FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
Quarterly Report under section 13 or 15(d)
of the Securities Exchange Act of 1934
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2001
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _______________ to _______________
Commission File number 0-14183
ENERGY WEST INCORPORATED
(Exact name of registrant as specified in its charter)
Montana 81-0141785
- --------------------------------------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1 First Avenue South, Great Falls, Mt. 59401
- -------------------------------------------------
(Address of principal executive (Zip Code)
offices)
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 9, 2001
(Common stock, $.15 par value) 2,544,333
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, 2001 and June 30, 2001 (Unaudited) 1
Condensed Consolidated Statements of Operations - three
months ended September 30, 2001 and 2000 (Unaudited) 2
Condensed Consolidated Statements of Cash Flows - three
months ended September 30, 2001 and 2000 (Unaudited) 3
Notes to Condensed Consolidated Financial Statements (Unaudited) 4-9
Item 2 - Management's Discussion and Analysis of Financial Condition and
Results of Operations 10-15
Item 3 - Quantitative and Qualitative Disclosures about Market Risk 16
Part II Other Information
Item 1 - Legal Proceedings 17-18
Item 2 - Changes in Securities 18
Item 3 - Defaults upon Senior Securities 18
Item 4 - Submission of Matters to a Vote of Security Holders 18
Item 5 - Other Information 18
Item 6 - Exhibits and Reports on Form 8-K 18
Signatures
Item 1. Financial Statements
FORM 10Q
ENERGY WEST INCORPORATED
CONDENSED CONSOLIDATED BALANCE SHEETS
ASSETS
September 30 June 30
2001 2001
----------------- ---------------
(Unaudited) (Audited)
Current Assets:
Cash and Cash Equivalents $ - $ 220,667
Accounts Receivable (Net) 7,980,549 10,331,403
Derivative Assets 6,797,991 3,444,861
Natural Gas and Propane Inventory 10,734,904 4,767,546
Materials and Supplies 665,128 631,574
Prepayments and Other 658,840 401,142
Refundable Income Tax Payments 1,115,157 0
Recoverable Cost of Gas Purchases 6,017,814 6,824,220
----------------- ---------------
Total Current Assets 33,970,383 26,621,413
----------------- ---------------
Notes Receivable Due After One Year 125,465 137,927
Property, Plant and Equipment (Net) 33,875,751 32,999,158
Deferred Charges 2,535,526 2,519,137
---------------- ---------------
Total Assets $ 70,507,125 $ 62,277,635
================= ===============
CAPITALIZATION AND LIABILITIES
Capitalization and Liabilities:
Current Liabilities:
Note Payable to Bank $ 12,789,034 $ 3,785,989
Long-Term Debt Due Within One Year 390,000 465,000
Accounts Payable - Gas and Electric Purchases 6,987,240 8,229,601
Accounts Payable - Other 469,153 1,075,519
Derivative Liabilities 7,375,798 3,921,354
Deferred Income Taxes Payable 855,104 631,305
Other Current and Accrued Liabilities 4,406,827 6,307,217
----------------- ---------------
Total Current Liabilities 33,273,156 24,415,985
----------------- ---------------
Deferred Income Tax Liability 3,886,389 3,835,513
Other Deferred Credits 2,588,982 2,531,863
Long-term obligations 15,856,000 15,881,000
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 -- 2,518,048 shares at
September 30, 2001;
2,513,383 at June 30, 2001 $377,015
377,714
Capital in Excess of Par Value 4,303,351 4,248,310
Retained Earnings 10,221,533 10,987,949
----------------- ---------------
Total Stockholders' Equity 14,902,598 15,613,274
----------------- ---------------
Total Capitalization and Liabilities $ 70,507,125 $ 62,277,635
================= ===============
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
----------------------------------
2000
2001 (Restated)
(Unaudited) (Unaudited)
------------- -------------
Operating Revenue:
Natural Gas Operations $ 4,871,559 $ 3,391,807
Propane Operations 1,116,079 1,704,832
Energy Marketing and Wholesale 11,594,600 11,322,790
------------- -------------
Total Revenue 17,582,238 16,419,429
------------- -------------
Operating Expenses:
Gas & Propane Purchased 4,042,945 3,134,708
Cost of Energy Marketing and Wholesale 11,562,060 10,216,588
Distribution, General and Administrative 2,284,572 2,118,647
Maintenance 95,241 98,062
Depreciation and Amortization 514,194 514,325
Other Taxes 176,398 152,871
------------- -------------
Total Operating Expenses 18,675,410 16,235,201
------------- -------------
Operating Income (Loss) (1,093,172) 184,228
Other Income - Net (Expense) 807,688 (561,900)
------------- -------------
Loss Before Interest Charges
and Income Tax Benefit (285,484) (377,672)
------------- -------------
Interest Charges:
Long-Term Debt 300,156 307,199
Other 76,678 216,170
------------- -------------
Total Interest Charges 376,834 523,369
Loss Before Income Tax Benefit (662,318) (901,041)
Provision for Income Tax Benefit (228,972) (307,707)
------------- -------------
Net Loss $ (433,346) $ (593,334)
------------- -------------
Basic and Diluted Loss Per Common Share $ (0.17) $ (0.24)
------------- -------------
Dividends Per Common Share $ 0.1300 $ 0.1250
Basic Weighted Average Common Shares 2,513,484 2,476,130
