-----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, S6gsNR/gzjJFiTRPqiE0wtSm0zpNvh/xLvlZe1cZhBHy59bpYdLUkcB3YclMg4NW 6aGM5ZPE72kYNSiQf8NN2A== 0000310103-97-000028.txt : 19971205 0000310103-97-000028.hdr.sgml : 19971205 ACCESSION NUMBER: 0000310103-97-000028 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19970930 FILED AS OF DATE: 19971204 SROS: NYSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: CONNECTICUT ENERGY CORP CENTRAL INDEX KEY: 0000310103 STANDARD INDUSTRIAL CLASSIFICATION: NATURAL GAS DISTRIBUTION [4924] IRS NUMBER: 060869582 STATE OF INCORPORATION: CT FISCAL YEAR END: 0930 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 001-08369 FILM NUMBER: 97732179 BUSINESS ADDRESS: STREET 1: 855 MAIN STREET CITY: BRIDGEPORT STATE: CT ZIP: 06604 BUSINESS PHONE: 8007607776 MAIL ADDRESS: STREET 1: 855 MAIN ST CITY: BRIDGEPORT STATE: CT ZIP: 06604 10-K405 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-K FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended September 30, 1997 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _____________ to _____________ Commission file number 1-8369 CONNECTICUT ENERGY CORPORATION (Exact name of registrant as specified in its charter) Connecticut 06-0869582 (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.) 855 Main Street Bridgeport, Connecticut 06604 (Address of Principal Executive Offices) (Zip Code) Registrant's telephone number, including area code (800) 760-7776 Securities registered pursuant to Section 12(b) of the Act: Title of Each Class Name of Each Exchange on Which Registered - --------------------------- ---------------------------------------- Common Stock ($1 par value) New York Stock Exchange Securities registered pursuant to Section 12(g) of the Act: None (Title of Class) Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] Aggregate market value of the voting stock held by non-affiliates of the registrant based on the closing price of such stock as of November 21, 1997: $259,070,351 APPLICABLE ONLY TO REGISTRANTS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PRECEDING FIVE YEARS: Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes [ ] No [ ] Class Outstanding at November 21, 1997 - -------------------------- -------------------------------- Common Stock, $1 par value 10,209,669 DOCUMENTS INCORPORATED BY REFERENCE Portions of Connecticut Energy Corporation's 1997 Annual Report to Shareholders are incorporated into Part II and Part IV. Portions of Connecticut Energy Corporation's Definitive Proxy Statement dated December 12, 1997 are incorporated into Part III. PART I ------ CONNECTICUT ENERGY CORPORATION Connecticut Energy Corporation ("Connecticut Energy" or "Company") and its subsidiaries and their representatives may, from time to time, make written or oral statements, including statements contained in the Company's filings with the Securities and Exchange Commission and in its annual report to shareholders, including its Form 10-K, which constitute or contain "forward-looking" information as that term is defined in the Private Securities Litigation Reform Act of 1995. All statements other than the financial statements and other statements of historical facts included in this Form 10-K regarding the Company's financial position and strategic initiatives and addressing industry developments are forward-looking statements. Where, in any forward-looking statement, the Company, or its management, expresses an expectation or belief as to future results, such expectation or belief is expressed in good faith and believed to have a reasonable basis, but there can be no assurance that the statement of expectation or belief will result or be achieved or accomplished. Factors which could cause actual results to differ materially from those stated in the forward-looking statements may include, but are not limited to, general and specific economic, financial and business conditions; federal and state regulatory, legislative and judicial developments which affect the Company or significant groups of its customers; the impact of competition on the Company's revenue; fluctuations in weather from normal levels; changes in development and operating costs; the availability and cost of natural gas; the availability and terms of capital; exposure to environmental liabilities; the costs and effect of unanticipated legal proceedings; the successful implementation and achievement of internal performance goals; the impact of unusual items resulting from ongoing evaluations of business strategies and asset valuations; and changes in business strategy. Item 1. Business - ----------------- General Connecticut Energy is a public utility holding company primarily engaged in the retail distribution of natural gas for residential, commercial and industrial uses through its principal subsidiary, The Southern Connecticut Gas Company ("Southern"), a Connecticut public service company. Southern's predecessor companies, New Haven Gas Company and The Bridgeport Gas Company, were originally incorporated in Connecticut in 1847 and 1849, respectively. The Company is exempt from registration under the Public Utility Holding Company Act of 1935. Southern serves approximately 157,000 customers in Connecticut, primarily in twenty-two towns along the southern Connecticut coast from Westport to Old Saybrook, which include the urban communities of Bridgeport and New Haven. Southern is also authorized to lay mains and sell gas in an additional ten towns in its service area, but does not currently provide any service to these towns. The percentage of Southern's revenues contributed by each class of customers for the last three fiscal years was as follows: Years ended September 30, 1997 1996 1995 - ----------------------------------------------------------------------- Residential 57.9% 58.0% 58.2% Commercial firm 19.5 21.4 20.5 Industrial firm 4.3 6.5 7.8 Firm transportation 2.4 0.3 --- Interruptible and other 15.9 13.8 13.5 ----- ----- ----- 100.0% 100.0% 100.0% ===== ===== ===== Southern is the sole distributor of natural gas, other than bottled gas, in its service area. Oil and electricity compete with gas in most industrial and commercial markets and for residential space and water heating. In general, Southern's firm rates are currently lower than electric rates for heating and, on average, are generally competitive with fuel oil. Southern's gas sales are affected by seasonal factors, and it experiences higher revenues during the winter months. In fiscal 1995, the Company formed two nonutility subsidiaries, CNE Development Corporation ("CNE Development") and CNE Energy Services Group, Inc. ("CNE Energy"). CNE Development is an equity holder in an entity formed to purchase and market natural gas and may potentially participate in other nonregulated activities; CNE Energy engages in activities relating to the selling, planning, purchasing and management of various energy services to commercial and industrial end users. In September 1997, CNE Energy formed a joint venture with Delmarva Power & Light Company's bulk energy group. The alliance was formed to sell natural gas, electricity, fuel oil and other services in New York and New England. The new energy marketing and sales company will operate under the name Conectiv/CNE Energy Services, LLC ("Conectiv/CNE"). In addition to selling energy products, Conectiv/CNE will market a full range of energy-related planning, financial, operational and maintenance services to commercial, industrial and municipal customers located in New York and New England. This alliance replaces the joint venture between CNE Energy and Louis Dreyfus Energy Corp. which was terminated in August 1997. In October 1996, the Company formed another nonutility subsidiary, CNE Venture-Tech, Inc. ("CNE Venture-Tech"). CNE Venture-Tech focuses on investing in technology companies and participating in ventures with technology partners serving the utility industry. In August 1997, CNE Venture-Tech made an initial investment in the Nth Power Technologies Fund I ("Nth Power") as a limited partner. Nth Power's venture capital fund invests in companies that produce or market technologically advanced, innovative energy- related products. Participation in the fund may provide business opportunities to its limited partners. As of September 30, 1997, the Company, through its subsidiaries, had 501 full-time employees, the majority of whom were employees of Southern. Customers General From 1992 through 1997, the average number of on-system customers served by Southern grew from approximately 152,100 to 156,600. Southern provides three types of gas service to its on-system customers: firm sales, firm transportation and interruptible. Firm service is provided to residential, commercial and industrial customers who require a continuous gas supply throughout the year. Southern serves approximately 181,000 firm residential units. Interruptible service is available to those customers that have dual fuel capabilities which allow them to alternate between natural gas and another fuel source. Firm service for residential use includes service to multi-family units. Firm transportation is available to commercial, industrial and multi-family customers who have secured their own gas supply and require that Southern transport this supply on its distribution system. Southern also provides transportation service to certain commercial and industrial customers on an interruptible basis, where the gas transported is owned by those customers. Additionally, Southern has the approval of the Connecticut Department of Public Utility Control ("DPUC") to participate in the off-system sales market. If gas supplies are available after meeting on-system loads, Southern can sell to customers within Connecticut or in out-of-state markets. The customers to whom these sales are made are not permanent customers of Southern. Firm Sales and Transportation In 1997, firm services represented approximately 84% of operating revenues and approximately 47% of total gas throughput. Firm sales to industrial customers are likely to constitute a smaller percentage of Southern's future total sales due to the changing character of the local economy and continuing regulatory developments affecting the natural gas industry. See section entitled "Rates and Regulation" for further detail. Southern concentrates on customer additions that are the most cost-effective to achieve. Over the past several years, Southern has focused on adding load along its existing mains, which generally requires a lower capital outlay. Approximately 59% of the residences along Southern's mains heat with natural gas. The conversion of these homes from an alternate fuel to natural gas heat has been a major factor in increased load growth. Interruptible Sales, Transportation and Special Contract Services Interruptible sales, which include off-system sales, and transportation services are priced flexibly and competitively compared to the price paid for alternate fuels by larger commercial and industrial customers. Southern's interruptible sales fluctuate primarily due to the relative price differentials between alternate fuels and natural gas as well as the availability of gas not needed to serve firm customers. In addition to interruptible sales, Southern transports gas, on an interruptible basis, for delivery to certain large commercial and industrial consumers. Because of recent regulatory developments, end users can contract more easily than in the past for transportation service on interstate pipelines to transport natural gas supplies purchased from producers/ suppliers, rather than purchase gas solely from the local gas distribution company ("LDCs"). In Southern's service area, gas is transported to customers using interstate pipeline transportation and Southern's distribution system. Interruptible transportation revenues are considerably less than revenues from gas sales because customers pay only a fee for the transportation service. Gas sales revenues include the cost of gas sold. Southern provides service to The Connecticut Light and Power Company's Devon electric generating station in accordance with rates specified in a Special Contract for the Transportation of Gas. In 1997, interruptible sales, transportation and Special Contract services represented approximately 15% of operating revenues and approximately 51% of total gas throughput. Southern's average margins on interruptible transportation service are less than its average margins on firm sales and are usually less than its average margins on interruptible sales. To the extent Southern negotiates its monthly prices for interruptible services below its monthly standard offering price, lower margins may result. The Company does not believe that the loss of any single customer or a few customers would have a long-term, material, adverse effect upon Southern's business. Marketing General Southern focuses its marketing efforts on three objectives: (1) to increase the number of households using natural gas for heating and hot water, (2) to improve system load factor by promoting additional interruptible sales and (3) to add new sales and retain existing sales to commercial and industrial customers through the use of both traditional and interruptible applications for natural gas. Marketing programs emphasize growth from within the existing distribution system and the addition of high load factor usage of natural gas such as water heating, air conditioning and electric power generation. Residential Market In the residential heating market, 2,641 customers were added in 1997 compared to 1,866 customers in 1996 and 2,366 in 1995. Residential conversions accounted for 60% of these additions in 1997 compared to 52% in 1996 and 68% in 1995. Southern's residential marketing programs include (1) a conversion burner program, (2) a high-efficiency heating program, (3) a trade ally program and (4) service contracts for natural gas heating equipment. Southern also uses employee incentives to promote heating conversions. Commercial and Industrial Markets In the commercial and industrial markets, emphasis is on adding new firm and interruptible sales while retaining existing load. Marketing programs for commercial and industrial customers include (1) a program to promote the use of high efficiency equipment, (2) a program offering customers the option of financing new equipment through Southern, (3) a conversion burner leasing program which provides customers with a low cost opportunity to switch to natural gas and (4) a major customer retention program. Effective April 1, 1996, firm transportation service became available to commercial and industrial customers. As of September 30, 1997, there were 682 firm transportation customers purchasing natural gas directly from marketers. In these cases, Southern offers customers the opportunity to purchase additional services such as balancing or stand-by services. Sales to cooling and cogeneration markets represent the potential for increasing natural gas usage. Advances in natural gas cooling technology, along with environmental and operational advantages, continue to increase the competitiveness of natural gas cooling in commercial buildings and for industrial process applications. Southern has added 9,912 tons of natural gas cooling since 1991. With the continuing deregulation of energy markets and advancements in natural gas turbine technologies, cogeneration is a viable economic solution for many industrial customers. For example, Yale University is installing a 13.5 megawatt cogeneration system that will provide both electricity and steam for many of its facilities. Natural Gas Vehicles Natural gas vehicles ("NGV") represent a significant opportunity to increase the base load usage of natural gas. Southern has been active in this market and has more than 130 natural gas vehicles operating in its service area. Customers include the U.S. Postal Service, The Southern New England Telephone Company, R. R. Donnelley and Sons, South Central Regional Water Authority, Bridgeport Hydraulic Company, the city of New Haven and the town of Westport. More fleets are expected to add natural gas vehicles during the next five years as federal legislation requires fleets to "phase-in" the use of cleaner alternate fuel vehicles. Natural gas is the leading alternate fuel for vehicle use. Southern's NGV marketing approach is designed to complement the federal phase-in of alternate fuels. This approach emphasizes developing NGV projects that serve multiple customers from central multi-fleet off-site stations. This approach allows fleets to buy fuel at off-site facilities and avoid investment and maintenance required for on-site NGV facilities. Station developers can pool volumes from multiple customers and take advantage of economies of scale for better profitability. As a method to increase demand for natural gas fuel, Southern is also assisting fleets to obtain state and federal grants whenever possible. In New Haven for instance, Southern helped the city and Yale to obtain more than $200,000 in federal and state grants to offset incremental natural gas vehicle costs. Gas Supply General Southern's long-term supply sources include (1) Canadian supplies purchased from Alberta Northeast Gas Limited ("Alberta Northeast") with transportation on Iroquois Gas Transmission System, L.P. ("Iroquois"), (2) transportation and storage services from Tennessee Gas Pipeline Company ("Tennessee") with direct purchase of supply from producers and marketers, (3) transportation and storage services from Texas Eastern Transmission Corporation ("Texas Eastern") with direct purchase of supply from producers and marketers, (4) transportation services from Algonquin Gas Transmission Company ("Algonquin"), (5) transportation and storage services from CNG Transmission Corporation ("CNG Transmission"), (6) transportation service from Transcontinental Gas Pipeline Corporation ("Transco"), (7) transportation service from National Fuel Gas Supply Corporation ("National Fuel") and (8) liquid and vapor supplies from Distrigas of Massachusetts Corporation ("Distrigas"). These arrangements result in gas deliveries into Southern's service territory through interconnections with three interstate pipelines: Algonquin, Iroquois and Tennessee. In addition to Southern's long-term firm supply arrangements, Southern purchases spot supplies and utilizes interruptible transportation services from interstate pipeline companies. Southern's supply, transportation and storage agreements require Southern to pay a fixed demand charge regardless of the amount of gas transported or stored. The Federal Energy Regulatory Commission ("FERC") regulates interstate pipeline companies in connection with the rates charged to Southern for transportation and storage of natural gas. Domestic Supply Southern's domestic supply arrangements consist mainly of purchasing storage and transportation services from interstate pipelines. Producers and marketers provide the gas supply to support these services. Southern has firm transportation and firm storage contracts with Tennessee. Under the transportation contract, Southern has 13,336,000 Mcf of pipeline capacity available on an annual basis. Southern's storage contract with Tennessee provides 1,195,000 Mcf of storage capacity. These contracts expire in the year 2000. Two other transportation contracts with Tennessee provide 516,000 Mcf of firm transportation service annually and expire in the year 2000. A transportation contract with Texas Eastern provides 5,972,000 Mcf of capacity on an annual basis. Additional contracts with Texas Eastern provide 1,383,000 Mcf of storage service and 12,108,000 Mcf of transportation service on an annual basis. Contracts with Texas Eastern expire in the year 2012. Southern has storage service contracts with CNG Transmission. One contract provides one hundred days of storage service with 648,000 Mcf of annual delivery. The remaining term of this contract is fifteen years. Under other contracts which have remaining terms of six to ten years, CNG Transmission provides 773,000 Mcf of annual firm storage service and 1,028,000 Mcf of annual transportation service. The gas is stored by CNG Transmission and delivered to Southern under transportation contracts with Texas Eastern and Algonquin. Algonquin furnishes only transportation services to Southern. The deliveries that Algonquin makes to Southern are gas supplies transported by other interstate pipelines interconnected to Algonquin. Southern has multiple, diverse purchase agreements with producers and marketers for firm supply behind its storage and transportation agreements. These agreements vary in terms of delivery obligations and the contract terms range from one month to five years. Southern pays a monthly reservation charge, but has no monthly purchase obligation under these agreements. Commodity prices are based on price indexes by supply area or are negotiated. Canadian Supply Southern receives Canadian supply under its long-term contracts with Alberta Northeast with firm transportation provided by Iroquois. These supply contracts with Alberta Northeast provide Southern with 12,775,000 Mcf of firm Canadian supply annually. Supply agreements with Alberta Northeast have remaining terms of five to nine years, and the transportation agreement with Iroquois has a remaining term of fourteen years. Supplemental Supply Southern has an agreement with Distrigas to purchase 328,000 Mcf annually on a firm basis. This contract continues for five years and includes a provision for either vapor or liquid delivery, with an option to increase maximum daily delivery over the term of the contract. Additionally, Southern has interruptible purchase contracts with Distrigas. Supplemental gas supplies from on-site liquefied natural gas ("LNG") and liquefied propane air storage facilities are available to meet peak and winter demand requirements. See section entitled "Connecticut Regulation" for the Decision in Docket No. 96-04-30. FERC Order No. 636 FERC Order No. 636 resulted in costs being incurred by Southern's interstate pipeline suppliers as they unbundled their services. FERC has allowed transition costs to be recovered by pipelines from their customers. Southern has recovered transition costs through the various recovery mechanisms authorized by the DPUC in Docket No. 94-01-12. Included in the recovery are Tennessee transition costs, the final amount of which was approved as part of a settlement by the FERC in Tennessee Gas Pipeline Co., 79 FERC Par. 61, 031 (1997). Straight-fixed-variable rates are in effect on the pipelines serving Southern as a result of FERC Order No. 636. Pipeline demand charges increased under the straight-fixed-variable rate design, while pipeline usage charges decreased. The change in gas costs due to straight-fixed-variable rates were incorporated in Southern's base cost of gas approved by the DPUC. On July 16, 1996, the U.S. Court of Appeals for the District of Columbia Circuit in United Distribution Companies v. FERC, 88 F.3d 1105 (D.C. Cir. 1996), upheld FERC Order No. 636 "in its broad contours and in most of its specifics." The Court remanded a number of issues to FERC for further explanation. On February 27, 1997 the FERC issued its order on remand, Order No. 636-C, 78 FERC Par. 61, 186 (1997). Of the major issues, the FERC reaffirmed its decision to allow natural gas pipelines to recover 100% of gas supply realignment costs caused by industry restructuring and modified its right of first refusal mechanism. The order directed pipelines to shorten from twenty to five years the period existing customers must agree to extend their contract in order to retain the right to continue service, a key ruling. FERC Order No. 636 continues to have an effect on how Southern conducts its business, moving Southern to the next phase of unbundling behind its city gates. See section entitled "Rates and Regulation" for further detail. Off-System Sales Southern's off-system sales program maximizes the use of its gas supply contracts, improves the usage of Southern's capacity on pipeline systems and lowers gas costs to firm customers through established margin sharing mechanisms. Pursuant to the DPUC Decision regarding