FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2002
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
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Commission File number 0-14183
ENERGY WEST INCORPORATED
------------------------
(Exact name of registrant as specified in its charter)
Montana 81-0141785
- ------- ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1 First Avenue South, Great Falls, Mt. 59401
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (406)-791-7500
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes /X/ No / /
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Outstanding at November 7, 2002
(Common stock, $.15 par value) 2,588,637 shares
ENERGY WEST INCORPORATED
INDEX TO FORM 10-Q
Page No.
Part I - Financial Information
Item 1 - Financial Statements
Condensed Consolidated Balance Sheets as of
September 30, 2002, and June 30, 2002 1
Condensed Consolidated Statements of Operations -
three months ended September 30, 2002 and 2001 2
Condensed Consolidated Statements of cash flows -
three months ended September 30, 2002 and 2001 3
Notes to Condensed Consolidated Financial Statements 4-8
Item 2 - Management's discussion and analysis of
financial condition and results of operations 8-17
Item 3 - Quantitative and Qualitative Disclosures about Market Risk 17
Part II Other Information
Item 1 - Legal Proceedings 19
Item 2 - Changes in Securities 20
Item 3 - Defaults upon Senior Securities 20
Item 4 - Submission of Matters to a Vote of Security Holders 20
Item 5 - Other Information 20
Item 6 - Exhibits and Reports on Form 8-K 20
Signatures 21-24
Item 1. Financial Statements
FORM 10Q
ENERGY WEST INCORPORATED
CONDENSED CONSOLIDATED BALANCE SHEETS
September 30 June 30
2002 2002
(Unaudited) (Unaudited)
----------- -----------
Current assets
Cash and cash equivalents $ 94,289 $ 367,657
Accounts receivable (Net) 5,710,019 8,244,239
Derivative assets 2,438,562 2,867,717
Natural gas and propane inventories 5,777,455 5,640,660
Materials and supplies 627,488 593,674
Prepayments and other 715,992 445,652
Deferred tax assets 1,328,184 931,147
Prepaid income taxes receivable 1,137,530
----------- -----------
Total current assets 17,829,519 19,090,746
Notes receivable 3,300
Property, plant and equipment, net 37,541,812 36,518,908
Deferred charges 1,905,341 1,935,263
Other assets 300,869 320,830
----------- -----------
Total assets $57,577,541 $57,869,047
=========== ===========
Capitalization and liabilities
Current liabilities:
Lines of credit $ 9,019,881 $ 3,500,000
Current portion of long term-debt 507,147 502,072
Accounts payable 4,930,926 7,413,693
Income tax payable 1,005,975
Refundable cost of gas purchases 227,514 2,024,159
Accrued and other current liabilities 5,215,369 5,453,304
----------- -----------
Total current liabilities 19,900,837 19,899,203
Long-term liabilities:
Deferred tax liabilities 4,745,249 4,043,038
Deferred investment tax credits 371,203 376,468
Other long-term liabilities 2,360,009 1,910,571
----------- -----------
Total 7,476,461 6,330,077
Long-Term Debt 15,281,260 15,367,424
Stockholders' equity
Preferred Stock-- $.15 Par Value
Authorized -- 1,500,000 Shares
Outstanding -- None
Common Stock -- $.15 Par Value
Authorized -- 3,500,000 Shares
Outstanding -- 2,575,565 Shares at September
30, 2002; 2,573,046 at June 30, 2002 386,341 385,964
Capital in excess of par value 4,884,927 4,863,113
Retained earnings 9,647,715 11,023,266
----------- -----------
Total stockholders' equity 14,918,983 16,272,343
----------- -----------
Total capitalization 30,200,243 31,639,767
----------- -----------
Total capitalization and liabilities $57,577,541 $57,869,047
=========== ===========
The accompanying notes are an integral part of these condensed
financial statements.
1
FORM 10Q
ENERGY WEST INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
Three Months Ended
and Year-To-Date
September 30
2002 2001
(Unaudited) (Unaudited)
------------------------------
Revenues:
Natural gas operations $ 3,055,375 $ 4,838,688
Propane operations 1,330,150 1,106,236
Gas and electric-wholesale 8,053,911 10,863,546
Pipeline 83,744
------------------------------
Total revenues 12,523,180 16,808,470
------------------------------
Expenses:
Gas & propane purchased 2,511,110 4,019,388
Gas and electric-wholesale 7,648,807 10,088,663
Distribution, general and administrative 2,729,594 2,284,573
Maintenance 164,551 95,241
Depreciation and amortization 558,301 514,194
Taxes other than income 222,552 176,398
------------------------------
Total operating expenses 13,834,915 17,178,457
------------------------------
Operating loss (1,311,735) (369,987)
Non-operating income 77,970 84,505
Interest expense:
Long-term debt 292,612 300,156
Lines of credit 94,488 76,678
------------------------------
Total interest expense 387,100 376,834
------------------------------
Loss before income taxes (1,620,865) (662,316)
Income tax benefit (600,290) (228,970)
------------------------------
Net loss $(1,020,575) $ (433,346)
==============================
Loss per common share:
Basic and diluted loss per common share $ (0.40) $ (0.17)
Weighted average common shares outstanding:
Basic 2,573,128 2,513,484
Diluted 2,573,128 2,513,484
The accompanying notes are an integral part of these condensed
financial statements.
2
FORM 10Q
ENERGY WEST INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Three Months Ended
September 30
2002 2001
(Unaudited) (Unaudited)
-------------------------------
Cash flows from operating activities:
Net Loss $ (1,020,575) $ (433,346)
Adjustment to reconcile net loss to net cash flows
used in operating activities
Depreciation and amortization, including deferred charges and
financing costs 605,065 516,076
Gain on sale of property, plant & equipment (22,936)
Deferred gain on sale of assets (5,907) (5,907)
Investment tax credit (5,265) (5,265)
Deferred income taxes 305,174 274,675
Change in operating assets and liabilities:
Accounts receivable 2,534,220 2,350,854
Derivative assets 429,155 (3,353,130)
Natural gas and propane inventories (136,795) (5,967,358)
Prepayments and other (270,340) (257,698)
Recoverable/refundable cost of gas purchases (1,796,645) 806,406
Accounts payable (4,482,767) (4,102,410)
Derivative liabilities 3,454,444
Other assets and liabilities 16,167 (1,056,325)
-------------------------------
Net cash used in operating activities (3,828,513) (7,801,920)
Cash flows from investing activities:
Construction expenditures (1,576,925) (1,368,604)
Proceeds from sale of property, plant & equipment 32,751
Proceeds from long-term notes receivable 3,300 12,462
Customer advances for construction 21,660
Proceeds from contributions in aid of constructions 1,104 246
-------------------------------
Net cash used in investing activities (1,550,861) (1,323,145)
Cash flows from financing activities:
Repayment of long-term debt (81,089) (75,000)
Proceeds from lines of credit 11,801,987 21,381,408
Repayment of lines of credit (6,282,106) (12,378,363)
Dividends paid on common stock (332,786) (277,330)
-------------------------------
Net cash provided by financing activities 5,106,006 8,650,715
-------------------------------
Net decrease in cash and cash equivalents (273,368) (474,350)
Cash and cash equivalents at beginning of period 367,657 220,667
-------------------------------
Cash and cash equivalents at end of period $ 94,289 $ (253,683)
===============================
The accompanying notes are an integral part of these condensed
financial statements.
