-----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, PmZHY3pVqLEVDuWrCeUDnMftM/5wdD4Ni6GCpLqLOXccirCZsba3pzQJWJ1NjFAn sW7W+UG/irYcw27ruG1ykw== 0000950172-98-000782.txt : 19980814 0000950172-98-000782.hdr.sgml : 19980814 ACCESSION NUMBER: 0000950172-98-000782 CONFORMED SUBMISSION TYPE: U-1/A PUBLIC DOCUMENT COUNT: 6 FILED AS OF DATE: 19980813 SROS: NYSE SROS: PHLX FILER: COMPANY DATA: COMPANY CONFORMED NAME: PP&L RESOURCES INC CENTRAL INDEX KEY: 0000922224 STANDARD INDUSTRIAL CLASSIFICATION: ELECTRIC SERVICES [4911] IRS NUMBER: 232758192 STATE OF INCORPORATION: PA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: U-1/A SEC ACT: SEC FILE NUMBER: 070-09165 FILM NUMBER: 98685283 BUSINESS ADDRESS: STREET 1: TWO N NINTH ST CITY: ALLENTOWN STATE: PA ZIP: 18101 BUSINESS PHONE: 6107745151 MAIL ADDRESS: STREET 1: TWO NORTH NINTH ST STREET 2: TWO NORTH NINTH STREET CITY: ALLENTOWN STATE: PA ZIP: 181011179 U-1/A 1 AMENDMENT 1 TO FORM U-1 As filed with the Securities and Exchange Commission on August 13, 1998 File No. 70-9165 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------------------------------- AMENDMENT NO. 1 TO FORM U-1 APPLICATION OR DECLARATION UNDER THE PUBLIC UTILITY HOLDING COMPANY ACT OF 1935 PP&L Resources, Inc. Two North Ninth Street Allentown, PA 18101 (Name of company or companies filing this statement and address of principal executive offices) None (Name of top registered holding company parent of each applicant or declarant) Robert J. Grey Senior Vice President General Counsel and Secretary PP&L Resources, Inc. Two North Ninth Street Allentown, PA 18101 (610) 774-5151 (Name and addresses of agents for service) -------------------------------------------- The Commission is requested to send copies of all notices, orders and communications in connection with this Application to: Clifford (Mike) M. Naeve, Esq. Skadden, Arps, Slate, Meagher & Flom LLP 1440 New York Avenue, N.W. Washington, D.C. 20005 The Application previously filed in this proceeding is hereby amended and restated in its entirety to read as follows: INTRODUCTION AND REQUEST FOR COMMISSION ACTION Pursuant to Sections 9(a)(2) and 10 of the Public Utility Holding Company Act of 1935 (the "Act"), PP&L Resources, Inc. (the "Company"), which is an exempt intrastate holding company under the Act, hereby requests that the Securities and Exchange Commission (the "Commission") authorize the Company's acquisition of all of the issued and outstanding common stock of Penn Fuel Gas, Inc. ("Penn Fuel"), which is an exempt intrastate holding company under the Act (the "Transaction"). The Company also requests an order under Section 3(a)(1) of the Act declaring it and each of its subsidiary companies exempt from all provisions of the Act except Section 9(a)(2) following consummation of the Transaction. The Transaction will be governed by the terms of an Agreement and Plan of Merger dated as of June 26, 1997 (the "Merger Agreement"), by and among the Company, Keystone Merger Corp., a Pennsylvania Corporation ("Keystone") and a wholly-owned subsidiary of the Company, and Penn Fuel. Under the terms of the Merger Agreement, Keystone will be merged into Penn Fuel, with Penn Fuel surviving as a wholly-owned subsidiary of the Company. Penn Fuel's Board of Directors approved the Transaction on June 25, 1997, and the Company's Board of Directors approved the Transaction on June 26, 1997. The Transaction was approved by the shareholders of Penn Fuel on October 1, 1997. The Transaction does not require approval of the Company's shareholders. A registration statement on Form S-4, which includes a Prospectus (the "Registration Statement"), was filed with the Commission on August 13, 1997 and was declared effective on September 5, 1997. The Transaction is conditioned, among other things, upon approval by the Pennsylvania Public Utility Commission ("Pennsylvania PUC"). On July 24, 1998 the Pennsylvania PUC approved the joint application of the Company and Penn Fuel filed with the Pennsylvania PUC on August 7, 1997 (attached as Exhibit D-1). (The Pennsylvania PUC Order is attached as Exhibit D-3.) The Maryland Public Service Commission ("Maryland PSC") was notified of the Transaction and has determined not to institute proceedings on the matter at this time. (See Exhibit D-4). In addition, the Transaction was subject to the 30-day waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976 (as amended) (the "HSR Act"). On October 7, 1997, the notices required pursuant to the HSR Act were filed by the Company and Penn Fuel, respectively. On October 24, 1997, the United States Department of Justice ("DOJ") granted early termination of the waiting period under the HSR Act with respect to the Transaction. The Company is the parent holding company of PP&L, Inc. (formerly Pennsylvania Power & Light Company) ("PP&L"), which provides regulated electric service in central eastern Pennsylvania. Penn Fuel is the parent holding company of PFG Gas, Inc. ("PFG Gas"), which provides regulated natural gas service in southern and eastern Pennsylvania and in a small portion of northern Maryland, and North Penn Gas Company ("North Penn"), which provides regulated natural gas service in northwestern and north central Pennsylvania. The Transaction is designed to create a merged company that will be able to compete effectively in the energy market -- which is being opened to competition at both the state and federal levels -- and to offer a broad array of energy services to customers of the merged company. For the Commission to approve the Transaction, Section 10 of the Act requires the Commission to find that the Transaction will tend towards the economical and efficient development of an integrated public-utility system and that state laws have been complied with. The Transaction clearly satisfies these requirements. While Section 10 also permits the Commission to disapprove an acquisition if certain adverse circumstances would result -- such as undue concentration of control or other harm to the public interest or the interests of investors or consumers -- these adverse circumstances are not present here. Accordingly, the Company submits that the Transaction meets all requirements of Section 10. With respect to the exemption requested under Section 3(a)(1), the holding company system must meet the intrastate requirements of the exemption and, in addition, the Commission must not find that the exemption would be detrimental to the public interest or the interests of investors or consumers. The Company submits that these criteria are satisfied as well. The Company requests expedited treatment of this application, so that upon receipt of other regulatory approvals, the Company and Penn Fuel will be in a position to consummate the Transaction promptly. Unless otherwise indicated, all financial information set forth herein is for the fiscal year ended December 31, 1997. ITEM 1. DESCRIPTION OF PROPOSED TRANSACTION. A. DESCRIPTION OF THE PARTIES TO THE TRANSACTION. 1. THE COMPANY. The Company is a public utility holding company incorporated under the laws of the Commonwealth of Pennsylvania,* which is exempt from regulation by the Commission under the Act (except for Section 9(a)(2) thereof) pursuant to Section 3(a)(1) of the Act and by order of the Commission.** Through its subsidiaries, the Company provides electric utility services and other energy-related products and services. -------------------- * The Company was incorporated in 1994 by PP&L in a corporate reorganization. ** PP&L Resources, Inc., File No. 70-8104, Rel. No. 35- 26248 (issued March 10, 1995). PP&L, the Company's principal subsidiary, is an operating electric utility incorporated in 1920 under the laws of the Commonwealth of Pennsylvania. PP&L serves approximately 1.2 million customers in its retail service territory in eastern and central Pennsylvania, sells retail electricity throughout Pennsylvania pursuant to Pennsylvania's Retail Access Pilot Program, and markets wholesale electricity throughout the Eastern United States. A map of PP&L's service area is attached as Exhibit E-1. PP&L operates its generating and transmission facilities as part of the Pennsylvania- New Jersey-Maryland Interconnection Association. PP&L owns a 90% undivided interest in each of two nuclear-fueled generating units at its Susquehanna station, and Allegheny Electric Cooperative, Inc. owns a 10% undivided interest in each of those units. PP&L also owns undivided interests of 12.2% in the Keystone generating station, 11.3% in the Conemaugh generating station and 8.37% in the Merrill Creek Reservoir generating station. Overall, PP&L produced about 40.9 billion kwh in plants it owned in 1997. PP&L purchased 13.4 billion kwh under purchase agreements and received 1.4 billion kwh as power pool interchange. During the year, PP&L delivered about 2.2 billion kwh as pool interchange and about 13.4 billion kwh under purchase agreements. PP&L owns 33.3% of the capital stock and 50% of the voting stock of Safe Harbor Water Power Corporation ("Safe Harbor"), a Pennsylvania corporation, which owns and operates a hydroelectric plant on the Susquehanna river in south central Pennsylvania. The remaining interest in Safe Harbor is held by Baltimore Gas & Electric Company ("BG&E"). Safe Harbor's plant has a total capacity of 417,500 kilowatts. The entire output of the plant is sold to PP&L and BG&E. PP&L is entitled by contract to one-third of this total capacity (139,000 kilowatts). In 1997, PP&L's purchases from Safe Harbor amounted to approximately $10 million; Safe Harbor's 1997 total operating revenues were approximately one percent of PP&L's 1997 utility operating revenues.* -------------------- * PP&L is exempt by order from the provisions of the Act (except for Section 9(a)(2)) pursuant to Section 3(a)(2). Pennsylvania Power & Light Company, Rel. No. 35-19725; SEC Docket 814 (1976). During 1997, 59.5% of the energy generated by PP&L's plants came from coal-fired stations, 36.9% from nuclear operations at the Susquehanna station, 2.1% from the Martins Creek oil and gas-fired steam station and 1.5% from hydroelectric stations. The Company is engaged in non-utility businesses, as well as certain other utility businesses that are not jurisdictional under the Act, through the subsidiaries listed below: PP&L Global, Inc. (formerly Power Markets Development Company) ("PP&L Global") engages in unregulated business activities through investments in electric generation, transmission and distribution facilities both overseas and domestically. As of December 31, 1997, PP&L Global had approximately $370 million of investments and commitments in such facilities in the United Kingdom, Bolivia, Peru, Argentina, Spain, Chile and Portugal. PP&L Global's investments are limited to those in Exempt Wholesale Generators ("EWGs") and Foreign Utility Companies ("FUCOs"). PP&L Spectrum, Inc. (formerly Spectrum Energy Services Corporation), an unregulated subsidiary, provides energy-related products and services both inside and outside of PP&L's service territory. Interstate Energy Company, a Delaware corporation, operates oil and gas pipeline facilities which supply fuel to PP&L's Martins Creek generating station. Realty Company of Pennsylvania and BDW Corporation own real estate and other interests related to the operation of PP&L's electric generating stations. PP&L Capital Funding, Inc., a Delaware corporation, engages in debt financing activities on behalf of the Company. CEP Group, Inc. holds passive investments in securities for investment purposes. Its investments are limited to those made for the benefit of associate companies. H. T. Lyons, Inc. is a heating, ventilating, and air-conditioning subsidiary. PP&L is subject to regulation by the Pennsylvania PUC with respect to its rates for retail sales of electricity as well as terms of service, issuance of certain securities, the encumbering or disposition of public utility properties, and accounting and other matters. In addition, PP&L is subject to regulation by the Federal Energy Regulatory Commission ("FERC") under the Federal Power Act with respect to rates for the sale of electricity for resale and other matters. PP&L is subject to the jurisdiction of the Nuclear Regulatory Commission in connection with its ownership and operation of the Susquehanna station nuclear units. PP&L is also subject to applicable federal and state environmental regulations. The common stock of the Company, par value $0.01 per share ("Company Common Stock"), is listed on the New York Stock Exchange (the "NYSE") and the Philadelphia Stock Exchange (the "PhSE"). As of the close of business on December 31, 1997, there were 166,248,284 shares of Company Common Stock issued and outstanding. For the year ended December 31, 1997, the Company's operating revenues on a consolidated basis were approximately $3.049 billion, of which approximately $90 million were attributable to non-utility activities. Consolidated assets of the Company and its subsidiaries at December 31, 1997 were approximately $9.985 billion, of which approximately $6.766 billion consisted of net electric plant and equipment. The Company's principal executive office is located at Two North Ninth Street, Allentown, Pennsylvania 18101. At December 31, 1997, PP&L, the Company's principal subsidiary, employed approximately 6,343 full-time employees. More detailed information concerning the Company and its subsidiaries is contained in the Company's Annual Report on Form 10-K for the year ended December 31, 1997, which is incorporated herein by reference as Exhibit G-1. 2. PENN FUEL. Penn Fuel is a public utility holding company organized under the laws of the Commonwealth of Pennsylvania and exempt from regulation by the Commission under the Act (except for Section 9(a)(2) thereof) pursuant to Section 3(a)(1) of the Act and by order of the Commission.* Penn Fuel provides natural gas service in Pennsylvania and Maryland through its public utility subsidiaries and supplies liquid propane gas to customers in Pennsylvania and Maryland. Penn Fuel is a closely- held corporation whose common stock is not actively traded. -------------------- * Penn Fuel Gas, Inc., et al., File No. 70-8068, Release No. 35-26050 (issued May 9, 1994). PFG Gas and North Penn, Penn Fuel's only subsidiaries, are Pennsylvania corporations which provide natural gas distribution and storage service to residential, commercial and industrial customers in 31 counties in Pennsylvania. PFG Gas provides natural gas sales and distribution service to approximately 35,000 customers in southern and eastern Pennsylvania and to approximately 200 customers in a small portion of Maryland. Ninety-nine percent of PFG Gas customers are located in Pennsylvania. North Penn provides natural gas sales and distribution services to approximately 34,500 customers located in north and northwestern Pennsylvania. North Penn also owns storage capacity in two underground natural gas storage facilities located in Pennsylvania: the Wharton Storage Field and the Tioga-Meeker Storage Complex. Maps of the PFG Gas and North Penn service territories are attached as Exhibits E-2 and E-3, respectively. PFG Gas and North Penn are subject to regulation by the Pennsylvania PUC as public utilities with respect to rates for service, terms of service, issuance of certain securities, the encumbering or disposition of public utility properties, the design, installation, testing, construction, and maintenance of pipeline facilities, and accounting and other matters. Penn Fuel and its subsidiaries must also comply with federal, state and local regulations related generally to the discharge of materials into the environment. PFG Gas's Maryland utility business is similarly subject to the jurisdiction of the Maryland PSC. North Penn's storage operations are subject to the jurisdiction of FERC, although FERC has deferred rate authority for storage to the Pennsylvania PUC. The authorized capital stock of Penn Fuel consists of 2,000,000 shares of common stock, par value $1.00 per share ("Penn Fuel Common Stock"); 500,000 shares of unissued Penn Fuel Prior Preferred Stock, no par value ("Unissued Preferred Stock"); and 2,000,000 shares of $1.40 cumulative preferred stock ("Penn Fuel $1.40 Preferred Stock"). As of the close of business on December 31, 1997, there were 717,583 shares of Penn Fuel Common Stock issued and outstanding, no shares of Unissued Preferred Stock issued and outstanding and 717,583 shares of Penn Fuel $1.40 Preferred Stock issued and outstanding. For the year ended December 31, 1997, Penn Fuel's operating revenues on a consolidated basis were approximately $119 million, of which approximately $106 million were attributable to its gas utility operations, and $13 million from propane operations and merchandise sales. Consolidated assets of Penn Fuel and its subsidiaries as of December 31, 1997 were approximately $208 million, of which approximately $150 million consisted of property, plant and equipment, $31 million were current assets and $27 million were deferred regulatory assets. Penn Fuel's principal executive office is located at 55 South Third Street, Oxford, Pennsylvania 19363. As of December 31, 1997, Penn Fuel directly and indirectly employed approximately 500 people. More detailed information concerning Penn Fuel and its subsidiaries is contained in Penn Fuel's Annual Report to Shareholders for the year ended December 31, 1997, which is attached as Exhibit G-2. 3. KEYSTONE. Keystone is a direct, wholly-owned subsidiary of the Company, organized under the laws of the Commonwealth of Pennsylvania solely for the purpose of merging with Penn Fuel. Keystone is not engaged in any business operations. The mailing address for Keystone is the same as that for the Company. B. DESCRIPTION OF THE TRANSACTION. 1. REASONS FOR THE TRANSACTION. The Transaction will combine two companies with complementary operations and expertise, and provide important strategic, financial and other benefits to the merging companies, their shareholders and their customers. The Transaction will allow the Company to better serve all the customers in its newly enlarged customer base. Pennsylvania is opening its retail electricity markets to competition, and legislation has been proposed to further open its gas markets in the near future. Following the Transaction, the Company will be able to compete in both energy markets and to provide gas or electricity to customers, depending on their needs. As a result of the Transaction, the Company will expand its customer base into additional areas in Pennsylvania. PFG Gas and North Penn's service regions include certain geographic areas not presently served by the Company. The Company's presence in a larger geographic region and its ability to provide both gas and electricity will enhance its ability to offer "behind the meter" consulting services and will provide the Company increased opportunities to provide the benefits of energy management systems to residential and commercial customers. Penn Fuel will have access to opportunities in the deregulated energy market that would be less available with its stand-alone, limited resources. Also, because of the increased size and resources the combined entity will have in comparison to Penn Fuel standing alone, the merger will greatly strengthen the foundation supporting services to Penn Fuel's customers at a high quality level. The merger is expected to give Penn Fuel a broader access to management and business systems, enable potential operating and management efficiencies and provide increased stability and other benefits to Penn Fuel inherent in being part of a much larger organization. By acquiring Penn Fuel and its utility subsidiaries, the Company will obtain expertise concerning alternative forms of energy, which will enhance its ability to compete in the increasingly deregulated energy market. Due to the incomplete geographical overlap of the service territories of PFG Gas and North Penn with PP&L's service territory, and because PP&L provides only electric utility service and PFG and North Penn provide only gas utility service, there is limited potential in the short term for achieving direct efficiencies in day- to-day utility operations as a result of the Transaction. However, as discussed in Item 3 below, the Company expects over time to reap substantial efficiencies through consolidation and coordination of various support functions such as accounting, finance, information systems, environmental management, gas marketing, and procurement. Various direct cost reductions, such as, inter alia, those resulting from consolidation of meter reading in overlapping service territories, are also anticipated. Moreover, as noted above and explained below in Item 3, the combination of the merging companies' expertise and resources will enable the Company to, inter alia, better address competition in the energy markets and provide its customers with a range of electric and natural gas products and services. 2. MERGER AGREEMENT. The Merger Agreement provides that, as soon as practicable following the satisfaction or waiver of the conditions to each party's obligation to consummate the Transaction, Keystone will be merged with and into Penn Fuel, the separate corporate existence of Keystone will cease, and Penn Fuel will continue as the surviving corporation in the merger, operating as a wholly-owned subsidiary of the Company. Each share of Penn Fuel Common Stock outstanding prior to the merger will be converted into the right to receive between 6.968 and 8.516 shares of Company Common Stock, depending upon the market price of the Company Common Stock at the time of the closing of the merger. Penn Fuel common stock shareholders will become Company shareholders, and the Company will become the sole holder of all of the outstanding common stock of Penn Fuel. Penn Fuel is taking all necessary action to redeem shares of the Penn Fuel $1.40 Preferred Stock in accordance with the terms of the preferred stock. Preferred shareholders will have the option of receiving the cash redemption price or converting their preferred shares into the right to receive between 0.682 and 0.833 shares of the Company Common Stock, depending upon the market price of the Company Common Stock at the time of the closing of the Transaction. Thus, Penn Fuel preferred shareholders may become common shareholders of the Company, and there will no longer be any shares of Penn Fuel preferred stock outstanding. 