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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 March 31, 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  [  ] Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [X]  No  [  ] 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 May 10, 2004  5,199,886 shares.




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ENERGYSOUTH, INC.
FORM 10-Q FOR THE QUARTER ENDED MARCH 31, 2004 INDEX Page No.PART I: FINANCIAL INFORMATIONItem 1 Financial Statements (Unaudited):(a)
Unaudited Condensed Consolidated Balance Sheets - March 31,
2004 and 2003 and September 30, 2003
    
    
    3-4(b) Unaudited Condensed Consolidated Statements of Income - Three and
Six Months Ended March 31, 2004 and 2003
    
    
    5(c)
Unaudited Condensed Consolidated Statements of Cash Flows - Six
Months Ended March 31, 2004 and 2003
    
    
    6(d) Notes to Unaudited Condensed Consolidated
Financial Statements
    
    
    7-16Item 2 Managements Discussion and Analysis of
Financial Condition and Results of Operations
    
    
    17-24Item 3 Quantitative and Qualitative Disclosures About
Market Risk
    
    
    25Item 4 Controls and Procedures
    
    
    25PART II: OTHER INFORMATIONItem 6 Exhibits and Reports on Form 8-K
    
    
    26-30Certification Pursuant to Section 302Certification Pursuant to Section 302Certification Pursuant to 18 U.S.C. Section 1350Certification Pursuant to 18 U.S.C. Section 1350
 2




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PART 1. FINANCIAL INFORMATION 
 ITEM 1: FINANCIAL STATEMENTS 
 UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS EnergySouth, Inc.
    
    March 31,
    
    September 30,In Thousands
    
    2004
    
    2003
    
    2003ASSETSCurrent AssetsCash and Cash Equivalents
    
    $
    10,050
    
    
    $
    7,502
    
    
    $
    4,082ReceivablesGas
    
    
    12,356
    
    
    
    13,422
    
    
    
    6,652Unbilled Revenue
    
    
    2,620
    
    
    
    2,855
    
    
    
    1,335Merchandise
    
    
    2,327
    
    
    
    2,509
    
    
    
    2,313Other
    
    
    978
    
    
    
    767
    
    
    
    939Allowance for Doubtful Accounts
    
    
    (1,708
    )
    
    
    (1,506
    )
    
    
    (889
    )Materials, Supplies, and Merchandise, Net (At Average Cost)
    
    
    1,341
    
    
    
    1,395
    
    
    
    1,457Gas Stored Underground (At Average Cost)
    
    
    1,628
    
    
    
    1,285
    
    
    
    3,703Regulatory Assets (Note 5)
    
    
    2,248
    
    
    
    2,044
    
    
    
    2,945Deferred Income Taxes
    
    
    1,104
    
    
    
    1,110
    
    
    
    406Prepayments
    
    
    780
    
    
    
    632
    
    
    
    1,166Total Current Assets
    
    
    33,724
    
    
    
    32,015
    
    
    
    24,109Property, Plant, and Equipment
    
    
    271,206
    
    
    
    229,843
    
    
    
    267,047Less: Accumulated Depreciation and Amortization
    
    
    66,868
    
    
    
    60,446
    
    
    
    63,063Property,
Plant, and Equipment - Net
    
    
    204,338
    
    
    
    169,397
    
    
    
    203,984Construction Work in Progress
    
    
    343
    
    
    
    32,020
    
    
    
    1,208Total Property, Plant, and Equipment
    
    
    204,681
    
    
    
    201,417
    
    
    
    205,192Other AssetsPrepaid Pension Cost
    
    
    1,019
    
    
    
    581
    
    
    
    856Deferred Charges
    
    
    690
    
    
    
    542
    
    
    
    569Prepayments
    
    
    986
    
    
    
    1,039
    
    
    
    1,015Regulatory Assets (Note 5)
    
    
    824
    
    
    
    1,202
    
    
    
    996Merchandise Receivables Due After One Year
    
    
    3,639
    
    
    
    4,271
    
    
    
    3,774Total Other Assets
    
    
    7,158
    
    
    
    7,635
    
    
    
    7,210Total
    
    $
    245,563
    
    
    $
    241,067
    
    
    $
    236,511
 See Accompanying Notes to Unaudited Condensed Consolidated Financial Statements 3




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UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS EnergySouth, Inc.
    
