NORTHWESTERN CORPORATION
1998 ANNUAL REPORT
MANAGEMENT'S DISCUSSION AND ANALYSIS
NORTHWESTERN CORPORATION
NorthWestern Corporation (the Corporation) is a provider of services and
solutions to customers across North America. The Corporation provides electric
and natural gas service to Midwestern customers through our energy division,
NorthWestern Public Service. In addition, the Corporation holds interests in
CornerStone Propane Partners, L.P. (NYSE:CNO), the nation's fourth largest
retail propane distributor; Expanets, Inc., a national provider of integrated
communication and data solutions and network services; and Blue Dot Services
Inc., a national provider of air conditioning, heating, plumbing and related
services (HVAC). The Corporation is also engaged in other service and nonenergy
related businesses.
RESULTS OF OPERATIONS
EARNINGS AND DIVIDENDS
Consolidated earnings for 1998 were $27.1 million or diluted $1.44 per
share, compared to $23.4 million or diluted $1.31 per share for 1997, and $22.9
million or diluted $1.19 per share for 1996, which excludes $.09 related to a
one-time gain from proceeds of refinancing transactions at CornerStone Propane
Partners, L.P. (CornerStone). Earnings per share in 1998 reflect a 5% increase
in average shares outstanding related to the public offering of five million
additional common shares completed in November 1998. The earnings increase in
1998 was primarily driven by growth in our HVAC and communications segments
through internal growth and companies acquired during the year partially offset
by abnormally warmer weather affecting our propane and natural gas operations.
The earnings increase in 1997 was primarily due to propane acquisitions,
improved electric and natural gas returns and increased investment income.
In November 1998, the Corporation's Board of Directors elected to
increase annual dividends six cents per share from $.97 to $1.03. Previously,
in November 1997, the board approved a five cent per share increase in annual
dividends from $.92 to $.97. The Corporation's financial strength, operating
performance, the success of its growth strategies and competitive changes in
the industry will be factors considered by the Corporation's Board of Directors
when evaluating future dividend payments.
CONSOLIDATED OPERATING RESULTS
Consolidated operating revenues increased by $269.1 million from $918.1
million in 1997 to $1.2 billion in 1998. This growth is mainly attributable to
acquisitions within the propane, communications and HVAC business segments
combined with internal growth within all business segments. The growth was
partially offset by abnormally warm weather that adversely affected propane and
natural gas sales during the winter heating season. Pro forma consolidated
operating revenues for 1998 are $2.0 billion, which is a 118.9% increase over
actual 1997 operating revenues. Actual 1998 results only include the operating
results of acquired companies from the date acquired. (Pro forma results
included here and elsewhere reflect operating results from acquired companies
as if they had been acquired on January 1 of the reporting period.) Selling,
general and administrative expenses increased $98.0 million from $132.8 million
in 1997 to $230.8 million in 1998. The largest part of these increases is
directly attributable to the growth by acquisitions in our propane,
communications and HVAC business segments. Depreciation and amortization also
increased $11.4 million from $31.2 million in 1997 to $42.6 million in 1998.
This increase is primarily due to companies acquired within the business
segments combined with a slight increase due to growth capital expenditures.The
other operating expense increases were incremental with the revenue increases
primarily due to the acquired companies and modest inflationary increases in
operating costs. Operating income increased by $14.9 million from $59.0 million
in 1997 to $73.9 million in 1998. This growth was primarily due to the
acquisitions in our propane, communications and HVAC businesses combined with
internal growth, which was partially offset by the adverse effect the warm
weather had on our propane and natural gas sales during the winter heating
season.
Consolidated operating revenues increased by $574.1 million from $344.0
million in 1996 to $918.1 million in 1997. The majority of this increase is
attributable to a full year of consolidated operations as well as significant
acquisitions in our propane segment. The increase was partially offset by
warmer than normal temperatures in 1997. The positive revenues were also driven
by customer increases and higher natural gas prices. Selling, general and
administrative expenses increased $39.0 million from $93.8 million in 1996 to
$132.8 million in 1997, while depreciation and amortization increased $11.8
million from $19.4 million in 1996 to $31.2 million in 1997. The majority of
these increases were related to the growth in the propane segment. The other
operating expense increases were incremental with the revenue growth in the
electric and natural gas revenues. Operating income increased by $8.6 million
from $50.4 million in 1996 to $59.0 million in 1997 primarily due to
acquisitions and growth in propane, but negatively impacted by the warmer than
normal temperatures in 1997.
PROPANE
Our results of operations in the propane segment for 1998 and 1997 include
a full year of operations from CornerStone as compared to 1996, which includes
revenues from CornerStone since December 18, 1996, Empire Energy Corporation
since October 7, 1996, and Synergy Group Incorporated for all of 1996. As of
December 31, 1998, the Corporation owned an effective combined 30% interest in
CornerStone (comprised of subordinated units and our general partner interests).
Because of the heavy use of propane for heating, propane sales are
extremely weather sensitive. The majority of propane revenues occur in the
first and fourth quarters when propane is heavily sold for residential and
commercial heating. 1998 weather averaged 9% warmer than normal in
CornerStone's market areas. While weather factors generally measure the
directional impact of temperatures on the business, other factors such as
product prices, geographic mix, magnitude and duration of temperature and
weather conditions can also impact sales.
Retail propane sales increased in 1998 to $297.8 million from $243.6
million in 1997 with gross margin also increasing from $116.1 million to $132.3
million. The increase in retail sales and margins are primarily due to
acquisitions during late 1998, partially offset by significantly warmer than
normal weather during the heating season. Retail propane gallons sold in 1998
increased to 231.8 million from 220.8 million in 1997 and 141.4 million in
1996.
Wholesale sales decreased in 1998 to $470.0 million from $499.4 million in
1997 due to lower product prices being caused by depressed oil and related
product prices resulting from an oversupply of oil. However, gross margin
increased to $16.7 million in 1998 from $14.7 million in 1997 due to higher
sales volumes. Propane operating income decreased slightly in 1998 to $23.3
million from $23.6 million in 1997. The decrease in operating income is
primarily attributable to warmer than normal weather in propane market areas
partially offset by acquisitions of retail service centers.
Operating revenue from propane sales increased in 1997 to $743.0 million
from $175.1 million in 1996. The large increase in sales is primarily due to a
full year of the wholesale operations combined with a full year of retail sales
and acquisitions during 1997. Operating income increased in 1997 to $23.6
million from $18.9 million in 1996. The increase in operating income is
primarily attributable to a full year of operations of CornerStone partially
offset by warmer than normal temperatures in 1997 combined with higher product
costs.
ELECTRIC
NorthWestern Public Service, a division of the Corporation, generates,
transmits and distributes electricity to customers in the Midwest. While
electricity is used year round, retail demand is higher in the summer months
for air conditioning causing sales of electricity to be weather sensitive.
In 1998, retail electric mwh sales increased by 1% and wholesale mwh sales
grew by 24%. The increase is due to warmer than prior year summer weather,
which resulted in higher use of air conditioning by retail customers combined
with increased usage by commercial and industrial customers. Electric revenues
increased by $1.7 million from $76.7 million in 1997 to $78.4 million in 1998
due to the increased retail and wholesale mwh sales. Operating income decreased
slightly by $1.6 million due to higher property taxes and salary costs nearly
offset by increases in retail and wholesale sales volumes.
In 1997, retail electric mwh sales grew by 3% reflecting weather, which was
slightly warmer than the previous year. Electric revenues increased due to the
increased retail mwh sales and an increase in wholesale sales. Operating income
increased primarily due to the increase in sales volumes combined with decreases
in maintenance and operating expenses.
HVAC
In 1997, Blue Dot Services Inc. (Blue Dot., formerly ServiCenter USA) was
formed by NorthWestern Growth Corporation (NGC), a wholly owned subsidiary of
the Corporation, to provide heating, ventilating, air conditioning, plumbing
and related services for residential and business customers in the U.S. Through
1998, the Corporation had invested $87 million in Blue Dot. to acquire 28
companies with operations in 18 states. 1998 revenues were $126.5 million and
operating income was $11.1 million. Pro forma 1998 revenues increased $23.4
million from $186.2 million in 1997 to $209.6 million in 1998 due principally
to the internal growth within the acquired companies. Pro forma operating
income increased $1.3 million from $15.9 million in 1997 to $17.2 million in
1998. Pro forma operating income increased due to increases in operating
revenues partially offset by increases in operating expenses directly related
to the revenue increase.
COMMUNICATIONS
Expanets, Inc. (Expanets, formerly Communication Systems USA) was formed
by NGC to provide communication, data and related services to business
customers. During 1998, the Corporation invested $108 million in Expanets to
acquire 18 companies with operations in 25 states. 1998 revenues were $127.9
million and operating income was $12.0 million. Pro forma 1998 revenues
increased $15.4 million from $233.4 million in 1997 to $248.8 million in 1998
due principally to the internal growth within the acquired companies. Pro forma
operating income increased $2.2 million from $22.3 million in 1997 to $24.5
million in 1998. Pro forma operating income increased due to increases in
operating revenues partially offset by increases in operating expenses directly
related to the revenue increase.
NATURAL GAS
One of the predominant factors affecting the Corporation's natural gas
operations is weather patterns during the winter heating season. Because
natural gas is heavily used for residential and commercial heating, the demand
for this product depends upon weather conditions. In 1998, the 13.3% decrease
in natural gas revenues from 1997 primarily reflects the negative impact from
significantly warmer weather than the prior year during the heating season.
This negative weather impact reduced operating gross margin for natural gas
from $22.5 million in 1997 to $20.0 million in 1998. During the first quarter
of 1998, weather was approximately 18% warmer than in 1997, while weather
during the last quarter of 1998 was also warmer than the prior year by
approximately 14%. The decrease in operating income is primarily due to the
decreased revenues and gross margins resulting from the warmer weather.
In 1997, the 7.3% increase in natural gas revenues over 1996 primarily
reflects higher market prices for natural gas supply, which were passed on to
customers through the purchased gas adjustment, a 1.5% increase in gas
customers and differing weather patterns during the year. During the first
quarter of 1997, weather was approximately 7% colder than 1996, while weather
during the last quarter of 1997 was approximately 15% warmer than the prior
year. The increase in operating income reflects the increased revenues
resulting from the expanding customer base and colder first quarter weather
combined with decreased operating and maintenance expenses.
OTHER INCOME STATEMENT ITEMS
Other operating revenues consists primarily of manufacturing revenues and
operating income related to the Corporation's former ownership interest in
Lucht Inc., a company that manufactured photographic processing and imaging
equipment used by high-volume photo processing laboratories. In November
1998, the Corporation sold its ownership interest in Lucht.
Other income decreased from $11.6 million in 1997 to $6.1 million in 1998
principally due to funds utilized in growing the Corporation's operations
through strategic acquisitions principally in the communications and HVAC
businesses. Interest expense increased $4.2 million from $31.5 million in 1997
to $35.7 million in 1998, principally due to increases in propane working
capital and acquisition borrowings. The Corporation also completed a new debt
offering in November 1998, which slightly increased interest expense in 1998.
