522) $ 115,175 $ -- $ 735,455
Comprehen-
sive in-
come:
Net
earn-
ings... -- -- -- -- -- 57,285 57,285
Unrea-
lized
loss in
invest-
ment
secur-
ities,
net of
tax
bene-
fit.... -- -- -- -- (96,323) -- (96,323)
Minimum
pension
liabil-
ity ad-
just-
ment;
net of
tax.... -- -- -- -- (4,324) -- (4,324)
Cumula-
tive
effect
of
change
in ac-
count-
ing
prin-
ciple,
net of
tax.... -- -- -- -- 826 -- 826
Unrea-
lized
loss on
hedging
activi-
ties,
net of
tax
bene-
fit.... -- -- -- -- (1,911) -- (1,911)
---------
Compre-
hen-
sive
income
(loss). (44,447)
---------
Payment on
note re-
ceivable. -- 290 -- -- -- -- 290
Purchase
of common
stock
held in
trust.... -- -- -- (4,009) -- -- (4,009)
5% stock
dividend. 2,556 49,626 -- -- -- (52,182) --
Benefit
plan
modifi-
cation... -- -- -- 6,560 -- -- 6,560
Issuance
of stock
for ac-
quisi-
tion..... 1,371 25,930 -- -- -- -- 27,301
Exercise
of stock
options.. 105 643 (315) 274 -- -- 707
------- -------- -------- -------- --------- -------- ---------
Balance
June 30,
2001...... 54,553 676,324 (15,869) (11,697) 13,443 5,103 721,857
Comprehen-
sive in-
come:
Net
loss... -- -- -- -- -- (30,907) (30,403)
Unrea-
lized
loss in
invest-
ment
securi-
ties,
net of
tax.... -- -- -- -- (13,907) -- (13,907)
Unrea-
lized
gain on
hedging
activi-
ties,
net of
tax.... -- -- -- -- 407 -- 407
---------
Compre-
hensive
income
(loss). (43,903)
---------
Purchase
of trea-
sury
stock... -- -- (1,698) -- -- -- (1,698)
Stock
compen-
sation
plans... -- 327 -- 372 -- -- 699
Exercise
of stock
options. 115 555 (488) 322 -- -- 504
------- -------- -------- -------- --------- -------- ---------
Balance
Septem-
ber 30,
2001...... $54,668 $677,206 $(18,055) $(11,003) $ (57) $(25,300) $ 677,459
======= ======== ======== ======== ========= ======== =========
See accompanying notes.
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6
SOUTHERN UNION COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
Three Months Ended September 30,
2001 2000
------------ ------------
(thousands of dollars)
Cash flows used in operating activities:
Net loss................................. $ (30,403) $ (13,974)
Adjustments to reconcile net loss to net
cash flows used in operating
activities:
Depreciation and amortization...... 21,877 15,966
Deferred income taxes.............. 1,476 (1,725)
Provision for bad debts............ 1,507 716
Business restructuring charges..... 29,400 --
Gain on sale of gas marketing
contracts held by a subsidiary.. (4,653) --
Gain on settlement of interest rate
swaps........................... (17,166) --
Financial derivative trading
(gain) losses................... (357) 3,195
Change in accounting principle..... -- (602)
Other.............................. 135 231
Changes in operating assets and
liabilities, net of acquisitions
and dispositions:
Accounts receivable, billed
and unbilled.............. 76,833 (5,398)
Accounts payable............. (13,598) (13,212)
Taxes and other liabilities.. (18,138) (1,056)
Customer deposits............ (105) (357)
Deferred gas purchase costs.. (411) (26,554)
Inventories.................. (68,108) (44,542)
Other........................ 1,068 (7,303)
------------ ------------
Net cash flows used in operating
activities...................... (20,643) (94,615)
------------ ------------
Cash flows from (used in) investing
activities:
Additions to property, plant and
equipment.......................... (24,390) (21,908)
Acquisition of operations, net of
cash received...................... -- (406,830)
Proceeds from sale of subsidiaries.... 21,077 --
Proceeds from sale of gas marketing
contracts held by a subsidiary..... 4,972 --
Proceeds from settlement of interest
rate swaps......................... 17,166 --
Increase (decrease) in customer
advances............................ (581) 529
Increase (decrease) in deferred
charges and credits................. 2,607 (408)
Other.................................. (135) (222)
----------- ------------
Net cash flows from (used in)
investing activities............. 20,716 (428,839)
----------- ------------
Cash flows from financing activities:
Issuance of long-term debt................ -- 480,000
Issuance cost of debt..................... (290) (2,538)
Repayment of debt and capital lease
obligation............................. (2,208) (114,706)
Net borrowings under revolving credit
facility............................... 2,400 135,450
Purchase of treasury stock................ (1,698) --
Other..................................... 504 109
----------- ------------
Net cash flows from financing
activities.......................... (1,292) 498,315
----------- ------------
Decrease in cash and cash equivalents........ (1,219) (25,139)
Cash and cash equivalents at beginning of
period.................................... 1,219 27,829
----------- ------------
Cash and cash equivalents at end of period... $ -- $ 2,690
=========== ============
Supplemental disclosures of cash flow
information:
Cash paid during the period for:
Interest............................ $ 28,311 $ 17,795
=========== ============
Income taxes........................ $ -- $ --
=========== ============
See accompanying notes.
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7
SOUTHERN UNION COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
Twelve Months Ended September 30,
2001 2000
------------ ------------
(thousands of dollars)
Cash flows (used in) from operating
activities:
Net earnings....................... $ 40,856 $ 1,971
Adjustments to reconcile net
earnings to net cash flows from
(used in) operating activities:
Depreciation and amortiza-
tion..................... 92,897 60,257
Deferred income taxes....... 30,979 325
Provision for bad debts..... 33,497 5,194
Business restructuring
charges.................. 29,400 --
Gain on sale of investment
securities............... (74,582) --
Gain on sale of subsidiary.. (707) --
Gain on sale of gas
marketing contracts held
by a subsidiary.......... (4,653) --
Gain on sale of real estate. (13,532) --
Gain on settlement of
interest rate swaps...... (17,166) --
Financial derivative
trading losses........... 2,132 5,431
Change in accounting
principle................ -- (602)
Other....................... 2,149 1,239
Changes in operating assets
and liabilities, net of
acquisitions and
dispositions:
Accounts receivable,
billed and
unbilled........... (46,944) (18,592)
Accounts payable...... (15,330) 20,872
Taxes and other
liabilities........ (23,861) 4,977
Customer deposits..... (899) (3,624)
Deferred gas purchase
costs.............. (41,733) (29,100)
Inventories........... (55,111) (33,580)
Other................. 1,403 (8,192)
----------- ------------
Net cash flows (used in) from
operating activities........... (61,205) 6,576
----------- ------------
Cash flows used in investing activities:
Additions to property, plant and
equipment......................... (126,258) (101,936)
Acquisition of operations, net of
cash received..................... (7,657) (445,196)
Proceeds from sale of investment
securit........................... 85,761 --
Proceeds from sale of real estate,
net of closing costs.............. 20,638 --
Proceeds from sale of subsidiaries... 24,377 --
Proceeds from settlement of interest
rate swaps ....................... 17,166 --
Purchase of investment securities.... (12,640) (19,588)
Increase in customer advances........ 88 1,044
Increase (decrease) in deferred
charges and credits............... (8,907) 458
Proceeds from sale of gas marketing
contracts.held by a subsidiary.... 4,972 12,150
Other................................ 5,340 (5,233)
----------- ------------
Net cash flows used in investing
activities..................... 2,880 (558,301)
----------- ------------
Cash flows from financing activities:
Issuance of long-term debt........... 55,000 780,000
Issuance cost of debt................ (1,226) (9,830)
Repayment of debt and capital lease
obligation........................ (54,772) (253,002)
Premium on early extinguishment of
debt.............................. -- (719)
Net borrowings under revolving credit
facility.......................... 57,547 51,350
Purchase of treasury stock........... (1,698) (14,425)
Other................................ 784 445
----------- ------------
Net cash flows from financing
activities..................... 55,635 553,819
----------- ------------
Change in cash and cash equivalents..... (2,690) 2,094
Cash and cash equivalents at beginning
of period............................ 2,690 596
----------- ------------
Cash and cash equivalents at end of
period............................... $ -- $ 2,690
=========== ============
Supplemental disclosures of cash flow
information:
Cash paid during the period for:
Interest....................... $ 118,386 $ 58,076
=========== ============
Income taxes................... $ 21,052 $ 4,321
=========== ============
See accompanying notes.
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8
SOUTHERN UNION COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FINANCIAL STATEMENTS
These interim financial statements should be read in conjunction with the
financial statements and notes thereto contained in Southern Union Company's
(Southern Union and, together with its wholly-owned subsidiaries, the Company)
Annual Report on Form 10-K for the fiscal year ended June 30, 2001. Certain
prior period amounts have been reclassified to conform with the current period
presentation.
The interim financial statements are unaudited but, in the opinion of
management, reflect all adjustments (including both normal recurring as well as
any non-recurring) necessary for a fair presentation of the results of
operations for such periods. Because of the seasonal nature of the Company's
operations, the results of operations and cash flows for any interim period are
not necessarily indicative of results for the full year. As further described
below, the Company acquired Providence Energy Corporation and Fall River Gas
Company on September 28, 2000, Valley Resources, Inc. on September 20, 2000 and
Pennsylvania Enterprises, Inc. on November 4, 1999. Accordingly, the operating
activities of the acquired operations are consolidated with the Company
beginning on the respective acquisition dates. Thus, the results of operations
of the Company for the periods subsequent to the acquisitions are not comparable
to those periods prior to the acquisitions nor are the fiscal 2002 results of
operations comparable with prior periods. Also, the results of operations for
the three- and twelve-month periods ended September 30, 2001 are not indicative
of results that would necessarily be achieved for a full year since the majority
of the Company's operating margin is earned during the winter heating season.