Diluted Weighted Average Common Shares 2,513,484 2,476,130
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
--------------------------------
2000
2001 (Restated)
(Unaudited) (Unaudited)
------------- -------------
Operating Activities:
Net Loss $ (433,346) $ (593,334)
Adjustment to Reconcile Net Loss to Cash Flows:
Depreciation and Amortization 514,194 514,325
Gain on Sale of Property, Plant & Equipment (22,936) 0
Deferred Gain on Sale of Assets (5,907) (5,907)
Investment Tax Credit - Net (5,266) (5,266)
Deferred Income Taxes - Net 274,675 474,802
Change in Operating Assets and Liabilities
Accounts Receivable - Net 2,350,854 (178,553)
Derivative Assets (3,353,130) (2,084,409)
Natural Gas and Propane Inventory (5,967,358) (2,191,951)
Prepayments and Other (257,698) (270,276)
Recoverable Cost of Gas Purchases 806,406 (1,137,310)
Accounts Payable - Gas and Electric Purchases (1,242,361) (1,045,319)
Accounts Payable - Other (606,366) 272,199
Derivative Liabilities 3,454,444 2,728,154
Other Assets and Liabilities (3,054,442) (734,322)
------------- -------------
Net Cash Used In Operating Activities (7,548,237) (4,257,167)
Investing Activities:
Construction Expenditures (1,368,604) (1,252,092)
Proceeds from Sale of Property, Plant & Equipment 32,751 0
Collection of Long-Term Notes Receivable 12,462 7,365
Customer Advances for Construction 0 (26,400)
Proceeds from Contributions in Aid of Construction 246 25,507
------------- -------------
Net Cash Used In Investing Activities (1,323,145) (1,245,620)
Financing Activities:
Repayment of Long-Term Debt (75,000) (75,000)
Proceeds from Note Payable to Bank 21,381,408 23,500,000
Repayment of Note Payable to Bank (12,378,363) (17,770,000)
Dividends on Common Stock (277,330) (264,387)
------------- -------------
Net Cash Provided by Financing Activities 8,650,715 5,390,613
------------- -------------
Net Decrease in Cash and Cash Equivalents (474,350) (603,368)
Cash and Cash Equivalents at Beginning of Period 220,667 112,174
------------- -------------
Cash and Cash Equivalents at End of Period $ 0 $ 0
------------- -------------
Supplemental schedule of noncash financing activities:
Certain dividends were paid through issuance of common stock
to shareholders in the amount of $55,741.
The accompanying notes are an integral part of these condensed financial
statements.
-3-
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
September 30, 2001
Note 1 - Basis of Presentation
The accompanying unaudited condensed consolidated financial statements 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 only of normal recurring accruals)
considered necessary for a fair presentation have been included. Certain
reclassifications have been made to the three month period ended September 30,
2000 to conform to the presentation of the three month period ended September
30, 2001. Operating results for the three month period ended September 30, 2001
are not necessarily indicative of the results that may be expected for the year
ended June 30, 2002 due to seasonal factors affecting gas utility, construction
and other operations. For further information, refer to the consolidated
financial statements and footnotes thereto included in the Energy West
Incorporated (the Company) annual report on Form 10-K for the year ended June
30, 2001.
Net income and loss amounts, including the per share amounts, for the first,
second and third quarters of fiscal 2001 differ from those previously reported
by the Company. Revenues and operating results do not differ from what was
previously reported. The differences in net results are due to the Company's
implementation of Statement of Financial Accounts Standards No. 133 (SFAS 133),
"Accounting for Derivative Instruments and Hedging Activities", as amended,
which requires that all derivative instruments be recorded at fair value on the
balance sheet. In order for the year-end amounts at June 30, 2001 to be
comparative to those of the quarters, adjustments were made to certain accounts
in the respective quarters to reflect the proper mark-to-market adjustments.
Please see the Company's most recently filed 10-K for the fiscal year ended June
30, 2001 for further information.
Note 2 - Derivative Instruments and Hedging Activity
The Company is exposed to risks relating to changes in certain commodity prices
and counter-party performance. In order to manage the various risks relating to
these exposures, the Company utilizes natural gas derivatives and has
established risk management oversight for these risks. The Company has
procedures to manage such risk and has established a comprehensive risk
management committee, overseen by the Audit Committee of the Company's Board of
Directors, to monitor compliance with the Company's risk management policies and
procedures.
Effective July 1, 2000, the Company adopted Statement of Financial Accounting
Standard No. 133 (SFAS 133), "Accounting for Derivative Instruments and Hedging
Activities," as amended, which requires that all derivative instruments be
reported on the balance sheet at fair value and establishes criteria for
designation and effectiveness of hedging relationships.
