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SECURITIES AND EXCHANGE COMMISSION  Form 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934 For Quarter Ended June 30, 2004 Commission File No. 0-29604 ENERGYSOUTH, INC.   Alabama
    
    58-2358943(State or other jurisdiction of
    
    (I.R.S. Employerincorporation or organization)
    
    Identification No.)2828 Dauphin Street, Mobile,
Alabama
    
    36606(Address of principal executive office)
    
    (Zip Code)
 Registrants telephone number, including area code 251-450-4774 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 o Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes x No o Indicate the number of shares outstanding of each of the issuers classes of
common stock, as of the latest practicable date. Common stock ($.01 par value) outstanding at August 2, 2004  5,210,529 shares.




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ENERGYSOUTH, INC.
FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 2004 INDEX Page No.PART I: FINANCIAL INFORMATIONItem 1 Financial Statements:(a) Unaudited Condensed Consolidated Balance Sheets June 30, 2004 and 2003 and September 30, 2003
    
    
    3 - 4(b) Unaudited Condensed Consolidated Statements of Income Three and Nine Months Ended June 30, 2004 and 2003
    
    
    5(c) Unaudited Condensed Consolidated Statements of Cash Flows Nine Months Ended June 30, 2004 and 2003
    
    
    6(d) Notes to Unaudited Condensed Consolidated Financial Statements
    
    
    7 - 17Item 2 Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    18 - 24Item 3 Quantitative and Qualitative Disclosures About Market Risk
    
    
    27Item 4 Controls and Procedures
    
    
    27PART II: OTHER INFORMATIONItem 6 Exhibits and Reports on Form 8-K
    
    
    28 - 32Certification Pursuant to Section 302Certification Pursuant to Section 302Certification Pursuant to Section 906Certification Pursuant to Section 906
  2




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PART 1. FINANCIAL INFORMATION 
 ITEM 1: FINANCIAL STATEMENTS
 
 UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS EnergySouth, Inc.
    
    June 30,
    
    September 30,In Thousands
    
    2004
    
    2003
    
    2003ASSETSCurrent AssetsCash and Cash Equivalents
    
    $
    10,739
    
    
    $
    5,766
    
    
    $
    4,082ReceivablesGas
    
    
    7,671
    
    
    
    7,422
    
    
    
    6,652Unbilled Revenue
    
    
    1,630
    
    
    
    1,540
    
    
    
    1,335Merchandise
    
    
    2,281
    
    
    
    2,455
    
    
    
    2,313Other
    
    
    1,011
    
    
    
    701
    
    
    
    939Allowance for Doubtful Accounts
    
    
    (1,889
    )
    
    
    (1,599
    )
    
    
    (889
    )Materials, Supplies, and Merchandise, Net (At Average Cost)
    
    
    1,229
    
    
    
    1,259
    
    
    
    1,457Gas Stored Underground (At Average Cost)
    
    
    3,330
    
    
    
    1,757
    
    
    
    3,703Regulatory Assets (Note 5)
    
    
    2,895
    
    
    
    2,051
    
    
    
    2,945Deferred Income Taxes
    
    
    766
    
    
    
    1,068
    
    
    
    406Prepayments
    
    
    1,165
    
    
    
    1,031
    
    
    
    1,166Total Current Assets
    
    
    30,828
    
    
    
    23,451
    
    
    
    24,109Property, Plant, and Equipment
    
    
    272,625
    
    
    
    263,116
    
    
    
    267,047Less: Accumulated Depreciation and Amortization
    
    
    68,678
    
    
    
    62,147
    
    
    
    63,063Property, Plant, and Equipment  Net
    
    
    203,947
    
    
    
    200,969
    
    
    
    203,984Construction Work in Progress
    
    
    201
    
    
    
    1,701
    
    
    
    1,208Total Property, Plant, and Equipment
    
    
    204,148
    
    
    
    202,670
    
    
    
    205,192Other AssetsPrepaid Pension Cost
    
    
    1,068
    
    
    
    712
    
    
    
    856Deferred Charges
    
    
    560
    
    
    
    494
    
    
    
    569Prepayments
    
    
    972
    
    
    
    1,029
    
    
    
    1,015Regulatory Assets (Note 5)
    
    
    742
    
    
    
    1,101
    
    
    
    996Merchandise Receivables Due After One Year
    
    
    3,421
    
    
    
    4,005
    
    
    
    3,774Total Other Assets
    
    
    6,763
    
    
    
    7,341
    
    
    
    7,210Total
    
    $
    241,739
    
    
    $
    233,462
    
    
    $
    236,511
 See Accompanying Notes to Unaudited Condensed Consolidated Financial Statements 3




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UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS EnergySouth, Inc.
    
    June 30,
    
    September 30,In Thousands, Except Share Data
    
    2004
    
    2003
    
    2003LIABILITIES AND CAPITALIZATIONCurrent LiabilitiesCurrent Maturities of Long-Term Debt
    
    $
    6,208
    
    
    $
    4,668
    
    
    $
    6,006Notes Payable
    
    
    
    
    
    
    
    
    
    
    250Accounts Payable
    
    
    5,224
    
    
    
    4,674
    
    
    
    6,389Dividends Declared
    
    
    1,562
    
    
    
    1,454
    
    
    
    1,463Customer Deposits
    
    
    1,469
    
    
    
    1,417
    
    
    
    1,469Taxes Accrued
    
    
    5,845
    
    
    
    4,311
    
    
    
    3,500Interest Accrued
    
    
    521
    
    
    
    578
    
    
    
    1,272Regulatory Liabilities (Note 5)
    
    
    895
    
    
    
    1,061
    
    
    
    909Other
    
    
    986
    
    
    
    1,159
    
    
    
    1,012Total Current Liabilities
    
    
    22,710
    
    
    
    19,322
    
    
    
    22,270Other LiabilitiesAccrued Postretirement Benefit Cost
    
    
    337
    
    
    
    474
    
    
    
    415Deferred Income Taxes
    
    
    20,919
    
    
    
    17,228
    
    
    
    18,484Deferred Investment Tax Credits
    
    
    275
    
    
    
    296
    
    
    
    288Regulatory Liabilities (Note 5)
    
    
    11,603
    
    
    
    10,816
    
    
    
    10,998Other
    
    
    1,558
    
    
    
    2,535
    
    
    
    2,619Total Other Liabilities
    
    
    34,692
    
    
    
    31,349
    
    
    
    32,804Total Liabilities
    
    
    57,402
    
    
    
    50,671
    
    
    
    55,074CapitalizationStockholders EquityCommon Stock, $.01 Par Value
(Authorized 10,000,000 Shares; Outstanding
June 2004 - 5,207,000;
June 2003 - 5,105,000;
September 2003 - 5,133,000 Shares)
    
    
    52
    
    
    
    51
    
    
    
    51Capital in Excess of Par Value
    
    
    25,844
    
    
    
    22,761
    
    
    
    23,490Grantor Trust, at cost (37,113 shares at June 30, 2004) (Note 7)
    
    
    (1,315
    )Deferred Compensation Liability (Note 7)
    
    
    1,315Retained Earnings
    
    
    68,368
    
    
    
    61,360
    
    
    
    61,114Total Stockholders Equity
    
    
    94,264
    
    
    
    84,172
    
    
    
    84,655Minority Interest
    
    
    4,592
    
    
    
    4,000
    
    
    
    4,142Long-Term Debt
    
    
    85,481
    
    
    
    94,619
    
    
    
    92,640Total Capitalization
    
    
    184,337
    
    
    
    182,791
    
    
    
    181,437Total
    
    $
    241,739
    
    
    $
    233,462
    
    
    $
    236,511
 See Accompanying Notes to Unaudited Condensed Consolidated Financial Statements 4




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UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF INCOME Three Months
    
    Nine MonthsEnded June 30,
    
    Ended June 30,In Thousands, Except Per Share Data
    
    2004
    
    2003
    
    2004
    
    2003Operating RevenuesGas Revenues
    
    $
    20,003
    
    
    $
    19,605
    
    
    $
    93,093
    
    
    $
    78,415Merchandise Sales
    
    
    663
    
    
    
    709
    
    
    
    2,382
    
    
    