ACQUISITIONS AND DIVESTITURES
On September 28, 2000, Southern Union completed the acquisition of Providence
Energy Corporation (ProvEnergy) for approximately $270,000,000 in cash plus the
assumption of approximately $90,000,000 in long-term debt. The ProvEnergy
natural gas distribution operations are Providence Gas and North Attleboro Gas,
which collectively serve approximately 177,000 natural gas customers. Providence
Gas serves natural gas customers in Providence and Newport, Rhode Island, and 23
other cities and towns in Rhode Island. North Attleboro Gas serves customers in
North Attleboro and Plainville, Massachusetts, towns adjacent to the
northeastern Rhode Island border. Sub sidiaries of the Company acquired in the
ProvEnergy merger include ProvEnergy Oil Enterprises, Inc. (ProvEnergy Oil), and
ProvEnergy Power Company, LLC. ProvEnergy Oil, which operated a fuel oil
distribution business through its subsidiary, ProvEnergy Fuels, Inc. (ProvEnergy
Fuels) for residential and commercial customers in Rhode Island and
Massachusetts, was sold for $15,776,000 in August 2001. No gain or loss was
recognized on this transaction. ProvEnergy Power Company owns 50% of Capital
Center Energy Company, LLC., a joint venture formed between ProvEnergy and ERI
Services, Inc. to provide retail power.
On September 28, 2000, Southern Union completed the acquisition of Fall River
Gas Company (Fall River Gas) for 1,370,629 shares (before adjustment for any
subsequent stock dividend) of Southern Union common stock and approximately
$27,000,000 in cash plus assumption of approximately $20,000,000 in long-term
debt. Fall River Gas serves approximately 49,000 customers in the city of Fall
River and the towns of Somerset, Swansea and Westport, all located in
southeastern Massachusetts. Also acquired in the Fall River Gas merger was Fall
River Gas Appliance Company, Inc., which rents water heaters and conversion
burners (primarily for residential use) in Fall River Gas' service area.
On September 20, 2000, Southern Union completed the acquisition of Valley
Resources, Inc. (Valley Resources) for approximately $125,000,000 in cash plus
the assumption of approximately $30,000,000 in long-term debt. Valley Resources
natural gas distribution operations are Valley Gas Company and Bristol and
Warren Gas Company, which collectively serve approximately 66,000 natural gas
customers. Valley Resources' three non-utility subsidiaries acquired in the
merger include Valley Appliance and Merchandising Company (VAMCO), Valley
Propane, Inc. (Valley Propane) and Morris Merchants, Inc. (Morris Merchants).
VAMCO merchandises and rents natural gas burning appliances, offers appliance
service contract programs, sells water filtration systems and provides
construction
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9
SOUTHERN UNION COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
management services for natural gas-related projects. Valley Propane, which
provided liquid propane to customers in Rhode Island and nearby Massachusetts,
was sold for $5,301,000 in September 2001. No gain or loss was recognized on
this transaction. Morris Merchants, which served as a manufacturers'
representative agency for franchised plumbing and heating contract supplies
throughout New England and New York was sold for $1,586,000 in October 2001. No
gain or loss was recognized on this transaction. Also, acquired in the
acquisition was Valley Resources' 90% interest (which is now 100%) in Alternate
Energy Corporation, which sells, installs and designs natural gas conversion
systems and facilities, is an authorized representative of the ONSI Corporation
fuel cell, holds patents for a natural gas/diesel co-firing system and for a
device to control the flow of fuel on dual-fuel equipment.
The Company funded the cash portion of the above described acquisitions and any
related refinancings of assumed debt with a bank note (the Term Note). See Debt
and Capital Lease. The assets of ProvEnergy, Fall River Gas and Valley Resources
(hereafter referred to as the Company's New England Operations) have been
included in the consolidated balance sheet of the Company at September 30, 2001
and the results of operations from the New England Operations have been included
in the statement of consolidated operations since their respective acquisition
dates. The New England Operations' primary business is the distribution of
natural gas through its public utility companies (collectively referred to as
the New England Division). The acquisitions were treated as a purchase with
related goodwill of approximately $355,000,000. Effective July 1, 2001,
goodwill, which was previously amortized on a straight-line basis over forty
years, is now accounted for on an impairment-only approach. See Goodwill. The
Company plans to sell or dispose of certain non-core businesses acquired in the
New England Operations.
On November 4, 1999, the Company acquired Pennsylvania Enterprises, Inc.
(hereafter referred to as the Pennsylvania Operations) in a transaction valued
at approximately $500,000,000, including assumption of long-term debt of
approximately $115,000,000. The Company issued approximately 16,700,000 shares
(before adjustment for any subsequent stock dividends) of common stock and paid
approximately $36,000,000 in cash to complete the transaction. The Company
funded the cash portion of the acquisition of the Pennsylvania Operations and
related refinancings with the sale of $300,000,000 of 8.25% Senior Notes due
2029 completed on November 3, 1999 (8.25% Senior Notes). See Debt and Capital
Lease.
The Pennsylvania Operations are headquartered in Wilkes-Barre, Pennsylvania with
natural gas distribution being its primary business. The principal operating
division of the Pennsylvania Operations is the PG Energy division of the Company
which serves more than 156,000 gas customers in northeastern and central
Pennsylvania. Subsidiaries of the Company acquired in the acquisition of the
Pennsylvania Operations include PG Energy Services Inc., (Energy Services), PEI
Power Corporation (PEI Power), Keystone Pipeline Services, Inc. (Keystone, a
wholly-owned subsidiary of Energy Services), and Theta Land Corporation. Through
Energy Services, the Company supplies propane and offers the inspection,
maintenance and servicing of residential and small commercial gas-fired
equipment. Through PEI Power, an exempt wholesale generator (within the meaning
of the Public Utility Holding Company Act of 1935), the Company provides
electricity services to the broad mid-Atlantic market of Pennsylvania, New
Jersey, Maryland, Delaware and the District of Columbia. Keystone, which engaged
primarily in the construc tion, maintenance, and rehabilitation of natural gas
distribution pipelines, was sold for $3,300,000 in June 2001 for a pre-tax gain
of $707,000. Theta Land Corporation, which owned and provided land management
and development services for more than 44,000 acres of land, was sold for
$12,150,000 in January 2000. No gain or loss was recognized on this transaction.
In July 2001, the commercial and industrial gas marketing contracts of Energy
Services were sold for approximately $4,972,000, resulting in a pre-tax gain of
$4,653,000. The Company also plans to sell or dispose of propane operations of
Energy Services, which are not material to the Company. The Company has not yet
sold these operations and there can be no assurance that a sale on terms
satisfactory to the Company will be completed.
The assets of the Pennsylvania Operations are included in the consolidated
balance sheet of the Company at September 30, 2001 and the results of operations
from the Pennsylvania Operations have been included in the statement of
consolidated operations since November 4, 1999. The acquisition was treated as a
purchase with
--------------------------------------------------------------------------------
10
SOUTHERN UNION COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
related goodwill of approximately $261,000,000. Effective July 1, 2001,
goodwill, which was previously amortized on a straight-line basis over forty
years, is now accounted for on an impairment-only approach. See Goodwill.
Pro Forma Financial Information
The following unaudited pro forma financial information for the three-month
periods ended September 30, 2001 and 2000 is presented as though the following
events had occurred at the beginning of the earliest period presented: (i)
acquisition of the New England Operations; (ii) the issuance of the Term Note;
and (iii) the refinancing of certain short-term and long-term debt at the time
of the acquisitions. The pro forma financial information is not necessarily
indicative of the results which would have actually been obtained had the
acquisition of the New England Operations, the issuance of the Term Note, or the
refinancings been completed as of the assumed date for the periods presented or
which may be obtained in the future.
Three Months Ended September 30,
2001 2000
------------ ------------
Operating revenues.......................... $ 173,969 $ 185,659
Income (loss) before extraordinary item..... (30,403) (35,035)
Net earnings (loss) available for common
stock.................................... (30,403) (35,035)
Net earnings (loss) per common stock:
Basic.................................... (.58) (.67)
Diluted.................................. (.58) (.67)
EARNINGS PER SHARE
Average shares outstanding, which excludes treasury stock, for basic earnings
per share were 52,424,847 and 51,018,217 for the three-month period ended
September 30, 2001 and 2000, respectively, and 52,427,252 and 49,818,381 for the
twelve-month period ended September 30, 2001 and 2000, respectively. Diluted
earnings per share includes average shares outstanding as well as common stock
equivalents from stock options and warrants. Common stock equivalents were nil
for both three-month periods ended September 30, 2001 and 2000, respectively,
and 1,937,705 and 1,407,824 for the twelve-month periods ended September 30,
2001 and 2000, respectively. At September 30, 2001, 1,127,883 shares of common
stock were held by various rabbi trusts for certain of the Company's benefit
plans and 61,264 shares were held in a rabbi trust for certain employees who
deferred receipt of Company shares for stock options exercised.
Subsequent to September 30, 2001, the Company repurchased 1,610,356 shares of
its' common stock outstanding at $20.50 per share in private off-market
transactions.
BUSINESS RESTRUCTURING CHARGES
In August 2001, the Company implemented a corporate reorganization and
restructuring which was initially announced in July 2001 as part of a Cash Flow
Improvement Plan designed to increase annualized pre-tax cash flow from
operations by at least $50 million by the end of fiscal year 2002. Actions taken
included (i) the offering of voluntary Early Retirement Programs ("ERPs") in
certain of its operating divisions and (ii) a limited reduction in force ("RIF")
within its corporate offices. ERPs, providing for increased benefits for those
electing retirement, were offered to approximately 400 eligible employees across
the Company's operating divisions, with approximately 60% of such eligible
employees accepting. The RIF was limited solely to certain corporate employees
in the Company's Austin and Kansas City offices with forty-eight employees being
offered severance packages.
