-----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, BX54meFN7eNRAF7fEmxoZe+Bv9kuIQpVslTybKthlPq3OkNu4hEyXURrSf03JSQz FfaASRP0T0uiAkeQumlAsQ== 0000310103-98-000027.txt : 19981207 0000310103-98-000027.hdr.sgml : 19981207 ACCESSION NUMBER: 0000310103-98-000027 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19980930 FILED AS OF DATE: 19981204 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CONNECTICUT ENERGY CORP CENTRAL INDEX KEY: 0000310103 STANDARD INDUSTRIAL CLASSIFICATION: NATURAL GAS DISTRIBUTION [4924] IRS NUMBER: 060869582 STATE OF INCORPORATION: CT FISCAL YEAR END: 0930 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 001-08369 FILM NUMBER: 98763879 BUSINESS ADDRESS: STREET 1: 855 MAIN STREET CITY: BRIDGEPORT STATE: CT ZIP: 06604 BUSINESS PHONE: 8007607776 MAIL ADDRESS: STREET 1: 855 MAIN ST CITY: BRIDGEPORT STATE: CT ZIP: 06604 10-K 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-K FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended September 30, 1998 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from __________ to __________ Commission file number 1-8369 CONNECTICUT ENERGY CORPORATION (Exact Name of Registrant as Specified in Its Charter) Connecticut 06-0869582 (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.) 855 Main Street Bridgeport, Connecticut 06604 (Address of Principal Executive Offices) (Zip Code) Registrant's telephone number, including area code (800) 760-7776 Securities registered pursuant to Section 12(b) of the Act: Title of Each Class Name of Each Exchange on Which Registered - --------------------------- ----------------------------------------- Common Stock ($1 par value) New York Stock Exchange Securities registered pursuant to Section 12(g) of the Act: None (Title of Class) 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. [ ] Aggregate market value of the voting stock held by non-affiliates of the registrant based on the closing price of such stock as of November 20, 1998: $289,281,972 APPLICABLE ONLY TO REGISTRANTS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PRECEDING FIVE YEARS: Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes [ ] No [ ] APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: Class Outstanding at November 20, 1998 ----- -------------------------------- Common Stock, $1 par value 10,331,499 DOCUMENTS INCORPORATED BY REFERENCE Portions of Connecticut Energy Corporation's 1998 Annual Report to Shareholders are incorporated into Part II and Part IV. Portions of Connecticut Energy Corporation's Definitive Proxy Statement dated December 11, 1998 are incorporated into Part III. PART I ------ CONNECTICUT ENERGY CORPORATION Connecticut Energy Corporation ("Connecticut Energy" or "Company") and its subsidiaries and their representatives may, from time to time, make written or oral statements, including statements contained in the Company's filings with the Securities and Exchange Commission and in its annual report to shareholders, including its Form 10-K, which constitute or contain "forward- looking" information as that term is defined in the Private Securities Litigation Reform Act of 1995. All statements other than the financial statements and other statements of historical facts included in this Form 10-K regarding the Company's financial position and strategic initiatives and addressing industry developments are forward-looking statements. Where, in any forward-looking statement, the Company, or its management, expresses an expectation or belief as to future results, such expectation or belief is expressed in good faith and believed to have a reasonable basis, but there can be no assurance that the statement of expectation or belief will result or be achieved or accomplished. Factors which could cause actual results to differ materially from those stated in the forward-looking statements may include, but are not limited to, general and specific economic, financial and business conditions; federal and state regulatory, legislative and judicial developments which affect the Company or significant groups of its customers; the impact of competition on the Company's revenues; fluctuations in weather from normal levels; changes in development and operating costs; the availability and cost of natural gas; the availability and terms of capital; exposure to environmental liabilities; the costs and effects of unanticipated legal proceedings; the successful implementation and achievement of internal performance goals; the impact of unusual items resulting from ongoing evaluations of business strategies and asset valuations; and changes in business strategy. Item 1. Business - ----------------- General Connecticut Energy is a public utility holding company primarily engaged in the retail distribution of natural gas for residential, commercial and industrial uses through its principal subsidiary, The Southern Connecticut Gas Company ("Southern"), a Connecticut public service company. Southern's predecessor companies, New Haven Gas Company and The Bridgeport Gas Company, were originally incorporated in Connecticut in 1847 and 1849, respectively. The Company is exempt from registration under the Public Utility Holding Company Act of 1935. Southern serves approximately 158,000 customers in Connecticut, primarily in 22 towns along the southern Connecticut coast from Westport to Old Saybrook, which include the urban communities of Bridgeport and New Haven. Southern is also authorized to lay mains and sell gas in an additional 10 towns in its service area, but does not currently provide any service to these towns. The percentage of the Company's revenues contributed by each class of customers for the last three fiscal years was as follows: Years ended September 30, 1998 1997 1996 - ---------------------------------------------------------------------- Residential 58.9% 57.9% 58.0% Commercial firm 17.7 19.5 21.4 Industrial firm 3.9 4.3 6.5 Firm transportation and firm contract 5.5 2.4 0.3 Interruptible and other 14.0 15.9 13.8 ----- ----- ----- 100.0% 100.0 100.0% ===== ===== ===== Southern is the sole distributor of natural gas, other than bottled gas, in its service area. Oil and electricity compete with gas in most industrial and commercial markets and for residential space and water heating. In general, Southern's firm rates are currently lower than electric rates for heating and, on average, are generally competitive with fuel oil. Southern's gas sales are affected by seasonal factors, and it experiences higher revenues during the winter months. Through its nonutility subsidiary, CNE Energy Services Group, Inc. ("CNE Energy"), the Company provides an array of energy products and services to commercial and industrial customers throughout New England and New York. The company also participates in a natural gas purchasing cooperative through another nonutility subsidiary, CNE Development Corporation. A third nonutility subsidiary, CNE Venture-Tech, Inc., invests in ventures that offer technologically advanced energy-related products. In September 1997, CNE Energy formed a joint venture with Delmarva Power & Light Company's bulk energy group. The venture operates under the name Conectiv/CNE Energy Services, LLC and sells natural gas, electricity, fuel oil and other services and markets a full range of energy-related planning, financial, operational and maintenance services to commercial, industrial and municipal customers in New England and New York. In February 1998, the venture formed an alliance with Berkshire Energy Marketing, a division of the Massachusetts natural gas distribution utility, Berkshire Gas Company. The alliance markets energy commodities and services to commercial and industrial customers in western Massachusetts, eastern New York and southern Vermont. As the result of a merger of Delmarva Power & Light Company and Atlantic Energy, Inc., a holding company under the name Conectiv was formed. In September 1998, CNE Energy and Conectiv Energy Supply, Inc., a subsidiary of Conectiv, formed two joint ventures, Total Peaking Services, LLC ("TPS") and CNE Peaking, LLC ("CNEP"). TPS, headquartered in Bridgeport, Connecticut, operates a 1.2 billion cubic foot liquefied natural gas ("LNG") open access storage facility in Milford, Connecticut. The facility has access to three major natural gas pipelines in New England: Algonquin Gas Transmission Company, Iroquois Gas Transmission System, L.P. and Tennessee Gas Pipeline Company. TPS has received Federal Energy Regulatory Commission ("FERC") approval of its market-based tariffs and is prepared to store and redeliver customer-owned LNG at the Milford facility beginning this winter. CNEP provides a firm in-market supply source to assist energy marketers and local gas distribution companies ("LDCs") in meeting the maximum demands of their customers by offering firm supplies for peak-shaving and emergency deliveries. CNEP operates out of Newark, Delaware. As of September 30, 1998, the Company, through its subsidiaries, had 488 full-time employees, the majority of whom were employees of Southern. Customers General From 1993 through 1998, the average number of on-system customers served by Southern grew from approximately 152,200 to 157,800. Southern provides three types of gas service to its on-system customers: firm sales, firm transportation and interruptible. Firm service is provided to residential, commercial and industrial customers who require a continuous gas supply throughout the year. Southern serves approximately 181,000 firm residential units. Interruptible service is available to those customers that have dual fuel capabilities which allow them to alternate between natural gas and another fuel source. Firm service for residential use includes service to multi-family units. Firm transportation is available to commercial, industrial and multi-family customers who have secured their own gas supply and require that Southern transport this supply on its distribution system. Southern also provides transportation service to certain commercial and industrial customers on an interruptible basis, where the gas transported is owned by those customers. Additionally, Southern has the approval of the Connecticut Department of Public Utility Control ("DPUC") to participate in the off-system sales market. If gas supplies are available after meeting on-system loads, Southern can sell to customers within Connecticut or in out-of-state markets. The customers to whom these sales are made are not permanent customers of Southern. Firm Sales, Firm Transportation and Firm Contract In 1998, firm services represented approximately 86% of operating revenues and approximately 61% of total gas throughput. Firm sales to industrial customers are likely to constitute a smaller percentage of Southern's future total sales due to the changing character of the local economy and continuing regulatory developments affecting the natural gas industry (see section entitled "Rates and Regulation" for further detail). Southern provides firm contract sales service to Yale University in accordance with rates specified in a DPUC-approved special contract for the sale of gas to this facility. Southern and CNE Energy provide firm transportation contract service to a 520 megawatt electric generating plant in Bridgeport in accordance with a DPUC-approved contract. Southern concentrates on customer additions that are the most cost-effective to achieve. Over the past several years, Southern has focused on adding load along its existing mains, which generally requires a lower capital outlay than adding load requiring new main. Approximately 59% of the residences along Southern's mains heat with natural gas. The conversion of these homes from an alternate fuel to natural gas heat has been a major factor in increased load growth. Interruptible Sales, Transportation and Special Contract Services Interruptible sales, which include off-system sales, and transportation services are priced flexibly and competitively compared to the price paid for alternate fuels by larger commercial and industrial customers. Southern's interruptible sales fluctuate primarily due to the relative price differentials between alternate fuels and natural gas as well as the availability of gas not needed to serve firm customers. In addition to interruptible sales, Southern transports gas, on an interruptible basis, for delivery to certain large commercial and industrial consumers. Because of recent regulatory developments, end users can contract more easily than in the past for transportation service on interstate pipelines to transport natural gas supplies purchased from producers/suppliers, rather than purchase gas solely from LDCs. In Southern's service area, gas is transported to customers using interstate pipeline transportation and Southern's distribution system. Transportation revenues are considerably less than revenues from gas sales because customers pay only a fee for the transportation service. Gas sales revenues include the cost of gas sold. Southern provides transportation service to The Connecticut Light and Power Company's Devon electric generating station in accordance with rates specified in a special contract for the transportation of gas. In 1998, interruptible sales, transportation and special contract services represented approximately 13% of operating revenues and approximately 37% of total gas throughput. Southern's average margins on interruptible transportation service are less than its average margins on firm sales and are usually less than its average margins on interruptible sales. To the extent Southern negotiates its monthly prices for interruptible services below its monthly standard offering price, lower margins may result. The Company does not believe that the loss of any single customer or a few customers would have a long-term, material, adverse effect upon Southern's business. Marketing General Southern's marketing focus has undergone change in the last year. While Southern continues to aggressively pursue new residential and commercial heating customers, markets which are increasingly being targeted include power generating plants, marketers and aggregators. Marketing emphasis on customer incentive programs has increased to also include building business relationships with this new customer group in addition to architects, engineers and municipalities. By recognizing these marketers as customers rather than competitors, Southern expects the marketer to establish and finance incentive programs with input from Southern. If Southern is allowed to exit the merchant function and becomes solely a distribution company, the key element to its future growth will be increasing system throughput. Southern's sales force has established an automated database to track consumer trends and reduce the amount of time necessary to enter a new business authorization into its costing network. Residential Market In the residential heating market, despite record low oil prices, 1,943 customers were added in 1998 compared to 2,641 customers in 1997 and 1,866 in 1996. Residential conversions accounted for 63% of these additions in 1998, compared to 60% in 1997 and 52% in 1996. Southern's residential marketing programs include a conversion burner program and an employee generated leads program for heating conversions. Southern has also established relationships with manufacturers and distributors in an effort to utilize their resources to attract new business. Commercial and Industrial Markets In the commercial and industrial markets, emphasis is placed on adding new firm and interruptible sales. Marketing programs for commercial and industrial customers include a program offering customers the option of financing new equipment through Southern and a conversion burner leasing program which provides customers with a low cost opportunity to switch to natural gas. Additionally, Southern's commercial and industrial sales group has embarked on a load retention program. Effective April 1, 1996, firm transportation service became available to commercial and industrial customers. As of September 30, 1998, there were 1,789 firm transportation customers representing 2,094 accounts purchasing natural gas directly from marketers. The trend is for more of Southern's commercial and industrial customers to exercise choice once they become aware of its benefits. Southern encourages all eligible commercial and industrial customers to proactively learn more about their options. The commercial marketing programs are targeted toward increasing natural gas consumption in the industrial sector by promoting the productivity, product quality, efficiency and environmental benefits of modern natural gas technologies to industrial plant managers and specifiers. For example, natural gas fired desiccant dehumidification equipment has begun to receive acceptance in supermarket and ice-rink applications. With the continuing deregulation of energy markets and advancements in natural gas turbine technologies, cogeneration is a viable economic solution for many industrial customers. For example, in 1998, Yale University installed a 13.5 megawatt cogeneration system that will provide both electricity and steam for many of its facilities. The new state-of-the-art cogeneration facility uses three gas turbines and other modern equipment to generate electricity and steam from natural gas to provide heating and cooling to the central campus. The Bridgeport Energy combined cycle generating plant is representative of new energy marketplace dynamics created by deregulation. The facility buys its gas supplies through third party marketers. Southern then transports the supplies to the plant via its new 11-mile natural gas distribution facility that links the plant with the Iroquois Gas Transmission System. This plant has the capability of consuming up to 30,000,000 Mcf of volume annually. Natural Gas Vehicles Natural gas vehicles ("NGVs") represent another opportunity to increase the base load usage of natural gas. Southern has been active in this market, and it is estimated that there will be more natural gas vehicles operating in its service area by January 1, 1999. Existing customers include the U.S. Postal Service, R.R. Donnelley and Sons Company, South Central Regional Water Authority, BHC Company and the town of Westport. More fleets expect to add natural gas vehicles during the next five years as federal legislation requires fleets to "phase-in" the use of cleaner alternate fuel vehicles. Natural gas is the leading alternate fuel for vehicle use. The strategic location of Southern's franchise area, which lies along the Interstate 95 and 91 corridor, is key to maximizing the profitability of the existing distribution system, specifically for natural gas vehicular fueling use. Gas Supply General Southern's long-term supply sources include (1) Canadian supplies purchased from Alberta Northeast Gas Limited ("Alberta Northeast") with transportation on Iroquois Gas Transmission System, L.P. ("Iroquois"), (2) transportation and storage services from Tennessee Gas Pipeline Company ("Tennessee") with direct purchase of supply from producers and marketers, (3) transportation and storage services from Texas Eastern Transmission Corporation ("Texas Eastern") with direct purchase of supply from producers and marketers, (4) transportation services from Algonquin Gas Transmission Company ("Algonquin"), (5) transportation and storage services from CNG Transmission Corporation ("CNG Transmission"), (6) transportation service from Transcontinental Gas Pipeline Corporation ("Transco"), (7) transportation service from National Fuel Gas Supply Corporation ("National Fuel") and (8) liquid and vapor supplies from Distrigas of Massachusetts Corporation ("Distrigas"). These arrangements result in gas deliveries into Southern's service territory through interconnections with three interstate pipelines: Algonquin, Iroquois and Tennessee. In addition to Southern's long-term firm supply arrangements, Southern purchases spot supplies and utilizes interruptible transportation services from interstate pipeline companies. Southern's supply, transportation and storage agreements require Southern to pay a fixed demand charge regardless of the amount of gas transported or stored. The FERC regulates interstate pipeline companies in connection with the rates charged to Southern for transportation and storage of natural gas. Domestic Supply Southern's domestic supply arrangements consist mainly of purchasing storage and transportation services from interstate pipelines. Producers and marketers provide the gas supply to support these services. Southern has firm transportation and firm storage contracts with Tennessee. Under the transportation contract, Southern has 13,336,000 Mcf of pipeline capacity available on an annual basis. Southern's storage contract with Tennessee provides 1,195,000 Mcf of storage capacity. These contracts expire in the year 2000. Two other transportation contracts with Tennessee provide 516,000 Mcf of firm transportation service annually and expire in the year 2000. A transportation contract with Texas Eastern provides 5,972,000 Mcf of capacity on an annual basis. Additional contracts with Texas Eastern provide 1,383,000 Mcf of storage service and 12,108,000 Mcf of transportation service on an annual basis. Contracts with Texas Eastern expire in the year 2012. Southern has storage service contracts with CNG Transmission. One contract provides 100 days of storage service with 648,000 Mcf of annual delivery. The remaining term of this contract is 14 years. Under other contracts which have remaining terms of five to nine years, CNG Transmission provides 773,000 Mcf of annual firm storage service and 1,028,000 Mcf of annual transportation service. The gas is stored by CNG Transmission and delivered to Southern under transportation contracts with Texas Eastern and Algonquin. Algonquin furnishes only transportation services to Southern. The deliveries that Algonquin makes to Southern are gas supplies transported by other interstate pipelines interconnected to Algonquin. Southern has multiple, diverse purchase agreements with producers and marketers for firm supply, which is delivered to customers under its transportation agreements or stored under its storage agreements for later delivery during peak periods. These agreements vary in terms of delivery obligations and the contract terms range from one month to three years. Southern pays a monthly reservation charge, but has no monthly purchase obligation under these agreements. Commodity prices are based on price indexes by supply area or are negotiated. Canadian Supply Southern receives Canadian supply under its long-term contracts with Alberta Northeast with firm transportation provided by Iroquois. These supply contracts with Alberta Northeast provide Southern with 12,775,000 Mcf of firm Canadian supply annually. Supply agreements with Alberta Northeast have remaining terms of four to eight years, and the transportation agreement with Iroquois has a remaining term of 13 years. Supplemental Supply Southern has an agreement with Distrigas to purchase 328,000 Mcf annually on a firm basis. This contract continues for four years and includes a provision for either vapor or liquid delivery, with an option to increase maximum daily delivery over the term of the contract. Additionally, Southern has interruptible purchase contracts with Distrigas. Supplemental gas supplies from on-site LNG and liquefied propane air storage facilities are available to meet peak and winter demand requirements (see section entitled "Connecticut Regulation" for the Decision in Docket No. 96-04-30). Recent FERC Initiatives The FERC recently announced several initiatives that will affect regulation of the natural gas industry. On July 29, 1998, the FERC issued a Notice of Inquiry in Docket No. RM98-12. In this proceeding, the FERC is seeking comments about the need to change its current regulatory policies relating to (1) the pricing of existing capacity, (2) the pricing of new capacity, (3) the use of index rates and benchmark adjustments to streamline rate filings, (4) means to employ performance-based incentive regulation, (5) the use of market-based rates for turn back capacity, (6) the use of market-based rates for unsubscribed capacity and (7) methods to negotiate pre-construction risk among parties to an expansion of pipeline capacity. On the same date that it issued its Notice of Inquiry, the FERC also issued a Notice of Proposed Rulemaking in Docket No. RM98-10. In this proceeding, the FERC proposes the removal of price caps in the short-term market and proposes revised regulations that would subject all released capacity to an auction process. The FERC is also proposing to permit pipelines to negotiate the terms and conditions of transportation service under limited conditions. On September 30, 1998, the FERC initiated two additional proceedings. In Docket No. RM98-9, the FERC proposes to modify its regulations governing applications to construct new pipeline capacity. Among other things, the FERC proposes to expand the scope of pipeline certificate authorizations to allow pipelines to replace and abandon more facilities than are currently covered by the blanket certificate, including replacements involving incrementally larger replacement pipe. In addition, the FERC proposes to establish an environmental checklist intended to add certainty to the environmental review aspect of certificate applications. Also on September 30, 1998, the FERC announced a Notice of Proposed Rulemaking in Docket No. RM98-16 to expand the use of collaborative procedures for applicants proposing to build new pipeline facilities as well as hydroelectric projects. The proposed regulations are intended to bring applicants and potentially affected parties together in a pre-filing collaborative process to resolve significant issues, including issues likely to be raised in the environmental review process. The above-mentioned initiatives are subject to the outcome of notice and comment procedures and have not yet taken the form of final, binding regulations. Therefore, it is difficult to ascertain the precise impact they will have on the business interest of LDCs like Southern. Recent Pipeline Rate Case Decisions On July 29, 1998, the FERC issued a Decision in the Iroquois Rate Case, Docket No. RP97-126. As a result of the FERC's Decision, Southern will experience a reduction in rates of approximately $2,300,000 per year, or 28%. The new rates became effective August 31, 1998. Iroquois has filed a request for rehearing and will have further opportunity to appeal the FERC's Decision. The FERC issued final approval of a Joint Stipulation and Agreement Amending a Global Settlement in Texas Eastern Docket No. RP98-198 on October 29, 1998. In this settlement between Texas Eastern and its customers, Texas Eastern will reduce its book depreciation rates as a funding mechanism to permit more rapid collection of gas contract reformation costs, the roll-in of certain rates, and a reduction in its rates. Texas Eastern agreed to accept all risks associated with turnback of capacity until December 31, 2003 and a rate moratorium until that date. Reductions in rates to Southern will be approximately $6,200,000. On August 31, 1998, CNG Transmission filed with the FERC an uncontested Stipulation Agreement of Settlement in Docket No. RP97-406. The FERC issued final approval of the settlement on November 24, 1998. Southern will experience a 23% reduction in rates and the roll-in of GSS-II storage over the next five years. Off-System Sales Southern's off-system sales program maximizes the use of its gas supply contracts, improves the usage of Southern's capacity on pipeline systems and lowers gas costs to firm customers through established margin sharing mechanisms. Pursuant to the DPUC Decision regarding FERC Order No. 636, Southern is allowed to enter into off-system sales under flexible terms and pricing for periods of less than one year without prior approval of the DPUC. In fiscal 1998, Southern dispatched approximately 4,484,100 Mcf of volume as part of its off-system sales program. Off-system sales are performed by Southern through an effective trading operation established over the last three years. Southern has established a recognized sales function in various natural gas markets in the United States. Southern's customers include other LDCs, marketers, electric generation and wholesale customers. Southern has pooling agreements and a unique asset base enabling it to deliver reliably and competitively along a significant portion of the eastern pipeline grid under the full range of operating and marketing conditions. Capacity release programs are available on all interstate pipelines serving Southern, and Southern actively participates in these programs. Demand charges recovered from a replacement shipper flow back as a reduction on the pipeline's monthly invoice. These demand reductions are used