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PAGE 1 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 September 30, 1997 ------------------------------------- Commission file number 1-40 --------------------------------------------- Pacific Enterprises ---------------------------------------------------------- (Exact name of registrant as specified in its charter) California 94-0743670 - ------------------------------- ------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 555 West Fifth Street, Suite 2900, Los Angeles, California 90013-1011 - ---------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) (213) 895-5000 ---------------------------------------------------------- (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) 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 ----- ----- The number of shares of common stock outstanding on November 3, 1997 was 83,389,972. PAGE 2 PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS. PACIFIC ENTERPRISES AND SUBSIDIARY COMPANIES CONDENSED STATEMENT OF CONSOLIDATED INCOME (Dollars are in Millions except number of shares and per share amounts) (Unaudited) Three Months Ended Nine Months Ended September 30 September 30 ------------------ ----------------- 1997 1996 1997 1996 ------ ------ ------ ------ Revenues and Other Income: Utility operating revenues $599 $575 $1,901 $1,744 Other operating revenues 10 21 94 43 Other 15 4 30 16 ---- ---- ----- ----- Total 624 600 2,025 1,803 ---- ---- ----- ----- Expenses: Utility cost of gas distributed 227 185 733 548 Other cost of sales 2 11 54 23 Operating expenses 207 206 625 608 Depreciation and amortization 64 66 192 192 Franchise payments and other taxes 23 22 73 73 Preferred dividends of a subsidiary 2 1 5 6 ---- ---- ----- ----- Total 525 491 1,682 1,450 ---- ---- ----- ----- Income from Operations Before Interest and Taxes 99 109 343 353 Interest 27 25 78 76 ---- ---- ----- ----- Income from Operations Before Income Taxes 72 84 265 277 Income Taxes 35 36 121 122 ---- ---- ----- ----- Net Income 37 48 144 155 Dividends on Preferred Stock 1 1 3 4 Preferred stock original issue discount 2 ---- ---- ----- ----- Net Income Applicable to Common Stock $ 36 $ 47 $141 $149 ==== ==== ===== ===== Net Income per Share of Common Stock $.44 $.57 $1.74 $1.80 ==== ==== ===== ===== Dividends Declared per Share of Common Stock $ $ $1.12 $1.06 ==== ==== ===== ===== Weighted Average Number of Shares of Common Stock Outstanding (000) 81,142 82,758 81,112 82,618 ====== ====== ====== ====== See Notes to Condensed Consolidated Financial Statements. PAGE 3 PACIFIC ENTERPRISES AND SUBSIDIARY COMPANIES CONDENSED CONSOLIDATED BALANCE SHEET ASSETS (Millions of Dollars) (Unaudited) September 30 December 31 1997 1996 ------------ ----------- Current Assets: Cash and cash equivalents $ 279 $ 256 Accounts receivable (less allowance for doubtful receivables of $19 million at September 30, 1997 and December 31, 1996) 314 481 Income taxes receivable 25 58 Deferred income taxes 4 9 Gas in storage 54 28 Other inventories 15 22 Regulatory accounts receivable 434 285 Prepaid expenses 21 22 ------ ------ Total current assets 1,146 1,161 ------ ------ Property, Plant and Equipment 6,109 6,080 Less Accumulated Depreciation and Amortization 2,946 2,843 ------ ------ Total property, plant and equipment-net 3,163 3,237 ------ ------ Deferred Charges and Other Assets: Other Investments 84 115 Other Receivables 43 16 Regulatory Assets 455 552 Other Assets 99 105 ------ ------ Total deferred charges and other assets 681 788 ------ ------ Total $4,990 $5,186 ====== ====== See Notes to Condensed Consolidated Financial Statements. PAGE 4 PACIFIC ENTERPRISES AND SUBSIDIARY COMPANIES CONDENSED CONSOLIDATED BALANCE SHEET LIABILITIES AND SHAREHOLDERS' EQUITY (Millions of Dollars) (Unaudited) September 30 December 31 1997 1996 ------------ ----------- Current Liabilities: Short-term debt $ 281 $ 262 Accounts payable 465 577 Other taxes payable 31 29 Long-term debt due within one year 274 149 Accrued interest 32 41 Other 76 80 ------- ------ Total current liabilities 1,159 1,138 ------- ------ Long-term debt 886 1,095 Debt of Employee Stock Ownership Plan 130 130 ------- ------ Total long-term debt 1,016 1,225 ------- ------ Deferred Credits and Other Liabilities: Long-Term Liabilities 189 166 Customer Advances for Construction 37 42 Postretirement Benefits Other than Pensions 222 224 Deferred Income Taxes 311 321 Deferred Investment Tax Credits 62 64 Other Deferred Credits 436 471 ------- ------ Total deferred credits and other liabilities 1,257 1,288 ------- ------ Preferred stocks of a subsidiary 95 95 ------- ------ Shareholders' equity: Capital stock: Preferred 80 80 Common 1,064 1,095 ------- ------ Total capital stock 1,144 1,175 Retained earnings, after elimination of accumulated deficit of $452 million against common stock at December 31, 1992 as part of quasi-reorganization 366 314 Deferred compensation relating