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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q
[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) OR
THE SECURITIES EXCHANGE ACT OF 1934
(NO FEE REQUIRED)
FOR THE TRANSITION PERIOD FROM ________ TO _________
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COMMISSION FILE NUMBER 1-4393
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PUGET SOUND ENERGY, INC.
(Exact name of registrant as specified in its charter)
WASHINGTON 91-0374630
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
411 - 108TH AVENUE N.E., BELLEVUE, WASHINGTON 98004-5515
(Address of principal executive offices)
(425) 454-6363
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) or the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file for such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No ____
The number of shares of registrant's common stock outstanding at March 31, 1999
was 84,560,545.
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1
TABLE OF CONTENTS
Page
Number
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Statements of Income - 3 month periods ended
March 31, 1999 and 1998 3
Consolidated Statements of Comprehensive Income - 3 month
periods ended March 31, 1999 and 1998 4
Consolidated Balance Sheets - March 31, 1999 and
December 31, 1998 5
Consolidated Statements of Cash Flows - 3 month periods
ended March 31, 1999 and 1998 7
Notes to Consolidated Financial Statements 8
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 10
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 19
Item 6. Exhibits and Reports on Form 8-K 19
SIGNATURE 20
2
PART I FINANCIAL INFORMATION
Item 1 FINANCIAL STATEMENTS
PUGET SOUND ENERGY, INC
CONSOLIDATED STATEMENTS OF INCOME
For the Three Month Periods Ended March 31
(Thousands except per share amounts)
(Unaudited)
1999 1998
--------- ---------
OPERATING REVENUES:
Electric $ 400,814 $ 368,596
Gas 170,843 147,822
Other 3,675 8,096
--------- ---------
Total operating revenue 575,332 524,514
--------- ---------
OPERATING EXPENSES:
Energy costs:
Purchased electricity 185,156 169,258
Purchased gas 78,256 67,928
Electric generation fuel 9,877 11,241
Residential Exchange (11,684) (15,507)
Utility operations and maintenance 62,552 60,217
Other operations and maintenance 7,689 5,683
Depreciation and amortization 42,621 40,736
Taxes other than federal income taxes 50,614 45,916
Federal income taxes 48,321 40,361
--------- ---------
Total operating expenses 473,402 425,833
--------- ---------
OPERATING INCOME 101,930 98,681
OTHER INCOME 3,747 1,764
--------- ---------
INCOME BEFORE INTEREST CHARGES 105,677 100,445
INTEREST CHARGES, net of AFUDC 35,922 34,442
--------- ---------
NET INCOME 69,755 66,003
Less: Preferred stock dividends accrual 2,876 3,309
INCOME FOR COMMON STOCK $ 66,879 $ 62,694
========= =========
COMMON SHARES OUTSTANDING - WEIGHTED AVERAGE 84,561 84,561
========= =========
BASIC & DILUTED EARNINGS PER COMMON SHARE: $ 0.79 $ 0.74
========= =========
The accompanying notes are an integral part of the financial statements.
3
PUGET SOUND ENERGY, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
For the Three Month Periods Ended March 31
(Dollars in Thousands)
(Unaudited)
1999 1998
--------- ----------
Net Income $ 69,755 $ 66,003
Other comprehensive income, net of tax:
Unrealized holding gains (losses) on
available for sale securities (780) 4,419
--------- ----------
Comprehensive Income $ 68,975 $ 70,422
========= ==========
The accompanying notes are an integral part of the financial statements.
4
PUGET SOUND ENERGY, INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in Thousands)
(Unaudited)
ASSETS
MARCH 31, DECEMBER 31,
1999 1998
--------- ------------
UTILITY PLANT:
Electric $ 3,734,778 $ 3,694,593
Gas 1,303,571 1,278,275
Common 176,999 179,140
Less: Accumulated depreciation and amortization 1,752,994 1,721,096
----------- -----------
Net utility plant 3,462,354 3,430,912
----------- -----------
OTHER PROPERTY AND INVESTMENTS 264,756 260,087
----------- -----------
CURRENT ASSETS:
Cash 48,719 28,216
Accounts receivable 183,039 189,638
Unbilled revenue 93,940 126,740
Materials and supplies, at average cost 46,792 58,534
Purchased gas receivable 5,591 5,492
Prepayments and other 11,650 7,990
----------- -----------
Total current assets 389,731 416,610
----------- -----------
LONG-TERM ASSETS:
Regulatory asset for deferred income taxes 237,813 241,406
PURPA buyout costs 223,035 221,802
Other 143,421 138,870
----------- -----------
Total long-term assets 604,269 602,078
----------- -----------
TOTAL ASSETS $ 4,721,110 $ 4,709,687
=========== ===========
The accompanying notes are an integral part of the financial statements.
