<PAGE> 1
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JULY 18, 2000.
REGISTRATION NO. 333-35390
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-------------------------
AMENDMENT NO. 1
TO
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
-------------------------
SOUTHERN ENERGY, INC.
(Exact name of registrant as specified in its charter)
-------------------------
<TABLE>
<S> <C> <C>
DELAWARE 4911 58-2056305
(State or other (Primary Standard Industrial (I.R.S. Employer
jurisdiction of Classification Code Number) Identification No.)
incorporation or
organization)
</TABLE>
900 ASHWOOD PARKWAY, SUITE 500
ATLANTA, GEORGIA 30338
(770) 821-7000
(Address, including zip code, and telephone number, including area code, of
registrant's principal executive offices)
-------------------------
RAYMOND D. HILL
CHIEF FINANCIAL OFFICER
SOUTHERN ENERGY, INC.
900 ASHWOOD PARKWAY, SUITE 500
ATLANTA, GEORGIA 30338
(770) 821-7000
(Name, address, including zip code, and telephone number, including area code,
of agent for service)
-------------------------
WITH A COPY TO:
<TABLE>
<S> <C>
JOHN T. W. MERCER, ESQ. JOHN A. MILLARD, ESQ.
TROUTMAN SANDERS LLP SHEARMAN & STERLING
BANK OF AMERICA PLAZA, SUITE 5200 599 LEXINGTON AVENUE
600 PEACHTREE STREET, N.E. NEW YORK, NEW YORK 10022
ATLANTA, GEORGIA 30308 (212) 848-4000
(404) 885-3000
</TABLE>
-------------------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as
practicable after the effective date of this registration statement.
If the only securities being registered on this form are being offered
pursuant to dividend or interest reinvestment plans, please check the following
box. [ ]
If any of the securities being registered on this form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, as amended, other than securities offered only in connection with dividend
or interest reinvestment plans, check the following box. [ ]
If this form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [ ]
If this form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If this form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [ ]
-------------------------
CALCULATION OF REGISTRATION FEE
<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------------------
PROPOSED PROPOSED
MAXIMUM MAXIMUM AMOUNT OF
TITLE OF EACH CLASS OF AMOUNT TO OFFERING PRICE AGGREGATE REGISTRATION
SECURITIES TO BE REGISTERED BE REGISTERED(1) PER UNIT(2) OFFERING PRICE FEE(3)
-------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Common Stock, $0.01 par 66,700,000
value per share.......... Shares $17.00 $1,133,900,000 $299,349.60
-------------------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Includes 8,700,000 shares of common stock issuable upon exercise of the
underwriters' over-allotment option.
(2) Estimated solely for the purpose of determining the registration fee and
calculated in accordance with Rule 457(o) under the Securities Act.
(3) The registration fee for the securities to be registered has previously
been calculated in accordance with Section 6(b) of the Securities Act.
An aggregate registration fee of $26,400 was paid on April 21, 2000.
-------------------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON
SUCH DATE AS THE SECURITIES AND EXCHANGE COMMISSION, ACTING PURSUANT TO SAID
SECTION 8(A), MAY DETERMINE.
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
<PAGE> 2
THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED. WE
MAY NOT SELL THESE SECURITIES UNTIL THE REGISTRATION STATEMENT FILED WITH
THE SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PROSPECTUS IS
NOT AN OFFER TO SELL THESE SECURITIES AND IT IS NOT SOLICITING AN OFFER TO
BUY THESE SECURITIES IN ANY STATE WHERE THE OFFER IS NOT PERMITTED.
SUBJECT TO COMPLETION, DATED [ ], 2000
PROSPECTUS
58,000,000 Shares
[LOGO]
Southern Energy, Inc.
Common Stock
-------------------------
This is an initial public offering of shares of common stock of Southern
Energy, Inc. All of the 58,000,000 shares of common stock are being sold by
Southern Energy. At the request of Southern Energy, the underwriters have
reserved at the initial public offering price up to [ ] shares of
common stock for sale to employees and other business associates of Southern
Energy.
Prior to this offering, there has been no public market for the common
stock. We estimate that the initial public offering price will be between $15.00
and $17.00 per share. We will apply for the listing of our common stock on the
New York Stock Exchange under the trading symbol "SOE."
OUR BUSINESS INVOLVES SIGNIFICANT RISKS. THESE RISKS ARE DESCRIBED UNDER
THE CAPTION "RISK FACTORS" BEGINNING ON PAGE 8.
Concurrently with this offering, a Delaware business trust that we own is
offering up to 6,000,000 [ ]% Convertible Trust Preferred Securities, Series
A by means of a separate prospectus.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or determined if this
prospectus is truthful or complete. Any representation to the contrary is a
criminal offense.
-------------------------
<TABLE>
<CAPTION>
PER SHARE TOTAL
--------- -----
<S> <C> <C> <C>
Public offering price....................................... $ $
Underwriting discounts and commissions...................... $ $
Proceeds to us.............................................. $ $
</TABLE>
The underwriters may also purchase up to an additional 8,700,000 shares of
common stock, at the public offering price, less the underwriting discounts and
commissions, within 30 days from the date of this prospectus to cover
over-allotments.
The underwriters expect to deliver the shares in New York, New York on
, 2000.
-------------------------
JOINT BOOK-RUNNING MANAGERS
GOLDMAN, SACHS & CO. MORGAN STANLEY DEAN WITTER
-------------------------
Prospectus dated [ ], 2000
<PAGE> 3
YOU SHOULD RELY ONLY ON THE INFORMATION PROVIDED IN THIS PROSPECTUS. WE
HAVE AUTHORIZED NO ONE TO PROVIDE YOU WITH DIFFERENT INFORMATION. WE ARE NOT
MAKING AN OFFER OF THESE SECURITIES IN ANY STATE WHERE THE OFFER IS NOT
PERMITTED. YOU SHOULD NOT ASSUME THAT THE INFORMATION IN THIS PROSPECTUS IS
ACCURATE AS OF ANY DATE OTHER THAN THE DATE ON THE FRONT OF THIS DOCUMENT.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary.............. 1
Risk Factors.................... 8
Our Separation from Southern
Company....................... 24
Use of Proceeds................. 27
Dividend Policy................. 27
Capitalization.................. 28
Dilution........................ 29
Selected Financial
Information................... 30
Management's Discussion and
Analysis of Financial
Condition and Results of
Operations.................... 32
Business........................ 50
Management...................... 109
Relationship with Southern
Company and Related
Transactions.................. 123
Agreements Between Us and
Southern Company.............. 124
</TABLE>
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Certain Federal Tax Matters
Related to Our Separation from
Southern Company.............. 132
Principal Stockholder........... 134
Description of Capital Stock.... 135
Description of Convertible Trust
Preferred Securities.......... 141
U.S. Federal Tax Considerations
for Non-U.S. Holders.......... 144
Shares Eligible for Future
Sale.......................... 147
Underwriting.................... 148
Legal Matters................... 150
Experts......................... 150
Where You Can Find More
Information................... 150
Index to Financial Statements... F-1
</TABLE>
Through and including [ ], 2000 (the 25th day after the date of
this prospectus), all dealers effecting transactions in these securities,
whether or not participating in this offering, may be required to deliver a
prospectus. This is in addition to a dealer's obligation to deliver a prospectus
when acting as an underwriter and with respect to an unsold allotment or
subscription.
i
<PAGE> 4
PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS THAT
STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK.
SPECIFICALLY, THE UNDERWRITERS MAY OVER-ALLOT IN CONNECTION WITH THE OFFERING
AND MAY BID FOR AND PURCHASE COMMON STOCK IN THE OPEN MARKET.
IN CONNECTION WITH THIS OFFERING, THE UNDERWRITERS MAY ENGAGE IN PASSIVE
MARKET MAKING TRANSACTIONS IN THE COMMON STOCK IN ACCORDANCE WITH RULE 103 OF
REGULATION M UNDER THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Some of the statements under "Prospectus Summary," "Risk Factors,"
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," "Business" and elsewhere in this prospectus constitute
forward-looking statements. These statements involve known and unknown risks and
relate to future events, our future financial performance or our projected
business results. In some cases, you can identify forward-looking statements by
terminology such as "may," "will," "should," "expects," "plans," "anticipates,"
"believes," "estimates," "predicts," "potential" or "continue" or the negative
of these terms or other comparable terminology.
Forward-looking statements are only predictions. Actual events or results
may differ materially from any forward-looking statement as a result of various
factors. These factors include:
- legislative and regulatory initiatives regarding deregulation and
restructuring of the electric utility industry;
- the extent and timing of the entry of additional competition in the
markets of our subsidiaries and affiliates;
- our pursuit of potential business strategies, including acquisitions or
dispositions of assets or internal restructuring;
- state, federal and other rate regulations in the United States and in
foreign countries in which our subsidiaries and affiliates operate;
- changes in or application of environmental and other laws and regulations
to which we and our subsidiaries and affiliates are subject;
- political, legal and economic conditions and developments in the United
States and in foreign countries in which our subsidiaries and affiliates
operate;
- financial market conditions and the results of our financing efforts;
changes in commodity prices and interest rates; weather and other natural
phenomena;
- our performance of projects undertaken and the success of our efforts to
invest in and develop new opportunities; and
- other factors, including the risks outlined under "Risk Factors."
Although we believe that the expectations reflected in the forward-looking
statements are reasonable, we cannot guarantee future results, events, levels of
activity, performance or achievements. We do not assume responsibility for the
accuracy or completeness of forward-looking statements. We do not undertake a
duty to update any of the forward-looking statements after the date of this
prospectus.
ii
<PAGE> 5
PROSPECTUS SUMMARY
You should read the following summary together with the more detailed
information regarding our company and the common stock being sold in this
offering and our consolidated financial statements and notes thereto appearing
elsewhere in this prospectus.
SOUTHERN ENERGY, INC.
We are one of the world's largest competitive providers of electricity and
energy-related products and services. We have regionally based businesses in the
Americas, Europe and the Asia-Pacific region. We have built and acquired a
portfolio of power plants in which we have net ownership interests totaling
13,214 megawatts (MW) of generation capacity. In addition, we have projects
under development or pending acquisition totaling 10,925 MW. We also market
energy and energy-linked commodities and manage the risk associated with market
price fluctuations of these commodities. By linking our electricity generation
capabilities and our access to natural gas supplies with our energy marketing
and risk management expertise, we are able to meet a wide range of customer
requirements as well as optimize the value of our electricity generating and gas
assets.
In North America, we own and operate power plants with a total generation
capacity of 7,391 MW. We control an additional 1,738 MW of generation capacity
through management contracts. We also have projects under development or pending
acquisition totaling 10,728 MW, including 5,154 MW of generation capacity that
we have recently agreed to acquire from Potomac Electric Power Company. Through
Southern Company Energy Marketing, L.P., our 60% owned affiliate, we market and
trade energy and energy-linked commodities, including electricity, gas, oil,
coal and emission allowances.
In Europe, we own a 26% interest in Bewag AG, the electric utility serving
2.1 million customers in Berlin, Germany. We also have a 49% economic interest
in, and operating control of, Western Power Distribution, which distributes
electricity to approximately 1.4 million end users in southwest England. We are
currently pursuing opportunities to grow these businesses. Our European
marketing and risk management business began trading power in the Nordic energy
market in 1999. We expect to begin marketing power in the Dutch, German, Swiss
and Italian energy markets in 2000.
In the Asia-Pacific region, we have interests in 3,159 MW of generation
capacity in the Philippines and China. Most of our revenues in the Asia-Pacific
region are derived from contracts with government entities or regional power
boards and are predominantly linked to the U.S. dollar.
In the Caribbean and South America, we have ownership interests in electric
utilities, power plants and transmission facilities. These assets are located in
the Bahamas, Trinidad and Tobago, Brazil, Argentina and Chile, and we are
acquiring an interest in an electricity generation and water distribution
company in the U.S. Virgin Islands. We are pursuing the sale of our Argentine
and Chilean subsidiaries.
THE POWER INDUSTRY
The power industry is one of the largest industries in the world. In the
United States alone, the power industry had an estimated end-user market of over
$225 billion of electricity sales in 1999 produced by an aggregate base of power
generation facilities with a capacity of approximately 785,000 MW. Historically,
the power generation industry has been characterized by electric utility
monopolies selling to a franchise customer base. In response to increasing
customer demand for access to low-
1
<PAGE> 6
cost electricity and enhanced services, new regulatory initiatives have been and
are continuing to be adopted to increase competition in the power industry.
We believe that increasing demand for electricity and the need to replace
old and inefficient power plants will create a significant need for additional
power generating capacity throughout the United States. We believe that these
market trends will create substantial opportunities for efficient, low-cost
power producers that can produce and sell energy to customers at competitive
rates.
Outside of the United States, many governments in developed economies are
privatizing their utilities, having realized that their energy assets can be
sold to raise capital without hindering system reliability. These countries are
developing regulatory structures that are expected to encourage competition in
the electricity sector. In developing countries, the demand for electricity is
expected to grow rapidly. In order to satisfy this anticipated increase in
demand, many countries have adopted government programs designed to encourage
private investment in power plants. We believe that these market trends will
continue to create opportunities to acquire and develop power generation plants
globally.
Industry trends and regulatory initiatives are transforming existing
franchise customer markets, which are characterized by vertically integrated,
price-regulated utilities, into markets in which generators compete with each
other for their principal customers (wholesale power suppliers and major
end-users) on the basis of price, service quality and other factors. This
transformation requires that generators and their principal customers manage the
risks associated with producing and delivering energy commodities, thereby
creating opportunities to profitably market energy commodities and provide
services to manage the risks associated with market price fluctuations of these
commodities.
STRATEGY
Our strategy is to be a leading competitive provider of electricity and
energy-related products and services in our target markets of North America,
Europe and the Asia-Pacific region. We intend to continue our growth through the
acquisition, development and operation of power plants and gas transportation
and storage assets primarily in our target markets. We also intend to capitalize
on our ability to integrate power plants and gas assets with the marketing of
energy commodities and the management of market risk associated with those
commodities.
We plan to implement our growth strategy by:
- Maximizing the financial and operational performance of our current
investments,
- Capitalizing on opportunities generated by our strong regional presence,
- Developing new power plants and expanding our existing plants,
- Acquiring power plants and gas assets competitively positioned in our
target markets,
- Entering into contractual arrangements for the management and control of
generation capacity and gas transportation and storage assets,
- Integrating energy marketing and risk management with ownership and
control of energy assets, and
- Exploiting energy information and e-commerce applications.
OUR RELATIONSHIP WITH SOUTHERN COMPANY
We are currently a wholly owned subsidiary of Southern Company. Upon the
completion of this offering, Southern Company will own over 80% of the
outstanding shares of our common stock. Southern Company has announced that it
currently plans to complete a spin-off of us within
2
<PAGE> 7
12 months after the completion of this offering by distributing the remaining
shares of our common stock to the holders of Southern Company's common stock.
Prior to the completion of this offering, we will enter into agreements
with Southern Company related to the separation of our business from Southern
Company. These separation agreements will provide for, among other things, the
assumption by us of liabilities relating to our business. In addition, after
this offering but prior to the distribution of our stock by Southern Company, we
will transfer the operations and obligations of our leasing and capital funding
subsidiaries to Southern Company.
The separation agreements between us and Southern Company will also govern
our various interim and ongoing relationships. In particular, we have entered
into agreements under which Southern Company will continue to provide various
interim services to us, including financial, accounting, engineering and other
services. All of these agreements were negotiated in the overall context of our
separation from Southern Company and the requirements of federal and state
regulations.
We believe that we will realize certain benefits from our complete
separation from Southern Company, including the following: reduced governmental
regulation, increased capital financing flexibility, increased strategic focus,
access to additional markets, increased speed and responsiveness, targeted
incentives for management and employees and a more targeted investment for
stockholders.
We were incorporated in Delaware on April 20, 1993 as a wholly owned
subsidiary of Southern Company. Our executive offices are located at 900 Ashwood
Parkway, Suite 500, Atlanta, Georgia 30338-4780, and our telephone number is
(770) 821-7000.
CONCURRENT OFFERING OF CONVERTIBLE TRUST PREFERRED SECURITIES
Concurrently with this offering of common stock, a Delaware business trust
that we own will sell up to 6,000,000 shares of its [ ]% Convertible Trust
Preferred Securities, Series A by means of a separate prospectus. The trust will
issue all of its common securities to us. The trust will use the proceeds from
the sale of preferred securities and the common securities to purchase from us
[ ]% Junior Convertible Subordinated Debentures, Series A due 2030. The
debentures will have the same financial terms as the preferred securities,
including conversion rights. Our obligations to pay the debentures are junior to
our payment obligations under our senior debt.
Holders of preferred securities will be entitled to receive cash
distributions at an annual rate of [ ]% of the $50 liquidation preference
per share of preferred securities. Holders of preferred securities generally
will not have any voting rights.
Holders of preferred securities will have the right to convert their
preferred securities into shares of our common stock at any time after
[ ], 2001 and prior to [ ], 2030, subject to our
option to make cash settlements from [ ] 2001 until the next business
day following the date of the distribution of our common stock held by Southern
Company. The preferred securities will convert into our common stock at an
initial conversion rate of [ ] shares of common stock for each
preferred security. This conversion rate is equivalent to a conversion price of
$[ ] per share of our common stock. The conversion rate may be subject
to adjustment.
We intend to complete the offering of our common stock regardless of
whether the offering of our preferred securities is completed.
3
<PAGE> 8
THE OFFERING
COMMON STOCK OFFERED:
Common stock offered................ 58,000,000 shares(1)
Common stock to be outstanding
immediately after the offering...... 330,000,000 shares(1)
Common stock to be held by Southern
Company immediately after the
offering.......................... 272,000,000 shares
Use of Proceeds..................... We intend to use a portion of the net
proceeds of this offering and the
concurrent offering of Convertible
Trust Preferred Securities, Series A to
repay short-term debt of approximately
$840 million. The remaining proceeds
from these offerings will be used for
general corporate purposes.
Proposed NYSE symbol................ "SOE"
-------------------------
(1) Assumes the underwriters' over-allotment option to purchase 8,700,000 shares
is not exercised.
4
<PAGE> 9
SUMMARY HISTORICAL FINANCIAL AND OPERATING DATA
You should read the following summary historical financial and operating
data together with our consolidated financial statements and the related notes
and with "Selected Financial Information" and "Management's Discussion and
Analysis of Financial Condition and Results of Operations" included elsewhere in
this prospectus.
Pro forma balance sheet amounts give effect to the following actions as
though these actions had been taken as of March 31, 2000:
- the transfer of the operations of our capital funding subsidiary,
Southern Company Capital Funding, Inc. (Capital Funding), to Southern
Company;
- the transfer of our leasing subsidiary, SE Finance Capital Corporation
(SE Finance), to Southern Company. As a result of our decision on April
17, 2000 to transfer SE Finance to Southern Company, we have included the
historical results of operations of the related subsidiaries as a
discontinued operation; and
- the payment by us of cash dividends to Southern Company in the aggregate
amount of $503 million, and short-term borrowings to fund those
dividends.
Pro forma, as adjusted balance sheet amounts give effect to our sale of
58,000,000 shares of common stock in this offering at an assumed initial public
offering price of $16.00 per share and the application of the proceeds from this
offering.
Pro forma, as further adjusted balance sheet amounts give effect to our
sale of 6,000,000 preferred securities at an assumed public offering price of
$50 per preferred security in a public offering concurrent with this offering
and the application of the proceeds from both offerings.
<TABLE>
<CAPTION>
QUARTERS ENDED
YEARS ENDED DECEMBER 31, MARCH 31,
---------------------------------------------- ---------------
1995 1996 1997 1998 1999 1999 2000
------- ------ ------- ------- ------- ------ ------
(DOLLARS IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Operating revenues(1)......................... $ 584 $1,600 $ 3,750 $ 1,819 $ 2,268 $ 521 $ 521
Write down of assets(2)....................... -- -- -- 308 60 -- 4
Operating income (loss)....................... 66 150 272 (5) 444 76 170
Other income (expense):
Interest income............................. 13 16 138 146 172 38 38
Interest expense............................ (64) (133) (345) (430) (502) (111) (147)
Gain on sales of assets..................... 11 66 24 41 313 8 1
Equity in income of affiliates.............. 10 13 58 135 111 99 27
Receivables recovery........................ -- -- -- 29 64 12 --
Other, net.................................. (1) 28 33 29 72 11 6
------- ------ ------- ------- ------- ----- -----
Total other income (expense).............. (31) (10) (92) (50) 230 57 (75)
------- ------ ------- ------- ------- ----- -----
Income (loss) from continuing operations
before income taxes and minority interest... 35 140 180 (55) 674 133 95
Provision (benefit) for income taxes:
Continuing operations....................... 8 54 27 (123) 129 36 (30)
Windfall profits tax(3)..................... -- -- 148 -- -- -- --
Minority interest............................. 13 13 29 80 183 21 30
------- ------ ------- ------- ------- ----- -----
Income (loss) from continuing operations...... 14 73 (24) (12) 362 76 95
Income from discontinued operations, net of
income tax of $10 in 1997, $22 in 1998 and
$15 in 1999................................. -- -- 8 12 10 4 6
------- ------ ------- ------- ------- ----- -----
Income (loss) before extraordinary item....... 14 73 (16) -- 372 80 101
Extraordinary gain on early extinguishment of
debt, net of income tax of $2 in 1995 and $5
in 1996..................................... 4 8 -- -- -- -- --
------- ------ ------- ------- ------- ----- -----
Net income (loss)......................... $ 18 $ 81 $ (16) $ -- $ 372 $ 80 $ 101
======= ====== ======= ======= ======= ===== =====
</TABLE>
5
<PAGE> 10
<TABLE>
<CAPTION>
QUARTERS ENDED
YEARS ENDED DECEMBER 31, MARCH 31,
---------------------------------------------- ---------------
1995 1996 1997 1998 1999 1999 2000
------- ------ ------- ------- ------- ------ ------
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AND RATIO DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
EARNINGS PER SHARE INFORMATION:
BASIC:
From continuing operations.................. $ 0.05 $ 0.27 $ (0.09) $ (0.04) $ 1.33 $0.28 $0.35
From discontinued operations................ -- -- 0.03 0.04 0.04 0.01 0.02
From extraordinary gain..................... 0.02 0.03 -- -- -- -- --
------- ------ ------- ------- ------- ----- -----
Net income................................ $ 0.07 $ 0.30 $ (0.06) $ -- $ 1.37 $0.29 $0.37
======= ====== ======= ======= ======= ===== =====
PRO FORMA BASIC(4):
From continuing operations.................. $ 1.19 $0.31
From discontinued operations................ 0.04 0.02
------- -----
Net income................................ $ 1.23 $0.33
======= =====
STATEMENT OF CASH FLOWS DATA:
Cash flow from operating activities........... $ 158 $ (226) $ 264 $ 402 $ 515 (17) (13)
Cash flow from investing activities........... (1,244) (136) (4,203) (1,741) (2,263) (123) (71)
Cash flow from financing activities........... 1,653 (193) 4,177 1,502 1,516 80 161
OTHER OPERATING DATA:
EBITDA(5)..................................... $ 122 $ 258 $ 512 $ 351 $ 825 229 279
</TABLE>
<TABLE>
<CAPTION>
AS OF MARCH 31, 2000
----------------------------------------------
PRO
FORMA,
PRO FORMA, AS FURTHER
ACTUAL PRO FORMA AS ADJUSTED ADJUSTED
------- --------- ----------- ----------
(DOLLARS IN MILLIONS)
(UNAUDITED)
<S> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents................................... $ 400 $ 384 $ 475 $ 775
Property, plant and equipment, net.......................... 6,048 6,048 6,048 6,048
Investments................................................. 1,472 1,401 1,401 1,401
Investment in leveraged leases.............................. 551 0 0 0
Total assets.............................................. 13,972 12,228 12,284 12,584
Non-recourse debt(6)........................................ 6,102 5,654 5,654 5,654
Total debt................................................ 7,192 7,247 6,454 6,454
Subsidiary obligated mandatorily redeemable preferred
securities(7)............................................. 1,030 80 80 80
Minority Interest
Company obligated mandatorily redeemable securities of a
subsidiary holding solely parent company debentures..... 300
Stockholder's equity........................................ 3,199 2,444 3,328 3,328
</TABLE>
(1) The decline in operating revenues in 1998 is due to our contribution, on
January 1, 1998, of our power marketing and risk management activities to
Southern Company Energy Marketing, L.P., our marketing and risk management
joint venture with Vastar formed in September 1997. When the joint venture
was formed in September 1997, we contributed only our gas marketing and risk
management assets to the venture. Prior to the formation of the joint
venture, our marketing and risk management activities were wholly owned and
consolidated. Currently, we account for this joint venture under the equity
method of accounting. For 1997, operating revenues would have been $1,768
million if we had not consolidated our marketing and risk management
operations.
(2) The write-down for 1998 includes write-downs of our investments in our
Argentine subsidiary, Alicura, and our Chilean subsidiary, EDELNOR, to
adjust for the difference between the carrying value of the assets and the
fair market value. The write-down for 1999 and the first quarter of 2000
includes further write-downs of our investments in Alicura and EDELNOR to
maintain the carrying value at the fair market value as well as a write-down
of $31 million at Western Power Distribution relating to impaired metering
assets.
(3) In 1997, the United Kingdom imposed a windfall profits tax on the United
Kingdom's privatized utilities.
6
<PAGE> 11
(4) Pro forma basic earnings per share information gives effect to the dividends
we paid to Southern Company in 2000 as though they had been paid during the
periods presented, in accordance with SEC Staff Accounting Bulletin Topic
1:B:3.
(5) EBITDA represents our operating income (loss) plus depreciation and
amortization and our equity in income of affiliates. EBITDA excludes the
impact of minority interests. EBITDA, as defined, is presented because it is
a widely accepted financial indicator used by some investors and analysts to
analyze and compare companies on the basis of operating performance. EBITDA,
as defined, is not intended to represent cash flows for the period, nor is
it presented as an alternative to operating income or as an indicator of
operating performance. It should not be considered in isolation or as a
substitute for a measure of performance prepared in accordance with
generally accepted accounting standards (GAAP) in the United States and is
not indicative of operating income or cash flow from operations as
determined under GAAP. Our method of computation may or may not be
comparable to other similarly titled measures by other companies.
(6) This debt is non-recourse to us but is recourse to the applicable
subsidiaries and their assets.
(7) As of March 31, 2000, this total included $950 million of preferred
securities and capital securities issued by special purpose financing
subsidiaries held by Capital Funding, the proceeds of which were loaned to
Southern Company. Southern Company pays interest on subordinated notes
issued in favor of the financing subsidiaries, which payments are used to
pay dividends on those preferred or capital securities. In addition,
Southern Company has guaranteed payments due under the terms of those
securities. These securities are non-recourse to us. In connection with our
separation from Southern Company, Capital Funding will be transferred to
Southern Company. The remaining $80 million of these securities were issued
by a special purpose finance subsidiary of Southern Investments UK plc
(SIUK). They are also non-recourse to us but they are not guaranteed by
Southern Company and they will remain outstanding after the offerings.
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RISK FACTORS
You should carefully consider the risks described below as well as other
information contained in this prospectus before buying shares in this offering.
These are the risks we consider to be material to your decision whether to
invest in our common stock at this time. There may be risks that you view in a
different way than we do and we may omit a risk that we consider immaterial but
that you would consider important. In addition, there may be risks and
uncertainties that we currently consider immaterial, but that may in fact impair
our business operations. If any of the following risks occur, our business,
financial condition or results of operations could be materially harmed. In that
case, the trading price of our common stock could decline, and you may lose all
or part of your investment.
RISKS RELATED TO OUR BUSINESS
CHANGES IN COMMODITY PRICES MAY INCREASE THE COST OF PRODUCING POWER AND
DECREASE THE AMOUNT WE RECEIVE FROM SELLING POWER.
Our generation and distribution businesses are subject to changes in power
prices and fuel costs which may impact our financial results and financial
position by increasing the cost of producing power and decreasing the amount we
receive from the sale of power. In addition, actual power prices and fuel costs
may differ from those assumed in our financial models. As a result, our
financial results may not meet our expectations.
WE MAY NOT BE ABLE TO FULLY HEDGE AGAINST CHANGES IN COMMODITY PRICES AND OUR
HEDGING PROCEDURES MAY NOT WORK AS PLANNED.
To lower our financial exposure related to commodity price fluctuations,
our energy marketing and risk management business routinely enters into
contracts to hedge purchase and sale commitments, weather conditions, fuel
requirements and inventories of natural gas, coal, electricity, crude oil and
other commodities. As part of this strategy, we routinely utilize fixed-price
forward physical purchase and sales contracts, futures, financial swaps and
option contracts traded in the over-the-counter markets or exchanges. However,
we do not expect to cover the entire exposure from market price volatility of
our assets and the coverage will vary over time. In addition, as a result of
marketplace illiquidity and other factors, our marketing and risk management
operations may, at times, be unable to fully hedge their portfolios for market
risks.
We may, at times, have an open position in the market, within established
guidelines, resulting from the management of our portfolio. To the extent open
positions exist, fluctuating commodity prices can impact financial results and
financial position, either favorably or unfavorably.
Commodity price variability results from multiple factors, including:
- weather,
- illiquid markets,
- transmission or transportation inefficiencies,
- availability of competitively priced alternative energy sources,
- demand for energy commodities,
- natural gas, crude oil and coal production,
- natural disasters, wars, embargoes and other catastrophic events, and
- federal, state and foreign energy and environmental regulation and
legislation.
Furthermore, the risk management procedures we have in place may not always
be followed or may not always work as planned. As a result of these and other
factors, we cannot predict with precision the impact that our risk management
decisions may have on our businesses, operating results or financial position.
Although we devote a considerable amount of management efforts to these issues,
their outcome is uncertain.
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OUR PROJECTS LOCATED OUTSIDE OF THE UNITED STATES EXPOSE US TO RISKS RELATED
TO LAWS OF OTHER COUNTRIES, TAXES, ECONOMIC CONDITIONS, FLUCTUATIONS IN
CURRENCY RATES, LABOR SUPPLY AND RELATIONS, POLITICAL CONDITIONS AND POLICIES
OF FOREIGN GOVERNMENTS. THESE RISKS MAY DELAY OR REDUCE OUR REALIZATION OF
VALUE FROM OUR INTERNATIONAL PROJECTS.
We have substantial operations outside the United States. In 1999, we
derived approximately 78% of our net income from our foreign operations. The
acquisition, financing, development and operation of projects outside the United
States entail significant political and financial risks, which vary by country,
including:
- changes in laws or regulations,
- changes in foreign tax laws and regulations, including unexpected tax
liabilities,
- changes in United States laws, including tax laws, related to foreign
operations,
- compliance with United States foreign corrupt practices laws,
- changes in government policies or personnel,
- changes in general economic conditions affecting each country,
- difficulty in converting our earnings to U.S. dollars or moving funds out
of the country in which the funds were earned,
- fluctuations in currency exchange rates,
- changes in labor relations in operations outside the United States,
- political instability and civil unrest, and
- expropriation and confiscation of assets and facilities.
Despite contractual protections we have against many of these risks for our
operations in the Philippines, China and any other countries in which we operate
or may invest in the future, our actual results may be affected by the
occurrence of any of these events. The occurrence of any of these events could
substantially delay or reduce the value of the project concerned.
Risk from fluctuations in currency exchange rates can arise when our
foreign subsidiaries borrow funds in one type of currency but receive revenue in
another. In such cases, an adverse change in exchange rates can reduce our
ability to meet debt service obligations. Foreign currency risk can also arise
when the revenues received by our foreign subsidiaries are not in U.S. dollars.
In such cases, a strengthening of the U.S. dollar could reduce the amount of
cash and income we receive from these foreign subsidiaries.
While we believe we have hedges and contracts in place to mitigate our most
significant foreign currency exchange risks, we do have some exposure that is
not hedged. For example, while we use long-term cross-currency agreements to
hedge a significant portion of our net investments in both WPD and Bewag, we do
have a portion that is not hedged. In addition, we do not have a hedge in place
in either Argentina or the Bahamas. However, the Argentine and Bahamas
currencies are pegged to the U.S. dollar, and, as a result, we will only be
exposed to foreign currency risk if these currencies become unpegged and
devalued. We also note that we have currency risks with our investment in
Companhia Energetica de Minas Gerais (CEMIG) in Brazil. We believe that these
risks are material but we have decided not to hedge them due to the high cost
and the uncertain effectiveness of implementing such a hedge.
Our international operations are subject to regulation by various foreign
governments and regulatory authorities. The laws and regulations of some
countries may limit our ability to hold a majority interest in some of the
projects that we may develop or acquire, thus limiting our ability to control
the development, construction and operation of those projects. In addition, the
legal environment in foreign countries in which we currently own assets or
projects or may develop projects in the future could make it more difficult for
us to enforce our rights under agreements relating to such projects. Our
international projects may also be subject to risks of being delayed,
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suspended or terminated by the applicable foreign governments or may be subject
to risks of contract invalidation by commercial or governmental entities. For
example, in the Philippines pending electricity reform laws and implementing
regulations are intended to break-up and privatize most of the Philippines
National Power Corporation (NPC), our main customer. We do not believe that
these regulations will have a material adverse effect on our operations in the
Philippines but we cannot assure you that this will be the case.
SOME OF OUR FACILITIES DEPEND ON ONLY ONE OR A FEW CUSTOMERS OR SUPPLIERS.
THESE PARTIES, AS WELL AS OTHER PARTIES WITH WHOM WE HAVE CONTRACTS, MAY FAIL
TO PERFORM THEIR OBLIGATIONS, WHICH MAY RESULT IN A DEFAULT OF PROJECT DEBT
AND MAY REQUIRE US TO INSTITUTE LEGAL PROCEEDINGS TO ENFORCE OUR AGREEMENTS.
Several of our power production facilities rely on a single customer or a
few customers to purchase all of the facility's output or on a single supplier
or a few suppliers to provide fuel, water and other services required for the
operation of the facility. Our sale and procurement agreements for these
facilities are long-term agreements that provide support for any project debt
used to finance the related facilities. The financial performance of these
facilities is dependent on the continued performance by customers and suppliers
of their obligations under their long-term agreements and, in particular, on the
credit quality of the facilities' customers. A facility's financial results
could be materially adversely affected if any one customer or supplier fails to
fulfill its contractual obligations and we are unable to find other customers or
suppliers to produce the same level of profitability. As a result of the failure
of a major customer or supplier to meet its contractual obligations, we may be
unable to repay obligations under our project or corporate debt.
Most significantly, for the year ended December 31, 1999, approximately 14%
and 35% of our revenues and net income, respectively, were attributable to sales
made by our Philippine operations under power sales agreements with NPC. NPC is
contractually committed to purchase a significant amount of power, which we
anticipate will generate significant revenues and net income in the future. We
cannot assure you that NPC will make the payments it has contracted to make or
that the Philippine government will promptly honor its guarantee of the
contracts.
In addition, our marketing and risk management operations are exposed to
the risk that counterparties which owe us money or energy as a result of market
transactions will not perform their obligations. We have had to sue some
counterparties in the past because of their failure to perform, and one
counterparty filed for bankruptcy protection as a result.
WE MAY BE UNABLE TO OBTAIN THE FINANCING WE NEED TO PURSUE OUR GROWTH STRATEGY
AND ANY FUTURE FINANCING WE RECEIVE MAY BE LESS FAVORABLE TO US THAN OUR
CURRENT ARRANGEMENTS.
Each of our projects under development and those projects and businesses we
may seek to acquire or construct will require substantial capital investment.
Our continued access to capital with acceptable terms is necessary for the
success of our growth strategy. Our attempts to consummate future financings may
not be successful or on favorable terms.
We have generally been able to arrange for a majority of the financing of
each project or business on a basis that is substantially non-recourse to us. We
may attempt to continue this practice where and when we determine it to be in
our best interest, but we cannot assure you that market conditions and other
factors will permit future project and acquisition financings on terms similar
to those our subsidiaries have previously received. Our ability to arrange for
financing on a substantially non-recourse basis and the costs of such capital
are dependent on numerous factors, including general economic and capital market
conditions, credit availability from banks, investor confidence, the continued
success of current projects and the continued existence of tax and securities
laws which are conducive to raising capital in this manner. If we are not able
to obtain financing for our projects on
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a substantially non-recourse basis, we may have to finance them using recourse
capital which could take one of the following forms:
- issue additional debt at the corporate level,
- issue additional equity securities,
- make larger equity investments in our projects, or
- provide more financial support for our projects.
We may decide not to build new plants or acquire facilities. Any of these
alternatives could have a material adverse effect on our growth prospects and
the market price of our common stock.
In addition, we may not be able to complete the offering of preferred
securities being conducted concurrently with this offering, or that offering may
not raise the amount of proceeds that we expect. Either of these events would
increase our need for financing by the amount of expected net proceeds of the
preferred securities offering, less any amount actually raised. We may not be
able to obtain alternative financing. Even if we are able to obtain alternative
financing, it may cost us more to service than if we completely sell the
preferred securities and it may include greater restrictions on the conduct of
our business than the proposed terms of the preferred securities.
In the past, a significant amount of our debt and equity capital needs have
been satisfied by Southern Company. Southern Company has also periodically
provided credit support to us. In addition, we believe that we have obtained
third party financing on relatively favorable terms based in part on Southern
Company's ownership interest in us. Following this offering, Southern Company
will no longer provide financing or credit support except for specified
transactions or for a limited period of time. As a result, we may not be able to
obtain third party financing on favorable terms or at all. We may require or
choose to obtain additional debt or equity financing in the future. Future
equity financings could be dilutive to existing holders of our common stock, and
future debt financings could involve restrictive covenants.
OUR ACTIVITIES ARE RESTRICTED BY SUBSTANTIAL INDEBTEDNESS WHICH MAY BE
ACCELERATED IF WE ARE UNABLE TO SERVICE IT.
We have incurred substantial indebtedness on a consolidated basis to
finance our business. As of March 31, 2000, our total consolidated indebtedness
was $8.2 billion, our total consolidated assets were $14.0 billion and our
stockholders' equity was $3.2 billion. Our ability to meet our debt service
obligations and to repay our outstanding indebtedness will depend primarily upon
cash flow produced by our business.
This indebtedness has important consequences, including:
- limiting our ability to borrow additional amounts for working capital,
capital expenditures, debt service requirements, execution of our growth
strategy or other purposes,
- limiting our ability to use operating cash flow in other areas of our
business because we must dedicate a substantial portion of these funds to
service our debt,
- increasing our vulnerability to general adverse economic and industry
conditions, and
- limiting our ability to capitalize on business opportunities and to react
to competitive pressures and adverse changes in government regulation.
In addition, some of our existing debt agreements contain restrictive
covenants which, among other things, can limit or prohibit the ability of us or
our subsidiaries to:
- incur indebtedness,
- make prepayments of indebtedness in whole or in part,
- pay dividends,
- make investments,
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- engage in transactions with affiliates,
- create liens,
- sell assets, and
- acquire facilities or other businesses.
If we are unable to comply with the terms of our debt agreements, we may be
required to refinance all or a portion of our debt or to obtain additional
financing. We may be unable to refinance or obtain additional financing because
of our high levels of debt and the debt incurrence restrictions under our debt
agreements. We may be forced to default on our debt obligations if cash flow is
insufficient and refinancing or additional financing is unavailable. If we
default under the terms of our indebtedness, the relevant debt holders may
accelerate the maturity of our obligations, which could cause cross-defaults or
cross-acceleration under our other obligations.
OUR COSTS OF COMPLIANCE WITH ENVIRONMENTAL LAWS ARE SIGNIFICANT AND THE COST
OF COMPLIANCE WITH NEW ENVIRONMENTAL LAWS COULD ADVERSELY AFFECT OUR
PROFITABILITY.
Our operations are subject to extensive federal, state, local and foreign
statutes, rules and regulations relating to environmental protection. To comply
with these legal requirements, we must spend significant sums on environmental
monitoring, pollution control equipment and emission fees. We may be exposed to
compliance risks from new projects, as well as from plants we have acquired. For
example, the State of New York has issued a notice of violation (NOV) to the
previous owners of Plant Lovett, which we have acquired, alleging violations in
the operation of the plant prior to our acquisition. Although we have not
received a NOV and we dispute the allegations, we may incur costs installing
pollution control equipment on the plant.
Our failure to comply with environmental laws may result in the assessment
of penalties and fines against us by regulatory authorities. With the trend
toward stricter standards, greater regulation, more extensive permitting
requirements and an increase in the number and types of assets operated by us
subject to environmental regulation, we expect our environmental expenditures to
be substantial in the future. As is true in many countries of the world, the
governments of the United States, China, the Philippines, various European
nations and Trinidad and Tobago recently have proposed increased environmental
regulation of many industrial activities, including increased regulation of air
quality, water quality and solid waste management. For example, the U.S.
Environmental Protection Agency (EPA) has recently promulgated more stringent
air quality standards for particulate matter emitted from power plants. The
scope and extent of new environmental regulations, including their effect on our
operations, is unclear. Unless our contracts with customers expressly permit us
to pass through increased costs attributable to new statutes, rules and
regulations, we may not be able to recover capital costs of complying with new
environmental regulations, which may adversely affect our profitability.
PRIOR TO OUR COMPLETE SEPARATION FROM SOUTHERN COMPANY, OUR BUSINESS WILL
CONTINUE TO BE SUBJECT TO REGULATION UNDER THE PUBLIC UTILITY HOLDING COMPANY
ACT. THAT ACT LIMITS OUR BUSINESS OPERATIONS, OUR ABILITY TO PAY DIVIDENDS,
OUR ABILITY TO RECEIVE DIVIDENDS FROM OUR SUBSIDIARIES AND OUR ABILITY TO
AFFILIATE WITH PUBLIC UTILITIES.
Until the distribution of our stock held by Southern Company, we will
continue to be subject to regulation under the Public Utility Holding Company
Act (PUHCA) as a subsidiary company of a public utility holding company
registered under PUHCA. As a result, we are subject to limitations under PUHCA
related to our acquisition, ownership and operation of energy assets outside of
our current business plan and payments of dividends by us and our subsidiaries
from unearned surplus. Additionally, as long as we are an affiliate of Southern
Company, we must obtain approval under PUHCA prior to acquiring the voting
securities of any public utility or taking any other actions that
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would result in affiliation with another public utility. Following the
distribution, we do not expect to be subject to the provisions of PUHCA either
as a subsidiary or an affiliate of Southern Company. Further, we believe that as
long as our domestic power plants qualify as either exempt wholesale generators
(EWGs) or qualifying facilities (QFs) under the Public Utility Regulatory
Policies Act of 1978, as amended (PURPA), and we do not otherwise acquire public
utility assets or securities of public utility companies, we will not be subject
to PUHCA. We do not currently intend to take actions that would cause us to
become subject to regulation under PUHCA.
Currently, we are authorized under orders issued by the Securities and
Exchange Commission (SEC) under PUHCA to acquire, own and operate energy
facilities or businesses such as EWGs, foreign utility companies (FUCOs) and
QFs, to engage in other energy-related activities in the United States and to
engage in energy marketing apart from investments in EWGs and FUCOs in the
United States and Canada. The SEC order expires on December 31, 2000. We intend
to file an application to extend the expiration date of this order so that the
order will not expire until after the distribution. If the SEC does not extend
the order and we are still an affiliate of Southern Company, our operations may
be adversely affected and we may not be able to pursue our business strategies.
Further, we and our subsidiaries are authorized under an order issued by the SEC
to pay dividends out of unearned surplus. This order is necessary to exempt us
and our subsidiaries from restrictions on the payment of dividends contained in
PUHCA. The order expires June 30, 2001. If Southern Company has not completed
the distribution of our common stock by June 30, 2001, and if the SEC does not
extend the order beyond that date, cash may be trapped in some of our
subsidiaries, reducing our cash management flexibility and increasing our need
for working capital and external financing.
Our energy marketing business units are authorized under orders issued by
the SEC to conduct electricity and natural gas marketing in the United States
and Canada and, through December 31, 2000, to invest up to $300 million to
acquire assets related to energy marketing in the United States and Canada.
Prior to the distribution, this restriction will limit our ability to make a
major acquisition of an energy asset (which is not a FUCO, EWG or a United
States energy-related company) without further PUHCA approvals.
OUR BUSINESS IN THE UNITED STATES IS SUBJECT TO COMPLEX GOVERNMENT REGULATIONS
AND MAY BE ADVERSELY AFFECTED BY CHANGES IN THESE REGULATIONS OR IN THEIR
IMPLEMENTATION.
The majority of our generation operations in the United States are EWGs
which sell electricity exclusively into the wholesale market. Generally, our
EWGs are subject to regulation by the Federal Energy Regulatory Commission
(FERC) regarding rate matters and state public utility commissions regarding
non-rate matters. The majority of our generation from EWGs is sold at market
prices under market rate authority exercised by FERC, although FERC has the
authority to impose "cost of service" rate regulation if it determines that
market pricing is not in the public interest. Any reduction by FERC of the rates
we may receive for our generation activities may adversely affect our results of
operations. For more information regarding relevant U.S. public utility
regulation, see "Business -- Regulation -- U.S. Public Utility Regulation."
For example, on June 7, 2000, an administrative law judge presiding over a
FERC proceeding involving our California operations issued an initial decision
allocating the responsibility for payment of a settled $158.8 million amount to
be paid under the reliability must-run contracts between our California
subsidiaries and the California Independent System Operator (CAISO). The
administrative law judge allocated 3% of the responsibility to the CAISO and the
remainder to our California subsidiaries. Our California subsidiaries had
proposed to allocate 75%, $120 million, of the responsibility to the CAISO. On
July 7, 2000, we filed an appeal of this decision with the FERC; however we
cannot assure you that our appeal will be successful. A final FERC order in this
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proceeding may be appealed to the U.S. Court of Appeals. If we are not
successful in this appeal, our results of operations would be adversely
affected. For more information regarding this proceeding, see "Business -- Legal
Proceedings."
To conduct our business, we must obtain licenses, permits and approvals for
our plants. We cannot assure you that we will be able to obtain and comply with
all necessary licenses, permits and approvals for our plants. If we cannot
comply with all applicable regulations, our business, results of operations and
financial condition could be adversely affected.
THE ENERGY INDUSTRY IS RAPIDLY CHANGING TO INCREASED COMPETITION AND WE MIGHT
NOT BE SUCCESSFUL IN RESPONDING TO THESE CHANGES.
We may not be able to respond in a timely or effective manner to the many
changes intended to increase competition in the energy industry in both domestic
and international markets. These changes may include deregulation of the
electric utility industry in some markets, privatization of the electric utility
industry in other markets and increasing competition in all markets. To the
extent competitive pressures increase and the pricing and sale of electricity
assumes more characteristics of a commodity business, the economics of our
business may come under increasing pressure. Industry deregulation and
privatization may not only continue to fuel the current trend toward
consolidation in the utility industry but may also encourage the disaggregation
of vertically integrated utilities into separate generation, transmission and
distribution businesses. As a result, additional significant competitors could
become active in our industry and we may not be able to maintain our revenues
and earnings in this competitive marketplace or to acquire or develop new assets
to pursue our growth strategy.
Many states are implementing or considering regulatory initiatives designed
to increase competition in the domestic power generation industry and increase
access for independent power producers and electricity consumers to electric
utilities' transmission and distribution systems. Industry restructuring in the
regions where we have substantial operations could affect our operations in a
manner which is difficult to predict, since the effects will depend on the form
and timing of the restructuring. Access to transmission and distribution systems
is essential to permit entry into markets by us and our competitors. In
addition, effective entry involves substantial investment in fixed assets, such
as building power plants. If a region's power transmission infrastructure is
inadequate, our recovery of costs and profits may be limited, and the imposition
of restrictive price regulation may result in reduced incentive to invest in
expansion of transmission infrastructures. In addition, regulations to which we
are subject may change in other ways which we cannot predict. The structure of
these energy regulations has been in the past, and may be in the future, the
subject of various challenges and restructuring proposals by utilities and other
industry participants. Regulatory initiatives in foreign countries where we have
or will have operations involve the same types of risks.
The United States Congress is considering legislation which would repeal
PURPA entirely, or at least eliminate prospectively the obligation of utilities
to purchase power from QFs. Various bills have also proposed repeal of PUHCA. In
the event of a PUHCA repeal, competition from independent power generators and
from utilities with generation, transmission and distribution would likely
increase. Repeal of PURPA or PUHCA may or may not be part of comprehensive
legislation to restructure the electric utility industry, allow retail
competition and deregulate most electric rates. We cannot predict the effect of
this type of legislation, although we anticipate that any legislation would
result in increased competition. If we were unable to compete in an increasingly
competitive environment, our business and results of operation may suffer.
FERC has issued power and gas transmission initiatives that require
electric and gas transmission services be offered on a common carrier basis
unbundled from commodity sales. Although these initiatives are designed to
encourage wholesale market transactions for electricity and gas, there is the
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potential that fair and equal access to transmissions systems will not be
available and we cannot predict the timing of industry changes as a result of
these initiatives or the adequacy of transmission additions in specific markets.
In Canada, national and provincial governments have instituted natural gas
regulations also designed to encourage the development of competitive markets.
However, we cannot predict the timing and scope of the development of a
competitive market in Canada or the effect of these or future regulations on
these markets.
We cannot predict whether the federal government, state legislatures or
foreign governments will adopt legislation relating to the deregulation of the
energy industry. We cannot assure you that the introduction of new laws or other
future regulatory developments will not have a material adverse effect on our
business, results of operations or financial condition.
CHANGES IN TECHNOLOGY MAY IMPAIR THE VALUE OF OUR POWER PLANTS AND MAY
SIGNIFICANTLY IMPACT OUR BUSINESS IN OTHER WAYS AS WELL.
A basic premise of our business is that central station power generation
achieves economies of scale and produces electricity at a low price, and
therefore is in demand. There are other technologies that can produce
electricity, most notably fuel cells, microturbines, windmills and photovoltaic
(solar) cells. The average cost for new central station generated electricity is
approximately 3c per kilowatt hour (kWh) while costs for current alternate
electricity generation methods range from approximately 5c/kWh to 20c/kWh.
Research and development activities are ongoing to seek improvements in the
alternate technologies. It is possible that advances will reduce the cost of
alternate methods of electric production to a level that is equal to or below
that of most central station electric production. If this were to happen, the
value of our power generation assets may be significantly impaired.
We make extensive use of computer software in the normal course of
conducting our business, particularly in our energy marketing business. This
technology is changing rapidly and upgrades are often necessary to support our
applications. These advances in technology could make our current applications
obsolete and the cost of upgrades could be material.
OUR FACILITIES MAY NOT OPERATE AS PLANNED, WHICH MAY LEAD TO POOR FINANCIAL
PERFORMANCE AND THE ACCELERATION OF OUR PROJECT DEBT.
Our operation of power production facilities involves many risks, including
the breakdown or failure of generation equipment or other equipment or
processes, labor disputes, fuel interruption and operating performance below
expected levels. For example, in 1998 an explosion and fire occurred at our
State Line facility in Indiana, which caused personal injuries and damage to
equipment. In addition, weather related incidents and other natural disasters
can disrupt both generation and transmission delivery systems. Operation of our
power production facilities below expected capacity levels may result in lost
revenues or increased expenses, including higher maintenance costs and
penalties. In addition, we may not be able to repay the project debt for an
under-performing facility, which could trigger default provisions in a project
subsidiary's or project affiliate's financing agreements and might allow the
affected lenders to accelerate that debt.
OUR OPERATIONS DEPEND SUBSTANTIALLY ON THE PERFORMANCE OF OUR SUBSIDIARIES AND
AFFILIATES, SOME OF WHICH WE DO NOT CONTROL AND SOME OF WHICH ARE SUBJECT TO
RESTRICTIONS AND TAXATION ON DIVIDENDS AND DISTRIBUTIONS.
Almost all of our operations are conducted through our subsidiaries and
affiliates. As a result, we depend almost entirely upon their earnings and cash
flow.
Seven of our major affiliates, listed below, are not subject to our control
of management and policies to the same extent as our consolidated subsidiaries:
- Southern Company Energy Marketing, L.P. (SCEM),
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- Birchwood Power Partners, L.P., which owns the Birchwood power plant in
Fredericksburg, Virginia,
- Bewag AG, the Berlin electric utility,
- Shajiao C,
- CEMIG,
- the Power Generation Company of Trinidad and Tobago, and
- Shandong International Power Development Company.
However, we do exercise significant influence over the operations of these
affiliates and we account for these investments using the equity method of
accounting. These affiliates contributed approximately 31% of our income from
continuing operations in 1999.
In addition, the debt agreements of some of our subsidiaries and affiliates
restrict their ability to pay dividends, make distributions or otherwise
transfer funds to us prior to the payment of other obligations, including
operating expenses, debt service and reserves. Further, if we elect to receive
distributions of earnings from our foreign operations, we may incur United
States taxes, net of any available foreign tax credits, on such amounts.
Dividend payments from our international projects to us are, in some countries,
also subject to withholding taxes.
OUR BUSINESS DEVELOPMENT ACTIVITIES MAY NOT BE SUCCESSFUL AND OUR PROJECTS
UNDER CONSTRUCTION MAY NOT COMMENCE OPERATION AS SCHEDULED DESPITE OUR
EXPENDITURE OF SIGNIFICANT AMOUNTS OF CAPITAL.
Our business involves numerous risks relating to the acquisition,
development and construction of large power generation facilities. Our success
in developing a particular project is contingent upon, among other things,
negotiation of satisfactory engineering, construction, fuel supply and power
sales contracts, receipt of required governmental permits and timely
implementation and satisfactory completion of construction. We may be
unsuccessful in accomplishing any of these matters or in doing so on a timely
basis. Although we may attempt to minimize the financial risks in the
development of a project by securing a favorable power sales agreement, to
obtain all required governmental permits and approvals and to arrange adequate
financing prior to the commencement of construction, the development of a power
project may require us to expend significant sums for preliminary engineering,
permitting and legal and other expenses before we can determine whether a
project is feasible, economically attractive or capable of being financed.
Currently, we have power generation facilities under development or
construction and we intend to pursue the expansion of existing facilities and
the development of other new plants. Our completion of these facilities without
delays or cost overruns is subject to substantial risks, including:
- changes in market prices,
- shortages and inconsistent qualities of equipment, material and labor,
- work stoppages,
- permitting and other regulatory matters,
- adverse weather conditions,
- unforeseen engineering problems,
- environmental and geological conditions,
- unanticipated cost increases, and
- our attention to other projects,
any of which could give rise to delays, cost overruns or the termination of the
plant expansion, construction or development.
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If we were unable to complete the development of a facility, we would
generally not be able to recover our investment in the project. The process for
obtaining initial environmental, siting and other governmental permits and
approvals is complicated, expensive and lengthy, often taking more than one
year, and is subject to significant uncertainties. In addition, construction
delays and contractor performance shortfalls can result in the loss of revenues
and may, in turn, adversely affect our results of operations. The failure to
complete construction according to specifications can result in liabilities,
reduced plant efficiency, higher operating costs and reduced earnings. We cannot
assure you that we will be successful in the development or construction of
power production facilities in the future.
WE HAVE TAKEN INCOME TAX REPORTING POSITIONS THAT HAVE NOT BEEN AUDITED BY THE
INTERNAL REVENUE SERVICE AND COULD BE DISALLOWED. ANY DISALLOWANCE WOULD
ADVERSELY AFFECT US.
In connection with the acquisition of our international operations we have
taken federal income tax reporting positions that have not been audited by the
Internal Revenue Service for any tax years after 1995. We believe that we have
substantial authority for the positions we have taken, and we have disclosed on
Southern Company's consolidated income tax returns that we have taken these
reporting positions. However, we cannot assure you that these or other reporting
positions will be sustained. The disallowance of one or more of these reporting
positions could have a material adverse effect on our cash flows and net income
and could impair, at least temporarily, our ability to finance new investments.
However, we do not expect any disallowance of tax reporting positions that we
have taken to prevent us from achieving our growth strategy.
RISKS RELATED TO OUR SEPARATION FROM SOUTHERN COMPANY
OUR CREDIT RATING WILL LIKELY DECLINE AS A RESULT OF OUR SEPARATION FROM
SOUTHERN COMPANY AND AS A RESULT WE MAY FACE INCREASED BORROWING COSTS, MORE
RESTRICTIVE COVENANTS AND REDUCED AMOUNTS OF CREDIT, WHICH MAY MAKE IT MORE
DIFFICULT OR EXPENSIVE TO PURSUE OUR GROWTH STRATEGY.
Our operation as a separate entity from Southern Company will likely have a
negative impact on our credit rating and may also affect the credit ratings of
our subsidiaries. In fact, rating agencies have recently announced that they
will re-assess our credit ratings and the credit ratings of our subsidiaries in
light of our separation from Southern Company. These announcements indicate that
our credit rating and the credit ratings of our subsidiaries will likely decline
upon completion of their re-assessment. Historically, Southern Company has
provided financing and credit support to us and our project financing
activities. Following this offering, Southern Company will no longer provide
financing or credit support for our operations except for specified transactions
and for a limited period of time. In addition, we may increase the proportion of
debt in our overall capital structure as part of our growth plan. These events
will likely negatively affect our credit rating. If our corporate credit rating
declines below an investment grade credit rating and we are unable to
restructure our indebtedness or obtain waivers, we may be in default under
several of our financing agreements unless we are able to cure those defaults.
In addition, we have performance guarantees related to SCEM's business that
require us to maintain an investment grade credit rating. If our credit rating
declines below investment grade, we will be obligated to provide credit
enhancement to the guaranteed party in the form of a pledge of cash collateral,
a letter of credit or other similar credit enhancement. Furthermore, if the
credit ratings of our energy marketing and risk management subsidiaries decline
below an investment grade credit rating, our trading partners may refuse to
trade with us or trade only on terms unfavorable to us.
Any of these events would likely result in increased borrowing costs, more
restrictive covenants and reduced lines of credit from lenders, suppliers and
counterparties, all of which would adversely affect our business and results of
operations and our ability to raise capital to pursue our growth
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strategy. We cannot assure you that our credit ratings will not be negatively
affected after our separation from Southern Company.
OUR FINANCING AGREEMENTS HAVE CHANGE OF CONTROL PROVISIONS THAT MUST BE
WAIVED, OR THE AGREEMENTS MUST BE REPLACED, PRIOR TO THE DISTRIBUTION OF OUR
COMMON STOCK BY SOUTHERN COMPANY.
The distribution of our common stock by Southern Company, if it occurs,
will constitute a change of control under provisions in all of our corporate
financing agreements and many of our subsidiary financing agreements. Without
the consent of or a waiver from the lenders under these agreements, the spin-off
will result in an event of default. In addition, an event of default under one
of these financing agreements may trigger an event of default under all other
financing agreements. Upon an event of default under these financing agreements,
the lenders may terminate any obligation to make further advances and declare
all outstanding indebtedness immediately due and payable. We will seek consents
or waivers of these provisions prior to the distribution of our common stock by
Southern Company. We may incur additional costs to obtain these consents and
waivers. In addition, we may be required to renegotiate the terms of these
agreements or replace them on terms less favorable than we currently enjoy. We
cannot assure you that we will be successful in obtaining consents or waivers on
favorable terms or at all. If we cannot obtain consents or waivers, we may incur
material costs to repay or refinance these financing agreements. We cannot
assure you that we will be able to repay or refinance these financing
agreements. Any of these events may have an adverse effect on our business and
our results of operations. In the case of very large project loans (in principal
amounts of approximately $1 billion or more), our inability to obtain consents
or waivers or to refinance the loan may require borrowing by us at the corporate
level which could constrain our ability to raise sufficient additional capital
to achieve our strategic growth objectives.
OUR SEPARATION FROM SOUTHERN COMPANY WILL RESULT IN A LOSS OF INTANGIBLE
BENEFITS AND THE QUALIFIED EMPLOYMENT POOL CURRENTLY PROVIDED BY OUR
ASSOCIATION WITH SOUTHERN COMPANY.
In the past we have enjoyed "brand" identification, goodwill and other
intangible benefits as a result of being one of Southern Company's subsidiaries.
We have also had access to the pool of Southern Company employees in filling our
management, administrative and technical positions. We will no longer have
access to or be able to rely on these benefits, which may adversely affect our
business.
OUR BUSINESS AND YOUR INVESTMENT IN OUR STOCK MAY BE ADVERSELY AFFECTED IF
SOUTHERN COMPANY DOES NOT COMPLETE THE DISTRIBUTION OF OUR COMMON STOCK
BECAUSE WE WOULD REMAIN SUBJECT TO REGULATORY RESTRICTIONS AS A SUBSIDIARY OF
A PUBLIC UTILITY HOLDING COMPANY AND BECAUSE WE WOULD REMAIN SUBJECT TO
CONTROL BY SOUTHERN COMPANY.
Although Southern Company has advised us that it currently intends to
complete the distribution of our common stock within 12 months after this
offering, we cannot assure you whether or when it will occur. Southern Company
is not obligated to complete the distribution of our common stock. Southern
Company currently intends that, subject to obtaining a ruling from the Internal
Revenue Service that the distribution will be tax-free to Southern Company and
its stockholders and will qualify as a reorganization, Southern Company will
distribute to its stockholders all of our common stock that it owns, although it
is not obligated to do so. At the time of this offering, we will not have a
ruling from the IRS regarding the tax treatment of the distribution. If Southern
Company does not receive a favorable tax ruling, it is not likely to make the
distribution in the expected time frame or at all.
In addition, our separation from Southern Company and the distribution of
our stock by Southern Company requires PUHCA authorization, and we cannot assure
you that such authorization will be received. Southern Company is requesting an
extension of its general authority to continue to
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own us, required under PUHCA to accomplish the distribution in calendar year
2001. The SEC also has general authority over transactions among Southern
Company affiliates under PUHCA. Southern Company and we will file a request with
the SEC to allow the distribution to proceed as contemplated by the separation
agreements. The SEC may impose conditions on or disapprove of the proposed
separation and any of the separation agreements.
If Southern Company fails to complete the distribution of our common stock,
or fails to complete it substantially within the time contemplated, our business
would be adversely affected. We would remain subject to regulatory restrictions
as a subsidiary of a regulated public utility holding company, we would not be
able to raise equity capital without compliance with regulatory requirements and
we would likely not realize the benefits we anticipate resulting from our
separation from Southern Company. We cannot assure you that we will obtain the
expected benefits or as to the timing of any benefits.
In addition, until this distribution occurs, the risks discussed below
relating to Southern Company's control of us and the potential business
conflicts of interest between Southern Company and us will continue to be
relevant to you. If the distribution is delayed or not completed at all, the
liquidity of our shares in the market may be constrained unless and until
Southern Company elects to sell some of its significant ownership. There are no
limits on these sales and the sale or potential sale by Southern Company could
adversely affect market prices. In addition, because of the limited liquidity
until the distribution occurs, relatively small trades of our stock may have a
disproportionate effect on our stock price.
WE WILL BE CONTROLLED BY SOUTHERN COMPANY AS LONG AS IT OWNS A MAJORITY OF OUR
COMMON STOCK, AND OUR NEW MINORITY STOCKHOLDERS WILL BE UNABLE TO AFFECT THE
OUTCOME OF STOCKHOLDER VOTING DURING THAT TIME.
After the completion of this offering, Southern Company will own over 80%
of our outstanding common stock. As long as Southern Company owns a majority of
our outstanding common stock, Southern Company will continue to be able to elect
our entire board of directors without calling a special meeting. Investors in
this offering, by themselves, will not be able to affect the outcome of any
stockholder vote prior to the planned distribution of our stock to Southern
Company stockholders. As a result, Southern Company, subject to any fiduciary
duty owed to our minority stockholders under Delaware law, will be able to
control all matters affecting us, including:
- the composition of our board of directors and, through it, any
determination with respect to our business direction and policies,
including the appointment and removal of officers,
- determination of incentive compensation which may affect our ability to
retain key employees,
- the allocation of business opportunities that may be suitable for
Southern Company and us,
- any determinations with respect to mergers or other business
combinations,
- our acquisition or disposition of assets,
- our financing decisions and our capital raising activities,
- changes to the agreements providing for our separation from Southern
Company,
- the payment of dividends on our common stock, and
- determinations with respect to our tax returns.
OUR HISTORICAL FINANCIAL RESULTS AS A SUBSIDIARY OF SOUTHERN COMPANY MAY NOT
BE REPRESENTATIVE OF OUR RESULTS AS A SEPARATE COMPANY.
The historical financial information we have included in this prospectus
does not necessarily reflect what our financial position, results of operations
and cash flows would have been had we been
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a separate, stand-alone entity during the periods presented. Our costs and
expenses reflect charges from Southern Company for centralized corporate
services and infrastructure costs, including:
- engineering,
- legal,
- accounting,
- information technology,
- investor relations and stockholder services,
- insurance and risk management,
- tax,
- environmental,
- human resources and payroll, and
- external affairs, including marketing and public relations.
These allocations have been determined based on regulatory limitations and
other bases that we and Southern Company considered to be reasonable reflections
of the utilization of services provided to us or for the benefits received by
us. This historical financial information is not necessarily indicative of what
our results of operations, financial position and cash flows will be in the
future. We may experience significant changes in our cost structure, funding and
operations as a result of our separation from Southern Company, including
increased costs associated with reduced economies of scale, increased marketing
expenses related to building a company brand identity separate from Southern
Company and increased costs associated with being a publicly traded, stand-alone
company.
IF THE DISTRIBUTION OF OUR STOCK BY SOUTHERN COMPANY TO ITS STOCKHOLDERS FAILS
TO QUALIFY AS A TAX-FREE TRANSACTION, WE MAY BE REQUIRED TO INDEMNIFY SOUTHERN
COMPANY FOR ANY RESULTING TAXES. THIS POTENTIAL OBLIGATION TO INDEMNIFY
SOUTHERN COMPANY MAY PREVENT OR DELAY A CHANGE OF CONTROL OF US AFTER SOUTHERN
COMPANY DISTRIBUTES OUR STOCK TO ITS SHAREHOLDERS.
Within 12 months after the completion of this offering, Southern Company
intends to distribute the shares of our stock it owns to Southern Company
stockholders. Prior to the distribution, Southern Company intends to receive a
ruling from the IRS that the distribution will be tax-free. However, under an
agreement between us and Southern Company, if we breach any representations in
connection with the ruling, take any action which causes our representations to
be untrue or engage in a transaction after the distribution that causes the
distribution to be taxable to Southern Company, we will be required to indemnify
Southern Company for any resulting taxes. The amount of any indemnification
payments would be substantial and we likely would not have sufficient financial
resources to achieve our growth strategy.
Current tax law provides for a presumption that the distribution of our
stock by Southern Company, if it occurs, may be taxable to Southern Company if
our company undergoes a 50% or greater change in stock ownership within two
years after the distribution. Under agreements between Southern Company and us,
Southern Company may require us to reimburse any taxation costs incurred by
Southern Company and its stockholders as a result of a transaction resulting in
a change in control of our company. These costs may be so great that they delay
or prevent a strategic acquisition or change in control of our company.
OUR DECONSOLIDATION FROM THE SOUTHERN COMPANY CONSOLIDATED TAX GROUP MAY
RESULT IN ADVERSE TAX CONSEQUENCES TO US.
Subsequent to the distribution of our stock by Southern Company, we will
cease to be a member of the Southern Company consolidated tax group. This
separation will have both current and future income tax implications to the
company. The event of deconsolidation itself will result in the recapture of
dual consolidated tax losses and the triggering of deferred intercompany gains.
We will
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recognize taxable income related to these gains and losses which will not have a
material impact on our net income and cash flow. We will also take appropriate
steps to continue the deferral of any other dual consolidated losses as provided
by the tax laws. Any potential future recapture of these losses would result in
material tax liabilities which may have a material adverse effect on our net
income and cash flow, but we do not expect them to materially affect our ability
to pursue our growth strategy.
In addition to the current income tax consequences triggered by the act of
deconsolidation discussed above, our separation from the Southern Company
consolidated tax group will change our overall future income tax posture. Based
on our current structure and net income, we could be limited in our future
ability to effectively use tax attributes such as foreign tax credits associated
with overseas operations. The inability to use these attributes could result in
material tax liabilities. We intend to undertake appropriate measures after
deconsolidation in order to mitigate any adverse tax effect of no longer being a
part of the Southern Company consolidated tax group. We cannot assure you that
these efforts will be successful; however, we do not expect any such tax
liabilities to effect our ability to pursue our growth strategy.
WE MAY HAVE POTENTIAL BUSINESS CONFLICTS OF INTEREST WITH SOUTHERN COMPANY
WITH RESPECT TO OUR PAST AND ONGOING RELATIONSHIPS AND, BECAUSE OF SOUTHERN
COMPANY'S CONTROLLING OWNERSHIP PRIOR TO THE DISTRIBUTION, WE MAY NOT BE ABLE
TO RESOLVE THESE CONFLICTS ON TERMS COMMENSURATE WITH THOSE POSSIBLE IN ARMS'
LENGTH TRANSACTIONS.
Conflicts of interest may arise between Southern Company and us in a number
of areas relating to our past and ongoing relationships. Conflicts of interest
with Southern Company may arise under many circumstances, including the
following:
- solicitation and hiring of employees from each other,
- the timing and manner of any sales or distributions by Southern Company
of all or any portion of its ownership interest in us,
- the nature and quality of transitional services Southern Company has
agreed to provide us,
- our business operations within Southern Company's service territory or
other business opportunities that would compete with Southern Company,
- actions and decisions of legislative bodies and administrative agencies,
and
- our dividend policy.
Following this offering, the agreements we have entered into with Southern
Company may be amended upon agreement of the parties. While we are controlled by
Southern Company, Southern Company may be able to require us to agree to
amendments to these agreements. We may not be able to resolve any potential
conflicts with Southern Company, and even if we do, the resolution may be less
favorable than if we were dealing with an unaffiliated party.
OUR DIRECTORS AND EXECUTIVE OFFICERS MAY HAVE CONFLICTS OF INTEREST BECAUSE OF
THEIR OWNERSHIP OF SOUTHERN COMPANY COMMON STOCK.
Many of our directors and executive officers own a substantial amount of
Southern Company common stock and options to purchase Southern Company common
stock. Ownership of Southern Company common stock by our directors and officers
after our separation from Southern Company could create, or appear to create,
potential conflicts of interest when directors and officers are faced with
decisions that could have different implications for Southern Company than they
do for us.
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OUR ABILITY TO OPERATE OUR BUSINESS MAY SUFFER IF WE DO NOT DEVELOP OUR OWN
INFRASTRUCTURE QUICKLY AND COST-EFFECTIVELY, AND WE CANNOT ASSURE YOU THAT THE
TRANSITIONAL SERVICES THAT SOUTHERN COMPANY HAS AGREED TO PROVIDE US WILL BE
SUFFICIENT FOR OUR NEEDS.
We currently use Southern Company systems to support some of our
operations, including human resources, payroll and wide-area computer networks.
We are in the process of creating our own systems to replace Southern Company's
systems. These systems are very complex and we may not be successful in
implementing these systems or transitioning data from Southern Company's systems
to our own. Any failure or significant downtime in Southern Company's or our own
information systems could prevent us from paying payroll or performing other
administrative services and could harm our business. In addition, the
transitional services generally have a term of two years or less following the
effective date of the applicable agreement. After the expiration of these
various arrangements, we may not be able to replace the transitional services
with a comparable quality of service or on terms and conditions as favorable as
those we will receive from Southern Company.
Following the offering, Southern Company has agreed to provide transitional
services to us, including, but not limited to, services related to:
- engineering and technical consulting,
- human resources, administration and payroll,
- accounting and treasury,
- procurement,
- auditing,
- legal,
- governmental affairs,
- information technology infrastructure, and
- insurance.
