UNITED STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended March 31, 2005
Commission File Number 1-3880
National Fuel Gas Company
(Exact name of registrant as specified in its charter)
| New Jersey | 13-1086010 |
|---|---|
| (State or other jurisdiction of | (I.R.S. Employer |
| incorporation or organization) | Identification No.) |
| 6363 Main Street | 14221 |
| Williamsville, New York | (Zip Code) |
(Address of principal executive offices)
(716) 857-7000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months and (2) has been subject to such filing requirements for the past 90 days. YES X NO
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). YES X NO
Indicate the number shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date:
Common stock, $1 par value, outstanding at April 30, 2005: 83,553,146 shares.
1
Company or Group of Companies for which Report is Filed:
NATIONAL FUEL GAS COMPANY
DIRECT SUBSIDIARIES: National Fuel Gas Distribution Corporation
National Fuel Gas Supply Corporation
Seneca Resources Corporation
Highland Forest Resources, Inc.
Leidy Hub, Inc.
Data-Track Account Services, Inc.
National Fuel Resources, Inc.
Horizon Energy Development, Inc.
Horizon LFG, Inc.
Horizon Power, Inc.
GLOSSARY OF TERMS
Frequently used abbreviations or acronyms used in this report:
National Fuel Gas Companies
Data-Track Data-Track Account Services, Inc.
Distribution Corporation National Fuel Gas Distribution Corporation
Empire Empire State Pipeline
ESNE Energy Systems North East, LLC
Highland Highland Forest Resources, Inc.
Horizon Horizon Energy Development, Inc.
Horizon LFG Horizon LFG, Inc.
Horizon Power Horizon Power, Inc.
Leidy Hub Leidy Hub, Inc.
Model City Model City Energy, LLC
National Fuel, the Company,
or the Registrant National Fuel Gas Company and its subsidiaries
NFR National Fuel Resources, Inc.
Seneca Seneca Resources Corporation
Seneca Energy Seneca Energy II, LLC
Supply Corporation National Fuel Gas Supply Corporation
Regulatory Agencies
FERC Federal Energy Regulatory Commission
NYPSC State of New York Public Service Commission
PaPUC Pennsylvania Public Utility Commission
2
GLOSSARY OF TERMS (Cont'd)
SEC Securities and Exchange Commission
Other
APB 25 Accounting Principles Board Opinion No. 25, Accounting for
Stock Issued to Employees
Bbl Barrel
CZK Czech korunas
Exchange Act Securities Exchange Act of 1934, as amended
GAAP Accounting principles generally accepted in the United States of America
Holding Company Act Public Utility Holding Company Act of 1935, as amended
LIFO Last-in, first-out
Mbbl Thousand barrels
Mcf Thousand cubic feet
MD&A Management's Discussion and Analysis of Financial Condition and
Results of Operations
MMcf Million cubic feet
SFAS Statement of Financial Accounting Standards
SFAS 123 Statement of Financial Accounting Standards No. 123, Accounting
for Stock-Based Compensation
SFAS 123R Statement of Financial Accounting Standards No. 123R,
Share-Based Payment
SFAS 133 Statement of Financial Accounting Standards No. 133,
Accounting for Derivative Instruments and Hedging
Activities
WNC Weather normalization clause
3
INDEX
Part I. Financial InformationReference to “the Company” in this report means the Registrant or the Registrant and its subsidiaries collectively, as appropriate in the context of the disclosure. All references to a certain year in this report are to the Company’s fiscal year ended September 30 of that year, unless otherwise noted.
This Form 10-Q contains “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934. Forward-looking statements should be read with the cautionary statements and important factors included in this Form 10-Q at Item 2 — MD&A, under the heading “Safe Harbor for Forward-Looking Statements.” Forward-looking statements are all statements other than statements of historical fact, including, without limitation, those statements that are designated with an asterisk (“*”) following the statement, as well as those statements that are identified by the use of the words “anticipates,” “estimates,” “expects,” “intends,” “plans,” “predicts,” “projects,” and similar expressions.
4
National Fuel Gas Company
Consolidated Statements of Income and Earnings
Reinvested in the Business
(Unaudited)
Three Months Ended
March 31,
(Thousands of Dollars, Except Per Common Share Amounts) 2005 2004
----------------- -----------------
INCOME
Operating Revenues $791,329 $801,678
- -------------------------------------------------------------------------------- ----------------- -----------------
Operating Expenses
Purchased Gas 440,254 445,909
Fuel Used in Heat and Electric Generation 26,192 24,053
Operation and Maintenance 116,482 119,683
Property, Franchise and Other Taxes 20,774 20,165
Depreciation, Depletion and Amortization 49,345 47,958
- -------------------------------------------------------------------------------- ----------------- -----------------
653,047 657,768
Adjustment of Loss on Sale of Oil and Gas Producing Properties - 4,645
- -------------------------------------------------------------------------------- ----------------- -----------------
Operating Income 138,282 148,555
Other Income (Expense):
Income from Unconsolidated Subsidiaries 455 13
Other Income 6,159 987
Interest Expense on Long-Term Debt (18,471) (21,303)
Other Interest Expense (1,936) (1,370)
- -------------------------------------------------------------------------------- ----------------- -----------------
Income Before Income Taxes and
Minority Interest in Foreign Subsidiaries 124,489 126,882
Income Tax Expense 51,401 47,973
Minority Interest in Foreign Subsidiaries 2,405 1,854
- -------------------------------------------------------------------------------- ----------------- -----------------
Net Income Available for Common Stock 70,683 77,055
- -------------------------------------------------------------------------------- ----------------- -----------------
EARNINGS REINVESTED IN THE BUSINESS
Balance at December 31 746,090 669,894
- -------------------------------------------------------------------------------- ----------------- -----------------
816,773 746,949
Dividends on Common Stock
(2005 - $0.28; 2004 - $0.27) 23,364 22,094
- -------------------------------------------------------------------------------- ----------------- -----------------
Balance at March 31 793,409 $724,855
================================================================================ ================= =================
Earnings Per Common Share:
Basic $0.85 $0.94
Diluted $0.83 $0.93
Weighted Average Common Shares Outstanding:
Used in Basic Calculation 83,313,191 81,796,698
================================================================================ ================= =================
Used in Diluted Calculation 84,770,068 82,985,451
================================================================================ ================= =================
See Notes to Consolidated Financial Statements
5
National Fuel Gas Company
Consolidated Statements of Income and Earnings
Reinvested in the Business
(Unaudited)
Six Months Ended
March 31,
(Thousands of Dollars, Except Per Common Share Amounts) 2005 2004
----------------- -----------------
INCOME
Operating Revenues $1,335,587 $1,334,191
- -------------------------------------------------------------------------------- ----------------- -----------------
Operating Expenses
Purchased Gas 696,410 696,686
Fuel Used in Heat and Electric Generation 48,403 45,109
Operation and Maintenance 217,328 219,865
Property, Franchise and Other Taxes 38,942 38,387
Depreciation, Depletion and Amortization 96,285 94,416
- -------------------------------------------------------------------------------- ----------------- -----------------
1,097,368 1,094,463
Adjustment of Loss on Sale of Oil and Gas Producing Properties - 4,645
- -------------------------------------------------------------------------------- ----------------- -----------------
Operating Income 238,219 244,373
Other Income (Expense):
Income from Unconsolidated Subsidiaries 1,239 96
Other Income 7,809 3,018
Interest Expense on Long-Term Debt (37,015) (44,272)
Other Interest Expense (4,354) (3,735)
- -------------------------------------------------------------------------------- ----------------- -----------------
Income Before Income Taxes and
Minority Interest in Foreign Subsidiaries 205,898 199,480
Income Tax Expense 81,436 69,540
Minority Interest in Foreign Subsidiaries 3,342 3,671
- -------------------------------------------------------------------------------- ----------------- -----------------
Net Income Available for Common Stock 121,120 126,269
- -------------------------------------------------------------------------------- ----------------- -----------------
EARNINGS REINVESTED IN THE BUSINESS
Balance at October 1 718,926 642,690
- -------------------------------------------------------------------------------- ----------------- -----------------
840,046 768,959
Dividends on Common Stock
(2005 - $0.56; 2004 - $0.54) 46,637 44,104
Balance at March 31 793,409 $724,855
================================================================================ ================= =================
Earnings Per Common Share:
Basic $1.46 $1.55
Diluted $1.43 $1.53
Weighted Average Common Shares Outstanding:
Used in Basic Calculation 83,231,435 81,683,750
================================================================================ ================= =================
Used in Diluted Calculation 84,711,134 82,612,639
================================================================================ ================= =================
See Notes to Consolidated Financial Statements
6
National Fuel Gas Company
Consolidated Balance Sheets
(Unaudited)
March 31, September 30,
2005 2004
-------------------- -------------------
(Thousands of Dollars)
ASSETS
Property, Plant and Equipment $4,761,063 $4,602,779
Less - Accumulated Depreciation, Depletion
and Amortization 1,701,260 1,596,015
- ---------------------------------------------------------------------------- -------------------- -------------------
3,059,803 3,006,764
- ---------------------------------------------------------------------------- -------------------- -------------------
Current Assets
Cash and Temporary Cash Investments 123,081 66,153
Receivables - Net of Allowance for Uncollectible Accounts of
$25,387 and $17,440, Respectively 317,869 129,825
Unbilled Utility Revenue 60,687 18,574
Gas Stored Underground 18,384 68,511
Materials and Supplies - at average cost 55,598 43,922
Unrecovered Purchased Gas Costs - 7,532
Prepayments 55,885 38,760
Fair Value of Derivative Financial Instruments - 23
- ---------------------------------------------------------------------------- -------------------- -------------------
631,504 373,300
- ---------------------------------------------------------------------------- -------------------- -------------------
Other Assets
Recoverable Future Taxes 83,847 83,847
Unamortized Debt Expense 18,581 19,573
Other Regulatory Assets 63,452 66,862
Deferred Charges 2,426 3,411
Other Investments 76,357 72,556
Investments in Unconsolidated Subsidiaries 16,163 16,444
Goodwill 5,476 5,476
Intangible Assets 44,663 45,994
Other 23,907 17,571
- ---------------------------------------------------------------------------- -------------------- -------------------
334,872 331,734
- ---------------------------------------------------------------------------- -------------------- -------------------
Total Assets $4,026,179 $3,711,798
============================================================================ ==================== ===================
See Notes to Consolidated Financial Statements
7
National Fuel Gas Company
Consolidated Balance Sheets
(Unaudited)
March 31, September 30,
2005 2004
-------------------- -------------------
(Thousands of Dollars)
CAPITALIZATION AND LIABILITIES
Capitalization:
Comprehensive Shareholders' Equity
Common Stock, $1 Par Value
Authorized - 200,000,000 Shares; Issued
And Outstanding - 83,508,614 Shares and
82,990,340 Shares, Respectively $83,509 $ 82,990
Paid in Capital 512,669 506,560
Earnings Reinvested in the Business 793,409 718,926
- ---------------------------------------------------------------------------- -------------------- -------------------
Total Common Shareholder Equity Before
Items of Other Comprehensive Loss 1,389,587 1,308,476
Accumulated Other Comprehensive Loss (59,185) (54,775)
- ---------------------------------------------------------------------------- -------------------- -------------------
Total Comprehensive Shareholders' Equity 1,330,402 1,253,701
Long-Term Debt, Net of Current Portion 1,126,401 1,133,317
- ---------------------------------------------------------------------------- -------------------- -------------------
Total Capitalization 2,456,803 2,387,018
- ---------------------------------------------------------------------------- -------------------- -------------------
Minority Interest in Foreign Subsidiaries 43,883 37,048
- ---------------------------------------------------------------------------- -------------------- -------------------
Current and Accrued Liabilities
Notes Payable to Banks and
Commercial Paper 113,200 156,800
Current Portion of Long-Term Debt 14,793 14,260
Accounts Payable 165,596 115,979
Amounts Payable to Customers 28,496 3,154
Other Accruals and Current Liabilities 254,481 91,164
Fair Value of Derivative Financial Instruments 141,053 95,099
- ---------------------------------------------------------------------------- -------------------- -------------------
717,619 476,456
- ---------------------------------------------------------------------------- -------------------- -------------------
Deferred Credits
Accumulated Deferred Income Taxes 439,700 458,095
Taxes Refundable to Customers 11,065 11,065
Unamortized Investment Tax Credit 7,147 7,498
Cost of Removal Regulatory Liability 84,467 82,020
Other Regulatory Liabilities 69,095 67,669
Pension Liability 91,706 91,587
Asset Retirement Obligation 33,318 32,292
Other Deferred Credits 71,376 61,050
- ---------------------------------------------------------------------------- -------------------- -------------------
807,874 811,276
- ---------------------------------------------------------------------------- -------------------- -------------------
Commitments and Contingencies - -
- ---------------------------------------------------------------------------- -------------------- -------------------
Total Capitalization and Liabilities $4,026,179 $3,711,798
============================================================================ ==================== ===================
See Notes to Consolidated Financial Statements
8
National Fuel Gas Company
Consolidated Statements of Cash Flows
(Unaudited)
Six Months Ended
March 31,
(Thousands of Dollars) 2005 2004
------------------- ---------------------
OPERATING ACTIVITIES
Net Income Available for Common Stock $121,120 $126,269
Adjustments to Reconcile Net Income to Net Cash
Provided by Operating Activities:
Adjustment of Loss on Sale of Oil and Gas Producing
Properties - (4,645)
Depreciation, Depletion and Amortization 96,285 94,416
Deferred Income Taxes (3,982) (13,635)
Income from Unconsolidated Subsidiaries, Net of
Cash Distributions 282 645
Minority Interest in Foreign Subsidiaries 3,342 3,671
Other (7,124) (1,931)
Change in:
Receivables and Unbilled Utility Revenue (228,969) (185,242)
Gas Stored Underground and Materials and
Supplies 38,862 74,100
Unrecovered Purchased Gas Costs 7,532 21,199
Prepayments (17,063) (2,199)
Accounts Payable 47,541 14,949
Amounts Payable to Customers 25,342 18,379
Other Accruals and Current Liabilities 163,077 167,706
Other Assets (5,506) 6,911
Other Liabilities 16,239 (33,849)
- ---------------------------------------------------------------------------- ------------------- ---------------------
Net Cash Provided by Operating Activities 256,978 286,744
- ---------------------------------------------------------------------------- ------------------- ---------------------
INVESTING ACTIVITIES
Capital Expenditures (114,624) (88,888)
Net Proceeds from Sale of Oil and Gas Producing Properties 85 5,041
Other 2,450 2,063
- ---------------------------------------------------------------------------- ------------------- ---------------------
