United States Securities and Exchange CommissionWashington, D.C. 20549
Form 10-QQUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended December 31, 2001
Commission File Number 1-3880
National Fuel Gas Company(Exact name of registrant as specified in its charter)
(Address of principal executive offices)
(716) 857-7000(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months and (2) has been subject to such filing requirements for the past 90 days. YES X NO
Indicate the number shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date:
Common Stock, $1 Par Value, outstanding at January 31, 2002: 79,637,354 shares.
INDEX
Part I. Financial Information PageItem 1. Financial Statements a. Consolidated Statements of Income and Earnings Reinvested in the Business - Three Months Ended December 31, 2001 and 2000 4 b. Consolidated Balance Sheets - December 31, 2001 and September 30, 2001 5 - 6 c. Consolidated Statement of Cash Flows - Three Months Ended December 31, 2001 and 2000 7 d. Consolidated Statement of Comprehensive Income - Three Months Ended December 31, 2001 and 2000 8 e. Notes to Consolidated Financial Statements 9 - 13 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 14 - 30 Item 3. Quantitative and Qualitative Disclosures About Market Risk 30Part II. Other InformationItem 1. Legal Proceedings 30 Item 2. Changes in Securities 30 Item 3. Defaults Upon Senior Securities o Item 4. Submission of Matters to a Vote of Security Holders 31 Item 5. Other Information 31 Item 6. Exhibits and Reports on Form 8-K 31 - 32 Signature 33 o The Company has nothing to report under this item.
Reference to "the Company" in this report means the Registrant or the Registrant and its subsidiaries collectively, as appropriate in the context of the disclosure. All references to a certain year in this report are to the Company's fiscal year ended September 30 of that year, unless otherwise noted.
This Form 10-Q contains "forward-looking statements" within the meaning of Section 21E of the Securities Exchange Act of 1934. Forward-looking statements should be read with the cautionary statements and important factors included in this Form 10-Q at Item 2 "Management's Discussion and Analysis of Financial Condition and Results of Operations" (MD&A), under the heading "Safe Harbor for Forward-Looking Statements." Forward-looking statements are all statements other than statements of historical fact, including, without limitation, those statements that are designated with an asterisk ("*") following the statement, as well as those statements that are identified by the use of the words "anticipates," "estimates," "expects," "intends," "plans," "predicts," "projects," and similar expressions.
Part I. Financial InformationItem 1. Financial Statements
National Fuel Gas CompanyConsolidated Statements of Income and EarningsReinvested in the Business(Unaudited)
Three Months Ended December 31, (Thousands of Dollars, Except Per Common Share Amounts) 2001 2000 ----------------- ----------------- INCOMEOperating Revenues $394,108 $549,999 - -------------------------------------------------------------------------------- ----------------- -----------------Operating ExpensesPurchased Gas 131,187 263,575 Fuel Used in Heat and Electric Generation 15,618 16,064 Operation 99,488 96,324 Maintenance 5,058 4,967 Property, Franchise and Other Taxes 17,205 21,453 Depreciation, Depletion and Amortization 44,045 39,136 Income Taxes 22,709 33,359 - -------------------------------------------------------------------------------- ----------------- ----------------- 335,310 474,878 - -------------------------------------------------------------------------------- ----------------- -----------------Operating Income 58,798 75,121Other Income 2,133 8,165 - -------------------------------------------------------------------------------- ----------------- -----------------Income Before Interest Charges and Minority Interest in Foreign Subsidiaries 60,931 83,286 - -------------------------------------------------------------------------------- ----------------- -----------------Interest ChargesInterest on Long-Term Debt 21,921 19,058 Other Interest 5,180 10,329 - -------------------------------------------------------------------------------- ----------------- ----------------- 27,101 29,387 - -------------------------------------------------------------------------------- ----------------- -----------------Minority Interest in Foreign Subsidiaries (623) (915) - -------------------------------------------------------------------------------- ----------------- -----------------Net Income Available for Common Stock 33,207 52,984 EARNINGS REINVESTED IN THE BUSINESS Balance at October 1 513,488 525,847 - -------------------------------------------------------------------------------- ----------------- ----------------- 546,695 578,831 Dividends on Common Stock (2001 - $0.2525; 2000 - $0.24) 20,061 18,891 - -------------------------------------------------------------------------------- ----------------- -----------------Balance at December 31 $526,634 $559,940 ================================================================================ ================= =================Earnings Per Common Share:Basic $0.42 $0.67 ================================================================================ ================= ================= Diluted $0.41 $0.66 ================================================================================ ================= =================Weighted Average Common Shares Outstanding:Used in Basic Calculation 79,471,820 78,760,226 ================================================================================ ================= ================= Used in Diluted Calculation 80,417,092 80,346,348 ================================================================================ ================= ================= See Notes to Consolidated Financial Statements
Item 1. Financial Statements (Cont.)
National Fuel Gas CompanyConsolidated Balance Sheets
December 31, 2001 September 30, (Unaudited) 2001 - ---------------------------------------------------------------------------- -------------------- ------------------- (Thousands of Dollars) ASSETSProperty, Plant and Equipment $4,324,694 $4,273,716 Less - Accumulated Depreciation, Depletion and Amortization 1,534,860 1,493,003 - ---------------------------------------------------------------------------- -------------------- ------------------- 2,789,834 2,780,713 - ---------------------------------------------------------------------------- -------------------- -------------------Current AssetsCash and Temporary Cash Investments 34,610 36,227 Receivables - Net 141,350 131,726 Unbilled Utility Revenue 61,109 25,375 Gas Stored Underground 54,658 83,231 Materials and Supplies - at average cost 34,510 33,710 Unrecovered Purchased Gas Costs 7,005 4,113 Prepayments 29,214 39,520 - ---------------------------------------------------------------------------- -------------------- ------------------- 362,456 353,902 - ---------------------------------------------------------------------------- -------------------- -------------------Other AssetsRecoverable Future Taxes 86,586 86,586 Unamortized Debt Expense 19,984 19,796 Other Regulatory Assets 23,560 23,253 Deferred Charges 7,421 9,136 Fair Value of Derivative Financial Instruments 41,824 37,585 Other 131,972 134,595 - ---------------------------------------------------------------------------- -------------------- ------------------- 311,347 310,951 - ---------------------------------------------------------------------------- -------------------- ------------------- $3,463,637 $3,445,566 ============================================================================ ==================== =================== See Notes to Consolidated Financial Statements
December 31, 2001 September 30, (Unaudited) 2001 -------------------- ------------------- (Thousands of Dollars) CAPITALIZATION AND LIABILITIESCapitalization: Comprehensive Shareholders' EquityCommon Stock, $1 Par Value Authorized - 200,000,000 Shares; Issued And Outstanding - 79,524,257 Shares and 79,406,105 Shares, Respectively $ 79,524 $ 79,406 Paid in Capital 432,582 430,618 Earnings Reinvested in the Business 526,634 513,488 - ---------------------------------------------------------------------------- -------------------- ------------------- Total Common Shareholder Equity Before Items of Other Comprehensive Loss 1,038,740 1,023,512 Accumulated Other Comprehensive Loss (10,965) (20,857) - ---------------------------------------------------------------------------- -------------------- -------------------Total Comprehensive Shareholders' Equity 1,027,775 1,002,655Long-Term Debt, Net of Current Portion 1,195,452 1,046,694 - ---------------------------------------------------------------------------- -------------------- -------------------Total Capitalization 2,223,227 2,049,349 - ---------------------------------------------------------------------------- -------------------- -------------------Minority Interest in Foreign Subsidiaries 24,011 22,324 - ---------------------------------------------------------------------------- -------------------- -------------------Current and Accrued LiabilitiesNotes Payable to Banks and Commercial Paper 356,497 489,673 Current Portion of Long-Term Debt 110,583 109,435 Accounts Payable 89,538 118,505 Amounts Payable to Customers 43,537 51,223 Other Accruals and Current Liabilities 99,115 94,634 - ---------------------------------------------------------------------------- -------------------- ------------------- 699,270 863,470 - ---------------------------------------------------------------------------- -------------------- -------------------Deferred CreditsAccumulated Deferred Income Taxes 349,430 340,559 Taxes Refundable to Customers 16,865 16,865 Unamortized Investment Tax Credit 9,424 9,599 Other Deferred Credits 130,034 126,319 Fair Value of Derivative Financial Instruments 11,376 17,081 - ---------------------------------------------------------------------------- -------------------- ------------------- 517,129 510,423 - ---------------------------------------------------------------------------- -------------------- -------------------Commitments and Contingencies - - - ---------------------------------------------------------------------------- -------------------- ------------------- $3,463,637 $3,445,566 ============================================================================ ==================== =================== See Notes to Consolidated Financial Statements