5
PUGET SOUND ENERGY, INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in Thousands)
(Unaudited)
CAPITALIZATION AND LIABILITIES
MARCH 31, DECEMBER 31,
1999 1998
--------- ------------
CAPITALIZATION:
Common shareholders' investment:
Common stock, $10 stated value,
150,000,000 shares authorized,
84,560,545 and 84,560,561 shares outstanding $ 845,605 $ 845,606
Additional paid-in capital 450,724 450,724
Earnings reinvested in the business 75,555 47,548
Accumulated other comprehensive income 8,022 8,802
Preferred stock not subject to
mandatory redemption 90,000 95,075
Preferred stock subject to
mandatory redemption 65,662 73,162
Corporation obligated, mandatorily redeemable
preferred securities of subsidiary
trust holding solely junior subordinated
debentures of the corporation 100,000 100,000
Long-term debt 1,714,759 1,475,106
----------- -----------
Total capitalization 3,350,327 3,096,023
----------- -----------
CURRENT LIABILITIES:
Accounts Payable 94,589 163,141
Short-term debt 225,943 450,905
Current maturities of long-term debt 107,000 107,000
Accrued expenses:
Taxes 115,177 59,764
Salaries and wages 20,112 18,650
Interest 31,632 39,062
Other 24,443 23,150
----------- -----------
Total current liabilities 618,896 861,672
----------- -----------
DEFERRED INCOME TAXES 630,451 628,554
----------- -----------
OTHER DEFERRED CREDITS 121,436 123,438
-----------
TOTAL CAPITALIZATION AND LIABILITIES $ 4,721,110 $ 4,709,687
=========== ===========
The accompanying notes are an integral part of the financial statements.
6
PUGET SOUND ENERGY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Three Month Periods Ended March 31
(Dollars in Thousands)
(Unaudited)
1999 1998
--------- ---------
OPERATING ACTIVITIES:
Net Income $ 69,755 $ 66,003
Adjustments to reconcile net income
to net cash provided by operating activities:
Depreciation and amortization 42,621 40,736
Deferred income taxes and tax credits - net 5,490 4,744
Other 4,763 (4,108)
Change in certain current assets
and liabilities (Note 3) 29,568 55,154
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Net Cash Provided by Operating Activities 152,197 162,529
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INVESTING ACTIVITIES:
Construction expenditures - excluding equity AFUDC (92,114) (67,864)
Additions to energy conservation program (678) (888)
Other 2,620 4,585
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Net Cash Used by Investing Activities (90,172) (64,167)
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FINANCING ACTIVITIES:
Change in short-term debt, net (224,962) (31,106)
Dividends paid (41,746) (42,225)
Redemption of preferred stock (12,578) (1,293)
Issuance of bonds 250,000 --
Redemption of bonds and notes (10,358) (15,022)
Issue costs of bonds and stock (1,878) (233)
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Net Cash Used by Financing Activities (41,522) (89,879)
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Net Increase in cash 20,503 8,483
Cash at Beginning of year 28,216 10,729
===============================================================================
Cash at End of Period $ 48,719 $ 19,212
===============================================================================
The accompanying notes are an integral part of the financial statements.
7
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) SUMMARY OF CONSOLIDATION POLICY
The consolidated financial statements include the accounts of Puget
Sound Energy, Inc. ("the Company") and its wholly-owned subsidiaries, after
elimination of all significant intercompany items and transactions. Certain
amounts previously reported have been reclassified to conform with current year
presentations with no effect on total equity or net income.
The consolidated financial statements contained in this Form 10-Q are
unaudited. In the opinion of management, all adjustments necessary for a fair
presentation of the results for the interim periods have been reflected and were
of a normal recurring nature. These condensed financial statements should be
read in conjunction with the Company's annual report on Form 10-K.
(2) EARNINGS PER COMMON SHARE
Basic earnings per common share have been computed based on weighted
average common shares outstanding of 84,561,000 for the three months ended March
31, 1999 and 1998.
Diluted earnings per common share have been computed based on weighted
average common shares outstanding of 84,829,000 and 84,661,000 for the three
months ended March 31, 1999 and 1998, respectively. These shares include the
dilutive effect of securities related to long-term employee compensation plans
approved by shareholders.