3
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
September 30, 2002
NOTE 1 - BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements
of Energy West Incorporated (the Company) and its subsidiaries have been
prepared in accordance with accounting principles generally accepted in the
United States of America for interim financial information and with the
instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do
not include all of the information and footnotes required by generally accepted
accounting principles for complete financial statements. In the opinion of
management, all adjustments (consisting of normal recurring accruals) considered
necessary for a fair presentation have been included. Operating results for the
three month period ended September 30, 2002 are not necessarily indicative of
the results that may be expected for the fiscal year ended June 30, 2003. The
financial statements should be read in conjunction with the audited consolidated
financial statements and footnotes thereto included in the Company's annual
report on Form 10-K for the fiscal year ended June 30, 2002.
To reflect recent management and business changes, the Company has
realigned its reporting segments effective July 1, 2002. A recently acquired and
renovated pipeline located in Wyoming and Montana is owned by the Company's
wholly owned subsidiary, Energy West Development, Inc. (EWD). The revenue and
expenses associated with this pipeline will be included as part of the "Pipeline
Operations" segment for financial reporting purposes. It is anticipated that
this activity will be regulated by the Federal Energy Regulatory Commission
(FERC), and an application has been made to begin operations. The other pipeline
is a gathering system. The revenue and expenses associated with this gathering
system were formerly reported as part of the segment "Energy Marketing and
Wholesale Operations," but are now being included as part of the "Pipeline
Operations" segment for financial reporting purposes. The operations of a
regulated propane distribution system located in Cascade, Montana will now be
reported as part of the "Natural Gas Operations" for financial reporting
purposes. This system was formerly reported as part of the Company's "Propane
Operations." Segment information for prior periods has been restated to reflect
the revised reportable segments.
NOTE 2 - DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITY
Management of Risks Related to Derivatives--The Company and its
subsidiaries are subject to certain risks related to changes in certain
commodity prices and risks of counter-party performance. The Company has
established certain policies and procedures to manage such risks. The Company
has a Risk Management Committee (RMC), comprised of Company officers to oversee
the Company's risk management program as defined in its risk management policy.
The purpose of the risk management program is to minimize adverse impacts on
earnings resulting from volatility of energy prices, counter-party credit risks,
and other risks related to the energy commodity business. The RMC is overseen by
the Audit Committee of the Company's Board of Directors.
General--From time to time the Company or its subsidiaries may use
derivative financial contracts to mitigate the risk of commodity price
volatility related to firm commitments to purchase and sell natural gas or
electricity. The Company may use such arrangements to protect its profit margin
on future obligations to deliver quantities of a commodity at a fixed price.
Conversely, such arrangements may be used to hedge against future market price
declines where the Company or a subsidiary enters into an obligation to purchase
a commodity at a fixed price in the future. The Company accounts for such
financial instruments in accordance with Statement of Financial Accounting
Standard (SFAS) No. 133, Accounting for Derivative Instruments and Hedging
Activities, as amended by SFAS No. 138, Accounting for Certain Derivative
Instruments and Certain Hedging Activities.
In accordance with SFAS No. 133, contracts that do not qualify as
normal purchase and sale contracts must be reflected in the Company's financial
statements at fair value, determined as of the date of the balance sheet. This
accounting treatment is also referred to as "mark-to-market" accounting.
Mark-to-market accounting treatment can result in a disparity between reported
earnings and realized cash flow, because changes in the value of the financial
instrument are reported as income or loss even though no cash payment may have
been made between the parties to the contract. If such contracts are held to
maturity, the cash flow from the contracts, and their hedges, are realized over
the life of the contract.
4
NOTE 2 - DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITY (CONTINUED)
Quoted market prices for natural gas derivative contracts of the
Company or its subsidiaries generally are not available. Therefore, to determine
the fair value of natural gas derivative contracts, the Company uses internally
developed valuation models that incorporate independently available current and
historical pricing information.
Wholesale Operations--During the first quarter of fiscal 2003, the
Company's wholly owned subsidiary, Energy West Resources (EWR) was party to a
number of contracts that were valued on a mark-to-market basis under SFAS No.
133. Although certain firm commitments for the purchase and sale of natural gas
could have been classified as normal purchases and sales and excluded from the
requirements of SFAS No. 133, as described above, EWR elected to treat these
contracts as derivative instruments under SFAS No. 133 in order to match
contracts for the purchase and sale of natural gas for financial reporting
purposes. Such contracts were recorded in the Company's consolidated balance
sheet at fair value. Periodic mark-to-market adjustments to the fair values of
these contracts are recorded as adjustments to gas costs.
During the third quarter of fiscal 2002, EWR terminated its existing
derivative contracts with Enron Canada Corporation (ECC), a subsidiary of Enron
Corp. Most of these contracts were commodity swaps that EWR had entered into to
mitigate the effects of fluctuations in the market price of natural gas. The
derivative contracts with ECC were entered into at various times in order to
lock in margins on certain contracts under which EWR had commitments to other
parties to sell natural gas at fixed prices (the "Future Supply Agreements").
EWR made the decision to terminate these ECC contracts because of concerns
relating to the bankruptcy of Enron Corp. At the date of termination, the market
price of natural gas was substantially lower than the price had been when EWR
entered into the contracts, resulting in a net amount due from EWR to ECC of
approximately $5,400,000. EWR paid this amount to ECC upon the termination of
the contracts, and thereby discharged the liability related to the contracts.
The costs related to such termination were reflected in the Company's
consolidated statement of income as adjustments to gas purchased for the fiscal
year ended June 30, 2002.
At the time the Company terminated the ECC derivative contracts, the
Company entered into new gas purchase contracts (the "Future Purchase
Agreements") at prices much lower than those provided for under the ECC
contracts. The Future Purchase Agreements and the Future Supply Agreements
continue to be valued on a mark-to market basis. As of September 30, 2002, these
agreements were reflected on the Company's consolidated balance sheet as
derivative assets at an approximate aggregate fair value as follows:
Contracts maturing in one year or less: $ 647,988
Contracts maturing in two to three years: 1,155,758
Contracts maturing in four to five years: 536,827
Contracts maturing in five years or more: 97,989
----------
Total $2,438,562
==========
During the first quarter of fiscal 2003, the Company has not entered into
any new contracts that have required mark-to-market accounting under SFAS No.
133.
Natural Gas Operations--In the case of the Company's regulated divisions,
gains or losses resulting from the derivative contracts are subject to deferral
under regulatory procedures approved by the public service regulatory
commissions of Montana, Wyoming and Arizona. Therefore, related derivative
assets and liabilities are offset with corresponding regulatory liability and
asset amounts included in "Recoverable Cost of Gas Purchases", pursuant to SFAS
No. 71, Accounting for the Effects of Certain Types of Regulation.
5
NOTE 3 - INCOME TAXES
Income tax benefit differs from the amount computed by applying the
federal statutory rate to pre-tax loss as demonstrated in the following table:
Three Months Ended
September 30
2002 2001
Tax benefit at statutory rates - 34%............................ ($551,094) ($223,396)
State tax benefit, net of federal tax benefit................... (37,349) (16,861)
Amortization of deferred investment tax credits................. (5,266) (5,266)
Other........................................................... (6,581) 16,551
---------- ----------
Total income tax benefit........................................ ($600,290) ($228,972)
========== ==========
NOTE 4 - CONTINGENCIES
ENVIRONMENTAL CONTINGENCY
The Company owns property on which it operated a manufactured gas plant
from 1909 to 1928. The site is currently used as a service center where certain
equipment and materials are stored. The coal gasification process utilized in
the plant resulted in the production of certain by-products, which have been
classified by the federal government and the State of Montana as hazardous to
the environment.
