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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C
-------------------------
FORM 10-Q
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarter Ended September 30, 1998
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from _____to_____
Commission Registrant, State of Incorporation, I.R.S. Employer
File Number Address and Telephone Number Identification No.
----------- ---------------------------------- -----------------
333-09033 Southern Investments UK plc None
(Registered in England & Wales)
800 Park Avenue
Aztec West
Almondsbury
Bristol
BS32 4SE, UK
(01144) 1454 201101
<PAGE>
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No __
<TABLE>
<CAPTION>
<S> <C> <C>
Description of Shares Outstanding
Registrant Common Stock at October 31, 1998
- ---------- --------------- -------------------
Southern Investments UK plc Par Value(pound)1 Per Share 500,400,587
</TABLE>
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
This Quarterly Report Form 10-Q of Southern Investments UK plc (the
"Company") contains forward-looking statements in addition to historical
information. The Company cautions that there are various important factors that
could cause actual results to differ materially from those indicated in the
forward-looking statements; accordingly, there can be no assurance that such
indicated results will be realized. These factors include legislative and
regulatory issues (such as the results of the current review of regulation, and
the results of the supply and distribution price reviews scheduled to take
effect April 1, 2000, see Management's Discussion and Analysis "Future Earnings
Potential"); the extent and timing of the entry of additional competition in the
supply market; potential business strategies, including acquisitions or
dispositions of assets or internal restructuring that may be pursued by the
Company or South Western Electricity plc ("SWEB"); changes in or application of
environmental and other laws and regulations to which the Company and SWEB are
subject; political, legal and economic conditions and developments in which the
Company and SWEB operate; financial market conditions and the results of
financing efforts; changes in commodity prices and interest rates; weather and
other natural phenomena; the performance of projects undertaken by the Company
or SWEB and the success of efforts to invest in and develop new opportunities;
and other factors discussed in the reports, filed from time to time by the
Company with the Securities and Exchange Commission ("SEC").
1
<PAGE>
<TABLE>
<CAPTION>
SOUTHERN INVESTMENTS UK plc and SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(In Millions)
<S> <C> <C>
For the Three Months Ended September 30,
----------------------------------------
1998 1997
---- ----
(Note A)
OPERATING REVENUES (pound) 169 $ 287 (pound) 162
COST OF SALES 103 175 101
----- ----- ------
GROSS MARGIN 66 112 61
----- ----- ------
OPERATING EXPENSES:
Maintenance 9 15 9
Depreciation and amortization 13 22 12
Selling, general, and administrative 13 22 15
------ ----- ------
Total operating expenses 35 59 36
------ ----- ------
Operating income 31 53 25
------ ----- ------
OTHER INCOME (EXPENSE):
Interest expense (15) (26) (15)
Other, net 1 2 3
------ ----- ------
Total other income (expense) (14) (24) (12)
------ ----- ------
INCOME BEFORE INCOME TAXES 17 29 13
INCOME TAXES:
Customary (5) (9) (11)
Effect of change in tax rates (Note I) 11 19 22
Windfall levy (Note J) - - (90)
------ ----- ------
NET INCOME (LOSS) (pound) 23 $ 39 (pound) (66)
====== ===== ======
The accompanying notes form an integral part of these condensed consolidated statements.
</TABLE>
2
<PAGE>
<TABLE>
<CAPTION>
SOUTHERN INVESTMENTS UK plc and SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(In Millions)
<S> <C> <C>
For the Six Months Ended September 30,
--------------------------------------
1998 1997
---- ----
(Note A)
OPERATING REVENUES (pound) 350 $ 595 (pound) 334
COST OF SALES 217 369 212
------ ------ ------
GROSS MARGIN 133 226 122
------ ------ ------
OPERATING EXPENSES:
Maintenance 17 29 17
Depreciation and amortization 25 43 23
Selling, general, and administrative 29 49 30
------ ------ ------
Total operating expenses 71 121 70
------ ------ ------
Operating income 62 105 52
------ ------ ------
OTHER INCOME (EXPENSE):
Interest expense (30) (51) (28)
Other, net 9 15 8
------ ------ ------
Total other income (expense) (21) (36) (20)
------ ------ ------
INCOME BEFORE INCOME TAXES 41 69 32
INCOME TAXES:
Customary (13) (22) (16)
Effect of change in tax rates (Note I) 11 19 22
Windfall levy (Note J) - - (90)
------ ------ ------
NET INCOME (LOSS) (pound) 39 $ 66 (pound) (52)
====== ====== =======
The accompanying notes form an integral part of these condensed consolidated statements.
</TABLE>
3
<PAGE>
<TABLE>
<CAPTION>
SOUTHERN INVESTMENTS UK plc and SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In Millions)
<S> <C> <C>
For the Six Months Ended September 30,
--------------------------------------
1998 1997
---- ----
(Note A)
NET CASH PROVIDED BY OPERATING ACTIVITIES
(pound) 88 $ 150 (pound) 95
------ ----- ------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (33) (56) (44)
Other 10 17 (2)
------ ----- ------
Net cash used in investing activities (23) (39) (46)
------ ----- ------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments of dividends (20) (34) (59)
Change in short-term borrowings (43) (73) 8
------ ----- ------
Net cash used in financing activities (63) (107) (51)
------ ----- ------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS 2 4 (2)
CASH AND CASH EQUIVALENTS, beginning of
period 5 8 3
------ ----- ------
CASH AND CASH EQUIVALENTS, end of period (pound) 7 $ 12 (pound) 1
====== ===== ======
SUPPLEMENTAL CASH FLOW DISCLOSURES:
Cash paid for interest (pound)(27) $ (46) (pound) (27)
====== ===== ======
Cash paid for income taxes (pound) - $ - (pound) (6)
====== ===== ======
The accompanying notes form an integral part of these condensed consolidated statements.
