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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 Quarter Ended September 30, 1997
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from _____to_____
Commission Registrant, State of Incorporation, I.R.S. Employer
File Number Address and Telephone Number Identification No.
----------- ---------------------------------- -----------------
333-09033 Southern Investments UK plc None
(Registered in England & Wales)
800 Park Avenue
Aztec West
Almondsbury
Bristol
BS32 4SE, UK
(01144) 1454 201101
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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 ___
Description of Shares Outstanding
Registrant Common Stock at October 31, 1997
- ---------- ------------ -------------------
Southern Investments UK plc Par Value(pound)1 Per Share 500,400,587
1
SOUTHERN INVESTMENTS UK plc and SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(In Millions)
For the Three Months Ended September 30,
----------------------------------------
1997 1996
---- ----
(Note F)
OPERATING REVENUES (pound) 162 $ 261 (pound) 179
COST OF SALES 101 163 122
------ ------ ------
GROSS MARGIN 61 98 57
------ ------ ------
OPERATING EXPENSES:
Maintenance 9 15 9
Depreciation and amortization 12 19 11
Selling, general, and administrative 15 24 13
------ ------ ------
Total operating expenses 36 58 33
------ ------ ------
Operating income 25 40 24
------ ------ ------
OTHER INCOME (EXPENSE):
Interest income 1 2 -
Interest expense (15) (24) (13)
Other, net 2 3 2
------ ------ ------
Total other income (expense) (12) (19) (11)
------ ------ ------
INCOME BEFORE INCOME TAXES 13 21 13
INCOME TAXES
Customary (11) (18) (5)
Effect of change in tax rates (Note G) 22 36 -
Windfall levy (Note G) (90) (145) -
------ ------ ------
NET (LOSS) INCOME (pound) (66) $ (106) (pound) 8
------ ------ ------
The accompanying notes form an integral part of these condensed consolidated statements.
2
SOUTHERN INVESTMENTS UK plc and SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(In Millions)
For the Six Months Ended September 30,
--------------------------------------
1997 1996
---- ----
(Note F)
OPERATING REVENUES (pound) 334 $ 538 (pound)360
COST OF SALES 212 342 244
------ ------ ------
GROSS MARGIN 122 196 116
------ ------ ------
OPERATING EXPENSES:
Maintenance 17 28 18
Depreciation and amortization 23 37 22
Selling, general, and administrative 30 48 25
------ ------ ------
Total operating expenses 70 113 65
------ ------ ------
Operating income 52 83 51
------ ------ ------
OTHER INCOME (EXPENSE):
Interest income 1 2 -
Interest expense (28) (45) (26)
Gain on sale of investments - - 1
Other, net 7 11 4
------ ------ ------
Total other income (expense) (20) (32) (21)
------ ------ ------
INCOME BEFORE INCOME TAXES 32 51 30
INCOME TAXES:
Customary (16) (26) (11)
Effect of change in tax rates (Note G) 22 36 -
Windfall levy (Note G) (90) (145) -
------ ------ ------
NET (LOSS) INCOME (pound) (52) $ (84) (pound) 19
------ ------ ------
The accompanying notes form an integral part of these condensed consolidated statements.
3
SOUTHERN INVESTMENTS UK plc and SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In Millions)
For the Six Months Ended September 30,
--------------------------------------
1997 1996
---- ----
(Note F)
NET CASH PROVIDED BY OPERATING
ACTIVITIES (pound) 95 $ 153 (pound) 63
------ ----- -----
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (44) (71) (30)
Other (2) (3) 4
------ ----- -----
Net cash used in investing activities (46) (74) (26)
------ ----- ----
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments of dividends (59) (95) (12)
Change in short-term borrowings 8 13 (42)
------ ----- -----
Net cash used in financing activities (51) (82) (54)
------ ----- -----
NET DECREASE IN CASH AND CASH EQUIVALENTS (2) (3) (17)
CASH AND CASH EQUIVALENTS, beginning of period 3 5 20
------ ----- -----
CASH AND CASH EQUIVALENTS, end of period (pound) 1 $ 2 (pound) 3
====== ===== =====
SUPPLEMENTAL CASH FLOW DISCLOSURES:
Cash paid for interest (pound) (27) $ (44) (pound) (27)
====== ===== =====
Cash (paid) received for income tax (pound) (6) $ (9) (pound) 16
====== ===== =====
The accompanying notes form an integral part of these condensed consolidated statements.