Net Cash Used in Investing Activities (112,089) (81,784)
- ---------------------------------------------------------------------------- ------------------- ---------------------
FINANCING ACTIVITIES
Change in Notes Payable to Banks and Commercial Paper (43,600) (5,400)
Reduction of Long-Term Debt (7,314) (135,861)
Dividends Paid on Common Stock (46,483) (43,962)
Proceeds from Issuance of Common Stock 6,301 8,076
- ---------------------------------------------------------------------------- ------------------- ---------------------
Net Cash Used in Financing Activities (91,096) (177,147)
- ---------------------------------------------------------------------------- ------------------- ---------------------
Effect of Exchange Rates on Cash 3,135 365
- ---------------------------------------------------------------------------- ------------------- ---------------------
Net Increase in Cash and Temporary Cash Investments 56,928 28,178
Cash and Temporary Cash Investments at October 1 66,153 51,421
- ---------------------------------------------------------------------------- ------------------- ---------------------
Cash and Temporary Cash Investments at March 31 $123,081 $79,599
============================================================================ =================== =====================
See Notes to Consolidated Financial Statements
9
National Fuel Gas Company
Consolidated Statements of Comprehensive Income
(Unaudited)
Three Months Ended
March 31,
(Thousands of Dollars) 2005 2004
------------------- ---------------------
Net Income Available for Common Stock $70,683 $77,055
- ---------------------------------------------------------------------------- ------------------- ---------------------
Other Comprehensive Income (Loss), Before Tax:
Foreign Currency Translation Adjustment (8,084) (7,147)
Unrealized Gain on Securities Available for Sale Arising
During the Period 222 1,071
Unrealized Loss on Derivative Financial Instruments
Arising During the Period (100,334) (24,696)
Reclassification Adjustment for Realized Gains on
Securities Available for Sale in Net Income (652) -
Reclassification Adjustment for Realized Losses on
Derivative Financial Instruments in Net Income 17,645 11,058
- ---------------------------------------------------------------------------- ------------------- ---------------------
Other Comprehensive Loss, Before Tax (91,203) (19,714)
- ---------------------------------------------------------------------------- ------------------- ---------------------
Income Tax Expense Related to Cumulative Translation
Adjustment 363 -
Income Tax Expense Related to Unrealized Gain
on Securities Available for Sale Arising During the Period 159 375
Income Tax Benefit Related to Unrealized Loss on
Derivative Financial Instruments Arising During the Period (38,380) (9,545)
Reclassification Adjustment for Income Tax Expense on
Realized Gains from Securities Available for Sale in Net Income (228) -
Reclassification Adjustment for Income Tax Benefit on
Realized Losses from Derivative Financial Instruments
In Net Income 6,671 4,105
- ---------------------------------------------------------------------------- ------------------- ---------------------
Income Taxes - Net (31,415) (5,065)
- ---------------------------------------------------------------------------- ------------------- ---------------------
Other Comprehensive Loss (59,788) (14,649)
- ---------------------------------------------------------------------------- ------------------- ---------------------
Comprehensive Income $10,895 $62,406
============================================================================ =================== =====================
See Notes to Consolidated Financial Statements
10
National Fuel Gas Company
Consolidated Statements of Comprehensive Income
(Unaudited)
Six Months Ended
March 31,
(Thousands of Dollars) 2005 2004
------------------- ---------------------
Net Income Available for Common Stock $121,120 $126,269
- ---------------------------------------------------------------------------- ------------------- ---------------------
Other Comprehensive Income (Loss), Before Tax:
Foreign Currency Translation Adjustment 22,900 8,799
Unrealized Gain on Securities Available for Sale Arising
During the Period 1,351 2,392
Unrealized Loss on Derivative Financial Instruments
Arising During the Period (80,232) (42,312)
Reclassification Adjustment for Realized Gains on
Securities Available for Sale in Net Income (652) -
Reclassification Adjustment for Realized Losses on
Derivative Financial Instruments in Net Income 35,841 16,795
- ---------------------------------------------------------------------------- ------------------- ---------------------
Other Comprehensive Loss, Before Tax (20,792) (14,326)
- ---------------------------------------------------------------------------- ------------------- ---------------------
Income Tax Expense Related to Cumulative Translation
Adjustment 363 -
Income Tax Expense Related to Unrealized Gain
on Securities Available for Sale Arising During the Period 554 837
Income Tax Benefit Related to Unrealized Loss
on Derivative Financial Instruments Arising During the Period (30,653) (15,886)
Reclassification Adjustment for Income Tax Expense on
Realized Gains from Securities Available for Sale in Net Income (228) -
Reclassification Adjustment for Income Tax Benefit on
Realized Losses from Derivative Financial Instruments
In Net Income 13,582 6,499
- ---------------------------------------------------------------------------- ------------------- ---------------------
Income Taxes - Net (16,382) (8,550)
- ---------------------------------------------------------------------------- ------------------- ---------------------
Other Comprehensive Loss (4,410) (5,776)
- ---------------------------------------------------------------------------- ------------------- ---------------------
Comprehensive Income $116,710 $120,493
============================================================================ =================== =====================
See Notes to Consolidated Financial Statements
11
National Fuel Gas Company
Notes to Consolidated Financial Statements
(Unaudited)
The preparation of the consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Earnings for Interim Periods. The Company, in its opinion, has included all adjustments that are necessary for a fair statement of the results of operations for the reported periods. The consolidated financial statements and notes thereto, included herein, should be read in conjunction with the financial statements and notes for the years ended September 30, 2004, 2003 and 2002 that are included in the Company’s 2004 Form 10-K. The 2005 consolidated financial statements will be examined by the Company’s independent registered public accounting firm after the end of the fiscal year.
The earnings for the six months ended March 31, 2005 should not be taken as a prediction of earnings for the entire fiscal year ending September 30, 2005. Most of the business of the Utility, International, and Energy Marketing segments is seasonal in nature and is influenced by weather conditions. Due to the seasonal nature of the heating business in the Utility, International, and Energy Marketing segments, earnings during the winter months normally represent a substantial part of the earnings that those segments are expected to achieve for the entire fiscal year.
Consolidated Statement of Cash Flows. For purposes of the Consolidated Statement of Cash Flows, the Company considers all highly liquid debt instruments purchased with a maturity of generally three months or less to be cash equivalents.
Gas Stored Underground — Current. In the Utility segment, gas stored underground – current is carried at lower of cost or market, on a LIFO method. Gas stored underground – current normally declines during the first and second quarters of the year and is replenished during the third and fourth quarters. In the Utility segment, the current cost of replacing gas withdrawn from storage is recorded in the Consolidated Statements of Income and a reserve for gas replacement is recorded in the Consolidated Balance Sheets under the caption “Other Accruals and Current Liabilities.” Such reserve, which amounted to $112.3 million at March 31, 2005, is reduced to zero by September 30 as the inventory is replenished.
Accumulated Other Comprehensive Income (Loss). The components of Accumulated Other Comprehensive Income (Loss), net of related tax effect, are as follows (in thousands):
12
At March 31, 2005 At September 30, 2004
----------------- ---------------------
Minimum Pension Liability Adjustment $(53,648) $(53,648)
Cumulative Foreign Currency
Translation Adjustment 74,053 51,516
Net Unrealized Loss on Derivative
Financial Instruments (84,053) (56,733)
Net Unrealized Gain on Securities
Available for Sale 4,463 4,090
--------- ---------
Accumulated Other Comprehensive Loss $(59,185) $(54,775)
========= =========
Earnings Per Common Share. Basic earnings per common share is computed by dividing income available for common stock by the weighted average number of common shares outstanding for the period. Diluted earnings per common share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. For purposes of determining earnings per common share, the only potentially dilutive securities the Company has outstanding are stock options. The diluted weighted average shares outstanding shown on the Consolidated Statements of Income reflects the potential dilution as a result of these stock options as determined using the Treasury Stock Method. Stock options that are antidilutive are excluded from the calculation of diluted earnings per common share. For the quarters ended March 31, 2005 and 2004, 21,434 and 2,324,100 stock options, respectively, were excluded as being antidilutive. For the six months ended March 31, 2005 and 2004, 10,599 and 4,466,722 stock options, respectively, were excluded as being antidilutive.
Stock-Based Compensation. The Company accounts for stock-based compensation for options granted using the intrinsic value method specified by APB 25 and related interpretations. Under that method, no compensation expense was recognized for options granted under the plans for the quarter and six months ended March 31, 2005 and 2004, other than for the Company’s restricted stock awards. Had compensation expense been determined based on fair value at the grant dates, which is the accounting treatment specified by SFAS 123, the Company’s net income and earnings per share would have been reduced to the pro forma amounts below:
Three Months Ended Six Months Ended
(Thousands of Dollars, Except Per March 31, March 31,
Common Share Amounts) 2005 2004 2005 2004
---- ---- ---- ----
Net Income Available for $70,683 $77,055 $121,120 $126,269
Common Stock as Reported
Add:
Stock-Based Compensation Expense
Included in Reported Net Income, 98 158 205 325
Net of Tax
Deduct:
Stock-Based Compensation Expense
Determined Based on Fair Value
At the Grant Dates, Net of Tax (317) (637) (680) (1,356)
------- -------- -------- --------
Pro Forma Net Income Available
For Common Stock $70,464 $76,576 $120,645 $125,238
======= ======== ======== ========
13
Earnings Per Common Share: Basic - As Reported $0.85 $0.94 $1.46 $1.55 Basic - Pro Forma $0.85 $0.94 $1.45 $1.53 Diluted - As Reported $0.83 $0.93 $1.43 $1.53 Diluted - Pro Forma $0.83 $0.92 $1.42 $1.52
New Accounting Pronouncements. In December 2004, the Financial Accounting Standards Board issued SFAS 123R. SFAS 123R replaces SFAS 123 and supercedes APB 25. The Company currently follows APB 25 in accounting for stock-based compensation, as disclosed above. SFAS 123R addresses the accounting for transactions in which an entity exchanges its equity instruments for goods or services. It also addresses transactions in which an entity incurs liabilities in exchange for goods or services that are based on the fair value of the entity’s equity instruments or that may be settled by the issuance of those equity instruments. This standard focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. Under this standard, companies are required to measure the cost of employee services received in exchange for an award of equity instruments based on the fair value of the award at the date of grant. That cost will be recognized over the period during which an employee is required to provide service in exchange for the award. The Company will adopt this standard during the first quarter of fiscal 2006. In accordance with SFAS 123R, the Company will use the modified version of prospective application. Under modified prospective application, SFAS 123R applies to new awards and to awards modified, repurchased, or cancelled after the required effective date. Additionally, compensation cost for the portion of awards for which the requisite service has not been rendered that are outstanding as of the required effective date shall be recognized as the requisite service is rendered on or after the required effective date. The compensation cost for that portion of awards shall be based on the grant-date fair value of those awards as calculated for the Company’s disclosure under SFAS 123. The Company will not restate any prior periods as a result of adopting SFAS 123R. The Company does not believe that adoption of SFAS 123R will have a material impact on its financial condition and results of operations, as highlighted by the disclosures above under “Stock-Based Compensation”.
During the quarter ended March 31, 2004, the Company recorded a $4.6 million earnings benefit related to the Company’s 2003 sale of Canadian oil properties. When the Company closed that transaction in September 2003, the initial proceeds it received were subject to adjustment based on actual working capital and the resolution of certain income tax matters. During the quarter ended March 31, 2004, the Company resolved those items with the buyer and, as a result, received an additional $4.6 million (U. S. dollars) of sales proceeds, which it recorded in the Adjustment of Loss on Sale of Oil and Gas Producing Properties line on the income statement.
The components of federal and state income taxes included in the Consolidated Statements of Income are as follows (in thousands):
14
Six Months Ended
March 31,
2005 2004
------------------- --------------------
Operating Expenses:
Current Income Taxes
Federal $62,850 $61,455
State 16,882 16,696
Foreign 5,686 5,024
Deferred Income Taxes
Federal (5,938) (10,068)
State (2,228) (2,094)
Foreign 4,184 (1,473)
------------------- --------------------
81,436 69,540
Other Income:
Deferred Investment Tax Credit (348) (348)
Minority Interest in Foreign Subsidiaries (1,142) (130)
------------------- --------------------
Total Income Taxes $79,946 $69,062
=================== ====================
The U.S. and foreign components of income before income taxes are as follows (in thousands):
Six Months Ended
March 31,
2005 2004
------------------- --------------------
U.S. $170,680 $164,635
Foreign 30,386 30,696
------------------- --------------------
$201,066 $195,331
=================== ====================
Total income taxes as reported differ from the amounts that were computed by applying the federal income tax rate to income before income taxes. The following is a reconciliation of this difference (in thousands):
Six Months Ended
March 31,
2005 2004
------------------- --------------------
Income Tax Expense, Computed at
Statutory Rate of 35% $70,373 $68,366
Increase (Reduction) in Taxes Resulting From:
State Income Taxes 9,525 9,491
Dividend from Foreign Subsidiary 3,837 -
Foreign Tax Differential (1,952) (2,149)
Foreign Tax Rate Reduction (1) - (5,174)
Miscellaneous (1,837) (1,472)
- ---------------------------------------------------------------------------- ------------------- --------------------
Total Income Taxes $79,946 $69,062
============================================================================ =================== ====================
15
(1) During the quarter ended December 31, 2003, legislation was enacted in the Czech Republic which reduces the corporate statutory income tax rate from 31% to 24% over a three year period.
