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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 December 31, 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
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 January 31, 1998
- ---------- ------------ -------------------
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 December 31,
---------------------------------------
1997 1996
---- ----
(Note F)
OPERATING REVENUES (pound) 209 $343 (pound) 242
COST OF SALES 136 223 173
------ ---- ------
GROSS MARGIN 73 120 69
------ ---- ------
OPERATING EXPENSES:
Maintenance 8 13 8
Depreciation and amortization 12 20 10
Selling, general, and administrative 15 25 12
------ ---- ------
Total operating expenses 35 58 30
------ ------ ------
Operating income 38 62 39
------ ------ ------
OTHER INCOME (EXPENSE):
Interest expense (14) (23) (13)
Other, net 2 3 1
------ ------ ------
Total other income (expense) (12) (20) (12)
------ ------ ------
INCOME BEFORE INCOME TAXES 26 42 27
INCOME TAXES:
Customary (8) (13) (11)
------ ------ ------
NET INCOME (pound) 18 $ 29 (pound) 16
====== ====== ======
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 Nine Months Ended December 31,
--------------------------------------
1997 1996
---- ----
(Note F)
OPERATING REVENUES (pound) 543 $892 (pound) 602
COST OF SALES 348 572 417
------ ----- ------
GROSS MARGIN 195 320 185
------ ----- ------
OPERATING EXPENSES:
Maintenance 25 41 26
Depreciation and amortization 35 57 32
Selling, general, and administrative 45 74 37
------ ----- ------
Total operating expenses 105 172 95
------ ----- ------
Operating income 90 148 90
------ ----- ------
OTHER INCOME (EXPENSE):
Interest expense (42) (69) (39)
Other, net 10 16 6
------ ----- ------
Total other income (expense) (32) (53) (33)
------ ----- ------
INCOME BEFORE INCOME TAXES 58 95 57
INCOME TAXES:
Customary (24) (39) (22)
Effect of change in tax rates (Note G) 22 36 -
Windfall levy (Note G) (90) (148) -
------ ----- ------
NET (LOSS) INCOME (pound) (34) $ (56) (pound) 35
====== ===== ======
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 Nine Months Ended December 31,
--------------------------------------
1997 1996
---- ----
(Note F)
NET CASH PROVIDED BY OPERATING ACTIVITIES (pound) 56 $ 92 (pound) 52
----- ----- -----
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (62) (102) (54)
Other 3 5 14
----- ----- -----
Net cash used in investing activities (59) (97) (40)
----- ----- -----
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments of dividends (59) (97) (12)
Proceeds of bond issues - - 300
Change in short-term borrowings 62 102 (318)
----- ----- -----
Net cash provided from/(used in) financing activities 3 5 (30)
----- ----- -----
NET DECREASE IN CASH AND CASH EQUIVALENTS - - (18)
CASH AND CASH EQUIVALENTS, beginning of period 3 5 20
----- ----- -----
CASH AND CASH EQUIVALENTS, end of period (pound) 3 $ 5 (pound) 2
===== ===== =====
SUPPLEMENTAL CASH FLOW DISCLOSURES:
Cash paid for interest (pound) (38) $ (63) (pound) (39)
===== ===== ======
Cash paid for income taxes:
Customary (pound) (5) $ (8) (pound) (9)
Windfall levy (Note G) (45) (74) -
----- ----- -----
Total cash paid for income taxes (pound) (50) $ (82) (pound) (9)
===== ===== =====
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
December 31, 1997 March 31,
----------------- --------
(Unaudited) 1997
----------- ----
(Note F)
PROPERTY, PLANT, AND EQUIPMENT: (pound) 1,373 $2,255 (pound) 1,312
Less accumulated depreciation 89 146 59
------ ------ ------
Property, plant, and equipment, net 1,284 2,109 1,253
------ ------ ------
OTHER ASSETS:
Investments 18 30 19
Prepaid pension cost 113 185 105
Goodwill, net of accumulated amortization of (pound)10 ($16) at
December 31 and (pound)7 at March 31 173 284 176
------ ------ ------
Total other assets 304 499 300
------ ------ ------
CURRENT ASSETS:
Cash and cash equivalents 3 5 3
Investments 17 28 18
Receivables:
Customer accounts, less provision for uncollectables of (pound)10 ($16) at
December 31 and (pound)12 at March 31 85 140 120
Other 19 31 12
------ ------ ------
Receivables, net 104 171 132
Materials and supplies 4 7 3
Prepaid expenses 17 28 12
------ ------ ------
Total current assets 145 239 168
------ ------ ------
Total assets (pound) 1,733 $2,847 (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
December 31, 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 $ 821 (pound) 500
Retained earnings (deficit) (Note B) (182) (299) (114)
------ ------ ------
Total stockholder's equity 318 522 386
------ ------ ------
COMPANY OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES OF SOUTHERN
INVESTMENTS UK CAPITAL TRUST I HOLDING COMPANY JUNIOR SUBORDINATED
DEBENTURES 50 82 50
NON-CURRENT LIABILITIES:
Long-term debt 301 495 301
Deferred income taxes 359 590 377
Provision for loss contracts (Note C) 71 116 67
Other 52 85 61
------ ------ ------
Total non-current liabilities 783 1,286 806
------ ------ ------
CURRENT LIABILITIES:
Commercial paper 45 74 250
Short-term borrowings 301 495 34
Accounts payable 46 76 46
Accrued income taxes 49 80 31
Windfall levy (Note G) 45 74 -
Unearned revenue 10 16 5
Common dividend declared - - 25
Accrued interest 11 18 9
Other 75 124 79
------ ------ ------
Total current liabilities 582 957 479
------ ------ ------
Total stockholder's equity and liabilities (pound) 1,733 $2,847 (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
December 31, 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
nine-month periods ended December 31, 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 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 Group plc provided cash in addition to that provided
from operations. The windfall levy of (pound)90 million also
contributed to this deficit.