4
SOUTHERN INVESTMENTS UK plc and SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In Millions)
ASSETS
September 30, 1997 March 31,
------------------ ---------
(Unaudited) 1997
----------- ----
(Note F)
PROPERTY, PLANT, AND EQUIPMENT: (pound) 1,352 $2,179 (pound) 1,312
Less accumulated depreciation 80 129 59
------ ------- -------
Property, plant, and equipment, net 1,272 2,050 1,253
------ ------ -------
OTHER ASSETS:
Investments 19 31 19
Prepaid pension cost 110 177 105
Goodwill, net of accumulated amortization of (pound)9 ($15) at
September 30 and(pound)7 at March 31 174 280 176
------ ------ -------
Total other assets 303 488 300
------ ------ -------
CURRENT ASSETS:
Cash and cash equivalents 1 2 3
Investments 21 34 18
Receivables:
Customer accounts, less provision for uncollectables of (pound)14 ($23) at
September 30 and(pound)12 at March 31 57 92 120
Other 11 17 12
------ ------ -------
Receivables, net 68 109 132
Materials and supplies 3 5 3
Prepaid expenses 17 27 12
------ ------ -------
Total current assets 110 177 168
------ ------ -------
Total assets (pound) 1,685 $2,715 (pound) 1,721
====== ====== =======
The accompanying notes are an integral part of these condensed consolidated balance sheets.
5
SOUTHERN INVESTMENTS UK plc and SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In Millions)
STOCKHOLDER'S EQUITY AND LIABILITIES
September 30, 1997 March 31,
------------------ --------
(Unaudited) 1997
---------- ----
(Note F)
STOCKHOLDER'S EQUITY:
Common stock, (pound)1 par value, 500,400,587 shares authorized, issued
and outstanding (pound) 500 $ 805 (pound) 500
Retained earnings (deficit) (Note B) (200) (322) (114)
------ ------ ------
Total stockholder's equity 300 483 386
------ ------ ------
COMPANY OBLIGATED MANDATORILY REDEEMABLE
PREFERRED SECURITIES OF SOUTHERN INVESTMENTS
UK CAPITAL TRUST I HOLDING COMPANY JUNIOR
SUBORDINATED DEBENTURES 50 81 50
NON-CURRENT LIABILITIES:
Long-term debt 301 485 301
Deferred income taxes 357 575 377
Windfall levy 45 72 -
Provision for loss contracts (Note C) 69 111 67
Other 58 94 61
------ ------ ------
Total non-current liabilities 830 1,337 806
------ ------ ------
CURRENT LIABILITIES:
Commercial paper 178 286 250
Short-term borrowings 114 184 34
Accounts payable 28 45 46
Accrued income taxes 42 68 31
Windfall levy 45 73 -
Unearned revenue 10 16 5
Common dividend declared - - 25
Accrued interest 8 13 9
Other 80 129 79
------ ------ ------
Total current liabilities 505 814 479
------ ------ ------
Total stockholder's equity and liabilities (pound) 1,685 $2,715 (pound) 1,721
====== ====== ======
The accompanying notes are an integral part of these condensed consolidated balance sheets.
