-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, MX5xOwME/bRoSEaxOkJi0v8QIY1RJbeTw8cxktGMR+OD4iBNxJLfWbV9zZMQ9Dhq a6T9Kfq3cKMpbrgNL1IZKA== 0000203248-02-000010.txt : 20020515 0000203248-02-000010.hdr.sgml : 20020515 20020515111209 ACCESSION NUMBER: 0000203248-02-000010 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 20020330 FILED AS OF DATE: 20020515 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SOUTHERN UNION CO CENTRAL INDEX KEY: 0000203248 STANDARD INDUSTRIAL CLASSIFICATION: NATURAL GAS DISTRIBUTION [4924] IRS NUMBER: 750571592 STATE OF INCORPORATION: DE FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-06407 FILM NUMBER: 02649087 BUSINESS ADDRESS: STREET 1: 504 LAVACA ST 8TH FL CITY: AUSTIN STATE: TX ZIP: 78701 BUSINESS PHONE: 5124775852 10-Q 1 fm10q-0302.txt 3RD QUARTER 2002 FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D. C. 20549 ---------------- FORM 10-Q For the quarterly period ended ------------------------------ March 31, 2002 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 in which registered ------------------- ----------------------------------------- Common Stock, par value $1 per share New York Stock Exchange Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- The number of shares of the registrant's Common Stock outstanding on May 10, 2002 was 52,378,438. SOUTHERN UNION COMPANY AND SUBSIDIARIES FORM 10-Q March 31, 2002 Index PART I. FINANCIAL INFORMATION Page(s) ------- Item 1. Financial Statements Consolidated statements of operations - three, nine and twelve months ended March 31, 2002 and 2001 2-4 Consolidated balance sheet - March 31, 2002 and 2001 and June 30, 2001 5-6 Consolidated statement of stockholders' equity - nine months ended March 31, 2002 and twelve months ended June 30, 2001 7 Consolidated statements of cash flows - three, nine and twelve months ended March 31, 2002 and 2001 8-10 Notes to consolidated financial statements 11-21 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 22-32 Item 3. Quantitative and Qualitative Disclosures about Market Risk 31 PART II. OTHER INFORMATION Item 1. Legal Proceedings (See "COMMITMENTS AND CONTINGENCIES" in Notes to Consolidated Financial Statements) 18-21 Item 6. Exhibits and Reports on Form 8-K Reports on Form 8-K Date Filed Description of Filing --------- ------------------------------------- 01/31/02 Announcement of operating performance for the quarter and six months ended December 31, 2001 and 2000 and filing, under Item 9, summary statements of income of the Company for the quarter and six months ended December 31, 2001 and 2000 (unaudited) and notes thereto. - -------------------------------------------------------------------------------- 1 SOUTHERN UNION COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENT OF OPERATIONS Three Months Ended March 31, ---------------------------- 2002 2001 ------------ ------------ (thousands of dollars, except shares and per share amounts) Operating revenues............................... $ 528,298 $ 914,653 Cost of gas and other energy..................... (331,853) (685,404) Revenue-related taxes............................ (20,398) (33,664) ----------- ----------- Operating margin................................. 176,047 195,585 Operating expenses: Operating, maintenance and general............. 54,903 69,766 Depreciation and amortization.................. 17,970 24,615 Taxes, other than on income and revenues....... 7,080 8,480 ----------- ----------- Total operating expenses..................... 79,953 102,861 ----------- ----------- Net operating revenues....................... 96,094 92,724 ----------- ----------- Other income (expense): Interest....................................... (21,920) (29,163) Dividends on preferred securities of subsidiary trust............................. (2,370) (2,370) Other, net..................................... 3,293 14,364 ----------- ----------- Total other expenses, net.................... (20,997) (17,169) ----------- ----------- Earnings before income taxes................. 75,097 75,555 Federal and state income taxes................... 31,309 34,749 ----------- ----------- Net earnings available for common stock.......... $ 43,788 $ 40,806 =========== =========== Net earnings per share: Basic.......................................... $ .86 $ .78 =========== =========== Diluted........................................ $ .82 $ .74 =========== =========== Weighted average shares outstanding: Basic.......................................... 50,877,363 52,436,073 =========== =========== Diluted........................................ 53,621,846 55,511,625 =========== =========== See accompanying notes. - -------------------------------------------------------------------------------- 2 SOUTHERN UNION COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENT OF OPERATIONS Nine Months Ended March 31, --------------------------- 2002 2001 ------------ ------------ (thousands of dollars, except shares and per share amounts) Operating revenues................................ $ 1,078,708 $ 1,664,461 Cost of gas and other energy...................... (651,791) (1,203,862) Revenue-related taxes............................. (39,980) (62,597) ----------- ----------- Operating margin................................ 386,937 398,002 Operating expenses: Operating, maintenance and general............... 162,061 168,935 Business restructuring charges................... 32,706 -- Depreciation and amortization.................... 57,821 64,319 Taxes, other than on income and revenues......... 22,756 21,290 ----------- ----------- Total operating expenses....................... 275,344 254,544 ----------- ----------- Net operating revenues......................... 111,593 143,458 ----------- ----------- Other income (expense) Interest......................................... (70,992) (75,772) Dividends on preferred securities of subsidiary trust.......................................... (7,110) (7,110) Other, net....................................... 26,482 23,761 ----------- ----------- Total other expenses, net...................... (51,620) (59,121) ----------- ----------- Earnings before income taxes and change in accounting principle......................... 59,973 84,337 Federal and state income taxes..................... 26,838 38,789 ----------- ----------- Earnings before change in accounting principle..... 33,135 45,548 Change in accounting principle, net of tax......... -- 602 ----------- ----------- Net earnings available for common stock............ $ 33,135 $ 46,150 =========== =========== Net earnings per share: Basic: Before change in accounting principle.......... $ .65 $ .88 Change in accounting principle, net of tax..... -- .01 ----------- ----------- $ .65 $ .89 =========== =========== Diluted: Before change in accounting principle.......... $ .61 $ .83 Change in accounting principle, net of tax..... -- .01 ----------- ----------- $ .61 $ .84 =========== =========== Weighted average shares outstanding: Basic............................................ 51,360,879 51,956,473 =========== =========== Diluted.......................................... 54,323,851 54,831,308 =========== =========== See accompanying notes. - -------------------------------------------------------------------------------- 3 SOUTHERN UNION COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENT OF OPERATIONS Twelve Months Ended March 31, ----------------------------- 2002 2001 ------------ ------------ (thousands of dollars, except shares and per share amounts) Operating revenues.............................. $ 1,347,060 $ 1,826,995 Cost of gas and other energy.................... (822,678) (1,299,378) Revenue-related taxes........................... (46,185) (68,077) ----------- ----------- Operating margin.............................. 478,197 459,540 Operating expenses: Operating, maintenance and general............ 232,679 206,875 Business restructuring charges................ 32,706 -- Depreciation and amortization................. 80,488 79,920 Taxes, other than on income and revenues...... 31,323 24,780 ----------- ----------- Total operating expenses.................... 377,196 311,575 ----------- ----------- Net operating revenues...................... 101,001 147,965 ----------- ----------- Other income (expense): Interest...................................... (98,739) (90,661) Dividends on preferred securities of subsidiary trust............................ (9,480) (9,480) Other, net.................................... 79,537 19,580 ----------- ----------- Total other expenses, net................... (28,682) (80,561) ----------- ----------- Earnings before income taxes and change in accounting principle...................... 72,319 67,404 Federal and state income taxes.................. 28,049 32,558 ----------- ----------- Earnings before change in accounting principle.. 44,270 34,846 Change in accounting principle, net of tax...... -- 602 ----------- ----------- Net earnings available for common stock......... $ 44,270 $ 35,448 =========== =========== Net earnings per share: Basic: Before change in accounting principle....... $ .86 $ .68 Change in accounting principle, net of tax.. -- .01 ----------- ----------- $ .86 $ .69 =========== =========== Diluted: Before change in accounting principle....... $ .81 $ .64 Change in accounting principle, net of tax.. -- .01 ----------- ----------- $ .81 $ .65 =========== =========== Weighted average shares outstanding: Basic......................................... 51,625,601 51,710,551 =========== =========== Diluted....................................... 54,584,600 54,433,177 =========== =========== See accompanying notes. - -------------------------------------------------------------------------------- 4 SOUTHERN UNION COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET ASSETS March 31, June 30, -------------------------- ------------ 2002 2001 2001 ------------ ------------ ------------ (thousands of dollars) Property, plant and equipment: Plant in service................. $ 2,231,923 $ 2,178,163 $ 2,201,975 Construction work in progress.... 31,844 27,158 25,520 ----------- ----------- ----------- 2,263,767 2,205,321 2,227,495 Less accumulated depreciation and amortization............. (812,358) (758,717) (771,170) ----------- ----------- ----------- Net property, plant and equipment.................. 1,451,409 1,446,604 1,456,325 ----------- ----------- ----------- Current assets: Cash and cash equivalents........ 9,844 8,166 1,219 Accounts receivable, billed and unbilled, net.................. 250,258 462,279 218,912 Inventories, principally at average cost................... 84,801 41,639 106,505 Deferred gas purchase costs...... 4,617 99,415 65,171 Investment securities available for sale....................... 4,339 92,241 29,447 Prepayments and other............ 10,992 14,730 14,778 ----------- ----------- ----------- Total current assets........... 364,851 718,470 436,032 ----------- ----------- ----------- Goodwill, net...................... 713,389 733,921 724,620 Deferred charges................... 225,496 212,711 209,644 Investment securities, at cost..... 19,227 20,081 19,081 Real estate........................ -- 2,552 2,506 Other.............................. 48,672 36,552 41,872 ----------- ----------- ----------- Total............................ $ 2,823,044 $ 3,170,891 $ 2,890,080 =========== =========== =========== See accompanying notes. - -------------------------------------------------------------------------------- 5 SOUTHERN UNION COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET (Continued) STOCKHOLDERS' EQUITY AND LIABILITIES March 31, June 30, -------------------------- ------------ 2002 2001 2001 ------------ ------------ ------------ (thousands of dollars) Common stockholders' equity: Common stock, $1 par value; authorized 200,000,000 shares; issued 54,843,683 shares....... $ 54,844 $ 51,992 $ 54,553 Premium on capital stock......... 679,347 626,253 676,324 Less treasury stock, 2,706,533 shares at cost................. (50,752) (15,869) (15,869) Less common stock held in trust.. (19.878) (17,547) (19,650) Deferred compensation plans...... 9,201 7,499 7,953 Accumulated other comprehensive income (loss).................. (2,042) 54,940 13,443 Retained earnings................ 38,238 46,150 5,103 ----------- ----------- ----------- Total common stockholders' equity......................... 708,958 753,418 721,857 Company-obligated mandatorily redeemable preferred securities of subsidiary trust holding solely subordinated notes of Southern Union................... 100,000 100,000 100,000 Long-term debt and capital lease obligation....................... 799,717 1,368,817 1,329,631 ----------- ----------- ----------- Total capitalization........... 1,608,675 2,222,235 2,151,488 Current liabilities: Long-term debt and capital lease obligation due within one year. 451,852 5,219 5,913 Notes payable.................... 132,300 211,600 190,600 Accounts payable................. 126,436 227,917 103,623 Federal, state and local taxes... 60,829 66,069 32,342 Accrued interest................. 17,913 18,544 16,105 Accrued dividends on preferred securities of subsidiary trust. 2,370 2,370 2,370 Customer deposits................ 20,271 20,584 20,285 Other............................ 58,024 68,830 67,383 ----------- ----------- ----------- Total current liabilities...... 869,995 621,133 438,621 ----------- ----------- ----------- Deferred credits and other......... 147,532 131,726 96,680 Accumulated deferred income taxes.. 196,842 195,797 203,291 Commitments and contingencies...... -- -- -- ----------- ----------- ----------- Total.......................... $ 2,823,044 $ 3,170,891 $ 2,890,080 =========== =========== =========== See accompanying notes. - -------------------------------------------------------------------------------- 6 SOUTHERN UNION COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY Accumu- lated Common Premium Common Other Stock, on Treasury Stock Compre- Retained $1 Par Capital Stock, Held in hensive Earnings/ Value Stock at Cost Trust Income (Deficit) Total -------- -------- --------- --------- -------- --------- --------- (thousands of dollars) Balance July 1, 2000....... $ 50,521 $599,835 $(15,554) $(14,522) $115,175 $ -- $735,455 Comprehen- sive income: Net earn- ings.... -- -- -- -- -- 57,285 57,285 Unreal- lized loss in invest- ment securi- ties, net of tax benefit. -- -- -- -- (96,323) -- (96,323) Minimum pension liabil- ity ad- just- ment; net of tax..... -- -- -- -- (4,324) -- (4,324) Cumula- tive ef- fect of change in ac- counting princi- ple, net of tax.. -- -- -- -- 826 -- 826 Unrea- lized loss on hedging activi- ties, net of tax benefit. -- -- -- -- (1,911) -- (1,911) -------- Compre- hensive income (loss). (44,447) -------- Payment on note re- ceivable. -- 290 -- -- -- -- 290 Purchase of common stock held in trust.... -- -- -- (4,009) -- -- (4,009) 5% stock dividend. 