(3) CONSOLIDATED STATEMENTS OF CASH FLOWS
The following provides additional information concerning cash flow
activities:
THREE MONTHS ENDED MARCH 31 1999 1998
- --------------------------- ---- ----
Changes in current asset and current liabilities:
Accounts receivable and unbilled revenue $ 39,399 $ 17,664
Materials and supplies 11,742 10,370
Prepayments and Other (3,660) 258
Purchased gas receivable (99) 11,470
Accounts payable (68,552) (24,928)
Accrued expenses and Other 50,738 40,320
==================================================== ======== ========
Net change in current assets and current liabilities $ 29,568 $ 55,154
==================================================== ======== ========
Cash payments:
Interest (net of capitalized interest) $ 44,641 $ 31,158
Income taxes -- $ 5,003
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8
(4) SEGMENT INFORMATION
The Company primarily operates in one business segment, Regulated Utility
Operations. The Company's regulated utility operation generates, purchases,
transports and sells electricity and purchases, transports and sells natural
gas. The Company's service territory covers approximately 6,000 square miles in
the state of Washington.
Principal non-utility lines of business include real estate investment
and development, home security services and energy-related services. Reconciling
items between segments are not material.
Financial data for business segments are as follows:
(Dollars in Thousands) Regulated
Three Months Ended March 31, 1999 Utility Other Total
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Revenues $ 571,657 $ 3,675 $ 575,332
Net Income 72,559 (2,804) 69,755
Total Assets 4,605,932 115,178 4,721,110
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Regulated
Three Months Ended March 31, 1998 Utility Other Total
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Revenues $ 516,418 $ 8,096 $ 524,514
Net Income 64,434 1,569 66,003
Total Assets 4,382,097 97,752 4,479,849
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(5) OTHER
In September 1998, the Company filed a shelf-registration statement
with the Securities and Exchange Commission for the offering, on a delayed or
continuous basis, of up to $500 million principal amount of Senior Notes secured
by a pledge of First Mortgage Bonds. On March 9, 1999, the Company issued $250
million principal amount of Senior Medium-Term Notes, Series B, which consisted
of $150 million principal amount due March 9, 2009 at an interest rate of 6.46%
and $100 million principal amount due March 9, 2029 at an interest rate of 7.0%.
During the first quarter of 1999, the Company adopted Issue 98-10,
"Accounting for Contracts Involved in Energy Trading and Risk Management
Activities" ("EITF 98-10") issued by the Emerging Issues Task Force of the
Financial Accounting Standards Board. EITF 98-10 addresses accounting for the
purchase and sale of energy trading contracts and is effective for fiscal years
beginning after December 15, 1998. The conclusion reached by the EITF was that
such contracts should be recorded at fair value when entered into for trading
activities with the mark-to-market gains or losses recorded in current earnings.
The Company does not consider its current operations to meet the definition of
trading activities as described by EITF 98-10. Accordingly, the adoption of EITF
98-10 did not have an impact on the Company's financial position or results of
operations.
In April 1998, the Accounting Standards Executive Committee issued
Statement of Position 98-5, "Reporting on the Costs of Start-Up Activities"
("SOP 98-5"). SOP 98-5 provides guidance on the financial reporting of start-up
costs and organization costs. It requires costs of start-up activities and
organization costs to be expensed as incurred and is effective for fiscal years
beginning after December 15, 1998. Adoption of SOP 98-5 did not have a material
impact on the Company's financial position or results of operations.
9
Item 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion of the Company's business includes some
forward-looking statements that involve risks and uncertainties. Words such as
"estimates," "expects," "anticipates," "plans," and similar expressions identify
forward-looking statements involving risks and uncertainties. Those risks and
uncertainties include, but are not limited to, the ongoing restructuring of the
electric and gas industries and the outcome of regulatory proceedings related to
that restructuring. The ultimate impacts of both increased competition and the
changing regulatory environment on future results are uncertain, but are
expected to fundamentally change how the Company conducts its business. The
outcome of these changes and other matters discussed below may cause future
results to differ materially from historic results, or from results or outcomes
currently expected or sought by the Company.
RESULTS OF OPERATIONS
Net income for the three months ended March 31, 1999, was $69.8 million
on operating revenues of $575.3 million, compared with net income of $66.0
million on operating revenues of $524.5 million for the same period in 1998.
Income for common stock was $66.9 million for the first quarter of 1999 compared
to $62.7 million for the first quarter of 1998. Basic and diluted earnings per
share were $0.79 for the first quarter of 1999 compared to $0.74 for the first
quarter of 1998.
