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 March 31, 1999 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 1-11429 PUBLIC SERVICE COMPANY OF NORTH CAROLINA, INCORPORATED (Exact name of registrant as specified in its charter) NORTH CAROLINA 56-0233140 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 400 COX ROAD, P.O. BOX 1398 28053-1398 GASTONIA, NORTH CAROLINA (Zip Code) (Address of principal executive offices) (704) 864-6731 (Registrant's telephone number, including area code) NONE (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. Number of shares of Common Stock, $1 par value, outstanding at April 30, 1999.....................................................20,577,967 PUBLIC SERVICE COMPANY OF NORTH CAROLINA, INCORPORATED AND SUBSIDIARIES PART I. FINANCIAL INFORMATION The condensed financial statements included herein have been prepared by the registrant without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Although 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, the registrant believes that the disclosures herein are adequate to make the information presented not misleading. It is recommended that these condensed financial statements be read in conjunction with the financial statements and the notes thereto included in the registrant's latest annual report on Form 10-K. 1 CONSOLIDATED STATEMENTS OF INCOME (Unaudited) (In thousands, except per share amounts) Three Months Ended Six Months Ended Twelve Months Ended March 31 March 31 March 31 ------------------ ------------------ ------------- 1999 1998 1999 1998 1999 1998 -------- -------- -------- -------- -------- ------- Operating revenues $134,326 $140,205 $207,528 $243,988 $294,211 $338,119 Cost of gas 63,747 71,719 97,149 134,779 136,670 181,604 -------- -------- -------- -------- -------- -------- Gross margin 70,579 68,486 110,379 109,209 157,541 156,515 -------- -------- -------- -------- -------- -------- Operating expenses and taxes: Operating and maintenance 18,164 15,761 37,381 30,528 66,770 60,630 Provision for depreciation 6,742 6,177 13,435 12,255 26,229 23,727 General taxes 6,248 6,266 10,143 11,124 16,203 17,152 Income taxes 13,666 14,056 15,825 18,288 12,663 15,078 -------- -------- -------- -------- -------- -------- 44,820 42,260 76,784 72,195 121,865 116,587 -------- -------- -------- -------- -------- -------- Operating income 25,759 26,226 33,595 37,014 35,676 39,928 Other income, net 913 833 1,657 1,900 3,277 3,729 Interest deductions 4,648 4,535 9,462 9,198 18,042 17,887 -------- -------- -------- -------- -------- -------- Net income $ 22,024 $ 22,524 $ 25,790 $ 29,716 $ 20,911 $ 25,770 ======== ======== ======== ======== ======== ======== Average common shares outstanding 20,546 20,081 20,453 19,987 20,336 19,841 Basic earnings per share $1.07 $1.12 $1.26 $1.49 $1.03 $1.30 Diluted common shares outstanding 20,778 20,210 20,652 20,107 20,478 19,941 Diluted earnings per share $1.06 $1.11 $1.25 $1.48 $1.02 $1.29 Cash dividends declared per share $.24 $.23 $.48 $.46 $.96 $.92 See notes to consolidated financial statements. 2 CONSOLIDATED BALANCE SHEETS (Unaudited) (In thousands) ASSETS Mar 31 Sep 30 Mar 31 1999 1998 1998 Gas utility plant $765,964 $743,721 $714,610 Less - Accumulated depreciation 239,368 224,204 215,604 -------- -------- -------- 526,596 519,517 499,006 -------- -------- -------- Non-utility property, net 572 595 618 -------- -------- -------- Current assets: Cash and temporary investments 2,943 3,277 4,541 Restricted cash and temporary investments 18,590 10,247 9,776 Receivables, less allowance for doubtful accounts 50,342 20,836 47,528 Materials and supplies 6,160 6,992 8,013 Stored gas inventory 13,878 24,406 10,815 Deferred gas costs, net 5,961 13,576 9,026 Prepayments and other 2,322 2,260 2,801 -------- -------- -------- 100,196 81,594 92,500 -------- -------- -------- Deferred charges and other assets 15,780 17,047 16,889 -------- -------- -------- Total $643,144 $618,753 $609,013 ======== ======== ======== CAPITALIZATION AND LIABILITIES Capitalization: Common equity - Common stock, $1 par $ 20,568 $ 20,274 $ 20,097 Capital in excess of par value 138,456 132,787 129,244 Retained earnings 85,730 69,778 84,376 -------- -------- -------- 244,754 222,839 233,717 Long-term debt 157,250 171,550 174,050 -------- -------- -------- 402,004 394,389 407,767 -------- -------- -------- Current liabilities: Maturities of long-term debt 6,800 9,300 9,300 Accounts payable 26,593 20,015 32,992 Accrued taxes 13,917 1,180 13,929 Customer prepayments and deposits 4,877 7,021 4,579 Cash dividends and interest 8,673 9,210 8,761 Restricted supplier refunds 18,590 10,247 9,776 Other 6,037 4,184 3,911 -------- -------- -------- 85,487 61,157 83,248 Interim bank loans 62,500 70,500 30,500 -------- -------- -------- 147,987 131,657 113,748 -------- -------- -------- Deferred credits and other liabilities: Income taxes, net 69,219 66,527 61,183 Investment tax credits 2,980 3,411 3,337 Accrued pension cost 4,834 7,985 8,929 Deferred revenues 1,632 2,121 2,610 Other 14,488 12,663 11,439 -------- -------- -------- 93,153 92,707 87,498 -------- -------- -------- Total $643,144 $618,753 $609,013 ======== ======== ======== See notes to consolidated financial statements. 3 CONSOLIDATED STATEMENTS OF RETAINED EARNINGS (Unaudited) (In thousands) Twelve Months Ended March 31 1999 1998 ------- ------- Balance beginning of period $84,376 $77,138 Add - Net income 20,911 25,770 Deduct - Common stock dividends and other 19,557 18,532 ------- ------- Balance end of period $85,730 $84,376 ======= ======= CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (In thousands) Six Months Ended Twelve Months Ended March 31 March 31 ----------------- -------------- 1999 1998 1999 1998 ------- ------- -------- ------- Cash Flows From Operating Activities: Net income $25,790 $29,716 $20,911 $25,770 Adjustments to reconcile net income to net cash provided by operating activities - Depreciation, depletion and other 15,223 14,092 29,627 27,042 Deferred income taxes, net 2,693 1,745 8,036 3,466 ------- ------- ------- ------- 43,706 45,553 58,574 56,278 Change in operating assets and liabilities: Receivables, net (30,221) (21,789) (3,518) 3,359 Inventories 11,360 9,707 (1,210) (2,054) Accounts payable 6,578 5,193 (6,399) 12,704 Accrued pension cost (3,151) (603) (4,095) (191) Other 21,319 15,275 7,248 8,023 ------- ------- ------- ------- 49,591 53,336 50,600 78,119 ------- ------- ------- ------- Cash Flows From Investing Activities: Construction expenditures (22,243) (31,121) (56,451) (67,455) Non-utility and other 784 (1,894) 1,152 379 ------- ------- ------- ------- (21,459) (33,015) (55,299) (67,076) ------- ------- ------- ------- Cash Flows From Financing Activities: Issuance of common stock through dividend reinvestment, stock purchase and stock option plans 6,101 6,254 9,644 10,222 Increase (decrease) in interim bank loans, net (8,000) (7,500) 32,000 7,000 Retirement of long-term debt and common stock (17,060) (7,060) (19,564) (9,564) Cash dividends (9,507) (9,115) (18,979) (17,942) ------- ------- ------- ------- (28,466) (17,421) 3,101 (10,284) ------- ------- ------- ------- Net increase (decrease) in cash and temporary investments (334) 2,900 (1,598) 759 Cash and temporary investments at beginning of period 3,277 1,641 4,541 3,782 ------- ------- ------- ------- Cash and temporary investments at end of period $ 2,943 $ 4,541 $ 2,943 $ 4,541 ======= ======= ======= ======= Cash paid during the period for: Interest (net of amount capitalized) $ 9,577 $ 9,342 $18,136 $17,747 Income taxes 1,435 7,280 6,257 13,095 See notes to consolidated financial statements. 4 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. The accompanying unaudited consolidated financial statements and notes should be read in conjunction with the audited consolidated financial statements and notes included in PSNC's 1998 Annual Report. In the opinion of management, all adjustments necessary for a fair statement of the results of operations for the interim periods have been recorded. Certain amounts previously reported have been reclassified to conform with the current period's presentation. PSNC's business is seasonal in nature; therefore, the financial results for any interim period are not necessarily indicative of those which may be expected for the annual period. 2. During the quarter ended December 31, 1998, PSNC recorded net restructuring charges of $4,027,000 in connection with Plan 2001, a three-year operating plan for translating PSNC's vision, mission, strategies and corporate goals into specific actions. These charges consisted of severance benefits of approximately $4,200,000, a one-time payment to 152 employees of approximately $1,100,000 in connection with an automobile fleet restructuring and a net curtailment loss on post-retirement benefit obligations of approximately $447,000 offset by pension gains of approximately $1,720,000. The severance charges are the result of a plan approved by the Board of Directors to eliminate approximately 200 positions from PSNC's workforce by August 1999 through the involuntary termination of selected employees or job classifications. Severance benefit arrangements under the plan were communicated to employees during the first quarter of fiscal 1999. The net curtailment loss on post-retirement benefits and the pension gains relate directly to the severance activity. The combined one-time impact on quarterly earnings from all of the above items was a decrease of $0.12 per share net of tax. 3. In June 1997, the Financial Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 130, "Reporting Comprehensive Income." This statement establishes standards for reporting and display of comprehensive income and its components. Comprehensive income is the total of net income and all other non-owner changes in equity. This statement was adopted by PSNC effective October 1, 1998. For the three months ended March 31, 1999, comprehensive income does not differ materially from net income. 4. In June 1997, the FASB issued SFAS No. 131, "Disclosure About Segments of an Enterprise and Related Information." This information introduces a new model for segment reporting based on the way senior management organizes segments within the company for operating decisions and assessing performance. This statement was adopted by PSNC October 1, 1998 and becomes effective for its 1999 annual financial statements. 5 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 5. In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." This statement establishes accounting and reporting standards requiring that every derivative instrument (including certain derivative instruments embedded in other contracts) be recorded in the balance sheet as either an asset or liability measured at fair value. The statement requires that changes in the derivative's fair value be recognized currently in earnings unless specific hedge accounting criteria are met. Special accounting for qualifying hedges allows a derivative's gains and losses to offset related results on the hedged item, in the income statement, and requires that a company must formally document, designate and assess the effectiveness of transactions that receive hedge accounting. This statement will be adopted by PSNC effective October 1, 1999. PSNC has not yet quantified the impact of adopting SFAS No. 133 on its financial statements and has not determined the method of adoption. 6. On February 16, 1999, PSNC and SCANA Corporation (SCANA), a South Carolina corporation, entered into an Agreement and Plan of Merger (Agreement) providing for a strategic business combination of the two companies. Pursuant to the Agreement, PSNC will be merged with and into a wholly owned subsidiary of SCANA. Under the terms of the Agreement, the holders of PSNC's $1.00 par value common stock will receive consideration valued at $33.00 per share. Each shareholder may elect to receive 100 percent of the consideration in SCANA common stock, 100 percent in cash, or a combination thereof, subject to the total cash allocated to PSNC shareholders being no higher than 50 percent of the total consideration received by PSNC shareholders. PSNC shareholders who elect to receive stock will receive between 1.02 and 1.45 shares of SCANA common stock depending upon the average price of SCANA common stock in the 20 business day period ending on the trading day immediately preceding the day of the closing of the mergers. This equates to a collar of between $22.75 and $32.40 for each share of SCANA's common stock. SCANA will allocate $700 million in cash for payment to PSNC and SCANA shareholders under the election process. A maximum of approximately $350 million, under a right of first refusal, will be allocated to PSNC's shareholders who elect to receive cash. The transaction will be accounted for as a purchase. The Agreement has been approved by the Boards of Directors of PSNC and SCANA. Consummation of the merger is subject to certain closing conditions, including the approvals by both companies' common shareholders and the appropriate governmental and regulatory bodies. In addition, the merger was conditioned upon the effectiveness of a joint proxy statement/registration statement filed on May 11, 1999 with respect to the SCANA common stock to be issued pursuant to the merger and to solicit shareholder votes for approval of the merger. The joint proxy statement/registration statement became effective May 12, 1999. A shareholders meeting to vote on the merger will be held at 9:30 a.m. on Thursday, July 1, 1999 at PSNC's corporate office. A SCANA shareholders meeting will be held simultaneously. Operating and maintenance expenses for the three months ended March 31, 1999 include merger-related charges of $1,594,000, or $0.05 per share after tax. Excluding these charges, diluted earnings per share for the second quarter of fiscal 1999 would have been $1.11, equal to the comparable period of the prior year. Currently, ten key executives have severance agreements with PSNC. Under these severance agreements, approximately $4,223,000 in the aggregate may be payable to them in connection with the merger. 