</TABLE>
4
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<TABLE>
<CAPTION>
SOUTHERN INVESTMENTS UK plc and SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In Millions)
ASSETS
<S> <C> <C>
September 30, 1998 March 31,
------------------ --------
(Unaudited) 1998
----------- ----
(Note A)
PROPERTY, PLANT, AND EQUIPMENT (pound) 1,410 $2,396 (pound) 1,389
Less accumulated depreciation 125 212 109
------ ------ ------
Property, plant, and equipment, net 1,285 2,184 1,280
------ ------ ------
OTHER ASSETS:
Investments 17 29 17
Prepaid pension cost 124 211 116
Goodwill, net of accumulated amortization of (pound)14 ($24) at
September 30, 1998 and(pound)11 at March 31, 1998 169 287 172
------ ------ ------
Total other assets 310 527 305
------ ------ ------
CURRENT ASSETS:
Cash and cash equivalents 7 12 5
Investments 17 29 17
Receivables:
Customer accounts, less provision for uncollectables of (pound)8 ($14) at
September 30, 1998 and(pound)9 at March 31, 1998 56 95 85
Other 13 22 14
------ ------ ------
Receivables, net 69 117 99
Materials and supplies 4 7 4
Prepaid expenses 20 34 18
------ ------ ------
Total current assets 117 199 143
------ ------ ------
TOTAL ASSETS (pound) 1,712 $2,910 (pound) 1,728
====== ====== ======
The accompanying notes are an integral part of these condensed consolidated balance sheets.
</TABLE>
5
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<TABLE>
<CAPTION>
SOUTHERN INVESTMENTS UK plc and SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In Millions)
STOCKHOLDER'S EQUITY AND LIABILITIES
<S> <C> <C>
September 30, 1998 March 31,
------------------ --------
(Unaudited) 1998
----------- ----
(Note A)
STOCKHOLDER'S EQUITY:
Common stock,(pound)1 par value, 500,400,587 shares authorized, issued
and outstanding (pound) 500 $ 850 (pound) 500
Retained earnings (deficit) (Note C) (144) (245) (163)
------ ------ ------
Total stockholder's equity 356 605 337
------ ------ ------
COMPANY OBLIGATED MANDATORILY REDEEMABLE
PREFERRED SECURITIES OF SOUTHERN INVESTMENTS
UK CAPITAL TRUST I HOLDING COMPANY JUNIOR
SUBORDINATED DEBENTURES 50 85 50
NON-CURRENT LIABILITIES:
Long-term debt 301 512 301
Deferred income taxes 352 598 361
Provision for loss contracts (Note D) 71 121 72
Other 42 71 46
------ ------ ------
Total non-current liabilities 766 1,302 780
------ ------ ------
CURRENT LIABILITIES:
Commercial paper 80 136 80
Short-term borrowings 240 408 283
Accounts payable 55 93 50
Accrued income taxes 93 158 82
Unearned revenue 5 8 4
Accrued interest 8 14 8
Other 59 101 54
------ ------ ------
Total current liabilities 540 918 561
------ ------ ------
TOTAL STOCKHOLDER'S EQUITY AND LIABILITIES (pound) 1,712 $2,910 (pound) 1,728
====== ====== ======
The accompanying notes are an integral part of these condensed consolidated balance sheets.
</TABLE>
6
<PAGE>
SOUTHERN INVESTMENTS UK plc and SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1998
(Unaudited)
(A) Solely for the convenience of the reader, certain pounds sterling
amounts included in the condensed consolidated financial statements
have been translated into US dollars at the exchange rate of $1.6995=
(pound)1.00, the noon buying rate in New York City for cable transfers
in pounds sterling as certified for customs purposes by the Federal
Reserve Bank of New York on September 30, 1998.
(B) The condensed consolidated financial statements included herein have
been prepared pursuant to the rules and regulations of the SEC and in
conformity with accounting principles generally accepted in the United
States. In the opinion of the Company's management, the information
furnished herein reflects all adjustments (which included only normal
recurring adjustments) necessary to present fairly the results of the
three-month and six-month periods ended September 30, 1998 and 1997.
The Company's fiscal year end is March 31. Certain information and
footnote disclosures normally included in consolidated financial
statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to such rules and
regulations, although the Company believes that the disclosures are
adequate to make the information presented not misleading.
It is suggested that these condensed consolidated financial
statements be read in conjunction with the financial statements
and the notes thereto included in the Company's report on form
10-K for the year ended March 31, 1998.
The condensed consolidated balance sheet as at March 31, 1998
included herein has been extracted from audited consolidated
financial statements; all other figures are unaudited. The
condensed consolidated financial statements included herein have
been reviewed by the Company's independent public accountants and
their report is included herein as Exhibit 15.
There were no items for inclusion in a consolidated statement of
comprehensive income other than net income as shown on the
condensed consolidated statements of income. Consequently, a
consolidated statement of comprehensive income has not been
included.
(C) The Company's main investment and only significant asset is the entire
share capital of SWEB, which is headquartered in Bristol, England. The
Company shows a retained earnings deficit primarily due to dividends
in the amount of (pound)191 million being declared and paid by the
Company during the fiscal year 1996 as proceeds from the sale of
SWEB's shares in The National Grid Group plc provided cash in addition
to that provided from operations. In addition, the first budget of the
Labour government included a "one-off windfall levy on the excess
profits of the privatized utilities"; SWEB estimated its liability to
be approximately (pound)90 million (see Note J).