National Fuel Gas CompanyConsolidated Statement of Cash Flows(Unaudited)
Three Months Ended December 31, ----------------------------------------- (Thousands of Dollars) 2001 2000 ------------------- ---------------------OPERATING ACTIVITIESNet Income Available for Common Stock $33,207 $52,984 Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities: Depreciation, Depletion and Amortization 44,045 39,136 Deferred Income Taxes 4,637 12,459 Minority Interest in Foreign Subsidiaries 623 915 Other 1,070 (26) Change in: Receivables and Unbilled Utility Revenue (44,865) (208,770) Gas Stored Underground and Materials and Supplies 27,880 (6,206) Unrecovered Purchased Gas Costs (2,892) (19,655) Prepayments 10,550 12,086 Accounts Payable (29,413) 77,845 Amounts Payable to Customers (7,686) (1,876) Other Accruals and Current Liabilities 4,407 68,389 Other Assets 8,825 350 Other Liabilities (1,713) 252 - ---------------------------------------------------------------------------- ------------------- ---------------------Net Cash Provided by Operating Activities 48,675 27,883 - ---------------------------------------------------------------------------- ------------------- ---------------------INVESTING ACTIVITIESCapital Expenditures (60,795) (69,319) Investment in Partnerships (383) (30) Other 15,848 8,229 - ---------------------------------------------------------------------------- ------------------- ---------------------Net Cash Used in Investing Activities (45,330) (61,120) - ---------------------------------------------------------------------------- ------------------- ---------------------FINANCING ACTIVITIESChange in Notes Payable to Banks and Commercial Paper (133,559) (137,938) Net Proceeds from Issuance of Long-Term Debt 148,977 197,294 Reduction of Long-Term Debt (1,537) (3,024) Dividends Paid on Common Stock (20,031) (18,844) Proceeds from Issuance of Common Stock 1,003 2,310 - ---------------------------------------------------------------------------- ------------------- ---------------------Net Cash Provided by (Used in) Financing Activities (5,147) 39,798 - ---------------------------------------------------------------------------- ------------------- ---------------------Effect of Exchange Rates on Cash 185 (1,806) - ---------------------------------------------------------------------------- ------------------- ---------------------Net Increase (Decrease) in Cash and Temporary Cash Investments (1,617) 4,755Cash and Temporary Cash Investments at October 1 36,227 32,125 - ---------------------------------------------------------------------------- ------------------- ---------------------Cash and Temporary Cash Investments at December 31 $34,610 $36,880 ============================================================================ =================== ===================== See Notes to Consolidated Financial Statements
National Fuel Gas CompanyConsolidated Statement of Comprehensive Income(Unaudited)
Three Months Ended December 31, ----------------------------------------- (Thousands of Dollars) 2001 2000 ------------------- --------------------- Net Income Available for Common Stock $33,207 $52,984 - ---------------------------------------------------------------------------- ------------------- --------------------- Other Comprehensive Income (Loss), Before Tax: Foreign Currency Translation Adjustment 2,909 8,606 Unrealized Gain on Securities Available for Sale 465 1,565 Unrealized Gain (Loss) on Derivative Financial Instruments 21,094 (42,039) Reclassification Adjustment for Realized (Gains) Losses on Derivative Financial Instruments in Net Income (10,822) 30,713 - ---------------------------------------------------------------------------- ------------------- --------------------- Other Comprehensive Income (Loss), Before Tax 13,646 (1,155) - ---------------------------------------------------------------------------- ------------------- --------------------- Income Tax Expense Related to Unrealized Gain on Securities Available for Sale Arising During the Period 162 548 Income Tax Expense (Benefit) Related to Unrealized Gain (Loss) on Derivative Financial Instruments Arising During the Period 7,846 (15,642) Reclassification Adjustment for Income Tax (Expense) Benefit on Realized (Gains) Losses from Derivative Financial Instruments In Income (4,254) 11,742 - ---------------------------------------------------------------------------- ------------------- --------------------- Income Taxes - Net 3,754 (3,352) - ---------------------------------------------------------------------------- ------------------- --------------------- Other Comprehensive Income (Loss), Before Cumulative Effect, Net of Tax 9,892 2,197 - ---------------------------------------------------------------------------- ------------------- --------------------- Cumulative Effect of Change in Accounting, Net of Tax - (69,767) - ---------------------------------------------------------------------------- ------------------- --------------------- Other Comprehensive Income (Loss), After Cumulative Effect, Net of Tax 9,892 (67,570) - ---------------------------------------------------------------------------- ------------------- --------------------- Comprehensive Income (Loss) $43,099 $(14,586) ============================================================================ =================== ===================== See Notes to Consolidated Financial Statements
National Fuel Gas CompanyNotes to Consolidated Financial Statements
Principles of Consolidation. The Company consolidates its majority owned entities. The equity method is used to account for minority owned entities. All significant intercompany balances and transactions are eliminated.
The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Quarterly Earnings.The Company, in its opinion, has included all adjustments that are necessary for a fair statement of the results of operations for the reported periods. The consolidated financial statements and notes thereto, included herein, should be read in conjunction with the financial statements and notes for the years ended September 30, 2001, 2000 and 1999 that are included in the Company’s 2001 Form 10-K. The 2002 consolidated financial statements will be examined by the Company’s independent accountants after the end of the fiscal year.
The earnings for the three months ended December 31, 2001 should not be taken as a prediction of earnings for the entire fiscal year ending September 30, 2002. Most of the Utility segment’s business is seasonal in nature and is influenced by weather conditions. Because of the seasonal nature of the Utility segment’s heating business, earnings during the winter months normally represent a substantial part of the Utility segment’s earnings for the entire fiscal year. The impact of abnormal weather on earnings during the heating season is partially reduced by the operation of a weather normalization clause (WNC) included in Distribution Corporation’s New York tariff. The WNC is effective for October through May billings. Distribution Corporation’s tariff for its Pennsylvania jurisdiction does not have a WNC. While the Pipeline and Storage segment’s business is influenced by weather conditions, Supply Corporation’s straight fixed-variable rate design, which allows for recovery of substantially all fixed costs in the demand or reservation charge, reduces the earnings impact of weather fluctuations.
Oil and Gas Exploration and Development Costs. Oil and gas property acquisition, exploration and development costs are capitalized under the full-cost method of accounting. All costs directly associated with property acquisition, exploration and development activities are capitalized, up to certain specified limits (the full-cost ceiling). The full-cost ceiling is calculated using proved reserve quantities and New York Mercantile Exchange reported pricing (adjusted to the location of the Company's reserves) at the end of each quarter. The quantities of the Company's proved reserves are based upon estimates by qualified Company geologists and engineers and at year-end are audited by independent petroleum engineers. If capitalized costs exceed the full-cost ceiling at the end of any quarter, a permanent impairment is required to be charged to earnings in that quarter.
At December 31, 2001, the Company’s capitalized costs under the full-cost method of accounting were below the full-cost ceiling. Since December 31, 2001, oil and gas prices have dropped to a level below the December 31, 2001 prices. If prices do not improve before March 31, 2002 and there are no other factors such as proved reserve additions to mitigate the lower ceiling that would be calculated by using such lower prices, the Company would be required to recognize an impairment at March 31, 2002. Due to the fact that the full-cost method of accounting requires the use of reserve estimates and commodity prices at March 31, 2002, and given the volatile nature of oil and gas prices, whether the Company must recognize an impairment, or the actual amount thereof, cannot be determined until March 31, 2002.
Consolidated Statement of Cash Flows. For purposes of the Consolidated Statement of Cash Flows, the Company considers all highly liquid debt instruments purchased with a maturity of generally three months or less to be cash equivalents.
Reclassification.Certain prior year amounts have been reclassified to conform with current year presentation.
Accumulated Other Comprehensive Income (Loss).The components of Accumulated Other Comprehensive Income (Loss) are as follows (in thousands):
At December 31, 2001 At September 30, 2001 -------------------- --------------------- Cumulative Foreign Currency Translation Adjustment $(36,184) $(39,093) Net Unrealized Gain on Derivative Financial Instruments 23,401 16,721 Net Unrealized Gain on Securities Available for Sale 1,818 1,515 -------- -------- Accumulated Other Comprehensive Loss $(10,965) $(20,857) ======== ========
Earnings Per Common Share. Basic earnings per common share is computed by dividing income available for common stock by the weighted average number of common shares outstanding for the period. Diluted earnings per common share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. The only potentially dilutive securities the Company has outstanding are stock options. The diluted weighted average shares outstanding shown on the Consolidated Statement of Income reflects the potential dilution as a result of these stock options as determined using the Treasury Stock Method.
