PENNSYLVANIA GAS AND WATER COMPANY
TABLE OF CONTENTS
PAGE
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Statements of Income for the three
months ended March 31, 1993 and 1994. . . . . . . . . . . 2
Balance Sheets as of December 31, 1993,
and March 31, 1994. . . . . . . . . . . . . . . . . . . . 3
Statements of Cash Flows for the three
months ended March 31, 1993 and 1994. . . . . . . . . . . 5
Notes to Financial Statements . . . . . . . . . . . . . . . 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations. . . . . . . . . . . . 12
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K . . . . . . . . . . . . . . 24
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PART I. FINANCIAL INFORMATION
PENNSYLVANIA GAS AND WATER COMPANY
STATEMENTS OF INCOME
[CAPTION]
Three Months Ended
March 31,
1993 1994
(Thousands of Dollars)
[S] [C] [C]
OPERATING REVENUES:
Gas $ 66,931 $ 80,233
Water 11,387 16,052
Total operating revenues 78,318 96,285
OPERATING EXPENSES:
Cost of gas 39,667 50,460
Other operation expenses 9,783 10,739
Maintenance 2,029 2,521
Depreciation 3,084 3,652
Deferred treatment plant costs, net (131) 146
Income taxes 5,211 7,453
Other taxes 5,360 5,422
Total operating expenses 65,003 80,393
OPERATING INCOME 13,315 15,892
OTHER INCOME (DEDUCTIONS), NET (Note 4) (232) 129
INCOME BEFORE INTEREST CHARGES 13,083 16,021
INTEREST CHARGES:
Interest on long-term debt 5,086 5,158
Other interest 692 514
Allowance for borrowed funds used
during construction (910) (71)
Deferred treatment plant carrying
charges (234) -
Total interest charges 4,634 5,601
NET INCOME 8,449 10,420
DIVIDENDS ON PREFERRED STOCK 1,622 1,383
EARNINGS APPLICABLE TO
COMMON STOCK $ 6,827 $ 9,037
COMMON STOCK:
Weighted average number of
shares outstanding 4,019,418 4,869,450
Earnings per share $ 1.70 $ 1.86
Cash dividends per share $ .71 $ .35
The accompanying notes are an integral part of the financial statements.
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PENNSYLVANIA GAS AND WATER COMPANY
BALANCE SHEETS
[CAPTION]
December 31, March 31,
1993 1994
(Thousands of Dollars)
[S] [C] [C]
ASSETS
UTILITY PLANT:
Gas plant, at original cost less
acquisition adjustments of $386,000 $ 245,969 $ 247,642
Water plant, at original cost plus
acquisition adjustments of $14,577,000 and
$14,568,000, respectively 360,996 363,236
Common plant, at original cost 26,212 26,845
633,177 637,723
Accumulated depreciation (86,287) (89,901)
546,890 547,822
OTHER PROPERTY AND INVESTMENTS:
Restricted funds held by trustee 12,853 11,376
Other 3,291 3,431
16,144 14,807
CURRENT ASSETS:
Cash and cash equivalents 2,714 1,918
Accounts receivable -
Customers 20,533 32,939
Others 1,258 1,268
Reserve for uncollectible accounts (1,223) (1,717)
Accrued utility revenues 16,123 12,344
Materials and supplies, at average cost 3,549 3,602
Gas held by suppliers, at average cost 26,650 2,901
Deferred cost of gas and supplier refunds, net 12,752 10,430
Prepaid expenses and other 2,026 4,696
84,382 68,381
DEFERRED CHARGES:
Deferred taxes collectible 51,382 52,217
Natural gas transition costs collectible - 8,990
Unamortized debt expense 5,745 5,615
Deferred treatment plant costs
and carrying charges 10,129 9,984
Deferred water utility billings 3,885 5,387
Other 7,751 7,813
78,892 90,006
TOTAL ASSETS $ 726,308 $ 721,016
The accompanying notes are an integral part of the financial statements.
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PENNSYLVANIA GAS AND WATER COMPANY
BALANCE SHEETS
[CAPTION]
December 31, March 31,
1993 1994
(Thousands of Dollars)
[S] [C] [C]
CAPITALIZATION AND LIABILITIES
CAPITALIZATION:
Common shareholder's investment $ 188,011 $ 195,465
Preferred stock -
Not subject to mandatory redemption, net 33,615 33,615
Subject to mandatory redemption 31,840 16,840
Long-term debt 266,259 254,132
519,725 500,052
CURRENT LIABILITIES:
Current portion of long-term debt and
preferred stock subject to mandatory
redemption 38,664 45,789
Notes payable -
Bank 2,000 -
Parent 3,680 1,840
Accounts payable -
Suppliers 22,401 13,514
Affiliates, net 1,888 1,923
Accrued general business and realty taxes 3,574 3,468
Accrued income taxes 4,984 10,210
Accrued interest 4,042 5,288
Accrued natural gas transition costs - 3,721
Other 2,440 2,940
83,673 88,693
DEFERRED CREDITS:
Deferred income taxes 87,005 89,143
Accrued natural gas transition costs - 7,117
Unamortized investment tax credits 9,183 9,118
Advances for construction 10,985 11,011
Contributions in aid of construction 9,810 9,811
Operating reserves 1,863 1,874
Other 4,064 4,197
122,910 132,271
COMMITMENTS AND CONTINGENCIES (Note 5)
TOTAL CAPITALIZATION AND LIABILITIES $ 726,308 $ 721,016
The accompanying notes are an integral part of the financial statements.
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PENNSYLVANIA GAS AND WATER COMPANY
STATEMENTS OF CASH FLOWS
[CAPTION]
Three Months Ended
March 31,
1993* 1994
(Thousands of Dollars)
[S] [C] [C]
CASH FLOW FROM OPERATING ACTIVITIES:
Net income $ 8,449 $ 10,420
Gain on sale of other property - (291)
Effects of noncash charges (credits) to income -
Depreciation 3,089 3,658
Deferred income taxes, net (263) 1,303
Provisions for self insurance 335 405
Deferred treatment plant costs and carrying
charges, net (365) 146
Allowance for equity funds used during construction - (15)
Deferred water utility billings (32) (1,610)
Other, net 414 1,033
Changes in working capital, exclusive of cash
and current portion of long-term debt -
Receivables and accrued utility revenues (2,855) (8,014)
Gas held by suppliers 19,876 23,749
Accounts payable (5,135) (7,297)
Deferred cost of gas and supplier refunds, net (3,760) 4,170
Other current assets and liabilities, net 3,921 4,143
Other operating items, net (637) (994)
Net cash provided by operating activities 23,037 30,806
CASH FLOW FROM INVESTING ACTIVITIES:
Additions to utility plant (net of allowance for
equity funds used during construction) (11,279) (4,978)
Other, net 635 326
Net cash used for investing activities (10,644) (4,652)
CASH FLOW FROM FINANCING ACTIVITIES:
Issuance of common stock 109 121
Dividends on common and preferred stock (4,475) (3,087)
Issuance of long-term debt 1,232 -
Repayment of long-term debt (1,902) (8,002)
Repayment of note payable to parent - (1,840)
Utilization of restricted funds held by trustee 2,611 1,577
Net decrease in bank borrowings (9,308) (15,555)
Other, net (343) (164)
Net cash used for by financing activities (12,076) (26,950)
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 317 (796)
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 570 2,714
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 887 $ 1,918
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest (net of amount capitalized) $ 4,061 $ 4,094
Income taxes $ 145 $ 500
*Reclassified to conform with 1994 financial statement presentation.
The accompanying notes are an integral part of the financial statements.
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PENNSYLVANIA GAS AND WATER COMPANY
NOTES TO FINANCIAL STATEMENTS
(1) GENERAL
The interim financial statements included herein have been prepared by
Pennsylvania Gas and Water Company ("PG&W"), without audit, pursuant to the
rules and regulations of the Securities and Exchange Commission. Certain
information and footnote disclosures normally included in financial statements
prepared in accordance with generally accepted accounting principles have been
condensed or omitted pursuant to such rules and regulations, although PG&W
believes that the disclosures are adequate to make the information presented not
misleading.