3. BACKGROUND AND NEGOTIATIONS LEADING TO THE TRANSACTION. The Company and Penn Fuel recognize that the utility industry is currently undergoing unprecedented change, including deregulation of electric power generation, which will significantly impact the competitiveness and business opportunities of the companies in the near future. The Company has been examining strategic alternatives to position itself to compete more effectively in the energy market. One such strategy is to combine electric and gas services so that the Company can create efficiencies, control costs, increase services available to consumers and expand its customer base. At the same time, in light of the changing of the utility industry, Penn Fuel also has been considering several alternatives regarding its future, including partnership opportunities or combining with an electric utility to strengthen its competitive position in the energy market. In early 1997, the Company and Penn Fuel entered into a confidentiality agreement and began preliminary discussions regarding the possibility of a business combination. In the months that followed, the Company and Penn Fuel exchanged a limited amount of confidential, nonpublic information and determined that further investigation of a possible transaction, including due diligence, was warranted. More in-depth due diligence was conducted in May-June of 1997. During this time, the companies considered alternative structures for a possible business combination and negotiated terms of the Merger Agreement. Periodically throughout this process, the Boards of both Penn Fuel and the Company were updated as to the ongoing status of negotiations. On June 25, 1997, the Penn Fuel Board of Directors approved the transaction, and on June 26, 1997, the Company Board of Directors approved the Transaction and the companies finalized and entered into the Merger Agreement. C. MANAGEMENT AND OPERATIONS OF THE COMPANY FOLLOWING THE TRANSACTION. Upon completion of the Transaction, Penn Fuel will become a subsidiary of the Company, which will own all of the issued and outstanding common stock of Penn Fuel. Penn Fuel will continue to own and operate its primary subsidiaries, PFG Gas and North Penn. Following the Transaction, the officers, directors, corporate charter and bylaws of Keystone immediately before the merger will become the officers, directors, corporate charter and bylaws of Penn Fuel, the surviving corporation. The Company's principal corporate and executive offices will continue to be in Allentown, Pennsylvania. Those of Penn Fuel will continue to be in Oxford, Pennsylvania. ITEM 2. FEES, COMMISSIONS AND EXPENSES. The fees, commissions and expenses to be paid or incurred, directly or indirectly, by both the Company and Penn Fuel, in connection with the Transaction, including registration of securities of the Company under the Securities Act of 1933, and other related matters, are estimated as follows: Commission filing fee for the Company Registration Statement on Form S-4 . . . . . . $24,930 HSR filing fee . . . . . . . . . . . . . . . . . $45,000 Accountants' fees . . . . . . . . . . . . . . . . $44,000 Shareholder communication (including prospectus printing and distribution). . . . . . . . . . . $25,000 NYSE/PhSE listing fee . . . . . . . . . . . . . . $53,500 Exchanging, printing, and engraving of stock certificates . . . . . . . . . . . . . . . . . $1,000 Investment bankers' fees and expenses . . . . . . $2,720,000 Legal fees and expenses (including regulatory and antitrust). . . . . . . . . . . . . . . . . $2,182,000 Miscellaneous (including consultants) . . . . . . $228,000 TOTAL (estimated) . . . . . . . . . . . . . . . . $5,323,430 ITEM 3. APPLICABLE STATUTORY PROVISIONS. A. STATEMENT OF APPLICABLE PROVISIONS. The Company believes that Sections 9(a)(2), 10, and 3(a)(1) of the Act are directly or indirectly applicable to the proposed Transaction. Under Section 9(a)(2), it is unlawful, without approval of the Commission, under the standards of Section 10, for any person to acquire, directly or indirectly, the securities of a public utility company, if that person will, by virtue of the acquisition, become an affiliate of that public utility and any other public utility or holding company. The term "affiliate" for this purpose means any person that directly or indirectly owns, controls, or holds with power to vote, five percent or more of the outstanding voting securities of the specified company. Pursuant to the Transaction, the Company will acquire, indirectly through its acquisition of Penn Fuel, securities of two public utilities, PFG Gas and North Penn. Following the Transaction, the Company will be an affiliate of the following public utilities: PP&L, Penn Fuel, Safe Harbor, PFG Gas and North Penn. Accordingly, the Transaction requires Commission approval under the standards of Section 10. Following the Transaction, the Company believes, for reasons explained below, that it will qualify for the intrastate exemption under Section 3(a)(1) of the Act, and requests an order granting such exemption. Under this section, the Commission must exempt, by rule or order, any holding company if that holding company, and each material public utility subsidiary company from which the holding company derives any material part of its income, are predominantly intrastate in character, and carry on their business in the state in which they are organized, unless and except insofar as the Commission finds the exemption detrimental to the public interest or the interest of investors or consumers. B. THE STANDARDS OF SECTION 10. The statutory standards to be considered by the Commission in evaluating the Transaction are set forth in Sections 10(b), 10(c) and 10(f) of the Act. 1. SECTION 10(B). Under Section 10(b) of the Act, the Commission must approve the Transaction unless the Commission finds that: (1) such acquisition will tend towards interlocking relations or the concentration of control of public-utility companies, of a kind or to an extent detrimental to the public interest or the interest of investors or consumers; (2) in case of the acquisition of securities or utility assets, the consideration, including all fees, commissions and other remuneration, to whomsoever paid, to be given, directly or indirectly, in connection with the acquisition is not reasonable or does not bear a fair relation to the sums invested in or the earning capacity of the utility assets to be acquired or the utility assets underlying the securities to be acquired; or (3) such acquisition will unduly complicate the capital structure of the holding-company system of the applicant or will be detrimental to the public interest or the interest of investors or consumers or the proper functioning of such holding company system. a. DETRIMENTAL "INTERLOCKING RELATIONS" OR "CONCENTRATION OF CONTROL". The Company believes that the Transaction will not result in detrimental interlocking relations or concentration of control. There is one common director of the Company and Penn Fuel and following consummation of the Transaction there may be additional common directors and officers of the Company and PFG Gas and North Penn. Such interlocking relationships, however, would serve to integrate the merging companies, and are characteristic of virtually every merger transaction subject to Section 9(a)(2). Thus, any interlocking relations which do occur will be of the kind generally approved of by the Commission and will not be detrimental to interests of consumers, investors or the public. The Transaction will also not result in a detrimental concentration of control. Penn Fuel is a small company relative to the Company and its acquisition by the Company will not make the Company excessively large. The acquisition of Penn Fuel will increase the Company's revenues and total assets by less than 4% and 2.1%, respectively. Following the Transaction, the Company will have total utility assets of $10 billion, total utility revenues of $3.1 billion, and will serve approximately 1.2 million utility customers. The utility activities of the Company following the Transaction will be confined almost entirely to central and eastern Pennsylvania. The Commission has approved a number of transactions which resulted in holding companies of a much larger size.* Competition is not adversely affected by the Transaction since neither PP&L nor Penn Fuel can exercise market power in any unregulated energy market and the merger of the two will not result in an increase in market share in any relevant energy market. As of November 1, 1997, PP&L began offering competitive retail electric power to the 5 percent of Pennsylvania retail electricity consumers who are participating in the state's Retail Access Pilot Program, under the recently enacted Pennsylvania Electricity Generation Customer Choice and Competition Act, 66 Pa. C.S. Ch. 28. Under this new law, PP&L will be required by January, 2001 to transmit and distribute electricity to all of its retail distribution customers that choose suppliers of electricity other than PP&L.** PP&L also currently competes in the wholesale electric energy and capacity markets. The FERC has found that PP&L does not possess market power in the electric energy generation markets in which it competes. Pennsylvania Power & Light Co., 80 F.E.R.C. paragraph 61,053 (1997). In addition, the FERC determined that PP&L could not exercise market power over the transmission of electricity since it had filed an open access transmission tariff pursuant to FERC Order No. 888 and 888a.*** -------------------- * See, e.g., TUC Holding Co., File No. 70-8953, Rel. No. 35-26749 (issued August 1, 1997). TUC Holding has utility assets of approximately $19.6 billion, operating utility revenues of approximately $6.9 billion and approximately 2.7 million utility customers. See also Entergy Corp., 51 S.E.C. 869 (combined utility assets after Gulf States acquisition of $21 billion). ** The local distribution of both electricity and gas in Pennsylvania will remain franchised regulated monopolies subject to the jurisdiction of the Pennsylvania PUC. *** See Promoting Wholesale Competition Through Open Access Nondiscriminatory Transmission Services by Public Utilities; Recovery of Stranded Costs by Public Utilities and Transmitting Utilities, Order No. 888, 61 Fed. Reg. 21,540 (1996), FERC Stats. & Regs. paragraph 31,036 (1996), order on reh'g, Order No. 888-A, 62 Fed. Reg. 12,274 (1997), FERC Stats. & Regs. paragraph 31,048 (1997), reh'g pending. Penn Fuel is a relatively small local gas distribution system. It provides gas and distribution services to small commercial and residential customers subject to regulation by the Pennsylvania PUC. Industrial distribution customers of Penn Fuel may buy gas from the company or use the company's regulated distribution system to transport gas purchased from other suppliers. Penn Fuel does not regularly engage in sales of natural gas at wholesale. Its share of natural gas sales at retail is insignificant compared to other large systems in Pennsylvania and nearby regions, such as Columbia Gas System, Inc., Consolidated Natural Gas Company, or UGI Utilities, Inc. Because the market shares of PP&L in electric markets and of Penn Fuel in gas markets are not sufficient to raise competitive concerns, it follows that in a hypothetical market embracing both fuels, their respective market shares would be even less significant. Combined electric and gas markets would necessarily include large electricity generators in the Pennsylvania- New Jersey-Maryland Interconnection ("PJM"), but also the countless marketers of natural gas that can reach the region through its numerous large open access interstate pipelines that operate under FERC Order No. 636.* Accordingly, the merger cannot lessen competition in a combined energy market. The Federal Trade Commission and the United States Department of Justice apparently reached the same conclusion when they both decided to grant early termination of the 30-day waiting period under the HSR Act. The Direct Testimony of Scott T. Jones, submitted to the Pennsylvania PUC** and attached as Exhibit D-2 to this Application, explains in detail why the Transaction will not harm competition. -------------------- * Pipeline Service Obligations and Revisions to Regulations Governing Self-Implementing Transportation Under Part 284 of the Commission's Regulations, Regulation of Natural Gas Pipelines After Partial Wellhead Decontrol, and Order Denying Rehearing in Part, Granting Rehearing in Part, and Clarifying Order No. 636 (Order No. 636-A), 57 Fed. Reg. 36,128 (August 12, 1992) (Citations omitted). ** Testimony filed in support of Application of PP&L and PFG Gas, and North Penn in Docket Nos. A- 1206SOF0006, A-1220SOF0003. On the contrary, the Transaction will provide important competitive benefits. By expanding its customer base, entering into the gas markets, and acquiring the expertise and experience of Penn Fuel in gas markets, the Company will be better positioned to compete with larger utilities in an evolving and increasingly competitive energy marketplace. This will enable the Company to provide its customers with expanded energy options. Additionally, the Transaction will result in efficiencies and economies for consumers, investors and the public. These benefits are outlined in Item 3(B)(2) of this Application, and are benefits which the Commission has weighed against any concerns about concentration of control it has had in other transactions. See American Electric Power Co., 46 S.E.C. 1299 (1978). For all of these reasons, the Company believes that the Transaction will not result in a concentration of control which is detrimental to the public interest. b. FAIRNESS OF CONSIDERATION. Section 10(b)(2), as applied to the Transaction, provides that the Commission shall approve the Transaction unless it finds that the consideration paid by the Company to the shareholders of Penn Fuel is not reasonable or does not bear a fair relation to the earning capacity of the utility assets underlying the Penn Fuel shares. In its determination as to whether or not consideration for an acquisition meets the fair and reasonable test of Section 10(b)(2), the Commission has considered whether the price was decided as the result of arm's-length negotiations* and whether each party's Board of Directors has approved the purchase price.** The Commission also considers the opinions of investment bankers*** and the earnings, dividends, and book and market value of the shares of the company to be acquired.**** -------------------- * American National Gas Co., 43 S.E.C. 203 (1966). ** Consolidated National Cas Co., 45 S.E.C. 672 (1990). *** Id. **** Northeast Utilities, 42 S.E.C. 963 (1966). Upon consummation of the Transaction, (i) Penn Fuel common stock shareholders would receive between 6.968 and 8.516 shares of the Company Common Stock for each share of Penn Fuel common stock and (ii) holders of Penn Fuel $1.40 Preferred Stock would receive the cash redemption price applicable to their shares, or, at the individual shareholder's option, between 0.682 and 0.833 shares of the Company Common Stock for each share of Penn Fuel $1.40 Preferred Stock. The exact exchange ratio would depend upon the closing price of the Company Common Stock prior to the closing of the Transaction. Based on the applicable exchange ratio, the aggregate value of the consideration to be issued upon consummation of the Transaction is expected to be approximately $121 million. The consideration to be paid by the Company was the result of arm's-length negotiations between the management and financial and legal advisors of the Company and Penn Fuel over a period of several months. The Boards of Directors of each of the Company and Penn Fuel approved the Transaction in meetings held on June 26, 1997 and June 25, 1997, respectively. In addition, nationally-recognized investment banking firms for each of the Company and Penn Fuel have reviewed extensive information concerning the companies and analyzed the respective conversion ratios employing several valuation methodologies. In connection with the approval of the Merger Agreement, (i) the Company's Board of Directors considered the opinion of its financial advisor, Morgan Stanley & Co. Incorporated ("Morgan Stanley"), to the effect that the consideration to be paid by the Company upon consummation of the Transaction is fair to the Company from a financial point of view, and (ii) the Penn Fuel Board of Directors considered the opinion of its financial advisor, First Union Capital Markets ("First Union"), to the effect that the consideration to be received by Penn Fuel common shareholders in connection with the Transaction is fair to such holders from a financial point of view. Each of the fairness opinions of Morgan Stanley and First Union are attached hereto as Exhibits H-1 and H-2, respectively, and incorporated herein by reference. In determining the consideration, the Company examined certain gas companies considered to be comparables as well as the consideration paid in other acquisitions in the gas utility industry. When examined in terms of multiples of earnings ("Earnings Multiple") and book value ("Book Value Multiple"), the consideration to be paid by the Company is reasonable when compared to the consideration offered in comparable acquisitions. Examples of such acquisitions are shown below. BOOK EARNINGS VALUE COMPARABLE COMPANIES MULTIPLE MULTIPLE -------------------- -------- -------- Southwest Gas 17.2x 1.2x Atmos Energy 14.8 2.1 Public Service Co. of NC 13.1 1.8 Connecticut National Gas 12.7 1.3 North Carolina National Gas 12.3 1.9 Connecticut Energy Corporation 12.4 1.4 MEAN 13.8 1.6 PRECEDENT TRANSACTIONS ---------------------- PanEnergy/Duke (11/96) 22.1x 3.2 Pacific Ent./Enova (10/96) 14.9 2.1 NorAm/Houston Industries (8/96) 31.6 2.4 United Cities Gas/Atmos Energy (7/96) 24.1 2.1 ENSERCH/Texas Utilities (4/96) 29.5 -- Washington Energy/Puget Sound (10/95) -- 3.7 Grand Valley Gas/Associated Natural Gas (2/94) 24.7 3.7 MEAN 24.5 2.6 IMPLIED MULTIPLES FOR THIS TRANSACTION 16.0X 1.6X Also significant is that Penn Fuel shareholders, as a result of the Transaction, will receive Company Common Stock which is listed on the NYSE, thus providing the Penn Fuel shareholders with a public market for their securities that they do not have as Penn Fuel shareholders. In addition, the Company's dividend is currently set at $1.67 per share per annum, which is substantially higher than Penn Fuel's current dividend payout, as adjusted for the exchange ratio. Moreover, the stock consideration to be received by Penn Fuel shareholders upon consummation of the Transaction is expected to be tax-free. The Transaction was approved by all of the shareholders of PFG who voted. There were no dissenters. In light of these fairness opinions and considering all relevant factors, the Company believes that the consideration to be paid for the Penn Fuel shares is reasonable and bears a fair relation to the earnings capacity of the utility assets underlying the Penn Fuel shares. Accordingly, the consideration to be paid by the Company meets the standards of Section 10(b)(2). c. REASONABLENESS OF FEES. The Company believes that the overall fees, commissions, and expenses incurred and to be incurred in connection with the Transaction are reasonable and fair in light of the size and complexity of the Transaction relative to other transactions and the anticipated benefits of the Transaction to the public, investors, and consumers; that they are consistent with recent precedent; and that they meet the standards of Section 10(b)(2). As stated at Item 2 above, the Company and Penn Fuel together expect to incur a combined total of approximately $5.3 million in fees, commissions, and expenses in connection with the Transaction. This amount is substantially less than the fees associated with recent transactions approved by the Commission,* and is clearly consistent with the standards of Section 10(b)(2). d. CAPITAL STRUCTURE AND THE PUBLIC INTEREST. Section 10 (b)(3) requires the Commission to determine whether the Transaction will unduly complicate the Company's capital structure or would be detrimental to the public interest, the interests of investors or consumers, or the proper functioning of the Company's system. Following the Transaction, the Company will have a capital structure which is substantially similar to capital structures which the Commission has approved in other orders.** After consummation of the Transaction, the Company will own 100 percent of the shares of Penn Fuel Common Stock, and indirectly will own 100 percent of Penn Fuel's two wholly-owned public utility subsidiaries, PFG Gas and North Penn. All outstanding preferred stock of Penn Fuel will be redeemed for either cash or the Company's Common Stock. Penn Fuel and its subsidiaries may continue to hold their debt, which will have no material effect on the Company's capital structure. The only issued and outstanding voting securities of the Company will be the Company Common Stock. For these reasons, the Company believes that the Transaction will not unduly complicate its capital structure. -------------------- * See TUC Holding Co., supra. (estimated fees and expenses of $37 million); Kansas Power & Light Co., Rel. No. 35-25465 (issued February 5, 1992) (estimated fees and expenses of approximately $30 million); New Century Energies, Inc., Rel. No. 35- 26748 (issued August 1, 1997) (estimated fees and expenses of $23.5 million). ** See, e.g., TUC Holding Co., supra; CINergy Corp., File No. 70-8427, Rel. No. 35-26146 (issued October 21, 1994); Entergy Corp., File No. 70-8059, Rel. No. 35-25952 (issued December 17, 1993). In each of these orders, the Commission approved mergers which resulted in a holding company acquiring 100 percent of a utility operating company's common stock. Set forth below are summaries of the historical capital structures (excluding short-term debt) of the Company and Penn Fuel as of December 31, 1997 and the pro forma consolidated capital structure of the Company as of the same date: The Company and Penn Fuel Historical Capital Structures (In Millions) Company Penn Fuel $ % $ % Long-term debt 2,585 45 46 36 Preferred and preference stock 347 6 11 9 Common equity 2,809 49 71 55 ------------------------ ----- --- --- --- Total Capitalization 5,741 100 128 100 The Company's Pro Forma Consolidated Capital Structure (In Millions) (unaudited) Company $ % Long-term debt 2,631 45 Preferred and preference stock 358 6 Common equity 2,880 49 ------------------------ ----- --- Total Capitalization 5,869 100 The ratio of consolidated common equity to total capitalization of the Company will be, on an unaudited pro forma basis, 49 percent. This figure substantially exceeds the traditionally acceptable ratio of approximately 30 percent. As discussed earlier in Item 1(B)(1), the Company believes that the Transaction, by achieving efficiencies and economies, will benefit the interests of the public, consumers and investors and will not impair the proper functioning of the holding company system. 2. SECTION 10(C). a. SECTION 10(C)(1). Under Section 10(c)(1), the Commission must not approve an acquisition which is "unlawful under the provisions of Section 8" or "detrimental to the carrying out of the provisions of Section 11." Section 8 prohibits an acquisition by a registered holding company of an interest in an electric utility and a gas utility serving substantially the same territory without the express approval of the state commission when state law prohibits or requires approval of the acquisition. Section 8 applies only to registered holding companies and is thus inapplicable to the Transaction. In any event, the Transaction will be consummated only if approval is received from the Pennsylvania PUC. Section 11(b)(1) requires a registered holding company, with limited exceptions, to limit its operations to a "single integrated public-utility system, and to such other businesses as are reasonably incidental, or economically necessary or appropriate to the operations of such integrated public-utility system." Section 2(a)(29) provides separate definitions for "integrated public-utility system" for gas and electric companies. For electric utility companies, the term means: a system consisting of one or more units of generating plants and/or transmission lines and/or distributing facilities, whose utility assets, whether owned by one or more electric utility companies, are physically interconnected or capable of physical interconnection and which under normal conditions may be economically operated as a single interconnected and coordinated system . . . . For gas utilities, the term means: a system consisting of one or more gas utility companies which are so located and related that substantial economies may be effectuated by being operated as a single coordinated system. With respect to either type of company, the system must be confined in its operations to a single area or region, in one or more States, not so large as to impair (considering the state of the art and the area or region affected) the advantages of localized management, efficient operation, and the effectiveness of regulation[.]* -------------------- * For gas companies, utilities deriving natural gas from a common source of supply may be deemed to be included in a single area or region. Section 11(b)(1) permits the acquisition and retention of more than one integrated utility system only if the requirements of Section 11(b)(1)(A)(C) are satisfied. The Commission has consistently recognized that compliance with the standards of Section 11 is not required where the resulting holding company is exempt under Section 3. See, e.g., Gaz Metropolitan, Inc., Holding Co. Act Release No. 26170 (Nov. 23, 1994). In applying Section 10(c)(1) to an exempt holding company, the Commission focuses upon whether the acquisition would be detrimental to the core concerns of Section 11, namely the protection of the public interest and the interests of investors and consumers. WPL Holdings, 49 S.E.C. 761 (1988), aff'd in part and rev'd in part sub nom. Wisconsin Environmental Decade, Inc. v. S.E.C., 882 F.2d 523 (D.C. Cir. 1989) (authorizing combination electric and gas exempt holding company); Dominion Resources Inc., Holding Co. Act Release No. 24618 (Apr. 5, 1988) (noting that the "only question" regarding acquisition of additional gas system is impact on public interest and investors and consumers, and emphasizing that Section 10(c)(1) "would bring Section 11(b)(1) into consideration only if Dominion Resources were not entitled to an exemption"). The Commission has also emphasized that an exempt holding company can acquire utility assets that would not, when combined with the acquiring company's existing utility assets, comply fully with the requirements of Section 11(b)(1), provided there is "de facto integration" of contiguous utility properties.