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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, 2002
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.)
One PEI Center, Second Floor 18711
Wilkes-Barre, Pennsylvania (Zip Code)
(Address of principal executive offices)
Registrant's telephone number, including area code: (570) 820-2400
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.
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The aggregate market value of the voting stock held by non-affiliates of the
registrant on September 20, 2002 was $353,459,367. The number of shares of the
registrant's Common Stock outstanding on September 20, 2002 was 55,328,534.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's Annual Report to Stockholders for the year ended
June 30, 2002, 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 5, 2002, are incorporated by reference into
Part III.
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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. The
Company's principal line of business is the distribution of natural gas as a
public utility to approximately 1.5 million customers through operating
divisions in Texas, Missouri, Pennsylvania, Rhode Island and Massachusetts.
Southern Union Gas, headquartered in Austin, Texas, serves approximately 541,000
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
157,000 customers in northeastern and central Pennsylvania (including
Wilkes-Barre, Scranton and Williamsport). New England Gas Company, headquartered
in Providence, Rhode Island, serves approximately 295,000 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 Southern Union's strategy for long-term growth includes, but is not
limited to, acquiring the right assets that will position the Company favorably
in an evolving competitive marketplace.
In September 2000, Southern Union acquired Providence Energy Corporation
(ProvEnergy), Fall River Gas Company (Fall River Gas), and Valley Resources
(Valley Resources). Collectively, these companies (hereafter referred to as the
Company's New England Operations) were acquired for approximately $422,000,000
in cash and 1,370,629 shares (before adjustment for any subsequent stock
dividends) of Southern Union common stock, as well as the assumption of
approximately $140,000,000 in long-term debt. The results of operations from
ProvEnergy and Fall River Gas have been included in the Company's consolidated
statement of operations since September 28, 2000, and the results of operations
from Valley Resources have been included in the Company's consolidated statement
of operations since September 20, 2000. Thus, the Company's consolidated results
of operations for the periods subsequent to these acquisitions are not
comparable to the same periods in prior years. These acquisitions were accounted
for using the purchase method.
The New England Operations' primary business is the distribution of natural gas
through the New England Gas Company, which serves approximately 295,000
customers throughout Rhode Island and southeastern Massachusetts. Subsidiaries
of the Company acquired with the New England Gas Company and currently operating
include ProvEnergy Power LLC, Fall River Gas Appliance Company, Valley Appliance
Merchandising Company and Alternate Energy Corporation (see Company Operations).
Subsidiaries acquired with the New England Gas Company and subsequently sold
include Morris Merchants, Inc., Valley Propane, Inc. and ProvEnergy Oil
Enterprises, Inc. (see Divestitures).
In November 1999, Southern Union acquired Pennsylvania Enterprises, Inc.
(hereafter referred to as the Company's Pennsylvania Operations) for
approximately $500,000,000, including assumption of approximately $115,000,000
of long-term debt. The Company issued approximately 16,700,000 shares (before
adjustment for any subsequent stock dividends) of common stock and paid
approximately $38,000,000 in cash to complete the transaction. The results of
operations from the Pennsylvania Operations have been included in the Company's
consolidated statement of operations since November 4, 1999. Thus, the Company's
consolidated results of operations for the periods subsequent to the acquisition
are not comparable to the same periods in prior years. The acquisition was
accounted for using the purchase method.
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The Pennsylvania Operations' primary business is the distribution of natural
gas through PG Energy, which serves approximately 157,000 customers in
northeastern and central Pennsylvania. Subsidiaries of the Company acquired with
PG Energy and currently operating include PG Energy Services Inc., (Energy
Services) and PEI Power Corporation (Power Corp.) (see Company Operations).
Subsidiaries and assets acquired with PG Energy and subsequently sold include
Energy Services' propane operations and its commercial and industrial gas
marketing contracts, Keystone Pipeline Services, Inc. and Theta Land Corporation
(see Divestitures).
Acquiring the New England Operations and Pennsylvania Operations provides
Southern Union with a strong presence in the northeastern market. These
operations provide the Company with greater geographic and weather diversity
to the Company's service areas. Going forward, Southern Union may consider
other acquisitions that will financially enhance growth and take advantage
of future market opportunities.
Divestitures In July 2001, the Company implemented a Cash Flow Improvement Plan
that was designed to increase annualized pre-tax cash flow from operations by at
least $50 million by the end of fiscal year 2002. The three-part initiative was
composed of strategies designed to achieve results enabling its operating
divisions to meet their allowed rates of return, restructure its corporate
operations, and accelerate the sale of non-core assets and use the proceeds
exclusively for debt reduction. The Company's non-core subsidiaries and assets
sold include:
Subsidiary or Asset Sold Date Sold Proceeds Pre-tax Gain (Loss)
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PG Energy Services' (Energy Ser-
vices) propane operations (a) April 2002 $ 2,300,000 $ 1,200,000
Carrizo Springs Pipeline (b) December 2001 1,000,000 561,000
South Florida Natural Gas and
Atlantic Gas Corporation (c) December 2001 10,000,000 (1,500,000)
Morris Merchants, Inc. (d) October 2001 1,586,000 --
Valley Propane, Inc. (Valley
Propane) (e) September 2001 5,301,000 --
ProvEnergy Oil Enterprises (f) August 2001 15,776,000 --
Energy Services' commercial and
industrial gas marketing
contracts July 2001 4,972,000 4,653,000
Keystone Pipeline Services,
Inc. (g) June 2001 3,300,000 707,000
Theta Land Corporation (h) January 2000 12,150,000 --
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(a) Sold liquid propane to residential, commercial and industrial customers in
northeastern and central Pennsylvania.
(b) Asset was a 43-mile pipeline operated by Southern Transmission Company.
(c) South Florida Natural Gas was a natural gas division of Southern Union and
Atlantic Gas Corporation was a propane subsidiary of the Company.
(d) Served as a manufacturers' representative agency for franchised plumbing and
heating contract supplies throughout New England.
(e) Sold liquid propane to residential, commercial and industrial customers in
Rhode Island and Massachusetts.
(f) Operated a fuel oil distribution business through its subsidiary, ProvEnergy
Fuels, Inc. for residential and commercial customers in Rhode Island and
Massachusetts.
(g) Engaged primarily in the construction, maintenance, and rehabilitation of
natural gas distribution pipelines.
(h) Owned approximately 44,000 acres of land.
The Company may sell or dispose of other non-core subsidiaries and assets if the
terms are satisfactory to the Company. Such sales may include investments in
marketable securities.
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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 New England
Gas Company divisions. The Company's gas utility operations are generally
seasonal in nature, with a significant percentage of its annual revenues and
earnings occurring in the traditional winter heating season. The Company's
management is committed to achieving profitable growth of its utility divisions
in an increasingly competitive business environment and to enhance shareholder
value. Management's strategies for achieving these objectives principally
consist of: (i) to focus the Company's divisions in meeting their allowable
rates of returns; (ii) manage capital spending and operating costs without
sacrificing customer safety or quality service; (iii) expanding the Company
through development of existing utility businesses and possibly by acquiring of
selective new utility businesses; and (iv) solidify the Company's relationships
with regulatory bodies that oversee the various operations. Management develops
and continually evaluates these strategies and their implementation 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 were 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 and distribute
propane. Additionally, the Company owns or holds 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.
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 that 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 that
sells electricity to the broad mid-Atlantic wholesale energy market administered
by PJM Interconnection, L.L.C.
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 17,000 customers 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 Appliance and Merchandising Company (VAMCO), a wholly-owned subsidiary of
Southern Union, rents natural gas burning appliances and offers appliance
service contract programs to residential customers. In fiscal 2002, VAMCO
provided construction management services for natural gas-related projects
to commercial and industrial customers.
Mercado Gas Services, Inc. (Mercado), a wholly-owned subsidiary of Southern
Union, markets natural gas to commercial 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.