to lower gas costs to firm customers through established margin sharing mechanisms approved by the DPUC. CNE Development has joined six other major eastern U.S. natural gas distribution companies or their affiliates to form the East Coast Natural Gas Cooperative, LLC to access competitively priced gas supplies. Southern has experienced reduced gas costs and increased operational flexibility as a result of the activities of the Cooperative. Rates and Regulation Connecticut Regulation General Southern is subject to the jurisdiction of the DPUC as to accounting, rates, charges, operating matters and the issuance of securities, both equity and debt, other than borrowings maturing in 12 months or less. Southern's firm sales rates change monthly pursuant to a DPUC-approved Purchased Gas Adjustment clause, under which purchased gas costs above or below a specified base cost are charged or credited to customers. In setting authorized rates for Southern, the DPUC allows prospective adjustments to a historical test year. Forward-looking adjustments to the mid-point of the rate year (the first year that rates will be in effect) for rate base, revenues, expenses and capital structure are allowed. The DPUC has found that these refinements provide for better synchronization of the ratemaking components. Costs used by the DPUC in determining Southern's rates may not be the same as actual costs incurred by Southern during the period rates are in effect. The sales used in establishing rates are based on "normal" weather patterns. Actual rates of return realized may not necessarily equal the authorized rates of return. Rate Review Docket In July 1998, the DPUC issued a Decision in Docket 97-12-21, DPUC Financial and Operational Review of the Southern Connecticut Gas Company. In this portion of the Docket, the DPUC initiated hearings which determined that the Company overearned historically and was likely to do so for the projected 12-month period ending June 30, 1999. The DPUC, therefore, ordered an interim rate decrease of $528,000 per year for the Company's firm sales customers. This reduction was implemented on July 8, 1998. The second phase of Docket 97-12-21 involves a four-year financial and operational review as required by Section 16-19a of the General Statutes of Connecticut. This section states: "The Department of Public Control shall, at intervals of not more than four years from the last previous general rate hearing of each gas and electric company having more than 75,000 customers, conduct a complete review and investigation of the financial and operating records of each such company..." The company expects to receive a Decision in this docket in December 1998. Unbundling of Natural Gas Services In August 1995, the DPUC issued a final Decision in Docket No. 94-11-12, DPUC Review of Connecticut Local Distribution Companies' Cost of Service Study Methodologies. In this docket, the DPUC investigated the issues surrounding the development of firm transportation rates at the state level in response to FERC Order No. 636. Effective April 1, 1996, commercial and industrial gas customers in Connecticut can contract for their gas supplies from sources other than the LDCs and pay the LDCs only for the transportation of that gas through their distribution systems at DPUC-approved rates. The firm transportation rates are designed to provide Southern with the same margins provided by bundled services. In August 1997, the DPUC initiated a generic docket, Docket 97-07-11, DPUC Generic Investigation into Issues Associated with the Unbundling of Natural Gas Services by Connecticut Local Distribution Companies, to investigate issues associated with the unbundling of natural gas firm sales and transportation services by LDCs in Connecticut, including Southern. The DPUC has conducted this proceeding in two phases. The first phase addressed issues relating to firm transportation service in its present form regarding delivery of sales and transportation service by LDCs and marketers. The DPUC reopened each LDC's latest rate case to consider proposed changes to its respective tariffs and rates. An Interim Decision was approved on October 28, 1998 which affected the way LDCs administer firm transportation services by providing for changes in the load balancing provisions in the LDCs' tariffs as well as for enhanced billing options for customers. The Interim Decision is scheduled to be finalized in January 1999. The second phase of this proceeding will investigate such issues as residential unbundling, codes of conduct for LDCs and marketers, and public policy issues. A schedule has not yet been established for this phase. Sublease of Liquefied Natural Gas Plant In August 1996, the DPUC issued a final Decision in Docket No. 96-04-30, Application of The Southern Connecticut Gas Company to Dispose of a Portion of Its Plant and Equipment. The DPUC approved certain proposals made by Southern regarding the operation of its LNG tank and related facilities, which included the sublease of the LNG tank and related facilities from Southern to CNE Energy, which would, in turn, sublease the LNG facility to TPS. TPS has received FERC approval of its market-based tariffs and is prepared to store and redeliver customer-owned LNG beginning this winter. Interruptible Margin Sharing In January 1996, Southern requested a reopening of its 1993 rate proceeding to propose a plan to redirect excess on-system interruptible margins, which would otherwise be returned to ratepayers, for calendar years 1996, 1997 and 1998 to two programs to fund certain economic development initiatives in Bridgeport and to provide grants to customers to reduce Southern's hardship assistance balances. Southern estimated that margins to be collected over the proposed three-year period would be approximately $14,000,000, which would be divided equally between the programs. Southern's proposal related to the economic development initiatives in Bridgeport included job training and services, certain loan subsidies and health promotion outreach services. Redirection of ratepayer margins for hardship assistance balances benefits Southern's hardship customers by reducing their accounts receivable arrearages and benefits Southern by reducing its provision for uncollectibles for such accounts. On April 26, 1996, the DPUC issued a final Decision regarding Southern's proposal. The DPUC effectively approved Southern's proposal with certain modifications in the direction of funding of the Bridgeport economic development initiatives, the imposition of a cap of $6,000,000 per year of ratepayer margins to be split equally between the programs and certain implementation and status reporting requirements. Federal Regulation Southern is affected by various federal regulations, including regulations which (1) provide for emergency authority and curtailment allocations under the Natural Gas Policy Act of 1978 when pipeline supplies are limited and (2) establish certain retail policies for natural gas utilities under the Public Utility Regulatory Policies Act of 1978. Southern is also subject to the Natural Gas Pipeline Safety Act of 1968 with respect to the construction, operation and maintenance of its mains, services and LNG facilities as well as other federal regulations pertaining to safety standards concerning such facilities. Currently, these federal regulations have a minimal impact on Southern's day-to-day operations. Southern must comply with various federal, state and local regulations with respect to environmental matters (including hazardous waste regulation), local zoning and other regulations. To date, such regulations have not materially impacted Southern's capital expenditures, earnings or operations. Regulations promulgated under the Clean Air Act Amendments of 1990 and the Energy Policy Act of 1992, which require reduced pollution levels and certain energy efficiency standards, have begun to affect Southern. Among other things, the Clean Air Act Amendments (1) impose stringent vehicle emissions standards beginning in 1994, (2) mandate the gradual phase-in of alternate fuel vehicles for fleets of more than 10 vehicles beginning in 1998 and (3) require power plants to phase-in significant emission reductions of sulfur dioxide and nitrogen oxide by the year 2000. Similarly, the Energy Policy Act of 1992 (1) requires that federal agencies begin phasing-in the use of alternate fuels in vehicles in 1993, (2) offers tax incentives to private parties who use or facilitate the use of alternate fuel vehicles and (3) requires a lessening reliance on foreign fuels. In 1996, the FERC also issued Order No. 888, mandating that electric utilities provide open access transmission at wholesale. This Order has expanded opportunities for the sale of power from gas fired generating units. Over time, these regulations will likely lead to an increasing demand for natural gas. Southern already has begun to participate in the expanded markets for natural gas emerging due to these regulatory mandates. Since 1986, the FERC has effected major changes in the regulations governing the natural gas industry, especially FERC Order No. 636 which mandated the unbundling of interstate pipeline services. The actions by the FERC have increased competition in the natural gas industry by requiring interstate pipeline companies to provide gas transportation to others on a nondiscriminatory basis. The FERC has also been involved in oversight of the Gas Industry Standards Board, a group comprised of interstate pipelines and shippers. The Board's actions to standardize essential terms of interstate pipeline transportation have an effect on the manner in which Southern interacts with suppliers and pipeline companies. The FERC has also announced recent rulemaking initiatives governing the prices and terms under which pipeline customers, including Southern, can purchase capacity or resell the capacity they currently hold, a point discussed in the section entitled "Gas Supply, Recent FERC Initiatives." These initiatives, if adopted, will also affect Southern's decisions regarding the acquisition and retention of interstate pipeline capacity; however, the nature of such impacts cannot now be predicted. Environmental Matters Southern has identified coal tar residue at three sites in Connecticut resulting from coal gasification operations conducted at those sites by Southern's predecessors from the late 1800s through the first part of this century. Many gas distribution companies throughout the country carried on such gas manufacturing operations during the same period. The coal tar residue is not designated a hazardous material by any federal or Connecticut agency, but some of its constituents are classified as hazardous. On April 27, 1992, Southern notified the Connecticut Department of Environmental Protection ("DEP") and the United States Environmental Protection Agency of the presence of coal tar residue at the sites. On November 9, 1994, the DEP informed Southern that it had performed a preliminary review of the information provided to it by Southern and had determined that, based on current priorities and limited staff resources, a comprehensive review of site conditions and subsequent participation by the DEP "are not possible at this time." On September 8, 1997, Southern received a letter from the DEP informing it that the three sites had been entered on the Connecticut Inventory of Hazardous Waste Sites. The letter states that the site located on Pine Street in Bridgeport, Connecticut, may be of particular interest to the state of Connecticut because of its proximity to the Connecticut Department of Transportation expansion project of the U.S. Highway Route Number 95 Corridor. Placement of the sites on the Inventory of Hazardous Waste Sites means that the DEP may pursue remedial action pursuant to the Connecticut General Statutes. Each site is located in an area that permits Southern to voluntarily perform any remedial action. Connecticut law also allows Southern to retain a Licensed Environmental Professional to conduct further environmental assessments and, if necessary, to develop remedial action plans in accordance with Connecticut Remediation Standard Regulations. Southern has conferred with officials of the DEP, including the DEP liaison for the Department of Transportation's U.S. Highway Route Number 95 Corridor expansion project, to establish priorities in connection with the environmental assessments. As a result of those conferences, Southern and the DEP have negotiated and executed a Consent Order with respect to the Pine Street site located in Bridgeport. Pursuant to the Consent Order, Southern has agreed to undertake an investigation of the Pine Street site and its immediate surrounding area to determine potential sources of contamination and remediate contamination which may be found to have emanated or be emanating from the Pine Street site as a result of Southern's activities on the site. The schedule and scope of the investigation have been agreed to by Southern and the DEP. As a result of this Consent Order, Southern has recorded and deferred $150,000 for costs related to this site investigation. When the investigation is complete, Southern should be able to propose to the DEP what, if any, plan for remediation is appropriate for the site. Until such investigation is complete, management cannot predict the cost, if any, of any appropriate remediation for the Pine Street site. Neither can management, at this time, predict the costs for any future site analysis and remediation for the remaining two sites, if any, nor can it estimate when any such costs, if any, would be incurred. While such future analytical and cleanup costs could possibly be significant, management believes, based upon the provisions of the Partial Settlement in Southern's most recent rate order and regulatory precedent with other local distribution companies in Connecticut, that Southern will be able to recover these costs through its customer rates. Although the method, timing and extent of any recovery remain uncertain, management currently does not expect that the incurrence of such costs will materially adversely impact the Company's financial condition, results of operations or cash flows. Year 2000 Readiness Disclosure Like other companies which use business-application software programs and rely on a computing infrastructure that includes embedded systems, the so-called Year 2000 issue also affects the Company and its subsidiaries. Certain of the Company's software programs and computing infrastructure that use two-digit years, rather than four-digit years, to define the applicable year may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in the computer or device shutting down, performing incorrect computations or performing inconsistently. In 1996, the Company began a project to address Year 2000 issues. It has been implementing individual strategies targeted at the specific nature of the Year 2000 issues in each of the following areas: (1) business-application systems, (2) embedded systems, (3) vendor and supplier relationships, (4) customers and (5) contingency planning. The Company's Year 2000 project is proceeding on schedule. To coordinate its comprehensive Year 2000 program, the Company established a Year 2000 Task Force, chaired by the Vice President, General Counsel and Secretary who reports directly to the Chairman and Chief Executive Officer. The Year 2000 Task Force includes executive management and employees with expertise from various disciplines including, but not limited to, information technology, operations, engineering, finance, facilities and communications, internal audit, purchasing and law. In addition, the Company has utilized the expertise of outside consultants to assist in the implementation of the Year 2000 program in such areas as project initiation and planning, business- application system inventory and analysis, business-application system remediation, business-application system replacement, and embedded systems inventory and analysis. The Company's principal subsidiary, Southern, is subject to regulation from the DPUC, among other governmental agencies. At the DPUC's request, Southern has previously reported the progress of its Year 2000 program to the DPUC on three separate occasions. On October 23, 1998, the DPUC announced that it was seeking to engage the services of a consultant to perform an audit of the computer systems at all of Connecticut's major utility companies, including Southern, to assess their readiness to handle the changeover to the Year 2000. See Management's Discussion and Analysis in the Company's 1998 Annual Report to Shareholders for further detail regarding the Year 2000 issue as it relates to the Company's operations. The estimates and conclusions herein contain forward-looking statements and are based on management's best estimates of future events. Risks to completing the Year 2000 Program include the availability of resources, the Company's ability to discover and correct the potential Year 2000 sensitive problems which could have a serious impact on specific facilities, and the ability of suppliers to bring their systems into Year 2000 compliance. Item 2. Properties - ------------------- The Company's physical plant and properties primarily consist of Southern's gas distribution facilities. Southern had 2,157 miles of main and 123,631 service units as of September 30, 1998. It leases office space in Bridgeport, New Haven, Orange and Madison, owns properties in Bridgeport and New Haven that were formerly manufacturing sites and owns a propane air facility in Trumbull. In 1995, the LNG plant lease agreement was renewed for two consecutive terms of 12 years. The lease contains an option to purchase the plant for a purchase price based on the then fair market sales value of the unit as defined therein. During 1998, Southern subleased the LNG facility to CNE Energy. CNE Energy, in turn, subleased the LNG facility to TPS. Southern will continue to operate the LNG facility under an agreement with TPS and will remain primarily responsible for the lease payments in the event that the sublessees do not make the required payments. Substantially all of Southern's utility properties and plant are subject to the lien of the indenture and supplemental indentures securing its first mortgage bonds. It is management's opinion that the physical plant and properties as described herein are suitable and adequate for the purpose of delivering gas for customer use. Item 3. Legal Proceedings - -------------------------- In a class action styled Connecticut Heating & Cooling Contractors Association, Inc. v. Connecticut Natural Gas Corp., et al., Connecticut Superior Court - Middletown, two trade associations and two plumbing and heating contractors in November 1995 sued Southern as well as the other Connecticut LDCs for violations of the Connecticut Unfair Trade Practices Act ("CUTPA") and tortious interference with business expectancies in connection with the LDCs' provision of service and maintenance to heating, cooling and ventilating systems and appliances. An Amended Complaint was filed in response to motions filed by the defendants in which one of the two contractor plaintiffs was removed from the case. In response to the court's granting a motion to strike the Complaint on the grounds of misjoinder filed by Southern and another defendant, the plaintiffs again amended their Complaint to add causes of action in conspiracy to violate the CUTPA and conspiracy to violate the antitrust laws. All three defendants filed motions to strike that complaint. The court struck all counts except the claim of conspiracy to violate the antitrust laws. The plaintiff contractor then sued each LDC separately, in their respective judicial districts, and Southern was sued in Bridgeport Superior Court, alleging the original class action claims of violation of the CUTPA, and tortious interference with business expectancies. The association plaintiffs and the contractor also sued all the LDCs, again in Middletown, alleging conspiracy to violate the CUTPA. Southern filed a motion to dismiss. There are, therefore, currently three pending cases against Southern. The plaintiffs moved to consolidate all five lawsuits against the LDCs and to transfer them to the new Complex Litigation Docket. Southern objected to consolidation, but agreed to the transfer. The complex litigation judge in Waterbury accepted the cases and denied the plaintiffs' motion to consolidate. She ordered the case against Connecticut Natural Gas alone proceed to prepare for a trial in August of 1999, stayed discovery on the remaining cases, and ordered the remaining cases to proceed to the point of closing the pleadings. The judge will rule on Southern's pending motion to dismiss in the conspiracy to violate the CUTPA case. Southern has prepared a motion to strike part of the Bridgeport case. Southern has answered the antitrust conspiracy case. The plaintiffs seek declaratory and injunctive relief. The plaintiffs seek treble damages in excess of $15,000, punitive damages and attorneys' fees. Southern intends to defend itself vigorously in these lawsuits, which management believes are without merit. In the opinion of management, resolution of these lawsuits is not expected to have a material adverse impact on the Company's financial condition or results of operations. Item 4. Submission of Matters to a Vote of Security Holders - ------------------------------------------------------------ None. PART II ------- Item 5. Market for Common Stock Equity and Related Stockholder Matters - ----------------------------------------------------------------------- Common Stock Data The Company's common stock is listed for trading on the New York Stock Exchange. The Company's common stock ticker symbol is CNE. The following table shows the quarterly high and low price ranges of the Company's common stock and quarterly dividends paid during the years ended September 30, 1998 and 1997. Market Price and Dividend Data 1998 Quarters ended High Low Dividend - ------------------- ---- --- -------- December 31, 1997 $30 7/16 $22 3/4 $0.33 March 31, 1998 $30 3/4 $25 11/16 $0.33 June 30, 1998 $32 1/4 $25 5/8 $0.335 September 30, 1998 $29 11/16 $25 1/16 $0.335 1997 Quarters ended High Low Dividend - ------------------- ---- --- -------- December 31, 1996 $22 1/4 $19 7/8 $0.33 March 31, 1997 $24 3/8 $21 $0.33 June 30, 1997 $24 1/4 $22 1/4 $0.33 September 30, 1997 $24 15/16 $22 3/8 $0.33 As of September 1998, the Company and its predecessors have paid 355 consecutive quarterly cash dividends. Cash dividends have been paid since 1850, and the Company currently expects that dividends will continue to be paid in the future. The major source of funds for payment of the Company's dividends are the dividends received on the shares of Southern's common stock owned by the Company. Southern's indentures relating to long-term debt contain restrictions as to the declaration or payment of cash dividends on, or the reacquisition of, capital stock. Under the most restrictive of such provisions, $46,838,000 of retained earnings at September 30, 1998 was available for such purposes. The approximate number of shareholders of record of the Company's common stock as of November 20, 1998 was 9,770. Item 6. Selected Financial Data - -------------------------------- The presentation under the "Eleven Year Financial Summary" for the five-year period ended September 30, 1998 on pages 42 and 43 of the Company's 1998 Annual Report to Shareholders is incorporated by reference herein. Item 7. Management's Discussion and Analysis of Financial Condition and - ------------------------------------------------------------------------ Results of Operations - --------------------- "Management's Discussion and Analysis of Financial Condition and Results of Operations" on pages 15 to 25 of the Company's 1998 Annual Report to Shareholders is incorporated by reference herein. Item 7a. Quantitative and Qualitative Disclosures About Market Risk - -------------------------------------------------------------------- Not applicable. Item 8. Financial Statements and Supplementary Data - ---------------------------------------------------- The Consolidated Statements of Income, Consolidated Balance Sheets, Consolidated Statements of Changes in Common Shareholders' Equity, Consolidated Statements of Cash Flows and Notes to Consolidated Financial Statements on pages 26 to 40 and the Report of Independent Accountants on page 41 of the Company's 1998 Annual Report to Shareholders are incorporated by reference herein. Item 9. Changes in and Disagreements with Accountants on Accounting and - ------------------------------------------------------------------------ Financial Disclosure - -------------------- None. PART III -------- Item 10. Directors and Executive Officers of the Registrant - ------------------------------------------------------------ Information required in this item regarding directors is contained in the Company's definitive Proxy Statement at pages 2 to 4, which will be mailed to shareholders on or about December 11, 1998, and is incorporated by reference herein. A list of executive officers of the registrant and Southern follows:
Executive Officers of Connecticut Energy Corporation and The Southern Connecticut Gas Company Name and Age Position and Business Experience for the Past Five Years - ------------------ -------------------------------------------------------- J. R. Crespo, 56 Chairman, President and Chief Executive Officer of the Company and Southern (1990). Thomas A. Trotta, 61 Senior Vice President of the Company and Executive Vice President and Chief Operating Officer of Southern (1996), Executive Vice President and Chief Operating Officer of Southern (1995), Senior Vice President and Chief Operating Officer of Southern (1992). Vincent L. Ammann, Jr., 39 Vice President and Chief Accounting Officer of the Company and Vice President, Technology Applications of Southern (1997), Vice President and Chief Accounting Officer of the Company and Vice President, Information Technology of Southern (1996), Vice President and Chief Accounting Officer of the Company and Group Vice President of Southern (1994), Vice President and Chief Accounting Officer of the Company and Southern (1991). Samuel W. Bowlby, 60 Vice President, General Counsel and Secretary of the Company and Southern (1997), Partner, Tyler, Cooper & Alcorn, New Haven, CT (1970-1997). Carol A. Forest, 50 Vice President, Finance, Chief Financial Officer, Treasurer and Assistant Secretary of the Company and Southern (1996), Vice President, Finance, Chief Financial Officer and Treasurer of the Company and Southern (1991). Janet L. Janczewski, 54 Senior Corporate Counsel and Assistant Secretary of the Company and Southern (1997), Corporate Counsel of Southern (1989). Larry S. McGaughy, 51 Vice President of the Company, President of CNE Development Corporation and President of CNE Energy (1998), President of CNE Energy (1996), Vice President, Corporate Engineering and Special Projects of Southern (1995), Vice President, Marketing and Corporate Engineering of Southern (1994), Vice President, Marketing and Gas Control of Southern (1991). Michael H. Pinto, 71 Vice President, Government Affairs of the Company (1991). Salvatore A. Ardigliano, 49 Group Vice President and Chief Information Officer of Southern (1998), Group Vice President of Southern (1998), Vice President, Marketing and Gas Supply Services of Southern (1995), Vice President, Gas Supply Services of Southern (1995), Group Director, Gas Supply Services of Southern (1993). Peter D. Loomis, 50 Group Vice President, Operations of Southern (1998), Group Vice President, Customer and Operating Services of Southern (1995), Vice President, Distribution and Customer Service of Southern (1992). Phyllis A. O'Brien, 53 Group Vice President of Southern (1996), Vice President, Accounting and Regulatory Services of Southern (1994), Vice President, Corporate and Regulatory Planning of Southern (1993). David Silverstone, 52 Group Vice President and Chief Administrative Officer of Southern (1998), Group Vice President of Southern (1998), Partner, Silverstone and Koontz (1983-1998). Ernest W. Karkut, 56 Vice President, Purchasing and Plant Services of Southern (1994), Vice President, Customer Relations of Southern (1993). Diane Nunn, 50 Vice President, Distribution and Gas Control Services (1998), Vice President, Customer and Distribution Services of Southern (1998), Group Director, Customer and Distribution Services of Southern (1996), Director, Human Resources of Southern (1990). Patricia A. Younger, 56* Vice President, Customer Relations of Southern (1995), Group Director, Customer Relations of Southern (1994), Director, Customer Information and Collections of Southern (1994), Director, Credit and Collections of Southern (1993), Manager, Credit and Collections of Southern (1986). *retired effective February 1, 1998.