* -------------------- * TUC Holding Co., supra; see also Gaz Metropolitan, Inc., supra. The Transaction is fully consistent with the standards of Section 10(c)(1) as applied to exempt holding companies. The merger will produce a combined enterprise which will better serve the needs of its customers and the interests of its investors by offering energy supply in competitive markets. The Transaction will not impede the ability of the Pennsylvania PUC or the Maryland PSC to carry out their statutory responsibilities with respect to the utility activities of PP&L, North Penn or PFG Gas. As noted above, the Transaction will not be finalized until approval is obtained from the Pennsylvania PUC, and the utility operations of the combined enterprise will continue to be regulated by the Pennsylvania PUC and the Maryland PSC after the merger. The Transaction also fully satisfies the "de facto" integration standard set forth in TUC Holding Co., even though following the merger PP&L and Penn Fuel will remain separate integrated public utility systems. The service territories of the PP&L and Penn Fuel public utility systems are largely located in adjacent or nearby geographic areas and will overlap to some degree. As discussed below, the systems of PP&L and Penn Fuel will be coordinated with respect to a number of operational, administrative, and support functions. Moreover, as noted above, the Transaction will produce a combined entity that will be able to compete more efficiently and effectively in providing energy services to customers. Thus, the Commission should find that the Transaction would not be detrimental to the interest of Section 11, and thereby satisfies the requirements of Section 10(c)(1). b. SECTION 10(C)(2). Section 10(c)(2) requires that the Commission not approve an acquisition unless "the Commission finds that such acquisition will serve the public interest by tending towards the economical and efficient development of an integrated public-utility system." The Commission has interpreted Section 10(c)(2) to permit the approval of acquisitions resulting in more than one integrated system. "[W]e have indicated in the past that acquisitions may be approved even if the combined system will not be a single integrated system. Section 10(c)(2) requires only that the acquisition tend 'towards the economical and the efficient development of an integrated public-utility system.'"* The Commission has held that "where a holding company will be exempt from registration under Section 3 of the Act following an acquisition of non-integrating utility assets, it suffices for purposes of Section 10(c)(2) to find benefits to one integrated system."** -------------------- * Gaz Metropolitan, Inc., 58 S.E.C. Docket 189, 192, Rel. No. 35-26170 (Nov. 23, 1994) (quoting Union Electric Company, 45 S.E.C. 489, 504-06 (1974), aff'd without op. sub nom. City of Cape Girardeau v. SEC, 521 F.2d 324 (D.C. Cir. 1975)). ** TUC Holding Co., supra. In this case, both integrated utility systems will realize a number of benefits from the Transaction. The Transaction will combine two companies with complementary operations and expertise, and provide important strategic, financial and other benefits to the merging companies, shareholders and customers. The Transaction will have a number of operational benefits that will result in economic efficiencies for the Company as a whole and for both integrated utility systems. The Company will experience economies by combining and coordinating operations with Penn Fuel with respect to accounting, finance, information systems, environmental management, gas marketing, and procurement. In addition, the Company expects that the Transaction will result in various direct operational cost reductions. For example, after the Transaction, PP&L and Penn Fuel distribution customers can be served out of common service centers, and separate after-hours answering systems can be consolidated. The operational benefits and efficiencies associated with the Transaction are discussed in detail in the testimony of Scott T. Jones, Paul T. Champagne, and John J. Hilyard, Jr., submitted in conjunction with the Application of PP&L, PFG Gas, and North Penn before the Pennsylvania PUC (Docket Nos. A-1206SOF0006, A- 1220SOF0003) (attached as Exhibit D-2). The Company estimates that approximately $5.9 million in annual savings will result from the integration of the merging companies' operations. These synergies will result from reductions of corporate administration and executive management, and elimination of the Penn Fuel Board of Directors (estimated annual savings of $4 million); reduced costs associated with procurement and other operations support functions ($1 million annual savings); and savings from consolidation of Penn Fuel's answering services into the Company's call center ($890,000 annual savings). The Transaction will also allow the Company to offer a greater range of services to customers, making it more competitive, and will provide significantly increased financial and other resources to Penn Fuel's integrated gas utility system, making it better able to meet customer needs. See Exhibit D-2. Although the amount of such benefits cannot be specifically quantified, the Commission has recognized that "specific dollar forecasts of future savings are not necessarily required; a demonstrated potential for economies will suffice even when these are not precisely quantifiable." Centerior Energy Corp., Rel. No. 35-24073 (issued April 29, 1986). The Commission has previously found that similar benefits satisfied the affirmative finding required under Section 10(c)(2). See, e.g., Union Electric Company, supra, 45 S.E.C. at 494 (provision of substantial resources made available by acquiring entity to acquired company demonstrated "efficiencies and economies by virtue of the affiliation"); WPL Holdings, Inc., 50 S.E.C. 233, 237 (1990) (benefits supporting Section 10(c)(2) finding include "[a] structure that could more effectively address the growing national competition in the energy industry, refocus various utility activities, facilitate selective diversification into non-utility business . . . and provide additional flexibility for financing . . ."). Accordingly, the Commission should find that the requirements of Section 10(c)(2) are satisfied with regard to the Transaction. 3. SECTION 10(F) -- COMPLIANCE WITH STATE REQUIREMENTS. To approve an acquisition, the Commission is required, under Section 10(f), to find that the acquisition has complied with all applicable state laws. The Transaction is expressly conditioned on receipt of all required regulatory approvals, including that of the Pennsylvania PUC. The Company filed an Application with the Pennsylvania PUC, a copy of which is filed as Exhibit D-1 hereto, and a copy of the Pennsylvania PUC's July 24, 1998 order approving the Application is attached as Exhibit D-3. The Maryland PSC has determined not to exercise jurisdiction over the Transaction in the absence of any material changes affecting Maryland aspects of the Transaction. (See Exhibit D-4). C. SECTION 3(A)(1). The Company believes that, following consummation of the Transaction, it and each of its subsidiary companies will be entitled to exemption under Section 3(a)(1) from all provisions of the Act (except for Section 9(a)(2) thereof).* Section 3(a)(1) authorizes the Commission to exempt any holding company: if such holding company, and every subsidiary company thereof which is a public-utility company from which such holding company derives, directly or indirectly, any material part of its income are predominantly intrastate in character and will carry on their businesses substantially within a single State in which such holding company and every such subsidiary company thereof are organized. Following the Transaction, the Company and each of its public utility subsidiaries will be organized in Pennsylvania. Each such public utility subsidiary will also earn all of its utility income in Pennsylvania with the exceptions of PFG Gas, which earns approximately 99% of its utility revenues in Pennsylvania, and Safe Harbor, which contributes only a de minimis amount of revenues to the Company. -------------------- * Following the transaction, PP&L will continue to meet the requirements for exemption under Section 3(a)(2), and Penn Fuel will continue to meet the requirements for an exemption under Section 3(a)(1). Under such circumstances, the Company will qualify as an exempt holding company, "unless and except insofar as [the Commission] finds the exemption detrimental to the public interest or the interest of investors or consumers . . . ." As discussed in Item 1(B)(1), the Company believes that the Transaction will result in efficiencies and economies which will benefit the interest of the public, investors and consumers. As noted above, the combination of electric and gas utility business resulting from the Transaction raises no public interest concerns. Therefore, the Company believes it is qualified for the Section 3(a)(1) exemption upon consummation of the Transaction, and requests an order from the Commission granting such exemption. ITEM 4. REGULATORY APPROVAL. The Transaction is conditioned on approval by the Pennsylvania PUC, which must approve the transfer of ownership of Penn Fuel to the Company through the Transaction. An Application seeking the Pennsylvania PUC's approval was filed with the Pennsylvania PUC on August 7, 1997. On July 24, 1998 the Pennsylvania PUC approved the Application, finding that the merger is necessary or proper for the service, accommodation, convenience or safety of the public. (The Pennsylvania PUC order is attached as Exhibit D-3.) The Transaction is also subject to the expiration or termination of the 30-day waiting period under the HSR Act and no action having been instituted by the DOJ or the Federal Trade Commission ("FTC") that is not withdrawn or terminated prior to the effective time of the Transaction. The HSR Act, and the rules and regulations thereunder, provide that certain merger transactions (including the Transaction) may not be consummated until required information and materials have been furnished to the DOJ and the FTC and certain waiting periods have expired or been terminated. On October 7, 1997, Penn Fuel and the Company made their respective filings with the DOJ and the FTC. On October 24, 1997, the DOJ granted early termination of the waiting period with respect to the Transaction. A Penn Fuel subsidiary, PFG Gas, has less than 300 customers in the State of Maryland. The Maryland PSC has been duly notified of the proposed transfer by merger, but has determined not to institute any proceedings on the matter at this time. (See Exhibit D-4). It is the Company's understanding that the Maryland PSC will not exercise jurisdiction over the Transaction, provided that no material changes affecting Maryland aspects of the Transaction will have occurred since the issuance of the Maryland PSC's determination. The Company believes that there is no likelihood that the Maryland PSC will institute proceedings concerning the Transaction. (See Exhibit F-3). Except as set forth above, no other state or federal agency has jurisdiction over the transactions described herein. ITEM 5. PROCEDURE. The Commission is respectfully requested to issue and publish not later than February 6, 1998 the requisite notice under Rule 23 with respect to the filing of this Application, such notice to specify a date not later than March 6, 1998 by which comments may be entered and a date not later than March 9, 1998 as a date after which an order of the Commission granting and permitting this Application to become effective may be entered by the Commission. It is submitted that a recommended decision by a hearing or other responsible officer of the Commission is not needed for approval of the proposed Transaction. The Division of Investment Management may assist in the preparation of the Commission's decision. There should be no waiting period between the issuance of the Commission's order and the date on which it is to become effective. ITEM 6. EXHIBITS AND FINANCIAL STATEMENTS. a. EXHIBITS. Tab A-1 Articles of Incorporation of the Company (incorporated by reference to Exhibit B to the Proxy Statement of PP&L and Registration Statement of the Company, dated March 9, 1995) (previously filed) . . . . . . . . . . . . . . . . . . . . . 1 A-2 By-Laws of the Company (incorporated by reference to Exhibit 3.2 to the Company's Registration Statement No. 33-5794) (previously filed). . . . . . . . . . . . . . . 2 A-3 Articles of Incorporation of Penn Fuel (previously filed). . 3 A-4 By-Laws of Penn Fuel (previously filed). . . . . . . . . . . 4 B-1 Agreement and Plan of Merger (filed as Annex I to the Registration Statement of the Company on Form S-4, filed on August 13, 1997, File No. 333-33565, and incorporated herein by reference) (previously filed) . . . . 5 C-1 Registration Statement of the Company on Form S-4 (filed on August 13, 1997, as amended to date (File No. 333-33565) and incorporated herein by reference) (previously filed). . . . . . . . . . . . . . . . 6 D-1 Application to the Pennsylvania PUC, dated August 7, 1997 (previously filed). . . . . . . . . . . . . . . . . . . 7 D-2 Direct Testimony of Scott T. Jones, Paul T. Champagne, and John J. Hilyard, Jr. submitted to the Pennsylvania PUC (previously filed). . . . . . . . . . . . . 8 D-3 Determination of Pennsylvania PUC. . . . . . . . . . . . . . 9 D-4 Letter of Executive Secretary, Maryland Public Service Commission . . . . . . . . . . . . . . . . . . . . . 10 E-1 Map of PP&L's service territory (previously filed) . . . . . 11 E-2 Map of PFG Gas service territory (previously filed). . . . . 12 E-3 Map of North Penn service territory (previously filed) . . . 13 E-4 Map showing the overlap of the service territories of PP&L with those of PFG Gas and North Penn (previously filed) . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 F-1 Opinion of Counsel . . . . . . . . . . . . . . . . . . . . . 15 F-2 Past Tense Opinion of Counsel [to be filed by amendment] . . . . . . . . . . . . . . . . . . . . . . . . . 16 F-3 Supplemental Opinion of Counsel. . . . . . . . . . . . . . . 17 G-1 The Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1997 (filed on March 3, 1998 (File No. 1-11459) and incorporated herein by reference). . . . . . . . . . . . . . 18 G-2 Penn Fuel's Annual Report to Shareholders for the fiscal year ended December 31, 1997. . . . . . . . . . . . . 19 H-1 Opinion of Morgan Stanley & Co., Incorporated (previously filed) . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 H-2 Opinion of First Union Capital Markets (previously filed) . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 I-1 Proposed Form of Notice (previously filed) . . . . . . . . . 22 b. FINANCIAL STATEMENTS. FS-1 Company Consolidated Balance Sheet as of December 31, 1997 (previously filed with the Commission in the Company Annual Report on Form 10-K for the year ended December 31, 1997 (Exhibit G-1 hereto), filed on March 3, 1998, File No. 1-11459, and incorporated herein by reference) . . . . . . . . . . . . . 23 FS-2 Company Consolidated Statement of Income for the 12 months ended December 31, 1997 (previously filed with the Commission in the Company Annual Report on Form 10-K for the year ended December 31, 1997 (Exhibit G-1 hereto), filed on March 3, 1998, File No. 1-11459, and incorporated herein by reference) . . . . . . . . . . . 24 FS-3 Penn Fuel Consolidated Balance Sheet as of December 31, 1997 (included in Penn Fuel Annual Report to Shareholders, Exhibit G-2 hereto at pp. 14-15) . . . . . . . 25 FS-4 Penn Fuel Consolidated Statement of Income for the 12 months ended December 31, 1997 (included in Penn Fuel Annual Report to Shareholders, Exhibit G-2 hereto, at p. 16 and incorporated herein by reference) . . . 26 FS-5 Pro Forma Combined Financial data for the Company and Penn Fuel (previously filed with the Commission in the Registration Statement of the Company on Form S-4 (Exhibit C-1 hereto), filed on August 13, 1997, as amended to date (File No. 333-33565) and incorporated herein by reference) (previously filed) . . . . . . . . . . . . . . . . . . . . . 27 ITEM 7. INFORMATION AS TO ENVIRONMENTAL EFFECTS. The Company believes that the Transaction will not involve major federal action significantly affecting the quality of the human environment as those terms are used in Section 102(2)(C) of the National Environmental Policy Act, 42 U.S.C. Section 4321 et seq. ("NEPA"). First, no major federal action within the meaning of NEPA is involved. Second, consummation of the Transaction will not result in changes in the operations of the subsidiaries of the Company or Penn Fuel that would have any significant impact on the environment. To the Company's knowledge, no federal agency is preparing an environmental impact statement with respect to this matter. SIGNATURE Pursuant to the requirements of the Public Utility Holding Company Act of 1935, the undersigned company has duly caused this Amendment No. 1 to the Application previously filed herein to be signed on its behalf by the undersigned thereunto duly authorized. PP&L RESOURCES, INC. By: /s/ Robert J. Grey Date: 08/13/98 ------------------------------ -------- Name: Robert J. Grey ------------------------------ Title: Senior Vice President, General Counsel and Secretary ------------------------------ EX-99.1 2 EXHIBIT D-3 PENNSYLVANIA PUBLIC UTILITY COMMISSION HARRISBURG, PA 17105-3265 PUBLIC MEETING HELD JULY 23, 1998 Commissioners Present: John M. Quain, Chairman Robert K. Bloom, Vice Chairman David W. Rolka Nora Mead Brownell Aaron Wilson, Jr. In Re: Application of Pennsylvania Power & Light Company, PFG Gas, Inc., and North Penn Gas Company for a A-120650F0006 certificate of public convenience evidencing Commission approval A-122050F0003 of the transfer from Penn Fuel Gas, Inc., to PP&L Resources, Inc., control of all property of Penn Fuel Gas Inc.'s public utility subsidiaries, PFG Gas, Inc., and North Penn Gas Company which is used or useful in the public service OPINION AND ORDER BEFORE THE COMMISSION: Before the Commission for consideration are the Initial Decision (I.D.) of Administrative Law Judge (ALJ) Richard M. Lovenwirth, issued May 13, 1998, and Exceptions filed thereto by Applicants, Pennsylvania Power and Light Company (PP&L), PFG Gas, Inc. (PFG) and North Penn Gas Company (North Penn) (collectively Applicants), on June 2, 1998. BACKGROUND (1) A description of the parties to the instant transaction is provided. - -------- 1 The Background is adapted from the Exceptions of the Applicants. PP&L RESOURCES, INC. PP&L Resources, Inc., (PP&L Resources) a public utility holding company, was organized in 1995, in conjunction with a restructuring of the PP&L corporate system. The Commission approved the reorganization in an Order entered on February 10, 1995, at Docket No. A-110500, F.206. As a result of the restructuring of the PP&L Corporate system, PP&L Resources owns all of the common stock of PP&L, a regulated electric utility which is one of the Applicants in this proceeding. The stock of PP&L Resources is widely held and is traded on the New York Stock Exchange. (PP&L/Penn Fuel Exhibit No. 1, pp. 2-3). PP&L PP&L is a Pennsylvania corporation organized in 1920, which provides electric public utility service in central and eastern Pennsylvania. PP&L serves approximately 1.2 million customers in a 10,000 square mile service territory in 29 counties of Pennsylvania, subject to the Commission's regulatory jurisdiction. (PP&L/Penn Fuel Exhibit No. 1, pp. 3-4). PP&L has recently had approved a restructuring plan, filed consistent with the Electricity Generation Customer Choice and Competition Act, 66 Pa. C.S. section 2806(d). See Application of Pennsylvania Power --- & Light Company for Approval of a Restructuring Plan Under Section 2806 of the Public Utility Code, Docket No. R-00973954 (Order entered June 15, 1998). PENN FUEL GAS, INC. Penn Fuel Gas, Inc (Penn Fuel) is a Pennsylvania corporation which owns all of the common stock of two subsidiaries, PFG and North Penn, each of which provides gas service subject to Commission jurisdiction. In addition to owning public utility subsidiaries, Penn Fuel sells propane to approximately 28,000 customers. Penn Fuel, since it was organized in 1944, has been a family-owned business. (Statement JJH-1, p.4).(2) - -------- 2 Although Penn Fuel is controlled by one family, a small minority of shares are owned by unrelated minority shareholders. PFG PFG provides gas sales and transportation services in portions of 27 Pennsylvania counties and in a small portion of northern Maryland. PFG owns and operates numerous local gas distribution systems that are dispersed throughout central, southern and eastern Pennsylvania. (PP&L/Penn Fuel Exhibit No. 1, p. 4). NORTH PENN North Penn owns and operates two local distribution systems, one in northwestern Pennsylvania and one in north central Pennsylvania. North Penn provides gas sales, transportation and storage services in ten counties in northern and northwestern Pennsylvania. (PP&L/Penn Fuel Exhibit No. 1, pp. 4-5). This proceeding involves an Application by PP&L, PFG Gas, Inc. and North Penn Gas Company for certificates of public convenience evidencing the Commission's approval, under Section 1102(a)(3) of the Public Utility Code, 66 Pa. C.S. section 1102(a)(3), as interpreted by the Commission's Statement of Policy on Utility Stock Transfers. 52 Pa. Code section 69.901. Pursuant to the Application filed in this matter, said Applicants seek the approval of the transfer from Penn Fuel Gas, Inc. to PP&L Resources, by merger, of the title to, or the possession or use of, all of the property of Penn Fuel's subsidiaries, PFG and North Penn, that is used or useful in the public service. See Paragraph No. 10, pp. 5-6 of the Application. --- As a result of the proposed transaction, Penn Fuel would cease being a family-controlled, comparatively small public utility holding company and is becoming a wholly-owned subsidiary of PP&L Resources, a publicly-held public utility holding company with its principal subsidiary PP&L, a regulated electric utility. (Applicants Exc., p. 1). Penn Fuel would thus become a direct or first-tier subsidiary of PP&L Resources. PFG and North Penn would remain subsidiaries of Penn Fuel and thereby become second-tier subsidiaries of PP&L Resources. (Id.). --- The principal parties to the transaction are PP&L Resources, Keystone Merger Corporation (Keystone), a newly-formed, wholly-owned subsidiary of PP&L, Penn Fuel, and Penn Fuel's wholly owned subsidiaries, PFG and North Penn. HISTORY OF THE PROCEEDINGS (3) On August 7, 1997, Applicants filed with the Commission an application for a certificate of public convenience evidencing the Commission's approval, under Section 1102(a)(3) of the Public Utility Code, of the transfer from current stockholders of Penn Fuel Gas, Inc. (Penn Fuel) to PP&L Resources, Inc. (PP&L Resources), all of Penn Fuel's common and preferred stock. See Paragraph 10, pp. 5-6 of the Application, which is --- PP&L/Penn Fuel Exhibit No. 1. - -------- 3 The History of Proceedings is adapted in large part from the Initial Decision. ALJ Lovenwirth noted that the caption of the proceeding fails to accurately describe the transaction(s) for which Commission approval is sought by the instant Application. Notice of the Application was published in newspapers of general circulation in the Applicants' service territories, once each during the weeks of September 1, 1997, and September 8, 1997. The Applicants filed proofs of publications of such notice on October 2, 1997. (I.D., p. 5). In addition, notice of the Application was published at 27 Pa. Bulletin No. 37, p. 4799 (September 13, 1997). ------------------- - ----------- On September 19, 1997, NE Hub Partners, L.P. (NE Hub) filed a Petition to Intervene and a Protest on September 29, 1997. This Protest was subsequently withdrawn by letter of its counsel dated April 28, 1998. In said April 28, 1998 letter, counsel indicated that subsequent to the filing of its Briefs, representatives of NE Hub met with representatives of PP&L and discussed issues related to the merger. Based on these discussions, NE Hub withdrew its objections to the proposed merger. Donald R. Williams, as agent for B.M. Davies, filed a Protest on ------------------------ September 18, 1997. Mr. Williams indicated at a prehearing conference that he saw no further purpose in his participation in these proceedings due to the ruling of the presiding ALJ that he could only participate in his capacity as a fiduciary. (I.D., p. 6, n. 6). Mr. Williams was thereafter served with notice of the scheduled hearings and of the Interim Orders of the presiding ALJ, including the briefing schedule, but never again participated in the proceedings. (Id. citing N.T., pp. 11-16). --- Consequently, his protest was dismissed for lack of prosecution. Wayne T. Stephens filed a Protest on September 25, 1997. UGI Utilities, Inc. filed a Petition to Intervene on September 29, 1997, which was granted. Subsequent to its intervention, UGI Utilities, Inc. did not participate in these proceedings. A telephonic prehearing conference was held on December 1, 1997, where certain preliminary rulings were made and a procedural schedule was established. Also, a Protective Order was issued by Order of January 22, 1998. A hearing was convened in Scranton, Pennsylvania on March 3, 1998. Applicants presented their prefiled written testimony and related exhibits of three witnesses as their case-in-chief and the testimony of four witnesses and related exhibits in rebuttal.