FERC Order No. 636, Southern is allowed to enter into off-system sales under flexible terms and pricing for periods of less than one year without prior approval of the DPUC. In fiscal 1997, Southern dispatched approximately 5,123,000 Mcf of volume as part of its off-system sales program. Off-system sales are performed by Southern through an effective trading operation established over the last three years. Southern has established a recognized trading function in various natural gas markets in the United States. Southern's customers include other LDCs, marketers, electric generation and wholesale customers. Southern has pooling agreements and a unique asset base enabling it to deliver reliably and competitively along a significant portion of the Eastern pipeline grid under the full range of operating and marketing conditions. Capacity release programs are available on all interstate pipelines serving Southern, and Southern actively participates in these programs. Demand charges recovered from a replacement shipper flow back as a reduction on the pipeline's monthly invoice. These demand reductions are used to lower gas costs to firm customers through established margin sharing mechanisms approved by the DPUC. CNE Development has joined six other major eastern U.S. natural gas distribution companies or their affiliates to form the East Coast Natural Gas Cooperative, L.L.C. to access competitively priced gas supplies. Southern has experienced reduced gas costs and increased operational flexibility as a result of the activities of this cooperative. Rates and Regulation Connecticut Regulation Southern is subject to the jurisdiction of the DPUC as to accounting, rates, charges, operating matters and the issuance of securities, both equity and debt, other than borrowings maturing in twelve months or less. Southern's firm sales rates change monthly pursuant to a DPUC-approved Purchased Gas Adjustment clause, under which purchased gas costs above or below a specified base cost are charged or credited to customers. In setting authorized rates for Southern, the DPUC allows prospective adjustments to a historical test year. Forward-looking adjustments to the mid-point of the rate year (the first year that rates will be in effect) for rate base, revenues, expenses and capital structure are allowed. The DPUC has found that these refinements provide for better synchronization of the ratemaking components. Costs used by the DPUC in determining Southern's rates may not be the same as actual costs incurred by Southern during the period rates are in effect. The sales used in establishing rates are based on "normal" weather patterns. Actual rates of return realized may not necessarily equal the authorized rates of return. In April 1993, Southern filed an application with the DPUC for an increase in rates designed to produce additional revenues of approximately $27,900,000, or 13.67%, over test year revenues. Southern's base rates had not been increased since April 1990. On December 1, 1993, the DPUC issued a final Decision on Southern's latest rate request. The Decision incorporated the Partial Settlement of Certain Issues ("Partial Settlement"), which was previously approved by the DPUC in September 1993, and resolved most of the significant financial aspects of Southern's original rate request, including an increase in base rates of $13,400,000 based upon Southern's sales forecast as originally filed, an allowed return on equity of 11.45% and the implementation of a Weather Normalization Adjustment. In addition, Southern was permitted to recover previously deferred costs over amortization periods from three to five years associated with shortfalls in energy assistance, its certified hardship arrearage forgiveness program, environmental remediation expenditures, economic development programs and undepreciated gas holder costs. The Partial Settlement also provided for current recovery of postretirement health care expenses accrued under Statement of Financial Accounting Standards No. 106 and the establishment of a target margin, net of gross earnings tax, for on-system sales and transportation to Southern's interruptible customers with excess margins shared between firm customers and shareholders on an 80%/20% split. As part of the Partial Settlement, Southern agreed that, except for certain adverse events, it would not file a general application to increase rates which would become effective on or before November 30, 1995. In January 1996, Southern requested a reopening of the 1993 rate proceeding to propose a plan to redirect excess on-system interruptible margins to be returned to ratepayers for calendar years 1996, 1997 and 1998 to two programs to fund certain economic development initiatives in Bridgeport and to provide grants to customers to reduce Southern's current hardship assistance balances. Southern estimated that margins to be collected over the proposed three-year period would be approximately $14,000,000, which would be divided equally between the programs. Southern's proposal related to the economic development initiatives in Bridgeport included job training and services, certain loan subsidies and health promotion outreach services. Redirection of ratepayer margins for hardship assistance balances would benefit Southern's hardship customers by reducing their accounts receivable arrearages and would benefit Southern by reducing its provision for uncollectibles for such accounts. On April 26, 1996, the DPUC issued a final Decision regarding Southern's proposal. The DPUC effectively approved Southern's proposal with certain modifications in the direction of the Bridgeport economic development funding initiatives, the imposition of a cap of $6,000,000 per year of ratepayer margins to be split equally between the programs and certain implementation and status reporting requirements. In August 1995, the DPUC issued a final Decision in Docket No. 94-11-12, DPUC Review of Connecticut Local Distribution Companies' Cost of Service Study Methodologies. In this docket, the DPUC investigated the issues surrounding the development of firm transportation rates at the state level in response to FERC Order No. 636. Effective April 1, 1996, commercial and industrial gas customers in Connecticut can contract for their gas supplies from sources other than the LDCs and pay the LDCs only for the transportation of that gas through their distribution systems at DPUC approved rates. The new firm transportation rates are designed to provide Southern with the same margins provided by bundled services. In August 1997, the DPUC instituted Docket 97-07-11, DPUC Generic Investigation into Issues Associated with Unbundling of Natural Gas Services by Connecticut Local Distribution Companies. The purpose of this docket will be to review issues relative to firm transportation service in its present form and to consider prospective changes to the existing LDC tariffs. On September 22, 1997, Southern submitted testimony which addressed the issues identified by the DPUC as Phase I items. The Company also submitted a "Vision Statement" which generally described the Company's near-term plan to offer firm transportation service to all customers while simultaneously structuring the Company in order to phase out of providing the merchant service function. The Company is currently awaiting a schedule in this docket. In August 1996, the DPUC issued a final Decision in Docket No. 96-04-30, Application of The Southern Connecticut Gas Company to Dispose of a Portion of Its Plant and Equipment. The DPUC approved certain proposals made by Southern regarding the operation of its LNG tank and related facilities, which include the sublease of the LNG tank and related facilities from Southern to its nonregulated affiliate, CNE Energy, which would, in turn, sublease the LNG facility to Total Peaking Services, L.L.C. The DPUC granted approval to move the LNG facility out of Southern and into an unregulated venture. However, federal approval necessary to finalize this venture and commence interstate operations is still pending. In February 1997, the Company and Southern requested a reopening of a DPUC Decision dated December 13, 1978, Docket No. 77-08-28, Application of The Southern Connecticut Gas Company for Approval of Corporate Reorganization and Merger and Formation of a Holding Company, for the purpose of addressing changed conditions in the Company's operations since 1978, which include the dissolution of certain subsidiaries and deregulation of the natural gas marketplace. On May 21, 1997, the DPUC issued a Decision in the reopened docket. The Decision modified or eliminated several conditions relating to the Company's nonregulated subsidiaries. The Company believes those subsidiaries will now have more flexibility to compete in the rapidly changing energy market on both a financial and operational basis. Southern, in accordance with Connecticut statutes, will undergo a periodic review of rates and services by the DPUC commencing in or after December 1997 if it does not file for a rate increase. A periodic review entails a complete review by the DPUC of Southern's financial and operating records. Public hearings will be held to determine whether the current rates are unreasonably discriminatory or more or less than just, reasonable and adequate. If Southern determines that a rate increase is required, a general rate case will be filed in lieu of a rate review. Federal Regulation Southern is affected by various federal regulations, including regulations which (1) provide for emergency authority and curtailment allocations under the Natural Gas Policy Act of 1978 when pipeline supplies are limited and (2) establish certain retail policies for natural gas utilities under the Public Utility Regulatory Policies Act of 1978. Southern is also subject to the Natural Gas Pipeline Safety Act of 1968 with respect to the construction, operation and maintenance of its mains, services and LNG facilities as well as other federal regulations pertaining to safety standards concerning such facilities. Currently, these federal regulations have a minimal impact on Southern's day-to-day operations. Southern must comply with various federal, state and local regulations with respect to environmental matters (including hazardous waste regulation), local zoning and other regulations. To date, such regulations have not materially impacted Southern's capital expenditures, earnings or operations. Regulations promulgated under the Clean Air Act Amendments of 1990 and the Energy Policy Act of 1992, which require reduced pollution levels and certain energy efficiency standards, have begun to affect Southern. Among other things, the Clean Air Act Amendments (1) impose stringent vehicle emissions standards beginning in 1994, (2) mandate the gradual phase-in of alternate fuel vehicles for fleets of more than ten vehicles beginning in 1998 and (3) require power plants to phase-in significant emission reductions of sulfur dioxide and nitrogen oxide by the year 2000. Similarly, the Energy Policy Act of 1992 (1) requires that federal agencies begin phasing-in the use of alternate fuels in vehicles in 1993, (2) offers tax incentives to private parties who use or facilitate the use of alternate fuel vehicles and (3) requires a lessening reliance on foreign fuels. In 1996, the FERC also issued Order No. 888, mandating that electric utilities provide open access transmission at wholesale. This Order has expanded opportunities for the sale of power from gas fired generating units. Over time, these regulations will likely lead to an increasing demand for natural gas. Southern already has begun to participate in the expanded markets for natural gas emerging due to these regulatory mandates. Since 1986, FERC has effected major changes in the regulations governing the natural gas industry, especially FERC Order No. 636 which mandated the unbundling of interstate pipeline services. Although the Company is not subject to FERC jurisdiction, FERC's actions increase competition in the natural gas industry by requiring interstate pipeline companies to provide gas transportation to others on a nondiscriminatory basis. Environmental Matters Southern has identified coal tar residue at three sites in Connecticut resulting from coal gasification operations conducted at those sites by Southern's predecessors from the late 1800s through the first part of this century. Many gas distribution companies throughout the country carried on such gas manufacturing operations during the same period. The coal tar residue is not designated a hazardous material by any federal or Connecticut agency, but some of its constituents are classified as hazardous. On April 27, 1992, Southern notified the Connecticut Department of Environmental Protection ("DEP") and the United States Environmental Protection Agency of the presence of coal tar residue at the sites. On November 9, 1994, the DEP informed Southern that it had performed a preliminary review of the information provided to it by Southern and had determined that, based on current priorities and limited staff resources, a comprehensive review of site conditions and subsequent participation by the DEP "are not possible at this time." On September 8, 1997, Southern received a letter from the DEP informing it that the three sites had been entered on the Connecticut Inventory of Hazardous Waste Sites. The letter states that the site located on Pine Street in Bridgeport, Connecticut may be of particular interest to the state of Connecticut because of its proximity to the Connecticut Department of Transportation expansion project of the U.S. Highway Route Number 95 Corridor. Placement of the sites on the Inventory of Hazardous Waste Sites means that the DEP may pursue remedial action pursuant to the Connecticut General Statutes. Each site is located in an area that permits Southern to voluntarily perform any remedial action. Connecticut law also allows Southern to retain a Licensed Environmental Professional to conduct further environmental assessments and, if necessary, to develop remedial action plans in accordance with Connecticut Remediation Standard Regulations. Southern intends to confer with officials of the DEP and the Department of Transportation to establish priorities in connection with the environmental assessments. Management cannot at this time predict the costs of any future site analysis and remediation, if any, nor can it estimate when any such costs, if any, would be incurred. While such future analytical and cleanup costs could possibly be significant, management believes, based upon the provisions of the Partial Settlement in Southern's most recent rate order and regulatory precedent with other LDCs in Connecticut, that Southern will be able to recover these costs through its customer rates. Although the method, timing and extent of any recovery remain uncertain, management currently does not expect that the incurrence of such costs will materially adversely impact the Company's financial condition or results of operations. Item 2. Properties - ------------------- The Company's physical plant and properties consist primarily of Southern's gas distribution facilities. Southern had 2,133 miles of main and 123,183 service units as of September 30, 1997. It leases office space in Bridgeport, New Haven, Orange and Madison, owns properties in Bridgeport and New Haven that were formerly manufacturing sites and owns a propane air facility in Trumbull. In 1995, the LNG plant lease agreement was renewed for two consecutive terms of twelve years. The lease contains an option to purchase the plant for a purchase price based on the then fair market sales value of the unit as defined therein. Substantially all of Southern's utility properties and plant are subject to the lien of the indenture and supplemental indentures securing its first mortgage bonds. It is management's opinion that the physical plant and properties as described herein are suitable and adequate for the purpose of delivering gas for customer use. Item 3. Legal Proceedings - -------------------------- In a class action styled Connecticut Heating & Cooling Contractors Association, Inc. v. Connecticut Natural Gas Corp., Connecticut Superior Court - Middlesex, two trade associations and two plumbing and heating contractors in November 1995 sued Southern as well as the other Connecticut LDCs for violations of the Connecticut Unfair Trade Practices Act and tortious interference with business expectancies in connection with the LDCs' provision of service and maintenance to heating, cooling and ventilating systems and appliances. An Amended Complaint was filed in response to motions filed by the defendants in which one of the two contractor plaintiffs was removed from the case. In response to the court's granting a motion to strike the Complaint on the grounds of misjoinder filed by Southern and another defendant, the plaintiffs again amended their Complaint to add causes of action in conspiracy to violate the Connecticut Unfair Trade Practices Act and conspiracy to violate the antitrust laws. All three defendants have filed new motions to strike the latest complaint. The motions have not been argued, but should be heard by the end of the year. The plaintiffs seek declaratory and injunctive relief. The plaintiffs seek treble damages in excess of $15,000, punitive damages and attorneys' fees. Southern intends to defend itself vigorously in this suit, which management believes is without merit. In the opinion of management, resolution of this lawsuit is not expected to have a material adverse impact on the Company's financial condition or results of operations. Item 4. Submission of Matters to a Vote of Security Holders - ------------------------------------------------------------ None. PART II ------- Item 5. Market for Common Stock Equity and Related Stockholder Matters - ----------------------------------------------------------------------- Common Stock Data The Company's common stock is listed for trading on the New York Stock Exchange. The Company's common stock symbol is CNE. The following table shows the quarterly high and low price ranges of the Company's common stock and quarterly dividends paid during the years ended September 30, 1997 and 1996. Market Price and Dividend Data 1997 Quarters ended High Low Dividend - ------------------- ---- --- -------- December 31, 1996 $22 1/4 $19 7/8 $0.33 March 31, 1997 $24 3/8 $21 $0.33 June 30, 1997 $24 1/4 $22 1/4 $0.33 September 30, 1997 $24 15/16 $22 3/8 $0.33 1996 Quarters ended High Low Dividend - ------------------- ---- --- -------- December 31, 1995 $22 1/2 $19 $0.325 March 31, 1996 $22 1/4 $18 5/8 $0.325 June 30, 1996 $20 7/8 $18 7/8 $0.33 September 30, 1996 $20 3/8 $19 $0.33 As of September 1997, the Company and its predecessors have paid 351 consecutive quarterly cash dividends. Cash dividends have been paid since 1850, and the Company currently expects that dividends will continue to be paid in the future. The major source of funds for payment of the Company's dividends are the dividends received on the shares of Southern's common stock owned by the Company. Southern's indentures relating to long-term debt contain restrictions as to the declaration or payment of cash dividends on, or the reacquisition of, capital stock. Under the most restrictive of such provisions, $29,633,000 of retained earnings at September 30, 1997 was available for such purposes. The approximate number of shareholders of record of the Company's common stock as of November 21, 1997 was 10,398. Item 6. Selected Financial Data - -------------------------------- The presentation under the "Eleven Year Financial Summary" for the five-year period ended September 30, 1997 on pages 38 and 39 of the Company's 1997 Annual Report to Shareholders is incorporated by reference herein. Item 7. Management's Discussion and Analysis of Financial Condition - -------------------------------------------------------------------- and Results of Operations - ------------------------- "Management's Discussion and Analysis of Financial Condition and Results of Operations" on pages 15 to 21 of the Company's 1997 Annual Report to Shareholders is incorporated by reference herein. Item 8. Financial Statements and Supplementary Data - ---------------------------------------------------- The Consolidated Statements of Income, Consolidated Balance Sheets, Consolidated Statements of Changes in Common Shareholders' Equity, Consolidated Statements of Cash Flows and Notes to Consolidated Financial Statements on pages 22 to 35 and the Report of Independent Accountants on page 37 of the Company's 1997 Annual Report to Shareholders are incorporated by reference herein. Item 9. Changes in and Disagreements with Accountants on Accounting and - ------------------------------------------------------------------------ Financial Disclosure - -------------------- None. PART III -------- Item 10. Directors and Executive Officers of the Registrant - ------------------------------------------------------------ Information required in this item regarding directors is contained in the Company's definitive Proxy Statement at pages 2 to 4, which will be mailed to shareholders on or about December 12, 1997, and is incorporated by reference herein. A list of executive officers of the registrant and Southern follows:
Executive Officers of Connecticut Energy Corporation and The Southern Connecticut Gas Company Name and Age Position and Business Experience for the Past Five Years - ------------ -------------------------------------------------------- J. R. Crespo, 55 Chairman, President and Chief Executive Officer of the Company and Southern (1990). Thomas A. Trotta, 60 Senior Vice President of the Company and Executive Vice President and Chief Operating Officer of Southern (1996), Executive Vice President and Chief Operating Officer of Southern (1995), Senior Vice President and Chief Operating Officer of Southern (1992). Vincent L. Ammann, Jr., 38 Vice President and Chief Accounting Officer of the Company and Vice President, Information Technology of Southern (1996), Vice President and Chief Accounting Officer of the Company and Group Vice President of Southern (1994), Vice President and Chief Accounting Officer of the Company and Southern (1991). Samuel W. Bowlby, 59 Vice President, General Counsel and Secretary of the Company and Southern (1997), Partner, Tyler, Cooper & Alcorn, New Haven, CT (1970- 1997). Carol A. Forest, 49 Vice President, Finance, Chief Financial Officer, Treasurer and Assistant Secretary of the Company and Southern (1996), Vice President, Finance, Chief Financial Officer and Treasurer of the Company and Southern (1991). Janet L. Janczewski, 53 Senior Corporate Counsel and Assistant Secretary of the Company and Southern (1997), Corporate Counsel of Southern (1989). Michael H. Pinto, 70 Vice President, Government Affairs of the Company (1991). Salvatore A. Ardigliano, 48 Vice President, Marketing and Gas Supply Services of Southern (1995), Vice President, Gas Supply Services of Southern (1995), Group Director, Gas Supply Services of Southern (1993), Director, Gas Control of Southern (1992). James P. Healy, 55 Vice President, Energy Services Planning of Southern (1995), Vice President, Information Technology of Southern (1992). Ernest W. Karkut, 55 Vice President, Purchasing and Plant Services of Southern (1994), Vice President, Customer Relations (1993), Vice President, Customer Support Services of Southern (1992). Peter D. Loomis, 49 Group Vice President, Customer and Operating Services of Southern (1995), Vice President, Distribution and Customer Service of Southern (1992). Phyllis A. O'Brien, 52 Group Vice President of Southern (1996), Vice President, Accounting and Regulatory Services of Southern (1994), Vice President, Corporate and Regulatory Planning of Southern (1993), Group Director, Corporate Regulatory and Supply Planning of Southern (1991). Patricia A. Younger, 55 Vice President, Customer Relations of Southern (1995), Group Director, Customer Relations of Southern (1994), Director, Customer Information and Collections of Southern (1994), Director, Credit and Collections of Southern (1993), Manager, Credit and Collections of Southern (1986).