6 PSNC sponsors a deferred compensation plan for outside directors and a retirement plan for all directors. Upon a change in control, approximately $2,656,000 will be payable in cash to directors pursuant to these plans. Of this amount, approximately $177,000 will be expensed for the deferred compensation plan, and approximately $472,000 will be expensed for the retirement plan. PSNC has two nonqualified stock option plans, a 1992 Nonqualified Stock Option Plan and a 1997 Nonqualified Stock Option Plan. In accordance with the plans, options are exercisable beginning two years and expiring five years from the date of the grant. An exception to the two-year exercise date is allowed upon the retirement, disability or death of a participant. An exception is also allowed upon a change in control as defined in the plans. Approximately 722,000 options, including 524,000 options that are unexercisable, are currently outstanding. All of these stock options become exercisable upon a change in control. The Agreement states, at the election of the optionee, participants in the plans can receive cash payments equal to the differential between each option exercise price and $33.00 per share for each option outstanding at the date of the transaction. These payments will be made from the approximately $350 million allocated by SCANA to PSNC's shareholders, as discussed above. SCANA is a holding company principally engaged, through subsidiaries, in electric and natural gas utility operations, telecommunications and other energy-related businesses. SCANA's subsidiaries serve approximately 517,000 electric customers in South Carolina and more than 500,000 natural gas customers in South Carolina and Georgia. SCANA also has significant investments in telecommunications companies that serve more than 350,000 customers throughout the Southeast. 7 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 7. The following tables summarize the effect on earnings per share of dilutive securities as required by SFAS No. 128: Three Months Ended Three Months Ended March 31, 1999 March 31, 1998 ------------------------------------------------ ---------------------------------------------- Income Shares Per Share Income Shares Per Share (Numerator) (Denominator) Amount (Numerator) (Denominator) Amount ------------------------------------------------ ----------------------------------------------- Basic EPS Net income $22,024,000 20,546,000 $1.07 $22,524,000 20,081,000 $1.12 Effect of dilutive securities (Options) 232,000 129,000 ----------- ---------- Diluted EPS Net income $22,024,000 20,778,000 $1.06 $22,524,000 20,210,000 $1.11 =========== ========== Six Months Ended Six Months Ended March 31, 1999 March 31, 1998 --------------------------------------------- ---------------------------------------------- Income Shares Per Share Income Shares Per Share (Numerator) (Denominator) Amount (Numerator) (Denominator) Amount Basic EPS Net income $25,790,000 20,453,000 $1.26 $29,716,000 19,987,000 $1.49 Effect of dilutive securities (Options) 199,000 120,000 ----------- ----------- Diluted EPS Net income $25,790,000 20,652,000 $1.25 $29,716,000 20,107,000 $1.48 ========== =========== Twelve Months Ended Twelve Months Ended March 31, 1999 March 31, 1998 ------------------------------------------------ ---------------------------------------------- Income Shares Per Share Income Shares Per Share (Numerator) (Denominator) Amount (Numerator) (Denominator) Amount ----------- ------------- --------- ----------- ------------- ------- Basic EPS Net income $20,911,000 20,336,000 $1.03 $25,770,000 19,841,000 $1.30 Effect of dilutive securities (Options) 142,000 100,000 ----------- ----------- Diluted EPS Net income $20,911,000 20,478,000 $1.02 $25,770,000 19,941,000 $1.29 ========== =========== 8 MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Changes in Results of Operations (Amounts in thousands except degree day and customer data) Three Months Ended March 31 ---------------------------------- Increase 1999 1998 (Decrease) % Gross margin $ 70,579 $ 68,486 $ 2,093 3 Less - Franchise taxes 4,318 4,506 (188) (4) -------- -------- -------- Net margin $ 66,261 $ 63,980 $ 2,281 4 ======== ======== ======== Total volume throughput (DT): Residential 10,734 10,425 309 3 Commercial/small industrial 5,561 5,492 69 1 Large commercial/industrial 8,774 9,729 (955) (10) -------- -------- -------- 25,069 25,646 (577) (2) ======== ======== ======== System average degree days: Actual 1,726 1,655 71 4 Normal 1,814 1,814 Percent colder (warmer) than normal (5%) (9%) Weather normalization adjustment income (refund), net of franchise taxes $ 3,044 $ 3,034 $ 10 Customers at end of period: Residential 298,711 283,184 15,527 5 Commercial/small industrial 41,975 41,165 810 2 Large commercial/industrial 2,431 2,431 - - -------- -------- -------- 343,117 326,780 16,337 5 ======== ======== ======== Net margin for the three months ended March 31, 1999 increased $2,281,000 as compared to the same period last year. This increase in net margin is attributable to the items shown below (in thousands): Commercial/ Large Small Commercial/ Residential Industrial Industrial Other Total Price variance * $2,496 $ 430 $(1,203) $ - $1,723 Volume variances, net 1,361 224 (515) - 1,070 Other - - - (512) (512) ------ ------ ------- ------ ------ Total $3,857 $ 654 $(1,718) $ (512) $2,281 ====== ====== ======= ====== ====== *Includes changes in sales mix. 9 MANAGEMENT'S DISCUSSION (Continued) The increase in net margin is attributable to the general rate increase which was effective November 1, 1998 and an increase in the number of customers served. Furthermore, throughput to non-weather normalization adjustment (WNA) large commercial