Exhibit 99.1
Management's Discussion and Analysis of Financial Condition and Results of
Operations:
The following commentary should be read in conjunction with the
Consolidated Financial Statements and accompanying Notes to Financial
Statements.
Eastern's acquisition of Essex County Gas Company ("Essex Gas") on
September 30, 1998 has been accounted for as a pooling of interests, as
discussed in Note 2 of Notes to Financial Statements. Accordingly, Eastern's
financial statements presented for include the financial information of Essex
Gas for all periods presented. Additionally Essex Gas' results have been
combined with Boston Gas' results and are presented herein as natural gas
distribution operations. Midland Enterprises is reported as marine
transportation. As Essex Gas' contribution to consolidated revenues and
operating earnings for 1995 through 1997 was less than 6% and 8%, respectively,
it did not have a material impact on the comparative analyses presented below.
Accordingly the discussion of natural gas distribution focuses on the revenues
and operating earnings of Boston Gas.
In June 1998, The U.S. Supreme Court held the Coal Industry Retiree
Health Benefit of 1992 ("Coal Act") to be unconstitutional as applied to
Eastern. As discussed in Note 13, the reversal of Coal Act provisions resulted
in an extraordinary gain of $74.5 million pre-tax, $48.4 million net, or $2.13
per share in the second quarter of 1998.
In October 1998 Eastern signed a definitive agreement to acquire
Colonial Gas Company ("Colonial Gas") for $37.50 in Eastern stock and cash, as
discussed in Note 3. The cash consideration has been fixed at $150.0 million and
will be financed from currently available resources. Colonial Gas is a gas
distribution utility serving about 150,000 customers in and around Lowell,
Massachusetts and on Cape Cod. The merger is expected to close in mid-1999,
subject to a number of conditions, including approval by regulators and the
shareholders of both Eastern and Colonial Gas.
1997 COMPARED TO 1996
Overview
The Company reported net earnings of $55.9 million, or $2.49 per share,
in 1997, compared to net earnings of $64.5 million, or $2.88 per share, in 1996.
(Per share figures are presented on a diluted basis, as described in Note 1.)
Excluding non-recurring items and Eastern's share of AllEnergy's losses,
earnings and earnings per share declined approximately 14% to $55.4 million, or
$2.47 per share, in 1997 versus $64.1 million, or $2.86 per share, in 1996.
1997 1996 Change
---- ---- ------
(In millions)
Revenues:
Natural gas distribution $ 754.5 $ 755.4 (0.1)%
Marine transportation 269.2 301.9 (10.8)%
--------- ---------
Total $1,023.7 $1,057.3 (3.2)%
======== ========
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The decrease in consolidated revenues from 1996 to 1997 primarily
reflects decreased demand and lower rates at marine transportation and lower
average usage and the migration of customers from firm gas sales to
transportation-only service, partially offset by sales to new customers, at
Boston Gas.
1997 1996 Change
---- ---- ------
(In millions)
Operating earnings:
Natural gas distribution $87.8 $ 77.3 13.6%
Marine transportation 34.6 58.4 (40.8)%
Headquarters (7.1) (5.5) (29.1)%
------ ------
Total $115.3 $130.2 (11.4)%
====== ======
The decrease in operating earnings from 1996 to 1997 primarily reflects
the impact of decreased revenues and poor operating conditions at marine
transportation, partially offset by higher rates and lower operating expenses at
Boston Gas. Other income primarily reflects losses of $5.5 million and $3.1
million in 1997 and 1996, respectively, representing Eastern's share of
AllEnergy's operating losses. Eastern sold its investment in AllEnergy in
December 1997. The effective tax rate in 1997 was 33%, which was 4% lower than
in 1996, primarily because of adjustments relating to prior year returns, as
described in Note 11.
Natural gas distribution
Revenues in 1997 were about the same as 1996, primarily because lower
average customer usage, the migration of customers from firm sales to
transportation-only service and the impact of comparatively warmer weather were
offset by sales to new customers and the full year impact of Boston Gas' 1996
rate increase. Weather for 1997 was 3% colder than normal, but 2% warmer than
1996.