    March 31,
    
    September 30,In Thousands, Except Share Data
    
    2004
    
    2003
    
    2003LIABILITIES AND CAPITALIZATIONCurrent LiabilitiesCurrent Maturities of Long-Term Debt
    
    $
    6,152
    
    
    $
    4,545
    
    
    $
    6,006Notes Payable
    
    
    
    
    
    
    
    
    
    
    250Accounts Payable
    
    
    7,337
    
    
    
    12,446
    
    
    
    6,389Dividends Declared
    
    
    1,469
    
    
    
    1,367
    
    
    
    1,463Customer Deposits
    
    
    1,534
    
    
    
    1,477
    
    
    
    1,469Taxes Accrued
    
    
    5,936
    
    
    
    3,660
    
    
    
    3,500Interest Accrued
    
    
    1,251
    
    
    
    1,382
    
    
    
    1,272Regulatory Liabilities (Note 5)
    
    
    900
    
    
    
    1,064
    
    
    
    909Unearned Revenue (Note 8)
    
    
    
    
    
    
    345Other
    
    
    1,002
    
    
    
    1,086
    
    
    
    1,012Total Current Liabilities
    
    
    25,581
    
    
    
    27,372
    
    
    
    22,270Other LiabilitiesAccrued Postretirement Benefit Cost
    
    
    356
    
    
    
    503
    
    
    
    415Deferred Income Taxes
    
    
    20,124
    
    
    
    16,640
    
    
    
    18,484Deferred Investment Tax Credits
    
    
    279
    
    
    
    301
    
    
    
    288Regulatory Liabilities (Note 5)
    
    
    11,400
    
    
    
    10,632
    
    
    
    10,998Other
    
    
    2,811
    
    
    
    2,337
    
    
    
    2,619Total Other Liabilities
    
    
    34,970
    
    
    
    30,413
    
    
    
    32,804Total Liabilities
    
    
    60,551
    
    
    
    57,785
    
    
    
    55,074CapitalizationStockholders EquityCommon Stock, $.01 Par Value
(Authorized 10,000,000 Shares; Outstanding
March 2004 - 5,158,000;
March 2003 - 5,062,000;
September 2003 - 5,133,000 Shares)
    
    
    52
    
    
    
    51
    
    
    
    51Capital in Excess of Par Value
    
    
    24,182
    
    
    
    21,946
    
    
    
    23,490Retained Earnings
    
    
    68,620
    
    
    
    61,827
    
    
    
    61,114Total Stockholders Equity
    
    
    92,854
    
    
    
    83,824
    
    
    
    84,655Minority Interest
    
    
    4,455
    
    
    
    3,903
    
    
    
    4,142Long-Term Debt
    
    
    87,703
    
    
    
    95,555
    
    
    
    92,640Total Capitalization
    
    
    185,012
    
    
    
    183,282
    
    
    
    181,437Total
    
    $
    245,563
    
    
    $
    241,067
    
    
    $
    236,511
 See Accompanying Notes to Unaudited Condensed Consolidated Financial Statements 4




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UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF INCOME Three Months
    
    Six MonthsEnded March 31,
    
    Ended March 31,In Thousands, Except Per Share Data
    
    2004
    
    2003
    
    2004
    
    2003Operating RevenuesGas Revenues
    
    $
    41,802
    
    
    $
    34,574
    
    
    $
    73,090
    
    
    $
    58,817Merchandise Sales
    
    
    632
    
    
    
    732
    
    
    
    1,719
    
    
    
    1,839Other
    
    
    411
    
    
    
    298
    
    
    
    753
    
    
    
    662Total Operating Revenues
    
    
    42,845
    
    
    
    35,604
    
    
    
    75,562
    
    
    
    61,318Operating ExpensesCost of Gas
    
    
    17,635
    
    
    
    13,156
    
    
    
    29,762
    
    
    
    20,783Cost of Merchandise
    
    
    616
    
    
    
    540
    
    
    
    1,350
    
    
    
    1,354Operations and Maintenance
    
    
    6,914
    
    
    
    6,605
    
    
    
    13,346
    
    
    
    12,588Depreciation
    
    
    2,434
    
    
    
    2,269
    
    
    
    4,868
    
    
    
    4,539Taxes, Other Than Income Taxes
    
    
    2,797
    
    
    
    2,432
    
    
    
    5,050
    
    
    
    4,329Total Operating Expenses
    
    
    30,396
    
    
    
    25,002
    
    
    
    54,376
    
    
    
    43,593Operating Income
    
    
    12,449
    
    
    
    10,602
    
    
    
    21,186
    
    
    

    17,725Other Income and (Expense)Interest Expense
    
    
    (1,992
    )
    
    
    (2,103
    )
    
    
    (4,022
    )
    
    
    (4,215
    )Allowance for Borrowed Funds Used During Construction
    
    
    4
    
    
    
    595
    
    
    
    12
    
    
    
    1,166Interest Income
    
    
    8
    
    
    
    20
    
    
    
    14
    
    
    
    39Minority Interest
    
    
    (199
    )
    
    
    (197
    )
    
    
    (395
    )
    
    
    (386
    )Total Other Income (Expense)
    
