UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-Q
(Mark One)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended June 30, 1994
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR
15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from
to
Commission file number 1-7179
SONAT INC.
(Exact name of registrant as specified in its charter)
DELAWARE 63-0647939
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization)Identification No.)
AMSOUTH-SONAT TOWER
BIRMINGHAM, ALABAMA 35203
(Address of principal executive offices)(Zip Code)
Registrant's telephone number: (205) 325-3800
NO CHANGE
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1)
has filed all reports required
to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that
the registrant was required to
file such reports), and (2) has been subject to such
filing requirements for the past
90 days.
Yes X No _
Indicate the number of shares outstanding of each
of the issuer's classes
of common stock, as of the latest practicable date.
COMMON STOCK, $1.00 PAR VALUE:
87,230,069 SHARES OUTSTANDING ON JULY 31, 1994
<PAGE>
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<CAPTION>
SONAT INC. AND SUBSIDIARIES
INDEX
<S> <S> <C>
Page No.
PART I. Financial Information
Item 1. Financial Statements
Condensed Consolidated Balance Sheets--
June 30, 1994 and December 31, 1993 1
Condensed Consolidated Statements of Income--
Three Months and Six Months Ended
June 30, 1994 and 1993 2
Condensed Consolidated Statements of Cash Flows--
Six Months Ended June 30, 1994 and 1993 3
Notes to Condensed Consolidated Financial
Statements 4 - 13
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 14 - 30
PART II. Other Information
Item 1. Legal Proceedings 31
Item 6. Exhibits and Reports on Form 8-K 31
</TABLE>
<PAGE>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
<TABLE>
<CAPTION>
SONAT INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
June 30, December 31,
1994 1993
(In Thousands)
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents $ 9,624 $ 10,822
Accounts and note receivable 265,476 256,925
Inventories 29,850 29,896
Gas supply realignment costs 48,556 59,862
Recoverable natural gas purchase contract
settlement costs 175 18,535
Gas imbalance receivables 35,191 43,867
Other 29,038 43,953
Total Current Assets 417,910 463,860
Investments in Unconsolidated Affiliates and Other 686,980 509,326
Plant, Property and Equipment 4,548,259 4,400,286
Less accumulated depreciation, depletion
and amortization 2,402,043 2,313,168
2,146,216 2,087,118
Deferred Charges:
Gas supply realignment costs 115,331 119,724
Other 30,122 33,969
145,453 153,693
$3,396,559 $3,213,997
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Unsecured notes and long-term debt due
within one year $ 226,204 $ 232,929
Accounts payable 167,260 193,383
Accrued income taxes 56,682 55,828
Accrued interest 44,876 49,853
Gas imbalance payables 40,346 59,144
Other 45,242 42,274
Total Current Liabilities 580,610 633,411
Long-Term Debt 899,020 741,161
Deferred Credits and Other:
Deferred income taxes 190,311 192,977
Reserves for regulatory matters 143,072 120,801
Other 181,570 162,432
514,953 476,210
Commitments and Contingencies
Stockholders' Equity:
Common stock and other capital 124,906 123,232
Retained earnings 1,277,070 1,239,983
Total Stockholders' Equity 1,401,976 1,363,215
$3,396,559 $3,213,997
</TABLE>
See accompanying notes.
<TABLE>
<CAPTION>
SONAT INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Three Months Six Months
Ended June 30, Ended June 30,
1994 1993 1994 1993
(In Thousands, Except Per-Share Amounts)
<S> <C> <C> <C> <C>
Operating Revenues $415,015 $356,492 $894,522 $853,405
Costs and Expenses:
Natural gas cost 180,714 117,271 394,289 327,304
Transition cost recovery
and gas purchase contract
settlement costs 27,529 11,471 70,449 28,154
Operating and maintenance 39,057 79,368 77,467 165,889
General and administrative 38,836 40,798 69,861 80,404
Depreciation, depletion
and amortization 66,350 54,000 132,644 106,707
Taxes, other than income 10,024 9,902 20,608 18,163
362,510 312,810 765,318 726,621
Operating Income 52,505 43,682 129,204 126,784
Other Income, Net:
Equity in earnings of
unconsolidated affiliates 11,560 9,361 16,382 10,693
Sale of subsidiary stock - 155,836 - 155,836
Other 2,426 2,790 6,877 5,568
13,986 167,987 23,259 172,097
Interest Income (Expense):
Interest income 1,192 2,363 3,113 31,932
Interest expense (23,632) (24,255) (45,061) (52,440)
Interest capitalized 1,956 823 3,571 1,834
(20,484) (21,069) (38,377) (18,674)
Income before Extraordinary
Item and Income Taxes 46,007 190,600 114,086 280,207
Income Taxes 11,466 64,735 29,935 85,419
Income before Extraordinary
Item 34,541 125,865 84,151 194,788
Extraordinary Loss, Net of
Income Tax Benefit of $1,972,000 - - - (3,829)
Net Income $ 34,541 $125,865 $ 84,151 $190,959
Earnings Per Share of Common Stock:
Earnings before extraordinary
item $ .40 $ 1.45 $ .97 $ 2.25
Extraordinary loss - - - (.04)
Earnings Per Share $ .40 $ 1.45 $ .97 $ 2.21
Weighted Average Shares Outstanding 87,193 86,561 87,185 86,379
Dividends Paid Per Share $ .27 $ .25 $ .54 $ .50
</TABLE>
See accompanying notes.
<TABLE>
<CAPTION>
SONAT INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six Months
Ended June 30,
1994 1993
(In Thousands)
<S> <C> <C>
Cash Flows from Operating Activities:
Net income $ 84,151 $ 190,959
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation, depletion and amortization 132,644 106,707
Deferred income taxes (3,089) 53,366
Equity in earnings of unconsolidated affiliates,
less distributions (8,809) (3,443)
(Gain) loss on sale of subsidiary stock and
disposal of assets (1,465) (156,368)
Reserves for regulatory matters 22,271 3,441
Gas supply realignment costs 15,699 -
Natural gas purchase contract settlement costs 18,360 28,274
Change in:
Accounts receivable (8,591) 26,870
Inventories 46 (3,381)
Accounts payable (26,123) (19,186)
Accrued interest and income taxes, net (4,035) (25,126)
Other current assets and liabilities 7,670 (3,399)
Other 33,282 29,321
Net cash provided by operating activities 262,011 228,035
Cash Flows from Investing Activities:
Plant, property and equipment additions (204,409) (159,074)
Net proceeds from sale of subsidiary stock and
disposal of assets 7,935 331,730
Advances to unconsolidated affiliates
and other (171,471) (12,760)
Net cash provided by (used in)
investing activities (367,945) 159,896
Cash Flows from Financing Activities:
Proceeds from issuance of long-term debt 2,110,000 220,000
Payments of long-term debt (2,053,160) (479,612)
Changes in short-term borrowings 94,294 -
Net changes in debt 151,134 (259,612)
Dividends paid (47,064) (43,167)
Other 666 15,479
Net cash provided by (used in)
financing activities 104,736 (287,300)
Net Increase (Decrease) in Cash and Cash Equivalents (1,198) 100,631
Cash and Cash Equivalents at Beginning of Period 10,822 58,007
Cash and Cash Equivalents at End of Period $ 9,624 $ 158,638
Supplemental Disclosures of Cash Flow Information
Cash Paid for:
Interest (net of amount capitalized) $ 42,051 $ 57,484
Income taxes, net 32,213 69,758
See accompanying notes.
</TABLE>
<PAGE>
1. Basis of Presentation
The accompanying condensed consolidated financial
statements of Sonat Inc. (Sonat) and its subsidiaries
(the Company) have been prepared in accordance with
the instructions to Form 10-Q and include the
information and footnotes required by such instruc-
tions. In the opinion of management, all adjustments
including those of a normal recurring nature have been
made that are necessary for a fair presentation of the
results for the interim periods presented herein.
Certain amounts in the 1993 condensed consolidated
financial statements have been reclassified to conform
with the 1994 presentation.
2. Changes in Operations
Stock Sale by Subsidiary - On June 4, 1993, the
initial public offering (IPO) of Sonat Offshore Drilling
Inc.'s (Sonat Offshore) common stock at $22.00 per share
was closed. Prior to the offering, the Company owned
100 percent of Sonat Offshore. Sonat Offshore issued
15.5 million shares, and the Company sold 1.448 million
of its shares resulting in a combined pretax gain of
$155.8 million. Net cash proceeds from the combined
transactions after underwriting commissions, expenses
and tax provisions totaled approximately $340 million.
The Company retained ownership of approximately
40 percent of Sonat Offshore's outstanding shares and
recognized an after-tax gain of $99.7 million, or $1.15
per share, from the combined transactions. At
June 30, 1994, the Company held 11.3 million shares of
Sonat Offshore common stock.
3. Unconsolidated Affiliates
The following table presents the components of equity
in earnings of unconsolidated affiliates.