(4) Mr. Stephens presented prefiled written testimony and also testified on his own behalf (N.T. 65-74). All witnesses were present at the hearing and available for cross examination. The transcript of the proceedings consists of 276 typewritten pages. (I.D., p. 7). On May 13, 1998, the Initial Decision was issued. ALJ Lovenwirth recommended that the Application be granted. The Recommended Ordering Paragraphs are reprinted below: 1. That the joint application of PP&L, Inc., PFG Gas, Inc., and North Penn Gas Company filed on August 7, 1997, at docket numbers A-120650F0006 and A-122050F0003 be and is hereby approved, and certificates of public convenience be issued to said applicants which, in summary, will authorize and/or ratify the following transactions: - -------- 4 As part of its Withdrawal of Protest filed on April 28, 1998, NE Hub moved that its evidence be stricken from the record. The ALJ granted that motion, excepting, however, certain portions of the N.T. at pages 238 and 239, which recorded a colloquy between the presiding ALJ and the witness. (I.D., p. 7, n. 8). a. PP&L Resources has organized a new Pennsylvania corporation, Keystone, as a wholly-owned subsidiary. b. Keystone will be merged into Penn Fuel; Penn Fuel will be the surviving corporation, and Keystone will cease to exist. c. Following the merger, the officers, directors, corporate charter and bylaws of Keystone prior to the merger will become the officers, directors, corporate charter and bylaws of the surviving corporation, Penn Fuel. d. In the merger, the outstanding shares of common stock of Penn Fuel will be converted into the right to receive shares of common stock of PP&L Resources. Penn Fuel's preferred stock, at the option of each preferred stockholder, may be redeemed for cash or converted into the right to receive shares of common stock of PP&L Resources. Following the acquisition of Penn Fuel by PP&L Resources, no preferred shares of Penn Fuel will remain outstanding. e. Immediately after the acquisition, Penn Fuel will continue to exist as a wholly-owned subsidiary of PP&L Resources, and PFG and North Penn will continue to exist and to own and operate their present facilities. 2. That approval of the joint application referenced in ordering paragraph one shall not abrogate the need for any necessary approvals of other regulatory authorities, including but not limited to The Federal Securities and Exchange Commission, the Federal Energy Regulatory Commission, the public utility regulatory body of the State of Maryland (where PFG provides public utility service), and the public utility regulatory body of the State of New York (where North Penn may provide public utility service). 3. That the protests of Donald R. Williams (acting as agent for B.M. Davies) and Wayne T. Stephens be and are hereby DISMISSED, without prejudice, i.e., any cause of action which said protestants may have against the applicants which are unrelated to the issues attendant upon this application proceeding will not be barred by virtue of this Order. 4. That all Orders previously issued by this Commission or by any other governmental agency which impose past or present liabilities or penalties upon any of the parties to this transaction shall be satisfied prior to the issuance of certificates of public convenience. 5. That PP&L, PFG Gas, North Penn, PP&L Resources, Penn Fuel, and Keystone shall comply fully with Chapter 21 of the Public Utility Code (66 Pa. C.S.A. 2101 et. seq.) (other --------------------------- than for those affiliated interest transactions which have been approved by these ordering paragraphs). Said parties shall comply with all sections of the Public Utility Code and this Commission's regulations, including 66 Pa. C.S.A. ------------- section 1506, so as to facilitate full employment by this ------------ Commission of 66 Pa. C.S.A. section 508. ------------------------- 6. NE Hub's motion that its evidence be stricken from the record is hereby granted, excepting, however, that the portion thereof appearing upon pages 238 and 239 of the transcript, which recorded the colloquy between the presiding judge and the witness, will be preserved. (I.D., pp. 37-40). The Exceptions of the Applicant were received June 2, 1998. The Exceptions are in the nature of objections to certain dicta in the Initial Decision, and objections to alleged overbreadth on Recommended Ordering Paragraph No. 4. DISCUSSION ALJ Lovenwirth reached 29 Findings of Fact and 6 Conclusions of Law. Those Findings of Fact and Conclusions of Law are incorporated by reference herein and are adopted. The pertinent Findings of Fact are set forth, below: * * * 9. The sole remaining protestant is these proceedings is one Wayne T. Stephens, an individual who resides at 2605 Appel Street S.W., Allentown, Pennsylvania 18103, and also at Box 31, R.D. 2, Coudersport, Pennsylvania 16915, which latter address is the subject matter of his protest, which brings into focus four matters (Stephens Hearing Statement 1 and N.T. 65 - 74), to wit: (1) that North Penn terminated the supply of "free gas" that had been initiated pursuant to a gas lease executed between a corporate predecessor of North Penn and a predecessor in title of Mr. Stephens in 1900, (2) that North Penn had not been willing to consider Mr. Stephens' claim for damages to his property approximately 12 years ago resulting from the freezing of certain water lines, (3) that North Penn was plugging certain wells, and (4) that North Penn had not removed all of its facilities from Mr. Stephens' property. 10. The flow of "free gas" to Mr. Stephens' premises originated pursuant to a lease dated December 18, 1900, between R.C. Stearns and Potter Gas Company, a predecessor of North Penn. Under that lease, however, North Penn had the right to surrender the lease at any time and thereafter to be relieved of all obligations under the lease, including the obligation to supply free gas (Statement JJH-2, pp. 9-10). There had been two wells on Mr. Stephens' property. One was abandoned in 1969. The second one was abandoned in 1996. When the last of the wells on Mr. Stephens' property was abandoned, North Penn surrendered the lease pursuant to its terms and terminated the flow of "free gas". 11. The damages to Mr. Stephens' home occurred approximately 12 years ago (JJH-2, p. 11). Mr. Stephens' claim was turned over to North Penn's liability insurance carrier for review. The insurance carrier determined, following review, that North Penn was not responsible for the damage. Thereafter, Mr. Stephens brought a legal action against North Penn seeking compensation for the damage. Mr. Stephens' attorney later discontinued the legal action and withdrew the claim against North Penn (Tr. 78-79). 12. North Penn explained why it is in the process of abandoning and plugging a large number of its natural gas wells. Pursuant to an order and agreement with the Department of Environmental Protection dated March 27, 1996, North Penn is required to plug approximately 24 old, non-productive wells per year until a total of 342 wells have been plugged. The wells are being plugged in order for North Penn to comply with applicable environmental regulations (St. JJH-2, pp. 12- 13). Mr. Stephens expressed also concern about the presence of certain facilities on his property. As North Penn has explained, North Penn's facilities on this property remain there pursuant to easements signed by Mr. Stephens' predecessors in title (Statement JJH-2, pp. 11- 13). 13. If the Commission approves the merger and issues appropriate certificates of public convenience, Penn Fuel Gas, Inc., a holding company owned primarily by one family, will become a wholly-owned subsidiary of PP&L Resources. No change of service or change of service territory is contemplated in these proceedings. Regardless of whether the Commission issues the appropriate certificates of public convenience, PP&L, PFG and North Penn will continue to provide services as they do presently in their present service territories to their present customers. 14. The Applicants' fitness to provide service is demonstrated most clearly by the fact that they have been rendering service in their present service territories for extended period of times. Further, the need for public utility service is demonstrated most readily by the fact that service is being provided presently to many customers. 15. All three Applicants have a demonstrated ability to provide the public utility services that they provide presently, and approval of the application and issuance of appropriate certificates of public convenience would not diminish their ability to provide service in their existing service territories. 16. Among the efficiencies arising from the merger will be Penn Fuel's ability to raise capital as part of the PP&L corporate system far more efficiently than as an independent corporate system. Efficiencies will arise with regard to equity, long-term debt and short-term debt. 17. Penn Fuel is a relatively small, family-controlled corporation, whose stock is not actively traded. Prior to the merger, Penn Fuel did not issue stock to the public in order to maintain family control of the business. Consequently, its sole means of raising equity capital was to retain earnings. In contrast, there is an active market for the stock of PP&L Resources; its stock is traded publicly on the New York Stock Exchange. PP&L Resources is included in the Standard & Poor's ("S&P") 500 Composite Index and the S&P Public Utilities. PP&L Resources is well known in financial markets. Statement JJH-1, p.4. * * * 20. Penn Fuel will benefit by approval of the application also with regard to short-term debt. Penn Fuel, on a stand alone basis, is simply too small to issue commercial paper (Statement JJH-2, p.5). Instead of using commercial paper to raise short-term debt, Penn Fuel relies upon lines of credit with three commercial banks. Because bank lines of credit are more costly than commercial paper, Penn Fuel pays more for bank borrowings than it would if it were able to issue commercial paper (Statement JJH-2, p. 5) (footnote omitted). Following the merger, Penn Fuel will be able to obtain short term funds through the issuance of commercial paper by the PP&L corporate system at a cost lower than Penn Fuel could obtain alone. 21. The merger will also create opportunities to combine operations. An example of operational savings is the future combination of the billing systems. Penn Fuel's own facilities for billing customers will be eliminated. In the future, bills for service furnished by Penn Fuel and its subsidiaries will be prepared by PP&L (Statement JJH-1, p.7). By this procedure, PP&L's fixed cost of preparing and printing bills will be spread over a larger customer base and number of bills, thereby reducing fixed costs per bill. * * * 25. Another function in which the merger will produce savings is procurement. Savings will result from elimination of positions and leveraging of PP&L's existing transportation network. In addition, certain warehouses will be eliminated. Using PP&L's transportation system to support delivery of Penn Fuel's supplies will not materially increase PP&L's costs, but use of PP&L's network will reduce significantly Penn Fuel's costs. Penn Fuel will also be able to utilize the substantial central warehouses of PP&L located in Humboldt and Harrisburg. Such utilization of central warehouse facilities also will produce cost savings (Statement TJM-1, p.5). Further, merging the two procurement functions into one will create cost saving opportunities by consolidating buying power and utilizing volume purchasers to obtain quantity discounts and by having one entity, instead of two, involved in developing single source suppliers and supplier relationships Statement TJM-1, p.5). 26. In the future, it may also be possible for PP&L and PFG to use one company's real estate holdings for construction of the other's electrical or pipeline facilities. Duplicate use of existing real estate holdings can be used to reduce future capital costs (Statement STJ-1, p.10). 27. Each merging entity, Penn Fuel and PP&L Resources, presently maintains a complete capability of providing all services necessary to conduct operations and meet all obligations and requirements placed upon each corporate system. When these two corporate systems are combined, inevitably, many of the functions in one of the corporate systems duplicate a function in the other corporate system. Following the merger, such duplication or redundancy can be eliminated, thereby reducitng costs (Statement STJ-2, P. 17). Further savings will be achieved from consolidation of other corporate functions. For example, following the merger Penn Fuel will no longer maintain an independent Board of Directors. Present senior managers of the PP&L corporate system will serve as directors of Penn Fuel. Thus, the costs of maintaining a separate, independent Board of Directors for Penn Fuel will be eliminated (Statement JJH-1, p.8; Statement TJM-1, p.5). 28. Penn Fuel's largest single expense presently is the cost of gas purchased for resale to customers. The merger will create opportunities for Penn Fuel and PP&L to cooperate in gas procurement. Acquisition of Penn Fuel will provide certain benefits to PP&L. By acquiring Penn Fuel, a source of gas supply, PP&L will improve supply security (Statement STJ-2, pp. 18-19). Further, by having an affiliate in the natural gas business, PP&L will gain increased In-house (sic) knowledge of gas costs which should improve the combined system's ability to negotiate favorable contract terms with natural gas suppliers (Statement STJ-2, p. 19-20)... 29. The granting of this application is not likely to result in anticompetitive or discriminatory conduct, including the unlawful exercise of market power, which will prevent retail electricity customers in this Commonwealth from obtaining the benefits of a properly functioning and workable competitive retail electricity market. (I.D., pp. 12-22) (Certain text omitted). A. THE STEPHENS PROTEST In his statement and testimony, Mr. Stephens expressed concerns about North Penn. His concerns were that North Penn terminated the supply of "free gas" that had been initiated pursuant to a gas lease executed between a corporate predecessor of North Penn and a predecessor in title of Mr. Stephens in 1900; (2) that North Penn had not been willing to consider Mr. Stephens' claim for damages to his property approximately 12 years ago resulting from the freezing of certain water lines; (3) that North Penn was plugging certain wells; and (4) that North Penn had not removed all of its facilities from Mr. Stephens' property. The claims raised by Mr. Stephens' Protest have been the subject of substantial correspondence between various counsel representing Mr. Stephens and North Penn. (I.D. p. 22 quoting Applicants' Main Brief). Concerning the claim involving "free gas" to Mr. Stephens' premises, North Penn asserts that when the last of two wells was abandoned, it surrendered the lease pursuant to its terms and terminated the flow of "free gas". Concerning Mr. Stephens' claim for damages resulting from water damage following freezing of water pipelines, on review of its files, North Penn indicated that the damages to Mr. Stephens' home occurred approximately 12 years ago (JJH-2, p. 11). The claim was turned over to North Penn's liability insurance carrier for review. The insurance carrier determined, following review, that North Penn was not responsible for the damage. Thereafter, Mr. Stephens brought a legal action against North Penn, which action was discontinued and withdrawn. (N.T. pp. 78-79). North Penn also explained why it is in the process of abandoning and plugging a large number of its natural gas wells. This was done, explained North Penn, pursuant to an order and agreement with the Department of Environmental Protection dated March 27, 1996. North Penn is, thereby, required to plug approximately 24 old, non-productive wells per year until a total of 342 wells have been plugged. The wells are being plugged in order for North Penn to comply with applicable environmental regulations. (St. JJH-2, pp. 12-13). In summary, the Applicants stated that "whatever claims Mr. Stephens may have against North Penn will not be prejudiced by the merger. Mr. Stephens will still be able to bring any action that is in his opinion appropriate against North Penn following the merger." (I.D., p. 24, quoting Applicants' Main Brief) APPLICANTS' EXCEPTION NO. 1 In Exception No. 1, Applicants state "the ALJ, Sua Sponte, Concluded Incorrectly in Dicta that Landowners' Retention of a Portion of Their own Natural Gas, Produced by Lessee Utilities Pursuant to a Natural Gas Lease, Is Utility Service for Which Tariff Rates Must Be Imposed." The above-cited exception is related to the ALJ's consideration of the Protest of Mr. Stephens. Specifically, at note 14 of page 23 of the Initial Decision, the ALJ stated: Although not cited by Applicants in their said brief, there is a principle of law which states that a public utility must charge for its product and services that which is set forth in its approved tariff, even though it had previously agreed to supply same "free of charge" in a prior contract between the public utility and its ratepayer. See Brockway Glass Company v. Pa. ----------------------------- P.U.C., 63 Pa Cmwlth 238, 437 A.2d 1067 (1981); Delph v. Pa. ------ ------------ P.U.C., 46 Pa. Cmwlth 552, 406 A.2d 1209 ((1979); LaPenna v. ------ ---------- Keystone Water Co.- Bangor District, Commission Order entered ----------------------------------- November 3, 1982 at C-822936 (which adopted the Initial Decision of the ALJ); and Kearney v. Pa. American Water Company, ------------------------------------- Commission Order entered June 1, 1995 (which adopted the Initial Decision of the ALJ). The Applicants note the issue of whether Mr. Stephens' retention of his gas for "free" under the old natural gas lease was utility service was not raised by any party and was not addressed in the evidence. (Applicants Exc., p.4). However, the Applicants are concerned that the presiding ALJ misunderstood the nature of the relationship between the landowner and North Penn under the natural gas lease. (Exc., p.6). As a result, argues Applicants, the cases relied upon by the presiding ALJ are cases which involved attempts to vary rates for electric utility service from the rates specified in the utilities' tariffs. Therefore, they argue, these cases have no application to North Penn's gas leases under which landowners retain their own natural gas. (Id.). --- Applicants cite Pa. PUC v. T.W. Phillips Gas & Oil Company, 19 Pa. P.U.C. 22 (1938), and Kepple v. Appollo Gas Co., Docket No. C-00934744 (Order entered July 25, 1994), for the proposition that "free gas" provisions which are found in North Penn's leases are widely used and a determination by this Commission that the retention by the landowners of their own gas constitutes utility service would, effectively, revise numerous gas leases across large portions of Pennsylvania involving many landowners and natural gas companies. (Exc., pp. 6-7). ANALYSIS On consideration of the Applicant's Exception No. 1, we shall grant said Exception only to the extent that the statement of the presiding ALJ is mere dicta, is not material to disposition of the issues relating to our approval of the proposed merger herein, and has no record support. In Appollo Gas Co. v. Fred A. Heilman, et al., Docket No. C- 00924405 (Order entered March 10, 1994), we extensively discussed our jurisdiction over "free gas" lease provisions. Further, in Kepple, we discussed the doctrine of "wasteful consumption." Under this doctrine, a utility could declare gas reserved for the landowners' use wasteful and, therefore, impose a charge. Otherwise, gas which had not been devoted to the public and would not have any potential for discrimination, is gas over which the Commission would not exercise jurisdiction. Such determinations are not material to the proceeding, and are not supported by evidence of record. Therefore, we shall grant the Exception of Applicants and strike this portion of the discussion of the ALJ. B. APPLICANTS' EXCEPTION NO. 2 TO ORDERING PARAGRAPH NO. 4 The Applicants object to Ordering Paragraph No. 4 of the Initial Decision which states: That all Orders previously issued by the Commission or by any other governmental agency which impose past or present liabilities or penalties upon any of the parties to the Transaction shall be satisfied prior to the issuance of certificates of public convenience. (I.D., p. 39). The Applicants argue that this paragraph is overly broad and unsupported by the record evidence. The Applicants question whether the phrase "other governmental agencies" as utilized by the ALJ in this ordering paragraph would include local highway and building inspectors, the Internal Revenue Service, other state and local taxing authorities, the Department of Environmental Protection, etc. According to the Applicants, no evidence was presented suggesting that the Applicants might have unsatisfied penalties or liabilities from any other governmental agency. The Applicants claim that because the utilities involved with the instant Application are fit, the instant Application should be approved, irrespective of whether the utilities have an unresolved controversy with a governmental agency. The Applicants also question how Ordering Paragraph No. 4, is to be interpreted and applied. The Applicants point out that that PFG and North Penn have entered into a consent order which contains a compliance schedule for the remediation of numerous manufactured gas plants sites and for plugging of numerous abandoned natural gas wells. The Applicants maintain while PFG and North Penn have complied with the schedule of the consent order thus far, it cannot be said that they have satisfied the consent order because much of the remediation work is to be done in the future in accordance with the consent order. The Applicants contend that Ordering Paragraph No. 4 is inappropriate because the Commission lacks statutory authority to act a collection agent for other governmental agencies. The Applicants argue the ordering paragraph would not change its obligations to other governmental agencies because the requirement to satisfy any penalties or liabilities, if any, with other governmental agencies would stand independently of the Commission's final resolution of this proceeding. The Applicants conclude that Ordering Paragraph No. 4, is inconsistent with Commission practice. The Applicants urge the Commission to strike the paragraph from the final order in this proceeding or in the alternative, to delete any references to any "governmental agency." (Exceptions, p. 8). ANALYSIS We note that in Finding of Fact No. 12, the ALJ found that pursuant to an Order and Agreement with the Department of Environmental Protection dated March 27, 1996, North Penn is required to plug approximately 24 old, non-productive wells per year until a total of 342 wells have been plugged. (I.D., p. 14). However, there is no mention in the Initial Decision of any record evidence indicating that North Penn or any other of the Applicants have outstanding liabilities or penalties with any other governmental agency which may impact upon the approval of this Application. We also note that this Application was published in newspapers of general circulation in each of the Applicants' service territories as well as in the Pennsylvania Bulletin at 27 Pa. Bulletin No. 37, p. 4799 ---------------------- (September 13, 1997). The record indicates that no governmental agency filed a protest or moved to intervene in this proceeding. But for the protest filed by Wayne T. Stephens dismissed by the ALJ, this Application was largely unopposed. The light of the record evidence as presented in this proceeding, we find that the reference to "any other governmental agency" in Ordering Paragraph No. 4, is overly broad and should be stricken. Accordingly, we will grant the Applicants' Exception No. 2, in part. C. THE PUBLIC INTEREST STANDARDS On consideration of the record, the ALJ concluded that the applicants are financially and technically fit. The individual, publicly-regulated entities, PP&L, PFG and North Penn, will continue to provide services as they do presently in their present service territories to their present customers. We note that the same legal entities will continue to provide regulated service pursuant to their same Commission-approved tariffs, currently on file. We further note that consistent with the case City of York, et al. v. Pa. PUC, 449 Pa. 136, 295 A. 2d 825 (1972), a merger must be approved upon a demonstration of a net benefit to the public. We conclude that the merger will produce financial savings, result in operational efficiencies, reduce cost of corporate functions, and enhance opportunities for efficient fuel procurement. We further conclude that the merger will not have an anticompetitive or discriminatory effect. 66 Pa. C.S. section 2811(e)(1); (2). CONCLUSION Our review of the proposed application leads us to conclude that the proposed merger is necessary or proper for the service, accommodation, convenience, or safety of the public, and that the Application should be approved as in the public interest; THEREFORE, IT IS ORDERED: 1. That the Joint Application of PP&L, Inc., PFG Gas, Inc. and North Penn Gas Company filed on August 7, 1997, is, hereby, approved 2. That the Exceptions of the Applicants are granted, in part, consistent with this Opinion and Order. 