The Company is exposed to market risk as the energy commodities purchased and
sold by the Company are subject to price volatility caused by weather, supply
conditions and other unpredictable factors. The principal commodity hedged by
the Company is natural gas. The Company's marketing and wholesale operations
uses exchange traded futures and options contracts to manage the volatility
related to firm commitments to purchase and sell. Though certain of these firm
commitments to purchase and sell could potentially qualify for the "normal
purchases and sales" exemption, the Company generally treats certain firm
commitments to purchase and sell that qualify as derivative, as well as the
futures and options contracts as derivatives and records them in the
consolidated balance sheet at fair value in derivative assets and derivative
liabilities in order to properly match the contracts. Quarterly mark-to-market
adjustments to the fair values of these instruments are recorded in other
income.
4
NOTE 2 - DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITY (CONTINUED)
The majority of the Company's contracts for the purchase, sale, transportation
and storage of natural gas and propane in the Company's natural gas and propane
operations constitute "normal purchases and sales" under SFAS 133, and as such,
are not subject to the accounting requirements of the new standards. In some
cases, i.e., the Company's regulated divisions, gains or losses resulting from
the eventual settlement of contracts are subject to deferral under the Company's
tariffs with the Montana, Wyoming and Arizona Utilities Commissions. Therefore,
any related derivative assets and liabilities are offset with corresponding
regulatory liability and asset amounts included in "Recoverable Cost of Gas
Purchases", pursuant to FAS No. 71. Thus, in these divisions, SFAS 133 has no
impact on earnings.
When possible, the Company may hedge certain transactions. The Company formally
documents its hedge relationships, including identification of the hedging
instruments and the hedged items, as well as its risk management objectives and
strategies for undertaking the hedge transaction. This process includes linking
derivatives that are designated as hedges of specific assets, liabilities, firm
commitments or forecasted transactions. The Company also formally assesses both
at inception and at least quarterly thereafter, whether the derivatives that are
used in hedging transactions are highly effective in offsetting changes in
either the fair value or cash flows of the hedged item.
NOTE 3 - INCOME TAXES
Income tax benefit from operations differs from the amount computed by applying
the federal statutory rate to pre-tax income for the following reasons:
Tax benefit at statutory rates - 34%......................... $(223,396)
State income tax benefit, net of federal income taxes........ (16,861)
Amortization of deferred investment tax credits.............. (5,266)
Other........................................................ 16,551
---------
Total income benefit......................................... $(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. To date, all contaminated soil has been
removed, and an asphalt cap has been placed over the site. The Company and its
consultants continue their work with the MDEQ relating to the remediation plan
for water contaminants.
5
NOTE 4 - CONTINGENCIES (CONTINUED)
Environmental Contingency (Continued)
The costs incurred in evaluating and making remediation to the site totaled
approximately $1,960,000 as of September 30, 2001. On May 30, 1995 the Company
received an order from the Montana Public Service Commission allowing for
recovery of the costs associated with evaluation and remediation of the site
through a surcharge on customer bills. As of September 30, 2001 that recovery
mechanism had generated approximately $1,108,000. The Company expects to recover
the full amount expended through the surcharge. The Commission's decision calls
for ongoing review by the Commission of the costs incurred for this matter. The
Company will submit an application for review by the Commission when the
remediation plan is approved by the MDEQ for water contaminants.
Litigation and Other Matters
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.
On September 4, 1998, the Company received correspondence from the Department of
Justice that a claim was being considered by the United States of America (U.S.)
against Energy West Incorporated. The correspondence indicated that a complaint
has been prepared by Jack Grynberg, acting as Relater on behalf of the U.S.,
alleging that the Company had utilized improper measurement procedures in the
measurement of gas which was produced from wells owned by it, by its
subsidiaries, or from which the Company may have acted as operator. The alleged
improper measurement procedure purportedly understated the amount of royalty
revenue, which would have been paid to the U.S. The complaint is substantially
identical to the complaint being made against seventy-seven other parties. The
Company is alleged to have been responsible for the measurement of over 150
wells during a five-year period. The Company has investigated this allegation
and believes it had measurement responsibility for one well. The quantity of
production from that well is small enough that the Company does not expect its
potential liability to be material from any adverse decision. Furthermore, the
Company believes that the allegations made by Mr. Grynberg are not sustainable.
In the spring of 1999 the United States declined to intervene in the action. Mr.
Grynberg has served the Company with the complaint, and the matter is currently
the subject of preliminary motions in Federal Court. The Company intends to
vigorously contest the claims made in the complaint.
On July 2, 2001, the Company's wholly-owned subsidiary Energy West Resources,
Inc. (EWR) filed a complaint against PPL Montana, LLC (PPLM) in the United
States District Court for the District of Montana. In its complaint, EWR sought
injunctive and declaratory relief relating to 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"). The Contract calls
for PPLM to sell wholesale electric energy to EWR for a two-year period
commencing July 1, 2000. EWR filed its July 2, 2001 lawsuit because PPLM had
threatened to terminate sales and deliveries of electric energy to EWR under the
Contract, and also demanded that EWR make substantial payments to PPLM relating
to past power sales under the Contract. On July 13, 2001, PPLM filed suit
against EWR in Montana state court seeking unspecified damages and other relief.