<TABLE>
<CAPTION>
Three Months Six Months
Ended June 30, Ended June 30,
1994 1993 1994 1993
(In Thousands)
<S> <C> <C> <C> <C>
Company's Share of Reported Earnings (Loss)
Exploration and Production:
Sonat/P $ - $1,530 $ - $ 2,524
Other exploration and
production affiliates 204 100 311 182
204 1,630 311 2,706
Natural Gas Transmission and Marketing:
Citrus Corp. 7,367 3,659 7,684 1,241
Amortization of Citrus basis
difference 345 523 692 1,047
Bear Creek Storage 2,213 2,093 4,494 4,513
Other natural gas transmission
and marketing affiliates (53) - (78) 16
9,872 6,275 12,792 6,817
Other:
Sonat Offshore Drilling 866 810 2,561 810
Other affiliates 618 646 718 360
1,484 1,456 3,279 1,170
$11,560 $9,361 $16,382 $10,693
</TABLE>
Exploration and Production Affiliate - Sonat
Exploration Company (Sonat Exploration) had an initial
49 percent interest in Sonat/P Anadarko Limited
Partnership (Sonat/P) which acquired oil and gas
reserves in the Anadarko Basin of Oklahoma from
Louisiana Land and Exploration Company in the third
quarter of 1992. On October 4, 1993, Sonat Exploration
acquired the remaining interest in Sonat/P not owned by
it, from Prudential Insurance Company. Sonat/P had
revenues of $5.9 million and $10.4 million and reported
earnings of $2.5 million and $4.0 million for the three-
month and six-month periods ended June 30, 1993,
respectively.
Natural Gas Transmission and Marketing
Affiliates - Sonat owns 50 percent of Citrus Corp.
(Citrus), the parent of Florida Gas Transmission
Company. Southern Natural Gas Company (Southern) owns
50 percent of Bear Creek Storage Company (Bear Creek),
an underground gas storage company.
The following is summarized income statement
information for Citrus:
<TABLE>
<CAPTION>
Three Months Six Months
Ended June 30, Ended June 30,
1994 1993 1994 1993
(In Thousands)
<S> <C> <C> <C> <C>
Revenues $134,385 $188,572 $237,869 $317,662
(Income) Expenses:
Natural Gas Cost 86,404 132,329 152,297 224,962
Operating Expenses 28,787 19,556 55,009 37,711
Depreciation 9,850 9,363 19,543 25,752
Other Expenses, Net 11,050 16,354 21,965 25,925
Allowance for Funds Used
During Construction (25,623) (625) (36,006) (656)
Income Taxes 9,183 4,277 9,694 1,487
Income Reported $ 14,734 $ 7,318 $ 15,367 $ 2,481
</TABLE>
In connection with the construction of the
Phase III expansion, the Company made net non-interest-
bearing advances to Citrus of $167.8 million during the
1994 period. The significant increase in allowance for
funds used during construction relates to the Phase III
expansion, which should be completed by year-end 1994.
The following is summarized income statement
information for Bear Creek. No provision for income
taxes has been included since its income taxes are paid
directly by the joint-venture participants.
<TABLE>
<CAPTION>
Three Months Six Months
Ended June 30, Ended June 30,
1994 1993 1994 1993
(In Thousands)
<S> <C> <C> <C> <C>
Revenues $8,843 $8,894 $17,873 $18,585
Expenses:
Operating Expenses 1,287 1,407 2,565 2,918
Depreciation 1,350 1,349 2,700 2,699
Other Expenses, Net 1,780 1,952 3,619 3,942
Income Reported $4,426 $4,186 $ 8,989 $ 9,026
</TABLE>
Other Affiliate - Since June 4, 1993, the Company has
owned 40 percent of Sonat Offshore, which provides
offshore drilling services. (See Note 2.)
The following is summarized income statement
information for Sonat Offshore. Amounts for 1993 are
for the period from the date of the IPO to
June 30, 1993.
<TABLE>
<CAPTION>
Three Months Six Months
Ended June 30, Ended June 30,
1994 1993 1994 1993
(In Thousands)
<S> <C> <C> <C> <C>
Revenues $58,922 $16,299 $125,029 $16,299
(Income) Expenses:
Operating Expenses 48,648 11,510 102,363 11,510
Depreciation 6,283 1,497 12,101 1,497
Other (Income) Expenses, Net 522 (350) 453 (350)
Income Taxes 1,299 1,611 3,695 1,611
Income Reported $ 2,170 $ 2,031 $ 6,417 $ 2,031
</TABLE>
4. Long-Term Debt and Lines of Credit
During the first six months of 1994, Sonat
borrowed $2.1 billion and repaid $1.9 billion under its
revolving credit agreement, which is classified as long-
term, resulting in $300 million outstanding at a rate of
4.58 percent at June 30, 1994.
On May 30, 1994, Sonat and Southern renewed their
short-term lines of credit with several banks to provide
for borrowings of up to $200 million and $50 million,
respectively. Borrowings are available through
May 29, 1995, in the form of unsecured promissory notes
and bear interest at rates based on the banks'
prevailing prime, international or money market lending
rates.
On June 15, 1994, Southern's 9 5/8 Percent Notes
matured and were redeemed. Funds were obtained by
increased borrowings under Sonat's floating rate
facilities.
On August 1, 1994, Sonat entered into a new 364-
day revolving credit agreement with a group of banks.
The revolving credit agreement provides for periodic
borrowings of up to $300 million through July 31, 1995.
Borrowings are supported by unsecured promissory notes
that, at the option of the Company, will bear interest
at the banks' prevailing prime or international lending
rate, or such rates as the banks may competitively bid.
Loans outstanding under all short-term credit
facilities are for a duration of less than three months.
5. Commitments and Contingencies
Rate Matters - Periodically, Southern and its
subsidiaries make general rate filings with the Federal
Energy Regulatory Commission (FERC) to provide for the
recovery of cost of service and a return on equity. The
FERC normally allows the filed rates to become
effective, subject to refund, until it rules on the
approved level of rates. Southern and its subsidiaries
provide reserves relating to such amounts collected
subject to refund, as appropriate, and make refunds upon
establishment of the final rates.
On September 1, 1989, Southern implemented new
rates, subject to refund, reflecting a general rate
decrease of $6 million. In January 1991 Southern
implemented new rates, subject to refund, that
restructured its rates consistent with a FERC policy
statement on rate design and increased its sales and
transportation rates by approximately $65 million
annually. These two proceedings have been consolidated
for hearing. On October 7, 1993, the presiding
administrative law judge certified to the FERC a
contested offer of settlement pertaining to the
consolidated rate cases that (1) resolved all
outstanding issues in the rate decrease proceeding,
(2) resolved the cost of service, throughput, billing
determinant and transportation discount issues in the
rate increase proceeding, and (3) provided a method to
resolve all other issues in the latter proceeding,
including the appropriate rate design. Under the
settlement, the FERC will decide the rate design issue
based on written submissions of the parties and the
existing record in the proceeding. By orders issued on
December 16, 1993, and May 5, 1994 (the FERC Orders),
the FERC approved the settlement.
On September 1, 1992, Southern implemented another
general rate change. The rates reflected the continuing
shift in the mix of throughput volumes away from sales
and toward transportation and a $5 million reduction in
annual revenues. On April 30, 1993, Southern submitted
a proposed settlement in the proceeding that, if
approved by the FERC, would resolve the throughput and
certain cost of service issues. The rate design issue
is consolidated with similar issues in Southern's rate
proceeding filed May 1, 1993, which is described below,
and will be resolved in that proceeding. The settlement
was approved by the FERC Orders described above.
On May 1, 1993, Southern implemented a general
rate change, subject to refund, that increased its sales
and transportation rates by approximately $57 million
annually. The filing is designed to recover increased
operating costs and to reflect the impact of competition
on both Southern's level and mix of services. A hearing
regarding various cost allocation and rate design issues
in this proceeding is set for November 29, 1994.
Sea Robin Pipeline Company (Sea Robin), a
subsidiary of Southern, has previously filed under the
provisions of Order No. 500 to recover $83.1 million in
gas purchase contract settlement payments from its
former pipeline sales customers, Koch Gateway Pipeline
Company (Koch), successor to United Gas Pipe Line
Company, and Southern. Those filings remain subject to
refund pending the outcome of any prudence challenges in
the proceedings. Although the eligibility issues have
been resolved, one party has reserved its rights to
challenge prudence until such time as certain take-or-
pay allocation issues are resolved with respect to the
flow-through of costs billed to Koch.
Southern is authorized to flow through to its
jurisdictional customers $38.1 million of the costs
allocated to it by Sea Robin as well as the
$32.7 million in Order No. 500 costs allocated to it by
Koch. Southern's flow-through of Koch and Sea Robin's
costs remains subject to refund pending the outcome of
any challenges to the costs or allocation of the costs
in those pipelines' Order No. 500 proceedings. The
Company does not believe that the outcome of any such
challenges will have a material adverse effect on its
results of operations.
On July 2, 1993, the FERC issued an order
reaffirming its approval of the non-take-or-pay aspects
of a settlement filed by Koch in 1988, which included
Southern's phased abandonment of its contract demand
with Koch. The order rejected the take-or-pay aspects
of the settlement, including Koch's proposed Order
No. 528 allocation methodology. As a consequence,
various parties that had originally supported the
settlement began contesting it. Koch evidenced its
intention to honor the non-take-or-pay aspects of the
1988 settlement and induced several of the parties to
withdraw their judicial appeals of the July 2 order. On
April 29, 1994, Koch filed multiple settlements that
settled its outstanding take-or-pay issues with
substantially all of its customers, including Southern.