    2,549Other
    
    
    330
    
    
    
    269
    
    
    
    1,083
    
    
    
    930Total Operating Revenues
    
    
    20,996
    
    
    
    20,583
    
    
    
    96,558
    
    
    
    81,894Operating ExpensesCost of Gas
    
    
    6,098
    
    
    
    5,855
    
    
    
    35,859
    
    
    
    26,632Cost of Merchandise
    
    
    522
    
    
    
    586
    
    
    
    1,872
    
    
    
    1,940Operations and Maintenance
    
    
    6,040
    
    
    
    6,414
    
    
    
    19,386
    
    
    
    19,002Depreciation
    
    
    2,439
    
    
    
    2,291
    
    
    
    7,308
    
    
    
    6,855Taxes, Other Than Income Taxes
    
    
    1,694
    
    
    
    1,601
    
    
    
    6,744
    
    
    
    5,929Total Operating Expenses
    
    
    16,793
    
    
    
    16,747
    
    
    
    71,169
    
    
    
    60,358Operating Income
    
    
    4,203
    
    
    
    3,836
    
    
    
    25,389
    
    
    
    21,536Other Income and (Expense)Interest Expense
    
    
    (1,958
    )
    
    
    (2,109
    )
    
    
    (5,979
    )
    
    
    (6,260
    )Allowance for Borrowed Funds Used During Construction
    
    
    4
    
    
    
    14
    
    
    
    16
    
    
    
    1,142Interest Income
    
    
    21
    
    
    
    18
    
    
    
    35
    
    
    
    56Minority Interest
    
    
    (188
    )
    
    
    (177
    )
    
    
    (583
    )
    
    
    (563
    )Total Other Income (Expense)
    
    
    (2,121
    )
    
    
    (2,254
    )
    
    
    (6,511
    )
    
    
    (5,625
    )Income Before Income Taxes
    
    
    2,082
    
    
    
    1,582
    
    
    
    18,878
    
    
    
    15,911Income Taxes
    
    
    784
    
    
    
    596
    
    
    
    7,139
    
    
    
    5,992Net Income
    
    $
    1,298
    
    
    $
    986
    
    
    $
    11,739
    
    
    $
    9,919Earnings Per ShareBasic
    
    $
    0.25
    
    
    $
    0.19
    
    
    $
    2.27
    
    
    $
    1.96Diluted
    
    $
    0.25
    
    
    $
    0.19
    
    
    $
    2.25
    
    
    $
    1.94Average Common Shares OutstandingBasic
    
    
    5,202
    
    
    
    5,080
    
    
    
    5,163
    
    
    
    5,058Diluted
    
    
    5,264
    
    
    
    5,133
    
    
    
    5,225
    
    
    
    5,116
 See Accompanying Notes to Unaudited Condensed Consolidated Financial Statements 5




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UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS Nine MonthsEnergySouth, Inc.
    
    Ended June 30,In Thousands
    
    2004
    
    2003Cash Flows from Operating ActivitiesNet Income
    
    $
    11,739
    
    
    $
    9,919Adjustments to Reconcile Net Income to Net Cash
Provided by Operating ActivitiesDepreciation and Amortization
    
    
    7,596
    
    
    
    7,141Provision for Losses on Receivables and Inventory
    
    
    1,096
    
    
    
    575Provision for Deferred Income Taxes
    
    
    2,123
    
    
    
    3,538Minority Interest
    
    
    583
    
    
    
    563Changes in Operating Assets and Liabilities:Receivables
    
    
    (1,046
    )
    
    
    (2,502
    )Inventory
    
    
    549
    
    
    
    1,633Payables
    
    
    528
    
    
    
    (1,292
    )Deferred Purchased Gas Adjustment
    
    
    (4
    )
    
    
    (4,822
    )Other
    
    
    312
    
    
    
    (1,603
    )Net Cash Provided by Operating Activities
    
    
    23,476
    
    
    
    13,150Cash
Flows from Investing ActivitiesCapital Expenditures
    
    
    (5,862
    )
    
    
    (11,251
    )Net Cash Used in Investing Activities
    
    
    (5,862
    )
    
    
    (11,251
    )Cash
Flows from Financing ActivitiesRepayment of Long-Term Debt
    
    
    (6,956
    )
    
    
    (3,267
    )Changes in Short-Term Borrowings
    
    
    (250
    )Payment of Dividends
    
    
    (4,485
    )
    
    
    (4,185
    )Dividend Reinvestment
    
    
    274
    
    
    
    264Exercise of Stock Options
    
    
    592
    
    
    
    701Partnership Distributions to Minority Interest Holders
    
    
    (132
    )
    
    
    (208
    )Net Cash Used in Financing Activities
    
    
    (10,957
    )
    
    
    (6,695
    )Net Increase (Decrease) in Cash and Cash Equivalents
    
    
    6,657
    
    
    
    (4,796
    )Cash and Cash Equivalents at Beginning of Period
    
    
    4,082
    
    
    
    10,562Cash and Cash Equivalents at End of Period
    
    $
    10,739
    
    
    $
    5,766
 See Accompanying Notes to Unaudited Condensed Consolidated Financial Statements 6




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NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS Note 1. Principles of Consolidation The consolidated financial statements of EnergySouth, Inc. (EnergySouth) and
its subsidiaries (collectively, the Company) include the accounts of Mobile Gas
Service Corporation (Mobile Gas); EnergySouth Services, Inc. (Services); MGS
Storage Services, Inc. (Storage); a 90.9% owned limited partnership, Bay Gas
Storage Company, Ltd. (Bay Gas), and a 51% owned partnership, Southern Gas
Transmission Company (SGT). Minority interest represents the respective other
owners proportionate shares of the income and equity of Bay Gas and SGT. All
significant intercompany balances and transactions have been eliminated. Note 2. Basis of Presentation The accompanying unaudited consolidated condensed financial statements have
been prepared in accordance with the instructions to Form 10-Q and do not
include all of the information and disclosures required by accounting
principles generally accepted in the United States of America for complete
financial statements. All adjustments, consisting of normal and recurring
accruals, which are, in the opinion of management, necessary to present fairly
the results for the interim periods have been made. The statements should be
read in conjunction with the summary of accounting policies and notes to
financial statements included in the Annual Report on Form 10-K of the Company
for the fiscal year ended September 30, 2003. Due to the high percentage of customers using gas for heating, the Companys
operations are seasonal in nature. Therefore, the results of operations for
the three and nine-month periods ended June 30, 2004 and 2003 are not
indicative of the results to be expected for the full year. 7




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The table below summarizes operating results for the twelve months ended June
30, 2004 and 2003: Twelve MonthsEnergySouth, Inc.
    
    Ended June 30,In Thousands, Except Per Share Data
    
    2004
    
    2003Operating Revenues
    
    $
    114,273
    
    
    $
    96,506Cost of Gas
    
    
    40,080
    
    
    
    28,769Cost of Merchandise
    
    
    2,403
    
    
    
    2,815Operations and Maintenance Expense
    
    
    24,811
    
    
    
    24,386Depreciation Expense
    
    
    9,401
    
    
    
    8,736Taxes, Other Than Income Taxes
    
    
    8,092
    
    
    
    7,112Operating Income
    
    
    29,486
    
    
    
    24,688Interest Income (Expense)  Net
    
    
    (7,976
    )
    
    
    (8,242
    )Allowance for Borrowed Funds Used
During Construction
    
    
    68
    
    
    
    1,695Less: Minority Interest
    
    
    (773
    )
    
    
    (770
    )Income Before Income Taxes
    
    $
    20,805
    
    
    $
    17,371Income Taxes
    
    
    7,850
    
    
    
    6,577Net Income
    
    $
    12,955
    
    
    $
    10,794Earnings Per ShareBasic
    
    $
    2.51
    
    
    $
    2.14Diluted
    
    $
    2.48
    
    
    $
    2.11Average Common Shares OutstandingBasic
    
    
    5,153
    
    
    
    5,048Diluted

    
    
    5,215
    
    
    
    5,108
 Note 3. Stock-Based Compensation The Company accounts for its employee stock option plans under the intrinsic
value recognition and measurement provisions of Accounting Principles Board
Opinion No. 25, Accounting for Stock Issued to Employees, and related
interpretations. As stock options have been issued with exercise prices equal
to the market value of the underlying shares on the grant date, no compensation
cost has been recognized. Had compensation cost for the plans been determined based on the fair value of
the options on the grant date, consistent with Statement of Financial
Accounting Standards No. 123, Accounting for Stock-Based Compensation, the
Companys net income and earnings per share would have been as follows: 8




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##### Table of Contents



Three Months
    
    Nine MonthsEnergySouth, Inc.
    
