PG ENERGY INC. TABLE OF CONTENTS PAGE PART I. FINANCIAL INFORMATION Item 1. Financial Statements Statements of Income for the three months ended March 31, 1996 and 1995. . . . . . . . . . . 2 Balance Sheets as of March 31, 1996, and December 31, 1995 . . . . . . . . . . . . . . . . . . 3 Statements of Cash Flows for the three months ended March 31, 1996 and 1995. . . . . . . . . . . 5 Notes to Financial Statements . . . . . . . . . . . . . . . 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. . . . . . . . . . . . 10 PART II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K . . . . . . . . . . . . . . 17 -1- PART I. FINANCIAL INFORMATION PG ENERGY INC. Statements of Income [CAPTION] Three Months Ended March 31, 1996 1995 (Thousands of Dollars) [S] [C] [C] OPERATING REVENUES $ 69,415 $ 68,237 Cost of gas 39,978 41,407 OPERATING MARGIN 29,437 26,830 OTHER OPERATING EXPENSES: Operation 6,557 5,824 Maintenance 1,214 968 Depreciation 1,899 1,792 Income taxes 5,927 4,867 Taxes other than income taxes 3,807 3,879 Total other operating expenses 19,404 17,330 OPERATING INCOME 10,033 9,500 OTHER INCOME, NET 150 234 INCOME BEFORE INTEREST CHARGES 10,183 9,734 INTEREST CHARGES: Interest on long-term debt 1,772 2,390 Other interest 335 249 Allowance for borrowed funds used during construction (46) (9) Total interest charges 2,061 2,630 INCOME FROM CONTINUING OPERATIONS 8,122 7,104 LOSS WITH RESPECT TO DISCONTINUED OPERATIONS (Note 2) (365) (3,704) NET INCOME 7,757 3,400 DIVIDENDS ON PREFERRED STOCK 637 691 EARNINGS APPLICABLE TO COMMON STOCK $ 7,120 $ 2,709 COMMON STOCK Earnings per share of common stock: Continuing operations $ 1.67 $ 1.16 Discontinued operations (.08) (.67) Total $ 1.59 $ .49 Weighted average shares outstanding 4,468,130 5,521,112 Cash dividends per share (Note 3) $ 10.217 $ .705 The accompanying notes are an integral part of the financial statements. -2- PG ENERGY INC. BALANCE SHEETS [CAPTION] March 31, December 31, 1996 1995 (Thousands of Dollars) ASSETS [S] [C] [C] UTILITY PLANT: At original cost $ 298,675 $ 295,895 Accumulated depreciation (78,594) (76,882) 220,081 219,013 OTHER PROPERTY AND INVESTMENTS 5,005 5,089 CURRENT ASSETS: Cash and cash equivalents 32,251 328 Accounts receivable - Customers 24,950 18,189 Affiliates 250 - Others 1,155 815 Reserve for uncollectible accounts (993) (781) Accrued utility revenues 8,217 10,319 Materials and supplies, at average cost 2,852 2,609 Gas held by suppliers, at average cost 1,726 15,140 Natural gas transition costs collectible 3,514 4,612 Deferred cost of gas and supplier refunds, net 3,529 - Prepaid expenses and other 4,443 3,281 81,894 54,512 DEFERRED CHARGES: Regulatory assets - Deferred taxes collectible 29,893 30,015 Natural gas transition costs collectible - 497 Other 3,027 2,516 Unamortized debt expense 1,283 1,340 34,203 34,368 NET ASSETS OF DISCONTINUED OPERATIONS (Note 2) - 204,250 TOTAL ASSETS $ 341,183 $ 517,232 The accompanying notes are an integral part of the financial statements. -3- PG ENERGY INC. BALANCE SHEETS [CAPTION] March 31, December 31, 1996 1995 (Thousands of Dollars) CAPITALIZATION AND LIABILITIES [S] [C] [C] CAPITALIZATION: (Note 4) Common shareholder's investment $ 97,045 $ 208,356 Preferred stock - Not subject to mandatory redemption, net 18,944 33,615 Subject to mandatory redemption 1,680 1,680 Long-term debt 55,000 55,000 172,669 298,651 CURRENT LIABILITIES: Current portion of long-term debt - 115,801 Preferred stock subject to mandatory redemption or repurchase 14,751 80 Note payable - 10,000 Accounts payable - Suppliers 16,080 17,781 Affiliates, net - 826 Deferred cost of gas and supplier refunds, net - 434 Accrued general business and realty taxes 2,330 1,542 Accrued income taxes 63,795 516 Accrued interest 979 2,062 Accrued natural gas transition costs 2,247 2,278 Other 5,254 3,162 105,436 154,482 DEFERRED CREDITS: Deferred income taxes 45,923 48,848 Accrued natural gas transition costs 588 1,144 Unamortized investment tax credits 4,895 4,938 Operating reserves 3,359 3,709 Other 8,313 5,460 63,078 64,099 COMMITMENTS AND CONTINGENCIES (Note 6) TOTAL CAPITALIZATION AND LIABILITIES $ 341,183 $ 517,232 The accompanying notes are an integral part of the financial statements. -4- PG ENERGY INC. STATEMENTS OF CASH FLOWS [CAPTION] Three Months Ended March 31, 1996 1995 (Thousands of Dollars) [S] [C] [C] CASH FLOW FROM OPERATING ACTIVITIES: Income from continuing operations $ 8,122 $ 7,104 Effects of noncash charges to income - Depreciation 1,912 1,799 Deferred income taxes, net 92 1,106 Provisions for self insurance 241 163 Other, net 530 916 Changes in working capital, exclusive of cash and current portion of long-term debt - Receivables and accrued utility revenues (5,037) (3,486) Gas held by suppliers 13,414 10,719 Accounts payable (1,885) (5,421) Deferred cost of gas and