On August 4, 1994, the FERC issued an order approving
the settlements and terminating all take-or-pay
proceedings of Koch. This action should also lead to
the termination of the take-or-pay proceedings of Sea
Robin.
Gas Purchase Contracts - Gas purchase contract
settlement payments (other than the gas supply
realignment payments discussed below) made by Southern
and not previously recovered or expensed are included on
the Condensed Consolidated Balance Sheet at
June 30, 1994, in "Current Assets". Pursuant to a final
and nonappealable FERC order, Southern collected these
amounts from its customers over a five-year period that
ended on April 30, 1994. Southern currently is
incurring no take-or-pay liabilities under its gas
purchase contracts. Southern regularly evaluates its
position relative to gas purchase contract matters,
including the likelihood of loss from asserted or
unasserted take-or-pay claims or above-market prices.
When a loss is probable and the amount can be reasonably
estimated, it is accrued.
Order No. 636 - In 1992 the FERC issued its Order
No. 636 (the Order). The Order required significant
changes in interstate natural gas pipeline services.
Interstate pipeline companies, including Southern, are
incurring certain costs (transition costs) as a result
of the Order, the principal one being costs related to
amendment or termination of existing gas purchase
contracts, which are referred to as gas supply
realignment (GSR) costs. The Order provided for the
recovery of 100 percent of the GSR costs and other
transition costs to the extent the pipeline can prove
that they are eligible, that is, incurred as a result of
customers' service choices in the implementation of the
Order, and were incurred prudently. The prudence review
will extend both to the prudence of the underlying gas
purchase contracts, based on the circumstances that
existed at the time the contracts were executed, and to
the prudence of the amendments or terminations of the
contracts. Numerous parties have appealed the Order to
the Circuit Courts of Appeal.
On September 3, 1993, the FERC generally approved
a compliance plan for Southern and directed Southern to
implement its restructured services pursuant to the
Order on November 1, 1993 (the September 3 order).
Pursuant to Southern's compliance plan, GSR costs that
are eligible for recovery include payments to reform or
terminate gas purchase contracts. Where Southern can
show that it can minimize transition costs by continuing
to purchase gas under the contract (i.e., it is more
economic to continue to perform), eligible GSR costs
would also include the difference between the contract
price and the higher of (a) the sales price for gas
purchased under the contract or (b) a price established
by an objective index of spot-market prices. Recovery
of these "price differential" costs is permitted for an
initial period of two years.
Southern's compliance plan contains two mechanisms
pursuant to which Southern is permitted to recover
100 percent of its GSR costs. The first mechanism is a
monthly fixed charge designed to recover 90 percent of
the GSR costs from Southern's firm transportation
customers. The second mechanism is a volumetric charge
designed to collect the remaining 10 percent of such
costs from Southern's interruptible transportation
customers. These funding mechanisms will continue until
the GSR costs are fully recovered or funded. The FERC
also indicated that Southern could file to recover any
GSR costs not recovered through the volumetric charge
after a period of two years. In addition, Southern's
compliance plan provides for the recovery of other
transition costs as they are incurred and any remaining
transition costs may be recovered through a regular rate
filing.
Southern's customers have generally opposed the
recovery of Southern's GSR costs based on both
eligibility and prudence grounds. The September 3 order
rejected the argument of certain customers that a 1988
take-or-pay recovery settlement bars Southern from
recovering GSR costs under gas purchase contracts
executed before March 31, 1989, which comprise most of
Southern's GSR costs. Those customers subsequently
filed motions urging the FERC to reverse its ruling on
that issue. On December 16, 1993, the FERC affirmed its
September 3 ruling with respect to the 1988 take-or-pay
recovery settlement (the December 16 order). The FERC's
finding that the 1988 settlement is not a bar in general
to the recovery as GSR costs of payments made to amend
or to terminate these contracts does not prevent an
eligibility challenge to specific payments, however, on
the theory that they are actually take-or-pay costs that
would have been unavoidable regardless of the Order.
The December 16 order generally approved Southern's
restructuring tariff submitted pursuant to the
September 3 order. Various parties have sought judicial
review of the September 3 and December 16 orders.
During 1993 Southern reached agreements to reduce
significantly the price payable under a number of above-
market gas purchase contracts in exchange for payments
of approximately $114 million. On December 1, 1993,
Southern filed with the FERC to recover such costs and
approximately $3 million of prefiling interest (the
December 1 filing). On December 30, 1993, the FERC
accepted such filing to become effective
January 1, 1994, subject to refund, and subject to a
determination through a hearing before an administrative
law judge as to whether such costs were prudently
incurred and are eligible for recovery under the Order.
Southern's customers are opposing its recovery of the
GSR costs in this proceeding based on both eligibility
and prudence grounds. The December 30 order rejected
arguments of various parties that, as a matter of law,
a pipeline's payments to affiliates, in this case
Southern's payment to a subsidiary of Sonat Exploration
that represented approximately $34 million of the
December 1 filing, may not be recovered under the Order.
The payment is still subject to challenge on both
eligibility and prudence grounds.
In December 1993 Southern reached agreement to
reduce the price under another contract in exchange for
payments having a present value of approximately
$52 million, which is included in "Deferred Credits and
Other" in the Consolidated Balance Sheet. Payments will
be made in equal monthly installments over an eight-year
period ending December 31, 2001. On February 14, 1994,
Southern made a rate filing to recover those costs as
well as approximately $3 million of other settlement
costs and prefiling interest. In an order issued on
March 16, 1994, the FERC accepted such filing to become
effective on April 1, 1994, subject to refund, and
subject to a hearing before an administrative law judge
as to whether such costs were prudently incurred and are
eligible for recovery under the Order. In its order the
FERC directed that the monthly installment payments be
recovered over the eight-year period during which they
will be incurred. Southern's customers are opposing, on
grounds of both eligibility and prudence, its recovery
of the GSR costs in this proceeding, which has been
consolidated with the proceeding on the December 1
filing.
Since November 1, 1993, Southern has also incurred
"price differential" costs while continuing to purchase
gas under contracts that are in excess of current market
prices. On March 1, 1994, Southern made a rate filing
to recover $17.5 million of these costs that had been
incurred through January 31, 1994. In an order issued on
March 31, 1994, the FERC accepted such filing to become
effective on April 1, 1994, subject to refund, and
subject to a hearing before an administrative law judge
as to whether such costs were prudently incurred and are
eligible for recovery under the Order. On May 31, 1994,
Southern made a rate filing to recover an additional
$15.4 million of these costs that had been incurred
through April 30, 1994. In an order issued on
June 30, 1994, the FERC accepted such filing to become
effective on July 1, 1994, subject to refund, and
subject to a hearing before an administrative law judge
as to whether such costs were prudently incurred and are
eligible for recovery under the Order. Southern's
customers are opposing, on grounds of both eligibility
and prudence, its recovery of the GSR costs in these
proceedings, which have been consolidated with the
proceedings on the December 1 filing and the February 14
filing.
On May 27, 1994, the FERC issued an order dealing
with compliance filings and rehearing requests that had
been filed in response to its earlier orders permitting
the recovery, subject to refund, of GSR costs sought to
be collected by Southern. In that order, the FERC
accepted revised tariff sheets that provide for the
recovery of GSR costs related to the termination or
amendment of gas purchase contracts over 36 months,
rather than through a direct bill or over a 15-month
period as earlier proposed by Southern, and permitted on
rehearing the amortization of price differential GSR
costs allocated to interruptible transportation
customers over 12 months, as originally proposed by
Southern, rather than over three months as required by
the FERC in its order of March 16, 1994. The FERC
further ordered that Southern remove certain
"transaction costs" that had been included in its
quarterly GSR filings, noting that they were more
properly included as administrative costs in the next
general rate filing of Southern. Finally, the FERC
ordered that Southern recompute on the basis of actual
prices rather than average prices, and authenticate
through supporting documentation, its claimed price
differential costs that had been included in its
quarterly GSR filings.
In compliance with the May 27 Order, Southern
filed revised tariff sheets that reduced its claimed GSR
costs by approximately $700,000. These revised tariff
sheets were accepted by the FERC in an order issued
June 30, 1994.
Southern plans to make additional rate filings
quarterly to recover its "price differential" costs and
any other GSR costs. Additionally, Southern continues
to make monthly filings designed to adjust the billing
determinants and associated surcharges for its firm
transportation customers to reflect changes in the level
of systemwide contract demands and effective carrying
charges that occur from time to time. The total GSR
costs of $164 million, net of recoveries, accrued
through June 30, 1994, are included in current and long-
term gas supply realignment costs in the Condensed
Consolidated Balance Sheet.
