-----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, DzjOK0G2i+CKo0SC3dQrW0UcCL5ws4HFVQMrJWMsFpmThsxSnou42vHzQJ/fU9vS 3dI8wymKibvVz+gqLQi5dw== 0000203248-98-000007.txt : 19981111 0000203248-98-000007.hdr.sgml : 19981111 ACCESSION NUMBER: 0000203248-98-000007 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19980930 FILED AS OF DATE: 19981110 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SOUTHERN UNION CO CENTRAL INDEX KEY: 0000203248 STANDARD INDUSTRIAL CLASSIFICATION: NATURAL GAS DISTRIBUTION [4924] IRS NUMBER: 750571592 STATE OF INCORPORATION: DE FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-06407 FILM NUMBER: 98743011 BUSINESS ADDRESS: STREET 1: 504 LAVACA ST 8TH FL CITY: AUSTIN STATE: TX ZIP: 78701 BUSINESS PHONE: 5124775852 10-Q 1 ================================================================= UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D. C. 20549 ------------------------ FORM 10-Q For the quarterly period ended ------------------------------ September 30, 1998 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.) 504 Lavaca Street, Eighth Floor 78701 Austin, Texas (Zip Code) (Address of principal executive offices) Registrant's telephone number, including area code: (512) 477-5852 Securities Registered Pursuant to Section 12(b) of the Act: Title of each class Name of each exchange in which registered - ------------------- ------------------------------- Common Stock, par New York Stock Exchange value $1 per share Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- The number of shares of the registrant's Common Stock outstanding on November 3, 1998 was 28,216,321. ================================================================= SOUTHERN UNION COMPANY AND SUBSIDIARIES FORM 10-Q September 30, 1998 Index PART I. FINANCIAL INFORMATION Page(s) ------- Item 1. Financial Statements Consolidated statements of operations - three and twelve months ended September 30, 1998 and 1997 Consolidated balance sheet - September 30, 1998 and 1997 and June 30, 1998 Consolidated statement of stockholders' equity - three months ended September 30, 1998 and twelve months ended June 30, 1998 Consolidated statements of cash flows - three and twelve months ended September 30, 1998 and 1997 Notes to consolidated financial statements Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations PART II. OTHER INFORMATION Item 1. Legal Proceedings (See "CONTINGENCIES" under Notes to Consolidated Financial Statements) Item 6. Exhibits and Reports on Form 8-K (a) Exhibit 27 - Financial Data Schedule (b) Reports on Form 8-K--None SOUTHERN UNION COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENT OF OPERATIONS Three Months Ended September 30, -------------------------------- 1998 1997 ------------ ------------ (thousands of dollars, except shares and per share amounts) Operating revenues............ $ 77,455 $ 74,039 Gas purchase costs............ 34,674 32,442 ----------- ----------- Operating margin.......... 42,781 41,597 Revenue-related taxes......... 3,437 2,984 ----------- ----------- Net operating margin 39,344 38,613 Operating expenses: Operating, maintenance and general............. 26,047 23,789 Depreciation and amortization............ 10,418 9,598 Taxes, other than on income and revenues..... 3,506 3,821 ----------- ----------- Total operating expenses.............. 39,971 37,208 ----------- ----------- Net operating revenues.. (627) 1,405 ----------- ----------- Other income (expenses): Interest.................. (8,740) (8,450) Dividends on preferred securities of subsidiary trust .................. (2,370) (2,370) Other, net................ 724 1,769 ----------- ----------- Total other expenses, net................... (10,386) (9,051) ----------- ----------- Loss before income taxes (benefit)....... (11,013) (7,646) Federal and state income taxes (benefit)............. (3,965) (2,737) ----------- ----------- Net loss attributable to common stock............. $ (7,048) $ (4,909) =========== =========== Net loss per share: Basic..................... $ (.25) $ (.18) =========== =========== Diluted................... $ (.25) $ (.18) =========== =========== Weighted average shares outstanding: Basic..................... 28,207,730 26,966,574 =========== =========== Diluted................... 28,207,730 26,966,574 =========== =========== See accompanying notes. SOUTHERN UNION COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENT OF OPERATIONS Twelve Months Ended September 30, 1998 1997 ----------- ------------ (thousands of dollars, except shares and per share amounts) Operating revenues............ $ 672,720 $ 710,239 Gas purchase costs............ 407,812 442,214 ------------ ------------ Operating margin.......... 264,908 268,025 Revenue-related taxes 35,340 38,576 ------------ ------------ Net operating margin...... 229,568 229,449 Operating expenses: Operating, maintenance and general............. 109,785 108,362 Depreciation and amortization............ 39,257 35,939 Taxes, other than on income and revenues..... 13,890 12,712 ------------ ------------ Total operating expenses............ 162,932 157,013 ------------ ------------ Net operating revenues............ 66,636 72,436 ------------ ------------ Other income (expenses): Interest.................. (35,174) (33,628) Dividends on preferred securities of subsidiary trust........ (9,480) (9,480) Write-off of regulatory assets.................. (8,163) -- Other, net............... 3,027 2,915 ------------ ------------ Total other expenses, net...... (49,790) (40,193) ------------ ------------ Earnings before income taxes....... 16,846 32,243 Federal and state income taxes...................... 6,757 12,714 ------------ ------------ Net earnings available for common stock........... $ 10,089 $ 19,529 ============ ============ Net earnings per share: Basic.................... $ .36 $ .73 ============ ============ Diluted.................. $ .35 $ .70 ============ ============ Weighted average shares outstanding: Basic.................. 27,893,050 26,920,655 ============ ============ Diluted................ 29,013,520 27,981,461 ============ ============ See accompanying notes. SOUTHERN UNION COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET ASSETS September 30, June 30, --------------------- 1998 1997 1998 ---------- ---------- ---------- (thousands of dollars) Property, plant and equipment: Plant in service........... $1,069,645 $ 983,275 $1,057,675 Construction work in progress................. 