6
SOUTHERN INVESTMENTS UK plc and SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1997
(Unaudited)
(A) The condensed consolidated financial statements included herein have been
prepared pursuant to the rules and regulations of the Securities and
Exchange Commission ("SEC") and in conformity with accounting principles
generally accepted in the United States. In the opinion of the Company's
management, the information furnished herein reflects all adjustments
(which included only normal recurring adjustments except for the provision
for windfall levy and credit to deferred taxes for an income tax rate
change) necessary to present fairly the results of the three-month and
six-month periods ended September 30, 1997 and 1996. The Company's fiscal
year end is March 31. Certain information and footnote disclosures normally
included in financial statements prepared in accordance with generally
accepted accounting principles have been condensed or omitted pursuant to
such rules and regulations, although the Company believes that the
disclosures are adequate to make the information presented not misleading.
(B) The condensed consolidated balance sheet as at March 31, 1997 included
herein has been extracted from audited financial statements; all other
figures are unaudited. The condensed financial statements included herein
have been reviewed by the Company's independent public accountants and
their report is included herein as Exhibit 15.
The Company's sole investment and only significant asset is the entire
share capital of South Western Electricity plc ("SWEB"), which is
headquartered in Bristol, England. The Company shows a retained earnings
deficit primarily due to the dividends in the amount of (pound)191
million being declared and paid by the Company during the fiscal year
1996 as proceeds from the sale of SWEB's shares in The National Grid
Holding plc ("NGH") provided cash in addition to that provided from
operations. Dividends in the amount of (pound)37 million for fiscal year
1997 and interim dividends of (pound)34 million for 1998 were declared by
the Company.
(C) SWEB has entered into a contract relating to the purchase of 200
megawatts of capacity from a 7.69% owned related party, Teesside Power
Limited ("Teesside"), for a period of 15 years beginning April 1, 1993.
The contract sets electricity purchase prices that oscillate by
predetermined indices. The Company has recognized an accrual at the
acquisition date for the excess of these Teesside power purchase costs in
each year over an estimate of the equivalent wholesale electricity
trading market (the "Pool") costs in that respective year. These costs
have been discounted at an appropriate rate to their present value of
(pound)69 million at September 30, 1997 and (pound)67 million at March
31, 1997.
(D) The Company and SWEB utilize certain financial derivative contracts for
the purpose of risk management. The Company's and SWEB's participation in
derivative contracts has been to hedge business exposure in connection
with fluctuations in interest rates, currency rates related to certain of
the Company liabilities, and electricity purchase costs. At September 30,
1997, the status of outstanding derivative contracts was as follows:
(i) Interest rate swaps are used by the Company and SWEB to hedge their
exposure to fluctuations in interest rates by allowing them to
effectively convert their outstanding variable-rate debt into fixed debt.
At September 30, 1997, sterling interest rate swaps expiring between 2001
and 2012 with notional amounts totalling (pound)500 million, resulted in
an unrealized loss of (pound)32 million.
7
SOUTHERN INVESTMENTS UK plc and SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(ii) Foreign currency swaps contracts are used by the Company to hedge
exposure to US dollar liabilities in respect of outstanding debt. At
September 30, 1997, currency swaps expiring between 2001 and 2007 with
notional amounts totalling (pound)350 million, resulted in an unrealized
profit of (pound)10 million.
(iii) SWEB has contracts for differences ("CFDs") to mitigate its
exposure to volatility in the prices of electricity purchased through the
Pool. CFDs are in place to hedge electricity purchases on approximately
22,790 GWh through the year 2008. Accordingly, the gains or losses on
such contracts are deferred and recognized as electricity is purchased.
It is not possible to estimate the fair value of these contracts at
present as the contract prices are based on future events, the effects of
which currently are not estimable.
(E) The Company and SWEB are routinely party to legal proceedings arising in
the ordinary course of business which are not material, either
individually or in aggregate. Neither the Company nor SWEB is a party to
any material legal proceedings nor are they currently aware of any
threatened material legal proceedings. As described below, the Company is
aware of an issue which could subsequently impact SWEB.