Under the separation agreements, Southern Company is only obligated to
provide services to us after it has satisfied its obligations to its other
subsidiaries and operating companies. In addition, Southern Company has wide
discretion on what employees it will utilize to provide services to us.
Consequently, the quality and quantity of the services we receive from Southern
Company may not be as good as the services we received prior to the
effectiveness of the separation agreements.
RISKS RELATED TO THE SECURITIES MARKETS AND OWNERSHIP OF OUR COMMON STOCK
SUBSTANTIAL SALES OF COMMON STOCK MAY OCCUR IN CONNECTION WITH THE
DISTRIBUTION, WHICH COULD CAUSE OUR STOCK PRICE TO DECLINE.
Southern Company currently intends to distribute all of the 272,000,000
shares of our common stock it owns to Southern Company stockholders within 12
months after this offering. Substantially all of these shares will be eligible
for immediate resale in the public market. We are unable to predict whether
significant amounts of common stock will be sold in the open market in
anticipation of, or following, the distribution, or by Southern Company if the
distribution does not occur. We are also unable to predict whether a sufficient
number of buyers will be in the market at that time. Any sales of substantial
amounts of common stock in the public market, or the perception that these sales
might occur, whether as a result of this distribution or otherwise, could lower
the market price of our common stock. In addition, we have entered into a
registration rights agreement which provides that if Southern Company does not
distribute to the holders of its common stock all of the shares of our common
stock that its owns, Southern Company and its transferees will have the right to
require us to register these shares of our common stock under the United States
securities laws for sale into the public market.
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THE INITIAL PUBLIC OFFERING PRICE OF OUR COMMON STOCK MAY NOT BE INDICATIVE OF
THE MARKET PRICE OF OUR STOCK AFTER THE OFFERING. IN ADDITION, OUR STOCK PRICE
MAY BE VOLATILE.
The initial public offering price of our common stock will be determined by
negotiations among us and the representatives of the underwriters. This price
will be based on numerous factors (discussed in the section of this prospectus
entitled "Underwriters") and may not be indicative of the market price for our
common stock after the initial public offering. The market price of our common
stock could be subject to significant fluctuations after the offering, and may
decline below the initial public offering price. We cannot assure you that you
will be able to resell your shares at or above the initial public offering
price. Among the factors that could affect our stock price are:
- quarterly variations in the rate of growth of our financial indicators,
such as earnings per share, net income and revenues,
- changes in revenue or earnings estimates or publication of research
reports by analysts,
- speculation in the press or investment community,
- strategic actions by us or our competitors, such as acquisitions or
restructurings,
- actions by institutional investors or by Southern Company prior to its
distribution of our stock,
- general market conditions, including fluctuations in commodity prices,
and
- domestic and international economic, legal and regulatory factors
unrelated to our performance.
The stock markets in general have experienced extreme volatility that has
often been unrelated to the operating performance of particular companies. These
broad market fluctuations may adversely affect the trading price of our common
stock.
PROVISIONS IN OUR CHARTER DOCUMENTS AND DELAWARE LAW MAY DELAY OR PREVENT
ACQUISITION OF US, WHICH COULD ADVERSELY AFFECT THE VALUE OF YOUR SHARES.
Our restated certificate of incorporation and our bylaws contain provisions
that could make it harder for a third party to acquire us after the full
distribution by Southern Company without the consent of our board of directors.
These provisions disallow actions by our stockholders by written consent once
Southern Company ceases to own a majority of our common stock. In addition,
these provisions include procedural requirements relating to stockholder
meetings and stockholder proposals that could make stockholder actions more
difficult. Beginning at the time Southern Company ceases to own 33 1/3% of our
common stock, our board of directors will be classified into three classes of
directors serving staggered, three-year terms and may be removed only for cause.
Any vacancy on the board of directors may be filled only by the vote of the
majority of directors then in office. Our board of directors has the right to
issue preferred stock without stockholder approval, which could be used to
dilute the stock ownership of a potential hostile acquirer. Delaware law also
imposes some restrictions on mergers and other business combinations between us
and any holder of 15% or more of our outstanding common stock. Although we
believe these provisions provide for an opportunity to receive a higher bid by
requiring potential acquirers to negotiate with our board of directors, these
provisions apply even if the offer may be considered beneficial by some
stockholders.
PURCHASERS IN THIS OFFERING WILL EXPERIENCE IMMEDIATE DILUTION IN NET TANGIBLE
BOOK VALUE PER SHARE.
Dilution per share represents the difference between the initial public
offering price and the net consolidated book value per share immediately after
the offerings of our common stock and the preferred securities. Purchasers of
our common stock in this offering will experience immediate dilution of $20.20
in net tangible book value per share. In addition, it is anticipated that
investors who purchase shares of our common stock in this offering will
contribute an aggregate of 23.7% of all cash paid for our common stock, but own
approximately 17.6% of our common stock. See the section of the prospectus
entitled "Dilution" for more information.
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OUR SEPARATION FROM SOUTHERN COMPANY
OVERVIEW
On April 17, 2000, Southern Company announced its plan to make Southern
Energy, currently a wholly owned subsidiary, an independent, publicly traded
company focused on the worldwide competitive energy markets. Unless Southern
Company completes the distribution of our stock to its stockholders, we will
continue as a subsidiary of Southern Company.
BENEFITS OF THE SEPARATION
We believe that we will realize certain benefits from our complete
separation from Southern Company, which includes the distribution by Southern
Company of our common stock, including the following:
- REDUCED GOVERNMENTAL REGULATION. Following the distribution by Southern
Company of our common stock, we will not be affiliated with any public
utility company within the meaning of PUHCA. As a result, we anticipate
that we will not be subject to regulation under PUHCA. For example, we
will not need to obtain PUHCA approval to acquire interests in businesses
other than public utility companies even though acquisition of those
businesses would not qualify as exempt from PUHCA approval requirements
if purchased by a holding company registered under PUHCA. In addition, we
will not need PUHCA approval for the acquisition of assets or securities
which results in affiliation with a single public utility. After the
distribution of our common stock by Southern Company, we expect to
conduct our business so that we remain outside of PUHCA regulation. In
addition, our complete separation from Southern Company will result in
fewer regulatory constraints on and less regulatory influence over our
operations.
- INCREASED CAPITAL FINANCING FLEXIBILITY. As a separate entity we expect
to be able to raise equity on more attractive terms because we expect our
earnings to grow faster than the regulated utility businesses of Southern
Company. Therefore, we expect our common stock to be valued at a higher
multiple of earnings than Southern Company's common stock. We will also
have the ability to use our equity securities as a form of consideration
for possible future acquisitions and to fund development projects. In
addition, Southern Company is limited in the amount of additional debt
that it can add to its consolidated balance sheet without affecting its
credit rating and its ability to recover the cost of its debt service
through rate increases. After the distribution, we will be able to raise
debt without this potential constraint related to the consolidated
Southern Company.
- PROVIDE A TARGETED INVESTMENT FOR OUR STOCKHOLDERS. The nature of
Southern Company's regulated utility business is substantially different
from our electricity and gas asset management and marketing and risk
management businesses. As a result of our complete separation from
Southern Company, we believe that we will offer an investment opportunity
that provides higher growth than that of the regulated utility business.
Our complete separation will allow investors to better align their
investment objectives through ownership of either Southern Company stock
or our stock.
- INCREASED STRATEGIC FOCUS. As a subsidiary of Southern Company we are
both capital constrained and limited in the businesses in which we can
enter by government regulations. We also have to compete with Southern
Company's other subsidiaries for investment opportunities and have a
longer review and approval process for new investments than many of our
competitors. As a separate entity, we will be able to develop our
strategy without regard to
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its effect on Southern Company and will thus have greater independence in
establishing and implementing our strategy than we do now.
- ACCESS TO ADDITIONAL MARKETS. We currently do not compete in Southern
Company's service territory in the southeastern United States. After the
distribution, we will be able to compete for wholesale and retail
customers and develop power plants in Southern Company's service
territory, thus giving us an additional opportunity to grow our business.
- INCREASED SPEED AND RESPONSIVENESS. After the distribution, we expect to
be able to make decisions more quickly and efficiently because we will no
longer have to review these decisions with Southern Company's management
and board of directors. As a result, we expect to be able to respond to,
approve and act on new development and acquisition opportunities more
quickly. This will allow us to compete better with companies that do not
have to obtain multiple levels of reviews and approvals.
- TARGETED INCENTIVES FOR MANAGEMENT AND EMPLOYEES. As a subsidiary of a
much larger company, it has been difficult for us to create employee
compensation programs that directly compensate our employees for the
performance of our company. As a separate public company we will be able
to offer our employees compensation directly linked to the performance of
our business, which we expect to enhance our ability to attract and
retain qualified personnel. We also expect that incentive compensation
programs tied to the market performance of our common stock will
strengthen the focus of our management and the motivation of our
employees and align their interests with those of our stockholders.
SEPARATION AND TRANSITIONAL AGREEMENTS
We have entered into agreements with Southern Company providing for the
separation of our business from Southern Company, including a master separation
and distribution agreement. These agreements generally provide for, among other
things, the transfer from Southern Company to us of assets and the assumption by
us of liabilities relating to our business. We have also entered into agreements
governing various interim and ongoing relationships between us and Southern
Company including transitional services Southern Company will provide to us. For
a summary description of these agreements, see "Agreements Between Us and
Southern Company."
In connection with our separation from Southern Company, we will transfer
two of our subsidiaries, SE Finance and Capital Funding, to Southern Company. In
order to facilitate the transfer to Southern Company, prior to this offering we
will issue one share of our redeemable preferred stock to Southern Company.
After this offering and prior to the distribution of our stock by Southern
Company, we will form a corporation with Southern Company Energy Solutions, Inc.
(SCES), a wholly-owned subsidiary of Southern Company. We will contribute the
stock of SE Finance and Capital Funding to the corporation in exchange for an
80% or greater interest. SCES will contribute its energy services assets to a
limited liability company owned by the corporation in exchange for a 20% or
lesser interest. We will then redeem the one share of redeemable preferred stock
issued by us to Southern Company in exchange for our entire interest in the
corporation. We currently have credit support obligations related to SE Finance.
Following the transfer, Southern Company will assume responsibility for these
obligations.
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THE DISTRIBUTION BY SOUTHERN COMPANY OF OUR COMMON STOCK
After completion of this offering, Southern Company will own over 80% of
the outstanding shares of our common stock. Southern Company has announced that
it currently plans to complete its divestiture of our company within 12 months
after the completion of this offering by distributing all of its shares of our
common stock to the holders of Southern Company common stock. However, Southern
Company is not obligated to complete the distribution, and we cannot assure you
as to whether or when it will occur. For a description of some of the
consequences that may result if Southern Company does not complete the
distribution, see "Risk Factors -- Risks Related to Our Separation from Southern
Company -- Our business may be adversely affected if Southern Company does not
complete the distribution of our common stock."
Southern Company has advised us that it would not complete the distribution
if its board of directors determines that the distribution is no longer in the
best interest of Southern Company and its stockholders. Southern Company has
further advised us that it currently expects that the principal factors that it
will consider in determining whether and when to complete the distribution
include:
- general market conditions and the relative market prices of our common
stock and of Southern Company's common stock,
- the receipt of a ruling from the IRS that the transaction will be
tax-free to Southern Company and its stockholders and that the
transaction will qualify as a tax-free distribution for United States
federal income tax purposes,
- receipt of necessary regulatory orders with terms and conditions
acceptable to Southern Company,
- the absence of any court orders, regulations, adverse regulatory action
or contractual restrictions prohibiting or restricting the completion of
the distribution,
- other conditions affecting our business or Southern Company's business,
and
- our ability to obtain waivers or consents from lenders or other parties
under our material financing agreements and other material contracts.
On June 2, 2000, we and Southern Company filed a request for a ruling from
the IRS that the transaction will be tax-free to Southern Company and its
stockholders for United States federal income tax purposes.
26
<PAGE> 31
USE OF PROCEEDS
We estimate that our net proceeds from the sale of the 58,000,000 shares of
common stock in this offering will be approximately $884 million (approximately
$1.017 billion if the underwriters' over-allotment option is exercised in full),
based on an assumed initial public offering price of $16.00 per share and after
deducting underwriting discounts and commissions. We estimate that our proceeds
from the concurrent sale of 6,000,000 of Convertible Trust Preferred Securities
will be approximately $300 million (approximately $345 million if the
underwriters' over-allotment option is exercised in full), based on an assumed
initial public offering price of $50 per preferred security.
We intend to use a portion of the net proceeds from these offerings to
repay commercial paper balances, which were approximately $390 million with a
weighted average interest rate of approximately 7.1% at June 30, 2000. In
addition, we intend to use a portion of the net proceeds to repay a short-term
loan of $450 million as of June 30, 2000 drawn against a 364-day Bank of America
credit facility with an interest rate of approximately 7.3%. We will use the
remaining proceeds from these offerings for general corporate purposes.
The borrowings from the Bank of America credit facility were used to pay
$450 million of the $503 million dividend to Southern Company. The commercial
paper borrowings were used for working capital.
No proceeds of these offerings will be distributed to Southern Company.
DIVIDEND POLICY
We currently intend to retain any future earnings to fund the development
and growth of our business. Therefore, we do not anticipate paying any cash
dividends on our common stock in the foreseeable future. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources" for a discussion of the
limitations of our subsidiaries to pay dividends to us.
In 1999, we paid cash dividends totalling $165 million to Southern Company.
On May 26, 2000, we paid a cash dividend to Southern Company in the amount of
$450 million, funded by short-term borrowings. On July 7, 2000, we paid an
additional cash dividend to Southern Company in the amount of $53 million,
funded by additional commercial paper borrowings. These dividends were
authorized under an order issued by the SEC which allows us to pay dividends out
of unearned surplus.
27
<PAGE> 32
CAPITALIZATION
The following table sets forth our capitalization as of March 31, 2000. Our
capitalization is presented:
- on an actual basis;
- on a pro forma basis to reflect the transfer of our SE Finance and
Capital Funding businesses to Southern Company and the borrowing of $503
million to finance the payment of cash dividends to Southern Company;
- on a pro forma, as adjusted basis to reflect the receipt and application
of the estimated net proceeds from the sale of 58,000,000 shares of
common stock in this offering, at an assumed initial public offering
price of $16.00 per share; and
- on a pro forma, as further adjusted basis to reflect the receipt and
application of the estimated net proceeds from the concurrent sale of
6,000,000 preferred securities, at an assumed public offering price of
$50 per preferred security.
You should read the information in this table together with our
consolidated financial statements and the related notes and with "Selected
Financial Information" and "Management's Discussion and Analysis of Financial
Condition and Results of Operations" included elsewhere in this prospectus.
<TABLE>
<CAPTION>
MARCH 31, 2000
----------------------------------------------
PRO FORMA,
PRO FORMA, AS FURTHER
ACTUAL PRO FORMA AS ADJUSTED ADJUSTED
------- --------- ----------- ----------
(IN MILLIONS)
(UNAUDITED)
<S> <C> <C> <C> <C>
Cash and cash equivalents................................... $ 400 $ 384 $ 475 $ 775
======= ====== ====== =======
Non-recourse short-term debt(1)............................. $ 1,687 $1,687 $1,687 $ 1,687
Current portion of non-recourse long-term debt(1)........... 278 243 243 243
Short-term debt............................................. 290 793 -- --
------- ------ ------ -------
Total short-term debt..................................... 2,255 2,723 1,930 1,930
------- ------ ------ -------
Non-recourse long-term debt(1).............................. 4,137 3,724 3,724 3,724
Senior notes and other long-term debt....................... 800 800 800 800
------- ------ ------ -------
Total long-term debt...................................... 4,937 4,524 4,524 4,524
------- ------ ------ -------
Subsidiary obligated mandatorily redeemable preferred
securities(2)............................................. 1,030 80 80 80
Minority Interest
Company obligated mandatorily redeemable securities of a
subsidiary holding solely parent company debentures..... 300
Stockholder's equity........................................
Common stock, $.01 par value.............................. 3 3 3 3
Additional paid-in capital.................................. 2,984 2,536 3,420 3,420
Accumulated other comprehensive loss........................ (95) (95) (95) (95)
Retained earnings........................................... 307 -- -- --
------- ------ ------ -------
Total capitalization...................................... $11,421 $9,771 $9,862 $10,162
======= ====== ====== =======
</TABLE>
-------------------------
(1) This debt is non-recourse to us but is recourse to the applicable
subsidiaries and their assets.
(2) Includes $950 million of preferred securities and capital securities issued
by special purpose financing subsidiaries held by Capital Funding, the
proceeds of which were loaned to Southern Company. Southern Company pays
interest on subordinated notes issued in favor of the financing
subsidiaries, which payments are used to pay dividends on those preferred or
capital securities. Southern Company also has guaranteed payments due under
the terms of those securities. These securities are non-recourse to us.
Capital Funding will be transferred to Southern Company prior to the
completion of this offering. The remaining $80 million of these securities
were issued by a special purpose finance subsidiary of SIUK. They are also
non-recourse to us but they are not guaranteed by Southern Company and will
remain outstanding after this offering.
28
<PAGE> 33
DILUTION
Our pro forma net tangible book value at March 31, 2000 was approximately
$(2.273) billion, or $(8.36) per share. After giving effect to our sale of
58,000,000 shares of common stock in this offering at an assumed initial public
offering price of $16.00 per share and after deducting an assumed underwriting
discount, our pro forma as adjusted net tangible book value at March 31, 2000
would have been approximately $(1.386) billion, or $(4.20) per share. This
represents an immediate increase in pro forma net tangible book value of $4.16
per share to our existing stockholder and an immediate dilution in pro forma net
tangible book value of $20.20 per share to new investors purchasing shares of
common stock in this offering. The following table illustrates this dilution per
share:
<TABLE>
<S> <C> <C>
Assumed initial public offering price per share..................... $ 16.00
Pro forma net tangible book value per share
as of March 31, 2000................................... $(8.36)
Increase in pro forma book value per share
attributable to new investors.......................... 4.16
------
Pro forma net tangible book value
per share after this offering.......................... (4.20)
-------
Dilution in pro forma net tangible book value
per share to new investors............................. $ 20.20
=======
</TABLE>
The discussion and table above assume no exercise of options granted
pursuant to the conversion of units awarded under our value creation plan. It
also assumes no issuance of shares reserved for future issuance under our
employee stock purchase plan. See the sections of this prospectus entitled
"Management -- Value Creation Plan Conversion" and "-- Southern Energy Employee
Stock Purchase Plan." To the extent that any options are granted and exercised,
there will likely be further dilution to new investors.
The following table sets forth, as of March 31, 2000 on the pro forma as
adjusted basis described above, the differences between the number of shares of
common stock purchased from us, the total price paid and average price per share
paid by Southern Company, our existing stockholder, and by the new investors in
this offering at an assumed initial public offering price of $16.00 per share,
before deducting the estimated underwriting discounts and commissions and
offering expenses payable by us.
<TABLE>
<CAPTION>
TOTAL CONSIDERATION
SHARES PURCHASED (DOLLARS IN MILLIONS)
------------------------ --------------------- AVERAGE PRICE
NUMBER PERCENTAGE AMOUNT PERCENTAGE PER SHARE
----------- ---------- ------- ----------- -------------
<S> <C> <C> <C> <C> <C>
Existing stockholder................ 272,000,000 82.4% $2,987 76.3% $10.98
New investors....................... 58,000,000 17.6 928 23.7 16.00
----------- ----- ------ ----- ------
Total.......................... 330,000,000 100.0% $3,915 100.0% $11.86
=========== ===== ====== ===== ======
</TABLE>
If the underwriters' option to purchase additional shares is exercised in
full, the following will occur:
- the number of shares of common stock held by our existing stockholder
will decrease to approximately 80.3% of the total number of shares of
common stock outstanding; and
- the number of shares held by new investors will increase to 66,700,000
shares or approximately 19.7% of the total number of shares of our common
stock outstanding after this offering.
29
<PAGE> 34
SELECTED FINANCIAL INFORMATION
The following tables present our selected consolidated financial
information. The information set forth below should be read together with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and our historical consolidated financial statements and the notes
to those statements included in this prospectus. Our consolidated income
statement data for the years ended December 31, 1995, 1996, 1997, 1998 and 1999
and the selected balance sheet data as of December 31, 1995, 1996, 1997, 1998
and 1999 are derived from our audited consolidated financial statements, which
were audited by Arthur Andersen LLP, independent public accountants. On April
17, 2000, we decided to transfer to Southern Company our leasing business, SE
Finance. As a result, we have included the historical results of operations of
the related subsidiaries as a discontinued operation. The consolidated income
statement data for the quarters ended March 31, 1999 and 2000 and the balance
sheet data as of March 31, 2000 have been derived from our unaudited financial
statements, which were prepared on a basis consistent with our audited
consolidated financial statements. The historical financial information may not
be indicative of our future performance and does not reflect what our financial
position and results of operations would have been had we operated as a
separate, stand-alone entity during the periods presented.
<TABLE>
<CAPTION>
QUARTERS ENDED
YEARS ENDED DECEMBER 31, MARCH 31,
--------------------------------------------- ---------------
1995 1996 1997 1998 1999 1999 2000
------- ------ ------ ------- ------- ------ ------
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AND RATIO DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Operating revenues(1)...................................... $ 584 $1,600 $3,750 $ 1,819 $ 2,268 $ 521 $ 521
------- ------ ------ ------- ------- ----- -----
Operating expenses(1):
Fuel..................................................... 17 75 74 47 392 42 125
Purchased power.......................................... 258 873 2,813 844 545 228 30
Maintenance.............................................. 19 71 74 80 116 23 30
Depreciation and amortization............................ 46 95 182 221 270 54 82
Selling, general and administrative...................... 108 174 188 160 253 59 30
Write down of assets(2).................................. -- -- -- 308 60 -- 4
Other.................................................... 70 162 147 164 188 39 50
------- ------ ------ ------- ------- ----- -----
Operating income........................................... 66 150 272 (5) 444 76 170
------- ------ ------ ------- ------- ----- -----
Other income (expense):
Interest income.......................................... 13 16 138 146 172 38 38
Interest expense......................................... (64) (133) (345) (430) (502) (111) (147)
Gain on sales of assets.................................. 11 66 24 41 313 8 1
Equity in income of affiliates........................... 10 13 58 135 111 99 27
Receivables recovery..................................... -- -- -- 29 64 12 --
Other, net............................................... (1) 28 33 29 72 11 6
------- ------ ------ ------- ------- ----- -----
Total other income (expense)........................... (31) (10) (92) (50) 230 57 (75)
------- ------ ------ ------- ------- ----- -----
Income (loss) from continuing operations before income
taxes and minority interest.............................. 35 140 180 (55) 674 133 95
Provision (benefit) for income taxes:
Continuing operations.................................... 8 54 27 (123) 129 36 (30)
Windfall profits tax(3).................................. -- -- 148 -- -- -- --
Minority interest.......................................... 13 13 29 80 183 21 30
------- ------ ------ ------- ------- ----- -----
Income (loss) from continuing operations................... $ 14 $ 73 $ (24) $ (12) $ 362 $ 76 $ 95
Income from discontinued operations, net of income tax of
$10 in 1997, $22 in 1998 and $15 in 1999................. -- -- 8 12 10 4 6
Income (loss) before extraordinary item.................... 14 73 (16) -- 372 80 101
------- ------ ------ ------- ------- ----- -----
Extraordinary gain on early extinguishment of debt, net of
income tax of $2 in 1995 and $5 in 1996.................. 4 8 -- -- -- -- --
------- ------ ------ ------- ------- ----- -----
Net income (loss).......................................... $ 18 $ 81 $ (16) $ -- $ 372 $ 80 $ 101
======= ====== ====== ======= ======= ===== =====
EARNINGS PER SHARE INFORMATION:
BASIC:
From continuing operations............................... $ 0.05 $ 0.27 $(0.09) $ (0.04) $ 1.33 $0.28 $0.35
From discontinued operations............................. -- -- 0.03 0.04 0.04 0.01 0.02
From extraordinary gain.................................. 0.02 0.03 -- -- -- -- --
------- ------ ------ ------- ------- ----- -----
Net income............................................. $ 0.07 $ 0.30 $(0.06) $ -- $ 1.37 $0.29 $0.37
======= ====== ====== ======= ======= ===== =====
</TABLE>
30
<PAGE> 35
<TABLE>
<CAPTION>
QUARTERS ENDED
YEARS ENDED DECEMBER 31, MARCH 31,
--------------------------------------------- ---------------
1995 1996 1997 1998 1999 1999 2000
------- ------ ------ ------- ------- ------ ------
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AND RATIO DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
PRO FORMA BASIC(4):
From continuing operations............................... $ 1.19 $0.31
From discontinued operations............................. 0.04 0.02
------- -----
Net income............................................. $ 1.23 $0.33
======= =====
STATEMENT OF CASH FLOWS DATA:
Cash flow from operating activities........................ $ 158 $ (226) $ 264 $ 402 $ 515 $ (17) $ (13)
Cash flow from investing activities........................ (1,244) (136) (4,203) (1,741) (2,263) (123) (71)
Cash flow from financing activities........................ 1,653 (193) 4,177 1,502 1,516 80 161
OTHER OPERATING DATA:
EBITDA(5).................................................. $ 122 $ 258 $ 512 $ 351 $ 825 $ 229 $ 279
</TABLE>
<TABLE>
<CAPTION>
AS OF DECEMBER 31, AS OF
--------------------------------------------- MARCH 31,
1995 1996 1997 1998 1999 2000
------ ------ ------- ------- ------- ---------
(DOLLARS IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents................................... $ 664 $ 161 $ 398 $ 561 $ 323 $ 400
Property, plant and equipment, net.......................... 2,312 2,627 4,255 4,691 6,025 6,048
Investments................................................. 431 219 1,159 1,540 1,490 1,472
Total assets............................................ 4,511 4,564 10,630 12,054 13,863 13,972
Non-recourse debt(6)........................................ 1,702 1,753 4,615 5,101 6,202 6,102
Notes payable to Southern Company........................... 422 -- 830 926 -- --
Total debt.............................................. 2,124 1,753 5,445 6,027 7,152 7,192
Subsidiary obligated mandatorily redeemable preferred
securities(7)............................................. -- -- 682 1,033 1,031 1,030
Stockholder's equity........................................ 778 988 2,132 2,642 3,102 3,199
</TABLE>
(1) The decline in operating revenues and operating expenses in 1998 is due to
our contribution, on January 1, 1998, of our power marketing and risk
management activities to Southern Company Energy Marketing, L.P., our
marketing and risk management joint venture with Vastar formed in September
1997. When the joint venture was formed in September 1997, we contributed
only our gas marketing and risk management assets to the venture. Prior to
the formation of the joint venture, our marketing and risk management
activities were wholly owned and consolidated. Currently, we account for
this joint venture under the equity method of accounting. For 1997,
operating revenues would have been $1,768 million and operating expenses
would have been $1,462 million if we had not consolidated our marketing and
risk management operations.
(2) The write-down for 1998 includes write-downs of our investments in Alicura
and EDELNOR to adjust for the difference between the carrying value of the
assets and the fair market value. The write-down for 1999 and first quarter
2000 includes further write-downs of our investments in Alicura and EDELNOR
to maintain the carrying value at the fair market value as well as a
write-down of $31 million at Western Power Distribution relating to impaired
metering assets.
(3) In 1997, the United Kingdom imposed a windfall profits tax on the United
Kingdom's privatized utilities.
(4) Pro forma basic earnings per share information gives effect to the dividends
we paid to Southern Company in 2000 as though they had been paid during the
periods presented, in accordance with SEC Staff Accounting Bulletin Topic
1:B:3.
(5) EBITDA represents our operating income (loss) plus depreciation and
amortization and our equity in income of affiliates. EBITDA excludes the
impact of minority interests. EBITDA, as defined, is presented because it is
a widely accepted financial indicator used by some investors and analysts to
analyze and compare companies on the basis of operating performance. EBITDA,
as defined, is not intended to represent cash flows for the period, nor is
it presented as an alternative to operating income or as an indicator of
operating performance. It should not be considered in isolation or as a
substitute for a measure of performance prepared in accordance with GAAP in
the United States and is not indicative of operating income or cash flow
from operations as determined under GAAP. Our method of computation may or
may not be comparable to other similarly titled measures by other companies.
(6) This debt is non-recourse to us but is recourse to the applicable
subsidiaries and their assets.
(7) As of March 31, 2000, this total included $950 million of preferred
securities and capital securities issued by special purpose financing
subsidiaries held by Capital Funding, the proceeds of which were loaned to
Southern Company. Southern Company pays interest on subordinated notes
issued in favor of the financing subsidiaries, which payments are used to
pay dividends on those preferred securities. In addition, Southern Company
has guaranteed payments due under the terms of those securities. These
securities are non-recourse to us. In connection with our separation from
Southern Company, Capital Funding will be transferred to Southern Company.
The remaining $80 million of these securities were issued by a special
purpose finance subsidiary of SIUK. They are also non-recourse to us but
they are not guaranteed by Southern Company and they will remain outstanding
after this offering.
31
<PAGE> 36
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
You should read the following discussion in conjunction with "Risk
Factors," "Summary Historical Financial and Operating Data," "Selected Financial
Data" and our consolidated financial statements and the related notes included
elsewhere in this prospectus.
2000 SECOND QUARTER RESULTS
We reported net income of $93 million for the second quarter of 2000,
compared with $77 million for the same period last year. This increase was
attributed primarily to an increase in profits from our Asia-Pacific operations.
OVERVIEW
We are one of the world's largest independent power providers with
regionally based businesses in the Americas, Europe and the Asia-Pacific region.
Through our 60% interest in SCEM, we are a leading energy marketer in the United
States. We meet our customers' specific requirements by integrating electricity
generation, management of gas assets, fuel procurement and marketing of energy
and energy-linked commodities. We also provide services to manage risk
associated with market price fluctuations in energy and energy-linked
commodities.
To support our businesses we have built and acquired a portfolio of power
plants, an electric distribution company and electric utilities. Through these
businesses, we have a net ownership interest in 13,214 MW of generation
capacity, 12,777 MW of which we operate. We have ownership interests in
electricity distribution companies and integrated utilities which sell or
distribute electricity to over eight million customers.
Our current operations in North America include six major power generation
subsidiaries and SCEM. We own or control generation capacity totaling 7,391 MW,
which represents approximately 60% of our worldwide total.
In Europe, we have a 49% economic interest in Western Power Distribution
(WPD), an electric distribution company in southwestern England, and we own 26%
of Bewag, the electric utility that serves Berlin. Together, these companies own
3,118 MW of generation capacity and provide electricity to approximately 3.5
million customers. Our net ownership interest in WPD and Bewag's generation
capacity is 848 MW.
In the Asia-Pacific region, we have a subsidiary that develops and owns
independent power projects in the Philippines and China with net ownership
interests in 3,159 MW of generation capacity, 2,308 MW of which we operate.
In the Caribbean and South America, we have ownership interests in electric
utilities, power plants and transmission facilities. These assets are located in
the Bahamas, Trinidad and Tobago, Brazil, Argentina and Chile, and we are
acquiring an interest in an electricity generation and water distribution
company in the U.S. Virgin Islands. We are pursuing the sale of our Argentine
and Chilean subsidiaries.
See Note 16 to our consolidated financial statements for information
regarding segment disclosure.
32
<PAGE> 37
EFFECTS OF CERTAIN ORGANIZATIONAL CHANGES
The following discussion and analysis of financial condition and results of
operations should be read in light of the organizational changes related to our
marketing and risk management operations and the resulting impacts on operating
revenues and expenses. On September 1, 1997, we formed SCEM, a joint venture
with Vastar, and both parties contributed substantially all of their North
American gas marketing and risk management assets to the venture. On January 1,
1998, we and Vastar contributed our North American electric marketing and risk
management operations into the SCEM joint venture. We currently account for our
investment in this joint venture under the equity method of accounting as Vastar
has significant participation rights in SCEM. As a result, our share of SCEM's
earnings is reported in other income in 1998 and 1999. Prior to the formation of
the joint venture, our marketing and risk management operations were
consolidated and, during 1997, contributed approximately $1,982 million in
operating revenues and $2,016 million in operating expenses to our consolidated
results of operations. For this period, power sales were the primary component
of marketing and risk management revenues, and purchased power expenses were the
primary component of operating expenses.
In September 1999, our U.K. subsidiary sold its supply business to London
Electricity plc for L160 million ($264 million) and the assumption of certain
liabilities. The supply business retained the name SWEB and we renamed the
remaining distribution business Western Power Distribution (WPD). As a result of
the sale, we recorded a gain of $286 million prior to related expenses, minority
interest and income taxes and a gain of $78 million after these items.
Our operating revenues and expenses are primarily driven by the operations
of our controlled subsidiaries, which are consolidated for accounting purposes.
Significant consolidated subsidiaries include Southern Energy California, L.L.C.
(SE California), our wholly owned subsidiaries in New York (SE New York) and New
England (SE New England), State Line Energy, L.L.C. (State Line Energy), WPD,
Southern Energy Asia-Pacific Limited (SE Asia-Pacific), Alicura, EDELNOR and
Freeport Power Company Limited (Freeport Power). Investments in companies over
which we exercise significant influence but do not control are accounted for
using the equity method of accounting and, accordingly, the operating results of
these entities impact other income in the form of equity in income of
affiliates. Major affiliates accounted for using the equity method include SCEM,
Birchwood, Bewag, SE Asia-Pacific's investment in the Shajiao C facility, CEMIG,
the Power Generation Company of Trinidad and Tobago (PowerGen) and SIPD.
SEPARATION FROM SOUTHERN COMPANY
On April 17, 2000, Southern Company announced a plan to make us, its wholly
owned subsidiary, into an independent, publicly traded company focused on
competing in the global energy markets. After the completion of this offering,
Southern Company will own over 80% of our outstanding common stock. Southern
Company has also announced its intention to distribute to its stockholders all
of its remaining interest in us within 12 months after the completion of this
offering, although we cannot assure you whether or when this distribution will
occur. We have entered into various agreements with Southern Company related to
interim and ongoing relationships between the two companies. For a description
of these agreements, see "Agreements Between Us and Southern Company."
BASIS OF PRESENTATION
Our consolidated financial statements include allocations to us of certain
Southern Company corporate assets, including pension assets; liabilities,
including profit sharing, pension and non-qualified deferred compensation
obligations; and expenses, including centralized engineering services, legal,
accounting and human resources, insurance services, information technology
services and other
33
<PAGE> 38
Southern Company corporate and infrastructure costs. The expense allocations,
which we believe meet the requirements of PUHCA, have been determined on bases
that Southern Company and we considered to be a reasonable reflection of the
utilization of the services provided to us or the benefit received by us. The
expense allocation methods include relative sales, investment, headcount, square
footage, transaction processing costs, adjusted operating expenses and others.
On April 17, 2000, our board of directors authorized the transfer of our
leasing business, SE Finance, to Southern Company. As a result, we have included
the historical results of operations of the related subsidiaries as a
discontinued operation in the consolidated statements of income. Additionally,
because we intend to transfer our Capital Funding subsidiary to Southern Company
and dispose of our investments in Alicura and EDELNOR, future results of
operations may not be comparable to the historical amounts presented after we
sell these investments.
The financial information presented in this prospectus is not indicative of
our future financial position, results of operations or cash flows nor is it
necessarily indicative of what our financial position, results of operations or
cash flows would have been had we been a separate, stand-alone entity for the
periods presented. The financial information presented in this prospectus does
not reflect the many significant changes that will occur in our funding and
operations as a result of our becoming a stand-alone entity, the offerings and
the distribution.
RESULTS OF OPERATIONS
The following table sets forth financial data as a percentage of operating
revenues for the years ended December 31, 1997, 1998 and 1999 and the quarters
ended March 31, 1999 and 2000.
<TABLE>
<CAPTION>
QUARTER ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
------------------------ ---------------
1997 1998 1999 1999 2000
---- ----- ----- ----- -----
<S> <C> <C> <C> <C> <C>
Operating revenues........................... 100% 100% 100% 100% 100%
OPERATING EXPENSES:
Fuel......................................... 2.0 2.6 17.3 8.1 24.0
Purchased power.............................. 75.0 46.4 24.0 43.8 5.8
Maintenance.................................. 2.0 4.4 5.1 4.4 5.8
Depreciation and amortization................ 4.8 12.2 11.9 10.4 15.7
Selling, general and administrative.......... 5.0 8.8 11.2 11.3 5.7
Write-down of assets......................... 0.0 16.9 2.6 0.0 0.8
Other........................................ 3.9 9.0 8.3 7.4 9.6
---- ----- ----- ----- -----
Total operating expenses................... 92.7 100.3 80.4 85.4 67.4
Operating income (loss)...................... 7.3 (0.3) 19.6 14.6 32.6
---- ----- ----- ----- -----
OTHER INCOME (EXPENSE):
Interest income.............................. 3.7 8.0 7.5 7.3 7.3
Interest expense............................. (9.2) (23.6) (22.1) (21.3) (28.2)
Gain on sales of assets...................... 0.6 2.2 13.8 1.5 0.2
Equity in income of affiliates............... 1.5 7.4 4.9 19.0 5.2
Receivables recovery......................... 0.0 1.6 2.8 2.3 0.0
Other, net................................... 0.9 1.6 3.2 2.1 1.1
---- ----- ----- ----- -----
Total other income (expense)............... (2.5) (2.8) 10.1 10.9 (14.4)
---- ----- ----- ----- -----
Income (loss) from continuing operations
before income taxes and minority
interest................................... 4.8 (3.1) 29.7 25.5 18.2
</TABLE>
34
<PAGE> 39
<TABLE>
<CAPTION>
QUARTER ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
------------------------ ---------------
1997 1998 1999 1999 2000
---- ----- ----- ----- -----
<S> <C> <C> <C> <C> <C>
PROVISION (BENEFIT) FOR INCOME TAXES:
Continuing operations........................ 0.7 (6.8) 5.7 6.9 (5.8)
Windfall profits tax......................... 3.9 0.0 0.0 0.0 0.0
Minority interest............................ 0.8 4.4 8.0 4.0 5.8
---- ----- ----- ----- -----
(Loss) income from continuing operations..... (0.6) (0.7) 16.0 14.6 18.2
Income from discontinued operations, net of
income tax of $10 million in 1997, $22
million in 1998 and $15 million in 1999.... 0.2 0.7 0.4 0.8 1.2
---- ----- ----- ----- -----
Net (loss) income.......................... (0.4)% 0.0% 16.4% 15.4% 19.4%
==== ===== ===== ===== =====
</TABLE>
QUARTER ENDED MARCH 31, 2000 AS COMPARED TO QUARTER ENDED MARCH 31, 1999
OPERATING REVENUES. Our operating revenues were $521 million during the
first quarter of 2000 as well as the first quarter of 1999. There was a $179
million increase in operating revenues attributable to the Americas region, the
majority of which resulted from our North American acquisitions in California
and New York. In addition, the commencement of operations of our Sual plant in
the Philippines contributed revenues of $59 million during the first quarter of
2000. Those increases were primarily offset by a reduction of $239 million, or
68%, in revenues at WPD, primarily as a result of the 1999 sale of the SWEB
supply business.
OPERATING EXPENSES. Operating expenses for the first quarter of 2000 were
$351 million, a decrease of $94 million, or 21%, from the same period in 1999.
This decrease was primarily attributable to a $237 million decrease in operating
expenses for WPD, primarily because of the sale of the SWEB supply business.
Operating expenses associated with acquisitions by SE California and SE New York
partially offset the large decrease in operating expense attributable to WPD.
OTHER INCOME (EXPENSE). Other expense was $75 million for the first
quarter of 2000 compared to other income of $57 million for the first quarter of
1999. The following factors were responsible for this $132 million increase in
other expense:
- Interest expense for the first quarter of 2000 was $147 million, an
increase of $36 million, or 32%, from the same period in 1999 due to
higher borrowing to finance acquisitions.
- Equity in income of affiliates for the first quarter of 2000 was $27
million, a decrease of $72 million, or 73%, from the same period in 1999
primarily due to a decrease in our income from China.
- Income from recovery of receivables during the first quarter of 1999 was
$12 million. The amount represents successful resolution of negotiations
with Hopewell Holdings Ltd. related to a warranty claim settlement.
- Other, net for the first quarter of 2000 was $6 million, a decrease of $5
million, or 45%, from the same period in 1999. This decrease is due to
receipt of a $5 million refund in 1999 of money previously advanced for
coal development related to a project in Pakistan.
INCOME TAXES. The tax benefit for the first quarter of 2000 was $30
million compared to tax expenses of $36 million, a decrease of $66 million from
the provision recorded for the same period in 1999. This decrease is due in part
to a tax provision of $28 million at SE Asia-Pacific in 1999 related to
operations in China. In addition, in February 2000, an agreement with the United
Kingdom Inland
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Revenue was reached related to prior year tax computations at WPD which resulted
in a $20 million reduction in accrued taxes payable, and we recognized
additional tax benefits as a result of additional debt borrowings to finance
acquisitions.
MINORITY INTEREST. Minority interest in income for the first quarter of
2000 was $30 million, an increase of $9 million from the same period in 1999.
The increase is primarily the result of the minority share of the tax settlement
at WPD.
NET INCOME. Net income for the first quarter of 2000 was $101 million, an
increase of $21 million from the same period in 1999. The increase in net income
is attributable to our business segments as follows:
AMERICAS
Net loss from our Americas operations totaled $3 million for the first
quarter of 2000, and $3 million for the first quarter of 1999. These losses
reflect the expected seasonal nature of earnings from our power plants in
North America. In addition to seasonal effects, overall earnings were also
negatively affected by mild weather in California. SCEM's results were
relatively flat compared to first quarter 1999. In addition, we recorded no
income in the first quarter of 2000 for our businesses in South America and
the Caribbean as compared to a net loss of $2 million for the same period
in 1999.
EUROPE
Net income from our European operations totaled $31 million for the
first quarter of 2000, a decrease of $9 million from the same period in
1999. The decrease is primarily the result of lower margins at Bewag and
start-up costs incurred by the our European marketing and risk management
activities. WPD's net income for the first quarter improved slightly as
compared to first quarter 1999 results. The decrease in revenues resulting
from the sale of WPD's supply business in September 1999 has been broadly
offset by reductions in operating and other costs and the first quarter
2000 results benefited from the favorable settlement of tax issues in the
U.K. Our share of Bewag earnings decreased in first quarter 2000 primarily
due to price reductions as a result of increased competition in the German
electricity market, and the weakening of the Euro against the U.S. dollar.
Continuing improvements in operations as a result of the company's
cost-cutting and on-going employee reduction program substantially offset
these negative items.
ASIA-PACIFIC
Our net income in Asia-Pacific for the first quarter of 2000 totaled
$83 million, representing an increase of $32 million from the same period
in 1999. The significant increase is primarily related to the commencement
of operations of the Sual plant in October 1999 and increased contributions
from our operations in China.
CORPORATE
After tax corporate costs, excluding discontinued operations, produced
a net loss of $16 million for the first quarter of 2000 compared to a $12
million net loss for the same period in 1999. The increased loss primarily
reflects additional interest expense from corporate debt borrowed in 1999
to finance acquisitions.
YEAR ENDED DECEMBER 31, 1999 AS COMPARED TO YEAR ENDED DECEMBER 31, 1998
OPERATING REVENUES. Our operating revenues were $2,268 million in 1999, an
increase of $449 million, or 25%, from 1998. This increase was primarily
attributable to a $678 million increase in the
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<PAGE> 41
Americas region, the majority of which resulted from our North American
acquisitions in New England, California and New York. In addition, the
commencement of commercial operations of our Sual plant in the Philippines
contributed revenues of $48 million in 1999. Those increases were partially
offset by a reduction of $297 million, or 23%, in revenues at WPD, primarily as
a result of the 1999 sale of the SWEB supply business. WPD estimates that its
annual revenues will decrease by approximately $60 million as the result of the
distribution price review, which is discussed in the section of this prospectus
entitled "Business -- Europe -- Western Power Distribution." As a result, WPD
has attempted to maximize efficiency, in part by reducing staffing levels.
OPERATING EXPENSES. Excluding the write-down of assets, our operating
expenses for 1999 were $1,764 million, an increase of $248 million, or 16%, from
1998. This increase was primarily attributable to a $574 million increase in the
Americas region, the majority of which resulted from our newly-acquired North
American business units. WPD's operating expenses decreased by $343 million, or
32%, primarily because of the sale of the SWEB supply business and cost
reduction efforts in 1999.
WRITE-DOWN OF ASSETS. The $308 million pre-tax write-down of assets in
1998 resulted from our decision to sell our investments in Alicura and EDELNOR.
This charge reduced the carrying value of these assets to their estimated fair
market value. The $60 million write-down of assets in 1999 consisted of two
principal components. First, as Alicura and EDELNOR continued to produce income
pending their sale, additional write-downs totaling $28 million were recorded to
avoid increasing the carrying value of these assets above their estimated fair
values. Second, we recorded a $32 million write-down primarily related to WPD's
metering assets to reflect their reduced value as the United Kingdom metering
business becomes competitive. Based on the proposed changes in regulation, we
determined that the assets were impaired by comparing associated undiscounted
cash flows to the carrying value of metering assets. As a result, we recorded an
impairment loss to reflect the amount by which the carrying value of metering
assets exceeds their fair market value. The fair market value was determined by
computing the present value of estimated future cash flows to be generated by
the assets.
OTHER INCOME (EXPENSE). Other income was $230 million in 1999, an increase
of $280 million, reflecting a large increase in income from an overall expense
in 1998. The following factors were responsible for this increase:
- Interest expense for 1999 was $502 million, an increase of $72 million,
or 17%, from 1998 due to higher borrowing to finance acquisitions.
- The increase in gain on sales of assets reflects a gain of $286 million
relating to the 1999 sale of the SWEB supply business, before related
expenses, minority interest and taxes. This is further explained in Note
12 to our consolidated financial statements included in this prospectus.
- Equity in income of affiliates for 1999 was $111 million, a decrease of
$24 million, or 18%, from 1998. This decline is primarily due to a $50
million reduction in income from Bewag as a result of provisions recorded
there for employee severance and early retirement, partially offset by
increases from our operations in China.
- Income from recovery of receivables in 1999 was $64 million, an increase
of $35 million, or 121%, from 1998. These amounts represent successful
resolution of negotiations that allowed us to recover certain receivables
previously determined uncollectible, as further explained in Note 1 to
our consolidated financial statements included in this prospectus.
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- Other, net for 1999 was $72 million, an increase of $43 million, or 148%,
from 1998. This increase resulted from several factors. We recognized an
insurance gain of $23 million in 1999 resulting from the receipt of
insurance proceeds in excess of book value of assets destroyed in an
explosion at the State Line plant in Indiana. Additionally, we recognized
higher equipment rental income at WPD and business interruption insurance
proceeds related to an equipment failure at EDELNOR.
INCOME TAXES. The provision for income taxes for 1999 was $129 million, an
increase of $252 million from the $123 million tax benefit recorded for 1998.
This increase is due in part to higher income from operations and the SWEB
supply business sale. In addition, the 1998 benefit reflects the tax effect of
the write-down of South American investments.
MINORITY INTEREST. Minority interest in income for 1999 was $183 million,
an increase of $103 million from 1998. This increase primarily relates to the
gain on the sale of the SWEB supply business.
NET INCOME. Net income for 1999 was $372 million, as compared to $0 for
1998. The increase in net income is attributable to our business segments as
follows:
AMERICAS
We recorded net income of $96 million in 1999 as compared to a net
loss of $180 million in 1998. This increase primarily resulted from the
1998 write down of $200 million, after tax, related to Alicura and EDELNOR
compared with write downs of $18 million, after tax, in 1999 to maintain
those investments for sale at fair value. The remaining increase resulted
from earnings attributable to our North American acquisitions in New
England, California and New York, the commencement of operations of
Southern Producer Services in 1999 and a gain from insurance proceeds
related to the 1998 fire and explosion at the State Line facility.
EUROPE
Net income from our European operations totaled $170 million for 1999,
an increase of $29 million over the prior year. The increase in 1999
earnings reflects a $78 million gain on the sale of the SWEB supply
business in the third quarter, offset by a total of $50 million in charges
at Bewag associated with personnel who accepted voluntary severance and
early retirement packages and the write down of WPD's metering assets
partially offset by cost reduction efforts at WPD.
ASIA-PACIFIC
Our net income in Asia-Pacific for 1999 totaled $175 million,
representing an increase of $107 million over the prior year. The
significant increase primarily related to the commencement of operations of
the Sual plant in October 1999, increased contributions from our operations
in China and successful resolution of negotiations that allowed us to
recover certain receivables previously determined to be uncollectible.
CORPORATE
After tax corporate costs excluding discontinued operations produced a
net loss of $69 million in 1999 versus a $29 million net loss for 1998. The
increased loss primarily reflects additional interest expense from
corporate debt incurred during 1999 to finance acquisitions.
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YEAR ENDED DECEMBER 31, 1998 AS COMPARED TO YEAR ENDED DECEMBER 31, 1997
OPERATING REVENUES. Our operating revenues were $1,819 million in 1998,
representing a decrease of $1,931 million, or 51%, from $3,750 million in 1997.
This decline is primarily explained by a change to the equity method of
accounting for our energy marketing and risk management activities upon the
formation of SCEM. Excluding revenues associated with marketing and risk
management activities, operating revenues for 1998 increased approximately $51
million, or 3%, from comparable operating revenues of $1,768 million in 1997.
This increase included a $40 million increase in operating revenues related to
our acquisition of the State Line generating facility in December 1997 and a $26
million increase in our Asia-Pacific operations primarily due to an additional
month of ownership in 1998, offset by a $16 million decrease in operating
revenues at Alicura due to low water inflow to the reservoir which serves this
hydroelectric facility.
OPERATING EXPENSES. Our operating expenses were $1,824 million in 1998,
representing a decrease of $1,654 million, or 48%, from $3,478 million in 1997.
This decrease resulted primarily from a $1,969 million, or 70%, decrease in
purchased power expenses from $2,813 million in 1997 to $844 million in 1998, as
a result of the change to the equity method of accounting for our energy
marketing and risk management activities. Excluding the operating expenses
associated with marketing and risk management activities, operating expenses for
1998 increased $358 million, or 25%, from comparable operating expenses of
$1,462 million in 1997. The increase in expenses net of purchased power is
primarily due to a $308 million write-down of South American assets and
increased expenses associated with State Line Energy which was acquired in
December 1997.
OTHER INCOME (EXPENSE). Other expense was $50 million in 1998,
representing a $42 million, or 46%, decrease from $92 million in 1997. The
decrease in other expense was primarily from a $77 million increase in equity in
income of affiliates from 1997 to 1998. This increase included $47 million
resulting from a full year of ownership of Bewag, a $26 million increase at
Shajiao C resulting from improved operations and an additional month of
ownership in 1998 and $7 million associated with the ownership of CEMIG. The
decrease in other expense is also related to the recovery of certain receivables
in 1998 previously deemed to be uncollectible. At the time of the acquisition of
SE Asia-Pacific, we had fully reserved for the value of these receivables due to
significant uncertainties as to their collectibility. Also contributing to the
decrease in other expense was an approximately $20 million gain on the sale of a
minority interest in WPD and increased interest income of $8 million.
Offsetting these items, our interest expense increased $85 million, or 25%,
from $345 million in 1997 to $430 million in 1998. This increase primarily
reflects the growth in long-term debt due to financing requirements for new
investments, including our investments in SE Asia-Pacific and Bewag, and
additional funding required by existing projects to finance construction
activities.
INCOME TAXES. We recorded a benefit related to income taxes in 1998 of
$123 million compared to a provision for income taxes of $175 million in 1997.
The 1998 benefit is primarily attributable to the income tax impact of the write
down of our Argentine and Chilean assets discussed above. The 1997 provision for
income taxes was impacted significantly by the windfall profits tax assessed in
the United Kingdom (See "Business -- Europe -- Western Power Distribution").
MINORITY INTEREST. Our minority interest was $80 million in 1998,
representing a $51 million, or 176%, increase from $29 million in 1997. The
increase was attributable to improved operating performance at WPD, the impact
of the windfall profits tax on minority interest in 1997 and our divestiture of
an additional economic interest in WPD during June 1998. The increase is also
related to the improved performance of our other majority owned consolidated
affiliates.
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NET INCOME. Net income for 1998 was $0, as compared to a net loss of $16
million in 1997. The increase in net income is attributable to our business
segments as follows:
AMERICAS
We recorded a net loss of $180 million in 1998 as compared to net
income of $2 million in 1997 in the Americas region. This decrease was
primarily related to a $200 million, after tax, write down of our
investments in Alicura and EDELNOR as a result of our decision to sell
those assets. In addition, in 1997 final construction profits (not
eliminated in consolidation) of $10 million were recorded related to
construction of a coal-fired facility in King George County, Virginia
(Birchwood), which we built under a fixed price contract for a 50 percent
owned and unconsolidated partnership. These decreases to net income were
partially offset by increases in net income related to the December 1997
acquisition of State Line and the January 1998 investment in CEMIG.
EUROPE
Net income from Europe was $141 million for 1998, an increase of $189
million from the net loss of $48 million for 1997. This improvement was
primarily due to the 1997 recognition of $111 million, net of minority
interest, in windfall profits tax imposed on WPD by the new Labor
government of Great Britain. Other factors contributing to the 1998
earnings improvement included a gain on the sale of a 26% minority interest
in WPD, improved operating income at WPD due to higher margins in the
supply business and ongoing cost control efforts and a full year's income
from our investment in Bewag.
ASIA-PACIFIC
Net income from Asia-Pacific was $68 million for 1998, an increase of
$29 million from net income of $39 million in 1997. This increase was
partially due to a full year's ownership of our Asia-Pacific operations in
1998, versus just six months at 80% ownership and five months at 100%
ownership in 1997. Improved operating performance in the Philippines and
successful resolution of negotiations with our supplier and partners in
China that allowed us to recover certain receivables previously determined
to be uncollectible also contributed to increased income for 1998.
CORPORATE
After tax corporate costs excluding discontinued operations produced a
net loss of $29 million in 1998 compared to a $9 million net loss in 1997.
This change is primarily related to increased interest expense from
corporate debt.
LIQUIDITY AND CAPITAL RESOURCES
Historically, we have obtained cash from operations, borrowings under
credit facilities, issuances of commercial paper and senior notes, borrowings
and capital contributions from Southern Company and proceeds from non-recourse
project financing. These funds have been used to finance operations, service
debt obligations, fund the acquisition, development and/or construction of
generating facilities and distribution businesses, finance capital expenditures
and meet other cash and liquidity needs. Some of the cash receipts associated
with our businesses have been transferred to Southern Company from time to time,
and Southern Company has provided funds to cover our disbursements from time
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<PAGE> 45
to time. After this offering, we do not expect to receive any additional funds
from Southern Company or pay cash dividends to Southern Company.
The projects that we develop typically require substantial capital
investment. Some of the projects in which we have an interest have been financed
primarily with non-recourse debt that is repaid from the project's cash flows.
This debt is often secured by interests in the physical assets, major project
contracts and agreements, cash accounts and, in some cases, the ownership
interest in that project subsidiary. These financing structures are designed to
ensure that we are not contractually obligated to repay the project subsidiary's
debt, that is, they are "non-recourse" to us and to our subsidiaries not
involved in the project. However, we have agreed to undertake limited financial
support for some of our project subsidiaries in the form of limited obligations
and contingent liabilities such as guarantees of specified obligations. To the
extent we become liable under these guarantees or other agreements in respect of
a particular project, we may have to use distributions we receive from other
projects to satisfy these obligations.
We intend to use a portion of the net proceeds from this offering and the
concurrent offering of preferred securities to repay commercial paper balances,
which were approximately $390 million with a weighted average interest rate of
approximately 7.1% per annum at June 30, 2000. In addition, we intend to use a
portion of the net proceeds to repay a short-term loan of $450 million as of
June 30, 2000 drawn against a 364-day Bank of America credit facility with an
interest rate of approximately 7.3% per annum. We will use the remaining
proceeds from these offerings for general corporate purposes. The proceeds from
the Bank of America credit facility were used to pay $450 million of the $503
million dividend to Southern Company. The proceeds from the commercial paper
borrowings were used for working capital and payment of $53 million of the $503
million dividend to Southern Company.
Effects of Our Separation From Southern Company
In connection with our separation from Southern Company, Southern Company
will transfer to us most of the Southern Company-owned assets and liabilities
that relate to our business on or prior to the distribution. As part of the
separation, we will transfer to Southern Company our leasing subsidiary SE
Finance. SE Finance had net cash flows from operations of $14 million in the
first quarter of 2000, $32 million in 1999, $(37) million in 1998, and $19
million in 1997. While there were no cash flows from investing activities for
the first quarter of 2000, SE Finance used cash flows for investing activities
of $271 million in 1999, $185 million in 1998 and $97 million in 1997. It also
obtained cash flows from financing activities of $10 million in the first
quarter of 2000, $240 million in 1999, $227 million in 1998 and $82 million in
1997.
Operating Activities
For the quarter ended March 31, 2000, we used net cash from operations of
approximately $13 million compared to approximately $17 million for the quarter
ended March 31, 1999, a decrease of approximately 24%. This decrease, despite a
$21 million increase in net income for the period, was the result of a higher
cash component of net income being offset by uses of cash for working capital
increases. Cash used by operating activities for the period resulted primarily
from net income adjusted for non-cash charges for depreciation and amortization,
deferred income taxes and changes in working capital.
For the year ended December 31, 1999, we generated net cash from operations
of approximately $515 million compared to approximately $402 million for the
year ended December 31, 1998, an increase of approximately 28%. Cash provided by
operating activities in 1999 resulted primarily from net income adjusted for
non-cash charges for depreciation and amortization, deferred income taxes,
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write-down of assets and changes in working capital. Cash flows provided by
operating activities are generally reinvested by our subsidiaries or used for
general corporate purposes, including business development activities.
Additionally, we have used a portion of these cash flows provided by operating
activities to fund investments in some of our subsidiary companies. As a result
of our proposed separation from Southern Company, we have reviewed our current
strategy of deferring distributions from Asia. On July 1, 2000, we adopted a
strategy under which only a portion of the future earnings will be deferred in
order to reinvest funds for further growth in Asia, fund construction efforts or
service debt obligations. The remaining earnings will be repatriated for
reinvestment elsewhere in the world or to service parent debt obligations.
Investing Activities
During the first quarter of 2000, we used $71 million in net cash in
investing activities compared to $123 million for the same period in 1999, a
decrease of approximately 42%. The decrease is primarily attributable to the
commencement of operations of our Sual plant in the Philippines, thus reducing
the amount of capital expenditures in the first quarter of 2000. We have used
cash flows provided by financing activities primarily to finance investments in
our subsidiaries. From January 1, 1997 through March 31, 2000, excluding the
transactions related to the subsidiary obligated preferred securities, we have
used approximately $7,298 million of cash for our investing activities. During
this period, our domestic and foreign investments totaled $5,694 million,
including $2,106 million for the acquisition of SE Asia-Pacific, $820 million
for the acquisition of a 26% interest in Bewag, $840 million for the acquisition
of SE California, $536 million for the acquisition of SE New England, $476 for
the acquisition of SE New York, $136 million for the purchase of a 3.6% economic
interest in CEMIG, $107 million for our 9.99% interest in SIPD, $68 million for
the acquisition of the State Line generating facility, $57 million for the
purchase of an additional 15% interest in EDELNOR and $64 million for investment
in SCEM. In addition, we invested $2,203 million in capital expenditures. These
cash flows used in investing activities have been partially provided by $673
million of cash from the sale of a portion of our investments in subsidiaries
and dividends from affiliated companies.
Financing Activities
During the quarter ended March 31, 2000, our financing activities provided
approximately $161 million in cash. Our financing activities during this quarter
included $119 million of proceeds from the issuance of short-term and long-term
debt. These inflows were partially offset by $36 million in payments of
long-term debt and $5 million in dividends to minority interests during this
quarter.
Our financing activities provided approximately $1,516 million in cash
during 1999. Financing activities for 1999 included $1,730 million of proceeds
from the issuance of short-term and long-term debt and $360 million of capital
contributions from Southern Company. These inflows were partially offset by $503
million in payments of long-term debt, $165 million of dividends paid to
Southern Company and $66 million in dividends to paid minority interests.
From January 1, 1997 through March 31, 2000, excluding the transactions
related to the subsidiary obligated preferred securities, our financing
activities provided cash totaling approximately $6,346 million. These financing
activities included a total of approximately $3,985 million of proceeds from the
issuance of short-term and long-term debt, net of repayments. During this period
we also received a total of $2,029 million in capital contributions from
Southern Company and paid $165 million of dividends to Southern Company.
During 1999, we received $385 million in funds from Southern Company in the
form of a $360 million capital contribution and $25 million in proceeds from the
issuance of notes payable. We paid $1,116 million to Southern Company during
1999 in the form of a $165 million dividend payment
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and total repayments of outstanding notes payable of $951 million. In addition,
we paid $108 million in interest related to notes payable to Southern Company.
We received no loans or capital contributions from Southern Company during the
first quarter of 2000. We made no interest payments to Southern Company during
this period.
During 1997 and 1998, $950 million of preferred securities and capital
securities were issued by special purpose financing subsidiaries held by Capital
Funding, the proceeds of which were loaned to Southern Company. Southern Company
pays interest on subordinated notes issued in favor of the financing
subsidiaries, which payments are used to pay dividends on those preferred or
capital securities. The payment terms and interest rates on the notes receivable
from Southern Company are identical to the related preferred securities. The
notes are due between 2027 and 2037 with fixed interest rates between 6.875% and
8.19%. Southern Company also has guaranteed payments due under the terms of
those securities. These securities are non-recourse to us. Capital Funding will
be transferred to Southern Company prior to the distribution of our shares by
Southern Company. The remaining $80 million of these securities were issued by a
special purpose finance subsidiary of SIUK. They are also non-recourse to us but
they are not guaranteed by Southern Company and they will remain outstanding
after this offering.
During 1999, we entered into three significant financing transactions in
order to refinance loans made to us by Southern Company related to our North
American acquisitions.
In April 1999, we entered into three revolving credit agreements with a
group of lending banks and Citibank, as agent, for commitments totaling $1.3
billion. Each of the corporate credit facilities is available for general
corporate purposes including the support of our commercial paper program.
Facility A, with total commitments of $500 million, was intended to be a
temporary facility until we completed subsequent financings. Accordingly, we
canceled this facility in October 1999. Facility B, a $350 million 364-day
revolving line of credit, was originally scheduled to mature in March 2000. We
extended the maturity date of this facility until March 2001. We may, at our
option, extend the maturity date of Facility B to March 2003. In addition,
Facility B has an extension and commitment increase option up to an additional
$500 million, subject to the lenders' approval. Facility C, totaling $450
million, also has letter of credit options and matures in April 2004. The
interest rate applicable to Facility B is LIBOR plus 60 basis points and an
additional 12.5 basis points if 33 1/3% of the aggregate commitments under both
Facility B and Facility C are outstanding at any time. The interest rate for
Facility C is LIBOR plus 57.5 basis points and an additional 12.5 basis points
if 33 1/3% of the aggregate commitments under both facilities are outstanding at
any time. No amounts were borrowed under these credit facilities at March 31,
2000. In April 1999, we also instituted a commercial paper program, which we use
in conjunction with the corporate credit facilities as an alternate funding
source.
The April 1999 credit agreements contain various business and financial
covenants including, among other things, (i) limitations on dividends,
redemptions and repurchases of capital stock, (ii) limitations on the incurrence
of indebtedness and liens, (iii) limitations on the ratio of recourse debt to
recourse capital and (iv) maintenance of minimum ratios of cash available for
corporate debt service to corporate interest. We are currently in compliance
with all of the covenants in these agreements. The distribution of our shares by
Southern Company would constitute a change in control under these credit
agreements and we cannot assure you that we will be able to obtain the required
lender consents.
In July 1999, we issued two series of senior unsecured notes totaling $700
million. The two series consist of $200 million of 7.40% Senior Notes due 2004
and $500 million of 7.90% Senior Notes due 2009. The proceeds from these senior
unsecured notes were used to repay debt owed to Southern Company and short-term
borrowings as well as for general corporate purposes.
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Also in 1999, we created Southern Energy North America Generating, Inc.
(SENAG) comprising substantially all of our generating facilities in North
America. In October 1999, SENAG completed a $1.45 billion bank financing
consisting of three credit facilities. Facility A is a $1,150 million, 364-day
term loan with a two-year term-out option. Facility B is a $250 million,
five-year revolver to be used for capital expenditures and Facility C is a $50
million, five-year revolver for working capital needs. The interest rate
applicable to Facility A is LIBOR plus 87.5 basis points. For both Facility B
and C, the interest rate is LIBOR plus 72.5 basis points and an additional 12.5
basis points if 33 1/3% of the particular facility is drawn at any time. The
total amount outstanding under these facilities on March 31, 2000 was $1,319
million. The majority of the proceeds from these facilities were used by SENAG
to repay intercompany debt to us relating to the acquisitions of SE New England,
SE California and SE New York. We used these proceeds to pay down short-term
borrowings under our commercial paper program and repay intercompany borrowings
to Southern Company.
The SENAG credit agreements contain various business and financial
covenants including, among other things, (i) limitations on dividends,
redemptions and repurchases of capital stock, (ii) limitations on the incurrence
of indebtedness and liens, (iii) limitations on the ratio of recourse debt to
recourse capital and (iv) maintenance of minimum ratios of corporate debt
service to corporate interest. We are currently in compliance with all of the
covenants in these agreements. The distribution of our shares by Southern
Company would constitute a change in control under these credit agreements and
we cannot assure you that we will be able to obtain the required lender
consents.
At March 31, 2000, we had total corporate level debt of approximately $890
million outstanding, comprised of $700 million of senior unsecured notes and
approximately $190 million of commercial paper. In addition, we had letters of
credit outstanding under Facility C in the amount of approximately $250 million.
In May 2000, we entered into a $550 million, 364-day credit facility with
Bank of America. In June 2000, the facility was amended to provide up to $1
billion, with Bank of America acting as agent for additional lenders. We may
extend the maturity date an additional 364 days at our option. The applicable
interest rate for this facility is LIBOR plus 87.5 basis points. We have
borrowed an aggregate of $450 million to pay dividends to Southern Company. This
credit agreement contains various business and financial covenants including,
among other things, (i) limitations on dividends, redemptions and repurchases of
capital stock, (ii) limitations on the incurrence of indebtedness and liens,
(iii) limitations on the ratio of recourse debt to recourse capital and (iv)
maintenance of minimum ratios of corporate debt service to corporate interest.
We are in compliance with all of the covenants in these agreements. The
distribution of our shares by Southern Company would constitute a change in
control under these credit agreements and we cannot assure you that we will be
able to obtain the required lender consents.
In May 2000, WPD Limited, an entity which we control, made a bid of L464
million (approximately $700 million) to purchase the entire ordinary share
capital of Hyder plc, the company which owns and runs the electricity network in
south Wales in the U.K. and the water distribution and waste water treatment
business for all of Wales. We currently have a 49% economic interest in WPD
Limited. The remaining 51% economic interest is held by a subsidiary of PPL
Corporation. We have operational and management control of WPD Limited with
50.5% of the voting interest. Our portion of the bid is supported by letters of
credit issued in favor of WPD Limited under dedicated credit facilities of ours
which are recourse to us. We cannot assure you that our bid will be successful.
44
<PAGE> 49
In June 2000 we agreed with Potomac Electric Power Company ("PEPCO") that
we will:
- purchase four power plants and related assets in Maryland and Virginia,
- assume PEPCO's entitlements under various power purchase agreements,
- operate two power stations in Washington, D.C. retained by PEPCO, and
- supply PEPCO with power required to meet its retail obligations for up to
four years pursuant to transition power agreements.
The purchase price of the transaction to be paid at closing is $2.65
billion plus amounts to be determined for working capital and reimbursement of
capital expenditures, and approximately $260 million in the event certain power
purchase agreements are not transferred to us. To fund this amount we plan to:
- enter into lease financing arrangements for a significant portion of the
PEPCO assets. We expect these lease transactions to provide $1.5 billion
of the purchase price at closing. The leases will be treated as operating
leases for book purposes whereby one of our subsidiaries will record
periodic lease rental expenses,
- issue $1.02 billion of debt at SENAG, of which approximately $938 million
will be drawn at closing, and
- provide the balance from committed credit lines.
We have received commitments from Credit Suisse First Boston for interim
loan facilities to ensure sufficient liquidity at closing. These commitments
provide a $1.5 billion credit facility without recourse to SENAG or us, but with
recourse to the entity acquiring the assets, in the event the lease is not in
place at closing, two facilities to SENAG totaling $1.02 billion and one
facility of $650 million to us. The applicable interest rate on these
commitments is LIBOR plus 87.5 basis points. We anticipate that the interim loan
facilities will be available for a one-year period from the signing of the
credit agreements and that we will be able to extend the loans for a further
term of one year at our option.
One of the largest power purchase agreements to be transferred to us will
require us to assume PEPCO's rights and obligations with respect to contracts
with Ohio Edison. In addition, a power purchase contract that may be transferred
to us would require us to assume PEPCO's rights and obligations with respect to
Panda-Brandywine L.P., a Delaware partnership. The Ohio Edison contract expires
in 2005 and provides 450 MW of capacity and energy, while the Panda-Brandywine
contract expires in 2021 and would provide capacity and energy from a 230 MW
combined-cycle generation facility designed to be a QF under PURPA. Both
contracts require the purchaser to pay prices above current market prices. The
transition power agreements entered into with PEPCO provide that we supply PEPCO
with power required to meet PEPCO's retail obligations at prices below current
market prices. These obligations will be retained by us. The cash shortfalls for
the power purchase agreements and transition power agreements will depend on
future market conditions, and we currently estimate that these shortfalls will
be in the range of $850 to $950 million over the next four years. We currently
are considering plans to segregate specific funds to meet a substantial portion
of these expected obligations.
Some of our credit facilities, including credit facilities of our
subsidiaries, provide that it will be an event of default if either Southern
Company ceases to own more than 50% of our stock or our credit rating declines
below investment grade. Consequently, prior to Southern Company's distribution
of our stock, we expect to seek waivers or refinance these credit agreements.
45
<PAGE> 50
Commitments and Capital Expenditures
We have commitments under operating leases with various terms and
expiration dates. Expenses associated with these commitments totaled
approximately $13 million, $25 million and $17 million during the years ended
December 31, 1997, 1998 and 1999, respectively. At December 31, 1999, estimated
minimum rental commitments for noncancellable operating leases were as follows
(in millions):
<TABLE>
<S> <C>
FISCAL YEAR ENDED:
2000........................................................ $ 16
2001........................................................ 16
2002........................................................ 15
2003........................................................ 14
2004........................................................ 14
Thereafter.................................................. 103
----
Total minimum payments $178
====
</TABLE>
We have made firm commitments to buy materials and services in connection
with our ongoing operations and planned expansion and have made financial
guarantees relative to some of our investments. The material commitments are as
follows:
<TABLE>
<CAPTION>
AT DECEMBER 31, AT MARCH 31,
1999 2000
--------------- ------------
(DOLLARS IN MILLIONS)
<S> <C> <C>
Financial guarantees related to SCEM
Minimum payments to Vastar................................ $ 125 $ 125
Trade credit support (notional amount).................... 395 391
Vastar gas purchase contract.............................. 90 90
Contingent commitment to buy an additional interest in
SCEM from Vastar....................................... 210 210
Turbine purchases for new and expanded generating plants.... 30 47
Long-term service agreements for new turbines............... 40 40
Other material construction-related commitments............. 132 121
Operating lease payments.................................... 178 264
------ ------
Total.................................................. $1,200 $1,228
====== ======
</TABLE>
The commitments for the turbine purchases and related long-term service
agreements reflect minimum required payments under termination clauses, where
applicable. If all the turbines are purchased as planned, the total payments
under these contracts will amount to $993 million and $791 million,
respectively, at either of the dates reflected in the table above. Since March
31, 2000, we have contracted to buy additional turbines valued at approximately
$809 million.