(D) SWEB has entered into a contract relating to the purchase of 200
megawatts of capacity from a 7.69% owned related party, Teesside Power
Limited ("Teesside"), for a period of 15 years beginning April 1,
1993. The contract sets escalating electricity purchase prices at
predetermined levels. The Company has recognized an accrual at the
acquisition date for the excess of these Teesside power purchase costs
in each year over an estimate of the equivalent Pool costs in that
respective year. These costs have been discounted at an appropriate
rate to their present value of(pound)71 million at September 30, 1998
and (pound)72 million at March 31, 1998. Over the past two years, the
Pool prices have been less than anticipated when the accrual was
recognized. The Company is continuing to review the trend of Pool
prices and an adjustment to the provision may be required in the
future.
7
<PAGE>
SOUTHERN INVESTMENTS UK plc and SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(E) Effective March 31, 1998, the Company adopted Financial Accounting
Standards Board ("FASB") Statement No. 131, "Disclosure About Segments
of an Enterprise and Related Information". The Company is primarily
engaged in two electric industry segments: distribution, which
involves the transfer of electricity from the high voltage
transmission system, and its delivery, across low voltage distribution
systems, to consumers; and supply, which involves bulk purchase of
electricity from the Pool and arranging for its sale and transfer to
its customers. All revenues are in respect of sales to customers in
the UK. Information about the Company's operations in these individual
segments, which also reflect its products and services, is detailed
below:
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C>
Distribution Supply Other Eliminations Consolidated
------------ ------ ----- ------------ ------------
(in millions)
Three months ended September 30, 1998:
--------------------------------------
Operating revenues (pound) 55 (pound) 157 (pound) 42 (pound) (85) (pound) 169
Operating income 23 3 5 - 31
Six months ended September 30, 1998:
------------------------------------
Operating revenues (pound) 110 (pound) 324 (pound) 57 (pound)(141) (pound) 350
Operating income 46 4 12 - 62
Total assets at September 30, 1998 (pound)1,553 (pound) 82 (pound) 77 (pound) - (pound) 1,712
Three months ended September 30, 1997:
--------------------------------------
Operating revenues (pound) 51 (pound) 148 (pound) 15 (pound) (52) (pound) 162
Operating income 24 6 (5) - 25
Six months ended September 30, 1997:
------------------------------------
Operating revenues (pound) 103 (pound) 304 (pound) 30 (pound)(103) (pound) 334
Operating income 45 12 (5) - 52
Total assets at September 30, 1997 (pound) 1,497 (pound) 86 (pound) 102 (pound) - (pound) 1,685
</TABLE>
Included in "Other" above are ancillary business activities of SWEB
that generally support its main electricity distribution and
supply businesses and assets not allocated to specific segments.
Interest expense and taxes are wholly allocated to "Other" and
are disclosed in the condensed consolidated statements of income.
The eliminations above primarily relate to internal sales from
the distribution business to the supply business for the use of
the network. Such sales are priced at rates applicable to SWEB
and other suppliers operating in SWEB's Authorized Area.
(F) The Company and SWEB have non-trading operations that are exposed
to certain market risks including changes in interest rates,
cross currency exchange rates and the volatility of prices of
electricity purchased in the Pool. To mitigate risk attributable
to these exposures the Company has entered into various
derivative financial instruments, the sole purpose of which is to
hedge exposure in these areas. At September 30, 1998, the status
of outstanding derivative contracts was as follows:
(i) The Company and SWEB utilize interest rate swaps to minimize
borrowing costs and mitigate their exposure to fluctuations in
interest rates by allowing them to effectively convert their
outstanding variable rate debt into fixed rate debt. These swaps
are designed as hedges of underlying debtobligations and, as
such, the interest rate differential is reflected as an
adjustment to interest expense over the life of the swaps. At
September 30, 1998, sterling interest rate swaps expiring between
2001 and 2012, with notional amounts totalling (pound)600
million, resulted in an unrealized loss of (pound)88 million.
8
<PAGE>
SOUTHERN INVESTMENTS UK plc and SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(ii) Foreign currency swap contracts are used by the Company and SWEB
to hedge exposure to currency fluctuations for US dollar
denominated debt. Gains and losses on these hedges are deferred
and recognized as an adjustment to the carrying amount when the
hedged transaction occurs. At September 30, 1998, currency swaps
expiring between 2001 and 2007, with notional mounts totalling
(pound)350 million, resulted in an unrealized gain of (pound)32
million.
(iii)SWEB utilizes contracts for differences ("CFDs") to mitigate its
exposure to volatility in the prices of electricity purchased
through the Pool. Such contracts allow the Company to effectively
convert the majority of its anticipated Pool purchases from
market prices to fixed prices. SWEB's goal is to obtain competitively
priced contracts to cover the majority of its purchase requirements.
The gains and losses on such contracts are deferred and recognized as
electricity is purchased. Management believes that the nature of
these contracts is such that the fair value is not materially
different from that recorded in the accounts. SWEB also has
commitments to purchase capacity under its long term contracts
(see Note D).
(iv) The Company is exposed to losses in the event of nonperformance
by counterparties to its financial instrument contracts. To
mitigate this credit risk, the Company selects counterparties
based on their credit ratings, limits its exposure to any one
counterparty under defined guidelines, and monitors the market
position of the programs and its relative market position with
each counterparty. The Company is unaware of any counterparty
which will fail to meet its obligations.
(G) The Company and SWEB are routinely party to legal proceedings arising
in the ordinary course of business which are not material, either
individually or in aggregate. Neither the Company nor SWEB is a party
to any material legal proceedings nor are they currently aware of any
threatened material legal proceedings. As described below, the Company
is aware of an issue which could subsequently impact SWEB.
