10-Q 1 0001.txt UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q [ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2000 ------------------------------------- Commission file number 1-14201 --------------------------------------------- Sempra Energy ---------------------------------------------------------- (Exact name of registrant as specified in its charter) California 33-0732627 ------------------------------- ------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 101 Ash Street, San Diego, California 92101 ------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) (619) 696-2034 ---------------------------------------------------------- (Registrant's telephone number, including area code) 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 ----- ----- Common stock outstanding on July 31, 2000: 204,141,740 --------------------- PART I FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS. SEMPRA ENERGY STATEMENTS OF CONSOLIDATED INCOME Dollars in millions, except per share amounts
Three Months Ended June 30, --------------- 2000 1999 ------ ------ Revenues and Other Income Utility revenues Natural gas $ 716 $ 706 Electric 473 646 Other operating revenues 298 159 Other income 49 6 ------ ------ Total 1,536 1,517 ------ ------ Expenses Cost of natural gas distributed 316 275 Electric fuel and net purchased power 264 109 Operating expenses 530 485 Depreciation and amortization 144 467 Other taxes and franchise payments 40 41 Preferred dividends of subsidiaries 3 3 Trust preferred distributions by subsidiary 4 -- ------ ------ Total 1,301 1,380 ------ ------ Income Before Interest and Income Taxes 235 137 Interest 76 54 ------ ------ Income Before Income Taxes 159 83 Income Taxes 49 1 ------ ------ Net Income $ 110 $ 82 ====== ====== Weighted-average number of shares outstanding (Basic)* 201,386 237,157 ------- ------ Weighted-average number of shares outstanding (Diluted)* 201,484 237,455 ------- ------ Net Income Per Share of Common Stock (Basic and Diluted) $0.55 $0.35 ====== ====== Common Dividends Declared Per Share $0.25 $0.39 ====== ====== *In thousands of shares See notes to Consolidated Financial Statements.
SEMPRA ENERGY STATEMENTS OF CONSOLIDATED INCOME Dollars in millions, except per share amounts
Six Months Ended June 30, --------------- 2000 1999 ------ ------ Revenues and Other Income Utility revenues Natural gas $1,537 $1,404 Electric 822 1,006 Other operating revenues 570 270 Other income 73 28 ------ ------ Total 3,002 2,708 ------ ------ Expenses Cost of natural gas distributed 706 566 Electric fuel and net purchased power 397 211 Operating expenses 1,029 873 Depreciation and amortization 278 609 Franchise payments and other taxes 91 86 Preferred dividends of subsidiaries 6 6 Trust preferred distributions by subsidiary 6 -- ------ ------ Total 2,513 2,351 ------ ------ Income Before Interest and Income Taxes 489 357 Interest 149 112 ------ ------ Income Before Income Taxes 340 245 Income Taxes 117 64 ------ ------ Net Income $ 223 $ 181 ====== ====== Weighted-average number of shares outstanding (Basic)* 214,834 237,111 ------- ------ Weighted-average number of shares outstanding (Diluted)* 214,920 237,444 ------- ------ Net Income Per Share of Common Stock (Basic and Diluted) $1.04 $0.76 ====== ====== Common Dividends Declared Per Share $0.50 $0.78 ====== ====== *In thousands of shares See notes to Consolidated Financial Statements.
SEMPRA ENERGY CONSOLIDATED BALANCE SHEETS Dollars in millions
Balance at ------------------------ June 30, December 31, 2000 1999 ----------- ----------- ASSETS Current assets Cash and cash equivalents $ 546 $ 487 Accounts receivable 589 552 Income taxes receivable -- 144 Energy trading assets 3,119 1,539 Inventories 79 147 Other 138 146 ---------------------------- Total current assets 4,471 3,015 ---------------------------- Investments and other assets Regulatory assets 879 606 Nuclear decommissioning trusts 551 551 Investments 1,245 1,164 Other assets 470 460 ---------------------------- Total investments and other assets 3,145 2,781 ---------------------------- Property, plant and equipment Property, plant and equipment 11,406 11,127 Less accumulated depreciation and amortization (5,975) (5,733) ---------------------------- Total property, plant and equipment - net 5,431 5,394 --------------------------- Total assets $13,047 $11,190 =========================== See notes to Consolidated Financial Statements.
SEMPRA ENERGY CONSOLIDATED BALANCE SHEETS Dollars in millions
Balance at ------------------------ June 30, December 31, 2000 1999 ----------- ----------- LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities Short-term debt $ -- $ 182 Accounts payable 670 546 Income taxes payable 26 -- Deferred income taxes 76 67 Energy trading liabilities 2,757 1,365 Dividends and interest payable 119 154 Regulatory balancing accounts - net 497 346 Customer refunds payable 388 -- Current portion of long-term debt 153 155 Other 431 421 --------------------------- Total current liabilities 5,117 3,236 --------------------------- Long-term debt 3,313 2,902 --------------------------- Deferred credits and other liabilities Customer advances for construction 70 72 Post-retirement benefits other than pensions 198 204 Deferred income taxes 641 615 Deferred investment tax credits 104 106 Deferred credits and other liabilities 780 865 --------------------------- Total deferred credits and other liabilities 1,793 1,862 --------------------------- Preferred stock of subsidiaries 204 204 --------------------------- Mandatorily redeemable trust preferred securities 200 -- --------------------------- Commitments and contingent liabilities (Note 3) SHAREHOLDERS' EQUITY Common Stock 1,412 1,966 Retained earnings 1,057 1,101 Deferred compensation relating to ESOP (40) (42) Accumulated other comprehensive income (9) (39) --------------------------- Total shareholders' equity 2,420 2,986 --------------------------- Total liabilities and shareholders' equity $13,047 $11,190 =========================== See notes to Consolidated Financial Statements.
