Exhibit 13
Cover:
Background: Photo featuring Martha Stewart standing at
stove cooking
Across Top: The Energy Magazine for Today's Investors
Top Left: YES
Yankee Energy System 1997 Annual Report
Left Center: Yankee Gas
Heats Up
YESCo
Takes shape
Service
Wows customers
The Environment
Gets Greener
Conversions
Make the switch
Bottom right: Martha Stewart
Warms up to natural gas
Inside Front Cover:
Left two-thirds of page:
Company Profile
Yankee Energy System, Inc. (YES or the Company), headquartered in
Meriden, Connecticut, is a diversified company specializing in
the distribution, conversion and control of energy to meet our
customers needs. Our principle operating subsidiary is Yankee
Gas Services Company (Yankee Gas).
Yankee Gas provides natural gas to a service area of 68 cities
and towns in Connecticut. The Company s other operating
subsidiaries support our core business in natural gas, or allow
us to expand our growing businesses in energy-related services.
Yankee Energy Services Company (YESCo) provides comprehensive
energy-related services through three principle divisions. YESCo
Power designs, builds and maintains on-site facilities for the
production of thermal and/or electric power. YESCo Controls is in
the business of engineering, installing, and maintaining building
control systems. YESCo Services provides comprehensive HVAC,
boiler and refrigeration equipment services and installation.
Other subsidiaries support the operations of Yankee Gas and
YESCo. NorConn Properties, Inc. (NorConn) owns selected system
real estate which it leases to Yankee Gas. Yankee Energy
Financial Services (Yankee Financial) provides energy equipment
financing. R.M. Services, Inc. (RMS) provides receivables
management services.
Right margin:
Yankee Stats
68 Towns
Yankee s service area covers approximately half of
Connecticut s land area.
$325+ Million
Gross annual revenue is on the rise for Yankee, and now
exceeds the $325 million mark.
181,000 customers
And growing. In 1997, Yankee added 22,000 more customers --
residential, commercial and industrial -- to its base.
Key characteristics
Strong management, attractive yield, low-risk
diversification strategy, and secure opportunities in basic
natural gas business.
Service Area
Graphic - Map of Connecticut highlighting Yankee Gas Service
Areas
End of Company Profile page
Top center: Yankee Energy System 1997 Annual Report
Contents
Left two-thirds: Photo inset background of sky and clouds with
text:
Yankee Gas
Imaginative Energy
Solutions
For Natural Gas
Three small photo insets of machinery parts
A - Absorption Process
E - Engine Driven
D - Desiccant Process
Photo inset of business man talking on
telephone
Cover Stories and Features
A Letter from Branko Terzic
1997. A year of transition, preparation, and action. Yankee
Energy System s CEO shares his news and views with
shareholders.
Yankee Gas
More people are using natural gas, and relying on Yankee for
gas-related services. Charles Gooley shares good news from
his side of the Company.
YESCo
The definition of YESCo is straightforward: Technicians and
trucks who go on-site to solve problems for industrial and
commercial clients. YESCo President Mike Bielonko lays the
groundwork.
Right margin:
"Wow"
A new customer service system. A record number of service
contracts. Improved dispatch and installation. Customers are
finding out that Yankee means service.
The switch is On
Natural gas conversions just keep on coming. Neighborhoods.
Multi-unit apartment buildings. And a rather high-profile
customer known for domestic perfection.
Doing Business Better
Online gas procurement and a dedication to transportation
services are two improvements moving Yankee closer to
customers.
New Applications, New Markets
The cost efficiencies of new natural gas applications open
up new markets. And natural gas vehicles keep on rolling.
Energy Experts
The 1997 Yankee management team is stronger and deeper than
ever.
Yankee by the numbers
Financial data in detail.
Bottom right:
Photo inset of man in hard hat checking equipment
Photo inset of Big Mo - Yankee Gas Mobile Office Vehicle
Bottom center: YES 1997
Bottom right: 1
Top half of page: Photo inset of Branko Terzic wearing hard
hat, job site in background
Chairman's Letter:
A Letter from Branko
This year -- a year of transition for your company, Yankee Energy
System, Inc. -- earnings from our regulated subsidiary, Yankee
Gas Services Company, were strong (despite the warm weather). Yet
losses from last year s startup diversification effort in Yankee
Energy Services Company (YESCo) meant our total earnings for the
year were less than anticipated.
The earnings for 1997 of $1.62 a share were down from the
previous year s earnings of $2.10, based on warmer weather and
other variables. The prior year s figure benefited from a $0.24
per share gain on the sale of our interest in the Iroquois
Pipeline. As an additional point of reference, 1995 earnings were
$1.20 per share (this included a one-time charge of $0.30 per
share related to the company s business re-engineering efforts).
Focused strategy, improved management
I take responsibility for our results and wish to inform you that
Yankee Energy is applying the lessons learned from our experience
this past year. As we begin a new fiscal year, strategic focus
has been sharpened, managerial improvements have been made, and
operating performance has improved. Our strategy to increase
shareholder wealth has not deviated from its path. We will
continue to improve the efficiency and sales effectiveness of
Yankee Gas Services Company while creating new earnings in our
YESCo subsidiary by focusing on energy-related mechanical
services, first in Connecticut and then in the rest of New
England.
This strategy fits well with the changes now driving the energy
sector of the U.S. economy. As I reported in last year s letter,
all indicators point to increased competition in the energy
industry. Thus, Yankee Energy s prospects continue to be
influenced by often unpredictable changes in state and federal
regulation of natural gas and electricity.
Deregulation and increased opportunities
Last year, competition was introduced in Connecticut by a
Department of Public Utility Control (DPUC) decision allowing
commercial and industrial customers to purchase commodity gas on
the market. This year, the DPUC has opened a proceeding to take
evidence and testimony on the issue of residential customer
choice in gas purchased from other marketers. Since Yankee Gas
has successfully implemented transportation services to
commercial and industrial customers, we are well-positioned to
provide residential gas transportation services. This new service
will be boosted by use of our automatic meter reading capability
and new informational technology investments.
Bottom left: 2
Bottom center: YES 1997
Changes in electric regulation -- particularly new laws
facilitating distributed electric generation -- will present a
number of opportunities for Yankee Energy subsidiaries. As the
largest gas distribution system in Connecticut, Yankee Gas is
ready to provide gas sales or gas delivery services to newly
constructed gas-fired electric generation facilities. Any new
construction of small distributed power plants also creates a
market for YESCo, which can provide installation, operation and
maintenance services for these types of energy conversion
technologies.
Diversification moves Yankee closer to customers
In contrast to the strategies of many other utilities, Yankee
Energy System has chosen to offer "technicians and trucks"
through our YESCo subsidiary. Many national companies advertising
"energy services" through telemarketing or direct mail are not
able to provide these capabilities. Yankee Energy System s
diversification strategy is to extend services beyond gas
delivery. This means we will offer services on the customer s
side of the meter for energy conversion, control, and gas-using
devices. Thus, YESCo revenues will increase by providing highly
trained and well-equipped field personnel to meet customers
needs on-site.
YESCo has chosen as its initial service area a region that will
benefit from the proximity of Yankee Gas Services. YESCo has
chosen as its market segment industrial and commercial targets
whose need for mechanical and energy-related services will,
within a short time, enable YESCo to become a regional market
leader. To enhance our competitive position further, YESCo
customers will have the convenience of one-stop financing from
its affiliate, Yankee Financial Services Company.
Our mission is to increase shareholder value. Yankee Energy will
accomplish that mission by the creation of service offerings that
will provide our customers with "imaginative and responsive
energy solutions."
Everyone at Yankee Energy clearly understands that mission. We
believe our plan to be well-designed with an appropriate balance
of risk and growth. Recent additions to management have
strengthened our organization and increased our prospects for
financial success even more.
I am keenly aware of your expectations as shareholders and of my
own responsibilities as Chief Executive Officer of your company.
Please feel free to contact me at any time with your critiques,
comments, or suggestions concerning your company s performance.
Branko Terzic Signature
Branko Terzic
Chairman, President and Chief Executive Officer
Caption Center Page: This was a year of transition and action
Bottom Right: Photo inset Branko Terzic and customer reading
blueprints
Caption: Terzic, a professional engineer, reviews plans for
the new Midstate Medical Center with Engineering
Services Manager Guenther Ohler.
Upper Left: Yankee Gas
Photo inset: Charles E. Gooley
Upper Right: We're closer to customers, and our sales show it.
Growth is the principal indicator of the health of any business,
and 1997 sales results clearly show the strength of our anchor
company, Yankee Gas, and the improved economic conditions in the
areas we serve. We have reorganized our sales force under
experienced sales and marketing professionals and doubled our
historic rate of customer growth, adding more than 2,300 new
customers. We exceeded our sales growth projections by more than
52 percent. Even as we meet the growing demands of almost 160,000
residential energy customers, we added 30 percent more
appliance-service customers in 1997.
Yankee Gas also was Connecticut s leader in promoting firm
transportation services, making our infrastructure available to
customers who choose to buy their own gas, and rely upon our
distribution system to deliver it. We identified gas-fired
electricity generation opportunities and effectively marketed
them to businesses throughout the state. Our gas cooling, air
compression, infrared heating and natural gas vehicle programs
all moved forward.
As we grew the business, we tightly controlled operating,
maintenance, and capital expenditures. Aggressive goals set for
all areas of operations were mostly met or exceeded.
That was last year. To succeed in 1998 and the longer term, we
need to have a clear understanding of what we are and must be to
our customers. We are a quality provider of natural gas
distribution and utilization services. We sell gas to those
customers who want to buy from us, and we deliver gas for other
customers who want to buy their own gas. We provide appliance and
equipment installation, maintenance and service directly to our
residential customers.
To prosper in the future, Yankee Gas must consistently be named
by customers as one of the top service companies with which they
do business. We no longer compare ourselves only to public
utilities, because our customers ceased doing that long ago. We
are now compared to the package delivery company, the lawn
service, and the local building contractor. Our service must
rival that of the "best in its class" of any type of company
serving consumers.
Because the price of energy is a primary customer concern, we
must keep our prices competitive with those of other energy
providers. We will do this through aggressive cost management and
sales efforts focused in areas where we already have distribution
facilities. Yankee Financial will continue to support our ability
to make natural gas an affordable option.
As changes in regulation require our customers to make choices,
we will be the source for clear, reliable information. Technology
does and will continue to play a major role in our customer
interactions, as is evidenced by our comprehensive Web site and a
new customer information system, scheduled for completion next
Fall. But technology will not replace the motivated,
well-trained, and courteous employees who have come to exemplify
Yankee Gas. Rather, it will enable them to delight our customers.
Customer delight, not customer satisfaction, is the new target at
which we are aiming.
Charles E. Gooley signature
Charles E. Gooley
President, Yankee Gas Services Company
Bottom left: Photo inset of people standing around gas grill
Bottom left: 4
Bottom Center: YES 1997
Upper left: YESCo
Upper left: We're prepared to supply a full range of energy
services.
Upper right: Photo inset of Michael E. Bielonko
Yankee Energy Services Company (YESCo) is being positioned in the
marketplace to provide a full range of energy equipment
mechanical services to commercial, industrial, and institutional
customers through YESCo s three divisions: Power, Controls, and
Services.
YESCo s Power division designs, builds and maintains on-site
facilities for the production of thermal and/or electric power.
This includes fuel cells, of which YESCo Power installed two in
the fourth quarter of fiscal 1997, and began its third
installation in the first quarter of 1998. YESCo Controls
specializes in the engineering, installation, and maintenance of
building control systems. Controls is an authorized installer of
Andover Controls, a leading building controls product that we are
now installing in major projects for customers such as Southern
New England Telecommunications (SNET) and the University of
Connecticut. YESCo Services now operates out of three locations,
two in Connecticut and one in Massachusetts, to provide
comprehensive HVAC, boiler, and refrigeration equipment services
and installation.
In fiscal 1997, YESCo incurred startup costs at new locations
associated with building a sales and marketing infrastructure,
and initiated negotiations that led to acquisitions just after
the end of the fiscal year. Several on-site energy generation
projects expected to begin in fiscal 1997 were also delayed to
early 1998. Nonetheless, our identity as a provider of
comprehensive energy-related mechanical services is taking shape
as we continue to provide excellent service.
