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 March 31, 2002
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
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ENERGY WEST INCORPORATED
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(Exact name of registrant as specified in its charter)
Montana 81-0141785
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(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 (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 May 13, 2002
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(Common stock, $.15 par value) 2,571,433
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ENERGY WEST INCORPORATED
INDEX TO FORM 10-Q
Page No.
Part I - Financial Information
Item 1 - Financial Statements
Condensed Consolidated Balance Sheets as of
March 31, 2002, March 31, 2001 and June 30, 2001 1
Condensed Consolidated Statements of Income -
three months and nine months ended March 31, 2002 and 2001 2
Condensed Consolidated Statements of Cash Flows -
nine months ended March 31, 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 9-17
Item 3 - Quantitative and Qualitative Disclosures about Market Risk 18
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
I. FINANCIAL INFORMATION
Item 1. Financial Statements
FORM 10Q
ENERGY WEST INCORPORATED
CONDENSED CONSOLIDATED BALANCE SHEETS
ASSETS
March 31 March 31 June 30
2002 2001 2001
(Unaudited) (Unaudited) (Unaudited)
----------- ----------- -----------
Current Assets:
Cash and Cash Equivalents -- $ 325,342 $ 220,667
Accounts Receivable-Net $14,666,308 20,511,379 10,331,403
Derivative Assets 4,165,217 8,019,766 3,444,861
Natural Gas and Propane Inventory 2,877,627 1,404,602 4,767,546
Materials and Supplies 671,644 622,140 631,574
Prepayments and Other 521,309 267,318 401,142
Refundable Income Tax Payments 223,083 283,739 0
Recoverable Cost of Gas Purchases 148,209 8,766,629 6,824,220
----------- ----------- -----------
Total Current Assets 23,273,397 40,200,915 26,621,413
Notes Receivable Due After One Year 3,300 142,329 137,927
Property, Plant and Equipment-Net 34,970,546 32,647,191 32,999,158
Deferred Charges 2,355,953 2,581,302 2,519,137
----------- ----------- -----------
Total Assets $60,603,196 $75,571,737 $62,277,635
=========== =========== ===========
CAPITALIZATION AND LIABILITIES
Current Liabilities:
Note Payable to Bank $ 7,879,841 $ 9,716,979 $ 3,785,989
Long-Term Debt Due within One Year 470,000 445,000 465,000
Accounts Payable - Gas and Electric Purchases 8,602,243 9,163,580 8,229,601
Accounts Payable - Other 582,791 330,452 1,075,519
Derivative Liabilities -- 8,029,422 3,921,354
Deferred Income Taxes 492,508 3,407,303 631,305
Other Current and Accrued Liabilities 3,894,534 5,409,550 6,307,217
----------- ----------- -----------
Total Current Liabilities 21,921,917 36,502,286 24,415,985
----------- ----------- -----------
Long-Term Deferred Income Taxes 3,919,810 3,859,673 3,835,513
Other Deferred Credits 2,434,378 2,504,645 2,531,863
Long-Term Obligations 15,776,000 16,271,000 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 -- 2,570,805 Shares at March
31, 2002; 2,475,435 at March 31, 2001;
2,513,383 at June 30, 2001 385,721 376,372 377,015
Capital in Excess of Par Value 4,847,663 4,198,415 4,248,310
Retained Earnings 11,317,707 11,859,346 10,987,949
----------- ----------- -----------
Total Stockholders' Equity 16,551,091 16,434,133 15,613,274
----------- ----------- -----------
Total Capitalization and Liabilities $60,603,196 $75,571,737 $62,277,635
=========== =========== ===========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
1
FORM 10Q
ENERGY WEST INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
Three Months Ended Nine Months Ended
March 31 March 31
2002 2001 2002 2001
(Unaudited) (Unaudited) (Unaudited) (Unaudited)
-----------------------------------------------------------
Operating Revenue
Natural Gas Operations $15,427,002 $16,598,493 $32,456,624 $32,852,078
Propane Operations 5,177,187 5,749,437 9,056,976 12,074,530
Energy Marketing and Wholesale 17,212,249 17,640,184 38,688,789 40,008,745
----------- ----------- ----------- -----------
Total Revenue 37,816,438 39,988,114 80,202,389 84,935,353
----------- ----------- ----------- -----------
Operating Expenses
Gas & Propane Purchased 15,010,422 17,143,437 29,986,689 33,347,736
Cost of Gas, Electric & Propane Trading 17,488,012 15,010,465 37,481,712 34,756,131
Distribution, General and Administrative 2,209,339 2,331,194 7,004,178 7,423,350
Maintenance 144,216 163,334 342,183 354,267
Depreciation and Amortization 503,855 492,562 1,533,336 1,520,795
Other Taxes 223,042 213,007 629,358 525,870
----------- ----------- ----------- -----------
Total Operating Expenses 35,578,886 35,353,999 76,977,456 78,140,945
----------- ----------- ----------- -----------
Operating Income 2,237,552 4,634,115 3,224,933 6,794,408
Other Income - Net 23,138 78,106 185,170 203,848
----------- ----------- ----------- -----------
Income Before Interest Charges & Income Taxes 2,260,690 4,712,221 3,410,103 6,998,256