Administrative Law Judge Ruling Concerning
Recoverability of Investment in Offshore Gas Supply
Facilities - In an initial decision issued on
May 2, 1994, an administrative law judge ruled, in a
rate case Southern had filed before the FERC, that
Southern could not include in its rates the
approximately $45 million cost of certain pipeline
facilities placed in service by Southern in 1992 to
connect to its interstate pipeline system extensive new
gas reserves being developed by Exxon Corporation
(Exxon) in the Mississippi Canyon and Ewing Bank Area
Blocks, offshore Louisiana (the Mississippi Canyon
Facilities). The judge ruled that Southern's recovery
of these costs was precluded by the 1988 settlement with
Southern's customers that limits the amount of take-or-
pay payments Southern may recover in its rates. The
judge found that the cost of the facilities constitutes
non-cash consideration to Exxon for a 1989 take-or-pay
settlement and is therefore subject to the dollar "cap"
on these payments contained in the 1988 settlement.
Southern has previously recovered the maximum amount
permitted by the 1988 settlement in its rates.
The judge found alternatively that the Mississippi
Canyon Facilities were underutilized for purposes of
certain "at-risk" conditions contained in the FERC
certificate authorizing the construction of the
facilities and that, in the event his decision that the
cost of the facilities is subject to the take-or-pay
settlement cap were to be overturned on appeal, Southern
should recover only the amount of the annual cost of
service of the facilities proportional to their level of
utilization during the period of time under review,
November 1, 1992, through April 30, 1993. He calculated
the utilization level at 32 percent, and when this
factor is applied to the $11.9 million cost of service
attributable to the facilities accepted by the judge,
Southern would be permitted to include only $3.8 million
of that amount in its rates for this period.
On July 29, 1994, Southern filed a brief on
exceptions with the FERC seeking to overturn the initial
decision of the administrative law judge as it relates
to the recoverability of its Mississippi Canyon
Facilities investment, but Southern cannot predict the
action that may be taken by the FERC or the outcome of
any subsequent appeal concerning the rate treatment of
the $45 million cost of these facilities.
With respect to the recoverability by Southern
under the Order of GSR costs associated with Southern's
gas supply contract with Exxon relating to the reserves
connected by the Mississippi Canyon Facilities,
Southern's customers have asserted in a separate
proceeding before the FERC that the gas supply contract
was non-cash consideration for the Exxon take-or-pay
settlement and that recovery by Southern of GSR costs
incurred with respect to such contract is also precluded
by the 1988 take-or-pay settlement. Estimated GSR costs
under this contract through the scheduled renegotiation
of its pricing provisions in 1997 are estimated to be in
the range of $65 million to $75 million on a present
value basis, although such estimate is subject to
significant uncertainty since the assumptions inherent
in the estimate (including underlying reserves, future
deliverability, and a range of estimated future gas
market prices) are not known today with certainty and
there is a wide range of possible outcomes for each
assumption. In addition, Southern has given notice to
Exxon that effective March 1, 1994, it has terminated
the gas purchase contract covering gas reserves
connected by the Mississippi Canyon Facilities pursuant
to certain provisions of the contract. Exxon has filed
suit against Southern seeking a declaratory judgment
that Southern does not have the right to terminate the
contract or alternatively for damages of an unspecified
amount arising out of the alleged repudiation or breach
of the contract by Southern. Southern cannot predict
the outcome of pending or future proceedings for the
recovery of GSR costs related to the gas supplies
connected by the Mississippi Canyon Facilities or its
pending litigation with Exxon regarding Southern's
notice of termination of the gas supply contract.
Settlement Discussions - Southern has continued to
have settlement discussions with its major customers in
an effort to resolve all of Southern's outstanding rate
and service agreement issues and its Order No. 636
transition cost recovery. Southern cannot predict the
outcome of those discussions or whether any settlement
will be reached with its customers. Southern is also
unable to predict all of the elements of the outcome of
its Order No. 636 restructuring proceeding or its rate
filings to recover its transition costs.
6. Income Taxes
Net income for the six-month period of 1993
includes a net gain of $21 million, or $.24 per share,
related to the settlement of an examination of the
Company's federal income tax returns for the years 1983
through 1985 and other tax issues.
7. Capital Stock
On April 28, 1994, the shareholders of the Company
approved an increase in the common stock shares
authorized from 200 million to 400 million.
<PAGE>
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations
SONAT INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
Operating Income
Sonat Inc. and its subsidiaries (the Company)
operate in the energy industry through its Exploration
and Production and Natural Gas Transmission and
Marketing segments.
<TABLE>
<CAPTION>
Three Months Six Months
Ended June 30, Ended June 30,
1994 1993 1994 1993
(In Millions)
<S> <C> <C> <C> <C>
Operating Income:
Exploration and production $22 $24 $ 44 $ 46
Natural gas transmission
and marketing 29 17 81 78
Other 2 3 4 3
Operating Income $53 $44 $129 $127
</TABLE>
EXPLORATION AND PRODUCTION
The Company is engaged in the exploration for and
the acquisition, development, and production of oil and
natural gas in the United States through Sonat
Exploration Company (Sonat Exploration). Beginning in
1988 Sonat Exploration implemented a strategy to acquire
gas properties with significant development potential.
As a result of this strategy, Sonat Exploration's proved
reserves totaled approximately 1.5 trillion cubic feet
of natural gas equivalent at June 30, 1994,
approximately a six fold increase since the beginning of
1988.
Sonat Exploration intends to continue to
aggressively acquire domestic gas properties with
significant development potential. During the first six
months of 1994, Sonat Exploration acquired oil and gas
interests and properties for a total of $57 million,
which increased proved reserves by approximately
108 billion cubic feet of natural gas equivalent. In
the largest acquisition of the second quarter of 1994,
Sonat Exploration paid approximately $26 million for
interests in oil and gas properties in south Texas
having proved reserves of approximately 46 billion cubic
feet of natural gas equivalent. Sonat Exploration's
other acquisitions in the second quarter were located
primarily in the southern and west Texas regions. Since
June 30, 1994, Sonat Exploration has acquired or is in
the process of acquiring properties having total proved
reserves of approximately 58 billion cubic feet of
natural gas equivalent for approximately $41 million.
Sonat Exploration has a substantial producing
property acreage position in the eastern extension of
the Austin Chalk trend in Texas and Louisiana. During
the first six months of 1994, Sonat Exploration
participated in the drilling of 18 wells, all of which
were successful. As of June 30, 1994, Sonat Exploration
had participated in the completion of 42 wells in the
Austin Chalk trend, 41 of which are commercial.
Sonat Exploration's proved reserves include a
portion that qualifies for Section 29 tax credits.
During the year ended December 31, 1993, Section 29 tax
credits totaled $19 million; however, production from
wells that qualify for these credits has decreased in
1994 as these wells follow their normal decline pattern.
Total capital expenditures for Sonat Exploration
are expected to approximate $390 million in 1994, which
would be down slightly from 1993. Capital spending in
1994 includes amounts for increased development drilling
and additional producing property acquisitions.
Sonat Exploration's natural gas and liquids
production is marketed primarily in the spot-market
almost entirely by Sonat Marketing Company (Sonat
Marketing), a subsidiary of Sonat Energy Services
Company (Sonat Energy Services) operating in the
Company's Natural Gas Transmission and Marketing
Segment. See Derivatives section for a discussion of
Sonat Exploration's hedging activities.
<PAGE>
Exploration and Production Operations
<TABLE>
<CAPTION>
Three Months Six Months
Ended June 30, Ended June 30,
1994 1993 1994 1993
(In Millions)
<S> <C> <C> <C> <C>
Revenues:
Sales to others $ 37 $55 $ 68 $ 97
Intersegment sales 71 31 146 68
Total Revenues $108 $86 $214 $165
Depreciation, Depletion and
Amortization $ 49 $33 $ 98 $ 64
Operating Income $ 22 $24 $ 44 $ 46
Equity in Earnings of
Unconsolidated Affiliates $ - $ 2 $ - $ 3
Net Sales Volumes:
(Includes Sonat/P)
Gas (Bcf) 44 36 87 71
Oil and condensate (MBbls) 1,064 754 2,017 1,446
Natural gas liquids (MBbls) 309 196 537 360
Average Sales Prices:
(Includes Sonat/P)
Gas ($/Mcf) $ 1.97 $ 2.01 $ 2.03 $ 1.95
Oil and condensate ($/Bbl) 16.77 18.78 15.01 18.37
Natural gas liquids ($/Bbl) 8.86 9.02 8.95 8.70
</TABLE>
Equity in earnings of unconsolidated affiliates
reflects Sonat Exploration's acquisition of the
remaining interest in Sonat/P Anadarko Limited
Partnership (Sonat/P) in late 1993.
Quarter-to-Quarter Analysis
Sonat Exploration's operating income was
$22 million in the second quarter of 1994, $2 million
less than the same period in 1993. Natural gas
production rose 22 percent, reflecting acquisitions
completed since the middle of 1993, as well as
aggressive development drilling. Oil and condensate
production rose 41 percent and natural gas liquids
volumes increased 58 percent, due primarily to continued
growth in production from the Austin Chalk trend in East
Texas. Increases in production levels were largely
offset by lower energy prices and by higher amortization
and other operating expenses as a result of the higher
production. Gas prices were down only slightly in the
second quarter of 1994 compared to 1993 while oil and
condensate prices were 11 percent lower than the 1993
period. Oil and condensate prices, however showed
significant improvement over the first quarter of 1994,
increasing 29 percent from the average price of
$13.04 per barrel.