Substantial progress was made against our aggressive multi-year
business plan. In the third quarter we established two additional
operations service centers, one in southern Connecticut and one
in eastern Massachusetts. Late in the fourth quarter we completed
two acquisitions that enhance our technical capabilities in both
our Controls and Services divisions.
Our goal is to become the largest provider of comprehensive
mechanical services in Connecticut and adjacent markets. In
fiscal 1998 we plan continued growth internally through targeted
sales efforts and acquisitions. All the necessary managerial,
financial, and cultural components are in place to enable us to
create real shareholder value and continue our acquisitions
program.
Our strategy of "technicians and trucks" dispatched to provide
on-site solutions for customers remains sound. In keeping with
the character of Yankee Energy System, YESCo is set for
long-term, steady growth.
Michael E. Bielonko signature
Michael E. Bielonko
President, YESCo
Bottom right: Photo inset YESCo installation
Bottom Center: YES 1997
Bottom right: 5
Top left: Customers
New system speeds customer service
Top right: Photo inset of family
Caption across page(s): Making 'em say "Wow"
(across pages 6 and 7)
Thanks to a state-of-the-art Microsoft NT-based client/server
system, more customer information will be at the fingertips of
Yankee Gas service personnel, helping them serve customers more
quickly and accurately. The system, created by IBM Global
Services, is a first in the natural gas industry and will provide
fast access to data on customer billing, sales, credit, repairs
and maintenance. Yankee believes the system will enhance the
company s growth strategies.
Charles Gooley, president of Yankee Gas, pointed out that
"utility customers will compare their utility providers' service
to all other service providers. The IBM-CSS system will help us
provide the service that will distinguish us from everyone else."
The installation is scheduled for completion in late 1998.
Word in background beneath copy: Satisfaction
Bottom center: Photo inset of person operating fork lift
inside Federal Paper Board facility.
Caption: Federal Paper Board in Sprague, Connecticut,
is one of Yankee's more than 20,000
commercial and industrial customers. And,
like almost 1,400 of those customers, Federal
Paper Board uses a marketer to supply their
natural gas while relying on Yankee to
transport it to their factory. We're proud
to serve these transportation customers.
Bottom left: 6
Bottom center: YES 1997
Top center: Service contracts soar
Word in background beneath copy: Growth
The growth of gas-appliance service contracts sold by Yankee Gas
skyrocketed this past year, exceeding all expectations. "We
marketed more aggressively than ever," said Yankee Vice President
of Marketing Steve Laden. "Seasonal specials and add-on contracts
for installations, conversion projects and new homeowners
resulted in thousands of new service contract customers."
Laden added that service contracts do more than provide another
revenue stream. "Having a contractual relationship with customers
encourages them to communicate with us," he said. "It s another
way of listening to them and staying in touch with what they
want."
Caption across page(s): Making 'em say "Wow"
(across pages 6 and 7)
Center left: Photo inset of business man talking to couple
Caption: Rebates, incentives, and financing programs enable
industrial, commercial, and residential customers
to purchase, install, or convert to natural gas
equipment more easily.
Center bottom: Photo inset of Big Mo - Yankee Gas Mobile Office
Vehicle
Caption: Big Mo is Yankee s mobile customer education and
outreach center. It s equipped with a clean,
natural gas-burning engine, two offices, and a
mainframe interface with Yankee headquarters. It s
another way Yankee is focused on customer service.
And that s Big.
Right margin:
CAD keeps Yankee Service running on time
When a request for service comes in to Yankee Gas, vehicles are
responding more efficiently because of Computer Aided Dispatch
(CAD). The system, installed last summer, coordinates a fast
response by linking service headquarters to computer terminals in
service vehicles. Yankee personnel are directed to the customer
and already informed about the nature of the problem when they
arrive. As the Yankee customer base expands in number and in
geographic distribution, CAD will keep Yankee service pointed in
the right direction.
Yankee OnCall completes customer service loop
Graphic of Yankee OnCall logo
Yankee Gas has traditionally provided natural gas to its
customers and provided service or repair work when needed. But
when residential customers wanted to buy and install natural-gas
equipment, Yankee could only recommend a contractor.
Yankee OnCall changes all that. Yankee OnCall is an
equipment-acquisition and installation service for residential
customers. "The customer benefits from better, more competitive
service through Yankee," said David Ferrante, director of
customer service. "And we re now able to provide energy solutions
seamlessly, from acquisition to installation, delivery, service,
and repairs."
Bottom center: YES 1997
Bottom right: 7
Top left: Conversions
Top center: the switch is on
Text in background: on
Yankee helps Martha Stewart feel right at home
Center left: Photo inset of Martha Stewart cooking at stove
Center right:
When it comes to the quest for the perfect home, one woman leads
the way. Martha Stewart has the last word on how to address
domestic dilemmas, from making artichoke dip to baking zucchini
bread. And she wouldn't cook with anything but natural gas.
"For precision cooking, nothing comes close to natural gas," she
said from her studio in Norwalk, where Yankee recently completed
a conversion that enabled the construction of two
commercial-grade kitchens. With gas now on-line for her new daily
television show, "Martha Stewart Living," the star will saute,
bake, broil, and boil with the accuracy for which she s known.
"We worked closely with our customer on this project," said
Yankee Gas Sales Representative Mike Collins. "We designed
subfloor lines to suit the studio layout. Once it was done, we
convinced Ms. Stewart to make her heating system natural gas,
too, and converted the whole building." Look for Martha
Stewart s new syndicated television show, and look for the Yankee
Gas name when the credits roll.
Yankee answers the need for cleaner power
The problem at the Laurel Gardens apartments wasn't that oil heat
was costly. It was that oil heat created maintenance problems and
environmental issues for the community.
Enter Rick Hughes, the Yankee Gas sales representative who called
the Director of Danbury's Housing Authority last February. He
showed the Director how natural gas could help improve air
quality, and today has converted 90 units in five apartment
buildings. "The tenants get cleaner heat. And Yankee gets more
satisfied customers on-line," said Hughes. Yankee Gas is now
focused on similar properties in Danbury -- and the other 67
towns in the service area -- that could use cleaner energy.
Bottom left background text: air quality
Bottom right:
Stonegate finds a cure for the common cold
Stonegate was a cold neighborhood. Ninety single-family Stamford
homes, all with poor insulation, all heated by electric heat
pumps. Each winter, kids got sick and the electric bills soared.
Yankee Gas Sales Representative Greta Mead connected with a
resident who wanted to sell his home, but because of the electric
heat, couldn't get the price he wanted. Together, they attended
neighborhood meetings, stuffed flyers in mailboxes, and
discovered a market ripe for natural gas.
"It was a domino effect," said Mead. "Momentum built on word of
mouth, and eventually we converted 60 of the 90 homes to natural
gas." Now natural gas furnaces, fireplaces, and water heaters are
getting hot. And kids are staying warmer.
Bottom right: Inset photo of Stonegate housing development
Bottom left: 8
Bottom center: YES 1997
Top left: Operations
Doing business better
Photo inset composite of man in front of computer,
women with headset and computer screen
Transportation Services keeps Yankee right in the middle of
things
As Yankee Gas "unbundles," separating its gas supply and gas
delivery services, more of Yankee s commercial and industrial
customers will purchase natural gas on the open market. The move
is expected to reduce Yankee s role as seller of natural gas, and
open up new sales opportunities in gas transportation. Hence the
formation of a new department: Transportation Services.
Transportation Services makes Yankee a partner with customers who
need gas and with those who supply gas, by providing the
infrastructure that enables gas to arrive at its destination. No
matter where customers buy their gas, Yankee gets it there.
The new department will also coordinate with Sales to identify
transportation-related business opportunities. "We can
communicate with people who need gas, and people who supply it,"
said Richard Tardif, manager of Transportation Services. "This
will keep our sales staff supplied with the market information
they need, and administer customer requests more effectively."
Bottom left: Illustration of virtual reality
Caption: Imaginative Energy Solutions
Virtual Reality technology brings customers into a
3-D world of natural gas cooling technology
solutions, making a persuasive -- and very cool --
case for absorption, engine-driven, and desiccant
technologies.
Right margin:
Background photo: Closeup of computer keyboard
EBB and flow.
On-line natural gas ordering heats up.
Now that marketers are opening up natural gas sales, they rely on
Yankee Gas more than ever for timely delivery of the product. For
this reason, Yankee has established an Electronic Bulletin Board,
operational since last summer.
The EBB keeps communications with marketers constant, current,
and paperless. Orders for natural gas arrive instantly. Marketers
receive daily summaries of account activity. The database
information is entered once (instead of twice, under the previous
faxing method). And, since EBB uses the Internet, no additional
hardware or software is required. Bottom line: Customers get the
gas they need at competitive prices when they need it.
Bottom right margin: Graphic of globe with text:
Come visit us at the web
http://www.yankegas.com
Bottom center: YES 1997
Bottom right: 9
Top left: Technology
Background copy across pages 10 and 11: Technology
Environment
Economics
Top center: Natural Advantages
Top center: Schematic of infrared
Two markets open up for natural gas.
Infrared heats up; air compression performs under pressure.
Background text: infrared
Owners of large facilities like warehouses, garages, and airplane
hangars have traditionally paid a premium to keep their vast
space warm enough to work in during cold, drafty winter months.
Until recently, that is.
Natural gas-based infrared heating is now replacing older, colder
convection heating systems by putting warm air into cold work
areas. Infrared heaters heat buildings the same way the sun heats
the Earth s surface. Ceiling-mounted units radiate heat that
warms walls, floors, equipment and people. Comfort is increased
and heat loss is minimized. This explains why infrared heat is
now warming an Air National Guard hangar, a large auto-service
garage, and a manufacturing facility, all in Connecticut.
Other firms are recognizing the benefits of natural gas as a
power source for air compression, important in many manufacturing
processes. Natural gas-fired air compression is cheaper than
electricity, and more reliable, too, since it keeps manufacturers
going during power outages. These are just a few reasons why
Yankee Gas sees great potential in both these technologies, and
will market them aggressively in 1998.
Bottom right background text: air compression
Bottom left: 10
Bottom center: YES 1997
Top left: Environment
Background copy across pages 10 and 11: Technology
Environment
Economics
NGV's hit the road
Natural Gas fleets expand
United Parcel Service and the U.S. Postal Service have added
natural gas-powered trucks to their Connecticut fleets, leading
the movement toward more fuel-efficient vehicles on our roads and
providing Yankee Gas Services sustained growth in the business of
engine conversions and fuel supply.
Federal laws mandate that certain fleets begin using alternative
fuels, so companies like UPS and the Postal Service are preparing
for the future. Ford, GM, and Chrysler all have plans for natural
gas vehicle (NGV) production as well.
For many companies, the reasons go beyond federal law. Natural
gas is less expensive -- about 90 cents a gallon -- and
cleaner-burning than gasoline, emitting approximately 90 percent
less carbon monoxide. Maintenance costs are lower and safety is
higher, since natural gas combusts at twice the temperature of
gasoline. That s smart driving.
NGVs are especially well-suited to fleet service, since such
vehicles rely on central fueling stations, of which Yankee now
has five in Connecticut. The latest, at Danby's Exxon station in
Meriden, was constructed by Yankee Gas Services last year, adding
a critical centrally located link in the state s natural gas fuel
network. Check out our web site for other locations.
Top right: Photo inset of man fueling UPS vehicle
Bottom third: Fuel cells power up.
Natural gas goes in, premium AC power comes out.
Fuel cells first caught the attention of NASA, which is always
looking for new ways to supply power in outer space. Back here on
Earth, YESCo is marketing fuel cell technologies for business,
highlighting the company s drive to fill the demands for
non-traditional, reliable, premium power generation. Fuel cells
are currently operating at the Naval Submarine Base in Groton as
well as Yankee s corporate headquarters.
Fuel cells create AC power by separating the hydrogen and oxygen
in natural gas. Thermal energy is also produced, and can be
recovered and re-used. The power output from one fuel cell can
reach 200 kilowatts at 85 percent efficiency, enough power for
about 150 homes.
Right now the up-front cost of fuel cells is steep, but the
federal government subsidizes their development, making them more
affordable. Still, the appeal of fuel cells remains high. They
ensure clean, high-quality power even during power outages,
eliminate the need for expensive backup systems, and because the
current is steady, fuel cells extend the life of the equipment
they power. Natural gas fuel cells produce no emissions, so
they re easy on Mother Nature.