Interest expense and minority interest on preferred securities in 1999 will
increase over 1998 due to a full year of outstanding borrowings from the new
debt and preferred securities offerings completed in November 1998. Income
taxes increased due to increased taxable income from the expanded operations of
the Corporation in 1998 as compared to 1997.
LIQUIDITY AND CAPITAL RESOURCES
During 1998, cash flow from operations, net of dividends paid, together
with proceeds from common stock, preferred securities and long-term debt
offerings and other external financing activities, provided the funds for
acquisition activities, growth and maintenance expenditures and other
requirements.
OPERATING ACTIVITIES
Cash flow from operating activities in 1998 increased $7.2 million or
11.5% from 1997 primarily due to growth in the Corporation's earnings as a
result of expanded operations. Liquidity is also provided from the availability
of substantial cash and investment balances. Cash and cash equivalents and
marketable securities totaled $157.3 million, $108.6 million and $179.9 million
at December 31, 1998, 1997 and 1996.
INVESTING AND FINANCING ACTIVITIES
The Corporation's principal investment activities in 1998 were related to
increased strategic development investments including the investments in Blue
Dot. and Expanets. The Corporation's principal financing activities related to
public offerings of common stock, preferred securities and senior debt
offerings completed in November 1998, and the sinking fund retirement of $5.0
million of 6.99% series general mortgage bonds. The offering transactions
resulted in gross proceeds to the Corporation of approximately $280 million.
These funds were used to repay short-term borrowings used to fund corporate
development activities of the Corporation in 1998 and general corporate
purposes. In January 1998, CornerStone completed a secondary offering of common
units with net proceeds of approximately $41 million. The proceeds were used to
repay amounts outstanding under the CornerStone credit facility and general
business purposes. In December 1998, CornerStone completed another secondary
offering of common units and issued additional senior notes with combined gross
proceeds of approximately $139 million. The proceeds were used to fund the
acquisition of Propane Continental Inc., the 19th largest retailer of propane,
repay amounts outstanding under the CornerStone credit facility and general
business purposes.
Unused lines of credit also provide working capital and other financial
resources. These lines may also be used to support commercial paper borrowings,
a primary source of short-term financing. At December 31, 1998 and 1997, the
Corporation had no outstanding borrowings under its lines of credit or
commercial paper borrowings. Unused short-term lines of credit totaled $75
million at December 31, 1998. CornerStone maintains a Bank Credit Facility,
which provides for combined working capital and acquisition borrowings of up to
$110 million subject to certain loan covenants and other limitations. At
December 31, 1998 and 1997, CornerStone had combined outstanding working
capital and acquisition borrowings of $1.7 million and $36.0 million. In
addition, the Corporation's other nonregulated businesses maintain credit
agreements with banks for revolving loans.
CAPITAL REQUIREMENTS
The Corporation's primary capital requirements include the funding of its
business segments, maintenance and expansion programs, the funding of debt and
preferred stock retirements, sinking fund requirements, the funding of its
corporate development and investment activities, payment of common dividends,
and the distributions to propane common unitholders.
Maintenance expenditure plans are subject to continual review and may be
revised as a result of changing economic conditions, variations in sales,
environmental requirements, investment opportunities and other ongoing
considerations. Expenditures for maintenance activities for 1998, 1997 and 1996
were $22.6 million, $22.4 million and $35.2 million. Consolidated maintenance
capital expenditures for 1999 and 2000 are estimated to be $27.3 million and
$26.2 million.
Capital requirements for the mandatory retirement of long-term debt
totaled $7.8 million, $1.2 million, and $400,000 for the years ended 1998,
1997 and 1996. It is expected that such mandatory retirements will be $20.1
million in 1999, $10.2 million in 2000, $8.9 million in 2001, $8.0 million in
2002, and $40.2 million in 2003. The Corporation anticipates that existing
investments and marketable securities, internally generated cash flows and
available external financing will meet future capital requirements.
The Corporation will continue to review the economics of retiring or
refunding remaining long-term debt and preferred stock to minimize long-term
financing costs. The Corporation will continue to make investments in its
strategic partner entities, Blue Dot. and Expanets. Also, the Corporation may
make other significant acquisition investments in related industries that might
require the Corporation to raise additional equity and/or incur debt financing,
which are therefore subject to certain risks and uncertainties. The
Corporation's financial coverage ratios are at levels in excess of those
required for the issuance of additional debt and preferred stock.
COMPETITION AND BUSINESS RISK
NorthWestern's strategy centers upon the development, acquisition and
expansions of operations offering integrated services and solutions within the
NorthWestern partner entities. In addition to maintaining a strong competitive
position in its electric, natural gas and propane distribution businesses, the
Corporation intends to pursue strategic development and acquisitions that have
long-term growth potential. While these strategic development and acquisition
activities can involve increased risk in comparison to the Corporation's energy
distribution businesses, they offer the potential for enhanced investment
returns. The Corporation's strategy to continue strategic development through
acquisitions will be subject to future availability of market capital to fund
such acquisitions. The NorthWestern strategy of integrating products and
services and acquired companies have other factors which may also increase the
risks of the Corporation. These factors include the adequacy and efficiency of
its information systems, business processes, related support functions and the
ability to attract and retain quality team members. The Corporation has taken
and continues to take steps to refine, improve and scale up its back-office
support systems and processes. There are no assurances that such efforts will
be sufficient to meet the future needs of the Corporation's operations. Future
changes in accounting rules and regulations could have a material impact upon
the Corporation's future financial statement presentation, results from
operations and financial position.
PROPANE
The retail propane business is a margin-based business in which gross
profits depend on the excess of sales prices over propane supply costs.
Consequently, CornerStone's profitability will be sensitive to changes in
wholesale propane prices. Propane is a commodity, the market price of which can
be subject to volatile changes in response to changes in supply or other market
conditions. As it may not be possible to immediately pass on to customers rapid
increases in the wholesale cost of propane, such increases could reduce
CornerStone's gross profits.
Weather conditions have a significant impact on propane demand for both
heating and agricultural purposes. The majority of CornerStone's customers rely
heavily on propane as a heating fuel. Actual weather conditions can vary
substantially from year to year, significantly affecting CornerStone's
financial performance. Furthermore, variations in weather in one or more
regions in which CornerStone operates can significantly affect the total
volumes sold by CornerStone and the margins realized on such sales and,
consequently, CornerStone's results of operations. These conditions may also
impact CornerStone's ability to meet various debt covenant requirements and
affect CornerStone's ability to pay common and subordinated unit distributions.
Propane competes with other sources of energy, some of which are less
costly for equivalent energy value. Propane distributors compete for customers
against suppliers of electricity, fuel oil and natural gas, principally on the
basis of price, service, availability and portability. Electricity is a
competitor of propane, but propane generally enjoys a competitive price
advantage over electricity for space heating, water heating and cooking.
Propane serves as an alternative to natural gas in rural and suburban areas
where natural gas is unavailable or portability of product is required. Natural
gas is generally a less expensive source of energy than propane, although in
areas where natural gas is available, propane is used for certain industrial and
commercial applications. The gradual expansion of the nation's natural gas
distribution systems has resulted in the availability of natural gas in some
areas that previously depended upon propane. However, natural gas pipelines are
not present in many regions of the country where propane is sold for heating and
cooking purposes.
CornerStone's profitability is affected by the competition for customers
among all participants in the retail propane business. Some of CornerStone's
competitors are larger or have greater financial resources than CornerStone.
Should a competitor attempt to increase market share by reducing prices,
CornerStone's financial condition and results of operations could be materially
adversely affected. In addition, propane competes with other sources of energy,
some of which may be less costly per equivalent energy value.
ELECTRIC AND NATURAL GAS
The electric and natural gas industries continue to undergo numerous
transformations, and the Corporation is operating in an increasingly
competitive marketplace. The Federal Energy Regulatory Commission (FERC), which
regulates interstate and wholesale electric transmissions, opened up
transmission grids and mandated that utilities must allow others equal access
to utility transmission systems. Various state regulatory bodies are supporting
initiatives to redefine the electric energy market and are experimenting with
retail wheeling, which gives some retail customers the ability to choose their
supplier of electricity. Traditionally, utilities have been vertically
integrated, providing bundled energy services to customers. The potential for
continued unbundling of customer services exists, allowing customers to buy
their own electricity and natural gas on the open market and having it
delivered by the local utility.
The growing pace of competition in the energy industry has been a primary
focus of management over the last few years. The Corporation's future financial
performance will be dependent on the effective execution of operating
strategies to address a more competitive and changing energy marketplace.
Business strategies focus on enhancing the Corporation's competitive position,
on expanding energy sales and markets with new products and services for
customers, and increasing shareholder value. The Corporation has realigned
various areas of its business to support customer services and marketing
functions. A new marketing plan, an expanded line of integrated customer
products and services, additional staff and new technologies are part of the
Corporation's strategy for providing responsive and superior customer service.
To strengthen the Corporation's competitive position, new technologies have and
will be added that enable team members to better serve customers. The
Corporation is centralizing activities to improve efficiency, and customer
responsiveness and business processes are being reengineered to apply best-
practices methodologies. Long-term supply contracts have been renegotiated to
lower customers' energy costs and new alliances help reduce expenses and add
innovative work approaches.
Weather conditions have a significant impact on electric and natural gas
demand for heating and cooling purposes. Actual weather conditions can vary
substantially from year to year, significantly affecting the Corporation's
financial performance.
As described in Note 1 to the consolidated financial statements, the
Corporation complies with the provisions of Statement of Financial Accounting
Standards No. 71 (SFAS 71), `Accounting for the Effects of Certain Types of
Regulation.' SFAS 71 provides for the financial reporting requirements of the
Corporation's regulated electric and natural gas operations, which requires
specific accounting treatment of certain costs and expenses that are related to
the Corporation's regulated operations. Criteria that could give rise to the
discontinuance of SFAS 71 include 1) increasing competition that restricts the
Corporation's ability to establish prices to recover specific costs and 2) a
significant change in the manner in which rates are set by regulators from
cost-based regulation to another form of regulation. The Corporation
periodically reviews these criteria to ensure the continuing application of
SFAS 71 is appropriate. Based on a current evaluation of the various factors
and conditions that are expected to impact future cost recovery, the
Corporation believes that its regulatory assets, including those related to
generation, are probable of future recovery. This evaluation of recovery must
be updated for any change, which might occur in the Corporation's current
regulatory environment.