In connection with the corporate reorganization and restructuring efforts, the
Company recorded a one-time charge of $32,706,000 during the quarter ended
September 30, 2001. The charge included $26.5 million of voluntary ERP's, RIF
within the corporate offices and employee separation benefits, and $6.2 million
connected with various business realignment and restructuring initiatives. The
Company expects that most of the restructuring actions will be completed by the
end of fiscal year 2002.
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11
SOUTHERN UNION COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
During the first fiscal quarter, the Company paid approximately $0.3 million and
$3 million in employee separation and other restructuring costs, respectively.
The balance sheet carries a remaining reserve of approximately $29.4 million in
estimated reorganization and restructuring expenditures as of September 30,
2001.
GOODWILL
Effective July 1, 2001, the Company adopted Goodwill and Other Intangible Assets
which was issued by the FASB in June 2001. In accordance with this Statement,
the Company has ceased amortization of goodwill. Goodwill, which was previously
classified on the consolidated balance sheet as additional purchase cost
assigned to utility plant and amortized on a straight-line basis over forty
years, is now subject to at least an annual assessment for impairment by
applying a fair-value based test.
The following table reflects the Company's comparative net loss before the
change in accounting principle and goodwill amortization under Goodwill and
Other Intangible Assets:
Three Months Ended September 30,
2001 2000
------------ ------------
(in thousands, except per
share amounts)
Reported loss before change in accounting
principle................................ $ (30,403) $ (14,576)
Goodwill, net of taxes...................... -- 2,605
------------ ------------
Adjusted net loss before change in
accounting principle..................... $ (30,403) $ (11,971)
============ ============
Basic earnings per share:
Reported loss before change in
accounting principle.................. $ (.58) $ (.28)
Goodwill, net of taxes................... -- .05
------------ ------------
Adjusted net loss before change in
accounting principle.................. $ (.58) $ (.23)
============ ============
Diluted earnings per share:
Reported loss before change in
accounting principle.................. $ (.58) $ (.28)
Goodwill, net of taxes................... -- .05
------------ ------------
Adjusted net loss before change in
accounting principle.................. $ (.58) $ (.23)
============ ============
The following displays changes in the carrying amount of goodwill for the
quarter ended September 30, 2001:
Total
---------
Balance as of July 1, 2001......................................... $724,620
Impairment losses.................................................. (3,358)
Other.............................................................. (10)
--------
Balance as of September 30, 2001................................... $721,252
========
In connection with the Company's Cash Flow Improvement Plan announced in July
2001, the Company began the divestiture of certain non-core subsidiaries and
assets. As a result of prices of comparable businesses for various non-core
properties, a goodwill impairment loss of $3,358,000 was recognized in
depreciation and amortization on the consolidated statement of operations for
the quarter ended September 30, 2001.
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12
SOUTHERN UNION COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
INVESTMENT SECURITIES
At September 30, 2001, the Company held securities of Capstone Turbine
Corporation (Capstone). This investment is classified as "available for sale"
under the Financial Accounting Standards Board Standard Accounting for Certain
Investments in Debt and Equity Securities. As of September 30, 2001, the
Company's investment in Capstone had a fair value of $8,052,000 and unrealized
gains, net of tax, related to this investment were $4,945,000. The Company has
classified this investment as current, as it plans to monetize its investment as
soon as practicable and use the proceeds to reduce outstanding debt.
All other securities owned by the Company are accounted for under the cost
method. The Company's other invest ments in securities consist primarily of
preferred stock in non-public companies whose value is not readily determinable.
OTHER INCOME
During the quarter ended September 30, 2001, the Company negotiated three
interest rate swaps that were not designated as hedges and did not meet the
criteria for hedge accounting. The first swap, effective July 5, 2001, carried
a notional amount of $100,000,000 and termination of June 30, 2005. The
remaining swaps, effective July 23, 2001 and August 1, 2001, carried notional
amounts of $300,000,000 and $200,000,000, respectively, with terminations of
November 15, 2004 and February 1, 2005, respectively. On September 19, 2001,
these interest rate swaps were settled, resulting in a pre-tax gain and cash
flow of $17,166,000.
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
Derivative Instruments and Hedging Activities The Company utilizes derivative
instruments on a limited basis to manage certain business risks. Interest rate
swaps are employed to hedge the effect of changes in interest rates related to
certain debt instruments and commodity swaps and options to manage price risk
associated with certain energy contracts.
In accordance with adoption of this Statement on July 1, 2000, the Company
recorded a net-of-tax cumulative-effect gain of $602,000 in earnings to
recognize the fair value of the gas derivative contracts at PG Energy Services,
Inc., a wholly-owned subsidiary, that are not designated as hedges. The Company
also recorded $826,000 in accumulated other comprehensive income which
recognizes the fair value of two interest rate swap derivatives that were
designated as cash flow hedges.
Cash Flow Hedges The Company manages exposure against volatility in interest
payments on variable rate debt through interest rate swaps. As of September 30,
2001, $866,000 in after-tax comprehensive income generated through the
expiration of one interest rate swap was partially offset by the fair value of
the Company's remaining obligation under two interest rate swaps which resulted
in $459,000 of unrealized losses, net of tax. During the first quarter of fiscal
year 2002, the Company recorded net settlement payments of $916,000 on these
derivatives through interest expense. The Company expects to reclassify as
interest expense $678,000 in derivative losses, net of taxes, from accumulated
other comprehensive income as the settlement of swap payments occur over the
next twelve months. The maximum term over which the Company is hedging exposures
to the variability of cash flows is 25 months.
Trading Contracts In March 2001, the Company discovered unauthorized financial
derivative energy trading activity by a non-regulated, wholly-owned subsidiary.
All unauthorized trading activity was subsequently closed in March and April of
2001 resulting in a cumulative cash expense of $191,000, net of taxes. During
the quarter ended September 30, 2001, the Company recorded expiration of
contracts resulting from this trading activity through other income, generating
$221,000 in earnings, after taxes. The majority of the remaining deferred
liability of $7,219,000
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13
SOUTHERN UNION COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
at September 30, 2001 related to these derivative instruments will be recognized
as income in the Consolidated Statement of Operations over the next four years
based on the related contracts.
Beginning in May 2001, the Company acquired natural gas commodity swap
derivatives and collar transactions in order to mitigate price volatility of
natural gas passed through to utility customers. The cost of the derivative
products and the settlement of the respective obligations are recorded through
the gas purchase adjustment clause as authorized by the applicable regulatory
authority and therefore do not impact earnings. As of September 30, 2001, the
fair value of the contracts, which expire at various times through May 2002, are
included in the consolidated financial statements as a liability and a matching
adjustment to deferred cost of gas of $5,068,000.
PREFERRED SECURITIES OF SUBSIDIARY TRUST
On May 17, 1995, Southern Union Financing I (Subsidiary Trust), a consolidated
wholly-owned subsidiary of Southern Union, issued $100,000,000 of 9.48% Trust
Originated Preferred Securities (Preferred Securities). In connection with the
Subsidiary Trust's issuance of the Preferred Securities and the related purchase
by Southern Union of all of the Subsidiary Trust's common securities (Common
Securities), Southern Union issued to the Subsidiary Trust $103,092,800
principal amount of its 9.48% Subordinated Deferrable Interest Notes, due 2025
(Subordinated Notes). The sole assets of the Subsidiary Trust are the
Subordinated Notes. The interest and other payment dates on the Subordinated
Notes correspond to the distribution and other payment dates on the Preferred
Securities and the Common Securities. Under certain circumstances, the
Subordinated Notes may be distributed to holders of the Preferred Securities and
holders of the Common Securities in liquidation of the Subsidiary Trust. The
Subordinated Notes are redeemable at the option of the Company on or after
May 17, 2000, at a redemption price of $25 per Subordinated Note plus accrued
and unpaid interest. The Preferred Securities and the Common Securities will be
redeemed on a pro rata basis to the same extent as the Subordinated Notes are
repaid, at $25 per Preferred Security and Common Security plus accumulated and
unpaid distributions. Southern Union's obligations under the Subordi nated Notes
and related agreements, taken together, constitute a full and unconditional
guarantee by Southern Union of payments due on the Preferred Securities. As of
September 30, 2001 and 2000, 4,000,000 shares of Preferred Securities were
outstanding.
DEBT AND CAPITAL LEASE
September 30, June 30,
2001 2001
------------- ------------
(thousands of dollars)
7.60% Senior Notes due 2024..................... $ 364,515 $ 364,515
8.25% Senior Notes due 2029..................... 300,000 300,000
Term Note, due 2002............................. 485,000 485,000
5.62% to 10.25% First Mortgage Bonds, due 2002
to 2029...................................... 150,482 150,815
7.70% Debentures, due 2027...................... 6,801 6,806
Capital lease and other......................... 26,535 28,408
------------- ------------
Total debt and capital lease.................... 1,333,336 1,335,544
Less current portion........................ 490,470 5,913
------------- ------------
Total long-term debt and capital lease.......... $ 842,866 $ 1,329,631
============= ============
Senior Notes On November 3, 1999, the Company completed the sale of $300,000,000
of 8.25% Senior Notes (8.25% Notes) due 2029. The net proceeds from the sale of
these 8.25% Notes were used to: (i) fund the acquisition of Pennsylvania
Enterprises, Inc.; (ii) repay approximately $109,900,000 of borrowings under the
revolving credit facility, and (iii) repay approximately $136,000,000 of long-
and short-term debt assumed in the acquisition.