----------- ----------- ----------- -----------
Interest Charges:
Long-Term Debt 299,096 306,170 898,348 919,536
Other 189,628 274,955 470,549 779,344
----------- ----------- ----------- -----------
Total Interest Charges 488,724 581,125 1,368,897 1,698,880
----------- ----------- ----------- -----------
Net Income Before Income Taxes 1,771,966 4,131,096 2,041,206 5,299,376
Income Taxes 598,228 1,549,468 678,270 1,989,025
----------- ----------- ----------- -----------
Net Income $ 1,173,738 $ 2,581,628 $ 1,362,936 $ 3,310,351
=========== =========== =========== ===========
Basic Earnings and Diluted Income Per Common Share $ 0.46 $ 1.04 $ 0.54 $ 1.33
----------- ----------- ----------- -----------
Dividends Per Common Share $ 0.130 $ 0.125 $ 0.390 $ 0.375
----------- ----------- ----------- -----------
Basic Weighted Average Shares 2,541,867 2,491,016 2,541,867 2,491,016
Diluted Weighted Average Shares 2,549,039 2,497,927 2,549,039 2,497,927
The accompanying notes are an integral part of these condensed consolidated
financial statements.
2
FORM 10Q
ENERGY WEST INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended
March 31
2002 2001
(Unaudited) (Unaudited)
-------------------------------
Operating Activities:
Net Income $ 1,362,936 $ 3,310,351
Adjustments to Reconcile Net Income to Cash Flow
Depreciation and Amortization 1,599,880 1,646,545
(Gain) Loss on Sale of Property, Plant & Equipment (139,167) 69
Deferred Gain on Sale of Assets (17,721) (17,721)
Investment Tax Credit (15,796) (15,796)
Deferred Income Taxes (54,500) 1,916,571
Changes in Operating Assets and Liabilities
Accounts Receivable - Net (4,334,905) (11,101,797)
Derivative Assets (720,356) (7,980,876)
Natural Gas and Propane Inventory 1,889,919 509,099
Prepayment and Other (120,167) 93,510
Recoverable Cost of Gas Purchased 6,676,011 (4,053,234)
Accounts Payable - Gas and Electric Purchases 372,642 3,394,091
Accounts Payable - Other (492,728) (259,355)
Derivative Liabilities (3,921,354) 8,029,422
Changes in Other Operating Assets and Liabilities (2,302,127) 3,164,637
------------ ------------
Net Cash Used In Operating Activities (217,433) (1,364,484)
Investing Activities:
Construction Expenditures (3,925,807) (2,366,286)
Collection of Long-Term Notes Receivable 134,627 20,057
Contributions in Aid of Construction (2,901) 25,150
Proceeds from Sale of Property, Plant & Equipment 549,630 775
Customer Advances for Construction (28,078) (66,949)
------------ ------------
Net Cash Used In Investing Activities (3,272,529) (2,387,253)
Financing Activities:
Proceeds from Notes Payable 42,934,447 69,552,831
Repayment of Notes Payable (38,840,595) (64,690,852)
Sale of Common Stock 204,574 20,700
Repayment of Long-Term Debt (100,000) (124,000)
Dividends Paid (929,131) (793,773)
------------ ------------
Net Cash Provided by Financing Activities 3,269,295 3,964,906
------------ ------------
Net Increase (Decrease) in Cash and Cash Equivalents (220,667) 213,169
Cash and Cash Equivalents at Beginning of Year 220,667 112,174
------------ ------------
Cash and Cash Equivalents at End of Period $ 0 $ 325,343
============ ============
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
March 31, 2002
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. Operating
results for the nine month period ended March 31, 2002 are not necessarily
indicative of the results that may be expected for the year ended June 30, 2002
due to seasonal factors. 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.
Due to the Company's implementation of Statement of Financial Accounting
Standards 133 (SFAS 133) "Accounting for Derivative Instruments and Hedging
Activities," 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. SFAS 133 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 Form
10-K for the fiscal year ended June 30, 2001 for further information.
In January 2002, the Company's wholly-owned subsidiary, Energy West Resources
(EWR) reclassified its mark to market valuation from "other income" to "gross
margin" to more accurately reflect the earnings of its natural gas marketing
business. The reclassification has been made to all periods presented.
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 policies
and procedures to manage such risks and has established a 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 SFAS 133 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 marketing operations of the Company's wholly owned subsidiary, Energy West
Resources (EWR), uses exchange traded futures and options contracts (derivative
contracts) to manage the volatility related to firm commitments to purchase and
sell natural gas in order to lock in a margin on a particular sales contract or
group of contracts. Though certain of the firm commitments to purchase and sell
could potentially qualify for the "normal purchases and sales" exemption under
SFAS 133, the Company treats these commitments 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 gross margin.