Item 11. Executive Compensation - -------------------------------- Information required in this Item is contained in the Company's definitive Proxy Statement on pages 9 to 10, which will be mailed to shareholders on or about December 11, 1998, and is incorporated by reference herein. Item 12. Security Ownership of Certain Beneficial Owners and Management - ------------------------------------------------------------------------ Information required in this Item is contained in the Company's definitive Proxy Statement on pages 4 to 5, which will be mailed to shareholders on or about December 11, 1998, and is incorporated by reference herein. Item 13. Certain Relationships and Related Transactions - -------------------------------------------------------- Information required in this Item is contained in the Company's definitive Proxy Statement on pages 10 to 12, which will be mailed to shareholders on or about December 11, 1998, and is incorporated by reference herein. PART IV ------- Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K - ------------------------------------------------------------------------- (a) List of documents filed as part of this Report: 1. Financial Statements -------------------- Among the responses to this Item 14(a) are the following financial statements which are incorporated by reference herein in Item 8 above: (i) Consolidated Statements of Income for the years ended September 30, 1998, 1997 and 1996. (ii) Consolidated Balance Sheets for the years ended September 30, 1998 and 1997. (iii) Consolidated Statements of Changes in Common Shareholders' Equity for the years ended September 30, 1998, 1997 and 1996. (iv) Consolidated Statements of Cash Flows for the years ended September 30, 1998, 1997 and 1996. (v) Notes to Consolidated Financial Statements. (vi) Report of Independent Accountants. 2. Financial Statements and Supplementary Data Required by Item 8 -------------------------------------------------------------- (A) Schedule Description Page -------- ----------- ---- Report of Independent Accountants on Financial Statement Schedule 21 II Valuation and Qualifying Accounts 22 All other schedules are omitted because they are not required, are inapplicable, or the information is otherwise shown in the financial statements or notes thereto. 3. Exhibits Required by Item 601 of Securities and Exchange Commission ------------------------------------------------------------------- Regulation S-K -------------- (A) The following such exhibits are filed as a separate section of this report. Exhibits -------- (3) Certificate of Incorporation and By-Laws ---------------------------------------- The Amended and Restated Certificate of Incorporation of Connecticut Energy Corporation is incorporated herein by reference to Item 6 of the Company's Form 10-Q filed for the quarter ended March 31, 1991 at pages 14 through 22. The Amended and Restated By-Laws of Connecticut Energy Corporation are incorporated herein by reference to Item 6 of the Company's Form 10-Q filed for the quarter ended March 31, 1995 at pages 20 through 31. The Amended and Restated Certificate of Incorporation of The Southern Connecticut Gas Company is incorporated herein by reference to Item 6 of Form 10-Q filed for the quarter ended June 30, 1990 at pages 40 through 51. The Amended and Restated By-Laws of The Southern Connecticut Gas Company are incorporated herein by reference to Item 6 of the Company's Form 10-Q filed for the quarter ended March 31, 1995 at pages 32 through 41. (4) Instruments Defining Rights of Security Holders, Including Indentures --------------------------------------------------------------------- (i) Shareholder Rights Plan, dated July 28, 1998, incorporated by reference to Form 8-K dated July 28, 1998. (ii) Indenture between The Bridgeport Gas Light Company and The Bridgeport City Trust Company, as Trustee, dated as of March 1, 1948. Incorporated herein by reference to Exhibit 4(b) (1) to Connecticut Energy Corporation Registration Statement 2-10566. (iii) In addition to the Indenture referred to in 4 (i) hereof, there have been 27 indentures supplemental thereto, copies of all of which the Company agrees to furnish to the Commission upon request. (10) Material Contracts ------------------ (i) Gas Transportation Contract between Tennessee Gas Pipeline Company and The Southern Connecticut Gas Company, Contract No. 10783, dated June 1, 1995, incorporated by reference to Form 10-K for the fiscal year ended September 30, 1996 at pages 24 to 32. (ii) Interruptible Gas Transportation Contract and Amendment No. 1, thereto, among Tenngasco Corporation, The Southern Connecticut Gas Company and The United Illuminating Company, dated May 14, 1987 and August 1, 1989, respectively, incorporated by reference to Form 10-K for the fiscal year ended December 31, 1989 at pages 238 to 258. (iii) Amendment No. 2 to Interruptible Gas Transportation Contract and Amendment No. 1, thereto, among Tenngasco Corporation, The Southern Connecticut Gas Company and The United Illuminating Company, dated November 1, 1990, incorporated by reference to Form 10-K for the transition period from January 1, 1990 to September 30, 1990 at pages 90 to 91. (iv) Gas Transportation Contract between Iroquois Gas Transmission System, L.P. and The Southern Connecticut Gas Company, dated February 7, 1991, incorporated by reference to Exhibit 10.32 to Connecticut Energy Corporation's Registration Statement No. 33-40232. (v) Gas Sales Agreement No. 1 by and between Alberta Northeast Gas Limited and The Southern Connecticut Gas Company, dated February 7, 1991, incorporated by reference to Exhibit 10.33 to Connecticut Energy Corporation's Registration Statement No. 33-40232. (vi) Gas Sales Agreement No. 2 by and between Alberta Northeast Gas Limited and The Southern Connecticut Gas Company, dated February 7, 1991, incorporated by reference to Exhibit 10.34 to Connecticut Energy Corporation's Registration Statement No. 33-40232. (vii) Gas Sales Agreement by and between Alberta Northeast Gas Limited and The Southern Connecticut Gas Company, dated February 7, 1991, incorporated by reference to Exhibit 10.35 to Connecticut Energy Corporation's Registration Statement No. 33-40232. (viii) Gas Sales Agreement by and between Alberta Northeast Gas Limited and The Southern Connecticut Gas Company, dated February 7, 1991, incorporated by reference to Exhibit 10.36 to Connecticut Energy Corporation's Registration Statement No. 33-40232. (ix) Gas Sales Agreement by and between Alberta Northeast Gas Limited and The Southern Connecticut Gas Company, dated February 7, 1991, incorporated by reference to Exhibit 10.37 to Connecticut Energy Corporation's Registration Statement No. 33-40232. (x) Storage Service Transportation Contract between Tennessee Gas Pipeline Company and The Southern Connecticut Gas Company, Contract No. 542, dated September 1, 1993, incorporated by reference to Form 10-K for the fiscal year ended September 30, 1996 at pages 33 to 42. (xi) Storage Service Agreement (GSS) between CNG Transmission Corporation and The Southern Connecticut Gas Company, dated October 1, 1993, incorporated by reference to Form 10-K for the fiscal year ended September 30, 1993 at pages 130 to 137. (xii) Storage Service Agreement (GSS-TE) between CNG Transmission Corporation and The Southern Connecticut Gas Company, dated October 1, 1993, incorporated by reference to Form 10-K for the fiscal year ended September 30, 1996 at pages 43 to 50. (xiii) Storage Service Agreement (GSS-II) between CNG Transmission Corporation and The Southern Connecticut Gas Company, dated September 1, 1993, incorporated by reference to Form 10-K for the fiscal year ended September 30, 1996 at pages 51 to 56. (xiv) Gas Storage Contract and Amendment No. 1, thereto, between Tennessee Gas Pipeline Company and The Southern Connecticut Gas Company, dated December 1, 1994 and July 1, 1995, respectively, incorporated by reference to Form 10-K for the fiscal year ended September 30, 1996 at pages 57 to 63. (xv) Gas Transportation Agreement between Tennessee Gas Pipeline Company and The Southern Connecticut Gas Company, dated August 19, 1993, incorporated by reference to Form 10-K for the fiscal year ended September 30, 1993 at pages 143 to 151. (xvi) Gas Transportation Agreement between Tennessee Gas Pipeline Company and The Southern Connecticut Gas Company, dated August 19, 1993, incorporated by reference to Form 10-K for the fiscal year ended September 30, 1993 at pages 152 to 159. (xvii) Service Agreement between Texas Eastern Transmission Corporation and The Southern Connecticut Gas Company, dated June 1, 1993, incorporated by reference to Form 10-K for the fiscal year ended September 30, 1993 at pages 160 to 170. (xviii) Service Agreement between Texas Eastern Transmission Corporation and The Southern Connecticut Gas Company, dated June 1, 1993, incorporated by reference to Form 10-K for the fiscal year ended September 30, 1993 at pages 171 to 180. (xix) Service Agreement between Texas Eastern Transmission Corporation and The Southern Connecticut Gas Company, dated June 1, 1993, incorporated by reference to Form 10-K for the fiscal year ended September 30, 1993 at pages 181 to 192. (xx) Service Agreement between Texas Eastern Transmission Corporation and The Southern Connecticut Gas Company, dated June 1, 1993, incorporated by reference to Form 10-K for the fiscal year ended September 30, 1993 at pages 193 to 204. (xxi) Service Agreement between Texas Eastern Transmission Corporation and The Southern Connecticut Gas Company, dated June 1, 1993, incorporated by reference to Form 10-K for the fiscal year ended September 30, 1993 at pages 214 to 220. (xxii) Service Agreement between Algonquin Gas Transmission Company and The Southern Connecticut Gas Company, dated June 1, 1993, incorporated by reference to Form 10-K for the fiscal year ended September 30, 1993 at pages 221 to 227. (xxiii) Service Agreement between Algonquin Gas Transmission Company and The Southern Connecticut Gas Company, dated June 1, 1993, incorporated by reference to Form 10-K for the fiscal year ended September 30, 1993 at pages 228 to 235. (xxiv) Service Agreement between Algonquin Gas Transmission Company and The Southern Connecticut Gas Company, dated June 1, 1993, incorporated by reference to Form 10-K for the fiscal year ended September 30, 1993 at pages 236 to 243. (xxv) Service Agreement between Algonquin Gas Transmission Company and The Southern Connecticut Gas Company, dated June 1, 1993, incorporated by reference to Form 10-K for the fiscal year ended September 30, 1993 at pages 244 to 251. (xxvi) Service Agreement between Algonquin Gas Transmission Company and The Southern Connecticut Gas Company, dated June 1, 1993, incorporated by reference to Form 10-K for the fiscal year ended September 30, 1993 at pages 252 to 257. (xxvii) Service Agreement between Algonquin Gas Transmission Company and The Southern Connecticut Gas Company, dated October 1, 1993, incorporated by reference to Form 10-K for the fiscal year ended September 30, 1993 at pages 258 to 277. Executive Compensation Plans and Arrangements --------------------------------------------- (xxviii) Employment Agreement between The Southern Connecticut Gas Company and J. R. Crespo, dated March 24, 1992, incorporated by reference to Form 10-K for the fiscal year ended September 30, 1992 at pages 213 to 229. (xxix) Amended and Restated Deferred Compensation Agreement between The Southern Connecticut Gas Company and Connecticut Energy Corporation and J. R. Crespo, dated November 8, 1996, incorporated by reference to Form 10-K for the fiscal year ended September 30, 1996 at pages 64 to 73. (xxx) The Southern Connecticut Gas Company Board of Directors Retirement Plan, dated October 1, 1997, incorporated by reference to Form 10-Q for the quarter ended December 31, 1997 at pages 20 to 23. (xxxi) The Southern Connecticut Gas Company, Management Compensation Plan, dated October 1, 1992, incorporated by reference to Form 10-K for the fiscal year ended September 30, 1992 at pages 251 to 253. (xxxii) Agreement between The Southern Connecticut Gas Company and Henry Chauncey, Jr. related to deferred compensation as a director, dated December 31, 1988, incorporated by reference to Form 10-K for the fiscal year ended December 31, 1988 at pages 63 to 67. (xxxiii) Supplemental Retirement Benefits Plan dated October 1, 1993, incorporated by reference to Form 10-Q for the quarter ended December 31, 1993 at pages 25 to 28. (xxxiv) Agreement between The Southern Connecticut Gas Company and Helen B. Wasserman related to deferred compensation as a director, dated December 31, 1994, incorporated by reference to Form 10-K for the fiscal year ended September 30, 1995 at pages 25 to 29. (xxxv) Agreement between The Southern Connecticut Gas Company and Connecticut Energy Corporation and Carol A. Forest related to change in control, dated October 1, 1996, incorporated by reference to Form 10-K for the fiscal year ended September 30, 1996 at pages 74 to 83. (xxxvi) Agreement between The Southern Connecticut Gas Company and Connecticut Energy Corporation and Thomas A. Trotta related to change in control, dated October 1, 1996, incorporated by reference to Form 10-K for the fiscal year ended September 30, 1996 at pages 94 to 104. (xxxvii) Connecticut Energy Corporation 1997 Restricted Stock Award Plan, dated January 28, 1997, incorporated by reference to Form 10-Q for the quarter ended March 31, 1997 at pages 23 to 35. (xxxviii) Connecticut Energy Corporation Non-Employee Director Stock Plan, dated January 28, 1997, incorporated by reference to Form 10-Q for the quarter ended March 31, 1997 at pages 36 to 40. (xxxix) Agreement between The Southern Connecticut Gas Company and Connecticut Energy Corporation and Samuel W. Bowlby related to change in control, dated July 1, 1997, incorporated by reference to Form 10-Q for the quarter ended March 31, 1998 at pages 21 to 31. (xxxx) Agreement between The Southern Connecticut Gas Company and Connecticut Energy Corporation and David Silverstone related to change in control, dated April 1, 1998, incorporated by reference to Form 10-Q for the quarter ended June 30, 1998 at pages 21 to 30. (13) Annual Report to Security Holders --------------------------------- The Company's 1998 Annual Report to Shareholders is filed herewith at pages 25 to 53. Such exhibit includes only those portions thereof which are expressly incorporated by reference in this Form 10-K. (21) Subsidiaries of the Registrant ------------------------------ A list of the Company's subsidiaries is filed herewith at page 54. (27) Financial Data Schedule ----------------------- Financial Data Schedule UT is submitted only in electronic format to the Securities and Exchange Commission. (B) Reports on Form 8-K filed during the last quarter of 1998: Form 8-K, dated July 28, 1998, concerning the Company's Shareholder Rights Plan was filed with the Securities and Exchange Commission on August 4, 1998. REPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE ----------------------------------------------------------------- To the Board of Directors and Shareholders of Connecticut Energy Corporation: Our audits of the consolidated financial statements referred to in our report dated October 30, 1998 appearing on page 41 of the 1998 Annual Report to Shareholders of Connecticut Energy Corporation (which report and consolidated financial statements are incorporated by reference in this Annual Report on Form 10-K) also included an audit of the financial statement schedule listed in Item 14(a)(2) of this Form 10-K. In our opinion, the financial statement schedule presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. /s/ PricewaterhouseCoopers LLP - ------------------------------ New York, New York October 30, 1998 CONSENT OF INDEPENDENT ACCOUNTANTS ---------------------------------- We consent to the incorporation by reference in the Prospectus constituting part of the Registration Statements on Form S-3 (No. 333-25691) and Form S-8 (No. 33-39245 and 33-51763) of Connecticut Energy Corporation of our report dated October 30, 1998, on our audits of the consolidated financial statements and financial statement schedule of Connecticut Energy Corporation as of September 30, 1998 and 1997, and for the years ended September 30, 1998, 1997 and 1996, appearing on page 41 of the 1998 Annual Report to Shareholders of Connecticut Energy Corporation which is incorporated by reference in this Annual Report on Form 10-K. /s/ PricewaterhouseCoopers LLP - ------------------------------ New York, New York December 4, 1998
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS CONNECTICUT ENERGY CORPORATION Years Ended September 30, 1998, 1997 and 1996 (in thousands) Col. A Col. B Col. C Col. D Col. E ------ ------ ------ ------ ------ Additions --------- Balance at Charged to Charged to Balance Beginning Costs and Other at End of Description of Period Expenses Accounts Deductions Period - ----------- ----------- ---------- ---------- ---------- --------- Allowance for Doubtful Accounts 1998 (1) $2,948 $7,735 $1,946 (2) $10,564 (3) $2,065 1997 (1) $2,742 $7,297 $2,851 (2) $9,942 (3) $2,948 1996 (1) $3,553 $6,549 $1,826 (2) $9,186 (3) $2,742 Notes: - ------ (1) Reserve deducted in the Consolidated Balance Sheet from the asset to which it applies (2) Recoveries on accounts previously charged off (3) Accounts charged off as uncollectible
SIGNATURES Pursuant to the requirements of Section 13 or 15 (d) 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. CONNECTICUT ENERGY CORPORATION (Registrant) By: /s/ J. R. Crespo -------------------------------------- J. R. Crespo, Chairman, President and Chief Executive Officer Dated: November 24, 1998 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. By: /s/ Henry Chauncey, Jr. By: /s/ Newman M. Marsilius ----------------------------- ------------------------------ Henry Chauncey, Jr., Director Newman M. Marsilius, Director Dated: November 24, 1998 Dated: November 24, 1998 By: /s/ James P. Comer By: /s/ Samuel M. Sugden ------------------------------ ------------------------------ James P. Comer, M.D., Director Samuel M. Sugden, Director Dated: November 24, 1998 Dated: November 30, 1998 By: /s/ J. R. Crespo By: /s/ Christopher D. Turner ------------------------------ ------------------------------ J. R. Crespo, Chairman, Christopher D. Turner, President and Chief Executive Officer Director Dated: November 24, 1998 Dated: November 19, 1998 By: /s/ Richard F. Freeman By: /s/ Helen B. Wasserman ------------------------------ ------------------------------ Richard F. Freeman, Director Helen B. Wasserman, Director Dated: November 24, 1998 Dated: November 24, 1998 By: /s/ Richard M. Hoyt By: /s/ Vincent L. Ammann, Jr. ------------------------------ ------------------------------ Richard M. Hoyt, Director Vincent L. Ammann, Jr. Dated: November 24, 1998 Vice President and Chief Accounting Officer (Principal Accounting Officer) Dated: November 24, 1998 By: /s/ Paul H. Johnson By: /s/ Carol A. Forest ------------------------------ ------------------------------ Paul H. Johnson, Director Carol A. Forest, Dated: November 24, 1998 Vice President, Finance, Chief Financial Officer, Treasurer and Assistant Secretary (Principal Financial Officer) Dated: November 24, 1998 EX-13 2 CONNECTICUT ENERGY CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Connecticut Energy Corporation ("Connecticut Energy" or "Company") and its subsidiaries and their representatives may, from time to time, make written or oral statements, including statements contained in the Company's filings with the Securities and Exchange Commission and in its annual report to shareholders, including its Form 10-K for the fiscal year ended September 30, 1998, which constitute or contain "forward-looking" information as that term is defined in the Private Securities Litigation Reform Act of 1995. All statements other than the financial statements and other statements of historical facts included in this annual report to shareholders regarding the Company's financial position and strategic initiatives and addressing industry developments are forward-looking statements. Where, in any forward-looking statement, the Company, or its management, expresses an expectation or belief as to future results, such expectation or belief is expressed in good faith and believed to have a reasonable basis, but there can be no assurance that the statement of expectation or belief will result or be achieved or accomplished. Factors which could cause actual results to differ materially from those stated in the forward-looking statements may include, but are not limited to, general and specific economic, financial and business conditions; federal and state regulatory, legislative and judicial developments which affect the Company or significant groups of its customers; the impact of competition on the Company's revenues; fluctuations in weather from normal levels; changes in development and operating costs; the availability and cost of natural gas; the availability and terms of capital; exposure to environmental liabilities; the costs and effects of unanticipated legal proceedings; the successful implementation and achievement of internal performance goals; the impact of unusual items resulting from ongoing evaluations of business strategies and asset valuations; and changes in business strategy. RESULTS OF OPERATIONS Net Income The Company's consolidated net income is detailed below:
(in thousands, except per share) Years ended September 30, 1998 1997 1996 - ------------------------------------------------------------------------------------------------------------------- Net income $19,011 $16,441 $15,165 - ------------------------------------------------------------------------------------------------------------------- Net income per share - diluted $ 1.88 $ 1.81 $ 1.70 - ------------------------------------------------------------------------------------------------------------------- Weighted average common shares outstanding - diluted 10,104 9,096 8,924 - -------------------------------------------------------------------------------------------------------------------