Operating earnings increased 13.6% from 1996, primarily reflecting
growth in throughput, lower operating expenses, higher rates and Boston Gas'
$2.0 million gain on the settlement of pension obligations, partially offset by
the margin impact of lower average usage and warmer weather and a higher charge
for depreciation, reflecting continued investment in system replacement and
expansion. While 1997 weather was only 2% warmer than 1996, weather for the
first quarter of 1997, when natural gas distribution operations generate most of
their revenues and earnings, was 9% warmer than the prior year. The migration of
customers from firm sales to transportation-only service has no impact on the
earnings of natural gas distribution operations, which earn all of their margins
on the local distribution of gas and none on the resale of the commodity itself.
During the fourth quarter of 1997 Boston Gas recorded non-recurring revenues of
approximately $8.9 million related to a change ordered by the 1996 rate ruling
regarding the recovery mechanism for the portion of bad debt expense associated
with gas costs. This income was largely offset by a charge of approximately $8.7
million related to Boston Gas' decision to exit the gas appliance repair and
service business.
Marine transportation
Revenues in 1997 decreased 10.8% primarily because of weak export
demand for coal and grain, lower contractual requirements for utility and
industrial coal customers and fewer barges. Weak demand depressed spot rates for
nearly all commodities, and traffic patterns were disrupted, reducing
operational efficiency. Operating conditions in 1997 were worse than those
experienced in 1996, as navigation was negatively impacted by record flooding on
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the Ohio River early in the year, and later by long traffic delays related to
low water and repairs to various key locks throughout the river system. These
uncontrollable events resulted in higher operating costs and lower fleet
productivity than in 1996. As a result of the weaker markets, marine
transportation slowed its fleet replacement program and did not renew expiring
charters of outside barges. These decisions, in addition to production delays
which postponed the delivery of new barges expected in the latter part of 1997,
reduced the size of marine transportation's barge fleet.
Tonnage and ton miles decreased 13% and 8%, respectively, reflecting
the weak market and operational issues discussed previously, although a change
in business mix and customer sourcing resulted in 5% longer average hauls. Coal
tonnage and ton miles decreased 17% and 14%, respectively, from the record
levels of 1996. Domestic coal volume, primarily for electric utilities, declined
due to the non-renewal of several multi-year contracts, unplanned plant outages
and milder temperatures. Export coal demand weakened as the strong U.S. dollar
effectively raised the prices of domestic supplies higher than foreign
competitors. Despite an ample grain harvest, the anticipated surge in
transportation volume and pricing for grain exports was short-lived, as much of
the harvest was put in storage due to reduced demand and the relative strength
of the U.S. dollar.
Ongoing improvement programs to lower vessel operating costs and
administrative expenses partially offset the higher operating costs discussed
above. Operating results at marine transportation's terminals were also lower,
reflecting the reduced demand for coal transportation. As a result of the
adverse market and operational issues discussed above, operating earnings
decreased by 40.8% in 1997.
1996 COMPARED TO 1995
1996 1995 Change
---- ---- ------
(In millions)
Revenues:
Natural gas distribution $ 755.4 $698.1 8.2%
Marine transportation 301.9 296.4 1.9%
-------- ------
Total $1,057.3 $994.5 6.3%
======== ======
The increase in consolidated revenues from 1995 to 1996 primarily
reflects higher customer usage, colder weather, and increased sales to new
customers for natural gas distribution and increased demand for coal and other
commodities at marine transportation.
1996 1995 Change
---- ---- ------
(In millions)
Operating earnings:
Natural gas distribution $ 77.3 $ 69.3 11.5%
Marine transportation 58.4 57.8 1.0%
Headquarters (5.5) (5.8) 5.2%
------ ------
Total $130.2 $121.3 7.3%
====== ======
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The increase in operating earnings from 1995 to 1996 primarily reflects
the gross margin impact of natural gas distribution operations' increased
revenues, as described above. Other income in 1996 includes increased interest
income on higher cash balances and decreased interest expense, reflecting lower
average rates principally due to the refinancing of $60.0 million of Boston Gas
debentures in December 1995 and lower balances of short term obligations. Partly
offsetting were the absence of a $20.6 million gain on the sale in 1995 of
Eastern's U.S. Filter investment and a $15.0 million provision for environmental
expenses, as described in Notes 10 and 12. In 1996, other income includes a loss
of $3.1 million, representing Eastern's share of AllEnergy's operating results.
The effective tax rate in 1996 was 8% higher than in 1995, principally because
the gain on the 1995 sale of the U.S. Filter investment was offset by a tax loss
realized on the sale of WaterPro Supplies Corp., which had been written down in
1993.