Item 11. Executive Compensation - -------------------------------- Information required in this Item is contained in the Company's definitive Proxy Statement on pages 9 to 10, which will be mailed to shareholders on or about December 12, 1997, and is incorporated by reference herein. Item 12. Security Ownership of Certain Beneficial Owners and Management - ------------------------------------------------------------------------ Information required in this Item is contained in the Company's definitive Proxy Statement on pages 4 to 5, which will be mailed to shareholders on or about December 12, 1997, and is incorporated by reference herein. Item 13. Certain Relationships and Related Transactions - -------------------------------------------------------- Information required in this Item is contained in the Company's definitive Proxy Statement on pages 10 to 12, which will be mailed to shareholders on or about December 12, 1997, and is incorporated by reference herein. PART IV ------- Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K - ------------------------------------------------------------------------- (a) List of documents filed as part of this Report: 1. Financial Statements -------------------- Among the responses to this Item 14(a) are the following financial statements which are incorporated by reference herein in Item 8 above: (i) Consolidated Statements of Income for the years ended September 30, 1997, 1996 and 1995. (ii) Consolidated Balance Sheets for the years ended September 30, 1997 and 1996. (iii) Consolidated Statements of Changes in Common Shareholders' Equity for the years ended September 30, 1997, 1996 and 1995. (iv) Consolidated Statements of Cash Flows for the years ended September 30, 1997, 1996 and 1995. (v) Notes to Consolidated Financial Statements. (vi) Report of Independent Accountants. 2. Financial Statements and Supplementary Data Required by Item 8 -------------------------------------------------------------- (A) Schedule Description Page -------- ----------- ---- Report of Independent Accountants on Financial Statement Schedules 18 II Valuation and Qualifying Accounts 19 All other schedules are omitted because they are not required, are inapplicable, or the information is otherwise shown in the financial statements or notes thereto. 3. Exhibits Required by Item 601 of Securities and Exchange Commission ------------------------------------------------------------------- Regulation S-K -------------- (A) The following such exhibits are filed as a separate section of this report. Exhibits -------- (3) Certificate of Incorporation and By-Laws ---------------------------------------- The Amended and Restated Certificate of Incorporation of Connecticut Energy Corporation is incorporated herein by reference to Item 6 of the Company's Form 10-Q filed for the quarter ended March 31, 1991 at pages 14 through 22. The Amended and Restated By-Laws of Connecticut Energy Corporation are incorporated herein by reference to Item 6 of the Company's Form 10-Q filed for the quarter ended March 31, 1995 at pages 20 through 31. The Amended and Restated Certificate of Incorporation of The Southern Connecticut Gas Company is incorporated herein by reference to Item 6 of Form 10-Q filed for the quarter ended June 30, 1990 at pages 40 through 51. The Amended and Restated By-Laws of The Southern Connecticut Gas Company are incorporated herein by reference to Item 6 of the Company's Form 10-Q filed for the quarter ended March 31, 1995 at pages 32 through 41. (4) Instruments Defining Rights of Security Holders, Including Indentures --------------------------------------------------------------------- (i) Indenture between The Bridgeport Gas Light Company and The Bridgeport City Trust Company, as Trustee, dated as of March 1, 1948. Incorporated herein by reference to Exhibit 4(b) (1) to Connecticut Energy Corporation Registration Statement 2-10566. (ii) In addition to the Indenture referred to in 4 (i) hereof, there have been twenty-seven indentures supplemental thereto, copies of all of which the Company agrees to furnish to the Commission upon request. (10) Material Contracts ------------------ (i) Gas Transportation Contract between Tennessee Gas Pipeline Company and The Southern Connecticut Gas Company, Contract No. 10783, dated June 1, 1995, incorporated by reference to Form 10-K for the fiscal year ended September 30, 1996 at pages 24 to 32. (ii) Interruptible Gas Transportation Contract and Amendment No. 1, thereto, among Tenngasco Corporation, The Southern Connecticut Gas Company and The United Illuminating Company, dated May 14, 1987 and August 1, 1989, respectively, incorporated by reference to Form 10-K for the fiscal year ended December 31, 1989 at pages 238 to 258. (iii) Amendment No. 2 to Interruptible Gas Transportation Contract and Amendment No. 1, thereto, among Tenngasco Corporation, The Southern Connecticut Gas Company and The United Illuminating Company, dated November 1, 1990, incorporated by reference to Form 10-K for the transition period from January 1, 1990 to September 30, 1990 at pages 90 to 91. (iv) Gas Transportation Contract between Iroquois Gas Transmission System, L.P. and The Southern Connecticut Gas Company, dated February 7, 1991, incorporated by reference to Exhibit 10.32 to Connecticut Energy Corporation's Registration Statement No. 33-40232. (v) Gas Sales Agreement No. 1 by and between Alberta Northeast Gas Limited and The Southern Connecticut Gas Company, dated February 7, 1991, incorporated by reference to Exhibit 10.33 to Connecticut Energy Corporation's Registration Statement No. 33-40232. (vi) Gas Sales Agreement No. 2 by and between Alberta Northeast Gas Limited and The Southern Connecticut Gas Company, dated February 7, 1991, incorporated by reference to Exhibit 10.34 to Connecticut Energy Corporation's Registration Statement No. 33-40232. (vii) Gas Sales Agreement by and between Alberta Northeast Gas Limited and The Southern Connecticut Gas Company, dated February 7, 1991, incorporated by reference to Exhibit 10.35 to Connecticut Energy Corporation's Registration Statement No. 33-40232. (viii) Gas Sales Agreement by and between Alberta Northeast Gas Limited and The Southern Connecticut Gas Company, dated February 7, 1991, incorporated by reference to Exhibit 10.36 to Connecticut Energy Corporation's Registration Statement No. 33-40232. (ix) Gas Sales Agreement by and between Alberta Northeast Gas Limited and The Southern Connecticut Gas Company, dated February 7, 1991, incorporated by reference to Exhibit 10.37 to Connecticut Energy Corporation's Registration Statement No. 33-40232. (x) Storage Service Transportation Contract between Tennessee Gas Pipeline Company and The Southern Connecticut Gas Company, Contract No. 542, dated September 1, 1993, incorporated by reference to Form 10-K for the fiscal year ended September 30, 1996 at pages 33 to 42. (xi) Storage Service Agreement (GSS) between CNG Transmission Corporation and The Southern Connecticut Gas Company, dated October 1, 1993, incorporated by reference to Form 10-K for the fiscal year ended September 30, 1993 at pages 130 to 137. (xii) Storage Service Agreement (GSS-TE) between CNG Transmission Corporation and The Southern Connecticut Gas Company, dated October 1, 1993, incorporated by reference to Form 10-K for the fiscal year ended September 30, 1996 at pages 43 to 50. (xiii) Storage Service Agreement (GSS-II) between CNG Transmission Corporation and The Southern Connecticut Gas Company, dated September 1, 1993, incorporated by reference to Form 10-K for the fiscal year ended September 30, 1996 at pages 51 to 56. (xiv) Gas Storage Contract and Amendment No. 1, thereto, between Tennessee Gas Pipeline Company and The Southern Connecticut Gas Company, dated December 1, 1994 and July 1, 1995, respectively, incorporated by reference to Form 10-K for the fiscal year ended September 30, 1996 at pages 57 to 63. (xv) Gas Transportation Agreement between Tennessee Gas Pipeline Company and The Southern Connecticut Gas Company, dated August 19, 1993, incorporated by reference to Form 10-K for the fiscal year ended September 30, 1993 at pages 143 to 151. (xvi) Gas Transportation Agreement between Tennessee Gas Pipeline Company and The Southern Connecticut Gas Company, dated August 19, 1993, incorporated by reference to Form 10-K for the fiscal year ended September 30, 1993 at pages 152 to 159. (xvii) Service Agreement between Texas Eastern Transmission Corporation and The Southern Connecticut Gas Company, dated June 1, 1993, incorporated by reference to Form 10-K for the fiscal year ended September 30, 1993 at pages 160 to 170. (xviii) Service Agreement between Texas Eastern Transmission Corporation and The Southern Connecticut Gas Company, dated June 1, 1993, incorporated by reference to Form 10-K for the fiscal year ended September 30, 1993 at pages 171 to 180. (xix) Service Agreement between Texas Eastern Transmission Corporation and The Southern Connecticut Gas Company, dated June 1, 1993, incorporated by reference to Form 10-K for the fiscal year ended September 30, 1993 at pages 181 to 192. (xx) Service Agreement between Texas Eastern Transmission Corporation and The Southern Connecticut Gas Company, dated June 1, 1993, incorporated by reference to Form 10-K for the fiscal year ended September 30, 1993 at pages 193 to 204. (xxi) Service Agreement between Texas Eastern Transmission Corporation and The Southern Connecticut Gas Company, dated June 1, 1993, incorporated by reference to Form 10-K for the fiscal year ended September 30, 1993 at pages 214 to 220. (xxii) Service Agreement between Algonquin Gas Transmission Company and The Southern Connecticut Gas Company, dated June 1, 1993, incorporated by reference to Form 10-K for the fiscal year ended September 30, 1993 at pages 221 to 227. (xxiii) Service Agreement between Algonquin Gas Transmission Company and The Southern Connecticut Gas Company, dated June 1, 1993, incorporated by reference to Form 10-K for the fiscal year ended September 30, 1993 at pages 228 to 235. (xxiv) Service Agreement between Algonquin Gas Transmission Company and The Southern Connecticut Gas Company, dated June 1, 1993, incorporated by reference to Form 10-K for the fiscal year ended September 30, 1993 at pages 236 to 243. (xxv) Service Agreement between Algonquin Gas Transmission Company and The Southern Connecticut Gas Company, dated June 1, 1993, incorporated by reference to Form 10-K for the fiscal year ended September 30, 1993 at pages 244 to 251. (xxvi) Service Agreement between Algonquin Gas Transmission Company and The Southern Connecticut Gas Company, dated June 1, 1993, incorporated by reference to Form 10-K for the fiscal year ended September 30, 1993 at pages 252 to 257. (xxvii) Service Agreement between Algonquin Gas Transmission Company and The Southern Connecticut Gas Company, dated October 1, 1993, incorporated by reference to Form 10-K for the fiscal year ended September 30, 1993 at pages 258 to 277. Executive Compensation Plans and Arrangements --------------------------------------------- (xxviii) Employment Agreement between The Southern Connecticut Gas Company and J. R. Crespo, dated March 24, 1992, incorporated by reference to Form 10-K for the fiscal year ended September 30, 1992 at pages 213 to 229. (xxix) Amended and Restated Deferred Compensation Agreement between The Southern Connecticut Gas Company and Connecticut Energy Corporation and J. R. Crespo, dated November 8, 1996, incorporated by reference to Form 10-K for the fiscal year ended September 30, 1996 at pages 64 to 73. (xxx) The Southern Connecticut Gas Company Board of Directors Retirement Plan, dated October 1, 1992, is incorporated by reference to Form 10-K for the fiscal year ended September 30, 1994 at pages 27 to 30. (xxxi) The Southern Connecticut Gas Company, Management Compensation Plan, dated October 1, 1992, incorporated by reference to Form 10-K for the fiscal year ended September 30, 1992 at pages 251 to 253. (xxxii) Agreement between The Southern Connecticut Gas Company and Henry Chauncey, Jr. related to deferred compensation as a director, dated December 31, 1988, incorporated by reference to Form 10-K for the fiscal year ended December 31, 1988 at pages 63 to 67. (xxxiii) Supplemental Retirement Benefits Plan dated October 1, 1993, incorporated by reference to Form 10-Q for the quarter ended December 31, 1993 at pages 25 to 28. (xxxiv) Agreement between The Southern Connecticut Gas Company and Helen B. Wasserman related to deferred compensation as a director, dated December 31, 1994, incorporated by reference to Form 10-K for the fiscal year ended September 30, 1995 at pages 25 to 29. (xxxv) Agreement between The Southern Connecticut Gas Company and Connecticut Energy Corporation and Carol A. Forest related to change in control, dated October 1, 1996, incorporated by reference to Form 10-K for the fiscal year ended September 30, 1996 at pages 74 to 83. (xxxvi) Agreement between The Southern Connecticut Gas Company and Connecticut Energy Corporation and Thomas A. Trotta related to change in control, dated October 1, 1996, incorporated by reference to Form 10-K for the fiscal year ended September 30, 1996 at pages 94 to 104. (xxxvii) Connecticut Energy Corporation 1997 Restricted Stock Award Plan, dated January 28, 1997, incorporated by reference to Form 10-Q for the quarter ended March 31, 1997 at pages 23 to 35. (xxxviii) Connecticut Energy Corporation Non-Employee Director Stock Plan, dated January 28, 1997, incorporated by reference to Form 10-Q for the quarter ended March 31, 1997 at pages 36 to 40. (13) Annual Report to Security Holders --------------------------------- The Company's 1997 Annual Report to Shareholders is filed herewith at pages 22 to 45. Such exhibit includes only those portions thereof which are expressly incorporated by reference in this Form 10-K. (21) Subsidiaries of the Registrant ------------------------------ A list of the Company's subsidiaries is filed herewith at page 46. (27) Financial Data Schedule ----------------------- Financial Data Schedule UT is submitted only in electronic format to the Securities and Exchange Commission. (B) Reports on Form 8-K filed during the last quarter of 1997: Form 8-K, dated April 23, 1997, concerning the Company's Form S-3 registration of 1,750,000 additional shares of common stock was filed with the Securities and Exchange Commission on July 10, 1997. Form 8-K, dated September 8, 1997, concerning the Company's receipt of a letter from the DEP regarding the revised status of its three sites formerly used for coal gasification operations was filed with the Securities and Exchange Commission on September 10, 1997. REPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE ----------------------------------------------------------------- To the Board of Directors and Shareholders of Connecticut Energy Corporation: Our report on the consolidated financial statements of Connecticut Energy Corporation has been incorporated by reference in this Form 10-K from page 37 of the 1997 Annual Report to Shareholders of Connecticut Energy Corporation. In connection with our audits of such financial statements, we have also audited the related financial statement schedule listed in Item 14(a)2 of this Form 10-K. In our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information required to be included therein. /s/ Coopers & Lybrand L.L.P. - ---------------------------- New York, New York October 31, 1997 CONSENT OF INDEPENDENT ACCOUNTANTS ---------------------------------- We consent to the incorporation by reference in the Prospectus constituting part of the Registration Statements on Form S-3 (No. 333-25691) and Form S-8 (No. 33-39245 and 33-51763) of Connecticut Energy Corporation of our report dated October 31, 1997, on our audits of the consolidated financial statements and financial statement schedule of Connecticut Energy Corporation as of September 30, 1997 and 1996, and for the years ended September 30, 1997, 1996 and 1995, appearing on page 37 of the 1997 Annual Report to Shareholders of Connecticut Energy Corporation which is incorporated by reference in this Annual Report on Form 10-K. /s/ Coopers & Lybrand L.L.P. - ---------------------------- New York, New York December 4, 1997
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS CONNECTICUT ENERGY CORPORATION Years Ended September 30, 1997, 1996 and 1995 (in thousands) Col. A Col. B Col. C Col. D Col. E ------ ------ ------ ------ ------ Additions Balance at Charged to Charged to Balance Beginning Costs and Other at End of Description of Period Expenses Accounts Deductions Period - ----------- --------- -------- -------- ---------- ------ Allowance for Doubtful Accounts 1997 (1) $2,742 $7,297 $2,851 (2) $9,942 (3) $2,948 1996 (1) $3,553 $6,549 $1,826 (2) $9,186 (3) $2,742 1995 (1) $3,747 $6,548 $2,235 (2) $8,977 (3) $3,553 Notes: - ------ (1) Reserve deducted in the Consolidated Balance Sheet from the asset to which it applies (2) Recoveries on accounts previously charged off (3) Accounts charged off as uncollectible