Net income for 1998 was a record for the Company. Net income increased approximately 16% and earnings per share were approximately 4% higher compared to 1997. Factors which contributed to increased net income for 1998 included higher firm margins earned by the Company's principal subsidiary, The Southern Connecticut Gas Company ("Southern"), lower taxes, higher other income and lower total interest expense. Additionally, the Company's nonutility subsidiaries contributed approximately $0.17 to earnings per share in 1998, representing approximately 9% of consolidated earnings per share for the year. The contribution to 1998 earnings by the nonutility subsidiaries was principally due to revenues generated by a contract to transport natural gas to an electric generating plant located at the Bridgeport Harbor Station and the sale of 50% interests in Total Peaking Services, LLC ("TPS") and CNE Peaking, LLC ("CNEP"), joint ventures of the Company's nonutility subsidiary, CNE Energy Services Group, Inc. ("CNE Energy"), to Conectiv Energy Supply, Inc., a subsidiary of Conectiv. Partially offsetting these positive impacts on net income for 1998 were lower interruptible margins and higher operating expenses in the areas of operations, maintenance and depreciation. Net income for 1997 increased approximately 8% compared to 1996. Factors which contributed to increased net income for 1997 included higher firm margins earned by Southern, lower operations and maintenance expenses, lower provisions for gross earnings and property taxes and lower other interest expense. Partially offsetting these positive impacts on net income were slightly lower interruptible margins and higher costs for depreciation, income taxes and long-term debt interest. 15 CONNECTICUT ENERGY CORPORATION Total Sales and Transportation Volumes The Company's total volumes of gas sold and transported were 36,260 MMcf in 1998, representing a decrease of approximately 21% compared to 1997. This decrease occurred in all sales categories and was primarily attributable to warmer weather and the competitive price of certain alternate fuels. Higher volumes of firm transportation and firm volumes under a contract to transport natural gas to an electric generating plant in Bridgeport during the 1998 period partially offset the overall decrease in total sales and transportation volumes. Southern's total volumes of gas sold and transported were 45,646 MMcf in 1997, which was a 14% increase from 1996. The 1997 level was higher principally due to increases in off-system sales and off-system transportation volumes. Partially offsetting these increases were lower firm sales volumes due to warmer weather and lower volumes for on-system interruptible services due to the competitive price of certain alternate fuels. Firm Sales, Firm Transportation and Firm Contract Volumes The Company's firm volumes for 1998 increased approximately 3% compared to 1997. This was primarily due to an increase in firm transportation and firm contract volumes, growth in Southern's customer base and the continued conversions of nonheating customers to heating customers. The overall increase in this category was partially offset by lower firm sales due to weather that was approximately 7% warmer than in 1997. Firm sales and transportation volumes for 1997 were approximately 4% lower compared to 1996. This decrease was principally due to weather that was approximately 7% warmer than in 1996. Growth in Southern's customer base and the conversions of nonheating customers to heating customers partially offset the overall decrease in this category. Interruptible Sales and Transportation Volumes Margins earned on volumes delivered to interruptible customers vary depending upon the relationship of the market price for alternate fuels to the cost of natural gas and related transportation. Margins earned, net of gross earnings tax, from on-system interruptible services in excess of an annual target were allocated through a margin sharing mechanism between Southern and its firm customers. Beginning June 1, 1996, excess on-system margins earned that would have been returned to Southern's firm customers have been redirected, with Connecticut Department of Public Utility Control ("DPUC") approval, to fund certain economic development and hardship assistance programs (see section entitled "Regulatory Matters" for further detail). Off-system margins earned, net of gross earnings tax, continue to be shared between Southern and its firm customers. Gross margin retained represents the difference between gross margin earned and margin to be allocated through the margin sharing mechanism. The chart below depicts Southern's volumes of gas sold to and transported for on-system interruptible customers, off-system sales volumes and off-system transportation volumes under a special contract with The Connecticut Light and Power Company for its Devon electric generating station as well as gross margin earned and retained due to the margin sharing mechanism on these services:
(dollars in thousands) Years ended September 30, 1998 1997 1996 - --------------------------------------------------------------------------------------------------------------------- Gross margin earned $ 9,867 $12,872 $12,674 - --------------------------------------------------------------------------------------------------------------------- Gross margin retained $ 5,981 $ 7,242 $ 7,643 - --------------------------------------------------------------------------------------------------------------------- Volumes sold and transported (MMcf) 13,690 23,794 17,211 - ---------------------------------------------------------------------------------------------------------------------
Gross margin earned and retained by Southern in 1998 was lower compared to 1997 principally due to the competitive price of other energy sources compared to natural gas. Gross margin earned by Southern in 1997 was higher than in 1996 principally due to increased off-system sales and off-system transportation activity. Lower margin retained for 1997 was principally due to the change in the sharing mechanism for certain off-system services as of April 1, 1996 which increased the allocation of margins to be returned to firm customers from 50% to 85%. Gross Margin The Company's gross margin in 1998 was approximately 2% higher than in 1997. The increase in gross margin was principally attributed to higher firm margins, which were a record for the Company. The increase in gross margin was partially offset by lower interruptible margins retained in 1998. 16 CONNECTICUT ENERGY CORPORATION The Company's gross margin in 1997 was relatively unchanged compared to 1996. Higher firm margins, which were attributed to growth in Southern's customer base, were partially offset by lower interruptible margins retained as well as lower revenues earned from bailment activities. Southern's firm rates include a Weather Normalization Adjustment ("WNA") which allows Southern to charge or credit the non-gas portion of its firm rates to reflect deviations from normal weather. Because weather during 1998 was approximately 9% warmer than normal, the operation of the WNA collected approximately $6,093,000 from firm customers compared to a collection of approximately $2,252,000 in 1997 and a return of approximately $2,771,000 to firm customers in 1996. Southern's firm sales rates include a Purchased Gas Adjustment clause ("PGA") which allows Southern to flow back to its customers, through periodic adjustments to amounts billed, increased or decreased costs incurred for purchased gas compared to base rate levels without affecting gross margin. Adjustments related to Southern's PGA increased revenues and gas costs for 1998, 1997 and 1996 by approximately $11,050,000, $6,206,000 and $6,717,000, respectively. Operations Expense Operations expense increased approximately 10% in 1998 compared to 1997 primarily due to higher costs for labor, partly due to early retirement incentives paid to union employees during the third quarter of 1998; outside services; customer service; uncollectibles; conservation expense; regulatory commission expense; and certain other general and administrative expenses. Also contributing to the increase in operations expense compared to last year were higher costs related to the Company's Restricted Stock Award Plan and higher operations expense recorded by the Company's nonutility subsidiaries. Partially offsetting the overall increase in operations expense for 1998 were lower expenses in the areas of pensions and postretirement health care as well as lower amortizations related to Southern's certified hardship forgiveness program due to the conclusion of the amortization period as of December 31, 1996. Operations expense was approximately 2% lower in 1997 compared to 1996 principally due to lower costs for labor, pensions, postretirement health care and regulatory commission expense, increased rates for service on customer premises and a lower insurance reserve for general claims. Additionally, a higher provision for uncollectibles in 1997 was more than offset by lower amortizations related to Southern's certified hardship forgiveness program due to the conclusion of the amortization period. The overall decrease in 1997 operations expense was partially offset by increases in costs incurred for outside services, insurance premiums and the Restricted Stock Award Plan established in 1997. Beginning in 1994, the DPUC has allowed Southern to recover certain deferred shortfalls in energy assistance funding from various state and federal agencies related to the 1991/92 and 1992/93 heating seasons as well as deferred costs associated with Southern's certified hardship forgiveness program. Accordingly, included in operations expense for 1998, 1997 and 1996 was approximately $620,000, $1,619,000 and $2,987,000, respectively, related to these amortizations. Depreciation Expense Depreciation expense for Southern has increased in each of the last three years due to additions to plant in service. Federal and State Income Taxes The total provision for federal and state income taxes decreased approximately 28% in 1998 compared to 1997 primarily due to a lower effective tax rate. The lower effective tax rate was principally due to the tax treatment of premiums paid for the refinancing of long-term debt in 1998 as well as the tax treatment of uncollectibles and property taxes. The total provision for federal and state income taxes increased approximately 17% in 1997 compared to 1996 primarily due to higher pre-tax income. Municipal, Gross Earnings and Other Taxes Municipal, gross earnings and other taxes decreased approximately 12% in 1998 compared to 1997. The decrease was primarily due to the DPUC Decision which required Southern to change its accounting treatment for accruing property taxes (see section entitled "Regulatory Matters" for further detail) and, to a lesser extent, lower gross earnings tax due to lower revenues. Municipal, gross earnings and other taxes decreased approximately 9% in 1997 compared to 1996. This decrease was primarily due to lower gross earnings taxes as a result of lower revenues and a lower provision for property taxes because of the establishment of a lower mill rate in the city of New Haven, Connecticut. 17 CONNECTICUT ENERGY CORPORATION Other (Income) Deductions, Net Other income for 1998 was higher compared to 1997 primarily due to the recognition of a gain in connection with the sale of a 50% interest in TPS by CNE Energy, the favorable operating results of the Company's nonutility subsidiaries and an increase in investment income related to investments in nonqualified employee benefit plan trusts. Other income for 1997 was higher compared to 1996 primarily due to the receipt of approximately $974,000 in interest income from one of Southern's interstate pipeline suppliers related to Southern's prepayment of transition costs associated with Federal Energy Regulatory Commission's ("FERC") Order No. 636 and the recognition of a payment received in connection with a joint venture formed by CNE Energy in 1997. Interest Expense Total interest expense decreased approximately 4% in 1998 compared to 1997 primarily due to lower short-term interest expense related to lower average short-term borrowings, lower long-term debt expense due to debt repayments and lower short-term interest expense on pipeline refunds not yet returned to firm customers. Partially offsetting the decrease in total interest expense was an increase in short-term interest expense on deferred purchased gas costs and borrowings by CNE Energy to finance a project to construct the distribution facilities to transport natural gas to the Bridgeport Harbor Station electric generating plant (see section entitled "Regulatory Matters" for further detail). Total interest expense increased approximately 6% in 1997 compared to 1996. Higher long-term debt costs for 1997 were associated with the issuance of $20,000,000 in secured Medium-Term Notes ("MTN") in August 1996. Higher short-term debt costs due to higher average short-term borrowings and higher short-term interest expense on pipeline refunds not yet returned to firm customers were more than offset by lower short-term interest expense on deferred gas cost balances. The Company obtains short-term funds at the most competitive rates by utilizing bank borrowings at money market rates. Short-term interest rates averaged 6.02% in 1998 compared to 5.71% in 1997 and 5.81% in 1996. Inflation Inflation as measured by the Consumer Price Index for all urban consumers was approximately 1.6%, 2.7% and 2.8% for 1998, 1997 and 1996, respectively. Operations and maintenance expenses increase as a result of inflation, as does depreciation expense due to higher replacement costs of plant and equipment. As a regulated utility, Southern's increases in expenses are generally recoverable from customers through rates approved by the DPUC. In management's opinion, inflation has not had a material impact on net income and the results of operations over the last three years. Regulatory Matters Rate Review Docket In accordance with Connecticut statutes, Southern is undergoing a periodic review of rates and services by the DPUC that commenced in January 1998. A periodic review entails a complete review by the DPUC of Southern's financial and operating records. Public hearings are held to determine whether Southern's current rates are unreasonably discriminatory or more or less than just, reasonable and adequate. On July 8, 1998 Southern received a Decision regarding the "overearnings" portion of the rate review docket. According to Connecticut statutes, the DPUC may review a utility which earns 100 basis points or more over its allowed rate of return for six consecutive months. In its Decision, the DPUC ordered a rate reduction of $528,000 on an annual basis. Management cannot predict the financial or operational impact of any Decision which may result from the review which is still ongoing. Special Contract with Duke Energy Trading and Marketing Southern received a Decision from the DPUC on its special contract with Duke Energy Trading and Marketing to transport natural gas to a 520 megawatt electric generating plant in Bridgeport. Under the contract, Southern will own, operate and maintain the 16-inch, nearly 11-mile gas main; and CNE Energy will be solely responsible for financing the project and its maintenance costs. This effectively removes any risk from Southern or its ratepayers for any future operating and maintenance costs. Construction was completed and the plant commenced operations in July 1998. 18 CONNECTICUT ENERGY CORPORATION Change in Accounting Treatment for Property Taxes In October 1997, Southern requested that the DPUC consider a proposed change in Southern's accounting treatment for property taxes which would allow Southern to account for such taxes as a prepaid expense. This method is consistent with the practice of other major public service companies in Connecticut. Southern had been accruing for property taxes in the year prior to the payment date. On November 19, 1997, under the reopened Docket No. 93-03-09, Application of The Southern Connecticut Gas Company to Increase Its Rates and Charges, the DPUC approved Southern's proposal. The stipulations in the Decision ordered Southern to reduce its reserve for property taxes by approximately $3,722,000, with 50%, or approximately $1,861,000, flowing through as a one-time reduction to property tax expense and the remaining 50% refunded to firm customers through the operation of the PGA in three equal amounts during the second quarter of fiscal 1998. Unbundling of Natural Gas Services Docket Effective April 1, 1996, the DPUC deregulated the sale of natural gas to firm commercial and industrial gas customers in Connecticut by giving these customers an option to purchase natural gas from independent brokers or marketers. Commercial and industrial customers electing to purchase natural gas in this manner pay a DPUC-approved firm transportation rate to local gas distribution companies ("LDCs") for the use of their distribution systems. In August 1997, the DPUC initiated a generic docket, Docket No. 97-07-11, DPUC Generic Investigation into Issues Associated with the Unbundling of Natural Gas Services by Connecticut Local Distribution Companies, to investigate issues associated with the unbundling of natural gas firm sales and transportation services by LDCs in Connecticut, including Southern. The DPUC has conducted this proceeding in two phases. The first phase addressed issues relating to firm transportation service in its present form regarding delivery of sales and transportation service by LDCs and marketers. The DPUC reopened each LDC's latest rate case to consider proposed changes to its respective tariffs and rates. An interim Decision was approved on October 28, 1998 which affected the way LDCs administer firm transportation services by providing for changes in the load balancing provisions in the LDCs' tariffs as well as for enhanced billing options for customers. The second phase of this proceeding will investigate such issues as residential unbundling, codes of conduct for LDCs and marketers, and public policy issues. Sublease of Liquefied Natural Gas Plant In August 1996, the DPUC issued a final Decision in Docket No. 96-04-30, Application of The Southern Connecticut Gas Company to Dispose of a Portion of Its Plant and Equipment. The DPUC approved certain proposals made by Southern regarding the operation of its liquefied natural gas ("LNG") tank and related facilities, which included the sublease of the LNG tank and related facilities from Southern to CNE Energy, which would, in turn, sublease the LNG facility to TPS. TPS has received FERC approval of its market-based tariffs and is prepared to store and redeliver customer-owned LNG beginning this winter. Interruptible Margin Sharing Pursuant to Southern's 1993 rate order, which incorporated the provisions of the previously approved Partial Settlement of Certain Issues ("Partial Settlement"), a target margin, net of gross earnings tax, was established for on-system sales and transportation to Southern's interruptible customers. Margins collected in excess of this target were shared between firm customers and Southern on an 80%/20% split. In January 1996, Southern requested a reopening of the 1993 rate proceeding to propose a plan to redirect excess on-system margins to be returned to ratepayers for calendar years 1996, 1997 and 1998 to fund certain economic development initiatives in Bridgeport and to provide grants to customers to reduce Southern's hardship assistance balances. Southern estimated that margins to be collected over the proposed three-year period would be approximately $14,000,000, which would be divided equally between the two programs. Southern's proposal related to the economic development initiatives in Bridgeport included job training and services, certain loan subsidies and health promotion outreach services. Redirection of ratepayer margins for hardship assistance balances benefits Southern's hardship customers by reducing their accounts receivable arrearages and benefits Southern by reducing its provision for uncollectibles for such accounts. On April 26, 1996, the DPUC issued a final Decision regarding Southern's proposal. The DPUC effectively approved Southern's proposal with certain modifications in the direction of funding of economic development initiatives, the imposition of a cap of $6,000,000 per year of ratepayer margins to be split equally between the programs, and certain implementation and status reporting requirements. 19 CONNECTICUT ENERGY CORPORATION Year 2000 General Like other companies which use business-application software programs and rely on a computing infrastructure that includes embedded systems, the so-called Year 2000 issue also affects the Company and its subsidiaries. Certain of the Company's software programs and computing infrastructure that use two-digit years, rather than four-digit years, to define the applicable year may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in the computer or device shutting down, performing incorrect computations or performing inconsistently. In 1996, the Company began a project to address Year 2000 issues. It has been implementing individual strategies targeted at the specific nature of the Year 2000 issues in each of the following areas: (1) business-application systems; (2) embedded systems; (3) vendor and supplier relationships; (4) customers; and (5) contingency planning. The Company's Year 2000 project is proceeding on schedule. To coordinate its comprehensive Year 2000 program, the Company established a Year 2000 Task Force, chaired by the Vice President, General Counsel and Secretary who reports directly to the Chairman and Chief Executive Officer. The Year 2000 Task Force includes executive management and employees with expertise from various disciplines including, but not limited to, information technology, operations, engineering, finance, facilities and communications, internal audit, purchasing and law. In addition, the Company has utilized the expertise of outside consultants to assist in the implementation of the Year 2000 program in such areas as project initiation and planning, business-application system inventory and analysis, business-application system remediation, business-application system replacement, and embedded systems inventory and analysis. The Company's principal subsidiary, Southern, is subject to regulation from the DPUC, among other governmental agencies. At the DPUC's request, Southern has previously reported the progress of its Year 2000 program to the DPUC on three separate occasions. On October 23, 1998, the DPUC announced that it was seeking to engage the services of a consultant to perform an audit of the computer systems at all of Connecticut's major utility companies, including Southern, to assess their readiness to handle the changeover to the year 2000. Business-Application Systems In March 1997, the Company completed its inventory and assessment of all of its business-application systems. This assessment has assisted management in developing a remediation plan consisting of replacing certain equipment, modifying certain software to recognize the turn of the century, replacing certain software systems with new systems that, in addition to providing additional business management information, recognize four-digit years, and eliminating certain software and equipment. By July 31, 1998, the Company had completed modifications to all of its Financial, Accounting, Purchasing, Inventory Control and Work Management business applications targeted for version upgrade by use of internal staff and outside resources. The Company has tested and placed back into the production environment business applications for the above-mentioned business functions. No additional Year 2000 remediation is needed for these systems. The Company initiated a project to update the Payroll and Human Resources business-application systems to the Year 2000 compliant versions of the software. This project should be completed in March 1999. In December 1997, the Company began a project to replace its Customer Information System with a vendor supplied business-application system. The project uses internal staff, resources from the system vendor and resources from outside business-application system consultants. The system is installed on a computer central processing unit and is being tested at the present time. The project plan includes a scheduled completion in April 1999 when the system is installed in a production environment. In September 1998, the Company began a project to upgrade the existing System Control and Data Acquisition System, which is used to monitor the flow of gas throughout the Company's distribution system, with a version that is Year 2000 compliant. The project should be completed in December 1998. In August 1998, the Company began a project to upgrade the existing Field Service Management system, which is used to assign and dispatch service technicians, with a version that is Year 2000 compliant. The project should be completed in April 1999. 