    
    (2,179
    )
    
    
    (1,685
    )
    
    
    (4,391
    )
    
    
    (3,396
    )Income Before Income Taxes
    
    
    10,270
    
    
    
    8,917
    
    
    
    16,795
    
    
    
    14,329Income Taxes
    
    
    3,898
    
    
    
    3,358
    
    
    
    6,355
    
    
    
    5,396Net Income
    
    $
    6,372
    
    
    $
    5,559
    
    
    $
    10,440
    
    
    $
    8,933Earnings Per ShareBasic
    
    $
    1.24
    
    
    $
    1.10
    
    
    $
    2.03
    
    
    $
    1.77Diluted
    
    $
    1.22
    
    
    $
    1.09
    
    
    $
    2.01
    
    
    $
    1.75Average Common Shares OutstandingBasic
    
    
    5,149
    
    
    
    5,060
    
    
    
    5,143
    
    
    
    5,056Diluted
    
    
    5,212
    
    
    
    5,118
    
    
    
    5,206
    
    
    
    5,116
 See Accompanying Notes to Unaudited Condensed Consolidated Financial Statements 5




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UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS Six MonthsEnergySouth, Inc.
    
    Ends March 31,In Thousands
    
    2004
    
    2003Cash Flows from Operating ActivitiesNet Income
    
    $
    10,440
    
    
    $
    8,933Adjustments to Reconcile Net Income to Net Cash
Provided by Operating ActivitiesDepreciation and Amortization
    
    
    5,073
    
    
    
    4,754Provision for Losses on Receivables and Inventory
    
    
    906
    
    
    
    413Provision for Deferred Income Taxes
    
    
    973
    
    
    
    2,892Minority Interest
    
    
    395
    
    
    
    386Changes in Operating Assets and Liabilities:Receivables
    
    
    (6,897
    )
    
    
    (10,153
    )Inventory
    
    
    2,093
    
    
    
    2,002Payables
    
    
    3,370
    
    
    
    6,357Deferred Purchased Gas Adjustment
    
    
    665
    
    
    
    (4,814
    )Other
    
    
    522
    
    
    
    (980
    )Net Cash Provided by Operating Activities
    
    
    17,540
    
    
    
    9,790Cash
Flows from Investing ActivitiesCapital Expenditures
    
    
    (4,104
    )
    
    
    (7,849
    )Net Cash Used in Investing Activities
    
    
    (4,104
    )
    
    
    (7,849
    )Cash
Flows from Financing ActivitiesRepayment of Long-Term Debt
    
    
    (4,791
    )
    
    
    (2,454
    )Changes in Short-Term Borrowings
    
    
    (250
    )Payment of Dividends
    
    
    (2,934
    )
    
    
    (2,731
    )Dividend Reinvestment
    
    
    191
    
    
    
    171Exercise of Stock Options
    
    
    396
    
    
    
    141Partnership Distributions to Minority Interest Holders
    
    
    (80
    )
    
    
    (128
    )Net Cash Used in Financing Activities
    
    
    (7,468
    )
    
    
    (5,001
    )Net Increase (Decrease) in Cash and Cash Equivalents
    
    
    5,968
    
    
    
    (3,060
    )Cash and Cash Equivalents at Beginning of Period
    
    
    4,082
    
    
    
    10,562Cash and Cash Equivalents at End of Period
    
    $
    10,050
    
    
    $
    7,502
 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 six-month periods ended March 31, 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 March
31, 2004 and 2003: Twelve MonthsEnergySouth, Inc.
    
    Ended March 31,In Thousands, Except Per Share Data
    
    2004
    
    2003Operating Revenues
    
    $
    113,860
    
    
    $
    92,308Cost of Gas
    
    
    39,837
    
    
    
    26,091Cost of Merchandise
    
    
    2,467
    
    
    
    2,665Operations and Maintenance Expense
    
    
    25,185
    
    
    
    24,430Depreciation Expense
    
    
    9,253
    
    
    
    8,496Taxes, Other Than Income Taxes
    
    
    7,999
    
    
    
    6,927Operating Income
    
    
    29,119
    
    
    
    23,699Interest
Income (Expense) - Net
    
    
    (8,130
    )
    
    
    (8,200
    )Allowance for Borrowed Funds Used
During Construction
    
    
    78
    
    
    
    2,231Less: Minority Interest
    
    
    (762
    )
    
    
    (735
    )Income Before Income Taxes
    
    $
    20,305
    
    
    $
    16,995Income Taxes
    
    
    7,662
    
    
    
    6,283Net Income
    
    $
    12,643
    
    
    $
    10,712Earnings Per ShareBasic
    
    $
    2.47
    
    
    $
    2.13Diluted
    
    $
    2.44
    
    
    $
    2.10Average Common Shares OutstandingBasic
    
    
    5,124
    
    
    
    5,035Diluted
    
    
    5,184
    
    
    
    5,104
 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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Three Months
    
    Six MonthsEnergySouth, Inc.
    