Several years ago the Company initiated an assessment of the site to
determine if remediation of the site was required. That assessment resulted in a
submission to the Montana Department of Environmental Quality (MDEQ) in 1994.
The Company has worked with the MDEQ since that time to obtain the data that
would lead to a remediation action acceptable to the MDEQ. In the summer of 1999
the Company received final approval from the MDEQ for its plan for remediation
of soil contaminants. The Company has completed its remediation of soil
contaminants and received in April of 2002 a closure letter from MDEQ. The
Company and its consultants continue their work with the MDEQ relating to the
remediation plan for water contaminants.
At September 30, 2002, the costs incurred in evaluating and beginning
the remediation have totaled approximately $2,010,000. On May 30, 1995, the
Company received an order from the Montana Public Service Commission (MPSC)
allowing for the recovery of the costs associated with the evaluation and
remediation of the site through a surcharge on customer bills. As of September
30, 2002, the recovery mechanism had generated approximately $1,360,000. The
Company expects to recover the full amount expended through the surcharge. The
MPSC's decision calls for ongoing review by the MPSC of any costs incurred. The
Company will submit a report for review by the MPSC when the water contaminants
remediation plan is approved by the MDEQ. Future costs are not estimable at this
time.
LEGAL PROCEEDINGS
From time to time the Company is involved in litigation relating to
claims arising from its operations in the normal course of business. The Company
utilizes various risk management strategies, including maintaining liability
insurance against certain risks, employee education and safety programs and
other processes intended to reduce liability risk.
In addition to other litigation referred to above, the Company or its
subsidiaries are currently involved in the following litigation.
EWR currently is involved in a lawsuit with PPL Montana, LLC (PPLM)
which is pending in the United States District Court for the District of
Montana. The lawsuit was filed on July 2, 2001, and involves a wholesale
electricity supply contract between EWR and PPLM dated March 17, 2000 and a
confirmation letter thereunder dated June 13, 2000 (together, the "Contract").
EWR received substantial imbalance payments as a result of the amount of power
that it scheduled and purchased from PPLM under the
6
NOTE 4 - CONTINGENCIES (CONTINUED)
Contract. PPLM claims that, as a result of EWR's scheduling under the Contract,
PPLM was deprived of the fair market value of energy which PPLM contends it
could have subsequently sold. PPLM estimates the fair market value of the excess
energy scheduled by EWR to be approximately $18.0 million. EWR denies that it
breached the agreement, and contends that, in any event, PPLM did not sustain
any damages. The Company believes that it has established adequate reserves with
respect to the litigation with PPLM; however, there can be no assurance that any
liability will not exceed such reserves. A liability in excess of the recorded
reserves could have a material adverse effect on the Company and its financial
condition.
By letter dated August 30, 2002, the Montana Department of Revenue
(DOR) notified the Company that the DOR's property tax audit of the Company for
the period January 1, 1997 through and including December 31, 2001 had
concluded. The notification stated that the DOR had determined that the Company
had willfully under-reported its personal property and that additional property
taxes and penalties should be assessed. The Company estimates that if the
additional assessment stands, it would owe approximately $3.9 million in
additional property taxes and penalties. The Company believes it has valid
defenses to the assessment of tax and penalties, and plans to vigorously contest
the proposed assessment. In any event the Company believes that the proposed
penalty (approximately $2 million of the total assessment) is unsupportable.
In the event that any tax deficiency related to the DOR assessment is
imposed on the Company, the Company will seek to recover the portion of such
deficiency related to regulated property through the rate making process. No
assurance can be given as to whether the Company will recover all or part of
such deficiency, and any related interest charges, through rates. The Company
does not anticipate that any penalty would be recoverable through rates. Because
of the uncertainties related to the DOR notification, the Company has not been
able to determine a range of potential losses; accordingly, no reserve has been
recorded. An adverse outcome in the matter, including the imposition of
penalties or failure of the Company to obtain relief through the rate making
process, could have a material adverse effect on the Company and its financial
condition.
NOTE 5 - OPERATIONS BY LINE OF BUSINESS
THREE MONTHS ENDED
SEPTEMBER 30
2002 2001
(Unaudited) (Unaudited)
Gross Margin (Operating
Revenue Less Gas and Power
Purchased):
Natural Gas Operations $1,439,477 $1,476,145
Propane Operations 434,938 449,391
Energy Marketing &
Wholesale 405,104 774,883
Pipeline Operations 83,744
----------- -----------
$2,363,263 $2,700,419
=========== ===========
Operating Income (Loss):
Natural Gas Operations ($703,971) ($357,404)
Propane Operations (427,520) (365,623)
Energy Marketing &
Wholesale (230,995) 353,838
Pipeline Operations 50,751 (798)
----------- -----------
($1,311,735) ($369,987)
=========== ===========
Net Income (Loss):
Natural Gas Operations ($617,930) ($348,997)
Propane Operations (274,025) (268,642)
Energy Marketing &
Wholesale (159,295) 185,193
Pipeline Operations 30,675 (900)
----------- ---------
($1,020,575) ($433,346)
=========== =========
7
NOTE 6 - NEW ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board (FASB) issued
SFAS 141, Business Combinations, and SFAS 142, Goodwill and Other Intangible
Assets. SFAS 141 establishes accounting and reporting standards for business
combinations. SFAS 141 is effective for business combinations initiated after
June 30, 2001. SFAS 142 establishes accounting and reporting standards for
goodwill and intangible assets, requiring impairment testing for goodwill and
intangible assets, and the elimination of periodic amortization of goodwill and
certain intangibles. The Company adopted the provisions of SFAS 142 on July 1,
2002. Management has determined that there is no current impact on the financial
statements of the Company.
In June 2001, the FASB issued SFAS 143, Accounting for Asset Retirement
Obligations, which requires asset retirement obligations to be recognized when
they are incurred and recorded as liabilities. The Company adopted this
statement effective July 1, 2002. Upon adoption of SFAS 143, the Company
recorded an estimated asset retirement obligation of $389,880 on its Condensed
Consolidated Balance Sheet in "Other long-term liabilities", and in "Property,
plant & equipment". This amount represents the Company's estimated liability as
of the adoption date to plug and abandon existing oil and gas wells owned by
EWR. EWR will depreciate the asset amount, and increase the liability over the
estimated useful life of these assets. EWR purchased these wells in the fourth
quarter of fiscal year 2002, and the cumulative affect of adopting this
statement was not material. The Company may have other obligations arising from
its operations; however, due to the fact that the majority of the Company's
assets have indeterminate useful lives, potential liabilities are not estimable
at this time.
In August 2001, the FASB issued SFAS 144, Accounting for the Impairment
or Disposal of Long-Lived Assets. SFAS 144 addresses accounting and reporting
for the impairment or disposal of long-lived assets, including the disposal of a
segment of business. The Company adopted SFAS 144 on July 1, 2002. Management
has determined there is no current impact on the consolidated financial
statements of the Company.
In April 2002, the FASB issued SFAS No. 145, Rescission of FASB
Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections. This statement eliminates the required classification of gain or
loss on extinguishment of debt as an extraordinary item of income and states
that such gain or loss be evaluated for extraordinary classification under the
criteria of Accounting Principles Board No. 30 "Reporting Results of
Operations." This statement also requires sale-leaseback accounting for certain
lease modifications that have economic effects that are similar to
sale-leaseback transactions, and makes various other technical corrections to
existing pronouncements. The Company adopted SFAS 145 on July 1, 2002, and has
determined there is no current impact on the consolidated financial statements
of the Company.