Natural gas distribution
Revenues in 1996 increased by 8.2% due principally to higher average
customer usage, the impact of colder weather, increased sales to new customers
and increased non-firm sales. The migration of firm sales to transportation
service was partially offsetting. Weather for 1996 was 5% colder than normal.
Weather for 1995 was near normal.
Operating earnings increased 11.5% from 1995, primarily reflecting the
margin impact of increased revenues. Benefits from ongoing reengineering
programs and the absence of severance costs and lower consulting expenses also
contributed to the increase in operating earnings. Wage increases and higher
charges for depreciation were partially offsetting.
Marine transportation
Revenues and operating earnings increased by 1.9% and 1.0%,
respectively, in 1996 over 1995, primarily reflecting the continued strong
demand for coal and other dry cargo commodities and favorable rates. Severe
icing and flooding during the first quarter of 1996 and generally more difficult
operating conditions later in the year resulted in higher operating costs and
lower fleet productivity than in 1995.
Tonnage and ton miles decreased 1% and 2%, respectively, reflecting
shorter average hauls due to reduced foreign demand for coal and a shortage of
grain supplies. Coal tonnage and ton miles increased 1% and 3%, respectively,
reflecting significantly increased shipments of domestic spot coal, while coal
shipments under multi-year contracts for utilities declined due to the
non-renewal of several contracts. Non-coal tonnage and ton miles declined 6% as
a result of weaker barge demand for grain exports on the lower Mississippi
River.
Ongoing programs to increase fleet productivity were offset by adverse
operating conditions and traffic pattern inefficiencies caused by the reduced
export tonnage. Fuel costs increased in 1996 due to rising fuel prices that
averaged 20% above 1995 levels.
YEAR 2000 ISSUES
The following discussion reflects year 2000 status as of September 1998, except
for information about the cost of year 2000 remeditation.
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State of Readiness
Eastern has assessed the impact of year 2000 issues with respect to its
information technology ("IT") systems and embedded chip systems as well as the
Company's exposure to significant third party risks. In such regard, Eastern has
initiated and completed substantial portions of its plans to replace or modify
existing systems and technology and to assure that major customers and critical
vendors are also addressing these issues. Year 2000 issues for Essex Gas are
being addressed by integration of its systems with those of Boston Gas, which is
scheduled for completion by the first quarter of 1999.
With respect to IT systems, Boston Gas has tested and certified four of
its eleven "mission critical" application systems. A fifth system is scheduled
for certification in the fourth quarter of 1998 and replacement of the remaining
six systems is in process and scheduled to be completed by the second quarter of
1999. All "less than critical" applications are scheduled to be tested and/or
upgraded by the second quarter of 1999. Conversion and testing of all mainframe
hardware and software has been completed. Replacements are in process for client
server, data/voice communications, e-mail and desktop hardware and software,
with completion scheduled by the second quarter of 1999.
With respect to embedded chip systems, Boston Gas has completed an
inventory and expects to complete its assessment and action plan in the fourth
quarter of 1998. All remediation, conversion and testing is scheduled for
completion by the second quarter of 1999.
Boston Gas has identified material third party relationships and
expects to complete its detailed survey and assessment of third party readiness
by the fourth quarter of 1998. Selected testing and implementation of risk
mitigation strategies for high risk vendors are scheduled for completion by the
second quarter of 1999.
Marine transportation has modified and tested all mainframe-based
programs and systems, which were operating on a new mainframe as of September
30, 1998. All non-mainframe (server) based systems have been tested and all have
been modified except for Accounts Receivable, which is scheduled for completion
in the second quarter of 1999. Marine transportation expects its personal
computers to be 100% compliant by mid-1999.
With respect to embedded chip systems, marine transportation's major
operating assets and sub-systems were reviewed for embedded chip technology.
Based on this review and actions taken, management believes year 2000 issues in
regards to internal chip technology will not impair its operating assets.
Marine transportation has assessed third party risk with respect to
critical suppliers, services and customers. Marine transportation is actively
seeking written confirmation of third party readiness. If such readiness is in
doubt, marine transportation expects to locate backup providers by the second
quarter of 1999.
Notwithstanding Eastern's efforts with third parties, there can be no
assurance that the systems of third parties on which Eastern's systems rely will
be timely converted or that any such failure to convert by a third party would
not have an adverse effect on Eastern's operations.