The Pensions Ombudsman (a UK statutorily appointed independent
arbitrator) has issued a determination in favor of complaints
made by members of the Electricity Supply Pension Scheme ("ESPS")
relating to another employer's use of ESPS surplus to offset the
employer's costs of providing early pensions on redundancies and
certain other items. Under that determination the Pensions
Ombudsman directed the employer to pay into ESPS the amount of
that use of the surplus plus interest. The determination was
challenged in the High Court by the employer, and the High Court
upheld the employer's appeal in a judgment delivered on June 10,
1997. The High Court also granted the complainants leave to
appeal to the Court of Appeal. The Court of Appeal hearing
commenced on October 26, 1998, the outcome of which cannot be
determined at this time. If the complainants' appeal is
successful, either at the Court of Appeal or on a subsequent
appeal to the House of Lords, it will have an adverse effect on
SWEB. Unless the High Court decision is reversed, this case
should not impact SWEB significantly; however it is not practical
to make an estimate of the exposure at the present time.
(H) The condensed consolidated financial statements included herein have
not been prepared in accordance with the policies of Statement of
Financial Accounting Standards No. 71 "Accounting for the Effects of
Certain Types of Regulation" ("SFAS No. 71"). This pronouncement,
under which most US electric utilities report financial statements,
applies to entities which are subject to cost-based rate regulation.
By contrast, SWEB is not subject to rate regulation, but rather, is
subject to price cap regulation and therefore the provisions of SFAS
No. 71 do not apply. Financial statements presented in accordance with
SFAS No. 71 often contain certain deferred items which have not been
included in rates charged to customers in compliance with the
respective regulatory authority rulings, but which would have been
included in the income statement of enterprises in general under US
GAAP. The accompanying consolidated financial statements of the
Company do not contain such deferrals.
9
<PAGE>
SOUTHERN INVESTMENTS UK plc and
SUBSIDIARIES NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(I) The UK government's Finance Bill 1998, which received Royal Assent on
July 31, 1998, included a reduction in the rate of UK corporation tax
from 31% to 30% effective April 1, 1999. This decrease resulted in an
accounting credit reducing SWEB's provision for deferred income taxes
by approximately (pound)11 million, during the second quarter fiscal
year 1999.
In the comparative second quarter fiscal year 1998, the UK
corporation tax rate was reduced from 33% to 31% with effect from
April 1, 1997. This decrease resulted in an accounting credit
reducing the Company's provision for deferred income taxes by
approximately (pound)22 million, during the second quarter fiscal
year 1998.
(J) On July 2, 1997 the Labour government presented its first budget which
included a "one-off windfall levy on the excess profits of the
privatized utilities". Based upon the legislation, SWEB estimated its
liability to be approximately (pound)90 million. The levy is payable
in two equal installments. The first installment was paid on December
1, 1997 and the second will be paid on or before December 1, 1998.
10
<PAGE>
SOUTHERN INVESTMENTS UK plc and SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
SECOND FISCAL QUARTER 1999 vs. SECOND FISCAL QUARTER 1998
AND
FISCAL YEAR-TO-DATE 1999 vs. FISCAL YEAR-TO-DATE 1998
INTRODUCTION
The Company is a wholly-owned subsidiary of SWEB Holdings Limited
("Holdings"). Holdings is a wholly-owned subsidiary of SWEB Holdings UK
("Holdings UK"), which is owned indirectly by Southern Company ("Southern") and
PP&L Resources, Inc. ("PP&L").
On June 18, 1998, Southern sold an additional 26 percent interest in
Holdings to PP&L. PP&L initially purchased a 25 percent stake in Holdings in
July 1996. This further sale increased PP&L's economic interest in Holdings to
51 percent. Subsequently on June 18, 1998, shares in Holdings held by Southern
and PP&L were exchanged for equivalent shares in Holdings UK. Under the terms of
the agreement, Southern retains operational and management control of SWEB and
the Holdings UK group. Southern continues to hold a majority of the voting
shares in Holdings UK and retains a majority of the Board of Directors.
On October 5, 1998, it was announced that the Chairman and Chief Executive
of SWEB, Gale Klappa, will be returning to the US later this year to assume new
responsibilities with Southern. The Board of Directors of SWEB has elected Paul
Bowers, who has been serving as senior vice president of marketing at Georgia
Power, an affiliated company, as the replacement for Gale Klappa.
The Company was incorporated as a public limited company under the laws of
England and Wales on June 23, 1995, as a vehicle for the acquisition of SWEB,
one of the 12 regional electricity companies ("RECs") in England and Wales
licensed to distribute, supply and, to a limited extent, generate electricity.
In September 1995, the Company gained effective control of SWEB. The Company's
main investment and only significant asset is the entire share capital of SWEB,
which is headquartered in Bristol, England.
SWEB's two main business lines are the distribution of electricity and the
supply of electricity to approximately 1.3 million customers in its Authorized
Area in southwest England. This area covers approximately 5,560 square miles and
has a resident population of approximately 2.8 million.
RESULTS OF OPERATIONS
Earnings
Operating income for the second quarter and year-to-date fiscal year 1999
was (pound)31 million and (pound)62 million, respectively, compared to (pound)25
million and (pound)52 million for the corresponding periods of fiscal year 1998.
The increase in operating income of (pound)6 million in the second quarter is
due to an increase in ancillary businesses of (pound)10 million, offset by
decreases in the supply business of (pound)3 million and distribution business
of (pound)1 million. The increase in the year-to-date operating income of
(pound)10 million is due to increases in the distribution business of (pound)1
million and ancillary businesses of (pound)17 million, offset by a decrease in
the supply business of (pound)8 million.
