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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-K
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
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ACT OF 1934
For the Fiscal Year Ended June 30, 2001
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
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EXCHANGE ACT OF 1934
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 on which registered
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Common Stock, par value $1 per share New York Stock Exchange
Securities Registered Pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
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Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.
The aggregate market value of the voting stock held by non-affiliates of the
registrant on September 19, 2001 was $740,961,553. The number of shares of the
registrant's Common Stock outstanding on September 19, 2001 was 53,824,027.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's Annual Report to Stockholders for the year ended
June 30, 2001, are incorporated by reference in Parts II and IV.
Portions of the registrant's proxy statement for its annual meeting of
stockholders to be held on November 14, 2001, are incorporated by reference into
Part III.
PART I
ITEM 1. Business.
Introduction
Southern Union Company (Southern Union and together with its subsidiaries, the
Company) was incorporated under the laws of the State of Delaware in 1932.
Southern Union is one of the top five natural gas utilities in the United
States, as measured by number of customers. The Company's principal line of
business is the distribution of natural gas as a public utility through its
operating divisions principally in Texas, Missouri, Florida, Pennsylvania since
November 1999, and Rhode Island and Massachusetts effective with three
acquisitions completed in September 2000 (see Acquisitions).
Southern Union Gas, headquartered in Austin, Texas, serves approximately 535,000
customers in Texas (including Austin, Brownsville, El Paso, Galveston,
Harlingen, McAllen and Port Arthur). Missouri Gas Energy, headquartered in
Kansas City, Missouri, serves approximately 498,000 customers in central and
western Missouri (including Kansas City, St. Joseph, Joplin and Monett). PG
Energy, headquartered in Wilkes-Barre, Pennsylvania, serves approximately
156,000 customers in northeastern and central Pennsylvania (including
Wilkes-Barre, Scranton and Williamsport). South Florida Natural Gas (SFNG),
headquartered in New Smyrna Beach, Florida, serves approxi mately 4,600
customers in central Florida (including New Smyrna Beach, Edgewater and areas of
Volusia County, Florida.) With the acquisition of Providence Energy Corporation,
Valley Resources, Inc. and Fall River Gas Company in September 2000 (whose
primary business is the distribution of natural gas through its public utility
companies and are collectively hereafter referred to as the New England
Division), the Company now serves approximately 292,000 customers in Rhode
Island and Massachusetts (including Providence, Newport and Cumberland, Rhode
Island and Fall River, North Attleboro and Somerset, Massachusetts.) The diverse
geographic areas of the Company's natural gas distribution systems should reduce
the overall sensitivity of Southern Union's operations to weather risk and local
economic conditions.
Acquisitions and Divestitures
Acquisitions 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. ProvEnergy Power
Company, LLC is a subsidiary acquired in the acquisition which 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 approximately 1,400,000 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 rent and sell appliances, offer service contract programs, sell liquid
propane in Rhode Island and nearby Massachusetts, and distribute as a wholesaler
franchised lines to plumbing and heating contractors. 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
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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 assets of ProvEnergy, Fall River Gas and Valley Resources (hereafter
referred to as the Company's New Eng land Operations) have been included in the
consolidated balance sheet of the Company at June 30, 2001 and the results of
operations from the New England Operations have been included in the statement
of consolidated opera tions since their respective acquisition dates in
September 2000. Thus, the results of operations for the year ended June 30, 2001
are not comparable to prior periods. The acquisitions were accounted for using
the purchase method. The Company plans to sell or dispose of certain non-core
businesses and 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. Income from the
Pennsylvania Operations have been included in the statement of consolidated
operations since November 4, 1999. Thus, the results of operations for the year
ended June 30, 2000 are not comparable to prior periods. The acquisition was
accounted for using the purchase method.
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 and currently operating in
the acquisition of the Pennsylvania Operations include PG Energy Services Inc.,
(Energy Services) and PEI Power Corporation (PEI Power). 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. The Company 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.
Divestitures The Company is currently identifying non-core subsidiaries and
assets and plans to sell or dispose of such properties. Such sales may include
investments in marketable securities. The majority of the net cash pro ceeds
obtained from the sale of non-core assets will be used to reduce long-term debt
or other long-term obligations.
The Company acquired ProvEnergy Oil Enterprises, Inc. (ProvEnergy Oil) through
the acquisition of ProvEnergy. 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 $15,800,000 in August 2001. No gain or loss was
recognized on this transaction.
In connection with the acquisition of the Pennsylvania Operations, the Company
acquired Energy Services, Keystone Pipeline Services, Inc. (Keystone, a
wholly-owned subsidiary of Energy Services) and Theta Land Corporation. In July
2001, the sale of Energy Services' commercial and industrial gas marketing
contracts was completed for approximately $5,000,000, resulting in a pre-tax
gain of $4,600,000. 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.
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Company Operations
The Company's principal line of business is the distribution of natural gas
through its Southern Union Gas, Missouri Gas Energy, PG Energy, and SFNG
divisions, and, effective with the September 2000 acquisitions, its New England
Division. (See Acquisitions) . The Company's gas utility operations are
generally seasonal in nature, with a sig nificant percentage of its annual
revenues and earnings occurring in the traditional winter heating season. As
such, the Company is a sales and market-driven energy company whose management
is committed to achieving profitable growth of its utility divisions in an
increasingly competitive business environment and partnering with companies
which complement Southern Union's existing customer service and core utility
business. Management's strategies for achieving these objectives principally
consist of: (i) promoting new sales opportunities and markets for natural gas;
(ii) enhancing financial and operating performance; (iii) expanding the Company
through development of existing utility businesses and possibly by acquiring of
selective new utility businesses; and (iv) investing selectively in
complementary businesses. Management develops and continually evaluates these
strategies and their imple mentation by applying their experience and expertise
in analyzing the energy industry, technological advances, market opportunities
and general business trends. Each of these strategies, as implemented throughout
the Company's existing businesses, reflects the Company's commitment to its core
natural gas utility business.
Subsidiaries of Southern Union have been established to support and expand
natural gas sales and other energy sales and to capitalize on the Company's
energy expertise. Subsidiaries of the Company market natural gas to end- users,
operate natural gas pipeline systems, generate electricity, distribute propane
and sell commercial gas air conditioning and other gas-fired engine-driven
applications. The Company distributes propane to 9,000, 3,100 and 1,800
customers in Texas, Pennsylvania and Florida, respectively. Additionally,
certain subsidiaries own or hold interests in real estate and other assets,
which are primarily used in the Company's utility business. Central to all of
the Company's present businesses and strategies is the distribution and
transportation of natural gas.
Southern Union Energy International, Inc. (SUEI) and Southern Union
International Investments, Inc. (Investments), both wholly-owned subsidiaries of
Southern Union, participate in energy-related projects internationally. Energia
Estrella del Sur, S. A. de C. V. (Estrella), a wholly-owned Mexican subsidiary
of SUEI and Investments, seeks to participate in energy-related projects in
Mexico. Estrella has a 43% equity ownership in a natural gas distribution com-
pany, along with other related operations, which currently serves 25,000 custo-
mers in Piedras Negras, Mexico, across the border from Southern Union Gas' Eagle
Pass, Texas service area.
Mercado Gas Services, Inc. (Mercado), a wholly-owned subsidiary of Southern
Union, markets natural gas to com mercial and industrial customers. Mercado's
sales and purchasing activities are made through short-term and long- term
contracts. These contracts and business activities are not subject to direct
rate regulation.
Southern Transmission Company (STC), a wholly-owned subsidiary of Southern
Union, owns and operates 165.3 miles of intrastate pipeline that serves
commercial, industrial and utility customers in central, south and coastal
Texas.
Norteno Pipeline Company (Norteno), a wholly-owned subsidiary of Southern Union,
owns and operates interstate pipelines that serve the gas distribution
properties of Southern Union Gas and the Public Service Company of New Mexico.
Norteno also transports gas through its interstate network to the country of
Mexico for Pemex Gas y Petroquimica Basica (PEMEX).
SUPro Energy Company (SUPro), a wholly-owned subsidiary of Southern Union,
provides propane gas services to customers located principally in Austin, El
Paso and Alpine, Texas as well as Las Cruces, New Mexico and sur rounding
communities. SUPro sold 5,859,000 and 5,734,000 gallons of propane for the years
ended June 30, 2001 and 2000.
Atlantic Gas Corporation, a wholly-owned subsidiary of Southern Union, provides
propane gas services to 1,800 cus tomers located in and around the communities
of New Symrna Beach, Lauderhill and Dunnellon, Florida. Atlantic Gas Corporation
sold 1,108,000 and 1,193,000 gallons of propane for the year ended June 30, 2001
and 2000, respectively.
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PG Energy Services, Inc. (Energy Services), a wholly-owned subsidiary of
Southern Union, supplies propane and offers the inspection, maintenance and
servicing of residential and small commercial gas-fired equipment to 3,100
residential, commercial and industrial users primarily in central and
northeastern Pennsylvania.
PEI Power Corporation (Power Corp.), a wholly-owned subsidiary of Southern
Union, an exempt wholesale generator (within the meaning of the Public Utility
Holding Company Act of 1935), generates and sells electricity provided by
two power plants which share a site in Archbald, Pennsylvania. Power Corp.
acquired the first plant, a 25-megawatt cogeneration facility fueled by a
combination of natural gas and methane, in November 1997. During fiscal year
2001 Power Corp. constructed an additional 45-megawatt natural gas-fired
facility in a joint venture with Cayuga Energy. Power Corp. owns 49.9% of the
second plant which is now in service and sells electricity to the broad mid-
Atlantic market of Pennsylvania, New Jersey, Maryland, Delaware and the District
of Columbia.
ProvEnergy Power Company LLC (ProvEnergy Power), a wholly-owned subsidiary of
Southern Union, provides outsourced energy management services and owns 50% of
Capital Center Energy Company LLC, a joint venture formed between ProvEnergy and
ERI Services, Inc. to provide retail power.