We expect our cash and financing needs over the next several years to be
met through a combination of cash flows from operations and debt and equity
financings. We have generally financed the operations of our project
subsidiaries primarily under financing arrangements requiring extensions of
credit to be repaid solely from each subsidiary's cash flows. In addition,
subsidiaries financed in this manner are often restricted in their ability to
pay dividends and management fees periodically to us by their respective project
credit documents. These limitations usually require that debt service payments
be current, debt service coverage ratios be met and there be no default or
46
<PAGE> 51
event of default under the relevant credit documents. There are also additional
limitations that are adapted to the particular characteristics of each project
affiliate.
Any projects we develop in the future and those assets we may seek to
acquire, including the transactions discussed above, are likely to require
substantial capital investment. Our ability to arrange financing on a
substantially non-recourse basis is dependent on numerous factors and to satisfy
the capital needs of our projects in the future, we may have to provide more
financial support for the project entity.
The table below describes expansions, our planned acquisitions and capital
expenditures for construction projects. These transactions will be funded
through a combination of equity and debt issuances.
<TABLE>
<CAPTION>
EXPENDITURES
PLANNED FOR THE
ACQUISITION EXPENDITURES QUARTER
OR AS OF ENDED
CONSTRUCTION DECEMBER 31, MARCH 31,
COSTS 1999 2000
------------ ------------ ------------
(DOLLARS IN MILLIONS)
<S> <C> <C> <C>
(I.) PENDING ACQUISITIONS
PEPCO....................................................... $2,650
WAPA........................................................ 105
(II.) PROJECTS UNDER CONSTRUCTION
SE California............................................... $ 650 $ 2 $ 2
Apex........................................................ 300 -- --
SE New York................................................. 360 1 1
SE New England.............................................. 500 4 1
State Line Energy........................................... 223 -- --
SEI Wisconsin............................................... 100 90 6
SEI Michigan................................................ 352 1 5
SEI Texas................................................... 215 81 12
Wrightsville................................................ 302 -- --
Freeport Power.............................................. 33 3 1
EDELNOR..................................................... 176 136 9
</TABLE>
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to market risks, including changes in interest rates and
currency exchange rates. Through various hedging mechanisms, we attempt to
mitigate some of the impact of changes in energy prices, fuel costs, interest
rates and exchange rates on our results of operations. To manage the volatility
inherent in these market risks, we net the exposures to take advantage of
natural offsets and we may enter into hedging transactions for the remaining
exposures as part of our risk management program.
We use interest rate swaps to hedge underlying debt obligations. These
swaps hedge specific debt issuances and currently qualify for hedge accounting.
Consequently, the interest rate differential associated with a swap is reflected
as an adjustment to interest expense over the life of the instruments.
Additionally, some of our subsidiaries have entered into interest rate swaps in
foreign currencies. These swaps are designated as hedges of those subsidiaries'
related debt issuances in the same currency. If we sustained a 100 basis point
change in interest rates for all variable rate debt in all currencies, the
change would affect net income by approximately $16 million, based on variable
rate debt and derivatives and other interest rate sensitive instruments
outstanding at December 31, 1999.
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<PAGE> 52
We use long-term cross-currency agreements to hedge a significant portion
of our net investments in both WPD and Bewag. These cross-currency agreements
hedge our exposure to fluctuations in the British Pound Sterling and Deutsche
Mark exchange rates with the U.S. dollar. We also have investments in various
emerging market countries where the net investments are not hedged, including
Argentina, Chile, Trinidad and Tobago, the Bahamas, the Philippines and China.
We rely on either contractual or regulatory links to the U.S. dollar to mitigate
currency risks attributable to these investments. As a result of these links to
the U.S. dollar, we do not believe we have a material exposure to changes in
exchange rates between the U.S. dollar and the currencies of these countries.
In addition, we have currency exposure which we are unable to hedge related
to our investment in CEMIG. Revenues at CEMIG and dividends from CEMIG are
denominated in Brazilian reais and a significant portion of debt incurred to
finance CEMIG is required to be repaid in other currencies. CEMIG's agreements
with the Brazilian government provide for rate increases in the event of a
devaluation of the real and indexes power purchases to the U.S. dollar. These
agreements provide us some protection against a devaluation of the real;
however, it does not completely cover our exposure. For example, the devaluation
of the real in January 1999 resulted in a write down of $83 million, net of
income tax effects, in the currency translation account category included in our
equity accounts.
We utilize currency swaps and forward agreements to hedge U.S.
dollar-denominated debt issued by our SIUK subsidiary. These swaps offset the
dollar cash flows, thereby effectively converting debt to the respective
subsidiary's functional currency. Gains and losses related to qualified hedges
of foreign currency firm commitments are deferred and included in the basis of
the underlying transactions. To the extent that a qualifying hedge is terminated
or ceases to be effective as a hedge, any deferred gains and losses to that
point continue to be deferred and are included in the basis of the underlying
transaction.
We have hedge transactions that may not continue to qualify for hedge
accounting under the Financial Accounting Standards Board (FASB) proposed
Statement of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" (SFAS No. 133) and No. 138, "Accounting for
Certain Derivative Instruments and Certain Hedging Activities" (SFAS No. 138).
We measure currency earnings risk related to our international holdings
based on changes in foreign currency rates using a sensitivity analysis. The
sensitivity analysis measures the potential loss in earnings based on a
hypothetical 10% change in currency exchange rates. We used exchange rates and
currency positions as of December 31, 1999 to perform the sensitivity analysis.
Such analysis indicates that a hypothetical 10% change in foreign currency
exchange rates would have decreased net income by approximately $10 million had
the U.S. dollar exchange rate increased relative to the currencies with which we
had exposure.
For all derivative financial instruments, we are exposed to losses in the
event of nonperformance by counterparties to these derivative financial
instruments. We have established controls to determine and monitor the
creditworthiness of counterparties to mitigate our exposure to counterparty
credit risk.
In addition to markets risks associated with our power plants, the business
and operations of our energy marketing and risk management subsidiaries
frequently involve market risks associated with managing energy commodities and
establishing open positions in the energy markets on a short-term basis. These
risks fall into three general categories: price and volume volatility, credit
risk of trading counterparties and adequacy of the control environment for
trading. We routinely enter into contracts
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<PAGE> 53
to hedge purchase and sale commitments, fuel requirements and inventories of
natural gas, coal, electricity, oil, emission allowances, weather derivatives
and other commodities to minimize the risk of market fluctuations on our
marketing and risk management operations. We measure our risk using the value at
risk (VAR) methodology described below for each aspect of our energy marketing
and trading activities in order to maintain our total exposure within
management-prescribed limits. We maintain clear policies for undertaking
risk-mitigating actions which may become necessary when measured risks
temporarily exceed limits as a result of market conditions. To the extent an
open position exists, fluctuating commodity prices can impact financial results
and financial position, either favorably or unfavorably. As a result, we cannot
predict with precision the impact that our risk management decisions may have on
our businesses, operating results or financial position.
Our marketing and risk management subsidiaries manage market risk through
formal oversight groups, which include senior management, mechanisms that
independently verify transactions and measure risk, and the use of a VAR
methodology on a daily basis. VAR is used to describe a probabilistic approach
to measuring the exposure to market risk. VAR models are relatively
sophisticated. However, the quantitative risk information is limited by the
parameters established in creating the model. The instruments being evaluated
may have features that may trigger a potential loss in excess of calculated
amounts if the changes in commodity prices exceed the confidence level of the
model used. The VAR methodology employs a seasonally adjusted volatility-based
approach with the following critical parameters: volatility estimates,
appropriate market-oriented holding periods and seasonally adjusted correlation
estimates. The holding periods account for the lengths of time that will be
needed to liquidate different portions of the portfolio of positions. Our
holding periods typically range from five days to three months, depending upon
the type of commodity, the term of the instrument, the liquidity of the
underlying market, and other factors. The volatility and correlation estimates
measure the impact of adverse price moves both at an individual position level
as well as at the total portfolio level. The confidence level established for
our purposes is 95%. For example, if VAR is calculated at $10 million, we can
state with a 95% confidence level that if prices moved against our positions,
our pre-tax loss in liquidating the portfolio would not exceed $10 million.
Based on VAR analysis of the overall commodity price risk exposure of the
trading businesses on March 31, 2000, we did not anticipate a materially adverse
effect on our consolidated financial statements as a result of market
fluctuations. However, we cannot assure you that market volatility, failure of
counterparties to meet their contractual obligations, transactions entered into
after that date or a failure of risk controls will not lead to significant
losses from our marketing and risk management activities. See "Risk
Factors -- We face risks attendant to changes in commodity prices."
We are also exposed to market risk through performance guarantees we and
Vastar have made to cover obligations of SCEM. We and Vastar have agreed to
indemnify each other against losses under those performance guarantees in
proportion to our respective ownership shares of the joint venture. At March 31,
2000, our exposure under these guarantees was approximately $197 million based
on the estimated fair value of SCEM's net contractual commitments.
ACCOUNTING PRONOUNCEMENTS
We continue to analyze the effects of adoption of the rules promulgated by
SFAS No. 133 and its amendment by SFAS No. 138. These statements establish
accounting and reporting standards for derivative instruments, including
derivative instruments imbedded in other contracts, and for hedging activities.
The FASB recently deferred implementation of the provisions of SFAS No. 133 to
fiscal periods beginning after June 15, 2000. We intend to adopt the provisions
of SFAS No. 133 and No. 138 within this time frame and in accordance with the
requirements provided by those statements. We are currently assessing the
financial statement impact of both statements, but we have not yet determined
the impact at this time. Adoption of SFAS No. 133 and No. 138 could increase the
volatility of our net income and other comprehensive income.
49
<PAGE> 54
BUSINESS
INTRODUCTION
We are a leading power provider with regionally based businesses in the
Americas, Europe and the Asia-Pacific region. We meet our customers' specific
requirements by integrating electricity generation and distribution, management
of gas assets, fuel procurement and marketing of energy and energy-linked
commodities. To support our business we have built and acquired a portfolio of
power plants that make us one of the world's largest independent power
producers.
According to the McGraw-Hill publication 205 Independent Power Companies:
Profiles of Industry Players and Projects, we were ranked as the sixth and third
largest independent power producer in July 1998 and July 1999, respectively.
These rankings were based on total megawatts of electric generating capacity
acquired or built through debt or equity financing. Currently, we own or control
13,214 MW of generation capacity and have 10,925 MW under development or pending
acquisition. We consider a project under development when we have contracted to
purchase machinery for the project, we own or control the project site and we
are in the permitting process. These projects may or may not have received all
of the necessary permits and approvals to begin construction. We cannot assure
you that these projects or pending acquisitions will be completed.
Our business also includes managing risk associated with market price
fluctuations of energy and energy-linked commodities for ourselves and our
customers. This provides us the opportunity to control the economic management
of additional power projects. We use these risk management capabilities to
optimize the value of our generating and gas assets and we also offer these risk
management services to others. We also own electric utilities with generation
transmission and distribution capabilities and an electricity distribution
company. We will seek to expand our business through control or ownership of
additional natural gas and electricity assets. Our strategy is to continue our
rapid growth by capitalizing on opportunities in markets where our unique
combination of strengths in physical asset management, electricity generation,
management of gas assets and power marketing and risk management services allows
us to position our company as a leading power provider.
Our regional operations reflect the prevailing political, regulatory and
market conditions where we operate. In North America, we own, operate and
control, through contractual arrangements, power plants and gas assets which are
supported by our power marketing and risk management activities. In Europe, the
pace of deregulation is accelerating and we expect to take advantage of
increasing opportunities to expand our asset operations and marketing and risk
management business. In the Asia-Pacific region, our revenues are primarily
derived from contracts with government entities or regional power boards.
In North America, we are an established leader in our industry. Excluding
international independent power producers, we were ranked as the fourth largest
independent power producer in North America in July 1998 and the second largest
independent power producer in North America in July 1999 by 205 Independent
Power Companies: Profiles of Industry Players and Projects. We operate power
plants in North America with a total generation capacity of 7,493 MW, of which
our net ownership interests represent 7,391 MW. We control an additional 1,738
MW in North America through management contracts. Additionally, we have
projects, which we will own and operate, under development or pending
acquisition in North America totaling 10,728 MW. We have integrated our
generating and natural gas assets with our marketing and risk management
capabilities to help optimize those assets, manage risk and enhance the value of
both our physical assets and our marketing and risk management business.
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<PAGE> 55
Through our 60% interest in SCEM, we are a leading energy marketer in North
America. In May 2000, Natural Gas Week ranked SCEM as the ninth largest North
American gas marketer for the first quarters of 1999 and 2000 based on billions
of cubic feet per day of natural gas sold. In June 2000, Power Markets Week
ranked SCEM as the third largest North American power marketer for the first
quarter of 2000 based on the total MWh of electricity sold. SCEM markets and
trades energy and energy-linked commodities, including electricity, natural gas,
oil, coal and emission allowances. According to Power Markets Week, in 1999 SCEM
was the number four-ranked physical marketer of electricity in the United States
by volume and, according to Gas Daily, was the number 13-ranked physical
marketer of gas by volume. Through SCEM, we also controlled 1.6 billion cubic
feet per day of natural gas production, 0.5 billion cubic feet per day of
natural gas transportation and 25.8 billion cubic feet of natural gas storage as
of December 31, 1999. Most of our power plants in the United States have entered
into various fuel supply, power purchase and other ancillary agreements with
SCEM.
In March 2000, SCEM and Utility.com, an Internet utility company, announced
an agreement under which SCEM will provide wholesale electricity to
Utility.com's customers. SCEM also recently announced that it co-founded a new
independent energy trading consortium, with 5 of the largest gas and electricity
marketers in the United States. The consortium will own and operate an Internet-
based over-the-counter energy trading platform which is expected to be in
operation by the end of 2000.
In Europe, as the markets deregulate, we intend to follow a strategy
similar to our North American strategy by integrating power plants with
marketing and risk management. We have developed an energy marketing and risk
management business in Europe, based in Amsterdam, The Netherlands. Our European
marketing and risk management business, which is operated separately from SCEM,
began trading power in the Nordic market in 1999. We also expect to begin
marketing power in the Dutch, German, Swiss and Italian energy markets in 2000.
We currently own a 26% interest in Bewag AG, the electric utility with
generation, transmission and distribution assets serving 2.1 million customers
in Berlin, Germany, and a 49% economic interest in, and operating control of,
WPD, which distributes electricity to approximately 1.4 million end users in
southwest England. We have opened three business development offices in our
target markets in Europe to continue our asset development activities.
In the Asia-Pacific region, SE Asia-Pacific owns power plants in the
Philippines and China with interests in 3,159 MW. Most of our current generation
in the Asia-Pacific region is under long-term power sale contracts, which are
predominantly linked to the U.S. dollar. We have experienced a growing revenue
base and strong operating performance during our three years in the region.
We also have operations in the Caribbean and South America. We currently
own a 63% interest in an electric utility in the Bahamas and a 39% interest in a
generation company in Trinidad and Tobago. We are in the process of acquiring an
80% interest in the Water and Power Authority of the U.S. Virgin Islands'
generation capacity and water desalination assets. In South America we have a
3.6% economic interest in an electric utility with generation, transmission and
distribution assets in Brazil which has a generation capacity of 5,514 MW and
serves 4.9 million customers. We also hold an 82% interest in an electric
generation and transmission company in Chile and a 55% interest in a
hydroelectric generation facility in Argentina. We are pursuing the sale of our
Argentine and Chilean subsidiaries.
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Our business has grown significantly between 1995 and 1999 as shown in the
table below. This table reflects one-time events, including changing to the
equity method of accounting for our power marketing and risk management business
in 1998, the 1998 write-down of our Argentine and Chilean investments, and the
1997 United Kingdom windfall profits tax. Please review this table in
conjunction with the Summary Historical Financial and Operating Data provided
earlier in this prospectus, which discusses these one-time events.
<TABLE>
<CAPTION>
COMPOUND ANNUAL
1995 1996 1997 1998 1999 GROWTH RATE
------ ------ ------- ------- ------- ---------------
(DOLLARS IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C>
Revenues....................... $ 584 $1,600 $ 3,750 $ 1,819 $ 2,268 40%
EBITDA(1)...................... 122 258 512 351 825 61
Net Income (Loss).............. 18 81 (16) -- 372 113
Total Assets................... 4,511 4,564 10,630 12,054 13,863 32
Cash Flows From Operating
Activities................... 158 (226) 264 402 515 34
</TABLE>
(1) EBITDA represents our operating income (loss) plus depreciation and
amortization and our equity in income of affiliates. EBITDA excludes the
impact of minority interests. EBITDA, as defined, is presented because it is
a widely accepted financial indicator used by some investors and analysts to
analyze and compare companies on the basis of operating performance. EBITDA,
as defined, is not intended to represent cash flows for the period, nor is
it presented as an alternative to operating income or as an indicator of
operating performance. It should not be considered in isolation or as a
substitute for a measure of performance prepared in accordance with
generally accepted accounting standards (GAAP) in the United States and is
not indicative of operating income or cash flow from operations as
determined under GAAP. Our method of computation may or may not be
comparable to other similarly titled measures by other companies.
INDUSTRY OVERVIEW
Power generation and delivery historically have been controlled by either
state-owned enterprises or state-regulated private businesses. In the last
decade, many governments and regulatory bodies have taken steps to transform
their energy sectors to encourage competition, to raise capital for other
purposes and, in some cases, to improve the operational performance of strategic
energy assets. We believe that the emerging model of the industry is the
disaggregation of the traditional utility functions of generation, transmission,
distribution and marketing of electricity into competitive or partially
regulated businesses. To varying degrees, countries in the Americas, Europe and
the Asia-Pacific region are opening their energy sectors to competition. As
governments deregulate and privatize state-owned utilities, the energy sector
will offer significant opportunities for investment worldwide. These
opportunities will also include a significant need for additional power
generating capacity both to satisfy increasing demand and to replace old and
inefficient generating facilities. In addition, investment opportunities will be
created by utilities, independent power producers and industrial companies
disposing of their power generation facilities as they adjust strategies for the
new markets.
In the United States, in response to increasing customer demand for access
to low cost electricity and enhanced services, significant aspects of the
industry are currently being restructured. As of early 1999, new regulatory
initiatives to increase competition in the domestic power generation industry
had been adopted or were being considered at the federal level and by many
states.
FERC issued Order 636 in 1992 and Order 888 in 1996 to increase competition
by easing entry into natural gas and electricity markets. These orders require
owners and operators of natural gas and power transmission systems,
respectively, to make transmission service available on a nondiscriminatory
basis to energy suppliers such as us. In order to better assure competitive
access to the transmission network on a nondiscriminatory basis, FERC issued
Order 2000 in December 1999,
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<PAGE> 57
which encourages electric utilities with power transmission assets to
voluntarily form regional transmission organizations to provide regional
management and control of transmission assets independent of control by firms
that sell electricity. These regional organizations will have the exclusive
authority to initiate rate changes for the transmission system under its
control, exclusive operational control over a broad transmission region,
exclusive control over security and short-term reliability, responsibility to
assure the availability of generation needed to support transmission services,
ultimate responsibility for transmission planning and expansion and
responsibility to assure that an adequate method of monitoring the
competitiveness of the regional electricity market is in place. These regional
organizations are also expected to facilitate inter-regional coordination. In
the event the response of transmission-owning utilities to FERC Order 2000 is
deemed inadequate, FERC has announced that it will reexamine this voluntary
approach, but there is no assurance that such action will be taken. The impact
of Order Nos. 636, 888 and 2000 on our business and operations depends on the
effect of these orders on the transmission operations in particular markets. We
believe there is a strong trend in the United States toward competitive electric
power and natural gas markets, but that our business will continue to be
affected by regional and local price regulation.
Outside the United States, many governments are privatizing their utilities
and their transmission and distribution networks and developing regulatory
structures that are expected to encourage competition in the sector. The growth
in both the number and reputation of energy companies which are operating
facilities globally has made many governments realize that their energy assets
can be sold to raise funds for other purposes while not hindering operating
performance or increasing costs to customers. As a result, many governments are
privatizing their existing energy and utility infrastructure facilities and
creating significant investment opportunities for industry participants. In
order to satisfy the anticipated increase in demand, many countries have adopted
active government programs designed to encourage private investment in power
generation facilities. We believe that these market trends will create
attractive opportunities to expand our business in those countries.
STRATEGY
Our strategy is to be a leading competitive power provider in our target
markets of North America, Europe and the Asia-Pacific region. We intend to
continue our growth through the acquisition, development and operation of power
plants and gas transportation and storage assets in our target markets. We also
intend to capitalize on our ability to integrate power plants and gas assets
with the marketing of energy products and the management of market risk
associated with these products. We plan to implement our strategy through the
development of new power plants (greenfield projects), the expansion of existing
power plants (brownfield projects), acquisitions of power and gas assets
competitively positioned in our targeted markets, contractual arrangements for
the control of generation capacity and gas management facilities, the expansion
of our marketing and risk management activities and the implementation of
information technology and e-commerce applications. To secure wholesale supply
agreements or to provide additional opportunities for growth, profitability or
revenue stability, we may enter into agreements to acquire, control or manage
distribution and supply businesses or other energy aggregators in selected
markets.
We will focus primarily on three regions of the world: North America,
Europe and the Asia-Pacific region.
North America
- We are focusing on competitive market opportunities in North America
created by the deregulation of regional energy markets. We believe that
the integration of our owned and managed generation and gas assets with
our marketing and risk management businesses
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enhances our ability to compete in the evolving energy supply business
and, through improved operating flexibility, enhances the value of our
physical assets. Accordingly, we have invested significant resources in
developing SCEM and in the acquisition of net ownership of approximately
7,391 MW of generation assets in the United States. We have been
successful in acquiring existing generation sites with opportunities for
expansion.
- Over the next several years, we intend to continue our growth by
investing in generating capacity in regions of North America that we
consider attractive and that will enable us to own or control a total of
approximately 25,000 to 30,000 MW of capacity. In addition we plan to
expand our access to, and marketing of, natural gas through SCEM by
acquiring or managing additional gas assets in areas of North America
where these resources complement our power business. We are focusing our
generation development in our West, Northeast, East and Gulf Coast
regions. Our goal by 2004 is to own or control generation which would be
relatively balanced across these regions. We expect over 60% of the
growth in generation capacity to come from the development of new power
plants (greenfield projects) and the expansion of existing plants
(brownfield projects), primarily consisting of gas-fired projects. We
expect gas to comprise over 70% of the total fuel consumed for generation
by 2004. In each of these regions, we are pursuing strategies
specifically tailored to that particular region's customer mix, fuel mix,
asset infrastructure and regulatory environment. We believe that our
flexibility in combining physical assets with products that fit evolving
customer needs is fundamental in pursuing these strategies. In the
Caribbean, we will continue to review potential acquisitions and
developments on an opportunistic basis.
Europe
- We will focus on developing a leading generation and marketing position
in those western and central European power markets where we can
capitalize on our commercial skills and current position and
relationships. As in North America, we plan to integrate our generation
and marketing and risk management capabilities. We currently trade power
in the Nordic market. As additional European markets develop and become
more liquid, we intend to expand our generation and marketing and risk
management activities throughout the Nordic region, the Benelux
countries, Germany, Switzerland, Italy and the Central European region.
Over the next several years we intend to acquire additional generation
capacity in these regions. Our target is to own or control at least
10,000 MW of capacity in Europe. We also intend to review opportunities
to acquire additional distribution assets to gain access to
noncompetitive markets as well as build on our investment in WPD.
Asia-Pacific
- We plan to build on the successful base of over 3,100 MW of generation
capacity we have established in the Philippines and China and to expand
into countries with more developed economies that are opening their
energy sectors to competition, such as Australia and Singapore. In
addition, we will continue to explore opportunities in countries in the
Asia-Pacific region where we can build significant business and achieve
economies of scale, such as India. Over the next several years, we intend
to acquire additional generation capacity such that we will hold or
control a total of approximately 8,000 to 10,000 MW of capacity in the
Asia-Pacific region. We also intend to review opportunities to acquire
distribution assets as a means to obtain significant scale in the
competitive supply business.
In addition to our growth initiatives, we consistently seek to enhance the
financial and operational performance of our businesses through financial
management, cost controls and review
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<PAGE> 59
and improvement of operations. We believe that our strengths in design,
engineering, finance, construction management, fuel procurement, operations and
marketing and risk management provide us with a competitive advantage essential
to achieving our strategy.
Although changes in industry structure and ownership are part of a global
trend, because of differences in current prices, the balance between supply and
demand within a single geographic area, fuel and transmission availability,
customer mix, political objectives and other factors, we believe that these
changes are essentially local in nature. We have experienced industry
restructuring and changes in regulations in the U.S., the United Kingdom,
Germany, Argentina, Chile, Brazil and the Nordic region. Our experience has
shown that each country, and in the case of the U.S., each state, has adopted
its own set of rules and regulations related to the restructuring of the
industry, each of which differs, sometimes significantly, based on local
interests and objectives. As a result, the parts of the energy sector open to
private ownership and the rules governing competition are expected to vary based
on local considerations. To compete successfully, we believe we must have the
flexibility to operate in a variety of environments and throughout the entire
energy value chain. Our strategy to achieve this goal is based on the following
key elements:
Maximize the Financial and Operational Performance of Current Investments
We place substantial emphasis on maximizing the operational and
financial performance of those assets we own or control. In many instances,
we have the opportunity to create value by operating assets more
effectively and efficiently than their traditional owners. Accordingly,
upon acquiring a business or as new assets are constructed, we generally
select senior managers familiar with our performance culture and industry
practices to manage those businesses. We also utilize a standard planning
process to establish annual financial and operational goals for each
business unit, and managers are compensated based on performance as
measured by these goals.
Capitalize on Opportunities Generated by Strong Regional Presence
We believe that we have begun to establish a strong regional presence,
both in terms of scale of operations and management, in each of our
targeted geographical markets. A strong presence in each market is
desirable because changes in energy markets are largely driven by regional
factors such as local economic growth, customer relationships and
preferences, infrastructure constraints (such as transmission grids and gas
pipelines) and local political choices. As a result, incumbent market
participants often have opportunities to expand or enhance their businesses
because of relationships with local partners and customers or information
specific to a geographical market. A significant presence within a region
is advantageous in order to achieve a scale of operations sufficient to
promote efficiency, increase operational flexibility and reliability and
make full use of the skills of management deployed to that region.
Integrate Energy Marketing and Risk Management with Ownership and Control of
Energy Assets
We expect that the deregulation of energy markets worldwide will lead
to the restructuring of energy markets. To be successful, we believe that a
company must be able to integrate asset ownership or control with the
ability to market energy products and the ability to manage market risk
associated with those products. Marketing and risk management enhances the
value of assets by assisting in optimizing capacity utilization, ensuring
physical delivery, providing a real-time market interface and managing
market price and fuel risks. Conversely, control of electric and gas assets
enhances the profitability of marketing and risk management by providing a
physical
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<PAGE> 60
hedge and real-time information, increasing volumes and allowing for a
broader range of product offerings and improving our credibility as an
energy provider to customers.
Exploit Energy Information and E-commerce Applications
We believe that emerging information technologies and their increasing
use by businesses and our customers will present us with opportunities to:
- rapidly and efficiently extend our market reach to a broader base
and larger number of customers and suppliers,
- lower many of the basic transaction costs inherent in our high
volume business with geographically diverse customers, and
- improve the effectiveness of providing and obtaining information to
and from our customers.
We have e-commerce initiatives that target retail marketing,
aggregators, direct wholesale and large industrial customers and the
network of the related businesses and service providers with whom we
transact daily. For example, we have investments in Utility.com and a new
leading energy trading consortium and an option to invest in TenFold
Energy, Inc.
COMPETITION
As an integrated power provider in the energy supply business, we face
intense competition in all phases of the business in which we compete, both in
the United States and in international markets. We encounter competition from
companies of all sizes, having varying levels of experience, financial and human
resources and differing strategies. On the power generation side, we compete in
the development and operation of energy-producing projects, and our competitors
in this business include various utilities, industrial companies and independent
power producers (including affiliates of utilities). In our energy marketing and
risk management business, we compete with international, national and regional
full service energy providers, merchants, producers and pipelines in our ability
to aggregate competitively priced supplies from a variety of sources and
locations and to utilize efficient transmission or transportation.
The following paragraphs summarize our competitive position in several of
our key markets:
- North America: Many power sales contracts in North America are now
awarded by competitive bidding, which both increases the associated costs
and decreases the chances of obtaining such contracts and results in
contracts which have terms significantly shorter than in the past. We
expect that, using our energy marketing and risk management capabilities,
the power plants that we own and manage in North America will achieve a
combination of fuel supply and performance that will meet or exceed the
performance of our competitors and help us obtain these highly
competitive power sales contracts from utilities.
- Germany: We also believe that as the German market opens, Bewag is well
positioned to build on its 2.1 million customer base in the important
Berlin market. We believe that by increasing our investment in the Berlin
market, we can dramatically influence cost and profitability. In
addition, our expertise in managing wholesale supply should assist Bewag
in gaining access to competitively priced generation relative to its
competitors.
- Philippines: Our coal-fired plants in the Philippines are among the
lowest operating cost plants in their market and have achieved or
exceeded their contractual availability requirements.
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<PAGE> 61
During the transition of the energy industry to competitive markets, it is
difficult for us to assess our position versus the position of existing power
providers and new entrants. This is due to the fact that each company may employ
widely differing strategies in their fuel supply and power sales contracts with
regard to pricing, terms and conditions. Further difficulties in making
competitive assessments of our company arise from the fact that many states and
countries are considering or implementing different types of regulatory and
privatization initiatives that are aimed at increasing competition in the power
industry. Increased competition that has resulted from some of these initiatives
has already contributed to a reduction in electricity prices and put pressure on
electric utilities to lower their costs, including the cost of purchased
electricity. Additionally, our business is rapidly becoming more competitive due
to technological advances in power generation, e-commerce enabling new ways of
conducting business, the increased role of full service providers and increased
efficiency of energy markets.
In general, however, we believe that our experience and expertise in
assessing and managing market and credit risk will allow us to remain
competitive during volatile or otherwise adverse market circumstances.
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<PAGE> 62
DESCRIPTION OF GENERATION AND DISTRIBUTION OPERATIONS
The following table describes our significant generation operations,
expansions of existing projects, new projects under development and pending
acquisitions.
<TABLE>
<CAPTION>
OWNED AND OPERATED
-------------------------------
OUR % NET EQUITY
OWNERSHIP TOTAL INTEREST IN OPERATED
POWER GENERATION BUSINESS LOCATION PRIMARY FUEL INTEREST(1) MW TOTAL MW MW
------------------------- ------------------- -------------------- ----------- ------ ----------- --------
<S> <C> <C> <C> <C> <C> <C>
NORTH AMERICA:
SE California.................. California Natural Gas 100% 3,065 3,065 3,065
Apex........................... Nevada Natural Gas 100 -- -- --
SE New York.................... New York Natural Gas/Hydro/ 100 1,794 1,794 1,794
Coal/Oil
SE New England(2).............. Massachusetts Natural Gas/Oil 100 1,245 1,245 1,236
State Line Energy.............. Indiana Coal/Natural Gas 100 490 490 490
Birchwood...................... Virginia Coal 50 222 111 222
SEI Wisconsin.................. Wisconsin Natural Gas 100 306 306 306
SEI Michigan................... Michigan Natural Gas 100 -- -- --
SE Mid-Atlantic (PEPCO)(3)..... Maryland/Virginia Coal/Oil/Gas 100 -- -- --
SE Wichita Falls............... Texas Natural Gas 100 80 80 80
SEI Texas...................... Texas Natural Gas 100 300 300 300
Wrightsville Project........... Arkansas Natural Gas 51 -- -- --
------ ------ ------
Subtotal..................... 7,502 7,391 7,493
CARIBBEAN:
Freeport Power................. Bahamas Oil 63 127 80 127
PowerGen....................... Trinidad & Tobago Natural Gas 39 1,154 450 1,154
WAPA(3)........................ U.S. Virgin Islands Oil 80 -- -- --
------ ------ ------
Subtotal..................... 1,281 530 1,281
SOUTH AMERICA:
CEMIG.......................... Brazil Hydro 3.6 5,514 199 --
EDELNOR........................ Chile Coal/Natural Gas 82.3 653 537 681
Alicura(4)..................... Argentina Hydro 55 1,000 550 1,000
------ ------ ------
Subtotal..................... 7,167 1,286 1,681
EUROPE:
WPD(5)......................... England Natural Gas 49 163 80 14
Bewag(6)....................... Germany Natural Gas/Oil/Coal 26 2,955 768 --
------ ------ ------
Subtotal..................... 3,118 848 14
------ ------ ------
ASIA-PACIFIC:
SIPD........................... China Coal 9.99 4,158 415 --
Shajiao C...................... China Coal 32 2,038 652 --
Sual........................... Philippines Coal 91.9 1,258 1,156 1,258
Pagbilao....................... Philippines Coal 87.2 735 641 735
Navotas I and II............... Philippines Oil 93 300 280 300
Bulacan........................ Philippines Diesel 100 15 15 15
------ ------ ------
Subtotal..................... 8,504 3,159 2,308
TOTAL........................ 27,572 13,214 12,777
====== ====== ======
<CAPTION>
UNDER DEVELOPMENT
---------------------------
NET EQUITY EXPECTED DATE
INTEREST IN OF COMMERCIAL
POWER GENERATION BUSINESS TOTAL MW(1) OPERATION
------------------------- ----------- -------------
<S> <C> <C>
NORTH AMERICA:
SE California.................. 1,050 2003
Apex........................... 1,000 2003
SE New York.................... 785 2003
SE New England(2).............. 835 2004
State Line Energy.............. 525 2003
Birchwood...................... -- --
SEI Wisconsin.................. -- --
SEI Michigan................... 848 2002
SE Mid-Atlantic (PEPCO)(3)..... 5,154 2000
SE Wichita Falls............... -- --
SEI Texas...................... 250 2001
Wrightsville Project........... 281 2002
------
Subtotal..................... 10,728
CARIBBEAN:
Freeport Power................. 8 2001
PowerGen....................... -- --
WAPA(3)........................ 189 2000
------
Subtotal..................... 197
SOUTH AMERICA:
CEMIG.......................... -- --
EDELNOR........................ -- --
Alicura(4)..................... -- --
------
Subtotal..................... --
EUROPE:
WPD(5)......................... -- --
Bewag(6)....................... -- --
------
Subtotal.....................
------
ASIA-PACIFIC:
SIPD........................... -- --
Shajiao C...................... -- --
Sual........................... -- --
Pagbilao....................... -- --
Navotas I and II............... -- --
Bulacan........................ -- --
------
Subtotal..................... --
TOTAL........................ 10,925
======
</TABLE>
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<PAGE> 63
<TABLE>
<CAPTION>
OWNERSHIP CUSTOMERS/
DISTRIBUTION BUSINESS INTEREST END USERS
--------------------- --------- --------------
(IN THOUSANDS)
<S> <C> <C> <C>
Freeport Power.................................. Bahamas 63% 17
WAPA(3)......................................... U.S. Virgin Islands 80 49
CEMIG........................................... Brazil 3.6 4,900
WPD............................................. England 49 1,400
Bewag........................................... Germany 26 2,100
-----
Total......................................... 8,466
=====
</TABLE>
-------------------------
(1) Amounts reflect our percent economic interest in the total MW.
(2) Total MW reflects a 1.4 percent interest in the 614 MW Wyman plant.
(3) Pending acquisition expected to close during 2000.
(4) We are pursuing the sale of our investment in Alicura. Please see the
section of this prospectus entitled "Business -- South America -- Alicura"
for further discussion.
(5) Total MW reflects a 7.7 percent interest (or 144 MW) in the 1,875 MW
Teesside plant.
(6) Total MW excludes 26 percent ownership of 5,740 MW of thermal capacity for
steam heating.
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<PAGE> 64
NORTH AMERICA
NORTH AMERICA -- WEST REGION
SE California
On April 16, 1999, our wholly owned subsidiary, Southern Energy California,
L.L.C. (SE California) through its wholly owned subsidiaries, Southern Energy
Delta, L.L.C. (SE Delta) and Southern Energy Potrero, L.L.C. (SE Potrero),
acquired various generating assets in California with a total capacity of 3,065
MW from Pacific Gas and Electric Company (PG&E) for $801 million plus $39
million for fuel inventory, capital expenditures and property taxes. These
assets consist of the Pittsburg Plant and the Contra Costa Plant (the Delta
Plants) owned by SE Delta and the Potrero Plant owned by SE Potrero.
The following table summarizes certain characteristics of SE California's
generating facilities in operation or under development:
<TABLE>
<CAPTION>
LOCATION TOTAL MW PRIMARY FUEL(1)
------------- -------- ---------------
<S> <C> <C> <C>
GENERATION OPERATIONS:
DELTA PLANTS
Pittsburg Units 1-4(2).................................... Pittsburg 4 x 163 Natural Gas
Pittsburg Unit 5.......................................... Pittsburg 325 Natural Gas
Pittsburg Unit 6.......................................... Pittsburg 325 Natural Gas
Pittsburg Unit 7(3)....................................... Pittsburg 720 Natural Gas
Contra Costa Unit 6....................................... Antioch 340 Natural Gas
Contra Costa Unit 7....................................... Antioch 340 Natural Gas
-------
Subtotal................................................ 2,702
POTRERO PLANT
Potrero Unit 3............................................ San Francisco 207 Natural Gas
Potrero Units 4-6......................................... San Francisco 3 x 52 Distillate Fuel
-------
Subtotal................................................ 363
-------
Total................................................... 3,065
=======
PROJECTS UNDER DEVELOPMENT:
Contra Costa Expansion.................................... Antioch 530 Natural Gas
Potrero Expansion......................................... San Francisco 520 Natural Gas
-------
Total................................................... 1,050
=======
</TABLE>
-------------------------
(1) All of the Delta Plants and Potrero Unit 3 are also capable of using fuel
oil as a secondary fuel.
(2) These "total MW" figures reflect nameplate ratings; available capacity may
be less than those nameplate ratings. These units are scheduled to be
retired at the end of 2001 because they are not expected to meet nitrogen
oxide (NOx) emission requirements in 2002 and because the cost of modifying
these plants to meet these requirements would not be economical.
(3) Due to boiler capacity limitations, Pittsburg Unit 7 has a maximum capacity
of 682 MW.
These generating assets, which include facilities which operate at both
high (intermediate load) and very high (peak) demand levels, are located in
close proximity to or in San Francisco. The Delta Plants comprise nine natural
gas-fired steam generating units with approximately 2,702 MW of generating
capacity located approximately ten miles apart along the Sacramento/San Joaquin
River Delta. The Potrero Plant has one natural gas-fired conventional steam
generating unit and three distillate-fueled combustion turbines with a combined
capacity of 363 MW.
On September 23, 1996, the California General Assembly enacted Assembly
Bill 1890 in an effort to restructure the electric utility industry and
stimulate wholesale and retail competition in California. In addition to
reducing rates and allowing for retail customers to choose their energy
suppliers, this bill created two market entities. This law created the
California Independent System Operator (CAISO), which is designed to ensure
system reliability and provide scheduling
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<PAGE> 65
coordinators with access to transmission services. CAISO also administers the
real-time markets for energy and ancillary services. CAISO is under the
jurisdiction of the FERC. The law also created a second market entity, the
California Power Exchange (PX). The PX is a wholesale electric market under the
jurisdiction of the FERC that provides a competitive auction for the
establishment of day-ahead and hour-ahead market prices, as well as forward
energy sales. The role of the PX is that of a scheduling coordinator that
matches unbalanced bids for the purchase and sale of power. It has no operating
role or authority and does not deal in real-time products, which is the
responsibility of CAISO.
The output from the Delta Plants and the Potrero Plant is sold into the
California market by means of daily energy sales to the PX, reliability-must-run
(RMR) contracts with the CAISO, discussed below, sales of real-time energy and
ancillary services to CAISO and forward sales.
SE Potrero and SE Delta have entered into fuel supply, service and
marketing agreements with SCEM through which SCEM: (i) supplies fuel to the
plants; (ii) bids, schedules and dispatches the units in the market; (iii)
handles the settlement and billing process for CAISO and PX sales; (iv)
purchases energy available for sale to the PX; and (v) assists in the
administration of and compliance with SE California's obligations under its
contracts with the CAISO.
We are currently planning to expand our Contra Costa and Potrero plants by
530 MW and 520 MW, respectively. In January 2000, SE Delta filed an application
for certification with the California Energy Commission for the proposed
expansion of the Contra Costa plant. SE Potrero filed a similar application for
certification in May 2000. We expect to have both of these projects in
commercial operation during the first half of 2003.
The SE California subsidiaries that acquired generation assets from PG&E in
April 1999 acquired these facilities subject to RMR agreements. These agreements
authorize the CAISO to dispatch SE California's generation units to provide
energy and ancillary services when required by the CAISO to ensure reliability
of the transmission system. At the time the SE California subsidiaries acquired
these assets, the rates, terms and conditions of the RMR agreements were the
subject of a pending FERC proceeding. SE California agreed to assume these
agreements from PG&E subject to the outcome of the FERC proceeding. See the
section of this prospectus entitled "Business -- Legal Proceedings."
On June 1, 2000, the CAISO implemented its pre-dispatch procedures,
pursuant to which the CAISO is permitted to call on units subject to RMR
agreements before the unit owner has had the opportunity to bid the unit's
output into the PX or CAISO-administered markets for energy or ancillary
services, thereby foreclosing the unit owner's access to subsequent, and often
more profitable, markets. In response to the implementation of pre-dispatch, the
SE California subsidiaries filed an amendment to their RMR agreements that would
authorize them to recover from the CAISO increased costs attributable to the
pre-dispatch of the units. The FERC has not yet acted on this filing.
On June 28, 2000, the CAISO's Governing Board convened an "emergency
meeting" at which they voted to reduce the price cap applicable to the
CAISO-administered energy and ancillary services markets from $750 per MWh to
$500 per MWh, effective July 1, 2000. At this meeting the CAISO board initially
considered a motion to lower the price cap to $250 per MWh, but the motion was
unsuccessful. On July 6, 2000, the CAISO board again voted on a motion to reduce
the price cap to $250 per MWh, but the motion was again defeated. Further
reductions in the price-cap may adversely affect our results of operations.
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Apex
We are developing a 500 MW natural gas-fired combined cycle project fifteen
miles northeast of Las Vegas, Nevada in the Apex industrial park. The power
project, which is scheduled for commercial operation in the first quarter of
2003, will be organized in a limited liability company that will be owned by
Southern Energy Nevada, which is our indirect wholly owned subsidiary. The
project is expected to have a capital cost of approximately $300 million. Land
and water rights purchase agreements have been executed with the Apex Industrial
Park, Inc. This project site is also expected to have an additional 500 MW
natural gas-fired combined cycle plant which is expected to begin the permitting
process in 2000.
The Apex project will sell its capacity and electric power output in
southern Nevada, Desert Southwest or the California SP-15 markets. SCEM will
assist the project in marketing its output and securing its fuel.
The Apex project is being developed to supply electricity into the southern
Nevada and neighboring markets. These markets are experiencing very high demand
growth, and peak period reserve margins are low, with small amounts of
generation located in the load centers. In addition, the State of Nevada has
passed legislation for the deregulation of its electricity market beginning in
2000, while California has already opened its generation market to competition,
and the other states of the Desert Southwest are in the process of doing so.
At its current stage of development, the Apex project faces a number of
market uncertainties. Among these are the price, terms and conditions of the
anticipated bilateral agreements as well as the ultimate market structure of
Nevada and the other Desert Southwest states.
NORTH AMERICA -- NORTHEAST REGION
SE New York
On June 30, 1999, three of our wholly owned subsidiaries (collectively
referred to as SE New York) acquired various power plants and related assets in
the state of New York with a total generating capacity of 1,794 MW from Orange
and Rockland Utilities, Inc. (ORU) and Consolidated Edison Company of New York,
Inc. (ConEd). Our net purchase price for these acquisitions was approximately
$493 million, which included an amount to cover the market value of existing
fuel inventories. SE New York was selected as the winning bidder for the power
plants following a competitive bid process.
SE New York has three principal subsidiaries: (i) Southern Energy Bowline
L.L.C. (SE Bowline), which owns the Bowline Station, a 1,227 MW natural
gas-fired plant comprised of two units rated at a capacity of approximately 600
MW each, and an approximately 98-acre site adjacent to the Bowline Station; (ii)
Southern Energy Lovett L.L.C. (SE Lovett), which owns the Lovett Station, a 447
MW coal-fired plant consisting of three units; and (iii) Southern Energy NY-Gen,
L.L.C. (SE NY-Gen), which owns two units intended to operate during periods of
very high (peak) demand (the Hillburn Gas Turbine Station and the Shoemaker Gas
Turbine Station), three hydroelectric stations (Mongaup 1-4, Swinging Bridge 1-2
and Rio 1-2) and an operational interest in the Grahamsville Hydroelectric
Station. All generating units at Bowline and Lovett have the capability of
burning natural gas and oil.
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<PAGE> 67
The following table summarizes certain characteristics of SE New York's
generating facilities in operation and under development:
<TABLE>
<CAPTION>
LOCATION TOTAL MW FUEL
--------------- -------- --------------------
<S> <C> <C> <C>
GENERATION OPERATIONS:
BOWLINE PLANT
Bowline 1................................................. West Haverstraw 612 Natural Gas/Oil
Bowline 2................................................. West Haverstraw 615 Natural Gas/Oil
-----
Subtotal................................................ 1,227
LOVETT PLANT
Lovett 3.................................................. Tomkins Cove 70 Natural Gas/Oil
Lovett 4.................................................. Tomkins Cove 177 Coal/Natural Gas/Oil
Lovett 5.................................................. Tomkins Cove 200 Coal/Natural Gas/Oil
-----
Subtotal................................................ 447
SE NY-GEN PLANTS
Mongaup 1-4............................................... Mongaup River 4 Hydro
Swinging Bridge 1-2....................................... Mongaup River 13 Hydro
Rio 1-2................................................... Mongaup River 10 Hydro
Grahamsville.............................................. Grahamsville 17 Hydro
Hillburn GT............................................... Ramapo 40 Natural Gas/Oil
Shoemaker GT.............................................. Middletown 36 Natural Gas/Oil
-----
Subtotal................................................ 120
-----
Total................................................... 1,794
=====
PROJECT UNDER DEVELOPMENT:
Bowline Expansion......................................... West Haverstraw 785 Natural Gas
</TABLE>
In connection with the acquisition of these power plants, the project
companies entered into various agreements with ORU through July 1, 2004, under
which SE New York will operate the plants as called upon by ORU to ensure ORU's
system reliability. The project companies also entered into various transition
agreements with ORU and ConEd to provide energy and installed capacity to ORU
and ConEd for specified periods after the closing. The only remaining obligation
under these transition agreements is a transition power sales agreement with ORU
under which SCEM, under an assignment from SE New York, is obligated to sell
capacity through October 31, 2000.
SE Bowline, SE Lovett and SE NY-Gen have entered into fuel supply, energy
services and power marketing agreements with SCEM through which SCEM (i)
supplies fuel to the plants; (ii) will bid, schedule and dispatch the units
through the New York Independent System Operator (NYISO) into the
newly-deregulated (since November 18, 1999) New York market; (iii) handles the
settlement and billing process for NYISO sales and sales under power purchase
and installed capacity sales agreements; (iv) purchases excess energy and
installed capacity not purchased through power purchase agreements and installed
capacity sales agreements for sale in the NYISO; and (v) assists in the
administration of and compliance with the obligations of SE Bowline, SE Lovett
and SE NY-Gen under various fuel supply and transportation contracts and power
purchase agreements, installed capacity agreements and other contracts for the
sale and purchase of energy, installed capacity or other energy products sold in
the NYISO.
On March 27, 2000, the NYISO filed a petition with FERC seeking to suspend
the market-based 10-minute spinning and non-spinning reserve market, two types
of ancillary services markets in which SE New York currently participates. In
the 10-minute spinning reserve market, generators are compensated to operate
units below their full output level, so that the additional output may be
quickly brought into service if system reliability is threatened. In the 10
minute non-spinning reserve market, generators are compensated to stand by with
"quick start" units that are not currently operating, such as combustion
turbines or certain hydroelectric units. In addition, the NYISO sought
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permission to make retroactive adjustments to market clearing prices for the
period from January 29, 2000 to March 28, 2000. In an order issued June 1, 2000,
the FERC rejected the proposed price cap on spinning reserves but allowed the
cap on non-spinning reserves through November 1, 2000, provided that suppliers
are able to recover their lost opportunity costs. Lost opportunity costs would
result when generators are withheld from energy market participation so that
they may stand by to meet unexpectedly high demand or other generators'
under-performance. The FERC also rejected the NYISO's proposals for retroactive
adjustment to market clearing prices in the reserve markets. As a result of the
FERC order, SE New York does not anticipate any adverse financial implications
due to the NYISO's reserve market filing.
On June 30, 2000, the NYISO sought rehearing of FERC's rejection of the
NYISO's proposal to retroactively adjust changes for 10-minute spinning reserves
for the January 29 to March 28, 2000 period. It also requested a stay of the
order's denial of authority to conduct an interim rebilling for operating
reserves for the month of March. The outcome of the NYISO appeal is uncertain.
On June 30, 2000, the board of directors of the NYISO sought from the FERC
authority to impose $1,300 per MWh bid caps on the day-ahead and real-time
energy markets, for the July 6 to October 28, 2000 period. SE New York does not
anticipate any adverse financial implications due to this filing.
In March 2000, SE Bowline filed an application with the State of New York
Department of Public Service for authorization to construct a 785 MW combined
cycle facility (a facility that utilizes both combustion and steam turbines) on
a 98-acre site adjacent to the Bowline plant. In addition, SE Bowline has filed
an application with the New York Department of Public Service to construct a 4.2
mile 24-inch natural gas line to meet the current and future natural gas needs
of the Bowline plant. This line would connect directly to the existing Columbia
gas transmission system. We expect to start commercial operation of the new
power facility in 2003 and the new gas line in 2001.
In October 1999, the State of New York announced an initiative to reduce
air emissions in the state beyond the requirements under the 1990 Clean Air Act
Amendments. Under this proposal, the standards would become effective in 2003
and would be phased in through 2007. A draft of the regulation is expected to be
proposed by year-end 2000. The impact of this potential regulation is uncertain
at this point. Along with several other electric utilities, SE New York received
an information request from the State of New York concerning the air quality
control implications of various repairs and maintenance activities at the Lovett
facility. SE New York responded fully to this request and provided all of the
information requested by the state. For more information about this matter, see
"-- Legal Proceedings."
A study is being conducted of the impact of water intake structures on fish
species in the Hudson River. Bowline's water intake is part of this study. The
resolution of this study is uncertain but could result in additional limitations
on Bowline's water intake or new technology requirements for the intake.
SE New England
On December 30, 1998, subsidiaries of our wholly owned subsidiary, Southern
Energy New England, L.L.C., acquired various power plants, with a total capacity
of 1,245 MW, from subsidiaries of Commonwealth Energy System (Commonwealth) and
Eastern Utilities Associates (EUA) for $536 million. The sales by Commonwealth
and EUA were required as part of deregulation plans adopted in Massachusetts and
Rhode Island. The assets consist of the Kendall Station (with five generating
units) acquired by Southern Energy Kendall, L.L.C. (SE Kendall) and the Canal
Station (Canal Units 1 and 2), the Martha's Vineyard Diesels and the Wyman Unit
4 Interest, all acquired
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by Southern Energy Canal, L.L.C. (SE Canal). In conjunction with the formation
of Southern Energy North America Generating, Inc. (SENAG), as an indirect wholly
owned subsidiary of Southern Energy, Southern Energy New England, L.L.C.
transferred its ownership interests in SE Canal and SE Kendall to subsidiaries
of SENAG in August 1999. These entities are collectively referred to herein as
SE New England.
The following table summarizes certain characteristics of SE New England's
generating facilities in operation and under development:
<TABLE>
<CAPTION>
LOCATION TOTAL MW FUEL
---------------------- -------- --------------------
<S> <C> <C> <C>
GENERATION OPERATIONS:
CANAL PLANT
Canal Unit 1............................................ Sandwich, MA 563 Oil
Canal Unit 2............................................ Sandwich, MA 560 Natural Gas/Oil
-----
Subtotal.............................................. 1,123
Martha's Vineyard Diesels............................... Martha's Vineyard, MA 12 Oil
Wyman Unit 4 Interest................................... Yarmouth, ME 9 Oil
-----
Subtotal.............................................. 21
KENDALL PLANT
Kendall Steam, Units 1-2-3.............................. Cambridge, MA 63 Natural Gas/Oil
Kendall Jets, Units 1 & 2............................... Cambridge, MA 38 Oil
-----
Subtotal.............................................. 101
-----
Total................................................. 1,245
=====
PROJECTS UNDER DEVELOPMENT:
Canal and Kendall Expansion............................... Sandwich/Cambridge, MA 835 Natural Gas/Fuel Oil
</TABLE>
The Canal and Kendall plants, which are designed to operate during periods
of high (intermediate load) and very high (peak) demand, are located in close
proximity to Boston, a major center for electricity demand in New England. The
Martha's Vineyard Diesels supply electricity on the island of Martha's Vineyard
during periods of high demand or in the event of a transmission interruption.
The Wyman Unit 4 Interest is a 1.4325% ownership interest (equivalent to 9 MW)
in the 614.5 MW Wyman Unit 4 located on Cousin's Island, Yarmouth, Maine. It is
primarily owned and operated by FPL Group. SE New England is planning to add
approximately 835 MW total capacity to the Canal and Kendall plants and expects
to complete the permitting process in the third quarter of 2000. We expect to
commence commercial operation of these expansions in 2002 for Kendall and in
mid-2004 for Canal.
The regulatory environment in the wholesale electricity market in the New
England region has evolved into a competitive market for electrical generation.
As such, the wholesale electricity market has changed away from a cost-based
structure to a bid-based structure. We believe that SE New England has better
opportunities for revenue enhancement under a competitive bid based system
because the bid based approach offers low cost, flexible generators, such as SE
New England, better opportunities to compete. The New England Power Pool
(NEPOOL) was formed in 1971 and is a voluntary association of utilities, power
marketers, generators, end-users and municipal entities. ISO-New England, Inc.
(ISO-NE) was established as a not-for-profit private corporation on July 1, 1997
following its approval by the FERC. The ISO-NE has responsibility for managing
the New England region's electric bulk power generation and transmission systems
and administering the regions open access transmission tariff. In addition,
since inception of the new bid-based markets on May 1, 1999, the ISO-NE has
administered the restructured wholesale electricity marketplace for the region.
Since the inception of the new markets, the ISO-NE has frequently taken
action to intervene in the market to change posted clearing prices that had been
set by the software used to dispatch the system and determine prices. The ISO-NE
stated that these interventions were necessary due to
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software errors and operator errors associated with the implementation of the
new system. The ISO-NE has intervened most often during periods of high
electrical demand and otherwise high clearing prices. The ISO-NE's actions have
sparked extensive discussions and debate among participants in the generating
sector in New England regarding the propriety of these interventions.
The ISO-NE and NEPOOL have made numerous market rule changes since market
inception including changes in the manner that the energy and ancillary services
markets are settled. The transition period has been difficult for the ISO-NE and
NEPOOL participants; and there is a significant amount of additional work that
still needs to be completed to implement a well functioning wholesale market
system in New England.
In February 2000, the Massachusetts Secretary of Environmental Affairs
requested certain generation owners to submit a voluntary plan for achieving
prescribed emissions reductions. The requested plans were to achieve these
reductions by 2005, 2007 or 2010 depending on the nature of the emissions. SE
Canal was one of the generation owners asked to submit a plan. In March 2000, SE
Canal submitted a plan describing the expansion project proposed at the Canal
site, which results in significant emissions reductions and meets the
quantifiable targets prescribed by the Secretary. In June 2000, the
Massachusetts Department of Environmental Protection (MADEP) proposed new
regulations that include the Canal plant as an affected unit. These regulations
are currently in a draft form for public comment. The draft regulations call for
reductions in sulfur dioxide (SO2), nitrogen oxides (NOx), and carbon dioxide
(CO2) beginning in the year 2004 and possible future reductions in mercury,
particulate matter and carbon monoxide.
In conjunction with the acquisition of its generating facilities, SE New
England also entered into an energy supply agreement with the utility
subsidiaries of Commonwealth. Under the terms of this agreement, SE New England
supplies electricity at wholesale to meet a portion of Commonwealth's
obligations to provide standard offer service at guaranteed rates to eligible
retail customers in Massachusetts. The agreement expires in 2005. SE New England
has entered into an agreement with SCEM for SCEM to supply the electricity to
meet SE New England's obligations under its agreement with Commonwealth in
exchange for payments by SE New England.
Except for the output from Canal Unit 1, which is committed to SE New
England and three other power purchasers under contracts through October 2002,
the capacity, energy and ancillary services from the generating units are sold
into NEPOOL through SCEM. SE Canal and SE Kendall have entered into arrangements
with SCEM regarding the marketing of capacity, energy and ancillary services
from the generating units. The arrangements with SCEM became effective on the
date of implementation of the NEPOOL bid-based markets. Under these
arrangements, SCEM bids the output of the units into NEPOOL and is responsible
for the supply of fuel to the units. SCEM also entered into a tolling
arrangement with SE New England for Canal Unit 2, Kendall Jets and Martha's
Vineyard Diesels in which SCEM provides fuel to these facilities and receives
the energy and ancillary services output in return for payments to SE New
England. Under this arrangement, SE New England has guaranteed operational
performance parameters of the units.
NORTH AMERICA -- EAST REGION
State Line Energy
In December 1997, we acquired, through an indirect, wholly owned
subsidiary, State Line Energy, L.L.C. (State Line Energy), the 490 MW State Line
facility from a subsidiary of Commonwealth Edison Company (ComEd) for $68
million. The State Line facility is located near Chicago, a major center of
electricity demand in the Midwest. The plant is comprised of two coal-fired
generating units, Unit 3 and Unit 4. ComEd retained the ownership of the
switchyard and
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transmission facilities connecting the State Line station to the ComEd
transmission system, as well as the coal inventory and the emissions allowances
associated with the State Line facility.
State Line Energy supplies power to ComEd under a 15-year power purchase
agreement (PPA) expiring in 2012. ComEd's territory consists of northern
Illinois and contains 70% of Illinois' population. In its regulated service
area, ComEd delivers power to 3.4 million customers. If State Line Energy builds
new capacity or increases the firm capacity of the plant above 490 MW, State
Line Energy may sell that additional capacity and associated energy to third
parties, after first offering ComEd the right to purchase that additional
capacity and energy. For short-term (non-firm) sales, State Line Energy has
contracted with SCEM to market additional energy not required under the ComEd
PPA. In addition, State Line Energy has contracted with ComEd to provide an
additional 25 MW capacity from the plant on a short-term arrangement.
The coal required to operate the facility is currently supplied by ComEd
under a coal supply agreement. Because ComEd has discontinued its fossil
generation business, it is considering transferring its coal supply and
transportation obligations to a third party. SCEM is currently negotiating with
ComEd to be a third-party manager of the coal supply.
State Line Energy is in the early stages of developing additional capacity
at its site to meet the growing demand for power in the region. The expansion,
if approved by all of the regulatory authorities, would consist of one gas-fired
combined cycle unit with a total generating capacity of 525 MW and is expected
to be completed in 2003.
On July 28, 1998, an explosion and fire occurred in a coal handling area at
the State Line facility. A total of 17 people were injured. The coal conveyor
system, which supplies coal to both units, sustained significant damage. Unit 4
was forced offline by the explosion and ensuing fire; however, it returned to
service on January 31, 1999. Unit 3 was offline undergoing a major maintenance
outage at the time of the incident and sustained less damage. Unit 3 returned to
service on February 8, 1999. Both units have met their net capacity under the
PPA since returning to service and have passed annual environmental testing.
The State Line facility is covered under Southern Company's umbrella
insurance policy, which provides up to $400 million of coverage for a
combination of property damage, liability, and business interruption with
liability limits of $210 million. State Line Energy expects that insurance
proceeds will cover costs of property damage during the fire and explosion.
The EPA and the Indiana Department of Environmental Management are
currently proposing stricter nitrogen oxide emission standards through one-hour
ozone regulations and NOx State Implementation Plan calls. The monthly capacity
charge (a fee charged to cover fixed costs based on the availability and
capacity of the plant) and a fee charged for the energy produced is adjusted by
a formula designed to pass through to ComEd the additional annual costs for
changes related to new NOx emission standards including an amortized portion of
the associated capital costs based on full amortization by the year 2022.
Accordingly, we do not expect stricter nitrogen oxide emission standards to have
a material adverse effect through the term of the PPA.
Unicom, the parent company of ComEd, announced a merger with PECO Energy
Services in September 1999. We do not expect any adverse effect on the PPA as a
result of this merger.
Birchwood
Birchwood Power Partners, L.P. is a limited partnership which owns the
nominal 222 MW Birchwood power facility. The facility is a coal-fired
cogeneration plant located approximately 12 miles southeast of Fredericksburg,
Virginia. We own a 50% interest in Birchwood, with the
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<PAGE> 72
remaining 50% owned by a subsidiary of Cogentrix Energy, Inc. The Birchwood
facility was our first new power plant (greenfield) project built in North
America, and one of our subsidiaries continues to operate and maintain the
Birchwood facility. Power generated at the plant is sold to Virginia Power, a
utility that provides electricity to two million customers in Virginia and North
Carolina. In addition, a subsidiary of ours and a subsidiary of Cogentrix
jointly own a greenhouse facility located adjacent to the Birchwood facility,
which uses steam generated by the Birchwood facility.
Birchwood sells electricity to Virginia Power under a 25-year PPA. Under
the PPA, Birchwood sells all electricity generated by the facility to Virginia
Power through 2021. Birchwood earns a fee based on a contractually determined
rate per kilowatt month for the available capacity of the facility, which is
determined by semiannual capacity tests. Variable operating and maintenance
charges are paid by Virginia Power on a per kilowatt-hour basis and are included
in Birchwood's electric revenues. Fuel costs are reimbursed by Virginia Power
under the PPA. Fuel charges are computed on the amount of kilowatt-hours
generated, as well as on a fixed heat rate and a contractually determined fuel
compensation price. Birchwood has fixed, indexed future costs for coal, coal
transportation, ash disposal and lime. Virginia Power has the option to
terminate the PPA for convenience on one year's notice. If this option is
exercised, Virginia Power must pay Birchwood the greater of the net book value
of the facility or the amount of the original permanent financing, adjusted by
an inflation base index, plus the net present value of all pre-tax profits for
the life of the PPA, plus all expenses associated with the termination. We have
entered into a separate agreement with Virginia Power to sell an additional 20
MW of capacity from the Birchwood facility.
The Virginia legislature recently passed legislation that will increase
competition in the power production industry in Virginia. Competition will be
phased in starting in 2002 with full retail competition in effect by 2004. We
have not yet determined what effect this legislation will have on the Birchwood
facility or the existing PPA. Virginia Power is in the process of determining
its strategy with respect to its current non-utility contracts, such as the PPA
with Birchwood. Virginia Power, as stated, has a termination option that it may
exercise that provides for Birchwood to be fully compensated if the option is
exercised.
On January 18, 2000, the EPA published a new regulation, known as the
"Section 126 Rule," which allocates nitrogen oxide emissions allowances to
electric generating facilities in Delaware, Indiana, Kentucky, Maryland,
Michigan, New Jersey, New York, North Carolina, Ohio, Pennsylvania, Virginia,
West Virginia and the District of Columbia. This regulation becomes effective on
May 1, 2003. If a plant's emissions exceed its allocated allowances under the
Section 126 Rule, the plant must purchase additional allowances from other
regulated plants. We believe that the nitrogen oxide allowances allocated to the
Birchwood facility are incorrect due to the use of incorrect data by the EPA. On
March 17, 2000, Birchwood filed an appeal of the Section 126 Rule with the EPA
to challenge the nitrogen oxide emission allowances for the Birchwood facility.
SEI Wisconsin
SEI Wisconsin, L.L.C. (SEI Wisconsin) is an indirect, wholly owned
subsidiary that was formed in 1998 to develop, construct, own, operate and
maintain the Neenah Power Plant. The Neenah plant is a 306 MW natural gas-fired
electric generating plant located in the Town of Neenah, Wisconsin. The plant
provides electricity during periods of very high (peak) demand. Construction of
the plant is complete and the final cost is expected to be approximately $100
million. The plant commenced operations on May 8, 2000.
SEI Wisconsin will initially sell all of its capacity and electric power
output to Wisconsin Electric Power Company (WEPCO) under an eight-year PPA
entered into in August 1998. WEPCO provides electric, gas and steam service to
more than two million customers in southeastern
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Wisconsin. The PPA is structured as a tolling arrangement, whereby WEPCO pays
SEI Wisconsin a monthly charge designed to provide SEI Wisconsin a return on
capital and to cover debt service and fixed operating costs. WEPCO also pays a
charge for each start and for each running hour for each combustion turbine.
These start charges and running hour charges are designed to recover variable
costs associated with operating and maintaining the plant. Under this tolling
arrangement, WEPCO supplies natural gas as well as any backup No. 2 fuel oil
used to run the plant at no cost to SEI Wisconsin. The PPA has bonus and penalty
provisions regarding capacity, heat rate and availability. WEPCO, prior to the
end of the sixth contract year, has the option to renew the PPA for another five
years beyond the current eight year term or purchase the Neenah plant from us
for $150 million at the end of the PPA term.
At the expiration of the PPA, SEI Wisconsin may convert the Neenah plant
from a facility primarily designed to provide power during periods of very high
(peak) demand to a facility with approximately 515 MW of capacity to be used
during periods of average (base load) and higher (intermediate load) demand. At
that time, SEI Wisconsin plans to sell the plant output to SCEM under a
long-term marketing agreement which may be structured as a tolling agreement.
This conversion may occur earlier through agreement with WEPCO, which would
contract for the increased output of the plant.
The Neenah plant is located in the Mid-America Interconnected Network
(MAIN) region under the North America Electric Reliability Council that covers
predominantly Illinois and eastern Wisconsin. The MAIN market is nominally a 55
GW-sized market that is dominated by coal (54%) and nuclear (28%) generating
capacity. The MAIN region is currently in need of both capacity designed for
very high (peak) demand periods as well as additional transmission capacity.
Deregulation of the electricity market in Wisconsin has been slow. The
Public Service Commission of Wisconsin and the state legislature are currently
studying the deregulation of the electricity market and no material legislation
has been enacted to date.
SEI Michigan
We are currently developing an 848 MW natural gas-fired electric generating
plant at a previously undeveloped (greenfield) site in Zeeland, Michigan. In
1999, we formed an indirect, wholly owned subsidiary, SEI Michigan, L.L.C. (SEI
Michigan), to develop, construct, own, operate and maintain the Zeeland power
plant. We received all necessary permits in spring 2000 and construction began
in early summer 2000. SEI Michigan is being built in two phases.
Phase I is a 298 MW facility designed to provide electricity during very
high (peak) demand periods. We expect this phase to become operational June 2001
and cost approximately $110 million. SEI Michigan will initially sell all of the
Phase I capacity and electricity power output to SCEM under a five-year power
purchase agreement. SCEM has in turn entered into an agreement with Engage
Energy to sell the output of this phase. At the expiration of the tolling
agreement, SEI Michigan may add heat recovery equipment and a steam turbine
(combined cycle unit), which would allow the plant to operate during periods of
average (base load) and higher (intermediate load) demand, and expand the
capacity of Phase I from 298 MW to 550 MW. SEI Michigan expects to enter into a
new marketing agreement with SCEM at that time.
Phase II is a 550 MW facility that uses both combustion and steam turbines
(a combined-cycle unit) which would allow the plant to operate during periods of
average (base load) and higher (intermediate load) demand. This phase is
expected to be operational in June 2002 and cost approximately $242 million. We
plan to sell the plant's capacity to customers in the East Central Area
Reliability Council (ECAR) market through marketing agreements with SCEM.
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The ECAR market is nominally a 106 GW market that is dominated by coal
generating capacity (82%). The region is currently in need of capacity during
periods of very high (peak) demand after having experienced brown outs and
curtailments on peak days and having excess available capacity of less than 10%.
Furthermore, the market faces the risk of the reduced availability of base and
intermediate resources due to retirement of nuclear plants and the possibility
that the market's coal-fired plants will be unable to reach newly mandated
environmental standards.
SE Mid-Atlantic
On June 7, 2000, we executed an asset purchase and sale agreement with
Potomac Electric Power Company (PEPCO) which sets forth the terms of sale and
purchase of PEPCO's generation business in Maryland and Virginia. Our purchase
price for these acquisitions is approximately $2.65 billion plus amounts to be
determined for working capital and approximately $400 million in the event
certain power purchase agreements are not transferred to us. We were selected as
the winning bidder for the generation business following a competitive bid
process.
Based on the current structure of this transaction, our newly formed
limited liability company subsidiary, Southern Energy Mid-Atlantic, LLC, will
acquire, among other things:
- the 1,412 MW coal and oil-fired Morgantown station located in Charles
County, Maryland, approximately 50 miles south of Washington, D.C.,
- the 2,423 MW coal, oil and gas-fired Chalk Point station located in
Prince George's County, Maryland, approximately 45 miles from Washington,
D.C., including the assignment of PEPCO's rights and obligations to the
84 MW Southern Maryland Electric Cooperative, Inc. combustion turbine
located at the Chalk Point station site,
- the 837 MW coal, oil and gas-fired Dickerson station located in upper
Montgomery County, Maryland, approximately 30 miles from Washington,
D.C., and
- the 482 MW coal and oil-fired Potomac River station located in
Alexandria, Virginia, in close proximity to Washington, D.C.
The following table summarizes certain characteristics of PEPCO's power
plants that we are in the process of acquiring:
<TABLE>
<CAPTION>
LOCATION TOTAL MW FUEL
GENERATION OPERATIONS: ---------------------- --------- --------
<S> <C> <C> <C>
Morgantown
Morgantown 1.............................................. Charles County 582 Coal/Oil
Morgantown 2.............................................. Charles County 582 Coal/Oil
Morgantown CTs 1 and 2.................................... Charles County 2 x 16 Oil
Morgantown CTs 3-6........................................ Charles County 4 x 54 Oil
------
Subtotal................................................ 1,412
Chalk Point
Chalk Point 1............................................. Prince George's County 341 Coal/Gas
Chalk Point 2............................................. Prince George's County 342 Coal/Gas
Chalk Point 3............................................. Prince George's County 612 Oil/Gas
Chalk Point 4............................................. Prince George's County 612 Oil/Gas
Chalk Point CT 1.......................................... Prince George's County 18 Oil
Chalk Point CT 2.......................................... Prince George's County 30 Oil
Chalk Point CT 3.......................................... Prince George's County 85 Gas/Oil
Chalk Point CT 4.......................................... Prince George's County 85 Gas/Oil
Chalk Point CT 5.......................................... Prince George's County 107 Gas/Oil
Chalk Point CT 6.......................................... Prince George's County 107 Gas/Oil
SMECO CT.................................................. Prince George's County 84 Gas/Oil
------
Subtotal................................................ 2,423
</TABLE>
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<TABLE>
<CAPTION>
LOCATION TOTAL MW FUEL
GENERATION OPERATIONS: ---------------------- --------- --------
<S> <C> <C> <C>
Dickerson
Dickerson 1............................................... Montgomery County 182 Coal/Oil
Dickerson 2............................................... Montgomery County 182 Coal/Oil
Dickerson 3............................................... Montgomery County 182 Coal/Oil
Dickerson DCT1............................................ Montgomery County 13 Oil
Dickerson H1CT............................................ Montgomery County 139 Gas/Oil
Dickerson H2CT............................................ Montgomery County 139 Gas/Oil
------
Subtotal................................................ 837
Potomac River
Potomac River 1........................................... Alexandria 88 Coal/Oil
Potomac River 2........................................... Alexandria 88 Coal/Oil
Potomac River 3........................................... Alexandria 102 Coal/Oil
Potomac River 4........................................... Alexandria 102 Coal/Oil
Potomac River 5........................................... Alexandria 102 Coal/Oil
------
Subtotal................................................ 482
------
Total................................................. 5,154
======
</TABLE>
In addition to our generation capacity, we have PPAs to purchase
approximately 735 MW of electricity. We are currently planning expansion
projects of 120 MW and 495 MW at the Dickerson plant in Montgomery County.