EWR has received substantial imbalance payments as a result of the amount of
power that it has scheduled and purchased from PPLM. The imbalance payments were
made to EWR by its transmission provider, The Montana Power Company (MPC),
pursuant to the imbalance provisions in MPC's transmission tariff on file with
the Federal Energy Regulatory Commission (FERC). PPLM claims that, as a result
of EWR's scheduling under the Contract, EWR made profits of approximately $7.5
million for the period from July 1, 2000 through December 31, 2000, and
additional profits for subsequent periods, and that PPLM is entitled to such
profits. PPLM also has taken the position that it has the right to terminate
deliveries of energy under the Contract. Any recovery of damages by PPLM, as
well as the resulting costs to EWR of securing alternative supplies in the event
of termination of the Contract could be material to the Company and its
financial statements.
EWR denies liability to PPLM. EWR believes that its scheduling practices were
reasonable under the circumstances, and that it is not in default under the
Contract.
On July 6, 2001, the U.S. District Court granted a temporary restraining order
barring PPLM from terminating sales and deliveries of energy to EWR under the
Contract. On July 19, 2001, the court stayed further proceedings in order to
permit PPLM to file a request with FERC to assert primary jurisdiction over the
parties' contract dispute. On July 20, 2001, PPLM filed a notice of cancellation
with FERC in which PPLM requested FERC to assert primary jurisdiction over the
dispute and to approve PPLM's request for early cancellation of the Contract.
EWR opposed PPLM's requests. On September 14, 2001, FERC issued an order
rejecting PPLM's notice of cancellation. In its order, FERC ruled that the
courts are the appropriate venue for adjudication of the parties' contract
dispute. The FERC order does not prevent PPLM from refiling a notice of
cancellation with FERC after the conclusion of appropriate judicial proceedings.
As a result of the FERC ruling, the litigation has returned to the U.S. District
Court in Montana. PPLM's separate state court action has been removed to the
U.S. District Court for the District of Montana and consolidated with EWR's
lawsuit in that court. The parties currently are engaged in the process of
discovery in the judicial proceeding. EWR intends to vigorously advocate and
defend its position in the ongoing litigation with PPLM. 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 the
amounts provided.
6
NOTE 5 - OPERATING REVENUES AND EXPENSES
Rocky Mountain Fuels, a division originally reported as part of the energy
marketing and wholesale operations during the quarter ended September 30, 2000
has been included as part of propane operations beginning July 1, 2001 to better
align the internal reporting structure. Both fiscal periods shown below have
been adjusted to reflect the operations of this division as part of the propane
operations. Natural gas, propane, and energy marketing and wholesale operating
revenues and expenses were as follows:
THREE MONTHS ENDED
SEPTEMBER 30
--------------------------------
2001 2000
---- ----
(Unaudited) (RESTATED)
(Unaudited)
OPERATING REVENUES:
Natural Gas Operations $4,871,559 $3,391,807
Propane Operations 1,116,079 1,704,832
Energy Marketing and Wholesale 11,594,600 11,322,790
----------------- -------------------
$17,582,238 $16,419,429
================= ===================
GAS AND POWER PURCHASES:
Natural Gas Operations $3,386,100 $1,900,261
Propane Operations 656,845 1,234,447
Energy Marketing and Wholesale 11,562,060 10,216,588
----------------- -------------------
$15,605,005 $13,351,296
================= ===================
DISTRIBUTION, GENERAL AND ADMINISTRATIVE:
Natural Gas Operations $1,293,645 $1,332,161
Propane Operations 606,706 575,647
Energy Marketing and Wholesale 384,221 210,839
----------------- -------------------
$2,284,572 $2,118,647
================= ===================
MAINTENANCE:
Natural Gas Operations $81,136 $83,750
Propane Operations 14,105 14,312
Energy Marketing and Wholesale 0 0
----------------- -------------------
$95,241 $98,062
================= ===================
DEPRECIATION AND AMORTIZATION:
Natural Gas Operations $328,184 $324,383
Propane Operations 165,547 185,409
Energy Marketing and Wholesale 20,463 4,533
----------------- -------------------
$514,194 $514,325
================= ===================
TAXES OTHER THAN INCOME:
Natural Gas Operations $116,350 $100,753
Propane Operations 49,661 39,617
Energy Marketing and Wholesale 10,387 12,501
----------------- -------------------
$176,398 $152,871
================= ===================
7
THREE MONTHS ENDED
SEPTEMBER 30
--------------------------------
2001 2000
---- ----
(Unaudited) (RESTATED)
(Unaudited)
OTHER INCOME (LOSS):
Natural Gas Operations $49,291 $38,751
Propane Operations 31,078 33,098
Energy Marketing and Wholesale 727,319 (633,749)
---------------- ------------------
$807,688 ($561,900)
================ ==================
INTEREST CHARGES:
Natural Gas Operations $228,399 $319,264
Propane Operations 97,654 132,247
Energy Marketing and Wholesale 50,781 71,858
---------------- ------------------
$376,834 $523,369
================ ==================
INCOME TAX EXPENSE (BENEFITS):
Natural Gas Operations ($181,513) ($221,346)
Propane Operations (163,071) (162,464)
Energy Marketing and Wholesale 115,612 76,103
---------------- ------------------
($376,834) ($523,369)
================= ===================
NOTE 6 - NEW ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standard (SFAS) No. 141, Business
Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No.