Significant components of the Company’s deferred tax liabilities (assets) were as follows (in thousands):
At March 31, 2005 At September 30, 2004
--------------------------------- ----------------------------
Deferred Tax Liabilities:
Property, Plant and Equipment $568,724 $568,114
Other 39,666 37,051
- ------------------------------------------------------ --------------------------------- ----------------------------
Total Deferred Tax Liabilities 608,390 605,165
- ------------------------------------------------------ --------------------------------- ----------------------------
Deferred Tax Assets:
Minimum Pension Liability Adjustment (28,887) (28,887)
Capital Loss Carryover (10,671) (12,546)
Unrealized Hedging Losses (50,760) (33,890)
Other (81,249) (74,624)
- ------------------------------------------------------ --------------------------------- ----------------------------
(171,567) (149,947)
Valuation Allowance 2,877 2,877
- ------------------------------------------------------ --------------------------------- ----------------------------
Total Deferred Tax Assets (168,690) (147,070)
- ------------------------------------------------------ --------------------------------- ----------------------------
Total Net Deferred Income Taxes $439,700 $458,095
====================================================== ================================= ============================
The Company has undistributed earnings of foreign subsidiaries that relate to its operations in the Czech Republic. With the exception of the anticipated dividend discussed below, these earnings are considered to be permanently reinvested outside the United States and, accordingly, no U.S. income taxes have been provided thereon. In the event such earnings are distributed, the Company may be subject to U.S. income taxes and foreign withholding taxes, net of allowable foreign tax credits or deductions. At March 31, 2005, undistributed earnings considered to be permanently reinvested and the related positive cumulative translation adjustment aggregate $39.1 million after adjustment for the anticipated foreign dividend.
The Company recorded a tax liability of $4.2 million during the quarter ended March 31, 2005 relating to an anticipated dividend of $80 million to be received during the current fiscal year from a foreign subsidiary. The tax is recorded at a rate of 5.25% in accordance with the applicable provisions of the American Jobs Creation Act of 2004. A portion of this tax amounting to $0.4 million is included in Other Comprehensive Loss.
A capital loss carryover of $30.5 million existed at March 31, 2005, which expires if not utilized by September 30, 2008. Although realization is not assured, management estimates that a portion of the deferred tax asset associated with this carryover will be realized during the carryover period, and a valuation allowance is recorded for the remaining portion. Adjustments to the valuation allowance may be necessary in the future if estimates of capital gain income are revised.
Common Stock. During the six months ended March 31, 2005, the Company issued 519,332 shares of common stock under the Company’s stock option and director compensation plans.
On March 29, 2005, 643,000 stock options were granted at an exercise price of $28.155 per share.
16
Environmental Matters. The Company is subject to various federal, state and local laws and regulations relating to the protection of the environment. The Company has established procedures for the ongoing evaluation of its operations to identify potential environmental exposures and comply with regulatory policies and procedures. It is the Company’s policy to accrue estimated environmental clean-up costs (investigation and remediation) when such amounts can reasonably be estimated and it is probable that the Company will be required to incur such costs. At March 31, 2005, the Company has estimated its remaining clean-up costs related to former manufactured gas plant sites and third party waste disposal sites will be $22.3 million. This liability has been recorded on the Consolidated Balance Sheet at March 31, 2005. In April 2005, the Company entered into a transfer agreement for environmental obligations related to a former manufactured gas plant site in New York. Under the terms of the agreement, the Company will pay $12.7 million to settle its remaining environmental obligations related to this site. This amount was included in the $22.3 million liability at March 31, 2005. Other than as discussed in Note G of the Company’s 2004 Form 10-K (referred to below), the Company is currently not aware of any material additional exposure to environmental liabilities. However, adverse changes in environmental regulations or other factors could impact the Company.
For further discussion, refer to Note G — Commitments and Contingencies under the heading “Environmental Matters” in Item 8 of the Company’s 2004 Form 10-K.
Other. The Company is involved in litigation arising in the normal course of business. Also in the normal course of business, the Company is involved in tax, regulatory and other governmental audits, inspections, investigations and other proceedings that involve state and federal taxes, safety, compliance with regulations, rate base, cost of service and purchased gas cost issues, among other things. While the resolution of such litigation or regulatory matters could have a material effect on earnings and cash flows in the quarterly and annual period of resolution, none of this litigation, and none of these regulatory matters, are expected to change materially the Company’s present liquidity position, nor have a material adverse effect on the financial condition of the Company.
The Company has six reportable segments: Utility, Pipeline and Storage, Exploration and Production, International, Energy Marketing, and Timber. The division of the Company’s operations into the reportable segments is based upon a combination of factors including differences in products and services, regulatory environment and geographic factors.
The data presented in the tables below reflect the reportable segments and reconciliations to consolidated amounts. There have been no changes in the basis of segmentation nor in the basis of measuring segment profit or loss from those used in the Company’s 2004 Form 10-K. There have been no material changes in the amount of assets for any operating segment from the amounts disclosed in the Company’s 2004 Form 10-K.
17
Quarter Ended March 31, 2005 (Thousands)
- --------------------------------------------------------------------------------------------------------------------------------------------
Exploration Total Corporate and
Pipeline and Energy Reportable Intersegment Total
Utility and Storage Production International Marketing Timber Segments All Other Eliminations Consolidated
--------------------------------------------------------------------------------------------------------------------------------------------
Revenue from
External
Customers $485,647 $36,029 $70,319 $55,487 $124,565 $18,971 $791,018 $ 311 $ - $791,329
Intersegment
Revenues $ 5,693 $21,517 $ - $ - $ - $ 1 $ 27,211 $3,263 $ (30,474) $ -
Segment Profit
(Loss):
Net Income $ 28,882 $18,457 $11,230 $ 5,159 $ 2,612 $ 2,893 $ 69,233 $ 652 $ 798 $ 70,683
Six Months Ended March 31, 2005 (Thousands)
- --------------------------------------------------------------------------------------------------------------------------------------------
Exploration Total Corporate and
Pipeline and Energy Reportable Intersegment Total
Utility and Storage Production International Marketing Timber Segments All Other Eliminations Consolidated
--------------------------------------------------------------------------------------------------------------------------------------------
Revenue from
External
Customers $802,476 $68,474 $142,157 $99,462 $188,059 $31,966 $1,332,594 $2,993 $ - $1,335,587
Intersegment
Revenues $ 9,998 $42,116 $ - $ - $ - $ 1 $ 52,115 $4,343 $(56,458) $ -
Segment Profit
(Loss):
Net Income $ 46,954 $30,734 $ 25,153 $ 9,329 $ 3,361 $ 3,646 $ 119,177 $1,252 $ 691 $ 121,120
Quarter Ended March 31, 2004 (Thousands)
- --------------------------------------------------------------------------------------------------------------------------------------------
Exploration Total Corporate and
Pipeline and Energy Reportable Intersegment Total
Utility and Storage Production International Marketing Timber Segments All Other Eliminations Consolidated
--------------------------------------------------------------------------------------------------------------------------------------------
Revenue from
External
Customers $502,440 $35,120 $79,750 $48,453 $116,403 $15,222 $797,388 $4,290 $ - $801,678
Intersegment
Revenues $ 5,914 $22,459 $ - $ - $ - $ - $ 28,373 $ - $ (28,373) $ -
Segment Profit
(Loss):
Net Income $ 33,123 $13,676 $18,735 $ 6,555 $ 3,541 $ 1,917 $ 77,547 $ 405 $ (897) $ 77,055
Six Months Ended March 31, 2004 (Thousands)
- --------------------------------------------------------------------------------------------------------------------------------------------
Exploration Total Corporate and
Pipeline and Energy Reportable Intersegment Total
Utility and Storage Production International Marketing Timber Segments All Other Eliminations Consolidated
--------------------------------------------------------------------------------------------------------------------------------------------
Revenue from
External
Customers $823,146 $62,868 $148,602 $90,600 $173,356 $28,551 $1,327,123 $7,068 $ - $1,334,191
Intersegment
Revenues $ 10,428 $44,729 $ - $ - $ - $ 2 $ 55,159 $ - $(55,159) $ -
Segment Profit
(Loss):
Net Income $ 49,604 $24,170 $ 29,243 $14,593 $ 4,347 $ 3,220 $ 125,177 $ 957 $ 135 $ 126,269
18
The components of the Company’s intangible assets were as follows (in thousands):
At September 30,
At March 31, 2005 2004
----------- ----------------- ----------- ---------------------
Gross Net Net
Carrying Accumulated Carrying Carrying
Amount Amortization Amount Amount
----------- ----------------- ----------- ---------------------
Intangible Assets Subject to Amortization
Long-Term Transportation Contracts $8,580 $(2,316) $6,264 $ 6,798
Long-Term Gas Purchase Contracts 31,864 (2,636) 29,228 30,025
Intangible Assets Not Subject to Amortization
Retirement Plan Intangible Asset 9,171 - 9,171 9,171
----------- ----------------- ----------- ---------------------
$49,615 $ (4,952) $44,663 $45,994
----------- ----------------- ----------- ---------------------
Aggregate Amortization Expense (Thousands)
Three Months Ended March 31, 2005 $665
Three Months Ended March 31, 2004 $666
Six Months Ended March 31, 2005 $1,331
Six Months Ended March 31, 2004 $1,236
Amortization expense for the long-term transportation contracts is estimated to be $0.5 million for the remainder of 2005 and $1.1 million annually for 2006, 2007, and 2008. Amortization in 2009 is estimated to be $0.5 million.
Amortization expense for the long-term gas purchase contracts is estimated to be $0.8 million for the remainder of 2005 and $1.6 million annually for 2006, 2007, 2008 and 2009.
Components of Net Periodic Benefit Cost (in thousands):
Three months ended March 31,
Retirement Plan Other Post-Retirement Benefits
--------------- ------------------------------
2005 2004 2005 2004
---- ---- ---- ----
Service Cost $3,429 $3,649 $1,538 $1,649
Interest Cost 10,520 10,141 6,446 6,885
Expected Return on Plan Assets (12,386) (12,070) (4,715) (3,453)
Amortization of Prior Service Cost 257 276 1 1
Amortization of Transition Amount - - 1,782 1,782
Amortization of Losses 2,618 2,360 3,116 5,381
Net Amortization and Deferral
For Regulatory Purposes (Including
Volumetric Adjustments) (1) 2,723 3,893 5,948 1,491
------ ------ ------- -------
Net Periodic Benefit Cost $7,161 $8,249 $14,116 $13,736
====== ====== ======= =======
19
Six months ended March 31,
Retirement Plan Other Post-Retirement Benefits
--------------- ------------------------------
2005 2004 2005 2004
---- ---- ---- ----
Service Cost 6,858 $7,299 $3,076 $3,298
Interest Cost 21,040 20,282 12,892 13,770
Expected Return on Plan Assets (24,772) (24,141) (9,430) (6,906)
Amortization of Prior Service Cost 514 552 2 2
Amortization of Transition Amount - - 3,564 3,564
Amortization of Losses 5,236 4,719 6,232 10,763
Net Amortization and Deferral
For Regulatory Purposes (Including
Volumetric Adjustments) (1) 3,605 614 5,235 (4,146)
------------- ------------- ------------------ ------------------
Net Periodic Benefit Cost $12,481 $9,325 $21,571 $20,345
============= ============= ================== ==================
(1) The Company’s policy is to record retirement plan and other post-retirement benefit costs in the Utility segment on a volumetric basis to reflect the fact that the Utility segment experiences higher throughput of natural gas in the winter months and lower throughput of natural gas in the summer months.
Employer Contributions. During the six months ended March 31, 2005, the Company contributed $26.3 million to its post-retirement benefit plan and $18.4 million to its retirement plan. In the remainder of 2005, the Company expects to contribute in the range of $8.0 million to $12.0 million to its retirement plan and to contribute an additional $13.0 million to its post-retirement benefit plan.
20
For a complete discussion of critical accounting policies, refer to “Critical Accounting Policies” in Item 7 of the Company’s 2004 Form 10-K. There have been no subsequent changes to that disclosure.
The Company’s earnings were $70.7 million for the quarter ended March 31, 2005 compared to earnings of $77.1 million for the quarter ended March 31, 2004. The decrease in earnings of $6.4 million is primarily the result of lower earnings in the Utility, Exploration and Production, International and Energy Marketing segments, partially offset by higher earnings in the Pipeline & Storage, and Timber segments, as shown in the table below. The International segment’s earnings for the quarter ended March 31, 2005 include a $3.8 million charge for U.S. taxes on the estimated $80 million dividend expected to be repatriated from the Company’s subsidiary in the Czech Republic. The Pipeline & Storage segment’s earnings for the quarter ended March 31, 2005 include a $2.6 million gain on the FERC approved sale of base gas by Supply Corporation’s jointly-owned Ellisburg Storage Pool. Earnings for the quarter ended March 31, 2004 include the earnings impact of $6.4 million of expense, allocated among all segments, associated with the settlement of a pension obligation. Also, the Exploration and Production segment’s earnings for the quarter ended March 31, 2004 include a $4.6 million benefit related to the Company’s September 2003 sale of Canadian oil properties.
The Company’s earnings were $121.1 million for the six months ended March 31, 2005 compared to earnings of $126.3 million for the six months ended March 31, 2004. The decrease in earnings of $5.2 million is primarily the result of lower earnings in the Utility, International, Exploration and Production, and Energy Marketing segments, offset by higher earnings in the Pipeline & Storage, and Timber segments, as shown in the table below. As mentioned above, earnings for the six months ended March 31, 2005 include a $3.8 million charge for U.S. taxes in the International segment and a $2.6 million gain on the sale of base gas in the Pipeline and Storage segment. Also, earnings in the International segment for the six months ended March 31, 2004 include a $5.2 million reduction to deferred income tax expense resulting from a change in the statutory income tax rate in the Czech Republic. Earnings for the six months ended March 31, 2004 include the earnings impact of $6.4 million of expense allocated among all segments associated with the settlement of a pension obligation. Also, the Exploration and Production segment’s earnings for the six months ended March 31, 2004 include a $4.6 million benefit related to the Company’s September 2003 sale of Canadian oil properties.