PG Energy Services, Inc. (Energy Services), a wholly-owned subsidiary of
Southern Union, offers the inspection, maintenance and servicing of
residential and small commercial gas-fired equipment to 17,300 residential
and commercial users primarily in central and northeastern Pennsylvania.
SUPro Energy Company (SUPro), a wholly-owned subsidiary of Southern Union,
provides propane gas services to 4,000 customers located principally in
Austin, El Paso and Alpine, Texas as well as Las Cruces, New Mexico and
surrounding communities. SUPro sold 5,434,000 and 5,859,000 gallons of
propane for the years ended June 30, 2002 and 2001.
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Southern Transmission Company (STC), a wholly-owned subsidiary of Southern
Union, owns and operates 118.8 miles of intrastate pipeline that serves
commercial, industrial and utility customers in central, south and coastal
Texas.
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, has a 43% equity ownership in a natural gas
distribution company, along with other related operations, which currently
serves 23,000 customers in Piedras Negras, Mexico, across the border from
Southern Union Gas' Eagle Pass, Texas service area.
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.
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 and conditioned air.
Alternate Energy Corporation (AEC), a wholly-owned subsidiary of Southern Union,
is an energy consulting firm that also 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. Additionally, through the acquisition of the
Pennsylvania Operations and New England Operations, the Company owns several
tracts of land, certain of which has been 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.
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 maintenance.
In late June 2000, Capstone completed its initial public offering (IPO). The
Company sold Capstone shares during fiscal year 2002 and 2001, realizing pre-tax
gains of $1,004,000 and $74,582,000, respectively. As of June 30, 2002, the
Company's 700,400 remaining shares of Capstone common stock were worth
$1,163,000 based on the closing price for Capstone shares that day.
The Company had invested $14,586,000 in PointServe, Inc. (PointServe), a
business-to-business online scheduling solution. The Company recorded a non-cash
charge of $10,380,000 in the fourth quarter of fiscal year 2002 to recognize the
decrease in fair value of its non-utility investment in PointServe. The Company
recognized this valuation adjustment to reflect significant lower private equity
valuation metrics and changes in the business outlook of PointServe. PointServe
is a closely held, privately owned company and, as such, has no published market
value.
As of June 30, 2002, Southern Union had a $5,433,000 equity interest in Advent
Networks, Inc. (Advent) and held $2,750,000 of convertible notes receivable from
Advent. 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. Subsequent to June 30, 2002, the
Company invested an additional $2,000,000 in convertible notes receivable to
Advent. All of the convertible notes convert into equity upon the next
equity financing of Advent or
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upon a change of control of Advent. Certain Southern Union executive management,
Board of Directors and employees have an equity ownership in Advent.
The Company reviews its portfolio of investment securities on a quarterly basis
to determine whether a decline in value is other than temporary. Factors
that are considered in assessing whether a decline in value is other than
temporary include, but are not limited to: earnings trends and asset
quality; near term prospects and financial condition of the issuer;
financial condition and prospects of the issuer's region and industry; and
Southern Union's intent and ability to retain the investment. If Southern
Union determines that the decline in value of an investment security is
other than temporary, the Company will record a charge on its consolidated
statement of operations to reduce the carrying value of the security to its
estimated fair value.
Competition
As energy providers, Southern Union Gas, Missouri Gas Energy, PG Energy, and
New England Gas Company have historically 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.
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 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. 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 under regulated transportation service
rates (with PG Energy serving as supplier of last resort). Customers can also
choose to remain with PG Energy as their supplier under regulated natural gas
sales rates. In either case, the applicable rate results in the same operating
margin to PG Energy. Despite customers' acquired right to choose,
higher-than-normal wholesale prices for natural gas have prevented suppliers
from offering competitive rates.
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 contracts.
The Company has been directly acquiring its gas supplies since the mid-1980s
when interstate pipeline systems 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 Federal Energy Regulatory Commission (FERC) required the "unbundling" of
services offered by interstate pipeline companies beginning in 1992. As a
result, gas purchasing and transportation decisions and associated
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risks have been shifted from the pipeline companies 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 2002 gas requirements for the utility operations of Southern
Union Gas, Missouri Gas Energy and PG Energy were delivered under short- and
long-term transportation contracts through five, four and four major pipeline
companies, respectively. The majority of 2002 gas requirements for the utility
operations of New England Gas Company were delivered under long-term
transportation contracts through four major pipeline companies. These contracts
have various expiration dates ranging from calendar year 2002 through 2023.
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, PG Energy,
and New England Gas Company all have firm supply commitments for all areas that
are supplied with gas purchased under short-term arrangements. Southern Union
Gas, Missouri Gas Energy, PG Energy and New England Gas Company hold contract
rights to over 4 Bcf, 17 Bcf, 11 Bcf and 7 Bcf of storage capacity,
respectively, to assist in meeting peak demands. Storage capacity in 2002
approximated 24% 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, or New England Gas Company 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, 2002, the Company has purchase commitments
for certain quantities of gas at variable, market-based prices that have an
annual value of $157,929,000. The Company's purchase commitments may extend
over a period of several 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.
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 Missouri
Public Service Commission (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, the Rhode Island Public Utilities Commission (RIPUC) approves
natural gas rates for the New England Gas Company. In Massachusetts natural gas
rates for the New England Gas Company are subject to the regulatory authority of
the Massachusetts Department of Telecommunications and Energy (MDTE). 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 these 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
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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 an 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,
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. Southern Union Gas has weather normalization
clauses in 23 Texas towns and cities, including Austin, Andrews and various El
Paso service areas, Galveston, Port Arthur and Mineral Wells. New England Gas
Company has a weather normalization clause in the tariff covering its Rhode
Island operations.
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 monthly fixed charges to gas sales service
customers. New rates became effective August 6, 2001, two months before the
statutory deadline for resolving the case. The approved settlement resulted in
the 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.
The MPSC approval of the January 31, 1994 acquisition of Missouri Gas Energy by
the Company 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 On May 24, 2002, the RIPUC approved a settlement agreement between
the New England Gas Company and the RIPUC. The settlement agreement resulted in
a $3,900,000 decrease in base revenues for New England Gas Company's Rhode
Island operations, a unified rate structure ("One State; One Rate") and an
integration/merger savings mechanism. The settlement agreement also allows New
England Gas Company to retain $2,049,000 of merger savings and to share
incremental earnings with customers when the division's Rhode Island operations
return on equity exceeds 11.25%. Included in the settlement agreement was a
conversion to therm billing and the approval of a reconciling Distribution
Adjustment Clause (DAC). The DAC allows New England Gas Company to continue its
low income assistance and weatherization programs, to recover environmental
response costs over a 10-year period, puts into place a new weather
normalization clause and allows for the sharing of nonfirm margins (non-firm
margin is margin earned from interruptible customers with the ability to switch
to alternative fuels). The weather normalization 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. New England Gas
Company 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 2% warmer-than-normal. The non-firm margin incentive mechanism allows New
England Gas Company to retain 25% of all non-firm margins earned in excess of
$1,600,000.
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 provided 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
contained a weather mitigation clause
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and a non-firm margin incentive mechanism. The weather mitigation clause
allowed Providence Gas to defer the margin impact of weather that was greater
than 2% colder-than-normal and to recover the margin impact of weather that was
greater than 3% warmer-than-normal by making the corresponding adjustment to the
deferred revenue account (DRA). The non-firm margin incentive mechanism allowed
Providence Gas to retain 25% of all non-firm margins earned in excess of
$1,200,000. Under the settlement agreement, Providence Gas was able to 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 approved a settlement agreement between
Providence Gas, the RIPUC, 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.
Pennsylvania In December 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 Effective September 24, 2002, Southern Union Gas received a
$2,000,000 revenue increase for the El Paso service area, and a rate design that
continues to increase the proportion of the Company's revenue stream collected
through the monthly customer charge.