The results for the interim periods are not indicative of the results to be
expected for the year, primarily due to the effect of seasonal variations in
weather. However, in the opinion of management, all adjustments, consisting of
only normal recurring accruals, necessary to present fairly the results for the
interim periods have been reflected in the financial statements. It is
suggested that these financial statements be read in conjunction with the
financial statements and the notes thereto included in PG&W's latest annual
report on Form 10-K.
(2) RATE MATTERS
Gas Utility Operations
Annual Gas Cost Adjustment. Pursuant to the provisions of the Pennsylvania
Public Utility Code, which require that the tariffs of larger gas distribution
companies, such as PG&W, be adjusted on an annual basis to reflect changes in
their purchased gas costs, the Pennsylvania Public Utility Commission (the
"PPUC") ordered PG&W to make the following changes during 1992 and 1993 to the
gas costs contained in its gas tariff rates:
[CAPTION]
Change in Calculated
Effective Rate per MCF Increase (Decrease)
Date From To in Annual Revenue
[S] [C] [C] [C]
December 1, 1992 $2.46 $2.79 $ 9,500,000
December 1, 1993 2.79 3.74 28,800,000
Such changes in gas rates on account of purchased gas costs have no effect
on PG&W's earnings since the change in revenue is offset by a corresponding
change in the cost of gas.
Recovery of Take-or-Pay Costs. On April 27, 1990, PG&W filed an application
with the PPUC seeking approval to recover 90% of its total take-or-pay
liabilities, and $250,000 of related carrying costs, through billings to
customers generally over a four-year period beginning June 1, 1990. The PPUC
approved this application effective June 1, 1990. As of March 31, 1994, PG&W's
estimated liability for take-or-pay costs totaled $18.1 million, of which
approximately $17.7 million had been billed to PG&W as of such date by its
pipelines. As of March 31, 1994, PG&W had absorbed approximately $1.8 million
of its take-or-pay liabilities and had billed $16.3 million of such costs,
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including related carrying charges, to its customers, resulting in an
approximate $190,000 balance to be applied against the $498,000 of estimated
future billings to PG&W by its pipelines for take-or-pay liabilities.
Recovery of FERC Order 636 Transition Costs. On October 15, 1993, the PPUC
adopted an annual purchased gas cost ("PGC") order (the "PGC Order") regarding
recovery of Federal Energy Regulatory Commission ("FERC") Order 636 transition
costs. The PGC Order states the PPUC believes that the recovery of Account 191
and New Facility Costs are subject to recovery through the annual PGC rate
filing made with the PPUC by PG&W and other similar local gas distribution
companies. The PGC Order also indicates that while Gas Supply Realignment and
Stranded Costs are not natural gas costs eligible for recovery under the PGC
rate filing mechanism, such costs are subject to full recovery by local
distribution companies through the filing of a tariff pursuant to either the
existing surcharge or base rate provisions of the Code. The PGC Order further
states that all such filings will be evaluated on a case-by-case basis. As of
February 1, 1994, PG&W began to recover the Account 191 Costs that are being
billed to PG&W by its interstate pipelines through an increase in its PGC rate.
It is currently estimated that these costs, which will be billed to PG&W over a
nineteen-month period extending through March 31, 1995, will aggregate $1.1
million, of which $526,000 had been billed to PG&W as of March 31, 1994.
Additionally, on January 14, 1994, PG&W filed tariffs pursuant to the surcharge
provisions of the Code seeking the full recovery of Gas Supply Realignment and
Stranded Costs that it estimates it will be billed by its interstate pipelines.
On February 24, 1994, the PPUC suspended the effectiveness of these proposed
tariffs for six months (i.e., until August 28, 1994) in order to institute an
investigation into the reasonableness of such tariffs. It is currently
estimated that $12.0 million of the Gas Supply Realignment and Stranded Costs
will be billed to PG&W, generally over a four-year period extending through the
fourth quarter of 1997, of which $1.4 million had been billed to PG&W as of
March 31, 1994. Although it cannot be certain, based on the provisions of the
PGC Order, PG&W believes it will be allowed the full recovery of all transition
costs it estimates will ultimately be billed to it pursuant to FERC Order 636.
PG&W has recorded a liability for the $10.8 million of such estimated transition
costs that remain to be billed as of March 31, 1994, and both a current asset
and a deferred asset representing the probable future rate recovery of such
liability.
Water Utility Operations
Scranton Area Water Rate Increase. On September 25, 1992, PG&W filed an
application with the PPUC seeking a water rate increase, designed to produce
$9.9 million in additional annual revenue. This rate increase request involved
the approximately 56,000 customers in PG&W's Scranton Water Rate Area at such
date. By Order entered June 23, 1993, the PPUC rejected the proposed rate
increase in its entirety "due to inadequate service" (i.e., water quality).
However, by the same Order, the PPUC granted PG&W the alternative of a rate
increase designed to produce an additional $5.0 million in annual revenue,
provided that PG&W dedicate the entire increase to augment the improvements to
its water distribution system until "...the demonstration by [PG&W] to [the
PPUC] that it is providing adequate service." PG&W accepted this alternative
and placed such $5.0 million rate increase into effect as of June 23, 1993.
On August 19, 1993, the PPUC approved a settlement agreement resolving
certain disputed issues relating to its June 23, 1993, Order. This settlement
agreement provided, among other things, for (i) modification by the PPUC of its
June 23, 1993, Order to reduce the amount of the revenue increase that it
ordered be dedicated to distribution system improvements by the related income
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taxes and other expenses and the $319,000 additional expense for retiree health
care and life insurance benefits that the PPUC allowed PG&W in its revenues
(which resulted in the requirement for an additional annual expenditure for
distribution system improvements by PG&W of $2.5 million), (ii) the agreement by
PG&W to spend a total of $4.9 million annually (an additional $2.5 million over
its actual average annual expenditure of $2.4 million during the three-year
period ended June 30, 1993) for distribution system improvements in the Scranton
Water Rate Area until the PPUC is satisfied that PG&W is providing adequate
service, (iii) the modification by the PPUC of its June 23, 1993, Order to
restore the Hollister Reservoir to PG&W's rate base, and (iv) the withdrawal by
PG&W and the Office of Consumer Advocate of their appeals to the Commonwealth
Court of Pennsylvania regarding the PPUC's June 23, 1993, Order.
Spring Brook Water Rate Increases. Crystal Lake Service Area. On June 30,
1992, PG&W filed an application with the PPUC seeking a water rate increase,
designed to produce $4.4 million in additional annual revenue, to be effective
August 29, 1992. This rate increase request involved the approximately 5,000
customers in the Spring Brook Water Rate Area served exclusively by the Crystal
Lake Water Treatment Plant, which became fully operational in August, 1992. On
December 15, 1992, PG&W and certain parties filing objections to the rate
increase request reached a settlement providing for an approximate 130% rate
increase designed to produce $2.0 million of additional annual revenue to be
phased-in over a two-year period under the terms of a qualified phase-in plan,
pursuant to Financial Accounting Standards Board ("FASB") Statement 92 entitled
"Regulated Enterprises-Accounting for Phase-in Plans." The settlement further
provided that $1.1 million of the increased revenue (an approximate 72% increase
in rates) was to be realized through an immediate rate increase and that the
remaining $900,000 in increased revenue (an additional 58% increase in rates)
was to be realized through another rate increase one year later (i.e., at the
beginning of year two of the phase-in period). The settlement also specified
that the $900,000 in revenue that would be deferred during the first year of the
phase-in period, as well as an approximate $243,000 in carrying charges, was to
be collected from customers in the form of a surcharge in years three through
five of the phase-in period. By Order adopted February 25, 1993, the PPUC
approved the settlement effective March 9, 1993. In accordance with the
provisions of FASB Statement 92, PG&W commenced recording the entire $2.0
million increase in annual revenue allowed by the PPUC as additional revenue
beginning March 9, 1993. However, pursuant to the terms of the settlement, PG&W
deferred the billing of approximately $900,000 of the increased revenue recorded
during the first year of the phase-in period (i.e., the period March 9, 1993,
through March 8, 1994). Effective March 9, 1995, PG&W will begin to bill the
approximate $900,000 that had been so deferred by means of the surcharge that
will be in effect in years three through five of the phase-in period.