3. That the Initial Decision of Administrative Law Judge Richard M. Lovenwirth issued May 13, 1998, is adopted, as modified, consistent with this Opinion and Order. BY THE COMMISSION, /s/ James J. McNulty James J. McNulty Secretary (SEAL) ORDER ADOPTED: July 23, 1998 ORDER ENTERED: July 24, 1998 EX-99.2 3 EXHIBIT D-4 [STATE OF MARYLAND LOGO] COMMISSIONERS BRYAN G. MOORHOUSE -------- GENERAL COUNSEL H. RUSSELL FRISBY, JR. DANIEL P. GAHAGAN CHAIRMAN EXECUTIVE SECRETARY CLAUDE M. LIGON GREGORY V. CARMEAN E. MASON HENDRICKSON EXECUTIVE DIRECTOR SUSANNE BROGAN GERALD L. THORPE PUBLIC SERVICE COMMISSION WILLIAM DONALD SCHAEFER TOWER 6 ST. PAUL STREET BALTIMORE, MARYLAND 21202-6806 (410) 767-8000 FAX NUMBER (410) 333-6495 #17,9/3/97AM;ML#58120,S-315 September 3, 1997 Thomas P. Perkins, III Venable, Baetjer and Howard, LLP 1800 Mercantile Bank & Trust Building Two Hopkins Plaza Baltimore, Maryland 21201 Dear Mr. Perkins: This is to advise you that the Commission has reviewed the August 1, 1997 filing by PFG Gas, Inc. regarding the Agreement and Plan of Merger by and among Penn Fuel Gas, Inc., PP&L Resources, Inc. and Keystone Merger Corp. After considering this matter at the September 3, 1997 Administrative Meeting, the Commission noted the transaction and retained authority to institute proceedings if and when appropriate, but declined to do so at this time. By Direction of the Commission, /s/ Daniel P. Gahagan ------------------------------- Daniel P. Gahagan Executive Secretary jrb EX-99.3 4 EXHIBIT F-1 Exhibit F-1 August 13, 1998 Securities and Exchange Commission Judiciary Plaza 450 Fifth Street, N.W. Washington, D.C. 20549 Re: Application of PP&L Resources, Inc. on Form U-1 under the Public Utility Holding Company Act of 1935 (File No. 70-9165) Ladies and Gentleman: I am Senior Counsel of PP&L, Inc., a direct subsidiary of PP&L Resources, Inc. (the "Company"), and, as such, am familiar with the Company's affairs, including the proposed transaction (as defined below). I am providing this opinion to the Securities and Exchange Commission (the "Commission") in connection with the filing with the Commission of the Application on Form U-1 (File No. 70-9165) (the "Application") of the Company under the Public Utility Holding Company Act of 1935, as amended (the "Act"). The Application requests that the Commission issue an order authorizing the acquisition by the Company of all of the issued and outstanding shares of common stock and preferred stock of Penn Fuel Gas, Inc. ("Penn Fuel"), a Pennsylvania corporation and an exempt intrastate holding company under the Act (the "Transaction"). Penn Fuel is the parent holding company of PFG Gas, Inc., which provides regulated natural gas service in southern and eastern Pennsylvania and in a small portion of northern Maryland, and of North Penn Gas Company, which provides regulated natural gas service in northwestern and north central Pennsylvania. In connection with this opinion, I have examined such corporate records, certificates, and other documents as I have considered relevant and necessary as a basis for the opinions expressed in this letter. The opinions expressed below with respect to the Transaction are subject to and rely upon the following assumptions and conditions: a. The Transaction shall have been duly authorized and approved, to the extent required by the governing corporate documents and applicable state laws, by the shareholders of the Company and Penn Fuel. b. All required approvals, authorizations, consents, certificates, rulings and orders of, and all filings and registrations with, all applicable federal and state commissions and regulatory authorities with respect to the Transaction shall have been obtained or made, as the case may be, and shall have become final and unconditional in all respects and shall remain in effect (including the approval and authorization of the Commission under the Act) and the Transaction shall have been accomplished in accordance with all such approvals, authorizations, consents, certificates, orders, filings and registrations. c. The Commission shall have duly entered an appropriate order or orders with respect to the Transaction granting and permitting the Application to become effective under the Act and the rules and regulations thereunder. d. The Registration Statement of the Company on Form S-4, as amended to date (File No. 33-33565), filed with the Commission in connection with the Transaction on August 13, 1997, amended on September 4, 1997, and declared effective by the Commission on September 5, 1997, shall remain effective pursuant to the Securities Act of 1933, as amended; no stop order shall have been entered with respect thereto. e. All corporate formalities required by the laws of the Commonwealth of Pennsylvania for the consummation of the Transaction shall have been taken; and the Transaction shall have become effective in accordance with the laws of the Commonwealth of Pennsylvania. f. The parties shall have obtained all consents, waivers and releases, if any, required for the Transaction under all applicable governing corporate documents, contracts, agreements, debt instruments, indentures, franchises, licenses and permits. g. The representations and warranties of Penn Fuel concerning the corporate organization and existence of Penn Fuel set forth in the Agreement and Plan of Merger By and Among PP&L Resources, Inc., Keystone Merger Corp. and Penn Fuel Gas, Inc. dated June 26, 1997 ("Agreement and Plan of Merger") are true and correct as of the date hereof and Penn Fuel has complied with all applicable covenants and conditions set forth in the Agreement and Plan of Merger. Based on the foregoing, and subject to the assumptions and conditions set forth herein, I am of the opinion that: 1. All laws of the Commonwealth of Pennsylvania applicable to the Transaction as described in the Application will have been complied with. 2. The Company and Penn Fuel are each a corporation validly organized and duly existing under the laws of the Commonwealth of Pennsylvania. 3. The shares of Company common stock to be issued in conjunction with the Transaction will be validly issued, fully paid and nonassessable, and the holders thereof will be entitled to the rights and privileges appertaining thereto set forth in the Articles of Incorporation of the Company. 4. The shares of Penn Fuel common and preferred stock to be acquired by the Company in the Transaction may be legally acquired by the Company. 5. The consummation of the Transaction will not violate the legal rights of the holders of any securities issued by the Company, or any associate company thereof. This opinion is being delivered solely for the benefit of the person to whom it is addressed; accordingly, it may not be utilized by any other person or for any other purpose without my prior written consent. I hereby consent to the use of this opinion as an exhibit to the Application. Very truly yours, /s/ Michael A. McGrail ---------------------- Michael A. McGrail EX-99.4 5 EXHIBIT F-3 VENABLE, BAETJER AND HOWARD, LLP Including professional corporations OFFICES IN 1800 Mercantile Bank & Trust Building MARYLAND Two Hopkins Plaza WASHINGTON, D.C. Baltimore, Maryland 21201-2978 VIRGINIA (410) 244-7400, Fax (410) 244-7742 VENABLE Thomas P. Perkins, III P.C. ATTORNEYS AT LAW (410) 244-7510 August 6, 1998 Securities and Exchange Commission 450 5th Street, N.W. Washington, DC 20549 Re: SEC File No. 70-9165 Application or Declaration Under the Public Utility Holding Company Act of 1935 of PP&L Resources, Inc. --------------------------------------------------- Ladies and Gentlemen: Attached hereto is a copy of the ruling ("Ruling") dated September 3, 1997, issued at the direction of the Maryland Public Services Commission (the "Maryland Commission"). The Maryland Commission's Ruling was based upon the joint request of PP&L Resources, Inc., Keystone Merger Corp., Penn Fuel Gas, Inc. and PFG Gas, Inc., requesting that the Maryland Commission not exercise jurisdiction in connection with the Agreement and Plan of Merger dated as of June 26, 1997 by and among PP&L Resources, Inc., Keystone Merger Corp. and Penn Fuel Gas, Inc. (the "Agreement"). The undersigned appeared as counsel for PP&L Resources, Inc. at the hearing held before the Maryland commissino on September 3, 1997. As set forth in the Ruling, the Maryland Commission declined to exercise jurisdiction on the grounds that the Agreement does not materially affect the franchise or rights of PFG Gas, Inc. in Maryland, within the meaning of Section 24(b)(1) of Article 78 of the Annotated Code of Maryland. In the eleven months since the issuance of the Ruling, the Maryland Commission has not taken any further action in connection with this matter. The "retained authority to institute proceedings" referenced in the Ruling is standard language generally included by the Maryland Commission in similar rulings to reserve its right to institute proceedings if, in any particular case, there is a material change in the facts in this matter with regard to the Maryland aspects of the Agreement. Based on extensive experience in appearing before the Maryland Commission, it is my considered opinion that the Agreement can be consummated without any likelihood that the Maryland Commission will institute any proceedings in connection therewith. Very truly yours, Venable, Baetjer and Howard, LLP By: /s/ Thomas P. Perkins, III -------------------------------- Thomas P. Perkins, III, P.C. BAODOCSI\0061107.01 [STATE OF MARYLAND LOGO] COMMISSIONERS BRYAN G. MOORHOUSE -------- GENERAL COUNSEL H. RUSSELL FRISBY, JR. DANIEL P. GAHAGAN CHAIRMAN EXECUTIVE SECRETARY CLAUDE M. LIGON GREGORY V. CARMEAN E. MASON HENDRICKSON EXECUTIVE DIRECTOR SUSANNE BROGAN GERALD L. THORPE PUBLIC SERVICE COMMISSION WILLIAM DONALD SCHAEFER TOWER 6 ST. PAUL STREET BALTIMORE, MARYLAND 21202-6806 (410) 767-8000 FAX NUMBER (410) 333-6495 #17,9/3/97AM;ML#58120,S-315 September 3, 1997 Thomas P. Perkins, III Venable, Baetjer and Howard, LLP 1800 Mercantile Bank & Trust Building Two Hopkins Plaza Baltimore, Maryland 21201 Dear Mr. Perkins: This is to advise you that the Commission has reviewed the August 1, 1997 filing by PFG Gas, Inc. regarding the Agreement and Plan of Merger by and among Penn Fuel Gas, Inc., PP&L Resources, Inc. and Keystone Merger Corp. After considering this matter at the September 3, 1997 Administrative Meeting, the Commission noted the transaction and retained authority to institute proceedings if and when appropriate, but declined to do so at this time. By Direction of the Commission, /s/ Daniel P. Gahagan ------------------------------- Daniel P. Gahagan Executive Secretary jrb EX-99.5 6 EXHIBIT G-2 PENN FUEL GAS, INC. 1997 Annual Report PENN FUEL GAS, INC. AND SUBSIDIARIES Table of Contents - --------------------------------------------------------------------------- PAGE Letter to Shareholders...................................................1 Management's Discussion and Analysis of Financial Condition and Results of Operations ......................................5 Independent Auditors' Report............................................13 Financial Statements: Consolidated Balance Sheets - December 31, 1997 and 1996............14 Consolidated Statements of Income, Years ended December 31, 1997, 1996, and 1995...............................16 Consolidated Statements of Retained Earnings, Years ended December 31, 1997, 1996, and 1995...............................17 Consolidated Statements of Cash Flows, Years ended December 31, 1997, 1996, and 1995...............................18 Notes to Consolidated Financial Statements - December 31, 1997, 1996, and 1995......................................................20 Selected Financial Data.................................................38 Statistical Review.....................................................39 Corporate Information...................................................42 PENN FUEL GAS, INC. AND SUBSIDIARIES To our Shareholders - -------------------------------------------------------------------------- Penn Fuel Gas, Inc. had a momentous year in 1997. We enjoyed near record earnings from our gas utility and propane businesses and increased the dividend to our common shareholders. Our customer growth continued at a pace above the national average and we extended our gas utility service areas. Most notably we entered, at mid-year, a merger agreement with PP&L Resources, Inc. that presents an exciting opportunity for growth and participation in an expanding energy services enterprise. As we celebrate our successes and anticipate the completion of the merger we also note with sadness the end of an era. John H. Ware 3rd, our Company's founder and leader for much of its history, passed away July 29, 1997. FINANCIAL HIGHLIGHTS Penn Fuel's net income available to common shareholders totaled $6.187 million or $8.62 per share in 1997 compared to $6.389 million or $8.90 per share in 1996. The 1997 results reflected the expensing of certain legal and other costs associated with the planned merger with PP&L. Without these nonrecurring charges Penn Fuel's 1997 net income from its business operations would have been approximately $6.72 million or $9.37 per share. In February 1997 the Board of Directors approved a 20% increase in the Company's annual common dividend to $2.88 per share. In February 1998 the Board increased the dividend by an additional 20% to $3.46 per year. This most recent increase marks the fourth consecutive annual 20% increase in Penn Fuel's return to its common shareholders. Penn Fuel's capital expenditure commitment to system improvements and expansions totaled $13.7 million in 1997, a record for the Company. Over $4.0 million of this investment was dedicated to servicing new customers and business opportunities. EXPANDED AND IMPROVED OPERATIONS During 1997 Penn Fuel continued its program of upgrading antiquated segments of its gas utility distribution and transmission system. At the same time, the Company complemented these replacement projects with marketing programs to stimulate new gas applications and customer additions along current pipeline routings. The Company worked closely with commercial developers and prospective gas customers to extend its natural gas systems and attract new customers. Approximately one thousand customers were added to Penn Fuel's utility service in 1997. A number of these were large volume industrial and commercial users which contribute to the economic health and growth of Penn Fuel serviced communities. Penn Fuel received approvals for two significant service territory expansions in 1997 and introduced natural gas service to major customers in each area. In south central Pennsylvania, a commitment to convert to natural gas by a large and expanding JLG industries complex will introduce gas into the Boro of McConnellsburg for the first time. A second conversion by Quaker State Farms similarly will provide natural gas service to a new segment of Schuylkill County Pennsylvania. In the Company's North Penn Gas utility, an engineering project to expand the capacity of the Meeker Storage Field was completed and implemented in 1997. This project, which required only minimal investment, increased the Company's valuable storage capability by approximately 5% or 500 thousand dekatherrns. IMPROVED SERVICE AND CUSTOMER CHOICE Penn Fuel has undertaken significant initiatives in 1997 to promote additional gas service expansions and to make choice of marketer/natural gas supplier available to our customers. A Company supported trade ally network of contractors and suppliers will be enhanced to provide sales and service support and promotion of natural gas throughout our service areas. These resources will supplement Penn Fuel's marketing applications and staffing. Customer choice of energy supplier has been available for some years for large volume industrial and commercial natural gas customers. In 1997 choice also began to become available to electric customers of all sizes in Pennsylvania as a result of "Customer Choice" legislation. Inevitably this supplier choice will be extended to small volume natural gas customers, including residential. Penn Fuel has implemented a variety of measures to prepare for this transition which is likely to occur before the millennium. Penn Fuel initiated, and in early 1998 received Pennsylvania Public Utility Commission approval for, a proposal to make supplier choice available to all our commercial and small industrial customers - some 9,000 in number. Penn Fuel will continue to provide the delivery service for this gas which customers will purchase directly from gas marketers. Since the Company currently earns no margin on gas purchased on behalf of its customers, this choice or conversion by customers does not affect Penn Fuel's operating profit. The extension of choice to commercial customers will provide us and our customers with valuable operating experience in an unbundled service environment. We have also taken additional steps to prepare for full retail unbundling by beginning to upgrade our utility customer service and billing system. Penn Fuel has also been an active participant in a collaborative effort by business, consumer and regulatory interests to develop the "ground rules" or legislation under which full residential natural gas customer choice can be accomplished in Pennsylvania. THE MERGER Following a thorough assessment by the Board of Directors of the Company's strategic direction, Penn Fuel entered a merger agreement with PP&L Resources on June 27, 1997. We look forward with anticipation to the closing of this merger which will be attractive for our shareholders, employees and customers. The merger will be accomplished through a tax-free exchange of Penn Fuel common stock for between 6.968 and 8.516 shares of PP&L Resources common stock, as described in the Merger Agreement and Prospectus which has been provided to Penn Fuel shareholders. Penn Fuel's shareholders approved the merger in October 1997 and several required regulatory approval steps have been completed. A merger approval application was submitted to the Pennsylvania PUC in August 1997 and currently is moving through the PUC review process. We anticipate that a PUC decision in our case and a final review by the Securities and Exchange Commission will be conducted so that the merger can be completed sometime in the summer of 1998. We look forward to participating in the growth of PP&L and its energy business. WE REMEMBER, WITH GRATITUDE Penn Fuel Gas lost a major influence on its history and direction with the death of John H. Ware 3rd on July 29, 1997. Mr. Ware founded Penn Fuel in l944 and for forty-five years lead the Company's growth as President and Chairman of the Board of Directors. In addition to his recognition as a natural gas utility and propane industry leader, Mr. Ware served as Chairman of the American Water Works, the largest investor owned water utility in the U.S. He also was highly regarded as a philanthropist and a civic and political leader. Mr. Ware served as a member of the Pennsylvania Senate from 1961 to 1971 and was a member of the U.S. House of Representatives from 1971 to 1975. We at Penn Fuel can attribute much of our recent success to Mr. Ware's insightful leadership and the business foundation he built over the years. We remember also the contribution of William F. Ryan who passed away December 27, 1997. Bill served with distinction as a member of Penn Fuel's Board of Directors from 1991 through 1996 - a period of significant change and upgrading of the Company's capabilities. In a different light, as we anticipate the completion of our merger with PP&L, we would like to acknowledge and express appreciation for the dedication of our Board of Directors who have, on your behalf, provided direction that has led to our business achievements. We recognize also the continued dedication of Penn Fuel's employees in focusing on your Company's businesses while at the same time planning for the transition to a merged Company with PP&L. The year 1998 and the completion of our merger will bring the end of a proud era as an independent company for Penn Fuel. We can look back for a brief moment with pride at the accomplishments that have been fashioned with your support and the commitment of Penn Fuel's employees. We are enthusiastic about the future, however, and the new opportunities to build shareholder value through energy customer choice, expansion of unbundled services, and growth with PP&L. We thank you for your continued confidence in Penn Fuel. /s/ Paul W. Ware /s/ Terry H. Hunt Paul W. Ware Terry H. Hunt Chairman President & Chief Executive Officer PENN FUEL GAS, INC. AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations - --------------------------------------------------------------------------- RESULTS OF OPERATIONS OVERVIEW Net income and basic net income per common share were $6,187,000 and $8.62, respectively, for 1997 compared to $6,389,000 and $8.90 for 1996 and $5,072,000 and $7.07 for 1995. Net income for 1995 includes $378,000 equivalent to $.53 per common share from the cumulative effect, net of tax, on prior years of a change in accounting principle. 1997 COMPARED WITH 1996 The change in net income in 1997 from 1996 represents a decrease of $202,000 (3.2%). Utility operating revenues less cost of gas (gross utility margin) increased $4,620,000 (8.5%) in 1997, the first full year that new rates for utility services approved by the Pennsylvania Public Utility Commission (PAPUC) in October 1996 were in effect. Gross margins from liquefied petroleum (LP) and merchandise sales decreased $103,000 (1.5%) and $92,000 (40.4%), respectively. Utility throughput in 1997 was 479,000 Dth (1.8%) below 1996. Deliveries to sales customers decreased 1,637,000 Dth (11.6%) while throughput to transportation customers increased 1,158,000 Dth (9.1%). Based on degree days measured by the Company 1997 was 4.7% warmer than normal and 1996 was 2.7% colder than normal. Sales customers typically use a significant portion of the natural gas they purchase for heating purposes during the winter months, therefore, it is expected their usage would be lower in warmer than normal periods. In addition to the impact of warmer than normal weather in 1997 on sales throughput, industrial and commercial customers increasingly are choosing transportation service versus sales service. In 1997 the number of transportation customers increased from 124 to 176 and the number of industrial sales customers decreased from 302 to 265. The Company added an educational institution as a new transportation customer in 1997 that used in excess of 200,000 Dth during the year. Generally, the gross margin the Company earns on sales and transportation throughput is the same for the same type of customer. Sales to LP customers declined to 788,000 Dth in 1997 from 841,000 Dth in 1996. Warmer than normal weather and a lower customer count contributed to the decrease in sales. The Company's customer count decreased during the year to 27,549 from 28,021 as competition for customers increased. During 1997 the Company determined that its needs for a new corporate headquarters building had changed after announcing its proposed merger with PP&L Resources, Inc. The project to construct the new building was canceled and related costs totaling $411,000 that had been deferred were charged to expense. The after tax effect of the charge was $244,000 ($.34 per share). Deferred and current income tax benefits resulting from a tax accounting change approved by the Internal Revenue Service (IRS) in 1996 amounted to $273,000 ($.38 per share) in 1997 compared to $868,000 ($1.21 per share) in 1996. 1996 COMPARED WITH 1995 The increase in net income in 1996 compared with 1995 is the result of several factors. Gross utility margin increased $4,406,000 (8.8%) in 1996. The full benefit of a rate increase approved by the PAPUC in 1995 is included in 1996 revenues as is part of the benefit of a rate increase approved in October 1996. Utility throughput in 1996 was almost the same as in 1995 as deliveries to sales customers increased 492,000 Dth (3.6%), and throughput to transportation customers decreased 405,000 Dth (3.1%). Sales to LP customers were almost the same at 841,000 Dth in 1996 compared to 830,000 Dth in 1995. The gross margin on LP sales increased $240,000 (3.6%) in 1996. Degree days in 1996 were 2.7% above normal while degree days in 1995 were 2.3% below normal. Also included in 1996 net income is $868,000 ($1.21 per share) representing the current tax benefits of a change in tax accounting method approved by the IRS during the year and $115,000 ($.16 per share) from the sale of real estate no longer used in operations. 1995 net income included $567,000 ($.79 per share) from the sale of assets by a subsidiary that accounted for all the Company's LP and merchandise sales in Delaware. OPERATING REVENUES Operating revenues were $119,213,000 in 1997, $113,507,000 in 1996, and $105,647,000 in 1995. Revenues from utility operations increased $6,676,000 in 1997 while revenues from LP and merchandise decreased $690,000 and $280,000, respectively. The net change in 1997 total operating revenues compared with 1996 is an increase of $5,706,000. In October 1996 the PAPUC approved increases in the Company's rates for utility services that were calculated to produce additional annual operating revenues of $6,725,000. 