HVAC
The markets served by Blue Dot. for residential and commercial heating,
ventilating, air conditioning, plumbing and other related services are highly
competitive. The principal competitive factors in these segments of the
industry are 1) timeliness, reliability and quality of services provided, 2)
range of products and services provided, 3) name recognition and market share
and 4)pricing. Many of Blue Dot.'s competitors in the HVAC business are small,
owner-operated companies typically located and operated in a single geographic
area.There are a small number of larger national companies engaged in providing
residential and commercial services in the service lines in which the
Corporation intends to focus. Future competition in both the residential and
commercial service lines may be encountered from other newly formed or existing
public or private service companies with aggressive acquisition programs, from
the unregulated business segments of regulated gas and electric utilities, or
from newly deregulated utilities in those industries entering into various
service areas.
COMMUNICATIONS
The market served by Expanets in the communications and data services
industry is also a highly competitive market. The Corporation believes that 1)
market acceptance of the products, services and technology advances the
Corporation provides, 2) pending and future legislation affecting the
communications and data industry, 3) name recognition and market share, 4)
larger competitors and 5) the Corporation's ability to provide integrated
communication and data solutions for customers in a dynamic industry are all
factors that could affect the Corporation's future operating results. Many of
Expanets competitors in the communications business are generally small, owner-
operated companies typically located and operated in a single geographic area.
There are a number of large, integrated national companies engaged in providing
commercial services in the service lines in which the Corporation intends to
focus and also manufacture and sell directly the products that the Corporation
services and sells. Future competition may be encountered from other newly
formed or existing public or private service companies with aggressive
acquisition programs.
YEAR 2000 READINESS
The Corporation utilizes software and various technologies throughout its
businesses that might be impacted by the date change in the year 2000. The year
2000 issue is a result of computer programs which were written using two digits
(rather than the actual four) to identify the year in the date field. This old
approach was intended to save processing time and storage space within
computers and was continued in use until the mid 1990s. If not corrected,
affected systems and devices containing computer chips or clocks could roll
back to 1900 instead of moving forward to 2000. Some systems and devices may
continue to function even if this occurs. Others may experience interruptions
in service, processes or obtain erroneous results.
In an effort to recognize these critical systems or devices with potential
business consequences, the Corporation is utilizing internal and external
resources to conduct detailed assessments of critical systems and devices. To
ensure a thorough approach to the year 2000, the Corporation has assembled a
diverse oversight and advisory team from all businesses with experienced
information systems, legal, communications and operating leadership to work on
our enterprise-wide year 2000 program. This initiative covers not only the
Corporation's information technology systems and computer applications, but also
considers hardware, embedded systems and components internal and external to our
organizations. The Corporation's program considers not only our businesses and
technology areas but also those of our customers and suppliers.
The Corporation's operations are dependent upon complex computer systems
for many aspects of its businesses. These different computer information systems
include AS/400, client server and distributed systems. The Corporation's goal is
to have mission-critical systems or devices that are required to maintain
operations ready for the year 2000. Year 2000 ready means that the system or
device has been deemed suitable to operate after December 31, 1999. Many of the
Corporation's mission-critical systems have been replaced or will be replaced
in advance of the year 2000. Remediation plans include prioritizing our efforts
based on when the systems might first experience malfunctions as well as
possible impact on our customers. The Corporation is on target to remediate all
critical applications early in 1999 and then will devote the remainder of 1999
to work on final interface issues, remediation, testing and fine-tuning
critical items.
The Corporation's costs to prepare for the year 2000 were approximately $2
million during 1998 and an estimated additional $2 million will be incurred
during 1999. These costs have been expensed as incurred or capitalized in
accordance with our accounting policy for software development costs.
The Corporation's systems and operations with respect to the year 2000
issue may also be affected by other third parties with which the Corporation
transacts business. We rely upon other companies to supply us with products and
services necessary to operate our businesses. If key third parties cannot
provide us with products and services as a result of their own year 2000
problem, it could have a material adverse effect upon our operations. The
extent of such impact would depend upon the duration of such interruption and
our costs and ability to find alternative sources of products and services.
The Corporation is currently working with third parties to determine the
potential adverse consequences, if any, that could result from such entities'
failure to effectively address the year 2000 issue.
The Corporation's primary focus has been directed at resolving the year
2000 problem. While the Corporation expects that the majority of its systems
and devices to be year 2000 ready, the Corporation is developing a contingency
plan specifying what will be done if the Corporation or important third parties
are not year 2000 ready. The Corporation anticipates that the majority of the
contingency plan will be based on manual backup systems, procedures and
practices, as well as the identification of alternative suppliers for key
products or services. The contingency plan is expected to be completed by June
30, 1999.
This Annual Report contains forward-looking statements within the meaning
of the securities laws. The Corporation cautions that, while it believes such
statements to be based on reasonable assumptions and makes such statements in
good faith, there can be no assurance that the actual results will not differ
materially from such assumptions or that the expectations set forth in the
forward-looking statements derived from such assumptions will be realized.
Investors should be aware of important factors that could have a material
impact on future results. These factors include, but are not limited to,
weather, the federal and state regulatory environment, the economic climate,
regional, commercial, industrial and residential growth in the service
territories served by the Corporation and its subsidiaries, customers' usage
patterns and preferences, the speed and degree to which competition enters the
Corporation's industries, the timing and extent of changes in commodity prices,
changing conditions in the capital and equity markets, and other uncertainties,
all of which are difficult to predict and many of which are beyond the control
of the Corporation.
REPORT OF MANAGEMENT
The management of NorthWestern is responsible for the integrity and
objectivity of the financial information contained in this Annual Report. The
consolidated financial statements, which necessarily include some amounts which
are based on informed judgments and estimates of management, have been prepared
in conformity with generally accepted accounting principles.
In meeting this responsibility, management maintains a system of internal
accounting controls, which is designed to provide reasonable assurance that the
assets of the Corporation are safeguarded and that transactions are executed in
accordance with management's authorization and are recorded properly for the
preparation of financial statements. This system is supported by written
policies, selection and training of qualified personnel, an appropriate
segregation of responsibilities within the organization and a program of
internal auditing. The Board of Directors, through its Audit Committee, which
is comprised entirely of outside directors, oversees management's
responsibilities for financial reporting. The Audit Committee meets regularly
with management and the independent public accountants to make inquiries as to
the manner in which each is performing its responsibilities. The independent
public accountants and the internal audit staff have unrestricted access to the
Audit Committee, without management's presence, to discuss auditing, internal
accounting control and financial reporting matters.
Arthur Andersen LLP, an independent public accounting firm, has been
engaged annually to perform an audit of the Corporation's financial statements.
Their audit is conducted in accordance with generally accepted auditing
standards and includes examining, on a test basis, supporting evidence,
assessing the Corporation's accounting principles and significant estimates
made by management, and evaluating the overall financial statement presentation
to the extent necessary to allow them to report on the fairness, in all
material respects, of the operating results and financial condition of the
Corporation.
Merle D. Lewis Richard R. Hylland
Chairman and President and
Chief Executive Officer Chief Operating Officer
Consolidated Statements of Income
Years Ended December 31,
(In Thousands Except Per Share Amounts)
1998 1997 1996
Operating Revenues $ 1,187,187 $ 918,070 $ 344,009
Cost of Sales 839,787 695,045 180,426
---------- -------- --------
Gross Margins 347,400 223,025 163,583
---------- -------- --------
Operating Expenses:
Selling, general and
administrative expenses 230,833 132,793 93,751
Depreciation and amortization 42,626 31,235 19,414
--------- -------- --------
273,459 164,028 113,165
--------- -------- --------
Operating Income 73,941 58,997 50,418
Interest Expense (35,732) (31,476) (18,668)
Investment Income and Other 6,145 11,564 9,719
--------- -------- --------
Income Before Income Taxes and
Minority Interests 44,354 39,085 41,469
Provision for Income Taxes (13,196) (11,111) (15,415)
---------- -------- ---------
Income Before Minority Interests 31,158 27,974 26,054
Minority Interests (767) (1,710) -
---------- -------- ---------
Net Income 30,391 26,264 26,054
Minority Interests on Preferred
Securities of Subsidiary Trusts (3,114) (2,641) (2,641)
Dividends on Cumulative
Preferred Stock (191) (212) (550)
---------- -------- ---------
Earnings on Common Stock $ 27,086 $ 23,411 $ 22,863
======= ======= =======
Average Common Shares Outstanding 18,660 17,843 17,840
Earnings Per Average Common Share
Basic $ 1.45 $ 1.31 $ 1.28
Diluted $ 1.44 $ 1.31 $ 1.28
Dividends Declared Per Average
Common Share $ .985 $ .933 $ .890
See Notes to Consolidated Financial Statements
Consolidated Statements of Cash Flows
Years Ended December 31,
(In Thousands) 1998 1997 1996
Operating Activities:
Net income $ 30,391 $ 26,264 $ 26,054
Items not affecting cash:
Depreciation and amortization 42,626 31,235 19,414
Deferred income taxes 1,548 4,439 5,830
Minority interests in net income
of consolidated subsidiaries 767 1,710 -
Investment tax credits (562) (559) (561)
Changes in current assets and
liabilities, net of acquisitions:
Accounts receivable 26,388 (363) (333)
Inventories 24,715 8,325 (4,374)
Other current assets (8,682) - (4,308)
Accounts payable (19,484) (11,364) 15,712
Accrued expenses (30,427) 6,945 4,501
Other, net 2,610 (3,965) (1,032)
--------- -------- --------
Cash flows provided by operating
activities 69,890 62,667 60,903
--------- -------- --------
Investment Activities:
Property, plant and equipment
additions (22,625) (22,400) (35,170)
Sale (purchase) of noncurrent
investments, net (68,974) 36,621 (107,426)
Acquisitions and growth
expenditures (318,113) (58,936) (26,521)
--------- -------- ---------
Cash flows used in investing
activities (409,712) (44,715) (169,117)
--------- -------- ----------
Financing Activities:
Dividends on common and preferred
Stock (19,092) (16,852) (16,428)
Minority interests on preferred
securities of subsidiary trusts (3,114) (2,641) (2,641)
Subsidiary payment of common unit
distributions (29,145) (17,708) -
Proceeds from issuance of common
