-----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, A0+vef2LxZcyofPJ8fdln038mPwybS87pbDLKF3BmCJC0P0P/nvDwnoyQjw/JEmc LFjz7809VN1XwTnPrdkwiw== 0000203248-04-000475.txt : 20040901 0000203248-04-000475.hdr.sgml : 20040901 20040901102106 ACCESSION NUMBER: 0000203248-04-000475 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 20040630 FILED AS OF DATE: 20040901 DATE AS OF CHANGE: 20040901 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-K SEC ACT: 1934 Act SEC FILE NUMBER: 001-06407 FILM NUMBER: 041009858 BUSINESS ADDRESS: STREET 1: ONE PEI CENTER CITY: WILKES-BARRE STATE: PA ZIP: 18711 BUSINESS PHONE: (570) 820-2400 10-K 1 form10k_6302004.txt 6-30-2004 10-K ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D. C. 20549 FORM 10-K X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF - --- THE SECURITIES EXCHANGE ACT OF 1934 For the Fiscal Year Ended June 30, 2004 OR - --- TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File No. 1-6407 SOUTHERN UNION COMPANY (Exact name of registrant as specified in its charter) Delaware 75-0571592 (State or other jurisdiction of (I.R.S.Employer incorporation or organization) Identification No.) One PEI Center, Second Floor 18711 Wilkes-Barre,Pennsylvania (Zip Code) (Address of principal executive offices) Registrant's telephone number, including area code: (570) 820-2400 Securities Registered Pursuant to Section 12(b) of the Act: Title of each class Name of each exchange on which registered - ------------------- ---------------------------------------------- Common Stock, par value New York Stock Exchange $1 per share 7.55% Depositary Shares New York Stock Exchange 5.75% Equity Units New York Stock Exchange Securities Registered Pursuant to Section 12(g) of the Act: None Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ---- ---- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ___ Indicate by check mark whether the registrant is an Accelerated Filer (as defined in Exchange Act Rule 12D-2). Yes X No ---- ---- The aggregate market value of the Common Stock held by non-affiliates of the Registrant as of December 31, 2003 was $1,002,204,375 (based on the closing sales price of Common Stock on the New York Stock Exchange on December 31, 2003). For purposes of this calculation, shares held by non-affiliates exclude only those shares beneficially owned by executive officers, directors and stockholders of more than ten percent of the Common Stock of the Company. The number of shares of the registrant's Common Stock outstanding on August 16, 2004 was 81,886,254. DOCUMENTS INCORPORATED BY REFERENCE Portions of the registrant's proxy statement for its annual meeting of stockholders to be held on October 28, 2004, are incorporated by reference into Part III. ================================================================================ PART I ITEM 1. Business. Our Business Introduction Southern Union Company (Southern Union and together with its subsidiaries, the Company) was incorporated under the laws of the State of Delaware in 1932. The Company is primarily engaged in the transportation, storage and distribution of natural gas in the United States. The Company's interstate natural gas transportation and storage operations are conducted through Panhandle Eastern Pipe Line Company, LP and its subsidiaries (hereafter collectively referred to as Panhandle Energy), which operate more than 10,000 miles of interstate pipelines that transport natural gas from the Gulf of Mexico, South Texas and the Panhandle regions of Texas and Oklahoma to major U.S. markets in the Midwest and Great Lakes regions. Panhandle Energy also operates a liquefied natural gas (LNG) import terminal, located on Louisiana's Gulf Coast, which is one of the largest operating LNG facilities in North America based on current send out capacity. The Company's local natural gas distribution operations are conducted through its three regulated utility divisions, Missouri Gas Energy, PG Energy and New England Gas Company, which collectively serve over 960,000 residential, commercial and industrial customers in Missouri, Pennsylvania, Rhode Island and Massachusetts. Acquisition of Panhandle Energy - On June 11, 2003, Southern Union acquired Panhandle Energy from CMS Energy Corporation for approximately $581,729,000 in cash and 3,000,000 shares of Southern Union common stock (before adjustment for subsequent stock dividends) valued at approximately $48,900,000 based on market prices at closing of the Panhandle Energy acquisition and in connection therewith incurred transaction costs of approximately $31,922,000. At the time of the acquisition, Panhandle Energy had approximately $1,157,228,000 of debt principal outstanding that it retained. The Company funded the cash portion of the acquisition with approximately $437,000,000 in cash proceeds it received for the January 1, 2003 sale of its Texas operations, approximately $121,250,000 of the net proceeds it received from concurrent common stock and equity unit offerings (see Note X - Stockholders' Equity) and with working capital available to the Company. The Company structured the Panhandle Energy acquisition and the sale of its Texas operations to qualify as a like-kind exchange of property under Section 1031 of the Internal Revenue Code of 1986, as amended. The acquisition was accounted for using the purchase method of accounting in accordance with accounting principles generally accepted within the United States of America with the purchase price paid and acquisition costs incurred by the Company allocated to Panhandle Energy's net assets as of the acquisition date. The Panhandle Energy assets acquired and liabilities assumed have been recorded at their estimated fair value as of the acquisition date based on the results of outside appraisals. Panhandle Energy's results of operations have been included in the Consolidated Statement of Operations since June 11, 2003. Thus, the Consolidated Statement of Operations for the periods subsequent to the acquisition is not comparable to the same periods in prior years. Panhandle Energy is primarily engaged in the interstate transportation and storage of natural gas and also provides LNG terminalling and regasification services and is subject to the rules and regulations of the Federal Energy Regulatory Commission (FERC). The Panhandle Energy entities include Panhandle Eastern Pipe Line Company, LP (Panhandle Eastern Pipe Line), Trunkline Gas Company, LLC (Trunkline), a wholly-owned subsidiary of Panhandle Eastern Pipe Line, Sea Robin Pipeline Company (Sea Robin), a Louisiana joint venture and an indirect wholly-owned subsidiary of Panhandle Eastern Pipe Line, Trunkline LNG Company, LLC (Trunkline LNG) which is a wholly-owned subsidiary of Trunkline LNG Holdings, LLC (LNG Holdings), an indirect wholly-owned subsidiary of Panhandle Eastern Pipe Line and Pan Gas Storage, LLC (d.b.a. Southwest Gas Storage), a wholly-owned subsidiary of Panhandle Eastern Pipe Line. Collectively, the pipeline assets include more than 10,000 miles of interstate pipelines that transport natural gas from the Gulf of Mexico, South Texas and the Panhandle regions of Texas and Oklahoma to major U.S. markets in the Midwest and Great Lakes region. The pipelines have a combined peak day delivery capacity of 5.4 billion cubic feet (Bcf) per day and 72 Bcf of owned underground storage capacity and 6.3 Bcf of above ground LNG storage capacity. Trunkline LNG, located on Louisiana's Gulf Coast, operates one of the largest LNG import terminals in North America, based on current send out capacity. Sale of Southern Union Gas and Related Assets - Effective January 1, 2003, the Company completed the sale of its Southern Union Gas natural gas operating division and related assets to ONEOK, Inc. (ONEOK) for approximately $437,000,000 in cash resulting in a pre-tax gain of $62,992,000. 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 distributed 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 marketed natural gas to commercial and industrial customers. SUPro provided 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 owned and operated 118.8 miles of intrastate pipeline that served commercial, industrial and utility customers in central, southern and coastal Texas. SUEI and Investments participated in energy-related projects internationally. Energia Estrella del Sur, S. A. de C. V., a wholly-owned Mexican subsidiary of SUEI and Investments, had a 43% equity ownership in a natural gas distribution company, along with other related operations, which served 23,000 customers in Piedras Negras, Mexico, across the border from Southern Union Gas' Eagle Pass, Texas service area. Norteno owned and operated interstate pipelines that served the gas distribution properties of Southern Union Gas and the Public Service Company of New Mexico. Norteno also transported gas through its interstate network to the country of Mexico for Pemex Gas y Petroquimica Basica. In accordance with accounting principles generally accepted in the United States of America, the results of operations and gain on sale have been segregated and reported as "discontinued operations" in the Consolidated Statement of Operations and as "assets held for sale" in the Consolidated Statement of Cash Flows for the respective periods. Other Sales - In July 2001, the Company implemented a Cash Flow Improvement Plan that was designed to increase annualized pre-tax cash flow from operations by at least $50 million by the end of fiscal year 2002. The three-part initiative was composed of strategies designed to achieve results enabling its utility divisions to meet their allowed rates of return, restructure its corporate operations, and accelerate the sale of non-core assets and use the proceeds exclusively for debt reduction. In connection with the Cash Flow Improvement Plan and subsequent strategic initiatives, the Company sold certain non-core subsidiaries and assets described below during the three-year period ended June 30, 2004.
Subsidiary or Asset Sold Date Sold Proceeds Pre-tax Gain(Loss) - ----------------------------------------------------- -------------- ------------- -------------------- ProvEnergy Power Company LLC (a) October 2003 $ 2,175,000 $(1,150,000) PG Energy Services' propane operations (b) April 2002 2,300,000 1,200,000 Carrizo Springs Pipeline (c) December 2001 1,000,000 561,000 South Florida Natural Gas and Atlantic Gas Corporation (d) December 2001 10,000,000 (1,500,000) Morris Merchants, Inc. (e) October 2001 1,586,000 -- Valley Propane, Inc. (f) September 2001 5,301,000 -- ProvEnergy Oil Enterprises (g) August 2001 15,776,000 -- PG Energy Services' commercial and industrial gas marketing contracts July 2001 4,972,000 4,653,000
- ---------------------------------------------------- (a) Provided outsourced energy management services and owned 50% of Capital Center Energy Company LLC. (b) Sold liquid propane to residential, commercial and industrial customers in northeastern and central Pennsylvania. (c) Asset was a 43-mile pipeline operated by Southern Transmission Company. (d) South Florida Natural Gas was a natural gas division of Southern Union and Atlantic Gas Corporation was a propane subsidiary of the Company. (e) Served as a manufacturers' representative agency for franchised plumbing and heating supplies throughout New England. (f) Sold liquid propane to residential, commercial and industrial customers in Rhode Island and Massachusetts. (g) Operated a fuel oil distribution business through its subsidiary, ProvEnergy Fuels, Inc. for residential and commercial customers in Rhode Island and Massachusetts. Business Segments The Company's operations include two reportable segments: o The Transportation and Storage segment, which is primarily engaged in the interstate transportation and storage of natural gas in the Midwest and Southwest and also provides LNG terminalling and regasification services. Its operations are conducted through Panhandle Energy, which the Company acquired on June 11, 2003; o The Distribution segment, which is primarily engaged in the local distribution of natural gas in Missouri, Pennsylvania, Rhode Island and Massachusetts. Its operations are conducted through the Company's three regulated utility divisions: Missouri Gas Energy, PG Energy and New England Gas Company. For a more detailed description of the Company's reportable segments, see Item 1. Business - Transportation and Storage Segment and Item 1. Business - Distribution Segment. The Company's operations also include certain subsidiaries established to support and expand natural gas sales and other energy sales, which are not included in the Transportation and Storage segment or the Distribution segment. These subsidiaries, described below, do not meet the quantitative thresholds for determining reportable segments and have been combined for disclosure purposes in the "All Other" category (for information about the revenues, operating income (which the Company formerly referred to as net operating revenues), assets and other financial information relating to the All Other category, see Note XXI - Reportable Segments). o PEI Power Corporation (Power Corp.), an exempt wholesale generator (within the meaning of the Public Utility Holding Company Act of 1935), generates and sells electricity provided by two power plants that share a site in Archbald, Pennsylvania. Power Corp. wholly owns one plant, a 25-megawatt cogeneration facility fueled by a combination of natural gas and methane. Power Corp. owns 49.9% of the second plant, a 45-megawatt natural gas-fired facility, in a joint venture with Cayuga Energy. These plants sell electricity to the broad mid-Atlantic wholesale energy market administered by PJM Interconnection, L.L.C. o Fall River Gas Appliance Company, Inc. rents water heaters and conversion burners (primarily for residential use) to over 16,400 customers and offers service contracts on gas appliances in the city of Fall River and the towns of Somerset, Swansea and Westport, all located in southeastern Massachusetts. o Valley Appliance and Merchandising Company (VAMCO) rents natural gas burning appliances and offers appliance service contract programs to residential customers. In fiscal 2002, VAMCO provided construction management services for natural gas-related projects to commercial and industrial customers. o PG Energy Services, Inc. (Energy Services) offers the inspection, maintenance and servicing of residential and small commercial gas-fired equipment to 16,100 residential and commercial users primarily in central and northeastern Pennsylvania. o Alternate Energy Corporation is an energy consulting firm that also retains patents on a natural gas/diesel co-firing system and on "Passport" FMS (Fuel Management System) which monitors and controls the transfer of fuel on dual-fuel equipment. The Company also has corporate operations that do not generate operating revenues. Corporate functions include Accounting, Corporate Communications, Human Resources, Information Technology, Internal Audit, Investor Relations, Legal, Payroll, Purchasing, Risk Management, Tax and Treasury. The Company also maintains a venture capital investment portfolio. The Company's significant venture capital investments are listed below. o PointServe, Inc. (PointServe) --The Company has a remaining investment of $2,603,000 in PointServe, a business-to-business online scheduling solution, after recording non-cash charges of $1,603,000 and $10,380,000 during fiscal 2004 and 2002, respectively to recognize a decrease in fair value. The Company recognized these valuation adjustments to reflect significant lower private equity valuation metrics and changes in the business outlook of PointServe. PointServe is a closely held, privately owned company and, as such, has no published market value. o Advent Networks, Inc. (Advent) -- Southern Union has a $5,433,000 equity interest in Advent and holds $11,500,000 of convertible notes receivable from Advent. Additionally, a wholly owned subsidiary of Southern Union has guaranteed a $4,000,000 line of credit between Advent and a bank. Advent's UltraBand(TM) technology is expected to deliver digital broadband services 40 times faster than digital subscriber lines (DSL) or cable modems, and 1,000 times faster than dial-up modems, over the "last mile". UltraBand(TM) should provide cable network overbuilders a competitive advantage with its capability to deliver content at a quality and speed that cannot be provided over cable modem. All of the convertible notes bear interest at 10% per annum and convert into equity at a ratio determined upon the next equity financing of Advent or upon a change of control of Advent. The convertible notes are due on demand at the request of Southern Union. Advent is a closely held, privately owned company and, as such, has no published market value. Certain Southern Union executive officers, directors and employees have invested an aggregate of approximately $2,600,000 in Advent and beneficially own in the aggregate approximately three percent equity ownership interest in Advent either directly, indirectly or through a partnership unrelated to Southern Union through which such persons vote their beneficial interest at their own discretion. As a result of an early round of financings, the Company has the right to name one of seven directors to the Advent Board. However, currently Thomas F. Karam and John E. Brennan, officers and directors of the Company, serve as the Company's representatives on the Advent Board of Directors. The Company reviews its portfolio of investment securities on a quarterly basis to determine whether a decline in value is other than temporary. Factors that are considered in assessing whether a decline in value is other than temporary include, but are not limited to: earnings trends and asset quality; near term prospects and financial condition of the issuer; financial condition and prospects of the issuer's region and industry; and Southern Union's intent and ability to retain the investment. If Southern Union determines that the decline in value of an investment security is other than temporary, it will record a charge on its Consolidated Statement of Operations to reduce the carrying value of the security to its estimated fair value. Transportation and Storage Segment Services The Transportation and Storage segment is primarily engaged in the interstate transportation and storage of natural gas in the Midwest and Southwest, and also provides LNG terminalling and regasification services. Its operations are conducted through Panhandle Energy, which the Company acquired on June 11, 2003. In fiscal 2004, this segment represented 27 percent of the Company's total operating revenues. Panhandle Energy owns and operates a large natural gas pipeline network consisting of more than 10,000 miles of pipeline. The pipeline network, consisting of the Panhandle Eastern Pipe Line transmission system, the Trunkline transmission system and the Sea Robin transmission system provides approximately 500 customers in the Midwest and Southwest with a comprehensive array of transportation and storage services. Panhandle Eastern Pipe Line's transmission system, with approximately 6,500 miles of pipeline, consists of four large diameter pipelines extending approximately 1,300 miles from producing areas in the Anadarko Basin of Texas, Oklahoma and Kansas through the states of Missouri, Illinois, Indiana, Ohio and into Michigan. Trunkline's transmission system, with approximately 3,500 miles of pipeline, consists of two large diameter pipelines extending approximately 1,400 miles from the Gulf Coast areas of Texas and Louisiana through the states of Arkansas, Mississippi, Tennessee, Kentucky, Illinois and Indiana to a point on the Indiana-Michigan border. Sea Robin's transmission system consists of two offshore Louisiana natural gas supply systems and is comprised of approximately 400 miles of pipeline extending approximately 81 miles into the Gulf of Mexico. Panhandle Energy has approximately 87 Bcf of total storage available for use in connection with its gas transmission systems. Panhandle Energy owns and operates 47 compressor stations, and has five gas storage fields located in Illinois, Kansas, Louisiana, Michigan and Oklahoma and with a combined maximum working storage capacity of 72 Bcf. Panhandle Energy also has contracts with third parties that provide for approximately 15 Bcf of storage. Through Trunkline LNG, Panhandle Energy owns and operates a LNG terminal in Lake Charles, Louisiana, which is one of the largest operating LNG facilities in North America based on its sustainable send out capacity of approximately .63 Bcf per day. Trunkline LNG is currently in the process of expanding the terminal, which will increase sustainable send out capacity to approximately 1.2 Bcf per day and increase terminal storage capacity to 9 Bcf from the current 6.3 Bcf. BG LNG Services has contract rights for the .57 Bcf per day of additional capacity. Construction on the Trunkline LNG expansion project (Phase I) commenced in September 2003 and is expected to be completed with an estimated cost totaling $137 million, plus capitalized interest, by the end of the 2005 calendar year. In February 2004, Trunkline LNG filed a further incremental LNG expansion project (Phase II) with FERC and is awaiting commission approval. Phase II is estimated to cost approximately $77 million, plus capitalized interest, and would increase the LNG terminal sustainable send out capacity to 1.8 Bcf per day. Phase II has an expected in-service date of mid-calendar 2006. BG LNG Services has contracted for all the proposed additional capacity, subject to Trunkline LNG achieving certain construction milestones at this facility. In February 2004, Trunkline filed an application with FERC to request approval of a 30-inch diameter, 23-mile natural gas pipeline loop from the LNG terminal. The estimated cost of this pipeline expansion is approximately $41 million, plus capitalized interest. The pipeline creates additional transport capacity in association with the Trunkline LNG expansion and also includes new and expanded delivery points with major interstate pipelines. A significant portion of Panhandle Energy's revenue comes from reservation fees related to long-term service agreements with local distribution company customers and their affiliates. Panhandle Energy also provides firm transportation services under contract to gas marketers, producers, other pipelines, electric power generators, and a variety of other end-users. In addition, the pipelines offer both firm and interruptible transportation to customers on a short-term or seasonal basis. Demand for gas transmission on Panhandle Energy's pipeline systems is somewhat seasonal, with the highest throughput and a higher portion of annual operating revenues and net earnings occurring in the traditional winter heating season in the first and fourth calendar quarters. In fiscal 2004 and 2003 (from June 12 to June 30, 2003), Panhandle Energy's combined throughput was 1,321 trillion British thermal units (TBtu) and 69 TBtu, respectively. In fiscal 2004, Panhandle Energy's operating revenues were $491,083,000, of which 86 percent was generated from transportation and storage services, 12 percent from LNG terminalling services, and 2 percent from other services. Aggregate sales to Panhandle Energy's top ten customers accounted for 70 percent of the segment's operating revenues in fiscal 2004 (see Item 7. Management's Discussion and Analysis - Other Matters (Customer Concentrations)). Panhandle Energy has no single customer, or group of customers under common control, which accounted for ten percent or more of the Company's total operating revenues in fiscal 2004. For information about the operating revenues, operating income, assets and other financial information relating to the Transportation and Storage segment, see ITEM 7. Management's Discussion and Analysis - Business Segment Results and Note XXI - Reportable Segments. Regulation Panhandle Energy is subject to regulation by various federal, state and local governmental agencies, including those specifically described below. See also Item 1. Business - Environmental. FERC has comprehensive jurisdiction over Panhandle Eastern Pipe Line, Southwest Gas Storage, Trunkline, Trunkline LNG and Sea Robin as natural gas companies within the meaning of the Natural Gas Act of 1938. FERC jurisdiction relates, among other things, to the acquisition, operation and disposal of assets and facilities and to the service provided and rates charged. FERC has authority to regulate rates and charges for transportation or storage of natural gas in interstate commerce. FERC also has authority over the construction and operation of pipeline and related facilities utilized in the transportation and sale of natural gas in interstate commerce, including the extension, enlargement or abandonment of service using such facilities. Panhandle Eastern Pipe Line, Trunkline, Sea Robin, Trunkline LNG, and Southwest Gas Storage hold certificates of public convenience and necessity issued by FERC, authorizing them to construct and operate the pipelines, facilities and properties now in operation for which such certificates are required, and to transport and store natural gas in interstate commerce. The Secretary of Energy regulates the importation and exportation of natural gas and has delegated various aspects of this jurisdiction to FERC and the Department of Energy's Office of Fossil Fuels. Panhandle Energy is also subject to the Natural Gas Pipeline Safety Act of 1968 and the Pipeline Safety Improvement Act of 2002, which regulate the safety of gas pipelines. Panhandle Energy is also subject to the Hazardous Liquid Pipeline Safety Act of 1979, which regulates oil and petroleum pipelines. For a discussion of the effect of certain FERC orders on Panhandle Energy, see Item 7. Management's Discussion and Analysis - Other Matters. Competition Panhandle Energy's interstate pipelines compete with other interstate and intrastate pipeline companies in the transportation and storage of natural gas. The principal elements of competition among pipelines are rates, terms of service and flexibility, and reliability of service. Panhandle Energy's direct competitors include Alliance Pipeline LP, ANR Pipeline Company, Natural Gas Pipeline Company of America, Northern Border Pipeline Company, Texas Gas Transmission Corporation, Northern Natural Gas Company and Vector Pipeline. Natural gas competes with other forms of energy available to Panhandle Energy's customers and end-users, including electricity, coal and fuel oils. The primary competitive factor is price. Changes in the availability or price of natural gas and other forms of energy, the level of business activity, conservation, legislation and governmental regulations, the capability to convert to alternate fuels, and other factors, including weather and natural gas storage levels, affect the demand for natural gas in the areas served by Panhandle Energy. Distribution Segment Services The Distribution segment is primarily engaged in the local distribution of natural gas in Missouri, Pennsylvania, Rhode Island and Massachusetts. Its operations are conducted through the Company's three regulated utility divisions: Missouri Gas Energy, PG Energy and New England Gas Company. Collectively, the utility divisions serve over 960,000 residential, commercial and industrial customers through local distribution systems consisting of 14,243 miles of mains, 9,605 miles of service lines and 76 miles of transmission lines. The utility divisions' operations are regulated as to rates and other matters by the regulatory commissions of the states in which each operates. The utility divisions' operations are generally sensitive to weather and seasonal in nature, with a significant percentage of annual operating revenues and net earnings occurring in the traditional winter heating season in the first and fourth calendar quarters. In fiscal 2004, this segment represented 72 percent of the Company's total operating revenues. In fiscal 2004, 2003 and 2002, the Distribution segment's operating revenues were $1,304,000,000, $1,159,000,000 and $968,900,000, respectively; average customers served totaled 949,978, 944,657 and 935,229, respectively; and gas volumes sold or transported totaled 173,119 million cubic feet (MMcf), 188,333 MMcf and 166,793 MMcf, respectively. The Distribution segment has no single customer, or group of customers under common control, which accounted for ten percent or more of the Company's total operating revenues in fiscal 2004. For information about the operating revenues, operating income, assets and other financial information relating to the Distribution segment, see ITEM 7. Management's Discussion and Analysis - Business Segment Results and Note XXI - Reportable Segments. A description of each of the Company's regulated utility divisions follows. Missouri Gas Energy - Missouri Gas Energy, headquartered in Kansas City, Missouri, serves approximately 503,000 customers in central and western Missouri (including Kansas City, St. Joseph, Joplin and Monett) through a local distribution system that consists of approximately 8,074 miles of mains, 5,022 miles of service lines and 47 miles of transmission lines. Its service territories have a total population of approximately 1.5 million. Missouri Gas Energy's natural gas rates are regulated by the Missouri Public Service Commission (MPSC) (see Item 1. Business - Regulation and Rates). The Missouri Gas Energy customers served, gas volumes sold or transported and weather-related information for the past three fiscal years are as follows:
Year Ended June 30, ------------------------- 2004 2003 2002 ---- ---- ---- Average number of customers: Residential ............................................................... 432,037 430,861 428,215 Commercial ................................................................ 61,957 60,774 58,749 Industrial ................................................................ 95 99 95 -------- -------- -------- Total average gas sales customers ..................................... 494,089 491,734 487,059 Transportation customers .................................................. 786 461 378 -------- -------- -------- Total average gas sales and transportation customers .................. 494,875 492,195 487,437 ======== ======== ======== Gas sales in millions of cubic feet (MMcf): Residential ............................................................... 36,880 39,821 35,039 Commercial ................................................................ 16,026 17,399 15,686 Industrial ................................................................ 338 391 417 -------- -------- -------- Gas sales billed ...................................................... 53,244 57,611 51,142 Net change in unbilled gas sales .......................................... 112 61 (16) -------- -------- -------- Total gas sales ....................................................... 53,356 57,672 51,126 Gas transported ........................................................... 25,761 26,893 27,324 -------- -------- -------- Total gas sales and gas transported ................................... 79,117 84,565 78,450 ======== ======== ======== Weather: Degree days (a)............................................................ 4,770 5,105 4,419 Percent of 10-year measure (b)............................................. 92% 98% 85% Percent of 30-year measure (b)............................................. 92% 98% 85% - --------------------------------------------------------------------------------
(a) "Degree days" are a measure of the coldness of the weather experienced. A degree day is equivalent to each degree that the daily mean temperature for a day falls below 65 degrees Fahrenheit. (b) Information with respect to weather conditions is provided by the National Oceanic and Atmospheric Administration. Percentages of 10- and 30-year measure are computed based on the weighted average volumes of gas sales billed. The 10- and 30-year measure is used for consistent external reporting purposes. Measures of normal weather used by the Company's regulatory authorities to set rates vary by jurisdiction. Periods used to measure normal weather for regulatory purposes range from 10 years to 30 years. PG Energy - PG Energy, headquartered in Wilkes-Barre, Pennsylvania, serves approximately 159,000 customers in northeastern and central Pennsylvania (including Wilkes-Barre, Scranton and Williamsport) through a local distribution system that consists of approximately 2,514 miles of mains, 1,515 miles of service lines and 29 miles of transmission lines. Its service territories have a total population of approximately 755,000. PG Energy's natural gas rates are regulated by the Pennsylvania Public Utility Commission (PPUC) (see Item 1. Business - Regulation and Rates). The PG Energy customers served, gas volumes sold or transported and weather-related information for the past three fiscal years are as follows:
Year Ended June 30, ------------------- 2004 2003 2002 ---- ---- ---- Average number of customers: Residential ............................................................... 142,422 141,769 141,223 Commercial ................................................................ 14,384 14,141 13,707 Industrial ................................................................ 116 120 104 Public authorities and other .............................................. 340 337 212 -------- -------- -------- Total average customers served ........................................ 157,262 156,367 155,246 Transportation customers .................................................. 602 613 624 -------- -------- -------- Total average gas sales and transportation customers .................. 157,864 156,980 155,870 ======== ======== ======== Gas sales in MMcf: Residential ............................................................... 17,133 18,372 15,053 Commercial ................................................................ 6,505 6,732 5,325 Industrial ................................................................ 379 376 277 Public authorities and other .............................................. 290 334 145 -------- -------- -------- Gas sales billed ...................................................... 24,307 25,814 20,800 Net change in unbilled gas sales .......................................... 34 4 (22) -------- --------- -------- Total gas sales ....................................................... 24,341 25,818 20,778 Gas transported ........................................................... 26,007 28,366 26,976 -------- -------- -------- Total gas sales and gas transported ................................... 50,348 54,184 47,754 ======== ======== ======== Weather: Degree days................................................................ 6,240 6,654 5,373 Percent of 10-year measure................................................. 100% 109% 89% Percent of 30-year measure................................................. 103% 106% 86%
New England Gas Company - New England Gas Company, headquartered in Providence, Rhode Island, serves approximately 301,000 customers in Rhode Island and Massachusetts (including Providence, Newport and Cumberland, Rhode Island and Fall River, North Attleboro and Somerset, Massachusetts) through a local distribution system that consists of approximately 3,655 miles of mains and 3,068 miles of service lines. Its service territories have a total population of approximately 1.2 million. In Rhode Island and Massachusetts, New England Gas Company's natural gas rates are regulated by the Rhode Island Public Utilities Commission (RIPUC) and Massachusetts Department of Telecommunications and Energy (MDTE), respectively (see Item 1. Business -Regulation and Rates). The New England Gas Company's customers served, gas volumes sold or transported and weather-related information for the past three fiscal years are as follows:
Year Ended June 30, ------------------- 2004 2003 2002 ---- ---- ---- Average number of customers: Residential ............................................................... 269,926 268,312 265,206 Commercial ................................................................ 25,798 25,442 21,696 Industrial and irrigation ................................................. 226 225 3,472 Public authorities and other .............................................. 47 41 43 -------- -------- -------- Total average customers served ........................................ 295,997 294,020 290,417 Transportation customers .................................................. 1,242 1,462 1,505 -------- -------- -------- Total average gas sales and transportation customers .................. 297,239 295,482 291,922 ======== ======== ======== Gas sales in MMcf: Residential ............................................................... 24,194 25,481 19,975 Commercial ................................................................ 9,753 9,725 6,196 Industrial and irrigation ................................................. 1,968 2,055 3,271 Public authorities and other .............................................. 25 28 23 -------- -------- -------- Gas sales billed ...................................................... 35,940 37,289 29,465 Net change in unbilled gas sales .......................................... (1,366) 1,336 (333) -------- -------- -------- Total gas sales ....................................................... 34,574 38,625 29,132 Gas transported ........................................................... 9,080 10,959 11,457 -------- -------- -------- Total gas sales and gas transported ................................... 43,654 49,584 40,589 ======== ======== ======== Weather: Degree days................................................................ 5,644 6,143 4,980 Percent of 10-year measure................................................. 98% 111% 88% Percent of 30-year measure ................................................ 102% 107% 85%
Gas Supply The cost and reliability of natural gas service is dependent upon the Company's ability to contract for favorable mixes of long-term and short-term gas supply arrangements and through favorable fixed and variable transportation contracts. The Company has been directly acquiring its gas supplies since the mid-1980s when interstate pipeline systems opened their systems for transportation service. The Company has the organization, personnel and equipment necessary to dispatch and monitor gas volumes on a daily, hourly and even a real-time basis to ensure reliable service to customers. FERC required the "unbundling" of services offered by interstate pipeline companies beginning in 1992. As a result, gas purchasing and transportation decisions and associated risks have been shifted from the pipeline companies to the gas distributors. The increased demands on distributors to effectively manage their gas supply in an environment of volatile gas prices provides an advantage to distribution companies such as Southern Union who have demonstrated a history of contracting favorable and efficient gas supply arrangements in an open market system. The majority of 2004 gas requirements for the utility operations of Missouri Gas Energy and PG Energy were delivered under short- and long-term transportation contracts through four major pipeline companies. The majority of 2004 gas requirements for the utility operations of New England Gas Company were delivered under long-term transportation contracts through four major pipeline companies. These contracts have various expiration dates ranging from calendar year 2005 through 2018. Missouri Gas Energy and New England Gas Company have firm supply commitments for all areas that are supplied with gas purchased under short- and long-term arrangements. PG Energy has firm supply commitments for all areas that are supplied with gas purchased under short-term arrangements. Missouri Gas Energy, PG Energy and New England Gas Company hold contract rights to over 17 Bcf, 11 Bcf and 7 Bcf of storage capacity, respectively, to assist in meeting peak demands. Storage capacity in 2004 approximated 31% of the utility operations' annual gas distribution volumes. Gas sales and/or transportation contracts with interruption provisions, whereby large volume users purchase gas with the understanding that they may be forced to shut down or switch to alternate sources of energy at times when the gas is needed for higher priority customers, have been utilized for load management by Southern Union and the gas industry as a whole. In addition, during times of special supply problems, curtailments of deliveries to customers with firm contracts may be made in accordance with guidelines established by appropriate federal and state regulatory agencies. There have been no supply-related curtailments of deliveries to Missouri Gas Energy, PG Energy, or New England Gas Company utility sales customers during the last ten years. Competition As energy providers, Missouri Gas Energy, PG Energy, and New England Gas Company have historically competed with alternative energy sources, particularly electricity, propane, fuel oil, coal, natural gas liquids and other refined products available in their service areas. At present rates, the cost of electricity to residential and commercial customers in the Company's regulated utility service areas generally is higher than the effective cost of natural gas service. There can be no assurance, however, that future fluctuations in gas and electric costs will not reduce the cost advantage of natural gas service. Competition between the use of fuel oils, natural gas and propane, particularly by industrial and electric generation customers has also increased, due to the volatility of natural gas prices and increased marketing efforts from various energy companies. In order to be more competitive with certain alternate fuels in Pennsylvania, PG Energy offers an Alternate Fuel Rate for eligible customers. This rate applies to commercial and industrial accounts that have the capability of using fuel oils or propane as alternate sources of energy. Whenever the cost of such alternate fuel drops below PG Energy's normal tariff rates, PG Energy is permitted by the PPUC to lower its price to these customers so that PG Energy can remain competitive with the alternate fuel. However, in no instance may PG Energy sell gas under this special arrangement for less than its average commodity cost of gas purchased during the month. Competition between the use of fuel oils, natural gas and propane, is generally greater in Pennsylvania and New England than in the Company's Missouri service area; however, this competition affects the nationwide market for natural gas. Additionally, the general economic conditions in the Company's regulated utility service areas continue to affect certain customers and market areas, thus impacting the results of the Company's operations. The Company's regulated utility operations are not currently in significant direct competition with any other distributors of natural gas to residential and small commercial customers within their service areas. In 1999, the Commonwealth of Pennsylvania enacted the Natural Gas Choice and Competition Act, which extended the ability to choose suppliers to small commercial and residential customers as well. Effective April 29, 2000, all of PG Energy's customers have the ability to select an alternate supplier of natural gas, which PG Energy will continue to deliver through its distribution system under regulated transportation service rates (with PG Energy serving as supplier of last resort). Customers can also choose to remain with PG Energy as their supplier under regulated natural gas sales rates. In either case, the applicable rate results in the same net operating revenues to PG Energy. Despite customers' acquired right to choose, higher-than-normal wholesale prices for natural gas have prevented suppliers from offering competitive rates. Regulation and Rates The utility operations are regulated as to rates and other matters by the regulatory commissions of the states in which each operates. In Missouri and Pennsylvania, natural gas rates are established by the MPSC and PPUC, respectively, on a system-wide basis. In Rhode Island, the RIPUC approves natural gas rates for New England Gas Company. In Massachusetts, natural gas rates for New England Gas Company are subject to the regulatory authority of the MDTE. The Company holds non-exclusive franchises with varying expiration dates in all incorporated communities where it is necessary to carry on its business as it is now being conducted. Providence, Rhode Island; Fall River, Massachusetts; Kansas City, Missouri; and St. Joseph, Missouri are the four largest cities in which the Company's utility customers are located. The franchise in Kansas City, Missouri expires in 2010. The Company fully expects this franchise to be renewed upon its expiration. The franchises in Providence, Rhode Island; Fall River, Massachusetts; and St. Joseph, Missouri are perpetual. Gas service rates are established by regulatory authorities to permit utilities the opportunity to recover operating, administrative and financing costs, and the opportunity to earn a reasonable return on equity. Gas costs are billed to customers through purchase gas adjustment (PGA) clauses, which permit the Company to adjust its sales price as the cost of purchased gas changes. This is important because the cost of natural gas accounts for a significant portion of the Company's total expenses. The appropriate regulatory authority must receive notice of such adjustments prior to billing implementation. Other than in Pennsylvania, the Company supports any service rate changes to its regulators using an historic test year of operating results adjusted to normal conditions and for any known and measurable revenue or expense changes. Because the regulatory process has certain inherent time delays, rate orders may not reflect the operating costs at the time new rates are put into effect. In Pennsylvania, a future test year is utilized for ratemaking purposes, therefore, rate orders more closely reflect the operating costs at the time new rates are put into effect. The monthly customer bill contains a fixed service charge, a usage charge for service to deliver gas, and a charge for the amount of natural gas used. While the monthly fixed charge provides an even revenue stream, the usage charge increases the Company's annual revenue and earnings in the traditional heating load months when usage of natural gas increases. Weather normalization clauses serve to stabilize earnings. New England Gas Company has a weather normalization clause in the tariff covering its Rhode Island operations. Missouri -- On November 4, 2003, Missouri Gas Energy filed a request with the MPSC to increase base rates by $44,800,000 and to implement a weather mitigation rate design that would significantly reduce the impact of weather-related fluctuations on customer bills. On January 30, 2004, Missouri Gas Energy filed an updated claim which raised the amount of the base rate increase request to $54,200,000. As of July 19, 2004, upon the close of the record and reflecting settlement of a number of issues, MGE's request stood at approximately $39,000,000 and the MPSC Staff's recommendation stood at approximately $13,000,000. Statutes require that the MPSC reach a decision in the case within an eleven-month period from the original filing date. It is not presently possible to determine what action the MPSC will ultimately take with respect to this rate increase request. Rhode Island -- On May 22, 2003, the RIPUC approved a Settlement Offer filed by New England Gas Company related to the final calculation of earnings sharing for the 21-month period covered by the Energize Rhode Island Extension settlement agreement. This calculation generated excess revenues of $5,277,000. The net result of the excess revenues and the Energize Rhode Island weather mitigation and non-firm margin sharing provisions was the crediting to customers of $949,000 over a twelve-month period starting July 1, 2003. On May 24, 2002, the RIPUC approved a settlement agreement between the New England Gas Company and the Rhode Island Division of Public Utilities and Carriers. The settlement agreement resulted in a $3,900,000 decrease in base revenues for New England Gas Company's Rhode Island operations, a unified rate structure ("One State; One Rate") and an integration/merger savings mechanism. The settlement agreement also allows New England Gas Company to retain $2,049,000 of merger savings and to share incremental earnings with customers when the division's Rhode Island operations return on equity exceeds 11.25%. Included in the settlement agreement was a conversion to therm billing and the approval of a reconciling Distribution Adjustment Clause (DAC). The DAC allows New England Gas Company to continue its low income assistance and weatherization programs, to recover environmental response costs over a 10-year period, puts into place a new weather normalization clause and allows for the sharing of nonfirm margins (non-firm margin is margin earned from interruptible customers with the ability to switch to alternative fuels). The weather normalization clause is designed to mitigate the impact of weather volatility on customer billings, which will assist customers in paying bills and stabilize the revenue stream. New England Gas Company will defer the margin impact of weather that is greater than 2% colder-than-normal and will recover the margin impact of weather that is greater than 2% warmer-than-normal. The non-firm margin incentive mechanism allows New England Gas Company to retain 25% of all non-firm margins earned in excess of $1,600,000. In addition to the regulation of its utility businesses, the Company is affected by other regulations, including pipeline safety requirements of the United States Department of Transportation, safety regulations under the Occupational Safety and Health Act, and various state and federal environmental statutes and regulations. The Company believes that its utility operations are in material compliance with applicable safety and environmental statutes and regulations. 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 ongoing 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 gas distribution service territories, principally in Texas, Arizona and New Mexico, and present gas distribution 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 distribution service territories certain MGP sites are currently the subject of governmental actions. The Company's interstate natural gas transportation operations are subject to federal, state and local regulations regarding water quality, hazardous and solid waste disposal and other environmental matters. The Company has identified environmental impacts at certain sites on its gas transmission systems and has undertaken cleanup programs at those sites. These impacts resulted from (i) the past use of lubricants containing polychlorinated bi-phenyls (PCBs) in compressed air systems; (ii) the past use of paints containing PCBs; (iii) the prior use of wastewater collection facilities; and (iv) other on-site disposal areas. The Company communicated with the United States Environmental Protection Agency (EPA) and appropriate state regulatory agencies on these matters, and has developed and is implementing a program to remediate such contamination in accordance with federal, state and local regulations. Some remediation is being performed by former Panhandle Energy affiliates in accordance with indemnity agreements that also indemnify against certain future environmental litigation and claims. The Company is also subject to various federal, state and local laws and regulations relating to air quality control. These regulations include rules relating to regional ozone control and hazardous air pollutants. The regional ozone control rules are known as State Implementation Plans (SIP) and are designed to control the release of nitrogen oxide (NOx) compounds. The rules related to hazardous air pollutants are known as Maximum Achievable Control Technology (MACT) rules and are the result of the 1990 Clean Air Act Amendments that regulate the emission of hazardous air pollutants from internal combustion engines and turbines. See Item 7. Management's Discussion and Analysis - Other Matters (Cautionary Statement Regarding Forward-Looking Information) and Note XVIII - Commitments and Contingencies. Real Estate The Company owns certain real estate that is neither material nor critical to its operations. Employees As of July 31, 2004, the Company had 3,006 employees, of whom 2,139 are paid on an hourly basis and 867 are paid on a salary basis. Of the 2,139 hourly paid employees, unions represent 61%. Of those employees represented by unions, Missouri Gas Energy employs 36%, New England Gas Company employs 32%, Panhandle Energy employs 18% and PG Energy employs 14%. Persons employed by segment are as follows: Distribution segment--1,862 persons; Transportation and Storage segment--1,060 persons; All Other subsidiary operations--20 persons. In addition, the corporate office of Southern Union employed a total of 64 persons. Effective May 1, 2004, the Company agreed to five-year contracts with each bargaining-unit representing Missouri Gas Energy employees. Effective April 1, 2004, the Company agreed to a three-year contract with a bargaining unit representing a portion of PG Energy employees. Effective, August 1, 2003, the Company agreed to a three-year contract with another bargaining unit representing the remaining PG Energy unionized employees. Effective May 28, 2003, Panhandle Energy agreed to a three-year contract with a bargaining unit representing Panhandle Energy employees. During fiscal 2003, the bargaining unit representing certain employees of New England Gas Company's Cumberland operations (formerly Valley Resources) was merged with the bargaining unit representing the employees of the Company's Fall River operations (formerly Fall River Gas). During fiscal 2002, the Company agreed to five-year contracts with two bargaining units representing employees of New England Gas Company's Providence operations (formerly ProvEnergy), which were effective May 2002; a four-year contract with one bargaining unit representing employees of New England Gas Company's Cumberland operations, effective May 2002; and a four-year contract with one bargaining unit representing employees of New England Gas Company's Fall River operations, effective April 2002; and a one year extension of a bargaining unit representing certain employees of the Company's Cumberland operations. Following its acquisition by the Company in June 2003, Panhandle Energy initiated a workforce reduction initiative designed to reduce the workforce by approximately 5 percent. The workforce reduction initiative was an involuntary plan with a voluntary component, and was fully implemented by September 30, 2003. In August 2001, the Company implemented a corporate reorganization and restructuring which was initially announced in July 2001 as part of the Cash Flow Improvement Plan. Actions taken included (i) the offering of voluntary Early Retirement Programs ("ERPs") in certain of its Distribution segment operations and (ii) a limited reduction in force ("RIF") within its corporate operations. ERPs, providing for increased benefits for those electing retirement, were offered to approximately 325 eligible employees across the Distribution segment operations, with approximately 59% 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 (see Item 7. Management's Discussion and Analysis - Results of Operations (Business Restructuring Charges)). The Company believes that its relations with its employees are good. From time to time, however, the Company may be subject to labor disputes. The Company did not experience any strikes or work stoppages during fiscal 2004 and 2003. During fiscal 2002, the Company and one of five bargaining units representing New England Gas Company employees (comprising approximately 8% of Southern Union's total workforce at that time) were unable to reach agreement on the renewal of a contract that expired in January 2002. The resulting work stoppage, which did not have a material adverse effect on the Company's results of operations, financial condition or cash flows for fiscal 2002, was settled in May 2002 when the Company and the bargaining unit agreed to a new five-year contract. Available Information The Company files annual, quarterly and special reports, proxy statements and other information with the Securities and Exchange Commission (SEC). Any document the Company files with the SEC may be read or copied at the SEC's public reference room at 450 Fifth Street, N.W., Washington, D.C. 20549. Please call the SEC at 1-800-SEC-0330 for information on the public reference room. The Company's SEC filings are also available at the SEC's website at http://www.sec.gov and through the Company's website at http://www.southernunionco.com. The information on Southern Union's website is not incorporated by reference into and is not made a part of this report. ITEM 2. Properties. Transportation and Storage See ITEM 1. Business - Transportation and Storage Segment for information concerning the general location and characteristics of the important physical properties and assets of the Transportation and Storage segment. Distribution See ITEM 1. Business - Distribution Segment for information concerning the general location and characteristics of the important physical properties and assets of the Distribution segment. Other Power Corp. retains ownership of two electric power plants that share a site in Archbald, Pennsylvania. Power Corp. acquired the first plant, a 25-megawatt cogeneration facility fueled by a combination of natural gas and methane, in November 1997. During fiscal 2001, Power Corp. constructed an additional 45-megawatt, natural gas-fired plant in a joint venture with Cayuga Energy. Power Corp. owns 49.9% of the second plant. ITEM 3. Legal Proceedings. See Note XVIII - Commitments and Contingencies for a discussion of the Company's legal proceedings. See ITEM 7. Management's Discussion and Analysis - Other Matters (Cautionary Statement Regarding Forward-Looking Information). ITEM 4. Submission of Matters to a Vote of Security Holders. There were no matters submitted to a vote of security holders of Southern Union during the quarter ended June 30, 2004. PART II ITEM 5. Market for the Registrant's Common Stock and Related Stockholder Matters. Market Information Southern Union's common stock is traded on the New York Stock Exchange under the symbol "SUG". The high and low sales prices (adjusted for any stock dividends) for shares of Southern Union common stock since July 1, 2002 are set forth below: $/Share --------------- High Low ------ ----- July 1 to August 16, 2004...................................$ 20.48 $18.00 (Quarter Ended) June 30, 2004........................................... 20.33 17.98 March 31, 2004.......................................... 18.81 16.90 December 31, 2003....................................... 17.82 15.88 September 30, 2003...................................... 17.00 14.10 (Quarter Ended) June 30, 2003........................................... 16.19 10.98 March 31, 2003.......................................... 15.62 10.95 December 31, 2002....................................... 15.41 9.21 September 30, 2002...................................... 15.48 9.25 Holders As of August 16, 2004, there were 6,876 holders of record of Southern Union's common stock and 81,886,254 shares of Southern Union's common stock outstanding. The holders of record do not include persons whose shares are held of record by a bank, brokerage house or clearing agency, but does include any such bank, brokerage house or clearing agency that is a holder of record. The shares as of August 16, 2004 reflect the 5% stock dividend distributed on August 31, 2004, as further discussed below. On August 16, 2004, 62,294,648 shares of Southern Union's common stock were held by non-affiliates (any director or executive officer, any of their immediate family members, or any holder known to be the beneficial owner of 10% or more of shares outstanding). Dividends Provisions in certain of Southern Union's long-term debt and its bank credit facilities limit the payment of cash or asset dividends on capital stock. Under the most restrictive provisions in effect, Southern Union may not declare or pay any cash or asset dividends on its common stock or acquire or retire any of Southern Union's common stock, unless no event of default exists and the Company meets certain financial ratio requirements, which presently are met. Southern Union's ability to pay cash dividends may be limited by debt restrictions at Panhandle Energy that could limit Southern Union's access to funds from Panhandle Energy for debt service or dividends. Southern Union has a policy of reinvesting its earnings in its businesses, rather than paying cash dividends. Since 1994, Southern Union has distributed an annual stock dividend of 5%. There have been no cash dividends on its common stock during this period. On August 31, 2004, July 31, 2003, and July 15, 2002, the Company distributed its annual 5% common stock dividend to stockholders of record on August 20, 2004, July 17, 2003, and July 1, 2002, respectively. A portion of the 5% stock dividend distributed on July 15, 2002 was characterized as a distribution of capital due to the level of the Company's retained earnings available for distribution as of the declaration date. Equity Compensation Plans Equity compensation plans approved by stockholders include the 2003 Stock and Incentive Plan, and the 1992 Long-Term Stock Incentive Plan (1992 Plan) in which options are still outstanding but no shares are available for future grant as the 1992 Plan expired on July 1, 2002. Under both plans, stock options are generally issued at the fair market value on the date of grant and typically vest ratably over five years. Equity compensation plans not approved by stockholders include the Pennsylvania Division Stock Incentive Plan and the Pennsylvania Division 1992 Stock Option Plan which were both assumed by Southern Union upon the November 4, 1999 acquisition of Pennsylvania Enterprises, Inc. Following the acquisition, options were no longer awarded under these plans. The following table sets forth, for each type of equity compensation plan, the number of outstanding options and the number of shares remaining available for issuance as of June 30, 2004:
Number of Securities Remaining Available for Number of Securities Future Issuance Under to be issued Upon Weighted-Average Equity Compensation Exercise of Exercise Price of Plans (excluding securities Plan Category Outstanding Options Outstanding Options reflected in first column) ------------- ------------------- ------------------- -------------------------- Plans approved by shareholders 3,349,921 $ 14.36 6,620,773 Plans not approved by shareholders 664,564 $ 9.70 --
ITEM 6. Selected Financial Data.