Additional discussion of earnings in each of the business segments can be found in the business segment information that follows. Note that all amounts used in the earnings discussions are after tax amounts.
Earnings (Loss) by Segment
- ------------------------------------ ------------------------------------------- -------------------------------------------
Three Months Ended Six Months Ended
March 31, March 31,
- ------------------------------------ ------------------------------------------- -------------------------------------------
Increase/ Increase/
(Thousands) 2005 2004 (Decrease) 2005 2004 (Decrease)
- ------------------------------------ ------------- ------------- --------------- ------------- ------------- ---------------
Utility $28,882 $33,123 $(4,241) $46,954 $49,604 $(2,650)
Pipeline and Storage 18,457 13,676 4,781 30,734 24,170 6,564
Exploration and Production 11,230 18,735 (7,505) 25,153 29,243 (4,090)
International 5,159 6,555 (1,396) 9,329 14,593 (5,264)
Energy Marketing 2,612 3,541 (929) 3,361 4,347 (986)
Timber 2,893 1,917 976 3,646 3,220 426
- ------------------------------------ ------------- ------------- --------------- ------------- ------------- ---------------
Total Reportable Segments 69,233 77,547 (8,314) 119,177 125,177 (6,000)
All Other 652 405 247 1,252 957 295
Corporate 798 (897) 1,695 691 135 556
- ------------------------------------ ------------- ------------- --------------- ------------- ------------- ---------------
Total Consolidated $70,683 $77,055 $(6,372) $121,120 $126,269 $(5,149)
- ------------------------------------ ------------- ------------- --------------- ------------- ------------- ---------------
21
Utility
Utility Operating Revenues
- ------------------------------- ------------------------------------------- ------------------------------------------
Three Months Ended Six Months Ended
March 31, March 31,
- ------------------------------- ------------------------------------------- ------------------------------------------
Increase/ Increase/
(Thousands) 2005 2004 (Decrease) 2005 2004 (Decrease)
- ------------------------------- ------------- -------------- -------------- ------------ -------------- --------------
Retail Sales Revenues:
Residential $386,623 $377,241 $9,382 $641,689 $603,472 $38,217
Commercial 69,367 68,946 421 111,150 106,284 4,866
Industrial 4,566 5,705 (1,139) 6,710 10,000 (3,290)
- ------------------------------- ------------- -------------- -------------- ------------ -------------- --------------
460,556 451,892 8,664 759,549 719,756 39,793
- ------------------------------- ------------- -------------- -------------- ------------ -------------- --------------
Off-System Sales - 28,298 (28,298) - 63,202 (63,202)
Transportation 30,600 30,164 436 51,559 50,480 1,079
Other 184 (2,000) 2,184 1,366 136 1,230
- ------------------------------- ------------- -------------- -------------- ------------ -------------- --------------
$491,340 $508,354 $(17,014) $812,474 $833,574 $(21,100)
- ------------------------------- ------------- -------------- -------------- ------------ -------------- --------------
Utility Throughput
- ------------------------------- ------------------------------------------- ------------------------------------------
Three Months Ended Six Months Ended
March 31, March 31,
- ------------------------------- ------------------------------------------- ------------------------------------------
Increase/ Increase/
(MMcf) 2005 2004 (Decrease) 2005 2004 (Decrease)
- ------------------------------- ------------- -------------- -------------- ------------ -------------- --------------
Retail Sales:
Residential 32,559 34,459 (1,900) 52,428 54,893 (2,465)
Commercial 6,072 6,607 (535) 9,526 10,207 (681)
Industrial 425 658 (233) 601 1,253 (652)
- ------------------------------- ------------- -------------- -------------- ------------ -------------- --------------
39,056 41,724 (2,668) 62,555 66,353 (3,798)
- ------------------------------- ------------- -------------- -------------- ------------ -------------- --------------
Off-System Sales - 4,190 (4,190) - 10,104 (10,104)
Transportation 22,465 23,075 (610) 36,568 37,674 (1,106)
- ------------------------------- ------------- -------------- -------------- ------------ -------------- --------------
61,521 68,989 (7,468) 99,123 114,131 (15,008)
- ------------------------------- ------------- -------------- -------------- ------------ -------------- --------------
Degree Days
- ---------------------------------- -------------- -------------- -------------------- --------------------------------
Percent
Three Months Ended Colder (Warmer) Than
--------------------------------
March 31 Normal 2005 2004 Normal Prior Year
- ---------------------------------- -------------- -------------- -------------------- ----------------- --------------
Buffalo 3,327 3,468 3,463 4.2 0.1
Erie 3,142 3,266 3,283 3.9 (0.5)
- ---------------------------------- -------------- -------------- -------------------- ----------------- --------------
Six Months Ended
March 31
- ---------------------------------- -------------- -------------- -------------------- ----------------- --------------
Buffalo 5,587 5,640 5,590 0.9 0.9
Erie 5,223 5,263 5,205 0.8 1.1
- ---------------------------------- -------------- -------------- -------------------- ----------------- --------------
Operating revenues for the Utility segment decreased $17.0 million for the quarter ended March 31, 2005 as compared with the quarter ended March 31, 2004. The decrease is attributable primarily to lower off-system sales revenues, offset partially by higher retail gas sales revenues. Off-system sales decreased $28.3 million for the quarter ended March 31, 2005 as compared with the quarter ended March 31, 2004. Effective September 22, 2004, Distribution Corporation stopped making off-system sales as a result of the FERC’s Order 2004, “Standards of Conduct for Transmission Providers,” as discussed more fully in the Rate Matters section below. As a result of this decision, Distribution Corporation most likely will not have any off-system sales in 2005.* However, due to profit sharing with retail customers, the margins resulting from off-system sales have been minimal and there should be no material impact to margins in 2005.* Retail gas sales revenues increased $8.7 million largely due to the recovery of higher gas costs (gas costs are recovered dollar for dollar in revenues), which more than offset the decrease in retail gas
22
sales revenues resulting from lower volumes. The decrease in volumes reflects lower average usage per customer stemming from customer conservation efforts.
Operating revenues for the Utility segment decreased $21.1 million for the six months ended March 31, 2005 as compared with the six months ended March 31, 2004. The decrease is primarily attributable to lower off-system sales revenues, offset partially by higher retail sales revenues. Off-system sales decreased $63.2 million for the six months ended March 31, 2005 as compared with the six months ended March 31, 2004 as a result of the FERC’s Order 2004 as noted above. Partially offsetting this decrease, the increase in retail gas sales revenues was largely a function of the recovery of higher gas costs, which more than offset lower retail sales volumes, as shown above.
The Utility segment’s earnings for the quarter ended March 31, 2005 were $28.9 million, a decrease of $4.2 million when compared with the quarter ended March 31, 2004. In the New York jurisdiction, earnings decreased by $2.2 million principally due to a decline in margin associated with lower average usage per customer ($3.4 million) as well as an increase in bad debt expense ($0.7 million). Somewhat offsetting these decreases is a $1.2 million charge associated with the settlement of a pension obligation that was recorded for the quarter ended March 31, 2004. That charge did not recur in 2005. In the Pennsylvania Division, earnings decreased by $2.0 million primarily due to a decline in margin associated with lower average usage per customer ($1.4 million), higher pension and post retirement expense ($0.8 million), and an increase in bad debt expense ($0.4 million). Offsetting these decreases, Pennsylvania earnings were positively impacted by $1.0 million of expense recorded in the quarter ended March 31, 2004 associated with the settlement of a pension obligation. That expense did not recur in 2005.
The impact of weather variations on earnings in the New York jurisdiction is mitigated by that jurisdiction’s WNC. The WNC in New York, which covers the eight-month period from October through May, has had a stabilizing effect on earnings for the New York rate jurisdiction. For the quarters ended March 31, 2005 and 2004, the WNC reduced earnings by approximately $1.5 million and $0.5 million, respectively, since those quarters were colder than normal. In periods of warmer than normal weather, the WNC benefits Distribution Corporation.
The Utility segment’s earnings for the six months ended March 31, 2005 were $47.0 million, a decrease of $2.6 million when compared with the earnings of $49.6 million for the six months ended March 31, 2004. In the New York jurisdiction, earnings increased by $0.9 million. While earnings decreased due to a decline in margin associated with lower average usage per customer ($4.0 million), this decrease was offset by $1.2 million charge associated with the settlement of a pension obligation recorded in the quarter ended March 31, 2004, which did not recur in 2005, as well as a decrease in interest expense ($1.2 million). The decline in interest expense is due primarily to lower debt balances. Another factor offsetting the decrease in margin was a decrease in pension and post-retirement expense of $0.7 million. For the Pennsylvania jurisdiction, earnings decreased by $3.5 million mostly due to a decline in margin associated with lower average usage per customer ($1.4 million) as well as an increase in pension and post retirement expense ($2.8 million). The 2003 Settlement Agreement with the PaPUC provided for a one-time credit to pension expense which the Company recognized during the quarter ended December 31, 2003. Partially offsetting these decreases was $1.0 million of expense associated with the settlement of a pension obligation recognized in the quarter ended March 31, 2004, as referenced above. That expense did not recur in 2005.
For the six months ended March 31, 2005 and March 31, 2004, the WNC did not have a significant impact on earnings as the weather was close to normal.
23
Pipeline and Storage
Pipeline and Storage Operating Revenues
- ------------------------------------ ---------------------------------------- -------------------------------------------
Three Months Ended Six Months Ended
March 31, March 31,
- ------------------------------------ ---------------------------------------- -------------------------------------------
Increase/ Increase/
(Thousands) 2005 2004 (Decrease) 2005 2004 (Decrease)
- ------------------------------------ ------------ ------------ -------------- --------------- ------------ --------------
Firm Transportation $32,086 $32,773 $(687) $61,616 $63,264 $(1,648)
Interruptible Transportation 922 733 189 1,848 1,538 310
- ------------------------------------ ------------ ------------ -------------- --------------- ------------ --------------
33,008 33,506 (498) 63,464 64,802 (1,338)
- ------------------------------------ ------------ ------------ -------------- --------------- ------------ --------------
Firm Storage Service 16,376 16,074 302 32,471 31,831 640
Other 8,162 7,999 163 14,655 10,964 3,691
- ------------------------------------ ------------ ------------ -------------- --------------- ------------ --------------
$57,546 $57,579 $(33) $110,590 $107,597 $2,993
- ------------------------------------ ------------ ------------ -------------- --------------- ------------ --------------
Pipeline and Storage Throughput
- ---------------------------------- ---------------------------------------- ---------------------------------------
Three Months Ended Six Months Ended
March 31, March 31,
- ---------------------------------- ---------------------------------------- ---------------------------------------
Increase/ Increase/
(MMcf) 2005 2004 (Decrease) 2005 2004 (Decrease)
- ---------------------------------- ------------ ------------ -------------- ----------- ----------- ---------------
Firm Transportation 129,851 129,444 407 213,593 218,211 (4,618)
Interruptible Transportation 1,180 1,861 (681) 2,842 3,896 (1,054)
- ---------------------------------- ------------ ------------ -------------- ----------- ----------- ---------------
131,031 131,305 (274) 216,435 222,107 (5,672)
- ---------------------------------- ------------ ------------ -------------- ----------- ----------- ---------------
Operating revenues for the Pipeline and Storage segment remained relatively unchanged for the quarter ended March 31, 2005 as compared with the quarter ended March 31, 2004. For the six months ended March 31, 2005, operating revenues for the Pipeline and Storage segment increased $3.0 million as compared with the six months ended March 31, 2004. Higher revenues from unbundled pipeline sales ($2.9 million), reported as part of other revenues in the table above, were the primary factor contributing to the increase. Higher cashout revenues of $0.6 million, reported as part of other revenues in the table above, also contributed to the increase. Cashout revenues represent a cash resolution of a gas imbalance whereby a customer pays Supply Corporation for gas the customer receives in excess of amounts delivered into Supply Corporation’s system by the customer’s shipper. Cashout revenues are completely offset by purchased gas expense. The decrease in transportation revenues of $1.3 million largely reflects lower rates charged for firm gathering services and the Utility segment’s cancellation of a portion of its firm transportation capacity in April 2004. Firm gathering rates are adjusted annually in January and will increase or decrease depending on the level of interruptible gathering revenues collected in the preceding calendar year. The Utility segment’s decision to cancel a portion of its firm transportation capacity was based on lower usage in its service territory. Supply Corporation has not been able to remarket this capacity to date.
The Pipeline and Storage segment’s earnings for the quarter ended March 31, 2005 were $18.5 million, an increase of $4.8 million when compared with earnings of $13.7 million for the quarter ended March 31, 2004. The main factors in this increase were the $2.6 million gain on the sale of base gas during the quarter ended March 31, 2005 by Supply Corporation’s jointly-owned Ellisburg Storage Pool which was approved by the FERC as well as $2.0 million of expense associated with the settlement of a pension obligation recognized in the quarter ended March 31, 2004. That expense did not recur in 2005. Lower pension expense ($1.2 million) and lower interest expense ($0.7 million) were partially offset by a reserve for preliminary project costs incurred during the quarter ended March 31, 2005 associated with the Empire State Pipeline Connector project ($0.5 million).
24
The Pipeline and Storage segment’s earnings for the six months ended March 31, 2005 were $30.7 million, an increase of $6.5 million when compared with earnings of $24.2 million for the six months ended March 31, 2004. The major factors contributing to the increase were higher revenues from unbundled pipeline sales ($1.9 million), the sale of Ellisburg base gas noted above ($2.6 million), the expense recognized in the quarter ended March 31, 2004 that did not recur in 2005 associated with the settlement of a pension obligation ($2.0 million), and lower interest expense ($1.6 million). Partially offsetting these increases was a reserve for preliminary project costs incurred for the six months ended March 31, 2005 associated with the Empire State Pipeline Connector project ($1.6 million).