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Cost of year 2000 remediation
Natural gas distribution and marine transportation expect the cost of
their year 2000 compliance to approximate $13 million and $2 million,
respectively, as detailed in the following chart:
Cost through December, Expected subsequent cost
(In millions) 1997
- ------------------------------------------------------------- --------------------------- ---------------------------
Natural gas distribution - capital $4.2 $4.2
- expense $1.6 $3.0
Marine transportation - capital (includes mainframe) $0.9 $0.0
- expense $0.3 $0.8
Risks of year 2000 issues
Boston Gas has assessed the most reasonably likely worst case year 2000
scenario. Given its efforts to minimize the risk of year 2000 failure by its
internal systems and its distribution network control systems, Boston Gas
believes the worst case scenario would occur if its primary telecommunications
vendor and/or its electric supplier should experience an outage due to a year
2000 failure. An outage would require Boston Gas to enact disaster recovery
measures to enable the continuation of service to its customers. Such measures
would include utilization of Boston Gas' co-generation capability for electrical
power, relocation of the customer inquiry function and use of a wireless network
for communications.
Marine transportation believes its worst case scenario would involve
failures by the Army Corps of Engineers, which operates the various lock and dam
systems on the inland waterways, or by rail services, which are essential for
bringing commodities to the rivers for transit in marine transportation's
barges. These failures could significantly disrupt marine transportation's
operations. The risk of failure by communications systems or fuel suppliers is
expected to be mitigated by the availability of alternate suppliers.
Contingency plans
Natural gas distribution and marine transportation are in the process
of developing contingency plans and anticipate having such plans in place by the
second quarter of 1999.
FORWARD-LOOKING INFORMATION:
This report and other company statements and statements issued or made
from time to time contain certain "forward-looking statements" concerning
projected future financial performance, expected plans or future operations.
Eastern cautions that actual results and developments may differ materially from
such projections or expectations.
Investors should be aware of important factors that could cause actual
results to differ materially from the forward-looking projections or
expectations. These factors include, but are not limited to: the effect of the
Colonial Gas merger and other strategic initiatives on earnings and cash flow,
difficulties encountered in integrating Eastern's gas utility operations,
temperatures above or below normal in eastern Massachusetts, changes in market
conditions for barge transportation, adverse weather and operating conditions on
the inland waterways, uncertainties regarding the start-up of ServicEdge,
including expense levels and customer acceptance, the timetable and cost for
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completion of Eastern's year 2000 plans, the impact of third parties' year 2000
issues, changes in economic conditions, including interest rates and the value
of the dollar versus other currencies, regulatory and court decisions and
developments with respect to Eastern's previously-disclosed environmental
liabilities. Most of these factors are difficult to predict accurately and are
generally beyond Eastern's control.
LIQUIDITY AND CAPITAL RESOURCES
Management believes that projected cash flow from operations, in
combination with currently available resources, is more than sufficient to meet
Eastern's 1998 capital expenditure and working capital requirements, potential
funding of its environmental liabilities, normal debt repayments, anticipated
dividends to shareholders and the planned acquisition of Colonial Gas.
In addition to cash and marketable investments of $175.7 million at
December 31, 1997, Eastern maintains availability of borrowings of $119 million
under long-term revolving credit agreements plus uncommitted lines, all of which
are available for general corporate purposes. At December 31, 1997, there were
borrowings of $3.3 million outstanding under these facilities.
To meet working capital requirements which reflect the seasonal nature
of its business, natural gas distribution had outstanding of $43.1 million
of short-term borrowings at December 31, 1997, a
decrease of $25.9 million from the prior year, primarily reflecting the issuance
of $10.0 million of long term debt at Essex Gas and lower balances for deferred
gas costs. In addition, natural gas distribution maintains bank credit
agreements which support the issuance of up to $80 million of gas inventory
financing to fund its inventory of gas supplies. At December 31, 1997,
natural gas distribution had outstanding $59.3 million of gas inventory
financing for this purpose.
Consolidated capital expenditures for 1998 are budgeted at
approximately $110 million, with about 55% at natural gas distribution and the
balance at marine transportation.
Eastern's capital structure is depicted in the chart below. Subject to
the effects of strategic initiatives which Eastern might undertake, Eastern
expects to continue its policy of capitalizing natural gas distribution and
marine transportation with approximately equal amounts of equity and long-term
debt. Boston Gas and midland currently maintain "A" ratings with the major
rating agencies. The chart below shows general improvement in interest coverage
at Boston Gas, but a decrease in coverage for marine transportation during the
current year, reflecting the weakness of transportation markets and poor
operating conditions in 1997.