As of and for the year ended June 30, ------------------------------------- 2004(a) 2003(a) 2002(b) 2001(c) 2000(d) ------- ------- ------- ------- ------- (dollars in thousands, except per share amounts) Total operating revenues....................... $ 1,799,974 $ 1,188,507 $ 980,614 $ 1,461,811 $ 566,833 Net earnings (loss): Continuing operations (e)................. 101,339 43,669 1,520 40,159 (10,251) Discontinued operations (f)............... -- 32,520 18,104 16,524 20,096 Available for common shareholders......... 101,339 76,189 19,624 57,285 9,845 Net earnings (loss) per diluted common share (g): Continuing operations .................... 1.30 .70 .02 .64 (.19) Discontinued operations................... -- .52 .29 .27 .37 Available for common shareholders......... 1.30 1.22 .31 .91 .18 Total assets................................... 4,572,458 4,590,938 2,680,064 2,907,299 2,021,460 Stockholders' equity........................... 1,261,991 920,418 685,346 721,857 735,455 Short-term debt and capital lease obligation................................ 99,997 734,752 108,203 5,913 2,193 Long-term debt and capital lease obligation, excluding current portion..... 2,154,615 1,611,653 1,082,210 1,329,631 733,774 Company-obligated mandatorily redeemable preferred securities of subsidiary trust.......................... -- 100,000 100,000 100,000 100,000 Average customers served (h)................... 948,831 945,705 942,849 970,927 605,000
(a) Panhandle Energy was acquired on June 11, 2003 and was accounted for as a purchase. The Panhandle Energy assets were included in the Company's Consolidated Balance Sheet at June 30, 2003 and its results of operations have been included in the Company's Consolidated Statement of Operations since June 11, 2003. For these reasons, the Consolidated Statement of Operations for the periods subsequent to the acquisition are not comparable to the same periods in prior years. (b) Effective July 1, 2001, the Company has ceased amortization of goodwill pursuant to the Financial Accounting Standards Board Standard Accounting for Goodwill and Other Intangible Assets. Goodwill, which was previously classified on the Consolidated Balance Sheet as additional purchase cost assigned to utility plant and amortized on a straight-line basis over forty years, is now subject to at least an annual assessment for impairment by applying a fair-value based test. Additionally, during fiscal year 2002, the Company recorded an after-tax restructuring charge of $8,990,000. See Note VII - Goodwill and Intangibles and Note XIV - Employee Benefits. (c) The New England Operations, formed through the acquisition of Providence Energy Corporation and Fall River Gas Company on September 28, 2000, and Valley Resources, Inc. on September 20, 2000, were accounted for as a purchase and are included in the Company's Consolidated Balance Sheet at June 30, 2001. The results of operations for the New England Operations have been included in the Company's Consolidated Statement of Operations since their respective acquisition dates. For these reasons, the Consolidated Statement of Operations for the periods subsequent to the acquisitions are not comparable to the same periods in prior years. (d) The Pennsylvania Operations were acquired on November 4, 1999 and were accounted for as a purchase. The Pennsylvania Operations' assets were included in the Company's Consolidated Balance Sheet at June 30, 2000 and its results of operations have been included in the Company's Consolidated Statement of Operations since November 4, 1999. For these reasons, the Consolidated Statement of Operations for the periods subsequent to the acquisition are not comparable to the same periods in prior years. (e) Net earnings from continuing operations is net of dividends on preferred stock. (f) Effective January 1, 2003, the Company sold its Southern Union Gas Company natural gas operating division and related assets, which have been accounted for as discontinued operations in the Consolidated Statement of Operations for the respective periods presented in this document. Net earnings from discontinued operations do not include any allocation of interest expense or other corporate costs, in accordance with generally accepted accounting principles. At the time of the sale, all outstanding debt of Southern Union Company and subsidiaries was maintained at the corporate level, and no debt was assumed by ONEOK, Inc. in the sale of the Texas Operations. (g) Earnings per share for all periods presented were computed based on the weighted average number of shares of common stock and common stock equivalents outstanding during the year adjusted for the 5% stock dividends distributed on August 31, 2004, July 31, 2003, July 15, 2002, August 30, 2001 and June 30, 2000. (h) Includes average customers served by continuing operations. ITEM 7. Management's Discussion and Analysis of Results of Operations and Financial Condition. Management's Discussion and Analysis of Results of Operations and Financial Condition is provided as a supplement to the accompanying consolidated financial statements and footnotes to help provide an understanding of Southern Union's financial condition, changes in financial condition and results of operations. The following section includes an overview of Southern Union's business as well as recent developments that the Company believes are important in understanding its results of operations, and to anticipate future trends in those operations. Subsequent sections include an analysis of Southern Union's results of operations on a consolidated basis and on a segment basis for each reportable segment, and information relating to Southern Union's liquidity and capital resources, quantitative and qualitative disclosures about market risk and other matters. Overview Southern Union Company (Southern Union and together with its subsidiaries, the Company) is primarily engaged in the transportation, storage and distribution of natural gas in the United States. The Company's interstate natural gas transportation and storage operations are conducted through Panhandle Energy, which operates more than 10,000 miles of interstate pipelines that transport natural gas from the Gulf of Mexico, South Texas and the Panhandle regions of Texas and Oklahoma to major U.S. markets in the Midwest and Great Lakes regions. The Company's local natural gas distribution operations are conducted through its three regulated utility divisions, Missouri Gas Energy, PG Energy and New England Gas Company, which collectively serve over 960,000 customers in Missouri, Pennsylvania, Rhode Island and Massachusetts. On June 11, 2003, Southern Union acquired Panhandle Energy from CMS Energy Corporation for approximately $581,729,000 in cash and 3,000,000 shares of Southern Union common stock (before adjustment for subsequent stock dividends) valued at approximately $48,900,000 based on market prices at closing of the Panhandle Energy acquisition and in connection therewith incurred transaction costs of approximately $31,922,000. At the time of the acquisition, Panhandle Energy had approximately $1,157,228,000 of debt principal outstanding that it retained. The Company funded the cash portion of the acquisition with approximately $437,000,000 in cash proceeds it received for the January 1, 2003 sale of its Texas operations, approximately $121,250,000 of the net proceeds it received from concurrent common stock and equity unit offerings (see Note X - Stockholders' Equity) and with working capital available to the Company. The Company structured the Panhandle Energy acquisition and the sale of its Texas operations to qualify as a like-kind exchange of property under Section 1031 of the Internal Revenue Code of 1986, as amended. The acquisition was accounted for using the purchase method of accounting in accordance with accounting principles generally accepted within the United States of America with the purchase price paid and acquisition costs incurred by the Company allocated to Panhandle Energy's net assets as of the acquisition date. The Panhandle Energy assets acquired and liabilities assumed have been recorded at their estimated fair value as of the acquisition date based on the results of outside appraisals. Panhandle Energy's results of operations have been included in the Consolidated Statement of Operations since June 11, 2003. Thus, the Consolidated Statement of Operations for the periods subsequent to the acquisition is not comparable to the same periods in prior years. Panhandle Energy is primarily engaged in the interstate transportation and storage of natural gas and also provides liquefied natural gas (LNG) terminalling and regasification services and is subject to the rules and regulations of the Federal Energy Regulatory Commission (FERC). The Panhandle Energy entities include Panhandle Eastern Pipe Line Company, LP (Panhandle Eastern Pipe Line), Trunkline Gas Company, LLC (Trunkline), a wholly-owned subsidiary of Panhandle Eastern Pipe Line, Sea Robin Pipeline Company (Sea Robin), a Louisiana joint venture and an indirect wholly-owned subsidiary of Panhandle Eastern Pipe Line, Trunkline LNG Company, LLC (Trunkline LNG) which is a wholly-owned subsidiary of Trunkline LNG Holdings, LLC (LNG Holdings), an indirect wholly-owned subsidiary of Panhandle Eastern Pipe Line and Pan Gas Storage, LLC (d.b.a. Southwest Gas Storage), a wholly-owned subsidiary of Panhandle Eastern Pipe Line. Collectively, the pipeline assets include more than 10,000 miles of interstate pipelines that transport natural gas from the Gulf of Mexico, South Texas and the Panhandle regions of Texas and Oklahoma to major U.S. markets in the Midwest and Great Lakes region. The pipelines have a combined peak day delivery capacity of 5.4 billion cubic feet (Bcf) per day and 72 Bcf of owned underground storage capacity and 6.3 Bcf of above ground LNG storage capacity. Trunkline LNG, located on Louisiana's Gulf Coast, operates one of the largest LNG import terminals in North America, based on current send out capacity. Upon acquiring Panhandle Energy it was determined that Panhandle Energy's operations could not be integrated efficiently into Southern Union, but that a new operating platform would have to be established. By doing this at Panhandle Energy, the Company obviated the need for any corporate information technology allocation and, established a more efficient platform from which to operate all of the Company's businesses. Direct integration savings of $15,000,000 were expected from this process of which, substantially, the entire amount has been achieved to date. Effective January 1, 2003, the Company completed the sale of its Southern Union Gas natural gas operating division and related assets to ONEOK, Inc. (ONEOK) for approximately $437,000,000 in cash resulting in a pre-tax gain of $62,992,000. In accordance with accounting principles generally accepted within the United States of America, the results of operations and gain on sale of the Texas operations have been segregated and reported as "discontinued operations" in the Consolidated Statement of Operations and as "assets held for sale" in the Consolidated Statement of Cash Flows for the respective periods. Results of Operations The Company's results of operations are discussed on a consolidated basis and on a segment basis for each of the two reportable segments. The Company's reportable segments include the Transportation and Storage segment and the Distribution segment. Segment results of operations are presented on an operating income basis, which is one of the financial measures that the Company uses to internally manage its business. For additional segment reporting information, see Note XXI - Reportable Segments. Consolidated Results The following table provides selected financial data regarding the Company's consolidated results of operations for fiscal 2004, 2003 and 2002:
Years Ended June 30, ------------------------------------------------ 2004 2003 2002 ------------- ------------- ------------- (thousands of dollars) Operating income: Distribution segment.......................................... $ 118,894 $ 142,762 $ 135,502 Transportation and storage segment............................ 193,702 9,635 -- All other..................................................... (3,514) 13 -- Business restructuring charges.................................... -- -- (29,159) Corporate..................................................... (3,555) (10,039) (15,218) ------------- ------------- ------------- Total operating income..................................... 305,527 142,371 91,125 Other income (expenses): Interest...................................................... (127,867) (83,343) (90,992) Dividends on preferred securities of subsidiary trust......... -- (9,480) (9,480) Other, net.................................................... 5,468 18,394 14,278 ------------- ------------- ------------- Total other expenses, net.................................. (122,399) (74,429) (86,194) ------------- ------------- ------------- Federal and state income taxes.................................... 69,103 24,273 3,411 ------------- ------------- ------------- Net earnings from continuing operations........................... 114,025 43,669 1,520 ------------- ------------- ------------- Discontinued operations: Earnings from discontinued operations before income taxes..... -- 84,773 29,801 Federal and state income taxes................................ -- 52,253 11,697 ------------- ------------- ------------- Net earnings from discontinued operations......................... -- 32,520 18,104 ------------- ------------- ------------- Net earnings ..................................................... 114,025 76,189 19,624 Preferred stock dividends......................................... (12,686) -- -- ------------- ------------- ------------- Net earnings available for common shareholders.................... $ 101,339 $ 76,189 $ 19,624 ============= ============= =============
Net Earnings - 2004 Compared to 2003. Southern Union Company's 2004 (fiscal year ended June 30) net earnings available for common shareholders were $101,339,000 ($1.30 per diluted share, hereafter referred to as per share), compared with $76,189,000 ($1.22 per share) in 2003. The $25,150,000 increase reflects a $57,670,000 increase in net earnings available for common shareholders from continuing operations (hereafter referred to as net earnings from continuing operations) and a $32,520,000 decrease in net earnings from discontinued operations, as further discussed below. Net earnings from continuing operations were $101,339,000 ($1.30 per share) in 2004 compared with $43,669,000 ($.70 per share) in 2003. The increase was primarily due to the following: o a $184,067,000 increase in operating income from the Transportation and Storage segment (see Business Segment Results - Transportation and Storage Segment); o a $6,484,000 decrease in corporate costs (see Corporate); and o a $9,480,000 decrease in dividends on preferred securities of subsidiary trust (see Dividends on Preferred Securities of Subsidiary Trust). The above items were partially offset by the following: o a $23,868,000 decrease in operating income from the Distribution segment (see Business Segment Results - Distribution Segment); o a $3,527,000 decrease in operating income from subsidiary operations included in the All Other category (see All Other Operations); o a $44,524,000 increase in interest expense (see Interest Expense); o a $12,926,000 decrease in other income (see Other Income (Expense), Net); o a $44,830,000 increase in income tax expense (see Federal and State Income Taxes); and o a $12,686,000 increase in preferred stock dividends (see Preferred Stock Dividends). Net earnings from discontinued operations were nil in 2004 compared with $32,520,000 ($.52 per share) in 2003. The Company sold its Texas operations effective January 1, 2003 (see Discontinued Operations). Net Earnings - 2003 Compared to 2002. Southern Union Company's 2003 net earnings available for common shareholders were $76,189,000 ($1.22 per share), compared with $19,624,000 ($.31 per share) in 2002. The $56,565,000 increase reflects a $42,149,000 increase in net earnings from continuing operations and a $14,416,000 increase in net earnings from discontinued operations, as further discussed below. Net earnings from continuing operations were $43,669,000 ($.70 per share) in 2003 compared with $1,520,000 ($.02 per share) in 2002. The increase was primarily due to the following: o a $7,260,000 increase in operating income from the Distribution segment (see Business Segment Results - Distribution Segment); o a $9,635,000 increase in operating income from the Transportation and Storage segment (see Business Segment Results - Transportation and Storage Segment); o a total of $29,159,000 in business restructuring charges, recorded in the first quarter of the fiscal 2002 with no comparable charge in fiscal 2003 (see Business Restructuring Charges); o a $5,179,000 decrease in corporate costs (see Corporate); o a $7,649,000 decrease in interest expense (see Interest Expense); and o a $4,116,000 increase in other income (see Other Income (Expense), Net). The above items were partially offset by a $20,862,000 increase in income tax expense (see Federal and State Income Taxes). Net earnings from discontinued operations were $32,520,000 ($.52 per share) in 2003 compared with $18,104,000 ($.29 per share) in 2002. The $14,416,000 increase was primarily due to the recording of an $18,928,000 after-tax gain on the sale of the Texas operations (see Discontinued Operations). All Other Operations. Operating income from subsidiary operations included in the All Other category in 2004 decreased by $3,527,000, resulting in a net operating loss of $3,514,000. The decrease in All Other operating income primarily reflects a $2,985,000 charge recorded by PEI Power Corporation in 2004 to provide for the estimated future debt service payments in excess of projected tax revenues for the tax incremental financing obtained for the development of PEI Power Park. Business Restructuring Charges. Business reorganization and restructuring initiatives were commenced in August 2001 as part of a previously announced Cash Flow Improvement Plan. Actions taken included (i) the offering of voluntary Early Retirement Programs (ERPs) in certain of its operating divisions and (ii) a limited reduction in force (RIF) within its corporate offices. ERPs, providing for increased benefits for those electing retirement, were offered to approximately 325 eligible employees across the Company's operating divisions, with approximately 59% 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 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. Corporate. Operating loss from Corporate operations in 2004 decreased by $6,484,000, or 65%, to $3,555,000. The decrease in Corporate operating loss primarily reflects the impact of the direct allocation and recording of various services provided by Corporate to Panhandle Energy in 2004, that were not applicable in 2003 due to the timing of the Panhandle Energy acquisition. Operating loss from Corporate operations in 2003 decreased by $5,179,000, or 34%, to $10,039,000. The decrease in Corporate operating loss primarily reflects the impact of the previously discussed business reorganization and restructuring initiatives that were commenced in August 2001. Interest Expense. Total interest expense in 2004 increased by $44,524,000, or 53%, to $127,867,000. Interest expense in 2004 was impacted by interest expense on Panhandle Energy debt of $47,628,000 (net of $10,783,000 of amortization of debt premiums established in purchase accounting related to the Panhandle Energy acquisition) and by $3,160,000 related to dividends on preferred securities of subsidiary trust (see Dividends on Preferred Securities of Subsidiary Trust). This increase was partially offset by decreased interest expense of $4,366,000 on the $311,087,000 bank note (the 2002 Term Note) entered into by the Company on July 15, 2002 to refinance a portion of the $485,000,000 Term Note entered into by the Company on August 28, 2000 to (i) fund the cash consideration paid to stockholders of Fall River Gas, ProvEnergy and Valley Resources, (ii) refinance and repay long- and short-term debt assumed in the New England Operations, and (iii) acquisition costs of the New England Operations. This decrease in the 2002 Term Note interest was due to reductions in LIBOR rates during fiscal 2004 and the principal repayment of $200,000,000 of the 2002 Term Note since its inception. Panhandle Energy's debt premium amortization is expected to be lower in 2005 than during 2004 due to post-acquisition debt retirements, while cash interest should be lower and partially offset the lower premium amortization. The average rate of interest on all debt decreased from 5.6% in 2003 to 5.1% in 2004. Interest expense on short-term debt in 2004 decreased by $627,000, or 7%, to $8,041,000, primarily due to the decrease in the average amount of short-term debt outstanding from $223,350,000 to $163,200,000 during the year. The decrease in the average amount of short-term debt outstanding during 2004 was primarily due to cash generated from operations, the excess proceeds from capital markets issuances over the amounts used for the redemption of securities, and the reduction of the Company's beginning of the year cash balances. Draws on short-term debt arise as Southern Union is required to make payments to natural gas suppliers in advance of the receipt of cash payments from the Company's customers and to fund other working capital requirements, if other funds are not then available. The average rate of interest on short-term debt decreased from 2.4% to 2.0% in 2004. Total interest expense in 2003 decreased by $7,649,000, or 8%, to $83,343,000. Interest expense decreased by $9,181,000 in 2003 on the $311,087,000 2002 Term Note due to reductions in LIBOR rates during 2003 and the principal repayment of $100,000,000 of the 2002 Term Note during 2003. The Company recorded $1,760,000 in interest on long-term debt related to the Panhandle Energy properties in 2003. Interest expense on short-term debt in 2003 increased by $1,481,000, or 21%, to $8,668,000, primarily due to the increase in the average amount of short-term debt outstanding from $176,600,000 to $223,350,000 during the year. The increase in the average amount of short-term debt outstanding during 2003 was primarily due to (i) higher than normal short-term debt outstanding due to high gas costs and accounts receivable in 2003 and (ii) the repayment of various principal amounts of the 2002 Term Note and other long-term debt with borrowings under the Company's credit facilities. The average rate of interest on short-term debt decreased from 3.2% to 2.4% in 2003. Dividends on Preferred Securities of Subsidiary Trust. Dividends on preferred securities of subsidiary trust in 2004, 2003 and 2002 were nil, $9,480,000 and $9,480,000, respectively. Effective July 1, 2003, the Company adopted the Financial Accounting Standards Board (FASB) standard, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity, which requires dividends on preferred securities of subsidiary trusts to be classified as interest expense; the reclassification of amounts reported as dividends in prior periods is not permitted. In accordance with the Statement, $3,160,000 of dividends on preferred securities of subsidiary trust recorded by the Company during the period July 1, 2003 to October 31, 2003 were classified as interest expense in 2004 (see Interest Expense). On October 1, 2003, the Company called the Subordinated Notes for redemption, and the Subordinated Notes and Preferred Securities were redeemed on October 31, 2003 (see Note XII - Preferred Securities). Other Income (Expense), Net. Other income, net in 2004 was $5,468,000 compared with $18,394,000 in 2003. Other income in 2004 includes a gain of $6,354,000 on the early extinguishment of debt and income of $2,230,000 generated from the sale and/or rental of gas-fired equipment and appliances from various operating subsidiaries. These items were partially offset by charges of $1,603,000 and $1,150,000 to reserve for the impairment of Southern Union's investments in a technology company and in an energy-related joint venture, respectively, and $836,000 of legal costs associated with the Company's attempt to collect damages from former Arizona Corporation Commissioner James Irvin related to the Southwest Gas Corporation (Southwest) litigation. Other income, net, in 2003 of $18,394,000 includes a gain of $22,500,000 on the settlement of the Southwest litigation and income of $2,016,000 generated from the sale and/or rental of gas-fired equipment and appliances. These items were partially offset by $5,949,000 of legal costs related to the Southwest litigation and $1,298,000 of selling costs related to the Texas operations' disposition. Other income, net, in 2002 of $14,278,000 includes gains of $17,166,000 generated through the settlement of several interest rate swaps, the recognition of $6,204,000 in previously recorded deferred income related to financial derivative energy trading activity, a gain of $4,653,000 realized through the sale of marketing contracts held by Energy Services, income of $2,234,000 generated from the sale and/or rental of gas-fired equipment and appliances, a gain of $1,200,000 realized through the sale of the propane assets of Energy Services, $1,004,000 of realized gains on the sale of investment securities, and power generation and sales income of $971,000. These items were partially offset by a non-cash charge of $10,380,000 to reserve for the impairment of the Company's investment in a technology company, $9,100,000 of legal costs associated with Southwest, and a $1,500,000 loss on the sale of South Florida Natural Gas and Atlantic Gas Corporation (the Florida Operations). Federal and State Income Taxes. Federal and state income tax expense from continuing operations in 2004, 2003 and 2002 was $69,103,000, $24,273,000 and $3,411,000, respectively. The Company's consolidated federal and state effective income tax rate was 38%, 36% and 69% in 2004, 2003 and 2002, respectively. The fluctuation in the effective federal and state income tax rate in 2004 compared with 2003 is primarily the result of the state income tax effect resulting from the operations of Panhandle Energy being included in the consolidated results of the Company for the entire year in 2004. The fluctuation in the effective federal and state income tax rate in 2003 compared with 2002 is primarily the result of non-tax deductible write-off of goodwill in 2002 as a result of the sale of the Florida Operations, along with the change in the level of pre-tax earnings. Preferred Stock Dividends. Dividends on preferred securities in 2004, 2003 and 2002 were $12,686,000, nil and nil, respectively. On October 8, 2003, the Company issued $230,000,000 of 7.55% Non-Cumulative Preferred Stock, Series A to the public. See ITEM 7. Management's Discussion and Analysis - Financial Condition. Discontinued Operations. Net earnings from discontinued operations in 2004, 2003 and 2002 were nil, $32,520,000 and $18,104,000, respectively. The Company completed the sale of its Texas operations effective January 1, 2003, resulting in the recording of an after-tax gain on sale of $18,928,000 during 2003 that is reported in earnings from discontinued operations in accordance with the FASB standard, Accounting for the Impairment or Disposal of Long-Lived Assets. The after-tax gain on the sale of the Texas operations was impacted by the elimination of $70,469,000 of goodwill related to these operations which was primarily non-tax deductible. Employees. The Company's continuing operations employed 3,012, 3,041, and 1,855 individuals as of June 30, 2004, 2003 and 2002, respectively. After gas purchases and taxes, employee costs and related benefits are the Company's most significant expense. Such expense includes salaries, payroll and related taxes, and employee benefits such as health, savings, retirement and educational assistance. Effective May 1, 2004, the Company agreed to five-year contracts with each bargaining-unit representing Missouri Gas Energy employees. Effective April 1, 2004, the Company agreed to a three-year contract with a bargaining unit representing a portion of PG Energy employees. Effective, August 1, 2003, the Company agreed to a three-year contract with another bargaining unit representing the remaining PG Energy unionized employees. Effective May 28, 2003, Panhandle Energy agreed to a three-year contract with a bargaining unit representing Panhandle Energy employees. During fiscal 2003, the bargaining unit representing certain employees of New England Gas Company's Cumberland operations (formerly Valley Resources) was merged with the bargaining unit representing the employees of the Company's Fall River operations (formerly Fall River Gas). During fiscal 2002, the Company agreed to five-year contracts with two bargaining units representing employees of New England Gas Company's Providence operations (formerly ProvEnergy), which were effective May 2002; a four-year contract with one bargaining unit representing employees of New England Gas Company's Cumberland operations, effective May 2002; and a four-year contract with one bargaining unit representing employees of New England Gas Company's Fall River operations, effective April 2002; and a one year extension of a bargaining unit representing certain employees of the Company's Cumberland operations. Business Segment Results Distribution Segment -- The Company's Distribution segment is primarily engaged in the local distribution of natural gas in Missouri, Pennsylvania, Rhode Island and Massachusetts. Its operations are conducted through the Company's three regulated utility divisions: Missouri Gas Energy, PG Energy and New England Gas Company. Collectively, the utility divisions serve over 960,000 residential, commercial and industrial customers through local distribution systems consisting of 14,243 miles of mains, 9,605 miles of service lines and 76 miles of transmission lines. The utility divisions' operations are regulated as to rates and other matters by the regulatory commissions of the states in which each operates. The utility divisions' operations are generally sensitive to weather and seasonal in nature, with a significant percentage of annual operating revenues and net earnings occurring in the traditional winter heating season in the first and fourth calendar quarters. In fiscal 2004, this segment represented 72 percent of the Company's total operating revenues. The Company's management is committed to achieving profitable growth of its utility divisions in an increasingly competitive business environment and to enhance shareholder value. Management's strategies for achieving these objectives principally consist of: (i) to focus the divisions in meeting their allowable rates of returns; (ii) manage capital spending and operating costs without sacrificing customer safety or quality of service; and (iii) solidify the Company's relationships with regulatory bodies that oversee the various operations. Further, when appropriate, management will continue to seek rate increases within each division. Management develops and continually evaluates these strategies and their implementation by applying their experience and expertise in analyzing the energy industry, technological advances, market opportunities and general business trends. Each of these strategies, as implemented throughout the Company's existing divisions, reflects the Company's commitment to its natural gas utility business. The following table provides summary data regarding the Distribution segment's results of operations for fiscal 2004, 2003 and 2002:
Years Ended June 30, ------------------------------------------------ 2004 2003 2002 ------------- ------------- ------------- (thousands of dollars) Financial Results Operating revenues................................................ $ 1,304,405 $ 1,158,964 $ 968,933 Cost of gas and other energy...................................... (863,637) (723,719) (568,447) Revenue-related taxes............................................. (45,395) (40,485) (33,410) ------------- ------------- ------------- Net operating revenues, excluding depreciation and amortization............................................... 395,373 394,760 367,076 Operating expenses: Operating, maintenance, and general........................... 194,394 171,463 154,906 Depreciation and amortization................................. 57,601 56,396 53,937 Taxes other than on income and revenues....................... 24,484 24,139 22,731 ------------- ------------- ------------- Total operating expense.................................... 276,479 251,998 231,574 ------------- ------------- ------------- Operating income........................................... $ 118,894 $ 142,762 $ 135,502 ============= ============= ============= Operating Information Gas sales volumes (MMcf).......................................... 112,271 122,115 101,036 Gas transported volumes (MMcf).................................... 60,848 66,218 65,757 Weather: Degree Days: Missouri Gas Energy service territories.................... 4,770 5,105 4,419 PG Energy service territories.............................. 6,240 6,654 5,373 New England Gas Company service territories................ 5,644 6,143 4,980 Percent of 30-year measure: Missouri Gas Energy service territories.................... 92% 98% 85% PG Energy service territories.............................. 103% 106% 86% New England Gas Company service territories................ 102% 107% 85%
Operating Revenues. Operating revenues in 2004 compared with 2003 increased $145,441,000, or 13%, to $1,304,405,000 while gas purchase and other energy costs increased $139,918,000, or 19%, to $863,637,000. The increase in both operating revenues and gas purchase costs between periods was primarily due to a 30% increase in the average cost of gas from $5.93 per thousand cubic feet (Mcf) in 2003 to $7.69 per Mcf in 2004, which was partially offset by an 8% decrease in gas sales volumes to 112,271 million cubic feet (MMcf) in 2004 from 122,115 MMcf in 2003. The increase in the average cost of gas is due to increases in the average spot market prices throughout the Company's distribution system as a result of current competitive pricing occurring within the entire energy industry. The decrease in gas sales volumes is primarily due to warmer weather in 2004 as compared with 2003 in all of the Company's service territories. Additionally impacting operating revenues in 2004 was a $4,910,000 increase in gross receipt taxes primarily due to an increase in gas purchase and other energy costs. Gross receipt taxes are levied on sales revenues billed to the customers and remitted to the various taxing authorities. Gas purchase costs generally do not directly affect earnings since these costs are passed on to customers pursuant to purchase gas adjustment (PGA) clauses. Accordingly, while changes in the cost of gas may cause the Company's operating revenues to fluctuate, net operating revenues are generally not affected by increases or decreases in the cost of gas. Increases in gas purchase costs indirectly affect earnings as the customer's bill increases, usually resulting in increased bad debt and collection costs being recorded by the Company. Gas transportation volumes in 2004 decreased 5,370 MMcf, or 8%, to 60,848 MMcf at an average transportation rate per Mcf of $.58 in 2003 and $.57 in 2004. Gas transportation volumes were impacted by certain customers utilizing alternative energy sources such as fuel oil, customer closure of certain facilities and various customers reducing production. Operating revenues in 2003 compared with 2002 increased $190,031,000, or 20%, to $1,158,964,000 while gas purchase and other energy costs increased $155,272,000, or 27%, to $723,719,000. The increase in both operating revenues and gas purchase and other energy costs between periods was primarily due to a 21% increase in gas sales volumes to 122,115 MMcf in 2003 from 101,036 MMcf in 2002 and by a 5% increase in the average cost of gas from $5.63 per Mcf in 2002 to $5.93 per Mcf in 2003. The increase in gas sales volume is primarily due to colder weather in 2003 as compared with 2002 in all of the Company's service territories. The increase in the average cost of gas is due to increases in average spot market gas prices throughout the Company's distribution system as a result of seasonal impacts on demands for natural gas as well as the competitive pricing occurring within the entire energy industry. Additionally impacting operating revenues in 2003 was a $7,076,000 increase in gross receipt taxes primarily due to an increase in gas purchase and other energy costs. Gas transportation volumes in 2003 increased 461 MMcf to 66,218 MMcf at an average transportation rate per Mcf of $.56 in 2002 and $.58 in 2003. Net Operating Revenues. Net operating revenues (which the Company formerly referred to as operating margin) in 2004 increased by $613,000, compared with an increase of $27,684,000 in 2003. Net operating revenues and earnings are primarily dependent upon gas sales volumes and gas service rates. The level of gas sales volumes is sensitive to the variability of the weather as well as the timing of acquisitions. Sales volumes, which benefited from colder-than-normal weather in 2004 and 2003 in the Company's Pennsylvania and New England service territories, were negatively impacted by unusually mild temperatures in all of the Company's service territories in 2002. Net operating revenues in 2003 were impacted by the RIPUC Settlement Offer of $5,227,000 filed by New England Gas Company related to excess revenues earned during the 21-month period covered by the Energize Rhode Island Extension settlement agreement. Missouri, Pennsylvania and New England accounted for 40%, 21% and 39%, respectively, of the segment's net operating revenues in 2004 and 37%, 24% and 39%, respectively, in 2003. Customers. The average number of customers served in 2004, 2003 and 2002 was 948,300, 944,657 and 935,229, respectively. Changes in customer totals between years primarily reflect growth, net of attrition, throughout the Company's service territories. Missouri Gas Energy served 494,875 customers in central and western Missouri. PG Energy served 157,864 customers in northeastern and central Pennsylvania, and New England Gas Company served 297,239 customers in Rhode Island and Massachusetts during 2004. Operating Expenses. Operating, maintenance and general expenses in 2004 increased $22,931,000, or 13%, to $194,394,000. The increase is primarily due to $8,917,000 of increased pension and other post retirement benefits costs primarily due to the impact of stock market volatility on plan assets, $6,371,000 of increased bad debt expense resulting from higher customer receivables due to higher gas prices, $1,596,000 of increased medical costs, $1,468,000 of increased insurance premiums and increased employee payroll costs due to general wage increases and increased overtime due to system maintenance and Sarbanes-Oxley Section 404 documentation procedures. Depreciation and amortization expense in 2004 increased $1,205,000 to $57,601,000. The increase was primarily due to normal growth in plant. Operating, maintenance and general expenses in 2003 increased $16,557,000, or 11%, to $171,463,000. The increase is primarily due to $6,370,000 of increased pension and other postretirement benefit costs as a result of volatility in the stock markets, $4,265,000 of increased insurance expense, and $3,547,000 of increased bad debt expense resulting from higher customer receivables due to higher gas prices and colder weather in 2003. The Company also experienced increases in employee payroll and other operating and maintenance costs as a result of the colder weather in 2003. These items were partially offset by realized savings in operating costs from the Cash Flow Improvement Plan (see Business Restructuring Charges). Depreciation and amortization expense in 2003 increased $2,459,000 to $56,396,000. The increase was primarily due to normal growth in plant. Taxes other than on income and revenues, principally consisting of property, payroll and state franchise taxes increased $1,408,000 to $24,139,000 in 2003, primarily due to an increase in state franchise taxes. Transportation and Storage Segment -- The Transportation and Storage segment is primarily engaged in the interstate transportation and storage of natural gas in the Midwest and Southwest, and also provides LNG terminalling and regasification services. Its operations are conducted through Panhandle Energy, which the Company acquired on June 11, 2003. In fiscal 2004, this segment represented 27 percent of the Company's total operating revenues. Panhandle Energy operates a large natural gas pipeline network, consisting of more than 10,000 miles of pipeline with approximately 87 Bcf of total available storage, which provides approximately 500 customers in the Midwest and Southwest with a comprehensive array of transportation and storage services. Panhandle Energy also operates one of the largest LNG terminal facilities in North America. Panhandle Energy's operations are regulated as to rates and other matters by FERC, and are somewhat sensitive to the weather and seasonal in nature with a significant percentage of annual operating revenues and net earnings occurring in the traditional winter heating season. The results of operations from Panhandle Energy have been included in the Consolidated Statement of Operations since June 11, 2003. The following table provides summary data regarding the Transportation and Storage segment's results of operations for fiscal 2004 and 2003 (from June 12 to June 30, 2003).
June 12, 2003 Year Ended to June 30, 2004 June 30, 2003 ------------- ------------- (thousands of dollars) Financial Results Natural gas transportation and storage revenues................... $ 423,755 $ 20,601 LNG terminalling revenues......................................... 57,988 3,244 Other revenues .................................................. 9,340 684 ----------------- ----------------- Total operating revenues...................................... 491,083 24,529 Operating expenses: Operating, maintenance, and general........................... 210,105 10,102 Depreciation and amortization................................. 59,988 3,197 Taxes other than on income and revenues....................... 27,288 1,595 ----------------- ----------------- Total operating expense.................................... 297,381 14,894 ----------------- ----------------- Operating income........................................... $ 193,702 $ 9,635 ================= ================= Operating Information Volumes transported (TBtu)........................................ 1,321 69
As a result of the acquisition, Panhandle Energy's assets acquired and liabilities assumed were recorded at estimated fair value as of the acquisition date based on the results of outside appraisals. The most significant impact of recording the assets and liabilities at fair value going forward, as compared to pre-acquisition operations, are expected to be higher depreciation expense due to the step-up of depreciable assets, assignment of purchase price to certain amortizable intangible assets, and lower interest costs (though not cash payments) for the remaining life of debt due to its revaluation and related debt premium amortization. Liquidity and Capital Resources Operating Activities. The seasonal nature of Southern Union's business results in a high level of cash flow needs to finance gas purchases and other energy costs, outstanding customer accounts receivable and certain tax payments. Additionally, significant cash flow needs may be required to finance current debt service obligations. To provide these funds, as well as funds for its continuing construction and maintenance programs, the Company has historically used cash flows from operations and its credit facilities. Because of available credit and the ability to obtain various types of market financing, combined with anticipated cash flows from operations, management believes it has adequate financial flexibility and access to financial markets to meet its short-term cash needs. The Company has increased the scale of its natural gas transportation, storage and distribution operations and the size of its customer base by pursuing and consummating business acquisitions. On June 11, 2003, the Company acquired Panhandle Energy (see Note II -- Acquisitions and Sales). Acquisitions require a substantial increase in expenditures that may need to be financed through cash flow from operations or future debt and equity offerings. The availability and terms of any such financing sources will depend upon various factors and conditions such as the Company's combined cash flow and earnings, the Company's resulting capital structure, and conditions in the financial markets at the time of such offerings. Acquisitions and financings also affect the Company's combined results due to factors such as the Company's ability to realize any anticipated benefits from the acquisitions, successful integration of new and different operations and businesses, and effects of different regional economic and weather conditions. Future acquisitions or related acquisition financing or refinancing may involve the issuance of shares of the Company's common stock, which could have a dilutive effect on the then-current stockholders of the Company. See Item 7. Management's Discussion and Analysis - Other Matters Cautionary Statement Regarding Forward-Looking Information. Cash flows provided by operating activities were $341,050,000 in 2004 compared with cash flows provided by operating activities of $55,696,000 in 2003 and $273,616,000 for 2002. Cash flows provided by operating activities before changes in operating assets and liabilities for 2004 were $306,675,000 compared with $147,061,000 and $177,715,000 for 2003 and 2002, respectively. Changes in operating assets and liabilities provided cash of $34,375,000 in 2004. Changes in operating assets and liabilities used cash of $91,365,000 in 2003 and provided cash of $95,901,000 in 2002. The unusually high accounts receivable balance that occurred due to high gas costs during both 2004 and 2003, the normal delay in the recovery of deferred gas purchase costs due to the regulatory lag in passing along such changes in purchased gas costs to customers and funds expended for replenishing natural gas stored in inventory in greater volumes and at higher rates, impacted working capital in both 2004 and 2003. At June 30, 2004, 2003 and 2002, the Company's primary source of liquidity included borrowings available under the Company's credit facilities. On May 28, 2004, the Company entered into a new five-year long-term credit facility in the amount of $400,000,000 (the Long-Term Facility) that matures on May 29, 2009. The Long-Term Facility replaced the Company's $150,000,000 and $225,000,000 credit facilities that expired on April 1, 2004 and May 29, 2004, respectively. The Company has additional availability under uncommitted line of credit facilities (Uncommitted Facilities) with various banks. Borrowings under the Long-Term Facility are available for Southern Union's working capital, letter of credit requirements and other general corporate purposes. The Long-Term Facility is subject to a commitment fee based on the rating of the Company's senior unsecured notes (the Senior Notes). As of June 30, 2004, the commitment fees were an annualized 0.15%. The Long-Term Facility requires the Company to meet certain covenants in order for the Company to be able to borrow under that agreement. A balance of $21,000,000 and $251,500,000 was outstanding under the Company's credit facilities at June 30, 2004 and 2003, respectively. As of August 16, 2004, there was a balance of $79,500,000 outstanding under the Long-Term Facility. The Company leases certain facilities, equipment and office space under cancelable and noncancelable operating leases. The minimum annual rentals under operating leases for the next five years ending June 30 are as follows: 2005--$17,777,000; 2006--$14,708,000; 2007--$13,970,000; 2008--$10,018,000; 2009--$6,549,000 and thereafter $8,102,000. The Company is also committed under various agreements to purchase certain quantities of gas in the future. At June 30, 2004, the Company's Distribution segment has purchase commitments for natural gas transportation services, storage services and certain quantities of natural gas at a combination of fixed, variable and market-based prices that have an aggregate value of approximately $1,099,972,000. The Company's purchase commitments may be extended over several years depending upon when the required quantity is purchased. The Company has purchase gas tariffs in effect for all its utility service areas that provide for recovery of its purchase gas costs under defined methodologies and the Company believes that all costs incurred under such commitments will be recovered through its purchase gas tariffs. Investing Activities. Cash flow used in investing activities increased $35,649,000 to $227,009,000 in 2004. Cash flow used in investing activities in 2003 increased $152,134,000 to $191,360,000. Investing activity cash flow was primarily affected by additions to property, plant and equipment, acquisition and sales of operations, and the settlement of interest rate swaps. During 2004, 2003 and 2002, the Company expended $226,053,000, $79,730,000, and $70,698,000, respectively, for capital expenditures excluding acquisitions. The Transportation and Storage segment expended $131,378,000 and $5,128,000 for capital expenditures in 2004 and 2003 (from June 12 to June 30, 2003), respectively. Included in these capital expenditures were a total of $67,087,000 and $1,166,000 relating to the LNG terminal Phase I and Phase II expansions and the Trunkline 30-inch diameter, 23-mile natural gas pipeline loop from the LNG terminal in 2004 and 2003, respectively. The remaining capital expenditures for the last three years primarily related to Distribution segment system replacement and expansion. Included in these capital expenditures were $6,878,000, $9,094,000, and $7,860,000 for the Missouri Gas Energy Safety Program in 2004, 2003 and 2002, respectively. Cash flow provided by operations has historically been utilized to finance capital expenditures and is expected to be the primary source for future capital expenditures. In June 2003, Southern Union acquired Panhandle Energy for approximately $581,729,000 in cash plus 3,000,000 shares of Southern Union common stock (before adjustment for any subsequent stock dividends). On the date of acquisition, Panhandle Energy had approximately $60,000,000 in cash and cash equivalents. In January 2003, the Company completed the sale of its Southern Union Gas natural gas operating division and related assets for approximately $437,000,000 in cash resulting in a pre-tax gain of $62,992,000. During 2003 and 2002, the Company expended $13,410,000 and $23,215,000, respectively, for capital expenditures relating to the assets of these operations which have been classified as held for sale. During 2004 and 2002, the Company sold non-core subsidiaries and assets which generated proceeds of $2,175,000 and $40,935,000, respectively, resulting in a net pre-tax loss of $1,150,000 in 2004 and net pre-tax gains of $4,914,000 in 2002. In September 2001, the settlement of three interest rate swaps which the Company had negotiated in July and August of 2001 and which were not designated as hedges, resulted in a pre-tax gain and cash flow of $17,166,000. The Company estimates expenditures associated with the Phase I and Phase II LNG terminal expansions and the Trunkline 30-inch diameter, 23-mile natural gas pipeline loop from the LNG terminal, excluding capitalized interest, to be $172,947,000 over the next 3 fiscal years. These estimates were developed for budget planning purposes and are subject to revision. On June 24, 2004, CCE Holdings, LLC (CCE Holdings), a joint venture of the Company and its equity partner, GE Commercial Finance Energy Financial Services, entered into a Purchase Agreement to acquire for cash 100% of the equity interests of CrossCountry Energy, LLC (CrossCountry) from Enron Corp. and its affiliates for a total transaction value of approximately $2,350,000,000, including assumed debt. The Purchase Agreement was granted "Stalking Horse" status by the United States Bankruptcy Court for the Southern District of New York by an Order entered June 24, 2004, which Order set forth certain bid procedures by which third-parties may submit higher and/or better offers through a court mandated auction process. Third-party bids had to be submitted by August 23, 2004 in order to be eligible to participate in the September 1, 2004 auction. If CCE Holdings is the successful bidder, the closing of the acquisition will then be subject to approval by certain state regulatory bodies, in addition to satisfaction of additional closing conditions. Closing is anticipated to occur no later than December 17, 2004. If CCE Holdings is not the successful bidder, approximately $3,890,000 of acquisition-related costs incurred by the Company in fiscal 2004 and included in the Consolidated Balance Sheet at June 30, 2004, would be expensed in fiscal 2005. CrossCountry holds interests in and operates Transwestern Pipeline Company (Transwestern), Citrus Corp. (Citrus) and Northern Plains Natural Gas Company (Northern Plains). The pipeline system owned or operated by CrossCountry is comprised of approximately 9,700 miles of pipeline and approximately 8.5 Bcf per day of natural gas capacity. Transwestern owns and operates an approximately 2,400-mile pipeline that transports natural gas from the San Juan, Anadarko and Permian Basins to markets in the Mid-Continent, Texas, Arizona, New Mexico and California. Its bi-directional flow capabilities provide flexibility to adapt rapidly to regional demand. Its customers include local distribution companies, producers, marketers, electric power generators and industrial end-users. Citrus owns Florida Gas Transmission (FGT) - an approximately 5,000-mile natural gas pipeline extending from south Texas to south Florida with mainline capacity of 2.1 Bcf per day. FGT has access to diverse natural gas supplies from the Gulf of Mexico, Texas and Louisiana. With over 240 delivery points and delivery connections to more than 50 natural gas fired electric generation plants, FGT serves the rapidly growing Florida peninsula. Its customers include electric utilities, independent power producers, co-generation facilities, municipal generators and local distribution companies. Northern Plains holds ownership interests in Northern Border Pipeline Company, Midwestern Gas Transmission Company, Viking Gas Transmission Company and Guardian Pipeline, LLC. Pursuant to a 1989 MPSC order, Missouri Gas Energy is engaged in a major gas safety program in its service territories (Missouri Gas Energy Safety Program). This program includes replacement of company and customer owned gas service and yard lines, the movement and resetting of meters, the replacement of cast iron mains and the replacement and cathodic protection of bare steel mains. In recognition of the significant capital expenditures associated with this safety program, the MPSC permits the deferral, and subsequent recovery through rates, of depreciation expense, property taxes and associated carrying costs. The continuation of the Missouri Gas Energy Safety Program will result in significant levels of future capital expenditures. The Company estimates incurring capital expenditures of $10,400,000 in 2005 related to this program and approximately $157,300,000 over the remaining life of the program of 15 years. Financing Activities. Cash flow used in financing activities was $181,067,000 in 2004 compared to cash flow provided by financing activities of $222,661,000 in 2003 and cash flow used in financing activities of $235,609,000 in 2002. Financing activity cash flow changes were primarily due to the net impact of acquisition financing, repayment and issuance of debt, net activity under the revolving credit facilities, issuance of preferred stock and the redemption of Preferred Securities of Subsidiary Trust. As a result of these financing transactions, the Company's total debt to total capital ratio at June 30, 2004 was 64.0%, compared with 69.7% and 60.3% at June 30, 2003 and 2002, respectively. The Company's effective debt cost rate under the current debt structure is 5.45% (which includes interest and the amortization of debt issuance costs and redemption premiums on refinanced debt). On March 12, 2004, Panhandle Energy issued $200,000,000 of its 2.75% Senior Notes due 2007, the proceeds of which were used to fund the redemption of the remaining $146,080,000 principal amount of its 6.125% Senior Notes due 2004 that matured on March 15, 2004 and to provide working capital to the Company, pending the repayment of the $52,455,000 principal amount of Panhandle Energy's 7.875% Senior Notes due 2004 that matured on August 15, 2004. On October 8, 2003, the Company issued 920,000 shares of its 7.55% Noncumulative Preferred Stock, Series A (Liquidation Preference $250 Per Share) to the public through the issuance of 9,200,000 Depositary Shares, each representing a one-tenth interest in a 7.55% Noncumulative Preferred Stock, Series A share at the public offering price of $25.00 per share, or $230,000,000 in the aggregate. After the payment of issuance costs, including underwriting discounts and commissions, the Company realized net proceeds of $223,410,000. The total net proceeds were used to repay debt under the Company's revolving credit facilities. The issuance of this Preferred Stock and use of proceeds is continued evidence of the Company's commitment to the rating agencies to strengthen the Company's balance sheet and solidify its current investment grade status. On October 1, 2003, the Company called its Subordinated Notes for redemption, and its Subordinated Notes and related Preferred Securities were redeemed on October 31, 2003. The Company financed the redemption with borrowings under its revolving credit facilities, which were paid down with the net proceeds of a $230,000,000 offering of preferred stock by the Company on October 8, 2003, as previously discussed. In July 2003, Panhandle Energy announced a tender offer for any and all of the $747,370,000 outstanding principal amount of five of its series of senior notes outstanding at that point in time (the Panhandle Tender Offer) and also called for redemption all of the outstanding $134,500,000 principal amount of its two series of debentures that were outstanding (the Panhandle Calls). Panhandle Energy repurchased approximately $378,257,000 of the principal amount of its outstanding debt through the Panhandle Tender Offer for total consideration of approximately $396,445,000 plus accrued interest through the purchase date. Panhandle Energy also redeemed approximately $134,500,000 of debentures through the Panhandle Calls for total consideration of $139,411,000, plus accrued interest through the redemption dates. As a result of the Panhandle Tender Offer, the Company has recorded a pre-tax gain on the extinguishment of debt of $6,354,000 in fiscal 2004. In August 2003, Panhandle Energy issued $300,000,000 of its 4.80% Senior Notes due 2008 and $250,000,000 of its 6.05% Senior Notes due 2013 principally to refinance the repurchased notes and redeemed debentures. Also in August and September 2003, Panhandle Energy repurchased $3,150,000 principal amount of its senior notes on the open market through two transactions for total consideration of $3,398,000, plus accrued interest through the repurchase date. On June 11, 2003, the Company issued 9,500,000 shares of common stock at the public offering price of $16.00 per share. After underwriting discounts and commissions, the Company realized net proceeds of $146,700,000. The Company granted the underwriters a 30-day over-allotment option to purchase up to an additional 1,425,000 shares of the Company's common stock at the same price, which was exercised on June 11, 2003, resulting in additional net proceeds to the Company of $22,000,000. Also on June 11, 2003, the Company issued 2,500,000 equity units at a public offering price of $50 per unit, resulting in net proceeds to the Company, after underwriting discounts and commissions, of $121,300,000. Each equity unit consists of a stock purchase contract for the purchase of shares of the Company's common stock and, initially, a senior note due August 16, 2006, issued pursuant to the Company's existing Indenture. The equity units carry a total annual coupon of 5.75% (2.75% annual face amount of the senior notes plus 3.0% annual contract adjustment payments). Each stock purchase contract issued as a part of the equity units carries a maximum conversion premium of up to 22% over the $16.00 issuance price (before adjustment for subsequent stock dividends) of the Company's common shares that were sold on June 11, 2003, as discussed previously. The present value of the equity units contract adjustment payments was initially charged to shareholders' equity, with an offsetting credit to liabilities. The liability is accreted over three years by interest charges to the Consolidated Statement of Operations. Before the issuance of the Company's common stock upon settlement of the purchase contracts, the purchase contracts will be reflected in the Company's diluted earnings per share calculations using the treasury stock method. In connection with the acquisition of the New England Operations, the Company entered into a $535,000,000 Term Note on August 28, 2000 to fund (i) the cash portion of the consideration to be paid to Fall River Gas' stockholders; (ii) the all cash consideration to be paid to the ProvEnergy and Valley Resources stockholders, (iii) repayment of approximately $50,000,000 of long- and short-term debt assumed in the New England mergers, and (iv) related acquisition costs. The Term Note, which initially expired on August 27, 2001, was extended through August 26, 2002. On July 16, 2002, the Company repaid the Term Note with the proceeds from the issuance of a $311,087,000 Term Note dated July 15, 2002 (the 2002 Term Note) and borrowings under its revolving credit facilities. The 2002 Term Note is held by a syndicate of sixteen banks, led by JPMorgan Chase Bank, as Agent. Eleven of the sixteen banks were also among the lenders of the Term Note. The 2002 Term Note carries a variable interest rate that is tied to either the LIBOR or prime interest rates at the Company's option. The interest rate spread over the LIBOR rate varies with the credit rating of the Senior Notes by Standard and Poor's Rating Information Service (S&P) and Moody's Investor Service, Inc. (Moody's), and is currently LIBOR plus 105 basis points. As of June 30, 2004, a balance of $111,087,000 was outstanding on this 2002 Term Note at an effective interest rate of 2.42%. The 2002 Term Note requires semi-annual principal repayments on February 15th and August 15th of each year, with payments of $35,000,000 each being due February 15, 2005 and August 15, 2005. The remaining principal amount of $41,087,000 is due August 26, 2005. No additional draws can be made on the 2002 Term Note. See Item 7. Management's Discussion and Analysis - Quantitative and Qualitative Disclosures About Market Risk. On July 30, 2004, the Company issued 4,800,000 shares of common stock at the public offering price of $18.75 per share, resulting in net proceeds to the Company, after underwriting discounts and commissions, of $86,900,000. The Company also sold 6,200,000 shares of the Company's common stock through forward sale agreements with its underwriters and granted the underwriters a 30-day over-allotment option to purchase up to an additional 1,650,000 shares of the Company's common stock at the same price, which was exercised by the underwriters. Under the terms of the forward sale agreements, the Company has the option to settle its obligation to the forward purchasers through either (i) paying a net settlement in cash, (ii) delivering an equivalent number of shares of its common stock to satisfy its net settlement obligation, or (iii) through the physical delivery of shares. The Company will only receive additional proceeds from the sale of the 7,850,000 shares of the Company's common stock that were sold through the forward sale agreements if it settles its obligation under such agreements through the physical delivery of shares, in which case it will receive additional net proceeds of $142,000,000. The forward sale agreements are required to be settled within 12 months from the date of the offering. The Company expects that it will only settle its obligation under the forward sale agreements through the physical delivery of shares if it is successful in its attempt to acquire CrossCountry Energy, LLC (see Item 7. Management's Discussion and Analysis - Liquidity and Capital Resources (Investing Activities)). The Company has an effective shelf registration statement on file with the Securities and Exchange Commission for a total principal amount of $1,000,000,000 in securities of which $762,812,500 in securities is available for issuance as of August 16, 2004, which may be issued by the Company in the form of debt securities, common stock, preferred stock, guarantees, warrants to purchase common stock, preferred stock and debt securities, stock purchase contracts, stock purchase units and depositary shares in the event that the Company elects to offer fractional interests in preferred stock, and also trust preferred securities to be issued by Southern Union Financing II and Southern Union Financing III. 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's ability to arrange financing, including refinancing, and its cost of capital are dependent on various factors and conditions, including: general economic and capital market conditions; maintenance of acceptable credit ratings; credit availability from banks and other financial institutions; investor confidence in the Company, its competitors and peer companies in the energy industry; market expectations regarding the Company's future earnings and probable cash flows; market perceptions of the Company's ability to access capital markets on reasonable terms; and provisions of relevant tax and securities laws. On July 3, 2003, Moody's changed its credit rating on the Company's senior unsecured debt to Baa3 with a negative outlook from Baa3 with a stable outlook. The Company's senior unsecured debt is currently rated BBB by S&P, a rating that it has held since March 2003 when it was downgraded from BBB+. S&P changed its outlook from stable to negative on March 12, 2004. Although no further downgrades are anticipated, such an event would not be expected to have a material impact on the Company. The Company is not party to any lending agreements that would accelerate the maturity date of any obligation due to a failure to maintain any specific credit ratings. The Company had standby letters of credit outstanding of $58,566,000 at June 30, 2004 and $7,761,000 at June 30, 2003, which guarantee payment of insurance claims and other various commitments. Other Matters Stock Splits and Dividends. On August 31, 2004, July 31, 2003 and July 15, 2002, Southern Union distributed a 5% common stock dividend to stockholders of record on August 20, 2004, July 17, 2003 and July 1, 2002, respectively. A portion of the July 15, 2002, 5% stock dividend was characterized as a distribution of capital due to the level of the Company's retained earnings available for distribution as of the declaration date. Unless otherwise stated, all per share data included herein and in the accompanying Consolidated Financial Statements and Notes thereto have been restated to give effect to the stock dividends. Customer Concentrations. In the Transportation and Storage segment, aggregate sales to Panhandle Energy's top 10 customers accounted for 70% of segment operating revenues and 19% of total operating revenues in fiscal 2004. This included sales to Proliance Energy, LLC, a nonaffiliated local distribution company and gas marketer, which accounted for 17% of segment operating revenues; sales to BG LNG Services, a nonaffiliated gas marketer, which accounted for 16% of segment operating revenues; and sales to CMS Energy Corporation, Panhandle Energy's former parent, which accounted for 11% of segment operating revenues. No other customer accounted for 10% or more of the Transportation and Storage segment operating revenues, and no single customer or group of customers under common control accounted for ten percent or more of the Company's total operating revenues in 2004. Off-Balance Sheet Arrangements and Aggregate Contractual Obligations. As of June 30, 2004, the Company had guarantees related to PEI Power and Advent Network, Inc. (in which Southern Union has an equity interest) of $8,710,000 and $4,000,000, respectively, letters of credit related to insurance claims and other commitments of $58,566,000 and surety bonds related to construction or repair projects of approximately $2,300,000. The Company believes that the likelihood of having to make payments under the letters of credit or the surety bonds is remote, and therefore has made no provisions for making payments under such instruments. The following table summarizes the Company's expected contractual obligations by payment due date as of June 30, 2004:
Contractual Obligations (thousands of dollars) -------------------------------------------------------------------------------- 2010 and Total 2005 2006 2007 2008 2009 thereafter ----------- ---------- -------- --------- --------- -------- ----------- Long-term debt, including capital leases (1) (2)......... $ 2,243,374 $ 99,997 $ 90,475 $ 565,718 $ 1,648 $301,646 $1,183,890 Short-term borrowing, including credit facilities (1).......... 21,000 21,000 -- -- -- -- -- Gas purchases (3) .......................... 1,099,972 266,023 196,081 158,678 141,508 127,461 210,221 Missouri Gas Energy Safety Program.......... 167,733 10,420 10,524 10,630 10,736 10,843 114,580 Storage contracts (4)....................... 447,389 79,790 68,538 63,316 53,075 49,015 133,655 LNG facilities and pipeline expansion....... 172,947 144,789 26,821 1,337 -- -- -- Operating lease payments.................... 71,124 17,777 14,708 13,970 10,018 6,549 8,102 Interest payments on debt................... 1,718,510 125,391 122,380 111,114 102,288 89,035 1,168,302 Benefit plan contributions.................. 25,657 25,657 -- -- -- -- -- Non-trading derivative liabilities.......... 19,405 6,461 6,838 6,106 -- -- -- ----------- ---------- -------- --------- --------- -------- ---------- Total contractual cash obligations....... $ 5,987,111 $ 797,305 $536,365 $ 930,869 $ 319,273 $ 584,549 $2,818,750 =========== ========== ======== ========= ========= ========= ==========
- --------------------------------- (1) The Company is party to certain debt agreements that contain certain covenants that if not satisfied would be an event of default that would cause such debt to become immediately due and payable. Such covenants require the Company to maintain a certain level of net worth, to meet certain debt to total capitalization ratios, and to meet certain ratios of earnings before depreciation, interest and taxes to cash interest expense. See Note XIII - Debt and Capital Lease. (2) The long-term debt cash obligations exclude $16,199,000 of unamortized debt premium as of June 30, 2004. (3) The Company has purchase gas tariffs in effect for all its utility service areas that provide for recovery of its purchase gas costs under defined methodologies. (4) Charges for third party storage capacity. Cash Management. On October 25, 2003, FERC issued the final rule in Order No. 634-A on the regulation of cash management practices. Order No. 634-A requires all FERC-regulated entities that participate in cash management programs (i) to establish and file with FERC for public review written cash management procedures including specification of duties and responsibilities of cash management program participants and administrators, specification of the methods for calculating interest and allocation of interest income and expenses, and specification of any restrictions on deposits or borrowings by participants, and (ii) to document monthly cash management activity. In compliance with FERC Order No. 634-A, Panhandle Energy filed its cash management plan with FERC on December 11, 2003. Contingencies. 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 gas distribution service territories, principally in Texas, Arizona and New Mexico, and present gas distribution 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 distribution service territories certain MGP sites are currently the subject of governmental actions. See Item 7. Management's Discussion and Analysis - Other Matters (Cautionary Statement Regarding Forward-Looking Information) and Note XVIII - Commitments and Contingencies. The Company's interstate natural gas transportation operations are subject to federal, state and local regulations regarding water quality, hazardous and solid waste disposal and other environmental matters. The Company has identified environmental impacts at certain sites on its gas transmission systems and has undertaken cleanup programs at those sites. These impacts resulted from (i) the past use of lubricants containing polychlorinated bi-phenyls (PCBs) in compressed air systems; (ii) the past use of paints containing PCBs; (iii) the prior use of wastewater collection facilities; and (iv) other on-site disposal areas. The Company communicated with the United States Environmental Protection Agency (EPA) and appropriate state regulatory agencies on these matters, and has developed and is implementing a program to remediate such contamination in accordance with federal, state and local regulations. Some remediation is being performed by former Panhandle Energy affiliates in accordance with indemnity agreements that also indemnify against certain future environmental litigation and claims. The Company is also subject to various federal, state and local laws and regulations relating to air quality control. These regulations include rules relating to regional ozone control and hazardous air pollutants. The regional ozone control rules are known as State Implementation Plans (SIP) and are designed to control the release of NOx compounds. The rules related to hazardous air pollutants are known as Maximum Achievable Control Technology (MACT) rules and are the result of the 1990 Clean Air Act Amendments that regulate the emission of hazardous air pollutants from internal combustion engines and turbines. See Item 7. Management's Discussion and Analysis - Other Matters (Cautionary Statement Regarding Forward-Looking Information) and Note XVIII - Commitments and Contingencies. During 1999, several actions were commenced in federal courts by persons involved in competing efforts to acquire Southwest Gas Corporation (Southwest). All of these actions eventually were transferred to the U.S. District Court for the District of Arizona, consolidated and lodged with Judge Roslyn Silver. As a result of summary judgments granted, there were no claims allowed against Southern Union. The trial of Southern Union's claims against the sole-remaining defendant, former 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 former Commissioner Irvin. The District Court denied former Commissioner Irvin's motions to set aside the verdict and reduce the amount of punitive damages. Former Commissioner Irvin has appealed to the Ninth Circuit Court of Appeals. A decision on the appeal by the Ninth Circuit is expected by the first calendar quarter of 2005. The Company intends to vigorously pursue collection of the award. With the exception of ongoing legal fees associated with the collection of damages from former Commissioner Irvin, 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. 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. This matter went into recess following a hearing in May of 2003. Following the May hearing, the Commission staff reduced its disallowance recommendation to approximately $9.3 million. The hearing concluded in November 2003 and the matter was fully submitted to the Commission in February 2004 and is awaiting decision by the Commission. 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 2003. No date for this hearing has been set. In 1993, the U.S. Department of the Interior announced its intention to seek, through its Minerals Management Service (MMS) additional royalties from gas producers as a result of payments received by such producers in connection with past take-or-pay settlements, buyouts, and buy downs of gas sales contracts with natural gas pipelines. Panhandle Energy's pipelines, with respect to certain producer contract settlements, may be contractually required to reimburse or, in some instances, to indemnify producers against such royalty claims. The potential liability of the producers to the government and of the pipelines to the producers involves complex issues of law and fact which are likely to take substantial time to resolve. If required to reimburse or indemnify the producers, Panhandle Energy's pipelines may file with FERC to recover a portion of these costs from pipeline customers. Panhandle Energy believes the outcome of this matter will not have a material adverse effect on its financial position, results of operations or cash flows. Southern Union and its subsidiaries are parties to other legal proceedings that management considers to be normal actions to which an enterprise of its size and nature might be subject, and not to be material to the Company's overall business or financial condition, results of operations or cash flows. (See Note XVIII - Commitments and Contingencies.) Inflation. The Company believes that inflation has caused and will continue to cause increases in certain operating expenses and has required and will continue to require assets to be replaced at higher costs. The Company continually reviews the adequacy of its rates in relation to the increasing cost of providing service and the inherent regulatory lag in adjusting those rates. Regulatory. The majority of the Company's business activities are subject to various regulatory authorities. 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. On November 4, 2003, Missouri Gas Energy filed a request with the MPSC to increase base rates by $44,800,000 and to implement a weather mitigation rate design that would significantly reduce the impact of weather-related fluctuations on customer bills. On January 30, 2004, Missouri Gas Energy filed an updated claim which raised the amount of the base rate increase request to $54,200,000. As of July 19, 2004, upon the close of the record and reflecting settlement of a number of issues, MGE's request stood at approximately $39,000,000 and the MPSC Staff's recommendation stood at approximately $13,000,000. Statutes require that the MPSC reach a decision in the case within an eleven-month period from the original filing date. It is not presently possible to determine what action the MPSC will ultimately take with respect to this rate increase request. On May 22, 2003, the RIPUC approved a Settlement Offer filed by New England Gas Company related to the final calculation of earnings sharing for the 21-month period covered by the Energize Rhode Island Extension settlement agreement. This calculation generated excess revenues of $5,277,000. The net result of the excess revenues and the Energize Rhode Island weather mitigation and non-firm margin sharing provisions was the crediting to customers of $949,000 over a twelve-month period starting July 1, 2003. On May 24, 2002, the RIPUC approved a settlement agreement between the New England Gas Company and the Rhode Island Division of Public Utilities and Carriers. The settlement agreement resulted in a $3,900,000 decrease in base revenues for New England Gas Company's Rhode Island operations, a unified rate structure ("One State; One Rate") and an integration/merger savings mechanism. The settlement agreement also allows New England Gas Company to retain $2,049,000 of merger savings and to share incremental earnings with customers when the division's Rhode Island operations return on equity exceeds 11.25%. Included in the settlement agreement was a conversion to therm billing and the approval of a reconciling Distribution Adjustment Clause (DAC). The DAC allows New England Gas Company to continue its low income assistance and weatherization programs, to recover environmental response costs over a 10-year period, puts into place a new weather normalization clause and allows for the sharing of nonfirm margins (non-firm margin is margin earned from interruptible customers with the ability to switch to alternative fuels). The weather normalization clause is designed to mitigate the impact of weather volatility on customer billings, which will assist customers in paying bills and stabilize the revenue stream. New England Gas Company will defer the margin impact of weather that is greater than 2% colder-than-normal and will recover the margin impact of weather that is greater than 2% warmer-than-normal. The non-firm margin incentive mechanism allows New England Gas Company to retain 25% of all non-firm margins earned in excess of $1,600,000. In December 2002, FERC approved a Trunkline LNG certificate application to expand the Lake Charles facility to approximately 1.2 Bcf per day of sustainable send out capacity versus the current sustainable send out capacity of .63 Bcf per day and increase terminal storage capacity to 9 Bcf from the current 6.3 Bcf. Construction on the Trunkline LNG expansion project (Phase I) commenced in September 2003 and is expected to be completed by the end of the 2005 calendar year. In February 2004, Trunkline LNG filed a further incremental LNG expansion project (Phase II) with FERC and is awaiting commission approval. Phase II would increase the LNG terminal sustainable send out capacity to 1.8 Bcf per day. Phase II has an expected in-service date of mid-calendar 2006. In February 2004, Trunkline filed an application with FERC to request approval of a 30-inch diameter, 23-mile natural gas pipeline loop from the LNG terminal. The pipeline creates additional transport capacity in association with the Trunkline LNG expansion and also includes new and expanded delivery points with major interstate pipelines. The Company continues to pursue certain changes to rates and rate structures that are intended to reduce the sensitivity of earnings to weather, including weather normalization clauses and higher monthly fixed customer charges for its regulated utility operations. New England Gas Company has a weather normalization clause in the tariff covering its Rhode Island operations. Critical Accounting Policies. The Company's consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and related disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Estimates and assumptions about future events and their effects cannot be perceived with certainty. On an ongoing basis, the Company evaluates its estimates based on historical experience, current market conditions and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Nevertheless, actual results may differ from these estimates under different assumptions or conditions. The following is a summary of the Company's most critical accounting policies, which are defined as those policies whereby judgments or uncertainties could affect the application of those policies and materially different amounts could be reported under different conditions or using different assumptions. For a summary of all of the Company's significant accounting policies, see Note I - Summary of Significant Accounting Policies. Effects of Regulation -- The Company is subject to regulation by certain state and federal authorities. The Company, in its Distribution segment, has accounting policies which conform to the FASB Standard, Accounting for the Effects of Certain Types of Regulation, and which are in accordance with the accounting requirements and ratemaking practices of the regulatory authorities. The application of these accounting policies allows the Company to defer expenses and revenues on the balance sheet as regulatory assets and liabilities when it is probable that those expenses and income will be allowed in the ratemaking process in a period different from the period in which they would have been reflected in the income statement by an unregulated company. These deferred assets and liabilities are then flowed through the results of operations in the period in which the same amounts are included in rates and recovered from or refunded to customers. Management's assessment of the probability of recovery or pass through of regulatory assets and liabilities requires judgment and interpretation of laws and regulatory commission orders. If, for any reason, the Company ceases to meet the criteria for application of regulatory accounting treatment for all or part of its operations, the regulatory assets and liabilities related to those portions ceasing to meet such criteria would be eliminated from the Consolidated Balance Sheet and included in the Consolidated Statement of Operations for the period in which the discontinuance of regulatory accounting treatment occurs. The aggregate amount of regulatory assets and liabilities reflected in the Consolidated Balance Sheets are $99,314,000 and $11,164,000 at June 30, 2004 and $107,696,000 and $10,084,000 at June 30, 2003, respectively. Long-Lived Assets -- Long-lived assets, including property, plant and equipment, goodwill and intangibles comprise a significant amount of the Company's total assets. The Company makes judgments and estimates about the carrying value of these assets, including amounts to be capitalized, depreciation methods and useful lives. The Company also reviews these assets for impairment on a periodic basis or whenever events or changes in circumstances indicate that the carrying amounts may not be recoverable. The impairment test consists of a comparison of an asset's fair value with its carrying value; if the carrying value of the asset exceeds its fair value, an impairment loss is recognized in the Consolidated Statement of Operations in an amount equal to that excess. Management's determination of an asset's fair value requires it to make long-term forecasts of future revenues and costs related to the asset, when the asset's fair value is not readily apparent from other sources. These forecasts require assumptions about future demand, future market conditions and regulatory developments. Significant and unanticipated changes to these assumptions could require a provision for impairment in a future period. During June 2004, the Company evaluated goodwill for impairment. The determination of whether an impairment has occurred is based on an estimate of discounted future cash flows attributable to the Company's reporting units that have goodwill, as compared to the carrying value of those reporting units' net assets. As of June 30, 2004, pursuant to the FASB Standard, Goodwill and Other Intangible Assets, no impairment had been indicated. 