SEMPRA ENERGY CONDENSED STATEMENTS OF CONSOLIDATED CASH FLOWS Dollars in millions
Six Months Ended June 30, ------------------------ 2000 1999 ------- ------- CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 223 $ 181 Adjustments to reconcile net income to net cash provided by operating activities Depreciation and amortization 278 609 Portion of depreciation arising from sales of generating plants -- (295) Application of balancing accounts to stranded costs -- (62) Deferred income taxes and investment tax credits 38 (83) Non-cash rate reduction bond revenue 11 (62) Other - net (51) (35) Net changes in other working capital components 313 462 ------------------------- Net cash provided by operating activities 812 715 ------------------------- CASH FLOWS FROM INVESTING ACTIVITIES Expenditures for property, plant and equipment (290) (194) Investment in Chilquinta Energia -- (420) Net proceeds from sale of generating plants -- 466 Other (25) (168) ------------------------- Net cash used in investing activities (315) (316) ------------------------- CASH FLOWS FROM FINANCING ACTIVITIES Common dividends (144) (187) Repurchase of common stock (722) -- Issuance of preferred securities 200 -- Issuance of long-term debt 504 189 Payments on long-term debt (85) (128) Decrease in short-term debt - net (182) (43) Other (9) 2 ------------------------- Net cash used in financing activities (438) (167) ------------------------- Increase (decrease) in Cash and Cash Equivalents 59 232 Cash and Cash Equivalents, January 1 487 424 ------------------------ Cash and Cash Equivalents, June 30 $ 546 $ 656 ======================== SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Interest payments, net of amounts capitalized $ 172 $ 115 ======================== Income tax payments (refunds) - net $ (58) $ 147 ======================== Real estate investments acquired $ -- $ 37 Cash paid -- (3) ------------------------ Liabilities assumed $ -- $ 34 ======================== See notes to Consolidated Financial Statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. GENERAL This Quarterly Report on Form 10-Q is that of Sempra Energy (the Company), a California-based Fortune 500 energy services company. Sempra Energy's principal subsidiaries are San Diego Gas & Electric Company (SDG&E), Southern California Gas Company (SoCalGas) (collectively referred to herein as the California utilities), Sempra Energy Trading and Sempra Energy International. The financial statements herein are the Consolidated Financial Statements of Sempra Energy and its subsidiaries. The accompanying Consolidated Financial Statements have been prepared in accordance with the interim-period-reporting requirements of Form 10-Q. Results of operations for interim periods are not necessarily indicative of results for the entire year. In the opinion of management, the accompanying statements reflect all adjustments necessary for a fair presentation. These adjustments are only of a normal recurring nature. Certain changes in classification have been made to prior presentations to conform to the current financial statement presentation. The Company's significant accounting policies are described in the notes to Consolidated Financial Statements in the Company's 1999 Annual Report. The same accounting policies are followed for interim reporting purposes. Information in this Quarterly Report is unaudited and should be read in conjunction with the Company's 1999 Annual Report. As described in the notes to Consolidated Financial Statements in the Company's 1999 Annual Report, the California utilities account for the economic effects of regulation on utility operations (excluding generation operations) in accordance with Statement of Financial Accounting Standards No. 71, "Accounting for the Effects of Certain Types of Regulation" (SFAS No. 71). 2. MAJOR FINANCIAL TRANSACTIONS Common Stock Repurchase On February 25, 2000, the Company completed a self tender offer, purchasing 36.1 million shares of its outstanding common stock at $20 per share. The Company issued $500 million of long-term 7.95% notes due 2010 and $200 million of 8.9% mandatorily redeemable trust preferred securities to finance substantially all of the repurchase. Additional Common Stock Repurchases Authorized On March 9, 2000, the Company's Board of Directors authorized the expenditure of up to $100 million to repurchase additional shares of common stock from time to time in the open market or in privately negotiated transactions. Authorization of the stock repurchase does not obligate the Company to acquire any particular amount of common stock or within any specific timeframe. Through July 31, 2000 the Company acquired 162,000 shares under this authorization (all in July 2000). Reduction in Common Dividends Dividends currently are paid quarterly to shareholders. The payment of future dividends is within the discretion of the board of directors. In January 2000 the Company reduced the quarterly dividend on shares of its common stock to $0.25 per share ($1.00 annualized rate) from its previous level of $0.39 per share ($1.56 annualized rate) commencing with the dividend payable in the second quarter of 2000. Investments in South America On June 10, 1999, Sempra Energy International (SEI) and Public Service Enterprise Group (PSEG) purchased (on a 50/50 basis) Chilquinta Energia S.A. (Energia), primarily a Chilean electric distribution company, for $840 million. SEI invested $260 million for the purchase of stock and refinanced $160 million of Energia's outstanding long-term debt. In September 1999, SEI and PSEG completed their acquisition of 47.5 percent of the outstanding shares of Luz del Sur S.A., a Peruvian electric distribution company. SEI's share of the transaction was $108 million in cash. This acquisition, combined with the 37 percent already owned through Energia, increased the companies' total joint ownership to 84.5 percent of Luz del Sur S.A. On July 11, 2000 the Company announced an agreement to purchase, for approximately $140 million, an additional 21.5-percent interest in two Argentine natural gas utility holding companies (Sodigas Pampeana S.A. and Sodigas Sur S.A.). Completion of the transaction, scheduled for the fourth quarter of 2000, would increase the Company's investment in the two Argentine companies from 21.5 percent to 43 percent. KN Energy On June 21, 1999, Sempra Energy and KN Energy, Inc. (KN) announced that they had agreed to terminate an agreement for the acquisition of KN by Sempra Energy. Expenses incurred in connection with the proposed acquisition were $11 million, after tax, for both the three- month and six-month periods ended June 30, 1999. 3. MATERIAL CONTINGENCIES ELECTRIC INDUSTRY RESTRUCTURING -- CALIFORNIA PUBLIC UTILITIES COMMISSION In September 1996, the State of California enacted a law restructuring California's electric utility industry (AB 1890). The legislation adopted the December 1995 policy decision of the California Public Utility Commission (CPUC) that was intended to restructure the industry to stimulate competition and reduce rates. Beginning on March 31, 1998, customers were given the opportunity to choose to continue to purchase their electricity from the local utility under regulated tariffs, to enter into contracts with other energy-service providers (direct access) or to buy their power from the independent Power Exchange (PX) that serves as a wholesale power pool allowing all energy producers to participate competitively. The PX obtains its power from qualifying facilities, from nuclear units and, lastly, from the lowest-bidding suppliers. California's investor-owned utilities (IOUs) are obligated to sell their power supply, including owned generation and purchased-power contracts, to the PX. The IOUs are also obligated to purchase from the PX the power that they distribute. An Independent System Operator (ISO) schedules power transactions and access to the transmission system. The local utility continues to provide distribution service regardless of the source from which the customer chooses to purchase electricity. Purchases by SDG&E from the PX/ISO are included in purchased-power expenses and revenues from sales to the PX/ISO have been netted therein on the Statements of Consolidated Income. Revenues from the PX/ISO reflect sales to the PX/ISO at market prices of energy from SDG&E's power plants and from its long-term purchased-power contracts. As discussed in the notes to Consolidated Financial Statements contained in the Company's 1999 Annual Report, AB 1890 allowed the IOUs a reasonable opportunity to recover their stranded costs via a competition transition charge (CTC) to customers through December 31, 2001. In June 1999, SDG&E completed the recovery of its stranded costs, other than the future above-market portion of qualifying facilities and other purchased-power contracts that were in effect at December 31, 1995, and San Onofre Nuclear Generating Station (SONGS) costs as described below, which will both continue