8,872 9,911 7,783 ---------- ---------- ---------- 1,078,517 993,186 1,065,458 Less accumulated depreciation and amortization............. (364,876) (336,063) (355,430) ---------- ---------- ---------- 713,641 657,123 710,028 Additional purchase cost assigned to utility plant, net...................... 137,360 130,845 138,381 ---------- ---------- ---------- Net property, plant and equipment............. 851,001 787,968 848,409 ---------- ---------- ---------- Current assets: Accounts receivable, billed and unbilled...... 36,958 39,961 53,760 Inventories, principally at average cost.......... 38,551 36,075 26,160 Deferred gas purchase costs.................... 1,269 25,210 -- Prepayments and other...... 4,084 929 4,747 ---------- ---------- ---------- Total current assets... 80,862 102,175 84,667 ---------- ---------- ---------- Deferred charges............... 95,270 107,591 94,550 Investment securities.......... 5,000 -- 5,000 Real estate.................... 9,601 9,192 9,741 Other.......................... 5,246 1,823 5,397 ---------- ---------- ---------- Total...................... $1,046,980 $1,008,749 $1,047,764 ========== ========== ========== See accompanying notes. SOUTHERN UNION COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET (Continued) STOCKHOLDERS' EQUITY AND LIABILITIES September 30, June 30, ---------------------- 1998 1997 1998 ---------- ---------- ---------- (thousands of dollars) Common stockholders' equity: Common stock, $1 par value; authorized 50,000,000 shares; issued chairs.......... $ 28,262 $ 17,174 $ 28,252 Premium on capital stock.. 252,568 225,267 252,638 Less treasury stock, at cost.................... (794) (794) (794) Retained earnings ........ 9,690 20,260 16,738 ---------- ---------- ---------- Total common stockholders' equity.................. 289,726 261,907 296,834 Company-obligated mandatorily redeemable preferred securities of subsidiary trust holding solely sub- ordinated notes of Southern Union............ 100,000 100,000 100,000 Long-term debt and capital lease obligation............ 412,475 392,921 406,407 ---------- ---------- ---------- Total capitalization...... 802,201 754,828 803,241 Current liabilities: Long-term debt and capital lease obligation due within one year......... 2,051 797 1,777 Notes payable............. 42,103 60,300 1,600 Accounts payable.......... 19,960 22,893 26,570 Federal, state and local taxes................... 8,559 9,395 14,017 Accrued interest.......... 5,633 4,118 12,699 Customer deposits......... 17,650 16,713 17,686 Deferred gas purchase costs................... -- -- 12,257 Other..................... 15,094 16,343 21,095 ---------- ---------- ---------- Total current liabilities......... 111,050 130,559 107,701 ---------- ---------- ---------- Deferred credits and other....................... 73,480 71,234 74,217 Accumulated deferred income taxes....................... 60,249 52,128 62,605 Commitments and contingencies. -- -- -- ---------- ---------- ---------- Total........................ $1,046,980 $1,008,749 $1,047,764 ========== ========== ========== See accompanying notes. SOUTHERN UNION COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY Trea- Unrea- Common Premium sury lized Stock, on Stock, Holding $1 Par Capital at Retained Gain Value Stock Cost Earnings (Loss) Total -------- -------- ------ -------- ------- -------- (thousands of dollars) Balance July 1, 1997.... $ 17,171 $225,252 $ (794)$ 25,169 $ 664 $267,462 Net earn- ings. -- -- -- 12,229 -- 12,229 5% stock dividend. 856 19,802 -- (20,658) -- -- Three- for-two stock split... 9,400 (9,400) -- (2) -- (2) Issuance of stock for acqu- isition.. 756 17,285 -- -- -- 18,041 Change in unrealiz- ed holding gain or loss..... -- -- -- -- (664) (664) Exercise of stock options.. 69 (301) -- -- -- (232) -------- -------- ------ -------- ------ -------- Balance June 30, 1998....... 28,252 252,638 (794) 16,738 -- 296,834 Net loss.. -- -- -- (7,048) -- (7,048) Exercise of stock options.. 10 (70) -- -- -- (60) -------- -------- ------ -------- ------ -------- Balance Sept- ember 30, 1998...... $ 28,262 $252,568 $ (794)$ 9,690 $ -- $289,726 ======== ======== ====== ======== ====== ======== See accompanying notes. SOUTHERN UNION COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS Three Months Ended September 30, 1998 1997 ------------- -------------- (thousands of dollars) Cash flows used in operating activities: Net loss.................. $ (7,048) $ (4,909) Adjustments to reconcile net loss to net cash flows used in opera- ting activities: Depreciation and amortization........ 10,418 9,598 Deferred income taxes............... (2,355) (1,492) Provision for bad debts............... 111 350 Gain on sale of in- vestment securi- ties................ -- (1,088) Deferred interest expense............. (195) (277) Other................. 372 198 Changes in assets and liabilities, net of acquisitions and dispositions: Accounts receiv- able, billed and unbilled..... 16,690 18,348 Accounts payable... (6,324) (10,053) Taxes and other liabilities...... (12,524) (13,026) Customer deposits......... (36) (501) Deferred gas pur- chase costs...... (13,527) (28,775) Inventories........ (12,390) (14,407) Other.............. 646 2,902 ------------- -------------- Net cash flows used in operating activities..... (26,162) (43,132) ------------- -------------- Cash flows from (used in) investing activities: Additions to property, plant and equipment...... (14,235) (17,008) Acquisition of opera- tions, net of cash received................. -- (745) Increase in customer advances................. 1,153 1,056 Decrease in deferred charges and credits...... (2,266) (4,615) Proceeds from sale of investment securities.... -- 6,531 Other...................... 1,840 309 ------------- -------------- Net cash flows used in investing activities..... (13,508) (14,472) ------------- -------------- Cash flows from (used in) financing activities: Repayment of debt and capital lease obliga- tion..................... (483) (225) Net borrowings under revolving credit facility................. 40,503 58,700 Change in cash overdraft... (285) (889) Other...................... (65) 18 ------------- -------------- Net cash flows from financing activities..... 39,670 57,604 ------------- -------------- Change in cash and cash equivalents.................. -- -- Cash and cash equivalents at beginning of period.......... -- -- ------------- -------------- Cash and cash equivalents at end of period................ -- $ -- ============= ============== Supplemental disclosures of cash flow information: Cash paid during the period for: Interest............... $ 15,272 14,994 ============= ============= Income taxes........... $ 100 $ -- ============= ============== See accompanying notes. SOUTHERN UNION COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS Twelve Months Ended September 30, 1998 1997 ------------ -------------- (thousands of dollars) Cash flows from operating activities: Net earnings............... $ 10,089 $ 19,529 Adjustments to reconcile net earnings to net cash flows from operat- ing activities: Depreciation and amortization......... 39,257 35,939 Deferred income taxes.. 5,500 4,319 Provision for bad debts................. 5,222 10,533 Gain on sale of in- vestment securities.. -- (3,633) Write-off of regula- tory assets.......... 8,163 -- Deferred interest expense.............. (1,589) (2,449) Other.................. 1,624 1,168 Changes in assets and liabilities, net of acquisitions and dispositions: Accounts receiv- able, billed and unbilled......... (1,526) (13,255) Accounts payable... (3,337) (2,214) Taxes and other liabilities...... 648 (2,333) Customer deposits.. 666 556 Deferred gas pur- chase costs...... 23,941 (16,000) Inventories........ (2,344) 7,318 Other.............. (1,087) 4,076 ------------ -------------- Net cash flows from oper- ating activities......... 85,227 43,554 ------------ -------------- Cash flows from (used in) investing activities: Additions to property, plant and equipment...... (74,245) (68,003) Acquisition of operations, net of cash received..... 7,247 (1,444) Purchase of investment securities............... (5,000) -- Increase in customer advances................. 3,659 2,122 Increase (decrease) in deferred charges and credits.................. 563 (2,955) Proceeds from sale of investment securities.... -- 19,858 Other...................... 3,106 1,445 ------------ -------------- Net cash flows used in investing activities... (64,670) (48,977) ------------ -------------- Cash flows from (used in) financing activities: Repayment of debt and capital lease obligation............... (1,567) (679) Net (payments) borrowings under revolving credit facility................. (18,197) 4,800 Change in cash overdraft... (341) 678 Other...................... (452) 624 ------------ -------------- Net cash flows from (used in) financing activities............ (20,557) 5,423 ------------ -------------- Change in cash and cash equivalents.................. -- -- Cash and cash equivalents at beginning of period....... -- -- ------------- -------------- Cash and cash equivalents at end of period................ $ -- $ -- ============= ============== Supplemental disclosures of cash flow information: Cash paid during the period for: Interest............... $ 34,275 $ 32,269 ============ ============== Income taxes........... $ 2,861 $ 5,371 ============ ============== See accompanying notes. SOUTHERN UNION COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FINANCIAL STATEMENTS The interim financial statements are unaudited but, in the opinion of management, reflect all adjustments (including both normal recurring as well as any non-recurring) necessary for afair presentation of the results of operations for such periods. Because of the seasonal nature of the Company's operations, the results of operations and cash flows for any interim period are not necessarily indicative of results for the full year. These financial statements should be read in conjunction with the financial statements and notes thereto contained in Southern Union Company's (Southern Union and, together with its wholly- owned subsidiaries, the Company) Annual Report on Form 10-K for the fiscal year ended June 30, 1998. Certain prior period amounts have been reclassified to conform with the current period presentation. ACQUISITIONS Effective December 31, 1997, the Company acquired Atlantic Utilities Corporation and Subsidiaries (Atlantic) for 755,650 pre-split shares of common stock valued at $18,041,000 and cash of $4,436,000. Atlantic is operated as South Florida Natural Gas, a natural gas division of Southern Union, and Atlantic Gas Corporation, a propane subsidiary of the Company. Atlantic currently serves 4,800 customers in central Florida. Atlantic's results of operations have been included in the Company's statements of consolidated operations and cash flows since January 1, 1998. On the date of acquisition, Atlantic had $11,683,000 of cash and cash equivalents. The acquisition was accounted for using the purchase method. The additional purchase cost assigned to utility plant of approximately $10,000,000 reflects the excess of the purchase price over the historical book carrying value of the net assets acquired. The additional purchase cost is amortized on a straight-line basis over forty years. WRITE-OFF OF REGULATORY ASSETS Pursuant to a 1989 Missouri Public Service Commission (MPSC) order, Missouri Gas Energy is engaged in a major gas safety program. In connection with this program, the MPSC issued an accounting authority order in 1994 which authorized Missouri Gas Energy to defer carrying costs at a rate of 10.54%. The MPSC rate order of January 22, 1997, however, retroactively reduced the 10.54% carrying cost rate used since early 1994 to an Allowance for Funds Used During Construction (AFUDC) rate of approximately 6%. The Company filed an appeal of this portion of the rate order in the Missouri State Court of Appeals, Western District, and on August 18, 1998 was notified that the appeal was denied. This resulted in a one-time non-cash write-off of $5,942,000 of previously deferred costs as of June 30, 1998. See Contingencies. On August 21, 1998, Missouri Gas Energy was notified by the MPSC of its decision to grant a $13,300,000 rate increase which, among other things, disallowed certain previously recorded deferred costs,requiring an additional pre-tax non-cash write-off of $2,221,000. Though the Company has requested a rehearing on significant portions of these disallowances, generally accepted accounting principles required the Company to record this charge to earnings, which Southern Union did as of June 30, 1998. EARNINGS PER SHARE During the three- and twelve-month periods ended September 30, 1998 and 1997, no adjustments were