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 and pursuant to the FASB Standard, Impairment of Long-Lived Assets and Assets to be Disposed Of, a goodwill impairment loss of $1,417,000 was recognized in depreciation and amortization on the Consolidated Statement of Operations for the quarter ended September 30, 2001. Investments in Securities -- As of June 30, 2004, all securities owned by the Company are accounted for under the cost method. These securities consist of common and preferred stock in non-public companies whose value is not readily determinable. A judgmental aspect of accounting for these securities involves determining whether an other-than-temporary decline in value has been sustained. Management reviews these securities on a quarterly basis to determine whether a decline in value is other-than-temporary. Factors that are considered in assessing whether a decline in value is other-than-temporary include, but are not limited to: earnings trends and asset quality; near term prospects and financial condition of the issuer; financial condition and prospects of the issuer's region and industry; and Southern Union's intent and ability to retain the investment. If management determines that a decline in value is other-than-temporary, a charge will be recorded on the Consolidated Statement of Operations to reduce the carrying value of the investment security to its estimated fair value. In September 2003 and June 2002, Southern Union determined that declines in the value of its investment in PointServe were other than temporary. Accordingly, the Company recorded non-cash charges of $1,603,000 and $10,380,000 during the quarters ended September 30, 2003 and June 30, 2002, respectively, to reduce the carrying value of this investment to its estimated fair value. The Company recognized these valuation adjustments to reflect significant lower private equity valuation metrics and changes in the business outlook of PointServe. PointServe is a closely held, privately owned company and, as such, has no published market value. The Company's remaining investment of $2,603,000 at June 30, 2004 may be subject to future market value risk. The Company will continue to monitor the value of its investment and periodically assess the impact, if any, on reported earnings in future periods. Pensions and Other Postretirement Benefits - The Company accounts for pension costs and other postretirement benefit costs in accordance with the FASB Standards Employers' Accounting for Pensions and Employers' Accounting for Postretirement Benefits Other Than Pensions, respectively. These Statements require liabilities to be recorded on the balance sheet at the present value of these future obligations to employees net of any plan assets. The calculation of these liabilities and associated expenses require the expertise of actuaries and are subject to many assumptions including life expectancies, present value discount rates, expected long-term rate of return on plan assets, rate of compensation increase and anticipated health care costs. Any change in these assumptions can significantly change the liability and associated expenses recognized in any given year. However, the Company expects to recover substantially all of its net periodic pension and other post-retirement benefit costs attributable to employees in its Distribution segment in accordance with the applicable regulatory commission authorization. For financial reporting purposes, the difference between the amounts of pension cost and post-retirement benefit cost recoverable in rates and the amounts of such costs as determined under applicable accounting principles is recorded as either a regulatory asset or liability, as appropriate. Derivatives and Hedging Activities -- The Company utilizes derivative instruments on a limited basis to manage certain business risks. Interest rate swaps and treasury rate locks are used to reduce interest rate risks and to manage interest expense. Commodity swaps have been utilized to manage price risk associated with certain energy contracts. The Company accounts for its derivatives in accordance with the FASB Standard, Accounting for Derivative Instruments and Hedging Activities, as amended. Under this Statement, all derivatives are recognized on the balance sheet at their fair value. On the date the derivative contract is entered into, management designates the derivative as either: (i) a hedge of the fair value of a recognized asset or liability or of an unrecognized firm commitment (a fair value hedge); (ii) a hedge of a forecasted transaction or of the variability of cash flows to be received or paid in connection with a recognized asset or liability (a cash flow hedge), or (iii) an instrument that is held for trading or non-hedging purposes (a trading or non-hedging instrument). Changes in the fair value of a derivative that qualifies as a fair-value hedge, along with the gain or loss on the hedged asset or liability that is attributable to the hedged risk, are recorded in earnings. Changes in the fair value of a derivative that qualifies as a cash-flow hedge, to the extent that the hedge is effective, are recorded in other comprehensive income, until earnings are affected by the variability of cash flows of the hedged transaction (e.g., until periodic settlements of a variable-rate asset or liability are recorded in earnings). Hedge ineffectiveness is recorded through earnings immediately. Lastly, changes in the fair value of derivative trading and non-hedging instruments are reported in current-period earnings. Fair value is determined based upon mathematical models using current and historical data. The Company formally assesses, both at the hedge's inception and on an ongoing basis, whether the derivatives that are used in hedging transactions have been highly effective in offsetting changes in the fair value or cash flows of hedged items and whether those derivatives may be expected to remain highly effective in future periods. The Company discontinues hedge accounting when: (i) it determines that the derivative is no longer effective in offsetting changes in the fair value or cash flows of a hedged item; (ii) the derivative expires or is sold, terminated, or exercised; (iii) it is no longer probable that the forecasted transaction will occur; or (iv) management determines that designating the derivative as a hedging instrument is no longer appropriate. In all situations in which hedge accounting is discontinued and the derivative remains outstanding, the Company will carry the derivative at its fair value on the balance sheet, recognizing changes in the fair value in current-period earnings. See Note XI -- Derivative Instruments and Hedging Activities. Commitments and Contingencies -- The Company is subject to proceedings, lawsuits and other claims related to environmental and other matters. Accounting for contingencies requires significant judgments by management regarding the estimated probabilities and ranges of exposure to potential liability. For further discussion of the Company's commitments and contingencies, see Note XVIII -- Commitments and Contingencies. Purchase Accounting -- The Company's acquisition of Panhandle Energy has been accounted for using the purchase method of accounting in accordance with the FASB Standard, Business Combinations. Under this Statement, the purchase price paid by the Company, including transaction costs, was allocated to Panhandle Energy's net assets as of the acquisition date. The Panhandle Energy assets acquired and liabilities assumed have been recorded at their estimated fair value as of the acquisition date based on the results of outside appraisals. Determining the fair value of certain assets acquired and liabilities assumed is judgmental in nature and often involves the use of significant estimates and assumptions. The accounting rules provide a one-year period following the consummation of an acquisition to finalize the fair value estimates. Accounting Pronouncements In April 2003, the FASB issued Amendment of Statement 133 on Derivative Instruments and Hedging Activities. The Statement is effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003. The Statement (i) clarifies under what circumstances a contract with an initial net investment meets the characteristic of a derivative, (ii) clarifies when a derivative contains a financing component, (iii) amends the definition of an underlying to conform it to language used in FASB Interpretation Guarantor's Accounting and Disclosure Requirement for Guarantees, Including Indirect Guarantees of Indebtedness of Others, and (iv) amends certain other existing pronouncements. The Statement did not materially change the methods the Company uses to account for and report its derivatives and hedging activities. Effective July 1, 2003, the Company adopted the FASB standard, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. The Statement establishes guidelines on how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. The Statement further defines and requires that certain instruments within its scope be classified as liabilities on the financial statements. The adoption of the Statement did not have a material impact on its financial position, results of operations or cash flows for the periods presented. Effective January 1, 2004 the Company adopted the FASB standard, Employers' Disclosures about Pensions and Other Postretirement Benefits - an amendment of FASB Statements No. 87, 88, and 106. The Statement revises employers' disclosures about pension plans and other postretirement benefit plans. It retains the disclosure requirements contained in FASB Statement No. 132, Employers' Disclosures about Pensions and Other Postretirement Benefits, which it replaces, and requires additional disclosure about the assets, obligations, cash flows and net periodic benefit cost of defined benefit pension plans and other defined benefit postretirement plans. The Statement does not change the measurement or recognition of those plans required by FASB Statements No. 87, Employers' Accounting for Pensions, No. 88, Employers' Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits, and No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions. In December 2003, the FASB issued Consolidation of Variable Interest Entities. The Interpretation introduced a new consolidation model, which determines control and consolidation based on potential variability in gains and losses of the entity being evaluated for consolidation. The Interpretation requires a company to consolidate a variable interest entity if the company is allocated a majority of the entity's gains and/or losses, including fees paid by the entity. The Interpretation is effective for companies that have an interest in variable interest entities or potential variable interest entities commonly referred to as special-purpose entities for periods ending after December 15, 2003. Application by companies for all other types of entities is required in financial statements for periods ending after March 15, 2004. The Company has not identified any material variable interest entities or interests in variable interest entities for which the provisions of this Interpretation would require a change in the Company's current accounting for such interests. In March 2004, the Emerging Issues Task Force (EITF) reached final consensuses on Issue 03-6, Participating Securities and the Two-Class Method under FASB 128, Earnings per Share. The Issue addresses the computation of earnings per share by companies that have issued securities other than common stock that contractually entitle the holder to participate in dividends and earnings of the company when, and if, it declares dividends on its common stock. The Issue is effective for interim periods beginning after March 31, 2004. Based on the Company's capital structure at June 30, 2004, this Issue did not change the method used by the Company to calculate its earnings per share for the period ended June 30, 2004. In accordance with FASB Financial Staff Position (FSP), Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003, the benefit obligation and net periodic post-retirement cost in the Company's consolidated financial statements and accompanying notes do not reflect the effects of the Act on the Company's post-retirement healthcare plan because the employer is unable to conclude whether benefits provided by the plan are actuarially equivalent to Medicare Part D under the Act. The method of determining whether a sponsor's plan will qualify for actuarial equivalency is pending until the US Department of Health and Human Services (HHS) completes its interpretative work on the Act. Once the interpretative guidance is released by HHS, if eligible, the Company will account for the subsidy as an actuarial gain pursuant to the guidelines of this standard. See the Notes to Consolidated Financial Statements for other accounting pronouncements followed by the Company. Cautionary Statement Regarding Forward-Looking Information. This Management's Discussion and Analysis of Results of Operations and Financial Condition and other sections of this Annual Report on Form 10-K 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. Similarly, statements that describe our objectives, plans or goals are or may be 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 results, performance and achievements may differ materially from what is expressed or forecasted in such forward-looking statements. The Company undertakes no obligation to publicly update 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 actual results to differ materially from those expressed in our forward-looking statements include, but are not limited to, the following: cost of gas; gas sales volumes; gas throughput volumes and available sources of natural gas; discounting of transportation rates due to competition; customer growth; abnormal 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 and the impact of future rate cases or regulatory rulings; the outcome of pending and future litigation; the speed and degree to which competition is introduced to our gas distribution business; new legislation and government regulations and proceedings affecting or involving the Company; unanticipated environmental liabilities; the Company's ability to comply with or to challenge successfully existing or new environmental regulations; changes in business strategy and the success of new business ventures; 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; exposure to customer concentration with a significant portion of revenues realized from a relatively small number of customers and any credit risks associated with the financial position of those customers; factors affecting operations such as maintenance or repairs, environmental incidents or gas pipeline system constraints; our or any of our subsidiaries debt securities ratings; the economic climate and growth in our industry and service territories and competitive conditions of energy markets in general; inflationary trends; changes in gas or other energy market commodity prices and interest rates; the current market conditions causing more customer contracts to be of shorter duration, which may increase revenue volatility; the possibility of war or terrorist attacks; 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. ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk. The Company has long-term debt and revolving credit facilities, which subject the Company to the risk of loss associated with movements in market interest rates. At June 30, 2004, the Company had issued fixed-rate long-term debt aggregating $1,866,308,000 in principal amount (excluding premiums on Panhandle Energy's debt of $16,199,000) and having a fair value of $1,959,225,000. These instruments are fixed-rate and, therefore, do not expose the Company to the risk of earnings loss due to changes in market interest rates. However, the fair value of these instruments would increase by approximately $84,263,000 if interest rates were to decline by 10% from their levels at June 30, 2004. In general, such an increase in fair value would impact earnings and cash flows only if the Company were to reacquire all or a portion of these instruments in the open market prior to their maturity. The Company's floating-rate obligations aggregated $398,066,000 at June 30, 2004 and primarily consisted of the 2002 Term Note, the debt assumed under the Panhandle Acquisition related to the Trunkline LNG facility, and amounts borrowed under the Long-Term Facility. The floating-rate obligations under the 2002 Term Note and the Long-Term Facility expose the Company to the risk of increased interest expense in the event of increases in short-term interest rates. If the floating rates were to increase by 10% from June 30, 2004 levels, the Company's consolidated interest expense would increase by a total of approximately $68,000 each month in which such increase continued. The risk of an economic loss is reduced at this time as a result of the Company's regulated status with respect to its Distribution segment operations. Any unrealized gains or losses are accounted for in accordance with the FASB Standard, Accounting for the Effects of Certain Types of Regulation, as a regulatory asset or liability. The change in exposure to loss in earnings and cash flow related to interest rate risk from June 30, 2003 to June 30, 2004 is not material to the Company. See Note XIII - Debt and Capital Lease. In connection with the acquisition of the Pennsylvania Operations, the Company assumed a guaranty with a bank whereby the Company unconditionally guaranteed payment of financing obtained for the development of PEI Power Park. In March 1999, the Borough of Archbald, the County of Lackawanna, and the Valley View School District (together the Taxing Authorities) approved a Tax Incremental Financing Plan (TIF Plan) for the development of PEI Power Park. The TIF Plan requires that: (i) the Redevelopment Authority of Lackawanna County raise $10,600,000 of funds to be used for infrastructure improvements of the PEI Power Park; (ii) the Taxing Authorities create a tax increment district and use the incremental tax revenues generated from new development to service the $10,600,000 debt; and (iii) PEI Power Corporation, a subsidiary of the Company, guarantee the debt service payments. In May 1999, the Redevelopment Authority of Lackawanna County borrowed $10,600,000 from a bank under a promissory note (TIF Debt), which was refinanced and modified in May 2004. Beginning May 15, 2004 the TIF Debt bears interest at a variable rate equal to three-quarters percent (.75%) lower than the National Prime Rate of Interest with no interest rate floor or ceiling. The TIF Debt matures on June 30, 2011. Interest-only payments were required until June 30, 2003, and semi-annual interest and principal payments are required thereafter. As of June 30, 2004, the interest rate on the TIF Debt was 3.25% and estimated incremental tax revenues are expected to cover approximately 25% of the fiscal 2005 annual debt service. Based on information available at this time, the Company believes that the amount provided for the potential shortfall in estimated future incremental tax revenues is adequate as of June 30, 2004. The balance outstanding on the TIF Debt was $8,710,000 as of June 30, 2004. As a result of the acquisition of Panhandle Energy, the Company is party to interest rate swap agreements with an aggregate notional amount of $197,947,000 as of June 30, 2004 that fix the interest rate applicable to floating rate long-term debt and which qualify for hedge accounting. For the year ended June 30, 2004, the amount of swap ineffectiveness was not significant. As of June 30, 2004, floating rate LIBOR-based interest payments are exchanged for weighted fixed rate interest payments of 5.88%, which does not include the spread on the underlying variable debt rate of 1.625%. Interest rate swaps are carried on the Consolidated Balance Sheet at fair value with the unrealized gain or loss adjusted through accumulated other comprehensive income. As such, payments or receipts on interest rate swap agreements, in excess of the liability recorded, are recognized as adjustments to interest expense. As of June 30, 2004 and 2003, the fair value liability position of the swaps was $14,445,000 and $26,058,000, respectively. As of June 30, 2004 and since the acquisition date, an unrealized gain of $1,776,000, net of tax, was included in accumulated other comprehensive income related to these swaps, of which approximately $1,068,000, net of tax, is expected to be reclassified to interest expense during the next twelve months as the hedged interest payments occur. Current market pricing models were used to estimate fair values of interest rate swap agreements. The Company was also party to an interest rate swap agreement with a notional amount of $8,199,000 at June 30, 2003 that fixed the interest rate applicable to floating rate long-term debt and which qualified for hedge accounting. The fair value liability position of the swap was $93,000 at June 30, 2003. In October 2003, the swap expired and $15,000 of unrealized after-tax losses included in accumulated other comprehensive income relating to this swap was reclassified to interest expense during the quarter ended December 31, 2003. In March and April 2003, the Company entered into a series of treasury rate locks with an aggregate notional amount of $250,000,000 to manage its exposure against changes in future interest payments attributable to changes in the benchmark interest rate prior to the anticipated issuance of fixed-rate debt. These treasury rate locks expired on June 30, 2003, resulting in a $6,862,000 after-tax loss that was recorded in accumulated other comprehensive income and will be amortized into interest expense over the lives of the associated debt instruments. As of June 30, 2004, approximately $981,000 of net after-tax losses in accumulated other comprehensive income will be amortized into interest expense during the next twelve months. The notional amounts of the interest rate swaps are not exchanged and do not represent exposure to credit loss. In the event of default by a counterparty, the risk in these transactions is the cost of replacing the agreements at current market rates. In March 2004, Panhandle Energy entered into an interest rate swap to hedge the risk associated with the fair value of its $200,000,000 2.75% Senior Notes. These swaps are designated as fair value hedges and qualify for the short cut method under FASB standard, Accounting for Derivative Instruments and Hedging Activities, as amended. Under the swap agreement Panhandle Energy will receive fixed interest payments at a rate of 2.75% and will make floating interest payments based on the six-month LIBOR. No ineffectiveness is assumed in the hedging relationship between the debt instrument and the interest rate swap. As of June 30, 2004, the fair value liability position of the swap was $4,960,000, which reduced the carrying value of the underlying debt. During fiscal 2004, the Company acquired natural gas commodity swap derivatives and collar transactions in order to mitigate price volatility of natural gas passed through to utility customers. The cost of the derivative products and the settlement of the respective obligations are recorded through the gas purchase adjustment clause as authorized by the applicable regulatory authority and therefore do not impact earnings. The fair value of the contracts is recorded as an adjustment to a regulatory asset/ liability in the Consolidated Balance Sheet. As of June 30, 2004, the fair values of the contracts, which expire at various times through March 2005, are included in the Consolidated Balance Sheet as a liability and a matching adjustment to deferred cost of gas of $1,337,000. In March 2001, the Company discovered unauthorized financial derivative energy trading activity by a non-regulated, wholly-owned subsidiary. All unauthorized trading activity was subsequently closed in March and April of 2001 resulting in a cumulative cash expense of $191,000, net of taxes, and deferred income of $7,921,000 at June 30, 2001. For fiscal years 2004, 2003 and 2002, the Company recorded $605,000, $605,000 and $6,204,000, respectively, through other income relating to the expiration of contracts resulting from this trading activity. The remaining deferred liability of $507,000 at June 30, 2004 related to these derivative instruments will be recognized as income in the Consolidated Statement of Operations over the next year based on the related contracts. The Company established new limitations on trading activities, as well as new compliance controls and procedures that are intended to make it easier to identify quickly any unauthorized trading activities. ITEM 8. Financial Statements and Supplementary Data. The information required here is included in the report as set forth in the Index to Consolidated Financial Statements on page F-1. ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. None. ITEM 9A. Controls and Procedures. Evaluation of Disclosure Controls and Procedures We performed an evaluation 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 the Company's disclosure controls and procedures (as defined in Rule 13a-15(e) or Rule 15d-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this report. Based on that evaluation, our CEO and CFO concluded that our disclosure controls and procedures were effective as of June 30, 2004 and have communicated that determination to the Audit Committee of our Board of Directors. Changes in Internal Controls There have been no significant changes in our internal controls or other factors that have materially affected or are reasonably likely to materially affect internal controls subsequent to June 30, 2004. ITEM 9B. Other Information. None. PART III ITEM 10. Directors and Executive Officers of the Registrant. There is incorporated in this Item 10 by reference the information that will appear in the Company's definitive proxy statement for the 2004 Annual Meeting of Stockholders under the captions Board of Directors -- Board Size and Composition, Report of the Audit Committee, and Executive Officers and Compensation -- Executive Officers Who Are Not Directors and Executive Officers and Compensation -- Section 16(a) Beneficial Owner Reporting Compliance. We have adopted a Code of Ethics for Senior Financial Officers, which applies to our Chief Executive Officer, Chief Financial Officer, controller and other individuals in our finance department performing similar functions. The Code of Ethics is available on our website at www.southernunionco.com. If any substantive amendment to the Code of Ethics is made or any waiver is granted thereunder, including any implicit waiver, our Chief Executive Officer, Chief Financial Officer or other authorized officer will disclose the nature of such amendment or waiver on our website at www.southernunionco.com or in a report on Form 8-K. ITEM 11. Executive Compensation. There is incorporated in this Item 11 by reference the information that will appear in the Company's definitive proxy statement for the 2004 Annual Meeting of Stockholders under the captions Executive Officers and Compensation -- Executive Compensation and Certain Relationships. ITEM 12. Security Ownership of Certain Beneficial Owners and Management. There is incorporated in this Item 12 by reference the information that will appear in the Company's definitive proxy statement for the 2004 Annual Meeting of Stockholders under the captions Executive Officers and Compensation - Equity Compensation Plans and Security Ownership. ITEM 13. Certain Relationships and Related Transactions. There is incorporated in this Item 13 by reference the information that will appear in the Company's definitive proxy statement for the 2004 Annual Meeting of Stockholders under the caption Certain Relationships. ITEM 14. Principal Accountants Fee and Services. There is incorporated in this Item 14 by reference the information that will appear in the Company's definitive proxy statement for the 2004 Annual Meeting of Stockholders under the caption Independent Auditors. PART IV ITEM 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K. (a)(1) and (2) Financial Statements and Financial Statement Schedules. See Index to Consolidated Financial Statements set forth on page F-1. (a)(3) Exhibits. Exhibit No. Description - ----------- ----------- 3(a) Restated Certificate of Incorporation of Southern Union Company. (Filed as Exhibit 3(a) to Southern Union's Transition Report on Form 10-K for the year ended June 30, 1994 and incorporated herein by reference.) 3(b) Amendment to Restated Certificate of Incorporation of Southern Union Company which was filed with the Secretary of State of Delaware and became effective on October 26, 1999. (Filed as Exhibit 3(a) to Southern Union's Quarterly Report on Form 10-Q for the quarter ended December 31, 1999 and incorporated herein by reference.) 3(c) Southern Union Company Bylaws, as amended. (Filed as Exhibit 3(a) to Southern Union's Quarterly Report on Form 10-Q for the quarter ended December 31, 1999 and incorporated herein by reference.) 4(a) Specimen Common Stock Certificate. (Filed as Exhibit 4(a) to Southern Union's Annual Report on Form 10-K for the year ended December 31, 1989 and incorporated herein by reference.) 4(b) Indenture between Chase Manhattan Bank, N.A., as trustee, and Southern Union Company dated January 31, 1994. (Filed as Exhibit 4.1 to Southern Union's Current Report on Form 8-K dated February 15, 1994 and incorporated herein by reference.) 4(c) Officers' Certificate dated January 31, 1994 setting forth the terms of the 7.60% Senior Debt Securities due 2024. (Filed as Exhibit 4.2 to Southern Union's Current Report on Form 8-K dated February 15, 1994 and incorporated herein by reference.) 4(d) Officer's Certificate of Southern Union Company dated November 3, 1999 with respect to 8.25% Senior Notes due 2029. (Filed as Exhibit 99.1 to Southern Union's Current Report on Form 8-K filed on November 19, 1999 and incorporated herein by reference.) 4(e) Certificate of Trust of Southern Union Financing I. (Filed as Exhibit 4-A to Southern Union's Registration Statement on Form S-3 (No. 33-58297) and incorporated herein by reference.) 4(f) Certificate of Trust of Southern Union Financing II. (Filed as Exhibit 4-B to Southern Union's Registration Statement on Form S-3 (No. 33-58297) and incorporated herein by reference.) 4(g) Certificate of Trust of Southern Union Financing III. (Filed as Exhibit 4-C to Southern Union's Registration Statement on Form S-3 (No. 33-58297) and incorporated herein by reference.) 4(h) Form of Amended and Restated Declaration of Trust of Southern Union Financing I. (Filed as Exhibit 4-D to Southern Union's Registration Statement on Form S-3 (No. 33-58297) and incorporated herein by reference.) 4(i) Form of Subordinated Debt Securities Indenture among Southern Union Company and The Chase Manhattan Bank, N. A., as Trustee. (Filed as Exhibit 4-G to Southern Union's Registration Statement on Form S-3 (No. 33-58297) and incorporated herein by reference.) Exhibit No. Description - ----------- ----------- 4(j) Form of Supplemental Indenture to Subordinated Debt Securities Indenture with respect to the Subordinated Debt Securities issued in connection with the Southern Union Financing I Preferred Securities. (Filed as Exhibit 4-H to Southern Union's Registration Statement on Form S-3 (No.33-58297) and incorporated herein by reference.) 4(k) Form of Southern Union Financing I Preferred Security (included in 4(g) above.) (Filed as Exhibit 4-I to Southern Union's Registration Statement on Form S-3 (No. 33-58297) and incorporated herein by reference.) 4(l) Form of Subordinated Debt Security (included in 4(i) above.) (Filed as Exhibit 4-J to Southern Union's Registration Statement on Form S-3 (No. 33-58297) and incorporated herein by reference.) 4(m) Form of Guarantee with respect to Southern Union Financing I Preferred Securities. (Filed as Exhibit 4-K to Southern Union's Registration Statement on Form S-3 (No. 33-58297) and incorporated herein by reference.) 4(n) First Mortgage Bonds Indenture of Mortgage and Deed of Trust dated as of March 15, 1946 by Southern Union Company (as successor to PG Energy, Inc. formerly, Pennsylvania Gas and Water Company, and originally, Scranton-Spring Brook Water Service Company) to Guaranty Trust Company of New York. (Filed as Exhibit 4.1 to Southern Union's Current Report on Form 8-K filed on December 30, 1999 and incorporated herein by reference.) 4(o) Twenty-Third Supplemental Indenture dated as of August 15, 1989 (Supplemental to Indenture dated as of March 15, 1946) between Southern Union Company and Morgan Guaranty Trust Company of New York (formerly Guaranty Trust Company of New York). (Filed as Exhibit 4.2 to Southern Union's Current Report on Form 8-K filed on December 30, 1999 and incorporated herein by reference.) 4(p) Twenty-Sixth Supplemental Indenture dated as of December 1, 1992 (Supplemental to Indenture dated as of March 15, 1946) between Southern Union Company and Morgan Guaranty Trust Company of New York. (Filed as Exhibit 4.3 to Southern Union's Current Report on Form 8-K filed on December 30, 1999 and incorporated herein by reference.) 4(q) Thirtieth Supplemental Indenture dated as of December 1, 1995 (Supplemental to Indenture dated as of March 15, 1946) between Southern Union Company and First Trust of New York, National Association (as successor trustee to Morgan Guaranty Trust Company of New York). (Filed as Exhibit 4.4 to Southern Union's Current Report on Form 8-K filed on December 30, 1999 and incorporated herein by reference.) 4(r) Thirty-First Supplemental Indenture dated as of November 4, 1999 (Supplemental to Indenture dated as of March 15, 1946) between Southern Union Company and U. S. Bank Trust, National Association (formerly, First Trust of New York, National Association). (Filed as Exhibit 4.5 to Southern Union's Current Report on Form 8-K filed on December 30, 1999 and incorporated herein by reference.) 4(s) Pennsylvania Gas and Water Company Bond Purchase Agreement dated September 1, 1989. (Filed as Exhibit 4.6 to Southern Union's Current Report on Form 8-K filed on December 30, 1999 and incorporated herein by reference.) 4(t) Letter Agreement dated as of July 26, 2004, between Southern Union Company and Merrill Lynch International. (Filed as Exhibit 99.1 to Southern Union's Current Report on Form 8-K filed on August 31, 2004 and incorporated herein by reference.) 4(u) Letter Agreement dated as of July 26, 2004, between Southern Union Company and JPMorgan Chase Bank, London Branch, acting through J.P. Morgan Securities Inc. as agent. (Filed as Exhibit 99.2 to Southern Union's Current Report on Form 8-K filed on August 31, 2004 and incorporated herein by reference.) 4(v) Southern Union is a party to other debt instruments, none of which authorizes the issuance of debt securities in an amount which exceeds 10% of the total assets of Southern Union. Southern Union hereby agrees to furnish a copy of any of these instruments to the Commission upon request. 10(a) Third Amended and Restated Revolving Credit Agreement between Southern Union Company and the Banks named therein dated May 28, 2004. Exhibit No. Description - ----------- ----------- 10(b) Amended and Restated Term Loan Credit Agreement between Southern Union Company and the Banks named therein dated April 3, 2003. (Filed as Exhibit 10(c) to Southern Union's Annual Report on Form 10-K for the year ended June 30, 2003 and incorporated herein by reference.) 10(c) Form of Indemnification Agreement between Southern Union Company and each of the Directors of Southern Union Company. (Filed as Exhibit 10(i) to Southern Union's Annual Report on Form 10-K for the year ended December 31, 1986 and incorporated herein by reference.) 10(d) Southern Union Company 1992 Long-Term Stock Incentive Plan, as Amended. (Filed as Exhibit 10(l) to Southern Union's Annual Report on Form 10-K for the year ended June 30, 1998 and incorporated herein by reference.)(*) 10(e) Southern Union Company Director's Deferred Compensation Plan. (Filed as Exhibit 10(g) to Southern Union's Annual Report on Form 10-K for the year ended December 31, 1993 and incorporated herein by reference.)(*) 10(f) Southern Union Company Amended Supplemental Deferred Compensation Plan with Amendments. (Filed as Exhibit 4 to Southern Union's Form S-8 filed May 27, 1999 and incorporated herein by reference.)(*) 10(g) [Reserved]. 10(h) Employment agreement between Thomas F. Karam and Southern Union Company dated December 28, 1999. (Filed as Exhibit 10(a) to Southern Union's Quarterly Report on Form 10-Q for the quarter ended December 31, 1999 and incorporated herein by reference.) 10(i) Secured Promissory Note and Security Agreements between Thomas F. Karam and Southern Union Company dated December 20, 1999. (Filed as Exhibit 10(b) to Southern Union's Quarterly Report on Form 10-Q for the quarter ended December 31, 1999 and incorporated herein by reference.) 10(j) Promissory Note between Dennis K. Morgan and Southern Union Company dated January 28, 2000. (Filed as Exhibit 10(k) to Southern Union's Annual Report on Form 10-K for the year ended June 30, 2002 and incorporated herein by reference.) 10(k) Southern Union Company Pennsylvania Division Stock Incentive Plan. (Filed as Exhibit 4 to Form S-8, SEC File No. 333-36146, filed on May 3, 2000 and incorporated herein by reference.)(*) 10(l) Southern Union Company Pennsylvania Division 1992 Stock Option Plan. (Filed as Exhibit 4 to Form S-8, SEC File No. 333-36150, filed on May 3, 2000 and incorporated herein by reference.)(*) 10(m) Employment agreement between David W. Stevens and Southern Union Company dated October 31, 2002. (Filed as Exhibit 10 to Southern Union's Quarterly Report on Form 10-Q for the quarter ended December 31, 2002 and incorporated herein by reference.) 10(n) Southern Union Company 2003 Stock and Incentive Plan. (Filed as Exhibit 4.1 to Form S-8, SEC File No. 333-112527, filed on February 5, 2004 and incorporated herein by reference.)(*) 14 Code of Ethics. 21 Subsidiaries of the Company. 23 Consent of Independent Registered Public Accounting Firm. Exhibit No. Description - ----------- ----------- 24 Power of Attorney. 31.1 Certificate by Chief Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) promulgated under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certificate by Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) promulgated under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certificate by Chief Executive Officer pursuant to Rule 13a-14(b) or Rule 15d-14(b) promulgated under the Securities Exchange Act of 1934 and Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350. 32.2 Certificate by Chief Financial Officer pursuant to Rule 13a-14(b) or Rule 15d-14(b) promulgated under the Securities Exchange Act of 1934 and Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350. (b) Reports on Form 8-K. Southern Union filed the following Current Reports on Form 8-K during the three months ended June 30, 2004. Date Filed Description of Filing - ----- -------------------------------------------------------------- 04/30/04 Announcement of operating performance for the quarter- and nine-months ended March 31, 2004 and 2003 and filing, under Item 12, summary statements of income of Southern Union Company for the quarter ended March 31, 2004 and 2003 (unaudited) and notes thereto. 06/23/04 Announcement that CCE Holdings, LLC, a joint venture of Southern Union and its 50% equity partner GE Commercial Finance Energy Financial Services, submitted an offer to acquire 100% of the equity interests of CrossCountry Energy, LLC from Enron Corp. and its affiliates. 06/25/04 Announcement that CCE Holdings, LLC entered into a Purchase Agreement to acquire 100% of the equity interests of CrossCountry Energy, LLC from Enron Corp. and its affiliates; announcement that the U.S. Bankruptcy Court for the Southern District of New York issued an Order establishing CCE Holding's Agreement as the "Stalking Horse" bid; and filing under Item 7, the Purchase Agreement among CCE Holdings, LLC, Enron Transportation Services, LLC, EOC Preferred, LLC and Enron Corp., dated as of June 24, 2004. - --------------------- (*) Indicates Management Compensation Plan. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Southern Union has duly caused this report to be signed by the undersigned, thereunto duly authorized, on August 31, 2004. SOUTHERN UNION COMPANY By THOMAS F. KARAM -------------------------- Thomas F. Karam President and Chief Operating Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of Southern Union and in the capacities indicated as of August 31, 2004. Signature/Name Title -------------- ----- GEORGE L. LINDEMANN* Chairman of the Board, Chief Executive Officer and Director JOHN E. BRENNAN* Director DAVID BRODSKY* Director FRANK W. DENIUS* Director KURT A. GITTER, M.D.* Director THOMAS F. KARAM Director --------------------- Thomas F. Karam ADAM M. LINDEMANN* Director GEORGE ROUNTREE, III* Director RONALD W. SIMMS* Director DAVID J. KVAPIL Executive Vice President and Chief Financial ------------------------ David J. Kvapil Officer (Principal Accounting Officer) *By THOMAS F. KARAM ----------------------- Thomas F. Karam Attorney-in-fact SOUTHERN UNION COMPANY AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Page Financial Statements: Consolidated statement of operations -- years ended June 30, 2004, 2003 and 2002.................................. F-2 Consolidated balance sheet -- June 30, 2004 and 2003............ F-3 to F-4 Consolidated statement of cash flows -- years ended June 30, 2004, 2003 and 2002........................................... F-5 Consolidated statement of common stockholders' equity -- years ended June 30, 2004, 2003 and 2002............................ F-6 Notes to consolidated financial statements...................... F-7 to F-44 Report of independent registered public accounting firm......... F-45 All schedules are omitted as the required information is not applicable or the information is presented in the consolidated financial statements or related notes. SOUTHERN UNION COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENT OF OPERATIONS
Year Ended June 30, ------------------------------------------- 2004 2003 2002 ------------- ------------ -------------- (thousands of dollars, except shares and per share amounts) Operating revenues: Gas distribution...................................................... $ 1,304,405 $ 1,158,964 $ 968,933 Gas transportation and storage........................................ 491,083 24,529 -- Other................................................................. 4,486 5,014 11,681 ------------- ------------ ------------- Total operating revenues.......................................... 1,799,974 1,188,507 980,614 Cost of gas and other energy............................................... (864,438) (724,611) (573,077) Revenue-related taxes...................................................... (45,395) (40,485) (33,409) ------------- ------------ ------------- Net operating revenues, excluding depreciation and amortization... 890,141 423,411 374,128 Operating expenses: Operating, maintenance and general.................................... 411,811 193,745 171,147 Business restructuring charges........................................ -- -- 29,159 Depreciation and amortization......................................... 118,755 60,642 58,989 Taxes, other than on income and revenues.............................. 54,048 26,653 23,708 ------------- ------------ ------------- Total operating expenses.......................................... 584,614 281,040 283,003 ------------- ------------ ------------- Operating income.................................................. 305,527 142,371 91,125 ------------- ------------ ------------- Other income (expenses): Interest ............................................................. (127,867) (83,343) (90,992) Dividends on preferred securities of subsidiary trust................. -- (9,480) (9,480) Other, net............................................................ 5,468 18,394 14,278 ------------- ------------ ------------- Total other expenses, net......................................... (122,399) (74,429) (86,194) ------------- ------------ ------------- Earnings from continuing operations before income taxes.................... 183,128 67,942 4,931 Federal and state income taxes ............................................ 69,103 24,273 3,411 ------------- ------------ ------------- Net earnings from continuing operations.................................... 114,025 43,669 1,520 ------------- ------------ ------------- Discontinued operations: Earnings from discontinued operations before income taxes............. -- 84,773 29,801 Federal and state income taxes........................................ -- 52,253 11,697 ------------- ------------ ------------- Net earnings from discontinued operations.................................. -- 32,520 18,104 ------------- ------------ ------------- Net earnings ............................................................. 114,025 76,189 19,624 Preferred stock dividends.................................................. (12,686) -- -- -------------- ------------ ------------- Net earnings available for common shareholders............................. $ 101,339 $ 76,189 $ 19,624 Net earnings available for common shareholders from continuing operations per share: Basic................................................................. $ 1.34 $ 0.72 $ 0.03 ============= ============= ============= Diluted............................................................... $ 1.30 $ 0.70 $ 0.02 ============= ============= ============= Net earnings available for common shareholders per share: Basic................................................................. $ 1.34 $ 1.26 $ 0.33 ============= ============= ============= Diluted............................................................... $ 1.30 $ 1.22 $ 0.31 ============= ============= ============= Weighted average shares outstanding: Basic................................................................. 75,442,238 60,584,293 59,420,048 ============= ============= ============= Diluted............................................................... 77,694,532 62,523,107 62,596,874 ============= ============= =============
See accompanying notes. SOUTHERN UNION COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET ASSETS
June 30, --------------------------------- 2004 2003 --------------------------------- (thousands of dollars) Property, plant and equipment: Plant in service................................................................. $ 3,772,616 $ 3,710,541 Construction work in progress.................................................... 169,264 75,484 -------------- -------------- 3,941,880 3,786,025 Less accumulated depreciation and amortization............................... (734,367) (641,225) -------------- -------------- Net property, plant and equipment............................................ 3,207,513 3,144,800 Current assets: Cash and cash equivalents........................................................ 19,971 86,997 Accounts receivable, billed and unbilled, net.................................... 181,924 192,402 Inventories...................................................................... 200,295 173,757 Deferred gas purchase costs...................................................... 3,933 24,603 Gas imbalances - receivable...................................................... 22,045 34,911 Prepayments and other............................................................ 27,561 18,971 -------------- -------------- Total current assets......................................................... 455,729 531,641 Goodwill, net of accumulated amortization of $27,510.................................. 640,547 642,921 Deferred charges...................................................................... 190,735 188,261 Investment securities, at cost........................................................ 8,038 9,641 Other................................................................................. 69,896 73,674 -------------- -------------- Total assets................................................................. $ 4,572,458 $ 4,590,938 ============== ==============
See accompanying notes. SOUTHERN UNION COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET (Continued) STOCKHOLDERS' EQUITY AND LIABILITIES
June 30, ------------------------------ 2004 2003 ------------------------------ (thousands of dollars) Stockholders' equity: Common stock, $1 par value; authorized 200,000,000 shares; issued 77,140,087 shares at June 30, 2004..................................... $ 77,141 $ 73,074 Preferred stock, no par value; authorized 6,000,000 shares; issued 920,000 shares at June 30, 2004........................................ 230,000 -- Premium on capital stock.......................................................... 975,104 909,191 Less treasury stock: 404,536 and 282,333 shares, respectively, at cost....................................................................... (12,870) (10,467) Less common stock held in trust: 1,089,147 and 1,061,656 shares, respectively.................................................................. (15,812) (15,617) Deferred compensation plans....................................................... 11,960 9,960 Accumulated other comprehensive income (loss)..................................... (50,224) (62,579) Retained earnings................................................................. 46,692 16,856 ------------- ------------- Total stockholders' equity........................................................ 1,261,991 920,418 Company-obligated mandatorily redeemable preferred securities of subsidiary trust holding solely subordinated notes of Southern Union......................... -- 100,000 Long-term debt and capital lease obligation............................................ 2,154,615 1,611,653 ------------- ------------- Total capitalization.......................................................... 3,416,606 2,632,071 Current liabilities: Long-term debt and capital lease obligation due within one year................... 99,997 734,752 Notes payable..................................................................... 21,000 251,500 Accounts payable.................................................................. 122,309 112,840 Federal, state and local taxes.................................................... 32,866 6,743 Accrued interest.................................................................. 36,891 40,871 Customer deposits................................................................. 12,043 12,585 Gas imbalances - payable.......................................................... 72,057 64,519 Other............................................................................. 116,783 130,196 ------------- ------------- Total current liabilities..................................................... 513,946 1,354,006 Deferred credits....................................................................... 292,946 322,154 Accumulated deferred income taxes...................................................... 348,960 282,707 Commitments and contingencies.......................................................... ------------- ------------- Total stockholders' equity and liabilities.................................... $ 4,572,458 $ 4,590,938 ============= =============
See accompanying notes. SOUTHERN UNION COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS
Year Ended June 30, ------------------------------------------- 2004 2003 2002 ------------------------------------------- (thousands of dollars) Cash flows from (used in) operating activities: Net earnings ........................................................ $ 114,025 $ 76,189 $ 19,624 Adjustments to reconcile net earnings to net cash flows provided by (used in) operating activities: Depreciation and amortization.................................... 118,755 60,642 58,989 Amortization of debt premium.............................................. (14,243) (1,307) -- Deferred income taxes............................................ 67,455 78,747 28,397 Provision for bad debts................................................... 21,216 17,873 12,260 Provision for impairment of other assets.................................. 1,603 -- 10,380 Financial derivative trading gains............................... (605) (605) (6,204) Amortization of debt expense.............................................. 4,143 2,919 2,936 Gain on sale of subsidiaries and other assets............................. -- (62,992) (6,414) Loss on sale of subsidiaries..................................... 1,150 -- 1,500 Gain on settlement of interest rate swaps........................ -- -- (17,166) Gain on extinguishment of debt................................... (6,354) -- -- Business restructuring charges................................... -- -- 24,440 Net cash provided (used by) assets held for sale................. -- (23,698) 48,618 Other ........................................................... (470) (707) 355 Changes in operating assets and liabilities, net of acquisitions: Accounts receivable, billed and unbilled.................... (6,181) (48,520) 71,932 Gas imbalance receivable.................................... 20,341 6,330 -- Accounts payable............................................ 9,469 22,728 (11,965) Gas imbalance payable....................................... (1,278) 4,851 -- Customer deposits........................................... (542) 5,013 (53) Deferred gas purchase costs................................. 20,670 (21,006) 53,436 Inventories................................................. (25,824) (34,583) 1,044 Deferred charges and credits................................ 13,773 (12,561) 16,804 Prepaids and other current assets........................... 8,978 2,541 (3,735) Taxes and other current liabilities......................... (5,031) (16,158) (31,562) ------------ ----------- ----------- Net cash flows provided by operating activities.................. 341,050 55,696 273,616 ------------ ----------- ----------- Cash flows (used in) provided by investing activities: Additions to property, plant and equipment........................... (226,053) (79,730) (70,698) Acquisition of operations, net of cash received........................... -- (522,316) -- Notes receivable..................................................... (2,000) (6,750) (2,750) Purchase of investment securities.................................... -- -- (938) Customer advances ........................................................ (3,600) (9,619) (403) Proceeds from sale of subsidiaries and other assets.................. 2,175 437,000 40,935 Proceeds from sale of interest rate swaps................................. -- -- 17,166 Net cash used in assets held for sale................................ -- (13,410) (23,215) Other................................................................ 2,469 3,465 677 ------------ ------------ ------------ Net cash flows used in investing activities...................... (227,009) (191,360) (39,226) ------------ ------------ ------------ Cash flows (used in) provided by financing activities: Issuance of long-term debt........................................... 750,000 311,087 -- Issuance costs of debt.................................................... (8,530) (313) (921) Issuance of preferred stock.......................................... 230,000 -- -- Issuance costs of preferred stock.................................... (6,590) -- -- Issuance of common stock............................................. -- 168,682 -- Issuance of equity units............................................. -- 125,000 -- Issuance cost of equity units........................................ -- (3,443) -- Purchase of treasury stock........................................... (2,403) (2,181) (41,632) Dividends paid on preferred stock.................................... (8,393) -- -- Repayment of debt and capital lease obligation....................... (908,773) (500,135) (145,131) Net (payments) borrowings under revolving credit facilities............... (230,500) 119,700 (58,800) Proceeds from exercise of stock options................................... 4,122 3,047 8,346 Other................................................................ -- 1,217 2,529 ------------ ------------ ------------ Net cash flows (used in) provided by financing activities................. (181,067) 222,661 (235,609) ------------- ------------ ------------ Change in cash and cash equivalents....................................... (67,026) 86,997 (1,219) Cash and cash equivalents at beginning of year............................ 86,997 -- 1,219 ------------ ------------ ------------ Cash and cash equivalents at end of year.................................. $ 19,971 $ 86,997 $ -- ============ ============ ============
Cash paid for interest, net of amounts capitalized, in 2004, 2003 and 2002 was $143,715,000, $90,462,000 and $99,643,000, respectively. Cash refunded for income taxes in 2004 and 2002 was $10,875,000 and $4,214,000, respectively, while cash paid for income taxes in 2003 was $2,351,000. See accompanying notes. SOUTHERN UNION COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
Accumulated Common Other Total Common Preferred Premium Treasury Stock Comprehen- Stock- Stock, $1 Stock, No on Capital Stock, at Held in sive Income Retained holders' Par Value Par Value Stock Cost Trust (Loss) Earnings Equity --------- --------- ----- ---- ----- ------ -------- ------ (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 benefit -- -- -- -- -- (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 (loss): Net earnings -- -- -- -- -- -- 76,189 76,189 Unrealized loss in investment securities, net of tax benefit -- -- -- -- -- (581) -- (581) Minimum pension liability adjustment, net of tax benefit -- -- -- -- -- (41,930) -- (41,930) Unrealized loss on hedging activities, net of tax benefit -- -- -- -- -- (5,568) -- (5,568) --------- Comprehensive income 28,110 --------- Payment on note receivable -- -- 305 -- -- -- -- 305 Purchase of treasury stock -- -- -- (2,181) -- -- -- (2,181) 5% stock dividend 3,468 -- 55,832 -- -- -- (59,333) (33) Stock compensation plan -- -- 480 -- 737 -- -- 1,217 Issuance of stock for acquisition -- -- -- 48,900 -- -- -- 48,900 Issuance of common stock 10,925 -- 157,757 -- -- -- -- 168,682 Issuance costs of equity units -- -- (3,443) -- -- -- -- (3,443) Contract adjustment payment -- -- (11,713) -- -- -- -- (11,713) Sale of common stock held in trust -- -- (243) -- 2,424 -- -- 2,181 Exercise of stock options 626 -- 2,304 487 (370) -- -- 3,047 -------- -------- -------- -------- -------- -------- -------- --------- Balance June 30, 2003 73,074 -- 909,191 (10,467) (5,657) (62,579) 16,856 920,418 Comprehensive income (loss): Net earnings -- -- -- -- -- -- 114,025 114,025 Unrealized loss in investment securities, net of tax benefit -- -- -- -- -- (21) -- (21) Minimum pension liability adjustment, net of tax -- -- -- -- -- 10,768 -- 10,768 Unrealized gain on hedging activities, net of tax -- -- -- -- -- 1,608 -- 1,608 --------- Comprehensive income 126,380 --------- Preferred stock dividends -- -- -- -- -- -- (12,686) (12,686) Payment on note receivable -- -- 347 -- -- -- -- 347 Purchase of treasury stock -- -- -- (2,403) -- -- -- (2,403) 5% stock dividend 3,656 -- 67,847 -- -- -- (71,503) -- Sale of common stock held in trust -- -- 598 -- 1,805 -- -- 2,403 Issuance of preferred stock -- 230,000 (6,590) -- -- -- -- 223,410 Exercise of stock options 411 -- 3,711 -- -- -- -- 4,122 -------- ---------- --------- ---------- -------- ----------- ---------- ---------- Balance June 30, 2004 $ 77,141 $ 230,000 $ 975,104 $ (12,870) $ (3,852) $ (50,224) $ 46,692 $1,261,991 ======== ========== ========= ========== ======== =========== ========== ==========
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 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS I Summary of Significant Accounting Policies Operations. Southern Union Company (Southern Union and together with its subsidiaries, the Company) is primarily engaged in the transportation, storage and distribution of natural gas in the United States. The Company's interstate natural gas transportation and storage operations are conducted through Panhandle Energy, which operates more than 10,000 miles of interstate pipelines that transport natural gas from the Gulf of Mexico, South Texas and the Panhandle regions of Texas and Oklahoma to major U.S. markets in the Midwest and Great Lakes regions. The Company's local natural gas distribution operations are conducted through its three regulated utility divisions, Missouri Gas Energy, PG Energy and New England Gas Company, which collectively serve over 960,000 customers in Missouri, Pennsylvania, Rhode Island and Massachusetts. Basis of Presentation. Effective June 11, 2003, the Company acquired Panhandle Energy from CMS Energy Corporation. The acquisition was accounted for using the purchase method of accounting in accordance with accounting principles generally accepted in the United States of America with the purchase price paid and acquisition costs incurred by the Company allocated to Panhandle Energy's net assets as of the acquisition date. The Panhandle Energy assets acquired and liabilities assumed have been recorded at their estimated fair value as of the acquisition date based on the results of outside appraisals. Panhandle Energy's results of operations have been included in the Consolidated Statement of Operations since June 11, 2003. Thus, the Consolidated Statement of Operations for the periods subsequent to the acquisition is not comparable to the same periods in prior years. Effective January 1, 2003, the Company completed the sale of its Southern Union Gas Company natural gas operating division and related assets to ONEOK, Inc. (ONEOK). In accordance with accounting principles generally accepted in the United States of America, the results of operations and gain on sale of the Texas operations have been segregated and reported as "discontinued operations" in the Consolidated Statement of Operations and as "assets held for sale" in the Consolidated Statement of Cash Flows for the respective periods. See Note II -- Acquisitions and Sales and Note XIX -- Discontinued Operations. Principles of Consolidation. The consolidated financial statements include the accounts of Southern Union and its wholly-owned subsidiaries. Investments, other than variable interest entities, in which the Company has significant influence over the operations of the investee are accounted for using the equity method. Investments that are variable interest entities are consolidated if the Company is allocated a majority of the entity's gains and/or losses, including fees paid by the entity. All significant intercompany accounts and transactions are eliminated in consolidation. All dollar amounts in the tables herein, except per share amounts, are stated in thousands unless otherwise indicated. Certain reclassifications have been made to prior years' financial statements to conform with the current year presentation. Segment Reporting. The Financial Accounting Standards Board (FASB) Standard, Disclosures about Segments of an Enterprise and Related Information, requires disclosure of segment data based on how management makes decisions about allocating resources to segments and measuring performance. The Company is principally engaged in the transportation, storage and distribution of natural gas in the United States and reports these operations under two reportable segments: the Transportation and Storage segment and the Distribution segment. Gas Utility Revenues and Gas Purchase Costs. In the Distribution segment, gas utility customers are billed on a monthly-cycle basis. The related cost of gas and revenue taxes are matched with cycle-billed revenues through utilization of purchased gas adjustment provisions in tariffs approved by the regulatory agencies having jurisdiction. Revenues from gas delivered but not yet billed are accrued, along with the related gas purchase costs and revenue-related taxes. The Company's operating revenue and other financial information by segment for fiscal 2004, 2003 and 2002 are presented in Note XXI -- Reportable Segments. Transportation and Storage Revenues. In the Transportation and Storage segment, revenues on transportation, storage and terminalling of natural gas are recognized as service is provided. Receivables are subject to normal trade terms and are reported net of an allowance for doubtful accounts. Prior to final Federal Energy Regulatory Commission (FERC) approval of filed rates, the Company is exposed to risk that FERC will ultimately approve the rates at a level lower than those requested. The difference is subject to refund and reserves are established, where required, for that purpose. The Company's operating revenues and other financial information by segment for fiscal 2004, 2003 and 2002 are presented in Note XXI -- Reportable Segments. Earnings Per Share. The Company's earnings per share presentation conforms to the FASB Standard, Earnings per Share. All share and per share data have been appropriately restated for all stock dividends and stock splits distributed through August 31, 2004 unless otherwise noted. Stock Based Compensation. The Company accounts for stock option grants using the intrinsic-value method in accordance with APB Opinion, Accounting for Stock Issued to Employees, and related authoritative interpretations. Under the intrinsic-value method, because the exercise price of the Company's employee stock options is greater than or equal to the market price of the underlying stock on the date of grant, no compensation expense is recognized. The following table illustrates the effect on net earnings and net earnings available for common shareholders per share if the Company had applied the fair value recognition provisions of the FASB Standard, Accounting for Stock-Based Compensation, as amended by the FASB Standard, Accounting for Stock-Based Compensation--Transition and Disclosure, to stock-based employee compensation:
Year Ended June 30, ----------------------------------- 2004 2003 2002 --------- --------- --------- Net earnings, as reported........................................... $ 114,025 $ 76,189 $ 19,624 Add stock-based employee compensation expense included in reported net earnings, net of related taxes......... -- -- -- Deduct total stock-based employee compensation expense determined under fair value based method for all awards, net of related taxes............................ 1,699 1,373 953 --------- --------- --------- Pro forma net earnings.............................................. $ 112,326 $ 74,816 $ 18,671 ========= ========= ========= Net earnings available for common shareholders per share: Basic -- as reported................................................ $ 1.34 $ 1.26 $ 0.33 Basic -- pro forma.................................................. 1.32 1.23 0.31 Diluted -- as reported.............................................. 1.30 1.22 0.31 Diluted -- pro forma................................................ 1.29 1.21 0.30
The fair value of each option is estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions used for grants in 2004 and 2002, respectively: dividend yield of nil for all years; volatility of 36.75% in 2004 and 33.5% for 2002; risk-free interest rate of 2.95% in 2004, and 3.75% in 2002; and expected life outstanding of 6 years for 2004 and 7 years for 2002. The weighted average fair value of options granted at fair market value at their grant date during 2004 and 2002 were $7.35 and $6.92, respectively. There were no options granted above fair market value at the grant date during 2004 and 2002, respectively. No options were granted in 2003. Accumulated Other Comprehensive Income. The Company reports comprehensive income and its components in accordance with the FASB Standard, Reporting Comprehensive Income. The main components of comprehensive income that relate to the Company are net earnings available for common shareholders, unrealized holding gains and losses on investment securities, minimum pension liability adjustments and unrealized gain (loss) on hedging activities, all of which are presented in the Consolidated Statement of Stockholders' Equity. The table below gives an overview of comprehensive income for the periods indicated.
Year Ended June 30, ---------------------------------- 2004 2003 2002 ---------------------------------- Net earnings ........................................................ $ 114,025 $ 76,189 $ 19,624 Other comprehensive income (loss): Unrealized loss in investment securities, net of tax benefit ..... (21) (581) (18,249) Unrealized gain (loss) on hedging activities, net of tax (benefit) 1,608 (5,568) 804 Minimum pension liability adjustment, net of tax (benefit) ...... 10,768 (41,930) (10,498) --------- --------- --------- Other comprehensive income (loss) ................................... 12,355 (48,079) (27,943) --------- --------- --------- Comprehensive income (loss) ......................................... $ 126,380 $ 28,110 $ (8,319) ========= ========= =========
Accumulated other comprehensive income (loss) reflected in the Consolidated Balance Sheet at June 30, 2004 and 2003 includes unrealized gains and losses on hedging activities and investment securities, and minimum pension liability adjustments. Significant Customers and Credit Risk. In the Distribution segment, concentrations of credit risk in trade receivables are limited due to the large customer base with relatively small individual account balances. In addition, Company policy requires a deposit from customers who lack a credit history or whose credit rating is substandard. The Company has recorded an allowance for doubtful accounts, totaling $13,502,000, $16,823,000, $15,324,000 and $28,347,000 at June 30, 2004, 2003, 2002 and 2001, respectively, relating to its Distribution segment trade receivables. The allowance for doubtful accounts is adjusted for changes in estimated uncollectible accounts and reduced for the write-off of trade receivables. In the Transportation and Storage segment, aggregate sales to Panhandle Energy's top 10 customers accounted for 70% of segment operating revenues and 19% of the Company's total operating revenues in fiscal 2004. This included sales to Proliance Energy, LLC, a nonaffiliated local distribution company and gas marketer, which accounted for 17% of segment operating revenues; sales to BG LNG Services, a nonaffiliated gas marketer, which accounted for 16% of segment operating revenues; and sales to CMS Energy Corporation, Panhandle Energy's former parent, which accounted for 11% of the segment operating revenues. No other customer accounted for 10% or more of the Transportation and Storage segment operating revenues, and no single customer or group of customers under common control accounted for 10% or more of the Company's total operating revenues in 2004. Panhandle Energy manages trade credit risks to minimize exposure to uncollectible trade receivables. Prospective and existing customers are reviewed for creditworthiness based upon pre-established standards. Customers that do not meet minimum standards are required to provide additional credit support. The Company has recorded an allowance for doubtful accounts totaling $1,422,000 and $4,138,000 at June 30, 2004 and 2003, respectively, relating to its Transportation and Storage segment trade receivables. Inventories. In the Distribution segment, inventories consist of natural gas in underground storage and materials and supplies, both of which are carried at weighted average cost. Natural gas in underground storage at June 30, 2004 and 2003 was $116,292,000 and $117,679,000, respectively, and consisted of 19,918,000 and 20,853,000 million British thermal units (MMBtu), respectively. In the Transportation and Storage segment, inventories consist of gas held for operations and materials and supplies. All gas held for operations and materials and supplies purchased are recorded at the lower of weighted average cost or market, while gas received from or owed back to customers is valued at market. The gas held for operations that is not expected to be consumed in operations in the next twelve months is reflected in non-current assets. Gas held for operations at June 30, 2004 was $94,586,000, or 17,562,000 MMBtu, of which $28,999,000 is classified as non-current. Gas held for operations at June 30, 2003 was $57,647,000, or 11,657,000 MMBtu, of which $22,769,000 is classified as non-current. Goodwill and Other Intangible Assets. The Company accounts for its goodwill and other intangible assets in accordance with the FASB Standard, Accounting for Goodwill and Other Intangible Assets. Under this Statement, the Company has ceased amortization of goodwill. Goodwill, which was previously classified on the consolidated balance sheet as additional purchase cost assigned to utility plant and amortized on a straight-line basis over forty years, is now subject to at least an annual assessment for impairment by applying a fair-value based test. See Note VII - Goodwill and Intangibles. Fair Value of Financial Instruments. The carrying amounts reported in the balance sheet for cash and cash equivalents, accounts receivable, accounts payable, derivative instruments and notes payable approximate their fair value. The fair value of the Company's long-term debt is estimated using current market quotes and other estimation techniques. Gas Imbalances. In the Transportation and Storage segment, gas imbalances occur as a result of differences in volumes of gas received and delivered. The Company records gas imbalance in-kind receivables and payables at cost or market, based on whether net imbalances have reduced or increased system gas balances, respectively. Net imbalances which have reduced system gas are valued at the cost basis of the system gas, while net imbalances which have increased system gas and are owed back to customers are priced, along with the corresponding system gas, at market. Fuel Tracker. Liability accounts are maintained in the Transportation and Storage segment for net volumes of fuel gas owed to customers collectively. Trunkline records an asset whenever fuel is due from customers from prior under recovery based on contractual and specific tariff provisions, which support the treatment as an asset. Panhandle Energy's other companies that are subject to fuel tracker provisions record an expense when fuel is under recovered. The pipelines' fuel reimbursement is in-kind and non-discountable. Interest Cost Capitalized. The Company capitalizes interest on certain qualifying assets that are undergoing activities to prepare them for their intended use in accordance with the FASB Standard, Capitalization of Interest Cost. Interest costs incurred during the construction period are capitalized and amortized over the life of the assets. Derivative Instruments and Hedging Activities. The Company accounts for its derivatives in accordance with the FASB Standard, Accounting for Derivative Instruments and Hedging Activities, as amended. Under this Statement, all derivatives are recognized on the balance sheet at their fair value. On the date the derivative contract is entered into, management designates the derivative as either: (i) a hedge of the fair value of a recognized asset or liability or of an unrecognized firm commitment (a fair value hedge); (ii) a hedge of a forecasted transaction or of the variability of cash flows to be received or paid in connection with a recognized asset or liability (a cash flow hedge); or (iii) an instrument that is held for trading or non-hedging purposes (a trading or non-hedging instrument). Changes in the fair value of a derivative that qualifies as a fair-value hedge, along with the gain or loss on the hedged asset or liability that is attributable to the hedged risk are recorded in earnings. Changes in the fair value of a derivative that qualifies as a cash-flow hedge, to the extent that the hedge is effective, are recorded in other comprehensive income, until earnings are affected by the variability of cash flows of the hedged transaction (e.g., until periodic settlements of a variable-rate asset or liability are recorded in earnings). Hedge ineffectiveness is recorded through earnings immediately. Lastly, changes in the fair value of derivative trading and non-hedging instruments are reported in current-period earnings. Fair value is determined based upon mathematical models using current and historical data. The Company formally assesses both at the hedge's inception and on an ongoing basis, whether the derivatives that are used in hedging transactions have been highly effective in offsetting changes in the fair value or cash flows of hedged items and whether those derivatives may be expected to remain highly effective in future periods. The Company discontinues hedge accounting when: (i) it determines that the derivative is no longer effective in offsetting changes in the fair value or cash flows of a hedged item; (ii) the derivative expires or is sold, terminated, or exercised; (iii) it is no longer probable that the forecasted transaction will occur; or (iv) management determines that designating the derivative as a hedging instrument is no longer appropriate. In all situations in which hedge accounting is discontinued and the derivative remains outstanding, the Company will carry the derivative at its fair value on the balance sheet, recognizing changes in the fair value in current-period earnings. See Note XI -- Derivative Instruments and Hedging Activities. The Company utilizes derivative instruments on a limited basis to manage certain business risks. Interest rate swaps and treasury rate locks are used to reduce interest rate risks and to manage interest expense. Commodity swaps have been employed to manage price risk associated with certain energy contracts. Asset Retirement Obligations. The Company accounts for its asset retirement obligations in accordance with the FASB Standard, Accounting for Asset Retirement Obligations (ARO). The Statement requires legal obligations associated with the retirement of long-lived assets to be recognized at their fair value at the time the obligations are incurred. Upon initial recognition of a liability, costs should be capitalized as part of the related long-lived asset and allocated to expense over the useful life of the 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 long-lived 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. Panhandle Energy has an ARO liability relating to the retirement of certain of its offshore lateral lines with an aggregate carrying amount of approximately $6,407,000 and $6,757,000 as of June 30, 2004 and 2003, respectively. During the year ended June 30, 2004, changes in the carrying amount of the ARO liability were attributable to $395,000 of additional liabilities incurred, and $628,000 of accretion expense. Liabilities settled and cash flow revisions were $1,373,000 for fiscal 2004. In fiscal 2003, the Company reclassified approximately $27,000,000 of negative salvage previously included in accumulated depreciation to deferred credits for amounts collected for asset retirement obligations on certain of the Panhandle Energy assets acquired which were not liabilities under the Statement but represented other regulatory obligations. New Pronouncements. In April 2003, the FASB issued Amendment of Statement 133 on Derivative Instruments and Hedging Activities. The Statement is effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003. The Statement (i) clarifies under what circumstances a contract with an initial net investment meets the characteristic of a derivative, (ii) clarifies when a derivative contains a financing component, (iii) amends the definition of an underlying to conform it to language used in FASB Interpretation Guarantor's Accounting and Disclosure Requirement for Guarantees, Including Indirect Guarantees of Indebtedness of Others, and (iv) amends certain other existing pronouncements. The Statement did not materially change the methods the Company uses to account for and report its derivatives and hedging activities. Effective July 1, 2003, the Company adopted the FASB Standard, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. The Statement establishes guidelines on how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. The Statement further defines and requires that certain instruments within its scope be classified as liabilities on the financial statements. The adoption of the Statement did not have a material impact on the Company's financial position, results of operations or cash flows for the periods presented. Effective January 1, 2004, the Company adopted the FASB Standard, Employers' Disclosures about Pensions and Other Postretirement Benefits - an amendment of FASB Statements No. 87, 88, and 106. The Statement revises employers' disclosures about pension plans and other postretirement benefit plans. It retains the disclosure requirements contained in FASB Statement No. 132, Employers' Disclosures about Pensions and Other Postretirement Benefits, which it replaces, and requires additional disclosure about the assets, obligations, cash flows and net periodic benefit cost of defined benefit pension plans and other defined benefit postretirement plans. The Statement does not change the measurement or recognition of those plans required by FASB Statements No. 87, Employers' Accounting for Pensions, No. 88, Employers' Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits, and No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions. In December 2003, the FASB issued Consolidation of Variable Interest Entities. The Interpretation introduced a new consolidation model, which determines control and consolidation based on potential variability in gains and losses of the entity being evaluated for consolidation. The Interpretation requires a company to consolidate a variable interest entity if the company is allocated a majority of the entity's gains and/or losses, including fees paid by the entity. The Interpretation is effective for companies that have an interest in variable interest entities or potential variable interest entities commonly referred to as special-purpose entities for periods ending after December 15, 2003. Application by companies for all other types of entities is required in financial statements for periods ending after March 15, 2004. The Company has not identified any material variable interest entities or interests in variable interest entities for which the provisions of this Interpretation would require a change in the Company's current accounting for such interests. In March 2004, the Emerging Issues Task Force (EITF) reached final consensuses on Issue 03-6, Participating Securities and the Two-Class Method under FASB 128, Earnings per Share. The Issue addresses the computation of earnings per share by companies that have issued securities other than common stock that contractually entitle the holder to participate in dividends and earnings of the company when, and if, it declares dividends on its common stock. The Issue is effective for interim periods beginning after March 31, 2004. Based on the Company's capital structure at June 30, 2004, this Issue did not change the method used by the Company to calculate its earnings per share for the period ended June 30, 2004. In accordance with FASB Financial Staff Position (FSP), Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003, the benefit obligation and net periodic post-retirement cost in the Company's consolidated financial statements and accompanying notes do not reflect the effects of the Act on the Company's post-retirement healthcare plan because the employer is unable to conclude whether benefits provided by the plan are actuarially equivalent to Medicare Part D under the Act. The method of determining whether a sponsor's plan will qualify for actuarial equivalency is pending until the US Department of Health and Human Services (HHS) completes its interpretative work on the Act. Once the interpretative guidance is released by HHS, if eligible, the Company will account for the subsidy as an actuarial gain pursuant to the guidelines of this standard. Use of Estimates. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. II Acquisitions and Sales On June 11, 2003, Southern Union acquired Panhandle Energy from CMS Energy Corporation for approximately $581,729,000 in cash and 3,000,000 shares of Southern Union common stock (before adjustment for subsequent stock dividends) valued at approximately $48,900,000 based on market prices at closing of the Panhandle Energy acquisition and in connection therewith incurred transaction costs of approximately $31,922,000. At the time of the acquisition, Panhandle Energy had approximately $1,157,228,000 of debt principal outstanding that it retained. The Company funded the cash portion of the acquisition with approximately $437,000,000 in cash proceeds it received for the January 1, 2003 sale of its Texas operations, approximately $121,250,000 of the net proceeds it received from concurrent common stock and equity unit offerings (see Note X - Stockholders' Equity) and with working capital available to the Company. The Company structured the Panhandle Energy acquisition and the sale of its Texas operations to qualify as a like-kind exchange of property under Section 1031 of the Internal Revenue Code of 1986, as amended. The acquisition was accounted for using the purchase method of accounting in accordance with accounting principles generally accepted within the United States of America with the purchase price paid and acquisition costs incurred by the Company allocated to Panhandle Energy's net assets as of the acquisition date. The Panhandle Energy assets acquired and liabilities assumed have been recorded at their estimated fair value as of the acquisition date based on the results of outside appraisals. Panhandle Energy's results of operations have been included in the Consolidated Statement of Operations since June 11, 2003. Thus, the Consolidated Statement of Operations for the periods subsequent to the acquisition is not comparable to the same periods in prior years. Panhandle Energy is primarily engaged in the interstate transportation and storage of natural gas and also provides liquefied natural gas (LNG) terminalling and regasification services and is subject to the rules and regulations of the Federal Energy Regulatory Commission (FERC). The Panhandle Energy entities include Panhandle Eastern Pipe Line Company, LP (Panhandle Eastern Pipe Line), Trunkline Gas Company, LLC (Trunkline), a wholly-owned subsidiary of Panhandle Eastern Pipe Line, Sea Robin Pipeline Company (Sea Robin), a Louisiana joint venture and an indirect wholly-owned subsidiary of Panhandle Eastern Pipe Line, Trunkline LNG Company, LLC (Trunkline LNG) which is a wholly-owned subsidiary of Trunkline LNG Holdings, LLC (LNG Holdings), an indirect wholly-owned subsidiary of Panhandle Eastern Pipe Line and Pan Gas Storage, LLC (d.b.a. Southwest Gas Storage), a wholly-owned subsidiary of Panhandle Eastern Pipe Line. Collectively, the pipeline assets include more than 10,000 miles of interstate pipelines that transport natural gas from the Gulf of Mexico, South Texas and the Panhandle regions of Texas and Oklahoma to major U.S. markets in the Midwest and Great Lakes region. The pipelines have a combined peak day delivery capacity of 5.4 billion cubic feet (Bcf) per day and 72 Bcf of owned underground storage capacity and 6.3 Bcf of above ground LNG storage capacity. Trunkline LNG, located on Louisiana's Gulf Coast, operates one of the largest LNG import terminals in North America, based on current send out capacity. The following table summarizes the estimated fair values of the Panhandle Energy assets acquired and liabilities assumed at the date of acquisition. These fair values were recorded based on the finalization of outside appraisals and reflect a net reduction of approximately $16,000,000 from the initial purchase price allocation as a result of purchase accounting adjustments during fiscal 2004. At June 11, 2003 ---------------- (in thousands) Property, plant and equipment (excluding intangibles) ...... $ 1,904,762 Intangibles ................................................ 9,503 Current assets (1).......................................... 217,645 Other non-current assets.................................... 30,098 ---------------- Total assets acquired.................................. 2,162,008 ---------------- Long-term debt.............................................. (1,207,617) Current liabilities......................................... (165,585) Other non-current liabilities............................... (125,785) ---------------- Total liabilities assumed.............................. (1,498,987) ---------------- Net assets acquired................................ $ 663,021 ================ (1) Includes cash and cash equivalents of approximately $60 million. Effective January 1, 2003, the Company completed the sale of its Southern Union Gas natural gas operating division and related assets to ONEOK, Inc. (ONEOK) for approximately $437,000,000 in cash resulting in a pre-tax gain of $62,992,000. In accordance with accounting principles generally accepted within the United States of America, the results of operations and gain on sale of the Texas operations have been segregated and reported as "discontinued operations" in the Consolidated Statement of Operations and as "assets held for sale" in the Consolidated Statement of Cash Flows for the respective periods. In April 2002, PG Energy Services' (Energy Services) propane operations, which sold liquid propane to residential, commercial and industrial customers, were sold for $2,300,000, resulting in a pre-tax gain of $1,200,000. In July 2001, Energy Services' commercial and industrial gas marketing contracts were sold for $4,972,000, resulting in a pre-tax gain of $4,653,000. In October 2001, Morris Merchants, Inc., 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, Inc., which sold liquid propane to residential, commercial and industrial customers, was sold for $5,301,000. In August 2001, ProvEnergy Oil Enterprises, Inc., 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. Pro Forma Financial Information The following unaudited pro forma financial information for the years ended June 30, 2003 and 2002 is presented as though the following events had occurred at the beginning of the earliest period presented: (i) acquisition of Panhandle Energy; (ii) the issuance of the common stock and equity units in June 2003; and (iii) the refinancing of certain short-term and long-term debt at the time of the Panhandle Energy acquisition. The pro forma financial information is not necessarily indicative of the results which would have actually been obtained had the acquisition of Panhandle Energy, the issuance of the common stock and equity units, or the refinancings been completed as of the assumed date for the period presented or which may be obtained in the future.