Fall River Gas Appliance Company, Inc. (Fall River Appliance), a wholly-owned
subsidiary of Southern Union, rents water heaters and conversion burners
(primarily for residential use) to over 18,000 customers, sells central heating
and air conditioning systems, water heaters and grills, and offers service
contracts on gas appliances in the city of Fall River and the towns of Somerset,
Swansea and Westport, all located in southeastern Massachusetts.
Valley Propane, Inc. (Valley Propane), a wholly-owned subsidiary of Southern
Union, sells liquid propane to 2,800 industrial, commercial and residential
customers in Rhode Island and nearby Massachusetts.
Valley Appliance and Merchandising Company (VAMCO), a wholly-owned subsidiary of
Southern Union, merchan dises and rents natural gas burning appliances, offers
appliance service contract programs, and sells water filtration systems to
residential customers. VAMCO also provides construction management services for
natural gas-related projects to commercial and industrial customers.
Morris Merchants, Inc. (Morris Merchants), a wholly-owned subsidiary of Southern
Union, serves as a manufacturer's representative agency for franchised plumbing
and heating contract supplies, and distributes as a wholesaler franchised lines
to plumbing and heating contractors.
Alternate Energy Corporation (AEC), a wholly-owned subsidiary of Southern Union,
is an energy consulting firm which equips vehicular and stationary engines with
natural gas fuel systems, builds natural gas fueling facilities, and is an
authorized representative of the ONSI Corporation fuel cell and Capstone Micro
Turbines. In addition, AEC retains patents on a natural gas/diesel co-firing
system and on "Passport" FMS (Fuel Management System) which monitors and
controls the transfer of fuel on dual-fuel equipment.
The Company also holds investments in commercially developed real estate in El
Paso, Harlingen and Kansas City through Southern Union's wholly-owned
subsidiary, Lavaca Realty Company (Lavaca Realty). Additionally, through the
acquisition of the Pennsylvania Operations and New England Operations, the
Company owns several tracts of land, certain of which is being prepared for
development, primarily in Lackawanna County of northeastern Pennsyl vania, and
various office buildings, parking garages and operational facilities throughout
Rhode Island and Massa chusetts. Depending upon market conditions, the Company
may sell certain of these investments from time to time.
Southern Union's strategy for long-term growth includes acquiring the right
assets that will position the Company favorably in an evolving competitive
marketplace. The Pennsylvania Operations and New England Operations acquisitions
provide Southern Union with a strong presence in the attractive northeastern
market. These acquisitions also provide geographic and weather diversity to the
Company's service areas. Going forward, Southern Union may consider other
acquisitions which will financially enhance growth and take advantage of future
market opportunities.
Company Investments
Over the past several years, the Company acquired an equity interest in Capstone
Turbine Corporation (Capstone). This company has developed a microturbine fueled
by natural gas or propane that produces electricity and creates less pollution
than conventional systems. The refrigerator-sized microturbine unit can
efficiently provide nearly 30 kilowatts of electricity to a small business.
Additionally, this technology is highly reliable and requires low mainte nance.
In late June 2000, Capstone completed its initial public offering (IPO). The
Company sold securities in Capstone during fiscal year 2001, realizing pre-tax
gains of $74,582,000. As of June 30, 2001 and August 31, 2001, the value of the
Company's remaining investment in Capstone was $29,447,000 and $6,652,000,
respectively, based on the closing prices for Capstone shares on those days. As
of June 30, 2001, the Company had 1,333,061 shares of Capstone common stock.
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Southern Union also holds a $14,586,000 equity interest in PointServe, Inc.
(PointServe), a business-to-business online scheduling solution. Patent-pending,
online scheduling technology should enable service providers to spend less and
earn more by creating accountability of marketing dollars and increasing
operational efficiencies, thus increasing customer satisfaction and loyalty.
Working closely with Southern Union Gas during 2001, PointServe developed a
comprehensive solution for the entire service supply chain, involving both
workforce management and the Company's customer service website. The plan, which
involves the deployment of PointServe's Service Logic(TM) technology, is
designed to help Southern Union Gas achieve tighter appointment time windows and
provide more reliable, responsive service to customers as well as a variety of
management measurement tools.
In April 2001, PointServe acquired Servana.com, Inc. (Servana), in which
Southern Union had an equity interest. Servana partners with utility companies
to deliver comprehensive e-commerce solutions to the customer's home. The
company is positioning itself to become the dominant utility-based home-service
portal, leveraging the utility's brand identity and prominence in local markets.
Servana's Internet-based solutions provide numerous consumer benefits, including
24/7 online access to utilities, no hold times, and better access to call center
staffers who can then handle unique customer care issues.
As of June 30, 2001, Southern Union had a $4,495,000 equity interest in Advent
Networks, Inc. (Advent), head quartered in Austin, Texas. Advent's UltraBand(TM)
technology is expected to deliver digital broadband services 40 times faster
than digital subscriber lines (DSL) or cable modems, and 1,000 times faster than
dial-up modems, over the "last mile". UltraBand(TM) should provide cable network
overbuilders a competitive advantage with its capability to deliver content at a
quality and speed that cannot be provided over cable modem.
Competition
Natural gas distribution has been evolving from a highly regulated environment
to one where competition and customer choice is being promoted. The
restructuring of natural gas distribution began in the 1990's when the Federal
Energy Regulatory Commission (FERC) required interstate pipeline companies to
separate, or unbundle, the merchant function of selling natural gas from the
transportation and storage services they provide and offer those services to end
users on the same terms as local distribution companies. As a result, certain
large volume custo mers, primarily industrial and significant commercial
customers, have had opportunities to access alternative natural gas supplies
and, in some instances, delivery service from other pipeline systems. The
Company has offered trans portation arrangements to customers who secure their
own gas supplies. These transportation arrangements, coupled with the efforts of
Southern Union's unregulated marketing subsidiaries, enable the Company to
provide competitively priced gas service to these large volume customers. In
addition, the Company has successfully used flexible rate provisions, when
needed, to retain customers who may have access to alternative energy sources.
As energy providers, Southern Union Gas, Missouri Gas Energy, PG Energy, New
England and SFNG have historic ally competed with alternative energy sources,
particularly electricity, propane, fuel oil, coal, natural gas liquids and other
refined products available in the Company's service areas. At present rates, the
cost of electricity to residential and commercial customers in the Company's
service areas generally is higher than the effective cost of natural gas
service. There can be no assurance, however, that future fluctuations in gas and
electric costs will not reduce the cost advantage of natural gas service. The
cost of expansion for peak load requirements of electricity in some of Southern
Union Gas' and Missouri Gas Energy's service areas has historically provided
opportunities to allow energy switching to natural gas pursuant to integrated
resource planning techniques. Electric competition has responded by offering
equipment rebates and incentive rates.
Competition between the use of fuel oils, natural gas and propane, particularly
by industrial, electric generation and agricultural customers, has also
increased due to the volatility of natural gas prices and increased marketing
efforts from various energy companies. In order to be more competitive with
certain alternate fuels in Pennsylvania, PG Energy offers an Alternate Fuel Rate
for eligible customers. This rate applies to commercial and industrial accounts
that have the capability of using fuel oils or propane as alternate sources of
energy. Whenever the cost of such alternate fuel drops below PG Energy's normal
tariff rates, PG Energy is permitted by the Pennsylvania Public Utility
Commission (PPUC) to lower its price to these customers so that PG Energy can
remain competitive with the alternate fuel. However, in no instance may PG
Energy sell gas under this special arrangement for less than its average
commodity cost of gas purchased during the month. Competition between the use of
fuel oils, natural gas and propane, is generally greater in Pennsylvania and New
England than the Company's remaining service areas; however, this competition
affects the nationwide market for natural gas. Additionally, the general
economic
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conditions in the Company's service areas continue to affect certain customers
and market areas, thus impacting the results of the Company's operations.
The Company's gas distribution divisions are not currently in significant direct
competition with any other distributors of natural gas to residential and small
commercial customers within their service areas, other than in Pennsylvania. In
1999, the Commonwealth of Pennsylvania enacted the Natural Gas Choice and
Competition Act, which extended the ability to choose suppliers to small
commercial and residential customers as well. Effective April 29, 2000, all of
PG Energy's customers have the ability to select an alternate supplier of
natural gas, which PG Energy will continue to deliver through its distribution
system. Customers can also choose to remain with PG Energy as their supplier
under regulated natural gas rates. In either case, PG Energy serves as the
supplier of last resort. Despite customers' recently acquired right to choose,
higher-than-normal wholesale prices for natural gas have prevented suppliers
from offering competitive rates. To date, due to the lack of offers that provide
any savings over PG Energy's current regulated gas rates, no commercial or
residential customers have switched to alternate suppliers. However, if a
moderation in the wholesale market for natural gas over time produces an
increase in offers competitive with PG Energy's rates, customers may eventually
choose alternate suppliers.
Gas Supply
The cost and reliability of natural gas service is dependent upon the Company's
ability to contract for favorable mixes of long-term and short-term gas supply
arrangements and through favorable fixed and variable transportation con tracts.
The Company has been directly acquiring its gas supplies since the mid-1980s
when interstate pipeline sys tems opened their systems for transportation
service. The Company has the organization, personnel and equipment necessary to
dispatch and monitor gas volumes on a daily, hourly and even a real-time basis
to ensure reliable service to customers.
The FERC required the "unbundling" of services offered by interstate pipeline
companies beginning in 1992. As a result, gas purchasing and transportation
decisions and associated risks have been shifted from the pipeline com panies to
the gas distributors. The increased demands on distributors to effectively
manage their gas supply in an environment of volatile gas prices provides an
advantage to distribution companies such as Southern Union who have demonstrated
a history of contracting favorable and efficient gas supply arrangements in an
open market system.