units 95,592 - -
Issuance of nonrecourse subsidiary
debt 84,723 29,499 21,654
Repayment of nonrecourse subsidiary
debt (37,107) (7,544) (340)
Issuance of long-term debt 97,161 - -
Repayment of long-term debt (5,000) (22,500) -
Issuance of preferred securities of
subsidiary trusts 49,816 - -
Issuance of common stock 107,813 - -
Proceeds from exercise of warrants 3,177 - -
Retirement of preferred stock - - (10)
Retirement of subsidiary preferred
stock - (2,687) -
Short-term borrowings 11,554 - 35,500
--------- -------- --------
Cash flows provided by
(used in) financing activities 356,378 (40,433) 37,735
--------- --------- --------
CornerStone Propane Partners
Formation Transactions:
Acquisition of CGI Holdings,
net of cash acquired - - (68,962)
Issuance of CornerStone Propane
Partners common units - - 191,804
Issuance of CornerStone Propane
Partners long-term debt - - 220,000
Repayment of long-term debt and
short-term financings - - (229,571)
Other fees and expenses - - (10,554)
--------- -------- ---------
Cash flows provided by CornerStone
Propane Partners formation
transactions - - 102,717
--------- -------- ----------
Increase (Decrease) in Cash and
Cash Equivalents 16,556 (22,481) 32,238
Cash and Cash Equivalents, beginning
of year 14,309 36,790 4,552
-------- -------- -------
Cash and Cash Equivalents,
end of year $ 30,865 $ 14,309 $ 36,790
======== ======== =======
See Notes to Consolidated Financial Statements
Consolidated Balance Sheets
December 31,
(In Thousands) 1998 1997
ASSETS
Current Assets:
Cash and cash equivalents $ 30,865 $ 14,309
Accounts receivable, net 131,541 90,749
Inventories 72,805 36,015
Other 31,957 15,335
---------- ----------
267,168 156,408
---------- ----------
Property, Plant and Equipment, Net 629,278 545,622
---------- ----------
Goodwill and Other Intangible
Assets, Net 631,029 237,044
---------- ----------
Other Assets:
Investments 152,470 121,587
Other 56,271 45,462
---------- ----------
208,741 167,049
---------- ----------
$ 1,736,216 $ 1,106,123
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Current maturities of
long-term debt $ 20,060 $ 7,814
Short-term debt - nonrecourse 11,554 -
Accounts payable 113,036 89,064
Accrued expenses 64,779 47,686
---------- ---------
209,429 144,564
---------- ---------
Long-term Debt 256,350 156,350
Long-term Debt of Subsidiaries
- nonrecourse 332,525 268,931
Deferred Income Taxes 74,072 72,884
Other Noncurrent Liabilities 101,787 60,826
---------- ---------
764,734 558,991
---------- ---------
Commitments and Contingencies
(Notes 2, 6, 7, 12)
Minority Interests 388,702 199,722
--------- ---------
Preferred Stock, Preference Stock
and Preferred Securities:
Preferred stock - 4 1/2% series 2,600 2,600
Redeemable preferred stock
- 6 1/2% series 1,150 1,150
Preference stock - -
Corporation obligated mandatorily
redeemable preferred securities of
subsidiary trusts 87,500 32,500
-------- --------
91,250 36,250
-------- --------
Shareholders' Equity:
Common stock 40,279 31,224
Paid-in capital 158,530 56,595
Retained earnings 81,100 72,915
Accumulated other comprehensive
income 2,192 5,862
------- --------
282,101 166,596
------- --------
$ 1,736,216 $ 1,106,123
========= =========
See Notes to Consolidated Financial Statements
Consolidated Statements of Shareholders' Equity
Accumulated
Number of Other Total
Common Common Paid-in Retained Comprehensive Shareholders'
(In Thousands) Shares Stock Capital Earnings Income Equity
Balance at December
31, 1995 17,840 $31,220 $56,595 $59,159 $5,704 $152,678
Comprehensive income:
Net income - - - 26,054 - 26,054
Other comprehensive
income, net of tax:
Unrealized gain on
marketable securities
net of reclassification
adjustment - - - - 4,142 4,142
Distributions declared on
minority interests in
preferred securities of
subsidiary trusts - - - (2,641) - (2,641)
Dividends declared on
preferred stock - - - (550) - (550)
Dividends declared on
common stock - - - (15,878) - (15,878)
--------- ------- ----- -------- ------- --------
Balance at December 31,
1996 17,840 31,220 56,595 66,144 9,846 163,805
Comprehensive income:
Net income - - - 26,264 - 26,264
Other comprehensive
income, net of tax:
Unrealized loss on
marketable securities
net of reclassification
adjustment - - - - (3,984) (3,984)
Common stock issued 3 4 - - - 4
Distributions declared on
minority interestsin
preferred securities of
subsidiary trusts - - - (2,641) - (2,641)
Dividends declared on
preferred stock - - - (212) - (212)
Dividends declared on
common stock - - - (16,640) - (16,640)
------- -------- ---- -------- ------ --------
Balance at December
31, 1997 17,843 31,224 56,595 72,915 5,862 166,596
Comprehensive income:
Net income - - - 30,391 - 30,391
Other comprehensive
income, net of tax:
Unrealized loss on
marketable securities
net of reclassification
adjustment - - - - (3,670) (3,670)
Common stock issued 5,000 8,750 99,063 - - 107,813
Proceeds from exercise of
warrants 174 305 2,872 - - 3,177
Distributions declared
on minority interests
in preferred securities
of subsidiary trusts - - - (3,114) - (3,114)
Dividends declared on
preferred stock - - - (191) - (191)
Dividends declared on
common stock - - - (18,901) - (18,901)
-------- -------- ------- -------- ------- -------
Balance at December
31, 1998 23,017 $ 40,279 $ 158,530 $81,100 $2,192 $282,101
====== ======= ======= ======= ====== ========
See Notes to Consolidated Financial Statements
NOTES TO FINANCIAL STATEMENTS
1. SIGNIFICANT ACCOUNTING POLICIES
NATURE OF OPERATIONS:
NorthWestern Corporation (the Corporation) is a service and solutions
company providing energy, communications and related services to customers
throughout North America. A division of the Corporation is engaged in the
regulated energy business of production, purchase, transmission, distribution
and sale of electricity and the delivery of natural gas to Midwestern
customers. Through CornerStone Propane Partners, L.P. (CornerStone), the
Corporation is engaged in retail and wholesale propane distribution business
located throughout North America. CornerStone is a publicly traded Delaware
limited partnership, formed to acquire and operate propane businesses and
assets. A wholly owned subsidiary of the Corporation serves as the general
partner of CornerStone and manages and operates CornerStone's business. (For a
detailed description of the Partnership Formation and related transactions, see
Note 2.) At December 31, 1998, the Corporation owns a combined 30% effective
interest in the Partnership. Through Blue Dot Services Inc. (Blue Dot.,
formerly ServiCenter USA), the Corporation has become a national provider of
heating, ventilating, air conditioning, plumbing and related services (HVAC) by
acquiring existing companies throughout the U.S. Through Expanets, Inc.
(Expanets, formerly Communication Systems USA), the Corporation has become a
national provider of integrated communications, data solutions and network
services to business customers by acquiring companies throughout the U.S.
BASIS OF CONSOLIDATION:
The accompanying consolidated financial statements include the accounts of
the Corporation and all wholly and majority-owned or controlled subsidiaries,
including CornerStone, Blue Dot. and Expanets. All significant intercompany
balances and transactions have been eliminated from the consolidated financial
statements. The Corporation's regulated businesses are subject to various state
and federal agency regulation. The public unitholders' interest in
CornerStone's net assets subsequent to the Partnership Formation is reflected
as a minority interest in the consolidated financial statements. Equity
interest of the former owners of companies acquired by Blue Dot. and Expanets
who continue to hold an interest in Blue Dot. and Expanets are reflected as
minority interests in the consolidated financial statements.
USES OF ESTIMATES:
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
CASH EQUIVALENTS:
The Corporation generally considers all highly liquid investments
purchased with a maturity of three months or less to be cash equivalents.
ACCOUNTS RECEIVABLE, NET:
Accounts receivable is stated net of allowance for doubtful accounts of
$6.1 million and $3.6 million at December 31, 1998 and 1997.
INVESTMENTS AND FAIR VALUE OF
FINANCIAL INSTRUMENTS:
The Corporation's investments consist primarily of short-maturity, fixed-
income securities and corporate preferred and common stocks. In addition, the
Corporation has investments in privately held entities and ventures, safe
harbor leases and various money market and tax exempt investment programs.
These investments are accounted for in accordance with Statement of Financial
Accounting Standards No. 115 (SFAS 115), `Accounting for Certain Investments in
Debt and Equity Securities.' SFAS 115 requires that certain investments in debt
and equity securities be reported at fair value.
The Corporation's securities are classified under the provisions of SFAS
115 as follows (in thousands):
Unrealized
Fair Value Cost Gain
December 31, 1998:
Preferred Stocks $41,547 $39,560 $1,987
Marketable Securities 30,045 27,376 2,669
December 31, 1997:
Preferred Stocks $64,849 $62,197 $2,652
Marketable Securities 29,470 23,094 6,376
The combined unrealized gain, net of tax, at December 31, 1998 and 1997,
was $3.0 million and $5.9 million. Held to maturity securities are reported at
cost, which approximated fair value and at December 31, 1998 and 1997, was
$80.9 million and $27.3 million.
The Corporation uses the specific identification method for determining
the cost basis of its investments in available for sale securities. Gross
proceeds and realized gains and losses on sales of its available for sale
securities were not material in 1998, 1997 and 1996.
Based on current market rates for debt of similar credit quality and
remaining maturities or quoted market prices for certain issues, the face value
of the Corporation's long-term debt approximates its market value.
CornerStone routinely uses commodity futures contracts to reduce the risk
of future price fluctuations for natural gas and liquefied petroleum gas (LPG)
inventories and contracts. Gains and losses on futures contracts purchased as
hedges are deferred and recognized in cost of sales as a component of the
product cost for the related hedged transaction. Net realized gains and losses
on these contracts are generally not material.
REVENUE RECOGNITION:
Electric and natural gas revenues are based on billings rendered to
customers rather than on meters read or energy delivered. Customers are billed
monthly on a cycle basis. Revenues from propane sales are recognized
principally when fuel products are shipped or delivered to customers. HVAC and
communication revenues are recognized as goods are delivered to customers or
services are performed.
PROPERTY, PLANT AND EQUIPMENT:
Property, plant and equipment are stated at cost of acquisition less a
depreciation reserve. Depreciation is computed using the straight-line method
based on the estimated useful lives of the various classes of property.
Depreciable property has estimated useful lives which range from 3 to 40 years.
Depreciation rates include a provision for the Corporation's share of the
estimated costs to decommission three coal-fired generating plants at the end
of the useful life of each plant. The annual provision for such costs is
included in depreciation expense, while the accumulated provisions are
included in other noncurrent assets.
When property for the propane, HVAC or communications interests are
retired or otherwise disposed, the cost and related accumulated depreciation is
removed from the accounts, and the resulting gain or loss is credited or
charged to operations. No profit or loss is recognized in connection with
ordinary retirements of depreciable electric and natural gas property.
Maintenance and repairs are expensed as incurred, while replacements and
betterments that extend estimated useful lives are capitalized. Property, plant
and equipment at December 31 consisted of the following (in thousands):
1998 1997
Land and improvements $ 19,871 $ 15,808
Building and improvements 66,941 63,658
Storage, distribution,
transmission and generation 611,052 567,514
Other equipment 128,002 73,912
----------- ----------
825,866 720,892
Less accumulated depreciation (196,588) (175,270)
----------- ----------
$ 629,278 $ 545,622
======= ========
COMPUTER SOFTWARE COSTS:
The Corporation includes in property, plant and equipment external and
incremental internal costs associated with computer software we develop for use
in our businesses. Capitalization begins when the costs of the preliminary
stage of the project is completed. These costs are amortized on a straight-line
basis over an estimated useful life once the installed software is ready for
its intended use.
