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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended June 30, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _______________ to _______________
Commission File number 0-14183
ENERGY WEST, INCORPORATED
(Exact name of registrant as specified in its charter)
Montana 81-0141785
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1 First Avenue South, Great Falls, Montana 59401
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (406) 791-7500
Securities to be registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Title of each class
Common Stock - Par Value $.15
Preferred Stock Purchase Rights
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 [ ] No [X]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K [ ].
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [ ] No [X].
The aggregate market value of the voting stock held by non-affiliates of the
registrant as of December 31, 2003: Common Stock, $.15 Par Value - $15,448,829.
The number of shares outstanding of the registrant's classes of common stock as
of December 15, 2004: Common Stock, $.15 Par Value - 2,596,422 shares.
1
PART I
ITEM 1. - BUSINESS
GENERAL
Energy West, Incorporated (the "Company") is a regulated public utility,
with certain non-utility operations conducted through its subsidiaries. The
Company was originally incorporated in Montana in 1909. The Company has four
business segments:
Natural Gas Operations Distribute natural gas to approximately 33,000
customers through regulated utilities operating in and
around Great Falls and West Yellowstone, Montana, and
Cody, Wyoming. The approximate population of the
service territories is 100,000.
Propane Operations Distribute propane to approximately 7,600 customers
through regulated utilities operating underground vapor
systems in and around Payson, Pine and Strawberry,
Arizona. Non-regulated operations include retail
distribution of bulk propane to approximately 2,200
customers in the same Arizona communities. The
approximate population of the service territories is
40,000.
Energy West Resources, Inc. Market approximately 3 billion cubic feet ("BCF") of
(EWR) natural gas to commercial and industrial customers in
Montana and Wyoming and manage midstream supply
and production assets for transportation customers and
utilities. EWR also has an ownership interest in
production and gathering assets.
Pipeline Operations (Energy Owns the Shoshone interstate and the Glacier gathering
West Development, Inc. pipeline assets located in Montana and Wyoming.
(EWD)) Certain natural gas producing wells owned by EWD are
being operated, managed, and reported in EWR.
See Note 10 to the Consolidated Financial Statements for summary results of
operations for each of the Company's segments and total assets.
2
RECENT DEVELOPMENTS
RESTATEMENT OF FINANCIAL RESULTS
On September 29, 2004, the Company announced that it was delaying the
filing of its Annual Report on Form 10-K in order to complete a review of the
accounting for certain contracts. Based on the results of its review, the
Company has corrected its accounting and previous valuation of certain of EWR's
contracts for fiscal years 2002 and 2003, and the first three quarters of fiscal
year 2004, and has restated its earnings for those periods.
The Company's review of EWR's contracts included an evaluation of a gas
purchase agreement and a gas sales agreement entered into during fiscal year
2002 involving counterparties who are affiliated with each other. The gas
purchase agreement has previously been reflected in the Company's financial
statements as a derivative asset. The gas sales agreement was previously
classified by the Company as a normal sales contract, and therefore was not
reflected on the Company's financial statements as a derivative liability. The
Company determined that a shorter period similar to that of the gas sales
agreement should have been used in the determination of the fair value of the
gas purchase agreement and that the gas sales agreement does not qualify for the
"normal purchase and sale" exception. As a result the consolidated financial
statements have been restated to reflect a significant reduced fair value for
the gas purchase agreement and the gas sales agreement as a derivative liability
at its estimated fair value.
3
In the course of its review, the Company also determined that the fair
value of a small gas purchase contract and a small gas sales contract entered
into by EWR during the fiscal quarter ended December 31, 2003, had not been
properly reflected in the Company's unaudited quarterly financial statements.
The Company has reflected the fair value of these contracts in its restated
quarterly financial information.
None of the adjustments affects the Company's cash flows or cash
balances. The Company's cumulative gain (loss) in the portfolio of contracts
valued on a mark-to-market basis will be realized in later periods as contracts
settle or are performed and/or as natural gas prices change. See Note 15 of the
Consolidated Financial Statements included in Item 8 of this Annual Report on
Form 10-K.
4
AMENDMENTS TO LOAN AGREEMENT
As of August 30, 2004, the Company and its lender under its credit
facility (the "LaSalle Facility") amended certain covenants as follows: (1)
increased the total debt to capital ratio from .65 to .70, (2) allowed the
inclusion of certain expenses incurred by the Company for legal fees and costs
of the PPLM litigation, expenses and costs associated with the credit
facilities, proxy contest costs, and the costs of adoption of the shareholder
rights plan, in determining the interest coverage ratio, and (3) waived
compliance with the ratios referred to in (1) and (2) above as of June 30, 2004
in addition to a shareholder's acquisition of more than 15% of the outstanding
common stock of the Company.
As of September 10, 2004, the LaSalle Facility was amended to extend from
September 30, 2004 until October 31, 2004, the deadline for the Company to repay
the $2,000,000 term loan under the LaSalle Facility, with an infusion of new
equity.
On October 20, 2004, but effective as of September 28, 2004, the LaSalle
Facility was amended to extend until October 29, 2004, the deadline for the
Company to deliver its audited financial statements for the fiscal year ended
June 30, 2004.
On November 2, 2004, the Company executed a letter agreement effective as
of September 28, 2004 amending the LaSalle Facility. The letter agreement
provides for the extension of the deadline to deliver audited financial
statements for fiscal year 2004 from October 29, 2004 to November 12, 2004.
As of November 2, 2004, the Company executed an amendment to the LaSalle
Facility, which provides for an extension from October 31, 2004 to November 30,
2004 of the deadlines under the LaSalle Facility in connection with: (i) the
termination date of the revolving facility and
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(ii) the date to consummate infusions of new equity of at least $2.0 million to
repay the $2.0 million term loan under the LaSalle Facility.
As of November 30, 2004, the Company executed an agreement with its
lender providing for (i) an extension of the revolving facility until
November 28, 2005; (ii) an extension of the date to consummate infusions of new
equity of at least $2.0 million and to repay the $2.0 million term loan to
October 1, 2005; (iii) a conditional waiver of the deadline to deliver audited
financial statements for fiscal year 2004 and the deadline to deliver financial
statements for the fiscal quarter ended September 30, 2004; (iv) a waiver of
the technical default that otherwise would have been caused by the restatement
of financial results of prior periods; (v) modification of interest rates
applicable to the $2.0 million term loan; (vi) a limitation of $1.0 million on
total loans and additional capital investment from the Company to EWR; and
(vii) waivers of certain financial covenant defaults as of September 30, 2004.
The following tables representing revenues for all operating segments are
after all intercompany eliminations, by customer class for the fiscal year
ended June 30, 2004 and the two preceding fiscal years.
NATURAL GAS OPERATIONS
The Company's natural gas operations consist of two divisions. The Montana
Division serves customers with operations in Great Falls, West Yellowstone, and
Cascade, Montana. It also manages certain storage and vaporization facilities in
Cascade, Montana for Energy West Propane. The Wyoming Division serves customers
in and around Cody, Meeteetse and Ralston, Wyoming. Generally, residential
customers use natural gas for space heating and water heating; commercial
customers use natural gas for space heating and cooking; and industrial
customers use natural gas as a fuel in industrial processing and space heating.
The Company's revenues from natural gas operations are generated under tariffs
regulated by the state utility commissions of Montana and Wyoming. The Montana
division received an interim order from the Montana Public Service Commission
("MPSC") effective January 1, 2004 for a rate increase for the Great Falls
operations due to increased property taxes. The MPSC approval of this increase
did not cover the entire tax increase experienced by the Company due to an
interpretation by the MPSC of a statute that permits such increases on an
after-tax basis. The Company has filed for a general rate increase which
includes the net of tax effect mentioned above. The Company has entered into a
stipulation agreement with the Montana Consumer Council ("MCC") and has received
an interim order from MPSC adopting the stipulation. The interim rate increase
was effective November 1, 2004 and is estimated to provide additional gross
margin of approximately $800,000 annually. In addition, an interim order for the
West Yellowstone general rate filing was approved for approximately $200,000
annually and became effective on November 1, 2004.
NATURAL GAS - MONTANA DIVISION
The Natural Gas - Montana division provides natural gas service to
customers in and around Great Falls and West Yellowstone, Montana and manages an
underground vapor system in Cascade, Montana. The division's service area has a
population of approximately 79,000 in the Great Falls area, 1,200 in the West
Yellowstone area and approximately 900 in the Cascade area.
The division has a franchise to distribute natural gas within the city of
Great Falls that expires in 2021. The division also provides natural gas
transportation service to certain customers who purchase natural gas from other
suppliers.
6
The following table shows the Natural Gas - Montana division's revenues by
customer class for the fiscal year ended June 30, 2004 and the two preceding
fiscal years:
GAS REVENUE
(in thousands)
Year Ended June 30,
-------------------
2004 2003 2002
---- ---- ----
Residential $16,427 $13,643 $17,563
Commercial 9,918 8,383 10,443
Transportation 1,856 1,789 1,958
------- ------- -------
Total $28,201 $23,815 $29,964
======= ======= =======
Note: Revenue increased in fiscal year 2004 compared to fiscal year 2003 due to
increases in gas pricing and rate relief from approved rate cases in
Montana. Revenues were lower in fiscal year 2003 compared to fiscal year
2002 due to termination of a surcharge for collection of previously
unrecovered gas costs and a lower volume of sales due to warmer than
normal temperatures.
The following table shows the volumes of natural gas, expressed in
millions of cubic feet (MMCF) sold or transported by the division for the fiscal
year ended June 30, 2004 and the two preceding fiscal years:
GAS VOLUMES
(MMcf)
Year Ended June 30,
-------------------
2004 2003 2002
---- ---- ----
Residential 2,206 2,267 2,417
Commercial 1,317 1,359 1,442
Transportation 1,443 1,462 1,522
----- ----- -----
Total Gas Sales 4,966 5,088 5,381
===== ===== =====
The Natural Gas - Montana division has 173 transportation customers. No
customer of the Natural Gas - Montana division accounted for more than 2% of the
consolidated revenues of the Company in fiscal 2004.
The operations of the Natural Gas - Montana division are subject to
regulation by the MPSC. The MPSC regulates rates, adequacy of service, issuance
of securities, compliance with U.S. Department of Transportation safety
regulations and other matters.
7
The MPSC allows customers to choose a natural gas supplier other than the
Energy West Natural Gas - Montana division, but the division provides gas
transportation to customers who purchase from other suppliers.
The Natural Gas - Montana division uses the NorthWestern Energy ("NWE")
pipeline transmission system to transport supplies of natural gas for its core
load and to provide transportation, distribution and balancing services to
customers who have chosen to obtain natural gas from other suppliers. In 2000,
the Company entered into a ten-year transportation agreement with NWE that fixes
the cost of pipeline and storage capacity for the Natural Gas - Montana
division.