The majority of 2001 gas requirements for the utility operations of Southern
Union Gas and the New England Division were delivered under short- and long-term
transportation contracts through five major pipeline companies. The majority of
2001 gas requirements for the utility operations of Missouri Gas Energy and PG
Energy were delivered under short- and long-term transportation contracts
through four major pipeline companies, while the majority of SFNG's 2001 gas
requirements were delivered under a management supply contract through one major
pipeline company. These contracts have various expiration dates ranging from
calendar year 2001 through 2018. Southern Union Gas also purchases significant
volumes of gas under long- and short-term arrangements with suppliers. The
amounts of such short-term purchases are contingent upon price. Southern Union
Gas, Missouri Gas Energy, the New England Division and SFNG all have firm supply
commitments for all areas that are supplied with gas purchased under short-term
arrangements. Missouri Gas Energy also holds contract rights to over 16 Bcf of
storage capacity. PG Energy, the New England Division and Southern Union Gas
each hold contract rights to over 11 Bcf, 5 Bcf and 4 Bcf of storage capacity,
respectively, to assist in meeting peak demands. Storage capacity approximates
20% of the Company's annual gas distribution volumes.
Gas sales and/or transportation contracts with interruption provisions, whereby
large volume users purchase gas with the understanding that they may be forced
to shut down or switch to alternate sources of energy at times when the gas is
needed for higher priority customers, have been utilized for load management by
Southern Union and the gas industry as a whole. In addition, during times of
special supply problems, curtailments of deliveries to customers with firm
contracts may be made in accordance with guidelines established by appropriate
federal and state regulatory agencies. There have been no supply-related
curtailments of deliveries to Southern Union Gas, Missouri Gas Energy, PG
Energy, the New England Division or SFNG utility sales customers during the last
ten years.
The Company is committed under various agreements to purchase certain quantities
of gas in the future. At June 30, 2001, the Company has purchase commitments for
certain quantities of gas at variable, market-based prices that have an annual
value of $204,999,000. The Company's purchase commitments may extend over a
period of several
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years depending upon when the required quantity is purchased. The Company has
purchase gas tariffs in effect for all its utility service areas that provide
for recovery of its purchase gas costs under defined methodologies.
Beginning in 1996, the Missouri Public Service Commission (MPSC) authorized a
series of experimental gas supply incentive plans for Missouri Gas Energy. The
initial three year plan, effective July 1, 1996, achieved a reduction in overall
gas costs of $6,900,000 resulting in savings to Missouri customers of $4,000,000
and additional revenues to the Company of $2,900,000 for the year ended June 30,
1999. The MPSC subsequently approved an additional two year gas supply incentive
plan that became effective August 31, 2000. Earnings under the current plan are
primarily dependent on certain market conditions and market prices for natural
gas which did not occur in fiscal 2001, and there is no assurance that the
Company will have an opportunity to generate earnings under this aspect of the
plan during fiscal 2002.
Utility Regulation and Rates
The Company's rates and operations are subject to regulation by local, state and
federal authorities. In Texas, municipalities have primary jurisdiction over
natural gas rates within their respective incorporated areas. Rates in adjacent
environs and appellate matters are the responsibility of the Railroad Commission
of Texas (RRC). In Missouri, natural gas rates are established by the MPSC on a
system-wide basis. In Pennsylvania, natural gas rates for PG Energy are approved
by the PPUC on a system-wide basis. In Rhode Island, natural gas rates for
Providence Gas, Valley Gas Company and Bristol and Warren Gas Company are
approved by the Rhode Island Public Utilities Commission (RIPUC). In
Massachusetts natural gas rates for Fall River Gas Company and North Attleboro
Gas are subject to the regulatory authority of the Massachusetts Department of
Telecommunications and Energy (MDTE). In Florida, natural gas rates are
established by the Florida Public Service Commission on a system-wide basis. The
FERC has jurisdiction over rates, facilities and services of Norteno and Power
Corp., and the RRC has jurisdiction over STC.
The Company holds non-exclusive franchises with varying expiration dates in all
incorporated communities where it is necessary to carry on its business as it is
now being conducted. Providence, Rhode Island; Fall River, Massachusetts; Kansas
City, Missouri; El Paso, Texas; Austin, Texas; St. Joseph, Missouri; and Port
Arthur, Texas; are the seven largest cities in which the Company's utility
customers are located. The franchises in the following cities expire as follows:
El Paso, Texas in 2030; Port Arthur, Texas in 2013; Kansas City, Missouri in
2010; and Austin, Texas in 2006. The Company fully expects these franchises to
be renewed upon their expiration. The franchises in Providence, Rhode Island;
Fall River, Massachusetts; and St. Joseph, Missouri are perpetual.
Gas service rates are established by regulatory authorities to permit utilities
the opportunity to recover operating, administrative and financing costs, and
the opportunity to earn a reasonable return on equity. Gas costs are billed to
customers through purchase gas adjustment (PGA) clauses which permit the Company
to adjust its sales price as the cost of purchased gas changes. This is
important because the cost of natural gas accounts for a significant portion of
the Company's total expenses. The appropriate regulatory authority must receive
notice of such adjustments prior to billing implementation.
Other than in Pennsylvania, the Company supports any service rate changes to its
regulators using a historic test year of operating results adjusted to normal
conditions and for any known and measurable revenue or expense changes. Because
the regulatory process has certain inherent time delays, rate orders may not
reflect the operating costs at the time new rates are put into effect. In
Pennsylvania, a future test year is utilized for ratemaking purposes, therefore,
there is no delay and rate orders more closely reflect the operating costs at
the time new rates are put into effect.
The monthly customer bill contains a fixed service charge, a usage charge for
service to deliver gas, and a charge for the amount of natural gas used. While
the monthly fixed charge provides an even revenue stream, the usage charge
increases the Company's annual revenue and earnings in the traditional heating
load months when usage of natural gas increases. In recent years, the majority
of the Company's rate increases in Texas have resulted in increased monthly
fixed charges which help stabilize earnings. Weather normalization clauses also
serve to stabilize earnings in 22 Texas towns and cities, including Austin,
Andrews and various El Paso service areas, Galveston, Port Arthur and Mineral
Wells.
--------------------------------------------------------------------------------
7
Missouri On July 5, 2001, the 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 customer service 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.
On August 21, 1998, Missouri Gas Energy was notified by the MPSC of its decision
to grant a $13,300,000 annual increase to revenue effective on September 2,
1998, which is primarily earned volumetrically.
The approval of the January 31, 1994 acquisition of the Missouri properties by
the MPSC was subject to the terms of a stipulation and settlement agreement,
which, among other things, requires Missouri Gas Energy to reduce rate base by
$30,000,000 (amortized over a ten-year period on a straight-line basis) to
compensate rate payers for rate base reductions that were eliminated as a result
of the acquisition.
Rhode Island Pursuant to the RIPUC's Written Order issued April 30, 2001,
Providence Gas' Price Stabilization Plan was extended through June 2002. The
related settlement agreement provides for additional gas distribution margin of
$12,030,000 over the 21-month period, October 2000 through June 2002, or
approximately $6,240,000 for the twelve months ended September 2001.
The settlement agreement also contains a weather mitigation clause and a
non-firm margin incentive mechanism (non-firm margin is margin earned from
interruptible customers with the ability to switch to alternative fuels). The
weather mitigation clause is designed to mitigate the impact of weather
volatility on customer billings, which will assist customers in paying bills and
stabilize the revenue stream to Providence Gas. Providence Gas will defer the
margin impact of weather that is greater than 2% colder-than-normal and will
recover the margin impact of weather that is greater than 3% warmer-than-normal
by making the corresponding adjustment to the deferred revenue account (DRA).
The non-firm margin incentive mechanism is designed to encourage Providence Gas
to promote the development of non-firm margins, which will reduce the cost of
service to all customers. Providence Gas will retain 25% of all non-firm margins
earned in excess of $1,200,000.
Under the settlement agreement, Providence Gas may earn up to 10.7%, but not
less than 7.0%, using the average return on equity for the two 12-month periods
of October 2000 through September 2001 and July 2001 through June 2002.
Effective October 1, 2000, the RIPUC had approved a settlement agreement between
Providence Gas, the Rhode Island Division of Public Utilities and Carriers, the
Energy Council of Rhode Island, and The George Wiley Center. The settlement
agreement recognized the need for an increase in distribution system revenues of
$4,500,000, recovered through an adjustment to the throughput portion of the gas
charge, and provided for a 21-month base rate freeze. In the settlement
agreement, the RIPUC authorized system improvement programs. Additionally,
higher levels of support for low income bill payment assistance was authorized
as well as the continuation of the utility's demand side management and
weatherization assistance programs.
Pennsylvania On April 3, 2000, PG Energy filed an application with the 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.
Other During the three-year period ended June 30, 2001, the Company did not file
for any other rate increases in any of its major service areas, although several
annual cost of service adjustments were filed.
--------------------------------------------------------------------------------
8
In addition to the regulation of its utility and pipeline businesses, the
Company is affected by numerous other regula tory controls, including, among
others, pipeline safety requirements of the United States Department of
Transporta tion, safety regulations under the Occupational Safety and Health
Act, and various state and federal environmental statutes and regulations. The
Company believes that its operations are in compliance with applicable safety
and environmental statutes and regulations.
Environmental
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
existing 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. See
Management's Discussion and Analysis of Results of Operations and Financial
Condition (MD&A) -- Cautionary Statement Regarding Forward-Looking Information
and Commitments and Contingencies in the Notes to the Consolidated Financial
Statements.
Investments in Real Estate
Lavaca Realty owns a two-story office building in El Paso, Texas as well as a
one-story office building in Harlingen, Texas. Other significant real estate
investments held at June 30, 2001 include 39,341 square feet of undeveloped land
in McAllen, Texas and 25,000 square feet of improved property in Kansas City,
Missouri, of which 40% is occupied by Missouri Gas Energy and the remainder by a
non-affiliated entity. Additionally, through the acquisition of the Pennsylvania
Operations and New England Operations, the Company owns several tracts of land,
certain of which are being prepared for development, primarily in Lackawanna
County of northeastern Pennsylvania, and various office buildings, parking
garages and operational facilities throughout Rhode Island and Massachusetts.
Depending upon market conditions, the Company may sell certain of these
investments from time to time.