The series of transactions contemplated in the asset purchase and sale
agreement includes the purchase of four electric generating stations in Maryland
and Virginia (as described above) totaling 5,154 MW; three separate coal ash
storage areas, a 51.5 mile oil pipeline serving the Chalk Point and Morgantown
stations, an engineering and maintenance service facility and related assets;
the lease of the land on which the Potomac River station is located; the sale of
power to PEPCO under two separate transition power agreements with terms of up
to four years; the sale of power to PEPCO under a local area support agreement
requiring the Potomac River station to operate for purposes of supporting a
local load pocket; the execution of a three-year operation and maintenance
agreement for PEPCO's two generating stations located in the District of
Columbia (Benning and Buzzard Point); the assumption of five of PEPCO's power
purchase agreements totaling 735 MW (Ohio Edison, Panda-Brandywine, Northeast
Maryland Waste Disposal Authority, Prince George's County Detention Center and
Gude Landfill); and the execution of a parent guarantee to support the
obligations under any of the project agreements in the event these obligations
are assigned to one of our wholly owned subsidiaries. It is estimated that
approximately 1,000 PEPCO employees will become our employees once the
transaction is consummated. The closing date for this transaction is targeted
for November 2000, pending regulatory approvals.
The PEPCO assets are located in the PJM Interconnection (PJM), which
encompasses New Jersey, Maryland, Delaware, the District of Columbia and most of
Pennsylvania. The PJM market is the largest centrally-dispatched power pool in
the United States with 56,000 MW of generating capacity. PJM has facilitated a
bid-based energy market since April 1997 and initiated operation as an
Independent System Operator (ISO) on January 1, 1998. PJM enables participants
to buy and sell energy and ancillary services, schedule bilateral transactions
and reserve transmission service.
The PEPCO assets provide a range of capacity across the PJM dispatch curve.
There is approximately 2,699 MW of baseload capacity, 1,400 MW of cycling
capacity, and 1,055 MW of peaking capacity. Likewise, there is a wide range of
fuels consumed at the facilities, and approximately 94% of the total generating
capacity can burn multiple fuels.
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Under the asset purchase and sale agreement, we will enter into two
separate transition power agreements with PEPCO to provide energy, capacity and
ancillary services to PEPCO's default retail customers. One of the transition
power agreements is for service to PEPCO's default customers in Maryland and has
a term through June 30, 2004. The other transition power agreement is for
service to PEPCO's default customers in the District of Columbia and expires 49
months from the closing of the transaction. Under both transition power
agreements, we are obligated to provide capacity and ancillary services for the
entire term. We are also obligated under both contracts to provide 100% of the
energy requirements for the first contract year and 75% of the energy
requirements for the second contract year. Beginning in the second contract
year, PEPCO has the option of purchasing additional energy requirements in 25%
increments up to the level purchased in the prior contract year. PEPCO's current
peak demand requirements for the existing retail customers are approximately
5,300 MW. With a total generation portfolio of 5,889 MW, including the PPAs,
these transition power agreements provide a significant portion of our revenues
for the first two to four years and thereby mitigate the market price volatility
risk. The pricing for these services in each of the agreements is below current
market prices and this was reflected in the total asset purchase price.
Under the asset purchase and sale agreement, we will assume the obligations
and benefits of five PPAs with a total capacity of 735 MW. On an aggregate
basis, the pricing terms of these PPAs is below market and this was reflected in
the total asset purchase price. Three of the PPAs (Ohio Edison, Panda-Brandywine
and Northeast Maryland Waste Disposal Authority) represent 730 MW. The Ohio
Edison PPA provides for the sale of 450 MW of capacity and the associated energy
from the Ohio Edison system to PEPCO. As an element of the Ohio Edison PPA,
PEPCO is a party to a "purchase and resale" agreement with Allegheny Power
System (APS) under which APS purchases this supply from Ohio Edison and resells
it to PEPCO at the points of interconnection between the APS and PEPCO systems.
PEPCO can also elect to forgo the transmission across the APS system and sell
the capacity and associated energy to third parties from the Ohio Edison system.
This allows PEPCO the option of selling this capacity and energy into either the
ECAR or PJM markets. The term of the Ohio Edison PPA is through December 31,
2005.
PEPCO has an agreement with Panda-Brandywine to purchase the capacity and
energy output from a cogeneration facility owned by Panda-Brandywine. The
Panda-Brandywine facility was designed to be a QF under PURPA. Under this
agreement, PEPCO is committed to purchase the dependable capacity and a portion
of the electrical output of the Panda-Brandywine facility. Specifically, PEPCO
is obligated to purchase approximately 99 MW of energy for 60 hours of each
week. The balance of the capacity is dispatchable at PEPCO's discretion. This
agreement has an expiration date of October 2021.
PEPCO and the owner of the Panda-Brandywine facility are involved in
various legal proceedings. Panda-Brandywine has filed two separate actions, one
in a Texas court and the other before the Maryland Public Service Commission, in
an attempt to prohibit PEPCO from either assigning the Panda-Brandywine PPA or
entering into a back-to-back arrangement involving that PPA. PEPCO has stated
its belief that it will ultimately prevail in both of these legal proceedings.
If PEPCO is successful in these proceedings, the Panda-Brandywine PPA will be
assigned to us at the closing, or PEPCO will enter into a back-to-back
arrangement with us at the closing, in either case as specifically contemplated
by our asset purchase and sale agreement with PEPCO. The asset purchase and sale
agreement does, however, also provide for the possibility that PEPCO will not be
able to either assign the Panda-Brandywine PPA or enter into a back-to-back
arrangement involving the PPA. In such event, the asset purchase and sale
agreement requires us to pay an additional amount of approximately $260 million
at closing into an escrow account, and PEPCO is entitled to the proceeds from
such account if the Panda-Brandywine PPA is neither assigned to us or the
subject of a back-to-back arrangement with us within 12 months of the closing.
The proceeds from such
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account revert to us in the event the Panda-Brandywine PPA is either assigned or
is the subject of a back-to-back arrangement during such 12-month period.
PEPCO has an agreement to purchase the energy and capacity output from a
solid waste recovery facility owned by Northeast Maryland Waste Disposal
Authority. This facility is located adjacent to the Dickerson Generating
Facility and has been certified as a qualifying small power production facility
under PURPA. The generating capacity of this facility is 50 MW but the facility
typically operates at a peak capacity of 32 MW. PEPCO is required to purchase
all electricity generated by the facility in excess of the facility's own total
requirements for electricity and to sell to the facility on a partial
requirements basis any electricity required in excess of the amount generated by
the facility. The price of electricity purchased under this contract is subject
to the "Standard Rates for Purchases from QFs" as set out in PEPCO's Rate
Schedule CG-SPP on file with the Maryland Public Service Commission. This
contract terminates in October 2019.
NORTH AMERICA -- GULF COAST REGION
SE Wichita Falls
In October 1999, we purchased, through an indirect wholly owned subsidiary,
Southern Energy Wichita Falls, L.P. (SE Wichita Falls), an 80 MW gas-fired
electric generating plant from Wichita Falls Energy Co. Ltd. of Fort Worth,
Texas for approximately $19 million. The plant is a facility designed for
periods of average (base load) demand, consisting of three gas turbines and one
steam turbine, fueled by natural gas transported through TXU Gas Company's Lone
Star pipeline. The turbines use propane gas as a backup fuel. The facility is
operated by Vetrotex CertainTeed Corporation (Vetrotex) under an operations and
steam sales agreement. Under this agreement, Vetrotex also purchases steam from
the plant. In addition, we have entered into a four-year PPA with SCEM for
electricity generated by the plant.
SE Wichita Falls is in the early stages of evaluating the addition of
capacity at its site to meet the growing demand for power in the region. The
proposed plan involves an expansion consisting of one or more combustion
turbines operating during periods of very high (peak) demand, with a combined
capacity of approximately 150 MW. The expected completion date for this
expansion, if it proceeds, is mid-2002. Depending on the availability of
equipment, the expansion could be completed as early as mid-2001.
SEI Texas
SEI Texas, L.P. (SEI Texas) is an indirect, wholly owned subsidiary that
was formed to develop, construct and operate a 550 MW natural gas-fired electric
generating plant in the Dallas-Fort Worth metropolitan area. The plant will
operate a total of four units with two operating during periods of very high
(peak) demand and a third combustion turbine with a corresponding steam turbine
that can be operated during periods of average (base load) and higher
(intermediate load) demand (a combined-cycle unit). Construction of the facility
is expected to cost approximately $215 million. Units 1 and 2, representing 300
MW, became operational on June 1, 2000. Construction has begun on the remaining
250 MW, Units 3 and 4, which we expect to become operational in June 2001.
SEI Texas has agreed to sell all of the capacity and electric power output
from Units 1 and 2 to SCEM under a five-year PPA expiring May 31, 2005. A
separate agreement for Units 3 and 4 is currently being negotiated with SCEM.
Under the existing PPA, all fuel required to run the facility will be provided
and paid for by SCEM.
At the expiration of the PPA, SEI Texas may add heat recovery equipment and
a steam turbine to Units 1 and 2, which would allow these units to operate
during periods of average (base load) and
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higher (intermediate load) demand, and expand the overall plant capacity to 750
MW. At that time, the plant's capacity and energy will be sold to customers in
the Electric Reliability Council of Texas (ERCOT) market through marketing
agreements with SCEM.
Texas has passed legislation for the deregulation of its electricity
market. The pilot phase of the deregulated market is scheduled to begin in June
2001, with full deregulation in place by January 2002. The underlying wholesale
market is going through a restructuring to support this legislation. Part of the
restructuring will include setting up ERCOT such that all of the generation
capacity in that market is managed through a common transmission system. Another
part of the restructuring may require investor owned utilities to divest of
large blocks of their generating assets. Both of these actions will enhance SEI
Texas' position in the marketplace by increasing liquidity in the market and
mitigating the market power of the incumbent utilities.
Mobile Energy
We have a 1% interest in Mobile Energy Services Company, L.L.C. (Mobile
Energy) through our wholly owned subsidiary Southern Energy Resources, Inc.
(SERI). The remaining 99% is indirectly owned by Southern Company through its
wholly owned subsidiary Mobile Energy Services Holdings, Inc. (MESH). Mobile
Energy is the owner of a facility that generates electricity, produces steam and
processes black liquor as part of a pulp and paper complex in Mobile, Alabama.
On May 5, 1998, Mobile Energy received notice from Kimberly-Clark Tissue Company
of its intention to close its pulp mill, effective September 1, 1999. The pulp
mill had historically provided approximately 50% of Mobile Energy's revenues.
On January 14, 1999, Mobile Energy and MESH, which guaranteed debt
obligations of Mobile Energy, filed voluntary petitions in the United States
Bankruptcy Court for the Southern District of Alabama, seeking protection under
Chapter 11 of the United States Bankruptcy Code.
Mobile Energy, certain of its debt holders and Kimberly-Clark have reached
a tentative settlement related to disputes arising from the shutdown of
Kimberly-Clark's pulp mill in Mobile, Alabama and reconfiguration of energy
services at the site. As part of that settlement, Kimberly-Clark and Mobile
Energy have agreed to a modified energy services agreement under which Mobile
Energy will provide electricity and steam processing services to
Kimberly-Clark's facility through August 31, 2019 at rates intended to
approximate market rates. The settlement is conditional and will not become
final unless a variety of conditions are satisfied, including having a plan of
reorganization become effective for Mobile Energy by October 30, 2000. If these
conditions are not satisfied, the settlement agreement terminates and the
parties' relationships will be governed by the contractual relationship that
existed prior to the settlement agreement. SERI has entered into a separate
agreement with Mobile Energy to develop and operate a 165 MW combined cycle,
gas-fired combustion turbine project. We have agreed to supply the combustion
turbines required for the project at our cost (approximately $26 million)
together with an associated long-term services agreement from the combustion
turbine vendor. The project is expected to reduce Mobile Energy's non-fuel
operating costs. Steam from the project will be used to meet on-site demands.
Power from the project is expected to be used to meet on-site demands and is
also expected to be sold into the wholesale power markets. Mobile Energy and
SERI are currently working to resolve transmission issues that may affect the
amount of the project's power output that can be sold into the wholesale power
markets during certain times. The project is expected to begin commercial
operation in 2002.
If certain conditions are met by September 29, 2000, we agreed that we or
an affiliate of ours will invest up to $30 million in Mobile Energy to fund the
equity required to support the cogeneration project. If Mobile Energy satisfies
those conditions and requires such an equity investment to be made, the
investment would likely be made by Southern Company because of restrictions
imposed by
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the PUHCA on ownership of entities, such as Mobile Energy, that qualify as
public utilities under that act. If Mobile Energy is successful in its attempt
to restructure existing energy services agreements it has with third parties to
enable it to qualify as an EWG under PUHCA, then any required investment in
Mobile Energy to fund the cogeneration project would likely be made by us. If
this occurs, Southern Company's indirect ownership interests in Mobile Energy
would be transferred to us. Such a restructuring of Mobile Energy's existing
energy services agreements requires the consent of the other parties to such
agreements, which consents Mobile Energy may not be able to obtain. In the event
that Mobile Energy does not or cannot require Southern Energy to fund the
cogeneration project, and EWG status is not obtained, then Southern Company
would likely continue to own the voting securities of and some small economic
interest in Mobile Energy.
Mobile Energy is also in the process of renegotiating its energy service
agreements with its other customer at the site -- Sappi Fine Paper (North
America) -- and is in discussion with a third party regarding the resumption of
a pulp mill operation at the site that would be about half of the size of the
previous pulp mill operation in terms of output. As part of the settlement with
Kimberly-Clark, Mobile Energy has an assignable option to purchase some of
Kimberly-Clark's pulp mill assets that it may exercise through August 30, 2000.
Wrightsville Project
We are currently developing a 550 MW natural gas-fired combined cycle
project in Wrightsville, Arkansas. The power project, which is scheduled for
commercial operation in June 2002, will be organized as a limited liability
company (LLC) that will be jointly owned by us and Kinder Morgan Power, a
subsidiary of Kinder Morgan. As currently contemplated, we will hold a 51%
interest in the Wrightsville project, with Kinder Morgan Power owning the
remaining 49%. Kinder Morgan Power will have responsibility for the engineering,
procurement and construction (EPC) of the power plant. Definitive project
agreements, including the LLC agreement, loan agreement and EPC agreement, are
currently under negotiation with Kinder Morgan. Major regulatory approvals and
permits required to construct and operate the plant have been applied for.
The project company will initially market all of its capacity and electric
power output through SCEM under a multi-year power purchase agreement (PPA). It
is anticipated that the PPA will be structured as a tolling agreement, whereby
SCEM will pay the project company a monthly capacity charge and other charges
designed to cover debt service, defray operations and maintenance expenses and
provide a return on investment to the project. Under the tolling arrangement,
SCEM would be responsible for supplying and paying for all fuel costs. Other
essential plant services, such as water supply, will be provided by contract
with appropriate parties.
The Wrightsville project is being developed to supply electricity during
periods of average (base load), higher-than-average (intermediate load) and very
high (peak) demand for sale into the Southwest Power Pool and neighboring
markets. These markets are experiencing increasing demand growth, particularly
in intermediate and peak periods, and peak period reserve margins are
constrained. In addition, the State of Arkansas has passed legislation for the
deregulation of its electricity market beginning in 2002. Deregulation would be
expected to increase the number of potential customers for electricity sales
within the state.
Louisiana Project
We are in the advanced stages of development of a 700 MW natural gas-fired
electric generating plant at a previously undeveloped site in the vicinity of
Monroe, Louisiana. The project is being developed in two phases. The first phase
is a 150 MW facility designed to provide electricity during very high (peak)
demand periods. We expect this phase to become operational during summer 2001.
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The second phase is a 550 MW facility that uses both combustion and steam
turbines (a combined cycle unit) which would allow the plant to operate during
periods of average (base load) and higher (intermediate load) demand. This phase
is expected to be operation in summer 2002. The project will be jointly owned
with a partner.
NORTH AMERICA -- MARKETING AND RISK MANAGEMENT OPERATIONS
Southern Company Energy Marketing (SCEM)
In September 1997, we formed SCEM as a limited partnership between us and
Vastar, an 82%-owned subsidiary of Atlantic Richfield Company (ARCO), a
subsidiary of BP Amoco p.l.c. Vastar is a crude oil and natural gas exploration
and production company. We currently own 60% of SCEM while Vastar owns the
remaining 40%. Under the terms of the partnership agreement, our ownership will
automatically increase to 75% on July 1, 2001 with no additional consideration.
Additionally, we have the option to purchase another 5% of SCEM in 2002 for $80
million. During the period from December 1, 2002 through the first business day
of 2003, Vastar has the right to sell its remaining ownership interest in SCEM
to us for $210 million (or $130 million if we exercise our option to acquire an
additional 5%).
We and Vastar have agreed in a transfer restriction agreement that in the
event of a change of control of Vastar or us, the party which has not caused the
change of control has the right to purchase the interest in SCEM owned by the
party which has caused the change of control at an agreed value determined
through an appraisal process. Vastar informed us by letter dated April 20, 2000
that the merger of BP Amoco p.l.c. and Atlantic Richfield Company was completed,
and as a result of the merger BP Amoco indirectly owned (through a subsidiary)
81.9% of Vastar's common stock. Vastar asked for our view as to whether the
merger resulted in a change of control of Vastar. On April 28, 2000, we informed
Vastar that we believed a change of control had occurred. On May 24, 2000, the
date on which BP Amoco announced that it agreed to purchase the remaining 18.1%
of the Vastar shares it did not already own, we sent to Vastar a letter
requesting the appointment of an independent appraiser to determine the agreed
value of Vastar's interests in SCEM under the procedures specified in the
transfer restriction agreement. By letter dated June 12, 2000, Vastar notified
us that it believed that a change of control had not occurred under the
agreement and stated that it was agreeable to arbitrating whether a change of
control had occurred under the arbitration provisions in the agreement.
Discussions are underway with Vastar in an effort to resolve this issue.
In connection with the establishment of the initial ownership structure, we
paid $40 million to Vastar on January 8, 1998. We have also guaranteed minimum
cash distributions from SCEM to Vastar of $20 million per year in 1998 and 1999,
$25 million in 2000 and $30 million per year in 2001 and 2002. These minimum
distributions are subject to reduction for Vastar's portion of agreed upon
categories of expenses, including credit losses.
We are currently involved in a dispute with Vastar concerning the 1998 cash
distribution. To date, we have only paid Vastar $5.8 million for the 1998 floor
payment as a result of credit losses in 1998. Vastar believes it is entitled to
a higher payment and has requested arbitration of this matter. We do not believe
that the outcome of this dispute will have a material effect on our financial
position. The 1999 floor payment in the amount of approximately $17 million,
which reflected deductions for Vastar's portion of expenses, has been agreed to
by both parties.
We formed SCEM for the purpose of marketing and risk-managing energy and
energy-linked commodities, including electricity, natural gas, oil, coal and
emissions credits in North America. In connection with the formation of SCEM, we
and Vastar entered into a non-competition agreement which prohibits either of us
from engaging in energy marketing and risk management activities in
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North America other than through SCEM. In addition to its agreement with Vastar
for the marketing of natural gas, SCEM procures fuel for and markets electricity
generated by our North American facilities that are not committed under
long-term contracts. In addition, SCEM provides marketing of these and other
energy-linked commodities to third parties. As of December 31, 1999, SCEM
employed approximately 409 people, located primarily in Atlanta, with a staff
divided between marketing, asset optimization, trading, logistics, risk control,
information technology and other support functions. In 1999, SCEM marketed an
average of 5.4 billion cubic feet of natural gas per day and sold 220 million
megawatt hours of electricity. According to year-end 1999 statistics published
in industry journals, SCEM ranked as the number four physical power marketer and
number 13 physical gas marketer in the United States based on trading volume.
SCEM owns two seats on and is a member of the New York Mercantile Exchange.
SCEM's strategy is to be the marketer and risk manager of our North
American generating assets, Vastar's gas production and other third-party
assets. SCEM's primary responsibilities are to optimize assets, develop markets,
procure fuel, manage risk and coordinate the logistical flow of power, natural
gas and other energy commodities as they relate to fixed assets. We believe that
energy marketing and risk management expertise and risk controls will add value
to our assets. Over the next decade, we expect SCEM to take advantage of the
expected deregulation of the energy business to build upon its position as a
leading energy marketer in North America through its marketing and risk
management expertise, risk controls and information systems.
Vastar has contracted with SCEM to sell most of its domestic natural gas
production at market index prices to the joint venture through a 10-year natural
gas supply agreement (beginning in September 1997). Currently, SCEM markets
approximately 1.2 billion cubic feet per day of Vastar's controlled production.
The volumes that SCEM markets for Vastar will vary over time. The volume is
defined as 100% of gas produced or owned in the contiguous 48 states of the
United States of America and the countries of Mexico and Canada, and the
respective territorial waters of the stated portion of the United States of
America and Mexico and Canada, other than certain excluded gas. Excluded gas
includes small non-operated well gas and other small quantities of gas. Vastar
has guaranteed minimum daily quantities of the greater of 875 million cubic feet
per day or 80% of the Vastar's annual equity volumes. Annual equity volumes are
defined as the total volume of gas produced and owned by Vastar in the above
listed areas for the preceding calendar year according to annual reports filed
with the SEC.
In 1998, SCEM signed a five-year agreement with the Brazos Electric Power
Cooperative (Brazos) to become the total wholesale electricity supplier to the
Texas generation and transmission cooperative. Under the agreement, known as a
"full requirements agreement," SCEM is obligated to meet Brazos' full wholesale
requirements. SCEM can meet these requirements from any source available to
SCEM, including Brazos' existing asset base, supplemented by market purchases
and sales. In addition, we expect 600 MW of capacity from our SEI Texas facility
to satisfy projected Brazos load growth. In addition, SCEM has the ability to
market excess energy from Brazos' more than 1,650 MW of generating and
contractual capacity. SCEM manages Brazos' generation and fuel supplies. By
combining these fuel and power supplies with its current trading portfolio, SCEM
is able to increase its trading volume and efficiency.
SCEM entered into a three and a half year agreement, effective June 1,
2000, to manage the assets of Pan-Alberta Gas Ltd., the second-largest Canadian
exporter of natural gas. As part of the transaction, SCEM subleased
Pan-Alberta's office in Calgary, Alberta and will administer Pan-Alberta's
businesses with SCEM's Atlanta-based marketing and risk management operations.
Pan Alberta retains all obligations for current transportation and customer
agreements, and SCEM will be entitled to use the assets at its discretion. SCEM
can optimize the use of these assets which includes 8.3 billion cubic feet of
storage capacity as part of the transaction. SCEM generates revenues when
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there is a difference between the price of gas supplied by Pan-Alberta and the
gas prices in other locations to which SCEM has access. When Pan-Alberta gas
prices exceed the gas prices in other locations, SCEM may fulfill Pan-Alberta's
customer agreement by buying the cheaper, non-Pan Alberta gas and selling
Pan-Alberta gas in local markets and at local prices. Recently, Pan-Alberta was
marketing approximately 1.2 billion cubic feet of gas per day.
In addition to the agreements related to Pan-Alberta, SCEM announced on
July 10, 2000 a similar relationship with Canadian West Gas Supply, Inc.
(CanWest). CanWest is the largest natural gas aggregator in British Columbia,
marketing the gas supply of more than 100 Canadian producers. The Pan-Alberta
infrastructure will be used to manage the additional 500 million cubic feet per
day previously marketed by CanWest.
In March 2000, SCEM signed an agreement to supply wholesale electricity to
Utility.com's customers. Through this agreement, SCEM becomes the preferred
wholesale electricity provider to Utility.com, an Internet utility company. SCEM
has also purchased an equity stake in Utility.com.
SCEM has announced the formation of a new independent energy trading
consortium with five of the largest gas and electricity marketers in the United
States. The consortium will own and operate an Internet-based over-the-counter
energy trading platform which is expected to be in operation by the end of the
year. The platform will provide increased trading liquidity and market
efficiency as well as cost savings.
SCEM has invested in systems to increase the efficiency and reliability of
its risk management and control processes. SCEM and TenFold Corporation are
jointly developing a suite of energy risk management applications known as
EnergyNow! We expect EnergyNow! to be a multi-commodity, multi-currency,
multi-unit industry application designed to provide end-to-end business process
support including pre-deal analytics, transaction processing, risk management,
commodity logistics and settlement/billing.
We and Vastar participate in the management of SCEM through representation
on its board of governors. The board has several working committees, including
the audit committee, the risk management and control committee (RMCC) and the
credit committee. The audit committee focuses on both procedures and compliance,
and approves all changes to the internal audit process. The RMCC is responsible
for establishing and modifying SCEM's risk management policy. The credit
committee has responsibility for SCEM's credit risk management policy. In
addition, an independent risk control officer who is not compensated based on
SCEM's profitability oversees mid-office operations and front office compliance
with RMCC policies.
SCEM's energy marketing and risk management business requires efficient
management of three types of risks: market price risk, credit risk and
operational risk. Market price risk is created by the volatility of energy
prices. Credit risk is characterized by risk of counterparty nonperformance or
default. Operational risk arises from a lack of clearly defined policies and
procedures and a lack of clear separation of duties and responsibilities. SCEM
has created a controls and risk management organization to manage and mitigate
these risks. Key processes executed by this organization include order entry and
transaction verification, control of structured transactions, internal and
external counterparty credit evaluation, VAR limits, stress tests, close
monitoring of all positions and VAR and an independent daily marked-to-market
portfolio valuation.
We, Southern Company, Vastar and ARCO have jointly agreed to provide up to
$700 million of contingent performance guarantees on behalf of SCEM. We have
agreed with Vastar to indemnify each other (subject to limitations of liability)
against loss in proportion to our respective ownership shares of SCEM with
respect to any amounts paid by any of us or our affiliates; although we would
pay more (up to 100%) of the losses incurred on these guarantees if necessary
for Vastar to receive
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the minimum cash distributions from SCEM (which are guaranteed by us) in the
years 1998 through 2002. If necessary to support SCEM's ongoing business, the
amount of the contingent performance guarantees can exceed $700 million, and to
the extent that the actual aggregate liability on all of these guarantees were
to exceed $700 million, we have agreed to provide (at a market-based price) any
amount in excess of $700 million. We may provide additional guarantees for
structured transactions and those guarantees may not be subject to any right of
indemnity or contribution between SCEM's parent companies. Contingent
performance guarantees are an industry standard used to support the physical and
financial delivery of products. These guarantees support contractual obligations
such as commodity delivery or payment. The gross amount represents total
counterparty authority, but our actual exposure under these guarantees is
limited by the amount of business conducted under each guarantee. For example,
SCEM may have a $20 million guarantee with a counterparty; however, SCEM is only
exposed for the dollar amount of business that is currently outstanding with the
counterparty. We will be obligated to make payments under these guarantees only
if SCEM's liquidity is exhausted.
We have performance guarantees related to SCEM's business which require us
to maintain an investment grade rating, which means the higher of a Moody's Baa3
rating or a S&P BBB- rating. These guarantees relate to the floor and put
payments, the guarantee to Vastar of the gas purchased under our gas supply
agreement and the guarantee to Brazos covering the Brazos full requirements
transaction. If we lose our investment grade rating, we are obligated to provide
credit enhancement to the guaranteed party in the form of a pledge of cash
collateral, a letter of credit or other similar credit enhancement.
Southern Company has agreed to maintain credit support arrangements related
to SCEM obligations which are outstanding on the separation date. See
"Agreements Between Us and Southern Company -- Master Separation and
Distribution Agreement -- Credit Support Obligations."
Capital resources required by SCEM have been furnished through the initial
capital contributions of Vastar and us, a $150 million credit facility (which is
recourse to SCEM only) and committed capital from Vastar and us in the amounts
of $20 million and $30 million, respectively. In addition, SCEM received capital
contributions during 2000 from us of approximately $31 million and utilizes
commercial paper to reduce funding costs. SCEM currently has approximately $200
million of capital employed in its business, with a maximum availability of
approximately $270 million.
Southern Producer Services
In February 1999, we formed Southern Producer Services, L.P. (SPS) to
engage in the business of providing secured financing to independent oil and gas
producers for the purpose of developing, acquiring or refinancing proved or
producing oil and gas properties in North America as a way of obtaining rights
to marketable oil and natural gas. We believe that SPS also enables SCEM to
aggregate gas commodities for its marketing efforts. Typically, SPS provides
financing in exchange for the rights to market those commodities, which rights
would be exercised by SCEM. SPS plans to utilize various structures for its
investments, including senior secured debt, volumetric production payments,
prepayment purchases and mezzanine financings. We expect all of SPS's
investments to be secured by the underlying commodity available for extraction
based on an independent appraisal of the value of the assets and for repayment
to be made from production proceeds.
All of SPS's loans are secured with collateral in excess of the loan
amounts. In connection with its investments, SPS intends to realize returns from
interest on debt instruments, marketing rights, royalty income and warrants. In
addition, SPS intends to market price risk management services to its customers.
SPS has entered into a marketing agreement with SCEM under which SCEM has a
right of first offer with respect to energy commodities obtained by SPS.
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SPS obtains its capital from us and from a credit facility that provides
capital for SPS assets on an unsecured basis. SPS has a $50 million facility
with Bank One with $22 million outstanding as of May 31, 2000. The interest rate
is LIBOR plus 200 basis points. As of May 31, 2000, SPS has provided $65 million
in financing, and has obtained marketing rights for approximately 100 million
cubic feet per day of natural gas and 10,000 barrels per day of crude oil. In
connection with the credit facility, we agreed to provide indemnities related to
title and environmental defects to the bank, the amounts of which are capped at
the borrowings under the credit facility related to the particular production
facility.
THE CARIBBEAN
FREEPORT POWER COMPANY LIMITED
Freeport Power Company Limited (Freeport Power) is an integrated utility
that generates, transmits, distributes and sells electricity on Grand Bahama
Island. It operates oil-fired generation facilities with a total capacity of 127
MW and provides electricity to approximately 16,500 residential, commercial and
industrial customers on the island.
We acquired a 50% interest in Freeport Power from the Grand Bahama
Development Company Limited (GBDC) for $35.5 million in 1993. At the same time,
GBDC assigned its remaining 50% interest in Freeport Power to ICD Utilities
Limited (ICDU). In 1996, we increased our effective ownership to 62.5% by
purchasing a 25% interest in ICDU for $15 million bringing our total investment
in Freeport Power to $50.5 million. Private investors own 50% of ICDU with the
remaining 25% held by the Bahamian public and the employees of Freeport Power.
We plan to sell up to 60% of our interest in ICDU which would make our effective
ownership in Freeport Power 55%.
Freeport Power has the exclusive right and obligation to supply electric
power to Grand Bahama Island. Freeport Power's power plants include three No. 6
oil-fired steam turbine generators, two simple cycle distillate-fired gas
turbines, two No. 2 oil-fired diesel engine generators and one 13.5 MW No. 6
oil-fired diesel engine generator. A second 13.5 MW No. 6 oil-fired diesel
engine generator is under construction and is scheduled to be operational in
2001. Freeport Power's distribution assets include three 69 kV transmission
lines, six substations and 25 distribution feeders. Freeport Power's rates are
approved by the Grand Bahama Port Authority. Rates have remained stable since
1995. A rate increase that averages 2.8% has been approved by the regulatory
board and went into effect on June 1, 2000 for May power consumption.
POWER GENERATION COMPANY OF TRINIDAD AND TOBAGO
The Power Generation Company of Trinidad and Tobago Limited (PowerGen) is a
1,154 MW power generation company that owns and operates three gas-fired plants
located on the Island of Trinidad in the Caribbean. The electricity produced by
PowerGen is provided to the Trinidad and Tobago Electricity Commission (T&TEC),
the state-owned transmission and distribution monopoly, which serves nearly
300,000 customers on the islands of Trinidad and Tobago and which holds a 51%
interest in PowerGen.
In 1994, we acquired a 39% interest in PowerGen through a competitive bid
process conducted by the government of Trinidad and Tobago. PowerGen initially
entered a into 15-year power purchase agreement (Trinidad PPA) with T&TEC, which
expires in 2009. T&TEC's obligations under the Trinidad PPA are unconditionally
guaranteed by the government of Trinidad and Tobago.
Our interest in PowerGen is held through one of our wholly owned
subsidiaries, Southern Electric International-Trinidad (SEI-Trinidad). Amoco
Trinidad Power Resources Corporation owns
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10% of PowerGen and T&TEC owns the remaining 51%. SEI-Trinidad and Amoco own "B"
shares in PowerGen, and T&TEC owns "A" shares. As "B" shareholders, we and Amoco
collectively select four members of the nine member board of directors and three
members of the six member management committee. We and Amoco have effective
control of the management committee as a result of our ability to appoint its
chairman, who has the right to cast the deciding vote in the event of a tied
issue. Amoco may appoint one member to each of the board and the management
committee, while SEI-Trinidad may appoint three members to the board and two
members to the management committee.
The Trinidad PPA entitles PowerGen to receive monthly capacity and energy
payments from T&TEC, as well as a heat rate bonus if operating conditions are
met. The capacity payment is based on a level of contracted capacity and is
payable regardless of whether energy is actually taken by T&TEC. The energy
payment is based upon the energy actually produced and delivered and varies from
month to month. Substantially all of the revenues are payments received from
T&TEC and are supported by an unsecured payment guarantee issued by the
government. T&TEC is obligated to provide gas and fuel oil to PowerGen. The
facilities of PowerGen are connected to T&TEC's transmission and distribution
system. PowerGen competes for additional load with InnCoGen, which has an
installed capacity of 225 MW and is Trinidad's only other generator.
Since the acquisition of the facilities in 1994, PowerGen has substantially
improved the operations of the power plants. During the four years prior to the
acquisition, the plants were available for operation approximately 69% of the
time. Since the acquisition, the operating availability of these facilities has
risen to approximately 82%.
In addition, PowerGen has completed a restructuring program that reduced
the number of jobs and job classifications, resulting in a more flexible and
productive workforce. PowerGen is conducting skill development training as part
of this process and has substantially completed an organizational transformation
program designed to create a team-driven business culture.
WATER AND POWER AUTHORITY OF THE U.S. VIRGIN ISLANDS
We are currently pursuing the acquisition of a portion of the Water and
Power Authority of the U.S. Virgin Islands (WAPA). WAPA is a vertically
integrated utility supplying both electricity and desalinated water to residents
and business entities on the islands of St. Thomas, St. Croix, St. John, Water
Island and Hassel Island and is regulated by the Virgin Islands Public Service
Commission (VIPSC). WAPA supplies 49,000 electricity customers and 8,400 water
customers, which consist of residential, commercial and industrial customers.
Electricity and water production plants are located on St. Thomas and St. Croix,
and the other islands are served via undersea cables and back up production
facilities. Seawater is desalinated using low level steam from the electricity
production process. Installed electricity generation capacity is 236 MW
consisting of combustion turbines and boiler/generators. Fuel oil, provided by
an oil refinery on St. Croix, is used for all generation. Water production
capacity is eight million gallons per day.
Under the proposed acquisition agreements, the government of the U.S.
Virgin Islands is expected to transfer the electric generation, water production
and water distribution assets of WAPA to Virgin Islands Electricity and Water,
LLC (VIEW), a new U.S. Virgin Islands limited liability company. One of our
subsidiaries, Southern Energy Virgin Islands, LLC (SEVI), will purchase an 80%
interest in VIEW, while the government will hold 20%. We expect the total
purchase price for the equity of WAPA to be approximately $105 million plus
closing costs. VIEW will lease the electric transmission and distribution assets
from WAPA. Pursuant to the lease arrangement, we anticipate the assets will
maintain eligibility for disaster relief from the Federal Emergency
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Management Agency of the United States (FEMA). The lease will be a pre-paid,
25-year lease that is coterminous with the franchise agreement described below.
VIEW will have responsibility for all operations and maintenance of all
power and water assets, including the transmission and distribution system. This
new company will operate with an exclusive franchise with an initial term of 25
years for the generation of electric power for retail sales in the geographic
territory of the U.S. Virgin Islands and water purification for retail and
wholesale sales within the same territory. Exceptions to this exclusive right
include self-generators of electricity and sales of potable water via means
other than a pipeline.
The VIPSC will regulate performance and rates of the new company. Base
non-fuel electricity rates will remain fixed for the first two years, changing
with a formula based on consumer price index and performance thereafter. At each
five-year interval thereafter, a full rate case will be presented to the VIPSC.
Water rates will remain fixed for the first two years and will increase 10% in
the third year, then stay constant for the term of the franchise. Cost of fuel
is passed through to customers.
SEVI and the government will manage their respective interests in the new
company through a seven-member managers' committee. SEVI will have the right to
appoint four members and the government will have the right to appoint three
members. Decisions of the managers' committee will be taken by majority vote,
except that decisions fundamentally affecting the business of the company will
be subject to supermajority or unanimous voting. The day-to-day management of
VIEW will be delegated to a four-member executive committee comprised of the
general manager, another officer of the company, together with one manager
appointed by SEVI and one manager appointed by the government. We will appoint
the general manager, the chief financial officer and the director of production.
In March 2000, the governor of the U.S. Virgin Islands signed the
participation agreement for the transaction with WAPA. In April 2000, the
governor presented legislation to the U.S. Virgin Islands legislature for
approval of the agreement. The Senate of the U.S. Virgin Islands has appointed a
third-party appraiser to evaluate the fairness of this transaction. Several
steps remain before the agreement is final, including approval from the U.S.
Virgin Islands legislature. Additionally, FEMA must determine that the new
structure will allow WAPA to continue to be eligible for disaster recovery
assistance.
SOUTH AMERICA
CEMIG
Companhia Energetica de Minas Gerais (CEMIG) is a fully integrated utility
that generates, transmits, distributes and sells electricity in the southeast
region of Brazil. On June 18, 1997, one of our wholly owned subsidiaries,
Southern Electric Brasil Participacoes, Ltda. (SEB), acquired approximately 33%
of the voting shares of CEMIG for $1.052 billion through a public auction. SEB
paid for the shares in two equal installments, on June 18, 1997 and June 13,
1998.
SEB obtained financing from Banco Nacional de Desenvolvimento Economico e
Social (BNDES) for approximately 50% of the total purchase price. The loan was
taken in two tranches. The first tranche of $125.6 million was drawn in June
1997 and is financed at 9.775% for a 12 year period. The second tranche of
$402.5 million was drawn in June 1998 and is financed at 8.823%, also for a 12
year period. The loan is secured by a pledge of SEB's shares in CEMIG. A portion
of a principal payment that was originally due May 15, 2000, in an amount of
$9.2 million, has been deferred. SEB paid $2.2 million of this principal payment
on May 15, 2000 and expects to pay the remaining $7.0 million on September 15,
2000. An interest payment of $107.8 million, also due on May 15, 2000, has been
deferred until May 15, 2001.
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On June 18, 1997, 524 Participacoes S/A, a group of Brazilian institutional
investors, acquired 9.4% of the equity interest in SEB for $38.2 million. On
June 19, 1998, we transferred the remaining 90.6% equity interest in SEB to
Cayman Energy Traders (CET) for $369.0 million. CET is jointly owned by us and
AES, and we own 51% of the voting shares.
We have made total equity contributions of $136.3 million, which
corresponds to a 27.59% economic interest in CET. Although we own less than a
50% economic interest in CET, we have always maintained a majority of CET's
voting shares. The following table shows the ownership percentages in voting and
economic interests of each company.
<TABLE>
<CAPTION>
COMPANY SHAREHOLDERS % VOTING SHARES % ECONOMIC INTEREST
------- --------------------- --------------- -------------------
<S> <C> <C> <C>
CEMIG State of Minas Gerais 50.96% 23.44%
SEB 32.96 14.41
Others 16.08 62.15
TOTAL 100.00% 100.00%
SEB CET 90.60 90.60
524 Participacoes 9.40 9.40
TOTAL 100.00% 100.00%
CET Southern Energy 51.0 27.59
AES 49.0 72.41
TOTAL 100.00% 100.00%
</TABLE>
As a result of our interest in CET, we have an indirect economic interest
of 3.6% in CEMIG (27.59% of CET, which owns 90.6% of SEB, which owns 14.41% of
CEMIG). We continue to hold the majority of voting capital at CET and
indirectly, SEB.
Upon its acquisition of shares of CEMIG, SEB entered into a shareholders
agreement with the State of Minas Gerais (which retained a majority of the CEMIG
voting shares). The agreement establishes, among other things, SEB's vote in the
management of CEMIG. It grants SEB the right to elect four of the 11 members of
the board of directors of CEMIG and grants SEB veto rights over key operating
issues such as significant changes in the budget. In addition, SEB may elect
three members of the eight-member management council.
SEB's rights under the shareholders agreement are currently the subject of
pending litigation brought by the state of Minas Gerais. In this litigation, the
state is seeking rescission of the shareholders agreement based upon the
assertion that SEB's veto rights are an unconstitutional transfer of control of
CEMIG from the state to SEB. On March 23, 2000, a state court in Minas Gerais
ruled that the shareholder agreement was invalid. SEB has appealed this
decision. The status of this litigation is more fully described under the
heading "Legal Proceedings" in this section of the prospectus.
CEMIG is the second largest Brazilian electric company, as measured by
gigawatt-hours (GWh) of energy sold, providing approximately 97% of the
electricity consumed in Minas Gerais. Minas Gerais is the second most populous
state in Brazil with approximately 17 million residents. Minas Gerais is the
most mineral-rich state in the southeast region of Brazil and has the region's
most extensive watershed. Minas Gerais is also a principal place of business for
companies that are among the most energy-intensive in the region -- including
companies in the aluminum, cement, steel and mining industries.
CEMIG has a distribution concession in Minas Gerais, covering an area of
approximately 216,300 square miles that expires on February 18, 2016. CEMIG may
apply for a 20 year extension of the concession. CEMIG has approximately 200,000
miles of transmission and distribution lines.
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CEMIG supplies electricity to approximately 4.9 million customers and has added
an average of approximately 200,000 new customers annually.
Virtually all of CEMIG's generation capacity is hydroelectric. As of
December 31, 1999, CEMIG operated 34 hydroelectric power plants, two thermal
plants and one wind farm. Seven hydroelectric plants account for approximately
92% of CEMIG's total capacity of 5,514 MW.
Through a treaty between Paraguay and Brazil, CEMIG is obligated to
purchase electricity from ITAIPU, a hydroelectric plant jointly owned by Brazil
and Paraguay. CEMIG is allocated approximately 1,730 MW, or 17%, of Brazil's
ITAIPU capacity. In 1999, CEMIG purchased 13,909 GWh of electricity from ITAIPU,
which represented approximately 34% of CEMIG's sales. The rate for energy
purchased from ITAIPU is U.S. dollar denominated and is set independently from
the rate set for CEMIG and other energy producers but is a direct pass through
to customers' tariffs.
CEMIG's customers are classified into five principal categories: industrial
(mining, manufacturing and processing activities), residential, commercial
(service oriented businesses, universities and hospitals), rural and others.
From 1993 to 1999, the compounded annual growth rate in the volume of electric
power sold to industrial customers was 0.2%. The growth rate for residential and
commercial customers during the same period was 7.6% and 9.0%, respectively. For
the year ended December 31, 1999, large industrial customers accounted for
approximately 53% of the volume of CEMIG energy sold and approximately 38% of
CEMIG revenues. The five largest industrial customers accounted for
approximately 11.9% of the energy consumed. CEMIG's total sales in 1999 were
40,413 GWh. CEMIG is also engaged in gas distribution through its subsidiary,
Companhia de Gas de Minas Gerais -- Gasmig (GASMIG). GASMIG currently supplies
approximately 800,000 cubic meters of gas per day to 55 industrial customers in
Minas Gerais.
CEMIG management has been able to implement several key operating
initiatives, including a downsizing program that has reduced staff from over
15,000 employees in June 1996 to less than 12,000 in 1999.
Regulatory Environment
In 1993, significant changes occurred in the regulation of electricity
rates in Brazil. Federal Law 8,631 abolished the concept of guaranteed returns
in favor of an individual rate structure for each utility. Under the new
structure, each utility proposes a rate structure based on its particular
circumstances -- including its rate of investment -- for approval by the federal
regulatory authorities. However, the Brazilian government, through the 1994
Federal Government Economic Stabilization Plan, suspended the rate setting
processes and froze rates in reais as of July 1, 1994. Since that date, rates
have been fixed on an annual basis by the federal government.
At the time of the share sale in 1997, CEMIG entered into a new 20-year
concession agreement with the Brazilian government. The new agreement superceded
any restrictions under the 1994 Federal Government Economic Stabilization Plan
and established an annual inflation-based formula for fixing rates which
provides CEMIG with more rate stability. The Brazilian government may grant more
frequent requests for rate increases at its discretion. In November 1995, CEMIG
was authorized to raise rates 11.8% and 59.5% to non-residential and other
concessionaires, respectively. The regulator also granted a reduction in
discounts for residential customers. Other annual increases were as follows:
- April 1997: 9.8% to final customers, 13.6% to wholesale supply and 9.9%
on average
- April 1998: 4.54% to both final customers and wholesale supply
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- April 1999: 16.25% to both final customers and wholesale supply
- June 1999: 3.85% to both final customers and wholesale supply
- May 2000: 12.23% to both final customers greater than 90 kWh/month
average and wholesale 6% to customers with between 90 and 180 average
monthly kWh usage; no increase to customers with less than 90 kWh average
monthly usage.
Revenues are denominated in the Brazilian real but a significant portion of
expenses, including power purchase expenses and some interest expense, are
denominated in U.S. dollars and other foreign currencies. Pursuant to the
concession agreement, power purchase expenses as well as taxes are a
pass-through item. We do not expect CEMIG to bear increased purchased power
costs attributable to currency moves.
In January 1999, Brazil's central bank removed trading bands which allowed
the real to float versus other currencies. Over the ensuing three days, the real
devalued by more than 45% versus the U.S. dollar and by the end of February 1999
had reached R$2.065 per U.S. dollar (a 70% devaluation). As a result we incurred
a reduction of $83 million, net of income tax effects, in the recorded amount of
our investment in CEMIG. The exchange rate has appeared to stabilize in recent
months at approximately R$1.8 per U.S. dollar. CEMIG continues to evaluate the
impact of the devaluation on overall earnings and may be able to achieve
additional rate relief to reduce the impact of devaluation on items not
specifically recoverable under the concession agreement (such as the cost of
foreign currency-denominated debt).
EDELNOR
Empresa Electrica del Norte Grande S.A. (EDELNOR) is a partially integrated
electric utility engaged in the generation, transmission and marketing of
electric power in the Sistema Interconectado del Norte Grande (SING), an
interconnected power grid in northern Chile. The major purchasers of electricity
in the SING are industrial mining companies that produce copper, Chile's largest
export, and five electric distribution companies that provide power to the
region's 740,000 inhabitants and to some small industrial and commercial
customers.
In 1993, our subsidiary SEI Chile, S.A. (SEI Chile) purchased approximately
35% of the shares of EDELNOR from Corporacion de Fomento de la Produccion and an
additional 3.5% interest from other sources to bring our total ownership at the
time to 38.5%. SEI Chile increased its ownership in EDELNOR to 65% in 1994 and
purchased an additional 2% in 1997 for a total ownership stake of 67%. In July
1998, SEI Chile invested $57 million to purchase additional shares of EDELNOR
via a rights offering. This investment increased our interest in EDELNOR to
82.3%.
In December 1998, we announced our intention to sell our interest in
EDELNOR. We are continuing to evaluate whether our investment in EDELNOR can be
recovered through a sale. We are uncertain whether we will be able to recover
the value of our investment.
EDELNOR owns generating facilities with a total capacity of approximately
653 MW, and operates 681 MW, including 28 MW which it leases. EDELNOR also owns
and operates approximately 1,060 km (657 miles) of high voltage transmission
lines, 15 substations and other ancillary transmission facilities.
EDELNOR currently owns an approximate 21% interest in Gasoducto Nor Andino
(Nor Andino), a 1,066 km (661 miles) natural gas pipeline project which
transports natural gas from gas fields in northern Argentina to northern Chile.
EDELNOR has invested approximately $91 million in the project. Electroandina, a
subsidiary of Tractebel, has signed U.S. dollar-indexed, substantially
"take-or-pay" gas transportation agreements with Nor Andino to supply two 412 MW
gas-fired
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plants. These contracts began during the last quarter of 1999. EDELNOR has
signed a similar agreement sufficient to supply its Mejillones III
combined-cycle unit.
EDELNOR's principal generating assets are two coal-fired units and one
combined cycle gas turbine located just north of Antofagasta in Mejillones. The
first coal unit, Mejillones I, has a generating capacity of 154 MW and began
operation in December 1995. Mejillones II, also a coal unit, has a generating
capacity of 164 MW and began operating at the end of March 1998. The gas unit,
Mejillones III, began commercial operation on June 17, 2000 and has a generating
capacity of 243 MW.
The Mejillones I and II generating units have used a blend of petroleum
coke and coal as an alternative fuel to pure coal. Petroleum coke, or pet coke,
is a by product from the petroleum refinery process. The use of pet coke allows
these units to produce electric energy with a significant reduction of
production costs compared to running on pure coal, making these units more
economical. Competitors of EDELNOR filed complaints with the applicable local
environmental agency, the COREMA Region II agency (COREMA), alleging that
EDELNOR does not have approval to burn pet coke as an alternative fuel. In
February 1999, COREMA requested that EDELNOR refrain from using pet coke as a
fuel for the Units. As a result of this request and several resulting
administrative penalties from the COREMA, EDELNOR ceased burning pet coke and
completed an environmental impact study on the use of pet coke as an alternative
fuel. EDELNOR submitted the environmental impact study to COREMA. On March 2,
2000, COREMA ruled against EDELNOR's application to use pet coke as an
alternative fuel. EDELNOR filed an appeal of this decision to the national
environmental agency, Comision Nacional del Medio Ambiente (CONAMA) on April 4,
2000. We believe that EDELNOR has demonstrated its ability to comply with all
applicable regulations; however, we cannot assure you that we will be successful
in our appeal. If we are unsuccessful in our appeal to the CONAMA, we will
attempt to reach an agreement with the authorities on an acceptable mixture of
pet coke and coal which would allow EDELNOR's generating units to maintain a
competitive position in the dispatch order of the SING. If EDELNOR is prohibited
from using any pet coke, the units will be required to rely on coal as the
primary fuel, which is not as economical as natural gas. If this occurs, there
may be a significant reduction in EDELNOR's energy and capacity revenues.
EDELNOR pursues a sales strategy comprising both contract and spot sales.
EDELNOR has contracts to supply the five distribution companies in the SING.
However, three of the five contracts, (representing approximately 167 MW) are
with the Chilean distributor EMEL S.A. and will expire on December 31, 2001. The
impact of the lost sales will begin in 2002 and is expected to be partially
mitigated by revenues EDELNOR believes it will derive from sales to the SING and
from charges to the new supplier for use of EDELNOR'S transmission facilities.
Further, EDELNOR has requested an investigation by the Antimonopoly Commission
into the contracting of EMEL S.A. with its new supplier. An investigation could
result in the nullification of these contracts and opening the contracts to bid.
If that occurs, EDELNOR may bid on the contracts again in an open process.
EDELNOR also supplies 12 other customers under long-term contracts
representing approximately 224 MW. These contracts have expiration dates ranging
from 2000 to 2017. Two of these contracts, representing approximately 60 MW,
expire in 2000. Energy sales to industrial customers increased 149% from 1993 to
1999. These contracts are denominated in U.S. dollars and payable in Chilean
pesos. Most of the economic activity in the SING is attributable, directly or
indirectly, to the copper mining industry which uses large amounts of
electricity. In 1999, the copper mining industry accounted for approximately 87%
of the energy sold in the SING. During this time, EDELNOR derived 52% of its
revenues from copper mining and copper mining related customers. Any significant
decline in the production of copper in northern Chile could lower the demand for
electricity used in
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the copper production process and might also result in lower demand for
electricity due to any resulting economic slowdown in the area.
ALICURA
In 1993 we acquired a 55% indirect interest in Hidroelectrica Alicura S.A.
(Alicura), an Argentine company. Alicura's principal asset is the remaining
years of a 30-year concession agreement, ending in August 2023, that allows
Alicura to operate a 1,000 MW hydroelectric plant in Neuquen Province, 1,545 km
(958 miles) southwest of Buenos Aires, Argentina. We acquired our interest in
Alicura through SEI y Asociados de Argentina S.A. (Asociados), which is the
majority shareholder. We currently own approximately 93% of Asociados, which in
turn owns 59% of Alicura, giving us a 55% interest overall. Asociados acquired
its interest in Alicura for $178 million, plus additional payments totaling $40
million. In addition, we provided credit support for $200 million of Alicura's
bank financing. Other shareholders of Alicura include the government of
Argentina (19.5%), the government of the province of Neuquen (19.5%) and the
employees (2%).
On February 21, 2000, we executed a stock purchase agreement with The AES
Corporation to sell our interest in Alicura for total consideration of $205
million including the assumption of debt. The closing was expected to occur on
June 28, 2000; however, it has not yet occurred. We cannot assure you that this
transaction will be consummated.
EUROPE
We currently have three businesses in Europe: WPD, which distributes
electricity in southwest England; a 26% interest in Bewag AG, the integrated
utility serving Berlin; and our business of marketing and managing market risk
associated with energy and energy-linked commodities. Our strategy in Europe is
to create a business unit that integrates our generation and distribution with
our marketing and risk management capabilities. We intend to build upon our
existing businesses by expanding our marketing and risk management operations in
several countries where electricity markets have been most significantly
liberalized, to seek acquisitions and contractual arrangements for the control
of generation and distribution and to develop new projects to meet our strategic
goals.
WESTERN POWER DISTRIBUTION
South Western Electricity plc, trading as Western Power Distribution (WPD),
is one of the privatized regional electricity companies in England and Wales
licensed to distribute, supply and, to a limited extent, generate electricity.
WPD's primary business is distribution of electricity.
WPD previously operated a supply business known as "SWEB" that purchased,
marketed and sold electricity to customers within its service territory and to
competitive customers throughout the United Kingdom. WPD sold that business,
together with the name SWEB, to London Electricity plc for L160 million ($264
million) and the assumption of certain liabilities. The sale was effective
September 30, 1999.
We acquired WPD, which included the SWEB supply business, in September 1995
for a total acquisition price of $1.8 billion. The acquisition price was
originally financed by Southern Investments UK plc (SIUK), our holding company
for WPD. SIUK is a wholly owned subsidiary of WPD Holdings Limited, which in
turn has been wholly owned by WPD Holdings UK (WPD Holdings) since June 1998. In
July 1996, we sold a 25% interest in WPD Holdings Limited to PPL Global, a
subsidiary of PPL Corporation, a utility holding company based in Allentown,
Pennsylvania. In June 1998, we sold an additional 26% economic interest in WPD
Holdings Limited to PPL Global for $170 million, and on the same day both
parties agreed to exchange their interests in WPD Holdings
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Limited for interests in WPD Holdings that carried substantially the same
rights. We currently have a 49% economic interest in WPD Holdings, yet retain
operational and management control of WPD Holdings with 50.5% of the voting
control.
On May 31, 2000, WPD Limited made a bid of L464 million (approximately $700
million) to purchase the entire ordinary share capital of Hyder plc, the company
which owns and runs the electricity network in South Wales and the water
distribution and waste water treatment business for the whole of Wales. This
represents a bid of L3 per share. If the bid is successful, we expect WPD to
manage the electricity network in South Wales. WPD Limited has already entered
into an agreement with a third party, United Utilities plc, under which United
Utilities will take on the day to day operations of the water company. The offer
has been circulated to Hyder plc shareholders and, in the absence of another
competing bidder, the outcome of the bid will be known no later than 81 days
from the posting of the offer document to the shareholders. The bid is being
reviewed by the regulatory authorities. This bid follows an earlier bid from St.
David's Capital Limited, owned by Principal Finance Group of Nomura
International, to purchase Hyder plc for L2.60 per share. We cannot assure you
that WPD Limited's bid will be successful.
Distribution Business
WPD's distribution business is the ownership, management and operation of
the electricity distribution network within WPD's authorized area in southwest
England. The primary activity of the distribution business is the receipt of
electricity from the national grid transmission system and its distribution to
end users of electricity that are connected to WPD's power lines. These end
users are customers of licensed supply businesses, which in turn are the WPD
distribution business customers. There are approximately 1.4 million end users
connected to WPD's network. Virtually all electricity supplied to end users in
WPD's area is transported through its distribution network, thus providing WPD
with distribution volume that is stable from year to year. WPD is the only
distributor of electricity in its authorized area, and we believe that economic,
environmental and regulatory factors are likely to prevent competitors from
entering the distribution business in WPD's authorized area.
WPD's authorized area extends from Bristol and Bath in the northeast to
Lands End and the Isles of Scilly in the southwest. The largest cities and towns
in this area are Bath, Bristol, Exeter, Plymouth and Taunton and the principal
industrial end users, in terms of electricity usage, are involved in china clay
extraction, ship repair, fertilizer production, aerospace, defense engineering,
cement and paper manufacturing and water supply. WPD's fastest growing
categories of distribution customers are large commercial and small industrial
customers. Commercial customers in the authorized area are largely financial and
technical service-based businesses.
Since our acquisition, WPD has reviewed and refined its distribution
strategy and has established key goals of cost reduction, improved customer
service and network performance. Staff reductions have played a key role in cost
savings. Since our acquisition, WPD has implemented a plan of voluntary and
other staff reductions, mainly in its distribution business. By December 31,
1999, staff numbers had been reduced by 752 persons (excluding staff transferred
to London Electricity as a result of the sale of the SWEB supply business). Part
of these reductions were made possible due to new work practices which WPD has
developed with the cooperation of WPD's unions. Team restructuring in the
engineering division and the establishment of multi-skilled independent field
teams has also contributed to improved cost efficiency. In addition, management
restructuring has produced a flatter organizational structure by reducing
management levels from seven to three. In September 1999, WPD transferred 833
employees to London Electricity in connection with the sale by WPD of the SWEB
supply business discussed above. Since December 1999, WPD has
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implemented further staff reductions as a consequence of a regulatory price
reduction as discussed below.
Improvements in customer service in the distribution business are a
significant part of WPD's strategy. WPD aims to meet or exceed all the
performance criteria established by the regulator who is responsible for setting
the performance standards and targets. WPD believes that achieving these goals
is important both for improving customer satisfaction and for maintaining good
relations with the regulator. Improvements in customer service are being
pursued, in part, through improvements in system performance.
Ancillary Businesses
WPD also has ancillary business activities that support its main
electricity distribution business. These include electricity generation, real
estate and telecommunications. WPD owns generating assets with 12 MW of capacity
used to back up the distribution network. In addition, WPD owns minority
interests in windfarms and a 7.7% interest in Teesside Power Limited, owner of a
1,875 MW natural gas-fired, combined-cycle plant. WPD markets and develops real
estate no longer used in the distribution business and is developing an income
stream from the rental of fiber optic cables primarily attached to WPD's
overhead distribution network.
Regulatory Environment
The political and regulatory climate in the United Kingdom has changed
significantly since our acquisition of WPD in 1995. There are currently a number
of issues affecting the electricity industry, including separation of
distribution and supply businesses, market dominance and new generation
build-up. We have proactively taken steps to adjust to these future changes, and
we do not expect any of these changes to have a material adverse impact on us.
Virtually all distribution customers in England and Wales are connected to
the distribution system of the regional electricity companies and cannot choose
their electricity distributor. The Office of Gas and Electricity Markets
controls the revenues earned by WPD in its distribution business and former
supply business by applying a price control formula. Distribution revenues are
regulated by a formula (DPCF) that sets the maximum average price per unit of
electricity distributed. The elements used in the formula are generally
established for a five-year period and are subject to review by the regulator.
In December 1999, the regulator published final price proposals following his
review of the DPCF for distribution businesses. For WPD, these proposals
represent a 20% reduction to distribution prices from April 1, 2000, followed by
a reduction in real terms of 3% each year after April 1, 2001. This price
control is scheduled to operate until March 2005. In response, WPD plans to
maximize efficiency and customer service as a focused distribution company. In
order to achieve these objectives, WPD is implementing a plan to reduce staffing
levels by approximately 10%. The reductions primarily affect administrative and
corporate functions, with minimal impact on field staff, in order to assure that
customer service is not affected. WPD is currently evaluating further
opportunities to reduce ongoing operating costs.
The U.K. electricity Regulator is introducing competition in metering
activities, namely meter fixing (providing, installing, certifying and repairing
meters) and meter reading. Meter fixing must be undertaken by authorized
providers, of which WPD is one. Based on the anticipated regulation, the
original carrying value of metering assets was impaired. As a result, WPD
recorded an impairment loss of $31 million in the fourth quarter of 1999 to
reflect the amount by which the carrying value of metering assets exceeded their
fair value. The fair value was determined by computing the present value of
estimated future cash flows attributable to the assets.
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WPD also faces regulatory issues related to its use of a pension surplus
which was primarily utilized to offset the cost of providing early pensions to
terminated employees. An independent pension arbitrator has issued a ruling
directing that another industry employer should refund such amounts with
interest to the Electricity Supply Pension Scheme (ESPS). The ESPS provides
pension and other related defined benefits, based on final pensionable pay, to
substantially all employees throughout the electricity supply industry in the
United Kingdom. This ruling is currently being appealed to the House of Lords.
The majority of WPD's employees are ESPS members. We cannot assure you that this
appeal will succeed or that WPD will not be required to refund to the ESPS any
amounts previously used to fund early retirement costs, which management
estimates to be approximately L24 million (approximately $36 million). Under
FASB 87 "Employers' Accounting for Pensions," we do not anticipate any immediate
impact to our net income.
BEWAG
In September 1997, we were part of a consortium that purchased 51% of Bewag
AG, the integrated utility serving Berlin, Germany. The consortium included
PreussenElektra AG (Preussen), a subsidiary of Veba AG, and Bayernwerk AG
(Bayernwerk), a subsidiary of VIAG AG. Including shares already held by Preussen
and Bayernwerk, the consortium controls 75% of Bewag. We hold a 26% interest in
Bewag, which we purchased for approximately $820 million, including
approximately $478 million of non-recourse debt.
Bewag's entire customer base is open to competition in accordance with
German electricity laws. Bewag serves approximately 2.1 million customers in the
city-state of Berlin. We believe Berlin and the surrounding region have
favorable prospects for long-term growth, in particular because Berlin has
resumed its position as the seat of the national government of Germany. In
addition, Bewag has direct access to Germany's high-voltage transmission lines,
which enhances its ability to purchase competitively priced power.
We entered into a 30-year shareholders agreement with Preussen, Bayernwerk
and VIAG. This agreement specifies governance issues and key financial elements.
Under the shareholders agreement, decisions on major business items (e.g., major
capital investments and divestments, establishment of new business lines, amount
of the dividend and ratification of Bewag's annually revised five-year business
plan) require approval by us and Bayernwerk, effectively giving both members
veto rights over major decisions made by the utility.
In June 2000, the European Union Commission approved a merger between Veba
AG and VIAG. The companies have stated their intention to merge Preussen and
Bayernwerk, creating a core energy division of the combined entity. The
Veba-VIAG merged entity is expected to have approximately 34% of the German
electricity market. As a result of the EU review process, Veba-VIAG made
concessions to the EU to obtain approval for the merger. Among these concessions
is the sell-down of several holdings, including the combined interest of the
merged utility in Bewag and in Vereinigte Energiewerke Aktiengesellschaft
(VEAG), the East German generation and high-voltage transmission company. We
have publicly stated our interest in acquiring a controlling position in Bewag
and supporting Bewag to acquire a controlling position in VEAG in order to
strengthen our position in the market.
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Bewag is a vertically integrated utility with 29 power and steam units
generating 2,955 MW of electricity and 5,740 MW of thermal energy sold for
heating. Bewag's generating assets are shown in the following table:
<TABLE>
<CAPTION>
PLANT ELECTRIC CAPACITY(MW) THERMAL CAPACITY(MW) FUEL
----- ---------------------- --------------------- ----------------------
<S> <C> <C> <C>
Reuter West.................................. 600 780 Coal
Lichterfelde................................. 450 720 Natural Gas
Charlottenburg............................... 330 610 Coal, Oil
Mitte........................................ 380 620 Natural Gas
Wilmersdorf.................................. 280 330 Oil
Reuter....................................... 202 240 Coal
Oberhavel.................................... 200 0 Coal
Klingenberg.................................. 140 320 Coal, Oil, Natural Gas
Rudow........................................ 175 130 Coal
Moabit....................................... 151 200 Oil, Natural Gas
Lichtenberg.................................. 36 1,100 Oil, Natural Gas
Kopenick..................................... 10 50 Oil, Natural Gas
Buch......................................... 1 130 Oil, Natural Gas
Heating plants............................... 0 510 Coal, Oil, Natural Gas
----- -----
Total...................................... 2,955 5,740
===== =====
</TABLE>
Electric power is transmitted to Bewag's approximately 2.1 million electric
customers over 39,000 kilometers of cable, most of which is underground.
Construction is underway to interconnect both sides of Berlin with a 380
kilovolt (kV) line that is expected to be connected to the supra regional German
380 kV grid in late 2000 or early 2001. At the end of June 1999, Bewag began
trial operations of a new centralized distribution control system. We expect
that the new system will enhance the reliability and operational cost
effectiveness of Berlin's distribution system. Bewag earns approximately 75% of
its revenues from electricity sales.
All households and a portion of the low voltage-special contract customers
are considered tariff customers by the Berlin regulator. Tariff customers
purchased approximately 48% of the electricity sold in 1999, while approximately
3,000 industrial and commercial customers purchased the remaining 52%. Special
contract customers typically purchase power from Bewag through a standard
agreement, which is renewable annually. Future growth in demand is expected to
come from growth in single households, growth in the number of appliances and
growth due to the relocation of the German government in 1999 from Bonn to
Berlin.
In addition to electricity, Bewag provides district heating for
approximately 500,000 residential and commercial customers. Bewag has an
approximate market share of 30% of the heating market in Berlin through its
district heating system. Heat sales comprised 22% of Bewag's revenue in the
fiscal year ended June 1999.
Bewag has also acquired additional market share as a result of its
purchase, along with Gaz de France, of a controlling interest in GASAG Berliner
Gaswerke Aktiengesellschaft (GASAG). Bewag believes GASAG has substantial
opportunity to grow its market share. GASAG provides service to approximately
744,000 customers, which is the largest customer base of any German natural gas
supplier, utilizing over 4,000 miles of pipeline network. In the first quarter
of 1998, Bewag, which then owned approximately 12% of GASAG, increased its
direct interest in GASAG to 24.9%. In July 1999, Bewag increased its share of
GASAG to 31.57% by purchasing shares from Gaz de France for the equivalent of
$100 million. With Gaz de France also owning 31.57%, the two companies have
effective control of GASAG and have made two key appointments to the management
board.
In July 1999, Bewag concluded a collective agreement with the trade unions
to implement a workforce reduction plan to reduce the number of full-time
employees from about 8,500 to between
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4,500 and 4,700 by the year 2002. As of July 1, 2000, the number of full-time
employees was reduced to approximately 6,300 and another 1,100 employees have
agreed to leave over the next two years. The costs associated with these
departures were recorded in 1999. Bewag expects to record additional employee
cost reduction charges in the future. Bewag remains committed to reevaluating
the competitive position of its cost structure in the market.
Regulatory Environment
In September 1999, the Federal Cartel Authority announced that Bewag would
have to allow access by other suppliers of approximately 20% of the 400 MW
access line into Berlin. When the new 380 kV line is completed, it will
interconnect both sides of Berlin. Once the line is completed, there will be few
restrictions on other suppliers wishing to supply power in Berlin. It is
expected that the line will be completed by the end of 2000.
The European Union has endorsed a directive which broadly aims to open
electricity markets to customer choice and competition known as the Directive
Concerning Common Rules for the Internal Market in Electricity. In response to
this directive a new German Energy Industry Act was introduced in April 1998.
The energy act provides for customer choice for all consumers of electricity,
and Bewag's customers may now choose their electricity supplier on a competitive
basis. In accordance with the requirements of the energy act, the eight
integrated generation companies which own the high voltage grid entered into a
voluntary agreement providing for third-party access to the transmission system,
subject to the exceptions permitted under the energy act. The voluntary
agreement has led to published pricing for transmission and distribution charges
in several areas of Germany and competition for customers. Further changes to
this agreement are expected to considerably simplify third-party access and lead
to a drop in fees. We believe that Bewag will need to continue to reduce its
costs and increase its supply pricing competitiveness as a result of the
deregulation of the German electricity market.
SE-EUROPE
We formed Southern Energy -- Europe B.V. (SE-Europe) in Amsterdam, in the
first quarter of 1999 to support our asset and business development activities,
acquisition efforts and future generation facilities in Europe through market
research and analysis, financial structuring consultation and joint marketing
efforts. SE Europe's services may include fuel procurement, market analysis,
risk management and control and physical and financial energy trading services
such as spot market price bidding and commercial dispatch, among others. We
intend to coordinate, where possible, SE-Europe's infrastructure development,
risk policies and procedures and overall corporate activities with SCEM to
ensure that knowledge, experiences, systems and governance philosophies are
appropriately leveraged.
During the second quarter of 1999, SE-Europe began trading electricity in
the Nordic power market, the most liquid and liberalized power market in Europe
at the time. By December 31, 1999, SE-Europe had traded approximately 77 TWh in
the Nordic market, primarily on the Nord Pool power exchange. SE-Europe's
volumes represented approximately 12% of the total volumes transacted in the
Nordic market over that period.
In addition to trading on the Nord Pool power exchange, SE-Europe has met
all requirements necessary for physical spot trading on the recently established
Amsterdam Power Exchange. Levels of activity will depend on market development
and liquidity of those markets. We are also in the process of obtaining
necessary legal and regulatory approvals to actively participate in physical and
financially settled trading throughout our target market extending through the
North-South corridor from the
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Nordic region through Central Europe to Northern Italy. We expect to commence
significant activity in these regions during 2000, where market development
permits.
Through coordinated efforts with our European asset development team,
SE-Europe intends to seek opportunities to position our European energy business
as a significant industry participant in the wholesale fuels, electric
generation and energy commodity trading segments of the European energy market.