Ceasetown and Watres Service Areas. On April 29, 1993, PG&W filed an
application with the PPUC seeking a water rate increase, designed to produce
$19.5 million in additional annual revenue. This rate increase request involved
approximately 59,300 customers in PG&W's Spring Brook Water Rate Area,
principally those customers (i) served by the Ceasetown Water Treatment Plant
which was placed in service on March 31, 1993, (ii) served by the Watres Water
Treatment Plant which was placed in service on September 30, 1993, (iii) served
jointly by the Ceasetown and Watres Water Treatment Plants, and (iv) who are
served exclusively by the Nesbitt Water Treatment Plant. On September 23, 1993,
PG&W and certain parties filing objections to the rate increase request reached
a settlement providing for an overall 119% rate increase involving approximately
44,900 customers, principally those served either exclusively or jointly by the
Ceasetown and Watres Water Treatment Plants, designed to produce $11.9 million
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of additional annual revenue to be phased-in over a two-year period under the
terms of a qualified phase-in plan, pursuant to FASB Statement 92. Under the
terms of the settlement, except for approximately 200 customers who were
previously served jointly by the Hillside and Nesbitt Water Treatment Plants,
none of the approximately 14,600 customers served exclusively by the Nesbitt
Water Treatment Plant would receive an increase. The settlement further
provided that $6.4 million of the increased revenue (an approximate 65% increase
in rates) was to be realized through an immediate rate increase and that the
remaining $5.5 million of the increased revenue (an additional 54% increase in
rates) was to be realized through a further rate increase one year later (i.e.,
at the beginning of year two of the phase-in period). The settlement also
specified that the $5.5 million in revenue to be deferred during the first year
of the phase-in period, as well as an approximate $1.3 million in related
carrying charges, is to be collected from customers in the form of a surcharge
in years three through five of the phase-in period. By Order adopted December
15, 1993, the PPUC approved the settlement effective December 16, 1993. In
accordance with the provisions of FASB Statement 92, PG&W commenced recording
the entire $11.9 million increase in annual revenue allowed by the PPUC as
additional revenue beginning December 16, 1993, along with the related carrying
charges on revenue deferred in accordance with the phase-in plan.
Deferred Treatment Plant Costs and Carrying Charges. Pursuant to an Order
of the PPUC entered September 5, 1990, PG&W deferred all operating expenses,
including depreciation and property taxes, and the carrying charges (equivalent
to the allowance for funds used during construction ("AFUDC")) relative to the
four new Scranton Area water treatment plants and related facilities from the
dates of commercial operation of the plants until March 23, 1991, the effective
date of the Scranton Area water rate increase approved by the PPUC on March 22,
1991. By its Order entered June 23, 1993, relative to the Scranton Water Rate
Area, the PPUC granted PG&W's request to recover the $5.1 million of costs so
deferred relative to the Scranton Area water treatment plants and related
facilities over a ten-year period beginning June 23, 1993.
Similarly, as permitted by an Order of the PPUC entered September 24, 1992,
PG&W has deferred all operating expenses, including depreciation and property
taxes, and the carrying charges relative to the Crystal Lake Water Treatment
Plant and related facilities from August 3, 1992 (the date of commercial
operation of that plant), until March 9, 1993, the effective date of the water
rate increase approved by the PPUC on February 25, 1993, for customers in PG&W's
Spring Brook Water Rate Area served exclusively by the Crystal Lake Water
Treatment Plant. Additionally, in accordance with an Order of the PPUC entered
July 28, 1993, PG&W deferred all expenses and the carrying charges relative to
the Ceasetown and Watres Water Treatment Plants and related facilities until
December 16, 1993, the effective date of the water rate increase for customers
served by the Ceasetown and Watres Water Treatment Plants approved by the PPUC
on December 15, 1993.
As of March 31, 1994, a total of $4.6 million of costs, consisting of
$424,000 of operating expenses and $745,000 of carrying charges relative to the
Crystal Lake Water Treatment Plant and related facilities, and $1.7 million of
operating expenses and $1.7 million of carrying charges relative to the
Ceasetown and Watres Water Treatment Plants and related facilities, had been so
deferred pursuant to the respective PPUC Orders permitting the deferral of such
costs.
As contemplated by the PPUC's Orders of September 24, 1992, and July 28,
1993, PG&W will seek recovery of the costs relative to the Crystal Lake,
Ceasetown and Watres Water Treatment Plants that have been deferred pursuant to
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such Orders in its next rate increase request relative to the Spring Brook Water
Rate Area. Although it cannot be certain, PG&W believes that the recovery of
such costs will be allowed by the PPUC in future rate increases, particularly in
view of the PPUC's action allowing the recovery of the costs deferred with
respect to the Scranton Area water treatment plants and related facilities.
(3) ACCOUNTING CHANGES
Postemployment Benefits
In December, 1992, FASB Statement 112, "Employers' Accounting for
Postemployment Benefits," was issued. The provisions of this statement require
the recording of a liability for postemployment benefits (such as disability
benefits, including workers' compensation, salary continuation and the
continuation of benefits such as health care and life insurance) provided to
former or inactive employees, their beneficiaries and covered dependents. PG&W
consistently recorded liabilities for benefits of this nature prior to the
effectiveness of FASB Statement 112 and, as a result, the provisions of FASB
Statement 112, which PG&W adopted effective January 1, 1994, did not have a
material impact on its financial position or results of operations.
(4) OTHER INCOME (DEDUCTIONS), NET
Other income (deductions), net was comprised of the following elements:
[CAPTION]
Three Months Ended
March 31,
1993 1994
(Thousands of Dollars)
[S] [C] [C]
Gain on sale of non-watershed land,
net of related income taxes $ - $ 166
Net interest expense on proceeds
remaining in construction fund (240) (121)
Other 8 84
Total $ (232) $ 129
(5) COMMITMENTS AND CONTINGENCIES
Valve Maintenance
On November 16, 1993, the PPUC staff issued an Emergency Order, subsequently
ratified by the PPUC (the "Emergency Order"), requiring PG&W by January 31,
1994, to survey its gas distribution system to verify the location and spacing
of its gas shut off valves, to add or repair valves where needed and to
establish programs for the periodic inspection and maintenance of all such
valves and the verification of all gas service line information. The Emergency
Order was issued following the occurrence of two gas incidents (one concerning
an explosion and the other a fire) in PG&W's service area in June and October,
1993, respectively, involving nearby gas shut off valves that had been paved
over by third parties and could not be readily located due to alleged inaccurate
service line records. The Emergency Order also cited four additional incidents
occurring since January 31, 1991, in which shut off valves had been paved over
or records were inaccurate. In connection with these incidents, the PPUC has
alleged that PG&W has violated certain federal and state regulations related to
gas pipeline valves. The PPUC has the authority to assess fines for such
violations. The PPUC ordered PG&W to develop a plan, including a timetable, by
December 30, 1993, for compliance with the terms of the Emergency Order. PG&W
met the December 30, 1993, deadline for submission of this plan. However, PG&W
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included in such plan, a timetable, which, in effect, requested an extension of
the January 31, 1994, deadline contained in the Emergency Order, which PG&W
viewed as unrealistic. On February 2, 1994, the PPUC staff notified PG&W that
it considers the plan submitted by PG&W "only a general plan of action to
address the problem with valving in [PG&W's] system" and that the plan "is
lacking in detail and more information is needed." Consequently, the PPUC staff
indicated that it intends to initiate an informal investigation of the matter,
including PG&W's responsibility for the incidents referred to in the Emergency
Order, although it has not done so pending discussions between the PPUC staff
and PG&W regarding the development of a mutually acceptable plan. As a result
of such discussions, PG&W submitted a detailed plan of action for complying with
the Emergency Order to the PPUC on April 11, 1994, which is presently being
reviewed by the PPUC staff. While it is not presently possible to determine
what action the PPUC will ultimately take with respect to alleged violations of
law and the matters raised by the Emergency Order, PG&W does not believe that
compliance with, or any liability that might result from such violations or the
Emergency Order will have a material adverse effect on its financial position or
results of operations.