to Employee Stock Ownership Plan (47) (49) ------- ------ Total shareholders' equity 1,463 1,440 ------- ------ Total $4,990 $5,186 ======= ====== See Notes to Condensed Consolidated Financial Statements. PAGE 5 PACIFIC ENTERPRISES AND SUBSIDIARY COMPANIES CONDENSED STATEMENT OF CONSOLIDATED CASH FLOWS (Millions of Dollars) (Unaudited) Nine Months Ended September 30 ------------------ 1997 1996 ------ ----- Cash Flows from Operating Activities: Net Income $ 144 $ 155 Adjustments to reconcile net income to net cash provided by continuing operations: Depreciation and amortization 192 192 Deferred income taxes (11) 7 Other 4 (34) Net change in other working capital components 1 175 ----- ----- Net cash provided by operating activities 330 495 ----- ----- Cash Flows from Investing Activities: Expenditures for property, plant and equipment (126) (127) Decrease (increase) in other investments 31 (55) Decrease (increase) in other receivables, regulatory assets and other assets (1) 4 ----- ----- Net cash used in investing activities (96) (178) ----- ----- Cash Flows from Financing Activities: Sale of common stock 11 6 Repurchase of common stock (42) Redemption of preferred stock (208) Decrease in long-term debt (101) (151) Increase (decrease) in short-term debt 19 (41) Common dividends paid (95) (88) Preferred dividends paid (3) (6) ----- ----- Net cash used in financing activities (211) (488) ----- ----- Increase (decrease) in Cash and Cash Equivalents 23 (171) Cash and Cash Equivalents, January 1 256 351 ----- ----- Cash and Cash Equivalents, September 30 $ 279 $ 180 ===== ===== Supplemental Disclosure of Cash Flow Information: Cash paid during the period for: Interest (net of amount capitalized) $ 87 $ 75 ===== ===== Income taxes $ 76 $ 116 ===== ===== See Notes to Condensed Consolidated Financial Statements. PAGE 6 PACIFIC ENTERPRISES AND SUBSIDIARY COMPANIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. MERGER AGREEMENT WITH ENOVA CORPORATION On October 14, 1996, Pacific Enterprises (the Company or PE) and Enova Corporation (Enova), the parent company of San Diego Gas & Electric (SDG&E), announced an agreement, which both Boards of Directors unanimously approved, for the combination of the two companies, tax-free, in a strategic merger of equals to be accounted for as a pooling of interests. The combination was approved by the shareholders of both companies on March 11, 1997. Shareholder votes in favor of the combination totaled 79% of the outstanding shares of PE and 76% for Enova (99% and 96% of total votes cast for PE and Enova, respectively). Completion of the combination remains subject to approval by regulatory and governmental agencies. As a result of the combination, the Company and Enova will become subsidiaries of a new holding company and their common shareholders will become common shareholders of the new holding company. The Company's common shareholders will receive 1.5038 shares of the new holding company's common stock for each of their shares of PE common stock, and Enova common shareholders will receive one share of the new holding company's common stock for each of their shares of Enova common stock. Preferred stock of the Company, Southern California Gas Company (SoCalGas or the Gas Company), and SDG&E will remain outstanding. The merger is subject to approval by certain governmental and regulatory agencies including the California Public Utility Commission (CPUC), the Federal Energy Regulatory Commission (FERC) (See FERC update below), the Securities and Exchange Commission, the Nuclear Regulatory Commission (NRC) (See NRC update below), and the Department of Justice. All remaining regulatory approvals and the commencement of combined operations are expected by the summer of 1998. In March 1997, the Company and Enova formed a joint venture (Energy Pacific) to provide integrated energy and energy related products and services. This new joint venture incorporates several existing unregulated businesses from each company. It is pursuing a variety of opportunities, including buying and selling natural gas for large users, integrated energy management PAGE 7 services targeted at large governmental and commercial facilities and consumer market products and services such as earthquake shutoff valves. On June 25, 1997, the FERC conditionally approved the proposed business combination subject to the filing of appropriate standards of conduct and the adoption by the CPUC of satisfactory rules primarily relating to affiliate transactions. On August 7, 1997, PE and Enova announced an agreement to jointly acquire AIG Trading Corporation, a natural gas and power marketing firm. Headquartered in Greenwich, Connecticut, AIG Trading Corporation is a subsidiary of AIG Trading Group Inc. Its business primarily focuses on wholesale trading and marketing of natural gas, power and oil. Total cost of the acquisition is approximately $225 million consisting of an acquisition price