SIGNATURES Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. CONNECTICUT ENERGY CORPORATION (Registrant) By: /s/ J. R. Crespo ------------------------------------- J. R. Crespo, Chairman, President and Chief Executive Officer Dated: November 25, 1997 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. By: /s/ Henry Chauncey, Jr. By: /s/ Newman M. Marsilius, III ----------------------------------- ---------------------------------- Henry Chauncey, Jr., Director Newman M. Marsilius, III, Director Dated: November 25, 1997 Dated: November 25, 1997 By: /s/ James P. Comer By: /s/ Samuel M. Sugden ----------------------------------- --------------------------------- James P. Comer, M.D., Director Samuel M. Sugden, Director Dated: November 25, 1997 Dated: November 25, 1997 By: /s/ J. R. Crespo By: /s/ Christopher D. Turner ------------------------------------ -------------------------------- J. R. Crespo, Chairman, Christopher D. Turner, Director President and Chief Executive Officer Dated: November 22, 1997 Dated: November 25, 1997 By: /s/ Richard F. Freeman By: /s/ Helen B. Wasserman ----------------------------------- -------------------------------- Richard F. Freeman, Director Helen B. Wasserman, Director Dated: November 25, 1997 Dated: November 25, 1997 By: /s/ Richard M. Hoyt By: /s/ Vincent L. Ammann, Jr. ---------------------------------- -------------------------------- Richard M. Hoyt, Director Vincent L. Ammann, Jr. Dated: November 25, 1997 Vice President and Chief Accounting Officer (Principal Accounting Officer) Dated: November 25, 1997 By: /s/ Paul H. Johnson By: /s/ Carol A. Forest ----------------------------------- -------------------------------- Paul H. Johnson, Director Carol A. Forest, Vice President, Dated: November 25, 1997 Finance, Chief Financial Officer, Treasurer and Assistant Secretary (Principal Financial Officer) Dated: November 25, 1997 EX-13 2 Management's Discussion and Analysis of Financial Condition and Results of Operations Connecticut Energy Corporation ("Connecticut Energy" or "Company") and its subsidiaries and their representatives may, from time to time, make written or oral statements, including statements contained in the Company's filings with the Securities and Exchange Commission ("SEC") and in its annual report to shareholders, including its Form 10-K for the fiscal year ended September 30, 1997, which constitute or contain "forward-looking" information as that term is defined in the Private Securities Litigation Reform Act of 1995. All statements other than the financial statements and other statements of historical facts included in this annual report to shareholders regarding the Company's financial position and strategic initiatives and addressing industry developments are forward-looking statements. Where, in any forward-looking statement, the Company, or its management, expresses an expectation or belief as to future results, such expectation or belief is expressed in good faith and believed to have a reasonable basis, but there can be no assurance that the statement of expectation or belief will result or be achieved or accomplished. Factors which could cause actual results to differ materially from those stated in the forward-looking statements may include, but are not limited to, general and specific economic, financial and business conditions; federal and state regulatory, legislative and judicial developments which affect the Company or significant groups of its customers; the impact of competition on the Company's revenue; fluctuations in weather from normal levels; changes in development and operating costs; the availability and cost of natural gas; the availability and terms of capital; exposure to environmental liabilities; the costs and effects of unanticipated legal proceedings; the successful implementation and achievement of internal performance goals; the impact of unusual items resulting from ongoing evaluations of business strategies and asset valuations; and changes in business strategy. RESULTS OF OPERATIONS Net Income The Company's consolidated net income for the fiscal years ended September 30 is detailed below: (in thousands, except per share) 1997 1996 1995 - -------------------------------------------------------------------------------- Net Income $16,441 $15,165 $14,060 - -------------------------------------------------------------------------------- Net income per share $ 1.81 $ 1.70 $ 1.60 - -------------------------------------------------------------------------------- Weighted average common shares outstanding 9,096 8,924 8,774 - -------------------------------------------------------------------------------- Net income for fiscal 1997 was a record for the Company and increased approximately 8% compared to fiscal 1996. Factors which contributed to increased net income for 1997 included higher firm margins earned by the Company's principal subsidiary, The Southern Connecticut Gas Company ("Southern"), lower operations and maintenance expenses, lower gross earnings and property taxes and lower other interest expense. Partially offsetting these positive impacts on net income were slightly lower interruptible margins and higher costs for depreciation, income taxes and long-term debt interest. Net income for 1996 increased approximately 8% compared to 1995. Factors affecting the improved results for 1996 were increased firm margins earned by Southern due to higher usage per customer, customer growth and conversion of nonheating customers to heating customers and lower operations expense. Partially offsetting the benefits of increased margins and lower operations expense were higher costs for depreciation, taxes and interest. Total Sales and Transportation Volumes Southern's total volumes of gas sold and transported were 45,646 MMcf in 1997, which was a 14% increase from 1996. The 1997 level was higher principally due to increases in off-system sales and off-system 15 Connecticut Energy Corporation transportation volumes. Partially offsetting these increases were lower firm sales volumes due to warmer weather and lower volumes for on-system interruptible services due to the competitive price of certain alternate fuels. Throughput in 1996 was 19% lower than in 1995 principally because of reductions in interruptible sales, off-system sales and off-system transportation volumes due to colder weather as well as the competitive price of certain alternate fuels. Partially offsetting these decreases were increases in firm sales and transportation volumes. Firm Sales and Transportation Volumes Firm sales and transportation volumes for 1997 were approximately 4% lower compared to 1996. This decrease was principally due to weather that was approximately 7% warmer than 1996. Growth in Southern's customer base and the continued conversions of nonheating customers to heating customers partially offset the overall decrease in this category. Firm sales and transportation volumes for 1996 were a record and were approximately 14% higher compared to 1995. This increase was principally due to weather that was approximately 17% colder than 1995, which contributed to higher usage per firm customer. Growth in Southern's firm customer base and the conversion of nonheating customers to heating customers also contributed to the increase in firm sales volumes. Interruptible Sales and Transportation Volumes Margins earned on volumes delivered to interruptible customers vary depending upon the relationship of the market price for alternate fuels to the cost of natural gas and related transportation. Additionally, margins earned, net of gross earnings tax, from on-system interruptible services in excess of an annual target were allocated through a margin sharing mechanism between Southern and its firm customers. Beginning June 1, 1996, excess on-system margins earned that would have been returned to Southern's firm customers have been redirected, with Connecticut Department of Public Utility Control ("DPUC") approval, to fund certain economic development and hardship assistance programs. See section entitled "Regulatory Matters" for additional information regarding this DPUC Decision. The chart below depicts volumes of gas sold to and transported for on-system interruptible customers, off-system sales volumes and off-system transportation volumes under a special contract with The Connecticut Light and Power Company for its Devon electric generating station as well as gross margin earned and retained due to the margin sharing mechanism on these services for the fiscal years ended September 30: (dollars in thousands) 1997 1996 1995 - -------------------------------------------------------------------------------- Gross margin earned $12,872 $12,674 $13,702 - -------------------------------------------------------------------------------- Gross margin retained $ 7,242 $ 7,643 $ 7,390 - -------------------------------------------------------------------------------- Volumes sold and transported (MMcf) 23,794 17,211 29,680 - -------------------------------------------------------------------------------- Gross margin earned by Southern in 1997 was higher than in 1996 principally due to increased off-system sales and off-system transportation activity. Lower margin retained for 1997 was principally due to the change in the sharing mechanism for certain off-system services as of April 1, 1996 which increased the allocation of margins to be returned to firm customers from 50% to 85%. Gross margin retained by Southern was higher for 1996 compared to 1995 principally due to the absence of allocating margins earned to recover previously deferred transition costs. Gross Margin The Company's gross margin in 1997 was relatively unchanged compared to 1996. Firm margins, which were a record for the Company, were attributed to growth in Southern's customer base, but were partially offset by lower interruptible margins retained as well as lower revenues earned from bailment activities. The Company's gross margin increased approximately 3% for 1996 compared to 1995. This increase was principally due to higher margins earned from firm sales and services and higher margins retained from interruptible sales and services. Southern's firm rates include a Weather Normalization Adjustment clause ("WNA") which allows Southern to charge or credit the non-gas portion of its firm rates to reflect deviations from normal weather. Because weather during 1997 was approximately 3% warmer than normal, the operation of the WNA collected approximately $2,252,000 from firm customers compared to a return of approximately $2,771,000 to firm customers in fiscal 1996. 16 Connecticut Energy Corporation Southern's firm sales rates also include a Purchased Gas Adjustment clause ("PGA") which allows Southern to flow back to its customers, through periodic adjustments to amounts billed, increased or decreased costs incurred for purchased gas compared to base rate levels without affecting gross margin. Adjustments related to Southern's PGA increased revenues and gas costs for 1997 and 1996 by approximately $6,206,000 and $6,717,000, respectively, and decreased revenues and gas costs for 1995 by approximately $3,756,000. Operations Expense Operations expense was approximately 2% lower in 1997 compared to 1996. This decrease was principally due to lower costs for labor, pensions, postretirement health care and regulatory commission expense, increased rates for service on customer premises and a lower insurance reserve for general claims. Additionally, a higher provision for uncollectibles in 1997 was more than offset by lower amortizations related to Southern's certified hardship forgiveness program due to the conclusion of the amortization period as of December 31, 1996. The overall decrease in operations expense in 1997 was partially offset by increases in costs incurred for outside services, insurance premiums and the recently established Restricted Stock Award Plan. Operations expense was approximately 3% lower in 1996 compared to 1995. This decrease was principally due to lower costs for labor, increased rates for service on customer premises and lower pension and postretirement health care costs. Partially offsetting these positive effects on operations expense was an increase in regulatory commission expense. In December 1992, the DPUC allowed Southern to defer certain shortfalls in energy assistance funding from various state and federal agencies related to the 1991/92 and 1992/93 heating seasons. The DPUC's action positively impacted Southern's provision for uncollectible accounts for 1993. Southern has been allowed to recover these costs as well as deferred costs associated with Southern's certified hardship forgiveness program beginning January 1994. Accordingly, included in operations expense for 1997, 1996 and 1995 was approximately $1,619,000, $2,987,000 and $2,987,000, respectively, related to these amortizations. Depreciation Expense Depreciation expense for Southern has increased in each of the last three years because of additions to plant in service. Federal and State Income Taxes The total provision for federal and state income taxes increased approximately 17% in 1997 compared to 1996 primarily due to higher pre-tax income. The total provision for federal and state income taxes increased approximately 2% in 1996 compared to 1995 primarily due to higher pre-tax income. Although pre-tax income was higher in fiscal 1996, the benefits related to the current deductibility of conservation program expenses, uncollectible accounts and various employee benefit plan contributions caused the effective tax rate to be slightly lower than in fiscal 1995. Municipal, Gross Earnings and Other Taxes Municipal, gross earnings and other taxes decreased approximately 9% in 1997 compared to 1996. This decrease was primarily due to lower gross earnings taxes as a result of lower revenues and a lower provision for property taxes because of the establishment of a lower mill rate in the city of New Haven, Connecticut. Municipal, gross earnings and other taxes increased approximately 10% in 1996 compared to 1995. This increase was principally due to a higher provision for property taxes, higher gross earnings taxes due to higher revenues and higher sales and use taxes. Other (Income) Deductions, Net Other income for 1997 was higher compared to 1996 primarily due to the receipt of approximately $974,000 in interest income from one of Southern's interstate pipeline suppliers related to Southern's prepayment of transition costs associated with the Federal Energy Regulatory Commission's Order No. 636 and the recognition of a payment received in connection with a newly formed subsidiary joint venture. See section entitled "Investing Activities" for additional information regarding this new joint venture. Interest Expense Total interest expense increased approximately 6% in 1997 compared to 1996. Higher long-term debt costs for 1997 were associated with the issuance of $20,000,000 in secured Medium-Term Notes ("MTN") in 17 Connecticut Energy Corporation August 1996. Higher short-term debt costs due to higher average short-term borrowings and higher short-term interest expense on pipeline refunds not yet returned to firm customers were more than offset by lower short-term interest expense on deferred gas cost balances. Total interest expense increased approximately 5% in 1996 compared to 1995. Higher long-term debt costs for 1996 were associated with the MTN issuance. Additionally, interest costs associated with higher average short-term borrowings, deferred gas costs and the operation of the margin sharing mechanism contributed to this increase. The Company borrows short-term funds at the most competitive rates by utilizing commercial paper and bank borrowings at money market rates. Short-term interest rates averaged 5.71% in 1997 compared to 5.81% in 1996 and 5.99% in 1995. Inflation Inflation as measured by the Consumer Price Index for all urban consumers was approximately 2.7%, 2.8% and 2.8% for 1997, 1996 and 1995, respectively. Operations and maintenance expenses increase as a result of inflation, as does depreciation expense due to higher replacement costs of plant and equipment. As a regulated utility, Southern's increases in expenses are generally recoverable from customers through rates approved by the DPUC. In management's opinion, inflation has not had a material impact on net income and the results of operations over the last three years. Regulatory Matters Effective April 1, 1996, the DPUC deregulated the sale of natural gas to firm commercial and industrial gas customers in Connecticut by giving these customers an option to purchase natural gas from independent brokers or marketers. Commercial and industrial customers electing to purchase natural gas in this manner pay a DPUC-approved firm transportation rate to the local gas distribution company ("LDCs") for the use of its distribution system. On August 21, 1997, the DPUC initiated a generic docket, Docket No. 97-07-11, DPUC Generic Investigation into Issues Associated with the Unbundling of Natural Gas Services by Connecticut Local Distribution Companies, to investigate issues associated with the unbundling of natural gas firm sales and transportation services by LDCs in Connecticut, including Southern. The DPUC intends to conduct this proceeding in two phases. The first phase will address issues relating to firm transportation service in its present form regarding delivery of sales and transportation service by LDCs and marketers. Depending on the findings for this phase, the DPUC may reopen a particular LDC's last rate case to consider any proposed changes to its respective tariffs and rates. The second phase of this proceeding will investigate such issues as residential unbundling, codes of conduct for LDCs and marketers and public policy issues. Southern, in accordance with Connecticut statutes, will undergo a periodic review of rates and services by the DPUC commencing in or after December 1997 if it does not file for a rate increase. A periodic review entails a complete review by the DPUC of Southern's financial and operating records. Public hearings will be held to determine whether the current rates are unreasonably discriminatory or more or less than just, reasonable and adequate. If Southern determines that a rate increase is required, a general rate case will be filed in lieu of a rate review. In February 1997, the Company and Southern requested a reopening of a DPUC Decision dated December 13, 1978, Docket No. 77-08-28, Application of The Southern Connecticut Gas Company for Approval of Corporate Reorganization and Merger and Formation of a Holding Company, for the purpose of addressing changed conditions in the Company's operations since 1978, which include the dissolution of certain subsidiaries and deregulation of the natural gas marketplace resulting from recent federal and state regulatory actions. On May 21, 1997, the DPUC issued a Decision in the reopened docket. The Decision modified or eliminated several conditions relating to the Company's nonregulated subsidiaries. The Company believes those subsidiaries will now have more flexibility to compete in the rapidly changing energy market on both a financial and operational basis. On April 23, 1997, the DPUC issued a final Decision in Docket No. 96-01-28, DPUC Review of the Purchased Gas Adjustment Clause. In this docket, the DPUC conducted a review to determine what modifications, if any, should be made to the PGA clause utilized by Connecticut's three LDCs. This review was conducted to consider the impact of deregulation on the gas industry. In its Decision, the DPUC determined that the PGA clause should continue because it has been found to be an effective tool in controlling volatility in earnings resulting from the instability of gas prices. 