-----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, WGvoMi31UdyRA1gCN+9SzFHVI+iq9mMVzlMmyp+ei0J9DiWrWpBfa11Mzyb1ZAjo UjDEWjdIKVzBKgzJCGEXHw== 0000203248-03-000020.txt : 20030214 0000203248-03-000020.hdr.sgml : 20030214 20030214152928 ACCESSION NUMBER: 0000203248-03-000020 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 20021231 FILED AS OF DATE: 20030214 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: 03567326 BUSINESS ADDRESS: STREET 1: 504 LAVACA ST 8TH FL CITY: AUSTIN STATE: TX ZIP: 78701 BUSINESS PHONE: 5124775852 10-Q 1 form10qdec02.txt FORM 10Q DEC 2002 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D. C. 20549 FORM 10-Q For the quarterly period ended December 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 February 7, 2003 was 55,578,868.
SOUTHERN UNION COMPANY AND SUBSIDIARIES FORM 10-Q December 31, 2002 Index PART I. FINANCIAL INFORMATION Page(s) ------- Item 1. Financial Statements Consolidated statements of operations - three, six and twelve months ended December 31, 2002 and 2001 2-4 Consolidated balance sheet - December 31, 2002 and 2001 and June 30, 2002 5-6 Consolidated statement of stockholders' equity - six months ended December 31, 2002 and twelve months ended June 30, 2002 7 Consolidated statements of cash flows - three, six and twelve months ended December 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 22-31 of Operations Item 3. Quantitative and Qualitative Disclosures about Market Risk 30 Item 4. Controls and Procedures 31 PART II. OTHER INFORMATION Item 1. Legal Proceedings (See "COMMITMENTS AND CONTINGENCIES" in Notes to Consolidated Financial Statements) 18-21 Item 4. Result of Votes of Security Holders 31 Item 6. Exhibits and Reports on Form 8-K: (a) Exhibits: 10 Employment agreement between David W. Stevens and Southern Union Company dated October 31, 2002 99.1 Certificate of the Chief Executive Officer pursuant to 18 U.S.C.ss.1350 (Section 906 of the Sarbanes-Oxley Act of 2002) 99.2 Certificate of the Chief Financial Officer pursuant to 18 U.S.C.ss.1350 (Section 906 of the Sarbanes-Oxley Act of 2002) (b) Reports on Form 8-K: Date Filed Description of Filing 12/23/02 Announcement that Southern Union Company was awarded over $60 million in punitive damages by an Arizona Federal District Court jury in its case against Arizona Corporation Commissioner James C. Irvin. 10/31/02 Announcement of operating performance for the quarter ended September 30, 2002 and 2001 and filing, under Item 9, summary statements of income of Southern Union Company for the quarter ended September 30, 2002 and 2001 (unaudited) and notes thereto. 10/30/02 Announcement that Southern Union Company entered into a definitive agreement with ONEOK, Inc. to sell its Southern Union Gas Company Texas division and related assets.
SOUTHERN UNION COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENT OF OPERATIONS
Three Months Ended December 31, 2002 2001 ------------- ------------ (thousands of dollars, except shares and per share amounts) Operating revenues ........................................... $ 346,104 $ 286,431 Cost of gas and other energy ................................. (215,505) (172,818) Revenue-related taxes ........................................ (12,568) (9,627) ------------ ------------ Operating margin ........................................ 118,031 103,986 Operating expenses: Operating, maintenance and general ...................... 42,249 43,030 Depreciation and amortization ........................... 14,067 13,759 Taxes, other than on income and revenues ................ 6,213 6,420 ------------ ------------ Total operating expenses ............................ 62,529 63,209 ------------ ------------ Net operating revenues .............................. 55,502 40,777 ------------ ------------ Other income (expense): Interest ................................................ (20,742) (21,736) Dividends on preferred securities of subsidiary trust ... (2,370) (2,370) Other, net .............................................. (2,712) (836) ------------ ------------ Total other expenses, net ........................... (25,824) (24,942) ------------ ------------ Earnings from continuing operations before income taxes ...... 29,678 15,835 Federal and state income taxes ............................... 11,159 6,017 ------------ ------------ Net earnings from continuing operations ...................... 18,519 9,818 ------------ ------------ Discontinued operations: Earnings from discontinued operations before income taxes 17,468 16,021 Federal and state income taxes .......................... 6,568 6,089 ------------ ------------ Net earnings from discontinued operations .................... 10,900 9,932 ------------ ------------ Net earnings available for common stock ...................... $ 29,419 $ 19,750 ============ ============ Net earnings from continuing operations per share: Basic ................................................... $ .34 $ .18 ============ ============ Diluted ................................................. $ .33 $ .17 ============ ============ Net earnings available for common stock per share: Basic ................................................... $ .54 $ .37 ============ ============ Diluted ................................................. $ .53 $ .35 ============ ============ Weighted average shares outstanding: Basic ................................................... 54,206,735 53,323,421 ============ ============ Diluted ................................................. 55,937,697 56,389,022 ============ ============
See accompanying notes.
SOUTHERN UNION COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENT OF OPERATIONS Six Months Ended December 31, 2002 2001 --------------- -------------- (thousands of dollars, except shares and per share amounts) Operating revenues.................................................................. $ 445,814 $ 407,010 Cost of gas and other energy........................................................ (257,565) (233,447) Revenue-related taxes............................................................... (15,754) (13,532) --------------- -------------- Operating margin............................................................... 172,495 160,031 Operating expenses: Operating, maintenance and general............................................. 83,620 85,531 Business restructuring charges................................................. -- 30,553 Depreciation and amortization.................................................. 28,451 29,483 Taxes, other than on income and revenues....................................... 12,711 13,121 --------------- -------------- Total operating expenses................................................... 124,782 158,688 --------------- -------------- Net operating revenues..................................................... 47,713 1,343 --------------- -------------- Other income (expense): Interest ...................................................................... (41,743) (48,721) Dividends on preferred securities of subsidiary trust.......................... (4,740) (4,740) Other, net..................................................................... 13,726 22,640 --------------- -------------- Total other expenses, net.................................................. (32,757) (30,821) --------------- -------------- Earnings (loss) from continuing operations before income taxes...................... 14,956 (29,478) Federal and state income taxes (benefit)............................................ 5,623 (8,715) --------------- -------------- Net earnings (loss) from continuing operations...................................... 9,333 (20,763) --------------- -------------- Discontinued operations: Earnings from discontinued operations before income taxes...................... 21,781 14,353 Federal and state income taxes................................................. 8,190 4,243 --------------- -------------- Net earnings from discontinued operations........................................... 13,591 10,110 --------------- -------------- Net earnings (loss) available for (attributable to) common stock.................... $ 22,924 $ (10,653) =============== ============== Net earnings (loss) from continuing operations per share: Basic.......................................................................... $ .17 $ (.38) =============== ============== Diluted........................................................................ $ .17 $ (.38) =============== ============== Net earnings (loss) available for (attributable to) common stock per share: Basic.......................................................................... $ .42 $ (.20) =============== ============== Diluted........................................................................ $ .41 $ (.20) =============== ============== Weighted average shares outstanding: Basic.......................................................................... 54,010,349 54,187,335 =============== ============== Diluted........................................................................ 55,875,307 54,187,335 =============== ==============
See accompanying notes. SOUTHERN UNION COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENT OF OPERATIONS
Twelve Months Ended December 31, 2002 2001 ------------- ------------- (thousands of dollars, except shares and per share amounts) Operating revenues ........................................... $ 1,018,954 $ 1,324,447 Cost of gas and other energy ................................. (596,732) (891,517) Revenue-related taxes ........................................ (35,630) (42,598) ------------ ------------ Operating margin ........................................ 386,592 390,332 Operating expenses: Operating, maintenance and general ...................... 171,810 197,756 Business restructuring charges .......................... (1,394) 30,553 Depreciation and amortization ........................... 56,722 67,251 Taxes, other than on income and revenues ................ 23,253 26,855 ------------ ------------ Total operating expenses ............................ 250,391 322,415 ------------ ------------ Net operating revenues .............................. 136,201 67,917 ------------ ------------ Other income (expense): Interest ................................................ (84,015) (105,302) Dividends on preferred securities of subsidiary trust ... (9,480) (9,480) Other, net .............................................. 2,999 84,068 ------------ ------------ Total other expenses, net ........................... (90,496) (30,714) ------------ ------------ Earnings from continuing operations before income taxes ...... 45,705 37,203 Federal and state income taxes ............................... 17,624 16,097 ------------ ------------ Net earnings from continuing operations ...................... 28,081 21,106 ------------ ------------ Discontinued operations: Earnings from discontinued operations before income taxes 40,886 35,575 Federal and state income taxes .......................... 15,766 15,393 ------------ ------------ Net earnings from discontinued operations .................... 25,120 20,182 ------------ ------------ Net earnings available for common stock ...................... $ 53,201 $ 41,288 ============ ============ Net earnings from continuing operations per share: Basic ................................................... $ .52 $ .39 ============ ============ Diluted ................................................. $ .50 $ .37 ============ ============ Net earnings available for common stock per share: Basic ................................................... $ .99 $ .76 ============ ============ Diluted ................................................. $ .95 $ .71 ============ ============ Weighted average shares outstanding: Basic ................................................... 53,797,778 54,622,089 ============ ============ Diluted ................................................. 56,002,239 57,807,411 ============ ============
See accompanying notes.
SOUTHERN UNION COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET ASSETS December 31, June 30, 2002 2001 2002 ------------- ------------- ------------ (thousands of dollars) Property, plant and equipment: Plant in service ............................. $ 1,790,878 $ 1,737,387 $ 1,767,349 Construction work in progress ................ 17,709 16,740 6,535 ----------- ----------- ----------- 1,808,587 1,754,127 1,773,884 Less accumulated depreciation and amortization (627,818) (586,415) (604,114) ----------- ----------- ----------- Net property, plant and equipment ....... 1,180,769 1,167,712 1,169,770 ----------- ----------- ----------- Current assets: Cash and cash equivalents .................... -- -- -- Accounts receivable, billed and unbilled, net 223,555 162,687 95,036 Inventories, principally at average cost ..... 107,339 155,881 101,076 Deferred gas purchase costs .................. 12,784 26,723 3,597 Investment securities available for sale ..... 630 7,201 1,163 Prepayments and other ........................ 9,836 9,802 13,527 Assets held for sale ......................... 446,851 447,352 395,446 ----------- ----------- ------------ Total current assets .................... 800,995 809,646 609,845 ----------- ----------- ------------ Goodwill, net ..................................... 642,921 642,921 642,921 Deferred charges .................................. 202,493 223,323 206,130 Investment securities, at cost .................... 9,786 19,226 9,786 Real estate ....................................... -- 2,482 -- Other ............................................. 41,317 41,983 41,612 ----------- ----------- ------------ Total assets .................................... $ 2,878,281 $ 2,907,293 $ 2,680,064 =========== =========== ============
See accompanying notes.
SOUTHERN UNION COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET (Continued) STOCKHOLDERS' EQUITY AND LIABILITIES December, June 30, 2002 2001 2002 ------------- ------------ ----------- (thousands of dollars) Common stockholders' equity: Common stock, $1 par value; authorized 200,000,000 shares; issued 58,593,309 shares ........................ $ 58,593 $ 54,686 $ 58,055 Premium on capital stock .................................... 710,287 678,039 707,912 Less treasury stock, 3,125,993 shares at cost ............... (57,673) (51,068) (57,673) Less common stock held in trust ............................. (18,329) (18,194) (17,821) Deferred compensation plans ................................. 10,539 7,499 9,373 Accumulated other comprehensive income (loss) ............... (14,717) (354) (14,500) Retained earnings (deficit) ................................. 22,924 (5,550) -- ----------- ----------- ----------- Total common stockholders' equity ........................... 711,624 665,058 685,346 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 ...................... 1,041,256 803,096 1,082,210 ----------- ----------- ----------- Total capitalization .................................... 1,852,880 1,568,154 1,867,556 Current liabilities: Long-term debt and capital lease obligation due within one year ................................................ 67,190 526,642 108,203 Notes payable ............................................... 290,000 214,950 131,800 Accounts payable ............................................ 128,979 94,064 71,532 Federal, state and local taxes .............................. 29,261 31,438 9,212 Accrued interest ............................................ 16,600 16,073 17,019 Accrued dividends on preferred securities of subsidiary trust -- -- 2,370 Customer deposits ........................................... 6,894 7,598 7,572 Other ....................................................... 45,387 55,359 38,385 Liabilities related to assets held for sale ................. 80,217 68,856 65,920 ----------- ----------- ----------- Total current liabilities ............................... 664,528 1,014,980 452,013 ----------- ----------- ----------- Deferred credits and other ....................................... 145,459 130,544 143,843 Accumulated deferred income taxes ................................ 215,414 193,615 216,652 ----------- ----------- ----------- Total stockholders' equity and liabilities .................. $ 2,878,281 $ 2,907,293 $ 2,680,064 =========== =========== ===========
See accompanying notes.
SOUTHERN UNION COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY Common Accumulated Common Premium Treasury Stock Other Stock, $1 on Capital Stock, at Held in Comprehen- Retained Par Value Stock Cost Trust sive Income Earnings Total --------- ---------- --------- ------- ----------- -------- ----- (thousands of dollars) Balance July 1, 2001................... $ 54,553 $ 676,324 $ (15,869) $(11,697) $ 13,443 $ 5,103 $721,857 Comprehensive income: Net earnings ..................... -- -- -- -- -- 19,624 19,624 Unrealized loss in investment securities, net of tax benefit . -- -- -- -- (18,249) -- (18,249) Minimum pension liability adjustment, net of tax ......... -- -- -- -- (10,498) -- (10,498) Unrealized gain on hedging activities, net of tax ......... -- -- -- -- 804 -- 804 --------- Comprehensive income (loss) ...... (8,319) --------- Payment on note receivable ......... -- 202 -- -- -- -- 202 Purchase of treasury stock ......... -- -- (41,632) -- -- -- (41,632) 5% stock dividend .................. 2,618 22,091 -- -- -- (24,727) (18) Stock compensation plan ............ -- 1,248 -- 1,257 -- -- 2,505 Sale of common stock held in trust ......................... -- 26 -- 1,945 -- -- 1,971 Exercise of stock options .......... 884 8,021 (172) 47 -- -- 8,780 --------- --------- --------- --------- --------- --------- --------- Balance June 30, 2002 ................. 58,055 707,912 (57,673) (8,448) (14,500) -- 685,346 Comprehensive income: Net earnings ..................... -- -- -- -- -- 22,924 22,924 Unrealized loss in investment securities, net of tax benefit . -- -- -- -- (346) -- (346) Unrealized gain on hedging activities, net of tax ......... -- -- -- -- 129 -- 129 --------- Comprehensive income ............. 22,707 --------- Stock compensation plan ............ -- 471 -- 658 -- -- 1,129 Exercise of stock options .......... 538 1,904 -- -- -- -- 2,442 --------- --------- --------- --------- --------- --------- --------- Balance December 31, 2002 ............. $ 58,593 $ 710,287 $ (57,673) $ (7,790) $ (14,717) $ 22,924 $ 711,624 ========= ========= ========= ========= ========= ========= ========= The Company's common stock is $1 par value. Therefore, the change in Common Stock, $1 Par Value is equivalent to the change in the number of shares of common stock outstanding. See accompanying notes.