The sale of Ellisburg base gas, which amounted to 660 MMcf, will open up 660 MMcf of space for ongoing storage service. At current rates between $1.49 and $1.70 per Mcf, it is expected that future storage service revenues may increase by approximately $1.0 million per year with almost no increase in operating expenses associated with the higher revenues.* The additional storage space has already been contracted for, effective April 1, 2005.
Exploration and Production
Exploration and Production Operating Revenues
- ----------------------------------- ---------------------------------------- -----------------------------------------
Three Months Ended Six Months Ended
March 31, March 31,
- ----------------------------------- ---------------------------------------- -----------------------------------------
Increase/ Increase/
(Thousands) 2005 2004 (Decrease) 2005 2004 (Decrease)
- ----------------------------------- ------------ ------------ -------------- ------------- ------------ --------------
Gas (after Hedging) $42,520 $46,487 $(3,967) $85,264 $86,292 $(1,028)
Oil (after Hedging) 25,624 30,936 (5,312) 52,520 58,655 (6,135)
Gas Processing Plant 8,344 7,286 1,058 17,048 13,629 3,419
Other 434 600 (166) 1,187 766 421
Intrasegment Elimination (1) (6,603) (5,559) (1,044) (13,862) (10,740) (3,122)
- ----------------------------------- ------------ ------------ -------------- ------------- ------------ --------------
$70,319 $79,750 $(9,431) $142,157 $148,602 $(6,445)
- ----------------------------------- ------------ ------------ -------------- ------------- ------------ --------------
(1) Represents the elimination of certain West Coast gas production revenue included in “Gas (after Hedging)” in the table above that was sold to the gas processing plant shown in the table above. An elimination for the same dollar amount was made to reduce the gas processing plant’s Purchased Gas expense.
- ----------------------------------------- -------------------------------------- --------------------------------------
Production Volumes Three Months Ended Six Months Ended
March 31, March 31,
- ----------------------------------------- -------------------------------------- --------------------------------------
Increase/ Increase/
2005 2004 (Decrease) 2005 2004 (Decrease)
- ----------------------------------------- ---------- ----------- --------------- ----------- ----------- --------------
Gas Production (MMcf)
Gulf Coast 2,844 4,823 (1,979) 6,069 9,487 (3,418)
West Coast 986 1,004 (18) 2,025 2,000 25
Appalachia 1,137 1,335 (198) 2,343 2,685 (342)
Canada 2,160 1,613 547 3,825 3,296 529
- ----------------------------------------- ---------- ----------- --------------- ----------- ----------- --------------
7,127 8,775 (1,648) 14,262 17,468 (3,206)
- ----------------------------------------- ---------- ----------- --------------- ----------- ----------- --------------
Oil Production (Mbbl)
Gulf Coast 261 412 (151) 550 789 (239)
West Coast 634 680 (46) 1,287 1,362 (75)
Appalachia 9 4 5 12 11 1
Canada 78 81 (3) 154 164 (10)
- ----------------------------------------- ---------- ----------- --------------- ----------- ----------- --------------
982 1,177 (195) 2,003 2,326 (323)
- ----------------------------------------- ---------- ----------- --------------- ----------- ----------- --------------
25
Average Prices
- ----------------------------------------- --------------------------------------- ----------------------------------------
Three Months Ended Six Months Ended
March 31, March 31,
- ----------------------------------------- --------------------------------------- ----------------------------------------
Increase/ Increase/
2005 2004 (Decrease) 2005 2004 (Decrease)
- ----------------------------------------- ----------- ----------- --------------- ------------ ------------ --------------
Average Gas Price/Mcf
Gulf Coast $6.75 $5.76 $0.99 $6.61 $5.26 $1.35
West Coast $6.20 $5.42 $0.78 $6.38 $5.22 $1.16
Appalachia $6.76 $6.27 $0.49 $7.26 $5.71 $1.55
Canada $5.52 $4.99 $0.53 $5.49 $4.78 $0.71
Weighted Average $6.30 $5.66 $0.64 $6.38 $5.24 $1.14
Weighted Average After Hedging $5.97 $5.30 $0.67 $5.98 $4.94 $1.04
Average Oil Price/bbl
Gulf Coast $46.42 $33.81 $12.61 $46.77 $31.75 $15.02
West Coast $37.67 $30.80 $6.87 $37.40 $28.68 $8.72
Appalachia $42.28 $30.21 $12.07 $42.85 $28.32 $14.53
Canada $41.08 $29.84 $11.24 $39.78 $28.01 $11.77
Weighted Average $40.31 $31.79 $8.52 $40.19 $29.67 $10.52
Weighted Average After Hedging $26.10 $26.30 $(0.20) $26.22 $25.22 $1.00
- ----------------------------------------- ----------- ----------- --------------- ------------ ------------ --------------
Operating revenues for the Exploration and Production segment decreased $9.4 million for the quarter ended March 31, 2005 as compared with the quarter ended March 31, 2004. Oil production revenue after hedging decreased $5.3 million due to a 195,000 barrel decline in production, particularly in the Gulf Coast of Mexico region where production decreased by approximately 151,000 barrels, and slightly lower weighted average prices after hedging ($0.20 per barrel). Gas production revenue after hedging decreased $4.0 million due to an overall decrease in gas production of 1,648 MMcf, which was partially offset by increases in the weighted average price of gas after hedging ($0.67 per Mcf). Most of the decrease in gas production occurred in the Gulf Coast region (a 1,979 MMcf decline), which is consistent with the expected decline rates for the Company’s production in this region.
Operating revenues for the Exploration and Production segment decreased $6.4 million for the six months ended March 31, 2005 as compared with the six months ended March 31, 2004. Oil production revenue after hedging decreased $6.1 million due to a 323,000 barrel decline in production offset partly by higher weighted average prices after hedging ($1.00 per barrel). The majority of the decrease can be attributed to the Gulf Coast region oil production decline of approximately 239,000 barrels. Gas production revenue after hedging decreased $1.0 million. Decreases in gas production of 3,206 MMcf more than offset increases in the weighted average price of gas after hedging ($1.04 per Mcf). The decrease in gas production occurred primarily in the Gulf Coast region (a 3,418 MMcf decline), which is consistent with the expected decline rates for the Company’s production in this region.
As shown above, this segment’s weighted average oil prices after hedging were $26.10 and $26.22, respectively, during the quarter and six months ended March 31, 2005. These prices reflect the lesser value of the West Coast’s heavy sour crude oil, which represents the bulk of the company’s oil production as compared to the generally quoted price for light sweet crude, which is in the $50.00 range. While prices of light sweet crude oil increased significantly during the quarter and six months ended March 31, 2005, prices for West Coast heavy sour crude oil did not increase as dramatically due to oversupply and refinery constraint issues. Historically, the prices of light sweet crude oil and heavy sour crude oil have largely moved in tandem, meaning that the price differential between light sweet crude oil and heavy sour crude oil has not changed significantly. The Company’s hedge effectiveness tests for the derivative financial instruments used in the Exploration and Production segment, as required by SFAS 133, have assumed that the differential between these two types of oil will return to their historical norms. However, if the current price differential continues, it is possible that these assumptions would change and that some of the derivative financial instruments used to hedge West Coast oil production may become ineffective.* To the extent that derivative financial instruments would ever be deemed to be ineffective, gains or losses from the derivative financial instruments would be marked-to-market on the income statement without regard to an underlying physical transaction.
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The Exploration and Production segment’s earnings for the quarter ended March 31, 2005 were $11.2 million, a decrease of $7.5 million when compared with earnings of $18.7 million for the quarter ended March 31, 2004. The decrease is partially attributable to declining oil and gas production as discussed above ($6.0 million), as well as the non-recurrence of a $4.6 million benefit related to the Company’s September 2003 sale of Canadian oil properties located in Southeast Saskatchewan, which was recorded in the quarter ended March 31, 2004. When the Southeast Saskatchewan transaction closed, the initial proceeds received were subject to an adjustment based on actual working capital and the resolution of certain income tax matters. During the quarter ended March 31, 2004, those items were resolved with the buyer and, as a result, the Company received an additional $4.6 million (U.S. dollars) of sales proceeds, which is recorded in the Adjustment of Loss on Sale of Oil and Gas Producing Properties line on the income statement. Partially offsetting these decreases was the non-recurrence of the expense associated with settlement of a pension obligation in the quarter ended March 31, 2004 ($0.9 million).
The Exploration and Production segment’s earnings for the six months ended March 31, 2005 were $25.2 million, a decrease of $4.0 million when compared with earnings of $29.2 million for the quarter ended March 31, 2004. As noted above, the decrease is a result of a decrease in oil and gas revenues caused by a decline in production ($4.7 million) and the non-recurrence of a $4.6 million earnings benefit recognized in the quarter ended March 31, 2004 related to the Company’s fiscal 2003 sale of Canadian oil properties, as discussed above. Partially offsetting these decreases was the non-recurrence of the expense associated with the settlement of a pension obligation in the quarter ended March 31, 2004 ($0.9 million), lower depreciation and depletion expense ($1.1 million), lower interest expense ($0.8 million) and higher interest income ($0.8 million).
International
International Operating Revenues
- -------------------------------------- ------------------------------------------- -------------------------------------------
Three Months Ended Six Months Ended
March 31, March 31,
- -------------------------------------- ------------------------------------------- -------------------------------------------
Increase/ Increase/
(Thousands) 2005 2004 (Decrease) 2005 2004 (Decrease)
- -------------------------------------- ------------- ------------- --------------- ------------- ------------- ---------------
Heating $42,803 $38,129 $4,674 $75,699 $69,310 $6,389
Electricity 11,448 9,102 2,346 21,375 19,163 2,212
Other 1,236 1,222 14 2,388 2,127 261
- -------------------------------------- ------------- ------------- --------------- ------------- ------------- ---------------
$55,487 $48,453 $7,034 $99,462 $90,600 $8,862
- -------------------------------------- ------------- ------------- --------------- ------------- ------------- ---------------
International Heating and Electric Volumes
- -------------------------------------- ------------------------------------------- -------------------------------------------
Three Months Ended Six Months Ended
March 31, March 31,
- -------------------------------------- ------------------------------------------- -------------------------------------------
Increase/
2005 2004 (Decrease) 2005 2004 (Decrease)
- -------------------------------------- ------------- ------------- --------------- ------------- ------------- ---------------
Heating Sales (Gigajoules) (1) 3,513,871 3,673,873 (160,002) 6,359,341 6,744,165 (384,824)
Electricity Sales
(megawatt hours) 270,197 266,169 4,028 535,005 581,921 (46,916)
- -------------------------------------- ------------- ------------- --------------- ------------- ------------- ---------------
(1) Gigajoules = one billion joules. A joule is a unit of energy.
Operating revenues for the International segment increased $7.0 million and $8.9 million, respectively, for the quarter and six months ended March 31, 2005 as compared with the quarter and six months ended March 31, 2004. For the quarter ended March 31, 2005 compared with the quarter ended March 31, 2004, heat revenues in CZKs were down due to lower throughput. However, this decrease was offset by higher electric revenues in CZKs. The increase in electric revenues resulted from a combination of higher volumes and prices. Since the combination of heat and electric revenues in CZKs was relatively static, the increase in revenues as measured in U.S. dollars can be attributed to an increase in the value of the CZK as compared to the U.S. dollar. For the six months ended March 31, 2005 compared with
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the six months ended March 31, 2004, both heat and electric revenues as measured in CZKs, were down due to lower volumes as a result of warmer weather. However, the increase in the value of the CZK as compared to the U.S. dollar more than offset this impact.
The International segment’s earnings for the quarter ended March 31, 2005 were $5.2 million, a decrease of $1.4 million when compared with earnings of $6.6 million for the quarter ended March 31, 2004. The decrease can be attributed to a $3.8 million charge for U.S. taxes on the estimated $80 million dividend to be repatriated from United Energy, a subsidiary of the Company in the Czech Republic. Under the American Jobs Creation Act of 2004, qualifying dividends received from foreign affiliates are eligible for a one-time substantially reduced tax rate of 5.25%, thus the repatriation tax was recognized in the quarter ended March 31, 2005 consistent with management’s intention to make such a repatriation during the current fiscal year. The total repatriation tax recorded was $4.2 million, of which $3.8 million was recorded to the income statement and $0.4 million was recorded to Other Comprehensive Loss. The repatriation tax was partly offset by an increase in the value of the CZK as compared to the U.S. dollar, which increased earnings by $1.4 million.
The International segment's earnings for the six months ended March 31, 2005 were $9.3 million, a decrease of $5.3 million when compared with earnings of $14.6 million for the six months ended March 31, 2004. The decrease can partly be attributed to a $5.2 million benefit to deferred income tax expense resulting from a change in the statutory income tax rate in the Czech Republic recognized during 2004 that did not recur in 2005. The government in the Czech Republic enacted legislation that gradually reduces the corporate statutory income tax from 31% to 24% (the reduction is phased in over a three-year period). In accordance with GAAP, the full $5.2 million benefit resulting from the change in the income tax rate was reflected as a reduction to deferred income tax expense in December 2003. Also contributing to the earnings decrease was the charge of $3.8 million for U.S. taxes on the estimated dividend to be repatriated, as discussed above. Partially offsetting these earnings decreases, an increase in the value of the CZK compared to the U.S. dollar increased earnings by approximately $2.0 million.