141 establishes accounting and reporting standards for business
combinations. SFAS No. 141 is effective for business combinations initiated
after June 30, 2001. SFAS No. 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 intends to adopt the provisions
of SFAS No. 142 effective for the fiscal year ending June 30, 2003. Management
is currently evaluating the impact of these pronouncements on the financial
statements.
In June 2001, the FASB issued SFAS No. 143, Accounting for Asset Retirement
Obligations, which requires asset retirement obligations to be recognized when
they are incurred and displayed as liabilities. SFAS 143 is effective for the
fiscal year ending June 30, 2003. Management is currently evaluating the impact
of this pronouncement on the financial statements.
In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets. SFAS No. 144 addresses accounting and
reporting for the impairment or disposal of long-lived assets, including
the disposal of a segment of business. SFAS No. 144 is effective for the fiscal
year ending June 30, 2003. Management is currently evaluating the impact of
this pronouncement on the financial statements.
8
FORM 10-Q
ENERGY WEST INCORPORATED
Item 2 - Management's Discussion and Analysis of Interim Financial Statements
The following discussion reflects results of operations of the Company and its
consolidated subsidiaries for the periods indicated. On July 1, 2000, the
Company underwent a change in its reporting and management structure.
Previously, operations were organized and managed according to geographic
location and the regulated or non-regulated nature of the business. After July
1, operations were organized according to similarities in the
business-regulated natural gas operations, regulated and non-regulated propane
operations, and marketing and wholesale operations.
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 Energy West Development, Inc. (EWD), a wholly owned
subsidiary. Earnings from EWD represents less than 1% of the Company's overall
earnings.
The Company's propane operations, operated by its wholly owned subsidiary Energy
West Propane, Inc. (EWP), include the distribution of regulated propane to the
public through underground propane vapor systems in the Payson, Arizona and
Cascade, Montana areas as well as non-utility retail and wholesale propane
operations in Wyoming, Montana, Arizona, Colorado, South Dakota, North Dakota
and Nebraska.
The Company's wholly owned subsidiary, Energy West Resources, Inc. (EWR)
conducts wholesale distribution activities involving the sale of natural gas and
electricity mainly in Montana and Wyoming.
Liquidity and Capital Resources
The Company's operating capital needs, as well as dividend payments and capital
expenditures are generally funded through cash flow from operating activities,
short-term borrowing and liquidation of temporary cash investments.
Historically, to the extent cash flow has not been sufficient to fund capital
expenditures, the Company has borrowed short-term funds. As the short-term debt
balance significantly exceeds working capital requirements, the Company has
issued long-term debt or equity securities to pay down short-term debt.
The Company's short-term borrowing requirements vary according to the seasonal
nature of its sales and expense activity. The Company has a 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. Short-term borrowing utilized for construction or property acquisitions
generally has been on an interim basis and converted to long-term debt and
equity when it becomes economical and feasible to do so.
9
Liquidity and Capital Resources - (Continued)
At September 30, 2001, the Company had $26,000,000 in bank lines of credit, of
which $12,789,000 had been borrowed under the credit agreement. The Company had
outstanding letters of credit totaling $8,700,000 related to electric and gas
purchase contracts. These letters of credit, when netted against the total bank
lines of credit, result in a total remaining borrowing capacity of $4,511,000.
An adverse outcome in the litigation with PPL Montana, LLC (PPLM) could have a
material adverse effect on the Company's liquidity and capital resources. See
"Part II, Item 1 - Legal Proceedings."
Cash Flow Analysis
The Company used net cash in operating activities for the three months ended
September 30, 2001 in the amount of approximately $7,548,000 as compared to
approximately $4,257,000 for the three months ended September 30, 2000. This
increase in cash used in operating activities of $3,291,000 was primarily due to
increased purchases in gas inventory of about $3,775,000, and payments of
income taxes of $1,841,000. Offsets to these increases in cash used were
collections on account receivable of $2,529,000.
Cash used in investing activities was approximately $1,323,000 for the three
months ended September 30, 2001, as compared to approximately $1,246,000 for the
three months ended September 30 2000. This increase of $77,000 was primarily due
to expenditures incurred for system expansion in utility operations.