The increase in net income and earnings per share in the first quarter
of 1999 compared to the first quarter of 1998 is primarily due to increased
energy sales during a period of near normal winter temperatures, compared to
warmer-than-normal weather in the first quarter last year. Also, favorable
hydroelectric conditions in the region during the first quarter of 1999 resulted
in improved electric margins. These benefits were partially offset by the added
utility operations and maintenance costs of restoring electric service following
a number of winter storms in the first quarter of 1999.
Total kilowatt-hour sales were 8.7 billion, including 2.7 billion in
sales to other utilities and marketers, for the first quarter of 1999, compared
to 7.6 billion, including 1.9 billion in sales to other utilities and marketers,
for the first quarter of 1998.
Total gas volumes were 392.3 million therms, including 69.1 million
therms in transportation volumes for the three months ended March 31, 1999,
compared to 351.9 million therms, including 75.7 million therms of
transportation, for the same period in 1998.
The Company's operating revenues and associated expenses are not
generated evenly during the year. Variations in energy usage by consumers do
occur from season to season and from month to month within a season, primarily
as a result of weather conditions. The Company normally experiences its highest
energy sales in the first and fourth quarters of the year. Electric sales to
other utilities and marketers also vary by quarter and year depending
principally upon water conditions for the generation of hydroelectric power,
retail customer usage and the energy requirements of other utilities.
Temperatures based on heating-degree-days measured at Seattle-Tacoma
airport during the three months ended March 31, 1999, were essentially near
normal and 10% colder than the same period in 1998.
10
Results of Operations
Comparative Three Month Periods Ending
March 31, 1999 vs. March 31, 1998
Increase (Decrease)
THREE MONTH PERIOD
(In Millions)
Operating revenue changes
General rate increase - electric $3.9
BPA Residential Purchase & Sale Agreement (2.2)
Sales to other utilities and marketers 15.1
Electric load and other changes 15.4
Gas revenue change 23.0
Other revenue changes (4.4)
---------
Total operating revenue change 50.8
---------
Operating expense changes
Energy costs:
Purchased electricity 15.9
Purchased gas 10.3
Electric generation fuel (1.4)
Residential exchange credit 3.8
Utility operations and maintenance 2.3
Other operations and maintenance 2.0
Depreciation and amortization 1.9
Taxes other than federal income taxes 4.7
Federal income taxes 8.0
---------
Total operating expense change 47.5
---------
Other income 2.0
Interest charges 1.5
=========
Net income change $3.8
=========
The following is additional information pertaining to the changes
outlined in the above table.
11
OPERATING REVENUES - ELECTRIC
Electric revenues for the quarter ended March 31, 1999 were $400.8
million, up $32.2 million or 8.7% over the same period in 1998. Revenues in the
first quarter of 1999 increased $3.9 million compared to the first quarter of
1998 due to a 1% general electric rate increase effective January 1, 1999.
Nearly normal temperatures in the quarter ended March 31, 1999 compared to
warmer-than-normal weather in the first quarter last year and a 2% increase in
the number of electric customers also contributed to the increase in revenues.
Revenues in 1999 and 1998 were reduced because of the credit that the
Company received through the Residential Purchase and Sale Agreement with the
Bonneville Power Administration ("BPA"). The agreement enables the Company's
residential and small farm customers to receive the benefits of lower-cost
federal power. A related reduction is included in purchased power expenses. On
January 29, 1997, the Company and BPA signed a Residential Exchange Termination
Agreement. The Agreement ends the Company's participation in the Residential
Purchase and Sale agreement with BPA. As part of the Termination Agreement, the
Company will receive payments by the BPA of approximately $235 million over an
approximately five-year period ending June 2001. Under the rate plan approved by
the Washington Commission in its merger order, the Company will continue to
reflect through the rate stability period in customers' bills, the current level
of Residential Exchange benefits. Over the remainder of the Residential Exchange
Termination Agreement from April 1999 through June 2001, it is projected that
the Company will credit customers approximately $148.1 million more than it will
receive from BPA during the following periods:
Dollars in
Period Millions
------ ----------
April- December 1999 $ 42.9
January - December 2000 68.3
January - June 2001 36.9
----------
$148.1
Electric sales to other utilities and marketers in the first quarter of
1999 increased $15.1 million or 47 percent over the same period in 1998 as
wholesale sales to marketers have increased. Related power cost expenses for the
periods also increased as the Company generated and purchased more power for
these sales.