The majority of the Company's contracts for the purchase, sale, transportation
and storage of natural gas and propane in the Company's regulated natural gas
and propane operations constitute "normal purchases and sales" under SFAS 133,
and as such, are exempt from SFAS 133. In the case of the Company's regulated
divisions, gains or losses resulting from the eventual settlement of derivative
contracts are subject to deferral under the regulatory procedures in place with
the Montana, Wyoming and Arizona Commissions. Therefore related derivative
assets and liabilities are offset with corresponding
4
NOTE 2 - DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITY (CONTINUED)
regulatory liability and asset amounts included in "Recoverable Cost of Gas
Purchases", pursuant to SFAS 71, "Accounting for Certain Types of Regulation."
Thus, in the Company's regulated operations SFAS 133 has no impact on earnings.
When possible, the Company will 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.
In January of 2002, EWR, the Company's wholly owned subsidiary, terminated
existing contracts with Enron Canada Corporation (ECC), a subsidiary of Enron,
Incorporated. Most of these contracts were commodity swaps in place in order to
protect EWR against fluctuations in the market price of natural gas. The
contracts were entered into at various points in time in order to protect
margins on certain sales contracts. The contracts with ECC were structured so
that EWR would pay funds to ECC when market prices were lower than the prices
in place at the time the contracts were executed, and would receive funds from
ECC when natural gas market prices were higher than those in place at the time
the contracts were executed. Due to the timing of the contracts (i.e. contracts
were initialed earlier in the year when market prices were higher), EWR was
settling monthly with ECC. However, due to ECC's precarious financial
condition, EWR no longer felt that potential increases in the market prices
would be protected by these same contracts, so it paid ECC the remaining market
value of the contracts of approximately $5,400,000 in order to terminate the
agreements. These costs are reflected in the Company's Condensed Consolidated
Statements of Income as "Cost of Gas, Electric, and Propane Trading" for the
three month period and nine month period ended March 31, 2002. EWR then secured
new contracts to protect its positions at prices much lower than those in place
with ECC. The future earnings will be captured through increased margins on the
current sales contracts. This transaction did not have a material impact on the
Company's earnings.
NOTE 3 - INCOME TAXES
Income tax expense from operations differs from the amount computed by applying
the federal statutory rate to pre-tax income for the following reasons:
Tax expense at statutory rates - 34% $ 694,010
State tax expense, net of federal tax expense 37,001
Amortization of deferred investment tax credits (15,797)
Deferred income taxes (benefits) (36,944)
---------
Total income tax expense $ 678,270
=========
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.
Costs incurred in evaluating and making remediation to the site totaled
$2,088,000 as of March 31, 2002. On May 30, 1995 the Company received an order
from the Montana Public Service Commission (MPSC) allowing for recovery of the
costs associated with evaluation and remediation of the site through a surcharge
on customer bills. As of March 31, 2002, that recovery mechanism had generated
$1,101,000. The Company expects to recover the full amount expended through the
surcharge. The MPSC'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 MPSC when the Company's water remediation plan is approved by the
MDEQ.
5
NOTE 4 - CONTINGENCIES (CONTINUED)
PROPERTY TAXES
In October of 2001, the Company's property tax returns for fiscal years 1996
through 2000 were audited by the State of Montana. The Company was informed at
the conclusion of the audit that it was not in compliance with the methodology
recommended by the State of Montana, and that it would probably receive an
assessment for back property tax owed to the State of Montana. At the time of
this filing, no assessment had been received from the State of Montana, and the
Company is unable to estimate the potential liability 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. This section discusses
litigation that the Company believes to be properly characterized as outside the
normal course of business and for which it is not indemnified.
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.
The Company's wholly-owned subsidiary Energy West Resources, Inc. (EWR) is
presently in litigation against PPL Montana, LLC (PPLM) in the United States
District Court for the District of Montana. The lawsuit related 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 received substantial imbalance payments as a result of the amount of power
that it 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 has alleged that EWR was not entitled
to retain such payments. PPLM alleges that EWR is liable to PPLM for $12.2
million relating to purchases under the contract during the twelve months ended
June 30, 2001 plus unspecified additional amounts for the period after June 30,
2001. 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 condition.