18 Connecticut Energy Corporation On August 21, 1996, the DPUC issued a final Decision in Docket No. 96-04-30, Application of The Southern Connecticut Gas Company to Dispose of a Portion of Its Plant and Equipment. The DPUC approved certain proposals made by Southern regarding the operation of its liquefied natural gas ("LNG") tank and related facilities, which include the sublease of the LNG tank and related facilities from Southern to its nonregulated affiliate, CNE Energy Services Group, Inc. ("CNE Energy"), which would, in turn, sublease the LNG facility to Total Peaking Services, L.L.C. ("TPS"). The members of TPS are CNE Energy and PanEnergy Plus Milford Ventures Company, a wholly-owned subsidiary of EnergyPlus Ventures Company which, in turn, was a wholly-owned subsidiary of PanEnergy Corp. (now Duke Energy Corporation). The DPUC granted approval to move the LNG facility out of Southern and into an unregulated venture. However, federal approval necessary to finalize this venture and commence interstate operations is still pending. Pursuant to Southern's 1993 rate order, which incorporated the provisions of the previously approved Partial Settlement of Certain Issues ("Partial Settlement"), a target margin, net of gross earnings tax, was established for on-system sales and transportation to Southern's interruptible customers. Margins collected in excess of this target were shared between customers and Southern on an 80%/20% split. In January 1996, Southern requested a reopening of the 1993 rate proceeding to propose a plan to redirect excess on-system margins to be returned to ratepayers for calendar years 1996, 1997 and 1998 to fund certain economic development initiatives in Bridgeport ("BEDI") and to provide grants to customers to reduce Southern's current hardship assistance balances ("HAB"). Southern estimated that margins to be collected over the proposed three-year period would be approximately $14,000,000, which would be divided equally between BEDI and HAB. Southern's proposal related to the BEDI included job training and services, certain loan subsidies and health promotion outreach services. Redirection of ratepayer margins for HAB would benefit Southern's hardship customers by reducing their accounts receivable arrearages and would benefit Southern by reducing its provision for uncollectibles for such accounts. On April 26, 1996, the DPUC issued a final Decision regarding Southern's proposal. The DPUC effectively approved Southern's proposal with certain modifications in the direction of BEDI funding initiatives, the imposition of a cap of $6,000,000 per year of ratepayer margins to be split equally between BEDI and HAB and certain implementation and status reporting requirements. Recent Accounting Developments In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 128, "Earnings per Share" ("SFAS 128"), which will be effective for the interim period ending December 31, 1997. This statement establishes standards for the computation and presentation of earnings per share ("EPS") by all entities with publicly held common stock or potential common stock. The statement replaces the presentation of primary EPS with a presentation of basic EPS. It also requires dual presentation of basic and diluted EPS on the face of the income statement for all entities with complex capital structures and requires a reconciliation of the numerator and denominator of the basic EPS computation to the numerator and denominator of the diluted EPS computation. The adoption of SFAS 128 is required by October 1, 1997, and the Company intends to adopt this statement prospectively. The impact of this standard is not expected to have a material effect on the Company's reported EPS. LIQUIDITY AND CAPITAL RESOURCES Operating Activities The seasonal nature of Southern's business creates large short-term cash demands primarily to finance gas purchases, customer accounts receivable and certain tax payments. To provide these funds, as well as funds for capital expenditure programs and other corporate purposes, Connecticut Energy and Southern have credit lines with a number of banks as detailed below: Shared Connecticut Connecticut Energy Southern Energy/Southern Total - -------------------------------------------------------------------------------- Committed Lines $5,000,000 $32,000,000 $20,000,000 $57,000,000 Uncommitted Lines -- $10,000,000 $10,000,000 $20,000,000 19 Connecticut Energy Corporation At September 30, 1997, the Company had unused lines of credit of $45,600,000. Because of the availability of short-term credit and the ability to issue long-term debt and additional equity, management believes it has adequate financial flexibility to meet its anticipated cash needs. Operating cash flows for 1997 were higher compared to 1996. The increase was principally due to lower accounts receivable balances due to warmer weather and more aggressive collection efforts, the receipt of pipeline refunds which are in the process of being returned to customers, lower inventory balances and higher comparative balances of deferred credits. Partially offsetting the overall increase in operating cash flows was the effect of warmer weather on the operation of the PGA and lower accounts payable balances. Operating cash flows for 1996 compared to 1995 were negatively impacted by higher accounts receivable, inventory, prepaid pension, postretirement health care and deferred certified hardship customer arrearage balances as well as lower balances related to Southern's interruptible margin sharing mechanism. These items were partially offset by higher net income and higher accounts payable, accrued tax and refundable purchased gas cost balances. Investing Activities Capital expenditures approximated $28,443,000 in 1997, $25,200,000 in 1996 and $27,600,000 in 1995. Capital expenditures for 1997 were approximately 13% higher compared to 1996 due to the impact of less severe winter weather on construction activity. Southern relies upon cash flows provided by operating activities to fund a portion of these expenditures, with the remainder funded by short-term borrowings and, at some later date, long-term debt and capital stock financings. Capital expenditures in 1998 will approximate $33,300,000. Approximately $22,800,000 of budgeted capital expenditures has been allocated to Southern, of which approximately 28% is earmarked for new business. The majority of Southern's remaining planned capital expenditures are to improve, protect and maintain its existing gas distribution system. Over the 1998-2002 period, it is estimated that total expenditures for new plant and equipment will range between $110,000,000 and $130,000,000. In September 1997, the Company's nonutility subsidiary, CNE Energy, formed a joint venture with Delmarva Power & Light Company's bulk energy group. The alliance was formed to sell natural gas, electricity, fuel oil and other services in New York and New England. The new energy marketing and sales company will operate under the name Conectiv/CNE Energy Services, LLC ("Conectiv/CNE"). In addition to selling energy products, Conectiv/CNE will market a full range of energy-related planning, financial, operational and maintenance services to commercial, industrial and municipal customers located in New York and New England. This alliance replaces the joint venture between CNE Energy and Louis Dreyfus Energy Corp. which was terminated on August 31, 1997. In September 1997, Southern announced it will construct the distribution facilities needed to transport natural gas from a gate station in Stratford, Connecticut to a new 520 megawatt electric generating plant located approximately ten miles away at the site of United Illuminating Company's Bridgeport Harbor Station. Included in the Company's 1998 capital expenditures budget is approximately $8,500,000 for this construction. When completed, the gas turbine plant will be the largest nonnuclear generating plant in Connecticut and will have the capacity to provide enough electricity to service up to 260,000 homes. Final contract negotiations with Duke Energy Trading and Marketing, LLC are still ongoing. Once completed, the contract will be submitted to the DPUC for review and approval. In August 1997, the Company's nonutility subsidiary, CNE Venture-Tech, Inc. ("CNE Venture-Tech"), made an initial investment in the Nth Power Technologies Fund I ("Nth Power") as a limited partner. Nth Power's venture capital fund invests in companies that produce or market technologically advanced, innovative energy-related products. Participation in the fund may provide business opportunities to its limited partners. CNE Venture-Tech is committed to invest up to $5,000,000 in the fund over the next three years. Financing Activities In November 1997, the Company completed a public sale of 1,035,000 shares of its common stock at a price of $24.25 per share and received net proceeds of approximately $24,013,000. The proceeds of this sale were used for the repayment of Southern's short-term debt. The method, timing and amounts of any future financings by the Company or its subsidiaries will depend on a variety of factors, including capitalization ratios, coverage ratios, interest costs, the state of the capital markets and general economic conditions. 20 Connecticut Energy Corporation Southern initiated an MTN program in fiscal 1996, which was approved by the DPUC. The program permits the issuance, from time to time, of up to $75,000,000 of secured MTNs over a four-year period in varying amounts and with varying terms. Proceeds from the sale of the MTNs will be used to reduce short-term borrowings incurred primarily in connection with Southern's capital expenditure program and for other general corporate purposes. On August 1, 1996, Southern made its first issuance and sale under the program of $20,000,000 in MTNs at a weighted average rate of 7.84%. As of June 1996, the quarterly dividend paid per share on the Company's common stock was increased to $0.33 per share, or an annual indicated dividend rate of $1.32 per share. In response to the competitive forces and regulatory changes being faced by the Company, the Company has from time to time considered, and expects to continue to consider, various strategies designed to enhance its competitive position. These strategies may include business combinations with other companies as well as acquisitions of related or unrelated businesses. The Company may, from time to time, be engaged in preliminary discussions regarding one or more of these potential strategies. No assurances can be given as to whether any potential transaction of the type described may actually occur, or as to the ultimate effect thereof on the financial condition or competitive position of the Company. Environmental Matters Southern has identified coal tar residue at three sites in Connecticut resulting from coal gasification operations conducted at those sites by Southern's predecessors from the late 1800s through the first part of this century. Many gas distribution companies throughout the country carried on such gas manufacturing operations during the same period. The coal tar residue is not designated a hazardous material by any federal or Connecticut agency, but some of its constituents are classified as hazardous. On April 27, 1992, Southern notified the Connecticut Department of Environmental Protection ("DEP") and the United States Environmental Protection Agency of the presence of coal tar residue at the sites. On November 9, 1994, the DEP informed Southern that it had performed a preliminary review of the information provided to it by Southern and had determined that, based on current priorities and limited staff resources, a comprehensive review of site conditions and subsequent participation by the DEP "are not possible at this time." On September 8, 1997, Southern received a letter from the DEP informing it that the three sites had been entered on the Connecticut Inventory of Hazardous Waste Sites. The letter states that the site located on Pine Street in Bridgeport, Connecticut may be of particular interest to the state of Connecticut because of its proximity to the Connecticut Department of Transportation expansion project of the U.S. Highway Route Number 95 Corridor. Placement of the sites on the Inventory of Hazardous Waste Sites means that the DEP may pursue remedial action pursuant to the Connecticut General Statutes. Each site is located in an area that permits Southern to voluntarily perform any remedial action. Connecticut law also allows Southern to retain a Licensed Environmental Professional to conduct further environmental assessments and, if necessary, to develop remedial action plans in accordance with Connecticut Remediation Standard Regulations. Southern intends to confer with officials of the DEP and the Department of Transportation to establish priorities in connection with the environmental assessments. Management cannot at this time predict the costs of any future site analysis and remediation, if any, nor can it estimate when any such costs, if any, would be incurred. While such future analytical and cleanup costs could possibly be significant, management believes, based upon the provisions of the Partial Settlement in Southern's most recent rate order and regulatory precedent with other LDCs in Connecticut, that Southern will be able to recover these costs through its customer rates. Although the method, timing and extent of any recovery remain uncertain, management currently does not expect that the incurrence of such costs will materially adversely impact the Company's financial condition or results of operations. 21 Connecticut Energy Corporation
Consolidated Statements of Income (dollars in thousands, except per share) Years ended September 30, 1997 1996 1995 - ----------------------------------------------------------------------------------------------------------------------- Operating Revenues $252,008 $261,093 $232,093 Purchased gas 132,672 141,628 115,583 - ----------------------------------------------------------------------------------------------------------------------- Gross margin 119,336 119,465 116,510 - ----------------------------------------------------------------------------------------------------------------------- Operating Expenses: Operations 46,773 47,821 49,113 Maintenance 3,579 3,784 3,743 Depreciation 15,774 14,752 14,050 Federal and state income taxes 8,935 7,606 7,436 Municipal, gross earnings and other taxes 15,386 16,838 15,282 - ----------------------------------------------------------------------------------------------------------------------- Total operating expenses 90,447 90,801 89,624 - ----------------------------------------------------------------------------------------------------------------------- Operating income 28,889 28,664 26,886 - ----------------------------------------------------------------------------------------------------------------------- Other (income) deductions, net (1,229) 546 519 - ----------------------------------------------------------------------------------------------------------------------- Interest Expense: Interest on long-term debt and amortization of debt issue costs 12,321 11,065 10,859 Other interest, net 1,356 1,888 1,448 - ----------------------------------------------------------------------------------------------------------------------- Total interest expense 13,677 12,953 12,307 - ----------------------------------------------------------------------------------------------------------------------- Net Income $ 16,441 $ 15,165 $ 14,060 - ----------------------------------------------------------------------------------------------------------------------- Net income per share $ 1.81 $ 1.70 $ 1.60 - ----------------------------------------------------------------------------------------------------------------------- Dividends paid per share $ 1.32 $ 1.31 $ 1.30 - ----------------------------------------------------------------------------------------------------------------------- Weighted average common shares outstanding 9,095,521 8,924,299 8,773,878 - ----------------------------------------------------------------------------------------------------------------------- See notes to consolidated financial statements.
22 Connecticut Energy Corporation
Consolidated Balance Sheets (dollars in thousands, except per share) As of September 30, 1997 1996 - ----------------------------------------------------------------------------------------------------------------------- Assets Utility Plant: Plant in service, at cost $396,263 $372,776 Construction work in progress 3,412 3,333 - ----------------------------------------------------------------------------------------------------------------------- Gross utility plant 399,675 376,109 Less: accumulated depreciation 130,553 118,348 - ----------------------------------------------------------------------------------------------------------------------- Net utility plant 269,122 257,761 Nonutility property, net 3,343 2,804 - ----------------------------------------------------------------------------------------------------------------------- Net utility plant and other property 272,465 260,565 - ----------------------------------------------------------------------------------------------------------------------- Current Assets: Cash and cash equivalents 6,644 5,121 Accounts and notes receivable (less allowance for doubtful accounts of $2,948 in 1997 and $2,742 in 1996) 29,179 30,873 Accrued utility revenues, net 2,541 2,608 Unrecovered purchased gas costs 5,523 -- Inventories 12,606 15,331 Prepaid expenses 4,067 1,841 - ----------------------------------------------------------------------------------------------------------------------- Total current assets 60,560 55,774 - ----------------------------------------------------------------------------------------------------------------------- Deferred Charges and Other Assets: Unamortized debt expenses 6,038 6,238 Unrecovered deferred income taxes 42,929 41,435 Other 42,289 35,216 - ----------------------------------------------------------------------------------------------------------------------- Total deferred charges and other assets 91,256 82,889 - ----------------------------------------------------------------------------------------------------------------------- Total assets $424,281 $399,228 - ----------------------------------------------------------------------------------------------------------------------- Capitalization and Liabilities Common Shareholders' Equity: Common stock -- par value $1 per share: authorized -- 20,000,000 shares; issued and outstanding -- 9,172,468 in 1997; 9,012,267 in 1996 $ 9,172 $ 9,012 Capital in excess of par value 94,540 91,079 Unearned compensation (1,068) -- Retained earnings 42,297 37,870 Adjustment for minimum pension liability (net of income taxes) (427) -- - ----------------------------------------------------------------------------------------------------------------------- Total common shareholders' equity 144,514 137,961 - ----------------------------------------------------------------------------------------------------------------------- Redeemable Preferred Stock -- -- Long-Term Debt 134,073 138,727 - ----------------------------------------------------------------------------------------------------------------------- Total capitalization 278,587 276,688 - ----------------------------------------------------------------------------------------------------------------------- Current Liabilities: Short-term borrowings 31,400 19,200 Current maturities of long-term debt 4,654 595 Accounts payable 12,609 14,250 Federal, state and deferred income taxes 5,017 2,424 Property and other accrued taxes 4,567 5,555 Interest payable 3,499 3,569 Customers' deposits 1,718 1,826 Refundable purchased gas costs -- 520 Refunds due customers 2,627 202 Other 3,892 3,545 - ----------------------------------------------------------------------------------------------------------------------- Total current liabilities 69,983 51,686 - ----------------------------------------------------------------------------------------------------------------------- Deferred Credits: Deferred income taxes 64,917 62,112 Deferred investment tax credits 2,976 3,269 Other 7,818 5,473 - ----------------------------------------------------------------------------------------------------------------------- Total deferred credits 75,711 70,854 - ----------------------------------------------------------------------------------------------------------------------- Commitments and contingencies -- -- - ----------------------------------------------------------------------------------------------------------------------- Total capitalization and liabilities $424,281 $399,228 - ----------------------------------------------------------------------------------------------------------------------- See notes to consolidated financial statements.