Environmental Matters
PG&W, like many gas distribution companies, once utilized manufactured gas
plants in connection with providing gas service to its customers. None of these
plants has been in operation since 1960, and several of the plant sites are no
longer owned by PG&W. Pursuant to the Comprehensive Environmental Response,
Compensation and Liability Act of 1980 ("CERCLA"), PG&W filed notices with the
United States Environmental Protection Agency (the "EPA") with respect to the
former plant sites. None of the sites is or was formerly on the proposed or
final National Priorities List. The EPA has conducted site inspections and made
preliminary assessments of each site and has concluded that no further remedial
action is planned. While this conclusion does not constitute a legal
prohibition against further regulatory action under CERCLA or other applicable
federal or state law, PG&W does not believe that additional costs, if any,
related to these manufactured gas plant sites would be material to its financial
position or results of operations since environmental remediation costs
generally are recoverable through rates over a period of time.
On February 4, 1994, PG&W was requested by the Pennsylvania Department of
Environmental Resources to perform an evaluation to determine if a pipeline
owned by PG&W was the source of certain soil contamination discovered by the
Pennsylvania Department of Transportation in late 1993 in an area adjacent to
that pipeline at a road crossing in Jackson Township, Northumberland County,
Pennsylvania. This pipeline was purchased by Scranton-Spring Brook Water
Service Company ("Scranton-Spring Brook"), a predecessor of PG&W, in 1956, but
was never operated by Scranton-Spring Brook or PG&W in the area in question.
Environmental consultants, engaged by PG&W to assist it in this matter, have
made various trench excavations and taken soil samples from the area between the
soil contamination and PG&W's pipeline. These samples showed no signs of
contamination, except in the immediate vicinity of the contaminated soil, and,
along with other analyses performed by the consultants, indicate that PG&W's
pipeline was not the source of the contaminated soil. Thus, while it cannot be
certain, PG&W does not believe that it is responsible for or has any liability
with respect to the subject contamination.
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PENNSYLVANIA GAS AND WATER COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
The following table expresses certain items in PG&W's statements of income
as percentages of total operating revenues for each of the three-month periods
ended March 31, 1993, and March 31, 1994:
[CAPTION]
Percentage of
Operating Revenues
Three Months Ended
March 31,
1993 1994
[CAPTION]
[S] [C] [C]
OPERATING REVENUES:
Gas........................................ 85.5% 83.3%
Water...................................... 14.5 16.7
Total operating revenues................. 100.0 100.0
OPERATING EXPENSES:
Cost of gas................................ 50.6 52.4
Other operation expenses................... 12.5 11.2
Maintenance and depreciation............... 6.5 6.4
Deferred treatment plant costs, net........ (0.2) 0.1
Income and other taxes..................... 13.6 13.4
Total operating expenses................. 83.0 83.5
OPERATING INCOME............................. 17.0 16.5
OTHER INCOME (DEDUCTIONS), NET............... (0.3) 0.1
INTEREST CHARGES............................. 5.9 5.8
DIVIDENDS ON PREFERRED STOCK................. 2.1 1.4
EARNINGS APPLICABLE TO
COMMON STOCK............................... 8.7% 9.4%
Operating Revenues. PG&W's operating revenues increased $18.0 million
(22.9%) from $78.3 million for the three-month period ended March 31, 1993, to
$96.3 million for the three-month period ended March 31, 1994.
Gas operating revenues increased by $13.3 million (19.9%) from $66.9 million
for the three-month period ended March 31, 1993, to $80.2 million for the three-
month period ended March 31, 1994, primarily as a result of a price increase
averaging 19.0% ($28.8 million on an annual basis) effective December 1, 1993,
due to increased costs of purchased gas. Also contributing to the increase in
gas operating revenues in 1994 was a 1.1 billion cubic feet (10.8%) increase in
sales to residential and commercial heating customers, primarily as a result of
heating degree days* that were 8.7% higher than normal during the first quarter
* A heating degree day ("degree day") represents each degree by which the
average of the high and low temperatures for a given day is below 650
Fahrenheit. Actual degree days represent the sum of the degree days for the
period.
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of 1994 and 10.4% higher than in the similar period in 1993. The effects of the
price increases and colder weather on gas operating revenues were partially
offset by the switching of certain commercial and industrial customers from
sales to transportation service.
Water operating revenues increased by $4.7 million (41.0%) from $11.4
million for the three-month period ended March 31, 1993, to $16.1 million for
the three-month period ended March 31, 1994. This increase in revenues was
largely the result of rate increases which the Pennsylvania Public Utility
Commission (the "PPUC") allowed PG&W, including a $2.0 million annual rate
increase effective March 9, 1993, for customers in the Spring Brook Water Rate
Area served exclusively by the Crystal Lake Water Treatment Plant, a $5.0
million annual rate increase effective June 23, 1993, for customers in the
Scranton Water Rate Area, and an $11.9 million annual rate increase effective
December 16, 1993, for customers in the Spring Brook Water Rate Area served by
the Ceasetown and Watres Water Treatment Plants, as more fully explained below
under "-Rate Matters-Water Rate Filings."
Operating Expenses. Operating expenses, including depreciation and income
taxes, increased $15.4 million (23.7%) from $65.0 million for the three-month
period ended March 31, 1993, to $80.4 million for the three-month period ended
March 31, 1994. As a percentage of operating revenues, total operating expenses
increased from 83.0% during the first quarter of 1993 to 83.5% during the first
quarter of 1994. Operating expenses related to gas utility operations increased
by $12.6 million (22.1%) from $56.8 million in the three-month period ended
March 31, 1993, to $69.4 million in the three-month period ended March 31, 1994,
primarily as a result of a $10.8 million increase in the cost of gas, higher
levels of operation and maintenance expense related to colder than normal
weather and increased income taxes. Operating expenses related to water utility
operations increased by $2.8 million (34.3%) from $8.2 million in the first
quarter of 1993 to $11.0 million in the first quarter of 1994, primarily as a
result of increased operation and maintenance costs, depreciation and income
taxes.
The cost of gas increased $10.8 million (27.2%) from $39.7 million for the
three-month period ended March 31, 1993, to $50.5 million for the three-month
period ended March 31, 1994. The effect of this increase, which was the result
of higher costs for purchased gas, was partially offset by a 3.9% (535 thousand
cubic feet) decrease in the volume of gas sold during the three-month period
ended March 31, 1994, compared to the similar period in 1993. This decreased
volume was largely attributable to the aforementioned switching of customers
from sales to transportation service. The gross margin on gas operations (gas
operating revenues less the cost of gas) increased $2.5 million or 9.2% in the
first quarter of 1994, primarily as a result of the increased sales to
residential and commercial heating customers due to the colder weather.
Other than the cost of gas and income taxes, operating expenses increased by
$2.4 million (11.7%) from $20.1 million for the three-month period ended March
31, 1993, to $22.5 million for the three-month period ended March 31, 1994.
This increase was largely attributable to a $1.4 million increase in other
operation and maintenance expenses, primarily as a result of a $431,000 increase
in payroll costs, increased provisions for uncollectible accounts of $224,000, a
$112,000 increase in contracted maintenance expense and a $277,000 decrease in
net deferred treatment plant costs during 1994, as more fully discussed below,
as well as a $568,000 increase in depreciation (primarily as a result of capital
additions and the change in December, 1993, from a 4% compound interest to a
straight-line method of depreciation with respect to water plant in the
Ceasetown and Watres Service Areas).
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Income taxes increased by $2.2 million (43.0%) from $5.2 million in the
first quarter of 1993 to $7.5 million in the first quarter of 1994 due to a
higher level of income before income taxes (for this purpose, operating income
net of interest charges) and the change, from 34% to 35%, in the federal
corporate income tax rate on taxable income in excess of $10.0 million. This
increase was the result of the enactment of the Omnibus Budget Reconciliation
Act of 1993 (the "1993 Tax Act") on August 10, 1993. The provisions of the 1993
Tax Act, which were recorded in the third quarter of 1993 retroactive to January
1, 1993, increased the Company's income tax expense by approximately $130,000
for the three-month period ended March 31, 1994.