The components of federal and state income taxes included in the Consolidated Statement of Income are as follows (in thousands):
Three Months Ended December 31, ---------------------------------------- 2001 2000 ------------------- -------------------- Operating Expenses: Current Income Taxes Federal $13,331 $13,656 State 4,556 3,835 Foreign 185 3,409 Deferred Income Taxes Federal 2,023 10,844 State 51 1,250 Foreign 2,563 365 - -------------------------------------------------- ------------------- -------------------- 22,709 33,359 Other Income: Deferred Investment Tax Credit (174) (175) Minority Interest in Foreign Subsidiaries (249) (407) - -------------------------------------------------- ------------------- -------------------- Total Income Taxes $22,286 $32,777 ================================================== =================== ====================
The U.S. and foreign components of income before income taxes are as follows (in thousands):
Three Months Ended December 31, 2001 2000 - ------------------------------------------------------------- ------------------- -------------------- U.S. $49,236 $76,751 Foreign 6,257 9,010 - ------------------------------------------------------------- ------------------- -------------------- $55,493 $85,761 ============================================================= =================== ====================
Total income taxes as reported differ from the amounts that were computed by applying the federal income tax rate to income before income taxes. The following is a reconciliation of this difference (in thousands):
Three Months Ended December 31, ---------------------------------------- 2001 2000 ------------------- -------------------- Income tax expense, computed at statutory rate of 35% $19,422 $30,016 Increase (reduction) in taxes resulting from: State income taxes 2,995 3,304 Depreciation 381 445 Foreign tax in excess of (less than) statutory rate 309 214 Miscellaneous (821) (1,202) - ------------------------------------------------------------- ------------------- -------------------- Total Income Taxes $22,286 $32,777 ============================================================= =================== ====================
Significant components of the Company's deferred tax liabilities (assets) were as follows (in thousands):
At December 31, 2001 At September 30, 2001 --------------------------------- ---------------------------- Deferred Tax Liabilities: Property, Plant and Equipment $394,017 $389,879 Other 28,483 27,047 - ------------------------------------------------------ --------------------------------- ---------------------------- Total Deferred Tax Liabilities 422,500 416,926 - ------------------------------------------------------ --------------------------------- ---------------------------- Deferred Tax Assets: Deferred Gas Costs (14,614) (20,178) Other (58,456) (56,189) - ------------------------------------------------------ --------------------------------- ---------------------------- Total Deferred Tax Assets (73,070) (76,367) - ------------------------------------------------------ --------------------------------- ---------------------------- Total Net Deferred Income Taxes $349,430 $340,559 ====================================================== ================================= ============================
Common Stock. During the three months ended December 31, 2001, the Company issued 118,152 shares of common stock under the Company’s stock and benefit plans.
On December 12, 2001, 600,000 stock options were granted at an exercise price of $22.28 per share.
Environmental Matters.The Company is subject to various federal, state and local laws and regulations relating to the protection of the environment. The Company has established procedures for the ongoing evaluation of its operations to identify potential environmental exposures and comply with regulatory policies and procedures. It is the Company’s policy to accrue estimated environmental clean-up costs (investigation and remediation) when such amounts can reasonably be estimated and it is probable that the Company will be required to incur such costs. At December 31, 2001, the Company has estimated its remaining clean-up costs related to former manufactured gas plant sites and third party waste disposal sites will be in the range of $5.3 million to $6.3 million. The minimum liability of $5.3 million has been recorded on the Consolidated Balance Sheet at December 31, 2001. Other than discussed in Note H of the 2001 Form 10-K (referred to below), the Company is currently not aware of any material additional exposure to environmental liabilities. However, adverse changes in environmental regulations or other factors could impact the Company.
For further discussion refer to Note H - Commitments and Contingencies under the heading “Environmental Matters” in Item 8 of the Company’s 2001 Form 10-K.
Other. The Company is involved in litigation arising in the normal course of business. The Company is involved in regulatory matters arising in the normal course of business that involve rate base, cost of service and purchased gas cost issues. While the resolution of such litigation or regulatory matters could have a material effect on earnings and cash flows in the year of resolution, none of this litigation, and none of these regulatory matters, are expected to have a material adverse effect on the financial condition of the Company at this time.
Note 5 – Business Segment Information. The Company has six reportable segments: Utility, Pipeline and Storage, Exploration and Production, International, Energy Marketing and Timber. The breakdown of the Company’s reportable segments is based upon a combination of factors including differences in products and services, regulatory environment and geographic factors.
The data presented in the tables below reflect the reportable segments and reconciliations to consolidated amounts. There have been no changes in the basis of segmentation nor in the basis of measuring segment profit or loss from those used in the 2001 Form 10-K. There have been no material changes in the amount of assets for any operating segment from the amounts disclosed in the 2001 Form 10-K.
Item 1. Financial Statements (Concl.)
Quarter Ended December 31, 2001 (Thousands) - --------------------------------------------------------------------------------------------------------------------------------------- Pipeline Exploration Total Corporate and and and Energy Reportable Intersegment Total Utility Storage Production International Marketing Timber Segments All Other Eliminations Consolidated - --------------------------------------------------------------------------------------------------------------------------------------- Revenue from External Customers $222,355 $20,794 $75,000 $30,538 $32,785 $10,331 $391,803 $2,305 $ - $394,108 Intersegment Revenues 5,633 22,151 - - - - 27,784 63 (27,847) - Segment Profit (Loss): Net Income 18,041 10,014 1,441 993 1,948 1,538 33,975 5 (773) 33,207 Quarter Ended December 31, 2000 (Thousands) - --------------------------------------------------------------------------------------------------------------------------------------- Pipeline Exploration Total Corporate and and and Energy Reportable Intersegment Total Utility Storage Production International Marketing Timber Segments All Other Eliminations Consolidated - --------------------------------------------------------------------------------------------------------------------------------------- Revenue from External Customers $348,131 $20,432 $91,749 $31,224 $48,186 $10,937 $550,659 $(660) $ - $549,999 Intersegment Revenues 6,037 22,233 - - - - 28,270 1,959 (30,229) - Segment Profit (Loss): Net Income 18,287 6,595 23,001 2,240 1,344 2,396 53,863 (732) (147) 52,984
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
RESULTS OF OPERATIONS
Critical Accounting Policies
The Company has prepared its consolidated financial statements in conformity with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. For a complete discussion of the Company's significant accounting policies, refer to Note A in Item 8 of the Company's 2001 Form 10-K. A summary of the Company's most critical accounting policies follows:
Regulation. The Company is subject to regulation by certain state and federal authorities. The Company has accounting policies which conform to Statement of Financial Accounting Standards No. 71, "Accounting for the Effect of Certain Types of Regulation" and which are in accordance with the accounting requirements and ratemaking practices of the regulatory authorities. The application of these accounting policies allows the Company to defer expenses and income on the balance sheet as regulatory assets and liabilities when it is probable that those expenses and income will be allowed in the ratesetting process in a period different from the period in which they would have been reflected in the income statement by an unregulated company. These deferred regulatory assets and liabilities are then flowed through the income statement in the period in which the same amounts are reflected in rates. If, for any reason, the Company ceases to meet the criteria for application of regulatory accounting treatment for all or part of its operations, the regulatory assets and liabilities related to those portions ceasing to meet such criteria would be eliminated from the balance sheet and included in the income statement for the period in which the discontinuance of regulatory accounting treatment occurs. Such amounts would be classified as an extraordinary item.
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (Cont.)
Earnings
The Company's earnings were $33.2 million, or $0.42 per common share ($0.41 per common share on a diluted basis), for the quarter ended December 31, 2001. This compares to earnings of $53.0 million, or $0.67 per common share ($0.66 per common share on a diluted basis), for the quarter ended December 31, 2000. The decrease in earnings of $19.8 million is primarily the result of lower earnings in the Exploration and Production segment. Additional discussion of earnings in each of the business segments can be found in the business segment information that follows.