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.
Galveston Texas Effective July 1, 2002, Southern Union Gas received approval of
a $323,000 revenue increase for the Galveston service area, along with
continuation of weather normalization and annual cost of service adjustment
clauses.
North Texas Southern Union Gas received annual rate increases in Jacksboro,
Weatherford and Mineral Wells, Texas in May 2000, September 2000 and May 2001,
respectively, totaling $600,000, that collect a greater portion of the Company's
revenue stream from the monthly customers' charge. In addition, weather
normalization clauses were implemented in Weatherford and Mineral Wells.
Other During the three-year period ended June 30, 2002, 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.
In addition to the regulation of its utility and pipeline businesses, the
Company is affected by numerous other regulatory controls, including, among
others, pipeline safety requirements of the United States Department of
Transportation, 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
present service territories in Texas, Missouri, Pennsylvania, Massachusetts and
Rhode Island. At the present time, the Company is aware of certain MGP sites in
these areas and is investigating those and certain other locations. While the
Company's evaluation of these Texas, Missouri, Arizona, New Mexico,
Pennsylvania, Massachusetts and Rhode Island MGP sites is in its preliminary
stages, it is likely that some compliance costs may be identified and become
subject to reasonable quantification. Within the Company's service territories
certain MGP sites are currently the subject of governmental actions. 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.
- --------------------------------------------------------------------------------
8
Real Estate
The Company owns certain real estate which is neither material nor critical to
its operations.
Employees
As of July 31, 2002, the Company had 2,662 employees, of whom 1,995 are paid on
an hourly basis, 664 are paid on a salary basis and three are paid on a
commission basis. Of the 1,995 hourly paid employees, unions represent 55%. Of
those employees represented by unions, Missouri Gas Energy employs 44%, PG
Energy employs 16% and New England Gas Company employs 40%.
In August 2001, the Company implemented a corporate reorganization and
restructuring which was initially announced in July 2001 as part of the Cash
Flow Improvement Plan. Actions taken included (i) the offering of voluntary
Early Retirement Programs ("ERPs") in certain of its operating divisions and
(ii) a limited reduction in force ("RIF") within its corporate offices. ERPs,
providing for increased benefits for those electing retirement, were offered to
approximately 400 eligible employees across the Company's operating divisions,
with approximately 60% of such eligible employees accepting. The RIF was limited
solely to certain corporate employees in the Company's Austin and Kansas City
offices where forty-eight employees were offered severance packages.
During fiscal year 2002, the Company agreed to five-year contracts with two
bargaining units representing employees of New England Gas Company's Providence
operations (formerly ProvEnergy), which were effective May 2002; a four-year
contract with one bargaining unit representing employees of New England Gas
Company's Cumberland operations (formerly Valley Resources), effective May 2002;
a four-year contract with one bargaining unit representing employees of New
England Gas Company's Fall River operations (formerly Fall River Gas), effective
April 2002; and a one year extension of a contract with one bargaining unit
representing employees of New England Gas Company's Cumberland operations, which
was effective May 2002.
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.
The Company believes that its relations with its employees are good. From time
to time, however, the Company may be subject to labor disputes. During fiscal
2002, the Company and one of five bargaining units representing New England Gas
Company employees (comprising approximately 8% of Southern Union's total
workforce) were unable to reach agreement on the renewal of a contract that
expired in January 2002. The resulting work stoppage, which did not have a
material adverse effect on the Company's results of operations, financial
condition or cash flows for the year ended June 30, 2002, was settled in May
2002 when the Company and the bargaining unit agreed to a new five-year
contract.
- --------------------------------------------------------------------------------
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,
----------------------------
2002 2001 2000
-------- -------- --------
Southern Union Gas:
Average number of gas sales customers served:
Residential................................... 496,543 491,086 483,220
Commercial.................................... 33,948 32,762 31,860
Industrial and irrigation..................... 249 251 253
Public authorities and other.................. 2,827 2,818 2,862
------- ------- -------
Total average customers served.............. 533,567 526,917 518,195
======= ======= =======
Gas sales in millions of cubic feet (MMcf):
Residential................................... 21,477 24,260 19,524
Commercial.................................... 9,303 10,069 8,677
Industrial and irrigation..................... 802 1,103 969
Public authorities and other.................. 2,492 2,855 2,377
------- ------- -------
Gas sales billed............................ 34,074 38,287 31,547
Net change in unbilled gas sales.............. (4) (97) 137
------- ------- -------
Total gas sales............................. 34,070 38,190 31,684
======= ======= =======
Weather:
Degree days (a)............................... 1,945 2,380 1,516
Percent of 10-year measure (b)................ 105% 130% 83%
Percent of 30-year measure (b)................ 93% 112% 71%
Gas transported in MMcf......................... 17,711 18,425 17,472
Missouri Gas Energy:
Average number of gas sales customers served:
Residential................................... 428,215 428,971 424,771
Commercial.................................... 59,060 59,742 58,323
Industrial.................................... 327 310 309
------- ------- -------
Total average customers served.............. 487,602 489,023 483,403
======= ======= =======
Gas sales in MMcf:
Residential................................... 35,039 44,011 34,999
Commercial.................................... 15,686 19,828 15,640
Industrial.................................... 417 598 412
------- ------- -------
Gas sales billed............................ 51,142 64,437 51,051
Net change in unbilled gas sales.............. (16) (64) 37
------- ------- -------
Total gas sales............................. 51,126 64,373 51,088
======= ======= =======
Weather:
Degree days (a)............................... 4,419 5,541 4,176
Percent of 10-year measure (b)................ 85% 107% 80%
Percent of 30-year measure (b)................ 85% 106% 80%
Gas transported in MMcf......................... 27,324 30,921 31,644
- -------------------------
(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
Eight
Year Ended Months
June 30, Ended
------------------ June 30,
2002 2001 2000(a)
-------- -------- ---------
PG Energy:
Average number of gas sales customers served:
Residential.................................. 141,223 140,815 140,019
Commercial................................... 14,108 13,991 13,872
Industrial................................... 218 206 209
Public authorities and other................. 321 310 314
------- ------- --------
Total average customers served............. 155,870 155,322 154,414
======= ======= ========
Gas sales in millions of cubic feet (MMcf):
Residential.................................. 15,053 17,965 14,830
Commercial................................... 5,325 6,561 4,969
Industrial .................................. 277 535 215
Public authorities and other................. 145 368 213
------- ------- --------
Gas sales billed........................... 20,800 25,429 20,227
Net change in unbilled gas sales............. (22) 40 (314)
------- ------- --------
Total gas sales............................ 20,778 25,469 19,913
======= ======= ========
Weather:
Degree days (b).............................. 5,373 6,621 5,287
Percent of 10-year measure (c)............... 89% 108% 86%
Percent of 30-year measure (c)............... 86% 105% 92%
Gas transported in MMcf........................ 26,976 25,430 19,403
Nine Months
Year Ended Ended
June 30, 2002 June 30, 2001(d)
------------- ----------------
New England Gas Company:
Average number of gas sales customers served:
Residential.................................. 265,206 264,349
Commercial................................... 21,696 21,634
Industrial and irrigation.................... 3,472 3,570
Public authorities and other................. 43 45
------- -------
Total average customers served............. 290,417 289,598
======= =======
Gas sales in millions of cubic feet (MMcf):
Residential.................................. 19,975 21,690
Commercial................................... 6,196 7,293
Industrial and irrigation.................... 3,271 2,721
Public authorities and other................. 23 22
------- -------
Gas sales billed........................... 29,465 31,726
Net change in unbilled gas sales............. (333) 286
------- -------
Total gas sales............................ 29,132 32,012
======= =======
Weather:
Degree days (b).............................. 4,980 5,273
Percent of 10-year measure (c)............... 88% 105%
Percent of 30-year measure (c).............. 85% 102%
Gas transported in MMcf........................ 11,457 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,
---------------------------------
2002 2001 2000
---------- ---------- ----------
Southern Union Gas:
Austin and other central and south
Texas communities...................... 192,992 190,696 183,872
El Paso and other west Texas communities. 194,373 189,134 187,189
Galveston and Port Arthur................ 49,026 49,292 50,237
Panhandle and north Texas communities.... 23,973 24,046 24,584
Rio Grande Valley communities and
Eagle Pass............................. 74,149 74,641 75,608
---------- ---------- ----------
534,513 527,809 521,490
---------- ---------- ----------
Missouri Gas Energy:
Kansas City, Missouri Metropolitan Area.. 384,222 379,057 379,804
St. Joseph, Joplin, Monett and others.... 103,797 103,469 104,432
---------- ---------- ----------
488,019 482,526 484,236
---------- ---------- ----------
PG Energy.................................. 156,313 155,439 154,399
New England Gas Company.................... 293,613 289,048 --
Other (a).................................. 14,375 44,103 25,971
---------- ---------- ----------
Total...................................... 1,486,833 1,498,925 1,186,096
========== ========== ==========
- -----------------------------
(a) Includes Mercado, South Florida Natural Gas and Atlantic Gas Corporation
(which the Company sold in December 2001), SUPro Energy Services, PG Energy
Services Inc., Valley Propane and ProvEnergy Fuels (which were sold in
September and August of 2001, respectively) 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 8,158 miles of mains, 4,493 miles of service lines and 98
miles of transmission lines. STC and Norteno have 118.8 miles and 8 miles,
respectively, of transmission lines. Missouri Gas Energy has 7,850 miles of
mains, 4,856 miles of service lines and 47 miles of transmission lines. PG
Energy has 2,487 miles of mains, 1,488 miles of service lines and 29 miles of
transmission lines. New England Gas Company has 3,627 miles of mains, 4,289
miles of service lines and no transmission lines. The Company considers its
systems to be in good condition and well-maintained, and it has continuing
replacement programs based on historical performance and system surveillance.