(Unaudited) Year Ended June 30, 2003 2002 ------------- -------------- Operating revenues.......................................... $ 1,671,114 $ 1,467,630 Net earnings from continuing operations..................... 132,458 56,073 Net earnings per share from continuing operations: Basic.................................................. 1.76 0.75 Diluted................................................ 1.72 0.72
III Other Income (Expense), Net Other income in 2004 of $5,468,000 includes a gain of $6,354,000 on the early extinguishment of debt and income of $2,230,000 generated from the sale and/or rental of gas-fired equipment and appliances from various operating subsidiaries. These items were partially offset by charges of $1,603,000 and $1,150,000 to reserve for the impairment of Southern Union's investments in a technology company and in an energy-related joint venture, respectively, and $836,000 of legal costs associated with the Company's attempt to collect damages from former Arizona Corporation Commissioner James Irvin related to the Southwest Gas Corporation (Southwest) litigation. Other income in 2003 of $18,394,000 includes a gain of $22,500,000 on the settlement of the Southwest litigation and income of $2,016,000 generated from the sale and/or rental of gas-fired equipment and appliances. These items were partially offset by $5,949,000 of legal costs related to the Southwest litigation and $1,298,000 of selling costs related to the Texas operations' disposition. Other income in 2002 of $14,278,000 includes gains of $17,166,000 generated through the settlement of several interest rate swaps, the recognition of $6,204,000 in previously recorded deferred income related to financial derivative energy trading activity of a former subsidiary, a gain of $4,653,000 realized through the sale of marketing contracts held by PG Energy Services Inc., income of $2,234,000 generated from the sale and/or rental of gas-fired equipment and appliances by various operating subsidiaries, a gain of $1,200,000 realized through the sale of the propane assets of PG Energy Services Inc., $1,004,000 of realized gains on the sale of a portion of Southern Union's holdings in Capstone, and power generation and sales income of $971,000 primarily from PEI Power Corporation. These items were partially offset by a non-cash charge of $10,380,000 to reserve for the impairment of the Company's investment in a technology company, $9,100,000 of legal costs associated with ongoing litigation from the unsuccessful acquisition of Southwest, and a $1,500,000 loss on the sale of the Florida Operations. IV Cash Flow Information The Company considers all highly liquid investments with an original maturity of three months or less to be cash equivalents. Short-term investments are highly liquid investments with maturities of more than three months when purchased, and are carried at cost, which approximates market. The Company places its temporary cash investments with a high credit quality financial institution which, in turn, invests the temporary funds in a variety of high-quality short-term financial securities. Under the Company's cash management system, checks issued but not presented to banks frequently result in overdraft balances for accounting purposes and are classified in accounts payable in the Consolidated Balance Sheet. V Earnings Per Share The following table summarizes the Company's basic and diluted earnings per share calculations for 2004, 2003, and 2002:
Year Ended June 30, ------------------------------------- 2004 2003 2002 ----------- ----------- ----------- Net earnings available for common shareholders from continuing operations net of dividends on preferred stock ..... $ 101,339 $ 43,669 $ 1,520 Net earnings from discontinued operations ............................... -- 32,520 18,104 ----------- ----------- ----------- Net earnings available for common shareholders .......................... $ 101,339 $ 76,189 $ 19,624 =========== =========== =========== Weighted average shares outstanding -- basic ............................ 75,442,238 60,584,293 59,420,048 ========== ========== ========== Weighted average shares outstanding -- diluted .......................... 77,694,532 62,523,107 62,596,874 ========== ========== ========== Basic earnings per share: Net earnings available for common shareholders from continuing operations net of dividends on preferred stock.... $ 1.34 $ 0.72 $ 0.03 Net earnings from discontinued operations............................ -- 0.54 0.30 ----------- ---------- ----------- Net earnings available for common shareholders....................... $ 1.34 $ 1.26 $ 0.33 =========== ========== =========== Diluted earnings per share: Net earnings available for common shareholders from continuing operations net of dividends on preferred stock.... $ 1.30 $ 0.70 $ 0.02 Net earnings from discontinued operations............................ -- 0.52 0.29 ----------- ---------- ----------- Net earnings available for common shareholders....................... $ 1.30 $ 1.22 $ 0.31 =========== ========== ===========
During the three-year period ended June 30, 2004, no adjustments were required in net earnings available for common shareholders for the earnings per share calculations. Diluted earnings per share include average shares outstanding as well as common stock equivalents from stock options, warrants and mandatory convertible equity units. Common stock equivalents were 1,095,220, 669,581 and 1,828,993 for the years ended June 30, 2004, 2003 and 2002, respectively. During 2004, 2003 and 2002, the Company repurchased 122,203, 156,340 and 2,115,916 shares of its common stock outstanding, respectively. Substantially all of these repurchases occurred in private off-market large-block transactions. Stock options to purchase 290,893 and 2,308,870, shares of common stock were outstanding during the years ended June 30, 2004 and 2003, 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 "anti-dilutive" options outstanding for the same period in 2002. At June 30, 2004, 1,089,147 shares of common stock were held by various rabbi trusts for certain of the Company's benefit plans and 110,996 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. On June 11, 2003, the Company issued 2,500,000 mandatory convertible equity units at a public offering price of $50.00 per share. Each equity unit consists of a $50.00 principal amount of the Company's 2.75% Senior Notes due 2006 (see Note XIII -- Debt and Capital Lease) and a forward stock purchase contract that obligates the holder to purchase Company common stock on August 16, 2006, at a price based on the preceding 20-day average closing price (subject to a minimum and maximum conversion price per share of $14.51 and $17.71, respectively, which are subject to adjustments for future stock splits or stock dividends). The Company will issue between 7,060,067 shares and 8,613,281 shares of its common stock (also subject to adjustments for future stock splits or stock dividends) upon the consummation of the forward purchase contract. Until the conversion date, the equity units will have a dilutive effect on earnings per share if the Company's average common stock price for the period exceeds the maximum conversion price. See Note X - Stockholder's Equity. VI Property, Plant and Equipment Plant. Plant in service and construction work in progress are stated at cost net of contributions in aid of construction and includes intangible assets and related amortization. The Company capitalizes all construction-related direct labor costs, as well as indirect construction costs. The cost of replacements and betterments that extend the useful life of property, plant and equipment is also capitalized. The cost of additions includes an allowance for funds used during construction and applicable overhead charges. Gain or loss is recognized upon the disposition of significant properties and other property constituting operating units. The Company capitalizes the cost of significant internally-developed computer software systems. See Note XIII -- Debt and Capital Lease.
June 30, ---------------------------- 2004 2003 ---------------------------- Distribution plant............................................................... $ 1,662,345 $ 1,611,098 Transmission plant............................................................... 1,159,825 1,238,972 General plant.................................................................... 529,599 462,730 Underground storage plant........................................................ 287,005 236,639 Gathering plant.................................................................. 39,746 56,076 Other............................................................................ 96,308 107,444 ------------- ------------- Total plant................................................................. 3,774,828 3,712,959 Less contributions in aid of construction........................................ (2,212) (2,418) ------------- ------------- Plant in service............................................................ 3,772,616 3,710,541 Construction work in progress.................................................... 169,264 75,484 ------------- ------------- 3,941,880 3,786,025 Less accumulated depreciation and amortization................................... (734,367) (641,225) ------------- ------------- Net property, plant and equipment........................................... $ 3,207,513 $ 3,144,800 ============= =============
Acquisitions of rate-regulated utilities are recorded at the historical book carrying value of utility plant. Depreciation and Amortization. Depreciation and amortization of plant is generally computed using the straight-line method at an average straight-line rate of approximately 3% per annum of the cost of such depreciable properties less applicable salvage. Franchises are amortized over their respective lives. Depreciation and amortization of other property is provided at straight-line rates estimated to recover the costs of the properties, after allowance for salvage, over their respective lives. Internally-developed computer software system costs are amortized over various periods. VII Goodwill and Intangibles Effective July 1, 2001, the Company adopted Goodwill and Other Intangible Assets which was issued by the FASB in June 2001. In accordance with this Statement, the Company has ceased amortization of goodwill. Goodwill, which was previously classified on the Consolidated Balance Sheet as additional purchase cost assigned to utility plant and amortized on a straight-line basis over forty years, is now subject to at least an annual assessment for impairment by applying a fair-value based test. The following displays changes in the carrying amount of goodwill: Total ------------ Balance as of July 1, 2001...................................... $ 652,048 Impairment losses............................................ (1,417) Sale of subsidiaries and other operations.................... (7,710) ------------ Balance as of June 30, 2002..................................... 642,921 Impairment losses............................................ -- Sale of subsidiaries and other operations.................... -- ------------ Balance as of June 30, 2003..................................... 642,921 Impairment losses............................................ -- Reversal of income tax reserve............................... (2,374) ------------ Balance as of June 30, 2004..................................... $ 640,547 ============ 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 on the Consolidated Statement of Operations for the quarter ended September 30, 2001. As a result of the sale of the Florida Operations, goodwill of $7,710,000 was eliminated during the quarter ended December 31, 2001. As a result of the sale of the Texas Operations, goodwill of $70,469,000 (See Note XIX- Discontinued Operations) was also eliminated during the quarter ended March 31, 2003. As a result of the reversal of income tax reserves related to the purchase of PG Energy, goodwill of $2,347,000 was eliminated during the quarter ended June 30, 2004. As of June 30, 2004, the Distribution segment has goodwill of $640,547,000. The Distribution segment is tested annually for impairment in the fourth quarter, after the annual forecasting process. There was no indication of impairment at June 30, 2004. On June 11, 2003, the Company completed its acquisition of Panhandle Energy. Based on purchase price allocations which rely on estimates and outside appraisals, the acquisition resulted in no recognition of goodwill as of the acquisition date. In addition, based on the purchase price allocations and the outside appraisals, the acquisition resulted in the recognition of intangible assets relating to customer relationships of approximately $9,503,000. These intangibles are currently being amortized over a period of twenty years, the remaining life of the contract for which the value is associated. As of June 30, 2004, the carrying amount of these intangibles was approximately $8,720,000 and is included in Property, Plant and Equipment on the Consolidated Balance Sheet. Amortization for fiscal 2004 and 2003 was approximately $583,000 and $200,000, respectively.
VIII Deferred Charges and Deferred Credits June 30, -------- 2004 2003 ---- ---- Deferred Charges Pensions...................................................................... $ 45,625 $ 39,088 Unamortized debt expense...................................................... 38,596 34,209 Income taxes.................................................................. 31,441 30,514 Retirement costs other than pensions.......................................... 26,008 29,028 Service Line Replacement program.............................................. 16,722 18,974 Environmental................................................................. 12,220 14,304 Other......................................................................... 20,123 22,144 ------------ ---------- Total Deferred Charges..................................................... $ 190,735 $ 188,261 ============ ==========
The Company's deferred charges include regulatory assets relating to Distribution segment operations in the aggregate amount of $99,314,000 and $107,696,000, respectively, at June 30, 2004 and 2003, of which $63,010,000 and $74,116,000, respectively, is being recovered through current rates. As of June 30, 2004 and 2003, the remaining recovery period associated with these assets ranges from 1 month to 208 months and from 6 months to 147 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.
June 30, ------------------- 2004 2003 ---- ---- Deferred Credits Pensions................................................................... $ 97,380 $ 88,016 Retirement costs other than pensions....................................... 60,404 65,144 Cost of Removal............................................................ 28,519 27,286 Environmental.............................................................. 23,082 32,322 Derivative instrument liability............................................ 13,704 26,151 Customer advances for construction......................................... 13,518 12,008 Provision for self-insured claims.......................................... 10,542 12,000 Investment tax credit...................................................... 5,367 5,791 Other...................................................................... 40,430 53,436 ------------ -------------- Total Deferred Credits................................................. $ 292,946 $ 322,154 ============ ==============
The Company's deferred credits include regulatory liabilities relating to Distribution segment operations in the aggregate amount of $11,164,000 and $10,084,000, respectively, at June 30, 2004 and 2003. These regulatory liabilities primarily relate to retirement benefits other than pensions, environmental insurance recoveries and income taxes. The Company records regulatory liabilities with respect to its Distribution segment operations in accordance with the FASB Standard Accounting for the Effects of Certain Types of Regulation. IX Investment Securities At June 30, 2004, all securities owned by the Company are accounted for under the cost method. The Company's investments in securities consist of common and preferred stock in non-public companies whose value is not readily determinable. Realized gains and losses on sales of these investments, as determined on a specific identification basis, are included in the Consolidated Statement of Operations when incurred, and dividends are recognized as income when received. Various Southern Union executive management, Board of Directors and employees also have an equity ownership in one 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, it will record a charge on its consolidated statement of operations to reduce the carrying value of the security to its estimated fair value. In September 2003 and June 2002, Southern Union determined that declines in the value of its investment in PointServe were other than temporary. Accordingly, the Company recorded non-cash charges of $1,603,000 and $10,380,000 during the quarters ended September 30, 2003 and June 30, 2002, respectively, to reduce the carrying value of this investment to its estimated fair value. The Company recognized these valuation adjustments to reflect significant lower private equity valuation metrics and changes in the business outlook of PointServe. PointServe is a closely held, privately owned company and, as such, has no published market value. The Company's remaining investment of $2,603,000 at June 30, 2004 may be subject to future market value risk. The Company will continue to monitor the value of its investment and periodically assess the impact, if any, on reported earnings in future periods. X Stockholders' Equity Stock Splits and Dividends. On August 31, 2004, July 31, 2003 and July 15, 2002, Southern Union distributed its annual 5% common stock dividend to stockholders of record on August 20, 2004, July 17, 2003 and July 1, 2002, respectively. A portion of the 5% stock dividend distributed on July 15, 2002 was characterized as a distribution of capital due to the level of the Company's retained earnings available for distribution as of the declaration date. Unless otherwise stated, all per share and share data included herein have been restated to give effect to the dividends. Common Stock. On November 4, 2003, the stockholders of the Company adopted the 2003 Stock and Incentive Plan (2003 Plan) under which options to purchase 7,350,000 shares were provided to be granted to officers and key employees at prices not less than fair market value on the date of the grant, until September 28, 2013. The 2003 Plan allows for the granting of stock appreciation rights, stock awards, performance units, dividend equivalents, incentive options, non-statutory options, and other equity-based rights. Options granted under the 2003 Plan are exercisable for periods of ten years from the date of the grant or such lesser period as may be designated for particular options, and become exercisable after a specified period of time from the date of grant in cumulative annual installments. The Company maintains its 1992 Long-Term Stock Incentive Plan (1992 Plan) under which options to purchase 8,491,540 shares were provided to be granted to officers and key employees at prices not less than the fair market value on the date of grant, until July 1, 2002. The 1992 Plan allowed for the granting of stock appreciation rights, dividend equivalents, performance shares and restricted stock. Options granted under the 1992 Plan are exercisable for periods of ten years from the date of grant or such lesser period as may be designated for particular options, and become exercisable after a specified period of time from the date of grant in cumulative annual installments. Options typically vest 20% per year for five years but may be a lesser or greater period as designated for a particular option grant. In connection with the acquisition of the Pennsylvania Operations, the Company adopted the Pennsylvania Division 1992 Stock Option Plan (Pennsylvania Option Plan) and the Pennsylvania Division Stock Incentive Plan (Pennsylvania Incentive Plan). Under the terms of the Pennsylvania Option Plan, a total of 459,467 shares were provided to be granted to eligible employees. Stock options awarded under the Pennsylvania Option Plan may be either Incentive Stock Options or Nonqualified Stock Options. Upon acquisition, individuals not electing a cash payment equal to the difference at the date of acquisition between the option price and the market price of the shares as to which such option related, were converted to Southern Union options using a conversion rate that maintained the same aggregate value and the aggregate spread of the pre-acquisition options. No additional options will be granted under the Pennsylvania Option Plan. During 2004 and 2003, no options and 15,538 options, respectively, were exercised and 443,929 options outstanding and exercisable still remain in the plan. Under the terms of the Pennsylvania Incentive Plan, a total of 220,635 shares were provided to be granted to eligible employees, officers and directors. Awards under the Pennsylvania Incentive Plan may take the form of stock options, restricted stock, and other awards where the value of the award is based upon the performance of the Company's stock. Upon acquisition, individuals not electing a cash payment equal to the difference at the date of acquisition between the option price and the market price of the shares as to which such option related, were converted to Southern Union options using a conversion rate that maintained the same aggregate value and the aggregate spread of the pre-acquisition options. No additional options will be granted under the Pennsylvania Incentive Plan. During 2004 and 2003, no options were exercised and 220,635 and 217,571 options outstanding and exercisable still remain in the plan. The following table provides information on stock options granted, exercised, canceled and outstanding under the 2003 Plan and the 1992 Plan for the past three years:
2003 Plan 1992 Plan --------- --------- Weighted Weighted Shares Under Average Shares Under Average Option Exercise Price Option Exercise Price ------ -------------- ------ -------------- Outstanding July 1, 2001........................... -- $ -- 4,957,666 $ 11.29 Granted .................................... -- -- 75,249 13.83 Exercised..................................... -- -- (1,020,546) 9.54 Canceled ..................................... -- -- (188,856) 14.45 ---------- ---------- Outstanding June 30, 2002.......................... -- -- 3,823,513 11.65 Granted ..................................... -- -- -- -- Exercised..................................... -- -- (662,982) 4.65 Canceled ..................................... -- -- (185,161) 14.67 ---------- ---------- Outstanding June 30, 2003.......................... -- -- 2,975,370 13.02 Granted ..................................... 729,227 17.67 -- -- Exercised..................................... -- -- (352,486) 9.91 Canceled ..................................... -- -- (2,190) 15.38 ---------- ---------- Outstanding June 30, 2004.......................... 729,227 17.67 2,620,694 13.44 ========== ==========
The following table summarizes information about stock options outstanding under the 1992 Plan at June 30, 2004:
Options Outstanding Options Exercisable - ----------------------------------------------------------------- --------------------------------- Weighted Average Weighted Weighted Range of Number of Remaining Average Number of Average Exercise Prices Options Contractual Life Exercise Price Options Exercise Price - --------------- -------- ----------------- -------------- ------- -------------- $ 0.00 - $ 7.99 154,292 1.4 years $ 6.75 124,598 $ 6.75 8.00 - 11.99 291,780 2.9 years 10.22 291,780 10.22 12.00 - 13.99 563,896 4.3 years 13.26 529,595 13.26 14.00 - 17.99 1,610,726 5.9 years 14.72 1,062,093 14.60 --------- ----------- 2,620,694 2,008,066 ========= ===========
The weighted average remaining contractual life of options outstanding under the 2003 Plan, the Pennsylvania Option Plan and the Pennsylvania Incentive Plan at June 30, 2004 was 9.6, 2.1 and 3.9 years, respectively. There were no shares available for future option grants under the 1992 Plan at June 30, 2004. The shares exercisable under the various plans and corresponding weighted average exercise price for the past three years are as follows: Pennsylvania Pennsylvania 1992 Option Incentive Plan Plan Plan ---- ---- ---- Shares exercisable at: June 30, 2004......................... 2,008,066 443,929 217,571 June 30, 2003......................... 1,966,753 443,929 214,507 June 30, 2002......................... 2,145,327 459,467 211,442 Weighted average exercise price at: June 30, 2004......................... $ 13.12 $ 9.21 $ 10.65 June 30, 2003......................... 12.29 9.21 10.60 June 30, 2002......................... 9.51 9.12 10.55 There were no shares exercisable under the 2003 Plan at June 30, 2004. Warrant. On February 10, 1994, Southern Union granted a warrant to purchase up to 122,165 shares of its common stock at an exercise price of $5.68 to the Company's outside legal counsel. On February 10, 2004, the Company's outside legal counsel exercised the warrant through a non-cash exercise resulting in the issuance of 84,758 shares of Company common stock. Retained Earnings. Under the most restrictive provisions in effect, as a result of the sale of Senior Notes, Southern Union will not declare or pay any cash or asset dividends on common stock (other than dividends and distributions payable solely in shares of its common stock or in rights to acquire its common stock) or acquire or retire any shares of Southern Union's common stock, unless no event of default exists and the Company meets certain financial ratio requirements. Currently, the Company is in compliance with the most restrictive provisions in the indenture governing the Senior Notes. Fiscal 2005 Equity Issuances. On July 30, 2004, the Company issued 4,800,000 shares of common stock at the public offering price of $18.75 per share, resulting in net proceeds to the Company, after underwriting discounts and commissions, of $86,900,000. The Company also sold 6,200,000 shares of the Company's common stock through forward sale agreements with its underwriters and granted the underwriters a 30-day over-allotment option to purchase up to an additional 1,650,000 shares of the Company's common stock at the same price, which was exercised by the underwriters. Under the terms of the forward sale agreements, the Company has the option to settle its obligation to the forward purchasers through either (i) paying a net settlement in cash, (ii) delivering an equivalent number of shares of its common stock to satisfy its net settlement obligation, or (iii) through the physical delivery of shares. The Company will only receive additional proceeds from the sale of the 7,850,000 shares of the Company's common stock that were sold through the forward sale agreements if it settles its obligation under such agreements through the physical delivery of shares, in which case it will receive additional net proceeds of $142,000,000. The forward sale agreements are required to be settled within 12 months from the date of the offering. Fiscal 2003 Equity Issuances. On June 11, 2003, the Company issued 9,500,000 shares of common stock at the public offering price of $16.00 per share. After underwriting discounts and commissions, the Company realized net proceeds of $146,700,000. The Company granted the underwriters a 30-day over-allotment option to purchase up to an additional 1,425,000 shares of the Company's common stock at the same price, which was exercised on June 11, 2003, resulting in additional net proceeds to the Company of $22,000,000. Also on June 11, 2003, the Company issued 3,000,000 shares of common stock from its treasury stock to CMS Energy Corporation to finance its acquisition of Panhandle Energy. The shares were valued at $16.30 per share, or $48,900,000, based on the closing price for the Company's common stock as of June 10, 2003. On June 11, 2003, the Company also issued 2,500,000 equity units at a public offering price of $50 per unit, resulting in net proceeds to the Company, after underwriting discounts and commissions, of $121,300,000. Each equity unit consists of a stock purchase contract for the purchase of shares of the Company's common stock and, initially, a senior note due August 16, 2006, issued pursuant to the Company's existing Indenture. The equity units carry a total annual coupon of 5.75% (2.75% annual face amount of the senior notes plus 3.0% annual contract adjustment payments). Each stock purchase contract issued as a part of the equity units carries a maximum conversion premium of up to 22% over the $16.00 issuance price (before adjustment for subsequent stock dividends) of the Company's common shares that were sold on June 11, 2003, as discussed previously. The present value of the equity units contract adjustment payments was initially charged to shareholders' equity, with an offsetting credit to liabilities. The liability is accreted over three years by interest charges to the Consolidated Statement of Operations. Before the issuance of the Company's common stock upon settlement of the purchase contracts, the purchase contracts will be reflected in the Company's diluted earnings per share calculations using the treasury stock method. XI Derivative Instruments and Hedging Activities The Company utilizes derivative instruments on a limited basis to manage certain business risks. Interest rate swaps and treasury rate locks are employed to manage the Company's exposure to interest rate risk. Cash Flow Hedges. As a result of the acquisition of Panhandle Energy, the Company is party to interest rate swap agreements with an aggregate notional amount of $197,947,000 as of June 30, 2004 that fix the interest rate applicable to floating rate long-term debt and which qualify for hedge accounting. For the year ended June 30, 2004, the amount of swap ineffectiveness was not significant. As of June 30, 2004, floating rate LIBOR-based interest payments are exchanged for weighted fixed rate interest payments of 5.88%, which does not include the spread on the underlying variable debt rate of 1.625%. Interest rate swaps are carried on the Consolidated Balance Sheet at fair value with the effective portion of the unrealized gain or loss adjusted through accumulated other comprehensive income. As such, payments or receipts on interest rate swap agreements, in excess of the liability recorded, are recognized as adjustments to interest expense. As of June 30, 2004 and 2003, the fair value liability position of the swaps was $14,445,000 and $26,058,000, respectively. As of June 30, 2004, approximately $1,068,000 of net after-tax gains included in accumulated other comprehensive income related to these swaps is expected to be reclassified to interest expense during the next twelve months as the hedged interest payments occur. Current market pricing models were used to estimate fair values of interest rate swap agreements. The Company was also party to an interest rate swap agreement with a notional amount of $8,199,000 at June 30, 2003 that fixed the interest rate applicable to floating rate long-term debt and which qualified for hedge accounting. The fair value liability position of the swap was $93,000 at June 30, 2003. In October 2003, the swap expired and $15,000 of unrealized after-tax losses included in accumulated other comprehensive income relating to this swap was reclassified to interest expense during the quarter ended December 31, 2003. In March and April 2003, the Company entered into a series of treasury rate locks with an aggregate notional amount of $250,000,000 to manage its exposure against changes in future interest payments attributable to changes in the benchmark interest rate prior to the anticipated issuance of fixed-rate debt. These treasury rate locks expired on June 30, 2003, resulting in a $6,862,000 after-tax loss that was recorded in accumulated other comprehensive income and will be amortized into interest expense over the lives of the associated debt instruments. As of June 30, 2004, approximately $981,000 of net after-tax losses in accumulated other comprehensive income will be amortized into interest expense during the next twelve months. The notional amounts of the interest rate swaps are not exchanged and do not represent exposure to credit loss. In the event of default by a counterparty, the risk in these transactions is the cost of replacing the agreements at current market rates. Fair Value Hedges. In March 2004, Panhandle Energy entered into an interest rate swap to hedge the risk associated with the fair value of its $200,000,000 2.75% Senior Notes. These swaps are designated as fair value hedges and qualify for the short cut method under FASB Standard, Accounting for Derivative Instruments and Hedging Activities, as amended. Under the swap agreement Panhandle Energy will receive fixed interest payments at a rate of 2.75% and will make floating interest payments based on the six-month LIBOR. No ineffectiveness is assumed in the hedging relationship between the debt instrument and the interest rate swap. As of June 30, 2004, the fair value liability position of the swap was $4,960,000, which reduced the carrying value of the underlying debt. Trading and Non-Hedging Activities. During fiscal 2004, the Company acquired natural gas commodity swap derivatives and collar transactions in order to mitigate price volatility of natural gas passed through to utility customers. The cost of the derivative products and the settlement of the respective obligations are recorded through the gas purchase adjustment clause as authorized by the applicable regulatory authority and therefore do not impact earnings. The fair value of the contracts is recorded as an adjustment to a regulatory asset/ liability in the Consolidated Balance Sheet. As of June 30, 2004, the fair values of the contracts, which expire at various times through March 2005, are included in the Consolidated Balance Sheet as an asset and a matching adjustment to deferred cost of gas of $1,337,000. In March 2001, the Company discovered unauthorized financial derivative energy trading activity by a non-regulated, wholly-owned subsidiary. All unauthorized trading activity was subsequently closed in March and April of 2001 resulting in a cumulative cash expense of $191,000, net of taxes, and deferred income of $7,921,000 at June 30, 2001. For fiscal years 2004, 2003 and 2002, the Company recorded $605,000, $605,000 and $6,204,000, respectively, through other income relating to the expiration of contracts resulting from this trading activity. The remaining deferred liability of $507,000 at June 30, 2004 related to these derivative instruments will be recognized as income in the Consolidated Statement of Operations over the next year based on the related contracts. The Company established new limitations on trading activities, as well as new compliance controls and procedures that are intended to make it easier to identify quickly any unauthorized trading activities. XII Preferred Securities 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, 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. On October 1, 2003, the Company called the Subordinated Notes for redemption, and the Subordinated Notes and the Preferred Securities were redeemed on October 31, 2003. The Company financed the redemption with borrowings under its revolving credit facilities, which were paid down with the net proceeds of a $230,000,000 offering of preferred stock by the Company on October 8, 2003, as further described below. On October 8, 2003, the Company issued 920,000 shares of its 7.55% Noncumulative Preferred Stock, Series A (Liquidation Preference $250 Per Share) to the public through the issuance of 9,200,000 Depositary Shares, each representing a one-tenth interest in a 7.55% Noncumulative Preferred Stock, Series A share at the public offering price of $25.00 per share, or $230,000,000 in the aggregate. The total net proceeds were used to repay debt under the Company's revolving credit facilities.
XIII Debt and Capital Lease June 30, -------- 2004 2003 ---- ---- Southern Union Company 7.60% Senior Notes due 2024...................................... $ 359,765 $ 359,765 8.25% Senior Notes due 2029...................................... 300,000 300,000 2.75% Senior Notes due 2006...................................... 125,000 125,000 Term Note, due 2005.............................................. 111,087 211,087 6.50% to 10.25% First Mortgage Bonds, due 2008 to 2029........... 113,435 115,884 7.70% Debentures, due 2027....................................... -- 6,756 Capital lease and other, due 2004 to 2007........................ 277 9,179 ------------ ------------ 1,009,564 1,127,671 Panhandle Energy 2.75% Senior Notes due 2007...................................... 200,000 -- 4.80% Senior Notes due 2008...................................... 300,000 -- 6.05% Senior Notes due 2013...................................... 250,000 -- 6.125% Senior Notes due 2004..................................... -- 292,500 7.875% Senior Notes due 2004..................................... 52,455 100,000 6.50% Senior Notes due 2009...................................... 60,623 158,980 8.25% Senior Notes due 2010...................................... 40,500 60,000 7.00% Senior Notes due 2029...................................... 66,305 135,890 Term Loan due 2007............................................... 263,926 275,358 7.95% Debentures due 2023........................................ -- 76,500 7.20% Debentures due 2024........................................ -- 58,000 Net premiums on long-term debt................................... 16,199 61,506 ------------ ------------ 1,250,008 1,218,734 Total consolidated debt and capital lease........................ 2,259,572 2,346,405 Less current portion......................................... 99,997 734,752 Less fair value swap of Panhandle Energy..................... 4,960 -- ------------ ------------ Total consolidated long-term debt and capital lease.............. $ 2,154,615 $ 1,611,653 ============ ============
The maturities of long-term debt and capital lease payments for each of the next five years ending June 30 are: 2005 -- $99,997,000; 2006 -- $90,475,000; 2007 -- $565,718,000; 2008 -- $1,648,000; 2009 -- $301,646,000 and thereafter $1,183,890,000. Each note, debenture or bond above is an obligation of Southern Union Company or a unit of Panhandle Energy, as noted above. The Panhandle Energy Term Loan due 2007 is debt related to Panhandle's Trunkline LNG Holdings subsidiary, and is non-recourse to other units of Panhandle Energy or Southern Union Company. The remainder of Panhandle Energy's debt is non-recourse to Southern Union. All debts that are listed as debt of Southern Union Company are direct obligations of Southern Union Company, and no debt is cross-collateralized. Debt issuance costs and premiums or discounts on the early extinguishment of debt are accounted for in accordance with that required by its various regulatory bodies having jurisdiction over the Company's operations. The Company recognizes gains or losses on the early extinguishment of debt to the extent it is provided for by its regulatory authorities, where applicable, and in some cases such gains or losses are deferred and amortized over the term of the new or replacement debt issues. The 8.25% Notes and the 7.60% Senior Notes traded at $1,166 and $1,079 (per $1,000 note), respectively on June 30, 2004, as quoted by a major brokerage firm. The carrying amount of long-term debt at June 30, 2004 and 2003 was $2,259,573,000 and $2,346,405,000, respectively. The fair value of long-term debt at June 30, 2004 and 2003 was $2,336,292,000 and $2,408,532,000, respectively. The Company is not party to any lending agreement that would accelerate the maturity date of any obligation due to a failure to maintain any specific credit rating. Certain covenants exist in certain of the Company's debt agreements that require the Company to maintain a certain level of net worth, to meet certain debt to total capitalization ratios, and to meet certain ratios of earnings before depreciation, interest and taxes to cash interest expense. A failure by the Company to satisfy any such covenant would be considered an event of default under the associated debt, which could become immediately due and payable if the Company did not cure such default within any permitted cure period or if the Company did not obtain amendments, consents or waivers from its lenders with respect to such covenants. 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 Fall River Gas' stockholders; (ii) the all cash consideration to be paid to the ProvEnergy and Valley Resources stockholders, (iii) repayment of approximately $50,000,000 of long- and short-term debt assumed in the New England mergers, and (iv) related acquisition costs. The Term Note, which initially expired on August 27, 2001, was extended through August 26, 2002. On July 16, 2002, the Company repaid the Term Note with the proceeds from the issuance of a $311,087,000 Term Note dated July 15, 2002 (the 2002 Term Note) and borrowings under its revolving credit facilities. The 2002 Term Note is held by a syndicate of sixteen banks, led by JPMorgan Chase Bank, as Agent. Eleven of the sixteen banks were also among the lenders of the Term Note. The 2002 Term Note carries a variable interest rate that is tied to either the LIBOR or prime interest rates at the Company's option. The interest rate spread over the LIBOR rate varies with the credit rating of the Senior Notes by Standard and Poor's Rating Information Service (S&P) and Moody's Investor Service, Inc. (Moody's), and is currently LIBOR plus 105 basis points. As of June 30, 2004, a balance of $111,087,000 was outstanding on this 2002 Term Note at an effective interest rate of 2.42%. The 2002 Term Note requires semi-annual principal repayments on February 15th and August 15th of each year, with payments of $35,000,000 each being due February 15, 2005 and August 15, 2005. The remaining principal amount of $41,087,000 is due August 26, 2005. No additional draws can be made on the 2002 Term Note. Additional Debt. In connection with the Panhandle Energy acquisition, the Company added a principal amount $1,157,228,000 in debt, which had a fair value of $1,207,617,000 as of the June 11, 2003 acquisition date. The debt included senior notes and debentures with interest rates ranging from 6.125% to 8.25% and floating rate debt totaling $275,358,000, all of which is non-recourse to Southern Union. Panhandle Refinancing. In July 2003, Panhandle Energy announced a tender offer for any and all of the $747,370,000 outstanding principal amount of five of its series of senior notes outstanding at that point in time (the Panhandle Tender Offer) and also called for redemption all of the outstanding $134,500,000 principal amount of its two series of debentures that were outstanding (the Panhandle Calls). Panhandle Energy repurchased approximately $378,257,000 of the principal amount of its outstanding debt through the Panhandle Tender Offer for total consideration of approximately $396,445,000 plus accrued interest through the purchase date. Panhandle Energy also redeemed approximately $134,500,000 of debentures through the Panhandle Calls for total consideration of $139,411,000, plus accrued interest through the redemption dates. As a result of the Panhandle Tender Offer, the Company has recorded a pre-tax gain on the extinguishment of debt of $6,354,000 in fiscal 2004. In August 2003, Panhandle Energy issued $300,000,000 of its 4.80% Senior Notes due 2008 and $250,000,000 of its 6.05% Senior Notes due 2013 principally to refinance the repurchased notes and redeemed debentures. Also in August and September 2003, Panhandle Energy repurchased $3,150,000 principal amount of its senior notes on the open market through two transactions for total consideration of $3,398,000, plus accrued interest through the repurchase date. On March 12, 2004, Panhandle Energy issued $200,000,000 of its 2.75% Senior Notes due 2007, the proceeds of which were used to fund the redemption of the remaining $146,080,000 principal amount of its 6.125% Senior Notes due 2004 that matured on March 15, 2004 and to provide working capital to the Company, pending the repayment of the $52,455,000 principal amount of Panhandle Energy's 7.875% Senior Notes due 2004 that matured on August 15, 2004. 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 June 30, 2004 and 2003, the capital lease obligation outstanding was nil and $8,793,000, respectively. This system has significantly improved meter reading accuracy and timeliness and provided electronic accessibility to meters in residential customers' basements, thereby assisting in the reduction of the number of estimated bills. Depreciation on the AMR system is provided at an average straight-line rate of approximately 5% per annum of the cost of such property. Credit Facilities. On May 28, 2004, the Company entered into a new five-year long-term credit facility in the amount of $400,000,000 (the Long-Term Facility) that matures on May 29, 2009. The Long-Term Facility replaced the Company's $150,000,000 and $225,000,000 credit facilities that expired on April 1, 2004 and May 29, 2004, respectively. The Company has additional availability under uncommitted line of credit facilities (Uncommitted Facilities) with various banks. Borrowings under the Long-Term Facility are available for Southern Union's working capital, letter of credit requirements and other general corporate purposes. The Long-Term Facility is subject to a commitment fee based on the rating of the Company's senior unsecured notes (the Senior Notes). As of June 30, 2004, the commitment fees were an annualized 0.15%. The Long-Term Facility requires the Company to meet certain covenants in order for the Company to be able to borrow under that agreement. A balance of $21,000,000 and $251,500,000 was outstanding under the Company's credit facilities at June 30, 2004 and 2003, respectively. As of August 16, 2004, there was a balance of $79,500,000 outstanding under the Long-Term Facility. XIV Employee Benefits Pension and Other Post-Retirement Benefits. In fiscal 2004, the Company adopted the FASB Standard, Employers' Disclosures about Pensions and Other Postretirement Benefits - an amendment of FASB Statements No. 87, 88, and 106, which changed the Company's reporting requirements for its pension and post-retirement benefit plans. See Note I - Summary of Significant Accounting Policies (New Pronouncements). The Company maintains eight trusteed non-contributory defined benefit retirement plans (Plans) which cover substantially all employees, except Panhandle Energy employees (see Panhandle Energy, below). The Company funds the Plans' cost in accordance with federal regulations, not to exceed the amounts deductible for income tax purposes. The Plans' assets are invested in cash, government securities, corporate bonds and stock, and various funds. The Company also has two supplemental non-contributory retirement plans for certain executive employees and other post-retirement benefit plans for its employees. The Company uses a March 31 measurement date for the majority of its plans. Post-retirement medical and other benefit liabilities are accrued on an actuarial basis during the years an employee provides services. The following table represents a reconciliation of the Company's retirement and other post-retirement benefit plans at June 30, 2004 and 2003.
Pension Benefits Post-Retirement Benefits ---------------------------- --------------------------- 2004 2003 2004 2003 ------------- ------------ ------------ ------------ Change in Benefit Obligation Benefit obligation at beginning of year.................. $ 350,860 $ 317,012 $ 90,344 $ 76,596 Service cost............................................. 6,533 5,655 3,993 1,177 Interest cost............................................ 22,591 22,899 8,739 5,579 Benefits paid............................................ (20,649) (20,046) (6,263) (6,676) Actuarial loss........................................... 21,796 26,350 7,687 13,357 Acquisition............................................ -- -- 42,752 -- Plan amendments.......................................... 7,703 1,095 5,173 311 Settlement recognition................................... (2,341) (2,105) -- -- ------------- ------------ ------------ ------------ Benefit obligation at end of year........................ $ 386,493 $ 350,860 $ 152,425 $ 90,344 ============= ============ ============ ============ Change in Plan Assets Fair value of plan assets at beginning of year........... $ 237,376 $ 284,911 $ 21,332 $ 22,408 Return on plan assets.................................... 55,725 (30,900) 3,211 27 Employer contributions................................... 6,043 5,516 15,724 5,572 Benefits paid............................................ (20,649) (20,046) (6,263) (6,675) Settlement recognition................................... (2,341) (2,105) -- -- ------------- ------------ ------------ ------------ Fair value of plan assets at end of year................. $ 276,154 $ 237,376 $ 34,004 $ 21,332 ============= ============ ============ ============
Pension Benefits Post-Retirement Benefits ---------------------------- --------------------------- 2004 2003 2004 2003 ------------- ------------ ------------ ------------ Funded Status Funded status at end of year............................. $ (110,339) $ (113,484) $ (118,421) $ (69,012) Unrecognized net actuarial loss.......................... 114,344 134,752 25,972 20,343 Unrecognized prior service cost.......................... 13,737 7,179 5,038 130 ------------- ------------ ------------ ------------ Prepaid/(accrued) prior to contributions for 3 months ended June 30.......................................... 17,742 28,447 (87,411) (48,539) Contributions for 3 months ended June 30................. 3,750 4,534 2,151 4,675 ------------- ------------ ------------ ------------ Net asset (liability) recognized at June 30.............. $ 21,492 $ 32,981 $ (85,260) $ (43,864) ============= ============ ============ ============ Amounts Recognized in the Consolidated Balance Sheet Prepaid benefit cost..................................... $ 28,172 $ 27,597 $ -- $ -- Accrued benefit liability................................ (87,448) (89,366) (85,260) (43,864) Intangible asset......................................... 10,366 3,671 -- -- Accumulated other comprehensive loss..................... 70,402 91,079 -- -- ------------- ------------ ------------ ------------ Net asset (liability) recognized......................... $ 21,492 $ 32,981 $ (85,260) $ (43,864) ============= ============ ============ ============
The projected benefit obligation, accumulated benefit obligation and fair value of plan assets for pension plans with accumulated benefit obligations in excess of plan assets as of June 30, 2004 were $355,095,000, $319,902,000, and $228,704,000, respectively, and for those same plans were $323,116,000, $291,811,000, and $197,911,000 as of June 30, 2003. The accumulated post-retirement benefit obligation and fair value of plan assets for post-retirement benefit plans with accumulated post-retirement benefit obligations in excess of fair value of plan assets as of June 30, 2004 were $152,425,000 and $34,004,000 respectively, and for those same plans were $90,344,000 and $21,332,000 respectively as of June 30, 2003. The minimum pension liability as of June 30, 2004 decreased by $20,677,000 due primarily to an increase in the fair value of plan assets attributable to higher than expected investment return. The minimum pension liability as of June 30, 2003 increased by $75,008,000 as a result of the decrease in the discount rate in 2003, decreases in the fair value of plan assets due to volatility in the stock markets and increases in liabilities due to early retirement programs. The weighted-average assumptions used to determine benefit obligations for the year ended June 30, 2004, 2003 and 2002 were:
Pension Benefits Post-Retirement Benefits -------------------------------------- -------------------------------------- 2004 2003 2002 2004 2003 2002 ---------- ----------- ----------- ---------- ---------- ---------- Discount rate Beginning of year.................. 6.50% 7.50% 7.50% 6.50% 7.50% 7.50% End of year........................ 6.00% 6.50% 7.50% 6.00% 6.50% 7.50% Rate of compensation increase (average). 3.60% 4.00% 5.00% N/A N/A N/A Health care cost trend rate............. N/A N/A N/A 13.00% 13.00% 12.00%
The assumed health care cost trend rate used in measuring the accumulated post-retirement benefit obligation was 13% during 2004. This rate was assumed to decrease gradually each year to a rate of 4.75% in 2012 and remain at that level thereafter. The assumed health care cost trend rate used in measuring the accumulated post-retirement benefit obligation was 13% during 2003. This rate was assumed to decrease gradually each year to a rate of 5% in 2011 and remain at that level thereafter. Net periodic benefit cost for the year ended June 30, 2004, 2003 and 2002 includes the following components:
Pension Benefits Post-Retirement Benefits -------------------------------------- -------------------------------------- 2004 2003 2002 2004 2003 2002 ---------- ----------- ----------- ---------- ---------- ---------- Service cost............................ $ 6,533 $ 5,655 $ 5,707 $ 3,993 $ 1,177 $ 1,136 Interest cost........................... 22,591 22,899 22,570 8,739 5,579 5,362 Expected return on plan assets.......... (21,477) (24,749) (25,868) (1,640) (1,734) (1,701) Amortization of prior service cost...... 1,145 790 984 266 (65) (100) Recognized actuarial gain (loss)........ 8,402 2,433 194 485 (234) (737) Curtailment............................. -- -- 8,905 -- -- 1,200 Special termination benefits............ -- -- 8,957 -- -- 1,309 Settlement recognition.................. (445) (558) (457) -- -- -- ---------- ----------- ----------- ---------- ---------- ---------- Net periodic pension cost............... $ 16,749 $ 6,470 $ 20,992 $ 11,843 $ 4,723 $ 6,469 ========== =========== =========== ========== ========== ==========
Curtailment and special termination benefit charges were recognized during 2002 in connection with the Company's corporate reorganization and restructuring initiatives. The Company has deferred, as a regulatory asset, certain of these charges that have historically been recoverable in rates. Amortization of unrecognized actuarial gains and losses for Missouri Gas Energy plans were recognized using a rolling five-year average gain or loss position with a five-year amortization period pursuant to a stipulation agreement with the Missouri Public Service Commission (MPSC). The Company has deferred, as a regulatory asset, the difference in amortization of unrecognized actuarial losses recognized under such method and that amount determined and reported as net periodic pension cost in accordance with the applicable FASB Standards. The weighted-average assumptions used to determine net periodic benefit cost for the year ended June 30, 2004, 2003 and 2002 were:
Pension Benefits Post-Retirement Benefits -------------------------------------- -------------------------------------- 2004 2003 2002 2004 2003 2002 ---------- ----------- ----------- ---------- ---------- ---------- Discount rate Beginning of year.................. 7.50% 7.50% 8.00% 7.50% 7.50% 7.50% End of year........................ 6.50% 7.50% 7.50% 6.50% 7.50% 7.50% Expected return on assets - tax exempt accounts............... 9.00% 9.00% 9.00% 7.00% 9.00% 9.00% Expected return on assets - taxable accounts.............................. N/A N/A N/A 5.00% 5.50% 5.40% Rate of compensation increase (average). 4.00% 5.00% 5.00% N/A N/A N/A Health care cost trend rate............. N/A N/A N/A 13.00% 12.00% 12.00%
The assumed health care cost trend rate used in determining the net periodic benefit cost was 13% during 2004. This rate was assumed to decrease gradually each year to a rate of 5% in 2011 and remain at that level thereafter. The assumed health care cost trend rate used in determining the net periodic benefit cost was 12% during 2003. This rate was assumed to decrease gradually each year to a rate of 6% in 2006 and remain at that level thereafter. Assumed health care cost trends rates have a significant effect on the amounts reported for health care plans. A one-percentage-point change in assumed health care cost trend rates would have the following effects:
One Percentage Point One Percentage Point Increase in Health Care Decrease in Health Care Trend Rate Trend Rate ---------- ---------- Effect on total service and interest cost components.............. $ 1,512 $ (1,227) Effect on post-retirement benefit obligation...................... $ 14,212 $ (11,628)
Plan Asset Information Pension Plan Assets. The Pension Plans' assets shall be invested in accordance with several investment practices that emphasize long-term investment fundamentals with an investment objective of long-term growth. The investment practices shall consider risk tolerance and the asset allocation strategy as described below. Investment theory and historical capital market return data suggest that, over long periods of time, there is a relationship between the level of risk assumed and the level of return that can be expected in an investment program. In general, higher risk (i.e., volatility of return) is associated with higher return. Given this relationship between risk and return, a fundamental step in determining the investment policy is the determination of an appropriate risk tolerance. The Company examined two important factors that affect the Company's risk tolerance, including the financial ability to accept risk within the investment program and willingness to accept return volatility. Positive factors that contribute to a higher risk tolerance are:(i) the financial strength of the Company; (ii) the relationship between the market value of Plan assets and Plan liabilities (a surplus can provide a cushion that would reduce the probability of making any required contributions in the short-term in the event of adverse experience versus actuarial assumptions); (iii) the Company's willingness to accept short-term volatility in the market value of the Plan for the sake of earning higher long-term returns; (iv) and the long-term time horizon available for investment provides the opportunity to benefit from opportunities for growth that may accrue to a patient investment strategy. Offsetting these factors are: (i)as a defined benefit pension plan, the risk of investment losses is borne by the Company and significant investment losses may require substantial contributions to the Plan to maintain required funding levels and such contributions may coincide with poor financial results for the Company; and (ii)cyclical business activity can significantly influence the finances of the Company and its financial ability to fund required contributions. Post-retirement Health and Life Plans' Assets. The Post-retirement Health and Life Plans' assets shall be invested in accordance with sound investment practices that emphasize long-term investment fundamentals. The Investment Committee has adopted an investment objective of income and growth for the Plan. This investment objective: (i) is a risk-averse balanced approach that emphasizes a stable and substantial source of current income and some capital appreciation over the long-term; (ii) implies a willingness to risk some declines in value over the short-term, so long as the Plan is positioned to generate current income and exhibits some capital appreciation; (iii) is expected to earn long-term returns sufficient to keep pace with the rate of inflation over most market cycles (net of spending and investment and administrative expenses), but may lag inflation in some environments; (iv) diversifies the Plan in order to provide opportunities for long-term growth and to reduce the potential for large losses that could occur from holding concentrated positions; and (v) recognizes that investment results over the long-term may lag those of a typical balanced portfolio since a typical balanced portfolio tends to be more aggressively invested. Nevertheless, this Plan is expected to earn a long-term return that compares favorably to appropriate market indices. It is expected that these objectives can be obtained through a well-diversified portfolio structure in a manner consistent with the investment policy. The Company's weighted average asset allocation at June 30, 2004, and 2003, by asset category is as follows: Pension Post-Retirement At June 30, At June 30, ------------ -------------- Asset Category 2004 2003 2004 2003 -------------- ---- ---- ---- ---- Equity securities......................... 68% 51% 21% 26% Debt securities........................... 26% 45% 50% 64% Other - cash equivalents.................. 6% 4% 29% 10% ---- ----- ----- ---- Total................................. 100% 100% 100% 100% ==== ===== ===== ==== Equity securities include Company common stock in the amounts of $16,615,000 and $12,716,000 at June 30, 2004, and 2003, respectively. Based on the Pension Plan objectives, asset allocations are maintained as follows: equity of 50% to 75%, fixed income of 25% to 50%, and cash and cash equivalents of 0% to 10%. Based on the Post-Retirement Benefit Plan objectives, asset allocations are maintained as follows: equity of 25% to 35%, fixed income of 65% to 75%, and cash and cash equivalents of 0% to 10%. The Company expects to contribute between the estimated amounts of $11,600,000 and $12,608,000 to its pension plans and the estimated amount of $13,553,000 to its other post-retirement benefit plans in 2005. The estimated benefit payments, which reflect expected future service, as appropriate, that are projected to be paid are as follows: Pension Other Benefits Benefits 2005................................................. $ 23,547 $ 6,572 2006................................................. 20,579 6,922 2007................................................. 21,161 6,994 2008................................................. 22,205 7,514 2009................................................. 22,543 8,210 Years 2010 - 2014.................................... 136,657 53,149 The Company's eight qualified defined benefit retirement Plans cover: (i) those employees who are employed by Missouri Gas Energy; (ii) those employees who are employed by the Pennsylvania Operations; (iii) union employees of ProvEnergy; (iv) non-union employees of ProvEnergy; (v) union employees of Valley Resources; (vi) non-union employees of Valley Resources; (vii) union employees of Fall River Gas; and (viii) non-union employees of Fall River Gas. On December 31, 1998, the Plan covering (i) above, exclusive of Missouri Gas Energy's union employees, was converted from the traditional defined benefit Plan with benefits based on years of service and final average compensation to a cash balance defined benefit plan in which an account is maintained for each employee. The initial value of the account was determined as the actuarial present value (as defined in the Plan) of the benefit accrued at transition (December 31, 1998) under the pre-existing traditional defined benefit plan. Future contribution credits to the accounts are based on a percentage of future compensation, which varies by individual. Interest credits to the accounts are based on 30-year Treasury Securities rates. Defined Contribution Plan. The Company provides a Savings Plan available to all employees. For Missouri Gas Energy non-union and corporate employees, the Company contributes 50% and 75% of the first 5% and second 5%, respectively, of the participant's compensation paid into the Savings Plan. For Missouri Gas Energy union employees, the Company contributes 50% of the first 7% of the participant's compensation paid into the Savings Plan. In Pennsylvania, the Company contributes 55% of the first 4% of the participant's compensation paid into the Savings Plan. For New England Gas Company's Fall River operations, the Company contributes 100% of the first 4% of non-union employee compensation paid into the Savings Plan and 100% of the first 3% of union employee compensation paid into the Savings Plan. For New England Gas Company's Providence operations, the Company contributes 50% of the first 10% of the participant's compensation paid into the Savings Plan. For New England Gas Company's Cumberland operations (formerly Valley Resources), the Company contributes 50% of the first 4% of the participant's compensation paid into the Savings Plan. Company contributions are 100% vested after five years of continuous service for all plans other than Missouri Gas Energy union and New England Gas Company's Cumberland operations, which are 100% vested after six years of continuous service. Company contributions to the plan during 2004, 2003 and 2002 were $4,058,000, $2,251,000 and $2,722,000, respectively. Effective January 1, 1999, the Company amended its defined contribution plan to provide contributions for certain employees who were employed as of December 31, 1998. These contributions were designed to replace certain benefits previously provided under defined benefit plans. Employer contributions to these separate accounts, referred to as Retirement Power Accounts, within the defined contribution plan were determined based on the employee's age plus years of service plus accumulated sick leave as of December 31, 1998. The contribution amounts are determined as a percentage of compensation and range from 3.5% to 8.5%. Company contributions to Retirement Power Accounts during 2004, 2003 and 2002 were $5,149,000, $1,469,000 and $826,000, respectively. Panhandle Energy. Following the June 11, 2003 acquisition by Southern Union, Panhandle Energy instituted certain retiree health care and life insurance benefits under other post employment benefits (OPEB) and added certain benefits to substantially all of its employees under a defined contribution 401(k) plan (Savings Plan). Under the Savings Plan, Panhandle Energy provides a matching contribution of 50% of the first 4% of the participant's compensation paid into the Savings Plan. In addition, Panhandle Energy makes additional contributions ranging from 4% to 6% of the employee's eligible pay, depending on the employee's age and years of service. The adoption of the OPEB plan resulted in the recording of a $43,000,000 liability as of June 11, 2003 and Panhandle Energy continues to fund the plan at approximately $8,000,000 per year. Since Panhandle Energy retirement eligible active employees have primary coverage through a benefit they are eligible to receive from the former owner of Panhandle Energy, no liability is currently recognized for these employees under the OPEB plan. Following its acquisition by the Company in June 2003, Panhandle Energy initiated a workforce reduction initiative designed to reduce the workforce by approximately 5 percent. The workforce reduction initiative was an involuntary plan with a voluntary component, and was fully implemented by September 30, 2003. Corporate Restructuring. Business reorganization and restructuring initiatives were commenced in August 2001 as part of a previously announced Cash Flow Improvement Plan. Actions taken included (i) the offering of voluntary Early Retirement Programs (ERPs) in certain of its operating divisions and (ii) a limited reduction in force (RIF) within its corporate offices. ERPs, providing for increased benefits for those electing retirement, were offered to approximately 325 eligible employees across the Company's operating divisions, with approximately 59% 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 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. Common Stock Held in Trust. From time to time, the Company purchases outstanding shares of common stock of Southern Union to fund certain Company employee stock-based compensation plans. At June 30, 2004 and 2003, 1,089,147 and 1,114,738 shares, respectively, of common stock were held by various rabbi trusts for certain of those Company's benefit plans. At June 30, 2004, 110,996 shares were held in a rabbi trust for certain employees who deferred receipt of Company shares for stock options exercised. XV Taxes on Income
Year Ended June 30, ------------------- 2004 2003 2002 ---- ---- ---- Income tax expense: Current: Federal..................................................... $ 1,497 $ (15,258) $ (8,848) State....................................................... 151 (6,563) (1,391) ---------- ---------- --------- 1,648 (21,821) (10,239) ---------- ---------- --------- Deferred: Federal.................................................... $ 60,380 38,926 13,050 State...................................................... 7,075 7,168 600 ---------- ---------- --------- 67,455 46,094 13,650 ---------- ---------- --------- Total income tax expense from continuing operations............. $ 69,103 $ 24,273 $ 3,411 ========== ========== =========
Deferred credits include $5,367,000 and $5,791,000 of unamortized deferred investment tax credit as of June 30, 2004 and 2003. Deferred income taxes result from temporary differences between the financial statement carrying amounts and the tax basis of existing assets and liabilities.
June 30, -------- 2004 2003 ---- ---- Deferred income tax assets: Alternative minimum tax credit................. $ 24,054 $ 6,263 Insurance accruals............................. 1,601 2,028 Bad debt reserves.............................. 5,721 4,096 Post-retirement benefits....................... 1,346 1,078 Minimum pension liability...................... 33,511 35,159 Other.......................................... 8,442 10,313 ------------ ------------ Total deferred income tax assets........... $ 74,675 $ 58,937 ------------ ------------
June 30, -------- 2004 2003 ---- ---- Deferred income tax liabilities: Property, plant and equipment................... $ (313,387) $ (261,100) Unamortized debt expense........................ (21,607) (5,455) Regulatory liability............................ (13,151) (14,483) Other........................................... (55,831) (56,510) ------------ ---------- Total deferred income tax liabilities....... (403,976) (337,548) ------------ ---------- Net deferred income tax liability.................... (329,301) (278,611) Less current income tax assets................... 19,659 4,096 ------------ ---------- Accumulated deferred income taxes................... $ (348,960) $ (282,707} ============ ==========
The Company accounts for income taxes utilizing the liability method which bases the amounts of current and future income tax assets and liabilities on events recognized in the financial statements and on income tax laws and rates existing at the time the temporary differences are expected to reverse.