Earnings (Loss) by Segment- ---------------------------------------------------------------------- ---------------- ----------------- ---------------- Increase Three Months Ended December 31 (Thousands) 2001 2000 (Decrease) - ---------------------------------------------------------------------- ---------------- ----------------- ---------------- Utility $ 18,041 $18,287 $ (246) Pipeline and Storage 10,014 6,595 3,419 Exploration and Production 1,441 23,001 (21,560) International 993 2,240 (1,247) Energy Marketing 1,948 1,344 604 Timber 1,538 2,396 (858) - ---------------------------------------------------------------------- ---------------- ----------------- ---------------- Total Reportable Segments 33,975 53,863 (19,888) All Other 5 (732) 737 Corporate (773) (147) (626) - ---------------------------------------------------------------------- ---------------- ----------------- ---------------- Total Consolidated $ 33,207 $52,984 $(19,777) - ---------------------------------------------------------------------- ---------------- ----------------- ----------------UtilityUtility Operating Revenues- ---------------------------------------------------------------------- ---------------- ----------------- ---------------- Increase Three Months Ended December 31 (Thousands) 2001 2000 (Decrease) - ---------------------------------------------------------------------- ---------------- ----------------- ---------------- Retail Sales Revenues: Residential $164,836 $252,558 $ (87,722) Commercial 25,994 43,819 (17,825) Industrial 3,166 11,405 (8,239) - ---------------------------------------------------------------------- ---------------- ----------------- ---------------- 193,996 307,782 (113,786) - ---------------------------------------------------------------------- ---------------- ----------------- ---------------- Off-System Sales 11,345 21,987 (10,642) Transportation 22,493 24,511 (2,018) Other 154 (112) 266 - ---------------------------------------------------------------------- ---------------- ----------------- ---------------- $227,988 $354,168 $(126,180) - ---------------------------------------------------------------------- ---------------- ----------------- ----------------Utility Throughput- ---------------------------------------------------------------------- ---------------- ----------------- ---------------- Increase Three Months Ended December 31 (million cubic feet) (MMcf) 2001 2000 (Decrease) - ---------------------------------------------------------------------- ---------------- ----------------- ---------------- Retail Sales: Residential 17,913 24,001 (6,088) Commercial 3,117 4,451 (1,334) Industrial 698 1,674 (976) - ---------------------------------------------------------------------- ---------------- ----------------- ---------------- 21,728 30,126 (8,398) - ---------------------------------------------------------------------- ---------------- ----------------- ---------------- Off-System Sales 3,949 3,181 768 Transportation 15,235 17,514 (2,279) - ---------------------------------------------------------------------- ---------------- ----------------- ---------------- 40,912 50,821 (9,909) - ---------------------------------------------------------------------- ---------------- ----------------- ----------------
Operating revenues for the Utility segment decreased $126.2 million for the quarter ended December 31, 2001 as compared with the quarter ended December 31, 2000. The decrease in revenues is primarily the result of a decrease in retail sales volumes, as shown above, a decrease in the average cost of purchased gas ($4.91 and $7.43 per thousand cubic feet (Mcf) during the quarters ended December 31, 2001 and 2000, respectively) and lower transportation volumes. Warmer weather, as shown in the table below, was the major factor for the decrease in retail sales volumes and transportation volumes. Off-system sales revenues decreased largely due to lower gas prices which more than offset slightly higher volumes. Due to profit sharing with retail customers, the margins resulting from off-system sales are minimal. Partly offsetting these decreases to revenue was the positive impact of a lower bill credit in the Utility’s New York jurisdiction. In connection with the three year rate settlement reached with the New York State Public Service Commission that went into effect October 1, 2000, the Utility’s New York customers received a $10.0 million rate decrease in the form of a bill credit for the November 1, 2000 through March 31, 2001 heating season. For the November 1, 2001 through March 31, 2002 heating season, the amount of the bill credit has been reduced to $5.0 million.
The Utility segment's earnings for the quarter ended December 31, 2001 were $18.0 million, a decrease of $0.2 million when compared with the quarter ended December 31, 2000. A significant factor for this decrease was the impact of weather, which in the Pennsylvania jurisdiction was approximately 29% warmer than last year's first quarter. The impact of weather variations on earnings in the New York jurisdiction is mitigated by that jurisdiction's weather normalization clause (WNC). The WNC in New York, which covers the eight-month period from October through May, has had a stabilizing effect on earnings for the New York rate jurisdiction. In addition, in periods of colder than normal weather, the WNC benefits Distribution Corporation's New York customers. For the quarter ended December 31, 2001, the WNC preserved earnings of $4.5 million (after tax) for Distribution Corporation since it was warmer than normal. For the quarter ended December 31, 2000, the WNC resulted in a benefit to customers of $1.1 million (after tax) since it was colder than normal. The negative earnings impact associated with weather in the Utility segment's Pennsylvania jurisdiction was largely offset by lower Operation and Maintenance (O & M) expense. For the quarter ended December 31, 2000, the Utility segment recorded stock appreciation right (SAR) expense of $2.6 million (after tax) due to an increase in the market price of the Company's common stock from September 30, 2000 ($28.03 per common share) to December 31, 2000 ($31.47 per common share). SAR expense is recorded in O & M expense and is spread across all segments, with the greatest impact on the Pipeline and Storage, Utility and Exploration and Production segments. For the quarter ended December 31, 2001, the earnings impact of SARs was minimal ($8,000 positive contribution to earnings). This small earnings impact is attributed to the cancellation of substantially all of the Company's SARs in November 2001. The canceled SARs were replaced with non-qualified stock options and there will be no future awards of SARs. As a result, future earnings will not be materially impacted by SAR expense or income. Another factor contributing to lower O & M expense was that the quarter ended December 31, 2000 included a non-recurring charge of approximately $0.6 million (after tax) for an early retirement offer accepted by certain employees in Pennsylvania. The positive earnings impact of the lower bill credit discussed above was largely offset by an estimated refund provision for a 50% sharing with customers of earnings over 11.5% as specified in the New York rate settlement that became effective October 1, 2000 and lower customer usage per account.
Degree Days- ---------------------------------- -------------- -------------- -------------------- -------------------------------- Percent (Warmer) Three Months Ended Colder Than -------------------------------- December 31 Normal 2001 2000 Normal Prior Year - ---------------------------------- -------------- -------------- -------------------- ----------------- -------------- Buffalo 2,320 1,799 2,488 (22.5) (27.7) Erie 2,019 1,659 2,332 (17.8) (28.9) - ---------------------------------- -------------- -------------- -------------------- ----------------- --------------Pipeline and Storage Pipeline and Storage Operating Revenues- ---------------------------------------------------------------------- ---------------- ----------------- ---------------- Increase Three Months Ended December 31 (Thousands) 2001 2000 (Decrease) - ---------------------------------------------------------------------- ---------------- ----------------- ---------------- Firm Transportation $22,383 $22,741 $(358) Interruptible Transportation 780 810 (30) - ---------------------------------------------------------------------- ---------------- ----------------- ---------------- 23,163 23,551 (388) - ---------------------------------------------------------------------- ---------------- ----------------- ---------------- Firm Storage Service 15,374 15,068 306 Interruptible Storage Service - 168 (168) - ---------------------------------------------------------------------- ---------------- ----------------- ---------------- 15,374 15,236 138 - ---------------------------------------------------------------------- ---------------- ----------------- ---------------- Other 4,408 3,878 530 - ---------------------------------------------------------------------- ---------------- ----------------- ---------------- $42,945 $42,665 $ 280 - ---------------------------------------------------------------------- ---------------- ----------------- ----------------Pipeline and Storage Throughput- ---------------------------------------------------------------------- ---------------- ----------------- ---------------- Increase Three Months Ended December 31 (Thousands) 2001 2000 (Decrease) - ---------------------------------------------------------------------- ---------------- ----------------- ---------------- Firm Transportation 72,050 89,542 (17,492) Interruptible Transportation 1,990 5,950 (3,960) - ---------------------------------------------------------------------- ---------------- ----------------- ---------------- 74,040 95,492 (21,452) - ---------------------------------------------------------------------- ---------------- ----------------- ----------------
Operating revenues for the Pipeline and Storage segment increased $0.3 million for the quarter ended December 31, 2001 as compared with the quarter ended December 31, 2000. This slight increase was due mainly to higher revenues from unbundled pipeline sales and open access transportation offset, in part, by lower cashout revenues (a cash resolution of a gas imbalance whereby a customer pays Supply Corporation for gas it receives in excess of amounts delivered into Supply Corporation’s system by the customer or by the customer’s transporter). Both of these items are included in “Other” revenue in the table above. Cashout revenues are offset by purchased gas expense. While transportation volumes decreased significantly, volume fluctuations generally do not have a significant impact on revenues as a result of Supply Corporation’s straight fixed-variable rate design.
Earnings in the Pipeline and Storage segment increased $3.4 million from $6.6 million for the quarter ended December 31, 2000 to $10.0 million for the quarter ended December 31, 2001. Major factors for this increase included higher revenues from unbundled pipeline sales and open access transportation ($2.1 million after tax) and lower SAR expense ($3.5 million after tax), as discussed above in the Utility segment. Also, the quarter ended December 31, 2000 included a non-recurring charge of approximately $0.6 million (after tax) for an early retirement offer accepted by certain employees in Pennsylvania. Partly offsetting these increases to earnings, the quarter ended December 31, 2000 included non-recurring income of $2.6 million (after tax) which was realized upon the buy-out by a customer of a long-term transportation contract. This income was recorded in Other Income on the Consolidated Statement of Income.