of $190 million and commitments of up to $35 million for certain long-term incentive compensation and retention arrangements. The acquisition is expected to be completed by the end of 1997. In October, the NRC approved the merger subject to two conditions relating to monitoring and oversight. The NRC oversees SDG&E's license to own the San Onofre Nuclear Generating Station of which SDG&E owns 20%. A total of $13 million, after-tax (16 cents per share), of expenses have been incurred in connection with the merger, of which $6 million (7 cents per share) was charged to income in the third quarter of 1997. These costs consist primarily of investment banking, legal, regulatory and consulting fees, and $4 million related to the merger related sale of small power plants. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The accompanying condensed consolidated financial statements have been prepared in accordance with the interim period reporting requirements of Form 10-Q. Reference is made to the Company's Annual Report on Form 10-K for the year ended December 31, 1996 for additional information. Results of operations for interim periods are not necessarily indicative of results for the entire year. In order to match revenues and costs for interim reporting purposes, SoCalGas defers revenue related to costs which are expected to be incurred later in the year. In the opinion of management, the accompanying statements reflect all adjustments which are necessary for a fair presentation. These adjustments are of a normal recurring nature. Certain changes in account classification have been made in the prior years' consolidated financial statements to conform to the 1997 financial statement presentation. Income tax expense recognized in a period is the amount of tax currently payable plus or minus the change in the aggregate deferred tax assets and Page 8 liabilities. Deferred taxes are recorded to recognize the future tax consequences of events that have been recognized in the financial statements or tax returns. Estimated liabilities for environmental remediation are recorded when the amounts are probable and estimable. Amounts authorized to be recovered in rates are recorded as regulatory assets. Possible recoveries of environmental remediation liabilities from third parties are not deducted from the liability shown on the balance sheet. 3. CONTINGENT LIABILITIES QUASI-REORGANIZATION. During 1993, the Company completed a strategic plan to refocus on utility and related businesses. The strategy included the divestiture of the Company's retailing operations and all of its oil and gas exploration and production business. In connection with the divestitures, the Company effected a quasi- reorganization for financial reporting purposes effective December 31, 1992. Certain of the liabilities established in connection with discontinued operations and the quasi-reorganization will be resolved in future years. As of September 30, 1997, the provisions previously established for these matters are adequate. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with the Condensed Consolidated Financial Statements contained in this Quarterly Report on Form 10-Q and Management's Discussion and Analysis contained in the Company's 1996 Annual Report to Shareholders and incorporated into the Company's Annual Report on Form 10-K for the year ended December 31, 1996. INFORMATION REGARDING FORWARD-LOOKING COMMENTS The following discussion includes forward-looking statements with respect to matters inherently involving various risks and uncertainties. These statements are identified by the words "estimates", "expects", "anticipates", "plans", "believes" and similar expressions. The analyses employed to develop these statements are necessarily based upon various assumptions involving judgments with respect to the future including, among others, national, regional and local economic, competitive conditions, regulatory and business trends and decisions, technological developments, inflation rates, weather conditions, and other uncertainties, all of which are difficult to predict and many of which are beyond the control of the Page 9 Company. Accordingly, while the Company believes that the assumptions upon which the forward-looking statements are based, are reasonable for purposes of making these statements, there can be no assurance that these assumptions will approximate actual experience or that the expectations set forth in the forward-looking statements derived from these assumptions will be realized. CONSOLIDATED Net income for the three months ended September 30, 1997 was $37 million, or $.44 per common share, compared to $48 million, or $.57 per common share in 1996. Net income for the nine months ended September 30, 1997 was $144 million, or $1.74 per common share, compared to $155 million, or $1.80 per common share, in 1996. Consolidated earnings continue to reflect the positive results of the Company's