As the demand for fuel cells in the premium power market grows,
YESCo will be there to meet it.
Bottom third right: Photo inset of fuel cell ribbon cutting
ceremony
Caption: Branko Terzic cuts the ribbon on
Yankee's natural gas-fired fuel cell.
Bottom center: YES 1997
Bottom right: 11
Left margin: Energy Experts
Background text: Experts
Charles Gooley was promoted in 1997 to President of Yankee Gas
Services from his former position as Executive Vice President of
Operations. While he was Director of Legal and External Affairs
at Northeast Utilities, Chuck led the effort that split Yankee
Gas from the NU System in 1989. He joined Yankee that year as
Vice President and General Counsel.
James Sepanski was a former partner and 15-year member of Arthur
Anderson, LLP, New York City, and joined Yankee Energy System in
July as its Chief Financial Officer. Jim s specialization has
long been with utilities, and he has been involved with
innovative financing, acquisitions and mergers. He will oversee
financial operations for Yankee Energy and its subsidiaries.
Michael Bielonko has taken the helm as the new President of
YESCo, after a successful tenure as Yankee Energy s CFO. Mike
brings with him more than 20 years of financial and utility
management experience with Yankee Energy and Northeast Utilities.
He began with Yankee in 1989, as Vice President and Treasurer. He
will direct the strategy to make YESCo a major provider of
mechanical energy services in the Northeast.
Kingsley Fink has joined Yankee Gas Services as Vice President,
Operations. Kingsley brings 15 years of experience in the Florida
utility industry where, as General Manager of Florida Power and
Light, he oversaw customer service, collections, meter reading,
billing, and remittance processing.
Dale Hedman has been promoted to Vice President for YESCo and now
leads the Power division. He has held three previous positions at
Yankee, including Director of Finance at YESCo, and Manager of
Financial Planning at Yankee Gas. Dale s extensive experience
with Yankee has made his transition to his new post a smooth one.
Eric Grondahl has been promoted to Vice President for YESCo and
now leads YESCo s Service division. Prior to joining YESCo in
late 1996, Eric, an engineer by training, previously worked at
Combustion Engineering and Northeast Utilities.
Right two-thirds of page:
Directors and Officers
Board of Directors
Photo inset: Branko Terzic
Caption: Branko Terzic (1)
Chairman, President and Chief Executive Officer
Yankee Energy System, Inc.
Meriden, CT
Photo inset: Sanford Cloud, Jr.
Caption: Sanford Cloud, Jr. (2), (3)
President and Chief Executive Officer
The National Conference of Christians and
Jews, Inc.
New York, NY
Photo inset: Eileen S. Kraus
Caption: Eileen S. Kraus (2), (4), (5)
Chairman
Connecticut Fleet National Bank
Hartford, CT
Photo inset: Frederick M. Lowther
Caption: Frederick M. Lowther (4), (5),
Partner
Dickstein Shapiro Morin & Oshinsky, LLP
Washington, D.C
Photo inset: Emery G. Olcott
Caption: Emery G. Olcott (1), (4), (5)
Chairman, President and Chief Executive Officer
Packard BioScience
Meriden, CT
Photo inset: John J. Rando
Caption: John J. Rando (2), (3)
Senior Vice President and General Manager
Digital Equipment Corporation
Stow, MA
Photo inset: Nicholas L. Trivisonno
Caption: Nicholas L. Trivisonno (1), (2), (3)
Chairman and Chief Executive Officer
ACNielsen
Stamford, CT
Photo inset: Patricia M. Worthy
Caption: Patricia M. Worthy (2), (3)
Professor
Howard University School of Law
Washington, D.C.
Committees of the Board
(1) Executive
(2) Audit
(3) Finance
(4) Organization and Compensation
(5) Committee on Board Affairs
Officers
Photo inset: Charles E. Gooley
Caption: Charles E. Gooley
Executive Vice President, YES
Photo inset: Mary J. Healey
Caption: Mary J. Healey
Vice President, General Counsel and Secretary, YES
Photo inset: Thomas J. Houde
Caption: Thomas J. Houde
Vice President, YES
Photo inset: Ellen J. Quinn
Caption: Ellen J. Quinn
Vice President, YES
Photo inset: Steven P. Laden
Caption: Steven P. Laden
Vice President, YES
Photo inset: Nicholas A. Rinaldi
Caption: Nicholas A. Rinaldi
Vice President, YES
Photo inset: James M. Sepanski
Caption: James M. Sepanski
Vice President and Chief Financial Officer, YES
Photo inset: Michael E. Bielonko
Caption: Michael E. Bielonko
Vice President, YES
Bottom left: 12
Bottom center: YES 1997
Background graphic: Contents
Columns of numbers
FINANCIAL INFORMATION
Contents
Management's Discussion and Analysis
Management and Independent Public Accountants Reports
Consolidated Statements of Income
Consolidated Balance Sheets
Consolidated Statements of Cash Flows
Consolidated Statements of Capitalization
Consolidated Statements of Common Shareholders' Equity
Notes to Consolidated Financial Statements
Selected Financial and Operating Data
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Financial Condition
OVERVIEW
Yankee Energy System, Inc. (YES or the Company) headquartered in
Meriden, Connecticut, is a diversified company specializing in
the distribution, conversion, and control of energy to meet our
customers' needs. Our principal operating subsidiary is Yankee
Gas Services Company (Yankee Gas). Yankee Gas provides retail
distribution of natural gas to a service area of 68 cities and
towns in Connecticut. The Company's other operating subsidiaries
support our core business in natural gas, or allow us to expand
our growing businesses in energy-related services. Yankee Energy
Services Company (YESCo) provides comprehensive energy-related
services through three principle divisions. YESCo Power designs,
builds and maintains on-site facilities for the production of
thermal and/or electric power. YESCo Controls is in the business
of engineering, installing, and maintaining building control
systems. YESCo Services provides comprehensive HVAC, boiler and
refrigeration equipment services and installation. Other
subsidiaries support the operations of Yankee Gas and YESCo.
NorConn Properties, Inc. (NorConn) owns selected system real
estate, which it leases to Yankee Gas. Yankee Energy Financial
Services (Yankee Financial) provides energy equipment financing.
R.M. Services, Inc. (RMS) provides receivables management
services.
The Company reported consolidated net income of $16.9 million, or
earnings per share of $1.62, for its fiscal year ended September
30, 1997. This compares with consolidated net income of $21.9
million and $12.4 million, reflecting earnings per share of $2.10
and $1.20, respectively, for fiscal years ended September 30,
1996 and 1995. Fiscal 1996 earnings include a gain of $2.5
million or an after-tax effect of $0.24 per share resulting from
the Company's sale of its Iroquois Gas Transmission System
(Iroquois) investment. Fiscal 1995 earnings reflect a one-time
operating charge of $5.4 million related to the Company's
business transformation efforts, or an after-tax effect of $0.30
per share. Earnings for fiscal year 1997 decreased primarily due
to operating losses incurred by the Company's non-regulated
subsidiaries. Delays in bringing new business on line and
integrating these companies into the Yankee Energy organization
have contributed to losses which are expected to be eliminated in
the next fiscal year. These losses were partially offset by
strong operating performance at Yankee Gas during the fiscal year
due primarily to a reduction in Operation and Maintenance expense
principally as a result of cost controls implemented by the
Company. The increase in 1996 earnings from fiscal 1995 was due
primarily to colder weather in fiscal 1996, the gain realized on
the sale of the Company's 10.5 percent equity interest in
Iroquois, and lower expenses relating to the Company's business
transformation.
Earnings on the Company's investment in Iroquois for the first
six months of fiscal 1996 were approximately $1.5 million and
contributed $0.14 to earnings per share as compared to $0.4
million in fiscal 1995, or $0.04 per share. On April 30, 1996,
the Company announced the sale of its entire 10.5 percent
interest in Iroquois. Earnings for fiscal 1996 reflect a $2.5
million net after-tax gain from the sale, or $0.24 per common
share, realized in the third quarter of fiscal year 1996. Thus,
total earnings related to the investment in Iroquois, including
the gain on sale, were $0.38 per common share.
The Company increased dividends paid per share to $1.32 in 1997,
up 3.1 percent from the $1.28 per share in 1996, the seventh
straight year the Company has increased its dividend.
Fiscal 1997 earnings per share are based on 10,451,165 weighted
average common shares outstanding. Earnings per share were based
on 10,435,231 and 10,322,447 weighted average common shares
outstanding for fiscal years 1996 and 1995. During fiscal 1997,
the Company issued 4,860 new shares of common stock under its
Long-term Incentive Plan. In fiscal 1996, the Company issued
52,212 new shares under its Shareholder Investment Plan and 820
shares under its Long-term Incentive Plan.
REGULATORY MATTERS
On August 25, 1996, Yankee Gas filed an application with the
Connecticut Department of Public Utility Control (DPUC) for a
Financial and Operational Review (Review). This Review was
required under Connecticut statute since Yankee Gas had not
undergone a rate proceeding within the previous four years.
Yankee Gas' last rate approval was on August 26, 1992, and this
Review was necessary to comply with the statute. On July 9,
1997, the DPUC issued its decision in Docket No. 96-08-05. The
DPUC decision, which is not a rate order, called for a lowering
of Yankee Gas' authorized Return on Equity (ROE) from 12.43
percent to 11.15 percent. The DPUC believed that lower current
interest rates and recently allowed rates of return for other
Connecticut utilities justified a lower ROE for Yankee Gas. On
October 1, 1997, the DPUC approved a settlement whereby Yankee
Gas will credit approximately $3.2 million to firm sales
customers through the Purchased Gas Adjustment Clause (PGA),
during the period November 1997 through March 1998. The
settlement also allows Yankee Gas to maintain its base rates
until the end of fiscal year 2000, resulting in an eight-year
period in which Yankee Gas will have gone without an increase to
its base rates.
On January 3, 1996, the DPUC issued a Final Decision in reopened
Docket No. 92-02-19 to approve a rate agreement Yankee Gas
reached with the Office of Consumer Counsel (OCC). The
agreement states that Yankee Gas may apply a portion of credits
received from pipeline refunds, excess interruptible margin,
deferred gas costs, capacity release agreements and off-system
sales margin to reduce or eliminate certain deferred regulatory
assets. These credits are provided by a mechanism established by
the DPUC for the Connecticut Local Distribution Companies (LDCs)
to recover the gas supply transition costs relating to Federal
Energy Regulatory Commission (FERC) Order No. 636.
Through September 30, 1997, Yankee Gas has paid approximately
$19.5 million of gas supply transition costs and an additional
$3.5 million are anticipated. To date, Yankee Gas has collected
$44.2 million through a combination of credits received from
pipeline refunds, capacity release agreements, deferred gas
costs, off-system sales margin, and excess interruptible margin.
These excess collections of approximately $24.7 million have been
applied against certain regulatory assets in accordance with the
January 3, 1996 DPUC decision.
On August 2, 1995, the DPUC issued a Final Decision in Docket No.
94-11-12, DPUC Review of Connecticut Local Distribution
Companies' Cost of Service Study Methodologies. The DPUC
investigated the issues surrounding the development of firm
transportation (FT) rates at the state level in response to FERC
Order No. 636. The Decision provided guidelines for the
development of FT rates to be offered by the state's three LDCs.
On January 24, 1996, the DPUC issued a Final Decision on Docket
No. 92-02-19 Reopen I. This Decision enabled Yankee Gas to
implement FT rates and services as contemplated in the DPUC
August 2, 1995 decision referenced above. The Decision allows
Yankee Gas to offer a broad array of service options to
commercial and industrial FT customers. Yankee Gas implemented
these new FT rates and services on April 1, 1996, and as of
September 30, 1997, Yankee Gas had approximately 1,460 customers
under the new FT service. Existing customers who switch to
transportation tariffs will result in decreased revenues for
Yankee Gas as that portion of revenues representing gas costs
will now be borne directly by those customers who buy their gas
directly. Yankee Gas does not expect customer conversions to
transportation services to affect its net income because the cost
of gas has traditionally been a pass through item with no income
impact.