Energy Marketing
Energy Marketing Operating Revenues
- ----------------------------------- -------------------------------------------- -----------------------------------------
Three Months Ended Six Months Ended
March 31, March 31,
- ----------------------------------- -------------------------------------------- -----------------------------------------
Increase/ Increase/
(Thousands) 2005 2004 (Decrease) 2005 2004 (Decrease)
- ----------------------------------- ------------- -------------- --------------- ------------ ------------- --------------
Natural Gas (after Hedging) $124,560 $116,399 $8,161 $188,050 $173,327 $14,723
Other 5 4 1 9 29 (20)
- ----------------------------------- ------------- -------------- --------------- ------------ ------------- --------------
$124,565 $116,403 $8,162 $188,059 $173,356 $14,703
- ----------------------------------- ------------- -------------- --------------- ------------ ------------- --------------
Energy Marketing Volumes
- ----------------------------------- -------------------------------------------- ----------------------------------------
Three Months Ended Six Months Ended
March 31, March 31,
- ----------------------------------- -------------------------------------------- ----------------------------------------
Increase/ Increase/
2005 2004 (Decrease) 2005 2004 (Decrease)
- ----------------------------------- ------------- -------------- --------------- ----------- ------------- --------------
Natural Gas - (MMcf) 15,184 16,429 (1,245) 23,191 25,990 (2,799)
- ----------------------------------- ------------- -------------- --------------- ----------- ------------- --------------
Operating revenues for the Energy Marketing segment increased $8.2 million and $14.7 million, respectively, for the quarter and six months ended March 31, 2005, as compared with the quarter and six months ended March 31, 2004. The increase for both the quarter and six month ended March 31, 2005 primarily reflects higher gas sales revenue due to an increase in the price of natural gas, offset in part by lower throughput.
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Earnings in the Energy Marketing segment decreased $0.9 million and $1.0 million, respectively, for the quarter and six months ended March 31, 2005 as compared with the quarter and six months ended March 31, 2004. The decrease primarily reflects lower margins caused by lower throughput and a reduction in the benefit of storage gas.
Timber
Timber Operating Revenues
- ------------------------------- ------------------------------------------- ---------------------------------------------
Three Months Ended Six Months Ended
March 31, March 31,
- ------------------------------- ------------------------------------------- ---------------------------------------------
Increase/ Increase/
(Thousands) 2005 2004 (Decrease) 2005 2004 (Decrease)
- ------------------------------- -------------- ------------- -------------- --------------- ------------- ---------------
Log Sales $8,768 $6,225 $2,543 $13,644 $12,399 $1,245
Green Lumber Sales 1,863 1,508 355 3,309 3,119 190
Kiln Dry Lumber Sales 7,822 7,164 658 14,096 12,532 1,564
Other 519 325 194 918 503 415
- ------------------------------- -------------- ------------- -------------- --------------- ------------- ---------------
Operating Revenues $18,972 $15,222 $3,750 $31,967 $28,553 $3,414
- ------------------------------- -------------- ------------- -------------- --------------- ------------- ---------------
Timber Board Feet
- ------------------------------- ------------------------------------------- ---------------------------------------------
Three Months Ended Six Months Ended
March 31, March 31,
- ------------------------------- ------------------------------------------- ---------------------------------------------
Increase/ Increase/
(Thousands) 2005 2004 (Decrease) 2005 2004 (Decrease)
- ------------------------------- -------------- ------------- -------------- --------------- ------------- ---------------
Log Sales 2,570 1,992 578 4,315 3,816 499
Green Lumber Sales 2,538 2,528 10 4,702 5,198 (496)
Kiln Dry Lumber Sales 3,897 3,976 (79) 7,263 7,085 178
- ------------------------------- -------------- ------------- -------------- --------------- ------------- ---------------
9,005 8,496 509 16,280 16,099 181
- ------------------------------- -------------- ------------- -------------- --------------- ------------- ---------------
Operating revenues for the Timber segment increased $3.8 million and $3.4 million, respectively, for the quarter and six months ended March 31, 2005, as compared with the quarter and six months ended March 31, 2004. For the quarter ended March 31, 2005, the increase can be attributed primarily to an increase in cherry veneer log sales of $2.5 million (384,000 board feet). The increase in log sales can be attributed to more favorable weather conditions experienced in the quarter ended March 31, 2005, which allowed more opportunity for harvesting. For the six months ended March 31, 2005, the operating revenue increase can be attributed to an increase in cherry veneer log sales and an increase in kiln dry lumber sales. Cherry veneer log sales increased $1.4 million (200,000 board feet), due mainly to the favorable weather conditions experienced in the quarter ended March 31, 2005. The increase in kiln dry lumber sales resulted from processing more cherry lumber volumes.
Earnings in the Timber segment increased $1.0 million and $0.4 million, respectively, for the quarter and six months ended March 31, 2005, as compared with the quarter and six months ended March 31, 2004. These increases primarily resulted from higher cherry veneer log sales.
Interest on long-term debt decreased $2.8 million and $7.3 million, respectively, for the quarter and six months ended March 31, 2005 as compared with the quarter and six months ended March 31, 2004. For both the quarter and six month periods, the decrease can be attributed primarily to lower average amounts of long-term debt outstanding.
Other interest charges increased $0.6 million for both the quarter and six months ended March 31, 2005 as compared with the quarter and six months ended March 31, 2004. These increases resulted primarily from an increase in weighted average interest rates.
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The Company’s primary source of cash during the six-month period ended March 31, 2005 consisted of cash provided by operating activities. This source of cash was supplemented by issuances of common stock under the Company’s stock option plans. During the six months ended March 31, 2005, issuances of common stock under the Company’s 401(k) plans and Direct Stock Purchase and Dividend Reinvestment Plan were made via open market purchases.
Internally generated cash from operating activities consists of net income available for common stock, adjusted for non-cash expenses, non-cash income and changes in operating assets and liabilities. Non-cash items include depreciation, depletion and amortization, deferred income taxes, income or loss from unconsolidated subsidiaries net of cash distributions, adjustment of loss on sale of oil and gas producing properties, and minority interest in foreign subsidiaries.
Cash provided by operating activities in the Utility and the Pipeline and Storage segments may vary from period to period because of the impact of rate cases. In the Utility segment, supplier refunds, over- or under-recovered purchased gas costs and weather may also significantly impact cash flow. The impact of weather on cash flow is tempered in the Utility segment’s New York rate jurisdiction by its WNC and in the Pipeline and Storage segment by Supply Corporation’s straight fixed-variable rate design.
Because of the seasonal nature of the heating business in the Utility, Energy Marketing and International segments, revenues in these segments are relatively high during the heating season, primarily the first and second quarters of the fiscal year, and receivable balances historically increase during these periods from the balances receivable at September 30.
The storage gas inventory normally declines during the first and second quarters of the year and is replenished during the third and fourth quarters. For storage gas inventory accounted for under the LIFO method, the current cost of replacing gas withdrawn from storage is recorded in the Consolidated Statements of Income and a reserve for gas replacement is recorded in the Consolidated Balance Sheets under the caption “Other Accruals and Current Liabilities.” Such reserve is reduced as the inventory is replenished.
Cash provided by operating activities in the Exploration and Production segment may vary from period to period as a result of changes in the commodity prices of natural gas and crude oil. The Company uses various derivative financial instruments, including price swap agreements and no cost collars in an attempt to manage this energy commodity price risk.
Net cash provided by operating activities totaled $257.0 million for the six months ended March 31, 2005, a decrease of $29.7 million compared with $286.7 million provided by operating activities for the six months ended March 31, 2004. Higher working capital requirements in the Utility segment was the main reason for this decrease. Partially offsetting this decrease, the Corporate operation experienced a significant cash outflow in January 2004 due to a $23.0 million lump sum payment to a participant of the Company’s nonqualified defined benefit plan under a provision of an agreement previously entered into between the Company and the participant. No such cash outflow occurred during the quarter ended March 31, 2005.
Expenditures for Long-Lived Assets
Expenditures for long-lived assets include additions to property, plant and equipment.
The Company’s expenditures for long-lived assets totaled $114.6 million during the six months ended March 31, 2005. The table below presents these expenditures:
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------------------------------------------------------------- ----------------------- -----------------------
Six Months Ended March 31, 2005
(in millions of dollars)
-------------------------------------- ---------------------- ----------------------- -----------------------
Total
Expenditures for
Long-Lived Assets
-------------------------------------- ---------------------- ----------------------- -----------------------
Utility $22.3
Pipeline and Storage 8.2
Exploration and Production 61.9
International 3.3
Timber 18.7
All Other and Corporate 0.2
-------------------------------------- ---------------------- ----------------------- -----------------------
$114.6
-------------------------------------- ---------------------- ----------------------- -----------------------
Utility
The majority of the Utility capital expenditures for the six months ended March 31, 2005 were made for replacement of mains and main extensions, as well as for the replacement of service lines.
Pipeline and Storage
The majority of the Pipeline and Storage capital expenditures for the six months ended March 31, 2005 were made for additions, improvements, and replacements to this segment’s transmission and gas storage systems.
The Company is pursuing a project to expand its natural gas pipeline operations to serve new markets in New York and elsewhere in the Northeast by extending the Empire State Pipeline.* This proposed extension project would provide an upstream supply link for Phase I of the Millennium Pipeline and will transport Canadian and other natural gas supplies to downstream customers, including Key Span Gas East Corporation, which has entered into a precedent agreement to be a major shipper, subject to the satisfaction of various conditions.* The pipeline extension will be designed to move at least 250 MMcf of natural gas per day.* The preliminary estimate of the cost for developing the Empire extension project is $140 million and the targeted in-service date is in calendar 2007.* As of March 31, 2005, the Company had incurred approximately $3.1 million in costs (all of which have been reserved) related to this project. Of this amount, $0.8 million and $2.5 million, respectively, were incurred during the quarter and six months ended March 31, 2005.
The Company completed a FERC approved sale of base gas from Supply Corporation’s jointly-owned Ellisburg Storage Pool in March 2005 for $4.6 million in sales proceeds. As a result of the sale, property, plant, and equipment was reduced by $0.7 million for the cost basis of the gas and a $3.9 million gain on the sale ($2.6 million after tax) was recognized by the Company in the quarter-ended March 31, 2005. The proceeds of this sale are included in Other Investing Activities on the Consolidated Statement of Cash Flows for the six months ended March 31, 2005. The gain is included in Other Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities.
Exploration and Production
The Exploration and Production segment capital expenditures for the six months ended March 31, 2005 included approximately $18.7 million for Canada, $25.2 million for the Gulf Coast region ($24.6 million for the off-shore program in the Gulf of Mexico), $15.1 million for the West Coast region and $2.9 million for the Appalachian region. These amounts included approximately $6.7 million spent to develop proved undeveloped reserves.
Estimated capital expenditures in 2005 for the Exploration and Production segment have been increased from $93.0 million to $112.0 million.* Estimated capital expenditures for Canada have been increased from $32.0 million to $41.0 million.* Estimated capital expenditures for the Gulf Coast region have been increased from $29.0 million to $35.0 million.* Estimated capital expenditures for the West
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Coast region have been increased from $20.0 million to $24.0 million and estimated capital expenditures for the Appalachian region remains unchanged at $12.0 million.* Drilling success in Canada, specifically the Sukunka region, and in the Gulf Coast region are the main reasons for this increase.
International
The majority of the International segment capital expenditures for the six months ended March 31, 2005 were concentrated in improvements and replacements within the district heating and power generation plants in the Czech Republic.
Timber
The majority of the Timber segment capital expenditures for the six months ended March 31, 2005 were made for the purchase of land and timber rights in Elk County, Pennsylvania in January 2005. The land and timber, consisting of approximately 12,324 acres, was purchased for approximately $17.6 million. The remaining $1.1 million of capital expenditures for the six months ended March 31, 2005 was made for purchases of equipment for Highland’s sawmill and kiln operations.
The Company continuously evaluates capital expenditures and investments in corporations and other entities. The amounts are subject to modification for opportunities such as the acquisition of attractive oil and gas properties, timber or storage facilities and the expansion of transmission line capacities. While the majority of capital expenditures in the Utility segment are necessitated by the continued need for replacement and upgrading of mains and service lines, the magnitude of future capital expenditures or other investments in the Company’s other business segments depends, to a large degree, upon market conditions.*
Consolidated short-term debt decreased $43.6 million during the six months ended March 31, 2005. The Company continues to consider short-term debt (consisting of short-term notes payable to banks and commercial paper) an important source of cash for temporarily financing capital expenditures and investments in corporations and/or partnerships, gas-in-storage inventory, unrecovered purchased gas costs, exploration and development expenditures and other working capital needs. Fluctuations in these items can have a significant impact on the amount and timing of short-term debt. At March 31, 2005, the Company had outstanding short-term notes payable to banks and commercial paper of $76.8 million and $36.4 million, respectively. The Company has SEC authorization under the Holding Company Act to borrow and have outstanding as much as $750.0 million of short-term debt at any time through December 31, 2005. The Company plans to file with the SEC during the summer of 2005 an application under the Holding Company Act for authority, among other things, to issue short-term debt securities, long-term debt securities and equity securities during the period commencing January 1, 2006 and ending December 31, 2008.* As for bank loans, the Company maintains a number of individual (bi-lateral) uncommitted or discretionary lines of credit with certain financial institutions for general corporate purposes. Borrowings under these lines of credit are made at competitive market rates. Each of these credit lines, which aggregate to $400.0 million, are revocable at the option of the financial institution and are reviewed on an annual basis. The Company anticipates that these lines of credit will continue to be renewed.* The total amount available to be issued under the Company’s commercial paper program is $200.0 million. The commercial paper program is backed by a syndicated committed credit facility totaling $220.0 million. Of that amount, $110.0 million is committed to the Company through September 25, 2005 and another $110.0 million is committed to the Company through September 30, 2005. The Company anticipates that it will be able to replace this facility at or before its maturity.*
Under the Company’s committed credit facility, the Company has agreed that its debt to capitalization ratio will not, at the last day of any fiscal quarter, exceed .60. At March 31, 2005, the Company’s debt to capitalization ratio (as calculated under the facility) was .49. The constraints specified in the committed credit facility would permit an additional $741.2 million in short-term and/or long-term debt to be outstanding before the Company’s debt to capitalization ratio would exceed .60. If a downgrade
32
in any of the Company’s credit ratings were to occur, access to the commercial paper markets might not be possible.* However, the Company expects that it could borrow under its uncommitted bank lines of credit or rely upon other liquidity sources, including cash provided by operations.*
Under the Company’s existing indenture covenants, at March 31, 2005, the Company would have been permitted to issue up to a maximum of $837.0 million in additional long-term unsecured indebtedness at then-current market interest rates (further limited by the debt to capitalization ratio constraints noted in the previous paragraph) in addition to being able to issue new indebtedness to replace maturing debt. The Company’s present liquidity position is believed to be adequate to satisfy known demands.*
The Company’s 1974 indenture pursuant to which $399.0 million (or 35%) of the Company’s long-term debt (as of March 31, 2005) was issued contains a cross-default provision whereby the failure by the Company to perform certain obligations under other borrowing arrangements could trigger an obligation to repay the debt outstanding under the indenture. In particular, a repayment obligation could be triggered if the Company fails (i) to pay any scheduled principal or interest on any debt under any other indenture or agreement or (ii) to perform any other term in any other such indenture or agreement, and the effect of the failure causes, or would permit the holders of the debt to cause, the debt to become due prior to its stated maturity, unless cured or waived.