primary subsidiary, SoCalGas (See SoCalGas Operations). Lower earnings on a consolidated basis are primarily due to non- recurring charges related to the merger with Enova Corporation. The weighted average number of shares of common stock outstanding for the third quarter of 1997 decreased to 81.1 million shares compared with 82.8 million shares for the third quarter of 1996. As of September 30, 1997, 2.2 million shares had been repurchased under a stock repurchase program authorizing the purchase of up to 4.25 million shares which began in the fourth quarter of 1996. No repurchases under this program were made in the third quarter. Page 10 A more detailed discussion of current period results can be found in the business segment information that follows. OPERATING REVENUES Three Months Ended Nine Months Ended ($ in Millions) September 30 September 30 1997 1996 1997 1996 ----------------- ------------------ SoCalGas $607 $575 $1,920 $1,692 Energy Mgmt. Svcs 64 64 267 160 International and Other (1) 3 4 7 55 ----------------- ------------------ 674 643 2,194 1,907 Less: Intersegment 65 47 199 120 ----------------- ------------------ $609 $596 $1,995 $1,787 ================= ================== NET INCOME Three Months Ended Nine Months Ended ($ in Millions) September 30 September 30 1997 1996 1997 1996 ------------------ ----------------- SoCalGas $54 $51 $ 182 $136 Energy Mgmt. Svcs (2) 2 (3) 3 International & Other (1) (15) (5) (35) 16 ------------------ ----------------- $37 $48 $ 144 $ 155 ================== ================= (1) Includes PE Corporate SOCALGAS OPERATIONS Net income for the third quarter of 1997 was $54 million compared to $51 million for the same period in 1996. Net income for the nine months ended September 30, 1997 was $182 million compared to $136 million for the same period in 1996. The increase in the third quarter of 1997 from the third quarter of 1996 is primarily due to increased throughput and revenue from Utility Electric Generation (UEG) customers as a result of increased demand for electricity, and an increase in the common equity component of SoCalGas' capital structure to 48% from 47.4%. The increase in net income for the quarter was partially offset by the two-month impact of the net reduction in annual base margin of $160 million effective August 1, 1997, resulting from SoCalGas' Performance Based Regulation (PBR) decision (See discussion below under Regulatory Activity Influencing Future Performance). The increase in net income for the nine months ended September 30, 1997 as compared to the same period of 1996, is primarily due to a reduction to earnings during the second quarter of 1996 due to a one-time non-cash $26.6 million charge, after-tax related to the Comprehensive Settlement of excess gas costs and other regulatory matters which did not affect consolidated Pacific Enterprises results. The reduction in net income for the period was partially offset by favorable litigation settlements totaling $13.6 million, after-tax. Also contributing to the increase in net income was increased Page 11 throughput to UEG customers as a result of increased demand for electricity. The remaining increase in net income for the nine months ended September 30, 1997 is due to savings resulting from lower operating and maintenance expenses than amounts authorized in rates until the PBR decision went into effect on August 1, 1997, and an increase in the common equity component of SoCalGas' capital structure to 48% from 47.4%. The table below compares SoCalGas' throughput and revenues by customer class for the three months ended September 30, 1997 and 1996. ($ in Millions, Gas Sales Trans. & Exchg. Total vol. in billion cubic feet) Throughput Revenue Throughput Revenue Throughput Revenue 1997: Residential 36 $294 1 $ 3 37 $297 Comm'l/Ind'l. 16 89 78 67 94 156 Utility Elec. 72 33 72 33 Wholesale 34 17 34 17 Exchange 2 0 2 0 ------------------------------------------------------------- Total in Rates 52 $383 187 $120 239 503 Balancing Accts. & Other 104 ----- Total Operating Rev. $607* ===== 1996: Residential 35 $266 1 $ 3 36 $269 Comm'l/Ind'l. 17 93 73 62 90 155 Utility Elec. 64 30 64 30 Wholesale 32 16 32 16 Exchange 2 2 ------------------------------------------------------------- Total in Rates 52 $359 172 $111 224 $470 Balancing Accts. & Other 105 ------ Total Operating Rev. $575* ====== * Includes inter-segment transactions Page 12 SoCalGas' operating revenue for the three and nine months ended September 30, 1997, increased $32 million and $228 million, respectively when compared to the same periods in 1996. The increase in operating revenue is due to increased throughput to UEG customers due to increased demand for electricity and higher gas costs to core customers. SoCalGas also recorded a non-cash charge recorded in the second quarter of 1996 of $47.7 million, $26.6 million after-tax, related to a previous accounting estimate for a Comprehensive Settlement