supplier refunds, net (2,955) 15,397 Other current assets and liabilities, net 4,995 (876) Other operating items, net (2,895) (418) Net cash provided by continuing operations 16,534 27,003 Net cash provided by discontinued operations 2,133 3,764 Net cash provided by operating activities 18,667 30,767 CASH FLOW FROM INVESTING ACTIVITIES: Additions to utility plant (2,973) (3,770) Proceeds from the sale of discontinued operations 261,752 - Other, net 68 158 Net cash provided (used) by investing activities 258,847 (3,612) CASH FLOW FROM FINANCING ACTIVITIES: Issuance of common stock 339 2,855 Repurchase of common stock (85,000) - Dividends on common and preferred stock (34,407) (4,584) Repayment of long-term debt (50,000) - Net decrease in bank borrowings (76,443) (24,925) Other, net (80) (10) Net cash used for financing activities (245,591) (26,664) NET INCREASE IN CASH AND CASH EQUIVALENTS 31,923 491 CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 328 304 CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 32,251 $ 795 SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the period for: Interest (net of amount capitalized) $ 3,082 $ 5,112 Income taxes $ 445 $ 437 The accompanying notes are an integral part of the financial statements. -5- PG ENERGY INC. NOTES TO FINANCIAL STATEMENTS (1) GENERAL Nature of the Business. PG Energy Inc. ("PGE"), formerly known as Pennsylvania Gas and Water Company, a wholly-owned subsidiary of Pennsylvania Enterprises, Inc. ("PEI"), is a regulated public utility subject to the jurisdiction of the Pennsylvania Public Utility Commission ("PPUC") for rate and accounting purposes. PGE distributes natural gas to a ten-county area in northeastern Pennsylvania, a territory that includes 116 municipalities, in addition to the cities of Scranton, Wilkes-Barre and Williamsport. The financial statements of PGE have been prepared in accordance with generally accepted accounting principles, including the provisions of Financial Accounting Standards Board ("FASB") Statement 71, "Accounting for the Effects of Certain Types of Regulation," which give recognition to the rate and accounting practices of regulatory agencies such as the PPUC. Interim Financial Statements. The interim financial statements included herein have been prepared by PGE, 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 PGE 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 PGE's latest annual report on Form 10-K. Use of Accounting Estimates. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. These estimates involve judgments with respect to, among other things, various future economic factors which are difficult to predict and are beyond the control of PGE. Therefore, actual amounts could differ from these estimates. (2) DISCONTINUED OPERATIONS Pursuant to an asset purchase agreement dated April 26, 1995, (the "Agreement") among PEI, PGE, American Water Works Company, Inc. ("American") and Pennsylvania-American Water Company ("Pennsylvania-American"), a wholly-owned subsidiary of American, PGE sold substantially all of the assets, properties and rights of its water utility operations to Pennsylvania-American on February 16, 1996. -6- Under the terms of the Agreement, Pennsylvania-American paid PGE approximately $413.5 million consisting of $266.4 million in cash and the assumption of $147.1 million of PGE's liabilities, including $141.1 million of its long-term debt. This price was subsequently reduced to $409.5 million as a result of certain post-closing adjustments and is subject to further post- closing adjustments, which currently are not expected to exceed $100-200,000. PGE continued to operate the water utility business until February 16, 1996. The sale price reflected a $6.5 million premium over the book value of the assets sold. However, after transaction costs and the net effect of other items, principally the write-off of certain deferred regulatory assets and deferred credits and the impact of pension and other postretirement benefit expenses relative to an early retirement plan, the sale resulted in an after tax loss of approximately $6.0 million, net of the income from the water operations during the phase-out period (which for financial reporting purposes was April 1, 1995, through February 15, 1996). The sale involved a gain for income tax purposes, primarily because of the accelerated depreciation that had been claimed by PGE with respect to the water utility plant that was sold. It is estimated that the income taxes payable on the sale, for which deferred income taxes had previously been provided, will be approximately $58.7 million. The net cash proceeds from the sale of approximately $203.1 million, net of the estimated $58.7 million payable for income taxes, are being used by PGE to retire debt, to repurchase stock (see Note 3 of these Notes to