The Natural Gas - Montana division files monthly gas trackers that adjust
the gas cost recovery component of its rates to current market pricing. This
process is designed to keep deferred gas cost balances at minimum expected
levels.
NATURAL GAS - WYOMING DIVISION
The Natural Gas - Wyoming division provides natural gas service to
customers in and around Cody, Meeteetse and Ralston, Wyoming. This service area
has a population of approximately 12,000. The Natural Gas - Wyoming division has
a certificate of public convenience and necessity granted by the Wyoming Public
Service Commission ("WPSC") for transportation and distribution covering the
west side of the Big Horn Basin, which extends approximately 70 miles north and
south and 40 miles east and west from Cody. As of June 30, 2004, the Natural Gas
- - Wyoming division provided service to 5,860 customers, including one industrial
customer. The division also offers transportation through its system. This
service is designed to permit producers and other purchasers of gas to transport
their gas to markets outside of the division's distribution and transmission
system.
8
The following table shows the Natural Gas - Wyoming division's revenues by
customer class for the fiscal year ended June 30, 2004 and the two preceding
fiscal years:
GAS REVENUE
(in thousands)
Year Ended June 30,
-------------------
2004 2003 2002
---- ---- ----
Residential $ 4,149 $3,119 $3,434
Commercial 3,606 2,591 3,035
Industrial 3,107 2,102 3,044
Transportation - - 38
------- ------ ------
Total $10,862 $7,812 $9,551
======= ====== ======
Note: Higher revenues were realized in fiscal year 2004 compared to fiscal
year 2003 due to a general rate increase approved by Wyoming Public
Service Commission at the end of fiscal year 2003 as well as higher
commodity pricing in fiscal year 2004. Lower revenues were realized
in fiscal year 2003 compared to fiscal year 2002 due to warmer than
normal temperatures and reduced sales to a large industrial
customer.
The following table shows volumes of natural gas, expressed in MMCF, sold
by the Natural Gas - Wyoming division for the fiscal year ended June 30, 2004
and the two preceding fiscal years:
GAS VOLUMES
(MMcf)
Year Ended June 30,
-------------------
2004 2003 2002
---- ---- ----
Residential 515 541 564
Commercial 540 531 550
Industrial 568 525 610
Transportation 1,280 1,383 1,588
----- ----- -----
Total Gas Sales 2,903 2,980 3,312
===== ===== =====
The Natural Gas - Wyoming division has an industrial customer whose gas
sales rates are subject to an industrial tariff, which provides for lower
incremental prices as higher volumes are used. In fiscal year 2004 this customer
accounted for approximately 28% of the revenues of the Natural Gas - Wyoming
division and approximately 8% of the consolidated revenues of the Natural Gas
segment. This customer's business is cyclical and dependent on the level of
national housing
9
starts. Gross revenues from this customer in fiscal year 2004 increased
approximately 48% over revenues in fiscal year 2003.
EWR is the Natural Gas - Wyoming division's supplier of natural gas,
pursuant to a three year agreement entered into in May of 2003.
The Natural Gas - Wyoming division transports gas for third parties
pursuant to a tariff filed with and approved by the WPSC. The terms of the
transportation tariff (currently between $.08 and $.31 per MCF) are approved by
the WPSC.
The Natural Gas - Wyoming division's revenues are generated under
regulated tariffs designed to recover a base cost of gas and administrative and
operating expenses and provide a sufficient rate of return to cover interest and
profit. The division's tariffs include a purchased gas adjustment clause which
allows the division to adjust rates periodically to recover changes in gas costs
from base gas costs. The Wyoming division received an approval from the WPSC for
a general rate increase effective June 1, 2003, which the Company estimates will
provide increased revenues of $722,000 annually.
PROPANE OPERATIONS
The Company reports as a separate business segment the regulated and
unregulated distribution of propane.
REGULATED PROPANE OPERATIONS
The Company is engaged in the regulated sale of propane under the business
name Energy West Arizona ("EWA"). EWA distributes propane in the Payson, Pine,
and Strawberry, Arizona area located about 75 miles northeast of Phoenix in the
Arizona Rim Country. The service area of EWA includes approximately 575 square
miles and has a population of approximately 31,000. The operations of EWA are
subject to regulation by the Arizona Corporation Commission ("ACC"), which
regulates rates, adequacy of service, and other matters. EWA's properties
include approximately 170 miles of underground distribution pipeline and an
office building leased from a third party. EWA purchases propane from the
Company's unregulated subsidiary, Energy West Propane, Inc. ("EWP"), under terms
reviewed periodically by the ACC. EWA has approximately 7,600 regulated
customers. Annual customer growth has averaged roughly 8% for the last five
years. The principal competition comes from bulk propane retailers who sell to
customers who use propane from storage tanks located at their homes or
businesses rather than using propane from EWA's underground distribution system.
10
The following tables show EWA revenues and propane volumes by customer
class for the fiscal year ended June 30, 2004 and the two preceding fiscal
years:
REGULATED PROPANE REVENUE
(in thousands)
Year Ended June 30,
-------------------
2004 2003 2002
---- ---- ----
Residential $3,844 $3,729 $3,384
Commercial 1,785 1,629 1,520
------ ------ ------
Total $5,629 $5,358 $4,904
====== ====== ======
REGULATED PROPANE VOLUME
(in thousands of gallons)
Year Ended June 30,
-------------------
2004 2003 2002
---- ---- ----
Residential 2,818 2,874 2,678
Commercial 1,309 1,070 1,012
----- ----- -----
Total 4,127 3,944 3,690
===== ===== =====
UNREGULATED PROPANE OPERATIONS
EWP is engaged in the bulk sale of propane through its two divisions:
Energy West Propane-Arizona, which serves the Payson, Pine, and Strawberry,
Arizona area, and Rocky Mountain Fuels Wholesale ("RMF") which has wholesale
operations primarily in Montana and Arizona. EWP had 2,163 unregulated customers
as of June 30, 2004. Decreases in revenues, volumes, and customers are a result
of the sale of certain assets of RMF in August 2003.
EWP's wholesale division, RMF, supplies propane for the Company's
underground propane-vapor systems serving the cities of Cascade, Montana and
Payson, Arizona and surrounding areas. The majority of RMF's Wyoming and Montana
assets, including the Superior, Montana terminal were sold on August 21, 2003
for approximately $1,370,000. The Company realized a $252,000 before-tax gain on
the sale of these assets.
EWP faces competition from other propane distributors and suppliers of
alternative fuels that compete with propane. Competition is based primarily on
price and there is a high degree of competition with other propane distributors
in each of the Company's service areas.
11
The following tables show the revenues and volumes for unregulated propane
operations by customer class for the fiscal year ended June 30, 2004 and the two
preceding fiscal years:
UNREGULATED PROPANE REVENUE
(in thousands)
Year Ended June 30,
-------------------
2004 2003 2002
---- ---- ----
Residential $1,612 $1,426 $1,354
Commercial 495 6,002 4,398
------ ------ ------
Total $2,107 $7,428 $5,752
====== ====== ======
Note: Revenues decreased in fiscal year 2004 compared to fiscal year
2003 due to lost sales volumes from the sale of RMF's Superior
operation. The increase in revenue from fiscal year 2002 to
fiscal year 2003 was due to increased sales activity from
RMF's wholesale operations.
UNREGULATED PROPANE VOLUME
(in thousands of gallons)
Year Ended June 30,
-------------------
2004 2003 2002
---- ---- ----
Residential 917 912 901
Commercial 786 10,870 6,934
----- ------ -----
Total 1,703 11,782 7,835
----- ------ -----
EWR
The Company's wholly-owned subsidiary, EWR, conducts certain marketing
activities involving the sale of natural gas in Montana and Wyoming and
electricity in Montana.
Montana legislation and subsequent MPSC orders permit open access on the
NWE transportation systems, and other systems in Montana have presented
opportunities for EWR to conduct business as a broker of natural gas and
electricity. EWR has from time to time entered into certain financial agreements
that hedge against the risks of fluctuation in prices of natural gas and
electricity. If the price obtained through such instruments is favorable or
unfavorable compared to subsequent market conditions, net earnings or losses can
result from such arrangements. See Item 7, "Management's Discussion and Analysis
of Financial Condition and Results of Consolidated Operations -- Derivatives and
Risk Management." During fiscal year 2003, EWR exited the
12
electricity marketing business, with the exception of maintaining one customer,
delivering less than one MW per hour pursuant to a contract in effect through
fiscal year 2005.
In order to provide a stable source of natural gas for a portion of its
requirements, EWR and EWD purchased two groups of producing natural gas
properties consisting of 163 wells and three gathering systems located in north
central Montana. The purchases were made in May 2002 and March 2003. The wells
are depleting based upon current levels of production at approximately 10% per
year.
This production gives EWR a natural hedge due to fixed production expenses
when market prices of natural gas are above the cost of production. EWR's and
EWD's portion of estimated daily gas production from the properties is
approximately 920 MCF's per day, or 4.5% of EWR's present volume requirements.
PIPELINE OPERATIONS
Pipeline Operations was added as a new segment as of July 1, 2002. The
results of this segment reflect operation of the "Glacier" natural gas gathering
system placed in service in fiscal year 2001 and the "Shoshone" transmission
pipeline placed in service on July 3, 2003. Both pipelines have sections located
in Wyoming and Montana. The revenues and expenses associated with the pipelines
are included in the "Pipeline Operations" segment.
AVAILABLE INFORMATION
The internet address for the Company is: http://www.ewst.com. The Company
makes available, free of charge, on its internet website annual reports on Form
10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and additional
filings of the Company filed or furnished pursuant to Section 13(a) or 15(d) of
the Exchange Act as soon as reasonably practicable after these filings have been
made with the SEC.
13
COMPETITION
The traditional competition faced by the Company in its distribution and
sales of natural gas is from suppliers of alternative fuels, including
electricity, oil, propane and coal. Traditionally, the principal considerations
affecting a customer's selection of utility gas service over competing energy
sources include service, price, equipment costs, reliability and ease of
delivery. In addition, the type of equipment already installed in businesses and
residences significantly affects the customer's choice of energy. However, with
respect to the majority of the Company's service territory, previously installed
equipment is not an issue. Households in recent years have generally preferred
the installation of gas heat. For example, the Company estimates that
approximately 97% of the homes and businesses in the Great Falls, Montana
service area use natural gas as their primary source for space heating fuel;
approximately 93% use gas for water heating, and approximately 99% of the new
homes built on or near the Company's Great Falls, Montana service mains in
recent years have selected natural gas as their energy source. The Company's
operations in West Yellowstone and Cascade, Montana and the Payson / Strawberry
area of Arizona face more intense competition due to the cost of competing fuels
than the Company faces in the Great Falls area of Montana and the Company's
service territory in Wyoming.
The Natural Gas - Wyoming division estimates that approximately 95% of the
homes and businesses in its service area use natural gas for space heating fuel;
approximately 90% use gas for water heating, and approximately 99% of the new
homes built on or near the division's service mains in recent years have
selected gas as their energy source.