The Pensions Ombudsman (a UK statutorily appointed independent
arbitrator) has issued a determination in favor of complaints made by
members of the Electricity Supply Pension Scheme ("ESPS") relating to
another employer's use of ESPS surplus to offset the employer's costs of
providing early pensions on redundancies and certain other items. Under
that determination the Pensions Ombudsman directed the employer to pay
into ESPS the amount of that use of the surplus plus interest. The
determination was challenged in the High Court by the employer, and the
High Court upheld the employer's appeal in a judgment delivered on June
10, 1997. The High Court also granted the complainants leave to appeal to
a higher court. No date has yet been set for any hearing in the Appeal
court. If the complainants' appeal is successful either at the Appeal
court or on a subsequent appeal to the House of Lords, it will have an
adverse effect on SWEB. No payments are required until such challenge has
been heard. It is not practical to make an estimate of the exposure at
the present time.
(F) Solely for the convenience of the reader, pounds sterling amounts have
been translated into US dollars at the exchange rate of $1.6117 =
(pound)1.00, the noon buying rate in New York City for cable transfers in
pounds sterling as certified for customs purposes by the Federal Reserve
Bank of New York on September 30, 1997.
(G) On July 2, 1997 the newly elected Labour government presented its first
budget which included a "one-off windfall levy on the excess profits of
the privatized utilities." Based upon the legislation, SWEB currently
estimates its liability to be approximately (pound)90 million. Earlier,
the Company filed an estimate of the windfall levy with the SEC. The
Company has refined its estimate based on final income data for the years
the tax impacted. The levy is payable in two equal installments on or
before December 1, 1997 and December 1, 1998.
The legislation also reduced the UK corporation tax rate from 33% to 31%
on April 1, 1997. Such a decrease results in an accounting credit
reducing SWEB's provision for deferred income taxes by approximately
(pound)22 million.
8
SOUTHERN INVESTMENTS UK plc and SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(H) The condensed consolidated financial statements included herein have not
been prepared in accordance with the policies of Statement of Financial
Accounting Standards No. 71 "Accounting for the Effects of Certain Types of
Regulation" ("SFAS No. 71"). This pronouncement, under which most US
electric utilities report financial statements, applies to entities which
are subject to cost-based rate regulation. By contrast, SWEB is not subject
to rate regulation, but, rather, is subject to price cap regulation and
therefore the provisions of SFAS No. 71 do not apply. Financial statements
presented in accordance with SFAS No. 71 often contain certain deferred
items which have not been included in rates charged to customers in
compliance with the respective regulatory authority rulings, but which
would have been included in the income statement of enterprises in general
under US GAAP. The accompanying financial statements of the Company do not
contain such deferrals.
9
SOUTHERN INVESTMENTS UK plc and SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
SECOND FISCAL QUARTER 1998 vs. SECOND FISCAL QUARTER 1997
AND
FISCAL YEAR TO DATE 1998 vs FISCAL YEAR TO DATE 1997
INTRODUCTION
The Company is a wholly-owned subsidiary of SWEB Holdings Limited (which
changed its name from Southern Investments UK Holdings Limited on September 16,
1997) of which 75% is owned indirectly by Southern Company and 25% is owned
indirectly by PP&L Resources, Inc. The Company was incorporated as a public
limited company under the laws of England and Wales on June 23, 1995, as a
vehicle for the acquisition of SWEB, one of the 12 regional electricity
companies in England and Wales licensed to distribute, supply and, to a limited
extent, generate electricity. In September 1995, the Company gained effective
control of SWEB. The Company's sole investment and only significant asset is the
entire share capital of SWEB, which is headquartered in Bristol, England.
SWEB's two main business lines are the distribution of electricity and the
supply of electricity to approximately 1.3 million customers, primarily in its
franchise area in southwest England. This area covers approximately 5,560 square
miles and has a resident population of approximately 2.8 million. SWEB also has
ancillary business activities, including electricity generation.