Deferred Treatment Plant Costs and Carrying Charges. Pursuant to an Order
of the PPUC entered September 5, 1990, PG&W deferred all operating expenses,
including depreciation and property taxes, and the carrying charges (equivalent
to the AFUDC) relative to the four new Scranton Area water treatment plants and
related facilities from the dates of commercial operation of the plants until
March 23, 1991, the effective date of the Scranton Area water rate increase
approved by the PPUC on March 22, 1991. By its Order entered June 23, 1993,
relative to the Scranton Water Rate Area, the PPUC granted PG&W's request to
recover the $5.1 million of costs so deferred with respect to the Scranton Area
water treatment plants and related facilities over a ten-year period beginning
June 23, 1993, of which $450,000 had been recovered as of March 31, 1994.
Similarly, as permitted by an Order of the PPUC entered September 24, 1992,
PG&W deferred all operating expenses, including depreciation and property taxes,
and the carrying charges relative to the Crystal Lake Water Treatment Plant and
related facilities from August 3, 1992 (the date of commercial operation of that
plant), until March 9, 1993, the effective date of the water rate increase
approved by the PPUC on February 25, 1993, for customers in PG&W's Spring Brook
Water Rate Area served exclusively by the Crystal Lake Water Treatment Plant.
Additionally, in accordance with an Order of the PPUC entered July 28, 1993,
PG&W has deferred all expenses and the carrying charges relative to the
Ceasetown and Watres Water Treatment Plants and related facilities incurred
prior to December 16, 1993, the effective date of the water rate increase
approved by the PPUC on December 15, 1993, for customers served by the Ceasetown
and Watres Water Treatment Plants.
As of March 31, 1994, a total of $4.6 million of costs, consisting of
$424,000 of operating expenses and $745,000 of carrying charges relative to the
Crystal Lake Water Treatment Plant and related facilities and $1.7 million of
expenses and $1.7 million of carrying charges relative to the Ceasetown and
Watres Water Treatment Plants and related facilities, had been so deferred
pursuant to the respective PPUC Orders permitting the deferral of such costs.
As contemplated by the PPUC's Orders of September 24, 1992, and July 28,
1993, PG&W will seek recovery of the costs relative to the Crystal Lake,
Ceasetown and Watres Water Treatment Plants and related facilities that have
been deferred pursuant to such Orders in its next rate increase request relating
to the Spring Brook Water Rate Area. Although it cannot be certain, PG&W
believes that the recovery of such costs will be allowed by the PPUC in future
rate increases, particularly in view of the PPUC's action allowing the recovery
of the costs deferred with respect to the Scranton Area water treatment plants
and related facilities.
Operating Income. As a result of the above, total operating income
increased by $2.6 million (19.4%) from $13.3 million for the three-month period
ended March 31, 1993, to $15.9 million for the three-month period ended March
31, 1994, but decreased as a percentage of total operating revenues for such
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periods from 17.0% in the first quarter of 1993 to 16.5% in the first quarter of
1994. Operating income from gas utility operations increased $716,000 (7.1%)
from $10.1 million in the first quarter of 1993 to $10.8 million in the first
quarter of 1994, primarily as a result of a $2.5 million increase in the gross
margin, the effect of which was partially offset by higher levels of other
operation and maintenance expenses related to the colder than normal weather and
increased income taxes. Operating income from water utility operations
increased $1.9 million (57.9%) from $3.2 million in the first quarter of 1993 to
$5.1 million in the first quarter of 1994. This increase was primarily the
result of rate increases effective March 9, 1993, June 23, 1993, and December
16, 1993, the effects of which were partially offset by increased operation and
maintenance costs, depreciation, and income taxes, as discussed above.
Other Income (Deductions), Net. Other income (deductions), net increased
$361,000 from a deduction of $232,000 for the three-month period ended March 31,
1993, to income of $129,000 for the three-month period ended March 31, 1994,
primarily as a result of a $291,000 gain ($166,000 net of related income taxes)
on the sale of non-watershed land and a decrease in net interest expense
associated with the unutilized portion of the proceeds from the issuance on
December 22, 1992, of the Luzerne County Industrial Development Authority (the
"Authority") Exempt Facilities Revenue Bonds, 1992 Series B (Pennsylvania Gas
and Water Company Project) (the "1992 Series B Bonds"). See "-Liquidity and
Capital Resources-Long-Term Debt and Capital Stock Financings." The proceeds
from the issuance of the 1992 Series B Bonds were deposited in a construction
fund held by PNC Bank (formerly Northeastern Bank of Pennsylvania), as trustee
for the 1992 Series B Bonds (the "IDA Trustee"), pending their utilization to
finance the construction of various additions and improvements to PG&W's water
facilities for which construction commenced subsequent to September 23, 1992.
Interest expense relative to the funds so utilized for the benefit of PG&W is
reflected as interest on long-term debt. The interest expense relating to the
portion of the funds held by the IDA Trustee, net of the income earned on the
temporary investment of such funds, is reflected in other income (deductions),
net.
Interest Charges. Interest charges increased by $967,000 (20.9%) from $4.6
million for the three-month period ended March 31, 1993, to $5.6 million for the
three-month period ended March 31, 1994. This increase was largely attributable
to decreased AFUDC and deferred treatment plant carrying charges associated with
the Crystal Lake, Ceasetown and Watres Water Treatment Plants.
Although the weighted average interest rate on indebtedness decreased from
8.42% during the first quarter of 1993 to 7.55% during the first quarter of
1994, interest on long-term debt increased by $72,000 (1.4%) from $5.1 million
during the three-month period ended March 31, 1993, to $5.2 million during the
three-month period ended March 31, 1994. This increase was largely attributable
to increased indebtedness to finance the construction of various additions and
improvements to PG&W's water utility plant. The weighted average indebtedness
outstanding during the first quarter of 1994 was $291.4 million as compared to
$274.3 million during the first quarter of 1993. Offsetting the effect of this
increase were reductions in letter of credit and commitments fees paid to
certain of PG&W's lenders.
Dividends on Preferred Stock. Dividends on preferred stock decreased
$239,000 (14.7%) from $1.6 million for the three-month period ended March 31,
1993, to $1.4 million for the three-month period ended March 31, 1994, as a
result of the redemption by PG&W of 100,000 shares of its 9.50% cumulative
preferred stock, $100 par value, on December 23, 1993.
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Earnings Applicable to Common Stock. Earnings applicable to common stock
increased $2.2 million (32.4%) from $6.8 million ($1.70 per share) for the
quarter ended March 31, 1993, to $9.0 million ($1.86 per share) for the quarter
ended March 31, 1994. The increased earnings in 1994 were the result of the
matters discussed above, principally the increases in water operating revenues
resulting from the rate increases which the PPUC allowed PG&W effective March 9,
1993, June 23, 1993, and December 16, 1993, and the increase in gross margin on
gas operations resulting primarily from the higher level of sales to residential
and commercial heating customers due to the colder weather in 1994. The effects
of these factors were partially offset by increased operating expenses.
The earnings per share for the quarter ended March 31, 1994, increased 9.4%
compared to the similar period in 1993 as a result of the 32.4% increase in
earnings applicable to common stock and despite a 21.1% increase in the weighted
average number of shares outstanding during 1994, that was caused by PG&W's sale
of common stock to Pennsylvania Enterprises, Inc. ("PEI"), the parent company of
PG&W, at various times during 1993 and 1994.
RATE MATTERS
In accordance with the Pennsylvania Public Utility Code (the "Code"), PG&W
files an annual purchased gas cost rate with the PPUC. From time to time, PG&W
also files for adjustments to its gas and water rates to, among other reasons,
recover interest charges and depreciation expenses relating to capital
expenditures, recover increased operating expenses and make adjustments to
existing surcharge rates approved by the PPUC.
The following is a summary of such filings (exclusive of those solely
involving state tax adjustment surcharges) with respect to which the PPUC has
issued an order since the beginning of 1993, or which are currently pending.
Gas Rate Filings. Pursuant to the provisions of the Code which require that
the tariffs of larger gas distribution companies, such as PG&W, be adjusted on
an annual basis to reflect changes in their purchased gas costs, the PPUC, by
Order adopted October 28, 1993, authorized PG&W to increase the gas costs
contained in its gas tariff rates from $2.79 to $3.74 per thousand cubic feet
effective December 1, 1993. This change in gas rates on account of purchased
gas costs, which was designed to provide an increase in annual revenue of $28.8
million, will have no effect on PG&W's earnings since the increase in revenue
will be offset by a corresponding increase in the cost of gas.