    Ended June 30,
    
    Ended June 30,In Thousands, Except per Share Data
    
    2004
    
    2003
    
    2004
    2003Net Income, as reported
    
    $
    1,298
    
    
    $

    986
    
    
    $
    11,739
    
    
    $
    9,919Deduct:Total stock-based employee compensation
expense determined under fair value based
method for all awards, net of related tax effects
    
    
    47
    
    
    
    42
    
    
    
    134
    
    
    
    117Pro forma net income
    
    $
    1,251
    
    
    $
    944
    
    
    $
    11,605
    
    
    $
    9,802Earnings per share:Basic  as reported
    
    $
    0.25
    
    
    $
    0.19
    
    
    $
    2.27
    
    
    $
    1.96Basic  pro forma
    
    $
    0.24
    
    
    $
    0.19
    
    
    $
    2.25
    
    
    $
    1.94Diluted  as reported
    
    $
    0.25
    
    
    $
    0.19
    
    
    $
    2.25
    
    
    $
    1.94Diluted  pro forma
    
    $
    0.24
    
    
    $
    0.18
    
    
    $
    2.22
    
    
    $
    1.92
 Note 4. Retirement Plans and Other Benefits The Company has a noncontributory, defined benefit plan covering substantially
all of its employees. Benefits are based on the greater of amounts resulting
from two different formulas: years of service and average compensation during
the last five years of employment, or years of service and average compensation
during the term of employment. The Company annually contributes to the plan
the amount deductible for federal income tax purposes. The Company also provides certain health care and life insurance benefits for
retired employees. Substantially all employees may become eligible for such
benefits if they retire under the provisions of the Companys retirement plan.
The Company is accruing the costs of such benefits over the expected service
period of the employees. In December 2003, the Financial Accounting Standards Board (FASB) issued a
revised Statement of Financial Accounting Standards No. 132 (revised 2003),
Employers Disclosures about Pensions and Other Postretirement Benefits (SFAS
132R) which, in part, requires interim disclosures of the net periodic benefit
cost recognized for each period for which a statement of income is presented. 9




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The projected unit credit actuarial method was used to determine service cost
and actuarial liability. In accordance with SFAS 132R, net periodic benefit
cost for the periods indicated included the following components: Pension
    
    PostretirementBenefits
    
    BenefitsFor the three months ended June 30, (in thousands)
    
    2004
    
    2003
    
    2004
    
    2003Service cost
    
    $
    214
    
    
    $
    173
    
    
    $
    29
    
    
    $
    25Interest cost
    
    
    391
    
    
    
    382
    
    
    
    62
    
    
    
    64Amortization of transition asset
    
    
    (32
    )
    
    
    (46
    )Amortization of prior service cost
    
    
    24
    
    
    
    24
    
    
    
    (11
    )
    
    
    (11
    )Amortization of unrecognized gain/(loss)
    
    
    (32
    )
    
    
    (89
    )
    
    
    3
    
    
    
    2Expected return on plan assets
    
    
    (645
    )
    
    
    (578
    )
    
    
    (71
    )
    
    
    (53
    )Net periodic benefit cost (credit)
    
    $
    (80
    )
    
    $
    (134
    )
    
    $
    12
    
    
    $
    27
 Pension
    
    PostretirementBenefits
    
    BenefitsFor the nine months ended June 30, (in thousands)
    
    2004
    
    2003
    
    2004
    
    2003Service cost
    
    $
    643
    
    
    $
    518
    
    
    $
    88
    
    
    $
    75Interest cost
    
    
    1,172
    
    
    
    1,145
    
    
    
    187
    
    
    
    191Amortization of transition asset
    
    
    (96
    )
    
    
    (137
    )Amortization of prior service cost
    
    
    71
    
    
    
    71
    
    
    
    (33
    )
    
    
    (33
    )Amortization of unrecognized (gain)/loss
    
    
    (96
    )
    
    
    (266
    )
    
    
    9
    
    
    
    5Expected return on plan assets
    
    
    (1,934
    )
    
    
    (1,733
    )
    
    
    (212
    )
    
    
    (158
    )Net periodic benefit cost (credit)
    
    $
    (240
    )
    
    $
    (402
    )
    
    $
    39
    
    
    $
    80
 For fiscal year 2004, the Company does not anticipate making any contributions
to its pension plan due to the fact that the plan is currently fully funded and
any contributions to the Companys postretirement benefit plan are expected to
be immaterial. Note 5. Rates and Regulatory Matters On June 10, 2002, the APSC approved Mobile Gas request for the Rate
Stabilization and Equalization (RSE) rate setting process to be effective
October 1, 2002 through September 30, 2005, and thereafter unless modified or
discontinued by APSC order. RSE is a ratemaking methodology already used by
the APSC to regulate certain other utilities. Rate adjustments, designed to
increase annual gas revenues by approximately $2.8 million and $2.2 million,
were implemented under the RSE tariff effective December 1, 2003 and 2002,
respectively. Increases are allowed only once each fiscal year, effective
December 1, and cannot exceed four percent of prior-year revenues. Under RSE,
the APSC has conducted reviews using fiscal year-to-date performance through
January and through April plus Mobile Gas budget projections to determine
whether Mobile Gas return on equity is expected to be
within the allowed range of 13.35% to 13.85% at the end of the fiscal year. No
reduction in 10




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rates has been made based on these reviews. For the twelve months
ended June 30, 2004, Mobile Gas return on equity as would be calculated for
RSE purposes was 14.56% on average equity of $61,625,000. Financial results in
the fourth quarter may lower this return on equity for the fiscal year to
within the allowed range under RSE. Should Mobile Gas complete the fiscal year
with a return on equity above the allowed range, however, an adjustment will be
made to current fiscal year earnings such that the return on average equity as
calculated for RSE purposes will equal 13.6%, the midpoint of the allowed
range, and a payable reflected for the amount owed to customers. A reduction
in rates would be made in the next fiscal year. RSE limits the amount of
Mobile Gas equity upon which a return is permitted to 60 percent of its total
capitalization and provides for certain cost control measures designed to
monitor Mobile Gas operations and maintenance (O&M) expense. Under the
inflation-based cost control measurement established by the APSC, if a change
in Mobile Gas O&M expense per customer falls within 1.5 percentage points
above or below the change in the Consumer Price Index for All Urban Customers
(index range), no adjustment is required. If the change in O&M expense per
customer exceeds the index range, three-quarters of the difference is returned
to customers. To the extent the change is less than the index range, the
utility benefits by one-half of the difference through future rate adjustments.
The increase in O&M expenses per customer was within the index range for the
rate year ended September 30, 2003; therefore, no adjustments were required. In conjunction with the approval of RSE, the APSC approved an Enhanced
Stability Reserve (ESR), beginning October 1, 2002, to which Mobile Gas may
charge the full amount of: 1) extraordinary O&M expenses resulting from force
majeureevents such as storms, severe weather, and outages, when one such event
results in more than $100,000 of additional O&M expense or a combination of two
or more such events results in more than $150,000 of additional O&M expense
during a fiscal year; or 2) losses of revenue from any individual industrial or
commercial customer in excess of $100,000 during the fiscal year, if such
losses cause Mobile Gas return on equity to fall below 13.35%. An initial ESR
balance of $1.0 million was recorded October 1, 2002 and is being recovered
from customers through rates. Subject to APSC approval, additional funding, up
to a maximum reserve balance of $1.5 million, may be provided by any future
non-recurring revenue should such revenue cause Mobile Gas return on equity
for the fiscal year to exceed 13.85%. During the year ended September 30, 2003,
Mobile Gas charged $146,000 against the ESR due to revenue losses from a large
industrial customer. Following a year in which a charge against the ESR is
made, the APSC provides for accruals to the ESR of no more than $15,000 monthly
until the maximum funding level is achieved; however, no such accruals have
been made during the three and nine-month periods ended June 30, 2004. The ESR
balance of $854,000 at June 30, 2004 is included in the Unaudited Condensed
Consolidated Financial Statements as part of Regulatory Liabilities. Mobile Gas rates contain a temperature adjustment rider which is designed to
offset the impact of unusually cold or warm weather on the Companys operating
margins. The adjustment is calculated monthly for the months of November
through April and applied to customers bills in the same billing cycle in
which the weather variation occurs. The
temperature adjustment rider applies to substantially all residential and small
commercial customers. 11