23 Connecticut Energy Corporation
Consolidated Statements of Changes in Common Shareholders' Equity (dollars in thousands, except per share) Adjust- Total Common Stock ment for Common ---------------- Capital in Unearned Minimum Share- Number Par Excess of Compen- Retained Pension holders' of Shares Value Par Value sation Earnings Liability Equity - ----------------------------------------------------------------------------------------------------------------------- Balance at September 30, 1994 8,700,266 $8,700 $85,265 -- $ 31,754 -- $125,719 Issuance through dividend reinvestment plan 164,944 165 3,030 -- -- -- 3,195 Net income -- -- -- -- 14,060 -- 14,060 Dividends paid on common stock ($1.30 per share) -- -- -- -- (11,413) -- (11,413) - ----------------------------------------------------------------------------------------------------------------------- Balance at September 30, 1995 8,865,210 $8,865 $88,295 -- $ 34,401 -- $131,561 Issuance through dividend reinvestment plan 147,057 147 2,784 -- -- -- 2,931 Net income -- -- -- -- 15,165 -- 15,165 Dividends paid on common stock ($1.31 per share) -- -- -- -- (11,696) -- (11,696) - ----------------------------------------------------------------------------------------------------------------------- Balance at September 30, 1996 9,012,267 $9,012 $91,079 -- $ 37,870 -- $137,961 Issuance through dividend reinvestment plan 107,054 107 2,205 -- -- -- 2,312 Issuance through restricted stock award plan and non- employee director stock plan 53,147 53 1,256 -- -- -- 1,309 Unearned compensation -- -- -- $(1,068) -- -- (1,068) Net income -- -- -- -- 16,441 -- 16,441 Dividends paid on common stock ($1.32 per share) -- -- -- -- (12,014) -- (12,014) Adjustment for minimum pension liability (net of income taxes) -- -- -- -- -- $(427) (427) - ----------------------------------------------------------------------------------------------------------------------- Balance at September 30, 1997 9,172,468 $9,172 $94,540 $(1,068) $ 42,297 $(427) $144,514 - ----------------------------------------------------------------------------------------------------------------------- See notes to consolidated financial statements.
24 Connecticut Energy Corporation
Consolidated Statements of Cash Flows (dollars in thousands) Years ended September 30, 1997 1996 1995 - -------------------------------------------------------------------------------------------------------------------------- Cash Flows from Operating Activities: Net income $ 16,441 $ 15,165 $ 14,060 Adjustments to Reconcile Net Income to Net Cash: Depreciation and amortization 16,704 15,747 14,985 Provision for losses on accounts receivable 7,297 6,549 6,548 (Increase) Decrease in Assets: Accounts and notes receivable (5,603) (13,966) (6,306) Accrued utility revenues, net 67 67 (45) Unrecovered purchased gas costs (5,523) 2,972 1,551 Inventories 2,725 (2,216) 1,563 Prepaid expenses (2,607) 140 (400) Unamortized debt expenses (42) (383) (7) Deferred charges and other assets (5,593) (6,229) (1,860) Increase (Decrease) in Liabilities: Accounts payable (1,641) 4,664 (1,300) Accrued taxes 1,605 577 (1,452) Refundable purchased gas costs (520) 520 -- Other current liabilities 2,594 (293) 82 Deferred income taxes and investment tax credits 1,303 1,743 2,627 Deferred credits and other liabilities 1,611 (2,635) 4,323 - -------------------------------------------------------------------------------------------------------------------------- Net cash provided by operating activities 28,818 22,422 34,369 - -------------------------------------------------------------------------------------------------------------------------- Cash Flows from Investing Activities: Capital expenditures (28,504) (25,251) (27,641) Contributions in aid of construction 61 71 32 Proceeds from (payments for) retirement of utility plant 462 (487) (390) Energy ventures (1,458) (1,910) -- Other -- -- 40 - -------------------------------------------------------------------------------------------------------------------------- Net cash used by investing activities (29,439) (27,577) (27,959) - -------------------------------------------------------------------------------------------------------------------------- Cash Flows from Financing Activities: Dividends paid on common stock (12,014) (11,696) (11,413) Issuance of common stock 2,553 2,931 3,195 Issuance of long-term debt -- 20,000 -- Repayments of long-term debt (595) (594) (594) Increase (decrease) in short-term borrowings 12,200 (5,000) 5,400 - -------------------------------------------------------------------------------------------------------------------------- Net cash provided (used) by financing activities 2,144 5,641 (3,412) - -------------------------------------------------------------------------------------------------------------------------- Net increase in cash and cash equivalents 1,523 486 2,998 Cash and cash equivalents at beginning of year 5,121 4,635 1,637 - -------------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents at end of year $ 6,644 $ 5,121 $ 4,635 - -------------------------------------------------------------------------------------------------------------------------- Supplemental Disclosures of Cash Flow Information Cash Paid During the Year for: Interest $ 14,200 $ 12,228 $ 11,701 Income taxes $ 5,041 $ 6,625 $ 6,636 Supplemental Schedule of Noncash Investing and Financing Activities: In the year ended September 30, 1997, 52,247 shares of unregistered common stock were issued pursuant to the Company's 1997 Restricted Stock Award Plan and 900 shares of unregistered common stock were issued pursuant to the Non-Employee Director Stock Plan. See notes to consolidated financial statements.
25 Connecticut Energy Corporation Notes to Consolidated Financial Statements (dollars in thousands, except per share) Note 1 -- Summary of Significant Accounting Policies General Connecticut Energy Corporation's ("Connecticut Energy" or "Company") consolidated financial statements include the accounts of all subsidiary companies, and all significant intercompany transactions and accounts have been eliminated. Certain prior year amounts have been reclassified to conform with the current format of financial statement presentation. The Company's principal subsidiary, The Southern Connecticut Gas Company ("Southern"), is subject to regulation by the Connecticut Department of Public Utility Control ("DPUC") with respect to rates charged for service and the maintenance of accounting records, among other things. Southern's accounting policies conform to generally accepted accounting principles ("GAAP") as applied to regulated public utilities and are in accordance with the accounting requirements and ratemaking practices of the DPUC. In preparing the financial statements in conformity with GAAP, the Company uses estimates. Estimates are disclosed when there is a reasonable possibility for change in the near term. For this purpose, near term is defined as a period of time not to exceed one year from the date of the financial statements. The Company's financial statements have been prepared based on management's estimates of the impact of regulatory, legislative and judicial developments on the Company or significant groups of its customers. The recorded amounts of certain accruals, reserves, deferred charges and assets could be materially impacted if circumstances change which affect these estimates. Line of Business Connecticut Energy is a public utility holding company primarily engaged in the retail distribution of natural gas for residential, commercial and industrial uses through its utility subsidiary, Southern. In fiscal 1995, the Company formed two nonutility subsidiaries, CNE Development Corporation ("CNE Development") and CNE Energy Services Group, Inc. ("CNE Energy"). CNE Development is an equity holder in an entity formed to purchase and market natural gas and may potentially participate in other nonregulated activities; CNE Energy engages in activities relating to the selling, planning, purchasing and management of various energy services to commercial and industrial end users. In September 1997, CNE Energy formed a joint venture with Delmarva Power & Light Company's bulk energy group. The alliance was formed to sell natural gas, electricity, fuel oil and other services in New York and New England. The new energy marketing and sales company will operate under the name Conectiv/CNE Energy Services, LLC ("Conectiv/CNE"). In addition to selling energy products, Conectiv/CNE will market a full range of energy-related planning, financial, operational and maintenance services to commercial, industrial and municipal customers located in New York and New England. This alliance replaces the joint venture between CNE Energy and Louis Dreyfus Energy Corp. which was terminated on August 31, 1997. In October 1996, the Company formed another nonutility subsidiary, CNE Venture-Tech, Inc. ("CNE Venture-Tech"). CNE Venture-Tech focuses on investing in technology companies and participating in ventures with technology partners serving the utility industry. In August 1997, CNE Venture-Tech made an initial investment in the Nth Power Technologies Fund I ("Nth Power") as a limited partner. Nth Power's venture capital fund invests in companies that produce or market technologically advanced, innovative energy-related products. Participation in the fund may provide business opportunities to its limited partners. Accounting for the Effects of Regulation Southern prepares its financial statements in accordance with the provisions of Statement of Financial Accounting Standards No. 71, "Accounting for the Effects of Certain Types of Regulation" ("SFAS 71"), which requires a cost-based, rate-regulated enterprise such as Southern to reflect the impact of regulatory decisions in its financial statements. The DPUC's actions through the ratemaking process can create regulatory assets in which costs are allowed for ratemaking purposes in a period other than the period in which the costs would be charged to expense if the reporting entity were unregulated. In the application of SFAS 71, Southern follows accounting policies that reflect the impact of the rate treatment of certain events or transactions. The most significant of these policies include the recording of deferred gas costs, deferred conservation costs, deferred hardship heating customer accounts receivable arrearages, deferred environmental evaluation costs and an unfunded deferred income tax liability, with a corresponding unrecovered asset, to account for temporary differences previously flowed through to ratepayers. 26 Connecticut Energy Corporation Notes to Consolidated Financial Statements (dollars in thousands, except per share) Southern had net regulatory assets as of September 30, 1997 and 1996 of $63,606 and $59,281, respectively. These amounts are included in deferred charges and other assets and deferred credits in the consolidated balance sheets and are solely due to the application of the provisions of SFAS 71. Effective April 1, 1996, the DPUC deregulated the sale of natural gas to firm commercial and industrial customers by giving these customers an option to purchase natural gas from independent brokers or marketers. Commercial and industrial customers electing to purchase natural gas in this manner pay a DPUC-approved firm transportation rate to the local gas distribution company ("LDCs") for the use of its distribution system. Southern is one of three Connecticut LDCs whose firm transportation rates are designed to provide the same margins earned from bundled services. Because the new rates are margin neutral, there has not been any impact upon Southern's ability to recover deferred costs through cost-based rate regulation. Firm transportation rates have eliminated only the gas cost component of the rates previously charged to these customers. The Company has not experienced any adverse impact on its earnings or results of operations from this change in rate structure. Additionally, the DPUC's initiatives for competition have not been directed toward services for certain groups of customers, including service to residential classes, which represent the majority of Southern's total throughput and gross margin. Management believes that Southern continues to meet the requirements of SFAS 71 because Southern's rates for regulated services provided to its customers are subject to DPUC approval; are designed to recover Southern's costs of providing regulated services and continue to be subject to cost-of-service based rate regulation by the DPUC. Utility Revenues The primary source of the Company's revenue is derived from Southern's retail distribution of natural gas. Southern's service area spans twenty-two Connecticut towns from Westport to Old Saybrook, including the urban communities of Bridgeport and New Haven. Southern bills its customers on a cycle basis throughout each month and accrues revenues related to volumes of gas consumed by customers, but not billed at month end. The accrual of unbilled revenues is recorded net of related gas costs and accrued expenses. Purchased Gas Costs Southern's firm sales rates include a Purchased Gas Adjustment clause ("PGA") under which purchased gas costs above or below base rate levels are charged or credited to customers. As prescribed by the DPUC, most differences between Southern's actual purchased gas costs and the current cost recovery are deferred for future recovery or refund through the PGA. Conservation Adjustment Mechanism In a Decision dated August 23, 1995, the DPUC provided the Connecticut LDCs with guidelines by which conservation-related expenditures not included in current rates charged would be evaluated by the DPUC for recovery through a Conservation Adjustment Mechanism ("CAM"). Based upon a DPUC review of Southern's monthly PGA filing in January 1996, Southern is allowed to include as part of its monthly PGA a separate CAM factor to recover these deferred charges. Weather Normalization Adjustment Southern's firm rates include a Weather Normalization Adjustment ("WNA") under which the non-gas portion of these rates is charged or credited monthly to reflect deviations from normal temperatures. The WNA was implemented in January 1994 and operates for ten months of the year (September through June). Federal Income Taxes In accordance with the requirements of the DPUC, the Economic Recovery Tax Act of 1981 and subsequent amendments to the Internal Revenue Code ("IRC"), income tax reductions to Southern resulting from such items as liberalized depreciation on 1981 to 1997 plant additions and investment tax credits on 1981 to 1986 plant additions are deferred and amortized to income over the useful lives of the related assets. Prior to 1981, Southern had treated the differences between tax and book depreciation on plant and equipment as adjustments to tax provisions ("flow-through method") and utilized the flow-through method on depreciation of pre-1981 assets. With specific permission from the DPUC, Southern also provides deferred federal income taxes for certain items, such as unrecovered purchased gas costs, that are reported in different time periods for tax purposes and financial reporting purposes. In February 1992, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" ("SFAS 109"). SFAS 109 establishes financial accounting and reporting standards for deferred income taxes using an asset and liability approach. SFAS 109 requires, among other things, the recognition of the effect on deferred taxes of enacted tax rate and law changes in the year in which they occur. 27 Connecticut Energy Corporation Notes to Consolidated Financial Statements (dollars in thousands, except per share) The Company adopted SFAS 109 on October 1, 1993 and has adjusted deferred tax balances to reflect the differences between the tax and financial statement basis of all assets and liabilities, regardless of whether deferred taxes had been previously provided. Deferred tax liabilities have been reduced to the extent they had been previously provided at federal statutory rates in excess of the rates in effect on the effective date of adoption. In accordance with SFAS 71, as of September 30, 1997 and 1996, the Company had a deferred tax liability and corresponding regulatory asset of approximately $42,929 and $41,435, respectively, due to the adoption of SFAS 109. The effect of the adoption of SFAS 109 on net income is not material since this adjustment will be recognized in income in future periods as the temporary differences reverse. Net Income per Share Net income per share is computed based upon the weighted average number of common shares outstanding during each year. Utility Plant Utility plant is stated at original cost. The costs of additions and major replacements of retired units are capitalized. Costs include labor, direct material and certain indirect charges such as engineering and supervision. Replacement of minor items of property and the cost of maintenance and repairs are included in maintenance expense. For normal retirements, the original cost of property, together with removal cost, less salvage value, is charged to accumulated depreciation when the property is retired and removed from service. Depreciation For financial accounting purposes, depreciation of utility plant is computed using the composite straightline rates prescribed by the DPUC. The annual composite rate allowed for book depreciation for Southern is 4.15% for all years presented. Depreciation of transportation and power-operated equipment is computed separately and based on their estimated useful lives. For federal income tax purposes, the Company computes depreciation using accelerated methods. Inventories Inventories are stated at the lower of cost or market, cost generally being determined on the basis of the average cost method. Inventories consist primarily of fuel stock and smaller amounts of materials, supplies and appliances. Deferred Charges and Other Assets Deferred charges and other assets include amounts related to the following: As of September 30, 1997 1996 - -------------------------------------------------------------------------------- Conservation costs $ 4,881 $ 3,954 Energy assistance funding shortfall 882 1,502 Environmental evaluation costs 718 915 Gas holder costs 308 554 Hardship heating customer accounts receivable arrearages 13,439 11,753 Hardship heating customer assistance grant program 634 -- Investment in energy ventures 3,418 1,960 Nonqualified benefit plans 2,302 1,160 Prepaid pension and postretirement medical contributions 13,228 11,395 Other 2,479 2,023 - -------------------------------------------------------------------------------- $42,289 $35,216 - -------------------------------------------------------------------------------- Southern has been allowed to recover various deferred charges in rates over periods ranging from three to five years in accordance with the DPUC's Decision in Southern's latest rate case. Deferred Credits Deferred credits include amounts related to the following: As of September 30, 1997 1996 - -------------------------------------------------------------------------------- Economic development initiatives $1,339 $ 675 Insurance reserves 1,122 722 Interruptible margin sharing 877 556 Nonqualified benefit plans 2,961 2,574 Other 1,519 946 - -------------------------------------------------------------------------------- $7,818 $5,473 - -------------------------------------------------------------------------------- 28 Connecticut Energy Corporation Notes to Consolidated Financial Statements (dollars in thousands, except per share) Stock-Based Compensation Plan The Company applies the provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"), to its restricted stock award plan in accordance with Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," as permitted by SFAS 123. Statement of Cash Flows For purposes of reporting cash flows, short-term investments having maturities of three months or less are considered to be cash equivalents. Recent Accounting Developments In February 1997, the FASB issued Statement of Financial Accounting Standards No. 128, "Earnings per Share" ("SFAS 128"), which will be effective for the interim period ending December 31, 1997. This statement establishes standards for the computation and presentation of earnings per share ("EPS") by all entities with publicly held common stock or potential common stock. The statement replaces the presentation of primary EPS with a presentation of basic EPS. It also requires dual presentation of basic and diluted EPS on the face of the income statement for all entities with complex capital structures and requires a reconciliation of the numerator and denominator of the basic EPS computation to the numerator and denominator of the diluted EPS computation. The adoption of SFAS 128 is required by October 1, 1997, and the Company intends to adopt this statement prospectively. The impact of this standard is not expected to have a material effect on the Company's reported EPS. Note 2 -- Provision for Income Taxes Effective October 1, 1993, the Company adopted SFAS 109 and recorded a regulatory asset of $33,943 related to the cumulative amount of income taxes to account for temporary differences previously flowed through to ratepayers. In addition, the Company has a deferred tax liability of $2,976 related to future tax benefits to be flowed back to ratepayers associated with unamortized investment tax credits and decreases in both federal and state statutory tax rates. Both the regulatory asset and liability are recognized over the regulatory lives of the related taxable bases concurrent with the realization in rates. The provision for income taxes includes the following: Years ended September 30, 1997 1996 1995 - -------------------------------------------------------------------------------- Taxes currently payable--federal $4,220 $5,463 $3,817 Taxes currently payable--state 1,232 1,669 1,535 - -------------------------------------------------------------------------------- $5,452 $7,132 $5,352 Deferred taxes--federal 3,483 474 2,084 - -------------------------------------------------------------------------------- Total income tax provision $8,935 $7,606 $7,436 - -------------------------------------------------------------------------------- Sources and tax effects of items which gave rise to deferred taxes are as follows: Years ended September 30, 1997 1996 1995 - -------------------------------------------------------------------------------- Amortization of deferred investment tax credits $ (292) $ (292) $ (292) Unrecovered purchased gas costs 2,180 (1,288) (542) Depreciation 1,775 1,817 1,956 Minimum tax credits -- 439 1,024 Other (180) (202) (62) - -------------------------------------------------------------------------------- $3,483 $ 474 $2,084 - -------------------------------------------------------------------------------- The following table reconciles the income tax provision calculated using the federal statutory tax rate to the book provision for federal and state income taxes: Years ended September 30, 1997 1996 1995 - -------------------------------------------------------------------------------- Statutory federal tax rate 35% 35% 35% Depreciation differences 3 4 3 Allowance for doubtful accounts, including amounts forgiven and deferred (1) (3) 1 Investment tax credits (1) (1) (1) Cost to retire assets, net of salvage (1) (1) (1) State taxes, net of federal tax benefit 3 5 5 Pension contribution (1) (3) (2) Conservation costs (1) (4) (3) Other, net (1) 1 (2) - -------------------------------------------------------------------------------- Effective tax rate 35% 33% 35% - -------------------------------------------------------------------------------- 29 Connecticut Energy Corporation Notes to Consolidated Financial Statements (dollars in thousands, except per share) Deferred income tax liabilities (assets) are composed of the following: As of September 30, 1997 1996 - -------------------------------------------------------------------------------- Tax effect of temporary differences for: Depreciation $24,056 $22,281 Regulatory assets - income taxes 42,929 41,435 Contributions in aid of construction (741) (715) Nonqualified benefit plans (928) (793) Other (399) (96) - -------------------------------------------------------------------------------- Net deferred income tax liability - long-term $64,917 $62,112 - -------------------------------------------------------------------------------- As of September 30, 1997 and 1996, the balance sheet caption "Federal, state and deferred income taxes" included approximately $1,933 and $(247), respectively, of current deferred federal and state income taxes. Note 3 -- Long-Term Debt Long-term debt outstanding consists of the following: As of September 30, 1997 1996 - -------------------------------------------------------------------------------- First Mortgage Bonds: Series L, 8%, due March 1, 1998 $ 4,200 $ 4,340 Series T, 10.02%, due September 1, 2003 2,727 3,182 Series U, 9.70%, due July 31, 2019 9,800 9,800 Series V, 9.85%, due July 31, 2020 15,000 15,000 Series W, 8.93% - 9.13%, due November 17, 2031 60,000 60,000 Series X, 7.67%, due December 15, 2012 15,000 15,000 Series Y, 7.08%, due October 1, 2013 12,000 12,000 - -------------------------------------------------------------------------------- $118,727 $119,322 Medium-Term Notes: Series MTN, 7.50% - 7.95%, due August 3, 2026 20,000 20,000 Less: amounts due within one year 4,654 595 - -------------------------------------------------------------------------------- $134,073 $138,727 - -------------------------------------------------------------------------------- Under the provisions of Southern's mortgage bond indenture dated March 1, 1948, as supplemented from time to time, sinking fund payments are required at various dates for Series L and Series T First Mortgage Bonds. Series W First Mortgage Bonds are due in bullet payments in the years 2021 and 2031, respectively. Series U, V, X and Y are due in single payments in the years 2019, 2020, 2012 and 2013, respectively. Substantially all of the utility plant of Southern is subject to the lien of its mortgage bond indentures. See Note 6, "Common Shareholders' Equity," for dividend restrictions. In August 1996, Southern issued and sold $20,000 in secured medium-term notes. These notes have a weighted average rate of 7.84% and a weighted average life of 25 years. They will be redeemed through payments of $5,000 and $15,000 in the years 2006 and 2026, respectively. Proceeds from the sale were principally used to reduce short-term borrowings incurred primarily in connection with Southern's construction program. The aggregate annual sinking fund contributions and principal maturities for the five fiscal years subsequent to September 30, 1997 are as follows: 1998 -- $4,654; 1999 -- $455; 2000 -- $454; 2001 -- $455; 2002 -- $455; total -- $6,473. Expenses incurred in connection with long-term borrowings are normally amortized on a straightline method over the respective lives of the issues giving rise thereto. Note 4 -- Short-Term Borrowings The Company follows the practice of borrowing on a short-term basis from banks and through the sale of commercial paper. The following information relates to these borrowings: As of September 30, 1997 1996 - -------------------------------------------------------------------------------- Bank Loans: Outstanding $31,400 $19,200 Weighted average interest rate 6.61% 6.10% Commercial Paper: Outstanding -- -- Weighted average interest rate -- -- - -------------------------------------------------------------------------------- 30 Connecticut Energy Corporation Notes to Consolidated Financial Statements (dollars in thousands, except per share) As of September 30, 1997, Connecticut Energy and Southern have lines of credit with a number of banks as detailed below: Shared Connecticut Connecticut Energy/ Energy Southern Southern Total - -------------------------------------------------------------------------------- Committed Lines $5,000 $32,000 $20,000 $57,000 Uncommitted Lines -- $10,000 $10,000 $20,000 As of September 30, 1997, the Company had unused lines of credit of $45,600. In lieu of compensating balances, Southern pays fees for its committed lines of credit which are approximately 1/5 of 1% of the amount of the line of credit. The aggregate annual commitment fees on these lines were $115, $110 and $96 for the years ended September 30, 1997, 1996 and 1995, respectively. Note 5 -- Redeemable Preferred Stock The following table summarizes the shares of preferred stock authorized, issued and outstanding: As of September 30, 1997 1996 - -------------------------------------------------------------------------------- The Southern Connecticut Gas Company: Cumulative preferred stock, $100 par value Authorized 200,000 200,000 Issued and outstanding -- -- - -------------------------------------------------------------------------------- Preferred stock, $1 par value Authorized 600,000 600,000 Issued and outstanding -- -- - -------------------------------------------------------------------------------- Preference stock, $1 par value Authorized 1,000,000 1,000,000 Issued and outstanding -- -- - -------------------------------------------------------------------------------- Connecticut Energy Corporation: Preference stock, $1 par value Authorized 1,000,000 1,000,000 Issued and outstanding -- -- - -------------------------------------------------------------------------------- Southern's $1 par value preferred stock ranks on a parity as to dividends and payments in liquidation with Southern's $100 par value preferred stock. While the preference stock is preferred as to dividends and payments in liquidation over Southern's common stock, it is subordinate to the other classes of preferred stock. Note 6 -- Common Shareholders' Equity Southern's indentures relating to long-term debt contain restrictions as to the declaration or payment of cash dividends on capital stock and the reacquisition of capital stock. Under the most restrictive of such provisions, $29,633 of Southern's retained earnings as of September 30, 1997 was available for such purposes. During the second quarter of fiscal 1997, 52,247 shares of unregistered common stock were issued to five senior officers pursuant to the Company's 1997 Restricted Stock Award Plan ("Stock Award Plan"). The purpose of the Stock Award Plan is to motivate participants to work toward achieving corporate objectives beneficial to the Company and its shareholders by awarding them shares of common stock which become vested upon achievement of the objectives. The total number of shares that may be issued under the Stock Award Plan may not exceed 300,000. This number is subject to adjustment to prevent the dilution or enlargement of any rights of any participant with respect to his or her stock. Such shares are exempt from registration pursuant to Section 4(2) of the Securities Act of 1933. Also during the second quarter of fiscal 1997, the Company established a Non-Employee Director Stock Plan ("Director Stock Plan"). The purpose of the Director Stock Plan is to align the interests of non-employee directors with the Company's shareholders by awarding them shares of common stock. The total number of shares that may be issued under the Director Stock Plan may not exceed 13,000. This number is subject to adjustment to prevent the dilution or enlargement of any rights of any participant with respect to his or her stock. As of September 30, 1997, 900 shares have been issued under the Director Stock Plan. 31 Connecticut Energy Corporation Notes to Consolidated Financial Statements (dollars in thousands, except per share) The Company currently issues common stock through the Dividend Reinvestment and Stock Purchase Plan ("DRP") and an employee savings plan ("Target Plan"). The DRP permits shareholders to automatically reinvest their cash dividends or invest optional limited amounts of cash payments in newly issued shares or open market purchases of the Company's common stock. As of September 30, 1997, there were 1,086,056 shares reserved for issuance under the DRP and Target Plan. Note 7 -- Employee Benefits Retirement Plans Southern maintains two noncontributory pension plans covering substantially all of its employees and employees of certain affiliates. The plan covering salaried employees provides pension benefits based on compensation during the five years before retirement and on years of service. The union plan provides negotiated benefits of stated amounts for each year of service. It is the Company's policy to fund annually the periodic pension cost of its retirement plans subject to the minimum and maximum contribution limitations of the IRC. A regulatory adjustment has been made to the net periodic pension cost to reflect the amount of pension cost that is realized through the ratemaking process. The Company recorded an additional minimum liability of $797 and $63 as of September 30, 1997 and 1996, respectively, representing the excess of the accumulated benefit obligation over the fair value of plan assets and accrued pension costs. This liability is offset by an intangible asset of $85 and $63 as of September 30, 1997 and 1996, respectively, which represents unrecognized prior service costs; and in 1997, the balance (net of income taxes) was charged to a separate component of shareholders' equity. The net periodic pension cost includes the following components: Years ended September 30, 1997 1996 1995 - -------------------------------------------------------------------------------- Service cost benefit earned during the period $ 2,255 $ 2,179 $ 1,868 Interest cost on projected benefit obligation 5,370 4,846 4,686 Actual return on plan assets (21,078) (9,372) (12,603) Net amortization and deferral 14,912 3,959 8,135 - -------------------------------------------------------------------------------- Net periodic pension cost $ 1,459 $ 1,612 $ 2,086 Regulatory adjustment 58 233 233 - -------------------------------------------------------------------------------- Net pension cost $ 1,517 $ 1,845 $ 2,319 - -------------------------------------------------------------------------------- Portion capitalized to utility plant $ 357 $ 351 $ 441 - -------------------------------------------------------------------------------- The following table sets forth the funded status of Southern's pension plans:
As of September 30, 1997 1996 - ----------------------------------------------------------------------------------------------------------------- Plans Where: Plans Where: Assets Accumulated Assets Accumulated Exceed Benefits Exceed Benefits Accumulated Exceed Accumulated Exceed Benefits Assets Benefits Assets - ----------------------------------------------------------------------------------------------------------------- Actuarial present value of benefit obligation: Vested benefit obligation $(55,770) $(1,814) $(50,819) $ (747) - ----------------------------------------------------------------------------------------------------------------- Accumulated benefit obligation $(61,451) $(1,965) $(55,986) $ (914) - ----------------------------------------------------------------------------------------------------------------- Actuarial present value of projected benefit obligation $(70,143) $(2,527) $(65,618) $(1,560) Plan assets at fair value 98,207 -- 79,526 -- - ----------------------------------------------------------------------------------------------------------------- Projected benefit obligation less than (in excess of) plan assets $ 28,064 $(2,527) $ 13,908 $(1,560) Transition obligation 490 -- 658 -- Prior service cost 3,608 250 4,102 273 Unrecognized (gain) loss (21,220) 1,109 (8,818) 368 Adjustment required to recognize minimum liability -- (797) -- (63) - ----------------------------------------------------------------------------------------------------------------- Prepaid pension cost (liability), net $ 10,942 $(1,965) $ 9,850 $ (982) - -----------------------------------------------------------------------------------------------------------------
32 Connecticut Energy Corporation Notes to Consolidated Financial Statements (dollars in thousands, except per share) Key assumptions used in the determination of the projected benefit obligations and the fair value of plan assets were: 1997 1996 1995 - -------------------------------------------------------------------------------- Discount rate 7 1/2% 8 % 7 1/4% Salary increase rate 4 3/4% 5 3/4% 5 1/4% Expected rate of return on assets 9 1/2% 9 1/4% 9 1/2% - -------------------------------------------------------------------------------- The majority of the assets of the pension plans is invested in common stock, fixed income securities and balanced mutual funds, with the balance in cash and short-term investments. Effective October 1, 1993, Southern established nonqualified pension programs to provide benefits on compensation in excess of the limitations imposed by the IRC and to provide additional retirement income to designated officers. Southern maintains a savings plan covering substantially all of its employees and employees of certain affiliates who meet minimum service and age requirements. Employees may elect to contribute to the plan through payroll deductions on either a taxable or a tax-deferred basis as permitted by Section 401(k) of the IRC. Participants receive a matching contribution of 50% of the first 6% of annual compensation and become vested in the matching contribution over a five year period. Benefits are payable upon retirement, death, disability or termination of employment. Amounts expensed under the plan were $782, $808 and $816 for years ended September 30, 1997, 1996 and 1995, respectively. Postretirement Health Care Benefits In addition to providing pension benefits, Southern provides certain health care benefits for its retired employees and retired employees of certain affiliates. Substantially all employees may become eligible for those benefits if they have reached age 55 while working for the Company and have completed at least five years of service. Prior to October 1, 1993, Southern recognized the cost of providing these benefits by expensing $350 annually in excess of paid medical claims in accordance with funding provided by a rate decision in 1990. Effective October 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 106, "Employers' Accounting for Postretirement Benefits Other than Pensions" ("SFAS 106"), which requires accrual accounting for postretirement benefits during an employee's years of service with Southern. Southern has elected to amortize the transition obligation over twenty years. In the DPUC's Decision on Southern's latest rate request, Southern was allowed current recovery of SFAS 106 costs through customer base rates which became effective December 9, 1993. The expense of implementing SFAS 106 prior to full recovery in rates, which totaled $367, was deferred and recovered over a three year period, which concluded in December 1996. The postretirement benefit cost includes the following components:
Years ended September 30, 1997 1996 1995 - ------------------------------------------------------------------------------------------------------------------------- Service cost benefit attributed to service during the period $ 354 $ 405 $ 340 Interest cost on accumulated postretirement benefit obligation 1,223 1,198 1,401 Actual return on plan assets (1,619) (837) (594) Net amortization and deferral 1,694 1,037 1,071 - ------------------------------------------------------------------------------------------------------------------------- Net periodic postretirement benefit cost $ 1,652 $1,803 $2,218 Regulatory adjustment 31 122 122 - ------------------------------------------------------------------------------------------------------------------------- Net postretirement benefit cost $ 1,683 $1,925 $2,340 - -------------------------------------------------------------------------------------------------------------------------
In 1990, Southern amended the Pension Plan for Salaried and Certain Other Employees to establish an account within the pension plan trust, as permitted under Section 401(h) of the IRC, to fund a portion of Southern's anticipated future postretirement health care benefits liability with amounts allowed through the ratemaking process. Through the use of the existing trust and the establishment in 1994 of a Voluntary Employees' Beneficiary Association ("VEBA") trust as permitted under Section 501(c)(9) of the IRC, Southern plans to fund its full postretirement benefit expense under SFAS 106. The majority of the assets of the VEBA trust is invested in a diversified fund consisting of common stock and fixed income securities, with the balance in cash and short-term investments. 33 Connecticut Energy Corporation Notes to Consolidated Financial Statements (dollars in thousands, except per share) The following table reconciles the funded status of the plan with the amounts recognized in the consolidated balance sheets:
As of September 30, 1997 1996 - ------------------------------------------------------------------------------------------------------------------------- Accumulated postretirement benefit obligation: Retirees $ (9,148) $ (8,796) Fully eligible active plan participants (2,028) (2,174) Other active plan participants (5,451) (4,865) - ------------------------------------------------------------------------------------------------------------------------- Total accumulated postretirement benefit obligation $(16,627) $(15,835) Plan assets at fair value 7,988 5,372 - ------------------------------------------------------------------------------------------------------------------------- Accumulated postretirement benefit obligation (in excess of) less than plan assets $ (8,639) $(10,463) Unamortized transition obligation 12,285 13,053 Unrecognized (gain) loss (4,442) (3,811) - ------------------------------------------------------------------------------------------------------------------------- (Accrued) prepaid postretirement benefit obligation $ (796) $ (1,221) - -------------------------------------------------------------------------------------------------------------------------
The expected long-term rate of return on plan assets is 9 1/2%. The assumed initial health care cost trend rates used to measure the expected cost of benefits are 8% for pre-age 65 claims and 7% for post-age 65 claims. The rates decline to 4 1/2% by the years 2004 and 2002, respectively. The weighted average discount rate used to measure the accumulated postretirement benefit obligation is 7 1/2%. A one percentage point change in the assumed health care cost trend rate would change the service cost and interest cost components of the net periodic postretirement benefit cost by approximately $6 and $44, respectively, and would change the accumulated postretirement health care benefit obligation by approximately $591. Note 8 -- Leases Total rental expense was $2,830, $3,035 and $3,074 for the years ended September 30, 1997, 1996 and 1995, respectively. Southern's approximate aggregate minimum rental commitments (exclusive of taxes, maintenance, etc.) under noncancelable operating leases for each of the five fiscal years subsequent to September 30, 1997 are as follows:
Years ending September 30, 1998 1999 2000 2001 2002 Thereafter - ----------------------------------------------------------------------------------------------------------------------- Office space $2,136 $2,130 $2,098 $2,087 $2,087 $25,136 LNG plant 609 608 609 608 609 11,259 Other 72 54 -- -- -- -- - ----------------------------------------------------------------------------------------------------------------------- Total commitment $2,817 $2,792 $2,707 $2,695 $2,696 $36,395 - -----------------------------------------------------------------------------------------------------------------------
In 1995, the liquefied natural gas ("LNG") plant lease agreement was renewed for two consecutive terms of twelve years. The lease contains an option to purchase the plant at a price based on the then fair market sales value of the unit as defined therein. Note 9 -- Quarterly Financial Data (Unaudited)
Dec. 31, March 31, June 30, Sept. 30, 1997 Quarters ended 1996 1997 1997 1997 - ------------------------------------------------------------------------------------------------------------------------------ Operating revenues $74,873 $106,866 $44,026 $26,243 Gross margin 34,564 51,130 21,487 12,155 Operating income (loss) 9,006 17,800 2,461 (378) Net income (loss) 5,409 15,211 (1,205) (2,974) Net income (loss) per share* 0.60 1.67 (0.13) (0.32) - ------------------------------------------------------------------------------------------------------------------------------ Dec. 31, March 31, June 30, Sept. 30, 1996 Quarters ended 1995 1996 1996 1996 - ------------------------------------------------------------------------------------------------------------------------------ Operating revenues $69,775 $120,189 $43,954 $27,175 Gross margin 32,282 53,423 21,127 12,633 Operating income (loss) 8,248 18,107 2,737 (428) Net income (loss) 5,029 14,635 (684) (3,815) Net income (loss) per share 0.57 1.64 (0.08) (0.42) - ------------------------------------------------------------------------------------------------------------------------------ *Calculated on the basis of weighted average shares outstanding during the applicable quarter.