GOODWILL AND OTHER INTANGIBLES:
The excess of the cost of businesses acquired over the fair market value
of all tangible and intangible assets acquired, net of liabilities assumed, has
been recorded as goodwill. Other intangibles, consists principally of costs of
covenants not to compete. Intangibles and goodwill are being amortized over the
estimated periods benefited, which range from 3 to 40 years. Financing costs are
amortized over the term of the applicable debt.
The Corporation's policy is to review property, goodwill and other
intangible assets for possible impairment whenever events or changes in
circumstances indicate that the carrying amount of such assets may not be
recoverable. If such review indicates that the carrying amount is not
recoverable, the Corporation's policy is to reduce the carrying amount of these
assets to fair value.
(in thousands) 1998 1997
Goodwill $611,847 $231,459
Noncompete agreements 17,585 4,266
Financing costs 21,936 7,949
-------- --------
651,368 243,674
Less accumulated amortization (20,339) (6,630)
-------- --------
$631,029 $237,044
======== ========
INCOME TAXES:
Deferred income taxes relate primarily to the difference between book and
tax methods of depreciating property, the difference in the recognition of
revenues for book and tax purposes, and natural gas costs, which are deferred
for book purposes but expensed currently for tax purposes.
For book purposes, investment tax credits were deferred and are being
amortized as a reduction of income tax expense over the useful lives of the
property which generated the credits.
REGULATORY ASSETS AND LIABILITIES:
The regulated operations of the Corporation are subject to the provisions
of Statement of Financial Accounting Standards No. 71 (SFAS 71), `Accounting
for the Effects of Certain Types of Regulations.' Regulatory assets represent
probable future revenue to the Corporation associated with certain costs, which
will be recovered from customers through the ratemaking process. Regulatory
liabilities represent probable future reductions in revenues associated with
amounts that are to be credited to customers through the ratemaking process.
If all or a separable portion of the Corporation's operations becomes no
longer subject to the provisions of SFAS 71, an evaluation of future recovery
from related regulatory assets and liabilities would be necessary. In addition,
the Corporation would determine any impairment to the carrying costs of
deregulated plant and inventory assets.
NEW ACCOUNTING STANDARDS:
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133 (SFAS 133), `Accounting for Derivative
Instruments and Hedging Activities.' The Statement establishes accounting and
reporting standards requiring that every derivative instrument (including
certain derivative instruments imbedded in other contracts) be recorded in the
balance sheet as either an asset or liability measured at its fair value. The
Statement requires changes in the derivative's fair value be recognized
currently in earnings unless specific hedge accounting criteria are met. SFAS
133 is effective for fiscal years beginning after June 15, 1999. The
Corporation is evaluating the impacts of adopting SFAS 133 on its financial
statements. The impact of SFAS 133 will likely depend upon the extent of use of
derivative instruments and their designation and effectiveness as hedges of
market risk.
RECLASSIFICATIONS:
Certain 1997 and 1996 amounts have been reclassified to conform to the
1998 presentation. Such reclassifications had no impact on net income or
shareholders' equity as previously reported. Shares outstanding and earnings
per share amounts have been adjusted to reflect the May 1997 stock split.
SUPPLEMENTAL CASH FLOW INFORMATION:
(in thousands) 1998 1997 1996
Cash paid during the year for:
Income taxes $17,629 $8,940 $6,271
Interest 35,162 30,090 18,645
Noncash transactions
during the year for:
Assumption of debt as
part of acquisitions 28,572 1,551 149,516
2. BUSINESS COMBINATIONS AND ACQUISTIONS
MASTER LIMITED PARTNERSHIP
OFFERING AND ACQUISITIONS:
On December 17, 1996, a wholly owned subsidiary of NorthWestern Growth
Corporation acquired CGI Holdings, Inc. (Coast). Immediately after the
acquisition, the Corporation combined the propane distribution businesses of
Coast, Empire Energy Corporation (Energy), Myers Propane Gas Corporation
(Myers), and Synergy Group Incorporated (Synergy) into CornerStone. As part of
an IPO on the same date, CornerStone sold a total of 9,821,000 Common Units at
a price to the public of $21 a Unit. In January 1998, CornerStone sold an
additional 1,960,000 Common Units at a price to the public of $22.125 per Unit.
The net proceeds of $191.8 million from the sale of 9,821,000 Common Units
of CornerStone and the net proceeds from the issuance of $220 million face
value of CornerStone Senior Notes were used to repay term and revolving debt of
Coast, Energy and Synergy, including accrued interest and any prepayment
premiums which were assumed by the Partnership. In addition, the preferred
stock of Synergy was redeemed at a premium. As a result of these repayments,
the Corporation recorded a one-time, after-tax gain of $.09 per share from the
prepayment of the term debt and redemption of preferred stock investment in
Synergy.
On December 11, 1998, the Partnership acquired the operations of Propane
Continental, Inc. (PCI), a retail and wholesale propane distributor for
approximately $121 million, including debt to be refunded. The acquisition was
financed with Common Unit equity and long-term debt. The acquisition was
accounted for under the purchase method of accounting. PCI operates 34 retail
propane customer service centers in 11 states. Through Tri Power Fuels, PCI's
wholesale business, PCI distributes propane and other natural gas liquids to
independent dealers, resellers and end users predominately in the West, Midwest
and Northeast sections of the country.
On December 31, 1998, the Partnership acquired the operations of ERI
Services Canada, Ltd. and ERI Services, Inc. for approximately $4.5 million.
Both of these entities are engaged in wholesale natural gas purchases and
sales. The majority of their business is in Canada with a limited amount of
business in the northeastern U.S.
At December 31, 1998, CornerStone's capital consisted of 16,444,096 Common
Units, 6,597,619 Subordinated Units representing limited partner interests and
a 2% aggregate general partner interest. At December 31, 1998, the
Corporation's wholly and majority-owned subsidiaries owned all 6,597,619
Subordinated Units and an aggregate 2% general partner interest in the
Partnership, or a combined 30% effective interest in the Partnership.
BLUE DOT SERVICES INC.:
In 1997, NorthWestern formed Blue Dot. to acquire and operate HVAC
companies in the U.S. At December 31, 1998, Blue Dot. had acquired 28 companies
in 18 states with a total NorthWestern investment of $87.0 million. At
December 31, 1998, NorthWestern owned a 94.8% voting interest in Blue Dot.
through common and preferred stock ownership.
EXPANETS, INC.:
In 1997, NorthWestern formed Expanets to acquire and operate communication
companies in the U.S. At December 31, 1998, Expanets had acquired 18 companies
in 25 states with a total NorthWestern investment of $108.3 million. At December
31, 1998, NorthWestern owned a 93.8% voting interest in Expanets through common
and preferred stock ownership.
The acquisitions made by Blue Dot. and Expanets were effected utilizing
cash or stock (of Blue Dot. or Expanets) and generally with a combination of
both. In connection with certain acquisitions where the merger consideration
included stock, both Blue Dot. and Expanets entered into exchange agreements
with the sellers that typically do not exceed two years. Under such agreements,
the seller can elect to exchange the stock of Blue Dot. or Expanets that they
received in connection with the acquisition back to the Corporation for, at the
Corporation's option, either stock of the Corporation or cash at a
predetermined exchange rate.
All acquisitions of CornerStone, Blue Dot. and Expanets were accounted for
under the purchase method of accounting with the excess of the purchase price
over the fair value of assets acquired recorded as goodwill based upon the
preliminary estimates of fair value and are subject to further changes. Had the
acquisitions of CornerStone, Blue Dot. and Expanets occurred on January 1,
1997, combined unaudited pro forma results for the year ended December 31,
1997, as prescribed under Accounting Principles Board Opinion No. 16 (APB 16)
`Business Combinations,' would have been: revenues $1.8 billion, net income
$37.7 million and diluted earnings per share $1.34. The combined unaudited pro
forma results for the year ended December 31, 1998, would have been: revenues
$2.0 billion, net income $41.1 million and diluted earnings per share $1.48.
The pro forma disclosures required under APB 16 are not indicative of past or
future operating results.
3. SHORT-TERM BORROWINGS
The Corporation may issue short-term debt in the form of bank loans and
commercial paper as interim financing for general corporate purposes. The bank
loans may be obtained under short-term lines of credit. At December 31, 1998,
the Corporation's aggregate lines of credit available were $75 million. The
Corporation pays an annual fee generally equivalent to .1% to .25% of the
unused lines. There were no line of credit borrowings or commercial paper
outstanding at December 31, 1998 and 1997.
Expanets entered into a Bank Credit Facility in December 1998 with a
commercial bank. The Bank Credit Facility consists of a $15 million Working
Capital Facility. There were $11.6 million of borrowings outstanding under the
Working Capital Facility at December 31, 1998. The Bank Credit Facility bears
interest at a variable rate tied to the Eurodollar or prime rate plus a stated
margin for each rate. The Bank Credit Facility matures in June 1999. The
Facility is not secured, however, Expanets is subject to restrictive covenants
which include a) restrictions on other indebtedness, b) limits on mergers,
acquisitions and dispositions, and c) minimum investment in Expanets by the
Corporation.
4. LONG-TERM DEBT
Substantially all of the Corporation's electric and natural gas utility
plant is subject to the lien of the indentures securing its general mortgage
bonds and pollution control obligations. General mortgage bonds of the
Corporation may be issued in amounts limited by property, earnings and other
provisions of the mortgage indenture. In March 1997, the Corporation retired
early the $7.5 million outstanding of the 8.9% series general mortgage bonds.
In July 1997, the Corporation retired early the $15 million outstanding of the
8.824% series general mortgage bonds. As part of a financing transaction in
November 1998, the Corporation issued $105 million of 6.95%, 30-year senior
unsecured debt. The proceeds were used to repay short-term indebtedness and for
general corporate purposes. The following tables summarize the Corporation's
long-term obligations at December 31 (in thousands):
Due 1998 1997
Long-Term Debt:
Senior Unsecured Debt - 6.95% 2028 $105,000 $ -
General mortgage bonds -
6.99% 2002 20,000 25,000
7.10% 2005 60,000 60,000
7% 2023 55,000 55,000
Pollution control obligations -
5.85%, Mercer Co., ND 2023 7,550 7,550
5.90%, Salix, IA 2023 4,000 4,000
5.90%, Grant Co., SD 2023 9,800 9,800
Less current maturities (5,000) (5,000)
------- -------
$256,350 $156,350
========= ========
Long-Term Debt of Subsidiaries - nonrecourse:
Senior Secured Debt -
7.53% 2010 $220,000 $220,000
7.33% 2010 85,000 -
Bank Credit Facility 1999 1,700 36,000
Other term debt 40,885 15,745
Less current maturities (15,060) (2,814)
--------- --------
$332,525 $268,931
========= =========
In conjunction with the Partnership Formation in December 1996, the
Partnership issued $220 million in First Mortgage Notes (Mortgage Notes). These
Mortgage Notes are collateralized by substantially all of the assets of the
Partnership and rank pari passu with the Bank Credit Facility. The Mortgage
Notes bear interest at a fixed rate of 7.53% payable semi-annually and mature
in the year 2010 with eight equal annual installments beginning in the year
2003. The Partnership may, at its option and under certain circumstances
following the disposition of assets, be required to offer to prepay the
Mortgage Notes in whole or in part. The Mortgage Notes agreement contains
restrictive covenants applicable to the Partnership including a) restrictions
on the incurrence of additional indebtedness, b) restrictions on the ratio of
consolidated cash flow to consolidated interest expense of the Partnership,
as defined, and c) restrictions on certain liens, loans and investments,
payments, mergers, consolidations, sales of assets and other transactions.