The PPUC has issued proposed regulations that would provide for the
quarterly adjustment of the purchased gas cost rate of larger gas distribution
companies, including PG&W. Except for reducing the amount of any over or
undercollections of gas costs, the adoption of these proposed regulations would
not have any material effect on PG&W's financial position or results of
operations.
On April 27, 1990, PG&W filed an application with the PPUC seeking approval
to recover 90% of its total take-or-pay liabilities, and $250,000 of related
carrying costs, through billings to customers generally over a four-year period
beginning June 1, 1990. The PPUC approved this application effective June 1,
1990. As of March 31, 1994, PG&W's estimated liability for take-or-pay costs
totaled $18.1 million, of which approximately $17.7 million had been billed to
PG&W as of such date by its pipelines. As of March 31, 1994, PG&W had absorbed
approximately $1.8 million of its take-or-pay liabilities and had billed $16.3
million of such costs, including related carrying charges, to its customers,
resulting in an approximate $190,000 balance to be applied against the $498,000
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of estimated future billings to PG&W by its pipelines for take-or-pay
liabilities.
On October 15, 1993, the PPUC adopted an annual purchased gas cost ("PGC")
order (the "PGC Order") regarding recovery of Federal Energy Regulatory
Commission ("FERC") Order 636 transition costs. The PGC Order states the PPUC
believes that the recovery of Account 191 and New Facility Costs are subject to
recovery through the annual PGC rate filing made with the PPUC by PG&W and other
similar local gas distribution companies. The PGC Order also indicates that
while Gas Supply Realignment and Stranded Costs are not natural gas costs
eligible for recovery under the PGC rate filing mechanism, such costs are
subject to full recovery by local distribution companies through the filing of a
tariff pursuant to either the existing surcharge or base rate provisions of the
Code. The PGC Order further states that all such filings will be evaluated on a
case-by-case basis. As of February 1, 1994, PG&W began to recover the Account
191 Costs that are being billed to PG&W by its interstate pipelines through an
increase in its PGC rate. It is currently estimated that these costs, which
will be billed to PG&W over a nineteen-month period extending through March 31,
1995, will aggregate $1.1 million, of which $526,000 had been billed to PG&W as
of March 31, 1994. Additionally, on January 14, 1994, PG&W filed tariffs
pursuant to the surcharge provisions of the Code seeking the full recovery of
the Gas Supply Realignment and Stranded Costs that it estimates it will be
billed by its interstate pipelines. On February 24, 1994, the PPUC suspended
the effectiveness of these proposed tariffs for six months (i.e., until August
28, 1994) in order to institute an investigation into the reasonableness of such
tariffs. It is currently estimated that $12.0 million of Gas Supply Realignment
and Stranded Costs will be billed to PG&W, generally over a four-year period
extending through the fourth quarter of 1997, of which $1.4 million had been
billed to PG&W as of March 31, 1994. Although it cannot be certain, based on
the provisions of the PGC Order, PG&W believes it will be allowed the full
recovery of all transition costs it estimates will ultimately be billed to it
pursuant to FERC Order 636. PG&W has recorded a liability for the $10.8 million
of such estimated transition costs that remain to be billed as of March 31,
1994, and both a current asset and a deferred asset representing the probable
future rate recovery of such liability.
Water Rate Filings. The rate relief granted in the past to PG&W by the PPUC
has been less than the full amounts requested. Generally, the amounts granted
have been determined through negotiated settlements with certain parties to the
proceedings in order to obtain rate relief earlier than expected and to avoid
the substantial expenses associated with further administrative and possible
appellate proceedings. However, the rate increase request filed by PG&W on
September 25, 1992, with respect to the Scranton Water Rate Area was fully
litigated, and PG&W was only granted approximately 50% of its requested
increase, as more fully discussed below. Nonetheless, PG&W expects that its
investments in water treatment facilities mandated by the Pennsylvania
Department of Environmental Resources will be recognized in future rates. PG&W
believes that it will be able to obtain adequate future rate relief as it makes
further improvements to its distribution system and is able to demonstrate it is
providing water that is suitable for all "household purposes," i.e., meeting
federal and state primary (health-related) and secondary (aesthetics-related,
particularly taste, odor and color) drinking water standards, and that meets all
applicable water quality standards. However, there can be no assurance that
such adequate rate relief will be granted. See "-Liquidity and Capital
Resources-Failure to Obtain Adequate Rate Relief."
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Crystal Lake Service Area. On June 30, 1992, PG&W filed an application with
the PPUC seeking a water rate increase, designed to produce $4.4 million in
additional annual revenue. This rate increase request involved the
approximately 5,000 customers in the Spring Brook Water Rate Area served
exclusively by the Crystal Lake Water Treatment Plant, which became fully
operational in August, 1992. On December 15, 1992, PG&W and certain parties
filing objections to the rate increase request reached a settlement providing
for an approximate 130% rate increase designed to produce $2.0 million of
additional annual revenue to be phased-in over a two-year period under the terms
of a qualified phase-in plan pursuant to Financial Accounting Standards Board
("FASB") Statement 92. The settlement further provided that $1.1 million of the
increased revenue (an approximate 72% increase in rates) was to be realized
through an immediate rate increase and that the remaining $900,000 in increased
revenue (an additional 58% increase in rates) was to be realized through another
rate increase one year later (i.e., at the beginning of year two of the phase-in
period). The settlement also specified that the $900,000 in revenue that would
be deferred during the first year of the phase-in period, as well as an
approximate $243,000 in related carrying charges, was to be collected from
customers in the form of a surcharge in years three through five of the phase-in
period. By Order adopted February 25, 1993, the PPUC approved the settlement
effective March 9, 1993. In accordance with the provisions of FASB Statement
92, PG&W commenced recording the entire $2.0 million increase in annual revenue
allowed by the PPUC as additional revenue beginning March 9, 1993. However,
pursuant to the terms of the settlement, PG&W deferred the billing of
approximately $900,000 of the increased revenue recorded during the first year
of the phase-in period (i.e., the period March 9, 1993, through March 8, 1994).
Effective March 9, 1995, PG&W will begin to bill the approximate $900,000 that
had been so deferred by means of the surcharge that will be in effect in years
three through five of the phase-in period.
Scranton Area. On September 25, 1992, PG&W filed an application with the
PPUC seeking a water rate increase, designed to produce $9.9 million in
additional annual revenue. This rate increase request involved the
approximately 56,000 customers in PG&W's Scranton Water Rate Area at such date.
By Order entered June 23, 1993, the PPUC rejected the proposed rate increase in
its entirety "due to inadequate service" (i.e., water quality). However, by the
same Order, the PPUC granted PG&W the alternative of a rate increase designed to
produce an additional $5.0 million in annual revenue, provided that PG&W
dedicate the entire increase to augment the improvements to its water
distribution system until "the demonstration by [PG&W] to [the PPUC] that it is
providing adequate service." PG&W accepted this alternative and placed such
$5.0 million rate increase into effect as of June 23, 1993.
On August 19, 1993, the PPUC approved a settlement agreement (the
"Settlement Agreement") resolving certain disputed issues relating to its June
23, 1993, Order. The Settlement Agreement provided, among other things, for (i)
modification by the PPUC of its June 23, 1993, Order to reduce the amount of the
revenue increase that it ordered be dedicated to distribution system
improvements by the related income taxes and other expenses and the $319,000
additional expense for retiree health care and life insurance benefits that the
PPUC allowed PG&W in its revenues (which resulted in the requirement for an
additional annual expenditure for distribution system improvements by PG&W of
$2.5 million), (ii) the agreement by PG&W to spend a total of $4.9 million
annually (an additional $2.5 million over its actual average annual expenditure
of $2.4 million during the three-year period ended June 30, 1993) for
distribution system improvements in the Scranton Water Rate Area until the PPUC
is satisfied that PG&W is providing adequate service, (iii) the modification by
the PPUC of its June 23, 1993, Order to restore the Hollister Reservoir to
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PG&W's rate base, and (iv) the withdrawal by PG&W and the Office of Consumer
Advocate (the "OCA") of their appeals to the Commonwealth Court of Pennsylvania
regarding the PPUC's June 23, 1993, Order.