Year Ended June 30, ------------------- 2004 2003 2002 ---- ---- ---- Computed statutory income tax expense from continuing operations at 35%......... $ 64,095 $ 23,780 $ 1,726 Changes in income taxes resulting from: State income taxes, net of federal income tax benefit...................... 4,697 326 695 Amortization/write-down of goodwill........................................ -- -- 3,113 Internal Revenue Service audit settlement.................................. -- -- (1,570) Investment Tax Credit amortization......................................... (424) (421) (608) Other...................................................................... 735 588 55 ----------- ---------- --------- Actual income tax expense from continuing operations............................ $ 69,103 $ 24,273 $ 3,411 =========== ========== =========
XVI Regulation and Rates Missouri Gas Energy. On November 4, 2003, Missouri Gas Energy filed a request with the MPSC to increase base rates by $44,800,000 and to implement a weather mitigation rate design that would significantly reduce the impact of weather-related fluctuations on customer bills. On January 30, 2004, Missouri Gas Energy filed an updated claim which raised the amount of the base rate increase request to $54,200,000. As of July 19, 2004, upon the close of the record and reflecting settlement of a number of issues, MGE's request stood at approximately $39,000,000 and the MPSC Staff's recommendation stood at approximately $13,000,000. Statutes require that the MPSC reach a decision in the case within an eleven-month period from the original filing date. It is not presently possible to determine what action the MPSC will ultimately take with respect to this rate increase request. New England Gas Company. On May 22, 2003, the RIPUC approved a Settlement Offer filed by New England Gas Company related to the final calculation of earnings sharing for the 21-month period covered by the Energize Rhode Island Extension settlement agreement. This calculation generated excess revenues of $5,277,000. The net result of the excess revenues and the Energize Rhode Island weather mitigation and non-firm margin sharing provisions was the crediting to customers of $949,000 over a twelve-month period starting July 1, 2003. On May 24, 2002, the RIPUC approved a settlement agreement between the New England Gas Company and the Rhode Island Division of Public Utilities and Carriers. The settlement agreement resulted in a $3,900,000 decrease in base revenues for New England Gas Company's Rhode Island operations, a unified rate structure ("One State; One Rate") and an integration/merger savings mechanism. The settlement agreement also allows New England Gas Company to retain $2,049,000 of merger savings and to share incremental earnings with customers when the division's Rhode Island operations return on equity exceeds 11.25%. Included in the settlement agreement was a conversion to therm billing and the approval of a reconciling Distribution Adjustment Clause (DAC). The DAC allows New England Gas Company to continue its low income assistance and weatherization programs, to recover environmental response costs over a 10-year period, puts into place a new weather normalization clause and allows for the sharing of nonfirm margins (non-firm margin is margin earned from interruptible customers with the ability to switch to alternative fuels). The weather normalization clause is designed to mitigate the impact of weather volatility on customer billings, which will assist customers in paying bills and stabilize the revenue stream. New England Gas Company will defer the margin impact of weather that is greater than 2% colder-than-normal and will recover the margin impact of weather that is greater than 2% warmer-than-normal. The non-firm margin incentive mechanism allows New England Gas Company to retain 25% of all non-firm margins earned in excess of $1,600,000. Panhandle Energy. In December 2002, FERC approved a Trunkline LNG certificate application to expand the Lake Charles facility to approximately 1.2 Bcf per day of sustainable send out capacity versus the current sustainable send out capacity of .63 Bcf per day and increase terminal storage capacity to 9 Bcf from the current 6.3 Bcf. Construction on the Trunkline LNG expansion project (Phase I) commenced in September 2003 and is expected to be completed by the end of the 2005 calendar year. In February 2004, Trunkline LNG filed a further incremental LNG expansion project (Phase II) with FERC and is awaiting commission approval. Phase II would increase the LNG terminal sustainable send out capacity to 1.8 Bcf per day. Phase II has an expected in-service date of mid-calendar 2006. In February 2004, Trunkline filed an application with FERC to request approval of a 30-inch diameter, 23-mile natural gas pipeline loop from the LNG terminal. The pipeline creates additional transport capacity in association with the Trunkline LNG expansion and also includes new and expanded delivery points with major interstate pipelines. XVII Leases The Company leases certain facilities, equipment and office space under cancelable and non-cancelable operating leases. The minimum annual rentals under operating leases for the next five years ending June 30 are as follows: 2005--$17,777,000; 2006--$14,708,000; 2007--$13,970,000; 2008--$10,018,000 2009--$6,549,000 and thereafter $8,102,000. Rental expense was $17,821,000, $4,342,000, and $5,759,000 for the years ended June 30, 2004, 2003 and 2002, respectively. XVIII 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 ongoing evaluation of its operations to identify potential environmental exposures and assure compliance with regulatory policies and procedures. 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. 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 will have a material adverse effect on the Company's financial position, results of operations or cash flows. Local Distribution Company Environmental Matters -- 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 gas distribution service territories, principally in Texas, Arizona and New Mexico, and present gas distribution 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 gas distribution service territories certain MGP sites are currently the subject of governmental actions. These sites are as follows: Missouri Gas Energy. 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 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 entered the two sites into MDNR's Voluntary Cleanup Program and, subsequently, performed environmental assessments of the sites. Following the submission of these assessments to MDNR, MGE was required by MDNR to initiate remediation of Station A. Following the selection of a qualified contractor in a competitive bidding process, the Company began remediation of Station A in the first calendar quarter of 2003. The project was completed in July 2003, at an approximate cost of $4 million. Remediation of Station B has not been requested by MDNR at this time. Following a failed tank tightness test, MGE removed an underground storage tank (UST) system in December, 2002 from a former MGP site in St. Joseph, Missouri. An UST closure report was filed with MDNR on August 12, 2003. In a letter dated September 26, 2003, MDNR indicated that its review of the analytical data submitted for this site indicated that contamination existed at the site above the action levels specified in Missouri guidance documents. In a letter dated January 28, 2004, MDNR indicated that the Department would provide MGE a final version of the Missouri Risk-Based Corrective Action (MRBCA) process. On April 28, 2004, MDNR provided MGE with information regarding the MRBCA process, and requested a work plan on the St. Joseph site within 60 days of MGE's receipt of this information. On June 16, 2004, MGE submitted a UST Site Characterization Work Plan to MDNR for review and approval. New England Gas Company. Prior to its acquisition by the Company in September 2000, Providence Gas performed environmental studies and initiated an environmental remediation project at Providence Gas' primary gas distribution facility located at 642 Allens Avenue in Providence, Rhode Island. Providence Gas spent more than $13 million on environmental assessment and remediation at this MGP site under the supervision of the Rhode Island Department of Environmental Management (RIDEM). Following the acquisition, environmental remediation at the site was temporarily suspended. During this suspension, the Company requested certain modifications to the 1999 Remedial Action Work Plan from RIDEM. After receiving approval to some of the requested modifications to the 1999 Remedial Action Work Plan, environmental work was reinitiated on April 17, 2002, by a qualified contractor selected in a competitive bidding process. Remediation was completed on October 10, 2002, and a Closure Report was filed with RIDEM in December 2002. The cost of environmental work conducted after remediation resumed was $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 RIDEM relating to possible contamination at a site that operated as a MGP in the early 1900s in Providence, Rhode Island. Subsequent to its use as a MGP, this site was operated for over eighty years as a bulk fuel oil storage yard by a succession of companies including Cargill, Inc. (Cargill). Cargill has also received a letter of responsibility from RIDEM for the site. An investigation has 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 Cargill, under which Providence Gas is responsible for approximately twenty percent (20%) of the costs related to the investigation. To date, approximately $300,000 has been spent on environmental assessment work at this site. Until RIDEM provides its final response to the investigation, and the Company knows its 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. Fall River Gas Company (acquired in September 2000 by the Company) was a defendant in a civil action seeking to recover anticipated remediation costs associated with contamination found at property owned by the plaintiffs (Cory's Lane Site) in Tiverton, Rhode Island. 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 Cory's Lane Site sufficient to obtain a final letter of compliance from the RIDEM. Following the performance of a site investigation, the Company submitted a Site Investigation Report on December 5, 2003, to RIDEM. On April 15, 2004, the Company obtained verbal approval from RIDEM to conduct additional investigation activity at the site. In a letter dated March 17, 2003, RIDEM sent the New England Gas Company (NEG) a letter of responsibility pertaining to alleged historical MGP impacted soils in a residential neighborhood along Bay and Judson Streets (Bay Street Area) in Tiverton, Rhode Island. The letter requested that NEG prepare a Site Investigation Work Plan (Work Plan) for submittal to RIDEM by April 10, 2003, and subsequently perform a site investigation of the Bay Street Area. Without admitting responsibility or accepting liability, NEG responded to RIDEM in a letter dated March 19, 2003, and agreed to perform the activities requested by the State within the period specified by RIDEM. After receiving approval from RIDEM on a Work Plan, NEG began assessment work on June 2, 2003. A Site Inspection Report and a Human Health Risk Assessment were filed with RIDEM on October 31, 2003, and RIDEM provided NEG comments to the Site Inspection Report in a letter dated January 27, 2004. The January 27, 2004, RIDEM letter included the comment that additional assessment work was necessary in the Bay Street Area. On July 19, 2004, NEG submitted a Supplemental Site Investigation Work Plan and Phase 2 Site Investigation Work Plan for the further assessment of the Bay Street Area. In a letter dated August 18, 2004, RIDEM communicated its conditional concurrence of NEG's work plans. In response, NEG notified RIDEM of its intent to begin assessment field work on August 26, 2004. In connection with the investigation of the Bay Street Area, two former residents of the area filed a tort action on August 20, 2003, against NEG alleging personal injury to the plaintiffs. This litigation has not been served on the Company. The Company has also received a demand letter dated July 1, 2004, sent by lawyers on behalf of the owners of a property in the Bay Street Area. This demand alleges property damage and personal injury. Parts of the Bay Street Area appear to have been built on fill placed at various times and include one or more historic dump sites. Research is therefore underway to identify other potentially responsible parties associated with the fill materials and the dumping. The Company received a Notice of Responsibility, Request for Information and Request for Immediate Response Action Plan dated July 1, 2004, for an area in Fall River, Massachusetts along State Avenue (State Avenue Area) that is contiguous to the Bay Street Area of Rhode Island. In response to this Notice from the Massachusetts Department of Environmental Protection (MADEP), the Company submitted an Immediate Response Action Plan (Action Plan) to the MADEP on July 26, 2004. The Action Plan proposes an investigation to determine whether or not coal gasification related material was historically dumped in the State Avenue Area. Valley Gas Company (acquired in September 2000 by the 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 gas 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 Environmental Protection Agency (EPA) (Commonwealth of Massachusetts v. Blackstone Valley Electric Company, 67 F.3d 981 (1995)). The requested rulemaking concerned the question of whether or not ferric ferrocyanide (FFC) is among the "cyanides" listed as toxic substances under the Clean Water Act and, therefore, is a "hazardous substance" under the Comprehensive Environmental Response, Compensation and Liability Act. On October 6, 2003, the United States Environmental Protection Agency (EPA) issued a Final Administrative Determination declaring that FFC is one of the "cyanides" under the environmental statutes. While the Blackstone Litigation was stayed, Valley Gas Company and Blackstone (merged in May 2000 with Narragansett Electric Company, a subsidiary of National Grid) 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. While the Blackstone Litigation has been stayed, National Grid and the Company have jointly pursued claims against the bankrupt Stone & Webster entities (Stone & Webster) based upon Stone & Webster's historic management of MGP facilities on behalf of the alleged predecessors of both companies. On January 9, 2004, the U.S. Bankruptcy Court for the District of Delaware issued an order approving a settlement between National Grid, the Company and Stone & Webster that provided for the payment of $5 million out of the bankruptcy estates. This payment is payable $1.25 million to the Company for payment of environmental costs associated with the former Fall River Gas Company, and $3.75 million payable to the Company and National Grid jointly for payment of future environmental costs at the Tidewater and Hamlet sites. The settlement further provides an admission of liability by Stone & Webster that gives National Grid and the Company additional rights against historic Stone & Webster insurers. In a letter dated March 11, 2003, the MADEP provided NEG a Notice of Responsibility for 66 5th Street in Fall River, Massachusetts. This Notice of Responsibility requested that site assessment activities be conducted at the former MGP at 66 5th Street to determine whether or not there was a release of cyanide into the groundwater at this site that impacted downgradient properties at 60 and 82 Hartwell Street. NEG submitted an Immediate Response Action (IRA) Work Plan on May 20, 2003. The IRA Report was submitted to MADEP on July 18, 2003. Investigation work performed to date indicates that cyanide concentrations at the downgradient properties are unrelated to the NEG property at 66 5th Street. In 2003, NEG conducted a Phase I environmental site assessment at a former MGP site in North Attleboro, Massachusetts (the Mt. Hope Street Site) to determine if the property could be redeveloped as a service center. During the site walk, coal tar was found in the adjacent creek bed, and notice to the MADEP was made. On September 18, 2003, a Phase I Initial Site Investigation Report and Tier Classification were submitted to MADEP. On November 25, 2003, MADEP issued a Notice of Responsibility letter to NEG. Based upon the Phase I filing, NEG is required to file a Phase II report with MADEP by September 18, 2005, to complete the site characterization. PG Energy. During 2002, PG Energy received inquiries from the Pennsylvania Department of Environmental Protection (PADEP) pertaining to three Pennsylvania former MGP sites located in Scranton, Bloomsburg and Carbondale. At the request of PADEP, PG Energy is currently performing environmental assessment work at the Scranton MGP site. On March 23, 2004, PG Energy filed an Initial Site Assessment Characterization report on the Scranton site and is preparing to submit a Comprehensive Site Assessment Characterization Work Plan for the further assessment of this site. PG Energy has participated financially in PPL Electric Utilities Corporation's (PPL) environmental and health assessment of an additional MGP site located in Sunbury, Pennsylvania. In May 2003, PPL commenced a remediation project at the Sunbury site that was completed in August 2003. PG Energy has contributed to PPL's remediation project by removing and relocating gas utility lines located in the path of the remediation. In a letter dated January 12, 2004, PADEP notified PPL of its approval of the Remedy Certification Report submitted by PPL for the Sunbury MGP cleanup project. On March 31, 2004, PG Energy entered into a Voluntary Consent Order and Agreement (Multi-Site Agreement) with the PADEP. This Multi-Site Agreement is for the purpose of developing and implementing an environmental assessment and remediation program for five MGP sites (including the Scranton, Bloomsburg and Carbondale sites) and six MGP holder sites owned by PG Energy in the State of Pennsylvania. Under the Multi-Site Agreement, PG Energy is to perform environmental assessments of these sites within two years of the effective date of the Multi-Site Agreement. Thereafter, PG Energy is required to perform additional assessment and remediation activity as is deemed to be necessary based upon the results of the initial assessments. The Company does not believe the outcome of these matters will have a material adverse effect on its financial position, results of operations or cash flows. 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 gas distribution 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 ten-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. Similarly, environmental costs associated with Massachusetts' facilities are recoverable in rates over a seven-year period. Panhandle Energy Environmental Matters -- Panhandle Energy has identified environmental impacts at certain sites on its systems and has undertaken clean-up programs at those sites. These impacts resulted from (i) the past use of lubricants containing polychlorinated bi-phenyls (PCBs) in compressed air systems; (ii) the past use of paints containing PCBs; (iii) the prior use of wastewater collection facilities; and (iv) other on-site disposal areas. Panhandle Energy communicated with the EPA and appropriate state regulatory agencies on these matters, and has developed and is implementing a program to remediate such contamination in accordance with federal, state and local regulations. Some remediation is being performed by former Panhandle Energy affiliates in accordance with indemnity agreements that also indemnify against certain future environmental litigation and claims. As part of the cleanup program resulting from contamination due to the use of lubricants containing PCBs in compressed air systems, Panhandle Eastern Pipe Line and Trunkline have identified PCB levels above acceptable levels inside the auxiliary buildings that house the air compressor equipment at thirty-three compressor station sites. Panhandle Energy has developed and is implementing an EPA-approved process to remediate this PCB contamination in accordance with federal, state and local regulations. Eight sites have been decontaminated per the EPA approved process as prescribed in the EPA regulations. At some locations, PCBs have been identified in paint that was applied many years ago. In accordance with EPA regulations, Panhandle Energy has implemented a program to remediate sites where such issues are identified during painting activities. If PCBs are identified above acceptable levels, the paint is removed and disposed of in an EPA approved manner. The Illinois Environmental Protection Agency (Illinois EPA) notified Panhandle Eastern Pipe Line and Trunkline, together with other non-affiliated parties, of contamination at three former waste oil disposal sites in Illinois. Panhandle Eastern Pipe Line's and Trunkline's estimated share for the costs of assessment and remediation of the sites, based on the volume of waste sent to the facilities, is approximately 17 percent. Panhandle Energy and 21 other non-affiliated parties conducted an initial voluntary investigation of the Pierce Oil Springfield site, one of the three sites. Based on the information found during the initial investigation, Panhandle Energy and the 21 other non-affiliated parties have decided to further delineate the extent of contamination by authorizing a Phase II investigation at this site. Once data from the Phase II investigation is evaluated, Panhandle Energy and the 21 other non-affiliated parties will determine what additional actions will be taken. In addition, Illinois EPA has informally indicated that it has referred the Pierce Oil Springfield site to the EPA so that environmental contamination present at the site can be addressed through the federal Superfund program. No formal notice has yet been received from either agency concerning the referral. However, the EPA is expected to issue special notice letters in calendar 2004 and has begun the process of listing the site on the National Priority List. Panhandle Energy and three of the other non-affiliated parties associated with the Pierce Oil Springfield site met with the EPA and Illinois EPA regarding this issue. Panhandle Energy was given no indication as to when the listing process was to be completed. Based on information available at this time, the Company believes the amount reserved for all of the above environmental matters is adequate to cover the potential exposure for clean-up costs. Air Quality Control In 1998, the EPA issued a final rule on regional ozone control that requires Panhandle Energy to place controls on certain large internal combustion engines in five midwestern states. The part of the rule that affects Panhandle Energy was challenged in court by various states, industry and other interests, including Interstate Natural Gas Association of America (INGAA), an industry group to which Panhandle Energy belongs. In March 2000, the court upheld most aspects of the EPA's rule, but agreed with INGAA's position and remanded to the EPA the sections of the rule that affected Panhandle Energy. The final rule was promulgated by the EPA in April 2004. The five midwestern states have one year to promulgate state laws and regulations to address the requirements of this rule. Based on an EPA guidance document negotiated with gas industry representatives in 2002, it is believed that Panhandle Energy will be required under state rules to reduce nitrogen oxide (NOx) emissions by 82% on the identified large internal combustion engines and will be able to trade off engines within the company and within each of the five Midwestern states affected by the rule in an effort to create a cost effective NOx reduction solution. The final implementation date is May 2007. The rule impacts 20 large internal combustion engines on the Panhandle Energy system in Illinois and Indiana at an approximate cost of $17 million for capital improvements through 2007, based on current projections. In 2002, the Texas Commission on Environmental Quality enacted the Houston/Galveston State Implementation Plan (SIP) regulations requiring reductions in NOx emissions in an eight-county area surrounding Houston. Trunkline's Cypress compressor station is affected and may require the installation of emission controls. New regulations also require certain grandfathered facilities in Texas to enter into the new source permit program which may require the installation of emission controls at five additional facilities. These two rules affect six Company facilities in Texas at an estimated cost of approximately $12 million for capital improvements through March 2007, based on current projections. The EPA promulgated various Maximum Achievable Control Technology (MACT) rules in August 2003 and February 2004. The rules require that Panhandle Eastern Pipe Line and Trunkline control Hazardous Air Pollutants (HAPs) emitted from certain internal combustion engines at major HAPs sources. Most of Panhandle Eastern Pipe Line and Trunkline compressor stations are major HAPs sources. The HAPs pollutant of concern for Panhandle Eastern Pipe Line and Trunkline is formaldehyde. As promulgated, the rule seeks to reduce formaldehyde emissions by 76% from these engines. Catalytic controls will be required to reduce emissions under these rules with a final implementation date of May 2007. Panhandle Eastern Pipe Line and Trunkline have 22 internal combustion engines subject to the rules. It is expected that compliance with these regulations will cost an estimated $5 million for capital improvements, based on current projections. Regulatory 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. This matter went into recess following a hearing in May of 2003. Following the May hearing, the Commission staff reduced its disallowance recommendation to approximately $9.3 million. The hearing concluded in November 2003 and the matter was fully submitted to the Commission in February 2004 and is awaiting decision by the Commission. 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 2003. No date for this hearing has been set. Southwest Gas Litigation During 1999, several actions were commenced in federal courts by persons involved in competing efforts to acquire Southwest Gas Corporation (Southwest). All of these actions eventually were transferred to the U.S. District Court for the District of Arizona, consolidated and lodged with Judge Roslyn Silver. As a result of summary judgments granted, there were no claims allowed against Southern Union. The trial of Southern Union's claims against the sole-remaining defendant, former 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 former Commissioner Irvin. The District Court denied former Commissioner Irvin's motions to set aside the verdict and reduce the amount of punitive damages. Former Commissioner Irvin has appealed to the Ninth Circuit Court of Appeals. A decision on the appeal by the Ninth Circuit is expected by the first calendar quarter of 2005. The Company intends to vigorously pursue collection of the award. With the exception of ongoing legal fees associated with the collection of damages from former Commissioner Irvin, the Company believes that the results of the above-noted Southwest litigation and any related appeals will not have a material adverse effect on the Company's financial condition, results of operations or cash flows. Other In 1993, the U.S. Department of the Interior announced its intention to seek, through its Minerals Management Service (MMS) additional royalties from gas producers as a result of payments received by such producers in connection with past take-or-pay settlements, buyouts, and buy downs of gas sales contracts with natural gas pipelines. Panhandle Energy's pipelines, with respect to certain producer contract settlements, may be contractually required to reimburse or, in some instances, to indemnify producers against such royalty claims. The potential liability of the producers to the government and of the pipelines to the producers involves complex issues of law and fact which are likely to take substantial time to resolve. If required to reimburse or indemnify the producers, Panhandle Energy's pipelines may file with FERC to recover a portion of these costs from pipeline customers. Panhandle Energy believes the outcome of this matter will not have a material adverse effect on its financial position, results of operations or cash flows. 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. Commitments. The Company is committed under various agreements to purchase certain quantities of gas in the future. At June 30, 2004, the Company's Distribution segment has purchase commitments for natural gas transportation services, storage services and certain quantities of natural gas at a combination of fixed, variable and market-based prices that have an aggregate value of approximately $1,099,972,000. The Company's purchase commitments may be extended over several years depending upon when the required quantity is purchased. The Company has purchase gas tariffs in effect for all its utility service areas that provide for recovery of its purchase gas costs under defined methodologies and the Company believes that all costs incurred under such commitments will be recovered through its purchase gas tariffs. In connection with the acquisition of the Pennsylvania Operations, the Company assumed a guaranty with a bank whereby the Company unconditionally guaranteed payment of financing obtained for the development of PEI Power Park. In March 1999, the Borough of Archbald, the County of Lackawanna, and the Valley View School District (together the Taxing Authorities) approved a Tax Incremental Financing Plan (TIF Plan) for the development of PEI Power Park. The TIF Plan requires that: (i) the Redevelopment Authority of Lackawanna County raise $10,600,000 of funds to be used for infrastructure improvements of the PEI Power Park; (ii) the Taxing Authorities create a tax increment district and use the incremental tax revenues generated from new development to service the $10,600,000 debt; and (iii) PEI Power Corporation, a subsidiary of the Company, guarantee the debt service payments. In May 1999, the Redevelopment Authority of Lackawanna County borrowed $10,600,000 from a bank under a promissory note (TIF Debt), which was refinanced and modified in May 2004. Beginning May 15, 2004 the TIF Debt bears interest at a variable rate equal to three-quarters percent (.75%) lower than the National Prime Rate of Interest with no interest rate floor or ceiling. The TIF Debt matures on June 30, 2011. Interest-only payments were required until June 30, 2003, and semi-annual interest and principal payments are required thereafter. As of June 30, 2004, the interest rate on the TIF Debt was 3.25% and estimated incremental tax revenues are expected to cover approximately 25% of the fiscal 2005 annual debt service. Based on information available at this time, the Company believes that the amount provided for the potential shortfall in estimated future incremental tax revenues is adequate as of June 30, 2004. The balance outstanding on the TIF Debt was $8,710,000 as of June 30, 2004. Effective May 1, 2004, the Company agreed to five-year contracts with each bargaining-unit representing Missouri Gas Energy employees. Effective April 1, 2004, the Company agreed to a three-year contract with a bargaining unit representing a portion of PG Energy employees. Effective, August 1, 2003, the Company agreed to a three-year contract with another bargaining unit representing the remaining PG Energy unionized employees. Effective May 28, 2003, Panhandle Energy agreed to a three-year contract with a bargaining unit representing Panhandle Energy employees. During fiscal 2003, the bargaining unit representing certain employees of New England Gas Company's Cumberland operations (formerly Valley Resources) was merged with the bargaining unit representing the employees of the Company's Fall River operations (formerly Fall River Gas). During fiscal 2002, the Company agreed to five-year contracts with two bargaining units representing employees of New England Gas Company's Providence operations (formerly ProvEnergy), which were effective May 2002; a four-year contract with one bargaining unit representing employees of New England Gas Company's Cumberland operations, effective May 2002; and a four-year contract with one bargaining unit representing employees of New England Gas Company's Fall River operations, effective April 2002; and a one year extension of a bargaining unit representing certain employees of the Company's Cumberland operations. Of the Company's employees represented by unions, Missouri Gas Energy employs 36%, New England Gas Company employs 32%, Panhandle Energy employs 18% and PG Energy employs 14%. The Company had standby letters of credit outstanding of $58,566,000 at June 30, 2004 and $7,761,000 at June 30, 2003, which guarantee payment of insurance claims and other various commitments. The Company has guaranteed a $4,000,000 line of credit between Advent Networks, Inc. (in which Southern Union has an equity interest) and a bank. XIX Discontinued Operations Effective January 1, 2003, the Company completed the sale of its Southern Union Gas natural gas operating division and related assets to ONEOK for approximately $437,000,000 in cash resulting in a pre-tax gain of $62,992,000. In accordance with accounting principles generally accepted in the United States, the results of operations and gain on sale have been segregated and reported as "discontinued operations" in the Consolidated Statement of Operations and as "assets held for sale" in the Consolidated Statement of Cash Flows for the respective periods. The following table summarizes the Texas Operations' results of operations that have been segregated and reported as "discontinued operations" in the Consolidated Statement of Operations:
Year Ended June 30, ------------------- 2003 2002 ------------- ----------- Operating revenues................................ $ 144,490 $ 309,936 ============= =========== Net operating revenues, excluding depreciation and amortization (a)........................... $ 51,480 $ 105,730 ============= =========== Net earnings from discontinued operations (b)..... $ 32,520 $ 18,104 ============= ===========
- --------------------------------- (a) Net operating revenues consist 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.
XX Quarterly Operations (Unaudited) Year Ended Quarter Ended June 30, 2004 September 30 December 31 March 31 June 30 Total ------------- --------------- --------------- ------------ ------------ ------------ Operating revenues.......................... $ 231,394 $ 507,113 $ 774,579 $ 286,888 $ 1,799,974 Net operating revenues, excluding depreciation and amortization............ 169,309 240,097 297,892 182,843 890,141 Net earnings (loss) from continuing operations............................... (3,707) 38,422 75,367 3,943 114,025 Net earnings (loss) available for common shareholders............................. (3,707) 34,418 71,026 (398) 101,339 Diluted net earnings (loss) per share available for common shareholders:(1) Continuing operations.................... (.05) .45 .91 (.01) 1.30 Available for common shareholders........ (.05) .45 .91 (.01) 1.30 Year Ended Quarter Ended June 30, 2003 September 30 December 31 March 31 June 30 Total ------------- --------------- -------------- ----------- ------------ ------------ Operating revenues.......................... $ 99,710 $ 346,104 $ 535,663 $ 207,030 $ 1,188,507 Net operating revenues, excluding depreciation and amortization............ 54,464 118,031 161,400 89,516 423,411 Net earnings (loss) from continuing operations............................... (9,186) 18,519 46,234 (11,898) 43,669 Net earnings from discontinued operations... 2,691 10,900 17,665 1,264 32,520 Net earnings (loss) available for common shareholders............................. (6,495) 29,419 63,899 (10,634) 76,189 Diluted net earnings (loss) per share available for common shareholders:(1) Continuing operations.................... (.16) .30 .75 (.19) .70 Discontinued operations.................. .05 .18 .29 .02 .52 Available for common shareholders........ (.11) .48 1.04 (.17) 1.22
(1) The sum of earnings per share by quarter may not equal the net earnings per common and common share equivalents for the year due to variations in the weighted average common and common share equivalents outstanding used in computing such amounts. XXI Reportable Segments The Company's operating segments are aggregated into reportable business segments based on similarities in economic characteristics, products and services, types of customers, methods of distribution and regulatory environment. The Company operates in two reportable segments. The Transportation and Storage segment is primarily engaged in the interstate transportation and storage of natural gas in the Midwest and Southwest, and also provides LNG terminalling and regasification services. Its operations are conducted through Panhandle Energy, which the Company acquired on June 11, 2003. The Distribution segment is primarily engaged in the local distribution of natural gas in Missouri, Pennsylvania, Rhode Island and Massachusetts. Its operations are conducted through the Company's three regulated utility divisions: Missouri Gas Energy, PG Energy and New England Gas Company. The Company evaluates segment performance based on several factors, of which the primary financial measure is operating income (which the Company formerly referred to as net operating revenues). The accounting policies of the segments are substantially the same as those described in the summary of significant accounting policies (see Note I - Summary of Significant Accounting Policies). Sales of products or services between segments are billed at regulated rates or at market rates, as applicable. There were no material intersegment revenues during 2004, 2003 or 2002. Prior to the acquisition of Panhandle Energy, the Company was primarily engaged in the natural gas distribution business and considered its operations to consist of one reportable segment. As a result of the acquisition of Panhandle Energy, management assessed the manner in which financial information is reviewed in making operating decisions and assessing performance, and concluded that in addition to Panhandle Energy's operations its regulated utility operations would be treated as one separate and distinct reportable segment. During fiscal 2003, the Company reported its Southern Union Gas natural gas operating division as discontinued operations. Accordingly, the Distribution segment results exclude the results of the Texas operations for all periods presented. Revenue included in the All Other category is attributable to several operating subsidiaries of the Company: PEI Power Corporation generates and sells electricity; PG Energy Services Inc., offer appliance service contracts; ProvEnergy Power Company LLC (ProvEnergy Power), which was sold effective October 31, 2003, provided outsourced energy management services and owned 50% of Capital Center Energy Company LLC, a joint venture formed between ProvEnergy and ERI Services, Inc. to provide retail power and conditioned air; and Alternate Energy Corporation provides energy consulting services. None of these businesses have ever met the quantitative thresholds for determining reportable segments individually or in the aggregate. The Company also has corporate operations that do not generate any revenues. The following table sets forth certain selected financial information for the Company's segments for fiscal 2004, 2003 and 2002. Financial information for the Transportation and Storage segment reflects the operations of Panhandle Energy beginning on its acquisition date of June 11, 2003.
Year Ended June 30, ------------------------------------------------ 2004 2003 2002 ---------------- -------------- ------------- Revenues from external customers: Distribution................................................. $ 1,304,405 $ 1,158,964 $ 968,933 Transportation and Storage................................... 491,083 24,529 -- All Other (a)................................................ 4,486 5,014 11,681 ------------- ------------- ------------- Total consolidated operating revenues............................. $ 1,799,974 $ 1,188,507 $ 980,614 ============= ============= ============= Depreciation and amortization: Distribution................................................. $ 57,601 $ 56,396 $ 53,937 Transportation and Storage................................... 59,988 3,197 -- All Other.................................................... 572 590 2,387 ------------- ------------- ------------- Total segment depreciation and amortization....................... 118,161 60,183 56,324 Reconciling Item -- Corporate..................................... 594 459 2,665 ------------- ------------- ------------- Total consolidated depreciation and amortization.................. $ 118,755 $ 60,642 $ 58,989 ============= ============= ============= Operating income: Distribution................................................. $ 118,894 $ 142,762 $ 135,502 Transportation and Storage................................... 193,702 9,635 -- All Other.................................................... (3,514) 13 -- ------------- ------------- ------------- Total segment operating income.................................... 309,082 152,410 135,502 Reconciling Items: Corporate.................................................... (3,555) (10,039) (15,218) Business restructuring charges............................... -- -- (29,159) ------------- ------------- ------------- Consolidated operating income..................................... $ 305,527 $ 142,371 $ 91,125 ============= ============= ============= Total assets: Distribution................................................. $ 2,231,970 $ 2,243,257 $ 2,156,106 Transportation and Storage................................... 2,197,289 2,212,467 -- All Other.................................................... 42,133 50,073 53,339 ------------- ------------- ------------- Total segment assets.............................................. 4,471,392 4,505,797 2,209,445 Reconciling Items: Corporate.................................................... 101,066 85,141 75,173 Sale of assets - Texas Operations............................ -- -- 395,446 ------------- ------------- ------------- Total consolidated assets......................................... $ 4,572,458 $ 4,590,938 $ 2,680,064 ============= ============= ============= Expenditures for long-lived assets: Distribution................................................. $ 78,791 $ 67,327 $ 68,042 Transportation and Storage................................... 131,378 5,128 -- All Other.................................................... 856 1,653 1,365 ------------- ------------- ------------- Total segment expenditures for long-lived assets.................. 211,025 74,108 69,407 Reconciling item - Corporate...................................... 15,028 5,622 1,291 ------------- ------------- ------------- Total consolidated expenditures for long-lived assets............. $ 226,053 $ 79,730 $ 70,698 ============= ============= ============= Reconciliation of operating income to earnings from continuing operations before income taxes: Operating income............................................. $ 305,527 $ 142,371 $ 91,125 Interest..................................................... (127,867) (83,343) (90,992) Dividends on preferred securities of subsidiary trust........ -- (9,480) (9,480) Other income, net............................................ 5,468 18,394 14,278 ------------- ------------- ------------- Earnings from continuing operations before income taxes. $ 183,128 $ 67,942 $ 4,931 ============= ============= =============
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Stockholders and Board of Directors of Southern Union Company: In our opinion, the accompanying consolidated balance sheet and the related consolidated statements of operations, of cash flows and of stockholders' equity, present fairly, in all material respects, the financial position of Southern Union Company and subsidiaries (the "Company") at June 30, 2004 and 2003, and the results of their operations and their cash flows for each of the three years in the period ended June 30, 2004, in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). These standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. PricewaterhouseCoopers LLP Houston, Texas August 31, 2004 Exhibit 21 SUBSIDIARIES OF THE COMPANY Name State or Country of Incorporation ---------------------- --------------------------------- Panhandle Eastern Pipe Line Company, LP Delaware Trunkline Gas Company, LLC Delaware Trunkline LNG Holdings, LLC Deleware Trunkline LNG Company, LLC Delaware Pan Gas Storage, LLC Deleware Note: Certain wholly-owned subsidiaries of Southern Union Company are not named above. Considered in the aggregate as a single subsidiary, these unnamed entities would not constitute a "significant subsidiary" at the end of the year covered by this report. Additionally, the Company has other subsidiaries that conduct no business except to the extent necessary to maintain their corporate name or existence. Exhibit 23 CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM We hereby consent to the incorporation by reference in the Registration Statements on Form S-3 (File No. 333-113757) and Form S-8 (File Nos. 33-37261, 33-69596, 33-69598, 33-61558, 333-79443, 333-08994, 333-42635, 333-89971, 333-36146, 333-36150, 333-47144 and 333-112527) of Southern Union Company of our report dated August 30, 2004 relating to the consolidated financial statements which appear in this Form 10-K. PricewaterhouseCoopers LLP Houston, Texas August 31, 2004 Exhibit 24 POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS that each person whose signature appears below constitutes and appoints Thomas F. Karam and David J. Kvapil, or any of them, acting individually or together, as such person's true and lawful attorney(s)-in-fact and agent(s), with full power of substitution and revocation, to act in any capacity for such person and in such person's name, place and stead in any and all capacities, to sign the Annual Report on Form 10-K for the fiscal year ended June 30, 2004 of Southern Union Company, a Delaware corporation, and any amendments thereto, and to file the same with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission and the New York Stock Exchange. Dated: August 30, 2004 GEORGE L. LINDEMANN ADAM M.LINDEMANN - --------------------------- ---------------------------------------- George L. Lindemann Adam M. Lindemann JOHN E. BRENNAN DAVID BRODSKY - --------------------------- ---------------------------------------- John E. Brennan David Brodsky THOMAS F. KARAM GEORGE ROUNTREE, III - -------------------------- ---------------------------------------- Thomas F. Karam George Rountree, III FRANK W. DENIUS RONALD W.SIMMS - -------------------------- ---------------------------------------- Frank W. Denius Ronald W. Simms KURT A. GITTER, M.D. - -------------------------- Kurt A. Gitter, M.D. Exhibit 31.1 CERTIFICATIONS I, George L. Lindemann, certify that: (1) I have reviewed this annual report on Form 10-K of Southern Union Company; (2) Based on my knowledge, this 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 report; (3) Based on my knowledge, the financial statements, and other financial information included in this 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 report; (4) The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, 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 report is being prepared; (b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and (5) The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: August 31, 2004 GEORGE L. LINDEMANN - ------------------------------ George L. Lindemann Chairman of the Board and Chief Executive Officer (principal executive officer) Exhibit 31.2 CERTIFICATIONS I, David J. Kvapil, certify that: (1) I have reviewed this annual report on Form 10-K of Southern Union Company; (2) Based on my knowledge, this 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 report; (3) Based on my knowledge, the financial statements, and other financial information included in this 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 report; (4) The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, 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 report is being prepared; (b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and (5) The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: August 31, 2004 DAVID J. KVAPIL - ------------------------------ David J. Kvapil Executive Vice President and Chief Financial Officer (principal financial officer) Exhibit 32.1 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-K of Southern Union Company (the "Company") for the fiscal year ended June 30, 2004, 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 to my knowledge (i) the Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, and (ii) 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 August 31, 2004 This Certification is being furnished solely to accompany the Report pursuant to 18 U.S.C. ss.1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, and shall not be deemed "filed" by the Company for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and shall not be incorporated by reference into any filing of the Company under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after the date of this Report, irrespective of any general incorporation language contained in such filing. A signed original of this written statement required by Section 906, or other documents authenticating, acknowledging, or otherwise adopting the signature that appears in typed form within the electronic version of this written statement required by Section 906, has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request. Exhibit 32.2 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-K of Southern Union Company (the "Company") for the fiscal year ended June 30, 2004, 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 to my knowledge (i) the Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, and (ii) 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 August 31, 2004 This Certification is being furnished solely to accompany the Report pursuant to 18 U.S.C. ss.1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, and shall not be deemed "filed" by the Company for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and shall not be incorporated by reference into any filing of the Company under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after the date of this Report, irrespective of any general incorporation language contained in such filing. A signed original of this written statement required by Section 906, or other documents authenticating, acknowledging, or otherwise adopting the signature that appears in typed form within the electronic version of this written statement required by Section 906, has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request. EX-10 2 exhibit10a.txt 3RD AMEND. REVOLVING CREDIT AGREEMENT Exhibit 10(a) THIRD AMENDED AND RESTATED REVOLVING CREDIT AGREEMENT DATED AS OF MAY 28, 2004 BY AND AMONG SOUTHERN UNION COMPANY as the Borrower AND THE BANKS NAMED HEREIN as the Banks AND JPMORGAN CHASE BANK as the Administrative Agent AND FLEET NATIONAL BANK as the Syndication Agent AND WESTLB AG, NEW YORK BRANCH as the Documentation Agent AND J.P. MORGAN SECURITIES INC. as the Sole Book Runner and Lead Arranger 8 050100:02807 : AUSTIN : 293492.6 THIRD AMENDED AND RESTATED REVOLVING CREDIT AGREEMENT Reference is hereby made to that certain Second Amended and Restated Revolving Credit Agreement (Long-Term Credit Facility) dated as of May 29, 2001, executed by and between SOUTHERN UNION COMPANY, a corporation organized under the laws of Delaware (the "Borrower"), the financial institutions listed on the signature pages of said Revolving Credit Agreement (each of said financial institutions now or hereafter a party to said Revolving Credit Agreement being hereinafter referred to collectively as "Banks" and individually as a "Bank"), and CHASE BANK OF TEXAS, NATIONAL ASSOCIATION, a national banking association now known as JPMORGAN CHASE BANK ("JPMorgan"), in its capacity as agent (the "Agent") for the Banks. The Borrower, the Banks and the Agent have previously amended said Second Amended and Restated Revolving Credit Agreement pursuant to the terms of a First Amendment to Second Amended and Restated Revolving Credit Agreement (Long-Term Credit Facility) dated as of June 10, 2002 (the "First Amendment") and the terms of a Second Amendment to Second Amended and Restated Revolving Credit Agreement (Long-Term Credit Facility) dated as of April 3, 2003 (the "Second Amendment"). Said Revolving Credit Agreement, as previously amended by the First Amendment and the Second Amendment, is referred to herein as the "Original Agreement." As a result of certain discussions between the Borrower, the Agent and the Banks, the parties to the Original Agreement now desire to amend and restate the Original Agreement in its entirety. Accordingly, the Original Agreement is hereby amended and restated in its entirety to hereafter be and read as follows: SOUTHERN UNION COMPANY, a corporation organized under the laws of Delaware (hereinafter called the "Borrower"), the financial institutions listed on the signature pages hereof (collectively, the "Banks" and individually, a "Bank"), JPMORGAN CHASE BANK, a New York banking corporation ("JPMorgan"), in its capacity as administrative agent (the "Agent") for the Banks hereunder, FLEET NATIONAL BANK, in its capacity as syndication agent ("Syndication Agent") for the Banks hereunder, and WESTLB AG, NEW YORK BRANCH, in its capacity as documentation agent ("Documentation Agent") for the Banks hereunder, hereby agree as follows: 1. CERTAIN DEFINITIONS. As used in this Agreement, the following terms shall have the following meanings: "Additional Costs" shall mean, with respect to any Rate Period in the case of any Eurodollar Rate Loan, all costs, losses or payments, as determined by any Bank in its sole and absolute discretion (which determination shall be conclusive in the absence of manifest error) that such Bank or its Domestic Lending Office or its Eurodollar Lending Office does, or would, if such Eurodollar Rate Loan were funded during such Rate Period by the Domestic Lending Office or the Eurodollar Lending Office of such Bank, incur, suffer or make by reason of: (a) any and all present or future taxes (including, without limitation, any interest equalization tax or any similar tax on the acquisition of debt obligations, or any stamp or registration tax or duty or official or sealed papers tax), levies, imposts or any other charge of any nature whatsoever imposed by any taxing authority on or with regard to any aspect of the transactions contemplated by this Agreement, except such taxes as may be measured by the overall net income of such Bank or its Domestic Lending Office or its Eurodollar Lending Office and imposed by the jurisdiction, or any political subdivision or taxing authority thereof, in which such Bank's Domestic Lending Office or its Eurodollar Lending Office is located; and (b) any increase in the cost to such Bank of agreeing to make or making, funding or maintaining any Eurodollar Rate Loan because of or arising from (i) the introduction of, or any change (other than any change by way of imposition or increase of reserve requirements, in the case of any Eurodollar Rate Loan, included in the Eurodollar Rate Reserve Percentage) in or in the interpretation or administration of, any law or regulation or (ii) the compliance with any request from any central bank or other governmental authority (whether or not having the force of law). "Affiliate" shall mean any Person controlling, controlled by or under common control with any other Person. For purposes of this definition, "control" (including "controlled by" and "under common control with") means the possession, directly or indirectly, of the power to direct or cause the direction of the management and policies of such Person, whether through the ownership of voting securities or otherwise. If any Person shall own, directly or indirectly, beneficially or of record, twenty percent (20%) or more of the voting equity (whether outstanding capital stock, partnership interests or otherwise) of another Person, such Person shall be deemed to be an Affiliate. "Agent" shall have the meaning set forth in the preamble hereto. "Agreement" shall mean this Revolving Credit Agreement, as the same may be amended, modified, supplemented or restated from time to time. "Alternate Base Rate" shall mean, for any day, a rate, per annum (rounds upward to the nearest 1/16 of 1%) equal to: (a) the greatest of (i) the Prime Rate (computed on the basis of the actual number of days elapsed over a year of 365 or 366 days, as the case may be) in effect on such day; or (ii) the Federal Funds Rate in effect for such day plus one-half of one percent (1/2%) (computed on the basis of the actual number of days elapsed over a year of 360 days). "Alternate Base Rate Loan" shall mean any Loan which bears interest at the Alternate Base Rate. "Applicable Lending Office" shall mean, with respect to each Bank, such Bank's (a) Domestic Lending Office in the case of an Alternate Base Rate Loan; and (b) Eurodollar Lending Office in the case of a Eurodollar Rate Loan. "Approved Fund" means any Person (other than a natural person) that is engaged in making, purchasing, holding or investing in bank loans and similar extensions of credit in the ordinary course of its business and that is administered or managed by (a) a Bank, (b) an Affiliate of a Bank or (c) an entity or an Affiliate of an entity that administers or manages a Bank. "Assignment and Acceptance" shall have the meaning set forth in Section 13.13. "Bank" shall have the meaning set forth in the preamble hereto and shall include the Agent, in its individual capacity. "Borrower" shall have the meaning set forth in the preamble hereto. "Borrowing Date" shall mean a date upon which the Borrower has requested a Loan is to be made in a Notice of Borrowing delivered pursuant to Section 2.1. "Business Day" shall mean a day when the Agent is open for business, provided that, if the applicable Business Day relates to any Eurodollar Rate Loan, it shall mean a day when the Agent is open for business and banks are open for business in the London interbank market and in New York City. "Capital Lease" shall mean any lease of any Property (whether real, personal, or mixed) which, in conformity with GAAP, is accounted for as a capital lease on the balance sheet of the lessee. "Capitalized Lease Obligations" shall mean, for the Borrower and its Subsidiaries, any of their obligations that should, in accordance with GAAP, be recorded as Capital Leases. "Cash Interest Expense" shall mean, for any period, total interest expense to the extent paid in cash (including the interest component of Capitalized Lease Obligations and capitalized interest and all dividends and interest paid on or with respect to Borrower's Structured Securities) of the Borrower and any Subsidiary for such period all as determined in conformity with GAAP. "Closing Date" shall mean May 28, 2004. "Code" shall mean the Internal Revenue Code of 1986, as amended, as now or hereafter in effect, together with all regulations, rulings and interpretations thereof or thereunder issued by the Internal Revenue Service. "Commitment" shall have the meaning set forth in Section 2.1(a) and "Commitments" shall mean, collectively, the Commitments of all of the Banks. "Consolidated Net Income" shall mean for any period the consolidated net income of the Borrower and all Subsidiaries, determined in accordance with GAAP, for such period. "Consolidated Net Worth" shall mean, for any period for the Borrower and all Subsidiaries, (a) the sum of the following consolidated items, all determined in accordance with GAAP and without duplication: the consolidated stockholders' equity of all classes of stock (whether common, preferred, mandatorily convertible preferred or preference) of the Borrower and its Subsidiaries; the Equity-Preferred Securities; the other preferred securities of the Borrower's Subsidiaries not constituting Equity-Preferred Securities; and the minority interests in the Borrower's Subsidiaries, less (b) the sum of the following consolidated items, without duplication: the book amount of any deferred charges (including, but not limited to, unamortized debt discount and expenses, organization expenses, experimental and development expenses, but excluding prepaid expenses) that are not permitted to be recovered by the Borrower or its applicable Subsidiaries under rates permitted under rate tariffs, plus (c) the sum of all amounts contributed or paid by the Borrower to the Rabbi Trusts for purposes of funding the same, but only to the extent such contributions and payments are required to be deducted from the consolidated stockholders' equity of the Borrower and its Subsidiaries in accordance with GAAP. "Consolidated Total Capitalization" shall mean at any time the sum of: (a) Consolidated Net Worth at such time; plus (b) the principal amount of outstanding Debt (other than Equity-Preferred Securities (to the extent included in Debt of the Borrower and its Subsidiaries) not to exceed 10% of Consolidated Total Capitalization [calculated for purposes of this clause without reference to any Equity-Preferred Securities]) of the Borrower and its Subsidiaries. "Consolidated Total Indebtedness" shall mean all Debt of the Borrower and all Subsidiaries including any current maturities thereof, plus, without duplication, all amounts outstanding under Standby Letters of Credit and, without duplication, all Facility Letter of Credit Obligations, less, without duplication and to the extent included in Debt of the Borrower and its Subsidiaries, Equity-Preferred Securities not to exceed 10% of Consolidated Total Capitalization (calculated for purposes of this clause without reference to any Equity-Preferred Securities). "Debt" means (without duplication), for any Person indebtedness for money borrowed determined in accordance with GAAP but in any event including, (a) indebtedness of such Person for borrowed money or arising out of any extension of credit to or for the account of such Person (including, without limitation, extensions of credit in the form of reimbursement or payment obligations of such Person relating to letters of credit issued for the account of such Person) or for the deferred purchase price of property or services, except indebtedness which is owing to trade creditors in the ordinary course of business and which is due within thirty (30) days after the original invoice date; (b) indebtedness of the kind described in clause (a) of this definition which is secured by (or for which the holder of such Debt has any existing right, contingent or otherwise, to be secured by) any Lien upon or in Property (including, without limitation, accounts and contract rights) owned by such Person, whether or not such Person has assumed or become liable for the payment of such indebtedness or obligations; (c) Capitalized Lease Obligations of such Person; (d) obligations under direct or indirect Guaranties other than Guaranties issued by the Borrower covering obligations of the Southern Union Trusts under the Structured Securities. Whenever the definition of Debt is being used herein in order to compute a financial ratio or covenant applicable to the consolidated business of the Borrower and its Subsidiaries, Debt which is already included in such computation by virtue of the fact that it is owed by a Subsidiary of the Borrower will not also be added by virtue of the fact that the Borrower has executed a guaranty with respect to such Debt that would otherwise require such guaranteed indebtedness to be considered Debt hereunder. Nothing contained in the foregoing sentence is intended to limit the other provisions of this Agreement which contain limitations on the amount and types of Debt which may be incurred by the Borrower or its Subsidiaries. "Debtor Laws" shall mean all applicable liquidation, conservatorship, bankruptcy, moratorium, arrangement, receivership, insolvency, reorganization, or similar laws, or general equitable principles from time to time in effect affecting the rights of creditors generally. "Default" shall mean any of the events specified in Section 11, whether or not there has been satisfied any requirement in connection with such event for the giving of notice, or the lapse of time, or the happening of any further condition, event or act. "Dollars" and "$" shall mean lawful currency of the United States of America. "Domestic Lending Office" shall mean, with respect to each Bank, the office of such Bank located at its "Address for Notices" set forth below the name of such Bank on the signature pages hereof or such other office of such Bank as such Bank may from time to time specify to the Borrower and the Agent. "EBDIT" shall mean for any period the sum of (a) consolidated net earnings for the Borrower and its Subsidiaries (excluding for all purposes hereof all extraordinary items), plus (b) each of the following to the extent actually deducted in deriving such net earnings: (i) depreciation and amortization expense; (ii) interest expense; (iii) federal and state income taxes; and (iv) dividends charged against income on or with respect to Structured Securities, in each case before adjustment for extraordinary items, as shown in the financial statements of Borrower and its Subsidiaries referred to in Section 7.2 hereof (excluding for all purposes hereof all extraordinary items), and determined in accordance with GAAP, and (c) plus (or minus, if applicable) the net amount of non-cash deductions from (or additions to, if applicable) such net earnings for such period attributable to fluctuations in the market price(s) of securities which the Borrower is obligated to purchase in future periods under any of the Rabbi Trusts, but only to the extent that such deductions (or additions, if applicable) are required to be taken in accordance with GAAP. "Eligible Assignee" shall mean: (i) any Bank, or any Affiliate of any Bank, any Approved Fund, or any institution 100% of the voting stock of which is directly, or indirectly owned by such Bank or by the immediate or remote parent of such Bank; or (ii) a commercial bank, a foreign branch of a United States commercial bank, a domestic branch of a foreign commercial bank or other financial institution having in each case assets in excess of $1,000,000,000.00. "Environmental Law" shall mean (a) the Comprehensive Environmental Response, Compensation and Liability Act of 1980 (as amended by the Superfund Amendments and Reauthorization Act of 1986, 42 U.S.C.A. ss. 9601 et seq.), as amended from time to time, and any and all rules and regulations issued or promulgated thereunder ("CERCLA"); (b) the Resource Conservation and Recovery Act (as amended by the Hazardous and Solid Waste Amendment of 1984, 42 U.S.C.A. ss. 6901 et seq.), as amended from time to time, and any and all rules and regulations promulgated thereunder ("RCRA"); (c) the Clean Air Act, 42 U.S.C.A. ss. 7401 et seq., as amended from time to time, and any and all rules and regulations promulgated thereunder; (d) the Clean Water Act of 1977, 33 U.S.CA ss. 1251 et seq., as amended from time to time, and any and all rules and regulations promulgated thereunder; (e) the Toxic Substances Control Act, 15 U.S.C.A. ss. 2601 et seq., as amended from time to time, and any and all rules and regulations promulgated thereunder; or (f) any other federal or state law, statute, rule, or emulation enacted in connection with or relating to the protection or regulation of the environment (including, without limitation, those laws, statutes, rules, and regulations regulating the disposal, removal, production, storing, refining, handling, transferring, processing, or transporting of Hazardous Materials) and any rules and regulations issued or promulgated in connection with any of the foregoing by any governmental authority, and "Environmental Laws" shall mean each of the foregoing. "EPA" shall mean the Environmental Protection Agency, or any successor organization. "Equity-Preferred Securities" means (i) Debt, preferred equity or any other securities that are mandatorily convertible by the issuer thereof at a date certain, without cash payment by the issuer, into common shares of stock of the Borrower or (ii) any other securities (A) that are issued by the Borrower or any Subsidiary, (B) that are not subject to mandatory redemption at any time, directly or indirectly, (C) that are perpetual or mature not less than 30 years from the date of issuance, (D) the Debt component, if any, issued in connection therewith, including any guaranty, is subordinate in right of payment to all other unsecured and unsubordinated Debt of the issuer of such Debt component (including any such guaranty, if applicable), and (E) the terms of which permit the issuer thereof to defer at any time, without any additional payment or premium, the payment of any and all interest and/or distributions thereon, as applicable, to a date occurring after the Maturity Date. "ERISA" shall mean the Employee Retirement Income Security Act of 1974, as amended from time to time, and all rules, regulations, rulings and interpretations thereof issued by the Internal Revenue Service or the Department of Labor thereunder. "Eurocurrency Liabilities" shall have the meaning assigned to that term in Regulation D of the Board of Governors of the Federal Reserve System, as in effect from time to time. "Eurodollar Lending Office" shall mean, with respect to each Bank, the office of such Bank located at its "Address for Notices" set forth below the name of such Bank on the signature pages hereof, or such other office of such Bank as such Bank may from time to time specify to the Borrower and the Agent. "Eurodollar Rate" shall mean with respect to the applicable Rate Period in effect for each Eurodollar Rate Loan, the sum of (a) the quotient obtained by dividing (i) the rate appearing on Page 3750 of the Dow Jones Market Service (or on any successor or substitute page of such Service, or any successor to or substitute for such Service, providing rate quotations comparable to those currently provided on such page of such Service, as determined by the Agent from time to time for purposes of providing quotations of interest rates applicable to dollar deposits in the London interbank market) at approximately 11:00 a.m., London time, two Business Days prior to the commencement of such Rate Period, as the rate for dollar deposits with a maturity comparable to such Rate Period (or in the event that such rate quote is not available at such time for any reason, then utilizing the rate at which dollar deposits of $5,000,000 and for a maturity comparable to such Rate Period are offered by the principal London office of the Agent in immediately available funds in the London interbank market at approximately 11:00 a.m., London time, two Business Days prior to the commencement of such Rate Period) by (ii) a percentage equal to 100% minus the Eurodollar Rate Reserve Percentage for such Rate Period, plus (b) an additional percentage per annum changing with the rating of the Borrower's unsecured, non-credit enhanced Senior Funded Debt and determined in accordance with the following grid: ================================================================================ Additional Rating of the Borrower's unsecured, non-credit enhanced Percentage Per Senior Funded Debt Annum - -------------------------------------------------------------------------------- Equal to or greater than A3 by Moody's Investor Service, Inc. and equal to or greater than A- by Standard and Poor's Ratings Group 0.500% - -------------------------------------------------------------------------------- Baa1 by Moody's Investor Service, Inc. or BBB+ by Standard and Poor's Ratings Group 0.625% - ------------------------------------------------------------------------------- Baa2 by Moody's Investor Service, Inc. or BBB by Standard and Poor's Ratings Group 0.750% - -------------------------------------------------------------------------------- Baa3 by Moody's Investor Service, Inc. or BBB- by Standard and Poor's Ratings Group 1.000% - -------------------------------------------------------------------------------- - - Equal to or less than Ba1 by Moody's Investor Service, Inc. and equal to or less than BB+ by Standard and Poor's Ratings Group 1.750% ================================================================================ Notwithstanding the foregoing provisions, in the event that ratings of the Borrower's unsecured, non-credit enhanced Senior Funded Debt under Standard & Poor's Ratings Group and under Moody's Investor Service, Inc. fall within different rating categories which are not functional equivalents, the Eurodollar Rate shall be based on the higher of such ratings if there is only one category differential between the functional equivalents of such ratings, and if there is a two category differential between the functional equivalents of such ratings, the component of pricing from the grid set forth above shall be based on the rating category which is then in the middle of or between the two category ratings which are then in effect, and if there is greater than a two category differential between the functional equivalents of such ratings, the component of pricing from the grid set forth above shall be based on the rating category which is then one rating category above the lowest of the two category ratings which are then in effect. Additionally, in the event that Borrower withdraws from having its unsecured, non-credit enhanced Senior Funded Debt being rated by Moody's Investor Service, Inc. or Standard and Poor's Ratings Group, so that one or both of such ratings services fails to rate the Borrower's unsecured, non-credit enhanced Senior Funded Debt, the component of pricing from the grid set forth above for purposes of determining the applicable Eurodollar Rate for all Rate Periods commencing thereafter shall be 1.750% until such time as Borrower subsequently causes its unsecured, non-credit enhanced Senior Funded Debt to be rated by both of said ratings services. "Eurodollar Rate Loan" shall mean any Loan that bears interest at the Eurodollar Rate. "Eurodollar Rate Reserve Percentage" of the Agent for any Rate Period for any Eurodollar Rate Loan shall mean the reserve percentage applicable during such Rate Period (or if more than one such percentages shall be so applicable, the daily average of such percentages for those days in such Rate Period during which any such percentage shall be so applicable) under regulations issued from time to time by the Board of Governors of the Federal Reserve System (or any successor) for determining the maximum reserve requirement (including, without limitation, any emergency, supplemental, or other marginal reserve requirement) for member banks of the Federal Reserve System with deposits exceeding $1,000,000,000 with respect to liabilities or assets consisting of or including Eurocurrency Liabilities having a term equal to such Rate Period. "Event of Default" shall mean any of the events specified in Section 11, provided that there has been satisfied any requirement in connection with such event for the giving of notice, or the lapse of time, or the happening of any further condition, event or act. "Expiration Date" shall mean the last day of a Rate Period. "Facility Letter(s) of Credit" shall mean, in the singular form, any Standby Letter of Credit issued by an Issuing Bank for the account of the Borrower pursuant to Section 3 and, in the plural form, all such Standby Letters of Credit issued for the account of the Borrower. "Facility Letter of Credit Fee Percentage" shall mean a fee expressed as a percent per annum for all periods equal to a percentage per annum changing with the rating of the Borrower's unsecured, non-credit enhanced Senior Funded Debt and determined in accordance with the following grid: ================================================================================ Rating of the Borrower's unsecured, non-credit enhanced Senior Additional Funded Debt Percentage Per Annum - -------------------------------------------------------------------------------- Equal to or greater than A3 by Moody's Investor Service, Inc. and equal to or greater than A- by Standard and Poor's Ratings Group 0.500% - -------------------------------------------------------------------------------- Baa1 by Moody's Investor Service, Inc. or BBB+ by Standard and Poor's Rating 0.625% - -------------------------------------------------------------------------------- - - Baa2 by Moody's Investor Service, Inc. or BBB by Standard and Poor's Rating Group 0.750% - -------------------------------------------------------------------------------- Baa3 by Moody's Investor Service, Inc. or BBB- by Standard and Poor's Rating Group 1.000% - -------------------------------------------------------------------------------- Equal to or less than Ba1 by Moody's Investor Service, Inc. and equal to or less than BB+ by Standard and Poor's Rating Group 1.750% ================================================================================ Notwithstanding the foregoing provisions, in the event that ratings of the Borrower's unsecured, non-credit enhanced Senior Funded Debt under Standard & Poor's Ratings Group and under Moody's Investor Service, Inc. fall within different rating categories which are not functional equivalents, the Facility Letter of Credit Fee Percentage shall be based on the higher of such ratings if there is only one category differential between the functional equivalents of such ratings, and if there is a two category differential between the functional equivalents of such ratings, the component of pricing from the grid set forth above shall be based on the rating category which is then in the middle of or between the two category ratings which are then in effect, and if there is greater than a two category differential between the functional equivalents of such ratings, the component of pricing from the grid set forth above shall be based on the rating category which is then one rating category above the lowest of the two category ratings which are then in effect. Additionally, in the event that Borrower withdraws from having its unsecured, non-credit enhanced Senior Funded Debt being