Financial Statements) and for working capital for its continuing operations. With the sale of PGE's water utility operations, the principal assets of PGE now consist of its gas utility operations and approximately 46,000 acres of land. The accompanying financial statements reflect PGE's water utility operations as "discontinued operations" effective March 31, 1995. Interest charges relating to indebtedness of PGE were allocated to the discontinued operations based on the relationship of the gross water utility plant that was sold to the total of PGE's gross gas and water utility plant. This is the same method as was utilized by PGE and the PPUC in establishing the revenue requirements of both PGE's gas and water utility operations. None of the dividends on PGE's preferred stock nor any of PEI's interest expense were allocated to the discontinued operations. -7- Selected financial information for the discontinued operations is set forth below: [CAPTION] Net Assets of Discontinued Operations As of December 31, 1995 (Thousands of Dollars) [S] [C] Net utility plant $ 368,742 Current assets (primarily accounts receivable and accrued revenues) 12,756 Deferred charges and other assets 25,752 Total assets acquired by Pennsylvania-American 407,250 Liabilities assumed by Pennsylvania-American Long-term debt 141,097 Other 5,983 147,080 Net assets acquired by Pennsylvania-American 260,170 Estimated liability for income taxes on sale of discontinued operations (56,710) Estimated net income of discontinued operations during the remainder of the phase-out period 790 Total net assets of discontinued operations $ 204,250 Loss With Respect to Discontinued Operations [CAPTION] Three Months Ended March 31, 1996 1995 (Thousands of Dollars) [S] [C] [C] Income from discontinued operations, net of related income taxes of $1,403,000* $ - $ 2,127 Estimated loss on disposal of discontinued operations, net of income during the phase-out period (365) (5,831) Loss with respect to discontinued operations $ (365) $ (3,704) * Reflects income only through March 31, 1995, the effective date of the discontinuance of PGE's water utility operations for financial statement purposes. (3) CASH DIVIDENDS The cash dividends per share for the three months ended March 31, 1996, include $9.077 with respect to a special $30.0 million dividend in the form of a 10.125% promissory note that was issued by PGE to PEI on February 16, 1996, in connection with the sale of PGE's water utility operations on such date. This note was paid in full by PGE on March 8, 1996. -8- (4) REPURCHASES OF STOCK On February 16, 1996, PGE repurchased 2,297,297 shares of its common stock from PEI for an aggregate consideration of $85.0 million. During April, 1996, PGE repurchased 128,359 shares of its 9% Cumulative Preferred Stock for an aggregate consideration of $13.9 million and 18,354 shares of its 4.10% Cumulative Preferred Stock for an aggregate consideration of $918,000, in each case pursuant to a self tender offer dated March 11, 1996. (5) ACCOUNTING CHANGES Long Lived Assets. In March 1995, FASB Statement 121, "Accounting for the Impairment of Long-Lived Assets", was issued. The provisions of this statement, which are effective for fiscal years beginning after September 15, 1995, require that long-lived assets, identifiable intangibles, capital leases and goodwill be reviewed for impairment whenever events occur or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. In addition, FASB Statement 121 requires that regulatory assets meet the recovery criteria of FASB Statement 71, "Accounting for Effects of Certain Types of Regulation", on an ongoing basis in order to avoid a writedown. The provisions of FASB Statement 121, which PGE adopted effective January 1, 1996, did not have a material impact on PGE's financial position or results of operations since the carrying amount of all assets, including regulatory assets, are considered recoverable. (6) 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 PGE 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. On March 31, 1995, the PPUC adopted an Order approving a plan submitted by PGE for complying with the Emergency Order. PGE does not believe that compliance with the terms of such Order will have a material adverse effect on its financial position or results of operations. Environmental Matters PGE, 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 PGE. Pursuant to the Comprehensive Environmental Response, Compensation and Liability Act of 1980 ("CERCLA"), PGE 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, PGE 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. -9- PG ENERGY INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS DISCONTINUED OPERATIONS Pursuant to an asset purchase agreement dated April 26, 1995, (the "Agreement") among PEI, PGE, American Water Works