We have identified the liberalizing markets of Western and Central Europe as the
focus of our growth strategy in Europe. In conjunction with our trading
operations in Amsterdam, we have integrated our marketing and business
development functions in these markets. We are seeking to apply our risk
management and fundamental market analysis skills to our European operations and
business development efforts. In addition to our operations in Amsterdam, we
have opened regional marketing and business development offices in Germany,
Italy and Switzerland. We expect to open an additional regional office in the
Nordic region during early 2001. Each office is charged with developing
opportunities ranging from structured and origination transactions to
acquisition of assets or control of assets through contractual arrangements. We
intend to support existing participants in the market and to forge alliances
that will prove mutually beneficial with local partners.
ASIA-PACIFIC
In January 1997, one of our wholly owned subsidiaries, Southern
Energy-Asia, Inc. (SE Asia), acquired 80% of Consolidated Electric Power Asia
Limited (CEPA), since renamed Southern Energy Asia-Pacific Limited (SE
Asia-Pacific), from Hopewell Holdings Limited (Hopewell) for approximately $2
billion. This acquisition was partially financed by SE Asia with a $792 million
bank loan. In August 1997, we purchased the remaining 20% of CEPA from Hopewell
for $150 million and the transfer to Hopewell of CEPA's interest in Tanjung Jati
B, a 1,320 MW power project then under development in Indonesia. Today, SE Asia
and one of its direct subsidiaries own 100% of SE Asia-Pacific.
SE Asia-Pacific is one of Asia's largest independent power producers and
has substantial experience in developing, constructing, holding an interest in
and operating electric power generation facilities in Asia. The majority of SE
Asia-Pacific's assets are located in the Philippines, with additional assets
located in China and Australia. By acquiring 100% of SE Asia-Pacific, we
acquired a net ownership interest in 3,388 MW of generating capacity operating
or under construction, a coal mining company in Australia and a development team
and corporate staff based in Hong Kong and the Philippines. We currently have a
net ownership interest in 3,159 MW of generating capacity. SE Asia-Pacific is
currently conducting business development activities in five countries:
Australia, China, India, the Philippines and Singapore. Specifically, SE
Asia-Pacific has a project in an advanced stage of development as one of SE
Asia-Pacific's Philippine subsidiaries has agreed to construct a sub-station and
two transmission lines in the Philippines to supply an industrial facility
partially from one of SE Asia-Pacific's other projects.
SE Asia-Pacific is known as a pioneer in the independent power business in
Asia. SE Asia-Pacific has been most successful in developing businesses in the
Philippines where it has a net ownership interest in five plants totaling 2,092
MW of capacity. SE Asia-Pacific has long-term energy conversion agreements with
National Power Corporation (NPC), under which SE Asia-Pacific accepts fuel from
NPC and converts that fuel to energy. NPC is the national electric company and
its obligations to SE Asia-Pacific's project companies are supported by Republic
of the Philippines' guarantees.
SE Asia-Pacific also owns a 32% interest in a 2,038 MW coal-fired power
plant in Guandong Province (Shajiao C) in China. We own, through our subsidiary
SE China Investments, Inc. (SE
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China), a 9.99% interest in Shandong International Power Development Company
Limited (SIPD). SIPD holds 18 units in Shandong province in China totaling 4,158
MW.
SE Asia-Pacific also holds a 100% interest in AQC, a coal mining company
located in Queensland, Australia. AQC has the mining rights to approximately 1.3
billion tons of low-sulfur, low-cost coal. Small amounts of coal are currently
being mined for sale in the domestic and overseas markets.
The following table depicts our investments in the Asia-Pacific region
currently in operation:
<TABLE>
<CAPTION>
NET
OWNERSHIP
INTEREST IN OPERATED
TOTAL MW OWNERSHIP % TOTAL MW MW
-------- ----------- ----------- --------
<S> <C> <C> <C> <C>
GENERATION OPERATIONS:
Philippines
Sual...................................................... 1,258 91.9% 1,156 1,258
Pagbilao.................................................. 735 87.2 641 735
Navotas I................................................. 200 90 180 200
Navotas II................................................ 100 100 100 100
Bulacan................................................... 15 100 15 15
China
Shajiao C................................................. 2,038 32 652 --
SIPD...................................................... 4,158 9.99 415 --
----- ----- -----
Total................................................... 8,504 3,159 2,308
===== ===== =====
</TABLE>
THE PHILIPPINES
SE Asia-Pacific's subsidiaries have entered into four separate energy
conversion agreements (ECAs) with NPC, one each for the Sual, Pagbilao, Navotas
I and Navotas II projects. The ECAs are build-operate-transfer agreements. At
the end of the term of each ECA, the associated plant is required to be
transferred to NPC, free from any lien or payment of compensation. NPC acts as
both the fuel supplier and the energy off-taker under the ECAs. NPC procures all
of the fuel necessary for each plant, at no cost to SE Asia-Pacific's
subsidiary, and has accepted substantially all fuel risks and fuel related
obligations other than each plant's actual fuel burning efficiency.
The SE Asia-Pacific subsidiaries receive compensation under the ECAs for
fixed capacity fees, variable energy fees and other incidental fees. Over 90% of
the revenues are expected to come from fixed capacity charges that are paid
without regard to dispatch level of the plant. Capital recovery fees,
infrastructure fees, and service fees, which comprise most of the fixed capacity
charges, are denominated in U.S. dollars. The fixed operating fees, energy fees
and other incidental fees have both U.S. dollar and Philippine peso components
that are both indexed to inflation rates.
The ECA contains a provision under which NPC bears the financial risks for
both political force majeure and change of law, including environmental
regulation. NPC's obligations under the ECAs are guaranteed by the full faith
and credit of the Philippine government. The following table
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summarizes the ECA terms, NPC transfer date and capacity information for each
asset in the Philippines:
<TABLE>
<CAPTION>
CAPACITY
PORTION OF 1999 COMMITTED
ECA LIFE TRANSFER REVENUES AS TO NPC
PROJECT (YEARS) TO NPC CAPACITY FEES (MW)
------- -------- --------- --------------- ---------
<S> <C> <C> <C> <C>
Sual 25 June 2025 94% 1,000
Pagbilao 29 Aug 2025 95% 735
Navotas I 12 Mar 2003 98% 200
Navotas II 12 July 2005 98% 100
</TABLE>
SE Asia-Pacific, through its operating companies, is responsible for
management, operations and maintenance of the plants. The operating companies
earn fees including potential bonus fees for providing those services. The
Navotas I, Navotas II and Bulacan project companies operate and maintain their
respective plants. The following table presents generation sold and availability
data for each asset in the Philippines:
<TABLE>
<CAPTION>
1999
----------
GENERATION 1999
SOLD ------------
PROJECT (GWH) AVAILABILITY
------- ---------- ------------
<S> <C> <C>
Sual(1) 1,231 94%
Pagbilao 3,996 84%
Navotas I 10.3 95%
Navotas II 8.4 83%
</TABLE>
(1) Began operation in late 1999
All of the projects in the Philippines have been granted preferred or
pioneer status which, among other things, has qualified them for income tax
abatements of three to six years. The expiration dates of the abatements for
Pagbilao and Sual are 2002 and 2005, respectively.
SUAL
SE Asia-Pacific holds a 91.91% interest in the Sual plant, a 1,258 MW
coal-fired plant at Sual, Pangasinan, located approximately 216 km (130 miles)
north of Manila in the Philippines. The Sual plant consists of two 629 MW units
that commenced commercial operation in October 1999. The International Finance
Corporation (IFC) and Commonwealth Development Corporation (CDC) are the other
shareholders.
When we acquired SE Asia-Pacific in 1997, the Sual plant was still under
construction. The construction was completed in October 1999. The total
construction cost, including inventories, was $1,282 million at March 31, 2000
and is expected to be approximately $1,300 million. The construction was funded
by third party non-recourse project loans of $942 million and equity financing
by SEAP and two minority shareholders in the amounts of $312 million and $28
million, respectively.
An SE Asia-Pacific subsidiary, Southern Energy Asia-Pacific Pangasinan
Limited (SEPI), formerly known as CEPA Pangasinan Electric Limited, has acceded
to the ECA with NPC. The ECA obligates NPC to purchase 1,000 MW of the total
plant capacity of 1,258 MW. Most of the net available capacity of 218 MW is not
currently under contract; however, SE Asia-Pacific expects this capacity to be
sold to NPC, large industrial or commercial users or distribution customers.
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A consortium of banks and various other lenders have committed non-recourse
project debt for the Sual plant totaling approximately $1 billion with an
expected average life of approximately five years and a final maturity in the
beginning of 2012. As of March 31, 2000, the balance of the project debt was
approximately $942 million. The distribution of our shares by Southern Company
would constitute a change in control under the loan agreement and we cannot
assure you that we will be able to obtain the required lender consents. Most
revenues are paid in U.S. dollars into an offshore account administrated by a
loan trustee.
The Sual project was not completed by the date specified in the
construction contract. As a result, SEPI currently has a claim against the
contractors for liquidated damages. SEPI is currently in discussions with the
contractors to resolve disputes regarding the amounts to be paid.
NPC has informed SE Asia-Pacific that, in NPC's opinion, the Sual plant was
not completed by the dates, as adjusted, contemplated in the ECA. However, no
formal claim for liquidated damages has been made by NPC. SEPI believes that the
plant was completed before the deadlines in the ECA and that its exposure to
potential claims is not material.
Under shareholder agreements, the minority shareholders of SEPI can
exercise a put option requiring SEPI to purchase the minority shareholders'
interests in the project. The put option can be exercised between the third and
sixth anniversaries of the completion of the project construction or, in the
event of any change in control, a change in SEPI's charter documents or the
transfer of sponsor in violation of the sponsor support agreement, the put
option may be exercised on the earlier of the date of such changes or the
twelfth anniversary of the completion of the project construction. The
distribution of our shares by Southern Company will not constitute a change in
control under the shareholder agreement. The price would be determined by a
formula including the present value of the remaining years of cash flow less the
liabilities outstanding plus the current assets.
PAGBILAO
SE Asia-Pacific holds an 87.2% interest in the Pagbilao plant, a 735 MW
coal-fired plant located 100 km (62 miles) southeast of Manila. The Pagbilao
plant consists of two 367.5 MW units that commenced commercial operation in June
1996 and August 1996, respectively. The International Finance Corporation (IFC),
Commonwealth Development Corporation and the Asia Development Bank (ADB) are the
other shareholders. Most revenues are paid in U.S. dollars into an offshore
account administered by a loan trustee.
The Pagbilao plant originally had non-recourse project debt totaling $698
million from banks and various other lenders. The balance of this debt as of
March 31, 2000 was $476 million, with the majority of the principal having a
final maturity in the beginning of 2007. This financing requires the project
company to maintain a debt service reserve equal to the amount due within the
next succeeding 12 months. Southern Company currently provides a $60 million
letter of credit, and we provide a $50 million letter of credit, for the benefit
of the lenders to satisfy this reserve requirement. At the time of the full
distribution of our stock by Southern Company, we expect to have to provide
letters of credit for the entire amount required by the financing. The
distribution of our shares by Southern Company would constitute a change in
control under the loan agreement and we cannot assure you that we will be able
to obtain the required lender consents.
Under shareholder agreements, the minority shareholders of the SE
Asia-Pacific subsidiary which holds the Pagbilao project (SEQI) can exercise a
put option requiring SEQI to purchase the minority shareholders' interests in
the project. The put option can be exercised between the sixth and twelfth
anniversaries of the completion of the project construction or, in the event of
any change in control, a change in SEQI's charter documents or the transfer of
sponsor in violation of the sponsor
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completion support agreement the put option may be exercised on the earlier of
the changes or the twelfth anniversary of the completion of the project
construction. The distribution of our shares by Southern Company will not
constitute a change in control under the shareholders agreement. The price would
be determined by a formula including the present value of the remaining years of
cash flow less the liabilities outstanding plus the current assets.
NAVOTAS I AND II
SE Asia-Pacific holds a 90% interest in the Navotas I plant, a 200 MW fuel
oil-fired plant located at the Navotas Fishport Complex north of Manila. The
Asian Development Bank is the other shareholder. SE Asia-Pacific also holds a
100% interest in the Navotas II plant, a 100 MW fuel oil-fired plant located at
the Navotas Fishport Complex.
BULACAN
SE Asia-Pacific owns a 100% interest in the Bulacan plant, a 15 MW plant
comprising four 3.75 MW diesel units located at the Navotas site. A SE
Asia-Pacific subsidiary has entered into a 15-year energy generation agreement
with Solid Development Corporation, a yarn manufacturing company. The agreement
term runs through 2012. Navotas staffing is used to operate the units.
BATAAN
A SE Asia-Pacific subsidiary has entered into an agreement with Bataan
Polyethylene Corporation (BPC) to supply the power requirements of BPC in
Bataan, the Philippines. BPC is expected to produce polyethylene products for
the Philippine market and the Asian region and is being financed by the IFC. BPC
is owned by BP Chemicals (a subsidiary of British Petroleum), Petronas
(Malaysian state oil company), Sumitomo Corporation and local Philippine
shareholders. Under this contract, the SE Asia-Pacific subsidiary is required to
construct a sub-station and two transmission lines to provide up to 40 MW of
power to the BPC plant. The construction of this sub-station and these
transmission lines is currently underway and we expect to complete the
construction during the third or fourth quarter of 2000. SE Asia-Pacific intends
to supply electricity to BPC sourced jointly from Sual and NPC.
MINDORO
SE Asia-Pacific has entered into a 20 year power sales agreement with the
Oriental Mindoro Electric Cooperative (ORMECO) pursuant to which SE Asia-Pacific
would install 7.5 MW of diesel generators on the Island of Mindoro to supply
ORMECO. SE Asia-Pacific intends to meet its obligations to ORMECO by moving two
units from its Bulacan station to Mindoro. SE Asia-Pacific would then meet its
obligations at Bulacan by utilizing the excess capacity at the Sual plant.
ILIJAN
We are currently pursuing the acquisition of a minority interest in a 1,251
MW gas-fired combined cycle power plant under construction at Batangas,
Philippines. Our initial equity investment is expected to be approximately $35
million.
DEREGULATION AND PRIVATIZATION
In April 2000, the Philippine House of Representatives passed the
Electricity Industry Reform Act (EIRA) substantially in the form of the
government legislative bill which had proposed
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comprehensive restructuring in order to deregulate the market for electricity.
The Senate has passed a series of bills which also propose deregulation but
along different lines from those passed by the House of Representatives. The
EIRA seeks to deregulate and privatize NPC to promote a competitive industry
structure and broaden the ownership base of various sectors of the electric
power industry. The EIRA is now awaiting the Conference Committee of the House
and Senate in order to agree on a joint version of the law.
The EIRA seeks to establish, within three years from its effectiveness,
competition in the retail supply of electricity and open access to the
transmission and distribution systems. Prior thereto, concerned government
agencies shall implement a wholesale electricity spot market and ensure the
unbundling of transmission and distribution wheeling rates and the establishment
of a cross-subsidy revenue scheme.
At least 70% of the NPC's generating assets and contracts would be
privatized within three years from the effectiveness of the EIRA. Thereafter,
any undisposed assets would be transferred to the so-called NPC Residual, which
would be a government-owned and controlled corporation. NPC Residual would
perform the remaining functions of NPC, such as administering the ECAs.
The EIRA, as it stands at the moment, presents no material impact on the
existing assets and operations of SE Asia-Pacific. Consistent with the announced
policy of the government, the EIRA contemplates continued payments under ECA
contracts such as those with SE Asia-Pacific subsidiaries. The ECAs of SE
Asia-Pacific are not assignable and will, therefore, remain with NPC following
privatization. NPC may sell its beneficial interest in the ECAs as part of the
privatization. These ECAs are in any event supported by a sovereign guarantee of
the Republic of the Philippines. NPC Residual will administer the ECAs and other
independent power contracts of NPC after its privatization.
CLEAN AIR ACT
In July 1999, the Philippines enacted legislation, the Clean Air Act, which
applies to stationary emission sources and other operating plants. The
Department of Environment and Natural Resources (DENR) will promulgate the Clean
Air Act's Implementing Rules and Regulations (IRR), probably by July 2000.
Pending promulgation of the IRR, the DENR has issued an administrative order
temporarily adopting the requirements of the Clean Air Act. Provisions of the
Clean Air Act affect the compliance of operating plants and their ability to
serve as base load capacity for the grid.
The provisions of the Clean Air Act and past practice of the DENR suggest
potentially increasingly stringent standards in emissions from all sources to
maintain and/or improve the air quality. This may require additional controls or
equipment on some of SE Asia-Pacific's plants in order to comply with the
emission reduction goals and targets set forth in the Clean Air Act.
We believe the Clean Air Act will not significantly affect the Sual plant,
which can comply with the current requirements of the Clean Air Act. Some
additional pollution control or other expenditures may be required for the
Pagbilao plant and Bulacan plant to comply with the new requirements. We do not
expect these expenditures to be material. We believe that the Navotas I and II
will not be affected significantly by the Clean Air Act. SE Asia-Pacific has
been closely following the development of the IRR and is making contingency
plans which are capable of meeting the standards and deadlines once finalized.
The DENR is permitted to allow a grace period of 18 months (with the
potential for up to a further 12 months) for the establishment of environmental
management systems and the installation of appropriate air pollution control
devices. In recent years, and for other air pollution legislation, the
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DENR has allowed long grace periods for existing sources to comply with new
environmental standards.
CHINA
SHAJIAO C
SE Asia-Pacific holds a 32% interest in the Shajiao C plant, a 2,038 MW
coal-fired power plant located close to Hong Kong at Shajiao, Guangdong
Province, China. Shajiao C is the largest coal-fired power plant in Guangdong
Province. The plant is made up of three 679.4 MW units that began commercial
operation in June 1996. The operation and off-take agreement has an initial term
of 20 years and expires in June 2016.
SE Asia-Pacific indirectly owns 80% of Southern Energy (Shajiao C) Limited
(SESCL). The other 20% of SESCL is owned by a number of minority shareholders,
including Bank of China and Kanematsu. Guangdong Province Shajiao (Plant C)
Power Generation Corporation (Guangdong Generation Corporation) and SESCL have
60% and 40% interests, respectively, in Guangdong Guanghope Power Co., Ltd.
(Guangdong Power), which is the joint venture company that controls the plant.
The majority partner, Guangdong Generation Corporation, is a Chinese corporation
directly owned by the Guangdong Electric Power Holding Company (GEPC).
All power produced at the plant is sold to Guangdong Generation Corporation
and GEPC. These two entities are responsible for operating and maintaining the
plant and are also responsible for coal supply. Each of them receives an
operations fee, calculated on the basis of electricity generated and plant
availability. While Guangdong Generation Corporation operates the plant pursuant
to a contractual agreement between the parties, SE-Asia, in its capacity as a
partner in the Guangdong Power joint venture, provides significant management
and operational support for the facilities on a day to day basis.
Payments to Guangdong Power are made in Renminbi. However, payments to
cover foreign currency expenses, debt service and an equity return are indexed
to U.S. dollars. For the first 10 years of operation (through June 2006),
Guangdong Generation Corporation receives the first 30% of distributable
after-tax profit. The remaining profits are split 60/40 between Guangdong
Generation Corporation (42% overall) and SESCL (28% overall). For years 11
through 20, Guangdong Generation Corporation receives the first 60% of
distributable after-tax profit. The remaining profits are split 60/40 between
Guangdong Generation Corporation (24% overall) and SESCL (16% overall). The
shareholders of Guangdong Power provided funding to that company through a
series of loans and capital contributions. It is expected that Guangdong Power
will begin repaying these loans in 2000. Shareholder loans and invested capital
are to be returned prior to the payment of dividends.
The loans and capital contributions made to Guangdong Power as of March 31,
2000 are summarized as follows:
<TABLE>
<CAPTION>
GUANGDONG
GENERATION SEAP AND ITS
CORPORATION SUBSIDIARIES
----------- ------------
(DOLLARS IN MILLIONS)
<S> <C> <C>
Registered Capital...................................... $225.0 $150.0
Shareholder Loans....................................... 270.8 194.8
Shortfall Loans......................................... 149.4 62.1
Early Generation Profit (EGP) Loans..................... 24.8 99.2
------ ------
Total................................................. $670.0 $506.1
====== ======
</TABLE>
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All shortfall finance, EGP and shareholder loans bear a coupon interest
rate of 10% and are to be repaid once Guangdong Power's external debt is paid in
full. Guangdong Power retired its external debt in March 2000. We expect that
all available cash will be used to repay loans prior to being applied to
dividend payments. We expect that substantially all of the loans we have
provided will be repaid by the end of 2003. Shortfall finance loans represent
loans made to fund construction costs not financed by equity or other debt.
Similarly, shareholder loans are loans made by shareholders to provide
additional financing for the construction of the plant. EGP loans relate to
early generation profit earned by Guangdong Power. EGP includes income from the
sale of electricity and other payments attributable to the time prior to
commercial operation. Such income, by agreement, is distributed to Guangdong
Power joint venture partners and then lent back to the joint venture company in
the form of an EGP loan.
Guangdong Generation Corporation and GEPC bear demand risk through a
contractual take-or-pay requirement, which imposes a minimum annual offtake
quantity of approximately 62% of total generation capability, subject to risks
such as force majeure and construction defects. The minimum offtake was not
achieved during the years 1996-1999. The capacity payment associated with the
shortfall in each year has been paid in the respective following year. Guangdong
Generation Corporation and GEPC also bear fuel risks. Force majeure affecting
fuel delivery does not relieve them of their take-or-pay obligation.
SHANDONG INTERNATIONAL POWER DEVELOPMENT COMPANY (SIPD)
On June 30, 1999, we acquired a 9.99% interest in SIPD for $107 million
through our subsidiary, SE China. SE China initially purchased 509.5 million, or
40%, of the 1.28 billion shares offered in SIPD's $261 million initial public
offering on the Hong Kong Stock Exchange.
SIPD is the largest independent power producer in China's Shandong
province. Shandong Electric Power (Group) Company (SEPCO), the sole purchaser of
electricity as well as the grid operator in Shandong province, is the largest
shareholder of SIPD. SIPD sells power to SEPCO under an offtake contract,
pursuant to which SEPCO agrees to purchase power in an amount based on average
generation of all Shandong Province plants under its jurisdiction. The power is
purchased by SEPCO at a price pursuant to a tariff intended to allow SIPD to
recover costs plus a specified return on its average net book value of fixed
assets. In addition, SEPCO has granted to SIPD the right of first refusal to
acquire any plant SEPCO chooses to sell. SEPCO has also granted to SIPD an
option to acquire, develop and operate future power projects within Shandong
province for which SEPCO has development rights.
At December 31, 1999, SIPD held interests in 18 coal-fired power generating
units including two 600 MW units, five 125 MW units and 11 330 MW units for a
total installed capacity of 5,125 MW, of which its net ownership interest
represents 4,158 MW.
Shandong province, with a population of 88 million people and an installed
electricity generating capacity of more than 18,000 MW, has China's
second-largest independent provincial power grid. Shandong is also one of six
provinces and municipalities that the Chinese central government has designated
as pilot sites for the deregulation of the power industry. We believe that SIPD
is well positioned for deregulation by being a low-cost provider with tariffs
below the average in the Shandong province and by being more focused on creating
shareholder value and having access to international capital markets for fund
raising as a publicly traded company.
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AUSTRALIA
Kogan Creek
Southern Energy Asia-Pacific has formed an alliance with CS Energy Limited
(CS Energy) to develop the Kogan Creek Power Station in Queensland and other
energy projects in Australia. The alliance stipulates the joint development of
the Kogan Creek station, which is expected to be a 750MW coal-fired power
station 280 km west of Brisbane, and the potential development of a 385 MW
natural gas fired station at Swanbank Power Station near Ipswich. Under the
proposed alliance agreement, we will own 60%, and CS Energy 40%, of Kogan Creek.
Kogan Creek has received all of its government approvals, including Environment
Australia sign-off as well as the Foreign Investment Review Board approval in
early June 2000.
Based on evaluations of the supply and demand balance in Queensland, we and
CS Energy are aware of a current surplus of generating capacity, and
consequently, plan to proceed with the Kogan Creek project at an undetermined
future date based on market demand.
INDIA
BALAGARH
We are currently pursuing development of a 500 MW coal-fired power project
north of Calcutta, India. We have entered into a shareholders agreement with the
Calcutta Electricity Supply Company Limited (CESC), a private sector company
which is the local public utility supplying power exclusively to major parts of
Calcutta. CESC is the main sponsor of the project and we are the co-sponsor.
International Finance Corporation is planning to take a 13% equity stake and to
provide approximately $215 million in credit facilities. The project has
received all major permits and clearances. We expect to invest approximately $50
million of equity in this project.
REGULATION
INTERNATIONAL REGULATION
Our international operations are subject to regulation by various foreign
governments and regulatory authorities. The laws and regulations that apply to
each of our international projects are more fully discussed under the
description of the particular project found elsewhere in this prospectus.
U.S. PUBLIC UTILITY REGULATION
The U.S. electric industry is subject to comprehensive regulation at the
federal and state levels. Currently, most of our U.S. facilities are EWGs under
PUHCA. Our EWGs are subject to regulation by FERC under the Federal Power Act
regarding rate matters and by state public utility commissions regarding
non-rate matters. The majority of our generation from EWGs is sold at market
prices under market rate authority granted by FERC, although FERC has the
authority to impose cost of service rate regulation if it determines that market
pricing is not in the public interest. Our EWGs are also subject to FERC
regulation relating to accounting and reporting requirements, as well as
oversight of mergers and acquisitions, securities issuances and dispositions of
facilities.
State or local authorities have historically regulated the distribution and
retail sale of electricity, as well as the need for siting and the construction
of generating facilities. In addition, our EWGs may be subject to a variety of
state and local regulations regarding maintenance and expansion of their
facilities and financing capital additions if the financing is subject to state
public service commission regulation. Outside of ERCOT, the wholesale power
sales of our EWGs are subject exclusively to
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FERC regulation under the FPA and to market regulation institutions, such as
regional transmission group and independent system operator market monitoring
initiatives authorized by FERC.
We are currently subject to regulation under PUHCA, as a wholly owned
subsidiary of a public utility holding company. Prior to the distribution of our
common stock by Southern Company, we must continue to conduct our business in
accordance with SEC orders authorizing Southern Company and us to engage in the
business of developing energy projects and owning and operating EWGs, FUCOs,
QFs, domestic and Canadian marketing of natural gas and electricity and other
energy-related activities. Prior to the distribution, we may not acquire public
utility assets or the securities of public utility companies, unless these
assets or companies qualify as EWGs, FUCOs or QFs, without SEC approval under
PUHCA.
In addition, Southern Company is limited in the amount of the aggregate
investment it may make in us through the proceeds of its security sales or
guarantees to an amount not to exceed 100% of Southern Company's consolidated
retained earnings. We and Southern Company have requests pending before the SEC
to increase Southern Company's authority to invest in us up to 175% of its
consolidated retained earnings and to increase its guarantee authority to a
similar extent. Following this offering, Southern Company will no longer provide
financing or credit support except for specified transactions or for a limited
period of time.
Southern Company's plan to distribute our common stock to its stockholders
requires regulatory approval from both the FERC under the FPA and the SEC under
PUHCA. We cannot assure you that the requisite approvals from FERC and the SEC
can be obtained on a timely basis or on conditions acceptable to Southern
Company and us. Southern Company may determine not to complete the distribution
based upon the lack of requisite regulatory approval or an assessment that
timely approval cannot be obtained or can be obtained only on conditions
unacceptable to Southern Company.
If any state public service commission becomes concerned that the plan for
the distribution of our common stock by Southern Company may adversely affect
the consumers in its jurisdiction, the state commission may undertake to review
the plan of distribution. Even though the state commission may have no
jurisdiction over the distribution, Southern Company or us, any review may delay
or prevent Southern Company from completing the distribution.
It is possible that one or more regulatory authorizations for Southern
Company and us to conduct our operations may expire. The authorization under
PUHCA which allows us and our subsidiaries to pay dividends from unearned
surplus, in accordance with applicable corporate law and applicable covenants to
security holders has been extended and will expire June 30, 2001. If Southern
Company has not completed the distribution of our common stock by June 30, 2001,
and if the SEC does not extend the order beyond that date, cash may be trapped
in some of our subsidiaries, reducing our cash management flexibility and
increasing our need for working capital and external financing.
In addition, the SEC order providing the general authorization for Southern
Company to acquire our securities and authorizing us to undertake our business
of developing and owning and operating FUCOs, EWGs and energy-related
subsidiaries is scheduled to expire on December 31, 2000. Southern Company and
we intend to seek an extension of this general authority. Other authorizations
under PUHCA pertaining to our business extend until the year 2003. Even though
rules exempting certain acquisitions and transactions from SEC approval may
alleviate the effect of an expiration of the SEC order, the effect of the
expiration may be adverse to our business operations.
Following the distribution we do not expect to be subject to PUHCA unless
or until we acquire the securities of a public utility company or public utility
assets that are not exempt as an EWG,
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FUCO or QF. PUHCA, the FPA and applicable state laws may limit Southern Company
and its remaining subsidiaries' ability to contract with or provide services to
us.
Following the distribution of our stock by Southern Company, we will
compete with Southern Company. As a result of market information restrictions
imposed by the FERC Code of Conduct, we have not had access to market
intelligence concerning the Southeast region that is possessed by Southern
Company and other energy marketers that have been active in the Southeast region
for a number of years.
Our energy marketing business units are authorized under orders issued by
the SEC to conduct electricity and natural gas marketing in the United States
and Canada and, through December 31, 2000, to invest up to $300 million to
acquire assets related to energy marketing in the United States and Canada. In
the event we were to undertake a major acquisition of energy assets in excess of
the authority currently authorized which is not a FUCO, EWG or a United States
energy-related company, we would be required to seek further PUHCA approvals.
Congress is considering legislation to modify federal laws affecting the
electric industry. Bills have been introduced in the Senate and the House of
Representatives that would, among other things, provide retail electric
customers with the right to choose their power suppliers. Modifications to PURPA
and PUHCA have also been proposed. In addition, various states have either
enacted or are considering legislation designed to deregulate the production and
sale of electricity. Deregulation is expected to result in a shift from
cost-based rates to market-based rates for electric energy and related services.
Although the legislation and regulatory initiatives vary, common themes include
the availability of market pricing, retail customer choice, recovery of stranded
costs and separation of generation assets from transmission, distribution and
other assets. It is unclear whether or when all power customers will obtain open
access to power supplies. Decisions by regulatory agencies may have a
significant impact on the future economics of the power marketing business.
FERC has issued power and gas transmission initiatives that require
electric and gas transmission services be offered on an open-access basis
unbundled from commodity sales. Although these initiatives are designed to
encourage wholesale market transactions for electricity and gas, we cannot
predict the timing of industry changes as a result of these initiatives or the
adequacy of transmission additions in specific markets.
In Canada, Canadian national and provincial governments have instituted
natural gas regulations also designed to encourage the development of
competitive markets. However, we cannot predict the timing and scope of the
development of a competitive market in Canada or the effect of these or future
regulations on these markets.
Our Birchwood facility is subject to regulation as a QF under PURPA. As a
QF, Birchwood is exempted from most provisions of the FPA and state laws
relating to securities, rate and financial regulation. PURPA requires electric
utilities (i) to purchase electricity generated by QFs at a price based on the
utility's avoided cost of purchasing electricity or generating electricity
itself, and (ii) to sell supplementary, back-up, maintenance and interruptible
power to QFs on a just, reasonable and non-discriminatory basis. To qualify for
QF status, the Birchwood facility must satisfy requirements regarding the
production of useful thermal energy as well as limitations on the extent of
ownership by utilities or utilities affiliates.
ENVIRONMENTAL REGULATION
Our operations are subject to extensive federal, state, local and foreign
laws and regulations relating to air quality, water quality, waste management,
natural resources and health and safety. Our projects and facilities in foreign
markets create exposures and obligations to the national, provincial
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and local laws of each host country, including environmental standards and other
requirements imposed by these governments. Our compliance with these
environmental requirements necessitates significant capital and operating
expenditures related to monitoring, pollution control equipment, emission fees
and permitting at various operating facilities. Our expenditures, while not
prohibitive in the past, are anticipated to increase in the future along with
the increase in stricter standards, greater regulation, more extensive
permitting requirements and an increase in the number and types of assets we
operate that are subject to environmental regulation. We cannot assure you that
future compliance with these environmental requirements will not adversely
affect our operations or financial condition.
Our operations in Europe are subject to comprehensive environmental
regulation similar to that in the United States, and these regulations are
expected to become more stringent in the future. Additionally, like many
countries of the world, the governments of China, the Philippines, Trinidad and
Tobago and several other countries recently have proposed increased
environmental regulation of many industrial activities, including increased
regulation of air quality, water quality and solid waste management. The scope
and extent of these newly proposed environmental regulations is unclear.
Over the past several years, the utility industry, state, federal and
foreign governments and international organizations have been concerned about
global climate change. Because our fossil fuel-fired plants emit carbon dioxide,
the costs of any "greenhouse gas" restrictions could adversely affect our
operations. The impact of the Kyoto Treaty on our domestic and foreign
facilities and operations remains uncertain.
The environmental laws and regulations in the United States illustrate the
comprehensive environmental regulations which govern our operations. Our most
significant environmental requirements in the U.S. result from the Clean Air Act
and the 1990 Clean Air Act Amendments. Under the Clean Air Act, we are required
to comply with a broad range of restrictions concerning air emissions, operating
practices and pollution control equipment. Several of our facilities are located
in metropolitan areas such as New York City, Boston, Chicago or San Francisco,
classified by EPA as not achieving the ambient air quality standards which
trigger the most stringent air regulation requirements.
In the future, we anticipate increased regulation of our facilities under
the Clean Air Act and applicable state laws and regulations concerning air
quality. EPA, several states and several foreign countries are in the process of
enacting more stringent air quality regulatory requirements. For example, EPA
recently promulgated a new regulation, known as the "Section 126 Rule," which
allocates nitrogen oxide (NOx) emissions allowances to various electric
generating facilities in Delaware, Indiana, Kentucky, Maryland, Michigan, New
Jersey, New York, North Carolina, Ohio, Pennsylvania, Virginia, West Virginia
and the District of Columbia. We expect to incur additional compliance costs as
a result of these developments. The Section 126 Rule becomes effective on May 1,
2003. If a plant exceeds its allocated allowances under this rule, the plant
must purchase additional, unused allowances from other regulated plants. EPA
also has established NOx emission caps for several eastern states which must be
implemented by these states beginning May 1, 2003. The State of New York is also
developing regulations to further reduce NOx and sulfur dioxide emissions.
Several other environmental laws in the United States also affect our
operations. For example, we are required under the Clean Water Act to comply
with effluent and intake requirements, technological controls and operating
practices. Our wastewater discharges are permitted under the Clean Water Act,
and our permits under the Clean Water Act are subject to review every five
years. As with air quality, the requirements applicable to water quality are
expected to increase in the future. We expect to incur additional compliance
costs as a result of the increased regulation of water quality.
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Our facilities are also subject to several waste management laws and
regulations in the United States. The Resource Conservation and Recycling Act
(RCRA) sets forth very comprehensive requirements for handling of solid and
hazardous wastes. The generation of electricity produces non-hazardous and
hazardous materials, and we incur substantial costs to store and dispose of
waste materials from our facilities. Recently, EPA indicated that it may begin
to regulate fossil fuel combustion materials, including types of coal ash, as
hazardous waste under RCRA. If EPA implements its initial proposals on this
issue, we may be required to change our current waste management practices and
expend significant resources on the increased waste management requirements
caused by EPA's change in policy.
From time to time, the federal Comprehensive Environmental Response,
Compensation and Liability Act, known as the Superfund or CERCLA, applies to our
facilities or other sites in the United States. CERCLA establishes a framework
for dealing with the cleanup of contaminated sites. Many states, like
Massachusetts, New Jersey and Georgia, have enacted state superfund statutes.
Under these laws, we are required to undertake, from time to time, corrective
action for soil and groundwater conditions identified at our facilities. We are
currently undertaking corrective action at some of our recently acquired
facilities for conditions that were identified during our due diligence related
to the acquisition. We have purchased environmental insurance to cover some of
these conditions, as well as other unknown environmental conditions, when we
initially acquired some of our facilities. We do not expect these corrective
actions to require significant expenditures.
In connection with asset acquisitions and other transactions, we also may
obtain or be required to provide indemnification against environmental
liabilities and responsibilities. Typically, indemnification we receive is
limited in scope and time period. In some transactions, we did not receive an
environmental indemnity. To minimize our exposure for such liabilities, we
conduct environmental assessments of the assets we wish to acquire or operate.
Thus far, we have not incurred any material environmental liabilities arising
from our acquisition or divestiture activities.
We have not incurred material costs for environmental remediation in the
past three years. We currently plan to spend approximately $50 million during
the remainder of 2000 and in 2001 to retrofit pollution control equipment on its
existing assets. We spent approximately $37 million during 1999 and the first
half of 2000 to retrofit pollution control equipment.
We believe we are in compliance in all material respects with applicable
environmental laws. However, while we believe our procedures and facilities
comply with applicable environmental laws and regulations, we cannot provide
assurances that additional costs will not be incurred as a result of more
stringent requirements.
EMPLOYEES
At December 31, 1999, our corporate offices and majority owned or
controlled subsidiaries employed approximately 6,400 persons. This number
includes approximately 700 in the corporate headquarters in Atlanta and at SCEM
and approximately 5,700 at operating facilities. Approximately 440 of our
domestic employees are subject to collective bargaining agreements with one of
the following unions: International Brotherhood of Electrical Workers (IBEW),
Utilities Workers of America or United Steel Workers. About 2,200 of our
employees in international business units belong to unions. These unions include
IBEW and Grand Bahamas Port Authority Workers in the Bahamas; Oilfield Workers
Trade Union and Senior Staff Association in Trinidad and Tobago; UNISON,
Amalgamated Engineering and Electrical Union, General Municipal Boilermakers
Union, Engineers and Managers Association and Transport and General Workers
Union in England; Sindicato de Luz y Fuerza in Argentina; and Sindicato
Arica-Parincota, Sindicato Trabajadores Edelnor Iquique, Sindicato Trabajadores
Segunda Region, Sindicato Edelnor S.A. and Sindicato
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Ingenieros de Ejecucion in Chile. We believe we have satisfactory relations with
both union and non-union employees.
FACILITIES/PROPERTIES
Our corporate offices currently occupy approximately 242,000 square feet of
leased office space in Atlanta, Georgia. We are in the process of relocating our
corporate offices into a new two-building facility occupying approximately
357,000 square feet, currently under construction in Atlanta, Georgia. SCEM
began occupying the first completed phase of this building, a 67,000 square feet
state-of-the-art marketing and risk management facility, in December 1999. We
anticipate moving the remainder of our corporate offices to the second building,
a 290,000 square foot office building, between September and December 2000. We
have signed long-term leases for these facilities.
In addition to our corporate office space, we lease or own various real
property and facilities relating to our projects and our development activities.
Our project facilities are generally described under the project descriptions
contained elsewhere in this prospectus. We believe that we have satisfactory
title to our project facilities in accordance with standards generally accepted
in the energy industry, subject to exceptions which, in our opinion, would not
have a material adverse effect on the use or value of the facilities.
We believe that all of our existing office and generating facilities,
including the facilities under construction, are adequate for our needs through
calendar year 2000. If we require additional space, we believe that we will be
able to secure space on commercially reasonable terms without undue disruption
to our operations.
LEGAL PROCEEDINGS
In September 1999, the State of Minas Gerais, Brazil filed a lawsuit in a
state court seeking temporary relief against SEB exercising voting and
appointment rights under the shareholders agreement between the state and SEB
regarding their interest in CEMIG, as well as a permanent rescission of the
agreement. The core issue in the dispute is whether the shareholders agreement
unconstitutionally transfers control of CEMIG from the state to SEB, which
transfer would have required specific legislative authorization. A lower court
judge denied the state's request, but one member of a three-judge State
Appellate Court granted a temporary injunction pending the outcome of the
litigation regarding rescission of the shareholders agreement. This injunction,
however, does not affect the status of the CEMIG directors appointed by SEB, as
SEB's right to appoint these directors is not derived from the agreement. On
March 23, 2000, the lower court judge in Minas Gerais ruled that the
shareholders agreement was invalid. SEB has appealed this decision. We cannot
assure you that we will be successful in appealing this ruling or in defending
the constitutionality of the provisions of the shareholders agreement. Our
failure to prevail on this matter would limit our control of the operations of
CEMIG, which may have an adverse effect on our investment in CEMIG.
SE California and its subsidiaries SE Delta and SE Potrero acquired
generation assets from PG&E in April 1999 subject to RMR agreements. SE
California assumed these agreements from PG&E subject to the outcome of a FERC
proceeding initiated in October 1997 that will determine the percentage of a
settled $158.8 million revenue requirement to be paid to the SE California
parties under the RMR agreements. SE California contends that the amount paid by
the ISO should reflect an allocation based on the ISO's right to call on the
units (as defined by the RMR agreements) and the ISO's actual calls. This
approach would result in annual payments by the ISO of approximately $120
million, or 75% of the settled fixed revenue requirement. The decision in this
case will affect the amount CAISO will pay to SE Delta and SE Potrero for the
period from June 1, 1999 through December 31, 2001. On June 7, 2000, the
administrative law judge (ALJ) presiding over the
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proceeding issued an initial decision in which the ALJ allocated responsibility
for payment of approximately 3% of the revenue requirement to the CAISO. On July
7, 2000, SE California appealed the ALJ's decision to the FERC. A final FERC
order in this proceeding may be appealed to the U.S. Court of Appeals. The
outcome of this appeal cannot now be determined.
If SE California is unsuccessful in its appeal of the ALJ's decision, SE
California will be required to refund certain amounts of the revenue requirement
billed to the CAISO for the period from June 1, 1999 until the final disposition
of the appeal. The amount of this refund as of May 31, 2000 would have been
approximately $91 million and would have reduced net income by approximately $50
million. These amounts do not include interest that would be payable in the
event of a refund. If SE California is unsuccessful in its appeal, it plans to
pursue other options available under the reliability must-run agreements to
mitigate the impact of the ALJ's decision upon its future operations. The
outcome of this appeal is very uncertain, and we cannot assure you that we will
be successful.
On January 18, 2000, EPA published a new regulation, known as the "Section
126 Rule," which allocates nitrogen oxide emissions allowances to various
electric generating facilities in Delaware, Indiana, Kentucky, Maryland,
Michigan, New Jersey, New York, North Carolina, Ohio, Pennsylvania, Virginia,
West Virginia and the District of Columbia. This regulation becomes effective on
May 1, 2003. We believe that the NOx allowances allocated to Birchwood are
incorrect due to EPA's use of incorrect data. On March 17, 2000, Birchwood filed
an appeal of the Section 126 Rule with EPA to challenge the NOx emission
allowances for the Birchwood facility. A brief in support of the appeal was
filed on June 14, 2000. EPA's response is expected in August 2000. We are
continuing with efforts to settle this dispute with EPA.
Along with several other electric generators which own facilities in New
York, in October 1999 we received an information request from the State of New
York concerning the air quality control implications of various repairs and
maintenance activities of SE New York at its Lovett facility. SE New York
responded fully to this request and provided all of the information requested by
the State. The State of New York issued notices of violation (NOV) to some of
the utilities being investigated. The state issued a NOV to the previous owner
of Plant Lovett, ORU, alleging violations associated with the operation of Plant
Lovett prior to the acquisition of the plant by SE New York. To date, SE New
York has not received a NOV. We disagree with the allegations of violations in
the NOV. The NOV does not specify corrective actions which the State of New York
may require. Under the sales agreement with ORU for Plant Lovett, ORU is
responsible for fines and penalties arising from historical operations, but SE
New York may be responsible for the cost of purchasing and installing emission
control equipment, the cost of which may be material.
We acquired the State Line station in Hammond, Indiana from Commonwealth
Edison on December 31, 1997. On July 28, 1998, an explosion occurred causing a
fire and substantial damage to the plant. The precise cause and origin of the
explosion and fire are still under investigation. Thus far, seven personal
injury lawsuits have been filed against us and our affiliates. Five of these
lawsuits were filed in the Circuit Court in Cook County, Illinois in August and
September, 1998. We filed a motion to dismiss all five of these cases in 1998
for lack of "in personam" jurisdiction. The motion was denied in August 1999. In
October 1999, the Appellate Court of Illinois granted our petition for leave to
appeal. Briefs and reply briefs have been filed on the jurisdiction issue and
the parties presently await the setting of a date for oral argument, which is
anticipated to occur before the end of September. Given the posture of the
motion, no discovery has been allowed to date. The outcome of this motion cannot
now be determined. The two remaining cases were filed in Lake County Circuit
Court, Crown Point, Indiana, one in July 1998 and the other in April 2000. The
plaintiffs in all of these cases are seeking money damages for personal injuries
and related costs and expenses.
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Except for the CEMIG litigation, the SE California proceedings, the
Birchwood Section 126 issue, the SE New York information request, the State Line
litigation and the NOV issued to the previous owners of Plant Lovett, we are not
a party to any material legal proceedings. We experience routine litigation from
time to time in the normal course of our business, none of which is expected to
have a material adverse effect on our financial condition or results of
operations.
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MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
The following table sets forth information with respect to our directors,
executive officers and key employees as of the date of this prospectus.
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
A. W. Dahlberg.................... 60 Director and Chairman of the Board
S. Marce Fuller................... 40 President, Chief Executive Officer and Director
Raymond D. Hill................... 53 Executive Vice President and Chief Financial Officer
Richard J. Pershing............... 53 Executive Vice President and Chief Executive Officer,
Americas
Frederick D. Kuester.............. 49 Senior Vice President and Chief Executive Officer,
Asia-Pacific
Barney S. Rush.................... 48 Senior Vice President and Chief Executive Officer,
Europe
Vance N. Booker................... 46 Senior Vice President, Administration and External
Affairs
Andrew J. Dearman, III............ 46 Senior Vice President and Chief Technical Officer
Douglas L. Miller................. 49 Senior Vice President and General Counsel
Gary J. Morsches.................. 40 President of Southern Company Energy Marketing, L.P.
James A. Ward..................... 47 Senior Vice President, Finance and Accounting
Edgardo A. Bautista............... 65 President, Southern Energy Holdings Philippines, Inc.
H. Allen Franklin................. 55 Director
Elmer B. Harris................... 61 Director
W. L. Westbrook................... 61 Director
</TABLE>
A. W. DAHLBERG is expected to be named our Chairman in August 2000 and has
served as one of our directors since April 1996. He also serves as Chairman of
the Board and Chief Executive Officer of Southern Company, a position he has
held since March 1995. Mr. Dahlberg previously served as President of Southern
Company from 1994 until June 1999. He is a director of Equifax, Inc., Protective
Life Corporation and SunTrust Banks, Inc. Mr. Dahlberg joined Southern Company
in 1960.
S. MARCE FULLER has been our President and Chief Executive Officer and one
of our Directors since July 1999. From September 1997 to July 1999, she was
President and Chief Executive Officer of SCEM and one of our Executive Vice
Presidents from October 1998 to July 1999. From May 1996 to September 1997, Ms.
Fuller was Senior Vice President of our North America division, in charge of our
North American operations and business development. Prior to that, from February
1994 to May 1996, she was our Vice President for domestic business development.
Ms. Fuller is also a director of Curtiss-Wright Corporation. Ms. Fuller joined
Southern Company in 1985 and joined us in 1992.
RAYMOND D. HILL has been our Chief Financial Officer since 1999 and one of
our Executive Vice Presidents since October 1998. He has responsibility for
overall financial management of our company. Mr. Hill is also the Chairman of
our subsidiary SE Asia-Pacific, having previously served as its Managing
Director from July 1997 to December 1998. From 1993 to July 1997, he served as
Chief Financial Officer and Senior Vice President. Prior to joining us in 1993,
Mr. Hill served as a Managing Director at Lehman Brothers, an investment banking
firm.
RICHARD J. PERSHING has been Chief Executive Officer, Americas group, since
August 1999 and one of our Executive Vice Presidents since October 1998. He is
responsible for our North American, South American and the Caribbean operations.
Mr. Pershing is also responsible for the development, acquisition, ownership and
operation of energy generation investments and marketing and risk
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management through SCEM. From November 1997 to October 1998, he was one of our
Senior Vice Presidents. Prior to joining us in 1992, Mr. Pershing previously
held various executive and management positions at Georgia Power. He joined
Southern Company in 1971.
FREDERICK D. KUESTER has been Chief Executive Officer, Asia-Pacific group,
since August 1999 and one of our Senior Vice Presidents since August 1999. He
oversees asset management and project development in the Asia-Pacific region. He
is also on the board of directors of SIPD, a power company in which we hold a
9.99% interest. In addition, since November 1998, he has served as Chief
Executive Officer of SE Asia-Pacific, one of the largest independent power
producers in Asia. From January 1997 to November 1998 Mr. Kuester served as
director of the commercial group at SE Asia-Pacific. Prior to that, Mr. Kuester
served as vice president of power generation for Mississippi Power Company, a
subsidiary of Southern Company. Mr. Kuester started his career at Southern
Company in 1971.
BARNEY S. RUSH has been Chief Executive Officer, Europe group and one of
our Senior Vice Presidents since August 1999. He is responsible for asset
management, business development and marketing and risk management operations
for the region. Mr. Rush is also chairman of the supervisory board of Bewag, the
German utility in which we have a 26% ownership interest. Until August 1999, he
served as vice president responsible for acquisitions and as managing director
of Southern Energy Development -- Europe, since May 1996 and September 1997,
respectively. Prior to joining us in May 1996, Mr. Rush was executive vice
president for business development and finance at Oxbow Power Corporation. He
has also held various positions at Lehman Brothers, including senior vice
president, in project finance and the utility and telecommunications group.
VANCE N. BOOKER has been our Senior Vice President, Administration and
External Affairs since August 1999. He is responsible for administration and
external affairs, which includes human resources, information resources,
corporate communications, economic development and corporate services. Mr.
Booker was previously our Vice President, Administration. Prior to joining us in
July 1996 he held various positions at Southern Company in strategic planning,
human resources, accounting and finance. Mr. Booker joined Southern Company in
1975.
ANDREW J. DEARMAN, III has been our Senior Vice President and Chief
Technical Officer since September 1999. He is responsible for our construction,
environmental, operations and maintenance technical support and safety programs.
Previously, from April 1997 until September 1999, Mr. Dearman was vice president
of power generation and delivery at Mississippi Power Company, a subsidiary of
Southern Company. From January 1995 to April 1997, he was division vice
president for Alabama Power Company, a subsidiary of Southern Company. Mr.
Dearman joined Southern Company in 1975.
DOUGLAS L. MILLER has been our Senior Vice President and General Counsel
since he joined us in October 1999. He directs outside counsel and oversees
company programs to comply with the laws and regulations of states and countries
where we conduct our business. From 1997 until he joined us in 1999, Mr. Miller
was managing partner of the Troutman Sanders LLP Hong Kong office where he
oversaw the Project Development and Finance Practice Group. Mr. Miller joined
Troutman Sanders in 1975.
GARY J. MORSCHES has been President of SCEM since October 1999. He oversees
marketing, asset and risk management, market development, legal, financial,
research and human resources functions of SCEM, our energy marketing and risk
management partnership with Vastar. From October 1998 to October 1999, Mr.
Morsches served as senior vice president and chief operating officer of SCEM.
Mr. Morsches joined us in 1997 as vice president of trading, a position he held
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<PAGE> 115
until October 1998. Prior to joining us he served in various commercial roles
with Sostram Corporation, Enron, Access Energy and Diamond Shamrock Refinery &
Marketing Company.
JAMES A. WARD has been our Senior Vice President, Finance and Accounting
and Controller since August 1999. He is responsible for overseeing our business
planning and financial and management reporting functions including SEC
reporting, tax planning, structuring and compliance. From June 1994 to August
1999, Mr. Ward served as our Vice President, Controller and Assistant Treasurer.
He joined Southern Company in 1978.
EDGARDO A. BAUTISTA has been President of Southern Energy Holdings
Philippines, Inc., a wholly-owned subsidiary of SE Asia-Pacific, since shortly
after our acquisition of SE Asia-Pacific in January 1997. Since December 1997,
he has also been a member of the SE Asia-Pacific board of directors. In his
current role, Mr. Bautista provides the overall leadership for our business in
the Philippines. From 1995 to 1997 he was President and Director of Hopewell
Energy Philippines Corporation, a predecessor company to Southern Energy
Holdings Philippines, Inc. Mr. Bautista joined us in 1997.
H. ALLEN FRANKLIN has been one of our directors since May 1993. He also
serves as President and Chief Operating Officer of Southern Company, a position
he has held since June 1999. Mr. Franklin previously served as President and
Chief Executive Officer of Georgia Power, and executive vice president of
Southern Company from 1994 until June 1999. He is a director of SouthTrust
Corporation and Southern Company subsidiaries Alabama Power Company, Georgia
Power Company and Gulf Power Company. Mr. Franklin joined Southern Company in
1970.
ELMER B. HARRIS has been one of our directors since April 1997. He also
serves as Executive Vice President of Southern Company and is President and
Chief Executive Officer of Alabama Power, a subsidiary of Southern Company,
positions he has held since March 1989. Mr. Harris joined Southern Company in
1958. He is a director of Southern Company, Alabama Power Company and AmSouth
Bancorporation.
W. L. WESTBROOK has been one of our directors since May 1993. He also
serves as Financial Vice President, Chief Financial Officer and Treasurer of
Southern Company and Executive Vice President of Southern Company Services, a
subsidiary of Southern Company, positions he has held since April 1995. Mr.
Westbrook is responsible for accounting, finance, tax, investor relations,
treasury and risk management functions at Southern Company. Mr. Westbrook joined
Southern Company in 1964.
BOARD STRUCTURE AND COMPENSATION
Beginning the day that Southern Company (or a majority-owned subsidiary of
Southern Company) ceases to own at least 33 1/3% of our common stock, our board
of directors will be divided into three classes serving staggered three-year
terms.
Directors who are also our employees or employees of Southern Company will
receive no remuneration for serving as directors or committee members. Our
non-employee directors will receive an annual retainer of $60,000 in our stock
and meeting fees of $2,500 for each board meeting and $1,250 for each committee
meeting. Directors may defer payment of their compensation. Directors do not
receive retirement, health or life insurance.
BOARD COMMITTEES
Our board will have three standing committees: an audit committee, a
compensation committee and a nominating committee. Messrs. [ ], [ ]
and [ ] will be appointed as the initial members of the audit committee.
Messrs. [ ], [ ] and [ ] will be
appointed as the initial members of the compensation committee.
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<PAGE> 116
Messrs. [ ], [ ] and [ ] will be appointed
as the initial members of the nominating committee.
As additional persons join the board in connection with and following this
offering, we expect that membership on some of these committees will be modified
and that we will complete the appointment of other members to some of these
committees. Upon the distribution of our common stock by Southern Company, all
of our directors who are directors or officers of Southern Company will resign
from their positions at either Southern Company or our company.
The nominating committee is charged with the nomination of new directors.
The nominating committee will also make recommendations, regarding the
compensation of directors. The audit committee will select the independent
public accountants to audit our annual financial statements and will establish
the scope and oversee the annual audit. The audit committee will also be
responsible for risk management and control and credit policies. The audit
committee will also be responsible for acting on our behalf in connection with
transactions in which Southern Company has an interest adverse to us. The
compensation committee will approve and administer compensation and employee
benefit plans and determine the compensation of the chief executive officer and
other senior officers. Our board may establish other committees from time to
time to facilitate the management of our business and affairs.
STOCK OWNERSHIP OF DIRECTORS AND EXECUTIVE OFFICERS
All of our stock is currently owned by Southern Company and thus none of
our officers, directors and director nominees own any of our common stock.
The following table sets forth information as of December 31, 1999 with
respect to the beneficial ownership of the Southern Company common stock by each
director, the named executive officers, and all of our directors and executive
officers as a group. Except as otherwise indicated in the footnotes, each
individual has sole voting and investment power with respect to the shares set
forth in the following table.
<TABLE>
<CAPTION>
SHARES BENEFICIALLY
OWNED INCLUDE
----------------------------------
SHARES
INDIVIDUALS HAVE
SHARES PERCENT RIGHTS TO ACQUIRE SHARES HELD BY
BENEFICIALLY OF WITHIN FAMILY
NAME OF BENEFICIAL OWNER OWNED(1) CLASS(2) 60 DAYS(3) MEMBERS(4)
------------------------ ------------ -------- ----------------- --------------
<S> <C> <C> <C> <C>
A. W. Dahlberg......................... 522,928 * 452,027 0
S. Marce Fuller........................ 23,842 * 19,650 0
Raymond D. Hill........................ 21,918 * 19,650 0
Richard J. Pershing.................... 44,685 * 19,650 0
Frederick D. Kuester................... 25,468 * 17,871 3,596
Barney S. Rush......................... 8,183 * 6,426 0
H. Allen Franklin...................... 220,337 * 191,114 0
Elmer B. Harris........................ 260,741 * 219,394 310
W. L. Westbrook........................ 116,450 * 48,959 76
Thomas G. Boren........................ 92,737 * 89,097 10
All executive officers and directors as
a group (14 persons)................. 1,391,050 * 1,119,334 3,992
</TABLE>
-------------------------
* Less than 1% of outstanding shares.
(1) Beneficial ownership means the sole or shared power to vote, or to direct
the voting of, a security, or investment power with respect to a security,
or any combination thereof.
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<PAGE> 117
(2) Based on 648,694,000 shares of Southern Company common stock outstanding on
March 27, 2000.
(3) Indicates shares of the Company's common stock that executive officers have
the right to acquire within 60 days. Shares indicated are included in the
Shares Beneficially Owned column.
(4) Each director and officer disclaims any interest in the shares held by
family members. Shares indicated are included in the Shares Beneficially
Owned column.
COMPENSATION OF EXECUTIVE OFFICERS
The following table sets forth compensation information for the chief
executive officer and the four other executive officers who, based on salary and
bonus compensation, were the most highly compensated for the year ended December
31, 1999. All information set forth in this table reflects compensation earned
by these individuals for services with us and our subsidiaries for the year
ended December 31, 1999.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
ANNUAL COMPENSATION LONG-TERM COMPENSATION
---------------------------------- ---------------------------------------
RESTRICTED NUMBER OF
OTHER ANNUAL STOCK SECURITIES
SALARY BONUS COMPENSATION AWARDS UNDERLYING LTIP ALL OTHER
NAME AND PRINCIPAL POSITION YEAR ($) ($) ($)(3) ($)(4) OPTIONS(5) PAYOUTS(6) COMPENSATION(7)
--------------------------- ---- -------- -------- ------------ ------------ ---------- ---------- ---------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
S. Marce Fuller............ 1999 $341,462 $465,231 $ 1,146 $400,000 17,988(SO) -- $17,274
Chief Executive
Officer(1) 88,851(SEI)
Raymond D. Hill............ 1999 297,616 300,000 75 300,000 12,988(SO) -- 16,078
EVP and CFO 88,851(SEI)
Richard J. Pershing........ 1999 297,616 300,000 18,652 300,000 12,988(SO) -- 16,462
EVP, Americas Group 88,851(SEI)
Frederick D. Kuester....... 1999 240,635 300,000 -- 100,000 10,391(SO) 39,737 13,299
SVP, Asia Group 52,375(SEI)
Barney S. Rush............. 1999 219,097 199,750 -- 100,000 7,689(SO) -- 11,874
SVP, Europe Group 46,919(SEI)
Thomas G. Boren............ 1999 235,577 256,667 6,582 -- 0(SO) -- 765,607
Chief Executive
Officer(2) 137,173(SEI)
</TABLE>
-------------------------
(1) S. Marce Fuller was named our president and chief executive officer on July
20, 1999.
(2) Thomas G. Boren served as our chief executive officer and executive vice
president of Southern Company until July 20, 1999. He retired on July 31,
1999. Upon his retirement, he was paid a severance amount of $750,000 and it
was agreed he would receive a pro-rata bonus through July 31, 1999 from the
Southern Energy Resources, Inc. Short-Term Incentive Plan for the 1999 plan
year. This has been paid and the amount ($256,667) is included in the above
table. Mr. Boren is also entitled to receive future payouts for awards under
the Southern Energy Resources, Inc. Deferred Incentive Compensation Plan and
the Southern Energy Resources, Inc. Value Creation Plan.
(3) No executive listed above received perquisites or personal benefits that
exceeded 25% of the total perquisites and other personal benefits reported.
The amounts in this column represent reimbursements during the fiscal year
for the payment of taxes.
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<PAGE> 118
(4) The amounts in the column reflect grants of phantom stock in 1999. Each of
these grants is more fully described in the "-- Employment Contracts"
section.
(5) (SO) indicates options to acquire Southern Company common stock.
(SEI) indicates units granted under the Southern Energy, Inc. Value Creation
Plan.
(6) Represents a payout to Mr. Kuester under the Southern Company Performance
Incentive Plan for the 4-year period ending December 31, 1999.
(7) Our contributions in 1999 to the Employee Savings Plan, Employee Stock
Ownership Plan, and non-pension related accruals under the Supplemental
Benefit Plan, as well as the separation payment to Mr. Boren described in
footnote (2) are provided in the following table:
<TABLE>
<CAPTION>
TOTAL ALL
SEPARATION OTHER
NAME PAYMENT ESP($) ESOP($) SBP($) COMPENSATION
---- ---------- ------ ------- ------- ------------
<S> <C> <C> <C> <C> <C>
S. Marce Fuller............................. -- 5,691 897 10,686 17,274
Raymond D. Hill............................. -- 7,200 897 7,981 16,078
Richard J. Pershing......................... -- 7,401 897 8,164 16,462
Frederick D. Kuester........................ -- 6,578 897 5,824 13,299
Barney S. Rush.............................. -- 6,891 897 4,086 11,874
Thomas G. Boren............................. 750,000 4,500 897 10,210 765,607
</TABLE>
SOUTHERN COMPANY STOCK OPTIONS
The following table shows all grants of options to acquire shares of
Southern Company common stock to the executive officers named in the summary
compensation table in the "-- Executive Compensation" section above in the year
ended December 31, 1999.
Unless exercised prior thereto, the options to purchase Southern Company
common stock reflected below will be replaced with options to purchase our
common stock in connection with the completion of the distribution. See
"Agreements Between Us and Southern Company -- Employee Matters Agreement."
SOUTHERN COMPANY OPTION GRANTS DURING FISCAL YEAR 1999
<TABLE>
<CAPTION>
NUMBER OF PERCENT OF TOTAL
SECURITIES OPTIONS
UNDERLYING GRANTED TO EXERCISE
OPTIONS EMPLOYEES IN PRICE EXPIRATION GRANT DATE
NAME GRANTED (#)(1) FISCAL YEAR(2) ($/SH) DATE PRESENT VALUE(3)
---- -------------- ---------------- -------- ---------- ----------------
<S> <C> <C> <C> <C> <C>
S. Marce Fuller............... 17,988 0.85% $26.5625 07/19/2009 $113,145
Raymond D. Hill............... 12,988 0.62 26.5625 07/19/2009 81,695
Richard J. Pershing........... 12,988 0.62 26.5625 07/19/2009 81,695
Frederick D. Kuester.......... 10,391 0.49 26.5625 07/19/2009 65,360
Barney S. Rush................ 7,689 0.36 26.5625 07/19/2009 48,364
Thomas G. Boren............... 0 0.00 -- -- --
</TABLE>
-------------------------
(1) Stock option grants in Southern Company common stock were made from Southern
Company's Performance Stock Plan on July 19, 1999 and vest annually at a
rate of 33% on the anniversary date of the grant. Grants fully vest upon
termination because of death, total disability or retirement. Exercise price
is the average of the high and low fair market value of Southern Company's
common stock on the date granted.
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<PAGE> 119
(2) A total of 2,108,818 stock options were granted in 1999.
(3) Value was calculated using the Black-Scholes option valuation model. The
actual value, if any, ultimately realized depends on the market value of
Southern Company's common stock at a future date. Significant assumptions
are shown below.
<TABLE>
<CAPTION>
DISCOUNT FOR
FORFEITURE RISK:
RISK-FREE --------------------
RATE OF DIVIDEND BEFORE BEFORE
VOLATILITY RETURN OPPORTUNITY TERM VESTING EXPIRATION
---------- ----------------- ----------- -------- ------- ----------
<S> <C> <C> <C> <C> <C>
20.74% 5.79% 50% 10 years 7.79% 13.40%
</TABLE>
AGGREGATED SOUTHERN COMPANY OPTIONS EXERCISED IN 1999 AND YEAR-END OPTION VALUES
The following table shows aggregate exercises of options to purchase
Southern Company common stock in the year ended December 31, 1999 by the
executive officers named in the summary compensation table in the "-- Executive
Compensation" section above.
1999 SOUTHERN COMPANY OPTION EXERCISES AND YEAR-END OPTION VALUES
<TABLE>
<CAPTION>
NUMBER OF SECURITIES
UNDERLYING UNEXERCISED VALUE OF UNEXERCISED
NUMBER OF OPTIONS AT IN-THE-MONEY OPTIONS AT
SHARES DECEMBER 31, 1999 DECEMBER 31, 1999(1)
ACQUIRED ON VALUE --------------------------- ---------------------------
NAME EXERCISE REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
---- ----------- -------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
S. Marce Fuller.................... 0 $0 19,650 32,660 $ 23,623 $11,258
Raymond D. Hill.................... 0 0 19,650 27,660 23,623 11,258
Richard J. Pershing................ 0 0 19,650 27,660 23,623 11,258
Frederick D. Kuester............... 0 0 17,871 20,217 25,403 7,884
Barney S. Rush..................... 0 0 6,426 14,240 9,450 4,725
Thomas G. Boren(2)................. 0 0 89,097 0 160,360 0
</TABLE>
-------------------------
(1) Represents the excess of the fair market value of Southern Company's common
stock of $23.50 per share, as of December 31, 1999, above the exercise price
of the options.
(2) Following the distribution, Mr. Boren's stock options will remain
exercisable for shares of Southern Company stock.
SOUTHERN ENERGY, INC. VALUE CREATION PLAN
In 1997, we initiated a long-term incentive plan, the value creation plan,
which grants units to eligible employees to receive appreciation over a base
value. The value creation plan was designed to mimic a stock option/stock
appreciation rights plan in almost all manners except that the valuation of
units is done internally and participants do not have a right to actual
ownership in our company.
Employees have been granted two types of units: standard units, which, when
exercised, pay the employee any appreciation over a fixed base value, and
indexed units which, when exercised, pay the eligible employee for any
appreciation over a base value which increases each year by 13%. Standard units
vest 25% per year for four years, and indexed units vest 100% after four years.
The value of these units is determined once per year and is based on our
discounted future cash flows ("DCF"). The subsequent increases/decreases in a
unit's value are based on the percentage
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<PAGE> 120
change in this DCF calculation year over year. The DCF calculation is computed
by us and verified by our independent auditors. The DCF calculation, in the year
that a unit is awarded, is the basis for determining the unit's base value.
We record compensation expense for any unit value in excess of the base
price, taking vesting into account. As of December 31, 1999, we had 3.1 million
standard units outstanding at an average base price of $10.67 per unit and 3.0
million indexed units outstanding at an average base price of $12.77 per unit.
For further discussion on how the outstanding units currently awarded under
the value creation plan will be treated following this transaction, see the
section below entitled "-- Value Creation Plan Conversion."
The table below describes the units awarded by the compensation committee
under the value creation plan to the executive officers named in the summary
compensation table in the "-- Executive Compensation" section above.
VALUE CREATION PLAN UNITS GRANTED DURING FISCAL YEAR 1999
<TABLE>
<CAPTION>
POTENTIAL REALIZED VALUE
AT ASSUMED ANNUAL RATES
PERCENT OF OF BASE VALUE
TOTAL UNITS APPRECIATION FOR UNIT
GRANTED TO BASE TERM
NUMBER OF EMPLOYEES IN PRICE EXPIRATION -------------------------
NAME UNITS GRANTED (1) FISCAL YEAR (2) ($/SH) DATE 5% 10%
---- ----------------- --------------- ------ ---------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
S. Marce Fuller........... 88,851 5.0% $11.61 6/30/2009 649,882 1,640,189
Raymond D. Hill........... 88,851 5.0 11.61 6/30/2009 649,882 1,640,189
Richard J. Pershing....... 88,851 5.0 11.61 6/30/2009 649,882 1,640,189
Frederick D. Kuester...... 52,375 2.9 11.61 6/30/2009 383,085 966,842
Barney S. Rush............ 46,919 2.6 11.61 6/30/2009 343,180 866,124
Thomas G. Boren........... 137,173 7.7 11.61 6/30/2009 1,003,324 2,532,213
</TABLE>
-------------------------
(1) The above value creation plan units were granted on March 15, 1999 with a
base price set at $11.61. These units vest annually at a rate of 25% on each
anniversary of their grant.
(2) Percentages based on a total of 1,780,793 units granted in 1999, consisting
of 1,455,655 standard units and 325,138 indexed units. No indexed units were
granted to the named executive officers.
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<PAGE> 121
The following table shows aggregate exercises of units in the year ended
December 31, 1999 by the executive officers named in the summary compensation
table in the "-- Executive Compensation" section above.
AGGREGATED UNITS EXERCISED IN 1999 AND YEAR END UNIT VALUES
<TABLE>
<CAPTION>
VALUE OF UNEXERCISED
IN-THE-MONEY UNITS AT
NUMBER OF UNITS AT DECEMBER 31,
NUMBER OF DECEMBER 31, 1999 (1) 1999 (2)
UNITS VALUE --------------------------- ----------------------------
NAME EXERCISED REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
---- --------- -------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
S. Marce Fuller............. 0 $0 40,128(S) 163,836(S) $164,817(S) $524,772(S)
0(I) 453,995(I) 0(I) 0(I)
Raymond D. Hill............. 0 0 40,128(S) 163,836(S) 164,817(S) 524,772(S)
0(I) 453,995(I) 0(I) 0(I)
Richard J. Pershing......... 0 0 40,128(S) 163,836(S) 164,817(S) 524,772(S)
0(I) 453,995(I) 0(I) 0(I)
Frederick D. Kuester........ 0 0 26,675(S) 103,059(S) 109,675(S) 336,605(S)
0(I) 58,685(I) 0(I) 0(I)
Barney S. Rush.............. 0 0 26,597(S) 113,031(S) 111,452(S) 391,458(S)
0(I) 27,357(I) 0(I) 0(I)
Thomas G. Boren............. 0 0 69,812(S) 270,343(S) 287,102(S) 883,479(S)
0(I) 762,712(I) 0(I) 0(I)
</TABLE>
-------------------------
(1) (S) = Standard Units. (I) = Indexed Units.
(2) Valued at the December 31, 1999 value of $13.99.
EMPLOYMENT CONTRACTS
The only compensation provided for in each of the employment agreements
discussed below is awards of phantom stock. In addition, the agreements with
Messrs. Hill and Pershing provide that additional years of service may be
included in pensions and supplemental executive retirement plan calculations.
The agreements do not provide for any payments of salary, bonus, other
compensation or severance payments. These agreements terminate when the employee
terminates his or her employment with us, or when the phantom stock is paid,
whichever occurs first. All of the awards granted under the following agreements
are forfeited upon termination for cause or resignation. Awards are paid
immediately if the employee dies, becomes disabled, or is terminated without
cause. It is anticipated that awards of Southern Company phantom stock granted
under the following agreements will convert to awards of our phantom stock upon
the distribution of our stock by Southern Company.
S. MARCE FULLER. On October 5, 1999, Southern Company, Southern Energy
Resources, Inc. and Ms. Fuller entered into an employment agreement. The
agreement provides for the award of $400,000 in phantom Southern Company stock,
valued as of the date of the agreement and paid out on July 1, 2003 if Ms.