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14
SOUTHERN UNION COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Assumed Debt In connection with the acquisition of the Pennsylvania Operations,
the Company assumed $45,000,000 of First Mortgage Bonds bearing interest between
8.375% and 9.34%. In connection with the acquisition of ProvEnergy, the Company
assumed $86,916,000 of First Mortgage Bonds bearing interest between 5.62% and
10.25%. In connection with the acquisition of Fall River Gas, the Company
assumed $19,500,000 of First Mortgage Bonds bearing interest between 7.24% and
9.44%. In connection with the acquisition of Valley Resources, the Company
assumed $6,905,000 of 7.70% Debentures.
Capital Lease The Company completed the installation of an Automated Meter
Reading (AMR) system at Missouri Gas Energy during the first quarter of fiscal
year 1999. The installation of the AMR system involved an investment of
approximately $30,000,000 which is accounted for as a capital lease obligation.
As of September 30, 2001, the capital lease obligation outstanding was
$22,706,000 ith a fixed rate of 5.79%. This system has significantly improved
meter reading accuracy and timeliness and provided electronic accessibility to
meters in residential customers' basements, thereby assisting in the reduction
of the number of estimated bills.
Credit Facilities On May 29, 2001, the Company restated and amended its
short-term and long-term credit facilities (together referred to as "Revolving
Credit Facilities"). The Company has available $150,000,000 under the short-
term facility, which expires May 28,2002, and $225,000,000 under the long-term
facility, which expires on May 29, 2004. The Company has additional availability
under uncommitted line of credit facilities with various banks. Borrowings under
the Revolving Credit Facilities are available for Southern Union's working
capital, letter of credit requirements and other general corporate purposes. A
balance of $193,000,000 was outstanding under the facilities at September 30,
2001.
Term Note On August 28, 2000 the Company entered into the Term Note to fund (i)
the cash portion of the con sideration to be paid to the Fall River Gas'
stockholders; (ii) the all cash consideration to be paid to the ProvEnergy and
Valley Resources stockholders, (iii) repayment of approximately $50,000,000 of
long- and short-term debt assumed in the mergers, and (iv) all related
acquisition costs. As of September 30, 2001, a balance of $485,000,000 was
outstanding under this Term Note. The Term Note, which initially expired on
August 27, 2001, has been extended through August 26, 2002 for a fee. No
additional draws can be made on the Term Note.
UTILITY REGULATION AND RATES
Missouri On July 5, 2001, the Missouri Public Service Commission (MPSC) issued
an order approving a unanimous settlement of Missouri Gas Energy's rate request.
The settlement provides for an annual $9,892,000 base rate increase, as well as
$1,081,000 in added revenue from new and revised service charges. The majority
of the rate increase will be recovered through increased monthly fixed charges
to gas sales service customers. New rates became effective August 6, 2001, two
months before the statutory deadline for resolving the case. The approved
settlement requires parties to seek dismissal of all pending judicial reviews of
prior rate cases. The settlement also provides for the development of a two-year
experimental low-income program that will help certain customers in the Joplin
area pay their natural gas bills.
New England Division On November 1, 2001, the New England Division of Southern
Union Company submitted a comprehensive filing with the Rhode Island Public
Utilities Commission (RIPUC) to implement a "One State; One Rate" simplified and
uniform rate structure. Such filing reflects the consolidated operations of the
various gas distribution operations in Rhode Island and fulfills the terms of a
settlement agreement associated with the merger of the Companies in Docket Nos.
D-00-2 and D-00-3.
The filing includes: merger-related savings; technology investments over a
five-year period; a commitment to developing Service Quality Standards in
collaboration with state regulators; a "community reinvestment program"; and
expansion of eligibility in the Business Choice program. The proposed rates
would increase annual operating revenues by $7.2 million or 3%, with individual
customer impacts varying as a result of the rate schedule
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15
SOUTHERN UNION COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
consolidation and restructuring. Other changes incorporated in the filing
include: separation of distribution charges from cost of gas charges; switching
from billing on the basis of the volumetric measure Ccf (hundred cubic feet) to
energy consumption (therms); customer- and company-sharing of any incremental
merger-related savings; and introduction of a weather adjustment to customer
bills.
The New England Division has requested that the new rate schedules take effect
on December 1, 2001. However, no rate change will take effect until the RIPUC
has conducted a full investigation on the proposed rate restructuring and
increase and actual implementation of changes is not expected until July 1,
2002.
Pennsylvania On April 3, 2000, PG Energy filed an application with the
Pennsylvania Public Utility Commission (PPUC) seeking an increase in its base
rates designed to produce $17,900,000 in additional annual revenues. On
December 7, 2000, the PPUC approved a settlement agreement that provided for a
rate increase designed to produce $10,800,000 of additional annual revenue. The
new rates became effective on January 1, 2001.
El Paso, Texas On October 18, 1999, Southern Union Gas filed a $1,696,000 rate
increase request for the El Paso service area with the City of El Paso. In
February 2000, the City of El Paso approved a $650,000 revenue increase, and an
improved rate design that collects a greater portion of the Company's revenue
stream from the monthly customer charge. Additionally, the City of El Paso
approved a new 30-year franchise for Southern Union Gas.
COMMITMENTS AND CONTINGENCIES
Environmental The Company is subject to federal, state and local laws and
regulations relating to the protection of the environment. These evolving laws
and regulations may require expenditures over a long period of time to control
environmental impacts. The Company has established procedures for the on-going
evaluation of its operations to identify potential environmental exposures and
assure compliance with regulatory policies and procedures.
The Company is investigating the possibility that the Company or predecessor
companies may have been associated with Manufactured Gas Plant (MGP) sites in
its former service territories, principally in Arizona and New Mexico, and
present service territories in Texas, Missouri, Pennsylvania, Massachusetts and
Rhode Island. At the present time, the Company is aware of certain MGP sites in
these areas and is investigating those and certain other locations.
While the Company's evaluation of these Texas, Missouri, Arizona, New Mexico,
Pennsylvania, Massachusetts and Rhode Island MGP sites is in its preliminary
stages, it is likely that some compliance costs may be identified and become
subject to reasonable quantification. Within the Company's service territories
certain MGP sites are currently the subject of governmental actions. These sites
are as follows:
Kansas City, Missouri MGP Sites In a letter dated May 10, 1999, the Missouri
Department of Natural Resources (MDNR) sent notice of a planned Site
Inspection/Removal Site Evaluation of the Kansas City Coal Gas Former
Manufactured Gas Plant site. This site (comprised of two adjacent MGP operations
previously owned by two separate companies and hereafter referred to as Station
A and Station B) is located at East 1st Street and Campbell in Kansas City,
Missouri and is owned by Missouri Gas Energy (MGE). A 1988 investigation of the
site performed by an Environmental Protection Agency (EPA) contractor determined
that further remedial assessment was not required under the Comprehensive
Environmental Response, Compensation and Liability Act of 1980 (CERCLA), as
amended by the SUPERFUND Amendments and Reauthorization Act of 1986. The MDNR
has stated that the reassessment of the Kansas City Coal Gas site is part of a
statewide effort to identify, evaluate, and prioritize the potential hazards
posed by all of Missouri's MGP sites. During July 1999, the Company sent
applications to MDNR submitting the two sites to the agency's Voluntary Cleanup
Program (VCP). The sites were accepted into the VCP on August 2, 1999 and MGE
subsequently performed environmental assessments at the sites and submitted
assessment results to MDNR on March 6, 2000. In a letter dated June 21, 2000,
MDNR responded to the Station A environmental report submitted by the Company.
In that letter, MDNR stated that soil remediation will be
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16
SOUTHERN UNION COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
necessary at the site (Station A) but that further exploration and delineation
of site contamination should be performed before remedial methods can be
determined. MGE performed additional assessment work in accordance with MDNR's
request. In a letter dated May 7, 2001, MDNR responded to the Station B
environmental report. That letter suggested that some soils would need to be
remediated, but that certain areas on Station B require further investigation to
determine whether significant contamination exists.
North of the Kansas City, Missouri Station A and B MGP sites, the City of Kansas
City Port Authority ("Port Authority") is developing a parcel of land adjacent
to the Missouri River and known as the "Riverfront Development." In the course
of developing this property, the Port Authority entered the Riverfront
Development into the Missouri Voluntary Cleanup Program. In a letter dated April
23, 2001, MDNR invited representatives of MGE, the Port Authority and Honeywell
International Inc. (the alleged successor to Barrett Manufacturing Company, a
tar manufacturer formerly located on a portion of the Riverfront Development) to
a technical meeting to discuss the investigation, cleanup, closure and
redevelopment of the Riverfront Development and MGE's properties. That meeting
was held on May 16, 2001. On July 18, 2001, representatives of MGE and the Port
Authority met to discuss MGE's proposal for a limited assessment and remediation
of a portion of the Port Authority property allegedly impacted by the historic
MGP. That proposal was set forth in a letter from MGE to the Port Authority
dated July 31, 2001. In a letter dated July 27, 2001, Honeywell International
Inc. proposed to the Port Authority that Honeywell perform a similar assessment
on the portion of the Riverfront Development formerly occupied by Barrett
Manufacturing Company. In a letter addressed to MGE and dated August 3, 2001,
the Port Authority set forth its demand that MGE assume responsibility for the
remediation of soil and groundwater at the Riverfront Development, and in a
letter dated August 15, 2001, the Port Authority granted a conditional
acceptance of MGE's proposal for MGE's limited assessment of the Riverfront
Development. In September and October 2001, Honeywell and MGE each performed
assessments of its proposed portion of the Port Authority property. Results of
these assessments will be presented to the Port Authority in November 2001.
Providence, Rhode Island Sites During 1995, Providence Gas began an
environmental evaluation at its primary gas distribution facility located at 642
Allens Avenue in Providence, Rhode Island. Environmental studies and a
subsequent remediation work plan were completed at an approximate cost of $4.5
million. Providence Gas also began a soil remediation project on a portion of
the site in July 1999. As of June 30, 2001, approximately $8,900,000 had been
expended on soil remediation under the remediation work plan. Based on the
results of the environmental investigation and the site information learned
during the performance of work under the remediation work plan, the Company
submitted a revised remedial action work plan ("RAWP") for the site to the Rhode
Island Department of Environmental Management ("RIDEM") on July 24, 2001.