Employees
As of July 31, 2001, the Company had 3,105 employees, of whom 2,320 are paid on
an hourly basis, 784 are paid on a salary basis and one is paid on a commission
basis. Of the 2,278 hourly paid employees, 50% are represented by unions. Of
those employees represented by unions, 44% are employed by Missouri Gas Energy,
19% are employed by PG Energy, 35% are employed by the New England Division and
2% by Southern Union Gas.
In August 2001, the Company announced implementation of a corporate
reorganization and restructuring which was initially announced in July 2001 as
part of a Cash Flow Improvement Plan. See MD&A -- Other Matters -- Corporate
Restructuring. 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 division. ERPs,
providing for increased benefits for those electing retirement, were offered to
approximately 400 eligible employees across the Company's operating divisions.
In connection with the RIF, 48 employees were offered severance packages.
During fiscal 2001, the Company agreed to three-year contracts with two
bargaining units representing Pennsylvania employees, which were effective in
April 2001 and August of 2000, respectively. In December 1998, the Company
agreed to five-year contracts with each bargaining-unit representing Missouri
employees, which were effective in May 1999.
Providence Gas' two bargaining units are covered by contracts through January
2002 and May 2002. Valley Resources' two bargaining units are covered by
contracts through March 2002 and May 2002. Fall River Gas' bargaining unit
employees are covered by a contract through April 2002.
From time to time the Company may be subject to labor disputes; however, such
disputes have not in recent years disrupted its business. The Company believes
that its relations with its employees are good.
--------------------------------------------------------------------------------
9
Statistics of Principal Utility and Related Operations
The following table shows certain operating statistics of the Company's gas
distribution divisions with operations in Texas, Missouri, Pennsylvania, and New
England (Rhode Island and Massachusetts), which the Company owned during the
years ended June 30:
Year Ended June 30,
------------------------------
2001 2000 1999
-------- -------- --------
Southern Union Gas:
Average number of gas sales customers served:
Residential.................................. 491,086 483,220 473,563
Commercial................................... 32,762 31,860 30,847
Industrial and irrigation.................... 251 253 258
Public authorities and other................. 2,818 2,862 2,849
-------- -------- --------
Total average customers served............. 526,917 518,195 507,517
======== ======== ========
Gas sales in millions of cubic feet (MMcf):
Residential.................................. 24,260 19,524 19,553
Commercial................................... 10,069 8,677 8,539
Industrial and irrigation.................... 1,103 969 1,082
Public authorities and other................. 2,855 2,377 2,266
-------- -------- --------
Gas sales billed........................... 38,287 31,547 31,440
Net change in unbilled gas sales............. (97) 137 175
-------- -------- --------
Total gas sales............................ 38,190 31,684 31,615
======== ======== ========
Weather:
Degree days (a).............................. 2,380 1,516 1,576
Percent of 10-year measure (b)............... 130% 83% 86%
Percent of 30-year measure (b)............... 112% 71% 74%
Gas transported in MMcf........................ 26,753 17,472 16,668
Missouri Gas Energy:
Average number of gas sales customers served:
Residential.................................. 428,971 424,771 418,266
Commercial................................... 59,742 58,323 57,247
Industrial................................... 310 309 313
-------- -------- --------
Total average customers served............. 489,023 483,403 475,826
======== ======== ========
Gas sales in MMcf:
Residential.................................. 44,011 34,999 36,578
Commercial................................... 19,828 15,640 16,842
Industrial................................... 598 412 375
-------- -------- --------
Gas sales billed........................... 64,437 51,051 53,795
Net change in unbilled gas sales............. (64) 37 204
-------- -------- --------
Total gas sales............................ 64,373 51,088 53,999
======== ======== ========
Weather:
Degree days (a).............................. 5,541 4,176 4,438
Percent of 10-year measure (b)............... 107% 80% 85%
Percent of 30-year measure (b).............. 106% 80% 85%
Gas transported in MMcf........................ 30,921 31,644 31,774
------------------------
(a) "Degree days" are a measure of the coldness of the weather experienced. A
degree day is equivalent to each degree that the daily mean temperature for
a day falls below 65 degrees Fahrenheit.
(b) Information with respect to weather conditions is provided by the National
Oceanic and Atmospheric Administration. Percentages of 10- and 30-year
measure are computed based on the weighted average volumes of gas sales
billed. The 10- and 30-year measure is used 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.
--------------------------------------------------------------------------------
10
Year Ended Eight Months Ended
June 30, 2001 June 30, 2000(a)
------------- ------------------
PG Energy:
Average number of gas sales customers served:
Residential................................ 140,815 140,019
Commercial................................. 13,991 13,872
Industrial................................. 206 209
Public Authorities and Other............... 310 314
-------- --------
Total average customers served........... 155,322 154,414
======== ========
Gas sales in MMcf:
Residential................................ 17,965 14,830
Commercial................................. 6,561 4,969
Industrial................................. 535 215
Public Authorities and Other............... 368 213
-------- --------
Gas sales billed......................... 25,429 20,227
Net change in unbilled gas sales........... 40 (314)
-------- --------
Total gas sales.......................... 25,469 19,913
======== ========
Weather:
Degree days (b)............................ 6,621 5,287
Percent of 10-year measure (c)............. 108% 86%
Percent of 30-year measure (c)............. 105% 92%
Gas transported in MMcf...................... 25,430 19,403
Nine Months Ended
June 30, 2001(d)
-----------------
New England Division:
Average number of gas sales customers served:
Residential................................ 264,349
Commercial................................. 21,634
Industrial................................. 3,570
Public Authorities and Other............... 45
--------
Total average customers served........... 289,598
========
Gas sales in MMcf:
Residential................................ 21,690
Commercial................................. 7,293
Industrial................................. 2,721
Public Authorities and Other............... 22
--------
Gas sales billed......................... 31,726
Net change in unbilled gas sales........... 286
--------
Total gas sales.......................... 32,012
========
Weather:
Degree days (b)............................ 5,273
Percent of 10-year measure (c)............. 105%
Percent of 30-year measure (c)............. 102%
Gas transported in MMcf...................... 7,399
-----------------------
(a) PG Energy was acquired on November 4, 1999. See Acquisitions.
(b) "Degree days" are a measure of the coldness of the weather experienced. A
degree day is equivalent to each degree that the daily mean temperature for
a day falls below 65 degrees Fahrenheit.
(c) Information with respect to weather conditions is provided by the National
Oceanic and Atmospheric Administration. Percentages of 10- and 30-year
measure are computed based on the weighted average volumes of gas sales
billed. The 10- and 30-year measure is used 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.
(d) Information for Fall River Gas and ProvEnergy, acquired September 28, 2000,
and Valley Resources, acquired September 20, 2000, is included since
October 1, 2000. See Acquisitions.
--------------------------------------------------------------------------------
11
Customers. The following table shows the number of customers served by the
Company, through its divisions, subsidiaries and affiliates, as of the end of
its last three fiscal years.
Gas Utility Customers at June 30,
----------------------------------
2001 2000 1999
---------- ---------- ----------
Southern Union Gas:
Austin and other central and south Texas
communities............................. 190,696 183,872 175,596
El Paso and other west Texas communities.. 189,134 187,189 182,516
Galveston and Port Arthur................. 49,292 50,237 50,543
Panhandle and north Texas communities..... 24,046 24,584 24,728
Rio Grande Valley communities and Eagle
Pass.................................... 74,641 75,608 75,983
---------- ---------- ----------
527,809 521,490 509,366
---------- ---------- ----------
Missouri Gas Energy:
Kansas City, Missouri Metropolitan Area... 379,057 379,804 374,020
St. Joseph, Joplin, Monett and others..... 103,469 104,432 103,052
---------- ---------- ----------
482,526 484,236 477,072
---------- ---------- ----------
PG Energy................................... 155,439 154,399 --
New England Division........................ 289,048 -- --
Other (a)................................... 44,103 25,971 24,947
---------- ---------- ----------
Total....................................... 1,498,925 1,186,096 1,011,385
========== ========== ==========
--------------------------
(a) Includes Mercado, South Florida Natural Gas, Atlantic Gas Corporation,
SUPro Energy Services, PG Energy Services, Inc., Valley Propane, ProvEnergy
Fuels and a natural gas distribution company serving customers in Piedras
Negras, Mexico, in which the Company has a 43% equity ownership, in each
case for the year-end in which the Company had such operations or
investments.
ITEM 2. Properties.
See Item 1, Business, for information concerning the general location and
characteristics of the important physical properties and assets of the Company.
Southern Union Gas has 8,062 miles of mains, 4,395 miles of service lines and
164 miles of transmission lines. STC and Norteno have 171 miles and 7 miles,
respectively, of transmission lines. Missouri Gas Energy has 7,767 miles of
mains, 4,776 miles of service lines and 47 miles of transmission lines. PG
Energy has 2,484 miles of mains, 1,472 miles of service lines and 29 miles of
transmission lines. New England has 3,613 miles of mains and 3,178 miles of
service lines. SFNG has 143 miles of mains and 85 miles of service lines. The
Company considers its systems to be in good condition and well-maintained, and
it has continuing replacement programs based on historical per formance and
system surveillance.
Power Corp. retains ownership of two electric power plants which share a site in
Archbald, Pennsylvania. Power Corp. acquired the first plant, a 25-megawatt
cogeneration facility fueled by a combination of natural gas and methane, in
November 1997. During fiscal year 2001 Power Corp. constructed an additional
45-megawatt, natural gas-fired plant in a joint venture with Cayuga Energy.
Power Corp. owns 49.9% of the second plant which is now in service and selling
electricity to the broad mid-Atlantic market of Pennsylvania, New Jersey,
Maryland, Delaware and the District of Columbia.
ITEM 3. Legal Proceedings.
See Commitments and Contingencies in the Notes to Consolidated Financial
Statements for a discussion of the Company's legal proceedings. See MD&A --
Cautionary Statement Regarding Forward-Looking Information.
ITEM 4. Submission of Matters to a Vote of Security Holders.
There were no matters submitted to a vote of security holders of Southern Union
during the quarter ended June 30, 2001.
--------------------------------------------------------------------------------
12
PART II
ITEM 5. Market for the Registrant's Common Stock and Related Stockholder
Matters.