The Propane - Arizona division estimates that approximately 67% of the
homes and businesses adjacent to the division's distribution pipeline use the
division's propane for space heating or water heating. Studies show that
approximately 90% of new subdivisions within the division's distribution system
are using propane as their primary fuel source.
The principal competition faced by the Company and its subsidiaries in the
distribution and sale of propane is from electricity suppliers and other propane
distributors. Competition is based primarily on price and customer service and
there is a high degree of competition from other propane distributors in all of
the service areas.
EWR's principal competition is from other gas marketing firms doing
business in the State of Montana.
14
GOVERNMENTAL REGULATION
The Company's utility operations are subject to regulation by the MPSC,
the WPSC, FERC and the ACC. Such regulation plays a significant role in
determining the Company's return on equity. The commissions approve rates
intended to permit a reasonable rate of return on investment. The Company's
tariffs allow gas cost to be recovered in full (barring a finding of imprudence)
in regular (as often as monthly) rate adjustments. This mechanism may result in
some delay between the incurrence and recovery of increased gas costs. However,
recent adjustments in the mechanism in Montana have substantially reduced that
delay. In addition, an interim order for West Yellowstone's and Energy West
Montana's general rate filings was approved for approximately $200,000 and
approximately $800,000, respectively, on an annual basis, for services rendered
on and after November 1, 2004.
SEASONALITY
The business of the Company and its subsidiaries in all segments is
temperature-sensitive. In any given period, sales volumes reflect the impact of
weather, in addition to other factors, with colder temperatures generally
resulting in increased sales by the Company. The Company anticipates that this
sensitivity to seasonal and other weather conditions will continue to be
reflected in the Company's sales volumes in future periods.
ENVIRONMENTAL MATTERS
The Company owns property on which it operated a manufactured gas plant
from 1909 to 1928. The site is currently used as an office facility for Company
field personnel and storage location for certain equipment and materials. The
coal gasification process utilized in the plant resulted in the production of
certain by-products which have been classified by the federal government and the
State of Montana as hazardous to the environment.
The Company has completed its remediation of soil contaminants at the
plant site and in April of 2002 received a closure letter from Montana
Department of Environmental Quality ("MDEQ") approving the completion of such
remediation program.
The Company and its consultants continue to work with the MDEQ relating to
the remediation plan for water contaminants. The MDEQ has established
regulations that allow water contaminants at a site to exceed standards if it is
technically impracticable to achieve those standards. Although the MDEQ has not
established guidance respecting the attainment of a technical waiver, the U.S.
Environmental Protection Agency ("EPA") has developed such guidance. The EPA
guidance lists factors which render mediations technically impracticable. The
Company has filed a request for a waiver from complying with certain standards
with the MDEQ.
At June 30, 2004, the Company had incurred cumulative costs of
approximately $1,925,000 in connection with its evaluation and remediation of
the site. On May 30, 1995, the Company received an order from the MPSC allowing
for recovery of the costs associated with the evaluation and remediation of the
site through a surcharge on customer bills. As of June 30, 2004, the Company had
recovered approximately $1,440,000 through such surcharges. As of June 30, 2004,
the cost remaining to be recovered is $485,000.
15
On April 15, 2003, the MPSC issued an Order to Show Cause Regarding the
Environmental Surcharge. The MPSC determined that the initial order allowing the
collection of the surcharge was intended by the MPSC to cover only a two year
collection period, after which it would contemplate additional filings by the
Company, if necessary. The Company responded to the Show Cause Order and the
MPSC subsequently ordered the termination of the Environmental Surcharge on
August 20, 2003. The Company filed a request with the commission to continue the
collection of the surcharge until all expenses have been recovered. This request
was approved by the MPSC and the surcharge was reinstated in September 2004. The
Company is required, under the Commission's most recent order, to file with the
MPSC every two years for approval to continue the recovery of the surcharge.
EMPLOYEES
The Company and its subsidiaries had a total of 115 employees as of June
30, 2004. Three of these employees were employed by EWR, 24 by the Company's
Propane Operations, 76 by the Company's Natural Gas Operations and 12 at the
corporate office. The Company's Natural Gas Operations include 17 employees
represented by two labor unions. Contracts with each of these unions expire on
June 30, 2006. However, both unions have requested to reopen wage negotiations
in the current agreement pursuant to wage opener provisions. The Company is
involved in negotiations with the two labor unions on this issue.
EXECUTIVE OFFICERS
The following table sets forth the names, ages, and the positions and
offices presently held by the executive officers of the Company:
NAME AGE POSITION
David A. Cerotzke 54 President, Chief
Executive Officer and
Director
John C. Allen 53 Senior Vice-President,
General Counsel and
Secretary
Tim A. Good 59 Vice-President and Manager
of Natural Gas Operations
Douglas R. Mann 57 Vice-President and Manager
of Propane Operations
16
James E. Morin 50 President of Energy West
Resources, Inc.
M. Shawn Shaw 43 Principal Financial Officer
DAVID A. CEROTZKE was appointed President and Chief Executive Officer on July 1,
2004. He has been a member of the Board of Directors of the Company since
December 2003. Prior to joining the Company he was a consultant in the energy
industry from January 2003 to December 2003. From 1990 to 2003, he served in
various executive capacities, including Vice-President of Engineering,
Vice-President of Operations, Vice-President of Marketing and Treasurer of Nicor
Inc., a diversified energy holding company.
JOHN C. ALLEN was appointed Senior Vice-President, General Counsel and Secretary
on July 1, 2004. He served as Interim President and Chief Executive Officer from
September 22, 2003 to June 30, 2004. He joined the Company in 1986 as Corporate
Counsel and Secretary and was appointed General Counsel, Vice-President and
Secretary of the Company in 1992. Prior to joining Energy West he was a Staff
Attorney for the Montana Consumer Counsel from 1979 to 1986.
TIM A. GOOD has been the Vice-President of the Company and Manager of the
Company's Natural Gas Operations since July 1, 2000. He served as Vice President
and Division Manager of the Natural Gas - Wyoming Division from 1988 to July 1,
2000.
DOUGLAS R. MANN has been the Vice-President and Manager of the Company's Propane
Operations since July 1, 2000. From February 1999 until July 1, 2000, he served
as Vice-President and Manager of the EWA Division. From 1995 until July 1, 1999,
he served as Assistant Vice-President and Manager of the Arizona Division. He
joined Energy West in 1983, after a 14 year career in computer engineering and
technical sales.
JAMES E. MORIN has been President of EWR since February 2003. From July 2001 to
February 2003 he served as Vice-President of Electricity Marketing and from
August 1997 to July 2001 he served as Manager of Industrial and Commercial
Marketing for EWR.
M. SHAWN SHAW was appointed Principal Financial Officer effective September 10,
2004. He has served the Company as a Senior Accountant in various financial and
regulatory capacities since 1991.
ITEM 2. - PROPERTIES
The Company owns and leases properties located in the following states:
MONTANA: In Great Falls, Montana, the Company owns a 9,000 square foot office
building, which serves as the Company's headquarters, and a 3,000 square foot
service and operating center (with various outbuildings) which supports
day-to-day maintenance and construction operations. The Company owns
approximately 400 miles of underground distribution lines ("mains"), and related
metering and regulating equipment in and around Great Falls, Montana. In West
Yellowstone,
17
Montana, the Company owns an office building and a liquefied natural gas plant
that provides natural gas through approximately 13 miles of underground mains
owned by the Company. The Company owns approximately 10 miles of underground
mains in the town of Cascade, as well as two large propane storage tanks.
EWR and EWD combined own 163 natural gas production wells and three
gathering systems in north central Montana.
At June 30, 2003, EWD owned approximately 30 acres of real property in
Great Falls, Montana. The property was sold on September 8, 2003, and EWD
realized a pre-tax gain of approximately $121,000. During fiscal year 2003, EWD
purchased a 40% ownership interest in natural gas production properties in north
central Montana that provide approximately 350 MCF of natural gas daily for
resale.
WYOMING: In Cody, Wyoming, the Company leases office and service buildings for
the Natural Gas - Wyoming division under long-term lease agreements. The Company
owns approximately 500 miles of transmission and distribution mains and related
metering and regulating equipment, all of which are located in or around Cody,
Meeteetse and Ralston.
EWD owns two pipelines in Wyoming and Montana. One is currently being
operated as a gathering system. The other pipeline began operating as a natural
gas interstate transmission pipeline on July 3, 2003. The pipelines extend from
north of Cody, Wyoming to Warren, Montana.
ARIZONA: The Company owns approximately 170 miles of distribution mains located
in and around the community of Payson. The Company owns five acres of land in
Payson, on which the Company maintains and operates a propane vapor system for
its operations. The Company leases an office building in Payson under an
agreement that expires in 2006. The Company has the right to extend the lease
for two successive five year periods. EWP owns several large bulk propane tanks
and numerous customer tanks located in Pine, Strawberry, Payson and Star Valley,
which are used to serve customers in those communities and surrounding areas.
ITEM 3. - LEGAL PROCEEDINGS
From time to time the Company is involved in litigation relating to claims
arising from its operations in the normal course of business. The Company
utilizes various risk management strategies, including maintaining liability
insurance against certain risks, employee education and safety programs and
other processes intended to reduce liability risk.
In addition to other litigation referred to above, the Company or its
subsidiaries are involved in the following described litigation.
On June 17, 2003, EWR and PPL Montana, LLC ("PPLM") reached agreement on a
settlement of a lawsuit involving a wholesale electricity supply contract. Under
the terms of the settlement, EWR paid PPLM a total of $3,200,000, consisting of
an initial payment of $1,000,000 on June 17, 2003, and a second payment of
$2,200,000 on September 30, 2003, terminating all proceedings in the case. EWR
had established reserves and accruals in fiscal year 2001 of
18
approximately $3,032,000 to pay a potential settlement with PPLM and the
remaining $168,000 was charged to operating expenses in fiscal year 2003.
On August 8, 2003, the Company reached agreement with the Montana
Department of Revenue ("DOR") to settle a claim that the Company had
under-reported its personal property for the years 1997 - 2002 and that
additional property taxes and penalties should be assessed. The settlement
amount is being paid in ten annual installments of $243,000 each, beginning
November 30, 2003.
The Company initially determined that it was entitled to recover the
amounts paid in connection with the DOR settlement through future rate
adjustments as a result of legislation permitting "automatic adjustments" to
rates to recover such property tax increases. The MPSC, however, interpreted the
new legislation as allowing recovery of only a portion of the higher property
taxes. Rates recovering the portion of the higher taxes permitted under the
MPSC's interpretation of the legislation went into effect on January 1, 2004.
The Company has since obtained interim rate relief which includes full recovery
of the property tax associated with the DOR settlement.