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 - OPERATIONS BY LINE OF BUSINESS
Three Months Ended Nine Months Ended
------------------ -----------------
March 31 March 31
-------- --------
2002 2001 2002 2001
---- ---- ---- ----
(in thousands) (in thousands)
Gross Margin (Operating
Revenue Less Gas and Power
Purchased):
Natural Gas Operations $ 3,512 $ 3,349 $ 7,814 $ 7,923
Propane Operations 2,082 1,855 3,713 3,656
Energy Marketing & Wholesale (276) 2,630 1,207 5,040
-------- -------- -------- --------
$ 5,318 $ 7,834 $ 12,734 $ 16,619
======== ======== ======== ========
Operating Income (Loss):
Natural Gas Operations $ 1,663 $ 1,416 $ 2,084 $ 1,944
Propane Operations 1,293 967 1,156 1,033
Energy Marketing & Wholesale (718) 2,251 (15) 3,817
-------- -------- -------- --------
$ 2,238 $ 4,634 $ 3,225 $ 6,794
======== ======== ======== ========
Net Income (Loss):
Natural Gas Operations $ 901 $ 701 $ 904 $ 638
Propane Operations 770 537 584 436
Energy Marketing & Wholesale (497) 1,344 (125) 2,236
-------- -------- -------- --------
$ 1,174 $ 2,582 $ 1,363 $ 3,310
======== ======== ======== ========
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 intends to adopt the provisions of SFAS 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 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 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. SFAS 144 is effective for the fiscal year ending June 30,
2003. Management is currently evaluating the impact of this pronouncement on the
financial statements.
7
NOTE 7 - SUBSEQUENT EVENTS
In April of 2002, as part of the Company's strategic emphasis on wholesale
operations, its wholly owned subsidiary, Energy West Propane (EWP) sold its
retail propane operations located in Wyoming. The sale consisted of $546,000 in
customer tanks and other assets utilized to serve bulk propane customers in and
around Cody, Wyoming, as well as an additional $116,000 in inventory and
accounts receivable resulting in a $230,000 gain to the Company before taxes.
The sale of assets represents 4% of EWP's total assets, and less than 1% of the
Company's consolidated assets. EWP has entered into a long-term contract to
supply wholesale propane to the purchaser of these assets.
8
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF INTERIM FINANCIAL STATEMENTS
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.
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, energy
marketing and wholesale operations, and other non-regulated activities.
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 represent less than 1% of the Company's overall
earnings.
The Company's propane operations 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, operated by its wholly owned subsidiary Energy West Propane, Inc.
(EWP). EWP currently markets its product throughout the Rocky Mountain states
including Wyoming, Montana, Arizona, Colorado, South Dakota, North Dakota and
Nebraska. In March 2002, as part of the Company's strategic emphasis on
wholesale propane, EWP sold its retail propane assets in Montana consisting of
$474,000 in customer tanks and other related assets and $81,000 in inventory and
accounts receivable. These assets served small retail customers in Montana. The
sale represents less than 4% of the assets of EWP, and less than 1% of the
Company's consolidated assets. EWP has entered into a long term contract to
supply wholesale propane to the purchaser of the assets. EWP made an additional
sale of assets in Wyoming subsequent to March 31, 2002. See Note 7, "Subsequent
Events" located in the "Notes to Condensed Consolidated Financial Statements."
The Company believes that the retail propane assets in Arizona remain a
strategic fit for the Company, and EWP has no plans to dispose of these assets
at the present time.
The Company's wholly-owned subsidiary, Energy West Resources, Inc. (EWR)
conducts marketing and distribution activities involving the sale of natural gas
and electricity mainly in Montana and Wyoming.
LIQUIDITY AND CAPITAL RESOURCES
Long and Short Term Borrowing
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. 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 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. 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 March 31, 2002, the Company had $26,000,000 in bank lines of credit, of which
$7,880,000 had been borrowed under the credit agreement. The Company had
outstanding letters of credit totaling $4,750,000 related to electric and gas
purchase contracts. These letters of credit, when combined with borrowings
against the line of credit, result in a total remaining borrowing capacity of
$13,370,000.
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 nine months ended
March 31, 2002 in the amount of $217,000 as compared to $1,364,000 for the nine
months ended March 31, 2001. This decrease in cash used in operating activities
of $1,147,000 was primarily due to the following: cash collections on refundable
gas costs in the Company's natural gas operations of $10,729,000, recovery of
accounts receivable of $6,767,000, and amounts injected into storage but not yet
paid of $1,381,000. The gas cost recoveries were a result of a rate increase
intended to bring these balances down by March of 2002. The accounts receivable
balances decreased mainly due to reduced commodity prices.
Offsetting these amounts were the following: reduction in net income of
$1,947,000, payments on accrued expenses including incentives and taxes related
to the record earnings experienced in fiscal 2001 of $7,438,000, a decrease in
the amount owed by the Company on gas and electric purchases of $3,021,000, as a
result of lower commodity prices as compared to those experienced one year ago,
a decrease in the Company's market receivable balance from derivative assets and
liabilities of $4,690,000, and other miscellaneous increases in cash paid out of
$633,000.
Cash used in investing activities was $3,273,000 for the nine months ended March
31, 2002, as compared to $2,387,000 for the nine months ended March 31, 2001.
This increase in cash used of $886,000 was primarily due to expenditures
incurred for the renovation of certain pipelines, as well as system expansion in
the natural gas segment.