Power Corp. retains ownership of two electric power plants that 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 that is in service and selling
electricity to the broad mid-Atlantic wholesale energy market administered by
PJM Interconnection, L.L.C.
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, 2002.
- --------------------------------------------------------------------------------
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, 2000
are set forth below:
$/Share
High Low
July 1 to September 20, 2002............................. $17.06 $10.20
(Quarter Ended)
June 30, 2002............................................ 18.90 14.11
March 31, 2002........................................... 19.23 15.81
December 31, 2001........................................ 21.33 15.81
September 30, 2001....................................... 23.03 16.67
(Quarter Ended)
June 30, 2001............................................ 20.33 15.91
March 31, 2001........................................... 23.92 17.24
December 31, 2000........................................ 25.34 15.42
September 30, 2000....................................... 18.82 14.51
Holders
As of September 20, 2002, there were 7,404 holders of record of Southern
Union's common stock and 55,328,534 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, 2002, 31,267,952 shares of Southern Union's common stock were held
by non-affiliates (any director or executive officer, any of their immediate
family members, or any holder known to be the beneficial owner 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 July 15, 2002, August 30, 2001, June 30, 2000 and
August 6, 1999, the Company distributed its annual 5% common stock dividend to
stockholders of record on July 1, 2002, August 16, 2001, June 19, 2000 and
July 23, 1999, respectively. A portion of each of the 5% stock dividends
distributed above 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,
------------------------------------------------------
2002(a) 2001(b) 2000(c) 1999 1998(d)
---------- ---------- ---------- ---------- ----------
(dollars in thousands, except per share amounts)
Total operating revenues. $1,290,550 $1,932,813 $ 831,704 $ 605,231 $ 669,304
Earnings from continuing
operations (e)......... 19,624 57,285 9,845 10,445 12,229
Earnings per common and
common share
equivalents (f)........ .35 .99 .20 .28 .34
Total assets............. 2,676,467 2,907,299 2,021,460 1,087,348 1,047,764
Common stockholders'
equity................. 685,364 721,857 735,455 301,058 296,834
Short-term debt and
capital lease
obligation............. 108,203 5,913 2,193 2,066 1,777
Long-term debt and
capital lease
obligation, excluding
current portion........ 1,082,210 1,329,631 733,774 390,931 406,407
Company-obligated
mandatorily redeemable
preferred securities of
subsidiary trust....... 100,000 100,000 100,000 100,000 100,000
Average customers served. 1,480,739 1,506,371 1,132,699 998,476 979,186
- -----------------------------
(a) Effective July 1, 2001, the Company has ceased amortization of goodwill
pursuant to the Financial Accounting Standards Board Standard Accounting
for Goodwill and Other Intangible Assets. Goodwill, which was previously
classified on the consolidated balance sheet as additional purchase cost
assigned to utility plant and amortized on a straight-line basis over forty
years, is now subject to at least an annual assessment for impairment by
applying a fair-value based test. Additionally, during fiscal year 2002,
the Company recorded an after-tax restructuring charge of $17,692,000. See
Goodwill and Employee Benefits in the Notes to Consolidated Financial
Statements.
(b) 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.
(c) 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.
(d) On December 31, 1997, Southern Union acquired Atlantic Utilities for
755,650 pre-split and pre-stock dividend shares of common stock valued at
$18,041,000 and cash of $4,436,000. Atlantic Utilities was sold in December
2001.
(e) 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.
(f) 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 July 15, 2002, August 30, 2001, June 30, 2000,
August 6, 1999 and December 9, 1998, 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 its four operating divisions. Southern Union Gas
serves 541,000 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 (acquired in November 1999) serves 157,000
customers in northeastern and central Pennsylvania (including Wilkes-Barre,
Scranton and Williamsport). New England Gas Company (acquired in September 2000)
serves 295,000 customers in Rhode Island and Massachusetts (including
Providence, Newport and Cumberland, Rhode Island, and Fall River, North
Attleboro and Somerset, Massachusetts). South Florida Natural Gas, which was
sold in December 2001, served 4,500 customers in central Florida (including New
Smyrna Beach, Edgewater and areas of Volusia County, Florida).
In September 2000, Southern Union acquired Providence Energy Corporation
(ProvEnergy), Fall River Gas Company (Fall River Gas), and Valley Resources
(Valley Resources). Collectively, these companies (hereafter referred to as the
Company's New England Operations) were acquired for approximately $422,000,000
in cash and 1,370,629 shares (before adjustment for any subsequent stock
dividends) of Southern Union common stock, as well as the assumption of
approximately $140,000,000 in long-term debt. The results of operations from
ProvEnergy and Fall River Gas have been included in the Company's consolidated
statement of operations since September 28, 2000, and the results of operations
from Valley Resources have been included in the Company's consolidated statement
of operations since September 20, 2000. Thus, the Company's consolidated results
of operations for the periods subsequent to these acquisitions are not
comparable to the same periods in prior years. These acquisitions were accounted
for using the purchase method.
The New England Operations' primary business is the distribution of natural gas
through the New England Gas Company. Subsidiaries of the Company acquired with
the New England Gas Company and currently operating include ProvEnergy Power LLC
(ProvEnergy Power), Fall River Gas Appliance Company (Fall River Appliance),
Valley Appliance Merchandising Company (VAMCO) and Alternate Energy Corporation
(AEC). ProvEnergy Power 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 and conditioned air.
Fall River Appliance rents water heaters and conversion burners, primarily to
residential customers. VAMCO rents natural gas burning appliances and offers
appliance service contract programs to residential customers. In fiscal 2002,
VAMCO also provided construction management services for natural gas-related
projects to commercial and industrial customers. AEC is an energy consulting
firm.