ITEM 4. - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
19
PART II
ITEM 5. - MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS,
AND ISSUER PURCHASES OF EQUITY SECURITIES
Common Stock Prices and Dividend Comparison - Fiscal Years 2004 and 2003
Prior to October 19, 2004, shares of the Company's Common Stock were
traded on the Nasdaq National Market under the symbol "EWST." Effective as of
the opening of business on October 19, 2004, shares of the Company's Common
Stock are being traded on the Nasdaq National Market under the symbol "EWSTE."
The following table sets forth the high and low bid prices for the Company's
common stock. These prices reflect inter-dealer prices, without retail mark-up,
mark-down or commission, and may not necessarily represent the actual
transactions.
PRICE RANGE -- FISCAL YEAR 2004 HIGH LOW
- ------------------------------- ---- ---
First Quarter $ 7.89 $ 6.00
Second Quarter $ 7.79 $ 5.95
Third Quarter $ 7.60 $ 6.01
Fourth Quarter $ 8.50 $ 6.42
Year $ 8.50 $ 5.95
PRICE RANGE -- FISCAL YEAR 2003 HIGH LOW
- ------------------------------- ---- ---
First Quarter $ 9.79 $ 8.40
Second Quarter $ 8.89 $ 7.25
Third Quarter $ 9.00 $ 7.31
Fourth Quarter $ 8.74 $ 4.74
Year $ 9.79 $ 4.74
As of June 30, 2004, there were approximately 1,700 holders of record of
the Company's common stock.
DIVIDEND POLICY
The Board of Directors historically considered approving common stock
dividends for payments in March, June, September and January. On June 17, 2003,
the Company's Board of Directors suspended the payment of quarterly cash
dividends. The LaSalle Facility contains restrictions respecting the payment of
dividends. (See Item 7 "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Liquidity and Capital Resources").
Quarterly dividend payments per common share for fiscal years 2004 and 2003
were:
2004 2003
---- ----
First Quarter - $ 0.1350
Second Quarter - $ 0.1350
Third Quarter - $ 0.1350
Fourth Quarter - -
20
ITEM 6.- SELECTED FINANCIAL DATA
The following table contains certain selected historical consolidated
financial information and is qualified by the more detailed Consolidated
Financial Statements and Notes thereto included elsewhere in this Annual Report
on Form 10-K. The information below should be read in conjunction with the
Consolidated Financial Statements and Notes thereto and "Management's Discussion
and Analysis of Financial Conditions and Results of Operations" included
elsewhere in this Annual Report on Form 10-K. (Dollar amounts are in thousands,
except per share and number of shares.)
2004 (1) 2003 (2) 2002 (2) 2001 2000
-------- -------- -------- ---- ----
(Restated) (Restated)
(See Note 15 (See Note 15
to Consolidated to Consolidated
Financial Financial
Statements) Statements)
Operating results
Operating revenue $ 73,291 $ 77,898 $ 89,240 $ 111,612 $ 64,398
Operating expenses
Gas and electric purchases 57,911 62,520 74,590 90,173 50,800
General and administrative 10,170 11,669 8,790 12,095 7,649
Maintenance 480 497 466 428 400
Depreciation and amortization 2,332 2,393 2,059 1,970 1,856
Taxes other than income (3) 1,210 888 946 723 639
----------- ------------ -------------- ----------- -----------
Total operating expenses 72,103 77,967 86,851 105,389 61,344
----------- ------------ -------------- ----------- -----------
Operating income 1,188 (69) 2,389 6,223 3,054
Other income-net 385 302 658 282 449
Total interest charges (4) 2,498 1,633 1,704 2,097 1,674
----------- ------------ -------------- ----------- -----------
Income (loss) before taxes (925) (1,400) 1,343 4,408 1,829
Income tax expense (benefit) (369) (543) 516 1,643 708
----------- ------------ -------------- ----------- -----------
Net Income (Loss) ($ 556) ($ 857) $ 827 $ 2,765 $ 1,121
----------- ------------ -------------- ----------- -----------
Basic earnings (loss) per common share ($ 0.21) ($ 0.33) ($ 0.32) $ 1.11 $ 0.46
Diluted earnings (loss) per common share ($ 0.21) ($ 0.33) ($ 0.32) $ 1.10 $ 0.46
Dividends per common share (5) $ 0.00 $ 0.41 $ 0.52 $ 0.51 $ 0.49
Weighted average common shares
Outstanding - diluted 2,596,454 2,586,487 2,558,782 2,509,738 2,456,555
At year end:
Current assets $ 16,739 $ 15,790 $ 18,517 $ 26,621 $ 16,387
Total assets $ 61,445 $ 60,027 $ 57,295 $ 62,278 $ 51,194
Current liabilities $ 16,725 $ 21,833 $ 19,899 $ 24,416 $ 14,831
Total long-term obligations $ 21,697 $ 14,834 $ 15,367 $ 15,881 $ 16,395
Total stockholders' equity $ 13,401 $ 13,957 $ 15,699 $ 15,613 $ 13,786
----------- ------------ -------------- ----------- -----------
Total capitalization $ 35,098 $ 28,791 $ 31,066 $ 31,494 $ 30,181
=========== ============ ============== =========== ===========
21
(1) First three quarters as restated, See "Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operations - Restatement of
Financial Results" and Note 16 to the consolidated financial statements
for a comparison of previously reported and restated condensed quarterly
financial data.
(2) As restated. See "Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations - Restatement of Financial
Results" and Note 15 to the consolidated financial statements for a
summary of the significant effects of the restatement.
(3) Taxes other than income includes approximately $290,000 in the fiscal year
2004 for additional personal property taxes assessed by the Montana
Department of Revenue.
(4) Total interest charges reflect the costs associated with the addition of
$8,000,000 long-term debt incurred by the Company in March 2004.
(5) There have been no cash dividends paid subsequent to March 2003.
22
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF CONSOLIDATED OPERATIONS
RECENT DEVELOPMENTS
RESTATEMENT OF FINANCIAL RESULTS
On September 29, 2004, the Company announced that it was delaying the
filing of its Annual Report on Form 10-K in order to complete a review of the
accounting for certain contracts. Based on the results of its review, the
Company has corrected its accounting and previous valuation of certain of EWR's
contracts for fiscal years 2002 and 2003, and the first three quarters of fiscal
year 2004, and has restated its earnings for those periods.
The Company's review of EWR's contracts included an evaluation of a gas
purchase agreement and a gas sales agreement entered into during fiscal year
2002 involving counterparties who are affiliated with each other. The gas
purchase agreement has previously been reflected in the Company's financial
statements as a derivative asset. The gas sales agreement was previously
classified by the Company as a normal sales contract, and therefore was not
reflected on the Company's financial statements as a derivative liability. The
Company determined that a shorter period similar to that of the gas sales
agreement should have been used in the determination of the fair value of the
gas purchase agreement and that the gas sales agreement does not qualify for the
"normal purchase and sale" exception. As a result the consolidated financial
statements have been restated to reflect a significant reduced fair value for
the gas purchase agreement and the gas sales agreement as a derivative liability
at its estimated fair value.
23
In the course of its review, the Company also determined that the fair
value of a small gas purchase contract and a small gas sales contract entered
into by EWR during the fiscal quarter ended December 31, 2003, had not been
properly reflected in the Company's unaudited quarterly financial statements.
The Company has reflected the fair value of these contracts in its restated
quarterly financial information.
None of the adjustments affects the Company's cash flows or cash
balances. The Company's cumulative gain (loss) in the portfolio of contracts
valued on a mark-to-market basis will be realized in later periods as contracts
settle or are performed and/or as natural gas prices change. See Note 15 of the
Consolidated Financial Statements included in Item 8 of this Annual Report on
Form 10-K.
24
AMENDMENTS TO LOAN AGREEMENT
The Company has recently entered into a number of amendments and waivers
with respect to its credit facility. See Liquidity and Capital Resources.
CRITICAL ACCOUNTING POLICIES
Critical accounting policies are those that are most significant to the
portrayal of the Company's condition and results of operations and require
difficult, subjective and complex judgments by management in order to make
estimates about the effect of matters that are inherently uncertain. In applying
such policies management must record income and expense amounts that are based
upon informed judgments and best estimates. Because of the uncertainty inherent
in these estimates, actual results could differ from estimates used in applying
critical accounting policies. Changes in estimates, based on more accurate
future information, may affect amounts reported in future periods. Management is
not aware of any reasonably likely events or circumstances which would result in
different amounts being reported that would materially affect the Company's
financial condition or results of operation
Note 1 to the Company's Consolidated Financial Statements contains a
summary of the Company's significant accounting policies. The Company believes
that its critical accounting policies are as follows:
EFFECTS OF REGULATION -- The Company follows SFAS No. 71, Accounting for
the Effects of Certain Types of Regulation, and its financial statements reflect
the effects of the different rate-making principles followed by the various
jurisdictions regulating the Company. The economic effects of regulation can
result in regulated companies recording costs that have been or are expected to
be allowed in the rate-making process in a period different from the period in
which the costs would be charged to expense by an unregulated enterprise. When
this occurs, costs are deferred as assets in the balance sheet (regulatory
assets) and recorded as expenses in the periods when those same amounts are
reflected in rates. Additionally, regulators can impose liabilities upon a
regulated utility for amounts previously collected from customers and for
amounts that are expected to be refunded to customers (regulatory liabilities).
Costs recovered through rates include income taxes, property taxes,
environmental remediation and costs of gas.
RECOVERABLE/ REFUNDABLE COSTS OF GAS AND PROPANE PURCHASES -- The Company
accounts for purchased gas costs in accordance with procedures authorized by the
MPSC, the WPSC and the ACC under which purchased gas and propane costs that are
different from those provided for in present rates are accumulated and recovered
or credited through future rate changes.
25
DERIVATIVES -- The Company accounts for certain derivative contracts that
are used to manage risk in accordance with SFAS No. 133.
Contracts that are required to be valued as derivatives under SFAS No. 133
are reflected at "fair value" under the mark-to-market method of accounting. The
market prices or fair values used in determining the value of the Company's
portfolio are management's best estimates utilizing information such as closing
exchange rates, over-the-counter quotes, historical volatility and the potential
impact on market prices of liquidating positions in an orderly manner over a
reasonable amount of time under current market conditions. As additional
information becomes available, or actual amounts are determinable, the recorded
estimates may be revised. As a result, operating results can be affected by
revisions to prior accounting estimates. Operating results can also be affected
by changes in underlying factors used in the determination of fair value of
portfolio such as the following:
- There is variability in mark-to-market earnings due to changes
in the market price for gas. The Company's portfolio is valued
based on current and expected future gas prices. Changes in
these prices can cause fluctuations in earnings.
- The Company discounts derivative assets and liabilities using
risk-free interest rates adjusted for credit standing in
accordance with SFAS No. 133, which is more fully described in
Statement of Financial Accounting Concepts No. 7, "Using Cash
Flow Information and Present Value in Accounting Measurement"
(SFAS Concept 7).