between the Gas Company and the CPUC in 1993. The increase is partially offset by $14.3 million ($8.0 million after-tax), of favorable litigation settlements relating to environmental insurance claims received in 1996. Operating revenues also increased due to an increase in the authorized common equity component of SoCalGas' capital structure on which SoCalGas earns a return. Cost of gas distributed was $236 million and $200 million for the three months ended September 30, 1997 and 1996 respectively. The increase is primarily due to an increase in the average cost of gas purchased to $2.52 per thousand cubic feet (MCF) for the third quarter of 1997 compared to $1.78 per MCF for the third quarter of 1996. For the nine months ended September 30, 1997 and 1996, the cost of gas distributed was $752 million and $594 million respectively. The increase is primarily due to an increase in the average cost of gas purchased to $2.46 per thousand cubic feet (MCF) for the nine months ended September 30, 1997 compared to $1.56 per MCF for the same period in 1996. Under the current regulatory framework and under PBR which takes effect on January 1, 1998, changes in revenue resulting from changes in volumes in the core market and cost of gas do not affect net income. Operating and maintenance expenses for the three months and nine months ended September 30, 1997, decreased $2.3 million and $3.1 million, respectively, compared to the same periods in 1996. The decrease for the three month and nine month periods ended September 30, 1997, is primarily due to SoCalGas' continued efforts to reduce costs. RECENT CPUC REGULATORY ACTIVITY The merger with Enova Corporation is subject to approval by certain governmental and regulatory agencies. All remaining regulatory approvals and the commencement of combined operations are expected by the summer of 1998. Earnings of the combined company could be negatively impacted in 1998, and to a lesser extent in subsequent years by delays in achieving cost savings from the combination caused by the later-than-expected effective combination date, the possibility that the CPUC might reduce the period or percentage for shareholder participation in the related cost savings, and slower-than- anticipated growth in revenues from Energy Pacific. On October 31, 1997, the CPUC issued the Administrative Law Judge's draft decision on guidelines for transactions between utilities and their non- utility affiliates. If the final decision of the CPUC were to be substantially the same as the draft decision, it would limit the ability of Page 13 SoCalGas and other California energy utilities to operate as integrated units with their non-utility affiliates by, among other things, restricting the sharing of information and facilities, which would reduce opportunities for synergies and impact marketing opportunities for the affiliates. In addition, an alternate draft decision sponsored by two of the CPUC's five commissioners would prohibit affiliates of San Diego Gas & Electric and those of other electric utilities from providing direct access electricity services within their affiliated electric utility's service territory for two years, and contains additional restrictions. REGULATORY ACTIVITY INFLUENCING FUTURE PERFORMANCE Future regulatory and gas industry restructuring, increased competitiveness in the industry and the electric industry restructuring will affect SoCalGas' future performance. On July 16, 1997, the CPUC issued its final decision on SoCalGas' Performance Based Regulation (PBR) application. Key elements of the PBR decision include a $160 million net reduction in annual base rates, an indexing mechanism that limits future rate increases to the inflation rate less a productivity factor, a sharing mechanism with customers if earnings exceed the authorized rate of return on ratebase, and rate refunds to customers if service quality deteriorates. These elements become effective on January 1, 1998. The net reduction in SoCalGas' base margin of $160 million became effective August 1, 1997. For a detailed discussion of the CPUC's decision, please refer to the Company's Report on Form 8-K filed on July 16, 1997, and second quarter 1997 Form 10-Q. It is the intent of management to control operating expenses and investment within the amounts authorized to be collected in rates in this PBR decision. SoCalGas intends to make the efficiency improvements, changes in operations and cost reductions necessary to achieve this objective and earn its authorized rate of return. However, in view of the earnings sharing mechanism and other elements of PBR authorized by the CPUC, it will be more difficult for SoCalGas to achieve the level of returns in excess of authorized returns it has recently experienced. Management believes that under the new PBR regulatory framework, the Company continues to meet the criteria of Statement of Financial Accounting Standards No. 71, "Accounting for the Effects