and industrial customers decreased 10% as compared to the same period in fiscal 1998 as a result of the warmer than normal weather for the period and price competition with alternate fuels. (Amounts in thousands except degree day data) Six Months Ended March 31 --------------------------------- Increase 1999 1998 (Decrease) % Gross margin $110,379 $109,209 $ 1,170 1 Less - Franchise taxes 6,679 7,853 (1,174) (15) -------- -------- --------- Net margin $103,700 $101,356 $ 2,344 2 ======== ======== ========= Total volume throughput (DT): Residential 15,008 16,549 (1,541) (9) Commercial/small industrial 8,293 9,098 (805) (9) Large commercial/industrial 17,117 19,035 (1,918) (10) -------- -------- --------- 40,418 44,682 (4,264) (10) ======== ======== ========= System average degree days: Actual 2,804 3,132 (328) (10) Normal 3,106 3,106 Percent colder (warmer) than normal (10%) 1% Weather normalization adjustment income (refund), net of franchise taxes $ 7,080 $ (398) $ 7,478 Net margin for the six months ended March 31, 1999 increased $2,344,000 as compared to the same period last year. This increase in net margin is attributable to the items shown below (in thousands): Commercial/ Large Small Commercial/ Residential Industrial Industrial Other Total Price variance * $ 3,313 $ 644 $(1,791) $ - $2,166 Volume variances, net 1,349 (83) (1,294) - (28) Other - - - 206 206 ------- ------ ------- ---- ------ Total $ 4,662 $ 561 $(3,085) $206 $2,344 ======= ====== ======= ==== ====== * Includes changes in sales mix. 10 The increase in net margin is due primarily to the general rate increase effective November 1, 1998 and an increase in the number of customers served. Although natural gas deliveries decreased over the same period the prior year, due to weather that was 10% warmer than the prior period, the WNA helped offset the impact that the warmer than normal weather had on net margin. Throughput to non-WNA large commercial and industrial customers decreased 10% as compared to the same period in fiscal 1998 as a result of the warmer than normal weather for the period and price competition with alternate fuels. (Amounts in thousands except degree day data) Twelve Months Ended March 31 --------------------------------- Increase 1999 1998 (Decrease) % Gross margin $157,541 $156,515 $ 1,026 1 Less - Franchise taxes 9,415 10,823 (1,408) (13) -------- -------- --------- Net margin $148,126 $145,692 $ 2,434 2 ======== ======== ========= Total volume throughput (DT): Residential 19,254 20,934 (1,680) (8) Commercial/small industrial 11,812 12,705 (893) (7) Large commercial/industrial 32,109 34,557 (2,448) (7) -------- -------- --------- 63,175 68,196 (5,021) (7) ======== ======== ========= System average degree days: Actual 3,038 3,560 (522) (15) Normal 3,382 3,382 Percent colder (warmer) than normal (10%) 5% Weather normalization adjustment income, net of franchise taxes $ 7,366 $ 508 $ 6,858 Net margin for the twelve months ended March 31, 1999 increased $2,434,000 as compared to the same period last year. This increase in net margin is attributable to the items shown below (in thousands): Commercial/ Large Small Commercial/ Residential Industrial Industrial Other Total Price variance * $ 2,934 $ 453 $ (2,227) $ - $ 1,160 Volume variances, net 1,183 (162) (1,436) - (415) Other - - - 1,689 1,689 ------- ----- -------- ------ ------- Total $ 4,117 $ 291 $ (3,663) $1,689 $ 2,434 ======= ===== ======== ====== ======= * Includes changes in sales mix. 11 MANAGEMENT'S DISCUSSION (Continued) The increase in net margin is due primarily to the general rate increase effective November 1, 1998, an increase in the number of customers served and, as a result of the warmer weather, a lower volume and cost of unaccounted-for gas. Although natural gas deliveries decreased over the same period the prior year, due to weather that was 15% warmer than the prior period, the WNA helped offset the impact that the warmer than normal weather had on net margin. Throughput to non-WNA large commercial and industrial customers decreased 7% as compared to the same period in fiscal 1998 as a result of the warmer than normal weather for the period and price competition with alternate fuels. Operating and maintenance expenses for the three, six and twelve months ended March 31, 1999 increased 15%, 22% and 10%, respectively, as compared to the same periods last year. The increase for the three months ended March 31, 1999 is due primarily to $1,594,000 of costs related to the proposed business combination with SCANA Corporation discussed further in Note 6 to the accompanying unaudited consolidated financial statements. The change for the six- and twelve-month periods also includes net restructuring charges recognized during the first quarter of fiscal 1999 of $4,027,000 in connection with Plan 2001, discussed further in Note 2. Excluding acquisition and restructuring charges, operating and maintenance expenses increased 5% and 4% for the three- and six-month periods, respectively, and remained flat for the twelve-month period. PSNC estimates that implementation of Plan 2001 over the course of fiscal 1999 should produce approximately $9,800,000 of pre-tax annualized cost savings and incremental margin. Additionally, PSNC expects Plan 2001 initiatives during the fiscal 2000-01 period to provide approximately $6,000,000 of pre-tax annualized cost savings and incremental margin. Depreciation expense increased for the three, six and twelve months ended March 31, 1999 due to utility plant additions. General taxes decreased for all three periods due primarily to decreased franchise taxes based on decreased operating revenues for the respective periods. Other income for the three months ended March 31, 1999 increased $80,000, while decreasing $243,000 and $452,000 for the six- and twelve-month periods, respectively, as compared to the same periods for the prior year. The decrease for the six- and twelve-month periods is primarily the result of a decrease in interest income on amounts due from customers through the operation of the Rider D rate mechanism. This mechanism allows PSNC to recover all prudently incurred gas costs from customers. It also allows PSNC to recover margin losses on negotiated sales to large commercial and industrial customers. Through an increment in its rates, PSNC collected previously under collected gas costs and was able to match its benchmark gas cost more closely to market prices. This resulted in a lower average Rider D receivable 12 balance. Additionally, contributing to the decrease in both periods is a $210,000 pre-tax write-down due to an anticipated loss on PSNC