    Ended March 31,
    
    Ended March 31,In Thousands, Except per Share Data
    
    2004
    
    2003
    
    2004
    
    2003Net Income, as reported
    
    $
    6,372
    
    
    $
    5,559
    
    
    $
    10,440
    
    
    $
    8,933Deduct:Total stock-based employee compensation
expense determined under fair value based
method for all awards, net of related tax effects
    
    
    41
    
    
    
    33
    
    
    
    88
    
    
    
    75Pro forma net income
    
    $
    6,331
    
    
    $
    5,526
    
    
    $
    10,352
    
    
    $
    8,858Earnings per share:Basic - as reported
    
    $
    1.24
    
    
    $
    1.10
    
    
    $
    2.03
    
    
    $
    1.77Basic - pro forma
    
    $
    1.23
    
    
    $
    1.09
    
    
    $
    2.01
    
    
    $
    1.75Diluted - as reported
    
    $
    1.22
    
    
    $
    1.09
    
    
    $
    2.01
    
    
    $
    1.75Diluted - pro forma
    
    $
    1.21
    
    
    $
    1.08
    
    
    $
    1.99
    
    
    $
    1.73
 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 March 31, (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
    
    $
    (80
    )
    
    $
    (135
    )
    
    $
    13
    
    
    $
    27


Pension
    
    PostretirementBenefits
    
    BenefitsFor the six months ended March 31, (in thousands)

    2004
    
    2003
    
    2004
    
    2003Service cost
    
    $
    429
    
    
    $
    346
    
    
    $
    59
    
    
    $
    50Interest cost
    
    
    782
    
    
    
    763
    
    
    
    125
    
    
    
    128Amortization of transition asset
    
    
    (64
    )
    
    
    (92
    )Amortization of prior service cost
    
    
    47
    
    
    
    47
    
    
    
    (22
    )
    
    
    (22
    )Amortization of unrecognized (gain)/loss
    
    
    (64
    )
    
    
    (178
    )
    
    
    6
    
    
    
    3Expected return on plan assets
    
    
    (1,289
    )
    
    
    (1,156
    )
    
    
    (141
    )
    
    
    (106
    )Net periodic benefit cost
    
    $
    (160
    )
    
    $
    (270
    )
    
    $
    26
    
    
    $
    53


For fiscal year 2004, the Company does not anticipate making any contributions
to its pension plan due to the fact 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. Under RSE, the APSC conducts quarterly reviews to
determine, based on Mobile Gas projections and fiscal year-to-date
performance, whether Mobile Gas return on equity is expected to be within the
allowed range of 13.35% to 13.85%. Reductions in rates can be made quarterly
to bring the projected return within the allowed range; increases, however, are
allowed only once each fiscal year, effective December 1, and cannot exceed
four percent of prior-year revenues. Mobile Gas rate adjustments, which became
effective December 1, 2003 and 2002, were designed to increase annual revenues
by approximately $2.8 million and $2.2 million, 10




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respectively. 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 six-month periods ended March 31, 2004. The ESR
balance of $854,000 at March 31, 2004 is included in the 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. 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): 11




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##### Table of Contents



March 31, 2004
    
    March 31, 2003
    
    September 30, 2003Current
    
    Noncurrent
    
    Current
    
    Noncurrent
    
    Current
    
    NoncurrentAssetsProperty, Plant, and Equipment
    
    $
    53
    
    
    
    
    
    
    $
    85
    
    
    $
    53
    
    
    $
    85
    
    
    $
    10Deferred Purchase Gas Adjustment
    
    
    1,868
    
    
    
    
    
    
    
    1,632
    
    
    
    
    
    
    
    2,533ESR Fund
    
    
    167
    
    
    
    584
    
    
    
    167
    
    
    
    750
    
    
    
    167
    
    
    
    666Bad Debt Reserve
    
    
    133
    
    
    
    199
    
    
    
    133
    
    
    
    331
    
    
    
    133
    
    
    
    265Other
    
    
    27
    
    
    
    41
    
    
    
    27
    
    
    
    68
    
    
    
    27
    
    
    
    55Regulatory Assets
    
    $
    2,248
    
    
    $
    824
    
    
    $
    2,044
    
    
    $
    1,202
    
    
    $
    2,945
    
    
    $
    996LiabilitiesBad Debt Reserve
    
    $
    31
    
    
    $
    10
    
    
    $
    49
    
    
    $
    40
    
    
    $
    40
    
    
    $
    20ESR Fund
    
    
    854
    
    
    