Subsidiaries acquired with the New England Gas Company and subsequently sold
include Morris Merchants, Inc. (Morris Merchants), Valley Propane, Inc. (Valley
Propane) and ProvEnergy Oil Enterprises, Inc. (ProvEnergy Oil). In October 2001,
Morris Merchants, which served as a manufacturers' representative agency for
franchised plumbing and heating contract supplies throughout New England, was
sold for $1,586,000. In September 2001, Valley Propane, which sold liquid
propane to residential, commercial and industrial customers, was sold for
$5,301,000. In August 2001, ProvEnergy Oil, which operated a fuel oil
distribution business through its subsidiary, ProvEnergy Fuels, Inc. for
residential and commercial customers, was sold for $15,776,000. No financial
gain or loss was recognized on any of these sales transactions.
In November 1999, Southern Union acquired Pennsylvania Enterprises, Inc.
(hereafter referred to as the Company's Pennsylvania Operations) for
approximately $500,000,000, including assumption of approximately $115,000,000
of long-term debt. The Company issued approximately 16,700,000 shares (before
adjustment for any subsequent stock dividends) of common stock and paid
approximately $38,000,000 in cash to complete the transaction. The results of
operations from the Pennsylvania Operations have been included in the Company's
consolidated statement of operations since November 4, 1999. Thus, the Company's
consolidated results of operations for the periods subsequent to the acquisition
are not comparable to the same periods in prior years. The acquisition was
accounted for using the purchase method.
The Pennsylvania Operations' primary business is the distribution of natural gas
through PG Energy. Subsidiaries of the Company acquired with PG Energy and
currently operating include PG Energy Services Inc., (Energy Services) and PEI
Power Corporation (Power Corp.). Energy Services offers the inspection,
maintenance and
- --------------------------------------------------------------------------------
15
servicing of residential and small commercial gas-fired equipment to residential
and commercial users. Power Corp., an exempt wholesale generator (within the
meaning of the Public Utility Holding Company Act of 1935), sells electricity
services to the broad mid-Atlantic wholesale energy market administered by PJM
Interconnection, L.L.C.
Subsidiaries and assets acquired with PG Energy and subsequently sold include
Energy Services' propane operations and its commercial and industrial gas
marketing contracts, Keystone Pipeline Services, Inc. (Keystone) and Theta
Land Corporation. In April 2002, Energy Services' propane operations, which
sold liquid propane to residential, commercial and industrial customers,
were sold for $2,300,000, resulting in a pre-tax gain of $1,200,000. In July
2001, Energy Services' commercial and industrial gas marketing contracts
were sold for $4,972,000, resulting in a pre-tax gain of $4,653,000. In June
2001, the Company sold Keystone, which engaged primarily in the construction,
maintenance, and rehabilitation of natural gas distribution pipelines, for
$3,300,000, resulting in a pre-tax gain of $707,000. In January 2000, Theta Land
Corporation, which owned approximately 44,000 acres of land, was sold for
$12,150,000. No financial gain or loss was recognized on this transaction.
Results of Operations
Net Earnings Southern Union Company's 2002 (fiscal year ended June 30) net
earnings were $19,624,000 ($.35 per common share, diluted for outstanding
options and warrants -- hereafter referred to as per share), compared with
$57,285,000 ($.99 per share) in 2001. Net earnings for the year ended June 30,
2002, were impacted by lower operating margin resulting from unusually mild
weather that was 19% warmer than in 2001, an after-tax restructuring charge of
$17,692,000 and a non-cash charge to reserve for the impairment of the Company's
investment in a technology company of $5,865,000, net of tax. These items were
partially offset by $9,699,000 in after-tax gains generated from the settlement
of interest rate swaps. Net earnings in 2002 also reflect the absence of
significant sales of the Company's holdings in Capstone Turbine Corporation and
real estate, which generated after-tax gains of $51,659,000 in 2001. In
addition, net earnings in 2001 reflect goodwill amortization of $17,463,000
while goodwill amortization ceased in 2002 as a result of the adoption of a new
accounting pronouncement. Average common and common share equivalents
outstanding decreased 2% in 2002 due to the repurchase of 2,115,916 shares of
the Company's common stock. Substantially all of these repurchases occurred in
private off-market large-block transactions.
The Company's 2001 net earnings were $57,285,000 ($.99 per share), compared with
$9,845,000 ($.20 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 that contributed $6,074,000 in net earnings. While operating
margin benefited from weather that was 36% colder than 2000, purchased 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.
Operating Revenues Operating revenues in 2002 compared with 2001 decreased
$642,263,000, or 33%, to $1,290,550,000 while gas purchase and other energy
costs decreased $611,183,000, or 44%, to $763,567,000.
The decrease in both operating revenues and gas purchase and other energy costs
between periods was primarily due to a 15% decrease in gas sales volumes to
150,227 MMcf in 2002 from 176,654 MMcf in 2001 and by a 28% decrease in the
average cost of gas from $6.98 per Mcf in 2001 to $5.04 per Mcf in 2002. The
decrease in gas sales volumes is primarily due to warmer-than-normal weather in
all of the Company's service territories as compared to colder-than-normal
weather in 2001. The decrease in the average cost of gas is due to decreases 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. Additionally
impacting operating revenues in 2002 was a $21,676,000 decrease in gross receipt
taxes primarily due to a decrease in gas purchase and other energy costs. Gross
receipt taxes are levied on sales revenues billed to the customers and remitted
to the various taxing authorities. The decrease in operating revenues in 2002
was partially offset by the timing of the acquisition of the New England
Operations in September 2000, as well as
- --------------------------------------------------------------------------------
16
the $10,973,000 annual revenue increase granted to Missouri Gas Energy effective
August 2001 and the $10,800,000 annual revenue increase granted to PG Energy
effective January 2001.
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 2002 increased 934 MMcf to 91,446 MMcf at an
average transportation rate per Mcf of $.50 in both 2002 and 2001.
Operating revenues in 2001 compared with 2000 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.
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 was 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. The acquisition of 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. 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 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 Gas Company contributed an increase of 7,399 MMcf, while PG Energy
experienced a net increase of 6,027 MMcf in 2001.
Operating Margin Operating margin in 2002 (operating revenues less gas purchase
and other energy costs and revenue-related taxes) decreased by $9,404,000,
compared with an increase of $190,152,000, in 2001. Operating margins and
earnings are primarily dependent upon gas sales volumes and gas service rates.
The level of gas sales volumes is sensitive to the variability of the weather as
well as the timing of acquisitions and divestitures. Sales volumes, which
benefited from colder-than-normal weather in 2001, were negatively impacted by
unusually mild temperatures throughout fiscal year 2002 as well as in 2000. If
normal weather had been present throughout the Company's service territories in
2002 and 2000, operating margin would have increased by approximately
$28,794,000 and $21,214,000, respectively. Texas, Missouri, Pennsylvania and New
England accounted for 21%, 29%, 19% and 30%, respectively, of the Company's
operating margin in 2002 and 21%, 29%, 18% and 30%, respectively, in 2001.
Weather Weather in the Missouri Gas Energy service territories in 2002 was 85%
of a 30-year measure, 20% warmer than in 2001. Weather in the Southern Union Gas
service territories in 2002 was 93% of a 30-year measure, 18% warmer than in
2001. About half of the customers served by Southern Union Gas are weather
normalized. Weather in the PG Energy service territories in 2002 was 86% of a
30-year measure, 19% warmer than in 2001. Weather in the New England service
territories in 2002 was 85% of a 30-year measure, 17% warmer than the nine
months ended June 30, 2001.
Weather in Missouri in 2001 was 106% of a 30-year measure, 33% colder than in
2000. Weather in Texas in 2001 was 112% of a 30-year measure, 58% colder than in
2000. Weather in Pennsylvania in 2001 was 105% of a 30-year measure, 14% colder
than for the eight months ended June 30, 2000. Weather in New England was 102%
of a 30-year measure for the nine months ended June 30, 2001.