FORWARD-LOOKING STATEMENTS
This report contains statements which, to the extent they are not
recitations of historical fact, constitute "forward-looking
statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. Such forward-looking statements
involve risks and uncertainties. Actual results may differ
materially from such forward-looking statements for reasons
including, but not limited to, changes to and developments in the
legislative and regulatory environments affecting the Company's
business, the impact of competitive products and services,
changes in the natural gas industry caused by deregulation and
other factors, and certain environmental matters, as well as
such other factors as set forth in the Company's Form 10-K for
the year ended September 30, 1997.
RESULTS OF OPERATIONS
OPERATING REVENUES
Operating revenues decreased $14.9 million from 1996 to 1997 and
increased $45.9 million from 1995 to 1996. The components of the
change in operating revenues for the past two years are provided
in the following table:
(Millions of Dollars)
Increase/(Decrease)
Years Ended September 30, 1997 vs 1996 1996 vs 1995
Firm sales and other $ (9.0) $12.7
Firm transportation 7.2 (0.4)
____ ____
Subtotal firm sales,
transportation and other
(excluding gas
cost recoveries) (1.8) 12.3
Interruptible/off-system sales
and transportation (excluding
gas cost recoveries) (1.4) 0.2
____ ____
Total (excluding gas cost
recoveries) $ (3.2) $12.5
Gas cost recoveries (16.9) 32.5
_____ _____
Total change in utility
revenues $ (20.1) $45.0
_____ _____
_____ _____
Nonutility revenues 5.2 0.9
Total change in operating
revenues $ (14.9) $45.9
_____ _____
_____ _____
The corresponding changes in Yankee Gas throughput were as
follows:
(Mcf-thousands)
Increase/(Decrease)
Years Ended September 30, 1997 vs 1996 1996 vs 1995
Firm sales (3,692) 4,485
Firm transportation 3,881 (411)
Interruptible/off-system sales (2,937) (342)
Interruptible transportation 4,409 (1,210)
_____ _____
Total change in throughput 1,661 2,522
_____ _____
_____ _____
The change in operating revenues primarily reflects a decrease in
firm sales volumes of approximately 10.5 percent in fiscal 1997
compared to fiscal 1996. This change primarily related to the
shift of firm sales to firm transportation and a decrease in
residential sales volumes related to warmer weather. Firm
transportation increased approximately $7.2 million from 1996 to
1997. The increase in firm and other revenues from 1995 to 1996
was due primarily to weather that was 13 percent colder in 1996,
partially offset by an 11.5 percent decrease in off-system sales,
interruptible sales and transportation from 1995 to 1996.
Revenues from non-regulated operations increased $5.2 million
from 1996 to 1997 and $0.9 million from 1995 to 1996 due to the
growth of nonutility subsidiaries during those years.
Gas cost recoveries decreased in fiscal 1997 compared to fiscal
1996 due to lower firm sales, offset by higher per-unit gas
costs. Gas cost recoveries increased in fiscal 1996 compared to
fiscal 1995 due to higher firm sales and higher per-unit gas
costs.
OPERATING EXPENSES
Total operating expenses decreased $11.2 million in 1997 compared
to 1996 and increased $34.1 million in 1996 compared to 1995 as a
result of the following items:
Cost of gas decreased $16.4 million in 1997 compared to 1996
and increased $33.8 million in 1996 compared to 1995.
Yankee Gas defers differences between actual purchased gas
costs and the current cost recovery and recovers or refunds
such differences in future periods. This deferral results
in an increase or decrease to gas costs in each fiscal year.
The 1997 decrease was due primarily to lower firm sales as a
result of the warmer weather, partially offset by higher
per-unit gas costs. The 1996 increase was primarily due to
higher volumes of gas purchased as a result of the colder
weather and full recovery of the prior year undercollection
of gas costs. Cost of goods sold increased $3.6 million in
1997 compared to 1996, due to increased YESCo activity.
Operation and maintenance expense increased $0.1 million in
1997 compared to 1996 and decreased $0.6 million in 1996
compared to 1995. The 1997 increase was primarily due to
increased expenses related to nonutility operations,
partially offset by a decrease in Yankee Gas operation and
maintenance expense.
Depreciation expense increased $0.9 million in 1997
compared to 1996 and increased $0.1 million in 1996 from
1995 levels. The 1997 increase was primarily due to
additions in plant assets.
Taxes other than income taxes increased $0.6 million in
1997 compared to 1996 and increased $0.5 million in 1996
compared to 1995. The 1997 increase was primarily due
to higher Connecticut unemployment taxes and municipal
taxes, partially offset by lower gross earnings taxes
resulting from lower revenues in 1997 compared to 1996. The
1996 increase was primarily due to higher gross earnings
taxes which resulted from higher revenues in 1996 compared
to 1995, and higher municipal taxes, partially offset by a
reduction in Connecticut state unemployment taxes. The
1997 increase and 1996 decrease in Connecticut unemployment
taxes was due to a decision by the Connecticut Supreme
Court concerning the Company's 1992 work stoppage which
allowed the Company to reverse, in fiscal 1996, an accrual
for unemployment tax expense associated with claims paid to
Yankee Gas bargaining unit employees in 1992.
Other income decreased $5.4 million in 1997 compared to 1996 and
increased $2.7 million in 1996 compared to 1995. The 1997
decrease was primarily due to the absence of earnings associated
with the Company's interest in Iroquois, while the 1996 increase
was primarily due to the gain on the sale of the Company's
interest in Iroquois.
Interest expense in 1997 decreased $2.1 million as compared to
1996 primarily due to lower levels of debt and lower interest
expense on Yankee Gas' deferred fuel balance. Interest expense
in 1996 decreased $0.2 million as compared to 1995 primarily due
to lower debt, offset by higher interest on Yankee Gas' deferred
fuel balance.
Federal and state income taxes decreased $2.0 million in 1997
compared to 1996, and increased $5.2 million in 1996 compared to
1995. The 1997 decrease was primarily due to lower taxable
income as a result of operating losses incurred by Yankee
Energy's nonutility subsidiaries. The 1996 increase was
primarily due to increased earnings from operations over fiscal
1995. Please refer to Note 2 to the Consolidated Financial
Statements for additional information concerning the components
of federal and state income taxes.
LIQUIDITY AND CAPITAL RESOURCES
Expenditures for plant, property and investments totaled $35.2
million in 1997 reflecting a $5.2 million increase from 1996, and
was funded primarily through cash generated from current
operations and short-term borrowings.
Cash flow (defined as net income adjusted for non-cash items such
as depreciation, deferred income taxes and the Company's non-cash
equity earnings from investments) represents the cash generated
from operations available for capital expenditures, dividends and
other needs. Cash flows from operating activities decreased $7.8
million in fiscal 1997 compared to fiscal 1996 primarily due to
lower net income and changes in working capital, and decreased
$2.1 million in fiscal 1996 compared to fiscal 1995.
The seasonal nature of gas revenues, inventory purchases and
construction expenditures create a need for short-term borrowing
to supplement internally generated funds. Yankee Gas has
arranged a $60 million revolving line of credit with a group of
four banks whereby funds may be borrowed on a short-term
revolving basis using either fixed or variable rate loans.
Yankee Gas also has an additional $27 million of credit lines
available on an uncommitted basis. Yankee Gas had $36.3 million
outstanding under its agreements at September 30, 1997 and $20.3
million outstanding at September 30, 1996. In addition, Yankee
Energy had $2.7 million outstanding as of September 30, 1997 and
no amounts outstanding at September 30, 1996 on a $15 million
line of credit, which is available to fund the development of the
Company's unregulated businesses. The weighted average interest
rates on short-term borrowings at September 30, 1997 and 1996
were 6.0 percent and 5.6 percent, respectively.
The long-term credit needs of Yankee Gas are being met by a first
mortgage bond indenture that provides for the issuance of bonds
from time to time as the need arises, subject to certain
restrictions. At September 30, 1997, indenture requirements,
including the required coverage ratio, would allow for the
issuance of an additional $216 million of bonds at an assumed
interest rate of 7.4 percent.
On February 1, 1996, the Company's system real estate subsidiary,
NorConn, secured a $6 million bank term loan to refinance two
existing real estate loans. Under the agreement, the interest
rate is fixed at 6.24 percent for the seven-year term of the loan
and requires an annual $250,000 sinking fund payment.
On April 1, 1997, Yankee Gas redeemed all $30 million Series A
Tranche C First Mortgage Bonds which matured on that date.
Yankee Gas used cash on hand and the issuance of a $30 million
principal amount of Series E First Mortgage Bonds on April 1,
1997, through a private placement. The bonds were sold by the
initial purchaser to "qualified institutional buyers" as defined
in and pursuant to Rule 144A under the Securities Act of 1933.
The bonds will mature April 1, 2012 and interest is payable at an
annual rate of 7.19 percent.
On November 4, 1994, Yankee Energy filed a Form S-3 registration
statement with the Securities and Exchange Commission to issue up
to 1,200,000 shares of common stock under its proposed
Shareholder Investment Plan (Plan). The Plan, which became
effective January 25, 1995, provides existing shareholders and
their family members the ability to acquire shares of common
stock through dividend reinvestment or voluntary cash purchases.
The Plan provides the Company the option to use new shares of
common stock or market purchases. The Company issued 52,212 new
shares which provided approximately $1.0 million of new equity
funding in fiscal 1996. No shares were issued under the Plan
during fiscal 1997. The new equity was used primarily to provide
capital contributions to the Company's nonregulated subsidiaries.
The Company's estimated capital expenditures for the fiscal years
1998 through 2002 are $194 million, including $55 million for
1998. Approximately $54 million, including $15 million for 1998
is for capital expenditures in nonutility operations. The 1998
utility capital expenditures, including the installation of a new
customer information system, are expected to be financed by a
combination of internally generated funds and short-term
borrowings. For Yankee Gas, long-term debt maturities and
sinking fund requirements will total $3.4 million in 1998.
The Company is currently implementing new systems and enhancing
existing systems to address year 2000 issues. Management
believes that all system changes will be installed and tested
prior to the manifestation of year 2000 issues. Currently, all
such charges associated with system enhancements have and will
continue be expensed and the costs of new systems will be
capitalized as appropriate. Expenditures are expected to
continue through the next two fiscal years.
In addition, Yankee Gas expects to incur expenditures for coal
tar remediation efforts, which is more fully discussed in Note 9
to the Consolidated Financial Statements. Yankee Gas expects to
finance such expenditures through a combination of internally
generated funds, short-term debt, and through insurance
settlements, which have totaled $9.6 million as of September 30,
1997.
MANAGEMENT REPORT
The consolidated financial statements of Yankee Energy System,
Inc. and subsidiaries and other sections of this Annual Report
were prepared by management, which is responsible for their
integrity and objectivity. These financial statements, which
were audited by Arthur Andersen LLP, were prepared in accordance
with generally accepted accounting principles using estimates and
judgement, where required, and giving consideration to
materiality.
The Company maintains a system of internal controls over
financial reporting, which is designed to provide reasonable
assurance to the Company's management and Board of Directors
regarding the preparation of reliable published financial
statements. The system contains self-monitoring mechanisms, and
actions are taken to correct deficiencies as they are identified.
Even an effective internal control system, no matter how well
designed, has inherent limitations, including the possibility of
the circumvention or overriding of controls, and such systems can
provide only reasonable assurance with respect to financial
statement preparation. Further, because of changes in conditions,
internal control system effectiveness may vary over time.
Through established programs, the Company regularly emphasizes to
its management employees their internal control responsibilities
and policies prohibiting conflicts of interest. The Audit
Committee of the Board of Directors is composed entirely of
outside directors. This Committee meets periodically with
management, the internal auditors and the independent auditors to
review the activities of each and to discuss audit matters,
financial reporting and the adequacy of internal controls.
Management believes that its system of internal accounting
controls and control environment provide reasonable assurance
that its assets are safeguarded from loss or unauthorized use and
that its financial records, which are the basis for the
preparation of all financial statements, are reliable.
Branko Terzic
Chairman, President and
Chief Executive Officer
James M. Sepanski
Vice President,
Chief Financial Officer and Treasurer
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Shareholders of Yankee Energy
System, Inc.:
We have audited the accompanying consolidated balance sheets and
consolidated statements of capitalization of Yankee Energy
System, Inc. (a Connecticut corporation) and subsidiaries (the
Company) as of September 30, 1997 and 1996, and the related
consolidated statements of income, common shareholders' equity
and cash flows, for each of the three years in the period ended
September 30, 1997. These financial statements are the
responsibility of the Company's management. Our responsibility
is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted
auditing standards. Those standards require that we plan and
perform the audits to obtain reasonable assurance about whether
the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating
the overall financial statement presentation. We believe that
our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above
present fairly, in all material respects, the financial position
of Yankee Energy System, Inc. and subsidiaries as of September
30, 1997 and 1996 and the results of their operations and their
cash flows for each of the three years in the period ended
September 30, 1997, in conformity with generally accepted
accounting principles.