Following RIDEM's rejection of Providence Gas' revised RAWP, a meeting was held
on October 9, 2001 with representatives of RIDEM, in which representatives of
Providence Gas agreed to submit a revised request, narrowed in scope, to RIDEM.
Although additional remediation work is planned for the site during calendar
year 2002, assessment and remediation costs will not exceed $500,000 during
calendar year 2001. Because the Company has not reached agreement with RIDEM on
the terms of the revised RAWP, the Company cannot offer any conclusions as to
the total future cost of remediation of the property at this time. However, one
estimate of the cost of the environmental work proposed under the revised RAWP
is $5,700,000.
In November 1998, Providence Gas received a letter of responsibility from the
RIDEM relating to possible contamination on previously owned property at 170
Allens Avenue in Providence. The current operator of the property has also
received a letter of responsibility. A work plan had been created and approved
by RIDEM. An investigation was then begun to determine the extent of
contamination, as well as the extent of the Company's responsibility. Providence
Gas entered into a cost-sharing agreement with the current operator of the
property, under which Providence Gas was responsible for approximately twenty
percent (20%) of the costs related to the investiga tion. Costs of testing at
this site as of June 30, 2001 were approximately $300,000. Until the results of
the investigation are known, the Company cannot offer any conclusions as to its
responsibility.
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17
SOUTHERN UNION COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Tiverton, Rhode Island Site Fall River Gas Company is a defendant in a civil
action seeking to recover anticipated remediation costs associated with
contamination found at property owned by the plaintiffs. This claim is based on
alleged dumping of material by Fall River Gas Company trucks at the site in the
1930s and 1940s.
Valley Gas Company Sites Valley Gas Company is a party to an action in which
Blackstone Valley Electric Company ("Blackstone") brought suit for contribution
to its expenses of cleanup of a site on Mendon Road in Attleboro, Massachusetts,
to which coal manufacturing waste was transported from a former MGP site in
Pawtucket, Rhode Island (the "Blackstone Litigation"). Blackstone Valley
Electric Company v. Stone & Webster, Inc., Stone & Webster Engineering
Corporation, Stone & Webster Management Consultants, Inc. and Valley Gas
Company, C. A. No. 94-10178JLT, United States District Court, District of
Massachusetts. Valley Gas Company takes the position in that litigation that it
is indemnified for any cleanup expenses by Blackstone pursuant to a 1961
agreement signed at the time of Valley Gas Company's creation. This suit was
stayed in 1995 pending the issuance of rulemaking at the United States EPA
(Commonwealth of Massachusetts v. Blackstone Valley Electric Company, 67 F.3d
981 (1995)). In January 2001, the EPA issued a Preliminary Administrative
Decision on this issue and announced that it was soliciting comments on the
Decision. While the public comment period has now closed, the EPA has yet to
reissue its decision. While this suit has been stayed, Valley Gas Company and
Blackstone (merged with Narragansett Electric Company in May 2000) have received
letters of responsibility from the RIDEM with respect to releases from two MGP
sites in Rhode Island. RIDEM issued letters of responsibility to Valley Gas
Company and Blackstone in September 1995 for the Tidewater MGP in Pawtucket,
Rhode Island, and in February 1997 for the Hamlet Avenue MGP in Woonsocket,
Rhode Island. Valley Gas Company entered into an agreement with Blackstone (now
Narragansett) in which Valley Gas Company and Blackstone agreed to share equally
the expenses for the costs associated with the Tidewater site subject to
reallocation upon final determination of the legal issues that exist between the
companies with respect to responsibility for expenses for the Tidewater site and
otherwise. No such agreement has been reached with respect to the Hamlet site.
To the extent that potential costs associated with former MGPs are quantified,
the Company expects to provide any appropriate accruals and seek recovery for
such remediation costs through all appropriate means, including in rates charged
to customers, insurance and regulatory relief. At the time of the closing of the
acquisition of the Company's Missouri service territories, the Company entered
into an Environmental Liability Agreement that provides that Western Resources
retains financial responsibility for certain liabilities under environmental
laws that may exist or arise with respect to Missouri Gas Energy. In addition,
at the time it was acquired, Providence Gas had in place a regulatory plan that
created a mechanism for the recovery of environmental-related costs. This plan
provided for recovery of environmental investigation and remediation costs
incurred through September 30, 1997, as well as costs incurred during the
three-year term of the plan, are to be amortized over a 10-year period, at a
level authorized under the plan. A new plan, effective October 1, 2000 through
June 30, 2002, establishes an environmental fund for the recovery of evaluation,
remedial and clean-up costs arising out of the Company's MGPs and sites
associated with the operation and disposal activities from MGPs.
Although significant charges to earnings could be required prior to rate
recovery, management does not believe that environmental expenditures for MGP
sites will have a material adverse effect on the Company's financial position,
results of operations or cash flows.
The Company follows the provisions of an American Institute of Certified Public
Accountants Statement of Position, Environmental Remediation Liabilities, for
recognition, measurement, display and disclosure of environmental remediation
liabilities.
Southwest Gas Litigation On February 1, 1999, Southern Union submitted a
proposal to the Board of Directors of Southwest Gas Corporation (Southwest) to
acquire all of Southwest's outstanding common stock for $32.00 per share.
Southwest at that time had a pending merger agreement with ONEOK, Inc. (ONEOK)
at $28.50 per share, executed on December 14, 1998. On February 22, 1999,
Southern Union and Southwest both publicly announced
--------------------------------------------------------------------------------
18
SOUTHERN UNION COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Southern Union's proposal, after the Southwest Board of Directors determined
that Southern Union's proposal was a Superior Proposal (as defined in the
Southwest merger agreement with ONEOK). At that time Southern Union entered into
a Confidentiality and Standstill Agreement with Southwest at Southwest's
insistence. On April 25, 1999, Southwest's Board of Directors rejected Southern
Union's $32.00 per share offer and accepted an amended offer of $30.00 per share
from ONEOK. On April 27, 1999, Southern Union increased its offer to $33.50 per
share and agreed to pay interest which, together with dividends, would provide
Southwest shareholders with a 6% annual rate of return on its $33.50 offer,
commencing February 15, 2000, until closing. Southern Union's revised proposal
was rejected by Southwest's Board of Directors. On January 21, 2000, ONEOK
announced that it was withdrawing from the Southwest merger agreement.
There are several lawsuits pending that relate to activities surrounding
Southern Union's efforts to acquire Southwest. Southern Union intends to
vigorously pursue its claims against Southwest, ONEOK, and certain individual
defendants, and vigorously defend itself against the claims by Southwest and
ONEOK. The Company believes that the results of the above-noted Southwest Gas
litigation will not have a materially adverse effect on the Company's financial
condition, results of operations or cash flows.
Regulatory In August 1998, a jury in Edinburg, Texas concluded deliberations on
the City of Edinburg's franchise fee lawsuit against PG&E Gas Transmission,
Texas Corporation (formerly Valero Energy Corporation (Valero)) and a number of
its subsidiaries, as well as former Valero subsidiary Rio Grande Valley Gas
Company (RGV) and RGV's successor company, Southern Union Company. Southern
Union purchased RGV from Valero in October 1993. The jury awarded the plaintiff
damages, against all defendants under several largely overlapping but mutually
exclusive claims, totaling approximately $13,000,000. The trial judge
subsequently reduced the award to approximately $700,000 against Southern Union
and $7,800,000 against Valero and Southern Union together. The trial court's
decision was appealed to the Thirteenth District of the Texas Court of Appeals
(Court of Appeals). In December 2000, the Court of Appeals reversed and modified
the trial court's judgment of approximately $8,500,000 and awarded the City of
Edinburg $585,000, plus pre-judgment interest of $190,000 against RGV and Valero
for breach of contract. The Court of Appeals upheld the award for attorneys'
fees of approximately $3,500,000 against Valero, RGV and Southern Union. In
subsequent decisions, the Court of Appeals first excluded Southern Union from,
then reinstated against Southern Union, the December 2000 judgment. The Court of
Appeals also remanded a portion of the case to the Trial Court with instructions
to retry certain issues. The Company will continue to pursue reversal on appeal.
The Company believes that the outcome of this matter will not have a material
adverse impact on the Company's results of operations, financial position or
cash flows. The Company also has entered into a settlement agreement to settle a
related class action lawsuit with a majority of the cities served by the Company
in Texas. The settlement will not have a material adverse impact on the
Company's results of operations, financial position or cash flows.
Other Southern Union and its subsidiaries are parties to other legal proceedings
that management considers to be normal actions to which an enterprise of its
size and nature might be subject, and not to be material to the Company's
overall business or financial condition, results of operations or cash flows.
--------------------------------------------------------------------------------
19
SOUTHERN UNION COMPANY AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview The Company's core business is the distribution of natural gas as a
public utility through: Southern Union Gas, Missouri Gas Energy (MGE); PG
Energy; Atlantic Utilities, doing business as South Florida Natural Gas (SFNG);
and, effective with the September 2000 acquisitions of Providence Energy
Corporation, Valley Resources, Inc. and Fall River Gas Company, its New England
Division. In addition, subsidiaries of Southern Union support and expand natural
gas sales and to capitalize on the Company's gas energy expertise. These
subsidiaries operate natural gas pipeline systems, generate electricity, market
natural gas to end-users and distribute propane. Certain subsidiaries also own
or hold interests in real estate and other assets, which are primarily used in
the Company's utility business.