1997 was the first full calendar year these new rates were in effect. The cost of gas sold to utility customers in 1997 was $2,056,000 higher than the cost of such gas in 1996. Cost of gas is recovered from customers and included in utility revenues. Utility operations accounted for $6,706,000 of the $7,860,000 increase in 1996 revenues. Several factors including the impact of rate case proceedings settled in 1996 and 1995, higher sales volumes and the recovery of purchased gas costs that were higher in 1996 than 1995 contributed to the increase in revenues. 1996 utility operating revenues include the increase in rates approved in September 1995 by the PAPUC. The rates were designed to provide $2,247,000 of additional annual revenues. Also included in 1996 utility operating revenues is a partial year's benefit of the rate increase approved by the PAPUC in October 1996. LP operating revenues of $11,604,000 in 1997 were $690,000 less than 1996 revenues. The lower revenues follow a 53,000 Dth decrease in 1997 sales volumes from 1996. Warmer than normal weather and increased competition primarily from new entrants into the business were the primary causes of the reduced LP sales. Gross margin declined slightly (1.5%) to $6,868,000 in 1997. LP operating revenues increased $1,285,000 in 1996 from $11,009,000 in 1995 while sales on a Dth basis remained essentially unchanged: 841,000 Dth in 1996 and 830,000 Dth in 1995. In 1996 the Company was able to recover higher product costs through increased selling prices and improve its gross margin by $240,000 (3.6%). OTHER OPERATING, ADMINISTRATIVE AND GENERAL, AND MAINTENANCE EXPENSES Other operating, administrative and general, and maintenance expenses increased $2,235,000 (6.7%) in 1997 versus 1996. During 1997 the Company continued its participation in proceedings concerning an application by another company to develop salt dome storage in the same area as the Company's existing underground storage facilities. Legal expenses associated with this matter were higher in 1997 than 1996. The Company's 1997 legal and consulting expenses also increased from 1996 as a result work related to its proposed merger with PP&L Resources, Inc. In 1997 the Company increased its accrued liability related to manufactured gas plant sites where costs are not recovered through the ratemaking process. The increase amounted to $287,000 and was recognized as an operating expense in 1997. Pension expense increased $97,000 in 1997. During 1997 an increasing number of municipalities where the Company has natural gas distribution facilities installed underground began adopting more stringent restoration requirements. Compliance with these new policies has increased the cost of maintenance projects that involve road excavation. Other operating, administrative and general, and maintenance expenses increased $ 1,146,000 (3.5%) in 1996 compared with 1995. During the year, the Company began a program to inspect the condition of a major transmission line that is part of its pipeline system. The program continued into 1997. To date, no significant anomalies have been identified through the program. The cost of the program and resulting repairs have been charged to expense in 1997 and 1996. Legal expense was higher in 1996 primarily because of the costs incurred to oppose an application by another Company with the Federal Energy Regulatory Commission (FERC) to develop salt dome storage in the same area as the Company's existing underground storage facilities. Other factors contributing to the increase in expense are higher payroll costs and uncollectible accounts expense. Expense reductions in 1996 included a $343,000 pension expense credit. The credit resulted from discontinuing an investment contract with an insurance company, funding outstanding guaranteed annuities under the contract, and placing the balance of the assets from the contract with an investment manager. Also, in 1996 the Company implemented a new purchasing and inventory control system. As part of the implementation of the new system, the Company expanded its definition of inventoriable items, redesigned its part numbers, and took a physical inventory. The cost of items included in the physical inventory net of reserves for loss contingencies resulted in a $141,000 reduction in 1996 expense. DEPRECIATION AND AMORTIZATION EXPENSE Depreciation and amortization expense increased $1,643,000 (29.7%) from 1995 to 1997 due to investment in property, plant, and equipment, and higher amortization of capitalized environmental costs. INCOME TAX EXPENSE Current and deferred income tax expense in 1997 and 1996 include the impact of a change in the Company's tax accounting method for cost of removal. In 1996 the Company received approval from the IRS to deduct cost of removal from taxable income beginning with the 1994 tax year. The approval applied to the deduction of applicable costs incurred in 1994 and subsequent years and to costs incurred by the Company prior to 1994 (accumulated costs). The accumulated costs are deductible pro rata over a six-year period also beginning with the 1994 tax year. Approval to begin deducting costs of removal created timing differences or current tax benefits depending on the vintage of the assets, the costs related to and the principles followed for recognizing differences between book and tax at the time. The combination of deferred taxes and current tax benefits recognized in 1996 as a result of the approval to deduct cost of removal reduced the year's tax expense $868,000. The comparable deferred and current tax benefits recognized in 1997 were $273,000. TAXES OTHER THAN INCOME Taxes other than income include taxes based on payroll and various state and local taxes. Beginning with 1995 utility revenues subject to gross receipts tax have been higher in each succeeding year and there has been a corresponding increase in taxes other than income. Further, the Company's payroll has increased each year resulting in higher payroll taxes. INTEREST EXPENSE Interest expense increased $126,000(2.9%) in 1997. In addition to reducing long-term debt by making the sinking fund payments required by the terms of the notes, the Company exercised its option to prepay the remaining balance of the 9.2% notes. For the year, interest related to long-term debt decreased by more than interest incurred through short bank borrowings increased. Interest expense related to the recovery of purchased gas and transition costs from customers was lower in 1997 than 1996 because the Company was in an undercollected position for most of the year. The Company does not earn interest or incur interest when it has underrecovered purchased gas related costs. As line of credit borrowings increased in 1997, the Company's temporary cash investments were reduced from 1996 and interest income declined. Interest expense for 1996 was $369,000 (7.8%) lower compared to 1995 expense. Lower interest costs resulting from reductions in long-term debt through required and optional prepayments more than offset interest incurred through higher levels of borrowings under the Company's lines of credit. In addition, interest costs related to the overcollection of purchased gas and transition costs were lower in 1996 because these amounts were refunded to customers during the year. A decrease in interest income from temporary cash investments was approximately offset by the amount of interest received from the settlement of prior years' income tax issues. OTHER EXPENSE After the announcement of its proposed merger with PP&L Resources, Inc., the Company concluded its needs had changed and canceled a new office building project initiated in 1995. Costs totaling $411,000 that were incurred in connection with the project but that had been deferred were charged to expense in 1997. The land acquired for the project is being offered for sale. Other expense (income) in 1996 includes $193,000 of pretax gain on the sale of real estate. In 1995 certain assets of an LP subsidiary located in Delaware were sold and a pretax gain of $945,000 was recognized as other income. The real estate sold in 1996 was previously used in the Delaware LP business. LIQUIDITY AND CAPITAL RESOURCES The Company's natural gas and LP businesses are both seasonal in nature and weather sensitive. The heating season of November through March is the Company's highest period of positive cash flow. However, cash requirements for capital expenditures and the acquisition of gas for storage are highest during the spring and fall of the year. Bank lines of credit are used to meet the Company's seasonal working capital requirements and as a source of funds for its capital investment program. Periodically, the Company refinances capital investments funded through its lines of credit by issuing long-term debt. At December 31, 1997 and December 31, 1996, the Company had outstanding line of credit borrowings of $20,475,000 and $7,500,000, respectively. The Company expects to negotiate bank lines of credit in 1998 at levels appropriate to meet its requirements. In 1997 the Company and its subsidiaries have unsecured committed and uncommitted bank lines of credit that in aggregate total $22,500,000 and $45,000,000, respectively. In the first quarter of 1995 the Company reinstated a common dividend to its stockholders at the annual rate of $2.00 per share. The annual rate of the common dividend was increased to $2.40 on February 27, 1996; $2.88 on March 7, 1997; and to $3.44 on February 24, 1998. The Company's 1998 capital improvement and environmental budgets total $16,485,000. In 1997 capital and environmental expenditures amounted to $15,633,000. Gas inventory is primarily natural gas (storage gas) but also includes smaller amounts of LP. Natural gas in storage is generally purchased during the warmer months of the year and held either in facilities owned by the Company or by interstate pipelines for withdrawal during the heating season. At December 31, 1997, the Company had 2,615,000 Dth of natural gas in inventory and 60,000 Dth of LP. At December 31, 1996, natural gas inventory totaled 3,305,000 Dth and LP totaled 60,000 Dth. The storage gas balance at December 31, 1997 reflects the results of the most recent test performed at the Company's largest underground storage field which indicate there is a difference between the amount of gas in the field and the Company's inventory records. Pending further analysis of the test data by the Company and the operator of the storage field, the Company has reclassified 672,000 Dth of gas with a cost of $527,000 from current assets - inventories gas to deferred debits - other. The amount reclassified represents the Company's proportionate share of the parties' preliminary estimate of the difference. Based on its prior experiences, the Company expects it would be permitted by the PAPUC to recover a difference between its recorded inventory and the amount of gas determined by its joint studies with the operator of the field through rates charged for its natural gas utility services. The Company's 1998 gas purchase program will provide for a sufficient level of storage injections to meet its requirements for the 1998-1999 heating season. Based on tests it conducted during 1997 the Company concluded one of its storage fields was capable of providing additional storage space. The Company has successfully marketed this additional space for the 1998-1999 storage season. MERGER AGREEMENT On June 27, 1997, the Company and PP&L Resources, Inc. (PP&L) announced they had signed a definitive agreement under which PP&L will acquire the Company. Under the terms of the agreement, upon consummation of the merger, which is subject to the receipt of various regulatory approvals, common stockholders of the Company will receive, subject to certain adjustments, between 6.968 and 8.516 shares of PP&L common stock for each share of the Company that they own. Penn Fuel's shareholders approved the merger in October 1997. The Company's preferred stock may be redeemed in accordance with its terms upon written approval of holders of at least 66 2/3% of the preferred shares outstanding, at a redemption price of $15 per share, plus accrued and unpaid dividends. Owners of more than 93.5% of the total number of the preferred shares outstanding as of July 31, 1997 have indicated their intent to provide the shareholder approval required for such redemption. Each share of preferred stock outstanding that is not redeemed in accordance with its terms will be converted into the right to receive between 0.682 and 0.833 shares of PP&L common stock, subject to certain adjustments. Costs related to the proposed merger that are contingent upon its consummation have not been recognized in the Company's financial statements. If incurred, the aggregate amount of such costs is expected to be material to the Company's results of operations. GAS UTILITY INDUSTRY RESTRUCTURING The restructuring of the natural gas industry to date has largely affected those aspects of the business regulated at the national or interstate level by the FERC. The Natural Gas Policy Act was passed in 1978 and started the gradual decontrol of natural gas prices at the wellhead. Subsequent orders issued by the FERC resulted in open access to pipeline transportation, resolution of take or pay liabilities, and finally the unbundling of merchant gas sales service from other interstate pipeline services such as storage and transportation. All of these FERC initiatives have had significant effects on the operations of local distribution companies, such as the Company's utility subsidiaries. Legislation has recently been introduced in Pennsylvania that among other things provides gas supply choice to all gas customers, not just those that use large volumes of the commodity, after April l, 1999. Certain aspects of the proposed legislation may change as the result of legislative hearings and collaborative negotiations among industry participants directed by the Chairman of the PAPUC, but it is expected that some measure of customer choice will be provided to all users of natural gas in Pennsylvania. As proposed, the restructuring plan is to include unbundled rates for gas distribution (transportation) and supply, a proposal to physically, operationally, and legally separate the gas supply merchant function from the distribution function and a proposed supplier of last resort mechanism. Under current regulations, the Company does not earn a profit from the gas supply merchant function. The return on investment or profit is part of the rate the Company charges for delivering the gas and providing other services. The proposed legislation would continue to have the distribution of natural gas regulated by the PAPUC. Legislation providing customer choice to users of electricity was enacted in Pennsylvania in December 1996. Most of the Company's large industrial and commercial customers now purchase their natural gas from a supplier other than the Company and utilize the Company's pipelines to deliver the gas to their facilities. The rate for this delivery or transportation service has been unbundled from the rate the Company charges for the cost of the gas. In situations where the customer is in a position to exercise its ability to build a connection to an interstate pipeline and bypass use of the Company's facilities, the Company has negotiated competitive rates. As a result of a Company proposal approved by the PAPUC on February 27, 1998, unbundled transportation service availability was expanded to include all industrial and commercial customers. YEAR 2000 The Company's principal computer systems are purchased software packages. Generally, these systems are year 2000 compliant. Where they are not, the Company either has scheduled the installation of a system upgrade or the software vendor has assured the Company their software will be made year 2000 compliant in the near future. The Company does not expect the cost of year 2000 compliance to have a material impact on its financial position. IMPACT OF RECENT ACCOUNTING PRONOUNCEMENTS In June 1997 the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 130, Reporting Comprehensive Income (SFAS 130). This statement requires that all items that are 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. The Company plans to adopt this statement on January l, 1998, as required. The Company does not have any items of comprehensive income, other than those presented on its consolidated statements of income, that would require disclosure and presentation of accumulated balances in the equity section of the balance sheet. In June 1997 the FASB issued Statement of Financial Accounting Standards No. 131, Disclosures About Segments of an Enterprise and Related Information (SFAS 131). This statement established standards for reporting information about operating segments in interim financial reports issued to shareholders. It also establishes standards for related disclosure about products and services, geographic areas and major customers. The Company plans to adopt this statement on January l, 1998 as required. In February 1998 the FASB issued Statement of Financial Accounting Standards No. 132, Employers' Disclosures About Pensions and Other Post-retirement Benefits (SFAS 132), which amends FASB Statements No. 87, 88, and 106. The statement revises employers' disclosures about pension and other post-retirement benefit plans. It does not change the measurement or recognition of these plans. The statement suggests combined formats for presentation of pension and other post-retirement benefit disclosures. The Company plans to adopt this statement on January 1, 1998 as required. KPMG Peat Marwick LLP 1600 Market Street Philadelphia, PA 19103 7212 INDEPENDENT AUDITORS' REPORT The Board of Directors Penn Fuel Gas, Inc.: We have audited the accompanying consolidated balance sheets of Penn Fuel Gas, Inc. and subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of income, retained earnings, and cash flows for each of the years in the three-year period ended December 31, 1997. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Penn Fuel Gas, Inc. and subsidiaries as of December 31, 1997 and 1996, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31. 1997, in conformity with generally accepted accounting principles. As discussed in note 1 to the consolidated financial statements, in 1995 the Company changed its method of recognizing revenues from sales of natural gas to residential and small commercial customers. As discussed in note 5 to the consolidated financial statements, in 1995 the Company changed its method of accounting for post-retirement benefits other than pensions to adopt the provisions of Financial Accounting Standards Board Statement of Financial Accounting Standards No. 106, Employers' Accounting for Post-retirement Benefits Other Than Pensions. /s/ KPMG Peat Marwick LLP Philadelphia, Pennsylvania April 3, 1998, except as to note 7 which is as of April 21, 1998 THIS PAGE LEFT BLANK INTENTIONALLY
PENN FUEL GAS, INC. AND SUBSIDIARIES Consolidated Balance Sheets December 31, 1997 and 1996 - ---------------------------------------------------------------------------------------------------------------------- Capitalization and Liabilities 1997 1996 - ---------------------------------------------------------------------------------------------------------------------- Capitalization: Stockholders' equity: Common, $1 par value; authorized 2,000,000 shares, issued and outstanding 717,583 shares in 1997 and 1996 $ 718 718 Preferred, no par value; authorized 500,000 shares, issued none -- -- Additional paid-in capital 714 714 Retained earnings 69,433 65,313 - ---------------------------------------------------------------------------------------------------------------------- 70,865 66,745 Redeemable preferred stock: $1.40 cumulative preferred stock; authorized 2,000,000 shares, issued and outstanding 717,583 shares in 1997 and 1996 10,764 10,764 Long-term debt, less amounts payable within one year 46,429 51,694 - ---------------------------------------------------------------------------------------------------------------------- 128,058 129,203 - ---------------------------------------------------------------------------------------------------------------------- Current liabilities: Notes payable 20,475 7,500 Long-term debt payable within one year 1,235 2,939 Accounts payable 9,135 11,346 Accrued environmental costs 1,815 1,811 Other current and accrued liabilities 5,848 4,554 - ---------------------------------------------------------------------------------------------------------------------- 38,508 28,150 - ---------------------------------------------------------------------------------------------------------------------- Deferred credits: Unamortized investment tax credits 1,914 1,990 Unamortized excess of equity value of subsidiary at acquisition over cost 431 537 Deferred income taxes 20,858 17,530 Accrued environmental costs 14,092 14,163 Accrued well plugging costs 3,596 3,792 Other 532 1,100 - ---------------------------------------------------------------------------------------------------------------------- 41,423 39,112 - ---------------------------------------------------------------------------------------------------------------------- $207,989 196,465 - ----------------------------------------------------------------------------------------------------------------------
PENN FUEL GAS, INC. AND SUBSIDIARIES Consolidated Statements of Income Years ended December 31, 1997, 1996, and 1995 (in thousands, except per share information) - --------------------------------------------------------------------------------------------------------- 1997 1996 1995 - -------------------------------------------------------------------------------------------------------- Operating revenue: Utility revenue $106,469 99,793 93,087 Liquefied petroleum gas revenue 11,604 12,294 11,009 Merchandise sales 1,140 1,420 1,551 - --------------------------------------------------------------------------------------------------------- 119,213 113,507 105,647 - -------------------------------------------------------------------------------------------------------- Operating revenue deductions: Cost of gas, utility 47,434 45,378 43,078 Cost of liquefied petroleum gas 4,736 5,323 4,278 Cost of sales, merchandise 1,004 1,192 1,319 Operating, administrative, and general expenses 31,881 30,274 29,235 Maintenance 3,866 3,238 3,131 Depreciation and amortization 7,184 6,246 5,541 Taxes, other than income 7,298 6,788 6,514 Income taxes 3,924 3,741 3,223 - -------------------------------------------------------------------------------------------------------- 107,327 102,180 96,319 - -------------------------------------------------------------------------------------------------------- Operating income 11,886 11,327 9,328 - ------------------------------------------------------------------------------------------------------- Other expense (income): Interest 4,488 4,362 4,731 Other 206 (429) (1,102) - -------------------------------------------------------------------------------------------------------- 4,694 3,933 3,629 - -------------------------------------------------------------------------------------------------------- Income before cumulative effect of a change in accounting principle 7,192 7,394 5,699 Cumulative effect on prior years (to December 31. 1994) of change to record unbilled revenue, net of tax -- -- 378 - -------------------------------------------------------------------------------------------------------- Net income 7,192 7,394 6,077 Dividend requirement on redeemable preferred stock (1.005) (1,005) (1,005) - -------------------------------------------------------------------------------------------------------- Net income applicable to common stock $ 6,187 6,389 5,072 - -------------------------------------------------------------------------------------------------------- Basic net income per common share: Income before cumulative effect of a change in accounting principle $ 8.62 8.90 6.54 Cumulative effect on prior years (to December 31, 1994) of change to record unbilled revenue, net of tax -- -- 0.53 - ----------------------------------------------------------------------------------------------------------- Total $ 8.62 8.90 7.07 - ----------------------------------------------------------------------------------------------------------- Diluted net income per common share: Income before cumulative effect of a change in accounting principle $ 8.52 8.87 6.52 Cumulative effect on prior years (to December 31. 1994) of change to record unbilled revenue. net of tax -- -- 0.52 - ------------------------------------------------------------------------------------------------------------ Total $ 8.52 8.87 7.04 - ------------------------------------------------------------------------------------------------------------ See accompanying notes to consolidated financial statements.