OPERATING REVENUES - GAS
Gas operating revenues for the quarter ended March 31, 1999 increased
by $23.0 million from the prior year quarter. Total gas volumes increased 11.5%
from 351.9 million therms to 392.3 million therms. Gas margin increased by $12.7
million, or 16.4% in the first quarter of 1999 as compared to the first quarter
of 1998. The primary reasons for the increase in gas sales volumes, gas sales
revenues and margin in the quarter ended March 31, 1999 were the 4% increase in
gas customers and near normal first quarter 1999 average temperatures in the
Pacific Northwest as compared to the warmer than normal first quarter 1998
period.
Other revenues for the quarter ended March 31, 1999 decreased $4.4
million compared to the same period in 1998 due to decreased revenues at the
Company's subsidiaries.
12
OPERATING EXPENSES
Purchased electricity expenses increased $15.9 million for the first
quarter of 1999 compared to the same period in 1998. The increase was due
primarily to increased sales of electricity partially offset by more favorable
hydroelectric conditions.
Purchased gas expenses increased $10.3 million for the first quarter of
1999 compared to the first quarter of 1998 primarily due to increased volumes of
purchases as a result of higher heating load.
Fuel expense decreased $1.4 million in the first quarter of 1999
compared to the same period in 1998 primarily as a result of a refund from a
coal supplier received in the first quarter of 1999.
Residential exchange credits associated with the Residential Purchase
and Sale Agreement with BPA decreased $3.8 million in the three months ended
March 31, 1999 when compared to the same period in 1998. The primary reason for
the decrease was the Residential Exchange Termination Agreement between the
Company and BPA in January 1997 discussed in "Operating Revenues - Electric".
Utility operations and maintenance expenses increased $2.3 million in
the first quarter of 1999 compared to the same period in 1998 primarily due to
costs associated with restoring electric service following a number of fierce
winter storms. Storm restoration costs were approximately $6.0 million higher in
the first quarter of 1999 compared to the same period in 1998. This increase was
partially offset by a $2.6 million decrease in vegetation management expense in
the first quarter of 1999 compared to the same period in 1998. The Company
performed the majority of planned annual vegetation management work in 1998
during the first six months of the year due to the availability of contractors,
favorable weather conditions and in anticipation of beginning a new Tree Watch
program under which trees are removed outside the Company's rights of way after
obtaining customer permission.
Other operations and maintenance expenses increased $2.0 million in the
first quarter of 1999 compared to the first quarter of 1998 primarily due to
increased sales expenses at one of the Company's subsidiaries.
Depreciation and amortization expense increased $1.9 million for the
first quarter of 1999 from the same period in 1998 due primarily to the effects
of new plant placed into service during the past year.
Taxes other than federal income taxes increased $4.7 million in the
first quarter of 1999 compared to the first quarter of 1998 primarily due to
increases in municipal and state excise taxes which are revenue based and
increased property taxes.
Federal income taxes increased $8.0 million for the first quarter of
1999 from the same period in 1998, primarily due to higher pre-tax operating
income for the quarter.
OTHER INCOME
Other income, net of federal income tax, increased $2.0 million in the
first quarter of 1999 compared to the same period in 1998 due primarily to
decreases in non-utility expenses.
13
INTEREST CHARGES
Interest charges, which consist of interest and amortization on
long-term debt and other interest, increased $1.5 million for the first quarter
of 1999 compared to the same period in 1998 primarily as a result of the
issuance of $200 million 6.74% Senior Medium-Term Notes, Series A, in June 1998
and $250 million Senior Medium-Term Notes, Series B, in March 1999. These
increases were partially offset by the repayment of $61 million in Secured
Medium-Term Notes since February 1999, and the redemption of $30 million 9.14%
Secured Medium-Term Notes, Series A, in June 1998.
CONSTRUCTION, CAPITAL RESOURCES AND LIQUIDITY
Construction expenditures which include energy conservation
expenditures and exclude AFUDC for the first quarter of 1999 were $90.2 million,
including $0.7 million of energy conservation expenditures, compared to $67.2
million, including $0.9 million of energy conservation expenditures, for the
first quarter of 1998. Construction expenditures for 1999 and 2000 are expected
to be $303 million and $259 million, respectively. Cash provided by operations
(net of dividends and AFUDC) as a percentage of construction expenditures
(excluding AFUDC) were 120% and 177% for the first quarters of 1999 and 1998,
respectively. Construction expenditure estimates are subject to periodic review
and adjustment.
On March 31, 1999, the Company had available $375 million in lines of
credit with various banks, which provide credit support for outstanding bank
loans and commercial paper of $36 million, effectively reducing the available
borrowing capacity under these lines of credit to $339 million. In addition, the
Company has agreements with several banks to borrow on an uncommitted, as
available, basis at money-market rates quoted by the banks. There are no costs,
other than interest, for these arrangements. There was $190 million outstanding
under these arrangements at March 31, 1999.