SOUTHERN UNION COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS Three Months Ended December 31, 2002 2001 ---------- ---------- (thousands of dollars) Cash flows from (used in) operating activities: Net earnings .............................................................. $ 29,419 $ 19,750 Adjustments to reconcile net earnings to net cash flows from (used in) operating activities: Depreciation and amortization ......................................... 14,067 13,759 Deferred income taxes ................................................. 1,249 1,546 Provision for bad debts ............................................... 2,912 3,940 Gain on sale of assets ................................................ -- (561) Loss on sale of assets ................................................ -- 1,500 Financial derivative trading gains .................................... (151) (1,976) Net cash provided by (used in) assets held for sale ................... (25,502) (16,445) Other ................................................................. 1,013 636 Changes in operating assets and liabilities, net of dispositions: Accounts receivable, billed and unbilled .......................... (149,177) (60,673) Accounts payable .................................................. 79,356 22,784 Customer deposits ................................................. (2) 161 Deferred gas purchase costs ....................................... 11,645 32,762 Inventories ....................................................... 24,694 2,478 Deferred charges and credits ...................................... (1,588) 1,696 Prepaids and other current assets ................................. 1,900 (1,307) Taxes and other current liabilities ............................... 19,974 14,944 --------- --------- Net cash flows from (used in) operating activities ...................... 9,809 34,994 --------- --------- Cash flows from (used in) investing activities: Additions to property, plant and equipment ................................ (18,206) (26,683) Changes in assets and liabilities held for sale ........................... (7,771) (6,182) Notes receivable .......................................................... (4,750) -- Proceeds from sale of subsidiaries and other assets ....................... -- 12,586 Customer advances ......................................................... 391 324 Other ..................................................................... (1,986) (172) --------- --------- Net cash flows from (used in) investing activities ...................... (32,322) (20,127) --------- --------- Cash flows from (used in) financing activities: Issuance cost of debt ..................................................... (313) (229) Repayment of debt and capital lease obligation ............................ (38,949) (3,597) Net borrowings under revolving credit facilities .......................... 59,300 21,950 Purchase of treasury stock ................................................ -- (33,012) Proceeds from exercise of stock options ................................... 1,490 21 --------- --------- Net cash flows from (used in) financing activities ...................... 21,528 (14,867) --------- --------- Change in cash and cash equivalents .......................................... (985) -- Cash and cash equivalents at beginning of period ............................. 985 -- --------- --------- Cash and cash equivalents at end of period ................................... $ -- $ -- ========= ========= Supplemental disclosures of cash flow information: Cash paid during the period for: Interest ................................................................ $ 22,337 $ 28,094 ========= ========= Income taxes ............................................................ $ 282 $ -- ========= ========= See accompanying notes.
SOUTHERN UNION COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS Six Months Ended December 31, 2002 2001 --------- ---------- (thousands of dollars) Cash flows from (used in) operating activities: Net earnings (loss) ......................................................... $ 22,924 $ (10,653) Adjustments to reconcile net earnings (loss) to net cash flows from (used in) operating activities: Depreciation and amortization ........................................... 28,451 29,483 Deferred income taxes ................................................... (1,120) 3,022 Provision for bad debts ................................................. 6,397 5,479 Business restructuring charges .......................................... -- 27,247 Gain on settlement of interest rate swaps ............................... -- (17,166) Gain on sale of subsidiaries and other assets ........................... -- (5,214) Loss on sale of subsidiaries ............................................ -- 1,500 Financial derivative trading gains ...................................... (302) (2,333) Net cash provided by (used in) assets held for sale ..................... (23,698) (10,672) Other ................................................................... 2,123 771 Changes in operating assets and liabilities, net of dispositions: Accounts receivable, billed and unbilled ............................ (128,166) 8,310 Accounts payable .................................................... 57,447 8,696 Customer deposits ................................................... (678) (33) Deferred gas purchase costs ......................................... (9,187) 30,310 Inventories ......................................................... (6,263) (53,761) Deferred charges and credits ........................................ 4,199 4,913 Prepaids and other current assets ................................... 4,184 390 Taxes and other liabilities ......................................... 25,693 (3,331) --------- --------- Net cash flows from (used in) operating activities ........................ (17,996) 16,958 --------- --------- Cash flows from (used in) investing activities: Additions to property, plant and equipment .................................. (38,106) (46,286) Changes in assets and liabilities held for sale ............................. (13,410) (10,943) Notes receivable ............................................................ (6,750) -- Proceeds from sale of subsidiaries and other assets ......................... -- 38,635 Customer advances ........................................................... 618 (283) Proceeds from settlement of interest rate swaps ............................. -- 17,166 Other ....................................................................... (1,664) (307) --------- --------- Net cash flows from (used in) investing activities ........................ (59,312) (2,018) --------- --------- Cash flows from (used in) financing activities: Issuance of long-term debt .................................................. 311,087 -- Issuance cost of debt ....................................................... (1,367) (519) Repayment of debt and capital lease obligation .............................. (393,054) (5,805) Net (payments) borrowings under revolving credit facilities ................. 158,200 24,350 Purchase of treasury stock .................................................. -- (34,711) Proceeds from exercise of stock options ..................................... 2,442 526 --------- --------- Net cash flows from (used in) financing activities ........................ 77,308 (16,159) --------- --------- Change in cash and cash equivalents ............................................ -- (1,219) Cash and cash equivalents at beginning of period ............................... -- 1,219 --------- --------- Cash and cash equivalents at end of period ..................................... $ -- $ -- ========= ========= Supplemental disclosures of cash flow information: Cash paid during the period for: Interest .................................................................. $ 48,161 $ 56,338 ========= ========= Income taxes .............................................................. $ 491 $ -- ========= ========= See accompanying notes.
SOUTHERN UNION COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS Twelve Months Ended December 31, 2002 2001 --------- ---------- (thousands of dollars) Cash flows from (used in) operating activities: Net earnings .............................................................. $ 53,201 $ 41,288 Adjustments to reconcile net earnings to net cash flows from (used in) operating activities: Depreciation and amortization ......................................... 56,722 67,251 Deferred income taxes ................................................. 24,255 36,760 Provision for bad debts ............................................... 13,178 28,120 Provision for investment impairment ................................... 10,380 -- Business restructuring charges ........................................ (1,394) 27,247 Gain on settlement of interest rate swaps ............................. -- (17,166) Gain on sale of subsidiaries and other assets ......................... (1,200) (5,921) Loss on sale of subsidiaries .......................................... -- 1,500 Financial derivative trading gains .................................... (4,173) (2,333) Gain on sale of investment securities ................................. (1,004) (65,713) Net cash provided by (used in) assets held for sale ................... 38,780 18,003 Other ................................................................. 4,234 (473) Changes in operating assets and liabilities, net of dispositions: Accounts receivable, billed and unbilled .......................... (64,545) 112,897 Accounts payable .................................................. 36,732 (141,915) Customer deposits ................................................. (698) (1,160) Deferred gas purchase costs ....................................... 13,939 22,012 Inventories ....................................................... 48,542 (42,654) Deferred charges and credits ...................................... 15,138 (16,313) Prepaids and other current assets ................................. 59 (4,200) Taxes and other liabilities ....................................... (3,486) (28,900) --------- --------- Net cash flows from (used in) operating activities ...................... 238,660 28,330 --------- --------- Cash flows from (used in) investing activities: Additions to property, plant and equipment ................................ (59,526) (96,755) Changes in assets and liabilities held for sale ........................... (26,917) (24,701) Acquisition of operations, net of cash received ........................... -- (9,366) Purchase of investment securities ......................................... (803) (135) Notes receivable .......................................................... (9,500) -- Proceeds from sale of subsidiaries and other assets ....................... 2,300 41,935 Proceeds from sale of investment securities ............................... 1,213 74,389 Customer advances ......................................................... 498 680 Proceeds from settlement of interest rate swaps ........................... -- 17,166 Other ..................................................................... (3,784) 7,778 --------- --------- Net cash flows from (used in) investing activities ...................... (96,519) 10,991 --------- --------- Cash flows from (used in) financing activities: Issuance of long-term debt ................................................ 311,087 -- Issuance cost of debt ..................................................... (1,768) (1,452) Repayment of debt and capital lease obligation ............................ (532,380) (51,195) Net (payments) borrowings under revolving credit facilities ............... 75,050 39,950 Purchase of treasury stock ................................................ (6,922) (34,711) Proceeds from exercise of stock options ................................... 10,771 247 Other ..................................................................... 2,021 -- --------- --------- Net cash flows from (used in) financing activities ...................... (142,141) (47,161) --------- --------- Change in cash and cash equivalents .......................................... -- (7,840) Cash and cash equivalents at beginning of period ............................. -- 7,840 --------- --------- Cash and cash equivalents at end of period ................................... $ -- $ -- ========= ========= Supplemental disclosures of cash flow information: Cash paid (refunded) during the period for: Interest ................................................................ $ 91,363 $ 116,700 ========= ========= Income taxes ............................................................ $ (3,575) $ 21,000 ========= =========
See accompanying notes. 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, 2002. 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. As of December 31, 2002 and 2001, the Company had a cash overdraft of $10,312,000 and $15,789,000, respectively, which is reflected in accounts payable on the consolidated balance sheet. 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. As further described below, the Company completed the sale of its Southern Union Gas Company (Southern Union Gas) natural gas operating division and related assets in January 2003. In accordance with the Financial Accounting Standards Board (FASB) standard, Accounting for the Impairment or Disposal of Long-Lived Assets, the assets and liabilities to be sold as of December 31, 2002, have been segregated and reported as "held for sale" in the consolidated balance sheet. In addition, the related results of operations have been segregated and reported as "discontinued operations" in the consolidated statement of operations and consolidated statement of cash flows for all periods presented in this Quarterly Report on Form 10-Q. 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. SIGNIFICANT ACCOUNTING POLICIES Effective July 1, 2002, the Company adopted the FASB standard, Accounting for Asset Retirement Obligations, which requires the fair value of a liability for an asset retirement legal obligation to be recognized in the period in which it is incurred and when the amount of the liability can be reasonably estimated. When the liability is initially recorded, associated costs are capitalized by increasing the carrying amount of the related long-lived asset. Over time, the liability is accreted to its present value each period, and the capitalized cost is depreciated over the useful life of the related asset. In certain rate jurisdictions, the Company is permitted to include annual charges for cost of removal in its regulated cost of service rates charged to customers. The adoption of the Statement did not have a material impact on the Company's financial position, results of operations or cash flows for all periods presented. Also effective July 1, 2002, the Company adopted the FASB standard, Accounting for the Impairment or Disposal of Long-Lived Assets. The Statement provides new guidance on the recognition of impairment losses on long-lived assets to be held and used or to be disposed of and also broadens the definition of what constitutes a discontinued operation and how the results of a discontinued operation are to be measured and presented. Under the Statement, assets held for sale that are a component of an entity will be included in discontinued operations if the operations and cash flows will be or have been eliminated from the ongoing operations of the entity and the entity will not have any significant continuing involvement in the operations prospectively. The Statement is not expected to materially change the methods the Company uses to measure impairment losses on long-lived assets, but will result in additional future dispositions being reported as discontinued operations than was previously permitted. In December 2002, the FASB issued Accounting for Stock-Based Compensation- Transition and Disclosure. This statement amends the previous standard, Accounting for Stock-Based Compensation, to provide alternative methods of transition for an entity that voluntarily changes to a fair value based method of accounting for stock-based employee compensation and amends disclosure provisions of that standard to require prominent disclosure about the effects on reported net income of an entity's accounting policy decisions with respect to such compensation. The Company expects to continue to account for stock-based compensation in accordance with Accounting Principles Board opinion, Accounting for Stock Issued to Employees, and will provide the prominent disclosures required in its annual and future interim financial statements. PENDING ACQUISITIONS On December 22, 2002, the Company along with AIG Highstar Capital, L.P. (AIG Highstar), a private equity fund sponsored by American International Group, Inc. (AIG), reached a definitive agreement with CMS Energy Corporation to acquire the CMS Panhandle Companies (CMS Panhandle). The agreement calls for a newly formed entity, Southern Union Panhandle Corporation, owned approximately 78% by Southern Union and 22% by AIG Highstar to acquire CMS Panhandle for approximately $662 million in cash and the assumption of $1.166 billion in debt. The CMS Panhandle Companies include CMS Panhandle Eastern Pipe Line Company, CMS Trunkline Gas Company, CMS Trunkline LNG Company, which operates an LNG terminal complex at Lake Charles, La., and CMS Sea Robin Pipeline Company. The CMS Panhandle Companies operate almost 11,000 miles of mainline natural gas pipeline extending from the Gulf of Mexico to the Midwest and Canada. These pipelines access the major natural gas supply regions of the Louisiana and Texas Gulf Coasts as well as the Midcontinent and Rocky Mountains. The pipelines have a combined peak day delivery capacity of 5.4 billion cubic feet per day, 88 billion cubic feet of underground storage capacity and 6.3 billion cubic feet of above ground LNG storage facilities. The transaction has been approved by the boards of directors of all companies and will close following clearance by the Federal Trade Commission under the Hart-Scott-Rodino Act and certain state regulatory approvals. This acquisition will be funded in part by proceeds received from the January 2003 sale of Southern Union Gas and related assets discussed below. DISCONTINUED OPERATIONS AND ASSETS HELD FOR SALE Effective January 1, 2003, the Company completed the sale of its Southern Union Gas natural gas operating division and related assets to ONEOK, Inc. for approximately $420,000,000 in cash, resulting in a pre-tax gain of approximately $75,000,000 that will be recorded during the third quarter ending March 31, 2003. In addition to Southern Union Gas, the sale involved the disposition of Mercado Gas Services, Inc. (Mercado), SUPro Energy Company (SUPro), Southern Transmission Company (STC), Southern Union Energy International, Inc. (SUEI), Southern Union International Investments, Inc. (Investments) and Norteno Pipeline Company (Norteno) (collectively, the Texas Operations). Southern Union Gas distributes natural gas as a public utility to approximately 535,000 customers throughout Texas, including the cities of Austin, El Paso, Brownsville, Galveston and Port Arthur. Mercado markets natural gas to commercial and industrial customers. SUPro provides propane gas services to approximately 4,000 customers located principally in Austin, El Paso and Alpine, Texas as well as Las Cruces, New Mexico and surrounding communities. STC owns and operates 118.8 miles of intrastate pipeline that serves commercial, industrial and utility customers in central, south and coastal Texas. SUEI and Investments participate in energy-related projects internationally. Energia Estrella del Sur, S. A. de C. V., a wholly-owned Mexican subsidiary of SUEI and Investments, has a 43% equity ownership in a natural gas distribution company, along with other related operations, which currently serves 23,000 customers in Piedras Negras, Mexico, across the border from Southern Union Gas' Eagle Pass, Texas service area. Norteno owns and operates interstate pipelines that serve the gas distribution properties of Southern Union Gas and the Public Service Company of New Mexico. Norteno also transports gas through its interstate network to the country of Mexico for Pemex Gas y Petroquimica Basica. The Company plans to re-deploy substantially all the sales proceeds towards its pending acquisition of CMS Panhandle. The following table summarizes the major classes of the Texas Operations' assets and liabilities that have been segregated and reported as "held for sale" in the Company's consolidated balance sheet:
December 31, June 30, ASSETS: 2002 2001 2002 --------- --------- --------- Property, plant and equipment: Utility plant, at cost ................................ $ 516,203 $ 490,421 $ 504,015 Accumulated depreciation and amortization ............. (221,573) (209,203) (217,425) --------- --------- --------- Net property, plant and equipment .................. 294,630 281,218 286,590 Current assets ............................................ 73,568 84,908 29,677 Goodwill, net ............................................. 70,469 70,469 70,469 Deferred charges and other assets ......................... 8,184 10,757 8,710 --------- --------- --------- Total assets held for sale ...................... $ 446,851 $ 447,352 $ 395,446 ========= ========= ========= LIABILITIES: Current liabilities ....................................... $ 61,277 $ 50,172 $ 43,874 Deferred credits and other liabilities .................... 18,940 18,684 22,046 --------- --------- --------- Total liabilities related to assets held for sale $ 80,217 $ 68,856 $ 65,920 ========= ========= =========
The following table summarizes the Texas Operations' results of operations that have been segregated and reported as "discontinued operations" in the Company's consolidated statement of operations:
Three Months Ended Six Months Ended Twelve Months Ended December 31, December 31, December 31, 2002 2001 2002 2001 2002 2001 Operating revenues .......................... $ 96,801 $ 90,010 $144,490 $143,400 $311,490 $408,968 ======== ======== ======== ======== ======== ======== Net operating margin (a) .................... $ 29,860 $ 31,954 $ 51,480 $ 50,859 $106,350 $107,403 ======== ======== ======== ======== ======== ======== Net earnings from discontinued operations (b) $ 10,900 $ 9,932 $ 13,591 $ 10,110 $ 25,120 $ 20,182 ======== ======== ======== ======== ======== ========
- ------------------------------------- (a) Net operating margin consists of operating revenues less gas purchase costs and revenue-related taxes. (b) Net earnings from discontinued operations do not include any allocation of interest expense or other corporate costs, in accordance with generally accepted accounting principles. All outstanding debt of Southern Union Company and subsidiaries is maintained at the corporate level, and no debt was assumed by ONEOK, Inc. in the sale of the Texas Operations. DIVESTITURES In April 2002, PG Energy Services Inc. ("Energy Services"), a wholly-owned subsidiary of Southern Union, sold its propane operations for $2,300,000, resulting in a pre-tax gain of $1,200,000. In December 2001, Southern Transmission Company, a wholly-owned 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 (collectively, the Florida Operations), for $10,000,000, resulting in a pre-tax loss of $1,500,000. In October 2001, Morris Merchants, a wholly-owned subsidiary of Southern Union which served as a manufacturers' representative agency for franchised plumbing and heating contract supplies throughout New England, was sold for $1,586,000. In September 2001, Valley Propane, a wholly-owned subsidiary of the Company which sold liquid propane to residential, commercial and industrial customers, was sold for $5,301,000. In August 2001, ProvEnergy Oil, a wholly-owned subsidiary of Southern Union which operated a fuel oil distribution business through its subsidiary, ProvEnergy Fuels, Inc. for residential and commercial customers, was sold for $15,776,000. No financial gain or loss was recognized on any of these sales transactions. In July 2001, Energy Services sold its commercial and industrial natural gas marketing contracts for $4,972,000, resulting in a pre-tax gain of $4,653,000. In June 2001, Keystone Pipeline Services, Inc., a wholly-owned subsidiary of Energy Services which engaged in the construction, maintenance, and rehabilitation of natural gas distribution pipelines, was sold for $3,300,000, resulting in a pre-tax gain of $707,000. EARNINGS PER SHARE The following table summarizes the Company's basic and diluted earnings per share calculations for the three-, six- and twelve-month periods ending December 31:
Three Months Ended Six Months Ended Twelve Months Ended December 31, December 31, December 31, ---------------------- ---------------------- ---------------------- 2002 2001 2002 2001 2002 2001 ---------- ----------- ---------- ---------- ---------- --------- Net earnings (loss) from continuing operations . $ 18,519 $ 9,818 $ 9,333 $ (20,763) $ 28,081 $ 21,106 Net earnings from discontinued operations....... 10,900 9,932 13,591 10,110 25,120 20,182 ---------- ----------- ---------- ----------- ----------- ---------- Net earnings (loss) available for common stock.. $ 29,419 $ 19,750 $ 22,924 $ (10,653) $ 53,201 $ 41,288 ========== =========== ========== =========== =========== ========== Weighted average shares outstanding - basic..... 54,206,735 53,323,421 54,010,349 54,187,335 53,797,778 54,622,089 =========== =========== ========== =========== =========== ========== Weighted average shares outstanding - diluted... 55,937,697 56,389,022 55,875,307 54,187,335 56,002,239 57,807,411 =========== =========== ========== =========== =========== ========== Basic earnings per share: Net earnings (loss) from continuing operations $ 0.34 $ 0.18 $ 0.17 $ (0.38) $ 0.52 $ 0.39 Net earnings from discontinued operations.... 0.20 0.19 0.25 0.18 0.47 0.37 ---------- ----------- ---------- ---------- ----------- ----------- Net earnings (loss) available for common stock $ 0.54 $ 0.37 $ 0.42 $ (0.20) $ 0.99 $ 0.76 =========== =========== ========== ========== =========== =========== Diluted earnings per share: Net earnings (loss) from continuing operations $ 0.33 $ 0.17 $ 0.17 $ (0.38) $ 0.50 $ 0.37 Net earnings from discontinued operations.... 0.20 0.18 0.24 0.18 0.45 0.34 ----------- ----------- --------- ---------- ----------- ----------- Net earnings (loss) available for common stock $ 0.53 $ 0.35 $ 0.41 $ (0.20) $ 0.95 $ 0.71 =========== =========== ========= ========== =========== ===========
Diluted earnings per share include average shares outstanding as well as common stock equivalents from stock options and warrants. Common stock equivalents were 519,777 and 1,807,455 for the three-month period ended December 31, 2002 and 2001, respectively; 678,689 and 1,978,504 for the six-month period ended December 31, 2002 and 2001, respectively; and 1,004,935 and 1,992,308 for the twelve-month period ended December 31, 2002 and 2001, respectively. Stock options to purchase 2,278,092, 2,278,092 and 1,658,070 shares of common stock were outstanding during the three-, six- and twelve-month periods ended December 31, 2002, respectively, but were not included in the computation of diluted earnings per share because the options' exercise price was greater than the average market price of the common shares during the respective period. There were no "antidilutive" options outstanding for the same periods in 2001. At December 31, 2002, 1,225,061 shares of common stock were held by various rabbi trusts for certain of the Company's benefit plans and 48,615 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. GOODWILL Effective July 1, 2001, the Company adopted Goodwill and Other Intangible Assets. In accordance with this Statement, the Company has ceased amortization of goodwill. Goodwill, which was previously 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. 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 $1,417,000 was recognized in depreciation and amortization from continuing operations and an impairment loss of $1,941,000 was recognized in discontinued operations 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 $7,872,000 was eliminated during the quarter ended December 31, 2001. As a result of the sale of the Texas Operations in January 2003, goodwill of $70,469,000 was classified as "held for sale" at December 31, 2002 and will be eliminated during the third quarter ended March 31, 2003. DEFERRED CHARGES AND CREDITS December 31, June 30, 2002 2002 -------- -------- Deferred Charges Pensions ........................... $ 52,288 $ 52,481 Income taxes ....................... 24,661 24,000 Unamortized debt expense ........... 33,831 33,897 Retirement costs other than pensions 31,412 33,032 Service Line Replacement Program ... 20,149 21,360 Environmental ...................... 14,365 16,646 Other .............................. 25,787 24,714 -------- -------- Total Deferred Charges .......... $202,493 $206,130 ======== ======== As of December 31, 2002 and June 30, 2002, the Company's deferred charges include regulatory assets in the aggregate amount of $79,771,000 and $91,116,000, respectively, of which $53,659,000 and $66,301,000, respectively, is being recovered through current rates. As of December 31, 2002 and June 30, 2002, the remaining recovery period associated with these assets ranges from 1 to 223 months and from 7 months to 230 months, respectively. None of these regulatory assets, which primarily relate to pensions, retirement costs other than pensions, income taxes, Year 2000 costs, Missouri Gas Energy's Service Line Replacement program and environmental remediation costs, are included in rate base. The Company records regulatory assets in accordance with the FASB standard, Accounting for the Effects of Certain Types of Regulation. December 31, June 30, 2002 2002 -------- -------- Deferred Credits Pensions ........................... $ 41,354 $ 45,642 Retirement costs other than pensions 32,527 37,669 Customer advances for construction . 11,737 11,119 Environmental ...................... 14,268 7,206 Investment tax credit .............. 5,742 6,082 Self-insurance ..................... 6,520 6,208 Other .............................. 33,311 29,917 -------- -------- Total Deferred Credits ........... $145,459 $143,843 ======== ======== The Company's deferred credits include regulatory liabilities in the aggregate amount of $14,078,000 and $6,389,000, respectively, at December 31, 2002, and June 30, 2002. These regulatory liabilities primarily relate to retirement benefits other than pensions, environmental insurance recoveries and income taxes. The Company records regulatory liabilities in accordance with the FASB standard, Accounting for the Effects of Certain Types of Regulation. INVESTMENT SECURITIES At December 31, 2002, the Company held securities of Capstone Turbine Corporation (Capstone). This investment is classified as "available for sale" under the FASB standard Accounting for Certain Investments in Debt and Equity Securities. As of December 31, 2002, the Company's investment in Capstone had a fair value of $630,000 and unrealized gains, net of tax, related to this investment were $257,000. 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. All other securities owned by the Company are accounted for under the cost method. The Company's other investments in securities consist of common and preferred stock in non-public companies whose value is not readily determinable. Various Southern Union executive management, Board of Directors and employees also have an equity ownership in certain of these investments. 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, including the availability and terms of any additional financing requirements; financial condition and prospects of the issuer's region and industry, customers and markets 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 On August 6, 2002, Southwest Gas Corporation ("Southwest") agreed to pay Southern Union $17,500,000 to settle the Company's claims of fraud and bad faith breach of contract related to Southern Union's attempts to purchase Southwest. The settlement resulted in a pre-tax gain and cash flow of $17,500,000 for the quarter ended September 30, 2002. During the quarter ended September 30, 2001, the Company settled three interest rate swaps that were not designated as hedges and did not meet the criteria for hedge accounting, 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. Cash Flow Hedges The Company is party to an interest rate swap created to manage exposure against volatility in interest payments on variable rate debt and which qualifies for hedge accounting. As of December 31, 2002, the derivative liability related to this designated cash flow hedge had a fair value of $321,000 and is classified under other current liabilities in the consolidated financial statements. For the six-month period ended December 31, 2002, the Company recorded net settlement payments of $316,000 on this swap through interest expense, and unrealized gains of $129,000, net of taxes, through accumulated other comprehensive income. Hedge ineffectiveness, which is recorded in interest expense, was immaterial. No component of the swaps' gain or loss was excluded from the assessment of hedge effectiveness. As of December 31, 2002, the Company expects to reclassify as interest expense $186,000 in derivative losses, net of taxes, from accumulated other comprehensive income as the settlement of swap payments occur over the next eleven months. The maximum length of time over which the Company is hedging its exposure to the payment of variable interest rates is 11 months. Trading and Non-Hedging Activities 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. For the six-month period ended December 31, 2002, the Company recorded $302,000 through other income relating to the expiration of contracts resulting from this trading activity. The majority of the remaining deferred liability of $1,415,000 at December 31, 2002 related to these derivative instruments will be recognized as income in the consolidated statement of operations over the next 30 months based on the related contracts. 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. Since May 17, 2000, the Subordinated Notes have been redeemable at the option of the Company, 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 December 31, 2002 and 2001, 4,000,000 shares of Preferred Securities were outstanding. DEBT AND CAPITAL LEASE December 31, June 30, 2002 2002 ---------- ---------- 7.60% Senior Notes, due 2024 ......................... $ 359,765 $ 362,515 8.25% Senior Notes, due 2029 ......................... 300,000 300,000 Term Note, due 2002 .................................. -- 350,000 Term Note, due 2005 .................................. 311,087 -- 5.62% to 10.25% First Mortgage Bonds, due 2003 to 2029 115,911 147,888 7.70% Debentures, due 2027 ........................... 6,756 6,776 Capital lease and other .............................. 14,927 23,234 ---------- ---------- Total debt and capital lease ......................... 1,108,446 1,190,413 Less current portion ............................. 67,190 108,203 ---------- ---------- Total long-term debt and capital lease ............... $1,041,256 $1,082,210 ========== ========== 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 December 31, 2002, the capital lease obligation outstanding was $14,396,000 with a fixed rate of 5.79%. Credit Facilities On June 10, 2002, the Company entered into an amended short-term credit facility in the amount of $150,000,000 (the "Short-Term Facility"), that matures on June 9, 2003. Also on June 10, 2002, the Company amended the terms and conditions of its $225,000,000 long-term credit facility (the "Long-Term Facility"), which expires on May 29, 2004. The Company has additional availability under uncommitted line of credit facilities (Uncommitted Facilities) with various banks. Borrowings under the facilities are available for Southern Union's working capital, letter of credit requirements and other general corporate purposes. The Short-Term Facility and the Long-Term Facility (together, the "Facilities") are subject to a commitment fee based on the rating of the Senior Notes. As of December 31, 2002, the commitment fees were an annualized 0.14% on the Facilities. The interest rate on borrowings on the Facilities is calculated based upon a formula using the LIBOR or prime interest rates. A balance of $290,000,000 was outstanding under the Facilities at December 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) all related acquisition costs. On July 16, 2002, the Company repaid the Term Note with the proceeds from the issuance of a $311,087,000 Term Note dated July 15, 2002 (the "2002 Term Note") and borrowings under the Company's lines of credit. The 2002 Term Note is held by a syndicate of banks and requires semi-annual principal repayments on February 15th and August 15th of each year, with payments of $25,000,000 each being due February 15, 2003, August 15, 2003, February 15, 2004, and August 15, 2004 and payments of $35,000,000 each being due February 15, 2005 and August 15, 2005. The remaining principal amount of $141,087,000 is due August 26, 2005. The 2002 Term Note carries a variable interest rate that is tied to either the LIBOR or prime rates at the Company's option. No additional draws can be made on the Term Note. UTILITY REGULATION AND RATES Missouri On July 5, 2001, the Missouri Public Service Commission (MPSC) issued an order approving a unanimous settlement of Missouri Gas Energy's rate request. The settlement provides for an annual $9,892,000 base rate increase, as well as $1,081,000 in added revenue from new and revised service charges. The majority of the rate increase will be recovered through increased monthly fixed charges to gas sales service customers. New rates became effective August 6, 2001, two months before the statutory deadline for resolving the case. The approved settlement resulted in the dismissal of all pending judicial reviews of prior rate cases. The settlement also provides for the development of a two-year experimental low-income program that will help certain customers in the Joplin area pay their natural gas bills. Rhode Island On May 24, 2002, the Rhode Island Public Utilities Commission (RIPUC) approved a settlement agreement between the New England Gas Company and the RIPUC. The settlement agreement resulted in a $3,900,000 decrease in base revenues effective July 1, 2002 for New England Gas Company's Rhode Island operations, a unified rate structure ("One State; One Rate") and an integration/merger savings mechanism. The settlement agreement also allows New England Gas Company to retain $2,049,000 of merger savings and to share incremental earnings with customers when the division's Rhode Island operations return on equity exceeds 11.25%. Included in the settlement agreement was a conversion to therm billing and the approval of a reconciling Distribution Adjustment Clause (DAC). The DAC allows New England Gas Company to continue its low income assistance and weatherization programs, to recover environmental response costs over a 10-year period, puts into place a new weather normalization clause and allows for the sharing of nonfirm margins (non-firm margin is margin earned from interruptible customers with the ability to switch to alternative fuels). The weather normalization clause is designed to mitigate the impact of weather volatility on customer billings, which will assist customers in paying bills and stabilize the revenue stream. New England Gas Company will defer the margin impact of weather that is greater than 2% colder-than-normal and will recover the margin impact of weather that is greater than 2% warmer-than-normal. The non-firm margin incentive mechanism allows New England Gas Company to retain 25% of all non-firm margins earned in excess of $1,600,000. 