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17
Customers The average number of customers served in 2002, 2001 and 2000 was
1,480,739, 1,506,371 and 1,132,699, respectively. These customer totals exclude
Southern Union's 43% equity ownership in a natural gas distribution company in
Piedras Negras, Mexico that currently serves 23,000 customers. Changes in
customer totals between years primarily reflect the impact of acquisitions and
divestitures. Southern Union Gas served 533,567 customers in Texas during 2002.
Missouri Gas Energy served 487,602 customers in central and western Missouri. PG
Energy served 155,870 customers in northeastern and central Pennsylvania, and
New England Gas Company served 290,417 customers in Rhode Island and
Massachusetts during 2002. SUPro Energy Company (SUPro), a propane subsidiary of
the Company, served 3,451 customers in Texas. South Florida Natural Gas and
Atlantic Gas Corporation, a propane subsidiary of the Company, served 4,376 and
661 customers, respectively, until their sale in December 2001. In Rhode Island
and Massachusetts, Valley Propane, which was sold in September 2001, served
2,800 propane customers while ProvEnergy Fuels, Inc., served 14,900 fuel oil
customers until its sale in August 2001. Energy Services served 2,600 propane
customers until April 2002, when the propane operations were sold.
Operating Expenses Operating, maintenance and general expenses in 2002
decreased $18,311,000, or 8%, to $221,243,000. A decrease in bad debt expense of
$19,853,000 resulted from a decrease in delinquent customer receivables as a
result of lower gas prices and warmer weather in 2002 as compared with 2001.
Additionally, in connection with the Company's Cash Flow Improvement Plan
announced in July 2001 and discussed below, the Company realized savings of
approximately $10,600,000 during 2002 primarily due to the acceptance of
voluntary Early Retirement Programs ("ERPs") in certain of its operating
divisions and a limited reduction in force ("RIF") within its corporate offices.
In connection with the Cash Flow Improvement Plan, the Company divested of
certain non-core assets in fiscal year 2002 which contributed $5,557,000 more in
operating expenses in 2001 as compared with 2002. Southern Union has begun to
recover certain amounts from various insurance carriers for past and future
environmental expenditures. To the extent that such related past expenditures
had been expensed by the Company, a portion of these recoveries are recorded as
a reduction to operating expenses. During 2002, the Company recognized a
reduction in operating expenses of $2,591,000 for past environmental
expenditures. See Commitments and Contingencies in the Notes to the Consolidated
Financial Statements. These items were partially offset by $12,931,000 of
increased operating expenses in 2002 due to the timing of the acquisition of the
New England Operations, and $7,762,000 of increased pension and other
postretirement benefits expense, primarily due to volatility in the stock
markets.
Depreciation and amortization expense in 2002 decreased $9,809,000 to
$77,176,000. The decrease was primarily due to the elimination of goodwill
amortization resulting from the Company's adoption of Goodwill and Other
Intangible Assets effective July 1, 2001. In accordance with this Standard, the
Company has ceased the amortization of goodwill, which generated $17,463,000 of
expense in 2001, and currently accounts for goodwill on an impairment-only
approach. See Other Matters - Critical Accounting Policies and Goodwill in the
Notes to the Consolidated Financial Statements. The decrease in 2002 also
reflects $5,941,000 of reduced depreciation expense from reduced depreciation
rates in Missouri as a result of changes in the previously mentioned rate
settlement. These items were partially offset by $5,845,000 of increased
depreciation expense in 2002, due to the timing of the acquisition of the New
England Operations, and normal growth in plant. Additionally, in connection with
the previously mentioned Cash Flow Improvement Plan, the Company began the
divestiture of certain non-core subsidiaries and assets. As a result of prices
of comparable businesses for various non-core properties, a goodwill impairment
loss of $3,358,000 and an asset impairment loss of $569,000 were recognized in
depreciation and amortization on the consolidated statement of operations in
2002. See Goodwill in the Notes to the Consolidated Financial Statements
included herein.
Taxes other than on income and revenues, principally consisting of property,
payroll and state franchise taxes decreased $1,302,000 to $28,558,000 in 2002.
Taxes decreased due to a reduction in employees resulting from the Company's
reorganization and restructuring initiatives as well as from the sale of
non-core subsidiaries and assets and reduced provisions for state franchise
taxes.
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
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18
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 as a result of the acquisition of the New England Operations and the
Pennsylvania Operations and normal growth in plant. Taxes other than on income
and revenues 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.
Business Restructuring Charges Business reorganization and restructuring
initiatives were commenced in August 2001 as part of a previously announced Cash
Flow Improvement Plan designed to increase annualized pre-tax cash flow from
operations by at least $50 million by the end of fiscal year 2002. Actions taken
by the Company included (i) the offering of voluntary ERPs in certain of its
operating divisions and (ii) a limited RIF within its corporate offices. ERPs,
providing for increased benefits for those electing retirement, were offered to
approximately 400 eligible employees across the Company's operating divisions,
with approximately 60% of such eligible employees accepting. The RIF was limited
solely to certain corporate employees in the Company's Austin and Kansas City
offices where forty-eight employees were offered severance packages. As a result
of actions associated with the business reorganization and restructuring, the
Company expects an annual cost savings in a range of $30 million to $35 million.
In connection with the corporate reorganization and restructuring efforts, the
Company recorded a one-time charge of $32,706,000 during the quarter ended
September 30, 2001. This charge was reduced by $1,394,000 during the quarter
ended June 30, 2002, as a result of the Company's ability to negotiate more
favorable terms on certain of its restructuring liabilities. The charge
included: $17.7 million of voluntary and accepted ERP's, primarily through
enhanced benefit plan obligations, and other employee benefit plan obligations;
$7.6 million of RIF within the corporate offices and related employee separation
benefits; and $6.0 million connected with various business realignment and
restructuring initiatives. All restructuring actions have been completed as of
June 30, 2002. See Business Restructuring Charges in the Notes to the
Consolidated Financial Statements included herein.
Employees The Company employed 2,625, 3,092 and 2,285 individuals as of
June 30, 2002, 2001 and 2000, 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.
During fiscal year 2002, the Company agreed to five-year contracts with two
bargaining units representing employees of New England Gas Company's Providence
operations (formerly ProvEnergy), which were effective May 2002; a four-year
contract with one bargaining unit representing employees of New England Gas
Company's Cumberland operations (formerly Valley Resources), effective May 2002;
a four-year contract with one bargaining unit representing employees of New
England Gas Company's Fall River operations (formerly Fall River Gas), effective
April 2002; and a one year extension of a contract with one bargaining unit
representing employees of New England Gas Company's Cumberland operations, which
was effective May 2002.
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.
Interest Expense and Dividends on Preferred Securities Total interest expense in
2002 decreased by $11,794,000, or 11%, to $91,725,000. Interest expense
decreased by $11,299,000 in 2002 on the $485,000,000 bank note (the Term Note)
entered into by the Company 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.
This decrease in Term Note interest was due to significant reductions in LIBOR
rates during 2002 and the principal repayment of $135,000,000 of the Term Note
during 2002.
Interest expense on short-term debt in 2002 decreased from $7,913,000 to
$7,187,000, primarily due to the significant decrease in LIBOR rates during
2002, which was partially offset by an increase in the average amount of
short-term debt outstanding from $123,829,000 to $176,600,000 during the
year. The increase in the average
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19
amount of short-term debt outstanding during 2002 was primarily due to (i)
higher than normal beginning short-term debt outstanding due to high gas costs
and accounts receivable in 2001, (ii) an increase in the Company's seasonal
borrowing requirements due to the acquisition of the New England Operations, and
(iii) the repayment of various principal amounts of the Term Note with
borrowings under the Company's credit facilities. Draws on short-term debt 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 decreased from 6.4% to 3.2% in 2002.