Company, Inc. ("American") and Pennsylvania-American Water Company ("Pennsylvania-American"), a wholly-owned subsidiary of American, PGE sold substantially all of the assets, properties and rights of its water utility operations to Pennsylvania-American on February 16, 1996. Under the terms of the agreement, Pennsylvania-American paid PGE approximately $413.5 million consisting of $266.4 million in cash and the assumption of $147.1 million of PGE's liabilities, including $141.1 million of its long-term debt. This price was subsequently reduced to $409.5 million as a result of certain post-closing adjustments and is subject to further post- closing adjustments, which currently are not expected to exceed $100-200,000. PGE continued to operate the water utility business until February 16, 1996. The sale price reflected a $6.5 million premium over the book value of the assets being sold. However, after transaction costs and the net effect of other items, principally the write-off of certain deferred regulatory assets and deferred credits and the impact of pension and other postretirement benefit expenses relative to an early retirement plan, the sale resulted in an after tax loss of approximately $6.0 million, net of the income from the water operations during the phase-out period (which for financial reporting purposes was April 1, 1995, through February 15, 1996.) The net cash proceeds from the sale of approximately $203.1 million, net of an estimated $58.7 million payable for income taxes, are being used by PGE to retire debt, to repurchase stock (see Note 3 of the accompanying Notes to Financial Statements) and for working capital for its continuing operations. With the sale of its water utility operations, the principal assets of PGE now consist of its gas utility operations and approximately 46,000 acres of land. In accordance with generally accepted accounting principles, PGE's financial statements reflect its water utility operations as "discontinued operations" effective March 31, 1995, and the following sections of Management's Discussion and Analysis generally relate only to PGE's continuing operations. For additional information regarding the discontinued operations, see Note 2 of the accompanying Notes to Financial Statements. -10- RESULTS OF CONTINUING OPERATIONS The following table expresses certain items in PGE's statements of income as percentages of total operating revenues for each of the three-month periods ended March 31, 1996, and March 31, 1995: [CAPTION] Percentage of Operating Revenues Three Months Ended March 31, 1996 1995 [S] [C] [C] OPERATING REVENUES............................ 100.0% 100.0% Cost of gas................................. 57.6 60.7 OPERATING MARGIN.............................. 42.4 39.3 OTHER OPERATING EXPENSES: Operation................................... 9.4 8.6 Maintenance................................. 1.8 1.4 Depreciation................................ 2.7 2.6 Income taxes................................ 8.5 7.1 Taxes other than income taxes............... 5.5 5.7 Total other operating expenses............ 27.9 25.4 OPERATING INCOME.............................. 14.5 13.9 OTHER INCOME, NET............................. 0.2 0.3 INTEREST CHARGES.............................. 3.0 3.8 INCOME FROM CONTINUING OPERATIONS............. 11.7 10.4 LOSS WITH RESPECT TO DISCONTINUED OPERATIONS.. (0.5) (5.4) NET INCOME.................................... 11.2 5.0 DIVIDENDS ON PREFERRED STOCK(1)............... 0.9 1.0 EARNINGS APPLICABLE TO COMMON STOCK........... 10.3 4.0 (1) None of the dividends on preferred stock was allocated to the discontinued operations. Three Months Ended March 31, 1996, Compared With Three Months Ended March 31, 1995 Operating Revenues. Operating revenues increased $1.2 million (1.7%) from $68.2 million for the three-month period ended March 31, 1995, to $69.4 million for the three-month period ended March 31, 1996. This increase was primarily the result of a 1.6 billion cubic feet (16.1%) increase in sales to residential and commercial heating customers as a result of a 509 (18.1%) increase in heating degree days. There were 3,321 heating degree days (104.1% of normal) during the first quarter of 1996 compared to 2,812 (88.2% of normal) during the first quarter in 1995. The effects of the increased sales to heating customers were partially offset by a reduction in the purchased gas cost component of PGE's tariff ("the gas cost rate"). See "-Rate Matters." Cost of Gas. The cost of gas decreased $1.4 million (3.5%) from $41.4 million for the three-month period ended March 31, 1995, to $40.0 million for the three-month period ended March 31, 1996, primarily because of the aforementioned reduction in the gas cost rate (see "-Rate Matters"), the effects -11- of which were partially offset by the increased sales to