Hartford, Connecticut Arthur Andersen LLP
November 7, 1997
YANKEE ENERGY SYSTEM, INC. AND SUBSIDIARIES
Consolidated Statements of Income
(Thousands of Dollars, except share information)
For the Years Ended September 30, 1997 1996 1995
Revenues:
Utility revenues $318,954 $339,045 $293,983
Nonutility revenues 6,087 895 39
________ ________ ________
Total Revenues 325,041 339,940 294,022
________ ________ ________
Operating Expenses:
Cost of gas/goods sold 176,757 189,504 155,404
Operations 58,569 58,375 59,222
Maintenance 6,382 6,477 6,251
Depreciation 17,521 16,649 16,520
Taxes other than income taxes 22,519 21,949 21,444
________ _______ _______
Total Operating Expenses 281,748 292,954 258,841
________ ________ _______
Operating Income 43,293 46,986 35,181
Other Income(Expense):
Other income, net 309 5,674 2,960
Interest charges, net (13,222) (15,290) (15,505)
________ _______ ________
Income Before Income Taxes 30,380 37,370 22,636
Provision for Income Taxes 13,423 15,451 10,278
________ ________ ________
Net Income $16,957 $21,919 $12,358
________ ________ ________
________ ________ ________
Earnings per Common Share $1.62 $2.10 $1.20
_____ _____ _____
_____ _____ _____
Weighted Average Common
Shares Outstanding 10,451,165 10,435,231 10,332,447
__________ _________ _________
__________ _________ _________
The accompanying notes are an integral part of these financial
statements.
YANKEE ENERGY SYSTEM, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(Thousands of Dollars)
At September 30, 1997 1996
ASSETS
Utility Plant, at original cost $524,221 $499,446
Less: Accumulated provision for depreciation 192,506 177,943
_______ _______
331,715 321,503
Construction work in progress 19,150 13,985
_______ _______
Total Net Utility Plant 350,865 335,488
_______ _______
Other Property and Investments 19,311 14,894
_______ _______
Current Assets:
Cash and temporary cash investments 2,239 7,853
Accounts receivable, less accumulated
provision for uncollectible accounts of
$7,713 in 1997 and $7,259 in 1996 27,002 25,623
Fuel supplies 10,370 11,465
Other materials and supplies 2,186 1,706
Accrued utility revenues 4,667 5,775
Prepaid taxes 8,031 2,925
Deferred gas costs, current portion 2,034 -
Other 5,901 4,373
_______ _______
Total Current Assets 62,430 59,720
_______ _______
Deferred Gas Costs 8,364 3,948
Recoverable Environmental Cleanup Costs 31,667 34,370
Recoverable Income Taxes 11,038 14,559
Recoverable Postretirement Benefits Costs 1,515 1,861
Other Deferred Debits 15,174 13,909
________ ________
Total Assets $500,364 $478,749
________ ________
________ ________
CAPITALIZATION AND LIABILITIES
Capitalization (see accompanying statements):
Common shareholders' equity $165,706 $162,066
Long-term debt, net of current portion 135,265 109,282
_______ _______
Total Capitalization 300,971 271,348
_______ _______
Current Liabilities:
Notes payable to banks 39,000 20,300
Long-term debt, current portion 4,017 34,017
Accounts payable 22,741 22,571
Accrued interest 2,008 3,494
Pipeline transition costs payable 3,538 422
Other 6,480 7,411
_______ _______
Total Current Liabilities 77,784 88,215
_______ _______
Accumulated Deferred Income Taxes 68,205 64,422
Accumulated Deferred Investment Tax Credits 8,703 9,080
Reserve for Environmental Cleanup Costs 35,000 35,000
Postretirement Benefits Obligation 2,840 3,361
Other Deferred Credits 6,861 7,323
Commitments and Contingencies (Note 9)
________ ________
Total Capitalization and Liabilities $500,364 $478,749
________ ________
________ ________
The accompanying notes are an integral part of these financial
statements.
YANKEE ENERGY SYSTEM, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(Thousands of Dollars)
For the Years Ended September 30, 1997 1996 1995
Cash Flows From Operating Activities:
Net Income $16,957 $21,919 $12,358
Adjusted for the following:
Depreciation 17,521 16,649 16,520
Equity earnings from investments (105) (2,766) (2,552)
Gain on sale of investment in Iroquois - (2,688) -
Deferred income taxes, net 6,927 9,267 (1,545)
Deferred gas costs activity and other
non-cash items (4,398) (3,740) 10,609
Changes in working capital:
Accounts receivable and
accrued utility revenues (271) (4,668) (519)
Accounts payable 170 4,271 495
Prepaid taxes (5,106) (2,644) 3,071
Other working capital (excludes cash) (3,089) 787 20
______ _______ _______
Net cash provided by
operating activities 28,606 36,387 38,457
_______ _______ _______
Cash Flows From Financing Activities:
Net proceeds from common
stock issuance 105 1,216 2,308
Issuance of long-term debt 30,000 2,150 20,000
Retirement of long-term debt (34,017) (5,817) (26,667)
Increase (decrease) in
short-term debt 18,700 (8,225) 3,925
Cash dividends-common stock (13,797)(13,357) (12,808)
_______ _______ _______
Net cash provided by (used for)
financing activities 991 (24,033) (13,242)
_______ _______ _______
Investment In Plant And Other:
Utility Plant (31,320)(25,663) (25,311)
Other property and investments (3,891) (4,380) (1,251)
Iroquois distribution - 2,625 1,470
Proceeds from Iroquois sale - 22,192 -
_______ _______ _______
Net cash used for plant and
other investments (35,211) (5,226) (25,092)
_______ _______ _______
Net (Decrease) Increase In Cash and
Temporary Cash Investments
For The Period (5,614) 7,128 123
Cash and Temporary Cash Investments,
beginning of period 7,853 725 602
_______ _______ _______
Cash and Temporary Cash Investments,
end of period $2,239 $7,853 $ 725
_______ _______ _______
_______ _______ _______
Supplemental Cash Flow Information:
Cash paid during the period for:
Interest, net of amounts capitalized $14,203 $13,484 $14,412
Income taxes $12,140 $14,213 $ 8,681
The accompanying notes are an integral part of these financial
statements.
YANKEE ENERGY SYSTEM, INC. AND SUBSIDIARIES
Consolidated Statements of Capitalization
(Thousands of Dollars)
At September 30, 1997 1996
Common Shareholders' Equity:
Common shares - $5 par value, authorized
20,000,000 shares; 10,454,414 and
10,449,554 shares outstanding at
September 30, 1997 and 1996 $52,272 $52,248
Capital surplus, paid in 88,151 88,086
Unearned compensation-restricted
stock awards (a) (148) (139)
Retained earnings 26,431 23,271
Employee stock ownership plan guarantee (b) (1,000) (1,400)
_______ _______
Total Common Shareholders' Equity 165,706 162,066
_______ _______
Long-term Debt:
First Mortgage Bonds (c)
Maturity Interest Rates
1997 9.90% - 30,000
2004 10.03% 23,532 26,899
2005 6.75% 20,000 20,000
2012 7.19% 30,000 -
2019 10.07% 19,000 19,000
2022 8.48% 20,000 20,000
2023 8.63% 20,000 20,000
_______ _______
Total First Mortgage Bonds 132,532 135,899
Term Loan Agreement, 6.24%
due February, 2003 (c) 5,750 6,000
Guarantee of Employee Stock Ownership Plan
Term Loan Agreement, 10.38%,
due July, 1999 (b) 1,000 1,400
_______ _______
Total Long-term Debt 139,282 143,299
Less amounts due within one year (b)(c) 4,017 34,017
_______ _______
Long-term Debt, Net 135,265 109,282
_______ _______
Total Capitalization $300,971 $271,348
________ ________
________ ________
(a) Consistent with the terms of the Non-Employee Directors'
Restricted Stock Plan, incentive awards of 3,817 shares and 900
shares of restricted common stock were granted to Directors
during 1997 and 1996, respectively. Under the Long-term Incentive
Compensation Plan the market value of the restricted stock awards
has been recorded as unearned compensation and is shown as a
separate component of shareholders' equity. The earned
compensation is charged to administrative and general expense as
shares become vested. Earned compensation was approximately
$66,000 for fiscal 1997 and $117,000 for fiscal 1996.
(b) On July 20, 1989, Yankee Energy became guarantor of a term
loan agreement between the Trustee for the Company's 401(k)
Employee Stock Ownership Plan (ESOP), and a commercial bank, in
the amount of $4,000,000. The proceeds were used by the Trustee
exclusively to acquire outstanding shares of Yankee Energy common
stock pursuant to the terms of the Company's ESOP. The final
maturity date of the agreement is July 1, 1999 with sinking fund
requirements of $400,000 for the fiscal year 1998 and $600,000
for the 1999 fiscal year.
(c) Long-term debt maturities and cash sinking fund requirements
on debt outstanding at September 30, 1997 for each of the fiscal
years 1998 through 2002 (excluding the ESOP sinking fund
requirement) are $3,617,000, $3,617,000, $4,567,000, $4,567,000,
and $4,567,000 respectively.
The accompanying notes are an integral part of these financial
statements.
YANKEE ENERGY SYSTEM, INC. AND SUBSIDIARIES
Consolidated Statements of Common Shareholders' Equity
(Thousands of Dollars)
Employee
Stock
Capital (a) Ownership
Common Surplus, Retained Plan
Shares Paid In Earnings Guarantee Total
Balance at
September
30, 1994 $51,438 $85,150 $15,159 $(2,200) $149,547
Net Income 12,358 12,358
Issuance of
108,839 common
shares - $5
par value 544 1,764 2,308
Cash dividends
on common
shares - $1.24
per share (12,808) (12,808)
Employee stock
ownership plan
loan repayment 400 400
Common stock
issuance expenses (92) (92)
Unearned
compensation-
restricted
stock awards (b) 40 40
_____ ______ ______ ______ _______
Balance at
September
30, 1995 $51,982 $86,862 $14,709 $(1,800) $151,753
Net Income 21,919 21,919
Issuance of
53,032 common
shares - $5
par value 266 973 1,239
Cash dividends on
common shares -
$1.28 per share (13,357) (13,357)
Employee stock
ownership plan
loan repayment 400 400
Unearned compensation-
restricted stock
awards (b) 112 112
_____ _______ _______ _______ _______
Balance at
September
30, 1996 $52,248 $87,947 $23,271 $(1,400) $162,066
Net Income 16,957 16,957
Issuance of
4,860
common shares -
$5 par value 24 81 105
Cash dividends
on common shares -
$1.32 per share (13,797) (13,797)
Employee stock
ownership plan
loan repayment 400 400
Unearned
compensation-
restricted stock
awards (b) (25) (25)
_______ _______ _______ _______ ________
Balance at
September
30, 1997 $52,272 $88,003 $26,431 $(1,000) $165,706
_______ _______ _______ _______ ________
_______ _______ _______ _______ ________
(a) Yankee Gas has dividend restrictions imposed by its Bond
Purchase Agreements. At September 30, 1997, retained earnings
available for common dividends under the terms of the Series A
Agreement totaled approximately $36.5 million and $46.9 million
under the terms of the Series B and C Agreements.
(b) See note (a) of the Consolidated Statements of
Capitalization.
The accompanying notes are an integral part of these financial
statements.
YANKEE ENERGY SYSTEM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1) Summary of Significant Accounting Policies
The Company: Yankee Energy System, Inc. (YES or the Company)
headquartered in Meriden, Connecticut, is a diversified company
specializing in the distribution, conversion, and control of
energy to meet our customers' needs. Our principal operating
subsidiary is Yankee Gas Services Company (Yankee Gas). Yankee
Gas provides retail distribution of natural gas to a service area
of 68 cities and towns in Connecticut. The Company's other
operating subsidiaries support our core business in natural gas,
or allow us to expand our growing businesses in energy-related
services. Yankee Energy Services Company (YESCo) provides
comprehensive energy-related services through three principle
divisions. YESCo Power designs, builds and maintains on-site
facilities for the production of thermal and/or electric power.