to be collected in rates. Recovery of the other stranded costs was effected by, among other things, the sale of SDG&E's South Bay and Encina fossil power plants and combustion turbines during the quarter ended June 30, 1999. SDG&E will operate and maintain both plants for the new owners until April 2001 and May 2001, respectively. Stranded costs included the cost of SONGS as of December 31, 1995. SDG&E retains ownership of its 20-percent interest in SONGS. Subsequent SONGS costs are recoverable only from the sales to the PX of power produced from SONGS, at rates previously fixed by the CPUC through December 31, 2003 and at market rates thereafter. If approved by the CPUC, SDG&E is planning to auction its interest in SONGS. A major issue being addressed is the management of the decommissioning trust to ensure that adequate funding is available at the time the plant is decommissioned. AB 1890 also required a 10-percent reduction of residential and small commercial customers' rates, beginning in January 1998, and provided for the issuance of rate-reduction bonds by an agency of the State of California to enable the IOUs to achieve this rate reduction. In December 1997, $658 million of rate-reduction bonds were issued on SDG&E's behalf at an average interest rate of 6.26 percent. These bonds are being repaid over 10 years by SDG&E's residential and small commercial customers via a non-bypassable charge on their electric bills. In 1997, SDG&E formed a subsidiary, SDG&E Funding LLC, to facilitate the issuance of the bonds. In exchange for the bond proceeds, SDG&E sold to SDG&E Funding LLC all of its rights to the revenue streams collected from such customers related to the non- bypassable charge. Consequently, the transaction is structured to cause such revenue streams not to be the property of SDG&E nor to be available to satisfy any claims of SDG&E's creditors. The sizes of the rate-reduction bond issuances were set so as to make the IOUs neutral as to the 10-percent rate reduction, and were based on a four-year period to recover stranded costs. Because SDG&E recovered its stranded costs in only 18 months (due to the greater- than-anticipated plant-sale proceeds), the bond sale proceeds were greater than needed. Accordingly, SDG&E will return to its customers $388 million of surplus bond proceeds. Pursuant to a June 8, 2000 CPUC decision, this refund, included in current liabilities at June 30, 2000, will take place during the third quarter of 2000. AB 1890 also includes a rate freeze for all IOU customers. The rate freeze was to have stayed in place until January 1, 2002. However, in connection with completion of its stranded cost recovery, SDG&E filed with the CPUC and received approval to reduce base rates (the non- commodity portion of rates) to all electric customers, effective July 1, 1999. The portion of the electric rate representing the commodity cost is passed through to customers with no markup and fluctuates with the price of electricity from the PX. As a result, although base rates are now below those implicit in the rate freeze, total rates charged by SDG&E may be above or below those set by the rate freeze depending on the cost of electricity. A number of factors, including recent supply/demand conditions, have resulted in abnormally high commodity prices, which are expected to continue through the heavy air-conditioning season in the southwestern United States. This has caused SDG&E's monthly customer bills to be substantially higher than normal. SDG&E and others have proposed various methods of responding to these high rates. On June 28, 2000 the ISO Board of Governors approved the reduction of the wholesale price cap for electricity in California from $750 per megawatt hour (MWh) to $500 per MWh. Subsequently, on August 1, 2000, they approved an additional reduction of the price cap from $500 per MWh to $250 per MWh. In a filing the following day, SDG&E requested that the Federal Energy Regulatory Commission (FERC) place an emergency order capping the price electricity generators offer to the PX/ISO wholesale markets at $250 per MWh. However, three large power- generating companies have requested a FERC ruling that any attempt to limit wholesale electricity prices be judged unjust and unreasonable and that the ISO be ordered to compensate them for actual damages and lost opportunity costs. On August 3, 2000 the CPUC approved a proposal by SDG&E to accelerate the refund to its electric customers of $100 million of certain balancing account overcollections to partially offset the high monthly bills. This is in addition to the $388 million return to residential and small commercial customers of surplus bond proceeds referred to above. In addition, the CPUC denied a proposal by others to place a ceiling on electric rates for residential and small commercial customers. It also ordered SDG&E not to disconnect the service of any customers who do not pay their high bills through November 2000, and directed SDG&E to expand its level pay plan to all customers who request it. This would allow a customer to level out payments over a year. The CPUC agreed to study the issues and hold hearings and did not rule out a rate freeze in the future. In addition, the CPUC granted SDG&E expanded authority to participate in the PX's Block Forward Market which allows SDG&E to utilize futures contracts to hedge electricity prices and purchase electricity for extended periods at fixed prices. On August 9, 2000 the California governor issued a press release calling on the CPUC to establish a one -or two-year rate reduction and stabilization plan to cut electricity rates by about one-half for SDG&E residential and business customers, but still allow SDG&E to eventually recover the prices paid for wholesale power. In response, a CPUC commissioner has issued a proposed decision which, if adopted by the CPUC, would impose an interim rate freeze on SDG&E's electric rates for residential, small commercial and lighting customers. Under the proposed decision these rates would be frozen through December 2003 at 110 percent of June 30, 1998 levels. A balancing account would be established to record related undercollections resulting from the frozen rates with undercollected amounts to be recovered in a manner (not specified in the proposed decision) intended to make SDG&E whole. A second CPUC commissioner has proposed an alternate decision which would impose a similar rate freeze only on monthly volumes of electricity used by the lowest-volume 70 percent of customers (500 kwh for residential customers and 1,500 kwh for commercial customers). This is intended to encourage conservation. The alternate proposal would also automatically switch all SDG&E customers to a level-pay plan, except for those customers who specifically indicate that they do not want to participate in this billing arrangement. This alternate proposal would provide for the deferred billings to be accumulated in an existing balancing account, to be recovered in a manner intended to make SDG&E whole. The proposed decisions will be reviewed by the CPUC, which may accept either one (with or without modification) or reject them both, in rendering a final decision on the matter. The CPUC has scheduled a special meeting on August 21, 2000 to address this matter. The California State Senate has approved emergency legislation to roll back and freeze rates at July 1999 levels in the San Diego area (effective June 1, 2000) and sent it to the State Assembly for its action. The bill requires the CPUC to initiate a proceeding to assess alternatives for recovering undercollections resulting from the rate freeze. The FERC is investigating the electric bulk power markets and California's attorney general is investigating whether there has been market manipulation. Various proposals have included application of any refunds from power suppliers, arising from such investigations, to help defray any billings deferred as a result of adoption of certain of the proposals. The proposed legislation, the proposed CPUC decisions and other proposals to respond to the high electricity rates would, if adopted, adversely affect the timing of revenue collections by SDG&E and related cash flows. They could also adversely affect the ultimate collectibility of these revenues, which are intended to recover the costs of electricity purchased by SDG&E to serve its customers. The Company is unable to predict whether any of these proposals will be adopted or their ultimate impact on SDG&E. However, SDG&E will vigorously oppose, through regulatory proceedings and otherwise, any proposal that does not assure the ultimate collectibility of its full costs of providing electricity service. The CPUC is currently deliberating on the legal, ratemaking and policy issues of ending the rate freeze for all the IOUs, including post-rate freeze ratemaking. The CPUC has now permitted SDG&E to purchase energy through the PX or a mixture of the PX and any other qualified exchange, if a qualified