residential and commercial heating customers. Operating Margin. The operating margin increased $2.6 million (9.7%) from $26.8 million in the first quarter of 1995 to $29.4 million in the first quarter of 1996 and, as a percentage of operating revenues, increased from 39.3% for the quarter ended March 31, 1995, to 42.4% for the quarter ended March 31, 1996, primarily because of the 1.6 billion cubic feet (16.1%) increase in consumption by residential and commercial heating customers. Other Operating Expenses. Other operating expenses increased $2.1 million (12.0%) for the three-month period ended March 31, 1996, compared to the three-month period ended March 31, 1995, and increased as a percentage of operating revenues from 25.4% in the first quarter of 1995 to 27.9% in the first quarter of 1996. These increases were attributable to a number of factors, the most significant of which was a $1.1 million (21.8%) increase in income taxes. Income taxes increased from $4.9 million in the first quarter of 1995 to $5.9 million in the first quarter of 1996 because of an increase in income before income taxes (for this purpose, operating income net of interest charges). Also contributing to the increase in other operating expenses was a higher level of operation expenses, which increased $733,000 (12.6%) principally as a result of higher payroll and payroll-related costs, a $246,000 (25.4%) increase in maintenance expenses, principally as a result of charges relative to the maintenance of gas valves, and increased depreciation expense of $107,000 (6.0%) as a result of additions to utility plant. Operating Income. As a result of the above, total operating income increased by $533,000 (5.6%) from $9.5 million for the three-month period ended March 31, 1995, to $10.0 million for the three-month period ended March 31, 1996, and increased as a percentage of total operating revenues for such periods from 13.9% in 1995 to 14.5% in 1996, primarily because of the increase in operating revenues resulting from the higher consumption by residential and commercial heating customers. Interest Charges. Interest charges decreased by $569,000 (21.6%) from $2.6 million for the three-month period ended March 31, 1995, to $2.1 million for the three-month period ended March 31, 1996. This decrease was largely attributable to the repayment of PGE's $50.0 million term loan and all of its outstanding bank borrowings on February 16, 1996, with proceeds from the sale of its regulated water utility operations on such date. Income From Continuing Operations. Income from continuing operations increased $1.0 million (14.3%) from $7.1 million for the quarter ended March 31, 1995, to $8.1 million for the quarter ended March 31, 1996. This increase was largely the result of the matters discussed above, principally the increase in operating margin and decrease in interest charges. Net Income. The increase in net income of $4.4 million from $3.4 million for the three-month period ended March 31, 1995, to $7.8 million for the three- month period ended March 31, 1996, was largely the result of increased income from continuing operations and the reduced loss with respect to discontinued operations. Earnings Applicable to Common Stock. The increase in earnings applicable to common stock of $4.4 million from $2.7 million for the three-month period ended March 31, 1995, to $7.1 million for the three-month period ended March 31, 1996, as well as the increase in earnings per share of common stock of $1.10 from $.49 per share for the quarter ended March 31, 1995, to $1.59 per share for the -12- quarter ended March 31, 1996, were largely the result of the increased income from continuing operations and the reduced loss with respect to discontinued operations. RATE MATTERS Annual Gas Cost Adjustment. Pursuant to the provisions of the Pennsylvania Public Utility Code (the "Code") relating to the annual purchased gas cost rate of larger gas distribution companies, such as PGE, the PPUC, by Order adopted May 11, 1995, authorized PGE to decrease the gas costs contained in its gas tariffs from $3.68 per thousand cubic feet to $2.42 per thousand cubic feet effective May 15, 1995, in order to refund overcollections from customers caused by lower than anticipated purchased gas costs and the receipt of supplier refunds during 1995. This change in gas rates on account of purchased gas costs was designed to produce a decrease in revenue of $8.2 million from its effective date through December 1, 1995. In accordance with the same provisions of the Code, the PPUC, by Order adopted November 9, 1995, authorized PGE to increase its gas cost rate to $2.75 per thousand cubic feet effective December 1, 1995. This change in gas rates on account of purchased gas costs is designed to produce a $9.6 million increase in annual revenue. The changes in