Capital expenditures of the Company are primarily for expansion and improvement
of its regulated utility properties. To a lesser extent, funds are also expended
to meet the equipment needs of the Company's operating subsidiaries and to meet
the Company's administrative needs. The Company's capital expenditures were
approximately $3.3 million in fiscal 2001, $4.8 million in fiscal 2000 and $3.7
million in fiscal 1999. During fiscal 2001, approximately $1.7 million was
expended for system expansion, construction and maintenance of the natural gas
liquefied natural gas systems. In addition, approximately $1 million was
expended for bulk tanks, customer tanks and equipment for the propane operating
entities. Capital expenditures are expected to be close to $5 million in fiscal
2002, including approximately $2.6 million for continued system expansion,
construction and maintenance of the Company's natural gas operations. In
addition, approximately $1.5 million is expected to be expended for propane
vapor systems, bulk tanks, customer tanks and equipment for the Company's
propane operations with the balance of $.9 million to be expended for the
Company's energy marketing and wholesale operations. The Company continues to
evaluate opportunities to expand its existing businesses from time to time.
10
Results of Consolidated Operations
Comparison of First Quarter of Fiscal 2002 Ended September 30, 2001 and Fiscal
2001 Ended September 30, 2000.
The Company's net loss for first quarter ended September 30, 2001 was a loss of
$433,000 compared to a loss of $593,000 for the quarter ended September 30,
2000. The loss decrease occurred mainly from items impacting the marketing and
wholesale operation. Although margins experienced in fiscal 2002 from the
remarketing of electricity were much lower than in fiscal 2001 due to the
stabilization of market prices, the unrealized gain from mark-to-market
valuation offset this loss during the first quarter of fiscal 2002.
Gross margin, which is defined as operating revenues less gas purchased,
decreased from approximately $3,068,000 in fiscal 2001 to $1,977,000 in fiscal
2002 or $1,091,000 primarily due to decreased margin from the marketing and
wholesale operations. During fiscal 2001, these operations experienced higher
margins from remarketing of electricity at unusually high market prices. Market
prices have stabilized in fiscal 2002 resulting in lower margins.
Distribution, general and administrative expenses increased from approximately
$2,119,000 in fiscal 2001 to $2,284,000 in fiscal 2002. This increase was
primarily due to the timing of certain expenses including legal expenses
incurred as a result of ongoing litigation.
Other income increased to $808,000 in fiscal 2002 from a loss of $562,000 in
fiscal 2001. The $1,370,000 increase was attributed mainly to the swing in the
wholesale operation's mark-to-market position.
Interest expenses were lower by $147,000 during the first quarter of fiscal
2002, moving down to $377,000 as of September 30, 2001 from $523,000 during the
same period last year. This reduction was due to lower short-term interest rates
during the quarter.
11
Natural Gas Operations
The natural gas segment saw a decrease in the loss from operations of
approximately 4% or $16,000. The loss in fiscal 2001 was approximately $350,000
and approximately $334,000 for the first three months of fiscal 2002. This
decrease came mainly from reductions in interest expense, but was offset
slightly by reduced margins resulting from warmer weather.
Operating Revenues -
Natural gas operating revenues in the first three months of fiscal 2002 were
approximately $4,872,000 compared to approximately $3,392,000 for the first
three months of fiscal 2001. The $1,480,000 increase was mainly due to higher
rates to the consumer that were approved by the Montana Public Service
Commission (MPSC) in November 2000 in response to higher commodity costs of gas.
Purchased Gas Costs -
The costs of natural gas increased 78% as a result of the increase in rates
approved by the MPSC in November 2000. The rate increase was necessary due to
higher commodity prices experienced during fiscal years 2000 and 2001. As a
result of the rate increase, allowed purchased gas costs rose to $3,386,000 in
the first three months of fiscal 2002 as compared to $1,900,000 in the same
period last year.
Gross Margin -
Gross margin, which is defined as operating revenues less gas purchased, was
$1,485,000 for the first three months of fiscal 2002 compared to a gross margin
of $1,492,000 for the first three months of fiscal 2001, primarily due to
slightly warmer than normal weather during fiscal 2002.
Operating Expenses -
Natural gas operating expenses, excluding the cost of gas purchased and federal
and state income taxes were approximately $1,819,000 for the first three months
of fiscal 2002 as compared to $1,841,000 for the same period in fiscal 2001. The
minor 1% decrease in the period was generally due to the timing of certain
expenses, and is not expected to continue throughout the year.
Interest Charges -
Interest charges allocable to the Company's natural gas operations were
approximately $228,000 for the first quarter of fiscal 2002, as compared to
$319,000 in the comparable period in fiscal 2001. Long-term debt interest
remained about the same as one year ago, but short-term debt interest decreased
due to a decrease in short-term borrowing rates during the quarter.
Income Taxes -
State and federal income tax benefits of the Company's natural gas operations
were approximately $181,000 for the first quarter of fiscal 2002 as compared to
approximately $221,000 in fiscal 2001. This was due to a lower pre-tax loss from
natural gas operations.