Production Corporation's investment in American Gas Finance Company, a limited liability company established by natural gas utilities to provide financing for residential energy-efficiency improvements. Partially offsetting these items is an increase in merchandising and jobbing income of $163,000, $247,000 and $563,000 for the three-, six- and twelve-month periods, respectively. Interest deductions for the three, six and twelve months ended March 31, 1999 increased 3%, 3% and 1%, respectively, as compared to the same periods last year. This reflects the increase in interest expense on short-term debt resulting from higher average short-term bank loans outstanding during the period. Also, included in this increase is $200,000 of debt expense recognized due to the prepayment on February 26, 1999 of the remaining $10,000,000 of 8.65% senior debentures due 2002. Partially offsetting these increases is a decrease in interest expense on long-term debt resulting from lower average long-term debt outstanding. The change in diluted earnings per share for the three-, six- and twelve-month periods reflects an increase of 3% in the average number of diluted common shares outstanding as compared to the same periods last year. These increases are primarily due to shares issued through PSNC's dividend reinvestment and stock option plans. In March 1999, PSNC began purchasing shares on the open market to satisfy the requirements of these plans. Changes in Financial Condition The capital expansion program, through the construction of lines, services, systems, and facilities, and the purchase of equipment, is designed to help PSNC meet the growing demand for its product. PSNC's fiscal 1999 construction budget is approximately $45,000,000, compared to actual construction expenditures for fiscal 1998 of $65,329,000. This 31% reduction in budgeted construction expenditures is partially due to the completion of PSNC's bare main replacement program and management's emphasis on improving the return made on capital investments. The construction program is regularly reviewed by management and is dependent upon PSNC's continuing ability to generate adequate funds internally and to sell new issues of debt and equity securities on acceptable terms. Construction expenditures during the six and twelve months ended March 31, 1999 were $22,243,000 and $56,451,000, respectively, as compared to $31,121,000 and $67,455,000 for the same periods for the prior year. PSNC generally finances its operations with internally generated funds, supplemented with bank lines of credit to satisfy seasonal requirements. PSNC also 13 MANAGEMENT'S DISCUSSION (Continued) borrows under its bank lines of credit to finance portions of its construction expenditures pending refinancing through the issuance of equity or long-term debt at a later date depending upon prevailing market conditions. PSNC has committed lines of credit with five commercial banks which vary monthly depending upon seasonal requirements and a five-year revolving line of credit with one bank. For the twelve-month period beginning April 1, 1999, total committed lines of credit range from a minimum of $40,000,000 to a winter-period maximum of $81,000,000, and uncommitted annual lines of credit total $45,000,000. Lines of credit are evaluated periodically by management and renegotiated to accommodate anticipated short-term financing needs. Management believes these lines are currently adequate to finance budgeted construction expenditures, stored gas inventories and other corporate needs. Restricted cash and temporary investments and restricted supplier refunds relate to refunds of $18,590,000 received from PSNC's pipeline transportation provider that have not been deposited into the expansion fund in the Office of the State Treasurer. This fund was created by an order of the NCUC to finance the construction of natural gas lines into unserved areas of PSNC's service territory that otherwise would not be economically feasible to serve. PSNC's business is seasonal in nature as fluctuations in weather dictate natural gas storage injections and withdrawals. Injections of natural gas into storage occur during periods of warm weather (April through October). Withdrawals from storage occur during periods of cold weather (November through March). This seasonality is the primary reason for lower volumes of gas in storage as of March 31, 1999 as compared to September 30, 1998. Seasonality also accounts for the increase in accounts receivable for the same period. As of March 31, 1999, September 30, 1998, and March 31, 1998, net deferred gas costs include $4,391,000, $863,000 and $5,023,000, respectively, of gas costs related to unbilled volumes. The remaining balance of net deferred gas costs fluctuates in response to the operation of PSNC's Rider D rate mechanism. This mechanism allows PSNC to recover from customers all prudently incurred gas costs. On a monthly basis, any difference in amounts paid and collected for these costs is recorded for subsequent refund to or collection from PSNC's customers. It also allows PSNC to recover margin losses on negotiated sales to large commercial and industrial customers with alternate fuel capability. Net deferred gas costs at March 31, 1999, September 30, 1998 and March 31, 1998 reflect undercollections from customers. PSNC's deferred gas costs balances are approved by the NCUC in annual gas cost prudence reviews and are collected from or refunded to customers over a subsequent twelve-month period. Amounts that have not been collected from or refunded to customers bear interest at an annual rate of 10% as required by the NCUC. PSNC's strategy is to manage the balance of deferred gas costs to a minimal level. On November 6, 1997, the NCUC issued an order permitting PSNC, on a two-year trial basis, to establish its commodity 14 cost of gas monthly for large commercial and industrial customers on the basis of market prices for natural gas. PSNC will continue to establish a benchmark cost of gas for residential and small commercial customers pursuant to its existing procedures, which are based upon market prices projected for the succeeding twelve months. Deferred charges and other assets decreased as compared to September 30, 1998 due primarily to a decrease in long-term restricted cash. Long-term restricted cash represents a restricted cash contribution from Sonat Marketing Company L.P. (Sonat Marketing), a subsidiary of Sonat Inc. PSNC's subsidiary, PSNC Production Corporation (PSNC Production), and Sonat Marketing created Sonat Public Service Company L.L.C. (Sonat Public Service) in December 1996. Upon