RESULTS OF OPERATIONS
Earnings
The first budget of the newly elected Labour government included a "one-off
windfall levy on the excess profits of the privatized utilities." SWEB estimates
its liability to be approximately (pound)90 million. The budget also reduced the
UK corporation tax rate from 33% to 31%. This decrease results in an accounting
credit reducing SWEB's provision for deferred income taxes by approximately
(pound)22 million.
The remainder of this discussion is on items other than the windfall levy
and deferred income taxes.
Operating income for the second quarter and year-to-date fiscal year 1998
was (pound)25 million and (pound)52 million, respectively, compared to (pound)24
million and (pound)51 million for the corresponding periods of fiscal year 1997.
The increase in operating income of (pound)1 million in both the second quarter
and year-to-date is due to increases in the distribution business of (pound)3
million and supply business of (pound)1 million, partly offset by a reduction in
ancillary businesses.
10
SOUTHERN INVESTMENTS UK plc and SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
Significant income statement items appropriate for discussion include the
following:
Increase (Decrease)
--------------------------------------------------------
Second Quarter Year-To-Date
--------------------------------------------------------
(in millions) % (in millions) %
Operating Revenues.................................. (pound) (17) (9) (pound) (26) (7)
Cost of sales....................................... (21) (17) (32) (13)
Selling, general and administrative expense......... 2 15 5 20
Interest expense.................................... 2 15 2 8
Income taxes - customary............................ 6 120 5 45
Operating revenues
Revenue decreases were primarily within the supply business where revenues
decreased by (pound)20 million for the quarter and (pound)34 million year to
date. This is due mainly to a reduction in the fossil fuel levy which is passed
through to customers.
Cost of sales
Cost of sales primarily relate to the purchase cost of electricity. The
decrease is largely due to the decrease in the fossil fuel levy, as mentioned
above.
Selling, general and administrative expense
The increase in cost primarily reflects a provision to restructure some of
the ancillary businesses.
Interest expense
The increase in interest expense is primarily due to an increase of 1% in
short-term interest rates over the period combined with the retirement of
floating rate debt funded with issuance of higher rate fixed interest preferred
securities during the 1997 fiscal year.
Income taxes - customary
The provision was increased for permanent differences and possible other
disallowable items.
11
SOUTHERN INVESTMENTS UK plc and SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
Future Earnings Potential
The results of operations discussed above are not necessarily indicative of
future earnings potential. The level of future earnings depends on numerous
factors including the level of energy sales and customer growth. A major impact
on future earnings will be the interest charges from funding requirements to
meet the windfall levy payments. An item that could also result in additional
funding requirements relates to the outcome of a court ruling related to a
pension matter. See Notes (G) and (E), respectively, in the "Notes to the
Condensed Consolidated Financial Statements", and also "Financial Condition"
herein for discussion of these matters.
The largest portion (approximately 79%) of SWEB's operating income, in the
year-to-date fiscal year 1998, is derived from its distribution business -
essentially the operation and maintenance of the electricity network in its
franchise area of the southwest of England. SWEB is the distributor of
electricity in this area, and management believes that economic, environmental
and regulatory factors are likely to prevent competitors from entering this
business in SWEB's service area.
The Director General of Electricity Supply (the "Regulator") controls the
revenues generated by SWEB in its distribution and supply businesses by applying
a price control formula, P + RPI -X, where P is the price level at the beginning
of each new regulatory period, RPI is the change in the Retail Price Index and X
is an adjustment factor determined by the Regulator. X is currently 3% for
distribution and 2% for supply.