In June 2002, the FASB issued SFAS No. 146, Accounting for Costs
Associated with Exit or Disposal Activities. This statement nullifies Emerging
Issues Task Force (EITF) Issue No. 94-3, Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit as Activity (including
Certain Costs Incurred in a Restructuring). This statement requires that a
liability for a cost associated with an exit or disposal activity be recognized
when the liability is incurred rather than the date of an entities commitment to
an exit plan. The provisions of SFAS No. 146 are effective for exit or disposal
activities that are initiated after December 31, 2002. Management has not
determined the impact, if any, that this statement will have on consolidated
financial statements of the Company.
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF INTERIM FINANCIAL STATEMENTS
CAUTIONARY STATEMENT FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS OF THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995
The foregoing Management's Discussion and Analysis and other portions
of this quarterly report on Form 10-Q contain various "forward looking
statements" within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Sections 21E of the Securities Exchange Act of 1934, as amended,
which represent the Company's expectations or beliefs concerning future events.
Forward-looking
8
statements can be identified by words such as "anticipates," "believes,"
"expects," "planned," "scheduled" or similar expressions. Although the Company
believes these forward-looking statements are based on reasonable assumptions,
statements made regarding future results are subject to a number of assumptions,
uncertainties and risks that could cause future results to be materially
different from the results stated or implied in this document.
Such forward-looking statements, as well as other oral and written
forward-looking statements made by or on behalf of the Company from time to
time, including statements contained in the Company's filings with the
Securities and Exchange Commission and its reports to shareholders, involve
known and unknown risks and other factors which may cause the Company's actual
results in future periods to differ materially from those expressed in any
forward-looking statements. Factors that could cause or contribute to such
differences include, but are not limited to: (i) fluctuations in energy
commodity prices, including prices for fuel and purchased power, (ii) the impact
of state and federal laws and regulations, (iii) the possibility that regulators
may not permit the Company to pass through all such increased costs to
customers, (iv) fluctuations in wholesale margins due to uncertainty in the
wholesale propane and power markets, (v) costs and expenses of, and
uncertainties relating to, pending litigation and other disputes, particularly
the litigation with PPLM and the property tax dispute with the DOR, and (vi)
other factors discussed above, including items under the heading "Risk Factors."
Any such forward-looking statement is qualified by reference to these
risks and factors. The Company cautions that these risks and factors are not
exclusive. The Company does not undertake to update any forward-looking
statement that may be made from time to time by or on behalf of the Company
except as required by law.
GENERAL BUSINESS DESCRIPTION
The following discussion reflects results of operations of the Company
and its consolidated subsidiaries for the periods indicated.
On July 1, 2002, certain oil and gas gathering system and natural gas
transmission pipeline assets were transferred from EWR to EWD. The results of
operations for these assets are reported under the Pipeline Operations Segment.
The Company's natural gas operations involve the distribution of
regulated natural gas to the public in the Great Falls and West Yellowstone,
Montana and the Cody, Wyoming areas. Also included in the natural gas operations
for reporting purposes is Cascade Gas, a small regulated propane operation. The
results of Cascade Gas had formerly been reported as part of the propane
segment.
The Company's propane operations include the distribution of regulated
propane to the public through an underground propane vapor system in Payson,
Arizona as well as unregulated retail and wholesale propane operations, operated
by its wholly owned subsidiary Energy West Propane, Inc. (EWP). EWP currently
markets propane in Wyoming, Montana, Arizona, Colorado, South Dakota, North
Dakota and Nebraska.
EWR conducts marketing and distribution activities involving the sale
of natural gas and electricity mainly in Montana and Wyoming.
CASH FLOW ANALYSIS
For the three months ended September 30, 2002, the Company, and its
subsidiaries, used $3,829,000 of cash in its operating activities compared to
$7,802,000 for the three months ended September 30, 2001. This decrease in cash
used of $3,973,000 was primarily due to reductions in natural gas inventory
purchases of $5,831,000, an increase in accounts receivable collections of
$184,000, an increase in cash provided from the Company's market receivable and
liability balance of $328,000 and a decrease in the timing of cash paid
out of $431,000. Also included is a $390,000 liability related to the adoption
of SFAS 143.
Offsetting these amounts was a reduction in net income of $587,000 and
a reduction in recoverable gas purchases of $2,603,000.
Cash used in investing activities was $1,551,000 for the three months
ended September 30, 2002, compared to $1,323,000 for the three months ended
September 30, 2001. This increase of $228,000 was mainly due to the adoption of
SFAS 143 which requires an asset obligation to be recorded as a liability with
an offset to property, plant and equipment.
9
Cash provided by financing activities was $5,106,000 for the three
months ended September 30, 2002, as compared to $8,651,000 for the three months
ended September 30, 2001. This decrease of $3,545,000 was due primarily to a
reduction in short-term borrowing requirements as a result of less cash used in
operations.
Capital expenditures of the Company are primarily for expansion and
improvement of its gas utility properties. To a lesser extent, funds are also
expended to meet the equipment needs of the Company and its operating
subsidiaries and to meet the Company's administrative needs. During fiscal year
2003 the Company's capital expenditures are expected to be approximately
$3,300,000. These capital expenditures are expected to be generally for routine
system expansion and operating needs. The Company continues to evaluate
opportunities to expand its existing business and continues to evaluate new
business opportunities, which could result in additional capital expenditures.
LIQUIDITY AND CAPITAL RESOURCES
The Company's utility operations are subject to regulation by the
Montana Public Service Commission (MPSC), the Wyoming Public Service Commission
(WYPSC), and the Arizona Corporation Commission (ACC). This regulation plays a
significant role in determining the Company's return on equity. The various
commissions approve rates that are intended to permit a specified rate of return
on investment. The Company's tariffs allow the cost of gas to be passed through
to customers. The pass-through causes some delay, however, between the time that
the gas cost are incurred by the Company and the time that the Company recovers
such costs from customers, which can adversely affect the Company's cash flow in
the event of increases in gas costs.
The business of the Company and its subsidiaries in all segments is
temperature-sensitive. In any given period, sales volumes reflect the impact of
weather, in addition to other factors, with colder temperatures generally
resulting in increased sales by the Company. The Company anticipates that this
sensitivity to seasonal and other weather conditions will continue to be
reflected in the Company's sales volumes in future periods.
The Company's operating capital needs, as well as dividend payments and
capital expenditures are generally funded through cash flow from operating
activities and short-term borrowing. To the extent cash flow has not been
sufficient to fund capital expenditures, the Company generally borrows
short-term funds. The Company's short-term borrowing requirements vary according
to the seasonal nature of its sales and expenses. The Company has greater need
for short-term borrowing during periods when internally generated funds are not
sufficient to cover all capital and operating requirements, including costs of
gas purchases and capital expenditures. In general, the Company's short-term
borrowing needs for purchases of gas inventory and capital expenditures are
greatest during the summer months and the Company's short-term borrowing needs
for financing of customer accounts receivable are greatest during the winter
months.
At September 30, 2002, the Company had $26,000,000 in bank lines of
credit, of which $9,020,000 had been borrowed, and the Company had outstanding
letters of credit totaling $4,450,000 related to electric and gas purchase
contracts. Based on the amount of borrowings and outstanding letters of credit,
at September 30, 2002, the Company had total remaining borrowing capacity of
$12,530,000 under its bank lines of credit.