Generally, as long as no default exists or would result, the Partnership is
permitted to make cash distributions not more frequently than quarterly in an
amount not to exceed available cash, as defined, for the immediately preceding
calendar quarter.
As part of a financing transaction in December 1998, the Partnership
issued$85 million of Senior Secured Notes (Senior Notes). These Senior Notes
are collateralized by substantially all of the assets of the Partnership and
ranks pari passu with existing notes and borrowings under the Bank Credit
Facility. The Senior Notes bear interest at a fixed rate of 7.33% payable semi-
annually and mature in the year 2010 with eight annual installments beginning
in the year 2003. The Senior Notes agreement contains the same restrictive
covenants as those associated with the 1996 Mortgage Notes.
The Partnership also has a Bank Credit Facility with a group of commercial
banks. The Bank Credit Facility consists of a combined $110 million Working
Capital and Acquisition Facilities to finance propane business acquisitions.
There were $1.7 million of combined borrowings outstanding under the Working
Capital and Acquisition Facilities. There were $36.0 million of combined
borrowings outstanding under the Working Capital and the Acquisition Facilities
at December 31, 1997. The Bank Credit Facility bears interest at a variable
rate tied to a certain Eurodollar index or prime rate plus a variable margin
for either rate which depends upon the Partnership's ratio of consolidated debt
to consolidated cash flow. The Bank Credit Facility matures in December 1999.
The Bank Credit Facility is collateralized by substantially all the assets of
the Partnership and ranks pari passu with the Mortgage Notes. The Bank Credit
Facility contains restrictive covenants applicable to the Partnership including
a) restrictions on the incurrence of additional indebtedness, b) restrictions
on the ratio of consolidated cash flow to consolidated interest expense of the
Partnership, as defined, and c) restrictions on certain liens, loans and
investments, payments, mergers, consolidations, sales of assets and other
transactions. They also require that the Partnership maintain a ratio of total
funded indebtedness to consolidated cash flow, as defined. Generally, as long
as no default exists or would result, the Partnership is permitted to make cash
quarterly distributions in an amount not to exceed Available Cash, as defined.
The balance of other nonrecourse debt is generally comprised of the debt
assumed and issued in conjunction with acquisitions of $40.9 million and $15.8
million at December 31, 1998 and 1997.
Annual scheduled consolidated retirements of long-term debt during the
next five years are $20.1 million in 1999, $10.2 million in 2000, $8.9 million
in 2001, $8.0 million in 2002 and $40.2 million in 2003.
5. INCOME TAXES
Income tax expense is comprised of the following (in thousands):
1998 1997 1996
Federal income:
Current tax expense $12,945 $4,620 $9,174
Deferred tax expense (1,069) 6,512 5,830
Investment tax credit (562) (559) (561)
State income 1,882 538 972
------- ------- --------
$13,196 $11,111 $15,415
======= ======= =======
The following table reconciles the Corporation's effective income tax rate
to the federal statutory rate:
1998 1997 1996
Federal statutory rate 35 % 35 % 35 %
State income, net of federal
benefit 2 1 2
Amortization of investment tax credit(1) (2) (1)
Dividends received deduction (7) (2) (1)
Other, net 1 1 2
---------- --------- --------
30 % 33 % 37 %
========== ========= =========
The components of the net deferred income tax liability recognized in the
Corporation's Consolidated Balance Sheets are related to the following temporary
differences at December 31 (in thousands):
1998 1997
Excess tax depreciation $ (80,556) $ (79,366)
Safe harbor leases (4,192) (4,514)
Property basis and life differences (11,027) (12,902)
Asset sales (3,967) (4,273)
Regulatory assets (2,732) (3,057)
Regulatory liabilities 4,125 4,512
Unbilled revenue 2,360 5,746
Unamortized investment tax credit 3,385 3,491
Unrealized gain on investments (3,308) (3,399)
Other, net 21,840 20,878
------------- ------------
$ (74,072) $ (72,884)
============= =============
6. TEAM MEMBER BENEFIT PLANS
The Corporation maintains a noncontributory defined benefit pension plan.
The benefits to which a team member is entitled under the plan are derived
using a formula based on the number of years of service and compensation
levels, as defined. The Corporation determines the annual funding for its
plan using the frozen initial liability cost method. The Corporation's annual
contribution is funded in accordance with the requirements of ERISA. Assets of
the plan consist primarily of debt and equity securities.
Following is a reconciliation of the changes in the plan's benefit
obligations and fair value of assets over the two-year period ending December
31, 1998, and a statement of the funded status as of December 31, of both years
(in thousands):
1998 1997
Reconciliation of benefit obligation:
Obligation at January 1 $54,656 $50,058
Service cost 1,012 981
Interest cost 3,689 3,499
Participant contributions - -
Amendments - 1,779
Actuarial (gain) loss 1,009 1,712
Acquisition - -
Benefits paid (3,649) (3,373)
---------- --------
Benefit obligation at end of year 56,717 54,656
---------- --------
Reconciliation of fair value of plan assets:
Fair value of plan assets at January 1 64,389 56,507
Actual return on plan assets 12,707 10,024
Acquisition - -
Employer contributions - 1,231
Participant contributions - -
Benefits paid (3,649) (3,373)
--------- ---------
Fair value of plan assets at end of year 73,447 64,389
--------- ---------
Funded status:
Funded status at December 31 16,730 9,734
Unrecognized transition amount 1,083 1,237
Unrecognized net actuarial loss (16,755) (10,665)
Unrecognized prior service cost 3,320 3,820
------- --------
Prepaid (accrued) benefit cost $4,378 $4,126
======= =======
The following table provides the components of net periodic benefit cost
for the plans for 1998, 1997 and 1996 (in thousands):
1998 1997 1996
Service cost $1,012 $981 $958
Interest cost 3,689 3,499 3,506
Expected return on plan assets (5,307) (4,681) (4,377)
Amortization of transition
(asset) obligation 155 155 155
Amortization of prior service cost 500 278 278
Amortization of net (gain) loss (302) (106) (193)
-------- -------- -------
Net periodic benefit cost $(253) $126 $327
======== ======== =======
The prior service costs are amortized on a straight-line basis over the
average remaining service period of active participants. Gains and losses in
excess of 10% of the greater of the benefit obligation and the market-related
value of assets are amortized over the average remaining service period of
active participants.
The assumptions used in calculating the projected benefit obligation for 1998,
1997 and 1996 were as follows:
1998 1997 1996
Discount rate 6.75% 7.00% 7.25%
Expected rate of return on assets 8.50% 8.50% 8.50%
Long-term rate of increase in
compensation levels 3.00% 3.00% 3.00%
The Corporation provides a team member savings plan, which permits a team
member to defer receipt of compensation as provided in Section 401(k) of the
Internal Revenue Code. Under the plan, a team member may elect to direct up to
12 percent of their gross compensation be contributed to the plan (subject to a
maximum dollar amount as specified by applicable regulations). The Corporation
contributes 50 cents for every one dollar contributed by the employee, up to a
maximum Corporation contribution of 3% of the team member's gross compensation.
The Corporation also provides an Employee Stock Ownership Plan (ESOP) for full-
time team members. The ESOP is funded primarily with federal income tax
savings, which arise from tax laws applicable to such team member benefit
plans. Certain Corporation contributions and shares of stock acquired by the
ESOP are allocated to participants' accounts in proportion to the compensation
of team members during the particular year for which allocation is made. Costs
incurred under the plan were $1.6 million, $1.5 million and $1.4 million in
1998, 1997 and 1996.
The Corporation also has various supplemental retirement plans for outside
directors and selected management team members. The plans are nonqualified
defined benefit plans that provide for certain amounts of salary continuation
in the event of death before or after retirement or certain supplemental
retirement benefits in lieu of any death benefits. In addition, the Corporation
provides life insurance benefits to beneficiaries of eligible team members who
represent a reasonable insurable risk. To minimize the overall cost of plans
providing life insurance benefits, the Corporation has obtained life insurance
coverage that is sufficient to fund benefit obligations. Costs incurred under
the plans were $1.5 million, $1.2 million and $1.3 million in 1998, 1997 and
1996.
CornerStone has a Restricted Unit Plan (the `Restricted Unit Plan') which
authorizes the issuance of Common Units with an aggregate value of $17.5
million to directors, executives, managers and selected supervisors of the
Partnership. The value of the Restricted Common Unit is established by the
market price of the Common Unit at the date of grant. As of December 31, 1998,
Restricted Common Units with a value of $13.8 million have been awarded.
CornerStone, Blue Dot. and Expanets provide various team member savings
plans, which permit team members to defer receipt of compensation as provided
in Section 401(k) of the Internal Revenue Code. Under the plans, the team
member may elect to direct a percentage of their gross compensation be
contributed to the plans. CornerStone, Blue Dot. and Expanets, at their
discretion, may match a portion of the team member contribution.
7. JOINTLY OWNED PLANTS
The Corporation has an ownership interest in three major electric
generating plants, all of which are operated by other utility companies. The
Corporation has an undivided interest in these facilities and is responsible
for its proportionate share of the capital and operating costs while being
entitled to its proportionate share of the power generated. The Corporation's
interest in each plant is reflected in the Consolidated Balance Sheets on a
prorate basis, and its share of operating expenses is reflected in the
Consolidated Statements of Income. The participants each finance their own
investment. Information relating to the Corporation's ownership interest in
these facilities at December 31, 1998, is as follows (in thousands):
Big Stone Neal #4 Coyote I
Plant in service $46,813 $33,711 $46,646
Accumulated depreciation $26,444 $18,059 $21,467
8. OPERATING LEASES
The Corporation leases office, office equipment and warehouse facilities
under various long-term operating leases. At December 31, 1998, future minimum
lease payments under noncancelable lease agreements are as follows:
1999 $8,456
2000 7,204
2001 5,723
2002 4,087
2003 2,887
Thereafter 3,734
9. STOCK OPTIONS AND WARRANTS
In May 1998, the Corporation adopted the NorthWestern Stock Option and
Incentive Plan (the `Plan'). Under the Plan, the Corporation has reserved
1,338,189 shares for issuance to officers, key team members and directors as
either incentive-based options or nonqualified options. The Nominating and
Compensation Committee of the Corporation's Board of Directors administers the
Plan. Unless established differently by the Committee, the per share option
exercise price shall be the fair market value of the Corporation's common stock
at the grant date. The options are outstanding for 10 years following the date
of grant. In addition, the Corporation issued 1,279,476 warrants to purchase
shares of NorthWestern common stock in connection with a previous acquisition.