Other activities consist of the purchasing of gas for utility operations,
which fall under the normal purchases and sales exception, and entering into
transactions to hedge risk associated with these purchases. These activities
require that management make certain judgments regarding election of the normal
purchases and sales exceptions and qualification of hedge accounting by
identifying hedge relationships and assessing hedge effectiveness.
RESULTS OF CONSOLIDATED OPERATIONS
The following discussion of the Company's financial condition and results of
operations should be read in conjunction with the Consolidated Financial
Statements and Notes thereto and other financial information included elsewhere
in this Report. The following gives effect to the restatement of the Company's
consolidated financial statements as discussed in Note 15 to the consolidated
financial statements.
FISCAL YEAR ENDED JUNE 30, 2004 COMPARED TO FISCAL YEAR ENDED JUNE 30, 2003
NET LOSS
The Company's net loss for fiscal year 2004 was $556,000 compared to a net
loss of $857,000 for fiscal year 2003, an improvement of $301,000. The
improvement in the Company's net loss from fiscal year 2003 to fiscal year 2004
was primarily the result of a reduction in distribution, general and
administrative expenses, costs of gas and electricity-wholesale and cost of
goods sold, and an increase in other income from fiscal year 2003 to fiscal year
2004, which were partially offset by an increase in interest expense, taxes and
gas purchased and a decrease in income tax benefits from fiscal year 2003 to
fiscal year 2004. The
26
principal changes that contributed to the improvement of $301,000 in net loss
from fiscal year 2003 to fiscal year 2004 are explained below.
REVENUES
The Company's revenues for fiscal year 2004 were $73,291,000 compared to
$77,898,000 in fiscal year 2003, a decrease of $4,607,000. The decrease was
primarily attributable to: (1) a $6,944,000 decrease in EWR marketing revenue
primarily due to the loss of revenues of $11,682,000 and $238,000 after the exit
from its electricity and appliance businesses, respectively, partially offset by
a $4,049,000 increase in volumes and prices of gas sales and the $932,000
increase in revenues as a result of mark-to-market accounting, and (2) a
reduction of $5,050,000 in revenue from Propane Operations primarily as a result
of the sale of wholesale propane assets in Superior, Montana. Revenues were
relatively flat in Pipeline Operations. The lower consolidated revenues were
partially offset by a $7,436,000 increase in revenue from Natural Gas Operations
resulting primarily from $6,136,000 of surcharges on higher gas costs and
$1,100,000 of increased revenue from higher rates approved by the respective
commissions in Montana and Wyoming as well as the approval of $200,000 for
property tax recovery in Montana.
GROSS MARGIN
Gross margins (revenues less cost of gas and electricity and costs of
goods sold) were nearly the same in fiscal years 2004 and 2003. Significant
changes in gross margins for the Company's segments from fiscal year 2003 to
fiscal year 2004 were: (1) decreased gross margins in EWR of $1,255,000,
primarily due to decreases in marketing activities, increases in prices related
to gas purchases necessary to satisfy fixed price contract agreements, and the
$932,000 adjustment under mark-to-market accounting, (2) decreased gross margins
in the Propane Operations of $288,000, due to the sale of the wholesale propane
assets in Superior, Montana, offset by gross margin increases in (1) Natural Gas
Operations of $1,307,000 due to the rate increases in Montana and Wyoming, and
(2) Pipeline Operations of $239,000 due to the placement in service of the
Shoshone interstate pipeline.
27
EXPENSES OTHER THAN COSTS OF GAS AND ELECTRICITY AND COSTS OF GOODS SOLD
Expenses other than costs of gas and electricity and costs of goods sold
decreased by $1,255,000 from fiscal year 2003 to fiscal year 2004 due to a
decrease in distribution, general and administrative expenses, and maintenance
and depreciation expenses, partially offset by an increase in taxes other than
taxes on income.
Distribution, general and administrative expenses decreased by $1,499,000.
This reduction resulted from the settlement of the PPLM litigation in fiscal
year 2003, and the resulting elimination for fiscal year 2004 of any costs and
expenses relating to the PPLM litigation, in fiscal year 2004. Such costs were
$1,552,000 in fiscal year 2003. Debt issuance expenses of $100,000 were included
in distribution, general and administrative expenses in fiscal year 2004
compared with $420,000 included in fiscal year 2003, a reduction of $561,000 in
operating expenses due to the sale of wholesale propane assets in fiscal year
2004, and cost savings of $376,000 related to a reduction in payroll and other
associated costs in fiscal year 2004. The reductions were partially offset by
proxy contest expenses of $570,000 incurred in fiscal year 2004, shareholder
rights plan expenses of $227,000 incurred in fiscal year 2004, an increase of
$337,000 in general liability insurance premiums in fiscal year 2004, and a
$175,000 increase in director expenses. (Additional debt issuance costs incurred
in fiscal year 2004 were amortized as interest expense. See table below.)
Maintenance and depreciation expenses decreased $77,000 for fiscal year
2004 as compared to fiscal year 2003.
Taxes other than taxes on income increased by $322,000 due to a Montana
DOR audit of assessed personal property values. The Company recovered
approximately $200,000 of this expense through higher rates in fiscal year 2004.
CERTAIN EXPENSES INCURRED DURING FISCAL YEARS 2002, 2003, AND 2004
The Company's consolidated results of operations were negatively affected
by certain costs and expenses that occurred during fiscal years 2002, 2003, and
2004. These expenses, summarized in the table below, include litigation expenses
in connection with the PPLM lawsuit during fiscal years 2002 and 2003, expenses
associated with the proxy contest during fiscal year 2004, and expenses
associated with the shareholder rights plan during fiscal year 2004.
In addition, the Company incurred significant expenses associated with
restructuring the Company's credit facilities during fiscal years 2003 and 2004.
These expenses are also summarized in the table. Although future expenses
associated with credit facilities and other capital-related expenses can be
expected in the normal course, the credit facility restructuring expenses
incurred during fiscal years 2003 and 2004 were substantially higher than
similar expenses incurred in previous periods. No assurance can be given with
respect to future levels of expenses related to capital needs.
28
2004 2003 2002 TOTAL
---- ---- ---- -----
Cost of PPLM litigation $1,552,000 $565,000 $2,117,000
Proxy Contest Expenses $ 570,000 570,000
Debt Issuance Expenses 663,000 420,000 * 1,083,000
Shareholder Rights Plan 227,000 227,000
---------- ---------- -------- ----------
Total $1,460,000 $1,972,000 $565,000 $3,997,000
========== ========== ======== ==========
*In fiscal year 2004, $696,000 of short-term debt issuance costs were
capitalized. Beginning October 31, 2003 these costs started amortizing at
$58,000 per month. At June 30, 2004, $522,000 of amortization had been included
as interest expense. In addition, $41,000 was included as interest expense at
June 30, 2004 for amortization of costs totaling $830,000 associated with
obtaining long-term debt. In fiscal year 2004, $100,000 related to obtaining
short-term financing was recorded in general and administrative expenses
compared to $420,000 in fiscal year 2003.
OTHER INCOME
Other income increased by $83,000 from $302,000 in fiscal year 2003 to
$385,000 in fiscal year 2004 primarily due to sale of non-operating real estate
assets located in Montana.
INTEREST EXPENSE
Interest expense increased by $866,000 or 53% from $1,633,000 in fiscal
year 2003 to $2,499,000 in fiscal year 2004 due to higher overall corporate
borrowings and amortization of $563,000 in costs associated with debt refinanced
in fiscal year 2004.
INCOME TAX BENEFITS
Income tax benefits decreased by $174,000 from a tax benefit of $543,000
in fiscal year 2003 to a tax benefit of $369,000 in fiscal year 2004 due to
decreased net loss.
FISCAL YEAR ENDED JUNE 30, 2003 (AS RESTATED) COMPARED TO FISCAL YEAR ENDED JUNE
30, 2002 (AS RESTATED).
NET INCOME (LOSS)
The Company's net loss for fiscal year 2003 was $857,000 compared to net
income of $827,000 in fiscal year 2002, a decrease of $1,684,000. The reduction
in net income is primarily a result of the following: Natural Gas Operations
reduction of $755,000 in net income due to reduced volumes and additional
operating expenses related to overhead and interest costs, and Propane
Operations had reduced net income of approximately $465,000 due to lower margins
resulting from higher costs of propane and additional overhead expense. The
Company's EWR segment experienced an increase in net loss of $324,000 due
primarily to additional legal fees of $987,000 related to the PPLM litigation,
and Pipeline Operations had reduced net income of $140,000 primarily due to
expenses incurred to obtain Federal Energy Regulatory Commission ("FERC")
regulatory approval of the Shoshone pipeline.
REVENUES
Operating revenues of the Company decreased $11,342,000 from $89,240,000
in fiscal year 2002 to $77,898,000 in fiscal year 2003. The Natural Gas
Operations' revenues decreased
29
$7,888,000 due to elimination of the surcharge approved by the MPSC in March
2001 for the recovery of increased gas costs that had been incurred prior to
March 2001. The increased gas costs were fully recovered by June 2002, and the
surcharge was eliminated. Also, warmer than normal weather experienced during
fiscal year 2003 resulted in lower volumes. EWR experienced lower revenues of
$5,880,000 due to decreased marketing activity and a $3,892,000 decrease in
revenue under mark-to-market accounting. Propane Operations experienced
$2,130,000 higher revenues due to both higher prices and sales volumes and the
Pipeline Operations experienced an increase in revenues of approximately
$295,000.
GROSS MARGIN
Gross margins (operating revenues less cost of gas and electricity and
cost of goods sold) increased $727,000 in fiscal year 2003. This increase was
attributable mainly to increased gross margins in the Company's EWR segment of
$1,120,000 offset by the $3,892,000 adjustment under mark-to-market accounting
and gross margin decreases in both the Propane Operations and Natural Gas
Operations resulting from higher than normal propane and gas costs.
EXPENSES OTHER THAN COSTS OF GAS AND ELECTRICITY AND COSTS OF GOODS SOLD
Expenses other than costs of gas and electricity and costs of goods sold
increased by $3,185,000 from fiscal year 2002 to fiscal year 2003.
Distribution, general and administrative expenses increased from
$8,790,000 in fiscal year 2002 to $11,669,000 in fiscal year 2003. This increase
of $2,879,000 was due in part to costs and expenses of the PPLM litigation of
$1,552,000 in fiscal year 2003 compared with $565,000 in fiscal year 2002.
Additional increases in these expenses included: $700,000 related to payroll and
employee benefit costs, $140,000 in general liability insurance expenses,
$462,000 in outside professional services, $80,000 in bad debt expense, $90,000
in director and shareholder expenses, and $420,000 related to restructuring the
Company's credit facilities.
Maintenance and depreciation increased $31,000 and $333,000,
respectively, with a decrease of $58,000 in taxes other than income.