34 Connecticut Energy Corporation Notes to Consolidated Financial Statements (dollars in thousands, except per share) Note 10 -- Fair Value of Financial Instruments The following methods and assumptions were used to estimate the fair value of each class of financial instrument for which it is practicable to estimate that value: Cash and Cash Equivalents The carrying amount approximates fair value because of the short-term maturity of those instruments. Long-term Debt The fair value of the Company's long-term debt is estimated based on quoted market prices for the same or similar issues or on current rates offered to the Company for debt of the same remaining maturities. The estimated fair value of the Company's financial instruments is as follows:
As of September 30, 1997 1996 - -------------------------------------------------------------------------------------------------------------------- Carrying Fair Carrying Fair Amount Value Amount Value - -------------------------------------------------------------------------------------------------------------------- Long-term debt (including current maturities) $(138,727) $(160,196) $(139,322) $(150,808) - --------------------------------------------------------------------------------------------------------------------
Note 11 -- Commitments and Contingencies Environmental Matters Southern has identified coal tar residue at three sites in Connecticut resulting from coal gasification operations conducted at those sites by Southern's predecessors from the late 1800s through the first part of this century. Many gas distribution companies throughout the country carried on such gas manufacturing operations during the same period. The coal tar residue is not designated a hazardous material by any federal or Connecticut agency, but some of its constituents are classified as hazardous. On April 27, 1992, Southern notified the Connecticut Department of Environmental Protection ("DEP") and the United States Environmental Protection Agency of the presence of coal tar residue at the sites. On November 9, 1994, the DEP informed Southern that it had performed a preliminary review of the information provided to it by Southern and had determined that, based on current priorities and limited staff resources, a comprehensive review of site conditions and subsequent participation by the DEP "are not possible at this time." On September 8, 1997, Southern received a letter from the DEP informing it that the three sites had been entered on the Connecticut Inventory of Hazardous Waste Sites. The letter states that the site located on Pine Street in Bridgeport, Connecticut may be of particular interest to the state of Connecticut because of its proximity to the Connecticut Department of Transportation expansion project of the U.S. Highway Route Number 95 Corridor. Placement of the sites on the Inventory of Hazardous Waste Sites means that the DEP may pursue remedial action pursuant to the Connecticut General Statutes. Each site is located in an area that permits Southern to voluntarily perform any remedial action. Connecticut law also allows Southern to retain a Licensed Environmental Professional to conduct further environmental assessments and, if necessary, to develop remedial action plans in accordance with Connecticut Remediation Standard Regulations. Southern intends to confer with officials of the DEP and the Department of Transportation to establish priorities in connection with the environmental assessments. Management cannot at this time predict the costs of any future site analysis and remediation, if any, nor can it estimate when any such costs, if any, would be incurred. While such future analytical and cleanup costs could possibly be significant, management believes, based upon the provisions of the Partial Settlement in Southern's most recent rate order and regulatory precedent with other LDCs in Connecticut, that Southern will be able to recover these costs through its customer rates. Although the method, timing and extent of any recovery remain uncertain, management currently does not expect that the incurrence of such costs will materially adversely impact the Company's financial condition or results of operations. 35 Connecticut Energy Corporation Report of Independent Accountants To the Board of Directors and Shareholders of Connecticut Energy Corporation We have audited the accompanying consolidated balance sheets of Connecticut Energy Corporation and its subsidiaries (the Company) as of September 30, 1997 and 1996 and the related consolidated statements of income, changes in common shareholders' equity and cash flows for each of the three years in the period ended September 30, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits 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 financial statements referred to above present fairly, in all material respects, the consolidated financial position of Connecticut Energy Corporation and its subsidiaries as of September 30, 1997 and 1996, and the consolidated results of their operations and their cash flows for each of the three years in the period ended September 30, 1997 in conformity with generally accepted accounting principles. /s/ Coopers & Lybrand L.L.P. New York, New York October 31, 1997 37 Connecticut Energy Corporation Eleven Year Financial Summary (dollars in thousands, except per share) Financial information presented for 1997 through 1990 is for the twelve month period ended September 30; all information for prior years is for the twelve month period ended December 31.
1997 1996 1995 1994 - ----------------------------------------------------------------------------------------------------------------------- Operations Operating revenues $252,008 $261,093 $232,093 $240,873 Purchased gas 132,672 141,628 115,583 126,870 Gross margin 119,336 119,465 116,510 114,003 Operations and maintenance expenses 50,352 51,605 52,856 54,244 Depreciation and depletion 15,774 14,752 14,050 13,031 Federal income taxes 7,703 5,937 5,901 3,938 Other taxes 16,618 18,507 16,817 17,778 Other (income) deductions, net (1,229) 546 519 586 Interest expense 13,677 12,953 12,307 11,575 Subsidiary preferred stock dividends -- -- -- 8 Income before cumulative effect of accounting change $ 16,441 $ 15,165 $ 14,060 $ 12,843 Cumulative effect of accounting change -- -- -- -- Net income $ 16,441 $ 15,165 $ 14,060 $ 12,843 Net income per share before cumulative effect of accounting change (d) $ 1.81 $ 1.70 $ 1.60 $ 1.58 Net income per share (d) $ 1.81 $ 1.70 $ 1.60 $ 1.58 Annual dividend paid per common share (d) $ 1.32 $ 1.31 $ 1.30 $ 1.29 - ----------------------------------------------------------------------------------------------------------------------- *Capitalization Common shareholders' equity $144,514 $137,961 $131,561 $125,719 Redeemable preferred stock -- -- -- -- Long-term debt 134,073 138,727 119,322 119,917 - ----------------------------------------------------------------------------------------------------------------------- Total capitalization $278,587 $276,688 $250,883 $245,636 - ----------------------------------------------------------------------------------------------------------------------- *Capitalization (% of total) Common shareholders' equity 51.9 49.9 52.4 51.2 Redeemable preferred stock -- -- -- -- Long-term debt 48.1 50.1 47.6 48.8 - ----------------------------------------------------------------------------------------------------------------------- Total capitalization 100.0 100.0 100.0 100.0 - ----------------------------------------------------------------------------------------------------------------------- *Common Stock (d) Shares outstanding at end of period 9,172,468 9,012,267 8,865,210 8,700,266 Book value per share at end of period $ 15.76 $ 15.31 $ 14.84 $ 14.45 Market value per share at end of period $ 24.69 $ 20.00 $ 19.38 $ 21.63 Average daily trading volume 9,000 9,000 5,000 5,500 Shareholders of record at end of period 10,546 11,274 11,688 12,094 Percent of institutional ownership 25 20 21 21 - ----------------------------------------------------------------------------------------------------------------------- Assets Gross utility plant $399,675 $376,109 $354,847 $331,953 Net utility plant $269,122 $257,761 $247,603 $234,495 *Capital expenditures $ 28,443 $ 25,180 $ 27,609 $ 26,618 Total assets $424,281 $399,228 $370,088 $352,920 - ----------------------------------------------------------------------------------------------------------------------- Ratios (% of total) Operations and maintenance expense as a % of gross margin 42.2 43.2 45.4 47.6 Dividend payout as a % of earnings 72.9 77.1 81.3 81.6 Effective federal tax rate 32.0 28.0 30.0 23.0 *Return on ending common equity 11.4 11.0 10.7 10.2 Price to earnings 13.6 11.8 12.1 13.7 Dividend yield 5.3 6.6 6.7 6.0 Market price as a % of book value 156.7 130.6 130.6 149.7 - ----------------------------------------------------------------------------------------------------------------------- *Information used in the National Association of Investors Corporation (NAIC) stock selection format. (a) The results for the years ended September 30, 1990 and December 31, 1989 include the results for the three months ended December 31, 1989, which included the effects of the unusually cold weather experienced in the month of December and a writedown of the value of oil and gas properties. (b) Includes the cumulative effect of accounting change for municipal property taxes which increased earnings by $0.21 per share. (c) The writedown of the value of oil and gas properties reduced earnings by $0.10 per share in 1990 and 1989 and $0.05 per share in 1987. (d) Adjusted to reflect the Company's 3-for-2 stock split in October 1989.
38 Connecticut Energy Corporation
1993 1992 1991 1990 1989 1988 1987 - ------------------------------------------------------------------------------------------------------------------------- (a)(b)(c) (a)(c) (c) $212,762 $203,011 $179,172 $174,059 $171,218 $156,978 $157,867 113,045 104,163 86,778 84,154 81,794 71,787 75,337 99,717 98,848 92,394 89,905 89,424 85,191 82,530 45,023 46,881 42,475 44,085 42,636 38,869 38,218 12,051 11,327 10,540 10,664 10,297 8,533 8,427 3,474 2,287 4,324 3,819 4,740 5,839 6,325 16,044 16,025 15,238 14,431 14,560 14,146 13,617 510 531 349 (228) 356 713 276 11,530 11,536 10,428 10,156 8,598 7,653 7,484 32 34 36 39 403 751 849 $ 11,053 $ 10,227 $ 9,004 $ 6,939 $ 7,834 $ 8,687 $ 7,334 -- -- -- 1,280 -- -- -- $ 11,053 $ 10,227 $ 9,004 $ 8,219 $ 7,834 $ 8,687 $ 7,334 $ 1.50 $ 1.43 $ 1.38 $ 1.12 $ 1.28 $ 1.49 $ 1.38 $ 1.50 $ 1.43 $ 1.38 $ 1.33 $ 1.28 $ 1.49 $ 1.38 $ 1.28 $ 1.265 $ 1.24 $ 1.23 $ 1.20 $ 1.17 $ 1.12 - ------------------------------------------------------------------------------------------------------------------------- $ 99,853 $ 92,605 $ 88,622 $ 74,413 $ 75,001 $ 73,311 $ 61,187 638 687 736 786 835 6,429 7,270 120,511 94,106 87,378 91,506 79,686 69,137 64,461 - ------------------------------------------------------------------------------------------------------------------------- $221,002 $187,398 $176,736 $166,705 $155,522 $148,877 $132,918 - ------------------------------------------------------------------------------------------------------------------------- 45.2 49.4 50.1 44.6 48.2 49.2 46.0 0.3 0.4 0.4 0.5 0.6 4.3 5.5 54.5 50.2 49.5 54.9 51.2 46.5 48.5 - ------------------------------------------------------------------------------------------------------------------------- 100.0 100.0 100.0 100.0 100.0 100.0 100.0 - ------------------------------------------------------------------------------------------------------------------------- 7,488,467 7,234,921 7,096,634 6,250,161 6,176,665 6,088,017 5,346,879 $ 13.33 $ 12.80 $ 12.49 $ 11.91 $ 12.14 $ 12.04 $ 11.45 $ 24.88 $ 22.25 $ 19.00 $ 16.63 $ 17.63 $ 14.50 $ 13.67 9,000 4,500 5,000 2,950 4,200 2,850 2,550 11,094 9,153 9,163 7,382 7,493 7,662 7,577 18 18 14 15 16 16 13 - ------------------------------------------------------------------------------------------------------------------------- $313,951 $293,687 $273,862 $255,446 $241,624 $222,236 $204,947 $221,800 $210,054 $198,695 $189,108 $181,358 $166,970 $155,289 $ 26,070 $ 22,634 $ 20,331 $ 23,102 $ 23,184 $ 19,471 $ 17,790 $299,795 $269,504 $247,969 $229,600 $239,327 $214,458 $193,842 - ------------------------------------------------------------------------------------------------------------------------- 45.2 47.4 46.0 49.0 47.7 45.6 46.3 85.3 88.5 89.9 92.5 93.8 78.5 81.2 24.0 18.0 32.0 35.0 37.0 38.0 44.0 11.1 11.0 10.2 11.0 10.4 11.8 12.0 16.6 15.6 13.8 12.5 13.8 9.7 9.9 5.1 5.7 6.5 7.4 6.8 8.1 8.2 186.6 173.8 152.1 139.6 145.2 120.4 119.4 - -------------------------------------------------------------------------------------------------------------------------
39 Connecticut Energy Corporation EX-21 3 EXHIBIT 21 SUBSIDIARIES OF CONNECTICUT ENERGY CORPORATION Name State of Incorporation ---- ---------------------- The Southern Connecticut Gas Company Connecticut CNE Development Corporation Connecticut CNE Energy Services Group, Inc. Connecticut CNE Venture-Tech, Inc. Connecticut 46 EX-27 4
UT 1,000 YEAR SEP-30-1997 SEP-30-1997 PER-BOOK 269,122 3,343 60,560 91,256 0 424,281 9,172 94,540 42,297 144,514 0 0 134,073 31,400 0 0 4,654 0 0 0 109,640 424,281 252,008 8,935 214,184 223,119 28,889 1,229 30,118 13,677 16,441 0 16,441 12,014 12,321 28,818 1.81 1.81
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