Exploration and Production Exploration and Production Operating Revenues- --------------------------------------------------------------------- ---------------- ----------------- ---------------- Increase Three Months Ended December 31 (Thousands) 2001 2000 (Decrease) - --------------------------------------------------------------------- ---------------- ----------------- ---------------- Gas (after Hedging) $35,104 $32,324 $ 2,780 Oil (after Hedging) 33,337 42,474 (9,137) Gas Processing Plant 4,219 10,517 (6,298) Other 5,442 15,939 (10,497) Intrasegment Elimination * (3,102) (9,505) 6,403 - --------------------------------------------------------------------- ---------------- ----------------- ---------------- $75,000 $91,749 $(16,749) - --------------------------------------------------------------------- ---------------- ----------------- ----------------
* Represents the elimination of certain West Coast gas production revenue included in “Gas (after Hedging)” in the table above that is sold to the gas processing plant shown in the table above. An elimination for the same dollar amount is made to reduce the gas processing plant’s Purchased Gas expense.
Production Volumes- ---------------------------------------------------------------- ---------------- ----------------- Three Months Ended December 31 2001 2000 - ---------------------------------------------------------------- ---------------- ----------------- Gas Production (million cubic feet)Gulf Coast 7,188 6,429 West Coast 1,246 1,044 Appalachia 1,058 1,043 Canada 1,831 122 - ---------------------------------------------------------------- ---------------- ----------------- 11,323 8,638 - ---------------------------------------------------------------- ---------------- ----------------- Oil Production (thousands of barrels)Gulf Coast 454 356 West Coast 748 745 Appalachia 2 2 Canada 755 741 - ---------------------------------------------------------------- ---------------- ----------------- 1,959 1,844 - ---------------------------------------------------------------- ---------------- -----------------Average Prices- ---------------------------------------------------------------- ---------------- ----------------- Three Months Ended December 31 2001 2000 - ---------------------------------------------------------------- ---------------- -----------------Average Gas Price/McfGulf Coast $2.41 $5.91 West Coast $2.35 $9.36 Appalachia $3.66 $4.18 Canada $2.07 $4.75 Weighted Average $2.47 $6.10 Weighted Average After Hedging $3.10 $3.74Average Oil Price/barrel (bbl)Gulf Coast $19.16 $31.80 West Coast $15.35 $26.94 Appalachia $24.93 $30.90 Canada $14.40 $28.01 Weighted Average $15.88 $28.31 Weighted Average After Hedging $17.01 $23.03 - ---------------------------------------------------------------- ---------------- -----------------
Operating revenues for the Exploration and Production segment decreased $16.7 million for the quarter ended December 31, 2001 as compared with the quarter ended December 31, 2000. Oil production revenue after hedging decreased $9.1 million from last year’s first quarter as the weighted average price of oil after hedging decreased 26%. Other revenues decreased $10.5 million primarily due to lower positive mark-to-market and other revenue adjustments related to derivative financial instruments. Offsetting these revenue decreases, gas production revenues increased $2.8 million, largely due to the Canadian properties acquired in June 2001 (i.e., the Player Petroleum Corporation acquisition), which more than offset a 17% decrease in the weighted average gas price after hedging.
The Exploration and Production segment’s earnings for the quarter ended December 31, 2001 were $1.4 million, a decrease of $21.6 million when compared with earnings of $23.0 million for the quarter ended December 31, 2000. As discussed above, a significant decrease in oil prices in the current quarter and lower positive mark-to-market adjustments on derivative financial instruments contributed to this earnings decrease. This segment also recorded a net $3.4 million (after tax) non-cash charge to reserve for the Company’s exposure to Enron Corp. (“Enron”). This reserve related to the fair market value of the Company’s hedging contracts with Enron extending to the first quarter of fiscal 2003. However, under hedge accounting rules, substantially all of this charge will reverse over the remaining three quarters of fiscal 2002. Therefore, the net impact on earnings for the entire fiscal year will be the same as if the Company had not entered into the Enron transactions.
International International Operating Revenues- --------------------------------------------------------------------- ---------------- ----------------- ---------------- Increase Three Months Ended December 31 (Thousands) 2001 2000 (Decrease) - --------------------------------------------------------------------- ---------------- ----------------- ---------------- Heating $22,673 $21,717 $ 956 Electricity 7,099 8,875 (1,776) Other 766 632 134 - --------------------------------------------------------------------- ---------------- ----------------- ---------------- $30,538 $31,224 $(686) - --------------------------------------------------------------------- ---------------- ----------------- ----------------International Heating and Electric Volumes- --------------------------------------------------------------------- ---------------- ----------------- ---------------- Increase Three Months Ended December 31 2001 2000 (Decrease) - --------------------------------------------------------------------- ---------------- ----------------- ---------------- Heating Sales (Gigajoules) (1) 3,231,692 3,365,555 (133,863) Electricity Sales (megawatt hours) 261,681 330,024 (68,343) - --------------------------------------------------------------------- ---------------- ----------------- ----------------(1) Gigajoules = one billion joules. A joule is a unit of energy.
Operating revenues for the International segment decreased $0.7 million for the quarter ended December 31, 2001 as compared with the quarter ended December 31, 2000. The decrease was primarily due to lower electric revenues, which resulted from lower volumes (principally attributable to the scheduled shutdown of a generating turbine that had reached the end of its useful life in the third quarter of 2001) and a decline in electric rates. Partially offsetting this decrease, heating revenues were up due to colder weather. In June 2001, United Energy, a.s., an indirect subsidiary of Horizon, sold its 65.78% ownership interest in Jablonecka teplarenska a realitni, a.s. (JTR). As a result of that sale, the quarter ended December 31, 2000
included heating revenues of $2.4 million and heating volumes of 243,255 gigajoules that did not recur during the quarter ended December 31, 2001.
The International segment’s earnings for the quarter ended December 31, 2001 were $1.0 million, a decrease of $1.2 million when compared with earnings of $2.2 million for the quarter ended December 31, 2000. This decrease can be attributed to lower margins resulting from the scheduled shutdown of a generating turbine and a decline in electric rates, as discussed above, combined with higher O & M expense.
Energy Marketing Energy Marketing Operating Revenues- ---------------------------------------------------------------------- ------------------- ---------------- ----------------- Increase Three Months Ended December 31 (Thousands) 2001 2000 (Decrease) - ---------------------------------------------------------------------- ------------------- ---------------- ----------------- Natural Gas (after Hedging) $32,804 $46,781 $(13,977) Electricity - 448 (448) Other (19) 957 (976) - ---------------------------------------------------------------------- ------------------- ---------------- ----------------- $32,785 $48,186 $(15,401) - ---------------------------------------------------------------------- ------------------- ---------------- -----------------Energy Marketing Volumes- ---------------------------------------------------------------------- ------------------- ---------------- ----------------- Increase Three Months Ended December 31 2001 2000 (Decrease) - ---------------------------------------------------------------------- ------------------- ---------------- ----------------- Natural Gas - (MMcf) 7,190 7,728 (538) - ---------------------------------------------------------------------- ------------------- ---------------- -----------------
Operating revenues for the Energy Marketing segment decreased $15.4 million for the quarter ended December 31, 2001 as compared with the quarter ended December 31, 2000. This decrease largely reflects lower gas sales revenue due to a decrease in the price of natural gas as well as lower volumes due to warmer weather.
The Energy Marketing segment’s earnings for the quarter ended December 31, 2001 were $1.9 million, an increase of $0.6 million when compared with earnings of $1.3 million for the quarter ended December 31, 2000. This increase is largely a result of lower interest and bad debt expense.
Timber Timber Operating Revenues- ---------------------------------------------------------------------- ------------------- ---------------- ----------------- Increase Three Months Ended December 31 (Thousands) 2001 2000 (Decrease) - ---------------------------------------------------------------------- ------------------- ---------------- ----------------- Log Sales $5,378 $6,412 $(1,034) Green Lumber Sales 1,644 1,331 313 Kiln Dry Lumber Sales 3,082 3,006 76 Other 227 188 39 - ---------------------------------------------------------------------- ------------------- ---------------- ----------------- Operating Revenues $10,331 $10,937 $(606) - ---------------------------------------------------------------------- ------------------- ---------------- -----------------
Timber Board Feet- ---------------------------------------------------------------------- ------------------- ---------------- ----------------- Increase Three Months Ended December 31 (Thousands) 2001 2000 (Decrease) - ---------------------------------------------------------------------- ------------------- ---------------- ----------------- Log Sales 2,123 2,061 62 Green Lumber Sales 3,010 2,266 744 Kiln Dry Lumber Sales 1,972 2,068 (96) - ---------------------------------------------------------------------- ------------------- ---------------- ----------------- 7,105 6,395 710 - ---------------------------------------------------------------------- ------------------- ---------------- -----------------
Operating revenues for the Timber segment decreased $0.6 million for the quarter ended December 31, 2001 as compared with the quarter ended December 31, 2000. Though sales in board feet increased, revenues were down due to a change in sales mix. Sales of high priced veneer logs, such as cherry and oak, decreased but sales of lower priced saw logs and green lumber increased.