Year-to-Date Analysis
Operating income for the 1994 year-to-date period
was $44 million compared to $46 million for the same
period in 1993. Significant increases in production of
23 percent for natural gas and 39 percent for oil and
condensate were due to the aggressive acquisition and
development activity since mid-1993. Natural gas
liquids increased 49 percent over last year as a result
of increased production from the Austin Chalk trend.
Gas prices were slightly higher, but oil prices,
although improved from first quarter levels, were still
18 percent under last year. Increases in operating
expenses due primarily to higher amortization resulting
from the increase in production were partially offset by
a $3 million decrease in stock-based employee
compensation.
NATURAL GAS TRANSMISSION AND MARKETING
The Company participates in the natural gas
transmission and marketing business through Southern
Natural Gas Company, Citrus Corp. (a 50 percent-owned
company), and Sonat Energy Services Company. Southern
and Florida Gas Transmission Company (Florida Gas), a
subsidiary of Citrus, operating in the natural gas
transmission industry, have historically provided
customers of their natural gas pipelines both merchant
and transportation services. Effective
November 1, 1993, Southern separated its transportation,
storage, and merchant services to comply with Order
No. 636. (See following discussion.) Florida Gas also
restructured its services in compliance with Order
No. 636 effective on November 1, 1993. As a result of
Order No. 636, both Southern and Florida Gas have
essentially become solely gas transporters, although
Southern continues to make limited sales pending the
expiration, termination, or assignment of its remaining
gas supply contracts. Sonat Energy Services, through
its subsidiaries, manages Sonat's unregulated natural
gas businesses, including natural gas marketing and
gathering and intrastate natural gas pipeline services.
Citrus provides natural gas marketing activities through
its affiliates, primarily to customers of Florida Gas.
The natural gas transmission industry, although
regulated, is very competitive. During the period from
the mid-1980's until the Order No. 636 restructuring,
customers had switched much of their volumes from a
bundled merchant service to transportation service,
reflecting an increased willingness to rely on gas
supply under unregulated arrangements such as those
provided by Sonat Marketing and affiliates of Citrus.
Southern competes with several pipelines for the
transportation business of its customers and at times
discounts its transportation rates in order to maintain
market share.
Southern is pursuing growth opportunities to
expand the level of services in its traditional market
area and to connect new gas supplies. On May 1, 1994,
Southern completed its second pipeline expansion into
northern Florida and southwestern Georgia that increased
firm daily capacity by 40 million cubic feet per day.
On July 22, 1994, Southern filed an application with the
FERC for authorization to construct a 21-mile pipeline
extension to a delivery point near Chattanooga that will
deliver natural gas to a group of new customers who have
agreed to sign ten-year contracts for firm
transportation volumes totaling over 11 million cubic
feet per day.
Florida Gas, which has a current pipeline system
capacity of 925 million cubic feet per day, is scheduled
to complete its current expansion project, known as
Phase III, by year-end 1994. This expansion will
increase system capacity by 530 million cubic feet per
day at a capital cost of approximately $900 million. As
part of Phase III, Florida Gas has contracted for
100 million cubic feet per day of new firm
transportation to be delivered from Southern's system.
The Company is advancing funds to Citrus for Phase III
and expects to increase its equity investment in Citrus
by $150 million by the end of the construction period.
Also in connection with this expansion, Florida Gas
entered into an agreement to acquire a 20 percent
interest in an existing pipeline in the Mobile Bay area
that, pursuant to the agreement, will be expanded by
over 300 million cubic feet per day and connected to
Florida Gas' pipeline system. Additionally, Florida Gas
is currently reviewing the prospects for further
expansions of its pipeline system into the Florida
market that could be in service in 1996 or 1997.
Sonat Marketing continues to expand its natural
gas marketing business. Prior to 1993, Sonat
Marketing's volumes were approximately 700 million cubic
feet per day and were primarily on the Southern system.
During 1993 Sonat Marketing assumed responsibility for
marketing almost all of the natural gas and liquids
production of Sonat Exploration, including execution of
Sonat Exploration's risk management program. This has
allowed Sonat Marketing to expand its presence in Gulf
Coast, Midwest, and Northeast markets and, in turn,
provide an attractive market to unaffiliated producers.
As a result of these efforts and due to increased
purchasing from third parties over historic levels,
Sonat Marketing's average daily sales volumes at
June 30, 1994, were approximately 1.4 billion cubic feet
per day, making it one of the twenty largest natural gas
marketers in the country.
See Derivatives section for a discussion of Sonat
Marketing's hedging activities.
<PAGE>
Natural Gas Transmission and Marketing Operations
<TABLE>
<CAPTION>
Three Months Six Months
Ended June 30, Ended June 30,
1994 1993 1994 1993
(In Millions)
<S> <C> <C> <C> <C>
Revenues:
Gas sold by Southern $ 43 $ 65 $115 $282
Gas sold by Sonat Marketing 216 125 445 229
Other sales 2 3 7 8
Total Gas Sold 261 193 567 519
Market transportation and storage 72 32 154 71
Supply transportation 10 12 21 24
Other 36 14 88 36
Total Revenues $379 $251 $830 $650
Natural Gas Cost:
Purchased from others $181 $117 $394 $327
Intersegment purchases 71 31 146 68
Total Natural Gas Cost $252 $148 $540 $395
Transition Cost Recovery and
Gas Purchase Contract
Settlement Costs $ 28 $ 11 $ 70 $ 28
Depreciation and Amortization $ 17 $ 17 $ 34 $ 33
Operating Income $ 29 $ 17 $ 81 $ 78
Equity in Earnings
of Unconsolidated Affiliates $ 10 $ 6 $ 13 $ 7
(Billion Cubic Feet)
Southern Volumes:
Gas sold - 8 - 61
Market transportation 113 98 269 201
Total Market Throughput 113 106 269 262
Supply transportation 83 84 161 167
Total Volumes 196 190 430 429
Transition gas sales 24 - 56 -
Sonat Marketing Sales Volumes 109 57 209 113
Florida Gas Volumes (100%):
Gas sold - 4 - 11
Market transportation 77 70 143 128
Total Market Throughput 77 74 143 139
Supply transportation 4 12 9 24
Total Volumes 81 86 152 163
</TABLE>
Quarter-to-Quarter Analysis
Southern's operating results for the second
quarter were up due primarily to a change to a less
seasonal rate design under Order No. 636. Operating
results were also favorably affected by lower general
and administrative expenses due to a $3 million
reduction in employee related benefit expenses. These
increases were partially offset by a reduction in rate
base resulting from the sale of working gas storage to
customers as part of the implementation of Order
No. 636.
Southern's gas sales revenues and gas costs
include $46 million of transition gas sales. Higher
market transportation revenues and volumes reflect the
implementation of Order No. 636.
Other revenue increased during the quarter due
primarily to the recovery of transition costs.
Sonat Marketing's sales volumes increased
significantly over the second quarter of 1993 as a
result of fully integrating the marketing of Sonat
Exploration's production and acquiring additional third-
party volumes. In addition, due to greater
concentration on value added services, margins have
shown good increases over last year.
Equity in earnings of Citrus for the second
quarter of 1994 increased $4 million from 1993 due to
increased allowance for funds used during contruction
(AFUDC) recognized on Phase III, lower depreciation
expense resulting from a change in the estimated useful
life of the pipeline system, and higher margins as a
result of restructuring the pricing terms of a gas
supply contract with one of its major customers. Equity
in earnings in 1993 included the favorable effect of the
sale of gas supply contracts at Citrus Marketing in
1993.
Year-to-Date Analysis
Southern's operating results for the six-month
period were down slightly from last year due to the
change to a less seasonal rate design and the rate base
reduction under Order No. 636. These declines were
partially offset by lower operating and maintenance
expense resulting from a $4 million reduction in fuel
gas liability and lower general and administrative
expenses due to a $7 million reduction in employee
related benefit expenses.
Southern's gas sales revenues and gas costs were
down significantly for the six-month period as a result
of implementing Order No. 636, but still include
$118 million of transition gas sales from supply
remaining under contract (see Order No. 636 discussion
below). Total market throughput increased three percent
for the six-month period; however, Order No. 636
resulted in a shift in volumes from sales to market
transportation.
Other revenue increased for the six-month period
due primarily to the recovery of transition costs.
Sonat Marketing's sales volumes increased
significantly over last year as a result of fully
integrating the marketing of Sonat Exploration's
production and acquiring additional third-party volumes.
In addition, due to greater concentration on value added
services, margins have shown good increases over last
year.
Equity in earnings of Citrus increased $6 million
from $2 million in 1993 due to the recognition of AFUDC
in the current year and to lower depreciation expense
resulting from a change in the estimated useful life of
the pipeline system. Equity in earnings in 1993
included the favorable effect of the sale of gas supply
contracts at Citrus Marketing in 1993. Higher margins
during the second quarter resulting from the
restructured gas supply contract with one of its major
customers were offset by higher prices for natural gas
relative to competing No. 6 fuel oil in the first
quarter. Earnings for Citrus in 1995 are expected to be
lower compared to 1994 due to the scheduled completion
of the Florida Gas expansion project at the end of 1994
and the resulting end of AFUDC recognition on the
project.