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 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 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 assumed $113,321,000 in long-tem debt of the New England
Operations and $45,000,000 in long-term debt of the Pennsylvania Operations
which was not refinanced or extinguished with the Term Note or the 8.25% Senior
Notes.
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 2001. The average rate of
interest on short-term debt increased from 6% in 2000 to 6.4% in 2001.
Other Income (Expense), Net Other income, net, in 2002 was $14,368,000,
compared with $76,819,000 in 2001. Other income in 2002 includes gains of
$17,166,000 generated through the settlement of several interest rate swaps, the
recognition of $6,204,000 in previously recorded deferred income related to
financial derivative energy trading activity of a wholly-owned subsidiary, a
gain of $4,653,000 realized through the sale of marketing contracts held by PG
Energy Services Inc., income of $2,369,000 generated from the sale and/or rental
of gas-fired equipment and appliances by various operating subsidiaries, a gain
of $1,200,000 realized through the sale of the propane assets of PG Energy
Services Inc., $1,004,000 of realized gains on the sale of a portion of Southern
Union's holdings in Capstone Turbine Corporation (Capstone), and power
generation and sales income of $971,000 primarily from PEI Power Corporation.
These items were partially offset by a non-cash charge of $10,380,000 to reserve
for the impairment of the Company's investment in a technology company,
$9,100,000 of legal costs associated with ongoing litigation from the
unsuccessful acquisition of Southwest Gas Corporation (Southwest), and a
$1,500,000 loss on the sale of South Florida Natural Gas, a natural gas division
of Southern Union, and Atlantic Gas Corporation, a Florida propane subsidiary of
the Company.
Other income in 2001 included realized gains on the sale of investment
securities of $74,582,000, a $13,532,000 gain on the sale of non-core real
estate and $7,643,000 of interest and dividend income. These items were
partially offset by $12,855,000 of legal costs associated with 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 of $9,708,000 included $10,363,000 of legal costs
associated with Southwest and $2,236,000 of non-cash trading losses. These
items were offset by net rental income of Lavaca Realty Company of
$1,757,000.
Federal and State Income Taxes Federal and state income tax expense in 2002,
2001 and 2000 was $15,108,000, $40,000,000 and $9,589,000, respectively. The
Company's consolidated federal and state effective income tax rate was 43%, 41%
and 49% in 2002, 2001 and 2000, respectively. The fluctuation in the effective
federal and state income tax rate is a result of non-tax deductible amortization
and write-off of goodwill, along with the level of pre-tax earnings.
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20
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, debt service and certain tax payments.
To provide these funds, as well as funds for its continuing construction and
maintenance programs, the Company has historically used cash flows from
operations and its credit facilities. Because of available credit and the
ability to obtain various types of market financing, combined with anticipated
cash flows from operations, management believes it has adequate financial
flexibility to meet its short-term cash needs.
The Company has increased the scale of its natural gas distribution operations
and the size of its customer base by pursuing and consummating 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 a substantial
increase in expenditures that 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 the 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 2002 were $150,030,000 compared with $123,260,000 and
$74,050,000 for 2001 and 2000, respectively. After changes in operating assets
and liabilities, cash flows from operating activities were $273,616,000 in 2002
compared with cash flows used in operating activities of $147,099,000 in 2001
and cash flows from operating activities of $66,865,000 for 2000. Changes in
operating assets and liabilities provided cash of $123,586,000 in 2002. Changes
in operating assets and liabilities used cash of $270,359,000 and $7,185,000 in
2001 and 2000, respectively. The current year changes in operating assets and
liabilities reflect the collection of the unusually high accounts receivable
balance that occurred due to the high gas costs during the winter season of 2001
that negatively impacted the Company's collection efforts and the recovery of
over $70 million in deferred purchased gas costs that the Company incurred
during 2001 due to the regulatory lag in passing along such increased purchased
gas costs to customers. The timing of acquisitions and the timing of natural gas
purchases stored in inventory also impacted operating activities in prior years.
At June 30, 2002, 2001 and 2000, the Company's primary source of liquidity
included borrowings available under the Company's credit facilities. On June 10,
2002, the Company entered into a short-term credit facility in the amount of
$150,000,000 (the "Short-Term Facility") that matures on June 9, 2003. The
Short-Term Facility replaced another short-term credit facility for the same
principal amount that expired on May 28, 2002. Also on June 10, 2002, the
Company amended the terms and conditions of its $225,000,000 long-term credit
facility (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 Short-Term
Facility and Long-Term Facility (together, the "Facilities") are available for
Southern Union's working capital, letter of credit requirements and other
general corporate purposes. The Facilities are subject to a commitment fee based
on the rating of the Senior Notes. As of June 30, 2002, the commitment fees were
an annualized 0.13% on the Short-Term Facility and 0.15% on the Long-Term
Facility. The Facilities require the Company to meet certain covenants in order
for the Company to be able to borrow under those agreements. A balance of
$131,800,000 and $190,600,000 was outstanding under the Facilities at June 30,
2002 and 2001, respectively. As of August 31, 2002 there was a balance of
$227,500,000 outstanding under these Facilities.
The Company leases certain facilities, equipment and office space under
cancelable and noncancelable operating leases. The minimum annual rentals under
operating leases for the next five years ending June 30 are as follows: 2003 --
$7,379,000; 2004 -- $6,514,000; 2005 -- $5,491,000; 2006 -- $4,816,000; 2007 --
$4,647,000 and thereafter $19,708,000. The Company is also committed under
various agreements to purchase certain quantities of gas in
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21
the future. At June 30, 2002, the Company has purchase commitments for certain
quantities of gas at variable, market-based prices that have an annual value of
$157,929,000. The Company's purchase commitments may be extended over several
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 and the
Company believes that all costs incurred under such commitments will be
recovered through its purchase gas tariffs.
Investing Activities Cash flow used in investing activities in 2002 decreased
$395,527,000 to $39,226,000. Cash flow used in investing activities increased by
$283,887,000 to $434,753,000 in 2001. 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, the sale of non-core
real estate and other assets, and the settlement of interest rate swaps.
During 2002, 2001 and 2000, the Company expended $93,279,000, $123,776,000 and
$100,446,000, respectively, for capital expenditures excluding acquisitions.
These expenditures primarily related to distribution system replacement and
expansion. Included in these capital expenditures were $7,860,000, $14,040,000
and $14,286,000 for the Missouri Gas Energy Safety Program in 2002, 2001 and
2000, respectively. Cash flow from operations has historically been utilized to
finance capital expenditures and is expected to be the primary source for future
capital expenditures.
During 2002, the Company sold non-core subsidiaries and
assets, which generated proceeds of $40,935,000, resulting in net pre-tax gains
of $4,914,000. In 2001, Southern Union sold its Austin, Texas headquarters
building, Lavaca Plaza, for $20,638,000, resulting in a pre-tax gain of
$13,532,000 and also disposed of a former subsidiary of the Pennsylvania
Operations, which generated proceeds of $3,300,000 resulting in a pre-tax gain
of $707,000. In January 2000, a former subsidiary of the Pennsylvania Operations
was sold for $12,150,000. No financial gain or loss was recognized on this
transaction.
In September 2001, the settlement of three interest rate swaps which the Company
had negotiated in July and August of 2001 and which were not designated as
hedges, resulted in a pre-tax gain and cash flow of $17,166,000.
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. In November 1999, Southern Union acquired the Pennsylvania
Operations for 16,713,735 pre-stock dividend shares of common stock and
$38,366,000 in cash. On the date of acquisition, Pennsylvania Operations had
$576,000 in cash and cash equivalents.