2,556 49,626 -- -- -- (52,182) -- Benefit plan modifica- tion..... -- -- -- 6,560 -- -- 6,560 Issuance of stock for ac- quisi- tion..... 1,371 25,930 -- -- -- -- 27,301 Exercise of stock options.. 105 643 (315) 274 -- -- 707 -------- -------- -------- -------- -------- -------- -------- Balance June 30, 2001....... 54,553 676,324 (15,869) (11,697) 13,443 5,103 721,857 Comprehen- sive income: Net earn- ings.... -- -- -- -- -- 33,135 33,135 Unrea- lized loss in invest- ment securi- ties, net of tax benefit. -- -- -- -- (16,320) -- (16,320) Unrea- lized gain on hedging activi- ties, net of tax..... -- -- -- -- 835 -- 835 -------- Compre- hensive income.. 17,650 -------- Purchase of treasury stock..... -- -- (34,711) -- -- -- (34,711) Stock com- pensation plans..... -- 967 -- 972 -- -- 1,939 Exercise of stock options... 291 2,056 (172) 48 -- -- 2,223 -------- -------- -------- -------- -------- -------- -------- Balance March 31, 2002....... $ 54,844 $679,347 $(50,752) $(10,677) $ (2,042) $ 38,238 $708,958 ======== ======== ======== ======== ======== ======== ======== See accompanying notes. - -------------------------------------------------------------------------------- 7 SOUTHERN UNION COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS Three Months Ended March 31, ---------------------------- 2002 2001 ------------ ------------ (thousands of dollars) Cash flows from (used in) operating activities: Net earnings.................................... $ 43,788 $ 40,806 Adjustments to reconcile net earnings to net cash flows from (used in) operating activities: Depreciation and amortization............... 17,970 24,615 Deferred income taxes....................... 4,202 4,398 Non-cash compensation expense............... -- (2,216) Provision for bad debts..................... 6,005 13,398 Financial derivative trading gains.......... (3,776) (3,360) Gain on sale of investment securities....... -- (12,494) Other....................................... 1,128 459 Changes in operating assets and liabilities: Accounts receivable, billed and unbilled............................ (24,224) (65,258) Accounts payable...................... 6,929 (54,194) Taxes and other liabilities........... 37,806 37,932 Customer deposits..................... 286 (368) Deferred gas purchase costs........... 16,254 (67,305) Inventories........................... 85,597 76,904 Other................................. 794 (4,411) ------------ ----------- Net cash flows from (used in) operating activities.................................. 192,759 (11,094) ------------ ----------- Cash flows from (used in) investing activities: Additions to property, plant and equipment...... (21,042) (25,469) Acquisition of operations, net of cash received. -- (1,646) Customer advances............................... (740) 806 Deferred charges and credits.................... (2,178) (12,105) Proceeds from sale of investment securities..... -- 15,405 Other........................................... 264 4,691 ------------ ----------- Net cash flows used in investing activities... (23,696) (18,318) ------------ ----------- Cash flows from (used in) financing activities: Issuance cost of debt........................... (98) -- Repayment of debt and capital lease obligation.. (78,169) (6,898) Net (payments) borrowings under revolving credit facility............................... (82,650) 36,600 Other........................................... 1,698 36 ------------ ----------- Net cash flows from (used in) financing activities.................................. (159,219) 29,738 ------------ ----------- Change in cash and cash equivalents............... 9,844 326 Cash and cash equivalents at beginning of period.. -- 7,840 ------------ ----------- Cash and cash equivalents at end of period........ $ 9,844 $ 8,166 ============ =========== Supplemental disclosures of cash flow information: Cash paid during the period for: Interest...................................... $ 19,435 $ 30,670 ============ =========== Income taxes ................................. $ 90 $ 1,000 ============ =========== See accompanying notes. - -------------------------------------------------------------------------------- 8 SOUTHERN UNION COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS Nine Months Ended March 31, --------------------------- 2002 2001 ------------ ------------ (thousands of dollars) Cash flows from (used in) operating activities: Net earnings.................................... $ 33,135 $ 46,150 Adjustments to reconcile net earnings to net cash flows from (used in) operating activities: Depreciation and amortization............... 57,821 64,319 Deferred income taxes....................... 7,224 (1,562) Business restructuring charges.............. 29,400 -- Gain on sale of assets...................... (561) -- Loss on sale of subsidiaries................ 1,500 -- Gain realized on sale of gas marketing contracts................................. (4,653) -- Gain on settlement of interest rate swaps... (17,166) -- Provision for bad debts..................... 11,479 19,345 Financial derivative trading (gains) losses. (6,109) 5,684 Gain on sale of investment securities....... -- (21,363) Gain on sale of real estate................. -- (13,532) Cumulative effect of change in accounting principle................................. . -- (602) Other....................................... 635 1,735 Changes in operating assets and liabilities, net of acquisitions and dispositions: Accounts receivable, billed and unbilled.............................. (46,752) (359,181) Accounts payable........................ 24,318 110,254 Taxes and other liabilities............. 26,359 56,410 Customer deposits....................... 244 (852) Deferred gas purchase costs............. 60,554 (102,120) Inventories............................. 19,527 33,316 Other................................... 6,435 (16,015) ------------ ----------- Net cash flows from (used in) operating activities.................................. 203,390 (178,014) ------------ ----------- Cash flows from (used in) investing activities: Additions to property, plant and equipment...... (78,189) (87,172) Acquisition of operations, net of cash received. -- (406,949) Proceeds from sale of subsidiaries.............. 33,663 -- Proceeds from sale of gas marketing contracts... 4,972 -- Proceeds from settlement of interest rate swaps. 17,166 -- Purchase of investment securities............... (145) (12,495) Notes receivable................................ -- 290 Customer advances............................... (1,267) 790 Deferred charges and credits.................... 4,149 (3,630) Proceeds from sale of investment securities..... -- 26,777 Proceeds from sale of real estate, net of closing costs................................. -- 20,638 Other........................................... 264 4,116 ------------ ----------- Net cash flows used in investing activities... (19,387) (457,635) ------------ ----------- Cash flows from (used in) financing activities: Issuance of long-term debt...................... -- 535,000 Issuance cost of debt........................... (617) (2,538) Repayment of debt and capital lease obligation.. (83,974) (14,607) Net (payments) borrowings under revolving credit facility...................................... (58,300) 211,597 Purchase of treasury stock...................... (34,711) -- Payment of merger debt assumed.................. -- (114,171) Other........................................... 2,224 705 ------------ ----------- Net cash flows from (used in) financing activities.................................. (175,378) 615,986 ------------ ----------- Change in cash and cash equivalents............... 8,625 (19,663) Cash and cash equivalents at beginning of period.. 1,219 27,829 ------------ ----------- Cash and cash equivalents at end of period........ $ 9,844 $ 8,166 ============ =========== Supplemental disclosures of cash flow information: Cash paid during the period for: Interest...................................... $ 76,455 $ 78,092 ============ =========== Income taxes.................................. $ 90 $ 1,052 ============ =========== See accompanying notes. - -------------------------------------------------------------------------------- 9 SOUTHERN UNION COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS Twelve Months Ended March 31, ----------------------------- 2002 2001 ------------ ------------ (thousands of dollars) Cash flows from (used in) operating activities: Net earnings................................... $ 44,270 $ 35,448 Adjustments to reconcile net earnings to net cash flows from (used in) operating activities: Depreciation and amortization.............. 80,488 79,920 Deferred income taxes...................... 36,564 (4,482) Provision for bad debts.................... 24,840 22,678 Business restructuring charges............. 29,400 -- Gain on settlement of interest rate swaps.. (17,166) -- Gain realized on sale of gas marketing contracts................................ (4,653) -- Gain on sale of assets..................... (561) -- Loss on sale of subsidiary................. 1,500 -- Gain on sale of subsidiary................. (707) -- Financial derivative trading (gains) losses................................... (6,109) 7,920 Cumulative effect of change in accounting principle................................ -- (602) Gain on sale of investment securities...... (53,219) (21,363) Gain on sale of real estate................ -- (13,532) Other...................................... 1,145 1,575 Changes in operating assets and liabilities, net of acquisitions and dispositions: Accounts receivable, billed and unbilled............................. 183,254 (307,844) Accounts payable....................... (100,880) 122,621 Taxes and other liabilities............ (33,412) 41,055 Customer deposits...................... (55) (4,382) Deferred gas purchase costs............ 94,798 (112,085) Inventories............................ (45,334) (245) Other.................................. 12,064 (4,015) ----------- ---------- Net cash flows from (used in) operating activities................................. 246,227 (157,333) ----------- ---------- Cash flows from (used in) investing activities: Additions to property, plant and equipment..... (114,793) (118,188) Acquisition of operations, net of cash received..................................... (7,548) (407,232) Purchase of investment securities.............. (145) (18,488) Notes receivable............................... -- 290 Deferred charges and credits................... (4,143) (7,046) Proceeds from sale of subsidiaries............. 36,963 -- Proceeds from sale of investment securities.... 58,984 26,777 Proceeds from sale of real estate, net of closing costs................................ -- 20,638 Customer advances.............................. (859) 698 Proceeds from sale of gas marketing contracts.. 4,972 -- Proceeds from settlement of interest rate swaps........................................ 17,166 -- Other.......................................... 976 1,604 ----------- ---------- Net cash flows used in investing activities.. (8,427) (500,947) ----------- ---------- Cash flows from (used in) financing activities: Issuance of long-term debt..................... -- 535,000 Issuance cost of debt.......................... (1,553) (3,187) Repayment of debt and capital lease obligation. (122,466) (15,129) Net (payments) borrowings under revolving credit facility.............................. (79,300) 211,597 Purchase of treasury stock..................... (34,711) (906) Payment of merger debt assumed................. -- (114,171) Other.......................................... 1,908 915 ----------- ---------- Net cash flows from (used in) financing activities................................. (236,122) 614,119 ----------- ---------- Change in cash and cash equivalents.............. 1,678 (44,161) Cash and cash equivalents at beginning of period. 8,166 52,327 ----------- ---------- Cash and cash equivalents at end of period....... $ 9,844 $ 8,166 =========== ========== Supplemental disclosures of cash flow information: Cash paid during the period for: Interest................................... $ 103,808 $ 95,315 =========== ========== Income taxes............................... $ 20,090 $ 3,652 =========== ========== See accompanying notes. - -------------------------------------------------------------------------------- 10 SOUTHERN UNION COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FINANCIAL STATEMENTS These interim financial statements should be read in conjunction with the financial statements and notes thereto contained in Southern Union Company's (Southern Union and, together with its wholly-owned subsidiaries, the Company) Annual Report on Form 10-K for the fiscal year ended June 30, 2001. All dollar amounts in the tables herein, except per share amounts, are stated in thousands unless otherwise indicated. Certain prior period amounts have been reclassified to conform with the current period presentation. The interim financial statements are unaudited but, in the opinion of management, reflect all adjustments (including both normal recurring as well as any non-recurring) necessary for a fair presentation of the results of operations for such periods. Because of the seasonal nature of the Company's operations, the results of operations and cash flows for any interim period are not necessarily indicative of results for the full year. As further described below, the Company acquired Providence Energy Corporation and Fall River Gas Company on September 28, 2000 and Valley Resources, Inc. on September 20, 2000. Accordingly, the operating activities of the acquired operations are consolidated with the Company beginning on the respective acquisition dates. Thus, the results of operations of the Company for the periods subsequent to the acquisitions are not comparable to those periods prior to the acquisitions nor are the fiscal 2002 results of operations comparable with prior periods. Also, the results of operations for the three- and nine-month periods ended March 31, 2002 are not indicative of results that would necessarily be achieved for a full year since the majority of the Company's operating margin is earned during the winter heating season. ACQUISITIONS AND DIVESTITURES In December 2001, a subsidiary of the Company sold its 43-mile Carrizo Springs Pipeline for cash of $1,000,000, resulting in a pre-tax gain of $561,000. Also in December 2001, the Company sold South Florida Natural Gas, a natural gas division of Southern Union, and Atlantic Gas Corporation, a Florida propane subsidiary of the Company (collectively, the Florida Operations), for $10,000,000, resulting in a pre-tax loss of $1,500,000. In September 2000, Southern Union completed the acquisitions of Providence Energy Corporation (ProvEnergy), Fall River Gas Company (Fall River Gas) and Valley Resources, Inc. (Valley Resources). Collectively, these operations (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 dividend) of Southern Union common stock, as well as the assumption of approximately $140,000,000 in long-term debt. 