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 Texas, Arizona and New Mexico, and present service territories in 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 ("MGP") 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"). 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, and MGE subsequently performed environmental assessments of Stations A and B and submitted the results of these assessments to MDNR. On September 6, 2002, MGE submitted a work plan for the remediation of Station A to MDNR. Following MDNR's approval of the Station A work plan, the Company selected a qualified remediation contractor in a competitive bidding process. The Company anticipates beginning remediation of Station A in the first calendar quarter of 2003. In August 2001, MGE received a demand from the Port Authority for MGE to assume responsibility for remediation of soil and groundwater at property owned by the Port Authority adjacent to MGE's Stations A and B. The Port Authority intends to develop its property adjacent to MGE as a commercial and residential area (the "Riverfront Redevelopment Site"), and seeks to have MGE and other parties who may be responsible remediate contamination on the Port Authority property allegedly resulting from the historic manufactured gas plant operations. Honeywell International Inc. has also been identified as a potentially responsible party, as the alleged successor to a tar manufacturing operation formerly located on a portion of the Port Authority property known as the Riverfront Development. MGE and other parties owning property in the area have performed assessments in 2001 and early 2002 of their own and of the alleged contaminated portions of the Port Authority property. In a letter dated July 24, 2002, the Port Authority demanded that the Company assume full financial responsibility for the design and implementation of a remedial action plan on the Riverfront Redevelopment Site allowing the Port Authority to obtain an "unrestricted" clearance for redevelopment of the site. The Port Authority provided MGE with several proposed remedial options and preliminary cost estimates for those options. MGE currently disputes the Port Authority's estimates and proposals, and believes that the cost of remediation of the Port Authority property could be significantly lower, pending further investigation, analysis and determination of appropriate soil and groundwater remedial standards. Accordingly, the Company sent the Port Authority a letter dated August 27, 2002, containing an alternative proposal for the remediation of a portion of the Port Authority's property. MGE's own estimate of the cost to perform its alternative proposal and obtain a "no further action" letter from MDNR for the portion of the Riverfront Redevelopment Site for which it is potentially responsible is less than $2 million. MGE continues to work with the Port Authority and MDNR toward resolution of the appropriate scope of investigation and remediation at the Riverfront Redevelopment Site. Providence, Rhode Island Sites During 1995, Providence Gas began an environmental evaluation at its primary gas distribution facility located at 642 Allens Avenue in Providence, Rhode Island. Environmental studies and a subsequent remediation work plan were completed at an approximate cost of $4.5 million. Providence Gas also began a soil remediation project on a portion of the site in July 1999. As of June 30, 2001, approximately $8.9 million had been expended on soil remediation under the remediation work plan. Based on the results of the environmental investigation and the site information learned during the performance of work under the remediation work plan, on January 15, 2002, the Company requested and subsequently received authorization from RIDEM to make certain specific modifications to the 1999 Remedial Action Work Plan. On April 17, 2002, RIDEM issued a Temporary Remedial Action Permit for Phase 1 remediation at the site. A contractor was selected by the Company in a competitive bidding process. Work on Phase 1 of the site remediation was initiated on April 17, 2002, and was completed on October 10, 2002. The approximate cost of the environmental work conducted since April 17, 2002 is $4 million. Remediation of the remaining 37.5 acres of the site (known as the "Phase 2" remediation project) is not scheduled at this time. 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 operator of the property at that time, Cargill, Inc., 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 September 30, 2002 were approximately $300,000. Until RIDEM provides its final response to the investigation, and the Company knows it's ultimate responsibility respective to other potentially responsible parties with respect to the site, the Company cannot offer any conclusions as to its ultimate financial responsibility with respect to the site. 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 a settlement 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. 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. Pennsylvania Sites PG Energy recently received inquiries from the Pennsylvania Department of Environmental Protection ("PADEP") pertaining to three former manufactured gas plant sites. PG Energy has participated in another Pennsylvania Utility's assessment of one site for the purpose of evaluating any environmental threat from the former gas manufacture operations at this site. In addition, PG Energy has met with PADEP representatives concerning two other sites and is currently performing environmental assessment work at one of the sites. To the extent that potential costs associated with former MGPs are quantified, the Company expects to provide any appropriate accruals and seek recovery for such remediation costs through all appropriate means, including in rates charged to customers, insurance and regulatory relief. At the time of the closing of the acquisition of the Company's Missouri service territories, the Company entered into an Environmental Liability Agreement that provides that Western Resources retains financial responsibility for certain liabilities under environmental laws that may exist or arise with respect to Missouri Gas Energy. In addition, the New England Division has reached agreement with its Rhode Island rate regulators on a regulatory plan that creates a mechanism for the recovery of environmental costs over a 10-year period. This plan, effective July 1, 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. In certain of the Company's jurisdictions the Company is allowed to recover environmental remediation expenditures through rates. Although significant charges to earnings could be required prior to rate recovery for jurisdictions that do not have rate recovery mechanisms, 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. 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 to approximately $8,500,000. 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; these issues were settled in December 2002 for a non-material amount. In August 2002, the Supreme Court of Texas granted the Company's petition for review. Oral arguments were made to the Court on November 20, 2002. Effective January 1, 2003, all potential remaining liability for this case was assigned to ONEOK as part of the sale of the Company's Texas Operations to ONEOK. On May 31, 2002, the staff of the MPSC recommended that the Commission disallow approximately $15 million in gas costs incurred during the period July 1, 2000 through June 30, 2001. Missouri Gas Energy filed its response in opposition to the Staff's recommendation on July 11, 2002, vigorously disputing the Commission staff's assertions. Missouri Gas Energy intends to vigorously defend itself in this proceeding. On November 4, 2002, the Commission adopted a procedural schedule setting the matter for hearing in May of 2003. On November 27, 2001, August 1, 2000 and August 12, 1999, the staff of the MPSC recommended that the Commission disallow approximately $5.9 million, $5.9 million and $4.3 million, respectively, in gas costs incurred during the period July 1, 1999 through June 30, 2000, July 1, 1998 through June 30, 1999, and July 1, 1997 through June 30, 1998, respectively. The basis of these proposed disallowances appears to be the same as was rejected by the Commission through an order dated March 12, 2002, applicable to the period July 1, 1996 through June 30, 1997. MGE intends to vigorously defend itself in these proceedings. On November 4, 2002, the Commission adopted a procedural schedule calling for a hearing in this matter some time after May of 2003. Southwest Gas Litigation Several actions were commenced by persons involved in competing efforts to acquire Southwest Gas Corporation (Southwest) during 1999. All of these actions eventually were transferred to the District of Arizona (the Court), consolidated and lodged with Judge Roslyn Silver. As a result of summary judgments granted, there are no claims remaining against Southern Union. Southern Union's claims against Southwest were settled on August 6, 2002, by Southwest's payment to Southern Union of $17,500,000. Southern Union's claims against ONEOK, Inc. and the individual defendants associated with ONEOK were settled on January 3, 2003, following the closing of Southern Union's sale of the Texas assets to ONEOK, by ONEOK's payment to Southern Union of $5,000,000. Southern Union's claims against Jack Rose, former aide to Arizona Corporation Commissioner James Irvin, were settled by Mr. Rose's payment to Southern Union of $75,000, which the Company donated to charity. The trial of Southern Union's claims against the sole-remaining defendant, Arizona Corporation Commissioner James Irvin, was concluded on December 18, 2002, with a jury award to Southern Union of nearly $400,000 in actual damages and $60,000,000 in punitive damages against Commissioner Irvin. The Court is currently in the process of considering Commissioner Irvin's post-trial motions for relief. With the exception of ongoing legal fees associated with the aforementioned litigation, the Company believes that the results of the above-noted Southwest litigation and any related appeals will not have a materially adverse effect on the Company's financial condition, results of operations or cash flows. Other Southern Union and its subsidiaries are parties to other legal proceedings that management considers to be normal actions to which an enterprise of its size and nature might be subject, Management does not consider these actions to be material to Southern Union's overall business or financial condition, results of operations or cash flows. SOUTHERN UNION COMPANY AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Overview Currently, the Company's core business is the distribution of natural gas as a public utility through its Missouri Gas Energy, PG Energy, and New England Gas Company divisions. Upon the completion of the acquisition of CMS Panhandle Companies, Southern Union will own approximately a 78% interest in various natural gas transportation pipelines and liquefied natural gas (LNG) facilities. This acquisition will be funded in part by proceeds received from the January 2003 sale of Southern Union Gas and related assets as discussed below. 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. Discontinued Operations and Assets Held For Sale Effective January 1, 2003, the Company completed the sale of its Southern Union Gas natural gas operating division and related assets to ONEOK, Inc. for approximately $420,000,000 in cash, resulting in a pre-tax gain of approximately $75,000,000 that will be recorded during the third quarter ending March 31, 2003. In addition to Southern Union Gas, the sale involved the disposition of Mercado Gas Services, Inc. (Mercado), SUPro Energy Company (SUPro), Southern Transmission Company (STC), Southern Union Energy International, Inc. (SUEI), Southern Union International Investments, Inc. (Investments) and Norteno Pipeline Company (Norteno) (collectively, the Texas Operations). Southern Union Gas distributes natural gas as a public utility to approximately 535,000 customers throughout Texas, including the cities of Austin, El Paso, Brownsville, Galveston and Port Arthur. Mercado markets natural gas to commercial and industrial customers. SUPro provides propane gas services to approximately 4,000 customers located principally in Austin, El Paso and Alpine, Texas as well as Las Cruces, New Mexico and surrounding communities. STC owns and operates 118.8 miles of intrastate pipeline that serves commercial, industrial and utility customers in central, south and coastal Texas. SUEI and Investments participate in energy-related projects internationally. Energia Estrella del Sur, S. A. de C. V., a wholly-owned Mexican subsidiary of SUEI and Investments, has a 43% equity ownership in a natural gas distribution company, along with other related operations, which currently serves 23,000 customers in Piedras Negras, Mexico, across the border from Southern Union Gas' Eagle Pass, Texas service area. Norteno owns and operates interstate pipelines that serve the gas distribution properties of Southern Union Gas and the Public Service Company of New Mexico. Norteno also transports gas through its interstate network to the country of Mexico for Pemex Gas y Petroquimica Basica. The Company plans to re-deploy substantially all the sales proceeds towards its pending acquisition of CMS Panhandle. The Company anticipates that the proceeds from the sale will qualify as part of a like-kind exchange of property covered by Section 1031 of the Internal Revenue Code thereby enabling the Company to achieve certain tax savings. Divestitures In April 2002, PG Energy Services Inc. ("Energy Services"), a wholly-owned subsidiary of Southern Union, sold its propane operations for $2,300,000, resulting in a pre-tax gain of $1,200,000. In December 2001, Southern Transmission Company, a wholly-owned 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 (collectively, the Florida Operations), for $10,000,000, resulting in a pre-tax loss of $1,500,000. In October 2001, Morris Merchants, a wholly-owned subsidiary of Southern Union which served as a manufacturers' representative agency for franchised plumbing and heating contract supplies throughout New England, was sold for $1,586,000. In September 2001, Valley Propane, a wholly-owned subsidiary of the Company which sold liquid propane to residential, commercial and industrial customers, was sold for $5,301,000. In August 2001, ProvEnergy Oil, a wholly-owned subsidiary of Southern Union which operated a fuel oil distribution business through its subsidiary, ProvEnergy Fuels, Inc. for residential and commercial customers, was sold for $15,776,000. No financial gain or loss was recognized on any of these sales transactions. In July 2001, Energy Services sold its commercial and industrial natural gas marketing contracts for $4,972,000, resulting in a pre-tax gain of $4,653,000. In June 2001, Keystone Pipeline Services, Inc., a wholly-owned subsidiary of Energy Services which engaged in the construction, maintenance, and rehabilitation of natural gas distribution pipelines, was sold for $3,300,000, resulting in a pre-tax gain of $707,000. As a result of the divestiture of non-core business assets and the seasonal nature of gas utility operations, the results of operations for the three-, six- and twelve-month periods ended December 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 December 31, 2002 and 2001 The Company recorded net earnings available for common stock of $29,419,000 for the three-month period ended December 31, 2002 compared with net earnings of $19,750,000 for the same period in 2001. Earnings per diluted share were $.53 in 2002 compared with $.35 in 2001. Continuing Operations Net earnings from continuing operations were $18,519,000 for the three-month period ended December 31, 2002 compared with $9,818,000 for the same period in 2001. Earnings from continuing operations per diluted share were $.33 in 2002 compared with $.17 in 2001. Operating revenues were $346,104,000 for the three-month period ended December 31, 2002, compared with $286,431,000 in 2001. Gas purchase and other energy costs for the three-month period ended December 31, 2002 were $215,505,000, compared with $172,818,000 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 increase in both operating revenues and gas purchase costs between periods was primarily due to a 30% increase in gas sales volumes to 38,549 MMcf in 2002 from 29,684 MMcf in 2001, which was partially offset by a 4% decrease in the average cost of gas from $5.82 per Mcf in 2001 to $5.59 per Mcf in 2002. The increase in gas sales volumes is primarily due to near-normal weather in 2002 as compared with warmer-than-normal weather in 2001, in all of the Company's service territories. The decrease in the average cost of gas was due to the ability to inject lower cost gas into storage during the summer of 2002 thereby lowering the overall cost of gas used during the winter. Current average spot market prices throughout the Company's distribution system have increased from 2001 to 2002. Weather in Missouri Gas Energy's service territories was 102% of a 30-year measure for the three-month period ended December 31, 2002, compared with 77% in 2001. PG Energy's service territories experienced weather that was 106% of a 30-year measure in 2002, compared with 82% in 2001. Weather for the New England Gas Company service territories was 103% of a 30-year measure for the three-month period ended December 31, 2002, compared with 86% in 2001. Operating margin (operating revenues less gas purchase and other energy costs and revenue-related taxes) increased $14,045,000 for the three-month period ended December 31, 2002 compared with the same period in 2001. Operating margin increased principally as a result of colder-than-normal