During 2002 and 2001, the Company sold a portion of its investment holdings in
Capstone for $1,213,000 and $84,762,000, respectively, resulting in pre-tax
gains of $1,004,000 and $74,582,000, respectively. During 2002, 2001 and 2000,
the Company purchased investment securities of $938,000, $12,495,000 and
$21,001,000, respectively.
Pursuant to a 1989 MPSC order, Missouri Gas Energy is
engaged in a major gas safety program in its service territories ("Missouri Gas
Energy Safety Program"). This program includes replacement of company- and
customer-owned gas service and yard lines, the movement and resetting of meters,
the replacement of cast iron mains and the replacement and cathodic protection
of bare steel mains. In recognition of the significant capital expenditures
associated with this safety program, the MPSC permits the deferral, and
subsequent recovery through rates, of depreciation expense, property taxes and
associated carrying costs. The continuation of the Missouri Gas Energy Safety
Program will result in significant levels of future capital expenditures. The
Company estimates incurring capital expenditures of $9,602,000 in 2003 related
to this program and up to $170 million over the remaining life of the program of
17 years.
Financing Activities Cash flow used in financing activities was
$235,609,000 in 2002 compared to cash flow from financing activities of
$555,242,000 and $111,830,000 in 2001 and 2000, 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 and
purchase of treasury stock. As a result of these financing transactions, the
Company's total debt to total capital ratio at June 30, 2002 was 60.3%, compared
with 61.9% and 46.8% at
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22
June 30, 2001 and 2000, respectively. The Company's effective debt cost rate
under the current debt structure is 6.60% (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, 2002, a balance of $350,000,000 was outstanding on this
Term Note. The Term Note, which initially expired on August 27, 2001, was
extended through August 26, 2002. On July 16, 2002, the Company repaid the Term
Note with the proceeds from the issuance of a $311,087,000 Term Note dated July
15, 2002 (the "2002 Term Note") and borrowings under the Facilities. The 2002
Term Note requires semi-annual principal repayments on February 15th and August
15th of each year, with payments of $25,000,000 each being due February 15,
2003, August 15, 2003, February 15, 2004, and August 15, 2004 and payments of
$35,000,000 each being due February 15, 2005 and August 15, 2005. The remaining
principal amount of $141,087,000 is due August 26, 2005. No additional draws can
be made on the 2002 Term Note. The interest rate on borrowings under the 2002
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 on November 4,
1999, the Company issued $300,000,000 of 8.25% Senior Notes due 2029 which were
used to: (i) fund the cash portion of the consideration to be paid to the
Pennsylvania 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 rank equally in right of payment with each other and with the
Company's other unsecured and unsubordinated obligations, including the 7.60%
Senior Notes due 2024. 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.
On December 6, 2001 and October 19, 2001, respectively, the Company filed shelf
registrations for $200,000,000 of subordinated debt securities and preferred
securities of financing trusts and $400,000,000 of senior debt securities.
Southern Union may sell such securities up to such amounts from time to
time, at prices determined at the time of any such offering. The Company
currently has regulatory approval to issue up to $88,900,000 of these
securities for certain uses.
The Company's ability to arrange financing, including refinancing, and its cost
of capital are dependent on various factors and conditions, including: general
economic and capital market conditions; maintenance of acceptable credit
ratings; credit availability from banks and other financial institutions;
investor confidence in the Company, its competitors and peer companies in the
energy industry; market expectations regarding the Company's future earnings and
probable cash flows; market perceptions of the Company's ability to access
capital markets on reasonable terms; and provisions of relevant tax and
securities laws.
On June 6, 2002, Moody's Investor Service, Inc. ("Moody's") reduced its credit
rating on the Company's senior unsecured debt to Baa3 with a stable outlook from
Baa2 with a negative outlook. The Company's senior unsecured debt is currently
rated BBB+ by Standard and Poor's Rating Information Service ("S&P"), a rating
that it has held since April 1998. Although no further downgrades are
anticipated, such an event would not have a material impact on the Company. The
Company is not party to any lending agreements that would accelerate the
maturity date of any obligation due to a failure to maintain any specific credit
ratings.
The Company had standby letters of credit outstanding of $30,541,000 at June 30,
2002 and $2,716,000 at June 30, 2001, which guarantee payment of natural gas
purchases, insurance claims and other various commitments.
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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, 2002, the Company had issued fixed-rate long-term debt, capital
lease and Preferred Securities aggregating $940,413,000 in principal amount and
having a fair value of $924,647,000. 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 $59,335,000 if interest and dividend rates were to
decline by 10% from their levels at June 30, 2002. 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 $481,800,000 at June 30, 2002
and primarily consisted of the Term Note entered into by the Company for the
acquisition of the New England Operations and amounts borrowed under the
Facilities of the Company. The floating-rate obligations under the Term Note and
the 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, 2002 levels, the Company's consolidated
interest expense would increase by a total of approximately $112,000 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 (FASB) Accounting for
the Effects of Certain Types of Regulation as a regulatory asset/liability.
The change in exposure to loss in earnings and cash flow related to interest
rate risk from June 30, 2001 to June 30, 2002 is not material to the Company.
See Preferred Securities of Subsidiary Trust and Debt and Capital Lease in the
Notes to the Consolidated Financial Statements.
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), which was refinanced in January 2002. The TIF Debt bears interest at a
floating rate with a floor of 6.0% and a ceiling of 7.75% and matures on June
30, 2011. The loan requires interest-only payments until June 30, 2003, and
semi-annual interest and principal payments thereafter. As of June 30, 2002, the
interest rate on the TIF Debt is 6.0% and estimated incremental tax revenues are
expected to cover approximately 45% of the fiscal year 2003 annual debt service.
The balance outstanding on the TIF Debt was $9,710,000 as of June 30, 2002.
In accordance with adoption of 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 2002, the Company was party to three interest rate swaps that
were created to manage exposure against volatility in interest payments on
variable rate debt and which qualify for hedge accounting. As of June 30, 2002,
$954,000 in after-tax comprehensive income generated through the expiration of
two of these swaps was partially offset by the fair value of the Company's
remaining obligation under one swap which resulted
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24
in $150,000 of unrealized losses, net of tax. For the fiscal year ended June 30,
2002, the Company recorded net settlement payments of $1,408,000 on these swaps
through interest expense. Hedge ineffectiveness, which is recorded in interest
expense, was immaterial for fiscal 2002. No component of the swaps' gain or loss
was excluded from the assessment of hedge effectiveness. At June 30, 2002, the
fair value of the remaining interest rate swap was a liability of $519,000 and
is offset by a matching adjustment to other comprehensive income. The Company
expects to reclassify as interest expense $291,000 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 17 months.
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.
Beginning in May 2001, the Company acquired natural gas commodity swap
derivatives and collar transactions in order to mitigate price volatility of
natural gas passed through to utility customers. The cost of the derivative
products and the settlement of the respective obligations are recorded through
the gas purchase adjustment clause as authorized by the applicable regulatory
authority and therefore do not impact earnings. 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, 2002, the Company owned
contracts representing 699,375 MMBtu of natural gas at an average strike price
of $3.97 per MMBtu. The fair value of the contracts, which expire at various
times through May 2003, are included in the consolidated financial statements as
an asset and a matching adjustment to deferred cost of gas of $100,000 at
June 30, 2002, and as a liability and a matching adjustment to deferred cost of
gas of $1,701,000 at June 30, 2001.
In March 2001, the Company discovered unauthorized financial derivative energy
trading activity by a non-regulated, wholly-owned subsidiary. All unauthorized
trading activity was subsequently closed in March and April of 2001 resulting in
a cumulative cash expense of $191,000, net of taxes, and a deferred liability of
$7,921,000 at June 30, 2001. For the fiscal year ended June 30, 2002, the
Company recorded $6,204,000 through other income relating to the expiration of
contracts resulting from this trading activity. The majority of the remaining
deferred liability of $1,717,000 at June 30, 2002 rela