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##### Table of Contents



The Company is subject to the provisions of FASB Statement No. 71, Accounting
for the Effects of Certain Types of Regulation (SFAS 71). Regulatory assets
represent probable future revenues associated with certain costs that are
expected to be recovered from customers through the ratemaking process.
Regulatory liabilities represent probable future reductions in revenues
associated with amounts that are expected to be credited to customers through
the ratemaking process. The following table presents the significant
regulatory assets and liabilities as of the stated dates (in thousands): June 30, 2004
    
    June 30, 2003
    
    September 30, 2003Current
    
    Noncurrent
    
    Current
    
    Noncurrent
    
    Current
    
    NoncurrentAssetsProperty, Plant, and Equipment
    
    $
    32
    
    
    
    
    
    
    $
    85
    
    
    $
    32
    
    
    $
    85
    
    
    $
    10Deferred Purchase Gas Adjustment
    
    
    2,537
    
    
    
    
    
    
    
    1,640
    
    
    
    
    
    
    
    2,533ESR Fund
    
    
    167
    
    
    
    542
    
    
    
    167
    
    
    
    708
    
    
    
    167
    
    
    
    666Bad Debt Reserve
    
    
    133
    
    
    
    166
    
    
    
    133
    
    
    
    299
    
    
    
    133
    
    
    
    265Other
    
    
    26
    
    
    
    34
    
    
    
    26
    
    
    
    62
    
    
    
    27
    
    
    
    55Regulatory Assets
    
    $
    2,895
    
    
    $
    742
    
    
    $
    2,051
    
    
    $
    1,101
    
    
    $
    2,945
    
    
    $
    996LiabilitiesBad Debt Reserve
    
    $
    25
    
    
    $
    5
    
    
    $
    45
    
    
    $
    30
    
    
    $
    40
    
    
    $
    20ESR Fund
    
    
    854
    
    
    
    
    
    
    
    1,000
    
    
    
    
    
    
    
    854Asset Retirement Obligations
    
    
    
    
    
    
    11,457
    
    
    
    
    
    
    
    10,630
    
    
    
    
    
    
    
    10,825Deferred Investment Tax Credit
    
    
    16
    
    
    
    141
    
    
    
    16
    
    
    
    156
    
    
    
    15
    
    
    
    153Regulatory Liabilities
    
    $
    895
    
    
    $
    11,603
    
    
    $
    1,061
    
    
    $
    10,816
    
    
    $
    909
    
    
    $
    10,998
 In the event that a portion of the Companys operations should no longer be
subject to the provisions of SFAS No. 71, the Company would be required to
write off related regulatory assets and liabilities that are not specifically
addressed through regulated rates. In addition, the Company would be required
to determine if any impairment to other assets exists, including plant, and
write down the assets, if impaired, to their fair market value. Note 6. Earnings Per Share Basic earnings per share are computed based on the weighted average number of
common shares outstanding during each period. Diluted earnings per share are
computed based on the weighted average number of common shares outstanding and
diluted potential common shares, using the treasury stock method, outstanding
during each period. Average common shares used to compute basic earnings per share differed from
average common shares used to compute diluted earnings per share by equivalent
shares of 62,000
and 53,000 for the three months ended June 30, 2004 and 2003, respectively, and
62,000 and 58,000 for the nine months ended June 30, 2004 and 2003. These
differences in equivalent shares are from outstanding stock options. 12




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##### Table of Contents



Note 7. Deferred Compensation The Company maintains The Second Amended and Restated EnergySouth, Inc.
Non-Employee Directors Deferred Fee Plan (the Plan) which is a nonqualified
deferred compensation plan available to each director of the Company who is not
an employee of the Company. Under the Plan, the Company provides each such
director with the opportunity to defer receipt of fees to be paid to such
director as a member of the Board of Directors of the Company. A director who
enrolls in the Plan may elect to have the deferred compensation credited in the
form of phantom stock and any payments from the Plan to satisfy the deferred
compensation obligations of such director will be made in shares of common
stock. On April 1, 2004, the Company established a non-qualified grantor trust
(the Trust) to assist in meeting obligations under the Plan. The assets held in
the Trust are intended to be used to pay benefits payable under the Plan, but
are subject to, among other things, the claims of general creditors of the
Company. A total of 60,000 shares of common stock of the Company have been reserved for
issuance in satisfaction of the deferred compensation obligations. As of June
30, 2004, approximately 37,000 shares of common stock of the Company have been
issued and are held by the Trust. Note 8. Segment Information The Company is principally engaged in two reportable business segments: Natural
Gas Distribution and Natural Gas Storage. The Natural Gas Distribution segment
is actively engaged in the distribution and transportation of natural gas to
residential, commercial and industrial customers through Mobile Gas and SGT.
The Natural Gas Storage segment provides for the underground storage of natural
gas and transportation services through the operations of Bay Gas and Storage.
Through Mobile Gas and Services, the Company also provides merchandising and
other energy-related services which are aggregated with EnergySouth, the
holding company, and included in the Other segment. Segment earnings information presented in the table below includes intersegment
revenues which are eliminated in consolidation. Such intersegment revenues are
primarily amounts paid by the Natural Gas Distribution segment to the Natural
Gas Storage segment. 13




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##### Table of Contents



For the three months ended
    
    Natural Gas
    
    Natural GasJune 30, 2004 (in thousands):
    
    Distribution
    
    Storage
    
    Other
    
    Eliminations
    
    ConsolidatedOperating Revenues
    
    $
    16,667
    
    
    $
    4,372
    
    
    $
    993
    
    
    $
    (1,036
    )
    
    $
    20,996Cost of Gas
    
    
    7,134
    
    
    
    
    
    
    
    
    
    
    
    (1,036
    )
    
    
    6,098Cost of Merchandise
    
    
    
    
    
    
    
    
    
    
    522
    
    
    
    
    
    
    
    522Operations and Maintenance Expense
    
    
    4,982
    
    
    
    695
    
    
    
    363
    
    
    
    
    
    
    
    6,040Depreciation Expense
    
    
    1,828
    
    
    
    611
    
    
    
    
    
    
    
    
    
    
    
    2,439Taxes, Other Than Income Taxes
    
    
    1,436
    
    
    
    246
    
    
    
    12
    
    
    
    
    
    
    
    1,694Operating Income
    
    
    1,287
    
    
    
    2,820
    
    
    
    96
    
    
    
    
    
    
    
    4,203Interest Income
    
    
    10
    
    
    
    11
    
    
    
    
    
    
    
    
    
    
    
    21Interest Expense
    
    
    (825
    )
    
    
    (1,114
    )
    
    
    (19
    )
    
    
    
    
    
    
    (1,958
    )Allow. for Borrowed Funds Used
During Construction
    
    
    4
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4Less: Minority Interest
    
    
    (29
    )
    
    
    (159
    )
    
    
    
    
    
    
    
    
    
    
    (188
    )Income Before Income Taxes
    
    $
    447
    
    
    $
    1,558
    
    
    $
    77
    
    
    
    
    
    
    $
    2,082
 For the three months ended
    
    Natural Gas
    
    Natural GasJune 30, 2003 (in thousands):
    
    Distribution
    
    Storage
    
    Other
    
    Eliminations
    
    ConsolidatedOperating Revenues
    
    $
    16,461
    
    
    $
    4,181
    
    
    $
    978
    
    
    $
    (1,037
    )
    
    $
    20,583Cost of Gas
    
    
    6,888
    
    
    
    
    
    
    
    
    
    
    
    (1,033
    )
    