PENN FUEL GAS, INC. AND SUBSIDIARIES Consolidated Statements of Retained Earnings Years ended December 31, 1997, 1996, and 1995 (in thousands, except per share information) - ----------------------------------------------------------------------------------------------------------- 1997 1996 1995 - ----------------------------------------------------------------------------------------------------------- Balance at beginning of year $ 65,313 60,646 57,009 Net income 7,192 7,394 6,077 Dividends: Redeemable preferred stock ($1.40 in 1997, 1996, and 1995) (1,005) (1,005) (1,005) Common stock ($2.88 in 1997, $2.40 in 1996, and $2.00 in 1995) (2,067) (1,722) (1,435) - ----------------------------------------------------------------------------------------------------------- Balance at end of year $ 69,433 65,313 60,646 - ----------------------------------------------------------------------------------------------------------- See accompanying notes to consolidated financial statements.
PENN FUEL GAS, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows Years ended December 31, 1997, 1996, and 1995 (in thousands) - -------------------------------------------------------------------------------------------------------------------- 1997 1996 1995 - -------------------------------------------------------------------------------------------------------------------- Cash flows from operating activities: Net income $7,192 7,394 6,077 - -------------------------------------------------------------------------------------------------------------------- Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 7,184 6,246 5,541 Amortization of extraordinary property loss -- 38 231 Deferred taxes and investment tax credits 2,342 3,874 1,701 Gain on sale of liquefied petroleum gas property -- (193) (945) Changes in assets and liabilities: Increase in accounts receivable (167) (1,671) (671) (Increase) decrease in gas inventory 87 (2,255) 3,722 Increase in unrecovered gas and transition costs (2,905) (3,450) (1,501) Increase in other inventories (510) (878) (353) Increase (decrease) in accounts payable and accrued liabilities (917) 3,881 (1,342) Increase (decrease) in other assets/liabilities, net 212 (1,175) (89) - -------------------------------------------------------------------------------------------------------------------- Total adjustments 5,326 4,417 6,294 - -------------------------------------------------------------------------------------------------------------------- Net cash provided by operating activities 12,518 11,811 12,371 - -------------------------------------------------------------------------------------------------------------------- Cash flows from investing activities: Capital expenditures (13,685) (12,561) (13,403) Proceeds on the sale of liquefied petroleum gas property -- 226 l,379 Other (2,029) (2,514) (2,380) - -------------------------------------------------------------------------------------------------------------------- Net cash used in investing activities (15,714) (14,849) (14,404) - -------------------------------------------------------------------------------------------------------------------- Cash flows from financing activities: Principal payments on long-term debt $ (6,969) (4,079) (2,458) Net increase in notes payable 12,975 7,000 500 Dividends paid: Preferred (1,005) (1,005) (1,005) Common (2,067) (1,722) (1,435) - --------------------------------------------------------------------------------------------------------------------- Net cash provided by (used in) financing activities 2,934 194 (4,398) - --------------------------------------------------------------------------------------------------------------------- Net decrease in cash and cash equivalents (262) (2,844) (6,431) Cash and cash equivalents at beginning of year 2,513 5,357 11,788 - --------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents at end of year $ 2,251 2,513 5,357 - --------------------------------------------------------------------------------------------------------------------- Supplementary disclosures of cash flow information: Cash paid for the year for: Interest $ 5,006 4,913 5,326 Income taxes 1,183 1,556 3,178 - --------------------------------------------------------------------------------------------------------------------- See accompanying notes to consolidated financial statements.
PENN FUEL GAS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1997, 1996, and 1995 - --------------------------------------------------------------------------- (1) DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES DESCRIPTION OF BUSINESS Penn Fuel Gas, Inc. (the Company) is an exempt public utility holding company whose utility subsidiaries provide natural gas distribution, transmission, and storage service from facilities in Pennsylvania. In addition, the Company provides gas distribution service to a small number of customers in Maryland. The Company also sells liquefied petroleum (LP) gas and merchandise in Pennsylvania and Maryland. In August 1995 the Company sold its LP operations in Delaware. (See Liquefied Petroleum Gas Property.) PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of the Company and its subsidiaries, each of which is wholly owned. All material intercompany accounts have been eliminated. The Company's utility subsidiaries maintain their accounting records in conformity with the uniform system of accounts prescribed by the Federal Energy Regulatory Commission (FERC), Pennsylvania Public Utility Commission (PAPUC) and the Maryland Public Service Commission. Significant accounting practices are summarized below. PROPERTY, PLANT, AND EQUIPMENTS Utility Plant Utility plant is carried at cost. Depreciation is computed using the straight-line method. Based on average utility plant, the composite straight-line rates for 1997, 1996, and 1995 were 2.6%, 2.8%, and 3.0%, respectively. For utility property, expenditures for replacements and renewals considered to be units of property are charged to utility plant accounts at cost. Expenditures for maintenance, repairs, renewals and replacements determined to be less than units of property are charged to maintenance. At the time utility properties are retired, replaced, or otherwise disposed of, accumulated depreciation, depletion, and amortization is charged with the cost of the properties plus the costs incurred in retiring, replacing or disposing of the property. As discussed in note 7, the Company has accrued the estimated cost of removal related to 337 producing and nonproducing gas wells. Gas stored underground - noncurrent represents the cost of the estimated volume of gas required to maintain pressures in the underground storage fields at levels sufficient to meet the service requirements of the Company's customers on a peak day. Liquefied Petroleum Gas Property Liquefied petroleum gas property is carried at cost. Depreciation is computed using the straight-line method. Based on average LP plant, the composite straight-line rate for 1997 was 3.1% and for 1996 and 1995 was 3.2%. Expenditures for maintenance, repairs, renewals, and replacements determined to be less than units of property are charged to maintenance. When assets are retired or otherwise disposed of, the cost and related accumulated depreciation are removed from the accounts and any resulting gain or loss is reflected in income for the period. In 1996 the real estate used by a wholly owned subsidiary that was previously engaged in the sale of LP was sold. The sale resulted in a gain before income tax of $193,000, which is reported as other income. On August 28, 1995, Gas-Oil Products, Inc. of Delaware (GOP), a wholly owned subsidiary of the Company, which accounted for all of the Company's business in Delaware, sold certain of its assets including tanks, inventory, motor vehicles, and accounts receivable. On a consolidated basis, GOP's operations accounted for approximately 9% of the Company's LP volume and approximately 2% of the Company's merchandise sales. The selling price of the assets was received in cash and resulted in a gain before income tax of $945,000, which is reported as other income. OPERATING UTILITY REVENUES Revenues from sales and transportation services are recorded based on meters read. Residential and small commercial customers' meters are read on a cycle basis throughout each month. Generally, large commercial and industrial and resale customers' meters are read on the last day of each month. Revenues from storage service are also recorded monthly. INVENTORIES Inventories of materials, supplies, and appliances are recorded partly on average cost and partly at the lower of cost, determined by the first-in, first-out method, or market. Gas inventory of one subsidiary is recorded on the last-in, first-out (LIFO) method. Approximately $437,000 and $1,899,000 of the Company's gas inventory at December 31, 1997 and 1996, respectively, was valued using the LIFO method. The estimated replacement cost exceeded the LIFO inventory cost by approximately $l,462,000 and $2,004,000 at December 31, 1997 and 1996, respectively. The gas inventory of the other utility subsidiary is valued at average cost. The results of the most recent tests performed at the Company's largest underground storage field indicate there is a difference between the amount of gas in the field and the Company's inventory records. Pending further analysis of the test data by the Company and the operator of the storage field, the Company has reclassified 672,000 Dth of gas with a cost of $527,000 from the current assets - inventories gas to deferred debits - other. The amount reclassified represents the Company's proportionate share of the parties' preliminary estimate of the difference. Based on its prior experiences, the Company expects it would be permitted by the PAPUC to recover a difference between its recorded inventory and the amount of gas determined by its joint studies with the operator of the field through rates charged for its natural gas utility services. DEFERRED DEBITS Environmental costs are regulatory assets established in conjunction with recognition in the financial statements of environmental liabilities. Where such liabilities are not recovered from other responsible parties (through cost recovery litigation) or insurance claims, the Company expects to continue to recover environmental costs associated with utility sites through PAPUC approved rates charged for its services. Well plugging costs are regulatory assets established in conjunction with recognition in the financial statements of the cost to plug and abandon wells in accordance with current regulations. Such costs have historically been recovered through the ratemaking process. Other deferred debits are amortized on the straight-line method over an appropriate number of years determined in regulatory proceedings. UNRECOVERED GAS COSTS Unrecovered gas costs represent net changes in gas costs which will be collected from customers by fuel cost adjustments in the future. Amounts to be collected over a subsequent period are classified as current in the financial statements. DEFERRED INCOME TAXES The Company provides deferred income taxes on timing differences between book and tax income based on policies and decisions established in regulatory proceedings. In 1996 the Company received approval from the Internal Revenue Service (IRS) to change its tax accounting method for cost of removal. Deferred taxes have been recognized in 1996 for certain timing differences related to the change in method. INVESTMENT TAX CREDITS Deferred investment tax credits are amortized to income on the straight-line method over the estimated useful lives of the related property. CASH EQUIVALENTS For the purpose of reporting cash flows, highly liquid investments purchased with a maturity of three months or less are considered to be cash equivalents. ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses reported during the period. Actual results could differ from those estimates. EXCESS OF EQUITY VALUE OVER COST OF ACQUISITION The excess of the equity value over the cost of acquisition, arising from the acquisition of North Penn Gas Company in 1977, is being amortized on the straight-line method over twenty-five (25) years. NET INCOME PER COMMON SHARE The Company has adopted Statement of Financial Accounting Standards No. 128, Earnings Per Share (FAS 128) in the fourth quarter of 1997. FAS 128 requires the Company to use methods for calculating earnings per share that differ from methods used in prior periods and requires the Company to restate net income per common share reported in prior periods. The adoption of this statement had no effect on the results of operations, financial conditions, or long-term liquidity. CHANGE IN ACCOUNTING PRINCIPLE Effective January 1, 1995, one utility subsidiary changed its method of recognizing revenue from sales of natural gas to residential and small commercial customers. Previously, revenues from these customers were recognized when the accounts were billed. Revenues related to gas delivered after billing and before the end of a month were recognized in the following month. In 1995 the subsidiary began accruing estimated revenues from gas service provided but not billed consistent with the industry practice which more closely matches revenues with the period in which service is provided and related expenses are incurred. The cumulative effect of the change at December 31, 1994 was to increase net income $378,000, net of income taxes. The change had the effect of increasing 1995 net income (excluding the beginning of the year cumulative effect of $378,000) by $156,000. RECLASSIFICATIONS Certain reclassifications were made to the 1996 financial statements to conform with the 1997 presentation. (2) DEBT At December 31, 1997, the Company and its subsidiaries have committed bank lines of credit that in aggregate total $22,500,000, and uncommitted bank lines of credit that in aggregate total $45,000,000. At December 31, 1996, the amount of the lines was $12,000,000 and $24,000,000, respectively. The credit lines, which are unsecured, are reviewed annually. The Company expects to negotiate bank lines of credit in 1998 at levels appropriate to meet its requirements. During 1997 and 1996 the maximum amount borrowed under the lines of credit at any month end was $21,575,000 and $7,500,000, respectively. Average monthly borrowings ranged from zero to $19,536,000 in 1997 and from zero to $6,874,000 in 1996. The weighted average interest rate on borrowings under the lines of credit at December 31, 1997 and 1996 was 6.31% and 6.89%, respectively. Long-term debt at December 31, 1997 and 1996, less amounts payable in one year, consisted of the following (in thousands):
Annual installments Due date 1997 1996 - --------------------------------------------------------------------------------------------- Notes payable: 9.20% $ 1,500 2001 $ -- 3,000 9.59% 750 (commencing 1996) 2005 3,750 5,250 9.64% 375 (commencing 1996) 2010 5,625 6,375 8.70% 833 (commencing 2011) 2023 10,000 10,000 7.51% 1,818 (commencing 2004) 2014 20,000 20,000 6.70% 1,400 (commencing 1999) 2003 7,000 7,000 - --------------------------------------------------------------------------------------------- 46,375 51,625 Capital leases 54 69 - --------------------------------------------------------------------------------------------- $ 46,429 51, 694 - ---------------------------------------------------------------------------------------------
The terms of the Company's and a wholly owned subsidiary's long-term debt agreements contain, among other things, restrictions relating to the creation of debt, liens, investments, disposition of assets, mergers and consolidations, purchase of shares, acceleration of debt payments, maintenance of equity to debt ratios, and the payment of dividends. At December 3l, 1997, the payment of dividends by this subsidiary was limited to $4,900,000 by the terms of its long-term debt agreements. The subsidiary's net assets at December 31, 1997 were $32,634,000. Under the most respective provisions, the amount of consolidated retained earnings available for preferred and common stock dividends at December 31, 1997 was approximately $ 11,090,000. In 1997 the Company elected to exercise its option to double the annual installment payments on the 9.59% and 9.64% notes and to prepay the balance of the 9.2% notes. Maturities of long-term notes and capital leases for the next five years are as: 1998 - $1,235,000; 1999 - $2,579,000; 2000 - $2,525,000; 2001 - $2,525,000, and 2002 - $2,525,000. (3) REDEEMABLE PREFERRED STOCK In November 1991 the Company authorized the creation of 2,000,000 shares of $1.40 cumulative preferred stock (Preferred Stock). The Company issued one share of Preferred Stock for each share of common stock outstanding on December 16, 1991. The Preferred Stock is subject to mandatory redemption at $15 per share over a ten-year period beginning January 1, 2018. Additionally, commencing January 1, 1997, all or part of the outstanding preferred stock is redeemable at the option of the Company at $15 per share provided that 66-2/3% of preferred shareholders approve such redemption. During 1997 the Company did not redeem any preferred stock. (4) INCOME TAXES Income tax expense for 1997, 1996, and 1995 consisted of the following (in thousands):
1997 1996 1995 ----------------------------------------------------------------------------------------- Current: Federal $ 1,030 523 1,232 State 402 201 289 ---------------------------------------------------------------------------------------- 1,432 724 1,521 Deferred 2,568 3,093 1,778 Amortization of deferred investment tax credits (76) (76) (76) ---------------------------------------------------------------------------------------- $ 3,924 3,741 3,223 ----------------------------------------------------------------------------------------
In 1996 the Company received approval from the IRS to change its tax accounting method for cost of removal. The change in method, which is effective for the tax year beginning January 1, 1994, created a combination of timing differences and current tax benefits. Deferred taxes have been recorded recognizing the timing differences. The tax effects of temporary differences between book and tax accounting that give rise to the deferred tax assets and deferred tax liabilities at December 31, 1997 and 1996 consist of the following (in thousands):
1997 1996 ------------------------------------------------------------------------------------ Deferred tax assets: Unbilled revenues $ 1,467 1,170 Investment tax credit 1,308 1,360 Allowance for doubtful accounts 334 402 Contribution in aid of construction 1,197 1,016 Other 1,156 1,270 ----------------------------------------------------------------------------------- Total gross deferred tax assets 5,462 5,218 Deferred tax liabilities: Utility plant depreciation 18,897 16,827 Environmental expenditures 2,409 2,198 Change in tax accounting method for cost of removal 1,120 1,037 Unrecovered gas and transition costs 2,047 291 Other 1,433 1,073 ------------------------------------------------------------------------------------ Total gross deferred tax liabilities 25,906 21,426 ------------------------------------------------------------------------------------ Net deferred tax liabilities $ 20,444 16,208 ------------------------------------------------------------------------------------
The primary difference between the Company's income tax expense at the federal statutory rate of 34% and the effective tax rate is state income taxes and the reduction in current tax expense resulting from the 1996 approved change in tax accounting method. (5) RETIREMENT PLANS Effective January l, 1996, two noncontributory defined benefit plans sponsored by the Company were merged to form one plan. The Company funds accrued pension costs subject to limitations included in the Internal Revenue Code and the Employee Retirement Income Security Act of 1974. Net pension (income) cost for the pension plan(s) for 1997, 1996, and 1995 includes the following components (in thousands):
1997 1996 1995 ------------------------------------------------------------------------------------------ Service cost $ 729 809 618 Interest cost 1,640 1,679 1,575 Return on assets (includes insurance contract settlement) (4,121) (3,734) (4,748) Net amortization and deferral 1,832 1,229 2,814 ---------------------------------------------------------------------------------------- Net pension (income) cost $ 80 (17) 259 ---------------------------------------------------------------------------------------- The assumptions used by the pension plan(s) in determining the actuarial present value of the plan's benefit obligations are as follows: 1997 1996 1995 ----------------------------------------------------------------------------------------- Discount rate 7.25% 7.75% 7.00% Weighted-average rate of increase in future compensation levels 5% 5% 5% -----------------------------------------------------------------------------------------
The funded status of the pension plan(s) at December 31, 1997 and 1996 is as follows (in thousands): 1997 1996 ----------------------------------------------------------------------- Vested benefit obligation $ 18,396 15,622 Accumulated benefit obligation 19,565 16,619 Additional benefits related to future compensation levels 4,329 3,947 ------------------------------------------------------------------------ Projected benefit obligation 23,894 20,566 Plan assets at fair value (28,154) (24,984) ------------------------------------------------------------------------ (4,260) (4,418) Unrecognized transition amount 795 958 Unrecognized net gain 4,416 4,385 Unrecognized prior service cost (562) (615) ------------------------------------------------------------------------ Accrued pension cost $ 389 310 ------------------------------------------------------------------------ In 1996 the Company discontinued an investment contract with an insurance company that was used to manage approximately $7,000,000 of pension assets. At the time the contract was discontinued, there were approximately $2,700,000 of outstanding guaranteed annuities under the contract. The insurance company issued certificates to retirees to guarantee their pension benefits under the program; the balance of the pension assets were transferred to an investment manager for reinvestment. Settlement of the investment contract resulted in a reduction of $343,000 to 1996 pension cost. Pension plan assets consist primarily of common stock and fixed income securities. The Company also sponsors an unfunded nonqualified Supplemental Executive Retirement Plan (SERP) which provides additional retirement benefits to certain employees. Effective February 1, 1996, the Company established an unfunded nonqualified retirement program for the benefit of its Board of Directors. The actuarially determined projected benefit obligation for the two nonqualified plans was $440,000 at December 31,1997 and $433,000 at December 31, 1996. Net expense re1ated to these plans was $72,000 in 1997, $229,000 in 1996, and $60,000 in 1995. Benefit payments under both plans are made directly by the Company to plan participants or their beneficiaries. In addition to providing pension benefits, the Company provides certain health care and life insurance benefits for retired employees of one subsidiary. These benefits are provided through an insurance company, and substantially all of the subsidiary's employees will become eligible for them if they reach their retirement age while working for the subsidiary. Up to and including December 31, 1994, the subsidiary recognized the cost of providing these benefits for retirees on the "pay as you go" basis. In the first quarter of 1995 the Company adopted the provisions of Statement of Accounting Standards No. 106 (FAS 106), Employers' Accounting for Postretirement Benefits Other than Pensions (PBOPs), issued by the Financial Accounting Standards Board in December 1990. FAS 106 requires the expected cost of PBOPs to be recognized on an accrual basis as employees perform services to earn the benefits. Also, during the first quarter of 1995, the Company filed a rate increase request with the PAPUC, which among other things, sought authorization for the recognition in rates of the cost of PBOPs on an accrual basis instead of the "pay as you go" basis. On September 27, 1995, the PAPUC adopted an order authorizing an increase in the Company's rates and the recovery of the cost of PBOPs in accordance with FAS 106. The Company recorded a liability of $435,000 and an associated regulatory asset representing the estimated FAS 106 costs incurred from January 1, 1995 to September 27, 1995 and began a five-year amortization of these costs in October 1995. The Pennsylvania Office of Consumer Advocate appealed the PAPUC's decision. In May 1997 the Commonwealth Court of Pennsylvania affirmed the PAPUC's decision concerning the Company's recovery of the $435,000 deferred cost. The Company has established trust funds for the deposit of FAS 106 costs being recovered through its rates. Net periodic PBOP expense in 1997, 1996, and 1995 consists of the following components (in thousands):
1997 1996 1995 ----------------------------------------------------------------------------------- Service cost $ 63 93 80 Interest cost 447 555 530 Return on assets (32) (66) - Net amortization and deferral 186 431 310 ---------------------------------------------------------------------------------- Net periodic post-retirement benefit expense $ 664 1,013 920 ---------------------------------------------------------------------------------
The funded status of the p1an at December 31, 1997 and 1996 is as follows (in thousands):