weather in 2002 as compared with warmer-than-normal weather in 2001, previously discussed. Operating expenses, which include operating, maintenance and general expenses, depreciation and amortization, and taxes other than on income and revenues, were $62,529,000 for the three-month period ended December 31, 2002, a decrease of $680,000, compared with $63,209,000 in 2001. Operating expenses for the quarter ended December 31, 2002 continue to be impacted by the Company's Cash Flow Improvement Plan announced in July 2001 and discussed below. This Plan was designed to improve pre-tax cash flow and control operating costs. Savings from this Plan were partially offset by increased pension and other postretirement benefits costs, primarily due to volatility in the stock markets. Interest expense was $20,742,000 for the three-month period ended December 31, 2002, compared with $21,736,000 in 2001. Interest expense primarily decreased due to a $221,292,000 reduction in long-term debt principal since December 31, 2001 which was partially offset by a $75,050,000 increase in notes payable outstanding since December 31, 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. A portion of the Term Note was refinanced on July 16, 2002. See Debt and Capital Lease in the Notes to the Consolidated Financial Statements included herein. The average effective interest rate for the three-month period ending December 31, 2002 increased to 6.0% as compared to 5.7% in 2001 primarily due to the reduction in lower-cost bank debt as a percentage of total debt. Other expense for the three-month period ended December 31, 2002 was $2,712,000 compared with other expense of $836,000 in 2001. Other expense for the three-month period ended December 31, 2002 includes $2,838,000 of legal costs related to the Southwest litigation and $1,298,000 of selling costs related to the Texas Operations' disposition. These items were partially offset by $669,000 of income generated from the sale and/or rental of gas-fired equipment and appliances by various operating subsidiaries and $79,000 of interest and dividend income. Other expense for the three-month period ended December 31, 2001 includes $3,300,000 of Southwest litigation costs and a $1,500,000 loss on the sale of South Florida Natural Gas, a natural gas division of Southern Union, and Atlantic Gas Corporation, a Florida propane subsidiary of the Company (collectively, the Florida Operations). These items were partially offset by the recognition of $1,976,000 of previously recorded deferred income related to financial derivative energy trading activity of a former subsidiary, $666,000 of income generated from the sale and/or rental of gas-fired equipment and appliances, a $561,000 gain on the sale of other assets and $284,000 of interest and dividend income. The consolidated federal and state effective income tax rate was 38% for the three-month periods ended December 31, 2002 and 2001. Discontinued Operations Net earnings from discontinued operations were $10,900,000 for the three-month period ended December 31, 2002 compared with $9,932,000 for the same period in 2001. Earnings from discontinued operations per diluted share were $.20 in 2002 compared with $.18 in 2001. The increase in earnings from discontinued operations was impacted by a $3,579,000 pre-tax reduction in depreciation expense which was partially offset by a $2,094,000 decrease in operating margin. In accordance with the FASB standard, Accounting for the Impairment or Disposal of Long-Lived Assets, once the assets of the Texas Operations were deemed to be "held for sale" in October 2002, depreciation of such asset ceased. Operating margin decreased due to a reduction in gas sales volumes from 14,507 MMcf in 2001 to 14,193 MMcf in 2002, as well as certain lost and unaccounted for cost of gas adjustments made during the three-month period ending December 31, 2002. Six Months Ended December 31, 2002 and 2001 The Company recorded net earnings available for common stock of $22,924,000 for the six-month period ended December 31, 2002 compared with a net loss attributable to common stock of $10,653,000 in 2001. Net earnings per diluted share were $.41 in 2002 compared with a net loss per common share, based on weighted average shares outstanding during the period, of $.20 in 2001. Continuing Operations Net earnings from continuing operations were $9,333,000 for the six-month period ended December 31, 2002 compared with a loss of $20,763,000 for the same period in 2001. Earnings from continuing operations per diluted share were $.17 in 2002 compared with a loss per common share of $.38 in 2001. Operating revenues were $445,814,000 for the six-month period ended December 31, 2002, compared with $407,010,000 in 2001. Gas purchase and other energy costs for the six-month period ended December 31, 2002 were $257,565,000, compared with $233,447,000 in 2001. The increase in both operating revenues and gas purchase costs between periods was primarily due to a 22% increase in sales volume from 37,886 MMcf in 2001 to 46,039 MMcf in 2002, which was partially offset by an 8% decrease in the average cost of gas from $6.09 per Mcf in 2001 to $5.59 per Mcf in 2002. The increase in gas sales volumes is primarily due to colder weather in 2002 as compared with 2001 in all of the Company's service territories. The decrease in the average cost of gas was due to the ability to inject lower cost gas into storage during the summer of 2002 thereby lowering the overall cost of gas used during the winter. Current average spot market prices throughout the Company's distribution system have increased from 2001 to 2002. Weather in Missouri Gas Energy's service territories was 99% of a 30-year measure for the six-month period ended December 31, 2002, compared with 77% in 2001. PG Energy's service territories experienced weather that was 103% of a 30-year measure in 2002, compared with 85% in 2001. Weather for the New England Gas Company service territories was 99% of a 30-year measure for the six-month period ended December 31, 2002, compared with 87% in 2001. Operating margin increased $12,464,000 for the six-month period ended December 31, 2002 compared with the same period in 2001. Operating margin increased principally as a result of near-normal weather in 2002 as compared with warmer-than-normal weather in 2001, previously discussed. Operating expenses, excluding business restructuring charges, were $124,782,000 for the six-month period ended December 31, 2002, a decrease of $3,353,000, compared with operating expenses of $128,135,000 in 2001. In connection with the Company's Cash Flow Improvement Plan announced in July 2001 and discussed below, the Company offered Early Retirement Programs ("ERPs") in certain of its operating divisions and a limited reduction in force ("RIF") within its corporate offices and began the divesture of certain non-core assets which contributed savings of $2,712,000 in operating expenses during the six-month period ended December 31, 2002, as compared with 2001. The Company also realized an increase in environmental insurance recoveries of $1,768,000 in 2002 as compared with 2001. Additionally, the Company recognized a goodwill impairment loss of $1,417,000 in depreciation and amortization expense in 2001, based on prices of comparable businesses for various non-core properties. These items were partially offset by increased pension and other postretirement benefit costs, primarily due to volatility in the stock markets, during the six-month period ended December 31, 2002. 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 ERPs in certain of its operating divisions and (ii) a limited RIF within its corporate offices. ERPs, providing for increased benefits for those electing retirement, were offered to approximately 400 eligible employees across the Company's operating divisions, with approximately 60% of such eligible employees accepting. The RIF was limited solely to certain corporate employees in the Company's Austin and Kansas City offices where forty-eight employees were offered severance packages. In connection with the corporate reorganization and restructuring efforts, the Company recorded a one-time charge of $30,553,000 during the quarter ended September 30, 2001. This charge was reduced by $1,394,000 during the quarter ended June 30, 2002, as a result of the Company's ability to negotiate more favorable terms on certain of its restructuring liabilities. The charge included: $16.4 million of voluntary and accepted ERP's, primarily through enhanced benefit plan obligations, and other employee benefit plan obligations; $6.8 million of RIF within the corporate offices and related employee separation benefits; and $6.0 million connected with various business realignment and restructuring initiatives. All restructuring actions were completed as of June 30, 2002. Interest expense was $41,743,000 for the six-month period ended December 31, 2002 compared with $48,721,000 in 2001. Interest expense decreased primarily due to the reduction in the principal on the previously mentioned Term Note. See Debt and Capital Lease in the Notes to the Consolidated Financial Statements included herein. Other income for the six-month period ended December 31, 2002 was $13,726,000 compared with $22,640,000 in 2001. Other income for the six-month period ended December 31, 2002 includes a gain of $17,500,000 on the settlement of the Southwest litigation, income of $1,242,000 generated from the sale and/or rental of gas-fired equipment and appliances and $345,000 of interest and dividend income. These items were partially offset by $4,969,000 of legal costs related to the Southwest litigation and $1,298,000 of selling costs related to the Texas Operations' disposition. Other income for the six-month period ended December 31, 2001 includes gains of $17,166,000 generated through the settlement of several interest rate swaps, a gain of $4,653,000 realized through the sale of marketing contracts held by PG Energy Services Inc., the recognition of $2,333,000 in previously recorded deferred income related to financial derivative energy trading activity of a former subsidiary, $1,402,000 of income generated from the sale and/or rental of gas-fired equipment and appliances, $884,000 of interest and dividend income and a $561,000 gain on the sale of other assets. These items were partially offset by $4,906,000 of Southwest litigation costs and a $1,500,000 loss on the sale of the Florida Operations. The consolidated federal and state effective income tax rate was 38% and 30% for the six-month period ended December 31, 2002 and 2001, respectively. The increase in the effective tax rate is a result of the level of pre-tax earnings. Discontinued Operations Net earnings from discontinued operations were $13,591,000 for the six-month period ended December 31, 2002 compared with $10,110,000 for the same period in 2001. Earnings from discontinued operations per diluted share were $.24 in 2002 compared with $.18 in 2001. The increase in earnings from discontinued operations was impacted by a $3,579,000 pre-tax reduction in depreciation expense, previously discussed. Additionally, the Texas Operations recorded a one-time charge of $2,153,000 during the quarter ended September 30, 2001 in connection with the previously discussed reorganization and restructuring efforts under the Cash Flow Improvement Plan. The Texas Operations also recognized a goodwill impairment loss of $1,941,000 in 2001, based on prices of comparable businesses for certain non-core properties. Twelve Months Ended December 31, 2002 and 2001 The Company recorded net earnings available for common stock of $53,201,000 for the twelve-month period ended December 31, 2002 compared with net earnings of $41,288,000 in 2001. Earnings per diluted share were $.95 in 2002 compared with $.71 in 2001. Continuing Operations Net earnings from continuing operations were $28,081,000 for the twelve-month period ended December 31, 2002 compared with $21,106,000 for the same period in 2001. Earnings from continuing operations per diluted share were $.50 in 2002 compared with $.37 in 2001. Operating revenues were $1,018,954,000 for the twelve-month period ended December 31, 2002, compared with $1,324,447,000 in 2001. Gas purchase and other energy costs for the twelve-month period ended December 31, 2002 were $596,732,000, compared with $891,517,000 in 2001. The decrease in both operating revenues and gas purchase costs between periods was primarily due to a 26% decrease in the average cost of gas from $7.37 per Mcf in 2001 to $5.43 per Mcf in 2002. The decrease in the average cost of gas is due to decreases in average spot market prices throughout the Company's distribution system as a result of seasonal impacts on demands for natural gas as well as the current competitive pricing occurring within the entire energy industry. Sales volume slightly decreased from 109,950 MMcf in 2001 to 109,573 MMcf in 2002, as weather was fairly consistent in both twelve-month periods. Weather in Missouri Gas Energy's service territories was 93% of a 30-year measure for the twelve-month period ended December 31, 2002, compared with 91% in 2001. PG Energy's service territories experienced weather that was 93% of a 30-year measure in both 2002 and 2001. Weather for the New England Gas Company service territories was 93% of a 30-year measure for the twelve-month period ended December 31, 2002, compared with 96% in 2001. Operating margin decreased $3,740,000 for the twelve-month period ended December 31, 2002 compared with the same period in 2001. The decrease in operating margin is primarily due to a net margin decrease of $9,245,000 in operating margin between periods due to the sale of the Florida Operations and various non-core subsidiaries in New England. 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, excluding business restructuring charges, which were previously discussed, were $251,785,000 for the twelve-month period ended December 31, 2002, a decrease of $40,077,000, compared with operating expenses of $291,862,000 in 2001. Operating expenses for the twelve-month period ended December 31, 2002 were positively impacted by a reduction in bad debt expense of $14,942,000 due to a decrease in delinquent customer receivables as a result of lower gas prices, realized savings of approximately $9,500,000 from the Cash Flow Improvement Plan, reduced operating expenses of $6,914,000 from the sale of non-core assets, an increase in environmental insurance recoveries of $2,343,000 in 2002, the recognition of the previously discussed goodwill impairment of $1,417,000 for the twelve-month period ended December 31, 2001, and the elimination of goodwill amortization resulting from the Company's adoption of Goodwill and Other Intangible Assets effective July 1, 2001. In accordance with this Statement, the Company has ceased the amortization of goodwill, which generated $8,643,000 of expense during the twelve-months ended December 31, 2001, and currently accounts for goodwill on an impairment-only basis. See Goodwill in the Notes to the Consolidated Financial Statements included herein. Additionally, taxes other than on income, which consists of property, payroll and state franchise taxes, decreased by $3,602,000 for the twelve-month period ended December 31, 2002, primarily due to a reduction in employees resulting from the Company's reorganization and restructuring initiatives as well as from the sale of non-core subsidiaries and assets. These items were partially offset by increased pension and other postretirement benefits costs, previously discussed. Interest expense was $84,015,000 for the twelve-month period ended December 31, 2002 compared with $105,302,000 in 2001. Interest expense decreased primarily due to the reduction in the principal on the previously mentioned Term Note. See Debt and Capital Lease in the Notes to the Consolidated Financial Statements included herein. Other income for the twelve-month period ended December 31, 2002 was $2,999,000 compared to $84,068,000 in 2001. Other income for the twelve-month period ended December 31, 2002 includes a gain of $17,500,000 on the settlement of the Southwest litigation, the recognition of $4,173,000 in previously recorded deferred income related to financial derivative energy trading activity of a former subsidiary and income of $2,195,000 generated from the sale and/or rental of gas-fired equipment and appliances. These items were partially offset by a non-cash charge of $10,380,000 to reserve for the impairment of the Company's investment in a technology company, $9,162,000 of legal costs related to the Southwest litigation and $1,298,000 of selling costs related to the Texas Operations' disposition. Other income for the twelve-month period ended December 31, 2001, includes realized gains on the sale of investment securities of $65,713,000, gains of $17,166,000 generated through the settlement of several interest rate swaps, interest and dividend income of $4,907,000, a gain of $4,653,000 realized through the sale of marketing contracts held by PG Energy Services Inc., income of $2,625,000 generated from the sale and/or rental of gas-fired equipment and appliances and the recognition of $2,333,000 of previously recorded deferred income related to financial derivative energy trading activity of a former subsidiary. These items were partially offset by $12,863,000 of Southwest litigation costs and a $1,500,000 loss on the sale of the Florida Operations. The consolidated federal and state effective income tax rate was 39% and 43% for the six-month period ended December 31, 2002 and 2001, respectively. The decline in the effective tax rate is a result of non-tax deductible amortization and write-off of goodwill, along with the level of pre-tax earnings. Discontinued Operations Net earnings from discontinued operations were $25,120,000 for the twelve-month period ended December 31, 2002 compared with $20,182,000 for the same period in 2001. Earnings from discontinued operations per diluted share were $.45 in 2002 compared with $.34 in 2001. The increase in earnings from discontinued operations was impacted by a $3,579,000 pre-tax reduction in depreciation expense, previously discussed. Additionally, the Texas Operations were also impacted by the previously discussed one-time charge of $2,153,000 during the quarter ended September 30, 2001 in connection with the reorganization and restructuring efforts under the Cash Flow Improvement Plan, a goodwill impairment loss of $1,941,000 in 2001 and the elimination of $1,237,000 in goodwill amortization resulting from the Company's adoption of Goodwill and Other Intangible Assets effective July 1, 2001. These items were partially offset by the recognition of $3,359,000 of income related to financial derivative energy trading activity of a former subsidiary for the twelve-month period ended December 31, 2001. The following table sets forth certain information regarding the Company's gas utility operations for the three- and twelve-month periods ended December 31, 2002 and 2001:
Three Months Twelve Months Ended December 31, Ended December 31, 2002 2001 2002 2001 --------- ----------- ---------- ------------ Average number of gas sales customers served: Residential ...................................... 838,892 836,542 838,950 836,617 Commercial ....................................... 100,279 94,304 97,830 95,084 Industrial and irrigation ........................ 778 3,973 2,415 4,044 Public authorities and other ..................... 521 351 446 351 ----------- ----------- ----------- ----------- Total average customers served .............. 940,470 935,170 939,641 936,096 =========== =========== =========== =========== Gas sales in millions of cubic feet (MMcf) Residential ...................................... 19,589 13,991 75,514 78,327 Commercial ....................................... 7,890 5,590 29,698 31,413 Industrial and irrigation ........................ 865 786 3,552 3,975 Public authorities and other ..................... 115 47 237 292 ----------- ----------- ----------- ----------- Gas sales billed ............................ 28,459 20,414 109,001 114,007 Net change in unbilled gas sales ................. 10,090 9,270 572 (4,057) ----------- ----------- ----------- ----------- Total gas sales ............................. 38,549 29,684 109,573 109,950 =========== =========== =========== =========== Gas sales revenues (thousands of dollars): Residential ...................................... $ 182,019 $ 155,046 $ 697,587 $ 866,642 Commercial ....................................... 65,283 53,773 243,014 321,535 Industrial and irrigation ........................ 5,787 7,086 26,329 36,259 Public authorities and other ..................... 657 425 1,732 2,155 ----------- ----------- ----------- ----------- Gas revenues billed ......................... 253,746 216,330 968,662 1,226,591 Net change in unbilled gas sales revenues ........ 77,813 57,986 106 (37,688) ----------- ----------- ----------- ----------- Total gas sales revenues .................... $ 331,559 $ 274,316 $ 968,768 $ 1,188,903 =========== =========== =========== =========== Gas sales revenue per thousand cubic feet (Mcf) billed: Residential ...................................... $ 9.29 $ 11.08 $ 9.24 $ 11.06 Commercial ....................................... 8.27 9.62 8.18 10.24 Industrial and irrigation ........................ 6.69 9.02 7.41 9.12 Public authorities and other ..................... 5.71 9.04 7.31 7.38 Weather: Degree days: Missouri Gas Energy service territories ..... 1,995 1,504 4,862 4,645 PG Energy service territories ............... 2,325 1,800 5,803 5,848 New England Gas Company service territories . 2,034 1,695 5,326 5,519 Percent of normal based on 30-year measure: Missouri Gas Energy service territories ..... 102% 77% 93% 91% PG Energy service territories ............... 106% 82% 93% 93% New England Gas Company service territories . 103% 86% 93% 96% Gas transported in millions of cubic feet (MMcf) ...... 18,236 17,505 65,683 64,399 Gas transportation revenues (thousands of dollars) .... $ 11,040 $ 10,208 $ 37,748 $ 34,875
The above information does not include the Company's Texas Operations, which were sold effective January 1, 2003 and are reported as discontinued operations in the consolidated statement of operations for all periods ended December 31, 2002 and 2001. 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. 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 June 10, 2002, the Company entered into an amended short-term credit facility in the amount of $150,000,000 (the "Short-Term Facility"), that matures on June 9, 2003. Also on June 10, 2002, the Company amended the terms and conditions of its $225,000,000 long-term credit facility (the "Long-Term Facility"), which expires on May 29, 2004. The Company has additional availability under uncommitted line of credit facilities (Uncommitted Facilities) with various banks. Borrowings under the facilities are available for Southern Union's working capital, letter of credit requirements and other general corporate purposes. The Short-Term Facility and the Long-Term Facility (together, the "Facilities") are subject to a commitment fee based on the rating of the Senior Notes. As of December 31, 2002, the commitment fees were an annualized 0.13% on the Facilities. The interest rate on borrowings on the Facilities is calculated based upon a formula using the LIBOR or prime interest rates. A balance of $290,000,000 was outstanding under the Facilities at December 31, 2002 and $245,000,000 at February 7, 2003. On August 28, 2000 the Company entered into the Term Note to fund (i) the cash portion of the consideration to be paid to the Fall River Gas' stockholders; (ii) the all cash consideration to be paid to the ProvEnergy and Valley Resources stockholders, (iii) repayment of approximately $50,000,000 of long- and short-term debt assumed in the mergers, and (iv) all related acquisition costs. On July 16, 2002, the Company repaid the Term Note with the proceeds from the issuance of a $311,087,000 Term Note dated July 15, 2002 (the "2002 Term Note") and borrowings under the Company's lines of credit. No additional draws can be made on the Term Note. The principal source of funds during the three-month period ended December 31, 2002 included $59,300,000 in net borrowings under revolving credit facilities. This provided funds of $38,949,000 for the repayment of debt and capital lease obligations and $18,206,000 for on-going property, plant and equipment additions. The principal source of funds during the six-month period ended December 31, 2002 were $311,087,000 from the issuance of long-term debt and $158,200,000 in net borrowings under revolving credit facilities. This provided funds of $393,054,000 for the repayment of debt and capital lease obligations and $38,106,000 for on-going property, plant and equipment additions; as well as seasonal working capital needs of the Company. The effective interest rate under the Company's current debt structure is 6.59% (including interest and the amortization of debt issuance costs and redemption premiums on refinanced debt). The Company retains its borrowing availability under the 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 January 7, 2003, the Company filed a shelf registration for $800,000,000 of debt securities, common stock, and preferred stock . Upon the Securities and Exchange Commission declaring this shelf registration effective, Southern Union may sell such securities up to such amounts from time to time, at prices determined at the time of any such offering. The Company currently has regulatory approval to issue up to $88,900,000 of these securities for certain uses, and is currently seeking regulatory approval to issue additional amounts. 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, 2002. 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, 2002, 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 Pending Acquisitions On December 22, 2002, the Company along with AIG Highstar Capital, L.P. (AIG Highstar), a private equity fund sponsored by American International Group, Inc. (AIG), reached a definitive agreement with CMS Energy Corporation to acquire the CMS Panhandle Companies (CMS Panhandle). The agreement calls for a newly formed entity, Southern Union Panhandle Corporation, owned approximately 78% by Southern Union and 22% by AIG Highstar to acquire CMS Panhandle for approximately $662 million in cash and the assumption of $1.166 billion in debt. The CMS Panhandle Companies include CMS Panhandle Eastern Pipe Line Company, CMS Trunkline Gas Company, CMS Trunkline LNG Company, which operates an LNG terminal complex at Lake Charles, La., and CMS Sea Robin Pipeline Company. The CMS Panhandle Companies operate almost 11,000 miles of mainline natural gas pipeline extending from the Gulf of Mexico to the Midwest and Canada. These pipelines access the major natural gas supply regions of the Louisiana and Texas Gulf Coasts as well as the Midcontinent and Rocky Mountains. The pipelines have a combined peak day delivery capacity of 5.4 billion cubic feet per day, 88 billion cubic feet of underground storage capacity and 6.3 billion cubic feet of above ground LNG storage facilities. The transaction has been approved by the boards of directors of all companies and will close following clearance by the Federal Trade Commission under the Hart-Scott-Rodino Act and certain state regulatory approvals. Southern Union's portion of this acquisition will be funded in part by proceeds received from the January 2003 sale of Southern Union Gas and related assets, previously discussed. Management Agreement On November 20, 2002, EnergyWorx, a wholly-owned subsidiary of Southern Union Company entered into a management services agreement with Southern Star Central Corporation (Southern Star), a wholly-owned subsidiary of AIG Highstar Capital, L.P. The assets under management by EnergyWorx consist primarily of the Southern Star Central Gas Pipeline which Southern Star purchased from Williams Gas Pipeline on November 15, 2002. These assets include an interstate natural gas pipeline with a transport capacity of 2.3 Bcf per day which traverses seven states and storage fields providing a seasonal storage capacity of 43 Bcf. Southern Star reimburses EnergyWorx for its expenses and provides EnergWorx with the opportunity to earn certain performance related fees upon the achievement of certain performance goals. 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, including the availability and terms of any additional financing requirements; financial condition and prospects of the issuer's region and industry, customers and markets 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. CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION This Management's Discussion and Analysis of Results of Operations and Financial Condition and other sections of this Form 10-Q may contain forward-looking statements that are based on current expectations, estimates and projections about the industry in which the Company operates, management's beliefs and assumptions made by management. Words such as "expects," "anticipates," "intends," "plans," "believes," "seeks," "estimates," variations of such words and similar expressions are intended to identify such forward-looking statements. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions, which are difficult to predict and many of which are outside the Company's control. Therefore, actual outcomes and results may differ materially from what is expressed or forecasted in such forward-looking statements. The Company undertakes no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise. Readers are cautioned not to put undue reliance on such forward-looking statements. Stockholders may review the Company's reports filed in the future with the Securities and Exchange Commission for more current descriptions of developments that could cause actual results to differ materially from such forward-looking statements. Factors that could cause or contribute to actual results differing materially from such forward-looking statements include the following: cost of gas; gas sales volumes; weather conditions in the Company's service territories; the achievement of operating efficiencies and the purchases and implementation of new technologies for attaining such efficiencies; impact of relations with labor unions of bargaining-unit employees; the receipt of timely and adequate rate relief; the outcome of pending and future litigation; governmental regulations and proceedings affecting or involving the Company; unanticipated environmental liabilities; changes in business strategy; the risk that the businesses acquired and any other businesses or investments that Southern Union has acquired or may acquire may not be successfully integrated with the businesses of Southern Union; the impairment or sale of investment securities; ability to access capital markets on reasonable terms; the possibility of war or terrorism attacks; 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. SOUTHERN UNION COMPANY AND SUBSIDIARIES CONTROLS AND PROCEDURES We performed an evaluation within the 90-day period prior to the filing of this quarterly report under the supervision and with the participation of our management, including our Chief Executive Officer ("CEO") and Chief Financial Officer ("CFO"), and with the participation of personnel from our Legal, Internal Audit, Risk Management and Financial Reporting Departments, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on that evaluation, our CEO and CFO concluded that our disclosure controls and procedures were effective as of December 31, 2002 and have communicated that determination to the Audit Committee of our Board of Directors. There have been no significant changes in our internal controls or other factors that could significantly affect internal controls subsequent to December 31, 2002. RESULTS OF VOTES OF SECURITY HOLDERS Southern Union held its Annual Meeting of Stockholders on November 5, 2002. The following matter was submitted for a vote by Southern Union's security holders: the election of three persons to serve as the Class III directors until the 2005 Annual Meeting of Stockholders or until their successors are duly elected and qualified. The number of votes cast for, abstaining or withheld for each nominee for director at the Annual Meeting of Stockholders, were:
For Abstaining Withheld Election of nominees as Class III Directors: George L. Lindemann 43,196,511 -- 2,381,740 David Brodsky 43,702,564 -- 875,686 Thomas F. Karam 43,178,413 -- 2,399,837
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 February 14, 2003 By DAVID J. KVAPIL ------------------------------ -------------------------------- David J. Kvapil Executive Vice President and Chief Financial Officer CERTIFICATION I, George L. Lindemann, certify that: (1) I have reviewed this quarterly report on Form 10-Q of Southern Union Company; (2) Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; (3) Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; (4) The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: (a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; (b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and (c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; (5) The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the Audit Committee of the Company's Board of Directors: (a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and (6) The registrant's other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. GEORGE L. LINDEMANN - ---------------------------------------------------------- George L. Lindemann Chairman of the Board and Chief Executive Officer February 14, 2003 CERTIFICATION I, David J. Kvapil, certify that: (1) I have reviewed this quarterly report on Form 10-Q of Southern Union Company; (2) Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; (3) Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; (4) The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: (a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; (b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and (c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; (5) The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the Audit Committee of the Company's Board of Directors: (a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and (6) The registrant's other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. DAVID J. KVAPIL - ---------------------------------------------------------- David J. Kvapil Executive Vice President and Chief Financial Officer February 14, 2003 Exhibit 99.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Form 10-Q of Southern Union Company (the "Company") for the quarter ended December 31, 2002, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, George L. Lindemann, Chairman of the Board and Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002, that the Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, and the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. GEORGE L. LINDEMANN - ---------------------------------------------------------- George L. Lindemann Chairman of the Board and Chief Executive Officer February 14, 2003 Exhibit 99.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Form 10-Q of Southern Union Company (the "Company") for the quarter ended December 31, 2002, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, David J. Kvapil, Executive Vice President and Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002, that the Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, and the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. DAVID J. KVAPIL - ---------------------------------------------------------- David J. Kvapil Executive Vice President and Chief Financial Officer February 14, 2003 EX-10 3 exhibit10dec200210q.txt EMPLOYMENT AGREEMENT EXHIBIT-10 DAVID W. STEVENS EMPLOYMENT AGREEMENT This EMPLOYMENT AGREEMENT (the "Agreement") is made and entered into as of this 31st day of October 2002, by and between Southern Union Company (hereinafter referred to as the "Company"), a Delaware corporation, and David W. Stevens (hereinafter referred to as the "Executive"). WHEREAS, the Executive is presently employed by the Company in the capacity of Executive Vice President Utility Operations and President and Chief Operating Officer of the Southern Union Gas Company Division; WHEREAS, the Company is desirous of assuring the continued employment of the Executive as a senior executive of Southern Union Company, and Executive is desirous of having such assurance. NOW, THEREFORE, in consideration of the foregoing and of the mutual covenants and agreements of the parties set forth in this Agreement, and of other good and valuable consideration the receipt and sufficiency of which are hereby acknowledged, the parties hereto, intending to be legally bound, agree as follows: Section 1. Terms of Employment; Prior Agreements 1.1 Employment Term. The Company hereby agrees to employ the Executive and the Executive hereby agrees to serve the Company, in accordance with the terms and conditions set forth herein, for an initial term of three (3) years commencing as of the date hereof and thereafter this Agreement shall automatically be extended for additional one (1) year terms (the "Term"), unless terminated by either party in accordance with the terms and conditions of this Agreement. 