The Timber segment’s earnings for the quarter ended December 31, 2001 were $1.5 million, a decrease of $0.9 million when compared with earnings of $2.4 million for the quarter ended December 31, 2000. This decrease is primarily the result of a non-recurring $2.1 million pre tax ($1.3 million after tax) gain on the sale of certain timber properties recorded in the quarter ended December 31, 2000. Lower interest expense partially offset this decrease to earnings.
Although variances in other income items and interest charges are discussed in the earnings discussion by segment above, following is a recap on a consolidated basis:
Other income decreased $6.0 million for the quarter ended December 31, 2001 compared with the quarter ended December 31, 2000. This decrease was principally due to a non-recurring buyout of a long-term transportation contract by a customer in the Pipeline and Storage segment as well as a non-recurring gain realized on the sale of certain timber properties in the Timber segment, both of which occurred in the quarter ended December 31, 2000.
Interest on long-term debt increased $2.9 million for the quarter ended December 31, 2001 as compared with the quarter ended December 31, 2000. This increase can be attributed to a higher average amount of long-term debt outstanding and slightly higher weighted average interest rates.
Other interest charges decreased $5.1 million for the quarter ended December 31, 2001 as compared with the quarter ended December 31, 2000. This decrease resulted mainly from a decrease in the average amount of short-term debt outstanding and lower weighted average interest rates.
The increase in the average amount of long-term debt outstanding and the decrease in the average amount of short-term debt outstanding and the resulting impact on interest expense can be attributed to the November 2000 and November 2001 medium-term note issuances. In November 2000, the Company issued $200.0 million of 7.50% medium-term notes due in November 2010 and in November 2001, the Company issued $150.0 million of 6.70% medium-term notes due in November 2011. In both cases, proceeds from the medium-term note issuances were used to reduce short-term borrowings.
The Company’s primary sources of cash during the three-month period ended December 31, 2001 consisted of cash provided by operating activities and long-term debt. These sources were supplemented by issuances of common stock under the Company’s stock and benefit plans.
Internally generated cash from operating activities consists of net income available for common stock, adjusted for non-cash expenses, non-cash income and changes in operating assets and liabilities. Non-cash items include depreciation, depletion and amortization, deferred income taxes and minority interest in foreign subsidiaries.
Cash provided by operating activities in the Utility and the Pipeline and Storage segments may vary from period to period because of the impact of rate cases. In the Utility segment, supplier refunds, over- or under-recovered purchased gas costs and weather may also significantly impact cash flow. The impact of weather on cash flow is tempered in the Utility segment’s New York rate jurisdiction by its WNC and in the Pipeline and Storage segment by Supply Corporation’s straight fixed-variable rate design.
Because of the seasonal nature of the heating business in the Utility, Energy Marketing and International segments, revenues in these segments are relatively high during the heating season, primarily the first and second quarters of the fiscal year, and receivables historically increase during these periods from what was receivable at September 30.
The storage gas inventory normally declines during the first and second quarters of the year and is replenished during the third and fourth quarters. For storage gas inventory accounted for under the last-in, first-out (LIFO) method, the current cost of replacing gas withdrawn from storage is recorded in the Consolidated Statements of Income and a reserve for gas replacement is recorded in the Consolidated Balance Sheets under the caption “Other Accruals and Current Liabilities.” Such reserve is reduced as the inventory is replenished.
Cash provided by operating activities in the Exploration and Production segment may vary from period to period as a result of changes in the commodity prices of natural gas and crude oil. The Company uses various derivative financial instruments, including price swap agreements, no cost collars and options in an attempt to manage this energy commodity price risk.
Net cash provided by operating activities totaled $48.7 million for the three months ended December 31, 2001, an increase of $20.8 million compared with the $27.9 million provided by operating activities for the three months ended December 31, 2000. Lower working capital requirements in the Utility and Energy Marketing segments due to lower gas prices more than offset lower cash receipts from the sale of oil and gas in the Exploration and Production segment. Oil and gas prices were down in the Exploration and Production segment and higher production did not compensate for the decrease in prices.
Expenditures for Long-Lived Assets
Expenditures for long-lived assets include additions to property, plant and equipment (capital expenditures) and investments in corporations (stock acquisitions) or partnerships, net of any cash acquired.
The Company’s expenditures for long-lived assets totaled $61.1 million during the three months ended December 31, 2001. The table below presents these expenditures:
------------------------------------------------------------- ----------------------- ----------------------- Three Months Ended December 31, 2001(in millions of dollars)-------------------------------------- ---------------------- ----------------------- ----------------------- Investments in Total Capital Corporations or Expenditures for Expenditures Partnerships Long-Lived Assets -------------------------------------- ---------------------- ----------------------- ----------------------- Utility $11.5 $ - $11.5 Pipeline and Storage 6.2 0.4 6.6 Exploration and Production 38.4 - 38.4 International 1.9 - 1.9 Timber 2.7 - 2.7 Energy Marketing - - - All Other - - - -------------------------------------- ---------------------- ----------------------- ----------------------- $60.7 $0.4 $61.1 -------------------------------------- ---------------------- ----------------------- -----------------------
Utility
The majority of the Utility capital expenditures were made for replacement of mains and main extensions, as well as for the replacement of service lines.
Pipeline and Storage
The majority of the Pipeline and Storage capital expenditures were made for additions, improvements, and replacements to this segment’s transmission and storage systems.
During the quarter ended December 31, 2001, SIP made an additional $383,000 investment in Independence. SIP’s total investment through December 31, 2001 was $15.0 million. The investment represents a one-third partnership interest in Independence. The investment has been financed with short-term borrowings. Independence intends to build the Independence Pipeline, a 400-mile natural gas pipeline from Defiance, Ohio to Leidy, Pennsylvania at an estimated cost of about $700 million.* If the Independence Pipeline project is not constructed, SIP’s share of the developmental costs (including SIP’s investment in Independence) is estimated not to exceed $15.5 million.* This amount represents the estimated maximum pre tax charge to earnings that would be recorded if the project is not constructed.*
In December 2001 the Federal Energy Regulatory Commission (FERC) placed the Independence Pipeline project on the agenda for its December 19, 2001 meeting. Prior to the meeting, however, FERC removed the project from the agenda. To date, FERC has not responded to a partial implementation plan that Independence filed on November 1, 2001 or to Independence's request to
extend the due date for a complete implementation plan to November 2003 and the in-service date to November 2004. If FERC were not to grant these extensions, it would be probable that Independence’s current FERC authorization would expire before the project could be built.* Regardless of what FERC may do, each owner of Independence is able to withdraw from the partnership at any time. The Company is uncertain about the future of the Independence project; in the event of significant negative developments, it is reasonably likely that the Company would record a pre tax charge to earnings estimated not to exceed $15.5 million.*
For a further discussion of SIP’s investment in Independence, refer to “Investing Cash Flow” under “Capital Resources and Liquidity” in Item 7 of the Company’s 2001 Form 10-K. Other than those matters discussed above, there have been no subsequent material changes regarding this investment.
The Company also continues to explore various opportunities to participate in transporting gas to the Northeast, either through Supply Corporation's system or in partnership with others. This includes the proposed Northwinds Pipeline that the Company and TransCanada PipeLines Limited are pursuing. This project would be a 215-mile, 30-inch natural gas pipeline that would originate in Kirkwall, Ontario, cross into the United States near Buffalo, New York and follow a southerly route to its destination in the Ellisburg-Leidy area in Pennsylvania.* The initial capacity of the pipeline would be approximately 500 million cubic feet of natural gas per day with the estimated cost of the pipeline ranging from $350-$400 million.* At December 31, 2001, the Company had not incurred any material costs associated with this project.