(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 fluctuate according to
predetermined indices. The Company has recognized an accrual at the
acquisition date for the expected excess of these Teesside power purchase
costs in each year over 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)71
million at December 31, 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 December 31, 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
rate debt. At December 31, 1997, sterling interest rate swaps expiring
between 2001 and 2012 with notional amounts totalling (pound)525
million, resulted in an unrealized loss of (pound)50 million.
Immediately after the period end, SWEB entered into a further
(pound)75 million of interest rate swaps expiring in 2008.
7
SOUTHERN INVESTMENTS UK plc and SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(ii) Foreign currency swap contracts are used by the Company to hedge
exposure to US dollar liabilities in respect of outstanding debt. At
December 31, 1997, currency swaps expiring between 2001 and 2007, with
notional amounts totalling (pound)350 million, resulted in an unrealized
profit of (pound)16 million.
(iii) SWEB has contracts for differences ("CFDs") to mitigate its
exposure to volatility in the prices of electricity purchased through the
Pool. At December 31, 1997, CFDs were in place to hedge electricity
purchases on approximately 19,531 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 determine the fair value
of these contracts at present as the contract prices are based on future
events, the effects of which currently are not capable of being
determined. SWEB is currently holding discussions with third parties
concerning future energy purchases on a long-term basis.
(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) had 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. Unless the High Court decision is reversed, this
case should not impact SWEB significantly; however, 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 $1.6427 =
(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 December 31, 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 estimated its
liability to be approximately (pound)90 million. The levy is payable in
two equal installments. The first installment was paid on December 1,
1997 and the second will be paid on or before December 1, 1998.
The legislation also reduced the UK corporation tax rate from 33% to 31%
on April 1, 1997. Such a decrease resulted 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
THIRD FISCAL QUARTER 1998 vs. THIRD 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 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.
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 estimated
its liability to be approximately (pound)90 million. The budget also reduced the
UK corporation tax rate from 33% to 31%. This decrease resulted in an accounting
credit reducing SWEB's provision for deferred income taxes by approximately
(pound)22 million. Both tax items were accounted for in the second quarter
fiscal year 1998.
The remainder of this discussion is on items other than the windfall levy
and deferred income taxes.
Operating income for the third quarter and year-to-date fiscal year 1998
was (pound)38 million and (pound)90 million, respectively, compared to (pound)39
million and (pound)90 million for the corresponding periods of fiscal year 1997.
The decrease in operating income of (pound)1 million in the third quarter is due
to a decrease in the distribution business of (pound)5 million, partly offset by
an increase in the supply business of (pound)3 million and ancillary businesses
of (pound)1 million. Year-to-date operating income is constant, although there
are decreases in the distribution business of (pound)2 million and ancillary
businesses of (pound)2 million, offset by an increase in the supply business of
(pound)4 million.
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)
--------------------------------------------------------
Third Quarter Year-To-Date
--------------------------------------------------------
(in millions) % (in millions) %
Operating revenues.................................. (pound) (33) (14) (pound) (59) (10)
Cost of sales....................................... (37) (21) (69) (17)
Selling, general and administrative expense......... 3 25 8 22
Interest expense.................................... 1 8 3 8
Other income, net................................... 1 50 4 67
Income taxes - customary............................ (3) (27) 2 9
Operating revenues
Revenue decreases were primarily within the supply business where revenues
decreased by (pound)26 million for the quarter and (pound)60 million
year-to-date. This is due mainly to a reduction in the fossil fuel levy which is
passed through to customers. Revenues from ancillary businesses decreased by
(pound)9 million for the third quarter due to lower activity in the gas
retailing business due to restructuring of that business, including a teaming
arrangement with another organization effective from October 1, 1997. This will
impact the level of future operating revenues.