required in net earnings available for common stock for the earnings per share calculations. Average shares outstanding for basic earnings per share were 28,207,730 and 26,966,574 for the three-month period ended September 30, 1998 and 1997, respectively, and 27,893,050 and 26,920,655 for the twelve-month period ended September 30, 1998 and 1997, respectively. Diluted earnings per share includes average shares outstanding as well as common stock equivalents from stock options and warrants. Common stock equivalents were nil for both three-month periods ended SOUTHERN UNION COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 1998 and 1997, respectively, and 1,120,470 and 1,060,806 for the twelve-month period ended September 30, 1998 and 1997, respectively. PREFERRED SECURITIES OF SUBSIDIARY TRUST On May 17, 1995, Southern Union Financing I (Subsidiary Trust), a consolidated wholly-owned subsidiary of Southern Union, issued $100,000,000 of 9.48% Trust Originated Preferred Securities (Preferred Securities). In connection with the Subsidiary Trust's issuance of the Preferred Securities and the related purchase by Southern Union of all of the Subsidiary Trust's common securities (Common Securities), Southern Union issued to the Subsidiary Trust $103,092,800 principal amount of its 9.48% Subordinated Deferrable Interest Notes, due 2025 (Subordinated Notes). The sole assets of the Subsidiary Trust are the Subordinated Notes. The interest and other payment dates on the wSubordinated Notes correspond to the distribution and other payment dates on the Preferred Securities and the Common Securities. Under certain circumstances, the Subordinated Notes may be distributed to holders of the Preferred Securities and holders of the Common Securities in liquidation of the Subsidiary Trust. The Subordinated Notes are redeemable at the option of the Company on or after May 17, 2000, at a redemption price of $25 per Subordinated Note plus accrued and unpaid interest. The Preferred Securities and the Common Securities will be redeemed on a pro rata basis to the same extent as the Subordinated Notes are repaid, at $25 per Preferred Security and Common Security plus accumulated and unpaid distributions. Southern Union's obligations under the Subordinated Notes and related agreements, taken together, constitute a full and unconditional guarantee by Southern Union of payments due on the Preferred Securities. As of September 30, 1998 and 1997, 4,000,000 shares of Preferred Securities were outstanding. DEBT AND CAPITAL LEASE September 30, June 30, 1998 1998 ------------- ---------- (thousands of dollars) 7.60% Senior notes due 2024................ $ 384,515 $ 384,515 Other..................... 30,011 23,669 ---------- ---------- Total debt and capital lease................... 414,526 408,184 Less current portion.. (2,051) (1,777) ---------- ---------- Total long-term debt and capital lease....... 412,475 $ 406,407 ========== ========== The Company has availability under two revolving credit facilities (the "Revolving Credit Facilities") underwritten by a syndicate of banks. Of the Revolving Credit Facilities, $40,000,000 is a short-term facility which expires June 30, 1999, while $60,000,000 is a long-term facility which expires June 30, 2001. The Company has additional availability under uncommitted line of credit facilities (Uncommitted Facilities) with various banks. Covenants under the Revolving Credit Facilities allow for up to $35,000,000 of borrowings under Uncommitted Facilities at any one time. Borrowings under these facilities are available for Southern Union's working capital, letter of credit requirements and other general corporate purposes. The amount outstanding under these facilities at September 30, 1998 and October 31, 1998 was $42,103,000 and $47,400,000, respectively. Capital Lease The Company began installing an Automated Meter - ------------- Reading (AMR) system at Missouri Gas Energy during fiscal year 1998 which was completed 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. During the three-month period ended September 30, 1998, the Company recorded an increase in long-term debt of $6,824,000. As of September 30, 1998, the capital lease obligation outstanding was $28,144,000. SOUTHERN UNION COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS UTILITY REGULATION AND RATES Under the order of the Federal Energy Regulatory Commission, a major supplier of gas to Missouri Gas Energy is allowed recovery of certain unrecovered deferred gas costs with a remaining balance of $2,900,000 at September 30, 1998. Missouri Gas Energy is allowed to recover these costs from its customers through a purchase gas adjustment mechanism which is filed with and approved by the MPSC. The receivable and liability associated with these costs have been recorded as a deferred charge and a deferred credit,respectively, on the consolidated balance sheet as of September 30, 1998 and 1997. On May 21, 1998, Southern Union Gas filed with the Railroad Commission of Texas (Commission) an appeal of the city of El Paso's actions to reduce the Company's rates and require a one- time cost of gas refund. In the de novo appeal, the City proposed a $4,136,000 rate reduction and an $884,000 one-time cost of gas refund. The Company requested a $1,964,000 rate increase and a finding that no cost of gas refund is warranted. After an administrative hearing, the hearing examiners issued their Proposal for Decision in October, 1998 in which they recommended that the Commission implement a $2,034,000 rate reduction and an $884,000 one-time cost of gas refund. The Company has filed extensive exceptions to the examiners' findings and recommendations. The Commission will consider the examiners' Proposal for Decision, exceptions filed relating to the Proposal, and all other evidence in the record in rendering a decision later in calendar year 1998. YEAR 2000 Similar to all business entities, the Company will be impacted by the inability of computer application software programs to distinguish between the year 1900 and 2000 due to a commonly-used programming convention. Unless such programs are modified or replaced prior to 2000, calculations and interpretations based on date-based arithmetic or logical operations performed by such programs may be incorrect. Management's plan addressing the impact of the Year 2000 issue on the Company focuses on the following areas: application systems, process