1997 1996 -------------------------------------------------------------------------------------- Accumulated post-retirement benefit obligation (APBO) As of December 31, 1997 and 1996: Fully eligible active employees $ 1,350 1,803 Other active employees 1,278 1,743 Retirees 3,651 4,292 ------------------------------------------------------------------------------------- 6,279 7,838 Plan assets at fair value (1,908) (1,157) ------------------------------------------------------------------------------------- Accumulated obligation in excess of plan assets 4,371 6,681 Unrecognized net transition obligation (5,330) (5,640) Unrecognized net gain (loss) 732 (778) ------------------------------------------------------------------------------------- Accrued (prepaid) postretirement benefit cost $ (227) 263 -------------------------------------------------------------------------------------
The discount rate used in determining the benefit obligation was 7.25% for 1997 and 7.75% for 1996. Annual rates of increase in the per capita cost of covered health care benefits of 10.10% and 11.20% were assumed for 1997 based on the age of plan participants. The Company assumed rates for 1996 were 10.6% and 11.8%. The rates were assumed to decrease gradually to 5.5% over ten years in both 1997 and 1996 and remain level thereafter. The health care cost trend rate assumption has a significant effect on amounts reported. For example, increasing the assumed health care cost trend rates by one percentage point would increase the APBO as of December 31, 1997 by $309,000 and the net periodic postretirement benefit expense for the year then ended by $24,000. As of December 31, 1996, the APBO would increase $386,000 and the net periodic postretirement benefit expense would increase $30,000 if a one percentage point increase in the health care cost trend rates was assumed. (6) REGULATORY MATTERS A $5,712,000 refund to its customers was included in the Company's annual purchased gas cost filing submitted to the PAPUC on August 31, 1995. Included in the refund was approximately $2,600,000 deferred in 1994 plus interest. The PAPUC granted the Company authorization to refund the amount as a lump-sum bill credit during December 1995. The balance of $2,969,000 was included as a refund in rates changed to customers during the period of November 1, 1995 through November 30, 1996. Revised rates for the recovery of the Company's purchased gas costs were approved by the PAPUC effective December l, 1996. The Company and the parties who participated in purchased gas cost proceedings agreed that $895,000 of cost for pipeline capacity that the Company would not need to meet its firm sales requirements during the next three winters (stranded costs) could be claimed through rates established under a different docket. The Company's filing in support of the recovery of these stranded costs through a component of the Company's existing transition surcharge was approved by the PAPUC by its order dated October 6, 1997. Formulae for the calculation and allocation of stranded costs consistent with the order were utilized in the purchased gas cost recovery proceeding which was approved by the PAPUC effective December 1, 1997. On January 27, 1995, the Company filed a rate increase request with the PAPUC seeking an increase in annual revenues of $5,022,000. The filing covered approximately half of the Company's utility customers. On September 27, 1995, the PAPUC adopted an order authorizing an increase in annual operating revenues of $2,247,000 effective on one day's notice for service rendered after September 27, 1995. The annual increase includes an allowance for the recovery of the cost of PBOPs calculated in accordance with FAS 106, including recovery and amortization over five years of such costs deferred from January 1, 1995 to September 27, 1995, as discussed in note 5. On February 27, 1996, the Company's two wholly owned public utility subsidiaries filed a request with the PAPUC for an increase in annual revenues of $10,955,000 and authorization to consolidate the tariffs of the two subsidiaries into one tariff and one set of rates. In October 1996 final approval of a settlement resolving the issues was received from the PAPUC. Under the settlement, the Companies were permitted to consolidate their tariffs and increase their rates to produce additional annual operating revenues of $6,725,000. Gas supply cost, including contracts with pipelines for delivery service (capacity cost), storage service and the cost of natural gas purchased for sale and delivery to customers is the Company's largest cost. The Company's tariffs provide for the recovery of these costs subject to regulatory review and approval. Rates to recover gas supply costs are based on projections of the volume of gas the Company will purchase; the cost of these purchases and the amount of gas its sales customers will use. Deviations between such projections and actual experience cause over or under recovery of the costs from customers which are adjusted in the Company's filings with the PAPUC and either refunded or collected. At December 31, 1997, the Company's undercollection resulting from past recovery of gas costs was $3,275,000, which is currently being recovered under rates that went into effect on December 1, 1997 and were adjusted on March 1, 1998. At December 31, 1996, the Company's rates for the recovery of gas costs plus its rates authorized to recover pipeline transition costs resulted in undercollection from customers of $370,000. At December 31, 1995, the Company overcollected gas and transition costs in the amount of $3,080,000 which has been paid back to the customers with interest. (7) COMMITMENTS AND CONTINGENCIES The Company and its subsidiaries are present or past owners of approximately 26 properties on which manufactured gas plants (MGP) were located. On March 27, 1996, the Company, North Penn Gas Company (North Penn), a wholly owned subsidiary of the Company, and the Pennsylvania Department of Environmental Protection (PADEP) signed a Consent Order and Agreement (1996 COA). This agreement, except for certain provisions which have been incorporated by reference, supersedes a previous COA signed in 1993. One such MGP site is the subject of separate agreements with the United States Environmental Protection Agency (USEPA). On January 1, 1997, the Company adopted AICPA Statement of Position 96-l, Environmental Remediation Liabilities. The impact of adopting the statement was not material. The 1996 COA provides that from 1996 through the year 2011 the Company will perform a minimum amount of work per year to investigate, and where necessary, clean up twenty (20) MGP sites and that North Penn will plug all of its non-producing wells. The 1996 COA has a term of 15 years, but may be terminated by either party after five years. Progress on the investigation, clean-up and well plugging activities covered by the 1996 COA will be measured through a point system, which is based on addressing the highest risks earlier in the process. In any year in which the Company's and North Penn's environmental costs defined by the 1996 COA exceed $1,750,000 (Environmental Cost Cap), the Company will not be required to achieve the minimum required points except that North Penn must meet the well plugging schedule set forth in the agreement regardless of whether the minimum required points or the Environmental Cost Cap are reached. The point system gives the Company and North Penn some flexibility in determining the activities to be undertaken in a given year, however, the 1996 COA does not relieve or limit the Company s or North Penn's obligation to comply with applicable statutes or regulations. The Company and North Penn satisfied the 1996 COA's minimum point requirement during 1997 and 1996. PADEP has approved the Company's 1998 annual plan. North Penn's estimate of the cost to plug the wells covered by the 1996 COA is $3,846,000 at December 31, 1997 and $4,038,000 at December 31, 1996. After recognizing North Penn's estimated well plugging cost, the Company allocated the balance of the Environmental Cost Cap to MGP site activities for the purposes of estimating the related total commitment under the 1996 COA. The estimated present value of the portion of the Environmental Cost Cap allocated to MGP site activities plus oversight cost reimbursements owed to PADEP during the term of the agreement is $15,657,000 at December 31, 1997 and $15,728,000 at December 31, 1996. The estimated present value was determined based on interest rates for United States Treasury obligations with maturities that coincide with the term of the 1996 COA. The Company has adopted the present value of its estimated total Environmental Cost Cap under the 1996 COA as the low end of the range of costs that may be incurred in connection with MGP site activities. A liability of $15,657,000 and an associated regulatory asset of $14,757,000 have been recorded at December 31, 1997. A liability of $15,728,000 and an associated regulatory asset of $15,115,000 were recorded at December 31, 1996. The Company's actual costs will depend on a number of factors including actual site conditions determined through the site assessment process, changing technology, government statutes and regulations, success in pursuing claims against and finalizing cost sharing arrangements with other potentially responsible parties and recoveries from insurers. At December 31, 1997, the Company estimated a range of environmental liability for the MGP sites of $8,772,000 and $37,018,000. At December 31, 1996 the estimated range was $9,517,000 to $38,702,000. In September 1994 the Company initiated a suit against some of its insurers seeking defense and/or indemnification from the insurers against claims involving former MGP sites. On April 21, 1998, the Company reached a settlement with one of its general liability insurers regarding claims arising from its current or former ownership of MGP sites and a compressor station at an underground storage field. The Company expects to receive the amount of the settlement in a lump sum cash payment during the second quarter of 1998. By agreement, the amount and terms of the settlement, which will provide funding that is material to the Company's accrued environmental liabilities as of December 31, 1997, are confidential. The Company estimates that approximately 89% of the amount provided for in the settlement applies to utility sites and 11% to nonutility sites. The proceeds attributable to the utility sites will be recorded as an offset to environmental and clean up expenditures capitalized by the Company and amortized over five years beginning in 1999. The amount of the settlement related to nonutility sites will be recognized as income in 1998. Localized minor amounts of petroleum hydrocarbon impacted soils have been identified in the process of removing and abandoning equipment at a former compressor station site. The removal and abandonment project was undertaken in accordance with a plan approved by state and federal environmental agencies. During 1997 a plan to remediate the impacted soil was developed and implemented. After reviewing the Company's report on the work performed, PADEP requested the Company to develop a plan for additional sampling at the site. The plan is scheduled to be submitted in the second quarter of 1998. The USEPA has concluded that removal of groundwater contamination at the Brodhead Creek superfund site is technically impractical, but has requested that certain wells be periodically monitored unless and until new technology becomes available. The costs incurred by the Company for work related to the impacted soils and Brodhead Creek will be counted against the Environmental Cost Cap included in the 1996 COA. The Company has received authorization from the PAPUC to capitalize environmental and cleanup expenditures and well plugging costs for accounting and ratemaking purposes and to amortize such expenditures over five years. The Company expects the PAPUC will continue to authorize the recovery of such expenditures associated with MGP sites previously or currently owned by its utility subsidiaries and the costs of plugging wells through the rates the Company charges for its services. Accruals sufficient to provide for the minimum range of costs associated with nonutility sites have been charged to expense. Such accruals which amounted to $900,000 and $613,000 at December 31, 1997 and December 31, 1996, respectively, are included in the accrued environmental liability reflected in the Company's balance sheet. Additional investigation and remediation may be required at the sites in the future, however, the scope of these activities cannot be determined and therefore any related cost has not been accrued. (8) COMMON STOCK The Company has a Stock Option Agreement under which 14,350 shares were granted in 1992. The options vest and become exercisable on a pro rata basis during a seven year period commencing in 1995. There are 6,027 options outstanding at December 31, 1997 exercisable at a price of $54.48 per share. The options will become fully vested concurrent with a change in control (as defined) of the Company. The proposed merger discussed in note 12 meets the definition of a change in control. (9) FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amount of current assets and liabilities which are considered financial instruments approximates their fair value as of the dates presented. The carrying amounts and estimated fair values of the Company's long-term financial liabilities as of December 31, 1997 are as follows (in thousands): Carrying Estimated amount fair value ----------------------------------------------------------------------- Long-term debt $ 46,375 50,327 Redeemable preferred stock 10,764 15,069 ---------------------------------------------------------------------- The fair value of long-term debt and preferred stock has been estimated based on market rates for similar instruments with approximately the same maturities. Management believes that the prepayment provisions of the Company's long-term debt do not make it economically feasible to refinance the debt at this time. (10) NET INCOME PER COMMON SHARE In December 1997 the Company adopted FAS 128, Earnings Per Share, which prescribes two methods for calculating earnings per common share: "Basic" and "Diluted" methods. These calculations differ from those used in prior periods and as a result all prior period net income per common share data reflect the adoption of FAS 128. Basic net income per common share is based on the weighted average number of common shares outstanding. Diluted net income per common share is based on the weighted average number of common shares outstanding and potentially dilutive effect of employee stock options. The adoption of this statement had no effect on the results of operations, financial conditions, or long-term liquidity of the Company. The following table summarizes the shares used in computing basic and diluted net income per common share:
Year ended December 31, ----------------------------------------------------------- 1997 1996 1995 ----------------------------------------------------------------------------------------------------------- Average common shares outstanding during the period for the Basic Computation 717,583 717,583 717,583 Dilutive effect of employee stock options 8,919 2,630 2,921 ----------------------------------------------------------------------------------------------------------- Average common shares outstanding during the period for Diluted computation. 726,502 720,213 720,504 -----------------------------------------------------------------------------------------------------------
(11) OPERATING LEASES Future minimum rental payments in the aggregate and for each of the five succeeding years and thereafter (in thousands): 1998 $ 1,086 1999 941 2000 657 2001 258 2002 100 Thereafter 61 ---------------------------------------- Total $ 3,103 ---------------------------------------- (12) ACQUISITION OF COMPANY On June 27, 1997, the Company and PP&L Resources, Inc. (PP&L) announced they had signed a definitive agreement under which PP&L will acquire the Company. Under the terms of the agreement, upon consummation of the merger, which is subject to the receipt of various regulatory approvals, common stockholders of the Company will receive, subject to certain adjustments, between 6.968 and 8.516 shares of PP&L common stock for each share of the Company that they own. Penn Fuel's shareholders approved the merger in October 1997. The Company's preferred stock may be redeemed in accordance with its terms upon written approval of holders of at least 66 2/3% of the preferred shares outstanding, at a redemption price of $15 per share, plus accrued and unpaid dividends. Owners of more than 93.5% of the total number of the preferred shares outstanding as of July 31, 1997 have indicated their intent to provide the shareholder approval required for such redemption. Each share of preferred stock outstanding that is not redeemed in accordance with its terms will be converted into the right to receive between 0.682 and 0.833 shares of PP&L common stock, subject to certain adjustments. Costs including retention, severance payments, and other costs related to the proposed merger that are contingent upon its consummation have not been recognized in the Company's financial statements. If incurred, the aggregate amount of such costs are expected to be material to the Company's results of operations. Pending receipt of the required regulatory approvals it is expected that the merger can be completed in the summer of 1998. PENN FUEL GAS, INC. AND SUBSIDIARIES Selected Financial Data Year ended December 31, 1997 (in thousands, except per share data)
- ----------------------------------------------------------------------------------------------------------------------- 1997 1996 1995 1994 1993 - ----------------------------------------------------------------------------------------------------------------------- Operating revenues $ 119,213 113,507 105,647 123,410 115,812 Cost of sales 53,174 51,893 48,675 67,188 63,432 Other operating expenses 54,153 50,287 47,644 46,035 42,940 - ----------------------------------------------------------------------------------------------------------------------- Operating income 11,886 11,327 9,328 10,187 9,440 Interest expense 4,488 4,362 4,731 4,347 4,320 Other (income) expense 206 (429) (1,102) 135 (185) - ----------------------------------------------------------------------------------------------------------------------- Income before cumulative effect of a change in accounting principle 7,192 7,394 5,699 5,705 5,305 Cumulative effect on prior years (to December 31, 1994) of change to record unbilled revenue, net of tax -- -- 378 -- -- - ----------------------------------------------------------------------------------------------------------------------- Net income $ 7,192 7,394 6,077 5,705 5,305 - ----------------------------------------------------------------------------------------------------------------------- Net income per common share (based on weighted average number of shares outstanding) - Basic $ 8.62 8.90 7.07 6.55 5.99 - ----------------------------------------------------------------------------------------------------------------------- Cash dividends per preferred share $ 1.40 1.40 1.40 1.40 1.40 - ----------------------------------------------------------------------------------------------------------------------- Cash dividends per common share $ 2.88 2.40 2.00 -- -- - ----------------------------------------------------------------------------------------------------------------------- Total assets $ 207,989 196,465 184,277 174,367 159,236 - ----------------------------------------------------------------------------------------------------------------------- Property, plant, and equipment, net $ 149,716 141,292 132,602 122,897 115,237 - ----------------------------------------------------------------------------------------------------------------------- Capitalization: Stockholders' equity $ 70,865 66,745 62,078 58,441 53,741 Redeemable preferred stock 10,764 10,764 10,764 10,764 10,764 Long-term debt 46,429 51,694 55,644 58,904 34,995 - ----------------------------------------------------------------------------------------------------------------------- $ 128,058 129,203 128,486 128,109 99,500 Notes payable and long-term debt payable within one year 21,710 10,439 3,568 2,266 24,395 - ----------------------------------------------------------------------------------------------------------------------- $ 149,768 139,642 132,054 130,375 123,895 - ----------------------------------------------------------------------------------------------------------------------- PENN FUEL GAS, INC. AND SUBSIDIARIES Statistical Review Year ended December 31, 1997 (converted to thousands) - ----------------------------------------------------------------------------------------------------------------------- 1997 1996 1995 1994 1993 - ----------------------------------------------------------------------------------------------------------------------- Throughput - DTH: (in thousands) (unaudited): Utility: Sales: Residential 6,866 7,316 6,513 6,790 6,597 Commercial 4,121 4,500 4,737 4,865 4,643 Industrial 1,474 2,282 2,303 4,017 4,423 Resale 11 11 64 161 307 - ----------------------------------------------------------------------------------------------------------------------- 12,472 14,109 13,617 15,833 15,970 Transportation 13,824 12,666 13,071 9,613 9,177 - ----------------------------------------------------------------------------------------------------------------------- 26,296 26,775 26,688 25,446 25,147 Liquefied petroleum 788 841 830 865 857 - ----------------------------------------------------------------------------------------------------------------------- Total 27,084 27,616 27,518 26,311 26,004 - ----------------------------------------------------------------------------------------------------------------------- Operating revenues (in thousands): Utility: Sales: Residential $ 54,249 47,914 40,025 47,377 42,358 Commercial 27,240 25,418 25,990 29,183 25,936 Industrial 7,857 10,681 11,339 20,124 21,039 Resale 56 49 222 682 1,120 - ----------------------------------------------------------------------------------------------------------------------- 89,402 84,062 77,576 97,366 90,453 Storage 6,388 6,157 5,570 5,101 5,167 Transportation 9,760 8,897 8,458 6,899 6,883 Other 919 677 1,483 843 583 - ----------------------------------------------------------------------------------------------------------------------- 106,469 99,793 93,087 110,209 103,086 Liquefied petroleum 11,604 12,294 11,009 11,648 11,359 - ----------------------------------------------------------------------------------------------------------------------- 118,073 112,087 104,096 121,857 114,445 Merchandise 1,140 1,420 1,551 1,553 1,367 - ----------------------------------------------------------------------------------------------------------------------- Total $ 119,213 113,507 105,647 123,410 115,812 - ----------------------------------------------------------------------------------------------------------------------- Customer (unaudited): Utility: Sales: Residential $ 62,414 61,504 60,688 59,130 58,068 Commercial 9,025 8,954 8,865 8,655 8,694 Industrial 265 302 323 342 356 Resale 2 2 2 2 3 - ----------------------------------------------------------------------------------------------------------------------- 71,706 70,762 69,878 68,130 67,121 Transportation 176 124 118 92 62 - ----------------------------------------------------------------------------------------------------------------------- 71,882 70,886 69,996 68,222 67,183 Liquefied petroleum 27,549 28,021 28,260 29,935 30,338 - ----------------------------------------------------------------------------------------------------------------------- Total 99,431 98,907 98,256 98,157 97,521 - ----------------------------------------------------------------------------------------------------------------------- Total degree days (unaudited) 5,089 5,494 5,223 5,411 5,352 - ----------------------------------------------------------------------------------------------------------------------- Percent of degree days to thirty-year average (unaudited) 95.3% 102.7% 97.7% 101.2% 100.1% - -----------------------------------------------------------------------------------------------------------------------
PENN FUEL GAS, INC. AND SUBSIDIARIES Board of Directors and Corporate Information - ------------------------------------------------------------------------------------------------------------------ BOARD OF DIRECTORS PENN FUEL GAS, INC. OFFICERS Carol W. Gates (2) Terry H. Hunt Oxford Advisory Board, Fulton Bank President and Chief Executive Officer Terry H. Hunt (l) George C. Rhodes, Sr. President and CEO, Penn Fuel Gas, Inc. Senior Vice President, Utility Operations and subsidiaries and Engineering Director, UTI Energy Corp. Ronald J. Frederick Marilyn Ware Lewis (1) (3) Vice President, Human Resources Chairman, American Water Works and Administration Company, Inc. Director, CIGNA Corporation Edward L. McCusker Director, PP&L Resources, Inc. Vice President and Treasurer W. Kirk Liddell (2) Charles C. Rogala President and CEO, Irex Corporation Vice President, Utility Operations Director, High Industries, Inc. Director, CoreStates Central/Northern George W. Ruth Regional Board Vice President, Gas Supply Loren D. Mellendorf (2) (3) Eleanor R. Ross Retired Executive Vice President, Secretary American Water Works Company, Inc. John P. Nitsche John H. Ware, IV (2) Assistant Secretary Director, Subsidiaries of American Water Works Company, Inc. SUBSIDIARIES Paul W. Ware (l) (2) (3) Chairman, Penn Fuel Gas, Inc. and subsidiaries PFG Gas, Inc. Director, American Water Works Company, Inc. North Penn Gas Company Director, The York Water Company Richard P. Wild (l) (3) Partner, Dechert Price & Rhoads
Committees: (1)Executive Committee (2) Audit Committee (3) Compensation Committee -----END PRIVACY-ENHANCED MESSAGE-----