    
    5,855Cost of Merchandise & Jobbing
    
    
    
    
    
    
    
    
    
    
    586
    
    
    
    
    
    
    
    586Operations and Maintenance Expense
    
    
    5,275
    
    
    
    817
    
    
    
    326
    
    
    
    (4
    )
    
    
    6,414Depreciation Expense
    
    
    1,756
    
    
    
    535
    
    
    
    
    
    
    
    
    
    
    
    2,291Taxes, Other Than Income Taxes
    
    
    1,420
    
    
    
    171
    
    
    
    10
    
    
    
    
    
    
    
    1,601Operating Income
    
    
    1,122
    
    
    
    2,658
    
    
    
    56
    
    
    
    
    
    
    
    3,836Interest Income
    
    
    8
    
    
    
    10
    
    
    
    
    
    
    
    
    
    
    
    18Interest Expense
    
    
    (838
    )
    
    
    (1,185
    )
    
    
    (86
    )
    
    
    
    
    
    
    (2,109
    )Allow. for Borrowed Funds Used
During Construction
    
    
    14
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    14Less: Minority Interest
    
    
    (42
    )
    
    
    (135
    )
    
    
    
    
    
    
    
    
    
    
    (177
    )Income Before Income Taxes
    
    $
    264
    
    
    $
    1,348
    
    
    $
    (30
    )
    
    
    
    
    
    $
    1,582
 14




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##### Table of Contents



For the nine months ended
    
    Natural Gas
    
    Natural GasJune 30, 2004 (in thousands):
    
    Distribution
    
    Storage
    
    Other
    
    Eliminations
    
    ConsolidatedOperating Revenues
    
    $
    83,153
    
    
    $
    13,087
    
    
    $
    3,465
    
    
    $
    (3,147
    )
    
    $
    96,558Cost of Gas
    
    
    39,006
    
    
    
    

    
    
    
    
    
    
    
    (3,147
    )
    
    
    35,859Cost of Merchandise
    
    
    
    
    
    
    
    
    
    
    1,872
    
    
    
    
    
    
    
    1,872Operations and Maintenance Expense
    
    
    15,871
    
    
    
    2,223
    
    
    
    1,292
    
    
    
    
    
    
    
    19,386Depreciation Expense
    
    
    5,484
    
    
    
    1,824
    
    
    
    
    
    
    
    
    
    
    
    7,308Taxes, Other Than Income Taxes
    
    
    6,049
    
    
    
    646
    
    
    
    49
    
    
    
    
    
    
    
    6,744Operating Income
    
    
    16,743
    
    
    
    8,394
    
    
    
    252
    
    
    
    
    
    
    
    25,389Interest Income
    
    
    14
    
    
    
    30
    
    
    
    
    
    
    
    (9
    )
    
    
    35Interest Expense
    
    
    (2,457
    )
    
    
    (3,378
    )
    
    
    (153
    )
    
    
    9
    
    
    
    (5,979
    )Allow. for Borrowed Funds Used
During Construction
    
    
    16
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    16Less: Minority Interest
    
    
    (117
    )
    
    
    (466
    )
    
    
    
    
    
    
    
    
    
    
    (583
    )Income Before Income Taxes
    
    $
    14,199
    
    
    $
    4,580
    
    
    $
    99
    
    
    
    
    
    
    $
    18,878
 For the nine months ended
    
    Natural Gas
    
    Natural GasJune 30, 2003 (in thousands):
    
    Distribution
    
    Storage
    
    Other
    
    Eliminations
    
    ConsolidatedOperating Revenues
    
    $
    71,191
    
    
    $
    10,397
    
    
    $
    3,475
    
    
    $
    (3,169
    )
    
    $
    81,894Cost of Gas
    
    
    29,775
    
    
    
    
    
    
    
    
    
    
    
    (3,143
    )
    
    
    26,632Cost of Merchandise & Jobbing
    
    
    
    
    
    
    
    
    
    
    1,940
    
    
    
    
    
    
    
    1,940Operations and Maintenance Expense
    
    
    15,989
    
    
    
    1,888
    
    
    
    1,151
    
    
    
    (26
    )
    
    
    19,002Depreciation Expense
    
    
    5,268
    
    
    
    1,587
    
    
    
    
    
    
    
    
    
    
    
    6,855Taxes, Other Than Income Taxes
    
    
    5,379
    
    
    
    512
    
    
    
    38
    
    
    
    
    
    
    
    5,929Operating Income
    
    
    14,780
    
    
    
    6,410
    
    
    
    346
    
    
    
    
    
    
    
    21,536Interest Income
    
    
    20
    
    
    
    38
    
    
    
    (2
    )
    
    
    
    
    
    
    56Interest Expense
    
    
    (2,651
    )
    
    
    (3,467
    )
    
    
    (142
    )
    
    
    
    
    
    
    (6,260
    )Allow. for Borrowed Funds Used
During Construction
    
    
    32
    
    
    
    1,110
    
    
    
    
    
    
    
    
    
    
    
    1,142Less: Minority Interest
    
    
    (189
    )
    
    
    (374
    )
    
    
    
    
    
    
    
    
    
    
    (563
    )Income Before Income Taxes
    
    $
    11,992
    
    
    $
    3,717
    
    
    $
    202
    
    
    
    
    
    
    $
    15,911
 Note 9. Unearned Revenue In November 2001, Bay Gas entered into an agreement which granted a customer a
nineteen-month option to transport additional volumes in excess of the volumes
under long-term contract. During the first quarter of fiscal 2002, Bay Gas
received $3,274,000 in consideration of the option agreement, which was fully
amortized as of the end of May 2003. Note 10. Contingencies Like many gas distribution companies, prior to the widespread availability of
natural gas, the Company manufactured gas for sale to its customers. In
contrast to some other companies which operated multiple manufactured gas
plants, the Company and its predecessor operated only one such plant, which
discontinued operations in 1933. The process for manufacturing gas produced
by-products and residuals, such as coal tar, and certain 15




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##### Table of Contents



remnants of these
residuals are sometimes found at former gas manufacturing sites. The Company conducted a preliminary assessment in 1994 of its former gas plant
site and has tested certain waters in the vicinity of the site. The Company
developed and has implemented a plan for the site based on the advice of
environmental consultants, which involves securing and monitoring the site, and
continued testing. In 2000, the Company commenced discussions with the City of
Mobile regarding the possible development of the property as a city park. As
part of this process, the Alabama Department of Environmental Management
(ADEM) is conducting a Brownfields evaluation of the property. Testing of
the site has been completed by ADEM; however, the Company is unable to predict
when ADEMs final report will be available. Preliminary data received from
ADEM has been reviewed by the Companys environmental consultants. Based on
information received to date, the Company does not believe that the site
currently poses any threat to human health
or the environment. At this time, the Company continues to believe that
material remediation costs are unlikely and has therefore established no
reserve for such costs in its financial statements. The Company intends that,
should further investigation or changes in environmental laws or regulations
require material expenditures for evaluation or remediation, with regard to the
site, it would apply to the APSC for appropriate rate recovery of such costs.
However, there can be no assurances that the APSC would approve the recovery of
such costs or the amount and timing of any such recovery. The Company is involved in litigation arising in the normal course of business.
Management believes that the ultimate resolution of such litigation will not
have a material adverse effect on the consolidated financial statements of the
Company. Note 11. New Accounting Pronouncements On December 8, 2003, President Bush signed into law a bill that expands
Medicare, adding a prescription drug benefit for Medicare-eligible retirees
starting in 2006. On May 19, 2004, the Financial Accounting Standards Board
(FASB) issued FASB Staff Position FAS 106-2, Accounting and Disclosure
Requirements Related to the Medicare Prescription Drug, Improvement and
Modernization Act of 2003 (FAS 106-2) which provides guidance on the
accounting and disclosures related to the subsidy for an employer that sponsors
a postretirement health care benefit plan that provides prescription drug
coverage. The Company does not provide health insurance coverage to retirees
past 65 years of age, therefore, FAS 106-2 will not have an impact on the
Companys financial statements. Note 12. Subsequent Event On July 30, 2004, the Board of Directors of EnergySouth declared a
three-for-two split of outstanding common stock whereby one additional share
will be issued for each two shares held as of the record date of August 16,
2004. Common stock will begin trading on the post split basis on September 2,
2004. The new shares will be issued to shareholders on September 1, 2004 with
cash to be paid in lieu of fractional shares resulting from the split. 16




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##### Table of Contents



Pro-forma earnings per share data for the periods ended June 30, 2004 as
reported in this Form 10-Q, and adjusted for the common stock split, is as
follows: Three Months
    
    Nine Months
    
    Twelve MonthsEnergySouth, Inc.
    