YEAR 2000 CONVERSION
BACKGROUND
The Year 2000 issue results from the use of two digits rather than four
digits in computer hardware and software to define the applicable year. If not
corrected on computer systems that must process dates both before and after
January 1, 2000, two-digit year fields may create processing errors or system
failures. The Company expects to be Year 2000 ready which means that all
mission-critical systems, devices, applications and business relationships have
been evaluated and are suitable for continued use into and beyond the Year 2000,
or contingency plans are in place.
PROJECT APPROACH AND PROGRESS
The number of people working full time and part time on the Company's
Year 2000 project fluctuates between 125 and 150. The Company has established a
central project team to coordinate all Year 2000 activities and identified
exposure in three categories: information technology; embedded chip technology;
and external non-compliance by customers and suppliers. The project team is
taking a phased approach in conducting the Year 2000 project for its internal
systems. The phases include inventory, assessment, planning/prioritizing,
remediation, testing, implementation and contingency planning. In addition, the
Company has engaged outside consultants and technicians to aid in formulating
and implementing its plan. All business units have completed the inventory and
assessment phases. Remediation, testing and implementation for all business
units, is scheduled to be completed during the second quarter of 1999 with the
exception of the Company's Customer Information System ("CIS") discussed below.
14
The Company has been upgrading mainframe and client server financial and
business applications since 1997 and replacing many of its business systems as
part of its business plans following its merger in 1997. In September 1998, the
Company implemented a Systems, Applications, Products in Data Processing ("SAP")
business system which includes essentially all of the Company's business
applications with the exception of its CIS. This SAP system is Year 2000
compliant. The remainder of applications and operating environments excluding
the CIS are in the remediation/testing phase. Full implementation of those
applications and components of the Company's internal systems are scheduled for
completion by mid-year 1999.
A new CIS, which is designed to be Year 2000 compliant, is currently
being developed by the Company. Development is expected to continue in 1999. The
Company has also begun implementation activities with respect to the new system
which will continue during 1999. The Company has also elected to remediate
critical elements of its existing CIS for Year 2000 compliance purposes. The
Company has formed a specialized team which has completed the inventory phase
and is currently conducting assessment and remediation activities for the
existing system. The Company completed the assessment phase of this project in
April of 1999. Remediation and testing activities are expected to be completed
in the third quarter of 1999.
A specialized embedded systems team has been formed by the Company to
inventory, assess and remediate microprocessor technology in its generation,
transmission and distribution systems for both gas and electric operations. The
inventory and assessment phases of the project are complete. Although some
remediation planning is still in process, significant remediation efforts are
underway and proceeding according to schedule. Testing and implementation are
scheduled to be completed by the end of the second quarter of 1999. Contingency
planning specific to the Year 2000 issue began in November 1998, and initial
reports were submitted to the Washington Commission and the North American
Electric Reliability Council ("NERC"). These plans will be refined and updated
as remediation and test results are analyzed, and are scheduled for finalization
in the third quarter of 1999.
The Company sent letters to its suppliers, financial institutions and
other business partners to coordinate Year 2000 conversion and determine the
extent to which the Company is exposed to third party compliance failures.
Approximately 99% of vendors and suppliers have been contacted to date. All
third party assessment is scheduled to be completed in May 1999. If the Company
identifies concerns, it follows up with third parties by telephone. In addition,
the Company schedules meetings with critical vendors described below in order to
assess and monitor compliance measures. Virtually all the vendors and suppliers
who have responded to the Company's written requests and follow up telephone
calls have indicated either that they are Year 2000 compliant or that they
expect to be compliant later in 1999. Approximately 5% of the vendors and
suppliers have not yet responded to inquiries from the Company. Company line
managers are seeking to obtain responses from them as well as to develop
alternate sources or other contingency plans for vendors and suppliers who
either do not respond or who indicate that they do not expect to be compliant.
The Company depends upon third parties for a significant portion of its
energy supply and transportation. The majority of the high voltage transmission
facilities used by the Company are owned and operated by Bonneville Power
Administration and the Company's natural gas supplies are transported to its
service area by natural gas pipelines in the western United States and Canada.
The Company purchases 100% of its natural gas supplies and approximately 75% of
its electric power supplies. Major energy suppliers and transporters are
considered critical vendors because their failure to supply or deliver energy to
the Company could adversely affect the reliability of the Company's electric or
gas service to its customers.