Order No. 636
In 1992 the FERC issued its Order No. 636 (the
Order). As required by the Order, interstate natural
gas pipeline companies have made significant changes in
the way they operate. The Order required pipelines,
among other things, to: (1) separate (unbundle) their
sales, transportation, and storage services; (2) provide
a variety of transportation services, including a "no-
notice" service pursuant to which the customer is
entitled to receive gas from the pipeline to meet
fluctuating requirements without having previously
scheduled delivery of that gas; (3) adopt a straight-
fixed-variable (SFV) method for rate design (which
assigns more costs to the demand component of the rates
than do other rate design methodologies previously
utilized by pipelines); and (4) implement a pipeline
capacity release program under which firm customers have
the ability to "broker" the pipeline capacity for which
they have contracted. The Order also authorized
pipelines to offer unbundled sales services at market-
based rates and allowed for pregranted abandonment of
some services.
In requiring that Southern provide unbundled
storage service, the Order resulted in a substantial
reduction of Southern's working storage gas inventory
and consequently a reduction in its rate base. This
reduction was effective on November 1, 1993, when
Southern restructured pursuant to the Order and sold, at
its cost, $123 million of its working storage gas
inventory to its customers. The Order also resulted in
rates that are less seasonal, thereby shifting revenues
and earnings for Southern out of the winter months.
The FERC issued an order on September 3, 1993 (the
September 3 order), that generally approved a compliance
plan for Southern and directed it to implement
restructured services on November 1, 1993. In
accordance with the September 3 order, Southern
solicited service elections from its customers in order
to implement its restructured services on
November 1, 1993. Southern's largest customer, Atlanta
Gas Light Company and its subsidiary, Chattanooga Gas
Company (collectively Atlanta) signed firm
transportation service agreements with transportation
demands of 582 million cubic feet per day for a one-year
term ending October 31, 1994, and 118 million cubic feet
per day for a term extending until April 30, 2007, at
the maximum FERC-approved rates. This represented an
aggregate reduction of 100 million cubic feet per day
from Atlanta's level of service prior to
November 1, 1993. Southern's other customers elected in
aggregate to obtain an amount of firm transportation
services that represented a slight increase from their
level of firm sales and transportation services from
Southern prior to Southern's implementation of Order
No. 636, at the maximum FERC-approved tariff rates, for
terms ranging from one to ten or more years.
Southern's discussions are continuing with Atlanta
and its other distribution customers regarding their
elections for firm transportation service on Southern's
system. It is possible that these discussions could
result in a rate reduction by Southern as part of an
overall settlement. Although management believes that
most of Southern's distribution customers ultimately
will commit to some type of new firm transportation
agreements with Southern under its restructuring program
beyond those described above, it is unable to predict at
what total contract level or for what duration such
commitments will be made.
Natural Gas Sales and Supply
As discussed in Note 5 of the Notes to Condensed
Consolidated Financial Statements, Southern is incurring
certain transition costs as a result of implementing
Order No. 636, and for Southern, those are primarily gas
supply realignment (GSR) costs relating to amendment or
termination of existing gas purchase contracts. In its
restructuring settlement discussions, Southern has
advised its customers that the amount of GSR costs that
it actually incurs will depend on a number of variables,
including future natural gas and fuel oil prices, future
deliverability under Southern's existing gas purchase
contracts, and Southern's ability to renegotiate certain
of these contracts. While the level of GSR costs is
impossible to predict with certainty because of these
numerous variables and the outcome of the lawsuit with
Exxon discussed in Note 5, based on current spot-market
prices, a range of estimates of future oil and gas
prices, recent contract renegotiations and "price
differential" costs actually incurred, the amount of GSR
costs are estimated to be in the range of approximately
$300-$325 million on a present value basis (including
the Exxon contract discussed in Note 5). This amount
includes the payments made to amend or terminate gas
purchase contracts described in Note 5.
Sales by Southern are anticipated to continue only
until Southern's remaining supply contracts expire, are
terminated, or are assigned. Southern is attempting to
terminate its remaining gas purchase contracts through
which it had traditionally obtained its long-term gas
supply. Some of these contracts contain clauses
requiring Southern either to purchase minimum volumes of
gas under the contract or to pay for it (take-or-pay
clauses). Although Southern currently is incurring no
take-or-pay liabilities under these contracts, the
annual weighted average cost of gas under these
contracts is in excess of current spot-market prices.
Pending the termination of these remaining supply
contracts, Southern has agreed to sell a portion of its
remaining gas supply to a number of its firm
transportation customers for a one-year term that began
November 1, 1993. The sales agreements with Atlanta
were extended through March 31, 1995. The remainder of
Southern's gas supply will be sold on a month-to-month
basis. Southern will file to recover as a GSR cost
pursuant to Order No. 636 the difference between the
cost associated with the gas supply contracts and the
revenue from the sales agreements and month-to-month
sales as well as any cost previously incurred or
incurred in the future as a result of Order No. 636 to
terminate or reduce the price under Southern's remaining
contracts.
Through June 30, 1994, Southern has paid
$125 million to reduce or terminate the price payable
under a number of above-market gas purchase contracts.
In addition, Southern has paid $43 million in excess of
current spot-market prices under its remaining gas
purchase contracts since implementing Order No. 636 on
November 1, 1993. Southern's rate filings to recover
these payments as GSR costs are described in Note 5.
Southern's purchase commitments under its
remaining gas supply contracts for the years 1994
through 1998 (which exclude those under the Exxon
contract related to the Mississippi Canyon Facilities
discussed in Note 5) are estimated as follows:
<TABLE>
<CAPTION>
Estimated
Purchase
Commitments
(In Millions)
<C> <C>
1994 $200
1995 150
1996 85
1997 70
1998 65
Total $570
</TABLE>
These estimates are subject to significant
uncertainty due both to the number of assumptions
inherent in these estimates and to the wide range of
possible outcomes for each assumption. None of the
three major factors that determine purchase commitments
(underlying reserves, future deliverability, and future
price) is known today with certainty.
Rate Matters
Several general rate changes have been implemented
by Southern and remain subject to refund. See Note 5 of
the Notes to Condensed Consolidated Financial Statements
for a discussion of rate matters.
Settlement Discussions
As discussed in Note 5, Southern's customers are
challenging its recovery of GSR costs and Southern is
subject to other litigation. Southern has continued to
have settlement discussions with its major customers in
an effort to resolve all of Southern's outstanding rate
and service agreement issues and its Order No. 636
transition cost recovery. Southern cannot predict the
outcome of those discussions or whether any settlement
will be reached with its customers. Southern is also
unable to predict all of the elements of the outcome of
its Order No. 636 restructuring proceeding or its rate
filings to recover its transition costs.
Citrus Corp.
Citrus' historical losses are mainly due to a high
level of depreciation and interest expense. Since
Citrus was acquired in mid-1986, however, cash generated
by operations has been sufficient to fund normal capital
expenditures and a portion of major expansion projects.
Citrus' restructuring of its services in 1990 has helped
to mitigate the effect of declines in the price of No. 6
fuel oil on its revenue and margins. The results of
operations from Citrus, however, have continued to be
strongly influenced by the level of No. 6 fuel oil
prices and the relationship of natural gas prices to
fuel oil prices. In May 1994 Citrus entered into a
binding letter agreement that restructured the pricing
provisions and extended the term of two gas supply
contracts with its major customer on a basis that should
eliminate or reduce the price volatility that has
historically been experienced under these contracts.
Florida Gas has terminated its gas purchase
contracts with a weighted average cost in excess of
current spot-market prices and has been negotiating with
its customers and the FERC to recover settlement
payments made to terminate such contracts as a part of
its Order No. 636 proceeding. On September 17, 1993,
Florida Gas received approval of its restructuring
settlement proposal (the Restructuring Settlement) with
regard to the Order. The Restructuring Settlement
includes a Transition Cost Recovery (TCR) mechanism that
allows Florida Gas, effective November 1, 1993, to
recover from its customers 100 percent of payments above
the $106 million level approved in a previous
settlement, up to $160 million. Florida Gas will be
allowed to recover 75 percent of any amounts greater
than $160 million. Florida Gas has substantially
completed the renegotiation and termination of these
contracts for less than $160 million, however, and
therefore expects to recover all of the amounts spent
and not already expensed through its approved TCR
mechanism.
Citrus has historically obtained its own financing
independent of its parent companies. Debt financing by
Citrus with outside parties is nonrecourse to its parent
companies and the Company has no contractual or legal
requirement to maintain Citrus' liquidity. Citrus
recently obtained a $300 million one-year financing that
has support provisions from its parent companies. In
connection with the construction of the Phase III
expansion, the Company is advancing funds to Citrus and
expects to have made a net equity investment of
approximately $150 million in 1994. See Capital
Expenditures below.