Ceasetown and Watres Service Areas. On April 29, 1993, PG&W filed an
application with the PPUC seeking a water rate increase, designed to produce
$19.5 million in additional annual revenue. This rate increase request involved
approximately 59,300 customers in PG&W's Spring Brook Water Rate Area,
principally those customers (i) served by the Ceasetown Water Treatment Plant
which was placed in service on March 31, 1993, (ii) served by the Watres Water
Treatment Plant which was placed in service on September 30, 1993, (iii) served
jointly by the Ceasetown and Watres Water Treatment Plants, and (iv) who are
served exclusively by the Nesbitt Water Treatment Plant. On September 23, 1993,
PG&W, the PPUC Office of Trial Staff, the OCA and the Office of Small Business
Advocate filed a settlement petition (the "Settlement Petition") with the
Administrative Law Judge ("ALJ") assigned to conduct the investigation of the
rate increase request. This Settlement Petition provided for an overall 119%
rate increase involving approximately 44,900 customers, principally those served
either exclusively or jointly by the Ceasetown and Watres Water Treatment
Plants, that was designed to produce $11.9 million of additional annual revenue
to be phased-in over a two-year period under the terms of a qualified phase-in
plan, pursuant to FASB Statement 92. Under the terms of the Settlement
Petition, except for approximately 200 customers who were previously served
jointly by the Hillside and Nesbitt Water Treatment Plants, none of the
approximately 14,600 customers served exclusively by the Nesbitt Water Treatment
Plant would receive an increase. The Settlement Petition further provided that
$6.4 million of the increased revenue (an approximate 65% increase in rates) was
to be realized through an immediate rate increase and that the remaining $5.5
million of the increased revenue (an additional 54% increase in rates) was to be
realized through a further rate increase one year later (i.e., at the beginning
of year two of the phase-in period). The Settlement Petition also specified
that the $5.5 million in revenue that was to be deferred during the first year
of the phase-in period, as well as an approximate $1.3 million in related
carrying charges, was to be collected from customers in the form of a surcharge
in years three through five of the phase-in period. By Order adopted December
15, 1993, the PPUC approved the Settlement Petition effective December 16, 1993.
In accordance with the provisions of FASB Statement 92, PG&W commenced recording
the entire $11.9 million increase in annual revenue allowed by the PPUC as
additional revenue beginning December 16, 1993, along with the related carrying
charges on revenue deferred in accordance with the phase-in plan.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity
The liquidity of PG&W is influenced significantly by the capital intensive
nature of its operations and the ratemaking practices of the PPUC, which
together effectively require external financing of a substantial portion of
PG&W's construction expenditures. See "-Construction Expenditures and Related
Financing" and "-Failure to Obtain Adequate Rate Relief." Additionally, because
of the seasonal nature of its gas utility operations and the ratemaking
practices of the PPUC regarding the recovery of purchased gas costs (see "-Rate
Matters-Gas Rate Filings"), it is necessary for PG&W to finance its gas
purchases and increases in its customer accounts receivable with bank borrowings
during certain periods of the year.
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PG&W's ability to generate sufficient internal funds and to obtain the
external funds that are required for its operations and construction
expenditures is affected materially by the timing and amount of rate relief it
is granted. This is a problem faced by all regulated utilities, and one that
had been particularly acute with respect to PG&W because of the denial by the
PPUC in 1986 and again in 1988, as a result of water quality issues, of water
rate increases requested by PG&W. Nonetheless, PG&W was able to generate and
raise sufficient capital resources despite these denials, and PG&W believes that
it will be granted sufficient rate relief to enable it to meet its future
anticipated capital requirements, particularly in view of the increases in
annual water revenue aggregating $35.8 million which it has been granted by the
PPUC since 1991 with respect to customers being supplied with filtered water.
PG&W also believes that additional rate increases will be allowed by the PPUC
for its approximately 131,600 water customers, all of whom are now receiving
filtered water, because of the relatively low level of earnings that PG&W is
realizing from its water utility operations and its expectation that with
filtration and further distribution system improvements, water quality should be
less of a concern in its requests for water rate increases. See "-Construction
Expenditures and Related Financing" and "-Failure to Obtain Adequate Rate
Relief."
If PG&W is denied future rate relief, it would be necessary, depending upon
the amount so denied, for PG&W to take various actions to reduce cash
expenditures. For a discussion of the actions PG&W would take to reduce cash
expenditures, see "-Failure to Obtain Adequate Rate Relief." Such measures
would continue until PG&W was allowed sufficient rate relief to increase its
earnings to a level that would permit it to raise additional debt and equity
capital. Concurrently with taking actions to reduce cash expenditures, PG&W
would file appropriate appeals with the Commonwealth Court of Pennsylvania,
alleging that, contrary to law, it had been denied an opportunity to earn a fair
rate of return on its prudent investment in used and useful utility property
devoted to public service.
PEI relies on a number of sources, primarily cash dividends from PG&W, to
provide the funds necessary to pay dividends on its common stock, to pay
interest on its outstanding debt, and to meet all of its other obligations
(other than the repayment of debt, for which PEI principally relies upon
periodic refinancings or sales of securities). The approximate amount of funds
required, net of the amounts provided to PEI by PG&W for use of PEI's federal
income tax credits, are expected to total $14.5 million in 1994, $15.2 million
in 1995 and $17.5 million in 1996.
Because of limitations imposed by the terms of PG&W's Restated Articles of
Incorporation, as amended, PG&W is prohibited, without the consent of the
holders of a majority of the outstanding shares of its preferred stock, from
issuing more than $12.0 million of unsecured debt due on demand or within one
year from issuance. PG&W had $1.8 million of unsecured debt due on demand or
within one year from issuance outstanding as of March 31, 1994.
In addition, PG&W is prohibited from paying any dividends to PEI in the
event of a default under certain of its debt instruments or failure to make any
required dividend payments due holders of PG&W's preferred stock. Furthermore,
any failure by PG&W to pay preferred stock dividends for four consecutive
quarters would permit the holders of the PG&W preferred stock to elect a
majority of the directors of PG&W.
PG&W presently has sufficient funding for its working capital needs, as well
as its construction program, through at least the third quarter of 1994, and
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believes that it will be able to raise such funds as are required for
construction expenditures, refinancings and other working capital requirements
beyond the third quarter of 1994.
PG&W believes that based on its current financial projections, it will be
able to achieve sufficient levels of earnings during 1994, as a result of
various cost control measures and water rate increases which have already been
granted, to enable it to meet its interest and fixed charge coverage
requirements and to give it the borrowing and other financing capability
necessary for its working capital needs and planned construction program.
However, if PG&W is not granted additional water rate increases in future years,
it may be necessary for PG&W to take various actions at such time to reduce
expenditures in order to satisfy its interest and fixed charge coverage
requirements and to maintain sufficient liquidity, and thereby lessen the amount
of debt and equity capital which must be raised. See "-Failure to Obtain
Adequate Rate Relief."
Interim Financing Practices
It is the practice of PG&W to use bank borrowings to finance certain of its
construction expenditures pending the periodic issuance of stock and long-term
debt. Additionally, because of the seasonal nature of its gas utility
operations and the ratemaking practices of the PPUC regarding the recovery of
purchased gas costs (see "-Rate Matters-Gas Rate Filings"), it is necessary for
PG&W to finance its gas purchases and increases in its customer accounts
receivable with bank borrowings during certain periods of the year.
In order to so finance construction expenditures and to meet its seasonal
borrowing requirements, PG&W has made arrangements for a total of $67.0 million
of unsecured revolving bank credit. Specifically, PG&W has entered into a
revolving bank credit agreement (the "Credit Agreement") with a group of six
banks under the terms of which $60.0 million is available for borrowing by PG&W.
The Credit Agreement terminates on April 30, 1995, at which time any borrowings
outstanding thereunder are due and payable. The interest rate on borrowings
under the Credit Agreement is generally less than prime. The Credit Agreement
also requires the payment of a commitment fee of 3/8 of 1% per annum on the
average daily amount of the unused portion of the available funds. As of May 9,
1994, $27.0 million of borrowings were outstanding under the Credit Agreement.