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 in the ProvEnergy merger include ProvEnergy Oil Enterprises, Inc. (ProvEnergy Oil), and ProvEnergy Power Company, LLC. ProvEnergy Oil, sold for $15,776,000 in August 2001, operated a fuel oil distribution business for residential and commercial customers in Rhode Island and Massachusetts. ProvEnergy Power Company owns 50% of Capital Center Energy Company, LLC, a joint venture formed between ProvEnergy and ERI Services, Inc. to provide retail power. Acquired in the Fall River Gas merger was Fall River Gas Appliance Company, Inc. which rents water heaters and conversion burners (primarily for residential use) in Fall River Gas' service area. Valley Resources' non-utility subsidiaries acquired in the merger were Valley Propane, Inc. (Valley Propane), Morris Merchants, Inc. (Morris Merchants), Valley Appliance Merchandising Company (VAMCO) and Alternate Energy Corporation (AEC). Valley Propane, sold for $5,301,000 in September 2001, provided liquid propane to customers in Rhode Island and nearby Massachusetts. Morris Merchants, sold for $1,586,000 in October 2001, served as a manufacturers' representative agency for franchised plumbing and heating contract supplies throughout New England. VAMCO merchandises and rents natural gas burning appliances, offers appliance service contract programs, sells water filtration systems and provides construction management services for natural gas-related projects. AEC sells, installs and designs natural gas conversion systems and facilities. No gain or loss was recognized on any of these New England Operations' sales transactions. - -------------------------------------------------------------------------------- 11 SOUTHERN UNION COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The Company funded the cash portion of the acquisition of the New England Operations and any related refinancing of assumed debt with a bank note (the Term Note). See Debt and Capital Lease. The assets of the New England Operations have been included in the consolidated balance sheet of the Company at March 31, 2002 and the results of operations have been included in the statement of consolidated operations since their respective acquisition dates. The acquisitions were treated as a purchase with related goodwill of approximately $355,000,000. Effective July 1, 2001, goodwill, which was previously amortized on a straight-line basis over forty years, is now accounted for on an impairment-only approach. See Goodwill. Subsidiaries of the Company acquired in the November 4, 1999 acquisition of Pennsylvania Enterprises, Inc. included PG Energy Services Inc. (Energy Services), PEI Power Corporation, Keystone Pipeline Services, Inc. (Keystone, a wholly-owned subsidiary of Energy Services), and Theta Land Corporation. Through Energy Services, the Company offers the inspection, maintenance and servicing of residential and small commercial gas-fired equipment. In July 2001, the commercial and industrial natural gas marketing contracts of Energy Services were sold for approximately $4,972,000, resulting in a pre-tax gain of $4,653,000. In April 2002, the propane operations of Energy Services were sold for approximately $2,300,000, resulting in a pre-tax gain of approximately $1,200,000. Keystone, sold for $3,300,000 in June 2001 for a pre-tax gain of $707,000, was engaged in the construction, maintenance, and rehabilitation of natural gas distribution pipelines. Theta Land Corporation, which owned and provided land management and development services for more than 44,000 acres of land, was sold for $12,150,000 in January 2000. No gain or loss was recognized on this transaction. Pro Forma Financial Information The following unaudited pro forma financial information for the nine-month period ended March 31, 2001 is presented as though the following events had occurred at the beginning of the period presented: (i) acquisition of the New England Operations; (ii) the issuance of the Term Note; and (iii) the refinancing of certain short-term and long-term debt at the time of the acquisitions. The pro forma financial information is not necessarily indicative of the results which would have actually been obtained had the acquisition of the New England Operations, the issuance of the Term Note, or the refinancings been completed as of the assumed date for the period presented or which may be obtained in the future. Nine Months Ended March 31, 2001 ----------------- Operating revenues........................................ $ 1,708,121 Income before extraordinary item.......................... 24,575 Net earnings available for common stock................... 24,575 Net earnings per common stock: Basic................................................... .47 Diluted................................................. .44 EARNINGS PER SHARE Average shares outstanding for basic earnings per share were 50,877,363 and 52,436,073 for the three-month period ended March 31, 2002 and 2001 respectively; 51,360,879 and 51,956,473 for the nine-month period ended March 31, 2002 and 2001, respectively; and 51,625,601 and 51,710,551 for the twelve-month period ended March 31, 2002 and - -------------------------------------------------------------------------------- 12 SOUTHERN UNION COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 2001, respectively. Diluted earnings per share include average shares outstanding as well as common stock equivalents from stock options and warrants. Common stock equivalents were 1,528,087 and 1,980,555 for the three-month period ended March 31, 2002 and 2001, respectively; 1,773,082 and 1,814,437 for the nine-month period ended March 31, 2002 and 2001, respectively; and 1,787,384 and 1,677,622 for the twelve-month period ended March 31, 2002 and 2001, respectively. At March 31, 2002, 1,170,405 shares of common stock were held by various rabbi trusts for certain of the Company's benefit plans and 46,300 shares were held in a rabbi trust for certain employees who deferred receipt of Company shares for stock options exercised. From time to time, the Company's benefit plans may purchase shares of Southern Union common stock subject to regular restrictions. During September and October of 2001, the Company repurchased 1,696,456 shares of its common stock outstanding at prices ranging from $18.75 to $21.51 per share. During April and May of 2002, the Company repurchased 419,460 shares of its common stock outstanding at a price of $16.50 per share. Substantially all of these repurchases occurred in private off-market large-block transactions. BUSINESS RESTRUCTURING CHARGES In August 2001, the Company implemented a corporate reorganization and restructuring which was initially announced in July 2001 as part of a Cash Flow Improvement Plan designed to increase annualized pre-tax cash flow from operations by at least $50 million by the end of fiscal year 2002. Actions taken included (i) the offering of voluntary Early Retirement Programs ("ERPs") in certain of its operating divisions and (ii) a limited reduction in force ("RIF") within its corporate offices. ERPs, providing for increased benefits for those electing retirement, were offered to approximately 400 eligible employees across the Company's operating divisions, with approximately 60% of such eligible employees accepting. The RIF was limited solely to certain corporate employees in the Company's Austin and Kansas City offices with forty-eight employees being offered severance packages. In connection with the corporate reorganization and restructuring efforts, the Company recorded a one-time charge of $32,706,000 during the quarter ended September 30, 2001. The charge included: $17.7 million of voluntary and accepted ERP's, primarily through enhanced benefit plan obligations, and other employee benefit plan obligations; $8.8 million of RIF within the corporate offices and related employee separation benefits; and $6.2 million connected with various business realignment and restructuring initiatives. The Company expects that most of the restructuring actions will be completed by the end of fiscal year 2002. During the quarter ended March 31, 2002, the Company paid approximately $1.2 million and nil in employee separation and other restructuring costs, respectively. Since implementation of the plan, the Company has paid approximately $4.3 million and $3 million in employee separation and other restructuring costs, respectively. The balance sheet carries a remaining reserve of approximately $7.8 million in estimated reorganization and restructuring expenditures as of March 31, 2002. GOODWILL Effective July 1, 2001, the Company adopted Goodwill and Other Intangible Assets which was issued by the FASB in June 2001. In accordance with this Statement, the Company has ceased amortization of goodwill. Goodwill, which was previously classified on the consolidated balance sheet as additional purchase cost assigned to utility plant and amortized on a straight-line basis over forty years, is now subject to at least an annual assessment for impairment by applying a fair-value based test. - -------------------------------------------------------------------------------- 13 SOUTHERN UNION COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following table reflects the Company's comparative net income before the change in accounting principle and goodwill amortization under Goodwill and Other Intangible Assets: Three Months Ended Nine Months Ended March 31, March 31, ------------------ ------------------ 2002 2001 2002 2001 -------- -------- -------- -------- Reported net income before change in accounting principle........... $ 43,788 $ 40,806 $ 33,135 $ 45,548 Goodwill amortization, net of taxes. -- 4,839 -- 12,163 -------- -------- -------- -------- Adjusted net income before change in accounting principle........... $ 43,788 $ 45,645 $ 33,135 $ 57,711 ======== ======== ======== ======== Basic earnings per share: Reported income before change in accounting principle............ $ .86 $ .78 $ .65 $ .88 Goodwill amortization, net of taxes........................... -- .09 -- .23 -------- -------- -------- -------- Adjusted net income before change in accounting principle......... $ .86 $ .87 $ .65 $ 1.11 ======== ======== ======== ======== Diluted earnings per share: Reported income before change in accounting principle............ $ .82 $ .74 $ .61 $ .83 Goodwill amortization, net of taxes........................... -- .08 -- .22 -------- -------- -------- -------- Adjusted net income before change in accounting principle......... $ .82 $ .82 $ .61 $ 1.05 ======== ======== ======== ======== The following displays changes in the carrying amount of goodwill for the nine-month period ended March 31, 2002: Total --------- Balance as of July 1, 2001......................................... $ 724,620 Impairment losses.................................................. (3,358) Sale of subsidiaries and other operations.......................... (7,873) --------- Balance as of March 31, 2002....................................... $ 713,389 ========= In connection with the Company's Cash Flow Improvement Plan announced in July 2001, the Company began the divestiture of certain non-core assets. As a result of prices of comparable businesses for various non-core properties, a goodwill impairment loss of $3,358,000 was recognized in depreciation and amortization on the consolidated statement of operations for the quarter ended September 30, 2001. As a result of the sale of the Carrizo Springs Pipeline and the Florida Operations, goodwill of $7,873,000 was eliminated during the quarter ended December 31, 2001. See Acquisitions and Divestitures in the Notes to the Consolidated Financial Statements included herein. INVESTMENT SECURITIES At March 31, 2002, the Company held securities of Capstone Turbine Corporation (Capstone). This investment is classified as "available for sale" under the Financial Accounting Standards Board Standard Accounting for Certain Investments in Debt and Equity Securities. As of March 31, 2002, the Company's investment in Capstone had a fair value of $4,339,000 and unrealized gains, net of tax, related to this investment were $2,532,000. The Company has classified this investment as current, as it plans to monetize its investment in the near future and use the proceeds to reduce outstanding debt. - -------------------------------------------------------------------------------- 14 SOUTHERN UNION COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS All other securities owned by the Company are accounted for under the cost method. The Company's other investments in securities consist primarily of preferred stock in non-public companies whose value is not readily determinable. 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. OTHER INCOME During the quarter ended September 30, 2001, the Company negotiated three interest rate swaps that were not designated as hedges and did not meet the criteria for hedge accounting. The first swap, effective July 5, 2001, carried a notional amount of $100,000,000 and termination of June 30, 2005. The remaining swaps, effective July 23, 2001 and August 1, 2001, carried notional amounts of $300,000,000 and $200,000,000, respectively, with terminations of November 15, 2004 and February 1, 2005, respectively. On September 19, 2001, these interest rate swaps were settled, resulting in a pre-tax gain and cash flow of $17,166,000. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES Derivative Instruments and Hedging Activities The Company utilizes derivative instruments on a limited basis to manage certain business risks. Interest rate swaps are employed to hedge the effect of changes in interest rates related to certain debt instruments and commodity swaps and options to manage price risk associated with certain energy contracts. In accordance with adoption of the FASB Standard, 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 PG Energy Services Inc., a wholly-owned subsidiary, that were not designated as hedges. The Company also recorded $826,000 in accumulated other comprehensive income which recognizes the fair value of two interest rate swap derivatives that were designated as cash flow hedges. Cash Flow Hedges The Company manages exposure against volatility in interest payments on variable rate debt through interest rate swaps. As of March 31, 2002, $954,000 in after-tax comprehensive income generated through the expiration of two interest rate swaps was partially offset by the fair value of the Company's remaining obligation under one interest rate swap which resulted in $119,000 of unrealized losses, net of tax. During the nine-month period ended March 31, 2002, the Company recorded net settlement payments of $1,227,000 on these derivatives through interest expense. The Company expects to reclassify as interest expense $332,000 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 20 months. Trading Contracts In March 2001, the Company discovered unauthorized financial derivative energy trading activity by a non-regulated, wholly-owned subsidiary. All unauthorized trading activity was subsequently closed in March and April of 2001 resulting in a cumulative cash expense of $191,000, net of taxes. During the nine-month period ended March 31, 2002, the Company recorded expiration of contracts resulting from this trading activity through other income, generating pre-tax earnings of $6,109,000. The majority of the remaining deferred liability of $1,467,000 at March 31, 2002 related to these derivative instruments will be recognized as income in the consolidated statement of operations over the next four years based on the related contracts. - -------------------------------------------------------------------------------- 15 SOUTHERN UNION COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Beginning in May 2001, the Company acquired natural gas commodity swap derivatives and collar transactions in order to mitigate price volatility of natural gas passed through to utility customers. The cost of the derivative products and the settlement of the respective obligations are recorded through the gas purchase adjustment clause as authorized by the applicable regulatory authority and therefore do not impact earnings. As of March 31, 2002, the fair value of the contracts, which expire at various times through May 2002, are included in the consolidated financial statements as a liability and a matching adjustment to deferred cost of gas of $16,000. PREFERRED SECURITIES OF SUBSIDIARY TRUST On May 17, 1995, Southern Union Financing I (Subsidiary Trust), a consolidated wholly-owned subsidiary of Southern Union, issued $100,000,000 of 9.48% Trust Originated Preferred Securities (Preferred Securities). In connection with the Subsidiary Trust's issuance of the Preferred Securities and the related purchase by Southern Union of all of the Subsidiary Trust's common securities (Common Securities), Southern Union issued to the Subsidiary Trust $103,092,800 principal amount of its 9.48% Subordinated Deferrable Interest Notes, due 2025 (Subordinated Notes). The sole assets of the Subsidiary Trust are the Subordinated Notes. The interest and other payment dates on the Subordinated Notes correspond to the distribution and other payment dates on the Preferred Securities and the Common Securities. Under certain circumstances, the Subordinated Notes may be distributed to holders of the Preferred Securities and holders of the Common Securities in liquidation of the Subsidiary Trust. The Subordinated Notes are redeemable at the option of the Company on or after May 17, 2000, at a redemption price of $25 per Subordinated Note plus accrued and unpaid interest. The Preferred Securities and the Common Securities will be redeemed on a pro rata basis to the same extent as the Subordinated Notes are repaid, at $25 per Preferred Security and Common Security plus accumulated and unpaid distributions. Southern Union's obligations under the Subordinated Notes and related agreements, taken together, constitute a full and unconditional guarantee by Southern Union of payments due on the Preferred Securities. As of March 31, 2002 and 2001, 4,000,000 shares of Preferred Securities were outstanding. DEBT AND CAPITAL LEASE March 31, June 30, 2002 2001 ---------- ---------- 7.60% Senior Notes due 2024....................... $ 362,515 $ 364,515 8.25% Senior Notes due 2029....................... 300,000 300,000 Term Note, due 2002............................... 410,000 485,000 5.62% to 10.25% First Mortgage Bonds, due 2002 to 2029......................................... 147,916 150,815 7.70% Debentures, due 2027........................ 6,801 6,806 Capital lease and other........................... 24,337 28,408 ---------- ---------- Total debt and capital lease...................... 1,251,569 1,335,544 Less current portion.......................... 451,852 5,913 ---------- ---------- Total long-term debt and capital lease............ $ 799,717 $1,329,631 ========== ========== Assumed Debt In connection with the acquisition of the Pennsylvania Operations, the Company assumed $45,000,000 of First Mortgage Bonds bearing interest between 8.375% and 9.34%. In connection with the acquisition of ProvEnergy, the Company assumed $86,916,000 of First Mortgage Bonds bearing interest between 5.62% and 10.25%. In connection with the acquisition of Fall River Gas, the Company assumed $19,500,000 of First Mortgage Bonds bearing interest between 7.24% and 9.44%. In connection with the acquisition of Valley Resources, the Company assumed $6,905,000 of 7.70% Debentures. - -------------------------------------------------------------------------------- 16 SOUTHERN UNION COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Capital Lease The Company completed the installation of an Automated Meter Reading (AMR) system at Missouri Gas Energy during the first quarter of fiscal year 1999. The installation of the AMR system involved an investment of approximately $30,000,000 which is accounted for as a capital lease obligation. As of March 31, 2002, the capital lease obligation outstanding was $21,694,000 with a fixed rate of 5.79%. Credit Facilities On May 29, 2001, the Company restated and amended its short-term and long-term credit facilities (together referred to as "Revolving Credit Facilities"). The Company has available $150,000,000 under the short-term facility, which expires May 28, 2002, and $225,000,000 under the long-term facility, which expires on May 29, 2004. The Company has additional availability under uncommitted line of credit facilities with various banks. Borrowings under the Revolving Credit Facilities are available for Southern Union's working capital, letter of credit requirements and other general corporate purposes. A balance of $132,300,000 was outstanding under the facilities at March 31, 2002. Term Note On August 28, 2000 the Company entered into the Term Note to fund (i) the cash portion of the consideration to be paid to the Fall River Gas stockholders; (ii) the all cash consideration to be paid to the ProvEnergy and Valley Resources stockholders; (iii) repayment of approximately $50,000,000 of long- and short-term debt assumed in the mergers; and (iv) related acquisition costs. The Term Note, which initially expired on August 27, 2001, has been extended through August 26, 2002 for a fee. No additional draws can be made on the Term Note. Prior to maturity, the Company will refinance some portion or all of the Term Note. Sources of future or alternative financing that the Company may consider include commercial and investment banks, institutional lenders, institutional investors and public securities markets. The availability and terms of any such financing sources will depend upon various factors and conditions such as the Company's combined cash flow and earnings, the Company's resulting capital structure, and conditions in financial markets at the time of such offerings. UTILITY REGULATION AND RATES Missouri On July 5, 2001, the Missouri Public Service Commission (MPSC) issued an order approving a unanimous settlement of Missouri Gas Energy's rate request. The settlement provides for an annual $9,892,000 base rate increase, as well as $1,081,000 in added revenue from new and revised service charges. The majority of the rate increase will be recovered through increased monthly fixed charges to gas sales service customers. New rates became effective August 6, 2001, two months before the statutory deadline for resolving the case. The approved settlement resulted in the dismissal of all pending judicial reviews of prior rate cases. The settlement provides for the development of a two-year experimental low-income program that will help certain customers in the Joplin area pay their natural gas bills. New England Gas Company On November 1, 2001, the New England Gas Company of Southern Union Company submitted a comprehensive filing with the Rhode Island Public Utilities Commission (RIPUC) to implement a "One State; One Rate" simplified and uniform rate structure. Such filing reflects the consolidated operations of the various gas distribution operations in Rhode Island and fulfills the terms of a settlement agreement associated with the merger of the Companies in Docket Nos. D-00-2 and D-00-3. The proposed rates would increase annual operating revenues by $7,200,000 or 3%, with individual customer impacts varying as a result of the rate schedule consolidation and restructuring. After extensive discovery and negotiation, the New England Gas Company and the Rhode Island Division of Public Utilities and Carriers reached a Settlement Agreement which was filed with the RIPUC on April 29, 2002. The Settlement Agreement will result in a $3,900,000 decrease in base revenues for Rhode Island operations, a unified rate structure and an integration/merger savings mechanism. The Settlement Agreement also allows the Company to retain $2,049,000 of merger savings and to share incremental earnings with customers when the Company's return on equity exceeds 11.25%. The Settlement Agreement is subject to approval by the RIPUC. The RIPUC held hearings on the Settlement Agreement in May 2002 and a decision is due by June 10, 2002. The Company can not predict the outcome of the RIPUC's review. - -------------------------------------------------------------------------------- 17 SOUTHERN UNION COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Pennsylvania On April 3, 2000, PG Energy filed an application with the Pennsylvania Public Utility Commission (PPUC) seeking an increase in its base rates. On December 7, 2000, the PPUC approved a settlement agreement that provided for a rate increase designed to produce $10,800,000 of additional annual revenue. The new rates became effective on January 1, 2001. 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. In addition, the Company received approval of an improved rate design that collects a greater portion of the Company's revenue stream from the monthly customers' charge and implementation of a Weather Normalization Adjustment Clause. COMMITMENTS AND CONTINGENCIES Environmental The Company is subject to federal, state and local laws and regulations relating to the protection of the environment. These evolving laws and regulations may require expenditures over a long period of time to control environmental impacts. The Company has established procedures for the on-going evaluation of its operations to identify potential environmental exposures and assure compliance with regulatory policies and procedures. The Company is investigating the possibility that the Company or predecessor companies may have been associated with Manufactured Gas Plant (MGP) sites in its former service territories, principally in Arizona and New Mexico, and present service territories in Texas, Missouri, Pennsylvania, Massachusetts and Rhode Island. At the present time, the Company is aware of certain MGP sites in these areas and is investigating those and certain other locations. While the Company's evaluation of these Texas, Missouri, Arizona, New Mexico, Pennsylvania, Massachusetts and Rhode Island MGP sites is in its preliminary stages, it is likely that some compliance costs may be identified and become subject to reasonable quantification. Within the Company's service territories, certain MGP sites are currently the subject of governmental actions. These sites are as follows: Kansas City, Missouri MGP Sites In a letter dated May 10, 1999, the Missouri Department of Natural Resources (MDNR) sent notice of a planned Site Inspection/Removal Site Evaluation of the Kansas City Coal Gas Former Manufactured Gas Plant site. This site (comprised of two adjacent MGP operations previously owned by two separate companies and hereafter referred to as Station A and Station B) is located at East 1st Street and Campbell in Kansas City, Missouri and is owned by Missouri Gas Energy (MGE). A 1988 investigation of the site performed by an Environmental Protection Agency (EPA) contractor determined that further remedial assessment was not required under the Comprehensive Environmental Response, Compensation and Liability Act of 1980 (CERCLA), as amended by the SUPERFUND Amendments and Reauthorization Act of 1986. The MDNR has stated that the reassessment of the Kansas City Coal Gas site is part of a statewide effort to identify, evaluate, and prioritize the potential hazards posed by all of Missouri's MGP sites. During July 1999, the Company sent applications to MDNR submitting the two sites to the agency's Voluntary Cleanup Program (VCP). The sites were accepted into the VCP on August 2, 1999 and MGE subsequently performed environmental assessments at the sites and submitted assessment results to MDNR on March 6, 2000. In a letter dated June 21, 2000, MDNR responded to the Station A environmental report submitted by the Company. In that letter, MDNR stated that soil remediation will be necessary at the site (Station A) but that further