Cost of sales
Cost of sales primarily relate to the purchase cost of electricity. The
decrease for both periods is largely due to the decrease in the fossil fuel
levy, as mentioned above, together with lower costs in the gas retailing
business.
Selling, general and administrative expense
The increase in costs for both periods primarily reflects a provision to
restructure some of the ancillary businesses, together with a write off of
uncollectable accounts in the gas retailing business.
Interest expense
The increase in interest expense is primarily due to an increase of over 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. The increase in short term borrowings in
the quarter, due to the payment of the windfall levy, has also contributed to
the increase in interest expense.
Other income, net
The increase year-to-date reflects additional dividends from an investment
in generating plant.
Income taxes - customary
The decrease in the quarter is primarily due to a lower rate and lower
permanent differences between book and tax income.
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 82%) 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 in 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
("DPCF") 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. On July 6, 1995, the
Regulator announced the result of a distribution price review which was
precipitated by certain market events in the UK electric utility industry. For
SWEB, such announcement meant a 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 anticipated that the Regulator will undertake the next DPCF
review commencing 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 ("SPCF"), similar to the DPCF, 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.
Following the announcement by the Regulator on October 16, 1997, in
respect of its latest SPCF review for Franchise Supply Customers, effective from
April 1, 1998, SWEB plans a tariff reduction of 2.8% effective from that date,
and a further 3% (before an 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, and also a fall in the
fossil fuel levy.
12
SOUTHERN INVESTMENTS UK plc and SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
The exclusive right to supply Franchise Supply Customers (largely domestic
and small commercial) was scheduled to be phased out over a six-month period
commencing April 1, 1998, after which all supply customers would have the
ability to choose their electricity supplier. A recent announcement by the
Regulator proposes that the phasing out of the exclusive right to supply
Franchise Supply Customers should be delayed until September 1998. SWEB intends
to maintain a significant share of these customers by providing superior service
and competitive pricing. 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 beyond April 1, 1998; any penalty imposed on
SWEB is not expected to have a material impact on earnings. The supply tariffs
in fiscal years 1999 and 2000 represent maximum price restraints intended to
protect domestic and small business customers.
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 SPCF 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 SPCF 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 nine months to December 31, 1997 was
the expenditure by SWEB of approximately (pound)62 million in property, plant,
and equipment, largely in respect of the distribution network. The funds for
these additions were derived primarily from operations.
13
SOUTHERN INVESTMENTS UK plc and SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
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. The first installment of the windfall levy was funded by short
term borrowings.
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 continue to 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. If full provision for deferred income tax were
required, SWEB's distributable reserves could be eliminated.
Financing Activities
SWEB established a commercial paper program in the US, first utilized in
February 1997, to replace some short-term bank loans. The maximum available
under the program, which is fully supported by a swingline and revolving credit
facility provided by a syndicate of banks, is $520 million. The amount not
utilized at December 31, 1997 was $446 million. SWEB enters into foreign
currency contracts to hedge the currency risk associated with the interest and
principal of each utilization under this program.
SWEB actively manages its short-term debt, which includes a number of bank
lines of credit in addition to the commercial paper program. At December 31,
1997 the Company and SWEB together had short-term debt of (pound)346 million
($569 million) outstanding ($74 million from commercial paper, $140 million from
the swingline and revolving credit facility, and $355 million in other
short-term loans). The increase in short-term debt is largely due to payment of
the first installment of the windfall levy.
Interest rate swaps are used to manage risk, as discussed in Note D.
During December 1997, the Company and SWEB decided to convert a further
(pound)100 million of variable-rate debt into fixed-rate debt through the use of
such swaps. At December 31, 1997, (pound)25 million of these swaps had been
executed, and the remainder were completed in early January.
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SOUTHERN INVESTMENTS UK plc and SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
Sources of Capital
To meet short-term cash needs and contingencies, the Company and SWEB
together had at December 31, 1997 approximately (pound)3 million of cash and
(pound)110 million of unutilized committed lines of credit with banks. Also
available was $306 million of the swingline and revolving credit facility
mentioned under "Financing Activities". The Company currently has sufficient
liquidity to meet the second installment of the windfall levy, and the pension
matter, discussed in Notes G and E.
15
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits.
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15 - Report of Independent Public Accountants
27 - Financial Data Schedule
(b) Reports on Form 8-K.
--------------------
No report on Form 8-K was filed by the Company during the quarter for
which this report is being filed.
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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.
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: February 12, 1998
17