    
    
    
    
    1,000
    
    
    
    
    
    
    
    854Asset Retirement Obligations
    
    
    
    
    
    
    11,246
    
    
    
    
    
    
    
    10,432
    
    
    
    
    
    
    
    10,825Deferred Investment Tax Credit
    
    
    15
    
    
    
    144
    
    
    
    15
    
    
    
    160
    
    
    
    15
    
    
    
    153Regulatory Liabilities
    
    $
    900
    
    
    $
    11,400
    
    
    $
    1,064
    
    
    $
    10,632
    
    
    $
    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 63,000 and 58,000 for the three months ended March 31, 2004 and 2003,
respectively, and 63,000 and 60,000 for the six months ended March 31, 2004 and
2003. These differences in equivalent shares are from outstanding stock
options. Note 7. 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 12




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##### Table of Contents



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. For the three months ended
    
    Natural Gas
    
    Natural GasMarch 31, 2004 (in thousands):
    
    Distribution
    
    Storage
    
    Other
    
    Eliminations
    
    ConsolidatedOperating Revenues
    
    $
    38,466
    
    
    $
    4,397
    
    
    $
    1,043
    
    
    $
    (1,061
    )
    
    $
    42,845Cost of Gas
    
    
    18,696
    
    
    
    
    
    
    
    
    
    
    
    (1,061
    )
    
    
    17,635Cost of Merchandise
    
    
    
    
    
    
    
    
    
    
    616
    
    
    
    
    
    
    
    616Operations and Maintenance Expense
    
    
    5,667
    
    
    
    798
    
    
    
    449
    
    
    
    
    
    
    
    6,914Depreciation Expense
    
    
    1,828
    
    
    
    606
    
    
    
    
    
    
    
    
    
    
    
    2,434Taxes, Other Than Income Taxes
    
    
    2,577
    
    
    
    202
    
    
    
    18
    
    
    
    
    
    
    
    2,797Operating Income
    
    
    9,698
    
    
    
    2,791
    
    
    
    (40
    )
    
    
    
    
    
    
    12,449Interest Income
    
    
    3
    
    
    
    10
    
    
    
    
    
    
    
    (5
    )
    
    
    8Interest Expense
    
    
    (803
    )
    
    
    (1,126
    )
    
    
    (68
    )
    
    
    5
    
    
    
    (1,992
    )Allow. for Borrowed Funds Used
During Construction
    
    
    4
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4Less: Minority Interest
    
    
    (44
    )
    
    
    (155
    )
    
    
    
    
    
    
    
    
    
    
    (199
    )Income Before Income Taxes
    
    $
    8,858
    
    
    $
    1,520
    
    
    $
    (108
    )
    
    
    
    
    
    $
    10,270
 For the three months ended
    
    Natural Gas
    
    Natural GasMarch 31, 2003 (in thousands):
    
    Distribution
    
    Storage
    
    Other
    
    Eliminations
    
    ConsolidatedOperating Revenues
    
    $
    32,459
    
    
    $
    3,186
    
    
    $
    1,030
    
    
    $
    (1,071
    )
    
    $
    35,604Cost of Gas
    
    
    14,215
    
    
    
    
    
    
    
    
    
    
    
    (1,059
    )
    
    
    13,156Cost of Merchandise & Jobbing
    
    
    
    
    
    
    
    
    
    
    540
    
    
    
    
    
    
    
    540Operations and Maintenance Expense
    
    
    5,632
    
    
    
    607
    
    
    
    378
    
    
    
    (12
    )
    
    
    6,605Depreciation Expense
    
    
    1,756
    
    
    
    513
    
    
    
    
    
    
    
    
    
    
    
    2,269Taxes, Other Than Income Taxes
    
    
    2,253
    
    
    
    171
    
    
    
    8
    
    
    
    
    
    
    
    2,432Operating Income
    
    
    8,603
    
    
    
    1,895
    
    
    
    104
    
    
    
    
    
    
    
    10,602Interest Income
    
    
    6
    
    
    
    11
    
    
    
    3
    
    
    
    
    
    
    
    20Interest Expense
    
    
    (899
    )
    
    
    (1,171
    )
    
    
    (33
    )
    
    
    
    
    
    
    (2,103
    )Allow. for Borrowed Funds Used
During Construction
    
    
    11
    
    
    
    584
    
    
    
    
    
    
    
    
    
    
    
    595Less: Minority Interest
    
    
    (74
    )
    
    
    (123
    )
    
    
    
    
    
    
    
    
    
    
    (197
    )Income Before Income Taxes
    
    $
    7,647
    
    
    $
    1,196
    
    
    $
    74
    
    
    
    
    