In addition to its bank lines of credit, the Company has outstanding
certain notes and industrial development revenue obligations. The total amount
of such obligations was $15,270,000 and $15,856,000 as of September 30, 2002 and
September 30, 2001, respectively. Under the terms of the long term debt
obligations, the Company is subject to certain restrictions, including
restrictions on total dividends and distributions, senior indebtedness, and
asset sales, and the Company is required to maintain certain financial debt and
interest ratios.
An adverse outcome in the litigation with PPL Montana, LLC (PPLM) or in
the tax dispute with the Montana DOR could have a material adverse effect on the
Company's consolidated financial statements. See "Part II, Item 1 - Legal
Proceedings."
10
RISK FACTORS
The major factors which affect the Company's future results include
general and regional economic conditions, weather, customer retention and
growth, the ability to meet competitive pressures and to contain costs, the
adequacy and timeliness of rate relief, cost recovery and necessary regulatory
approvals, and continued access to capital markets. In addition, changes in the
competitive environment particularly related to the Company's propane and energy
marketing segments could have a significant impact on the performance of the
Company.
The regulatory structure is in transition. Legislative and regulatory
initiatives, at both the federal and state levels, are designed to promote
competition. Changes in regulation of the gas industry have allowed certain
customers to negotiate their own gas purchases directly with producers or
brokers. To date, the regulatory changes affecting the gas industry have not had
a negative impact on earnings or cash flow of the Company's natural gas
operations.
The Company's regulated natural gas and propane vapor operations
follow Statement of Accounting Standards (SFAS) 71 "Accounting for the Effects
of Certain Types of Regulation," and its financial statements reflect the
effects of the different rate making principles followed by the various
jurisdictions regulating the Company. The economic effects of regulation can
result in regulated companies recording costs that have been or are expected to
be allowed in the ratemaking process in a period different from the period in
which the costs would be charged to expense by an unregulated enterprise. When
this occurs, costs are deferred as assets in the balance sheet (regulatory
assets) and recorded as expenses in the periods when those same amounts are
reflected in rates. Additionally, regulators can impose liabilities upon a
regulated company for amounts previously collected from customers and for
amounts that are expected to be refunded to customers (regulatory liabilities).
If the Company's natural gas and propane vapor operations were to discontinue
the application of SFAS 71, the accounting impact would be an extraordinary,
non-cash charge to operations that could be material to the financial position
and results of operation of the Company. However, the Company is unaware of any
circumstances or events in the foreseeable future that would cause it to
discontinue the application of SFAS 71.
In addition to the factors discussed above, the following are important
factors that could cause actual results to differ materially from any results
projected, forecasted, estimated or budgeted:
- Fluctuating energy commodity prices, including prices for fuel and
purchased power;
- The possibility that regulators may not permit the Company to pass
through all such increased costs to customers;
- Fluctuations in wholesale margins due to uncertainty in the wholesale
propane and power markets;
- Changes in general economic conditions in the United States and changes
in the industries in which the Company conducts business;
- Changes in federal or state laws and regulations to which the Company is
subject, including tax, environmental and employment laws and
regulations;
- The impact of FERC and state public service commission statutes and
regulation, including allowed rates of return, the pace of deregulation
in retail natural gas and electricity markets, and the resolution of
other regulatory matters;
- The ability of the Company and its subsidiaries to obtain governmental
and regulatory approval of various expansion or other projects;
- The costs and effects (including the possibility of adverse outcomes) of
legal and administrative claims and proceedings against the Company or
its subsidiaries, particularly the litigation with PPLM and the property
tax dispute with the DOR;
- Conditions of the capital markets the Company utilizes to access capital
to finance operations;
- The ability to raise capital in a cost-effective way;
- The effect of changes in accounting policies, if any;
- The ability to manage growth of the Company;
- The ability to control costs;
- The ability of each business unit to successfully implement key systems,
such as service delivery systems;
- The ability of the Company and its subsidiaries to develop expanded
markets and product offerings as well as their ability to maintain
existing markets;
- The ability of customers of the energy marketing and trading business to
obtain financing for various projects;
- The ability of customers of the energy marketing and trading business to
obtain governmental and regulatory approval of various projects;
11
- Future utilization of pipeline capacity, which can depend on energy
prices, competition from alternative fuels, the general level of
natural gas and propane demand, decisions by customers not to renew
expiring natural gas or propane contracts, and weather conditions; and
- Global and domestic economic repercussions from terrorist activities
and the government's response thereto.
ENERGY WEST INCORPORATED AND SUBSIDIARIES
SEPTEMBER 30, 2002
QUARTERLY RESULTS OF CONSOLIDATED OPERATIONS
The Company's net loss for the first quarter of fiscal 2002, ended
September 30, 2002 was $1,021,000 compared to $433,000 for the first quarter
ended September 30, 2001. The decrease in earnings of $588,000 was due primarily
to a reduction in margins realized on wholesale gas and electricity sales and
increases in distribution, general and administrative expenses.
Gross margin, which is defined as operating revenue less gas purchased,
decreased $337,000, from $2,700,000 in the first quarter of fiscal 2002 to
$2,363,000 in the first quarter of fiscal 2003. The majority of this decrease
was due to decreased margins of $532,000 from the Company's marketing and
wholesale operations caused by lower prices experienced during the current
fiscal year, a decrease in natural gas margins of $37,000 due to lower volumes
and warmer temperatures affecting the Wyoming operations and a reduction of
$14,000 from the Arizona propane operations. This decrease in gross margins was
partially offset by $162,000 in margins generated from the Company's recently
purchased production properties and gross margins generated from the recently
developed pipeline operations of $84,000.
Distribution, general and administrative expenses increased by $445,000
in the first quarter of fiscal 2003 primarily due to increased legal expenses
related to the PPLM litigation (See "Part II, Item 1 - Legal Proceedings"),
operating expenses associated with the recently developed pipeline operations
and the timing of certain expenses in the natural gas operations.
Maintenance expenses increased by $70,000 during the first quarter of
fiscal 2003 compared to the first quarter of fiscal 2002 primarily due to
increased expenses associated with maintaining our natural gas facilities in
Montana.
Depreciation expense increased by $44,000 during the first quarter of
fiscal 2003 compared to the first quarter of fiscal 2002 due to the addition of
various pipeline facilities and depletion of the recently purchased production
properties.
Other income decreased by approximately $6,000 during the first quarter
of fiscal 2003 primarily due to a reduction in service and appliance sales in
the Company's natural gas operations.
Interest expense increased by approximately $11,000 during the first
quarter of fiscal 2003 due to the timing of the Company's short term borrowings.
RESULTS OF THE COMPANY'S NATURAL GAS OPERATIONS
FIRST QUARTER
ENDED SEPTEMBER 30
2002 2001
(Unaudited) (Unaudited)
Natural Gas Revenue $ 3,055,375 $ 4,838,688
Natural Gas Purchased 1,615,898 3,362,543
----------------------------
Gross Margin 1,439,477 1,476,145
Operating Expenses 2,143,448 1,833,549
----------------------------
Operating Loss (703,971) (357,404)
Other Income (28,661) (46,773)
Interest Expense 262,474 230,135
Income Taxes (319,854) (191,769)
----------------------------
Net Natural Gas Loss ($617,930) ($348,997)
----------------------------
12
QUARTERLY RESULTS FOR NATURAL GAS OPERATIONS
The natural gas segment incurred a loss from operations of
approximately $618,000 for the quarter ending September 30, 2002 compared to a
loss of $349,000 for the quarter ending September 30, 2001. This increase was
primarily due to warmer temperatures affecting our Wyoming operations, an
increase in operating expenses of approximately $310,000, an increase in
interest expense of approximately $32,000 and a decrease in other income of
approximately $18,000. These increases were partially offset by an increase in
income tax benefits of approximately $128,000.