    Ended June 30,
    
    Ended June 30,
    
    Ended June 30,In Thousands, Except per Share Data
    
    2004
    
    2003
    
    2004
    
    2003
    
    2004
    
    2003Net Income
    
    $
    1,298
    
    
    $
    986
    
    
    $
    11,739
    
    
    $
    9,919
    
    
    $
    12,955
    
    
    $
    10,794Earnings Per ShareBasic
    
    $
    0.17
    
    
    $
    0.13
    
    
    $
    1.52
    
    
    $
    1.31
    
    
    $
    1.68
    
    
    $
    1.43Diluted
    
    $
    0.16
    
    
    $
    0.13
    
    
    $
    1.50
    
    
    $
    1.29
    
    
    $
    1.66
    
    
    $
    1.41Average Common Shares OutstandingBasic
    
    
    7,803
    
    
    
    7,620
    
    
    
    7,745
    
    
    
    7,587
    
    
    
    7,730
    
    
    
    7,572Diluted
    
    
    7,895
    
    
    
    7,700
    
    
    
    7,838
    
    
    
    7,674
    
    
    
    7,823
    
    
    
    7,662
 17




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##### Table of Contents



Item 2 Managements Discussion and Analysis of Financial Condition and Results of Operations The Company EnergySouth, Inc. (EnergySouth) is a holding company for a family of energy
businesses. EnergySouth and its consolidated subsidiaries are collectively
referred to herein as the Company. The Company, through Mobile Gas Service
Corporation (Mobile Gas) and Southern Gas Transmission Company (SGT), is
engaged in the distribution of natural gas to residential, commercial and
industrial customers in southwest Alabama. Through Bay Gas Storage Company,
Ltd. (Bay Gas), the Company provides underground natural gas storage services
and transportation services. Other EnergySouth subsidiaries are engaged in
merchandising, financing, and other energy-related services. Results Of Operations Consolidated Earnings All earnings per share amounts referred to herein are computed on a diluted
basis. Earnings per share for the three and nine months ended June 30, 2004
increased $0.06 and $0.31, increases of 32% and 16%, respectively, as compared
to the same prior year periods due primarily to increased earnings from Mobile
Gas natural gas distribution system and Bay Gas natural gas storage business.
Financial information by business segment is shown in Note 8 to the unaudited
Consolidated Financial Statements above. Earnings from the Companys natural gas distribution business increased $0.02
and $0.23, per share, respectively, for the three and nine-month periods ended
June 30, 2004 as compared to the same prior year periods. Mobile Gas earnings
were positively impacted by rate adjustments which became effective December 1,
2003 and 2002 based upon the guidelines established under the Rate
Stabilization and Equalization (RSE) tariff. For further information on RSE,
see Natural Gas Distribution below. Earnings were also positively impacted
by an increase in temperature-sensitive customers gas consumption, when
adjusted for weather, during the first and second quarters of fiscal year 2004
as compared to the same prior year periods and a decrease in O&M expenses
during the three and nine-month periods. The Companys natural gas storage business, operated by Bay Gas, contributed
increased earnings per share of $0.02 and $0.09, respectively, for the three
and nine-month periods ended June 30, 2004 as compared to the same prior year
periods. The positive earnings contributions are due primarily to increased
storage revenues from its second storage cavern placed in service on April 1,
2003. Increased revenues for the nine-month period ended June 30, 2004 were
partially offset by additional operations and maintenance costs, depreciation
expense and property taxes due to the completion of the second storage cavern. 18




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##### Table of Contents



Earnings from other business operations increased $0.02 for the three-month
period ended June 30, 2004 as compared to the same prior year period due to
additional costs recognized in the same prior year period to establish reserves
for slow-moving merchandise inventory and a reduction in current year interest
expense. Earnings from other business operations for the nine-month period
ended June 30, 2004 decreased $0.01 as compared to the same prior year period
due to a decrease in interest income from financing activities and additional
reserves for bad debts. Natural Gas Distribution The natural gas distribution segment of the Company is actively engaged in the
distribution and transportation of natural gas to residential, commercial and
industrial customers in southwest Alabama through Mobile Gas and SGT. The Alabama Public Service Commission (APSC) regulates the Companys gas
distribution operations. Mobile Gas rate tariffs for gas distribution allow
rate adjustments to pass through to customers the cost of gas, certain taxes,
and incremental costs associated with the replacement of cast iron mains. These
costs, therefore, have little direct impact on the Companys margins, which are
defined as natural gas distribution revenues less the cost of gas and related
taxes. In fiscal year 2002, the APSC approved Mobile Gas request for a Rate
Stabilization and Equalization (RSE) tariff, a ratemaking methodology already
used by the APSC to regulate certain other utilities. Rate adjustments,
designed to increase annual gas revenues by approximately $2.8 million and $2.2
million, were implemented under the RSE tariff effective December 1, 2003 and
2002, respectively. Increases are allowed only once each fiscal year,
effective December 1, and cannot exceed four percent of prior-year revenues.
Under RSE, the APSC has conducted reviews using fiscal year-to-date performance
through January and through April plus Mobile Gas budget projections to
determine whether Mobile Gas return on equity is expected to be within the
allowed range of 13.35% to 13.85% at the end of the fiscal year. No reduction
in rates has been made based on these reviews. For the twelve months ended
June 30, 2004, Mobile Gas return on equity as would be calculated for RSE
purposes was 14.56% on average equity of $61,625,000. Financial results in the
fourth quarter may lower this return on equity for the fiscal year to within
the allowed range under RSE. Should Mobile Gas complete the fiscal year with a
return on equity above the allowed range, however, an adjustment will be made
to current fiscal year earnings such that the return on average equity as
calculated for RSE purposes will equal 13.6%, the midpoint of the allowed
range, and a payable reflected for the amount owed to customers. A reduction
in rates would be made in the next fiscal year. See Note 5 to the Unaudited
Condensed Consolidated Financial Statements. The Companys distribution business is highly seasonal and
temperature-sensitive since residential and commercial customers use more gas
during colder weather for space heating. As a result, gas revenues, cost of gas
and related taxes in any given period reflect, in addition to other factors,
the impact of weather, through either increased or decreased sales 19




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volumes. The Company utilizes a temperature rate adjustment rider during the
months of November through April to mitigate the impact that unusually cold or
warm weather has on operating margins by reducing the base rate portion of
customers bills in colder than normal weather and increasing the base rate
portion of customers bills in warmer than normal weather. Normal weather for
the Companys service territory is defined as the 30-year average temperature
as determined by the National Weather Service. Natural gas distribution revenues increased $206,000 (1%) and $11,962,000
(17%), respectively, during the three and nine-month periods ended June 30,
2004 as compared to the same prior year periods due primarily to the rate
adjustments to recover increased gas costs paid to suppliers. Revenues also
increased during the current year periods as a result of the RSE rate
adjustments which went into effect on December 1, 2003 and 2002. The increase
in revenues during the nine-month period was slightly offset by a 4% decline in
volumes delivered to temperature-sensitive customers due to temperatures that
were 9% warmer than the same period last year and a slight decline in the
number of temperature-sensitive customers served during the current year
period. Revenues from the sale of natural gas to large commercial and industrial
customers decreased $221,000 (10%) for the three-month period ended June 30,
2004 primarily due to an 18% decline in volumes delivered to these customers in
the current year period which more than offset the higher natural gas prices
and RSE adjustments. Revenues from the sale of natural gas to large commercial
and industrial customers for the nine-month period ended June 30, 2004
increased $247,000 (4%) due to the increase in the price of natural gas and the
RSE adjustments. The cost of natural gas increased $246,000 (4%) and $9,231,000 (31%),
respectively, for the three and nine-month periods ended June 30, 2004 as
compared to the same prior year periods due to higher commodity gas prices.
Natural gas distribution margins were flat for the three-month period ended
June 30, 2004. Margins increased 6% for the nine-month period ended June 30,
2004 primarily as a result of the RSE rate adjustments. Also, consumption by
temperature-sensitive customers, when adjusted for weather, increased during
the current year heating season as compared to the prior year heating season.
The increase in margin for the nine-month period was partially offset by a
slight decline in the number of temperature-sensitive customers served during
the current year period and the declines in volumes delivered to large
commercial and industrial customers which are not subject to the temperature
rate adjustment rider. Revenues from transportation customers declined $92,000 (5%) and $265,000 (5%),
respectively, for the three and nine-month periods ended June 30, 2004 as
compared to the same prior year periods with a corresponding decline in volumes
of 11% and 10%, respectively, due primarily to increased gas prices and general
economic conditions. In addition to plant closings in recent years, a chemical
company, which was a customer of Mobile Gas, ceased operations of its Mobile
plant in June 2003 and some industrial plants have decreased production or
switched to alternative fuels. Operations and maintenance (O&M) expenses decreased $293,000 (6%) and $118,000 20