Fuller is still employed by us. Should Ms. Fuller meet this criterion, she will
receive a payment of the phantom stock in cash, valued as of July 1, 2003,
including the reinvestment of any dividends paid during the period of the
agreement. In addition, the taxes due by Ms. Fuller for this payment will be
grossed up if certain goals are met. The goals for this agreement are to meet
and exceed net income and return on equity targets for the next three fiscal
years (2000, 2001, 2002). The targets for each of these goals will be determined
prior to the beginning of each year and will be the same as the goals for our
short-term incentive plan. Our board of directors, in conjunction with
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<PAGE> 122
Southern Company's board of directors, will determine whether or not these
targets have been achieved. This agreement will terminate at the earlier of (1)
when Ms. Fuller terminates her employment with us or (2) when the phantom stock
is paid.
MESSRS. HILL AND PERSHING. In October 1999, we entered into compensation
agreements with Raymond D. Hill and Richard J. Pershing. Each of these
agreements provides for an award of $300,000 in phantom Southern Company stock,
valued as of the date of the agreement. Mr. Hill will receive the phantom stock
payment on March 1, 2003 if he is still employed by us on that date, and Mr.
Pershing will receive the phantom stock payment on May 1, 2003 if he is still
employed by us on that date. In addition, if Mr. Hill is still employed by us on
March 1, 2003, his retirement payments are calculated as if 10 years of
additional service are included in the pension and supplemental executive
retirement plan calculations. If Mr. Pershing is still employed by us on
November 1, 2002, his retirement payments are calculated as if three years of
additional service are included in the pension and supplemental executive
retirement plan calculations. These agreements terminate at the earlier of (1)
when Mr. Hill or Mr. Pershing terminates his employment with us or (2) when the
phantom stock is paid.
MESSRS. KUESTER AND RUSH. Effective December 9, 1999, we also entered into
compensation agreements with Frederick D. Kuester and Barney Rush. The
agreements provide for the award of $100,000 in our phantom stock, at the
December 31, 1998 base value under the value creation plan. Under the terms of
these agreements, if the executives are still employed by us on January 1, 2003,
this award will be paid at the then current base value under the value creation
plan. In addition, Mr. Kuester has an agreement in place that would immediately
vest all of his outstanding value creation plan units upon his return from his
current assignment at SE Asia-Pacific. It is anticipated that awards based on
the base value under our value creation plan will be converted to awards of our
phantom stock upon the initial public offering.
CHANGE IN CONTROL ARRANGEMENTS
Our executive officers named in the summary compensation table in the
"-- Executive Compensation" section above have change in control agreements that
are effective upon a change in control of either Southern Company or us. Neither
this offering nor the distribution of our shares by Southern Company will
constitute a change in control under those agreements.
Within two years following a change in control of us, if an executive is
involuntarily terminated, other than for cause, or voluntarily terminated for
good reason, which is defined as a material diminution of duties, a significant
reduction in compensation or benefits or relocation, the agreements provide for:
- a lump sum payment of three times annual compensation for Ms. Fuller and
Messrs. Hill and Pershing and two times annual compensation for Messrs.
Kuester and Rush,
- up to five years' coverage under group health and life insurance plans,
- immediate vesting of all stock options and stock appreciation rights
previously granted,
- payment of any accrued long-term and short-term bonuses and dividend
equivalents, and
- payment of any excise tax liability incurred as a result of payments made
under the agreement for Ms. Fuller and Messrs. Hill and Pershing.
Payments of any excise tax liability incurred as a result of payments
made under this agreement are capped at IRS limits for Messrs. Kuester
and Rush.
The Southern Company and Southern Energy plans also provide for pro-rata
payments at not less than target-level performance for some incentive plans if a
change in control occurs and the plans are not continued or replaced with
comparable plans.
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<PAGE> 123
At such time as Southern Company owns less than 50% of our stock, we intend
to replace the existing agreements with similar arrangements for our executive
officers and other employees. We intend to maintain the current definition of
"change in control," which includes the following events:
- acquisition by a person of at least 20% of our stock,
- a defined change in the majority of the members of our board of
directors,
- a merger or other business combination that results in our stockholders
immediately before the merger owning less than 65% of the voting power
after the merger, or
- a sale of substantially all of our assets.
INCENTIVE PLANS
Following the offering, we plan to grant, within the provisions of the
omnibus plan (discussed further below) annual short-term incentive opportunities
and annual awards of stock options. We intend for these targeted incentive
opportunities to be such that total compensation approximates the median for
similarly situated executives at similar companies.
The short-term incentive plan will measure, for each executive officer
named in the summary compensation table, primarily our net income and return on
equity. A smaller portion of the incentive opportunities will be based on
individual performance and Southern Company's earnings per share through full
distribution.
SOUTHERN ENERGY OMNIBUS INCENTIVE COMPENSATION PLAN
We have adopted, with the approval of Southern Company as our sole
stockholder, the Southern Energy Omnibus Incentive Plan. The omnibus plan will
be administered by our board of directors or the compensation committee of our
board. The following is a description of the material provisions of the omnibus
plan.
The objectives of the omnibus plan are to:
- optimize our profitability and growth through annual and long-term
incentives that are consistent with our goals, are market based and link
the personal interests of participants to those of our stockholders,
- provide participants with an incentive for excellence in individual
performance, and
- promote teamwork among participants.
The omnibus plan is further intended to provide flexibility to us in our
ability to attract, motivate and retain the services of participants who make
significant contributions to our success and allow participants to share in our
success.
Our board will determine eligibility for awards under the omnibus plan for
all of our employees, officers and directors. The omnibus plan permits grants of
stock options, restricted stock, stock appreciation rights (SARs), performance
units (PUs), performance shares (PSs) and/or cash-based awards to eligible
participants in amounts and upon terms, and at any time and from time to time,
as determined by our board.
A total of 27,200,000 shares are reserved for issuance under the omnibus
plan. Shares received upon exercise of a stock option may be newly issued
shares, treasury shares or shares obtained by us through purchases on the open
market. It is anticipated that approximately 450 employees initially will
participate in the omnibus plan.
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Options granted under the omnibus plan may be either incentive stock
options (ISOs) or non-qualified stock options, as determined by the board. ISOs
are options intended to qualify as "incentive stock options" within the meaning
of Section 422 of the Internal Revenue Code of 1986, as amended (Internal
Revenue Code).
The terms of any option will be determined by the board, but no ISO may be
exercised later than 10 years after the date of grant. Options shall be
exercisable only in accordance with the terms and conditions established by the
board at the time of the grant.
Our board may grant SARs, PUs, PSs or cash-based awards to individuals,
from time to time, in amounts as it may determine. Each SAR or PS relates to one
share of our common stock, subject to adjustments described in the omnibus plan.
The value of a PU will be at the discretion of the board. SARs, PUs, PSs and
cash-based awards will be awarded without consideration other than the rendering
of services, unless the board decides otherwise. SARs, PUs, PSs and cash-based
awards shall vest, subject to the satisfaction of various conditions, at the
time or times determined by the board. In addition, the board may establish
performance vesting criteria with respect to all or any portion of a grant of
SARs, PUs, PSs and cash-based awards based on business criteria set forth in the
omnibus plan.
Awards which are subject to Section 162(m) of the Internal Revenue Code are
intended to qualify as performance based under that section and the provisions
of these awards will be interpreted in a manner consistent with that intent to
the extent appropriate.
Our board generally has the power and authority to amend, modify, suspend
or terminate the omnibus plan at any time without the approval of our
stockholders, subject to applicable federal securities and tax law limitations
and NYSE regulations.
SOUTHERN ENERGY EMPLOYEE STOCK PURCHASE PLAN
In order to encourage our employees to become stockholders, we have
established the Southern Energy Stock Purchase Plan. This plan is intended to
comply with Section 423 of the Internal Revenue Code and has been approved by
our current shareholder, Southern Company.
This plan will permit eligible employees to purchase our common stock
through payroll deductions at a price per share which is equal to the lesser of
85% of the fair market value of the common stock on the first or last day of an
offering period. Each offering period will be up to, but not longer than 2
years.
Under this plan, participants will be permitted to purchase shares of
common stock with an aggregate fair market value of no more than $25,000 in any
one calendar year.
There are a total of 3,400,000 shares reserved for issuance under this
plan. The compensation committee of our board will administer this plan.
VALUE CREATION PLAN CONVERSION
Upon this offering, all outstanding value creation plan units will be
converted into options to purchase our stock. The conversion will be made at the
plan's final base value, maintaining the same face value. When converted, each
option will maintain its in-the-money value and other material terms (such as
the length of a unit's term and vesting). The plan's base value will be
determined by Southern Company's Compensation Committee based on our most recent
discounted cash flow analysis.
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Approximately 250 employees participate in this plan and will become stock
option holders as a result of the conversion. These grants will be made pursuant
to the Southern Energy Omnibus Incentive Compensation Plan.
INITIAL EQUITY GRANTS
In connection with the offering, and in order to provide incentive and
retention for employees going forward, we will make grants of performance
restricted stock, stock units or stock options to approximately 350 employees
prior to this offering. These grants will be made pursuant to the Southern
Energy Omnibus Incentive Compensation Plan. Options will have an exercise price
equal to the initial public offering price, and will vest 33% on each of the
first three anniversaries of the date of grant. We anticipate that the grants of
performance restricted stock and/or units will vest 20% each time our stock
price increases 20% over our initial public offering price. We intend to make
initial equity grants with a face value of approximately $60,000,000. Of this,
approximately $6,500,000 will be made in the form of performance-restricted
stock and/or performance-restricted stock units. The remaining, $53,500,000 will
be made in stock options.
DEFERRED COMPENSATION PLAN
We have, through Southern Company, a voluntary deferred compensation plan
which allows executives to forgo current compensation and invest it on a phantom
basis in Southern Company stock or a prime rate fund. The amounts deferred under
the Southern Company deferred compensation plan for named officers as of
December 31, 1999 are as follows:
<TABLE>
<CAPTION>
NAME AMOUNT
---- ------
<S> <C>
S. Marce Fuller............................................. $ 237,206
Raymond D. Hill............................................. 1,478,798
Richard J. Pershing......................................... 52,741
Frederick D. Kuester........................................ 465,428
Barney S. Rush.............................................. 0
Thomas G. Boren............................................. 0
</TABLE>
After the offering, we intend to establish a similar plan and these amounts
will be transferred into the plan we establish.
DEFERRED INCENTIVE COMPENSATION PLAN
We maintain a Deferred Incentive Compensation Plan in which incentive
awards paid to participants may be deferred. No new awards paid to participants
can be deferred in the plan. Balances grow at the rate of our value increase
determined under our value creation plan. The plan has approximately 20
participants but no new participants are anticipated to become eligible. We will
continue this plan according to its terms with our public stock values replacing
phantom values.
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The amounts deferred under the Southern Energy deferred incentive
compensation plan for named officers as of December 31, 1999 are as follows:
<TABLE>
<CAPTION>
NAME AMOUNT
---- ------
<S> <C>
S. Marce Fuller............................................. $ 358,425
Raymond D. Hill............................................. 555,244
Richard J. Pershing......................................... 559,331
Frederick D. Kuester........................................ 0
Barney S. Rush.............................................. 61,471
Thomas G. Boren............................................. 928,590
</TABLE>
PENSION PLANS
Our employees participate in the tax-qualified Southern Company Pension
Plan. Our benefit liabilities and pension assets are separately accounted for as
if our employees were in a separate pension plan. This separate accounting will
be continued until no later than the full distribution of our stock by Southern
Company. At that time, Southern Company will transfer from its pension plan our
employees' benefit liabilities and related assets (in an amount not less than
that required by the relevant legal requirements) to a tax-qualified pension
plan sponsored by us. Our pension plan will provide employees benefits that are
substantially the same as the benefits provided to them under the Southern
Company plan.
In addition, our executive officers are eligible for supplemental executive
retirement plan benefits. This plan primarily provides pension benefits related
to executives' pay in excess of what is counted towards tax-qualified pension
benefits (including a portion of executives' short-term incentives).
The following table shows the approximate total monthly pension benefits
that our executive officers are expected to receive based on their pay and years
of accredited service classifications. These amounts are shown prior to
reduction for an offset related to Social Security benefits.
<TABLE>
<CAPTION>
YEARS OF ACCREDITED SERVICE
PENSIONABLE ------------------------------------------------------------------
COMPENSATION 10 15 20 25 30 35 40
-------------- ------ ------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C>
$300,000 $4,300 $ 6,400 $ 8,500 $10,600 $12,800 $14,900 $17,000
350,000 5,000 7,400 9,900 12,400 14,900 17,400 19,800
400,000 5,700 8,500 11,300 14,200 17,000 19,800 22,700
450,000 6,400 9,600 12,800 15,900 19,100 22,300 25,500
500,000 7,100 10,600 14,200 17,700 21,300 24,800 28,300
550,000 7,800 11,700 15,600 19,500 23,400 27,300 31,200
600,000 8,500 12,800 17,000 21,300 25,500 29,800 34,000
</TABLE>
The benefits in the above table are amounts payable monthly as single life
annuities starting at age 65, the pension plan's normal retirement age. Pension
benefits will be based on the average of executives' highest three years of
pensionable compensation out of their final 10 years of pensionable
compensation. Pensionable compensation includes base salary and short term bonus
in excess of 15% of base salary.
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Pensionable compensation and accredited service for pension determination
purposes as of December 31, 1999 is shown below for each of the executive
officers named in the summary compensation table in the "-- Executive
Compensation" section above:
<TABLE>
<CAPTION>
YEARS OF PENSIONABLE
NAME SERVICE COMPENSATION
---- -------- ------------
<S> <C> <C>
S. Marce Fuller............................................. 14.3 $577,822
Raymond D. Hill............................................. 6.0 494,472
Richard J. Pershing......................................... 27.8 494,472
Frederick D. Kuester........................................ 26.9 392,406
Barney S. Rush.............................................. 2.8 333,936
</TABLE>
RELATIONSHIP WITH SOUTHERN COMPANY AND RELATED TRANSACTIONS
We have agreements with Southern Company Services, Inc. (a wholly owned
subsidiary of Southern Company) and each of the operating companies owned by
Southern Company under which those companies provide the following services to
us at cost: general engineering, design engineering, accounting and statistical
budgeting, business promotion and public relations, systems and procedures,
training, and administrative and financial services. In addition to these
services, facilities of Southern Company subsidiaries are made available to us
and our customers. We reimburse Southern Company subsidiaries at cost for these
services. Such costs amounted to approximately $20 million during 1999. As of
June 30, 2000, such costs have totalled $11.4 million during the current fiscal
year.
During 1999, we incurred interest expense on a note payable to Southern
Company of $37 million. We repaid the principal and interest on the note in
1999.
Our special purpose financing subsidiaries have issued subsidiary obligated
mandatorily redeemable preferred securities. Substantially all of the assets of
these special financing entities are junior subordinated notes issued by us. We
have loaned $950 million of the proceeds from the issuance of these subsidiary
obligated mandatorily redeemable preferred securities and an additional $30
million related to equity to Southern Company. Payment terms and interest rates
on the notes receivable from Southern Company are identical to the related
preferred securities. The notes are due between 2027 and 2037 with fixed
interest rates between 6.875% and 8.19%.
Periodically, we borrow funds from Southern Company to finance acquisitions
or working capital needs. We pay interest to Southern Company based on Southern
Company's short-term borrowing rate. No amounts were outstanding at December 31,
1999.
We and the other subsidiaries of Southern Company file a consolidated
federal income tax return. Under a joint income tax agreement, each company's
current and deferred tax expense is computed on a stand alone basis. Under this
agreement, we received tax allocation payments from Southern Company of
approximately $99 million during 1999.
For purposes of governing on-going relationships between us and Southern
Company, we will enter into, or continue in effect, various agreements and
relationships, including those described in this prospectus. The agreements
described below were negotiated in the context of our separation from Southern
Company and therefore are not the result of arm's-length negotiations between
independent parties.
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AGREEMENTS BETWEEN US AND SOUTHERN COMPANY
We have provided below a summary description of the master separation and
distribution agreement (referred to as the separation agreement) that we have
entered into with Southern Company, as well as key related agreements. Until the
distribution of our shares by Southern Company, these agreements, including the
pricing of services to be provided to us by Southern Company, will be subject to
the jurisdiction of the SEC under PUHCA. We are in the process of preparing an
application to the SEC for affirmative authorization of these agreements to the
extent the SEC deems necessary.
This summary describes the material terms of these agreements, but may omit
a term or provision that you would consider important. We encourage you to read
the full text of these agreements, which have been filed with the SEC as
exhibits to the registration statement of which this prospectus is a part.
MASTER SEPARATION AND DISTRIBUTION AGREEMENT
The master separation and distribution agreement contains the key
provisions relating to the separation, this offering and the distribution.
THE SEPARATION. The separation agreement became effective, and we began
operating independently from Southern Company, on [ ]. This date
is referred to as the separation date. Southern Company will deliver additional
agreements governing various interim and ongoing relationships between Southern
Company and us following the separation date. The ancillary agreements include:
- a transitional services agreement,
- an indemnification and insurance matters agreement,
- a technology and intellectual property ownership and license agreement,
- a confidential disclosure agreement,
- an employee matters agreement,
- a tax indemnification agreement, and
- agreements providing for the transfer of SE Finance and Capital Funding to
Southern Company.
To the extent that the terms of any of these ancillary agreements conflict
with the separation agreement, the terms of these ancillary agreements govern.
These agreements are described more fully below.
THE INITIAL PUBLIC OFFERING. Under the separation agreement, we are
obligated to use our reasonable commercial efforts to satisfy the following
conditions prior to the consummation of this offering (any of which may be
waived by Southern Company):
- the registration statement containing this prospectus must be effective,
- applicable state and foreign securities laws must be satisfied,
- our common stock must be approved for listing on the New York Stock
Exchange,
- all conditions to the obligations of the parties under the underwriting
agreement must have been met or waived,
- Southern Company must be satisfied that it will own more than 80% of our
stock after this offering and must be satisfied that the distribution
will be tax free to it and to its U.S. stockholders,
- all required government approvals must be in effect,
- no legal restraints must exist preventing the separation or this offering
or any other transactions contemplated by the separation agreement,
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- the separation must have occurred, and
- the separation agreement must not have been terminated.
THE DISTRIBUTION. Within 12 months after this offering, Southern Company
intends to distribute the remaining shares of our common stock to its
stockholders on a pro rata basis. We will prepare an information statement with
Southern Company and send it to Southern Company's stockholders before the
distribution becomes effective. The information statement will inform the
stockholders of the distribution and its specifics. Southern Company may, in its
sole discretion, change the terms of the distribution, including the
distribution date, or decide not to complete the distribution. Southern Company
intends to consummate the distribution only if the following conditions are met
(any of which may be waived by Southern Company):
- the IRS must issue a favorable tax ruling on the tax-free status of the
transaction to Southern Company and its U.S. stockholders and that the
transaction qualifies as a tax-free distribution under Section 355 of the
Internal Revenue Code,
- all required government approvals must be in effect,
- no legal restraints must exist preventing the distribution, and
- nothing must have happened in the intervening time between the initial
public offering and the distribution that makes the distribution harmful
to Southern Company or its stockholders.
COVENANTS BETWEEN SOUTHERN COMPANY AND US. The separation agreement
includes covenants obligating us and Southern Company to cooperate in the
exchange of information, in auditing practices, to resolve disputes in
particular ways and other matters.
INFORMATION EXCHANGE. Both we and Southern Company have agreed to share
information with each other, at no cost to the requesting party, for the
following purposes, and to avoid doing so in a manner that would be commercially
detrimental:
- Each party has agreed to maintain adequate internal accounting to allow
the other party to satisfy its own reporting obligations and prepare its
own financial statements.
- Each party will retain records that may be beneficial to the other party
for a specified period of time. If the records are going to be destroyed,
the destroying party will give the other party an opportunity to retrieve
all relevant information from the records.
- Each party will do its best to provide the other party with personnel,
directors, officers or agents for use as witnesses in legal proceedings.
AUDITING PRACTICES. So long as we remain a subsidiary of Southern Company,
we have agreed to:
- not change independent accounting firms without Southern Company's prior
consent,
- use reasonable commercial efforts to cause our auditors to date their
opinion on our audited annual financial statements on the same date as
Southern Company's auditors' date their opinion on Southern Company's
consolidated financial statements,
- provide Southern Company with all relevant information to enable Southern
Company to prepare their consolidated financial statements (and Southern
Company has agreed to provide us all relevant information to enable us to
prepare our financial statements),
- grant each other's internal auditors access to our records, and
- notify each other of any change in our accounting principles.
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DISPUTE RESOLUTION. If problems arise between us and Southern Company,
both parties have agreed to the following procedures:
- The parties will make a good faith effort to first resolve the dispute
through negotiation.
- If negotiations fail, the parties agree to attempt to resolve the dispute
through non-binding mediation.
- If mediation fails, the parties can resort to litigation. In addition,
nothing prevents either party acting in good faith from initiating
litigation at any time if failure to do so would substantially
disadvantage that party.
REGULATORY MATTERS. We and Southern Company have agreed to cooperate in
various respects to obtain any required governmental approvals and to achieve
the intended regulatory effect of the distribution. We also have agreed that,
for 18 months after the distribution, we will not initiate, intervene in or
participate in specified proceedings or matters before the FERC or any agency or
legislature of the states of Alabama, Florida, Georgia or Mississippi which
involve Southern Company or any of its subsidiaries.
SOUTHERN ENERGY BOARD REPRESENTATION. Although Southern Company intends to
distribute the remaining shares of our common stock that it holds to its
stockholders, we cannot be certain of whether or when the distribution will
occur. Consequently, we have agreed that if Southern Company should own in the
future more than 25% but less than 50% of our outstanding common shares,
Southern Company will be entitled to designate up to two persons to be nominated
for election to our board of directors. This right will only be available if and
to the extent Southern Company is not otherwise already represented on our board
of directors in a class of directors that is not up for election at that time.
CREDIT SUPPORT OBLIGATIONS. Southern Company has agreed to continue credit
support arrangements with respect to our existing business and to provide
additional credit support for certain of our subsidiaries up to a limit prior to
the distribution. We will pay Southern Company a fee based on the amount of the
credit support obligations then outstanding, for the maintenance of these credit
support obligations after the distribution occurs.
EXPENSES. We will pay 4.75% of underwriting fees, discounts and
commissions incurred for this offering. Southern Company will pay the remaining
underwriting fees, discounts and commissions, as well as all of our other
out-of-pocket costs and expenses related to this offering, the distribution and
the preparation of the agreements providing for the separation, the distribution
and related transactions.
TERMINATION OF THE AGREEMENT. Southern Company in its sole discretion can
terminate the separation agreement and all ancillary agreements and abandon the
distribution at any time prior to the closing of this offering. The separation
agreement and all ancillary agreements may be terminated at any time after the
closing of this offering only with the consent of Southern Company and us. As
long as we are controlled by Southern Company, Southern Company will be able to
require us to terminate or amend these agreements.
TRANSITIONAL SERVICES AGREEMENT
Southern Company will provide various interim services to us, including
financial, accounting, engineering, information technology, legal and other
services, in a manner similar to the manner in which such services were provided
to us prior to the separation. The transitional services generally will be
provided for a fee equal to the greater of the cost, including the actual direct
and indirect costs, of providing the services or the market value for such
services.
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These transitional services will generally have a term of two years or less
from the date of separation. However, some transitional services, including
those for engineering services and payroll and information technology services,
may be extended beyond the initial two-year period.
INDEMNIFICATION AND INSURANCE MATTERS AGREEMENT
GENERAL RELEASE OF PRE-SEPARATION CLAIMS. Effective as of the separation
date, except for contractual agreements between us and Southern Company, we will
release Southern Company and its affiliates, agents, successors and assigns, and
Southern Company will release us and our affiliates, agents, successors and
assigns, from any liabilities arising from events occurring on or before the
separation date, including events occurring on or before the separation date in
connection with the activities to implement the separation, the initial public
offering and the distribution. This provision will not impair a party from
enforcing any intercompany agreement, the separation agreement, any ancillary
agreement or any arrangement specified in any of these agreements.
INDEMNIFICATION. The indemnification and insurance matters agreement also
contains provisions governing indemnification. In general, we have agreed to
indemnify Southern Company and its affiliates, agents, successors and assigns
from all liabilities to any third party to the extent those liabilities arise
from:
- our acts or omissions or alleged acts or omissions in the conduct of our
business or in connection with this offering or the distribution,
- any breach by us of the separation agreement or any ancillary agreement,
and
- any of our liabilities or any liabilities related to credit support
provided by Southern Company on our behalf.
Southern Company has agreed to indemnify us and our affiliates, agents,
successors and assigns from all liabilities to any third party to the extent
those liabilities arise from:
- acts or omissions or alleged acts or omissions of Southern Company in the
conduct of Southern Company's business or in connection with this
offering,
- any breach by Southern Company of the separation agreement or any
ancillary agreement, and
- any liabilities of Southern Company other than the credit support
arrangements provided by Southern Company on our behalf.
The indemnifying party will make all indemnification payments net of
insurance proceeds that the indemnified party receives. The agreement also
contains provisions governing notice and indemnification procedures.
INSURANCE MATTERS. The agreement also contains provisions governing our
insurance coverage from the separation date until the distribution date. In
general, we agree to reimburse Southern Company for premium expenses related to
insurance coverage during this period. Prior to the distribution, Southern
Company will maintain insurance policies on our behalf that are generally
comparable to those currently maintained for our benefit at Southern Company.
ASSIGNMENT. The indemnification and insurance matters agreement is not
assignable by either party without prior written consent.
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TECHNOLOGY AND INTELLECTUAL PROPERTY OWNERSHIP AND LICENSE AGREEMENT
We have entered into an agreement with Southern Company to govern the
division, transfer and license of technology used in our business. Pursuant to
this agreement, Southern Company has licensed to us technology owned by Southern
Company.
Also, Southern Company has agreed to license to us various Southern
Company-owned trademarks, including "Southern Energy," "Southern Company,"
"Southern Company Energy Marketing," "Energy to Serve Your World" and the
"Triangle Logo." The license to use these marks expires as of the distribution
and thereafter we may use these marks only if Southern Company grants us an
extension of the license. Southern Company may not use the "Southern Energy" or
"Southern Company Energy Marketing" marks for 18 months from the date we cease
use of those marks.
Southern Company also has transferred and/or agreed to license to us other
technology (which includes copyrights, database rights, computer software,
domain names and other intellectual property rights, with the exception of
trademarks and patents) owned by Southern Company and currently used by us.
Southern Company will also use reasonable efforts to have us made a party to or
sublicense other agreements wherein Southern Company is a licensee for
technology we currently use.
CONFIDENTIAL DISCLOSURE AGREEMENT
The confidential disclosure agreement provides that both parties agree not
to disclose confidential information of the other party except in specific
circumstances.
EMPLOYEE MATTERS AGREEMENT
We have entered into an employee matters agreement with Southern Company to
allocate assets, liabilities and responsibilities relating to our current and
former employees and to address their participation in the benefit plans,
including stock plans, that Southern Company currently sponsors and maintains.
All of our eligible employees not subject to a collective bargaining
agreement will continue to participate in the Southern Company benefit plans. We
will establish comparable benefit plans for our current and former employees not
later than the time of the distribution. Certain of our plans, such as the
Southern Energy short-term incentive plan, will be terminated but replaced with
other plans to provide a more cohesive design. However, our goal is to provide a
total compensation package that is comparable to that currently provided.
Our employees who participate in Southern Company plans and who retire
before the distribution of our stock by Southern Company will remain the
responsibility of Southern Company and will continue to participate in plans
after the distribution. We and Southern Company have established a mutually
acceptable method to allocate the liabilities and the assets attributable to
this assumption of responsibility by Southern Company.
All of our eligible employees who are subject to a collective bargaining
agreement and currently participate in our plans will continue to participate in
the same benefits plans currently maintained on their behalf subject to
collective bargaining agreements.
Once we establish our own corresponding or new benefit plans, we may modify
or terminate any plan we maintain in accordance with its terms and our policies.
None of our benefit plans will provide benefits that duplicate benefits provided
under any corresponding Southern Company benefit plan at the time of the
distribution. Each of our benefit plans will provide that all service,
compensation and
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other benefits criteria that, as of the distribution, were recognized under the
corresponding Southern Company benefit plan will be taken into account under our
benefit plans.
We will assume a spun-off portion of the Southern Company pension plan for
the benefit of eligible employees not subject to a collective bargaining
agreement. Southern Company will transfer appropriate assets held in its master
trust under this plan to a master trust to be established by us. We will also
receive assets attributable to pension plans maintained for our employees
covered under collective bargaining agreements.
Prior to the distribution, our employees and employees of Southern Company
may not freely transfer employment. In order to transfer, a notice of transfer
request must be given and approved by each employing company.
In connection with the completion of the distribution, we will issue
substitute options for our common stock to our employees in exchange for their
Southern Company options. The conversion process will follow FASB Interpretation
No. 44, "Accounting for Certain Transactions Involving Stock Compensation,"
which dictates the following:
- The aggregate intrinsic value of the options immediately after the
conversion will be equal to the aggregate intrinsic value prior to the
conversion.
- The ratio of the stock price (fair market value) per option to the
exercise price per option will remain the same.
In addition, because we will not establish a plan comparable to the
Southern Performance Dividend Plan (a bonus plan paying dividend equivalents),
we may grant additional options to our employees to make-up for this lost
compensation opportunity.
After distribution, eligible management employees will participate in
non-qualified deferred compensation plans.
We have agreed to indemnify Southern Company for employment liabilities
arising from any acts of our employees, from claims by our officers against
Southern Company and from any breach of any of the separation agreements.
Southern Company has agreed to indemnify us for employment liabilities related
to Southern Company or employees of Southern Company, from claims by Southern
Company officers against us or from any breach by Southern Company of any of the
separation agreements.
TAX INDEMNIFICATION AGREEMENT
We have entered into a tax indemnification agreement with Southern Company
to govern the allocation of U.S. income tax liabilities and to set forth
agreements with respect to other tax matters. Under the Internal Revenue Code of
1986, as amended, we will cease to be a member of the Southern Company
consolidated group upon completion of the distribution or if at any time
Southern Company owns less than 80% of our outstanding capital stock.
Southern Company generally will be responsible for filing any returns
required to be filed on a consolidated basis through the date of distribution in
accordance with the existing income tax allocation agreement. For taxable
periods ending on or before the date of distribution, payments to Southern
Company or us, as the case may be, will continue to be made in accordance with
past practices. There may be U.S. state and local jurisdictions in which we file
separate income tax returns, not combined or consolidated with Southern Company,
for tax periods prior to tax deconsolidation. Each party will, at all times, be
responsible for filing and paying taxes related to these separate returns.
However, Southern Company will be responsible for filing any tax returns
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related to the newly-formed subsidiary to be used for the transfer of SE Finance
and Capital Funding to Southern Company.
Southern Company will determine all tax elections for tax periods during
which we are a member of the Southern Company consolidated group unless we
request Southern Company to make a particular election with respect to us, in
which case Southern Company will not unreasonably withhold consent to such
request. We will prepare and file all tax returns required to be filed by us for
all tax periods after we cease to be a member of the Southern Company
consolidated group.
If there are tax adjustments related to us arising after the distribution
date, which relate to a tax return filed for a pre-distribution period, we will
be responsible for any increased taxes and receive the benefit of any tax
refunds (except with respect to the new SE Finance/Capital Funding subsidiary
described below). In addition, we and Southern Company have agreed to cooperate
in any tax audits, litigation or appeals that involve, directly or indirectly,
tax returns filed for pre-distribution periods and to provide information
related to such periods. We and Southern Company have agreed to indemnify each
other for any tax liabilities resulting from the failure to pay any amounts due
under the terms of the agreement or for costs resulting from either party's
negligence in providing accurate or complete information in the preparation of
any tax return.
We and Southern Company have agreed that any taxes associated with the
transfer and operation of the new SE Finance/Capital Funding subsidiary will be
the responsibility of Southern Company. We and Southern Company have agreed that
any and all taxes arising from the deconsolidation of us from the Southern
Company consolidated group will be the responsibility of the entity that is
liable for such taxes under applicable law.
We and Southern Company are required to comply with representations made to
the Internal Revenue Service in connection with the private letter ruling that
we expect to be issued to Southern Company regarding the tax-free nature of the
distribution of our stock by Southern Company to Southern Company stockholders.
In addition, we and Southern Company have agreed not to enter into transactions
after the date of the distribution that would result in a change of control of
either party pursuant to a plan unless a ruling is obtained from the IRS that
the transaction will not affect the tax-free nature of the distribution. In the
event either party takes any action which results in the distribution becoming a
taxable transaction, such party will indemnify the other party for any and all
taxes, on an after-tax basis, resulting from such actions. Moreover, the party
who would be subject to the additional tax may be entitled to injunctive relief
unless we or Southern Company, as the case may be, provides an opinion that such
proposed transaction will not result in adverse tax consequences to the other
party, or if such transaction will result in additional taxes to the other
party, such party agrees to provide adequate assurances to the other party of
its ability to satisfy the indemnity obligation under the agreement.
REGISTRATION RIGHTS AGREEMENT
As noted above, Southern Company intends to distribute the remaining shares
of our common stock to its stockholders on a pro rata basis. We cannot, however,
assure you as to whether or when this distribution will occur. See "Risk
Factors -- Risks Related to our Separation from Southern Company -- Our business
and your investment in our stock may be adversely affected if Southern Company
does not complete the distribution of our common stock because we would remain
subject to regulatory restrictions as a subsidiary of a public utility holding
company and because we would remain subject to control by Southern Company." In
the event that Southern Company does not divest itself of all of its shares of
our common stock in the distribution, Southern Company could not freely sell all
of those shares without registration under the Securities Act. Accordingly, we
have entered into a registration rights agreement with Southern Company to
provide it with registration
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rights relating to the shares of our common stock which it holds. These
registration rights generally become effective at such time as Southern Company
informs us that it no longer intends to proceed with or complete the
distribution.
Under the registration rights agreement, at the request of Southern
Company, we will use our best efforts to register shares of our common stock
that are held by Southern Company upon the completion of this offering, and any
additional shares issued in respect of those shares, for public sale under the
Securities Act. Southern Company also will have the right to include the shares
of our common stock it holds upon the completion of this offering, and any
additional shares issued in respect of those shares, in future registrations of
our securities under the Securities Act. We have agreed to cooperate in these
registrations and any related offering. If the registration is at Southern
Company's request, Southern Company will pay 80% of our out-of-pocket costs and
expenses related to our registration of Southern Company's shares.
ARRANGEMENTS RELATING TO THE TRANSFER OF SE FINANCE AND CAPITAL FUNDING
In connection with our separation from Southern Company, we will transfer
two of our subsidiaries, SE Finance and Capital Funding, to Southern Company. In
order to facilitate the transfer to Southern Company, prior to this offering we
will issue one share of our redeemable preferred stock to Southern Company.
After this offering and prior to the distribution of our stock by Southern
Company, we will form a corporation with Southern Company Energy Solutions, Inc.
(SCES), a wholly owned subsidiary of Southern Company. We will contribute the
stock of SE Finance and Capital Funding to the corporation in exchange for an
80% or greater interest. SCES will contribute its energy services assets to a
limited liability company owned by the corporation in exchange for a 20% or
lesser interest. We will then redeem the one share of redeemable preferred stock
issued by us to Southern Company in exchange for our entire interest in the
corporation. Following the transfer, Southern Company will assume responsibility
for these obligations.
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FEDERAL TAX MATTERS RELATED TO OUR SEPARATION FROM SOUTHERN COMPANY
Southern Company currently owns 100% of our common stock. Thus, we are
currently affiliated and are members of the same consolidated group. As members
of the same consolidated group, we file a consolidated federal income tax return
with Southern Company. This allows Southern Company to offset its federal
taxable income with our tax losses. After this offering, we and Southern Company
will continue to be affiliated and will continue to file a consolidated federal
income tax return.
Within 12 months after this offering, Southern Company intends to
distribute its remaining ownership interest in us to all Southern Company
stockholders in direct proportion to their holdings of Southern Company stock.
Southern Company intends to receive a ruling from the IRS that the distribution
is tax-free under Section 355 of the Internal Revenue Code. However, if we
breach any representations with respect to the ruling or take any action which
causes such representations to be untrue or we engage in transactions after the
distribution that cause the spin-off to be taxable, we will be required to
indemnify Southern Company for any and all taxes resulting from the failure of
the spin-off to qualify as a tax-free transaction as provided in the tax
indemnification agreement. Any indemnification payments by us would be material.
SE Finance and Capital Funding are currently subsidiaries of ours. Southern
Company desires to retain the business and operations of these subsidiaries
following the separation. Accordingly, we will contribute the stock of SE
Finance and Capital Funding to a newly formed holding company, which stock will
subsequently be distributed to Southern Company prior to the distribution
transaction. We intend to receive a ruling from the IRS that such a distribution
is a tax-free distribution, but we will make the distribution even if a ruling
is not obtained. If tax-free distribution treatment is not obtained, we will be
treated as having sold the stock of the holding company to Southern Company in a
taxable transaction. However, Southern Company has agreed to indemnify us for
any and all taxes related to such transaction.
Subsequent to the distribution, we will cease to be a member of the
Southern Company consolidated group. As such, there will then exist two separate
groups, the Southern Company group and our group. Each group will file separate
consolidated federal income tax returns, and Southern Company will not be able
to use our tax losses unless we request Southern Company to carry back losses
arising after the date of the distribution to a pre-distribution tax return to
the extent permitted by applicable law.
Under the current tax sharing agreement between Southern Company and us,
Southern Company is obligated to pay us for the utilization of net operating
losses generated by us to offset Southern Company's consolidated federal income
tax liability. After the distribution Southern Company will no longer have the
ability to use these net operating losses. Consequently, we will no longer
receive these payments from the Southern Company. Furthermore, under the tax
indemnification agreement with Southern Company, we may be required to make
other payments to Southern Company for tax liabilities.
Subsequent to the distribution of our stock by Southern Company, we will
cease to be a member of the Southern Company consolidated tax group. This
separation will have both current and future income tax implications to the
company. The event of deconsolidation itself will result in the recapture of
dual consolidated tax losses and the triggering of deferred intercompany gains.
We will recognize taxable income related to these gains and losses which will
not have a material impact on our net income and cash flow. We will also take
appropriate steps to continue the deferral of any other dual consolidated losses
as provided by the tax laws. Any potential future recapture of these losses
would result in material tax liabilities which may have a material adverse
effect on our net income and cash flow, but we do not expect them to affect our
ability to pursue our growth strategy.
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In addition to the current income tax consequences triggered by the act of
deconsolidation discussed above, our separation from the Southern Company
consolidated tax group will change our overall future income tax posture. Based
on our current structure and net income, we could be limited in our future
ability to effectively use tax attributes such as foreign tax credits associated
with overseas operations. The inability to use these attributes could result in
material tax liabilities. We intend to undertake appropriate measures after
deconsolidation in order to mitigate any adverse tax effect of no longer being a
part of the Southern Company consolidated tax group. We cannot assure you that
these efforts will be successful; however, we do not expect any such tax
liabilities to effect our ability to pursue our growth strategy.
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PRINCIPAL STOCKHOLDER
Prior to this offering, all of the outstanding shares of our common stock
have been owned by Southern Company. After this offering, Southern Company will
own approximately 82.4% of our common stock, or approximately 80.3% if the
underwriters fully exercise their option to purchase additional shares of our
common stock. Under Delaware corporate law and our charter documents, prior to
the distribution by Southern Company of its ownership of our common stock,
Southern Company will be able, acting alone, to elect our entire board of
directors and to approve any action requiring the approval of our stockholders.
Except for Southern Company, we are not aware of any person or group that will
beneficially own more than 5% of the outstanding shares of our common stock
following this offering. None of our executive officers, directors or director
nominees currently owns any shares of our common stock, but those who own shares
of Southern Company common stock will be treated on the same terms as other
holders of Southern Company stock in any distribution by Southern Company. See
"Stock Ownership of Directors and Executive Officers" for a description of the
ownership of Southern Company stock by our directors and executive officers.
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DESCRIPTION OF CAPITAL STOCK
GENERAL
Under our restated certificate of incorporation, our authorized capital
stock consists of 2,125,000,000 shares, of which 2,000,000,000 shares are common
stock, par value $0.01 per share, and 125,000,000 shares are preferred stock,
par value $0.10 per share. Immediately following the offering, 330,000,000
shares of common stock, or 338,700,000 shares if the U.S. underwriters exercise
their over-allotment option in full, will be outstanding.
The following descriptions are summaries of material terms of our restated
certificate of incorporation and bylaws. This summary is qualified by our
certificate of incorporation and bylaws, copies of which have been filed as
exhibits to the registration statement of which this prospectus is a part, and
by the provisions of applicable law.
COMMON STOCK
Each share of common stock entitles the holder to one vote on all matters
on which holders are permitted to vote. Subject to preferences that may be
applicable to any outstanding preferred stock, the holders of common stock are
entitled to dividends when, as and if declared by the board of directors out of
funds legally available for that purpose. Upon liquidation, subject to
preferences that may be applicable to any outstanding preferred stock, the
holders of common stock are entitled to a pro rata share in any distribution to
shareholders. The common stock has no preemptive or conversion rights or other
subscription rights. There are no redemption or sinking fund provisions
applicable to the common stock. All outstanding shares of common stock are fully
paid and nonassessable.
PREFERRED STOCK
Our board of directors is authorized, without approval of Southern Company,
our sole stockholder, to cause shares of preferred stock to be issued from time
to time in one or more series, and our board of directors may fix the
designation, powers, privileges, preferences and rights and the qualifications,
limitations and restrictions of the shares of each series.
The specific matters that our board of directors may determine include the
following:
- the designation of each series,
- the number of shares of each series,
- the rate of any dividends,
- whether any dividends shall be cumulative or non-cumulative,
- the amount payable in the event of any voluntary or involuntary
liquidation, dissolution or winding up of our company,
- the terms of any redemption,
- rights and terms of any conversion or exchange, and
- any voting rights.
The issuance of shares of preferred stock, or the issuance of rights to
purchase shares of preferred stock, could be used to discourage an unsolicited
acquisition proposal. For example, a
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business combination could be impeded by issuing a series of preferred stock
containing class voting rights that would enable the holder or holders of this
series to block that transaction. Alternatively, a business combination could be
facilitated by issuing a series of preferred stock having sufficient voting
rights to provide a required percentage vote of the stockholders. In addition,
under certain circumstances, the issuance of preferred stock could adversely
affect the voting power and other rights of the holders of the common stock.
Although our board is required to make any determination to issue any preferred
stock based on its judgment as to the best interests of our stockholders, it
could act in a manner that would discourage an acquisition attempt or other
transaction that some, or a majority, of our stockholders might believe to be in
their best interests or in which stockholders might receive a premium for their
stock over prevailing market prices of the stock. Our board does not at present
intend to seek stockholder approval prior to any issuance of currently
authorized stock unless otherwise required by law or applicable stock exchange
requirements.
REDEEMABLE PREFERRED STOCK
Prior to this offering, we will issue one share of Series A Preferred Stock
to Southern Company to facilitate the transfer of our SE Finance and Capital
Funding subsidiaries to Southern Company in connection with our separation from
Southern Company. In order to transfer SE Finance and Capital Funding to
Southern Company, after this offering and prior to the distribution of our stock
by Southern Company, we will form a joint venture with Southern Company Energy
Solutions, Inc. (SCES), a wholly owned subsidiary of Southern Company. We will
contribute the stock of SE Finance and Capital Funding to the joint venture in
exchange for an 80% interest. SCES will contribute its assets to a subsidiary of
the joint venture in exchange for a 20% interest. We will then redeem the one
share of redeemable preferred stock issued by us to Southern Company in exchange
for our entire interest in the joint venture.
The shares of Series A Preferred Stock ranks senior to all classes of
common stock and on par with each other class of stock issued by us as to
liquidation, winding-up and dissolution. Except as provided by Delaware law,
ownership of the share of Series A Preferred Stock does not give Southern
Company any voting rights, nor does it grant Southern Company any entitlement to
receive dividends. The share of Series A Preferred Stock may be redeemed, at our
option. Upon redemption, the share of the Series A Preferred Stock shall be
retired, canceled and restored to the status of an authorized but unissued share
of preferred stock without designation as to series.
ANTI-TAKEOVER EFFECTS OF DELAWARE LAWS AND OUR CERTIFICATE AND BY-LAW PROVISIONS
Some provisions of Delaware law and our restated certificate of
incorporation and bylaws could make the following more difficult:
- acquisition of us by means of a tender offer,
- acquisition of us by means of a proxy contest or otherwise, or
- removal of our incumbent officers and directors.
These provisions, as well as our ability to issue preferred stock, are
designed to discourage coercive takeover practices and inadequate takeover bids.
These provisions are also designed to encourage persons seeking to acquire
control of us to first negotiate with our board of directors. We believe that
the benefits of increased protection give us the potential ability to negotiate
with the proponent of an unfriendly or unsolicited proposal to acquire or
restructure us, and that the benefits of this increased protection outweigh the
disadvantages of discouraging those proposals, because negotiation of those
proposals could result in an improvement of their terms.
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ELECTION AND REMOVAL OF DIRECTORS
Our board of directors will be comprised of between two and 21 directors,
the exact number to be fixed from time to time by resolution of our board of
directors. Beginning at the time Southern Company (or a majority-owned
subsidiary of Southern Company) owns less than 33 1/3% of our stock, our board
of directors will be divided into three classes. The directors in each class
will serve for a three-year term, one class being elected each year by our
stockholders. See "Management -- Directors and Executive Officers." This system
of electing and removing directors may discourage a third party from making a
tender offer or otherwise attempting to obtain control of us because it
generally makes it more difficult for stockholders to replace a majority of the
directors. In addition, beginning at the time Southern Company (or a
majority-owned subsidiary of Southern Company) owns less than 33 1/3% of our
stock, no director may be removed except for cause, and directors may be removed
for cause by a majority of the shares then entitled to vote at an election of
directors. Any vacancy occurring on the board of directors, and any newly
created directorship, may only be filled by a majority of the remaining
directors in office. The provisions described in this paragraph may not be
amended or repealed except by the vote of the holders of at least 66 2/3% of the
voting power of all outstanding shares of stock entitled to vote in the election
of directors.
STOCKHOLDER MEETINGS AND ADVANCED NOTICE REQUIREMENTS FOR STOCKHOLDER
NOMINATIONS AND PROPOSALS
Our restated certificate of incorporation and our bylaws provide that
special meetings of holders of common stock may be called only by the chairman
of our board of directors, our president and chief executive officer, or a
majority of the board of directors and may not be called by the holders of
common stock. In addition, as of the day that Southern Company (or a
majority-owned subsidiary of Southern Company) ceases to own at least a majority
of our common stock, our restated certificate of incorporation specifically
denies any power of the stockholders to call a special meeting. These provisions
may not be amended or repealed except by the vote of the holders of at least
66 2/3% of the voting power of all outstanding shares of stock entitled to vote
in the election of directors.
Our bylaws require that advance notice be delivered to us of any business
to be brought by a stockholder before an annual or special meeting of
stockholders and provide for procedures to be followed by stockholders in
nominating persons for election to our board of directors. In the case of an
annual meeting, stockholders generally must give written notice of a nomination
or proposal to the secretary of our company not later than 90 days nor earlier
than 120 days prior to the first anniversary of the preceding year's annual
meeting.
For special meetings, only business set forth in the notice of that special
meeting may be conducted. Nominations for the election of directors at special
meetings may be made only by the board of directors or, if the board of
directors has determined that directors shall be elected at a special meeting,
then by a stockholder who is a stockholder at the time notice was given and at
the time of that special meeting. If we call a special meeting of stockholders
to elect directors, a stockholder must give notice of a nomination to the
secretary of our company not earlier than 120 days prior to the special meeting
and not later than 90 days prior to the special meeting or the 10th day after
notice of the meeting.
With regard to either an annual or a special stockholder meeting, a
stockholder's notice must set forth specific information regarding the
stockholder giving the notice, the director nominee or other business proposed
by the stockholder, as applicable, as provided in our bylaws.
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ELIMINATION OF STOCKHOLDER ACTION BY WRITTEN CONSENT
Our restated certificate of incorporation and our bylaws provide that,
beginning the day that Southern Company (or a majority-owned subsidiary of
Southern Company) ceases to own at least a majority of our common stock, holders
of our common stock will not be able to act by written consent without a
meeting. Prior to the distribution of our common stock, Southern Company will be
able to take any action requiring approval of our stockholders by written
consent and without the affirmative vote of our other stockholders. This
provision may not be amended or repealed except by the vote of the holders of at
least 66 2/3% of the voting power of all outstanding shares of stock entitled to
vote in the election of directors.
NO CUMULATIVE VOTING
Our restated certificate of incorporation and bylaws do not provide for
cumulative voting in the election of directors.
LIMITATION ON LIABILITY OF DIRECTORS
Our restated certificate of incorporation provides that no director shall
be personally liable to us or our stockholders for monetary damages for breach
of fiduciary duty as a director, except as required by law, as in effect from
time to time. Currently, Delaware law requires that liability be imposed for the
following:
- any breach of the director's duty of loyalty to our company or our
stockholders,
- any act or omission not in good faith or which involved intentional
misconduct or a knowing violation of law,
- unlawful payments of dividends or unlawful stock repurchases or
redemptions as provided in Section 174 of the Delaware General
Corporate Law, and
- any transaction from which the director derived an improper personal
benefit.
Our bylaws provide that, to the fullest extent permitted by law, we will
indemnify any person made or threatened to be made a party to any action by
reason of the fact that the person is or was our director or officer, or served
any other enterprise at our request as a director or officer. We will reimburse
the expenses, including attorneys' fees, incurred by a person indemnified by
this provision when we receive an undertaking to repay such amounts if it is
ultimately determined that the person is not entitled to be indemnified by us.
Amending this provision will not reduce our indemnification obligations relating
to actions taken before an amendment.
TRANSACTIONS AND CORPORATE OPPORTUNITIES
Our restated certificate of incorporation includes provisions which
regulate and define the conduct of certain business and affairs of our company
from the time of the completion of this offering until the time Southern Company
ceases to be a significant stockholder of our company. These provisions serve to
determine and delineate the respective rights and duties of our company,
Southern Company and some of our directors and officers in anticipation of the
following:
- directors, officers and/or employees of Southern Company continuing
to serve as directors;
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- Southern Company engaging in lines of business that are the same as,
similar or related to, or overlap or compete with our lines of
business; and
- we and Southern Company engaging in material business transactions,
including transactions pursuant to the various agreements related to
our separation from Southern Company described elsewhere in this
prospectus.
We may, from time to time, enter into and perform agreements with Southern
Company to engage in any transaction, and to agree to compete or not to compete
with each other, including to allocate, or to cause our and their respective
directors, officers and employees to allocate, corporate opportunities between
Southern Company and us. Our restated certificate of incorporation provides that
no such agreement, or its performance, shall be considered contrary to any
fiduciary duty of Southern Company, as the controlling stockholder of our
company, or of any such director or officer, if any of the following conditions
are satisfied:
- the agreement was entered into before our company ceased to be a
wholly-owned subsidiary of Southern Company and is continued in
effect after this time;
- the agreement or transaction was approved, after being made aware of
the material facts as to the agreement or transaction, by:
- our board, by affirmative vote of a majority of directors who are
not interested persons,
- a committee of our board consisting of members who are not
interested persons, by affirmative vote of a majority of those
members, or
- one or more of our officers or employees who is not an interested
person and who was authorized by our board or a board committee
as specified above or, in the case of an employee, to whom
authority has been delegated by an officer to whom the authority
to approve such an action has been so delegated;
- the agreement or transaction was fair to us as of the time it was
entered into; or
- the agreement or transaction was approved by the affirmative vote of
a majority of the shares of capital stock entitled to vote and which
do vote on the agreement or transaction, excluding Southern Company
and any interested person in respect of such agreement or
transaction.
For purposes of these provisions, an interested person is generally an
individual who has a financial interest in the relevant transaction.
The provisions of our restated certificate of incorporation with regard to
such transactions and/or corporate opportunities shall terminate when Southern
Company, together with its affiliates, ceases to be the owner of voting stock
representing 20% or more of the votes entitled to be cast by the holders of all
the then outstanding voting stock; provided, however, that the termination shall
not terminate the effect of these provisions with respect to any agreement
between us and Southern Company that was entered into before the time of
termination or any transaction entered into in the performance of such
agreement, whether entered into before or after such time, or any transaction
entered into between us and Southern Company or the allocation of any
opportunity between them before such time. These provisions do not alter the
fiduciary duty of loyalty of our directors under applicable Delaware law. By
becoming a stockholder in our company, you will be deemed to have notice of and
consented to these provisions of our restated certificate of incorporation.
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DELAWARE BUSINESS COMBINATION STATUTE
We are subject to Section 203 of the Delaware General Corporation Law, an
anti-takeover law. In general, Section 203 prohibits a publicly held Delaware
corporation from engaging in a "business combination" with an "interested
stockholder" for a period of three years following the date the person became an
interested stockholder, unless the "business combination" or the transaction in
which the person became an interested stockholder is approved in a prescribed
manner. Generally, a "business combination" includes a merger, asset or stock
sale or other transaction resulting in a financial benefit to the interested
stockholder. Generally, an "interested stockholder" is a person who, together
with affiliates and associates, owns or, within three years prior to the
determination of interested stockholder status, did own, 15% or more of a
corporation's voting stock. The existence of this provision may have an
anti-takeover effect with respect to transactions not approved in advance by the
board of directors, including discouraging attempts that might result in a
premium over the market price for the shares of common stock held by
stockholders. Because Southern Company will own more than 15% of our voting
stock before we become a public company and upon completion of the offering,
Section 203 by its terms is currently not applicable to business combinations
with Southern Company even though Southern Company owns more than 15% of our
outstanding stock. If any other person acquires 15% or more of our outstanding
stock, that person will be subject to the provisions of Section 203.
LISTING OF COMMON STOCK
We have applied for the listing of our common stock on the New York Stock
Exchange under the symbol "SOE."
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar of our common stock is [ ].
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DESCRIPTION OF CONVERTIBLE TRUST PREFERRED SECURITIES
Concurrently with the offering of our commons stock, we and SEI Trust I
will offer 6,000,000 shares of % Convertible Trust Preferred Securities at
an initial public offering price of $50.00 per preferred security. In addition,
the trust has granted the underwriters an option, exercisable for 30 days, to
purchase up to an additional 900,000 preferred securities at the initial public
offering price. Each preferred security represents a preferred undivided
beneficial interest in the assets of the trust, which will consist of debentures
that we will sell to the trust.
The trust will use the proceeds from the sale of the preferred securities
and common securities to purchase from us [ ]% Junior Convertible
Subordinated Debentures, Series A due 2030. The debentures will have the same
financial terms as the preferred securities, including conversion rights.
The trust will also issue common securities to us. The common securities
represent common undivided beneficial interests in the assets of the trust. We
will own all of the common securities.
SEI Trust I is a Delaware business trust and a subsidiary of us. The
address of its principal office is 1403 Faulk Road, Suite 102, Wilmington,
Delaware 19803, and its telephone number is (302) 427-1935.
DISTRIBUTIONS
Holders of the preferred securities will be entitled to receive cash
distributions at an annual rate of [ ]% of the $50 liquidation preference
per preferred security. Distributions are cumulative and will begin to
accumulate on the date of original issuance of the preferred securities, which
we expect to be [ ], 2000. Distributions will be payable quarterly
in arrears on [ ], [ ] , [ ] and
[ ] of each year beginning [ ], 2000, unless we defer
interest payments on the debentures.
DISTRIBUTION DEFERRAL
We can, on one or more occasions, defer interest payments on the debentures
for up to 20 consecutive quarterly periods unless an event of default on the
debentures has occurred and is continuing. Interest payments will not be due and
payable on the debentures during a deferral period. We cannot, however, defer
interest payments beyond the maturity date of the debentures, which is
[ ] , 2030. If we defer interest payments on the debentures, the
trust will defer distribution payments on the preferred securities and the
common securities. During a deferral period, distributions will continue to
accumulate on the preferred securities. Additional cash distributions will
accumulate on any deferred distributions.
Compounded interest will accrue on any deferred interest payments. While
interest payments on the debentures are deferred, we will generally not be
permitted to pay cash dividends on our common stock or pay on debt that is pari
passu with or junior to the debentures.
CONVERSION INTO COMMON STOCK
Unless we have redeemed the debentures, and subject to our right to elect a
cash settlement as discussed below, holders of preferred securities will have
the right to convert their preferred securities into shares of our common stock
at any time after [ ], 2001 and prior to [ ], 2030.
Preferred securities that have been called for redemption may only be converted
on or before the business day prior to the close of business on the applicable
redemption date. The preferred securities will convert into our common stock at
an initial conversion rate of [ ] shares
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of common stock for each preferred security. This conversion rate is equivalent
to the conversion price of $[ ] per share of our common stock. The initial
conversion rate may be subject to adjustment.
From [ ], 2001 and until the next business day following the
date of the distribution of our common stock held by Southern Company to its
stockholders, as discussed in this prospectus, we may elect to make a cash
settlement in respect of any preferred securities surrendered for conversion.
The amount of cash that holders of the preferred securities will receive if we
elect a cash settlement will be equal to the value of the underlying shares of
common stock.
RANKING
The preferred securities and common securities of the trust will generally
rank on par with each other and will generally have equivalent terms. Our
obligations to pay the debentures are junior to our payment obligations under
our senior debt.
REDEMPTION BY THE TRUST
The trust will redeem all of its outstanding preferred securities and
common securities when the debentures are paid at maturity on [ ],
2030. In addition, we can make the trust redeem all or some of the preferred
securities at any time on or after [ ], 2003 by redeeming the
debentures at the applicable redemption price, plus any accrued and unpaid
distributions. If that happens, the trust will use the cash it receives from our
redemption of the debentures to redeem, on a pro rata basis, preferred
securities and common securities of an aggregate liquidation amount equal to the
aggregate principal amount of the debentures redeemed.
SPECIAL EVENT REDEMPTION OR DISTRIBUTION
We may redeem all outstanding debentures at the special event redemption
price upon the occurrence of a tax event described below or a change in law that
could require the trust to register as an investment company under the
Investment Company Act of 1940 (and thus cause the redemption of the preferred
securities at that price). Upon the occurrence of a tax event, we may elect to
pay additional interest to the trust so that the distributions to holders of the
preferred securities are not reduced because of the tax event. In addition, we
have the right to dissolve the trust at any time; if a tax event or a change in
law that could require the trust to register as an investment company under the
Investment Company Act occurs, we may elect to redeem the preferred securities
by distributing the debentures to holders of preferred securities.
A tax event generally means specified tax changes that could result in:
- the trust being subject to United States federal income taxes or more
than a de minimis amount of other governmental charges, or
- the non-deductibility of interest payments on the debentures.
CONDITIONAL RIGHT TO SHORTEN STATED MATURITY OF THE DEBENTURES
We can shorten the stated maturity of the debentures to as early as
[ ], 2015 if there are specified tax changes that could result in
the non-deductibility of interest payments on the debentures. If we exercise
this option, the trust will redeem all of the outstanding preferred securities
when the debentures are paid on their new maturity date.
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<PAGE> 147
LIQUIDATION PREFERENCE
If the trust is liquidated and the debentures are not distributed to
holders of preferred securities, the holders of preferred securities will
generally be entitled to receive $50 per preferred security plus any accumulated
and unpaid distributions on each preferred security held.
THE GUARANTEE
We will guarantee the trust's payment obligations, but only to the extent
the trust has sufficient funds to make payments on the preferred securities. If
we do not make payments on the debentures, the trust will not have sufficient
funds to make payments on the preferred securities, in which case holders of
preferred securities will be unable to rely on the guarantee for payment.
Generally, our obligations under the guarantee are junior to our obligations to
make payments on all of our other liabilities.
DISSOLUTION OF THE TRUST AND DISTRIBUTION OF THE DEBENTURES
We have the right to dissolve the trust at any time. If we exercise this
right, the trust will redeem the preferred securities by distributing the
debentures to holders of preferred securities and to us, as the holder of the
common securities, on a pro rata basis. If the trust distributes the debentures,
we will use our best efforts to have the debentures listed on the New York Stock
Exchange or on any national exchange or automated quotation system on which the
preferred securities are listed.
FORM OF PREFERRED SECURITIES
The preferred securities will initially be represented by a global
certificate registered in the name of Cede & Co., as nominee for The Depository
Trust Company.
VOTING RIGHTS
Generally, holders of the preferred securities will not have any voting
rights as a holder of preferred securities.
LISTING
We will apply to have the preferred securities listed on the New York Stock
Exchange. We expect trading of the preferred securities to begin within 30 days
after they are first issued. We expect the preferred securities to trade under
the symbol "SOE PrA."
OFFERING OF COMMON STOCK NOT CONDITIONED ON OFFERING OF PREFERRED SECURITIES
We intend to complete the offering of our common stock regardless of
whether the offering of our preferred securities is successfully completed.
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<PAGE> 148
U.S. FEDERAL TAX CONSIDERATIONS FOR NON-U.S. HOLDERS
GENERAL
This is a general discussion of United States federal tax consequences of
the acquisition, ownership, and disposition of our common stock by a holder
that, for U.S. federal income tax purposes, is not a U.S. person as we define
that term below. A holder of our common stock who is not a U.S. person is a
non-U.S. holder. We assume in this discussion that you will hold our common
stock issued pursuant to the offering as a capital asset (generally, property
held for investment). We do not discuss all aspects of U.S. federal taxation
that may be important to you in light of your individual investment
circumstances, such as special tax rules that would apply to you, for example,
if you are a dealer in securities, financial institution, bank, insurance
company, tax-exempt organization, partnership or owner of more than 5% of our
common stock. Our discussion is based on current provisions of the Internal
Revenue Code, Treasury regulations, judicial opinions, published positions of
the IRS and other applicable authorities, all as in effect on the date of this
prospectus and all of which are subject to differing interpretations or change,
possibly with retroactive effect. We have not sought, and will not seek, any
ruling from the IRS with respect to the tax consequences to non-U.S. persons
discussed in this prospectus, and there can be no assurance that the IRS will
not take a position contrary to the tax consequences discussed below or that any
position taken by the IRS would not be sustained. We urge you to consult your
tax advisor about the U.S. federal tax consequences of acquiring, holding and
disposing of our common stock, as well as any tax consequences that may arise
under the laws of any foreign, state, local or other taxing jurisdiction.
For purposes of this discussion, a U.S. person means any one of the
following:
- a citizen or resident of the U.S.;
- a corporation, partnership or other entity created or organized in the
U.S. or under the laws of the U.S. or of any political subdivision of the
U.S.;
- an estate, the income of which is includible in gross income for U.S.
federal income tax purposes regardless of its source; or
- a trust, the administration of which is subject to the primary
supervision of a U.S. court and that has one or more U.S. persons who
have the authority to control all substantial decisions of the trust.
DIVIDENDS
Dividends paid to a non-U.S. holder will generally be subject to
withholding of U.S. federal income tax at the rate of 30% or such lower rate as
may be provided by an income tax treaty for which a holder may be eligible.
Non-U.S. holders should consult their tax advisors regarding their entitlement
to benefits under a relevant income tax treaty. Dividends that are effectively
connected with a non-U.S. holder's conduct of a trade or business in the United
States are generally subject to U.S. federal income tax on a net basis at
regular graduated rates, but are not generally subject to the 30% withholding
tax if the non-U.S. holder complies with applicable certification and disclosure
requirements. Any such U.S. trade or business income received by a non-U.S.
holder that is a corporation may also be subject to an additional "branch
profits tax" at a 30% rate or such lower rate as may be specified by an
applicable income tax treaty.
Under current applicable U.S. tax regulations, dividends paid to an address
in a foreign country are presumed, absent actual knowledge to the contrary, to
be paid to a resident of that country for the purposes of determining whether
amounts are required to be withheld and for the purposes of
144
<PAGE> 149
determining the applicability of a tax treaty rate. Under U.S. tax regulations,
which are generally effective for payments made after December 31, 2000,
however, a non-U.S. holder of our common stock who wishes to claim the benefit
of an applicable treaty rate generally will be required to satisfy applicable
certification and other requirements.
The U.S. tax regulations generally effective for payments made after
December 31, 2000 also provide special rules for dividend payments made to
foreign intermediaries, U.S. or foreign wholly owned entities that are treated
as fiscally transparent for U.S. federal income tax purposes, and entities that
are disregarded for U.S. federal income tax purposes, the applicable income tax
treaty jurisdiction, or both. In addition, income tax treaty benefits may be
denied to foreigners receiving income derived through a partnership, or
otherwise fiscally transparent entity. Prospective investors should consult
their own tax advisors concerning the effect, if any, of these new tax
regulations on an investment in our common stock.
GAIN ON DISPOSITIONS
A non-U.S. holder will generally not be subject to United States federal
income tax, including by way of withholding, on gain recognized on a sale or
other disposition of our common stock unless:
- the gain is effectively connected with the conduct of a trade or business
in the U.S. by the non-U.S. holder, (in which case the branch profits tax
may also apply);
- the non-U.S. holder is a nonresident alien individual present in the U.S.
for 183 or more days in the taxable year of the disposition and other
requirements are met;
- the non-U.S. holder is subject to tax pursuant to provisions of the U.S.
federal income tax law applicable to U.S. expatriates; or
- we are or have been at any time during the shorter of the five-years
preceding the disposition or the period the non-U.S. holder held our
common shares a "United States real property holding corporation" (a
"USRPHC") for U.S. federal income tax purposes.
If we are or have been a USRPHC, a non-U.S. holder will generally not be
subject to U.S. federal income tax on gain recognized on a sale or other
disposition of our common stock provided that:
- the non-U.S. holder does not hold, and has not held during certain
periods, directly or indirectly, more than 5% of our outstanding common
stock; and
- our common stock is and continues to be regularly traded on an
established securities market.
We believe that our common stock will be regularly traded on an established
securities market for this purpose in any quarter during which it is listed on
the NYSE.
If we are or have been a USRPHC for the period described above and the
exception for less than 5% shareholders of securities regularly traded on an
established securities market does not apply, a non-U.S. holder will be subject
to U.S. federal income tax with respect to the gain realized on any sale or
other disposition of our common stock. The gain may be subject to a withholding
tax of 10% if our common stock ceases to be regularly traded on an established
securities market. To the extent the 10% withheld exceeds a non-U.S. holder's
maximum tax liability, as determined by the Secretary, such holder may obtain a
refund of amounts withheld. If the non-U.S. holder is subject to tax on the gain
as a result of a our being or having been a USRPHC, the holder will generally be
subject to tax at the graduated U.S. tax rates. If the non-U.S. holder is a
corporation, this gain may also be subject to the 30% branch profits tax unless
reduced by an applicable treaty.
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<PAGE> 150
UNITED STATES FEDERAL ESTATE TAXES
Our common stock that is owned or treated as owned by an individual who is
not a citizen or resident of the U.S., as specially defined for U.S. federal
estate tax purposes, on the date of that person's death will be included in his
or her estate for U.S. federal estate tax purposes, unless an applicable estate
tax treaty provides otherwise.
INFORMATION REPORTING AND BACKUP WITHHOLDING
Generally, we must report annually to the IRS and to each non-U.S. holder
the amount of dividends that we paid to a holder, and the amount of tax that we
withheld on those dividends. This information may also be made available to the
tax authorities of a country in which the non-U.S. holder resides.
Under U.S. tax regulations, backup withholding, which generally requires a
withholding tax of 31% on payments to persons that do not provide specified
information under the U.S. information reporting requirements, will not
generally apply to (i) dividends paid to a non-U.S. holder that is subject to
the 30% withholding or is not subject to the 30% withholding (or is subject to a
lower rate) as a result of an applicable tax treaty or (ii) prior to January 1,
2001, to dividends paid to a non-U.S. holder at an address outside the United
States unless the payor has actual knowledge that the payee is a U.S. person.
Payments of the proceeds of a sale or other taxable disposition of our common
stock by a U.S. office of a broker are subject to both backup withholding at a
rate of 31% and information reporting, unless the holder certifies as to its
non-U.S. holder status under penalties of perjury or otherwise establishes an
exemption. Information reporting requirements, but not backup withholding tax,
will also apply to payments of the proceeds of a sale or other taxable
disposition of our common stock by foreign offices of U.S. brokers or foreign
brokers with certain types of relationships to the U.S., unless the broker has
documentary evidence in its records that the holder is a non-U.S. holder and
other conditions are met or the holder otherwise established an exemption.
The U.S. Treasury Department has issued final regulations effective for
payments made after December 31, 2000 that may change the rules related to
backup withholding and information reporting. Non-U.S. holders should consult
their own tax advisors as to the application of the new tax regulations to
payments made after December 31, 2000 and the procedures for establishing an
exemption from backup withholding.
Backup withholding is not an additional tax. Any amounts that we withhold
under the backup withholding rules will be refunded or credited against the
non-U.S. holder's U.S. federal income tax liability if the required information
is furnished to the IRS.
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<PAGE> 151
SHARES ELIGIBLE FOR FUTURE SALE
After this offering, we will have 330,000,000 shares of our common stock
outstanding. If the underwriters exercise their over-allotment option in full,
we will have a total of 338,700,000 shares of common stock outstanding. All of
the shares of our common stock sold in this offering will be freely tradable
without restriction under the Securities Act, except for any shares which may be
acquired by an affiliate of ours, as that term is defined in Rule 144 under the
Securities Act. Persons who may be deemed to be affiliates generally include
individuals or entities that control, are controlled by, or are under common
control with, us and may include our directors and officers as well as our
significant stockholders, if any. Southern Company and we have agreed not to
offer or sell any shares of our common stock for a period of 180 days after the
date of this prospectus, without the prior written consent of the underwriters,
except for issuances under employee or director compensation plans. We can give
no assurance concerning how long these parties will continue to hold their
common stock after this offering.
Southern Company currently plans to complete the distribution of our common
stock within 12 months following this offering. Shares of our common stock
distributed to Southern Company stockholders in the distribution generally will
be freely transferable, except for shares of common stock received by persons
who may be deemed to be affiliates. Persons who are affiliates will be permitted
to sell the shares of common stock that are issued in this offering or that they
receive in the distribution only through registration under the Securities Act,
or under an exemption from registration, such as the one provided by Rule 144.
The 272,000,000 shares of our common stock held by Southern Company before
distribution are deemed "restricted securities" as defined in Rule 144, and may
not be sold other than through registration under the Securities Act or under an
exemption from registration, such as the one provided by Rule 144.
In general, a stockholder subject to Rule 144 who has owned common stock of
an issuer for at least one year may, within any three-month period, sell up to
the greater of:
- 1% of the total number of shares of common stock then outstanding; and
- the average weekly trading volume of the common stock during the four
weeks preceding the stockholder's required notice of sale.
Rule 144 requires stockholders to aggregate their sales with other
affiliated stockholders for purposes of complying with this volume limitation. A
stockholder who has owned common stock for at least two years, and who has not
been an affiliate of the issuer for at least 90 days, may sell common stock free
from the volume limitation and notice requirements of Rule 144.
In connection with this offering, we are granting options to purchase
approximately [ ] shares of our outstanding common stock. Immediately
after this offering, we intend to file a registration statement on Form S-8
covering all options granted under the Southern Energy Omnibus Incentive
Compensation Plan. Shares of our common stock registered under this registration
statement will be available for sale in the open market, subject to vesting
restrictions. Any sales of these shares by an affiliate will be subject to the
volume limitations of Rule 144 described above.
We have granted Southern Company registration rights with respect to our
shares it will hold after this offering. These registration rights generally
become effective at such time as Southern Company informs us that it no longer
intends to complete the distribution of these shares to its stockholders. See
"Agreements Between Us and Southern Company -- Registration Rights Agreement."