Gross Margin
The Natural Gas Operations segment's revenues and costs of gas
purchased decreased due to warmer than normal temperatures affecting our Wyoming
operations and decreased purchases by a large industrial facility in the service
area of the Wyoming operations. Gross margin, defined as operating revenues less
purchased gas costs, decreased by $37,000 from the first quarter of fiscal 2002
to the first quarter of fiscal 2003 due to these warmer temperatures and
reduction in volumes.
Operating Expenses
The Natural Gas Operations segment's operating expenses were $2,143,000
for the first quarter of fiscal 2003 compared to $1,833,000 for the
corresponding period in fiscal 2002. The increase in operating expenses of
$310,000 is due primarily to increase in number of personnel, employee overtime
related to computer system upgrades and construction projects, increased
property taxes, increase in general liability insurance expense, increases in
employee benefit costs and increased expenses associated with maintaining the
natural gas facilities in Great Falls, Montana.
Interest Expense
Interest charges allocable to the Company's Natural Gas Operations
segment increased by $32,000 from the first quarter of fiscal 2002 to the first
quarter of fiscal 2003 due to the change in allocation of interest based on
capital employed.
Income Taxes
Income tax benefits increased from $192,000 for the first quarter of
fiscal 2002 to $320,000 for the first quarter of fiscal 2003. The increase in
tax benefits is the result of an increase in pre tax losses relate do natural
gas operations.
RESULTS OF THE COMPANY'S PROPANE OPERATIONS
FIRST QUARTER
ENDED SEPTEMBER 30
2002 2001
(Unaudited) (Unaudited)
Propane Revenue $ 1,330,150 $ 1,106,236
Propane Purchased 895,212 656,845
--------------------------
Gross Margin 434,938 449,391
Operating Expenses 862,458 815,014
--------------------------
Operating Loss (427,520) (365,623)
Other Income (47,789) (32,764)
Interest Expense 96,957 92,012
Income Taxes (202,663) (156,229)
--------------------------
Net Propane Loss ($274,025) ($268,642)
---------------------------
13
QUARTERLY RESULTS FOR PROPANE OPERATIONS
Operating Revenues and Gross Margin
The Propane Operations segment's revenues for the first quarter of
fiscal 2003 were $1,330,000 compared to $1,106,000 for the first quarter of
fiscal 2002, an increase of $224,000. The increase was due mainly to increased
sales prices in the Company's regulated utility operations in Arizona and
increased sales volumes in the Rocky Mountain Fuel wholesale operations. Gross
margin decreased by approximately $14,000 due to reduced margins from bulk
retail operations in Arizona.
Operating Expenses
The Propane Operations segment's operating expenses were $862,000 for
the first quarter of fiscal 2003 as compared to $815,000 during the same period
in fiscal 2002. The $47,000 increase in the period was due to additional
marketing expenses incurred by the wholesale operations.
Interest Expense
Interest charges allocable to the Company's Propane Operations segment
were $97,000 for the first quarter of fiscal 2003, compared to $92,000 in the
comparable period in fiscal 2002. This increase of $5,000 is due mainly to the
change in interest allocation based on capital employed.
Income Taxes
Income tax benefits increased from $156,000 in the first quarter fiscal
2002 to $203,000 for the first quarter of fiscal 2003. The increase in tax
benefits of $47,000 is due to the increase in pre-tax losses related to propane
operations.
RESULTS OF THE ENERGY MARKETING AND WHOLESALE OPERATIONS
First Quarter
Ended September 30
2002 2001
(Unaudited) (Unaudited)
Marketing Revenue $8,053,911 $10,863,546
Purchases 7,648,807 10,088,663
---------------------------
Gross Margin 405,104 774,883
Operating Expenses 636,099 421,045
---------------------------
Operating Income (Loss) (230,995) 353,838
Other Income (1,520) (4,264)
Interest Expense 26,895 53,353
Income Taxes (97,075) 119,556
---------------------------
Net Marketing Income (Loss) ($159,295) $185,193
---------------------------
QUARTERLY RESULTS FOR ENERGY MARKETING AND WHOLESALE OPERATIONS
Gross Margin
EWR's energy marketing and wholesale operations experienced a reduction
in gross margin of $370,000 during the first quarter of fiscal 2003 compared to
the same period in fiscal 2002. This decrease was due primarily to reductions in
both electricity and natural gas margins resulting from lower prices which was
partially offset by an increase in margins from commencement of operations of
the recently purchased natural gas production properties.
14
Operating Expenses
Operating expenses for EWR's energy marketing and wholesale operations
were $636,000 for the first quarter of fiscal 2003 as compared to $421,000 for
the same period in fiscal 2002. The increase in operating expenses of $215,000
was due primarily to increased legal costs as a result of the PPLM litigation,
and operating expenses associated with newly acquired natural gas production
properties.
Interest Expense
Interest charges for the first quarter of fiscal 2003 decreased by
$26,000 from $53,000 in the first quarter of fiscal 2002 to $27,000 in the first
quarter of fiscal 2003. This decrease is due primarily to the method of
allocating interest to business segments based on capital employed.
Income Taxes
State and federal income tax expense of EWR's energy marketing and
wholesale operations decreased from $119,000 for the first quarter of fiscal
2002 to an income tax benefit of $97,000 in the first quarter of fiscal 2003,
due to a reduction in pre-tax income from the energy marketing and wholesale
operations.
RESULTS OF THE COMPANY'S PIPELINE OPERATIONS
First Quarter
Ended September 30
2002 2001
(Unaudited) (Unaudited)
Transmission Revenue $83,744
Purchases
--------------------------
Gross Margin 83,744
Operating Expenses 32,993 798
--------------------------
Operating Income (Loss) 50,751 (798)
Other Income (704)
Interest Expense 774 1,334
Income Taxes 19,302 (528)
--------------------------
Net Transmission Income (Loss) $30,675 $(900)
--------------------------
Pipeline Operations is a new segment for financial reporting purposes.
The results of this segment reflect operation of oil and gas gathering systems
placed into service in fiscal 2002, and transferred from EWR to EWD. For fiscal
year 2002 and prior years EWD consisted primarily of real estate holdings and
incurred minimum expenses. The financial operations of EWD's pipeline assets and
real estate holdings are now being reported as Pipeline Operations for segment
purposes. The Company anticipates that EWD will begin operations of a
refurbished transmission pipeline upon receipt of approval from FERC.
CONTRACTS ACCOUNTED FOR AT FAIR VALUE
Management of Risks Related to Derivatives--The Company and its
subsidiaries are subject to certain risks related to changes in certain
commodity prices and risks of counter-party performance. The Company has
established certain policies and procedures to manage such risks. The Company
has a Risk Management Committee (RMC), comprised of Company officers to oversee
the Company's risk management program as defined in its risk management policy.
The purpose of the risk management program is to minimize adverse impacts on
earnings resulting from volatility of energy prices, counter-party credit risks,
and other risks related to the energy commodity business. The RMC is overseen by
the Audit Committee of the Company's Board of Directors.
General--From time to time the Company or its subsidiaries may use
derivative financial contracts to mitigate the risk of commodity price
volatility related to firm commitments to purchase and sell natural gas or
electricity. The Company may use such arrangements to protect its profit margin
on future
15
obligations to deliver quantities of a commodity at a fixed price. Conversely,
such arrangements may be used to hedge against future market price declines
where the Company or a subsidiary enters into an obligation to purchase a
commodity at a fixed price in the future. The Company accounts for such
financial instruments in accordance with Statement of Financial Accounting
Standard (SFAS) No. 133, Accounting for Derivative Instruments and Hedging
Activities, as amended by SFAS No. 138, Accounting for Certain Derivative
Instruments and Certain Hedging Activities.