11
<PAGE>
SOUTHERN INVESTMENTS UK plc and SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
Significant income statement items appropriate for discussion include the
following:
<TABLE>
<CAPTION>
<S> <C> <C>
Increase (Decrease)
--------------------------------------------------------
Second Quarter Year-To-Date
--------------------------------------------------------
(in millions) % (in millions) %
Operating revenues....................... (pound) 7 4 (pound) 16 5
Cost of sales............................ 2 2 5 2
Interest expense......................... - - 2 7
Other income, net........................ (2) (67) 1 12
Income taxes - customary................. (6) (55) (3) (19)
</TABLE>
Operating revenues
Revenue increases were primarily within the supply business where revenues
increased by (pound)9 million for the quarter and (pound)20 million
year-to-date. The number of electricity units supplied increased by 12% for the
quarter and by 15% year-to-date when compared to the corresponding periods in
fiscal year 1998, due primarily to an increase in units supplied to Unregulated
Supply Customers. Revenues also increased within the distribution business by
(pound)4 million for the quarter and (pound)7 million year-to-date. Revenues
from ancillary businesses, after intra-business eliminations, decreased by
(pound)6 million for the quarter and by (pound)11 million year-to-date,
primarily reflecting lower activity in the gas retailing business due to
restructuring of that business, including a teaming arrangement with another
organization.
Cost of sales
The increase in the cost of sales primarily relates to energy purchases
due to the increase in units supplied as explained above. This increase in
energy purchases is partly offset by reduced costs in the gas retailing
business.
Interest expense
The increase in the year-to-date interest expense is largely due to
increased short-term borrowings to finance the first installment of the windfall
levy.
Other income, net
The increase year-to-date reflects the gain on the disposition of certain
non-core assets, partly offset by additional income from an investment in
generating plant in the corresponding period of fiscal year 1998.
Income taxes - customary
The decrease year-to-date is primarily due to an increase to the
provision in the corresponding period of fiscal year 1998 to cover possible
disallowable items.
12
<PAGE>
SOUTHERN INVESTMENTS UK plc and SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
Future Earnings Potential
The results of operations discussed above are not necessarily indicative
of future earnings potential. The level of future earnings depends on numerous
factors including the outcome of the current distribution price review discussed
below, future regulatory price reviews and the level of energy sales and
customer growth/retention in the electricity businesses. A major impact on
future earnings will be the interest charges from funding requirements to meet
the second installment of the windfall levy. An item that could also result in
additional funding requirements relates to the outcome of a court ruling related
to a pension matter. See Notes (J) and (G), respectively, in the Notes to the
Condensed Consolidated Financial Statements.
There are currently a number of issues which impact the electricity
industry and which are the subject of discussion and consultation papers. The
principal ones are:
(i) In March 1998 the government published a discussion paper ("Green Paper") on
the regulation of the water, electricity, gas and telecommunications utilities
within the UK entitled "A Fair Deal for Consumers: Modernizing the Framework for
Utility Regulation". The government's stated objective for the review is to set
a long term stable framework for utilities which is seen to be fair by all the
interested groups involved. The guiding principles are that regulation must be
transparent, consistent and predictable. The closing date for responses was May
31, 1998. On July 27, 1998 the government announced its conclusions on reform of
utility regulation. Key decisions include merging the electricity and gas
regulators, the retention of RPI - X (see below), social and environmental
actions to be issued by Ministers, and greater transparency. These proposals
will be the subject of new legislation as soon as Parliamentary time permits.
(ii) In May 1998, the Director General of Electricity Supply (the "Regulator")
issued a consultation paper concerning the separation of businesses in the
context of the reviews of the price controls post 2000. It is the Regulator's
view that full separation of supply and distribution would be desirable.
However, he recognizes that it is likely that interim arrangements will be
necessary.
(iii) In October 1997, the government's Minister for Science, Energy and
Industry asked the Regulator to consider how a review of electricity trading
arrangements (including the operation of the Pool) might be undertaken, together
with changes in legislation. In March, 1998, the Minister agreed to the
Regulator's recommended terms of reference on development of new trading
arrangements. In July, 1998 the Regulator published his proposals, which are for
a market-based trading arrangement using forward contracts for the physical
delivery of electricity. A short-term bilateral market is proposed to enable
"fine tuning" of contract positions. The System Operator ("The National Grid
Company") will be responsible for balancing generation and demand from about
four hours before each half-hour trading period. Suppliers and generators will
be charged an imbalance fee for differences between their contractual and
physical positions by the System Operator. The Regulator also proposes to take a
higher degree of control than in the present trading arrangements. On October 8,
1998, the government published its "Conclusions of the review of energy sources
for power generation", in which the Minister confirmed that he viewed the
Regulator's proposals as moving in the right direction. Further development and
implementation is to be taken forward by the government and the Regulator.
13
<PAGE>
SOUTHERN INVESTMENTS UK plc and SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
(iv) The current distribution price control review expected to be effective
April 1, 2000 (see below).
As these papers and review are only consultative at this time, it is not
possible for the Company to determine the impact until after such issues have
been finalized by the government, and firm proposals are made by the Regulator.
On the separation issue, the additional costs to the Company could be
significant if full separation was ultimately required.
The largest portion of SWEB's operating income, approximately 80% in the
fiscal year 1998, is derived from its distribution business - essentially the
operation and maintenance of the electricity network in its Authorized Area in
the southwest of England. SWEB is the only distributor of electricity in this
area, and management believes that economic, environmental and regulatory
factors are likely to prevent competitors from entering this business in SWEB's
Authorized Area.