rated by Moody's Investor Service, Inc. or Standard and Poor's Ratings Group, so that one or both of such ratings services fails to rate the Borrower's unsecured, non-credit enhanced Senior Funded Debt, the component of pricing from the grid set forth above for purposes of determining the applicable Facility Letter of Credit Fee Percentage for all periods thereafter shall be 1.750% until such time as the Borrower subsequently causes its unsecured, non-credit enhanced Senior Funded Debt to be rated by both of said ratings services. "Facility Letter of Credit Obligations" shall mean, at any particular time, the sum of (a) the Reimbursement Obligations, plus (b) the aggregate undrawn face amount of all outstanding Facility Letters of Credit, in each case as determined by the Agent. "Federal Funds Rate" shall mean, for any period, a fluctuating interest rate per annum equal for each day during such period to the weighted average of the rates (rounded to the nearest 1/100 of 1%) on overnight federal fund transactions with members of the Federal Reserve System arranged by federal funds brokers, as published for such day (or, if such day is not a Business Day, for the next preceding Business Day) by the Federal Reserve Bank of New York, or, if such rate is not so published for any day which is a Business Day, the average of the quotations for such day on such transactions received by the Agent from Fulton Prebon and Garvin Guy Butler or two other federal funds brokers of recognized standing selected by the Agent. "Funded Debt" means all Debt of a Person which matures more than one year from the date of creation or matures within one year from such date but is renewable or extendible, at the option of such Person, by its terms or by the terms of any instrument or agreement relating thereto, to a date more than one year from such date or arises under a revolving credit or similar agreement which obligates Banks to extend credit during a period of more than one year from such date, including, without limitation, all amounts of any Funded Debt required to be paid or prepaid within one year from the date of determination of the existence of any such Funded Debt. "GAAP" shall mean generally accepted accounting principles, applicable to the circumstances as of the date of determination, applied consistently with such principles as applied in the preparation of the Borrowers audited financial statements referred to in Section 7.2. "General Intangibles" shall mean all of the Borrower's contract rights now existing or hereafter acquired, arising or created under contracts or arrangements for the purchase, sale, storage or transportation of gas or other Inventory. "Governmental Authority" shall mean any (domestic or foreign) federal, state, county, municipal, parish, provincial, or other government, or any department, commission, board, court, agency (including, without limitation, the EPA), or any other instrumentality of any of them or any other political subdivision thereof, and any entity exercising executive, legislative, judicial, regulatory, or administrative functions of, or pertaining to, government, including, without limitation, any arbitration panel, any court, or any commission. "Governmental Requirement" means any Order, Permit, law, statute (including, without limitation, any Environmental Protection Statute), code, ordinance, rule, regulation, certificate, or other direction or requirement of any Governmental Authority. "Guaranty" means, with respect to any Person, any obligation, contingent or otherwise, of such Person directly or indirectly guaranteeing any Debt of another Person, including, without limitation, by means of an agreement to purchase or pay (or advance or supply funds for the purchase or payment of) such Debt or to maintain financial covenants, or to assure the payment of such Debt by an agreement to make payments in respect of goods or services regardless of whether delivered or to purchase or acquire the Debt of another, or otherwise, provided that the term "Guaranty" shall not include endorsements for deposit or collection in the ordinary course of business. "Hazardous Materials" shall mean any substance which, pursuant to any Environmental Laws, requires special handling in its collection, use, storage, treatment or disposal, including but not limited to any of the following: (a) any "hazardous waste" as defined by RCRA; (b) any "hazardous substance" as defined by CERCLA; (c) asbestos; (d) polychlorinated biphenyls; (e) any flammables, explosives or radioactive materials; and (f) any substance, the presence of which on any of the Borrower's or any Subsidiary's properties is prohibited by any Governmental Authority. "Highest Lawful Rate" shall mean, with respect to each Bank, the maximum nonusurious interest rate, if any, that at any time or from time to time may be contracted for, taken, reserved, charged, or received with respect to the Notes or on other amounts, if any, due to such Bank pursuant to this Agreement, under laws applicable to such Bank which are presently in effect, or, to the extent allowed by law, under such applicable laws which may hereafter be in effect and which allow a higher maximum nonusurious interest rate than applicable laws now allow. "Indemnified Parties" shall have the meaning set forth in Section 13.16. "Interest Payment Date" shall mean (a) as to any Eurodollar Rate Loan in which the Rate Period with respect thereto is not greater than three (3) months, the date on which such Rate Period ends; (b) as to any Eurodollar Rate Loan in which the Rate Period with respect thereto is greater than three (3) months, the date on which the third month of such Rate Period ends, and the date on which each such Rate Period ends; (c) as to any Alternate Base Rate Loan in which the Rate Period with respect thereto is not greater than ninety (90) days, the date on which such Rate Period ends; (d) as to any Alternate Base Rate Loan in which the Rate Period with respect thereto is greater than ninety (90) days, the ninetieth (90th) day of such Rate Period, and the date on which each such Rate Period ends; and (e) as to all Loans, such time as the principal of and interest on the Notes shall have been paid in full. "Inventory" means, with respect to Borrower or any Subsidiary, all of such Person's now owned or hereafter acquired or created inventory in all of its forms and of every nature, wherever located, whether acquired by purchase, merger, or otherwise, and all raw materials, work in process therefor and finished goods thereof, and all supplies, materials, and products of every nature and description used, usable, or consumed in connection with the manufacture, packing, shipping, advertising, selling, leasing, furnishing, or production of such goods, and shall include, in any event, all "inventory" (within the meaning of such term in the Uniform Commercial Code in effect in any applicable jurisdiction), whether in mass or joint, or other interest or right of any kind in goods which are returned to, repossessed by, or stopped in transit by such Person, and all accessions to any of the foregoing and all products of any of the foregoing. "Investment" of any Person means any investment so classified under GAAP, and, whether or not so classified, includes (a) any direct or indirect loan advance made by it to any other Person; (b) any direct or indirect Guaranty for the benefit of such Person; provided, however, that for purposes of determining Investments of Borrower hereunder, the existing Guaranty by Borrower of certain tax increment financing extended by The Fidelity Deposit and Discount Bank to The Redevelopment Authority of the County of Lackawanna shall be deemed to not be an Investment; (c) any capital contribution to any other Person; and (d) any ownership or similar interest in any other Person; and the amount of any Investment shall be the original principal or capital amount thereof (plus any subsequent principal or capital amount) minus all cash returns of principal or capital thereof. "Issuing Bank" shall mean (a) any Bank and/or any Affiliate of any Bank listed on the signature pages of this Agreement attached hereto and made a part hereof, or (b) any Bank or any Affiliate of any Bank not listed on the signature pages of this Agreement, but only in the event that such Bank or such Affiliate agrees, in its sole discretion at the request of the Borrower, and on the terms and conditions mutually acceptable to such Bank or such Affiliate, as the case may be, to become an Issuing Bank for the purpose of issuing one or more Facility Letters of Credit pursuant to Section 3. When a Bank is referred to as an Issuing Bank under this Agreement, such reference to such Bank shall be interpreted to refer to such Bank solely in its capacity as an Issuing Bank. "L/C Subfacility" shall mean that portion of the Commitments equal to $40,000,000.00. "Letter(s) of Credit" shall mean, in the singular form, any letter of credit issued by any Person for the account of the Borrower and, in the plural form, all such letters of credit issued by any Person for the account of the Borrower. "Letter of Credit Commitment" shall mean, with respect to each Issuing Bank, such Issuing Bank's commitment to issue Facility Letters of Credit. "Letter of Credit Reimbursement Agreement" shall mean, with respect to a Facility Letter of Credit, such form of application therefor and form of reimbursement agreement therefor (whether in a single or several documents, taken together) as the Issuing Bank from which the Facility Letter of Credit is requested may employ in the ordinary course of business for its own account, whether or not providing for collateral security, with such modifications thereto as may be agreed upon by such Issuing Bank and the account party and as are not materially adverse to the interests of any Bank; provided, however, in the event of any conflict between the terms of any Letter of Credit Reimbursement Agreement and this Agreement, the terms of this Agreement shall control; and provided, further, that any grant or purported grant of a security interest in favor of the Issuing Bank contained in any Letter of Credit Reimbursement Agreement shall be void. "Lien" shall mean any mortgage, deed of trust, pledge, security interest, encumbrance, lien (including without limitation, any such interest arising under any Environmental Law), or similar charge of any kind (including without limitation, any agreement to give any of the foregoing, any conditional sale or other title retention agreement or any lease in the nature thereof), or the interest of the lessor under any Capital Lease. "Loan" or "Loans" shall mean a loan or loans, respectively, from the Banks to the Borrower made under Section 2.1. "Loan Document" shall mean this Agreement, any Note, or any other document, agreement or instrument now or hereafter executed and delivered by the Borrower or any other Person in connection with any of the transactions contemplated by any of the foregoing, as any of the foregoing may hereafter be amended, modified, or supplemented, and "Loan Documents" shall mean, collectively, each of the foregoing. "Majority Bank" shall mean at any time Banks holding more than 50% of the unpaid principal amounts outstanding under the Notes, or, if no such amounts are outstanding, more than 50% of the Pro Rata Percentages. "Material Adverse Effect" shall mean any material adverse effect on (a) the financial condition, business, properties, assets, prospects or operations of the Borrower and its Subsidiaries taken as a whole, or (b) the ability of the Borrower to perform its obligations under this Agreement, any Note or any other Loan Document on a timely basis. "Maturity Date" shall mean May 28, 2009. "Non-Facility Letter of Credit" shall mean any Letter of Credit which is not a Facility Letter of Credit. "Note" or "Notes" shall mean a promissory note or notes, respectively, of the Borrower, executed and delivered under this Agreement. "Notice of Borrowing" shall have the meaning set forth in Section 2.1(c). "Obligations" shall mean (a) all obligations of the Borrower to the Bank under this Agreement, the Notes and all other Loan Documents to which it is a party; (b) all Reimbursement Obligations; and (c) any other obligations of the Borrower with respect to a Facility Letter of Credit. "Officer's Certificate" shall mean a certificate signed in the name of the Borrower or a Subsidiary, as the case may be, by either its President, one of its Vice Presidents, its Treasurer, its Secretary, or one of its Assistant Treasurers or Assistant Secretaries. "Panhandle Eastern" shall mean Panhandle Eastern Pipe Line Company, a Delaware corporation. "Panhandle Eastern Refinancing Debt" shall mean any Debt of Panhandle Eastern and/or any of its Subsidiaries issued in exchange for, or the net proceeds of which are used to extend, refinance, renew, replace, defease or refund, any Debt of Panhandle Eastern and/or any of its Subsidiaries existing as of the Closing Date, provided, that: (a) the principal amount of such Panhandle Eastern Refinancing Debt does not exceed the then outstanding principal amount of the Debt so extended, refinanced, renewed, replaced, defeased or refunded; (b) the interest rate or rates to accrue under such Panhandle Eastern Refinancing Indebtedness do not exceed the lesser of (i) the interest rate or rates then accruing on the Debt so extended, refinanced, renewed, replaced, defeased or refunded or (ii) the prevailing market interest rate or rates which are then applicable to, and generally available for, Debt which is similar in type, amount, maturity and other terms to the Indebtedness so extended, refinanced, renewed, replaced, defeased or refunded; (c) the maturities, amortization schedules, covenants, defaults, remedies, collateral security provisions (or absence thereof) and other terms of such Panhandle Eastern Refinancing Indebtedness, including without limitation, any restrictions on the payment by Panhandle Eastern and/or its applicable Subsidiaries of any dividends or other shareholder distributions, are in each case the same or more favorable to Panhandle Eastern and/or its applicable Subsidiaries as those in the Debt so extended, refinanced, renewed, replaced, defeased or refunded; and (d) no Default or Event of Default has occurred and is continuing or would result from the issuance or origination of such Panhandle Eastern Refinancing Indebtedness. "Person" shall mean an individual, partnership, joint venture, corporation, joint stock company, bank, trust, unincorporated organization and/or a government or any department or agency thereof. "Plan" shall mean any plan subject to Title IV of ERISA and maintained for employees of the Borrower or of any member of a "controlled group of corporations," as such term is defined in the Code, of which the Borrower or any Subsidiary is a member, or any such plan to which the Borrower or any Subsidiary is required to contribute on behalf of its employees. "Prime Rate" shall mean, on any day, the rate determined by the Agent as being its prime rate for that day. Without notice to the Borrower or any other Person, the Prime Rate shall change automatically from time to time as and in the amount by which said Prime Rate shall fluctuate, with each such change to be effective as of the date of each change in such Prime Rate. The Prime Rate is a reference rate and does not necessarily represent the lowest or best rate actually charged to any customer. The Agent may make commercial or other loans at rates of interest at, above or below the Prime Rate. "Prior Acquisitions" shall mean collectively the Borrower's previous acquisitions of and mergers with Fall River Gas Company, Providence Energy Corporation and Valley Resources, Inc. "Pro-Rata Percentage" shall mean with respect to any Bank, a fraction (expressed as a percentage), the numerator of which shall be the amount of such Bank's Commitment and the denominator of which shall be the aggregate amount of all the Commitments of the Banks, as adjusted from time to time in accordance with Section 4.6. "Property" shall mean any interest or right in any kind of property or asset, whether real, personal, or mixed, owned or leased, tangible or intangible, and whether now held or hereafter acquired. "Qualifying Assets" shall mean (i) equity interests owned one hundred percent (100%) by the Borrower in entities engaged primarily in one or more of the Borrower's lines of business described in Section 7.15 (singly, a "Qualified Entity," collectively, "Qualified Entities"), or productive assets used in one or more of such lines of business; and (ii) equity interests of less than one hundred percent (100%) owned by the Borrower in one or more Qualifying Entities, provided that at any time the aggregate amount of the Borrower's investment in Qualifying Assets described in clause (ii) that are then held by the Borrower as of the applicable determination date (measured by the aggregate purchase price paid therefor, including the aggregate amount of Debt assumed or deemed incurred by Borrower in connection with such acquisitions) does not exceed twenty percent (20%) of the Consolidated Net Worth of the Borrower and its Subsidiaries as of the applicable determination date. "Rabbi Trusts" shall mean those four (4) certain non-qualified deferred compensation irrevocable trusts existing as of the Closing Date, previously established by the Borrower for the benefit of its executive employees, so long as the assets in each of such trusts which have not yet been distributed to one or more executive employees of the Borrower remain subject to the claims of the Borrower's general creditors. "Rate Period" shall mean the period of time for which the Alternate Base Rate or the Eurodollar Rate shall be in effect as to any Alternate Base Rate Loan or Eurodollar Rate Loan, as the case may be, commencing with the Borrowing Date or the Expiration Date of the immediately preceding Rate Period, as the case may be, applicable to and ending on the effective date of any reborrowing made as provided in Section 2.2(a) as the Borrower may specify in the related Notice of Borrowing, subject, however, to the early termination provisions of the second sentence of Section 2.3(c) relating to any Eurodollar Rate Loan; provided, however, that any Rate Period that would otherwise end on a day which is not a Business Day shall be extended to the next succeeding Business Day unless such Business Day falls in another calendar month, in which case such Rate Period shall end on the next preceding Business Day. For any Alternate Base Rate Loan, the Rate Period shall be 90 days; and for any Eurodollar Rate Loan the Rate Period may be 15 days, 1, 2, 3, or 6 months, in each case as specified in the applicable Notice of Borrowing, subject to the provisions of Sections 2.2 and 2.3. "Reimbursement Obligations" shall mean the reimbursement or repayment obligations of the Borrower to Issuing Banks pursuant to this Agreement or the applicable Letter of Credit Reimbursement Agreement with respect to Facility Letters of Credit issued for the account of the Borrower. "Release" shall mean a "release", as such term is defined in CERCLA. "Restricted Payment" shall mean the Borrower's declaration or payment of any dividend on, or purchase or agreement to purchase any of, or making of any other distribution with respect to, any of its capital stock, except any such dividend, purchase or distribution consisting solely of capital stock of the Borrower, and except any dividend or interest paid on or with respect to the Borrower's Structured Securities to the extent that such amounts are included in Cash Interest Expense. "Securities Act" shall have the meaning set forth in Section 13.1. "Senior Funded Debt" shall mean Funded Debt of the Borrower excluding Debt that is contractually subordinated in right of payment to any other Debt. "Senior Notes" means (a) the $475,000,000 of 7.6% Senior Notes of the Borrower previously placed with investors on or about January 31, 1994, and (b) the $300,000,000 of 8.25% Senior Notes of the Borrower previously placed with investors on or about November 3, 1999, as such Senior Notes may be amended, modified, or supplemented from time to time in accordance with the terms of this Agreement; and "Senior Note" means each such note individually. "Significant Property" shall mean at any time property or assets of the Borrower or any Subsidiary having a book value (net of accumulated depreciation taken in accordance with GAAP) of at least $5,000,000.00 or that contributed (or is an integrated physical portion of an assemblage of assets that contributed) at least 5% of the gross income of the owner thereof for the fiscal quarter most recently ended. "Southern Union Panhandle" shall mean Southern Union Panhandle Corp., a Delaware corporation formed by the Borrower for the purpose of ultimately owning and holding 100% of all issued and outstanding equity interests in Panhandle Eastern. "Southern Union Trust" means any of those certain Delaware business trusts organized for the sole purpose of purchasing Subordinated Debt Securities constituting a portion of, and described in the definition of, Structured Securities and issuing the Preferred Securities and Common Securities also constituting a portion of, and described in the definition of, Structured Securities, and having no assets other than the Borrower's Subordinated Debt Securities, the Guaranties (as described in the definition of Structured Securities) and the proceeds thereof. Southern Union Trusts shall be considered to be Subsidiaries for purposes hereof so long as their affairs are consolidated under GAAP and for federal income tax purposes with the affairs of the Borrower. "Standby Letter of Credit" shall mean any standby letter of credit issued to support obligations (contingent or otherwise) of the Borrower. "Structured Securities" shall mean collectively (a) the Subordinated Debt Securities, the Guaranties, the Common Securities and the Preferred Securities of the Southern Union Trusts, all as described and defined in the Registration Statement on Form S-3 filed by the Borrower with the Securities and Exchange Commission on March 25, 1995, and (b) subordinated debt securities, guaranties, common securities and/or preferred securities issued in connection with the consummation of the Prior Acquisitions in an aggregate face amount of not more than $150,000,000 upon terms and conditions substantially similar in all material respects to the terms and conditions described and defined in such Registration Statement on Form S-3 filed by the Borrower with the Securities and Exchange Commission on March 25, 1995. For all purposes of this Agreement, the amounts payable by Southern Union Trusts under the Preferred Securities and Common Securities (or similar securities provided for under subclause (b) above) and the amounts payable by the Borrower under the Subordinated Debt Securities or the Guaranties (or similar securities provided for under subclause (b) above) shall be treated without duplication, it being recognized that the amounts payable by Southern Union Trusts are funded with payments made or to be made by the Borrower to Southern Union Trusts and are also guaranteed by the Borrower under the Guaranties described in the S-3 mentioned above (or similar guaranties provided for under subclause (b) above). "Subsidiary" or "Subsidiaries" shall mean any corporation or corporations organized under the laws of any state of the United States of America, Canada, or any province of Canada, which conduct(s) the major portion of business in the United States of America or Canada and of which not less than 50% of the voting stock of every class (except for directors' qualifying shares), at the time as of which any determination is being made, is owned by the Borrower either directly or indirectly through other Subsidiaries. "Term Loan Facility" shall mean (a) that certain term loan facility to be provided to the Borrower in an aggregate amount of $311,086,956.00 under the terms of that certain Amended and Restated Term Loan Credit Agreement dated July 15, 2002 by and among the Borrower, JPMorgan Chase Bank, as administrative agent, and the banks or financial institutions now or hereafter a party thereto, and (b) any and all amendments, modifications, increases, supplements and/or restatements of said credit facility now or hereafter existing from time to time. "Trunkline LNG Holdings" shall mean CMS Trunkline LNG Holdings, LLC, a Delaware limited liability company. "Trunkline LNG Holdings Sale" shall mean the sale by Panhandle Eastern to a third-party that is not an Affiliate of the Borrower of all or substantially all of the assets of Trunkline LNG Holdings and its Subsidiaries or all or a portion of the issued and outstanding stock and other equity interests, if any, in Trunkline LNG Holdings, so long as such sale is finalized and consummated in substantial compliance with the following specified terms: (a) all cash proceeds received by Panhandle Eastern from such sale, less customary and reasonable transaction fees and the amount of all taxes payable by the Panhandle Eastern attributable to such sale, shall by fully distributed by Panhandle Eastern to Southern Union Panhandle, and in turn by Southern Union Panhandle to the Borrower; (b) all cash proceeds distributed to the Borrower from such sale shall be immediately applied against the Borrower's Debt under the Term Loan Facility, to the extent then outstanding; and (c) all requisite approvals and consents from any Governmental Authority with respect to such sale shall have been received by Panhandle Eastern in a form acceptable to the Agent. "Type" shall mean, with respect to any Loan, any Alternate Base Rate Loan or any Eurodollar Rate Loan. "Unused L/C Subfacility" shall mean, at any time, the amount, if any, by which the L/C Subfacility then in effect exceeds the aggregate outstanding amount of all Facility Letter of Credit Obligations. 2. THE LOANS 2.1 The Loans (a) Subject to the terms and conditions and relying upon the representations and warranties of the Borrower herein set forth, each Bank severally agrees to make Loans to the Borrower on any one or more Business Days prior to the Maturity Date, up to an aggregate principal amount of Loans not exceeding at any time outstanding: (i) the amount set opposite such Banks name on the signature pages hereof (such Bank's "Commitment"); minus (ii) such Bank's Pro Rata Percentage of the Facility Letter of Credit Obligations. Within such limits and during such period and subject to the terms and conditions of this Agreement, the Borrower may borrow, repay and reborrow hereunder. (b) The Borrower shall execute and deliver to the Agent for each Bank to evidence the Loans made by each Bank under such Bank's Commitment, a Note, which shall be: (i) dated the date of the Closing Date; (ii) in the principal amount of such Bank's maximum Commitment; (iii) in substantially the form attached hereto as Exhibit A, with blanks appropriately filled; (iv) payable to the order of such Bank on the Maturity Date; and (v) subject to acceleration upon the occurrence of an Event of Default. Each Note shall bear interest on the unpaid principal amount thereof from time to time outstanding at the rate per annum determined as specified in Sections 2.2(a), 2.2(b), 2.3(b) and 2.3(c), payable on each Interest Payment Date and at maturity, commencing with the first Interest Payment Date following the date of each Note. (c) Each Loan shall be: (i) in the case of any Eurodollar Rate Loan, in an amount of not less than $1,000,000.00 or an integral multiple of $1,000,000.00 in excess thereof; or (ii) in the case of any Alternate Base Rate Loan, in an amount of not less than $500,000.00 or an integral multiple of $100,000.00 in excess thereof and, at the option of the Borrower, any borrowing under this Section 2.1(c) may be comprised of two or more such Loans bearing different rates of interest. Each such borrowing shall be made upon prior notice from the Borrower to the Agent in the form attached hereto as Exhibit B (the "Notice of Borrowing") delivered to the Agent not later than 11:00 am (Houston time): (i) on the third Business Day prior to the Borrowing Date, if such borrowing consists of Eurodollar Rate Loans; and (ii) on the Borrowing Date, if such borrowing consists of Alternate Base Rate Loans. Each Notice of Borrowing shall be irrevocable and shall specify: (i) the amount of the proposed borrowing and of each Loan comprising a part thereof; (ii) the Borrowing Date; (iii) the rate of interest that each such Loan shall bear; (iv) the Rate Period with respect to each such Loan and the Expiration Date of each such Rate Period; and (v) the demand deposit account of the Borrower at JPMorgan into which the proceeds of the borrowing are to be deposited by the Agent. The Borrower may give the Agent telephonic notice by the required time of any proposed borrowing under this Section 2.1(c); provided that such telephonic notice shall be confirmed in writing by delivery to the Agent promptly (but in no event later than the Borrowing Date relating to any such borrowing) of a Notice of Borrowing. Neither the Agent nor any Bank shall incur any liability to the Borrower in acting upon any telephonic notice referred to above which the Agent believes in good faith to have been given by the Borrower, or for otherwise acting in good faith under this Section 2.1(c). (d) In the case of a proposed borrowing comprised of Eurodollar Rate Loans, the Agent shall promptly notify each Bank of the applicable interest rate under Section 2.2. Each Bank shall, before 11:00 am (Houston time) on the Borrowing Date, make available for the account of its Applicable Lending Office to the Agent at the Agent's address set forth in Section 13.4, in same day funds, its Pro Rata Percentage of such borrowing. After the Agent's receipt of such funds and upon fulfillment of the applicable conditions set forth in Section 8, on the Borrowing Date, the Agent shall make the borrowing available to the Borrower at its Applicable Lending Office in immediately available funds. Each Bank shall post on a schedule attached to its Note(s): (i) the date and principal amount of each Loan made under such Note; (ii) the rate of interest each such Loan will bear; and (iii) each payment of principal thereon; provided, however, that any failure of such Bank so to mark such Note shall not affect the Borrower's obligations thereunder; and provided further that such Bank's records as to such matters shall be controlling whether or not such Bank has so marked such Note. Any deposit to the Borrower's demand deposit account by the Agent or by JPMorgan Chase Bank (of funds received from the Agent) pursuant to a request (whether written or oral) believed by the Agent or by JPMorgan Chase Bank to be an authorized request by the Borrower for a Loan hereunder shall be deemed to be a Loan hereunder for all purposes with the same effect as if the Borrower had in fact requested the Agent to make such Loan. (e) Unless the Agent shall have received notice from a Bank prior to the date of any borrowing that such Bank will not make available to the Agent such Bank's Pro Rata Percentage of such borrowing, the Agent may assume that such Bank has made such portion available to the Agent on the date of such borrowing in accordance with this Section 2.1 and the Agent may, in reliance upon such assumption, make available to the Borrower on such date a corresponding amount. If and to the extent that such Bank shall not have so made such Pro Rata Percentage available to the Agent, such Bank and the Borrower severally agree to repay to the Agent forthwith on demand such corresponding amount together with interest thereon, for each day from the date such amount is made available to the Borrower until the date such amount is repaid to the Agent, (i) in the case of the Borrower, at the interest rate applicable at the time to the Loans comprising such borrowing, and (ii) in the case of such Bank, at the Federal Funds Rate. If such Bank shall repay to the Agent such corresponding amount, such amount so repaid shall constitute such Bank's Loan as part of such borrowing for purposes of this Agreement. (f) The failure of any Bank to make the Loan to be made by it as part of any borrowing shall not relieve any other Bank of its obligation, if any, hereunder to make its Loan on the date of such borrowing, but no Bank shall be responsible for the failure of any other Bank to make the Loan to be made by such other Bank on the date of any borrowing. 2.2 Interest Rate Determination (a) Except as specified in Sections 2.3(b) and 2.3(c), the Loans shall bear interest on the unpaid principal amount thereof from time to time outstanding, until maturity, at a rate per annum (calculated based on a year of 360 days in the case of the Eurodollar Rate or the Alternate Base Rate based on the Federal Funds Rate and a year of 365 or 366 days, as the case may be, in the case of the Alternate Base Rate based on the Prime Rate) equal to the lesser of (A) the rate specified in the Notice of Borrowing with respect thereto or (B) the Highest Lawful Rate from the first day to, but not including, the Expiration Date of the Rate Period then in effect with respect thereto. (b) Any principal, interest, fees or other amount owing hereunder, under any Note or under any other Loan Document that is not paid when due (whether at stated maturity, by acceleration or otherwise) shall bear interest at a rate per annum equal to the lesser of (i) two percent (2%) above the Alternate Base Rate in effect from time to time or (ii) the Highest Lawful Rate. 2.3 Additional Interest Rate Provisions (a) The Note may be held by each Bank for the account of its respective Domestic Lending Office or its respective Eurodollar Lending Office, and may be transferred from one to the other from time to time as each Bank may determine. (b) If the Borrower shall have chosen the Eurodollar Rate in a Notice of Borrowing and prior to the Borrowing Date, any Bank in good faith determines (which determination shall be conclusive) that (i) deposits in Dollars in the principal amount of such Eurodollar Rate Loan are not being offered to the Eurodollar Lending Office of such Bank in the Eurodollar interbank market selected by such Bank in its sole discretion in good faith or (ii) adequate and reasonable means do not exist for ascertaining the chosen Eurodollar Rate in respect of such Eurodollar Rate Loan or (iii) the Eurodollar Rate for any Rate Period for such Eurodollar Rate Loan will not adequately reflect the cost to such Bank of making such Eurodollar Rate Loan for such Rate Period, then such Bank will so notify the Borrower and the Agent and such Eurodollar Rate shall not become effective as to such Eurodollar Rate Loan on such Borrowing Date or at any time thereafter until such time thereafter as the Borrower receives notice from the Agent that the circumstances giving rise to such determination no longer apply. (c) Anything in this Agreement to the contrary notwithstanding, if at any time any Bank in good faith determines (which determination shall be conclusive) that the introduction of or any change in any applicable law, rule or regulation or any change in the interpretation or administration thereof by any governmental or other regulatory authority charged with the interpretation or administration thereof shall make it unlawful for the Bank (or the Eurodollar Lending Office of such Bank) to maintain or fund any Eurodollar Rate Loan, such Bank shall give notice thereof to the Borrower and the Agent. With respect to any Eurodollar Rate Loan which is outstanding when such Bank so notifies the Borrower, upon such date as shall be specified in such notice the Rate Period shall end and the lesser of (i) the Alternate Base Rate or (ii) the Highest Lawful Rate shall commence to apply in lieu of the Eurodollar Rate in respect of such Eurodollar Rate Loan and shall continue to apply unless and until the Borrower changes the rate as provided in Section 2.2(a). No more than five (5) Business Days after such specified date, the Borrower shall pay to such Bank (x) accrued and unpaid interest on such Eurodollar Rate Loan at the Eurodollar Rate in effect at the time of such notice to but not including such specified date plus (y) such amount or amounts (to the extent that such amount or amounts would not be usurious under applicable law) as may be necessary to compensate such Bank for any direct or indirect costs and losses incurred by it (to the extent that such amounts have not been included in the Additional Costs in calculating such Eurodollar Rate), but otherwise without penalty. If notice has been given by such Bank pursuant to the foregoing provisions of this Section 2.3(c), then, unless and until such Bank notifies the Borrower that the circumstances giving rise to such notice no longer apply, such Eurodollar Rate shall not again apply to such Loan or any other Loan and the obligation of such Bank to continue any Eurodollar Rate Loan as a Eurodollar Rate Loan shall be suspended. Any such claim by such Bank for compensation under clause (y) above shall be accompanied by a certificate setting forth the computation upon which such claim is based, and such certificate shall be conclusive and binding for all purposes, absent manifest error. (d) THE BORROWER WILL INDEMNIFY EACH BANK AGAINST, AND REIMBURSE EACH BANK ON DEMAND FOR, ANY LOSS (INCLUDING LOSS OF REASONABLY ANTICIPATED PROFITS DETERMINED USING REASONABLE ATTRIBUTION AND ALLOCATION METHODS), OR REASONABLE COST OR EXPENSE INCURRED OR SUSTAINED BY SUCH BANK (INCLUDING WITHOUT LIMITATION, ANY LOSS OR EXPENSE INCURRED BY REASON OF THE LIQUIDATION OR REEMPLOYMENT OF DEPOSITS OR OTHER FUNDS ACQUIRED BY SUCH BANK TO FUND OR MAINTAIN ANY EURODOLLAR RATE LOAN) AS A RESULT OF (i) ANY ADDITIONAL COSTS INCURRED BY SUCH BANK; (ii) ANY PAYMENT OR REPAYMENT (WHETHER AUTHORIZED OR REQUIRED HEREUNDER OR OTHERWISE) OF ALL OR A PORTION OF ANY LOAN ON A DAY OTHER THAN THE EXPIRATION DATE OF A RATE PERIOD FOR SUCH LOAN; (iii) ANY PAYMENT OR PREPAYMENT (WHETHER REQUIRED HEREUNDER OR OTHERWISE) OF ANY LOAN MADE AFTER THE DELIVERY OF A NOTICE OF BORROWING BUT BEFORE THE APPLICABLE BORROWING DATE IF SUCH PAYMENT OR PREPAYMENT PREVENTS THE PROPOSED BORROWING FROM BECOMING FULLY EFFECTIVE; OR (iv) AFTER RECEIPT BY THE AGENT OF A NOTICE OF BORROWING, THE FAILURE OF ANY LOAN TO BE MADE OR EFFECTED BY SUCH BANK DUE TO ANY CONDITION PRECEDENT TO A BORROWING NOT BEING SATISFIED BY THE BORROWER OR DUE TO ANY OTHER ACTION OR INACTION OF THE BORROWER. ANY BANK DEMANDING PAYMENT UNDER THIS SECTION 2.3(d) SHALL DELIVER TO THE BORROWER AND THE AGENT A STATEMENT REASONABLY SETTING FORTH THE AMOUNT AND MANNER OF DETERMINING SUCH LOSS, COST OR EXPENSE. THE FACTS SET FORTH IN SUCH STATEMENT SHALL BE CONCLUSIVE AND BINDING FOR ALL PURPOSES, ABSENT MANIFEST ERROR. (e) If, after the date of this Agreement, any Bank shall have determined that the adoption of any applicable law, rule, guideline, interpretation or regulation regarding capital adequacy, or any change therein, or any change in the interpretation or administration thereof by any governmental authority, central bank or comparable agency charged with the interpretation or administration thereof, or compliance by such Bank with any request or directive regarding capital adequacy (whether or not having the force of law) of any such authority, central bank or comparable agency, has or would have the effect of reducing the rate of return on such Bank's capital as a consequence of its obligations hereunder and under similar lending arrangements to a level below that which such Bank could have achieved but for such adoption, change or compliance (taking into consideration such Bank's policies with respect to capital adequacy) by an amount deemed by such Bank to be material then the Borrower shall pay to such Bank such additional amount or amounts as will compensate such Bank for such reduction. (f) A certificate of such Bank setting forth such amount or amounts as shall be necessary to compensate such Bank as specified in subparagraph (e) above shall be delivered as soon as practicable to the Borrower (with a copy thereof to the agent) and to the extent determined in accordance with subparagraph (e) above shall be conclusive and binding, absent manifest error. The Borrower shall pay such Bank the amount shown as due on any such certificate within fifteen (15) days after such Bank delivers such certificate. In preparing such certificate, such Bank may employ such assumptions and allocations (consistently applied with respect to advances made by such Bank or commitments by such Bank to make advances) of costs and expenses as it shall in good faith deem reasonable and may use any reasonable averaging and attribution method (consistently applied with respect to advances made by such Bank or commitments by such Bank to make advances). 2.4 Increase of Commitments (a) At any time after the Closing Date, provided that no Default or Event of Default shall have occurred and be continuing, the Borrower may request from time to time one or more increases of the Commitments by notice to the Agent in writing of the amount of each such proposed increase (each such notice, a "Commitment Increase Notice"). Any such Commitment Increase Notice must offer each Bank the opportunity to subscribe for its pro rata share of the requested increase in the Commitments, and the Agent shall promptly provide to each Bank a copy of any Commitment Increase Notice received by the Agent. Within 10 Business Days after receipt by the Agent of the applicable Commitment Increase Notice, each Bank wishing to subscribe for its pro rata share of the requested increase in the Commitments must deliver written notice of such fact to the Agent. If any portion of the requested increase in the Commitments is not subscribed for by the Banks within such 10-day period, the Borrower may, in its sole discretion, but with the consent of the Agent as to any Person that is not at such time a Bank (which consent shall not be unreasonably withheld or delayed so long as such Person is an Eligible Assignee), offer to any existing Bank or to one or more additional banks or financial institutions the opportunity to participate in all or a portion of such unsubscribed portion of the requested increase in the Commitments pursuant to Section 2.4 (b) or (c) below, as applicable; (b) Any additional bank or financial institution that the Borrower selects to offer a participation in the unsubscribed portion of the increased Commitments, and that elects to become a party to this Agreement and obtain a Commitment, shall execute an agreement (a "New Bank Agreement"), in the form required by the Agent, with the Borrower and the Agent, whereupon such bank or financial institution (a "New Bank") shall become a Bank for all purposes hereunder to the same extent as if originally a party hereto and shall be bound by and entitled to the benefits of this Agreement, and the signature pages hereof shall be deemed to add the name and Commitment of such New Bank, provided that the Commitment of any such New Bank shall be in an amount not less than $5,000,000; (c) Any Bank that accepts an offer by the Borrower to increase its Commitment pursuant to this Section 2.4 shall, in each case, execute a commitment increase agreement (a "Commitment Increase Agreement"), in the form required by the Agent, with the Borrower and the Agent, whereupon such Bank shall be bound by and entitled to the benefits of this Agreement with respect to the full amount of its Commitment as so increased, and the signature pages hereof shall be deemed to be amended to reflect such increase in the Commitment of such Bank; (d) The effectiveness of any New Bank Agreement or Commitment Increase Agreement shall be contingent upon receipt by the Agent of such corporate resolutions of the Borrower and legal opinions of in-house counsel to the Borrower, if any, as the Agent shall reasonably request with respect thereto; (e) If any bank or financial institution becomes a New Bank pursuant to Section 2.4(b) or if any Bank's Commitment is increased pursuant to Section 2.4(c), additional Loans and additional liability for Facility Letters of Credit made or issued on or after the effectiveness thereof (the "Re-Allocation Date") shall be made pro rata based on each Bank's (including each New Bank's) respective Commitment in effect on and after such Re-Allocation Date (except to the extent that any such pro rata borrowings or incurring of liability would result in any Bank making an aggregate principal amount of Loans and incurring liability for the Facility Letters of Credit in excess of its Commitment, in which case such excess amount will be allocated to, and made or incurred by, such New Bank and/or Banks with such increased Commitments to the extent of, and pro rata based on, their respective Commitments), and continuations of Eurodollar Rate Loans outstanding on such Re-Allocation Date shall be effected by repayment of such Eurodollar Rate Loans on the last day of the Rate Period applicable thereto and the extension of new Eurodollar Rate Loans pro rata based on the Banks' respective Commitments in effect on and after such Re-Allocation Date. In the event that on any such Re-Allocation Date there are Alternate Base Rate Loans outstanding, the Borrower shall make prepayments thereof and borrow new Alternate Base Rate Loans so that, after giving effect thereto, the Alternate Base Rate Loans outstanding are held pro rata based on the Banks' respective Commitments in effect on and after such Re-Allocation Date. In the event that on any such Re-Allocation Date there are Eurodollar Rate Loans outstanding, such Eurodollar Rate Loans shall remain outstanding with the respective holders thereof until the expiration of their respective Rate Periods (unless the Borrower elects to prepay any thereof in accordance with the applicable provisions of this Agreement), and interest on and repayments of such Eurodollar Rate Loans will be paid thereon to the respective Banks holding such Eurodollar Rate Loans pro rata based on the respective principal amounts thereof outstanding; (f) Notwithstanding anything to the contrary in this Section 2.4, (i) no Bank shall have any obligation to increase its Commitment under this Section 2.4 unless it agrees in writing to do so in its sole discretion, (ii) no Bank shall have any right to decrease the amount of its Commitment as a result of any requested increase of the Commitments pursuant to this Section 2.4, (iii) the Agent shall have no obligation to find or locate any New Bank to participate in any unsubscribed portion of any increase in the Commitments requested by the Borrower, (iv) each increase in the Commitments requested by the Borrower shall not be less than $10,000,000, (v) after giving effect to any increase in the Commitments pursuant to this Section 2.4, the sum of the Commitments shall not exceed $500,000,000, and (vi) in the event the Borrower reduces the Commitments pursuant to Section 4.6 or any other provision of this Agreement more than one time during the term of this Agreement, the ability of the Borrower to request increases in the Commitments pursuant to this Section 2.4 shall automatically terminate; and (g) The Borrower shall execute and deliver to the Agent (for delivery by the Agent to each applicable Bank) a new Note payable to each applicable Bank (including each New Bank) participating in any increase of the Commitments in the original principal amount of such Bank's Commitment after giving effect to any such increase of the Commitments. 3. LETTERS OF CREDIT 3.1 Obligation to Issue. Subject to the terms and conditions of this Agreement, and in reliance upon the representations and warranties of the Borrower set forth herein or in any other Loan Document, each Issuing Bank hereby severally agrees to issue, from time to time during the period commencing on the Closing Date and ending on the Business Day immediately prior to the Maturity Date, for the account of the Borrower through such of the Issuing Bank's branches as it and the Borrower may jointly agree, one or more Facility Letters of Credit in accordance with this Section 3. Notwithstanding the foregoing, no Issuing Bank shall have any obligation to issue, and shall not issue, any Facility Letter of Credit at any time if: (a) the aggregate undrawn face amount of Facility Letters of Credit theretofore issued by such Issuing Bank, after giving effect to all requested but unissued Facility Letters of Credit, exceeds any limit imposed by law or regulation upon such Issuing Bank; (b) after taking into account the face amount of the requested Facility Letter of Credit the aggregate principal amount of Facility Letter of Credit Obligations with respect to Facility Letters of Credit issued by such Issuing Bank for the account of the Borrower (which amount shall be calculated without giving effect to the participation of the Banks pursuant to Section 3.5) would exceed such Issuing Bank's Letter of Credit Commitment; (c) immediately after giving effect to the issuance of such Facility Letter of Credit, the aggregate Facility Letter of Credit Obligations would exceed the L/C Subfacility; (d) immediately after giving effect to the issuance of such Facility Letter of Credit, the aggregate of outstanding Loans, would exceed the Banks' aggregate Commitments; or (e) such Facility Letter of Credit has an expiry date (i) more than one year after the date of issuance; or (ii) after the Business Day immediately preceding the Maturity Date. 3.2 Conditions. The obligation of an Issuing Bank to issue any Facility Letter of Credit, and of each Bank to participate therein as provided in Section 3.5 is subject to the satisfaction in full of the applicable conditions precedent set forth in Section 8 and each of the following conditions: (a) the Borrower shall have delivered to the Issuing Bank, at such times and in such manner as such Issuing Bank may prescribe, a Letter of Credit application, a Letter of Credit Reimbursement Agreement, and such other documents and materials as may be required pursuant to the terms thereof; (b) the terms of the proposed Facility Letter of Credit shall not be inconsistent with any term or provision of this Agreement and otherwise shall be satisfactory to such Issuing Bank; and (c) as of the date of issuance of such Facility Letter of Credit, no order, judgment, or decree of any court, arbitrator, or governmental authority shall purport by its terms to enjoin or restrain the Issuing Bank from issuing such Facility Letter of Credit, and no law, rule, or regulation applicable to such Issuing Bank, and no request or directive (whether or not having the force of law) from any governmental authority having jurisdiction over such Issuing Bank, shall prohibit or request that such Issuing Bank refrain from the issuance of Letters of Credit, generally or the issuance of such Facility Letter of Credit. 3.3 Issuance of Facility Letters of Credit (a) The Borrower shall give the Agent written notice (or telephonic notice confirmed in writing by the Borrower not later than the requested issuance date of the Facility Letter of Credit) of its request for the issuance of a Facility Letter of Credit no later than 11:00 a.m. four (4) Business Days prior to the date such Facility Letter of Credit is requested to be issued. Such notice shall be irrevocable and shall specify, with respect to such requested Facility Letter of Credit, the face amount, beneficiary, effective date of issuance, expiry date (which effective date and expiry date shall be a Business Day and, with respect to the expiry date, shall be no later than the Business Day immediately preceding the Maturity Date), the identity of the Issuing Bank selected by the Borrower, and the purpose for which such Facility Letter of Credit is to be issued. At the time a request for the issuance of a Facility Letter of Credit is made, the Borrower shall also provide the Agent with a copy of the form of Letter of Credit that the proposed Issuing Bank has agreed to issue. If the face amount of the requested Facility Letter of Credit is less than or equal to the Unused L/C Subfacility, as determined by the Agent as of the close of business on the date of its receipt of written notice of the requested issuance, the Agent shall so notify the proposed Issuing Bank in writing (or by telephonic notice promptly confirmed thereafter in writing) not later than the close of business on the second Business Day following the Agent's receipt of the Borrower's written notice. The Issuing Bank shall issue such Facility Letter of Credit on the date requested by the Borrower, unless (i) on or before the Business Day prior to such issuance date, such Issuing Bank shall have received written notice from the Agent or any Bank that the conditions precedent to the issuance of a Facility Letter of Credit as set forth in Section 3.2 have not been met; or (ii) on the requested issuance date, such Issuing Bank has actual knowledge that such conditions precedent have not been met. If an Issuing Bank receives written notice, or has actual knowledge, that the conditions precedent to the issuance of a Facility Letter of Credit have not been met, then such Issuing Bank shall have no obligation to issue, and shall not issue, any Facility Letter of Credit until (i) such notice is withdrawn; or (ii) such Issuing Bank receives a notice from the Agent that the condition(s) described in such notice have been waived in accordance with the provisions of this Agreement. The Issuing Bank shall give the Agent prompt written notice (or telephonic notice promptly confirmed in writing) of the issuance of any Facility Letter of Credit. Any Letter of Credit issued by an Issuing Bank in compliance with the provisions of this Section 3.3 shall be a Facility Letter of Credit. (b) An Issuing Bank shall not extend or amend any Facility Letter of Credit unless the requirements of this Section 3.3 are met as though a new Facility Letter of Credit was being requested and issued. (c) An Issuing Bank or any Bank may issue Non-Facility Letters of Credit for its own account, and at its own risk. None of the provisions of this Section 3 shall apply to any Non-Facility Letter of Credit. 3.4 Reimbursement Obligations; Duties of Issuing Bank (a) Notwithstanding any provisions to the contrary in any Letter of Credit Reimbursement Agreement: (1) the Borrower shall reimburse the applicable Issuing Bank for a drawing under a Facility Letter of Credit issued by such Issuing Bank no later than the earlier of (A) the time specified in the related Letter of Credit Reimbursement Agreement; or (B) one (1) Business Day after the payment of such drawing by such Issuing Bank; and (2) the Borrower's Reimbursement Obligations with respect to a drawing under a Facility Letter of Credit shall bear interest from the date of such drawing to the date paid in full at the higher of (A) the interest rate specified in the applicable Letter of Credit Reimbursement Agreement; or (B) the interest rate for past due Alternate Base Rate Loans; but not greater than the Highest Lawful Rate. (b) No action taken or omitted to be taken by an Issuing Bank in connection with any Facility Letter of Credit shall (i) result in any liability on the part of such Issuing Bank to any Bank, unless such Issuing Bank's action or omission constitutes willful misconduct or gross negligence; or (ii) relieve any Bank of any of its obligations to such Issuing Bank hereunder, unless the Facility Letter of Credit in question was issued in contravention of the provisions of Section 3.3 or at a time during which a notice, described in Section 3.3, from such Bank to such Issuing Bank remained in effect. Each Bank agrees that, prior to making any payment to a beneficiary with respect to a drawing under a Facility Letter of Credit, the Issuing Bank shall be responsible only to confirm that documents required by the terms of such Facility Letter of Credit to be delivered as a condition precedent to such drawing have been delivered and that the same appear on their face to conform with the requirements thereof. Each Bank further agrees that such Issuing Bank may assume that documents appearing on their face to be the documents required to be delivered as a condition precedent to a drawing do in fact comply. 3.5 Participations (a) Immediately upon the issuance by an Issuing Bank of any Facility Letter of Credit in compliance with the provisions of Section 3.3, and immediately upon conversion of a Letter of Credit of an Issuing Bank to a Facility Letter of Credit pursuant to Section 3.10, each Bank shall be deemed to have irrevocably and unconditionally purchased and received from such Issuing Bank, without recourse or warranty, an undivided interest and participation to the extent of such Bank's Pro Rata Percentage in such Facility Letter of Credit, including without limitation, all obligations of the Borrower with respect thereto and any security therefor or guaranty pertaining thereto. (b) An Issuing Bank shall promptly notify the Agent, and the Agent shall promptly notify the other Banks, if the Borrower fails to reimburse such Issuing Bank for payments made by such Issuing Bank in respect of drawings by a beneficiary under a Facility Letter of Credit. Upon each such other Banks receipt of such notice, such Bank shall unconditionally pay to the Agent, for the account of such Issuing Bank, an amount equal to such Bank's Pro Rata Percentage of the unreimbursed payment made by such Issuing Bank under the Facility Letter of Credit. Such payment shall be made by such Bank in Dollars and in same day funds on the day such Bank receives notice from the Agent that such payment is owing, if such notice is received by such Bank prior to 11:00 a.m. (Houston time) on a Business Day; if such notice is not received by such time, then such Bank shall remit its payment on the next Business Day following the day such notice is received. Any amount payable by a Bank under this Section 3.5(b) which is not paid when due pursuant to the terms hereof shall be payable on demand, together with interest thereon at the Federal Funds Rate from the date such payment was due until paid in full. The failure of any Bank to make any payment owing by it under this Section 3.5(b) shall neither relieve nor increase the obligation of any other Bank to make any payment owing by it under this Section 3.5(b). The Agent shall promptly remit to the applicable Issuing Bank all amounts received by the Agent, for the account of such Issuing Bank, from each Bank pursuant to this Section 3.5(b). No payment made by a Bank pursuant to this Section 3.5(b) shall prejudice the ability of such Bank to claim that the Issuing Bank to which such payment is made is subject to liability under Section 3.4(b). (c) Whenever an Issuing Bank receives a payment with respect to a Reimbursement Obligation (including any interest thereon) for which such Issuing Bank has received payments from a Bank pursuant to Section 3.5(b), such Issuing Bank shall promptly remit to the Agent and the Agent shall promptly remit to each Bank which has funded its participating interest therein, in Dollars and in the kind of funds so received, an amount equal to each Bank's Pro Rata Percentage thereof. Each such payment shall be made by the Issuing Bank or the Agent, as the case may be, on the Business Day on which such Person receives the funds paid to such Person pursuant to the preceding sentence, if received prior to 11:00 a.m. (Houston time) on such Business Day, and otherwise on the next succeeding Business Day. (d) Upon the request of the Agent or any Bank, an Issuing Bank shall furnish to the Agent or each Bank copies of any Facility Letter of Credit, Letter of Credit Reimbursement Agreement, or Letter of Credit application to which Issuing Bank is party, and such other documentation as may reasonably be requested by the Agent or such Bank with respect to a Facility Letter of Credit issued by such Issuing Bank. (e) The obligations of a Bank under Section 3.5(b) to make payments to the Agent for the account of an Issuing Bank with respect to a Facility Letter of Credit shall be irrevocable, not subject to any qualification or exception whatsoever, and shall be made in accordance with, but not subject to, the terms and conditions of this Agreement under all circumstances (assuming that such Issuing Bank has issued such Facility Letter of Credit in compliance with the provisions of Section 3.3), including, without limitation, any of the following circumstances: (i) any lack of validity or enforceability of this Agreement or any other Loan Document; (ii) the existence of any claim, set off, defense, or other right which the Borrower may have at any time against a beneficiary named in a Facility Letter of Credit or any transferee of any Facility Letter of Credit (or any Person for whom any such transferee may be acting), the Agent, any Bank, the Issuing Bank, or any Person, whether in connection with this Agreement, any Facility Letter of Credit, the transactions contemplated herein, or any unrelated transactions (including any underlying transactions between the Borrower and the beneficiary named in any Facility Letter of Credit); (iii) any draft, certificate, of any other document presented under the Facility Letter of Credit proving to be forged, fraudulent, invalid, or insufficient in any respect or any statement therein being untrue or inaccurate in any respect; (iv) the surrender or impairment of any security for the performance or observance of any of the terms of any Loan Document; (v) any failure by the Agent or an Issuing Bank to make any reports required pursuant to Section 3.8; or (vi) the occurrence of any Default or Event of Default. 3.6 Payment of Reimbursement Obligations (a) The Borrower agrees to pay to each Issuing Bank the amount of all Reimbursement Obligations, interest, and other amounts payable to such Issuing Bank under or in connection with any Facility Letter of Credit immediately when due, irrespective of any claim, set off, defense, or other right which the Borrower may have at any time against any Issuing Bank or any other Person. (b) In the event any payment by the Borrower received by an Issuing Bank with respect to a Facility Letter of Credit and distributed to Banks on account of their respective participation is thereafter set aside, avoided, or recovered from such Issuing Bank in connection with any Debtor Laws, each Bank which received such distribution shall, upon demand by such Issuing Bank, contribute each Bank's Pro Rata Percentage of the amount set aside, avoided, or recovered together with interest at the rate required to be paid by the Issuing Bank upon the amount required to be repaid by it. 3.7 Exoneration. As between the Borrower, each Bank, and each Issuing Bank, the Borrower assumes all risks of the acts and omissions of, or misuse of the Facility Letter of Credit issued by such Issuing Bank by, the respective beneficiaries of such Facility Letter of Credit. In furtherance and not in limitation of the foregoing, subject to the provisions of the Letter of Credit applications, the Issuing Bank and the Banks shall not be responsible for: (a) the form, validity, sufficiency, accuracy, genuineness, or legal effect of any document submitted by any party in connection with the application for and issuance of a Facility Letter of Credit, even if it should in fact prove to be in any or all respects invalid, insufficient, inaccurate, fraudulent, or forged; (b) the validity or sufficiency of any instrument transferring or assigning or purporting to transfer or assign a Facility Letter of Credit or the rights or benefits thereunder or proceeds thereof, in whole or in part, which may prove to be invalid or ineffective for any reason; (c) failure of the beneficiary of a Facility Letter of Credit to comply duly with conditions required in order to draw upon such Facility Letter of Credit, provided that the Issuing Bank complies with the provisions of Section 3.4(b); (d) errors, omissions, interruptions, or delays in transmission or delivery of any messages, by mail, cable, telegraph, telex, or otherwise, whether or not they be in cipher; (e) errors in interpretation of technical terms; (f) any loss or delay in the transmission or otherwise of any document required in order to make a drawing under any Facility Letter of Credit or of the proceeds thereof; (g) the misapplication by the beneficiary of a Facility Letter of Credit; or (h) any consequences arising from causes beyond the control of the Agent, any Bank, or any Issuing Bank, including, without limitation, any act or omission, whether rightful or wrongful, of any present or future de jure or de facto government or Governmental Authority. In furtherance and extension and not in limitation of the specific provisions hereinabove set forth, any action taken or omitted by an Issuing Bank under or in connection with the Facility Letters of Credit or any related certificates, if taken or omitted in good faith and not constituting gross negligence or willful misconduct, shall not put the Issuing Bank, the Agent, or any Bank under any resulting liability to the Borrower or relieve the Borrower of any of its obligations hereunder to any such Person. 3.8 Issuing Bank's Reporting Requirements. In addition to the reports required by Section 3.5, each Issuing Bank shall, no later than the tenth (10th) Business Day following the last day of each quarter of such Issuing Bank's fiscal year, provide to the Agent and the Borrower a schedule for Standby Letters of Credit issued as Facility Letters of Credit, in form and substance reasonably satisfactory to the Agent, showing the date of issue, beneficiary, face amount, expiration date, and the reference number of each Facility Letter of Credit issued by such Issuing Bank which was outstanding at any time during such quarter and the aggregate amount payable by the Borrower during the quarter pursuant to Section 3.9. 3.9 Compensation for Facility Letters of Credit (a) Facility Letter of Credit Fee. The Borrower agrees to pay to the Agent, for the account of each Bank, in the case of each Letter of Credit issued as, or converted to (for transactions which convert Letters of Credit in existence on the Closing Date to Facility Letters of Credit pursuant to Section 3.10), a Facility Letter of Credit, a facility letter of credit fee (the "Facility Letter of Credit Fee") payable quarterly in arrears equal to the applicable Facility Letter of Credit Fee Percentage of the average amount available to be drawn under such Letter of Credit during the quarter then ending multiplied by the actual number of days during such quarter on which such Letter of Credit was outstanding, divided by 360 but no less than $500.00 per Facility Letter of Credit per year. The Borrower shall also pay to the Agent in the event of any extension or modification of a Facility Letter of Credit which extends the expiration date or increases the maximum amount available for drawing thereunder an additional fee calculated and payable on the same basis as that set forth in the first sentence of this Section 3.9(a) with respect to any such extension or additional amount. Whenever an Issuing Bank receives a payment from the Borrower with respect to any fees incurred in connection with any Facility Letter of Credit issued by such Issuing Bank, such Issuing Bank shall promptly remit to the Agent, and the Agent shall promptly remit to each Bank which has funded its participation in such Facility Letter of Credit, in Dollars and in same day funds, an amount equal to such Bank's Pro Rata Percentage of such fees. (b) Issuing Bank's Charges. Each Issuing Bank shall have the right to receive, solely for its own account, such amounts as it and the Borrower may agree, in writing, to compensate such Issuing Bank with respect to issuance fees and such Issuing Bank's out-of-pocket costs of issuing and servicing Facility Letters of Credit. (c) Increased Capital. If either (i) the introduction of or any change in or in the interpretation of any law or regulation, or (ii) compliance by any Issuing Bank or any Bank with any guideline or request from any central bank or other Governmental Authority (whether or not having the force of law) affects or would affect (by an amount deemed by such Issuing Bank to be material) the capital required or expected to be maintained by it or any corporation controlling it, and such Bank or such Issuing Bank determines, on the basis of reasonable allocations, that the amount of such capital is increased by (an amount deemed by such Issuing Bank to be material) or is based (to a degree deemed by such Issuing Bank to be material) upon its issuance or maintenance of or participation in, or commitment to issue or to participate in, the Facility Letters of Credit then, upon demand by such Bank or such Issuing Bank, the Borrower shall immediately pay to the Agent (for the account of each Bank) or such Issuing Bank, from time to time as specified by such Bank or such Issuing Bank, additional amounts sufficient to compensate such Bank or such Issuing Bank therefor. A certificate as to such amounts submitted to the Borrower by such Bank or such Issuing Bank shall, in the absence of manifest error, be conclusive and binding for all purposes. 3.10 Transitional Provisions. Schedule 3.10 contains a schedule of certain Letters of Credit issued for the account of the Borrower prior to the Closing Date by one or more of the Issuing Banks. Subject to the satisfaction of the conditions precedent contained in Section 8, on the Closing Date (a) such Letters of Credit shall be deemed to be converted into Facility Letters of Credit issued pursuant to Section 3.3; and (b) the face amount of such Letters of Credit shall be included in the calculation of the Facility Letter of Credit Obligations. 4. PAYMENTS AND PREPAYMENTS 4.1 Required Prepayments (a) The Borrower agrees that if at any time it or the Agent determines that the sum of (i) the aggregate principal amount of Loans outstanding and (ii) the face amount of Facility Letters of Credit issued hereunder exceeds the Commitments, then the Borrower shall make a prepayment of principal of the Loans in an amount at least equal to such excess. (b) Upon the Borrower's reduction or termination of the Commitments under Section 4.6, the Borrower shall make such prepayments as are required by the terms of Section 4.6. (c) All cash proceeds distributed to the Borrower from the Trunkline LNG Holdings Sale shall be immediately applied against the Borrower's Debt under the Term Loan Facility, to the extent then outstanding. 4.2 Repayment of the Loans. Borrower shall repay the principal amount of each Loan, on the last day of the Rate Period for such Loan, together with all accrued and unpaid interest thereon as of such date, irrespective of any claim, set off, defense, or other right which the Borrower may have at any time against any Bank, the Agent or any other Person. 4.3 Place of Payment or Prepayment. All payments and prepayments made in accordance with the provisions of this Agreement or of the Notes or of any other Loan Document or of the Letter of Credit Reimbursement Agreements in respect of commitment fees or of principal or interest on the Notes shall be made to the Agent for the account of the Banks at its Domestic Lending Office, no later than noon, Houston time, in immediately available funds. Unless the Agent shall have received notice from the Borrower prior to the date on which any payment is due to the Banks hereunder that the Borrower will not make any payment due hereunder in full, the Agent may assume that the Borrower has made such payment in full to the Agent on such date and the Agent may, in reliance upon such assumption, cause to be distributed to each Bank on such due date an amount equal to the amount then due to such Bank. If and to the extent the Borrower shall not have so made such payment in full to the Agent, each Bank shall repay to the Agent forthwith on demand such amount distributed to such Bank together with interest thereon, for each day from the date such amount is distributed to such Bank until the date such Bank repays such amount to the Agent, at the Federal Funds Rate. If and to the extent that the Agent receives any payment or prepayment from the Borrower and fails to distribute such payment or prepayment to the Banks ratably on the basis of their respective Pro Rata Percentage on the day the Agent receives such payment or prepayment, and such distribution shall not be so made by the Agent in full on the required day, the Agent shall pay to each Bank such Bank's Pro Rata Percentage thereof together with interest thereon at the Federal Funds Rate for each day from the date such amount is paid to the Agent by the Borrower until the date the Agent pays such amount to such Bank. 4.4 No Prepayment Premium or Penalty. Each prepayment pursuant to Section 4.1 or 4.3 shall be without premium or penalty, subject in the case of Eurodollar Rate Loans to the provisions of Section 2.3(d). 4.5 Taxes. All payments (whether of principal, interest, reimbursements or otherwise) under this Agreement or on the Notes or in respect of Facility Letter of Credit Obligations shall be made by the Borrower without set off or counterclaim and shall be made free and clear of and without deduction for any present or future tax, levy, impost or any other charge, if any, of any nature whatsoever now or hereafter imposed by any taxing authority. If the making of such payments is prohibited by law, unless such a tax, levy, impost or other charge is deducted or withheld therefrom, the Borrower shall pay to the Banks, on the date of each such payment, such additional amounts as may be necessary in order that the net amounts received by the Banks after such deduction or withholding shall equal the amounts which would have been received if such deduction or withholding were not required. 4.6 Reduction or Termination of Commitments. The Borrower may at any time or from time to time reduce or terminate the Commitment of each Bank by giving not less than ten (10) full Business Days' prior written notice to such effect to the Agent, provided that any partial reduction shall be in the amount of $1,000,000.00 or an integral multiple thereof. Concurrently with each such reduction or termination, all amounts in excess of the reduced Commitments shall be automatically due and payable and it is a condition to the effectiveness of such reduction that the Borrower shall immediately prepay the entire amount of such excess together with all accrued interest thereon and such other amounts that may be required to be paid in consequence of such prepayment under Section 2.3(d). Promptly after the Agent's receipt of such notice of reduction, the Agent shall notify each Bank of the proposed reduction and such reduction shall be effective on the date specified in the Borrower's notice with respect to such reduction and shall reduce the Commitment of each Bank proportionately in accordance with its Pro Rata Percentage (and such reduction shall also ratably reduce the Commitments related to Facility Letters of Credit). After each such reduction, the commitment fee shall be calculated upon the Commitments as so reduced. The Commitment of each Bank shall automatically terminate on the Maturity Date or in the event of acceleration of the maturity date of the Notes. Each reduction of the Commitment hereunder shall be irrevocable. 5. COMMITMENT FEE AND OTHER FEES 5.1 Commitment Fee. The Borrower agrees to pay to the Agent for the account of each Bank a commitment fee based on a year of 360 days, from the Closing Date to, but not including, the Maturity Date (or such earlier date as of which all Commitments shall have terminated), on the daily average unused amount of each Bank's Commitment, such commitment fee to be payable quarterly in arrears on (a) the last day of each March, June, September, and December, commencing on June 30, 2004 and (b) the Maturity Date, at a rate per annum changing with the rating of the Borrower's unsecured, non-credit enhanced Senior Funded Debt, and determined in accordance with the following grid: ============================================================================== Rating of the Borrower's unsecured, non-credit enhanced Senior Percentage Per Funded Debt Annum - -------------------------------------------------------------------------------- Equal to or greater than A3 by Moody's Investor Service, Inc. and equal to or greater than A- by Standard and Poor's Ratings Group 0.100% - -------------------------------------------------------------------------------- Baa1 by Moody's Investor Service, Inc. or BBB+ by Standard and Poor's Ratings Group 0.125% - -------------------------------------------------------------------------------- Baa2 by Moody's Investor Service, Inc. or BBB by Standard and Poor's Ratings Group 0.150% - -------------------------------------------------------------------------------- Baa3 by Moody's Investor Service, Inc. or BBB- by Standard and Poor's Ratings Group 0.175% - -------------------------------------------------------------------------------- Equal to or less than Ba1 by Moody's Investor Service, Inc. and equal to or less than BB+ by Standard and Poor's Ratings Group 0.300% ================================================================================ Notwithstanding the foregoing provisions, in the event that ratings of the Borrower's unsecured, non-credit enhanced Senior Funded Debt under Standard & Poor's Ratings Group and under Moody's Investor Service, Inc. fall within different rating categories which are not functional equivalents, the above-described commitment fee shall be based on the higher of such ratings if there is only one category differential between the functional equivalents of such ratings, and if there is a two category differential between the functional equivalents of such ratings, the component of pricing from the grid set forth above shall be based on the rating category which is then in the middle of or between the two category ratings which are then in effect, and if there is greater than a two category differential between the functional equivalents of such ratings, the component of pricing from the grid set forth above shall be based on the rating category which is then one rating category above the lowest of the two category ratings which are then in effect. Additionally, in the event that Borrower withdraws from having its unsecured, non-credit enhanced Senior Funded Debt being rated by Moody's Investor Service, Inc. or Standard and Poor's Ratings Group, so that one or both of such ratings services fails to rate the Borrower's unsecured, non-credit enhanced Senior Funded Debt, the component of pricing from the grid set forth above for purposes of determining the applicable commitment fee for all periods thereafter shall be 0.300% until such time as the Borrower subsequently causes its unsecured, non-credit enhanced Senior Funded Debt to be rated by both of said ratings services. 