In accordance with SFAS No. 133, contracts that do not qualify as
normal purchase and sale contracts must be reflected in the Company's financial
statements at fair value, determined as of the date of the balance sheet. This
accounting treatment is also referred to as "mark-to-market" accounting.
Mark-to-market accounting treatment can result in a disparity between reported
earnings and realized cash flow, because changes in the value of the financial
instrument are reported as income or loss even though no cash payment may have
been made between the parties to the contract. If such contracts are held to
maturity, the cash flow from the contracts, and their hedges, are realized over
the life of the contract.
Quoted market prices for natural gas derivative contracts of the
Company or its subsidiaries generally are not available. Therefore, to determine
the fair value of natural gas derivative contracts, the Company uses internally
developed valuation models that incorporate available current and historical
independent pricing information.
Wholesale Operations--During the first quarter of fiscal 2003, the
Company's wholly owned subsidiary, Energy West Resources (EWR) was party to a
number of contracts that were valued on a mark-to-market basis under SFAS No.
133. Although certain firm commitments for the purchase and sale of natural gas
could have been classified as normal purchases and sales and excluded from the
requirements of SFAS No. 133, as described above, EWR elected to treat these
contracts as derivative instruments under SFAS No. 133 in order to match
contracts for the purchase and sale of natural gas for financial reporting
purposes. Such contracts were recorded in the Company's consolidated balance
sheet at fair value. Periodic mark-to-market adjustments to the fair values of
these contracts are recorded as adjustments to gas costs.
During the third quarter of fiscal 2002, EWR terminated its existing
derivative contracts with Enron Canada Corporation (ECC), a subsidiary of Enron
Corp. Most of these contracts were commodity swaps that EWR had entered into to
mitigate the effects of fluctuations in the market price of natural gas. The
derivative contracts with ECC were entered into at various times in order to
lock in margins on certain contracts under which EWR had commitments to other
parties to sell natural gas at fixed prices (the "Future Supply Agreements").
EWR made the decision to terminate these ECC contracts because of concerns
relating to the bankruptcy of Enron Corp. At the date of termination, the market
price of natural gas was substantially lower than the price had been when EWR
entered into the contracts, resulting in a net amount due from EWR to ECC of
approximately $5,400,000. EWR paid this amount to ECC upon the termination of
the contracts, and thereby discharged the liability related to the contracts.
The costs related to such termination were reflected in the Company's
consolidated statement of income as adjustments to gas purchased for the fiscal
year ended June 30, 2002.
At the time the Company terminated the ECC derivative contracts, the
Company entered into new gas purchase contracts (the "Future Purchase
Agreements") at prices much lower than those provided for under the ECC
contracts. The Future Purchase agreements and the Future Supply Agreements
continue to be valued on a mark-to market basis. As of September 30, 2002, these
Agreements were reflected on the Company's consolidated balance sheet at an
approximate aggregate fair value as follows:
Contracts maturing in one year or less: $ 647,988
Contracts maturing in two to three years: 1,155,758
Contracts maturing in four to five years: 536,827
Contracts maturing in five years or more: 97,989
-----------
Total $ 2,438,562
===========
During the first quarter of fiscal 2003, the Company has not entered into
any new contracts that have required mark-to-market accounting under SFAS No.
133.
Natural Gas Operations--In the case of the Company's regulated divisions,
gains or losses resulting from the derivative contracts are subject to deferral
under regulatory procedures approved by the public service regulatory
commissions of Montana, Wyoming and Arizona. Therefore, related derivative
assets
16
and liabilities are offset with corresponding regulatory liability and asset
amounts included in "Recoverable Cost of Gas Purchases", pursuant to SFAS No.
71, Accounting for the Effects of Certain Types of Regulation.
RELATED PARTY TRANSACTIONS
The Company has no material related party transactions.
CRITICAL ACCOUNTING POLICIES
The Company believes its critical accounting policies are as follows:
Effects of Regulation--The Company follows SFAS 71, "Accounting for the
Effects of Certain Types of Regulation", and its financial statements reflect
the effects of the different rate making principles followed by the various
jurisdictions regulating the Company. The economic effects of regulation can
result in regulated companies recording costs that have been or are expected to
be allowed in the ratemaking process in a period different from the period in
which the costs would be charged to expense by an unregulated enterprise. When
this occurs, costs are deferred as assets in the balance sheet (regulatory
assets) and recorded as expenses in the periods when those same amounts are
reflected in rates. Additionally, regulators can impose liabilities upon a
regulated company for amounts previously collected from customers and for
amounts that are expected to be refunded to customers (regulatory liabilities).
Recoverable/ Refundable Costs of Gas and Propane Purchases--The Company
accounts for purchased-gas costs in accordance with procedures authorized by the
MPSC, the WPSC and the ACC under which purchased-gas and propane costs that are
different from those provided for in present rates are accumulated and recovered
or credited through future rate changes.
Derivatives--The Company accounts for certain derivative contracts that
are used to manage risk in accordance with SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities", as amended by SFAS No. 138,
"Accounting for Certain Derivative Instruments and Certain Hedging Activities",
which the Company adopted July 1, 2000.
ITEM 3 - THE QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's is subject to certain market risks, including commodity
price risk (i.e., natural gas and propane prices) and interest rate risk. The
adverse effects of potential changes in these market risks are discussed below.
The sensitivity analyses presented do not consider the effects that such adverse
changes may have on overall economic activity nor do they consider additional
actions management may take to mitigate the Company's exposure to such changes.
Actual results may differ.
Commodity Price Risk
The Company protects itself against price fluctuations on natural gas
and electricity by limiting the aggregate level of net open positions, which are
exposed to market price changes and through the use of natural gas derivative
instruments. The net open position is actively managed with strict policies
designed to limit the exposure to market risk, and which require at least weekly
reporting to management of potential financial exposure. The risk management
committee has limited the types of financial instruments the company may trade
to those related to natural gas commodities. Additionally, the Company's
regulated operations are allowed recovery of the costs associated with the
purchase of natural gas. In most cases, these costs are recoverable within one
year.
Interest Rate Risk
The Company's results of operations are affected by fluctuations in
interest rates (e.g. interest expense on debt). The Company mitigates this risk
by entering into long-term debt agreements with fixed
17
interest rates. Based on the amount of the outstanding notes payable on
September 30, 2002, a one percent increase (decrease) in average interest rates
would result in a decrease (increase) in annual pre-tax income of approximately
$31,000.
Credit Risk
Credit risk relates to the risk of loss that the Company would incur as
a result of non-performance by counterparties of their contractual obligations
under the various instruments with the Company. Credit risk may be concentrated
to the extent that one or more groups of counterparties have similar economic,
industry or other characteristics that would cause their ability to meet
contractual obligations to be similarly affected by changes in market or other
conditions. In addition, credit risk includes not only the risk that a
counterparty may default due to circumstances relating directly to it, but also
the risk that a counterparty may default due to circumstances which relate to
other market participants which have a direct or indirect relationship with such
counterparty. The Company seeks to mitigate credit risk by evaluating the
financial strength of potential counterparties. However, despite mitigation
efforts, defaults by counterparties may occur from time to time. To date, no
such default has occurred.