gas rates on account of purchased gas costs have no effect on PGE's earnings since the changes in revenue are offset by corresponding changes in the cost of gas. Quarterly Gas Cost Adjustment. Effective September 14, 1995, the PPUC adopted regulations that provide for the quarterly adjustment of the annual purchased gas cost rate of larger gas distribution companies, including PGE. Such adjustments are allowed when the actual purchased gas costs vary from the estimated costs reflected in the respective company's tariffs by 2% or more. Except for reducing the amount of any over or undercollections of gas costs, these regulations will not have any material effect on PGE's financial position or results of operations, and PGE will still be required to file an annual purchased gas cost rate. As of May 10, 1996, no such quarterly gas cost adjustments had been made to PGE's tariffs. 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 stated that Account 191 and New Facility Costs ("Gas Transition Costs") are subject to recovery through the annual PGC rate filings made with the PPUC by PGE and other larger local gas distribution companies. The PGC Order also indicated that while Gas Supply Realignment and Stranded Costs ("Non-Gas Transition 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 stated that all such filings would be evaluated on a case-by-case basis. PGE was billed a total of $1.3 million of Gas Transition Costs by its interstate pipelines. Of this amount, $858,000 was recovered by PGE over a twelve-month period ended January 31, 1995, through an increase in its PGC rate, $252,000 are being recovered by PGE in its annual PGC rate that the PPUC has approved effective December 1, 1995, and the recovery of the remaining $213,000 will be sought by PGE in its PGC rate that is expected to become effective December 1, 1996. By Order of the PPUC entered August 26, 1994, PGE began recovering the Non- Gas Transition Costs that it estimates it will ultimately be billed pursuant to -13- FERC Order 636 through the billing of a surcharge to its customers effective September 12, 1994. It is currently estimated that $9.4 million of Non-Gas Transition Costs will be billed to PGE, generally over a four-year period extending through the fourth quarter of 1997, of which $6.6 million had been billed to PGE and $5.9 million had been recovered from its customers as of March 31, 1996. PGE has recorded the estimated Non-Gas Transition Costs that remain to be billed to it and the amounts remaining to be recovered from its customers. LIQUIDITY AND CAPITAL RESOURCES Sale of Water Utility Operations On February 16, 1996, PGE sold its regulated water operations and certain related assets to Pennsylvania-American for approximately $413.5 million, consisting of $266.4 million in cash and the assumption of $147.1 million of PGE's liabilities, including $141.1 million of its long-term debt. This price was subsequently reduced to $409.5 million as a result of certain post-closing adjustments and is subject to further post-closing adjustments, which currently are not expected to exceed $100-200,000. PGE is using the $203.1 million of cash proceeds from the sale, after the payment of an estimated $58.7 million of federal and state income taxes, to retire debt, to repurchase stock and for working capital purposes. In this regard on February 16, 1996, PGE repurchased 2,297,297 shares of its common stock from PEI for an aggregate consideration of $85.0 million and repaid its $50.0 million term loan and all of its outstanding bank borrowings. Additionally, PGE temporarily invested $67.0 million of the proceeds from the sale pending the use of such funds for (i) the repayment on March 8, 1996, of its $30.0 million 10.125% promissory note which was issued to PEI as a common stock dividend on February 16, 1996, (ii) the repurchase of 128,359 shares of its 9% cumulative preferred stock at a price of $108 per share (for an aggregate consideration of $13.9 million) in April, 1996, (iii) the repurchase of 18,354 shares of its 4.10% cumulative preferred stock at a price of $50 per share (for an aggregate consideration of $918,000) in April, 1996, and (iv) for other working capital purposes. As of May 10, 1996, PGE had temporary cash investments totaling approximately $13.0 million. With the repayment of its term loan and all its bank borrowings on February 16, 1996, and the availability of cash proceeds from the sale of its regulated water operations that have been temporarily invested, PGE terminated its $60.0 million bank credit agreement and one additional bank line of credit under which $3.0 million was available for borrowing by PGE. PGE has retained and currently has three bank lines of credit with an aggregate borrowing capacity of $14.5 million (See "-Liquidity"), which is deemed adequate for its