Distribution revenues are subject to price cap regulation. The Regulator
applies a price control formula ("DPCF"), P + RPI - X, where P is the price
level at the beginning of each new regulatory period, RPI is the change in the
Retail Price Index and X is an adjustment factor determined by the Regulator. X
is currently 3% for SWEB.
The DPCF is usually set for a five-year period, subject to more frequent
adjustments as determined necessary by the Regulator. At each review, the
Regulator can require a one-time price adjustment. An initial review by the
Regulator of allowable income in the distribution business led to a reduction of
the price level by 14% for SWEB starting April 1, 1995, followed by efficiency
factors of X = 2% for each year until March 2000. In July 1995, the Regulator
announced the result of a further distribution price review which was
precipitated by certain market events in the UK electric utility industry. For
SWEB, such announcement meant a real reduction of 11% in allowable distribution
income for the twelve months from April 1, 1996, followed by an efficiency
factor of X = 3% for each year thereafter, before an allowed increase for
inflation. The Regulator is currently undertaking the next DPCF review expected
to become effective from April 1, 2000.
Within the supply business, customers fall into two categories,
Unregulated and Regulated. Until March 31, 1998, Unregulated Supply Customers
were defined as customers who had an electricity demand of more than 100kW. From
April 1, 1998, Unregulated Supply Customers are defined as customers who are
non-domestic and who have an annual consumption in excess of 12,000kWh.
Unregulated Supply Customers may contract for their electricity from any holder
of a supply license, however, Supply Customers with demand less than 100kW must
continue to take supply from their host REC until the new systems are completed
(expected to be November 1998 for SWEB), and competition is allowed (see below).
Regulated Supply Customers are those customers who are not Unregulated
Supply Customers and largely comprise domestic and small business customers.
Prices charged to Regulated Supply Customers by a REC within its Authorized Area
are controlled by regulation. Until March 31, 1998, the calculation of the
maximum supply charge was based on a supply price control formula ("SPCF"),
similar to the DPCF, plus an ability to pass through certain costs, principally
the costs of energy purchases, transmission and distribution use of system
charges. For the four-year period ending March 31, 1998, an efficiency factor of
X = 2% (before an allowed increase for inflation) was applied to SWEB, offset by
an allowance for both unit and customer growth. From April 1, 1998 supply
business charges to Regulated Supply Customers are subject to a price cap
instead of being based on the SPCF; the concept of pass through costs no longer
applies.
14
<PAGE>
SOUTHERN INVESTMENTS UK plc and SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
Following the announcement by the Regulator in October 1997, in respect of
its latest supply price review for Regulated Supply Customers effective from
April 1, 1998, SWEB has implemented a tariff reduction of 2.8% effective from
that date. A further 3% reduction (before an allowed increase for inflation) is
planned to be implemented for fiscal year 2000. This average tariff reduction
primarily reflects the expected reduction in power purchase costs after March
31, 1998 when expensive CFDs, (Note F), agreed by the government at the time of
privatization of the electricity industry, ended, and the fossil fuel levy will
be further reduced.
The exclusive right to supply Regulated Supply Customers (as defined prior
to April 1, 1998) was scheduled to be phased out over a six-month period
commencing April 1, 1998, after which all supply customers would have the
ability to choose their electricity supplier. An announcement by the Regulator
in October 1997 stated that the exclusive right to supply Regulated Supply
Customers should be phased out from September 1998. Each REC has an authorized
start date for competition to commence in its Authorized Area, and SWEB's is
scheduled for November 30, 1998. Once a REC's Authorized Area is open to
competition, then it can compete in the Authorized Area of other RECs where
competition has commenced, and vice versa.
The Regulator has also proposed a penalty on all RECs, including SWEB,
related to the delay in opening competition to Regulated Supply Customers beyond
the April 1, 1998 deadline; any penalty imposed on SWEB is not expected to have
a material impact on earnings. The supply tariffs in fiscal years 1999 and 2000
represent maximum price restraints intended to protect each REC's Regulated
Supply Customers which it supplies within its Authorized Area.
SWEB's distribution business does not involve the purchase and sale of
electricity, and therefore SWEB's risk management efforts are focused on the
supply business which is exposed to Pool price volatility. SWEB uses CFDs to
hedge against Pool price volatility. CFDs are contracts predominantly between
generators and suppliers which fix the price of electricity for a contracted
quantity of electricity over a specific time period. Differences between the
actual price set by the Pool and the agreed prices give rise to difference
payments between the parties to the particular CFD. At the present time, SWEB's
forecast total demand for fiscal year 1999 is substantially hedged through
various types of agreements, including CFDs.
The most common contracts for supply to Unregulated Supply Customers are
for a twelve-month term and contain fixed rates. SWEB is exposed to two
principal risks associated with such contracts: load shape risk (the risk
associated with a shift in the customer's usage pattern, including absolute
amounts demanded and timing of amounts demanded); and, purchasing price risk
(the cost of purchased electricity relative to the price received from the
supply customer). SWEB employs risk management methods to maximize its return
consistent with an acceptable level of risk. SWEB manages load shape risk by
setting individual customer sales prices based on their expected load shape and
including an additional premium to cover the risk of load shape variation.
Variable volume CFDs are also used when available at a competitive price. SWEB
hedges purchasing price risk by employing a variety of risk management tools,
including management of its supply contract portfolio, hedging contracts and
other means which mitigate risk of future Pool price volatility.
SWEB's ability to manage its purchasing price risk depends, in part, on
the future availability of properly priced risk management mechanisms such as
CFDs. SWEB intends to purchase cover at competitive prices and constantly
evaluates market conditions. No assurance can be given that an adequate,
transparent market for such products will in fact be available and thus that
contracts will be available at competitive prices.