creation of Sonat Public Service, Sonat Marketing contributed $4,944,000 for its 50% ownership, of which $4,845,000 was restricted. Restricted cash of equal amounts are being released annually beginning in December 1998 through December 2001. PSNC Production received its first payment of $1,211,000 in December 1998, lowering the balance in long-term restricted cash to $3,634,000 at March 31, 1999. Sonat Marketing is entitled to a partial refund of its contribution if the economics of the transaction are adversely modified by any regulatory body over a five-year period. PSNC has not determined what operating or financial impacts, if any, the proposed mergers of PSNC and SCANA Corporation or Sonat Inc. and El Paso Energy Corporation will have on the joint venture. The decrease in long-term debt at March 31, 1999 reflects the prepayment of the remaining $10,000,000 of 8.65% senior debentures due 2002. The decrease in accounts payable at March 31, 1999 of $6,399,000 as compared to March 31, 1998 is primarily the result of natural gas purchased at lower costs and decreased natural gas brokering and transportation pooling activities. The change in deferred credits and other liabilities from September 30, 1998 includes a decrease in accrued pension cost of $1,720,000 offset by an increase of $447,000 in post-retirement benefits, both related to the company's severance activity. Regulatory Matters On October 30, 1998, the NCUC issued an order in PSNC's general rate case filed in April 1998. The order, effective November 1, 1998, granted PSNC additional annual revenue of $12,400,000 and allowed a 9.82% overall rate of return on PSNC's net utility investment. It also approved the continuation of the Weather Normalization Adjustment, Rider D mechanism and full margin transportation rates. The Carolina Utility Customers Association, Inc. (CUCA), a party to PSNC's general rate case, has formally appealed the general rate case order. Management cannot predict the outcome of this appeal. On February 22, 1999, the NCUC approved PSNC's application to use expansion funds to extend natural gas service into Alexander County, and authorized 15 MANAGEMENT'S DISCUSSION (Continued) disbursements from the fund of $4,301,000. Most of Alexander County lies within PSNC's certificated service territory and is not currently provided natural gas service. PSNC estimates that the project will be completed prior to April 2000 at a cost of $6,188,000. PSNC and a subsidiary of Piedmont Natural Gas Company, Inc. (Piedmont) formed Cardinal Pipeline Company, LLC (Cardinal) in March 1994, to construct and operate a 24-inch, 37.5-mile natural gas pipeline. PSNC owns 64.5% of the pipeline, which extends from Wentworth to near Haw River, North Carolina, where it interconnects with PSNC and Piedmont. It was placed in service on December 31, 1994, and provides 130 million cubic feet per day (mmcf/day) of additional firm capacity (70 mmcf/day for PSNC and 60 mmcf/day for Piedmont). In 1995, PSNC, Piedmont, Transcontinental Gas Pipe Line Corporation (Transco) and North Carolina Natural Gas Corporation (NCNG) formed Cardinal Extension Company, LLC (Cardinal Extension) to purchase and extend the Cardinal Pipeline. The new pipeline will extend 67 miles from the existing termination point of Cardinal Pipeline near Haw River to a point southeast of Raleigh and will provide 140 mmcf/day of additional capacity (100 mmcf/day for PSNC and 40 mmcf/day for NCNG). The extension is project-financed with an estimated cost of approximately $75,000,000. Through their respective subsidiaries, PSNC will own approximately 33%, Piedmont will own approximately 17%, Transco will own approximately 45% and NCNG will own approximately 5% of Cardinal Extension. PSNC, through a subsidiary, will contribute to Cardinal Extension its net book investment in the existing pipeline plus additional equity capital of approximately $1,000,000. On November 6, 1997, the NCUC issued an order approving this project and the merger of Cardinal Pipeline and Cardinal Extension, with the surviving entity being named Cardinal Pipeline, LLC. Construction began in November 1998. The facilities are expected to be in service on or before November 1, 1999. Pine Needle LNG Company, LLC (Pine Needle) was formed by subsidiaries of Transco, Piedmont, NCNG, Amerada Hess, and PSNC, and the Municipal Gas Authority of Georgia. Pine Needle owns and operates a liquefied natural gas storage facility, built at a cost of approximately $107,000,000. This facility is located on a site near Transco's pipeline northwest of Greensboro, North Carolina, and has a storage capacity of four billion cubic feet with vaporization capability of 400 mmcf/day. The facility became operational on May 1, 1999. PSNC, through its subsidiary, PSNC Blue Ridge Corporation (Blue Ridge), owns 17% of the facility, and PSNC has contracted to use 25% of the facility's gas storage capacity and withdrawal capabilities. Blue Ridge made its required capital contribution of $9,095,000 on May 3, 1999. On March 24, 1999, PSNC filed an application with the NCUC requesting authorization to issue and sell up to $150,000,000 of senior unsecured debt securities. This amount includes $25,000,000 of senior debt previously authorized by the NCUC that has not been issued and sold. On April 14, 1999, the NCUC issued an order permitting PSNC to issue and sell senior unsecured debt as described and requested in its application. PSNC will use these funds primarily to repay all of its then outstanding short-term bank loans and to finance the construction of facilities. A registration statement under Form S-3 will be filed with the Securities and Exchange Commission during the third quarter fiscal 1999. 