1.2 Prior Agreements. This Agreement supersedes all prior agreements and understandings (including verbal agreements) between Executive and the Company and/or any of its Affiliates regarding the terms of Executive's employment with the Company and/or of its Affiliates. For purposes of this Agreement, an "Affiliate" shall mean any entity that, directly or indirectly, through one or more intermediaries is controlled by, controls or is under common control with the Company. Section 2. Position and Responsibilities. During the Term of this Agreement, the Executive agrees to serve as a senior executive of the Company and/or its Affiliates. In such capacity, the Executive shall have such level of duties and responsibilities as Executive may be assigned from time to time by the President of the Company. The Executive shall have the same status, privileges and responsibilities normally inherent in similarly situated senior executives of the Company. Section 3. Standard of Care. During the Term of this Agreement, the Executive agrees to devote his full business time and reasonable best efforts to the business of the Company and/or its Affiliates, as may be assigned from time to time by the President of the Company. Executive shall not be engaged in any other business activity, whether or not such business activity is pursued for gain, profit or other pecuniary advantage, without the prior written consent of the President. The Executive may serve on the board of directors or trustees of any business corporation or charitable organizations so long as such service is not injurious to the Company and is agreed upon by the President. This Section 3 shall not be construed as preventing the Executive from holding, as a passive investor, up to two percent (2%) of the common stock of any public company. Section 4. Compensation. As remuneration for all services to be rendered by the Executive during the Term of this Agreement, and as consideration for complying with the covenants herein, the Company shall pay and provide to the Executive the following: 4.1 Base Salary. During the Term, the Company shall pay the Executive a Base Salary in an amount which shall be established from time to time by the President; provided, however, that such Base Salary shall in no event be less than $15,384.62 per biweekly pay period ("Base Salary"). This Base Salary shall be paid to the Executive in equal installments throughout the year, consistent with the normal payroll practices of the Company. While this Agreement is in force, the Base Salary shall be reviewed at least annually, to ascertain whether, in the judgment of the President, such Base Salary should be increased, based primarily on the performance of the Executive during the year and on the base salary of similarly situated executives at comparable companies. If so increased, the Base Salary as stated above shall, likewise, be increased for all purposes of this Agreement. 4.2 Annual Cash Incentive Compensation. The Company shall provide the Executive with the opportunity to earn an annual cash incentive compensation payment, at a level no less than similarly situated senior executive officers of the Company ("Annual Cash Incentive Compensation"), based upon reasonable goals and measures for the Executive, established by the President and which are substantially similar to goals and measures for similarly situated executives of the Company or such other goals and measures as are mutually agreed upon in writing by the President and the Executive. 4.3 Long-Term Incentives. The Company shall provide the Executive with the opportunity to earn a long-term incentive award by participating in the Company's Long-Term Incentive Stock Option Plan at a level no less favorable than that provided to similarly situated senior executives of the Company. 4.4 Supplemental Retirement Benefits. The Company shall provide the Executive the opportunity to participate in the Southern Union Company Supplemental Deferred Compensation Plan and the Southern Union Company Employee Retirement Plan, both as may be amended from time to time, at a level no less favorable than that provided to similarly situated senior executives of the Company. 4.5 Employee Benefits. During the Term, the Company shall provide the Executive with those qualified retirement plan benefits and welfare benefits that are, in the aggregate, substantially equivalent to those benefits currently provided to the Executive and which are, in no event, less than those benefits that any other similarly situated senior executives of the Company are generally entitled, without duplication of benefits. The Executive shall be entitled to paid vacation in accordance with the standard written policy of the Company with regard to vacations of employees. The Company shall provide to the Executive, at the Company's cost, the amount and type of perquisites that are, in the aggregate, substantially equivalent to those perquisites currently provided to the Executive. Section 5. Expenses The Company shall pay, or reimburse the Executive, for all ordinary and necessary expenses that the Executive incurs in performing his duties under this Agreement in accordance with the Company's policy. Section 6. Termination of Employment 6.1 General. Executive's employment may be terminated in accordance with any of the provisions set forth in this Section 6, and the Term shall terminate upon the effective date of such termination of employment. Upon such termination, Executive shall be entitled solely to the rights and benefits set forth in the applicable provisions of this Section 6. 6.2 Termination Due to Death or Disability. (a) Executive's employment may be terminated by the Company on account of Executive's Disability, and shall be terminated upon Executive's death. The Company shall have the right to terminate Executive's employment on account of Disability if, as a result of Executive's incapacity due to physical or mental illness, Executive shall have been absent from the full-time performance of his duties with the Company for six (6) consecutive months. (b) If the Executive's employment is terminated due to death or Disability, the Company shall pay Executive: (i) his accrued but unpaid Base Salary and accrued vacation pay through the date of his termination; (ii) any unpaid Annual Incentive Compensation earned but not paid in the previous year; (iii) the entire potential Annual Cash Incentive Compensation established for the fiscal year of Executive's termination; plus (iv) any amounts otherwise payable to Executive under the terms of the Company benefit plans and programs in which he is a participant, at the times such payments are due. With the exception of the foregoing obligations of the Company, and, in the case of Disability, the covenants of Executive contained in Section 7 (which shall survive such termination), the Company and the Executive thereafter shall have no further obligations under this Agreement. 6.3 Voluntary Termination by the Executive. (a) The Executive may terminate this Agreement at any time by giving the President written notice of Executive's intent to terminate, delivered at least thirty (30) calendar days prior to the effective date of such termination. The termination shall become effective automatically upon the expiration of the thirty (30) day notice period. Such notice shall also constitute the resignation by the Executive of any positions he may hold as an officer and/or director of the Company and/or its Affiliates. (b) In the event such termination is other than for Good Reason, death or Disability, the Company shall pay the Executive: (i) his accrued but unpaid Base Salary and accrued vacation pay through the date of termination; (ii) any unpaid Annual Incentive Compensation earned but not paid in the previous year; plus (iii) any amounts otherwise payable to Executive under the terms of the Company benefit plans and programs in which he is a participant, at the times such payments are due. With the exception of the foregoing obligations of the Company and the covenants of the Executive contained in Section 7 (which shall survive such termination), the Company and the Executive thereafter shall have no further obligations under this Agreement. 6.4 Involuntary Termination by the Company Without Cause. The Company may terminate the Executive's employment at any time by notifying the Executive in writing of the Company's intent to terminate, effective thirty (30) calendar days following the date on which the Company delivers such notice to the Executive. If Executive's employment is terminated by the Company for reasons other than death, Disability or for Cause, then the Executive shall be entitled to the benefits provided below: (a) The Company shall pay the Executive an amount equal to: (i) his accrued but unpaid Base Salary and accrued vacation pay through the date of termination; (ii) any unpaid Annual Incentive Compensation earned but not paid in the previous year; (iii) a Separation Payment equal to .75 times the Executive's Covered Compensation (as hereinafter defined); (iv) subject to the terms of Section 13 of this Agreement, 2.25 times the Executive's Covered Compensation as a Non-Compete Payment (the "Non-Compete Payment") over the term set forth below; plus (v) any amounts otherwise payable to Executive under the terms of the Company benefit plans and programs in which he is a participant, at the time such payments are due. "Covered Compensation" shall mean the Executive's annualized Base Salary (determined by multiplying the biweekly rate of Base Salary in effect at the effective date of termination by 26) plus the entire potential Annual Incentive Compensation established for the fiscal year in which the Executive's termination occurs. As long as Executive remains in material compliance with the terms and conditions of this Agreement, the Executive shall be paid the Non-Compete Payment in thirty-six (36) equal monthly installments, with the first payment to be made within twenty (20) days of Executive's termination in accordance with this Section 6.4, and the final payment to be made to the Executive thirty-five (35) months after the first payment. Notwithstanding anything herein to the contrary, in the event of a material breach by the Executive of any of the provisions contained in Section 13 of this Agreement, that is not cured within thirty (30) calendar days following Executive's receipt of written notice from the Company identifying the material breach, the Executive shall immediately forfeit his right to any and all of the remaining scheduled Non-Compete Payments set forth herein. (b) For three (3) years after Executive's termination, the Company shall provide the Executive with life and medical benefits substantially similar to those provided from time to time to similarly situated active senior executives of the Company. In the event that the Employee obtains substantially similar benefits or coverage from another employer, these life and medical benefits shall be correspondingly reduced during such period following the Executive's termination. Executive agrees to report any such coverage or benefits he obtains to the Company. (c) Upon approval by the appropriate Company Board Committee, any unvested stock options held by the Executive at the time of his termination shall be deemed fully vested and exercisable, and Executive shall have three (3) years from the date of his termination to exercise such stock options. In the event and to the extent appropriate Board Committee approval is not obtained for the foregoing, the Company shall pay the Executive an equivalent amount in cash, as determined by the Company in its reasonable discretion using acceptable valuation methodologies such as the Black-Scholes method to value the stock options. (d) Executive shall be provided with title to the Company automobile used by the Executive at the time of his termination or, at the Company's option, the market value of the Company automobile in cash within a reasonable time. With the exceptions of the foregoing obligations of the Company and the Executive's covenants contained in Section 7 herein (which shall survive such termination), the Company and the Executive hereafter shall have no further obligations under this Agreement or any severance plans of the Company or its Affiliates. 6.5 Termination for Cause. (a) The Company may terminate the Executive's employment for "Cause". "Cause" shall mean willful misconduct, fraud, conviction of a felony, consistent gross neglect of duties or wanton negligence by the Executive in the performance of his duties to the Corporation or its Affiliate, or the material breach by Executive of the terms of this Agreement, which material breach is not cured within thirty (30) days after notice to Executive of such default. Notwithstanding the foregoing, the Executive shall not be deemed to have been terminated for Cause unless and until there shall have been delivered to the Executive a copy of a written notice of termination which shall include a determination by the Board of Directors (after reasonable notice to the Executive and an opportunity for the Executive, together with the Executive's counsel, to be heard by the Board of Directors) finding that, in the good faith opinion of the Board of Directors, the Executive was guilty of conduct constituting "Cause" as set forth in this paragraph and specifying the particulars thereof in detail. The termination of employment shall be effective upon the giving of such notice in accordance with the provisions of this Section. (b) In the event of termination of the Executive's employment for "Cause," the Company shall pay the Executive his accrued and unpaid Base Salary through the date notice of termination is delivered to the Executive in accordance with the provisions of this Section, plus any amounts otherwise payable to Executive under the terms of the Company benefit plans and programs in which he is a participant, at the times such payments are due. Except for the foregoing obligations of the Company and the Executive's covenants under Section 7 (which shall survive such termination), upon delivery to the Executive of written notice of termination in accordance with the provisions of this Section, the Company and the Executive thereafter shall have no further obligations under this Agreement. 6.6 Termination for Good Reason. (a) The Executive may terminate his employment for Good Reason (as defined below) by giving the President thirty (30) days' written notice of termination, stating in reasonable detail that facts and circumstances claimed to provide a basis for such termination. In the event of termination for Good Reason, the Company shall pay and provide to the Executive the amounts and benefits set forth in Section 6.4 hereof in the manner specified therein. With the exceptions of the foregoing obligations of the Company and the Executive's covenants contained in Section 7 herein (which shall survive such termination), the Company and the Executive hereafter shall have no further obligations under this Agreement. (b) Good Reason shall mean, without the Executive's express written consent, the occurrence of any one or more of the following: (i) The assignment to the Executive of any duties inconsistent with his status as a senior executive of the Company or an Affiliate of the Company or a substantial reduction in the nature or status of the Executive's responsibilities from those set forth in Section 2 hereof. (ii) A reduction by the Company in the Executive's Base Salary payable under Section 4.1 hereof, as the same may be increased from time to time; (iii) The Company's requiring the Executive to be based at a location which is more than fifty (50) miles from the current principal location of Executive's employment; (iv) The failure by the Company to continue to provide the Executive with the incentive compensation and benefits set forth in Section 4 hereof; (v) The failure by the Company to pay the Executive any portion of the Executive's current cash compensation, when due; (vi) The failure of the Company to obtain a satisfactory agreement from any successor to assume and agree to perform the Agreement, as contemplated in Section 9.1 hereof; or (vii) Any purported termination of the Executive's employment which does not comply with the applicable provisions of Section 6 of this Agreement, and, for purposes of the Agreement, no such purported termination shall be effective. Notwithstanding the foregoing, none of the events described in clauses (i) through (vii) of this Section 6.6(b) shall constitute Good Reason unless Executive shall have notified the Company in writing describing the events which constitute Good Reason and then only if the Company shall have failed to cure such event within thirty (30) days after the Company's receipt of such written notice. (c) The Executive's right to terminate employment for Good Reason shall not be affected by the Executive's incapacity due to physical or mental illness. However, the Executive's failure to assert Good Reason within six (6) months from the time he had knowledge of the circumstance constituting Good Reason shall constitute a waiver of his right to terminate employment for Good Reason with respect to such event. 6.7 Voluntary Termination by the Executive, following a "Change of Control" (as defined below). (a) In the event the Executive elects to terminate his employment within one (1) year following the date of a Change of Control, the Company shall pay and provide to the Executive the amounts and benefits set forth in Section 6.4 hereof in the manner specified therein. (b) For purposes of this Agreement, a "Change of Control" of the Company shall be deemed to have occurred if and when: (i) there shall be consummated either: (i) any consolidation or merger of the Company in which the majority of the Board of Directors are not on the continuing or surviving Board of Directors or pursuant to which shares of the Company's common stock are converted into cash, securities or other property, other than a consolidation or merger of the Company in which each holder of the Company's common stock immediately prior to the merger has, upon consummation of the merger, the same proportionate ownership of common stock of the surviving corporation as such holder had of the Company's common stock immediately prior to the merger; or (ii) any sale, lease exchange or other transfer (in one transaction or a series of transactions contemplated or arranged by any party as a single plan) or all or substantially all of the assets of the Company; or (ii) the shareholders of the Company shall approve any plan or proposal for the liquidation or dissolution of the Company; With the exception of the foregoing obligations of the Company and the Executive's covenants contained in Section 7 herein (which shall survive such termination), the Company and the Executive hereafter shall have no further obligations. 