15
<PAGE>
SOUTHERN INVESTMENTS UK plc and SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
SWEB constantly evaluates whether owning its own source of generation or
contracting for such source or sources is the most appropriate method for
managing purchase price risk, but no assurance can be given that such methods
would be available to, or economically appropriate for, SWEB.
In June 1998, the FASB issued Statement No. 133, "Accounting for
Derivative Instruments and Hedging Activities", which establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities. This
statement is effective for fiscal years beginning after June 15, 1999. While the
Company has not yet quantified the impact of adopting this statement on its
financial statements, it could increase volatility in earnings and other
comprehensive income.
YEAR 2000 READINESS
Year 2000 Challenge
To save valuable storage space, mainframe computer programmers in the
1960s and 1970s shortened the year portion of date entries to just two digits.
The date January 1, 1998, for example, was recorded by a computer as 01/01/98.
Computers assumed, in effect, that all years began with "19". This practice was
widely adopted by programmers of additional computer platforms, such as personal
computers, and hard wired into computer chips and processors found in some
equipment. This approach, intended to save processing time and storage space
within computers, was used until the mid-90s.
If these functions are not corrected before the Year 2000 arrives,
affected software systems and devices containing computer chips or clocks could
automatically roll back to 1900 instead of moving forward to 2000. Some affected
software and devices will function without incident. Others may experience
erroneous results or the interruption of a process. This challenge does not
affect all software or all computer-controlled equipment.
SWEB depends on complex computer systems for many aspects of its
operations, which is primarily the distribution of electricity, as well as other
business support activities. SWEB's goal is to have mission-critical assets Year
2000 ready by June 1999. "Mission-critical" refers to devices or software that
are required to maintain operations. "Year 2000 ready" means that the system or
application is determined suitable for continued use through the Year 2000.
Mission-critical systems include, but are not limited to, control center
computer systems, customer service systems, and telephone switches and
equipment.
Year 2000 Program
SWEB executive management recognizes the seriousness of the Year 2000
challenge and has dedicated resources it considers adequate to address the
issue. An executive steering committee reviews Millennium Project progress on a
regular basis, and Southern Company receives periodic updates and progress
reports.
SWEB's Millennium Project is divided into two phases:
Phase 1 began in 1996 and consisted of identifying and assessing corporate
assets (software systems and devices that contain a computer chip or clock).
This first phase was completed on schedule July 31, 1997.
16
<PAGE>
SOUTHERN INVESTMENTS UK plc and SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
Phase 2, which consists of testing and remediating high priority systems
and devices, is targeted for completion in June 1999. Contingency planning is
included in this phase. The Millennium Project will continue to monitor SWEB's
affected computer systems, devices and applications through the end of 1999, and
into the year 2000.
Material Third Parties
SWEB is currently reviewing the Year 2000 readiness of material third
parties which provide goods and services crucial to SWEB's operations. SWEB is
developing contingency plans based on its assessment of each third party's
ability to continue supplying critical goods and services to SWEB. Among such
critical third parties are the National Grid, telecommunications, water, and
other suppliers.
Year 2000 Preparation Costs
Current projected costs of SWEB's Year 2000 readiness are approximately
$25 million. This includes costs for time and labor necessary to identify, test
and renovate affected devices and systems during a process that will last almost
four years. From its inception through September 30, 1998, the Year 2000 program
costs, recognized as expense, amounted to $14 million.
Risks associated with Year 2000 Challenge
SWEB is implementing a detailed process to minimize the possibility of
service interruptions related to the Year 2000 challenges. Because SWEB
is taking what it believes to be prudent steps to prepare for the Year 2000,
SWEB considers any interruptions in service that may occur to be isolated and
short in duration.
SWEB has followed a proven methodology for identifying and assessing
software and devices containing potential Year 2000 challenges. Remediation and
testing of those devices has been scheduled. SWEB is also assessing risks
associated with critical assets and third-party suppliers. Following risk
assessment, SWEB is preparing contingency plans as appropriate and is
participating with the UK Electricity Industry. A description of SWEB's
contingency planning follows below.
There is a potential for some earnings erosion caused by reduced
electrical demand by customers because of their Year 2000 issues.
Contingency Plans
Because of experience with storms, SWEB is skilled at using contingency
plans in unusual circumstances. As part of Year 2000 business continuity and
contingency planning, SWEB is drawing on that experience in making risk
assessments and developing additional plans to deal specifically with situations
that could arise relative to external suppliers and other Year 2000 challenges.
SWEB is participating with the rest of the UK Electricity Industry and
also with other utilities (water, telecommunications and gas) through the Year
2000 Utilities Interest Group where the focus now is very much on contingency
planning.
17
<PAGE>
SOUTHERN INVESTMENTS UK plc and SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
FINANCIAL CONDITION
Overview
The major change in the Company's financial condition during the six
months to September 30, 1998 was the expenditure by SWEB of approximately
(pound)33 million in property, plant, and equipment, largely in respect of the
distribution network. The funds required for such additions were derived
primarily from operations. It is expected that SWEB's capital requirements in
the foreseeable future for its investment in property, plant, and equipment will
be generated from operating activities.
The significant requirement of the second installment of the windfall levy
and possible requirements of a pension matter (see notes J and G respectively),
will require external financing, and result in increased interest expense. The
first installment of the windfall levy was funded by short-term borrowings.
Demand for electricity in Great Britain, in general, and in SWEB's
Authorized Area, in particular, is seasonal, with demand being higher in the
winter months and lower in the summer months. SWEB balances the effect of this
and other cyclical influences on its working capital needs with drawings under
its available credit facilities.