Market Information
Southern Union's common stock is traded on the New York Stock Exchange under the
symbol "SUG". The high and low sales prices (adjusted for any stock dividends
and stock splits) for shares of Southern Union common stock since July 1, 1999
are set forth below:
$/Share
--------------
High Low
------ ------
July 1 to September 19, 2001................................. $24.18 $17.81
(Quarter Ended)
June 30, 2001................................................ 21.35 16.71
March 31, 2001............................................... 25.12 18.10
December 31, 2000............................................. 26.61 16.19
September 30, 2000............................................ 19.76 15.24
(Quarter Ended)
June 30, 2000................................................. 16.44 13.72
March 31, 2000................................................ 17.29 12.02
December 31, 1999............................................. 19.05 15.82
September 30, 1999............................................ 19.67 16.33
Holders
As of September 19, 2001, there were 7,724 holders of record of Southern Union's
common stock and 53,824,027 shares of Southern Union's common stock outstanding.
The holders of record do not include persons whose shares are held of record by
a bank, brokerage house or clearing agency, but does include any such bank,
brokerage house or clearing agency that is a holder of record.
On August 31, 2001 36,618,220 shares of Southern Union's common stock were held
by non-affiliates (i.e., not beneficially held by directors, executive officers,
their immediate family members, or holders of 10% or more of shares
outstanding).
Dividends
Provisions in certain of Southern Union's long-term debt and its bank credit
facilities limit the payment of cash or asset dividends on capital stock. Under
the most restrictive provisions in effect, Southern Union may not declare or pay
any cash or asset dividends on its common stock or acquire or retire any of
Southern Union's common stock, unless no event of default exists and the Company
meets certain financial ratio requirements, which presently are met.
Southern Union has a policy of reinvesting its earnings in its businesses,
rather than paying cash dividends. Since 1994, Southern Union has distributed an
annual stock dividend of 5%. There have been no cash dividends on its common
stock during this period. On August 30, 2001, June 30, 2000, August 6, 1999 and
December 9, 1998, the Company distributed its annual 5% common stock dividend to
stockholders of record on August 16, 2001, June 19, 2000, July 23, 1999 and
November 23, 1998, respectively. A portion of each of the 5% stock dividends
distributed on August 30, 2001, June 30, 2000, August 6, 1999 and December 9,
1998 was characterized as a distribution of capital due to the level of the
Company's retained earnings available for distribution as of the declaration
date.
--------------------------------------------------------------------------------
13
ITEM 6. Selected Financial Data.
As of and for the year ended June 30,
------------------------------------------------------
2001(a) 2000(b) 1999 1998(c) 1997
---------- ---------- ---------- ---------- ----------
(dollars in thousands, except per share amounts)
Total operating
revenues................ $1,932,813 $ 831,704 $ 605,231 $ 669,304 $ 717,031
Earnings from continuing
operations (d).......... 57,285 9,845 10,445 12,229 19,032
Earnings per common and
common share equiva-
lents (e)............... 1.04 .21 .29 .35 .56
Total assets............. 2,896,871 2,021,460 1,087,348 1,047,764 990,403
Common stockholders'
equity.................. 721,857 735,455 301,058 296,834 267,462
Short-term debt and capi-
tal lease obligation.... 5,913 2,193 2,066 1,777 687
Long-term debt and capi-
tal lease obligation,
excluding current
portion................. 1,329,631 733,774 390,931 406,407 386,157
Company-obligated manda-
torily redeemable pre-
ferred securities of
subsidiary trust........ 100,000 100,000 100,000 100,000 100,000
Average customers served. 1,506,371 1,132,699 998,476 979,186 955,838
---------------------
(a) The New England Operations, formed through the acquisition of Providence
Energy Corporation and Fall River Gas Company on September 28, 2000, and
Valley Resources, Inc. on September 20, 2000, were accounted for as a
purchase and are included in the Company's consolidated balance sheet at
June 30, 2001. The results of operations for the New England Operations
have been included in the Company's consolidated results of operations
since their respective acquisition dates. For these reasons, the
consolidated results of operations of the Company for the periods
subsequent to the acquisitions are not comparable to the same periods in
prior years.
(b) The Pennsylvania Operations were acquired on November 4, 1999 and were
accounted for as a purchase. The Pennsylvania Operations' assets were
included in the Company's consolidated balance sheet at June 30, 2000 and
its results of operations have been included in the Company's consolidated
results of operations since November 4, 1999. For these reasons, the
consolidated results of operations of the Company for the periods
subsequent to the acquisition are not comparable to the same periods in
prior years.
(c) On December 31, 1997, Southern Union acquired Atlantic for 755,650
pre-split and pre-stock dividend shares of common stock valued at
$18,041,000 and cash of $4,436,000.
(d) As of June 30, 1998, Missouri Gas Energy wrote off $8,163,000 pre-tax in
previously recorded regulatory assets as a result of announced rate orders
and court rulings.
(e) Earnings per share for all periods presented were computed based on the
weighted average number of shares of common stock and common stock
equivalents outstanding during the year adjusted for (i) the 5% stock
dividends distributed on August 30, 2001, June 30, 2000, August 6, 1999,
December 9, 1998 and December 10, 1997, and (ii) the 50% stock dividend
distributed on July 13, 1998.
--------------------------------------------------------------------------------
14
ITEM 7. Management's Discussion and Analysis of Results of Operations and
Financial Condition.
Overview Southern Union Company's core business is the distribution of natural
gas as a public utility through: Southern Union Gas; Missouri Gas Energy; 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. Southern Union Gas serves 535,000 customers in Texas (including
Austin, Brownsville, El Paso, Galveston, Harlingen, McAllen and Port Arthur).
Missouri Gas Energy serves 498,000 customers in central and western Missouri
(including Kansas City, St. Joseph, Joplin and Monett). PG Energy serves 156,000
customers in northeastern and central Pennsylvania (including Wilkes-Barre,
Scranton and Williamsport). SFNG serves 4,600 customers in portions of central
Florida (including New Smyrna Beach, Edgewater and areas of Volusia County,
Florida). The New England Division serves approximately 292,000 customers in
Rhode Island and Massachusetts (including Providence, Newport and Cumberland,
Rhode Island, and Fall River, North Attleboro and Somerset, Massachusetts).
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 $15,800,000 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 approximately 1,400,000 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 Propane Inc. (Valley Propane), Morris Merchants Inc.
(Morris Merchants) and Valley Appliance and Merchandising Company (VAMCO).
Valley Propane sells liquid propane to 2,800 customers in Rhode Island and
nearby Massachusetts. Morris Merchants serves as a manufacturers'
representative agency for franchised plumbing and heating contract supplies
throughout New England and New York. 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. 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 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 June 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. Thus, the
results of operations for the year ended June 30, 2001 are not comparable to
prior periods. 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
--------------------------------------------------------------------------------
15
accounted for using the purchase method. 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 Pennsyl vania 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 income from
the Pennsylvania Operations have been included in the statement of consolidated
operations since November 4, 1999. Thus, the results of operations for the year
ended June 30, 2000 are not comparable to prior periods. The acquisition was
accounted for using the purchase method.
The Pennsylvania Operations natural gas utility businesses are being operated as
the PG Energy division of the Company. Through the acquisition of the
Pennsylvania Operations the Company acquired and now operates PG Energy Services
Inc., (Energy Services) and PEI Power Corporation (PEI Power). 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. In July 2001, the commercial and industrial gas
marketing contracts of Energy Services were sold for approximately $5,000,000,
resulting in a pre-tax gain of $4,600,000. 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.
Results of Operations
Net Earnings Southern Union Company's 2001 (fiscal year ended June 30) net
earnings were $57,285,000 ($1.04 per common share, diluted for outstanding
options and warrants -- hereafter referred to as per share), compared with
$9,845,000 ($.21 per share) in 2000. Net earnings for the year ended June 30,
2001 were positively impacted by the sale of a portion of Southern Union's
holdings in Capstone Turbine Corporation realizing after-tax gains of
$43,726,000. Net earnings in 2001 also reflect the acquisition of the New
England Operations which contributed $6,074,000 in net earnings. While operating
margin benefited from weather that was 36% colder than 2000, pur chased gas
costs increased over 90% in 2001 compared with the prior year resulting in an
increase in bad debt expense of $16,642,000, net of tax. Average common and
common share equivalents outstanding increased 15% in 2001 due to the issuance
of 1,370,629 shares and 16,713,735 shares, before adjustment for any subsequent
stock dividends, of the Company's common stock in connection with the
acquisition of Fall River Gas and the Pennsylvania Operations, respectively. The
Company earned 8.8% on average common equity in 2001.
The Company's 2000 net earnings were $9,845,000 ($.21 per share), compared with
$10,445,000 ($.29 per share) in 1999. The acquisition of the Pennsylvania
Operations, net of interest expense on $300,000,000 of 8.25% Senior Notes issued
on November 3, 1999, contributed $4,266,000 in net earnings. Throughout fiscal
year 2000, the Company experienced extremely warm winter weather in all of its
service territories. In addition, the Company expended costs associated with
unsuccessful acquisition activities and related litigation. Also, during fiscal
year 2000, the Company incurred non-cash losses of $1,207,000, net of tax from
unauthorized financial derivative energy trading activity. This was partially
offset by an increase in the average number of customers served. Though weather
in the Southern Union Gas service territories during 2000 was 4% warmer than
1999, gas sales volumes in the corresponding period remained constant due to an
increase of 11,000 average number of customers served. In the Missouri service
territories weather was 6% warmer during 2000 than 1999 and gas sales volumes in
the corresponding period decreased 5%. An increase of 8,000 average number of
customers served in Missouri partially offset the decrease in gas sales volumes
in 2000. During fiscal years 2000 and 1999, the Company incurred pre-tax costs
of $10,363,000 and $3,839,000, respectively, related to an unsuccessful
acquisition effort and related litigation, impacting per share earnings by $.12
and $.06, respectively. Average common and common share equivalents out standing
increased 33% in 2000 due to the issuance of 16,713,735 pre-stock dividend
shares of the Company's common stock on November 4, 1999 in connection with the
acquisition of the Pennsylvania Operations. The Company earned 1.9% and 3.5% on
average common equity in 2000 and 1999, respectively.