exchange is authorized by future advice letter filings. A "qualified exchange" is defined as one that provides continuous trading in either a bid/ask or second price auction type market, equal nondiscriminatory access and a mechanism for timely, anonymous price transparency. The CPUC also made numerous changes in cost allocations among customer classes, adjusted various ratemaking mechanisms, granted SDG&E's request to close certain balancing accounts, and ordered hourly pricing to be implemented for customers with hourly meters. The CPUC rejected as premature an SDG&E proposal for an incentive mechanism for commodity prices. Thus far, electric-industry restructuring has been confined to generation. Transmission and distribution have remained subject to traditional cost-of-service regulation. However, the CPUC is exploring the possibility of opening up electric distribution to competition. During 2000, the CPUC will consider whether any changes should be made in electric distribution regulation. A CPUC staff report on this issue was submitted to the CPUC in July 2000, with dissenting opinions recommending against changing electric distribution regulation at this time due to the current state of electric-industry restructuring. The recent electricity supply/demand conditions have combined with other factors to affect natural gas supplies and prices. The lack of surplus natural gas production and the current need to store gas for the coming winter competes directly with the need to use gas supplies to generate electricity to meet demand. On August 1, 2000 SDG&E requested that the CPUC allow San Diego County's two major fossil- fuel power plants to use alternative fuels such as oil to generate electricity when demand for natural gas exceeds supply. The new operators of the power plants, which SDG&E sold in 1999, apparently intend to protest the proposal, citing potential supply interruptions and increased pollution. ELECTRIC INDUSTRY RESTRUCTURING -- FEDERAL ENERGY REGULATORY COMMISSION On December 20, 1999, the Federal Energy Regulatory Commission (FERC) issued "Order 2000". As described in the Company's 1999 Annual Report, the rule discusses the formation of Regional Transmission Organizations, grid management, transmission pricing reform and related matters. The impact of Order 2000 on SDG&E depends on the results of this process and other implementation issues. Transmission Access Charge On March 31, 2000, the ISO filed with the FERC a transmission access charge (TAC) which separates the transmission systems in California into two groups (high and low voltage) as the basis for allocating the costs of maintaining the transmission systems among the various transmission owners. SDG&E voted against the TAC and filed a protest with the FERC in April 2000. In June 2000, the FERC approved the TAC subject to refund and settlement agreement. Settlement efforts among all parties are ongoing. Resolution is not expected before 2001. Once the TAC is in effect, Internal Revenue Service (IRS) regulations may require SDG&E to refinance the industrial development bonds that support its transmission facilities, the face value of which totals $168 million. If this occurs, SDG&E's estimated annual pretax cost of replacing the bonds with debt, the interest on which is taxable to the holders, would be $4 million, most of which would be recovered in rates. SDG&E recently submitted a request for a private letter ruling from the IRS. In addition, pending federal legislation could resolve this issue. NATURAL GAS INDUSTRY RESTRUCTURING The natural gas industry experienced an initial phase of restructuring during the 1980s by deregulating natural gas sales to noncore customers. On January 21, 1998, the CPUC released a staff report initiating a project to assess the current market and regulatory framework for California's natural gas industry. The general goals of the plan are to consider reforms to the current regulatory framework emphasizing market-oriented policies benefiting California's natural gas consumers. In July 1999, after hearings, the CPUC issued a decision stating which gas regulatory changes it found most promising, encouraging parties to submit settlements addressing those changes, and providing for further hearings if necessary. In October 1999, the State of California enacted a law (AB 1421) which requires that natural gas utilities provide "bundled basic gas service" (including transmission, storage, distribution, purchasing, revenue-cycle services and after-meter services) to all core customers, unless the customer chooses to purchase natural gas from a non-utility provider. The law prohibits the CPUC from unbundling most distribution-related natural gas services (including meter reading) and after-meter services (including leak investigation, inspecting customer piping and appliances, pilot relighting and carbon monoxide investigation) for core customers. The objective is to preserve both customer safety and customer choice. Between late 1999 and April 2000, several conflicting settlements were filed by various groups of parties that address the changes the CPUC found promising in July 1999. Hearings were held in May and June of 2000, and a CPUC decision is expected by year-end 2000. The principal issues in dispute include: whether firm, tradable rights to capacity on SoCalGas' major gas transmission lines should be created, with SoCalGas at risk for market demand for the recovery of the cost of these facilities; the extent to which SoCalGas' storage services should be further unbundled and SoCalGas be put at greater risk for recovery of storage costs; the manner in which interstate pipeline capacity held by SoCalGas to serve core markets should be allocated to core customers who purchase gas from energy service providers other than SoCalGas; and the recovery of the utilities' costs to implement whatever regulatory changes are adopted. Additional proposals include improving the access of energy service providers to sell gas supply to core customers of SoCalGas and SDG&E. Consistent with Sempra Energy's corporate policies favoring the unbundling of commodity and nonessential services, the California utilities are supporting changes that they believe will provide greater customer choice in utility services and greater access to gas supply service from energy service providers in the core market. However, a coalition of gas-fired electric generators and consumer groups has also proposed the CPUC require SoCalGas to absorb 25 percent of the above-market cost of some capacity SoCalGas has contracted for on interstate pipelines. SoCalGas is actively opposing this proposal, contending that regulatory changes developed after the capacity was committed should not be considered in evaluating the propriety of the commitment. Certain parties contend that the restructuring process is an appropriate venue for addressing whether SoCalGas should refund retroactively to September 1999 the cost in rates of ownership and operation of one SoCalGas storage field. SoCalGas is also actively opposing this proposal and the propriety of this venue for its resolution. NUCLEAR INSURANCE SDG&E and the co-owners of SONGS have purchased primary insurance of $200 million, the maximum amount available, for public-liability claims. An additional $9.3 billion of coverage is provided by secondary financial protection required by the Nuclear Regulatory Commission and provides for loss sharing among utilities owning nuclear reactors if a costly accident occurs. SDG&E could be assessed retrospective premium adjustments of up to $36 million in the event of a nuclear incident involving any of the licensed, commercial reactors in the United States, if the amount of the loss exceeds $200 million. In the event these coverages are insufficient, the Price- Anderson Act provides for Congress to enact further revenue-raising measures to pay claims, which could include an additional assessment on all licensed reactor operators. Insurance coverage is provided for up to $2.75 billion of property damage and decontamination liability. Coverage is also provided for the cost of replacement power, which includes indemnity payments for up to three years and six weeks, after a waiting period of 12 weeks. Coverage is provided primarily through a mutual insurance company owned by utilities with nuclear facilities. If losses at any of the nuclear facilities covered by the risk-sharing arrangements were to exceed the accumulated funds available from these insurance programs, SDG&E could be assessed retrospective premium adjustments of up to $5 million. QUASI-REORGANIZATION In 1993, PE divested its merchandising operations and most of its oil and gas exploration and production business. In connection with the divestitures, PE effected a quasi-reorganization for financial reporting purposes effective December 31, 1992. Unitary tax issues and certain other liabilities established in connection with the quasi-reorganization were favorably resolved in November 1999. Excess reserves of $80 million resulting from the favorable resolution of these issues were added to shareholders' equity at that time. Other liabilities established in connection with discontinued operations and the quasi-reorganization will be resolved in future years. Management believes the provisions for these matters are adequate. 