20 CONNECTICUT ENERGY CORPORATION In January 1998, the Company completed a project to upgrade all of the Personal Computer ("PC") software and Network software with versions that are Year 2000 compliant. As part of this project, all of the Company's PCs were upgraded or replaced and all of the Company's servers were upgraded or replaced. No additional Year 2000 remediation is needed for this hardware and software. Embedded Systems The Company performed a review of its equipment that includes embedded systems. This review identified a number of components that are potentially date sensitive. The Company has contacted manufacturers of those components that it has identified as critical to operations and continues to contact other manufacturers of embedded components to determine whether their components are Year 2000 compliant. A test plan will be developed by the end of 1998 and executed in early 1999 to test the gas distribution network for embedded systems. The Company also plans to test the equipment associated with its LNG operations to ensure that it is Year 2000 compliant. The quality of the responses received from manufacturers of other equipment, the estimated impact of the individual system on the Company and the ability of the Company to perform meaningful tests will influence its decision to conduct independent testing of embedded systems. Vendors and Suppliers The Company has contacted, in writing, vendors and suppliers of products and services that it considers critical to its operations. These contacts have included suppliers of interstate transportation capacity, natural gas producers, financial institutions, and electric, telephone and water companies. The quality of the responses received from vendors and suppliers is not uniform. As a result, the Company will continue to work with these vendors and suppliers to determine their level of Year 2000 compliance. The Company will evaluate the degree of its vendors' and suppliers' readiness and, to the extent the Company cannot test or verify readiness, will develop a contingency plan which may include considering new business relationships with alternate providers of products and services as necessary and to the extent alternatives are available. Customers The Company has no single customer, residential, commercial or industrial, which generates a material portion of the Company's annual revenues. The Company continues to identify its major firm, interruptible and transportation customers. The Company does not currently have any formal information concerning the Year 2000 compliance status of its major customers, but has received indications that many of its customers are working on Year 2000 compliance. The Company will communicate with its major customers to attempt to identify their level of Year 2000 compliance. The Company will remind them about potential vulnerability of application systems and of embedded systems. The Company will inform them that they should assess the need to include potential remediation and/or replacement of these systems as part of their Year 2000 programs. This activity is planned for completion by December 15, 1998. Contingency Planning The Company's Year 2000 strategies include contingency planning, encompassing business continuity both within the Company and in the external business environment. The planning effort includes critical Company areas such as computing, networks, vendors and suppliers, operations, personnel, and business systems as well as systems and infrastructure external to the Company. As part of its normal business practice, the Company maintains plans to follow during emergency circumstances, some of which could arise from Year 2000-related problems. Its contingency planning for the Year 2000 will address various alternatives and will include assessing a variety of scenarios that could emerge which will require the Company to react. Presently, the Company continues to develop its contingency plans for potential Year 2000-related problems. 21 CONNECTICUT ENERGY CORPORATION Potential Risks The Company believes the most significant potential risks to its internal operations are as follows: (1) the ability to use electronic devices to control and operate its distribution system; (2) the ability to render timely bills to its customers; and (3) the ability to maintain continuous operation of its computer systems. The Company's Year 2000 program addresses each of these risks and the remediation or replacement of these systems is well underway. Furthermore, the contingency plan will outline alternatives in the event that any Year 2000-related situations may occur. The Company relies on the producers of natural gas and suppliers of interstate transportation capacity to deliver natural gas to the Company's distribution system. External infrastructure, such as electric, telephone, and water service, is necessary for the Company's basic operations as well as the operations of many of its customers. Should any of these critical vendors fail, the impact of any such failure could become a significant challenge to the Company's ability to meet the demands of its customers, to operate its distribution system and to communicate with its customers. It could also have a material adverse financial impact, including but not limited to, lost sales revenues, increased operating costs and claims from customers related to business interruptions. The Company's program to address Year 2000 issues emphasizes continued monitoring and/or testing of the progress of these critical vendors and suppliers toward meeting the projected completion of their Year 2000 programs. Financial Implications The Company currently expects to generate nonrecurring expenses of approximately $300,000 to $500,000 over the three fiscal-year period ending September 30, 1999, for business application systems remediation, embedded systems replacement, and certain existing business-applications system replacement. Over the same time period, the Company will capitalize costs of approximately $9,000,000 to $11,000,000 incurred to replace certain existing business-application software systems with new systems that will be Year 2000 operational and provide additional business management information. Each of the components of the Company's Year 2000 program is progressing and the Company believes it is taking all reasonable steps necessary to be able to operate successfully through and beyond the turn of the century. New Legislation On October 19, 1998, the Year 2000 Information and Readiness Disclosure Act ("Y2K Readiness Act") was signed into federal law to encourage the disclosure and exchange of information about computer processing problems, solutions, test practices and test results, and related matters in connection with the transition to the year 2000. The Company expects to benefit from the Y2K Readiness Act in that it will significantly reduce the potential liability of the Company for sharing most types of Year 2000 information. The estimates and conclusions herein contain forward-looking statements and are based on management's best estimates of future events. Risks to completing the Year 2000 Program include the availability of resources, the Company's ability to discover and correct the potential Year 2000 sensitive problems which could have a serious impact on specific facilities, and the ability of suppliers to bring their systems into Year 2000 compliance. Recent Accounting Developments Effective October 1, 1998, the Company will adopt Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income." This Statement establishes standards for reporting and presentation of comprehensive income and its components in general-purpose financial statements and requires that all items required to be recognized under accounting standards as components of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. Adoption of this Statement is not expected to have a significant impact on the Company's financial condition or results of operations. Effective October 1, 1999, the Company will adopt Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities." This Statement establishes standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. Adoption of this Statement is not expected to have a significant impact on the Company's financial condition or results of operations. 22 CONNECTICUT ENERGY CORPORATION Liquidity and Capital Resources Operating Activities The seasonal nature of Southern's business creates large short-term cash demands primarily to finance gas purchases, customer accounts receivable and certain tax payments. To provide these funds, as well as funds for capital expenditure programs and other corporate purposes, Connecticut Energy and Southern have credit lines with a number of banks as detailed below:
Shared Connecticut Connecticut As of September 30, 1998 Energy Southern Energy/Southern Total - ----------------------------------------------------------------------------------------------------------------------- Committed Lines $5,000,000 $32,000,000 $20,000,000 $57,000,000 Uncommitted Lines -- $10,000,000 $10,000,000 $20,000,000
Effective January 1, 1998, Connecticut Energy and Southern entered into an agreement with one bank for a shared committed line of credit in the amount of $20,000,000, replacing an existing line that expired on December 20, 1997. The new agreement extends the credit line term until December 31, 1998, and the initial term may be extended from year to year thereafter dependent upon the operating cash requirements of the Company and its subsidiary and approval by the bank. As of September 30, 1998, unused lines of credit totaled $54,600,000. Operating cash flows for 1998 were slightly lower compared to 1997 primarily due to lower accrued taxes, pipeline refunds which were returned to firm customers and lower liabilities related to margins earned which were used to fund certain economic development initiatives in Bridgeport. The decrease in operating cash flows in 1998 was partially offset by collections from customers through the operation of the PGA. Operating cash flows for 1997 were higher compared to 1996. The increase was principally due to lower accounts receivable balances due to warmer weather and more aggressive collection efforts, the receipt of pipeline refunds which were in the process of being returned to customers, lower inventory balances and higher comparative balances of deferred credits. Partially offsetting the overall increase in operating cash flows were the effect of warmer weather on the operation of the PGA and lower accounts payable balances. Because of the availability of short-term credit and the ability to issue long-term debt and additional equity, management believes it has adequate financial flexibility to meet its anticipated cash needs. Investing Activities Capital Expenditures Capital expenditures, net of contributions in aid of construction, approximated $24,614,000 in 1998, $28,443,000 in 1997 and $25,180,000 in 1996. Southern relies upon cash flows provided by operating activities to fund a portion of these expenditures, with the remainder funded by short-term borrowings and, at some later date, long-term debt and capital stock financings. Capital expenditures in 1999 will approximate $30,000,000. Approximately $24,500,000 of budgeted capital expenditures has been allocated to Southern, of which approximately 25% is earmarked for new business. The majority of Southern's remaining planned capital expenditures are to improve, protect and maintain its existing gas distribution system. Over the 1999-2003 period, it is estimated that total expenditures for new plant and equipment will range between $130,000,000 and $150,000,000. Energy Ventures In September 1997, CNE Energy formed a joint venture with Delmarva Power & Light Company's bulk energy group. The venture operates under the name Conectiv/CNE Energy Services, LLC and sells natural gas, electricity, fuel oil and other services and markets a full range of energy-related planning, financial, operational and maintenance services to commercial, industrial and municipal customers in New England and New York. In February 1998, the venture formed an alliance with Berkshire Energy Marketing, a division of the Massachusetts natural gas distribution utility, Berkshire Gas Company. The alliance markets energy commodities and services to commercial and industrial customers in western Massachusetts, eastern New York and southern Vermont. 23 CONNECTICUT ENERGY CORPORATION As the result of a merger of Delmarva Power & Light Company and Atlantic Energy, Inc., a holding company under the name Conectiv was formed. In September 1998, CNE Energy and Conectiv Energy Supply, Inc., a subsidiary of Conectiv, formed two joint ventures, TPS and CNEP. TPS, headquartered in Bridgeport, Connecticut, operates a 1.2 billion cubic foot LNG open access storage facility in Milford, Connecticut. The facility has access to three major natural gas pipelines in New England: Algonquin Gas Transmission Company, Iroquois Gas Transmission System, L.P. and Tennessee Gas Pipeline Company. TPS has received FERC approval of its market-based tariffs and is prepared to store and redeliver customer-owned LNG at the Milford facility beginning this winter. CNEP provides a firm in-market supply source to assist energy marketers and LDCs in meeting the maximum demands of their customers by offering firm supplies for peak-shaving and emergency deliveries. CNEP operates out of Newark, Delaware. Bridgeport Harbor Station Plant In July 1998, Southern completed construction on the distribution facilities needed to transport natural gas from a gate station in Stratford, Connecticut, to a new 520 megawatt electric generating plant in Bridgeport. The gas turbine plant is the largest nonnuclear generating plant in Connecticut and has the capacity to provide enough electricity to service up to 260,000 homes. Other Investments In August 1997, the Company's nonutility subsidiary, CNE Venture-Tech, Inc. ("CNE Venture-Tech"), made an initial investment in the Nth Power Technologies Fund I as a limited partner. This venture capital fund invests in companies that produce or market technologically advanced, innovative energy-related products. Participation in the fund may provide business opportunities to its limited partners. CNE Venture-Tech is committed to invest up to $5,000,000 in the fund over a period of three to five years from the initial investment date. Financing Activities Common Stock Dividends In June 1998 and June 1996, the quarterly dividend paid per share on the Company's common stock was increased to $0.335 and $0.33 per share, or an annual indicated dividend rate of $1.34 and $1.32 per share, respectively. Public Offering In November 1997, the Company completed a public sale of 1,035,000 shares of its common stock at a price of $24.25 per share and received net proceeds of approximately $24,224,000. The proceeds of this sale were used for the repayment of Southern's short-term debt. MTN Program In 1996, Southern initiated an MTN program, which was approved by the DPUC. The program permits the issuance, from time to time, of up to $75,000,000 of secured MTNs over a four-year period in varying amounts and with varying terms. Proceeds from the sale of the MTNs are used to reduce short-term borrowings primarily incurred in connection with Southern's capital expenditure program and for other general corporate purposes. In August 1996, Southern made its first issuance and sale under the program of $20,000,000 in MTNs at a weighted average rate of 7.84%. In September 1998, Southern issued and sold $17,000,000 in secured MTNs. These MTNs have a weighted average rate of 6.71% and a weighted average life of 25.5 years. They will be redeemed through payments of $3,000,000 and $14,000,000 in the years 2003 and 2028, respectively. Proceeds from the sale were used to repurchase $12,073,000 of Series T and Series U First Mortgage Bonds. These long-term debt securities had sinking fund requirements and principal payments of $12,527,000 during the 1998-2019 period. The DPUC has allowed the deferral of the unamortized issuance costs of the aforementioned MTNs as well as the premiums related to the repurchase of these notes. The total of these unamortized issuance costs and repurchase premiums was approximately $4,857,000, which will be amortized over the average life of this series of MTNs. Term Loan Agreement In May 1998, CNE Energy entered into a term loan agreement with a bank to be utilized to reimburse Southern for costs incurred to construct distribution facilities to transport natural gas to an electric generating plant in 24 CONNECTICUT ENERGY CORPORATION Bridgeport. Borrowings were completed in August 1998. As of September 30, 1998, borrowings for the construction of these facilities totaled $12,328,000. The method, timing and amounts of any future financings by the Company or its subsidiaries will depend on a variety of factors, including capitalization ratios, coverage ratios, interest costs, the state of the capital markets and general economic conditions. Other In response to the competitive forces and regulatory changes being faced by the Company, the Company has from time to time considered, and expects to continue to consider, various strategies designed to enhance its competitive position. These strategies may include business combinations with other companies as well as acquisitions of related or unrelated businesses. The Company may, from time to time, be engaged in preliminary discussions regarding one or more of these potential strategies. No assurances can be given as to whether any potential transaction of the type described may actually occur, or as to the ultimate effect thereof on the financial condition or competitive position of the Company. Environmental Matters Southern has identified coal tar residue at three sites in Connecticut resulting from coal gasification operations conducted at those sites by Southern's predecessors from the late 1800s through the first part of this century. Many gas distribution companies throughout the country carried on such gas manufacturing operations during the same period. The coal tar residue is not designated a hazardous material by any federal or Connecticut agency, but some of its constituents are classified as hazardous. On April 27, 1992, Southern notified the Connecticut Department of Environmental Protection ("DEP") and the United States Environmental Protection Agency of the presence of coal tar residue at the sites. On November 9, 1994, the DEP informed Southern that it had performed a preliminary review of the information provided to it by Southern and had determined that, based on current priorities and limited staff resources, a comprehensive review of site conditions and subsequent participation by the DEP "are not possible at this time." On September 8, 1997, Southern received a letter from the DEP informing it that the three sites had been entered on the Connecticut Inventory of Hazardous Waste Sites. The letter states that the site located on Pine Street in Bridgeport, Connecticut, may be of particular interest to the state of Connecticut because of its proximity to the Connecticut Department of Transportation expansion project of the U.S. Highway Route Number 95 Corridor. Placement of the sites on the Inventory of Hazardous Waste Sites means that the DEP may pursue remedial action pursuant to the Connecticut General Statutes. Each site is located in an area that permits Southern to voluntarily perform any remedial action. Connecticut law also allows Southern to retain a Licensed Environmental Professional to conduct further environmental assessments and, if necessary, to develop remedial action plans in accordance with Connecticut Remediation Standard Regulations. Southern has conferred with officials of the DEP, including the DEP liaison for the Department of Transportation's U.S. Highway Route Number 95 Corridor expansion project, to establish priorities in connection with the environmental assessments. As a result of those conferences, Southern and the DEP have negotiated and executed a Consent Order with respect to the Pine Street site located in Bridgeport. Pursuant to the Consent Order, Southern has agreed to undertake an investigation of the Pine Street site and its immediate surrounding area to determine potential sources of contamination and remediate contamination which may be found to have emanated or be emanating from the Pine Street site as a result of Southern's activities on the site. The schedule and scope of the investigation have been agreed to by Southern and the DEP. As a result of this Consent Order, Southern has recorded and deferred $150,000 for costs related to this site investigation. When the investigation is complete, Southern should be able to propose to the DEP what, if any, plan for remediation is appropriate for the site. Until such investigation is complete, management cannot predict the cost, if any, of any appropriate remediation for the Pine Street site. Neither can management, at this time, predict the costs for any future site analysis and remediation for the remaining two sites, if any, nor can it estimate when any such costs, if any, would be incurred. While such future analytical and cleanup costs could possibly be significant, management believes, based upon the provisions of the Partial Settlement in Southern's most recent rate order and regulatory precedent with other local distribution companies in Connecticut, that Southern will be able to recover these costs through its customer rates. Although the method, timing and extent of any recovery remain uncertain, management currently does not expect that the incurrence of such costs will materially adversely impact the Company's financial condition, results of operations or cash flows. 25 CONNECTICUT ENERGY CORPORATION CONSOLIDATED STATEMENTS OF INCOME (dollars in thousands, except per share)
Years ended September 30, 1998 1997 1996 - ----------------------------------------------------------------------------------------------------------------------------- Operating Revenues $242,431 $252,008 $261,093 Purchased gas 120,572 132,672 141,628 - ----------------------------------------------------------------------------------------------------------------------------- Gross margin 121,859 119,336 119,465 - ----------------------------------------------------------------------------------------------------------------------------- Operating Expenses: Operations 51,471 46,773 47,821 Maintenance 3,701 3,579 3,784 Depreciation 16,904 15,774 14,752 Federal and state income taxes 6,438 8,935 7,606 Municipal, gross earnings and other taxes 13,525 15,386 16,838 - ----------------------------------------------------------------------------------------------------------------------------- Total operating expenses 92,039 90,447 90,801 - ----------------------------------------------------------------------------------------------------------------------------- Operating income 29,820 28,889 28,664 - ----------------------------------------------------------------------------------------------------------------------------- Other (income) deductions, net (2,331) (1,229) 546 - ----------------------------------------------------------------------------------------------------------------------------- Interest Expense: Interest on long-term debt and amortization of debt issue costs 12,086 12,321 11,065 Other interest, net 1,054 1,356 1,888 - ----------------------------------------------------------------------------------------------------------------------------- Total interest expense 13,140 13,677 12,953 - ----------------------------------------------------------------------------------------------------------------------------- Net Income $ 19,011 $ 16,441 $ 15,165 - ----------------------------------------------------------------------------------------------------------------------------- Net income per share - basic $ 1.89 $ 1.81 $ 1.70 - ----------------------------------------------------------------------------------------------------------------------------- Net income per share - diluted $ 1.88 $ 1.81 $ 1.70 - -------------------------------------------------------------------------------------------- -------------------------------- Dividends paid per share $ 1.33 $ 1.32 $ 1.31 - ----------------------------------------------------------------------------------------------------------------------------- Weighted average common shares outstanding - basic 10,051,868 9,060,308 8,924,299 - ----------------------------------------------------------------------------------------------------------------------------- Weighted average common shares outstanding - diluted 10,104,115 9,095,521 8,924,299 - -----------------------------------------------------------------------------------------------------------------------------