The Company’s $220.0 million committed credit facility also contains a cross-default provision whereby the failure by the Company or its significant subsidiaries to make payments under other borrowing arrangements, or the occurrence of certain events affecting those other borrowing arrangements, could trigger an obligation to repay any amounts outstanding under the committed credit facility. In particular, a repayment obligation could be triggered if (i) the Company or its significant subsidiaries fail to make a payment when due of any principal or interest on any other indebtedness aggregating $20.0 million or more or (ii) an event occurs that causes, or would permit the holders of any other indebtedness aggregating $20.0 million or more to cause, such indebtedness to become due prior to its stated maturity. As of March 31, 2005, the Company had no debt outstanding under the committed credit facility.
The Company also has authorization from the SEC, under the Holding Company Act, to issue long-term debt securities and equity securities in an aggregate amount of up to $1.5 billion during the order’s authorization period, which commenced in November 2002 and extends to December 31, 2005. The Company has an effective registration statement on file with the SEC under which it has available capacity to issue an additional $550.0 million of debt and equity securities under the Securities Act of 1933, and within the authorization granted by the SEC under the Holding Company Act. The Company may sell all or a portion of the remaining registered securities if warranted by market conditions and the Company’s capital requirements. Any offer and sale of the above mentioned $550.0 million of debt and equity securities will be made only by means of a prospectus meeting the requirements of the Securities Act of 1933 and the rules and regulations thereunder.
The amounts and timing of the issuance and sale of debt or equity securities will depend on market conditions, indenture requirements, regulatory authorizations and the capital requirements of the Company.
The Company has entered into certain off-balance sheet financing arrangements. These financing arrangements are primarily operating and capital leases. The Company’s consolidated subsidiaries have operating leases having a remaining lease commitment of approximately $55.6 million. These leases have been entered into for the use of buildings, vehicles, construction tools, meters, computer equipment and other items and are accounted for as operating leases. The Company’s unconsolidated subsidiaries, which are accounted for under the equity method, have capital leases of electric generating equipment having a remaining lease commitment of approximately $10.1 million. The Company has guaranteed 50% or $5.1 million of these capital lease commitments.
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The Company is involved in litigation arising in the normal course of business. Also in the normal course of business, the Company is involved in tax, regulatory and other governmental audits, inspections, investigations and other proceedings that involve state and federal taxes, safety, compliance with regulations, rate base, cost of service and purchased gas cost issues, among other things. While the resolution of such litigation or regulatory matters could have a material effect on earnings and cash flows in the quarterly and annual period of resolution, none of this litigation, and none of these regulatory matters, are expected to change materially the Company’s present liquidity position, nor have a material adverse effect on the financial condition of the Company.
For a complete discussion of market risk sensitive instruments, refer to “Market Risk Sensitive Instruments” in Item 7 of the Company’s 2004 Form 10-K. There have been no subsequent material changes to the Company’s exposure to market risk sensitive instruments.
Base rate adjustments in both the New York and Pennsylvania jurisdictions do not reflect the recovery of purchased gas costs. Such costs are recovered through operation of the purchased gas adjustment clauses of the appropriate regulatory authorities.
On October 11, 2000, the NYPSC approved a settlement agreement (Agreement) between Distribution Corporation, Staff of the Department of Public Service, the New York State Consumer Protection Board and Multiple Intervenors (an advocate for large commercial and industrial customers) (collectively, “Parties”) that established rates for the three-year period ending September 30, 2003. For a complete discussion of this Agreement, refer to “Rate Matters” in Item 7 of the Company’s 2004 Form 10-K. On July 25, 2003, the Parties and other interests executed a settlement agreement (“Settlement”) to extend the terms of the Agreement and Distribution Corporation’s restructuring plan one year commencing October 1, 2003. The Settlement was approved by the NYPSC in an order issued on September 18, 2003. As approved, the Settlement continued existing base rates, but reduced the level above which earnings are shared 50/50 with customers from the previous 11.5% return on equity to 11.0%. In addition, the Settlement increased the combined pension and other post employment benefit expense by $8.0 million, without a corresponding increase in revenues. Most other features of Distribution Corporation’s service remained largely unchanged.
In April 2004 Distribution Corporation commenced confidential settlement negotiations with the NYPSC and other parties concerning, among other things, its revenue requirement for the year ending September 30, 2005. Those settlement discussions failed to produce an agreement prior to the expiration of the Settlement. On August 27, 2004, Distribution Corporation filed proposed tariff amendments and supporting testimony designed to increase its annual revenues by $41.3 million beginning October 1, 2004. Parties filed responsive testimony recommending a base rate decrease, among other things. Thereafter the Parties and other interests commenced settlement negotiations. On April 15, 2005, Distribution Corporation, the Parties and others executed an agreement settling all outstanding issues. The settlement agreement provides for a rate increase of $21 million by means of the elimination of bill credits ($5.2 million) and an increase in base rates ($15.8 million). For the two-year term of the plan and thereafter, the level above which earnings must be shared with rate payers will be increased from 11.0% to 11.5%. If approved by the NYPSC, rates under the settlement agreement would become effective on August 1, 2005. Distribution Corporation is unable to ascertain the outcome of the rate proceeding at this time. The existing base rates and certain other provisions of the Settlement that expired on September 30, 2004 will continue to be in effect until the NYPSC issues an order concerning the April 15, 2005 settlement agreement.
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On June 1, 2004, Distribution Corporation submitted a filing to the NYPSC supporting the removal of a $5 million annual bill credit originally established under the terms of the Agreement. The filing requested removal of the bill credit effective October 1, 2004. On September 28, 2004, the NYPSC issued an order rejecting Distribution Corporation’s request for the stated reason that Distribution Corporation’s earnings were adequate, in the NYPSC’s opinion, without removal of the bill credit. Distribution filed a petition for rehearing with respect to the NYPSC’s order and the NYPSC has not yet acted on the petition.
In another order issued on September 28, 2004, the NYPSC directed the continuation, with modification, of four programs under the July 25, 2003 Settlement that were scheduled to expire on September 30, 2004. The effect of the NYPSC’s order was to unilaterally extend the terms of the Settlement without Distribution Corporation’s consent. Although the NYPSC’s order stated that it provided for funding of the programs, Distribution Corporation petitioned Supreme Court, Albany County for an injunction to allow the programs to expire on their own terms. Distribution Corporation’s petition was partially successful, and the proceeding remains pending.
On September 15, 2004, Distribution Corporation filed proposed tariff amendments with PaPUC to increase annual revenues by $22.8 million to cover increases in the cost of service to be effective November 14, 2004. The rate request was filed to address throughput reductions and increased operating costs such as uncollectibles and personnel expenses. Applying standard procedure, the PaPUC suspended Distribution Corporation’s tariff filing to perform an investigation and hold hearings. On February 16, 2005, the parties reached a settlement of all issues. The settlement was submitted to the Administrative Law Judge, who, on March 2, 2005 issued a decision recommending adoption of the settlement. The settlement provides for a base rate increase of $12.0 million and terminates the tracking of pension expenses versus the rate allowance. The settlement was approved by the PaPUC on March 23, 2005, and the new rates went into effect on April 15, 2005.
Supply Corporation currently does not have a rate case on file with the FERC. Management will continue to monitor Supply Corporation’s financial position to determine the necessity of filing a rate case in the future.
On November 25, 2003, the FERC issued Order 2004 “Standards of Conduct for Transmission Providers”. Order 2004 was clarified in Order 2004-A on April 16, 2004 and Order 2004-B on August 2, 2004. Order 2004, which went into effect September 22, 2004, regulates the conduct of transmission providers (such as Supply Corporation) with their “energy affiliates”. The FERC broadened the definition of “energy affiliates” to include any affiliate of a transmission provider if that affiliate engages in or is involved in transmission (gas or electric) transactions, or manages or controls transmission capacity, or buys, sells, trades or administers natural gas or electric energy or engages in financial transactions relating to the sale or transmission of natural gas or electricity. Supply Corporation’s principal energy affiliates are Seneca, NFR, and, possibly, Distribution Corporation.* Order 2004 provides that companies may request waivers, which the Company has done with respect to Distribution Corporation and is awaiting rulings. Order 2004 also provides an exemption for local distribution companies that are affiliated with interstate pipelines (such as Distribution Corporation), but the exemption is limited, with very minor exceptions, to local distribution corporations that do not make any off-system sales. Distribution Corporation stopped making such off-system sales effective September 22, 2004, although it continues to make certain sales permitted by a prior FERC order; FERC has required Supply Corporation to provide arguments justifying the continued effectiveness of that order. Supply Corporation and Distribution Corporation would like to continue operating as they do, whether by waiver, amendment or further clarification of the new rules, or by complying with the requirements applicable if Distribution Corporation were an energy affiliate. Treating Distribution Corporation as an energy affiliate, without any waivers, would require changes in the way Supply Corporation and Distribution Corporation operate which would decrease efficiency, but probably would not increase capital or operating expenses to an extent that would be material to the financial condition of the Company.* Until there is further clarification from the FERC on the scope of these exemptions and rulings on the Company’s waiver requests, the Company is unable to
35
predict the impact Order 2004 will have on the Company. As previously mentioned, Distribution Corporation stopped making off-system sales, effective September 22, 2004. The Company does not expect that change to have a material effect on the Company’s results of operations, as margins resulting from off-system sales are minimal as a result of profit sharing with retail customers.*
Empire currently does not have a rate case on file with the NYPSC. Management will continue to monitor Empire’s financial position in the New York jurisdiction to determine the necessity of filing a rate case in the future.
The Company is subject to various federal, state and local laws and regulations relating to the protection of the environment. The Company has established procedures for the ongoing evaluation of its operations to identify potential environmental exposures and comply with regulatory policies and procedures. It is the Company’s policy to accrue estimated environmental clean-up costs (investigation and remediation) when such amounts can reasonably be estimated and it is probable that the Company will be required to incur such costs. At March 31, 2005, the Company has estimated its remaining clean-up costs related to former manufactured gas plant sites and third party waste disposal sites will be $22.3 million. This liability has been recorded on the Consolidated Balance Sheet at March 31, 2005. In April 2005, the Company entered into a transfer agreement for environmental obligations related to a former manufactured gas plant site in New York. Under the terms of the agreement, the Company will pay $12.7 million to settle its remaining environmental obligations related to this site. This amount was included in the $22.3 million liability at March 31, 2005. The Company expects to recover its environmental clean-up costs from a combination of insurance proceeds and rate recovery.* Other than as discussed in Note G of the Company’s 2004 Form 10-K (referred to below), the Company is currently not aware of any material additional exposure to environmental liabilities. However, adverse changes in environmental regulations or other factors could impact the Company.*
For further discussion refer to Note G — Commitments and Contingencies under the heading “Environmental Matters” in Item 8 of the Company’s 2004 Form 10-K, and to Part II, Item 1, “Legal Proceedings.”
In December 2004, the FASB issued SFAS 123R, “Share Based Payment”. SFAS 123R replaces SFAS 123 and supercedes APB 25. The Company currently follows APB 25 in accounting for stock-based compensation, as disclosed above. SFAS 123R focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. The Company does not believe that adoption of SFAS 123R will have a material impact on its financial condition and results of operations.* For further discussion of SFAS 123R and its impact on the Company, refer to Item 1 at Note 1 — Summary of Significant Accounting Policies.