YESCo Controls is in the business of engineering, installing, and
maintaining building control systems. YESCo Services provides
comprehensive HVAC, boiler and refrigeration equipment services
and installation. Other subsidiaries support the operations of
Yankee Gas and YESCo. NorConn Properties, Inc. (NorConn) owns
selected system real estate, which it leases to Yankee Gas.
Yankee Energy Financial Services (Yankee Financial) provides
energy equipment financing. R.M. Services, Inc. (RMS) provides
receivables management services.
Principles of Consolidation: The consolidated financial
statements of Yankee Energy include the accounts of all
subsidiaries. Intercompany transactions have been eliminated in
consolidation.
Public Utility Regulation: Yankee Gas is subject to regulation
for rates and other matters by the Connecticut Department of
Public Utility Control (DPUC) and follows accounting policies
prescribed by the DPUC. The Company prepares its financial
statements in accordance with generally accepted accounting
principles which include the provisions of Statement of
Financial Accounting Standards No. 71, "Accounting for the
Effects of Certain Types of Regulation," (FAS 71). FAS 71
requires a cost-based, rate-regulated enterprise such as Yankee
Gas to reflect the impact of regulatory decisions in its
financial statements. The DPUC, through the rate regulation
process, can create regulatory assets that result when costs are
allowed for ratemaking purposes in a period other than the period
in which the costs would be charged to expense by an unregulated
enterprise.
Following the provisions of FAS 71, the Company has recorded
regulatory assets or liabilities as appropriate primarily related
to deferred gas costs, pipeline transition costs, hardship
customer receivables, environmental cleanup costs, income taxes
and postretirement benefits costs. The specific amounts related
to these items are disclosed in the consolidated balance sheets.
Yankee Gas continues to be subject to cost-of-service-based rate
regulation by the DPUC. Based upon current regulation and recent
regulatory decisions, the Company believes that its use of
regulatory accounting is appropriate and in accordance with the
provisions of FAS 71.
Revenues: Utility revenues are based on authorized rates applied
to each customer's use of gas. Rates can be changed only through
a formal proceeding before the DPUC. At the end of each
accounting period, a revenue estimate for the amount of gas
delivered but unbilled is accrued.
Depreciation: The provision for utility depreciation is
calculated using the straight-line method based on estimated
remaining useful lives of depreciable utility plant in service,
adjusted for net salvage value and removal costs as approved by
the DPUC. The depreciation rates for the several classes of
plant in service are equivalent to an overall composite rate of
3.3 percent in fiscal year 1997, 3.3 percent in fiscal year 1996
and 3.4 percent in fiscal year 1995.
Purchased Gas Adjustment Clause (PGA): The DPUC-approved rates
include an adjustment clause under which gas costs above or below
base rate levels are charged or credited to customers. As
prescribed by the DPUC, differences between the actual purchased
gas costs and the current cost recovery are deferred and
recovered or refunded over future periods.
Equity Accounting: The Company accounts for YESCo's investments
in energy production facilities using the equity method,
recording their proportionate share of earnings (losses) with
corresponding increases (decreases) in their investment.
Distributions received reduce the carrying amount of these
investments.
Income Taxes: Differences exist between the periods in which
transactions affect income in the financial statements and the
periods in which they affect the determination of income subject
to tax. The tax effect of such timing differences is accounted
for in accordance with the ratemaking treatment required by the
DPUC.
Additionally, in accordance with FAS 71, as of September 30,
1997, the Company has a deferred tax liability and a
corresponding regulatory asset of approximately $11.0 million,
due to the effect of Statement of Financial Accounting Standards
No. 109, "Accounting for Income Taxes".
Reclassifications: Certain prior year amounts have been
reclassified to conform with current year classifications.
Use 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.
Impairment of Long-Lived Assets: Yankee Energy adopted Statement
of Financial Accounting Standards No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be
Disposed Of" (FAS 121), in fiscal 1997. The implementation of
FAS 121 did not have a material adverse effect on the
consolidated financial statements of Yankee Energy.
Earnings per Share: Earnings per share is computed based on the
weighted average number of common shares outstanding during each
year. The Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 128, "Earnings per Share"
(FAS 128). FAS 128 specifies the computation, presentation and
disclosure requirements for basic and diluted earnings per share.
Yankee Energy will adopt FAS 128 in fiscal 1998, and the Company
expects that this statement will have no material effect on
earnings per share.
Note 2) Income Tax Expense
The components of the federal and state income tax provisions
are:
Years Ended September 30, 1997 1996 1995
(Thousands of Dollars)
Charged to income:
Current income taxes:
Federal $ 4,509 $ 5,297 $ 8,733
State 1,979 894 3,090
________ _______ _______
Total current 6,488 6,191 11,823
________ _______ _______
Deferred income taxes, net:
Investment tax credits (377) (377) (377)
Federal 6,004 8,158 (108)
State 1,308 1,479 (1,060)
________ _______ _______
Total deferred 6,935 9,260 (1,545)
________ _______ _______
Total income tax expense $13,423 $15,451 $10,278
_______ _______ _______
_______ _______ _______
Deferred income tax liabilities (assets) are comprised of the
following:
At September 30, 1997 1996
Depreciation $70,428 $70,118
Other (2,223) (5,696)
_______ ______
Net deferred income tax
liability $68,205 $64,422
_______ _______
_______ _______
In accordance with required regulatory treatment, deferred income
taxes are not provided for certain timing differences. This
treatment, along with other items, causes differences between the
statutory income tax rate and the effective income tax rate. The
differences between the effective income tax rate recorded by the
Company and the statutory federal tax rate are as follows:
1997 1996 1995
Federal statutory income
tax rate 35.0% 35.0% 35.0%
Tax effect of differences:
Depreciation 5.1 3.7 5.6
State income taxes net
of federal benefit 6.9 3.9 6.1
Effective tax rate
adjustment (0.5) (3.0) (1.8)
Federal tax credits (1.5) (1.0) (1.7)
Bad debt reserve and
amortization 0.3 1.7 (1.9)
Litigation reserve - (2.0) 3.3
Remediation costs - 1.4 -
Miscellaneous (1.1) 1.6 0.8
____ ____ ____
Effective income tax rate 44.2% 41.3% 45.4%
____ ____ ____
____ ____ ____
Note 3) Leases
Yankee Gas has entered into operating lease agreements for the
use of office equipment, vehicles and buildings. For fiscal
1997, 1996 and 1995, these rental payments were $2,064,000,
$1,939,000 and $1,751,000, respectively.
Future minimum rental payments, excluding associated costs
such as property taxes, state use taxes, insurance and
maintenance, under long-term noncancelable leases as of September
30, 1997, are approximately:
Year (Thousands of Dollars)
1998 $1,791
1999 1,615
2000 1,343
2001 1,056
2002 637
After 2002 586
______
Future minimum lease
payments $7,028
______
______
Note 4) Postretirement Benefits
The Company has a noncontributory defined benefit retirement plan
covering employees of Yankee Gas, YESCo, and RMS. Benefits are
based on years of service and employees' highest consecutive 60
months of compensation during the last 120 months of employment.
It is the Company's policy to fund annually an amount at least
equal to that which will satisfy the requirements of the Employee
Retirement Income Security Act and the Internal Revenue Code. No
contributions were required or made in fiscal 1997 and fiscal
1996. Pension assets are invested primarily in equity securities
and investment grade bonds.
The components of net pension cost (credit) were:
Years Ended September 30, 1997 1996 1995
(Thousands of Dollars)
Service cost $1,992 $1,890 $1,817
Interest cost 4,522 4,216 3,715
Net amortization 13,128 4,373 4,969
Less: Return on plan assets 20,147 10,577 10,524
______ ______ ______
Net pension credit $ (505) $ (98) $ (23)
______ ______ ______
______ ______ ______
In addition, in fiscal 1995 a cost of $2,734,000 was recognized
as a result of special termination benefits under the pension
plan and is included in the Company's 1995 Statement of Income
under the Operations category.
Total pension cost resulted in income of $420,000 for the year
ended September 30, 1997, income of $13,000 for the year ended
September 30, 1996 and expense of $62,000 for the year ended
September 30, 1995. Pension cost for 1997, 1996, and 1995
includes $85,000 in cost of living increases each year for
Northeast Utilities (NU) retirees who were previously employed in
the gas business operated by The Connecticut Light and Power
Company (CL&P), a subsidiary of NU. These payments were agreed
to at the time of divestiture from NU.
For calculating the plan's cost and year-end funded status, the
following assumptions were used:
Years Ended September 30, 1997 1996 1995
Discount rate 7.50% 7.75% 7.75%
Expected long-term rate
of return 9.00% 9.00% 9.00%
Compensation/progression rate 4.50% 4.50% 4.50%
The following table represents the plan's funded status
reconciled to the consolidated balance sheets:
At September 30, 1997 1996
(Thousands of Dollars)
Accumulated benefit obligation,
including $50,045 of vested benefits
at September 30, 1997 and $46,113 at
September 30, 1996 $51,210 $47,220
_______ _______
_______ _______
Projected benefit obligation $64,845 $60,053
Less: Market value of plan assets 89,966 72,969
_______ _______
Plan surplus 25,121 12,916
Unrecognized transition amount (703) (789)
Unrecognized prior service costs (26) (28)
Unrecognized net gain (27,728) (15,940)
________ ________
Accrued pension liability $(3,336) $(3,841)
________ ________
________ ________
During fiscal 1994, the Company adopted an Excess Benefit Plan
(EBP) that provides retirement benefits to executive officers and
other key management staff. The EBP recognizes total
compensation and service that would otherwise be disregarded due
to Internal Revenue Code limitations on compensation in
determining benefits under the regular retirement plan. The EBP
is not funded and benefits are paid when due from general
corporate assets.
Note 5) Postretirement Benefits Other Than Pensions
The Company provides certain health care and life insurance
benefits to its retired Yankee Gas, YESCo, and RMS employees. On
July 1, 1990, in accordance with terms of the divestiture, Yankee
Gas began compensating the NU System for a portion of the NU
System's liability for certain health care and life insurance
expenses of retirees or surviving spouses. Yankee Gas and the NU
System will share costs in a defined manner until June 30, 2005.
The cost of providing those benefits for NU retirees was
approximately $1,103,000 for the fiscal year ended September 30,
1997 and $1,104,000 and $1,070,000 for the comparable periods in
1996 and 1995, respectively.
Yankee Gas has established two Internal Revenue Code Section
501(c)(9) Voluntary Employee Beneficiary Association (VEBA)
Trusts, one for union employees and one for non-union employees,
to fund its future liabilities for retiree health care and life
insurance benefits. Contributions to the VEBA Trusts totaled
$1.728 million for both fiscal 1997 and fiscal 1996. Assets of
the VEBA Trusts are invested primarily in equity securities and
investment grade bonds.
The Company recognizes the cost of postretirement benefits over
the employment period that encompasses eligibility to receive
such benefits.
The components of net postretirement benefits costs were:
Years Ended September 30, 1997 1996
(Thousands of Dollars)
Service cost $ 913 $ 937
Interest cost 1,685 1,644
Net transition amortization 875 875
Net other deferrals 1,055 (28)
Less: Return on assets 1,646 729
______ ______
Net postretirement benefits costs $2,882 $2,699
______ ______
______ ______
For Yankee Gas, the DPUC is allowing $1.728 million of associated
expenses to be recovered in rates and up to an additional $1.5
million annually which is being collected through the rate
settlement process further described under Note 9, as part of
the DPUC re-opened Docket No. 92-02-19.
For calculating the plan's year-end funded status, as well as the
ensuing year's postretirement benefits costs, the following
assumptions were used:
Years Ended September 30, 1997 1996
Discount rate 7.50% 7.75%
Expected long-term rate of return 9.00% 9.00%
Health care cost trend rate
- First year 8.00% 9.00%
- Ultimate 5.00% 5.00%
Trend rates are assumed to decrease one percent per year until
they reach the ultimate rate. A one percent increase in the
weighted average trend rate assumption of health care claims
would result in a 16 percent increase in accumulated benefit
obligations and a 35 percent increase in net periodic
postretirement benefits costs.