Operating Revenues Operating revenues in 2001 increased $1,101,109,000, or 132%,
to $1,932,813,000 while gas purchase and other energy costs increased
$877,052,000, or 176%, to $1,374,750,000.
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The increase in both operating revenues and gas purchase and other energy costs
between periods was primarily due to a 47% increase in gas sales volumes to
176,654 MMcf in 2001 from 119,778 MMcf in 2000 and by a 90% increase in the
average cost of gas from $3.67 per Mcf in 2000 to $6.98 per Mcf in 2001. The
increase in the average cost of gas is due to increases in average spot market
gas prices throughout the Company's distribution system as a result of seasonal
impacts on demands for natural gas as well as the current competitive pricing
occurring within the entire energy industry. The New England Operations
contributed $429,074,000 to the overall increase in operating revenues,
$270,599,000 in gas purchase and other energy costs and 32,012 MMcf of the
increase in gas sales volume. The Pennsylvania Operations generated a net
increase from 2000 to 2001 of $155,093,000 in operating revenues, $135,766,000
in gas purchase and other energy costs, and 5,557 MMcf of the increase in gas
sales volume. Additionally impacting operating revenues in 2001 was a
$33,905,000 increase in gross receipt taxes primarily due to an increase in gas
purchase and other energy costs in the Texas and Missouri service territories in
2001 as compared to 2000 as well as the acquisition of the New England
Operations. Gross receipt taxes are levied on sales revenues billed to the
customers and remitted to the various taxing authorities. The remaining increase
in operating revenues, gas purchase and other energy costs, and gas sales volume
resulted principally from the colder-than-normal weather in the Texas and
Missouri service territories in 2001 as compared to the unusually mild
temperatures in 2000.
Gas purchase costs generally do not directly affect earnings since these costs
are passed on to customers pursuant to purchase gas adjustment (PGA) clauses.
Accordingly, while changes in the cost of gas may cause the Company's operating
revenues to fluctuate, operating margin is generally not affected by increases
or decreases in the cost of gas. Increases in gas purchase costs indirectly
affect earnings as the customer's bill increases, usually resulting in increased
bad debt and collection costs being recorded by the Company.
Gas transportation volumes in 2001 increased 13,489 MMcf to 90,504 MMcf at an
average transportation rate per Mcf of $.50 compared with $.43 in 2000. The New
England Division contributed an increase of 7,399 MMcf, while PG Energy
experienced a net increase of 6,027 MMcf in 2001.
Operating revenues in 2000 compared with 1999 increased $226,473,000, or 37%, to
$831,704,000, while gas purchase and other energy costs increased $155,397,000,
or 45%, to $497,698,000.
The increase in both operating revenues and gas purchase and other energy costs
was primarily due to a 14% increase in gas sales volumes from 105,156 MMcf in
1999 to 119,778 MMcf in 2000 and by a 14% increase in the average cost of gas
from $3.23 per Mcf in 1999 to $3.67 per Mcf in 2000. The acquisition of PG
Energy contributed 19,913 MMcf of the increase while the remaining operations of
the Company resulted in a gas sales volume decrease of 5,291 MMcf. The increase
in the average cost of gas was due to increases in average spot market gas
prices resulting from seasonal impacts on demands as noted above. Also impacting
operating revenues in 2000 was a $2,862,000 increase in gross receipt taxes
primarily due to the acquisition of the Pennsylvania Operations. Operating
revenues in 2000 compared with 1999 were also impacted by a $2,900,000 decrease
in revenues from the gas supply incentive plan approved by the MPSC in July,
1996. Under the plan, Southern Union and its Missouri customers shared in
certain savings below benchmark levels of gas costs incurred as a result of the
Company's gas procurement activities. Operating revenues were marginally
impacted by the $13,300,000 annual increase to revenues granted to Missouri Gas
Energy, effective as of September 2, 1998, as this rate increase is primarily
earned volumetrically and therefore was negatively impacted by the
warmer-than-normal weather in both 2000 and 1999.
Gas transportation volumes in 2000 increased 21,323 MMcf to 77,015 MMcf at an
average transportation rate per Mcf of $.43 compared with $.36 in 1999. PG
Energy contributed 19,403 MMcf of the increase in 2000. Transporta tion volumes
at Missouri Gas Energy in 2000 were relatively flat and increased from 23,918
MMcf to 25,969 MMcf in 2000 for Southern Union Gas and the Company's pipeline
subsidiaries. This increase was primarily due to a 15% increase, or 990 MMcf, in
the amount of volumes transported into Mexico by Norteno Pipeline Company
(Norteno), a subsidiary of the Company.
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Operating Margin Operating margin in 2001 (operating revenues less gas purchase
and other energy costs and revenue-related taxes) increased by $190,152,000,
compared with an increase of $68,214,000, in 2000. Operating margins and
earnings are primarily dependent upon gas sales volumes, gas service rates, and
the timing of the acquisition of the New England Operations and Pennsylvania
Operations. The level of gas sales volumes is sensitive to the variability of
the weather. Sales volumes, which were negatively impacted by unusually mild
temperatures throughout fiscal years 2000 and 1999, benefited from colder
weather during 2001. If normal weather had been present throughout the Company's
service territories in 2000 and 1999, operating margin would have increased by
approximately $21,214,000 and $20,334,000, respectively. Texas, Missouri and
Pennsylvania accounted for 21%, 29% and 18%, respectively, of the Company's
operating margin in 2001 and 32%, 42% and 23%, respectively, in 2000. New
England accounted for 30% of the Company's operating margin in 2001.
Weather Weather in the Missouri Gas Energy service territories in 2001 was 106%
of a 30-year measure, 33% colder than in 2000. Weather in the Southern Union Gas
service territories in 2001 was 112% of a 30-year measure, 58% colder than in
2000. About half of the customers served by Southern Union Gas are weather
normalized. Weather in the PG Energy service territories in 2001 was 105% of a
30-year measure, 14% colder than for the eight months ended June 30, 2000.
Weather in the New England service territories was 102% of a 30-year measure for
the nine months ended June 30, 2001.
Weather in Missouri in 2000 was 80% of a 30-year measure, 6% warmer than in
1999. Weather in Texas in 2000 was 71% of a 30-year measure, 4% warmer than in
1999. Weather in the PG Energy service territories was 92% of a 30-year measure
for the eight months ended June 30, 2000.
Customers The average number of customers served in 2001, 2000 and 1999 was
1,506,371, 1,132,699 and 998,476, respectively. These customer totals exclude
Southern Union's 43% equity ownership in a natural gas distribution company in
Piedras Negras, Mexico which currently serves 25,000 customers. Southern Union
Gas served 526,917 customers in Texas during 2001. Missouri Gas Energy served
489,023 customers in central and western Missouri. PG Energy served 155,322
customers in northeastern and central Pennsylvania, and the New England Division
served 289,598 customers in Rhode Island and Massachusetts during the nine
months ended June 30, 2001. SFNG and Atlantic Gas Corporation, a propane
subsidiary of the Company, served 4,385 and 764 customers, respectively, during
2001. SUPro Energy Company (SUPro), a subsidiary of the Company, served 8,836
propane customers while PG Energy Services, Inc. (Energy Services), a subsidiary
of the Company, served 14,990 electric, propane and natural gas customers during
2001. In Rhode Island and Massachusetts, Valley Propane, Inc. (Valley Propane),
a subsidiary of the Company, served 2,800 propane customers while ProvEnergy
Fuels, Inc. (ProvEnergy Fuels), a fuel oil subsidiary of the Company, served
14,000 customers during the nine months ended June 30, 2001.
Operating Expenses Operating, maintenance and general expenses in 2001 increased
$102,967,000, or 75%, to $239,554,000. Increases of $65,878,000 and $12,737,000
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 $18,294,000 resulted from an increase
in delinquent customer receivables as a result of higher gas prices and colder
weather. Also impacting operating expenses were increases in employee payroll
and benefit costs.
Depreciation and amortization expense in 2001 increased $31,845,000 to
$86,985,000. The increase was primarily due to the New England Operations and
the Pennsylvania Operations, respectively, and normal growth in plant. Taxes
other than on income and revenues, principally consisting of property, payroll
and state franchise taxes increased $12,591,000 to $29,860,000 in 2001. The
increase was also primarily the result of the acquisition of the New England
Operations. See Other Matters -- Accounting Pronouncements.
Operating, maintenance and general expenses in 2000 increased $26,894,000, or
25%, to $136,587,000. An increase of $23,804,000 was the result of the
acquisition of the Pennsylvania Operations. Increased expenses associated with
increased bad debt expense and inventory write-downs for SUPro, as well as
increases in Company employee benefit costs also contributed to the increase in
2000.
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Depreciation and amortization expense in 2000 increased $13,285,000 to
$55,140,000 as a result of the acquisition of the Pennsylvania Operations and
normal growth in plant. Taxes other than on income and revenues, principally
consisting of property, payroll and state franchise taxes increased $2,768,000
to $17,269,000 in 2000. The increase was primarily the result of the acquisition
of the Pennsylvania Operations. See Other Matters -- Accounting Pronouncements.
Employees The Company employed 3,092, 2,285 and 1,554 individuals as of June 30,
2001, 2000 and 1999, respectively. After gas purchases and taxes, employee costs
and related benefits are the Company's most significant expense. Such expense
includes salaries, payroll and related taxes and employee benefits such as
health, savings, retirement and educational assistance.
In August 2001, the Company announced implementation of a corporate
reorganization and restructuring which was initially announced in July 2001 as
part of a Cash Flow Improvement Plan. See Corporate Restructuring. 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 division. ERPs, providing for increased benefits for those
electing retirement, were offered to approximately 400 eligible employees across
the Company's operating divisions. In connection with the RIF, 48 employees were
offered severance packages.