OTHER INCOME
Other income decreased by $356,000 from $658,000 in fiscal year 2002 to
$302,000 in fiscal year 2003 primarily due to a $300,000 settlement received by
EWR in fiscal year 2002 as part of a transaction to purchase a group of
producing natural gas reserves.
INTEREST EXPENSE
Interest expense decreased by $71,000 from $1,704,000 in fiscal year 2002
to $1,633,000 in fiscal year 2003 due to lower overall corporate borrowings in
fiscal year 2003.
INCOME TAX BENEFIT (EXPENSE)
Income taxes benefits increased by $1,058,000 from a $515,000 tax expense
in fiscal year 2002 to a $543,000 tax benefit in fiscal year 2003 due to a loss
in fiscal 2003.
30
OPERATING RESULTS OF THE COMPANY'S NATURAL GAS OPERATIONS
Year Ended June 30
------------------
2004 2003 2002
---- ---- ----
(in thousands)
NATURAL GAS OPERATIONS
Operating revenues $ 39,063 $ 31,627 $ 39,515
Gas purchased 27,883 21,754 29,465
--------- -------- --------
Gross margin 11,180 9,873 10,050
Operating expenses 9,843 8,542 7,497
--------- -------- --------
Operating income 1,337 1,331 2,553
Other (income) (97) (94) (153)
--------- -------- --------
Income before interest and taxes $ 1,434 $ 1,425 $ 2,706
========= ======== ========
FISCAL YEAR ENDED JUNE 30, 2004 COMPARED TO FISCAL YEAR ENDED JUNE 30, 2003
NATURAL GAS REVENUES AND GROSS MARGINS
The Natural Gas Operations' operating revenues in fiscal year 2004
increased to $39,063,000 from $31,627,000 in fiscal year 2003. This was
primarily due to surcharges related to higher gas costs and increased rates
related to property tax recovery in Montana and higher rates from approved rate
cases in Montana and Wyoming.
Gross margin, which is defined as operating revenues less gas purchased,
was approximately $11,180,000 for fiscal year 2004 compared to approximately
$9,873,000 in fiscal year 2003. The increase of $1,307,000 is primarily due to
general rate increases placed in effect on December 15, 2002 of $600,000 and
June 1, 2003 for an additional $80,000 in Montana and $722,000 on June 1, 2003
in Wyoming. On January 1, 2004 an additional rate increase of approximately
$500,000 per year went into effect to recover property taxes in Montana.
Gas purchases in Natural Gas Operations increased by $6,129,000 from
$21,754,000 in fiscal year 2003 to $27,883,000 in fiscal year 2004. The increase
in gas costs reflect higher gas prices during the fiscal year.
NATURAL GAS OPERATING EXPENSES
Natural Gas Operations' operating expenses were approximately $9,843,000
for fiscal year 2004, as compared to $8,542,000 for fiscal year 2003. The
increase of $1,301,000 is due mainly to $672,000 increase in overhead costs,
$274,000 in personal property tax, $100,000 in bad debt expense, and $184,000 in
insurance expenses and $52,000 in depreciation expense.
31
NATURAL GAS OTHER INCOME
Other income increased by $3,000 from $94,000 in fiscal year 2003 to
$97,000 in fiscal year 2004. The increase was due primarily to miscellaneous
fixed assets sales during fiscal year 2004.
FISCAL YEAR ENDED JUNE 30, 2003 COMPARED TO FISCAL YEAR ENDED JUNE 30, 2002
NATURAL GAS REVENUES AND GROSS MARGINS
Natural Gas Operations' operating revenues decreased from approximately
$39,515,000 in fiscal year 2002 to approximately $31,627,000 in fiscal year
2003. This decrease of $7,888,000 was due primarily to the elimination of the
surcharge approved by the MPSC in March 2001 for the recovery of increased gas
costs that had been incurred prior to March 2001. The increased gas costs were
fully recovered by June 2002, and the surcharge was eliminated. Also, warmer
than normal weather experienced during fiscal year 2003 and reduced volumes sold
to a large industrial customer by Natural Gas - Wyoming resulted in lower total
volumes of natural gas sold of approximately 369,000 MCF, a 6% reduction from
fiscal year 2002.
Gross margin, defined as operating revenues less cost of natural gas,
declined from approximately $10,050,000 in fiscal year 2002 to approximately
$9,873,000 in fiscal year 2003, primarily due to the reduction in sales volumes
experienced during fiscal year 2003.
Natural gas purchases decreased from $29,465,000 in fiscal year 2002 to
$21,754,000 in fiscal year 2003. The decrease in gas costs of $7,711,000 is due
to lower volumes being sold and the lower cost of natural gas during fiscal year
2003.
NATURAL GAS OPERATING EXPENSES
Natural Gas Operations' operating expenses were $8,542,000 for fiscal year
2003 compared to $7,497,000 for fiscal year 2002. The increase in operating
expenses of $1,045,000 was due primarily to an increase in property taxes, an
increase in general liability insurance premiums, increases in employee benefit
costs and increases in overhead costs.
NATURAL GAS OTHER INCOME
Other income decreased by $59,000 from $153,000 in fiscal year 2002 to
$94,000 in fiscal year 2003. The decrease was primarily due to a reduction in
service sales related to home and industrial installations.
32
OPERATING RESULTS OF THE COMPANY'S PROPANE OPERATIONS
Year Ended June 30
------------------
2004 2003 2002
---- ---- ----
(in thousands)
PROPANE OPERATIONS
Operating revenues $ 7,736 $ 12,786 $ 10,656
Gas purchased 4,000 8,762 6,407
-------- --------- ---------
Gross margin 3,736 4,024 4,249
Operating expenses 3,039 3,600 3,065
-------- --------- ---------
Operating income 697 424 1,184
Other (income) (181) (187) (199)
-------- --------- ---------
Income before interest and taxes $ 878 $ 611 $ 1,383
======== ========= =========
FISCAL YEAR ENDED JUNE 30, 2004 COMPARED TO FISCAL YEAR ENDED JUNE 30, 2003
PROPANE REVENUE AND GROSS MARGINS
Propane Operations' revenues decreased $5,050,000 from $12,786,000 in
fiscal year 2003 to $7,736,000 in fiscal year 2004 as a result of the sale of
the wholesale propane assets located at Superior, Montana. Cost of propane sold
decreased from $8,762,000 to $4,000,000 for the same period due to the decrease
in volumes sold by the Company's wholesale operations, partially offset by
increases in the cost of propane for both the regulated utility and the
wholesale propane operations. These decreases in revenues and corresponding
decrease in cost of propane resulted in a $288,000 decrease in gross margin,
from $4,024,000 in fiscal year 2003 to $3,736,000 in fiscal year 2004.
Crude oil prices play a significant role in wholesale pricing for propane.
Wholesale propane prices move up as the cost of crude oil increases and play a
significant role in the Company's ability to stay competitive. While propane
normally enjoys a significant cost performance advantage over electricity, crude
oil price increases over the past year have eroded that advantage. Designers and
home builders are beginning to view propane and electricity as equal in cost
performance. Because electric generation uses crude oil as well as natural gas,
in time the Company expects electric rates to increase due to fuel price
increases. However, currently in the Company's markets, electric rates have not
been significantly impacted by the crude oil price increases.
PROPANE OPERATING EXPENSES
Operating expenses were $3,039,000 for fiscal year 2004 compared to
$3,600,000 for fiscal year 2003. This decrease of $561,000 is related to the
gain on the sale of wholesale propane assets of $252,000, decreases in operating
costs of $474,000, which includes savings from exiting the wholesale propane
market in Superior, Montana, and a decrease in depreciation and maintenance
expense of $76,000. Offsetting these expense reductions was an increase in
overhead costs (much of which the Company believes are nonrecurring) of
approximately $198,000 and an increase in taxes other than income of $43,000,
primarily related to increased property tax expense.
PROPANE OTHER INCOME
Other income decreased by $6,000 from $187,000 in fiscal year 2003 to
$181,000 in fiscal year 2004. Increases in interest income from the note
receivable from the buyer of the RMF
33
wholesale propane assets, and an increase in the revenue from contracted
services related to the sale, were offset by a decrease in other miscellaneous
income.
FISCAL YEAR ENDED JUNE 30, 2003 COMPARED TO FISCAL YEAR ENDED JUNE 30, 2002
PROPANE REVENUES AND GROSS MARGINS
The Propane Operations segment's revenues rose from $10,656,000 in fiscal
year 2002 to $12,786,000 in fiscal year 2003, an increase of $2,130,000 or 20%.
This increase in revenues was due to increased sales prices in the second half
of fiscal year 2003 in the Company's wholesale propane operations, coupled with
an overall increase in volume in the Propane Operations segment. Total volume
for the Propane Operations segment increased from 12,816,000 gallons in fiscal
year 2002 to 16,033,000 gallons in fiscal year 2003, an increase of 25%. Cost of
propane increased from $6,407,000 to $8,762,000 for the same period, a 37%
increase, due to the increase in volumes sold and increases in the cost of
propane for both the regulated utility and the wholesale propane operations. The
increase in revenues and the increase in cost of propane resulted in a decrease
of $225,000 in gross margin, or 5%, from $4,249,000 in fiscal year 2002 to
$4,024,000 in fiscal year 2003.
PROPANE OPERATING EXPENSES
Operating expenses were $3,600,000 for fiscal year 2003 compared to
$3,065,000 for fiscal year 2002. The increase of $535,000 was primarily related
to increases in depreciation, overhead costs, and increased sales expenses in
the wholesale propane operation.
PROPANE OTHER INCOME
Other income decreased by $12,000 from $199,000 in fiscal year 2002 to
$187,000 in fiscal year 2003. This decrease was due primarily to the collection
of a previously written off account in fiscal year 2002.
34
OPERATING RESULTS OF THE COMPANY'S EWR OPERATIONS
Years Ended June 30
2004 2003 2002
---- ---- ----
(in thousands)
ENERGY WEST RESOURCES ("EWR")
Operating revenues $ 26,091 $ 33,035 $ 38,914
Gas purchased 26,028 31,717 38,717
---------- ----------- ----------
Gross margin 63 1,318 197
Operating expenses 1,096 3,040 1,628
---------- ----------- ----------
Operating loss (1,033) (1,722) (1,431)
Other (income) expense 13 (19) (304)
---------- ----------- ----------
(Loss) before interest and taxes ($ 1,046) ($ 1,703) ($ 1,127)
========== =========== ==========
Note: Revenues are declining over the last three years due to decreased
sales market and impact of net derivative values.