Cash provided by financing activities was $3,269,000 for the nine months ended
March 31, 2002, as compared to $3,965,000 for the nine months ended March 31,
2001. This decrease in cash provided by financing activities of $696,000 is due
primarily to payments made on the Company's short-term notes payable.
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's operating subsidiaries and to meet the
Company's administrative needs. During fiscal year 2002, the Company is
undergoing two significant capital projects. One project involves looping an 8
inch main around Cody, Wyoming to enhance the safety and security of the gas
supply to this community. The Company expects to spend $1,000,000 on this
project. The other project is the renovation of a pipeline in Wyoming
strategically located in relation to both the Company's existing line near Cody,
Wyoming, as well as a major transport line located near the Montana border. This
project is expected to cost the Company $550,000. The rest of the Company's
capital expenditures of approximately $3,550,000 are routine expenditures for
system expansion and operating needs, though the Company continues to evaluate
opportunities to expand its existing businesses from time to time.
Off Balance Sheet Arrangements
The Company is not engaged in any material off balance sheet activity.
10
ENERGY WEST INCORPORATED AND SUBSIDIARIES
MARCH 31, 2002
QUARTERLY RESULTS OF CONSOLIDATED OPERATIONS
The Company's net income for the third quarter of fiscal 2002, ended March 31,
2002 was $1,174,000 compared to $2,582,000 for the third quarter ended March 31,
2001. The decrease in earnings of $1,408,000 occurred mainly from the reduction
in margins related to the remarketing of electricity in the Company's marketing
and wholesale operation as market prices have continued to stabilize.
Gross margin, which is defined as operating revenue less gas purchased,
decreased $2,516,000 going from $7,834,000 in the third quarter of fiscal 2001
to $5,318,000 in the third quarter of fiscal 2002. The majority of this decrease
was due to decreased margin from the Company's marketing and wholesale
operations. During fiscal 2001, these operations experienced higher margins from
remarketing of electricity at unusually high market prices. Market prices have
continued to stabilize in fiscal 2002, resulting in lower margins. During the
quarter EWR reclassified its mark to market valuation from "other income" to
"gross margin" to more accurately reflect the earnings of its natural gas
marketing business. The reclassification has been made to all periods
presented.
Distribution, general and administrative expenses decreased in the third
quarter of fiscal 2002 primarily due to the reduction of certain expenses
including incentives and commissions paid or accrued in the same quarter of
fiscal 2001 as well as the gain resulting from the sale of certain retail
propane assets in Montana in the Company's propane segment. In addition, in
fiscal 2001, the Company incurred expenses related to strategic development
which were not incurred in the current fiscal year. Offsetting these decreases
in expenses have been additional legal costs incurred primarily as a result of
the litigation with PPLM (See "Part II, Item 1 - Legal Proceedings").
Interest expenses were lower by $92,000 during the third quarter of fiscal 2002,
moving from $581,000 in fiscal 2001 down to $489,000 in the same period this
year. This reduction was mainly due to lower short-term interest rates during
the quarter, and lower borrowing.
NINE MONTH RESULTS FOR CONSOLIDATED OPERATIONS
The Company's net income for the nine months ended March 31, 2002 was $1,363,000
compared to $3,310,000 for the nine months ended March 31, 2001. The decrease in
earnings was mainly due to the reduction in margins associated with the
remarketing of electricity.
Gross margin decreased from $16,619,000 for the first nine months of fiscal 2001
to $12,734,000 for the first nine months of fiscal 2002, a decrease of
$3,885,000. This was primarily due to the reduction of margins in 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 continued to stabilize in fiscal 2002, resulting in lower
margins.
Distribution, general and administrative expenses decreased $419,000 in the
first nine months of fiscal 2002 as compared to the same period in fiscal 2001,
as expenses related to incentives and commissions, as well as the gain resulting
from the sale of certain retail propane assets in Montana in the Company's
propane segment. In addition, in fiscal 2001, the Company incurred expenses
related to strategic development which were not incurred in the current fiscal
year. Offsetting some of these decreases in expenses has been an increase in
legal costs of approximately $350,000 primarily related to the litigation with
PPLM (See "Part II, Item 1 - Legal Proceedings").
Interest costs for the Company decreased by $330,000 when comparing the first
nine months of fiscal 2001 to the same period of fiscal 2002 due to reductions
in short-term borrowing rates, and reduced borrowing.