of Certain Types of Regulation." For 1997, SoCalGas is authorized to earn a rate of return on common equity of 11.6 percent and a 9.49 percent return on rate base, compared to 11.6 percent and 9.42 percent, respectively, in 1996. The CPUC also authorized a 60 basis point increase in SoCalGas' authorized common equity ratio to 48.0 percent in 1997 compared to 47.4 percent in 1996. The 60 basis point increase in the common equity component could potentially add $2 million to earnings in 1997. Page 14 ENERGY MANAGEMENT SERVICES Energy Management Services (EMS) consists of a number of operations including an interstate pipeline subsidiary, a subsidiary which operates centralized heating and cooling plants, an unregulated subsidiary which markets natural gas, and a subsidiary which provides energy products and services. In September 1997, the Company sold its small electric generation plants which comprised much of Pacific Energy (PEn) to Ogden Corporation. Under the Public Utility Regulatory Policies Act, the Company was required to cause its ownership in these facilities (together with that of all other electric utilities or utility holding companies) to be not more than 50% prior to the completion of the combination. Prior to their sale in the third quarter of 1997, PEn developed and operated alternate energy facilities including geothermal, hydro-power, biogas and woodburning plants. EMS continues to operate centralized heating and cooling plants for large building complexes. Ensource, which was established in 1996, buys and arranges transportation, storage and delivery of natural gas for large-volume customers. Currently most of the operations of Ensource are being curtailed and its functions will be assumed by AIG after the acquisition has been completed. Pacific Enterprises Energy Services (PEES), which also was established in 1996, provides energy related products and services to both commercial and residential customers. Pacific Interstate Company (PIC), which is regulated by the FERC, purchases gas from producers in Canada and from federal waters offshore California and transports it for sale to SoCalGas and others. Pacific Enterprises Energy Management Services (PEEMS) is the holding company of all the EMS operating units. EMS' operating revenue was $64 million for the third quarter of 1997 representing no change from the third quarter of 1996. EMS' operating revenue was $267 million for the nine months ended September 30, 1997, compared to operating revenue of $160 million for the same period in 1996. The increase for the nine months ended September 30, 1997, is primarily from operating revenues at Ensource as operations began in the second quarter of 1996. EMS also experienced increased operating revenues from PIC due to increased off-system sales partially offset by lost revenues from the PEn plants which were sold during the third quarter of 1997. EMS had a net loss of $2.2 million for the third quarter of 1997, compared to net income of $1.6 million for the third quarter of 1996. EMS had a net loss of $2.8 million for the nine month period ended September 30, 1997, compared with net income of $3.2 million for the same period of 1996. The decline in 1997 as compared with 1996 is primarily due to start-up costs and increased operating expenses incurred by PEES during the first nine months of 1997, as well as the loss of revenues from PEn plants during the third quarter of 1997 due to the sale of those facilities. These items were partially offset by higher earnings resulting from increased production from PEn plants during the first six months of 1997 and increased sales by PIC. Page 15 In March 1997, PE and Enova launched a new joint venture, Energy Pacific. This new joint venture incorporated several existing unregulated businesses from each company. Energy Pacific is pursuing a variety of opportunities, including buying and selling natural gas for large users, integrated energy management services targeted at large governmental and commercial facilities and consumer market products and services such as earthquake shutoff valves. The Company has contributed PEES, Ensource, Pacific Enterprises Liquefied Natural Gas (LNG), Energy Alliance I, PEEMS and Pacific Enterprises Leasing Co. to the joint venture. This contribution of assets was matched with contributions made by Enova Corporation. Due to the start-up nature of the joint venture, it is expected to continue incurring losses through 1998. INTERNATIONAL OPERATIONS Pacific Enterprises International (PEI) incurred a net loss of $2.5 million for the third quarter of 1997 compared to a net loss of $1.7 million for the same period of 1996. For the nine months ended September 30, 1997, PEI realized a net loss of $5.3 million compared to a net loss of $2.7 million for the same period of 1996. The increase in net loss for the nine month period is primarily due to increased expenditures for project costs related to bids for various