15
In addition, the Company is working with various industry groups
including the NERC and the regional reliability council, the Western Systems
Coordinating Council ("WSCC") during the millennium transition. The United
States Department of Energy has asked NERC to assume a leadership role in
preparing the U.S. electric industry for the transition to the Year 2000.
COSTS
While the replacement of business systems under business plans developed
as a result of the Merger are not included in the Company's Year 2000 project,
those replacements substantially reduce the number of internal business
applications that require remediation. In addition to the costs of replacing new
business systems, the Company has expended approximately $5.7 million through
March 31, 1999, on Year 2000 remediation efforts, exclusive of internal labor
costs. Most of the expenditures through 1998 were for costs associated with the
inventory and assessment phases of the Year 2000 project. Although it is
difficult to determine the total remaining costs of implementing the Year 2000
plan, the Company's current estimate is approximately $11 million, most of which
will be expended for the remediation phase. Approximately $2 million of the
remaining expenditures related to replacements of capital assets are expected to
be capitalized.
RISK ASSESSMENT
The electric power supply systems of North America are connected into
three major interconnections called grids. The western grid covers the western
third of the U.S., western Canada and parts of Mexico. The BPA is the largest
supplier of transmission services in the Pacific Northwest. The Company's
reasonably likely worst case scenario is that operational component failures of
any entity connected to the grid could cause other failures in that grid. Such
failures would adversely affect the Company's ability to provide reliable
service to its customers and correspondingly reduce revenues. The Company will
need to continue to assess this risk as the millennium approaches to evaluate
the likelihood of power failures and develop approaches for mitigating the risk
of failures.
Much of the natural gas and electric distribution systems are comprised
of wires, poles and pipes containing no embedded chips. However, these systems
do employ some computer components that could be affected by the Year 2000
transition. Since many of the components used by the Company exist in multiple
sub-station locations, there is a risk that a component could be missed, a
component manufacturer could provide erroneous information, or the component
(while deemed and tested compliant) could fail in a specific configuration found
at the Company . The Company has formed a special team to handle these types of
components (embedded systems), and has retained an independent engineering firm
with specific utility experience to assist in the effort. Results of assessment
to date reveal that there are fewer components that are not Year 2000 ready than
initially thought. This is consistent with industry findings published in the
NERC report to the Department of Energy dated January 11, 1999.
The failure to correct a material Year 2000 problem could result in an
interruption in, or a failure of, Company business activities or operations.
Such failures could materially and adversely affect the Company's results of
operations, liquidity and financial condition. Due to the general uncertainty
inherent in the Year 2000 problem, resulting in part from the uncertainty of the
Year 2000 readiness of third-party suppliers and customers, the Company is
unable to determine at this time whether the consequences of Year 2000 failures
will have a material impact on the Company's results of operations, liquidity or
financial condition. The Year 2000 project is expected to significantly reduce
the Company's level of uncertainty about the Year 2000 problem and the Year 2000
readiness of its material vendors. The Company believes that, with the
implementation of new business systems and completion of the project as
scheduled, the possibility of significant interruptions of normal operations
should be reduced.
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As discussed above, elements of the Company's current CIS are not Year
2000 compliant. If the current CIS remediation activities are not successful by
the year 2000, certain normal business activities such as customer billing and
collections could be adversely affected by interruptions.
CONTINGENCY PLANS
The Company is identifying various scenarios that could occur in the
event that Year 2000 issues are not resolved in a timely manner. These efforts
will build upon the work in scenario development and contingency planning that
is being done by the WSCC contingency planning task force. A specialized team
has been formed that will develop contingency plans and update existing
emergency preparedness plans to identify and address risk scenarios for the
Company. Contingency planning is scheduled to continue through the third quarter
of 1999.
FORWARD LOOKING STATEMENTS
Readers are cautioned that forward-looking statements contained in the
Year 2000 update are based on management's best estimates and may be influenced
by factors that could cause actual outcomes and results to be materially
different than projected. Specific factors that might cause differences between
the estimates and actual results include, but are not limited to, the
availability and cost of personnel trained in these areas, the ability to locate
and correct all relevant computer code, timely responses to and corrections by
third-parties and suppliers, the ability to implement new systems in a timely
manner, the ability to implement interfaces between the new systems and the
systems not being replaced, and similar uncertainties. Due to the general
uncertainty inherent in the Year 2000 problem, resulting in part from the
uncertainty of the Year 2000 readiness of third-parties and the interconnection
of global businesses, the Company cannot ensure its ability to timely and
cost-effectively resolve problems associated with Year 2000 issues that may
affect its operations and business, or expose it to third-party liability.