12
Propane Operations
Propane revenues in the first three months of fiscal 2002 were approximately
$1,116,000 compared to approximately $1,705,000 for the first three months of
fiscal 2001. This $589,000 decrease was primarily due to the drop in the market
price of propane. Correspondingly, commodity costs of propane have also
decreased approximately $579,000, from $1,234,000 in the first three months of
fiscal 2001 to $657,000 in the same period this year. The results of these two
factors have combined to drop gross margin 2% to $459,000 in fiscal 2002 from
$470,000 in fiscal 2001. The Company believes this is a timing difference, and
does not expect to sustain this margin loss throughout the year.
Operating losses have increased nearly 9% from approximately $345,000 in fiscal
2001 to $377,000 for the first three months of fiscal 2002. This increase in
operating loss was due to an increase in operating expenses of approximately
$21,000 and a decrease in gross margin of approximately $11,000.
Operating Expenses -
Propane operating expenses, excluding the cost of propane purchased and federal
and state income taxes were approximately $836,000 for the first three months of
fiscal 2002 as compared to $815,000 for the same period in fiscal 2001. The
increase in the period was generally due to the timing of certain expenses, and
is not expected to continue throughout the year.
Interest Charges -
Interest charges allocable to the Company's propane operations were
approximately $98,000 for the first quarter of fiscal 2002, as compared to
$132,000 in the comparable period in fiscal 2001. Long-term debt remained about
the same as the prior year, however, short-term debt interest decreased due to
the decrease in short-term borrowing rates for the first quarter of fiscal 2002.
Energy Marketing and Wholesale Operations
Operating Revenues -
Revenues from energy marketing and wholesale gas and electric sales in the first
three months of fiscal 2002 were approximately $11,595,000 compared to
approximately $11,322,000 for the first three months of fiscal 2001. The
increase in revenues for the quarter resulted from higher gas commodity prices
charged to customers.
Gross Margin -
Gross margin, consisting of revenue less gas and power purchases, decreased by
$1,073,000. Gross margin went from $1,106,000 during the first three months of
fiscal 2001, to $33,000 during the same period in the current year. During the
first quarter of fiscal 2001, the wholesale operations experienced remarketing
of electricity at unusually high market prices. Market prices have stabilized in
fiscal 2002 resulting in lower margins.
13
Energy Marketing and Wholesale Operations - (Continued)
Operating Expenses -
Operating expenses for energy marketing and wholesale energy sales, excluding
the cost of gas and electricity purchased and federal and state income taxes
increased $187,000 to $415,000 for the first three months of fiscal 2002 as
compared to $228,000 for the same period in fiscal 2001. The increase in the
period was mainly due to legal and professional expenses incurred as a result of
ongoing litigation.
Other Income -
Other income increased by $1,361,000 from a net expense of $634,000 for the
first quarter of fiscal 2001 to net other income of $727,000 for the first
quarter of fiscal 2002. The other income and losses for the first quarter of
both fiscal years is mainly due to the mark-to-market requirements related to
the impact of SFAS 133. This position will fluctuate on a quarterly basis, and
is not necessarily indicative of what the wholesale operation will record at the
end of the fiscal year. The mark-to-market position at the end of September 30,
2001 was a gain of $944,000 compared to a loss of $644,000 during the same
period last year.
Income Taxes -
State and federal income tax expense of the Company's energy marketing and
wholesale operations was approximately $116,000 for the first quarter of fiscal
2002 as compared to $76,000 in fiscal 2001, due to slightly higher pre-tax
income from the energy marketing operations.
Safe Harbor for Forward Looking Statement
The Company is including the following cautionary statement in this Form 10-Q to
make applicable and to take advantage of the safe harbor provisions of the
Private Securities Litigation Reform Act of 1995 for any 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,
including the outcome of pending litigation, particularly the litigation with
PPLM discussed in "Part II - Other Information, Item 1. Legal Proceedings". In
addition, statements containing expressions such as "believes", "anticipates",
"estimates", "expects", "intends", "plans", or "predicts", used in the Company's
periodic reports on Forms 10-K and 10-Q filed with the SEC are intended to
identify forward-looking statements. The Company cautions that these and similar
statements included in this report and in previously filed periodic reports
including reports filed on Forms 10-K and 10-Q are further qualified by
important factors that could cause actual results to differ materially from
those in the forward looking statement.
14
Item 3 - The Quantitative and Qualitative Disclosures about Market Risk
The Company 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.
Commodity Price Risk
The Company protects itself against price fluctuations on natural gas by
limiting the aggregate level of net open positions exposed to market price
changes 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 enter into to those related to
natural gas commodities. The Company's results of operations are significantly
impacted by changes in the price of natural gas. In order to provide short-term
protection against a sharp increase in natural gas prices, the Company from time
to time enters into natural gas call and put options, swap contracts and
purchase commitments. The Company's gas hedging strategy could result in the
Company not fully benefiting from certain gas price declines.
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 interest rates. The Company's
notes payable, however, are subject to variable interest rates. A hypothetical
10% change in market rates applied to the balance of the notes payable would not
have a material effect on the Company's earnings.