16 On November 14, 1996, PSNC filed an application with the NCUC requesting deferral accounting for the costs of a project to ensure that PSNC's computer operating systems function properly in the year 2000. On April 29, 1997, the NCUC issued an order authorizing the deferral of each year's costs and requiring a three-year amortization of these costs beginning in the year incurred. Approximately $4,200,000 of these costs have been incurred to date. PSNC began amortizing these costs in September 1997. The NCUC allowed recovery of a majority of the unamortized Year 2000 costs in the general rate case order issued on October 30, 1998. Year 2000 Readiness The Year 2000 issue exists because many computer systems and applications, including those with embedded chips in equipment or facilities, use two digit date fields rather than four digit date fields to designate the applicable year. As a result, these date-sensitive applications may not properly recognize the year 2000 or years thereafter, or process data containing them, potentially causing critical systems including, but not limited to, business and operational systems to function improperly or not at all. PSNC's overall goal is to address Year 2000 readiness requirements by mid-1999. PSNC began its Year 2000 efforts in 1995 by interviewing vendors and gaining awareness of this issue. An assessment of PSNC's Year 2000 impact was performed in 1996, and PSNC began addressing its major business computer systems. PSNC decided to renovate its customer information system and to replace its financial and the materials management systems. The renovation of PSNC's customer information system was completed in September 1998. Year 2000 ready financial and materials management systems were implemented on April 1, 1999. Upgrades to the Supervisory Control and Data Acquisition (SCADA) system that monitors the flow of gas through PSNC's distribution system are targeted for completion in June 1999. Assessment of embedded chips within critical equipment continues, with a target completion date of June 1999. Our remaining activities include completion of scheduled desktop hardware and software upgrades and additional forward date testing of our computer systems that will continue throughout 1999. During 1998, PSNC established a centrally managed, company-wide Year 2000 project office. PSNC's Year 2000 project scope was expanded to include: business continuity planning; embedded systems containing microprocessors, i.e., automated meter reading and process control equipment; end-user computing hardware and software, i.e., personal computers; facility equipment, such as heating and cooling systems and facsimile devices; and business relationships with PSNC's customers and key suppliers. The Year 2000 project office reports daily to the chief information officer. Frequent formal and informal discussions are held with the chief financial officer as the Year 2000 project executive. The audit committee of the board of directors is updated quarterly by the chief financial officer and the internal audit department. The full board is updated by the audit committee. Senior officers of PSNC are updated monthly on the project team's status, and they participate in making contingency planning decisions related to their functional areas. While PSNC believes that it has minimized the risks of encountering serious problems associated with the Year 2000 issue, it still faces the risk that some systems 17 MANAGEMENT'S DISCUSSION (Continued) and processes that are not Year 2000 ready either will not be identified or will not be corrected before 2000. Additionally, PSNC has no assurance that the Year 2000 issues of other entities will not have a material impact on PSNC's systems or results of operations. Year 2000 Costs The estimated cost of completion, including costs incurred to date, is $17,000,000. This estimated cost includes external contractors and service providers, the purchase of computer hardware and software, and dedicated internal resources. The majority of these costs are currently being recovered in rates charged to PSNC's customers. A portion of PSNC's costs will not be incremental costs, but a redeployment of existing resources. PSNC does not track the cost and time of internal employees who are not fully dedicated to the Year 2000 effort. Approximately $12,500,000 to replace existing systems is being capitalized as plant. Approximately $10,000,000 of these costs has been incurred. Approximately $4,500,000 to modify existing computer systems is being expensed over a three-year period in accordance with the NCUC order discussed more fully in Regulatory Matters. Approximately $4,200,000 of these costs has been incurred. These costs are estimates based on PSNC's analysis to date and are subject to change after the modifications of its systems are completed. The project completion dates and costs are estimates based on numerous assumptions. These assumptions include the continued availability of personnel resources and third-party vendor compliance. Risk Assessment At this time, PSNC believes a "worst case scenario" is that its customers could experience some temporary disruptions in their gas service. The natural gas that PSNC distributes and sells to its sales customers, and the natural gas that it transports and delivers to its transportation customers, comes principally from the producing areas along the Gulf of Mexico (including the states of Alabama, Louisiana, Mississippi, and Texas, and adjacent offshore areas). Prior to PSNC's receipt of that gas, it must be extracted and processed to be useable. It is then delivered to an interstate pipeline company (or companies) for transportation to PSNC or to storage for PSNC's account; the gas that is stored for PSNC's account must then be withdrawn and delivered to PSNC by an interstate pipeline, generally in the winter. A disruption in PSNC's service to its customers could be caused by a disruption in the extraction or processing of this gas, the transmission and/or storage of such gas or finally the distribution of such gas by PSNC. Even if the flow of gas is not disrupted, customers may not be able to use the available gas if electrical service is disrupted and electronic controls do not work. Although PSNC does not believe that these disruptions will occur, it has no assurance that such disruptions will not occur. PSNC has assessed the impact of such 18 a scenario and continues to evaluate this scenario. PSNC believes that its contingency plans will lessen the impact of any disruption. If such disruption does occur, PSNC does not believe that it will have a material adverse impact on its financial position, cash flows or results of operations. Contingency Plans Business continuity planning is underway, with a target date of June 1999 for the initial version of a plan based on worst case scenarios. Testing of the plan will continue throughout 1999. The plan will address the mitigation of risks associated with key business processes and those processes critical to the delivery of gas services. It will include the short-term localized impact of losing one or more of the following services: electricity, telecommunications, water/sewer, gas pressure, information technology systems and staffing (order does not imply priority). PSNC is not implying that disruption will occur, but that the risk does exist. The assessment of critical supplier and third-party vendor progress, although external to PSNC, will continue throughout calendar 1999. PSNC cannot quantify the impact of any