In the distribution business, the Distribution Price Control Formula
("DPCR") is usually set for a five-year period, subject to more frequent
adjustments as determined necessary by the Regulator. At each review, the
Regulator can require a one-time price adjustment. An initial review by the
Regulator of allowable income in the distribution business led to a reduction of
the price level by 14% for SWEB starting April 1, 1995, followed by efficiency
factors of X = 2% for each year until March 2000 (before an allowed increase for
inflation). On July 6, 1995, the Regulator announced the result of a further
distribution price review which was precipitated by certain market events in the
UK electric utility industry. For SWEB, such announcement meant a further real
reduction of 11% in allowable distribution income for the twelve months from
April 1, 1996, followed by an efficiency factor of X = 3% for each year until
March 31, 2000, before an allowed increase for inflation. It is expected that
the Regulator will undertake the next DPCR review in 1998 to become effective
from April 1, 2000.
Within the supply business, the non-franchise market above 1MW was opened
to full competition during privatization in 1990 and the non-franchise market
above 100kW was opened to full competition in April 1994. Regulation in respect
of supply business charges currently applies only to Franchise Supply Customers.
The calculation of the maximum supply charge is based on a Supply Price Control
Formula ("SPCR"), similar to the DPCR, and is set for a four-year period. In
1993, the Regulator announced the supply franchise market (i.e. customers with
demand of not more than 100kW) income entitlement for the four-year period
ending March 1998. An efficiency factor of X = 2% (before an allowed increase
for inflation) was applied to SWEB, offset by an allowance for both unit and
customer growth.
The exclusive right to supply Franchise Supply Customers (largely
domestic and small commercial) is scheduled to be phased out over a six-month
period commencing April 1, 1998, after which all supply customers will have the
ability to choose their electricity supplier. SWEB intends to maintain a
significant share of these customers by providing superior service and
competitive pricing.
On October 16, 1997 the Regulator announced the result of its current SPCR
review for Franchise Supply Customers, effective from April 1, 1998. For SWEB,
such announcement meant an average tariff reduction of 4.9% (before an allowed
increase for inflation) for fiscal year 1999, after taking account of any over
or under recovery from the existing formula, and a further 3% (before an
12
SOUTHERN INVESTMENTS UK plc and SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
allowed increase for inflation) for fiscal year 2000. This average tariff
reduction primarily reflects the expected reduction in power purchase costs
after March 31, 1998 when expensive contracts for differences ("CFDs",
see below), agreed by the government at the time of privatization
of the electricity industry, will end. The resultant average tariffs in fiscal
years 1999 and 2000 represent maximum price restraints intended to protect
domestic and small business customers. Second tier suppliers, however, can
price below the maximum price constraints in order to attract or retain
customers when the remaining market is opened to competition. The Regulator
has also proposed a penalty on all regional electricity companies, including
SWEB, if the opening of the franchise market to competition is delayed; any
penalty imposed on SWEB is not expected to be material.
CFDs are used to hedge pool price risk in the electricity supply
business. These are contracts predominantly between generators and suppliers
which fix the price of electricity for a contracted quantity of electricity over
a specific time period. Differences between the actual price set by the Pool and
the agreed prices give rise to payments between the parties to the particular
CFD. The current SPCR governing the franchise supply market permits the
pass-through to customers of prudent costs which include the cost of
arrangements such as CFDs to hedge against Pool price volatility; the SPCR
effective from April 1,1998 does not permit the automatic pass-through to
customers of such costs. At the present time, SWEB's forecast franchise supply
market demand for fiscal year 1998 is substantially hedged through various types
of agreements including CFDs. See Note D in the "Notes to the Condensed
Consolidated Financial Statements".
The most common contracts for supply to Non-Franchise Supply Customers
are for a twelve-month term and contain fixed rates. SWEB is exposed to two
principal risks associated with such contracts: load shape risk (the risk
associated with a shift in the customer's usage pattern, including absolute
amounts demanded and timing of amounts demanded) and purchasing price risk (the
cost of purchased electricity relative to the price received from the supply
customer). SWEB employs risk management methods to maximize its return
consistent with an acceptable level of risk. Generally load shape risk decreases
as SWEB's portfolio of supply customers in the non-franchise supply market
increases. SWEB hedges purchasing price risk by employing a variety of risk
management tools, including management of its supply contract portfolio, hedging
contracts, and other means which mitigate risk of future Pool price volatility.