PG&W also has three other bank lines of credit with an aggregate borrowing
capacity of $7.0 million which provide for borrowings at interest rates
generally less than prime and mature during mid-1995. As of May 9, 1994, PG&W
had no borrowings outstanding under these bank lines of credit.
Current Maturities of Long-Term Debt and Preferred Stock
As of March 31, 1994, $45.8 million of PG&W preferred stock and long-term
debt was required to be repaid within twelve months. Such amount included a
note in the principal amount of $30.0 million, that is subject to repayment on
December 1, 1994, issued in 1987 to PNC Bank (formerly Northeastern Bank of
Pennsylvania) as trustee (the "IDA Trustee") in connection with the issuance by
the Luzerne County Industrial Development Authority (the "Authority") of $30.0
million of its Exempt Facilities Revenue Bonds, 1987 Series B (Pennsylvania Gas
and Water Company Project) due 2017.
Also included in such current maturities was $15.0 million principal amount
of PG&W's 9.50% 1988 series cumulative preferred stock which is subject to
redemption on May 31, 1994 (the "Redemption Date"). On April 28, 1994, PG&W
called for redemption all 150,000 outstanding shares of its 9.50% 1988 series
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cumulative preferred stock, $100 par value, at a price of $103.5625 per share
(plus accrued dividends to the Redemption Date), which included a voluntary
redemption premium of $3.5625 per share ($534,375 in the aggregate). PG&W plans
to redeem the $15.0 million of its 9.50% 1988 series cumulative preferred stock
with proceeds from the sale of common stock to PEI on or about the Redemption
Date. PEI plans to purchase the common stock of PG&W with funds obtained from a
term loan from PNC Bank. On April 28, 1994, PEI accepted a proposal from PNC
Bank, whereby PNC Bank fully-committed to underwriting a $20.0 million five-year
term loan to PEI, generally bearing interest at less than prime, subject to the
execution and delivery of satisfactory loan documentation by PEI. If for some
unanticipated reason, PEI's loan from PNC Bank does not close, PG&W would
utilize borrowings under the Credit Agreement as the source of funds with which
to redeem the 9.50% 1988 series cumulative preferred stock.
PG&W believes that it will have sufficient cash flow and borrowing capacity
to repay current maturities of its preferred stock and long-term debt and to
meet its other obligations based on its present earnings and financing
capabilities, capitalization and banking arrangements and relationships.
Long-Term Debt and Capital Stock Financings
PG&W periodically engages in long-term debt and capital stock financings in
order to obtain funds required for construction expenditures, the refinancing of
existing debt and various working capital purposes.
No long-term debt or capital stock financings were consummated by PG&W
during the three-month period ended March 31, 1994. However, during the period,
PG&W realized $121,000 from the issuance of common stock to PEI in connection
with PEI's Dividend Reinvestment and Stock Purchase Plan.
Also, during the three-month period ended March 31, 1994, PG&W utilized $1.6
million of the proceeds from the issuance by the Authority on December 22, 1992,
of its $30.0 million of 1992 Series B Bonds and with respect to which PG&W
issued its $30.0 million of 7.125% First Mortgage Bonds to the IDA Trustee on
December 22, 1992, as security for the 1992 Series B Bonds. The proceeds from
the issuance of the 1992 Series B Bonds were deposited in a construction fund
held by the IDA Trustee for the Authority's 1992 Series B Bonds, pending their
utilization to finance the construction of various additions and improvements to
PG&W's water facilities for which construction commenced subsequent to September
23, 1992. As of March 31, 1994, $11.4 million was held by the IDA Trustee and
was available to finance the future construction of qualified water facilities
for PG&W.
PG&W's rated first mortgage bonds are currently rated BBB- (investment
grade) by Standard & Poor's Corporation ("S&P"), Baa3 (investment grade) by
Moody's Investors Services ("Moody's") and Class 2 by the National Association
of Insurance Commissioners ("NAIC"). On November 29, 1993, S&P said PG&W's
outlook was "stable" and that "continued, though slow, improvements in PG&W's
financial profile are expected as the last [water] treatment plant is completed
in 1993, and adequate water rate relief is granted." However, S&P noted that
"significant capital expenditures and an excessive dividend payout...will
continue to challenge management over the short term."
If PG&W's rated first mortgage bonds are downgraded below Class 2 (i.e.,
below investment grade) by the NAIC, this downgrade would cause the stated
interest rate on PG&W's $50.0 million of 9.57% Series First Mortgage Bonds due
1996 to increase to 11.17% per annum (which increase would cost PG&W $800,000
per year in additional interest expense, exclusive of tax benefits). Also, any
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downgrading of PG&W's rated first mortgage bonds below investment grade by
either S&P or Moody's would result in the interest rate charged on borrowings
under the Credit Agreement being increased by one half percent per annum (which
increase could cost PG&W as much as $300,000 per year in additional interest
expense, exclusive of tax benefits, depending on the amount of borrowings
outstanding under the Credit Agreement). Additionally, any downgrading of
PG&W's rated first mortgage bonds by S&P, Moody's or the NAIC could have a
material adverse effect on the cost and difficulty of issuing additional debt
and preferred stock, which in turn could significantly impair PEI's and PG&W's
ability to refinance debt and fund future capital expenditures. See "-Failure
to Obtain Adequate Rate Relief."
Construction Expenditures and Related Financing
Expenditures for the construction of utility plant totaled $4.9 million
during the first three months of 1994 and are currently estimated to be $41.9
million during the remainder of the year. A portion of PG&W's expenditures for
water facilities during 1994, which it is presently estimated will total $29.8
million, are being financed with proceeds from the issuance of the Authority's
1992 Series B Bonds being held by the IDA Trustee for the benefit of PG&W and
with revenues from the water rate increase for Scranton Water Rate Area
customers which was effective June 23, 1993 (see "-Rate Matters-Water Rate
Filings"). The balance of PG&W's expenditures for water facilities, as well as
its currently estimated $17.0 million in expenditures for gas facilities, are
being financed with internally-generated funds and bank borrowings, pending the
periodic issuance of stock and long-term debt.
Failure to Obtain Adequate Rate Relief
If PG&W is unable to obtain adequate rate relief in future rate increase
applications filed with the PPUC, PG&W would be forced to restrict its cash
expenditures by, among other actions, reducing or eliminating dividends on its
common stock, thereby resulting in a reduction of PEI's common stock dividends,
curtailing or deferring work on various capital projects, considering the sale
of selected assets and reducing its operating expenses, all of which could
negatively impact the quality and reliability of services rendered to the public
by PG&W.
Notwithstanding the PPUC's decision in its June 23, 1993, Order (see "-Rate
Matters-Water Rate Filings"), PG&W believes it will be able to obtain adequate
future rate relief, although there can be no assurance that such rate relief
will be obtained. However, if PG&W were unable to obtain adequate rate relief
from the PPUC under circumstances where PG&W believed that it is entitled as a
matter of law to such rate relief, PG&W would file appropriate appeals with the
Commonwealth Court of Pennsylvania, claiming that, contrary to law, the PPUC by
its actions had denied PG&W an opportunity to earn a fair rate of return on its
prudent investment in property which is used and useful in providing public
utility service.
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PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) No exhibits are required to be filed with this report on Form 10-Q.
(b) No reports on Form 8-K have been filed during the quarter for which this
report is filed.
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PENNSYLVANIA GAS AND WATER COMPANY
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.
PENNSYLVANIA GAS AND WATER COMPANY
(Registrant)
[CAPTION]
[S] [C]
Date: May 10, 1994 By: /s/ Thomas J. Ward
Thomas J. Ward
Secretary
Date: May 10, 1994 By: /s/ John F. Kell, Jr.
John F. Kell, Jr.
Vice President, Finance
(Principal Financial Officer and
Principal Accounting Officer)
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PENNSYLVANIA GAS AND WATER COMPANY
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.
PENNSYLVANIA GAS AND WATER COMPANY
(Registrant)
[CAPTION]
[S] [C]
Date: May 10, 1994 By:
Thomas J. Ward
Secretary
Date: May 10, 1994 By:
John F. Kell, Jr.
Vice President, Finance
(Principal Financial Officer and
Principal Accounting Officer)
<PAGE>