FISCAL YEAR ENDED JUNE 30, 2004 COMPARED TO FISCAL YEAR ENDED JUNE 30, 2003 (AS
RESTATED)
EWR REVENUES AND GROSS MARGINS
Revenues were negatively impacted by declines in derivative values of
$1,244,000 at the end of fiscal year 2004 from the end of fiscal year 2003,
under mark-to-market accounting. Fiscal year 2003 included revenues of $245,000
from electricity marketing and $27,000, from appliance sales which decreased in
fiscal year 2004 as the Company elected to not sell any new electricity
contracts or gas appliances. EWR's fiscal year 2004 gross margin of $63,000
represents a decrease of $1,255,000 from gross margins earned in fiscal 2003.
This decrease was due primarily to $2,091,000 more in fiscal year 2004 to
purchase natural gas to satisfy fixed price contract agreements. The decrease in
natural gas margins was partially offset by an increase in production margins of
$175,000.
EWR OPERATING EXPENSES
Operating expenses of EWR decreased approximately $1,944,000, from
$3,040,000 for fiscal year 2003 to $1,096,000 for fiscal year 2004. This
decrease is due primarily to the decreased legal expenses related to the
settlement of the PPLM litigation in fiscal 2003. Legal expenses related to the
PPLM litigation in 2003 were approximately $1,552,000. The remainder of the
decrease is due to a reduction in general and administrative expenses related to
payroll and associated costs, travel and training and other cost savings
measures.
EWR OTHER INCOME (EXPENSE)
Other expense was approximately $13,000 in fiscal year 2004 compared to
other income of approximately $19,000 for fiscal year 2003. The reduction is
primarily due to EWR devaluing an investment in a distributorship for $17,000.
The decrease was partially offset by the gain on the sale of two vehicles and a
gathering system compressor.
35
FISCAL YEAR ENDED JUNE 30, 2003 (AS RESTATED) COMPARED TO FISCAL YEAR ENDED JUNE
30, 2002 (AS RESTATED)
EWR REVENUES AND GROSS MARGINS
Revenues were negatively impacted by declines in derivative values of
$2,177,000 at the end of fiscal year 2003 from the end of fiscal year 2002,
under mark-to-market accounting. EWR's gross margin was approximately $1,318,000
for fiscal year 2003 compared to $197,000 for fiscal year 2002, an increase of
$1,121,000. This increase was primarily due to a $1,509,000 increase in natural
gas margins (primarily from the sale of storage inventories during the third
quarter) and an increase in margins of $338,000 from production properties
purchased in fiscal year 2002, offset by a decline of approximately $411,000 in
gross margins from the sale of electricity.
EWR OPERATING EXPENSES
Operating expenses for EWR were approximately $3,040,000 for fiscal year
2003 compared to $1,628,000 for the previous fiscal year. The most significant
factor causing the increase of $1,412,000 was legal expenses related to the PPLM
litigation. The costs of the PPLM litigation were approximately $1,552,000 for
fiscal year 2003 compared to approximately $535,000 for fiscal year 2002. The
remainder of the increase in operating expenses of $395,000 was due primarily to
increases in liability insurance, employee benefits, increased uncollectible
expenses and an increase in the amount of allocated corporate overhead.
EWR OTHER INCOME
Other income was approximately $19,000 in fiscal year 2003 compared to
approximately $304,000 for fiscal year 2002. The reduction is primarily due to a
$300,000 settlement on the purchase of production properties during fiscal year
2002 that was not repeated during fiscal year 2003.
OPERATING RESULTS OF THE COMPANY'S PIPELINE OPERATIONS
Years Ended June 30
2004 2003 2002
---- ---- ----
(in thousands)
PIPELINE OPERATIONS
Operating revenues $ 401 $ 449 $ 154
Gas purchased 0 287 0
------- -------- ------
Gross margin 401 162 154
Operating expenses 214 265 71
------- -------- ------
Operating income (loss) 187 (103) 83
Other (income) expense (121) (1) 0
------- -------- ------
Income (loss) before interest and taxes $ 308 ($ 102) $ 83
======= ======== ======
36
FISCAL YEAR ENDED JUNE 30, 2004 COMPARED TO FISCAL YEAR ENDED JUNE 30, 2003
PIPELINE REVENUES AND GROSS MARGINS
Pipeline Operations added the Shoshone pipelines as of July 2003, which
produced revenue of $337,000 in fiscal year 2004. For fiscal year 2004
reporting, Pipeline Operations revenue consists only of gathering revenues
related to the pipelines located in Wyoming and Montana. Revenues and expenses
associated with the interests in natural gas production acquired in fiscal years
2002 and 2003 have been transferred to EWR.
Pipeline Operations' margin increased from $162,000 in fiscal year 2003
to $401,000 in fiscal year 2004. The increase of $239,000 was due primarily to
the addition of $337,000 in revenues from the addition of the Shoshone pipeline
in July 2003. This increase was partially offset by a reduction in margins of
$98,000 due to the transfer of operation of natural gas production interests to
EWR effective as of fiscal year 2004.
PIPELINE OPERATING EXPENSES
Operating expenses decreased from $265,000 in fiscal year 2003 to $214,000
in fiscal year 2004. The decrease of $51,000 was due to a reduction in payroll
and related expenses.
PIPELINE OTHER INCOME
Other income for fiscal year 2004 included the sale of certain
non-operating real estate assets located in Montana, which resulted in a gain of
$121,000.
FISCAL YEAR ENDED JUNE 30, 2003 COMPARED TO FISCAL YEAR ENDED JUNE 30, 2002
PIPELINE REVENUES AND GROSS MARGINS
Pipeline Operations' revenues increased from $154,000 in fiscal year 2002
to approximately $449,000 in fiscal year 2003. The increase of $295,000 was due
primarily to revenues generated from natural gas production properties purchased
in fiscal year 2003. The cost of gas purchased increased $287,000 from fiscal
year 2003 compared to fiscal year 2002 due to the increased cost of production.
PIPELINE OPERATING EXPENSES
Operating expenses increased from $71,000 in fiscal year 2002 to $265,000
in fiscal year 2003. The increase of $194,000 was due to additional expenses
associated with production properties and additional expenses incurred in
obtaining FERC regulatory approval to operate the Shoshone pipeline.
CONSOLIDATED CASH FLOW ANALYSIS
CASH FLOWS USED IN OPERATING ACTIVITIES
Cash flows used in operations in fiscal 2004 were unfavorable as a result
of the net loss incurred in fiscal 2004. The Company's fiscal 2004 operating
cash flows were driven by the following events and factors:
37
- Higher prices of natural gas and propane inventories.
- A significant pay down of trade accounts payable and other
liabilities.
The amount of debt has substantially increased resulting in higher
interest costs, which will continue to negatively impact operating cash flows.
The Company is currently required to retire debt through the use of proceeds
generated from the sale of equity securities under the terms of the LaSalle
Facility.
The Company is attempting to improve operating cash flows by improving the
efficiency of the core businesses, increasing revenues through utility rates,
retiring debt and restructuring existing debt obligations.
CASH FLOWS USED IN INVESTING ACTIVITIES
Cash flows used in investing activities decreased in fiscal 2004 compared
to fiscal 2003. This decrease mainly stemmed from reduced capital expenditures
in 2004, a result of a management decision to limit fiscal 2004 expenditures. In
addition, RMF propane assets were sold in August 2003.
Cash used in investing activities in fiscal 2003 decreased from fiscal
2002. This decrease primarily stemmed from a $1,445,000 reduction in capital
expenditures for system extensions as well as the replacement and improvement of
existing transmission, distribution, gathering and general facilities. In
addition, $957,000 was expended for the acquisition of producing natural gas
properties in May 2002.
CASH FLOWS FROM FINANCING ACTIVITIES
Cash flows from financing activities increased in fiscal 2004 compared to
fiscal 2003. Fiscal 2004 net cash provided from financing activities stems from
the $8,000,000 proceeds from additional long-term debt, net of $1,526,000 in
debt issuance costs.
Cash flows from financing activities increased in fiscal 2003 compared to
fiscal 2002. Net cash provided from financing activities in fiscal 2003 is the
net effect of lower repayments on lines of credit.
GOVERNMENTAL REGULATION
The Company's utility operations are subject to regulation by the MPSC,
the WPSC, and the ACC. Such regulation plays a significant role in determining
the Company's return on equity. The commissions approve rates that are intended
to permit a reasonable rate of return on investment. The Company's tariffs allow
the cost of gas to pass through to the customers. There is some delay, however,
between the time that the gas costs are incurred by the Company and the time
that the Company recovers such costs from customers as part of its gas cost
recovery mechanism. The interim rate increase became effective November 1, 2004
and is estimated to provide additional gross margin of approximately $800,000
annually. In addition, an interim order for the West
38
Yellowstone general rate filing was approved for approximately $200,000 annually
and became effective on November 1, 2004.
SEASONALITY
The business of the Company and its subsidiaries in all segments is
temperature-sensitive. In any given period, sales volumes reflect the impact of
weather, in addition to other factors, with colder temperatures generally
resulting in increased sales by the Company. The Company anticipates that this
sensitivity to seasonal and other weather conditions will continue to be
reflected in the Company's sales volumes in future periods.
LIQUIDITY AND CAPITAL RESOURCES
The Company's operating capital needs, as well as dividend payments and
capital expenditures, are generally funded through cash flow from operating
activities and short-term borrowing. Historically, to the extent cash flow has
not been sufficient to fund capital expenditures, the Company has borrowed
short-term funds. When the short-term debt balance significantly exceeds working
capital requirements, the Company has issued long-term debt or equity securities
to pay down short-term debt. The Company has greater need for short-term
borrowing during periods when internally generated funds are not sufficient to
cover all capital and operating requirements, including costs of gas purchased
and capital expenditures. In general, the Company's short-term borrowing needs
for purchases of gas inventory and capital expenditures are greatest during the
summer and fall months and the Company's short-term borrowing needs for
financing customer accounts receivable are greatest during the winter months.
The Company substantially restructured its credit facilities during fiscal
year 2004. On September 30, 2003, the Company established a $23.0 million
short-term revolving credit facility with LaSalle Bank National Association, as
Agent for certain banks (collectively, the "Lender"), replacing a previous
short-term line of credit. The MPSC order granting approval of the $23.0 million
credit facility imposes restrictions on the use of the proceeds to utility
purposes, and requires the Company to provide monthly reports to the MPSC with
respect to the financial condition of the Company. The Company continues to be
subject to these MPSC requirements.
On March 31, 2004, the Company entered into a restated credit agreement
with the Lender. Pursuant to the restated credit agreement, the previous $23.0
million revolving credit facility was replaced with a $15.0 million short-term
revolving credit facility, a $6.0 million term loan maturing on March 31, 2009,
and a $2.0 million term loan maturing on September 30, 2004 (collectively
referred to as the "LaSalle Facility").
As of August 30, 2004, the Company and its lender under its credit
facility (the "LaSalle Facility") amended certain covenants as follows: (1)
increased the total debt to capital ratio from .65 to .70, (2) allowed the
inclusion of extraordinary expenses incurred by the Company for legal fees and
costs of the PPLM litigation, expenses and costs associated with the credit
facilities, proxy contest costs, and the costs of adoption of the shareholder
rights plan, in determining the interest coverage ratio, and (3) waived
compliance with the ratios referred to in (1) and (2) above as of June
39
30, 2004 in addition to a shareholder's acquisition of more than 15% of the
outstanding common stock of the Company.