control systems (embedded chips), technology infrastructure, physical infrastructure, and third party business partners and suppliers with which the Company has significant relationships. Management's analysis and review of these areas is comprised primarily of five phases: developing an inventory of hardware, software and embedded chips; assessing the degree to which each area is currently in compliance with Year 2000 requirements; performing renovations and repairs as needed to attain compliance; testing to ensure compliance; and developing a contingency plan if repair and renovation efforts are either unsuccessful or untimely. Management has substantially completed the inventory and assessment phases regarding application systems, process control systems and technology infrastructure, and is performing renovations, repairs and testing of the former two categories. The review of physical infrastructure and business partners, gas transporters and suppliers is in the inventory stage. While the Company anticipates that any additional inventory and assessment efforts will be completed by the end of calendar year 1998, renovation, repair and testing of affected areas will continue through calendar year 1999. Costs incurred to date have primarily consisted of labor from the redeployment of existing information technology, legal and operational resources. The Company expects to spend approximately $3,000,000 for these Year 2000 compliance efforts. To the extent that such costs are incurred in Year 2000 compliance efforts, the Company will attempt recovery for such costs through regulatory relief. In addition to the activities described above, the Company is currently replacing some of its financial and operating software programs with new programs that will be Year 2000 compliant. These new programs have significantly reduced the costs the Company expects to incur to become Year 2000 compliant. However, the Company has formed a contingency team to develop a work plan in the event that such programs are not fully operational by the end of calendar year 1999. The costs associated with this effort are being evaluated and cannot yet be determined. Although the Company does not presently anticipate a material business interruption as a result of the Year 2000, the worst case scenario if all of the Company's Year 2000 efforts failed, including the failure of third party providers to deliver services, SOUTHERN UNION COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS could result in daily lost revenues of approximately $3,200,000. This estimate is based on historical revenues recognized in the month of January. CONTINGENCIES Southern Union and Western Resources entered into an Environmental Liability Agreement (Environmental Liability Agreement) at the closing of the Missouri Acquisition. Subject to the accuracy of certain representations made by Western Resources in the Missouri Asset Purchase Agreement, the Environmental Liability Agreement provides for a tiered approach to the allocation of substantially all liabilities under environmental under environmental laws that may exist or arise with respect to Missouri Gas Energy. At the present time and based upon information available to management, the Company believes that the costs of any remediation efforts that may be required for these sites for which it may ultimately have responsibility will not exceed the aggregate amount subject to substantial sharing by Western Resources. In addition to the various Missouri Gas Energy sites described above, the Company is investigating the possibility that the Company or predecessor companies may have been associated with Manufactured Gas Plant (MGP) sites in other of its former service territories, principally in Arizona and New Mexico, and present service territories in Texas. At the present time, the Company is aware of certain plant sites in some of these areas and is investigating those and certain other locations. While the Company's evaluation of these Texas, Arizona and New Mexico MGP sites is in its preliminary stages, it is likely that some compliance costs may be identified and become subject to reasonable quantification. To the extent that such potential costs are quantified, the Company expects to provide any appropriate accruals and seek recovery for such remediation costs through all appropriate means, including insurance and regulatory relief. Although significant charges to earnings could be required prior to rate recovery, management does not believe that environmental expenditures for such MGP sites will have a material adverse effect on the Company's financial position, results of operations or cash flows. Pursuant to a 1989 MPSC order, Missouri Gas Energy is engaged in a major gas safety program in its service area. 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 (Missouri Safety Program). In connection with this program, the MPSC issued an accounting authority order (AAO) in Case No. GO-92-234 in 1994 which authorized Missouri Gas Energy to defer depreciation expenses, property taxes and carrying costs at a rate of 10.54% on the costs incurred in the Missouri Safety Program. This AAO was consistent with those which were issued by the MPSC from 1990 through 1993 to the predecessor owner of Missouri Gas Energy. The MPSC rate order of January 22, 1997, however, retroactively reduced the carrying cost rate applied by the Company on the expenditures incurred on the Missouri Safety Program since early 1994 to an Allowance for Funds Used During Construction (AFUDC) rate of approximately 6%. The Company filed an appeal of that portion of the rate order in the Missouri State Court of Appeals, Western District. On August 18, 1998, the Missouri State Court of Appeals denied the Company's appeal resulting in a one-time non-cash write-off of $5,942,000 of previously recorded deferred costs which was recorded during fiscal year 1998. The Company believes that the inconsistent treatment by the MPSC in subse- quently changing to the AFUDC rate from the previously ordered rate of 10.54% constitutes retroactive ratemaking. Unfortunate- ly, the decision by the Missouri State Court of Appeals failed to address certain specific language within the 1994 AAO that the Company believed prevented the MPSC from retroactively changing the carrying cost rate. Southern Union is seeking a transfer of the case to the Missouri Supreme Court; however, the likelihood