Exploration and Production
The Exploration and Production segment capital expenditures for the three months ended December 31, 2001 included approximately $30.2 million for on-shore drilling construction and recompletion costs for wells located in Louisiana, Texas, California and Canada as well as onshore geological and geophysical costs and fixed asset purchases. Of the $30.2 million amount, $10.7 million was spent on the Exploration and Production segment’s Canadian properties. The Exploration and Production segment’s capital expenditures also included approximately $8.2 million for Seneca’s offshore program in the Gulf of Mexico, including offshore drilling expenditures, offshore construction, lease acquisition costs and geological and geophysical expenditures.
With the expectation of continued low commodity prices, the Company anticipates reducing the Exploration and Production segment's 2002 capital expenditures from $141.0 million, as previously disclosed in the Company's 2001 Form 10-K, to $92 million.*
During the quarter ended December 31, 2001, the Exploration and Production segment sold oil and gas properties amounting to $15.7 million. These proceeds were recorded as a reduction of property, plant and equipment and are reflected in Other Investing Activities on the Consolidated Statement of Cash Flows.
International
The majority of the International segment capital expenditures were concentrated in improvements and replacements within the district heating and power generation plants in the Czech Republic.
Timber
The majority of the Timber segment capital expenditures were made for purchases of land and timber for Seneca’s timber operations, as well as equipment for Highland’s sawmill and kiln operations.
The Company continuously evaluates capital expenditures and investments in corporations and partnerships. The amounts are subject to modification for opportunities such as the acquisition of attractive oil and gas properties, timber or storage facilities and the expansion of transmission line capacities. While the majority of capital expenditures in the Utility segment are necessitated by the continued need for replacement and upgrading of mains and service lines, the magnitude of future capital expenditures or other investments in the Company’s other business segments depends, to a large degree, upon market conditions.*
In November 2001, the Company issued $150.0 million of 6.70% medium-term notes due in November 2011. After deducting underwriting discounts and commissions, the net proceeds to the Company amounted to $149.0 million. The proceeds of this debt issuance were used to reduce short-term debt.
Consolidated short-term debt decreased $133.2 million during the first quarter of 2002 primarily due to the November 2001 medium-term note issuance discussed above. The Company continues to consider short-term debt an important source of cash for temporarily financing capital expenditures and investments in corporations and/or partnerships, gas-in-storage inventory, unrecovered purchased gas costs, exploration and development expenditures and other working capital needs. Fluctuations in these items can have a significant impact on the amount and timing of short-term debt. The Company has Securities and Exchange Commission (SEC) authorization under the Public Utility Holding Company Act of 1935, as amended, to borrow and have outstanding as much as $750.0 million of short-term debt at any time through December 31, 2002. The total amount available to be issued under the Company’s commercial paper program is $200.0 million. The commercial paper program is backed up by a $200.0 million 364-day credit facility, which would be available as long as the Company maintains an investment grade credit rating. With regards to the Company’s short-term notes payable to banks, the Company utilizes uncommitted bank lines of credit aggregating to $620.0 million. These uncommitted bank lines of credit are revocable at the option of the financial institutions and are reviewed on an annual basis. The Company anticipates that these lines of credit will continue to be renewed.* If a downgrade in the Company’s commercial paper program credit ratings were to occur, access to the commercial paper markets might not be possible. However, the Company could borrow under its uncommitted bank lines of credit or seek other liquidity sources, including cash provided by operations. At December 31, 2001, the Company had outstanding short-term notes payable to banks and commercial paper of $295.8 million and $60.7 million, respectively.
The Company also has authorization from the SEC, under the Public Utility Holding Company Act of 1935, to issue long-term debt securities and equity securities in amounts not exceeding $2.0 billion at any one time outstanding during the order’s authorization period, which extends to December 31, 2002. In August 1999, the Company registered $625 million of debt and equity securities under the Securities Act of 1933. Of the $625 million that was originally registered, the Company currently has $125.0 million of securities available to be issued under the Securities Act of 1933.
The Company’s indenture contains covenants which limit, among other things, the incurrence of funded debt. Funded debt basically is indebtedness maturing more than one year after the date of issuance. Because of the impairment of oil and gas producing properties recorded by the Company in September 2001, the earnings impact of warm weather and low commodity prices in the quarter ended December 31, 2001, and higher long-term debt interest requirements stemming from the November 2001 medium-term note issuance discussed above, these covenants will restrict the Company’s ability to issue additional funded debt, with certain exceptions, until at least the first quarter of fiscal 2003.*This will not, however, limit the Company’s issuance of funded debt to refund existing funded debt. Also, these covenants will not limit the Company’s ability to utilize short-term debt, which is discussed above.
The Company has entered into certain off-balance sheet financing arrangements. These financing arrangements are primarily operating and capital leases. The Company’s consolidated subsidiaries have operating leases, the majority of which are with the Utility and the Pipeline and Storage segments, having a remaining lease commitment of approximately $34.6 million. These leases have been entered into for the use of vehicles, construction tools, meters, computer equipment and other items and are accounted for as operating leases. The Company’s minority owned entities, which are accounted for under the equity method, have capital leases of electric generating equipment having a remaining lease commitment of approximately $10.6 million. The Company has guaranteed 50% or $5.3 million of these capital lease commitments.
The following table summarizes the Company’s contractual financial commitments at December 31, 2001 and the twelve-month periods over which they occur:
- -------------------------------------- ----------------------------------------------------------------------------------------- Payments by Expected Maturity Dates ----------------------------------------------------------------------------------------- (Millions of Dollars) 2002 2003 2004 2005 2006 Thereafter Total - -------------------------------------- ------------ ------------ ----------- ----------- ----------- -------------- ------------ Long-Term Debt $ 110.6 $ 160.3 $ 229.1 $ 4.1 $ 2.8 $ 799.1 $1,306.0 Short-Term Bank Notes 295.8 - - - - - 295.8 Commercial Paper 60.7 - - - - - 60.7 Operating Lease Commitments 1.6 4.0 2.9 4.6 2.3 19.2 34.6 Capital Lease Commitments 1.2 1.2 1.2 1.5 1.4 4.1 10.6 - -------------------------------------- ------------ ------------ ----------- ----------- ----------- -------------- ------------
The amounts and timing of the issuance and sale of debt and/or equity securities will depend on market conditions, indenture requirements, regulatory authorizations, and the requirements of the Company.
The Company is involved in litigation arising in the normal course of business. The Company is involved in regulatory matters arising in the normal course of business that involve rate base, cost of service and purchased gas cost issues, among other things. While the resolution of such litigation or regulatory matters could have a material effect on earnings and cash flows in the year of resolution, none of this litigation, and none of these regulatory matters, are expected to change materially the Company’s present liquidity position, nor have a material adverse effect on the financial condition of the Company.*
For a complete discussion of market risk sensitive instruments, refer to “Market Risk Sensitive Instruments” in Item 7 of the Company’s 2001 Form 10-K. There have been no subsequent material changes to the Company’s exposure to market risk sensitive instruments.
On October 11, 2000, the NYPSC approved a settlement agreement (Agreement) between Distribution Corporation, Staff of the Department of Public Service, the New York State Consumer Protection Board and Multiple Intervenors (an advocate for large commercial and industrial customers) that establishes rates for a three-year period beginning October 1, 2000. The Agreement provides that customers will receive a bill credit of $17.6 million in the first year, of which $7.6 million relates to customers’ share of earnings accumulated under previous settlements. The credit will be reduced to $5.0 million in the second year, and in the third and subsequent years the credit will remain at $5.0 million unless the Company can demonstrate that it is no longer justified. Also, earnings beyond a target level of 11.5% return on equity will be shared equally between shareholders and customers. The Agreement provided further that the Company and interested parties would resume discussions to address the NYPSC’s competition initiatives, including changes to “customer choice” transportation services, among other things. Those discussions commenced in November 2000 and produced an interim “Joint Proposal,” or settlement agreement, addressing several discrete issues of interest to the parties and the NYPSC. In an order issued on May 30, 2001, the NYPSC adopted the parties’ Joint Proposal. As recommended by the parties, the Joint Proposal modified Distribution Corporation’s operations relating to transportation services and transactions with marketers and producers of indigenous natural gas. Under the Joint Proposal, the parties also agreed to continue negotiations to implement additional features of the NYPSC’s restructuring initiative (described below). Those confidential discussions, dubbed “Phase III negotiations,” concluded on January 18, 2002 when the parties executed a “Comprehensive Joint Proposal”. The Comprehensive Joint Proposal proposes a number of changes to Distribution Corporation’s rates and services through September 30, 2003, including the following:
The Comprehensive Joint Proposal was filed with the Commission on January 23, 2002 and requires approval before an anticipated effective date of April 1, 2002. Distribution Corporation’s base rates would not be materially changed under the Comprehensive Joint Proposal, which is not intended to modify the rate and revenue requirements established in the Agreement described above.