4. COMPREHENSIVE INCOME Comprehensive income for the three-month periods ended June 30, 2000 and 1999 was $68 million and $82 million, respectively. Comprehensive income for the six-month periods ended June 30, 2000 and 1999 was $254 million and $181 million, respectively. For the 2000 periods, the following is a reconciliation of net income to comprehensive income. Three months Six months ended ended (Dollars in millions) June 30, 2000 June 30, 2000 -------------------------------------------------------------------- Net income $ 110 $ 223 Change in unrealized gain on marketable securities (12) 21 Foreign currency adjustments (30) 9 Minimum pension liability adjustments -- 1 -------------------------------- Comprehensive income $ 68 $ 254 -------------------------------------------------------------------- For the 1999 periods, comprehensive income was equal to net income. As was the case for the three-month and six-month periods ended June 30, 2000, it is likely that comprehensive income in future periods will differ significantly from net income and will be more volatile than net income. 5. SEGMENT INFORMATION The Company is primarily an energy-services company and has three separately managed reportable segments comprised of SDG&E, SoCalGas and Sempra Energy Trading (SET). The two utilities operate in essentially separate service territories under separate regulatory frameworks and rate structures set by the CPUC. As described in the notes to Consolidated Financial Statements in the Company's 1999 Annual Report, SDG&E provides electric and natural gas service to San Diego County and electric service to southern Orange County. SoCalGas is a natural gas distribution utility, serving customers throughout most of southern California and part of central California. SET is based in Stamford, Connecticut and is engaged in the wholesale trading and marketing of natural gas, power and petroleum in the U.S. and in other countries. The accounting policies of the segments are the same as those described in the notes to Consolidated Financial Statements in the Company's 1999 Annual Report, and segment performance is evaluated by management based on reported net income. Intersegment transactions generally are recorded the same as sales or transactions with third parties. Utility transactions are based primarily on rates set by the CPUC and FERC. There were no significant changes in segment assets during the six-month period ended June 30, 2000. Information concerning SoCalGas' own segments is provided in its Annual Report on Form 10-K and Quarterly Reports on Form 10-Q. --------------------------------------------------------------------- Three-month periods Six-month periods ended June 30, ended June 30, ---------------------------------------- (Dollars in millions) 2000 1999 2000 1999 --------------------------------------------------------------------- Operating Revenues: San Diego Gas & Electric $ 574 $ 740 $1,045 $1,201 Southern California Gas 630 624 1,328 1,231 Sempra Energy Trading 207 109 383 182 Intersegment revenues (3) (9) (14) (23) Other 79 47 187 89 ---------------------------------------- Total $1,487 $1,511 $2,929 $2,680 --------------------------------------------------------------------- Net Income: San Diego Gas & Electric* $ 40 $ 46 $ 92 $ 99 Southern California Gas* 47 46 97 93 Sempra Energy Trading 40 3 58 4 Other (17) (13) (24) (15) ---------------------------------------- Total $ 110 $ 82 $ 223 $ 181 --------------------------------------------------------------------- * after preferred dividends 6. SEMPRA ENERGY GLOBAL ENTERPRISES Sempra Energy Global Enterprises (SEGE), formerly named Sempra Energy Holdings, a wholly owned subsidiary of Sempra Energy, has a $500 million credit agreement that expires in October 2000 and is available to support commercial paper. Borrowings under the agreement would bear interest at various rates based on market rates and Sempra Energy's credit rating. At June 30, 2000, SEGE had no borrowings or commercial paper obligations outstanding. Borrowings and the commercial paper would be guaranteed by Sempra Energy. On May 5, 1999, SEGE and certain affiliates filed a shelf registration for the issuance of up to $1.1 billion of securities, guaranteed by Sempra Energy, to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933. At June 30, 2000, other affiliates had issued $0.7 billion of securities under this registration statement; SEGE has not issued any securities under the registration statement. Summarized financial information of SEGE is provided below. (Dollars in millions) At June 30, At December 31, 2000 1999 ------------- -------------- Current assets $3,860 $2,271 Non-current assets 1,285 1,317 Current liabilities 3,477 2,124 Non-current liabilities 628 502 ---------------------------------------- Three-month periods Six-month periods ended June 30, ended June 30, ---------------------------------------- 2000 1999 2000 1999 ---------------------------------------- Operating revenues $294 $157 $577 $271 Operating expenses 293 157 565 286 Net income (loss) 40 3 54 (7) ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with the financial statements contained in this Form 10-Q and Management's Discussion and Analysis of Financial Condition and Results of Operations contained in the Company's 1999 Annual Report. INFORMATION REGARDING FORWARD-LOOKING STATEMENTS This Quarterly Report on Form 10-Q contains statements that are not historical fact and constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The words "estimates," "believes," "expects," "anticipates," "plans," intends," "may" and "should" or similar expressions, or discussions of strategy or of plans are intended to identify forward-looking statements that involve risks, uncertainties and assumptions. Future results may differ materially from those expressed in the forward- looking statements. These statements are necessarily based upon various assumptions involving judgments with respect to the future and other risks, including, among others, local, regional, national and international economic, competitive, political and regulatory conditions and developments; technological developments; capital market conditions; inflation rates; interest rates; exchange rates; energy markets, including the timing and extent of changes in commodity prices; weather conditions; business, regulatory or legal decisions; the pace of deregulation of retail natural gas and electricity delivery; the timing and success of business development efforts; and other uncertainties -- all of which are difficult to predict and many of which are beyond the control of the Company. Readers are cautioned not to rely unduly on any forward-looking statements and are urged to review and consider carefully the risks, uncertainties and other factors which affect the Company's business described in this quarterly report and other reports filed by the Company from time to time with the Securities and Exchange Commission. See also "Factors Influencing Future Performance" below. MAJOR FINANCIAL TRANSACTIONS See Note 2 of the notes to Consolidated Financial Statements concerning common stock repurchases, a reduction in common dividends, South American investments and the agreement to terminate the KN Energy acquisition. The effect of the self-tender stock repurchase, which did not affect the number of common shares outstanding until March 9, 2000, was to increase earnings per share by $0.05 for each of the three-month and six-month periods ended June 30, 2000, respectively. The impact of this repurchase on future periods is dependent on the amount of future net income and cannot be predicted, and could even be negative if net income fell to the level where the cost of the repurchases' financing had a greater impact on earnings per share than did the reduction in the number of shares. However, if the repurchase had taken place on January 1, 1999 and been financed at the cost of the actual repurchase in 2000, the impact would have been to increase 1999's earnings per share by $0.12. CAPITAL RESOURCES AND LIQUIDITY The Company's California utility operations continue to be the major source of liquidity. In addition, working capital requirements are met through the issuance of short-term and long-term debt. Cash and cash equivalents at June 30, 2000 are available for investment in utility plant, the retirement of debt, energy-related domestic and international projects and other corporate purposes. Approximately $450 million of the cash and cash equivalents at June 30, 2000 is that of the California utilities. Major changes in cash flows not described elsewhere are described below. CASH FLOWS