The following table represents the postretirement benefit plan's
funded status reconciled to the consolidated balance sheets:
At September 30, 1997 1996
(Thousands of Dollars)
Accumulated benefit obligation $21,803 $22,156
Less: Market value of assets 10,790 6,613
______ ______
Accumulated benefit obligation
(greater than) plan assets (11,013) (15,543)
Unrecognized transition amount 13,607 14,483
Unrecognized net gain (6,730) (3,597)
______ ______
Accrued postretirement benefit
liability $(4,136) $(4,657)
________ ________
________ ________
Note 6) Stock-Based Compensation
Yankee Energy established Long-term Incentive Compensation Plans,
in 1991 and 1996. Options on 65,600 shares of common stock were
granted under the 1991 plan and options on 63,800 shares of
common stock were granted under the 1996 plan. Under the terms
of the options granted, the exercise price of any option may not
be less than 100 percent of the fair market value of the common
stock on the date of grant. The stock options vest over a five
year period, with 20 percent becoming exercisable on each of the
first five anniversaries of the grant. All stock options expire
ten years from the date of grant.
The Company accounts for stock options in accordance with
Accounting Principles Board Opinion No. 25, under which no
compensation costs have been recognized for stock option awards.
Had compensation costs of option awards been determined under a
fair value alternative method as stated in Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based
Compensation", the Company would have been required to value such
options and record such amount in the financial statements as
compensation expense. Proforma net income and net income per
share for fiscal 1997 and fiscal 1996 would have been $16,919,000
and $1.62 and $21,881,000 and $2.10, respectively. Yankee Gas
arrived at the fair value of the stock grants at the date of the
grant by using the Black Scholes option pricing model with the
following weighted average assumptions: risk-free interest rate
of 5.375 percent, expected life of 5.0 years, expected volatility
of 18.0 percent and a dividend yield of 5.7 percent.
The following summarizes stock option transactions for the fiscal
years ended September 30, 1997 and 1996:
Weighted Number
Option Prices Average Price of Shares
Outstanding Options
September 30, 1995 $21.375-$21.63 $21.59 61,120
Granted $23.69 $23.69 63,800
Exercised $21.63 $21.63 (820)
Canceled $21.63 -$23.69 $21.92 (9,100)
______
Outstanding Options
September 30, 1996 $21.375-$23.69 $22.73 115,000
Exercised $21.63 -$23.69 $21.73 (4,860)
Canceled $21.63 -$23.69 $22.97 (8,980)
_______
Outstanding Options
September 30, 1997 $21.375-$23.69 $22.75 101,160
At September 30, 1997 and 1996 there were exercisable 38,136
options and 21,000 options, respectively, which have weighted
average exercise prices of $22.20 per share and $21.58 per share,
respectively.
Note 7) Short-Term Debt
Yankee Gas has arranged a $60 million revolving line of credit
with a group of four banks whereby funds may be borrowed on a
short-term revolving basis using either fixed or variable rate
loans. Yankee Gas also has an additional $27 million of credit
lines available on an uncommitted basis. Yankee Gas had $36.3
million and $20.3 million outstanding under its agreements at
September 30, 1997 and 1996, respectively. In addition, Yankee
Energy had $2.7 million outstanding at September 30, 1997 and no
amounts outstanding at September 30, 1996 on a $15 million line
of credit. The weighted average interest rates on short-term
debt at September 30, 1997 and 1996 were 6.0 percent and 5.6
percent, respectively.
Note 8) Fair Value of Financial Instruments
The following methods and assumptions were used to estimate the
fair value of each of the following financial instruments:
Cash and Temporary Cash Investments: The carrying amount
approximates fair value.
First Mortgage Bonds: The fair value of the Company's fixed rate
long-term debt is based upon borrowing rates currently available
to the Company. Adjustable rate securities are assumed to have a
fair value equal to their carrying value.
The carrying amount of the Company's financial instruments and
the estimated fair value at September 30, 1997 and 1996 are as
follows:
September 30, 1997 1996
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
(Thousands of Dollars)
First mortgage
bonds $132,532 $142,896 $135,899 $146,663
________ ________ ________ ________
The fair values shown above have been reported to meet the
disclosure requirements of Statement of Financial Accounting
Standards No. 107, "Disclosures About Fair Values of Financial
Instruments," and do not purport to represent the amounts at
which those obligations would be settled.
Note 9) Commitments and Contingencies
Construction Program: The Company's estimated capital
expenditures for the fiscal years 1998 through 2002 are $194
million, including $55 million for fiscal 1998. The Company
intends to use $140 million over this period, including $39
million for fiscal 1998, of these estimated expenditures to
maintain the reliability of the distribution system and in
projects that will generate or support gas sales and
transportation activities, including the installation of a new
customer information system. The remaining $54 million,
including $15 million for fiscal 1998, is expected to be invested
in energy related projects and businesses.
Environmental Matters: Fourteen sites containing coal tar became
the property of Yankee Gas at divestiture from Northeast
Utilities. Contamination at these sites was caused by operations
of former manufactured gas plants at those locations. Yankee Gas
has reported the results of its environmental studies to the
Connecticut Department of Environmental Protection (DEP). The
DEP has not required that any remedial action be undertaken to
date. However, of the fourteen, eight sites are presently listed
on the Connecticut Inventory of Hazardous Waste Sites. Inclusion
of a site on this list indicates that remediation may be required
in the future.
Remediation has been conducted at three of these properties. In
addition, Yankee Gas has developed a cost estimate for the
remaining sites based on various factors including the
probability of clean-up. As a result of this effort, Yankee Gas
recorded a liability of $35 million in fiscal 1993 for future
environmental clean-up.
Recovery of remediation costs has been specifically allowed by
Yankee Gas' 1992 rate case decision. Presently, $325,000 is
allowed annually in rates. If costs are expected to exceed $2.5
million on an annual basis, Yankee Gas is required to go to the
DPUC for review. The DPUC has stated that "to the extent that
coal tar remediation expenses are prudently incurred, they should
be allowed as proper operating expenses."
Yankee Gas has received funds from certain of its insurance
carriers in settlement of certain claims for actual or potential
contamination at certain sites that may give rise to
environmental liabilities. The terms of the aforementioned
settlements are subject to confidentiality provisions in
agreements between Yankee Gas and its insurance carriers. The
proceeds are being reflected as reductions in the regulatory
asset associated with recoverable environmental clean-up costs,
as shown in the accompanying balance sheets.
Transition Costs-Order No. 636: On April 8, 1992, the FERC
issued Order No. 636 on pipeline restructuring. In essence, the
FERC found that absent the unbundling of traditional merchant
services, pipelines would not be able to achieve the FERC's long-
term goal of open access and provide transportation services that
are indifferent to the seller of the gas. Order No. 636,
therefore, required all pipelines to implement restructuring of
their services by the winter of 1993-94. The three major
pipeline systems serving Yankee Gas (Iroquois, Tennessee Gas
Pipeline Company and Algonquin Gas Transmission Company and its
affiliate, Texas Eastern Transmission Company), have all
restructured pursuant to the FERC directive. Yankee Gas has
concurrently replaced the gas supply traditionally obtained from
the pipeline companies' merchant services with firm purchases
directly from producers and/or marketing companies. Yankee Gas
present annual capacity commitment is approximately $82.7
million.
Order No. 636 acknowledges that the restructuring of the
pipelines' traditional services will cause pipelines to incur
transition costs in several areas and provides mechanisms for the
pipelines to fully recover prudently incurred transition costs
attributable to the implementation of Order No. 636.
On July 8, 1994, the DPUC issued a decision on the implementation
of FERC Order No. 636 by the Connecticut Local Distribution
Companies (LDCs). The DPUC is allowing the LDCs to offset the
transition costs billed by pipelines under Order No. 636 with
recoveries from capacity release activity, refunds of deferred
gas costs for the 1992-93 period and all subsequent annual
deferred gas costs, gas supplier refunds, off-system sales margin
and interruptible margin earned in excess of target amounts.
Through September 30, 1997, Yankee Gas has paid approximately
$19.5 million of transition costs and an additional $3.5 million
are anticipated. To date, Yankee Gas has collected $44.2 million
through a combination of credits received from gas supplier
refunds, deferred gas costs, excess interruptible margin, off-
system sales margin, and capacity release agreements.
On January 3, 1996, the DPUC issued a Final Decision in reopened
Docket No. 92-02-19. The Docket allows for recovery of certain
deferred regulatory assets with the stipulation that Yankee Gas
would not increase its rates before October 1, 1998, except in
the event of certain circumstances which would adversely affect
Yankee Gas' financial condition. Yankee Gas may apply a portion
of excess transition credits received from pipeline refunds,
interruptible excess margin, deferred gas costs, capacity release
activity, and off-system sales margin to certain regulatory
assets. As of September 30, 1997, excess collections of
approximately $24.7 million were applied against the deferred
regulatory assets specified in the decision.
Firm Transportation: On August 2, 1995, the DPUC issued a Final
Decision in Docket No. 94-11-12, DPUC Review of Connecticut Local
Distribution Companies' Cost of Service Study Methodologies. The
docket was intended to investigate the issues surrounding the
development of firm transportation (FT) rates at the state level
in response to FERC Order No. 636. The Decision provides
guidelines for the development of FT rates to be offered by the
State's three LDCs, one of which is Yankee Gas.
On January 24, 1996, the DPUC issued a Final Decision on Docket
No. 92-02-19 Reopen I. This decision enabled Yankee Gas to
implement FT rates and services as contemplated in the August 2,
1995 decision referenced above. The Decision allows Yankee Gas
to offer a broad array of service options to commercial and
industrial FT customers. Yankee Gas implemented these new FT
rates and services on April 1, 1996, and as of September 30, 1997
had approximately 1,460 customers under the new FT service. A
switch by existing sales customers to transportation tariffs will
result in decreased revenues for Yankee Gas as the portion of
revenues representing gas costs will now be borne directly by
those customers. Yankee Gas, however, does not expect customer
conversions to transportation services to affect its net income
because the cost of gas has traditionally been a pass through
item with no income impact. This Decision did not address Yankee
Gas' revenue requirement; Yankee Gas has maintained the existing
margin recovery and rates of return established in the last rate
case decision issued for Yankee Gas in 1992.
Rate Review: On August 25, 1996, Yankee Gas filed an application
with the DPUC for a Financial and Operational Review (Review).
This Review was required under Connecticut statute since Yankee
Gas had not undergone a rate proceeding within the last four
years. Yankee Gas' last rate application was approved on August
26, 1992, and this Review was necessary to comply with the
statute. On July 9, 1997, the DPUC issued its decision in Docket
No. 96-08-05. The DPUC decision, which is not a rate order,
called for a lowering of Yankee Gas' authorized Return on Equity
(ROE) from 12.43 percent to 11.15 percent. The DPUC believed
that lower current interest rates and recently allowed rates of
return for other Connecticut utilities justified a lower ROE for
Yankee Gas. On October 1, 1997, the DPUC approved a settlement
whereby Yankee Gas will credit approximately $3.2 million to
firm sales customers through the PGA during the period November
1997 through March 1998. The settlement also allows Yankee Gas to
maintain its base rates until the end of fiscal year 2000,
resulting in an eight-year period in which Yankee Gas will have
gone without an increase in its base rates.
Gas Supply Hedging Activities: Yankee Gas has gas service
agreements with two customers to supply gas at fixed prices.
Because Yankee Gas purchases gas on a variable price basis, it
has found it necessary to hedge gas prices with derivatives to
respond to customers' needs for fixed pricing. Both agreements
are similar in structure in that Yankee Gas executed a commodity
swap contract with a commodity trading firm. Under a master
commodity swap agreement, the price of a specified quantity of
gas is fixed over the term of the gas service agreement with the
customer. In both cases, Yankee Gas is acting as an agent using
its credit to provide fixed pricing to its customers using a
commodity swap. Yankee Gas' results of operations are unaffected
by the hedge transaction given that it passes through the cost of
the hedge to either the commodity trading firm or its customer
depending on the difference in the fixed and floating prices for
gas. Also, the customers are accountable for all costs incurred
by Yankee Gas to execute and maintain the commodity swap
contract.
Of the two gas service hedging agreements currently in force,
only one is material relative to the significance of gas volumes
being hedged. This agreement has a ten-year term and requires
Yankee Gas to supply approximately one BCF of gas per year, with
relatively low margin, at a fixed price beginning August 1, 1995.