For a complete discussion of New York Jurisdiction Rate Matters, refer to “New York Jurisdiction” under “Rate Matters” in Item 7 of the Company’s 2001 Form 10-K. Other than those matters discussed above, there have been no subsequent material changes regarding rate matters in the New York Jurisdiction.
Distribution Corporation currently does not have a rate case on file with the Pennsylvania Public Utility Commission (PaPUC). Management will continue to monitor its financial position in the Pennsylvania jurisdiction to determine the necessity of filing a rate case in the future.
For a complete discussion of Pennsylvania Jurisdiction Rate Matters, refer to “Pennsylvania Jurisdiction” under “Rate Matters” in Item 7 of the Company’s 2001 Form 10-K. There have been no subsequent material changes regarding rate matters in the Pennsylvania Jurisdiction.
Base rate adjustments in both the New York and Pennsylvania jurisdictions do not reflect the recovery of purchased gas costs. Such costs are recovered through operation of the purchased gas adjustment clauses of the appropriate regulatory authorities.
Supply Corporation currently does not have a rate case on file with the FERC. Management will continue to monitor Supply Corporation’s financial position to determine the necessity of filing a rate case in the future.
Environmental Matters. The Company is subject to various federal, state and local laws and regulations relating to the protection of the environment. The Company has established procedures for the ongoing evaluation of its operations to identify potential environmental exposures and comply with regulatory policies and procedures. It is the Company’s policy to accrue estimated environmental clean-up costs (investigation and remediation) when such amounts can reasonably be estimated and it is probable that the Company will be required to incur such costs. At December 31, 2001, the Company has estimated its remaining clean-up costs related to former manufactured gas plant sites and third party waste disposal sites will be in the range of $5.3 million to $6.3 million.* The minimum liability of $5.3 million has been recorded on the Consolidated Balance Sheet at December 31, 2001. Other than discussed in Note H of the 2001 Form 10-K (referred to below), the Company is currently not aware of any material additional exposure to environmental liabilities. However, adverse changes in environmental regulations or other factors could impact the Company.*
Safe Harbor for Forward-Looking Statements. The Company is including the following cautionary statement in this Form 10-Q to make applicable and take advantage of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 for any forward-looking statements made by, or on behalf of, the Company. Forward-looking statements include statements concerning plans, objectives, goals, strategies, future events or performance, and underlying assumptions and other statements which are other than statements of historical facts. From time to time, the Company may publish or otherwise make available forward-looking statements of this nature. All such subsequent forward-looking statements, whether written or oral and whether made by or on behalf of the Company, are also expressly qualified by these cautionary statements. Certain statements contained herein, including without limitation those which are designated with an asterisk (“*”), are forward-looking statements and accordingly involve risks and uncertainties which could cause actual results or outcomes to differ materially from those expressed in the forward-looking statements. The forward-looking statements contained herein are based on various assumptions, many of which are based, in turn, upon further assumptions. The Company’s
expectations, beliefs and projections are expressed in good faith and are believed by the Company to have a reasonable basis, including, without limitation, management’s examination of historical operating trends, data contained in the Company’s records and other data available from third parties, but there can be no assurance that management’s expectations, beliefs or projections will result or be achieved or accomplished. In addition to other factors and matters discussed elsewhere herein, the following are important factors that, in the view of the Company, could cause actual results to differ materially from those discussed in the forward-looking statements:
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (Concl.)
The Company disclaims any obligation to update any forward-looking statements to reflect events or circumstances after the date hereof.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Refer to the “Market Risk Sensitive Instruments” section in Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Part II. Other Information
Item 1. Legal Proceedings
For a discussion of various environmental matters, refer to Part I, Item 1 at Note 4 and Part I, Item 2 – MD&A of this report under the heading “Other Matters.”
Item 2. Changes in Securities
On October 1, 2001, the Company issued a total of 1,680 unregistered shares of Company common stock to the seven non-employee directors of the Company, 240 shares to each such director. These shares were issued as partial consideration for the directors’ services during the quarter ended December 31, 2001, pursuant to the Company’s Retainer Policy for Non-Employee Directors. These transactions were exempt from registration by Section 4(2) of the Securities Act of 1933 as transactions not involving a public offering.
Bernard J. Kennedy served as Chief Executive Officer of the Company from August 1988 through September 30, 2001. He retired as Chairman of the Board effective January 2, 2002. In consideration of Mr. Kennedy's waiver of the balance of his employment agreement with the Company, his undertaking to be bound permanently by comprehensive confidentiality and non-disclosure arrangements, and his agreement to broad, three-year, non-compete covenants, the Company entered into a Retirement and Consulting Agreement with Mr. Kennedy in September 2001. Among other things, the Retirement and Consulting Agreement obligated the Company to pay to Mr. Kennedy, in October 2001, 100,000 shares of Company Common Stock. The Company purchased those shares on the open market in October 2001. The transfer of the shares to Mr. Kennedy was exempt from registration by Section 4(2) of the Securities Act of 1933 as a transaction not involving a public offering.
Item 4. Submission of Matters to a Vote of Security Holders
A Special Meeting of Stockholders was held on October 16, 2001. At that meeting, the stockholders approved Amendments to the National Fuel Gas Company 1997 Award and Option Plan and the National Fuel Gas Company 1993 Award and Option Plan.
Item 4. Submission of Matters to a Vote of Security Holders (Concl.)
The total votes were as follows:For Against AbstainApproval of Amendments to the National Fuel Gas Company 1997 Award and Option Plan and the National Fuel Gas Company 1993 Award and Option Plan 22,829,075 7,099,894 556,519
Item 5. Other Information
On December 13, 2001, the Board of Directors of the Company elected Philip C. Ackerman to the position of Chairman of the Board, effective January 3, 2002. Mr. Ackerman became Chief Executive Officer of the Company on October 1, 2001. He succeeds Bernard J. Kennedy in both capacities.
Effective November 5, 2001, Darrell Ibach became President of National Fuel Exploration Corporation, the Canadian subsidiary of Seneca Resources Corporation, the Company's Exploration and Production segment.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits ExhibitNumber Description of Exhibit(12) Statements regarding Computation of Ratios: Ratio of Earnings to Fixed Charges for the Twelve Months Ended December 31, 2001 and the Fiscal Years Ended September 30, 1997 through 2000. (99) National Fuel Gas Company Consolidated Statement of Income for the Twelve Months Ended December 31, 2001 and 2000. (b) Reports on Form 8-K A report on Form 8-K dated October 16, 2001 was filed on October 17, 2001 to report shareholder approval of amendments to the Company's 1993 Award and Option Plan and 1997 Award and Option Plan under Item 5, "Other Events." These amendments provided for the conversion of outstanding stock appreciation rights (SARs) into non-qualified stock options, and eliminated all future awards of SARs from those plans. The Report also reported the filing of a Consent of McDaniel & Associates Consultants Ltd. as an exhibit. Exhibits were reported under Item 7, "Financial Statements, Pro Forma Financial Information and Exhibits."
Item 6. Exhibits and Reports on Form 8-K (Concl.)
A report on Form 8-K dated October 17, 2001 was filed on October 18, 2001 to report that a decline in crude oil and natural gas prices would require Seneca to write down the cost of its Canadian oil and gas producing properties at the end of the fiscal 2001 fourth quarter. This information was filed under Item 5, "Other Events." An exhibit was filed under Item 7, "Financial Statements, Pro Forma Financial Information and Exhibits." A report on Form 8-K dated October 25, 2001 was filed on October 26, 2001 regarding press releases issued by the Company and Seneca, concerning earnings for the fiscal year ended September 30, 2001 and certain earnings projections for fiscal 2002, as disclosed in a conference call on October 26, 2001. This Information was filed under Item 5, "Other Events." Exhibits were filed under Item 7, "Financial Statements, Pro Forma Financial Information and Exhibits." A report on Form 8-K dated November 7, 2001 was filed on November 7, 2001 regarding Seneca's projected oil and gas production in fiscal 2002 and 2003 under Item 5, "Other Events." An exhibit was filed under Item 7, "Financial Statements, Pro Forma Financial Information and Exhibits."
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
NATIONAL FUEL GAS COMPANY ------------------------- (Registrant) /s/Joseph P. Pawlowski ------------------------------ Joseph P. Pawlowski Treasurer and Principal Accounting Officer
EXHIBIT INDEX(Form 10-Q)
Exhibit 12 Statements regarding Computation of Ratios: Ratio of Earnings to Fixed Charges for the Twelve Months Ended December 31, 2001 and the Years Ended September 30, 1997 through 2000. Exhibit 99 National Fuel Gas Company Consolidated Statement of Income for the Twelve Months Ended December 31, 2001 and 2000.