    
    $
    8,917
 13




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##### Table of Contents



For the six months ended
    
    Natural Gas
    
    Natural GasMarch 31, 2004 (in thousands):
    
    Distribution
    
    Storage
    
    Other
    
    Eliminations
    
    ConsolidatedOperating Revenues
    
    $
    66,486
    
    
    $
    8,716
    
    
    $
    2,471
    
    
    $
    (2,111
    )
    
    $
    75,562Cost of Gas
    
    
    31,873
    
    
    
    
    
    
    
    
    
    
    
    (2,111
    )
    
    
    29,762Cost of Merchandise
    
    
    
    
    
    
    
    
    
    
    1,350
    
    
    
    
    
    
    
    1,350Operations and Maintenance Expense
    
    
    10,890
    
    
    
    1,527
    
    
    
    929
    
    
    
    
    
    
    
    13,346Depreciation Expense
    
    
    3,656
    
    
    
    1,212
    
    
    
    
    
    
    
    
    
    
    
    4,868Taxes, Other Than Income Taxes
    
    
    4,613
    
    
    
    400
    
    
    
    37
    
    
    
    
    
    
    
    5,050Operating Income
    
    
    15,454
    
    
    
    5,577
    
    
    
    155
    
    
    
    
    
    
    
    21,186Interest Income
    
    
    5
    
    
    
    19
    
    
    
    
    
    
    
    (10
    )
    
    
    14Interest Expense
    
    
    (1,633
    )
    
    
    (2,265
    )
    
    
    (134
    )
    
    
    10
    
    
    
    (4,022
    )Allow. for Borrowed Funds Used
During Construction
    
    
    12
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    12Less: Minority Interest
    
    
    (87
    )
    
    
    (308
    )
    
    
    
    
    
    
    
    
    
    
    (395
    )Income Before Income Taxes
    
    $
    13,751
    
    
    $
    3,023
    
    
    $
    21
    
    
    
    
    
    
    $
    16,795
 For the six months ended
    
    Natural Gas
    
    Natural GasMarch 31, 2003 (in thousands):
    
    Distribution
    
    Storage
    
    Other
    
    Eliminations
    
    ConsolidatedOperating Revenues
    
    $
    54,730
    
    
    $
    6,216
    
    
    $
    2,498
    
    
    $
    (2,126
    )
    
    $
    61,318Cost of Gas
    
    
    22,887
    
    
    
    
    
    
    
    
    
    
    
    (2,104
    )
    
    
    20,783Cost of Merchandise & Jobbing
    
    
    
    
    
    
    
    
    
    
    1,354
    
    
    
    
    
    
    
    1,354Operations and Maintenance Expense
    
    
    10,714
    
    
    
    1,071
    
    
    
    825
    
    
    
    (22
    )
    
    
    12,588Depreciation Expense
    
    
    3,512
    
    
    
    1,027
    
    
    
    
    
    
    
    
    
    
    
    4,539Taxes, Other Than Income Taxes
    
    
    3,959
    
    
    
    341
    
    
    
    29
    
    
    
    
    
    
    
    4,329Operating Income
    
    
    13,658
    
    
    
    3,777
    
    
    
    290
    
    
    
    
    
    
    
    17,725Interest Income
    
    
    13
    
    
    
    24
    
    
    
    2
    
    
    
    
    
    
    
    39Interest Expense
    
    
    (1,814
    )
    
    
    (2,341
    )
    
    
    (60
    )
    
    
    
    
    
    
    (4,215
    )Allow. for Borrowed Funds Used
During Construction
    
    
    18
    
    
    
    1,148
    
    
    
    
    
    
    
    
    
    
    
    1,166Less: Minority Interest
    
    
    (147
    )
    
    
    (239
    )
    
    
    
    
    
    
    
    
    
    
    (386
    )Income Before Income Taxes
    
    $
    11,728
    
    
    $
    2,369
    
    
    $
    232
    
    
    
    
    
    
    $
    14,329
 Note 8. 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 9. 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 remnants of these
residuals are sometimes found at former gas manufacturing sites. 14




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##### Table of Contents



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. It is
anticipated that this assessment will be completed by mid-2004. 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 10. Accounting Principles In June 2001, the FASB issued Statement of Financial Accounting Standards No.
143, Accounting for Asset Retirement Obligations (SFAS 143). SFAS 143
addresses the recognition and measurement of a liability for an asset
retirement obligation and the associated asset retirement costs. It requires
that an existing legal obligation associated with the retirement of a tangible
long-lived asset be recognized as a liability when incurred and outlines the
method of measuring that liability. Management has determined that the Company
has no material legal obligations for the retirement of its assets. However,
the Company provides a provision, as part of its depreciation expense, for the
ultimate cost of asset retirements and removal. Removal costs are not a legal
obligation as defined by SFAS No. 143 but rather the result of cost-based
regulation and therefore are accounted for under provision of SFAS No. 71,
Accounting for the Effects of Certain Types of Regulation. Upon adoption of
SFAS No. 143 on October 1, 2002, the Company reclassified removal costs,
previously recognized within accumulated depreciation, that do not have an
associated legal retirement obligation as a regulatory liability, in accordance
with regulatory treatment. 15