exploration and delineation of site contamination should be performed before remedial methods can be determined. MGE performed additional assessment work in accordance with MDNR's request. In a letter dated May 7, 2001, MDNR responded to the Station B environmental report. That letter suggested that some soils would need to be remediated, but that certain areas on Station B require further investigation to determine whether significant contamination exists. In a letter dated April 5, 2002, RIDEM stated that MGE had moved at a "reasonable pace with respect to investigation of the Station A and Station B" sites. This letter also encouraged the Company to proceed with the development of a remediation plan for Station A. - -------------------------------------------------------------------------------- 18 SOUTHERN UNION COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS North of the Kansas City, Missouri Station A and B MGP sites, the City of Kansas City Port Authority ("Port Authority") is developing a parcel of land adjacent to the Missouri River and known as the "Riverfront Development." In the course of developing this property, the Port Authority entered the Riverfront Development into the Missouri Voluntary Cleanup Program. In a letter dated April 23, 2001, MDNR invited representatives of MGE, the Port Authority and Honeywell International Inc. (the alleged successor to Barrett Manufacturing Company, a tar manufacturer formerly located on a portion of the Riverfront Development) to a technical meeting to discuss the investigation, cleanup, closure and redevelopment of the Riverfront Development and MGE's properties. That meeting was held on May 16, 2001. On July 18, 2001, representatives of MGE and the Port Authority met to discuss MGE's proposal for a limited assessment and remediation of a portion of the Port Authority property allegedly impacted by the historic MGP. That proposal was set forth in a letter from MGE to the Port Authority dated July 31, 2001. In a letter dated July 27, 2001, Honeywell International Inc. proposed to the Port Authority that Honeywell perform a similar assessment on the portion of the Riverfront Development formerly occupied by Barrett Manufacturing Company. In a letter addressed to MGE and dated August 3, 2001, the Port Authority set forth its demand that MGE assume responsibility for the remediation of soil and groundwater at the Riverfront Development, and in a letter dated August 15, 2001, the Port Authority granted a conditional acceptance of MGE's proposal for MGE's limited assessment of the Riverfront Development. In September and October 2001, Honeywell and MGE each performed assessments of its proposed portion of the Port Authority property. Results of these assessments were provided to the Port Authority in November of 2001 and to the MDNR in April 2002. Providence, Rhode Island Sites During 1995, Providence Gas began an environmental evaluation of its primary gas distribution facility located at 642 Allens Avenue in Providence, Rhode Island. Environmental studies were completed and a subsequent remediation work plan was developed at an approximate cost of $4.5 million. Providence Gas began a soil remediation project on a 4.2 acre portion of the site ("Phase 1") in July 1999 under the terms of a remedial action work plan established in 1999 ("1999 RAWP"). Work under the 1999 RAWP was suspended in March 2001 pending the negotiation of modifications to the 1999 RAWP with the Rhode Island Department of Environmental Management ("RIDEM"). As of March 31, 2002, approximately $8,900,000 had been expended on soil remediation at the site. Based on the results of the environmental studies and the site information learned during the performance of work under the remediation work plan, the Company submitted a revised remedial action work plan ("Revised RAWP") for the site to RIDEM on July 24, 2001. RIDEM did not accept the Revised RAWP, and in a letter dated December 13, 2001, the agency directed the Company to complete Phase 1 under the terms of the 1999 RAWP within a nine-month period during 2002. RIDEM subsequently authorized certain specific modifications to the 1999 RAWP ("RAWP Modifications") that had been submitted by the Company on January 15, 2002. On April 17, 2002, RIDEM issued a Temporary Remedial Action Permit for the Phase 1 remediation at the site. At the completion of a competitive bidding process, a contractor was selected by the Company, and work on Phase 1 of the site remediation was initiated on April 17, 2002. The Company has reserved $5.8 million for completion of this phase. In November 1998, Providence Gas received a letter of responsibility from the RIDEM relating to possible contamination on previously owned property at 170 Allens Avenue in Providence. The current operator of the property has also received a letter of responsibility. A work plan had been created and approved by RIDEM. An investigation was then begun to determine the extent of contamination, as well as the extent of the Company's responsibility. Providence Gas entered into a cost-sharing agreement with the current operator of the property, under which Providence Gas was responsible for approximately twenty percent (20%) of the costs related to the investigation. Costs of testing at this site as of March 31, 2002, were approximately $300,000. Until the results of the investigation are known, the Company cannot offer any conclusions as to its responsibility. Tiverton, Rhode Island Site Fall River Gas Company was a defendant in a civil action seeking to recover anticipated remediation costs associated with contamination found at property owned by the plaintiffs. This claim was based on alleged dumping of material by Fall River Gas Company trucks at the site in the 1930s and 1940s. In an agreement effective December 3, 2001, the Company agreed to perform all assessment, remediation and monitoring activities at the site sufficient to obtain a final letter of compliance from the Rhode Island Department of Environmental Management. - -------------------------------------------------------------------------------- 19 SOUTHERN UNION COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Valley Gas Company Sites Valley Gas Company is a party to an action in which Blackstone Valley Electric Company ("Blackstone") brought suit for contribution to its expenses of cleanup of a site on Mendon Road in Attleboro, Massachusetts, to which coal manufacturing waste was transported from a former MGP site in Pawtucket, Rhode Island (the "Blackstone Litigation"). Blackstone Valley ----------------- Electric Company v. Stone & Webster, Inc., Stone & Webster Engineering - ---------------------------------------------------------------------- Corporation, Stone & Webster Management Consultants, Inc. and Valley Gas - ------------------------------------------------------------------------ Company, C. A. No. 94-10178JLT, United States District Court, District of - ------- Massachusetts. Valley Gas Company takes the position in that litigation that it is indemnified for any cleanup expenses by Blackstone pursuant to a 1961 agreement signed at the time of Valley Gas Company's creation. This suit was stayed in 1995 pending the issuance of rulemaking at the United States EPA (Commonwealth of Massachusetts v. Blackstone Valley Electric Company, 67 F.3d - -------------------------------------------------------------------- 981 (1995)). In January 2001, the EPA issued a Preliminary Administrative Decision on this issue and announced that it was soliciting comments on the Decision. While the public comment period has now closed, the EPA has yet to reissue its decision. While this suit has been stayed, Valley Gas Company and Blackstone (merged with Narragansett Electric Company in May 2000) have received letters of responsibility from the RIDEM with respect to releases from two MGP sites in Rhode Island. RIDEM issued letters of responsibility to Valley Gas Company and Blackstone in September 1995 for the Tidewater MGP in Pawtucket, Rhode Island, and in February 1997 for the Hamlet Avenue MGP in Woonsocket, Rhode Island. Valley Gas Company entered into an agreement with Blackstone (now Narragansett) in which Valley Gas Company and Blackstone agreed to share equally the expenses for the costs associated with the Tidewater site subject to reallocation upon final determination of the legal issues that exist between the companies with respect to responsibility for expenses for the Tidewater site and otherwise. No such agreement has been reached with respect to the Hamlet site. Other Environmental To the extent that potential costs associated with former MPGs are quantified, the Company shall provide any appropriate accruals and seek recovery for such remediation costs through all appropriate means, including recovery of claims against other potentially responsible parties, insurance and regulatory relief. During fiscal year 2002, the Company entered into agrements with several of its historical insurance carriers in settlement of certain environmental claims. Of these settlement proceeds, $2,591,000 was recorded to income as it represented reimbursement for amounts previously expensed by the Company. The $6.1 million balance of the settlement proceeds is deferred pending future environmental assessments and remediation efforts as well as any future rate filings. At the time of the closing of the acquisition of the Company's Missouri service territories, the Company entered into an Environmental Liability Agreement that provides that Western Resources retains financial responsibility for certain liabilities under environmental laws that may exist or arise with respect to MGE. In addition, at the time it was acquired, Providence Gas had in place a regulatory plan that created a mechanism for the recovery of environmental-related costs. This plan provided that recovery of environmental investigation and remediation costs incurred through September 30, 1997, as well as costs incurred during the three-year term of the plan, are to be amortized over a 10-year period, at a level authorized under the plan. A plan, effective October 1, 2000 through June 30, 2002, establishes an environmental fund for the recovery of evaluation, remedial and clean-up costs arising out of the Company's MGPs and sites associated with the operation and disposal activities from MGPs. Although significant charges to earnings could be required prior to rate recovery, management does not believe that environmental expenditures for MGP sites will have a material adverse effect on the Company's financial position, results of operations or cash flows. The Company follows the provisions of an American Institute of Certified Public Accountants Statement of Position, Environmental Remediation Liabilities, for recognition, measurement, display and disclosure of environmental remediation liabilities. - -------------------------------------------------------------------------------- 20 SOUTHERN UNION COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Southwest Gas Litigation On February 1, 1999, Southern Union submitted a proposal to the Board of Directors of Southwest Gas Corporation (Southwest) to acquire all of Southwest's outstanding common stock for $32.00 per share. Southwest at that time had a pending merger agreement with ONEOK, Inc. (ONEOK) at $28.50 per share, executed on December 14, 1998. On February 22, 1999, Southern Union and Southwest both publicly announced Southern Union's proposal, after the Southwest Board of Directors determined that Southern Union's proposal was a Superior Proposal (as defined in the Southwest merger agreement with ONEOK). At that time, Southern Union entered into a Confidentiality and Standstill Agreement with Southwest at Southwest's insistence. On April 25, 1999, Southwest's Board of Directors rejected Southern Union's $32.00 per share offer and accepted an amended offer of $30.00 per share from ONEOK. On April 27, 1999, Southern Union increased its offer to $33.50 per share and agreed to pay interest which, together with dividends, would provide Southwest shareholders with a 6% annual rate of return on its $33.50 offer, commencing February 15, 2000, until closing. Southern Union's revised proposal was rejected by Southwest's Board of Directors. On January 21, 2000, ONEOK announced that it was withdrawing from the Southwest merger agreement. There are several lawsuits pending that relate to activities surrounding Southern Union's efforts to acquire Southwest. Southern Union intends to vigorously pursue its claims against Southwest, ONEOK, and certain individual defendants. As a result of summary judgments granted, there are no claims remaining against Southern Union and Southern Union's damage claims have been limited to its out-of-pocket losses and punitive damages. With the exception of ongoing legal fees associated with the aforementioned litigation, the Company believes that the results of the above-noted Southwest Gas litigation will not have a materially adverse effect on the Company's financial condition, results of operations or cash flows. Regulatory In August 1998, the City of Edinburg obtained a jury verdict totaling approximately $13,000,000 jointly and severally against PG&E Gas Transmission - -Texas Corporation (formerly Valero Energy Corporation (Valero)), and a number of its subsidiaries, as well as former Valero subsidiary Rio Grande Valley Gas Company (RGV) and RGV's successor company, Southern Union Company for the alleged underpayment of franchise fees. (Southern Union purchased RGV from Valero in 1993.) The trial court reduced the jury award. Subsequently, the Texas (13th District) Court of Appeals further reduced the award to $4,085,000. The Court of Appeals also remanded a portion of the case to the trial court with instructions to retry certain issues. The Company continues to pursue reversal on appeal. The Company believes that the outcome of the matter will not have a material adverse impact on the Company's results of operations, financial position or cash flows. Other Legal Southern Union and its subsidiaries are parties to other legal proceedings that management considers to be normal actions to which an enterprise of its size and nature might be subject, and not to be material to the Company's overall business or financial condition, results of operations or cash flows. - -------------------------------------------------------------------------------- 21 SOUTHERN UNION COMPANY AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Overview The Company's core business is the distribution of natural gas as a public utility through: Southern Union Gas, Missouri Gas Energy, PG Energy, and the New England Gas Company (effective with the September 2000 acquisitions of Providence Energy Corporation, Valley Resources, Inc. and Fall River Gas Company). In addition, subsidiaries of Southern Union exist to support and expand natural gas sales and to capitalize on the Company's gas energy expertise. These subsidiaries operate natural gas pipeline systems, generate electricity, market natural gas to end-users and distribute propane. Certain subsidiaries also own or hold interests in real estate and other assets, which are primarily used in the Company's utility business. Several of these business activities are subject to regulation by federal, state or local authorities where the Company operates. Thus, the Company's financial condition and results of operations have been and will continue to be dependent upon the receipt of adequate and timely adjustments in rates. In addition, the Company's business is affected by seasonal weather impacts, competitive factors within the energy industry and economic development and residential growth in its service areas. Acquisitions and Divestitures In December 2001, a subsidiary of the Company sold its 43-mile Carrizo Springs Pipeline for $1,000,000, resulting in a pre-tax gain of $561,000. Also in December 2001, the Company sold South Florida Natural Gas, a natural gas division of Southern Union, and Atlantic Gas Corporation, a Florida propane subsidiary of the Company, for $10,000,000, resulting in a pre-tax loss of $1,500,000. On September 28, 2000, Southern Union completed the acquisitions of Providence Energy Corporation (ProvEnergy) and Fall River Gas Company (Fall River Gas), and on September 20, 2000, Southern Union completed the acquisition of Valley Resources, Inc. (Valley Resources). Collectively, these operations (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 dividend) of Southern Union common stock, as well as the assumption of approximately $140,000,000 in long-term debt. 