During fiscal 2001, the Company agreed to three-year contracts with two
bargaining units representing Pennsylvania employees, which were effective in
April 2001and August 2000, respectively. In December 1998, the Company agreed to
five-year contracts with each of the bargaining units representing Missouri
employees, which were effective in May 1999.
Interest Expense and Dividends on Preferred Securities Total interest expense in
2001 increased by $52,027,000, or 101%, to $103,519,000. Interest expense on
long-term debt and capital leases increased by $46,725,000 in 2001 primarily due
to a $485,000,000 bank note (the Term Note) entered into by the Company for the
acquisition of the New England Operations, 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 and the assumption of debt by the Company from the New
England Operations and Pennsylvania Operations. The Company entered into the
Term Note on August 28, 2000 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. The 8.25% Senior
Notes were issued to fund the acquisition of Pennsylvania Enterprises, Inc. and
to extinguish $135,000,000 in existing debt of the Pennsylvania Operations. The
Company also assumed $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.
.
Interest expense on short-term debt in 2001 increased $6,647,000 to $7,913,000
primarily due to the increase in the average short-term debt outstanding by
$102,827,000 to $123,829,000. An increase in the average outstanding balance of
short-term credit facilities reflects the higher cost of gas and the expansion
of the Company's operations into Rhode Island and Massachusetts with the
acquisition of the New England Operations during the current fiscal year. Draws
on short-term debt also arise as Southern Union is required to make payments to
natural gas suppliers in advance of the receipt of cash payments from the
Company's customers. The average rate of interest on short- term debt increased
from 6% in 2000 to 6.4% in 2001.
Total interest expense in 2000 increased by $15,493,000, or 43%, to $51,492,000.
Interest expense on long-term debt and capital leases increased by $17,736,000
in 2000 primarily due to the issuance of the 8.25% Senior Notes for the
acquisition of the Pennsylvania Operations.
Interest expense on short-term debt in 2000 decreased $284,000 to $1,266,000
primarily due to the decrease in the average short-term debt outstanding by
$6,472,000 to $21,002,000. The average rate of interest on short-term debt
increased from 5.6% in 1999 to 6% in 2000.
Other Income (Expense), Net Other income, net, in 2001 was $76,819,000, compared
to other expense, net of $9,708,000 in 2000. Other income in 2001 includes
realized gains on the sale of a portion of Southern Union's holdings in Capstone
Turbine Corporation of $74,582,000, a $13,532,000 gain on the sale of non-core
real estate
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19
and interest and dividend income of $7,643,000. These items were offset by
$12,855,000 of legal costs associated with ongoing litigation associated with
the unsuccessful acquisition of Southwest Gas Corporation (Southwest) and
$5,684,000 of non-cash trading losses. See Quantitative and Qualitative
Disclosure About Market Risk for further discussion of these non-cash trading
losses.
Other expense in 2000 included $10,363,000 of costs associated with the
aforementioned unsuccessful acquisition efforts and related litigation and
$2,236,000 of non-cash trading losses. These items were offset by net rental
income of Lavaca Realty Company (Lavaca Realty) of $1,757,000.
Other expense in 1999 included $3,839,000 of costs associated with various
acquisition efforts and a net expense of $619,000 related to the amortization
and current deferral of interest and other expenses associated with the Missouri
Gas Energy Safety Program. These items were offset by net rental income of
Lavaca Realty of $1,448,000 and equity earnings of $609,000 from Southern
Union's 43% equity ownership of a natural gas distribution company in Piedras
Negras, Mexico.
Federal and State Income Taxes Federal and state income tax expense in 2001,
2000 and 1999 was $40,000,000, $9,589,000 and $7,109,000, respectively. The
Company's consolidated federal and state effective income tax rate was 41%, 49%
and 40% in 2001, 2000 and 1999, respectively. The fluctuation in the effective
federal and state income tax rate is a result of non-tax deductible amortization
of additional purchase cost along with the level of pre- tax earnings.
Liquidity and Capital Resources
Operating Activities The seasonal nature of Southern Union's business results in
a high level of cash flow needs to finance gas purchases and other energy costs,
outstanding customer accounts receivable and certain tax pay ments. To provide
these funds, as well as funds for its continuing construction and maintenance
programs, the Com pany has historically used its credit facilities along with
internally-generated funds. Because of available short-term credit and the
ability to obtain various market financing, management believes it has adequate
financial flexibility to meet its cash needs.
The Company has increased the scale of its operations and the size of its
customer base by pursuing and consum mating business combination transactions.
On September 20, 2000, the Company acquired Valley Resources, on September 28,
2000, the Company acquired both Fall River Gas and ProvEnergy, and on November
4, 1999, the Company acquired the Pennsylvania Operations. See Business --
Acquisitions. Acquisitions require substantial increase in expenditures which
may need to be financed through cash flow from operations or future debt and
equity offerings. The availability and terms of any such financing sources will
depend upon various factors and conditions such as the Company's combined cash
flow and earnings, the Company's resulting capital structure, and conditions in
financial markets at the time of such offerings. Acquisitions and financings
also affect the Company's combined results due to factors such as the Company's
ability to realize any anticipated benefits from the acquisitions, successful
integration of new and different operations and businesses, and effects of
different regional economic and weather conditions. Future acquisitions or
merger-related refinancing may involve the issuance of shares of the Company's
common stock, which could have a dilutive effect on the then-current
stockholders of the Company. See Other Matters -- Cautionary Statement Regarding
Forward-Looking Information.
Cash flows from operating activities before changes in operating assets and
liabilities for 2001 were $123,260,000 compared with $74,050,000 and $65,069,000
for 2000 and 1999, respectively. After changes in operating assets and
liabilities, cash flows used in operating activities was $135,177,000 in 2001.
Cash flow from operating activities was $70,522,000 and $76,583,000 for 2000 and
1999, respectively. Changes in operating assets and liabilities used cash of
$258,437,000 in 2001 compared with $3,528,000 in 2000. Changes in operating
assets and liabilities provided cash of $11,784,000 in 1999. The current year
changes in operating assets and liabilities reflect an increase in gas sales
volumes coupled with an increase in the average cost of gas resulting in a
higher level of accounts receivable. Operating activities were also impacted by
the timing of acquisitions and the timing of natural gas purchases stored in
inventory by Missouri Gas Energy, PG Energy and the New England Operations.
At June 30, 2001, 2000 and 1999, the Company's primary source of liquidity
included borrowings available under the Company's credit facilities. A balance
of $190,600,000 and nil was outstanding under the credit facilities at June 30,
2001 and 2000, respectively. In May, 2001, the Company amended and restated
these credit facilities. As of August 31, 2001 there was a balance of
$211,800,000 outstanding under these credit facilities.
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Investing Activities Cash flow used in investing activities in 2001 increased
$292,152,000 to $446,675,000 and increased by $73,314,000 to $154,523,000 in
2000. Investing activity cash flow was primarily affected by additions to
property, plant and equipment, acquisition and sales of operations, sales and
purchases of investment securities and the sale of non-core real estate.
During 2001, 2000 and 1999, the Company expended $123,776,000, $100,446,000 and
$73,147,000, respectively, for capital expenditures excluding acquisitions.
These expenditures primarily related to distribution system replace ment and
expansion. Included in these capital expenditures were $14,040,000, $14,286,000
and $17,951,000 for the Missouri Gas Energy Safety Program in 2001, 2000 and
1999, respectively. This program is anticipated to be completed by fiscal year
2020. Cash flow from operations has historically been utilized to finance
capital expenditures and is expected to be the primary source for future capital
expenditures.
In September 2000, Southern Union acquired the New England Operations for
1,370,629 pre-stock dividend shares of Southern Union common stock and
$414,497,000 in cash. On December 15, 2000, the Company sold its Austin, Texas
headquarters building, Lavaca Plaza, for $20,638,000, resulting in a pre-tax
gain of $13,532,000. On June 8, 2001, the disposal of a former subsidiary of the
Pennsylvania Operations generated proceeds of $3,300,000 and a pre-tax gain of
$707,000.
On November 4, 1999, Southern Union acquired the Pennsylvania Operations for
16,713,735 pre-stock dividend shares of common stock and $36,152,000 in cash. On
the date of acquisition, Pennsylvania Operations had $576,000 in cash and cash
equivalents. In January 2000, a former subsidiary of the Pennsylvania Operations
was sold for $12,150,000. No gain or loss was recognized on this transaction.
During 2001, the Company realized proceeds and a net gain on the sale of
investment securities in Capstone Turbine Corporation (Capstone) of $84,762,000
and $74,582,000, respectively. As of August 31, 2001, the fair value of the
Company's remaining investment in Capstone was $6,652,000. Subject to market
conditions, the Company expects to monetize its remaining investment. The
Company intends to use the proceeds from such sales to reduce outstanding debt.
During 2001, 2000 and 1999, the Company purchased investment securities of
$12,495,000, $21,001,000 and $7,000,000, respectively.
The Company completed the installation of an 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 June 30, 2001, the capital lease obligation
outstanding was $23,200,000.
Financing Activities Cash flow from financing activities was $555,242,000,
$111,830,000 and $4,356,000 in 2001, 2000 and 1999, respectively. Financing
activity cash flow changes were primarily due to the net impact of acquisition
financing, repayment of debt, net activity under the revolving credit
facilities, purchase of treasury stock and changes in cash overdrafts. As a
result of these financing transactions, the Company's total debt to total
capital ratio at June 30, 2001 was 61.8%, compared with 46.8% and 49.0% at June
30, 2000 and 1999, respectively. The Company's effective debt cost rate under
the current debt structure is 7.98% (which includes interest and the
amortization of debt issuance costs and redemption premiums on refinanced debt).
In connection with the acquisition of the New England Operations, the Company
entered into a $535,000,000 Term Note on August 28, 2000 to fund (i) the cash
portion of the consideration to be paid to 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 New England mergers, and (iv) related acquisition
costs. As of June 30, 2001, a balance of $485,000,000 was outstanding on this
Term Note. The Term Note, which initially expired on August 27, 2001, has been
extended through August 26, 2002. No additional draws can be made on the Term
Note. The interest rate on borrowings under the Term Note is a floating rate
based on LIBOR or prime interest rates. See Quantitative and Qualitative
Disclosures About Market Risk.