A summary of the activity of stock options and warrants are as follows:
Stock Options
Exercise
Shares Price
Outstanding at December 31, 1997 - -
Issued 188,500 $23.00
Exercised - -
-------- -------
Outstanding at December 31, 1998 188,500 $23.00
======== =======
Stock Warrants
Exercise
Shares Price
Outstanding at December 31, 1997 - -
Issued 1,279,476 $ 18.225
Exercised 174,318 $ 18.225
--------- --------
Outstanding at December 31, 1998 1,105,158 $ 18.225
========= ========
The Corporation follows Accounting Principles Board Opinion 25, `Accounting
for Stock Issued to Employees,' to account for stock option plans. No
compensation cost is recognized because the option exercise price is equal to
the market price of the underlying stock on the date of grant.
An alternative method of accounting for stock options is SFAS 123,
`Accounting for Stock-Based Compensation.' Under SFAS 123, team member stock
options are valued at grant date using the Black-Scholes valuation model and
compensation cost is recognized ratably over the vesting period. Had
compensation cost for the Corporation's stock option plan been determined based
on the Black-Scholes value at the grant dates for awards as prescribed by SFAS
123, the pro forma information for 1998 would have been as follows (in thousands
except per share amounts):
Earnings on common stock:
As reported $27,086
Pro forma $26,607
Diluted earnings per share:
As reported $1.44
Pro forma $1.41
The weighted average Black-Scholes value of options granted under the
stock option plan during 1998 was $3.91. The 1998 value was estimated using an
expected life of eight years, 3.8% dividend yield, volatility of 16.9% and
risk-free interest rate of 5.08%.
10. EARNINGS PER SHARE
In 1998, the Corporation adopted SFAS No. 128, `Earnings Per Share,' which
establishes two methods for calculating earnings per share, basic and diluted,
and simplifies the previous standards for computing earnings per share. Basic
earnings per share is computed on the basis of the weighted average number of
common shares outstanding. Diluted earnings per share is computed on the basis
of the weighted average number of common shares outstanding plus the effect of
the outstanding stock options and warrants. The following table presents the
shares used in computing the basic and diluted earnings per share for 1998,
1997 and 1996 (in thousands):
1998 1997 1996
Average common
shares outstanding for
basic computation 18,660 17,843 17,840
Dilutive effect of:
Stock options 5 - -
Stock warrants 151 - -
------- ------- ------
Average common
shares outstanding for
diluted computation 18,816 17,843 17,840
====== ====== ======
11. PARTNERSHIP DISTRIBUTIONS
The Partnership makes distributions to its partners with respect to each
fiscal quarter of the Partnership in an aggregate amount equal to its Available
Cash for such quarter. Available Cash generally means, with respect to any
fiscal quarter of the Partnership, all cash on hand at the end of such quarter
plus all additional cash on hand as of the date of determination resulting from
borrowings subsequent to the end of such quarter less the amount of cash
reserves established by the General Partner in its reasonable discretion for
future cash requirements. These reserves are retained for the proper conduct of
the Partnership's business, for the payment of debt principal and interest, and
for distributions during the next four quarters.
Distributions by the Partnership, in an amount equal to 100% of its
Available Cash, will generally be made 98% to the Common and Subordinated
Unitholders and 2% to the General Partners. Distributions are subject to the
payment of incentive distributions in the event Available Cash exceeds the
Quarterly Distribution of $.594 on all Units. To the extent there is sufficient
Available Cash, the holders of Common Units have the right to receive the
Minimum Quarterly Distribution, plus any arrearages, prior to the distribution
of Available Cash to holders of Subordinated Units. Common Units will not
accrue arrearages for any quarter after the Subordination Period (as defined
below), and Subordinated Units will not accrue any arrearages with respect to
distributions for any quarter.
The Subordination Period will generally extend until the first day of any
quarter beginning on or after December 31, 2001, in respect of which a)
distributions of Available Cash from operating surplus equal or exceed the
Minimum Quarterly Distribution on each of the outstanding Common and
Subordinated Units for each of the three consecutive four-quarter periods
immediately preceding such date, b) the adjusted operating surplus generated
during each of the three consecutive four-quarter periods immediately preceding
such date equals or exceeds the Minimum Quarterly Distribution on each of the
Common and Subordinated Units and the related distribution on the General
Partner interests in the Partnership during such periods, and c) there are no
outstanding Common Unit arrearages.
In addition, 1,649,405 Subordinated Units will convert into Common Units
for any quarter ending on or after December 31, 1999, and an additional
1,649,405 Subordinated Units will convert into Common Units for any quarter
ending on or after December 31, 2000, if a) distributions of Available Cash
from operating surplus on each of the outstanding Common and Subordinated Units
equal or exceed the Minimum Quarterly Distribution for each of the three
consecutive four-quarter periods immediately preceding such date, b) the
adjusted operating surplus generated during the immediately preceding two
consecutive four-quarter periods equals or exceeds the Minimum Quarterly
Distribution on all of the Common and Subordinated Units outstanding during
that period and c) there are no arrearages on the Common Units.
The Partnership will make distributions of its Available Cash
approximately 45 days after the end of each quarter ending March, June,
September and December to holders of record on the applicable record dates. For
the quarter ended December 31, 1997, and year ended December 31, 1998, the
Partnership and the Corporation elected to forgo the Subordinated Unit
distributions continuing the support for the Common Unitholders.
12. ENVIRONMENTAL MATTERS
The Corporation is subject to environmental regulations from numerous
entities. The Clean Air Act Amendments of 1990 (the Act) stipulate limitations
on sulfur dioxide and nitrogen oxide emissions from coal-fired power plants.
The Corporation believes it can economically meet such sulfur dioxide emission
requirements at its generating plants by the required compliance dates and that
it is in compliance with all presently applicable environmental protection
requirements and regulations. The Corporation is also subject to other
environmental regulations including matters related to former manufactured gas
plant sites. In 1995, the Corporation remediated a site located at Huron, South
Dakota, through thermal desorption of residues in the soil. Adjustments of the
Corporation's natural gas rates to reflect the costs associated with the
remediation were approved through the regulatory process. The Corporation is
pursuing recovery from insurance carriers. No administrative or judicial
proceedings involving the Corporation are now pending or known by the
Corporation to be contemplated under present environmental protection
requirements.
13. CAPITAL STOCK
In December 1996, the Corporation's Board of Directors declared, pursuant
to a shareholders' rights plan, a dividend distribution of one Right on each
outstanding share of the Corporation's common stock. Each Right becomes
exercisable, upon the occurrence of certain events, at an exercise price of $50
per share, subject to adjustment. The Rights are currently not exercisable and
will be exercisable only if a person or group of affiliated or associated
persons (Acquiring Person) either acquires ownership of 15% or more of the
Corporation's common stock or commences a tender or exchange offer that would
result in ownership of 15% or more. In the event the Corporation is acquired in
a merger or other business combination transaction or 50% or more of its
consolidated assets or earnings power are sold, each Right entitles the holder
to receive such number of shares of common stock of the Acquiring Person having
a market value of two times the then current exercise price of the Right. The
Rights, which expire in December 2006, are redeemable in whole, but not in
part, at a price of $.005 per Right, at the Corporation's option at any time
until any Acquiring Person has acquired 15% or more of the Corporation's common
stock.
The Corporation is authorized to issue 1,000,000 shares of $100 par
cumulative preferred stock. As of December 31, 1998 and 1997, there were 37,500
shares outstanding of which 26,000 were 6 1/2% Series and 11,500 were 4 1/2%
Series. The provisions of the 6 1/2% Series stock contain a five-year put
option exercisable by the holders of the securities and a 10-year redemption
option exercisable by the Corporation. In any event, redemption will occur
at par value. The 4 1/2% Series may be redeemed in whole or in part at the
option of the Board of Directors at any time upon at least 30 days notice at
$110.00 per share plus accrued dividends.
In the event of involuntary dissolution, all Corporation preferred stock
outstanding would have a preferential interest of $100 per share, plus
accumulated dividends, before any distribution to common shareholders.
There were 2,500 shares of subsidiary preferred stock outstanding at
December 31, 1996. The subsidiary preferred stock was redeemed in January 1997.
The Corporation is also authorized to issue a maximum of 1,000,000 shares
of preference stock at a par value of $50 per share. No preference shares have
ever been issued.
As of December 31, 1998 and 1997, the Corporation had 3,500,000 and
1,300,000 shares of preferred securities outstanding. The 1,300,000 outstanding
at December 31, 1997, were issued in 1995 at 8 1/8% with a $25 par value. The
additional 2,200,000 shares were issued as part of a financing transaction in
November 1998 when the Corporation sold $55,000,000 of its 7.2% preferred
capital securities at $25 par value. The proceeds were used for general
corporate purposes.
14. SEGMENT AND RELATED INFORMATION
In 1998, the Corporation adopted Statement of Financial Accounting
Standards No. 131 (SFAS 131), `Disclosures About Segments of an Enterprise and
Related Information,' which requires the reporting of certain financial
information by business segment. For the purpose of providing segment
information, the Corporation's six principal business segments are its
electric, natural gas, retail propane, wholesale propane, HVAC and
communications operations. All other includes the results of the manufacturing
operations, activities and assets of the parent, any reconciling or eliminating
amounts and amortization of purchase accounting adjustments of $3.8 million in
1998 related to the acquisitions of HVAC and communication companies.