6.8 Excise Tax Equalization Payment (a) Anything in this Agreement to the contrary notwithstanding, in the event it shall be determined that any payment or distribution by the Company to the Executive or for the Executive's benefit (whether paid or payable or distributed or distributable pursuant to the terms of the Agreement or otherwise) but determined without regard to any additional payments required under this Section (a "Payment") would be subject to the excise tax imposed by Section 4999 of the Code or any interest or penalties are incurred by the Executive with respect to such excise tax (such excise tax, together with any such interest and penalties, are hereinafter collectively referred to as the "Excise Tax"), then the Executive shall be entitled to receive an additional payment (a "Gross-Up Payment") in an amount such that after payment by the Executive of all taxes (including any interest or penalties imposed with respect to such taxes), including, without limitation, any income taxes (and any interest and penalties imposed with respect thereto) and Excise Tax imposed upon the Gross-Up Payment, the Executive retains an amount of the Gross-Up Payment equal to the Excise Tax imposed upon the Payments, less $10,000. (b) Subject to the provisions of Section 6.8(c) below, all determinations required to be made under this Section, including whether and when a Gross-Up Payment is required and the amount of such Gross-Up Payment and the assumptions to be utilized in arriving at such determination, shall be made by the Company's independent audit firm (the "Accounting Firm") which shall provide detailed supporting calculations both to the Company and to the Executive within sixty (60) business days of the making of the Payment by the Company or the Company's receipt of notice from the Executive that there has been a Payment, or such earlier time as is requested by the Company. All fees and expenses of the Accounting Firm shall be borne solely by the Company. Any Gross-Up Payment, as determined pursuant to this Section 6.8, shall be paid by the Company to the Executive within ten (10) business days of the receipt of the Accounting Firm's determination. Any determination by the Accounting Firm shall be binding upon the Company and the Executive for purposes of this Agreement. As a result of the uncertainty in the application of Section 4999 of the Code at the time of the initial determination by the Accounting Firm hereunder, it is possible that the Gross-Up Payment made by the Company is less than the payment which should have been made ("Underpayment"), consistent with the calculations required to be made hereunder. In the event that the Company exhausts its remedies pursuant to this Section and the Executive is thereafter required to make a payment of any Excise Tax, the Accounting Firm shall determine the amount of the Underpayment that has occurred and any such Underpayment shall be promptly paid by the Company to the Executive or for the Executive's benefit. (c) The Executive shall notify the Company in writing of any claim by the Internal Revenue Service that, if successful, would require the payment by the Company of the Gross-Up Payment. Such notification shall be given as soon as practicable but no later than ten (10) business days after the Executive is informed in writing of such claim and shall apprise the Company of the nature of such claim and the date on which such claim is requested to be paid. The Executive shall not pay such claim prior to the expiration of the thirty (30) day period following the date on which the Executive gives such notice to the Company (or such shorter period ending on the date that any payment of taxes with respect to such claim is due). If the Company notifies the Executive in writing prior to the expiration of such period that it desires to contest such claim, the Executive shall: (i) give the Company any information reasonably requested by the Company relating to such claim; (ii) take such action in connection with contesting such claim as the Company shall reasonably request in writing from time to time, including, without limitation, accepting legal representation with respect to such claim by an attorney reasonably selected by the Company; (iii) cooperate with the Company in good faith in order to effectively contest such claim; and (iv) permit the Company to participate in any proceedings relating to such claim. provided, however, that the Company shall bear and pay directly all costs and expenses (including additional interest and penalties) incurred in connection with such contest, and shall indemnify and hold the Executive harmless, on an after-tax basis, for any Excise Tax or income tax (including interest and penalties with respect thereto) imposed as a result of such representation (to the extent it relates to issues with respect to which a Gross-Up Payment would be payable hereunder) and payment of related costs and expenses. Without limitation on the foregoing provisions of this Section 6.8, the Company shall control all proceedings taken in connection with such contest and, at its sole option, may pursue or forgo any and all administrative appeals, proceedings, hearings and conferences with the taxing authority in respect of such claim and may, as its sole option, either direct the Executive to pay the tax claimed and sue for a refund or contest the claim in any permissible manner, and the Executive agrees to prosecute such contest to a determination before any administrative tribunal, in a court of initial jurisdiction and in one or more appellate courts, as the Company shall determine; provided, however, that if the Company directs the Executive to pay such claim and sue for a refund, the Company shall advance the amount of such payment to the Executive, on an interest-free basis, and shall indemnify and hold the Executive harmless, on an after-tax basis, from any Excise Tax or income tax (including interest or penalties with respect thereto) imposed with respect to such advance or with respect to any imputed income with respect to such advance; and further provided that any extension of the statute of limitations relating to payment of taxes for the Executive's taxable year with respect to which such contested amount is claimed to be due is limited solely to such contested amount. Furthermore, the Company's control of the contest shall be limited to issues with respect to which a Gross-Up Payment would be payable hereunder, and the Executive shall be entitled to settle or contest, as the case may be, any other issue raised by the Internal Revenue Service or any other taxing authority. (d) If, after the Executive's receipt of the amount advanced by the Company pursuant to this Section 6.8, the Executive becomes entitled to receive any refund with respect to such claim, the Executive shall (subject to the Company's complying with the requirements of this Section 6.8) promptly pay to the Company the amount of such refund (together with any interest paid or credited thereon after taxes applicable thereto). If, after the Executive's receipt of an amount advanced by the Company pursuant to this Section 6.8, a determination is made that the Executive shall not be entitled to any refund with respect to such claim and the Company does not notify the Executive in writing of its intent to contest such denial of refund prior to the expiration of thirty (30) days after such determination, then such advance shall be forgiven and shall not be required to be repaid and the amount of such advance shall offset, to the extent thereof, the amount of Gross-Up Payment required to be paid. 6.9 Payments Conditioned on Waiver. Notwithstanding any other provision of this Agreement, where a payment is due to Executive under Section 6.4, 6.6 or 6.7 hereunder, no such payments shall be made unless and until Executive (or his Estate) shall have executed a copy of a waiver and release in the form annexed hereto as Exhibit "A", provided, however, that any such waiver and release shall expressly protect all rights and benefits of Executive under this Agreement, including without limitation, the rights under Sections 6.4, 6.6 and 6.7. 6.10 Payments. Except as specifically provided herein, all obligations of the Company to make payments and take any actions under this Agreement shall be discharged with all reasonable promptness and in no event greater than thirty (30) days following the date upon which such obligation or action arises. Section 7. Confidentiality 7.1 Confidentiality. During the Term of this Agreement and thereafter for a period of five (5) years, the Executive will not directly or indirectly divulge or appropriate to his own use, or to the use of any third party, any "trade secrets" or "confidential information" (as defined in Section 7.2) of the Company or any of the Company's Affiliates (hereinafter, the Company and its subsidiaries and affiliates shall be collectively referred to as the "Company Group"), except as may be in public domain other than by violation of the Agreement or as may be required by law. 7.2 Trade Secrets and Confidential Information. "Trade Secrets" as used herein means all secret discoveries, inventions, formulae, designs, methods, processes, techniques of production and know-how relating to the Company Group's business. "Confidential Information" as used herein means the Company's internal policies and procedures, suppliers, customers, financial information and marketing practices, as well as secret discoveries, inventions, formulae, designs, techniques of production, know-how and other information relating to the Company Group's business not rising to the level of a trade secret under applicable law. Section 8. Indemnification The Company hereby covenants and agrees, to the fullest extent permitted by law, to indemnify and hold harmless the Executive fully, completely and absolutely against and in respect to any and all actions, suits, proceedings, claims, demands, judgments, costs, expenses (including reasonable attorney's fees), losses, and damages resulting from the Executive's good faith performance of his duties and obligations under the terms of this Agreement. Section 9. Assignment 9.1 Assignment by the Company. This Agreement may be assigned or transferred to, and shall be binding upon and shall inure to the benefit of, any successor of the Company, and any successor shall be deemed substituted for the "Company" for all purposes under this Agreement. As used in this Agreement, the term "successor" shall mean any person, firm, corporation, or business entity which at any time, whether by merger, purchase, or otherwise, acquires all or substantially all of the assets of the Company. Except as herein provided, this Agreement may not be assigned by the Company. 9.2 Assignment by Executive. This Agreement shall inure to the benefit and be enforceable by the Executive's personal or legal representatives, executors, and administrators, successors, heirs, distributes, devisees and legatees. If the Executive should die while any amounts payable to the Executive hereunder remain outstanding, all such amounts, unless otherwise provided herein, shall be paid in accordance with the terms of this Agreement to the Executive's devisee, legatee, or other designee or, in the absence of such designee, to the Executive's estate. Section 10. Dispute Resolution and Notice 10.1 Arbitration. Any dispute or controversy arising under or in connection with this Agreement shall be settled by arbitration, conducted before a panel of three (3) arbitrators sitting in a location selected by the Executive within fifty (50) miles of the location of his employment with the Company, in accordance with the rules of the American Arbitration Association then in effect. Judgment may be entered on the award of the arbitrator in any court having proper jurisdiction. All expenses of such arbitration including, but not limited to, all fees, costs and expenses of counsel for the Executive shall be paid by the Company as incurred by the Executive. Executive shall have the authority, in his sole discretion, to hire counsel to represent the Executive in such arbitration proceeding. 10.2 Notice. For the purpose of this Agreement, any notices, requests, demands, or other communications provided for by this Agreement shall be in writing and shall be deemed to have been duly given when delivered or mailed by United States registered or certified mail, return receipt requested, postage prepaid, or by recognized overnight delivery service (such as, but not limited to, Federal Express), to the Executive at the last address he has filed in writing with the Company or, in the case of the Company, at its principal offices, to the attention of the President. Section 11. Miscellaneous 11.1 Gender and Number. Except where otherwise indicated by the context, any masculine term used herein also shall include the feminine, the plural shall include the singular, and the singular shall include the plural. 11.2 Modification. This Agreement shall not be varied, altered, modified, canceled, changed, or in any way amended except by mutual agreement of the parties in a written instrument executed by the parties hereto or their legal representatives. 11.3 Severability. In the event that any provision or portion of this Agreement shall be determined to be invalid or unenforceable for any reason, the remaining provisions of this Agreement shall be unaffected thereby and shall remain in full force and effect. 11.4 Counterparts. This Agreement may be executed in one (1) or more counterparts, each of which shall be deemed to be an original, but all of which together will constitute one and the same Agreement. 11.5 Tax Withholding. The Company may withhold from any benefits payment under this Agreement all federal, state, city, or other taxes as may be required pursuant to any law or governmental regulation or ruling. 11.6 Beneficiaries. The Executive may designate one or more persons or entities as the primary and/or contingent beneficiaries of any amounts to be received under this Agreement in the event of Executive's Death or Disability. Such designation must be in the form of a signed writing acceptable to the President. The Executive may make or change such designation at any time. Section 12. Governing Law To the extent not preempted by federal law, the provisions of this Agreement shall be construed and enforced in accordance with the laws of the state of Texas, without regard to conflicts of law principles. Section 13. Non-Compete Agreement Executive acknowledges that the Company has a reasonable and legitimate business interest in protecting its Trade Secrets and Confidential Information from use by or disclosure to other individuals, companies or entities that compete with the regulated natural gas distribution and interstate transmission businesses of the Company (the "Restricted Business"). (a) In the event of a Termination under Section 6.4 (Involuntary Termination by the Company without Cause) or 6.7 (Voluntary Termination by Executive Following a Change in Control) and in consideration for the Non-Compete Payment (as defined in Section 6.4(a)) to Executive set forth in this Agreement and in order to protect the Company's Confidential Information and Trade Secrets from intentional or inadvertent disclosure to or use by a competitor, Executive agrees that in the specified Geographical Area (as that term is hereinafter defined) for a period of three (3) years after the Termination Date, Executive will not alone, or in any capacity with another firm, corporation, institution, individual or other entity: (1) directly or indirectly engage in the Restricted Business in the Specified Geographic Area, nor will Executive become a significant investor in or a principal, officer, director, employee, representative or agent of any venture or enterprise of whatever kind that is engaged in the Restricted Business within the Specified Geographic Area (except as a passive investor in publicly held companies) provided that, nothing in this Section shall restrict the Executive's employment by or association with any entity, venture or enterprise which engages in the Restricted Business in the Specified Geographic Area so long as the following conditions are complied with: (A) the Executive's employment or association with such entity, venture or enterprise is limited to work which is not part of the Restricted Business of such entity; (B) the Executive's employer takes all reasonable measures to ensure that the Executive is not involved with or consulted in any aspect of developing, marketing or servicing of such Restricted Business; and (C) the Executive, prior to accepting employment with any new employer, (for which the Executive has a reasonable belief that his new position is or may be contrary to this Agreement) informs that employer of this Section of the Agreement and provides that employer with a copy of this Section of the Agreement, (2) directly interfere or attempt to interfere with the Company's relationships with any of its current customers or suppliers, (3) directly or indirectly through others, induce, encourage or solicit, or attempt to induce, encourage or solicit, any employee of the Company, or its Affiliates, to terminate the employee's employment with the Company or Affiliate (it being understood that, e.g., newspaper advertisements and other similar general solicitations or hiring an employee of the Company who has already ceased employment with the Company shall not be a violation of this provision), or (4) unless otherwise required by law or agreed to in writing by Company or in connection with generic proceedings not specifically targeting the Company, directly or indirectly through others, provide testimony or consulting advisory services to or for any (i) current customer or supplier of the Restricted Business of the Company, (ii) competitor of the Restricted Business of the Company in the Geographic Area, or (iii) intervenor, federal agency, public utility commission, division or any governmental agency in or for, with respect to any of clauses (i), (ii) or (iii) above, a proceeding, docket or investigation that directly affects the Restricted Business of the Company and/or in a proceeding which the Company is a participant, in the case of each of the foregoing within the Specified Geographic Area. (b) "Specified Geographic Area" shall mean any city, town, municipality or environs in which the Company provides the Restricted Business as of or immediately prior to the Termination. It is understood that the Specified Geographical Area set forth in this Section 13 is divisible so that if this Section 13 is found to be invalid or unenforceable in an included geographical area, that area shall be severable and this Section 13 shall remain in effect for the remaining included geographical areas in which this Section is valid. (c) Executive agrees that the limitations imposed in this Section 13 as to duration of restrictions, geographical area, and/or scope of activity to be restrained are reasonable and not greater than necessary to protect the Company's Trade Secrets and Confidential Information and its legitimate business interests. Executive further agrees that the non-competition provisions of this Agreement are valid, enforceable and are ancillary to an otherwise enforceable agreement. In the event that, notwithstanding the foregoing, any of the provisions of this Section 13 hereof shall be held to be invalid or unenforceable, the remaining provisions thereof shall nevertheless continue to be valid and enforceable as though the invalid or unenforceable parts had not been included therein. In the event that any provision of this Section 13 relating to time period and/or areas of restriction shall be declared by a court of competent jurisdiction to exceed the maximum time period or areas such court deems reasonable and enforceable, said time period and/or areas of restriction shall be deemed to become and thereafter be the maximum time period and/or areas which such court deems reasonable and enforceable. (d) For each new job or position with a company or entity in the regulated natural gas business in the specified Geographic Area or that sells or supplies such products and/or services, in the specified Geographic Area, that the Executive accepts during the three (3) year period following the Termination Date, Executive shall disclose in writing the identity of the new employer and the new job duties of the Executive. Executive shall provide such information to the Company within ten (10) business days of Executive's acceptance of such position or job. The Company shall keep all such information confidential and not disclose such information to any third party. IN WITNESS WHEREOF, the Executive and the Company have executed this Agreement, as of the day and year first above written. SOUTHERN UNION COMPANY EXECUTIVE By: THOMAS F. KARAM DAVID W. STEVENS ----------------------------- ------------------ Thomas F. Karam David W. Stevens President -----END PRIVACY-ENHANCED MESSAGE-----