See notes to consolidated financial statements. 26 CONNECTICUT ENERGY CORPORATION CONSOLIDATED BALANCE SHEETS (dollars in thousands, except per share)
As of September 30, 1998 1997 - ----------------------------------------------------------------------------------------------------------------------------- Assets Utility Plant: Plant in service, at cost $406,948 $396,263 Construction work in progress 5,767 3,412 - ----------------------------------------------------------------------------------------------------------------------------- Gross utility plant 412,715 399,675 Less: accumulated depreciation 137,493 130,553 - ----------------------------------------------------------------------------------------------------------------------------- Net utility plant 275,222 269,122 Nonutility property, net 4,526 3,343 - ----------------------------------------------------------------------------------------------------------------------------- Net utility plant and other property 279,748 272,465 - ----------------------------------------------------------------------------------------------------------------------------- Current Assets: Cash and cash equivalents 10,091 6,644 Accounts and notes receivable (less allowance for doubtful accounts of $2,065 in 1998 and $2,948 in 1997) 26,921 29,179 Accrued utility revenues, net 2,511 2,541 Unrecovered purchased gas costs 2,529 5,523 Inventories 10,491 2,606 Prepaid expenses 5,863 4,067 - ----------------------------------------------------------------------------------------------------------------------------- Total current assets 58,406 60,560 - ----------------------------------------------------------------------------------------------------------------------------- Deferred Charges and Other Assets: Unamortized debt expenses 10,841 6,038 Unrecovered deferred income taxes 49,800 42,929 Other 60,606 42,289 - ----------------------------------------------------------------------------------------------------------------------------- Total deferred charges and other assets 121,247 91,256 - ----------------------------------------------------------------------------------------------------------------------------- Total assets $459,401 $424,281 - ----------------------------------------------------------------------------------------------------------------------------- Capitalization and Liabilities Common Shareholders' Equity: Common stock - par value $1 per share: authorized - 20,000,000 shares; issued and outstanding -10,289,692 in 1998; 9,172,468 in 1997 $ 10,290 $ 9,172 Capital in excess of par value 119,961 94,540 Unearned compensation (310) (1,068) Retained earnings 47,685 42,297 Adjustment for minimum pension liability (net of income taxes) (473) (427) - ----------------------------------------------------------------------------------------------------------------------------- Total common shareholders' equity 177,153 144,514 - ----------------------------------------------------------------------------------------------------------------------------- Redeemable Preferred Stock -- -- Long-Term Debt 150,007 134,073 - ----------------------------------------------------------------------------------------------------------------------------- Total capitalization 327,160 278,587 - ----------------------------------------------------------------------------------------------------------------------------- Current Liabilities: Short-term borrowings 22,400 31,400 Current maturities of long-term debt 1,321 4,654 Accounts payable 10,499 12,609 Federal, state and deferred income taxes 1,537 5,017 Property and other accrued taxes 2,024 4,567 Interest payable 3,386 3,499 Customers' deposits 1,627 1,718 Refunds due customers 454 2,627 Other 4,886 3,892 - ----------------------------------------------------------------------------------------------------------------------------- Total current liabilities 48,134 69,983 - ----------------------------------------------------------------------------------------------------------------------------- Deferred Credits: Deferred income taxes 72,884 64,917 Deferred investment tax credits 2,684 2,976 Other 8,389 7,818 - ----------------------------------------------------------------------------------------------------------------------------- Total deferred credits 83,957 75,711 - ----------------------------------------------------------------------------------------------------------------------------- Commitments and contingencies 150 -- - ----------------------------------------------------------------------------------------------------------------------------- Total capitalization and liabilities $459,401 $424,281 - -----------------------------------------------------------------------------------------------------------------------------
See notes to consolidated financial statements. 27 CONNECTICUT ENERGY CORPORATION CONSOLIDATED STATEMENTS OF CHANGES IN COMMON SHAREHOLDERS' EQUITY (dollars in thousands, except per share)
Adjust- Total ment for Common Common Stock Capital in Unearned Minimum Share- Number Par Excess of Compen- Retained Pension holders' of Shares Value Par Value sation Earnings Liability Equity - ----------------------------------------------------------------------------------------------------------------------------- Balance at September 30, 1995 8,865,210 $ 8,865 $ 88,295 -- $ 34,401 -- $131,561 Issuance through Dividend Reinvestment Plan 147,057 147 2,784 -- -- -- 2,931 Net income -- -- -- -- 15,165 -- 15,165 Dividends paid on common stock ($1.31 per share) -- -- -- -- (11,696) -- (11,696) - ----------------------------------------------------------------------------------------------------------------------------- Balance at September 30, 1996 9,012,267 9,012 91,079 -- 37,870 -- 137,961 Issuance through Dividend Reinvestment Plan 107,054 107 2,205 -- -- -- 2,312 Issuance through Restricted Stock Award Plan and Non- Employee Director Stock Plan 53,147 53 1,256 -- -- -- 1,309 Unearned compensation -- -- -- $(1,068) -- -- (1,068) Net income -- -- -- -- 16,441 -- 16,441 Dividends paid on common stock ($1.32 per share) -- -- -- -- (12,014) -- (12,014) Adjustment for minimum pension liability (net of income taxes) -- -- -- -- -- $(427) (427) - ----------------------------------------------------------------------------------------------------------------------------- Balance at September 30, 1997 9,172,468 9,172 94,540 (1,068) 42,297 (427) 144,514 Public Offering 1,035,000 1,035 23,189 -- -- -- 24,224 Issuance through Dividend Reinvestment Plan 81,324 82 2,208 -- -- -- 2,290 Issuance through Non-Employee Director Stock Plan 900 1 24 -- -- -- 25 Unearned compensation -- -- -- 758 -- -- 758 Net income -- -- -- -- 19,011 -- 19,011 Dividends paid on common stock ($1.33 per share) -- -- -- -- (13,623) -- (13,623) Adjustment for minimum pension liability (net of income taxes) -- -- -- -- -- (46) (46) - ----------------------------------------------------------------------------------------------------------------------------- Balance at September 30, 1998 10,289,692 $10,290 $119,961 $ (310) $47,685 $(473) $177,153 - -----------------------------------------------------------------------------------------------------------------------------
See notes to consolidated financial statements. 28 CONNECTICUT ENERGY CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (dollars in thousands) (dollars in thousands)
Years ended September 30, 1998 1997 1996 - ----------------------------------------------------------------------------------------------------------------------------- Cash Flows from Operating Activities: Net income $ 19,011 $ 16,441 $ 15,165 Adjustments to Reconcile Net Income to Net Cash: Depreciation and amortization 18,065 16,704 15,747 Provision for losses on accounts receivable 7,735 7,297 6,549 (Increase) Decrease in Assets: Accounts and notes receivable (5,477) (5,603) (13,966) Accrued utility revenues, net 30 67 67 Unrecovered purchased gas costs 2,994 (5,523) 2,972 Inventories 2,115 2,725 (2,216) Prepaid expenses (2,096) (2,607) 140 Unamortized debt expenses (185) (42) (383) Deferred charges and other assets (6,231) (5,593) (6,229) Increase (Decrease) in Liabilities: Accounts payable (2,110) (1,641) 4,664 Accrued taxes (6,023) 1,605 577 Refundable purchased gas costs -- (520) 520 Other current liabilities (1,383) 2,594 (293) Deferred income taxes and investment tax credits 854 1,303 1,743 Deferred credits and other liabilities 482 1,611 (2,635) - ----------------------------------------------------------------------------------------------------------------------------- Net cash provided by operating activities 27,781 28,818 22,422 - ----------------------------------------------------------------------------------------------------------------------------- Cash Flows from Investing Activities: Capital expenditures (24,681) (28,504) (25,251) Contributions in aid of construction 67 61 71 Proceeds from (payments for) retirement of utility plant 33 462 (487) Investment in special contract distribution main (11,394) -- -- Energy ventures (777) (1,458) (1,910) - ----------------------------------------------------------------------------------------------------------------------------- Net cash used by investing activities (36,752) (29,439) (27,577) - ----------------------------------------------------------------------------------------------------------------------------- Cash Flows from Financing Activities: Dividends paid on common stock (13,623) (12,014) (11,696) Issuance of common stock 27,297 2,553 2,931 Issuance of long-term debt 29,328 -- 20,000 Repayments of long-term debt (4,654) (595) (594) Repurchase of long-term debt (12,073) -- -- Payment of premium on repurchase of long-term debt (4,857) -- -- (Decrease) increase in short-term borrowings (9,000) 12,200 (5,000) - ---------------------------------------------------------------------------------------------------------------------------- Net cash provided by financing activities 12,418 2,144 5,641 - ---------------------------------------------------------------------------------------------------------------------------- Net increase in cash and cash equivalents 3,447 1,523 486 Cash and cash equivalents at beginning of year 6,644 5,121 4,635 - ---------------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents at end of year $ 10,091 $ 6,644 $ 5,121 - ---------------------------------------------------------------------------------------------------------------------------- Supplemental Disclosures of Cash Flow Information Cash Paid During the Year for: Interest $ 13,321 $14,200 $ 12,228 Income taxes $ 9,050 $ 5,041 $ 6,625
Supplemental Schedule of Noncash Investing and Financing Activities: In the year ended September 30, 1998, 900 shares of unregistered common stock were issued pursuant to the Non-Employee Director Stock Plan. In the year ended September 30, 1997, 52,247 shares of unregistered common stock were issued pursuant to the Company's Restricted Stock Award Plan and 900 shares of unregistered common stock were issued pursuant to the Non-Employee Director Stock Plan. See notes to consolidated financial statements. 29 CONNECTICUT ENERGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except per share) NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES General Connecticut Energy Corporation's ("Connecticut Energy" or "Company") consolidated financial statements include the accounts of all subsidiary companies, and all significant intercompany transactions and accounts have been eliminated. The Company's principal subsidiary, The Southern Connecticut Gas Company ("Southern"), is subject to regulation by the Connecticut Department of Public Utility Control ("DPUC") with respect to rates charged for service and the maintenance of accounting records, among other things. Southern's accounting policies conform to generally accepted accounting principles ("GAAP") as applied to regulated public utilities and are in accordance with the accounting requirements and ratemaking practices of the DPUC. In preparing the financial statements in conformity with GAAP, the Company uses estimates. Estimates are disclosed when there is a reasonable possibility for change in the near term. For this purpose, near term is defined as a period of time not to exceed one year from the date of the financial statements. The Company's financial statements have been prepared based on management's estimates of the impact of regulatory, legislative and judicial developments on the Company or significant groups of its customers. The recorded amounts of certain accruals, reserves and deferred charges could be materially impacted if circumstances change which affect these estimates. Line of Business Connecticut Energy is a public utility holding company primarily engaged in the retail distribution of natural gas for residential, commercial and industrial uses through its utility subsidiary, Southern. Through its nonutility subsidiary, CNE Energy Services Group, Inc. ("CNE Energy"), the Company provides an array of energy products and services to commercial and industrial customers throughout New England and New York. The Company also participates in a natural gas purchasing cooperative through another nonutility subsidiary, CNE Development Corporation. A third nonutility subsidiary, CNE Venture-Tech, Inc., invests in ventures that offer technologically advanced energy-related products. In September 1997, CNE Energy formed a joint venture with Delmarva Power & Light Company's bulk energy group. The venture operates under the name Conectiv/CNE Energy Services, LLC and sells natural gas, electricity, fuel oil and other services and markets a full range of energy-related planning, financial, operational and maintenance services to commercial, industrial and municipal customers in New England and New York. In February 1998, the venture formed an alliance with Berkshire Energy Marketing, a division of the Massachusetts natural gas distribution utility, Berkshire Gas Company. The alliance markets energy commodities and services to commercial and industrial customers in western Massachusetts, eastern New York and southern Vermont. As the result of a merger of Delmarva Power & Light Company and Atlantic Energy, Inc., a holding company under the name Conectiv was formed. In September 1998, CNE Energy and Conectiv Energy Supply, Inc., a subsidiary of Conectiv, formed two joint ventures, Total Peaking Services, LLC ("TPS") and CNE Peaking, LLC ("CNEP"). TPS, headquartered in Bridgeport, Connecticut, operates a 1.2 billion cubic foot liquefied natural gas ("LNG") open access storage facility in Milford, Connecticut. The facility has access to three major natural gas pipelines in New England: Algonquin Gas Transmission Company, Iroquois Gas Transmission System, L.P. and Tennessee Gas Pipeline Company. TPS has received Federal Energy Regulatory Commission approval of its market-based tariffs and is prepared to store and redeliver customer-owned LNG at the Milford facility beginning this winter. CNEP provides a firm in-market supply source to assist energy marketers and local gas distribution companies ("LDCs") in meeting the maximum demands of their customers by offering firm supplies for peak-shaving and emergency deliveries. CNEP operates out of Newark, Delaware. Accounting for the Effects of Regulation Southern prepares its financial statements in accordance with the provisions of Statement of Financial Accounting Standards No. 71, "Accounting for the Effects of Certain Types of Regulation" ("SFAS 71"), which requires a cost-based, rate-regulated enterprise such as Southern to reflect the impact of regulatory decisions in its financial statements. The DPUC's actions through the ratemaking process can create regulatory assets in which costs are allowed for ratemaking purposes in a period other than the period in which the costs would be charged to expense if the reporting entity were unregulated. 30 CONNECTICUT ENERGY CORPORATION NOTES TO CONSOLIDATED STATEMENTS (dollars in thousands, except per share) In the application of SFAS 71, Southern follows accounting policies that reflect the impact of the rate treatment of certain events or transactions. The most significant of these policies include the recording of deferred gas costs, deferred conservation costs, deferred hardship heating customer accounts receivable arrearages, deferred environmental evaluation costs and an unfunded deferred income tax liability, with a corresponding unrecovered asset, to account for temporary differences previously flowed through to ratepayers. Southern had net regulatory assets as of September 30, 1998 and 1997 of $74,955 and $63,606, respectively. These amounts are included in deferred charges and other assets and deferred credits in the consolidated balance sheets and are solely due to the application of the provisions of SFAS 71. Effective April 1, 1996, the DPUC deregulated the sale of natural gas to firm commercial and industrial customers by giving these customers an option to purchase natural gas from independent brokers or marketers. Commercial and industrial customers electing to purchase natural gas in this manner pay a DPUC-approved firm transportation rate to LDCs for the use of their distribution systems. Southern is one of three Connecticut LDCs whose firm transportation rates are designed to provide the same margins earned from bundled services. Because these rates are margin neutral, there has not been any impact upon Southern's ability to recover deferred costs through cost-based rate regulation. Firm transportation rates have eliminated only the gas cost component of the rates previously charged to these customers. The Company has not experienced any adverse impact on its earnings or results of operations from this change in rate structure. Additionally, the DPUC's initiatives for competition have not been directed toward services for certain groups of customers, including service to residential classes, which represent the majority of Southern's total throughput and gross margin. Management believes that Southern continues to meet the requirements of SFAS 71 because Southern's rates for regulated services provided to its customers are subject to DPUC approval; are designed to recover Southern's costs of providing regulated services; and continue to be subject to cost-of-service based rate regulation by the DPUC. Utility Revenues The primary source of the Company's revenue is derived from Southern's retail distribution of natural gas. Southern's service area spans 22 Connecticut towns from Westport to Old Saybrook, including the urban communities of Bridgeport and New Haven. Southern bills its customers on a cycle basis throughout each month and accrues revenues related to volumes of gas consumed by customers, but not billed at month end. The accrual of unbilled revenues is recorded net of related gas costs and accrued expenses. Purchased Gas Costs Southern's firm sales rates include a Purchased Gas Adjustment clause ("PGA") under which purchased gas costs above or below base rate levels are charged or credited to customers. As prescribed by the DPUC, most differences between Southern's actual purchased gas costs and the current cost recovery are deferred for future recovery or refund through the PGA. Conservation Adjustment Mechanism In a Decision dated August 23, 1995, the DPUC provided the Connecticut LDCs with guidelines by which conservation-related expenditures not included in current rates charged would be evaluated by the DPUC for recovery through a Conservation Adjustment Mechanism ("CAM"). Based upon an annual DPUC review of Southern's filing, which was last approved in December 1997, Southern is allowed to include as part of its monthly PGA a separate CAM factor to recover these deferred charges. Firm transportation customers, who are not subject to the PGA, are charged a specific CAM. Weather Normalization Adjustment Southern's firm rates include a Weather Normalization Adjustment ("WNA") under which the non-gas portion of these rates is charged or credited monthly to reflect deviations from normal temperatures. The WNA was implemented in January 1994 and operates for ten months of the year (September through June). 31 CONNECTICUT ENERGY CORPORATION NOTES TO CONSOLIDATED STATEMENTS (dollars in thousands, except per share) Federal Income Taxes The Company and its eligible subsidiaries file a consolidated federal income tax return. Federal income taxes are deferred under the liability method in accordance with Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes." Under the liability method, deferred income taxes are provided for all differences between financial statement and tax basis of assets and liabilities. Additional deferred income taxes and offsetting regulatory assets or liabilities are recorded to recognize that income taxes will be recoverable or refundable through future revenues. With specific permission from the DPUC, Southern also provides deferred federal income taxes for certain items, such as unrecovered purchased gas costs, that are reported in different time periods for tax purposes and financial reporting purposes. Net Income per Share Net income per share is computed based upon the weighted average number of common shares outstanding during each year. Effective October 1, 1997, the Company adopted Statement of Financial Accounting Standards No. 128, "Earnings per Share." This Statement establishes standards for the computation and presentation of earnings per share ("EPS") by all entities with publicly held common stock or potential common stock. The Statement replaces the presentation of primary EPS with a presentation of basic EPS. It also requires dual presentation of basic and diluted EPS on the face of the income statement for all entities with complex capital structures. The sole difference between basic and diluted EPS relates to the common shares granted under the Company's Restricted Stock Award Plan. Adoption of this Statement did not have a significant impact on the Company's financial condition or results of operations. Utility Plant Utility plant is stated at original cost. The costs of additions and major replacements of retired units are capitalized. Costs include labor, direct material and certain indirect charges such as engineering and supervision. Replacement of minor items of property and the cost of maintenance and repairs are included in maintenance expense. For normal retirements, the original cost of the property, plus removal cost, less salvage value, is charged to accumulated depreciation when the property is retired and removed from service. Depreciation For financial accounting purposes, depreciation of utility plant is computed using the composite straightline rates prescribed by the DPUC. The annual composite rate allowed for book depreciation for Southern is 4.15% for all years presented. Depreciation of transportation and power-operated equipment is computed separately and based on their estimated useful lives. For federal income tax purposes, the Company computes depreciation using accelerated methods. Inventories Inventories are stated at the lower of cost or market, cost generally being determined on the basis of the average cost method. Inventories consist primarily of fuel stock and smaller amounts of materials, supplies and appliances. Deferred Charges and Other Assets Deferred charges and other assets include amounts related to the following:
As of September 30, 1998 1997 - ----------------------------------------------------------------------------------------------------------------------------- Conservation costs $ 5,004 $ 4,881 Energy assistance funding shortfall 262 882 Environmental evaluation costs 684 718 Gas holder costs 62 308 Hardship heating customer accounts receivable arrearages 16,399 13,439 Hardship heating customer assistance grant program 1,748 634 Investment in energy ventures 4,195 3,418 Investment in special contract distribution main 11,394 -- LNG facility 207 -- Nonqualified benefit plans 3,023 2,302 Prepaid pension and postretirement medical contributions 14,207 13,228 Other 3,421 2,479 - ----------------------------------------------------------------------------------------------------------------------------- $60,606 $42,289 - -----------------------------------------------------------------------------------------------------------------------------
Southern has been allowed to recover various deferred charges in rates over periods ranging from three to five years in accordance with the DPUC's Decision in Southern's latest rate case. 32 CONNECTICUT ENERGY CORPORATION NOTES TO CONSOLIDATED STATEMENTS (dollars in thousands, except per share) Deferred Credits Deferred credits include amounts related to the following:
As of September 30, 1998 1997 - ----------------------------------------------------------------------------------------------------------------------------- Economic development initiatives $ 397 $1,339 Insurance reserves 1,153 1,122 Interruptible margin sharing 1,210 877 Nonqualified benefit plans 3,522 2,961 Other 2,107 1,519 - ----------------------------------------------------------------------------------------------------------------------------- $ 8,389 $7,818 - -----------------------------------------------------------------------------------------------------------------------------
Stock-Based Compensation Plan The Company applies the provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"), to its Restricted Stock Award Plan in accordance with Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," as permitted by SFAS 123 (see Note 6, "Common Shareholders' Equity," for further detail). Statement of Cash Flows For purposes of reporting cash flows, short-term investments having maturities of three months or less are considered to be cash equivalents. Recent Accounting Developments Effective October 1, 1998, the Company will adopt Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income." This Statement establishes standards for reporting and presentation of comprehensive income and its components in general-purpose financial statements and requires that all items required to be recognized under accounting standards as components of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. Adoption of this Statement is not expected to have a significant impact on the Company's financial condition or results of operations. Effective October 1, 1999, the Company will adopt Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities." This Statement establishes standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. Adoption of this Statement is not expected to have a significant impact on the Company's financial condition or results of operations. This Statement is effective for all fiscal quarters of fiscal years beginning after June 15, 1999. Adoption of this Statement is not expected to have a significant impact on the Company's financial condition or results of operations. NOTE 2 - PROVISION FOR INCOME TAXES The provision for income taxes includes the following:
Years ended September 30, 1998 1997 1996 - ----------------------------------------------------------------------------------------------------------------------------- Taxes currently payable - federal $ 4,840 $ 4,220 $ 5,463 Taxes currently payable - state 1,793 1,232 1,669 - ----------------------------------------------------------------------------------------------------------------------------- 6,633 5,452 7,132 Deferred taxes - federal/state (195) 3,483 474 - ----------------------------------------------------------------------------------------------------------------------------- Total income tax provision $ 6,438 $ 8,935 $ 7,606 - -----------------------------------------------------------------------------------------------------------------------------
Sources and tax effects of items which gave rise to deferred tax expense are as follows:
Years ended September 30, 1998 1997 1996 - ----------------------------------------------------------------------------------------------------------------------------- Amortization of deferred investment tax credits $ (292) $ (292) $ (292) Depreciation 1,468 1,775 1,817 Minimum tax credits -- -- 439 Unrecovered purchased gas costs (1,048) 2,180 (1,288) Other (323) (180) (202) - ----------------------------------------------------------------------------------------------------------------------------- $ (195) $ 3,483 $ 474 - -----------------------------------------------------------------------------------------------------------------------------
33 CONNECTICUT ENERGY CORPORATION NOTES TO CONSOLIDATED STATEMENTS (dollars in thousands, except per share) The following table reconciles the income tax provision calculated using the federal statutory tax rate to the actual income tax expense:
Years ended September 30, 1998 1997 1996 - ----------------------------------------------------------------------------------------------------------------------------- Statutory federal tax rate 35% 35% 35% Allowance for doubtful accounts, including amounts forgiven and deferred (5) (1) (3) Conservation costs -- (1) (4) Cost to retire assets, net of salvage (1) (1) (1) Depreciation differences 3 3 4 Investment tax credits (1) (1) (1) Pension contribution 2 (1) (3) Premium paid - cancellation of bonds (7) -- -- Property taxes - effect of accounting treatment change (3) -- -- State taxes, net of federal tax benefit 5 3 5 Other, net (3) (1) 1 - ----------------------------------------------------------------------------------------------------------------------------- Effective tax rate 25% 35% 33% - -----------------------------------------------------------------------------------------------------------------------------
Deferred income tax liabilities (assets) are composed of the following:
As of September 30, 1998 1997 - ----------------------------------------------------------------------------------------------------------------------------- Tax effect of temporary differences for: Depreciation $25,523 $24,056 Regulatory assets - income taxes 49,800 42,929 - ----------------------------------------------------------------------------------------------------------------------------- Gross liabilities 75,323 66,985 - ----------------------------------------------------------------------------------------------------------------------------- Contributions in aid of construction (758) (741) Nonqualified benefit plans (1,124) (928) Other (557) (399) - ----------------------------------------------------------------------------------------------------------------------------- Gross assets (2,439) (2,068) - ----------------------------------------------------------------------------------------------------------------------------- Net deferred income tax liability - long-term $72,884 $64,917 - -----------------------------------------------------------------------------------------------------------------------------
As of September 30, 1998 and 1997, the balance sheet caption "Federal, state and deferred income taxes" includes approximately $885 and $1,933, respectively, of current deferred federal and state income taxes. NOTE 3 - LONG-TERM DEBT Long-term debt outstanding consists of the following: As of September 30, 1998 1997 - ----------------------------------------------------------------------------------------------------------------------------- First Mortgage Bonds: Series L, 8%, due March 1, 1998 $ -- $ 4,200 Series T, 10.02%, due September 1, 2003 -- 2,727 Series U, 9.70%, due July 31, 2019 -- 9,800 Series V, 9.85%, due July 31, 2020 15,000 15,000 Series W, 8.93%-9.13%, due November 17, 2031 60,000 60,000 Series X, 7.67%, due December 15, 2012 15,000 15,000 Series Y, 7.08%, due October 1, 2013 12,000 12,000 - ----------------------------------------------------------------------------------------------------------------------------- 102,000 118,727 Medium-Term Notes: MTN1, Series 1, 7.50%-7.95%, due August 3, 2026 20,000 20,000 MTN1, Series 2, 5.95%-6.88%, due September 15, 2028 17,000 -- - ----------------------------------------------------------------------------------------------------------------------------- 37,000 20,000 Term Loan: Term loan, due August 1, 2005 12,328 -- Less: current maturities of long-term debt 1,321 4,654 - ----------------------------------------------------------------------------------------------------------------------------- $150,007 $134,073 - -----------------------------------------------------------------------------------------------------------------------------
34 CONNECTICUT ENERGY CORPORATION NOTES TO CONSOLIDATED STATEMENTS (dollars in thousands, except per share) Series W First Mortgage Bonds are due in bullet payments in the years 2021 and 2031, respectively. Series V, X and Y are due in single payments in the years 2020, 2012 and 2013, respectively. Substantially all of the utility plant of Southern is subject to the lien of its mortgage bond indenture dated March 1, 1948, as supplemented from time to time. See Note 6, "Common Shareholders' Equity," for dividend restrictions. In May 1998, CNE Energy entered into a term loan agreement with a bank to be utilized to reimburse Southern for costs incurred to construct distribution facilities to transport natural gas to an electric generating plant in Bridgeport. Borrowings were completed in August 1998. The interest rate on outstanding borrowings will vary in accordance with prevailing interest rates. In September 1998, Southern issued and sold $17,000 in secured Medium-Term Notes ("MTN1, Series 2"). These notes have a weighted average rate of 6.71% and a weighted average life of 25.5 years. They will be redeemed through payments of $3,000 and $14,000 in the years 2003 and 2028, respectively. Proceeds from the sale of MTN1, Series 2, were used to repurchase $12,073 of Series T and Series U First Mortgage Bonds. The DPUC has allowed the deferral of the unamortized issuance costs of the aforementioned MTNs as well as the premiums related to the repurchase of these notes. The total of these unamortized issuance costs and repurchase premiums was approximately $4,857 which will be amortized over the average life of this series of MTNs. Principal maturities for the five fiscal years subsequent to September 30, 1998 are as follows: 1999 - $1,321; 2000 - $1,585; 2001 - $1,761; 2002 - $1,761; 2003 - $4,761; total - $11,189. Expenses incurred in connection with long-term borrowings are normally amortized on a straightline basis over the respective lives of the issues giving rise thereto. NOTE 4 - SHORT-TERM BORROWINGS The Company follows the practice of borrowing from banks on a short-term basis. The following information relates to these borrowings:
As of September 30, 1998 1997 - ------------------------------------------------------------------------------------------------------------------------------ Outstanding $22,400 $31,400 Weighted average interest rate 5.73% 6.61% - ------------------------------------------------------------------------------------------------------------------------------
As of September 30, 1998, Connecticut Energy and Southern have credit lines with a number of banks as detailed below:
Shared Connecticut Connecticut Energy/ Energy Southern Southern Total - ------------------------------------------------------------------------------------------------------------------------------ Committed Lines $ 5,000 $ 32,000 $ 20,000 $ 57,000 Uncommitted Lines -- $ 10,000 $ 10,000 $ 20,000
In lieu of compensating balances, Southern pays fees for its committed lines of credit, which are approximately 1/5 of 1% of the amount of the line of credit. The aggregate annual commitment fees on these lines were $88, $115 and $110 for the years ended September 30, 1998, 1997 and 1996, respectively. As of September 30, 1998, unused lines of credit totaled $54,600. NOTE 5 - REDEEMABLE PREFERRED STOCK The following table summarizes the shares of preferred stock authorized, issued and outstanding:
As of September 30, 1998 1997 - ------------------------------------------------------------------------------------------------------------------------------ The Southern Connecticut Gas Company: Cumulative preferred stock, $100 par value Authorized 200,000 200,000 Issued and outstanding -- -- - ------------------------------------------------------------------------------------------------------------------------------ Preferred stock, $1 par value Authorized 600,000 600,000 Issued and outstanding -- -- - ------------------------------------------------------------------------------------------------------------------------------ Preference stock, $1 par value Authorized 1,000,000 1,000,000 Issued and outstanding -- -- - ------------------------------------------------------------------------------------------------------------------------------ Connecticut Energy Corporation: Preference stock, $1 par value Authorized 1,000,000 1,000,000 Issued and outstanding -- -- - ------------------------------------------------------------------------------------------------------------------------------
35 CONNECTICUT ENERGY CORPORATION NOTES TO CONSOLIDATED STATEMENTS (dollars in thousands, except per share) Southern's $1 par value preferred stock ranks on a parity as to dividends and payments in liquidation with Southern's $100 par value preferred stock. While the preference stock is preferred as to dividends and payments in liquidation over Southern's common stock, it is subordinate to the other classes of preferred stock. NOTE 6 - COMMON SHAREHOLDERS' EQUITY Southern's indentures relating to long-term debt contain restrictions as to the declaration or payment of cash dividends on capital stock and the reacquisition of capital stock. Under the most restrictive of such provisions, $46,838 of Southern's retained earnings as of September 30, 1998 was available for such purposes. In 1997, the Company established a Restricted Stock Award Plan and issued 52,247 shares of unregistered common stock to five senior officers of the Company and its subsidiaries. The purpose of the Restricted Stock Award Plan is to motivate participants to work toward achieving corporate objectives beneficial to the Company and its shareholders by awarding them shares of common stock which become vested upon achievement of the objectives. The total number of shares that may be issued under the Restricted Stock Award Plan may not exceed 300,000. This number is subject to adjustment to prevent the dilution or enlargement of any rights of any participant with respect to his or her stock. Such shares are exempt from registration pursuant to Section 4(2) of the Securities Act of 1933. In 1997, the Company also established a Non-Employee Director Stock Plan. The purpose of the Non-Employee Director Stock Plan is to align the interests of non-employee directors with the Company's shareholders by awarding them shares of common stock. The total number of shares that may be issued under the plan may not exceed 13,000. This number is subject to adjustment to prevent the dilution or enlargement of any rights of any participant with respect to his or her stock. As of September 30, 1998, 1,800 shares have been issued under the Non-Employee Director Stock Plan. The Company issues common stock through the Dividend Reinvestment and Stock Purchase Plan ("DRP") and an employee savings plan ("Target Plan"). The DRP permits shareholders to automatically reinvest their cash dividends or invest optional limited amounts of cash payments in newly issued shares or open market purchases of the Company's common stock. As of September 30, 1998, there were 674,308 shares reserved for issuance under the DRP and Target Plan. NOTE 7 - EMPLOYEE BENEFITS Pension Plans Southern maintains two noncontributory pension plans covering substantially all of its employees and employees of certain affiliates. The plan covering salaried employees provides pension benefits based on compensation during the five years before retirement and on years of service. The union plan provides negotiated benefits of stated amounts for each year of service. It is the Company's policy to fund annually the periodic pension cost of its retirement plans subject to the minimum and maximum contribution limitations of the Internal Revenue Code ("IRC"). A regulatory adjustment has been made to the net periodic pension cost for fiscal years 1997 and 1996 to reflect the amount of pension cost that is realized through the ratemaking process. The Company recorded an additional minimum liability of $1,036 and $797 as of September 30, 1998 and 1997, respectively, representing the excess of the accumulated benefit obligation over the fair value of plan assets and accrued pension costs. This liability is offset by an intangible asset of $228 and $85 as of September 30, 1998 and 1997, respectively, which represents unrecognized prior service costs; and in 1998 and 1997, the balance (net of income taxes) was charged to a separate component of shareholders' equity. The net periodic pension cost includes the following components:
Years ended September 30, 1998 1997 1996 - ------------------------------------------------------------------------------------------------------------------------------ Service cost benefit earned during the period $ 2,284 $ 2,255 $ 2,179 Interest cost on projected benefit obligation 5,438 5,370 4,846 Actual return on plan assets (4,430) (21,078) (9,372) Net amortization and deferral (2,442) 14,912 3,959 - ------------------------------------------------------------------------------------------------------------------------------ Net periodic pension cost 850 1,459 1,612 Regulatory adjustment -- 58 233 - ------------------------------------------------------------------------------------------------------------------------------ Net pension cost $ 850 $ 1,517 $ 1,845 - ------------------------------------------------------------------------------------------------------------------------------ Portion capitalized to utility plant $ 179 $ 357 $ 351 - ------------------------------------------------------------------------------------------------------------------------------
36 CONNECTICUT ENERGY CORPORATION NOTES TO CONSOLIDATED STATEMENTS (dollars in thousands, except per share) The following table sets forth the funded status of Southern's pension plans:
As of September 30, 1998 1997 - ------------------------------------------------------------------------------------------------------------------------------ Plans Where: Plans Where: Assets Accumulated Assets Accumulated Exceed Benefits Exceed Benefits Accumulated Exceed Accumulated Exceed Benefits Assets Benefits Assets - ------------------------------------------------------------------------------------------------------------------------------ Actuarial present value of benefit obligation: Vested benefit obligation $(63,238) $ (2,302) $(55,770) $ (1,814) - ------------------------------------------------------------------------------------------------------------------------------ Accumulated benefit obligation $(69,765) $ (2,525) $(61,451) $ (1,965) - ------------------------------------------------------------------------------------------------------------------------------ Actuarial present value of projected benefit obligation $(78,902) $ (3,251) $(70,143) $ (2,527) Plan assets at fair value 97,560 -- 98,207 -- - ------------------------------------------------------------------------------------------------------------------------------ Projected benefit obligation less than (in excess of) plan assets 18,658 (3,251) 28,064 (2,527) Transition obligation 321 -- 490 -- Prior service cost 3,115 228 3,608 250 Unrecognized (gain) loss (11,606) 1,534 (21,220) 1,109 Adjustment required to recognize minimum liability -- (1,036) -- (797) - ------------------------------------------------------------------------------------------------------------------------------ Prepaid pension cost (liability), net $ 10,488 $ (2,525) $ 10,942 $ (1,965) - ------------------------------------------------------------------------------------------------------------------------------
Key assumptions used in the determination of the projected benefit obligations and the fair value of plan assets were:
1998 1997 1996 - ------------------------------------------------------------------------------------------------------------------------------ Discount rate 6-3/4% 7-1/2% 8% Salary increase rate 4% 4-3/4% 5-3/4% Expected rate of return on assets 9-1/2% 9-1/2% 9-1/4% - ------------------------------------------------------------------------------------------------------------------------------
The majority of the assets of the pension plans are invested in common stock, fixed income securities and balanced mutual funds, with the balance in cash and short-term investments. Southern maintains nonqualified pension programs to provide benefits on compensation in excess of the limitations imposed by the IRC and to provide additional retirement income to designated officers of the Company and its subsidiaries. Retirement Savings Plan Southern maintains a savings plan ("Target Plan") covering substantially all of its employees and employees of certain affiliates who meet minimum service and age requirements. Employees may elect to contribute to the plan through payroll deductions on either a taxable or a tax-deferred basis as permitted by Section 401(k) of the IRC. Participants receive a matching contribution of 50% of the first 6% of annual compensation and become vested in the matching contribution over a five year period. Benefits are payable upon retirement, death, disability or termination of employment. Amounts expensed under the plan were $778, $782 and $808 for years ended September 30, 1998, 1997 and 1996, respectively. Postretirement Health Care Benefits Southern provides certain health care benefits for retired employees of Southern and certain affiliates who were hired prior to November 1, 1995. Substantially all employees may become eligible for those benefits if they have reached age 55 and have completed at least five years of service with the Company before retirement. Health care benefits are also extended to qualifying dependents. 37 CONNECTICUT ENERGY CORPORATION NOTES TO CONSOLIDATED STATEMENTS (dollars in thousands, except per share) The postretirement benefit cost includes the following components:
Years ended September 30, 1998 1997 1996 - ------------------------------------------------------------------------------------------------------------------------------ Service cost benefit attributed to service during the period $ 369 $ 354 $ 405 Interest cost on accumulated postretirement benefit obligation 1,207 1,223 1,198 Actual return on plan assets (589) (1,619) (837) Net amortization and deferral 415 1,694 1,037 - ------------------------------------------------------------------------------------------------------------------------------ Net periodic postretirement benefit cost 1,402 1,652 1,803 Regulatory adjustment -- 31 122 - ------------------------------------------------------------------------------------------------------------------------------ Net postretirement benefit cost $ 1,402 $ 1,683 $ 1,925 - ------------------------------------------------------------------------------------------------------------------------------ Portion capitalized to utility plant $ 294 $ 396 $ 366 - ------------------------------------------------------------------------------------------------------------------------------