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(1%), respectively, for the three and nine-month periods ended June 30, 2004
due in part to reductions in promotional and advertising campaigns. Also
contributing to the decrease in O&M expenses for the three-month period was a
decrease in payroll costs and associated benefits related to the elimination of
sixteen positions during the second quarter of 2004. In accordance with
Statement of Financial Accounting Standards No. 88, Employers Accounting for
Settlements and Curtailments of Defined Benefit Pension Plans and for
Termination Benefits, Mobile Gas expensed $270,000 during the second quarter
of fiscal year 2004 related to the special termination benefits. The savings
realized in the nine-month period were partially offset by the recognition of
the additional expense. Also partially offsetting the decreases in other O&M expenses for the three and
nine-month periods was an increase in bad debt reserves. O&M expenses for bad
debt reserves increased $74,000 and $382,000, respectively, during the three
and nine-month periods ended June 30, 2004 as compared to the same prior year
periods due to a rise in gas revenues associated with the increase in natural
gas prices discussed above. In response to the corresponding increase in
revenues, Mobile Gas has established additional reserves for anticipated
uncollectible account balances for gas delivered during the current year winter
heating season. Depreciation expense increased $72,000 (4%) and $216,000 (4%), respectively,
for the three and nine-month periods ended June 30, 2004 as compared to the
same prior year periods due to Mobile Gas capital expansion projects and
increased investment in property, plant and equipment. Other taxes primarily consist of property taxes and business license taxes that
are based on gross revenues and fluctuate accordingly. Other taxes increased
$16,000 (1%) and $670,000 (12%), respectively, for the three and nine-month
periods ended June 30, 2004 due primarily to the increased revenues discussed
above. Interest expense decreased $13,000 (2%) and $194,000 (7%), respectively, for
the three and nine-month periods ended June 30, 2004 as compared to the same
prior year periods due to principal payments on long-term debt. Minority interest reflects the minority partners share of pre-tax earnings of
the SGT partnership, of which EnergySouths subsidiary holds a controlling
interest. Minority interest decreased $13,000 (31%) and $72,000 (38%),
respectively, during the three and nine-month periods ended June 30, 2004 as
compared to the same prior year periods due to a decline in pretax earnings of
the partnership. Natural Gas Storage The natural gas storage segment provides for the underground storage of natural
gas and transportation services, through the operations of Bay Gas. The APSC
certificated Bay Gas as an Alabama gas storage public utility in 1992. Through
its first storage cavern with 2.3 Bcf of 21




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working gas capacity and connected pipeline, Bay Gas thereafter began providing
substantial, long-term services for Mobile Gas and other customers that include
storage and transportation of natural gas from interstate and intrastate
sources. The APSC does not regulate rates for Bay Gas interstate gas storage
and storage-related services. The Federal Energy Regulatory Commission (FERC),
which has jurisdiction over interstate services, allows Bay Gas to charge
market-based rates for such services. Market-based rates minimize regulatory
involvement in the setting of rates for storage services and allow Bay Gas to
respond to market conditions. Bay Gas also provides interstate
transportation-only firm and interruptible services. The FERC last issued
orders on October 11, 2001 and June 3, 2002 approving rates for such services.
On March 9, 2004 in accordance with FERC filing requirements, Bay Gas filed a
petition with the FERC requesting approval of rates for transportation-only
service. The construction of natural gas-fired electric generation facilities in the
Southeast has provided opportunities to provide gas storage and transportation
services. Construction of Bay Gas second storage cavern was completed and the
cavern was placed into service April 1, 2003. Bay Gas entered into a
fifteen-year contract with Southern Company Services, Inc. (Southern), an
affiliate of Southern Company, for a substantial portion of the second cavern
capacity. During fiscal year 2004, the remaining capacity of the second cavern
was fully subscribed on a firm basis. Currently, the second salt-dome storage
cavern has a working capacity of 3.7 Bcf. Continuing cavern development is
planned to provide for an additional 1.0 Bcf of working gas capacity.
Together, the two caverns at Bay Gas hold 6.0 Bcf, with injection and
withdrawal capacity of 200 MMcf and 610 MMcf per day, respectively, but are
currently planned to hold 7.0 Bcf, with injection and withdrawal capacity of
300 MMcf and 700 MMcf per day, respectively. The additional cavern development
is projected to continue through fiscal 2006 without interruption of storage
operations. With the current working capacity of both caverns fully subscribed, Bay Gas
recently began a process that could lead to additional cavern development. As
a first step, Bay Gas has concluded a non-binding open season to assess
interest for up to a 5Bcf of additional working capacity. Bay Gas is currently
following up with the respondents in an effort to secure agreements for firm
storage services. Bay Gas plans to move forward with development of a third
storage cavern subject to its ability to execute sufficient firm storage
agreements with the interested parties. Bay Gas revenues increased $191,000 (5%) and $2,690,000 (26%), respectively,
during the three and nine-month periods ended June 30, 2004 as compared to the
same prior year periods due primarily to additional storage revenues associated
with the commencement of operations of the second cavern and a new storage
agreement which was signed during the first quarter of fiscal year 2004.
Storage revenues were partially offset by the expiration in May 2003 of an
option agreement for transportation services over and above contracted volumes.
Bay Gas entered into an agreement in November 2001 which granted to a customer
an option to order transportation of additional volumes in excess of the
volumes currently under long-term contract. Bay Gas received $3,274,000 in
consideration of the option agreement which was amortized over the
nineteen-month option period. See Note 9 to the Unaudited Condensed
Consolidated Financial Statements for additional information 22




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pertaining to the option agreement. Operations and maintenance (O&M) expenses decreased $122,000 (15%) during the
three-month period ended June 30, 2004 and increased $335,000 (18%) during the
nine-month period ended June 30, 2004 as compared to the same prior year
periods. The decrease during the three-month period ended June 30, 2004 is due
primarily to non-routine non-recurring operational expenses which occurred in
the third quarter of 2003 in connection with the start-up of the second cavern.
The increase in O&M expenses during the nine-month period ended June 30, 2004
is primarily due to a general increase in operating costs as a result of the
expansion activities of Bay Gas. Depreciation expense increased $76,000 (14%) and $237,000 (15%), respectively,
for the three and nine-month periods ended June 30, 2004 as compared to the
same prior year periods due primarily to the second storage cavern which was
placed in service in April 2003. Other taxes consist primarily of property taxes and those taxes increased as a
result of the commencement of operations of Bay Gas second storage cavern. Allowance for borrowed funds used during construction represents the
capitalization of interest costs to construction work-in-progress. Capitalized
interest costs decreased $1,110,000 for the nine-month period ended June 30,
2004 as compared to the same prior year period due to the completion of Bay
Gas second storage cavern. Minority interest reflects the minority partners share of pre-tax earnings of
the Bay Gas limited partnership, of which EnergySouths subsidiary holds a
controlling interest. Minority interest increased $24,000 (18%) and $92,000
(25%), respectively, during the three and nine-month periods ended June 30,
2004 as compared to the same prior year periods due to increased pretax
earnings of the limited partnership. Other Through Mobile Gas and EnergySouth Services, Inc., which are aggregated with
EnergySouth, the holding company, the Company provides merchandising,
financing, and other energy-related services to comprise the Other category.
See Note 8 to the Unaudited Condensed Consolidated Financial Statements above
for segment disclosure. Income before income taxes from Other business activities increased for the
three-month period ended June 30, 2004 as compared to the same prior year
period as a result of a reduction in current year interest expense and
additional costs recognized in the same prior year period to establish reserves
for slow-moving merchandise inventory. For the nine-month period ended June
30, 2004, income before income taxes from Other business activities decreased
due primarily to the establishment of additional bad debt reserves associated
with financing activities. 23