As of September 10, 2004, the LaSalle Facility was amended to extend from
September 30, 2004 until October 31, 2004, the deadline for the Company to repay
the $2,000,000 term loan under the LaSalle Facility, with an infusion of new
equity.
On October 20, 2004, but effective as of September 28, 2004, the LaSalle
Facility was amended to extend until October 29, 2004, the deadline for the
Company to deliver its audited financial statements for the fiscal year ended
June 30, 2004.
On November 2, 2004, the Company executed a letter agreement effective as
of September 28, 2004 amending the LaSalle Facility. The letter agreement
provides for the extension of the deadline to deliver audited financial
statements for fiscal year 2004 from October 29, 2004 to November 12, 2004.
As of November 2, 2004, the Company executed an amendment to the LaSalle
Facility, which provides for an extension from October 31, 2004 to November 30,
2004 of the deadlines under the LaSalle Facility in connection with: (i) the
termination date of the revolving facility and (ii) the date to consummate
infusions of new equity of at least $2.0 million to repay the $2.0 million term
loan under the LaSalle Facility.
As of November 30, 2004, the Company executed an agreement with its
lender providing for (i) an extension of the revolving facility until
November 28, 2005; (ii) an extension of the date to consummate infusions of new
equity of at least $2.0 million and to repay the $2.0 million term loan to
October 1, 2005; (iii) a conditional waiver of the deadline to deliver audited
financial statements for fiscal year 2004 and the deadline to deliver financial
statements for the fiscal quarter ended September 30, 2004; (iv) a waiver of
the technical default that otherwise would have been caused by the restatement
of financial results of prior periods; (v) modification of interest rates
applicable to the $2.0 million term loan; (vi) a limitation of $1.0 million on
total loans and additional capital investment from the Company to EWR; and
(vii) waivers of certain financial covenant default as of September 30, 2004.
Borrowings under the LaSalle Facility are secured by liens on
substantially all of the assets of the Company and its subsidiaries. The
Company's obligations under certain other notes and industrial development
revenue obligations are secured on an equal and ratable basis with the Lender in
the collateral granted to secure the borrowings under the LaSalle Facility with
the exception of the first $1.0 million of debt under the LaSalle Facility.
Under the LaSalle Facility the Company may elect to pay interest on
portions of the amounts outstanding under the $15.0 million revolving line of
credit at the London interbank offered rate (LIBOR), plus 250 basis points, for
interest periods selected by the Company. For all other balances outstanding
under the $15.0 million revolving line of credit, the Company pays interest at
the rate publicly announced from time to time by LaSalle Bank as its "prime
rate" (the "Prime Rate"). For the $6.0 million term loan under the LaSalle
Facility, the Company may elect to pay interest at either the applicable LIBOR
rate plus 350 basis points or at the Prime Rate plus 200 basis points. Pursuant
to the November 30, 2004 amendment to the LaSalle Facility, the interest rate on
the $2.0 million term loan will be: the Prime Rate plus 200 basis points through
March 31, 2005; the Prime Rate plus 300 basis points from April 1, 2005 through
June 30, 2005; and the Prime Rate plus 400 basis points from and after July 1,
2005. The Company also pays a commitment fee of 35 basis points for the daily
unutilized portion of the $15.0 million revolving credit facility.
The LaSalle Facility requires the Company to maintain compliance with a
number of financial covenants, including meeting limitations on annual capital
expenditures, maintaining a total debt to total capital ratio of not more than
..70 to 1.00 and an interest coverage ratio of no less than
40
2.00 to 1.00. At June 30, 2004, the Company would not have been in compliance
with the financial covenants under the LaSalle Facility had the Lender not
waived or modified certain financial covenants. The LaSalle Facility also
restricts the Company's ability to pay dividends during any period to a certain
percentage of cumulative earnings of the Company over that period, and restricts
open positions and Value at Risk (VaR) in the Company's wholesale operations.
In June 2003, the Company's Board of Directors suspended the Company's
fourth quarter dividend to allow for strengthening of the Company's balance
sheet. No determination has been made with respect to resumption of cash
dividend payments.
At June 30, 2004, the Company had approximately $1.3 million of cash on
hand. In addition, at June 30, 2004, the Company had borrowed approximately $6.7
million under the LaSalle Facility revolving line of credit. The Company's
short-term borrowings under its lines of credit during fiscal year 2004 had a
daily weighted average interest rate of 4.48% per annum. At June 30, 2004, the
Company had outstanding letters of credit totaling $1,700,000 related to
electricity and gas purchase contracts. These letters of credit are netted
against the Company's bank line of credit, which resulted in net availability at
June 30, 2004, of approximately $6.6 million under the LaSalle Facility
revolving line of credit. At December 1, 2004, the Company had borrowed
approximately $14.6 million under the LaSalle Facility revolving line of credit.
Accordingly, the Company had net availability at December 1, 2004, of
approximately $371,000 under the LaSalle Facility revolving line of credit. As
discussed above, the Company's short-term borrowing needs for purchases of gas
inventory and capital expenditures are greatest during the summer and fall
months. The Company's availability normally increases in January as monthly
heating bills are paid and gas purchases are no longer necessary.
In addition to the LaSalle Facility, the Company has outstanding certain
notes and industrial development revenue obligations (collectively "Long Term
Notes and Bonds"). The Company's Long Term Notes and Bonds are made up of three
separate debt issues: $8.0 million of Series 1997 notes bearing interest at an
annual rate of 7.5%; $7.8 million of Series 1993 notes bearing interest at
annual rates ranging from 6.20% to 7.60%; and Cascade County, Montana Series
1992B Industrial Development Revenue Obligations in the amount of $1.8 million
bearing interest at annual rates ranging from 6.0% to 6.5%. The Company's
obligations under the Long Term Notes and Bonds are secured on an equal and
ratable basis with the Lender in the collateral granted to secure the LaSalle
Facility with the exception of the first $1.0 million of debt under the LaSalle
Facility.
Under the terms of the Long Term Notes and Bonds, the Company is subject
to certain restrictions, including restrictions on total dividends and
distributions, liens and secured indebtedness, and asset sales, and is
restricted from incurring additional long-term indebtedness if it does not meet
certain debt to interest and debt to capital ratios.
In the event that the Company's obligations under the LaSalle Facility
were declared immediately due and payable as a result of an event of default,
such acceleration also could result in events of default under the Company's
Series 1993 Notes and Series 1997 Notes. In such circumstances, an event of
default under either series of notes would occur if (a) the Company were given
notice to that effect either by the trustee under the indenture governing such
series of notes, or the holders of at least 25% in principal amount of the notes
of such series then outstanding, and (b) within 10 days after such notice from
the trustee or the note holders to the Company, the acceleration of the
Company's obligations under the LaSalle Facility has not been rescinded or
annulled and the obligations under the LaSalle Facility have not been
discharged. There is no similar cross-default provision with respect to the
Cascade County, Montana Series 1992B Industrial Development Revenue Bonds and
the related Loan Agreement between the Company and Cascade County, Montana. If
the Company's obligations were accelerated under the terms of any of the LaSalle
Facility, the Series 1993 Notes or the Series 1997 Notes, such acceleration
(unless rescinded or cured)
41
could result in a loss of liquidity and cause a material adverse effect on the
Company and its financial condition.
The total amount outstanding under all of the Company's long term debt
obligations was approximately $21.7 million and $15.4 million, at June 30, 2004
and June 30, 2003, respectively. The portion of such obligations due within one
year was approximately $973,000 and $530,000 at June 30, 2004, and June 30,
2003, respectively.
The Company would not have been in compliance with certain covenants under the
LaSalle Facility had the lender not waived or modified the covenants. The
Company is currently evaluating its options with respect to raising equity
capital to fund the repayment of the $2.0 million term loan, which matures on
October 1, 2005.
CONTRACTUAL OBLIGATIONS
A table of the Company's long-term debt obligations, as well as other
long-term commitments and contingencies, and the corresponding maturity dates
are listed below.
PAYMENTS DUE BY PERIOD
Less
Contractual than 2 - 3 4 - 5 After 5
Obligations Total 1 year Years Years Years
- ----------- ----------- ---------- ---------- ---------- -----------
Long-Term Debt $22,669,992 $ 972,706 $ 4,071,302 $ 1,615,000 $16,010,984
Operating Lease Obligations 473,046 142,599 233,223 97,224 --
Transportation and Storage Obligation 24,378,587 4,367,715 8,653,816 8,517,792 2,839,264
----------- ---------- ----------- ----------- -----------
Total Obligations $47,521,625 $5,483,020 $12,958,341 $10,230,016 $18,850,248
----------- ---------- ----------- ----------- -----------
42
CAPITAL EXPENDITURES
The Company conducts ongoing construction activities in all of its utility
service areas in order to support expansion, maintenance and enhancement of its
gas and propane pipeline systems. In fiscal years 2004, 2003 and 2002, total
capital expenditures for the Company were approximately $2,317,000, $4,130,000
and $6,442,000, respectively, including purchases of natural gas production
properties. Expenditures for fiscal year 2002 were higher than usual due to the
renovation of a transmission pipeline between Wyoming and Montana and a by-pass
pipeline loop around Cody, Wyoming. Expenditures for fiscal year 2004 were
limited to essential needs only. Expenditures in fiscal year 2005 are expected
to be limited to essential needs only.
The Company estimates future cash requirements for capital expenditures
will be as follows:
ESTIMATED
FUTURE CASH
ACTUAL REQUIREMENTS
------ ------------
(in thousands) 2004 2005
Natural Gas Operations $1,632 $1,041
Propane Operations 515 836
Energy West Resources 75 200
Pipeline Operations 95 0
------ ------
Total capital expenditures $2,317 $2,077
====== ======
NEW ACCOUNTING PRONOUNCEMENTS
In April 2003, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 149, Amendments of Statement 133 on Derivative Instruments and Hedging
Activities. SFAS No. 149 amends and clarifies accounting for derivative
instruments, including certain derivative instruments embedded in other
contracts, and hedging activities. The Statement is effective for contracts
entered into or modified after June 30, 2003 and for hedging relationships
designated after June 30, 2003. Management adopted this standard on July 1, 2003
and determined that there is no current impact from SFAS No. 149 on the
consolidated financial statements.
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity, which
provides standards for how an issuer classifies and measures certain financial
instruments with characteristics of both liabilities and equity. The Statement
is effective for financial instruments entered into or modified after May 31,
2003 and for pre-existing instruments as of the beginning of the first interim
period beginning after June 15, 2003. Management has determined that there is no
current impact from SFAS No. 150 on the consolidated finan