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<PAGE> 152
UNDERWRITING
We and the underwriters for the offering named below have entered into an
underwriting agreement with respect to the shares being offered. Subject to
certain conditions, each underwriter has severally agreed to purchase the number
of shares indicated in the following table. Goldman, Sachs & Co. and Morgan
Stanley & Co. Incorporated are the representatives of the underwriters.
<TABLE>
<CAPTION>
UNDERWRITERS Number of Shares
------------ ----------------
<S> <C>
Goldman, Sachs & Co.........................................
Morgan Stanley & Co. Incorporated...........................
-------
Total.............................................
=======
</TABLE>
Under the terms of the underwriting agreement, the underwriters are
committed to take and pay for all of the shares being offered, if any are taken,
other than the shares covered by the over-allotment option unless and until this
option is exercised. If the underwriters sell more than the total number of
shares set forth in the table above, the underwriters have an option to buy up
to an additional 8,700,000 shares from us to cover such sales. They may exercise
the option for 30 days. If any shares are purchased pursuant to this option, the
underwriters will severally purchase shares in approximately the same proportion
as set forth in the table above. If the underwriters' option is exercised in
full, the total underwriting discounts and commissions payable to the
underwriters by us would be $[ ]. If the underwriters' option is not
exercised, the total underwriting discounts and commissions payable to the
underwriters by us would be $[ ].
Shares sold by the underwriters to the public will initially be sold at the
initial public offering price set forth on the cover of this prospectus. Any
shares sold by the underwriters to securities dealers may be sold at a discount
of up to $[ ] per share from the initial public offering price. Any
such securities dealers may resell any shares purchased from the underwriters to
certain other brokers and dealers at a discount of up to $[ ] per share
from the initial public offering price. If all of the shares are not sold at the
initial public offering price, the representatives may change the offering price
and the other selling terms.
We and Southern Company have agreed with the underwriters not to dispose of
or hedge any of our common stock or securities convertible into or exchangeable
for shares of our common stock during the period from the date of this
prospectus continuing through the date 180 days after the date of this
prospectus, except with the prior written consent of Goldman, Sachs & Co. and
Morgan Stanley & Co. Incorporated. This agreement does not apply to issuances
under our employee or director compensation plans.
At our request, the underwriters have reserved for sale at the initial
public offering price up to [ ] shares of common stock for sale to our
employees and other business associates. Any shares purchased by these
individuals will be subject to a lock-up agreement containing terms identical to
those described in the preceding paragraph.
Prior to this offering, there has been no public market for the shares. The
initial public offering price will be negotiated among us and the
representatives. Among the factors to be considered in determining the initial
public offering price of the shares, in addition to prevailing market
conditions, will be our historical performance, an assessment of our management
and the consideration of the above factors in relation to the market valuation
of companies in related businesses.
We have applied for the listing of our common stock on the New York Stock
Exchange under the symbol "SOE." The underwriters intend to sell shares of
common stock to a minimum of 2,000 beneficial owners in lots of 100 or more
shares so as to meet the NYSE distribution requirements for trading.
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<PAGE> 153
In connection with the offering, the underwriters may purchase and sell
shares of common stock in the open market. These transactions may include short
sales, stabilizing transactions and purchases to cover positions created by
short sales. Short sales involve the sale by the underwriters of a greater
number of shares than they are required to purchase in the offering. "Covered"
short sales are sales made in an amount not greater than the underwriters'
option to purchase additional shares from us in the offering. The underwriters
may close out any covered short position by either exercising their option to
purchase additional shares or purchasing shares in the open market. In
determining the source of shares to close out the covered short position, the
underwriters will consider, among other things, the price of shares available
for purchase in the open market as compared to the price at which they may
purchase shares through the over-allotment option. "Naked" short sales are any
sales in excess of such option. The underwriters must close out any naked short
position by purchasing shares in the open market. A naked short position is more
likely to be created if the underwriters are concerned that there may be
downward pressure on the price of the common stock in the open market after
pricing that could adversely affect investors who purchase in the offering.
Stabilizing transactions consist of various bids for or purchases of common
stock made by the underwriters in the open market prior to the completion of the
offering.
The underwriters may also impose a penalty bid. This occurs when a
particular underwriter repays to the underwriters a portion of the underwriting
discount received by it because the representatives have repurchased shares sold
by or for the account of such underwriter in stabilizing or short covering
transactions.
Purchases to cover a short position and stabilizing transactions may have
the effect of preventing or retarding a decline in the market price of our
stock, and, together with the imposition of the penalty bid, may stabilize,
maintain or otherwise affect the market price of the common stock. As a result,
the price of the common stock may be higher than the price that otherwise might
exist in the open market. If these activities are commenced, they may be
discontinued at any time. These transactions may be effected on the New York
Stock Exchange, in the over-the-counter market or otherwise.
We will pay [ ]% of underwriting fees, discounts and commissions
incurred for this offering. Southern Company will pay the remaining underwriting
fees, discounts and commissions, as well as all of our other out-of-pocket costs
and expenses related to this offering, the distribution and the preparation of
the agreements providing for the separation, the distribution and related
transactions. These out-of-pocket costs and expenses are estimated to be
approximately $[ ] million.
We have agreed to indemnify the several underwriters against certain
liabilities, including liabilities under the Securities Act.
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LEGAL MATTERS
The validity of the common stock offered hereby will be passed on for us by
Troutman Sanders LLP, Atlanta, Georgia and for the underwriters by Shearman &
Sterling, New York, New York.
EXPERTS
The financial statements of Southern Energy, Inc. as of December 31, 1999
and 1998 and for each of the three years in the period ended December 31, 1999
included in this prospectus and elsewhere in the registration statement have
been audited by Arthur Andersen LLP, independent public accountants, as
indicated in their reports with respect thereto, and are included herein in
reliance upon the authority of said firm as experts in giving said reports.
The financial statements of Berliner Kraft-und Licht
(Bewag)-Aktiengesellschaft (currently Bewag AG) as of June 30, 1998 and for the
year ended June 30, 1998 included in this prospectus have been audited by KPMG
Deutsche Treuhand-Gesellschaft, independent accountants, as indicated in their
report with respect thereto, and are included herein in reliance upon the
authority of said firm as experts in accounting and auditing.
WHERE YOU CAN FIND MORE INFORMATION
We have filed with the SEC, Washington, D.C., a registration statement on
Form S-1 under the Securities Act with respect to the common stock offered
hereby. This prospectus does not contain all of the information set forth in the
registration statement and the exhibits and schedules thereto. Certain items are
omitted in accordance with the rules and regulations of the SEC. For further
information about us and our common stock, refer to the registration statement
and the exhibits and any schedules filed therewith. Statements contained in this
prospectus as to the contents of any contract or other document referred to are
not necessarily complete and in each instance, if such contract or document is
filed as an exhibit, reference is made to the copy of such contract or other
documents filed as an exhibit to the registration statement, each statement
being qualified in all respects by such reference. A copy of the registration
statement, including the exhibits and schedules thereto, may be read and copied
at the SEC's Public Reference Room at 450 Fifth Street, N.W., Washington, D.C.
20549. Information on the operation of the Public Reference Room may be obtained
by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains an Internet
site at http://www.sec.gov, from which interested persons can electronically
access the registration statement, including the exhibits and any schedules
thereto, as well as reports, proxy and information statements, and other
information regarding issuers that file electronically with the SEC.
As a result of the offering, we will become subject to the full
informational requirements of the Securities Exchange Act of 1934, as amended.
We will fulfill our obligations with respect to such requirements by filing
periodic reports and other information with the SEC. We intend to furnish our
shareholders with annual reports containing consolidated financial statements
certified by an independent public accounting firm.
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INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Unaudited Consolidated Balance Sheet as of March 31, 2000... F-2
Unaudited Consolidated Statements of Income for the Three
Months Ended
March 31, 1999 and 2000................................... F-3
Unaudited Consolidated Statements of Cash Flows for the
Three Months Ended
March 31, 1999 and 2000................................... F-4
Notes to Unaudited Consolidated Financial Statements........ F-5
Report of Independent Public Accountants.................... F-11
Consolidated Balance Sheets as of December 31, 1998 and
1999...................................................... F-12
Consolidated Statements of Income for the Years Ended
December 31, 1997, 1998, and 1999......................... F-13
Consolidated Statements of Stockholder's Equity for the
Years Ended December 31, 1997, 1998, and 1999............. F-14
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1997, 1998, and 1999......................... F-15
Notes to Consolidated Financial Statements.................. F-16
</TABLE>
F-1
<PAGE> 156
SOUTHERN ENERGY, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED BALANCE SHEET
MARCH 31, 2000
(IN MILLIONS)
<TABLE>
<CAPTION>
PRO FORMA
(NOTE J)
---------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents................................... $ 400 $ 400
Restricted deposits......................................... 24 24
Receivables:
Customer accounts, less provision for uncollectibles of
$31..................................................... 230 230
Other, less provision for uncollectibles of $4............ 517 517
Other....................................................... 190 190
------- -------
Total current assets.................................... 1,361 1,361
------- -------
PROPERTY, PLANT, AND EQUIPMENT.............................. 4,176 4,176
Less accumulated provision for depreciation................. (462) (462)
------- -------
3,714 3,714
Leasehold interests, net of accumulated amortization of
$158...................................................... 1,918 1,918
Construction work in progress............................... 416 416
------- -------
Total property, plant, and equipment, net............... 6,048 6,048
------- -------
NONCURRENT ASSETS:
Concession agreement, net of accumulated amortization of
$91....................................................... 267 267
Investments................................................. 1,472 1,472
Notes and other receivables, less provision for
uncollectibles of $31..................................... 1,312 1,312
Goodwill, net of accumulated amortization of $178........... 2,042 2,042
Other intangible assets, net of accumulated amortization of
$17....................................................... 490 490
Investment in leveraged leases.............................. 551 551
Miscellaneous deferred charges.............................. 429 429
------- -------
Total noncurrent assets................................. 6,563 6,563
------- -------
Total assets............................................ $13,972 $13,972
======= =======
LIABILITIES AND STOCKHOLDER'S EQUITY
CURRENT LIABILITIES:
Short-term debt............................................. 1,977 2,480
Current portion of long-term debt........................... 278 278
Accounts payable............................................ 556 556
Taxes accrued............................................... 222 222
Other....................................................... 118 118
------- -------
Total current liabilities............................... 3,151 3,654
------- -------
NONCURRENT LIABILITIES:
Subsidiary obligated mandatorily redeemable preferred
securities................................................ 1,030 1,030
Notes payable............................................... 4,540 4,540
Other long-term debt........................................ 397 397
Deferred income taxes....................................... 711 711
Miscellaneous deferred credits.............................. 193 193
------- -------
Total noncurrent liabilities............................ 6,871 6,871
------- -------
MINORITY INTEREST IN SUBSIDIARY COMPANIES................... 751 751
------- -------
COMMITMENTS AND CONTINGENT MATTERS
STOCKHOLDER'S EQUITY:
Common stock, $.01 par value; 2,000,000,000 shares
authorized; 272,000,000 shares issued and outstanding..... 3 3
Additional paid-in capital.................................. 2,984 2,788
Accumulated other comprehensive loss........................ (95) (95)
Retained earnings........................................... 307 0
------- -------
Total stockholder's equity.............................. 3,199 2,696
------- -------
Total liabilities and stockholder's equity.............. $13,972 $13,972
======= =======
</TABLE>
The accompanying notes are an integral part of this consolidated balance sheet.
F-2
<PAGE> 157
SOUTHERN ENERGY, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF INCOME
FOR THE THREE MONTHS ENDED MARCH 31, 1999 AND 2000
(IN MILLIONS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
1999 2000
----- -----
<S> <C> <C>
OPERATING REVENUES.......................................... $ 521 $ 521
OPERATING EXPENSES:
Fuel........................................................ 42 125
Purchased power............................................. 228 30
Maintenance................................................. 23 30
Depreciation and amortization............................... 54 82
Selling, general, and administrative........................ 59 30
Write-down of assets........................................ -- 4
Other....................................................... 39 50
----- -----
Total operating expenses.................................. 445 351
----- -----
OPERATING INCOME............................................ 76 170
OTHER INCOME (EXPENSE):
Interest income............................................. 38 38
Interest expense............................................ (111) (147)
Gain on sales of assets..................................... 8 1
Equity in income of affiliates.............................. 99 27
Receivables recovery........................................ 12 --
Other, net.................................................. 11 6
----- -----
Total other income (expense).............................. 57 (75)
----- -----
INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES AND
MINORITY INTEREST......................................... 133 95
Provision (Benefit) for Income Taxes........................ 36 (30)
MINORITY INTEREST........................................... 21 30
----- -----
INCOME FROM CONTINUING OPERATIONS........................... 76 95
INCOME FROM DISCONTINUED OPERATIONS, NET OF TAX BENEFIT OF
$6 AND $4 IN 1999 AND 2000, RESPECTIVELY.................. 4 6
----- -----
NET INCOME.................................................. $ 80 $ 101
===== =====
EARNINGS PER SHARE:
Basic
From continuing operations................................ $0.28 $0.35
From discontinued operations.............................. 0.01 0.02
----- -----
Net income................................................ $0.29 $0.37
===== =====
Pro forma basic
From continuing operations................................ $0.31
From discontinued operations.............................. 0.02
-----
Net income................................................ $0.33
=====
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-3
<PAGE> 158
SOUTHERN ENERGY, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 1999 AND 2000
(IN MILLIONS)
<TABLE>
<CAPTION>
1999 2000
----- -----
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income................................................ $ 80 $ 101
Adjustments to reconcile net income to net cash provided
by operating activities:
Equity in net income of affiliates...................... (95) (21)
Depreciation and amortization........................... 57 85
Write-down of assets.................................... -- 4
Deferred income taxes................................... 35 36
Gain on sales of assets................................. (9) --
Minority interest....................................... 21 30
Other, net.............................................. 5 (55)
Changes in certain assets and liabilities:
Receivables, net..................................... (34) (80)
Other current assets................................. 25 5
Accounts payable..................................... (113) (42)
Taxes accrued........................................ (44) 3
Other current liabilities............................ 55 (79)
----- -----
Total adjustments.................................. (97) (114)
----- -----
Net cash used in operating activities.............. (17) (13)
----- -----
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures...................................... (133) (89)
Property insurance proceeds............................... -- 14
Proceeds received from the sale of investments............ 9 --
Dividends received from equity investments................ 4 5
Other..................................................... (3) (1)
----- -----
Net cash used in investing activities.............. (123) (71)
----- -----
CASH FLOWS FROM FINANCING ACTIVITIES:
Capital contributions from minority interest.............. 18 --
Issuance of notes receivable.............................. (2) (4)
Repayments on notes receivable............................ 85 88
Payment of dividends to minority interests................ (38) (5)
Proceeds from issuance of short-term debt, net............ (10) 23
Proceeds from issuance of long-term debt.................. 248 96
Repayment of long-term debt............................... (221) (36)
Bond discount and debt expenses, net...................... -- (1)
----- -----
Net cash provided by financing activities.......... 80 161
----- -----
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH
EQUIVALENTS............................................... -- --
----- -----
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS........ (60) 77
CASH AND CASH EQUIVALENTS, beginning of period.............. 561 323
----- -----
CASH AND CASH EQUIVALENTS, end of period.................... $ 501 $ 400
===== =====
SUPPLEMENTAL CASH FLOW DISCLOSURES:
Cash paid for interest, net of amounts capitalized........ $ 130 $ 204
===== =====
Cash paid for income taxes................................ $ 18 $ 2
===== =====
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-4
<PAGE> 159
SOUTHERN ENERGY, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2000
A. ACCOUNTING AND REPORTING POLICIES
BASIS OF ACCOUNTING. The Company's accounting and reporting policies are
summarized in the Notes to the Consolidated Financial Statements ("Notes")
elsewhere in this prospectus. These interim financial statements should be read
in conjunction with the consolidated financial statements and the accompanying
footnotes. Management believes that the accompanying unaudited consolidated
financial statements reflect all adjustments, consisting of normal recurring
items, necessary for a fair statement of results for the interim periods
presented.
CONCENTRATION OF REVENUES. Revenues earned under the Company's long-term
power sales agreements with the Philippines' National Power Corporation ("NPC")
approximated 23% and 50% of the Company's total revenues and net income,
respectively, as of the three months ended March 31, 1999 and 2000,
respectively. NPC has long-term contractual agreements to purchase future power
production. These agreements are supported by a sovereign guarantee by the
Philippines' government. If this agreement were terminated, it could have a
material adverse effect on the future operating results and liquidity of the
Company.
RECEIVABLES RECOVERY. During the quarter ended March 31, 1999, the Company
recorded amounts totaling approximately $12 million, plus related interest, in
successful resolution of negotiations by the Company which allowed it to record
receivables that were assumed in conjunction with the SE Asia-Pacific business
acquisition. The Company has rights to an additional $40 million, plus related
interest, as of March 31, 2000, which it has fully reserved due to the risk of
collection.
B. COMPREHENSIVE INCOME
The Company's comprehensive (loss) income consists of net income and
foreign currency translation adjustments. Total comprehensive (loss) income for
the three months ended March 31, 1999 and 2000 was $(26) million and $98
million, respectively.
C. EARNINGS PER SHARE
We calculate basic earnings per share by dividing the income available to
common shareowners by the weighted average number of common shares outstanding.
The following table shows our computation of basic earnings per share for the
quarters ended March 31, 1999 and 2000 (in millions, except per share data)
after giving effect to the stock split that will be effected in conjunction with
the offering of common stock (Note J). Pro forma basic earnings per share
information gives effect to the dividend paid to Southern in 2000 as though it
had occurred during 1999. See Note J and Note 17 of the Notes.
<TABLE>
<CAPTION>
FROM FROM
CONTINUING DISCONTINUED NET
OPERATIONS OPERATIONS INCOME
---------- ------------ ------
<S> <C> <C> <C>
Basic, 1999:
Income.................................................... $ 76 $ 4 $ 80
Shares.................................................... 272 272 272
----- ----- -----
Earnings per share........................................ $0.28 $0.01 $0.29
===== ===== =====
</TABLE>
F-5
<PAGE> 160
SOUTHERN ENERGY, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
FROM FROM
CONTINUING DISCONTINUED NET
OPERATIONS OPERATIONS INCOME
---------- ------------ ------
<S> <C> <C> <C>
Basic, 2000:
Income.................................................... $ 95 $ 6 $ 101
Shares.................................................... 272 272 272
----- ----- -----
Earnings per share........................................ $0.35 $0.02 $0.37
===== ===== =====
Pro forma basic, 2000:
Income.................................................... $ 95 $ 6 $ 101
Shares.................................................... 272 272 272
Shares assumed due to dividend to Southern................ 31 31 31
----- ----- -----
Earnings per share........................................ $0.31 $0.02 $0.33
===== ===== =====
</TABLE>
D. DEBT
Facility B, a $350 million 364-day revolving line of credit, was extended
to March 2001 during March 2000. See Note 7 of the Notes.
E. FINANCIAL INSTRUMENTS
Southern Energy engages in commodity related marketing and price risk
management activities. At March 31, 2000, the status of outstanding non-trading
related derivative contracts was as follows (in millions):
<TABLE>
<CAPTION>
YEAR OF
MATURITY OR NOTIONAL UNRECOGNIZED
TYPE TERMINATION AMOUNT GAIN (LOSS)
---- ----------- -------- ------------
(IN THOUSANDS)
<S> <C> <C> <C>
Interest rate swaps............................. 2000-2012 $1,972 $ (1)
2001-2012 L600 (46)
2002-2007 DM691 (5)
Cross currency swaps............................ 2001-2007 L394 5
Cross currency swaption......................... 2003 DM435 22
</TABLE>
L -- Denotes British pounds sterling. DM -- Denotes Deutsche Mark.
F-6
<PAGE> 161
SOUTHERN ENERGY, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
F. INVESTMENTS IN AFFILIATES
The following table sets forth certain summarized income statement
information of the Company's investments in 50% or less-owned investments
accounted for under the equity method for the quarters ended March 31, 1999 and
2000 (in millions):
<TABLE>
<CAPTION>
MARCH 31,
-----------
1999 2000
---- ----
<S> <C> <C>
COMBINED INVESTMENTS, excluding Bewag
INCOME STATEMENT:
Revenues.................................................... $347 $673
Operating income............................................ 204 406
Net income from continuing operations....................... 192 131
BEWAG
INCOME STATEMENT:
Revenues.................................................... $613 $528
Operating income............................................ 140 72
Net income from continuing operations....................... 91 55
</TABLE>
G. SEGMENT REPORTING
Southern Energy's principal business segments primarily consist of the
geographic areas in which the Company conducts business -- Americas,
Asia-Pacific, and Europe. The other reportable business segments are the
Company's financing segment ("SE Finance") and the Company's business
development and general corporate activities segment ("Corporate"). Intersegment
revenues are not material. Financial data for the Company's business segments is
as follows (in millions):
BUSINESS SEGMENTS
<TABLE>
<CAPTION>
CONSOLIDATED AMERICAS EUROPE ASIA-PACIFIC SE FINANCE CORPORATE TOTAL
------------ -------- ------ ------------ ---------- --------- -----
<S> <C> <C> <C> <C> <C> <C>
Quarter Ended March 31, 2000:
Operating revenues.............. $280 $111 $126 $0 $ 4 $521
Segment net (loss) income....... (3) 31 83 6 (16) 101
Quarter Ended March 31, 1999:
Operating revenues.............. $102 $350 $ 66 $0 $ 3 $521
Segment net (loss) income....... (3) 40 51 4 (12) 80
</TABLE>
F-7
<PAGE> 162
SOUTHERN ENERGY, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
H. ACQUISITIONS AND DIVESTITURES
SE NEW YORK
The Company has finalized its purchase price allocation for the SE New York
acquisition. The final allocation is as follows (in millions):
<TABLE>
<S> <C>
Current assets.............................................. $ 60
Property plant and equipment................................ 433
Acquired intangibles........................................ 47
Liabilities assumed and other............................... (47)
----
Purchase price.............................................. $493
====
</TABLE>
SALE OF HIDROELECTRICA ALICURA
On February 22, 2000, Southern Energy agreed to sell its interest in
Hidroelectrica Alicura, a 1,000 megawatt hydroelectric plan in Argentina, for
$205 million. The selling price releases the Company from its debt obligations
and allows it to buy out minority partners. The sale is subject to the approval
of Argentine regulatory authorities. There will be no impact on the Company's
results of operations due to the fact that the investment is carried at fair
value which is equal to the sales price. See Note J.
I. COMMITMENTS AND CONTINGENT MATTERS
COMPANHIA ENERGETICA DE MINAS GERAIS ("CEMIG"). In September 1999, the
state of Minas Gerais filed a lawsuit in a state court seeking temporary relief
against Southern Electric Brasil Participacoes, Ltda. ("SEB") exercising voting
rights under the shareholders agreement, between the state and SEB regarding
SEB's interest in CEMIG, as well as a permanent recision of the agreement. The
core issue in the dispute is whether the shareholders agreement
unconstitutionally transfers control of CEMIG from the state to SEB, which
transfer would have required specific legislative authorization. On March 23,
2000, a state court in Minas Gerias, Brazil, ruled that the shareholder
agreement was invalid. SEB is planning to appeal this decision.
SEB obtained financing from Banco Nacional de Desenvolvimento Economico e
Social (BNDES) for approximately 50% of the total purchase price of the CEMIG
shares which is secured by a pledge of SEB's shares in CEMIG. SEB is currently
in discussions with BNDES to defer a $117 million principal and interest payment
due on May 15, 2000. Based on our ownership of SEB, our portion of this amount
is $29 million. See Note J.
ENERGY MARKETING AND RISK MANAGEMENT ACTIVITIES. The Company and Vastar
Resources, Inc. ("VRI") have jointly agreed to provide up to $700 million of
contingent performance guarantees and trade credits on behalf of Southern
Company Energy Marketing ('SCEM"). At March 31, 2000, outstanding guarantees
related to the estimated fair value of SCEM's net contractual commitments were
approximately $197 million.
UNCERTAINTIES RELATED TO CONTRACT SALES. Several of the Company's
significant power generation facilities rely on either PPAs or energy conversion
agreements ("ECAs" and collectively with the PPAs the "Power Contracts") with
one or a limited number of entities for the majority of, and in some cases all
of, the relevant facility's output over the life of the Power Contract.
F-8
<PAGE> 163
SOUTHERN ENERGY, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Power Contracts related to the Company's facilities are generally
long-term agreements covering the sale of power for 20 or more years. However,
the operation of such facilities is dependent on the continued performance by
customers and suppliers of their obligations under the relevant Power Contract,
and, in particular, on the credit quality of the purchasers. If a substantial
portion of the Company's long-term Power Contracts were modified or terminated,
the Company would be adversely affected to the extent that it was unable to find
other customers at the same level of profitability. Some of the Company's
long-term Power Contracts are for prices above current spot market prices. The
loss of one or more significant Power Contracts or the failure by any of the
parties to a Power Contract to fulfill its obligations thereunder could have a
material adverse effect on the Company's business, results of operations and
financial condition.
SE CALIFORNIA. Southern Energy California LLC ("SE California"), a wholly
owned subsidiary of the Company, and its subsidiaries are parties to a Federal
Energy Regulatory Commission ("FERC") proceeding that will determine the
percentage of a settled $158.8 million revenue requirement to be paid to the SE
California parties under the reliability must-run ("RMR") agreements between the
SE California parties and the California Independent System Operator ("CAISO").
Hearings were conducted before a FERC administrative law judge in March 2000.
The SE California parties have proposed to allocate approximately 75% of the
responsibility for payment of the revenue requirement to the CAISO, while CAISO
and other aligned parties argue that CAISO should pay no more than approximately
7%. The decision in this case will affect the amount CAISO will pay to SE
California and its subsidiaries for the period commencing June 1, 1999 through
December 31, 2001. See Note J.
J. SUBSEQUENT EVENTS
See Note 17 of the Notes to Consolidated Financial Statements.
F-9
<PAGE> 164
After the stock split discussed in Note 17 to Southern Energy, Inc.'s
consolidated financial statements is effected, we expect to be in a position to
render the following audit report.
/s/Arthur Andersen LLP
February 16, 2000
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Southern Energy, Inc.:
We have audited the accompanying consolidated balance sheets of SOUTHERN
ENERGY, INC. (a Delaware corporation) AND SUBSIDIARIES as of December 31, 1998
and 1999, and the related consolidated statements of income, stockholder's
equity, and cash flows for each of the three years in the period ended December
31, 1999. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Southern Energy, Inc. and
subsidiaries as of December 31, 1998 and 1999, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1999, in conformity with accounting principles generally accepted
in the United States.
Atlanta, Georgia
February 16, 2000 (except with respect to
the matters discussed in Notes 15 and 17,
as to which the date is _________ )
F-10
<PAGE> 165
SOUTHERN ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1998 AND 1999
(IN MILLIONS)
<TABLE>
<CAPTION>
1998 1999
------- -------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents................................... $ 561 $ 323
Restricted deposits (Note 1)................................ 59 50
Receivables:
Customer accounts, less provision for uncollectibles of
$34 and $23 for 1998 and 1999, respectively............. 212 236
Other, less provision for uncollectibles of $67 and $21
for 1998 and 1999, respectively......................... 521 481
Other....................................................... 113 195
------- -------
Total current assets.................................... 1,466 1,285
------- -------
PROPERTY, PLANT, AND EQUIPMENT (NOTES 2 AND 4):............. 3,108 4,147
Less accumulated provision for depreciation................. (312) (421)
------- -------
2,796 3,726
Leasehold interests, net of accumulated amortization of $85
and $137 for 1998 and 1999, respectively (Note 1)......... 927 1,934
Construction work in progress............................... 968 365
------- -------
Total property, plant, and equipment, net............... 4,691 6,025
------- -------
NONCURRENT ASSETS:
Concession agreement, net of accumulated amortization of $84
and $90 for 1998 and 1999, respectively (Notes 1 and 2)... 258 268
Investments (Notes 1, 3, 12 and 13)......................... 1,540 1,490
Notes and other receivables, less provision for
uncollectibles of $40 and $61 for 1998 and 1999,
respectively.............................................. 1,216 1,276
Goodwill, net of accumulated amortization of $106 and $164
for 1998 and 1999, respectively (Notes 1 and 12).......... 2,125 2,106
Other intangible assets, net of accumulated amortization of
$0 and $13 for 1998 and 1999, respectively (Notes 1 and
12)....................................................... 154 447
Investment in leveraged leases (Note 14).................... 264 556
Miscellaneous deferred charges.............................. 340 410
------- -------
Total noncurrent assets................................. 5,897 6,553
------- -------
Total assets............................................ $12,054 $13,863
======= =======
LIABILITIES AND STOCKHOLDER'S EQUITY
CURRENT LIABILITIES:
Short-term debt (Note 7).................................... $ 702 $ 1,961
Note payable to Southern Company (Notes 5 and 7)............ 926 0
Current portion of long-term debt (Note 7).................. 480 237
Accounts payable............................................ 564 626
Taxes accrued............................................... 196 218
Other....................................................... 184 173
------- -------
Total current liabilities............................... 3,052 3,215
------- -------
NONCURRENT LIABILITIES:
Subsidiary obligated mandatorily redeemable preferred
securities (Note 7)....................................... 1,033 1,031
Notes payable (Note 7)...................................... 3,499 4,557
Other long-term debt (Note 7)............................... 420 397
Deferred income taxes (Note 8).............................. 573 680
Miscellaneous deferred credits.............................. 300 156
------- -------
Total noncurrent liabilities............................ 5,825 6,821
------- -------
MINORITY INTEREST IN SUBSIDIARY COMPANIES................... 535 725
------- -------
COMMITMENTS AND CONTINGENT MATTERS (NOTES 3, 7, 10, AND 11)
STOCKHOLDER'S EQUITY:
Common stock, $.01 par value; 2,000,000,000 shares
authorized; 272,000,000 shares issued and outstanding
(Note 17)................................................. 3 3
Additional paid-in capital.................................. 2,624 2,984
Accumulated other comprehensive income (loss)............... 15 (92)
Retained earnings........................................... 0 207
------- -------
Total stockholder's equity.............................. 2,642 3,102
------- -------
Total liabilities and stockholder's equity.............. $12,054 $13,863
======= =======
</TABLE>
The accompanying notes are an integral part of these consolidated balance
sheets.
F-11
<PAGE> 166
SOUTHERN ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31, 1997, 1998, AND 1999
(IN MILLIONS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
1997 1998 1999
------ ------ ------
<S> <C> <C> <C>
OPERATING REVENUES.......................................... $3,750 $1,819 $2,268
------ ------ ------
OPERATING EXPENSES:
Fuel........................................................ 74 47 392
Purchased power............................................. 2,813 844 545
Maintenance................................................. 74 80 116
Depreciation and amortization............................... 182 221 270
Selling, general, and administrative........................ 188 160 253
Write-down of assets (Note 2)............................... 0 308 60
Other....................................................... 147 164 188
------ ------ ------
Total operating expenses.................................. 3,478 1,824 1,824
------ ------ ------
OPERATING INCOME (LOSS)..................................... 272 (5) 444
------ ------ ------
OTHER INCOME (EXPENSE):
Interest income............................................. 138 146 172
Interest expense............................................ (345) (430) (502)
Gain on sales of assets (Note 12)........................... 24 41 313
Equity in income of affiliates (Notes 1, 3, and 13)......... 58 135 111
Receivables recovery (Note 1)............................... 0 29 64
Other, net.................................................. 33 29 72
------ ------ ------
Total other (expense) income.............................. (92) (50) 230
------ ------ ------
INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES
AND MINORITY INTEREST..................................... 180 (55) 674
PROVISION (BENEFIT) FOR INCOME TAXES:
Continuing operations....................................... 27 (123) 129
Windfall profits tax........................................ 148 0 0
------ ------ ------
Total Provision (Benefit) for Income Taxes................ 175 (123) 129
MINORITY INTEREST........................................... 29 80 183
------ ------ ------
(LOSS) INCOME FROM CONTINUING OPERATIONS.................... (24) (12) 362
------ ------ ------
INCOME FROM DISCONTINUED OPERATIONS, NET OF TAX BENEFIT OF
$10, $22, AND $15 IN 1997, 1998, AND 1999, RESPECTIVELY... 8 12 10
------ ------ ------
(LOSS) NET INCOME........................................... $ (16) $ 0 $ 372
====== ====== ======
(LOSS) EARNINGS PER SHARE:
Basic
From continuing operations................................ $(0.09) $(0.04) $ 1.33
From discontinued operations.............................. 0.03 0.04 0.04
------ ------ ------
Net income................................................ $(0.06) $ -- $ 1.37
====== ====== ======
Pro forma basic -- unaudited (Note 17)
From continuing operations................................ $ 1.18
From discontinued operations.............................. 0.04
------
Net income................................................ $ 1.22
======
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-12
<PAGE> 167
SOUTHERN ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1997, 1998, AND 1999
(IN MILLIONS)
<TABLE>
<CAPTION>
ACCUMULATED
ADDITIONAL OTHER
COMMON PAID-IN RETAINED COMPREHENSIVE COMPREHENSIVE
STOCK CAPITAL EARNINGS INCOME (LOSS) (LOSS) INCOME
------ ---------- -------- ------------- -------------
<S> <C> <C> <C> <C> <C>
BALANCE, DECEMBER 31, 1996.............. 3 $ 955 $ 16 $ 14
Net loss.............................. 0 0 (16) 0 $ (16)
Cumulative translation adjustment, net
of tax............................. 0 0 0 (7) (7)
-----
Comprehensive loss.................... $ (23)
=====
Capital contributions................. 0 1,167 0 0
---- ------ ----- -----
BALANCE, DECEMBER 31, 1997.............. 3 2,122 0 7
Net income............................ 0 0 0 0 $ 0
Cumulative translation adjustment, net
of tax............................. 0 0 0 8 8
-----
Comprehensive income.................. $ 8
=====
Capital contributions................. 0 502 0 0
---- ------ ----- -----
BALANCE, DECEMBER 31, 1998.............. 3 2,624 0 15
Net income............................ 0 0 372 0 $ 372
Cumulative translation adjustment, net
of tax............................. 0 0 0 (107) (107)
-----
Comprehensive income.................. $ 265
=====
Dividends............................. 0 0 (165) 0
Capital contributions................. 0 360 0 0
---- ------ ----- -----
BALANCE, DECEMBER 31, 1999.............. 3 $2,984 $ 207 $ (92)
==== ====== ===== =====
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-13
<PAGE> 168
SOUTHERN ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1998, AND 1999
(IN MILLIONS)
<TABLE>
<CAPTION>
1997 1998 1999
------- ------- -------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) income........................................... $ (16) $ 0 $ 372
------- ------- -------
Adjustments to reconcile net (loss) income to net cash
provided by operating activities:
Equity in income of affiliates............................ (53) (121) (95)
Depreciation and amortization............................. 203 229 286
Write-down of assets...................................... 0 308 60
Deferred income taxes..................................... 15 (40) 166
Gain on sales of assets................................... (24) (41) (313)
Minority interest......................................... 29 80 183
Other, net................................................ 15 (27) (93)
Changes in certain assets and liabilities, excluding
effects from acquisitions:
Receivables, net........................................ (214) 133 (133)
Other current assets.................................... 38 (47) (15)
Accounts payable........................................ 137 (141) (81)
Taxes accrued........................................... 114 (12) 22
Other current liabilities............................... 20 81 156
------- ------- -------
Total adjustments..................................... 280 402 143
------- ------- -------
Net cash provided by operating activities............. 264 402 515
------- ------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures........................................ (720) (647) (747)
Cash paid for acquisitions.................................. (2,925) (998) (1,771)
Funds loaned to Southern Company............................ (619) (361) 0
Purchase of preferred shares................................ 0 0 (121)
Property insurance proceeds................................. 0 0 34
Proceeds received from the sale of investments (Note 12).... 32 198 284
Dividends received from equity investments.................. 29 67 58
------- ------- -------
Net cash used in investing activities................. (4,203) (1,741) (2,263)
------- ------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Capital contributions from Southern Company................. 1,167 502 360
Capital contributions from minority interests............... 0 0 18
Issuance of notes receivable................................ (84) (191) (199)
Repayments on notes receivable.............................. 231 398 341
Payment of dividends to Southern Company.................... 0 0 (165)
Payment of dividends to minority interests.................. (7) (22) (66)
Proceeds from issuance of short-term debt, net.............. 749 122 358
Proceeds from issuance of long-term debt.................... 1,847 730 1,372
Proceeds from issuance of subsidiary obligated mandatorily
redeemable preferred securities........................... 672 338 0
Repayment of long-term debt................................. (398) (375) (503)
------- ------- -------
Net cash provided by financing activities............. 4,177 1,502 1,516
------- ------- -------
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH
EQUIVALENTS............................................... (1) -- (6)
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS........ 237 163 (238)
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR................ 161 398 561
------- ------- -------
CASH AND CASH EQUIVALENTS, END OF YEAR...................... $ 398 $ 561 $ 323
======= ======= =======
SUPPLEMENTAL CASH FLOW DISCLOSURES:
Cash paid for interest, net of amounts capitalized.......... $ 269 $ 349 $ 419
======= ======= =======
Cash paid (refunds received) for income taxes............... $ 66 $ (33) $ (114)
======= ======= =======
BUSINESS ACQUISITIONS:
Fair value of assets acquired............................... $ 4,768 $ 1,072 $ 1,803
Less cash paid.............................................. 2,925 998 1,771
------- ------- -------
Liabilities assumed....................................... $ 1,843 $ 74 $ 32
======= ======= =======
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-14
<PAGE> 169
SOUTHERN ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1998, AND 1999
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
GENERAL
Southern Energy, Inc. is a wholly owned subsidiary of Southern Company
("Southern" or the "Parent") and was incorporated in Delaware in 1993. Southern
Energy, Inc. and its subsidiaries (collectively, "Southern Energy" or the
"Company") acquire, develop, build, own, and operate power production and
delivery facilities and provide a broad range of energy-related services to
utilities and industrial companies around the world. The Company's business
includes independent power projects, integrated utilities, a distribution
company, and energy marketing and trading operations. Southern Energy has
operations and development offices in North America and the Caribbean, Asia,
Europe, and South America. Additionally, the Company operates a business
development and management entity. Operating entities, of which the Company has
less than 100% ownership, are as follows:
<TABLE>
<CAPTION>
ECONOMIC VOTING
OWNERSHIP INTEREST
PERCENTAGE AT PERCENTAGE
COUNTRY OF YEAR OF DECEMBER 31, DECEMBER 31,
OPERATIONS INVESTMENT 1999 1999
---------- ---------- ------------- ------------
<S> <C> <C> <C> <C>
ENTITIES CONSOLIDATED:
Western Power Distribution ("WPD"),
formerly "SWEB" (Note 2)............ United Kingdom 1995 49.0% 50.5%
Hidroelectrica Alicura S.A.
("Alicura") (Note 2)................ Argentina 1993 55.1 55.1
EDELNOR S.A. (Note 2)................. Chile 1993 82.3 82.3
Freeport Power Company................ Bahamas 1993 62.5 62.5
ENTITIES NOT CONSOLIDATED, ACCOUNTED
FOR UNDER EQUITY METHOD:
Southern Company Energy Marketing LP
("SCEM")............................ United States 1997 60.0 60.0
Birchwood Power Partners L.P.
("Birchwood")....................... United States 1994 50.0 50.0
BEWAG AG ("BEWAG").................... Germany 1997 26.0 26.0
Guangdong Guanghope Power Company
Limited ("Shajiao C")............... China 1997 32.0 44.44
Companhia Energetica de Minas Gerais
("CEMIG")........................... Brazil 1998 3.6 8.24
The Power Generation Company of
Trinidad and Tobago ("PowerGen").... Trinidad 1994 39.0 39.0
Shandong International Power
Development Company Limited
("SIPD")............................ China 1999 9.9 9.9 to 38
Carbontronics Synfuels Investors LP... United States 1998 25.0 25.0
Clairton 1314B LLC.................... United States 1997 27.0 27.0
</TABLE>
F-15
<PAGE> 170
SOUTHERN ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
ECONOMIC VOTING
OWNERSHIP INTEREST
PERCENTAGE AT PERCENTAGE
COUNTRY OF YEAR OF DECEMBER 31, DECEMBER 31,
OPERATIONS INVESTMENT 1999 1999
---------- ---------- ------------- ------------
<S> <C> <C> <C> <C>
ENTITY NOT CONSOLIDATED, ACCOUNTED FOR
UNDER COST METHOD:
Mobile Energy Services Company, LLC
("Mobile Energy")................... United States 1994 1.0 1.0
</TABLE>
Mobile Energy's remaining 99% ownership interest is held by Southern. Southern
Energy currently has a 49% economic interest in WPD Holdings UK, the UK parent
of WPD, yet retains operational and management control with 50.5% of the voting
rights and the right to appoint a majority of the board of directors. The
Company's economic interest in Shajiao C is stated after a preferential
distribution to Guangdong Generation Corporation, the joint venture partner in
China. The Company's voting interest in SIPD can increase to 38% when certain
shareholders become ineligible to vote on matters when there is a conflict of
interest, according to rules governing the listing of securities on the Stock
Exchange of Hong Kong Ltd.
BASIS OF PRESENTATION
The consolidated financial statements of the Company are presented in U.S.
dollars in conformity with accounting principles generally accepted in the
United States ("U.S. GAAP"). The accompanying financial statements have not been
prepared in accordance with Statement of Financial Accounting Standards ("SFAS")
No. 71, "Accounting for the Effects of Certain Types of Regulation." This
pronouncement, under which most rate regulated U.S. electric utilities report
financial statements, applies to entities that are subject to cost-based rate
regulation. By contrast, the Company's operating investments generally are not
subject to cost-based rate regulation, and therefore, the provisions of SFAS No.
71 do not apply. Financial statements presented in accordance with SFAS No. 71
contain deferred items which have not yet been included in rates charged to
customers in compliance with the respective regulatory authorities, but which
would have been included in the income statement of enterprises in general under
U.S. GAAP. The accompanying financial statements of the Company do not contain
such deferrals.
The financial statements include the accounts of the Company and its wholly
owned and its controlled majority-owned subsidiaries and have been prepared from
records maintained by the Company and its subsidiaries in their respective
countries of operation. Certain prior year amounts have been reclassified to
conform with the current year financial statement presentation.
All significant intercompany accounts and transactions have been eliminated
in consolidation. Investments in companies in which the Company exercises
significant influence over operating and financial policies are accounted for
using the equity method. In addition, majority or jointly owned affiliates where
control does not exist are accounted for using the equity method of accounting.
Mobile Energy is the only investment accounted for using the cost method.
F-16
<PAGE> 171
SOUTHERN ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
USE OF ESTIMATES
The preparation of financial statements in conformity with U.S. GAAP
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosures of contingent assets and
liabilities at the date of the financial statements and reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates.
REVENUE RECOGNITION
Revenues derived from power generation are recognized upon output, product
delivery, or satisfaction of specific targets, all as specified by contractual
terms. To the extent that power generation billings exceed the cumulative
average price per unit delivered, cumulative average revenues are recorded.
Substantially all of the Company's energy trading and marketing operations are
accounted for under a mark-to-market accounting methodology.
CONCENTRATION OF REVENUES AND NET INCOME
For the year ended December 31, 1999 approximately 14% and 35% of our
revenues and net income, respectively, were attributable to sales made by our
Philippine operations under power sales agreements with National Power
Corporation (NPC). NPC has long-term contractual agreements to purchase future
power production. These agreements are supported by a sovereign guarantee by the
Philippines' government. If this agreement were terminated, it could have a
material adverse effect on the future operating results and liquidity of the
Company.
CASH AND CASH EQUIVALENTS
The Company considers all short-term investments with an original maturity
of three months or less to be cash equivalents.
LONG-LIVED ASSETS AND INTANGIBLES
The Company records goodwill for the difference between the excess of the
fair value of investments over the purchase price. Goodwill is amortized on a
straight-line basis over a period between 30 and 40 years. The Company
recognizes specifically identifiable intangibles when specific rights and
contracts are acquired. These intangibles are amortized on a straight-line basis
over the lesser of their contractual or estimated useful lives between 20 and 30
years. The Company evaluates long-lived assets, such as property, plant and
equipment, goodwill, and specifically identifiable intangibles, when events or
changes in circumstances indicate that the carrying value of such assets may not
be recoverable. The determination of whether an impairment has occurred is based
on an estimate of undiscounted cash flows attributable to the assets, as
compared to the carrying value of the assets. If an impairment has occurred, the
amount of the impairment recognized is determined by estimating the fair value
of the assets and recording a provision for loss if the carrying value is
greater than fair value. For assets identified as held for sale, the carrying
value is compared to the estimated fair value less cost to sell to determine if
an impairment provision is required. Until the assets are disposed of, their
estimated fair value is reevaluated when circumstances or events change.
F-17
<PAGE> 172
SOUTHERN ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
RESTRICTED DEPOSITS
The Company has restricted deposits for self-insurance reserves,
contractual, legal, or other corporate purposes.
PROPERTY, PLANT, AND EQUIPMENT
Property, plant, and equipment are recorded at cost to the Company, which
includes materials, labor, appropriate administrative and general costs, and the
estimated cost of debt funds used during construction. The cost of maintenance,
repairs, and replacement of minor items of property is charged to maintenance
expense as incurred.
Depreciation of the recorded cost of depreciable property, plant, and
equipment is provided by using primarily composite straight-line rates (Note 4).
Leasehold improvements are amortized over the shorter of the respective lease
terms or the useful lives of the improvements. The Company's capitalization
policy expenses the cost of certain immaterial assets when purchased.
Upon the retirement or sale of assets, the cost of such assets and the
related accumulated depreciation are removed from the balance sheet and the gain
or loss, if any, is credited or charged to income.
LEASEHOLD INTERESTS
Certain of SE Asia Pacific Limited's ("SE Asia-Pacific") (formerly
Consolidated Electric Power Asia Limited) power generation facilities are
developed under "build, operate, and transfer agreements" ("BOT") with the
respective local country government. Under these agreements, SE Asia-Pacific
builds power generation facilities, operates them for a period of several years
(a "cooperation period"), and transfers ownership to the local country
government at the end of the cooperation period. Additionally, the land subject
to the BOT agreements is not controlled by SE Asia-Pacific. During construction,
the cost of these facilities is recorded as construction work in progress. Upon
completion of a facility, its entire cost is reclassified to leasehold interests
where the balance is amortized over the length of the respective cooperation
period.
CONCESSION AGREEMENT
The amount recorded as a concession agreement in the accompanying balance
sheets corresponds with the total value, net of amortization, assigned by the
Argentine government to the assets delivered to Alicura for operating purposes
pursuant to the concession contract for the Alicura hydroelectric complex. This
value was originally determined, without allocating any specific value to each
of the assets involved in the concession, based on the amount paid by the
Company to acquire 59% of the share capital of the company which holds the
concession, plus the proportion of the capital retained by the Argentine
government (41%), plus the liabilities undertaken by the concessionaire upon
signing the concession contract and the disbursements incurred by the Company
and subsequently transferred to Alicura to effect the acquisition.
This intangible asset is being amortized using the straight-line method
over 30 years (the concession period) from August 1993, which was the takeover
date of the hydroelectric complex.
F-18
<PAGE> 173
SOUTHERN ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
During December 1998, Southern Energy, having received the appropriate
approval from executive management and the board of directors, committed itself
to a formal plan to dispose of its investment in Alicura. See Notes 2 and 17 for
further discussion.
LEVERAGED LEASES
The Company's net investment in leveraged leases consist of rentals
receivable, net of principal and interest on the related nonrecourse debt, the
estimated residual value of the leased facilities, and unearned income. The
earned income is included in the consolidated statements of income. Initial
direct costs incurred in consummating a leveraged lease transaction are
accounted for as part of the investment in the lease and are amortized over the
term of the lease.
INCOME TAXES
SFAS No. 109, "Accounting for Income Taxes," requires the asset and
liability approach for financial accounting and reporting for deferred income
taxes. The Company uses the liability method of accounting for deferred income
taxes and provides deferred income taxes for all significant income tax
temporary differences.
RECEIVABLES RECOVERY
In 1998 and 1999, the Company received amounts totaling approximately $29
million and $64 million, respectively, plus related interest in successful
resolution of negotiations by the Company with its supplier and partners in
China which allowed it to collect receivables that were assumed in conjunction
with the SE Asia-Pacific business acquisition. At the time of the purchase, the
Company did not place value on the receivables due to the uncertain credit
standing of the parties with whom the receivables were secured. The Company has
rights to an additional $40 million, plus related interest, as of December 31,
1999, which it has fully reserved due to the risk of collection.
FOREIGN CURRENCY TRANSLATION
Assets and liabilities of international operations where the local currency
is the functional currency have been translated at year-end exchange rates, and
revenues and expenses have been translated using average exchange rates
prevailing during the year. Adjustments resulting from translation have been
recorded in other comprehensive income. The financial statements of
international operations where the U.S. dollar is the functional currency
reflect certain transactions denominated in a local currency that have been
remeasured in U.S. dollars. The remeasuring of local currencies into U.S.
dollars creates gains and losses from foreign currency transactions that are
included in net income in the amount of $(2), $4 and $2 million for 1997, 1998,
and 1999, respectively. The effect of the translation adjustment on other
comprehensive income is disclosed in the statements of stockholder's equity.
COMPREHENSIVE INCOME
The Company's comprehensive income consists of net income and foreign
currency translation adjustments and is presented in the financial statements.
The objective of the statement is to report a
F-19
<PAGE> 174
SOUTHERN ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
measure of all changes in common stock equity of an enterprise that result from
transactions and other economic events of the period other than transactions
with owners.
FINANCIAL INSTRUMENTS
Southern Energy engages in price risk management activities for both
nontrading and trading purposes. Nontrading financial instruments are used to
hedge exposures to fluctuations in interest rates, foreign currency exchange
rates, and certain commodity prices. Gains and losses on qualifying hedges are
deferred and recognized either in income or as an adjustment to the carrying
amount when the hedged transaction occurs.
Financial instruments used for trading purposes are recorded at either
quoted market value or, when market prices are not readily available for
specific contracts, at fair value, which is determined under an alternative
approach, such as model pricing. The determination of market or fair value
considers various factors, including closing exchange or over-the-counter
("OTC") market price quotations, time value and volatility factors underlying
options and contractual commitments, price activity for equivalent or synthetic
instruments in markets located in different time zones, counterparty credit
quality, and the potential impact on market prices of liquidating the Company's
positions in an orderly manner over a reasonable period of time under present
market conditions. All trading transactions and related expenses are recorded on
a trade-date basis. See Note 9 where financial instruments are discussed
further.
NEW ACCOUNTING STANDARDS
In March 1998, the American Institute of Certified Public Accountants
("AICPA") issued a new Statement of Position ("SOP") 98-1, "Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use." This
statement requires capitalization of certain costs of internal-use software.
Southern Energy adopted this statement in December 1998 without a material
impact on the financial statements.
The American Institute of Certified Public Accountants' SOP 98-5,
"Reporting on the Costs of Start-Up Activities," was implemented in the fourth
quarter of 1998. This statement requires that costs of start-up activities and
organizational costs be expensed as incurred. The new accounting requirement did
not have a significant effect on net income.
In December 1998, the Emerging Issues Task Force ("EITF") of the Financial
Accounting Standards Board ("FASB") issued EITF No. 98-10, "Accounting for
Contracts Involved in Energy Trading and Risk Management Activities." The EITF
requires that energy trading contracts be marked to market through the income
statement, with gains or losses reflected rather than revenues and purchased
power. Energy trading contracts are defined as energy contracts entered into
with the objective of generating profits on or from exposure to shifts or
changes in market prices. The adoption of this accounting in January 1999 did
not have a material impact on the financial statements.
The Company continues to analyze the effects of adoption of the rules
promulgated by SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities." This statement establishes accounting and reporting standards for
derivative instruments, including certain derivative instruments imbedded in
other contracts, and for hedging activities. The FASB recently deferred
implementation of the provisions of SFAS No. 133 to fiscal periods beginning
after June 15, 2000. The Company
F-20
<PAGE> 175
SOUTHERN ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
intends to adopt the provisions of SFAS No. 133 within this time frame and in
accordance with the requirements provided by this statement. Management is
currently assessing the financial statement impact of the statement, but we have
not determined the impact at this time. Adoption of SFAS No. 133 could increase
the volatility of earnings and other comprehensive income.
2. WRITE-DOWN OF ASSETS
In December 1998, Southern Energy designed and implemented a plan to
dispose of its Argentine and Chilean investments. As a result, Southern Energy
recorded a write-down of approximately $308 million in 1998 to reflect the
difference between the carrying value of these assets and the estimated fair
value of the businesses. The Company recorded an additional write-down of $28
million in 1999 to eliminate the impact of net earnings from the investments, in
order to prevent increasing the carrying value of these assets above their
estimated fair market value. Depreciation expense was suspended at the time of
the initial write-down. Southern Energy estimated the fair value of the
businesses held for sale based on bids received from prospective buyers, if
available, or the discounted expected future cash flows to be generated by the
assets. The adjusted carrying value of the Argentine and Chilean assets held for
disposal at December 31, 1999 was $92 million. See Note 17 for further
discussion. These assets impacted the financial statements of income as follows
(in millions):
<TABLE>
<CAPTION>
OPERATING OPERATING CONSOLIDATED
REVENUES INCOME NET INCOME
--------- --------- ------------
<S> <C> <C> <C>
Year:
1997..................................................... $180 $37 $5
1998..................................................... 180 37 5
1999..................................................... 171 23 2
</TABLE>
Additionally during 1999, Southern Energy recorded a write-down of
approximately $32 million, primarily related to certain metering assets of WPD.
These assets are to be held and used by WPD. Future cash flows will be derived
from competitive markets being introduced in the UK for metering activities. An
estimate of these undiscounted future cash flows was compared to the carrying
value of the assets and it was determined that the assets were impaired. The
fair value of the assets was then determined by discounting the future cash
flows. The amount of the write-down was then computed by comparing the carrying
value to the fair value of the assets.
3. JOINT VENTURE INFORMATION
On September 1, 1997, Southern Energy and Vastar Resources, Inc. ("VRI")
entered into a 99-year partnership agreement designed to further develop both
parties' energy marketing and risk management operations and formed SCEM. Also
on such date, Southern Energy contributed $24.1 million, which includes
substantially all of its gas marketing and risk management assets and a working
capital contribution to the venture. As part of this transaction, VRI
contributed substantially all of the operating assets of Vastar Gas Marketing,
Inc. (a wholly owned subsidiary of VRI) to SCEM on September 1, 1997.
On January 1, 1998, VRI contributed substantially all operating assets of
Vastar Power Marketing, Inc. (a wholly owned subsidiary of VRI) to SCEM;
concurrently, certain long-term
F-21
<PAGE> 176
SOUTHERN ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
natural gas supply contracts were contributed by Vastar Gas Marketing, Inc.
Additionally, on January 1, 1998, Southern Energy paid VRI $40 million and
contributed $14.1 million, or substantially all of the remaining energy
marketing and trading assets of Southern Energy Trading and Marketing, Inc., to
SCEM.
The general and limited partnership interest is 60% owned, indirectly, by
Southern Energy and 40% owned, indirectly, by VRI. Income and partnership
distributions will be made according to the ownership percentage, subject to
certain minimum distributions, provided for by the partnership agreement, to VRI
for the first five years of the partnership. These minimum distributions can be
reduced in the event that certain extraordinary items are experienced by SCEM.
To date, the Company has only paid VRI $5.8 million for the 1998 minimum
distribution as a result of credit losses in 1998. VRI believes it is entitled
to a higher payment and has requested arbitration in the matter. The Company
does not believe that the outcome of this matter will have a material effect on
its financial statements.
Historical cost was used, as Southern Energy and VRI accounted for their
respective initial investments in SCEM as a joint venture. However, due to the
fact that both entities were marketing and energy trading operations,
substantially all of the contributed assets and liabilities were accounted for
using mark-to-market accounting. The partnership agreement provides both
Southern Energy and VRI with significant participatory rights with respect to
the operations of SCEM. Accordingly, Southern Energy accounts for its interest
in the joint venture under the equity method of accounting.
Under the partnership agreement, Southern Energy's ownership interest
automatically increases to 75% of SCEM on July 1, 2001. During calendar year
2002, Southern Energy may exercise a call provision to purchase an additional 5%
interest for $80 million. Beginning December 1, 2002 and ending January 2, 2003,
VRI may put its remaining ownership interest to Southern Energy for an amount of
either $130 million or $210 million depending on the interest owned by VRI at
that time, plus certain other contractual considerations. Both of these put and
call provisions provide for cash payments equal to the pro rata portion of
certain unamortized capital expenditures and the pro rata portion of the market
or fair values of financial instruments owned by the partnership on the date of
the option exercise. The partnership agreement also provides that in the event
of a change of control of VRI or the Company, the other party has a right to
purchase the interest in SCEM owned by the party affected by the change of
control. The purchase price would be determined by an appraisal.
4. PROPERTY, PLANT, AND EQUIPMENT
The Company records depreciation expense on a straight-line basis, using
the following estimated useful lives (in years):
<TABLE>
<S> <C>
Production.................................................. 15 to 40
Transmission and distribution............................... 35 to 40
Other....................................................... 3 to 30
</TABLE>
F-22
<PAGE> 177
SOUTHERN ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Property, plant, and equipment consisted of the following at December 31,
1998 and 1999 (in millions):
<TABLE>
<CAPTION>
1998 1999
------ ------
<S> <C> <C>
Production.................................................. $ 551 $1,615
Transmission and distribution............................... 2,463 2,417
Other....................................................... 94 115
------ ------
$3,108 $4,147
====== ======
</TABLE>
5. RELATED-PARTY TRANSACTIONS
The Company has agreements with Southern Company Services, Inc. (a wholly
owned subsidiary of Southern) and each of the system operating companies owned
by Southern under which those companies provide the following services to the
Company at cost: general engineering, design engineering, accounting and
statistical budgeting, business promotion and public relations, systems and
procedures, training, and administrative and financial services. In addition to
these services, certain facilities of the system companies are made available to
the Company and its customers. The Company reimburses the service company and
the various system operating companies at cost for these services. Such costs
amounted to approximately $28 million, $17 million, and $20 million, during
1997, 1998, and 1999, respectively.
The Company incurred interest expense on a note payable to Southern Company
of $17 million $53 million, and $37 million during 1997, 1998, and 1999,
respectively. See Note 7 for discussion of related-party debt transactions.
The Company has various agreements with SCEM in which SCEM has agreed to
develop and manage its bidding strategy, manage fuel requirements, sell the
energy and provide accounting and settlement services for several generating
plants of the Company. These agreements apply to the Company's California, New
York, and New England operating entities and generally cover a term of 1 to 2.5
years. The first of these agreements was in place in December 1998 and the most
recent in July 1999 as amended in January 2000. Total fees paid to SCEM under
the marketing agreements totaled $16.8 million in 1999, and payments made for
fuel to SCEM totaled $257.9 million.
In January 1999, the Company contracted with SCEM to operate and maintain
the generating assets of Brazos Electric Power Cooperative in Texas for a period
of five years ending 2003.
For all agreements, the Company has obligated itself to meet certain
operating factors.
The Company's revenues and expenses related to its agreements with SCEM
during 1999 were $445.1 million and $274.7 million, respectively. Intercompany
profits and losses recognized by SCEM on a market to market accounting basis are
appropriately eliminated in consolidation. Activity with SCEM during 1998 was
not material to the Company.
F-23
<PAGE> 178
SOUTHERN ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
6. EMPLOYEE BENEFIT PLANS
PENSION PLANS
The Company offers pension benefits to its WPD, Freeport Power Company and
North American employees, through various pension plans.
WPD participates in the Electricity Supply Pension Scheme ("ESPS"), which
provides pension and other related defined benefits based on final pensionable
pay to substantially all employees throughout the electricity supply industry in
the United Kingdom. The measurement date for WPD is December 31 for each year
presented. See Note 11 for further discussion.
As a result of WPD's sale to London Electricity of its supply business
(Note 12) during 1999, a curtailment and settlement of a portion of WPD's
pension plan occurred for the pension assets and obligations that transferred to
the buyer. In accordance with SFAS No. 88, "Employers' Accounting for
Settlements and Curtailments of Defined Benefit Pension Plans and for
Termination Benefits", a curtailment gain of $5 million and a settlement loss of
$14 million were recorded during 1999 in conjunction with this event.
Southern Energy participates in the Southern Company Pension Plan, a
defined benefit, trusteed, noncontributory plan covering substantially all
regular employees. The measurement date for the Domestic Benefit Plans is
September 30 for each year presented.
Freeport Power Company participates in a defined benefit, trusteed,
contributory pension plan that covers substantially all union employees. Plan
benefits are based on the employees' years of service and employment grades.
Plan assets are primarily invested in equity and debt securities. The
measurement date for Freeport Power is December 31 for each year presented.
All employees of Freeport Power Company not under the union are covered
under a defined benefit, noncontributory pension plan. Benefits earned under
this plan reflect the employee's years of service, age at retirement, and
average compensation for the highest five years out of the ten years immediately
preceding retirement. Plan assets are primarily invested in equity and debt
securities.
The Company also has noncontributory, defined benefit plans covering
substantially all union employees at recently acquired facilities. These plan
benefits are based on final average pay, age at retirement, and service at the
Company and the former employer. These Plans are funded according to Internal
Revenue Code requirements and are accounted for pursuant to SFAS No. 87,
"Accounting for Pensions."
The rates assumed in the actuarial calculations for the WPD pension plan as
of December 31, 1999 and 1998 were as follows:
<TABLE>
<CAPTION>
1998 1999
---- ----
<S> <C> <C>
Discount rate............................................... 5.75% 6.50%
Rate of compensation increase............................... 4.00 4.00
Expected return on plan assets.............................. 8.75 8.75
</TABLE>
F-24
<PAGE> 179
SOUTHERN ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following tables show the actuarial results for the WPD defined benefit
pension plan as of December 31 for the respective years (in millions):
<TABLE>
<CAPTION>
PENSION PLAN
---------------
1998 1999
------ ------
<S> <C> <C>
CHANGE IN BENEFIT OBLIGATION:
Benefit obligation, beginning of year....................... $ 890 $1,063
Service cost.............................................. 12 13
Interest cost............................................. 67 59
Benefits paid............................................. (61) (70)
Actuarial loss (gain)..................................... 143 (91)
Amendments................................................ 0 41
Curtailment............................................... 0 (7)
Settlement................................................ 0 (41)
Foreign currency exchange rate change..................... 12 (30)
------ ------
Benefit obligation, end of year........................ $1,063 $ 937
====== ======
CHANGES IN PLAN ASSETS:
Fair value of plan assets, beginning of year................ $1,152 $1,308
Return on plan assets..................................... 195 233
Employer contributions.................................... 1 0
Participants contributions................................ 6 4
Benefits paid............................................. (61) (70)
Settlement................................................ 0 (59)
Foreign currency exchange rate change..................... 15 (37)
------ ------
Fair value of plan assets, end of year................. $1,308 $1,379
====== ======
FUNDED STATUS:
Funded status at the end of year............................ $ 245 $ 442
Unrecognized prior service cost............................. 4 42
Unrecognized net gain....................................... (27) (251)
------ ------
Net amount recognized on the consolidated balance
sheets................................................ $ 222 $ 233
====== ======
</TABLE>
The rates assumed in the actuarial calculations for the pension plans
(excluding WPD) of the Company summarized below, as of their respective
measurement dates, were as follows:
<TABLE>
<CAPTION>
1998 1999
----- -----
<S> <C> <C>
Discount rate............................................... 6.25% 7.00%
Rate of compensation increase............................... 4.75 5.50
Expected return on plan assets.............................. 8.00 8.00
</TABLE>
F-25
<PAGE> 180
SOUTHERN ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following tables show the collective actuarial results for the defined
benefit pension plans (excluding WPD) of the Company (in millions):
<TABLE>
<CAPTION>
PENSION PLAN
-------------
1998 1999
----- -----
<S> <C> <C>
CHANGE IN BENEFIT OBLIGATION:
Benefit obligation, beginning of year....................... $ 27 $ 32
Service cost.............................................. 1 3
Interest cost............................................. 2 3
Actuarial loss............................................ 1 2
Amendments................................................ 1 0
Acquisitions.............................................. 0 17
---- ----
Benefit obligation, end of year...................... $ 32 $ 57
==== ====
CHANGES IN PLAN ASSETS:
Fair value of plan assets, beginning of year................ $ 26 $ 30
Return on plan assets..................................... 1 4
Employer contributions.................................... 1 1
Receivables due to transfers.............................. 2 9
---- ----
Fair value of plan assets, end of year............... $ 30 $ 44
==== ====
FUNDED STATUS:
Funded status at end of year................................ $ (2) $(13)
Unrecognized prior service cost........................... 3 2
Unrecognized net loss..................................... (6) (14)
Accruals for acquisitions................................. (12) 0
---- ----
Net amount recognized on the consolidated balance
sheets.............................................. $(17) $(25)
==== ====
</TABLE>
The components of the Company's pension plans' net pension income (a
portion of which is capitalized) during the years ended December 31 are shown
below (in millions):
<TABLE>
<CAPTION>
1997 1998 1999
----- ----- -----
<S> <C> <C> <C>
Service cost................................................ $ 13 $ 13 $ 16
Interest cost............................................... 73 71 62
Expected return on plan assets.............................. (98) (107) (104)
Employee contributions...................................... (6) (6) (4)
Curtailment................................................. 0 0 (5)
Settlement.................................................. 0 0 14
Net amortization............................................ 0 0 2
----- ----- -----
Net pension income.......................................... $ (18) $ (29) $ (19)
===== ===== =====
</TABLE>
F-26
<PAGE> 181
SOUTHERN ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
OTHER POSTRETIREMENT BENEFITS
Southern Energy also provides certain medical care and life insurance
benefits for its retired employees, substantially all of whom may become
eligible for these benefits when they retire.
Under SFAS No. 106, "Employers' Accounting for Postretirement Benefits
Other Than Pensions," medical care and life insurance benefits for retired
employees are accounted for on an accrual basis using a specified actuarial
method based on benefits and years of service.
An additional assumption used in measuring the accumulated postretirement
benefit obligation was a weighted average medical care cost trend rate of 7.74%
for 1999, decreasing gradually to 5.5% through the year 2005 and remaining at
that level thereafter. An annual increase or decrease in the assumed medical
care cost trend rate of 1% would correspondingly increase or decrease the
accumulated benefit obligation at December 31, 1999 by $2 million. All other
components would not be affected materially by a 1% change in the medical care
cost trend rate.
The weighted average rates assumed in the actuarial calculations for the
other postretirement benefits of the Company summarized below, as of their
respective measurement dates were as follows:
<TABLE>
<CAPTION>
1998 1999
---- ----
<S> <C> <C>
Discount rate............................................... 6.75% 7.50%
Rate of compensation increase............................... 4.25 5.00
Expected return on plan assets.............................. 8.50 8.50
</TABLE>
<TABLE>
<CAPTION>
OTHER
POSTRETIREMENT
BENEFITS
---------------
1998 1999
------ ------
<S> <C> <C>
CHANGE IN BENEFIT OBLIGATION:
Benefit obligation, beginning of year....................... $ 5 $ 8
Service cost.............................................. 0 1
Interest cost............................................. 1 1
Actuarial gain............................................ 0 (1)
Amendments................................................ 1 0
Acquisitions.............................................. 1 10
---- ----
Benefit obligation, end of year............................. $ 8 $ 19
==== ====
FUNDED STATUS:
Funded status at end of year................................ $ (8) $(19)
Unrecognized net loss..................................... 2 1
Accruals for acquisitions................................. (8) 0
---- ----
Net amount recognized....................................... $(14) $(18)
==== ====
</TABLE>
The postretirement benefits were unfunded at December 31, 1998 and 1999.
The actuarially based costs of Southern Energy's postretirement benefits during
1997, 1998, and 1999 were not material.
F-27
<PAGE> 182
SOUTHERN ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
STOCK-BASED COMPENSATION
In 1997, the Company initiated a long-term incentive plan, the value
creation plan, which grants appreciation rights to eligible employees to receive
share appreciation over a preestablished price on a stated number of shares per
employee. Employees are granted two types of appreciation rights: standard
appreciation rights which pay each eligible employee for any appreciation over a
fixed base value and indexed appreciation rights which pay each eligible
employee for any appreciation over a base value which increases each year by a
predetermined interest rate. Standard appreciation rights vest 25% per year for
four years, and indexed appreciation rights vest 100% after four years. The
Company records compensation expense ratably during the vesting period for any
intrinsic value of the units in accordance with APB Opinion 25. This expense
amounted to $1.7 million in 1999 and was not material in 1997 and 1998. Pursuant
to SFAS No. 123 "Accounting for Stock-Based Compensation," the Company has
elected to account for its stock-based compensation plan under APB Opinion 25
"Accounting for Stock Issued to Employees" and adopt the disclosure only
provisions of SFAS No. 123. Under SFAS No. 123, stock-based compensation awards
which are settled in cash are valued at grant date using the Black-Scholes
valuation model and compensation costs are recognized ratably over the vesting
period. Accounting for cash-settled awards under SFAS No. 123 is consistent with
the accounting for such awards under APB Opinion No. 25.
Transactions are summarized as follows:
<TABLE>
<CAPTION>
WEIGHTED WEIGHTED
AVERAGE AVERAGE
STANDARD EXERCISE INDEXED EXERCISE
RIGHTS PRICE RIGHTS PRICE
--------- -------- --------- --------
<S> <C> <C> <C> <C>
Outstanding at December 31, 1996................. 0 0 0 0
Granted.......................................... 559,579 $10.00 2,729,011 $10.00
Exercised........................................ 0 0 0 0
Forfeited........................................ 0 0 0 0
--------- ------ --------- ------
Outstanding at December 31, 1997................. 559,579 10.00 2,729,011 10.00
Granted.......................................... 1,093,849 9.73 54,582 11.30
Exercised........................................ 0 0 0 0
Forfeited........................................ 0 0 0 0
--------- ------ --------- ------
Outstanding at December 31, 1998................. 1,653,428 9.82 2,783,593 11.30
Granted.......................................... 1,456,665 $11.61 325,138 $11.61
Exercised........................................ (14,411) 9.90 0 0
Forfeited........................................ (24,995) 9.83 (91,216) 12.77
--------- ------ --------- ------
Outstanding at December 31, 1999................. 3,070,687 $10.67 3,017,515 $12.77
========= ====== ========= ======
Units exercisable at December 31, 1997........... 0 $ 0.00 0 $ 0.00
========= ====== ========= ======
Units exercisable at December 31, 1998........... 139,883 $10.00 0 $ 0.00
========= ====== ========= ======
Units exercisable at December 31, 1999........... 538,816 $ 9.87 0 $ 0.00
========= ====== ========= ======
</TABLE>
F-28
<PAGE> 183
SOUTHERN ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Exercise prices for standard rights outstanding as of December 31, 1999
ranged from $9.73 to $11.61. The following table provides certain information
with respect to standard rights outstanding at December 31, 1999:
<TABLE>
<CAPTION>
WEIGHTED AVERAGE
RIGHTS WEIGHTED AVERAGE REMAINING
EXERCISE PRICES OUTSTANDING EXERCISE PRICE CONTRACTUAL LIFE (YEARS)
--------------- ----------- ---------------- ------------------------
<S> <C> <C> <C>
Under $11.00............................. 1,614,022 $ 9.82 8.2
Over $11.00.............................. 1,456,665 11.61 9.5
--------- ------ ---
Total.................................. 3,070,687 $10.67 8.8
========= ====== ===
</TABLE>
The exercise price for indexed rights outstanding as of December 31, 1999
was $12.77, and such rights had a weighted average remaining contractual life of
7.7 years.