11
RESULTS OF THE COMPANY'S NATURAL GAS OPERATIONS
Third Quarter Nine Months
Ended March 31 Ended March 31
2002 2001 2002 2001
(In thousands) (In thousands)
Natural Gas Revenue $ 15,427 $ 16,599 $ 32,457 $ 32,852
Natural Gas Purchased 11,915 13,250 24,643 24,929
-------- -------- -------- --------
Gross Margin 3,512 3,349 7,814 7,923
Operating Expenses 1,849 1,933 5,730 5,979
-------- -------- -------- --------
Operating Income 1,663 1,416 2,084 1,944
Other (Income) Expense 17 (40) (88) (69)
Interest Expense 311 328 877 983
Income Taxes 434 427 391 392
-------- -------- -------- --------
Net Natural Gas Income $ 901 $ 701 $ 904 $ 638
======== ======== ======== ========
QUARTERLY RESULTS FOR NATURAL GAS OPERATIONS
Net income for the third quarter of 2002 was $901,000 compared to $701,000 for
the same period of 2001. The $200,000 increase, or 28%, was due to colder than
normal weather experienced in both Montana and Wyoming during March of 2002.
GROSS MARGIN --
The natural gas segment has seen a decrease in revenues as well as the cost of
gas purchased due to the reduction in the commodity price of gas as compared to
one year ago. Gross margin, defined as operating revenues less purchased gas
costs, increased by $163,000 due to colder than normal temperatures in March
2002.
OPERATING EXPENSES -
Natural gas operating expenses were $1,849,000 for the third quarter of fiscal
2002 as compared to $1,933,000 for the same period in fiscal 2001. The 4%
decrease in the period was generally due to the timing of certain expenses, and
the nonrecurring nature of certain expenses related to strategic development
incurred in fiscal 2001.
12
RESULTS OF THE COMPANY'S NATURAL GAS OPERATIONS -- CONTINUED
NINE MONTH RESULTS FOR NATURAL GAS OPERATIONS
GROSS MARGIN
The Company experienced a decrease in gross margin of $109,000 due to slightly
warmer temperatures compared to one year ago. In the Company's principal
operations in Montana and Wyoming, temperatures during the first nine months of
fiscal 2002 on average were 8% warmer and 10% warmer respectively compared to
temperatures during the corresponding period of fiscal 2001. The temperatures
experienced in March 2002 were actually colder than those in March of 2001,
which helped to partially offset the negative impact from warmer weather earlier
in the year.
OPERATING EXPENSES -
Natural gas operating expenses were $5,730,000 for the first nine months of
fiscal 2002 as compared to $5,979,000 for the same period in fiscal 2001. The 4%
decrease in the period was due mainly to the timing of certain expenses, and
non-recurring expenditures related to strategic development which were incurred
in the prior year.
INTEREST CHARGES -
Interest charges allocable to the Company's natural gas operations were $877,000
for the first nine months of fiscal 2002, as compared to $983,000 during the
same period in fiscal 2001, a decrease of $106,000. This decrease is due mainly
to more favorable short-term borrowing rates, as well as reduced borrowing by
the natural gas operations.
RESULTS OF THE COMPANY'S PROPANE OPERATIONS
Third Quarter Nine Months
Ended March 31 Ended March 31
2002 2001 2002 2001
(In thousands) (In thousands)
ENERGY WEST PROPANE (EWP)
Operating Revenues $ 5,177 $ 5,749 $ 9,057 $ 12,075
Cost of Propane 3,095 3,894 5,344 8,419
-------- -------- -------- --------
Gross Margin 2,082 1,855 3,713 3,656
Operating Expenses 789 888 2,557 2,623
-------- -------- -------- --------
Operating Income 1,293 967 1,156 1,033
Other Income 39 34 105 101
Interest Expense 118 137 347 422
Income Taxes 441 327 330 276
-------- -------- -------- --------
Net Propane Income $ 770 $ 537 $ 584 $ 436
======== ======== ======== ========
13
RESULTS OF THE COMPANY'S PROPANE OPERATIONS -- CONTINUED
QUARTERLY RESULTS FOR PROPANE OPERATIONS
OPERATING REVENUES AND GROSS MARGIN
Propane revenues in the third quarter of fiscal 2002 were $5,177,000 compared to
$5,749,000 for the third quarter of fiscal 2001, a decline of $572,000. The
decrease was due mainly to a lower spot market for propane sold during the third
quarter of fiscal 2002. The propane operations were able to utilize the lower
market prices advantageously to purchase lower priced propane for some of its
operations, and propane purchases decreased $799,000 in the third quarter of
fiscal 2002 compared to purchases during the same period one year ago. This
resulted in an increase in gross margin of $227,000 during the third quarter of
2002 in comparison to the third quarter of 2001.
OPERATING EXPENSES -
Propane operating expenses were $789,000 for the third quarter of fiscal 2002 as
compared to $888,000 during the same period in fiscal 2001. The $99,000 decrease
in the period was due to the sale of certain non-regulated retail propane
operations in Montana. Though the assets used to serve the customers were sold,
the Company's wholesale operations will continue to supply propane to the
purchaser of these assets.
INTEREST CHARGES -
Interest charges allocable to the Company's propane operations were $118,000 for
the third quarter of fiscal 2002, as compared to $137,000 in the comparable
period in fiscal 2001. This is due mainly to the decrease in short-term
borrowing rates during the third quarter of fiscal 2002.