The Company is including the following cautionary statement in this Form 10-Q to make applicable and take advantage of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 for any forward-looking statements made by, or on behalf of, the Company. Forward-looking statements include statements concerning plans, objectives, goals, projections, strategies, future events or performance, and underlying assumptions and other statements which are other than statements of historical facts. From time to time, the Company may publish or otherwise make available forward-looking statements of this nature. All such subsequent forward-looking statements, whether written or oral and whether made by or on behalf of the Company, are also expressly qualified by these cautionary statements. Certain statements contained in this report, including, without limitation, those which are designated with an asterisk (“*”) and those which are identified by the use of the words “anticipates,” “estimates,” “expects,” “intends,” “plans,” “predicts,” “projects,” and similar expressions, are “forward-looking” statements as defined in the Private Securities Litigation Reform Act of 1995 and accordingly involve risks and uncertainties which could cause actual results or outcomes to differ materially from those
36
expressed in the forward-looking statements. The forward-looking statements contained herein are based on various assumptions, many of which are based, in turn, upon further assumptions. The Company’s expectations, beliefs and projections are expressed in good faith and are believed by the Company to have a reasonable basis, including, without limitation, management’s examination of historical operating trends, data contained in the Company’s records and other data available from third parties, but there can be no assurance that management’s expectations, beliefs or projections will result or be achieved or accomplished. In addition to other factors and matters discussed elsewhere herein, the following are important factors that, in the view of the Company, could cause actual results to differ materially from those discussed in the forward-looking statements:
| 1. | Changes in economic conditions, including economic disruptions caused by terrorist activities or acts of war; |
| 2. | Changes in demographic patterns and weather conditions, including the occurrence of severe weather; |
| 3. | Changes in the price of natural gas or oil and the effect of such changes on the accounting treatment or valuation of derivative financial instruments or the Company’s natural gas and oil reserves; |
| 4. | Changes in the availability and/or price of derivative financial instruments; |
| 5. | Changes in the availability and/or price of natural gas, oil and coal; |
| 6. | Inability to obtain new customers or retain existing ones; |
| 7. | Significant changes in competitive factors affecting the Company; |
| 8. | Governmental/regulatory actions, initiatives and proceedings, including those involving acquisitions, financings, rate cases (which address, among other things, allowed rates of return, rate design and retained gas), affiliate relationships, industry structure, franchise renewal, and environmental/safety requirements; |
| 9. | Unanticipated impacts of restructuring initiatives in the natural gas and electric industries; |
| 10. | Significant changes from expectations in actual capital expenditures and operating expenses and unanticipated project delays or changes in project costs; |
| 11. | The nature and projected profitability of pending and potential projects and other investments; |
| 12. | Occurrences affecting the Company’s ability to obtain funds from operations, debt or equity to finance needed capital expenditures and other investments, including any downgrades in the Company’s credit ratings; |
| 13. | Uncertainty of oil and gas reserve estimates; |
| 14. | Ability to successfully identify and finance acquisitions and ability to operate and integrate existing and any subsequently acquired business or properties; |
| 15. | Ability to successfully identify, drill for and produce economically viable natural gas and oil reserves; |
| 16. | Significant changes from expectations in the Company’s actual production levels for natural gas or oil; |
| 17. | Regarding foreign operations, changes in trade and monetary policies, inflation and exchange rates, taxes, operating conditions, laws and regulations related to foreign operations, and political and governmental changes; |
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Concl.)
| 18. | Significant changes in tax rates or policies or in rates of inflation or interest; |
| 19. | Significant changes in the Company’s relationship with its employees or contractors and the potential adverse effects if labor disputes, grievances or shortages were to occur; |
| 20. | Changes in accounting principles or the application of such principles to the Company; |
| 21. | Changes in laws and regulations to which the Company is subject, including tax, environmental, safety and employment laws and regulations; |
| 22. | The cost and effects of legal and administrative claims against the Company; |
| 23. | Changes in actuarial assumptions and the return on assets with respect to the Company’s retirement plan and post-retirement benefits; |
| 24. | Increasing health care costs and the resulting effect on health insurance premiums and on the obligation to provide post-retirement benefits; or |
| 25. | Increasing costs of insurance, changes in coverage and the ability to obtain insurance. |
The Company disclaims any obligation to update any forward-looking statements to reflect events or circumstances after the date hereof.
Refer to the “Market Risk Sensitive Instruments” section in Item 2 – MD&A.
The following information includes the evaluation of disclosure controls and procedures by the Company’s Chief Executive Officer and Principal Financial Officer, along with any significant changes in internal controls of the Company.
The term “disclosure controls and procedures” is defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934 (Exchange Act). These rules refer to the controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files under the Exchange Act is recorded, processed, summarized and reported within required time periods. The Company’s management, including the Chief Executive Officer and Principal Financial Officer, evaluated the effectiveness of the Company’s disclosure controls and procedures as of the end of the period covered by this report. Based upon that evaluation, the Company’s Chief Executive Officer and Principal Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of the end of the period covered by this report.
The Company maintains a system of internal control over financial reporting that is designed to provide reasonable assurance that the Company’s transactions are properly authorized, the Company’s assets are safeguarded against unauthorized or improper use, and the Company’s transactions are properly recorded and reported to permit preparation of the Company’s financial statements in conformity with generally accepted accounting principles in the United States of America. There were no changes in the Company’s internal control over financial reporting that occurred during the period covered by this report that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
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Part II. Other Information
In an action instituted in the New York State Supreme Court, Chautauqua County on January 31, 2000 against Seneca, NFR and “National Fuel Gas Corporation,” Donald J. and Margaret Ortel and Brian and Judith Rapp, “individually and on behalf of all those similarly situated,” allege, in an amended complaint which adds National Fuel Gas Company as a party defendant that (a) Seneca underpaid royalties due under leases operated by it, and (b) Seneca’s co-defendants (i) fraudulently participated in and concealed such alleged underpayment, and (ii) induced Seneca’s alleged breach of such leases. Plaintiffs seek an accounting, declaratory and related injunctive relief, and compensatory and exemplary damages. Defendants have denied each of plaintiffs’ material substantive allegations and set up twenty-five affirmative defenses in separate verified answers.
A motion was made by plaintiffs on July 15, 2002 to certify a class comprising all persons presently and formerly entitled to receive royalties on the sale of natural gas produced and sold from wells operated in New York by Seneca (and its predecessor Empire Exploration, Inc). On December 23, 2002, the court granted certification of the proposed class, as modified to exclude those leaseholders whose leases provide for calculation of royalties based upon a flat fee, or flat fee per cubic foot of gas produced. The court’s order states that there are approximately 749 potential class members. Discovery is proceeding on the merits of the claims.
In an action instituted in the New York State Supreme Court, Kings County on February 18, 2003 against Distribution Corporation and Paul J. Hissin, an unaffiliated third party, plaintiff Donna Fordham-Coleman, as administratrix of the estate of Velma Arlene Fordham, alleges that Distribution Corporation’s denial of natural gas service in November 2000 to the plaintiff’s decedent, Velma Arlene Fordham, caused decedent’s death in February 2001. Plaintiff seeks damages for wrongful death and pain and suffering, plus punitive damages. Distribution Corporation has denied plaintiff’s material allegations, set up seven affirmative defenses in separate verified answers and filed a cross-claim against the co-defendant. Distribution Corporation believes and will vigorously assert that plaintiff’s allegations lack merit. The Court changed venue of the action to New York State Supreme Court, Erie County. The litigation is in the early stages of discovery.
On December 22, 2003, the Pennsylvania Department of Environmental Protection (DEP) issued an order to Seneca to halt its timber harvesting operations on 21,000 acres in Cameron, Elk and McKean counties in Pennsylvania. The order asserts certain violations of DEP regulations concerning erosion, sedimentation and stream crossings. The order requires Seneca to apply for certain permits, control erosion, submit plans for removal of water encroachments not included in permit applications, notify the DEP of additional current or planned timber harvesting operations, and grant the DEP access to timber acreage. On January 9, 2004, Seneca filed with the Pennsylvania Environmental Hearing Board (Hearing Board) a notice of appeal, objecting to each finding and order contained in the order, and asserting that the DEP’s findings are factually incorrect, an arbitrary exercise of the DEP’s functions and duties, and contrary to law. Also on January 9, 2004, Seneca filed with the Hearing Board a petition requesting a stay of operation of portions of the order. On January 20, 2004, the parties settled Seneca’s request for a stay. Seneca has resumed its timber harvesting operations pursuant to the terms of the settlement. The settlement preserves various issues raised by the DEP’s order for a hearing on the merits of Seneca’s notice of appeal. Seneca is actively pursuing its appeal, which it expects to be litigated.* The most substantial question in the appeal involves whether Seneca is required to apply for a permit under Section 102.5(b) of Title 25 of the Pennsylvania Code, governing earth disturbance activities of greater than 25 acres. The DEP takes the position that Seneca must aggregate the acreage of all of its logging sites across its entire 21,000 acre tract for purposes of determining whether its earth disturbing activities meet the 25 acres threshold. Seneca maintains that no permit is required, because the law does not require aggregation and each of its individual logging sites disturbs less than 25 acres.
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The Company believes, based on the information presently known, that the ultimate resolution of these matters, individually or in the aggregate, will not be material to the consolidated financial condition, results of operations, or cash flow of the Company.* No assurances can be given, however, as to the ultimate outcomes of these matters, and it is possible that the outcomes, individually or in the aggregate, could be material to results of operations or cash flow for a particular quarter or annual period.*
For a discussion of various environmental matters, refer to Part I, Item 1 at Note 4 and Part I, Item 2 – MD&A of this report under the heading “Environmental Matters.”
The Company is involved in litigation arising in the normal course of business. Also in the normal course of business, the Company is involved in tax, regulatory and other governmental audits, inspections, investigations and other proceedings that involve state and federal taxes, safety, compliance with regulations, rate base, cost of service and purchased gas cost issues, among other things. While the resolution of such litigation or regulatory matters could have a material effect on earnings and cash flows in the quarterly and annual period of resolution, none of this litigation, and none of these regulatory matters, are expected to change materially the Company’s present liquidity position, nor have a material adverse effect on the financial condition of the Company.*
On January 3, 2005, the Company issued a total of 1,958 unregistered shares of Company common stock to the seven non-employee directors of the Company then serving on the Board of Directors: 158 shares to Bernard S. Lee, Ph.D., whose service as a director came to an end on February 17, 2005, and 300 shares to each of the other six non-employee directors. On February 17, 2005, the Company issued 141 unregistered shares of Company common stock to Craig G. Matthews, who was elected to the Board as a non-employee director of the Company on that date. All of these unregistered shares were issued as partial consideration for the directors’ services during the quarter ended March 31, 2005, pursuant to the Company’s Retainer Policy for Non-Employee Directors. These transactions were exempt from registration by Section 4(2) of the Securities Act of 1933 as transactions not involving a public offering.
Issuer Purchases of Equity Securities
- ------------------------- ---------------------- ----------------------- ---------------------- ----------------------
Total Number of
Shares Purchased as Maximum Number of
Part of Publicly Shares that May
Total Number of Announced Share Yet Be Purchased
Shares Average Price Repurchase Plans or Under Share Repurchase
Period Purchased(a) Paid Per Share Programs Plans or Programs
- ------------------------- ---------------------- ----------------------- ---------------------- ----------------------
Jan. 1 - 31, 2005 16,742 $27.11 - -
- ------------------------- ---------------------- ----------------------- ---------------------- ----------------------
Feb. 1 - 28, 2005 45,075 $28.36 - -
- ------------------------- ---------------------- ----------------------- ---------------------- ----------------------
Mar. 1 - 31, 2005 204,271 $28.98 - -
- ------------------------- ---------------------- ----------------------- ---------------------- ----------------------
Total 266,088 $28.76 - -
- ------------------------- ---------------------- ----------------------- ---------------------- ----------------------
(a) Represents (i) shares of common stock of the Company purchased on the open market with Company “matching contributions” for the accounts of participants in the Company’s 401(k) plans, and (ii) shares of common stock of the Company tendered to the Company by holders of stock options or shares of restricted stock for the payment of option exercise prices and/or applicable withholding taxes.
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The Annual Meeting of Shareholders of National Fuel Gas Company was held on February 17, 2005. At that meeting, the shareholders elected directors, appointed independent accountants, approved amendments to the Company’s Restated Certificate of Incorporation, and rejected a shareholder proposal to limit future retirement benefits for executive officers.
The total votes were as follows:
For Withheld
--- --------
(i) Election of directors to
serve for a three-year
term:
- Robert T. Brady 64,641,101 8,531,206
- Rolland E. Kidder 59,832,197 13,340,110
Election of directors to
serve for a two-year
term:
- Craig G. Matthews 71,898,897 1,273,410
- Richard G. Reiten 71,909,518 1,262,789
Other directors whose term of office continued after the meeting:
Term expiring in 2006: R. Don Cash, George L. Mazanec, and John F. Riordan.
Term expiring in 2007: Philip C. Ackerman.
Broker
For Against Abstain Non-Votes
--- ------- ------- ---------
(ii) Appointment of
PricewaterhouseCoopers
LLP as independent
accountants 71,937,468 957,515 277,324 -
(iii) Approval of amendments
to the Company's Restated
Certificate of Incorporation 34,770,816 21,582,111 866,713 15,952,667
(iv) Adoption of shareholder
proposal to limit future
retirement benefits for
executive officers 7,365,900 47,768,223 2,085,517 15,952,667
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(a) Exhibits
Exhibit
Number Description of Exhibit
------- ----------------------
10.1 Description of performance goals for certain executive officers.
10.2 Administrative Rules of the Compensation Committee of the Board of Directors of National Fuel Gas Company, as amended and
restated effective March 9, 2005.
12 Statements regarding Computation of Ratios:
Ratio of Earnings to Fixed Charges for the Twelve Months Ended March 31, 2005 and the Fiscal Years
Ended September 30, 2000 through 2004.
31.1 Written statements of Chief Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) under
the Securities Exchange Act of 1934.
31.2 Written statements of Principal Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a)
under the Securities Exchange Act of 1934.
32 Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
99 National Fuel Gas Company Consolidated Statement of Income for the Twelve Months Ended March 31,
2005 and 2004.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
NATIONAL FUEL GAS COMPANY
(Registrant)
/s/R. J. Tanski
R. J. Tanski
Treasurer and Principal Financial Officer
/s/K. M. Camiolo
K. M. Camiolo
Controller and Principal Accounting Officer
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EXHIBIT INDEX
(Form 10-Q)
Exhibit 10.1 Description of Performance Goals for Certain Executive Officers.
Exhibit 10.2 Administrative Rules of the Compensation Committee of the Board of
Directors of National Fuel Gas Company, as amended and restated
effective March 9, 2005.
Exhibit 12 Statements regarding Computation of Ratios:
Ratio of Earnings to Fixed Charges for the Twelve
Months Ended March 31, 2005 and the Fiscal Years Ended
September 30, 2000 through 2004.
Exhibit 31.1 Written statements of Chief Executive Officer pursuant to Rule 13a-14(a) or
Rule 15d-14(a) under the Securities Exchange Act of 1934.
Exhibit 31.2 Written statements of Principal Financial Officer pursuant to Rule 13a-14(a) or
Rule 15d-14(a) under the Securities Exchange Act of 1934.
Exhibit 32 Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
Exhibit 99 National Fuel Gas Company Consolidated Statement of
Income for the Twelve Months Ended March 31, 2005
and 2004.