Several of these business activities are subject to regulation by federal, state
or local authorities where the Company operates. Thus, the Company's financial
condition and results of operations have been and will continue to be dependent
upon the receipt of adequate and timely adjustments in rates. In addition, the
Company's business is affected by seasonal weather impacts, competitive factors
within the energy industry and economic development and residential growth in
its service areas.
Acquisitions and Divestitures On September 28, 2000, Southern Union completed
the acquisition of Providence Energy Corporation (ProvEnergy) for approximately
$270,000,000 in cash plus the assumption of approximately $90,000,000 in
long-term debt. The ProvEnergy natural gas distribution operations are
Providence Gas and North Attleboro Gas, which collectively serve approximately
177,000 natural gas customers. Providence Gas serves natural gas customers in
Providence and Newport, Rhode Island, and 23 other cities and towns in Rhode
Island. North Attleboro Gas serves customers in North Attleboro and Plainville,
Massachusetts, towns adjacent to the northeastern Rhode Island border.
Subsidiaries of the Company acquired in the ProvEnergy merger include ProvEnergy
Oil Enterprises, Inc. (ProvEnergy Oil), and ProvEnergy Power Company, LLC.
ProvEnergy Oil, which operated a fuel oil distribution business through its
subsidiary, ProvEnergy Fuels, Inc. (ProvEnergy Fuels) for residential and
commercial customers in Rhode Island and Massachusetts, was sold for $15,776,000
in August 2001. No gain or loss was recognized on this transaction. ProvEnergy
Power Company owns 50% of Capital Center Energy Company, LLC., a joint venture
formed between ProvEnergy and ERI Services, Inc. to provide retail power.
On September 28, 2000, Southern Union completed the acquisition of Fall River
Gas Company (Fall River Gas) for 1,370,629 shares (before adjustment for any
subsequent stock dividend) of Southern Union common stock and approximately
$27,000,000 in cash plus assumption of approximately $20,000,000 in long-term
debt. Fall River Gas serves approximately 49,000 customers in the city of Fall
River and the towns of Somerset, Swansea and Westport, all located in
southeastern Massachusetts. Also acquired in the Fall River Gas merger was Fall
River Gas Appliance Company, Inc., which rents water heaters and conversion
burners (primarily for residential use) in Fall River Gas' service area.
On September 20, 2000, Southern Union completed the acquisition of Valley
Resources, Inc. (Valley Resources) for approximately $125,000,000 in cash plus
the assumption of approximately $30,000,000 in long-term debt. Valley Resources
natural gas distribution operations are Valley Gas Company and Bristol and
Warren Gas Company, which collectively serve approximately 66,000 natural gas
customers. Valley Resources' three non-utility subsidiaries acquired in the
merger include Valley Appliance and Merchandising Company (VAMCO), Valley
Propane Inc. (Valley Propane) and Morris Merchants, Inc. (Morris Merchants).
VAMCO merchandises and rents natural gas burning appliances, offers appliance
service contract programs, sells water filtration systems and provides
construction management services for natural gas-related projects. Valley
Propane, which provided liquid propane to customers in Rhode Island and nearby
Massachusetts, was sold for $5,301,000 in September 2001. No gain or loss was
recognized on this transaction. Morris Merchants, which served as a
manufacturers' representative agency for franchised plumbing and heating
contract supplies throughout New England and New York was sold for $1,586,000 in
October 2001. No gain or loss was recognized on this transaction. Also acquired
in the acquisition was Valley Resources' 90% interest (which is now 100%) in
Alternate Energy Corporation, which sells, installs and designs
--------------------------------------------------------------------------------
20
SOUTHERN UNION COMPANY AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
natural gas conversion systems and facilities, is an authorized representative
of the ONSI Corporation fuel cell, holds patents for a natural gas/diesel
co-firing system and for a device to control the flow of fuel on dual-fuel
equipment.
Collectively, the operations from the above-mentioned acquisitions are referred
to as the New England Operations. The Company plans to sell or dispose of
certain non-core businesses acquired in the New England Operations.
On November 4, 1999, the Company acquired Pennsylvania Enterprises, Inc.
(hereafter referred to as the Pennsylvania Operations) in a transaction valued
at approximately $500,000,000, including assumption of long-term debt of
approximately $115,000,000. The Company issued approximately 16,700,000 shares
(before adjustment for any subsequent stock dividends) of common stock and paid
approximately $36,000,000 in cash to complete the transaction. The Pennsylvania
Operations are headquartered in Wilkes-Barre, Pennsylvania with natural gas
distribution being its primary business. The principal operating division of the
Pennsylvania Operations is the PG Energy division of the Company which serves
more than 156,000 gas customers in northeastern and central Pennsylvania.
Subsidiaries of the Company acquired in the acquisition of the Pennsylvania
Operations include PG Energy Services Inc., (Energy Services), PEI Power
Corporation (PEI Power), Keystone Pipeline Services, Inc. (Keystone, a
wholly-owned subsidiary of Energy Services), and Theta Land Corporation. Through
Energy Services, the Company supplies propane and offers the inspection,
maintenance and servicing of residential and small commercial gas-fired
equipment. Through PEI Power, an exempt wholesale generator (within the meaning
of the Public Utility Holding Company Act of 1935), the Company provides
electricity services to the broad mid-Atlantic market of Pennsylvania, New
Jersey, Maryland, Delaware and the District of Columbia. Keystone, which engaged
primarily in the construction, maintenance, and rehabilitation of natural gas
distribution pipelines, was sold for $3,300,000 in June 2001 for a pre-tax gain
of $707,000. Theta Land Corporation, which owned and provided land management
and development services for more than 44,000 acres of land, was sold for
$12,150,000 in January 2000. No gain or loss was recognized on this transaction.
In July 2001, the commercial and industrial gas marketing contracts of Energy
Services were sold for approximately $4,972,000, resulting in a pre-tax gain of
$4,653,000. The Company also plans to sell or dispose of propane operations of
Energy Services, which are not material to the Company. The Company has not yet
sold these operations and there can be no assurance that a sale on terms
satisfactory to the Company will be completed.
The operating activities of the acquired operations are consolidated with the
Company beginning on their respective acquisition dates. Thus, the results of
operations for the three- and twelve-month periods ended September 30, 2001 are
not indicative of results that would necessarily be achieved for a full year
since the majority of the Company's operating margin is earned during the winter
heating season. For these reasons, the results of operations of the Company for
the periods subsequent to the acquisitions are not comparable to those periods
prior to the acquisitions nor are the fiscal 2002 results of operations
comparable with prior periods.
RESULTS OF OPERATIONS
Three Months Ended September 30, 2001 and 2000
The Company recorded a net loss attributable to common stock of $30,403,000 for
the three-month period ended September 30, 2001 compared with a net loss of
$13,974,000 for the three-month period ended September 30, 2000. Net loss per
common share, based on weighted average shares outstanding during the period,
was $.58 in 2001 compared with a net loss per common share of $.27 in 2000. The
current quarter net loss was principally impacted by a pre-tax charge for
business restructuring of $32,706,000 ($.39 per basic and diluted share). Due to
the seasonal nature of the gas utility business, the three-month period ending
September 30 is typically a loss period.
--------------------------------------------------------------------------------
21
SOUTHERN UNION COMPANY AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Operating revenues were $173,969,000 for the three-month period ended
September 30, 2001, compared with operating revenues of $144,468,000 in 2000.
Gas purchase and other energy costs for the three-month period ended
September 30, 2001 were $92,987,000, compared with $84,533,000 in 2000. The
Company's operating revenues are affected by the level of sales volumes and by
the pass-through of increases or decreases in the Company's gas purchase costs
through its purchased gas adjustment clauses. Additionally, revenues are
affected by increases or decreases in gross receipts taxes (revenue-related
taxes) which are levied on sales revenue as collected from customers and
remitted to the various taxing authorities. The increase in both operating
revenues and gas purchase costs between periods was primarily due to an 11%
increase in gas sales volume to 15,265 MMcf in 2001 from 13,731 MMcf in 2000 and
by a 27% increase in the average cost of gas from $4.56 per Mcf in 2000 to $5.81
per Mcf in 2001. Changes in the average cost of gas resulted from seasonal
impacts on demands for natural gas and the ensuing competitive pricing within
the industry. The New England Operations generated a net increase of $37,122,000
in operating revenues, $18,214,000 in gas purchase and other energy costs and
2,754 MMcf of the increase in gas sales volume.
Operating margin (operating revenues less gas purchase and other energy costs
and revenue-related taxes) increased $20,094,000 for the three-month period
ended September 30, 2001 compared with the same period in 2000. Net operating
margin increased principally as a result of the acquisition of the New England
Operations which contributed a net increase of $18,162,000 for the quarter ended
September 30, 2001. The remaining increase is primarily due to the timing of a
$10,973,000 annual revenue increase granted to Missouri Gas Energy effective
August 6, 2001 and the $17,900,000 annual revenue increase granted to PG Energy
effective on January 1, 2001.
Operating expenses, which include operating, maintenance and general expenses,
depreciation and amortization, and taxes other than on income and revenues, were
$83,290,000 for the three-month period ended September 30, 2001, an increase of
$25,447,000, compared with $57,843,000 in 2000. Operating expenses increased
primarily as a result of the acquisition of the New England Operations which
generated a net increase of $25,148,000. This was partially offset by the
elimination of goodwill amortization resulting from the Company's adoption of
Goodwill and Other Intangible Assets effective July 1, 2001. In accordance with
this Standard, the Company has ceased the amortization of goodwill, which
generated $2,735,000 of expense during the quarter ending September 30, 2000,
and currently accounts for goodwill on an impairment-only approach.
Additionally, in connection with the Company's Cash Flow Improvement Plan
announced in July 2001, the Company began the divestiture of certain non-core
subsidiaries and assets. As a result of prices of comparable businesses for
various non-core properties, a goodwill impairment loss of $3,358,000 was
recognized in depreciation and amortization on the consolidated statement of
operations for the quarter ended September 30, 2001. See Goodwill in the Notes
to the Consolidated Financial Statements included herein.