FROM OPERATING ACTIVITIES For the six-month period ended June 30, 2000, the increase in cash flows from operations is primarily due to higher income tax refunds and increases in accounts payable, offset by an increase in net energy trading assets. CASH FLOWS FROM INVESTING ACTIVITIES Capital expenditures for property, plant and equipment by the California utilities are estimated to be $500 million for the full year 2000 and will be financed primarily by internally generated funds. Construction, investment and financing programs are continuously reviewed and revised in response to changes in competition, customer growth, inflation, customer rates, the cost of capital, and environmental and regulatory requirements. CASH FLOWS FROM FINANCING ACTIVITIES For the six-month period ended June 30, 2000, the decrease in cash flows from financing activities is primarily due to greater short- term debt repayments in 2000 compared to the corresponding period in 1999. As described in Note 2 of the notes to Consolidated Financial Statements, the Company repurchased 36.1 million shares of its outstanding common stock at $20.00 per share. The Company issued $500 million of notes and $200 million of preferred securities to finance substantially all of the repurchase. As described in Note 2 of the notes to Consolidated Financial Statements, the Company announced a reduction of its quarterly dividend per share to $0.25 from its previous level of $0.39 commencing with the dividend payable in the second quarter of 2000. In May 2000, SDG&E called its 9-5/8 percent First Mortgage Bonds due in 2020 at a cost of $104.04 per bond, or $10 million including accrued interest. RESULTS OF OPERATIONS Net income increased 34 percent and 23 percent for the three-month and six-month periods ended June 30, 2000, respectively, compared to the same periods in 1999, primarily due to higher earnings at Sempra Energy Trading and Sempra Energy International. Net income per share increased 57 percent and 37 percent for the same periods due to the increased net income and the effects of the Company's common stock purchases described in Note 2 of the notes of Consolidated Financial Statements. UTILITY OPERATIONS The tables below summarize the natural gas and electric volumes and revenues by customer class for the six-month periods ended June 30, 2000 and 1999. Sempra Energy Gas Sales, Transportation and Exchange For the six-month periods ended June 30 (Volumes in billion cubic feet, dollars in millions)
Gas Sales Transportation & Exchange Total ---------------------------------------------------------------------- Volumes Revenue Volumes Revenue Volumes Revenue ---------------------------------------------------------------------- 2000: Residential 156 $1,164 2 $ 8 158 $1,172 Commercial and industrial 56 345 169 132 225 477 Utility electric generation -- -- 118 43 118 43 Wholesale -- -- 14 12 14 12 --------------------------------------------------------------- 212 $1,509 303 $195 515 1,704 Balancing accounts and other (167) -------- Total $1,537 -------------------------------------------------------------------------------------------- 1999: Residential 187 $1,190 1 $ 4 188 $1,194 Commercial and industrial 60 301 161 131 221 432 Utility electric generation* 18 7 49 20 67 27 Wholesale -- -- 15 4 15 4 --------------------------------------------------------------- 265 $1,498 226 $159 491 1,657 Balancing accounts and other (253) --------- Total $1,404 -------------------------------------------------------------------------------------------- * For the months prior to the sale of its electric plants, the portion of revenue related to SDG&E's sales to the plants includes margin only.
Natural gas revenues increased 9 percent for the six-month period ended June 30, 2000 compared to the same period in 1999. The increase is primarily due to higher natural gas prices. Sempra Energy Electric Distribution and Transmission For the six-month periods ended June 30 (Volumes in millions of Kwhrs, dollars in millions)
2000 1999 ------------------------------------------ Volumes Revenue Volumes Revenue ------------------------------------------ Residential 3,130 $ 332 3,134 $ 315 Commercial 2,913 274 2,994 271 Industrial 1,139 84 968 69 Direct access 1,744 59 1,403 48 Street and highway lighting 33 3 38 3 Off-system sales 253 11 52 1 ------------------------------------------ 9,212 763 8,589 707 Balancing and other 59 299 ------------------------------------------ Total 9,212 $ 822 8,589 $1,006 ------------------------------------------
Electric revenues decreased 18 percent for the six-month period ended June 30, 2000 compared to the same period in 1999. The decrease is primarily due to the decrease in base electric rates (the non-commodity portion) from the completion of stranded cost recovery (described in Note 3 of the notes to Consolidated Financial Statements), offset by the effect of higher prices, as discussed below. Cost of natural gas distributed increased 25 percent for the six- month period ended June 30, 2000 compared to the corresponding period in 1999. The increase was primarily due to higher natural gas prices. Under the current regulatory framework, changes in core-market natural gas prices do not affect net income since, as explained more fully in the 1999 Annual Report, current or future customer rates normally recover the actual cost of natural gas. Electric fuel and net purchased power expense increased 88 percent for the six-month period ended June 30, 2000 compared to the corresponding period in 1999. The increase was primarily due to the higher price of electricity from the PX reflecting the recent supply/demand conditions described in Note 3 of the notes to Consolidated Financial Statements. Under the current regulatory framework, changes in on-system prices do not affect net income, as explained in the 1999 Annual Report. Operating expenses increased 18 percent for the six-month period ended June 30, 2000 compared to the same period in 1999. The increase is primarily due to increased operating expenses at Sempra Energy Trading, offset by reduced operating expenses at SoCalGas and SDG&E. Depreciation and amortization expense decreased 54 percent for the six-month period ended June 30, 2000, compared to the corresponding period in 1999 due to the sale of SDG&E's fossil power plants and combustion turbines. Net income at SoCalGas increased slightly for the three-month and six-month periods ended June 30, 2000, compared to the same periods in 1999, due to reduced operating and maintenance expenses. Net income at SDG&E decreased for the three-month and six-month periods ended June 30, 2000, compared to the same periods in 1999, due to decreased rate base and authorized rate of return on equity, and increased interest expense on rate reduction bond refunds (all of which began in mid 1999 and which are related to industry restructuring) offset by the elimination of a regulatory balancing account at the end of 1999. With the elimination of the balancing account, SDG&E's net income now fluctuates with changes in natural gas demand, due to seasonal and other factors. During the six-month period ended June 30, 2000, this resulted in a $10 million increase in net income. This was based on a timing difference that likely will reverse later in the year. FACTORS INFLUENCING FUTURE PERFORMANCE Base results of the Company in the near future will depend primarily on the results of the California utilities. Earnings growth and fluctuations will depend on changes in the utility industry and activities at SEI, SET and other businesses. "Other Operations" below notes the volatility in the earnings of SET. As SET and/or similar operations become increasingly more significant to the Company's results, it is likely that consolidated results will be more volatile than in prior periods. In addition, the ratemaking and regulatory process, electric- and natural gas-industry restructuring, changing energy marketplace, developments in the businesses other than the California utilities, and other factors will influence future financial performance. These factors are summarized below. As noted in Note 3 of the notes to Consolidated Financial Statements, a number of factors, including recent supply/demand conditions, have resulted in abnormally high commodity prices, which are expected to continue through the heavy air-conditioning season in the southwestern United States. This has caused SDG&E's monthly customer bills to be substantially higher than normal. SDG&E and others have proposed various methods of responding to these high rates. On June 28, 2000 the ISO Board of Governors approved the reduction of the wholesale price cap for electricity in California from $750 per megawatt hour (MWh) to $500 per MWh. Subsequently, on August 1, 2000, they approved an additional reduction of the price cap from $500 per MWh to $250 per MWh. In a filing the following day, SDG&E requested that the Federal Energy Regulatory Commission (FERC) place an emergency order