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 in the ProvEnergy merger include ProvEnergy Oil Enterprises, Inc. (ProvEnergy Oil) and ProvEnergy Power Company, LLC. ProvEnergy Oil, sold for $15,776,000 in August 2001, operated a fuel oil distribution business for residential and commercial customers in Rhode Island and Massachusetts. ProvEnergy Power Company owns 50% of Capital Center Energy Company, LLC, a joint venture formed between ProvEnergy and ERI Services, Inc. to provide retail power. Acquired in the Fall River Gas merger was Fall River Gas Appliance Company, Inc., which rents water heaters and conversion burners (primarily for residential use) in Fall River Gas' service area. Valley Resources' non-utility subsidiaries acquired in the merger were Valley Propane, Inc. (Valley Propane), Morris Merchants, Inc. (Morris Merchants), Valley Appliance Merchandising Company (VAMCO) and Alternate Energy Corporation (AEC). Valley Propane, sold for $5,301,000 in September 2001, provided liquid propane to customers in Rhode Island and nearby Massachusetts. Morris Merchants, sold for $1,586,000 in October 2001, served as a manufacturers' representative agency for franchised plumbing and heating contract supplies throughout New England. VAMCO merchandises and rents natural gas burning appliances, offers appliance service contract programs, sells water filtration systems and provides construction management services for natural gas-related projects. AEC sells, installs and designs natural gas conversion systems and facilities. No gain or loss was recognized on any of these New England Operations' sales transactions. Subsidiaries of the Company acquired in the November 4, 1999 acquisition of Pennsylvania Enterprises, Inc. included PG Energy Services Inc. (Energy Services), PEI Power Corporation, Keystone Pipeline Services, Inc. (Keystone, a wholly-owned subsidiary of Energy Services), and Theta Land Corporation. Through Energy Services, the Company offers the inspection, maintenance and servicing of residential and small commercial gas-fired equipment. In July 2001, the commercial and industrial natural gas marketing contracts of Energy Services were sold for approximately $4,972,000, resulting in a pre-tax gain of $4,653,000. In April 2002, the propane operations of Energy Services were sold for approximately $2,300,000, resulting in a pre-tax gain of approximately $1,200,000. Keystone, sold for - -------------------------------------------------------------------------------- 22 SOUTHERN UNION COMPANY AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS $3,300,000 in June 2001 for a pre-tax gain of $707,000, was engaged in the construction, maintenance, and rehabilitation of natural gas distribution pipelines. Theta Land Corporation, which owned and provided land management and development services for more than 44,000 acres of land, was sold for $12,150,000 in January 2000. No gain or loss was recognized on this transaction. The operating activities of the acquired operations are consolidated with the Company beginning on their respective acquisition dates. As a result of acquisitions, the divestiture of non-core business assets and the seasonal nature of gas utility operations, the results of operations for the three-, nine- and twelve-month periods ended March 31, 2002 are not indicative of results that would necessarily be achieved for a full year. The majority of the Company's operating margin is earned during the winter heating season. RESULTS OF OPERATIONS Three Months Ended March 31, 2002 and 2001 The Company recorded net earnings available for common stock of $43,788,000 for the three-month period ended March 31, 2002 compared with net earnings of $40,806,000 for the same period in 2001. Earnings per diluted share were $.82 in 2002, compared to $.74 in 2001. Weighted average diluted shares outstanding decreased 3% in 2002 due to the repurchase of 1,696,456 shares of the Company's common stock in September and October 2001. Operating revenues were $528,298,000 for the three-month period ended March 31, 2002, compared with $914,653,000 in 2001. Gas purchase and other energy costs for the three-month period ended March 31, 2002 were $331,853,000, compared with $685,404,000 in 2001. The Company's operating revenues are affected by the level of sales volumes and by the pass-through of increases or decreases in the Company's gas purchase costs through its purchased gas adjustment clauses. Additionally, revenues are affected by increases or decreases in gross receipts taxes (revenue-related taxes) which are levied on sales revenue as collected from customers and remitted to the various taxing authorities. The decrease in both operating revenues and gas purchase costs between periods was primarily due to a 12% decrease in gas sales volume to 68,052 MMcf in 2002 from 77,671 MMcf in 2001 and by a 41% decrease in the average cost of gas from $8.17 per Mcf in 2001 to $4.86 per Mcf in 2002. Changes in the average cost of gas resulted from seasonal impacts on demands for natural gas and the ensuing competitive pricing within the industry. The decrease in gas sales volumes is primarily due to the warmer-than-normal weather in 2002 as compared to 2001 in all of the Company's service territories. Weather in Southern Union Gas service territories was 97% of a 30-year measure for the three-month period ended March 31, 2002, compared with 102% in 2001. About half of the customers served by Southern Union Gas are weather normalized. Missouri Gas Energy's service territories experienced weather that was 90% of a 30-year measure in 2002, compared with 100% in 2001. Weather for the PG Energy service territories was 84% of a 30-year measure for the three-month period ended March 31, 2002, compared with 98% in 2001. The New England Gas Company service territories experienced weather that was 85% of a 30-year measure in 2002, compared with 100% in 2001. Operating margin (operating revenues less gas purchase and other energy costs and revenue-related taxes) decreased $19,538,000 for the three-month period ended March 31, 2002 compared with the same period in 2001. Operating margin decreased principally as a result of the warmer-than-normal weather, previously discussed. This decrease was partially offset by the timing of a $10,973,000 annual revenue increase granted to Missouri Gas Energy effective August 6, 2001. Operating expenses, which include operating, maintenance and general expenses, depreciation and amortization, and taxes other than on income and revenues, were $79,953,000 for the three-month period ended March 31, 2002, a decrease of $22,908,000, compared with $102,861,000 in 2001. Operating expenses were impacted by a reduction in bad debt expense of $7,393,000 due to a decrease in customer receivables as a result of lower gas prices as previously discussed, and the elimination of goodwill amortization resulting from the Company's adoption of Goodwill - -------------------------------------------------------------------------------- 23 SOUTHERN UNION COMPANY AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS and Other Intangible Assets effective July 1, 2001. In accordance with this Standard, the Company has ceased the amoritzation of goodwill, which generated $4,969,000 of expense during the quarter ending March 31, 2001, and currently accounts for goodwill on an impairment-only approach. See Goodwill in the Notes to the Consolidated Financial Statements included herein. Additionally, in connection with the Company's Cash Flow Improvement Plan announced in July 2001 and discussed below, the Company realized savings of approximately $4,000,000 during the three-month period ended March 31, 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 $4,600,000 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 the quarter ended March 31, 2002, the Company recognized a reduction in operating expenses of $575,000 for past environmental expenditures. See Commitments and Contingencies in the Notes to the Consolidated Financial Statements included herein. Operating expenses for the three-month period ended March 31, 2001 were impacted by the reversal of $2,216,000 in non-cash compensation expense associated with shares of common stock held in a trust for one of the Company's benefit plans. The Company amended this plan during the third quarter of fiscal year 2001 which eliminated any future expense, or income volatility, associated with the accounting treatment for such benefit plan. Interest expense was $21,920,000 for the three-month period ended March 31, 2002, compared to $29,163,000 in 2001. Interest expense decreased due to a $122,466,000 reduction in long-term debt principal since March 31, 2001 and a $79,300,000 reduction in notes payable outstanding since March 31, 2001. Additionally, the effective interest rate on the current debt structure has been reduced to 6.4% at March 31, 2002 as compared to 7.8% in 2001. Principal was primarily reduced on the bank note (the Term Note) entered into by the Company on August 28, 2000 for the acquisition of the New England Operations. The Company entered into the Term Note to (i) fund the cash consideration paid to stockholders of Fall River Gas, ProvEnergy and Valley Resources, (ii) refinance and repay long- and short-term debt assumed in the New England Operations, and (iii) acquisition costs of the New England Operations. See Debt and Capital Lease in the Notes to the Consolidated Financial Statements included herein. Other income for the three-month period ended March 31, 2002 was $3,293,000 compared to $14,364,000 in 2001. Other income for the three-month period ended March 31, 2002, includes the recognition of $3,776,000 in previously recorded deferred income related to financial derivative energy trading activity of a wholly-owned subsidiary. This was partially offset by $1,200,000 of legal costs associated with ongoing litigation from the unsuccessful acquisition of Southwest Gas Corporation (Southwest). Other income for the three-month period ended March 31, 2001 primarily consisted of realized gains on the sale of a portion of Southern Union's investment holdings in Capstone Turbine Corporation of $12,494,000, the recognition of $3,360,000 in non-cash trading gains and $1,680,000 of interest and dividend income. These items were partially offset by $3,568,000 of costs associated with the aforementioned unsuccessful acquisition and related litigation. The consolidated federal and state effective income tax rate was 42% and 46% for the three months ended March 31, 2002 and 2001, respectively. The decline in the effective tax rate is due to the Company's adoption of Goodwill and Other Intangible Assets, previously discussed, which eliminates the amortization of goodwill, in which the majority was non-tax deductible. - -------------------------------------------------------------------------------- 24 SOUTHERN UNION COMPANY AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Nine Months Ended March 31, 2002 and 2001 The Company recorded net earnings available for common stock of $33,135,000 for the nine-month period ended March 31, 2002 compared with net earnings of $46,150,000 in 2001. Earnings per diluted share were $.61 in 2002 compared to $.84 in 2001. The nine-month period ended March 31, 2002 net earnings were impacted by a pre-tax charge for business restructuring of $32,706,000 ($.33 per share). Operating revenues were $1,078,708,000 for the nine-month period ended March 31, 2002, compared with $1,664,461,000 in 2001. Gas purchase and other energy costs for the nine-month period ended March 31, 2002 were $651,791,000, compared with $1,203,862,000 in 2001. The decrease in both operating revenues and gas purchase costs between periods was primarily due to a 17% decrease in sales volume from 154,432 MMcf in 2001 to 127,830 MMcf in 2002 and by a 28% decrease in the average cost of gas from $7.06 per Mcf in 2001 to $5.06 per Mcf in 2002. Changes in the average cost of gas resulted from seasonal impacts on demands for natural gas and the ensuing competitive pricing within the industry. The decrease in gas sales volumes is primarily due to the warmer-than-normal weather in 2002 as compared to 2001 in all of the Company's service territories. Weather in Southern Union Gas service territories was 94% of a 30-year measure for the nine-month period ended March 31, 2002, compared with 113% in 2001. About half of the customers served by Southern Union Gas are weather normalized. Missouri Gas Energy's service territories experienced weather that was 84% of a 30-year measure in 2002, compared with 110% in 2001. Weather for the PG Energy service territories was 84% of a 30-year measure for the nine-month period ended March 31, 2002, compared with 107% in 2001. The New England Gas Company service territories experienced weather that was 86% of a 30-year measure in 2002, compared with 104% for the nine-month period ended March 31, 2001. Operating margin decreased $11,065,000 for the nine-month period ended March 31, 2002 compared with the same period in 2001, principally as a result of the warmer-than-normal weather, previously discussed. This decrease was partially offset by the timing of a $10,973,000 annual revenue increase granted to Missouri Gas Energy effective August 6, 2001, a $10,800,000 annual revenue increase granted to PG Energy effective on January 1, 2001, and the acquisition of the New England Operations in September 2000. Operating expenses, excluding business restructuring charges, were $242,638,000 for the nine-month period ended March 31, 2002, a decrease of $11,906,000 compared with $254,544,000 in 2001. Operating expenses decreased as a result of the elimination of goodwill amortization resulting from the Company's adoption of Goodwill and Other Intangible Assets, previously discussed, which generated $12,552,000 of expense during the nine-month period ended March 31, 2001. Operating expenses for the nine-month period ended March 31, 2002 were also impacted by $7,866,000 in reduced bad debt expense due to a decrease in customer receivables, realized savings of approximately $6,500,000 from the Cash Flow Improvement Plan, reduced operating expenses of $6,400,000 from the sale of non-core assets and $2,591,000 of environmental insurance recoveries, all previously discussed. These items were partially offset by $21,249,000 of increased operating expenses for the nine-month period ended March 31, 2002, due to the timing of the acquisition of the New England Operations. 