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Income Taxes Income taxes fluctuate with the change in income before income taxes. Income
tax expense increased $188,000 (32%) and $1,147,000 (19%), respectively, for
the three and nine-month periods ended June 30, 2004 as compared to the same
prior year periods. Liquidity and Capital Resources The Company generally relies on cash generated from operations and, on a
temporary basis, short-term borrowings, to meet working capital requirements
and to finance normal capital expenditures. The Company issues debt and equity
for longer term financing as needed. Impacts of operating, investing, and
financing activities are shown on the Unaudited Condensed Consolidated
Statements of Cash Flows. Cash provided by operating activities increased $10.3
million during the nine-month period ended June 30, 2004 as compared to the
same period last year due primarily to collections of increased gas costs from
customers, an increase in net income, and an increase in payables. See the
Natural Gas Distribution section for additional information regarding the
pass-through to customers of the cost of gas. Cash used in investing activities reflects the capital-intensive nature of the
Companys business. During the nine months ended June 30, 2004 and 2003, the
Company used cash of $5.9 million and $11.3 million, respectively, for the
construction of distribution and storage facilities, purchases of equipment and
other general improvements. Financing activities used cash of $11.0 and $6.7 million during the nine months
ended June 30, 2004 and 2003, respectively. The $4.3 million change in
financing activities is due primarily to repayments of long-term debt,
including an additional principal payment of $1.7 million on Mobile Gas 7.27%
Bonds. Funds for the Companys short-term cash needs are expected to come from cash
provided by operations and borrowings under the Companys revolving credit
agreement. At June 30, 2004 the Company had $20.0 million available for
borrowing on its revolving credit agreement. The Company pays a fee for its
committed lines of credit rather than maintain compensating balances. The
commitment fee is 0.125% of the average daily unborrowed amount during the
annual period of calculation. The Company believes it has adequate financial
flexibility to meet its expected cash needs in the foreseeable future. Under its gas supply strategy, Mobile Gas enters into forward purchases of
natural gas to lock in prices for a majority of its expected gas sales for the
upcoming winter heating season. See Gas Supply under Managements
Discussion and Analysis of Financial Condition and Results of Operation
included in the Annual Report on Form 10-K of the Company for the fiscal year
ended September 30, 2003 for further information. The table below summarizes the Companys contractual obligations and commercial
commitments as of June 30, 2004: 24




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Remaining
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Fiscal YearsType of Contractual
    
    Fiscal Year
    
    Fiscal Year
    
    Fiscal Year
    
    Fiscal Year
    
    Fiscal Year
    
    2009 andObligations (in thousands):
    
    2004
    
    2005
    

    2006
    
    2007
    
    2008
    
    thereafterLong-Term Debt
    
    $
    749
    
    
    $
    6,248
    
    
    $
    6,463
    
    
    $
    6,769
    
    
    $
    5,300
    
    
    $
    66,160Interest Payments
    
    
    1,283
    
    
    
    7,253
    
    
    
    6,750
    
    
    
    6,289
    
    
    
    5,867
    
    
    
    32,394Gas Supply Contracts
    
    
    3,424
    
    
    
    15,880
    
    
    
    1,170
    
    
    
    1,187
    
    
    
    1,187
    
    
    
    3,215
 Critical Accounting Policies See Critical Accounting Policies under Managements Discussion and Analysis
of Financial Condition and Results of Operation included in the Annual Report
on Form 10-K of the Company for the fiscal year ended September 30, 2003. Forward-Looking Statements Statements contained in this report, which are not historical in nature, are
forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995. Such forward-looking statements are made as of
the date of this report and involve known and unknown risks, uncertainties and
other important factors that could cause the actual results, performance or
achievements of EnergySouth or its affiliates, or industry results, to differ
materially from any future results, performance or achievement expressed or
implied by such forward-looking statements. Such risks, uncertainties and
other important factors include, among others, risks associated with
fluctuations in natural gas prices, including changes in the historical
seasonal variances in natural gas prices and changes in historical patterns of
collections of accounts receivable; the prices of alternative fuels; the
relative pricing of natural gas versus other energy sources; the availability
of other natural gas storage capacity; disruption or interruption of pipelines
serving the Bay Gas storage facilities due to accidents or other events; risks
generally associated with the transportation and storage of natural gas; the
possibility that contracts with storage customers could be terminated under
certain circumstances, or not renewed or extended upon expiration; the prices
or terms of any extended or new contracts; possible loss or material change in
the financial condition of one or more major customers; liability for remedial
actions under environmental regulations; liability resulting from litigation;
national and global economic and political conditions; and changes in tax and
other laws applicable to the business. Additional factors that may impact
forward-looking statements include, but are not limited to, the Companys
ability to successfully achieve internal performance goals, competition, the
effects of state and federal regulation, including rate relief to recover
increased capital and operating costs, general economic conditions, specific
conditions in the Companys service area, and the Companys dependence on
external suppliers, contractors, partners, operators, service providers, and 25




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governmental agencies. 26




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Item 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK At June 30, 2004 the Company had approximately $91.7 million of long-term debt
at fixed interest rates. Interest rates range from 6.9% to 9.00% and the
maturity dates of such debt extend to 2023. See the information provided under
the captions The Company, Gas Supply, and Liquidity and Capital Resources
in the Companys Annual Report on Form 10-K for the fiscal year ended September
30, 2003 for a discussion of the Companys risks related to regulation,
weather, gas supply and prices, and the capital-intensive nature of the
Companys business. 
 Item 4 CONTROLS AND PROCEDURES Evaluation of Disclosure Controls and Procedures As of the end of the period covered by this report, an evaluation (the
Evaluation) was carried out, under the supervision and with the participation
of the Companys President and Chief Executive Officer (CEO) and Chief
Financial Officer (CFO), of the effectiveness of the design and operation of
the Companys disclosure controls and procedures (Disclosure Controls).
Based on the Evaluation, the CEO and CFO concluded that the Companys
Disclosure Controls are effective in timely alerting them to material
information required to be included in the Companys periodic SEC reports. Changes in Internal Control Internal controls for financial reporting were also evaluated and there have
been no significant changes in internal controls or in other factors that could
significantly affect those controls subsequent to the date of their last
evaluation. Limitations on the Effectiveness of Controls A control system, no matter how well conceived and operated, can provide only
reasonable, not absolute, assurance that the objectives of the control system
are met. Because of the inherent limitations in all control systems, no
evaluation of controls can provide absolute assurance that all control issues
and instances of fraud, if any, within the Company have been detected. 27




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PART II. OTHER INFORMATION 
 Item 6. Exhibits and Reports on Form 8-K (a)

    
    Exhibit No.
    
    Description31.1
    
    
    Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002  Chief Executive Officer31.2
    
    
    Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002  Chief Financial Officer32.1
    
    
    Certification Pursuant to 18 U.S.C. Section 1350, as adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002  Chief Executive Officer32.2
    
    
    Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002  Chief Financial Officer(b)
    
    Reports on Form 8-KOn May 4, 2004, EnergySouth, Inc. filed its current report on Form 8-K reporting earnings for the quarter ended March 31, 2004 and
declaration of a dividend.
 
 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. ENERGYSOUTH, INC.(Registrant)Date: August 3, 2004
    
    /s/ John S. DavisJohn S. DavisPresident and Chief Executive OfficerDate: August 3, 2004
    
    /s/ Charles P. HuffmanCharles P. HuffmanSenior Vice President and Chief Financial Officer
 28