Business reorganization and restructuring initiatives were commenced in August
2001 as part of a previously announced Cash Flow Improvement Plan designed to
increase annualized pre-tax cash flow from operations by at least $50 million by
the end of fiscal year 2002. Actions taken included (i) the offering of
voluntary Early Retirement Programs ("ERPs") in certain of its operating
divisions and (ii) a limited reduction in force ("RIF") within its corporate
offices. ERPs, providing for increased benefits for those electing retirement,
were offered to approximately 400 eligible employees across the Company's
operating divisions, with approximately 60% of such eligible employees
accepting. The RIF was limited solely to certain corporate employees in the
Company's Austin and Kansas City offices with forty-eight employees being
offered severance packages. As a result of actions associated with the business
reorganization and restructuring, the Company expects an annual cost savings in
a range of $30 million to $35 million. In connection with the business
reorganization and restructuring, the Company recorded a one-time charge of
$32,706,000 during the quarter ended September 30, 2001. The charge included
$26.5 million of voluntary ERP's, RIF within the corporate offices and employee
separation benefits, and $6.2 million connected with various business
realignment and restructuring initiatives. The Company expects that most of the
restructuring actions will be completed by the end of fiscal 2002. See Business
Restructuring Charges in the Notes to the Consolidated Financial Statements
included herein.
Interest expense was $27,159,000 for the three-month period ended September 30,
2001, compared to $16,306,000 in 2000. Interest expense increased primarily due
to a $485,000,000 bank note (the Term Note) entered into by the
--------------------------------------------------------------------------------
22
SOUTHERN UNION COMPANY AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Company on August 28, 2000 for the acquisition of the New England Operations.
The Company entered into the Term Note to (i) fund the cash consideration paid
to stockholders of Fall River Gas, ProvEnergy and Valley Resources, (ii)
refinance and repay long- and short-term debt assumed in the New England
Operations, and (iii) acquisition costs of the New England Operations. The
Company also assumed $113,321,000 in long-term debt of the New England
Operations which was not refinanced or extinguished with the Term Note. See Debt
and Capital Lease in the Notes to the Consolidated Financial Statements included
herein.
Other income for the three-month period ended September 30, 2001 was $23,596,000
compared to other expense of $5,513,000 in 2000. Other income for the
three-month period ended September 30, 2001, includes gains of $17,166,000
generated through the settlement of several interest rate swaps, a gain of
$4,653,000 realized through the sale of marketing contracts held by PG Energy
Service, Inc. and $1,905,000 in interest and dividend income. This was partially
offset by $1,606,000 of legal costs associated with ongoing litigation
associated with the unsuccessful acquisition of Southwest Gas Corporation
(Southwest). Other expense for the three-month period ended September 30, 2000
primarily consists of $3,195,000 of non-cash trading losses and $2,041,000 of
costs associated with the aforementioned unsuccessful acquisition and related
litigation.
The effective federal and state income tax rate is 35% and 46% for the three
months ended September 30, 2001 and 2000, respectively. The decline in the
effective tax rate is due to the Company's recent adoption of Goodwill and Other
Intangible Assets, previously discussed, which eliminates the amortization of
goodwill, in which the majority was non-tax deductible.
The Company adopted the Statement of Financial Accounting Standards Board (FASB)
Accounting for Derivative Instruments and Hedging Activities on July 1, 2000. In
accordance with the transition provisions of the Statement, the Company recorded
a net-of-tax cumulative-effect-type gain of $602,000 in earnings to recognize
the fair value of the derivative instruments that do not qualify for hedge
accounting treatment under the Statement. The Company also recorded a net-of-tax
cumulative effect-type gain of $826,000 in accumulated other comprehensive
income to recognize at fair value all derivative instruments designated as cash
flow hedging instruments.
Twelve Months Ended September 30, 2001 and 2000
The Company recorded net earnings available for common stock of $40,856,000 for
the twelve-month period ended September 30, 2001 compared with net earnings of
$1,971,000 in 2000. Earnings per diluted share were $.74 in 2001 compared with
earnings per diluted share of $.04 in 2000.
Operating revenues were $1,962,314,000 for the twelve-month period ended
September 30, 2001, compared with operating revenues of $891,387,000 in 2000.
Gas purchase and other energy costs for the twelve-month period ended September
30, 2001 were $1,383,203,000, compared with $542,955,000 in 2000. Both operating
revenues and gas purchase costs were primarily impacted by a 47% increase in gas
sales volume from 121,483 MMcf in 2000 to 178,188 MMcf in 2001 and by an 85%
increase in the average cost of gas from $3.82 per Mcf in 2000 to $7.07 per Mcf
in 2001 due to increases in average spot market gas prices. The New England
Operations and the Pennsylvania Operations generated a net increase of
$463,727,000 and $105,108,000, respectively, in operating revenues, $287,439,000
and $95,182,000, respectively, in gas purchase and other energy costs and 34,765
MMcf and 3,762 MMcf, respectively, of the increase in gas sales volume. The
remaining increases in operating revenue, gas purchase and other energy costs,
and gas sales volume resulted principally from the colder weather in the Texas
and Missouri Service territories in 2001 as compared to 2000.
Missouri Gas Energy service territories experienced weather which was 107% of a
30-year measure for the twelve- month period ended September 30, 2001 compared
with 79% in 2000. Weather for Southern Union Gas service territories for the
twelve-month period ended September 30, 2001 was 112% of a 30-year measure
compared with
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23
SOUTHERN UNION COMPANY AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
71% in 2000. About half of the customers served by Southern Union Gas are
weather normalized. Weather in the PG Energy service territories was 104% of a
30-year measure for the twelve-month period ended September 30, 2001 compared
with 95% of a 30-year measure for the eleven-month period ended September 30
,2000. Weather in the New England Division service territories was 102% of a
30-year measure for the twelve-month period ended September 30, 2001.
Operating expenses, excluding business restructuring charges which was
previously discussed, were $381,845,000 for the twelve-month period ended
September 30, 2001, compared with operating expenses of $227,103,000 in 2000.
Increases of $124,419,000 and $3,222,000 were the result of the acquisitions of
the New England Operations and the Pennsylvania Operations, respectively. An
increase in bad debt expense in the Texas and Missouri service territories of
$18,150,000 resulted from an increase in delinquent customer receivables as a
result of higher gas prices and colder weather. Also impacting operating
expenses for the twelve-month period ended September 30, 2001 were increases in
employee payroll and benefit costs and a goodwill impairment loss of $3,358,000,
previously discussed.
Interest expense was $114,372,000 for the twelve-month period ended September
30, 2001 compared to $59,434,000 in 2000. Interest expense increased primarily
due to the Term Note entered into by the Company for the acquisition of the New
England Operations, previously discussed, and the issuance of $300,000,000 of
8.25% Senior Notes on November 3, 1999 (8.25% Senior Notes) for the acquisition
of the Pennsylvania Operations. The Company issued 8.25% Senior Notes to fund
the acquisition of Pennsylvania Enterprises, Inc. and to extinguish $136,000,000
in existing debt of the Pennsylvania Operations. The Company also assumed
long-term debt of the New England Operations, previously discussed, and
$45,000,000 in long-term debt of the Pennsylvania Operations which was not
refinanced or extinguished with the Term Note or the 8.25% Senior Notes. See
Debt and Capital Lease in the Notes to the Consolidated Financial Statements
included herein.
Other income for the twelve-month period ended September 30, 2001 was
$105,928,000 compared to other expense of $14,064,000 in 2000. Other income for
the twelve-month period ended September 30, 2001 includes realized gains on the
sale of a portion of Southern Union's holdings in Capstone Turbine Corporation
of $74,582,000, gains of $17,166,000 generated through the settlement of several
interest rate swaps, previously discussed, a $13,532,000 gain on the sale of
non-core real estate, a gain of $4,653,000 realized through the sale of
marketing contracts held by PG Energy Service, Inc., also previously discussed,
and $8,831,000 in interest and dividend income. These items were partially
offset by $12,420,000 of legal costs associated with ongoing litigation
associated with the unsuccessful acquisition of Southwest and $2,489,000 of
non-cash trading losses. Other expense for the twelve-month period ended
September 30, 2000 included: $12,404,000 of legal costs associated with the
aforementioned unsuccessful acquisition and related litigation and $5,431,000 of
non-cash trading losses which was partially offset by net rental income of
Lavaca Realty of $1,985,000.
The Company's consolidated federal and state effective income tax rate was 47%
and 42% for the twelve-month period ended September 30, 2001 and 2000,
respectively. The increase in the effective federal and state income tax rate is
a result of non-tax deductible amortization of goodwill associated with the
purchase of the New England Operations and Pennsylvania Operations.