failure by a critical supplier or third-party vendor at this time. PSNC is presently developing a contingency plan to address the mitigation of risks and continuance of operations if critical suppliers or third-party vendors have a failure. PSNC has a verbal mutual agreement with its major pipeline transporter to begin developing a contingency plan in mid-1999. The foregoing information is based on PSNC's current best estimates, which were derived using numerous assumptions of future events, including the availability and future costs of certain technological and other resources, third-party modifications and remediation actions and other factors. Given the complexity of the issues and possible as yet unidentified risks, actual results may vary from those anticipated and discussed above. Specific factors that might cause such differences include, among others, the availability and cost of trained personnel, the ability to locate and correct all affected computer code, the timing and success of remedial efforts of third-party suppliers and similar uncertainties. Each of the components of PSNC's Year 2000 program is progressing, and the company believes it is taking all reasonable steps necessary to be able to operate successfully through and beyond the turn of the century. Year 2000 Communications PSNC meets quarterly with the other North Carolina gas utilities to exchange information and discuss the best practices that may be used to address Year 2000 requirements. Additionally, PSNC frequently participates in industry and community forums attended by representatives of the electric and telecommunications industries. Electric and telecommunications service providers to PSNC will be further evaluated during the business continuity planning process. 19 SCANA Corporation reviewed PSNC's Year 2000 program strategy during its due diligence efforts prior to the execution of the merger agreement referred to in Note 6 to the accompanying consolidated financial statements. PSNC will continue to share information with SCANA throughout the due diligence and integration process. PSNC will distribute a customer bill insert and additional customer awareness information mid-1999. Forward-looking Statements Statements contained in this document and the notes to the financial statements which are not historical in nature are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are subject to risks and uncertainties that may cause future results to differ materially from those set forth in such forward-looking statements. PSNC undertakes no obligation to update forward-looking statements to reflect events or circumstances after the date hereof. Such risks and uncertainties with respect to PSNC include, but are not limited to, its ability to successfully implement internal performance goals, performance issues with natural gas suppliers and transporters, the capital-intensive nature of PSNC's business, regulatory issues (including rate relief to recover increased capital and operating costs), legislative issues, competition, weather, exposure to environmental issues and liabilities, variations in natural gas prices and general and specific economic conditions. From time to time, subsequent to the date of the filing of this document, PSNC may include forward-looking statements in oral statements or other written documents. 20 PART II. OTHER INFORMATION Item 1. Legal Proceedings As more fully disclosed in Part I under "Environmental Matters" and in Part II in Note 7 to the audited consolidated financial statements in the Annual Report on Form 10-K for the period ending September 30, 1998, PSNC owns, or has owned, all or portions of six sites in North Carolina on which manufactured gas plants were formerly operated and is cooperating with the North Carolina Department of Environment and Natural Resources to investigate these sites. Item 2. Changes in Securities None. Item 3. Defaults Upon Senior Securities None. Item 4. Submission of Matters to a Vote of Security Holders At the Annual Meeting of Shareholders held on January 29, 1999, the following members were re-elected to serve on the Board of Directors for a term expiring at the annual meeting in the month and year indicated or until their successors are elected and qualified. Director Term Ending Votes in Favor Votes Withheld Bert Collins January 2002 16,780,420 120,813 John W. Copeland January 2002 16,750,221 151,012 D. Wayne Peterson January 2002 16,748,957 152,276 Charles E. Zeigler, Jr. January 2002 16,754,941 146,293 The following are directors whose term of office continued after the meeting: William C. Burkhardt, William A.V. Cecil, Van E. Eure, William L. O'Brien, Jr., Ben R. Rudisill II, and G. Smedes York. The shareholders approved an amendment to PSNC's Employee Stock Purchase Plan to restate the total number of shares authorized under the Plan after taking into effect the 3-for-2 stock split of the Common Stock that occurred in January 1993. After giving effect to the stock split, the total authorized shares under the Plan are 1,265,706. For - 16,177,424 Against - 470,402 Abstain - 265,378 The shareholders also ratified the selection of Arthur Andersen LLP as PSNC's independent public accountants for the fiscal year ending September 30, 1999. For - 16,707,971 Against - 92,654 Abstain - 100,607 21 Item 5. Other Information None. Item 6. Exhibits and Reports on Form 8-K (a) Part I Exhibits: 27 - Financial Data Schedule. Part II Exhibits: 10-A-33.2 Amendment of Amended and Restated Natural Gas Sales Agreement between PSNC and Transco Energy Marketing Company dated November 1, 1990. 10-A-39 Firm Transportation Service Agreement under Rate Schedule FT Service, dated June 26, 1998, between PSNC and Cardinal Extension Company, LLC. 10-A-40 Firm Transportation Service Agreement under Rate Schedule FT Service, dated June 26, 1998, between PSNC and Cardinal Extension Company, LLC. 10-A-41 Amendment to Firm Service Agreements (Exhibits 10-A-9, 10-A-10 and 10-A-11) under Rate Schedule FT, dated August 1, 1991, between PSNC and Transcontinental Gas Pipe Line Corporation, dated August 1, 1991. (b) Reports on Form 8-K PSNC filed on February 22, 1999 a current report on Form 8-K which included the Agreement and Plan of Merger between Public Service Company of North Carolina, Incorporated and SCANA Corporation. 22 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. PUBLIC SERVICE COMPANY OF NORTH CAROLINA, INCORPORATED (Registrant) Date 05/14/99 /s/ Charles E. Zeigler, Jr. Charles E. Zeigler, Jr. Chairman, President and Chief Executive Officer Date 05/14/99 /s/ Jack G. Mason Jack G. Mason Vice President - Finance 23