[BAR CHART]
Capital Structure
($ in millions)
Debt Equity Total Capital
1993 352 391 743
1994 388 403 791
1995 379 426 805
1996 368 461 829
1997 372 484 856
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[BAR CHART]
Interest Coverage
93 94 95 96 97
------------------------------------
Boston Gas 4.3 4.8 4.8 6.2 6.8
Marine transportation 4.2 4.0 5.7 5.8 4.5
(pre-tax earnings plus depreciation, amortization
and interest expense divided by interest expense)
OTHER MATTERS
In December 1997, Eastern sold its 50% interest in AllEnergy Marketing
Company, L.L.C. for $5.4 million.
On May 16, 1997 Boston Gas received a decision from the Massachusetts
Department of Telecommunications and Energy (the "Department"), formerly the
Department of Public Utilities, concerning its request for reconsideration,
clarification and recalculation of the Department's November 1996 rate order.
The Department granted Boston Gas an additional $1.9 million rate increase (a
$6.3 million increase was granted in the November 1996 order) and reduced the
productivity offset portion of the performance-based rate formula established in
its November 1996 order by 50 basis points, from 2.00% to 1.50%. Compared to the
Department's original decision, these changes will add approximately $3.5
million to projected revenue in 1998, increasing to about $8.0 million by 2002,
the last year of the performance-based rate plan. On June 5, 1997, Boston Gas
filed a notice of appeal of the Department's orders to the Massachusetts Supreme
Judicial Court. Boston Gas expects the appeal to be heard some time in 1999.
As a result of its ten year rate freeze, Essex Gas will discontinue
application of SFAS No. 71, "Accounting for the Effects of Certain Types of
Regulation," as described in Note 2.
Eastern is aware of certain non-utility sites, associated with former
operations, for which it may have or share environmental remediation
responsibility or ongoing maintenance. Eastern has accrued a reserve of
approximately $25 million at December 31, 1997, to cover the remediation and
maintenance costs of these sites, the principal of which is a former coal tar
processing facility in Everett, Massachusetts, as discussed in Note 12. While
Eastern has provided reserves to cover the estimated probable costs of
remediation and maintenance for environmental sites based on the information
available at the present time, the extent of Eastern's potential liability at
such sites is not yet determined.
Eastern's natural gas distribution operations, like many other
companies in the natural gas industry, are parties to governmental proceedings
requiring investigation and possible remediation of former manufactured gas
plant ("MGP") sites. Boston Gas and Essex Gas may have or share responsibility
under applicable environmental law for the remediation of 18 such sites, as
described in Note 12. A subsidiary of New England Electric System ("NEES") has
assumed responsibility for remediating 10 of these sites, subject to a limited
contribution from Boston Gas. Boston Gas and Essex Gas have recorded liabilities
of $19.5 million, which represent their best estimate at this time of
remediation costs, which may reasonably be estimated to range from $17 million
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to $31 million. However, there can be no assurance that actual costs will not
vary considerably from these estimates. Factors that may bear on actual costs
differing from estimates include, without limit, changes in regulatory
standards, changes in remediation technologies and practices and the type and
extent of contaminants discovered at the sites.
Boston Gas and Essex Gas are aware of 26 other former MGP sites within
their service territories. The NEES subsidiary has provided full indemnification
to Boston Gas with respect to eight of these sites. At this time, there is
substantial uncertainty as to whether Boston Gas or Essex Gas have or share
responsibility for remediating any of these other sites. No notice of
responsibility has been issued to Boston Gas or Essex Gas for any of these sites
from any governmental environmental authority.
By a rate order issued on May 25, 1990, the Department approved the
recovery of all prudently incurred environmental response costs associated with
former MGP sites over separate, seven-year amortization periods, without a
return on the unamortized balance. Eastern's natural gas operations have
recognized an insurance receivable of $3.4 million, reflecting a negotiated
settlement with an insurance carrier for environmental expense indemnity, and a
regulatory asset of $16.1 million, representing the expected rate recovery of
environmental remediation costs, net of the insurance settlement. Eastern
currently believes, in light of the indemnity agreement with the NEES subsidiary
and the Department rate order on environmental cost recovery, that it is not
probable that such costs will materially affect its financial condition or
results of operations.
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