NINE MONTH RESULTS FOR PROPANE OPERATIONS
OPERATING REVENUES AND GROSS MARGIN
Propane revenues in the first nine months of fiscal 2002 were $9,057,000
compared to $12,075,000 for the first nine months of fiscal 2001, a decrease of
$3,018,000. The decrease was due mainly to lower spot market prices for propane
sold compared to one year ago. The costs for propane also decreased from
$8,419,000 in the first nine months of fiscal 2001 to $5,344,000 in the first
nine months of fiscal 2002. This decrease of $3,075,000 was also due to the
lower spot market prices, providing the propane operations the opportunity to
acquire lower cost propane. This resulted in an increase in gross margin of
$57,000 for the first nine months of fiscal 2002 in comparison to the first
nine months of 2001.
14
RESULTS OF THE COMPANY'S PROPANE OPERATIONS -- CONTINUED
OPERATING EXPENSES -
Propane operating expenses were $2,557,000 for the first nine months of fiscal
2002 as compared to $2,623,000 for the same period in fiscal 2001. The decrease
of $66,000 was due to the sale of certain non-regulated retail propane
operations in Montana. The Company's wholesale operations will continue to
supply propane to the purchaser of these assets.
INTEREST CHARGES -
Interest charges allocable to the Company's propane operations were $347,000 for
the first nine months of fiscal 2002 as compared to $422,000 in the comparable
period in fiscal 2001. This decrease of $75,000 was related to decreases in
short term borrowing rates compared to the same period one year ago.
RESULTS OF THE COMPANY'S ENERGY MARKETING AND WHOLESALE OPERATIONS
Third Quarter Nine Months
Ended March 31 Ended March 31
2002 2001 2002 2001
(In thousands) (In thousands)
Gas, Electric & Propane Trading $ 17,212 $ 17,640 $ 38,689 $ 40,009
Cost of Gas, Electric & Propane Trading 17,488 15,010 37,482 34,969
-------- -------- -------- --------
Gross Margin (276) 2,630 1,207 5,040
Operating Expenses 442 379 1,222 1,223
-------- -------- -------- --------
Operating Income (718) 2,251 (15) 3,817
Other (Income) Expense 0 (4) 8 (33)
Interest Expense 59 117 145 293
Income Tax Expense (Benefit) (280) 794 (44) 1,321
-------- -------- -------- --------
Net Income (Loss) $ (497) $ 1,344 $ (124) $ 2,236
======== ======== ======== ========
15
RESULTS OF THE COMPANY'S ENERGY MARKETING AND WHOLESALE OPERATIONS--(CONTINUED)
QUARTERLY RESULTS FOR ENERGY MARKETING AND WHOLESALE OPERATIONS
GROSS MARGIN --
The Company's energy marketing and wholesale operations experienced a reduction
in gross margin of $2,906,000 during the third quarter of fiscal 2002 compared
to the same period last year. The majority of the decrease was due to the
reduction in margins associated with the remarketing of electricity at unusually
high market prices during the first nine months of fiscal 2001. Those same
market conditions have not been present during the current fiscal year, nor are
they expected to occur during the remainder of the year.
OPERATING EXPENSES -
Operating expenses for energy marketing and wholesale operations were $442,000
for the third quarter of fiscal 2002 as compared to $379,000 for the same period
in fiscal 2001. Though the energy marketing and wholesale operations have seen
reduced costs related to incentives and commissions during the third quarter of
fiscal 2002 compared to the third quarter fiscal 2001, these operations have
also incurred legal expenses related to ongoing litigation with PPL, Montana
(described in Part II, Item 1, Legal Proceedings) which have increased the
operating expenses of the energy marketing and wholesale operations by $63,000
compared to those experienced one year ago.
INTEREST CHARGES -
Interest charges for the third quarter of fiscal 2002 decreased $58,000 from
$117,000 in the third quarter of 2001 to $59,000 in the third quarter of 2002
due mainly to decreases in short-term borrowing rates, and reductions in
borrowing.
INCOME TAXES -
State and federal income tax expense of the Company's energy marketing and
wholesale operations decreased from $794,000 for the third quarter of fiscal
2001 to an income tax benefit of $280,000 in fiscal 2002, due to a reduction in
pre-tax income from the energy marketing and wholesale operations.
16
RESULTS OF THE COMPANY'S ENERGY MARKETING AND WHOLESALE OPERATIONS--(CONTINUED)
NINE MONTHS RESULTS FOR ENERGY MARKETING AND WHOLESALE OPERATIONS
GROSS MARGIN --
The Company's energy marketing and wholesale operations experienced gross margin
during the first nine months of fiscal year 2002 of $1,207,000 compared to
$5,040,000 in fiscal year 2001, a decrease of $3,833,000. This decrease was due
to the reduction in margins associated with the remarketing of electricity at
unusually high market prices during the first nine months of fiscal 2001. Those
same market conditions have not been present during the current fiscal year, nor
are they expected to occur during the remainder of the year.