The accounting policies of the operating segments are the same as those
described in the summary of significant accounting policies except that the
parent allocates some of its operating expenses and interest expense to the
operating segments according to a methodology designed by management for
internal reporting purposes and involves estimates and assumptions. Financial
data for the business segments are as follows (in thousands):
Total
Electric and Total Communi- All
Natural Gas Propane HVAC cations Other Total
1998
Operating revenues $145,645 $767,735 $126,510 $127,898 $19,399 $1,187,187
Cost of sales 62,595 618,754 77,045 71,214 10,179 839,787
--------- -------- -------- -------- ------- ----------
Gross margins 83,050 148,981 49,465 56,684 9,220 347,400
Selling, general and
administrative 37,445 105,520 36,690 42,964 8,214 230,833
Depreciation and
amortization 14,759 20,154 1,659 1,701 4,353 42,626
--------- -------- ------- ------- ------- ------
Operating income 30,846 23,307 11,116 12,019 (3,347) 73,941
Interest expense (12,059) (20,321) (25) (561) (2,766) (35,732)
Investment income
and other 1,261 - 208 (17) 4,693 6,145
--------- -------- ------- ------- ------- -------
Income before taxes and
minority interests 20,048 2,986 11,299 11,441 (1,420) 44,354
Provision for taxes (7,379) (999) (4,301) (3,523) 3,006 (13,196)
--------- -------- ------- -------- ------ --------
Income before minority
interests $ 12,669 $ 1,987 $ 6,998 $ 7,918 $ 1,586 $31,158
========= ======== ======== ======= ======= =======
Total assets $ 321,847 $759,232 $ 57,035 $77,418 $520,684 $1,736,216
Maintenance capital
expenditures $ 14,366 $ 2,898 $ 2,641 $ 2,161 $ 559 $ 22,625
1997
Operating revenues $ 154,288 $743,038 - - $ 20,744 $ 918,070
Cost of sales 69,595 612,305 - - 13,145 695,045
--------- -------- ------- ----- ------- ----------
Gross margins 84,693 130,733 - - 7,599 223,025
Selling, general and
administrative 36,384 90,344 - - 6,065 132,793
Depreciation and
amortization 13,901 16,784 - - 550 31,235
--------- -------- ------- ------ ------- ---------
Operating income 34,408 23,605 - - 984 58,997
Interest expense (12,186) (18,980) - - (310) (31,476)
Investment income and other 689 - - - 10,875 11,564
----- -------- ------- ------ ------- --------
Income before taxes and
minority interests 22,911 4,625 - - 11,549 39,085
Provision for taxes (8,334) (1,283) - - (1,494) (11,111)
--------- -------- -------- ------ ------- --------
Income before minority
interests $ 14,577 $ 3,342 - - $10,055 $ 27,974
======== ======= ======= ====== ====== ======
Total assets $ 306,930 $622,077 - - $177,116$1,106,123
Maintenance capital
expenditures $ 18,210 $ 4,056 - - $ 134 $ 22,400
1996
Operating revenues $ 145,686 $175,102 - - $ 23,221 $ 344,009
Cost of sales 64,518 101,360 - - 14,548 180,426
---------- -------- ------ ------ -------- ---------
Gross margins 81,168 73,742 - - 8,673 163,583
Selling, general and
administrative 37,897 49,065 - - 6,789 93,751
Depreciation and
amortization 13,112 5,730 - - 572 19,414
----------- -------- ------- ------- -------- -------
Operating income 30,159 18,947 - - 1,312 50,418
Interest expense (13,611) (13,085) - - 8,028 (18,668)
Investment income and other 850 - - - 8,869 9,719
----------- -------- ------- ------- -------- --------
Income before taxes
and minority
interests 17,398 5,862 - - 18,209 41,469
Provision for taxes (5,741) (2,879) - - (6,795) (15,415)
----------- -------- ------- ------- ------- --------
Income before minority
interests $ 11,657 $ 2,983 - - $ 11,414 $ 26,054
======= ====== ======= ======= ======= ========
Total assets $ 289,475 $ 611,707 - - $212,534 $1,113,716
Maintenance capital
expenditures $ 227,770 $ 7,349 - - $ 51 $ 35,170
1998 1997 1996
----------------- -------------- -----------------
Electric Natural Gas Electric Natural Gas Electric Natural Gas
Operating revenues $78,401 $ 67,244 $ 76,727 $ 77,56 $ 73,417 $ 72,269
Cost of sales 15,390 47,205 14,560 55,035 13,347 51,171
------- ------- ------ ------- ------ ---------
Gross margins 63,011 20,039 62,16 22,52 60,070 21,098
Selling, general and
administrative 25,534 11,911 23,685 12,699 24,801 13,096
Depreciation and
amortization 11,870 2,889 11,305 2,596 10,794 2,318
-------- ------- ------- ------ ------- ------
Operating income $ 25,607 $ 5,239 27,177 $ 7,231 $ 24,475 $ 5,684
======= ======= ======= ====== ======= ========
1998 1997 1996
-------------------- ------------------ ----------------------
Retail Wholesale Retail Wholesale Retail Wholesale
Propane Propane Propane Propane Propane Propane
Operating revenues $297,779 $469,956 $243,589 $499,449 $153,571 $21,531
Cost of sales 165,526 453,228 127,529 484,776 80,264 21,096
--------- -------- --------- -------- -------- -------
Gross margins $132,253 $ 16,728 $116,060 $ 14,673 $ 73,307 $ 435
========= ======== ========= ======== ======== ========
15. QUARTERLY FINANCIAL DATA (UNAUDITED)
(In Thousands Except Per Share Amounts)
First Second Third Fourth
1998
Operating revenues* $ 298,964 $ 233,145 $ 276,896 $ 378,182
Operating income* $ 29,836 $ 6,938 $ 11,545 $ 25,622
Net income $ 11,004 $ 3,355 $ 4,582 $ 11,450
Average common shares
outstanding 17,843 17,843 17,860 21,068
Basic earnings per average
common share** $ .58 $ .15 $ .21 $ .49
Diluted earnings per
average common share** $ .58 $ .15 $ .20 $ .48
1997
Operating revenues $ 284,406 $ 165,451 $ 185,084 $ 283,129
Operating income $ 27,932 $ 4,497 $ 4,033 $ 22,535
Net income $ 10,523 $ 3,158 $ 3,722 $ 8,861
Average common shares
outstanding 17,842 17,843 17,843 17,843
Basic earnings per average
common share $ .55 $ .14 $ .17 $ .45
Diluted earnings per average
common share $ .55 $ .14 $ .17 $ .45
*Operating revenues and operating income for the first, second and third
quarters have been restated to reflect the consolidation of Blue Dot. and
Expanets effective January 1, 1998. There was no impact upon net income and
earnings per share from those restated periods.
**The 1998 quarterly earnings per average common share do not total to the
1998 annual earnings per average common share due to the effect of common stock
issuances during the year.
ELEVEN-YEAR FINANCIAL SUMMARY
In Thousands,
Except Per Share Data
1998 1997 1996 1995 1994 1993 1992 1991 1990 1989 1988
Financial Results
Operating revenues $1,187,187 $918,070 $344,009 $204,970 $157,266 $153,257 $119,197 $122,900 $115,980 $117,671 $117,375
---------- -------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Gross margins 347,400 223,025 163,583 108,545 82,366 80,259 67,275 69,509 64,940 66,166 65,180
Operating expenses 273,459 164,028 113,165 70,448 51,830 52,986 42,466 42,061 40,744 41,171 40,337
---------- -------- -------- -------- -------- -------- -------- -------- --------- ------- ------
Operating income 73,941 58,997 50,418 38,097 30,536 27,273 24,809 27,448 24,196 24,995 24,843
Interest expense (35,732) (31,476) (18,668) (11,694) (9,670) (8,945) (8,105) (7,244) (6,804) (6,886) (6,981)
Investment income
and other 6,145 11,564 9,719 3,029 2,444 4,431 2,690 1,834 6,890 4,314 (64)
----------- -------- ------- ------- ------- --------- -------- ------- ------ ------- -------
Income before income
taxes and minority
interests 44,354 39,085 41,469 29,432 23,310 22,759 19,394 22,038 24,282 22,423 17,798
Provision for income
taxes (13,196) (11,111)(15,415) (10,126) (7,869) (7,568) (5,673) (7,223) (6,776) (6,300) (3,922)
----------- -------- -------- -------- ------- ------- ------- ------- ------- ------- ------
Income before minority
Interests 31,158 27,974 26,054 19,306 15,441 15,191 13,721 14,815 17,506 16,123 13,876
Minority interests (767) (1,710) - - - - - - - - -
----------- -------- -------- -------- ------- ------- ------- ------ ------- --------- ------
Net income $30,391 $26,264 $26,054 $19,306 $15,441 $15,191 $13,721 $14,815 $17,506 $16,123 $13,876
Common Stock Data
Basic earnings
per share* $1.45 $1.31 $1.28 $1.11 $1.00 $0.98 $0.88 $0.94 $1.12 $1.02 $0.86
Diluted earnings
per share* $1.44 $1.31 $1.28 $1.11 $1.00 $0.98 $0.88 $0.94 $1.12 $1.02 $0.86
Basic and diluted earnings
pershare (excluding one
time gains)* - - $1.19 - - - - - $.89 $.88 -
Average shares outstanding*:
Basic 18,660 17,843 17,840 16,261 15,354 15,354 15,354 15,354 15,354 15,354 15,354
Diluted 18,816 17,843 17,840 16,261 15,354 15,354 15,354 15,354 15,354 15,354 15,354
Dividends paid per
common share* $.985 $.933 $.890 $.873 $.835 $.815 $.795 $.768 $.738 $.708 $.675
Annual dividend rate
at year end* $1.03 $.97 $.92 $.88 $.85 $.83 $.81 $.79 $.76 $.73 $.70
Book value per share
at year end* $12.26 $9.34 $9.18 $8.56 $7.47 $7.14 $6.98 $6.89 $6.72 $6.34 $6.03
Common stock price range*:
High $27.375 $23.500 $18.250 $14.188 $14.813 $16.750 $14.375 $13.438 $10.250 $10.125 $9.625
Low $20.250 $16.938 $13.375 $12.125 $12.250 $13.125 $11.750 $10.125 $8.375 $8.250 $7.813
Close $26.438 $23.000 $17.130 $14.000 $13.380 $14.380 $14.000 $12.940 $10.250 $10.000 $8.750
Price earnings ratio 18.4x 17.6x 13.4x 12.7 13.4x 14.7x 15.8x 13.8x 9.2x 9.8x 10.2x
Dividend payout ratio
(from ongoing operations)68.4% 71.2% 74.8% 79.0% 83.5% 83.2% 89.8% 81.6% 66.1% 69.4% 78.5%
Return on average common
Equity 14.6% 14.1% 14.4% 13.7% 13.1% 13.7% 12.8% 13.7% 17.0% 16.2% 14.3%
Common shareholders at
year end 10,116 8,845 8,750 8,738 8,132 8,231 8,279 8,262 8,014 8,246 8,473
Financial Position
(As of December 31)
Total assets $1,736,216 $1,106,123 $1,113,716 $558,721 $359,066 $343,574 $308,194 $297,761 $283,073 $272,260 $264,810
Working capital 57,739 11,844 44,922 31,859 (3,033) 6,121 5,774 (4,010) (4,599) 678 (1,403)
Long-term debt,
excluding current
portion 256,350 156,350 183,850 183,850 127,053 126,600 106,422 92,003 78,236 79,469 80,702
Total debt (including
subsidiaries) 608,935 433,095 425,657 213,410 127,623 127,200 106,572 93,236 79,469 80,702 81,935
Shareholders' equity 282,101 166,596 163,805 152,678 114,705 109,667 107,111 105,780 103,120 97,322 92,546
Other equity 479,952 235,972 225,464 38,760 2,640 2,670 2,700 5,590 5,785 5,980 6,175
Total equity $762,053 $402,568 $389,269 $191,438$117,345 $112,337 $109,811 $111,370 $108,905 $103,302 $98,721
*Adjusted for the two-for-one stock split in May 1997 and the two-for-one stock
split in June 1988.