5.2 Facility Letter of Credit Fee. The Borrower shall pay to the Agent, for the account of each Issuing Bank, the Facility Letter of Credit Fees as set forth in Section 3.9. 5.3 Fees Not Interest; Nonpayment. The fees described in this Agreement represent compensation for services rendered and to be rendered separate and apart from the lending of money or the provision of credit and do not constitute compensation for the use, detention, or forbearance of money, and the obligation of the Borrower to pay each fee described herein shall be in addition to, and not in lieu of, the obligation of the Borrower to pay interest, other fees described in this Agreement, and expenses otherwise described in this Agreement. Fees shall be payable when due in Dollars and in immediately available funds. The commitment fee referred to in Section 5.1 shall be non-refundable, and shall, to the fullest extent permitted by law, bear interest, if not paid when due, at a rate per annum equal to the lesser of (a) five percent (5%) above the Alternate Base Rate as in effect from time to time or (b) the Highest Lawful Rate. 5.4 Utilization Fee. The Borrower agrees to pay to Agent, for the account of each Bank, a utilization fee at a rate per annum equal to 0.125%, based on a year of 360 days, from the Closing Date to, but not including, the Maturity Date (or such earlier date as of which the Commitments have been terminated), on the daily average of the aggregate principal amount of the Loans outstanding on those days when such aggregate principal amount of the Loans outstanding exceeds thirty-three percent (33%) of the aggregate amount of the Commitments, such utilization fee to be payable quarterly in arrears on (a) the last day of each March, June, September, and December, commencing on June 30, 2004, and (b) the Maturity Date. 6. APPLICATION OF PROCEEDS 6.1 Application of Proceeds. The Borrower agrees that the proceeds of the Loans shall be used to provide working capital and for general corporate purposes, including without limitation, financing the Borrower's (i) acquisition of Qualifying Assets, (ii) open market acquisition of its Senior Notes, and (iii) repurchase of its own common stock and preferred equity securities to the extent permitted under the terms of Section 10.11. 7. REPRESENTATIONS AND WARRANTIES The Borrower represents and warrants that: 7.1 Organization and Qualification. The Borrower and each Subsidiary: (a) are corporations duly organized, validly existing, and in good standing under the laws of their respective states of incorporation; (b) have the corporate or organizational power to own their respective properties and to carry on their respective businesses as now conducted; and (c) are duly qualified as foreign corporations (or, in the case of any Southern Union Trust, trusts) to do business and are in good standing in every jurisdiction where such qualification is necessary except when the failure to so qualify would not or does not have a Material Adverse Effect. The Borrower is a corporation organized under the laws of Delaware and has the Subsidiaries listed on Schedule 7.1 attached hereto and made a part hereof for all purposes, and no others, each of which is a Delaware corporation unless otherwise noted on Schedule 7.1. None of the Subsidiaries listed on Schedule 7.1 as "Inactive Subsidiaries" conducts or will conduct any business, and none of such Subsidiaries has any assets other than minimum legal capitalization. 7.2 Financial Statements. The Borrower has furnished the Banks with (a) the Borrower's annual audit reports containing the Borrower's consolidated balance sheets, statements of income and stockholder's equity and a cash flow statements as at and for the twelve month period ending June 30, 2003, accompanied by the certificate of Price Waterhouse Coopers and (b) the Borrower's unaudited financial report as of the fiscal quarter ending December 31, 2003. These statements are complete and correct and present fairly in accordance with GAAP, consistently applied throughout the periods involved, the consolidated financial position of the Borrower and the Subsidiaries and the results of its and their operations as at the dates and for the periods indicated subject, as to interim statements only, to changes resulting from customary end-of-year credit adjustments which in the aggregate will not be material. There has been no material adverse change in the condition, financial or otherwise, of the Borrower or any Subsidiary since December 31, 2003. 7.3 Litigation. Except as disclosed on Schedule 7.3 or pursuant to Section 7.16, there is no: (a) action or proceeding pending or, to the knowledge of the Borrower, threatened against the Borrower or any Subsidiary before any court, administrative agency or arbitrator which is reasonably expected to have a Material Adverse Effect; (b) judgment outstanding against the Borrower for the payment of money; or (c) other outstanding judgment, order or decree affecting the Borrower or any Subsidiary before or by any administrative or governmental authority, compliance with or satisfaction of which may reasonably be expected to have a Material Adverse Effect. 7.4 Default. Neither the Borrower nor any Subsidiary is in default under or in violation of the provisions of any instrument evidencing any Debt or of any agreement relating thereto or any judgment, order, writ, injunction or decree of any court or any order, regulation or demand of any administrative or governmental instrumentality which default or violation might have a Material Adverse Effect. 7.5 Title to Assets. The Borrower and each Subsidiary have good and marketable title to their respective assets, subject to no Liens except those permitted in Section 10.2. 7.6 Payment of Taxes. The Borrower and each Subsidiary have filed all tax returns required to be filed and have paid all taxes shown on said returns and all assessments which are due and payable (except such as are being contested in good faith by appropriate proceedings for which adequate reserves for their payment have been provided in a manner consistent with the accounting practices followed by the Borrower as of December 31, 2003). The Borrower is not aware of any pending investigation by any taxing authority or of any claims by any governmental authority for any unpaid taxes, except as disclosed on Schedule 7.6. 7.7 Conflicting or Adverse Agreements or Restrictions. Neither the Borrower nor any Subsidiary is a party to any contract or agreement or subject to any restriction which would have a Material Adverse Effect. Neither the execution and delivery of this Agreement or the Notes or any other Loan Document nor the consummation of the transactions contemplated hereby nor fulfillment of and compliance with the respective terms, conditions and provisions hereof or of the Notes or of any instruments required hereby will conflict with or result in a breach of any of the terms, conditions or provisions of, or constitute a default under, or result in any violation of, or result in the creation or imposition of any lien (other than as contemplated or permitted by this Agreement) on any of the property of the Borrower or any Subsidiary pursuant to (a) the charter or bylaws applicable to the Borrower or any Subsidiary; (b) any law or any regulation of any administrative or governmental instrumentality; (c) any order, writ, injunction or decree of any court; or (d) the terms, conditions or provisions of any agreement or instrument to which the Borrower or any Subsidiary is a party or by which it is bound or to which it is subject. 7.8 Authorization, Validity, Etc. The Borrower has the corporate power and authority to make, execute, deliver and carry out this Agreement and the transactions contemplated herein, to make the borrowings provided for herein, to execute and deliver the Notes and to perform its obligations hereunder and under the Notes and the other Loan Documents to which it is a party and all such action has been duly authorized by all necessary corporate proceedings on its part. This Agreement has been duly and validly executed and delivered by the Borrower and constitutes the valid and legally binding agreement of the Borrower enforceable in accordance with its terms, except as limited by Debtor Laws; and the Notes and the other Loan Documents, when duly executed and delivered by the Borrower pursuant to the provisions hereof, will constitute the valid and legally binding obligation of the Borrower enforceable in accordance with the terms thereof and of this Agreement, except as limited by Debtor Laws. 7.9 Investment Company Act Not Applicable. Neither the Borrower nor any Subsidiary is an "investment company" or a company "controlled" by an "investment company", within the meaning of the Investment Company Act of 1940, as amended. 7.10 Public Utility Holding Company Act Not Applicable. Neither the Borrower nor any Subsidiary is a "holding company", or a "subsidiary company" of a "holding company", or an "affiliate" of a "holding company", or an affiliate of a "subsidiary company" of a "holding company", as such terms are defined in the Public Utility Holding Company Act of 1935, as amended. 7.11 Regulations G, T, U and X. No Loan shall be a "purpose credit secured directly or indirectly by margin stock" within the meaning of Regulation U of the Board of Governors of the Federal Reserve System ("margin stock"); none of the proceeds of any Loan will be used to extend credit to others for the purpose of purchasing or carrying any margin stock, or for any other purpose which would constitute this transaction a "purpose credit secured directly or indirectly by margin stock" within the meaning of said Regulation U, as now in effect or as the same may hereafter be in effect. Neither the Borrower nor any Subsidiary will take or permit any action which would involve the Banks in a violation of Regulation G, Regulation T, Regulation U, Regulation X or any other regulation of the Board of Governors of the Federal Reserve System or a violation of the Securities Exchange Act of 1934, in each case as now or hereafter in effect. After applying proceeds of the Loans used to acquire the equity interests described in the definition of "Qualifying Assets", not more than twenty-five percent (25%) of the value (as determined by any reasonable method) of the assets subject to the negative pledge set forth in Section 10.2 of the Credit Agreement and the restrictions on disposition of assets set forth in Section 10.8 of the Credit Agreement is represented by margin stock. 7.12 ERISA. No Reportable Event (as defined in ss. 4043(b) of ERISA) has occurred with respect to any Plan. Each Plan complies in all material respects with a applicable provisions of ERISA, and the Borrower and each Subsidiary have filed all reports required by ERISA and the Code to be filed with respect to each Plan. The Borrower has no knowledge of any event which could result in a liability of the Borrower or any Subsidiary to the Pension Benefit Guaranty Corporation. The Borrower and each Subsidiary have met all requirements with respect to funding the Plans imposed by ERISA or the Code. Since the effective date of Title IV of ERISA, there have not been any, nor are there now existing any, events or conditions that would permit any Plan to be terminated under circumstances which would cause the lien provided under ss. 4068 of ERISA to attach to any property of the Borrower or any Subsidiary. The value of the Plans' benefits guaranteed under Title IV of ERISA on the date hereof does not exceed the value of such Plans' assets allocable to such benefits as of the date of this Agreement and shall not be permitted to do so hereafter. 7.13 No Financing of Certain Security Acquisitions. None of the proceeds of any Loan will be used to acquire any security in any transaction that is subject to ss.13 or ss.14 of the Securities Exchange Act of 1934, as amended, except the equity interests described in subparagraph (ii) of the definition of "Qualifying Assets". 7.14 Franchises, Co-Licenses, Etc. The Borrower and each Subsidiary own or have obtained all the material governmental permits, certificates of authority, leases, patents, trademarks, service marks, trade names, copyrights, franchises and licenses, and rights with respect thereto, required or necessary (or, in the sole and independent judgment of the Borrower, prudent) in connection with the conduct of their respective businesses as presently conducted or as proposed to be conducted. 7.15 Lines of Business. The nature of the Borrower's lines of business are predominately the following: (a) the operation of energy distribution and transportation services, including without limitation, natural gas sales and transportation and distribution, propane sales and distribution and promotion, marketing and sale of compressed natural gas and liquified natural gas; (b) the development and marketing of fuel cell and distributive energy options; (c) electric marketing/generation; (d) the operation of fuel oil distribution and transportation networks; and (e) sales and rentals of appliances utilizing one or more of the fuel or energy options specified in this Section 7.15. 7.16 Environmental Matters. Except as disclosed in Schedule 7.16, all facilities and property owned or leased by the Borrower or any Subsidiary have been and continue to be, owned or leased and operated by the Borrower and each Subsidiary in material compliance with all Environmental Laws; (i) there has not been (during the period of the Borrower's, or a Subsidiary's ownership or lease) any Release of Hazardous Materials at, on or under any property now (or, to the Borrower's knowledge, previously) owned or leased by the Borrower or any Subsidiary (A) in quantities that would be required to be reported under any Environmental Law, (B) that required, or may reasonably be expected to require, the Borrower to expend funds on remediation or cleanup activities pursuant to any Environmental Law except for remediation or clean-up activities that would not be reasonably expected to have a Material Adverse Effect, or (C) that otherwise, singly or in the aggregate, has, or may reasonably be expected to have, a Material Adverse Effect; (ii) the Borrower and each Subsidiary have been issued and are in material compliance with all permits, certificates, approvals, orders, licenses and other authorizations relating to environmental matters necessary for their respective businesses; and (iii) there are no polychlorinated biphenyls (PCB's) or asbestos-containing materials or surface impoundments in any of the facilities now (or, to the knowledge of the Borrower, previously) owned or leased by the Borrower or any Subsidiary, except for asbestos-containing materials of the type and in quantities that, to the knowledge of the borrower, do not currently require remediation, and if remediation of such asbestos-containing materials is hereafter required for any reason, such remediation activities would not reasonably be expected to have a Material Adverse Effect; (iv) Hazardous Materials have not been generated, used, treated, recycled, stored or disposed of in any of the facilities or on any of the property now (or, to the knowledge of the Borrower, previously) owned or leased by the Borrower or any Subsidiary during the time of the Borrower's or such Subsidiary's ownership or leased by the Borrower or any Subsidiary during the time of the Borrower's or such Subsidiary's ownership except in material compliance with all applicable Environmental Laws; and (v) all underground storage tanks located on the property now (or, to the knowledge of the Borrower, previously) owned or leased by the Borrower or any Subsidiary have been (and to the extent currently owned or leased are) operated in material compliance with all applicable Environmental Laws. 7.17 No Agreements Prohibiting Pledge of Southern Union Panhandle Stock. Except for the applicable negative covenants of this Agreement and the Term Loan Facility, the Borrower is not a party to any contract or other agreement with any Person that directly or indirectly prohibits the Borrower from granting any Lien against the stock or other equity interests in Southern Union Panhandle (whether common, preferred or another class of equity ownership) at any time owned and held by the Borrower as security for any Debt of the Borrower or any of its Subsidiaries. 8. CONDITIONS The obligation of the Banks to make any Loans or issue any Facility Letters of Credit is subject to the following conditions: 8.1 Representations True and No Defaults (a) The representations and warranties contained in Section 7 shall be true and correct on and as of the particular Borrowing Date as though made on and as of such date; (b) The Borrower shall not be in default in the due performance of any covenant on its part contained in this Agreement; (c) no material adverse change shall have occurred with respect to the business, assets, properties or condition (financial or otherwise) of the Borrower reflected in the quarterly financial statements of the Borrower dated December 31, 2003 (copies of such audited financial statements having been supplied to the Agent and each Bank); and (d) no Event of Default or Default shall have occurred and be continuing. 8.2 Governmental Approvals. The Borrower shall have obtained all orders, approvals or consents of all public regulatory bodies required for the making and carrying out of this Agreement, the making of the borrowings pursuant hereto, the issuance of the Notes to evidence such borrowings, and the execution and delivery of the Security Documents. 8.3 Compliance With Law. The business and operations of the Borrower and each Subsidiary as conducted at all times relevant to the transactions contemplated by this Agreement to and including the close of business on the particular Borrowing Date shall have been and shall be in compliance in all material respects with all applicable State and Federal laws, regulations and orders affecting the Borrower and each Subsidiary and the business and operations of any of them. 8.4 Notice of Borrowing and Other Documents. On each Borrowing Date, the Banks shall have received (a) a Notice of Borrowing; and (b) such other documents and certificates relating to the transactions herein contemplated as the Banks may reasonably request. 8.5 Payment of Fees and Expenses. The Borrower shall have paid (a) all expenses of the type described in Section 13.3 through the date of such Loan or the issuance of such Facility Letter of Credit and (b) all closing, structuring and other invoiced fees owed as of the Closing Date to the Agent, any of the Banks and/or J. P. Morgan Securities Inc. by the Borrower under this Agreement or any other written agreement between the Borrower and the Agent, the applicable Bank(s) or J. P. Morgan Securities Inc. 8.6 Loan Documents, Opinions and Other Instruments. As of the Closing Date, the Borrower shall have delivered to the Agent the following: (a) this Agreement, each of the Notes and all other Loan Documents required by the Agent and the Banks to be executed and delivered by the Borrower in connection with this Agreement; (b) a certificate from the Secretary of State of the State of Delaware as to the continued existence and good standing of the Borrower in the State of Delaware; (c) a certificate from Secretary of State of the State of Texas as to the continued qualification of the Borrower to do business in the State of Texas; (d) a current certificate from the Office of the Comptroller of the State of Texas as to the good standing of the Borrower in the State of Texas; (e) a Secretary's Certificate executed by the duly elected Secretary or a duly elected Assistant Secretary of the Borrower, in a form acceptable to the Agent, whereby such Secretary or Assistant Secretary certifies that one or more corporate resolutions adopted by the Board of Directors of the Borrower remain in full force and effect authorizing the Borrower to secure Loans and Facility Letters of Credit in accordance with the terms of this Agreement; and (f) a legal opinion from in-house counsel for the Borrower, dated as of the Closing Date, addressed to the Agent and the Lenders and otherwise acceptable in all respects to the Agent in its discretion. 9. AFFIRMATIVE COVENANTS The Borrower covenants and agrees that, so long as the Borrower may borrow hereunder and until payment in full of the Notes, and its other obligations under this Agreement and the other Loan Documents the Borrower will: 9.1 Financial Statements and Information. Deliver to the Banks: (a) as soon as available, and in any event within 120 days after the end of each fiscal year of the Borrower, a copy of the annual audit report of the Borrower and the Subsidiaries for such fiscal year containing a balance sheet, statements of income and stockholders equity and a cash flow statement, all in reasonable detail and certified by Price Waterhouse Coopers or another independent certified public accountant of recognized standing satisfactory to the Banks. The Borrower will obtain from such accountants and deliver to the Banks at the time said financial statements are delivered the written statement of the accountants that in making the examination necessary to said certification they have obtained no knowledge of any Event of Default or Default, or if such accountants shall have obtained knowledge of any such Event of Default or Default, they shall state the nature and period of existence thereof in such statement; provided that such accountants shall not be liable directly or indirectly to the Banks for failure to obtain knowledge of any such Event of Default or Default; and (b) as soon as available, and in any event within sixty (60) days after the end of each quarterly accounting period in each fiscal year of the Borrower (excluding the fourth quarter), an unaudited financial report of the Borrower and the Subsidiaries as at the end of such quarter and for the period then ended, containing a balance sheet, statements of income and stockholders equity and a cash flow statement, all in reasonable detail and certified by a financial officer of the Borrower to have been prepared in accordance with GAAP, except as may be explained in such certificate; and (c) copies of all statements and reports sent to stockholders of the Borrower or filed with the Securities and Exchange Commission; and (d) such additional financial or other information as the Banks may reasonably request including, without limitation, copies of such monthly, quarterly, and annual reports of gas purchases and sales that the Borrower is required to deliver to or file with governmental bodies pursuant to tariffs and/or franchise agreements. All financial statements specified in clauses (a) and (b) above shall be furnished in consolidated and consolidating form for the Borrower and all Subsidiaries with comparative consolidated figures for the corresponding period in the preceding year. Together with each delivery of financial statements required by clauses (a) and (b) above, the Borrower will deliver to the Banks (i) such schedules, computations and other information as may be required to demonstrate that the Borrower is in compliance with its covenants in Section 10.1 or reflecting any noncompliance therewith as at the applicable date and (ii) an Officer's Certificate stating that there exists no Event of Default or Default, or, if any such Event of Default or Default exists, stating the nature thereof, the period of existence thereof and what action the Borrower has taken or proposes to take with respect thereto. The Banks are authorized to deliver a copy of any financial statement delivered to it to any regulatory body having jurisdiction over them, and to disclose same to any prospective assignees or participant Lenders. 9.2 Lease and Investment Schedules. Deliver to the Banks: (a) from time to time and, in any event, with each delivery of annual financial statements under Section 9.1(a), a current, complete schedule (in the form of Schedule 9.2) of all agreements to rent or lease any property (personal, real or mixed, but not including oil and gas leases) to which the Borrower or any Subsidiary is a party lessee and which, considered independently or collectively with other leases with the same lessor, involve an obligation by the Borrower or a Subsidiary to make payments of at least $1,000,000.00 in any year, showing the total amounts payable under each such agreement, the amounts and due dates of payments thereunder and containing a description of the rented or leased property, and all other information the Majority Banks may request; and (b) with each delivery of annual financial statements under Section 9.1(a) a current complete schedule (in the form of Schedule 9.2) listing all debt exceeding $1,000,000.00 in principal amount outstanding and equity owned or held by the Borrower or any Subsidiary containing all information required by, and in a form satisfactory to, the Banks, except for such debt or equity of Subsidiaries. 9.3 Books and Records. Maintain, and cause each Subsidiary to maintain, proper books of record and account in accordance with sound accounting practices in which true, full and correct entries will be made of all their respective dealings and business affairs. 9.4 Insurance. Maintain, and cause each Subsidiary to maintain, insurance with financially sound, responsible and reputable companies in such types and amounts and against such casualties, risks and contingencies as is customarily carried by owners of similar businesses and properties, and furnish to the Banks, together with each delivery of annual financial statements under Section 9.1(a), an Officer's Certificate containing full information as to the insurance carried. 9.5 Maintenance of Property. Cause its Significant Property and the Significant Property of each Subsidiary to be maintained, preserved, protected and kept in good repair, working order and condition so that the business carried on in connection therewith may be conducted properly and efficiently, except for normal wear and tear; provided, however, that the improved properties of Lavaca Realty Company should be maintained, preserved and protected in a manner consistent with the maintenance, preservation and protection of improved real property held for sale. 9.6 Inspection of Property and Records. Permit any officer, director or agent of the Agent or any Bank, on written notice and at such Banks expense, to visit and inspect during normal business hours any of the properties, corporate books and financial records of the Borrower and each Subsidiary and discuss their respective affairs and finances with their principal officers, all at such times as the Agent or any Bank may reasonably request. 9.7 Existence, Laws, Obligations. Maintain, and cause each Subsidiary to maintain, its corporate existence and franchises, and any license agreements and tariffs that permit the recovery of a return that the Borrower considers to be fair (and as to licenses, franchises, and tariffs that are subject to regulatory determinations of recovery of returns, the Borrower has presented or is presenting favorable defense thereof); and to comply, and cause each Subsidiary to comply, with all statutes and governmental regulations noncompliance with which might have a Material Adverse Effect, and pay, and cause each Subsidiary to pay, all taxes, assessments, governmental charges, claims for labor, supplies, rent and other obligations which if unpaid might become a lien against the property of the Borrower or any Subsidiary except liabilities being contested in good faith. Notwithstanding the foregoing, the Borrower may dissolve those certain inactive and minimally capitalized Subsidiaries designated as such on Schedule 7.1. 9.8 Notice of Certain Matters. Notify the Agent Bank immediately upon acquiring knowledge of the occurrence of any of the following events: (a) the institution or threatened institution of any lawsuit or administrative proceeding affecting the Borrower or any Subsidiary that is not covered by insurance (less applicable deductible amounts) and which, if determined adversely to the Borrower or such Subsidiary, could reasonably be expected to have a Material Adverse Effect; (b) the occurrence of any material adverse change, or of any event that in the good faith opinion of the Borrower is likely, to result in a material adverse change, in the assets, liabilities, financial condition, business or affairs of the Borrower or any Subsidiary; (c) the occurrence of any Event of Default or any Default; or (d) a change by Moody's Investors Service, Inc. or by Standard and Poor's Ratings Group in the rating of the Borrower's Funded Debt. 9.9 ERISA. At all times: (a) maintain and keep in full force and effect each Plan; (b) make contributions to each Plan in a timely manner and in an amount sufficient to comply with the minimum funding standards requirements of ERISA; (c) immediately upon acquiring knowledge of any "reportable event" or of any "prohibited transaction" (as such terms are defined in the Code ss. 4043) in connection with any Plan, furnish the Banks with a statement executed by the president or chief financial officer of the Borrower setting forth the details thereof and the action which the Borrower proposes to take with respect thereto and, when known, any action taken by the Internal Revenue Service with respect thereto; (d) notify the Banks promptly upon receipt by the Borrower or any Subsidiary of any notice of the institution of any proceeding or other action which may result in the termination of any Plan and furnish to the Banks copies of such notice; (e) acquire and maintain in amounts satisfactory to the Banks from either the Pension Benefit Guaranty Corporation or authorized private insurers, when available, the contingent employer liability coverage insurance required under ERISA; (f) furnish the Banks with copies of the summary annual report for each Plan filed with the Internal Revenue Service as the Agent or the Banks may request; and (g) furnish the Banks with copies of any request for waiver of the funding standards or extension of the amortization periods required by ss. 303 and ss. 304 of ERISA or ss. 412 of the Code promptly after the request is submitted to the Secretary of the Treasury, the Department of Labor or the Internal Revenue Service, as the case may be. 9.10 Compliance with Environmental Laws. At all times: (a) use and operate, and cause each Subsidiary to use and operate, all of their respective facilities and properties in material compliance with all Environmental Laws; keep, and cause each Subsidiary to keep, all necessary permits, approvals, orders, certificates, licenses and other authorizations relating to environmental matters in effect and remain in material compliance therewith; handle, and cause each Subsidiary to handle, all Hazardous Materials in material compliance with all applicable Environmental Laws; and dispose, and cause each Subsidiary to dispose, of all Hazardous Materials generated by the Borrower or any Subsidiary or at any property owned or leased by them at facilities or with carriers that maintain valid permits, approvals, certificates, licenses or other authorizations for such disposal under applicable Environmental Laws; (b) promptly notify the Agent and provide copies upon receipt of all written claims, complaints, notices or inquiries relating to the condition of the facilities and properties of the Borrower and each Subsidiary under, or their respective compliance with, applicable Environmental Laws wherein the condition or the noncompliance that is the subject of such claim, complaint, notice, or inquiry involves, or could reasonably be expected to involve, liability of or expenditures by the Borrower and its Subsidiaries of $10,000,000.00 or more; and (c) provide such information and certifications which the Banks may reasonably request from time to time to evidence compliance with this Section 9.10. 9.11 PGA Clauses. The Borrower will use its best efforts to maintain in force provisions in all of its tariffs and franchise agreements that permit the Borrower to recover from customers substantially all of the amount by which the cost of gas purchases exceeds the amount currently billed to customers for the delivery of such gas (sometimes referred to as PGA clauses). 10. NEGATIVE COVENANTS So long as the Borrower may borrow hereunder and until payment in full of the Notes, except with the written consent of the Banks: 10.1 Capital Requirements. The Borrower will not: (a) permit its Consolidated Net Worth at the end of any fiscal quarter to be less than the sum of (i) $1,267,663,000, (ii) 40% of Consolidated Net Income (if positive) for the period commencing on January 1, 2004 and ending on the date of determination, and treated as a single accounting period; (iii) the difference between (A) 100% of the net proceeds of any issuance of capital or preferred stock or any other Equity-Preferred Securities by the Borrower or any consolidated Subsidiary received by the Borrower or such consolidated Subsidiary at any time after January 1, 2004; and (B) the aggregate amount of all redemption or repurchase payments hereafter made, if any, by the Borrower and any such consolidated Subsidiary in connection with the repurchase by the Borrower or any such consolidated Subsidiary of any of their respective capital or preferred stock; (iv) without duplication, the difference between (A) 100% of the net proceeds heretofore and hereafter received by the Borrower and any consolidated Subsidiary in respect of the issuance by the Borrower or such consolidated Subsidiary of the Structured Securities, and (B) the aggregate amount of all redemption payments hereafter made, if any, by the Borrower and any such consolidated Subsidiary in connection with the redemption of any of the Structured Securities; and (v) the minority interests in the Borrower's Subsidiaries; or (b) permit the ratio of its Consolidated Total Indebtedness to its Consolidated Total Capitalization to be greater than 0.65 to 1.00 at the end of any fiscal quarter; or (c) acquire, or permit any Subsidiary to acquire, any assets other than (i) investments permitted under Section 10.4, or (ii) Qualifying Assets; or (d) permit the ratio of EBDIT to Cash Interest Expense for the four fiscal quarters most recently ended (considered as a single accounting period) at any time to be less than 2.00 to 1.00 at all times. 10.2 Mortgages, Liens, Etc. The Borrower will not, and will not permit any Subsidiary to, create or permit to exist any Lien (including the charge upon assets purchased under a conditional sales agreement, purchase money mortgage, security agreement or other title retention agreement) upon any of its respective assets, whether now owned or hereafter acquired, or assign or otherwise convey any right to receive income, except: (a) Liens for taxes not yet due or that are being contested in good faith by appropriate proceedings; (b) other Liens incidental to the conduct of its business or the ownership of its assets that were not incurred in connection with the borrowing of money or the obtaining of advances or credit, and that do not in the aggregate materially detract from the value of such assets or materially impair the use thereof in the operation of such business; (c) Liens on assets of a Subsidiary to secure obligations of such Subsidiary to the Borrower or another Subsidiary; and (d) Liens on property existing at the time of acquisition thereof by the Borrower or any Subsidiary, including without limitation, (i) any property acquired by the Borrower in consummating and finalizing any of the Prior Acquisitions, (ii) any Liens existing on any property of Panhandle Eastern or any of its Subsidiaries to secure existing Debt of Panhandle Eastern or any of its Subsidiaries as of the Closing Date, and (iii) any Liens against any property of Panhandle Eastern or any of its Subsidiaries to secure Panhandle Eastern Refinancing Debt (provided such Liens are limited to property of Panhandle Eastern or any of its Subsidiaries securing the Debt so extended, refinanced, renewed, replaced, defeased or refunded), or purchase money Liens placed on an item of real or personal property purchased by the Borrower or any Subsidiary to secure a portion of the purchase price of such property; provided that no such Lien may encumber or cover any other property of the Borrower or any Subsidiary. 10.3 Debt. The Borrower will not, and will not permit any Subsidiary to, incur or permit to exist any Debt, except: (a) Debt evidenced by the Notes, the Facility Letter of Credit Obligations or outstanding under the Term Loan Facility and any Equity-Preferred Securities (to the extent the same constitutes Debt) not in default, as well as (i) Debt of Panhandle Eastern and/or any of its Subsidiaries outstanding as of the Closing Date, (ii) any Panhandle Eastern Refinancing Debt, (iii) any loans or advances by the Borrower to Panhandle Eastern and/or any of the Borrower's other Subsidiaries permitted under Section 10.4(b) and (iv) any working capital credit facility or facilities provided directly to Panhandle Eastern and/or any of Panhandle Eastern's Subsidiaries by any party other than the Borrower, so long as the principal amount of all such outstanding working capital facilities, together with the outstanding principal amount of any working capital loans or advances by the Borrower to Panhandle Eastern and/or any of Panhandle Eastern's Subsidiaries, does not exceed (A) $50,000,000 in the aggregate at any time that the ratio of Consolidated Total Indebtedness to Consolidated Total Capitalization for Panhandle Eastern and Panhandle Eastern's Subsidiaries (excluding the Borrower and all other Subsidiaries of the Borrower for purposes of such calculation) is greater 0.65 to 1.00 and (B) $75,000,000 in the aggregate at any time that the ratio of Consolidated Total Indebtedness to Consolidated Total Capitalization for Panhandle Eastern and Panhandle Eastern's Subsidiaries (excluding the Borrower and all other Subsidiaries of the Borrower for purposes of such calculation) is less than or equal to 0.65 to 1.00; (b) Debt of any Subsidiary to the Borrower or any other Subsidiary, except to the extent limited by the terms of Section 10.4(b), and Debt of the Borrower to any Subsidiary; (c) Debt existing as of December 31, 2003 as reflected on financial statements delivered under Section 7.2(b) and refinancings thereof other than Debt that has been refinanced by the proceeds of Loans; (d) endorsements in the ordinary course of business of negotiable instruments in the course of collection; (e) Debt of the Borrower or any Subsidiary representing the portion of the purchase price of property acquired by the Borrower or such Subsidiary that is secured by Liens permitted by the provisions of Section 10.2(d); provided, however, that at no time may the aggregate principal amount of such Debt outstanding exceed thirty percent (30%) of the Consolidated Net Worth of the Borrower and its Subsidiaries as of the applicable determination date; (f) Debt evidenced by Senior Notes; (g) additional Debt of the Borrower and Structured Securities of the Borrower and the Southern Union Trusts provided that after giving effect to the issuance thereof, there shall exist no Default or Event of Default; and: (i) the ratio of Consolidated Total Indebtedness to Consolidated Total Capitalization shall be no greater than 0.65 to 1.00 at all times; (ii) the ratio of EBDIT for the four fiscal quarters most recently ended to pro forma Cash Interest Expense for the following four fiscal quarters shall be no less than 2.00 to 1.0 at all times; provided, however, that if the additional Debt for which the determinations required to be made by this subparagraph (g) will be used to finance in whole or in part the consideration to be paid by the Borrower for the acquisition of any entity otherwise permitted under the terms of this Agreement, the determination of EBDIT for purposes of this ratio shall include not only the EBDIT of the Borrower and its Subsidiaries for the four fiscal quarters most recently ended, but shall also include the EBDIT of such entity to be acquired for such four fiscal quarters most recently ended; and (iii) (A) such Debt and Structured Securities shall have a final maturity or mandatory redemption date, as the case may be, no earlier than the Maturity Date and shall mature or be subject to mandatory redemption or mandatory defeasance no earlier than the Maturity Date (as so extended) and shall be subject to no mandatory redemption or "put" to the Borrower or any Southern Union Trust exercisable, or sinking fund or other similar mandatory principal payment provisions that require payments to be made toward principal, prior to such Maturity Date (as so extended); or (B) (x) such additional Debt shall have a final maturity date prior to the Maturity Date, (y) such additional Debt shall not exceed Two Hundred Fifty Million Dollars ($250,000,000.00) in the aggregate plus Twenty Million Dollars ($20,000,000.00) of reimbursement obligations incurred in connection with Non-Facility Letters of Credit issued by a Bank or Banks or by any other financial institution; provided, however, that for purposes of determining the aggregate amount of such additional Debt for purposes of this subclause (y), the Debt of the Borrower under the Term Loan Facility shall not be included and such Debt under the Term Loan Facility shall be deemed to be permitted Debt for purposes of this subclause (y), and (z) such additional Debt shall be borrowed from a Bank or Banks as a loan or loans arising independent of this Agreement or the Term Loan Facility or shall be borrowed from a financial institution that is not a Bank under this Agreement or the Term Loan Facility; and (h) additional Debt of Trunkline LNG Holdings or any of its Subsidiaries, so long as (i) such Debt is to Trunkline LNG Holdings and/or any of its Subsidiaries only and is not recourse in any respect to the Borrower or any other Subsidiary of the Borrower (other than Panhandle Eastern and its Subsidiaries), (ii) the proceeds of such Debt is used solely to finance capital expenditures of Trunkline LNG Holdings and/or its Subsidiaries, and (iii) after giving effect to such Debt, no Default or Event of Default shall exist. 10.4 Loans, Advances and Investments. The Borrower will not, and will not permit any Subsidiary to, make or have outstanding any loan or advance to, or own or acquire any stock or securities of or equity interest or other Investment in, any Person, except (without duplication): (a) stock or other equity interests of (i) the Subsidiaries named in Section 7.1; (ii) other entities that are acquired by the Borrower or any Subsidiary but that are promptly merged with and into the Borrower; (iii) Southern Union Panhandle, Panhandle Eastern and any Subsidiaries of Panhandle Eastern acquired as a result of the Panhandle Eastern Acquisition; and (iv) the same Qualifying Entities as the Qualifying Entities under subparagraph (ii) of the definition of "Qualifying Assets," provided that at any time the aggregate purchase price paid for such stock and other equity interests in such Qualifying Entities then held by the Borrower as of the applicable determination date, including the aggregate amount of Debt assumed or deemed incurred by Borrower in connection with the purchase of such stock and other equity interests, is not more than twenty percent (20%) of the Consolidated Net Worth of the Borrower and its Subsidiaries as of the applicable determination date; (b) loans or advances to a Subsidiary; provided, however, that the principal amount of such loans and advances for working capital purposes at any time outstanding to Panhandle Eastern and/or any of Panhandle Eastern's Subsidiaries, together with the principal amount of any outstanding working capital credit facility or facilities provided directly to Panhandle Eastern and/or any of Panhandle Eastern's Subsidiaries by any party other than the Borrower, does not exceed $25,000,000 in the aggregate at any time; (c) Securities maturing no more than 180 days after Borrower's purchase that are either: (i) readily marketable securities issued by the United States or its agencies or instrumentalities; or (ii) commercial paper rated "Prime 2" by Moody's Investors Service, Inc. ("Moody's") or A-2 by Standard and Poor's Ratings Group ("S & P"); or (iii) certificates of deposit or repurchase contracts on customary terms with financial institutions in which deposits are insured by any agency or instrumentality of the United States; or (iv) readily marketable securities received in settlement of liabilities created in the ordinary course of business; or (v) obligations of states, agencies, counties, cities and other political subdivisions of any state rated at lest MIG2, VMIG2 or Aa by Moody's or AA by S & P; or (vi) loan participations in credits in which the borrower's debt is rated at least Aa or Prime 2 by Moody's or AA or A-2 by S & P; or (vii) money market mutual funds that are regulated by the Securities and Exchange Commission, have a dollar-weighted average stated maturity of 90 days or fewer on their investments and include in their investment objectives the maintenance of a stable net asset value of $1 for each share. (d) other equity interests owned by a Subsidiary on the date of this Agreement and such additional equity interests to the extent (but only to the extent) that such Subsidiary is legally obligated to acquire those interests on the date of this Agreement, in each case as disclosed to the Banks in writing; (e) loans or advances by the Borrower to customers in connection with and pursuant to marketing and merchandising products that the Borrower reasonably expects to increase sales of the Borrower or Subsidiaries, provided that: (i) such loans must be either less than $2,000,000.00 to any one customer (or group of affiliated customers, shown on the Borrower's records to be Affiliates) or must be disclosed on Schedule 9.2 hereof; and (ii) all such loans must not exceed $24,000,000.00 in the aggregate outstanding at any time; (f) travel and expense advances in the ordinary course of business to officers and employees; (g) stock or securities of or equity interests in, any Person provided that, after giving effect to the acquisition and ownership thereof, the Borrower is in compliance with the provisions of Section 10.1(c) of this Agreement; and (h) loans, advances or other Investments by the Borrower or any Subsidiary not otherwise permitted under the other provisions of this Section 10.4, so long as the sum of the outstanding balance of all of such loans and advances and the purchase price paid for all of such other Investments does not exceed in the aggregate seven percent (7%) of the Consolidated Net Worth of the Borrower and its Subsidiaries as of the applicable determination date. 10.5 Stock and Debt of Subsidiaries. The Borrower will not, and will not permit any Subsidiary to, sell or otherwise dispose of any shares of stock, other equity interests or Debt of any Subsidiary, or permit any Subsidiary to issue or dispose of its stock (other than directors' qualifying shares), except for the following: (i) the sale, transfer or issuance of stock, other equity interests or Debt of any Subsidiary to the Borrower or another Subsidiary of the Borrower; (ii) the sale of stock in Trunkline LNG Holdings and Debt of Trunkline LNG Holdings as a result of the Trunkline LNG Holdings Sale; (iii) the sale of stock in Sea Robin Pipeline Company and Debt of Sea Robin Pipeline Company, (iv) the issuance by Southern Union Trusts of preferred beneficial interests in public offerings of Borrower's Structured Securities, and (v) the issuance by other Subsidiaries of the Borrower formed for the purpose of issuing Equity-Preferred Securities. 10.6 Merger, Consolidation, Etc. The Borrower will not, and will not permit any Subsidiary to, merge or consolidate with any other Person or sell, lease, transfer or otherwise dispose of (whether in one transaction or a series of transactions) all or a substantial part of its assets or acquire (whether in one transaction or a series of transactions) all or a substantial part of the assets of any Person, except that: (a) any Subsidiary may merge or consolidate with the Borrower (provided that the Borrower shall be the continuing or surviving corporation) or with any one or more Subsidiaries; (b) any Subsidiary may sell, lease, transfer or otherwise dispose of any of its assets to the Borrower or another Subsidiary; (c) the Borrower may acquire the assets of any Person, provided that, after giving effect to such acquisition, the Borrower is in compliance with the provisions of Sections 10.1(c); and (d) the Borrower or any Subsidiary may sell, lease, assign or otherwise dispose of assets as otherwise permitted under Section 10.8. 10.7 Supply and Purchase Contracts. The Borrower will not, and will not permit any Subsidiary to, enter into or be a party to any contract for the purchase of materials, supplies or other property if such contract requires that payment for such materials, supplies or other property shall be made regardless of whether or not delivery is ever made or tendered of such materials, supplies and other property, except in those circumstances and involving those supply or purchase contracts that the Borrower reasonably considers to be necessary or helpful in its operations in the ordinary course of business and that the Borrower reasonably considers not to be unnecessarily burdensome on the Borrower or its Subsidiaries. 10.8 Sale or Other Disposition of Assets. The Borrower will not, and will not permit any Subsidiary to, except as permitted under this Section 10.8, sell, assign, lease, or otherwise dispose of (whether in one transaction or in a series of transactions) all or any part of its Property (whether now owned or hereafter acquired); provided, however, that (i) the Borrower or any Subsidiary may in the ordinary course of business dispose of (a) Property consisting of Inventory; and (b) Property consisting of goods or equipment that are, in the opinion of the Borrower or any Subsidiary, obsolete or unproductive, but if in the good faith judgment of the Borrower or any Subsidiary such disposition without replacement thereof would have a Material Adverse Effect, such goods and equipment shall be replaced, or their utility and function substituted, by new or existing goods or equipment; (ii) the Borrower may transfer or dispose of any of its Significant Property (in any transaction or series of transactions) to any Subsidiary or Subsidiaries only if such Property so transferred or disposed of after the Closing Date has an aggregate value (determined after depreciation and in accordance with GAAP) of not more than ten percent (10%) of the aggregate value of all of the Borrower's and its Subsidiaries' real property and tangible personal property other than Inventory considered on a consolidated basis and determined after depreciation and in accordance with GAAP, as of December 31, 2003; (iii) the Borrower may dispose of its real property in one or more sale/leaseback transactions, provided that any Debt incurred in connection with such transaction does not create a Default as defined herein; (iv) a Southern Union Trust may distribute the Borrower's subordinated debt securities constituting a portion of the Structured Securities, on the terms and under the conditions set out in the registration statement therefor filed with the Securities and Exchange Commission on March 25, 1995 or any similar registration statement filed with the Securities and Exchange Commission in connection with any other Structured Securities issued in connection with the Prior Acquisitions; (v) the Borrower or any Subsidiary may dispose of real property or tangible personal property other than Inventory (in consideration of such amount as in the good faith judgment of the Borrower or such Subsidiary represents a fair consideration therefor), provided that the aggregate value of such property disposed of (determined after depreciation and in accordance with GAAP) after the Closing Date does not exceed ten percent (10%) of the aggregate value of all of the Borrower's and its Subsidiaries' real property and tangible personal property other than Inventory considered on a consolidated basis and determined after depreciation and in accordance with GAAP, as of December 31, 2003; (vi) the Borrower may dispose of Qualifying Assets of the type described in clause (ii) of the definition of Qualifying Assets, provided that the Borrower applies the net proceeds from such disposition against the Borrower's Debt under the Term Loan Facility, to the extent then outstanding, and the balance of such net sales proceeds, if any, shall be applied against the Loans in an amount equal to the lesser of (a) the balance of such net sales proceeds not applied against the Term Loan Facility, and (b) the amount of Loan proceeds previously advanced to finance the acquisition of such clause (ii) Qualifying Assets; (vii) the Borrower may dispose of other Investments of the type acquired under the terms of Section 10.4(h), provided that the Borrower applies the net proceeds from such disposition against the Borrower's Debt under the Term Loan Facility, to the extent then outstanding, and the balance of such net sales proceeds, if any, shall be applied against the Loans in an amount equal to the lesser of (a) the balance of such net sales proceeds not applied against the Term Loan Facility, and (b) the amount of Loan proceeds previously advanced to finance the acquisition of such other Investments; (viii) Panhandle Eastern may sell all stock or all or substantially all of the assets in Trunkline LNG Holdings pursuant to the Trunkline LNG Holdings Sale; and (ix) the Borrower may sell all stock or all or substantially all of the assets in Sea Robin Pipeline Company. 10.9 Discount or Sale of Receivables. The Borrower will not, and will not permit any Subsidiary, other than Southern Union Total Energy Services, Inc., to discount or sell with recourse, or sell for less than the face value thereof (including any accrued interest) any of its notes receivable, receivables under leases or other accounts receivable, unless all net proceeds received by the Borrower from any such discount or sale are applied against the Borrower's Debt under the Term Loan Facility. 10.10 Change in Accounting Method. The Borrower will not, and will not permit any Subsidiary to, make any change in the method of computing depreciation for either tax or book purposes or any other material change in accounting method representing any departure from GAAP without the Majority Banks' prior written approval. 10.11 Restricted Payment. The Borrower will not pay or declare any Restricted Payment unless immediately prior to such payment and after giving effect to such payment, the Borrower could incur at least $1 of additional Debt without violating the provisions of Section 10.3(g) and after giving effect thereto no Default or Event of Default exists hereunder; provided, however, that the Borrower's ability to purchase or agree to purchase its common stock and/or preferred equity securities (including without limitation, Equity-Preferred Securities) shall be limited as follows: (a) not more than $50,000,000 in the aggregate of common stock and preferred equity securities may be repurchased per each fiscal year of the Borrower at any time the ratio of Consolidated Total Indebtedness to Consolidated Total Capitalization for the Borrower and its Subsidiaries is greater than 0.60 to 1.00; (b) not more than $100,000,000 in the aggregate of common stock and preferred equity securities may be repurchased per each fiscal year of the Borrower at any time the ratio of Consolidated Total Indebtedness to Consolidated Total Capitalization for the Borrower and its Subsidiaries is less than or equal to 0.60 to 1.00; and (c) no repurchases of common stock or preferred equity securities may be made if the Borrower's unsecured, non-credit enhanced senior debt as specified by Standard & Poor's Ratings Group and Moody's Investor Service, Inc. falls below either BBB- or Baa3, respectively. 10.12 Securities Credit Regulations. Neither the Borrower nor any Subsidiary will take or permit any action which might cause the Loans or the Facility Letter of Credit Obligations or this Agreement to violate Regulation G, Regulation T, Regulation U, Regulation X or any other regulation of the Board of Governors of the Federal Reserve System or a violation of the Securities Exchange Act of 1934, in each case as now or hereafter in effect. 10.13 Nature of Business; Management. The Borrower will not, and will not permit any Subsidiary to: (a) change its principal line of business; or (b) enter into any business not within the scope of Section 7.15 and the definition of Qualifying Assets; or (c) permit any material overall change in the management of the Borrower. 10.14 Transactions with Related Parties. The Borrower will not, and will not permit any Subsidiary to, enter into any transaction or agreement with any officer, director or holder of ten percent (10%) or more of any class of the outstanding capital stock of the Borrower or any Subsidiary (or any Affiliate of any such Person) unless the same is upon terms substantially similar to those obtainable from wholly unrelated sources. 10.15 Hazardous Materials. The Borrower will not, and will not permit any Subsidiary to (a) cause or permit any Hazardous Materials to be placed, held, used, located, or disposed of on, under or at any of such Person's property or any part thereof by any Person in a manner which could reasonably be expected to have a Material Adverse Effect; (b) cause or permit any part of any of such Person's property to be used as a manufacturing, storage, treatment or disposal site for Hazardous Materials, where such action could reasonably be expected to have a Material Adverse Effect; or (c) cause or suffer any liens to be recorded against any of such Person's property as a consequence of, or in any way related to, the presence, remediation, or disposal of Hazardous Materials in or about any of such Person's property, including any so-called state, federal or local "superfund" lien relating to such matters, where such recordation could reasonably be expected to have a Material Adverse Effect. 10.16 Limitations on Payments on Subordinated Debt. The Borrower will not, and will not permit any Subsidiary to, make any payment in respect of interest on, principal of, or otherwise relating to, the borrower's subordinated debt securities issued in connection with the Structured Securities if, after giving effect to such payment, a Default or Event of Default would exist. 10.17 No Agreements Prohibiting Pledge of Southern Union Panhandle Stock. The Borrower will not enter into any contract or other agreement with any Person that directly or indirectly prohibits the Borrower from granting any Lien against the stock or other equity interests in Southern Union Panhandle (whether common, preferred or another class of equity ownership) at any time owned and held by the Borrower as security for any Debt of the Borrower or any of its Subsidiaries, other than the applicable negative covenants of this Agreement and the Term Loan Facility. 11. EVENTS OF DEFAULT; REMEDIES If any of the following events shall occur, then the Agent shall at the request, or may with the consent, of the holders of more than fifty percent (50%) in principal amount of the Notes then outstanding or, if no Note is then outstanding, Banks having more than fifty percent (50%) of the Commitments, (a) by notice to the Borrower, declare the Commitment of each Bank and the several obligation of each Bank to make Loans hereunder to be terminated, whereupon the same shall forthwith terminate, and (b) declare the Notes and all interest accrued and unpaid thereon, and all other amounts payable under the Notes, this agreement and the other Loan Documents, to be forthwith due and payable, whereupon the Notes, all such interest and all such other amounts, shall become and be forthwith due and payable without presentment, demand, protest, or further notice of any kind (including, without limitation, notice of default, notice of intent to accelerate and notice of acceleration), all of which are hereby expressly waived by the Borrower; provided, however, that with respect to any Event of Default described in Sections 11.7 or 11.8 hereof, (i) the Commitment of each Bank and the obligation of the Banks to make Loans shall automatically be terminated and (ii) the entire unpaid principal amount of the Notes, all interest accrued and unpaid thereon, and all such other amounts payable under the Notes, this Agreement and the other Loan Documents, shall automatically become immediately due and payable, without presentment demand, protest, or any notice of any kind (including, without limitation, notice of default, notice of intent to accelerate and notice of acceleration), all of which are hereby expressly waived by the Borrower: 11.1 Failure to Pay Principal or Interest. The Borrower does not pay, repay or prepay any principal of or interest on any Note when due. 11.2 Failure to Pay Commitment Fee or Other Amounts. The Borrower does not pay any commitment fee or any other obligation or amount payable under this Agreement, the Notes, or any Letter of Credit Reimbursement Agreement within five (5) calendar days after the same shall have become due. 11.3 Failure to Pay Other Debt. The Borrower or any Subsidiary fails to pay principal or interest on any other Debt aggregating more than $3,000,000.00 when due and any related grace period has expired, or the holder of any of such other Debt declares such Debt due prior to its stated maturity because of the Borrower's or any Subsidiary's default thereunder and the expiration of any related grace period. 11.4 Misrepresentation or Breach of Warranty. Any representation or warranty made by the Borrower herein or otherwise furnished to the Bank in connection with this Agreement or any other Loan Document shall be incorrect, false or misleading in any material respect when made. 11.5 Violation of Negative Covenants. The Borrower violates any covenant, agreement or condition contained in Sections 10.2, 10.3, 10.5, 10.6, 10.8, 10.9, 10.10, 10.11, or 10.15. 11.6 Violation of Other Covenants, Etc. The Borrower violates any other covenant, agreement or condition contained herein (other than the covenants, agreements and conditions set forth or described in Sections 11.1, 11.2, 11.3, 11.4, and 11.5 above) or in any other Loan Document and such violation shall not have been remedied within (30) days after the earlier of (i) actual discovery by the Borrower of such violation or (ii) written notice has been received by the Borrower from the Bank or the holder of the Note. 11.7 Bankruptcy and Other Matters. The Borrower or any Subsidiary (a) makes an assignment for the benefit of creditors; or (b) admits in writing its inability to pay its debts generally as they become due; or (c) generally fails to pay its debts as they become due; or (d) files a petition or answer seeking for itself, or consenting to or acquiescing in, any reorganization, arrangement, composition, readjustment, liquidation, dissolution, or similar relief under any applicable Debtor Law (including, without limitation, the Federal Bankruptcy Code); or (i) there is appointed a receiver, custodian, liquidator, fiscal agent, or trustee of the Borrower or any Subsidiary or of the whole or any substantial part of their respective assets; or (ii) any court enters an order, judgment or decree approving a petition filed against the Borrower or any Subsidiary seeking reorganization, arrangement, composition, readjustment, liquidation, dissolution, or similar relief under any Debtor Law and either such order, decree or judgment so filed against it is not dismissed or stayed (unless and until such stay is no longer in effect) within thirty (30) days of entry thereof or an order for relief is entered pursuant to any such law. 11.8 Dissolution. Any order is entered in any proceeding against the Borrower or any Subsidiary decreeing the dissolution, liquidation, winding-up or split-up of the Borrower or such Subsidiary, and such order remains in effect for thirty (30) days. 11.9 Undischarged Judgment. Final Judgment or judgments in the aggregate, that might be or give rise to Liens on any property of the Borrower or any Subsidiary, for the payment of money in excess of $5,000,000.00 shall be rendered against the Borrower or any Subsidiary and the same shall remain undischarged for a period of thirty (30) days during which execution shall not be effectively stayed. 11.10 Environmental Matters. The occurrence of any of the following events that could result in liability to the Borrower or any Subsidiary under any Environmental Law or the creation of a Lien on any property of the Borrower or any Subsidiary in favor of any governmental authority or any other Person for any liability under any Environmental Law or for damages arising from costs incurred by such Person in response to a Release or threatened Release of Hazardous Materials into the environment if any such asserted liability or Lien exceeds $10,000,000.00 and if any such lien would cover any property of the Borrower or any Subsidiary which property is or would reasonably be considered to be integral to the operations of the Borrower or any Subsidiary in the ordinary course of business: (a) the Release of Hazardous Materials at, upon, under or within the property owned or leased by the Borrower or any Subsidiary or any contiguous property; (b) the receipt by the Borrower or any Subsidiary of any summons, claim, complaint, judgment, order or similar notice that it is not in compliance with or that any governmental authority is investigating its compliance with any Environmental Law; (c) the receipt by the Borrower or any Subsidiary of any notice or claim to the effect that it is or may be liable for the Release or threatened Release of Hazardous Materials into the environment; or (d) any governmental authority incurs costs or expenses in response to the Release of any Hazardous Material which affects in any way the properties of the Borrower or any Subsidiary. 11.11 Other Remedies. In addition to and cumulative of any rights or remedies expressly provided for in this Section 11, if any one or more Events of Default shall have occurred, the Agent shall at the request, and may with the consent, of the Majority Banks proceed to protect and enforce the rights of the Banks hereunder by any appropriate proceedings. The Agent shall at the request, and may with the consent, of the Majority Banks also proceed either by the specific performance of any covenant or agreement contained in this Agreement or by enforcing the payment of the Notes or by enforcing any other legal or equitable right provided under this Agreement or the Notes or otherwise existing under any law in favor of the holder of the Notes. 11.12 Remedies Cumulative. No remedy, right or power conferred upon the Banks is intended to be exclusive of any other remedy, right or power given hereunder or now or hereafter existing at law, in equity, or otherwise, and all such remedies, rights and powers shall be cumulative. 11.13 Default under Term Loan Facility. The occurrence of an Event of Default (as defined under the credit agreement evidencing the Term Loan Facility) shall also constitute an Event of Default under this Agreement. 12. THE AGENT 12.1 Authorization and Action. Each Bank hereby appoints JPMorgan as its Agent under and irrevocably authorizes the Agent (subject to Sections 12.1 and 12.7) to take such action as the Agent on its behalf and to exercise such powers under this Agreement and the Notes as are delegated to the Agent by the terms thereof, together with such powers as are reasonably incidental thereto. Without limitation of the foregoing, each Bank expressly authorizes the Agent to execute, deliver, and perform its obligations under this Agreement, and to exercise all rights, powers, and remedies that the Agent may have hereunder. As to any matters not expressly provided for by this Agreement (including, without limitation, enforcement or collection of the Notes), the Agent shall not be required to exercise any discretion or take any action, but shall be required to act, or to refrain from acting (and shall be fully protected in so acting or refraining from acting), upon the instructions of the Majority Banks, and such instructions shall be binding upon all the Banks and all holders of any Note; provided, however, that the Agent shall not be required to take any action which exposes the Agent to personal liability or which is contrary to this Agreement or applicable law. The Agent agrees to give to each Bank prompt notice of each notice given to it by the Borrower pursuant to the terms of this Agreement. 12.2 Agent's Reliance, Etc. Neither the Agent nor any of its directors, officers, agents, or employees shall be liable to any Bank for any action taken or omitted to be taken by it or them under or in connection with this Agreement, the Notes and the other Loan Documents, except for its or their own gross negligence or willful misconduct. Without limitation of the generality of the foregoing, the Agent: (a) may treat the original or any successor holder of any Note as the holder thereof until the Agent receives notice from the Bank which is the payee of such Note concerning the assignment of such Note; (b) may employ and consult with legal counsel (including counsel for the Borrower), independent public accountants, and other experts selected by it and shall not be liable to any Bank for any action taken, or omitted to be taken, in good faith by it or them in accordance with the advice of such counsel, accountants, or experts received in such consultations and shall not be liable for any negligence or misconduct of any such counsel, accountants, or other experts; (c) makes no warranty or representation to any Bank and shall not be responsible to any Bank for any opinions, certifications, statements, warranties, or representations made in or in connection with this Agreement; (d) shall not have any duty to any Bank to ascertain or to inquire as to the performance or observance of any of the terms, covenants, or conditions of this Agreement or any other instrument or document furnished pursuant thereto or to satisfy itself that all conditions to and requirements for any Loan have been met or that the Borrower is entitled to any Loan or to inspect the property (including the books and records) of the Borrower or any Subsidiary; (e) shall not be responsible to any Bank for the due execution, legality, validity, enforceability, genuineness, sufficiency, or value of this Agreement or any other instrument or document furnished pursuant thereto; and (f) shall incur no liability under or in respect of this Agreement by acing upon any notice, consent, certificate, or other instrument or writing (which may be by telegram, cable, telex, or otherwise) believed by it to be genuine and signed or sent by the proper party or parties. 12.3 Defaults. The Agent shall not be deemed to have knowledge of the occurrence of a Default (other than the nonpayment of principal of or interest hereunder or of any fees) unless the Agent has received notice from a Bank or the Borrower specifying such Default and stating that such notice is a Notice of Default. In the event that the Agent receives such a notice of the occurrence of a Default, the Agent shall give prompt notice thereof to the Banks (and shall give each Bank prompt notice of each such nonpayment). The Agent shall (subject to Section 12.7) take such action with respect to such Default; provided that, unless and until the Agent shall have received the directions referred to in Sections 12.1 or 12.7, the Agent may (but shall not be obligated to) take such action, or refrain from taking such action, with respect to such Default as it shall deem advisable and in the best interest of the Banks. 12.4 JPMorgan and Affiliates. With respect to its Commitment, any Loan made by it, and the Note issued to it, JPMorgan shall have the same rights and powers under this Agreement as any other Bank and may exercise the same as though it were not the Agent; and the term "Bank" or "Banks" shall, unless otherwise expressly indicated, include JPMorgan in its individual capacity. JPMorgan and its respective Affiliates may accept deposits from, lend money to, act as trustee under indentures of, and generally engage in any kind of business with, the Borrower, any of its respective Affiliates and any Person who may do business with or own securities of the Borrower or any such Affiliate, all as if JPMorgan were not the Agent and without any duty to account therefor to the Banks. 12.5 Non-Reliance on Agent and Other Banks. Each Bank agrees that it has, independently and without reliance on the Agent or any other Bank, and based on such documents and information as it has deemed appropriate, made its own credit analysis of the Borrower and each Subsidiary and its decision to enter into the transactions contemplated by this Agreement and that it will, independently and without reliance upon the Agent or any other Bank, and based on such documents and information as it shall deem appropriate at the time, continue to make its own analysis and decisions in taking or not taking action under this Agreement. The Agent shall not be required to keep itself informed as to the performance or observance by the Borrower of this Agreement or to inspect the properties or books of the Borrower or any Subsidiary. Except for notices, reports, and other documents and information expressly required to be furnished to the Banks by the Agent hereunder, the Agent shall not have any duty or responsibility to provide any Bank with any credit or other information concerning the affairs, financial condition, or business of the Borrower or any Subsidiary (or any of their Affiliates) which may come into the possession of the Agent or any of its Affiliates. 12.6 Indemnification. Notwithstanding anything to the contrary herein contained, the Agent shall be fully justified in failing or refusing to take any action hereunder unless it shall first be indemnified to its satisfaction by the Banks against any and all liabilities, obligations, losses, damages, penalties, actions, judgments, suits, costs, expenses, and disbursements of any kind or nature whatsoever which may be imposed on, incurred by or asserted against the Agent in any way relating to or arising out of its taking or continuing to take any action. Each Bank agrees to indemnify the Agent (to the extent not reimbursed by the Borrower), according to such Bank's Commitment, from and against any and all liabilities, obligations, losses, damages, penalties, actions, judgments, suits, costs, expenses, and disbursements of any kind or nature whatsoever which may be imposed on, incurred by, or asserted against the Agent in any way relating to or arising out of this Agreement or the Notes or any action taken or omitted by the Agent under this Agreement or the Notes; provided that no Bank shall be liable for any portion of such liabilities, obligations, losses, damages, penalties, actions, judgments, suits, costs, expenses, or disbursements resulting from the gross negligence or willful misconduct of the person being indemnified; and provided further that it is the intention of each Bank to indemnify the Agent against the consequences of the Agent's own negligence, whether such negligence be sole, joint, concurrent, active or passive. Without limitation of the foregoing, each Bank agrees to reimburse the Agent promptly upon demand for its Pro Rata Percentage of any out-of-pocket expenses (including attorneys' fees) incurred by the Agent in connection with the preparation, administration, or enforcement of, or legal advice in respect of rights or responsibilities under, this Agreement and the Notes, to the extent that the Agent is not reimbursed for such expenses by the Borrower. 12.7 Successor Agent. The Agent may resign at any time as Agent under this Agreement by giving written notice thereof to the Banks and the Borrower and may be removed at any time with or without cause by the Majority Banks. Upon any such resignation or removal, the Majority Banks shall have the right to appoint a successor Agent. If no successor Agent shall have been so appointed by the Majority Banks or shall have accepted such appointment within thirty (30) days after the retiring Agent's giving of notice of resignation or the Majority Banks' removal of the retiring Agent, then the retiring Agent may, on behalf of the Banks, appoint a successor Agent, which shall be a commercial bank organized under the laws of the United States of America or of any State thereof and having a combined capital and surplus of at least $500,000,000.00. Upon the acceptance of any appointment as Agent hereunder by a successor Agent, such successor Agent shall thereupon succeed to and become vested with all the rights, powers, privileges and duties of the retiring Agent, and the retiring Agent shall be discharged from its duties and obligations under this Agreement. After any retiring Agent's resignation or removal hereunder as Agent, the provisions of this Section 12 shall inure to its benefit as to any actions taken or omitted to be taken by it while it was Agent under this Agreement. 12.8 Agent's Reliance. The Borrower shall notify the Agent in writing of the names of its officers and employees authorized to request a Loan on behalf of the Borrower and shall provide the Agent with a specimen signature of each such officer or employee. The Agent shall be entitled to rely conclusively on such officer's or employee's authority to request a Loan on behalf of the Borrower until the Agent receives written notice from the Borrower to the contrary. The Agent shall have no duty to verify the authenticity of the signature appearing on any Notice of Borrowing, and, with respect to any oral request for a Loan, the Agent shall have no duty to verify the identity of any Person representing himself as one of the officers or employees authorized to make such request on behalf of the Borrower. Neither the Agent nor any Bank shall incur any liability to the Borrower in acting upon any telephonic notice referred to above which the Agent or such Bank believes in good faith to have been given by a duly authorized officer or other Person authorized to borrow on behalf of the Borrower or for otherwise acting in good faith. 