OPERATING EXPENSES --
Operating expenses for the energy marketing and wholesale operations were
$1,222,000 for the first nine months of fiscal 2002 as compared to $1,223,000
for the same period in fiscal 2001. The wholesale operations have experienced a
decrease in operating expenses during the current period due to reductions in
incentives and commissions; however, the wholesale operations have increased
legal expenses by approximately $350,000 during the first nine months of fiscal
2002 versus those experienced during the corresponding period of fiscal 2001 due
to the ongoing litigation with PPL, Montana (discussed at Part II, Item 1, Legal
Proceedings).
OTHER INCOME --
Other income decreased by $41,000 from an income of $33,000 for the first nine
months of fiscal 2001 compared to a loss of $8,000 for the first nine months of
fiscal 2002. The wholesale operations received interest income in the prior year
on a note receivable from one of its customers. The note was paid off early in
this fiscal year resulting in a reduction in interest income.
INTEREST CHARGES -
Interest charges decreased by $148,000 from $293,000 during the first nine
months of fiscal 2001 to $145,000 during the first nine months of fiscal 2002.
This was due to the decrease in short-term borrowing rates experienced during
the current year.
INCOME TAXES -
State and federal income tax expense of the Company's energy marketing and
wholesale operations were a benefit of $44,000 for the first nine months of
fiscal 2002 as compared to an expense of $1,321,000 during the first nine months
of fiscal 2001, due to the reduction in pre-tax income from the energy marketing
and wholesale operations.
17
CONTRACTS ACCOUNTED FOR AT FAIR VALUE
Certain of the Company's natural gas contracts are classified as derivatives
under SFAS 133. These contracts are carried on the balance sheet at fair value.
This accounting treatment is also referred to as mark-to-market accounting.
Mark-to-market accounting can create a timing difference between recorded
earnings and realized cash flow. Marking a contract to market consists of
reevaluating the market value of the entire term of the contract at each
reporting period and reflecting the resulting gain or loss of value in earnings
for the period. This change in value represents the difference between the
contract price and the current market value of the contract. Changes in the
market value of the contract could result in large gains or losses recorded in
earnings at each subsequent reporting period. The gain or loss in income
generated from the change in market value of natural gas derivative contracts
is a non-cash event.
Quoted market prices for the Company's natural gas derivative contracts are
generally 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.
As of March 31, 2002, natural gas derivative contracts had an aggregate fair
market value as follows:
<Table>
Contracts maturing in one year or less: $ 1,113,313
Contracts maturing in two to three years: 1,843,873
Contracts maturing in four to five years: 950,839
Contracts maturing in five years or more: 257,192
-----------
Total Derivative Assets $ 4,165,217
===========
</Table>
RELATED PARTY TRANSACTIONS
The Company has no material related party transactions.
CRITICAL ACCOUNTING POLICIES
The Company follows SFAS 71, "Accounting for the Effects of Certain Types of
Regulation," and the Company's financial statements reflect the effects of the
different rate making principles followed by the various jurisdictions
regulating the Company. The primary result of this policy is that the Company
has $1,276,000 in deferred regulatory assets at March 31, 2002. These assets
represent costs incurred by the Company in its regulated operations which it
expects to recover through adjustments in the rates charged to its customers.
Of this amount, $148,000 relates to current year power supply expenditures.
While the Company expects to fully recover this amount, such recovery is
subject to final review by the regulatory entitles.
The Company values natural gas derivatives using mark-to-market accounting
under SFAS 133. As explained previously, this accounting requires the Company
to consider several factors, including current relevant market prices, market
depth and liquidity, potential model error, and expected credit losses at the
counterparty level. Due to the volatility of energy markets and certain model
assumptions, and potential changes in market conditions, the amounts of gains
or losses ultimately realized in settlement of the contracts could be
substantially different from the values at which such contracts are currently
reflected in the Company's financial statements.
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.
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. 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. This section discusses
litigation that the Company believes to be properly characterized as outside the
normal course of business and for which it is not indemnified.
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.
The Company's wholly-owned subsidiary Energy West Resources, Inc. (EWR) is
presently in litigation against PPL Montana, LLC (PPLM) in the United States
District Court for the District of Montana. The lawsuit related 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 received substantial imbalance payments as a result of the amount of power
that it 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 has alleged that EWR was not entitled
to retain such payments. PPLM alleges that EWR is liable to PPLM for $12.2
million relating to purchases under the contract during the twelve months ended
June 30, 2001 plus unspecified additional amounts for the period after June 30,
2001. 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 condition.
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.
19
FORM 10-Q
PART II - OTHER INFORMATION (CONTINUED)
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. No exhibits are being filed for the quarter ended March 31, 2002.
B. No reports on Form 8-K have been filed during the quarter ended
March 31, 2002.
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, Signing on
Behalf of the Registrant, and as
Principal Executive, Financial and
Accounting Officer
Dated May 15, 2002