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##### Table of Contents



Note 11. Subsequent Event 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 registered with the Securities and
Exchange Commission a total of 60,000 shares of common stock of the Company to
be reserved for issuance in satisfaction of the deferred compensation
obligations. The Company has established a non-qualified grantor trust (the Trust) to assist
in meeting obligations under the Plan. On April 2, 2004, the Company issued
36,727 shares of common stock to fund the Trust. 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. 16




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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 six months ended March 31, 2004
increased $0.13 and $0.26, increases of 12% and 15%, respectively, as compared
to the same prior year periods due 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 7 to the unaudited
Consolidated Financial Statements above. Earnings from the Companys natural gas distribution business increased $0.13
and $0.22, per share, respectively, for the three and six-month periods ended
March 31, 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. Increased margins during the
current year three and six-month periods were partially offset by increased
operating expenses. The Companys natural gas storage business, operated by Bay Gas, contributed
increased earnings per share of $0.03 and $0.07, respectively, for the three
and six-month periods ended March 31, 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 were partially offset by additional operations and
maintenance costs, depreciation expense and property taxes due to the
completion of the second storage cavern. 17




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##### Table of Contents



Earnings from other business operations decreased $0.03 for each of the three
and six-month periods ended March 31, 2004 as compared to the same prior year
periods due to a decrease in the second quarter of fiscal year 2004 in interest
income from financing activities and additional reserves for bad debt and
slow-moving inventory. 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. See Note 5 to the Unaudited Condensed Consolidated
Financial Statements for a more detailed explanation. 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 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 $6,007,000 (19%) and $11,756,000
(22%), respectively, during the three and six-month periods ended March 31,
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. These
increases in revenues were slightly offset by a 4% decline in volumes delivered
to temperature-sensitive customers during the three and six-month periods due
to temperatures that were 8% and 10%, respectively, warmer than the same
periods last year and a slight decline in the number of temperature-sensitive
customers served during the current year periods. 18




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##### Table of Contents



Revenues from the sale of natural gas to large commercial and industrial
customers increased $366,000 (16%) and $469,000 (11%), respectively, for the
three and six-month periods ended March 31, 2004 as compared to the same prior
year periods due to the increase in the price of natural gas and the RSE
adjustments. The increases were partially offset by 10% and 19% declines,
respectively, in volumes delivered to these customers due to higher natural gas
prices and general economic conditions. The cost of natural gas increased $4,481,000 (32%) and $8,986,000 (39%),
respectively, for the three and six-month periods ended March 31, 2004 as
compared to the same prior year periods due to higher commodity gas prices.
Natural gas distribution margins increased for the three and six-month periods
ended March 31, 2004 primarily as a result of the RSE rate adjustments. Also,
consumption by temperature-sensitive customers, when adjusted for weather,
increased during the first two quarters of fiscal year 2004 compared to the
same prior year periods. These increases in margin were partially offset by a
slight decline in the number of temperature-sensitive customers served during
the current year periods 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 $97,000 (5%) and $175,000 (5%),
respectively, for the three and six-month periods ended March 31, 2004 as
compared to the same prior year periods with a corresponding decline in volumes
of 12% and 8%, 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 increased $35,000 (1%) and $176,000
(2%), respectively, for the three and six-month periods ended March 31, 2004 as
compared to the same prior year periods. On January 16, 2004, Mobile Gas
eliminated sixteen positions, primarily in its marketing and operations
divisions. Termination benefits were offered to those employees that included
a lump sum payment based upon their years of service with Mobile Gas,
outplacement services, one-on-one counseling and job search assistance. 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. O&M expenses for bad debt reserves increased $217,000 and $308,000,
respectively, during the three and six- month periods ended March 31, 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. Also contributing to
the increase in O&M expenses for the three and six month periods were increases
in each period in insurance and benefits expense. 19