ITEM 4. CONTROLS AND PROCEDURES
The Company's President and Chief Executive Officer, Edward J. Bernica
and the Company's Assistant Vice President and Controller (principal financial
officer) Robert B. Mease have evaluated the Company's internal controls and
disclosure controls systems within 90 days of the filing of this report. They
have concluded that the Company's disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) are effective as of the date of this
Quarterly Report on Form 10-Q to provide reasonable assurance that the Company
can meet its disclosure obligations. As of the date of this Quarterly Report on
Form 10-Q there have not been any significant changes in internal controls or in
other factors that could significantly affect these controls subsequent to the
date of their evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
18
Form 10-Q
Part II - Other Information
ITEM 1 LEGAL PROCEEDINGS
From time to time the Company is involved in litigation relating to
claims arising from its operations in the normal course of business and the
Company does not believe that any such litigation is material to the Company's
business or financial condition. The Company utilizes various risk management
strategies, including maintaining liability insurance against certain risks,
employee education and safety programs and other processes intended to reduce
liability risk.
In addition to other litigation referred to above, the Company or its
subsidiaries are currently involved in the following litigation.
EWR currently is involved in a lawsuit with PPL Montana, LLC (PPLM)
which is pending in the United States District Court for the District of
Montana. The lawsuit was filed on July 2, 2001, and involves a wholesale
electricity supply contract between EWR and PPL dated March 17, 2000 and a
confirmation letter thereunder dated June 13, 2000 (together, the "Contract").
EWR received substantial imbalance payments as a result of the amount of power
that it scheduled and purchased from PPLM under the Contract. PPLM claims that,
as a result of EWR's scheduling under the Contract, PPLM was deprived of the
fair market value of energy which PPLM contends it could have subsequently sold.
PPLM estimates the fair market value of the excess energy scheduled by EWR to be
approximately $18.0 million. EWR denies it breached the agreement, and contends
that, in any event, PPLM did not sustain any damages. The Company believes that
it has established adequate reserves with respect to the litigation with PPLM;
however, there can be no assurance that any liability will not exceed such
reserves. A liability in excess of the recorded reserves could have a material
adverse effect on the Company and in financial condition.
By letter dated August 30, 2002, the Montana Department of Revenue
("DOR") notified the Company that the DOR's property tax audit of the Company
for the period January 1, 1997 through and including December 31, 2001 had
concluded. The notification stated that the DOR had determined that the Company
had willfully under-reported its personal property and that additional property
taxes and should be assessed. The Company estimates that if the additional
assessment stands, it would owe approximately $3.9 million in additional
property taxes and penalties. The Company believes it had valid defenses to the
assessment of tax and penalties, and plans to vigorously contest the proposed
assessment. In any event the Company believes that the proposed penalty
(approximately $2 million of the total assessment) is unsupportable.
In the event that any tax deficiency related to the DOR assessment is
imposed on the Company, the Company will seek to recover the portion of such
deficiency related to regulated property through the rates making process. No
assurance can be given as to whether the Company will recover all or part of
such deficiency, and any related interest charges, through rates. The Company
does not anticipate that any penalty would be recoverable through rates. Because
of the uncertainties related to the DOR notification, the Company has not been
able to determine a range of potential losses; accordingly, no reserve has been
recorded. An adverse outcome in the matter, including the imposition of
penalties or failure of the Company to obtain relief through the rate making
process, could have a material adverse effect on the Company and its financial
condition.
19
Item 2. Changes in Securities - Not Applicable
Item 3. Defaults upon Senior Securities - Not Applicable
Item 4. Submission of Matters to a Vote of Security Holders - Not
Applicable
Item 5. Other Information - Not Applicable
Item 6. Exhibits and Reports on Form 8-K
A. Exhibits for the first quarter ended September 30, 2002.
10.1 Energy West Incorporated 2002 Stock Option Plan
(incorporated by reference to Appendix A to the
Company's proxy statement filed with the Commission
on October 29, 2002)
99.1 Certification of Principal Executive Officer
99.2 Certification of Principal Financial Officer
B. The Company filed a Current Report on Form 8-K during the first
quarter ended September 30, 2002 as follows.
Date Filed Item No.
---------- --------
September 25, 2002 Item 7 - Press Release dated September
24, 2002
Item 9 - Announcement of information in
connection with the Montana Department
of Revenue audit
20
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ENERGY WEST INCORPORATED
/s/ Edward J. Bernica
- -------------------------------
Edward J. Bernica, President and
Chief Executive Officer
(principal executive officer)
/s/ Robert B. Mease
- -------------------------------
Robert B. Mease, Assistant Vice-President
and Controller
(principal financial officer)
Dated November 14, 2002
21
CERTIFICATIONS
I, Edward J. Bernica, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Energy
West Incorporated.
2. Based on my knowledge, this quarterly report does not contain
any untrue statement of a material fact or omit to state a
material fact necessary to make the statements made, in light
of the circumstances under which such statements were made,
not misleading with respect to the period covered by this
quarterly report; and
3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report fairly
present in all material respects the financial condition,
results of operations and cash flows of the registrant as of,
and for, the periods presented in this quarterly report.
4. The registrant's other certifying officers and I are
responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules
13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during
the period in which this quarterly report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior
to the filing date of this quarterly report (the
"Evaluation Date"); and
c) presented in this quarterly report our conclusions about
the effectiveness of the disclosure controls and
procedures based on our evaluation as of the Evaluation
Date;
5. The registrant's other certifying officers and I have
disclosed, based on our most recent evaluation, to the
registrant's auditors and the audit committee of registrant's
board of directors (or persons performing the equivalent
function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and
report financial data and have identified for the
registrant's auditors any material weaknesses in internal
controls; and
b) any fraud, whether or not material, that involves
management or other employees who have a significant role
in the registrant's internal controls; and
6. The registrant's other certifying officers and I have
indicated in this quarterly report whether or not there were
significant changes in internal controls or in other factors
that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and
material weaknesses.
Date: November 14, 2002
/s/ Edward J. Bernica
-------------------------------------
Edward J. Bernica
President and Chief Executive Officer
(principal executive officer)
22
I, Robert B. Mease, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Energy
West Incorporated.
2. Based on my knowledge, this quarterly report does not contain
any untrue statement of a material fact or omit to state a
material fact necessary to make the statements made, in light
of the circumstances under which such statements were made,
not misleading with respect to the period covered by this
quarterly report; and
3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report fairly
present in all material respects the financial condition,
results of operations and cash flows of the registrant as of,
and for, the periods presented in this quarterly report.
4. The registrant's other certifying officers and I are
responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules
13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during
the period in which this quarterly report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior
to the filing date of this quarterly report (the
"Evaluation Date"); and
c) presented in this quarterly report our conclusions about
the effectiveness of the disclosure controls and
procedures based on our evaluation as of the Evaluation
Date;
5. The registrant's other certifying officers and I have
disclosed, based on our most recent evaluation, to the
registrant's auditors and the audit committee of registrant's
board of directors (or persons performing the equivalent
function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and
report financial data and have identified for the
registrant's auditors any material weaknesses in internal
controls; and
b) any fraud, whether or not material, that involves
management or other employees who have a significant role
in the registrant's internal controls; and
6. The registrant's other certifying officers and I have
indicated in this quarterly report whether or not there were
significant changes in internal controls or in other factors
that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and
material weaknesses.
Date: November 14, 2002
/s/ Robert B. Mease
---------------------------------------
Robert B. Mease
Assistant Vice President and Controller
(principal financial officer)
23