of transfer is uncertain. On August 18, 1998, a jury in Edinburg, Texas concluded deliberations on the City of Edinburg's franchise fee lawsuit against Valero Energy Corporation (Valero) and a number of its subsidiaries, as well as former Valero subsidiary Rio Grande Valley Gas Company (RGV) and RGV's successor company, Southern Union Company. The case, based upon SOUTHERN UNION COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS events that occurred between 1985-1987, centers on specific contractual language in the 1985 franchise agreement between RGV and the City of Edinburg. Southern Union purchased RGV from Valero in October 1993. The jury awarded the plaintiff damages, under several largely overlapping but mutually exclusive claims, totaling approximately $13,000,000. The actual amount and appropriate allocation of the surviving portions of the damage awards will not be determined until further proceedings are completed, including the trial judge's decision on post-trial motions. The Company is pursuing having the jury's verdict overturned or reduced by the trial judge, and if necessary will vigorously pursue a reversal on appeal. The Company believes it will ultimately prevail and thus has not provided for any loss relative to this matter in its financial statements. Furthermore, the Company has not determined what impact, if any, this jury decision may have on other city franchises in Texas. 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. SOUTHERN UNION COMPANY AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The Company's principal line of business is the distribution of natural gas as a public utility through three divisions: Southern Union Gas, Missouri Gas Energy (MGE) and Atlantic Utilities doing business as South Florida Natural Gas (SFNG). In addition, subsidiaries of Southern Union have been established to support and expand natural gas sales and to capitalize on the Company's gas energy expertise. These subsidiaries operate natural gas pipeline systems, market natural gas to end-users and distribute propane. By providing "one-stop shopping," the Company can serve its various customers' specific energy needs, which encompass substantially all of the natural gas distribution and sales businesses from natural gas sales to specialized energy consulting services. Certain subsidiaries own or hold interests in real estate and other assets, which are primarily used in the Company's utility business. Several of these business activities are subject to regulation by federal, state or local authorities where the Company operates. Thus, the Company's financial condition and results of operations have been and will continue to be dependent upon the receipt of adequate and timely adjustments in rates. In addition, the Company's business is affected by seasonal weather impacts, competitive factors within the energy industry and economic development and residential growth in its service areas. RESULTS OF OPERATIONS Three Months Ended September 30, 1998 and 1997 - ---------------------------------------------- The Company recorded a net loss attributable to common stock of $7,048,000 for the three-month period ended September 30, 1998 compared to a net loss of $4,909,000 for the three-month period ended September 30, 1997. Net loss per common share, based on weighted average shares outstanding during the period, was $.25 in 1998 compared with a net loss per common share of $.18 in 1997. Weighted average shares outstanding increased 5% in 1998 due to the issuance of 755,650 pre-split shares of the Company's common stock on December 31, 1997 in connection with the acquisition of Atlantic Utilities Corporation and Subsidiaries (Atlantic Utilities) in Florida. Due to the seasonal nature of the gas utility business, the three-month period ending September 30 is typically a loss period. Operating revenues were $77,455,000 for the three-month period ended September 30, 1998, compared with operating revenues of $74,039,000 in 1997. Gas purchase costs for the three-month period ended September 30, 1998 were $34,674,000, compared with $32,442,000 in 1997. The Company's operating revenues are affected by the level of sales volumes and by the pass-through of increases or decreases in the Company's gas purchase costs through its purchased gas adjustment clauses. Additionally, revenues are affected by increases or decreases in gross receipts taxes (revenue-related taxes) which are levied on sales revenue as collected from customers and remitted to the various taxing authorities. The increase in both operating revenues and gas purchase costs between periods was primarily due to a 2% increase in gas sales volumes to 12,151 MMcf in 1998 from 11,909 MMcf in 1997, as well as an increase in the average cost of gas from $2.69 per Mcf in 1997 to $2.80 per Mcf in 1998. Changes in the average cost of gas result from seasonal impacts on demands for natural gas and the ensuing competitive pricing within the industry. Net operating margin (operating margin less revenue-related taxes) increased $731,000 for the three-month period ended September 30, 1998 compared with the same period in 1997. Net operating margin increased due to a $13,300,000 annual increase to revenues in the Missouri service territories granted by the Missouri Public Service Commission (MPSC) effective as of September 2, 1998 as well as the increased gas sales volumes discussed above. Additionally, net operating margin increased $368,000 for the three-month period ended September 30, 1998 compared with the same period in 1997 due to the acquisition of Atlantic Utilities, which was effective as of December 31, 1997. Operating expenses, which include operating, maintenance and general expenses, depreciation and amortization, and taxes other than on income and revenues, were $39,971,000 for the three- month period ended September 30, 1998, an increase of $2,763,000, compared with $37,208,000 in 1997. The increase is primarily a result of an SOUTHERN UNION COMPANY AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS increase in depreciation and amortization as a result of including certain costs into rate base that were previously deferred and an increase in reserves for various litigation claims and settlements. Interest expense was $8,740,000 for the three-month period ended September 30, 1998, compared to $8,450,000 in 1997. Interest expense increased in 1998 primarily due to MGE's capital