The price is allowed to escalate by a predetermined rate every
year after the first year. The commodity swap contract for this
hedging agreement was executed August 17, 1994. Yankee Gas is
responsible for margin calls collateralizing the commodity swap
contract from August 17, 1994 through the term of the gas service
agreement. Currently, Yankee Gas has a letter of credit in the
amount of $2.0 million issued to the commodity trading firm
collateralizing the commodity contract.
Tax/Legal Issues: In fiscal 1996, Yankee Gas received revised
property tax bills from the City of Meriden, Connecticut (the
City). The City is asserting a claim for approximately $5.0
million for back taxes and interest resulting from a retroactive
reassessment and revaluation of Yankee Gas' personal property
filings. The City did not locate or identify any property which
Yankee Gas omitted from its filings. The tax bills reflect a
reassessment of property at higher rates than those previously
accepted by the City. Yankee Gas is currently in the process of
litigating this retroactive reassessment. Although it is
anticipated that the outcome of this claim will not have a
material impact on the Company, based on the information
available at this time, management cannot predict what the
ultimate impact might be.
In November 1995, a class action suit was filed against Yankee
Gas and the state's two other LDCs by the Connecticut Heating and
Cooling Contractors' Association, Inc., claiming the LDCs engaged
in unfair trade practices. The action alleges that the LDCs
unfairly competed with licensed plumbers and contractors by
performing customer service work using customer service employees
who did not possess state trade licenses.
The LDCs have asserted that such licenses are not required for
this work based on a statutory exemption enacted in 1965 and
amended in 1967. However, in a separate proceeding, a
Connecticut Superior Court has upheld an administrative ruling
against the LDCs' position, which was affirmed on appeal. In
1995, the Connecticut General Assembly enacted legislation that
established, on a going-forward basis, a separate procedure for
state certification of gas service employees.
While the ultimate results of the class action suit cannot be
determined, management does not expect that it will have a
material adverse effect on the Company's consolidated results of
operations or financial position.
Note 10) Quarterly Financial Data (Unaudited)
The following table provides information with respect to the
consolidated quarterly results of operations for the fiscal years
ended September 30, 1997 and 1996, and reflects the seasonal
nature of the Company's operations. The results of any one
quarter during the year are not indicative of the results of
future quarters.
(Thousands of Dollars, except share information)
Quarter Ended
Fiscal Year 1997 December 31 March 31 June 30 September 30
Operating
Revenues $95,681 $127,568 $59,435 $42,357
Operating Income
(Loss) 19,162 27,769 2,663 (6,301)
Net Income
(Loss) 8,879 13,478 (442) (4,958)
Earnings (Loss)per
Common Share (1) $0.84 $1.29 $(0.04) $(0.47)
Quarter Ended
Fiscal Year 1996 December 31 March 31 June 30 September 30
Operating
Revenues $98,199 $139,559 $60,136 $42,046
Operating Income
(Loss) 20,220 29,849 3,172 (6,255)
Net Income (Loss) 9,838 15,327 1,822 (5,068)
Earnings (Loss) per
Common Share (1) $0.95 $1.47 $0.17 $(0.49)
(1) Earnings (Loss) per common share were calculated on the
weighted average common shares outstanding of 10,451,165 and
10,435,231 for the twelve months ended September 30, 1997
and 1996, respectively.
YANKEE ENERGY SYSTEM, INC. AND SUBSIDIARIES
Selected Financial and Operating Data
September 30, 1997 1996 1995 1994 1993
Balance Sheet Data:
(Thousands)
Net Utility
Plant $350,865 $335,488 $324,870 $315,063 $308,384
Total Assets 500,364 478,749 479,301 481,518 441,293
Total
Capitalization 300,971 271,348 292,802 276,513 311,197
Income and Share Data:
(Thousands except share data)
Operating
Revenues $325,041 $339,940 $294,022 $317,298 $302,657
Cost of Gas 176,757 189,504 155,404 168,816 157,816
Other O&M
Expenses 64,951 64,852 65,473 62,733 59,142
Depreciation 17,521 16,649 16,520 16,993 17,133
Net Income (1) 16,957 21,919 12,358 19,485 17,479
Earnings
per Share (1) $1.62 $2.10 $1.20 $1.89 $1.70
Revenues:
(Thousands)
Gas:
Residential $140,750 $145,364 $127,493 $140,403 $133,846
Commercial 95,098 103,787 88,983 95,286 93,045
Industrial 70,743 82,725 73,715 77,850 72,940
Miscellaneous 2,312 6,217 2,161 3,328 1,884
Transportation 10,051 952 1,631 431 942
_______ _______ _______ _______ _______
Total Gas $318,954 $339,045 $293,983 $317,298 $302,657
Nonutility
Revenue 6,087 895 39 - -
_______ _______ _______ _______ _______
Total Operating
Revenues $325,041 $339,940 $294,022 $317,298 $302,657
Sales and Transportation:
(Mcf-Thousands)
Firm:
Residential 12,473 13,185 11,591 13,101 12,691
Commercial 9,222 10,521 9,022 9,998 9,703
Industrial 9,862 11,438 10,007 10,421 9,600
Transportation 4,059 178 589 128 167
Unbilled and
Other (111) 969 793 245 129
______ ______ ______ ______ ______
Total Firm 35,505 36,291 32,002 33,893 32,290
Non-Firm:
Commercial 1,595 1,746 1,809 1,549 1,663
Industrial 4,983 6,792 7,286 7,149 5,336
Transportation 6,853 2,444 3,654 559 1,400
______ ______ ______ ______ ______
Total
Non-Firm 13,431 10,982 12,749 9,257 8,399
______ ______ ______ ______ ______
Total Sales and
Transportation 48,936 47,273 44,751 43,150 40,689
Customers:
(Average)
Residential 159,541 157,526 156,539 155,874 155,385
Commercial (2) 18,930 19,313 19,167 19,156 19,139
Industrial (2) 2,005 2,112 2,145 1,980 1,893
Firm
Transportation 766 19 - - -
Resale - 2 1 1 1
_______ _______ _______ _______ _______
Total
Customers 181,242 178,972 177,852 177,011 176,418
Sources of Gas:
(Mcf-Thousands)
Domestic 15,594 21,331 13,534 16,162 7,474
Canadian Gas
Firm 24,919 24,721 24,283 24,440 23,970
Spot Market Gas 97 710 2,836 2,318 8,155
Produced Gas 34 19 9 30 6
Company Use/
Unaccounted For (414) (1,285) (405) (488) (608)
_______ _______ _______ _______ _______
Total Sources 40,230 45,496 40,257 42,462 38,997
Peak Day Data:
Peak Day Send
Out (Mcf per
day) (3) 250,448 239,348 250,518 262,794 247,315
Peak Day Date 1/17/97 2/05/96 2/06/95 1/19/94 2/01/93
Peak Day
Degree Days 55 62 59 55 54
Total Annual
Heating
Degree Days 5,979 6,302 5,595 6,454 6,232
(1) Exclusive of an $879,900 charge, or $0.08 per share,
resulting from the early redemption premium on the Company's
preferred stock in fiscal 1994. All per share amounts have been
restated to give retroactive effect to the three-for-two stock
split on June 28, 1993.
(2) Non-firm transportation customers who utilize both sales gas
and transportation service are included in these customer
categories. Average non-firm transportation customers are as
follows: 1997:18, 1996:12, 1995:23, 1994:17,and 1993:25.
(3) Converted from BTU-millions assuming 1,020 BTU per CF. 1994
sendout includes one time delivery of 17,425 Mcf to Con Ed.
Shareholder and Stock Information
Left side of page:
Annual Meeting
The Annual Meeting of Shareholders will take place on Friday,
January 30, 1998, at 10:30 a.m. at the Ramada Plaza Hotel in
Meriden, Connecticut.
Market for Common Stock
As of October 31, 1997, there were 26,329 holders of record of
Yankee Energy common stock. Yankee Energy's stock is quoted on
the New York Stock Exchange (NYSE) under the symbol "YES"
although it is frequently presented as "YanEnS" in various
financial publications.
High and Low Stock Prices and Dividend Information
($/Share)
Year Ended
September 30, 1997 High Low Dividend
First Quarter, 1997 23.625 21.250 0.325
Second Quarter, 1997 23.750 21.125 0.325
Third Quarter, 1997 24.750 21.000 0.335
Fourth Quarter, 1997 24.625 22.750 0.335
Year Ended
September 30, 1996 High Low Dividend
First Quarter, 1996 25.500 20.875 0.315
Second Quarter, 1996 25.750 21.875 0.315
Third Quarter, 1996 22.500 20.375 0.325
Fourth Quarter, 1996 23.625 20.750 0.325
Dividends
Dividends are considered quarterly by the Board of Directors and,
if declared, are payable at the end of March, June, September and
December. The dividend record date is generally three weeks
prior to the dividend payable date. Yankee Energy offers
registered shareholders the ability to have quarterly dividends
deposited directly into their bank account.
Shareholder Investment Plan
The Yankee Energy Shareholder Investment Plan is administered by
the Company's stock transfer agent, ChaseMellon Shareholder
Services (ChaseMellon). The Plan provides registered
shareholders and their family members a convenient way to acquire
shares of common stock. Shares can be purchased by having
quarterly dividends automatically reinvested in additional shares
or by sending in funds to purchase additional shares. In
addition, holders of fewer than 100 shares may sell all their
shares at any time for no fee. The Plan also offers charitable
donation and share safekeeping services as well. Copies of the
Plan are available from ChaseMellon or Yankee Energy.
Right side of page:
Transfer Agent
Shareholders who have questions about their accounts or desire to
transfer their stock from one name to another should contact
ChaseMellon at 1.800.288.9541 or write:
For Transfers and Transfer Inquiries:
ChaseMellon Shareholder Services, L.L.C.
85 Challenger Road
Ridgefield Park, NJ 07660
All Other Inquiries:
ChaseMellon Shareholder Services, L.L.C.
P.O. Box 590 Overpeck Centre
Ridgefield Park, NJ 07660
Yankee Energy News and Information
Yankee Energy has a toll-free news and information service which
includes current news releases, a Chairman's message, earnings
and dividend information as well as access to the transfer agent
or the Company's Investor Relations Department.
1.800.YES.9989
Shareholders, interested investors and analysts may also contact
Yankee Energy by calling or writing to:
Thomas D. Dorsey
Director, Investor Relations
Yankee Energy System, Inc.
599 Research Parkway
Meriden, CT 06450-1030
Phone 203.639.4407
Fax 203.639.4011
Email: invest@yankeegas.com
Yankee Energy will provide shareholders with a copy of its 1997
Annual Report to the Securities and Exchange Commission on Form
10-K, without charge, upon written request.
Bottom left: 32
Bottom Center: YES 1997
Inside Back Cover
Top left: Yankee Energy Logo
(Two columns)
Left Column:
Yankee Energy System, Inc.
599 Research Parkway
Meriden, CT 06450-1030
203.639.4000
Yankee Energy Services Company
270 Farmington Avenue, Suite 181
Farmington, CT 06032-1909
860.678.6710
R.M. Services, Inc.
639 Research Parkway
Meriden, CT 06450-1030
203-639-4501
YESCo Industrial Energy Services, Inc.
11C Kripes Road
East Granby, CT 06026-9646
860.653.5667
Right Column:
Yankee Gas Services Company
599 Research Parkway
Meriden, CT 06450-1030
203.639.4000
Yankee Energy Financial Services Company
599 Research Parkway
Meriden, CT 06450-1030
203.639.4462
YESCo Power
33 Christa McAuliffe Blvd.
Plymouth, MA 02360-4867
508.746.5500
YESCo Mira Systems
270 Farmington Avenue, Suite 181
Farmington, CT 06032-1909
860.678.6700
Bottom center of page:
YES
Listed
NYSE
For additional copies of this Annual Report, contact Corporate
Communications at 203.639.4439
Outside Back Cover
Background graphic of sky and clouds with words:
safe
reliable
efficient
clean
Spread across center of page from top to bottom:
Yankee Energy
Imaginative
and Responsive
Energy Solutions
For your home
or business.
Bottom left: Yankee Energy logo
Bottom right: Yankee Energy System, Inc.
599 Research Parkway
Meriden, CT 06450-1030
http://www.yankeegas.com