<TABLE>
<CAPTION>
Three Months Six Months
Ended June 30, Ended June 30,
1994 1993 1994 1993
(In Millions)
<S> <C> <C> <C> <C>
Other Income, Equity in
Earnings of Unconsolidated
Affiliates
Exploration and production$ - $ 2 $ - $ 3
Natural gas transmission
and marketing 10 6 13 7
Sonat Offshore Drilling 1 1 2 1
Other 1 - 1 -
$ 12 $ 9 $ 16 $ 11
</TABLE>
Equity in earnings of unconsolidated affiliates in
the Exploration and Production and Natural Gas
Transmission and Marketing segments was discussed
earlier. On a 100 percent basis, Sonat Offshore's
results for the three-month period were level with that
of last year. For the six-month period of 1994, Sonat
Offshore's results were lower primarily due to the
inclusion of $24 million ($16 million after-tax) of
interest relating to an IRS tax settlement covering the
years 1983-1985 and lower operating income from turnkey
operations, partially offset by improved operating
results in Egypt and the inclusion of 100 percent of the
Polar Pioneer in 1994.
<TABLE>
<S> <C> <C> <C> <C>
Other Income - Other $ 2 $ 3 $ 7 $ 6
</TABLE>
The decrease in other income for the three-month
period is due to the recognition of expenses related to
a discontinued operation, largely offset by net gains on
the disposal of assets.
The increase for the six-month period is due
primarily to net gains on the disposal of assets
partially offset by expenses related to a discontinued
operation.
<TABLE>
<S> <C> <C> <C> <C>
Interest Income (Expense), Net$(20) $(21) $(38) $(19)
</TABLE>
Net interest expense decreased for the three-month
period due primarily to lower interest rates.
The increase in net interest expense for the six-
month period is due to the recognition of $27 million in
net interest income in 1993 related to an IRS tax
settlement covering the years 1983-1985. Otherwise, net
interest expense is down due to lower interest rates.
<TABLE>
<S> <C> <C> <C> <C>
Income Taxes $ 11 $ 65 $ 30 $ 85
</TABLE>
Income taxes for both 1993 periods includes taxes
of $56 million on the gain recognized on the sale of
Sonat Offshore common stock. Otherwise, income taxes
for the three-month period of 1994 increased due to
higher pretax income, lower Section 29 tax credits and
to an increase in the federal income tax rate.
Income taxes for the six-month period of 1993
include the $56 million increase mentioned above and a
$3 million reduction in taxes due to the IRS tax
settlement relating to the years 1983-1985. Otherwise,
taxes for the 1994 period decreased due to lower pretax
earnings partially offset by lower Section 29 tax
credits and an increase in the federal income tax rate.
LIQUIDITY AND CAPITAL RESOURCES
<TABLE>
<CAPTION>
CASH FLOWS
Six Months
Ended June 30,
1994 1993
(In Millions)
<S> <C> <C>
Operating Activities $ 262 $ 228
</TABLE>
Net cash provided by operating activities
increased due to higher cash flow from Sonat
Exploration's operations. Southern's cash flow
decreased when compared to the 1993 period due to
implementation of Order No. 636. In previous periods
Southern's merchant role resulted in significant gas and
inventory sales in the winter months. Under Order
No. 636 Southern's rates are less seasonal and Southern
no longer has to replace significant quantities of
inventory in the warm weather months. These factors
should result in a more uniform cash flow for Southern.
Also contributing to the increase is the fact that the
1993 period included cash tax payments relating to the
Teleco sale in 1992.
<TABLE>
<S> <C> <C>
Investing Activities $(368) $ 160
</TABLE>
Net cash used in investing activities in 1994
reflects $204 million in capital expenditures and net
advances of $167.8 million to Citrus for the Phase III
expansion. Net cash provided by investing activities in
1993 includes the net cash proceeds of approximately
$340 million from the sale of Sonat Offshore common
stock partially offset by $159 million in capital
expenditures.
<TABLE>
<S> <C> <C>
Financing Activities $ 105 $(287)
</TABLE>
Net cash provided by financing activities
primarily reflects increased net borrowings under the
Company's revolving credit agreement in 1994. In June,
Southern's 9 5/8 Percent Notes matured and were
redeemed. Funds were obtained by increased borrowings
under Sonat's floating rate facilities.
Net cash used in 1993 reflects the redemption of
Sonat's 7 1/4 Percent Zero Coupon, Subordinated
Convertible Notes and 9 7/8 Notes.
<TABLE>
<CAPTION>
Six Months
Ended June 30,
1994 1993
(In Millions)
Capital Expenditures
Capital expenditures for the Company's business
segments (excluding unconsolidated affiliates) were as
follows:
<S> <C> <C>
Exploration and Production $180 $129
Natural Gas Transmission and Marketing 22 19
Other 2 11
Total $204 $159
</TABLE>
The Company's share of capital expenditures by its
unconsolidated affiliates was $244 million and
$17 million in the first six months of 1994 and 1993,
respectively. The Company expects that a majority of
the $900 million capital requirements for Citrus'
Phase III expansion will be independently financed by
Florida Gas or Citrus. The Company expects that its
total equity contribution to Citrus will be
approximately $150 million in 1994 when the financing is
complete. During the first six months of 1994 the
Company made net non-interest-bearing advances to Citrus
of $167.8 million.
Capital Resources
At June 30, 1994, the Company had lines of credit
and a revolving credit agreement with a total capacity
of $750 million. Of this, $242.9 million was unborrowed
and available. The amount available under the lines of
credit has been reduced by the amount of commercial
paper outstanding of $200.0 million to reflect the
Company's policy that credit line and commercial paper
borrowings in the aggregate will not exceed the maximum
amount available under its lines of credit and revolving
credit agreement. In 1993 Sonat filed a shelf
registration with the Securities and Exchange Commission
(SEC) for up to $500 million in debt securities. The
net proceeds from the sale of these debt securities are
expected to be used for general corporate purposes,
which may include refinancing of indebtedness, working
capital increases, capital expenditures, possible future
acquisitions, and redemption of securities. Southern
also has a shelf registration with the SEC for up to
$200 million in debt securities of which $100 million
has been issued. On August 1, 1994, Sonat entered into
a new 364-day revolving credit agreement with a group of
banks. The revolving credit agreement provides for
borrowings of up to $300 million through July 31, 1995.
The Company expects to continue to use cash from
operations and borrowings on the public or private
markets or loans from affiliates to finance its capital
and other corporate expenditures.
In April 1994 the Board of Directors of the
Company authorized the repurchase of up to two million
shares of the Company's common stock. Purchases will be
made from time-to-time in the open market or in
privately negotiated transactions. Shares purchased
under the authorization are expected to be reissued in
connection with employee stock option and restricted
stock programs.
The Company holds four million shares of Baker
Hughes Incorporated convertible preferred stock as well
as 11.3 million shares of Sonat Offshore common stock.
These resources, when combined with a strong cash flow
and borrowings in the public or private markets, provide
the Company with the means to fund operations and
currently planned investment and capital expenditures.
<TABLE>
<CAPTION>
Capitalization Information
June 30, December 31,
1994 1993
<S> <C> <C>
Debt to Capitalization 45% 42%
Book Value Per Share $16.08 $15.64
</TABLE>
The increase in the debt to capitalization ratio
is due to additional borrowings.
DERIVATIVES
Futures contracts are used as hedges by Sonat
Exploration and Sonat Marketing to reduce the effects of
spot-market prices on operating results. Natural gas
futures contracts are traded on the New York Merchantile
Exchange (NYMEX). Contracts are for fixed units of
10,000 MMBtu and are available for up to 18 months in
the future.
Sonat Exploration uses futures contracts to lock
in the price of a portion of its expected future natural
gas production when it believes that prices are
comparatively high. Generally, contracts have been sold
no more than six months into the future and represent
less than 50 percent of budgeted monthly gas production.
At June 30, 1994, Sonat Exploration had 800 contracts
open.
Sonat Marketing buys and resells natural gas as
part of its normal business operations. In situations
where natural gas is not bought and sold simultaneously,
Sonat Marketing will use futures contracts to reduce the
risk of price volatility. For example, Sonat Marketing
may purchase certain natural gas volumes before a
customer has been identified. In order to reduce the
risk of price fluctuation, Sonat Marketing may sell an
equivalent volume in natural gas futures contracts or
options on futures contracts. All futures transactions
or options are identified with a specific gas purchase
or sale transaction and are generally one year or less
in duration; however, one option agreement extends five
years. At June 30, 1994, Sonat Marketing had 736 long
and 283 short futures contracts open.
Sonat Exploration and Sonat Marketing engage in
oil and gas price swap agreements with certain
counterparties to hedge cash transactions. Price swap
agreements call for one party to make payments to (or
receive payments from) other parties based upon the
differential between a fixed and a variable price for a
notional volume specified by the contract. Gains or
losses equal to the cash payment on price swap
agreements are recognized monthly.
Sonat Exploration had four natural gas price swap
agreements at June 30, 1994, which expire January 1995.
Under the terms of these price swap agreements, Sonat
Exploration will receive a fixed price and pay a spot
price determined monthly based on a combined notional
volume of 50,000 MMBtu per day. If the spot price
exceeds a specified level the notional volume will
double.
Sonat Marketing has one price swap agreement for
a term of four years to March 1996, which matches a
fixed price cash transaction with a customer. Under the
terms of this swap agreement, Sonat Marketing will pay
an escalating fixed price and receive a spot price
determined monthly based on a notional volume of
5,000 MMBtu per day.