SWEB's ability to manage its purchasing price risk depends, in part, on
the future availability of properly priced risk management mechanisms such as
CFDs. No assurance can be given that an adequate, transparent market for such
products will in fact be available.
SWEB is also investigating whether owning its own source of generation or
contracting for such source or sources would be an appropriate method for
partially managing purchase price risk, but no assurance can be given that such
methods would be available to, or economically appropriate for, SWEB.
FINANCIAL CONDITION
Overview
Other than the windfall levy discussed in Note G, the major change in the
Company's financial condition during the six months to September, 1997 was the
addition by SWEB of approximately (pound)44 million in property, plant, and
equipment, largely in respect of the distribution network. The funds for these
additions were derived primarily from operations. It is expected that SWEB's
capital requirements in the foreseeable future for its investment in property,
plant, and equipment will be met by cash generated from its operating
activities. However, the significant requirements of the windfall levy and
possible requirements of a pension matter, both discussed above, will require
external financing, and result in increased interest expense.
13
SOUTHERN INVESTMENTS UK plc and SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
In addition to the windfall levy, the government also removed the ability
of pension schemes to obtain a refund of tax credits previously allowed on
dividends received. This could result in an increase to the pension cost charged
against Net Income and result in additional funding requirements to meet the
pension plan requirements.
Demand for electricity in Great Britain, in general, and in SWEB's
franchise area, in particular, is seasonal, with demand being higher in the
winter months and lower in the summer months. SWEB balances the effect of this
and other cyclical influences on its working capital needs with drawings under
its available credit facilities.
The Company's sole investment and only significant asset is the entire
share capital of SWEB. The Company is therefore dependent upon dividends from
SWEB for its cash flow. SWEB can make distribution of dividends to the Company
under English law to the extent that it has distributable reserves, subject to
the retention of sufficient financial resources to conduct its supply and
distribution businesses as required by its regulatory license. The Company
believes that currently sufficient distributable reserves will exist at SWEB to
allow for reasonable and necessary dividends from SWEB, through operations, to
be distributed to the Company. In the UK, the Accounting Standards Board
currently has a discussion paper reviewing the treatment of deferred income tax
accounting to be required in the future. SWEB's distributable reserves could be
significantly reduced by this matter.
Financing Activities
SWEB has established a commercial paper program in the US, first utilized
in February 1997 to reduce short-term bank loans. The maximum available under
the program, which is fully supported by a swingline facility provided by a
syndicate of banks, is $520 million. The amount not utilized at September 30,
1997 was $235 million. SWEB enters into foreign currency contracts to hedge the
currency risk associated with the interest and principal of each issue under
this program.
Sources of Capital
To meet short-term cash needs and contingencies, the Company and SWEB
together had at September 30, 1997 approximately (pound)1 million of cash and
cash equivalents and (pound)260 million of other lines of credit with banks.
Also undrawn is $520 million of committed lines of credit, which are reserved
for use as standby for the commercial paper program. At September 30, 1997 the
Company and SWEB together had short-term debt of (pound)292 million outstanding.
The Company currently has sufficient liquidity to meet the required payments of
the windfall levy and the pension matter.
14
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits.
---------
15 - Report of Independent Public Accountants
27 - Financial Data Schedule
(b) Reports on Form 8-K.
-------------------
The Company filed a Current Report on Form 8-K dated July 16, 1997:
Items reported: Item 5
Financial statements filed: None
15
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.
SOUTHERN INVESTMENTS UK plc
/s/ Gale E. Klappa
By Gale E. Klappa
Director
/s/ C. B. (Mike) Harreld
By C. B. (Mike) Harreld
Director, Chief Financial and Accounting Officer
Date: November 13, 1997