lease obligation incurred for the installation of an Automated Meter Reading (AMR) system. See "Debt and Capital Lease" in the Notes to the Consolidated Financial Statements included herein. Other income for the three-month period ended September 30, 1998 was $724,000 compared to $1,769,000 in 1997. Other income for the three-month period ended September 30, 1998 consists of $340,000 in net rental income from Lavaca Realty Company ("Lavaca Realty"), the Company's real estate subsidiary, and $195,000 related to the deferral of interest and other expenses associated with the Missouri Gas Energy Safety Program. Other income for 1997 included $1,088,000 in realized gains on the sale of investment securities, $277,000 related to the deferral of interest and other expenses associated with the Missouri Gas Energy Safety Program, and net rental income from Lavaca Realty of $266,000. For the three-month period ended September 30, 1998, the federal and state income tax benefit increased $1,228,000, over the same period in 1997 due primarily to an increase in the pre-tax loss described above. The effective tax rate was 36% in both 1997 and 1998. Twelve Months Ended September 30, 1998 and 1997 - ----------------------------------------------- The Company recorded net earnings available for common stock of $10,089,000 for the twelve-month period ended September 30, 1998 compared with net earnings of $19,529,000 in 1997. Earnings per diluted share were $.35 in 1998 compared with earnings per diluted share of $.70 in 1997. Weighted average common and common share equivalents increased 4% during the twelve-month period ended September 30, 1998 compared with 1997 due to the issuance of common stock for the acquisition of Atlantic Utilities, previously discussed. Operating revenues were $672,720,000 for the twelve-month period ended September 30, 1998, a decrease of 5%, compared with operating revenues of $710,239,000 in 1997. Gas purchase costs for the twelve-month period ended September 30, 1998 were $407,812,000, a decrease of 8%, compared with gas purchase costs of $442,214,000 in 1997. Both operating revenues and gas purchase costs were primarily impacted by a 4% decrease in gas sales volume from 120,470 MMcf in 1997 to 115,524 MMcf in 1998. The decrease in sales volume was primarily due to significantly warmer weather in the Missouri service areas during the twelve- month period ended September 30, 1998. Also contributing to the decrease in operating revenues and gas purchase costs was a 4% decrease in the average cost of gas to $3.50 per Mcf in 1998 from $3.66 per Mcf in 1997 as a result of decreases in average spot market gas prices. Operating revenues were affected by an 8% decrease in revenue-related taxes, as well as an $8,847,000 annual increase to rates granted to Missouri Gas Energy, effective as of February 1, 1997. Missouri Gas Energy service territories experienced weather which was 90% of a 30-year measure for the twelve-month period ended September 30, 1998 compared with 104% in 1997. Weather for Southern Union Gas service territories for the twelve-month period ended September 30, 1998 was 98% of a 30-year measure compared with 92% in 1997. About half of the customers served by Southern Union Gas are weather normalized. Operating expenses were $162,932,000 for the twelve-month period ended September 30, 1998, an increase of 4%, compared with operating expenses of $157,013,000 in 1997. The increase is primarily a result of a $3,318,000 increase in depreciation and amortization and a $1,178,000 increase in taxes, other than on income and revenues, as a result of including certain costs into rate base that were previously deferred. Additionally contri- buting to this variance was an increase in various legal claims and assessments which was partially offset by a reduction in bad debt expense. SOUTHERN UNION COMPANY AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Interest expense was $35,174,000 for the twelve-month period ended September 30, 1998 compared to $33,628,000 in 1997. The increase in interest expense is due to increased borrowings under the various financing facilities as well as an increase in long term debt from the AMR capital lease, previously discussed. See "Debt and Capital Lease" in the Notes to the Consolidated Financial Statements for the period ended September 30, 1998 included herein. During fiscal year 1998, the Company was impacted by pre-tax non- cash write-offs totaling $8,163,000 of previously recorded regulatory assets. On August 18, 1998, the Missouri Court of Appeals denied the previously disclosed appeal by the Company of the MPSC's January 1997 Rate Order granted to MGE. Because of this decision, the Company recorded a one-time non-cash write-off of $5,942,000 of deferred costs recorded since 1994. On August 21, 1998, the MPSC also granted MGE a rate increase which, among other things, disallowed certain previously recorded deferred costs requiring an additional pre-tax non-cash write-off of $2,221,000. See "Write-Off of Regulatory Assets" and "Contingencies" in the Notes to the Consolidated Financial Statements for the period ended September 30, 1998 included herein. Other income for the twelve-month period ended September 30, 1998 was $3,027,000 compared to $2,915,000 in 1997. Other income for the twelve-month period ended September 30, 1998 included: $1,589,000 in deferral of interest and other expenses associated with the MGE Safety Program; and net rental income of Lavaca Realty of $1,193,000. Other income for the twelve-month period ended September 30, 1997 included: realized gains on the sale of investment securities of $3,633,000; deferral of interest and other expenses associated with the Missouri Gas Energy Safety Program of $2,449,000; and net rental income from Lavaca Realty of $1,242,000. This was partially offset by $2,125,000 for the settlement of certain billing errors at Missouri Gas Energy and the write-off of $1,750,000 acquisition-related costs from the termination of various acquisition activities. For the twelve-month period ended September 30, 1998, federal and state income taxes decreased $5,957,000 over the same period in 1997 due to a reduction in pre-tax earnings as discussed above. The Company's consolidated federal and state effective income tax rate was 40% for the twelve-month period ended September 30, 1998 compared to 39% in 1997. SOUTHERN UNION COMPANY AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following table sets forth certain information regarding the Company's domestic gas utility operations for the three- and twelve-month periods ended September 30, 1998 and 1997: Three Months Ended Twelve Months Ended September 30, September 30, 1998 1997 1998 1997 --------- --------- --------- --------- Average number of gas sales customers served: Residential........... 