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24
SOUTHERN UNION COMPANY AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following table sets forth certain information regarding the Company's gas
utility operations for the three- and twelve- month periods ended September 30,
2001 and 2000:
Three Months Ended Twelve Months Ended
September 30, September 30,
2001 2000 2001 2000
---------- ---------- ---------- ----------
Average number of gas
sales customers served:
Residential............ 1,313,526 1,052,786 1,328,356 1,044,172
Commercial............. 125,102 103,348 128,480 103,775
Industrial and
irrigation........... 4,237 773 4,310 751
Public authorities
and other............ 3,156 3,151 3,162 3,147
Pipeline and marketing. 350 370 352 263
---------- ---------- ---------- ----------
Total average
customers served. 1,446,371 1,160,428 1,464,660 1,152,108
========== ========== ========== ==========
Gas sales in millions of
cubic feet (MMcf)
Residential............ 6,960 5,518 109,468 70,271
Commercial............. 3,675 3,279 44.324 29,886
Industrial and
irrigation........... 1,009 527 5,440 1,797
Public authorities
and other............ 245 290 3,201 2,625
Pipeline and marketing. 2,982 3,388 15,925 17,083
---------- ---------- ---------- ----------
Gas sales billed... 14,871 13,002 178,358 121,662
Net change in unbilled
gas sales............ 394 729 (170) (179)
---------- ---------- ---------- ----------
Total gas sales.... 15,265 13,731 178,188 121,483
========== ========== ========== ==========
Gas sales revenues
(thousands of dollars):
Residential............ $ 96,788 $ 61,576 $1,155,138 $ 494,133
Commercial............. 36,186 24,780 429,417 183,246
Industrial and
irrigation........... 7,713 3,264 46,198 10,493
Public authorities
and other............ 1,599 1,846 26,346 12,904
Pipeline and marketing. 11,482 13,713 76,649 52,151
---------- ---------- ---------- ----------
Gas revenues
billed........... 153,768 105,179 1,733,748 752,927
Net change in unbilled
gas sales revenues... 3,374 5,363 4,807 3,664
---------- ---------- ---------- ----------
Total gas sales
revenues......... $ 157,142 $ 110,542 $1,738,555 $ 756,591
========== ========== ========== ==========
Gas sales margin
(thousands of dollars)... $ 61,103 $ 43,029 $ 409,311 $ 257,593
========== ========== ========== ==========
Gas sales revenue per
thousand cubic feet
(Mcf) billed:
Residential............ $ 13.91 $ 11.16 $ 10.55 $ 7.03
Commercial............. 9.85 7.56 9.69 6.13
Industrial and
irrigation........... 7.64 6.19 8.49 5.84
Public authorities
and other............ 6.53 6.37 8.23 4.92
Pipeline and marketing. 3.85 4.05 4.81 3.05
Weather:
Degree days:
Southern Union Gas
service territories.. 2 5 2,377 1,516
Missouri Gas Energy
service territories.. 67 66 5,542 4,150
PG Energy service
territories.......... 195 260 6,556 5,547
New England service
territories.......... 118 -- 6,009 --
Percent of normal based
on 30-year measure:
Southern Union Gas
service terri-
tories............. 36.7% 100.0% 112.0% 70.6%
Missouri Gas Energy
service terri-
tories............. 108.1% 111.9% 106.5% 79.1%
PG Energy service
territories........ 162.5% 216.7% 104.2% 94.5%
New England service
territories........ 120.1% -- 102.1% --
Gas transported in
millions of cubic feet
(MMcf)................... 19,483 16,910 93,429 81,332
Gas transportation reve-
nues (thousands of
dollars)................. $ 7,012 $ 7,414 $ 45,209 $ 36,294
----------------------
The above information does not include the Company's 43% equity ownership in a
natural gas distribution company serving 25,000 customers in Piedras Negras,
Mexico. Information for Fall River Gas and ProvEnergy, acquired September 28,
2000, and Valley Resources, acquired September 20, 2000, is included since
October 1, 2000. The 30-year measure is used above for consistent external
reporting purposes. Measures of normal weather used by the Company's regulatory
authorities to set rates vary by jurisdiction. Periods used to measure normal
weather for regulatory purposes range from 10 years to 30 years.
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25
SOUTHERN UNION COMPANY AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FINANCIAL CONDITION
The Company's gas utility operations are seasonal in nature with a significant
percentage of the annual revenues and earnings occurring in the traditional
heating-load months. This seasonality results in a high level of cash flow needs
immediately preceding the peak winter heating season months, resulting from the
required payments to natural gas suppliers in advance of the receipt of cash
payments from the Company's customers. The Company has historically used
internally generated funds and its credit facilities to provide funding for its
seasonal working capital, continuing construction and maintenance programs and
operational requirements.
On May 29, 2001, the Company restated and amended its short-term and long-term
credit facilities (together referred to as "Revolving Credit Facilities"). The
Company has available $150,000,000 under the short-term facility, which expires
May 28, 2002, and $225,000,000 under the long-term facility, which expires on
May 29, 2004. The Company has additional availability under uncommitted line of
credit facilities with various banks. Borrowings under the Revolving Credit
Facilities are available for Southern Union's working capital, letter of credit
requirements and other general corporate purposes. A balance of $193,000,000 was
outstanding under the facilities at September 30, 2001.
On August 28, 2000 the Company entered into the Term Note to fund (i) the cash
portion of the consideration to be paid to the Fall River Gas' stockholders;
(ii) the all cash consideration to be paid to the ProvEnergy and Valley
Resources stockholders, (iii) repayment of approximately $50,000,000 of long-
and short-term debt assumed in the mergers, and (iv) all related acquisition
costs. As of September 30, 2001, a balance of $485,000,000 was outstanding under
this Term Note. The Term Note, which initially expired on August 27, 2001, has
been extended through August 26, 2002 for a fee. No additional draws can be made
on the Term Note.
Concurrent with the closing of the Pennsylvania Enterprises, Inc. merger on
November 4, 1999, the Company issued $300,000,000 of 8.25% Senior Notes due 2029
which were used to: (i) fund the cash portion of the consideration to be paid to
the Pennsylvania Enterprises, Inc. shareholders; (ii) refinance and repay
certain debt of Pennsylvania Enterprises, Inc., and (iii) repay outstanding
borrowings under the Company's various credit facilities. These senior notes are
senior unsecured obligations and will rank equally in right of payment with each
other and with the Company's other unsecured and unsubordinated obligations,
including the 7.60% Senior Notes due 2024.
The principal sources of funds during the three-month period ended September 30,
2001 were $17,166,000 generated from the settlement of interest rate swaps,
proceeds from the sale of various subsidiaries of $21,077,000 and $4,972,000
generated through the sale of commercial and industrial gas marketing contracts
held by PG Energy Services, Inc. This provided funds of $24,390,000 for on-going
property, plant and equipment additions; as well as seasonal working capital
needs of the Company.
The effective interest rate under the Company's current debt structure is 5.27%
(including interest and the amortization of debt issuance costs and redemption
premiums on refinanced debt).
The Company retains its borrowing availability under its Revolving Credit
Facilities, as discussed above. Borrowings under these credit facilities will
continue to be used, as needed, to provide funding for the seasonal working
capital needs of the Company. Internally-generated funds from operations will be
used principally for the Company's ongoing construction and maintenance programs
and operational needs and may also be used periodically to reduce outstanding
debt.
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26
SOUTHERN UNION COMPANY AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There are no material changes in market risks faced by the Company from those
reported in the Company's Annual Report on Form 10-K for the year ended June 30,
2001.
The information contained in Item 3 updates, and should be read in conjunction
with, information set forth in Part II, Item 7 in the Company's Annual Report on
Form 10-K for the year ended June 30, 2001, in addition to the interim
consolidated financial statements, accompanying notes, and Management's
Discussion and Analysis of Financial Condition and Results of Operations
presented in Items 1 and 2 of this Quarterly Report on Form 10-Q.
ACCOUNTING PRONOUNCEMENTS
In June 2001, the FASB issued Accounting for Asset Retirement Obligations, which
addresses financial accounting and reporting for obligations and the related
retirement costs associated with the retirement of tangible long-lived assets.
Accounting for Asset Retirement Obligations is effective for all fiscal years
beginning after June 15, 2002. The Statement's purpose is to develop consistent
financial treatment of asset retirement obligations and the associated costs,
improve disclosure regarding the impact of retirement obligations on future cash
outflows, leverage and liquidity, and provide more information related to gross
investment in long-lived assets. The Company is currently evaluating the effect
this Statement will have on the earnings and financial condition of the Company.
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
This Management's Discussion and Analysis of Financial Condition and Results of
Operations and other sections of this Form 10-Q may contain forward-looking
statements that are based on current expectations, estimates and projections
about the industry in which the Company operates, management's beliefs and
assumptions made by management. Words such as "expects," "anticipates,"
"intends," "plans," "believes," "seeks," "estimates," variations of such words
and similar expressions are intended to identify such forward-looking
statements. These statements are not guarantees of future performance and
involve certain risks, uncertainties and assumptions, which are difficult to
predict and many of which are outside the Company's control. Therefore, actual
outcomes and results may differ materially from what is expressed or forecasted
in such forward-looking statements. The Company undertakes no obligation to
update publicly any forward-looking statements, whether as a result of new
information, future events or otherwise. Readers are cautioned not to put undue
reliance on such forward-looking statements. Stockholders may review the
Company's reports filed in the future with the Securities and Exchange
Commission for more current descriptions of developments that could cause actual
results to differ materially from such forward-looking statements.
Factors that could cause or contribute to actual results differing materially
from such forward-looking statements include the following: cost of gas; gas
sales volumes; weather conditions in the Company's service territories; the
achievement of operating efficiencies and the purchases and implementation of
new technologies for attaining such efficiencies; impact of relations with labor
unions of bargaining-unit employees; the receipt of timely and adequate rate
relief; the outcome of pending and future litigation; governmental regulations
and proceedings affecting or involving the Company; unanticipated environmental
liabilities; changes in business strategy; the risk that the businesses acquired
and any other businesses or investments that Southern Union has acquired or may
acquire may not be successfully integrated with the businesses of Southern
Union; and the nature and impact of any extraordinary transactions such as any
acquisition or divestiture of a business unit or any assets. These are
representative of the factors that could affect the outcome of the
forward-looking statements. In addition, such statements could be affected by
general industry and market conditions, and general economic conditions,
including interest rate fluctua tions, federal, state and local laws and
regulations affecting the retail gas industry or the energy industry generally,
and other factors.
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27
SOUTHERN UNION COMPANY AND SUBSIDIARIES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SOUTHERN UNION COMPANY
----------------------
(Registrant)
Date November 14, 2001 By DAVID J. KVAPIL
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David J. Kvapil
Executive Vice President and
Chief Financial Officer
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