OTHER
In May 1999, the Company sold its investment in the common stock of Cabot
Oil and Gas Company. The Company also determined that it would refocus the
business of one of its wholly-owned subsidiaries and exit two product lines. The
gain from the sale of its investment will exceed the costs of exiting the
product lines by approximately $9 million (before consideration of amounts
received from sales of the product lines).
On April 30, 1999, the Company filed a registration statement and
prospectus for the formation of a holding company structure. The holding company
proposal will be voted upon by shareholders at the Company's annual meeting on
June 23, 1999. The proposed holding company structure is also subject to
approval by the Washington Utilities and Transportation Commission and the
Federal Energy Regulatory Commission.
The Company has an Optional Large Power Sales Rate and certain "special
contracts" for its largest customers. Customers who elect the Optional Large
Power Sales Rate are no longer considered "core" customers, and the Company no
longer has an obligation to plan for future resources to serve their needs. The
non-core customers receive access to electric energy that is priced at current
market cost and pay a charge for energy delivery (including a charge for
conservation programs) and a transition charge (representing the difference
between the Company's present cost and the current market cost of electric
energy and capacity). The transition charge will be phased out before the end of
the year 2000. Non-core customers also take on the risk that market costs could
become volatile and that electricity could be unavailable on the open market. In
November 1998, a number of industrial customers filed a complaint with the
Washington Commission that the Company was incorrectly billing for energy under
the Optional Large Power Sales Rate. If the Washington Commission finds that the
Company used an incorrect index, the Company would owe approximately $2.8
million in refunds. However, management believes the proper index has been used
and expects the Company will prevail on this issue.
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MARKET RISKS
The Company is exposed to market risks, including changes in commodity
prices and interest rates.
COMMODITY PRICE RISK
The prices of energy commodities and transportation services are subject
to fluctuations due to unpredictable factors including weather, transportation
congestion and other factors which impact supply and demand. This commodity
price risk is a consequence of purchasing energy at fixed and variable prices
and providing deliveries at different tariff and variable prices. Costs
associated with ownership and operation of production facilities are another
component of this risk. The Company may use forward delivery agreements and
option contracts for the purpose of hedging commodity price risk. Unrealized
changes in the market value of these derivatives are deferred and recognized
upon settlement along with the underlying hedged transaction. In addition, the
Company believes its current rate design, including its Optional Large Power
Sales Rate, various special contracts and the PGA mechanism mitigate a portion
of this risk.
Market risk is managed subject to parameters established by the Board of
Directors. A Risk Management Committee separate from the units that create these
risks monitors compliance with the Company's policies and procedures. In
addition, the Audit Committee of the Company's Board of Directors has oversight
of the Risk Management Committee.
INTEREST RATE RISK
The Company believes interest rate risks of the Company primarily relate
to the use of short-term debt instruments and new long-term debt financing
needed to fund capital requirements. The Company manages its interest rate risk
through the issuance of mostly fixed-rate debt of various maturities. The
Company does utilize bank borrowings, commercial paper and line of credit
facilities to meet short-term cash requirements. These short-term obligations
are commonly refinanced with fixed rate bonds or notes when needed and when
interest rates are considered favorable. The Company may enter into swap
instruments to manage the interest rate risk associated with these debts, and
one interest rate swap was outstanding as of March 31, 1999.
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PART II OTHER INFORMATION
Item 1 LEGAL PROCEEDINGS
Contingencies arising out of the normal course of the Company's
business, exist at March 31, 1999. The ultimate resolution of these issues is
not expected to have a material adverse impact on the financial condition,
results of operations or liquidity of the Company.
Item 6 EXHIBITS AND REPORTS ON FORM 8-K
(a) The following exhibits are filed herewith:
12-a Statement setting forth computation of ratios of earnings
to fixed charges (1994 through 1998 and 12 months ended
March 31, 1999)
12-b Statement setting forth computation of ratios of earnings
to combined fixed charges and preferred stock dividends
(1994 through 1998 and 12 months ended March 31, 1999)
27 Financial Data Schedule
(b) Reports on Form 8-K
Form 8-K dated March 4, 1999, Item 5 - Other Events and Item 7 -
Exhibits, related to a Distribution Agreement entered into by the
Company for the issuance and sale of Senior Medium-Term Notes,
Series B.
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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.
PUGET SOUND ENERGY, INC.
JAMES W. ELDREDGE
------------------------
JAMES W. ELDREDGE
Corporate Secretary and Controller
Date: May 14, 1999 Chief accounting officer and
officer duly authorized to sign
this report on behalf of the
registrant
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