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 was recognized in depreciation and amortization on the consolidated statement of operations during the nine-month period ended March 31, 2002. See Goodwill in the Notes to the Consolidated Financial Statements included herein. - -------------------------------------------------------------------------------- 25 SOUTHERN UNION COMPANY AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 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 Early Retirement Programs ("ERPs") in certain of its operating divisions and (ii) a limited reduction in force ("RIF") within its corporate offices. ERPs, providing for increased benefits for those electing retirement, were offered to approximately 400 eligible employees across the Company's operating divisions, with approximately 60% of such eligible employees accepting. The RIF was limited solely to certain corporate employees in the Company's Austin and Kansas City offices with forty-eight employees being offered severance packages. As a result of actions associated with the business reorganization and restructuring, the Company expects an annual cost savings in a range of $30 million to $35 million. In connection with the corporate reorganization and restructuring efforts, the Company recorded a one-time charge of $32,706,000 during the quarter ended September 30, 2001. The charge included: $17.7 million of voluntary and accepted ERP's, primarily through enhanced benefit plan obligations, and other employee benefit plan obligations; $8.8 million of RIF within the corporate offices and related employee separation benefits; and $6.2 million connected with various business realignment and restructuring initiatives. The Company expects that most of the restructuring actions will be completed by the end of fiscal year 2002. See Business Restructuring Charges in the Notes to the Consolidated Financial Statements included herein. Interest expense was $70,992,000 for the nine-month period ended March 31, 2002, compared to $75,772,000 in 2001. Interest expense decreased primarily due to both the reduction in the principal and variable interest rate on the previously mentioned Term Note entered into by the Company on August 28, 2000 for the acquisition of the New England Operations. This was partially offset by the assumption by the Company of $113,321,000 in long-term debt of the New England Operations which was not refinanced or extinguished with the Term Note. See Debt and Capital Lease in the Notes to the Consolidated Financial Statements included herein. Other income for the nine-month period ended March 31, 2002 was $26,482,000 compared to $23,761,000 in 2001. Other income for the nine-month period ended March 31, 2002, includes gains of $17,166,000 generated through the settlement of several interest rate swaps, the recognition of $6,109,000 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 $1,787,000 generated from the sale and/or rental of gas-fired equipment and appliances by various operating subsidiaries, power generation and sales income of $1,228,000 from PEI Power Corporation, $658,000 in interest and dividend income, and a $561,000 gain on the sale of a 43-mile pipeline also by a subsidiary of the Company. These items were partially offset by $6,106,000 of legal costs associated with Southwest, and a $1,500,000 loss on the sale of the Florida Operations in December 2001. Other income for the nine-month period ended March 31, 2001 primarily consisted of realized gains on the sale of investment securities of $21,363,000, a $13,532,000 gain on the sale of non-core real estate, and $3,385,000 of interest and dividend income. This was partially offset by $5,684,000 of non-cash trading losses and $8,466,000 of costs associated with Southwest. The effective federal and state income tax rate is 45% and 46% for the nine months ended March 31, 2002 and 2001, respectively. The decline in the effective tax rate is due to the Company's adoption of Goodwill and Other Intangible Assets, previously discussed, which was partially offset by the sale of various non-core assets that contained non-tax deductible goodwill. The Company adopted the Statement of Financial Accounting Standards Board (FASB) Accounting for Derivative Instruments and Hedging Activities on July 1, 2000. In accordance with the transition provisions of the Statement, the Company recorded a net-of-tax cumulative-effect-type gain of $602,000 in earnings for the nine-month period ended March 31, 2001, to recognize the fair value of the derivative instruments that do not qualify for hedge accounting treatment under the Statement. - -------------------------------------------------------------------------------- 26 SOUTHERN UNION COMPANY AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Twelve Months Ended March 31, 2002 and 2001 The Company recorded net earnings available for common stock of $44,270,000 for the twelve-month period ended March 31, 2002 compared with net earnings of $35,448,000 in 2001. Earnings per diluted share were $.81 in 2002 compared with earnings per diluted share of $.65 in 2001. Operating revenues were $1,347,060,000 for the twelve-month period ended March 31, 2002, compared with operating revenues of $1,826,995,000 in 2001. Gas purchase and other energy costs for the twelve-month period ended March 31, 2002 were $822,678,000, compared with $1,299,378,000 in 2001. The decrease in both operating revenues and gas purchase costs between periods was primarily due to a 13% net decrease in sales volume from 172,986 MMcf in 2001 to 150,563 MMcf in 2002 and by an 23% decrease in the average cost of gas from $6.75 per Mcf in 2001 to $5.22 per Mcf in 2002. Changes in the average cost of gas resulted from seasonal impacts on demands for natural gas and the ensuing competitive pricing within the industry. The net decrease in gas sales volumes is primarily due to the warmer-than-normal weather in 2002 as compared to 2001 in all of the Company's service territories, which was partially offset by an increase in gas sales volumes from the New England Operations due to the timing of the acquisi tion. Weather in Southern Union Gas service territories was 93% of a 30-year measure for the twelve-month period ended March 31, 2002, compared with 111% in 2001. About half of the customers served by Southern Union Gas are weather normalized. Missouri Gas Energy's service territories experienced weather that was 82% of a 30-year measure in 2002, compared with 108% in 2001. Weather for the PG Energy service territories was 86% of a 30-year measure for the twelve-month period ended March 31, 2002, compared with 106% in 2001. The New England Gas Company service territories experienced weather that was 86% of a 30-year measure in 2002, compared with 107% in 2001. Operating margin increased $18,657,000 for the twelve-month period ended March 31, 2002 compared with the same period in 2001, principally as a result of the acquisition of the New England Operations which contributed a net increase of $30,471,000. The timing of a $10,973,000 annual revenue increase granted to Missouri Gas Energy effective August 6, 2001 and the $10,800,000 annual revenue increase granted to PG Energy effective on January 1, 2001 also impacted operating margin. These items were partially offset by the warmer-than-normal weather, previously discussed. Operating expenses, excluding business restructuring charges, which were previously discussed, were $344,490,000 for the twelve-month period ended March 31, 2002, compared with operating expenses of $311,575,000 in 2001. An increase of $48,200,000 was the result of the timing of the acquisition of the New England Operations. Also impacting operating expenses for the twelve-month period ended March 31, 2002 was a goodwill impairment loss of $3,358,000, previously discussed, and $2,162,000 of increased bad debt expense. These items were partially offset by the elimination of goodwill amortization resulting from the Company's adoption of Goodwill and Other Intangible Assets, also previously discussed, which generated a net increase in expense of $10,335,000 during the twelve-month period ended March 31, 2001, as compared to the same period in 2002. See Goodwill in the Notes to the Consolidated Financial Statements included herein. The increase in operating expense between periods was also partially offse by savings of $6,500,000 realized through the Cash Flow Improvement Plan, reduced operating expenses of $6,400,000 from the sale of non-core assets and $2,591,000 of environmental insurance recoveries, all previously discussed. Interest expense was $98,739,000 for the twelve-month period ended March 31, 2002 compared to $90,661,000 in 2001. Interest expense increased primarily due to the previously mentioned Term Note entered into by the Company for the acquisition of the New England Operations, as well as the assumption by the Company of long-term debt of the New England Operations, also previously discussed. The increase was partially offset by the lower variable interest rate and the repayment of principal related to the Term Note during the twelve-month period ended March 31, 2002. See Debt and Capital Lease in the Notes to the Consolidated Financial Statements included herein. - -------------------------------------------------------------------------------- 27 SOUTHERN UNION COMPANY AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Other income for the twelve-month period ended March 31, 2002 was $79,537,000 compared to $19,580,000 for the twelve-month period ended March 31, 2001. Other income for the twelve-month period ended March 31, 2002, includes realized gains on the sale of investment securities of $53,219,000, gains of $17,166,000 generated through the settlement of several interest rate swaps, the recognition of $6,109,000 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 $2,659,000 generated from sale and/or rental of gas-fired equipment and appliances by various operating subsidiaries, power generation and sales income of $2,071,000 from PEI Power Corporation, $936,000 in interest and dividend income, and a $561,000 gain on the sale of a 43-mile pipeline also by a subsidiary of the Company. These items were partially offset by $10,495,000 of legal costs associated with Southwest and a $1,500,000 loss on the sale of the Florida Operations, both previously discussed. Other income for the twelve-month period ended March 31, 2001 primarily consisted of realized gains on the sale of investment securities of $21,363,000, a $13,532,000 gain on the sale of non-core real estate, and $5,002,000 in interest and dividend income. These items were partially offset by $12,165,000 of costs associated with Southwest and $7,921,000 of non-cash trading losses. The Company's consolidated federal and state effective income tax rate was 39% and 48% for the twelve-month period ended March 31, 2002 and 2001, respectively. The decline in the effective tax rate is due to the Company's adoption of Goodwill and Other Intangible Assets, previously discussed. - -------------------------------------------------------------------------------- 28 SOUTHERN UNION COMPANY AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following table sets forth certain information regarding the Company's gas utility operations for the three- and twelve-month periods ended March 31, 2002 and 2001: Three Months Twelve Months Ended March 31, Ended March 31, ---------------------- ---------------------- 2002 2001 2002 2001 ---------- ---------- ---------- ---------- Average number of gas sales customers served: Residential............... 1,346,493 1,341,714 1,330,592 1,195,591 Commercial................ 133,019 132,319 128,736 117,247 Industrial and irrigation. 4,178 4,372 4,213 2,553 Public authorities and other................... 3,292 3,177 3,270 3,157 Pipeline and marketing.... 352 356 350 331 ---------- ---------- ---------- ---------- Total average customers served................ 1,487,334 1,481,938 1,467,161 1,318,879 ========== ========== ========== ========== Gas sales in millions of cubic feet (MMcf) Residential............... 47,542 56,833 91,050 102,539 Commercial................ 17,795 22,191 36,571 42,035 Industrial and irrigation. 1,130 1,871 3,798 4,195 Public authorities and other................... 1,480 1,450 3,769 3,119 Pipeline and marketing.... 5,226 5,113 15,531 16,712 ---------- ---------- ---------- ---------- Gas sales billed........ 