The Company's main investment and only significant asset is the entire
share capital of SWEB. The Company is dependent upon dividends from SWEB for its
cash flow. SWEB can make distribution of dividends to the Company under English
law to the extent that it has distributable reserves, subject to the retention
of sufficient financial resources to conduct its supply and distribution
businesses as required by its regulatory license. The Company believes that
currently sufficient distributable reserves will continue to exist at SWEB to
allow for reasonable and necessary dividends from SWEB, through operations, to
be distributed to the Company. In the UK, the Accounting Standards Board is
currently reviewing the treatment of deferred income tax accounting. If full
provision for deferred income tax were required, SWEB's distributable reserves
could be eliminated.
Financing Activities
The Company has a US commercial paper program under which the maximum
available is $520 million. This program is supported by a swingline and
revolving credit facility provided by a syndicate of banks. The amount available
under the program, which is supported by the swingline and revolving credit
facility, at September 30, 1998 was $166 million. SWEB enters into foreign
currency contracts to hedge the currency risk associated with the interest and
principal of each utilization under this program.
SWEB actively manages its short-term debt, which includes a number of bank
lines of credit in addition to the commercial paper program. At September 30,
1998 the Company and SWEB together had short-term debt of (pound)320 million
($544 million) outstanding ($136 million from commercial paper, $218 million
from a swingline and revolving credit facility, and $190 million in other
short-term loans).
To meet short-term cash needs and contingencies, the Company and SWEB
together had at September 30, 1998 approximately (pound)7 million of cash and
(pound)85 million of unutilized committed lines of credit with banks. Also
available was $166 million of the swingline and revolving credit facility
mentioned above.
At September 30, 1998, the Company and SWEB have sterling interest rate
swaps expiring between 2001 and 2012, with notional amounts totalling (pound)600
million, and have cross currency swaps expiring between 2001 and 2007, with
notional amounts totalling (pound)350 million.
18
<PAGE>
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits.
--------
15 - Report of Independent Public Accountants
27 - Financial Data Schedule
(b) Reports on Form 8-K.
--------------------
No report on Form 8-K was filed by the Company during the quarter for which
this report is being filed.
19
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SOUTHERN INVESTMENTS UK plc
/s/ Gale E. Klappa
By Gale E. Klappa
Director
/s/ C. B. (Mike) Harreld
By C. B. (Mike) Harreld
Director, Chief Financial and Accounting Officer
Date: November 12, 1998
20
ARTHUR ANDERSEN
Exhibit 15
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors of Southern Investments UK plc
We have reviewed the accompanying condensed consolidated balance sheet of
SOUTHERN INVESTMENTS UK plc (a company incorporated in England and Wales) as of
September 30, 1998, and the related condensed consolidated statements of income
for the three-month and six-month periods ended September 30, 1998 and 1997,
and the condensed consolidated statements of cash flows for the six-month
periods ended September 30, 1998 and 1997. These financial statements are the
responsibility of the Company's management.
We conducted our review in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures to
financial data and making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an audit conducted in
accordance with generally accepted auditing standards, the objective of which is
the expression of an opinion regarding the financial statements taken as a
whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that
should be made to the financial statements referred to above for them to be in
conformity with generally accepted accounting principles in the United States.
We have previously audited, in accordance with generally accepted auditing
standards in the United States, the consolidated balance sheet of SOUTHERN
INVESTMENTS UK plc as of March 31, 1998, and, in our report dated June 19, 1998,
we expressed an unqualified opinion on that consolidated balance sheet. In our
opinion, the information set forth in the accompanying condensed consolidated
balance sheet as of March 31, 1998, is fairly stated, in all material respects,
in relation to the consolidated balance sheet from which it has been derived.
/s/ ARTHUR ANDERSEN
ARTHUR ANDERSEN
Bristol, England
November 12, 1998
<TABLE> <S> <C>
<ARTICLE> UT
<LEGEND>
This schedule contains summary financial information extracted from Southern
Investments UK plc Form 10-Q for the six months ended September 30, 1998, and
is qualified in its entirety by reference to such financial statements. Values
are in (pound) sterling.
</LEGEND>
<MULTIPLIER> 1,000,000
<CURRENCY> British Pounds Sterling
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> MAR-31-1999
<PERIOD-START> APR-1-1998
<PERIOD-END> SEP-30-1998
<EXCHANGE-RATE> 1.6995
<BOOK-VALUE> PER-BOOK
<TOTAL-NET-UTILITY-PLANT> 1,273
<OTHER-PROPERTY-AND-INVEST> 322
<TOTAL-CURRENT-ASSETS> 117
<TOTAL-DEFERRED-CHARGES> 0
<OTHER-ASSETS> 0
<TOTAL-ASSETS> 1,712
<COMMON> 0
<CAPITAL-SURPLUS-PAID-IN> 500
<RETAINED-EARNINGS> (144)
<TOTAL-COMMON-STOCKHOLDERS-EQ> 356
50
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<LONG-TERM-DEBT-NET> 301
<SHORT-TERM-NOTES> 240
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<GROSS-OPERATING-REVENUE> 350
<OTHER-OPERATING-EXPENSES> 288
<TOTAL-OPERATING-EXPENSES> 288
<OPERATING-INCOME-LOSS> 62
<OTHER-INCOME-NET> 9
<INCOME-TAX-EXPENSE> 2
<INCOME-BEFORE-INTEREST-EXPEN> 69
<TOTAL-INTEREST-EXPENSE> 30
<NET-INCOME> 39
0
<EARNINGS-AVAILABLE-FOR-COMM> 0
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</TABLE>