Concurrent with the acquisition of the Pennsylvania Operations, 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 Operations
shareholders; (ii) refinance and repay certain debt of Pennsylvania Operations,
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
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21
obligations, including the 7.60% Senior Notes due 2024. In connection with the
acquisition of the Pennsylvania Operations, the Company assumed $30,000,000 of
8.375% Series First Mortgage Bonds due in December 2002 and $15,000,000 of 9.34%
Series First Mortgage Bonds due in 2019.
In fiscal year 2002, the Company may choose to refinance some portion or all of
the Term Note. Sources of future or alternative financing that the Company may
consider include commercial and investment banks, institutional lenders,
institutional investors and public securities markets. The availability and
terms of any such financing sources will depend upon various factors and
conditions such as the Company's combined cash flow and earnings, the Company's
resulting capital structure, and conditions in financial markets at the time of
such offerings. Acquisitions and financing will also affect the Company's
combined results due to factors such as the Company's ability to realize any
anticipated benefits from the mergers and any other acquisitions, successful
integration of new and different operations and businesses, and effects of
different regional economic and weather conditions. See Other Matters --
Cautionary Statement Regarding Forward-Looking Information.
In June 1999, the Company repurchased $20,000,000 of Senior Notes. Depending
upon market conditions and available cash balances, the Company may repurchase
additional debt securities in the future. See Preferred Securities of Subsidiary
Trust and Debt and Capital Lease in the Notes to the Consolidated Financial
Statements.
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 (Uncommitted Facilities) with various banks. Borrowings under
the facilities are available for Southern Union's working capital, letter of
credit requirements and other general corporate purposes. The Revolving Credit
Facilities are subject to a commitment fee based on the rating of the Senior
Notes. As of June 30, 2001, the commitment fee was an annualized 0.14%.
The Company had standby letters of credit outstanding of $2,716,000 at June 30,
2001 and $6,199,000 at June 30, 2000, which guarantee payment of insurance
claims and other various commitments.
Quantitative and Qualitative Disclosures About Market Risk
The Company has long-term debt, Preferred Securities and Revolving Credit
Facilities, which subject the Company to the risk of loss associated with
movements in market interest rates.
At June 30, 2001, the Company had issued fixed-rate long-term debt, capital
lease and Preferred Securities aggregating $950,544,000 in principal amount and
having a fair value of $932,667,000. These instruments are fixed- rate and,
therefore, do not expose the Company to the risk of earnings loss due to changes
in market interest rates. However, the fair value of these instruments would
increase by approximately $42,320,000 if interest and dividend rates were to
decline by 10% from their levels at June 30, 2001. In general, such an increase
in fair value would impact earnings and cash flows only if the Company were to
reacquire all or a portion of these instruments in the open market prior to
their maturity.
The Company's floating-rate obligations aggregated $675,600,000 at June 30, 2001
and primarily consisted of the Term Note entered into by the Company for the
acquisition of the New England Operations and amounts borrowed under Revolving
Credit Facilities of the Company. The floating-rate obligations under the Term
Note and Revolving Credit Facilities expose the Company to the risk of increased
interest expense in the event of increases in short-term interest rates. If the
floating rates were to increase by 10% from June 30, 2001 levels, the Company's
consolidated interest expense would increase by a total of approximately
$194,000 each month in which such increase continued.
The risk of an economic loss is reduced at this time as a result of the
Company's regulated status. Any unrealized gains or losses are accounted for in
accordance with the Financial Accounting Standards Board Accounting for the
Effects of Certain Types of Regulation as a regulatory asset/liability because
the Company believes that its future contributions which are currently recovered
through the rate-making process will be adjusted for these gains and losses.
The change in exposure to loss in earnings and cash flow related to interest
rate risk from June 30, 2000 to June 30, 2001 is not material to the Company.
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See Preferred Securities of Subsidiary Trust and Debt and Capital Lease in the
Notes to the Consolidated Financial Statements.
The Company owns approximately 1.3 million shares of Capstone common stock. This
investment is classified as "available for sale" under the Financial Accounting
Standards Board Accounting for Certain Investments in Debt and Equity
Securities. Unrealized gains and losses resulting from changes in the market
value of Capstone are recorded in Other Comprehensive Income. The Capstone
investment exposes the Company to losses in the fair value of Capstone common
stock. A 10% decline in the market value per share of Capstone common stock from
the June 30, 2001 levels would result in an $2,900,000 loss in value to the
Company.
In connection with the acquisition of the Pennsylvania Operations, the Company
assumed a guaranty with a bank whereby the Company unconditionally guaranteed
payment of financing obtained for the development of PEI Power Park. In March
1999, the Borough of Archbald, the County of Lackawanna, and the Valley View
School District (together the Taxing Authorities) approved a Tax Incremental
Financing Plan (TIF Plan) for the development of PEI Power Park. The TIF Plan
requires that: (i) the Redevelopment Authority of Lackawanna County raise
$10,600,000 of funds to be used for infrastructure improvements of the PEI Power
Park; (ii) the Taxing Authorities create a tax increment district and use the
incremental tax revenues generated from new development to service the
$10,600,000 debt; and (iii) PEI Power Corporation, a subsidiary of the Company,
guarantee the debt service payments. In May 1999, the Redevelopment Authority of
Lackawanna County borrowed $10,600,000 from a bank under a promissory note (TIF
Debt). The TIF Debt has a 12-year term, with a 7.75% annual interest rate, and
requires semi-annual principal and interest payments of approximately $725,000
(interest only for the first year). As of June 30, 2001, incremental tax
revenues cover approximately 17% of the annual debt service. The balance
outstanding on the TIF Debt was $9,943,000 as of June 30, 2001.
In accordance with effective adoption of Financial Accounting Standard Board
(FASB), Accounting for Derivative Instruments and Hedging Activities 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 Energy
Services 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.
During fiscal year 2001, the Company was party to an interest rate swap designed
to reduce exposure to changes in the fair value of a fixed rate lease
commitment. This interest rate swap, designated as a fair value hedge, was
terminated in October 2000 resulting in a pre-tax gain of $182,000 which will be
amortized through the remaining term of the underlying lease obligation. The
Company also continues to be obligated under three interest rate swaps created
to hedge exposure against volatility in interest payments on variable rate debt.
At June 30, 2001 the fair value of these interest rate derivatives was a
liability of $2,009,000 and is offset by a matching adjustment to other
comprehensive income. For the fiscal year ended June 30, 2001 net settlement
payments of $1,733,000 were made related to these derivatives and recorded to
interest expense. The Company expects to reclassify as interest expense
$1,911,000 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 28 months.
Subsequent to June 30, 2001, the Company entered three interest rate swaps, in
order to take advantage of market interest rate reductions. The first derivative
instrument, effective July 5, 2001, carries a notional amount of $100,000,000
and terminates June 30, 2005. The remaining derivative instruments, effective
July 23, 2001 and August 1, 2001, carry notional amounts of $300,000,000 and
$200,000,000, respectively, and terminate November 15, 2004 and February 1,
2005, respectively. On September 19, 2001, these interest rate swaps were
unwound, resulting in a pre-tax gain and cash flow of $17,200,000.
In March 2001, the Company discovered unauthorized financial derivative energy
trading activity by a non-regulated, wholly-owned subsidiary. During March 2001
and April 2001, all unauthorized trading activity was closed resulting in a
cumulative cash expense of $191,000, net of taxes. The remaining deferred
liability of $7,921,000 at June 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.
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
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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. The fair value of the contracts are
recorded as an adjustment to a regulatory asset/liability in the consolidated
financial statements. As of June 30, 2001, the Company owned contracts
representing 3,718,840 MMBtu of natural gas at an average strike price of $4.20
per MMBtu. The fair value of the contracts, which expire in May 2002, are
included in the consolidated financial statements as a liability and a matching
adjustment to deferred cost of gas of $1,701,000.
Other Matters
Corporate Restructuring In August 2001, the Company announced implementation of
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 ERPs
in certain of its operating divisions and (ii) a limited RIF within its
corporate division. ERPs, providing for increased benefits for those electing
retirement, were offered to approxi mately 400 eligible employees across the
Company's operating divisions.
In connection with the corporate reorganization and restructuring, Southern
Union is decentralizing certain of its corporate management functions and will
transfer those functions to its divisions in Texas, Missouri, Pennsylvania and
New England. The resulting RIF is limited solely to certain corporate employees
in the Company's Austin and Kansas City offices. The resulting organization will
have employees transferred to operating divisions and others in shared service
positions. Forty-eight employees were offered severance packages.
As a result of actions associated with the corporate reorganization and
restructuring described above and the disposal of certain assets, the Company
expects an annual cost savings in a range of $35 million to $40 million.
The Company anticipates a one-time charge of between $25 million to $32 million
for the quarter ending September 30, 2001. This charge will include costs
associated with the ERP and corporate reorganization and restructuring, costs
connected with redundant IT systems, and certain other related costs. The size
of this charge may be reduced subject to favorable regulatory treatment of the
ERP costs in certain operating divisions. The Company expects that most of the
restructuring actions will be completed by the end of fiscal 2002.
Foreign Operations On July 23, 1997, Energia Estrella del Sur, S. A. de C. V.,
a wholly-owned subsidiary of Southern Union Energy International, Inc. and
Southern Union International Investments, Inc., both subsidiaries of the Com-
pany, acquired an equity ownership in a natural gas distribution company and
other operations which currently serves 25,000 customers in Piedras Negras,
Mexico, which is across the border from the Company's Eagle Pass, Texas service
area. Southern Union currently has a 43% equity ownership in this company.
Financial results of foreign operations did not have a significant impact on the
Company's financial results during 2001, 2000 and 1999.
Stock Splits and Dividends On August 30, 2001, June 30, 2000, August 6, 1999 and
December 9, 1998, Southern Union distributed a 5% common stock dividend to
stockholders of record on August 16, 2001, June 19, 2000, July 23, 1999 and
November 23, 1998. A portion of each of these 5% stock dividends was
c