In the opinion of the Company, the effect of these
transactions are not material to its results of
operations.
ENVIRONMENTAL MATTERS
The Company provides the following information as
an update of the discussion of "Environmental Matters"
provided in Part I of its Report on Form 10-K for the
year ended December 31, 1993. Please refer to that
Form 10-K for a complete discussion of environmental
matters affecting the Company.
Southern has been named by the EPA as a
potentially responsible party (PRP) at Superfund site
known as the Fuels and Chemicals Site, at which a joint
defense group of PRPs had earlier advised Southern they
might seek to add it as a PRP. Southern and the other
named PRPs at the site are required to remediate any
contaminated soil and equipment pursuant to the terms of
a unilateral order issued by the EPA. The costs of this
remediation have not been quantified at this time.
Based on the estimated relative volume of material
contributed to this site by Southern (less than one
percent based on the EPA's lists of contributors),
Southern believes that its status at this site is that
of a de minimis contributor and that its potential share
of these remediation costs will not be significant.
Another company named as a PRP at this site, in which a
subsidiary of Sonat Exploration is a 50-percent
shareholder, contributed a significantly larger amount
of material to this site than Southern. Based on the
number of other financially responsible PRPs at this
site, however, and other information that it currently
possesses, Sonat currently estimates that neither
Southern nor the subsidiary of Sonat Exploration will
incur liabilities related to this site in an amount
material to Sonat.
Southern has now completed the characterization
and clean-up of all thirteen of its sites that evidenced
some level of PCB contamination for a total cost of
approximately $9 million.
Southern has determined that its pipeline meters
may in the past have been the source of small releases
of elemental mercury. Southern is soliciting bids from
several environmental contractors for site
characterization and intends to take appropriate
remedial action upon completion of site
characterization. Southern is unable to estimate the
cost of mercury remediation, because costs will vary
based on a number of factors particular to each site and
because regulatory standards for elemental mercury
clean-up are uncertain at this time. Neither the EPA
nor any state in which Southern operates has yet issued
clean-up levels or guidelines with respect to
contamination from past releases or spills of mercury.
Based on its experience with other remediation projects,
industry experience to date with remediation of mercury,
and its preliminary analysis of the possible extent of
the contamination, Southern believes that its
remediation of any mercury contamination will not have
a material adverse effect on its financial condition or
results of operations.
Sonat generally considers environmental assessment
and remediation costs and costs associated with
compliance with environmental standards incurred by
Southern to be recoverable through rates since they are
prudent costs incurred in the ordinary course of
business and, accordingly, Southern would expect to seek
recovery of such costs through rate filings, although no
assurance can be given with regard to their ultimate
recovery.
Southern operates three compressor stations in
areas that do not meet the National Ambient Air Quality
Standards (NAAQS) established under the federal Clean
Air Act for ozone. Two of these stations are located in
Louisiana, and one is located in Alabama. Title I of
the Clean Air Act Amendments of 1990 and the state
regulations promulgated thereunder require Southern to
submit an emissions control plan for each of these
stations that may require the addition of emissions
control technology.
The Louisiana Department of Environmental Quality
has instructed Southern to suspend the implementation of
its Louisiana emissions control plans until
September 1, 1994, because of the possibility that the
emissions of nitrogen oxides are not the cause of the
area's failure to meet NAAQS. Alabama Regulators have
not yet published specific emissions control
requirements for nitrogen oxides. Further, Alabama
regulators have undertaken to have the area in which
Southern's station is located recharacterized as meeting
the NAAQS for nitrogen oxides. Based on these actions,
Southern does not currently know whether it will be
required to implement emissions control plans for these
stations.
Based on Southern's projected cost of implementing
its emissions control plans in Louisiana, its estimate
of the possible cost of implementing a similar emissions
control plan in Alabama, and its projected cost of
complying with other applicable provisions of the
1990 Amendments, Sonat currently estimates that the
maximum costs that Southern may incur to implement such
plans and to comply with the 1990 Amendments is
approximately $13 million.
Sonat Exploration currently estimates that its
costs necessary to comply with the 1990 Amendments will
not be material to its operations.
<PAGE>
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Arcadian Corporation v. Southern Natural Gas
Company and Atlanta Gas Light Company, an antitrust
lawsuit described in Item 3. Legal Proceedings of the
Company's Annual Report on Form 10-K for the year ended
December 31, 1993, had been settled pending final,
nonappealable approval by the FERC of the direct
connection and transportation service requested by
Arcadian Corporation. On May 12, 1994, the FERC issued
an order granting such approval. Atlanta Gas Light
Company ("Atlanta") and others sought rehearing of the
May 12 order. Atlanta also filed a petition for review
of such order in the Court of Appeals. The FERC has not
acted upon the rehearing requests other than to give
itself more time to consider the rehearing petition.
Pursuant to the settlement, the lawsuit will be
dismissed with prejudice when the FERC order becomes
final and nonappealable.
Item 6.Exhibits and Reports on Form 8-K
(a) Exhibits (1)
Exhibit
Number Exhibits
11* Computation of Earnings per
Share
12* Computation of Ratio of
Earnings to Fixed Charges
* Filed with this Report
(b) Reports on Form 8-K
The Company did not file any report on Form 8-K
during the quarter ended June 30, 1994.
(1) The Company will furnish to requesting security
holders the exhibits on this list upon the payment of a
fee of 10 cents per page up to a maximum of $5.00 per
exhibit. Requests must be in writing and should be
addressed to Beverley T. Krannich, Secretary, Sonat
Inc., P. O. Box 2563, Birmingham, Alabama 35202-2563.
<TABLE>
SONAT INC. AND SUBSIDIARIES
SIGNATURES
<S> <C>
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.
SONAT INC.
Date: August 12, 1994 By: /s/ Thomas W. Barker, Jr.
Thomas W. Barker, Jr.
Vice President-Finance and
Treasurer
Date: August 12, 1994 By: /s/ Ronald B. Pruet, Jr.
Ronald B. Pruet, Jr.
Vice President & Controller
</TABLE>
<TABLE>
<CAPTION>
Exhibit 11
SONAT INC. AND SUBSIDIARIES
COMPUTATION OF EARNINGS PER SHARE
Three Months Six Months
Ended June 30, Ended June 30,
1994 1993 1994 1993
(In Thousands Except Per-Share Amounts)
Primary Earnings Per Share (1)
<S> <C> <C> <C> <C>
Earnings:
Income from Continuing Operations
before Extraordinary Item $34,541 $125,865 $84,151 $194,788
Extraordinary Loss - - - (3,829)
Net Income $34,541 $125,865 $84,151 $190,959
Common Stock and Common Stock Equivalents:
Weighted Average Number of Shares
of Common Stock Outstanding 87,193 86,561 87,185 86,379
Common Stock Equivalents Applicable
to Outstanding Stock Options 868 1,049 908 926
Weighted Average Number of Shares
of Common Stock and Common Stock
Equivalents Outstanding 88,061 87,610 88,093 87,305
Primary Earnings Per Share:
Income from Continuing Operations
before Extraordinary Item $ .39 $ 1.44 $ .96 $ 2.23
Extraordinary Loss - - - (.04)
$ .39 $ 1.44 $ .96 $ 2.19
</TABLE>
(1) This calculation is submitted in accordance with Regulation S-K
Item 601(b)(11) although not required by Footnote 2 to Paragraph 14 of
APB Opinion No. 15 because it results in dilution of less than 3%. For this
reason, the primary earnings per share amounts shown for both periods do not
agree with primary earnings per share shown on the Condensed Consolidated
Statements of Income in Part I.
<TABLE>
<CAPTION>
EXHIBIT 12-(1)
SONAT INC. AND SUBSIDIARIES
Computation of Ratios of Earnings
from Continuing Operations to Fixed Charges
Total Enterprise (a)
Six Months Ended June 30, Years Ended December 31,
1994 1993 1993 1992 1991 1990 1989
(In Thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
Earnings from Continuing Operations:
Income (loss) before income taxes $115,296 $280,499 $364,198 $133,728 $ 98,374 $127,811 $145,333
Fixed charges (see computation below) 62,516 70,956 128,468 156,428 175,980 165,021 145,873
Less allowance for interest capitalized (3,571) (1,834) (4,101) (8,422) (7,951) (6,184) (6,116)
Total Earnings Available for Fixed Charges $174,241 $349,621 $488,565 $281,734 $266,403 $286,648 $285,090
Fixed Charges:
Interest expense before deducting
interest capitalized $59,128 $ 67,401 $122,204 $149,165 $168,510 $158,550 $141,029
Rentals(b) 3,388 3,555 6,264 7,263 7,470 6,471 4,844
$62,516 $ 70,956 $128,468 $156,428 $175,980 $165,021 $145,873
Ratio of Earnings to Fixed Charges 2.8 4.9 3.8 1.8 1.5 1.7 2.0
</TABLE>
________________
(a) Amounts include the Company's portion of the captions as they relate to
persons accounted for by the equity method.
(b) These amounts represent 1/3 of rentals which approximate the interest
factor applicable to such rentals of the Company and its subsidiaries and
continuing unconsolidated
affiliates.