The following table provides certain information with respect to rights
exercisable at December 31, 1999:
<TABLE>
<CAPTION>
STANDARD
UNITS WEIGHTED AVERAGE
RANGE OF EXERCISE PRICES EXERCISABLE EXERCISE PRICE
------------------------ ----------- ----------------
<S> <C> <C>
Under $11.00................................................ 538,816 $ 9.87
Over $11.00................................................. 0 0.00
------- ------
Total..................................................... 538,816 $ 9.87
======= ======
</TABLE>
In the event that the Company becomes publicly traded, the compensation
committee of the Southern Company has the right to convert the appreciation
rights into stock options or other appreciation rights of the Company.
F-29
<PAGE> 184
SOUTHERN ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Stock option grants in Southern common stock have been made from Southern
Company's Performance Stock Plan periodically and vest annually at a rate of 33%
on the anniversary date of the grant. Grants fully vest upon termination because
of death, total disability or retirement. Exercise price is the average of the
high and low fair market value of Southern Company's common stock on the date
granted.
Transactions are summarized as follows:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
SOUTHERN EXERCISE
OPTIONS PRICE
--------- ----------
<S> <C> <C>
Outstanding at December 31, 1996 255,844 $ 22.41
Granted 273,940 21.25
Exercised 0 0.00
Forfeited (12,413) 21.97
--------- ----------
Outstanding at December 31, 1997 517,371 $ 21.81
Granted 283,864 27.03
Exercised (4,071) 21.87
Forfeited (1,693) 23.00
--------- ----------
Outstanding at December 31, 1998 795,471 $ 23.67
Granted 516,967 26.56
Exercised (6,001) 22.46
Forfeited (21,845) 25.31
--------- ----------
Outstanding at December 31, 1999 1,284,592 $ 24.81
========= ==========
Units exercisable at December 31, 1997 116,760 $ 21.92
========= ==========
Units exercisable at December 31, 1998 277,788 $ 21.91
========= ==========
Units exercisable at December 31, 1999 507,276 $ 22.83
========= ==========
</TABLE>
Exercise prices for Southern stock options outstanding as of December 31,
1999 ranged from $18.09 to $27.03. The following table provides certain
information with respect to Southern stock options outstanding at December 31,
1999:
<TABLE>
<CAPTION>
WEIGHTED
WEIGHTED AVERAGE
AVERAGE REMAINING
OPTIONS EXERCISE CONTRACTUAL
RANGE OF EXERCISE PRICES OUTSTANDING PRICE LIFE
------------------------ ----------- -------- ----------------
<S> <C> <C> <C>
$18.00 - $21.00.................................. 14,684 $18.77 4.2
$21.01 - $24.00.................................. 484,004 21.89 6.9
$24.01 - $28.00.................................. 785,904 26.72 9.2
---------
Total....................................... 1,284,592 $24.81 8.3
=========
</TABLE>
F-30
<PAGE> 185
SOUTHERN ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following table provides certain information with respect to rights
exercisable at December 31, 1999:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
OPTIONS EXERCISE
RANGE OF EXERCISE PRICES EXERCISABLE PRICE
------------------------ ----------- --------
<S> <C> <C>
$18.00 - $21.00............................................. 14,684 $18.77
$21.01 - $24.00............................................. 397,946 22.03
$24.01 - $28.00............................................. 89,646 27.03
-------
Total.................................................. 502,276 $22.93
======= ======
</TABLE>
The weighted average fair values at date of grant for options granted
during 1997, 1998 and 1999 were $4.26, $5.69 and $6.29, respectively, and were
estimated using the Black-Scholes option valuation model with the following
weighted-average assumptions:
<TABLE>
<CAPTION>
1997 1998 1999
----- ----- -----
<S> <C> <C> <C>
Expected life in years...................................... 10 10 10
Interest rate............................................... 6.49% 5.46% 5.79%
Volatility.................................................. 17.47% 19.16% 20.74%
Dividend yield.............................................. 6.1% 5.0% 5.0%
</TABLE>
Pro forma information for the years ended December 31, 1997, 1998 and 1999
is provided below, to take into account the amortization of stock-based
compensation to expense on a straight-line basis over the vesting period. Had
compensation costs been determined as prescribed by SFAS No. 123, the Company's
net income would have been reduced by less than $1 million in each of 1997 and
1998, and by less than $2 million in 1999. Earnings per share would have been
reduced by less than one cent in each period presented.
F-31
<PAGE> 186
SOUTHERN ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
7. DEBT
At December 31, 1998 and 1999, the Company's long-term debt (including
current maturities) was as follows (in millions):
<TABLE>
<CAPTION>
1998 1999
------ ------
<S> <C> <C>
Senior notes:
Dollar-denominated:
7.40% notes, due 2004.................................. $ 0 $ 200
7.90% notes, due 2009.................................. 0 500
Variable rate (7.19% to 7.32% at December 31, 1999),
due 2004.............................................. 0 140
Sterling-denominated:
6.38% notes, due 2001.................................. 168 163
6.80% notes, due 2006.................................. 332 321
7.75% and 10.5% senior loan participation certificate, due
2005 and 2006............................................. 340 340
Debt supported by long-term banking arrangements:
Dollar-denominated:
6.07% to 11.00% note, due 2000......................... 289 71
7.10% to 7.34% note, due 2001.......................... 6 6
6.58% note, due 2002................................... 792 792
9.75% note, due 2003................................... 27 21
6.44% to 9.50% notes, due 2004......................... 119 89
5.43% note, due 2004, guaranteed by Company............ 0 100
7.75% to 10% notes, due 2005........................... 166 417
6.93% to 9.70% notes, due 2006......................... 47 51
7.16% to 10.25% notes, due 2007........................ 566 495
5.95% to 10.56% notes, due 2011........................ 630 742
8.12% notes, due 2018.................................. 153 153
Deutsche mark-denominated:
3.81% to 3.96% note, due 2004.......................... 515 522
Other long-term debt:
Dollar-denominated:
6.13% to 8.38% loans, due 1999......................... 162 0
5.76% to 11% loans, due 2000 to 2007................... 16 24
Sterling-denominated:
0% to 7.64% loans, due 2000 and 2002................... 11 13
Deutsche mark-denominated:
3.07% to 5.50% loan, due 2008.......................... 60 31
------ ------
Total long-term debt................................. 4,399 5,191
Less current maturities..................................... 480 237
------ ------
Total................................................ $3,919 $4,954
====== ======
</TABLE>
F-32
<PAGE> 187
SOUTHERN ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
At December 31, 1999, the annual scheduled maturities of long-term debt
during the next five years were as follows (in millions):
<TABLE>
<S> <C>
2000........................................................ $ 237
2001........................................................ 373
2002........................................................ 1,027
2003........................................................ 239
2004........................................................ 1,153
</TABLE>
BANK ARRANGEMENTS
The Company has bank credit arrangements with various lending institutions
totaling approximately $3.021 billion. At December 31, 1999, unused credit
arrangements with banks totaled $1.256 billion, of which $574 million expires
during 2000 and $682 million during 2001 and beyond. The credit arrangements
generally require payment of commitment fees based on the unused portion of the
commitments or the maintenance of compensating balances with the banks. These
balances are not legally restricted from withdrawal.
In April 1999, Southern Energy entered into three revolving credit
agreements with a group of lending banks, as agent, with commitments totaling
$1.3 billion. Each of the corporate credit facilities is available for general
corporate purposes, including commercial paper backstop. Facility A with total
commitments of $500 million was intended to be a temporary facility until the
Company completed subsequent financings. Accordingly, this facility was
cancelled in October 1999. Facility B, a $350 million, 364-day revolving line of
credit with an annual commitment fee of $2.1 million, matures in March 2000;
however, it has extension and commitment increase options subject to the
lenders' approval. Facility C, totaling $450 million with an annual commitment
fee of $3.15 million, also has a letter of credit option and matures in April
2004. No amounts were drawn under this credit arrangement at December 31, 1999.
However, the Company had letters of credit outstanding under Facility C in the
amount of $250 million at December 31, 1999. In April 1999, the Company also
instituted a commercial paper program which is used in conjunction with the
corporate credit facilities as an alternate funding source. $50 million was
outstanding at December 31, 1999 under this program.
The April 1999 Credit Agreements contain various business and financial
covenants including, among other things, (i) limitations on dividends,
redemptions and repurchases of capital stock, (ii) limitations on the incurrence
of indebtedness and liens, (iii) limitations on capital expenditures, (iv)
limitations on ratio of recourse debt to recourse capital (v) maintenance of
minimum ratios of Corporate Debt Service to Corporate Interest. The Company is
in compliance with all of the covenants in the agreements governing this
indebtedness.
In October 1999, Southern Energy North America Generating, Inc. ("SENAG")
completed a $1.45 billion corporate-style bank financing consisting of three
credit facilities. Facility A is a $1.15 billion 364-day term loan with a
two-year term-out option and no commitment fee. Facility B is a $250 million
five-year revolver, with an annual commitment fee of $1.5 million, to be used
for capital expenditures, and Facility C is a $50 million five-year revolver,
with an annual commitment fee of $300,000, for working capital needs. The draws
under Facilities B and C, in the amount of $140 million, are included in
long-term debt in the accompanying financial statements. The SENAG facilities
contain covenants substantially equivalent to those discussed above for the
April 1999 Credit
F-33
<PAGE> 188
SOUTHERN ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Agreement. SENAG is in compliance with all of the covenants in the agreements
governing this indebtedness.
In addition, Southern Energy, from time-to-time, borrows under uncommitted
lines of credit with banks and through commercial paper programs that have the
liquidity support of committed bank credit arrangements.
PREFERRED SECURITIES
In a series of transactions during 1997 and 1998, subsidiaries of the
Company borrowed $682 million and $350 million respectively, dollar denominated
income preferred securities. The securities are due between 2027 and 2037 with
fixed interest rates between 6.875% and 8.235%. The Company entered into a swap
agreement to effectively convert the $82 million security borrowed in 1997, to
British pound sterling at the time of issuance. Based on year end exchange
rates, $1,033 million and $1,031 million was outstanding on the securities at
December 31, 1998 and 1999 respectively. See Note 9 for further discussion of
the Company's liability management program.
Subsidiary obligated mandatorily redeemable preferred securities have been
issued by special purpose financing entities of Southern Energy. Substantially
all of the assets of these special financing entities are junior subordinated
notes issued by the Company. The Company has loaned $950 million of the proceeds
from the issuance of these subsidiary obligated mandatorily redeemable preferred
securities and an additional $30 million related to equity to Southern. Payment
terms and interest rates on the notes receivable from Southern Company are
identical to the related preferred securities. The notes are due between 2027
and 2037 with fixed interest rates between 6.875% and 8.19%. These receivables
from Southern are included in notes receivable in the accompanying balance
sheets.
NOTE PAYABLE TO SOUTHERN COMPANY
Periodically, the Company borrows funds from Southern to finance
acquisitions or working capital needs. The Company pays interest to Southern
based on Southern Company's short-term borrowing rate. At December 31, 1998 this
interest rate was 5.47%. No amounts were outstanding at December 31, 1999.
F-34
<PAGE> 189
SOUTHERN ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
8. INCOME TAXES
Details of the income tax provision for the years ended December 31, 1997,
1998, and 1999 are as follows (in millions):
<TABLE>
<CAPTION>
1997 1998 1999
---- ----- ----
<S> <C> <C> <C>
INCOME TAX PROVISION:
Income tax from continuing operations:
United States:
Current benefit........................................ $(24) $ (87) $(16)
Deferred provision (benefit)........................... 35 (44) 36
International:
Current provision...................................... 45 15 18
Windfall profits tax assessed in the United Kingdom.... 148 0 0
Deferred (benefit) provision........................... (29) (7) 91
---- ----- ----
Total provision (benefit) from continuing
operations.......................................... $175 $(123) $129
==== ===== ====
Income tax from discontinued operations:
Current benefit........................................ (19) (33) (54)
Deferred provision..................................... 9 11 39
---- ----- ----
Total benefit from discontinued operations........... $(10) $ (22) $(15)
==== ===== ====
</TABLE>
In July 1997, the new Labor government in the United Kingdom introduced its
first budget, which became effective July 31, 1997. This budget included a
one-time windfall profit tax on privatized utilities in the United Kingdom,
which included the Company's subsidiary, WPD. As reflected in the accompanying
statements of income, the effect of this tax was recorded during fiscal year
1997. The Company paid the first installment of this tax on December 1, 1997 and
made the second and final installment on December 1, 1998.
F-35
<PAGE> 190
SOUTHERN ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The tax effects of temporary differences between the carrying amounts of
assets and liabilities in the financial statements and their respective tax
bases which give rise to deferred tax assets and liabilities are as follows (in
millions):
<TABLE>
<CAPTION>
1998 1999
---- ----
<S> <C> <C>
DEFERRED TAX LIABILITIES:
Property, plant, and equipment basis differences............ $626 $699
Pensions.................................................... 65 64
Taxes accrued on undistributed earnings..................... 27 0
Other....................................................... 23 49
---- ----
Total..................................................... $741 $812
==== ====
DEFERRED TAX ASSETS:
Impairment loss............................................. $ 67 $ 85
Deferred costs.............................................. 11 20
Accrued expenses............................................ 71 20
Other....................................................... 19 7
---- ----
Total..................................................... 168 132
---- ----
Net deferred tax liabilities.............................. $573 $680
==== ====
</TABLE>
A reconciliation of the Company's federal statutory income tax rate to the
effective income tax rate for continuing operations for the years ended December
31, 1997, 1998, and 1999 is as follows:
<TABLE>
<CAPTION>
1997 1998 1999
---- ---- ----
<S> <C> <C> <C>
Statutory income tax rate................................... 35% (35)% 35%
State income tax, net of federal benefit.................... 0 3 1
Windfall profits tax........................................ 82 0 0
Non-U.S. taxes.............................................. (19) (192) (17)
Other....................................................... (1) 0 0
--- ---- ---
Effective income tax rate................................. 97% (224)% 19%
=== ==== ===
</TABLE>
The difference between the statutory rate and the effective income tax rate
for discontinued operations for 1997, 1998, and 1999 is primarily due to the
utilization of domestic tax credits.
The Company and the other subsidiaries of Southern file a consolidated
federal income tax return. Under a joint income tax agreement, each company's
current and deferred tax expense is computed on a stand-alone basis. Under this
agreement, the Company received tax refunds from Southern of approximately $118
million and $99 million during 1998 and 1999, respectively. Approximately $65
million and $100 million of the other current receivables balance at December
31, 1998 and 1999, respectively, are comprised of tax refunds under the
consolidated income tax agreement or from various tax authorities. Approximately
$83 million and $152 million of the other current payables balance at December
31, 1998 and 1999, respectively, are comprised of income taxes currently payable
to various tax authorities.
F-36
<PAGE> 191
SOUTHERN ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The undistributed earnings of certain foreign subsidiaries aggregated $435
million as of December 31, 1999, which, under existing tax law, will not be
subject to U.S. income tax until distributed. Of the total undistributed
earnings, provisions for U.S. taxes have not been accrued on $210 million
related to earnings that have been, or are intended to be, indefinitely
reinvested.
9. FINANCIAL INSTRUMENTS
COMMODITY-RELATED TRADING ACTIVITIES
During 1999, Southern Energy created an energy trading company in
Amsterdam, which provides risk management services associated with the energy
industry to its customers in the European market. These services are provided
primarily through a variety of exchange-traded energy contracts including
forward contracts, futures contracts, option contracts, and financial swap
agreements. These contractual commitments, which represent risk management
assets and liabilities, are accounted for using the mark-to-market method of
accounting. Accordingly, they are reflected at fair value, net of future
delivery costs, in the consolidated balance sheets.
The Amsterdam trading operations engage in risk management activities. All
such transactions and related expenses are recorded on a trade-date basis.
Financial instruments and contractual commitments utilized in connection with
these activities are accounted for using the mark-to-market method of
accounting. Under the mark-to-market method of accounting, financial instruments
and contractual commitments, including derivatives used for these purposes, are
recorded at fair value. The determination of fair value considers various
factors, including closing exchange or over-the-counter (OTC) market price
quotations, time value and volatility factors underlying options and contractual
commitments, price activity for equivalent or synthetic instruments in markets
located in different regions, and counterparty credit quality.
Net unrealized gains from risk management services related to the Amsterdam
trading operation are immaterial at December 31, 1999. The volumetric weighted
average maturity of the contractual commitments was 1.35 years. The net notional
amount of the risk management assets and liabilities at December 31, 1999 was
5.3 billion kilowatt-hours. The notional amount is indicative only of the volume
of activity and not of the amount exchanged by the parties to the financial
instruments. Consequently, these amounts are not a measure of market risk. The
fair value of these risk management assets and liabilities averaged $0.2 million
and $4 million, respectively. The averages for 1999 were based on month-end
balances. The fair value of these assets and liabilities at December 31, 1999
was $1 million and $5 million, respectively.
The Amsterdam trading operations involve elements of credit risk. Credit
risk relates to the risk of loss that the company would incur as a result of
nonperformance by counterparties pursuant to the terms of their contractual
obligations. The trading operation has attempted to mitigate this risk by
establishing controls to determine and monitor the creditworthiness of
counterparties. The Company monitors credit risk on both an individual and group
counterparty basis. Accordingly, Southern Energy does not anticipate any
material impact to its financial position or results of operations as a result
of counterparty nonperformance.
Effective in January 1998, Southern Energy and VRI combined their energy
trading and marketing activities to form a North American joint venture, SCEM
(Note 3). Southern Energy's investment in the joint venture is accounted for
under the equity method of accounting.
F-37
<PAGE> 192
SOUTHERN ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
ASSET AND LIABILITY MANAGEMENT
The Company is exposed to market risk, including changes in interest rates,
currency exchange rates, and certain commodity prices. To manage the volatility
relating to these exposures, the Company enters into various derivative
transactions pursuant to the Company's policies in such areas such as
counterparty exposure and hedging practices.
The Company's policy is to manage interest expense using a combination of
fixed and variable rate debt. To manage this mix in a cost-efficient manner, the
Company enters into interest rate swaps in which the Company agrees to exchange,
at specified intervals, the difference between fixed and variable interest
amounts calculated by reference to an agreed-upon notional principal amount.
These swaps are designated to hedge underlying debt obligations. For qualifying
hedges, the interest rate differential is reflected as an adjustment to interest
expense over the life of the swaps. Gains and losses resulting from the
termination of qualified hedges prior to their stated maturities are recognized
ratably over the remaining life of the instrument being hedged.
Currency swaps are used by the Company to hedge its net investment in
certain foreign subsidiaries. Gains or losses on these currency swaps designated
as hedges of net investments are offset against the translation effects
reflected in other comprehensive income, net of tax.
The company utilizes currency swaps and forward agreements to hedge U.S.
dollar-denominated debt issued by our Southern Investments UK plc subsidiary.
These swaps offset the dollar cash flows, thereby effectively converting debt to
the respective subsidiary's functional currency. Gains and losses related to
qualified hedges of foreign currency firm commitments are deferred and included
in the basis of the underlying transactions.
Off-balance sheet derivative financial instruments at December 31, 1998 and
1999 held for purposes other than trading were as follows (in millions):
<TABLE>
<CAPTION>
YEAR OF
MATURITY OR 1998 1998 1999 1999
UNRECOGNIZED NOTIONAL UNRECOGNIZED NOTIONAL UNRECOGNIZED
TERMINATION AMOUNT GAIN (LOSS) AMOUNT GAIN (LOSS)
------------ -------- ------------ -------- ------------
<S> <C> <C> <C> <C> <C>
TYPE:
Interest rate swaps............ 2000-2016 $ 928 $ (69) $ -- $ --
2000-2012 -- -- 1,910 (3)
2001-2012 L600 (130) L600 (49)
2002-2007 DM691 (30) DM691 (5)
CROSS CURRENCY:
Swaps.......................... 2001-2007 L429 11 L414 (11)
Swaption....................... 2003 DM555 (18) DM435 11
</TABLE>
-------------------------
L --denotes British Pound Sterling.
DM --denotes Deutsche Mark.
The unrecognized gain/loss for interest rate swaps is determined based on
the estimated amount that the Company would receive or pay to terminate the swap
agreement at the reporting date based
F-38
<PAGE> 193
SOUTHERN ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
on third-party quotations. The unrecognized gain/loss for cross-currency
financial instruments is determined based on current foreign exchange rates.
Prior to the sale of its supply business, the Company's subsidiary, WPD,
utilized contracts to mitigate its exposure to volatility in the prices of
electricity purchased through the wholesale electricity market. Such contracts
allowed WPD to effectively convert the majority of its anticipated wholesale
electricity purchases from market prices to fixed prices. Due to the immaturity
of the electricity trading market in the United Kingdom and the complexity of
WPD's existing contracts, it was not practicable to estimate the fair value of
these contracts. Such contracts were sold in connection with the electricity
supply business sale.
MARKET RISK
Market risk is the potential loss the Company may incur as a result of
changes in the market or fair value of a particular instrument or commodity. All
financial and commodities-related instruments, including derivatives, are
subject to market risk. The Company's exposure to market risk is determined by a
number of factors, including the size, duration, composition, and
diversification of positions held, the absolute and relative levels of interest
rates, as well as market volatility and illiquidity. The most significant factor
influencing the overall level of market risk to which the Company is exposed is
its use of hedging techniques to mitigate such risk. The Company manages market
risk by actively monitoring compliance with stated risk management policies as
well as monitoring the effectiveness of its hedging policies and strategies. The
Company's risk management policies limit the amount of total net exposure and
rolling net exposure during stated periods. These policies, including related
risk limits, are regularly assessed to ensure their appropriateness given the
Company's objectives.
CREDIT RISK
The Company is exposed to losses in the event of nonperformance by
counterparties to its derivative financial instruments. Credit risk is measured
by the loss the Company would record if its counterparties failed to perform
pursuant to terms of their contractual obligations and the value of collateral
held, if any, was not adequate to cover such losses. The Company has established
controls to determine and monitor the creditworthiness of counterparties, as
well as the quality of pledged collateral, and uses master netting agreements
whenever possible to mitigate the Company's exposure to counterparty credit
risk. Additionally, the Company may require counterparties to pledge additional
collateral when deemed necessary.
Concentrations of credit risk from financial instruments, including
contractual commitments, exist when groups of counterparties have similar
business characteristics or are engaged in like activities that would cause
their ability to meet their contractual commitments to be adversely affected, in
a similar manner, by changes in the economy or other market conditions. The
Company monitors credit risk on both an individual and group counterparty basis.
FAIR VALUES
SFAS No. 107, "Disclosures About Fair Value of Financial Instruments,"
requires the disclosure of the fair value of all financial instruments.
Financial instruments recorded at market or fair value include cash and
interest-bearing equivalents, financial instruments used for trading purposes,
F-39
<PAGE> 194
SOUTHERN ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
commodities, and related instruments used for trading purposes, including
options and contractual commitments. The following methods were used by the
Company to estimate its fair value disclosures for financial instruments not
carried at fair value on the accompanying balance sheets:
NOTES RECEIVABLE. The fair value of the Company's note receivables is
estimated using interest rates the Company would receive based on similar
types of arrangements.
NOTES PAYABLE AND OTHER LONG- AND SHORT-TERM DEBT. The fair value of
the Company's notes payable and long- and short-term debt is estimated
using discounted cash flow analysis based on current market interest rates
for similar types of borrowing arrangements and market quotes, when
available.
SUBSIDIARY OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES. The
fair value of the Company's preferred securities is calculated based on
current market price.
The carrying or notional amounts and fair values of the Company's financial
instruments at December 31, 1998 and 1999 were as follows (in millions):
<TABLE>
<CAPTION>
1998 1999
----------------- -----------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
-------- ------ -------- ------
<S> <C> <C> <C> <C>
Notes receivable, including current portion............. $1,517 $1,564 $1,368 $1,277
Notes payable and long- and short-term debt............. 6,027 5,722 7,152 6,779
Subsidiary obligated mandatorily redeemable preferred
securities............................................ 1,033 1,098 1,031 907
</TABLE>
10. REGULATORY MATTERS
The Office of Gas & Electricity Markets controls the revenues earned by WPD
in its distribution business and former supply business by applying a price
control formula. Distribution revenues are regulated by a formula ("DPCF") that
sets the maximum average price per unit of electricity distributed. The elements
used in the formula are generally established for a five-year period and are
subject to review by the regulator. In December 1999, the regulator published
final price proposals following his review of the DPCF for distribution
businesses. For WPD, these proposals represent a 20% reduction to distribution
prices from April 1, 2000, followed by a reduction in real terms of 3% each year
after April 1, 2001. This price control is scheduled to operate until March
2005.
11. COMMITMENTS AND CONTINGENT MATTERS
STATE LINE
On July 28, 1998, an explosion occurred at State Line causing a fire and
substantial damage to the plant. The precise cause of the explosion and fire has
not been determined. Thus far, seven personal injury lawsuits have been filed
against the Company, five of which were filed in Cook County, Illinois. The
Company filed a motion to dismiss these five cases in 1998 for lack of "in
personam" jurisdiction. The motion was denied in August 1999. In October 1999,
the Appellate Court of Illinois granted our petition for leave to appeal. The
outcome of these proceedings cannot now be determined and an estimated range of
loss cannot be made.
F-40
<PAGE> 195
SOUTHERN ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
COMPANHIA ENERGETICA DE MINAS GERAIS
In September 1999, the state of Minas Gerais filed a lawsuit in a state
court seeking temporary relief against Southern Electric do Brazil
Parficipacoes, S.A. ("SEB") exercising voting rights under the shareholders
agreement, between the state and SEB regarding SEB's interest in Companhia
Energetica de Minas Gerais ("CEMIG"), as well as a permanent recision of the
agreement. The core issue in the dispute is whether the shareholders agreement
unconstitutionally transfers control of CEMIG from the state to SEB, which
transfer would have required specific legislative authorization. A lower court
judge denied the state's request, but one member of a three-judge State
Appellate Court granted a temporary injunction pending the outcome of the
litigation regarding recision of the shareholders agreement. This injunction,
however, does not affect the status of the CEMIG directors appointed by SEB,
which rights are not derived from the agreement.
SEB obtained financing from Banco Nacional de Desenvolvimento Economico e
Social (BNDES) for approximately 50% of the total purchase price of the CEMIG
shares which is secured by a pledge of SEB's shares in CEMIG. SEB is currently
in discussions with BNDES to defer a $117 million principal and interest payment
due on May 15, 2000. Based on our ownership of SEB, our portion of this amount
is $29 million.
SE CALIFORNIA
Southern Energy California LLC ("SE California"), a wholly owned subsidiary
of the Company, and its subsidiaries are parties to a Federal Energy Regulatory
Commission ("FERC") proceeding that will determine the percentage of a settled
$158.8 million revenue requirement to be paid to the SE California parties under
the reliability must-run ("RMR") agreements between the SE California parties
and the California Independent System Operator ("CAISO"). Hearings were
conducted before a FERC administrative law judge in March 2000. The SE
California parties have proposed to allocate approximately 75% of the
responsibility for payment of the revenue requirement to the CAISO, while CAISO
and other aligned parties argue that CAISO should pay no more than approximately
7%. The decision in this case will affect the amount CAISO will pay to SE
California and its subsidiaries for the period commencing June 1, 1999 through
December 31, 2001. The outcome of this proceeding is uncertain, and the parties
have recently commenced settlement discussions. The Company's failure to prevail
in this matter would adversely effect our results of operations.
WPD PENSION SCHEME
WPD participates in the ESPS in the United Kingdom, which includes members
from the Regional Electricity Companies as well as other industry members. WPD
used a portion of its pension surplus to fund early pension payments to
terminated employees. An independent pension arbitrator has issued a ruling
directing that another industry employer refund similar amounts paid, with
interest to ESPS. This ruling is currently being appealed to the House of Lords.
The majority of WPD's employees are ESPS members. Based on the Company's
assessment of the current legal position, it anticipates that a payment by WPD
into the ESPS of L24 million ($36 million) will ultimately be required, should
the other industry employer's appeal fail and WPD then be named in a similar
action. Management does not believe such payment would have a material adverse
impact on the Company's financial position, liquidity or results of operations.
Under SFAS No. 87, "Employers'
F-41
<PAGE> 196
SOUTHERN ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Accounting for Pensions," there would be no immediate impact to the Company's
results of operations.
In addition to the matters discussed above, the Company is party to legal
proceedings arising in the ordinary course of business. In the opinion of
management, the disposition of these matters will not have a material adverse
impact on the results of operations or financial position of the Company.
ENERGY MARKETING AND RISK MANAGEMENT COMMITMENTS
The company and VRI have jointly agreed to provide up to $700 million of
contingent performance guarantees and trade credits on behalf of SCEM. Southern
Company, Southern Energy, Vastar, and ARCO provide the actual guarantees.
Southern Energy and Vastar have agreed to indemnify each other (subject to
certain limitations of liability) against loss in proportion to their respective
ownership shares of the SCEM (Note 3) entities with respect to any amounts paid
by Southern Company, Southern Energy, Vastar or their affiliates; although
Southern Energy would pay more (up to 100%) of the losses incurred on such
guarantees if necessary for Vastar to receive the minimum cash distributions
from SCEM (which are guaranteed by Southern Energy) in the years 1998 through
2002. If necessary to support SCEM's ongoing business, the amount of the
contingent performance guarantees and trade credits can exceed $700 million, and
to the extent that the actual aggregate liability on all such parent guarantees
were to exceed $700 million, Southern Energy has agreed to provide (at a
market-based price) for the amount in excess of $700 million. Additional
guarantees may be provided for structured transactions with certain approvals
and those guarantees may not be subject to any right of indemnity or
contribution between SCEM's parent companies. Contingent performance guarantees
are an industry standard used to backstop the physical and financial delivery of
product. The gross amount represents total counterparty authority, but actual
exposure under these guarantees is limited by the amount of business conducted
under each guarantee. Payments will be made under these guarantees only if
SCEM's liquidity is exhausted. At December 31, 1999, outstanding guarantees
related to the estimated fair value of SCEM's net contractual commitments were
approximately $146 million.
Based on the Company's analysis, the potential exposure under these
contractual commitments would not materially differ from the estimated fair
value. SCEM's gross revenues and cost of trading for 1999 were $11,859 million
and $11,755 million, respectively.
The notional amount of SCEM's guarantees at December 31 are broken down as
follows (in millions):
<TABLE>
<CAPTION>
1998 1999
------------------------- -------------------------
PERFORMANCE OTHER PERFORMANCE OTHER
GUARANTOR GUARANTEES GUARANTEES GUARANTEES GUARANTEES
--------- ----------- ---------- ----------- ----------
<S> <C> <C> <C> <C>
SEI.......................................... $ 6 $240 $ 10 $315
Southern..................................... 207 -- 306 --
Vastar....................................... 421 -- 322 --
ARCO......................................... 38 -- 19 --
</TABLE>
Southern Energy has guaranteed certain minimum annual cash distributions
owed by SCEM to VRI. These guaranteed cash distributions can be reduced by
certain extraordinary items. For 1999, this distribution, after adjustments, was
$17 million. Scheduled minimum cash distributions to VRI
F-42
<PAGE> 197
SOUTHERN ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
are $25 million in 2000 and $30 million in each of 2001 and 2002. See Note 3
where arbitration related to the 1998 minimum cash distribution is discussed.
Southern Energy has also guaranteed the performance of SCEM's obligations
under a multiyear agreement entered into by SCEM with Brazos Electric Power
Cooperative ("Brazos"). Under the agreement, effective January 1999, SCEM
provides all the electricity required to meet the needs of the distribution
cooperatives served by Brazos. Also, SCEM is entitled to the output of Brazos'
generation facilities and its rights to electricity under power purchase
agreements Brazos has entered into with third parties. Southern Energy's
guarantee is $75 million for the first year of the agreement and declines by $5
million per year to $55 million in the fifth year of the agreement.
To the extent that the Company does not maintain an investment grade
rating, it would be forced to provide alternative collateral to Brazos and VRI
only. Such collateral might be in the form of letters of credit. As mentioned
above, performance guarantees assure a subsidiary's performance of contractual
obligations whether it is commodity delivery or payment.
POWER PURCHASE AGREEMENTS
The Company recognized a liability at the WPD acquisition date for the
excess power purchase costs over an estimate equivalent pool costs. The balance
of the recorded liability was $116 million at December 31, 1998 and was sold as
part of the electricity supply business of WPD. See Note 12.
OPERATING LEASES
The Company has commitments under operating leases with various terms and
expiration dates. Expenses associated with these commitments totaled
approximately $13 million, $25 million, and $17 million during the years ended
December 31, 1997, 1998, and 1999, respectively. At December 31, 1999, estimated
minimum rental commitments for noncancellable operating leases were as follows
(in millions):
<TABLE>
<S> <C>
FISCAL YEAR ENDED:
2000........................................................ $ 16
2001........................................................ 16
2002........................................................ 15
2003........................................................ 14
2004........................................................ 14
Thereafter.................................................. 103
----
Total minimum payments $178
====
</TABLE>
LABOR SUBJECT TO COLLECTIVE BARGAINING AGREEMENTS
Substantially all of WPD's employees are subject to one of five collective
bargaining agreements. Such agreements are ongoing in nature, and WPD's employee
participation level is consistent with that of the electric utility industry in
Great Britain.
At its State Line facility in Hammond, Indiana, Southern Energy has a labor
contract with the United Steel Workers that extends to January 1, 2004.
F-43
<PAGE> 198
SOUTHERN ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Southern Energy Canal LLC and Southern Energy Kendall LLC, both
subsidiaries of Southern Energy, have contracts with the Utilities Workers'
Union of America which expire on June 1, 2001 and March 1, 2001, respectively.
UNCERTAINTIES RELATED TO CONTRACT SALES
Several of the Company's significant power generation facilities rely on
either PPAs or energy conversion agreements ("ECAs" and collectively with the
PPAs the "Power Contracts") with one or a limited number of entities for the
majority of, and in some cases all of, the relevant facility's output over the
life of the Power Contract. For example, for the year ended December 31, 1999,
approximately 14% of the Company's revenues were attributable to revenue
received by its the Philippines facilities pursuant to agreements with NPC. See
Note 1 where concentration of revenues is discussed.
The Power Contracts related to the Company's facilities are generally
long-term agreements covering the sale of power for 20 or more years. However,
the operation of such facilities is dependent on the continued performance by
customers and suppliers of their obligations under the relevant Power Contract,
and, in particular, on the credit quality of the purchasers. If a substantial
portion of the Company's long-term Power Contracts were modified or terminated,
the Company would be adversely affected to the extent that it was unable to find
other customers at the same level of profitability. Some of the Company's
long-term Power Contracts are for prices above current spot market prices. The
loss of one or more significant Power Contracts or the failure by any of the
parties to a Power Contract to fulfill its obligations thereunder could have a
material adverse effect on the Company's business, results of operations and
financial condition.
The Company has entered into two significant power contracts. These two
contracts are Energy Conversion Agreements between subsidiaries of SE
Asia-Pacific and the National Power Corporation ("NPC") of the Philippines. The
contract for the Pagbilao plant is for 29 years and terminates in August 2025.
The contract for the Sual plant is for 25 years and terminates in June 2025. The
contracted capacity is 735 MW and 1,000 MW for Pagbilao and Sual, respectively.
The capacity fees are payable as compensation for capacity available for power
generation. These fees consist of capital recovery fees, fixed operating fees,
infrastructure fees and the components of service fees. Over 90% of the revenues
are expected to come from fixed capacity charges that are paid without regard to
dispatch level of the plant. The energy fees are based on energy sold and are
designed to cover variable operating and maintenance costs. In accordance with
the contracts, NPC assumes all fuel risks, including price and delivery.
MINORITY SHAREHOLDER PUT OPTIONS
Sual
Under shareholder agreements, the minority shareholders of the SE
Asia-Pacific subsidiary which holds the Sual project (SEPI) can exercise a put
option requiring SEPI to purchase the minority shareholders' interest in the
project. The put option can be exercised between the third and sixth
anniversaries of the completion of the project construction or, in the event of
any change in control, a change in SEPI's charter documents or the transfer of
sponsor in violation of the sponsor support agreement, the put option may be
exercised on the earlier of the date of such changes or the twelfth anniversary
of the completion of the project construction. The price would be determined by
a
F-44
<PAGE> 199
SOUTHERN ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
formula including the present value of the remaining years of cash flow less the
liabilities outstanding plus the current assets.
Pagbilao
Under shareholder agreements, the minority shareholders of the SE
Asia-Pacific subsidiary which holds the Pagbilao project (SEQI) can exercise a
put option requiring SEQI to purchase the minority shareholders' interests in
the project. The put option can be exercised between the sixth and twelfth
anniversaries of the completion of the project construction or, in the event of
any change in control, a change in SEQI's charter documents or the transfer of
sponsor in violation of the sponsor completion support agreement the put option
may be exercised on the earlier of the date of such changes or the twelfth
anniversary of the completion of the project construction. The price would be
determined by a formula including the present value of the remaining years of
cash flow less the liabilities outstanding plus the current assets.
12. ACQUISITIONS AND DIVESTITURES
SE CALIFORNIA
On April 16, 1999, the Company, through SE California, acquired various
generating assets in California with a total capacity of 3,065 MW from Pacific
Gas & Electric Company for $801 million plus $39 million for fuel inventory,
capital expenditures and property taxes.
SE NEW YORK
On June 30, 1999, the Company, through certain of its wholly owned
subsidiaries (collectively referred to as SE New York), acquired the generating
asset business in the state of New York with a total capacity of 1,794 MW, from
Orange and Rockland Utilities, Inc. and Consolidated Edison Company of New York
for a net purchase price of approximately $476 million, plus an additional $17
million to cover the market value of existing inventories. The acquisition was
recorded under the purchase method of accounting. A portion of the purchase
price has been allocated to assets acquired and liabilities assumed based on the
estimated fair market value at the date of acquisition while the balance of $48
million was recorded as goodwill. The purchase price allocation for this
acquisition is preliminary and further refinements will be made based on the
completion of the final valuation studies. The pro forma operating results of
this acquisition for the years presented was not materially different from
actual results. The initial allocation of the purchase price is as follows (in
millions):
<TABLE>
<S> <C>
Current assets.............................................. $ 28
Property, plant and equipment............................... 417
Acquired intangibles........................................ 15
Goodwill.................................................... 48
Liabilities assumed and other............................... (15)
----
Purchase price......................................... $493
====
</TABLE>
F-45
<PAGE> 200
SOUTHERN ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
SIPD
On June 30, 1999, the Company, through a wholly owned subsidiary, acquired
a 9.99% interest in SIPD for $107 million. As of December 31, 1999, SIPD had an
ownership interest in 18 coal-fired power generating units with a total
installed capacity of 5,125 MW in China's Shandong province. The Company
accounts for its investment in SIPD under the equity method of accounting due to
the preferential board representation and significant operating influence.
WPD (FORMERLY SWEB)
In September 1999, SWEB sold its electricity supply business to London
Electricity for the British Pound Sterling equivalent of $264 million and the
assumption of certain liabilities resulting in a gain of $286 million prior to
expenses, minority interest, and income taxes, and a gain of $78 million after
these items. The Company retained its 49% interest in the distribution business,
the trading name of which has been changed to Western Power Distribution. The
Company continues to own 49% economic interest (50.5% voting interest) of WPD.
LOUISIANA GENERATING LLC
During September 1999, the Company sold its 50% investment in Louisiana
Generating LLC to its partner for $17 million. The Company recognized
approximately $10 million as an after-tax gain on the sale which is included in
the accompanying statements of income.
CEMIG
In January 1998, Southern Energy, participating in a consortium, exercised
its option to maintain participation in the CEMIG project by transferring
approximately $114 million to the consortium and in May 1998, completed this
transaction by transferring an additional $21 million. The Company accounts for
this investment under the equity method due to significant influence evidenced
by 33% voting shares held by the Company and its investing partner.
EDELNOR
During 1998, the Company purchased an additional 15% interest in its
Chilean investment in Empresa Electrica del Norte Grande S.A. for approximately
$57 million. The purchase price resulted in $32 million of negative goodwill
which was recorded as a reduction in the basis of the Company's long-lived
assets.
WPD (FORMERLY SWEB)
On June 18, 1998, Southern Energy sold a 26% interest in its subsidiary,
SWEB Holdings Limited ("Holdings") to PP&L for approximately $170 million. The
Company recorded a pretax gain of approximately $20 million on the sale, which
is included in the accompanying statements of income. This sale increased PP&L's
economic interest in Holdings to 51% and, conversely, reduced Southern Energy's
economic interest to 49%. Subsequently, on June 18, 1998, shares of Holdings
held by Southern Company and PP&L were exchanged for equivalent shares in SWEB
Holdings U.K. ("Holdings U.K."). Under the terms of the agreement, Southern
Energy retains operational and
F-46
<PAGE> 201
SOUTHERN ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
management control of Holdings U.K. and its subsidiaries. Southern Energy
continues to hold 50.5% of the voting shares in Holdings U.K. and retains a
majority of the seats on the board of directors.
SE NEW ENGLAND
On December 30, 1998, the Company, through a wholly owned subsidiary,
Southern Energy New England, LLC ("SE New England"), acquired the generating
asset business, with a total capacity of 1,245 MW, from subsidiaries of
Commonwealth Energy Systems and Eastern Utilities Associates for $536 million.
The acquisition was recorded under the purchase method of accounting. A portion
of the purchase price has been allocated to assets acquired and liabilities
assumed based on the estimated fair market value at the date of acquisition
while the balance of $261 million was recorded as goodwill. The pro forma
operating results of this acquisition for 1997 and 1998 was not materially
different from actual results. The purchase price was allocated as follows (in
millions):
<TABLE>
<S> <C>
Current assets.............................................. $ 13
Property, plant, and equipment.............................. 188
Acquired intangibles........................................ 143
Goodwill.................................................... 261
Liabilities assumed and other............................... (69)
----
Purchase price............................................ $536
====
</TABLE>
SE ASIA-PACIFIC
On January 29, 1997, the Company completed its acquisition of 80% of SE
Asia-Pacific, the largest independent power producer in Asia, for a total net
investment of approximately $2 billion (Note 2). Subsequently, in August 1997,
Southern Energy acquired the remaining 20% minority interest in SE Asia-Pacific
in exchange for approximately $150 million in cash and SE Asia-Pacific's
interest in the Tanjung Jati B project in Indonesia. The acquisition was
financed with a combination of long-term borrowings and a capital contribution
from Parent. The acquisition of SE Asia-Pacific was accounted for using the
purchase method of accounting in accordance with APB No. 16, "Accounting for
Business Combinations." The purchase price of SE Asia-Pacific was allocated to
the underlying assets and liabilities based on the estimated fair values at the
date of acquisition. The acquisition cost exceeded the estimated fair market
value of net assets acquired by $1.6 billion and is considered goodwill (Note
1).
The net purchase price of $2.1 billion was allocated as follows (in
millions):
<TABLE>
<S> <C>
Leasehold interest.......................................... $ 1,003
Construction work in progress............................... 45
Current assets.............................................. 635
Other assets................................................ 711
Investments................................................. 70
Goodwill.................................................... 1,649
Current liabilities......................................... (809)
Other liabilities........................................... (1,198)
-------
Purchase price.............................................. $ 2,106
=======
</TABLE>
F-47
<PAGE> 202
SOUTHERN ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
SE Asia-Pacific's operations have been included in the financial statements
since January 29, 1997. The following unaudited pro forma results of operations
for 1997 have been prepared assuming the acquisition of SE Asia-Pacific occurred
on January 1, 1997 and was financed with a combination of long-term debt,
short-term debt and a capital contribution. The pro forma results are not
necessarily indicative of the actual results that would have been realized had
the acquisition occurred on the assumed date, nor are they necessarily
indicative of future results. Pro forma operating results for 1997 are for
information purposes only and are as follows (in millions):
<TABLE>
<CAPTION>
AS PRO
REPORTED FORMA
-------- ------
<S> <C> <C>
Operating revenues.......................................... $3,750 $3,771
Income before extraordinary item............................ (16) (11)
Net income.................................................. (16) (11)
</TABLE>
BEWAG
During September 1997, the Company completed the acquisition of a 26%
interest in the Berlin, Germany, electric utility Bewag for approximately $820
million. The entire acquisition was funded through a combination of short-term
and long-term borrowings. The Company is part of a consortium with two German
utilities which, together with the Company, own a 75% total interest in Bewag.
Bewag is an integrated electric utility located in Berlin, Germany. The
Company's investment in Bewag is being accounted for under the equity method of
accounting.
STATE LINE
In December 1997, the Company acquired the assets of the State Line
Generating Station from Commonwealth Edison Company for approximately $68
million.
13. INVESTMENTS IN AFFILIATES
The Company has investments in various international and domestic energy
projects. The equity method of accounting is applied to such investments in
affiliated entities, which include corporations, joint ventures and
partnerships, because the ownership structure prevents the Company from
exercising a controlling influence over operating and financial policies. Under
this method, equity in income or losses of these entities is reflected as equity
in earnings of unconsolidated affiliates in the accompanying consolidated
statements of income.
F-48
<PAGE> 203
SOUTHERN ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following table sets forth summarized financial information of the
Company's investments in 50% or less-owned investments accounted for under the
equity method (Note 1) as of December 31, 1998 and 1999 and for the years ended
December 31, 1997, 1998 and 1999 or periods from the respective affiliates'
acquisition date, if shorter:
<TABLE>
<CAPTION>
1997 1998 1999
---- ------ ------
(IN MILLIONS)
<S> <C> <C> <C>
COMBINED INVESTMENTS, EXCLUDING BEWAG
INCOME STATEMENT:
Revenues.................................................... $723 $2,685 $3,441
Operating income............................................ 383 728 831
Net income from continuing operations....................... 50 324 184
BALANCE SHEET:
Current assets.............................................. 629 1,189
Noncurrent assets........................................... 3,413 5,569
Current liabilities......................................... 1,056 1,611
Noncurrent liabilities...................................... 2,569 3,604
BEWAG
INCOME STATEMENT:
Revenues.................................................... $589 $2,366 $2,167
Operating income............................................ 82 419 (128)
Net income from continuing operations....................... 41 216 (84)
BALANCE SHEET:
Current assets.............................................. 677 605
Noncurrent assets........................................... 7,037 6,073
Current liabilities......................................... 1,464 1,582
Noncurrent liabilities...................................... 2,424 1,930
</TABLE>
As of December 31, 1999 the Company had accumulated $23 million in
undistributed earnings of entities accounted for by the equity method of
accounting.
14. SE-FINANCE
The company has investments in leveraged leases through it's leasing
subsidiary SE-Finance. The company entered into leveraged leases in December of
1996, 1998 and 1999. The Company's net investment in leveraged leases consists
of the following at December 31, 1998 and 1999 (in millions):
<TABLE>
<CAPTION>
1998 1999
--------- ----------
<S> <C> <C>
Net rentals receivable...................................... $ 583 $ 1,339
Unearned income............................................. (319) (783)
--------- ----------
Investment in leveraged leases.............................. 264 556
Deferred taxes arising from leveraged leases................ (22) (58)
--------- ----------
Net investment in leveraged leases.......................... $ 242 $ 498
========= ==========
</TABLE>
F-49
<PAGE> 204
SOUTHERN ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following is a summary of the components of the income from leveraged
leases for the years ended December 31, 1998 and 1999 (in millions):
<TABLE>
<CAPTION>
1998 1999
------ -------
<S> <C> <C>
Pretax leveraged lease income............................... $ 5 $ 28
Income tax expense.......................................... 2 10
------ -------
Income from leveraged leases................................ $ 3 $ 18
====== =======
</TABLE>
15. EARNINGS PER SHARE
We calculate basic earnings per share by dividing net income available to
common shareholders by the weighted average number of common shares outstanding.
The following table shows our computation of earnings per share (in millions,
except per share data) after giving effect to the stock split that was effected
in conjunction with the offering of common stock (Note 17). Pro forma basic
earnings per share information gives effect to the dividend paid to Southern in
2000 as though it had occurred during 1999. See Note 17.
<TABLE>
<CAPTION>
FROM FROM
CONTINUING DISCONTINUED
OPERATIONS OPERATIONS NET
---------- ------------ -------
<S> <C> <C> <C>
Basic, 1997:
(Loss) income............................................. $ (24) $ 8 $ (16)
Shares.................................................... 272 272 272
------- ----- -------
(Loss) earnings per share................................. $ (0.09) $0.03 $ (0.06)
======= ===== =======
Basic, 1998:
(Loss) income............................................. $ (12) $ 12 $ --
Shares.................................................... 272 272 272
------- ----- -------
(Loss) earnings per share................................. $ (0.04) $0.04 $ --
======= ===== =======
Basic, 1999:
Income.................................................... $ 362 $ 10 $ 372
Shares.................................................... 272 272 272
------- ----- -------
Earnings per share........................................ $ 1.33 $0.04 $ 1.37
======= ===== =======
Pro forma basic, 1999:
Income.................................................... $ 362 $ 10 $ 372
Shares.................................................... 272 272 272
Shares assumed due to dividend to Southern................ 31 31 31
------- ----- -------
Earnings per share........................................ $ 1.19 $0.04 $ 1.23
======= ===== =======
</TABLE>
16. SEGMENT REPORTING
Effective December 31, 1997, Southern Energy adopted SFAS No. 131,
"Disclosure About Segments of an Enterprise and Related Information." Southern
Energy's principal business segments consist of the geographic areas in which
the Company conducts business -- Americas, Asia-Pacific, and Europe. The other
reportable business segments are the Company's financing segment ("Southern
Energy Finance") and its business development and general corporate activities
segment
F-50
<PAGE> 205
SOUTHERN ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
("Corporate"). Intersegment revenues are not material. Financial data for
business segments, products and services, and geographic areas is as follows (in
millions):
BUSINESS SEGMENTS
<TABLE>
<CAPTION>
SOUTHERN
ENERGY
AMERICAS EUROPE ASIA-PACIFIC FINANCE CORPORATE CONSOLIDATED
-------- ------ ------------ --------- --------- ------------
<S> <C> <C> <C> <C> <C> <C>
1997:
Operating revenues............ $2,201 $1,282 $ 247 $ 0 $ 20 $3,750
Depreciation and
amortization................ 40 63 76 0 3 182
Interest income............... 9 4 84 0 41 138
Interest expense.............. 43 95 151 0 56 345
Income taxes from
operations.................. (12) 50 (7) 0 (4) 27
Windfall profit tax........... 0 148 0 0 0 148
Net income from equity method
subsidiaries................ 20 18 20 0 0 58
Segment net income (loss)..... 2 (48) 39 8 (17) (16)
Total assets.................. 1,783 3,701 4,304 176 666 10,630
Investments in equity method
subsidiaries................ 127 822 85 94 0 1,128
Gross property additions...... 115 130 475 0 0 720
Increase in goodwill.......... 0 0 1,649 0 0 1,649
1998:
Operating revenues............ 261 1,273 273 0 12 1,819
Depreciation and
amortization................ 44 79 96 0 2 221
Interest income............... 10 0 74 0 62 146
Interest expense.............. 59 123 141 0 107 430
Income taxes from
operations.................. (113) 22 (12) 0 (20) (123)
Write-down of generating
assets...................... 308 0 0 0 0 308
Net income from equity method
subsidiaries................ 27 64 44 0 0 135
Segment net income (loss)..... (180) 141 68 12 (41) 0
Total assets.................. 2,166 3,890 4,520 428 1,050 12,054
Investments in equity method
subsidiaries................ 373 923 131 84 0 1,511
Gross property additions...... 101 120 426 0 0 647
Increase in goodwill.......... 261 0 0 0 0 261
</TABLE>
F-51
<PAGE> 206
SOUTHERN ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
SOUTHERN
ENERGY
AMERICAS EUROPE ASIA-PACIFIC FINANCE CORPORATE CONSOLIDATED
-------- ------ ------------ --------- --------- ------------
<S> <C> <C> <C> <C> <C> <C>
1999:
Operating revenues............ $ 939 $ 976 $ 342 $ 0 $ 11 $2,268
Depreciation and
amortization................ 73 90 104 0 3 270
Interest income............... 18 6 72 0 76 172
Interest expense.............. 90 121 125 0 166 502
Income taxes from
operations.................. 34 96 25 0 (26) 129
Write-down of generating
assets...................... 29 31 0 0 0 60
Net income from equity method
subsidiaries................ 16 10 83 0 2 111
Segment net income (loss)..... 96 170 175 10 (79) 372
Total assets.................. 4,071 3,810 4,430 722 830 13,863
Investments in equity method
subsidiaries................ 248 762 254 76 0 1,340
Gross property additions...... 419 115 194 0 19 747
Increase in goodwill.......... 48 0 0 0 0 48
</TABLE>
PRODUCTS AND SERVICES
<TABLE>
<CAPTION>
GENERATION DISTRIBUTION MARKETING FINANCE OTHER TOTAL
---------- ------------ --------- ------- ----- ------
(REVENUE IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C>
1997............................... 427 1,283 1,982 0 58 3,750
1998............................... 494 1,273 1 0 51 1,819
1999............................... $1,222 $ 977 $ 0 $ 0 $69 $2,268
</TABLE>
GEOGRAPHIC AREAS
<TABLE>
<CAPTION>
INTERNATIONAL
-----------------------------
UNITED THE UNITED ALL
STATES PHILIPPINES KINGDOM OTHER CONSOLIDATED
------ ----------- ------- ----- ------------
(REVENUE IN MILLIONS)
<S> <C> <C> <C> <C> <C>
1997....................................... 2,003 247 1,282 218 3,750
1998....................................... 53 273 1,273 220 1,819
1999....................................... $ 736 $342 $ 976 $214 $2,268
</TABLE>
<TABLE>
<CAPTION>
INTERNATIONAL
-----------------------------
UNITED THE UNITED ALL
STATES CHINA PHILIPPINES KINGDOM OTHER CONSOLIDATED
------ ----- ----------- ------- ------ ------------
(LONG-LIVED ASSETS IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C>
1997................................ 913 546 1,493 2,428 3,477 8,857
1998................................ 2,156 368 1,834 2,463 3,427 10,248
1999................................ $3,989 $534 $1,966 $2,449 $3,254 $12,192
</TABLE>
F-52
<PAGE> 207
SOUTHERN ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
17. SUBSEQUENT EVENTS
PROPOSED INITIAL PUBLIC OFFERING
On April 17, 2000 the Company and Southern Company approved plans to
execute a 272,000 to 1 stock split and register with the Securities and Exchange
Commission 66,700,000 new shares of Southern Energy common stock with an
anticipated offering price of $16.00. The offering is expected to reduce
Southern's ownership to approximately 80%. There can be no assurance that this
offering (the "Offering") will be completed.
In conjunction with the Offering, the Company will convert the units
outstanding under the Value Creation Plan (Note 6) into options to purchase
shares of the Company's common stock. The intrinsic value of the options will
equal the final value of units being converted. The measurement of compensation
expense for stock options as prescribed by APB Opinion No. 25 equals the
compensation expense that would be recorded for units under the Value Creation
Plan.
Within twelve months following the completion of the Offering, Southern
Company plans to distribute all of the remaining shares of the Company owned by
Southern Company to the holders of Southern common stock. There can be no
assurance that this distribution will be completed.
In connection with the completion of the distribution, substitute options
for the Company's common stock will be issued to our employees in exchange for
their Southern Company options. The conversion process will follow FASB
Interpretation No. 44 "Accounting for Certain Transactions Involving Stock
Compensation," which dictates the following:
- The aggregate face value of the options immediately after the conversion
will be equal to the aggregate face value prior to the conversion.
- The ratio of the stock price (fair market value) per option to the
exercise price per option will remain the same.
See Note 6 where Southern options held by the Company's officers and
employees are further discussed.
The Company has negotiated service agreements with Southern to provide
transition services following the initial public offering of the Company's
shares in the areas of finance, accounting, human resources, auditing, legal,
information technology and engineering services. These services will be provided
at cost or at fair market value, whichever is greater. The Company has the
option to decline or terminate service with reasonable advance notice. Under
arrangements for similar services currently in effect with Southern and its
operating companies, under which services are provided at cost, the Company paid
$20 million in 1999. See Note 5.
Also on April 17, 2000, the Company's and Southern's respective boards of
directors voted to transfer Southern Energy's leveraged lease and capital
funding subsidiaries to Southern. These transfers are contingent upon the
successful completion of the Offering. The Company's interest in its SE Finance
leveraged leasing subsidiary has been treated as a discontinued operation in the
accompanying financial statements.
F-53
<PAGE> 208
SOUTHERN ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
DIVIDEND TO SOUTHERN (UNAUDITED)
A short-term credit facility was obtained by the Company to fund cash
dividend payments to Southern in the aggregate amount of $503 million. Pro forma
basic earnings per share data for 1999 gives effect to such dividend in
accordance with Staff Accounting Bulletin Topic 1:B:3.
POTOMAC ELECTRIC POWER COMPANY ("PEPCO") (UNAUDITED). On June 8, 2000, the
Company announced it had entered into an agreement to purchase the bulk of
PEPCO's electric generation business for $2.65 billion plus amounts to be
determined for working capital and approximately $400 million in the event
certain purchase power agreements are not transferred to the Company. The
transaction is expected to be completed in late 2000 and will be accounted for
by the Company as a purchase.
SE CALIFORNIA (UNAUDITED). On June 7, 2000, the administrative law judge
("ALJ") presiding over the proceeding between SE California and the CAISO (See
Note 1 and Note 11 of the Notes) issued an initial decision in which the ALJ
allocated responsibility for payment of approximately 3% of the revenue
requirement to the CAISO. On July 7, 2000, SE California filed an appeal of the
ALJ's decision with the FERC. The outcome of this appeal is uncertain. A final
FERC order in this proceeding may be appealed to the U.S. Court of Appeals. If
SE California is ultimately unsuccessful in its appeal of the ALJ's decision, SE
California will be required to refund certain amounts of the revenue requirement
billed to the CAISO for the period from June 1, 1999 until the final disposition
of the appeal. The amount of this refund as of May 31, 2000 would have been
approximately $91 million and would have reduced net income by approximately $50
million. These amounts do not include interest that would be payable in the
event of a refund. The Company's failure to prevail in this matter would
adversely affect its results of operations.
CEMIG (UNAUDITED). SEB obtained financing from Banco Nacional De
Desenvolvimento Economico e Social (BNDES) for approximately 50% of the total
purchase price of the CEMIG shares which is secured by a pledge of SEB's shares
in CEMIG. A portion of a principal payment that was originally due May 15, 2000,
in an amount of $9.2 million, has been deferred. SEB paid $2.2 million of this
principal payment on May 15, 2000 and expects to pay the remaining $7.0 million
on September 15, 2000. An interest payment of $107.8 million, also due on May
15, 2000, has been deferred until May 15, 2001.
ALICURA (UNAUDITED). On February 21, 2000, we executed a stock purchase
agreement with The AES Corporation to sell our interest in Alicura. The Closing
was expected to occur on June 28, 2000; however, it has not yet occurred. We
cannot assure you that this transaction will be consummated.
2000 SECOND QUARTER RESULTS (UNAUDITED)
We reported net income of $93 million for the second quarter of 2000,
compared with $77 million for the same period last year. This increase was
attributed primarily to an increase in profits from our Asia-Pacific operations.
F-54
<PAGE> 209
[LOGO]
<PAGE> 210
PART II
INFORMATION NOT REQUIRED IN THE PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The expenses to be paid in connection with the issuance and distribution of
the securities being registered, other than underwriting discounts and
commissions, are as follows:
<TABLE>
<S> <C>
SEC registration fee........................................ $299,349.60
NASD filing fee............................................. 30,500
NYSE listing fee............................................ *
Printing and engraving costs................................ *
Accounting fees and expenses................................ *
Legal fees and expenses..................................... *
Blue sky fees and expenses.................................. *
Transfer agent and registrar fees........................... *
Miscellaneous............................................... *
-----------
Total..................................................... $ *
===========
</TABLE>
---------------
* To be filed by amendment.
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS
Southern Energy, Inc. is incorporated under the laws of the State of
Delaware. Section 145 ("Section 145") of Title 8 of the Delaware Code gives a
corporation power to indemnify any person who was or is a party or is threatened
to be made a party to any threatened, pending or completed action, suit or
proceeding, whether civil, criminal, administrative or investigative (other than
an action by or in the right of the corporation) by reason of the fact that the
person is or was a director, officer, employee or agent of the corporation, or
is or was serving at the request of the corporation as a director, officer,
employee or agent of another corporation, partnership, joint venture, trust or
other enterprise, against expenses (including attorneys' fees), judgments, fines
and amounts paid in settlement actually and reasonably incurred by the person in
connection with such action, suit or proceeding if the person acted in good
faith and in a manner the person reasonably believed to be in or not opposed to
the best interests of the corporation, and, with respect to any criminal action
or proceeding, had no reasonable cause to believe the person's conduct was
unlawful. Section 145 also gives a corporation power to indemnify any person who
was or is a party or is threatened to be made a party to any threatened, pending
or completed action or suit by or in the right of the corporation to procure a
judgment in its favor by reason of the fact that the person is or was a
director, officer, employee or agent of the corporation, or is or was serving at
the request of the corporation as a director, officer, employee or agent of
another corporation, partnership, joint venture, trust or other enterprise
against expenses (including attorneys' fees) actually and reasonably incurred by
the person in connection with the defense or settlement of such action or suit
if the person acted in good faith and in a manner the person reasonably believed
to be in or not opposed to the best interests of the corporation and except that
no indemnification shall be made in respect of any claim, issue or matter as to
which such person shall have been adjudged to be liable to the corporation
unless and only to the extent that the Court of Chancery or the court in which
such action or suit was brought shall determine upon application that, despite
the adjudication of liability but in view of all the circumstances of the case,
such person is fairly and reasonably entitled to indemnity for such expenses
which the Court of Chancery or such other court shall deem proper. Also, Section
145 states that, to the extent that a present or former director or officer of a
corporation has been
II-1
<PAGE> 211
successful on the merits or otherwise in defense of any such action, suit or
proceeding, or in defense of any claim, issue or matter therein, such person
shall be indemnified against expenses (including attorneys' fees) actually and
reasonably incurred by such person in connection therewith.
Section 145 further authorizes a corporation to purchase and maintain
insurance on behalf of any person who is or was a director, officer, employee or
agent of the corporation, or is or was serving at the request of the corporation
as a director, officer, employee or agent of another corporation or enterprise,
against any liability asserted against him and incurred by him in any such
capacity, arising out of his status as such, whether or not the corporation
would otherwise have the power to indemnify him under Section 145.
Southern Energy's Restated Certificate of Incorporation and Bylaws provide
for the indemnification of officers and directors to the fullest extent
permitted by the General Corporation Law.
All of Southern Energy's directors and officers will be covered by
insurance policies maintained by Southern Energy against certain liabilities for
actions taken in their capacities as such, including liabilities under the
Securities Act of 1933, as amended.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES
On July 26, 1999, we sold $200,000,000 7.4% senior notes due 2004 and
$500,000,000 7.9% senior notes due 2009. The purchase price of these notes was
paid in cash by the certain institutional investors. All of these notes were
offered and sold only to qualified institutional buyers in transactions not
involving a public offering in reliance upon the exemption provided by Section
4(2) of the Securities Act of 1933, as amended.
ITEM 16. EXHIBITS
(a) The following exhibits are filed as part of this Registration
Statement:
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S> <C>
1.1** -- Form of Underwriting Agreement.
3.1** -- Form of Restated Certificate of Incorporation.
3.2** -- Bylaws.
4.1** -- Specimen Stock Certificate.
4.2 -- Certificate of Trust (Designated in Registration No. 333-
[ ] as Exhibit 4.2).
4.3 -- Trust Agreement (Designated in Registration No. 333- [ ] as
Exhibit 4.3).
4.4** -- Form of Amended and Restated Trust Agreement.
4.5** -- Form of Preferred Security (included in Exhibit 4.4).
4.6** -- Form of Junior Convertible Subordinated Note Indenture.
4.7** -- Form of First Supplemental Indenture.
4.8** -- Form of Junior Convertible Subordinated Note (included in
Exhibit 4.7).
4.9** -- Form of Guarantee.
4.10 -- Form of Agreement as to Expenses and Liabilities (included
in Exhibit 4.4).
5.1** -- Opinion of Troutman Sanders LLP.
</TABLE>
II-2
<PAGE> 212
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S> <C>
10.1* -- Form of Master Separation and Distribution Agreement.
10.2* -- Form of Transitional Services Agreement.
10.3* -- Form of Indemnification and Insurance Matters Agreement.
10.4* -- Form of Technology and Intellectual Property Ownership and
Licenses Agreement.
10.5* -- Form of Confidential Disclosure Agreement.
10.6* -- Form of Employee Matters Agreement.
10.7* -- Form of Tax Indemnification Agreement.
10.8* -- Form of Registration Rights Agreement.
10.9* -- Form of Southern Energy Employee Stock Purchase Plan.
10.10* -- Form of Southern Energy Omnibus Incentive Compensation Plan.
10.11 -- Deferred Compensation Agreement with S. Marce Fuller.
10.12 -- Deferred Compensation Agreement with Raymond D. Hill.
10.13 -- Deferred Compensation Agreement with Richard J. Pershing.
10.14 -- Amended and Restated Employment Retention Agreement with
Frederick D. Kuester.
10.15 -- Employment Retention Agreement with Barney S. Rush.
10.16** -- Form of Change in Control Agreement.
10.17 -- Formation Agreement by and between SEI Holdings, Inc. and
Vastar Resources, Inc. dated August 8, 1997.
10.18 -- Energy Conversion Agreement for a Coal Fired Thermal Power
Station at Sual Pangasinan, Philippines between National
Power Corporation and CEPA Pangasinan Electric Limited dated
May 20, 1994.
10.19 -- Build, Operate and Transfer Project Agreement for a Gas
Turbine Power Station in Navotas, Manila between National
Power Corporation and Hopewell Project Management Company
Limited dated 16th November, 1988.
10.20 -- Navotas II, Build, Operate and Transfer Project Agreement
for a Gas Turbine Power Station in Navotas, Manila between
National Power Corporation and Hopewell Energy International
Limited, dated 29 June, 1992.
10.21 -- Energy Conversion Agreement for a Coal Fired Thermal Power
station at Barangay Ibabang Pulo, Pagbilao, Quezon,
Philippines between National Power Corporation and Hopewell
Energy International Limited, dated 9th November, 1991.
10.22 -- Amendment Agreement, dated the 30th day of March 1993, to an
Energy Conversion Agreement between Hopewell Energy
International Limited, National Power Corporation and
Hopewell Power (Philippines) Corp. dated 9th November 1991.
21.1* -- Subsidiaries of Registrant.
23.1 -- Consent of Arthur Andersen LLP.
23.2 -- Consent of KPMG Deutsche Treuhand-Gesellschaft.
23.3** -- Consent of Troutman Sanders LLP (included in Exhibit 5.1).
24.1* -- Power of Attorney (included on signature page).
27.1 -- Financial Data Schedule (for SEC use only).
</TABLE>
II-3
<PAGE> 213
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S> <C>
99.1 -- Financial Statements of Bewag Aktiengesellschaft.
</TABLE>
Exhibits listed above that have been filed with the Commission and that
were designated as noted above are hereby incorporated herein by reference and
made a part hereof with the same effect as if filed herewith.
-------------------------
* Previously filed.
** To be filed by amendment.
(b) The following financial statement schedule is filed as part of this
Registration Statement:
SCHEDULE II -- Valuation and Qualifying Accounts and Reserves of Southern
Energy, Inc. and Subsidiary Companies for the years ended December 31, 1997,
1998 and 1999.
ITEM 17. UNDERTAKINGS
The undersigned registrant hereby undertakes to provide to the underwriters
at the closing specified in the underwriting agreement certificates in such
denominations and registered in such names as required by the underwriters to
permit prompt delivery to each purchaser.
Insofar as the indemnification for liabilities arising under the Securities
Act of 1933 may be permitted to directors, officers and controlling persons of
the registrant pursuant to the foregoing provisions, or otherwise, the
registrant has been advised that in the opinion of the Securities and Exchange
Commission such indemnification is against public policy as expressed in the
Securities Act and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by the
registrant of expenses incurred or paid by a director, officer or controlling
person of the registrant in the successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered, the registrant will, unless in
the opinion of its counsel the matter has been settled by controlling precedent,
submit to a court of appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in the Securities
Act and will be governed by the final adjudication of such issue.
The undersigned registrant hereby undertakes that:
(1) For purposes of determining any liability under the Securities Act of
1933, the information omitted from the form of prospectus filed as part
of this registration statement in reliance upon Rule 430A and contained
in a form of prospectus filed by the registrant pursuant to Rule
424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed to
be part of this registration statement as of the time it was declared
effective.
(2) For the purpose of determining any liability under the Securities Act
of 1933, each post-effective amendment that contains a form of
prospectus shall be deemed to be a new registration statement relating
to the securities offered therein, and the offering of such securities
at that time shall be deemed to be the initial bona fide offering
thereof.
II-4
<PAGE> 214
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the registrant
has duly caused this registration statement to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of Atlanta, State of
Georgia, on July 18, 2000.
SOUTHERN ENERGY, INC.
By: *
------------------------------------
S. Marce Fuller
President and Chief Executive
Officer
Pursuant to the requirements of the Securities Act of 1933, this
registration statement has been signed by the following persons in the
capacities indicated below and as of the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<C> <S> <C>
* President, Chief Executive Officer and *
------------------------------------------ Director (Principal Executive Officer)
S. Marce Fuller
* Executive Vice President and Chief *
------------------------------------------ Financial Officer (Principal Financial
Raymond D. Hill Officer)
* Senior Vice President, Finance and *
------------------------------------------ Accounting (Principal Accounting Officer)
James A. Ward
* Director *
------------------------------------------
A. W. Dahlberg
* Director *
------------------------------------------
H. Allen Franklin
* Director *
------------------------------------------
Elmer B. Harris
* Director *
------------------------------------------
W. L. Westbrook
*By: /s/ DOUGLAS L. MILLER July 18, 2000
------------------------------------
Douglas L. Miller
Attorney-in-Fact
</TABLE>
II-5
<PAGE> 215
SOUTHERN ENERGY, INC. AND SUBSIDIARY COMPANIES
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1998 AND 1999
(Stated in Thousands of Dollars)
<TABLE>
<CAPTION>
ADDITIONS
-----------------------------
BALANCE AT BEGINNING CHARGED TO CHARGED TO OTHER BALANCE AT END
DESCRIPTION OF PERIOD INCOME ACCOUNTS DEDUCTIONS OF PERIOD
----------- -------------------- ---------- ---------------- ---------- --------------
<S> <C> <C> <C> <C> <C>
Provision for
uncollectible
accounts (current)
1999................. $101,243 $ 19,566 $(11,805) $65,418(Note1) $ 43,586
1998................. 67,443 33,082 6,153 5,435(Note1) 101,243
1997................. 23,806 14,522 36,220 7,105(Note1) 67,443
Provision for
uncollectible
accounts (long-term)
1999................. $ 40,000 $ 30,543 $(10,000) $ 0 $ 60,543
1998................. 0 40,000 0 0 40,000
1997................. 0 0 0 0 0
Write-Down of Assets
1999................. $308,000 $ 60,000 $ 0 $ 0 $368,000
1998................. 0 308,000 0 0 308,000
1997................. 0 0 0 0 0
</TABLE>
---------------
Note 1: Represents write-off of accounts considered to be uncollectible, less
recoveries of amounts previously written off.