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Partially offsetting the increase in O&M expenses for the three and six month
periods were reductions in promotional and advertising campaigns and
non-routine maintenance expenses which occurred in the prior year three month
period. Depreciation expense increased $72,000 (4%) and $144,000 (4%), respectively,
for the three and six-month periods ended March 31, 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
$324,000 (14%) and $654,000 (17%), respectively, for the three and six-month
periods ended March 31, 2004 due primarily to the increased revenues discussed
above. Interest expense decreased $96,000 (11%) and $181,000 (10%), respectively, for
the three and six-month periods ended March 31, 2004 as compared to the same
prior year periods due to a slight decline in short-term borrowing rates. 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 $30,000 (41%) and $60,000 (41%),
respectively, during the three and six-month periods ended March 31, 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 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. On March 4, 2004 in accordance with FERC filing requirements, Bay
Gas filed a petition with the FERC requesting approval of rates for
transportation-only service. The FERC last issued orders on October 11, 2001
and June 3, 2002 approving rates for such services. The construction of natural gas-fired electric generation facilities in the
Southeast has created opportunities to provide gas storage and transportation
services. Construction of Phase I of 20




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Bay Gas second storage cavern was
completed and the cavern was placed into service April 1, 2003. Bay Gas has
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. Currently, the second storage cavern has a working
capacity of 3.7 Bcf and will provide sufficient capacity to serve the new
long-term contract with Southern as well as other customers. 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 in fiscal 2004 without interruption of
storage operations. Bay Gas revenues increased $1,211,000 (38%) and $2,500,000 (40%),
respectively, during the three and six-month periods ended March 31, 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 8 to the Unaudited Condensed
Consolidated Financial Statements for additional information pertaining to the
option agreement. Operations and maintenance (O&M) expenses increased $191,000 (31%) and $456,000
(43%), respectively, during the three and six-month periods ended March 31,
2004 as compared to the same prior year periods primarily due to a general
increase in operating costs as a result of the expansion activities of Bay Gas. Depreciation expense increased $93,000 (18%) and $185,000 (18%), respectively,
for the three and six-month periods ended March 31, 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 $584,000 and $1,148,000, respectively, for the three
and six-month periods ended March 31, 2004 as compared to the same prior year
periods 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 $32,000 (26%) and $69,000
(29%), respectively, during the three and six- 21




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month periods ended March 31,
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 7 to the Unaudited Condensed Consolidated Financial Statements above
for segment disclosure. Income before income taxes from Other business activities decreased $182,000
and $211,000 for the three and six-month periods ended March 31, 2004 as
compared to the same prior year periods due to a decrease in interest income
from financing activities and the establishment of additional reserves for
slow-moving merchandise inventory and bad debt reserves associated with
financing activities during the second quarter of fiscal year 2004. Income Taxes Income taxes fluctuate with the change in income before income taxes. Income
tax expense increased $540,000 (16%) and $959,000 (18%), respectively, for the
three and six-month periods ended March 31, 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 Consolidated Statements of Cash
Flows. Cash provided by operating activities increased $7.8 million during the
six-month period ended March 31, 2004 as compared to the same period last year
due primarily to collections of increased gas costs from customers. 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 six months ended March 31, 2004 and 2003, the
Company used cash of $4.1 million and $7.8 million, respectively, for the
construction of distribution and storage facilities, purchases of equipment and
other general improvements. Also included in the $4.0 million is Mobile Gas
acquisition of a natural gas distribution system located in Mt. Vernon, Alabama
located just north of its service territory and costs associated with the
continuing expansion of Bay Gas second cavern. 22




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Financing activities used cash of $7.5 and $5.0 million during the six months
ended March 31, 2004 and 2003, respectively. The $2.5 million change in
financing activities is due primarily to repayments of long-term debt,
including an additional principal payment of $1.7 million allowed under Mobile
Gas 7.27% Series First Mortgage Bond Agreement. 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 March 31, 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. The table below summarizes the Companys contractual obligations and commercial
commitments as of March 31, 2004: Type of Contractual
    
    
    RemainingFiscal Year
    
    Fiscal Year
    
    Fiscal Year
    
    Fiscal Year
    
    Fiscal Year
    
    Fiscal Years2009 andObligations (in thousands):
    
    

    2004
    

    2005
    

    2006
    
    2007
    
    2008
    
    thereafterLong-Term Debt
    
    
    $
    2,916
    
    
    $
    6,248
    
    
    $
    6,463
    
    
    $
    6,769
    
    
    $
    5,300
    
    
    $
    66,160Gas Supply Contracts
    
    
    
    353
    
    
    
    1,169
    
    
    
    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 23




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##### Table of Contents



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
governmental agencies. 24




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Item 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK At March 31, 2004 the Company had approximately $93.9 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. 25




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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-K
  On January 30, 2004, EnergySouth, Inc. filed its current report on
Form 8-K reporting earnings for the quarter ended December 31, 2003
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:      May 17, 2004
    
    /s/ John S.Davis
John S. Davis
President and
Chief Executive OfficerDate:      May 17, 2004
    
    /s/ Charles P.Huffman
Charles P. Huffman
Senior Vice President and
Chief Financial Officer
 26