13. MISCELLANEOUS 13.1 Representation by the Banks. Each Bank represents that it is the intention of such Bank, as of the date of its acquisition of its Note, to acquire the Note for its account or for the account of its Affiliates, and not with a view to the distribution or sale thereof, and, subject to any applicable laws, the disposition of such Bank's property shall at all times be within its control. The Notes have not been registered under the Securities Act of 1933, as amended (the "Securities Act"), and may not be transferred, sold or otherwise disposed of except (a) in a registered Offering under the Securities Act; (b) pursuant to an exemption from the registration provisions of the Securities Act; or (c) if the Securities Act shall not apply to the Notes or the transactions contemplated hereunder as commercial lending transactions. 13.2 Amendments, Waivers, Etc. No amendment or waiver of any provision of any Loan Document, nor consent to any departure by the Borrower therefrom, shall in any event be effective unless the same shall be in writing and signed by the Borrower and the Majority Banks, and then such waiver or consent shall be effective only in the specific instance and for the specific purpose for which given; provided, however, that no amendment, waiver, or consent shall, unless in writing and signed by each Bank, do any of the following: (a) waive any of the conditions specified in Section 8; (b) increase the Commitment of any Bank or alter the term thereof, or subject any Bank to any additional or extended obligations; (c) change the principal of, or rate of interest on, any Note, or any fees or other amounts payable hereunder; (d) postpone any date fixed for any payment of principal of, or interest on, any Note, or any fees (including, without limitation, any fee) or other amounts payable hereunder; (e) change the percentage of the Commitments or of the aggregate unpaid principal amount of any Note, or the number of Banks which shall be required for Banks, or any of them, to take any action hereunder; or (f) amend this Section 13.2; and provided, further, that no amendment, waiver, or consent shall, unless in writing and signed by the Agent in addition to each Bank, affect the rights or duties of the Agent under any Loan Document. No failure or delay on the part of any Bank or the Agent in exercising any power or right hereunder shall operate as a waiver thereof nor shall any single or partial exercise of any such right or power, or any abandonment or discontinuance of steps to enforce such a right or power, preclude any other or further exercise thereof or the exercise of any other right or power. No course of dealing between the Borrower and any Bank or the Agent shall operate as a waiver of any right of any Bank or the Agent. No modification or waiver of any provision of this Agreement or the Note nor consent to any departure by the Borrower therefrom shall in any event be effective unless the same shall be in writing, and then such waiver or consent shall be effective only in the specific instance and for the purpose for which given. No notice to or demand on the Borrower in any case shall entitle the Borrower to any other or further notice or demand in similar or other circumstances. 13.3 Reimbursement of Expenses. The Borrower agrees to reimburse each Bank for its reasonable out-of-pocket expenses, including the reasonable fees and expenses of counsel to each Bank, in connection with the transactions contemplated by this Agreement, whether or not such contemplated transactions shall be consummated, or any of them, or otherwise in connection with this Agreement, including its negotiation, preparation, execution, administration, modification and enforcement, and all reasonable fees, including the reasonable fees and expenses of counsel to the Agent and each Bank, costs and expenses of the Agent for environmental consultants and costs and expenses of the Agent and each Bank in connection with due diligence, transportation, computer time and research and duplication. The Borrower agrees to pay any and all stamp and other taxes which may be payable or determined to be payable in connection with the execution and delivery of this Agreement or the Notes, and to save any holder of any Note harmless from any and all liabilities with respect to or resulting from any delay or omission to pay any such taxes. The obligations of the Borrower under this Section 13.3 shall survive the termination of this Agreement and/or the payment of the Notes. 13.4 Notices. All notices and other communications provided for herein shall be in writing (including telex, facsimile, or cable communication) and shall be mailed, telecopied, telexed, cabled or delivered addressed as follows: (a) If to the Borrower, to it at: Southern Union Company One PEI Center Wilkes-Barre, Pennsylvania 18711-0601 Attention: Mr.Richard N.Marshall Fax:(570) 820-2401 with copies to: Southern Union Company One PEI Center Wilkes-Barre, Pennsylvania 18711-0601 Attention: Dennis K. Morgan, Esq. Fax: (570) 820-2402 (b) If to the Agent,to it at: JPMorgan Chase Bank 700 Lavaca, 2nd Floor Austin, Texas 78701 Attention: Manager/Commercial Lending Fax: (512) 479-2853 with a copy to: JPMorgan Chase Bank Loan and Agency Services 1111 Fannin, Floor 10 Houston, Texas 77002 Attention: Michelle Straley Fax: (713) 427-6307 and if to any Bank, at the address specified below its name on the signature pages hereof, or as to the Borrower or the Agent, to such other address as shall be designated by such party in a written notice to the other party and, as to each other party, at such other address as shall be designated by such party in a written notice to the Borrower and the Agent. All such notices and communications shall, when mailed, telecopied, telexed, transmitted, or cabled, become effective when deposited in the mail, confirmed by telex answer back, transmitted to the telecopier, or delivered to the cable company, except that notices and communications to the Agent under Sections 2.1(c) or 2.2 shall not be effective until actually received by the Agent. 13.5 Governing Law; Venue. THIS AGREEMENT AND THE NOTES SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF TEXAS AND THE UNITED STATES OF AMERICA; provided, however, that Chapter 346 of the Texas Finance Code, as amended, shall not apply to this Agreement and the Notes issued hereunder. Travis County, Texas shall be a proper place of venue to enforce payment or performance of this Agreement and the other Loan Documents by the Borrower, unless the Agent shall give its prior written consent to a different venue. The Borrower hereby irrevocably waives, to the fullest extent permitted by law, any objection which it may now or hereafter have to the laying of venue of any suit, action or proceeding arising out of or relating to any of the Loan Documents in the District Courts of Travis County, Texas, or in the United States District Court for the Western District of Texas, Austin Division, and hereby further irrevocably waives any claims that any such suit, action or proceeding brought in any such court has been brought in an inconvenient forum. The Borrower hereby irrevocably agrees that, provided that the Borrower can obtain personal jurisdiction over and service of process upon the Agent or the applicable Bank, any legal proceeding against the Agent or any Bank arising out of or in connection with this Agreement or the other Loan Documents shall be brought in the district courts of Travis County, Texas, or in the United States District Court for the Western District of Texas, Austin Division. Nothing contained in this Section or in any other provision of any Loan Document (unless expressly provided otherwise) shall be deemed or construed as an agreement by any Bank to be subject to the jurisdiction of such courts. 13.6 Survival of Representations, Warranties and Covenants. All representations, warranties and covenants contained herein or made in writing by the Borrower in connection herewith shall survive the execution and delivery of this Agreement and the Notes, and will bind and inure to the benefit of the respective successors and assigns of the parties hereto, whether so expressed or not, provided that the undertaking of the Banks to make the Loans to the Borrower shall not inure to the benefit of any successor or assign of the Borrower. No investigation at any time made by or on behalf of the Banks shall diminish the Banks' rights to rely on any representations made herein or in connection herewith. All statements contained in any certificate or other written instrument delivered by the Borrower or by any Person authorized by the Borrower under or pursuant to this Agreement or in connection with the transactions contemplated hereby shall constitute representations and warranties hereunder as of the time made by the Borrower. 13.7 Counterparts. This Agreement may be executed in several counterparts, and by the parties hereto on separate counterparts, and each counterpart, when so executed and delivered, shall constitute an original instrument and all such separate counterparts shall constitute but one and the same instrument. 13.8 Separability. Should any clause, sentence, paragraph or section of this Agreement be judicially declared to be invalid, unenforceable or void, such decision shall not have the effect of invalidating or voiding the remainder of this Agreement, and the parties hereto agree that the part or parts of this Agreement so held to be invalid, unenforceable or void will be deemed to have been stricken herefrom and the remainder will have the same force and effectiveness as if such part or parts had never been included herein. Each covenant contained in this Agreement shall be construed (absent an express contrary provision herein) as being independent of each other covenant contained herein, and compliance with any one covenant shall not (absent such an express contrary provision) be deemed to excuse compliance with one or more other covenants. 13.9 Descriptive Headings. The section headings in this Agreement have been inserted for convenience only and shall be given no substantive meaning or significance whatsoever in construing the terms and provisions of this Agreement. 13.10 Accounting Terms. All accounting terms used herein which are not expressly defined in the Agreement, or the respective meanings of which are not otherwise qualified, shall have the respective meanings given to them in accordance with GAAP. 13.11 Limitation of Liability. No claim may be made by the Borrower or any other Person against the Agent or any Bank or the Affiliates, directors, officers, employees, attorneys, or agents of the Agent or any Bank for any special, indirect, consequential, or punitive damages in respect to any claim for breach of contract arising out of or related to the transactions contemplated by this Agreement, or any act, omission, or event occurring in connection herewith and the Borrower hereby waives, releases, and agrees not to sue upon any claim for any such damages, whether or not accrued and whether or not known or suspected to exist in its favor. 13.12 Set-Off. The Borrower hereby gives and confirms to each Bank a right of set-off of all moneys, securities and other property of the Borrower (whether special, general or limited) and the proceeds thereof, now or hereafter delivered to remain with or in transit in any manner to such Bank, its Affiliates, correspondents or agents from or for the Borrower, whether for safekeeping, custody, pledge, transmission, collection or otherwise or coming into possession of such Bank, its Affiliates, correspondents or agents in any way, and also, any balance of any deposit accounts and credits of the Borrower with, and any and all claims of security for the payment of the Notes and of all other liabilities and obligations now or hereafter owed by the Borrower to such Bank, contracted with or acquired by such Bank, whether such liabilities and obligations be joint, several, absolute, contingent, secured, unsecured, matured or unmatured, and the Borrower hereby authorizes each Bank, its Affiliates, correspondents or agents at any time or times, without prior notice, to apply such money, securities, other property, proceeds, balances, credits of claims, or any part of the foregoing, to such liabilities in such amounts as it may select, whether such liabilities be contingent, unmatured or otherwise, and whether any collateral security therefor is deemed adequate or not. The rights described herein shall be in addition to any collateral security, if any, described in any separate agreement executed by the Borrower. 13.13 Sale or Assignment (a) Subject to the prior written consent of the Agent and the Borrower, such consent not to be unreasonably withheld or delayed, each Bank may assign to an Eligible Assignee all or a portion of its rights and obligations under this Agreement (including, without limitation, all or a portion of its Commitments and the Note held by it); provided, however, that: (i) each such assignment shall be of a constant, and not a varying, percentage of all of the assigning Banks rights and obligations under this Agreement; (ii) the amount of the Commitments so assigned shall equal or exceed $5,000,000.00; (iii) the Commitment of each Bank shall be not less than $5,000,000.00 (subject only to reductions pursuant to Sections 4.6 and 11 hereof); (iv) the parties to each such assignment shall execute and deliver to the Agent, for its acceptance and recording in the Register (as hereinafter defined), an Assignment and Acceptance in the form of Exhibit C attached hereto and made a part hereof (the "Assignment and Acceptance"), together with any Note subject to such assignment and a processing and recordation fee of $5,000.00; (v) any such assignment from one Bank to another Bank shall not require the consent of the Agent or the Borrower if such assignment does not result in any Bank holding more than 60% of the aggregate outstanding Commitments; and (vi) any such assignment shall not require the consent of the Borrower if a Default or Event of Default shall have occurred and is then continuing. Upon such execution, delivery, acceptance, and recording, from and after the effective date specified in each Assignment and Acceptance, which effective date shall be the date on which such Assignment and Acceptance is accepted by the Agent, (A) the Eligible Assignee thereunder shall be a party hereto and, to the extent that rights and obligations hereunder have been assigned to it pursuant to such Assignment and Acceptance, have the rights and obligations of a Bank under the Loan Documents, and (B) the Bank assignor thereunder shall, to the extent that rights and obligations hereunder have been assigned by it pursuant to such Assignment and Acceptance, relinquish its rights and be released from its obligations under the Loan Documents (and, in the case of an Assignment and Acceptance covering all or the remaining portion of an assigning Bank's rights and obligations under the Loan Documents, such Bank shall cease to be a party thereto). (b) By executing and delivering an Assignment and Acceptance, the Bank assignor thereunder and the Eligible Assignee thereunder confirm to and agree with each other and the other parties hereto as follows: (i) other than as provided in such Assignment and Acceptance, such assigning Bank makes no representation or warranty and assumes no responsibility with respect to any statements, warranties, or representations made in or in connection with any Loan Document or the execution, legality, validity, enforceability, genuineness, sufficiency, or value of any Loan Document or any other instrument or document furnished pursuant thereto; (ii) such assigning Bank makes no representation or warranty and assumes no responsibility with respect to the financial condition of the Borrower or any Subsidiary or the performance or observance by the Borrower of any of its obligations under any Loan Document or any other instrument or document furnished pursuant thereto; (iii) such Eligible Assignee confirms that it has received a copy of the Loan Documents, together with copies of the financial statements referred to in Section 7.2 and such other documents and information as it has deemed appropriate to make its own credit analysis and decision to enter into such Assignment and Acceptance; (iv) such Eligible Assignee, independently and without reliance upon the Agent, such assigning Bank, or any Bank and based on such documents and information as it shall deem appropriate at the time, will continue to make its own credit decisions in taking or not taking action under this Agreement; (v) such Eligible Assignee appoints and authorizes the Agent to take such action as agent on its behalf and to exercise such powers under any Loan Document as are delegated to the Agent by the terms thereof, together with such powers as are reasonably incidental thereto; and (vi) such Eligible Assignee agrees that it will perform in accordance with their terms all of the obligations which by the terms of any Loan Document are required to be performed by it as a Bank. (c) The Agent shall maintain at its address referred to in Section 13.4 a copy of each Assignment and Acceptance delivered to and accepted by it and a register for the recordation of the names and addresses of Banks and the Commitment of, and principal amount of the Loans owing to, each Bank from time to time (the "Register"). The entries in the Register shall be conclusive and binding for all purposes, absent manifest error, and the Borrower, the Agent, and Banks may treat each Person whose name is recorded in the Register as Bank hereunder for all purposes of the Loan Documents. The Register shall be available for inspection by the Borrower or any Bank at any reasonable time and from time to time upon reasonable prior notice. (d) Upon its receipt of an Assignment and Acceptance executed by an assigning Bank, together with any Note subject to such assignment, the Agent, if such Assignment and Acceptance has been completed and is in substantially the form of Exhibit C, shall (i) accept such Assignment and Acceptance; (ii) record the information contained therein in the Register; and (iii) give prompt notice thereof to the Borrower. Within three (3) Business Days after its receipt of such notice, the Borrower at its own expense, shall execute and deliver to the Agent in exchange for each surrendered Note a new Note to the order of such Eligible Assignee in an amount equal to the Commitment assumed by it pursuant to such Assignment and Acceptance and, if the assigning Bank has retained a Commitment hereunder, a new Note to the order of the assigning Bank in an amount equal to the Commitment retained by it hereunder. The new Notes shall be in an aggregate principal amount equal to the aggregate principal amount of the surrendered Notes, shall be dated the effective date of such Assignment and Acceptance and shall otherwise be in substantially the form of Exhibit C attached hereto and made a part hereof. Upon receipt by the Agent of each such new Note conforming to the requirements set forth in the preceding sentences, the Agent shall return to the Borrower each such surrendered Note marked to show that each such surrendered Note has been replaced, renewed, and extended by such new Note. (e) Each Bank may sell participations to one or more banks or other entities in or to all or a portion of its rights and/or obligations under this Agreement (including, without limitation, all or a portion of its Commitment and the Note held by it); provided, however, that (i) each Bank's obligations under this Agreement (including, without limitation, its Commitment to the Borrower hereunder) shall remain unchanged; (ii) such Bank shall remain solely responsible to the other parties hereto for the performance of such obligations; (iii) except as provided below, such Bank shall remain the holder of any such Note for all purposes of this Agreement; and (iv) the participating banks or other entities shall be entitled to the benefits of Sections 2.3 and 4.6 to recover costs, losses and expenses in the circumstances, and to the extent provided in Section 2.3, as though such participant were a Bank; provided, however, the amounts to which a participant shall be entitled to obtain pursuant to Sections 2.3 and 4.6 shall be determined by reference to such participant's selling Bank and shall be recoverable solely from such selling Bank and (v) the Borrower, the Agent and the other Banks shall continue to deal solely and directly with the selling Bank in connection with such Bank's rights and obligations under this Agreement and the other Loan Documents; provided, however, the selling Bank may grant a participantrights with respect to amendments, modification or waivers with respect to any fees payable hereunder to such Bank (including the amount and the dates fixed for the payment of any such fees) or the amount of principal or the rate of interest payable on, the dates fixed for any payment of principal or interest on, the Loans, or the release of any obligations of the Borrower hereunder and under the other Loan Documents, or the release of any security for any of the Obligations. Except with respect to cost protections contained in Sections 2.3 and 4.6, no participant shall be a third party beneficiary of this Agreement and shall not be entitled to enforce any rights provided to its selling Bank against the Company under this Agreement. (f) Notwithstanding anything herein to the contrary, each Bank may pledge and assign all or any portion of its rights and interests under the Loan Documents to any Federal Reserve Bank. (g) Notwithstanding anything herein to the contrary, each Bank may assign all or a portion of its interests, rights and obligations under this Agreement (including, without limitation, all or a portion of its Commitments and the Note held by it) to one or more Bank Affiliates without the prior written consent of the Borrower. For purposes of this Section 12.13, "Bank Affiliate" shall mean (a) with respect to any Bank, (i) an Affiliate of such Bank or (ii) any entity (whether a corporation, partnership, trust or otherwise) that is engaged in making, purchasing, holding or otherwise investing in bank loans and similar extensions of credit in the ordinary course of its business and is administered or managed by a Bank or an Affiliate of such Bank and (b) with respect to any Bank that is a fund which invests in bank loans and similar extensions of credit, any other fund that invests in bank loans and similar extensions of credit and is managed by the same investment advisor as such Bank or by an Affiliate of such investment advisor. Each Bank Affiliate shall be deemed for purposes hereof to be an "Eligible Assignee." 13.14 Non U.S. Banks. Prior to the date of the initial Borrowings hereunder, and from time to time thereafter if requested by the Borrower or the Agent, each Bank organized under the laws of a jurisdiction outside the United States of America shall provide the Agent and the Borrower with the forms prescribed by the Internal Revenue Service of the United States of America certifying such Banks exemption from United States withholding taxes with respect to all payments to be made to such Bank hereunder or under such Bank's Note. Unless the Borrower and the Agent have received forms or other documents satisfactory to them indicating that payments hereunder or under such Bank's Note are not subject to United States withholding tax or are subject to such tax at a rate reduced by an applicable tax treaty, the Borrower or the Agent shall withhold taxes from such payments at the applicable statutory rate in the case of payments to or for any Bank organized under the laws of a jurisdiction outside the United States. 13.15 Interest. All agreements between the Borrower, the Agent or any Bank, whether now existing or hereafter arising and whether written or oral, are hereby expressly limited so that in no contingency or event whatsoever, whether by reason of demand being made on any Note or otherwise, shall the amount paid, or agreed to be paid, to the Agent or any Bank for the use, forbearance, or detention of the money to be loaned under this Agreement or otherwise or for the payment or performance of any covenant or obligation contained herein or in any document related hereto exceed the amount permissible at the Highest Lawful Rate. If, as a result of any circumstances whatsoever, fulfillment of any provision hereof or of any of such documents, at the time performance of such provision shall be due, shall involve transcending the limit of validity prescribed by applicable usury law, then, ipso facto, the obligation to be filled shall be reduced to the limit of such validity, and if, from any such circumstance, the Agent or any Bank shall ever receive interest or anything which might be deemed interest under applicable law which would exceed the amount permissible at the Highest Lawful Rate, such amount which would be excessive interest shall be applied to the reduction of the principal amount owing on account of the Notes or the amounts owing on other obligations of the Borrower to the Agent or any Bank under this Agreement or any document related hereto and not to the payment of interest, or if such excessive interest exceeds the unpaid principal balance of the Notes and the amounts owing on other obligations of the Borrower to the Agent or any Bank under this Agreement or any document related hereto, as the case may be, such excess shall be refunded to the Borrower. All sums paid or agreed to be paid to the Agent or any Bank for the use, forbearance, or detention of the indebtedness of the Borrower to the Agent or any Bank shall, to the extent permitted by applicable law, be amortized, prorated, allocated, and spread throughout the full term of such indebtedness until payment in full of the principal thereof (Including the period of any renewal or extension thereof) so that the interest on account of such indebtedness shall not exceed the Highest Lawful Rate. The terms and provisions of this Section 13.15 shall control and supersede every other provision of all agreements between the Borrower and the Banks. 13.16 Indemnification. THE BORROWER AGREES TO INDEMNIFY, DEFEND, AND SAVE HARMLESS THE AGENT, EACH BANK AND THEIR RESPECTIVE OFFICERS, DIRECTORS, EMPLOYEES, AGENTS, AND ATTORNEYS, AND EACH OF THEM (THE "INDEMNIFIED PARTIES"), FROM AND AGAINST ALL CLAIMS, ACTIONS, SUITS, AND OTHER LEGAL PROCEEDINGS, DAMAGES, COSTS, INTEREST, CHARGES, TAXES, COUNSEL FEES, AND OTHER EXPENSES AND PENALTIES (INCLUDING WITHOUT LIMITATION ALL ATTORNEY FEES AND COSTS OR EXPENSES OF SETTLEMENT) WHICH ANY OF THE INDEMNIFIED PARTIES MAY SUSTAIN OR INCUR BY REASON OF OR ARISING OUT OF (a) THE MAKING OF ANY LOAN HEREUNDER, THE EXECUTION AND DELIVERY OF THIS AGREEMENT AND THE NOTES AND THE CONSUMMATION OF THE TRANSACTIONS CONTEMPLATED THEREBY AND THE EXERCISE OF ANY OF THE BANKS' RIGHTS UNDER THIS AGREEMENT AND THE NOTES OR OTHERWISE, INCLUDING, WITHOUT LIMITATION, DAMAGES, COSTS, AND EXPENSES INCURRED BY ANY OF THE INDEMNIFIED PARTIES IN INVESTIGATING, PREPARING FOR, DEFENDING AGAINST, OR PROVIDING EVIDENCE, PRODUCING DOCUMENTS, OR TAKING ANY OTHER ACTION IN RESPECT OF ANY COMMENCED OR THREATENED LITIGATION UNDER ANY FEDERAL SECURITIES LAW OR ANY SIMILAR LAW OF ANY JURISDICTION OR AT COMMON LAW OR (b) ANY AND ALL CLAIMS OR PROCEEDINGS (WHETHER BROUGHT BY A PRIVATE PARTY, GOVERNMENTAL AUTHORITY OR OTHERWISE) FOR BODILY INJURY, PROPERTY DAMAGE, ABATEMENT, REMEDIATION, ENVIRONMENTAL DAMAGE, OR IMPAIRMENT OR ANY OTHER INJURY OR DAMAGE RESULTING FROM OR RELATING TO THE RELEASE OF ANY HAZARDOUS MATERIALS LOCATED UPON, MIGRATING INTO, FROM, OR THROUGH OR OTHERWISE RELATING TO ANY PROPERTY OWNED OR LEASED BY THE BORROWER OR ANY SUBSIDIARY (WHETHER OR NOT THE RELEASE OF SUCH HAZARDOUS MATERIALS WAS CAUSED BY THE BORROWER, ANY SUBSIDIARY, A TENANT, OR SUBTENANT OF THE BORROWER OR ANY SUBSIDIARY, A PRIOR OWNER, A TENANT, OR SUBTENANT OF ANY PRIOR OWNER OR ANY OTHER PARTY AND WHETHER OR NOT THE ALLEGED LIABILITY IS ATTRIBUTABLE TO THE HANDLING, STORAGE, GENERATION, TRANSPORTATION, OR DISPOSAL OF ANY HAZARDOUS MATERIALS OR THE MERE PRESENCE OF ANY HAZARDOUS MATERIALS ON SUCH PROPERTY; PROVIDED THAT THE BORROWER SHALL NOT BE LIABLE TO THE INDEMNIFIED PARTIES WHERE THE RELEASE OF SUCH HAZARDOUS MATERIALS OCCURS AT ANY TIME AT WHICH THE BORROWER OR ANY SUBSIDIARY CEASES TO OWN OR LEASE SUCH PROPERTY); AND PROVIDED FURTHER THAT NO INDEMNIFIED PARTY SHALL BE ENTITLED TO THE BENEFITS OF THIS SECTION 13.16 TO THE EXTENT ITS OWN GROSS NEGLIGENCE OR WILLFUL MISCONDUCT CONTRIBUTED TO ITS LOSS; AND PROVIDED FURTHER THAT IT IS THE INTENTION OF THE BORROWER TO INDEMNIFY THE INDEMNIFIED PARTIES AGAINST THE CONSEQUENCES OF THEIR OWN NEGLIGENCE. THIS AGREEMENT IS INTENDED TO PROTECT AND INDEMNIFY THE INDEMNIFIED PARTIES AGAINST ALL RISKS HEREBY ASSUMED BY THE BORROWER. FOR PURPOSES OF THE FOREGOING SECTION 13.16, THE PHRASE "CONSUMMATION OF THE TRANSACTIONS CONTEMPLATED THEREBY" SET FORTH IN SUBPARAGRAPH (a) ABOVE SHALL INCLUDE, BUT NOT BE LIMITED TO, THE FINANCING OF ANY CORPORATE TAKEOVER PERMITTED HEREUNDER AND THE BORROWER'S USE OF THE LOAN PROCEEDS FOR THE PURPOSE OF ACQUIRING ANY EQUITY INTERESTS DESCRIBED IN SUBPARAGRAPH (ii) OF THE DEFINITION OF "QUALIFYING ASSETS" SET FORTH IN THIS AGREEMENT (AS AMENDED). THE OBLIGATIONS OF THE BORROWER UNDER THIS SECTION 13.16 SHALL SURVIVE ANY TERMINATION OF THIS AGREEMENT AND THE REPAYMENT OF THE NOTES. 13.17 Payments Set Aside. To the extent that the Borrower makes a payment or payments to the Agent or any Bank or the Agent or any Bank exercises its right of set off, and such payment or payments or the proceeds of such set off or any part thereof are subsequently invalidated, declared to be fraudulent or preferential, set aside and/or required to be repaid to a trustee, receiver or any other Person under any Debtor Law or equitable cause, then, to the extent of such recovery, the obligation or part thereof originally intended to be satisfied, and all rights and remedies therefor, shall be revived and shall continue in full force and effect as if such payment had not been made or set off had not occurred. 13.18 Loan Agreement Controls. If there are any conflicts or inconsistencies among this Agreement and any other document executed in connection with the transactions connected herewith, the provisions of this Agreement shall prevail and control. 13.19 Obligations Several. The obligations of each Bank under this Agreement and the Note to which it is a party are several, and no Bank shall be responsible for any obligation or Commitment of any other Bank under this Agreement and the Note to which it is a party. Nothing contained in this Agreement or the Note to which it is a party, and no action taken by any Bank pursuant thereto, shall be deemed to constitute the Banks to be a partnership, an association, a joint venture, or any other kind of entity. 13.20 Pro Rata Treatment. All Loans under, and all payments and other amounts received in connection with this Agreement (including, without limitation, amounts received as a result of the exercise by any Bank of any right of set off) shall be effectively shared by the Banks ratably in accordance with the respective Pro Rata Percentages of the Banks. If any Bank shall obtain any payment (whether voluntary, involuntary, through the exercise of any right of set off, or otherwise) on account of the principal of, or interest on, or fees in respect of, any Note held by it (other than pursuant to Section 2.3(d)) in excess of its Pro Rata Percentage of payments on account of similar Notes obtained by all the Banks, such Bank shall forthwith purchase from the other Banks such participations in the Notes or Loans made by them as shall be necessary to cause such purchasing Bank to share the excess payment ratably with each of them; provided, however, that if all or any portion of such excess payment is thereafter recovered from such purchasing Bank, such purchase from each Bank shall be rescinded and such Bank shall repay to the purchasing Bank the purchase price to the extent of such recovery together with an amount equal to such Bank's ratable share (according to the proportion of (a) the amount of such Bank's required repayment to (b) the total amount so recovered from the purchasing Bank) of any interest or other amount paid or payable by the purchasing Bank in respect of the total amount so recovered. Disproportionate payments of interest shall be shared by the purchase of separate participations in unpaid interest obligations, disproportionate payments of fees shall be shared by the purchase of separate participations in unpaid fee obligations, and disproportionate payments of principal shall be shared by the purchase of separate participations in unpaid principal obligations. The Borrower agrees that any Bank so purchasing a participation from another Bank pursuant to this Section 13.20 may, to the fullest extent permitted by law, exercise all its rights of payment (including the right of set-off) with respect to such participation as fully as if such Bank were the direct creditor of the Borrower in the amount of such participation. Notwithstanding the foregoing, a Bank may receive and retain an amount in excess of its Pro Rata Percentage to the extent but only to the extent, that such excess results from such Bank's Highest Lawful Rate exceeding another Bank's Highest Lawful Rate. 13.21 No Rights, Duties or Obligations of Syndication Agent or Documentation Agent. The Borrower, the Agent and each Bank acknowledge and agree that except for the rights, powers, obligations and liabilities under this Agreement and the other Loan Documents as a Bank, Fleet National Bank, as Syndication Agent, and WestLB AG, New York Branch, as Documentation Agent, shall have no additional rights, powers, obligations or liabilities under this agreement or any other Loan Documents in their capacities as Syndication Agent or Documentation Agent, respectively 13.22 Final Agreement. THIS WRITTEN AGREEMENT REPRESENTS THE FINAL AGREEMENT BETWEEN THE PARTIES AND MAY NOT BE CONTRADICTED BY EVIDENCE OF PRIOR, CONTEMPORANEOUS, OR SUBSEQUENT ORAL AGREEMENT'S OF THE PARTIES. THERE ARE NO UNWRITTEN ORAL AGREEMENTS BETWEEN THE PARTIES. 13.23 WAIVER OF JURY TRIAL. EACH PARTY HERETO HEREBY WAIVES, TO THE FULLEST EXTENT PERMITTED BY APPLICABLE LAW, ANY RIGHT IT MAY HAVE TO A TRIAL BY JURY IN ANY LEGAL PROCEEDING DIRECTLY OR INDIRECTLY ARISING OUT OF OR RELATING TO THIS AGREEMENT OR THE TRANSACTIONS CONTEMPLATED HEREBY (WHETHER BASED ON CONTRACT, TORT OR ANY OTHER THEORY). EACH PARTY HERETO (A) CERTIFIES THAT NO REPRESENTATIVE, AGENT OR ATTORNEY OF ANY OTHER PARTY HAS REPRESENTED, EXPRESSLY OR OTHERWISE, THAT SUCH OTHER PARTY WOULD NOT, IN THE EVENT OF LITIGATION, SEEK TO ENFORCE THE FOREGOING WAIVER AND (B) ACKNOWLEDGES THAT IT AND THE OTHER PARTIES HERETO HAVE BEEN INDUCED TO ENTER INTO THIS AGREEMENT BY, AMONG OTHER THINGS, THE MUTUAL WAIVERS AND CERTIFICATIONS IN THIS SECTION. IN WITNESS WHEREOF, the parties hereto, by their respective officers thereunto duly authorized, have executed this Agreement on the dates set forth below to be effective as of May 28, 2004. SOUTHERN UNION COMPANY By: s/ Richard N. Marshall -------------------------------------------- Name: Richard N. Marshall -------------------------------------------- Title: Vice President and Treasurer -------------------------------------------- Commitment: JPMORGAN CHASE BANK, $28,000,000 for itself and as Agent for the Banks By: s/ Ken M. Sample -------------------------------------------- Name: Ken M. Sample -------------------------------------------- Title: Vice President -------------------------------------------- Commitment: FLEET NATIONAL BANK $20,000,000 By: s/ Kevin P. Bertelsen -------------------------------------------- Name: Kevin P. Bertelsen -------------------------------------------- Title: Vice President -------------------------------------------- Address for Notices: Fleet National Bank 100 N. Tryon Street, 13th Floor Charlotte, North Carolina 28255 Attention: Kevin Bertelsen Fax No.: (704) 386-1319 Separate Domestic and Eurodollar Lending Office: Fleet National Bank 100 Federal Street Boston, Massachusetts 02110 Commitment: WESTLB AG, NEW YORK BRANCH $20,000,000 By: s/ Duncan Robertson s/ Jeffrey S. Davidson ------------------------------------------------ Name: Duncan Robertson Jeffrey S. Davidson ------------------------------------------------ Title: Executive Director Associate Director ------------------------------------------------ Address for Notices: WestLB AG, New York Branch 1211 Avenue of the Americas New York, New York 10036 Attention: Jeffrey S. Davidson Fax No.: (212) 852-6148 Commitment: KBC BANK N.V. $20,000,000 By: s/ Robert Snauffer s/ Eric Raskin ----------------------------------------------- Name:Robert Snauffer Eric Raskin ----------------------------------------------- Title: First Vice President Vice President ------------------------------------------------ Address for Notices: KBC Bank, N.V. Atlanta Representative Office 245 Peachtree Center Avenue, Suite 2550 Atlanta, Georgia 30303 Attention: Thomas Van Craen Fax No.: (404) 584-5465 Separate Domestic and Eurodollar Lending Office: KBC Bank, N.V. New York Branch 125 West 55th Street New York, New York 10019 Commitment: WELLS FARGO BANK, NA $20,000,000 By: s/ Carlos L. Quinteros ----------------------------------------------- Name: Carlos L. Quinteros ----------------------------------------------- Title: Relationship Manager ----------------------------------------------- Address for Notices: Wells Fargo Bank, NA 1000 Louisiana Street, 3rd Floor Houston, Texas 77002 Attention: Carlos Quinteros Fax No.: (713) 739-1087 Separate Domestic and Eurodollar Lending Office: Wells Fargo Bank, NA 1740 Broadway, 3rd Floor Denver, Colorado 80274 Commitment: CALYON NEW YORK BRANCH $20,000,000 By: s/ Olivier Audemard ------------------------------------------ Name: Olivier Audemard ------------------------------------------ Title:Managing Director ------------------------------------------ Address for Notices: Calyon New York Branch 1301 Travis, Suite 2100 Houston, Texas 77002 Attention: Fabien Stal Fax No.: (713) 890-8666 Separate Domestic and Eurodollar Lending Office: Calyon New York Branch 1301 Avenue of the Americas New York, New York 10019 Commitment: MERRILL LYNCH BANK USA $20,000,000 By: s/ Louis Alder Name: Louis Alder ------------------------------------- Title: Director ------------------------------------- Address for Notices: Merrill Lynch Bank USA 15 W. South Temple, Suite 300 Salt Lake City, Utah 84101 Attention: Derek Befus Fax No.: (801) 531-7470 Commitment: SOVEREIGN BANK $20,000,000 By: s/ Robert Lanigan ------------------------------------- Name: Robert Lanigan --------------- Title: Senior Vice President ------------------------------------- Address for Notices: Sovereign Bank 75 State Street, 4th Floor Boston, Massachusetts 02109 Attention: Robert Lanigan Fax No.: (617) 346-7249 Commitment: MANUFACTURERS AND TRADERS TRUST $20,000,000 COMPANY By: s/ Thomas V. Amico --------------------- Name: Thomas V. Amico --------------------- Title: Vice President --------------------- Address for Notices: Manufacturers and Traders Trust Company 15 South Franklin Wilkes-Barre, Pennsylvania 18711 Attention: Thomas V. Amico Fax No.: (570) 821-8639 Separate Domestic and Eurodollar Lending Office: Manufacturers and Traders Trust Company One Fountain Plaza Buffalo, New York 14204 Commitment: THE NORINCHUKIN BANK, NEW YORK BRANCH $20,000,000 By: s/ Fumiaki Ono ------------------ Name: Fumiaki Ono ------------------ Title: General Manager ------------------ Address for Notices: The Norinchukin Bank, New York Branch 245 Park Ave., 29th Floor New York, New York 10167 Attention: Kenji Kawashima Fax No.: (212) 697-5754 Commitment: BAYERISCHE LANDESBANK, $15,000,000 CAYMAN ISLANDS BRANCH By: s/ Dietmar Rieg s/ Richard Jackson Jr. ------------------------------------------- Name: Dietmar Rieg Richard Jackson Jr. ------------------------------------------- Title:Senior Vice President Second Vice President ------------------------------------------- Address for Notices: Bayerische Landesbank, Cayman Islands Branch 560 Lexington Avenue New York, New York 10022 Attention: Stephen Christenson Fax No.: (212) 310-9868 Commitment: BANK HAPOALIM B.M. $15,000,000 By: s/ James P. Surless s/ Laura Anne Raffa ------------------------------------------ Name: James P. Surless Laura Anne Raffa ------------------------------------------ Title:Vice President Exec VP & Corp. Manager ------------------------------------------ Address for Notices: Bank Hapoalim B.M. 1177 Avenue of the Americas New York, New York 10036 Attention: James P. Surless Fax No.: (212) 782-2382 Commitment: CREDIT SUISSE FIRST BOSTON $15,000,000 By: s/ Sarah Wu s/ David J. Dodd ------------------------------------------- Name: Sarah Wu David J. Dodd ------------------------------------------- Title:Vice President Associate ------------------------------------------- Address for Notices: Credit Suisse First Boston Eleven Madison Avenue New York, New York 10010 Attention: Sarah Wu Fax No.: (212) 325-8321 Commitment: PNC BANK, NATIONAL ASSOCIATION $15,000,000 By: s/ Michael Nardo ----------------- Name: Michael Nardo ----------------- Title:Managing Director ----------------- Address for Notices: PNC Bank, National Association Two Tower Center Blvd. East Brunswick, New Jersey 08816 Attention: Michael Nardo Fax No.: (732) 220-3270 Commitment: SUMITOMO MITSUI BANKING CORP., $15,000,000 NEW YORK By: s/ Leo E. Pagarigan -------------------------------------- Name: Leo E. Pagarigan -------------------------------------- Title: Senior Vice President ------------------------- Address for Notices: Sumitomo Mitsui Banking Corp., New York 277 Park Avenue New York, New York 10172 Attention: Robert Dupree Fax No.: (212) 224-4384 Commitment: UFJ BANK LIMITED, NEW YORK BRANCH $15,000,000 By: s/ John T. Feeney ------------------ Name: John T. Feeney ------------------ Title: Vice President ----------------- Address for Notices: UFJ Bank Limited, New York Branch 55 East 52nd Street New York, New York 10055 Attention: John T. Feeney Fax No.: (212) 754-1304 Commitment: MIZUHO CORPORATE BANK (USA) $15,000,000 By: s/ Michisuke Araki ----------------------- Name: Michisuke Araki ----------------------- Title: President & CEO ----------------------- Address for Notices: Mizuho Corporate Bank (USA) 1251 Avenue of the Americas New York, New York 10020-1104 Attention: Yoshimi Tsushima Fax No.: (212) 282-4488 Commitment: CITIZENS BANK OF RHODE ISLAND $12,000,000 By: s/ Timothy M. Cadigan ----------------------- Name: Timothy M. Cadigan -------------------- Title: Vice President ----------------------- Address for Notices: Citizens Bank of Rhode Island One Citizens Plaza Mail Stop RC0480 Providence, Rhode Island 02903 Attention: Marian L. Barrette Fax No.: (401) 455-5404 Commitment: BANK OF TOKYO-MITSUBISHI, LTD. $12,000,000 By: s/ Donald W. Herrick Jr. ------------------------- Name: Donald W. Herrick Jr. ------------------------- Title:Vice President ------------------------- Address for Notices: Bank of Tokyo-Mitsubishi, Ltd. 1100 Louisiana, Suite 2800 Houston, Texas 77002 Attention: Bryan E. Hulshof Fax No.: (713) 658-0116 Commitment: CHANG HWA COMMERCIAL BANK, LTD., $12,000,000 LOS ANGELES BRANCH By: s/ Jim Chen ---------------------- Name: Jim Chen ---------------------- Title:VP & General Manager ---------------------- Address for Notices: Chang Hwa Commercial Bank, Ltd., Los Angeles Branch 3333 South Grand Avenue, Suite 600 Loa Angeles, California 90071 Attention: Cecilia Huynh Fax No.: (213) 620-7227 Commitment: BANK OF CHINA, NEW YORK BRANCH $12,000,000 By: s/ William W. Smith Jr. ------------------------- Name: William W. Smith Jr. ------------------------- Title: Chief Lending Officer ------------------------- Address for Notices: Bank of China, New York Branch 410 Madison Avenue New York, New York 10017 Attention: Joseph Zeng Fax No.: (212) 308-4993 Commitment: ROYAL BANK OF CANADA $12,000,000 By: s/ David A. McCluskey -------------------------- Name: David A. McCluskey -------------------------- Title: Authorized Signatory -------------------------- Address for Notices: Royal Bank of Canada New York Branch One Liberty Plaza, 3rd Floor New York, NY 10006-1404 Attention: Compton Singh Fax No.: (212) 428-2372 Commitment: UMB BANK, N.A. $12,000,000 By: s/ David A. Proffitt ---------------------- Name: David A. Proffitt ------------------ Title:Senior Vice President ---------------------- Address for Notices: UMB Bank, N.A. 1010 Grand Blvd. Kansas City, Missouri 64106 Attention: David A. Proffitt Fax No.: (816) 860-7143 Commitment: BANK OF COMMUNICATIONS, $5,000,000 NEW YORK BRANCH By: s/ Hong Tu -------------------- Name: Hong Tu -------------------- Title: General Manager -------------------- Address for Notices: Bank of Communications, New York Branch One Exchange Plaza 55 Broadway, 31st Floor New York, New York 10006-3008 Attention: Richard Thornhill Fax No.: (212) 376-8089 Commitment: BANK OF TAIWAN, NEW YORK AGENCY $5,000,000 By: s/ Eunice S. J. Teh --------------------- Name: Eunice S. J. Yeh --------------------- Title: SVP & GM ------------ Address for Notices: Bank of Taiwan, New York Agency 100 Wall Street, 11th Floor New York, New York 10005 Attention: Jeffrey Wang Fax No.: (212) 968-8370 Commitment: CHINATRUST COMMERCIAL BANK, $5,000,000 NEW YORK BRANCH By: s/ Eric Kan ----------------------- Name: Eric Kan ----------------------- Title: Senior Vice President ----------------------- Address for Notices: Chinatrust Commercial Bank, New York Branch 366 Madison Avenue, 3/F New York, New York 10017 Attention: Laurence Chui Fax No.: (212) 949-4774 EXHIBIT A REVOLVING NOTE $___________ ____________, 200__ FOR VALUE RECEIVED, the undersigned, SOUTHERN UNION COMPANY, a corporation organized under the laws of Delaware (the "Borrower"), HEREBY PROMISES TO PAY to the order of ___________________________________ (the "Bank"), on or before _______________________ (the "Maturity Date"), the principal sum of ________________ Million and No/ 100ths Dollars ($_,000,000.00) in accordance with the terms and provisions of that certain Third Amended and Restated Revolving Credit Agreement dated May ____, 2004, by and among the Borrower, the Bank, the other banks named on the signature pages thereof, and JPMORGAN CHASE BANK, as Agent (the "Credit Agreement"). Capitalized terms used herein and not otherwise defined shall have the meanings ascribed to such terms in the Credit Agreement. The outstanding principal balance of this Revolving Note shall be payable at the Maturity Date. The Borrower promises to pay interest on the unpaid principal balance of this Revolving Note from the date of any Loan evidenced by this Revolving Note until the principal balance thereof is paid in full. Interest shall accrue on the outstanding principal balance of this Revolving Note from and including the date of any Loan evidenced by this Revolving Note to but not including the Maturity Date at the rate or rates, and shall be due and payable on the dates, set forth in the Credit Agreement. Any amount not paid when due with respect to principal (whether at stated maturity, by acceleration or otherwise), costs or expenses, or, to the extent permitted by applicable law, interest, shall bear interest from the date when due to and excluding the date the same is paid in full, payable on demand, at the rate provided for in Section 2.2(b) of the Credit Agreement. Payments of principal and interest, and all amounts due with respect to costs and expenses, shall be made in lawful money of the United States of America in immediately available funds, without deduction, set off or counterclaim to the account of the Agent at the principal office of JPMorgan Chase Bank in Houston, Texas (or such other address as the Agent under the Credit Agreement may specify) not later than noon (Houston time) on the dates on which such payments shall become due pursuant to the terms and provisions set forth in the Credit Agreement. If any payment of interest or principal herein provided for is not paid when due, then the owner or holder of this Revolving Note may at its option, by notice to the Borrower, declare the unpaid, principal balance of this Revolving Note, all accrued and unpaid interest thereon and all other amounts payable under this Revolving Note to be forthwith due and payable, whereupon this Revolving Note, all such interest and all such amounts shall become and be forthwith due and payable in full, without presentment, demand, protest, notice of intent to accelerate, notice of actual acceleration or further notice of any kind, all of which are hereby expressly waived by the Borrower. If any payment of principal or interest on this Revolving Note shall become due on a Saturday, Sunday, or public holiday on which the Agent is not open for business, such payment shall be made on the next succeeding Business Day and such extension of time shall in such case be included in computing interest in connection with such payment. In addition to all principal and accrued interest on this Revolving Note, the Borrower agrees to pay (a) all reasonable costs and expenses incurred by the Agent and all owners and holders of this Revolving Note in collecting this Revolving Note through any probate, reorganization bankruptcy or any other proceeding and (b) reasonable attorneys' fees when and if this Revolving Note is placed in the hands of an attorney for collection after default. All agreements between the Borrower and the Bank, whether now existing or hereafter arising and whether written or oral, are hereby expressly limited so that in no contingency or event whatsoever, whether by reason of demand being made on this Revolving Note or otherwise, shall the amount paid, or agreed to be paid, to the Bank for the use, forbearance, or detention of the money to be loaned under the Credit Agreement and evidenced by this Revolving Note or otherwise or for the payment or performance of any covenant or obligation contained in the Credit Agreement or this Revolving Note exceed the amount permissible at Highest Lawful Rate. If as a result of any circumstances whatsoever, fulfillment of any provision hereof or of the Credit Agreement at the time performance of such provision shall be due, shall involve transcending the limit of validity prescribed by applicable usury law, then, ipso facto, the obligation to be fulfilled shall be reduced to the limit of such validity, and if from any such circumstance, the Bank shall ever receive interest or anything which might be deemed interest under applicable law which would exceed the amount permissible at the Highest Lawful Rate, such amount which would be excessive interest shall be applied to the reduction of the principal amount owing on account of this Revolving Note or the amounts owing on other obligations of the Borrower to the Bank under the Credit Agreement and not to the payment of interest, or if such excessive interest exceeds the unpaid principal balance of this Revolving Note and the amounts owing on other obligations of the Borrower to the Bank under the Credit Agreement, as the case may be, such excess shall be refunded to the Borrower. In determining whether or not the interest paid or payable under any specific contingencies exceeds the Highest Lawful Rate, the Borrower and the Bank shall, to the maximum extent permitted under applicable law, (a) characterize any nonprincipal payment as an expense, fee or premium rather than as interest; (b) exclude voluntary prepayments and the effects thereof, and (c) amortize, prorate, allocate and spread in equal parts during the period of the full stated term of this Revolving Note, all interest at any time contracted for, charged, received or reserved in connection with the indebtedness evidenced by this Revolving Note. This Revolving Note is one of the Notes provided for in, and is entitled to the benefits of, the Credit Agreement, which Credit Agreement, among other things, contains provisions for acceleration of the maturity hereof upon the happening of certain stated events, for prepayments on account of principal hereof prior to the maturity hereof upon the terms and conditions and with the effect therein specified, and provisions to the effect that no provision of the Credit Agreement or this Revolving Note shall require the payment or permit the collection of interest in excess of the Highest Lawful Rate. It is contemplated that by reason of prepayments or repayments hereon prior to the Maturity Date, there may be times when no indebtedness is owing hereunder prior to such date; but notwithstanding such occurrence this Revolving Note shall remain valid and shall be in full force and effect as to Loans made pursuant to the Credit Agreement subsequent to each such occurrence. Except as otherwise specifically provided for in the Credit Agreement, the Borrower and any and all endorsers, guarantors and sureties severally waive grace, demand, presentment for payment, notice of dishonor or default, protest, notice of protest, notice of intent to accelerate, notice of acceleration and diligence in collecting and bringing of suit against any party hereto, and agree to all renewals, extensions or partial payments hereon and to any release or substitution of security hereof, in whole or in part, with or without notice, before or after maturity. THIS REVOLVING NOTE SHALL BE GOVERNED BY, AND CONSTRUED IN ACCORDANCE WITH, THE LAWS OF THE STATE OF TEXAS AND APPLICABLE FEDERAL LAW. IN WITNESS WHEREOF, the Borrower has caused this Revolving Note to be executed and delivered by its officer thereunto duly authorized effective as of the date first above written. SOUTHERN UNION COMPANY By:_________________________________ Name:_______________________________ Title:________________________________ EXHIBIT B NOTICE OF BORROWING The undersigned hereby certifies that s/he is an officer of SOUTHERN UNION COMPANY, a corporation organized under the laws of Delaware (the "Borrower"), authorized to execute this Notice of Borrowing on behalf of the Borrower. With reference to that certain Third Amended and Restated Revolving Credit Agreement dated May ___, 2004 (as same may be amended, modified, increased, supplemented and/or restated from time to time, the "Credit Agreement") entered into by and between the Borrower, JPMORGAN CHASE BANK, as Agent, and the Banks identified therein, the undersigned further certifies, represents and warrants to Banks on behalf of the Borrower that to his best knowledge and belief after reasonable and due investigation and review, all of the following statements are true and correct (each capitalized term used herein having the same meaning given to it in the Credit Agreement unless otherwise specified): (a) Borrower requests that the Banks advance to the Borrower the aggregate sum of $__________by no later than ____________, 200__ (the "Borrowing Date"). Immediately following such Loan, the aggregate outstanding balance of Loans shall equal $__________. Borrower requests that the Loans bear interest as follows: (i) The principal amount of the Loans, if any, which shall bear interest at the Alternate Base Rate requested to be made by the Banks is $________. The initial Rate Period for such Loans shall be 90 days. (ii) The principal amount of the Loans, if any, which shall bear interest at the Eurodollar Rate for which the Rate Period shall be fifteen days requested to be made by the Banks is $----------------. (iii) The principal amount of the Loans, if any, which shall bear interest at the Eurodollar Rate for which the Rate Period shall be one month requested to be made by the Banks is $__________. (iv) The principal amount of the Loans, if any, which shall bear interest at the Eurodollar Rate for which the Rate Period shall be two months requested to be made by the Banks is $_________. (v) The principal amount of the Revolving Loans, if any, which shall bear interest at the Eurodollar Rate for which the Rate Period shall be three months requested to be made by the Banks is $---------. (vi) The principal amount of the Revolving Loans, if any, which shall bear interest at the Eurodollar Rate for which the Rate Period shall be six months requested to be made by the Banks is $----------. (b) The proceeds of the borrowing shall be deposited into Borrower's demand deposit account at JPMorgan Chase Bank more fully described as follows: Account No. 09916100522, styled Southern Union Company. (c) Of the aggregate sum to be advanced, $_____________ will be advanced to provide working capital pursuant to Section 6.1(a) of the Credit Agreement and $__________will be advanced for the purposes set forth in Section 6.1(b) of the Credit Agreement; and $__________ will be advanced for the purposes set forth in Section 6.1(c) of the Credit Agreement; and $___________ will be advanced for the purposes of replacing Loans currently outstanding under the Credit Agreement. (d) The Expiration Date of each Rate Period specified in (a) above shall be the last day of such Rate Period. (e) As of the date hereof, and as a result of the making of the requested Loans, there does not and will not exist any Default or Event of Default. (f) The representations and warranties contained in Section 7 of the Credit Agreement are true and correct in all material respects as of the date hereof and shall be true and correct upon the making of the requested Loan, with the same force and effect as though made on and as of the date hereof and thereof. (g) No change that would cause a material adverse effect on the business, operations or condition (financial or otherwise) of the Borrower has occurred since the date of the most recent financial statements provided to the Banks dated as of __________, 200__. EXECUTED AND DELIVERED this _____ day of _______________, 200__. SOUTHERN UNION COMPANY By:_________________________ Name:_______________________ Title:________________________ EXHIBIT C ASSIGNMENT AND ACCEPTANCE [NAME AND ADDRESS OF ASSIGNING BANK] _______________, 200__ Re: Southern Union Company Third Amended and Restated Revolving Credit Agreement Ladies and Gentlemen: We have entered into a Third Amended and Restated Revolving Credit Agreement dated as of May ___, 2004 (the "Credit Agreement"), among certain banks (including us), JPMorgan Chase Bank (the "Agent") and Southern Union Company (the "Company"). Capitalized terms used herein and not otherwise defined shall have the meanings ascribed to such terms in the Credit Agreement. Each reference to the Credit Agreement, the Notes, or any other document evidencing or governing the Loans (all such documents collectively, the "Financing Documents") includes each such document as amended, modified, extended or replaced from time to time. All times are Houston times. 1. ASSIGNMENT. We hereby sell you and assign to you without recourse, and you hereby unconditionally and irrevocably acquire for your own account and risk, a percent ( %) undivided interest ("your assigned share") in each of the following (the "Assigned Obligations"): a. our Note; b. all Loans and interest thereon as provided in Section 2 of the Credit Agreement [,except that interest shall accrue on your assigned share in the principal of Alternate Base Rate Loans and Eurodollar Rate Loans at an annual rate equal to the rate provided in the Credit Agreement minus _____%]; and c. commitment fees payable pursuant to Section 5 of the Credit Agreement[, except that your assigned share in such fees shall be at an annual rate equal to the rate provided in the Credit Agreement minus ____%]. 2. MATERIALS PROVIDED ASSIGNEE a. We will promptly request that the Company issue new Notes to us and to you in substitution for our Note to reflect the assignment set forth herein. Upon issuance of such substitute Notes, (i) you will become a Bank under the Credit Agreement, (ii) you will assume our obligations under the Credit Agreement to the extent of your assigned share, and (iii) the Company will release us from our obligations under the Credit Agreement to the extent, but only to the extent, of your assigned share. The Company consents to such release by signing this Agreement where indicated below. As a Bank, you will be entitled to the benefits and subject to the obligations of a "Bank", as set forth in the Credit Agreement, and your rights and liabilities with respect to the other Banks and the Agent will be governed by the Credit Agreement, including without limitation Section 12 thereof. b. We have furnished you copies of the Credit Agreement, our Note and each other Financing Document you have requested. We do not represent or warrant (i) the priority, legality, validity, binding effect or enforceability of any Financing Document or any security interest created thereunder, (ii) the truthfulness and accuracy of any representation contained in any Financing Document, (iii) the filing or recording of any Financing Document necessary to perfect any security interest created thereunder, (iv) the financial condition of the Company or any other Person obligated under any Financing Document, any financial or other information, certificate, receipt or other document furnished or to be furnished under any Financing Document or (v) any other matter not specifically set forth herein having any relation to any Financing Document, your interest in one Note, the Company or any other Person. You represent to us that you are able to make, and have made, your own independent investigation and determination of the foregoing matters, including, without limitation, the credit worthiness of the Company and the structure of the transaction. 3. GOVERNING LAW; JURISDICTION. This Agreement shall be governed by, and construed in accordance with, the laws of the State of Texas. You irrevocably submit to the jurisdiction of any State or Federal court sitting in Austin, Texas in any suit, action or proceeding arising out of or relating to this Agreement and irrevocably waive any objection you may have to this laying of venue of any such suit, action or proceeding brought in any such court and any claim that any such suit, action or proceeding has been brought in an inconvenient forum. We may serve process in any manner permitted by law and may bring proceedings against you in any other jurisdiction. 4. NOTICES. All notices and other communications given hereunder to a party shall be given in writing (including bank wire, telecopy, telex or similar writing) at such party's address set forth on the signature pages hereof or such other address as such party may hereafter specify by notice to the other party. Notice may also be given by telephone to the Person, or any other officer in the office, listed on the signature pages hereof if confirmed promptly by telex or telecopy. Notices shall be effective immediately, if given by telephone; upon transmission, if given by bank wire, telecopy or telex; five days after deposit in the mails, if mailed; and when delivered, if given by other means. 5. AUTHORITY. Each of us represents and warrants that the execution and delivery of this Agreement have been validly authorized by all necessary corporate action and that this Agreement constitutes a valid and legally binding obligation enforceable against it in accordance with its terms. 6. COUNTERPARTS. This Agreement may be executed in one or more counterparts, and by each party on separate counterparts, each of which shall be an original but all of which taken together shall be but one instrument. 7. AMENDMENTS. No amendment modification or waiver of any provision of this Agreement shall be effective unless in writing and signed by the party against whom enforcement is sought. If the foregoing correctly sets forth our agreement, please so indicate by signing the enclosed copy of this Agreement and returning it to us. Very truly yours, ------------------------------------------ By: _________________________________________ Name: _______________________________________ Title: _____________________________________ [Street Address] ____________________________ [City, State, Zip Code] ______________________ Telephone: ___________________________________ Telecopy: ___________________________________ AGREED AND ACCEPTED: - ------------------------------- By:____________________________ ____________________________ ____________________________ ____________________________ Attention: ___________________ Telephone: ___________________ Telecopy: ___________________ Account for Payments: _______________ ASSIGNMENT APPROVED PURSUANT TO SECTION 13.13 OF THE CREDIT AGREEMENT AND RELEASE APPROVED IN SECTION 2 OF THIS AGREEMENT: SOUTHERN UNION COMPANY By: _______________________ Name: _______________________ Title: _______________________ EX-99.A11 3 exhibit14code.txt CODE OF ETHICS Exhibit 14 SOUTHERN UNION COMPANY CODE OF ETHICS AND BUSINESS CONDUCT The Board of Directors of the Company (the "Board") maintains policies and procedures (which we refer to as the "Code") that represent both the code of ethics for the principal executive officer, principal financial officer and principal accounting officer under Securities and Exchange Commission rules, and the code of business conduct and ethics for members of the Board (the "Directors"), officers and employees under New York Stock Exchange listing standards. The Code applies to all Directors, officers and employees. The Code is posted on the Company's Internet web site at www.southernunionco.com and is available free of charge by calling the Company at (570) 820-2418 or by writing to: Southern Union Company Attn: Corporate Secretary One PEI Center Wilkes-Barre, PA 18711 The Code is also filed as an exhibit to the Company's Annual Report on Form 10-K. Any amendment to the Code will be promptly posted on the Company's Internet web site. The Audit Committee of the Board (the "Audit Committee") is authorized to review any issues under the Code, retain legal counsel and report its findings to the Board. The Board does not envision that any waivers of the Code will be granted, but should a waiver be granted for any Director or executive officer, it will also be promptly disclosed on the Company's Internet web site. The Code consists of the Ethics Policy, the Conflicts of Interest/Corporate Opportunity Policy, the Corporate Assets Policy, the Directorships Policy, the Procedures and Open Door Communication Policy and the Enforcement Policy. The Code follows: Ethics Policy It is the policy of Southern Union Company to comply with all governmental laws, rules and regulations applicable to its business. The Company's Ethics policy does not stop there. Even where the law is permissive, the Company prefers the course of highest integrity. Local customs, traditions and mores differ from place to place, and this must be recognized. But honesty is not subject to criticism in any culture. A well-founded reputation for scrupulous dealing is itself a priceless corporate asset. The Company cares how results are obtained, not just that they are obtained. Directors, officers and employees should deal fairly with each other, with the Company's customers and with other third parties. The Company expects compliance with its standard of integrity throughout the organization and will not tolerate employees who achieve results at the cost of violation of law or this Code. The Company's Directors and officers support, and expect the Company's employees to support, any employee who passes up an opportunity or advantage that would sacrifice ethical standards. It is the Company's policy that all transactions will be accurately reflected in its books and records. This, of course, means that falsification of books and records and the creation or maintenance of any off-the-record bank account is strictly prohibited. Employees are required to record all transactions accurately in the Company's books and records, and to be honest and forthcoming with the Company's internal and independent auditors. The Company expects candor from employees at all levels and adherence to its policies and internal controls. One harm that results when employees conceal information from higher management or the auditors is that other employees think they are being given a signal that the Company's policies and internal controls can be ignored when they are inconvenient. That can result in corruption and demoralization of an organization. The Company's system of management will not work without honesty. It is the Company's policy to make full, fair, accurate, timely and understandable disclosure in reports and documents that the Company files with the Securities and Exchange Commission and in other public communications. All employees are responsible for reporting relevant material information known to them to higher management so that the information will be available to senior executives responsible for making disclosure decisions. Conflicts of Interest/Corporate Opportunity Policy It is the policy of Southern Union Company that Directors, officers and employees are expected to avoid any actual or apparent conflict between their own personal interests and the interests of the Company. A conflict of interest can arise when a Director, officer or employee takes actions or has personal interests that may interfere with the effective performance of work for the Company. For example, Directors, officers and employees are required to avoid actual or apparent conflicts in dealings with suppliers, customers, competitors and other third parties. Directors, officers and employees are required to refrain from taking for themselves opportunities discovered through their use of corporate assets or information or through their positions with the Company and are prohibited from using corporate property, information, or position for personal gain. Directors, officers and employees are required to avoid securities transactions based on material, nonpublic information learned through their positions with the Company. Directors, officers and employees are required to refrain from competing with the Company. Corporate Assets Policy It is the policy of Southern Union Company that Directors, officers and employees are expected to protect the assets of the Company and use them efficiently to advance the Company's interests. Those assets include tangible assets and intangible assets, such as confidential information of the Company. No Director, officer or employee should use or disclose at any time during or subsequent to employment or other service to the Company, without proper authority or mandate, confidential information obtained from any source in the course of the Company's business. Examples of confidential information include nonpublic information about the Company's business, plans, earnings, financial forecasts, business forecasts, discoveries, competitive bids, technologies and personnel. Directorships Policy It is the policy of Southern Union Company to restrict the holding by officers and employees of directorships in nonaffiliated for-profit organizations and to prohibit the acceptance by any officer or employee of such directorships that could involve a conflict of interest with, or interfere with, the discharge of the officer's or employee's duties to the Company. Any officer or employee may hold directorships in nonaffiliated non-profit organizations, unless such directorships would involve a conflict of interest with, or interfere with, the discharge of the officer's or employee's duties to the Company, or obligate the Company to provide support to the nonaffiliated non-profit organizations. Officers and employees may serve as directors of affiliated companies and such service may be part of their normal work assignments. All directorships in public companies held by Company Directors are subject to review and approval by the Board. In all other cases, directorships in nonaffiliated, for-profit organizations are subject to review and approval by the management of the Company, as directed by the Company's Chairman of the Board. Procedures and Open Door Communication Policy Southern Union Company encourages employees to ask questions, voice concerns and make appropriate suggestions regarding the business practices of the Company. Employees are expected to report promptly to management suspected violations of law, the Company's policies and internal controls, so that management can take appropriate corrective action. The intent of the Company is to promptly investigate reports of suspected violations of law, policies and internal control procedures. Management and the Audit Committee are ultimately responsible for the investigation of and appropriate response to reports of suspected violations of law, policies and internal control procedures. The Company's Internal Audit Department has primary responsibility for investigating violations of internal controls, with assistance from others, depending on the subject matter of the inquiry. The persons who investigate suspected violations are expected to exercise independent and objective judgment. Towards this end, most investigations will be conducted by outside legal counsel at the direction of the Audit Committee. Normally, an employee should first discuss suspected violations of law, policies or internal control procedures, with the employee's immediate supervisor. Each supervisor is expected to be available to subordinates for that purpose. If an employee is dissatisfied following such a discussion with the employee's immediate supervisor, the employee is encouraged to request further reviews, in the presence of the supervisor or otherwise. Reviews should continue to the level of management appropriate to resolve the issue. Depending on the circumstances and/or subject matter of the question, concern or suggestion, each employee also has access to alternate channels of communication, for example, the Office of the Controller; the Internal Audit Department; the Human Resources Department; the Office of General Counsel; the Risk, Safety & Loss Control Department; the Environmental Department; the Office of the Treasurer; and the Chief Ethics Officer. Suspected violations of law or the Company's policies involving a Director or executive officer, as well as any concern regarding questionable accounting or auditing matters, should be referred directly to the Audit Committee and the Chief Ethics Officer. The Audit Committee is authorized to review and direct the investigation of all issues involving Directors or executive officers, and, in its sole discretion, may refer any or all such issues to the Board. Employees may also address communications to individual non-employee directors or to the non-employee directors as a group by writing them at Southern Union Company, One PEI Center, Wilkes-Barre, PA 18711, or such other addresses as the Company may designate and publish from time to time. Employees wishing to make complaints without identifying themselves may do so by telephoning the Company's Ethics and Compliance Hotline at 1-877-888-0002, or by writing the Chief Ethics Officer at Watson Bishop London Brophy, P.C., attention Daniel W. Bishop, II, Esq., 106 East 6th Street, Suite 700, Austin, TX 78701, or such other telephone numbers, names and addresses as the Company may designate and publish from time to time. All complaints to those telephone numbers and addresses concerning accounting, internal accounting controls or auditing matters will be referred to the Audit Committee. All persons responding to employees' questions, concerns, complaints and suggestions are expected to use appropriate discretion regarding anonymity and confidentiality, although the preservation of anonymity and confidentiality may or may not be practical, depending on the circumstances. For example, investigations of significant complaints typically necessitate revealing to others information about the complaint and complainant. Similarly, disclosure can result from government investigations and litigation. No action may be taken or threatened against any employee for asking questions, voicing concerns, or making complaints or suggestions in conformity with the procedures described above, unless the employee acts with willful disregard of the truth. All employees must cooperate fully with any and all investigations relating to a potential violation of this Code. Such cooperation shall include, without limitation, being accessible to answer questions, disclosing relevant information and generally aiding the investigation in any reasonable manner requested. Failure to behave honestly, and failure to comply with law, the Company's policies and internal controls, including cooperating fully with any and all investigations, may each result in disciplinary action, up to and including termination. Only the Board or the Audit Committee has the authority to make exceptions or grant waivers to these policies. If there is an exception or waiver granted, the Board or the Audit Committee will specifically find that such a waiver or exception is warranted and is being granted and shall promptly disclose such information to shareholders. In those instances where the Company, through the Audit Committee or directly through the Board after review, approves an activity or situation, including without limitation a related party transaction, without specifically citing a waiver or exception to these policies, the Company is not granting an exception or waiver but is determining that there is no policy violation. It is recognized that there will be questions about the application of the policies to specific activities and situations. In cases of doubt, Directors, officers and employees are expected to seek clarification and guidance. If the Company determines that there is or would be a policy violation, appropriate action will be taken. Enforcement Policy Ultimate responsibility for enforcement of the Code shall lie with the Audit Committee. The Chief Ethics Officer of the Company, working at the direction of the Audit Committee, shall provide legal advice as to the interpretation of the Code. The Audit Committee shall have the authority to direct Code investigations and take such actions as are necessary to end any conduct found to be in violation of the Code. No inquiry or investigation shall be commenced unless authorized and requested by the Audit Committee, which may instruct the Chief Ethics Officer, an outside law firm or other unrelated entity or internal Company personnel to perform such inquiry or investigation. In order to eliminate the possibility of an internal conflict of interest, the Company has appointed the following outside counsel to serve as its Chief Ethics Officer: Daniel W. Bishop, II, Esq. Watson Bishop London Brophy, P.C. 106 East 6th Street, Suite 700 Austin, TX 78701 512-481-3752 The Board or the Audit Committee may, at its sole discretion, change the Chief Ethics Officer. If such change shall occur, the Company will update the information on its Internet web site. Please note that the Code is not intended to and does not create a contract of employment between employees and the Company, and compliance with the Code is expected, but does not guarantee that employment with the Company will continue. -----END PRIVACY-ENHANCED MESSAGE-----