international gas systems. During the third quarter of 1996, DGN was awarded a license to build and operate a natural gas distribution system in Mexicali, Baja California. DGN will provide service to more than 25,000 commercial, industrial and residential users. During the second quarter of 1997, construction of the border pipeline crossing for the Mexicali system was completed. In August, the system began distributing 5 to 7 million cubic feet per of natural gas day primarily to commercial customers in Mexicali. PEI is not expected to be profitable through 1998. PARENT COMPANY Parent company and interest expense, excluding merger related expenses, for the three months ended September 30, 1997 was $7.4 million, after tax, compared to $3.5 million, after tax, for the same period of 1996. For the nine months ended September 30, 1997, Parent company and interest expense were $20.6 million compared to $9.9 million in 1996. For the nine months ended September 30, 1997, the parent incurred $3.6 million, after-tax, of employee labor charges relating to the merger. For the same period the Parent also incurred $2 million, after-tax, in stock option expenses compared to $1.7 million in 1996. This increase is due to the Company's higher stock price in 1997 than in 1996. Parent expenses for the nine months ended September 30, 1997, also include stock appreciation rights charged to subsidiaries throughout 1996. The expenses will be charged to subsidiaries during the fourth quarter of 1997, thereby eliminating the increase from 1996. Page 16 The Parent incurred merger related expenses of $6 million, after tax, and $13 million, after tax, for the three and nine months ended September 30, 1997, respectively. CAPITAL RESOURCES AND LIQUIDITY Net Cash provided by operating activities was $330 million for the nine months ended September 30, 1997. This represents a decrease of $165 million from 1996. The decrease is primarily due to lower collections of regulatory accounts receivable in 1997 compared to 1996, partially offset by collection of taxes receivable. Capital expenditures were $126 million for the nine months ended September 30, 1997 which is a decrease of $1 million from 1996. This decrease is primarily due to a reduction in capital expenditures of $13 million at SoCalGas partially offset by increased capital expenditures of $11 million at Pacific Interstate for plant expansions. Cash flows used in financing activities were $211 million for the nine months ended September 30, 1997. This primarily represents repayment of commercial paper of $80 million, repurchase of common stock of $42 million, and dividend payments of $98 million. On October 23, 1997, SoCalGas issued $120 million 4-year medium-term notes at a fixed rate of 6.38%. Proceeds from the notes will be used to refinance debt maturities. Cash and cash equivalents at September 30, 1997 was $279 million consolidated, of which $248 million was at the Parent. This cash is available for investment in new energy-related domestic and international projects, repurchase of common and preferred stock, the retirement of debt and other corporate purposes. For the nine months ended September 30, 1997, the Company paid dividends of $95 million on common stock and $3 million on preferred stock for a total of $98 million. This compares to $88 million on common stock and $6 million on preferred stock for the same period in 1996. The common stock dividend increase in 1997 is due to the increase in the quarterly common stock dividend rate from $.36 per share in 1996 to $.38 per share in the second quarter of 1997 partially offset by lower preferred stock dividends resulting from the redemption of preferred stock. During the first quarter of 1996, the Company redeemed $110 million of Parent Remarketed, Series A preferred stocks and $50 million of SoCalGas Series A Flexible Auction preferred stock. In connection with the redemption of the Remarketed preferred stock, the Company recorded a $2.4 million non-recurring reduction to earnings per share to reflect the original issues underwriting discount. Page 17 In April 1996, the Board of Directors authorized the buyback of up to 4.25 million shares of PE's common stock representing approximately 5% of outstanding shares over a two-year period. During the third quarter of 1997, PE did not repurchase any shares of common stock. Since inception of the Repurchase program, the Company has repurchased a total of 2.2 million shares at a total cost of $66 million. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (b) Reports on Form 8-K filed during the quarter ended September 30, 1997. Other events - July 9, 1997 Other events - July 16, 1997 SIGNATURE 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. PACIFIC ENTERPRISES - ------------------- (Registrant) - ----------------------------- Ralph Todaro Vice President and Controller (Chief Accounting Officer and duly authorized signatory) Date: November 5, 1997