In 1990, Southern amended the Pension Plan for Salaried and Certain Other Employees to establish an account within the pension plan trust, as permitted under Section 401(h) of the IRC, to fund a portion of Southern's anticipated future postretirement health care benefits liability with amounts allowed through the ratemaking process. In 1994, a Voluntary Employees' Beneficiary Association ("VEBA") trust was established as permitted under Section 501(c)(9) of the IRC. The majority of the assets of the VEBA trust are invested in a diversified fund consisting of common stock and fixed income securities, with the balance in cash and short-term investments. The following table reconciles the funded status of the plan with the amounts recognized in the consolidated balance sheets:
As of September 30, 1998 1997 - ------------------------------------------------------------------------------------------------------------------------------ Accumulated postretirement benefit obligation: Retirees $ (9,332) $ (9,148) Fully eligible active plan participants (2,749) (2,028) Other active plan participants (6,081) (5,451) - ------------------------------------------------------------------------------------------------------------------------------ Total accumulated postretirement benefit obligation (18,162) (16,627) Plan assets at fair value 9,771 7,988 - ------------------------------------------------------------------------------------------------------------------------------ Accumulated postretirement benefit obligation (in excess of) less than plan assets (8,391) (8,639) Unamortized transition obligation 11,517 12,285 Unrecognized gain (3,154) (4,442) - ------------------------------------------------------------------------------------------------------------------------------ Accrued postretirement benefit obligation $ (28) $ (796) - ------------------------------------------------------------------------------------------------------------------------------
The expected long-term rate of return on plan assets is 9 1/2%. The assumed initial health care cost trend rates used to measure the expected cost of benefits are 7 1/2% for pre-age 65 claims and 6 1/2% for post-age 65 claims. The rates decline to 4 1/2% by the years 2004 and 2002, respectively. The weighted average discount rate used to measure the accumulated postretirement benefit obligation is 6 3/4%. A one percentage point change in the assumed health care cost trend rate would change the service cost and interest cost components of the net periodic postretirement benefit cost by approximately $7 and $43, respectively, and would change the accumulated postretirement health care benefit obligation by approximately $646. NOTE 8 - LEASES Total rental expense was $3,050, $2,830 and $3,035 for the years ended September 30, 1998, 1997 and 1996, respectively. The approximate aggregate minimum rental commitments (exclusive of taxes, maintenance, etc.) under noncancelable operating leases for each of the five fiscal years subsequent to September 30, 1998 are as follows:
Years ending September 30, 1999 2000 2001 2002 2003 Thereafter - ------------------------------------------------------------------------------------------------------------------------------ Office space $2,130 $2,098 $2,087 $2,087 $2,218 $22,918 LNG plant 609 609 609 609 609 10,649 Other 76 76 76 67 -- -- - ------------------------------------------------------------------------------------------------------------------------------ Total commitment $2,815 $2,783 $2,772 $2,763 $2,827 $33,567 - ------------------------------------------------------------------------------------------------------------------------------
38 CONNECTICUT ENERGY CORPORATION NOTES TO CONSOLIDATED STATEMENTS (dollars in thousands, except per share) In 1995, the LNG plant lease agreement was renewed for two consecutive terms of 12 years. The lease contains an option to purchase the plant at a price based on the then fair market sales value of the unit as defined therein. During 1998, Southern subleased the LNG facility to CNE Energy. CNE Energy, in turn, subleased the LNG facility to TPS. Southern will continue to operate the LNG facility under an agreement with TPS and will remain primarily responsible for the lease payments in the event that the sublessees do not make the required payments. NOTE 9 - QUARTERLY FINANCIAL DATA (UNAUDITED)
Dec. 31, March 31, June 30, Sept. 30, 1998 Quarters ended 1997 1998 1998 1998 - ------------------------------------------------------------------------------------------------------------------------------ Operating revenues $76,507 $100,773 $38,002 $27,149 Gross margin 34,031 52,599 20,155 15,074 Operating income (loss) 9,366 18,376 2,222 (144) Net income (loss) 6,166 15,250 (1,019) (1,386) Net income (loss) per share-diluted* 0.64 1.49 (0.10) (0.13) - ------------------------------------------------------------------------------------------------------------------------------ Dec. 31, March 31, June 30, Sept. 30, 1997 Quarters ended 1996 1997 1997 1997 - ------------------------------------------------------------------------------------------------------------------------------ Operating revenues $74,873 $106,866 $44,026 $26,243 Gross margin 34,564 51,130 21,487 12,155 Operating income (loss) 9,006 17,800 2,461 (378) Net income (loss) 5,409 15,211 (1,205) (2,974) Net income (loss) per share-diluted 0.60 1.67 (0.13) (0.32) - ------------------------------------------------------------------------------------------------------------------------------
*Calculated on the basis of diluted weighted average shares outstanding during the applicable quarter. NOTE 10 - FAIR VALUE OF FINANCIAL INSTRUMENTS The following methods and assumptions were used to estimate the fair value of each class of financial instrument for which it is practicable to estimate that value: Cash and Cash Equivalents The carrying amount approximates fair value because of the short-term maturity of those instruments. Long-term debt The fair value of the Company's long-term debt is estimated based on quoted market prices for the same or similar issues or on current rates offered to the Company for debt of the same remaining maturities. The estimated fair value of the Company's long-term debt is as follows:
As of September 30, 1998 1997 - ------------------------------------------------------------------------------------------------------------------------------ Carrying Fair Carrying Fair Amount Value Amount Value - ------------------------------------------------------------------------------------------------------------------------------ Long-term debt (including current maturities) $151,328 $181,854 $138,727 $160,196 - ------------------------------------------------------------------------------------------------------------------------------
NOTE 11 - COMMITMENTS AND CONTINGENCIES Environmental Matters Southern has identified coal tar residue at three sites in Connecticut resulting from coal gasification operations conducted at those sites by Southern's predecessors from the late 1800s through the first part of this century. Many gas distribution companies throughout the country carried on such gas manufacturing operations during the same period. The coal tar residue is not designated a hazardous material by any federal or Connecticut agency, but some of its constituents are classified as hazardous. On April 27, 1992, Southern notified the Connecticut Department of Environmental Protection ("DEP") and the United States Environmental Protection Agency of the presence of coal tar residue at the sites. On November 9, 1994, the DEP informed Southern that it had performed a preliminary review of the information provided to it by Southern and had determined that, based on current priorities and limited staff resources, a comprehensive review of site conditions and subsequent participation by the DEP "are not possible at this time." 39 CONNECTICUT ENERGY CORPORATION NOTES TO CONSOLIDATED STATEMENTS (dollars in thousands, except per share) On September 8, 1997, Southern received a letter from the DEP informing it that the three sites had been entered on the Connecticut Inventory of Hazardous Waste Sites. The letter states that the site located on Pine Street in Bridgeport, Connecticut, may be of particular interest to the state of Connecticut because of its proximity to the Connecticut Department of Transportation expansion project of the U.S. Highway Route Number 95 Corridor. Placement of the sites on the Inventory of Hazardous Waste Sites means that the DEP may pursue remedial action pursuant to the Connecticut General Statutes. Each site is located in an area that permits Southern to voluntarily perform any remedial action. Connecticut law also allows Southern to retain a Licensed Environmental Professional to conduct further environmental assessments and, if necessary, to develop remedial action plans in accordance with Connecticut Remediation Standard Regulations. Southern has conferred with officials of the DEP, including the DEP liaison for the Department of Transportation's U.S. Highway Route Number 95 Corridor expansion project, to establish priorities in connection with the environmental assessments. As a result of those conferences, Southern and the DEP have negotiated and executed a Consent Order with respect to the Pine Street site located in Bridgeport. Pursuant to the Consent Order, Southern has agreed to undertake an investigation of the Pine Street site and its immediate surrounding area to determine potential sources of contamination and remediate contamination which may be found to have emanated or be emanating from the Pine Street site as a result of Southern's activities on the site. The schedule and scope of the investigation have been agreed to by Southern and the DEP. As a result of this Consent Order, Southern has recorded and deferred $150 for costs related to this site investigation. When the investigation is complete, Southern should be able to propose to the DEP what, if any, plan for remediation is appropriate for the site. Until such investigation is complete, management cannot predict the cost, if any, of any appropriate remediation for the Pine Street site. Neither can management, at this time, predict the costs for any future site analysis and remediation for the remaining two sites, if any, nor can it estimate when any such costs, if any, would be incurred. While such future analytical and cleanup costs could possibly be significant, management believes, based upon the provisions of the Partial Settlement in Southern's most recent rate order and regulatory precedent with other local distribution companies in Connecticut, that Southern will be able to recover these costs through its customer rates. Although the method, timing and extent of any recovery remain uncertain, management currently does not expect that the incurrence of such costs will materially adversely impact the Company's financial condition, results of operations or cash flows. NOTE 12 - NONUTILITY OPERATIONS The Company has two nonutility subsidiaries that engage in activities related to the purchasing and marketing of natural gas as well as the selling, planning, purchasing and management of various energy services to commercial and industrial end users. In addition, another nonutility subsidiary focuses on investing in technology companies and participating in ventures with technology partners serving the utility industry. In fiscal 1998, the Company's nonutility subsidiaries contributed approximately $0.17 to earnings per share, representing approximately 9% of consolidated earnings per share for the year. The contribution to 1998 earnings by the nonutility subsidiaries was principally due to revenues generated by a contract to transport natural gas to an electric generating plant located at the Bridgeport Harbor Station and the sale of 50% interests in TPS and CNEP, joint ventures of the Company's nonutility subsidiary, CNE Energy, to Conectiv Energy Supply, Inc., a subsidiary of Conectiv. The chart below depicts net income, earnings per share and total assets for the Company's nonutility operations:
Years ended September 30, 1998 1997 1996 - ------------------------------------------------------------------------------------------------------------------------------ Net Income $ 1,707 $ 418 $ (167) Earnings per share - diluted $ 0.17 $ 0.05 $ (0.02) Total assets $ 25,370 $ 4,887 $ 2,504 - ------------------------------------------------------------------------------------------------------------------------------
40 CONNECTICUT ENERGY CORPORATION MANAGEMENT RESPONSIBILITY FOR FINANCIAL STATEMENTS The management of Connecticut Energy Corporation is responsible for the preparation and integrity of the consolidated financial statements and all other financial information included in this annual report. The financial statements were prepared in conformity with generally accepted accounting principles consistently applied and they necessarily include amounts which are based on estimates and judgments made with due consideration to materiality. Management maintains a system of internal accounting controls which it believes provides reasonable assurance that Company policies and procedures are complied with, assets are safeguarded and transactions are executed in accordance with appropriate corporate authorization and recorded in a manner which permits management to meet its responsibility for the preparation of financial statements. The Company's system of controls includes the communication and enforcement of written policies and procedures. The Audit Committee of the Board of Directors, comprised of non-employee directors, meets periodically and as necessary with management, the internal auditors and PricewaterhouseCoopers LLP to review audit plans and results and the Company's accounting, financial reporting and internal control practices, procedures and results. Both PricewaterhouseCoopers LLP and the Company's internal audit department have full and free access to all levels of management. /s/ Carol A. Forest /s/ Vincent L. Ammann, Jr. Carol A. Forest Vincent L. Ammann, Jr. Vice President, Finance, Vice President and Chief Financial Officer, Treasurer Chief Accounting Officer and Assistant Secretary REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Shareholders of Connecticut Energy Corporation In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, changes in common shareholders' equity and of cash flows present fairly, in all material respects, the financial position of Connecticut Energy Corporation and its subsidiaries at September 30, 1998 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended September 30, 1998, in conformity with generally accepted accounting principles. 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 generally accepted auditing standards which 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 the opinion expressed above. /s/ PricewaterhouseCoopers LLP New York, New York October 30, 1998 41 CONNECTICUT ENERGY CORPORATION ELEVEN YEAR FINANCIAL SUMMARY (dollars in thousands, except per share) Financial information presented for 1998 through 1990 is for the twelve month period ended September 30; all information for prior years is for the twelve month period ended December 31.
1998 1997 1996 1995 - ----------------------------------------------------------------------------------------------------------------------------- Operations Operating revenues $ 242,431 $ 252,008 $ 261,093 $ 232,093 Purchased gas 120,572 132,672 141,628 115,583 Gross margin 121,859 119,336 119,465 116,510 Operations and maintenance expenses 55,172 50,352 51,605 52,856 Depreciation and depletion 16,904 15,774 14,752 14,050 Federal income taxes 4,598 7,703 5,937 5,901 Other taxes 15,365 16,618 18,507 16,817 Other (income) deductions, net (2,331) (1,229) 546 519 Total interest expense 13,140 13,677 12,953 12,307 Subsidiary preferred stock dividends -- -- -- -- Income before cumulative effect of accounting change $ 19,011 $ 16,441 $ 15,165 $ 14,060 Cumulative effect of accounting change -- -- -- -- Net income $ 19,011 $ 16,441 $ 15,165 $ 14,060 Net income per share before cumulative effect of accounting change (d) $ 1.88 $ 1.81 $ 1.70 $ 1.60 Net income per share (d) $ 1.88 $ 1.81 $ 1.70 $ 1.60 Annual dividend paid per common share (d) $ 1.33 $ 1.32 $ 1.31 $ 1.30 - ---------------------------------------------------------------------------------------------------------------------------- *Capitalization Common shareholders' equity $ 177,153 $ 144,514 $ 137,961 $ 131,561 Redeemable preferred stock -- -- --- -- Long-term debt 150,007 134,073 138,727 119,322 --------------------------------------------------------------------------------------------------------------------------- Total capitalization $ 327,160 $ 278,587 $ 276,688 $ 250,883 - ---------------------------------------------------------------------------------------------------------------------------- *Capitalization (% of total) Common shareholders' equity 54.1 51.9 49.9 52.4 Redeemable preferred stock -- -- -- -- Long-term debt 45.9 48.1 50.1 47.6 - ---------------------------------------------------------------------------------------------------------------------------- Total capitalization 100.0% 100.0% 100.0% 100.0% - ---------------------------------------------------------------------------------------------------------------------------- *Common Stock (d) Shares outstanding at end of period 10,289,692 9,172,468 9,012,267 8,865,210 Book value per share at end of period $ 17.22 $ 15.76 $ 15.31 $ 14.84 Market value per share at end of period $ 27.00 $ 24.69 $ 20.00 $ 19.38 Average daily trading volume 15,000 9,000 9,000 5,000 Shareholders of record at end of period 9,863 10,546 11,274 11,688 Institutional ownership (%) 35 25 20 21 - ---------------------------------------------------------------------------------------------------------------------------- Assets Gross utility plant $ 412,715 $399,675 $ 376,109 $ 354,847 Net utility plant $ 275,222 $269,122 $ 257,761 $ 247,603 Capital expenditures (e) $ 24,614 $ 28,443 $ 25,180 $ 27,609 Total assets $ 459,401 $424,281 $ 399,228 $ 370,088 - ---------------------------------------------------------------------------------------------------------------------------- Ratios (%) Operations and maintenance expense as a % of gross margin 45.3 42.2 43.2 45.4 Dividend payout as a % of earnings 70.7 72.9 77.1 81.3 Effective federal tax rate 19.0 32.0 28.0 30.0 Return on ending common equity 10.7 11.4 11.0 10.7 Price to earnings 14.4 13.6 11.8 12.1 Dividend yield 4.9 5.3 6.6 6.7 Market price as a % of book value 156.8 156.7 130.6 130.6 - ---------------------------------------------------------------------------------------------------------------------------- *Information used in the National Association of Investors Corporation (NAIC) stock selection format. (a) The results for the years ended September 30, 1990 and December 31, 1989 include the results for the three months ended December 31, 1989, which included the effects of the unusually cold weather experienced in the month of December and a writedown of the value of oil and gas properties.
42
1994 1993 1992 1991 1990 1989 1988 - ----------------------------------------------------------------------------------------------------------------------------- (a)(b)(c) (a)(c) $240,873 $212,762 $203,011 $179,172 $174,059 $171,218 $156,978 126,870 113,045 104,163 86,778 84,154 81,794 71,787 114,003 99,717 98,848 92,394 89,905 89,424 85,191 54,244 45,023 46,881 42,475 44,085 42,636 38,869 13,031 12,051 11,327 10,540 10,664 10,297 8,533 3,938 3,474 2,287 4,324 3,819 4,740 5,839 17,778 16,044 16,025 15,238 14,431 14,560 14,146 586 510 531 349 (228) 356 713 11,575 11,530 11,536 10,428 10,156 8,598 7,653 8 32 34 36 39 403 751 $ 12,843 $ 11,053 $ 10,227 $ 9,004 $ 6,939 $ 7,834 $ 8,687 -- -- -- -- 1,280 -- -- $ 12,843 $ 11,053 $ 10,227 $ 9,004 8,219 $ 7,834 $ 8,687 $ 1.58 $ 1.50 $ 1.43 $ 1.38 $ 1.12 $ 1.28 $ 1.49 $ 1.58 $ 1.50 $ 1.43 $ 1.38 $ 1.33 $ 1.28 $ 1.49 $ 1.29 $ 1.28 $ 1.265 $ 1.24 $ 1.23 $ 1.20 $ 1.17 - ----------------------------------------------------------------------------------------------------------------------------- $ 125,719 $ 99,853 $ 92,605 $ 88,622 $ 74,413 $ 75,001 $ 73,311 -- 638 687 736 786 835 6,429 $ 119,917 120,511 $ 94,106 $ 87,378 91,506 79,686 69,137 ---------------------------------------------------------------------------------------------------------------------------- $ 245,636 $221,002 $187,398 $176,736 $ 166,705 $ 155,522 $148,877 - ----------------------------------------------------------------------------------------------------------------------------- 51.2 45.2 49.4 50.1 44.6 48.2 49.2 -- 0.3 0.4 0.4 0.5 0.6 4.3 48.8 54.5 50.2 49.5 54.9 51.2 46.5 - ---------------------------------------------------------------------------------------------------------------------------- 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% - ----------------------------------------------------------------------------------------------------------------------------- 8,700,266 7,488,467 7,234,921 7,096,634 6,250,161 6,176,665 6,088,017 $ 14.45 $ 13.33 $ 12.80 $ 12.49 $ 11.91 $ 12.14 $ 12.04 $ 21.63 $ 24.88 $ 22.25 $ 19.00 $ 16.63 $ 17.63 $ 14.50 5,500 9,000 4,500 5,000 2,950 4,200 2,850 12,094 11,094 9,153 9,163 7,382 7,493 7,662 21 18 18 14 15 16 16 - ----------------------------------------------------------------------------------------------------------------------------- $331,953 $313,951 $293,687 $273,862 $255,446 $241,624 $255,236 $234,495 $221,800 $210,054 $198,695 $189,108 $181,358 $166,970 $ 26,618 $ 26,070 $ 22,634 $ 20,331 $ 23,102 $ 23,184 $ 19,471 $352,920 $299,795 $269,504 $247,969 $229,600 $239,327 $214,458 - ---------------------------------------------------------------------------------------------------------------------------- 47.6 45.2 47.4 46.0 49.0 47.7 45.6 81.6 85.3 88.5 89.9 92.5 93.8 78.5 23.0 24.0 18.0 32.0 35.0 37.0 38.0 10.2 11.1 11.0 10.2 11.0 10.4 11.8 13.7 16.6 15.6 13.8 12.5 13.8 9.7 6.0 5.1 5.7 6.5 7.4 6.8 8.1 149.7 186.6 173.8 152.1 139.6 145.2 120.04 - ----------------------------------------------------------------------------------------------------------------------------- (b) Includes the cumulative effect of accounting change for municipal property taxes which increased earnings by $0.21 per share. (c) The write down of the value of oil and gas properties reduced earnings by $0.10 per share in 1990 and 1989. (d) Adjusted to reflect the Company's 3-for-2 stock split in October 1989. (e) Stated net of contributions in aid of construction.
43 EX-21 3 EXHIBIT 21 SUBSIDIARIES OF CONNECTICUT ENERGY CORPORATION Name State of Incorporation ----- ---------------------- The Southern Connecticut Gas Company Connecticut CNE Development Corporation Connecticut CNE Energy Services Group, Inc. Connecticut CNE Venture-Tech, Inc. Connecticut EX-27 4
UT THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED STATEMENTS OF INCOME, BALANCE SHEETS AND STATEMENTS OF CASH FLOWS OF CONNECTICUT ENERGY CORPORATION AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 YEAR SEP-30-1998 SEP-30-1998 PER-BOOK 275,222 4,526 58,406 121,247 0 459,401 10,290 119,961 47,685 177,153 0 0 150,007 22,400 0 0 1,321 0 0 0 108,520 459,401 242,431 6,438 206,173 212,611 29,820 2,331 32,151 13,140 19,011 0 19,011 13,623 12,086 27,781 1.89 1.88
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