immediate needs through June 30, 1996, when the last $5.0 million of these lines will expire. PGE plans to arrange new and replacement bank lines of credit as the proceeds from the sale of its water utility operations are fully utilized and as it requires bank borrowings for working capital and other purposes. Liquidity The primary capital needs of PGE are the funding of its construction program and the seasonal funding of its gas purchases and increases in its customer accounts receivable. PGE's revenues are highly seasonal and weather-sensitive, with approximately 75% of its revenues normally being realized in the first and fourth quarters of the calendar year when the temperatures in its service area are the coldest. -14- The cash flow from PGE's operations is generally sufficient to fund a portion of its construction expenditures. However, to the extent external financing is required, it is the practice of PGE to use bank borrowings to fund such expenditures, pending the periodic issuance of stock and long-term debt. Bank borrowings are also used by PGE for the seasonal funding of its gas purchases and increases in customer accounts receivable. In order to so finance construction expenditures and to meet its seasonal borrowing requirements, PGE has made arrangements for a total of $14.5 million of unsecured revolving bank credit and plans to arrange other bank lines of credit as its needs require (See "-Sale of Water Utility Operations"). Specifically, PGE currently has three bank lines of credit with an aggregate borrowing capacity of $14.5 million which provide for borrowings at interest rates generally less than prime. Two of these bank lines providing for an aggregate borrowing capacity of $9.5 million expire on May 31, 1996, and the third line, which provides for borrowings up to $5.0 million, expires June 30, 1996. However, PGE currently has no borrowings outstanding under these bank lines of credit, and it intends to arrange new and replacement bank lines of credit when it again has a need for bank borrowings. Additionally, PGE plans to borrow funds from PEI during 1996 for its construction expenditures and other working capital requirements to the extent that PEI has funds available for lending to PGE. Any such interim borrowings from PEI will be repaid with proceeds from bank borrowings by PGE. PGE believes that it will be able to raise in a timely manner such funds as are required for its future construction expenditures, refinancings and other working capital requirements. Long-Term Debt and Capital Stock Financings PGE 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 PGE during the three-month period ended March 31, 1996. PGE also obtains external funds from the sale of its common stock to PEI in connection with PEI's Dividend Reinvestment and Stock Purchase Plan (the "DRP"). During the three-month period ended March 31, 1996, PGE realized $340,000 from the issuance of common stock to PEI under the DRP. Construction Expenditures and Related Financings Expenditures for the construction of utility plant totaled $2.8 million during the first three months of 1996 and are currently estimated to be $26.8 million during the remainder of the year. Such expenditures are being financed with proceeds from the sale of PGE's regulated water operations, internally- generated funds and bank borrowings, pending the periodic issuance of stock and long-term debt. Current Maturities of Long-Term Debt and Preferred Stock As of March 31, 1996, $80,000 of PGE's preferred stock was required to be repaid within twelve months. An additional $14.7 million of PGE's preferred stock, which was repurchased in April, 1996, pursuant to self tender offers, was also reflected as a current liability as of March 31, 1996. -15- Forward-Looking Statements Certain statements made above relating to plans, conditions, objectives and economic performance go beyond historical information and may provide an indication of future results. To that extent, they are forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, and each is subject to factors that could cause actual results to differ from those in the forward-looking statement. -16- PART II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K (a) Exhibits 27-1 Financial Data Schedule -- filed herewith. (b) PGE filed a report on Form 8-K dated February 28, 1996, pursuant to Item 5. Other Events, regarding the sale by PGE on February 16, 1996, of its regulated water utility operations and certain related assets. -17- PG ENERGY INC. 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. PG ENERGY INC. (Registrant) Date: May 14, 1996 By: /s/ Thomas J. Ward Thomas J. Ward Secretary Date: May 14, 1996 By: /s/ John F. Kell, Jr. John F. Kell, Jr. Vice President, Financial Services (Principal Financial Officer and Principal Accounting Officer) -18-