73,173 87,458 150,719 168,600 Net change in unbilled gas sales............... (5,121) (9,787) (156) 4,386 ---------- ---------- ---------- ---------- Total gas sales....... 68,052 77,671 150,563 172,986 ========== ========== ========== ========== Gas sales revenues (thousands of dollars): Residential............... $ 381,139 $ 596,129 $ 876,856 $1,009,451 Commercial................ 133,122 224,916 310,747 378,704 Industrial and irrigation. 9,716 17,562 33,154 34,045 Public authorities and other................... 7,557 13,937 20,632 25,092 Pipeline and marketing.... 14,920 29,126 55,704 73,963 ---------- ---------- ---------- ---------- Gas revenues billed..... 546,454 881,670 1,297,093 1,521,255 Net change in unbilled gas sales revenues.......... (33,028) (47,269) (40,898) 76,772 ---------- ---------- ---------- ---------- Total gas sales revenues............ $ 513,426 $ 834,401 $1,256,195 $1,598,027 ========== ========== ========== ========== Gas sales revenue per thousand cubic feet (Mcf) billed: Residential............... $ 8.02 $ 10.49 $ 9.63 $ 9.85 Commercial................ 7.48 10.14 8.50 9.01 Industrial and irrigation. 8.60 9.39 8.73 8.12 Public authorities and other................... 5.11 9.61 5.47 8.04 Pipeline and marketing.... 2.86 5.70 3.59 4.43 Weather: Degree days: Southern Union Gas service territories............. 1,208 1,259 1,977 2,372 Missouri Gas Energy service territories..... 2,439 2,809 4,266 5,643 PG Energy service territories............. 2,592 3,120 5,320 6,651 New England Gas Company service territories..... 2,547 2,980 5,087 5,174 Percent of normal based on 30-year measure: Southern Union Gas service territories............. 97% 102% 93% 111% Missouri Gas Energy service territories..... 90% 100% 82% 108% PG Energy service territories............. 84% 98% 86% 106% New England Gas Company service territories..... 85% 100% 86% 107% Gas transported in millions of cubic feet (MMcf)........ 27,770 26,822 89,643 91,264 Gas transportation revenues (thousands of dollars)...... $ 15,464 $ 17,606 $ 45,166 $ 47,624 The above information does not include the Company's 43% equity ownership in a natural gas distribution company serving 23,000 customers in Piedras Negras, Mexico. Information for Fall River Gas and ProvEnergy, acquired September 28, 2000, and Valley Resources, acquired September 20, 2000, is included since October 1, 2000. The 30-year measure of weather is used above for consistent external reporting purposes. Measures of normal weather used by the Company's regulatory authorities to set rates vary by jurisdiction. Periods used to measure normal weather for regulatory purposes range from 10 years to 30 years. - -------------------------------------------------------------------------------- 29 SOUTHERN UNION COMPANY AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FINANCIAL CONDITION The Company's gas utility operations are seasonal in nature with a significant percentage of the annual revenues and earnings occurring in the traditional heating-load months. This seasonality results in a high level of cash flow needs immediately preceding the peak winter heating season months, due to the required payments to natural gas suppliers in advance of the receipt of cash payments from the Company's customers. The Company has historically used internally generated funds and its credit facilities to provide funding for its seasonal working capital, continuing construction and maintenance programs and operational requirements. On May 29, 2001, the Company renewed and amended its short-term and long-term credit facilities (together referred to as "Revolving Credit Facilities"). The Company has available $150,000,000 under the short-term facility, which expires May 28, 2002, and $225,000,000 under the long-term facility, which expires on May 29, 2004. The Company is currently negotiating with its lenders to renew its $150,000,000 short-term facility for an additional 364-day period, or until May 27, 2003. The Company has additional availability under uncommitted line of credit facilities with various banks. Borrowings under the Revolving Credit Facilities are available for Southern Union's working capital, letter of credit requirements and other general corporate purposes. A balance of $132,300,000 was outstanding under the Revolving Credit Facilities at March 31, 2002 and $99,900,000 at May 14, 2002. On August 28, 2000 the Company entered into the Term Note to fund (i) the cash portion of the consideration to be paid to the Fall River Gas stockholders; (ii) the all cash consideration to be paid to the ProvEnergy and Valley Resources stockholders; (iii) repayment of approximately $50,000,000 of long- and short-term debt assumed in the mergers; and (iv) related acquisition costs. As of March 31, 2002, a balance of $410,000,000 was outstanding on this Term Note and, as of May 14, 2002, the balance outstanding was $350,000,000. No additional draws can be made on the Term Note. Prior to maturity, the Company plans to refinance some portion or all of the Term Note. Sources of future or alternative financing that the Company may consider include commercial and investment banks, institutional lenders, institutional investors and public securities markets. The availability and terms of any such financing sources will depend upon various factors and conditions such as the Company's combined cash flow and earnings, the Company's resulting capital structure, and conditions in financial markets at the time of such offerings. The principal source of funds during the three-month period ended March 31, 2002 was $192,759,000 in cash flow from operations. The principal uses of funds during this period included $82,650,000 for the repayment of borrowings under the Company's Revolving Credit Facilities, $78,169,000 for the retirement of long-term debt and $21,042,000 for on-going property, plant and equipment additions. The principal sources of funds during the nine-month period ended March 31, 2002 were $203,390,000 in cash flow from operations, proceeds of $33,663,000 from the sale of various subsidiaries, and proceeds of $17,166,000 generated from the settlement of interest rate swaps. The principal uses of funds during this period included $83,974,000 for the retirement of long-term debt, $78,189,000 for on-going property, plant and equipment additions, $58,300,000 for the repayment of borrowings under the Company's Revolving Credit Facilities, and $34,711,000 for the repurchase of Company common stock. The effective interest rate under the Company's current debt structure is 6.40% (including interest and the amortization of debt issuance costs and redemption premiums on refinanced debt). The Company retains its borrowing availability under its Revolving Credit Facilities, as discussed above. Borrowings under these credit facilities will continue to be used, as needed, to provide funding for the seasonal working capital needs of the Company. Internally-generated funds from operations will be used principally for the Company's ongoing construction and maintenance programs and operational needs and may also be used periodically to reduce outstanding debt. On December 6, 2001 and October 19, 2001, the Company filed shelf registrations of $200,000,000 and $400,000,000, respectively. Under these shelf registrations, Southern Union may sell a combination of senior debt securities, subordinated debt securities and preferred securities of financing trusts from time to time, at prices determined at the time of any offering. - -------------------------------------------------------------------------------- 30 SOUTHERN UNION COMPANY AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK There are no material changes in market risks faced by the Company from those reported in the Company's Annual Report on Form 10-K for the year ended June 30, 2001. The information contained in Item 3 updates, and should be read in conjunction with, information set forth in Part II, Item 7 in the Company's Annual Report on Form 10-K for the year ended June 30, 2001, in addition to the interim consolidated financial statements, accompanying notes, and Management's Discussion and Analysis of Financial Condition and Results of Operations presented in Items 1 and 2 of this Quarterly Report on Form 10-Q. OTHER MATTERS Employees During the quarter ended March 31, 2002, New England Gas 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. This has resulted in a work stoppage in the area previously serviced by Providence Gas Company. Currently, both parties continue to negotiate in good faith and have reached tentative agreements on most issues. The work stoppage did not have a significant impact on the Company's financial statements for the quarter ended March 31, 2002, and the Company believes the outcome of the matter will not have a material adverse impact on the Company's results of operations, financial condition or cash flows. In March 2002, New England Gas Company and two other bargaining units representing New England Gas Company employees successfully reached new four-year contract agreements in advance of contract expiration dates; these two contracts became effective April 1, 2002 and May 1, 2002, respectively. New England Gas Company and its remaining two bargaining units are preparing for upcoming negotiations, as both contracts expire at the end of May 2002. Investment Securities 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. ACCOUNTING PRONOUNCEMENTS In June 2001, the FASB issued Accounting for Asset Retirement Obligations, which addresses financial accounting and reporting for obligations and the related costs associated with the retirement of tangible long-lived assets. Accounting for Asset Retirement Obligations is effective for all fiscal years beginning after June 15, 2002. The Statement's purpose is to develop consistent financial treatment of asset retirement obligations and the associated costs, improve disclosure regarding the impact of retirement obligations on future cash outflows, leverage and liquidity, and provide more information related to gross investment in long-lived assets. The Company is currently evaluating the effect this Statement will have on the earnings and financial condition of the Company. In August 2001, the FASB issued Accounting for the Impairment or Disposal of Long-Lived Assets, which addresses financial accounting and reporting for the impairment or disposal of long-lived assets and broadens the presentation of discontinued operations to include more disposal transactions. Accounting for the Impairment or Disposal of Long-Lived Assets is effective for all fiscal years beginning after December 15, 2001. The Statement's purpose is to develop a single accounting model for long-lived assets to be disposed of by sale and enhance disclosure regarding the effects of a disposal transaction on ongoing operations. The Company is currently evaluating the effect this Statement will have on the earnings and financial condition of the Company. CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION This Management's Discussion and Analysis of Financial Condition and Results of Operations and other sections of this Form 10-Q may contain forward-looking statements that are based on current expectations, estimates and projections about the industry in which the Company operates, management's beliefs and assumptions made by management. Words such as "expects," "anticipates," "intends," "plans," "believes," "seeks," "estimates," variations of such words and similar expressions are intended to identify such forward-looking statements. These statements are not - -------------------------------------------------------------------------------- 31 SOUTHERN UNION COMPANY AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS guarantees of future performance and involve certain risks, uncertainties and assumptions, which are difficult to predict and many of which are outside the Company's control. Therefore, actual outcomes and results may differ materially from what is expressed or forecasted in such forward-looking statements. The Company undertakes no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise. Readers are cautioned not to put undue reliance on such forward-looking statements. Stockholders may review the Company's reports filed in the future with the Securities and Exchange Commission for more current descriptions of developments that could cause actual results to differ materially from such forward-looking statements. Factors that could cause or contribute to actual results differing materially from such forward-looking statements include the following: cost of gas; gas sales volumes; weather conditions in the Company's service territories; the achievement of operating efficiencies and the purchases and implementation of new technologies for attaining such efficiencies; impact of relations with labor unions of bargaining-unit employees; the receipt of timely and adequate rate relief; the outcome of pending and future litigation; governmental regulations and proceedings affecting or involving the Company; unanticipated environmental liabilities; changes in business strategy; the risk that the businesses acquired and any other businesses or investments that Southern Union has acquired or may acquire may not be successfully integrated with the businesses of Southern Union; the impairment or sale of investment securities; and the nature and impact of any extraordinary transactions such as any acquisition or divestiture of a business unit or any assets. These are representative of the factors that could affect the outcome of the forward-looking statements. In addition, such statements could be affected by general industry and market conditions, and general economic conditions, including interest rate fluctuations, federal, state and local laws and regulations affecting the retail gas industry or the energy industry generally, and other factors. - -------------------------------------------------------------------------------- 32 SOUTHERN UNION COMPANY AND SUBSIDIARIES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. SOUTHERN UNION COMPANY ------------------------------------------------ (Registrant) Date May 15, 2002 By DAVID J. KVAPIL ---------------------- --------------------------------------------- David J. Kvapil Executive Vice President and Chief Financial Officer - -------------------------------------------------------------------------------- -----END PRIVACY-ENHANCED MESSAGE-----