capping the price electricity generators offer to the PX/ISO wholesale markets at $250 per MWh. However, three large power- generating companies have requested a FERC ruling that any attempt to limit wholesale electricity prices be judged unjust and unreasonable and that the ISO be ordered to compensate them for actual damages and lost opportunity costs. On August 3, 2000 the CPUC approved a proposal by SDG&E to accelerate the refund to its electric customers of $100 million of certain balancing account overcollections to partially offset the high monthly bills. This is in addition to the $388 million return to residential and small commercial customers of surplus bond proceeds referred to above. In addition, the CPUC denied a proposal by others to place a ceiling on electric rates for residential and small commercial customers. It also ordered SDG&E not to disconnect the service of any customers who do not pay their high bills through November 2000, and directed SDG&E to expand its level pay plan to all customers who request it. This would allow a customer to level out payments over a year. The CPUC agreed to study the issues and hold hearings and did not rule out a rate freeze in the future. In addition, the CPUC granted SDG&E expanded authority to participate in the PX's Block Forward Market which allows SDG&E to utilize futures contracts to hedge electricity prices and purchase electricity for extended periods at fixed prices. On August 9, 2000 the California governor issued a press release calling on the CPUC to establish a one- or two-year rate reduction and stabilization plan to cut electricity rates by about one-half for SDG&E residential and business customers, but still allow SDG&E to eventually recover the prices paid for wholesale power. In response, a CPUC commissioner has issued a proposed decision which, if adopted by the CPUC, would impose an interim rate freeze on SDG&E's electric rates for residential, small commercial and lighting customers. Under the proposed decision these rates would be frozen through December 2003 at 110 percent of June 30, 1998 levels. A balancing account would be established to record related undercollections resulting from the frozen rates with undercollected amounts to be recovered in a manner (not specified in the proposed decision) intended to make SDG&E whole. A second CPUC commissioner has proposed an alternate decision which would impose a similar rate freeze only on monthly volumes of electricity used by the lowest-volume 70 percent of customers (500 kwh for residential customers and 1,500 kwh for commercial customers). This is intended to encourage conservation. The alternate proposal would also automatically switch all SDG&E customers to a level-pay plan, except for those customers who specifically indicate that they do not want to participate in this billing arrangement. This alternate proposal would provide for the deferred billings to be accumulated in an existing balancing account, to be recovered in a manner intended to make SDG&E whole. The proposed decisions will be reviewed by the CPUC, which may accept either one (with or without modification) or reject them both, in rendering a final decision on the matter. The CPUC has scheduled a special meeting on August 21, 2000 to address this matter. The California State Senate has approved emergency legislation to roll back and freeze rates at July 1999 levels in the San Diego area (effective June 1, 2000) and sent it to the State Assembly for its action. The bill requires the CPUC to initiate a proceeding to assess alternatives for recovering undercollections resulting from the rate freeze. The FERC is investigating the electric bulk power markets and California's attorney general is investigating whether there has been market manipulation. Various proposals have included application of any refunds from power suppliers, arising from such investigations, to help defray any billings deferred as a result of adoption of certain of the proposals. The proposed legislation, the proposed CPUC decisions and other proposals to respond to the high electricity rates would, if adopted, adversely affect the timing of revenue collections by SDG&E and related cash flows. They could also adversely affect the ultimate collectibility of these revenues, which are intended to recover the costs of electricity purchased by SDG&E to serve its customers. The Company is unable to predict whether any of these proposals will be adopted or their ultimate impact on SDG&E. However, SDG&E will vigorously oppose, through regulatory proceedings and otherwise, any proposal that does not assure the ultimate collectibility of its full costs of providing electricity service. See Note 3 of the notes to Consolidated Financial Statements for further discussion. South American Acquisitions See Note 2 of the notes to Consolidated Financial Statements and "International Operations" below for a discussion of the 1999 acquisitions of Chilquinta Energia S.A. and Luz del Sur S.A. and the recent increase in the Company's Argentine investments. Industry Restructuring See discussion of industry restructuring in Note 3 of the notes to Consolidated Financial Statements. Electric-Generation Assets and Electric Rates Note 3 of the notes to Consolidated Financial Statements describes regulatory and legislative actions that affect SDG&E's electric rates. Performance-Based Regulation (PBR) To promote efficient operations and improved productivity and to move away from reasonableness reviews and disallowances, the CPUC has been directing utilities to use PBR. PBR has replaced the general rate case and certain other regulatory proceedings for the California utilities. Under PBR, regulators require future income potential to be tied to achieving or exceeding specific performance and productivity goals, as well as cost reductions, rather than relying solely on expanding utility plant in a market where a utility already has a highly developed infrastructure. Each utility's PBR mechanism is scheduled to be updated at December 31, 2002, to reflect, among other things, changes in costs and volumes. Key elements of the mechanisms include an initial reduction in base rates, an indexing mechanism that limits future rate increases to the inflation rate less a productivity factor, a sharing mechanism with customers if earnings exceed the authorized rate of return on rate base, and rate refunds to customers if service quality deteriorates or awards if service quality exceeds set standards. Specifically, the key elements of the mechanisms include the following: -- Earnings up to 25 basis points in excess of the authorized rate of return on rate base are retained 100 percent by shareholders. Earnings that exceed the authorized rate of return on rate base by greater than 25 basis points are shared between customers and shareholders on a sliding scale that begins with 75 percent of the additional earnings being given back to customers and declining to 0 percent as earned returns approach 300 basis points above authorized amounts. There is no sharing if actual earnings fall below the authorized rate of return. In 1999, SDG&E and SoCalGas were authorized to earn 9.05 percent and9.49 percent, respectively, on rate base. For 2000, the authorized return is 8.75 percent for SDG&E and 9.49 percent for SoCalGas. -- Base rates are indexed based on inflation less an estimated productivity factor. -- SDG&E would be authorized to earn or be penalized up to a maximum of $14.5 million annually as a result of its performance related to employee safety, electric reliability, customer satisfaction, and call-center responsiveness. The SoCalGas mechanism authorizes penalties of up to $4 million annually, or more in certain, limited situations. -- A SoCalGas mechanism allows for pricing flexibility for residential and small-commercial customers, with any shortfalls in revenue being borne by shareholders and with any increase in revenue shared between shareholders and customers. -- Annual cost of capital proceedings are replaced by an automatic adjustment mechanism. If changes in certain indices exceed established tolerances, there would be an automatic adjustment of rates for the change in the cost of capital according to a formula which applies a percentage of the change to various capital components. Cost of Capital For 2000, SoCalGas is authorized to earn a rate of return on common equity (ROE) of 11.6 percent and a 9.49 percent return on rate base (ROR), the same as in 1999, unless interest-rate changes are large enough to trigger an automatic adjustment as discussed in the Company's 1999 Annual Report. For SDG&E, electric-industry restructuring has changed the method of calculating the utility's annual cost of capital. In June 1999, the CPUC adopted a 10.6 percent ROE and an 8.75 percent ROR for SDG&E's electric-distribution and natural gas businesses. The electric-transmission cost of capital is determined under a separate FERC proceeding. Biennial Cost Allocation Proceeding (BCAP) The BCAP determines how a utility's natural gas transportation costs are allocated among various customer classes (residential, commercial, industrial, etc.). In October 1998, the California utilities filed 1999 BCAP applications requesting that new rates become effective August 1, 1999, and remain in effect through December 31, 2002. On April 20, 2000, the CPUC issued a decision adopting overall decreases in natural gas revenues of $210 million for SoCalGas and $37 million for SDG&E for transportation rates effective June 1, 2000. Since the decrease reflects anticipated changes in corresponding costs, it has no effect on net income. Gas Cost Incentive Mechanism (GCIM) This mechanism for evaluating SoCalGas' natural gas purchases substantially replaced the previous process of reasonableness reviews. GCIM compares SoCalGas' cost of natural gas with a benchmark level, which is the average price of 30-day firm spot supplies in the basins in which SoCalGas purchases natural gas. The mechanism permits full recovery of all costs within a tolerance band above the benchmark price and refunds all savings within a tolerance band below the benchmark price. The costs or savings outside the tolerance band are shared equally between customers and shareholders. The CPUC approved the use of natural gas futures for managing risk associated with the GCIM. SoCalGas enters into natural gas futures contracts in the open market on a limited basis to mitigate risk and better manage natural gas costs. In June 1999, SoCalGas filed its annual GCIM application with the CPUC, requesting an award of $8 million for the annual period ended March 31, 1999. On June 8, 2000 the CPUC approved the $8 million award and deferred decision regarding extending the GCIM beyond March 31, 2000 until an evaluation is performed by the Commission staff. The evaluation report is expected in January 2001. In June 2000, SoCalGas filed its annual GCIM application with the CPUC, requesting an award of $10 million for the annual period ended March 31, 2000. A CPUC decision is expected during the first quarter of 2001. INTERNATIONAL OPERATIONS On July 11, 2000 the Company announced an agreement to purchase, for approximately $140 million, an additional 21.5-percent interest in two Argentine natural gas utility holding companies (Sodigas Pampeana S.A. and Sodigas Sur S.A.). Completion of the transaction, scheduled for the fourth quarter of 2000, would increase the Company's investment in the two Argentine companies from 21.5 percent to 43 percent. As discussed in Note 2 of the notes to Consolidated Financial Statements, Sempra Energy invested in two additional utility companies in South America during 1999. Results for international operations for the three-month and six- month periods ended June 30, 2000 were net income of $7 million and $12 million, respectively, compared to losses of $2 million and $8 million, respectively, for the corresponding period in 1999. (The 1999 loss has been restated to reflect the current configuration of this business unit, which now includes two small, domestic natural gas utilities.) The increase in net income is primarily due to income from Chilquinta Energia S.A. and Luz del Sur S.A. Accounting for international operations has resulted in foreign currency translation adjustments, as discussed in Note 4 of the notes to Consolidated Financial Statements. OTHER OPERATIONS Sempra Energy Trading (SET) is a leading energy trading and marketing firm headquartered in Stamford, Connecticut. SET engages primarily in natural gas, petroleum and power marketing (domestic and international). For the three-month and six-month periods ended June 30, 2000, SET recorded net income of $40 million and $58 million, respectively, compared to $3 million and $4 million, respectively, for the corresponding periods in 1999. The increase in income was primarily due to increased volatility in energy prices and greater penetration of all customer segments, resulting in higher volumes traded in the six-month period ended June 30, 2000. In addition, natural gas and petroleum trading contributed significantly to increased earnings in 2000. During the three-month period ended June 30, 2000, SET further expanded its international operations with the opening of an office in Singapore. Sempra Energy Financial (SEF) invests as a limited partner in affordable-housing properties and alternative-fuel projects. SEF's portfolio includes over 1,250 properties throughout the United States. These investments are expected to provide income-tax benefits (primarily from income-tax credits) over 10-year periods. For the three-month and six-month periods ended June 30, 2000, SEF recorded net income of $7 million and $15 million, respectively, compared to $7 million and $14 million, respectively, for the corresponding periods in 1999. This is expected to decline as the various 10-year periods expire, unless SEF makes sufficient new investments. SEF's future investment policy is dependent on the Company's future domestic income-tax position. NEW ACCOUNTING STANDARDS In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 133 "Accounting for Derivative Instruments and Hedging Activities." As amended, SFAS 133, which is effective for the company on January 1, 2001, requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position, measure those instruments at fair value and recognize changes in the fair value of derivatives in earnings in the period of change unless the derivative qualifies as an effective hedge that offsets certain exposures. The effect of this standard on the company's Consolidated Financial Statements has not yet been determined. In December 1999, the Securities Exchange Commission (SEC) staff issued Staff Accounting Bulletin (SAB) 101 " Revenue Recognition. SABs are not rules issued by the SEC. Rather, they represent interpretations and practices followed by the SEC's staff in administering the disclosure requirements of the federal securities laws. SAB 101 provides guidance on the recognition, presentation and disclosure of revenue in financial statements; it does not change the existing rules on revenue recognition. SAB 101 sets forth the basic criteria that must be met before revenue should be recorded. Implementation of SAB 101 is required by the fourth quarter of 2000 and will have no effect on the company's Consolidated Financial Statements. ITEM 3. MARKET RISK There have been no significant changes in the risk issues affecting the Company subsequent to those discussed in the Annual Report on Form 10-K for 1999. The diversified Value at Risk used to measure market risk of SET's portfolio increased to $6.3 million at June 30, 2000 as compared to $2.6 million at December 31, 1999 due to increased natural gas prices, combined with increased price volatility in the power markets. PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS Neither the Company nor its subsidiaries are party to, nor is their property the subject of, any material pending legal proceedings other than routine litigation incidental to their businesses. ITEM 4. SUBMISSION OF MATTERS TO VOTE Sempra Energy's 14-member board of directors is divided into three classes whose terms are staggered so that the term of one class expires at each Annual Meeting of Shareholders. At the annual meeting on May 2, 2000, the shareholders of Sempra Energy re-elected five directors for a three-year term expiring in 2003. A shareholder proposal regarding voting approval requirements, recommending a simple majority vote rule on all issues that are submitted to shareholder vote, was not approved. Details of the votes are provided in the Company's Quarterly Report on Form 10-Q for the three-month period ended March 31, 2000. Additional information concerning the election of the board of directors and the shareholder proposal is contained in the Company's Notice of 2000 Annual Meeting of Shareholders and Proxy Statement. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits Exhibit 12 - Computation of ratios 12.1 Computation of Ratio of Earnings to Combined Fixed Charges and Preferred Stock Dividends. Exhibit 27 - Financial Data Schedules 27.1 Financial Data Schedule for the six-month period ended June 30, 2000. (b) Reports on Form 8-K The following reports on Form 8-K were filed after March 31, 2000: Current Report on Form 8-K filed April 28, 2000, filing as an exhibit the Company's press release of April 27, 2000 giving the financial results for the three-month period ended March 31, 2000. Current Report on Form 8-K filed August 2, 2000, filing as an exhibit the Company's press release of July 27, 2000 giving the financial results for the three-month period ended June 30, 2000. SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly cause this report to be signed on its behalf by the undersigned thereunto duly authorized. SEMPRA ENERGY ------------------- (Registrant) Date: August 11, 2000 By: /s/ F. H. Ault ---------------------------- F. H. Ault Vice President and Controller