880,018 864,408 885,363 868,407 Commercial............ 85,953 84,073 88,152 86,221 Industrial and irrigation........... 578 570 565 580 Public authorities and other................ 2,801 2,653 2,792 2,694 Pipeline and marketing............ 229 225 232 202 --------- --------- --------- -------- Total average customers served.. 969,579 951,929 977,104 958,104 ========= ========= ========= ======== Gas sales in millions of cubic feet (MMcf) Residential........... 4,590 4,846 64,129 68,229 Commercial............ 2,738 2,850 28,119 30,518 Industrial and irrigation........... 414 366 1,656 1,865 Public authorities and other................ 233 245 2,740 2,767 Pipeline and marketing............ 3,960 3,387 18,925 17,844 --------- --------- --------- -------- Gas sales billed.. 11,935 11,694 115,569 121,223 Net change in unbilled gas sales............ 216 215 (45) (753) --------- --------- --------- --------- Total gas sales... 12,151 11,909 115,524 120,470 ========= ========= ========= ========= Gas sales revenues (thousands of dollars): Residential........... $ 41,591 $ 40,096 $ 409,245 $ 434,865 Commercial............ 15,302 14,657 159,828 173,467 Industrial and irrigation........... 1,689 1,640 7,796 9,355 Public authorities and other........... 936 1,078 11,141 13,168 Pipeline and marketing........... 9,427 7,986 46,403 46,577 --------- --------- --------- --------- Gas revenues billed............ 68,945 65,457 634,414 677,432 Net change in unbill- ed gas sales reven- ues................. 1,242 2,215 195 (3,825) --------- --------- --------- --------- Total gas sales revenues.......... $ 70,187 $ 67,672 $ 634,609 $ 673,607 ========= ========= ========= ========= Gas sales margin (thousands of dollars).............. $ 32,672 $ 32,601 $ 194,899 $ 194,119 ========= ========= ========= ========= Gas sales revenue per thousand cubic feet (Mcf) billed: Residential.......... $ 9.062 $ 8.274 $ 6.382 $ 6.374 Commercial........... 5.590 5.143 5.684 5.684 Industrial and irrigation.......... 4.076 4.481 4.708 5.016 Public authorities and other........... 4.011 4.400 4.066 4.759 Pipeline and marketing........... 2.381 2.358 2.452 2.610 Weather: Degree days: Southern Union Gas service territories........ 0 1 2,119 1,956 Missouri Gas Energy service territor- ies................ 8 23 4,708 5,443 30-year measure: Southern Union Gas service territor- ies................ 5 5 2,152 2,127 Missouri Gas Energy service territor- ies................ 59 59 5,218 5,246 Gas transported in mil- lions of cubic feet (MMcf)................ 14,655 15,562 58,247 63,867 Gas transportation revenues (thousands of dollars)........... $ 3,776 $ 3,834 $ 19,591 $ 21,174 - -------------------- The above information does not include the Company's 42% equity ownership in a natural gas distribution company serving 17,800 customers in Piedras Negras, Mexico. SOUTHERN UNION COMPANY AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FINANCIAL CONDITION The Company's gas utility operations are seasonal in nature with a significant percentage of the annual revenues and earnings occurring in the traditional heating-load months. This seasonality results in a high level of cash flow needs during the peak winter heating season months, resulting from the required payments to natural gas suppliers in advance of the receipt of cash payments from the Company's customers. The Company has historically used internally generated funds and its credit facilities to provide funding for its seasonal working capital, continuing construction and maintenance programs and operational requirements. The principal source of funds during the three-month period ended September 30, 1998 was $40,503,000 borrowed under the credit facilities. This provided funds for additions to property, plant and equipment of $14,235,000, operating outflows of $26,162,000 and other seasonal working capital needs of the Company. The effective interest rate under the Company's current debt structure is 7.71% (including interest and the amortization of debt issuance costs and redemption premiums on refinanced debt). The Company has availability under two revolving credit facilities (the "Revolving Credit Facilities") underwritten by a syndicate of banks. Of the Revolving Credit Facilities, $40,000,000 is a short-term facility which expires June 30, 1999, while $60,000,000 is a long-term facility which expires June 30, 2001. The Company had additional availability under uncommitted line of credit facilities (Uncommitted Facilities) with various banks. Covenants under the Revolving Credit Facilities allow for up to $35,000,000 of borrowings under Uncommitted Facilities at any one time. Borrowings under the facilities are available for Southern Union's working capital, letter of credit requirements and other general corporate purposes. Amounts outstanding under these facilities at September 30, 1998 and October 31, 1998 were $42,103,000 and $47,400,000, respectively. SOUTHERN UNION COMPANY AND SUBSIDIARIES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. SOUTHERN UNION COMPANY ------------------------------------ (Registrant) Date November 10, 1998 By RONALD J. ENDRES --------------------- --------------------------------- Ronald J. Endres Executive Vice President and Chief Financial Officer Date November 10, 1998 By DAVID J. KVAPIL --------------------- --------------------------------- David J. Kvapil Senior Vice President and Corporate Controller (Principal Accounting Officer) EXHIBIT 27 FINANCIAL DATE SCHEDULE FINANCIAL DATA SCHEDULE EX-27 2
UT JUN-30-1998 SEP-30-1998 3-MOS PER-BOOK $ 851,001,000 $ 14,601,000 $ 80,862,000 $ 95,270,000 $ 5,246,000 $1,046,980,000 $ 28,262,000 $ 252,568,000 $ 9,690,000 $ 289,726,000 $ 0 $ 100,000,000 $ 412,475,000 $ 42,103,000 $ 0 $ 0 $ 2,051,000 $ 0 $ 0 $ 0 $ 200,625,000 $1,046,980,000 $ 77,455,000 $ (3,965,000) $ 26,047,000 $ 39,971,000 $ (627,000) $ 724,000 $ 1,692,000 $ 8,740,000 $ (7,048,000) $ 0 $ (7,048,000) $ 0 $ 0 $ (26,162,000) $ (.25) $ (.25)
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