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 changing 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 occur from time to time. To date, any such
defaults have not had a material effect on the Company's earnings.
15
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. The Company does
not believe that the outcome of any presently pending claims or litigation will
cause a material adverse effect. 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.
On September 4, 1998, the Company received correspondence from the Department of
Justice that a claim was being considered by the United States of America (U.S.)
against Energy West Incorporated. The correspondence indicated that a complaint
has been prepared by Jack Grynberg, acting as Relater on behalf of the U.S.,
alleging that the Company had utilized improper measurement procedures in the
measurement of gas which was produced from wells owned by it, by its
subsidiaries, or from which the Company may have acted as operator. The alleged
improper measurement procedure purportedly understated the amount of royalty
revenue, which would have been paid to the U.S. The complaint is substantially
identical to the complaint being made against seventy-seven other parties. The
Company is alleged to have been responsible for the measurement of over 150
wells during a five-year period. The Company has investigated this allegation
and believes it had measurement responsibility for one well. The quantity of
production from that well is small enough that the Company does not expect its
potential liability to be material from any adverse decision. Furthermore, the
Company believes that the allegations made by Mr. Grynberg are not sustainable.
In the spring of 1999 the United States declined to intervene in the action. Mr.
Grynberg has served the Company with the complaint, and the matter is currently
the subject of preliminary motions in Federal Court. The Company intends to
vigorously contest the claims made in the complaint.
On July 2, 2001, the Company's wholly-owned subsidiary Energy West Resources,
Inc. (EWR) filed a complaint against PPL Montana, LLC (PPLM) in the United
States District Court for the District of Montana. In its complaint, EWR sought
injunctive and declaratory relief relating to 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"). The Contract calls
for PPLM to sell wholesale electric energy to EWR for a two-year period
commencing July 1, 2000. EWR filed its July 2, 2001 lawsuit because PPLM had
threatened to terminate sales and deliveries of electric energy to EWR under the
Contract, and also demanded that EWR make substantial payments to PPLM relating
to past power sales under the Contract. On July 13, 2001, PPLM filed suit
against EWR in Montana state court seeking unspecified damages and other relief.
EWR has received substantial imbalance payments as a result of the amount of
power that it has scheduled and purchased from PPLM. The imbalance payments were
made to EWR by its transmission provider, The Montana Power Company (MPC),
pursuant to the imbalance provisions in MPC's transmission tariff on file with
the Federal Energy Regulatory Commission (FERC). PPLM claims that, as a result
of EWR's scheduling under the Contract, EWR made profits of approximately $7.5
million for the period from July 1, 2000 through December 31, 2000, and
additional profits for subsequent periods, and that PPLM is entitled to such
profits. PPLM also has taken the position that it has the right to terminate
deliveries of energy under the Contract. Any recovery of damages by PPLM, as
well as the resulting costs to EWR of securing alternative supplies in the event
of termination of the Contract could be material to the Company and its
financial statements.
EWR denies liability to PPLM. EWR believes that its scheduling practices were
reasonable under the circumstances, and that it is not in default under the
Contract.
16
FORM 10-Q
Part II - Other Information (continued)
Item 1. Legal Proceedings (Continued)
On July 6, 2001, the U.S. District Court granted a temporary restraining order
barring PPLM from terminating sales and deliveries of energy to EWR under the
Contract. On July 19, 2001, the court stayed further proceedings in order to
permit PPLM to file a request with FERC to assert primary jurisdiction over the
parties' contract dispute. On July 20, 2001, PPLM filed a notice of cancellation
with FERC in which PPLM requested FERC to assert primary jurisdiction over the
dispute and to approve PPLM's request for early cancellation of the Contract.
EWR opposed PPLM's requests. On September 14, 2001, FERC issued an order
rejecting PPLM's notice of cancellation. In its order, FERC ruled that the
courts are the appropriate venue for adjudication of the parties' contract
dispute. The FERC order does not prevent PPLM from refiling a notice of
cancellation with FERC after the conclusion of appropriate judicial proceedings.
As a result of the FERC ruling, the litigation has returned to the U.S. District
Court in Montana. PPLM's separate state court action has been removed to the
U.S. District Court for the District of Montana and consolidated with EWR's
lawsuit in that court. The parties currently are engaged in the process of
discovery in the judicial proceeding. EWR intends to vigorously advocate and
defend its position in the ongoing litigation with PPLM. 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 the
amounts provided.
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
16.0 Notification of Change of Independent Auditors
B. We filed the following reports on Form 8-K:
Date Subject
---- -------
October 31, 2001 Item 9. Regulation FD Disclosure
Item 9. Regulation FD Disclosure.
On October 31, 2001, Energy West Incorporated filed an 8-K with the
Securities and Exchange Commission noting a change in independent
auditors. A copy of this 8-K is attached as Exhibit 16.1 hereto and
incorporated herein by reference.
17
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.
/s/Edward J. Bernica
- ---------------------------------------
Edward J. Bernica, President and Chief Executive Officer (Principal
Executive Financial and Accounting Officer)
Dated November 14, 2001